[Title 26 CFR ]
[Code of Federal Regulations (annual edition) - April 1, 2004 Edition]
[From the U.S. Government Printing Office]
[[Page i]]
26
Part 1 (Sec. Sec. 1.908 to 1.1000)
Revised as of April 1, 2004
Internal Revenue
________________________
Containing a codification of documents of general
applicability and future effect
As of April 1, 2004
With Ancillaries
Published by
Office of the Federal Register
National Archives and Records
Administration
A Special Edition of the Federal Register
[[Page ii]]
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[[Page iii]]
Table of Contents
Page
Explanation................................................. v
Title 26:
Chapter I--Internal Revenue Service, Department of
the Treasury (Continued) 5
Finding Aids:
Table of CFR Titles and Chapters........................ 739
Alphabetical List of Agencies Appearing in the CFR...... 757
Table of OMB Control Numbers............................ 767
List of CFR Sections Affected........................... 785
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Cite this Code: CFR
To cite the regulations in
this volume use title,
part and section number.
Thus, 26 CFR 1.911-1
refers to title 26, part
1, section 911-1.
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[[Page v]]
EXPLANATION
The Code of Federal Regulations is a codification of the general and
permanent rules published in the Federal Register by the Executive
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parts covering specific regulatory areas.
Each volume of the Code is revised at least once each calendar year
and issued on a quarterly basis approximately as follows:
Title 1 through Title 16.................................as of January 1
Title 17 through Title 27..................................as of April 1
Title 28 through Title 41...................................as of July 1
Title 42 through Title 50................................as of October 1
The appropriate revision date is printed on the cover of each
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The Paperwork Reduction Act of 1980 (Pub. L. 96-511) requires
Federal agencies to display an OMB control number with their information
collection request.
[[Page vi]]
Many agencies have begun publishing numerous OMB control numbers as
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OBSOLETE PROVISIONS
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of provisions in effect on a given date in the past by using the
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1963, 1964-1972, 1973-1985, or 1986-2000, published in 11 separate
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[[Page vii]]
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Raymond A. Mosley,
Director,
Office of the Federal Register.
April 1, 2004.
[[Page ix]]
THIS TITLE
Title 26--Internal Revenue is composed of twenty volumes. The
contents of these volumes represent all current regulations issued by
the Internal Revenue Service, Department of the Treasury, as of April 1,
2004. The first thirteen volumes comprise part 1 (Subchapter A--Income
Tax) and are arranged by sections as follows: Sec. Sec. 1.0-1-1.60;
Sec. Sec. 1.61-1.169; Sec. Sec. 1.170-1.300; Sec. Sec. 1.301-1.400;
Sec. Sec. 1.401-1.440; Sec. Sec. 1.441-1.500; Sec. Sec. 1.501-1.640;
Sec. Sec. 1.641-1.850; Sec. Sec. 1.851-1.907; Sec. Sec. 1.908-1.1000;
Sec. Sec. 1.1001-1.1400; Sec. Sec. 1.1401--1.1503-2A; and Sec.
1.1551-1 to end. The fourteenth volume containing parts 2-29, includes
the remainder of subchapter A and all of Subchapter B--Estate and Gift
Taxes. The last six volumes contain parts 30-39 (Subchapter C--
Employment Taxes and Collection of Income Tax at Source); parts 40-49;
parts 50-299 (Subchapter D--Miscellaneous Excise Taxes); parts 300-499
(Subchapter F--Procedure and Administration); parts 500-599 (Subchapter
G--Regulations under Tax Conventions); and part 600 to end (Subchapter
H--Internal Revenue Practice).
The OMB control numbers for Title 26 appear in Sec. 602.101 of this
chapter. For the convenience of the user, Sec. 602.101 appears in the
Finding Aids section of the volumes containing parts 1 to 599.
For this volume, Ruth Green was Chief Editor. The Code of Federal
Regulations publication program is under the direction of Frances D.
McDonald, assisted by Alomha S. Morris.
[[Page x]]
[[Page 1]]
TITLE 26--INTERNAL REVENUE
(This book contains part 1, Sec. Sec. 1.908 to 1.1000)
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Part
chapter i--Internal Revenue Service, Department of the
Treasury (Continued)...................................... 1
[[Page 3]]
CHAPTER I--INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY
(CONTINUED)
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Editorial Note: IRS published a document at 45 FR 6088, Jan. 25, 1980,
deleting statutory sections from their regulations. In Chapter I cross-
references to the deleted material have been changed to the
corresponding sections of the IRS Code of 1954 or to the appropriate
regulations sections. When either such change produced a redundancy, the
cross-reference has been deleted. For further explanation, see 45 FR
20795, March 31, 1980.
SUBCHAPTER A--INCOME TAX (CONTINUED)
Part Page
1 Income taxes................................ 5
Supplementary Publications: Internal Revenue Service Looseleaf
Regulations System.
Additional supplementary publications are issued covering Alcohol and
Tobacco Tax Regulations and Regulations Under Tax Conventions.
[[Page 5]]
SUBCHAPTER A_INCOME TAX (CONTINUED)
PART 1_INCOME TAXES--Table of Contents
Normal Taxes and Surtaxes
Tax Based on Income From Sources Within or Without the United States
Earned Income of Citizens or Residents of United States
1.911-1 Partial exclusion for earned income from sources within a
foreign country and foreign housing costs.
1.911-2 Qualified individuals.
1.911-3 Determination of amount of foreign earned income to be excluded.
1.911-4 Determination of housing cost amount eligible for exclusion or
deduction.
1.911-5 Special rules for married couples.
1.911-6 Disallowance of deductions, exclusions, and credits.
1.911-7 Procedural rules.
1.911-8 Former deduction for certain expenses of living abroad.
earned income of citizens of united states
1.912-1 Exclusion of certain cost-of-living allowances.
1.912-2 Exclusion of certain allowances of Foreign Service personnel.
1.921-1T Temporary regulations providing transition rules for DISCs and
FSCs.
1.921-2 Foreign Sales Corporation--general rules.
1.921-3T Temporary regulations; Foreign Sales Corporation general rules.
1.922-1 Requirements that a corporation must satisfy to be a FSC or a
small FSC.
1.923-1T Temporary regulations; exempt foreign trade income.
1.924(a)-1T Temporary regulations; definition of foreign trading gross
receipts.
1.924(c)-1 Requirement that a FSC be managed outside the United States.
1.924(d)-1 Requirement that economic processes take place outside the
United States.
1.924(e)-1 Activities relating to the disposition of export property.
1.925(a)-1T Temporary regulations; transfer pricing rules for FSCs.
1.925(b)-1T Temporary regulations; marginal costing rules.
1.926(a)-1 Distributions to shareholders.
1.926(a)-1T Temporary regulations; distributions to shareholders.
1.927(a)-1T Temporary regulations; definition of export property.
1.927(b)-1T Temporary regulations; definition of gross receipts.
1.927(d)-1 Other definitions.
1.927(d)-2T Temporary regulations; definitions and special rules
relating to Foreign Sales Corporation.
1.927(e)-1 Special sourcing rule.
1.927(e)-2T Temporary regulations; effect of boycott participation on
FSC and small FSC benefits.
1.927(f)-1 Election and termination of status as a Foreign Sales
Corporation.
possessions of the united states
1.931-1 Citizens of the United States and domestic corporations deriving
income from sources within a certain possession of the United
States.
1.932-1 Status of citizens of U.S. possessions.
1.933-1 Exclusion of certain income from sources within Puerto Rico.
1.934-1 Limitation on reduction in income tax liability incurred to the
Virgin Islands.
1.935-1 Coordination of U.S. and Guam individual income taxes.
1.936-1 Elections.
1.936-4 Intangible property income in the absence of an election out.
1.936-5 Intangible property income when an election out is made:
Product, business presence, and contract manufacturing.
1.936-6 Intangible property income when an election out is made: cost
sharing and profit split options; covered intangibles.
1.936-7 Manner of making election under section 936 (h)(5); special
election for export sales; revocation of election under
section 936(a).
1.936-7T Manner of making election under section 936(h)(5); special
election for export sales; revocation of election under
section 936(a) (temporary).
1.936-8T Qualified possession source investment income (temporary).
[Reserved]
1.936-9T Source of qualified possession source investment income
(temporary). [Reserved]
1.936-10 Qualified investments.
1.936-11 New lines of business prohibited.
china trade act corporations
1.941-1 Special deduction for China Trade Act corporations.
1.941-2 Meaning of terms used in connection with China Trade Act
corporations.
1.941-3 Illustration of principles.
1.943-1 Withholding by a China Trade Act corporation.
controlled foreign corporations
1.951-1 Amounts included in gross income of United States shareholders.
[[Page 6]]
1.951-2 Coordination of subpart F with election of a foreign investment
company to distribute income.
1.951-3 Coordination of subpart F with foreign personal holding company
provisions.
1.952-1 Subpart F income defined.
1.952-2 Determination of gross income and taxable income of a foreign
corporation.
1.953-1 Income from insurance of United States risks.
1.953-2 Actual United States risks.
1.953-3 Risks deemed to be United States risks.
1.953-4 Taxable income to which section 953 applies.
1.953-5 Corporations not qualifying as insurance companies.
1.953-6 Relationship of sections 953 and 954.
1.954-0 Introduction.
1.954-1 Foreign base company income.
1.954-2 Foreign personal holding company income.
1.954-3 Foreign base company sales income.
1.954-4 Foreign base company services income.
1.954-5 Increase in qualified investments in less developed countries;
taxable years of controlled foreign corporations beginning
before January 1, 1976.
1.954-6 Foreign base company shipping income.
1.954-7 Increase in qualified investments in foreign base company
shipping operations.
1.954-8 Foreign base company oil related income.
1.955-0 Effective dates.
1.955-1 Shareholder's pro rata share of amount of previously excluded
subpart F income withdrawn from investment in less developed
countries.
1.955-2 Amount of a controlled foreign corporation's qualified
investments in less developed countries.
1.955-3 Election as to date of determining qualified investments in less
developed countries.
1.955-4 Definition of less developed country.
1.955-5 Definition of less developed country corporation.
1.955-6 Gross income from sources within less developed countries.
1.955A-1 Shareholder's pro rata share of amount of previously excluded
subpart F income withdrawn from investment in foreign base
company shipping operations.
1.955A-2 Amount of a controlled foreign corporation's qualified
investments in foreign base company shipping operations.
1.955A-3 Election as to qualified investments by related persons.
1.955A-4 Election as to date of determining qualified investment in
foreign base company shipping operations.
1.956-1 Shareholder's pro rata share of a controlled foreign
corporation's increase in earnings invested in United States
property.
1.956-1T Shareholder's pro rata share of a controlled foreign
corporation's increase in earnings invested in United States
property (temporary).
1.956-2 Definition of United States property.
1.956-2T Definition of United States property (temporary).
1.956-3T Certain trade or service receivables acquired from United
States persons (temporary).
1.957-1 Definition of controlled foreign corporation.
1.957-2 Controlled foreign corporation deriving income from insurance of
United States risks.
1.957-3 Corporations organized in United States possessions.
1.957-4 United States person defined.
1.958-1 Direct and indirect ownership of stock.
1.958-2 Constructive ownership of stock.
1.959-1 Exclusion from gross income of United States persons of
previously taxed earning and profits.
1.959-2 Exclusion from gross income of controlled foreign corporations
of previously taxed earnings and profits.
1.959-3 Allocation of distributions to earnings and profits of foreign
corporations.
1.959-4 Distributions to United States persons not counting as
dividends.
1.960-1 Foreign tax credit with respect to taxes paid on earnings and
profits of controlled foreign corporations.
1.960-2 Interrelation of section 902 and section 960 when dividends are
paid by third-, second-, or first-tier corporation.
1.960-3 Gross-up of amounts included in income under section 951.
1.960-4 Additional foreign tax credit in year of receipt of previously
taxed earnings and profits.
1.960-5 Credit for taxable year of inclusion binding for taxable year of
exclusion.
1.960-6 Overpayments resulting from increase in limitation for taxable
year of exclusion.
1.960-7 Effective dates.
1.961-1 Increase in basis of stock in controlled foreign corporations
and of other property.
1.961-2 Reduction in basis of stock in foreign corporations and of other
property.
1.962-1 Limitation of tax for individuals on amounts included in gross
income under section 951(a).
1.962-2 Election of limitation of tax for individuals.
1.962-3 Treatment of actual distributions.
1.962-4 Transitional rules for certain taxable years.
1.963-0 Repeal of section 963; effective dates.
[[Page 7]]
1.963-1 Exclusion of subpart F income upon receipt of minimum
distribution.
1.963-2 Determination of the amount of the minimum distribution.
1.963-3 Distributions counting toward a minimum distribution.
1.963-4 Limitations on minimum distribution from a chain or group.
1.963-5 Foreign corporations with variation in foreign tax rate because
of distributions.
1.963-6 Deficiency distribution.
1.963-7 Transitional rules for certain taxable years.
1.963-8 Determination of minimum distribution during the surcharge
period.
1.964-1 Determination of the earnings and profits of a foreign
corporation.
1.964-1T Special rules for computing earnings and profits of controlled
foreign corporations in taxable years beginning after December
31, 1986 (temporary).
1.964-2 Treatment of blocked earnings and profits.
1.964-3 Records to be provided by United States shareholders.
1.964-4 Verification of certain classes of income.
1.964-5 Effective date of subpart F.
Export Trade Corporations
1.970-1 Export trade corporations.
1.970-2 Elections as to date of determining investments in export trade
assets.
1.970-3 Effective date of subpart G.
1.971-1 Definitions with respect to export trade corporations.
1.972-1 Consolidation of group of export trade corporations.
1.981-0 Repeal of section 981; effective dates.
1.981-1 Foreign law community income for taxable years beginning after
December 31, 1966, and before January 1, 1977.
1.981-2 Foreign law community income for taxable years beginning before
January 1, 1967.
1.981-3 Definitions and other special rules.
1.985-0 Outline of regulation.
1.985-1 Functional currency.
1.985-2 Election to use the United States dollar as the functional
currency of a QBU.
1.985-3 United States dollar approximate separate transactions method.
1.985-4 Method of accounting.
1.985-5 Adjustments required upon change in functional currency.
1.985-6 Transition rules for a QBU that uses the dollar approximate
separate transactions method for its first taxable year
beginning in 1987.
1.985-7 Adjustments required in connection with a change to DASTM.
1.985-8 Special rules applicable to the European Monetary Union
(conversion to the euro).
1.987-1 Profit and loss method of accounting for a qualified business
unit of a taxpayer having a different functional currency from
the taxpayer. [Reserved]
1.987-2 Accounting for gain or loss on certain transfers of property.
[Reserved]
1.987-3 Termination. [Reserved]
1.987-4 Special rules relating to QBU branches of foreign taxpayers.
[Reserved]
1.987-5 Transition rules for certain qualified business units using a
profit and loss method of accounting for taxable years
beginning before January 1, 1987.
1.988-0 Taxation of gain or loss from a section 988 transaction; table
of contents.
1.988-1 Certain definitions and special rules.
1.988-2 Recognition and computation of exchange gain or loss.
1.988-3 Character of exchange gain or loss.
1.988-4 Source of gain or loss realized on a section 988 transaction.
1.988-5 Section 988(d) hedging transactions.
1.989(a)-1 Definition of a qualified business unit.
1.989(b)-1 Definition of weighted average exchange rate.
1.989(c)-1 Transition rules for certain branches of United States
persons using a net worth method of accounting for taxable
years beginning before January 1, 1987.
Domestic International Sales Corporations
1.991-1 Taxation of a domestic international sales corporation.
1.992-1 Requirements of a DISC.
1.992-2 Election to be treated as a DISC.
1.992-3 Deficiency distributions to meet qualification requirements.
1.992-4 Coordination with personal holding company provisions in case of
certain produced film rents.
1.993-1 Definition of qualified export receipts.
1.993-2 Definition of qualified export assets.
1.993-3 Definition of export property.
1.993-4 Definition of producer's loans.
1.993-5 Definition of related foreign export corporation.
1.993-6 Definition of gross receipts.
1.993-7 Definition of United States.
1.994-1 Inter-company pricing rules for DISC's.
1.994-2 Marginal costing rules.
1.995-1 Taxation of DISC income to shareholders.
1.995-2 Deemed distributions in qualified years.
1.995-3 Distributions upon disqualification.
1.995-4 Gain on disposition of stock in a DISC.
1.995-5 Foreign investment attributable to producer's loans.
1.995-6 Taxable income attributable to military property.
[[Page 8]]
1.996-1 Rules for actual distributions and certain deemed distributions.
1.996-2 Ordering rules for losses.
1.996-3 Divisions of earnings and profits.
1.996-4 Subsequent effect of previous disposition of DISC stock.
1.996-5 Adjustment to basis.
1.996-6 Effectively connected income.
1.996-7 Carryover of DISC tax attributes.
1.996-8 Effect of carryback of capital loss or net operating loss to
prior DISC taxable year.
1.997-1 Special rules for subchapter C of the Code.
Authority: 26 U.S.C. 7805.
Section 1.911-7 also issued under 26 U.S.C. 911(d)(9).
Sections 1.924(c)-1, 1.924(d)-1, and 1.924(e)-1 also issued under 26
U.S.C. 924(d).
Section 1.925(a)-1 also issued under 26 U.S.C. 925(b)(1) and (2) and
927(d)(2)(B).
Section 1.925(a)-1T is also issued under 26 U.S.C. 925(b)(1) and (2)
and 927(d)(2)(B).
Section 1.925(b)-1T is also issued under 26 U.S.C. 925(b)(1) and (2)
and 927(d)(2)(B).
Section 1.927(d)-1 also issued under 26 U.S.C. 927(d)(1)(B).
Section 1.927(e)-1 also issued under 26 U.S.C. 927(e)(1).
Section 1.927(e)-2T also issued under 26 U.S.C. 927(e)(2).
Section 1.927(f)-1 also issued under 26 U.S.C. 927(f).
Section 1.936-4 also issued under 26 U.S.C. 936(h).
Section 1.936-5 also issued under 26 U.S.C. 936(h).
Section 1.936-6 also issued under 26 U.S.C. 863(a) and (b), and 26
U.S.C. 936(h).
Section 1.936-7 also issued under 26 U.S.C. 936(h).
Sections 1.936-11 also issued under 26 U.S.C. 936(j).
Section 1.952-11T is also issued under 26 U.S.C. 852(b)(3)(C),
852(b)(8), and 852(c).
Section 1.953-2 also issued under 26 U.S.C. 7701(b)(11).
Section 1.954-0 also issued under 26 U.S.C. 954 (b) and (c).
Section 1.954-1 also issued under 26 U.S.C. 954 (b) and (c).
Section 1.954-2 also issued under 26 U.S.C. 954 (b) and (c).
Section 1.956-3T also issued under 26 U.S.C. 864(d)(8).
Section 1.957-1 also issued under 26 U.S.C. 957.
Section 1.960-1 also issued under 26 U.S.C. 960(a).
Sectns 1.985-0 through 1.985-5 also issued under 26 U.S.C. 985.
Sections 1.987-1 through 1.987-5 also issued under 26 U.S.C. 987.
Sections 1.988-0 through 1.988-5 also issued under 26 U.S.C. 988.
Sections 1.989(a)-0T and 1.989(a)-1T also issued under 26 U.S.C.
989(c).
Section 1.989(b)-1 also issued under 26 U.S.C. 989(b).
Section 1.989-1(c) also issued under 26 U.S.C. 989(c).
Source: T.D. 6500, 25 FR 11910, Nov. 26, 1960; 25 FR 14021, Dec. 31,
1960, unless otherwise noted.
Earned Income of Citizens or Residents of United States
Sec. 1.911-1 Partial exclusion for earned income from sources within a
foreign country and foreign housing costs.
(a) In general. Section 911 provides that a qualified individual may
elect to exclude the individual's foreign earned income and the housing
cost amount from the individual's gross income for the taxable year.
Foreign earned income is excludable to the extent of the applicable
limitation for the taxable year. The housing cost amount for the taxable
year is excludable to the extent attributable to employer provided
amounts. If a portion of the housing cost amount for the taxable year is
attributable to non-employer provided amounts, such amount may be
deductible by the qualified individual subject to a limitation. The
amounts excluded under section 911(a) and the amount deducted under
section 911(c)(3)(A) for the taxable year shall not exceed the
individual's foreign earned income for such taxable year. Foreign earned
income must be earned during a period for which the individual qualifies
to make an election under section 911(d)(1). A housing cost amount that
would be deductible except for the application of this limitation may be
carried over to the next taxable year and is deductible to the extent of
the limitation for that year. Except as otherwise provided, Sec. Sec.
1.911-1 through 1.911-7 apply to taxable years beginning after December
31, 1981. These sections do not apply to any item of income, expense,
deduction, or credit arising before January 1, 1982, even if such item
is attributable to services performed after December 31, 1981.
(b) Scope. Section 1.911-2 provides rules for determining whether an
individual qualifies to make an election under section 911. Section
1.911-3 provides rules for determining the amount
[[Page 9]]
of foreign earned income that is excludable under section 911(a)(1).
Section 1.911-4 provides rules for determining the housing cost amount
and the portions excludable under section 911(a)(2) or deductible under
section 911(c)(3). Section 1.911-5 provides special rules applicable to
married couples. Section 1.911-6 provides for the disallowance of
deductions, exclusions, and credits attributable to amounts excluded
under section 911. Section 1.911-7 provides procedural rules for making
or revoking an election under section 911. Section 1.911-8 provides a
reference to rules applicable to taxable years beginning before January
1, 1982.
(Sec. 911 (95 Stat. 194; 26 U.S.C. 911) and sec. 7805 (68A Stat. 917; 26
U.S.C. 7805) of the Internal Revenue Code of 1954)
[T.D. 8006, 50 FR 2964, Jan. 23, 1985]
Sec. 1.911-2 Qualified individuals.
(a) In general. An individual is a qualified individual if:
(1) The individual's tax home is in a foreign country or countries
throughout--
(i) The period of bona fide residence described in paragraph
(a)(2)(i) of this section, or
(ii) The 330 full days of presence described in paragraph (a)(2)(ii)
of this section, and
(2) The individual is either--
(i) A citizen of the United States who establishes to the
satisfaction of the Commissioner or his delegate that the individual has
been a bona fide resident of a foreign country or countries for an
uninterrupted period which includes an entire taxable year, or
(ii) A citizen or resident of the United States who has been
physically present in a foreign country or countries for at least 330
full days during any period of twelve consecutive months.
(b) Tax home. For purposes of paragraph (a)(i) of this section, the
term ``tax home'' has the same meaning which it has for purposes of
section 162(a)(2) (relating to travel expenses away from home). Thus,
under section 911, an individual's tax home is considered to be located
at his regular or principal (if more than one regular) place of business
or, if the individual has no regular or principal place of business
because of the nature of the business, then at his regular place of
abode in a real and substantial sense. An individual shall not, however,
be considered to have a tax home in a foreign country for any period for
which the individual's abode is in the United States. Temporary presence
of the individual in the United States does not necessarily mean that
the individual's abode is in the United States during that time.
Maintenance of a dwelling in the United States by an individual, whether
or not that dwelling is used by the individual's spouse and dependents,
does not necessarily mean that the individual's abode is in the United
States.
(c) Determination of bona fide residence. For purposes of paragraph
(a)(2)(i) of this section, whether an individual is a bona fide resident
of a foreign country shall be determined by applying, to the extent
practical, the principles of section 871 and the regulations thereunder,
relating to the determination of the residence of aliens. Bona fide
residence in a foreign country or countries for an uninterrupted period
may be established, even if temporary visits are made during the period
to the United States or elsewhere on vacation or business. An individual
with earned income from sources within a foreign country is not a bona
fide resident of that country if:
(1) The individual claims to be a nonresident of that foreign
country in a statement submitted to the authorities of that country, and
(2) The earned income of the individual is not subject, by reason of
nonresidency in the foreign country, to the income tax of that country.
If an individual has submitted a statement of nonresidence to the
authorities of a foreign country the accuracy of which has not been
resolved as of any date when a determination of the individual's bona
fide residence is being made, then the individual will not be considered
a bona fide resident of the foreign country as of that date.
(d) Determination of physical presence. For purposes of paragraph
(a)(2)(ii) of this section, the following rules apply.
(1) Twelve-month test. A period of twelve consecutive months may
begin with any day but must end on the day
[[Page 10]]
before the corresponding day in the twelfth succeeding month. The
twelve-month period may begin before or after arrival in a foreign
country and may end before or after departure.
(2) 330-day test. The 330 full days need not be consecutive but may
be interrupted by periods during which the individual is not present in
a foreign country. In computing the minimum 330 full days of presence in
a foreign country or countries, all separate periods of such presence
during the period of twelve consecutive months are aggregated. A full
day is a continuous period of twenty-four hours beginning with midnight
and ending with the following midnight. An individual who has been
present in a foreign country and then travels over areas not within any
foreign country for less than twenty-four hours shall not be deemed
outside a foreign country during the period of travel. If an individual
who is in transit between two points outside the United States is
physically present in the United States for less than twenty-four hours,
such individual shall not be treated as present in the United States
during such transit but shall be treated as travelling over areas not
within any foreign country. For purposes of this paragraph (d)(2), the
term ``transit between two points outside the United States'' has the
same meaning that it has when used in section 7701(b)(6)(C).
(3) Illustrations of the physical presence requirement. The physical
presence requirement of paragraph (a)(2)(ii) of this section is
illustrated by the following examples:
Example 1. B, a U.S. citizen, arrives in Venezuela from New York at
12 noon on April 24, 1982. B remains in Venezuela until 2 p.m. on March
21, 1983, at which time B departs for the United States. Among other
possible twelve month periods, B is present in a foreign country an
aggregate of 330 full days during each of the following twelve month
periods: March 21, 1982 through March 20, 1983; and April 25, 1982
through April 24, 1983.
Example 2. C, a U.S. citizen, travels extensively from the time C
leaves the United States on March 5, 1982, until the time C departs the
United Kingdom on January 1, 1984, to return to the United States
permanently. The schedule of C's travel and the number of full days at
each location are listed below:
----------------------------------------------------------------------------------------------------------------
Full days
in
Country Time and date of arrival Time and date of departure foreign
country
----------------------------------------------------------------------------------------------------------------
United States................................ .......................... 10 p.m. (by air) Mar. 5, .........
1982.
United Kingdom............................... 9 a.m. Mar. 6, 1982....... 10 p.m. (by ship) June 25, 110
1982.
United States................................ 11 a.m. June 30, 1982..... 1 p.m. (by ship) July 19, 0
1982.
France....................................... 3 p.m. July 24, 1982...... 11 a.m. (by air) Aug. 22, 393
1983.
United States................................ 4 p.m. Aug. 22, 1983...... 9 a.m. (by air) Sept. 4, 0
1983.
United Kingdom............................... 9 a.m. Sept. 5, 1983...... 9 a.m. (by air) Jan. 1, 117
1984.
United States................................ 1 p.m. Jan. 1, 1984....... .......................... .........
----------------------------------------------------------------------------------------------------------------
Among other possible twelve-month periods, C is present in a foreign
country or countries an aggregate of 330 full days during the following
twelve-month periods: March 2, 1982 through March 1, 1983; and January
21, 1983 through January 20, 1984. The computation of days with respect
to each twelve month period may be illustrated as follows:
First twelve-month period (March 2, 1982 through March 1, 1983):
------------------------------------------------------------------------
Full days
in
foreign
country
------------------------------------------------------------------------
Mar. 2, 1982 through Mar. 6, 1982............................ 0
Mar. 7, 1982 through June 24, 1982........................... 110
June 25, 1982 through July 24, 1982.......................... 0
July 25, 1982 through Mar. 1, 1983........................... 220
----------
Total full days.......................................... 330
------------------------------------------------------------------------
Second twelve-month period (January 21, 1983 through January 20,
1984):
------------------------------------------------------------------------
Full days
in
foreign
country
------------------------------------------------------------------------
Jan. 21, 1983 through Aug. 21, 1983.......................... 213
Aug. 22, 1983 through Sept. 5, 1983.......................... 0
Sept. 6, 1983 through Dec. 31, 1983.......................... 117
Jan. 1, 1984 through Jan. 20, 1984........................... 0
----------
Total full days.......................................... 330
------------------------------------------------------------------------
(e) Special rules. For purposes only of establishing that an
individual is a qualified individual under paragraph (a) of this
section, residence or presence in a foreign country while there employed
by the U.S. government or any agency or instrumentality of the
[[Page 11]]
U.S. government counts towards satisfaction of the requirements of Sec.
1.911-2(a). (But see section 911(b)(1)(B)(ii) and Sec. 1.911-3(c)(3)
for the rule excluding amounts paid by the U.S. government to an
employee from the definition of foreign earned income.) Time spent in a
foreign country prior to January 1, 1982, counts toward satisfaction of
the bona fide residence and physical presence requirements, even though
no exclusion or deduction may be allowed under section 911 for income
attributable to services performed during that time. For purposes or
paragraph (a)(2)(ii) of this section, the term ``resident of the United
States'' includes an individual for whom a valid election is in effect
under section 6013 (g) or (h) for the taxable year or years during which
the physical presence requirement is satisfied.
(f) Waiver of period of stay in foreign country due to war or civil
unrest. Notwithstanding the requirements of paragraph (a) of this
section, an individual whose tax home is in, a foreign country, and who
is a bona fide resident of, or present in a foreign country for any
period, who leaves the foreign country after August 31, 1978, before
meeting the requirements of paragraph (a) of this section, may as
provided in this paragraph, qualify to make an election under section
911(a) and Sec. 1.911-7(a). If the Secretary determines, after
consultation with the Secretary of State or his delegate, that war,
civil unrest, or similar adverse conditions existed in a foreign
country, then the Secretary shall publish the name of the foreign
country and the dates between which such conditions were deemed to
exist. In order to qualify to make an election under this paragraph, the
individual must establish to the satisfaction of the Secretary that the
individual left a foreign country, the name of which has been published
by the Secretary, during the period when adverse conditions existed and
that the individual could reasonably have expected to meet the
requirements of paragraph (a) of this section but for the adverse
conditions. The individual shall attach to his return for the taxable
year a statement that the individual expected to meet the requirements
of paragraph (a) of this section but for the conditions in the foreign
country which precluded the normal conduct of business by the
individual. Such individual shall be treated as a qualified individual,
but only for the actual period of residence or presence. Thus, in
determining the number of the individual's qualifying days, only days
within the period of actual residence or presence shall be counted.
(g) United States. The term ``United States'' when used in a
geographical sense includes any territory under the sovereignty of the
United States. It includes the states, the District of Columbia, the
possessions and territories of the United States, the territorial waters
of the United States, the air space over the United States, and the
seabed and subsoil of those submarine areas which are adjacent to the
territorial waters of the United States and over which the United States
has exclusive rights, in accordance with international law, with respect
to the exploration and exploitation of natural resources.
(h) Foreign country. The term ``foreign country'' when used in a
geographical sense includes any territory under the sovereignty of a
government other than that of the United States. It includes the
territorial waters of the foreign country (determined in accordance with
the laws of the United States), the air space over the foreign country,
and the seabed and subsoil of those submarine areas which are adjacent
to the territorial waters of the foreign country and over which the
foreign country has exclusive rights, in accordance with international
law, with respect to the exploration and exploitation of natural
resources.
(Sec. 911 (95 Stat. 194; 26 U.S.C. 911) and sec. 7805 (68A Stat. 917; 26
U.S.C. 7805) of the Internal Revenue Code of 1954)
[T.D. 8006, 50 FR 2965, Jan. 23, 1985]
Sec. 1.911-3 Determination of amount of foreign earned income to be excluded.
(a) Definition of foreign earned income. For purposes of section 911
and the regulations thereunder, the term ``foreign earned income'' means
earned income (as defined in paragraph (b) of this section) from sources
within a foreign country (as defined in Sec. 1.911-2(h)) that
[[Page 12]]
is earned during a period for which the individual qualifies under Sec.
1.911-2(a) to make an election. Earned income is from sources within a
foreign country if it is attributable to services performed by an
individual in a foreign country or countries. The place of receipt of
earned income is immaterial in determining whether earned income is
attributable to services performed in a foreign country or countries.
(b) Definition of earned income--(1) In general. The term ``earned
income'' means wages, salaries, professional fees, and other amounts
received as compensation for personal services actually rendered
including the fair market value of all remuneration paid in any medium
other than cash. Earned income does not include any portion of an amount
paid by a corporation which represents a distribution of earnings and
profits rather than a reasonable allowance as compensation for personal
services actually rendered to the corporation.
(2) Earned income from business in which capital is material. In the
case of an individual engaged in a trade or business (other than in
corporate form) in which both personal services and capital are material
income producing factors, a reasonable allowance as compensation for the
personal services actually rendered by the individual shall be
considered earned income, but the total amount which shall be treated as
the earned income of the individual from such trade or business shall in
no case exceed thirty percent of the individual's share of the net
profits of such trade or business.
(3) Professional fees. Earned income includes all fees received by
an individual engaged in a professional occupation (such as doctor or
lawyer) in the performance of professional activities. Professional fees
constitute earned income even though the individual employs assistants
to perform part or all of the services, provided the patients or clients
are those of the individual and look to the individual as the person
responsible for the services rendered.
(c) Amounts not included in foreign earned income. Foreign earned
income does not include an amount:
(1) Excluded from gross income under section 119;
(2) Received as a pension or annuity (including social security
benefits);
(3) Paid to an employee by an employer which is the U.S. government
or any U.S. government agency or instrumentality;
(4) Included in the individual's gross income by reason of section
402(b) (relating to the taxability of a beneficiary of a nonexempt
trust) or section 403(c) (relating to the taxability of a beneficiary
under a nonqualified annuity or under annuities purchased by exempt
organizations);
(5) Included in gross income by reason of Sec. 1.911-6(b)(4)(ii);
or
(6) Received after the close of the first taxable year following the
taxable year in which the services giving rise to the amounts were
performed. For treatment of amounts received after December 31, 1962,
which are attributable to services performed on or before December 31,
1962, and with respect to which there existed on March 12, 1962, a right
(whether forfeitable or nonforfeitable) to receive such amounts, see
Sec. 1.72-8.
(d) Determination of the amount of foreign earned income that may be
excluded under section 911(a)(1)--(1) In general. Foreign earned income
described in this section may be excluded under section 911(a)(1) and
this paragraph only to the extent of the limitation specified in
paragraph (d)(2) of this section. Income is considered to be earned in
the taxable year in which the services giving rise to the income are
performed. The determination of the amount of excluded earned income in
this manner does not affect the time for reporting any amounts included
in gross income.
(2) Limitation--(i) In general. The term ``section 911(a)(1)
limitation'' means the amount of foreign earned income for a taxable
year which may be excluded under section 911(a)(1). The section
911(a)(1) limitation shall be equal to the lesser of the qualified
individual's foreign earned income for the taxable year in excess of
amounts that the individual elected to exclude from gross income under
section 911(a)(2) or the product of the annual rate for the taxable year
(as specified in paragraph (d)(2)(ii) of this section) multiplied by the
following fraction:
[[Page 13]]
[GRAPHIC] [TIFF OMITTED] TC14NO91.137
(ii) Annual rate for the taxable year. The annual rate for the
taxable year is the rate set forth in section 911(b)(2)(A).
(3) Number of qualifying days. For purposes of section 911 and the
regulations thereunder, the number of qualifying days is the number of
days in the taxable year within the period during which the individual
met the tax home requirement and either the bona fide residence
requirement or the physical presence requirement of Sec. 1.911-2(a).
Although the period of bona fide residence must include an entire
taxable year, the entire uninterrupted period of residence may include
fractional parts of a taxable year. For instance, if an individual who
was a calendar year taxpayer established a tax home and a residence in a
foreign country as of November 1, 1982, and maintained the tax home and
the residence through March 31, 1984, then the uninterrupted period of
bona fide residence includes fractional parts of the years 1982 and
1984, and all of 1983. The number of qualifying days in 1982 is sixty-
one. The number of qualifying days in 1983 is 365. The number of
qualifying days in 1984 is ninety-one. The period during which the
physical presence requirement of Sec. 1.911-2(a)(2)(ii) is met is any
twelve consecutive month period during which the individual is
physically present in one or more foreign countries for 330 days and the
individual's tax home is in a foreign country during each day of such
physical presence. Such period may include days when the individual is
not physically present in a foreign country, and days when the
individual does not maintain a tax home in a foreign country. Such
period may include fractional parts of a taxable year. Thus, if an
individual's period of physical, presence is the twelve-month period
beginning June 1, 1982, and ending May 31, 1983, the number of
qualifying days in 1982 is 214 and the number of qualifying days in 1983
is 151.
(e) Attribution rules--(1) In general. Foreign earned income is
considered to be earned in the taxable year in which the individual
performed the services giving rise to the income. If income is earned in
one taxable year and received in another taxable year, then, for
purposes of determining the amount of foreign earned income that the
individual may exclude under section 911(a), the individual must
attribute the income to the taxable year in which the services giving
rise to the income were performed. Thus, any reimbursement would be
attributable to the taxable year in which the services giving rise to
the obligation to pay the reimbursement were performed, not the taxable
year in which the reimbursement was received. For example, tax
equalization payments are normally received in the year after the year
in which the services giving rise to the obligation to pay the tax
equalization payment were performed. Therefore, such payments will
almost always have to be attributed to the prior year. Foreign earned
income attributable to services performed in a preceding taxable year
shall be excludable from gross income in the year of receipt only to the
extent such amount could have been excluded under paragraph (d)(1) in
the preceding taxable year, had such amount been received in the
preceding taxable year. The taxable year to which income is attributable
will be determined on the basis of all the facts and circumstances.
(2) Priority of use of the section 911(a)(1) limitation. Foreign
earned income received in the year in which it is earned shall be
applied to the section 911(a)(1) limitation for that year before
applying income earned in that year that is received in any other year.
Foreign earned income that is earned in one year and received in another
year shall be applied to the section 911(a)(1) limitation for the year
in which it was earned, on a year by year basis, in any order that the
individual chooses. (But see section 911(b)(1)(B)(iv)). An individual
may not amend his return to change the treatment of income with respect
to the section 911(a)(1) exclusion after the period provided by section
6511(a). The special period of limitation provided by section 6511(d)(3)
does not apply for this purpose. For example, C, a qualified individual,
receives an advance bonus of $10,000 in
[[Page 14]]
1982, salary of $70,000 in 1983, and a performance bonus of $10,000 in
1984, all of which are foreign earned income for 1983. C has a section
911(a)(1) limitation for 1983 of $80,000, and has no housing cost amount
exclusion. On his income tax return for 1983, C elects to exclude
foreign earned income of $70,000 received in 1983. C may also exclude
his $10,000 advance bonus received in 1982 (by filing an amended return
for 1982), or he may exclude the $10,000 performance bonus received in
1984 on his 1984 income tax return. However, C may not exclude part of
the 1982 bonus and part of the 1984 bonus.
(3) Exception for year-end payroll period. Notwithstanding paragraph
(e)(1) of this section, salary or wage payments of a cash basis taxpayer
shall be attributed entirely to the year of receipt under the following
circumstances:
(i) The period for which the payment is made is a normal payroll
period of the employer which regularly applies to the employee;
(ii) The payroll period includes the last day of the employee's
taxable year;
(iii) The payroll period does not exceed 16 days; and
(iv) The payment is part of a normal payroll of the employer that is
distributed at the same time, in relation to the payroll period, that
such payroll would normally be distributed, and is distributed before
the end of the next succeeding payroll period.
(4) Attribution of bonuses and substantially nonvested property to
periods in which services were performed--(i) In general. Bonuses and
substantially nonvested property are attributable to all of the services
giving rise to the income on the basis of all the facts and
circumstances. If an individual receives a bonus or substantially
nonvested property (as defined in Sec. 1.83-3(b)) and it is determined
to be attributable to services performed in more than one taxable year,
then, for purposes of determining the amount eligible for exclusion from
gross income in the year the bonus is received or the property vests, a
portion of such amount shall be treated as attributable to services
performed in each taxable year (or portion thereof) during the period
when services giving rise to the bonus or the substantially nonvested
property were performed. Such portion shall be determined by dividing
the amount of the bonus or the excess of the fair market value of the
vested property over the amount paid, if any, for the vested property,
by the number of months in the period when services giving rise to such
amount were performed, and multiplying the quotient by the number of
months in such period in the taxable year. For purposes of this section,
the term ``month'' means a calendar month. A fraction of a calendar
month shall be deemed a month if it includes fifteen or more days.
(ii) Examples. The following examples illustrate the application of
this paragraph (e)(4).
Example 1. A, an employee of M Corporation during all of 1983 and
1984, worked in the United States from January 1 through April 30, 1983,
and received $12,000 of salary for that period. A worked in country F
from May 1, 1983 through the end of 1984, and is a qualified individual
under Sec. 1.911-2(a) for that period. For the period from May 1
through December 31, 1983, A received $32,000 of salary. M pays a bonus
on December 20, 1983 to each of M's employees in an amount equal to 10
percent of the employee's regular wages or salary for the 1983 calendar
year. The amount of A's bonus is $4,400 for 1983. The portion of A's
bonus that is attributable to services performed in country F and is
foreign earned income for 1983 is $3,200, or $32,000x10 percent. The
remaining $1,200 of A's bonus is attributable to services performed in
the United States, and is not foreign earned income.
Example 2. The facts are the same as in example 1, except that M
determines bonuses separately for each country based on the productivity
of the employees in that country. M pays a bonus to employees in country
F, in the amount of 15 percent of each employee's wages or salary earned
in country F. A's country F bonus is $4,800 for 1983 ($32,000x15
percent), and is foreign earned income for 1983. If A also receives a
bonus (or if A's bonus is increased) for working in the United States
during 1983, that amount is not foreign earned income.
Example 3. X corporation offers its employees a bonus of $40,000 if
the employee accepts employment in a foreign country and remains in a
foreign country for a period of at least four years. A, an employee of
X, is a calendar year and cash basis taxpayer. A accepts employment with
X in foreign country F. A begins work in F on July 1, 1983 and
[[Page 15]]
continues to work in F for X until June 30, 1987. In 1987 X pays A a
$40,000 bonus. The bonus is attributable to services A performed from
July 1, 1983 through June 30, 1987. The amount of the bonus attributable
to 1987 is $5,000 (($40,000/48)x6). The amount of the bonus attributable
to 1986 is $10,000 (($40,000/48)x12). A may exclude the $10,000
attributable to 1986 only to the extent that amount could have been
excluded under section 911(a)(1) had A received it in 1986. The
remaining $25,000 is attributable to services performed in taxable years
before 1986. Such amounts may not be excluded under section 911 because
they are received after the close of the taxable year following the
taxable year in which the services giving rise to the income were
performed.
(iii) Special rule for elections under section 83(b). If an
individual receives substantially nonvested property and makes an
election under section 83(b) and Sec. 1.83-2(a) to include in his gross
income the amount determined under section 83(b)(1)(A) and (B) and Sec.
1.83-2(a) for the taxable year in which the property is transferred (as
defined in Sec. 1.83-3(a)), then, for the purpose of determining the
amount eligible for exclusion in the year of receipt, the individual may
elect either of the following options:
(A) Substantially nonvested property may be treated as attributable
entirely to services performed in the taxable year in which an election
to include it in income is made. If so treated, then the amount
otherwise included in gross income as determined under Sec. 1.83-2(a)
will be excludable under section 911(a) for such year subject to the
limitation provided in Sec. 1.911-3(d)(2) for such year.
(B) A portion of the substantially nonvested property may be treated
as attributable to services performed or to be performed in each taxable
year during which the substantial risk of forfeiture (as defined in
section 83(c) and Sec. 1.83-3(c)) exists. The portion treated as
attributable to services performed or to be performed in each taxable
year is determined by dividing the amount of the substantially nonvested
property included in gross income as determined under Sec. 1.83-2(a) by
the number of months during the period when a substantial risk of
forfeiture exists. The quotient is multiplied by the total number of
months in the taxable year during which a substantial risk of forfeiture
exists. The amount determined to be attributable to services performed
in the year the election is made shall be excluded from gross income for
such year as provided in paragraph (d)(2) of this section. Amounts
treated as attributable to services performed in subsequent taxable
years shall be excludable in the year of receipt only to the extent such
amounts could be excluded under paragraph (d)(2) of this section in such
subsequent years. An individual may obtain such additional exclusion by
filing an amended return for the taxable year in which the property was
transferred. The individual may only amend his or her return within the
period provided by section 6511(a) and the regulations thereunder.
(5) Moving expense reimbursements--(i) Source of reimbursements. For
the purpose of determining whether a moving expense reimbursement is
attributable to services performed within a foreign country or within
the United States, in the absence of evidence to the contrary, the
reimbursement shall be attributable to future services to be performed
at the new principal place of work. Thus, a reimbursement received by an
employee from his employer for the expenses of a move to a foreign
country will generally be attributable to services performed in the
foreign country. A reimbursement received by an employee from his
employer for the expenses of a move from a foreign country to the United
States will generally be attributable to services performed in the
United States. For purposes of this paragraph (e)(5), evidence to the
contrary includes, but is not limited to, an agreement, between the
employer and the employee, or a statement of company policy, which is
reduced to writing before the move to the foreign country and which is
entered into or established to induce the employee or employees to move
to a foreign country. The writing must state that the employer will
reimburse the employee for moving expenses incurred in returning to the
United States regardless of whether the employee continues to work for
the employer after the employee returns to the United States. The
writing may contain conditions upon which the right to reimbursement is
determined as long as the
[[Page 16]]
conditions set forth standards that are definitely ascertainable and the
conditions can only be fulfilled prior to, or through completion of the
employee's return move to the United States that is the subject of the
writing. In no case will an oral agreement or statement of company
policy concerning moving expenses be considered evidence to the
contrary. For the purpose of determining whether a storage expense
reimbursement is attributable to services performed within a foreign
country, in the case of storage expenses incurred after December 31,
1983, the reimbursement shall be attributable to services performed
during the period of time for which the storage expenses are incurred.
(ii) Attribution of foreign source reimbursements to taxable years
in which services are performed--(A) In general. If a reimbursement for
moving expenses is determined to be from foreign sources under paragraph
(e)(5)(i) of this section, then for the purpose of determining the
amount eligible for exclusion in accordance with paragraphs (d)(2) and
(e)(2) of this section, the reimbursement shall be considered
attributable to services performed in the year of the move as long as
the individual is a qualified individual for a period that includes 120
days in the year of the move. The period that is used in determining the
number of qualifying days for purposes of the individual's section
911(a)(1) limitation (under paragraph (d)(2) of this section) must also
be used in determining whether the individual is a qualified individual
for a period that includes 120 days in the year of the move. If the
individual is not a qualified individual for such period, then the
individual shall treat a portion of the reimbursement as attributable to
services performed in the year of the move, and a portion as
attributable to services performed in the succeeding taxable year, if
the move is from the United States to a foreign country, or to the prior
taxable year, if the move is from a foreign country to the United
States. The portion of the reimbursement treated as attributable to
services performed in the year of the move shall be determined by
multiplying the total reimbursement by the following fraction:
[GRAPHIC] [TIFF OMITTED] TC14NO91.138
The remaining portion of the reimbursement shall be treated as
attributable to services performed in the year succeeding or preceding
the year of the move. Amounts treated as attributable to services
performed in a year succeeding or preceding the year of the move shall
be excludable in the year of receipt only to the extent such amounts
could be excluded under paragraph (d)(2) of this section in such
succeeding or preceding year.
(B) Moves beginning before January 1, 1984. Notwithstanding
paragraph (e)(5)(ii)(A) of this section, this paragraph (e)(5)(ii)(B)
shall apply for moves begun before January 1, 1984. If a reimbursement
for moving expenses is determined to be from foreign sources under
paragraph (e)(5)(i) of this section, then for the purpose of determining
the amount eligible for exclusion in accordance with paragraphs (d)(2)
and (e)(2) of this section, the reimbursement shall be considered
attributable to services performed in the year of the move. However, if
the individual does not qualify under section 911(d)(1) and Sec. 1.911-
2(a) for the entire taxable year of the move, then the individual shall
treat a portion of the reimbursement as attributable to services
performed in the succeeding taxable year, if the move is from the United
States to a foreign country, or to the prior taxable year, if the move
is from a foreign country to the United States. The portion of the
reimbursement treated as attributable to services performed in the year
succeeding
[[Page 17]]
or preceding the move shall be determined by multiplying the total
reimbursement by the following fraction:
[GRAPHIC] [TIFF OMITTED] TC14NO91.139
and subtracting the product from the total reimbursement. Amounts
treated as attributable to services performed in a year succeeding or
preceding the year of the move shall be excludable in the year of
receipt only to the extent such amounts could be excluded under
paragraph (d)(2) of this section in such succeeding or preceding year.
(f) Examples. The following examples illustrate the application of
this section.
Example 1. A is a U.S. citizen and calendar year taxpayer. A's tax
home was in foreign country F and A was physically present in F for 330
days during the period from July 4, 1982 through July 3, 1983. The
number of A's qualifying days in 1982 as determined under paragraph
(d)(2) of this section is 181. In 1982 A receives $40,000 attributable
to services performed in foreign country F in 1982. Under paragraph
(d)(2) of this section A's section 911(a)(1) limitation is $37,192, that
is the lesser of $40,000 (foreign earned income) or
[GRAPHIC] [TIFF OMITTED] TC09OC91.000
Example 2. The facts are the same as in example 1 except that in
1982 A receives $30,000 attributable to services performed in foreign
country F. A excludes this amount from gross income under paragraph (d)
of this section. In addition, in 1983 A receives $10,000 attributable to
services performed in F in 1982 and $35,000 attributable to services
performed in F in 1983. On his return for 1983, A must report $45,000 of
income. A's section 911(a)(1) limitation for 1983 is the lesser of
$35,000 (foreign earned income) or $49,329, the annual rate for the
taxable year multiplied by a fraction the numerator of which is A's
qualifying days in the taxable year and the denominator of which is the
number of days in the taxable year ($80,000x184/365). On his tax return
for 1983 A may exclude $35,000 attributable to services performed in
1983. A may only exclude $7,192 of the $10,000 received in 1983
attributable to services performed in 1982 because such amount is only
excludable in 1983 to the extent such amount could have been excluded in
1982 subject to the section 911(a)(1) limitation for 1982 which is
$37,192 ($75,000x181/365). No portion of amounts attributable to
services performed in 1982 may be used in calculating A's section
911(a)(1) limitation for 1983. Thus, even though A could have excluded
an additional $5,329 in 1983 if A had had more foreign earned income
attributable to 1983, A may not exclude the $2,808 of remaining foreign
earned income attributable to 1982.
Example 3. C is a U.S. citizen and calendar year taxpayer. C
establishes a bona fide residence and a tax home in foreign country J on
March 1, 1982, and maintains a tax home and a residence in J until
December 31, 1986. In March of 1982 C's employer, Y corporation,
transfers stock in Y to C. The stock is subject to forfeiture if C
returns to the U.S. before January 1, 1985. C elects under section 83(b)
to include $15,000, the amount determined with respect to such stock
under section 83(b)(1), in gross income in 1982. C's other foreign
earned income in 1982 is $58,000. C elects under paragraph
(e)(4)(iii)(B) of this section to treat the stock as if earned over the
period of the substantial risk of forfeiture. The number of months in
the period of the substantial risk of forfeiture is thirty-four. The
number of months in the taxable year 1982 within the period of foreign
employment is ten. For purposes of determining C's section 911(a)(1)
limitation, $4,412 (($15,000/34)x10) of the amount included in gross
income under section 83(b) is treated as attributable to services
performed in 1982, $5,294 is treated as attributable to services to be
performed in 1983, and $5,294 is treated as attributable to services to
be performed in
[[Page 18]]
1984. In 1982, C excludes $62,412 under section 911(a)(1). That is the
lesser of foreign earned income for 1982 ($58,000+$4,412) or the annual
rate for the taxable year multiplied by a fraction the numerator of
which is C's qualifying days in the taxable year and the denominator of
which is the number of days in the taxable year ($75,000x306/365). C
continues to perform services in foreign country J throughout 1983 and
1984. C would be able to exclude the remaining $5,294 attributable to
services performed in 1983 and $5,294 attributable to services performed
in 1984 if those amounts would be excludable if they had been received
in 1983 or 1984 respectively. If C is entitled to exclude the additional
amounts, C must claim the exclusion by filing an amended return for
1982.
Example 4. D is a U.S. citizen and a calendar year taxpayer. In
September, 1984 D moves to a foreign country K. D is physically present
in K, and D's tax home is in K, from September 15, 1984 through December
31, 1985. D receives $6,000 in April, 1985 from his employer, as a
reimbursement for expenses of moving to K, pursuant to a written
agreement that such moving expenses would be reimbursed to D upon
successful completion of 6 months employment in K. Under paragraph
(e)(15)(i) of this section, the reimbursement is attributable to
services performed in K. Under the physical presence test of Sec.
1.911-2(a)(2)(ii), among other periods D is a qualified individual for
the period of August 10, 1984 through August 9, 1985, which includes 144
days in 1984. Under paragraph (e)(5)(ii)(A) of this section, for the
purpose of determining the amount eligible for exclusion, the
reimbursement is considered attributable to services performed in 1984
(the year of the move) because D is a qualified individual under Sec.
1.911-2(a) for a period that includes 120 days in 1984. The
reimbursement may be excluded under paragraphs (d)(2) and (e)(2) of this
section, to the extent that D's foreign earned income for 1984 that was
earned and received in 1984 was less than the annual rate for the
taxable year multiplied by the number of D's qualifying days in the
taxable year over the number of days in D's taxable year ($80,000x144/
366), or $31,475.
Example 5. The facts are the same as in example 4 except that D is
not a qualified individual under the physical presence test, but is a
qualified individual under the bona fide residence test for the period
of September 15, 1984 through December 31, 1985. Under paragraph
(e)(5)(ii)(A) of this section, for the purpose of determining the amount
eligible for exclusion, the reimbursement is considered attributable to
services performed in 1984 and 1985 because D is not a qualified
individual for a period that includes 120 days in 1984 (the year of the
move). The portion of the reimbursement treated as attributable to
services performed in 1984 is $6,000x108/366, or $1,770, and may be
excluded, subject to D's 1984 section 911(a)(1) limitation. The balance
of the reimbursement, $4,230, is treated as attributable to services
performed in 1985, and may be excluded to the extent provided in
paragraphs (d)(2) and (e)(2) of this section.
Example 6. The facts are the same as in example 4, with the
following additions. Before D moved to K, D and his employer signed a
written agreement that D would perform services for the employer for at
least one year, primarily in country K, and, if D did not voluntarily
cease to work for the employer primarily in country K before one year
had elapsed, the employer would reimburse D for one half of D's
expenses, up to a maximum of $4,000, of moving back to the United
States. The agreement also stated that, if D did not voluntarily leave
the employment in K before two years had elapsed, the employer would
reimburse D for all of D's reasonable expenses of moving back to the
United States. The agreement further stated that D's right to
reimbursement would not be conditioned upon the performance of services
after D ceased to work in K. D worked in country K for all of 1985. On
January 1, 1986, D left K and moved to the United States. In February,
1986 the employer paid D $3,500 as reimbursement for one-half of D's
expenses of moving to the United States. Although D did not fulfill the
condition in the agreement to receive full reimbursement, all of the
conditions in the agreement set forth definitely ascertainable standards
and no condition could be fulfilled after D moved back to the United
States. The agreement fulfills the requirements of paragraph (e)(5)(i)
of this section, and therefore is evidence that the reimbursement should
not be attributable to future services to be performed at D's new
principal place of work. Under the facts and circumstances, the
reimbursement is attributable to services performed in K. Under
paragraph (e)(5)(ii)(A) of this section, the entire reimbursement is
attributable to services performed in 1985. The amount attributable to
1985 may be excluded to the extent provided in paragraphs (d)(2) and
(e)(2) of this section.
(Sec. 911 (95 Stat. 194; 26 U.S.C. 911) and sec. 7805 (68A Stat. 917; 26
U.S.C. 7805) of the Internal Revenue Code of 1954)
[T.D. 8006, 50 FR 2966, Jan. 23, 1985]
Sec. 1.911-4 Determination of housing cost amount eligible for exclusion
or deduction.
(a) Definition of housing cost amount. The term ``housing cost
amount'' means an amount equal to the reasonable expenses paid or
incurred (as defined in section 7701(a)(25)) during the taxable year by
or on behalf of the individual attributable to housing in a
[[Page 19]]
foreign country for the individual and any spouse or dependents who
reside with the individual (or live in a second foreign household
described in paragraph (b)(5) of this section) less the base housing
amount as defined in paragraph (c) of this section. The housing cost
amount must be reduced by the amount of any military or section 912
allowance or similar allowance excludable from gross income that is
intended to compensate the individual or the individual's spouse in
whole or in part for the expenses of housing during the same period for
which the individual claims a housing cost amount exclusion or
deduction.
(b) Housing expenses--(1) Included expenses. For purposes of
paragraph (a) of this section, housing expenses include rent, the fair
rental value of housing provided in kind by the employer, utilities
(other than telephone charges), real and personal property insurance,
occupancy taxes not described in paragraph (b)(2)(v) of this section,
nonrefundable fees paid for securing a leasehold, rental of furniture
and accessories, household repairs, and residential parking.
(2) Excluded expenses. Housing expenses do not include:
(i) The cost of house purchase, improvements, and other costs that
are capital expenditures;
(ii) The cost of purchased furniture or accessories or domestic
labor (maids, gardeners, etc.);
(iii) Amortized payments of principal with respect to an evidence of
indebtedness secured by a mortgage on the taxpayer's housing;
(iv) Depreciation of housing owned by the taxpayer, or amortization
or depreciation of capital improvements made to housing leased by the
taxpayer;
(v) Interest and taxes deductible under section 163 or 164 or other
amounts deductible under section 216(a) (relating to deduction of
interest and taxes by cooperative housing corporation tenant);
(vi) The expenses of more than one foreign household except as
provided in paragraph (b)(5) of this section;
(vii) Expenses excluded from gross income under section 119;
(viii) Expenses claimed as deductible moving expenses under section
217; or
(ix) The cost of a pay television subscription.
(3) Limitation. Housing expenses are taken into account for purposes
of this section only to the extent attributable to housing for portions
of the taxable year within the period during which the individual
satisfies the requirements of Sec. 1.911-2(a). Housing expenses are not
taken into account for the period during which the value of the
individual's housing is excluded from gross income under section 119,
unless the individual maintains a second foreign household described in
paragraph (b)(5) of this section. If an individual maintains two foreign
households, only expenses incurred with respect to the abode which bears
the closest relationship, not necessarily geographic, with respect to
the individual's tax home shall be taken into account, unless one of the
households is a second foreign household.
(4) Reasonableness. An amount paid for housing shall not be treated
as reasonable, for purposes of paragraph (a) of this section, to the
extent that the expense is lavish or extravagant under the
circumstances.
(5) Expenses of a second foreign household--(i) In general. The term
``second foreign household'' means a separate abode maintained by an
individual outside of the U.S. for his or her spouse or dependents (who,
if minors, are in the individual's legal custody or the joint custody of
the individual and the individual's spouse) at a place other than the
tax home of the individual because of adverse living conditions at the
individual's tax home. If an individual maintains a second foreign
household the expenses of the second foreign household may be included
in the individual's housing expenses under paragraph (b)(1) of this
section. Under no circumstances shall an individual be considered to
maintain more than one second foreign household at the same time.
(ii) Adverse living conditions. Solely for purposes of paragraph
(b)(5)(i) of this section, adverse living conditions
[[Page 20]]
are living conditions which are dangerous, unhealthful, or otherwise
adverse. Adverse living conditions include a state of warfare or civil
insurrection in the general area of the individual's tax home. Adverse
living conditions exist if the individual resides on the business
premises of the employer for the convenience of the employer and,
because of the nature of the business (for example, a construction site
or drilling rig), it is not feasible for the employer to provide housing
for the individual's spouse or dependents. The criteria used by the
Department of State in granting a separate maintenance allowance are
relevant, but not determinative, for purposes of determining whether a
separate household is provided because of adverse living conditions.
(c) Base housing amount--(1) In general. The base housing amount is
equal to the product of 16 percent of the annual salary of an employee
of the United States who is compensated at a rate equal to the annual
salary rate paid for step 1 of grade GS-14, multiplied by the following
fraction:
[GRAPHIC] [TIFF OMITTED] TC14NO91.140
For purposes of the above fraction, the number of qualifying days is
determined in accordance with Sec. 1.911-3(d)(3).
(2) Annual salary of step 1 of grade GS-14. The annual salary rate
for a step 1 of grade GS-14 is determined on January first of the
calendar year in which the individual's taxable year begins.
(d) Housing cost amount exclusion--(1) Limitation. A qualified
individual who has elected to exclude his or her housing cost amount may
only exclude the lesser of the full amount of either the individual's
housing cost amount attributable to employer provided amounts or the
individual's foreign earned income for the taxable year. A qualified
individual who elects to exclude his or her housing cost amount may not
claim less than the full amount of the housing cost exclusion determined
under this paragraph.
(2) Employer provided amounts. For purposes of this section, the
term ``employer provided amounts'' means any amounts paid or incurred on
behalf of the individual by the individual's employer which are foreign
earned income included in the individual's gross income for the taxable
year (without regard to section 911). Employer provided amounts include,
but are not limited to, the following amounts: Any salary paid by the
employer to the employee; any reimbursement paid by the employer to the
employee for housing expenses, educational expenses for the individual's
dependents, or as part of a tax equalization plan; the fair market value
of compensation provided in kind (including lodging, unless excluded
under section 119, relating to meals and lodging furnished for the
convenience of the employer); and any amount paid by the employer to any
third party on behalf of the employee. An individual will only have
earnings that are not employer provided amounts if the individual has
earnings from self-employment.
(3) Housing cost amount attributable to employer provided amounts.
For the purpose of determining what portion of the housing cost amount
is excludable and what portion is deductible the following rules apply.
If the individual has no income from self-employment, then the entire
housing cost amount is attributable to employer provided amounts and is,
therefore, excludable to the extent of the limitation provided in
paragraph (d)(1) of this section. If the individual only has income from
self-employment, then the entire housing cost amount is attributable to
non-employer provided amounts and is, therefore, deductible to the
extent of the limitation provided in paragraph (e) of this section. In
all other instances, the housing cost amount attributable to employer
provided amounts shall be determined by multiplying the housing cost
amount by the following fraction: Employer provided amounts over foreign
earned income for the taxable year. The housing cost amount attributable
to non-employer provided amounts shall be determined by subtracting the
portion of the housing cost amount attributable to employer provided
amounts from the total housing cost amount.
[[Page 21]]
(e) Housing cost amount deduction--(1) In general. If a portion of
the individual's housing cost amount is determined under paragraph
(d)(3) of this section to be attributable to non-employer provided
amounts, the individual may deduct that amount from gross income for the
taxable year but only to the extent of the individual's foreign earned
income (as defined in Sec. 1.911-3) for the taxable year in excess of
foreign earned income excluded and the housing cost amount excluded from
gross income for the taxable year under Sec. 1.911-3 and this section.
(2) Carryover. If any portion of the individual's housing cost
amount deduction is disallowed for the taxable year under paragraph
(e)(1) of this section, such portion shall be carried over and treated
as a deduction from gross income for the succeeding taxable year (but
only for the succeeding taxable year) to the extent of the excess, if
any, of:
(i) The amount of foreign earned income for the succeeding taxable
year less the foreign earned income and the housing cost amount excluded
from gross income under Sec. 1.911-3 and this section for the
succeeding taxable year over,
(ii) The portion, if any, of the housing cost amount that is
deductible under paragraph (e)(1) of this section for the succeeding
taxable year.
(f) Examples. The following examples illustrate the application of
this section. In all examples the annual rate for a step 1 of GS-14 as
of January first of the calendar year in which the individual's taxable
year begins is $39,689.
Example 1. B, a U.S. citizen is a calendar year taxpayer who was a
bona fide resident of and whose tax home was located in foreign country
G for the entire taxable year 1982. B receives an $80,000 salary from
B's employer for services performed in G. B incurs no business expenses.
B receives housing provided by B's employer with a fair rental value of
$15,000. The value of the housing furnished by B's employer is not
excluded from gross income under section 119. B pays $10,000 for housing
expenses. B's gross income and foreign earned income for 1982 is
$95,000. B elects the foreign earned income exclusion of section
911(a)(1) and the housing cost amount exclusion of section 911(a)(2). B
must first compute his housing cost amount exclusion. B's housing cost
amount is $18,650 determined by reducing B's housing expenses, $25,000
($15,000 fair rental value of housing and $10,000 of other expenses), by
the base housing amount of $6,350 (($39,689x.16)x365/365). Because B has
no income from self-employment, the entire amount is attributable to
employer provided amounts and therefore, is excludable. B's section
911(a)(1) limitation is $75,000. That is the lesser of $75,000x365/365
or $95,000-18,650. B's total exclusion for 1982 under section 911(a)(1)
and (2) is $93,650.
Example 2. The facts are the same as in example 1 except that B's
salary for 1982 is $70,000. B's foreign earned income for 1982 is
$85,000. B's housing cost amount is $18,650, all of which is
attributable to employer provided amounts. B's housing cost amount is
excludable to the extent of the lesser of B's housing cost amount
attributable to employer provided amounts, $18,650, or the foreign
earned income for the taxable year, $85,000. Thus, B excludes $18,650
under section 911(a)(2). B's section 911(a)(1) limitation for 1982 is
$66,350 (the lesser of $75,000x365/365 or $85,000-18,650). B's total
exclusion for 1982 under section 911(a)(1) and (2) is $85,000.
Example 3. The facts are the same as in example 2 except that in
1983, B receives $5,000 attributable to services performed in 1982. B
may exclude the entire $5,000 in 1983 because such amount would have
been excludable under Sec. 1.911-3(d)(1) had it been received in 1982.
Example 4. C is a U.S. citizen self-employed and a calendar year and
cash basis taxpayer. C arrived in foreign country H on October 3, 1982,
and departed from H on March 8, 1984. C's tax home was located in H
throughout that period. C was physically present for 330 full days
during the twelve consecutive month period August 30, 1982, through
August 29, 1983. The number of C's qualifying days in 1982 is 124.
During 1982 C had $35,000 of foreign earned income, none of which was
attributable to employer provided amounts and $8,000 of reasonable
housing expenses. C's housing cost amount is $5,843 ($8,000-
((39,689x.16)x124/365)). C elects to exclude her foreign earned income
under Sec. 1.911-3(d)(1). C's section 911(a)(1) limitation for 1982 is
$25,479 (the lesser of C's foreign earned income for the taxable year
($35,000) or the annual rate for the taxable year multiplied by the
number of C's qualifying days over the number of days in the taxable
year ($75,000x124/365=$25,479). C may not claim the housing cost amount
exclusion under section 911(a)(2) because no portion of the housing cost
amount is attributable to employer provided amounts. C may deduct the
lesser of her housing cost amount ($5,843) or her foreign earned income
in excess of amounts excluded under section 911(a) ($35,000-
25,479=$9,521). Thus, C's housing cost amount deduction is $5,843.
Example 5. The facts are the same as in example 4 except that C had
$30,000 of foreign
[[Page 22]]
earned income for 1982, none of which was attributable to employer
provided amounts. C elects to exclude $25,479 under Sec. 1.911-3(d)(1).
C may only deduct $4,521 of her housing cost amount under paragraph
(e)(1) of this section because her foreign earned income in excess of
amounts excluded under section 911(a) is $4,521($30,000-25,479). The
$1,322 of unused housing cost amount deduction may be carried over to
the subsequent taxable year.
Example 6. The facts are the same as in example 4 except that C had
$15,000 of foreign earned income of 1982, none of which was attributable
to employer provided amounts. C elects to exclude the entire $15,000
under Sec. 1.911-3(d)(1). C is not entitled to a housing cost amount
deduction for 1982 since she has no foreign earned income in excess of
amounts excluded under section 911(a). C may carry over her entire
housing cost amount deduction to 1983.
Example 7. The facts are the same as in example 6. In addition,
during taxable year 1983 C had $115,000 of foreign earned income, none
of which was attributable to employer provided amounts, and $40,000 of
reasonable housing expenses C elects to exclude her foreign earned
income under Sec. 1.911-3(d)(1). C's section 911(a)(1) limitation is
the lesser of $115,000 or $80,000 ($80,000x365/365). C's housing cost
amount for 1983 is $33,650 (40,000-(39,689x.16)x365/365). Since no
portion of that amount is attributable to employer provided amounts, C
may not claim a housing cost amount exclusion. C may deduct the lesser
of her housing cost amount ($33,650) or her foreign earned income in
excess of amounts excluded under section 911(a) ($115,000-
80,000=35,000). Thus, C may deduct her $33,650 housing cost amount in
1983. In addition, C may deduct $1,350 of the housing cost amount
deduction carried over from taxable year 1982.
(($115.000-80,000)-33,650=$1,350). The remaining $4,493 ($5,843-1,350)
of the housing cost amount deduction carried over from taxable year 1982
may not be deducted in 1983 or carried over to 1984.
Example 8. D is a U.S. citizen and a calendar year and cash basis
taxpayer. D is a bona fide resident of and maintains his tax home in
foreign country J for all of taxable year 1984. In 1984, D earns $80,000
of foreign earned income, $60,000 of which is an employer provided
amount and $20,000 of which is a non-employer provided amount. D's total
housing cost amount for 1984 is $25,000. D elects to exclude, under
section 911(a)(2), the portion of his housing cost amount that is
attributable to employer provided amounts. D's excludable housing cost
amount is $18,750; that is the total housing cost amount ($25,000)
multiplied by employer provided amounts for the taxable year ($60,000)
over foreign earned income for the taxable year ($80,000). D also elects
to exclude his foreign earned income under Sec. 1.911-3(d)(1). D's
section 911(a)(1) limitation for 1984 is $61,250 (the lesser of $80,000-
$18,750 or $80,000x366/366). D's total exclusion for 1984 under section
911(a)(1) and (2) is $80,000. D cannot claim a housing cost amount
deduction in 1984 because D has no foreign earned income in excess of
his foreign earned income and housing cost amount excluded from gross
income for the taxable year under Sec. 1.911-3 and this section. D may
carry over his housing cost amount deduction of $6,250, the total
housing cost amount less the portion attributable to employer provided
amounts ($25,000-18,750), to taxable year 1985.
(Sec. 911 (95 Stat. 194; 26 U.S.C. 911) and sec. 7805 (68A Stat. 917; 26
U.S.C. 7805) of the Internal Revenue Code of 1954)
[T.D. 8006, 50 FR 2970, Jan. 23, 1985]
Sec. 1.911-5 Special rules for married couples.
(a) Married couples with two qualified individuals--(1) In general.
In the case in which a husband and wife both are qualified individuals
under Sec. 1.911-2(a), each individual may make one or more elections
under Sec. 1.911-7 and exclude from gross income foreign earned income
and exclude or deduct housing cost amounts subject to the rules of
paragraphs (a)(2) and (3) of this section.
(2) Computation of excluded foreign earned income. The amount of
excludable foreign earned income is determined separately for each
spouse under the rule of Sec. 1.911-3 on the basis of the income
attributable to the services of that spouse. If the spouses file
separate returns each may exclude the amount of his or her foreign
earned income attributable to his or her services subject to the
limitations of Sec. 1.911-3(d)(2). If the spouses file a joint return,
the sum of these foreign earned income amounts so determined for each
spouse may be excluded. For example, H and W both qualify under Sec.
1.911-2(a)(2)(i) for the entire 1983 taxable year. During 1983 W earns
$100,000 of foreign earned income and H earns $45,000 of foreign earned
income. H and W file a joint return for 1983. On their joint return H
and W may exclude from gross income a total of $125,000. That amount is
determined by adding W's section 911(a)(1) limitation, $80,000 (the
lesser of $80,000x365/365 or $100,000), and H's section 911(a)(1)
limitation, $45,000 (the lesser of $80,000x365/365 or $45,000).
[[Page 23]]
(3) Computation of housing cost amount--(i) Spouses residing
together. If the spouses reside together, and file a joint return, they
may compute their housing cost amount either jointly or separately. If
the spouses reside together and file separate returns, they must compute
their housing cost amounts separately. If the spouses compute their
housing cost amounts separately, they may allocate the housing expenses
to either of them or between them for the purpose of calculating
separate housing cost amounts, but each spouse claiming a housing cost
amount exclusion or deduction must use his or her full base housing
amount in such computation. If the spouses compute their housing cost
amount jointly, then only one of the spouses may claim the housing cost
amount exclusion or deduction.
Either spouse may claim the housing cost amount exclusion or deduction;
however, if the spouses have different periods of residence or presence
and the spouse with the shorter period of residence or presence claims
the exclusion or deduction, then only the expenses incurred in that
shorter period may be claimed as housing expenses. The spouse claiming
the exclusion or deduction may aggregate the couple's housing expenses,
and subtract his or her base housing amount. For example, H and W reside
together and file a joint return. H was a bona fide resident of and
maintained his tax home in foreign country M from August 17, 1982,
through December 31, 1983. W was a bona fide resident of and maintained
her tax home in foreign country M from September 15, 1982, through
December 31, 1983. During 1982, H and W earn and receive, respectively,
$25,000 and $10,000 of foreign earned income. H paid $10,000 for
qualified housing expenses in 1982, $7,500 of that was for qualified
housing expenses incurred from September 15, 1982, through December 31,
1982. W paid $3,000 for qualified housing expenses in 1982 all of which
were incurred during her period of residence. H and W may choose to
compute their housing cost amount jointly. If they do so and H claims
the housing cost amount exclusion his exclusion would be $10,617. H's
housing expenses would be $13,000 ($10,000+$3,000) and his base housing
amount would be $2,383 ((39,689x.16)x137/365=$2,383). If instead W
claims the housing cost amount exclusion her exclusion would be $8,621.
W's housing expenses would be $10,500 ($7,500+3,000) and her base
housing amount would be $1,879 (($39,689x.16)x108/365=$1,879). If H and
W file jointly and both claim a housing cost amount exclusion, then H's
and W's housing cost amounts would be, respectively, $7,617 ($10,000-
2,383) and $1,121 ($3,000-1,879).
(ii) Spouses residing apart. If the spouses reside apart, both
spouses may exclude or deduct their housing cost amount if the spouses
have different tax homes that are not within reasonable commuting
distance (as defined in Sec. 1.119-1(d)(4)) of each other and neither
spouse's residence is within a reasonable commuting distance of the
other spouse's tax home. If the spouses' tax homes, or one spouse's
residence and the other spouse's tax home, are within a reasonable
commuting distance of each other, only one spouse may exclude or deduct
his or her housing cost amount. Regardless of whether the spouses file
joint or separate returns, the amount of the housing cost amount
exclusion or deduction must be determined separately for each spouse
under the rules of Sec. 1.911-4. If both spouses claim a housing cost
amount exclusion or deduction directly as qualified individuals, neither
may claim any such exclusion or deduction under section
911(c)(2)(B)(ii), relating to a second foreign household maintained for
the other spouse. If one spouse fails to claim a housing cost amount
exclusion or deduction which that spouse could claim directly, the other
spouse may claim such exclusion or deduction under section
911(c)(2)(B)(ii), relating to a second foreign household maintained for
the first spouse, provided that all the requirements of that section are
met. Spouses may not claim more than one second foreign household and
the expenses of such household may only be claimed by one spouse. For
example, if both H and W are qualified individuals and H's tax home is
in London and W's tax home is in Paris, then both H and W may exclude or
deduct their housing cost
[[Page 24]]
amounts; however, H and W must compute these amounts separately
regardless of whether they file joint or separate returns. If instead of
living in Paris, W lives in an area where there are adverse living
conditions and W maintains H's home in London, then W may add those
housing expenses to her housing expenses and compute one base housing
amount. In that case H may not claim a housing cost amount exclusion or
deduction.
(iii) Housing cost amount attributable to employer provided amounts.
Each spouse claiming a housing cost amount exclusion or deduction shall
compute the portion of the housing cost amount that is attributable to
employer provided amounts separately, based on his or her separate
foreign earned income, in accordance with Sec. 1.911-4(d)(3).
(b) Married couples with community income. The amount of excludable
foreign earned income of a husband and wife with community income is
determined separately for each spouse in accordance with paragraph (a)
of this section on the basis of income attributable to that spouse's
services without regard to community property laws. See sections 879 and
6013 (g) and (h) for special rules regarding treatment of community
income of a nonresident alien individual married to a U.S. citizen or
resident.
(Sec. 911 (95 Stat. 194; 26 U.S.C. 911) and sec. 7805 (68A Stat. 917; 26
U.S.C. 7805) of the Internal Revenue Code of 1954)
[T.D. 8006, 50 FR 2972, Jan. 23, 1985]
Sec. 1.911-6 Disallowance of deductions, exclusions, and credits.
(a) In general. No deduction or exclusion from gross income under
subtitle A of the Code or credit against the tax imposed by chapter 1 of
the Code shall be allowed to the extent the deduction, exclusion, or
credit is properly allocable to or chargeable against amounts excluded
from gross income under section 911(a). For purposes of the preceding
sentence, deductions, exclusions, and credits which are definitely
related (as provided in Sec. 1.861-8), in whole or in part, to earned
income shall be allocated and apportioned to foreign earned income and
U.S. source earned income in accordance with the rules contained in
Sec. 1.861-8. Deductions, exclusions, and credits which are definitely
related to all gross income under Sec. 1.861-8, including deductions
for interest described in Sec. 1.861-8(e)(2)(ii), are definitely
related, in whole or in part, to earned income. In the case of interest
expense allocable, in whole or in part, to foreign earned income under
Sec. 1.861-8(e)(2)(ii), the expense shall normally be apportioned under
option one of the optional gross income methods of apportionment (Sec.
1.861-8(e)(2)(v)i(A)), but without regard to conditions (1) and (2) of
subdivision (vi)(A) (the fifty percent conditions). Such interest
expense shall not normally be apportioned under the asset method of
Sec. 1.861-8(e)(2)(v). This is because, where section 911 is the
operative section, the expense normally relates more closely to gross
income generated from activities than to the amount of capital utilized
or invested in activities or property. Deductions that are allocated and
apportioned to foreign earned income must then be allocated and
apportioned to foreign earned income that is excluded under section
911(a). If an individual has foreign earned income from both self-
employment and other employment, the amount excluded under section
911(a)(1) shall be deemed to include a pro rata amount of the self-
employment income and the income from other employment; thus, a pro rata
portion of deductible expenses attributable to self-employment income
must be disallowed. For purposes of section 911 (d)(6) and this section
only, deductions, exclusions, or credits which are not definitely
related to any class of gross income shall not be allocable or
chargeable to excluded amounts and are, therefore, deductible to the
extent allowed by chapter 1 of the Code. Examples of deductions that are
not definitely related to a class of gross income are personal and
family medical expenses, qualified retirement contributions (but see
section 219(b)(1)), real estate taxes and mortgage interest on a
personal residence, charitable contributions, alimony payments, and
deductions for personal exemptions. In addition, for purposes of this
section, amounts excludable or deductible under section 911 or 119 shall
not be allocable or chargeable to other amounts excluded under section
911(a).
[[Page 25]]
Thus, an individual's housing cost amount which is excludable or
deductible under Sec. 1.911-4(d) for a taxable year is not apportioned
in part to the individual's foreign earned income which is excluded for
such year under Sec. 1.911-3(d). Therefore, the entire amount of such
exclusion or deduction is allowed to the extent provided in Sec. 1.911-
4. This section does not affect the time for claiming any deduction,
exclusion, or credit that is not allocated or apportioned to excluded
amounts.
(b) Moving expenses--(1) In general. No deduction shall be allowed
for moving expenses under section 217 to the extent the deduction is
properly allocable to or chargeable against amounts of foreign earned
income excluded from gross income under section 911(a). If an
individual's new principal place of work is in a foreign country,
deductible moving expenses will be allocable to foreign earned income.
If an individual treats a reimbursement from his employer for the
expenses of a move from a foreign country to the United States as
attributable to services performed in a foreign country under Sec.
1.911-3(e)(5)(i), then deductible moving expenses attributable to that
move will be allocable to foreign earned income. If the individual is a
qualified individual who elects to exclude foreign earned income under
section 911(a), then some or all of such moving expenses must be
disallowed as a deduction.
(2) Attribution of moving expense deduction to taxable years in
which services are performed. If a moving expense deduction is properly
allocable to foreign earned income, the deduction shall be considered
attributable to services performed in the year of the move as long as
the individual is a qualified individual under Sec. 1.911-2(a) for a
period that includes 120 days in the year of the move. If the individual
is not a qualified individual for such period, then the individual shall
treat the deduction as attributable to services performed in both the
year of the move and the succeeding taxable year, if the move is from
the United States to the foreign country, or the prior taxable year, if
the move is from a foreign country to the United States. Notwithstanding
the preceding two sentences, storage expenses incurred after December
31, 1983 shall be treated as attributable to services performed in the
year in which the expenses are incurred.
(3) Formula for disallowance of moving expense deduction. The
portion of the moving expense deduction that is disallowed shall be
determined by multiplying the moving expense deduction by a fraction the
numerator of which is all amounts excluded under section 911(a) for the
year or years to which the deduction is attributable (under paragraph
(b)(2) of this section) and the denominator of which is foreign earned
income (as defined in Sec. 1.911-3(a)) for that year or years.
(4) Effect of disallowance based on attribution of deduction to
subsequent year's income. An individual may claim a moving expense
deduction in the taxable year in which the amount of the expense is paid
or incurred even if attributable, in part, to the succeeding year.
However, at such time as the individual excludes income under section
911(a) for the year or years to which the deduction is attributable, the
individual shall either--
(i) File an amended return for the year in which the deduction was
claimed that does not claim the portion of the deduction that is
disallowed because it is chargeable against excluded income, or
(ii) Include in income for the year following the year in which the
deduction was claimed an amount equal to the amount of the deduction
that is disallowed.
Any amount included in income under paragraph (b)(4)(ii) of this section
is not foreign earned income.
(5) Moves beginning before January 1, 1984. Notwithstanding
paragraphs (b)(1) through (3) of this section, the rules of this
paragraph (b)(5) shall apply for moves beginning before January 1, 1984.
(i) Individual qualifies for the entire taxable year of the move. If
the individual is a qualified individual for the entire taxable year of
the move, then the amount of moving expense disallowed shall be
determined by multiplying the moving expense deduction otherwise
allowable by a fraction the numerator of which is the foreign earned
income excluded under section 911(a) for the taxable year of the move
[[Page 26]]
and the denominator of which is the foreign earned income for the same
taxable year.
(ii) Individual qualifies for less than the entire taxable year of
the move. If the individual is a qualified individual for less than the
entire taxable year of the move, then, for the purpose of determining
the portion of the otherwise allowable moving expense deduction that is
disallowed, the individual must attribute a portion of the otherwise
allowable moving expense deduction either to the succeeding taxable
year, if the move is from the United States to a foreign country, or to
the prior taxable year, if the move is from a foreign country to the
United States. The
portion of the moving expense deduction treated as attributable to
services performed in the year of the move shall be determined by
multiplying the otherwise allowable moving expense deduction by the
following fraction:
[GRAPHIC] [TIFF OMITTED] TC14NO91.141
The portion of the moving expense deduction treated as attributable to
the year succeeding or preceding the move shall be determined by
subtracting the portion of the moving expense deduction that is
attributable to the year of the move from the total moving expense
deduction. The allocation of a portion of the moving expense deduction
to a succeeding or preceding taxable year does not affect the time for
claiming the allowable moving expense deduction. The portion of the
moving expense deduction that is disallowed shall be determined by
multiplying the moving expense deduction attributable to the year of the
move or the succeeding or preceding year, as the case may be, by a
fraction the numerator of which is amounts excluded under section 911(a)
for that year and the denominator of which is foreign earned income for
that year.
(c) Foreign taxes--(1) Amount disallowed. No deduction or credit is
allowed for foreign income, war profits, or excess profits taxes paid or
accrued with respect to amounts excluded from gross income under section
911. To determine the amount of disallowed foreign taxes, multiply the
foreign tax imposed on foreign earned income (as defined in Sec. 1.911-
3(a)) received or accrued during the taxable year by a fraction, the
numerator of which is amounts excluded under section 911(a) in such
taxable year less deductible expenses properly allocated to such amounts
(see paragraphs (a) and (b) of this section), and the denominator of
which is foreign earned income (as defined in Sec. 1.911-3(a)) received
or accrued during the taxable year less deductible expenses properly
allocated or apportioned thereto. For the purpose of determining the
extent to which foreign taxes are disallowed, the housing cost amount
deduction is treated as definitely related to foreign earned income that
is not excluded. If the foreign tax is imposed on foreign earned income
and some other income (for example earned income from sources within the
United States or an amount not subject to tax in the United States), and
the taxes on the other amount cannot be segregated, then the denominator
equals the total of the amounts subject to tax less deductible expenses
allocable to all such amounts.
(2) Definitions and special rules--(i) Taxable year. For purposes of
paragraph (c)(1) of this section, the term ``taxable year'' means the
individual's taxable year for U.S. tax purposes. Such term includes the
portion of any foreign taxable year within the individual's U.S. taxable
year and excludes the portion of any foreign taxable year not within the
individual's U.S. taxable year.
(ii) Apportionment of foreign taxes. For purposes of this paragraph
(c), foreign taxes imposed on foreign earned income shall be deemed to
accrue, on a pro rata basis, to income as the income
[[Page 27]]
is received or accrued. The taxes so accrued shall be apportioned to the
taxable year during which the income is received or accrued. This rule
applies for all individuals, regardless of their method of accounting.
(iii) Effect of disallowance. The disallowance of foreign taxes
under this paragraph (c) shall not affect the time for claiming any
deduction or credit for foreign taxes paid. Rather, the disallowance
shall only affect the amount of taxes considered paid or accrued to any
foreign country.
(iv) Interest on foreign taxes. Any interest expense incurred on a
liability for foreign taxes is allocated and apportioned not under this
paragraph (c) but under paragraph (a) of this section to foreign earned
income and then to excluded foreign earned income and to that extent
disallowed as a deduction under paragraph (a). In that regard, see also
Sec. 1.861-8(e)(2) for the specific rules for allocation and
apportionment of interest expense.
(d) Examples. The following examples illustrate the application of
this section.
Example 1. In 1982 A, an architect, operates his business as a sole
proprietorship in which capital is not a material income producing
factor. A receives $1,000,000 in gross receipts, all of which is foreign
source earned income, and incurs $500,000 of otherwise deductible
business expenses definitely related to the foreign earned income. A
elects to exclude $75,000 under section 911(a)(1). The expenses must be
apportioned to excluded earned income as follows: $500,000x$75,000/
1,000,000. Thus, $37,500 of the business expenses are not deductible.
Example 2. The facts are the same as in example 1, except that
$100,000 of A's gross receipts is U.S. source earned income and $68,000
of A's business expenses are attributable to the U.S. source earned
income. Thus, A has $900,000 of foreign earned income and $432,000 of
deductions allocated to foreign earned income. The expenses apportioned
to excluded earned income are $432,000x$75,000/$900,000, or $36,000,
which are not deductible.
Example 3. B is a U.S. citizen, calendar year and cash basis
taxpayer. B moves to foreign country N and maintains a tax home and is
physically present there from July 1, 1984 through May 26, 1985. Among
other possible periods, B is a qualified individual for 219 days in the
year of the move. B pays $6,000 of otherwise deductible moving expenses
in 1984. For 1984, B's foreign earned income is $60,000 and B excludes
$47,869 ($80,000x219/366) under section 911(a). Under paragraph (b)(2)
of this section, B's moving expenses are attributable to services
performed in 1984. Under paragraph (b)(3) of this section,
$6,000x$47,869/$60,000, or $4,789, of B's moving expense deduction is
disallowed. B may deduct $1,211 of moving expenses on his 1984 return.
Example 4. The facts are the same as in example 3 except that B
maintains a tax home and is physically present in foreign country N from
October 9, 1984 through September 3, 1985. Among other possible periods,
B is a qualified individual for no more than 119 days in 1984 and 281
days in 1985. B's foreign earned income for 1984 is $60,000. B's foreign
earned income for 1985 is $150,000. Because B is a qualified individual
for less than 120 days in the year of the move, under paragraph (b)(2)
of this section, B's moving expenses are attributable to services
performed in 1984 and 1985. At the close of 1984, B may either seek an
extension of time to file under Sec. 1.911-7(c) or may file an income
tax return without claiming the exclusions or deduction under section
911. B does not seek an extension and files without excluding foreign
earned income; thus B may deduct his moving expenses in full. B later
amends his 1984 return and excludes foreign earned income for that year.
B excludes foreign earned income for 1985. B must determine the portion
of the moving expense deduction that is disallowed. The portion of the
moving expense deduction that is disallowed is determined by multiplying
the otherwise allowable moving expense deduction by a fraction. The
numerator of the fraction is the sum of amounts excluded under section
911(a) for 1984 and 1985, that is $26,082 or $80,000x119/365, plus
$61,589, or $80,000x281/365, which totals $87,671. The denominator of
the fraction is the sum of foreign earned income for 1984 and 1985, that
is $60,000 plus $150,000, or $210,000. B's allowable moving expense
deduction is $3,495, or $6,000-($6,000x$87,671/$210,000). If B does not
file an amended 1984 return (and does not exclude foreign earned income
for 1984), but excludes foreign earned income under section 911(a) for
1985, a portion of his moving expense deduction is disallowed, based on
the same formula. The amount disallowed is $6,000x$61,589/$210,000, or
$1,760. This amount may be recaptured either by filing an amended return
for 1984 or by including it in income for 1985 (in which case it is not
foreign earned income).
Example 5. C is a U.S. citizen, a self-employed individual, and a
cash basis and calendar year taxpayer. For the entire 1982 taxable year
C maintained his tax home and his bona fide residence in foreign country
P. During 1982 C earned and received $120,000 of foreign earned income,
none of which was attributable to employer provided amounts. C paid
$40,000 of business expenses. C elected to
[[Page 28]]
exclude foreign earned income under section 911(a)(1) and claimed a
housing cost amount deduction of $15,000. C received $10,000 of foreign
source interest income which was included with C's earned income in a
single tax base and taxed at graduated rates. For 1982, C paid $30,000
in income tax to foreign country P. The amount of C's business expenses
that is properly apportioned to excluded amounts (and therefore, not
deductible) equals $25,000, which is determined by multiplying the
otherwise allowable deductions by C's excluded amounts over C's foreign
earned income ($40,000x75,000/120,000). The amount of country P tax that
is properly apportioned to excluded amounts (and therefore, not
deductible or creditable) equals $20,000, which is determined by
multiplying the tax of $30,000 by the following fraction:
[GRAPHIC] [TIFF OMITTED] TC14NO91.142
Example 6. D is a U.S. citizen and an accrual basis and calendar
year taxpayer for U.S. tax purposes. For the entire period from January
1, 1982 through December 31, 1983, D maintains his tax home and his bona
fide residence in foreign country R. For purposes of R's income tax, D
is a cash basis taxpayer and uses a fiscal year that begins on April 1
and ends on the following March 31. During his entire period of
residence in R, D receives foreign earned income of $10,000 each month,
all of which is attributable to employer provided amounts. For his
foreign taxable year ending March 31, 1982, D pays $10,000 of income tax
to R. For his foreign taxable year ending March 31, 1983, D pays $54,000
of income tax to R. Under paragraph (c)(2)(ii) of this section, all of
the $10,000 of tax paid for this foreign taxable year ending March 31,
1982 is imposed on foreign earned income received in 1982, as is
$40,500, or \9/12\x$54,000, of tax paid for his foreign taxable year
ending March 31, 1983. (D received $10,000 per month for the last 3
months of his foreign taxable year ending March 31, 1982, all of which
are within his U.S. taxable year ending December 31, 1982 under
paragraph (c)(2)(i) of this section, and $10,000 per month for each
month of his foreign taxable year ending March 31, 1983, of which the
first 9 months are within his U.S. taxable year ending December 31,
1982. Under paragraph (c)(2)(ii) of this section, foreign taxes are
deemed to accrue on a pro rata basis to income as it is received or
accrued. Thus, all of the $10,000 of foreign taxes imposed on the income
received during D's foreign taxable year ending March 31, 1982 accrue to
D's 1982 foreign earned income, as do \9/12\ (or $90,000/120,000) of
foreign taxes imposed on income received during D's foreign taxable year
ending March 31, 1983, for purposes of determining the amount of D's
foreign taxes that is disallowed.) For 1982, D has no deductible
expenses, and elects to exclude his housing cost amount of $21,000 under
section 911(a)(2) and foreign earned income of $75,000 under section
911(a)(1). The amount of D's foreign taxes disallowed for deduction or
credit purposes for 1982 is $8,000 (that is, $10,000x$96,000/$120,000)
of the taxes for his foreign taxable year ending March 31, 1982, plus
$32,400 (that is, $40,500x$96,000/$120,000) of the taxes for his foreign
taxable year ending March 31, 1983, or $40,400. From 1982, D has $2,000
($10,000-$8,000) of deductible or creditable taxes accrued on March 31,
1982, and $8,100 ($40,500-$32,400) of deductible or creditable taxes
accrued on March 31, 1983, after the disallowance based on his 1982
excluded income.
Example 7. E is a United States citizen, calendar year and cash
basis taxpayer. E is physically present in and establishes his tax home
in foreign country S on May 1, 1981. For purposes of country S, E's
taxable year begins on April 1 and ends the following March 31. E
receives foreign earned income of $15,000 each month beginning on May 1,
1981. At the end of his foreign taxable year ending on March 31, 1982, E
pays $70,000 of income tax to S on $165,000 of foreign earned income.
Under section 911, as in effect for taxable years beginning before
January 1, 1982, E may not exclude any income that is earned or received
during 1981. None of E's taxes paid in 1982 that are attributable to
income earned or received in 1981 are subject to disallowance because,
under paragraph (c)(2)(ii) of this section, the only taxes disallowed
are those deemed to accrue on income earned and received after December
31, 1981, and excluded from gross income. The amount of E's taxes paid
in 1982 that are attributable to 1981 is $50,909, or $70,000x$120,000/
$165,000. E elects to exclude foreign earned income for 1982. The amount
of E's taxes paid to S in 1982 that accrue to
[[Page 29]]
1982 foreign earned income, and are therefore subject to disallowance
based on excluded income, is $19,091, or $70,000x$45,000/$165,000.
(Sec. 911 (95 Stat. 194; 26 U.S.C. 911) and sec. 7805 (68A Stat. 917; 26
U.S.C. 7805) of the Internal Revenue Code of 1954)
[T.D. 8006, 50 FR 2973, Jan. 23, 1985]
Sec. 1.911-7 Procedural rules.
(a) Elections of a qualified individual --(1) In general. In order
to receive either exclusion provided by section 911(a), a qualified
individual must elect, separately with respect to each exclusion, to
exclude foreign earned income under section 911(a)(1) and the housing
cost amount under section 911(a)(2). Any such elections may be made on
Form 2555 or on a comparable form. Each election must be filed either
with the income tax return, or with an amended return, for the first
taxable year of the individual for which the election is to be
effective. An election once made remains in effect for that year and all
subsequent years unless revoked under paragraph (b) of this section.
Each election shall contain information sufficient to determine whether
the individual is a qualified individual as provided in Sec. 1.911-2.
The statement shall include the following information:
(i) The individual's name, address, and social security number;
(ii) The name of the individual's employer;
(iii) Whether the individual claimed exclusions under section 911
for earlier years after 1981 and within the five preceding taxable
years;
(iv) Whether the individual has revoked a previously made election
and the taxable year for which such revocation was effective;
(v) The exclusion or exclusions the individual is electing;
(vi) The foreign country or countries in which the individual's tax
home is located and the date when such tax home was established;
(vii) The status (either bona fide residence or physical presence)
under which the individual claims the exclusion;
(viii) The individual's qualifying period of residence or presence;
(ix) The individual's foreign earned income for the taxable year
including the fair market value of all noncash remuneration; and,
(x) If the individual elects to exclude the housing cost amount, the
individual's housing expenses.
(2) Requirement of a return--(i) In general. In order to make a
valid election under this paragraph (a), the election must be made:
(A) With an income tax return that is timely filed (including any
extensions of time to file),
(B) With a later return filed within the period prescribed in
section 6511(a) amending the foregoing timely filed income tax return,
(C) With an original income tax return that is filed within one year
after the due date of the return (determined without regard to any
extension of time to file); this one year period does not constitute an
extension of time for any purpose--it is merely a period during which a
valid election may be made on a late return, or
(D) With an income tax return filed after the period described in
paragraphs (a)(2)(i)(A), (B), or (C) of this section provided--
(1) The taxpayer owes no federal income tax after taking into
account the exclusion and files Form 1040 with Form 2555 or a comparable
form attached either before or after the Internal Revenue Service
discovers that the taxpayer failed to elect the exclusion; or
(2) The taxpayer owes federal income tax after taking into account
the exclusion and files Form 1040 with Form 2555 or a comparable form
attached before the Internal Revenue Service discovers that the taxpayer
failed to elect the exclusion.
(3) A taxpayer filing an income tax return pursuant to paragraph
(a)(2)(i)(D)(1) or (2) of this section must type or legibly print the
following statement at the top of the first page of the Form 1040:
``Filed Pursuant to Section 1.911-7(a)(2)(i)(D).''
(ii) Election for 1982 and 1983 taxable years. Solely for purposes
of paragraph (a)(2)(i)(A) of this section, an income tax return for any
taxable year beginning before January 1, 1984, shall be considered
timely filed if it is filed on or before July 23, 1985.
[[Page 30]]
(3) Housing cost amount deduction. An individual does not have to
make an election in order to claim the housing cost amount deduction.
However, such individual must provide the Commissioner with information
sufficient to determine the individual's correct amount of tax. Such
information shall include the following: The individual's name, address,
and social security number; the name of the individual's employer; the
foreign country in which the individual's tax home was established; the
status under which the individual claims the deduction; the individual's
qualifying period of residence or presence; the individual's foreign
earned income for the taxable year; and the individual's housing
expenses.
(4) Effect of immaterial error or omission. An inadvertent error or
omission of information required to be provided to make an election
under this paragraph (a) shall not render the election invalid if the
error or omission is not material in determining whether the individual
is a qualified individual or whether the individual intends to make the
election.
(b) Revocation of election--(1) In general. An individual may revoke
any election made under paragraph (a) of this section for any taxable
year. A revocation must be made separately with respect to each
election. The individual may revoke an election for any taxable year,
including the first taxable year for which an election was effective, by
filing a statement that the individual is revoking one or more of the
previously made elections. The statement must be filed with the income
tax return, or with an amended return, for the first taxable year of the
individual for which the revocation is to be effective. A revocation
once made is effective for that year and all subsequent years. If an
election is revoked for any taxable year, including the first taxable
year for which the election was effective, the individual may not,
without the consent of the Commissioner, again make the same election
until the sixth taxable year following the taxable year for which the
revocation was first effective. For example, a qualified individual
makes an election to exclude foreign earned income under section
911(a)(1) and files it with his 1982 income tax return. The individual
files 1983 and 1984 income tax returns on which he excludes his foreign
earned income. Then, within 3 years after filing his 1982 income tax
return, the individual files an amended 1982 income tax return with a
statement revoking his election to exclude foreign earned income under
section 911(a)(1). The revocation of the election is effective for
taxable years 1982, 1983, and 1984. The individual may not elect to
exclude income under section 911(a)(1) for any taxable year before 1988,
unless he obtains consent to reelect under paragraph (b)(2) of this
section.
(2) Reelection before sixth taxable year after revocation. If an
individual revoked an election under paragraph (b)(1) of this section
and within five taxable years the individual wishes to reelect the same
exclusion, then the individual may apply for consent to the reelection.
The application for consent shall be made by requesting a ruling from
the Associate Chief Counsel (Technical), National Office, Internal
Revenue Service, 1111 Constitution Avenue NW., Washington, DC 20224. In
determining whether to consent to reelection the Associate Chief Counsel
or his delegate shall consider any facts and circumstances that may be
relevant to the determination. Relevant facts and circumstances may
include the following: a period of United States residence, a move from
one foreign country to another foreign country with differing tax rates,
a substantial change in the tax laws of the foreign country of residence
or physical presence, and a change of employer.
(c) Returns and extensions--(1) In general. Any return filed before
completion of the period necessary to qualify an individual for any
exclusion of deduction provided by section 911 shall be filed without
regard to any exclusion or deduction provided by that section. A claim
for a credit or refund of any overpayment of tax may be filed, however,
if the taxpayer subsequently qualifies for any exclusion or deduction
under section 911. See section 6012(c) and Sec. 1.6012-1(a)(3),
relating to returns to be filed and information to be furnished by
individuals who qualify for
[[Page 31]]
any exclusion or deduction under section 911.
(2) Extensions. An individual desiring an extension of time (in
addition to the automatic extension of time granted by Sec. 1.6081-2)
for filing a return until after the completion of the qualifying period
described in paragraph (c)(1) of this section for claiming any exclusion
or deduction under section 911 may apply for an extension. An individual
whose moving expense deduction is attributable to services performed in
two years may apply for an extension of time for filing a return until
after the end of the second year. The individual may make such
application on Form 2350 or a comparable form. The application must be
filed with the Director, Internal Revenue Service Center, Philadelphia,
Pennsylvania 19255. The application must set forth the facts relied on
to justify the extension of time requested and must include a statement
as to the earliest date the individual expects to become entitled to any
exclusion or deduction by reason of completion of the qualifying period.
(d) Declaration of estimated tax. In estimating gross income for the
purpose of determining whether a declaration of estimated tax must be
made for any taxable year, an individual is not required to take into
account income which the individual reasonably believes will be excluded
from gross income under the provisions of section 911. In computing
estimated tax, however, the individual must take into account, among
other things, the denial of the foreign tax credit for foreign taxes
allocable to the excluded income (see Sec. 1.911-6(c)).
(Sec. 911 (95 Stat. 194; 26 U.S.C. 911) and sec. 7805 (68A Stat. 917; 26
U.S.C. 7805) of the Internal Revenue Code of 1954)
[T.D. 8006, 50 FR 2976, Jan. 23, 1985, as amended by T.D. 8480, 58 FR
34885, June 30, 1993]
Sec. 1.911-8 Former deduction for certain expenses of living abroad.
For rules relating to the deduction for certain expenses of living
abroad applicable to taxable years beginning before January 1, 1982, see
26 CFR 1.913-1 through 1.913-13 as they appeared in the Code of Federal
Regulations revised as of April 1, 1982.
(Sec. 911 (95 Stat. 194; 26 U.S.C. 911) and sec. 7805 (68A Stat. 917; 26
U.S.C. 7805) of the Internal Revenue Code of 1954)
[T.D. 8006, 50 FR 2977, Jan. 23, 1985
earned income of citizens of united states
Sec. 1.912-1 Exclusion of certain cost-of-living allowances.
(a) Amounts received by Government civilian personnel stationed
outside the continental United States as cost-of-living allowances in
accordance with regulations approved by the President are, by the
provisions of section 912(1), excluded from gross income. Such
allowances shall be considered as retaining their characteristics under
section 912(1) notwithstanding any combination thereof with any other
allowance. For example, the cost-of-living portion of a ``living and
quarters allowance'' would be excluded from gross income whether or not
any other portion of such allowance is excluded from gross income.
(b) For purposes of section 912(1), the term ``continental United
States'' includes only the 48 States existing on February 25, 1944 (the
date of the enactment of the Revenue Act of 1943 (58 Stat. 21)) and the
District of Columbia.
Sec. 1.912-2 Exclusion of certain allowances of Foreign Service personnel.
Gross income does not include amounts received by personnel of the
Foreign Service of the United States as allowances or otherwise under
the provisions of chapter 9 of title I of the Foreign Service Act of
1980 or the provisions of section 28 of the State Department Basic
Authorities Act (formerly section 914 of title IX of the Foreign Service
Act of 1946).
[T.D. 8256, 54 FR 28620, July 6, 1989]
Sec. 1.921-1T Temporary regulations providing transition rules for DISCs and FSCs.
(a) Termination of a DISC--(1) At end of 1984.
Q-1: What is the effect of the termination on December 31, 1984, of
a DISC's taxable year?
[[Page 32]]
A-1: Without regard to the annual accounting period of the DISC, the
last taxable year of each DISC beginning during 1984 shall be deemed to
close on December 31, 1984. The corporation's DISC election also shall
be deemed revoked at the close of business on December 31, 1984. (A DISC
that does not elect to be an interest charge DISC as of January 1, 1985,
in addition to a corporation described in section 992(a)(3), shall be
referred to as a ``former DISC''.) A corporation which wishes to be
treated as a FSC, a small FSC, or an interest charge DISC must make an
election as provided under paragraph (b) (Q & A 1) of this
section.
(2) Deemed distributions for short taxable years.
Q-2: If the termination of the DISC's taxable year on December 31,
1984, results in a short taxable year, how are the deemed distributions
under section 995(b)(1)(E) determined?
A-2: The deemed distributions are determined on the basis of the
DISC's taxable income for its short taxable year ending on December 31,
1984. In computing the incremental distribution under section
995(b)(1)(E), the export gross receipts for the short taxable year must
be annualized.
(3) Qualification as a DISC for 1984.
Q-3: Must the DISC satisfy all the tests set forth in section
992(a)(1) for the DISC's taxable year ending December 31, 1984?
A-3: All of the tests under section 992(a)(1), except the qualified
assets test under section 992(a)(1)(B), must be satisfied.
(4) Commissions for 1984.
Q-4: Must commissions be paid by a related supplier to a DISC with
respect to the DISC's taxable year ending December 31, 1984?
A-4: No.
Q-4A: Must commissions which were earned prior to January 1, 1985,
be paid by a related supplier if the last date payment is required (as
set forth in Sec. 1.994-1(e)(3)) is after December 31, 1984?
A-4A: No.
(5) Producer's loans of 1984.
Q-5: Must the producer's loan rules under section 993(d) be
satisfied with respect to the DISC's taxable year ending December 31,
1984?
A-5: Yes.
(6) Accumulated DISC income.
Q-6. Under what circumstances is any remaining accumulated DISC
income treated as previously taxed income (and not taxed)?
A-6. The accumulated DISC income of a DISC (but not a DISC described
in section 992(a)(3)) as of December 31, 1984, is treated as previously
taxed income when actually distributed after December 31, 1984. Any
amounts distributed by the former DISC (including a DISC which has
elected to be an interest charge DISC) after December 31, 1984, shall be
treated as made first out of current earnings and profits and then out
of previously taxed income to the extent thereof. For purposes of the
preceding sentence, amounts distributed before July 1, 1985, shall be
treated as made first out of previously taxed income to the extent
thereof. If property other than money is distributed and if such
property was a qualified export asset within the meaning of section
993(b) on December 31, 1984, then for purposes of section 311, no gain
or loss will be recognized on the distribution and the distributee will
have the same basis in the property as the distributor.
Q-7: May a DISC that was previously disqualified, but has
requalified as of December 31, 1984, treat any accumulated DISC income
as previously taxed income?
A-7: If a DISC was previously disqualified, but has requalified as
of December 31, 1984, any accumulated DISC income previously required to
be taken into income upon prior disqualification shall not be treated as
previously taxed income. All accumulated DISC income derived since
requalification, however, will be treated as previously taxed income.
(7) Distribution of previously taxed income.
Q-8: What effect will the distribution of previously taxed income
have on the earnings and profits of corporate shareholders of the former
DISC?
A-8: The earnings and profits of the corporate shareholders of the
former DISC will be increased by the amount of money and the adjusted
basis of any property which is distributed out of previously taxed
income.
[[Page 33]]
Q-9: Will the distribution of the former DISC's accumulated DISC
income as previously taxed income after December 31, 1984, result in a
reduction in the shareholder's basis of the stock of the former DISC and
consequent taxation of the excess of the distribution over such basis as
capital gain under section 996(d)?
A-9: No. This distribution will be treated both as amounts
representing deemed distributions under section 995(b)(1) and as
previously taxed income. Thus, no capital gain will arise.
(8) Qualifying distributions.
Q-10: How is a qualifying distribution to satisfy the qualified
export receipts tests under section 992(c)(1)(A) which is made with
respect to the DISC's taxable year ending on December 31, 1984, treated?
A-10: The distribution will not be treated as previously taxed
income but will be taxed to the shareholder of the former DISC, as
provided under section 992(c) and 996(a)(2) and the regulations
thereunder, in the shareholder's taxable year in which the distribution
is made.
(9) Deficiency distributions.
Q-11: With respect to an audit adjustment made after December 31,
1984, may a deficiency distribution be made, and if so, in what manner
may it be made?
A-11: A deficiency distribution may be made notwithstanding the fact
that after December 31, 1984, the former DISC is a taxable corporation
under subchapter C, has elected to be treated as an interest charge
DISC, or has been liquidated, reorganized or is otherwise no longer in
existence. However, such deficiency distribution shall be treated as
made out of accumulated DISC income which is not previously taxed income
because it will be treated as distributed prior to December 31, 1984, to
the DISC's shareholders.
Q-11A: Must a former DISC remain in existence in order for a former
DISC shareholder to take advantage of the spread provided in section
995(b)(2) with respect to DISC disqualification?
A-11A: No. With respect to distributions deemed to be received by a
former DISC shareholder under section 995(b)(2) for taxable years
beginning after December 31, 1984, if the former DISC shareholder
elects, the rules of section 995(b)(2)(B) shall apply even though the
former DISC does not continue in existence. If the former DISC is no
longer in existence, the former DISC's shareholders will be deemed to
have received the distribution on the last day of their taxable years
over the applicable period of time determined under section 995(b)(2) as
if the former DISC had remained in existence.
(10) Deemed distribution for 1984.
Q-12: How is the deemed distribution to a shareholder for the DISC's
taxable year ending December 31, 1984, taken into account?
A-12 (i) If the taxable year of the DISC ending on December 31,
1984, (A) is the first taxable year of the DISC which begins in 1984,
(B) begins after the date in 1984 on which the taxable year of the
DISC's shareholder begins, and (C) if the DISC's shareholder makes an
election under section 805(b)(3) of the Tax Reform Act of 1984, the
deemed distribution under section 995(b) with respect to income derived
by the DISC for such taxable year of the DISC shall be treated as
received by the shareholder in 10 equal installments (unless the
shareholder elects to be treated as receiving the deemed distribution in
income over a smaller number of equal installments). The first
installment shall be treated as received by the shareholder on the last
day of the shareholder's second taxable year beginning in 1984 (if any),
or if the shareholder had only one taxable year which began in 1984, on
the last day of the shareholder's first taxable year beginning in 1985.
One installment shall be treated as received by the shareholder on the
last day of each succeeding taxable year of the shareholder until the
entire amount of the DISC's 1984 deemed distribution has been included
in the shareholder's taxable income. To make the election under section
805(b)(3) of the Tax Reform Act of 1984, the DISC shareholder must
attach a statement to its timely filed tax return (including extensions)
for its taxable year which includes December 31, 1984, indicating the
total amount of the shareholder's pro rata share of the DISC's deemed
distribution for 1984 (determined under section 995(b) of the Code
without regard to the election
[[Page 34]]
under section 805(b)(3) of the Tax Reform Act of 1984), and the number
of equal installments, if less than 10, over which the shareholder
wishes to spread its pro rata share of the deemed distribution for 1984.
If the election under section 805(b)(3) of the Tax Reform Act of 1984 is
made, it may not be changed or revoked. In determining estimated tax
payments, the portion of the deemed distribution includible in the
shareholder's taxable income for any taxable year under this subdivision
(i) shall be treated as received by the shareholder on the last day of
such taxable year.
(ii) Except as provided in subdivision (i), the deemed distribution
under section 995(b) with respect to income derived by the DISC for its
taxable year ending on December 31, 1984, shall be included in the
shareholder's taxable income for its taxable year which includes
December 31, 1984. Thus, if the taxable year of the DISC and the DISC's
shareholder both begin on January 1, 1984, and end on December 31, 1984
(or, if the taxable year of the DISC beginning in 1984 begins before the
taxable year of the DISC's shareholder), the deemed distribution with
respect to the DISC's taxable year ending on December 31, 1984, will be
included in the DISC shareholder's taxable year ending on (or including)
December 31, 1984, and the election described in subdivision (i) may not
be made.
(iii) The provisions of this Question and Answer-12 apply without
regard to any existence of the DISC after December 31, 1984, as an
interest charge DISC.
Q-12A: If under section 805(b)(3) of the Tax Reform Act of 1984 the
shareholders of the DISC are permitted to make an election to treat the
DISC's 1984 deemed distribution as received over a 10-year period, must
the DISC distribute that amount to its shareholders ratably over the 10-
year period?
A-12A: No. Under section 805(b)(3) of the Tax Reform Act of 1984, if
the DISC's deemed distribution for its taxable year which ended on
December 31, 1984, is a qualified distribution, the shareholders of the
DISC are permitted to make an election to treat the distribution as
received over a 10-year period. The 10-year treatment applies even
though the amount of the deemed distribution is distributed to the
DISC's shareholders prior to the period in which the distribution is
taken into income by the shareholders. In addition, under section 996(e)
of the Code, the shareholder's basis in the stock of the DISC will be
considered as increased, as of the date of liquidation, by the
shareholder's pro rata share of the amount of the undistributed
qualified distribution even though that amount is treated as received by
the shareholder in later years. Further, the actual distribution in
liquidation of the former DISC after 1984 will increase the earnings and
profits of a corporate distributee, and the amount actually distributed
shall be treated under the rules of section 996.
(11) Conformity of accounting period.
Q-13: May a DISC be established or change its annual accounting
period for taxable years beginning after March 21, 1984, and before
January 1, 1985?
A-13: A DISC that is established or that changes its annual
accounting period after March 21, 1984, must conform its annual
accounting period to that of its principal shareholder (the shareholder
with the highest percentage of voting power as defined in section
441(h)).
(12) DISC gains and distributions from U.S. sources.
Q-14: What is the effective date of the amendment to section 996(g),
made by section 801(d)(10) of the Tax Reform Act of 1984, which treats
certain DISC gains and distributions as derived from sources within the
United States?
A-14: Under section 805(a)(3) of the Act, the amendment to section
996(g) shall apply to all gains referred to in section 995(c) and all
distributions out of accumulated DISC income including deemed
distributions made on or after June 22, 1984.
(b) Establishing and electing status as a FSC, small FSC or interest
charge DISC--(1) Ninety-day period.
Q-1: How does a corporation elect to be treated as a FSC, a small
FSC, or an interest charge DISC?
A-1: A corporation electing FSC or small FSC status must file Form
8279. A corporation electing interest charge DISC status must file Form
4876A. A corporation electing to be treated as a
[[Page 35]]
FSC, small FSC, or interest charge DISC for its first taxable year shall
make its election within 90 days after the beginning of that year. A
corporation electing to be treated as a FSC, small FSC, or interest
charge DISC for any taxable year other than its first taxable year shall
make its election during the 90-day period immediately preceding the
first day of that taxable year. The election to be a FSC, small FSC, or
interest charge DISC may be made by the corporation, however, during the
first 90 days of a taxable year, even if that taxable year is not the
corporation's first taxable year, if that taxable year begins before
July 1, 1985. Likewise, the election to be a FSC (or a small FSC) may be
made during the first 90 days of any taxable year of a corporation if
the corporation had in a prior taxable year elected small FSC (or FSC)
status and the corporation revokes the small FSC (or FSC) election
within the 90 day period. A corporation which was a DISC for its taxable
year ending December 31, 1984, which wishes to be treated as an interest
charge DISC beginning with its first taxable year beginning after
December 31, 1984, may make the election to be treated as an interest
charge DISC by filing Form 4876A on or before July 1, 1987. Also, if a
corporation which has elected FSC, small FSC or interest charge DISC
status, or a shareholder of that corporation, is acquired in a qualified
stock purchase under section 338(d)(3), and if an election under section
338(a) is effective with regard to that corporation, the corporation may
re-elect FSC, small FSC or interest charge DISC status, (whichever is
applicable) not later than the date of the election under section
338(a), see section 338(g)(i) and Sec. 1.338-2(d). This re-election is
necessary because the original elections are deemed terminated if an
election is made under section 338(a). The rules contained in Sec.
1.992-2 (a)(1), (b)(1) and (b)(3) shall apply to the manner of making
the election and the manner and form of shareholder consent.
(2) FSC incorporated in a possession.
Q-2: Where does a FSC which is incorporated in a U.S. possession
file its election?
A-2: The election is filed with the Internal Revenue Service Center,
Philadelphia, Pennsylvania 19255.
(3) Information returns.
Q-3: Must Form 5471 be filed with respect to the organization of a
FSC pursuant to section 6046 or to provide information with respect to a
FSC pursuant to section 6038?
A-3: A Form 5471 required under section 6046 need not be filed with
respect to the organization of a FSC. The requirements of section 6046
shall be satisfied by the filing of a Form 8279 dealing with the
election to be treated as a FSC or small FSC. However, a Form 5471 will
be required with respect to a reorganization of a FSC (or small FSC) or
an acquisition of stock of a FSC (or small FSC), as required under
section 6046 and the regulations thereunder. Provided that a Form 1120
FSC is filed, a Form 5471 need not be filed to satisfy the requirements
of section 6038.
(4) Conformity of accounting period.
Q-4: Since a FSC, small FSC, and interest charge DISC must use the
same annual accounting period as the principal shareholder, must such
corporation delay the beginning of its first taxable year beyond January
1, 1985 if the principal shareholder (the shareholder with the highest
percentage of voting power as defined in section 441(h)) is not a
calendar year taxpayer?
A-4: No. Where the principal shareholder is not a calendar year
taxpayer, a corporation may elect to be treated as a FFSC, small FSC, or
interest charge DISC for a taxable year beginning January 1, 1985.
However, such corporation must close its first taxable year and adopt
the annual accounting period of its principal shareholder as of the
first day of the principal shareholder's first taxable year beginning in
1985. A FSC, small FSC, or interest charge DISC need not obtain the
consent of the Commissioner under section 442 to conform its annual
accounting period to the annual accounting period of its principal
shareholder.
(5) Dollar limitations for short taxable years.
Q-5: If a small FSC or an interest charge DISC has a short taxable
year, how are the dollar limitations on foreign trading export gross
receipts and
[[Page 36]]
qualified export gross receipts, respectively, determined for small FSCs
and interest charge DISCs?
A-5: The dollar limitations are to be prorated on a daily basis.
Thus, for example, if for its 1985 taxable year a small FSC has a short
taxable year of 73 days, then in determining exempt foreign trade
income, any foreign trading gross receipts that exceed $1 million (73/
365 x $5 million) will not be taken into account.
(6) Change of accounting period.
Q-6: If the principal shareholder of a FSC, a small FSC, or an
interest charge DISC (hereinafter referred to as a ``FSC'') changes its
annual accounting period or is replaced by a new principal shareholder
during a taxable year, is it necessary for the FSC to change its annual
accounting period?
A-6: If the principal shareholder changes its annual accounting
period, the FSC must also change its annual accounting period to conform
to that of its principal shareholder. If the voting power of the
principal shareholder is reduced by an amount equal to at least 10
percent of the total shares entitled to vote and such shareholder is no
longer the principal shareholder, the FSC must conform its accounting
period to that of its new principal shareholder. However, in determining
whether a shareholder is a principal shareholder, the voting power of
the shareholders is determined as of the beginning of the FSC's taxable
year. Thus, for example, assume that for 1985 a FSC adopts a calendar
year period as its annual accounting period to conform to that of its
principal shareholder. Assume further than in March 1985 there is a 10
percent change in voting power and a different shareholder whose annual
accounting period begins on July 1 becomes the new principal
shareholder. The FSC will not be required to adopt the annual accounting
period of its new principal shareholder until July 1, 1986. The FSC will
have a short taxable year for the period January 1 to June 30, 1986.
(7) Transition transfers.
Q-7. Under what circumstances may a DISC or former DISC transfer its
assets to a FSC or small FSC without incurring any tax liability on the
transfer?
A-7. A DISC or former DISC will recognize no income, gain, or loss
on a transfer of its qualified assets (as defined in section 993(b)) to
a FSC or small FSC if all of the following conditions are met:
(i) The assets transferred were held by the DISC on August 4, 1983,
and were transferred by the DISC or former DISC to the FSC or small FSC
in a transfer completed before January 1, 1986; and
(ii) The assets are transferred in a transaction which would qualify
for nonrecognition under subchapter C of chapter 1 of the Code, or would
so qualify but for section 367 of the Code.
In such case, section 367 shall not apply to the transfer.
In addition, other provisions of subchapter C will apply to the
transfer, such as section 358 (basis to shareholders), section 362
(basis to corporations), and section 381 (carryovers in corporate
acquisitions). In determining whether a transfer by a DISC to a FSC or
small FSC qualifies for nonrecognition under subchapter C, a liquidation
of the assets of the DISC into a parent corporation followed by a
transfer by the parent of those assets to the FSC or small FSC will be
treated as a transaction described in section 368(a)(1)(D).
Notwithstanding the foregoing answer, a taxpayer which transfers a
right to use its corporate name to a FSC in a transaction described in
sections 332, 351, 354, 356 and 361 shall not be treated as having sold
that right under section 367(d) or as having transferred that right to
an entity that is not a corporation under section 367(a) provided that
the corporate name is used only by the FSC and is not licensed or
otherwise made available to others by the FSC.
(8) Completed contract method.
Q-8: Under what conditions is a taxpayer using the completed
contract method of accounting as defined in Sec. 1.451-3(d) exempted
from satisfying the foreign management and foreign economic process
requirements of subsections (c) and (d) of section 924?
A-8: If the taxpayer has entered into a binding contract before
March 16, 1984, or has on March 15, 1984, and at all times thereafter a
firm plan, evidenced in writing, to enter the contract and
[[Page 37]]
enters into a binding contract by December 31, 1984, then the taxpayer
will be treated as having satisfied the foreign management tests of
section 924(c) for periods before December 31, 1984, and the foreign
economic process tests of section 924(d) with respect to costs incurred
before December 31, 1984, with respect to the transaction. The FSC rules
will apply to the income from the long-term contract if an election is
made and the general FSC requirements under section 922 are satisfied.
However, such taxpayer need not satisfy the activities test under
section 925(c) for activities which occur before January 1, 1985 in
order to use the transfer pricing rules under section 925.
(9) Long-term contract--before March 15, 1984.
Q-9: Under what conditions is a taxpayer who enters into a binding
long-term contract (i.e., a contract which is not completed in the
taxable year in which it is entered into) before March 15, 1984, but
does not use the completed contract method of accounting exempted from
satisfying the foreign management and economic process requirements of
subsections (c) and (d) of section 924?
A-9: If a taxpayer enters into a binding contract before March 15,
1984, the taxpayer will be treated as having satisfied the foreign
management tests of section 924(c) for periods before December 31, 1984,
and the foreign economic process tests of section 924(d) with respect to
costs incurred before December 31, 1984, but only with respect to income
attributable to such contracts that is recognized before December 31,
1986. The FSC rules will apply to the income from the long-term contract
if an election is made and the general FSC requirements under section
922 are satisfied. However, such taxpayer need not satisfy the
activities test under section 925(c) for activities which occur before
January 1, 1985, in order to use the transfer pricing rules under
section 925.
(10) Long-term contract--after March 15, 1984.
Q-10: Under what conditions is a taxpayer who has a long-term
contract (i.e., a contract which is not completed in the taxable year in
which it is entered into) but does not use the completed contract method
of accounting exempted from satisfying the foreign management and
economic process requirements of subsections (c) and (d) of section 924
if such taxpayer enters into a binding contract after March 15, 1984 and
before January 1, 1985?
A-10: If a taxpayer enters into a contract after March 15, 1984, and
before January 1, 1985, the taxpayer will be treated as having satisfied
the foreign management tests of section 924(c) for periods before
December 31, 1984, and the foreign economic process tests of section
924(d) with respect to costs incurred before December 31, 1984, but only
with respect to income attributable to such contract that is recognized
before December 31, 1985.
The FSC rules will apply to the income from the long-term contract
if an election is made and the general requirements under section 922
are satisfied. However, such taxpayer need not satisfy the activities
test under section 925(c) for activities which occur before January 1,
1985 in order to use the transfer pricing rules under section 925.
(11) Incomplete transactions.
Q-11: In computing its foreign trade income, how should a FSC treat
transfers of export property from a related supplier to a DISC which is
subsequently resold by a FSC after the DISC's termination?
A-11: In applying the gross receipts and combined taxable income
methods under section 925 (a)(1) and (a)(2), the transaction is treated
as if the transfer of export property were made by the related supplier
to the FSC except that the foreign management and economic processes
tests under section 924 and the activities test under section 925(c)
shall be deemed to be satisfied for purposes of the transaction.
(12) Pre-effective date costs and activities.
Q-12: Are costs incurred and activities performed prior to January
1, 1985 taken into account for purposes of satisfying the foreign
management and foreign economic processes requirements of subsections
(c) and (d) of section 924 and the activities test under section 925(c)?
A-12: For purposes of determining the costs incurred and the
activities performed to be taken into account with
[[Page 38]]
respect to contracts entered into after December 31, 1984, only those
costs incurred and activities performed after December 31, 1984, are
taken into consideration. Costs incurred and activities performed by a
related supplier prior to January 1, 1985 (or prior to the effective
date of a corporation's election to be treated as a FSC if other than
January 1, 1985) with respect to transactions occurring after January 1,
1985 (or after the effective date of a corporation's election to be
treated as a FSC) need not be taken into account for purposes of
computing the FSC's profit under section 925 but are treated for section
925(c) purposes as if they were performed on behalf of the FSC.
(13) FSC and interest charge DISC.
Q-13: Can a FSC and an interest charge DISC be members of the same
controlled group?
A-13: A FSC and an interest charge DISC cannot be members of the
same controlled group. If any controlled group of corporations of which
an interest charge DISC is a member establishes a FSC, then any interest
charge DISC which is a member of such group shall be treated as having
terminated its status as an interest charge DISC.
(c) Export Trade Corporations--(1) Previously taxed income.
Q-1: Under what circumstances are earnings of an export trade
corporation that have not been included in income under section 951
treated as previously taxed income previously included in the income of
a U.S. shareholder for purposes of section 959 (and not taxed)?
A-1: A corporation which qualifies as an export trade corporation
(ETC) with respect to its last taxable year beginning before January 1,
1985, and elects to discontinue operations as an ETC for all taxable
years beginning after December 31, 1984, shall not be required to take
into income earnings attributable to previously excluded export trade
income, as defined in Sec. 1.970-1(b), derived with respect to taxable
years beginning before January 1, 1985. However, any amounts distributed
by the former ETC (i.e. a corporation which was an ETC for its last
taxable year beginning before January 1, 1985) shall be treated as being
made out of current earnings and profits and then out of previously
taxed income. For purposes of determining the shareholder's basis in the
ETC stock, distributions of previously excluded export trade income
shall be treated as if made out of previously taxed income which has
already been included in gross income under section 951(a)(1)(B). Thus,
no basis adjustment under section 961 is necessary. In addition, upon
the sale or exchange of the stock of such corporation in a transaction
described in section 1248(a), the earnings and profits of the
corporation attributable to such previously untaxed income shall not be
subject to section 1248(a).
(2) Qualification as an ETC for last year.
Q-2: Must an ETC satisfy all of the tests set forth in section
971(a)(1) for the ETC's last taxable year beginning before January 1,
1985?
A-2: All of the tests in section 971(a)(1) must be satisfied, except
that for purposes of the working capital requirements set forth in
section 971(c)(1), the working capital of the ETC at the close of its
last taxable year beginning before January 1, 1985 shall be deemed
reasonable.
(3) Continuation of ETC status.
Q-3: May a corporation which chooses to remain an ETC after December
31, 1984, continue to do so?
A-3: Yes. However, previously untaxed income of such ETC shall not
be treated as previously taxed income in accordance with Q&A 1
of this section.
(4) Discontinuation of ETC status.
Q-4: How does an ETC make an election to discontinue its operation
as an ETC?
A-4: The United States shareholders (as defined in section 951(b))
must file a statement of election on behalf of the ETC indicating the
intent of the ETC to discontinue operations as an ETC for taxable years
beginning after December 31, 1984. In addition, the statement of
election must include the name, address, taxpayer identification number
and stock interest of each United States shareholder. The statement must
also indicate that the corporation on behalf of which the shareholders
are making the election qualified as an ETC for its last taxable year
beginning before January 1, 1985, and
[[Page 39]]
also the amount of earnings attributable to previously excluded export
trade income. The statement must be jointly signed by each United States
shareholder with each shareholder stating under penalties of perjury
that he or she holds the stock interest specified for such shareholder
in the statement of election. A copy of the statement of election must
be attached to Form 5471 (information return with respect to a foreign
corporation) filed with respect to the ETC's last taxable year beginning
before January 1, 1985.
(5) Transition transfers.
Q-5: Under what circumstances may an electing ETC transfer its
assets to a FSC without incurring any tax liability on the transfer?
A-5: An electing ETC will recognize no income, gain, or loss on a
transfer of its assets to a FSC but only if all of the following
conditions are met:
(i) The assets transferred were held by the ETC on August 4, 1983,
and were transferred by the ETC to the FSC in a transfer completed
before January 1, 1986; and
(ii) The assets are transferred in a transaction which would qualify
for nonrecognition under subchapter C of chapter 1 of the Code, or would
so qualify but for section 367 of the Code.
In such case, section 367 shall not apply to the transfer. In
addition, other provisions of subchapter C will apply to the transfer
such as section 358 (basis to shareholders), section 362 (basis to
corporation) and section 381 (carryovers in corporate acquisitions). In
determining whether a transfer by an ETC to a FSC qualifies for
nonrecognition under subchapter C, a liquidation of the assets of the
ETC into a parent corporation followed by a transfer by the parent of
those assets to the FSC will be treated as a transaction described in
section 368(a)(1)(D).
(Secs. 803 and 805 of the Tax Reform Act of 1984 (98 Stat. 1001) and
sec. 7805 of the Internal Revenue Code of 1954 (68A Stat. 917; 26 U.S.C.
7805); sec. 805 (b)(3)(C) and (D) of the Tax Reform Act of 1984 (98
Stat. 1002), and sec. 7805 of the Code (68A Stat. 917; 26 U.S.C. 7805);
secs. 367, 927, and 7805 of the Internal Revenue Code of 1954 (98 Stat.
662, 26 U.S.C. 367; 98 Stat. 663, 26 U.S.C. 367; 98 Stat. 993, 26 U.S.C.
927; 98 Stat. 994, 26 U.S.C. 927; and 68A Stat. 917, 26 U.S.C. 7805);
sec. 805 of the Tax Reform Act of 1984 (Pub. L. 98-69, 98 Stat. 1000))
[T.D. 7983, 49 FR 40013, Oct. 12, 1984, as amended by T.D. 7992, 49 FR
48283, Dec. 12, 1984; T.D. 7993, 49 FR 48291, Dec. 12, 1984; T.D. 7992,
49 FR 49450, Dec. 20, 1984; T.D. 8126, 52 FR 6434, 6435, Mar. 3, 1987;
T.D. 8515, 59 FR 2984, Jan. 20, 1994; T.D. 8858, 65 FR 1237, Jan. 7,
2000; T.D. 8940, 66 FR 9929, Feb. 13, 2001]
Sec. 1.921-2 Foreign Sales Corporation--general rules.
(a) Definition of a FSC and the Effect of a FSC Election.
Q-1. What is the definition of a Foreign Sales Corporation
(hereinafter referred to as a ``FSC'' (All references to FSCs include
small FSCs unless indicated otherwise))?
A-1. As defined in section 922(a), an FSC must satisfy the following
eight requirements.
(i) The FSC must be a corporation organized or created under the
laws of a foreign country that meets the requirements of section
927(e)(3) (a ``qualifying foreign country'') or a U.S. possession other
than Puerto Rico (an ``eligible possession''). See Q&As 3, 4, and 5 of
Sec. 1.922-1.
(ii) A FSC may not have more than 25 shareholders at any time during
the taxable year. See Q&A 6 of Sec. 1.922-1.
(iii) A FSC may not have any preferred stock outstanding during the
taxable year. See Q&As 7 and 8 of Sec. 1.922-1.
(iv) A FSC must maintain an office outside of the United States in a
qualifying foreign country or an eligible possession and maintain a set
of permanent books of account (including invoices or summaries of
invoices) at such office. See Q&As 9, 10, 11, 12, 13, 14, and 15 of
Sec. 1.922-1.
(v) A FSC must maintain within the United States the records
required
[[Page 40]]
under section 6001. See Q&A 16 of Sec. 1.922-1.
(vi) The FSC must have a board of directors which includes at least
one individual who is not a resident of the United States at all times
during the taxable year. See Q&As 17, 18, 19, 20, and 21 of Sec. 1.922-
1.
(vii) A FSC may not be a member, at any time during the taxable
year, of any controlled group of corporations of which an interest
charge DISC is a member. See Q&A 2 of this section and Q&A 13, of Sec.
1.921-1T(b)(13).
(viii) A FSC must have made an election under section 927(f)(1)
which is in effect for the taxable year. See Q&A 1 of Sec. 1.921-
1T(b)(1) and Sec. 1.927(f)-1.
In addition, under section 441(h), the taxable year of a FSC must
conform to the taxable year of its principal shareholder. See Q&A 4 of
Sec. 1.921-1T(b)(4).
Q-2. Does the reference to a DISC under section 922(a)(1)(F) which
provides that a FSC cannot be a member, at any time during the taxable
year, of any controlled group of corporations of which a DISC is a
member refer solely to an interest charge DISC?
A-2. Yes.
(b) Small FSC.
Q-3. What is a small FSC?
A-3. A small FSC is a Foreign Sales Corporation which meets the
requirements of section 922(a)(1) enumerated in Q&A 1 of this section as
well as the requirements of section 922(b). Section 922(b) requires that
a small FSC make a separate election to be treated as a small FSC. See
Q&A 1 of Sec. 1.921-1T(b) and Sec. 1.927(f)-1. In addition, section
922(b) requires that the small FSC not be a member, at any time during
the taxable year, of a controlled group of corporations which includes a
FSC unless such FSC is a small FSC.
Q-4. What is the effect of an election as a small FSC?
A-4. Under section 924(b)(2), a small FSC need not meet the foreign
management and economic processes tests of section 924(b)(1) in order to
have foreign trading gross receipts. However, in determining the exempt
foreign trade income of a small FSC, any foreign trading gross receipts
for the taxable year in excess of $5 million are not taken into account.
If the foreign trading gross receipts of a small FSC for the taxable
year exceed the $5 million limitation, the FSC may select the gross
receipts to which the limitation is allocated. In order to use the
administrative pricing rules under section 925(a), a small FSC must
satisfy the activities test under section 925(c). In addition, under
section 441(h), the taxable year of a small FSC must conform to the
taxable year of its principal shareholder (defined in Q&A 4 of Sec.
1.921-1T(b)(4) as the shareholder with the highest percentage of its
voting power).
Q-5. What is the effect on a small FSC (or FSC) (``target'') if it
is acquired, directly or indirectly, by a corporation if that acquiring
corporation (``acquiring''), or a member of the acquiring corporation's
controlled group, is a FSC (or small FSC)?
A-5. Unless the corporations in the controlled group elect to
terminate the FSC (or small (FSC) election of the acquiring corporation,
the target's small FSC's (or FSC's) taxable year and election will
terminate as of the day preceding the date the target small FSC and
acquiring FSC became members of the same controlled group. The target
small FSC will receive FSC benefits for the period prior to termination,
but the $5 million small FSC limitation will be reduced to the amount
which bears the same ratio to the $5 million as the number of days in
the short year created by the termination bears to 365. The due date of
the income tax return for the short taxable year created by this
provision will be the date prescribed by section 6072(b), including
extensions, starting with the last day of the short taxable year. If the
short taxable year created by this provision ends prior to March 3,
1987, the filing date of the tax return for the short taxable year will
be automatically extended until the earlier of May 18, 1987 or the date
under section 6072 (b) assuming a short taxable year had not been
created by these regulations.
(c) Comparison of FSC to DISC.
Q-6. How does a FSC differ from a DISC?
A-6. A DISC is a domestic corporation which is not itself taxable
while a FSC must be created or organized under the laws of a
jurisdiction which is outside of the United States (including certain
U.S. possessions) and may
[[Page 41]]
be taxable on its income except for its exempt foreign trade income. The
DISC provisions enable a shareholder to obtain a partial deferral of tax
on income from export sales and certain services, if 95 percent of its
receipts and assets are export related. The FSC provisions contain no
assets test, but a portion of income for export sales and certain
services is exempt from U.S. taxes if the FSC satisfies certain foreign
presence, foreign management, and foreign economic processes tests.
(d) Organization of a FSC.
Q-7. Under the laws of what countries may a FSC be organized?
A-7. A FSC may not be created or organized under the laws of the
United States, a state, or other political subdivision. However, a FSC
may be created or organized under the laws of a possession of the United
States, including Guam. American Samoa, the Commonwealth of the Northern
Mariana Islands and the Virgin Islands of the United States, but not
Puerto Rico. These eligible possessions are located outside the U.S.
customs territory. In addition, a FSC may incorporate under the laws of
a foreign country that is a party to--
(i) An exchange of information agreement that meets the standards of
the Caribbean Basin Economic Recovery Act of 1983 (Code section
274(h)(6)(C)), or
(ii) A bilateral income tax treaty with the United States if the
Secretary certifies that the exchange of information program under the
treaty carries out the purpose of the exchange of information
requirements of the FSC legislation as set forth in section 927(e)(3),
if the company is covered under the exchange of information program
under subdivision (i) or (ii). The Secretary may terminate the
certification. Any termination by the Secretary will be effective six
months after the date of the publication of the notice of such
termination in the Federal Register.
(e) Foreign Trade Income.
Q-8. How is foreign trade income defined?
A-8. Foreign trade income, defined in section 923(b), is gross
income of an FSC attributable to foreign trading gross receipts. It
includes both the profits earned by the FSC itself from exports and
commissions earned by the FSC from products and services exported by
others.
(f) Investment Income and Carrying Charges.
Q-9. What do the terms ``investment income'' and ``carrying
charges'' mean?
A-9.
(i) Investment income means:
(A) Dividends,
(B) Interest,
(C) Royalties,
(D) Annuities,
(E) Rents (other than rents from the lease or rental of export
property for use by the lessee outside of the United States);
(F) Gains from the sale of stock or securities,
(G) Gains from future transactions in any commodity on, or subject
to the rules of, a board of trade or commodity exchange (other than
gains which arise out of a bona fide hedging transaction reasonably
necessary to conduct the business of the FSC in the manner in which such
business is customarily conducted by others),
(H) Amounts includable in computing the taxable income of the
corporation under part I of subchapter J, and
(I) Gains from the sale or other disposition of any interest in an
estate or trust.
(ii) Carrying charges means:
(A) Charges that are imposed by a FSC or a related supplier and that
are identified as carrying charges, (``stated carrying charges'') and
(B)(1) Charges that are considered to be included in the price of
the property or services sold by an FSC or a related supplier, as
provided under Q&As 1 and 2 of Sec. 1.927(d)-1, and
(2) Any other unstated interest.
Q-10. How are investment income and carrying charges treated?
A-10. Investment income and carrying charges are not foreign trading
gross receipts. Investment income and carrying charges are includable in
the taxable income of an FSC, except in the case of a commission FSC
where carrying charges are treated as income of the related supplier,
and are treated as income effectively connected with a trade or business
conducted through a permanent establishment within the
[[Page 42]]
United States. The source of investment income and carrying charges is
determined under sections 861, 862, and 863 of the Code.
(g) Small Businesses.
Q-11. What options are available to small businesses engaged in
exporting?
A-11. A small business may elect to be treated as either a small FSC
or an interest charge DISC. See Q&As 3 & 4 of Sec. 1.921-2 relating to
a small FSC. Rules with respect to interest charge DISCs are the subject
of another regulations project.
[T.D. 8127, 52 FR 6469, Mar. 3, 1987]
Sec. 1.921-3T Temporary regulations; Foreign sales corporation general
rules.
(a) Exclusion--(1) Classifications of income. The extent to which
income of a FSC (any further reference to a FSC in this section shall
include a small FSC unless indicated otherwise) is subject to the
corporate income tax of section 11, or, in the alternative, section
1201(a), is dependent upon the allocation of the FSC's income to the
following five categories:
(i) Exempt foreign trade income determined under section 923 and
Sec. 1.923-1T;
(ii) Non-exempt foreign trade income determined with regard to the
administrative pricing rules of section 925(a)(1) or (2);
(iii) Non-exempt foreign trade income determined without regard to
the administrative pricing rules of section 925(a)(1) or (2) (section
923(a)(2) non-exempt income as defined in section 927(d)(6));
(iv) Investment income and carrying charges; and
(v) Other non-foreign trade income.
(2) Source and characterization of FSC income--(i) Exempt foreign
trade income. The exempt foreign trade income of a FSC determined under
section 923 and Sec. 1.923-1T is treated as foreign source income which
is not effectively connected with a United States trade or business. See
Sec. 1.923-1T(a) for the definition of foreign trade income and Sec.
1.923-1T(b) for the definition of exempt foreign trade income.
(ii) Non-exempt foreign trade income determined with regard to the
administrative pricing rules. The FSC's non-exempt foreign trade income
with respect to a transaction or group of transactions will be treated
as United States source income which is effectively connected with the
FSC's trade or business which is conducted through its permanent
establishment within the United States if either of the administrative
pricing rules of section 925(a)(1) or (2) is used to determine the FSC's
foreign trade income from a transaction or group of transactions. See
Sec. 1.923-1T(b) for the definition of non-exempt foreign trade income.
(iii) Non-exempt foreign trade income determined without regard to
the administrative pricing rules. The source and taxation of the FSC's
non-exempt foreign trade income not classified in paragraph (a)(2)(ii)
of this section will be determined under the appropriate sections of the
Internal Revenue Code and the regulations under those sections. This
type of income (section 923(a)(2) non-exempt income) includes both
income that is not effectively connected with the conduct of a trade or
business in the United States and income that is effectively connected.
(iv) Investment income and carrying charges. All of the FSC's
investment income and carrying charges will be treated as income which
is effectively connected with the FSC's trade or business which is
conducted through its permanent establishment within the United States.
The source of that income will be determined under the appropriate
sections of the Internal Revenue Code and the regulations under those
sections. See Sec. 1.921-2(f) (Q & A9) for definition of investment
income and carrying charges.
(v) Non-foreign trade income (other than investment income and
carrying charges). The source and taxation of the FSC's non-foreign
trade income (other than investment income and carrying charges) will be
determined under the appropriate sections of the Internal Revenue Code
and the regulations under those sections.
(b) Allocation and apportionment of deductions. Expenses, losses and
deductions incurred by the FSC shall be allocated and apportioned under
the rules set forth in Sec. 1.861-8 to the FSC's foreign trade income
and to the FSC's
[[Page 43]]
non-foreign trade income. Any deductions incurred by the FSC on a
transaction, or group of transactions, which are allocated and
apportioned to the FSC's foreign trade income from that transaction, or
group of transactions, shall be allocated on a proportionate basis
between exempt foreign trade income and non-exempt foreign trade income.
(c) Net operating losses and capital losses--(1) General rule. (i)
If a FSC for any taxable year incurs a deficit in earnings and profits
attributable to foreign trade income determined without regard to the
administrative pricing rules of section 925(a)(1) or (2), that deficit
shall be applied to reduce current earnings and profits, if any,
attributable to--
(A) First, exempt foreign trade income determined with regard to the
administrative pricing rules,
(B) Second, non-exempt foreign trade income determined with regard
to the administrative pricing rules,
(C) Third, investment income and carrying charges, and
(D) Fourth, other non-foreign trade income.
(ii) If a FSC for any taxable year incurs a deficit in earnings and
profits attributable to non-foreign trade income (other than investment
income, carrying charges and net capital losses), that deficit shall be
applied to reduce current earnings and profits, if any, attributable
to--
(A) First, investment income and carrying charges,
(B) Second, exempt foreign trade income determined with regard to
the administrative pricing rules,
(C) Third, exempt foreign trade income determined without regard to
the administrative pricing rules,
(D) Fourth, non-exempt foreign trade income determined with regard
to the administrative pricing rules, and
(E) Fifth, section 923(a)(2) non-exempt income.
(iii) If a FSC for any taxable year incurs a deficit in earnings and
profits attributable to investment income and carrying charges, that
deficit shall be applied to reduce current earnings and profits, if any,
attributable to--
(A) First, non-foreign trade income other than capital gains,
(B) Second, exempt foreign trade income determined with regard to
the administrative pricing rules,
(C) Third, exempt foreign trade income determined without regard to
the administrative pricing rules,
(D) Fourth, non-exempt foreign trade income determined with regard
to the administrative pricing rules, and
(E) Fifth, section 923(a)(2) non-exempt income.
(iv) Net capital losses will be available for carryback or carryover
pursuant to paragraph (c)(2) of this section.
(v) Because the no-loss rules provide that a related supplier may
always compensate the FSC for its expenses either as part of the
commission payment or as part of the transfer price if the
administrative pricing rules are used (see Sec. 1.925(a)-1T(e)(1)(i)),
a FSC will not have a deficit in its earnings and profits relating to
foreign trade income determined with regard to the administrative
pricing rules. To determine the amount of any division of earnings and
profits for the purpose of determining under Sec. 1.926(a)-1T (a) and
(b) the treatment and order of distributions, the portion of a deficit
in earnings and profits chargeable under this paragraph to such division
prior to such distribution shall be determined in a manner consistent
with the rules in Sec. 1.316-2(b) for determining the amount of
earnings and profits available on the date of any distribution.
(2) Carryback or carryover of net operating losses and capital
losses to other taxable years of a FSC (or former FSC). (i) The amount
of the deduction for the taxable year under section 172 for a net
operating loss carryback or carryover, or under section 1212 for a
capital loss carryback or carryover, shall be determined in the same
manner as if the FSC were a foreign corporation which had not elected to
be treated as a FSC. Thus, the amount of the deduction will be the same
whether or not the corporation was a FSC in the year of the loss or in
the year to which the loss is carried.
(ii) Any carryback or carryover of a FSC's (or former FSC's) net
operating loss which is attributable to transactions which give rise to
foreign trade income shall be charged--
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(A) First, to earnings and profits attributable to exempt foreign
trade income which is determined without regard to the administrative
pricing rules,
(B) Second, to earnings and profits attributable to section
923(a)(2) non-exempt income,
(C) Third, to earnings and profits attributable to exempt foreign
trade income determined with regard to the administrative pricing rules,
(D) Fourth, to earnings and profits attributable to non-exempt
foreign trade income determined with regard to the administrative
pricing rules,
(E) Fifth, to earnings and profits attributable to investment income
and carrying charges (other than capital gain income), and
(F) Sixth, to earnings and profits attributable to non-foreign trade
income (other than investment income, carrying charges and capital gain
income).
(iii) Any carryback or carryover of a FSC's (or former FSC's) net
operating loss which is attributable to non-foreign trade income (other
than capital gain income) shall be charged--
(A) First, to earnings and profits attributable to non-foreign trade
income (other than investment income, carrying charges and capital gain
income),
(B) Second, to earnings and profits attributable to investment
income and carrying charges,
(C) Third, to earnings and profits attributable to exempt foreign
trade income determined with regard to the administrative pricing rules,
(D) Fourth, to earnings and profits attributable to non-exempt
foreign trade income determined with regard to the administrative
pricing rules,
(E) Fifth, to earnings and profits attributable to exempt foreign
trade income which is determined without regard to the administrative
pricing rules, and
(F) Sixth, to earnings and profits attributable to section 923(a)(2)
non-exempt income.
(iv) Any carryback or carryover of a net operating loss to a year in
which the corporation was (or is) a FSC from a taxable year in which the
corporation was not a FSC shall be applied in a manner consistent with
subdivision (iii) of this paragraph.
(d) Credits against tax--(1) General rule. Notwithstanding any other
provision of chapter 1, subtitle A, a FSC is allowed under section
921(c) as credits against tax only the following credits:
(i) The foreign tax credit, section 27(a);
(ii) The credit for tax withheld at source on foreign corporations,
section 33; and
(iii) The certain uses of gasoline and special fuels credit, section
34.
(2) Foreign tax credit. (i) The direct foreign tax credit of section
901(b)(4) as determined under section 906 for income, war profits, and
excess profits taxes (or taxes in lieu thereof) paid or accrued to any
foreign country or possession of the United States is allowed a FSC only
to the extent that those taxes are attributable to the FSC's foreign
source non-foreign trade income which is effectively connected with its
conduct of a trade or business within the United States. See section
906(b)(5).
(ii) The foreign tax credit for domestic corporate shareholders in
foreign corporations (the deemed paid credit) provided under section
901(a) as determined under section 902 is allowed for income, war
profits, and excess profits taxes deemed paid or accrued by a FSC (or
former FSC) only to the extent those taxes are deemed paid or accrued
with respect to the FSC's (or former FSC's) section 923(a)(2) non-exempt
income and its non-foreign trade income.
(iii) The foreign tax credit allowed by sections 901 and 903 for tax
withheld at source is allowed only to the extent the dividends paid to
the FSC's (or former FSC's) shareholder are attributable to the FSC's
(or former FSC's) section 923(a)(2) non-exempt income and its non-
foreign trade income.
(3) Foreign tax credit limitation. (i) For purposes of computation
of the direct foreign tax credit of section 901(b)(4) as determined
under section 906, the separate limitation of section 904(d)(1)(C) for
the FSC's taxable income attributable to its foreign trade income will
apply. The direct foreign tax credit is not allowed to a FSC with regard
to taxes it paid which are attributable to its foreign trade income.
Since the foreign tax credit is not allowed for that type of income, the
effect of the separate limitation is to remove the FSC's
[[Page 45]]
foreign trade income from the numerator of the fraction used to compute
the FSC's overall foreign tax credit limitation.
(ii) A separate limitation under section 904(d)(1)(D) is provided
for distributions from a FSC (or former FSC) that arise through
operation of the deemed paid credit of section 902 and are attributable
to foreign trade income earned during the period when the distributing
corporation was a FSC. This limitation is computed by multiplying the
FSC's shareholder's tentative United States tax by a fraction the
numerator of which is the foreign source dividend (determined with
regard to section 78) attributable to the foreign trade income less
dividends received deductions and other expenses allocated and
apportioned under Sec. 1.861-8 allowed to the shareholder and the
denominator of which is the shareholder's worldwide income. The effect
of this separate limitation is to remove dividends attributable to the
FSC's foreign trade income from the numerator of the fraction used to
compute the overall foreign tax credit limitation of the FSC's
shareholder.
(iii) The separate limitation under section 904(d)(1)(D) also
applies to the foreign tax credit allowed to a FSC shareholder by
sections 901 and 903 for tax withheld at source on dividends paid by the
FSC. The numerator of this fraction is the part of the dividend
attributable to the FSC's foreign trade income and the denominator is
the shareholder's worldwide income. The effect of this separate
limitation is to remove dividends attributable to foreign trade income
of a FSC (or former FSC) from the numerator of the fraction used to
compute the overall foreign tax credit limitation of the FSC's
shareholder.
(e) Deduction for foreign income, war profits and excess profits
taxes. Under section 275(a)(4)(B), income, war profits and excess
profits taxes imposed by a foreign country or possession of the United
States may not be deducted by a FSC to the extent those taxes are paid
or accrued with respect to its foreign trade income.
(f) Payment of estimated tax. Every FSC which is subject to tax
under section 11 or 1201(a) and section 882 must make payment of its
estimated tax in accordance with section 6154 and the regulations under
that section. In determining the amount of the estimated tax, the FSC
must treat the tax imposed by section 881 as though it were a tax
imposed by section 11. See section 6154(g).
(g) Accumulated earnings, personal holding company and foreign
personal holding company. The provisions covering the accumulated
earnings tax (sections 531 through 537), personal holding companies
(sections 541 through 547) and foreign personal holding companies
(sections 551 through 558) apply to FSCs to the extent they would apply
to foreign corporations that are not FSCs.
(h) Subpart F income and increase of earnings invested in U.S.
property. For the mandatory inclusion in the gross income of the U.S.
shareholders of the subpart F income and of the increase in earnings
invested in U.S. property of a FSC, see sections 951 through 964 and the
regulations under those sections. However, the foreign trade income
(other than section 923(a)(2) non-exempt income) and, generally, the
investment income and carrying charges of a FSC and any deductions which
are allocated and apportioned to those classes of income, are not taken
into account under sections 951 through 964. See sections 951(e) and
952(b).
(i) Certain accumulations of earnings and profits. For the inclusion
in the gross income of U.S. persons as a dividend on the gain recognized
on certain sales or exchanges of stock in a FSC, to the extent of
certain earnings and profits attributable to the stock which were
accumulated while the FSC was a controlled foreign corporation, see
section 1248 and the regulations under that section. However, section
1248 and the regulations under that section do not apply to a FSC's
earnings and profits attributable to foreign trade income, see section
1248(d)(6).
(j) Limitations on certain multiple tax benefits. The provisions of
section 1561, Limitations on Certain Multiple Tax Benefits in the Case
of Certain Controlled Corporations, and section 1563, Definitions and
Special Rules, and the
[[Page 46]]
regulations under those sections apply to a FSC and its controlled
group.
[T.D. 8126, 52 FR 6435, Mar. 3, 1987]
Sec. 1.922-1 Requirements that a corporation must satisfy to be a FSC
or a small FSC.
(a) FSC requirements.
Q-1. What are the requirements that a corporation must satisfy to be
an FSC?
A-1. A corporation must satisfy all of the requirements of section
922(a).
(b) Small FSC requirements.
Q-2. What are the requirements that a corporation must satisfy to be
a small FSC?
A-2. A corporation must satisfy all of the requirements of sections
922(a)(1) and (b).
(c) Definition of corporation.
Q-3. What type of entity is considered a corporation for purposes of
qualifying as an FSC or a small FSC under section 922?
A-3. A foreign entity that is classified as a corporation under
section 7701(a)(3) (other than an insurance company) is considered a
corporation for purposes of this requirement.
(d) Eligible possession.
Q-4. For purposes of meeting the place of incorporation requirement
of section 922(a)(1)(A), what is a possession of the United States?
A-4. For purposes of section 922(a)(1)(A), the possessions of the
United States are Guam, American Samoa, the Commonwealth of the Northern
Mariana Islands, and the Virgin Islands of the United States (``eligible
possessions''). Puerto Rico, although a possession for certain tax
purposes, does not qualify as a jurisdiction in which a FSC or small FSC
may be incorporated.
(e) Qualifying countries.
Q-5. For purposes of meeting the place of incorporation requirement
of section 922(a)(1)(A), what is a foreign country and which foreign
countries meet the requirements of section 927(e)(3)?
A-5. (i) A foreign country is a jurisdiction outside the 50 states,
the District of Columbia, the Commonwealth of Puerto Rico, and the
possessions of the United States. (ii) A list of the foreign countries
that meet the requirements of section 927(e)(3) (''qualifying
countries'') will be published from time to time in the Federal Register
and the Internal Revenue Bulletin. A corporation is considered to be
created or organized under the laws of a foreign country that meets the
requirements of section 927(e)(3) only if the foreign country is a party
to (A) an exchange of information agreement under the Caribbean Basin
Economic Recovery Act (Code section 274(h)((6)(C)), or (B) a bilateral
income tax treaty with the United States if the Secretary certifies that
the exchange of information program under the treaty carries out the
purposes of the exchange of information requirements of the FSC
legislation as set forth in Code section 927(e)(3) and if the
corporation is covered under exchange of information program under
subdivision (A) or (B).
(f) Number of shareholders.
Q-6. Who is counted as a shareholder of a corporation for purposes
of determining whether a corporation meets the limitation on the number
of shareholders to no more than 25 under section 922(a)(1)(B)?
A-6. Solely for purposes of the limitation on the number of
shareholders, the following rules apply:
(i) In general, an individual who owns an interest in stock of the
corporation is counted as a shareholder. In the case of joint owners,
each joint owner is counted as a shareholder. A member of a
corporation's board of directors who holds qualifying shares that are
required to be owned by a resident of the country of incorporation is
not counted as a shareholder.
(ii) A corporation that owns an interest in stock of the corporation
is counted as a single shareholder.
(iii) An estate that owns an interest in stock of the corporation is
counted as a single shareholder. If the limitation on number of
shareholders is not satisfied by reason of the closing of an estate, the
FSC will continue to qualify for the taxable year of the FSC in which
the estate is closed.
(iv) A trust is not counted as a shareholder. In the case of a trust
all of which is treated as owned by one or more persons under sections
671 through 679, those persons are counted as shareholders. In the case
of all other
[[Page 47]]
trusts, a beneficiary is counted as a shareholder.
(v) A partnership is not counted as a shareholder. A general or
limited partner is counted as a shareholder if it is a corporation, an
individual, or an estate, under the rules contained in subdivisions (i)
through (iii). A general or limited partner is not counted as a
shareholder if it is a partnership or a trust; the rules contained in
subdivision (iv) and this subdivision (v) apply to the determination of
who is counted as a shareholder.
(g) Class of stock.
Q-7. What is preferred stock for purposes of determining whether a
corporation satisfies the requirement under section 922(a)(1)(C) that no
preferred stock be outstanding?
A-7. Preferred stock is stock that is limited and preferred as to
dividends or distributions in liquidation.
Q-8. Can a corporation have outstanding more than one class of
common stock?
A-8. Yes. However, the rights of a class of stock will be
disregarded if the right has the effect of avoidance of Federal income
tax. For instance, dividend rights may not be used to direct dividends
from exempt foreign trade income to shareholders that have taxable
income and to direct other dividends to shareholders that have met
operating loss carryovers.
(h) Office.
Q-9. What is an office for purposes of determining whether a
corporation satisfies the requirement of section 922(a)(1)(D)(i)?
A-9. An office is a place for the transaction of the business of the
corporation. To be an office a place must meet all of the following
requirements;
(i) It must have a fixed location. A transient location is not a
fixed location.
(ii) It must be a building or a portion of a building consisting of
at least one room. A room is a partitioned part of the inside of a
building. The building or portion thereof used as the corporation's
office must be large enough to accommodate the equipment required in
subdivison (iii) of this answer 9 and the activity required in
subdivision (iv) of this answer 9. However, an office is not limited to
a room with communication equipment or an adjacent room. Non-contiguous
space within the same building will also constitute an office if it is
equipped for the retention of the documentation required to be stored by
the FSC and if access to the necessary communication equipment is
available for use by the FSC.
(iii) It must be equipped for the performance of the corporation's
business. An office must be equipped for the communication and retention
of information and must be supplied with communication services.
(iv) It must be regularly used for some business activity of the
corporation. A corporation's business activities must include the
maintenance of the documentation described in Q&A 12 of this section.
These documents need not be prepared at the office. Any person, whether
or not related to the corporation, may perform the business activities
of the corporation at the office if the activity is performed pursuant
to a contract, oral or written, for the performance of the activity on
behalf of the corporation.
(v) It must be operated, and owned or leased, by the corporation or
by a person, whether or not related to the corporation, under contract
to the corporation.
(vi) It must be maintained by the corporation or by a person,
whether or not related, to the corporation, under contract to the
corporation at all times during the taxable year. In the case of a
corporation newly organized as a FSC, thirty days may elapse between the
time the corporation is organized as a FSC (i.e., the first day for
which the FSC election is effective) and the time an office is
maintained by the corporation or a person under contract with the
corporation. A place that meets the requirements in subdivision (i)
through (vi) of this answer 9 can also be used for activities that are
unrelated to the business activity of the corporation.
Q-10 Can a corporation locate an office in any foreign country if it
has at least one office in a U.S. possession or in a foreign country
that meets the requirements of section 927 (e)(3) as provided Q&A 5 of
this section?
A-10. Yes.
Q-11. Must a corporation locate the office that is required under
section
[[Page 48]]
922(a)(1)(D)(i) in the country or possession of its incorporation?
A-11. No.
(i) Documentation.
Q-12. What documentation must be maintained at the corporation's
office for purposes of section 922(a)(1)(D)(ii)?
A-12. At least the following documentation must be maintained at the
corporation's office under section 922(a)(1)(D)(ii):
(i) The quarterly income statements, a final year-end income
statement and a year-end balance sheet of the FSC; and
(ii) All final invoices (or a summary of them) or statements of
account with respect to (A) sales by the FSC, and (B) sales by a related
person if the FSC realizes income with respect to such sales. A final
invoice is an invoice upon which payment is made by the customer. A
invoice must contain, at a minimum, the customer's name or idenfitying
number and, with respect to the transaction or transactions, the date,
product or product code or service of service code, quantity, price, and
amount due. In the alternative, a document will be acceptable as a final
invoice even though it does not include all of the above listed
information if the FSC establishes that the document is considered to be
a final invoice under normal commercial practices. An invoice forwarded
to the customer after payment has been tendered or received pursuant to
a letter of credit, as a receipt for payment, satisfies this definition.
A single final invoice may cover more than one transaction with a
customer.
(iii) A summary of final invoices may be in any reasonable form
provided that the summary contains all substantive information from the
invoices. All substantive information includes the customer's name or
identifying number, the invoice number, date, product or product code,
and amount owed. In the alternative, all substantive information
includes a summary of the information that is included on documents
considered to be final invoices under normal commercial practice. A
statement of account is any summary statement forwarded to a customer to
inform of, or confirm, the status of transactions occurring within an
accounting period during a taxable year that is not less than one month.
A statement of account must contain, at a minimum, the customer's name
or identifying number, date of the statement of account and the balance
due (even if the balance due is zero) as of the last day of the
accounting period covered by the statement of account. In the
alternative, a document will be accepted as a statement of account even
though it does not include all of the above listed information if the
FSC establishes that the document is considered a statement of account
under normal commercial practice. For these purposes, a document will be
considered to be a statement of account under normal commercial practice
if it is sent to domestic as well as to export customers in order to
inform the customers of the status of transactions during an accounting
period. With regard to quarterly income statements, a reasonable
estimate of the FSC's income and expense items will be acceptable. If
the FSC is a commission FSC, 1.83% of the related supplier's gross
receipts will be considered a reasonable estimate of the FSC's income.
The documents required by this Q&A 12 need not be prepared by the FSC.
In addition they need not be prepared at the FSC's office.
(iv) The FSC will satisfy the requirement that the documents be
maintained at its office even if not all final invoices (or summaries)
or statements of account or items to be included on statements of
account are maintained at its office as long as it makes a good faith
effort to do so and provided that any failure to maintain the required
documents is cured within a reasonable time of discovery of the failure.
Q-13. If the required documents are not prepared at the FSC's
office, by what date must the documents be maintained at its office?
A-13. With regard to the applicable quarters of years prior to March
3, 1987, the quarterly income statements, final invoices (or summaries),
or statements of account and the year-end balance sheet must be
maintained at the FSC's office no later than the due date, including
extensions, of the FSC tax return for the applicable taxable year in
which the period ends. With regard to
[[Page 49]]
the applicable quarters or years ending after March 3, 1987, the
quarterly income statements for the first three quarters of the FSC year
must be maintained at the FSC's office no later than 90 days after the
end of the quarter. The quarterly income statement for the fourth
quarter of the FSC year, the final year-end income statement, the year-
end balance sheet, and the final invoices (or summaries) or statements
of account must be maintained at the FSC's office no later than the due
date, including extensions, of the FSC tax return for the applicable
taxable year.
Q-14. In what form must the documentation required under section
922(a)(1)(D)(ii) be maintained?
A-14. The documentation required to be maintained by the office may
be originals or duplicates and may be in any form that qualifies as a
record under Rev. Rul. 71-20, 1971-1 C.B. 392. Therefore, documentation
may be maintained in the form of punch cards, magnetic tapes, disks, and
other machine-sensible media used for recording, consolidating, and
summarizing accounting transactions and records within a taxpayer's
automatic data processing system. The corporation need not maintain at
its office equipment capable of reading the machine-sensible media. That
equipment, however, must be situated in a location that is readily
accessible to the corporation. The equipment need not be owned by the
corporation.
Q-15. How long must the documentation required under section
922(a)(1)(D)(ii) be maintained?
A-15. The documentation required under section 922(a)(1)(D)(ii) for
a taxable year must be maintained at the FSC's office described in
section 922(a)(1)(D)(i) until the period of limitations for assessment
of tax for the taxable year has expired under section 6501.
Q-16. Under what circumstances will a coporation be considered to
satisfy the requirement of section 922(a)(1)(D)(iii) that it maintain
the records it is required to keep under section 6001 at a location
within the United States?
A-16. A corporation will be considered to satify this requirement if
the records required under section 6001 are kept by any person at any
location in the United States provided that the records are retained in
accordance with section 6001 and the regulations thereunder.
(j) Board of directors.
Q-17. What is a corporation's ``board of directors'' for purposes of
the requirement under section 922(a)(1)(E) that, at all times during the
taxable year, the corporation must have a board of directors which
includes at least one individual who is not a resident of the United
States?
A-17. The ``board of directors'' is the body that manages and
directs the corporation according to the law of the qualifying country
or eligible possession under the laws of which the corporation was
created or organized.
Q-18. Can the member of the board of directors who is a nonresident
of the United States be a citizen of the United States?
A-18. Yes. For purposes of meeting the requirement under section
922(a)(1)(E), the member of the board who cannot be a United States
resident can be a United States citizen. The principles of section
7701(b) shall be used to determine whether a United States citizen is a
United States resident.
Q-19. If the only member of the board of directors who is not a
resident of the United States dies, or resigns, is removed from the
board or becomes a resident of the United States will the corporation be
considered to fail the requirement under section 922(a)(1)(E)?
A-19. If the corporation appoints a new member who is a nonresident
of the United States to the board within 30 days after the death,
resignation or removal of the former nonresident member, the corporation
will be considered to satisfy the requirement under section
922(a)(1)(E). Also, the corporation will be considered to satisfy the
requirement under section 922(a)(1)(E) if the corporation appoints a new
member who is a nonresident of the United States to the board within 30
days after the corporation has knowledge, or reason to know, that the
board's former nonresident member was in fact a resident of the United
States.
[[Page 50]]
Q-20. Is a nonresident alien individual who elects to be treated as
a resident of the United States for a taxable year under section 6013(g)
considered a nonresident of the United States for purposes of the
requirement under section 922(a)(1)(E)?
A-20. Yes.
Q-21. Will the requirement that a FSC's board of directors have a
nonresident member at all times during the taxable year be satisfied if
the nonresident member is elected or appointed to the board of directors
no later than 30 days after the first day for which the FSC election is
effective?
A-21. Yes.
[T.D. 8127, 52 FR 6470, Mar. 3, 1987]
Sec. 1.923-1T Temporary regulations; exempt foreign trade income.
(a) Foreign trade income. Foreign trade income of a FSC is the FSC's
gross income attributable to its foreign trading gross receipts. (Any
further reference to a FSC in this section shall include a small FSC
unless indicated otherwise.) If the FSC is the principal on the sale of
export property which it purchased from a related supplier, the FSC's
gross income is determined by subtracting from its foreign trading gross
receipts the transfer price determined under the transfer pricing
methods of section 925(a). If the FSC is the commission agent on the
sale of export property by its related supplier, the FSC's gross income
is the commission paid or payable by the related supplier to the FSC
with respect to the transactions that would have generated foreign
trading gross receipts had the FSC been the principal on the
transaction. See Sec. 1.925(a)-1T(f) Examples 1 and 6 for illustrations
of the computation of a FSC's foreign trade income, exempt foreign trade
income and taxable income.
(b) Exempt foreign trade income--(1) Determination. (i) If a FSC
uses either of the two administrative pricing rules, provided for by
sections 925(a)(1) and (2), to determine its income from a transaction,
or group of transactions, to which section 925 applies (see Sec.
1.925(a)-1T(b)(2) (ii) and (iii)), 15/23 of the foreign trade income
that it earns from the transaction, or group of transactions, will be
exempt foreign trade income. If a FSC has a non-corporate shareholder
(shareholders), 16/23 of its foreign trade income attributable to the
noncorporate shareholder's (shareholders') proportionate interest in the
FSC will be exempt foreign trade income. See section 291(a)(4).
(ii) If a FSC does not use the administrative pricing rules to
determine its income from a transaction, or group of transactions, which
gives rise to foreign trade income, 30 percent of its foreign trade
income will be exempt foreign trade income. If a FSC has a non-corporate
shareholder (shareholders), 32 percent of its foreign trade income
attributable to the non-corporate shareholder's (shareholders')
proportionate interest in the FSC will be exempt foreign trade income.
See section 291(a)(4).
(iii) Exempt foreign trade income so determined under subdivisions
(1)(i) and (ii) of this paragraph is treated as foreign source income
which is not effectively connected with the conduct of a trade or
business within the United States. See section 921(a).
(2) Special rule for foreign trade income allocable to a qualified
cooperative. (i) Pursuant to section 923(a)(4), if a qualified
cooperative is a shareholder of a FSC, the FSC's non-exempt foreign
trade income determined by use of either of the administrative pricing
methods of section 925(a)(1) or (2) which is allocable to the marketing
of agricultural or horticultural products, or the providing of related
services, for any taxable year will be treated as exempt foreign trade
income to the extent that it is distributed to the qualified cooperative
shareholder. A qualified cooperative is defined as any organization to
which chapter 1, subchapter T, part 1 of the Code applies. See section
1381(a).
(ii) This special rule of section 923(a)(4) shall apply only if the
distribution is made before the due date under section 6072(b),
including extensions, for filing the FSC's income tax return for that
year. Any distribution which satisfies this requirement will be treated
as made on the last day of the FSC's taxable year. In addition, this
special rule shall apply only if the income of the cooperative is based
on arm's length transactions between the
[[Page 51]]
cooperative and its members or patrons.
(iii) Income attributable to the marketing of agricultural or
horticultural products, or the providing of related services, shall be
allocated to the FSC shareholders on a per share basis. See Sec.
1.926(a)-1T(b) for ordering rules for distributions from a FSC.
(3) Special rule for military property. (i) Under section 923(a)(5),
the exempt foreign trade income of a FSC relating to the disposition of,
or services relating to, military property shall be equal to 50 percent
of the amount which, but for section 923(a)(5), would be treated as
exempt foreign trade income under section 923(a)(2) or (3). The foreign
trade income no longer treated as exempt because of this special rule of
section 923(a)(5) will remain income of the FSC and will be treated as
non-exempt foreign trade income.
(ii) The term ``military property'' is defined in section
995(b)(3)(B) and includes any property which is an arm, ammunition, or
implement of war designated in the munitions list published pursuant to
section 38 of the International Security Assistance and Arms Export
Control Act of 1976 (22 U.S.C. 2778) (which repealed and replaced the
Military Security Act of 1954).
[T.D. 8126, 52 FR 6438, Mar. 3, 1987]
Sec. 1.924(a)-1T Temporary regulations; definition of foreign trading
gross receipts.
(a) In general. The term ``foreign trading gross receipts'' means
any of the five amounts described in paragraphs (b) through (f) of this
section, except to the extent that any of the five amounts is an
excluded receipt within the meaning of paragraph (g) of this section.
These amounts will not be foreign trading gross receipts if the FSC is
not managed outside the United States, pursuant to section 924(c), or if
the economic processes with regard to a transaction, or group of
transactions, that are required of a FSC by section 924(d) do not take
place outside the United States. The requirement that these activities
take place outside the United States does not apply to a small FSC. The
activities required by sections 924 (c) and (d) may be performed either
by the FSC or by any person (whether or not related to the FSC) acting
under contract with the FSC for the performance of the required
activities. Sections 1.924(c)-1 and 1.924(d)-1 provide rules to
determine whether these requirements have been met. For purposes of this
section--
(1) FSC. All references to a FSC in this section mean a FSC, except
when the context indicates that such term means a corporation in the
process of meeting the conditions necessary for that corporation to
become a FSC. All references to a FSC in this section shall include a
small FSC unless indicated otherwise.
(2) Sale and lease. The term ``sale'' includes an exchange or other
disposition and the term ``lease'' includes a rental or a sublease. The
term ``license'' includes a sublicense. All rules under this section
applicable to leases of export property apply in the same manner to
licenses of export property. See Sec. 1.927(a)-1T(f)(3) for a
description of intangible property which cannot be export property.
(3) Gross receipts. The term ``gross receipts'' is defined by
section 927(b) and Sec. 1.927(b)-1T.
(4) Export property. The term ``export property'' is defined by
section 927(a) and Sec. 1.927(a)-1T.
(5) Controlled group. The term ``controlled group'' is defined by
paragraph (h) of this section.
(6) Related supplier and related party. The terms related supplier
and related party are defined by Sec. 1.927(d)-2T.
(b) Sales of export property. Foreign trading gross receipts of a
FSC include gross receipts from the sale of export property by the FSC,
or by any principal for whom the FSC acts as a commission agent (whether
or not the principal is a related supplier), pursuant to the terms of a
contract entered into with a purchaser by the FSC or by the principal at
any time or by any other person and assigned to the FSC or the principal
at any time prior to the shipment of the property to the purchaser. Any
agreement, oral or written, which constitutes a contract at law,
satisfies the contractual requirements of this paragraph. Gross receipts
from the sale of export property, whenever received, do not constitute
foreign trading gross
[[Page 52]]
receipts unless the seller (or the corporation acting as commission
agent for the seller) is a FSC at the time of the shipment of the
property to the purchaser. For example, if a corporation which sells
export property under the installment method is not a FSC for the
taxable year in which the property is shipped to the purchaser, gross
receipts from the sale do not constitute foreign trading gross receipts
for any taxable year of the corporation.
(c) Leases of export property--(1) In general. Foreign trading gross
receipts of a FSC include gross receipts from the lease of export
property provided that--
(i) The property is held by the FSC (or by a principal for whom the
FSC acts as commission agent with respect to the lease) either as an
owner or lessee at the beginning of the term of the lease, and
(ii) The FSC qualified (or was treated) as a FSC for its taxable
year in which the term of the lease began.
(2) Prepayment of lease receipts. If the gross receipts from a lease
of export property are prepaid, then--
(i) All the prepaid gross receipts are foreign trading gross
receipts of a FSC if it is reasonably expected at the time of the
prepayment that, throughout the term of the lease, the lease will meet
the requirements of this paragraph and the property will be export
property; or
(ii) If it is reasonably expected at the time of the prepayment that
the prepaid receipts would not be foreign trading gross receipts
throughout the term of the lease if those receipts were not received as
a prepayment, then only those prepaid receipts, for the taxable years of
the FSC for which they would be foreign trading gross receipts, are
foreign trading gross receipts. Thus, for example, if a lessee makes a
prepayment of the first and last years' rent, and it is reasonably
expected that the leased property will be export property for the first
half of the lease period but not the second half of such period, the
amount of the prepayment which represents the first year's rent will be
considered foreign trading gross receipts if it would otherwise qualify,
whereas the amount of the prepayment which represents the last year's
rent will not be considered foreign trading gross receipts.
(d) Related and subsidiary services--(1) In general. Foreign trading
gross receipts of a FSC include gross receipts from services furnished
by the FSC which are related and subsidiary to any sale or lease (as
described in paragraph (b) or (c) of this section) of export property by
the FSC or with respect to which the FSC acts as a commission agent,
provided that the FSC derives foreign trading gross receipts from the
sale or lease. The services may be performed within or without the
United States.
(2) Services furnished by the FSC. Services are considered to be
furnished by a FSC for purposes of this paragraph if the services are
provided by--
(i) The person who sold or leased the export property to which the
services are related and subsidiary, provided that the FSC acts as a
commission agent with respect to the sale or lease of the property and
with respect to the services,
(ii) The FSC as principal, or any other person pursuant to a
contract with the FSC, provided the FSC acted as principal or commission
agent with respect to the sale or lease of the property, or
(iii) A member of the same controlled group as the FSC if the sale
or lease of the export property is made by another member of the
controlled group provided, however, that the FSC acts as principal or
commission agent with respect to the sale or lease and as commission
agent with respect to the services.
(3) Related services. Services which may be related to a sale or
lease of export property include but are not limited to warranty
service, maintenance service, repair service, and installation service.
Transportation (including insurance related to such transportation) will
be related to a sale or lease of export property, if the cost of the
transportation is included in the sale price or rental of the property
or, if the cost is separately stated, is paid by the FSC (or its
principal) which sold or leased the property to the person furnishing
the transportation service. Financing or the obtaining of financing for
a sale
[[Page 53]]
or lease is not a related service for purposes of this paragraph. A
service is related to a sale or lease of export property if--
(i) The service is of the type customarily and usually furnished
with the type of transaction in the trade or business in which the sale
or lease arose, and
(ii) The contract to furnish the service--
(A) Is expressly provided for in or is provided for by implied
warranty under the contract of sale or lease,
(B) Is entered into on or before the date which is 2 years after the
date on which the contract under which the sale or lease was entered
into, provided that the person described in paragraph (d)(2) of this
section which is to furnish the service delivers to the purchaser or
lessor a written offer or option to furnish the services on or before
the date on which the first shipment of goods with respect to which the
service is to be performed is delivered, or
(C) Is a renewal of the services contract described in subdivisions
(ii)(A) and (B) of this paragraph.
(4) Subsidiary services--(i) In general. Services related to a sale
or lease of export property are subsidiary to the sale or lease only if
it is reasonably expected at the time of the sale or lease that the
gross receipts from all related services furnished by the FSC (as
defined in this paragraph (d)(2)) will not exceed 50 percent of the sum
of the gross receipts from the sale or lease and the gross receipts from
related services furnished by the FSC (as described in this paragraph
(d)(2)). In the case of a sale, reasonable expectations at the time of
the sale are based on the gross receipts from all related services which
may reasonably be performed at any time before the end of the 10-year
period following the date of the sale. In the case of a lease,
reasonable expectations at the time of the lease are based on the gross
receipts from all related services which may reasonably be performed at
any time before the end of the term of the lease (determined without
regard to renewal options).
(ii) Allocation of gross receipts from services. In determining
whether the services related to a sale or lease of export property are
subsidiary to the sale or lease, the gross receipts to be treated as
derived from the furnishing of services may not be less than the amount
of gross receipts reasonably allocated to the services as determined
under the facts and circumstances of each case without regard to
whether--
(A) The services are furnished under a separate contract or under
the same contract pursuant to which the sale or lease occurs, or
(B) The cost of the services is specified in the contract of sale or
lease.
(iii) Transactions involving more than one item of export property.
If more than one item of export property is sold or leased in a single
transaction pursuant to one contract, the total gross receipts from the
transaction and the total gross receipts from all services related to
the transaction are each taken into account in determining whether the
services are subsidiary to the transaction. However, the provisions of
this subdivision apply only if the items could be included in the same
product line, as determined under Sec. 1.925(a)-1T(c)(8).
(iv) Renewed service contracts. If under the terms of a contract for
related services, the contract is renewable within 10 years after a sale
of export property, or during the term of a lease of export property,
related services to be performed under the renewed contract are
subsidiary to the sale or lease if it is reasonably expected at the time
of the renewal that the gross receipts from all related services which
have been and which are to be furnished by the FSC (as described in
paragraph (d)(2) of this section) will not exceed 50 percent of the sum
of the gross receipts from the sale or lease and the gross receipts from
related services furnished by the FSC (as so described). Reasonable
expectations are determined as provided in subdivision (i) of this
paragraph.
(v) Parts used in services. If a services contract described in
paragraph (d)(3) of this section provides for the furnishing of parts in
connection with the furnishing of related services, gross receipts from
the furnishing of the parts are not taken into account in determining
whether under this paragraph (d)(4) the services are subsidiary. See
paragraph (b) or (c) of this section to
[[Page 54]]
determine whether the gross receipts from the furnishing of parts
constitute foreign trading gross receipts. See Sec. 1.927(a)-1T (c)(2)
and (e)(3) for rules regarding the treatment of the parts with respect
to the manufacture of export property and the foreign content of the
property, respectively.
(5) Relation to leases. If the gross receipts for services which are
related and subsidiary to a lease of property have been prepaid at any
time for all the services which are to be performed before the end of
the term of the lease, then the rules in paragraph (c)(2) of this
section (relating to prepayment of lease receipts) will determine
whether prepaid services under this paragraph (d)(5) are foreign trading
gross receipts. Thus, for example, if it is reasonably expected that
leased property will be export property for the first year of the term
of the lease but will not be export property for the second year of the
term, prepaid gross receipts for related and subsidiary services to be
furnished in the first year may be foreign trading gross receipts.
However, any prepaid gross receipts for the services to be furnished in
the second year cannot be foreign trading gross receipts.
(6) Relation with export property determination. The determination
as to whether gross receipts from the sale or lease of export property
constitute foreign trading gross receipts does not depend upon whether
services connected with the sale or lease are related and subsidiary to
the sale or lease. Thus, for example, assume that a FSC receives gross
receipts of $1,000 from the sale of export property and gross receipts
of $1,100 from installation and maintenance services which are to be
furnished by the FSC within 10 years after the sale and which are
related to the sale. The $1,100 which the FSC receives for the services
would not be foreign trading gross receipts since the gross receipts
from the services exceed 50 percent of the sum of the gross receipts
from the sale and the gross receipts from the related services furnished
by the FSC. The $1,000 which the FSC receives from the sale of export
property would, however, be foreign trading gross receipts if the sale
met the requirements of paragraph (b) of this section.
(e) Engineering and architectural services--(1) In general. Foreign
trading gross receipts of a FSC include gross receipts from engineering
services (as described in paragraph (e)(5) of this section) or
architectural services (as described in paragraph (e)(6) of this
section) furnished by such FSC (as described in paragraph (e)(7) of this
section) for a construction project (as defined in paragraph (e)(8) of
this section) located, or proposed for location, outside the United
States. Such services may be performed within or without the United
States.
(2) Services included. Engineering and architectural services
include feasibility studies for a proposed construction project whether
or not such project is ultimately initiated.
(3) Excluded services. Engineering and architectural services do not
include--
(i) Services connected with the exploration for oil or gas, or
(ii) Technical assistance or know-how. For purposes of this
paragraph, the term ``technical assistance or know-how'' includes
activities or programs designed to enable business, commerce, industrial
establishments, and governmental organizations to acquire or use
scientific, architectural, or engineering information.
(4) Other services. Receipts from the performance of construction
activities other than engineering and architectural services constitute
foreign trading gross receipts to the extent that the activities are
related and subsidiary services (within the meaning of paragraph (d) of
this section) with respect to a sale or lease of export property.
(5) Engineering services. For purposes of this paragraph,
engineering services in connection with any construction project (within
the meaning of paragraph (e)(8) of this section) include any
professional services requiring engineering education, training, and
experience and the application of special knowledge of the mathematical,
physical, or engineering sciences to those professional services as
consultation, investigation, evaluation, planning, design, or
responsible supervision of construction for the purpose of assuring
compliance with plans, specifications, and design.
[[Page 55]]
(6) Architectural services. For purposes of this paragraph,
architectural services include the offering or furnishing of any
professional services such as consultation, planning, aesthetic and
structural design, drawings and specifications, or responsible
supervision of construction (for the purpose of assuring compliance with
plans, specifications, and design) or erection, in connection with any
construction project (within the meaning of paragraph (e)(8) of this
section).
(7) Definition of ``furnished by the FSC''. For purposes of this
paragraph, the term ``furnished by the FSC'' means architectural and
engineering services furnished:
(i) By the FSC,
(ii) By another person (whether or not that person is a United
States person) pursuant to a contract entered into with the FSC at any
time prior to the furnishing of the services, provided that the FSC acts
as principal, or
(iii) By another person (whether or not that person is a United
States person) pursuant to a contract for the furnishing of the services
entered into by, or assigned to, the person at any time, provided that
the FSC acts as a commission agent for the furnishing of the services.
(8) Definition of ``construction project''. For purposes of this
paragraph, the term ``construction project'' includes the erection,
expansion, or repair (but not including minor remodeling or minor
repairs) of new or existing buildings or other physical facilities
including, for example, roads, dams, canals, bridges, tunnels, railroad
tracks, and pipelines. The term also includes site grading and
improvement and installation of equipment necessary for the
construction. Gross receipts from the sale or lease of construction
equipment are not foreign trading gross receipts unless the equipment is
export property.
(f) Managerial services--(1) In general. Foreign trading gross
receipts of a first FSC for its taxable year include gross receipts from
the furnishing of managerial services provided for an unrelated FSC or
unrelated interest charge DISC to aid the unrelated FSC or unrelated
interest charge DISC in deriving foreign trading gross receipts or
qualified export receipts, as the case may be, provided that at least 50
percent of the first FSC's gross receipts for such year consists of
foreign trading gross receipts derived from the sale or lease of export
property and the furnishing of related and subsidiary services. For
purposes of this paragraph, managerial services are considered furnished
by a FSC if the services are provided--
(i) By the first FSC,
(ii) By another person (whether or not a United States person)
pursuant to a contract entered into by that person with the first FSC at
any time prior to the furnishing of the services, provided that the
first FSC acts as principal with respect to the furnishing of the
services, or
(iii) By another person (whether or not a United States person)
pursuant to a contract for the furnishing of services entered into at
any time prior to the furnishing of the services provided that the first
FSC acts as commission agent with respect to those services.
(2) Definition of ``managerial services''. The term ``managerial
services'' as used in this paragraph means activities relating to the
operation of an unrelated FSC or an unrelated interest charge DISC which
derives foreign trading gross receipts or qualified export receipts as
the case may be from the sale or lease of export property and from the
furnishing of services related and subsidiary to those sales or leases.
The term includes staffing and operational services necessary to operate
the unrelated FSC or unrelated interest charge DISC, but does not
include legal, accounting, scientific, or technical services. Examples
of managerial services are: conducting export market studies, making
shipping arrangements, and contacting potential foreign purchasers.
(3) Status of recipient of managerial services. Foreign trading
gross receipts of a first FSC include receipts from the furnishing of
managerial services during any taxable year of a recipient of such
services if the recipient qualifies as a FSC or interest charge DISC for
the taxable year. For purposes of this paragraph, a recipient is deemed
to qualify as a FSC or interest charge DISC for its taxable year if the
first FSC obtains from the recipient a copy
[[Page 56]]
of the recipient's election to be treated as a FSC or interest charge
DISC together with the recipient's sworn statement that an election has
been timely filed with the Internal Revenue Service Center. The
recipient may mark out the names of its shareholders on a copy of its
election to be treated as a FSC or interest charge DISC before
submitting it to the first FSC. The copy of the election and the sworn
statement of the recipient must be received by the first FSC within six
months after the first FSC furnishes managerial services for the
recipient. The copy of the election and the sworn statement of the
recipient need not be obtained by the first FSC for subsequent taxable
years of the recipient. A recipient of managerial services is not
treated as a FSC or interest charge DISC with respect to the services
performed during a taxable year for which the recipient does not qualify
as a FSC or interest charge DISC if the first FSC performing such
services does not believe or if a reasonable person would not believe
(taking into account the furnishing FSC's managerial relationship with
such recipient FSC or interest charge DISC) at the beginning of such
taxable year that the recipient will qualify as a FSC or an interest
charge DISC for such taxable year.
(g) Excluded receipts--(1) In general. Notwithstanding the
provisions of paragraphs (b) through (f) of this section, foreign
trading gross receipts of a FSC do not include any of the six amounts
described in paragraphs (g)(2) through (7) of this section.
(2) Sales and leases of property for ultimate use in the United
States. Property which is sold or leased for ultimate use in the United
States does not constitute export property. See Sec. 1.927(a)-1T(d)(4)
relating to determination of where the ultimate use of the property
occurs. Thus, foreign trading gross receipts of a FSC described in
paragraph (b) or (c) of this section do not include gross receipts of
the FSC from the sale or lease of this property.
(3) Sales or leases of export property and furnishing of services
accomplished by subsidy. Foreign trading gross receipts of a FSC do not
include gross receipts described in paragraphs (b) through (f) of this
section if the sale or lease of export property or the furnishing of
services is accomplished by a subsidy granted by the United States or
any instrumentality thereof, see section 924(f)(1)(B). Subsidies covered
by section 924(f)(1)(B) are listed in subdivisions (i) through (vi) of
this paragraph.
(i) The development loan program, or grants under the technical
cooperation and development grants program of the Agency for
International Development, or grants under the military assistance
program administered by the Department of Defense, pursuant to the
Foreign Assistance Act of 1961, as amended (22 U.S.C. 2151) unless the
FSC shows to the satisfaction of the Commissioner that, under the
conditions existing at the time of the sale (or at the time of lease or
at the time the services were rendered), the purchaser (or lessor or
recipient of the services) had a reasonable opportunity to purchase (or
lease or contract for services) on competitive terms and from a seller
(or lessor or performer of services) who was not a U.S. person, goods
(or services) which were substantially identical to such property (or
services) and which were not manufactured, produced, grown, or extracted
in the United States (or performed by a U.S. person);
(ii) The Public Law 480 program authorized under Title I of the
Agricultural Trade Development and Assistance Act of 1954, as amended (7
U.S.C. 1691, 1701-1714);
(iii) The Export Payment program of the Commodity Credit Corporation
authorized by sections 5 (d) and (f) of the Commodity Credit Corporation
Charter Act, as amended (15 U.S.C. 714c (d) and (f));
(iv) The section 32 export payment programs authorized by section 32
of the Act of August 24, 1935, as amended (7 U.S.C. 612c);
(v) The Export Sales program of Commodity Credit Corporation
authorized by sections 5 (d) and (f) of the Commodity Credit Corporation
Charter Act, as amended (15 U.S.C. 714c (d) and (f)), other than the
GSM-4 program provided under 7 CFR part 1488, and section 407 of the
Agricultural Act of 1949, as amended (7 U.S.C. 1427), for the purpose of
disposing of surplus agricultural commodities and exporting or
[[Page 57]]
causing to be exported agricultural commodities; and
(vi) The Foreign Military Sales direct credit program (22 U.S.C.
2763) or the Foreign Military Sales loan guaranty program (22 U.S.C.
2764) if--
(A) The borrowing country is released from its contractual liability
to repay the United States government with respect to those credits or
guaranteed loans;
(B) The repayment period exceeds twelve years; or
(C) The interest rate charged is less than the market rate of
interest as defined in 22 U.S.C. 2763(c)(2)(B);
unless the FSC shows to the satisfaction of the Commissioner that, under
the conditions existing at the time of the sale, the purchaser had a
reasonable opportunity to purchase, on competitive terms from a seller
who was not a U.S. person, goods which were substantially identical to
this property and which were not manufactured, produced, grown, or
extracted in the United States. Information regarding whether an export
is financed, in whole or in part, with funds derived from the programs
identified in this subdivision may be obtained from the Comptroller,
Defense Security Assistance Agency, Department of Defense, Washington,
DC 20301.
(4) Sales or leases of export property and furnishing of
architectural or engineering services for use by the United States--(i)
In general. Foreign trading gross receipts of a FSC do not include gross
receipts described in paragraph (b), (c), or (e) of this section if a
sale or lease of export property, or the furnishing of architectural or
engineering services, is for use by the United States or an
instrumentality thereof in any case in which any law or regulation
requires in any manner the purchase or lease of property manufactured,
produced, grown, or extracted in the United States or requires the use
of architectural or engineering services performed by a United States
person. See section 924(f)(1)(A)(ii). For example, a sale by a FSC of
export property to the Department of Defense for use outside the United
States would not produce foreign trading gross receipts for the FSC if
the Department of Defense purchased the property from appropriated funds
subject to either any provision of the Department of Defense Federal
Acquisition Regulations Supplement (48 CFR chapter 2) or any
appropriations act for the Department of Defense for the applicable year
if the regulations or appropriations act requires that the items
purchased must have been grown, reprocessed, reused, or produced in the
United States. The Department of Defense's regulations do not require
that items purchased by the Department for resale in post or base
exchanges and commissary stores located on United States military
installations in foreign countries be items grown, reprocessed, reused
or produced in the United States. Therefore, receipts arising from the
sale by a FSC to those post or base exchanges and commissary stores will
not be excluded from the definition of foreign trading gross receipts by
this paragraph (g)(4).
(ii) Direct or indirect sales or leases. Any sale or lease of export
property is for use by the United States or an instrumentality thereof
if such property is sold or leased by a FSC (or by a principal for whom
the FSC acts as commission agent) to--
(A) A person who is a related person with respect to the FSC or such
principal and who sells or leases the property for use by the United
States or an instrumentality thereof, or
(B) A person who is not a related person with respect to the FSC or
such principal if, at the time of the sale or lease, there is an
agreement or understanding that the property will be sold or leased for
use by the United States or an instrumentality thereof (or if a
reasonable person would have known at the time of the sale or lease that
the property would be sold or leased for use by the United States or an
instrumentality thereof) within 3 years after the sale or lease.
(iii) Excluded programs. The provisions of subdivisions (4)(i) and
(ii) of this paragraph do not apply in the case of a purchase by the
United States or an instrumentality thereof if the purchase is pursuant
to--
(A) The Foreign Military Sales Act, as amended (22 U.S.C. 2751 et
seq.), or a program under which the United States government purchases
property for resale, on commercial terms, to a foreign
[[Page 58]]
government or agency or instrumentality thereof, or
(B) A program (whether bilateral or multilateral) under which sales
to the United States government are open to international competitive
bidding.
(5) Services. Foreign trading gross receipts of a FSC do not include
gross receipts described in paragraph (d) of this section (concerning
related and subsidiary services) if the services from which such gross
receipts are derived are related and subsidiary to the sale or lease of
property which results in excluded receipts under this paragraph.
(6) Receipts within controlled group. (i) For purposes of the
transfer pricing methods of section 925(a), gross receipts of a
corporation do not constitute foreign trading gross receipts for any
taxable year of the corporation if at the time of the sale, lease, or
other transaction resulting in the gross receipts, the corporation and
the person from whom the gross receipts are directly or indirectly
derived (whether or not such corporation and such person are the same
person) are members of the same controlled group, and either
(A) The corporation and the person each qualifies as a FSC (or if
related FSCs are commission agents of each party to the transaction) for
its taxable year in which its receipts arise, or
(B) With regard to sale transactions, a sale of export property to a
FSC (or to a related person if the FSC is the commission agent of the
related person) by a non-FSC within the same controlled group follows
any sale of the export property to a FSC (or to a related person if the
FSC is the commission agent of the related person) within the same
controlled group if foreign trading gross receipts resulted from the
sale. Thus for example, assume that R, S, X, and Y are members of the
same controlled group and that X and Y are FSCs. If R sells property to
S and pays X a commission relating to that sale and if S sells the same
property to an unrelated foreign party and pays Y a commission relating
to that sale, the receipts received by X from the sale of such property
by R to S will be considered to be derived from Y, a FSC which is a
member of the same controlled group as X, and thus will not result in
foreign trading gross receipts to X. The receipts received by Y from the
sale to an unrelated foreign party may, however, result in foreign
trading gross receipts to Y. For another example, if R and S both assign
the commissions to X, receipts derived from the sale from R to S will be
considered to be derived from X acting as commission agent for S and
will not result in foreign trading gross receipts to X. Receipts derived
by X from the sale of property by S to an unrelated foreign party may,
however, constitute foreign trading gross receipts.
(ii) Section 1.927(a)-1T(f)(2) provides rules regarding property not
constituting export property in certain cases where such property is
leased to any corporation which is a member of the same controlled group
as the lessor.
(7) Factoring of receivables by a related supplier. If an account
receivable arising with respect to export property is transferred to any
person for an amount reflecting a discount from the selling price of the
export property, then the gross receipts from the sale which are treated
as foreign trading gross receipts for purposes of computing a FSC's
profit under the administrative pricing methods of section 925(a)(1) and
(2) shall be reduced by the amount of the discount. See Sec. 1.925(a)-
1T(f) Example 11 for illustration of how this special rule affects
computation of combined taxable income of a FSC and its related
supplier.
(h) Definition of ``controlled group''. For purposes of sections 921
through 927 and the regulations under those sections, the term
``controlled group'' has the same meaning as is assigned to the term
``controlled group of corporations'' by section 1563(a), except that (1)
the phrase ``more than 50 percent'' is substituted for the phrase ``at
least 80 percent'' each place the latter phrase appears in section
1563(a), and (2) section 1563(b) shall not apply. Thus, for example, a
foreign corporation subject to tax under section 882 may be a member of
a controlled group. Furthermore, two or more corporations (including a
foreign corporation) are members of a controlled group at any time such
corporations meet the requirements of section 1563(a) (as modified by
this paragraph).
[[Page 59]]
(i) FSC's entitlement to income--(1) Application of administrative
pricing rules of section 925(a). A corporation which meets the
requirements of section 922(a) (or section 922(b) if the corporation
elects small FSC status) and Sec. 1.921-2(a) (Q&A1) to be treated as a
FSC (or small FSC) for a taxable year is entitled to income, and the
administrative pricing rules of section 925(a)(1) or (2) apply, in the
case of any transaction described in Sec. 1.925(a)-1T(b)(iii) between
the FSC and its related supplier (as defined in Sec. 1.927(d)-2T(a)) as
long as the FSC, or someone under contract to it, satisfies the
requirements of section 925(c). The requirements of section 925(c) must
be met by a commission FSC as well as by a buy-sell FSC. See Sec. 1.925
(a)-1T(a)(3)(i) and (b)(2)(ii).
(2) Other transactions. In the case of a transaction to which the
provisions of paragraph (i)(1) of this section do not apply but from
which a FSC derives gross receipts, the income to which the FSC is
entitled as a result of the transaction is determined pursuant to the
terms of the contract for the transaction and, if applicable, section
482 and the regulations under that section. For applicability of the
section 482 transfer pricing method, see Sec. 1.925(a)-1T (a)(3)(ii)
and (b)(2)(i).
(j) Small FSC limitation--(1) In general. Under section
924(b)(2)(B), in determining exempt foreign trade income of a small FSC,
the foreign trading gross receipts of the small FSC for the taxable year
which exceed $5 million are not taken into account. The foreign trading
gross receipts of the small FSC not taken into account for purposes of
computing the small FSC's exempt foreign trade income shall be taken
into account in computing the small FSC's non-exempt foreign trade
income. If the foreign trading gross receipts of the small FSC exceed
the $5 million limitation, the small FSC may select the gross receipts
to which the limitation is allocated. See section 922(b) and Sec.
1.921-2(b) (Q&A3) for a definition of a small FSC.
(2) Members of a controlled group limited to one $5 million amount--
(i) General rule. All small FSCs which are members of a controlled group
on a December 31, shall, for their taxable years which include that
December 31, be limited to one $5 million amount. The $5 million amount
shall be allocated equally among the member small FSCs of the controlled
group for their taxable years including that December 31, unless all of
the member small FSCs consent to an apportionment plan providing for an
unequal allocation of the $5 million amount. The apportionment plan
shall provide for the apportionment of a fixed dollar amount to one or
more of the corporations, and the sum of the amounts so apportioned
shall not exceed the $5 million amount. If the taxable year including
the December 31 of any member small FSC is a short period (as defined in
section 443), the portion of the $5 million amount allocated to that
member small FSC for that short period under the preceding sentence
shall be reduced to the amount which bears the same ratio to the amount
so allocated as the number of days in such short period bears to 365.
The consent of each member small FSC to the apportionment plan for the
taxable year shall be signified by a statement which satisfies the
requirements of and is filed in the manner specified in Sec. 1.1561-
3(b). An apportionment plan may be amended in the manner prescribed in
Sec. 1.1561-3(c), except that an original or an amended plan may not be
adopted with respect to a particular December 31 if at the time the
original or amended plan is sought to be adopted, less than 12 full
months remain in the statutory period (including extensions) for the
assessment of a deficiency against any shareholder of a member small FSC
the tax liability of which would change by the adoption of the original
or amended plan. If less than 12 full months of the period remain with
respect to any such shareholder, the director of the service center with
which the shareholder files its income tax return will, upon request,
enter into an agreement extending the statutory period for the limited
purpose of assessing any deficiency against that shareholder
attributable to the adoption of the original or amended apportionment
plan.
(ii) Membership determined under section 1563(b). For purposes of
this paragraph (j)(2), the determination of whether a small FSC is a
member of a
[[Page 60]]
controlled group of corporations with respect to any taxable year shall
be made in the manner prescribed in section 1563(b) and the regulations
under that section.
(iii) Certain short taxable years--(A) General rule. If a small FSC
has a short period (as defined in section 443) which does not include a
December 31, and that small FSC is a member of a controlled group of
corporations which includes one or more other small FSC's with respect
to the short period, then the amount described in section 924(b)(2)(B)
with respect to the short period of that small FSC shall be determined
by--
(1) Dividing $5 million by the number of small FSCs which are
members of that group on the last day of the short period, and
(2) Multiplying the result by a fraction, the numerator of which is
the number of days in the short period and the denominator of which is
365.
For purposes of the preceding sentence, section 1563(b) shall be applied
as if the last day of the short period were substituted for December 31.
Except as provided in subdivision (2)(iii)(B) of this paragraph, the
small FSC having a short period not including a December 31 may not
enter into an apportionment plan with respect to the short period.
(B) Exception. If the short period not including a December 31 of
two or more small FSCs begins on the same date and ends on the same date
and those small FSCs are members of the same controlled group, those
small FSCs may enter into an apportionment plan for such short period in
the manner provided in subdivision (2)(i) of this paragraph with respect
to the combined amount allowed to each of those small FSCs under
subdivision (2)(iii)(A) of this paragraph.
[T.D. 8126, 52 FR 6438, Mar. 3, 1987]
Sec. 1.924(c)-1 Requirement that a FSC be managed outside the United States.
(a) In general. Section 924(b)(1)(A) provides that a FSC shall be
treated as having foreign trading gross receipts for the taxable year
only if the management of the FSC during the year takes place outside
the United States, as provided in section 924(c). Section 924(c) and
this section set forth the management activities that must take place
outside the United States in order to satisfy the requirement of section
924(b)(1)(A). Paragraph (b) of this section provides rules for
determining whether the requirements of section 924(c)(1) have been met.
Section 924(c)(1) requires that all meetings of the board of directors
of the FSC during the taxable year and all meetings of the shareholders
of the FSC during the taxable year take place outside the United States.
Paragraph (c) of this section provides rules for maintaining the FSC's
principal bank account outside the United States as provided in section
924(c)(2). Paragraph (d) of this section provides rules for
disbursements required by section 924(c)(3) to be made from bank
accounts of the FSC maintained outside the United States.
(b) Meetings of board of directors and meetings of shareholders must
be outside the United States. All meetings of the board of directors of
the FSC and all meetings of the shareholders of the FSC that take place
during a taxable year must take place outside the United States to meet
the requirements of section 924(c)(1). Only meetings that are formally
convened as meetings of the board of directors or as shareholder
meetings will be taken into account in determining whether those
requirements have been met. In addition, all such meetings must comply
with the local laws of the foreign country or possession of the United
States in which the FSC was created or organized. The local laws
determine whether a meeting must be held, when and where it must be held
(if it is held at all), who must be present, quorum requirements, use of
proxies, and so on. Where the local law permits action by the board of
directors or shareholders to be taken by written consent without a
meeting, use of such procedure will not constitute a meeting for
purposes of section 924(c)(1). Section 924(c)(1) and this section impose
no other requirements except the requirement that meetings that are
actually held take place outside the United States. If the participants
in a meeting are not
[[Page 61]]
all physically present in the same location, the location of the meeting
is determined by the location of the persons exercising a majority of
the voting power (including proxies) participating in the meeting. For
example, a FSC has five directors, and is organized in country A.
Country A's law requires that a majority of the directors of a
corporation must participate in a meeting to constitute a quorum (and,
thus, a meeting), but there is no requirement that the meeting be held
in country A or that the directors must be physically present to
participate. One director is in country A, another director is in
country B, and a third director is in the United States.
These three directors convene a meeting by telephone that
constitutes a meeting under the law of country A. The meeting occurs
outside the United States because the persons exercising a majority of
the voting power participating in the meeting are located outside the
United States.
(c) Maintenance of the principal bank account outside the United
States--(1) In general. For purposes of section 924(c), the bank account
that shall be regarded as the principal bank account of a FSC is the
bank account from which the disbursements described in paragraph (d) of
this section are made. A FSC may have more than one principal bank
account. The bank account that is regarded as the principal bank account
must be maintained in a foreign country which meets the requirements of
section 927(e)(3), or in any possession of the United States (as defined
in section 927(d)(5)), and it must be so maintained at all times during
the taxable year. For taxable years beginning on or after February 19,
1987, a principal bank account or accounts must be designated on the
annual return of the FSC by providing the bank name(s) and account
number(s).
(2) Maintenance of the account in a bank. The bank account that is
regarded as the principal bank account must be maintained in an
institution that is engaged in the conduct of a banking, financing, or
similar business, as defined in Sec. 1.954-2(d)(2)(ii) (without regard
to whether it is a controlled foreign corporation). The institution may
be a U.S. bank, provided that the account is maintained in a branch
outside the United States.
(3) Maintenance of an account outside the United States. Maintenance
of the principal bank account outside the United States means that the
account regarded as the principal bank account must be an account
maintained on the books of the banking institution at an office outside
the United States, but does not require that access to the account may
be made only outside the United States. Instructions providing for
deposits into or disbursements from the account may originate in the
United States without affecting the status of maintenance of the account
outside the United States.
(4) Maintenance of the account at all times during the taxable year.
The term ``at all times during the taxable year'' generally means for
each day of the taxable year. In the case of a newly created or
organized corporation, thirty days may elapse between the effective date
of the corporation's election to be treated as a FSC and the date a bank
account is opened without causing the FSC to fail the requirement that
it maintain its principal bank account outside the United States at all
times during the taxable year. For example, if a corporation is created
or organized prior to January 1, 1985, and makes an election to be
treated as a FSC within the first 90 days of 1985, the election is
effective as of January 1, 1985. Thus, the FSC must open a bank account
within 30 days of January 1, or as of January 31, 1985, to satisfy this
requirement. Also, a FSC shall be treated as satisfying this requirement
if the account that is regarded as its principal bank account is
terminated during the taxable year, provided that (i) such termination
is the result of circumstances beyond the FSC's control, and (ii) the
FSC establishes a new principal bank account within thirty days after
such termination. A FSC may close its principal bank account and replace
it with another account that qualifies under this paragraph (c) as a
principal bank account at any time provided that no lapse of time occurs
between the closing of the principal bank account and the opening of the
replacement account.
[[Page 62]]
(5) Other accounts. The FSC may maintain other bank accounts in
addition to its principal bank account. Such other accounts may be
located anywhere, without limitation. The mere existence of such other
accounts will not cause the FSC to fail to satisfy the requirements of
section 924(c).
(d) Disbursement of dividends, legal and accounting fees, and
salaries of officers and directors out of the principal bank account of
the FSC--(1) In general. All dividends, legal fees, accounting fees,
salaries of officers of the FSC, and salaries or fees paid to members of
the board of directors of the FSC that are disbursed during the taxable
year must be disbursed out of bank account(s) of the FSC maintained
outside the United States. Such an account is treated as the principal
bank account of the FSC for purposes of section 924(c). Dividends,
however, may be netted against amounts owed to the FSC (e.g.,
commissions) by a related supplier through book entries. If the FSC
regularly disburses its legal or accounting fees, salaries of officers,
and salaries or fees of directors out of its principal bank account, the
occasional, inadvertent payment by mistake of fact or law of such
amounts out of another bank account will not be considered a
disbursement by the FSC if, upon determination that such payment was
made from another account, reimbursement to such other account is made
from the principal bank account of the FSC within a reasonable period
from the date of the determination. Disbursement out of the principal
bank account of the FSC may be made by transferring funds from the
principal bank account to a U.S. account of the FSC provided that (i)
the payment of the dividends, salaries or fees to the recipients is made
within 12 months of the transfer, (ii) the purpose of the expenditures
is designated and, (iii) the payment of the dividends, salaries or fees
is actually made out of the same U.S. account that received the
disbursement from the principal bank account.
(2) Reimbursement. Legal or accounting fees, salaries of officers,
and salaries or fees of directors that are paid by a related person
wholly or partially on behalf of a FSC must be reimbursed by the FSC.
The amounts paid by the related person are not considered disbursed by
the FSC until the related person is reimbursed by the FSC. The related
person must be reimbursed no later than the last date prescribed for
filing the FSC's tax return (including extensions) for the taxable year
to which the reimbursement relates. Any reimbursement for amounts paid
on behalf of the FSC must be disbursed out of the FSC's principal bank
account (and not netted against any obligation owed by the related
person to the FSC), as set forth in paragraph (c) of this section. To
determine the amounts paid on behalf of the FSC, the FSC may rely upon a
written statement or invoice furnished to it by the related person which
shows the following:
(i) The actual fees charged for performing the legal or accounting
services for the FSC or, if such fees cannot be ascertained by the
related person, a good faith estimate thereof, and the actual salaries
or fees paid for services as officers and directors of the FSC, and
(ii) The person who performed or provided the services.
(3) Good faith exception. If, after the FSC has filed its tax
return, a determination is made by the Commissioner that all or a part
of the legal or accounting fees, salaries of officers, and salaries or
fees of directors of the FSC were paid by a related person without
receiving reimbursement, the FSC may, nonetheless, satisfy the
requirements of section 924(c)(3) if the fees and salaries were paid by
the related person in good faith, and the FSC reimburses the related
person for the fees and salaries paid within 90 days after the
determination. The reimbursement shall be treated as made as of the end
of the taxable year of the FSC for which the reimbursement is made.
(4) Dividends--(i) Definition. For purposes of section 924(c) and
this section only, the term ``dividends'' refers solely to cash
dividends (including a dividend paid in a foreign functional currency)
actually paid pursuant to a declaration or authorization by the FSC.
Accordingly, a ``dividend'' will not include a constructive dividend
that is deemed to be paid (regardless of the source of such constructive
dividend) or a distribution of property that is a dividend under section
316 other than a
[[Page 63]]
distribution of U.S. dollars or a foreign functional currency.
(ii) Offset accounting entries. Payment of dividends by the FSC to
its related supplier may be in the form of an accounting entry
offsetting an amount payable to the related supplier for the dividend
against an existing debt owed to the FSC. The offset accounting entries
must be clearly identified in the books of account of both the related
supplier and the FSC.
(5) Legal and accounting fees. For purposes of this section, legal
and accounting fees do not include salaries paid to legal and accounting
employees of the FSC (or a related person). Legal and accounting fees
are limited to fees paid to independent persons performing legal or
accounting services for or with respect to the FSC.
(6) Salaries of officers and directors. For purposes of this
section, salaries of officers and salaries or fees of directors are only
those salaries or fees paid for services as officers or directors of the
FSC. Salaries do not include reimbursed travel and entertainment
expenses. If an individual officer, director, or employee of a related
person is also an officer or director of a FSC and receives additional
compensation for services performed for the FSC, the portion of the
compensation paid to the individual which is for services performed for
the FSC is required to be disbursed out of the FSC's principal bank
account. For purposes of this section, the term ``compensation'' is
defined as set forth in paragraphs (d)(1) and (2) of Sec. 1.415-2.
[T.D. 8125, 52 FR 5089, Feb. 19, 1987]
Sec. 1.924(d)-1 Requirement that economic processes take place outside
the United States.
(a) In general. Section 924(b)(1)(B) provides that a FSC has foreign
trading gross receipts from any transaction only if economic processes
with respect to such transaction take place outside the United States as
provided in section 924(d). Section 924(d) and this section set forth
the rules for determining whether a sufficient amount of the economic
processes of a transaction take place outside the United States.
Generally, a transaction will qualify if the FSC satisfies two different
requirements: Participation outside the United States in the sales
portion of the transaction, and satisfaction of either the 50-percent or
the 85-percent foreign direct cost test. The activities comprising these
economic processes may be performed by the FSC or by any other person
acting under contract with the FSC. (All references to ``FSC'' in
Sec. Sec. 1.924(d)-1 and 1.924(e)-1 shall mean the FSC or, if
applicable, the person performing the relevant activity under contract
on behalf of the FSC.) The FSC may act upon standing instructions from
another person in the performance of any activity, whether a sales
activity under paragraph (c) of this section or an activity relating to
the disposition of export property under paragraph (d) of this section
and Sec. 1.924(e)-1. The identity of the FSC as a separate entity is
not required to be disclosed in the performance of any of the activities
comprising the economic processes. Except as otherwise provided, the
location of any activity is determined by the place where the activity
is initiated by the FSC, and not by the location of any person
transmitting instructions to the FSC.
(b) Activities performed by another person--(1) In general. Any
person, whether domestic or foreign, and whether related or unrelated to
the FSC, may perform any activity required to satisfy this section,
provided that the activity is performed pursuant to a contract for the
performance of that activity on behalf of the FSC. Such a contract may
be any oral or written agreement which constitutes a contract at law.
The person performing the activity is not required to enter into a
contract directly with the FSC and, thus, may be a direct or indirect
subcontractor of a person under contract with the FSC. For example,
assume that a buy-sell FSC enters into an agreement with its related
supplier in which the related supplier agrees to perform on behalf of
the FSC all sales activities with respect to the FSC's transactions with
its foreign customers. Through its existing agreements with a domestic
unrelated person, the related supplier subcontracts the performance of
these activities to the domestic unrelated person, who, in turn,
subcontracts the performance of the sales activities to
[[Page 64]]
foreign sales agents. The sales activities performed by the foreign
sales agents are considered to be performed on behalf of the FSC for
purposes of meeting the requirements of section 924(d)(1)(A).
(2) Proof of compliance. If the FSC does not perform the activity
itself, it must maintain records adequate to establish, with respect to
each transaction or group of transactions, that the activity was
performed and that the performance of such activity took place outside
the United States. If the person who performed the activity on behalf of
the FSC is an independent contractor, the FSC may rely upon a written
declaration from that person stating that the activities were performed
by that person on behalf of the FSC, and were performed outside the
United States. An invoice or a receipt for payment will be considered to
be such a written declaration if it specifies that the activities were
performed outside the United States or specifies a particular place
outside the United States where the activities were performed. If the
person performing the activities on behalf of the FSC is a related
person, the FSC must maintain records adequate to establish that the
activities were actually performed and where the activities were
performed. Such records may be stored with the related person provided
that the FSC makes such records available to the Commissioner upon
request.
(c) Participation outside the United States in the sales portion of
the transaction--(1) In general. The requirement of section 924(d)(1)(A)
is met with respect to the gross receipts of a FSC derived from any
transaction if the FSC has participated outside the United States in the
solicitation, the negotiation, or the making of the contract relating to
such transaction (hereinafter described as ``sales activities''), as
provided in this paragraph (c). A sale need not occur in order that the
solicitation or negotiation tests be satisfied. Once the FSC has
participated outside the United States in an activity that constitutes
the solicitation, negotiation, or the making of the contract with
respect to a transaction, any prior or subsequent activity by the FSC
with respect to such transaction that would otherwise constitute the
sales activity will be disregarded for purposes of determining whether
the FSC has met the requirements of section 924(d)(1)(A). For example,
if a FSC sells a product to a foreign customer by first meeting with the
customer in New York to discuss the product and then by mailing to it
from outside the United States a brochure describing the product, the
prior meeting is disregarded and only the mailing is considered in
determining whether there was solicitation outside the United States by
the FSC with respect to the transaction which has occurred.
(2) Solicitation (other than advertising). For purposes of this
paragraph (c), ``solicitation'' refers to any communication (by any
method, including, but not limited to, telephone, telegraph, mail, or in
person) by the FSC, at any time during the 12 month period (measured
from the date the communication is mailed or transmitted) immediately
preceding the execution of a contract relating to the transaction to a
specific, targeted customer or potential customer, that specifically
addresses the customer's attention to the product or service which is
the subject of the transaction. For purposes of paragraph (c)(2) of this
section, communication by mail means depositing the communication in a
mailbox. Except as provided in Sec. 1.924(e)-1(a)(1) with respect to
second mailings, activities that would otherwise constitute advertising
(such as sending sales literature to a customer or potential customer)
will be considered solicitation if the activities are directed at a
specific, targeted customer or potential customer, and the costs of the
activity are not taken into account as advertising under the foreign
direct cost tests. Activities that would otherwise constitute sales
promotion (such as a promotional meeting in person with a customer) will
be considered to be solicitation if the activities are directed at a
specific, targeted customer or potential customer, and the costs of the
activity are not taken into account as sales promotion under the foreign
direct cost tests. Except as provided in Sec. 1.924(e)-1(a)(1) with
respect to second mailings, the same or similar activities cannot be
considered both solicitation
[[Page 65]]
and advertising, or both solicitation and sales promotion, with respect
to the same customer. Solicitation, however, may take place at the same
time as, and in conjunction with, another sales activity. Additionally,
it may take place with respect to any person, whether domestic or
foreign, and whether or not related to the FSC.
(3) Negotiation. For purposes of this paragraph (c), ``negotiation''
refers to any communication by the FSC to a customer or potential
customer aimed at an agreement on one or more of the terms of a
transaction, including, but not limited to, price, credit terms,
quantity, or time or manner of delivery. For purposes of this paragraph
(c)(3), communication by mail has the same meaning as provided in
paragraph (c)(2) of this section. Negotiation does not include the mere
receipt of a communication from a customer (such as an order) that
includes terms of a sale. Negotiation may take place at the same time
as, and in conjunction with, another sales activity. Additionally, it
may take place with respect to any person, whether domestic or foreign,
and whether or not related to the FSC.
(4) Making of a contract. For purposes of this paragraph (c),
``making of a contract'' refers to performance by the FSC of any of the
elements necessary to complete a sale, such as making an offer or
accepting an offer. A requirements contract is considered an open offer
to be accepted from time to time when the customer submits an order for
a specified quantity. Thus, the acceptance of such an order will be
considered the making of a contract. The written confirmation by the FSC
to the customer of the acceptance of the open order will also be
considered the making of a contract. Acceptance of an unsolicited bid or
order is considered the ``making of a contract'' even if no solicitation
or negotiation occurred with respect to the transaction. The written
confirmation by the FSC to the customer of an oral or written agreement
which confirms variable contract terms, such as price, credit terms,
quantity, or time or manner of delivery, or specifies (directly or by
cross-reference) additional contract terms will be considered the making
of a contract. A written confirmation is any confirmation expressed in
writing, including a telegram, telex, or other similar written
communication. The making of a contract may take place at the same time
as, and in conjunction with, another sales activity. Additionally, it
may take place with respect to any person, whether domestic or foreign,
and whether or not related to the FSC.
(5) Grouping transactions. Generally, the sales activities under
this paragraph (c) are to be applied on a transaction-by-transaction
basis. By annual election of the FSC, however, any of the sales
activities may be applied on the basis of a group as set forth in this
paragraph (c)(5). Any groupings used must be supported by adequate
documentation of performance of activities relating to the groupings
used. An election by the FSC to group transactions must be made on its
annual income tax return. The FSC, however, may amend its tax return to
group in a manner different from that elected on its original return
before the expiration of the statute of limitations.
(i) Standards of groups. A determination by a FSC as to a grouping
will be accepted by a district director if such determination conforms
to any of the following standards:
(A) Product or product line groupings. A product or product line
grouping may be based upon either a recognized trade or industry usage,
or upon a two digit major group (or on any inferior classification or
combination of inferior classifications within a major group) of the
Standard lndustrial Classification as prepared by the Statistical Policy
Division of the Office of Management and Budget, Executive Office of the
President. For taxable years beginning on or before February 19, 1987,
any sales activity that is performed outside the United States with
respect to any transaction covered by the product or product line
grouping during the FSC's taxable year shall apply to all transactions
covered by the product or product line. However, for taxable years
beginning after February 19, 1987, the requirement of section
924(d)(1)(A) is met with respect to all transactions covered by the
product or product line grouping only if the sales activities are
performed outside
[[Page 66]]
the United States with respect to customers with sales representing
either:
(i) 20 percent or more of the foreign trading gross receipts of the
product or product line grouping during the current year or
(ii) 50 percent or more of the foreign trading gross receipts of the
product or product line grouping for the prior year irrespective of
whether any sales occurred within the current year to the prior year
customers.
If during the prior taxable year, the controlled group of which the FSC
is a member had a DISC or interest charge DISC, the FSC may use the 50
percent rule with respect to the preceding DISC or interest charge DISC
year, substituting qualified export receipts for foreign trading gross
receipts. A corporation which has not been treated in the prior year as
a FSC, interest charge DISC, or DISC does not have to meet either the 20
percent test or the 50 percent test for the first year in which it is
treated as a FSC.
(B) Customer groupings. A customer grouping includes all
transactions of the FSC with a particular customer during the FSC's
taxable year. Thus, any sales activity that is performed outside the
United States with respect to any transaction with the customer during
the taxable year shall apply to all transactions within the customer
grouping.
(C) Contract groupings. A contract grouping includes all
transactions of the FSC under a particular contract for a taxable year.
Thus, any sales activity that is performed outside the United States
with respect to any transaction under the contract will apply to all
transactions under the contract for such taxable year. For long-term
contracts between unrelated parties, the sales activities tests need be
satisfied only once for the life of the contract. With respect to
requirements contracts and long-term contracts between related parties,
the sales activities test must be satisfied annually.
(D) Product or product line groupings within customer or contract
groupings. Groupings may be based upon product or product line groupings
within customer or contract groupings. If, however, the primary grouping
is a customer or contract grouping, the 20 percent test set forth in
subdivision (A) of this paragraph relating to product or product line
grouping will not be applicable.
(ii) Transactions included in a grouping. A choice by a FSC to group
transactions shall generally apply to all transactions within the scope
of that grouping. The choice of a grouping, however, applies only to
transactions covered by the grouping and, for transactions not
encompassed by the grouping, the determinations may be made on a
transaction-by-transaction basis or other grouping basis. For example, a
FSC may choose a product grouping with respect to one product and use
the transaction-by-transaction method for another product within the
same taxable year. In addition, if a FSC applies sales activity rules on
the basis of other types of groupings, such as all sales to a particular
customer, transactions included in those other groupings shall be
excluded from product groupings.
(iii) Different groupings allowed for different purposes. A choice
by the FSC to group transactions may be made separately for each of the
sales activities under section 924(d)(1)(A). Groupings used for purposes
of section 924(d)(1)(A) will have no relationship to groupings used for
other purposes, such as satisfying the foreign direct cost tests. This
paragraph (c)(5) does not apply for purposes of section 925.
(6) Examples. The provisions of this paragraph (c) may be
illustrated by the following examples:
Example 1. In November, a calendar year FSC mailed from its foreign
office its catalog to a potential foreign customer. The catalog
displayed numerous products along with a brief description and the price
of each. In February of the following year, the FSC sold to the customer
a product displayed in the catalog. Since the FSC communicated with the
customer during the 12-month period prior to the sale, although during
the previous taxable year, the FSC participated outside the United
States in the solicitation relating to the transaction.
Example 2. A FSC with a taxable year ending April 30, 1986, solicits
customer X during that taxable year with respect to Product A. In the
previous taxable year, the FSC sold product A to customers V, W, X, Y,
Z, none of whom were customers in the taxable year ending April 30,
1986. The sales proceeds from sales to customer X represented 50 percent
of
[[Page 67]]
the foreign trading gross receipts for the previous FSC year. The FSC
meets the 50 percent test for product or product line grouping for the
taxable year ending April 30, 1986. If the facts were changed so that
there was not a FSC, DISC or interest charge DISC in the same controlled
group in the previous taxable year, the single solicitation directed to
any customer would qualify all transactions within the product group as
meeting the solicitation requirement for that taxable year. For
subsequent taxable years, the 50 percent test or the 20 percent test
would be applicable.
Example 3. A FSC earns commissions on the sale of export property by
its domestic related supplier to United States wholesalers for final
sale to foreign customers. The related supplier receives an order from
one of its United States wholesalers. The related supplier telephones
the United States wholesaler to inform it of the new price and the
probability of another price increase soon. The United States wholesaler
orally agrees to the new price and the related supplier instructs the
FSC to telex the wholesaler from its foreign office a confirmation that
the product will be sold at the current new price. The written
confirmation by the FSC of an oral agreement on a variable contract term
constitutes the making of a contract. Thus, the requirements of section
924(d)(1)(A) are met with respect to the transaction relating to the
product.
(d) Satisfaction of either the 50-percent or the 85-percent foreign
direct cost test--(1) In general. Section 924(d)(1)(B) requires, in
order for the gross receipts of a transaction to qualify as foreign
trading gross receipts, that the foreign direct costs incurred by the
FSC attributable to the transaction equal or exceed 50 percent of the
total direct costs incurred by the FSC attributable to the transaction.
The direct costs are those costs attributable to activities described in
the five categories of section 924(e). Section 924(d)(2) provides that,
instead of satisfying the 50-percent foreign direct cost test of section
924(d)(1)(B), the FSC may incur foreign direct costs attributable to
activities described in each of two of those categories that equal or
exceed 85 percent of the total direct costs incurred by the FSC
attributable to the activity described in each of the two categories. If
no direct costs are incurred by the FSC in a particular category, that
category shall not be taken into account for purposes of determining
satisfaction of either the 50-percent or the 85-percent foreign direct
cost test. If any amount of direct costs is incurred in a particular
category, that category shall be taken into account for purposes of the
foreign direct costs tests.
(2) Direct costs--(i) Definition of direct costs. For purposes of
section 924 (d), direct costs are those costs which are incident to and
necessary for the performance of any activity described in section
924(e). Direct costs include the cost of materials which are consumed in
the performance of the activity, and the cost of labor which can be
identified or associated directly with the performance of the activity
(but only to the extent of wages, salaries, fees for professional
services, and other amounts paid for personal services actually
rendered, such as bonuses or compensation paid for services on the basis
of a percentage of profits). Direct costs also include the allowable
depreciation deduction for equipment or facilities (or the rental cost
for use thereof) that can be specifically identified or associated with
the activity, as well as the contract price of an activity performed on
behalf of the FSC by a contractor. If costs of services or the use of
facilities are only incidentally related to the performance of an
activity described in section 924(e), only the incremental cost is
considered to be identified directly with the activity. For example,
supervisory, administrative, and general overhead expenses, such as
telephone service, normally are not identified directly with particular
activities described in section 924(e). The cost of a long distance
telephone call made to arrange for delivery of export property, however,
is identified directly with the activities described in section
924(e)(2). Direct costs for purposes of section 924(d) do not
necessarily include all of the expenses taken into account for purposes
of determining the taxable income of the FSC or the combined taxable
income of the FSC and its related supplier.
(ii) Allocation of direct costs. For purposes of this section only,
if costs are identified with more than one activity (whether or not all
of the activities are described in section 924(e)), the portion of the
costs attributable to each activity shall be determined by allocating
the costs among the activities in any manner that is consistently
applied
[[Page 68]]
and, if applicable, that reasonably reflects relative costs that would
be incurred by performing each activity independently. If costs of an
activity are attributable to more than one transaction or grouping of
transactions, the portion of the costs attributable to each transaction
or grouping shall be determined by allocating the costs among the
transactions or groupings in any manner that is consistently applied
and, if applicable, that reasonably reflects relative costs that would
be incurred by performing the activity independently with respect to
each transaction or grouping.
(3) Total direct costs. The term ``total direct costs'' means all of
the direct costs of any transaction attributable to activities described
in any paragraph of section 924(e). For purposes of the 50-percent
foreign direct cost test of section 924(d)(1)(B), total direct costs are
determined based on the direct costs of all activities described in all
of the paragraphs of section 924(e). For purposes of the 85-percent
foreign direct cost test of section 924(d)(2), however, the total direct
costs are determined separately for each paragraph of section 924(e). If
more than one activity is included within a paragraph of section 924(e),
direct costs must be incurred with respect to at least one activity
listed in the paragraph. If costs are incurred with respect to more than
one activity, all direct costs must be considered for purposes of
satisfying the direct costs test.
(4) Foreign direct costs. The term ``foreign direct costs'' means
the portion of the total direct costs of any transaction which is
attributable to activities performed outside the United States. For
purposes of the 50-percent foreign direct cost test, foreign direct
costs are determined based on the direct costs of all activities
described in all of the paragraphs of section 924(e). For purposes of
the 85-percent foreign direct cost test, however, foreign direct costs
are determined separately for each paragraph of section 924(e).
(5) Fifty percent foreign direct cost test. To satisfy the
requirement of section 924(d)(1)(B), the foreign direct costs incurred
by the FSC attributable to the transaction must equal or exceed 50
percent of the total direct costs attributable to the transaction. This
test looks to the cost of the activities described in section 924(e) on
an aggregate basis; therefore, it is not necessary that the foreign
direct costs of each activity, or of each paragraph of section 924(e),
equal or exceed 50 percent of the total direct costs of that activity or
paragraph.
(6) Eighty-five percent foreign direct cost test--(i) General rule.
To satisfy the requirement of section 924(d)(2), the foreign direct
costs of a transaction incurred by the FSC attributable to activities
described in each of at least two paragraphs of section 924(e) must
equal or exceed 85 percent of the total direct costs attributable to
activities described in that paragraph. This test looks to costs of the
activities on a paragraph-by-paragraph basis (but not on an activity-by-
activity basis). As an example, the foreign direct costs of advertising
and sales promotion are aggregated with each other for this purpose, but
they are not aggregated with the foreign direct costs of transportation.
(ii) Satisfaction of the 85-percent test. If, after the FSC files
its tax return indicating that it has satisfied the 85-percent foreign
direct cost test with respect to each of at least two paragraphs of
subsection 924(e) and a determination is made by the Commissioner that
the foreign direct costs attributable to one or both of the two
paragraphs of section 924(e) specified on the return did not equal or
exceed 85 percent of the total direct costs attributable to such
activities, the FSC may, nonetheless, satisfy the 85-percent foreign
direct cost test if the foreign direct costs attributable to any two
paragraphs of section 924 (e) equal or exceed 85 percent of the total
direct costs attributable to those other paragraphs.
(e) Grouping transactions. Generally, the foreign direct cost tests
under paragraph (d) of this section are to be applied on a transaction-
by-transaction basis. By annual election of the FSC, however, the
foreign direct cost tests may be applied on a customer, contract or
product or product line grouping basis. Any groupings used must be
supported by adequate documentation of performance of activities
[[Page 69]]
and costs of activities relating to the groupings used. An election by
the FSC to group transactions must be made on its annual income tax
return. The FSC may, however, amend its tax return before the expiration
of the statute of limitations under section 6501 of the Code to group in
a manner different from that elected on its original return.
(1) Standards for groupings. A determination by a FSC as to a
grouping will be accepted by the district director if such determination
conforms to any of the following standards:
(i) Product or product line groupings. A product or product line
grouping may be based either on a recognized trade or industry usage, or
on a two digit major grouping (or on any inferior classification or
combination of inferior classifications within a major grouping) of the
Standard Industrial Classification as prepared by the Statistical Policy
Division of the Office of Management and Budget, Executive Office of the
President.
(ii) Customer groupings. A customer grouping includes all
transactions of the FSC with a particular customer during the FSC's
taxable year.
(iii) Contract groupings. A contract grouping includes all
transactions of the FSC under a particular contract, including a
requirements contract. The tests will be applied to all transactions
within a contract grouping during each taxable year of the FSC; however,
by election of the FSC, all transactions under a contract that occur in
the first or the last year of the contract may be included with,
respectively, the next succeeding or the immediately preceding taxable
year in applying these tests. For example, if with respect to
transactions during the first calendar year of a 5-year contract, a
calendar year FSC incurs direct costs attributable to the transactions
of $100X for advertising, all of which are foreign direct costs, and
$10X for processing of customers orders and for arranging for delivery,
$9X (or 90 percent of the total direct costs) of which are foreign
direct costs, the FSC has satisfied the 85-percent foreign direct cost
test with respect to those transactions for the taxable year. If with
respect to transactions during the second year of the contract, the FSC
only incurs $18X of direct costs for processing of customer orders and
arranging for delivery, $15X (83.3 percent of the total direct costs) of
which are foreign direct costs, the FSC may include the transactions
from the first year of the contract to meet the 85-percent foreign
direct cost test in the second taxable year. Thus, with respect to the
transactions in the second year, the FSC satisfies the foreign direct
costs test for advertising (because the entire $100X of direct costs are
foreign direct costs) and for processing of customer orders and
arranging for delivery (because of the $28X of direct costs, $24X or
85.7 percent of the total direct costs are foreign direct costs). If,
however, with respect to transactions in the third year, the FSC
satisfies the foreign direct costs test, those transactions cannot be
included with the transactions in the fourth year. The FSC may aggregate
the direct costs in the fourth and fifth years in the same manner as for
the first and second years as described above in order to satisfy the 85
percent foreign direct costs test.
(iv) Product or product line groupings within customer or contract
groupings. Groupings may be based on product or product line groupings
within customer or contract groupings.
(2) Transactions included in a grouping. An election by the FSC to
group transactions shall generally apply to all transactions within the
scope of that grouping. The election of a grouping, however, applies
only to transactions covered by the grouping and, as to transactions not
encompassed by the grouping, the determinations may be made on a
transaction-by-transaction basis or other grouping basis. For example,
the FSC may elect a product grouping with respect to one product and
elect the transaction-by-transaction method for another product within
the same taxable year. In addition, if a FSC is permitted to apply
either the 50-percent or the 85-percent foreign direct cost test on the
basis of other types of groupings, such as all transactions with respect
to a particular customer, transactions included in those other groupings
shall be excluded from product groupings.
[[Page 70]]
(3) Different groupings allowed for different purposes. An election
by the FSC to group transactions may be made separately for each of the
activities relating to disposition of export property under section
924(d)(1)(B) or section 924(d)(2). Groupings used for purposes of
section 924 will have no bearing on groupings for other purposes. This
paragraph (e) does not apply for purposes of section 925.
(f) Exception for foreign military property--(1) General rule. The
requirements of this section do not apply to any activities performed in
connection with foreign military sales except those activities described
in section 924(e). The FSC is deemed to have satisfied the requirements
of section 924(d)(1)(A).
(2) Example. The principles of paragraph (f)(1) of this section may
be illustrated by the following example:
Example. A FSC earns commissions on foreign military sales by its
related supplier. All solicitation, negotiation, and contract making
activities occur in the United States solely between the related
supplier and the United States government. The property is delivered,
title passes, and payment is made in the United States in accordance
with standard United States government practices. The FSC incurs direct
costs in the amount of $155X to process the government's orders and
arrange for delivery of the goods, all of which are foreign direct
costs. In addition, it incurs foreign direct costs in the amount of
$250X for assembling and transmitting its final invoice to the
government from outside the U.S. and foreign direct costs of $200X
associated with receiving payment from the related supplier in
accordance with the rules of Sec. 1.924(e)-1(d)(2)(iii). No other
activities occur with respect to the foreign military sales. The FSC has
satisfied the 85-percent foreign direct cost test and thus has foreign
trading gross receipts with respect to the foreign military sales. The
fact that the FSC did not participate outside the United States in any
of the sales activities has no bearing on the qualification of the
receipts since the FSC is deemed to have met the requirements of section
924(d)(1)(A).
[T.D. 8125, 52 FR 5090, Feb. 19, 1987]
Sec. 1.924(e)-1 Activities relating to the disposition of export property.
(a) Advertising and sales promotion. For purposes of section 924(e),
advertising and sales promotion are defined as follows.
(1) Advertising--(i) Advertising defined--(A) General rule.
Advertising means the announcement or description of property or
services described in section 924(a), in some medium of mass
communication (such as radio, television, newspaper, trade journals,
mass mailings, or billboards), in order to induce multiple customers or
potential customers to buy or rent the property or services from the FSC
or related supplier. Advertising is not required to be directed to the
general public, but may be focused toward any group of export customers
or potential export customers. Advertising except for the advertising
described in Sec. 1.924(e)-1(a)(1)(B) must describe one or more
specific products or product lines (or services) and identify the
product as a product offered by the FSC or related supplier. Advertising
intended solely to build a favorable image of a company or group of
companies is not included in this definition of advertising.
Additionally, advertising primarily directed at customers or potential
customers in the United States is not included in this definition of
advertising, nor is advertising related to property or services not
described in section 924(a).
(B) Special rules for sales to distributors. If the customer is a
distributor (whether domestic or foreign, related or unrelated to the
FSC), an expense that is incurred by the distributor and charged to the
FSC or related supplier as a reduction in the purchase price or as a
separate charge for an announcement or description described in
paragraph (a)(1)(A) of this section to induce the distributor's
customers, potential customers, or the ultimate users to buy or rent the
property or services is advertising for these purposes (i) if the FSC
incurs 20 percent or more of the total advertising costs of the
distributor or (ii) if the FSC pays the total charge of an advertisement
either directly or indirectly. For these purposes, a distributor is
anyone other than an end user or a final consumer. A FSC may incur
direct advertising costs to a foreign end consumer even though the FSC
sells to a U.S. distributor.
(ii) Direct costs of advertising. Direct costs of advertising
include costs of transmitting, displaying, or distributing the
advertising to customers or potential customers and the costs of
[[Page 71]]
printing in the case of sales literature, but do not include fees paid
to an independent advertising agency to develop the announcement or
description, translation costs, or costs of preparing the announcement
or description for potential use as advertising. Direct costs of sending
sales literature to customers or potential customers may be taken into
account as advertising costs as long as the activity is not taken into
account for purposes of the sales activity requirements of Sec.
1.924(d)-1(c).
(iii) Location of advertising--(A) General rule. The location of
advertising activity is the place to which the advertising is
transmitted, displayed, distributed, mailed, or otherwise conveyed to
the customers or potential customers (or in the case of advertising
described in paragraph (a)(i)(B) of this section, the distributor's
customers, or the ultimate users). For example, a television
advertisement that is broadcast to a foreign country constitutes
advertising activity outside the United States even though the broadcast
signal originates in the United States. Therefore, the cost of that
advertising activity is a foreign cost. The FSC may rely upon the
distribution statistics of the publisher of print media or the
broadcaster of broadcast media through which the advertising is
distributed. If the distribution statistics show that 85 percent or more
of the readership, radio listeners, or viewership are outside the United
States, all direct costs of advertising are considered foreign direct
costs of advertising.
(B) Foreign editions of journals, magazines, etc. Costs related to
advertising in foreign English editions of U.S. publications as well as
advertising in any publication in a foreign language are foreign direct
costs.
(C) United States editions. Costs related to advertising in United
States publications are not treated as direct costs even if the
publication also has a foreign edition in English.
(iv) Second mailings. In general, direct costs of sending sales
literature to customers may be treated as solicitation or advertising,
but not both. A distinction may be made, however, between a first and
second mailing so that one may be treated as advertising and the other
may be treated as solicitation. To qualify under this second mailing
rule, the two mailings must be generically different items such as a
price list and a description of the product itself. An amended price
list would not be distinguishable from an original price list and would,
therefore, not constitute a second mailing.
(v) Examples. The principles of paragraph (a)(1) of this section may
be illustrated by the following examples:
Example 1. The related supplier, under contract with a buy-sell FSC
to advertise export product D on the ``FSC's'' behalf to its foreign
unrelated customers, engaged a French advertising agency to develop an
advertising campaign to induce French customers to buy the product. As a
part of the advertising campaign, the agency places a one-page
advertisement in a relevant French trade journal. The advertisement
constitutes advertising within the meaning of paragraph (a)(1) of this
section.
Example 2. A United States weekly magazine publishes, in addition to
its United States edition, a Canadian edition in English and a Mexican
edition in Spanish. A FSC incurs costs of $200 X for a one-page display
in each of the three editions for a total advertising cost of $600 X.
The $200 X cost relating to the advertising in the United States edition
is not a direct cost because it relates to United States sales. The
total costs of $400 X relating to advertising in the English language
Canadian edition and the Spanish language Mexican edition are foreign
direct costs.
Example 3. A FSC earns commissions on the sale of export product E
by its domestic related supplier to United States distributors for
resale to Canadian retail customers. The related supplier, under
contract with the FSC to advertise product E, pays an amount equal to 1
percent of its annual gross receipts with respect to product E under a
cooperative advertising arrangement with the distributor. The amount,
which represents 20 percent of the total advertising costs for product
E, is reimbursed by the FSC. The 20-percent amount represents a
significant portion of the total advertising costs and thus constitutes
advertising within the meaning of paragraph (a)(1)(i) of this section.
Example 4. A FSC mails two items to each customer on its customer
list within one taxable year. The first mailing consists of a price list
which merely lists the various products by name and provides a price
next to each product name. The second mailing consists of a brochure
which fully describes and illustrates each product. The two mailings are
generically different. Therefore, one mailing may be counted as
advertising while
[[Page 72]]
the other mailing may be counted as solicitation.
(2) Sales promotion--(i) Sales promotion defined. Sales promotion
means an appeal made in person to an export customer or potential export
customer for the sale or rental of property or services described in
section 924(a), made in the context of a trade show or customer meeting.
A customer meeting means a periodic meeting (e.g., quarterly, semi-
annual, or annual) in which 10 or more customers or potential customers
are reasonably expected to attend. However, for taxable years beginning
before February 19, 1987, a customer meeting may, at the option of the
taxpayer, mean any meeting with a customer or potential customer
regardless of the frequency of the meetings or the number of customers
or potential customers in attendance. A meeting, show or event in the
United States that is primarily aimed at the export of goods or services
described in section 924(a) constitutes sales promotion. Sales promotion
does not include an appeal made in the context of any meeting, show or
event primarily aimed at U.S. customers or an appeal for the sale or
rental of property or services not described in section 924(a). Whether
any meeting, show or event is primarily aimed at U.S. customers or at
the export of goods or services described in section 924(a) shall be
determined by all of the facts and circumstances including the announced
objective of the meeting, show or event; the attendees; the location of
the meeting, show or event; and the product or special feature of the
product.
(ii) Direct costs of sales promotion. Direct costs of sales
promotion include costs such as rental of space at trade shows, payments
to organizers or other persons hired for the event, rental of display
equipment and decorations for the event, and costs of maintaining a
showroom. Direct costs of sales promotion also include costs for travel,
meals, and lodging for direct sales people attending the event if these
costs are paid by the FSC or related supplier. In the case of a customer
meeting, direct costs of sales promotion include the costs of materials
printed specifically for the meeting and the costs of travel, lodging,
and food for both the direct sales people and customers or potential
customers attending the meeting. Direct costs of sales promotion do not
include the cost of salaries and commissions of direct sales people or
the cost of discount coupons, samples of the product, or printed
advertising materials that are used for general advertising as well as
sales promotion.
(iii) Location of sales promotion. The location of sales promotion
activity is the place where the trade show or customer meeting is held.
(iv) Examples. The principles of paragraph (a)(2)(i) of this section
may be illustrated by the following examples:
Example 1. The related supplier sells various export products
described in section 924(a) to its foreign customers. As a commission
agent for the related supplier with respect to such sales, the FSC
performs sales promotion. It contracts with the related supplier to
serve as its agent for such purposes. To stimulate the sale of its
export products, the related supplier conducts semi-annual meetings with
the purchasing agents of its customers at its Kansas City headquarters.
Ten or more purchasing agents are reasonably expected to attend each
meeting. At such meetings, the purchasing agents see the related
supplier's manufacturing facilities, visit with its executives, attend
technical updates, and see new export products. These semi-annual
customer meetings constitute sales promotion within the meaning of
paragraph (a)(2)(i) of this section. Direct costs incurred with respect
to the customer meetings are U.S. direct costs because the sales
promotion activities occur within the United States.
Example 2. Assume the same facts as in Example 1, except that the
related supplier exhibits products that only operate on 220 volts at a
trade show in the United States. According to the trade show sponsors,
the purpose of the show is to increase sales abroad of United States-
manufactured products. Since the products exhibited are designed for
operation in foreign countries and the purpose of the trade show is to
boost sales in those countries, the trade show held in the United States
is primarily aimed at the export products described in section 924(a)
and not at United States customers. Thus, the trade show constitutes
sales promotion within the meaning of paragraph (a)(2)(i) of this
section and the direct costs incurred in connection with the trade show
are treated as United States direct costs.
[[Page 73]]
(b) Processing of customer orders and arranging for delivery of the
export property. For purposes of section 924(e), the processing of
customer orders and the arranging for delivery of the export property
are defined in paragraph (b)(1) and paragraph (b)(2), respectively, of
this section. For taxable years beginning after February 19, 1987, if
the FSC performs the activities of processing of customer orders and
arranging for delivery of the export property and elects to group its
transactions, it is considered to have performed the activities with
respect to all transactions in the grouping elected by the FSC under
Sec. 1.924(d)-1(e) during the taxable year if it performs the
activities of processing of customer orders and arranging for delivery
of the export property with respect to customers generating 20 percent
or more of foreign trading gross receipts within the elected grouping.
(1) Processing of customer orders--(i) Processing of customer orders
defined. The processing of customer orders means notification by the FSC
to the related supplier of the order and of the requirements for
delivery. The related supplier may have independent knowledge of the
order and requirements for delivery. If the FSC does not have a related
supplier, the processing of customer orders means communication with the
customer by any method such as telephone, telegram, or mail to
acknowledge receipt of the order and requirements for delivery. Once the
related supplier has been notified by the FSC, or the customer has
received an acknowledgement from the FSC, of the order and requirements
for delivery, subsequent or prior communications with respect to an
order (such as changes in quantity or prospective delivery date) are not
included in the definition of processing of customer orders.
(ii) Direct costs of processing customer orders. Direct costs of
processing of customer orders include salaries of clerical personnel and
costs of telephone, telegram, mail, or other communication media
(including the costs of operating transmission equipment).
(iii) Location of processing of customer orders. The location of
this activity is the place where the communication is initiated by the
FSC.
(iv) Examples. The principles of paragraph (b)(1) of this section
may be illustrated by the following examples:
Example 1. A domestic related supplier, using a FSC as its
commission agent on the sale of export property to foreign customers,
receives an order from one of its foreign customers. Information
concerning the receipt of such order and its requirements for delivery
are transmitted to the FSC. The FSC from its office outside the United
States notifies the related supplier of the order and the requirements
for delivery by telex. This notification by the FSC to the related
supplier constitutes the processing of the customer's order within the
meaning of paragraph (b)(1)(i) of this section. In addition, its direct
costs of processing the customer's order are foreign direct costs
because the communication is initiated by the FSC from outside the
United States.
Example 2. A domestic unrelated supplier manufactures a product
which it sells to a buy-sell FSC located in Germany for resale to the
FSC's German customers. Upon receiving an order from one of its
customers, the FSC telephones the customer from its German office to
acknowledge receipt of the order and the requirements for delivery. The
acknowledgement constitutes the processing of the customer's order
within the meaning of paragraph (b)(1)(i) of this section and the direct
costs attributable thereto are foreign direct costs.
(2) Arranging for delivery--(i) Arranging for delivery defined. The
arranging for delivery of export property means the taking of necessary
steps to have the export property delivered to the customer in
accordance with the requirements of the order. Arranging for delivery
does not include preparation of shipping documents (e.g., bill of
lading) or the property for shipment (i.e., packaging or crating), or
shipment of property (i.e., transportation). Arranging for delivery does
include communications with a carrier or freight forwarder to provide
transportation (as defined in Sec. 1.924(e)-1(c)(1), but without regard
to when the commission relationship for purposes of transportation
begins) for the export property from the FSC or related supplier to the
place where the customer takes possession of the property. Arranging for
delivery also includes communications with the customer to notify the
customer of the time and place of delivery. The carrier or freight
forwarder and the customer may already have knowledge of the information
communicated. If the FSC
[[Page 74]]
has communicated with the carrier or freight forwarder, where
applicable, and the customer to notify it of the time and place of
delivery, prior or subsequent communications to either about delivery
are not included in the definition of arranging for delivery.
(ii) Direct costs of arranging for delivery. The direct costs of
arranging for delivery include salaries of clerical personnel and costs
of telephone, telegraph, mail, and other communications media, but do
not include any actual shipping costs.
(iii) Location of arranging for delivery. The location of arranging
for delivery activity is the place where the activity is initiated by
the FSC.
(iv) Examples. The principles of paragraph (b)(2)(i) of this section
may be illustrated by the following examples:
Example 1. A FSC earns commissions on the sale of export property by
its domestic related supplier to foreign customers. The shipment term of
all of the related supplier's sales is F.O.B. (Free on Board) its
manufacturing plant in Gary, Indiana. Thus, there is no transportation
as defined in Sec. 1.924(e)-1(c)(1) with respect to its sales. From its
shipping department at the plant, the related supplier telephones
carriers to arrange for delivery. It also notifies the FSC by mail of
the time and place of delivery of the customer's orders. The FSC from
its office outside the United States transmits the received information
to the customers. Because there is no transportation to be arranged,
this communication alone by the FSC to the customers to notify them of
the time and place of delivery constitutes arranging for delivery within
the meaning of paragraph (b)(2)(i) of this section.
Example 2. Assume the same facts as in Example 1, except that the
shipment term of all of the related supplier's sales is C.I.F. (Cost,
Insurance, Freight) and that the commission relationship for
transportation begins after the export property leaves the United States
customs territory. The related supplier telephones a trucking firm and
an overseas carrier from its plant in Gary, Indiana to ascertain
information on transporting its property by truck to the docks, and by
overseas carrier from the docks to the place where the customer takes
possession. Upon receiving the necessary information, the related
supplier electronically transmits to the FSC the shipping information
and the time and place of delivery to the customer. In addition, it
instructs the FSC to communicate the necessary shipping information to
the carriers to ensure shipment and to notify the customer of the time
and place of delivery. The FSC does both from its office located outside
of the United States. The communications by the FSC to the carriers and
the customer constitute arranging for delivery within the meaning of
paragraph (b)(2)(i) of this section.
(c) Transportation--(1) Transportation defined. For purposes of
section 924(e), transportation means moving or shipping the export
property during the period when the FSC owns or is responsible for the
property, or, if the FSC is acting as a commission agent, during the
period when the related supplier owns or is responsible for the property
but after the commission relationship for purposes of transportation
begins (even if the relationship begins after the property leaves the
U.S. customs territory). The FSC or related supplier is treated as
responsible for the property when it either has title, bears the risk of
loss, or insures the property during shipment. Since a commission FSC
will not generally have title or bear the risk of loss, it will,
nevertheless, satisfy the transportation test if the related supplier
has either title, bears the risk of loss, or insures the property during
shipment. Examples of methods of shipping which would qualify as
transportation include F.O.B. (Free on Board) destination, C.I.F. (Cost,
Insurance, Freight), Ex Ship, and Ex Quay, but do not include C. & F.
(Cost and Freight) or F.O.B. shipping point.
(2) Direct costs of transportation. The direct costs of
transportation include the expenses of shipping, such as fees paid to
carriers and freight forwarders, costs of freight insurance, and
documentation fees. With respect to fungible commodities, direct costs
include only those costs incurred after the goods have been identified
to a contract. Transportation costs do not include any of the costs of
arranging for delivery. The FSC is considered to engage in
transportation activity whenever it pays the costs of shipping the
export property and the property is shipped during the period when the
FSC owns or is responsible for the property as provided in paragraph
(c)(1) of this section. If the customer pays the shipping costs
directly, the FSC is not considered to engage in transportation
activity. If, however, the FSC pays the shipping costs, the ultimate
[[Page 75]]
transfer of those costs to the customer will not disqualify the FSC from
engaging in transportation for purposes of section 924(e) regardless of
whether the costs are included in the sale price of the export property
or separately stated.
(3) Location of transportation. The location of transportation
activity is the area over which the property is transported. Thus, the
portion of total direct costs of transportation treated as foreign
direct costs is the portion attributable to transportation outside the
United States, determined on the basis of the ratio of mileage outside
the U.S. customs territory to total mileage. For purposes of determining
mileage outside U.S. customs territory, goods are treated as leaving
U.S. customs territory when they have been tendered to an international
carrier for shipment to a foreign location, as long as they are not
removed from the custody of the carrier before they reach a point
outside U.S. customs territory. The same rule for determining mileage
outside the U.S. customs territory will apply to freight forwarders if
(i) the forwarder has the risk of loss or is an insurer of the goods,
and (ii) the property is shipped on a single bill of lading issued to
the FSC or its agent as the shipper.
(4) Examples. The principles of paragraph (c) of this section may be
illustrated by the following examples:
Example 1. A buy-sell FSC sells export property to a customer
located in Canada. The contract between the FSC and the customer
requires that the property be shipped F.O.B. its Canadian destination.
Under this shipment term, the FSC holds title and bears the risk of loss
until the property is tendered at its Canadian destination. Thus, it is
responsible for the property during shipment. The FSC instructs its
related supplier to ship the property from its manufacturing facilities
in St. Louis. The related supplier negotiates two contracts, one for
domestic transportation and the second for foreign transportation. A
domestic trucking firm transports the property to the Canadian border
where a Canadian trucking company is used to transport the property to
its Canadian destination. The documentation fees and the fees for the
two trucking firms are paid by the FSC. Because the FSC paid the costs
of shipping and the property was shipped during the period when the FSC
was responsible for the property, the FSC has engaged in transportation
activity, the direct costs of which are the fees paid by the FSC. If 70
percent of the mileage from St. Louis to the Canadian destination is
associated with the transportation from the Canadian border to the
Canadian destination, 70 percent of the FSC's direct transportation
costs are foreign direct costs. If, instead of using two trucking firms,
the FSC had tendered the goods to a freight forwarder for shipment to a
foreign location and the freight forwarder assumed the risk of loss for
the goods and issued a single bill of lading, all of the fees paid by
the FSC to the freight forwarder would be foreign direct costs.
Example 2. A related supplier sells export property to its foreign
customer in Liverpool, England. The contract between the related
supplier and the customer requires that the property be shipped C.I.F.
Liverpool. The related supplier engages the FSC as its commission agent
with respect to its sales to the customer, requiring the FSC to provide
transportation to the customer. The FSC contracts with the related
supplier to provide the transportation on behalf of the FSC. The
commission agreement between the related supplier and the FSC provides
that the FSC's responsibilities with respect to transportation of the
export property begins after the property leaves the U.S. customs
territory. The related supplier hires a domestic trucking firm to
transport the shipment to a New York City port where it is loaded on a
cargo ship destined for Liverpool at a total cost of $3,000X, $2,750X of
which is allocable to mileage from the U.S. customs territory to
Liverpool, England. Because the related supplier insures the property
during shipment under C.I.F., the property is shipped during the period
when the related supplier is treated as responsible for the property.
Thus, the FSC, as the related supplier's commission agent, has satisfied
the transportation test. In addition, because the FSC's responsibilities
with respect to transportation begins when the property leaves U.S.
customs territory, the FSC's payment of $2,750X is a foreign direct cost
of transportation. The remaining $250X is not a direct cost of
transportation to the FSC because the amount was expended before the
commission relationship between the FSC and related supplier began.
Example 3. A FSC earns commissions on sales by the related supplier
of export property, all of which falls within a single two-digit SIC
group. The related supplier is under contract to the FSC to perform on
the FSC's behalf all of the section 924(e) activities attributable to
the sales. Of all of the sales made during the year, the FSC has no
transportation costs with respect to the sales to customer R because the
shipment term is F.O.B. the related supplier's Chicago plant. With
respect to the sales to customer S, the FSC ships the property F.O.B.
its destination
[[Page 76]]
and pays 100 percent of the transportation costs, all of which are
foreign direct costs because the commission relationship for
transportation begins outside the U.S. customs territory. For purposes
of determining whether the FSC has satisfied the 85-percent foreign
direct cost test for transportation, the FSC groups the sales by
product. Because the transportation costs for sales to customer S are
100-percent foreign direct costs and because there are no transportation
costs on sales to customer R, the FSC is considered to have met the 85-
percent foreign direct cost test for transportation for all the sales in
the single two-digit SIC group.
(d) Determination and transmittal of a final invoice or statement of
account and receipt of payment. For purposes of section 924(e), the
determination and transmittal of a final invoice or statement of account
and the receipt of payment are defined as follows.
(1) Determination and transmittal of a final invoice or statement of
account--(i) Definitions--(A) In general. The determination and
transmittal of a final invoice or statement of account means the
assembly of either a final invoice or statement of account and the
forwarding of that document to the customer. A FSC may elect to send
either final invoices or statements of account and disregard any costs
of the alternative not elected. For taxable years beginning after
February 19, 1987, a special grouping rule is provided. If the FSC
assembles and forwards either a statement of account or a final invoice
from outside the United States to customers with sales representing 50
percent of the current year foreign trading gross receipts within a
product or product line grouping or to customers with sales representing
50 percent of the prior year foreign trading gross receipts within a
product or product line grouping utilized for the current year, all
other U.S. costs will be disregarded and the FSC will be deemed to have
no U.S. costs with respect to the determination and transmittal of a
final invoice or statement of account. If, during the prior taxable
year, the controlled group of which the FSC is a member had a DISC or
interest charge DISC, the FSC may apply the 50 percent rule by taking
into account the customers and sales of the DISC or interest charge DISC
for the preceding taxable year. If no foreign trading gross receipts (or
qualified export receipts for DISC purposes) were received in the prior
year either by the FSC or by a DISC or interest charge DISC within the
controlled group of which the FSC is a member, the FSC must apply the 50
percent rule taking into account customers and foreign trading gross
receipts for the current year. In the event that the 50 percent rule is
not satisfied, all costs associated with assembly and forwarding of the
selected documents (invoices or statements of account) must be included
in the costs attributable to activities described in section 924(e)(4).
(B) Final invoice defined. A final invoice is an invoice upon which
payment is made by the customer. A final invoice must contain the
customer's name or identifying number and, with respect to the
transaction or transactions, the date, product or service, quantity,
price, and amount due. In the alternative, a document will be acceptable
as a final invoice even though it does not include all of the above
listed information if the FSC establishes that the document is
considered to be a final invoice under normal commercial practices. An
invoice forwarded to the customer after payment has been tendered or
received pursuant to a letter of credit as a receipt for payment
satisfies this definition.
(C) Statement of account defined. A statement of account is any
summary statement forwarded to a customer to inform of, or confirm, the
status of transactions occurring within an accounting period during a
taxable year that is not less than one month. A statement of account
must contain, at a minimum, the customer's name or identifying number,
date of the statement of account as of the last day of the accounting
period covered by the statement of account and the balance due (even if
the balance due is zero). A single final invoice or statement of account
can cover more than one transaction with one customer. In the
alternative, a document will be accepted as a statement of account even
though it does not include all of the above listed information if the
FSC establishes that the document is considered a statement of account
under normal commercial practice. For these purposes, a
[[Page 77]]
document will be considered to be a statement of account under normal
commercial practices if it is sent to domestic as well as to export
customers in order to inform the customers of the status of transactions
during an accounting period. Additional information may be sent
separately, such as summary statements forwarded to a related party for
purposes of reconciling intercompany accounts for financial reporting
requirements. If the information is sent separately, the direct costs
associated with the assembly and forwarding of that information are not
considered for purposes of section 924(d).
(D) Assembly and forwarding defined. Assembly means folding the
documents (where applicable), filling envelopes, and addressing
envelopes (if window envelopes are not used). Forwarding means mailing
or delivery.
(ii) Direct costs of determination and transmittal of final invoice
or statement of account. Direct costs of this activity include costs of
office supplies, office equipment, clerical salaries and costs of
mailing or other delivery services, if the costs can be identified or
associated directly with the assembly and transmittal of a final invoice
or statement of account. Costs of establishing a price, or of
communicating prices or other billing information between the FSC and a
related supplier are not direct costs of this activity. In addition, the
costs of preparing and mailing the final invoices or statements of
account to the FSC and the costs of accumulating and formatting data for
invoicing or statements of account on computer discs, tapes, or some
other storage media along with the costs of transmitting or transporting
this data to the FSC are not direct costs of this activity.
(iii) Location of determination and transmittal of a final invoice
or statement of account. For taxable years beginning before February 19,
1987, the location of this activity is the place where the final invoice
or statement of account is assembled for forwarding to the customer or
the place from which it is forwarded to the customer. Thus, the
forwarding of the final invoice or statement of account from outside the
United States is sufficient to source this activity outside the United
States. For all other taxable years, the location of this activity is
the place where the final invoice or statement of account is both
assembled and forwarded to the customer.
(iv) Examples. The principles of paragraph (d)(1) of this section
may be illustrated by the following examples, all of which apply to
taxable years beginning on or after February 19, 1987.
Example 1. A related supplier sells export property to its foreign
customers. The related supplier engages the FSC as its commission agent
with respect to the sales, requiring the FSC to determine and transmit
final invoices or statements of account to the customers with respect to
the sales. Annually, the FSC assembles and forwards statements of
account to customers representing 40 percent of current year export
sales and 35 percent of prior year sales. The statements are sent from
its office outside of the United States. The remaining statements of
account are sent from the Albany, New York office of the related
supplier. The statements are recognized in its industry as a statement
of account. Although the statement does not contain all of the
information described in Sec. 1.924(e)-1(d)(1)(i), it is sent to both
domestic and foreign customers of the related supplier to inform the
customer of the status of its transactions with the related supplier.
The document qualifies as a statement of account under Sec. 1.924(e)-
1(d)(1)(i); however, the 50 percent test set forth in Sec. 1.924(e)-
1(d)-1(d)(1)(i)(A) is not satisfied. Therefore, the FSC must take into
account all domestic direct costs attributable to assembly and
forwarding of statements of account from its domestic office in
determining whether the FSC has satisfied the direct costs test with
respect to section 924(e)(4) and Sec. 924 (e)-1(d).
Example 2. Employees of a FSC, in the FSC's foreign office, fold and
place in envelopes the sheet or sheets that constitute the final
invoices provided by the related supplier. In addition, the employees
address, affix postage to, and mail the envelopes. These activities
constitute the determination and transmittal of the final invoices
within the meaning of paragraph (d)(1)(i) of this section and, because
the final invoices are assembled and forwarded to the customers from
outside the United States, all the direct costs of the activities are
foreign direct costs.
Example 3. The related supplier sends to the FSC's foreign office a
computer tape to be used to prepare a statement of account. A management
company, working under contract with the FSC, transcribes the data to a
piece of paper which is a statement of account for purposes of Sec.
1.924(d)(1)(i), folds the
[[Page 78]]
document, and fills, affixes postage to, and mails the envelopes. Only
the costs performed by the management company under contract with the
FSC that constitute the assembly and forwarding of a statement of
account under Sec. 1.924(e)-1(d)(1)(i)(D) are direct costs. Therefore,
the costs attributable to transcribing the data to a piece of paper are
not direct costs for purposes of section 924(e)(4).
(2) Receipt of payment--(i) Receipt of payment defined. Receipt of
payment means the crediting of the FSC's bank account by an amount which
is not less than 1.83 percent of the gross receipts (``gross receipts
amount'') associated with the transaction. The FSC's bank account is not
credited unless the FSC has the authority to withdraw the amount
deposited. Where sales proceeds are factored or where payments from
related foreign subsidiaries are netted against amounts owed to these
foreign subsidiaries in an intercompany account, crediting of the FSC's
bank account with no less than the gross receipts amount of the
factoring proceeds or the proceeds, net of offsets, respectively,
qualifies as receipt of payment. In addition, where a FSC is precluded
from receiving a portion of the proceeds of the export transaction, the
FSC may satisfy receipt of payment by receiving no less than the gross
receipts amount of the remaining portion of the proceeds in its bank
account. In the case of advance or progress payments, each payment
constitutes a payment for receipt of payment purposes.
(ii) Direct costs of receipt of payment. Direct costs of receiving
payment include the expenses of maintaining a bank account of the FSC in
which payment is deposited, any fees or service charges incurred for
converting the payment into U.S. currency, and any transfer fees
incurred with respect to the transfer of funds into and out of the FSC's
bank account in accordance with the 35 calendar day rule in paragraph
(d)(2)(iii) of this section. The transfer fees and the fees or service
charges incurred for currency conversion are considered to be foreign
direct costs of receiving payment; however, exchange losses are not
costs of receiving payment.
(iii) Location of receipt of payment. The location of this activity
is the office of the banking institution at which the account is
maintained. If payment is made by the purchaser directly to the FSC or
the related supplier in the United States, and the FSC or related
supplier transfers the gross receipts amount associated with the
transaction to a bank account of the FSC outside the United States after
receipt of payment (i.e., cash, check, wire transfer, etc.), but no
later than 35 calendar days after receipt of good funds (i.e., the
clearance of the check) the FSC is considered to have received payment
outside the United States. Therefore, all transfer fees and the costs of
the foreign bank account are treated as foreign direct costs. The United
States bank costs are disregarded. If, however, the related supplier
does not transfer the gross receipts amount within 35 calendar days,
United States bank costs are not disregarded and are domestic direct
costs. In either case, the transfer costs, currency conversion charges,
and foreign bank costs remain foreign direct costs. The preceding rules
apply both to commission FSCs and buy-sell FSCs.
(iv) Examples. The principles of paragraph (d)(2) of this section
may be illustrated by the following examples:
Example 1. A FSC earns commissions on sales of export property by
its related supplier. The related supplier manufactures and sells its
export property to its foreign subsidiaries for resale in their
respective countries. From time to time, the foreign subsidiaries will
return products to the related supplier for credit and, from time to
time, the foreign subsidiaries purchase products in their respective
countries and sell such products to the related supplier. These
transactions result in various amounts being owed to the foreign
subsidiaries. Each month the various inter-company obligations are
reviewed. The result of such review of inter-company indebtedness is a
netting out of the various intercompany liabilities on the books, to the
extent possible, and a flow of funds for the net obligation. Due to the
nature of these transactions, the amounts owed by the foreign
subsidiaries exceed the amounts which the related supplier owes to the
foreign subsidiaries. The gross receipts amount (i.e., 1.83 percent of
this net amount) is credited to the FSC's bank account. This constitutes
receipt of payment for purposes of paragraph (d)(2)(i) of this section.
Example 2. In a leveraged lease transaction, a FSC-lessor obtains
purchase financing
[[Page 79]]
from a lending institution. The lending institution retains a security
interest in the proceeds and requires that a portion of each rental
payment be paid by the lessee directly to the lending institution. Since
the FSC is precluded from receiving a portion of the proceeds of the
export transaction, the FSC may satisfy the receipt of payment
requirement by receiving the gross receipts amount with respect to the
remaining proceeds.
Example 3. A buy-sell FSC sells its export property to a foreign
customer and is paid by means of a ``draw-down'' letter of credit. Over
a substantial period of time prior to delivery of the export property,
amounts are advanced to the FSC under the letter of credit. At delivery,
the remaining amount available is paid. Each payment made to the FSC
constitutes a payment for receipt of payment purposes and thus the gross
receipts amount related to each payment must be credited to the FSC's
bank account.
Example 4. An FSC earns commissions on sales of export property by
its related supplier. The related supplier regularly collects payments
from its foreign customers in a San Francisco bank account and, after
the San Francisco bank has collected on the checks, transfers, within 35
calendar days, the gross receipts amounts from its New York bank account
to the FSC's bank account located outside the United States. The FSC
incurred transfer fees of $160X in addition to a fee of $35X for the
maintenance of the FSC's bank account outside the United States during
the 35 calendar day period. The maintenance fee relating to the United
States bank account for the 35 calendar day period is $45X. The receipt
of payment test is met because the gross receipts amounts are
transferred after payment but within 35 calendar days to the FSC's bank
account located outside the United States. The transfer fees of $160X
and the maintenance fee of $35X relating to the FSC's foreign bank
account are foreign direct costs. The $45X maintenance fee related to
the United States bank account is not a direct cost. If the gross
receipts amounts had not been transferred to the FSC's foreign bank
account within 35 calendar days, the $45X maintenance fee related to the
United States bank account would be considered a United States direct
cost. The transfer fee of $160X and the maintenance fee of $35X relating
to the FSC's foreign bank account, however, would, nonetheless, be
considered as foreign direct costs. The same funds received in San
Francisco need not be transferred to the FSC's foreign bank account
because money is fungible. For the same reason, the gross receipts
amounts need not be transferred from the same bank account in which the
payments are received.
(e) Assumption of credit risk--(1) Assumption of credit risk
defined. For purposes of section 924(e), the assumption of credit risk
means bearing the economic risk of nonpayment with respect to a
transaction. If the FSC is acting as a commission agent for the related
supplier, this risk is borne by the FSC if the commission contract
transfers the costs of the economic risk of nonpayment with respect to
the transaction from the related supplier to the FSC. The FSC may elect
on its annual return to bear the economic risk of nonpayment with
respect to its transactions during a taxable year by either--
(i) Assuming the risk of a bad debt in accordance with the rules of
paragraph (e)(4)(i) of this section,
(ii) Obtaining insurance to cover nonpayment,
(iii) Investigating credit of a customer or a potential customer,
(iv) Factoring trade receivables, or
(v) Selling by means of letters of credit or banker's acceptances.
Only the alternative elected to be performed by the FSC during a taxable
year is relevant for purposes of section 924(d). For example, if a buy-
sell FSC elects to bear the economic risk of nonpayment with respect to
its transaction during a taxable year by assuming the risk of a bad debt
in accordance with the rules of paragraph (e)(4)(i) of this section, and
also factors the transaction's trade receivables, only the direct costs
of assuming the risk of a bad debt are relevant for purposes of section
924(d). For purposes of this paragraph, a potential customer is an
unrelated person who is engaged in the purchase or sale of export
property on whom an investigation is performed, but with whom no export
sales contract is executed.
(2) Direct costs of assumption of credit risk. (i) With respect to
assuming the risk of a bad debt, the direct costs of the assumption of
credit risk in the case of a buy-sell FSC include debts that become
uncollectible and charges taken into account in determining additions to
bad debt reserves of the FSC. In the case of a commission FSC, the
direct costs of the assumption of credit risk include the assumption of
the debts and charges of the related supplier attributable to export
sales that are allowed as deductions under section 166.
[[Page 80]]
(ii) With respect to insurance, the direct costs of the assumption
of credit risk are the costs of obtaining insurance against the risk of
nonpayment. Qualifying insurance must be obtained from an unrelated
insurer and must cover the risk of nonpayment due to default and
bankruptcy by the purchaser. Insurance obtained from a related insurer,
or insurance that covers default and bankruptcy due to risks of war or
political unrest without covering ordinary default or bankruptcy is not
sufficient.
(iii) With respect to investigating credit, the direct costs of
assumption of credit risk are the external costs of investigating credit
for customers or potential customers, including costs of membership in a
credit agency or association for that purpose (but not the costs of
approving credit by an internal credit agency).
(iv) With respect to factoring trade receivables, the direct costs
of assumption of credit risk are the costs of factoring trade
receivables of related and unrelated customers (e.g. the amount of the
discount and the fees relating to factoring).
(v) With respect to letters of credit or banker's acceptances, the
direct costs of assumption of credit risk are the costs of letters of
credit or banker's acceptances and the documentary collection costs.
(3) Location of assumption of credit risk. The location of the
activity of assumption of credit risk is the location of the customer or
obligor whose payment is at risk, except that the location of
investigating credit is the location of the credit agency or association
performing the investigation. A foreign branch of a United States
corporation and a foreign office of the United States government are not
foreign obligors for purposes of this test. A foreign branch of a United
States credit investigation agency or association, however, is treated
as located outside the United States.
(4) Special rules--(i) Assuming the risk of a bad debt--(A) In
general. If a FSC chooses to bear the economic risk of nonpayment by
assuming the risk of a bad debt with respect to a transaction or
grouping of transactions and an actual bad debt loss on a foreign
trading gross receipt is not incurred in any three consecutive years,
the FSC will be deemed to have performed this activity during the first
two years of the three year period. For the third year, the FSC will not
be deemed to have performed this activity and must satisfy the 85
percent foreign direct costs test by satisfying any two paragraphs
included within section 924(e) other than assumption of credit risk
activity under section 924(e)(5). An actual bad debt loss will only
satisfy the activity test with respect to a single three consecutive
year period.
(B) Example. The principles of this paragraph may be illustrated by
the following example:
Example. In year 1, a related supplier of a commission FSC incurs a
bad debt with respect to foreign trading gross receipts owed by a
foreign obligor. This expense is the only bad debt incurred with respect
to foreign trading gross receipts in year 1. Therefore, the direct costs
for the bearing of the economic risk of nonpayment for year 1 are all
foreign direct costs and the 85-percent test is satisfied. In year 2,
the FSC incurs a bad debt with respect to a U.S. broker/consolidator.
The direct costs for year 2 are U.S. direct costs and, therefore, the
85-percent test is not satisfied. No bad debt is incurred in year 3.
Because a bad debt with respect to a foreign obligor is incurred in year
1, the FSC is deemed to have satisfied the economic risk of nonpayment
for each of years 1, 2 and 3.
(ii) Grouping with respect to other risk activities. For taxable
years beginning after February 19, 1987, if a FSC elects to bear the
economic risk of nonpayment by performing one of the activities
described in paragraph (e) of this section and elects to group
transactions, it is considered to have performed the elected activity
with respect to all transactions within the group during the taxable
year if it performs the activity in accordance with the following rules.
If a FSC elects to factor trade receivables, at least 20 percent of the
face amount of a group's receivables must be factored. If a FSC elects
to sell by means of letters of credit or banker's acceptances, a fee
must be incurred with respect to 20 percent of the foreign trading gross
receipts attributable to sales within the
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group. If the FSC elects to obtain insurance to cover nonpayment, 20
percent of the face amount of receivables attributable to sales included
in the Sec. 1.924(d)-1(e) grouping elected by the FSC must be insured.
If a FSC elects to investigate credit of customers or potential
customers, 20 percent of new or potential customers for which a credit
investigation is performed must be investigated.
[T.D. 8125, 52 FR 5094, Feb. 19, 1987]
Sec. 1.925(a)-1 Transfer pricing rules for FSCs.
(a)-(c)(7) [Reserved] For further guidance, see Sec. 1.925(a)-1T(a)
through (c)(7).
(c)(8) Grouping transactions. (i) The determinations under this
section are to be made on a transaction-by-transaction basis. However,
at the annual choice made by the related supplier if the administrative
pricing methods are used, some or all of these determinations may be
made on the basis of groups consisting of products or product lines. The
election to group transactions shall be evidenced on Schedule P of the
FSC's U.S. income tax return for the taxable year. No untimely or
amended returns filed later than one year after the due date of the
FSC's timely filed (including extensions) U.S. income tax return will be
allowed to elect to group, to change a grouping basis, or to change from
a grouping basis to a transaction-by-transaction basis (collectively
``grouping redeterminations''). The rule of the previous sentence is
applicable to taxable years beginning after December 31, 1999. For any
taxable year beginning before January 1, 2000, a grouping
redetermination may be made no later than the due date of the FSC's
timely filed (including extensions) U.S. income tax return for the FSC's
first taxable year beginning on or after January 1, 2000.
Notwithstanding the time limits for filing grouping redeterminations
otherwise specified in the previous three sentences, a grouping
redetermination may be made at any time during the one-year period
commencing upon notification of the related supplier by the Internal
Revenue Service of an examination, provided that both the FSC and the
related supplier agree to extend their respective statutes of
limitations for assessment by one year. In addition, any grouping
redeterminations made under this paragraph must meet the requirements
under Sec. 1.925(a)-1T(e)(4) with respect to redeterminations other
than grouping. The language ``or grouping of transactions'' is removed
from the fourth sentence of Sec. 1.925(a)-1T(e)(4), applicable to
taxable years beginning after December 31, 1997. See also Sec.
1.925(b)-1T(b)(3)(i).
(c)(8)(ii)-(f) [Reserved] For further guidance, see Sec. 1.925(a)-
1T(c)(8)(ii) through (f).
(g) Effective date. The provisions of this section apply on or after
March 2, 2001.
[T.D. 8944, 66 FR 13428, Mar. 6, 2001]
Sec. 1.925(a)-1T Temporary regulations; transfer pricing rules for FSCs.
(a) Scope--(1) Transfer pricing rules. In the case of a transaction
described in paragraph (b) of this section, section 925 permits a
related party to a FSC to determine the allowable transfer price charged
the FSC (or commission paid to the FSC) by its choice of the three
transfer pricing methods described in paragraphs (c)(2), (3), and (4) of
this section: The ``1.83 percent'' gross receipts method and the ``23
percent'' combined taxable income method (the administrative pricing
rules) of section 925(a)(1) and (2), respectively, and the section 482
method of section 925(a)(3). (Any further reference to a FSC in this
section shall include a small FSC unless indicated otherwise.) Subject
to the special no-loss rule of Sec. 1.925(a)-1T(e)(1)(iii), any, or
all, of the transfer pricing methods may be used in the same taxable
year of the FSC for separate transactions (or separate groups of
transactions). If either of the administrative pricing methods (the
gross receipts method or combined taxable income method) is applied to a
transaction, the Commissioner may not make distributions,
apportionments, or allocations as provided by section 482 and the
regulations under that section. The transfer price charged the FSC (or
the commission paid to the FSC) on a transaction with a person that is
not a related party to the FSC may be determined in any manner agreed to
by the FSC and that person. However, the Commissioner will use special
scrutiny
[[Page 82]]
to determine whether a person selling export property to a FSC (or
paying a commission to a FSC) is a related party to the FSC with respect
to a transaction if the FSC earns a profit on the transaction in excess
of the profit it would have earned had the administrative pricing rules
applied to the transaction.
(2) Special rules. For rules as to certain ``incomplete
transactions'' and for computing full costing combined taxable income,
see paragraphs (c)(5) and (6) of this section. For a special rule as to
cooperatives and computation of their combined taxable incomes, see
paragraph (c)(7) of this section. Grouping of transactions for purposes
of applying the administrative pricing method chosen is provided for by
paragraph (c)(8) of this section.
The rules in paragraph (c) of this section are directly applicable only
in the case of sales or exchanges of export property to a FSC for
resale, and are applicable by analogy to leases, commissions, and
services as provided in paragraph (d) of this section. For a rule
providing for the recovery of the FSC's costs in an overall loss
situation, see paragraph (e)(1)(i) of this section. Paragraph (e)(2) of
this section provides for the applicability of section 482 to resales by
the FSC to related persons or to sales between related persons prior to
the sale to the FSC. Paragraph (e)(3) of this section provides for the
creation of receivables if the transfer price, rental payment,
commission or payment for services rendered is not paid by the due date
of the FSC's income tax return for the taxable year under section
6072(b), including extensions provided for by section 6081. Provisions
for the subsequent determination and further adjustment to the relevant
amounts are set forth in paragraphs (e)(4) and (5) of this section.
Paragraph (f) of this section has several examples illustrating the
provisions of this section. Section 1.925(b)-1T prescribes the marginal
costing rules authorized by section 925(b)(2). Section 1.927(d)-2T
provides definitions of related supplier and related party.
(3) Performance of substantial economic functions--(i)
Administrative pricing methods. The application of the administrative
pricing methods of section 925 (a)(1) and (2) does not depend on the
extent to which the FSC performs substantial economic functions beyond
those required by section 925(c). See paragraph (b)(2)(ii) of this
section and Sec. 1.924(a)-1T(i)(1).
(ii) Section 482 method. In order to apply the section 482 method of
section 925(a)(3), the arm's length standards of section 482 and the
regulations under that section must be satisfied. In applying the
standards of section 482, all of the rules of section 482 will apply.
Thus, if the FSC would not be recognized as a separate entity, it would
also not be recognized on application of the section 482 method.
Similarly, if a FSC performs no substantial economic function with
respect to a transaction, no income will be allocable to the FSC under
the section 482 method. See Sec. 1.924(a)-1T(i)(2). If a related
supplier performs services under contract with a FSC, the FSC will not
be deemed to have performed substantial economic functions for purposes
of the section 482 method unless it compensates the related supplier
under the provisions of Sec. 1.482-2(b)(1) through (7). See Sec.
1.925(a)-1T(c)(6)(ii) for the applicability of the regulations under
section 482 in determination of the FSC's profit under the
administrative pricing methods.
(b) Transactions to which section 925 applies--(1) In general. The
transfer pricing methods of section 925 (the administrative pricing
methods and the section 482 method) will apply, generally, only if a
transaction, or group of transactions, gives rise to foreign trading
gross receipts (within the meaning of section 924(a) and Sec. 1.924(a)-
1T) to the FSC (or small FSC, as defined in section 922(b) and Sec.
1.921-2(b) (Q&A3)). However, the transfer pricing methods will apply as
well if the FSC is acting as commission agent for a related supplier
with regard to a transaction, or group of transactions, on which the
related supplier is the principal if the transaction, or group of
transactions, would have resulted in foreign trading gross receipts had
the FSC been the principal.
(2) Application of the transfer pricing rules--(i) Section 482
method. The section 482 transfer pricing method may be applied to any
transaction between
[[Page 83]]
a related supplier and a FSC if the requirements of paragraph (a)(3)(ii)
of this section have been met.
(ii) Administrative pricing methods. The administrative pricing
methods may be applied in situations in which the FSC is either the
principal or commission agent on the transaction, or group of
transactions, only if the requirements of section 925(c) are met.
Section 925(c) requires that the FSC performs all the activities
described in subsections (d)(1)(A) and (e) of section 924 that are
attributable to a particular transaction, or group of transactions. The
FSC need not perform any activities with respect to a particular
transaction merely to comply with section 925(c) if that activity would
not have been performed but for the requirements of that subsection. The
FSC need not perform all of the activities outside the United States.
None of the activities need be performed outside the United States by a
small FSC. Rather than the FSC itself performing the activities required
by section 925(c), another person under contract, written or oral,
directly or indirectly, with the FSC may perform the activities (see
Sec. 1.924(d)-1(b)). If a related supplier is performing the required
activities on behalf of the FSC with regard to a transaction, or group
of transactions, the requirements of section 925(c) will be met if the
FSC pays the related supplier an amount equal to the direct and indirect
expenses related to the required activities. See paragraph (c)(6)(ii) of
this section for the amount of compensation due the related supplier.
The payment made to the related supplier must be reflected on the FSC's
books and must be taken into account in computing the FSC's and related
supplier's combined taxable income. If it is determined that the related
supplier was not compensated for all the expenses related to the
required activities or if the entire payment is not reflected on the
FSC's books or in computing combined taxable income, the administrative
pricing methods may be used but proper adjustments will be made to the
FSC's and related supplier's books or income. At the election of the FSC
and related supplier, the requirements of section 925(c) will be deemed
to have been met if the related supplier is paid by the FSC an amount
equal to all of the costs under paragraph (c)(6)(iii)(D) of this section
(limited by paragraph (c)(6)(ii) of this section) related to the export
sale, other than expenses relating to activities performed directly by
the FSC or by a person other than the related supplier, and if that
payment is reflected on the FSC's books and in computing the FSC's and
related supplier's combined taxable income on the transaction, or group
of transactions. If it is determined that the related supplier was not
compensated for all its expenses or if the entire payment is not
reflected on the FSC's books or in computing combined taxable income,
the administrative pricing methods may be used but proper adjustments
will be made to the FSC's and related supplier's books or income. All
activities that are performed in connection with foreign military sales
are considered to be performed by the FSC, or under contract with the
FSC, if they are performed by the United States government even though
the United States government has not contracted for the performance of
those activities. All actual costs incurred by the FSC and related
supplier in connection with the performance of those activities must be
taken into account, however, in determining the combined taxable income
of the FSC and related supplier.
(iii) Allowable transactions for purposes of the administrative
pricing methods. If the required performance of activities has been met,
the administrative pricing methods may be applied to a transaction
between a related supplier and a FSC only in the following
circumstances.
(A) The related supplier sells export property (as defined in
section 927(a) and Sec. 1.927(a)-1T) to the FSC for resale or the FSC
acts as a commission agent for the related supplier on sales by the
related supplier of export property to third parties, whether or not
related parties. For purposes of this section, references to sales
include references to exchanges or other dispositions.
(B) The related supplier leases export property to the FSC for
sublease for a comparable period with comparable terms of payment, or
the FSC acts as
[[Page 84]]
commission agent for the related supplier on leases of export property
by the related supplier, to third parties whether or not related
parties.
(C) Services are furnished by a FSC as principal or by a related
supplier if a FSC is a commission agent for the related supplier which
are related and subsidiary to any sale or lease by the FSC, acting as
principal or commission agent, of export property under subdivision
(iii)(A) and (B) of this paragraph.
(D) Engineering or architectural services for construction projects
located (or proposed for location) outside of the United States are
furnished by the FSC if the FSC is acting as principal, or by the
related supplier if the FSC is a commission agent for the related
supplier, with respect to the furnishing of the services to a third
party whether or not a related party.
(E) The FSC acting as principal, or the related supplier where the
FSC is a commission agent, furnishes managerial services in furtherance
of the production of foreign trading gross receipts of an unrelated FSC
or the production of qualified export receipts of an unrelated interest
charge DISC.
This subdivision (iii)(E) shall not apply for any taxable year unless at
least 50 percent of the gross receipts for such taxable year of the FSC
or of the related supplier, whichever party furnishes the managerial
services, is derived from activities described in subdivision (iii)(A),
(B), or (C) of this paragraph.
(c) Transfer price for sales of export property--(1) In general.
Under this paragraph, rules are prescribed for computing the allowable
price for a transfer from a related supplier to a FSC in the case of a
sale, described in paragraph (b)(2)(iii)(A) of this section, of export
property.
(2) The ``1.83 percent'' gross receipts method. Under the gross
receipts method of pricing, described in section 925(a)(1), the transfer
price for a sale by the related supplier to the FSC is the price as a
result of which the profit derived by the FSC from the sale will not
exceed 1.83 percent of the foreign trading gross receipts of the FSC
derived from the sale of the export property. Pursuant to section
925(d), the amount of profit derived by the FSC under this method may
not exceed twice the amount of profit determined under, at the related
supplier's election, either the combined taxable income method of Sec.
1.925(a)-1T(c)(3) or the marginal costing rules of Sec. 1.925(b)-1T.
For FSC taxable years beginning after December 31, 1986, if the related
supplier elects to determine twice the profit determined under the
combined taxable income method using the marginal costing rules, because
of the no-loss rule of Sec. 1.925(a)-1T(e)(1)(i), the profit that may
be earned by the FSC is limited to 100% of the full costing combined
taxable income as determined under Sec. 1.925(a)-1T(c)(3) and (6).
Interest or carrying charges with respect to the sale are not foreign
trading gross receipts.
(3) The ``23 percent'' combined taxable income method. Under the
combined taxable income method of pricing, described in section
925(a)(2), the transfer price for a sale by the related supplier to the
FSC is the price as a result of which the profit derived by the FSC from
the sale will not exceed 23 percent of the full costing combined taxable
income (as defined in paragraph (c)(6) of this section) of the FSC and
the related supplier attributable to the foreign trading gross receipts
from such sale.
(4) Section 482 method. If the methods of paragraph (c)(2) and (3)
of this section are inapplicable to a sale or if the related supplier
does not choose to use them, the transfer price for a sale by the
related supplier to the FSC is to be determined on the basis of the
sales price actually charged but subject to the rules provided by
section 482 and the regulations for that section and by Sec. 1.925(a)-
1T(a)(3)(ii).
(5) Incomplete transactions. (i) For purposes of the gross receipts
and combined taxable income methods, if export property which the FSC
purchased from the related supplier is not resold by the FSC before the
close of either the FSC's taxable year or the taxable year of the
related supplier during which the export property was purchased by the
FSC from the related supplier, then--
(A) The transfer price of the export property sold by the FSC during
that year shall be computed separately from
[[Page 85]]
the transfer price of the export property not sold by the FSC during
that year.
(B) With respect to the export property not sold by the FSC during
that year, the transfer price paid by the FSC for that year shall be the
related supplier's cost of goods sold (see paragraph (c)(6)(iii)(C) of
this section) with respect to the property.
(C) For the subsequent taxable year during which the export property
is resold by the FSC, an additional amount shall be paid by the FSC (to
be treated as income for the later year in which it is received or
accrued by the related supplier) equal to the excess of the amount which
would have been the transfer price under this section had the transfer
to the FSC by the related supplier and the resale by the FSC taken place
during the taxable year of the FSC during which it resold the property
over the amount already paid under subdivision (B) of this paragraph.
(D) The time and manner of payment of transfer prices required by
subdivisions (i)(B) and (C) of this paragraph shall be determined under
paragraphs (e)(3), (4) and (5) of this section.
(ii) For purposes of this paragraph, a FSC may determine the year in
which it received property from a related supplier and the year in which
it resells property in accordance with the method of identifying goods
in its inventory properly used under section 471 or section 472
(relating respectively to the general rule for inventories and to the
rule for LIFO inventories). Transportation expense of the related
supplier in connection with a transaction to which this paragraph
applies shall be treated as an item of cost of goods sold with respect
to the property if the related supplier includes the cost of
intracompany transportation between its branches, divisions, plants, or
other units in its cost of goods sold (see paragraph (c)(6)(iii)(C) of
this section).
(6) Full costing combined taxable income--(i) In general. For
purposes of section 925 and this section, if a FSC is the principal on
the sale of export property, the full costing combined taxable income of
the FSC and its related supplier from the sale is the excess of the
foreign trading gross receipts of the FSC from the sale over the total
costs of the FSC and related supplier including the related supplier's
cost of goods sold and its and the FSC's noninventoriable costs (see
Sec. 1.471-11(c)(2)(ii)) which relate to the foreign trading gross
receipts. Interest or carrying charges with respect to the sale are not
foreign trading gross receipts.
(ii) Section 482 applicability. Combined taxable income under this
paragraph shall be determined after taking into account under paragraph
(e)(2) of this section all adjustments required by section 482 with
respect to transactions to which the section is applicable. If a related
supplier performs services under contract with a FSC, the FSC shall
compensate the related supplier an arm's length amount under the
provisions of Sec. 1.482-2(b) (1) through (6). Section 1.482-2(b)(7),
which provides that an arm's length charge shall not be deemed equal to
costs or deductions with respect to services which are an integral part
of the business activity of either the member rendering the services
(i.e., the related supplier) or the member receiving the benefit of the
services (i.e., the FSC), shall not apply if the administrative pricing
methods of section 925(a)(1) and (2) are used to compute the FSC's
profit and if the related supplier is the person rendering the services.
Section 1.482-2(b)(7) shall apply, however, if a related person other
than the related supplier is the person rendering the services or if the
section 482 method of section 925(a)(3) is used to compute the FSC's
profit. See Sec. 1.925(a)-1T(a)(3)(ii). For a special rule for
computation of combined taxable income where the related supplier is a
qualified cooperative shareholder of the FSC, see paragraph (c)(7) of
this section.
(iii) Rules for determination of gross receipts and total costs. In
determining the gross receipts of the FSC and the total costs of the FSC
and related supplier which relate to such gross receipts, the rules set
forth in subdivisions (iii)(A) through (E) of this paragraph shall
apply.
(A) Subject to the provisions of subdivisions (iii)(B) through (E)
of this paragraph, the methods of accounting used by the FSC and related
supplier to compute their taxable incomes will be
[[Page 86]]
accepted for purposes of determining the amounts of items of income and
expense (including depreciation) and the taxable year for which those
items are taken into account.
(B) A FSC may, generally, choose any method of accounting
permissible under section 446(c) and the regulations under that section.
However, if a FSC is a member of a controlled group (as defined in
section 927(d)(4) and Sec. 1.924(a)-1T(h)), the FSC may not choose a
method of accounting which, when applied to transactions between the FSC
and other members of the controlled group, will result in a material
distortion of the income of the FSC or of any other member of the
controlled group. Changes in the method of accounting of a FSC are
subject to the requirements of section 446(e) and the regulations under
that section.
(C) Cost of goods sold shall be determined in accordance with the
provisions of Sec. 1.61-3. See sections 471 and 472 and the regulations
thereunder with respect to inventories. With respect to property to
which an election under section 631 applies (relating to cutting of
timber considered as a sale or exchange), cost of goods sold shall be
determined by applying Sec. 1.631-1 (d)(3) and (e) (relating to fair
market value as of the beginning of the taxable year of the standing
timber cut during the year considered as its cost).
(D) Costs (other than cost of goods sold) which shall be treated as
relating to gross receipts from sales of export property are the
expenses, losses, and deductions definitely related, and therefore
allocated and apportioned thereto, and a ratable part of any other
expenses, losses, or deductions which are not definitely related to any
class of gross income, determined in a manner consistent with the rules
set forth in Sec. 1.861-8. The deduction for depletion allowed by
section 611 relates to gross receipts from sales of export property and
shall be taken into account in computing the combined taxable income of
the FSC and its related supplier.
(7) Cooperatives and combined taxable income method. If a qualified
cooperative, as defined in section 1381(a), sells export property to a
FSC of which it is a shareholder, the combined taxable income of the FSC
and the cooperative shall be computed without taking into account
deductions allowed under section 1382 (b) and (c) for patronage
dividends, per-unit retain allocations and nonpatronage distributions.
The FSC and cooperative must take into account, however, when computing
combined taxable income, the cooperative's cost of goods sold, or cost
of purchases.
(8) Grouping transactions. (i) [Reserved] For further guidance, see
Sec. 1.925(a)-1(c)(8)(i).
(ii) A determination by the related supplier as to a product or a
product line will be accepted by a district director if such
determination conforms to either of the following standards: Recognized
trade or industry usage, or the two-digit major groups (or any inferior
classifications or combinations thereof, within a major group) of the
Standard Industrial Classification as prepared by the Statistical Policy
Division of the Office of Management and Budget, Executive Office of the
President. A product shall be included in only one product line for
purposes of this section if a product otherwise falls within more than
one product line classification.
(iii) A choice by the related supplier to group transactions for a
taxable year on a product or product line basis shall apply to all
transactions with respect to that product or product line consummated
during the taxable year. However, the choice of a product or product
line grouping applies only to transactions covered by the grouping and,
as to transactions not encompassed by the grouping, the determinations
are to be made on a transaction-by-transaction basis. For example, the
related supplier may choose a product grouping with respect to one
product and use the transaction-by-transaction method for another
product within the same taxable year. Sale transactions may not be
grouped, however, with lease transactions.
(iv) For purposes of this section, transactions involving military
property, as defined in section 923(a)(5) and Sec. 1.923-1T(b)(3)(ii),
may be grouped only with other military property included within the
same product or product line grouping determined under the standards of
subdivision (8)(ii) of this
[[Page 87]]
paragraph. Non-military property included within a product or product
line grouping which includes military property may be grouped, at the
election of the related supplier, under the general grouping rules of
subdivisions (i) through (iii) of this paragraph.
(v) A special grouping rule applies to agricultural and
horticultural products sold to the FSC by a qualified cooperative if the
FSC satisfies the requirements of section 923(a)(4). Section 923(a)(4)
increases the amount of the FSC's exempt foreign trade income with
regard to sales of these products, see Sec. 1.923-1T(b)(2). This
special grouping rule provides that if the related supplier elects to
group those products that no other export property may be included
within that group. Export property which would have been grouped under
the general grouping rules of subdivisions (i) through (iii) of this
paragraph with the export property covered by this special grouping rule
may be grouped, however, at the election of the related supplier, under
the general grouping rules.
(vi) For rules as to grouping certain related and subsidiary
services, see paragraph (d)(3)(ii) of this section.
(vii) If there is more than one FSC (or more than one small FSC)
within a controlled group of corporations, the same grouping of
transactions, if any, must be used by all FSCs (or small FSCs) within
the controlled group. If the same grouping of transactions is required
by this subdivision, and if grouping is elected, the same transfer
pricing method must be used to determine each FSC's (or small FSC's)
taxable income with respect to that grouping.
(viii) The product or product line groups that are established for
purposes of determining combined taxable income may be different from
the groups that are established with regard to economic processes (see
Sec. 1.924(d)-1(e)).
(d) Rules under section 925(a)(1) and (2) for transactions other
than sales by a FSC. The following rules are prescribed for purposes of
applying the gross receipts method or combined taxable income method to
transactions other than sales by a FSC.
(1) Leases. In the case of a lease of export property by a related
supplier to a FSC for sublease by the FSC, the amount of rent the FSC
must pay to the related supplier shall be computed in a manner
consistent with the rules in paragraph (c) of this section for computing
the transfer price in the case of sales and resales of export property
under the gross receipts method or combined taxable income method.
Transactions may not be so grouped on a product or product line basis
under the rules of paragraph (c)(8) of this section as to combine in any
one group of transactions both lease transactions and sale transactions.
(2) Commissions. If any transaction to which section 925 applies is
handled on a commission basis for a related supplier by a FSC and if
commissions paid to the FSC give rise to gross receipts to the related
supplier which would have been foreign trading gross receipts under
section 924(a) had the FSC made the sale directly then--
(i) The administrative pricing methods of section 925(a)(1) and (2)
may be used to determine the FSC's commission income only if the
requirements of section 925(c) (relating to activities that must be
performed in order to use the administrative pricing methods) are met,
see Sec. 1.925(a)-1T(b)(2)(ii).
(ii) The amount of the income that may be earned by the FSC in any
year is the amount, computed in a manner consistent with paragraph (c)
of this section, which the FSC would have been permitted to earn under
the gross receipts method, the combined taxable income method, or the
section 482 method if the related supplier had sold (or leased) the
property or service to the FSC and the FSC had in turn sold (or
subleased) to a third party, whether or not a related party.
(iii) The combined taxable income of a FSC and the related supplier
from the transaction is the excess of the related supplier's gross
receipts from the transaction which would have been foreign trading
gross receipts had the sale been made by the FSC directly over the
related supplier's and the FSC's total costs, excluding the commission
paid or payable to the FSC, but including the related supplier's cost of
goods sold and its and the FSC's noninventoriable
[[Page 88]]
costs (see Sec. 1.471-11(c)(2)(ii)) which relate to the gross receipts
from the transaction. The related supplier's gross receipts for purposes
of the administrative pricing methods shall be reduced by carrying
charges, if any, as computed under Sec. 1.927(d)-1(a)(Q&A2). These
carrying charges shall remain income of the related supplier.
(iv) The maximum commission the FSC may charge the related supplier
is the amount of income determined under subdivisions (ii) and (iii) of
this paragraph plus the FSC's total costs for the transaction as
determined under paragraph (c)(6) of this section.
(3) Receipts from services--(i) Related and subsidiary services
attributable to the year of the export transaction. The gross receipts
for related and subsidiary services described in paragraph
(b)(2)(iii)(C) of this section shall be treated as part of the receipts
from the export transaction to which such services are related and
subsidiary, but only if, under the arrangement between the FSC and its
related supplier and the accounting method otherwise employed by the
FSC, the income from such services is includible for the same taxable
year as income from such export transaction.
(ii) Other services. Income from the performance of related and
subsidiary services will be treated as a separate type of income if
subdivision (i) of this paragraph does not apply. Income from the
performance of engineering and architectural services and certain
managerial services, as defined in paragraphs (b)(2)(iii)(D) and (E),
respectively, of this section, will in all situations be treated as
separate types of income. If this subdivision (ii) applies, the amount
of taxable income which the FSC may derive for any taxable year shall be
determined under the arrangement between the FSC and its related
supplier and shall be computed in a manner consistent with the rules in
paragraph (c) of this section for computing the transfer price in the
case of sales for resale of export property under the transfer pricing
rules of section 925. Related and subsidiary services to which the above
subdivision (i) of this paragraph does not apply may be grouped, under
the rules for grouping of transactions in paragraph (c)(8) of this
section, with the products or product lines to which they are related
and subsidiary, so long as the grouping of services chosen is consistent
with the grouping of products or product lines chosen for the taxable
year in which either the products or product lines were sold or in which
payment for the services is received or accrued. Grouping of
transactions shall not be allowed with respect to the determination of
taxable income which the FSC may derive from services described in
paragraph (b)(2)(iii)(D) or (E) of this section whether performed by the
FSC or by the related supplier. Those determinations shall be made only
on a transaction-by-transaction basis.
(e) Special rules for applying paragraphs (c) and (d) of this
section--(1) Limitation on FSC income (``no loss'' rules). (i) If there
is a combined loss on a transaction or group of transactions, a FSC may
not earn a profit under either the combined taxable income method or the
gross receipts method. Also, for FSC taxable years beginning after
December 31, 1986, in applying the gross receipts method, the FSC's
profit may not exceed 100% of full costing combined taxable income
determined under the full costing method of Sec. 1.925(a)-1T(c)(3) and
(6). This rule prevents pricing at a loss to the related supplier. The
related supplier may in all situations set a transfer price or rental
payment or pay a commission in an amount that will allow the FSC to
recover an amount not in excess of its costs, if any, even if to do so
would create, or increase, a loss in the related supplier.
(ii) For purposes of determining whether a combined loss exists, the
basis for grouping transactions chosen by the related supplier under
paragraph (c)(8) of this section for the taxable year shall apply.
(iii) If a FSC recognizes income while the related supplier
recognizes a loss on a sale transaction under the section 482 method,
neither the combined taxable income method nor the gross receipts method
may be used by the FSC and related supplier (or by a FSC in the same
controlled group and the related supplier) for any other sale
transaction, or group of sale transactions, during a year which fall
within the
[[Page 89]]
same three digit Standard Industrial Classification as the subject sale
transaction. The reason for this rule is to prevent the segregation of
transactions for the purposes of allowing the related supplier to
recognize a loss on the subject transactions, while allowing the FSC to
earn a profit under the administrative pricing methods on other
transactions within the same three digit Standard Industrial
Classification.
(2) Relationship to section 482. In applying the administrative
pricing methods, it may be necessary to first take into account the
price of a transfer (or other transaction) between the related supplier
(or FSC) and a related party which is subject to the arm's length
standard of section 482. Thus, for example, if a related supplier sells
to a FSC export property which the related supplier purchased from
related parties, the costs taken into account in computing the combined
taxable income of the FSC and the related supplier are determined after
any necessary adjustment under section 482 of the price paid by the
related supplier to the related parties. In applying section 482 to a
transfer by a FSC to a related party, the parties are treated as if they
were a single entity carrying on all the functions performed by the FSC
and the related supplier with respect to the transaction. The FSC shall
be allowed to receive under the section 482 standard the amount the
related supplier would have received had there been no FSC.
(3) Creation of receivables. (i) If the amount of the transfer price
or rental payment actually charged by a related supplier to a FSC or the
sales commission actually charged by a FSC to a related supplier has not
been paid, an account receivable and payable will be deemed created as
of the due date under section 6072(b), including extensions provided for
under section 6081, of the FSC's tax return for the taxable year of the
FSC during which a transaction to which section 925 is applicable
occurs. The receivable and payable will be in an amount equal to the
difference between the amount of the transfer price or rental payment or
commission determined under section 925 and this section and the amount
(if any) actually paid or received. For example, a calendar year FSC's
related supplier paid the FSC on July 1, 1985, a commission of $50 on
the sale of export property. On September 15, 1986, the extended due
date of the FSC's income tax return for taxable year 1985, the related
supplier determined that the commission should have been $60. The
additional $10 of commission had not been paid. Accordingly, an
interest-bearing payable to the FSC from the related supplier in the
amount of $10 was created as of September 15, 1986. A $10 interest
bearing receivable was also created on the FSC's books.
(ii) An indebtedness arising under the above subdivision (i) shall
bear interest at an arm's length rate, computed in the manner provided
by Sec. 1.482-2(a)(2), from the due date under section 6072(b),
including extensions provided for under section 6081, of the FSC's tax
return for the taxable year of the FSC in which the transaction occurred
which gave rise to the indebtedness to the date of payment of the
indebtedness. The interest so computed shall be accrued and included in
the taxable income of the person to whom the indebtedness is owed for
each taxable year during which the indebtedness is unpaid if that person
is an accrual basis taxpayer or when the interest is paid if a cash
basis taxpayer. Because the transactions covered by this subdivision are
between the related supplier and FSC, the carrying charges provisions of
Sec. 1.927(d)-1(a) do not apply.
(iii) Payment of dividends, transfer prices, rents, commissions,
service fees, receivables, or payables may be in the form of money,
property, sales discount, or an accounting entry offsetting the amount
due the related supplier, or FSC, whichever applies, against an existing
debt of the other party to the transaction. This provision does not
eliminate the requirement that actual cash payments be made by the
related supplier to a commission FSC if the receipt of payment test of
section 924(e)(4) is used to meet the foreign economic process
requirements of section 924(d). The offset accounting entries must be
clearly identified in both the related supplier's and FSC's books of
account.
(4) Subsequent determination of transfer price, rental income or
commission. The
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FSC and its related supplier would ordinarily determine under section
925 and this section the transfer price or rental payment payable by the
FSC or the commission payable to the FSC for a transaction before the
FSC files its return for the taxable year of the transaction. After the
FSC has filed its return, a redetermination of those amounts by the
Commissioner may only be made if specifically permitted by a Code
provision or regulations under the Code. Such a redetermination would
include a redetermination by reason of an adjustment under section 482
and the regulations under that section or section 861 and Sec. 1.861-8
which affects the amounts which entered into the determination. In
addition, a redetermination may be made by the FSC and related supplier
if their taxable years are still open under the statute of limitations
for making claims for refund under section 6511 if they determine that a
different transfer pricing method may be more beneficial. Also, the FSC
and related supplier may redetermine the amount of foreign trading gross
receipts and the amount of the costs and expenses that are used to
determine the FSC's and related supplier's profits under the transfer
pricing methods. Any redetermination shall affect both the FSC and the
related supplier. The FSC and the related suppler may not redetermine
that the FSC was operating as a commission FSC rather than a buy-sell
FSC, and vice versa.
(5) Procedure for adjustments to redeterminations. (i) If a
redetermination under paragraph (e)(4) of this section is made of the
transfer price, rental payment or commission for a transaction, or group
of transactions, the person who was underpaid under this redetermination
shall establish (or be deemed to have established), at the date of the
redetermination, an account receivable from the person with whom it
engaged in the transaction equal to the difference between the amounts
as redetermined and the amounts (if any) previously paid and received,
plus the amount (if any) of the account receivable determined under
paragraph (e)(3) of this section that remains unpaid. A corresponding
account payable will be established by the person who underpaid the
amount due.
(ii) An account receivable established in accordance with the above
subdivision (5)(i) of this paragraph shall bear interest at an arm's
length rate, computed in the manner provided by Sec. 1.482-2(a)(2),
from the day after the date the account receivable is deemed established
to the date of payment. The interest so computed shall be accrued and
included in the taxable income for each taxable year during which the
account receivable is outstanding of an accrual basis taxpayer or when
paid if a cash basis taxpayer.
(iii) In lieu of establishing an account receivable in accordance
with the above subdivision (5)(i) of this paragraph for all or part of
an amount due a related supplier, the related supplier and FSC are
permitted to treat all or part of any current or prior distribution
which was made by the FSC as an additional payment of transfer price or
rental payment or repayment of commission (and not as a distribution)
made as of the date the distribution was made. Any additional amount
arising on the redetermination due the related supplier after this
treatment shall be represented by an account receivable established
under the above subdivision (5)(i) of this paragraph. To the extent that
a distribution is so treated under this subdivision (5)(iii), it shall
cease to qualify as a distribution for any Federal income tax purpose.
If all or part of any distribution made to a shareholder other than the
related supplier is recharacterized under this subdivision (5)(iii), the
related supplier shall establish an account receivable from that
shareholder for the amount so recharacterized. The Commissioner may
prescribe by Revenue Procedure conditions and procedures that must be
met in order to obtain the relief provided by this subdivision (5)(iii).
(iv) The procedure for adjustments to transfer price provided by
this paragraph does not apply to incomplete transactions described in
paragraph (c)(5) of this section. Such procedure will, however, be
applied to any such transaction with respect to the taxable year in
which the transaction is completed.
[[Page 91]]
(f) Examples. The provisions of this section may be illustrated by
the following examples:
Example 1. In 1985, F, a FSC, purchases export property from R, a
domestic manufacturer of export property A. R is F's related supplier.
The sale from R to F is made under a written agreement which provides
that the transfer price between R and F shall be that price which
allocates to F the maximum amount permitted to be received under the
transfer pricing rules of section 925. F resells property A in 1985 to
an unrelated purchaser for $1,000. The terms of the sales contract
between F and the unrelated purchaser provide that payment of the $1,000
sales price will be made within 90 days after sale. The purchaser pays
the entire sales price within 60 days. F incurs indirect and direct
expenses in the amount of $260 attributable to the sale which relate to
the activities and functions referred to in section 924 (c), (d) and
(e). In addition, F incurs additional expenses attributable to the sale
in the amount of $35. R's cost of goods sold attributable to the export
property is $550. R incurred direct selling expenses in connection with
the sale of $50. R's deductible general and administrative expenses
allocable to all gross income are $200. Apportionment of those
supportive expenses on the basis of gross income does not result in a
material distortion of income and is a reasonable method of
apportionment. R's direct selling expenses and its general and
administrative expenses were not required to be incurred by F. R's gross
income from sources other than the transaction is $17,550 resulting in
total gross income of R and F (excluding the transfer price paid by F)
of $18,000 ($450 plus $17,550). For purposes of this example, it is
assumed that if R sold the export property to F for $690, the price
could be justified as satisfying the standards of section 482. Under
these facts, F may earn, under the combined taxable income method, the
more favorable of the three transfer pricing rules, a profit of $23 on
the sale. (Unless otherwise indicated, all examples in this section
assume that the marginal costing method of Sec. 1.925(b)-1T does not
result in a higher profit than the profit under the full costing
combined taxable income method of paragraphs (c)(3) and (6) of this
section.) F's profit and the transfer price to F from the transaction,
using the administrative pricing methods, and F's profit if the transfer
price is determined under section 482, would be as follows:
Combined taxable income:
F's foreign trading gross receipts....................... $1,000.00
R's cost of goods sold................................... (550.00)
------------
Combined gross income................................ 450.00
------------
Less:
R's direct selling expenses............................ 50.00
F's expenses........................................... 295.00
Apportionment of R's general and administrative expenses:
R's total G/A expenses................................. 200.00
Combined gross income.................................. 450.00
R's and F's total gross income (foreign and domestic).. 18,000.00
Apportionment of G/A expenses:
$200x$450/$18,000...................................... 5.00
------------
Total................................................ (350.00)
------------
Combined taxable income.................................. 100.00
============
The section 482 method--Transfer price to F and F's profit:
Transfer price to F...................................... $690.00
============
F's profit:
F's foreign trading gross receipts..................... 1,000.00
------------
Less:
F's cost of goods sold............................... 690.00
F's expenses......................................... 295.00
------------
Total............................................ (985.00)
------------
F's profit............................................. 15.00
============
The gross receipts method--
F's profit and transfer price to F:
F's profit--lesser of 1.83% of F's foreign trading gross 18.30
receipts ($18.30) or two times F's profit under the
combined taxable income method ($46.00) (See below)
(Unless otherwise indicated, all examples in this
section assume that the marginal costing method of Sec.
1.925(b)-1T does not result in a higher profit than the
profit under the full costing combined taxable income
method).................................................
============
Transfer price to F:
F's foreign trading gross receipts..................... 1,000.00
------------
Less:
F's expenses......................................... 295.00
F's profit........................................... 18.30
------------
Total............................................ (313.30)
------------
Transfer price......................................... 686.70
============
[[Page 92]]
The combined taxable income method-- F's profit and
transfer price to F:
F's profit--23% of combined taxable income ($100)........ $23.00
============
Transfer price to F:
F's foreign trading gross receipts..................... 1,000.00
------------
Less:
F's expenses......................................... 295.00
F's profit........................................... 23.00
------------
Total.............................................. (318.00)
------------
Transfer price........................................... 682.00
============
With a profit of $23 under the most favorable of the transfer pricing
methods, F's exempt foreign trade income under section 923 would be
$207.39, computed as follows:
F's foreign trading gross receipts....................... $1,000.00
F's costs of purchases (transfer price).................. (682.00)
------------
F's foreign trade income................................. 318.00
============
F's exempt foreign trade income $318x15/23............... 207.39
============
F's taxable income would be $8.00, computed as follows:
F's foreign trade income................................. $318.00
F's exempt foreign trade income.......................... (207.39)
------------
F's non-exempt foreign trade income.................... 110.61
Less:
F's expenses allocable to non-exempt foreign trade (102.61)
income $295x$110.61/$318..............................
------------
F's taxable income..................................... 8.00
============
Of F's total expenses, $192.39 ($295x$207.39/$318) are allocated to F's
exempt foreign trade income and are disallowed for purposes of computing
F's taxable income.
Example 2. Assume the same facts as in Example 1 except that the
purchaser pays the entire sales price 96 days after delivery, well
beyond the 60 day period in which payment must be made to avoid
recharacterization of part of the contract price as carrying charges.
Therefore, the contract price of $1,000 includes $10 of carrying
charges, assuming a discount rate of 10%. See Sec. 1.927(d)-1(a) (Q &
A2) for computation method for determining amount of carrying charges.
Under these facts, F may earn, under the combined taxable income method,
the most favorable of the three transfer pricing rules, a profit of
$20.73 on the sale. F's profit and the transfer price to F under the
transfer pricing rules, assuming that a carrying charge is incurred,
would be as follows:
Combined taxable income:
F's foreign trading gross receipts....................... $990.00
R's cost of goods sold................................... (550.00)
------------
Combined gross income................................ 440.00
------------
Less:
R's direct selling expenses.............................. 50.00
R's apportioned G/A expenses:
$200x$440/$18,000........................................ 4.89
F's expenses............................................. 295.00
------------
Total................................................ (349.89)
------------
Combined taxable income.............................. 90.11
============
The combined taxable income method--F's profit and transfer
price to F:
F's profit--23% of combined taxable income ($90.11)...... $20.73
============
Transfer price to F:
F's foreign trading gross receipts....................... 990.00
------------
Less:
F's expenses............................................. 295.00
F's profit............................................... 20.73
------------
Total................................................ (315.73)
------------
Transfer price....................................... 674.27
============
The gross receipts method--F's profit and transfer price to
F:
F's profit--lesser of 1.83% of F's foreign trading gross $18.12
receipts ($18.12) or two times F's profit under the
combined taxable income method ($41.46).................
============
Transfer price to F: F's foreign trading gross receipts.. 990.00
------------
Less:
F's expenses......................................... 295.00
F's profit........................................... 18.12
------------
Total.............................................. (313.12)
------------
Transfer price........................................... 676.88
============
The section 482 method--Transfer price to F and F's profit:
Transfer price to F...................................... 690.00
============
F's profit:
F's foreign trading gross receipts..................... 990.00
------------
[[Page 93]]
Less:
F's cost of goods sold............................... 690.00
F's expenses......................................... 295.00
------------
Total.............................................. (985.00)
------------
F's profit............................................... 5.00
============
Example 3. R and F are calendar year taxpayers. R, a domestic
manufacturing company, owns all the stock of F, a FSC for the taxable
year. During 1985, R produces and sells a product line of export
property to F for $157, a price which can be justified as satisfying the
arm's length price standard of section 482. The sale from R to F is made
under a written agreement which provides that the transfer price between
R and F shall be that price which allocates to F the maximum amount
permitted to be received under the transfer pricing rules of section
925. F resells the export property for $200. R's cost of goods sold
attributable to the export property is $115 so that the combined gross
income from the sale of the export property is $85 (i.e., $200 minus
$115). R incurs $18 in direct selling expenses in connection with the
sale of the property. R's deductible general and administrative expenses
allocable to all gross income are $120. R's direct selling and its
general and administrative expenses were not required to be incurred by
F. R's gross income from sources other than the transaction is $5,015
resulting in total gross income of R and F (excluding the transfer price
paid by F) of $5,100 (i.e., $85 plus $5,015). F incurs $50 in direct and
indirect expenses attributable to resale of the export property. Of
those expenses, $45 relate to activities and functions referred to in
section 924 (c), (d) and (e). The maximum profit which F may earn with
respect to the product line is $3.66, computed as follows:
Combined taxable income:
F's foreign trading gross receipts....................... $200.00
R's cost of goods sold................................... (115.00)
------------
Combined gross income.................................. 85.00
------------
Less:
R's direct selling expenses............................ 18.00
R's apportioned G/A expenses: $120x$85/$5,100.......... 2.00
F's expenses........................................... 50.00
------------
Total................................................ (70.00)
------------
Combined taxable income.................................. 15.00
============
The combined taxable income method--F's profit:
F's profit--23% of combined taxable income ($15)......... $ 3.45
============
The gross receipts method--F's profit:
F's profit--lesser of 1.83% of F's foreign trading gross $3.66
receipts ($3.66) or two times F's profit under the
combined taxable income method ($6.90)..................
============
The section 482 method--F's profit:
F's foreign trading gross receipts....................... 200.00
------------
Less:
F's cost of goods sold................................. 157.00
F's expenses........................................... 50.00
------------
Total.............................................. (207.00)
------------
F's profit (loss)........................................ (7.00)
============
Since the gross receipts method results in a greater profit to F ($3.66)
than does either the combined taxable income method ($3.45) or the
section 482 method (a loss of $7), and does not exceed twice the profit
under the combined taxable income method, F may earn a maximum profit of
$3.66. Accordingly, the transfer price from R to F may be readjusted as
long as the transfer price is not readjusted below $146.34, computed as
follows:
Transfer price to F:
F's foreign trading gross receipts....................... $ 200.00
Less:
F's expenses........................................... 50.00
F's profit............................................. 3.66
------------
Total.............................................. (53.66)
------------
Transfer price........................................... 146.34
============
Example 4. R and F are fiscal year May 31 year-end taxpayers. R, a
domestic manufacturing company, owns all the stock of F, a FSC for the
taxable year. During August of 1987, R produces and sells 100 units of
export property A to F under a written agreement which provides that the
transfer price between R and F shall be that price which allocates to F
the maximum profit permitted to be received under the transfer pricing
rules of section 925. Thereafter, the 100 units are resold for export by
F for $950. R's cost of goods sold attributable to the 100 units is
$650. R incurs costs, both direct and indirect, in the amount of $270
with regard to activities and functions referred to in section 924 (c),
(d) and (e) which it was under contract with F to perform for F. R's
direct selling expenses are $40. Those expenses were not required to be
incurred by F. For purposes of this example, assume that R has no
general and administrative expenses other than those relating to the
section 924 (c), (d) and (e) activities and functions. F incurs expenses
in the amount of $290 attributable to
[[Page 94]]
the resale which relate to the activities and functions referred to in
section 924 (c), (d) and (e). Of that amount, $270 was paid to R under
contract to perform the activities in section 924. The remaining $20 was
paid to independent contractors. R chooses not to apply the section 482
transfer pricing method to determine F's profit on the transaction. F
may not earn any income under either the gross receipts (see the special
no-loss rule of paragraph (e)(1)(i) of this section) or the combined
taxable income administrative pricing methods with respect to resale of
the 100 units because there is a combined loss of $(30) on the
transaction, computed as follows:
Combined taxable income:
F's foreign trading gross receipts....................... $ 950.00
R's cost of goods sold................................... (650.00)
------------
Combined gross income................................ 300.00
------------
Less:
R's direct selling expenses............................ 40.00
F's expenses........................................... 290.00
------------
Total.............................................. (330.00)
------------
Combined taxable income (loss)........................... (30.00)
============
Under paragraph (e)(1)(i) of this section, F is permitted to recover its
expenses attributable to the sale ($290) even though such recovery
results in a loss or increased loss to the related supplier.
Accordingly, the transfer price from R to F may be readjusted as long as
the transfer price is not readjusted below $660, computed as follows:
Transfer price to F:
F's foreign trading gross receipts....................... $950.00
Less:
F's expenses........................................... (290.00)
------------
Transfer price....................................... 660.00
============
Example 5. Assume the same facts as in Example 4 except that F
performs the section 924 (c), (d) and (e) activities and functions and
that R chooses to apply the section 482 transfer pricing method. Under
the standards of section 482, a transfer price from R to F of $650 is an
arm's length price. Accordingly, the transfer price to F and F's profit
on the subsequent resale of product A ($10) are as follows:
The section 482 method--Transfer price to F and F's profit:
Transfer price to F...................................... $650.00
============
F's profit:
F's foreign trading gross receipts..................... 950.00
F's cost of purchases.................................. (650.00)
------------
F's gross income....................................... 300.00
------------
Less:
F's expenses........................................... (290.00)
------------
F's profit............................................... 10.00
============
This sale of product A results in a loss to R of $40 (transfer price of
$650 less R's cost of goods sold of $650 and direct selling expenses of
$40). Since R chose to use the section 482 transfer pricing method on
this loss transaction, under the special no loss rule of paragraph
(e)(1)(iii) of this section, the administrative pricing methods of
section 925(a)(1) and (2) may not be used for any other sale
transactions, or group of sale transactions, during the same year of
other products which fall within the same three digit Standard
Industrial Classification as product A. F's profit, if any, on these
sales must be computed under the section 482 transfer pricing method.
Example 6. R and F are calendar year taxpayers. R, a domestic
manufacturing company, owns all the stock of F, a FSC for the taxable
year. During 1985, R manufactures 100 units of export property A. R
enters into a written agreement with F whereby F is granted a sales
franchise with respect to export property A and F will receive
commissions with respect to these exports equal to the maximum amount
permitted to be received under the administrative pricing rules of
section 925 (a)(1) and (2). Thereafter, the 100 units are sold for
export by R for $1,000. The total sales price of $1,000 was paid by the
purchaser to R within 60 days of the sales transaction. The entire
$1,000 would have been foreign trading gross receipts had F been the
principal on the sale. R's cost of goods sold attributable to the 100
units is $650. R's direct selling expenses so attributable are $50. R's
deductible general and administrative expenses, other than those
attributable to the section 924 (c), (d) and (e) activities and
functions, allocable to all gross income are $200. Apportionment of
those supportive expenses on the basis of gross income does not result
in a material distortion of income and is a reasonable method of
apportionment. R's direct selling expenses and the portion of the
general and administrative expenses not relating to the activities and
functions referred to in section 924 (c), (d) and (e) were not required
to be incurred by F. R's gross income from sources other than the
transaction is $17,650 resulting in total gross income of $18,000 ($350
plus $17,650). R and a related person perform on F's behalf the
activities and functions referred to in section 924 (c), (d) and (e). In
performing these activities, R and the related person incurred expenses,
both direct
[[Page 95]]
and indirect, of $200 and $45, respectively. F pays $200 to R under
contract and $50 to the related person. The maximum profit which F may
earn under the franchise pursuant to the administrative pricing rules is
$18.30, computed as follows:
Combined taxable income:
R's gross receipts from the sale......................... $1,000.00
R's cost of goods sold................................... (650.00)
------------
Combined gross income.................................. 350.00
------------
Less:
R's direct selling expenses............................ 50.00
F's expenses........................................... 250.00
Apportionment of R's general and administrative
expenses:
R's total G/A expenses............................... 200.00
Combined gross income................................ 350.00
R's and F's total gross income (foreign and domestic) 18,000.00
============
Apportionment of G/A expenses:
$200x$350/$18,000.................................. 3.89
Total............................................ (303.89)
------------
Combined taxable income.................................. 46.11
============
As reflected in the above computation, F included on its books $200 of
expenses related to the section 924 activities and performed by R on
behalf of F. R incurred $253.89 of expenses. These expenses were
reflected on its books. Under paragraph (b)(2)(ii) of this section, R
and F may elect to include all of the expenses related to the export
sales on F's books. This will satisfy the requirements of section 925(c)
without requiring an allocation of the expenses between R and F. Under
this election, as reflected in the following computation, combined
taxable income will still be $46.11 but, as reflected in a later part of
this example, the commission due F will be increased by $253.89:
Combined taxable income:
R's gross receipts from the sale......................... $1,000.00
R's cost of goods sold................................... (650.00)
------------
Combined gross income................................ 350.00
------------
Less:
F's expenses............................................. (303.89)
------------
Combined taxable income.............................. 46.11
============
The combined taxable income method--F's profit:
F's profit--23% of combined taxable income ($46.11)...... $10.61
============
The gross receipts method--F's profit:
F's profit--lesser of 1.83% of R's gross receipts $18.30
($18.30) or two times F's profit under the combined
taxable income method ($21.22)..........................
============
If the election provided for in paragraph (b)(2)(ii) of this section is
not made, F may receive a commission from R in the amount of $268.30,
computed as follows:
F's expenses............................................. $250.00
F's profit............................................... 18.30
------------
F's commission....................................... 268.30
============
This $268.30 is F's foreign trade income. F's exempt foreign trade
income is $174.98 ($268.30x15/23). F's taxable income is $6.37,
computed as follows:
F's foreign trade income................................. $268.30
F's exempt foreign trade income.......................... (174.98)
------------
F's non-exempt foreign trade income.................. 93.32
------------
Less:
F's expenses allocable to non-exempt foreign trade income (86.95)
$250x$93.32/$268.30.....................................
------------
F's taxable income................................... 6.37
============
Of F's total expenses, $163.05 ($250x$174.98/$268.30) are allocated to
F's exempt foreign trade income and are disallowed for purposes of
computing F's taxable income.
If R and F make the election provided for in paragraph (b)(2)(ii) of
this section, F may receive a commission from R in the amount of
$322.19, computed as follows:
F's expenses............................................. $303.89
F's profit............................................... 18.30
------------
F's commission......................................... 322.19
============
With this election, this $322.19 is F's foreign trade income. F's exempt
foreign trade income is $210.12 ($322.19x15/23). F's taxable income is
still $6.37, computed as follows:
F's foreign trade income................................. $322.19
F's exempt foreign trade income.......................... (210.12)
------------
F's non-exempt foreign trade income.................... 112.07
------------
[[Page 96]]
Less:
F's expenses allocable to non-exempt foreign trade (105.70)
income $303.89x$112.07/$322.19........................
------------
F's taxable income..................................... 6.37
============
Of F's total expenses, $198.19 ($303.89x$210.12/$322.19) are allocated
to F's exempt foreign trade income and are disallowed for purposes of
computing F's taxable income.
Example 7. Assume the same facts as in Example 6 except that R's
direct selling expenses are $60. The profit which F may earn under the
franchise pursuant to the administrative pricing rules is $16.62,
computed as follows:
Combined taxable income:
R's gross receipts from the sale......................... $1,000.00
R's cost of goods sold................................... (650.00)
------------
Combined gross income.................................. 350.00
------------
Less:
R's direct selling expenses............................ 60.00
R's apportioned G/A expenses........................... 3.89
F's expenses........................................... 250.00
------------
(313.89)
Combined taxable income.................................. 36.11
============
The combined taxable income method--F's profit:
F's profit--23% of combined taxable income ($36.11)...... 8.31
============
The gross receipts method--F's profit:
F's profit--lesser of 1.83% of R's gross receipts ($ 16.62
18.30) or two times F's profit under the combined
taxable income method ($16.62)..........................
============
F may receive a commission from R in the amount of $266.62, computed as
follows:
F's expenses............................................. $250.00
F's profit............................................... 16.62
------------
F's commission......................................... 266.62
============
If the election provided for in paragraph (b)(2)(ii) of this section is
made by R and F, the profit which F may earn under the franchise
pursuant to the administrative pricing rules will remain at $16.62 but
will be computed as follows:
Combined taxable income:
R's gross receipts from the sale......................... $1,000.00
R's cost of goods sold................................... (650.00)
------------
Combined gross income.................................. 350.00
------------
Less: F's expenses....................................... (313.89)
------------
Combined taxable income.................................. 36.11
============
The combined taxable income method--F's profit:
F's profit--23% of combined taxable income ($36.11)...... 8.31
============
The gross receipts method--F's profit:
F's profit--lesser of 1.83% of R's gross receipts 16.62
($18.30) or two times F's profit under the combined
taxable income method ($16.62)..........................
============
F may receive a commission from R in the amount of $330.51,
computed as follows:
F's expenses............................................. 313.89
F's profit............................................... 16.62
------------
F's commission......................................... 330.51
============
As illustrated by Example 6, F's exempt taxable income and taxable
income will be the same regardless of which method is used to compute
F's commission.
Example 8. Assume the same facts as in Example 6 except that F's
expenses are $300. With this assumption, there is a combined loss of
$(3.89) on the transaction under the full costing combined taxable
income method, computed as follows:
Combined taxable income:
R's gross receipts from the sale......................... $1,000.00
R's cost of goods sold................................... (650.00)
------------
Combined gross income.................................. 350.00
------------
Less:
R's direct selling expenses............................ 50.00
R's apportioned G/A expenses........................... 3.89
F's expenses........................................... 300.00
------------
(353.89)
------------
Combined taxable income (loss)........................... (3.89)
============
Since there is a combined loss, F will not have a profit under the full
costing combined taxable income method. However, for purposes of this
example, it is assumed that under the marginal costing rules of Sec.
1.925(b)-1T the maximum combined taxable income is $75 and the overall
profit percentage limitation is $30. Accordingly, F's profit would be
$6.90 (23% of $30) under the marginal costing rules. F's profit under
the gross receipts method will be $13.80 (1.83% of $1,000 limited by
section 925(d) to two times the profit determined under marginal
costing). The commission F may receive from R is $313.80. Had all of the
expenses been reflected on F's books pursuant to the election of
paragraph (b)(2)(ii) of this section, F's commission would have been
$367.69.
Example 9. Assume the same facts as in Example 6 except that F's
expenses are $300 and that the transaction occurred in 1987. F will not
earn a profit under the sales franchise pursuant to the administrative
pricing rules. This is shown by the following computation:
Combined taxable income:
R's gross receipts from the sale................ $1,000.00
R's cost of goods sold.......................... (650.00)
---------------------
Combined gross income......................... 350.00
---------------------
[[Page 97]]
Less:
R's direct selling expenses................... 50.00
R's apportioned G/A expenses.................. 3.89
F's expenses.................................. 300.00
---------------------
(353.89)
---------------------
Combined taxable income (loss).................. (3.89)
=====================
F will not have a profit under the full costing combined taxable income
method since there is a combined loss of $(3.89). Also, F will not have
a profit under the gross receipts method due to section 925(d) and the
special no loss rule of paragraph (e)(1)(i) of this section. In
addition, F will not have a profit under the marginal costing rules
because the profit may not exceed full costing combined taxable income,
see Sec. 1.925 (b)-1T(b)(4). Although F may not earn a profit, it is
entitled to recoup its expenses. Therefore, the commission F may receive
from R is $300.00. R will bear the entire loss. Had all of the expenses
been reflected on F's books pursuant to the election of paragraph
(b)(2)(ii) of this section, F's commission would have been $353.89.
Example 10. Assume the same facts as in Example 6 except that R
receives total payment of the sale price of $1,000 on the 96th day after
delivery, well beyond the 60 day period in which payment must be made to
avoid recharacterization of part of the contract price as carrying
charges. Therefore, the contract price of $1,000 includes $10 of
carrying charges, assuming a discount rate of 10%. See Sec. 1.927(d)-1
(a) (Q & A2) for computation method for determining amount of carrying
charges. This $10 of carrying charges is R's income. The profit which F
may earn under the franchise pursuant to the administrative pricing
rules is $16.66, computed as follows (the election of paragraph
(b)(2)(ii) of this section is not made by R and F):
Combined taxable income:
R's gross receipts from the sale.......................... $990.00
R's cost of goods sold.................................... (650.00)
-----------
Combined gross income................................... 340.00
-----------
Less:
R's direct selling expenses............................. 50.00
R's apportioned G/A expenses: $200x$340/$18,000......... 3.78
F's expenses............................................ 250.00
-----------
Total................................................. (303.78)
-----------
Combined taxable income................................... 36.22
===========
The combined taxable income method-- F's profit: F's profit-- $8.33
23% of combined taxable income ($36.22)
===========
The gross receipts method--F's profit:
F's profit--lesser of 1.83% of R's gross receipts ($18.12) $16.66
or two times F's profit under the combined taxable income
method ($16.66)..........................................
===========
F may receive a commission from R in the amount of $266.66,
computed as follows:
F's expenses.............................................. $250.00
F's profit................................................ 16.66
-----------
F's commission.......................................... 266.66
===========
Example 11. Assume the same facts as in Example 6. In addition,
assume that R also manufactures products K, L, M, N, and P all of which
are export property as defined in section 927(a). Product K is military
property as defined in section 923(a)(5) and Sec. 1.923-1T(b)(3)(ii).
Assume further that products A, L, and P are included within product
line X and that products K, L, M, and N are included within product line
W. R has entered into a written agreement with F under which F is
granted a sales franchise with respect to exporting the products. Under
this agreement, F will receive commissions with respect to those exports
equal to the maximum amount permitted to be received under the
administrative pricing rules. The table set forth below details F's
foreign trading gross receipts, R's cost of goods sold and R's and F's
expenses allocable and apportioned under Sec. 1.861-8 to the sale of
products A, L, M, N, and P. For purposes of this example, it is assumed
that R does not incur any general and administrative expenses. Because
of the special grouping rule of paragraph (c)(8)(ii) of this section,
product L may be included for purposes of the administrative pricing
rules in only one product line, at the option of R. Also for these
purposes, product K, which is military property, may not be grouped with
products L, M, and N. See paragraph (c)(8)(iv) of this section. Under
these facts, F will have profits under the franchise agreement from the
sale of products A, L, M, N, and P and may receive commissions from R
relating to the sale of those products, assuming the election of
paragraph (b)(2)(ii) of this section is not made, in the following
amounts:
F's
Profit Expenses Commissions
Product Line X (products A and P)...... $36.34 $490.00 $526.34
Product Line W (products L, M, and N).. $40.48 $421.00 $461.48
On the sale of product K, R received gross receipts of $150. R's cost of
goods sold was $130. R's and F's expenses allocable to product K totaled
$10 ($7 of R's expenses and $3 of F's). Under the gross receipts method,
F earned a profit of $2.75 (1.83% of $150) and $2.30 under the combined
taxable income method. F may receive a commission, assuming the election
of paragraph (b)(2)(ii) of this section is made by R and F, from R in
the amount of $12.75, computed as follows:
F's expenses.................................................. $10.00
[[Page 98]]
F's profit.................................................... 2.75
---------
F's commission............................................ $12.75
=========
----------------------------------------------------------------------------------------------------------------
Product A Product L Product M Product N Product P Total
----------------------------------------------------------------------------------------------------------------
Product Line X
Combined Taxable Income
R's GR From sale.................... $1,000 .......... .......... .......... $1,000 $2,000
R's cost of goods sold.............. (650) .......... .......... .......... (650) (1,300)
-------------
Combined gross income............. 350 .......... .......... .......... 350 700
-------------
Less:
R's expenses...................... 50 .......... .......... .......... 81 131
F's expenses...................... 250 .......... .......... .......... 240 490
-------------
Total........................... (300) .......... .......... .......... (321) (621)
-------------
Combined taxable income (loss)...... $50 .......... .......... .......... $29 $79
=============
23% of CTI............................ $11.50 .......... .......... .......... $6.67 $18.17
=============
1.83% of GR from sale................. $18.30 .......... .......... .......... $13.34 $36.34
=============
Product Line W
Combined Taxable Income
R's GR from sale.................... .......... $1,000 $625 $1,800 .......... $3,425
R's cost of goods sold.............. .......... (650) (445) (1,600) .......... (2,695)
-------------
Combined gross income............. .......... 350 180 200 .......... 730
-------------
Less:
R's expenses...................... .......... 81 70 70 .......... 221
F's expenses...................... .......... 230 60 131 .......... 421
-------------
Total........................... .......... (311) (130) (201) .......... (642)
-------------
Combined taxable income (loss)...... .......... $39 $50 $(1) .......... $88
=============
23% of CTI............................ .......... $8.97 $11.50 $0 .......... $20.24
=============
1.83% of GR From sale................. .......... $17.94 $11.44 $0 .......... $40.48
=============
----------------------------------------------------------------------------------------------------------------
Example 12. R and F are calendar year taxpayers. R owns all the
stock of F, an FSC for the taxable year. During 1985, R purchases 100
units of export property A from B, an unrelated domestic manufacturing
company for $850. R's direct selling expenses so attributable are $20. R
enters into a written agreement with F whereby F is granted a sales
franchise with respect to export product A and F will receive
commissions with respect to these exports equal to the maximum amount
permitted to be received under the administrative pricing rules of
section 925. Thereafter, the 100 units are sold for export by R for
$1,050. R factors the trade receivable to unrelated person X for $1,000.
Under Sec. 1.924(a)-1T(g)(7), total gross receipts for purposes of
computing R's and F's combined taxable income is $1,000 (total receipts
($1,050) less the discount ($50)). This $1,000 would have been foreign
trading gross receipts had F been the principal on the sale. For
purposes of this example, it is assumed that R did not incur any general
and administrative expenses. F incurs expenses in the amount of $110,
all of which were performed by R under contract to F. The profit which F
may earn under the franchise pursuant to the administrative pricing
rules is $9.20 computed as follows:
Combined taxable income:
R's gross receipts from the sale......................... $1,000.00
R's cost of goods sold................................... (850.00)
------------
150.00
------------
Less:
R's direct selling expenses............................ 20.00
F's expenses........................................... 110.00
------------
Total................................................ 130.00
------------
Combined taxable income.................................. $20.00
============
The combined taxable income method--F's profit:
F's profit--23% of combined taxable income ($20)......... $4.60
============
[[Page 99]]
The gross receipts method--F's profit:
F's profit--lesser of 1.83% of R's gross receipts $9.20
($18.30) or two times F's profit under the combined
taxable income, method ($9.20)..........................
============
F may receive a commission from R in the amount of $119.20,
computed as follows (the election of Sec. 1.925(a)-
1T(b)(2)(ii) has not been made):
F's expenses............................................. $110.00
F's profit............................................... 9.20
------------
F's commission......................................... $119.20
============
Example 13. R and F are calendar year taxpayers. R, a domestic
manufacturing company, owns all the stock of F, an FSC for the taxable
year. During March 1985, R manufactures office equipment, export
property within the definition of section 927(a)(1), which it leases on
April 1, 1985, to F for a term of 1 year at a monthly rental of $1,000,
a rent which satisfies the standard of arm's length rental under section
482. F subleases the product on April 1, 1985, for a term of 1 year at a
monthly rental of $1,200. R's cost for the product leased is $40,000.
R's other deductible expenses attributable to the product are $200, all
of which are incurred in 1985. Those expenses were not incurred under
contract to F. F's expenses attributable to sublease of the export
property are $1,150, all of which are incurred in 1985 directly by F. R
depreciates the property on a straight line basis, using a half-year
convention, assuming a 10 year recovery period (see section
168(f)(2)(C), Sec. 1.48-1(g)). The profit which F may earn with respect
to the transaction is $1,483.50 for 1985 and $600 for 1986, computed as
follows:
Computation for 1985
Combined taxable income:
F's sublease rental receipts for year ($1,200 x 9 $10,800.00
months)................................................
-------------
Less:
R's depreciation (($40,000 x1/10)x9/12)................. 3,000.00
R's expenses............................................ 200.00
F's expense............................................. 1,150.00
-------------
Total............................................... (4,350.00)
-------------
Combined taxable income................................... 6,450.00
=============
The combined taxable income method--F's profit:
F's profit--23% of combined taxable income ($6,450)..... $1,483.50
=============
The gross receipts method--F's profit:
F's profit--lesser of 1.83% of F's foreign trading gross $197.64
receipts ($197.64) or two times F's profit under the
combined taxable income method ($2,967)................
=============
The section 482 method--F's profit:
F's sublease rental receipts for year................... $10,800.00
-------------
Less:
F's lease rental payments for year...................... 9,000.00
F's expenses............................................ 1,150.00
-------------
Total............................................... (10,150.00)
-------------
F's profit.......................................... 650.00
=============
Since the combined taxable income method results in greater profit to F
($1,483.50) than does either the gross receipts method ($197.64) or the
section 482 method ($650), F may earn a profit of $1,483.50 for 1985.
Accordingly, the monthly rental payable by F to R for 1985 may be
readjusted as long as the monthly rental payable is not readjusted below
$907.39, computed as follows:
Monthly rental payable by F to R for 1985:
F's sublease rental receipts for year................... $10,800.00
-------------
Less:
F's expenses............................................ 1,150.00
F's profit.............................................. 1,483.50
-------------
Total............................................... (2,633.50)
-------------
Rental payable for 1985............................. 8,166.50
=============
Rental payable each month ($8,166.50/9 months)...... $907.39
=============
Computation for 1986
Combined taxable income:
F's sublease rental receipts for year ($1,200 x 3 months) $3,600.00
------------
Less:
R's depreciation (($40,000 x \1/10\) x \3/12\)........... (1,000.00)
------------
Combined taxable income.............................. 2,600.00
============
The combined taxable income method--F's profit:
F's profit--23% of combined taxable income ($2,600)...... 598.00
============
[[Page 100]]
The gross receipts method--F's profit:
F's profit--lesser of 1.83% of F's foreign trading gross 65.88
receipts ($3,600) or two times F's profit under the
combined taxable income method ($1,196).................
============
The section 482 method--F's profit:
F's sublease rental receipts for year.................... $3,600.00
------------
Less:
F's lease rental payments for year....................... (3,000.00)
------------
F's profit........................................... 600.00
============
Since the section 482 method results in a greater profit to F ($600)
than does either the combined taxable income method ($598) or the gross
receipts method ($65.88), F may earn a profit of $600 for 1986.
Accordingly, the monthly rental payable by F to R for 1986 may be
readjusted as long as the monthly rental payable is not readjusted below
$1,000, computed as follows:
Monthly rental payable by F to R for 1986:
F's sublease rental receipts for year.................... $3,600.00
------------
Less:
F's profit............................................... (600.00)
------------
Rental payable for 1986.................................. 3,000.00
============
Rental payable for each month ($3,000/3 months).......... 1,000.00
============
(g) Effective date. The provisions of this section and Sec.
1.925(b)-1T apply with respect to taxable year ending after December 31,
1984, except that a corporation may not be a FSC for any taxable year
beginning before January 1, 1985.
[T.D. 8126, 52 FR 6443, Mar. 3, 1987, as amended by T.D. 8764, 63 FR
10306, Mar. 3, 1998; T.D. 8944, 66 FR 13426, Mar. 6, 2001]
Sec. 1.925(b)-1T Temporary regulations; marginal costing rules.
(a) In general. This section prescribes the marginal costing rules
authorized by section 925(b)(2). If under paragraph (c)(1) of this
section a FSC is treated for its taxable year as seeking to establish or
maintain a foreign market for sales of an item, product, or product line
of export property (as defined in Sec. 1.927(a)-1T) from which foreign
trading gross receipts (as defined in Sec. 1.924(a)-1T) are derived,
the marginal costing rules prescribed in paragraph (b) of this section
may be applied at the related supplier's election to compute combined
taxable income of the FSC and related supplier derived from those sales.
(Any further reference to a FSC in this section shall include a small
FSC unless indicated otherwise.) The combined taxable income determined
under these marginal costing rules may be used to determine whether the
``twice the amount determined under the combined taxable income method''
limitation for the 1.83% of gross receipts test of section 925(d) has
been met.
For FSC taxable years beginning after December 31, 1986, if the marginal
costing rules are used to determine the section 925(d) limitation, the
FSC may not earn more than 100% of full costing combined taxable income
determined under the full costing combined taxable income method of
Sec. 1.925(a)-1T(c)(3) and (6). The marginal costing rules may be
applied even if the related supplier does not manufacture, produce,
grow, or extract the export property sold. The marginal costing rules do
not apply to sales of export property which in the hands of a purchaser
related under section 954(d)(3) to the seller give rise to foreign base
company sales income as described in section 954(d) unless, for the
purchaser's year in which it resells the export property, section
954(b)(3)(A) is applicable or that income is under the exceptions in
section 954(b)(4). In addition, the marginal costing rules do not apply
to leases of property or to the performances of any services even if
they are related and subsidiary services (as defined in Sec. 1.924(a)-
1T(d) and Sec. 1.925(a)-1T(b)(2)(iii)(C)).
(b) Marginal costing rules--(1) In general. Marginal costing is a
method under which only direct production costs of producing a
particular item, product, or product line are taken into account for
purposes of computing the combined taxable income of the FSC and its
related supplier under section 925(a)(2). The costs to be taken into
account are the related supplier's direct material and labor costs (as
defined in
[[Page 101]]
Sec. 1.471-11(b)(2)(i)). Costs which are incurred by the FSC and which
are not taken into account in computing combined taxable income are
deductible by the FSC only to the extent of the FSC's non-foreign trade
income. If the related supplier is not the manufacturer or producer of
the export property that is sold, the related supplier's purchase price
shall be taken into account.
(2) Overall profit percentage limitation. Under marginal costing,
the combined taxable income of the FSC and its related supplier may not
exceed the overall profit percentage (determined under paragraph (c)(2)
of this section) multiplied by the FSC's foreign trading gross receipts
if the FSC is the principal on the sale (or the related supplier's gross
receipts if the FSC is a commission agent) from the sale of export
property.
(3) Grouping of transactions. (i) In general, for purposes of this
section, an item, product, or product line is the item or group
consisting of the product or product line pursuant to Sec. 1.925(a)-
1T(c)(8) used by the taxpayer for purposes of applying the full costing
combined taxable income method of Sec. 1.925(a)-1T(c)(3) and (6).
(ii) However, for purposes of determining the overall profit
percentage under paragraph (c)(2) of this section, any product or
product line grouping permissible under Sec. 1.925(a)-1T(c)(8) may be
used at the annual choice of the FSC even though it may not be the same
item or grouping referred to in subdivision (i) of this paragraph as
long as the grouping chosen for determining the overall profit
percentage is at least as broad as the grouping referred to in the above
subdivision (i) of this paragraph. A product may be included for this
purpose, however, in only one product group even though under the
grouping rules it would otherwise fall in more than one group. Thus, the
marginal costing rules will not apply with respect to any regrouping if
the regrouping does not include any product (or products) that was
included in the group for purposes of the full costing method.
(4) Application of limitation on FSC income (``no loss'' rules). The
marginal costing rules of this section will not apply if there is a
combined loss of the related supplier and the FSC determined in
accordance with paragraph (b)(1) of this section. In addition, for FSC
taxable years beginning after December 31, 1986, the profit determined
under the marginal costing method may be allowed to the FSC only to the
extent it does not exceed the FSC's and the related supplier's full
costing combined taxable income determined under the full costing
combined taxable income method of Sec. 1.925(a)-1T(c)(3) and (6). This
rule prevents pricing at a loss to the related supplier. If either of
these ``no loss'' rules apply, the related supplier may nonetheless
charge a transfer price or pay a commission in an amount that will allow
the FSC to recover an amount not in excess of its full costs, if any,
even if to do so would create or increase a loss in the related
supplier. The effect of these no-loss rules and of the overall profit
percentage limitation of paragraph (c)(2) of this section is that the
FSC's profit under these marginal costing rules is limited to the lesser
of the following:
(i) 23% of maximum combined taxable income determined under the
marginal costing rules,
(ii) 23% of the overall profit percentage limitation, or
(iii) For FSC taxable years beginning after December 31, 1986, 100%
of the full costing combined taxable income determined under the full
costing combined taxable income method of Sec. 1.925(a)-1T(c)(3) and
(6).
(c) Definitions--(1) Establishing or maintaining a foreign market. A
FSC shall be treated for its taxable year as seeking to establish or
maintain a foreign market with respect to sales of an item, product, or
product line of export property from which foreign trading gross
receipts are derived if the combined taxable income computed under
paragraph (b) of this section is greater than the full costing combined
taxable income computed under the full costing combined taxable income
method of Sec. 1.925(a)-1T(c)(3) and (6).
(2) Overall profit percentage. (i) For purposes of this section, the
overall profit percentage for a taxable year of the FSC for a product or
product line is the percentage which--
[[Page 102]]
(A) The combined taxable income of the FSC and its related supplier
from the sale of export property plus all other taxable income of its
related supplier from all sales (domestic and foreign) of such product
or product line during the FSC's taxable year, computed under the full
costing method, is of
(B) The total gross receipts (determined under Sec. 1.927(b)-1T) of
the FSC and related supplier from all sales of the product or product
line.
(ii) At the annual option of the related supplier, the overall
profit percentage for the FSC's taxable year for all products and
product lines may be determined by aggregating the amounts described in
subdivisions (i)(A) and (B) of this paragraph of the FSC, and all
domestic members of the controlled group (as defined in section
927(d)(4) and Sec. 1.924(a)-1T(h)) of which the FSC is a member, for
the FSC's taxable year and for taxable years of the members ending with
or within the FSC's taxable year.
(iii) For purposes of determining the amounts in subdivisions (i)
and (ii) of this paragraph, a sale of property between a FSC and its
related supplier or between domestic members of the controlled group
shall be taken into account only during the FSC's taxable year (or
taxable year of the member ending within the FSC's taxable year) during
which the property is ultimately sold to a person which is not related
to the FSC or if related, is a foreign person that is not a FSC.
(3) Full costing method. For purposes of section 925 and this
section, the term ``full costing combined taxable income method'' is the
method for determining full costing combined taxable income set forth in
Sec. 1.925(a)-1T(c)(3) and (6).
(d) Examples. The provisions of this section may be illustrated by
the following examples:
Example 1. R and F are calendar year taxpayers. R, a domestic
manufacturing company, owns all the stock of F, a FSC for the taxable
year. During 1985, R produces and sells 100 units of export property A
to F under a written agreement which provides that the transfer price
between R and F shall be that price which allocates to F the maximum
profit permitted to be received under the administrative pricing rules
of section 925(a)(1) and (2). Thereafter, the 100 units are resold for
export by F for $950. R's cost of goods sold attributable to the 100
units is $650 consisting in part of $400 of direct materials and $200 of
direct labor. R incurs selling expenses directly attributable to the
sale in the amount of $100. Those expenses were not required to be
incurred by F. For purposes of this example, it is assumed that R does
not have general and administrative expenses that are not definitely
allocable to any item of gross income. F's expenses attributable to the
resale of the 100 units are $120. For purposes of this example, R and F
have gross receipts of $4,000 from all domestic and foreign sales. R's
total cost of goods sold and total expenses relating to its foreign and
domestic sales are $2,730 and $450, respectively. Under full costing,
the combined taxable income will be $80, computed as follows:
Combined taxable income--full costing:
F's foreign trading gross receipts........................ $950.00
R's cost of goods sold.................................... (650.00)
-----------
Combined gross income................................... 300.00
-----------
Less:
R's direct selling expenses............................. 100.00
F's expenses............................................ 120.00
-----------
Total................................................. (220.00)
-----------
Combined taxable income (loss)............................ 80.00
===========
F's profit under the full costing combined taxable income method is
$18.40, i.e., 23% of full costing combined taxable income ($80). F's
profit under the gross receipts method will be $17.39, i.e., 1.83% of
F's foreign trading gross receipts ($950). However, under the marginal
costing rules, F would have a profit attributable to the export sale in
the amount of $38.24, i.e., 23% of combined taxable income as determined
under the marginal costing rules (23% of $166.25). As shown by the
computation below, the combined taxable income under marginal costing is
limited to the overall profit percentage limitation ($166.25) since that
amount is less than the maximum combined taxable income amount ($350):
Maximum combined taxable income (determined under paragraph
(b)(1) of this section):
F's foreign trading gross receipts........................ $950.00
-----------
Less:
R's direct materials.................................... 400.00
R's direct labor........................................ 200.00
-----------
Total................................................. (600.00)
-----------
[[Page 103]]
Maximum combined total income............................. 350.00
===========
Overall profit percentage limitation calculation
(determined under paragraph (c)(2) of this section):
Gross receipts of R and F from all domestic and foreign $4,000.00
sales...................................................
R's cost of goods sold................................... (2,730.00)
------------
Combined gross income................................ 1,270.00
------------
Less:
R's expenses........................................... 450.00
F's expenses........................................... 120.00
------------
Total................................................ (570.00)
------------
Total taxable income from all sales computed on a 700.00
full costing method.................................
============
Overall profit percentage (total taxable income ($700) 17.5%
divided by total gross receipts ($4,000)................
============
Overall profit percentage limitation Overall profit $166.25
percentage times F's foreign trading gross receipts
(17.5% times $950.00)...................................
============
The transfer price from R to F may be set at $791.76, computed as
follows:
Transfer price to F:
F's foreign trading gross receipts....................... $950.00
------------
Less:
F's expenses............................................. 120.00
F's profit............................................... 38.24
------------
Total................................................ (158.24)
------------
Transfer price........................................... 791.76
============
Example 2. Assume the same facts as in Example 1 except that F's
expenses are $170. Under full costing, the combined taxable income will
be $30, computed as follows:
Combined taxable income--full costing:
F's foreign trading gross receipts......................... $950.00
R's cost of goods sold..................................... (650.00)
----------
Combined gross income.................................. 300.00
----------
Less:
R's expenses............................................... 100.00
F's expenses............................................... 170.00
==========
Total.................................................. (270.00)
----------
Combined taxable income (loss)......................... 30.00
----------
F's profit under the full costing combined taxable income method is
$6.90, i.e., 23% of combined taxable income, $30. Under the marginal
costing rules, F may earn a profit attributable to the export sale in
the amount of $35.51, i.e., 23% of combined taxable income as determined
under the marginal costing rules (23% of $154.38). Had the transaction
occurred in 1987, F would have had a profit attributable to the export
sale under these marginal costing rules of only $30, i.e., 23% of
combined taxable income as determined under the marginal costing rules
(23% of $154.38) limited, for FSC taxable years beginning after December
31, 1986, to combined taxable income determined under full costing
($30), see paragraph (b)(4) of this section. F's profit under the gross
receipts method will be $17.39 i.e., 1.83% of F's foreign trading gross
receipts ($950). The computations are as follows:
Maximum combined taxable income (determined under paragraph
(b)(1) of this section):
F's foreign trading gross receipts....................... $950.00
------------
Less:
R's direct materials................................... 400.00
R's direct labor....................................... 200.00
------------
Total................................................ (600.00)
------------
Maximum combined taxable income 350.00
============
Overall profit percentage limitation calculation
(determined under paragraph (c)(2) of this section):
Gross receipts of R and F from all domestic and foreign 4,000.00
sales...................................................
R's cost of goods sold................................... (2,730.00)
------------
Combined gross income.................................... 1,270.00
------------
Less:
R's expenses........................................... 450.00
F's expenses........................................... 170.00
------------
Total................................................ (620.00)
------------
Total taxable income from all sales computed on a full 650.00
costing method..........................................
============
Overall profit percentage (total taxable income ($650) 16.25%
divided by total gross receipts ($4,000)).................
============
Overall profit percentage limitation Overall profit 154.38
percentage times F's foreign trading gross receipts
(16.25% times $950.00)....................................
============
[[Page 104]]
The transfer price from R to F may be set at $744.49,
computed as follows:
Transfer price to F:
F's foreign trading gross receipts..................... 950.00
------------
Less:
F's expenses......................................... 170.00
F's profit........................................... 35.51
------------
Total.............................................. (205.51)
------------
Transfer price......................................... 744.49
============
Example 3. Assume the same facts as in Example 1 except that the
transaction occurs in 1987 and that F incurs expenses in the amount of
$250. Since a $50 combined loss, as computed below, is incurred, F will
not have any profit under either the full costing combined taxable
income method, the gross receipts method or the marginal costing rules:
Combined taxable income--full costing:
F's foreign trading gross receipts..................... $950.00
R's cost of goods sold................................. (650.00)
------------
Combined gross income................................ 300.00
------------
Less:
R's expenses......................................... 100.00
F's expenses......................................... 250.00
------------
Total.............................................. (350.00)
------------
Combined taxable income (loss)......................... (50.00)
============
The transfer price to R may be set at $700 so that F may recover its
expenses.
Example 4. R and F are calendar year taxpayers. R, a domestic
manufacturing company, owns all the stock of F, a FSC for the taxable
year. During 1985, R manufactures export property A. R enters into a
written agreement with F whereby F will receive a commission with
respect to sales of export property A by R which result in gross
receipts to R which would have been foreign trading gross receipts had F
and not R been the principal on the sale. F will receive commissions
with respect to such export sales equal to the maximum amount permitted
to be received under the transfer pricing rules of section 925. The
maximum commission may be earned by F under these marginal costing
rules. In this example, R received $950 from the sale of export property
A. R's cost of goods sold for that property was $620. R incurred direct
selling expenses of $20. Also, it is assumed that R incurred total
general and administrative expenses, in addition to those incurred
relating to its contract to perform on behalf of F the functions and
activities of section 924 (c), (d) and (e), of $50. R incurred direct
and indirect expenses of $130 in performing those functions and
activities on behalf of F. During 1985, R had gross receipts from all
domestic and foreign sales of $3,500, total cost of goods sold and total
expenses relating to the domestic and foreign sales of $1,600 and $259,
respectively. The election provided for in Sec. 1.925(a)-1T(b)(2)(ii)
was not made by R and F.
Combined taxable income--full costing:
R's gross receipts from the sale of the export ....... $950.00
property.....................................
R's cost of goods sold........................ ....... (620.00)
----------
Combined gross income....................... ....... 330.00
----------
Less:
R's direct selling expenses................. ....... 20.00
F's expenses................................ ....... 130.00
Apportionment of R's general and
administrative expenses:
R's total G/A expenses...................... $50 ...........
Combined gross income....................... 330 ...........
R's total gross income...................... 1,900 ...........
Apportionment of G/A expenses $50 x $330/ ....... 8.68
$1,900.....................................
------------
Total..................................... ....... (158.68)
------------
Combined taxable income (loss)................ ....... 171.32
============
Maximum combined taxable income (determined under paragraph
(b)(1) of this section):
R's gross receipts from the sale of the export property.. $950.00
------------
Less:
R's direct materials................................... 450.00
R's direct labor....................................... 100.00
------------
Total................................................ (550.00)
------------
Maximum combined taxable income.......................... 400.00
============
[[Page 105]]
Overall profit percentage limitation calculation
(determined under paragraph (c)(2) of this section):
Gross receipts of R from all domestic and foreign sales.. 3,500.00
R's cost of goods sold................................... (1,600.00)
------------
Combined gross income.................................. 1,900.00
------------
Less:
R's total expenses..................................... 259.00
F's total expenses..................................... 130.00
------------
Total................................................ (450.00)
------------
Total taxable income from all sales computed on a full 1,511.00
costing method..........................................
============
Overall profit percentage (total taxable income ($1,511) 43.17%
divided by total gross receipts ($3,500)).................
============
Overall profit percentage limitation Overall profit 410.12
percentage times R's gross receipts from the sale of
export property (i.e., 43.17% times $950.00)..............
============
Since the overall profit percentage limitation ($410.12) is greater than
the maximum combined taxable income ($400), combined taxable income
under marginal costing and for purposes of computing F's commission is
limited to $400. Under these marginal costing rules, F will have a
profit attributable to the sale of $92, i.e., 23% of combined taxable
income as determined under the marginal costing rules (23% of $400).
Accordingly, the commission F receives from R is $222, i.e., F's
expenses ($130) plus F's profit ($92).
Example 5. Assume the same facts as in Example 4, except that R's
gross receipts from the sale of export property which would have been
foreign trading gross receipts had F been the principal on the sale are
$1,050 and gross receipts from all sales, domestic and foreign, remain
at $3,500. For purposes of applying the combined taxable income method,
R and F may compute their combined taxable income attributable to the
product line of export property under the marginal costing rules as
follows:
Combined taxable income--full costing:
R's gross receipts from the sale of the export property.. $1,050.00
R's cost of goods sold................................... (620.00)
------------
Combined gross income.................................. 430.00
------------
Less:
R's direct selling expenses............................ 20.00
F's expenses........................................... 130.00
Apportionment of R's G/A expenses $50 x $430/$1,900.... 11.32
------------
Total................................................ (161.32)
------------
Combined taxable income (loss)........................... 268.68
============
Maximum combined taxable income (determined under
paragraph (b)(1) of this section):
R's gross receipts from the sale of export property... $1,050.00
---------------
Less:
R's direct materials.................................. 450.00
R's direct labor...................................... 100.00
---------------
Total............................................. (550.00)
---------------
Maximum combined taxable income....................... 500.00
===============
Overall profit percentage (see example 4)............. 43.17%
===============
Overall profit percentage limitation (determined under 453.29
paragraph (c)(2) of this section) (R's gross receipts
from sale ($1,050.00) times the overall profit
percentage (43.17%)).................................
===============
Since maximum combined taxable income ($500) is greater than the overall
profit percentage limitation ($453.29), combined taxable income under
marginal costing and for purposes of computing F's commission is limited
to $453.29. Under these marginal costing rules, F will have a profit
attributable to the sales of $104.26, i.e., 23% of combined taxable
income (23% of $453.29). Accordingly, the commission F receives from R
is $234.26, i.e., F's expenses ($130) plus F's profit ($104.26).
Example 6. Assume the same facts as in Example 5, except that F has
expenses of $140 and R's cost of goods sold for the export sale was
$900. R does not incur any direct selling expenses. Since cost of goods
sold has increased by $280, R's total gross income has been reduced from
$1,900 to $1,620. For purposes of applying the combined taxable income
method, R and F may compute their combined taxable income under the
marginal costing rules as follows:
Combined taxable income--full costing:
R's gross receipts from the sale of export property..... $1,050.00
R's cost of goods sold.................................. (900.00)
-------------
Combined gross income................................. 150.00
-------------
[[Page 106]]
Less:
F's expenses............................................ 140.00
Apportionment of R's G/A expenses $50 x $150/$1,620..... 4.63
-------------
Total............................................... (144.63)
-------------
Combined taxable income (loss).......................... 5.37
=============
Maximum combined taxable income (determined under
paragraph (b)(1) of this section):
R's gross receipts from the sale of export property..... $1,050.00
-------------
Less:
R's direct materials.................................... 630.00
R's direct labor........................................ 200.00
-------------
Total............................................... (830.00)
-------------
Maximum combined taxable income......................... 220.00
=============
Overall profit percentage limitation calculation
(determined under paragraph (c)(2) of this section):
Gross receipts of R and F from all domestic and foreign $3,500.00
sales..................................................
R's cost of goods sold.................................. (1,880.00)
-------------
Combined gross income............................... 1,620.000
-------------
Less:
R's total expenses...................................... 259.00
F's total expenses...................................... 140.00
-------------
Total............................................... (399.00)
-------------
Total taxable income from all sales computed on a full $1,221.00
costing method.........................................
-------------
Overall profit percentage (total taxable income ($1,221) 34.89%
divided by total gross receipts ($3,500))..............
=============
Overall profit percentage limitation--overall profit $366.35
percentage times R's gross receipts from the sale of
export property (i.e., 34.89% times $1,050)............
=============
Since the overall profit percentage limitation ($366.35) is greater than
the maximum combined taxable income ($220), combined taxable income
under marginal costing and for purposes of computing F's commission is
limited to $220. Under these marginal costing rules, F will have a
profit attributable to the sale of $50.60, i.e., 23% of combined taxable
income as determined under the marginal costing rules (23% of $220). If
the transaction occurred in 1987, F's profit would be limited, however,
by paragraph (b)(4) of this section to the full costing combined taxable
income of $5.37.
[T.D. 8126, 52 FR 6455, Mar. 3, 1987, as amended by T.D.8764, 63 FR
10306, Mar. 3, 1998; T.D. 8944, 66 FR 13429, Mar. 6, 2001]
Sec. 1.926(a)-1 Distributions to shareholders.
(a) Treatment of distributions. [Reserved] For guidance, see Sec.
1.926(a)-1T(a).
(b) Order of distribution--(1) In general--(i) Distributions by a
FSC received by a shareholder in a taxable year of the shareholder
beginning before January 1, 1990. Any actual distribution to a
shareholder by a FSC (all references to a FSC in this section shall
include a small FSC and a former FSC) that is received by the
shareholder in a taxable year of the shareholder beginning before
January 1, 1990, and made out of earnings and profits shall be treated
as made in the following order, to the extent thereof--
(A) Out of earnings and profits attributable to exempt foreign trade
income determined solely because of operation of section 923(a)(4),
(B) Out of earnings and profits attributable to other exempt foreign
trade income,
(C) Out of earnings and profits attributable to non-exempt foreign
trade income determined under either of the administrative pricing
methods of section 925(a)(1) or (2),
(D) Out of earnings and profits attributable to section 923(a)(2)
non-exempt income, and
(E) Out of other earnings and profits.
(ii) Distributions by a FSC received by a shareholder in a taxable
year of the shareholder beginning after December 31, 1989. Any actual
distribution to a shareholder by a FSC that is received by the
shareholder in a taxable year beginning after December 31, 1989, and
that is made out of earnings and profits shall be treated as made in the
following order, to the extent thereof--
(A) Out of earnings and profits attributable to exempt foreign trade
income determined solely because of the operation of section 923(a)(4),
(B) Out of earnings and profits attributable to foreign trade income
(other
[[Page 107]]
than exempt foreign trade income determined solely because of the
operation of section 923(a)(4)) allocable to the marketing of
agricultural or horticultural products (or the providing of related
services) by a qualified cooperative which is a shareholder of the FSC,
(C) Out of earnings and profits attributable to non-exempt foreign
trade income and other exempt foreign trade income determined under
either of the administrative pricing methods of section 925(a)(1) and
(2). Distributions out of this classification will be made on a pro rata
basis so that 15/23 (16/23 with regard to distribution to a non-
corporate shareholder) of each distribution will be out of earnings and
profits attributable to exempt foreign trade income and the remainder
will be out of earnings and profits attributable to non-exempt foreign
trade income. To the extent the distributions are out of earnings and
profits attributable to the disposition of, or services related to,
military property, 7.5/23 (8/23 with regard to distributions to a non-
corporate shareholder) of each distribution will be out of earnings and
profits attributable to exempt foreign trade income and the remainder
will be out of earnings and profits attributable to non-exempt foreign
trade income,
(D) Out of earnings and profits attributable to other exempt foreign
trade income determined under the transfer pricing method of section
925(a)(3),
(E) Out of earnings and profits attributable to section 923(a)(2)
non-exempt income,
(F) Out of earnings and profits attributable to effectively
connected income, as defined in section 245(c)(4)(B), and
(G) Out of other earnings and profits.
(2) Determination of earnings and profits. [Reserved] For guidance,
see Sec. 1.926(a)-1T(b)(1).
(c) Definition of ``former FSC''. [Reserved] For guidance, see Sec.
1.926(a)-1T(c).
(d) Personal holding company income. [Reserved] For guidance, see
Sec. 1.926(a)-1T(d).
(e) Sale of stock if section 1248 applies. [Reserved] For guidance,
see Sec. 1.926(a)-1T(e).
[T.D. 8340, 56 FR 11093, Mar. 15, 1991]
Sec. 1.926(a)-1T Temporary regulations; distributions to shareholders.
(a) Treatment of distributions. Any distribution by a FSC (or former
FSC) to its shareholder with respect to its stock will be includible in
the shareholder's gross income in accordance with the provisions of
section 301. (Any further reference to a FSC in this section shall
include a small FSC unless indicated otherwise.) See section 245(c) for
treatment of distributions to domestic corporate shareholders of the
FSC. If earnings and profits of a FSC (or former FSC) attributable to
foreign trade income are distributed to a shareholder which is a foreign
person (or a nonresident alien individual), that distribution shall be
treated as United States source income which is effectively connected
with the conduct of a trade or business conducted through a permanent
establishment of such shareholder within the United States. For this
purpose, distributions to a foreign partnership, foreign trust, foreign
estate or other foreign entities that would be treated as pass-through
entities under U.S. law shall be treated as made directly to the
partners of beneficiaries in proportion to their respective interest in
the entity.
(b) Order of distributions--(1) In general. For guidance, see Sec.
1.926(a)-1(b)(1).
(2) Determination of earnings and profits. For purposes of this
section, the earnings and profits of a FSC (or former FSC) shall be the
earnings and profits computed in accordance with the rules, where
applicable, prescribed in Sec. 1.964-1 (relating to determination of
the earnings and profits of a foreign corporation) other than
subsections (d) and (e) of that section.
(c) Definition of ``former FSC''. Under section 926(c), the term
``former FSC'' refers to a corporation which is not a FSC for a taxable
year but which was a FSC for a prior taxable year. However, a
corporation is not a former FSC for a taxable year unless such
corporation has, at the beginning of such taxable year, earnings and
profits attributable to foreign trade income. A corporation which is a
former FSC for a taxable year is a former FSC for all purposes of the
Code.
(d) Personal holding company income--(1) Treatment of dividends. Any
amount
[[Page 108]]
includible in a shareholder's gross income as a dividend with respect to
the stock of a FSC (or former FSC) under paragraph (a) of this section
shall be treated as a dividend for all purposes of the Code, except that
that part of the dividend attributable to foreign trade income, other
than an amount attributable to section 923(a)(2) non-exempt income,
shall not be considered in applying the personal holding company and
foreign personal holding company provisions (sections 541 through 547
and 551 through 558, respectively).
(2) Look through option. With regard to distributions from a FSC (or
former FSC) which are not treated as personal holding company income
under paragraph (d)(1) of this section, the shareholder may, however,
treat any amount of that distribution as an item of income described
under section 543 (or section 553) (for example, rents) if it
establishes to the satisfaction of the Commissioner that such amount is
attributable to earnings and profits of the FSC derived from such item
of income. For example, distributions from a FSC relating to section
923(a)(2) non-exempt income will be treated as dividends for purposes of
the personal holding company provisions of sections 541 through 547
unless the look through option is elected. Under this option, if
earnings and profits out of which those distributions are made are
attributable to the lease of export property, the FSC shareholder may
treat the distribution for purposes of the personal holding company
provisions as rents rather than as dividends. This may be beneficial to
the shareholder because rents are not considered under section 543(a)(2)
as personal holding company income, if in general, rents constitute 50%
or more of the shareholder's adjusted ordinary gross income.
(e) Sale of stock if section 1248 applies. For purposes of section
1248, the earnings and profits of a FSC (or former FSC) shall not
include earnings and profits attributable to foreign trade income.
[T.D. 8126, 52 FR 6458, Mar. 3, 1987, as amended by T.D. 8340, 56 FR
11093, Mar. 15, 1991]
Sec. 1.927(a)-1T Temporary regulations; definition of export property.
(a) General rule. Under section 927 (a), except as otherwise
provided with respect to excluded property in paragraphs (f), (g) and
(h) of this section and with respect to certain short supply property in
paragraph (i) of this section, export property is property in the hands
of any person (whether or not a FSC) (any further reference to a FSC in
this section shall include a small FSC unless indicated otherwise)--
(1) U.S. manufactured, produced, grown or extracted. Manufactured,
produced, grown, or extracted in the United States by any person or
persons other than a FSC (see paragraph (c) of this section),
(2) Foreign use, consumption or disposition. Held primarily for
sale, lease or rental in the ordinary course of a trade or business by a
FSC to a FSC or to any other person for direct use, consumption, or
disposition outside the United States (see paragraph (d) of this
section),
(3) Foreign content. Not more than 50 percent of the fair market
value of which is attributable to articles imported into the United
States (see paragraph (e) of this section), and
(4) Non-related FSC purchaser or user. Which is not sold, leased or
rented by a FSC, or with a FSC as commission agent, to another FSC which
is a member of the same controlled group (as defined in section
927(d)(4) and Sec. 1.924(a)-1T(h)) as the FSC.
(b) Services. For purposes of this section, services (including the
written communication of services in any form) are not export property.
Whether an item is property or services shall be determined on the basis
of the facts and circumstances attending the development and disposition
of the item. Thus, for example, the preparation of a map of a particular
construction site would constitute services and not export property, but
standard maps prepared for sale to customers generally would not
constitute services and would be export property if the requirements of
this section were otherwise met.
(c) Manufacture, production, growth, or extraction of property--(1)
By a person
[[Page 109]]
other than a FSC. Export property may be manufactured, produced, grown,
or extracted in the United States by any person, provided that that
person does not qualify as a FSC. Property held by a FSC which was
manufactured, produced, grown or extracted by it at a time when it did
not qualify as a FSC is not export property of the FSC. Property which
sustains further manufacture, production or processing outside the
United States prior to sale or lease by a person but after manufacture,
production, processing or extraction in the United States will be
considered as manufactured, produced, grown or extracted in the United
States by that person only if the property is reimported into the United
States for further manufacturing, production or processing prior to
final export sale. In order to be considered export property, the
property manufactured, produced, grown or extracted in the United States
must satisfy all of the provisions of section 927(a) and this section.
(2) Manufactured, produced or processed. For purposes of this
section, property which is sold or leased by a person is considered to
be manufactured, produced or processed by that person or by another
person pursuant to a contract with that person if the property is
manufactured or produced, as defined in Sec. 1.954-3(a)(4). For
purposes of this section, however, in determining if the 20% conversion
test of Sec. 1.954-3(a)(4)(iii) has been met, conversion costs include
assembly and packaging costs but do not include the value of parts
provided pursuant to a services contract as described in Sec. 1.924(a)-
1T(d)(3). In addition, for purposes of this section, the 20% conversion
test is extended and applied to the export property's adjusted basis
rather than to its cost of goods sold if it is leased or held for lease.
(d) Foreign use, consumption or disposition--(1) In general. (i)
Under paragraph (a)(2) of this section, export property must be held
primarily for the purpose of sale, lease or rental in the ordinary
course of a trade or business, by a FSC to a FSC or to any other person,
and the sale or lease must be for direct use, consumption, or
disposition outside the United States. Thus, property cannot qualify as
export property unless it is sold or leased for direct use, consumption,
or disposition outside the United States. Property is sold or leased for
direct use, consumption, or disposition outside the United States if the
sale or lease satisfies the destination test described in subdivision
(2) of this paragraph, the proof of compliance requirements described in
subdivision (3) of this paragraph, and the use outside the United States
test described in subdivision (4) of this paragraph.
(ii) Factors not taken into account. In determining whether property
which is sold or leased to a FSC is sold or leased for direct use,
consumption, or disposition outside the United States, the fact that the
acquiring FSC holds the property in inventory or for lease prior to the
time it sells or leases it for direct use, consumption, or disposition
outside the United States will not affect the characterization of the
property as export property. Fungible export property must be physically
segregated from non-export property at all times after purchase by or
rental by a FSC or after the start of the commission relationship
between the FSC and related supplier with regard to the export property.
Non-fungible export property need not be physically segregated from non-
export property.
(2) Destination test. (i) For purposes of paragraph (d)(1) of this
section, the destination test of this paragraph is satisfied with
respect to property sold or leased by a seller or lessor only if it is
delivered by the seller or lessor (or an agent of the seller or lessor)
regardless of the F.O.B. point or the place at which title passes or
risk of loss shifts from the seller or lessor--
(A) Within the United States to a carrier or freight forwarder for
ultimate delivery outside the United States to a purchaser or lessee (or
to a subsequent purchaser or sublessee),
(B) Within the United States to a purchaser or lessee, if the
property is ultimately delivered outside the United States (including
delivery to a carrier or freight forwarder for delivery outside the
United States) by the purchaser or lessee (or a subsequent purchaser or
sublessee) within 1 year after the sale or lease,
[[Page 110]]
(C) Within or outside the United States to a purchaser or lessee
which, at the time of the sale or lease, is a FSC or an interest charge
DISC and is not a member of the same controlled group as the seller or
lessor,
(D) From the United States to the purchaser or lessee (or a
subsequent purchaser or sublessee) at a point outside the United States
by means of the seller's or lessor's own ship, aircraft, or other
delivery vehicle, owned, leased, or chartered by the seller or lessor,
(E) Outside the United States to a purchaser or lessee from a
warehouse, storage facility, or assembly site located outside the United
States, if the property was previously shipped by the seller or lessor
from the United States, or
(F) Outside the United States to a purchaser or lessee if the
property was previously shipped by the seller or lessor from the United
States and if the property is located outside the United States pursuant
to a prior lease by the seller or lessor, and either (1) the prior lease
terminated at the expiration of its term (or by the action of the prior
lessee acting alone), (2) the sale occurred or the term of the
subsequent lease began after the time at which the term of the prior
lease would have expired, or (3) the lessee under the subsequent lease
is not a related person with respect to the lessor and the prior lease
was terminated by the action of the lessor (acting alone or together
with the lessee).
(ii) For purposes of this paragraph (d)(2) (other than paragraphs
(d)(2)(i)(C) and (F)(3)), any relationship between the seller or lessor
and any purchaser, subsequent purchaser, lessee, or sublessee is
immaterial.
(iii) In no event is the destination test of this paragraph (d)(2)
satisfied with respect to property which is subject to any use (other
than a resale or sublease), manufacture, assembly, or other processing
(other than packaging) by any person between the time of the sale or
lease by such seller or lessor and the delivery or ultimate delivery
outside the United States described in this paragraph (d)(2).
(iv) If property is located outside the United States at the time it
is purchased by a person or leased by a person as lessee, such property
may be export property in the hands of such purchaser or lessee only if
it is imported into the United States prior to its further sale or lease
(including a sublease) outside the United States. Paragraphs (a)(3) and
(e) of this section (relating to the 50 percent foreign content test)
are applicable in determining whether such property is export property.
Thus, for example, if such property is not subjected to manufacturing or
production (as defined in paragraph (c) of this section) within the
United States after such importation, it does not qualify as export
property.
(3) Proof of compliance with destination test--(i) Delivery outside
the United States. For purposes of paragraph (d)(2) of this section
(other than subdivision (i)(C) thereof), a seller or lessor shall
establish ultimate delivery, use, or consumption of property outside the
United States by providing--
(A) A facsimile or carbon copy of the export bill of lading issued
by the carrier who delivers the property,
(B) A certificate of an agent or representative of the carrier
disclosing delivery of the property outside the United States,
(C) A facsimile or carbon copy of the certificate of lading for the
property executed by a customs officer of the country to which the
property is delivered,
(D) If that country has no customs administration, a written
statement by the person to whom delivery outside the United States was
made,
(E) A facsimile or carbon copy of the Shipper's Export Declaration,
a monthly shipper's summary declaration filed with the Bureau of
Customs, or a magnetic tape filed in lieu of the Shipper's Export
Declaration, covering the property, or
(F) Any other proof (including evidence as to the nature of the
property or the nature of the property or the nature of the transaction)
which establishes to the satisfaction of the Commissioner that the
property was ultimately delivered, or directly sold, or directly
consumed outside the United States within 1 year after the sale or
lease.
(ii) The requirements of subdivision (i)(A), (B), (C), or (E) of
this paragraph
[[Page 111]]
will be considered satisfied even though the name of the ultimate
consignee and the price paid for the goods is marked out provided that,
in the case of a Shipper's Export Declaration or other document listed
in subdivision (i)(E) of this paragraph or a document such as an export
bill of lading, such document still indicates the country in which
delivery to the ultimate consignee is to be made and, in the case of a
certificate of an agent or representative of the carrier, that the
document indicates that the property was delivered outside the United
States.
(iii) A seller or lessor shall also establish the meeting of the
requirement of paragraph (d)(2)(i) of this section (other than
subdivision (i)(C) thereof), that the property was delivered outside the
United States without further use, manufacture, assembly, or other
processing within the United States.
(iv) For purposes of paragraph (d)(2)(i)(C) of this section, a
purchaser or lessee of property is deemed to qualify as a FSC or an
interest charge DISC for its taxable year if the seller or lessor
obtains from the purchaser or lessee a copy of the purchaser's or
lessee's election to be treated as a FSC or interest charge DISC
together with the purchaser's or lessee's sworn statement that the
election has been timely filed with the Internal Revenue Service Center.
The copy of the election and the sworn statement of the purchaser or
lessee must be received by the seller or lessor within 6 months after
the sale or lease. A purchaser or lessee is not treated as a FSC or
interest charge DISC with respect to a sale or lease during a taxable
year for which the purchaser or lessee does not qualify as a FSC or
interest charge DISC if the seller or lessor does not believe or if a
reasonable person would not believe at the time the sale or lease is
made that the purchaser or lessee will qualify as a FSC or interest
charge DISC for the taxable year.
(v) If a seller or lessor fails to provide proof of compliance with
the destination test as required by this paragraph (d)(3), the property
sold or leased is not export property.
(4) Sales and leases of property for ultimate use in the United
States--(i) In general. For purposes of paragraph (d)(1) of this
section, the use test in this paragraph (d)(4) is satisfied with respect
to property which--
(A) Under subdivision (4)(ii) through (iv) of this paragraph is not
sold for ultimate use in the United States, or
(B) Under subdivision (4)(v) of this paragraph is leased for
ultimate use outside the United States.
(ii) Sales of property for ultimate use in the United States. For
purposes of subdivision (4)(i) of this paragraph, a purchaser of
property (including components, as defined in subdivision (4)(vii) of
this paragraph) is deemed to use the property ultimately in the United
States if any of the following conditions exist:
(A) The purchaser is a related party with respect to the seller and
the purchaser ultimately uses the property, or a second product into
which the property is incorporated as a component, in the United States.
(B) At the time of the sale, there is an agreement or understanding
that the property, or a second product into which the property is
incorporated as a component, will be ultimately used by the purchaser in
the United States.
(C) At the time of the sale, a reasonable person would have believed
that the property or the second product would be ultimately used by the
purchaser in the United States unless, in the case of a sale of
components, the fair market value of the components at the time of
delivery to the purchaser constitutes less than 20 percent of the fair
market value of the second product into which the components are
incorporated (determined at the time of completion of the production,
manufacture, or assembly of the second product).
For purposes of subdivision (4)(ii)(B) of this paragraph, there is an
agreement or understanding that property will ultimately be used in the
United States if, for example, a component is sold abroad under an
express agreement with the foreign purchaser that the component is to be
incorporated into a product to be sold back to the United States. As a
further example, there
[[Page 112]]
would also be such an agreement or understanding if the foreign
purchaser indicated at the time of the sale or previously that the
component is to be incorporated into a product which is designed
principally for the United States market. However, such an agreement or
understanding does not result from the mere fact that a second product,
into which components exported from the United States have been
incorporated and which is sold on the world market, is sold in
substantial quantities in the United States.
(iii) Use in the United States. For purposes of subdivision (4)(ii)
of this paragraph, property (including components incorporated into a
second product) is or would be ultimately used in the United States by
the purchaser if, at any time within 3 years after the purchase of such
property or components, either the property is or the components (or the
second product into which the components are incorporated) are resold by
the purchaser for use by a subsequent purchaser within the United States
or the purchaser or subsequent purchaser fails, for any period of 365
consecutive days, to use the property or second product predominantly
outside the United States (as defined in subdivision (4)(vi) of this
paragraph).
(iv) Sales to retailers. For purposes of subdivision (4)(ii)(C) of
this paragraph, property sold to any person whose principal business
consists of selling from inventory to retail customers at retail outlets
outside the United States will be considered to be used predominantly
outside the United States.
(v) Leases of property for ultimate use outside the United States.
For purposes of subdivision (4)(i) of this paragraph, a lessee of
property is deemed to use property ultimately outside the United States
during a taxable year of the lessor if the property is used
predominantly outside the United States (as defined in subdivision
(4)(vi) of this paragraph) by the lessee during the portion of the
lessor's taxable year which is included within the term of the lease. A
determination as to whether the ultimate use of leased property
satisfies the requirements of this subdivision is made for each taxable
year of the lessor. Thus, leased property may be used predominantly
outside the United States for a taxable year of the lessor (and thus,
constitute export property if the remaining requirements of this section
are met) even if the property is not used predominantly outside the
United States in earlier taxable years or later taxable years of the
lessor.
(vi) Predominant use outside the United States. For purposes of this
paragraph (d)(4), property is used predominantly outside the United
States for any period if, during that period, the property is located
outside the United States more than 50 percent of the time. An aircraft,
railroad rolling stock, vessel, motor vehicle, container, or other
property used for transportation purposes is deemed to be used
predominantly outside the United States for any period if, during that
period, either the property is located outside the United States more
than 50 percent of the time or more than 50 percent of the miles
traversed in the use of the property are traversed outside the United
States. However, property is deemed to be within the United States at
all times during which it is engaged in transport between any two points
within the United States, except where the transport constitutes
uninterrupted international air transportation within the meaning of
section 4262(c)(3) and the regulations under that section (relating to
tax on air transportation of persons). An orbiting satellite is deemed
to be located outside the United States. For purposes of applying
section 4262(c)(3) to this subdivision, the term ``United States''
includes the Commonwealth of Puerto Rico.
(vii) Component. For purposes of this paragraph (d)(4), a component
is property which is (or is reasonably expected to be) incorporated into
a second product by the purchaser of such component by means of
production, manufacture, or assembly.
(e) Foreign content of property--(1) The 50 percent test. Under
paragraph (a)(3) of this section, no more than 50 percent of the fair
market value of export property may be attributable to the fair market
value of articles which were imported into the United States. For
purposes of this paragraph (e), articles
[[Page 113]]
imported into the United States are referred to as ``foreign content.''
The fair market value of the foreign content of export property is
computed in accordance with paragraph (e)(4) of this section. The fair
market value of export property which is sold to a person who is not a
related person with respect to the seller is the sale price for such
property (not including interest, finance or carrying charges, or
similar charges.)
(2) Application of 50 percent test. The 50 percent test is applied
on an item-by-item basis. If, however, a person sells or leases a large
volume of substantially identical export property in a taxable year and
if all of that property contains substantially identical foreign content
in substantially the same proportion, the person may determine the
portion of foreign content contained in that property on an aggregate
basis.
(3) Parts and services. If, at the time property is sold or leased
the seller or lessor agrees to furnish parts pursuant to a services
contract (as provided in Sec. 1.924(a)-1T(d)(3)) and the price for the
parts is not separately stated, the 50 percent test is applied on an
aggregate basis to the property and parts. If the price for the parts is
separately stated, the 50 percent test is applied separately to the
property and to the parts.
(4) Computation of foreign content--(i) Valuation. For purposes of
applying the 50 percent test, it is necessary to determine the fair
market value of all articles which constitutes foreign content of the
property being tested to determine if it is export property. The fair
market value of the imported articles is determined as of the time the
articles are imported into the United States.
(A) General rule. Except as provided in paragraph (e)(4)(i)(B), the
fair market value of the imported articles which constitutes foreign
content is their appraised value, as determined under section 403 of the
Tariff Act of 1930 (19 U.S.C. 1401a) in connection with their
importation. The appraised value of the articles is the full dutiable
value of the articles, determined, however, without regard to any
special provision in the United States tariff laws which would result in
a lower dutiable value.
(B) Special election. If all or a portion of the imported article
was originally manufactured, produced, grown, or extracted in the United
States, the taxpayer may elect to determine the fair market value of the
imported articles which constitutes foreign content under the provisions
of this paragraph (e)(4)(i)(B) if the property is subjected to
manufacturing or production (as defined in paragraph (c) of this
section) within the United States after importation. A taxpayer making
the election under this paragraph may determine the fair market value of
the imported articles which constitutes foreign content to be the fair
market value of the imported articles reduced by the fair market value
at the time of the initial export of the portion of the property that
was manufactured, produced, grown, or extracted in the United States.
The taxpayer must establish the fair market value of the imported
articles and of the portion of the property manufactured, produced,
grown, or extracted in the United States at the time of the initial
export in accordance with subdivision (4)(ii)(B) of this paragraph.
(ii) Evidence of fair market value-- (A) General rule. For purposes
of subdivision (4)(i)(A) of this paragraph, the fair market value of the
imported articles is their appraised value, which may be evidenced by
the customs invoice issued on the importation of such articles into the
United States. If the holder of the articles is not the importer (or a
related person with respect to the importer), the appraised value of the
articles may be evidenced by a certificate based upon information
contained in the customs invoice and furnished to the holder by the
person from whom the articles (or property incorporating the articles)
were purchased. If a customs invoice or certificate described in the
preceding sentences is not available to a person purchasing property,
the person shall establish that no more than 50 percent of the fair
market value of such property is attributable to the fair market value
of articles which were imported into the United States.
(B) Special election. For purposes of the special election set forth
in subdivision (4)(i)(B) of this paragraph, if
[[Page 114]]
the initial export is made to a controlled person within the meaning of
section 482, the fair market value of the imported articles and of the
portion of the articles that are manufactured, produced, grown, or
extracted within the United States shall be established by the taxpayer
in accordance with the rules under section 482 and the regulations under
that section. If the initial export is not made to a controlled person,
the fair market value must be established by the taxpayer under the
facts and circumstances.
(iii) Interchangeable component articles. (A) If identical or
similar component articles can be incorporated interchangeably into
property and a person acquires component articles that are imported into
the United States and other component articles that are not imported
into the United States, the determination whether imported component
articles were incorporated in the property that is exported from the
United States shall be made on a substitution basis as in the case of
the rules relating to drawback accounts under the customs laws. See
section 313(b) of the Tariff Act of 1930, as amended (19 U.S.C.
1313(b)).
(B) The provisions of subdivision (4)(iii)(A) of this paragraph may
be illustrated by the following example:
Example. Assume that a manufacturer produces a total of 20,000
electronic devices. The manufacturer exports 5,000 of the devices and
subsequently sells 11,000 of the devices to a FSC which exports the
11,000 devices. The major single component article in each device is a
tube which represents 60 percent of the fair market value of the device
at the time the device is sold by the manufacturer. The manufacturer
imports 8,000 of the tubes and produces the remaining 12,000 tubes. For
purposes of this subdivision, in accordance with the substitution
principle used in the customs drawback laws, the 5,000 devices exported
by the manufacturer are each treated as containing an imported tube
because the devices were exported prior to the sale to the FSC. The
remaining 3,000 imported tubes are treated as being contained in the
first 3,000 devices purchased and exported by the FSC. Thus, since the
50 percent test is not met with respect to the first 3,000 devices
purchased and exported by the FSC, those devices are not export
property. The remaining 8,000 devices purchased and exported by the FSC
are treated as containing tubes produced in the United States, and those
devices are export property (if they otherwise meet the requirements of
this section).
(f) Excluded property--(1) In general. Notwithstanding any other
provision of this section, the following property is not export
property--
(i) Property described in subdivision (2) of this paragraph
(relating to property leased to a member of controlled group),
(ii) Property described in subdivision (3) of this paragraph
(relating to certain types of intangible property),
(iii) Products described in paragraph (g) of this section (relating
to oil and gas products), and
(iv) Products described in paragraph (h) of this section (relating
to certain export controlled products).
(2) Property leased to member of controlled group--(i) In general.
Property leased to a person (whether or not a FSC) which is a member of
the same controlled group as the lessor constitutes export property for
any period of time only if during the period--
(A) The property is held for sublease, or is subleased, by the
person to a third person for the ultimate use of the third person;
(B) The third person is not a member of the same controlled group;
and
(C) The property is used predominantly outside the United States by
the third person.
(ii) Predominant use. The provisions of paragraph (d)(4)(vi) of this
section apply in determining under subdivision (2)(i)(C) of this
paragraph whether the property is used predominantly outside the United
States by the third person.
(iii) Leasing rule. For purposes of this paragraph (f)(2), leased
property is deemed to be ultimately used by a member of the same
controlled group as the lessor if such property is leased to a person
which is not a member of the controlled group but which subleases the
property to a person which is a member of the controlled group. Thus,
for example, if X, a FSC for the taxable year, leases a movie film to Y,
a foreign corporation which is not a member of the same controlled group
as X, and Y then subleases the film to persons which are members of the
controlled group for showing to the general public, the film is not
export property. On the other hand, if X, a FSC for
[[Page 115]]
the taxable year, leases a movie film to Z, a foreign corporation which
is a member of the same controlled group as X, and Z then subleases the
film to Y, another foreign corporation, which is not a member of the
same controlled group for showing to the general public, the film is not
disqualified from being export property.
(iv) Certain copyrights. With respect to a copyright which is not
excluded by subdivision (3) of this paragraph from being export
property, the ultimate use of the property is the sale or exhibition of
the property to the general public. Thus, if A, a FSC for the taxable
year, leases recording tapes to B, a foreign corporation which is a
member of the same controlled group as A, and if B makes records from
the recording tape and sells the records to C, another foreign
corporation, which is not a member of the same controlled group, for
sale by C to the general public, the recording tape is not disqualified
under this paragraph from being export property, notwithstanding the
leasing of the recording tape by A to a member of the same controlled
group, since the ultimate use of the tape is the sale of the records
(i.e., property produced from the recording tape).
(3) Intangible property. Export property does not include any
patent, invention, model, design, formula, or process, whether or not
patented, or any copyright (other than films, tapes, records, or similar
reproductions, for commercial or home use), goodwill, trademark,
tradebrand, franchise, or other like property. Although a copyright such
as a copyright on a book or computer software does not constitute export
property, a copyrighted article (such as a book or standardized, mass
marketed computer software) if not accompanied by a right to reproduce
for external use is export property if the requirements of this section
are otherwise satisfied. Computer software referred to in the preceding
sentence may be on any medium, including, but not limited to, magnetic
tape, punched cards, disks, semi-conductor chips and circuit boards. A
license of a master recording tape for reproduction outside the United
States is not disqualified under this paragraph from being export
property.
(g) Oil and gas--(1) In general. Under section 927(a)(2)(C), export
property does not include oil or gas (or any primary product thereof).
(2) Primary product from oil or gas. A primary product from oil or
gas is not export property. For purposes of this paragraph--
(i) Primary product from oil. The term ``primary product from oil''
means crude oil and all products derived from the destructive
distillation of crude oil, including--
(A) Volatile products,
(B) Light oils such as motor fuel and kerosene,
(C) Distillates such as naphtha,
(D) Lubricating oils,
(E) Greases and waxes, and
(F) Residues such as fuel oil.
For purposes of this paragraph, a product or commodity derived from
shale oil which would be a primary product from oil if derived from
crude oil is considered a primary product from oil.
(ii) Primary product from gas. The term ``primary product from gas''
means all gas and associated hydrocarbon components from gas wells or
oil wells, whether recovered at the lease or upon further processing,
including--
(A) Natural gas,
(B) Condensates,
(C) Liquefied petroleum gases such as ethane, propane, and butane,
and
(D) Liquid products such as natural gasoline.
(iii) Primary products and changing technology. The primary products
from oil or gas described in subdivisions (2)(i) and (ii) of this
paragraph and the processes described in those subdivisions are not
intended to represent either the only primary products from oil or gas,
or the only processes from which primary products may be derived under
existing and future technologies. For example, petroleum coke, although
not derived from the destructive distillation of crude oil, is a primary
product from oil derived from an existing technology.
(iv) Non-primary products. For purposes of this paragraph,
petrochemicals, medicinal products, insecticides and alcohols are not
considered primary products from oil or gas.
[[Page 116]]
(h) Export controlled products--(1) In general. Section 927(a)(2)(D)
provides that an export controlled product is not export property. A
product or commodity may be an export controlled product at one time but
not an export controlled product at another time. For purposes of this
paragraph, a product or commodity is an ``export controlled product'' at
a particular time if at that time the export of such product or
commodity is prohibited or curtailed under section 7(a) of the Export
Administration Act of 1979, to effectuate the policy relating to the
protection of the domestic economy set forth in paragraph (2)(C) of
section 3 of the Export Administration Act of 1979. That policy is to
use export controls to the extent necessary to protect the domestic
economy from the excessive drain of scarce materials and to reduce the
serious inflationary impact of foreign demand.
(2) Products considered export controlled products--(i) In general.
For purposes of this paragraph, an export controlled product is a
product or commodity, which is subject to short supply export controls
under 15 CFR part 377. A product or commodity is considered an export
controlled product for the duration of each control period which applies
to such product or commodity. A control period of a product or commodity
begins on and includes the initial control date (as defined in
subdivision (2)(ii) of this paragraph) and ends on and includes the
final control date (as defined in subdivision (2)(iii) of this
paragraph).
(ii) Initial control date. The initial control date of a product or
commodity which is subject to short supply export controls is the
effective date stated in the regulations to 15 CFR part 377 which
subjects the product or commodity to short supply export controls. If
there is no effective date stated in these regulations, the initial
control date of the product or commodity will be thirty days after the
effective date of the regulations which subject the product or commodity
to short supply export controls.
(iii) Final control date. The final control date of a product or
commodity is the effective date stated in the regulations to 15 CFR part
377 which removes the product or commodity from short supply export
controls. If there is no effective date stated in those regulations, the
final control date of the product or commodity is the date which is
thirty days after the effective date of the regulations which remove the
product or commodity from short supply export control.
(iv) Expiration of Export Administration Act. An initial control
date and final control date cannot occur after the expiration date of
the Export Administration Act under the authority of which the short
supply export controls were issued.
(3) Effective dates--(i) Products controlled on January 1, 1985. If
a product or commodity was subject to short supply export controls on
January 1, 1985, this paragraph shall apply to all sales, exchanges,
other dispositions, or leases of the product or commodity made after
January 1, 1985, by the FSC or by the FSC's related supplier if the FSC
is the commission agent on the transaction.
(ii) Products first controlled after January 1, 1985. If a product
or commodity becomes subject to short supply export controls after
January 1, 1985, this paragraph applies to sales, exchanges, other
dispositions, or leases of such product or commodity made on or after
the initial control date of such product or commodity, and to owning
such product or commodity on or after such date.
(iii) Date of sales, exchange, lease, or other disposition. For
purposes of this paragraph (h)(3), the date of sale, exchange, or other
disposition of a product or commodity is the date as of which title to
such product or commodity passes. The date of a lease is the date as of
which the lessee takes possession of a product or commodity. The
accounting method of a person is not determinative of the date of sale,
exchange, other disposition, or lease.
(i) Property in short supply. If the President determines that the
supply of any property which is otherwise export property as defined in
this section is insufficient to meet the requirements of the domestic
economy, he may by Executive Order designate such property as in short
supply. Any property so designated will be treated under section
927(a)(3) as property
[[Page 117]]
which is not export property during the period beginning with the date
specified in such Executive Order and ending with the date specified in
an Executive Order setting forth the President's determination that such
property is no longer in short supply.
[T.D. 8126, 52 FR 6459, Mar. 3, 1987]
Sec. 1.927(b)-1T Temporary regulations; Definition of gross receipts.
(a) General rule. Under section 927(b), for purposes of sections 921
through 927, the gross receipts of a person for a taxable year are--
(1) Business income. The total amounts received or accrued by the
person from the sale or lease of property held primarily for sale or
lease in the ordinary course of a trade or business, and
(2) Other income. Gross income recognized from whatever source
derived, such as, for example, from--
(i) The furnishing of services (whether or not related to the sale
or lease of property described in subdivision (1) of this paragraph),
(ii) Dividends and interest (including tax exempt interest),
(iii) The sale at a gain of any property not described in
subdivision (1) of this paragraph, and
(iv) Commission transactions to the extent described in paragraph
(e) of this section.
(b) Non-gross receipts items. For purposes of paragraph (a) of this
section, gross receipts do not include amounts received or accrued by a
person from--
(1) Loan transactions. The proceeds of a loan or of the repayment of
a loan, or
(2) Non-taxable transactions. A receipt of property in a transaction
to which section 118 (relating to contribution to capital) or section
1032 (relating to exchange of stock for property) applies.
(c) Non-reduction of total amounts. For purposes of paragraph (a) of
this section, the total amounts received or accrued by a person are not
reduced by costs of goods sold, expenses, losses, a deduction for
dividends received, or any other deductible amounts. The total amounts
received or accrued by a person are reduced by returns and allowances.
(d) Method of accounting. For purposes of paragraph (a) of this
section, the total amounts received or accrued by a person shall be
determined under the method of accounting used in computing its taxable
income. If, for example, a FSC receives advance or installment payments
for the sale or lease of property described in paragraph (a)(1) of this
section, for the furnishing of services, or which represent recognized
gain from the sale of property not described in paragraph (a)(1) of this
section, any amount of such advance payments is considered to be gross
receipts of the FSC for the taxable year for which such amount is
included in the gross income of the FSC.
(e) Commission transactions--(1) In general--(i) With a related
supplier. In the case of transactions which give rise to a commission
from the FSC's related supplier on the sale or lease of property or the
furnishing of services by a principal, the FSC's gross income from all
such transactions is the commission paid or payable to the FSC by the
related supplier. The FSC's gross receipts for purposes of computing its
profit under the administrative pricing methods of section 925(a)(1) and
(2) shall be the gross receipts (other than gross receipts which would
not be foreign trading gross receipts had they been received by the FSC)
derived by the related supplier from the sale or lease of the property
or from the furnishing of services, with respect to which the
commissions are derived. Also, in determining whether the 50% test in
section 924(a) has been met, the relevant gross receipts are the gross
receipts of the related supplier.
(ii) With an unrelated principal. In the case of transactions which
give rise to a commission from an unrelated principal to a FSC on the
sale or lease of property or the furnishing of services by a principal,
the amount recognized by the FSC as gross income from all such
transactions shall be the commission received from the principal.
(2) Selective commission arrangements--(i) In general. A commission
arrangement between the FSC and its related supplier may provide that
the FSC will not be the related supplier's commission agent with respect
to sales or leases of export property, or the furnishing of services,
which do not result
[[Page 118]]
in foreign trading gross receipts. In addition, the commission agreement
may provide that the FSC will not be the related supplier's commission
agent on transactions which would result in a loss to the related
supplier under the transfer pricing rules of section 925(a). In a buy-
sell FSC situation, selective commission arrangements are not
applicable. Determination of which transactions fall within the
selective commission arrangement may be made up to the due date under
section 6072(b), including extensions provided for under section 6081,
of the FSC's income tax return for the taxable year of the FSC during
which a transaction occurs.
(ii) Example. The treatment of a selective commission arrangement
may be illustrated by the following example:
Example. A calendar year commission FSC (``F'') entered into a
selective commission arrangement with related supplier RS which provided
that F will not be RS's commission agent on transactions which would
result in a loss to RS under the transfer pricing rules of section
925(a). During 1987, RS sold three different articles of export property
A, B and C, all of which fall within the same three digit Standard
Industrial Classification. In July of 1988, while preparing the FSC's
1987 income tax return, RS determined that the sale of export property A
resulted in a loss to RS under the section 482 method of section
925(a)(3) and that applying that method to the sales of export property
B and C resulted in only a small amount of income to both RS and F. In
addition, RS determined that grouping export property B and C, while
excluding export property A from the grouping, resulted in the highest
profit to F under the combined taxable income administrative pricing
method of section 925(a)(2). Using the same grouping, the gross receipts
method of section 925(a)(1) would result in a lower profit to F. Under
the special no-loss rule of Sec. 1.925(a)-1T(e)(1)(iii), RS would be
prohibited from using the combined taxable income administrative pricing
method to determine F's profit for the grouping of export property B and
C if it used the section 482 method on the sale of export property A.
This results because there was a loss to RS on the sale of export
property A. Under the selective commission arrangement, RS could
exercise its option and exclude the sale of export property A. Since F
is no longer deemed to have been operating as RS's commission agent on
that sale, the combined taxable income method may be used to compute F's
profit on the grouping of the sales of export property B and C.
(f) Example. The definition of gross receipts under this section may
be illustrated by the following example:
Example. During 1985, M, a related supplier of N, is engaged in the
manufacture of machines in the United States. N, a calendar year FSC, is
engaged in the sale and lease of such machines in foreign countries. N
furnishes services which are related and subsidiary to its sale and
lease of those machines. N also acts as a commission agent in foreign
countries for Z, an unrelated supplier, with respect to Z's sale of
products. N receives dividends on stock owned by it, interest on loans,
and proceeds from sales of business assets located outside the United
States resulting in recognized gains and losses. N's gross receipts for
1985 are $3,550, computed on the basis of the additional facts assumed
in the table below:
N's sales receipts for machines manufactured by M (without $1,500
reduction for cost of goods sold and selling expenses).......
N's lease receipts for machines manufactured by M (without 500
reduction for depreciation and leasing expenses).............
N's gross income from related and subsidiary services for 400
machines manufactured by M (without reduction for service
expenses)....................................................
N's sales receipts for products manufactured by Z (without 550
reduction for Z's cost of goods sold, commissions on sales
and commission sales expenses)...............................
Dividends received by N....................................... 150
Interest received by N........................................ 200
Proceeds received by N representing recognized gain (but not 250
losses) for sales of business assets located outside the
United States................................................
---------
N's gross receipts............................................ 3,550
=========
[T.D. 8126, 52 FR 6464, Mar. 3, 1987]
Sec. 1.927(d)-1 Other definitions.
(a) Carrying Charges.
Q-1. Under what circumstances is the sales price of property or
services sold by a FSC or a related supplier considered to include
carrying charges as defined in subdivision (ii)(B)(1) of Q&A-9 of Sec.
1.921-2?
A-1. (i) The proceeds received from a sale of export property by a
FSC or a related supplier (or the amount paid for services rendered or
from rental of export property) may include carrying charges if any part
of the sale proceeds
[[Page 119]]
(or service or rental payment) is paid after the end of the normal
payment period. If the export property is sold or leased by, or if the
services are rendered by, the FSC, the entire carrying charges amount as
determined in Q&A-2 of this section will be the income of the FSC. If,
however, the FSC is the commission agent of a related supplier on these
transactions, the carrying charges amount so determined is income of the
related supplier. The commission payable to the FSC will be computed by
reducing the related supplier's gross receipts from the transaction by
the amount of the carrying charges. No carrying charges will be assessed
on the commissions paid by the related supplier to the FSC. The carrying
charges provisions, likewise, do not apply to any other transaction that
does not give rise to foreign trading gross receipts.
(ii) The normal payment period for a sale transaction is 60 days
from the earlier of date of sale or date of exchange of property under
the contract. For this purpose, the date of sale will be the date the
sale is recorded on the seller's books of account under its normal
accounting method. The date the transaction was recorded on the seller's
books of account shall be disregarded if recording is delayed in order
to delay the start of the normal payment period. In these circumstances,
the earlier of the date of the contract or date of exchange of property
will be deemed the date of sale. For related and subsidiary services
that are not separately stated from the sale or lease transaction, the
earlier of the date of the sale or date the export property is delivered
to the purchaser is the applicable date. For related and subsidiary
services which are separately stated from the sale or lease transaction
and for other services, such as engineering and architectural services,
the normal payment period is 60 days from the earlier of the date
payment is due for the services or the date services under the contract
are completed. The date of completion of a services contract is the date
of final approval of the services by the recipient. With regard to
transactions involving the lease or rental of export property, the
normal payment period will begin on the date the rental payment is due
under the lease. The date the normal payment period begins under this
subdivision (ii) will be the same whether or not the transaction is with
a related person.
(iii) The carrying charges are computed for the period beginning
with the first day after the end of the normal payment period and ending
with the date of payment. A FSC may elect at any time prior to the close
of the statute of limitations of section 6501(a) for the FSC taxable
year to treat the final date of payment stated in the contract as the
date of payment if--
(A) The contracts for all transactions completed during the taxable
year require that payment be received within the normal payment period,
(B) No more than 20% of transactions for which final payment is
received in the taxable year involve payment after the end of the normal
payment period. For FSC taxable years beginning after March 3, 1987, the
20% test will apply only to the dollar value of the transactions and not
to the number of transactions. For prior taxable years, the 20% test
will apply to either the dollar value of the transactions or to the
number of transactions. The special grouping rules applicable to
determination of the FSC's profit under the administrative pricing rules
of section 925 may be applied to this elective provision. Accordingly,
transactions may be grouped into product or product-line groupings to
determine whether 20% or less of the dollar value (or number of
transactions, if applicable) of the grouped transactions involve payment
after the end of the normal payment period.
Q-2. How are carrying charges as defined in subdivision (ii)(B)(1)
of Q&A 9 of Sec. 1.921-9 computed?
A-2. If carrying charges as defined in subdivision (ii)(B)(1) of Q&A
9 of Sec. 1.921-9 are considered to be included in the sale price of
property income or rental payment services, the amount of the carrying
charges is equal to the amount in subdivision (i) of this answer if the
contract provides for stated interest or the amount in subdivisions (ii)
or (iii) of this answer, whichever is applicable, if the contract does
not so provide.
[[Page 120]]
(i) If a contract provides for stated interest beginning on the day
after the end of the normal payment period, carrying charges will accrue
only if the stated interest rate is less than the short-term, monthly
Federal rate as of the day after the end of normal payment period and
then only to the extent the stated interest is less than the short-term,
monthly Federal rate. The short-term, monthly Federal rate is that rate
as determined for purposes of section 1274(d) and which is published in
the Internal Revenue Bulletin. Carrying charges will not accrue,
however, unless payments are made after the end of the normal payment
period.
(ii) If a contract for a transaction does not provide for stated
interest, and if the taxpayer does not elect the method described in
subdivision (iii) of this answer, the amount of carrying charges is
equal to the excess of--
(A) The amount of the sales price of property, services income or
rental payment that is unpaid on the day after the end of the normal
payment period, over
(B) The present value, as of the day after the end of the normal
payment period, of all payments that are required to be made under the
contract and that are unpaid on the day after the end of the normal
payment period. The amount of the sales price of property, service
income or rental payment is the amount under the contract whether it be
the sales price, amount paid for services or the rental amount
determined as of the actual payment date unless a FSC makes the election
provided under subdivision (iii) of Q&A 1. If a FSC makes the election
provided under subdivision (III) of Q&A 1, the amount of the sales price
is the sales price, services income or rental payment under the contract
determined as of the final payment date stated in the contract. All
payments that are required to be made under the contract include the
stated sales price, services income or rental payment as well as stated
amounts of interest and carrying charges. The discount rate for the
present value computation is simple interest at the short-term monthly
Federal rate published in the Internal Revenue Bulletin, determined as
of the day after the end of the normal payment period. The present value
of a payment is calculated as follows:
[GRAPHIC] [TIFF OMITTED] TC14NO91.143
P=present value of a payment that is required and unpaid after the end
of the normal payment period
S=amount of a payment that is required and unpaid after the end of the
normal payment period
i=the short-term monthly Federal rate
t=the number of days after the end of the normal payment period and
before date of payment divided by 365.
If a sale is made, or if services are completed, or if rent is due under
a lease in a taxable year and the required date of payment is in a later
taxable year, carrying charges for the first taxable year are computed
for the number of days after the end of the normal payment period and
before the end of the taxable year. For the following taxable year,
carrying charges are computed for the number of days after the beginning
of the taxable year and before the date of payment.
(iii) At the election of the taxpayer, the amount of carrying
charges may be determined under the method described in this subdivision
(iii). If the taxpayer elects this method, it must be used for all
applicable transactions within the taxable year of the FSC. If this
optional method is used, the computation of carrying charges must be
made separately for transactions involving related persons and for those
transactions involving unrelated persons. In addition, the computation
of carrying charges must be made separately for each of the five types
of income of the FSC (or of the related supplier if the related supplier
is the principal on the transaction) listed in subparagraph (1) through
(5) of section 924(a). These groupings are separate and distinct from
the groupings that are established for purposes of determining the FSC's
profit on the export transactions. The optional method allowed in this
subdivision provides that the amount of carrying charges for a taxable
year of a FSC (or related supplier if the related supplier is the
principal on the export
[[Page 121]]
transaction) is computed using the average of receivables of unrelated
persons (or of related persons) and the average time those receivables
are outstanding. Receivables are included in this computation only if
they are from transactions on which foreign trading gross receipts, as
defined in section 924(a), are received by the FSC (or which are
received by a related supplier of a FSC and which would have been
foreign trading gross receipts had they been received by the FSC).
Carrying charges are calculated under this method as follows:
CC=(AR) (I/365) (X) (Y)
CC=Carrying charges
AR=Average monthly receivables balance for the taxable year
I=The average short-term, monthly Federal rate for the year
X=The number of times receivables turn over in the year
Y=The number of days the average receivables are outstanding over 60
days.
This optional method is illustrated in Example 5 in subdivision (v) of
this answer.
(iv) The computation of carrying charges under this answer 2 applies
only to the determination of carrying charges under subdivision
(ii)(B)(1) of Q&A 9 of Sec. 1.921-2 and does not apply to the
determination of any other unstated interest or for any other purpose.
(v) The following examples illustrate the computation of carrying
charges under this section:
Example 1. On January 1, 1985, a FSC sells export property for
$10,000. The export property is delivered to the purchaser on January
10, 1985. The terms of the contract require payment within 90 days after
sale. The normal payment period is 60 days. The FSC does not make an
election under subdivision (iii) of Q&A. The contract does not require
the payment of any interest or carrying charges. The purchaser pays the
entire sales price on March 1, 1985. The sales price is not considered
to include any carrying charges because the purchase paid the entire
sales price within the normal payment period.
Example 2. The facts are the same as in example 1 except that the
purchaser pays the entire sales price on April 6, 1985, 96 days after
the earlier of the date of sale or date of delivery (i.e., January 1,
1985). Therefore, the sales price is considered to include carrying
charges computed as follows:
Step 1: Determines the short-term monthly Federal rate as of the
earlier of date of sale or date of delivery. For purposes of this
example, the rate is 10%.
Step 2: Determine the fraction of the year represented by the number
of days after 60 days and before date of payment. In this example, the
number of days beyond 60 is 96-60=36, which is divided by 365
[GRAPHIC] [TIFF OMITTED] TC09OC91.001
Step. 3: Using the short-term monthly Federal rate and the fraction
of the year, compute the present value of the payment.
[GRAPHIC] [TIFF OMITTED] TC09OC91.002
[GRAPHIC] [TIFF OMITTED] TC09OC91.003
P=$10,000 (.99)
P=$9,900
Step 4: Using the present value of all payments, compute the
carrying charges.
Carrying Charges=Sales Price less Present Value.
[GRAPHIC] [TIFF OMITTED] TC09OC91.004
Example 3. On October 15, 1985, F, a FSC, leases export property to
X for one month with a total rental due of $20,000. Under the terms of
the lease, A agreed to pay F $10,000 on October 15, 1985, and the
remaining $10,000 on January 15, 1986. The contract does not require the
payment of any interest or carrying charges. The second $10,000 payment
is made on January 3, 1986. This payment does not include any carrying
charges because X paid the $10,000 before the start of the normal
payment period.
Example 4. On October 15, 1985, F, a FSC, leases export property to
X, for one month with a total amount due under the lease of $10,000,
payable on October 15, 1985. X delays payment until January 19, 1986,
which was 96 days after the start of the normal payment period. The 60
day normal payment period terminated on December 14, 1985. Therefore,
the lease payment is considered to include carrying charges of $100
computed in the same manner as in Example 2. Of this $100, 17/36, or
$47.22, is carrying charges for 1985 (i.e., 17 days in December), and
19/36, or $52.78, is carrying charges for 1986.
Example 5. During 1986, F, a FSC, sold on account export properties
A and B to related and unrelated persons.
[[Page 122]]
(A) Unrelated persons. During 1986, the sales on account to
unrelated persons totaled $6,000. On the last day of each of the months
of 1986, F had total receivables from unrelated persons from sales of
export properties A and B, as follows:
January 31..................................................... $1,400
February 28.................................................... 1,400
March 31....................................................... 1,000
April 30....................................................... 1,000
May 31......................................................... 1,200
June 30........................................................ 1,300
July 31........................................................ 1,000
August 31...................................................... 1,300
September 30................................................... 1,500
October 31..................................................... 1,100
November 30.................................................... 1,200
December 31.................................................... 1,000
--------
14,400
========
Carrying charges for 1986 with unrelated persons under the optional
method of subdivision (iii) of this answer will be $19.23, computed as
follows:
Step 1: Determine the average short-term, monthly Federal rate for
the year. For purposes of this example, the rate is assumed to be 9%.
Step 2: Determine the average receivables for the year. This average
is calculated by totaling the end of the month receivables balance of
each month of the year and dividing by twelve. In this example, the
average monthly receivables balance is $1,200, calculated as follows:
$1,200=$14,400/12
Step 3: Determine the number of times the receivables turn over
during the year. This is calculated by dividing the sales on account for
the year by the average monthly receivables balance for the year. For
purposes of this example, receivables turned over 5 times for 1986,
computed as follows:
[GRAPHIC] [TIFF OMITTED] TC09OC91.005
Step 4: Determine the number of days the average receivables are
outstanding in excess of 60 days. In this example, there are 13
receivable days in excess of 60 days, computed as follows:
[GRAPHIC] [TIFF OMITTED] TC09OC91.071
Step 5: The amount of carrying charges, $19.23, is calculated by
using the following equation:
CC=(AR) (I/365) (X)(Y)
CC=Carrying charges
AR=Average monthly receivables balance for the taxable year (step 2)
I=The average short-term monthly Federal rate for the year (step 1)
X=The number of times receivables turn over in the year (step 3)
Y=The number of days the average receivables are outstanding over 60
days (step 4).
CC=$19.23=($1,200) (.09/365) (5) (13)
(B) Related persons. Carrying charges, if any, on the sales on
account to related persons must be computed separately using this
optional method.
Q-3. Is a discount from the sales price of property or services for
prompt payment considered to be stated carrying charges as defined in
subdivision (ii)(A) of Q&A 9 of Sec. 1.921-2?
A-3. No.
Q-4. Is the receipt of an arm's length factoring payment from an
unrelated person considered a payment of the sales proceeds for purposes
of determining whether payment is made within the normal payment period
and the possible imposition of carrying charges?
A-4. Yes.
[T.D. 8127, 52 FR 6473, Mar. 3, 1987]
Sec. 1.927(d)-2T Temporary regulations; definitions and special rules
relating to Foreign Sales Corporation.
(a) Definition of related supplier. For purposes of sections 921
through 927 and the regulations under those sections, the term ``related
supplier'' means a related party which directly supplies to a FSC any
property or services which the FSC disposes of in a transaction
producing foreign trading gross receipts, or a related party which uses
the FSC as a commission agent in the disposition of any property or
services producing foreign trading gross receipts. A FSC may have
different related suppliers with respect to different transactions. If,
for example, X owns all the stock of Y, a corporation, and of F, a FSC,
and X sells a product to Y which is resold to F, only Y is the related
supplier of F. If, however, X sells directly to F and Y also sells
directly to F, then, as to the transactions involving direct sales to F,
each of X and Y is a related supplier of F.
(b) Definition of related party. The term ``related party'' means a
person which is owned or controlled directly or indirectly by the same
interests as the FSC within the meaning of section 482 and Sec. 1.482-
1(a).
[T.D. 8126, 52 FR 6465, Mar. 3, 1987]
[[Page 123]]
Sec. 1.927(e)-1 Special sourcing rule.
(a) Source rules for related persons--(1) In general. The income of
a person described in section 482 from a sale of export property giving
rise to foreign trading gross receipts of a FSC that is treated as from
sources outside the United States shall not exceed the amount that would
be treated as foreign source income earned by such person if the pricing
rule under section 994 that corresponds to the rule used under section
925 with respect to such transaction applied to such transaction. This
special sourcing rule also applies if the FSC is acting as a commission
agent for the related supplier with respect to the transaction described
in the first sentence of this paragraph (a)(1) that gives rise to
foreign trading gross receipts and the transfer pricing rules of section
925 are used to determine the commission payable to the FSC. No
limitation results under this section with respect to a transaction to
which the section 482 pricing rule under section 925(a)(3) applies.
(2) Grouping of transactions. If, for purposes of determining the
FSC's profits under the administrative pricing rules of sections 925(a)
(1) and (2), grouping of transactions under Sec. 1.925(a)-1T(c)(8) was
elected, the same grouping shall be used for making the determinations
under the special sourcing rule in this section.
(3) Corresponding DISC pricing rules--(i) In general. For purposes
of this section--
(A) The DISC gross receipts pricing rule of section 994(a)(1)
corresponds to the gross receipts pricing rule of section 925(a)(1);
(B) The DISC combined taxable income pricing rule of section
994(a)(2) corresponds to the combined taxable income pricing rule of
section 925(a)(2); and
(C) The DISC section 482 pricing rule of section 994(a)(3)
corresponds to the section 482 pricing rule of section 925(a)(3).
(ii) Special rules. For purposes of this section--
(A) The DISC pricing rules of section 994(a)(1) and (2) shall be
determined without regard to export promotion expenses;
(B) Qualified export receipts under section 994(a)(1) and
(2) Shall be deemed to be an amount equal to the foreign trading
gross receipts arising from the transaction; and
(C) Combined taxable income for purposes of section 994(a)(2) shall
be deemed to be an amount equal to the combined taxable income for
purposes of section 925(a)(2) arising from the transaction.
(b) Examples. The provisions of this section may be illustrated by
the following examples:
Example 1. (i) R and F are calendar year taxpayers. R, a domestic
manufacturing company, owns all the stock of F, which is a FSC acting as
a commission agent for R. For the taxable year, R and F used the
combined taxable income pricing rule of section 925(a)(2). For the
taxable year, the combined taxable income of R and F is $100 from the
sale of export property, as defined in section 927(a), manufactured by R
using production assets located in the United States. Title to the
export property passed outside of the United States.
(ii) Under section 925(a)(2), 23 percent of the $100 combined
taxable income of R and F ($23) is allocated to F and the remaining $77
is allocated to R. Absent the special sourcing rule, under section
863(b) the $77 income allocated to R would be sourced $38.50 U.S. source
and $38.50 foreign source. Under the special sourcing rule, the amount
of foreign source income earned by a related supplier of a FSC shall not
exceed the amount that would result if the corresponding DISC pricing
rule applied. The DISC combined taxable income pricing rule of section
994(a)(2) corresponds to the combined taxable income pricing rule of
section 925(a)(2). Under section 994(a)(2), $50 of the combined taxable
income ($100 x .50) would be allocated to the DISC and the remaining $50
would be allocated to the related supplier. Under section 863(b), the
$50 income allocated to the DISC's related supplier would be sourced $25
U.S. source and $25 foreign source. Accordingly, under the special
sourcing rule, the foreign source income of R shall not exceed $25.
Example 2. (i) Assume the same facts as in Example 1 except that R
and F used the gross receipts pricing rule of section 925(a)(1). In
addition, for the taxable year foreign trading gross receipts derived
from the sale of the export property are $2,000.
(ii) Under section 925(a)(1), 1.83 percent of the $2,000 foreign
trading gross receipts ($36.60) is allocated to F and the $63.40
remaining combined taxable income ($100-$36.60) is allocated to R.
Absent the special sourcing rule, under section 863(b) the $63.40 income
allocated to R would be
[[Page 124]]
sourced $31.70 U.S. source and $31.70 foreign source. Under the special
sourcing rule, the amount of foreign source income earned by a related
supplier of a FSC shall not exceed the amount that would result if the
corresponding DISC pricing rule applied. The DISC gross receipts pricing
rule of section 994(a)(1) corresponds to the gross receipts pricing rule
of section 925(a)(1). Under section 994(a)(1), $80 ($2,000 x .04) would
be allocated to the DISC and the $20 remaining combined taxable income
would be allocated to the related supplier. Under section 863(b), the
$20 income allocated to the DISC's related supplier would be sourced $10
U.S. source and $10 foreign source. Accordingly, under the special
sourcing rule, the foreign source income of R shall not exceed $10.
(c) Effective date. The rules of this section are applicable to
taxable years beginning after December 31, 1997.
[T.D. 8782, 63 FR 50144, Sept. 21, 1998]
Sec. 1.927(e)-2T Temporary regulations; effect of boycott participation
on FSC and small FSC benefits.
(a) International boycott factor. If the FSC (or small FSC) or any
member of the FSC's (or small FSC's) controlled group participates in or
cooperates with an international boycott within the meaning of section
999, the FSC's (or small FSC's) exempt foreign trade income as
determined under section 923 (a) shall be reduced by an amount equal to
the product of the FSC's (or small FSC's) exempt foreign trade income
multiplied by the international boycott factor determined under section
999. The amount of the reduction will be considered as non-exempt
foreign trade income.
(b) Specifically attributable taxes and income method. If the
taxpayer clearly demonstrates that the income earned for the taxable
year is attributable to specific operations, then in lieu of applying
the international boycott factor for such taxable year, the amount of
the exempt foreign trade income as determined under section 923(a) that
will be reduced by this section shall be the amount specifically
attributable to the operations in which there was participation in or
cooperation with an international boycott under section 999(b)(1). The
amount of the reduction will be considered as non-exempt foreign trade
income.
[T.D. 8126, 52 FR 6465, Mar. 3, 1987]
Sec. 1.927(f)-1 Election and termination of status as a Foreign Sales
Corporation.
(a) Election of status as a FSC or a small FSC.
Q-1. What is the effect of an election by a corporation to be
treated as a FSC or small FSC?
A-1. A valid election to be treated as a FSC or a small FSC applies
to the taxable year of the corporation for which made and remains in
effect for all succeeding taxable years in which the corporation
qualifies to be a FSC unless revoked by the corporation or unless the
corporation fails for five consecutive years to qualify as a FSC (in
case of a FSC election) or as a small FSC (in case of a small FSC
election).
Q-2. Can a corporation established prior to January 1, 1985 be
treated as a FSC or a small FSC prior to making a FSC or a small FSC
election?
A-2. A corporation cannot be treated as a FSC or a small FSC until
it has made a FSC or a small FSC election. An election made within the
first 90 days of 1985 relates back to January 1, 1985 unless the
taxpayer indicates otherwise.
Q-3. If a shareholder who has not consented to a FSC or small FSC
election transfers some or all of its shares before or during the first
taxable year for which the election is made, may the holder of the
transferred shares consent to the election?
A-3. A holder of the transferred shares may consent to a FSC or
small FSC elction under the circumstances described in Sec. 1.922-
2(c)(1). The rules contained in Sec. 1.992-(c) shall apply to the
consent by a holder of transferred shares.
Q-4. If a shareholder who has consented to a FSC or a small FSC
election transfers some or all of its shares before the first taxable
year for which the election is made, must the holder of the transferred
shares consent to the election?
A-4. Yes. Consent must be made by any recipient of such shares on or
before the 90th day after the first day of such first taxable year. If
such recipient fails to file his consent on or before such 90th day, and
extension of time for filing such consent may be granted
[[Page 125]]
in the manner, and subject to the conditions, described in paragraph
(b)(3) of Sec. 1.992-2.
Q-5. May an election of a corporation to be a FSC or a small FSC be
effective as of a time other than the start of the corporation's taxable
year?
A-5. No.
Q-6. If a fiscal year foreign corporation was in existence on
December 31, 1984, must it wait until the first day of its taxable year
beginning after January 1, 1985, to elect FSC status?
A-6. No. If a fiscal year foreign corporation was in existence on
December 31, 1984, its taxable year will be deemed to have terminated on
that date if the foreign corporation elects FSC status to be effective
January 1, 1985. An income tax return will be required for any short
years created by the deemed closing of the taxable year unless the
corporation is relieved from the necessity of making a return by section
6012 and the regulations under that section. If the corporation's
taxable year is deemed closed by operation of this regulation, the
filing date of tax returns for the short taxable year ended on December
31, 1984, will be automatically extended until May 18, 1987.
Q-7. What is the effect of an election to be treated as a FSC or as
a small FSC if the corporation or any other member of the controlled
group has in effect an election to be treated as an interest charge
DISC?
A-7. The interest charge DISC election shall be treated as revoked
for all purposes under the Code as of the date the FSC election is
effective. An affirmative revocation of the DISC election is
unnecessary. The FSC election shall take effect. As long as the FSC
election remains in effect, neither the corporation nor any other member
of the controlled group is permitted to elect to be treated as an
interest charge DISC for any taxable year including any part of a
taxable year during which the corporation's FSC election continues to be
effective.
Q-8. What is the effect of an election to be treated as a small FSC
if the corporation or any other member of the controlled group has in
effect an election to be treated as a FSC?
A-8. As long as a FSC election remains in effect, neither the
corporation nor any other member of the controlled group is permitted to
elect to be treated as a small FSC for any taxable year including any
part of a taxable year during which a FSC election continues to be
effective. Any FSC within the controlled group must affirmatively revoke
its FSC election for a taxable year including any part of a taxable year
for which small FSC status is elected.
Q-9. What is the effect of an election to be treated as a FSC if the
corporation or any other member of the controlled group has in effect an
election to be treated as a small FSC?
A-9. As long as a small FSC election remains in effect, neither the
corporation nor any other member of the controlled group is permitted to
elect to be treated as a FSC for any taxable year including any part of
the taxable year during which a small FSC election continues to be
effective. Any small FSC within the controlled group must affirmatively
revoke its small FSC election for a taxable year including any part of a
taxable year for which FSC status is elected. An election to be treated
as a small FSC is permitted if the corporation or any other member of
the controlled group has in effect an election to be treated as a small
FSC. For a special rule providing for conversion of a small FSC to a FSC
within one taxable year, see Sec. 1.921-1T(b)(1) (Q&A-1).
(b) Termination of election of status as a FSC or a small FSC.
Q-10. How is the status of a corporation as a FSC or as a small FSC
terminated?
A-10. The status of a corporation as a FSC or as a small FSC is
terminated through revocation or by its continued failure to be a FSC.
Q-11. For what taxable year may a corporation revoke its election to
be treated as a FSC or as a small FSC?
A-11. A corporation may revoke its election to be treated as a FSC
or as a small FSC for any taxable year of the corporation after the
first taxable year for which the election is effective.
Q-12. When must a corporation revoke a FSC or a small FSC election
if revocation is to be effective for the taxable year in which
revocation takes place?
[[Page 126]]
A-12. If a corporation files a statement revoking its election to be
treated as a FSC or as a small FSC during the first 90 days of a taxable
year (other than the first taxable year for which such election is
effective), such revocation will be effective for such taxable year and
all taxable years thereafter. If the corporation files a statement
revoking its election to be treated as a FSC or a small FSC after the
firs 90 days of a taxable year, the revocation will be effective for all
taxable years following such taxable year.
Q-13. Can a FSC change its status to a small FSC, or can a small FSC
change its status to a FSC as of a date other than the first day of a
taxable year?
A-13. No. Since a revocation of an election to be a FSC or a small
FSC is effective only for entire taxable year, a corporation's change
between FSC and small FSC status is effective as of the first day of a
taxable year.
Q-14. How may a corporation revoke an election by a corporation to
be treated as a FSC or a small FSC?
A-14. A corporation may revoke its election by filing a statement
that the corporation revokes its election under section 922(a) to be
treated as a FSC or under section 922(b) to be treated as a small FSC.
Such statement shall indicate the corporation's name, address, employer
identification number, and the first taxable year of the corporation for
which the revocation is to be effective. The statement shall be signed
by any person authorized to sign a corporate return under section 6062.
Such revocation shall be filed with the Service Center with which the
corporation filed its return.
Q-15. What if the effect is a corporation that has elected to be
treated as a FSC or a small FSC fails to qualify as a FSC because it
does not meet the requirements of section 922 for a taxable year?
A-15. If a corporation that has elected to be treated as a FSC or a
small FSC does not qualify as a FSC or a small FSC for a taxable year,
the corporation will not be treated as a FSC or a small FSC for the
taxable year. However, the failure of a corporation to qualify to be
treated as a FSC or a small FSC for a taxable year does not terminate
the election of the corporation to be treated as FSC or a small FSC
unless the corporation does not qualify under section 922 for each of 5
consecutive taxable years, as provided in Q&A 16 of this section.
Q-16. Under what circumstances is the FSC or small FSC election
terminated for continued failure to be a FSC?
A-16. If a corporation that has elected to be treated as a FSC or a
small FSC does not qualify under section 922 to be treated as a FSC or
small FSC for each of 5 consecutive taxable years, such election
terminates and will not be effective for any taxable year after such
fifth taxable year. Such termination will be effective automatically
without notice to such corporation or to the Internal Revenue Service.
[T.D. 8127, 52 FR 6475, Mar. 3, 1987]
possessions of the united states
Sec. 1.931-1 Citizens of the United States and domestic corporations
deriving income from sources within a certain possession of the United States.
(a) Definitions. (1) As used in section 931 and this section, the
term ``possession of the United States'' includes American Samoa, Guam,
Johnston Island, Midway Islands, the Panama Canal Zone, Puerto Rico, and
Wake Island. However, the term does not include (i) the Virgin Islands
and (ii), when used with respect to citizens of the United States, the
term does not include Puerto Rico or, in the case of taxable years
beginning after December 31, 1972, Guam.
(2) As used in section 931 and this section, the term ``United
States'' includes only the States, the Territories of Alaska and Hawaii,
and the District of Columbia.
(b) General rule--(1) Qualifications. In the case of a citizen of
the United States or a domestic corporation satisfying the following
conditions, gross income means only gross income from sources within the
United States--
(i) If 80 percent or more of the gross income of such citizen or
domestic corporation (computed without the benefit of section 931) for
the 3-year period immediately preceding the close of the taxable year
(or for such part of such
[[Page 127]]
period immediately preceding the close of such taxable year as may be
applicable) was derived from sources within a possession of the United
States, and
(ii) If 50 percent or more of the gross income of such citizen or
domestic corporation (computed without the benefit of section 931) for
such period or such part thereof was derived from the active conduct of
a trade or business within a possession of the United States. In the
case of a citizen, the trade or business may be conducted on his own
account or as an employee or agent of another. The salary or other
compensation paid by the United States to the members of its civil,
military, or naval personnel for services rendered within a possession
of the United States represents income derived from the active conduct
of a trade or business within a possession of the United States. The
salary or other compensation paid for services performed by a citizen of
the United States as an employee of the United States or any agency
thereof shall, for the purposes of section 931 and this section, be
deemed to be derived from sources within the United States. Dividends
received by a citizen from a corporation whose income was derived from
the active conduct of a business within a possession of the United
States, does not represent income derived from the active conduct of a
trade or business within the possession of the United States even though
such citizen was actively engaged in the management of such corporation.
For a determination of income from sources within the United States, see
part I (section 861 and following), subchapter N, chapter 1 of the Code,
and section 931(i), and the regulations thereunder.
(2) Relationship of sections 931 and 911. A citizen of the United
States who cannot meet the 80-percent and the 50-percent requirements of
section 931 but who receives earned income from sources within a
possession of the United States, is not deprived of the benefits of the
provisions of section 911 (relating to the exemption of earned income
from sources outside the United States), provided he meets the
requirements thereof. In such a case none of the provisions of section
931 is applicable in determining the citizen's tax liability. For what
constitutes earned income, see section 911(b).
(3) Meaning of ``gross income'' on joint return. In the case of a
husband and wife making a joint return, the term ``gross income,'' as
used in this section, means the combined gross income of the spouses.
(4) Returns. A citizen entitled to the benefits of section 931 is
required to file with his individual return Form 1040 the schedule on
Form 1040E. If a citizen entitled to the benefits of section 931 has no
income from sources within the United States and does not receive within
the United States any income derived from sources without the United
States he is not required to file a return or the schedule on Form
1040E.
(5) Illustration of the operation of section 931. This section may
be illustrated by the following example:
Example. On July 1, 1954, A, who is a citizen of the United States,
went to a possession of the United States and established a business
there which he actively conducted during the remainder of that year. His
gross income from the business during such period was $20,000. In
addition, he made a profit of $12,000 from the sale during the latter
part of 1954 of some real estate located in such possession and not
connected with his trade or business. In the first six months of 1954 he
also derived $8,000 gross income from rental property located in the
United States. He derived a like amount of gross income from such
property during the last six months of 1954. On these facts, A may
exclude the $32,000 derived from sources within the possession of the
United States, since he qualified under section 931 with respect to that
amount. The period of July 1, 1954, through December 31, 1954,
constitutes the applicable part of the 3-year period immediately
preceding the close of the taxable year (the calendar year 1954), and
for that period, 80 percent of A's gross income was derived from sources
within a possession of the United States ($32,000, or 80 percent of
$40,000) and 50 percent or more of A's gross income was derived from the
active conduct of a trade or business within a possession of the United
States ($20,000, or 50 percent of $40,000). A is required to report on
his return for 1954 only the gross income derived by him from sources
within the United States ($16,000 from the rental property located in
the United States).
(c) Amounts received in the United States. Notwithstanding the
provisions of section 931(a), there shall be included in the gross
income of citizens
[[Page 128]]
and domestic corporations therein specified all amounts, whether derived
from sources within or without the United States, which are received by
such citizens or corporations within the United States. From the amounts
so included in gross income there shall be deducted only the expenses
properly apportioned or allocated thereto. For instance, if in the
example set forth in paragraph (b)(5) of this section, the taxpayer
during the latter part of 1954 returned to the United States for a few
weeks and while there received the proceeds resulting from the sale of
the real estate located in the possession, the profits derived from such
transaction should be reported in gross income. Such receipt in the
United States, however, would not deprive the taxpayer of the benefits
of section 931 with respect to other items of gross income excluded by
that section.
(d) Deductions--(1) Individuals. In the case of a citizen entitled
to the benefits of section 931, the deductions allowed in computing
taxable income, except the standard deduction and a deduction for one
personal exemption (see sections 142(b)(2) and 931(e), respectively),
are allowed only if and to the extent that they are connected with
income from sources within the United States. The provisions of section
873 and the regulations thereunder, relating to the allowance to
nonresident alien individuals, who at any time within the taxable year
were engaged in trade or business within the United States, of the
deductions provided in section 165(c)(2) and (3) for losses not
connected with the trade or business, are applicable in the case of
citizens entitled to the benefits of section 931. The provisions of
section 873 (c) and the regulations thereunder pertaining to the
allowance to such nonresident alien individuals of deductions for
contributions provided in section 170 are also applied in the case of
such citizens.
(2) Corporations. Corporations entitled to the benefits of section
931 are allowed the same deductions from their gross income arising from
sources within the United States as are allowed to domestic corporations
to the extent that such deductions are connected with such gross income,
except that the so-called charitable contribution deduction provided by
section 170 to corporations is allowed whether or not connected with
income from sources within the United States. The proper apportionment
and allocation of the deductions with respect to sources within and
without the United States shall be determined as provided in part I
(section 861 and following), subchapter N, chapter 1 of the Code, and
the regulations thereunder.
(e) Deduction for personal exemption. A citizen of the United States
entitled to the benefits of section 931 is allowed a deduction for only
one exemption under section 151.
(f) Allowance of deductions and credits. Unless a citizen of the
United States or a domestic corporation entitled to the benefits of
section 931 shall file or cause to be filed with the district director a
true and accurate return of total income from all sources within the
United States, in the manner prescribed in subtitle F of the Code, the
tax shall be collected on the basis of the gross income (not the taxable
income) from sources within the United States. If such citizen or
corporation fails to file a necessary income tax return, the
Commissioner will cause a return to be made, including therein all
income from sources within the United States and allowing no deductions
or credits (except credit for tax withheld at source).
(g) Foreign tax credit. Persons entitled to the benefits of section
931 are not allowed the credits provided for in section 901 (relating to
credits for taxes of foreign countries and possessions).
(h) Internees. If a citizen of the United States--
(1) Was interned by the enemy while serving as an employee within a
possession of the United States; and
(2) Was confined in any place not within a possession of the United
States, then
(i) Such place of confinement shall be considered as within a
possession of the United States for the purposes of section 931; and
(ii) Section 931 (b) shall not apply to any compensation received
within the United States by such citizen attributable to the period of
time during
[[Page 129]]
which such citizen was interned by the enemy.
(i) Employees of the United States. For the purposes of section 931,
amounts paid for services performed by a citizen of the United States as
an employee of the United States or any agency thereof shall be deemed
to be derived from sources within the United States.
(j) Nonapplication to a DISC or shareholder thereof. Section 931
does not apply to a corporation for a taxable year (1) for which it
qualifies (or is treated) as a DISC or (2) during which it owns directly
or indirectly at any time stock in a corporation which, at such time, is
(or is treated as) a DISC or former DISC. (See section 992(a)(1) and
(3), respectively, for the definitions of the terms ``DISC'' and
``former DISC''.) For example, assume X Corporation and Y Corporation
have the same taxable years. On the first day of its taxable year, X
owns and sells all of the stock in Y, Y on such day owns and sells all
of the stock in Z Corporation, and Z qualifies as a DISC as of such day.
Section 931 will not apply to X and Y for their taxable years. Section
931 will likewise not apply to Z for the taxable year for which it
qualifies as a DISC.
(Secs. 7805 (68A Stat. 917; 26 U.S.C. 7805) and 7654(e) (86 Stat. 1496;
26 U.S.C. 7654 (c)) of the Internal Revenue Code of 1954)
[T.D. 6500, 25 FR 11910, Nov. 26, 1960, as amended by T.D. 7283, 38 FR
20825, Aug. 3, 1973; T.D. 7385, 40 FR 50260, Oct. 29, 1975]
Sec. 1.932-1 Status of citizens of U.S. possessions.
(a) General rule--(1) Definition and treatment. A citizen of a
possession of the United States (except Puerto Rico and, for taxable
years beginning after December 31, 1972, Guam), who is not otherwise a
citizen or resident of the United States, including only the States and
the District of Columbia, is treated for the purpose of the taxes
imposed by subtitle A of the Code (relating to income taxes) as if he
were a nonresident alien individual. However, for purposes of the tax
imposed on self-employment income by chapter 2 of the Code, the term
``possession of the United States'' as used in section 932 and the
preceding sentence does not include American Samoa, Guam, or the Virgin
Islands. See section 1402(a)(9). See subpart A (section 871 and
following), part II, subchapter N, chapter 1 of the Code, and the
regulations thereunder, for rules relating to imposition of tax on
nonresident alien individuals. For Federal income tax purposes, a
citizen of a possession of the United States who is not otherwise a
citizen of the United States is a citizen of a possession of the United
States who has not become a citizen of the United States by
naturalization in a State, Territory, or the District of Columbia. The
fixed or determinable annual or periodical income from sources within
the United States of a citizen of a possession of the United States who
is treated as if he were a nonresident alien individual is subject to
withholding. See section 1441.
(2) Classification of citizens of United States possessions. For the
purpose of this section citizens of the possessions of the United States
who are not otherwise citizens of the United States are divided into two
classes:
(i) Citizens of possessions of the United States who at any time
within the taxable year are not engaged in trade or business within the
United States, and
(ii) Citizens of possessions of the United States who at any time
within the taxable year are engaged in trade or business within the
United States.
The provisions of subpart A (section 871 and following) and the
regulations thereunder, applicable to nonresident alien individuals not
engaged in trade or business within the United States are applicable to
the citizens of possessions falling within the first class, while the
provisions of such sections applicable to nonresident alien individuals
who at any time within the taxable year are engaged in trade or business
within the United States are applicable to citizens of possessions
falling within the second class.
(b) Nonapplication to citizen of Puerto Rico or Guam. The provisions
of section 932(a) and paragraph (a) of this section do not apply in the
case of a citizen of Puerto Rico or, for taxable years beginning after
December 31, 1972, a citizen of Guam. Thus, for example, any such
citizen who is not a resident of the United States will not be treated
by
[[Page 130]]
the United States as a nonresident alien individual for purposes of
section 2 (b)(3)(A) or (d), relating to definitions and special rules;
section 4(d)(1), relating to taxpayers not eligible to use the optional
tax tables; section 37(h), relating to denial of retirement income
credit; section 116(d), relating to taxpayers ineligible for dividend
exclusion; section 142(b)(1), relating to taxpayers ineligible for
standard deduction; section 152(b)(3), relating to definition of
``dependent''; section 402(a)(4), relating to distributions by the
United States to nonresident aliens; section 545(d), relating to certain
foreign corporations; section 565(e), relating to certain consent
dividends; section 861(a)(1), relating to interest from sources within
the United States; sections 871 to 877, relating to nonresident alien
individuals; section 1303(b), relating to individuals not eligible for
income averaging; section 1371(a)(3), relating to definition of small
business corporation; section 1402(b), relating to definition of ``self-
employment income''; section 1441, relating to withholding of tax on
nonresident aliens; section 3401(a), relating to definition of wages;
section 6013(a)(1), relating to inability to make a joint return;
section 6015 (b) and (i), relating to declaration of estimated income
tax by nonresident alien individuals; section 6017, relating to self-
employment tax returns; section 6042(b)(2), relating to returns
regarding payments of dividends; section 6049(b)(2), relating to returns
regarding payments of interest; section 6072 (c), relating to time for
filing returns of nonresident alien individuals; section 6091(b),
relating to place for filing returns of nonresident aliens; and section
6096(a), relating to designation of tax payments to Presidential
Election Campaign Fund. For other rules applicable to citizens of Puerto
Rico, see Sec. Sec. 1.1-1(b) and 1.933-1. For other rules applicable to
citizens of Guam, see Sec. Sec. 1.1-1(b) and 1.935-1 of this chapter
(Income Tax Regulations) and Sec. 301.7654-1 of this chapter
(Regulations on Procedure and Administration).
(Secs. 7805 (68A Stat. 917; 26 U.S.C. 7805) and 7654(e) (86 Stat. 1496;
26 U.S.C. 7654 (e)) of the Internal Revenue Code of 1954)
[T.D. 6500, 25 FR 11910, Nov. 26, 1960, as amended by T.D. 7385, 40 FR
50260, Oct. 29, 1975]
Sec. 1.933-1 Exclusion of certain income from sources within Puerto Rico.
(a) General rule. An individual (whether a United States citizen or
an alien), who is a bona fide resident of Puerto Rico during the entire
taxable year, shall exclude from his gross income the income derived
from sources within Puerto Rico, except amounts received for services
performed as an employee of the United States or any agency thereof.
Whether the individual is a bona fide resident of Puerto Rico shall be
determined in general by applying to the facts and circumstances in each
case the principles of Sec. Sec. 1.871-2, 1.871-3, 1.871-4, and 1.871-
5, relating to what constitutes residence or nonresidence, as the case
may be in the United States in the case of an alien individual. Once
bona fide residence in Puerto Rico has been established, temporary
absence therefrom in the United States or elsewhere on vacation or
business trips will not necessarily deprive an individual of his status
as a bona fide resident of Puerto Rico. An individual taking up
residence in Puerto Rico during the course of the taxable year is not
entitled for such year to the exclusion provided in section 933.
(b) Taxable year of change of residence from Puerto Rico. A citizen
of the United States who changes his residence from Puerto Rico after
having been a bona fide resident thereof for a period of at least two
years immediately preceding the date of such change in residence shall
exclude from his gross income the income derived from sources within
Puerto Rico which is attributable to that part of such period of Puerto
Rican residence which preceded the date of such change in residence,
except amounts received for services performed as an employee of the
United States or any agency thereof.
[[Page 131]]
(c) Deductions. In any case in which any amount otherwise
constituting gross income is excluded from gross income under the
provisions of section 933, there shall not be allowed as a deduction
from gross income any items of expenses or losses or other deductions
(except the deduction under section 151, relating to personal
exemptions) properly allocable to, or chargeable against, the amounts so
excluded from gross income.
Sec. 1.934-1 Limitation on reduction in income tax liability incurred
to the Virgin Islands.
(a) General rule. Section 934(a) provides that tax liability
incurred to the Virgin Islands shall not be reduced or remitted in any
way, directly or indirectly, whether by grant, subsidy, or other similar
payment, by any law enacted in the Virgin Islands, except to the extent
provided in section 934 (b) or (c). For purposes of the preceding
sentence, the term ``tax liability'' means the liability incurred to the
Virgin Islands pursuant to subtitle A of the Code, as made applicable in
the Virgin Islands by the Act of July 12, 1921 (48 U.S.C. 1397), or
pursuant to section 28(a) of the Revised Organic Act of the Virgin
Islands (48 U.S.C. 1642).
(b) Exception for certain domestic and Virgin Islands corporations--
(1) General rule. Section 934(b) provides an exception to the
application of section 934(a). Under this exception, section 934(a) does
not apply with respect to tax liability incurred to the Virgin Islands
by a domestic or Virgin Islands corporation for any taxable year (or for
such part of such year as may be applicable) to the extent that such tax
liability is attributable to income derived from sources without the
United States, if such corporation satisfies the conditions provided in
section 934(b)(1) and (2), and if the information required by section
934(d) is supplied. These conditions are enumerated in the remainder of
this paragraph, and the information requirement is set forth in
paragraph (d) of this section.
(2) Conditions to be satisfied for exception. A domestic or Virgin
Islands corporation satisfies the conditions of section 934(b)(1) and
(2) if--
(i) Eighty percent or more of the gross income of such corporation
for the 3-year period immediately preceding the close of the taxable
year (or for such part of such period immediately preceding the close of
such taxable year as may be applicable) was derived from sources within
the Virgin Islands; and
(ii) Fifty percent or more of the gross income of such corporation
for such period (or such part thereof) was derived from the active
conduct of a trade or business within the Virgin Islands.
(3) Computation rule. Except as provided in subparagraph (5) of this
paragraph, tax liability incurred to the Virgin Islands by a domestic or
Virgin Islands corporation for the taxable year (or such part of such
year as may be applicable) attributable to income derived from sources
without the United States shall be computed as follows:
(i) Add to the income tax liability incurred to the Virgin Islands
any credit against the tax allowed under section 901(a);
(ii) Multiply by taxable income from sources without the United
States for the applicable period;
(iii) Divide by total taxable income for the period;
(iv) Subtract any credit against the tax allowed under section
901(a). Tax liability incurred to the Virgin Islands attributable to
income derived from sources without the United States, as computed in
this subparagraph, however, shall not exceed the total amount of income
tax liability actually incurred.
(4) Examples. The rule of the preceding subparagraph may be
illustrated by the following examples:
Example 1. Corporation X, which satisfies the requirements of
section 934(b), incurs an income tax liability to the Virgin Islands for
taxable year 1963 of $290, as follows:
Taxable income from sources within the U.S.... $200 ...........
Taxable income from sources without the U.S... 800 ...........
-------------
Total taxable income....................................... $1,000
Credit allowed under section 901(a)........................ 10
Tax liability incurred to the Virgin Islands............... 290
The income tax liability incurred to the Virgin Islands
attributable to income derived from sources without the
United States is $230, computed as follows:
(i) Tax liability incurred to the Virgin 290 ...........
Islands....................................
[[Page 132]]
Plus credit allowed under section 901(a).... 10 ...........
-------------
........... 300
(ii) Multiply by taxable income from sources 800 ...........
without the U.S............................
-------------
........... 240,000
(iii) Divide by total taxable income........ 1,000 ...........
-------------
........... 240
(iv) Subtract credit allowed under section 10 ...........
901(a).....................................
-------------
........... 230
Example 2. Corporation Y, which satisfies the requirements of
section 934(b), incurs an income tax liability to the Virgin Islands for
taxable year 1963 of $140, as follows:
Taxable income from sources within the U.S.... ($300 net ...........
loss)
Taxable income from sources without the U.S... 800 ...........
-------------
Total taxable income....................................... $500
Credit allowed under section 901(a)........................ 10
Tax liability incurred to the Virgin Islands............... 140
The income tax liability incurred to the Virgin Islands
attributable to income derived from sources without the
United States is 140, computed as follows:
(i) Tax liability incurred to the Virgin 140 ...........
Islands....................................
Plus credit allowed under section 901(a).... 10 ...........
-------------
........... 150
(ii) Multiply by taxable income from sources 800 ...........
without the U.S............................
-------------
........... 120,000
(iii) Divide by total taxable income........ 500 ...........
-------------
........... 240
(iv) Subtract credit allowed under section 10 ...........
901(a).....................................
-------------
........... 230
Since the $230 derived from the computation is in excess of the actual
tax liability incurred, the income tax liability incurred to the Virgin
Islands attributable to income derived from sources without the United
States is limited to $140, the actual liability incurred.
(5) Special computation rule for certain domestic corporations. For
purposes of section 934(b) and this paragraph, tax liability incurred to
the Virgin Islands by a domestic corporation which is required to file
an income tax return with the United States for the taxable year (or
such part of such year as may be applicable) attributable to income
derived from sources without the United States shall be the actual
income tax liability incurred to the Virgin Islands for such year.
(6) Source of income. For purposes of section 934(b) and this
paragraph, the income of a Virgin Islands corporation, and the sources
from which the income of such corporation is derived, shall be
determined as if such corporation were a domestic corporation. However,
all amounts received by a corporation within the United States, whether
derived from sources within or without the United States, shall be
considered as being derived from sources within the United States. In
determining the sources from which the income of a domestic or Virgin
Islands corporation is derived, the principles of part 1 (section 861
and following), subchapter N, chapter 1 of the Code, and the regulations
thereunder shall apply.
(c) Exception for certain residents of the Virgin Islands--(1)
General rule. Section 934(c) provides another exception to the
application of section 934(a). Under this exception, section 934(a) does
not apply with respect to the tax liability incurred by an individual
citizen of the United States to the Virgin Islands for any taxable year
to the extent that such tax liability is attributable to income derived
from sources within the Virgin Islands, if such individual is a bona
fide resident of the Virgin Islands during the entire taxable year and
if he supplies the information required under section 934(d).
(2) Definition--bona fide resident and United States citizen. In
determining whether a United States citizen is a bona fide resident of
the Virgin Islands, the principles of Sec. Sec. 1.871-2, 1.871-3,
1.871-4, and 1.871-5, relating to the determination of residence and
nonresidence in the United States, shall apply. Once a bona fide
residence in the Virgin Islands is established by an individual,
temporary absence therefrom will not necessarily deprive such individual
of his status as a bona fide resident of the Virgin Islands. For
purposes of section 934(c), a citizen of the United States includes any
individual who is a citizen of the United States by reason of being a
citizen of any possession of the United States.
(3) Computation rule. For purposes of section 934(c) and this
paragraph, tax
[[Page 133]]
liability incurred to the Virgin Islands for the taxable year
attributable to income derived from sources within the Virgin Islands
shall be computed as follows:
(i) Add to the income tax liability incurred to the Virgin Islands
any credit against the tax allowed under section 901(a);
(ii) Multiply by taxable income from sources within the Virgin
Islands;
(iii) Divide by total taxable income. Tax liability incurred to the
Virgin Islands attributable to income derived from sources within the
Virgin Islands, as computed in this subparagraph, however, shall not
exceed the total amount of income tax liability actually incurred.
(4) Examples. The rule of the preceding subparagraph may be
illustrated by the following examples:
Example 1. A, an individual who satisfies the requirements of
section 934(c), incurs an income tax liability to the Virgin Islands for
taxable year 1963 of $380, as follows:
Taxable income from sources within the Virgin $1,200 .........
Islands..........................................
Taxable income from sources without the Virgin 800 .........
Islands..........................................
-----------
Total taxable income......................................... $2,000
Credit allowed under section 901(a).......................... 20
Tax liability incurred to the Virgin Islands................. 380
The income tax liability incurred to the Virgin Islands
attributable to income derived from sources within the
Virgin Islands is $240, computed as follows:
(i) Tax liability incurred to the Virgin Islands 380 .........
Plus credit allowed under section 901(a)........ 20 .........
-----------
......... 400
(ii) Multiply by taxable income from sources 1,200 .........
within the Virgin Islands......................
-----------
480,000
(iii) Divide by total taxable income....................... $2,000
----------
......... 240
Example 2. B, an individual who satisfies the requirements of
section 934(c), incurs an income tax liability to the Virgin Islands for
taxable year 1963 of $100, as follows:
Taxable income from sources within the Virgin $800 ...........
Islands......................................
Taxable income from sources without the Virgin (200 net ...........
Islands...................................... loss)
--------------
Total taxable income....................................... $600
Credit allowed under section 901(a)........................ 20
Tax liability incurred to the Virgin Islands............... 100
The income tax liability incurred to the Virgin Islands
attributable to income derived from sources within the
Virgin Islands is $100, computed as follows:
(i) Tax liability incurred to the Virgin 100 ...........
Islands....................................
Plus credit allowed under section 901(a).... 20 ...........
-------------
........... 120
(ii) Multiply by taxable income from sources 800 ...........
within the Virgin Islands..................
-------------
........... 96,000
(iii) Divide by total taxable income........ 600 ...........
-------------
........... 160
Since the $160 derived from the computation is in excess of the actual
tax liability incurred, the income tax liability incurred to the Virgin
Islands attributable to income derived from sources within the Virgin
Islands is limited to $100, the actual liability incurred.
(5) Source of income. For purposes of section 934(c) and this
paragraph, in determining taxable income from sources within and without
the Virgin Islands the principles of part 1 (section 861 and following),
subchapter N, chapter 1 of the Code, and the regulations thereunder
shall apply, except that--
(i) Any deductions for personal exemptions allowable under section
151 shall be deducted in computing taxable income from sources within
the Virgin Islands but shall not be deducted in computing taxable income
from sources without the Virgin Islands;
(ii) Amounts received for services performed as an employee of the
United States or any agency thereof shall not be considered as income
derived from sources within the Virgin Islands;
(iii) Gain or loss from the sale or exchange of any security (as
defined in section 165(g)(2)) shall not be treated as derived from
sources within the Virgin Islands.
(6) Definition--``taxable income'' on a joint return. In the case of
a husband and wife making a joint return, the term ``taxable income'',
as used in this paragraph, means the combined taxable income of both
spouses.
(d) Information required. Section 934(d) provides that the
exceptions in section 934 (b) and (c) shall apply only in the case of
persons who supply such information as the Secretary or his delegate
[[Page 134]]
may by regulations prescribe for purposes of determining the
applicability of such exceptions. The following portions of this
paragraph, together with paragraphs (e) and (f) of this section,
prescribe the information which must be filed. Any person seeking to
come within an exception must provide the following information:
(1) The name and address of such person;
(2) If such person is one of two or more organizations, trades, or
businesses (whether or not incorporated, whether or not organized in the
United States, and whether or not affiliated) owned or controlled
directly or indirectly by the same interests within the meaning of
section 482 and the regulations thereunder--
(i) The name and address of each such organization, trade, or
business;
(ii) The relationship which each such organization, trade, or
business bears to the other organizations, trades, or businesses in such
group;
(iii) The nature of the activity or activities conducted by each
such organization, trade, or business.
(3) Any person seeking to come within an exception must make
available for inspection by the Director of International Operations
such records, and underlying contracts and documents, as are necessary
to determine the applicability of section 934(b) or (c).
(e) Information required--corporations. Corporations seeking to come
within the exception provided in section 934(b) shall, in addition to
the information required by paragraph (d) of this section, submit the
following information with respect to each taxable year:
(1) The date and place of incorporation;
(2) The name and address of any shareholder of record owning at any
time during the taxable year 5 percent or more of the voting stock of
any class or 5 percent or more of the value of any class of outstanding
stock, and the nature and amount of the stock owned;
(3) For the 3-year period immediately preceding the close of the
corporation's taxable year (or for such part of such period immediately
preceding the close of such taxable year as may be applicable)--
(i) The total amount of its gross income;
(ii) The amount of such gross income derived from the active conduct
of a trade or business within the Virgin Islands;
(iii) The amount of such gross income from sources within (a) the
Virgin Islands, (b) the United States (including therein and
specifically itemizing all amounts received within the United States),
and (c) all other countries as a group;
(iv) The ratio which gross income derived from sources within the
Virgin Islands bears to total gross income;
(v) The ratio which gross income derived from the active conduct of
a trade or business within the Virgin Islands bears to total gross
income.
(f) Information required--individuals. Individuals seeking to come
within the exception provided in section 934(c) shall, in addition to
the information required by paragraph (d) of this section, submit the
following information with respect to each taxable year:
(1) The date on which such individual became a bona fide resident of
the Virgin Islands;
(2) If such individual maintains a place of abode for himself or his
family in the United States or elsewhere outside the Virgin Islands, the
location of such place of abode and the purpose for which such place is
maintained;
(3) The beginning and the ending dates of each period of absence
from the Virgin Islands during such taxable year;
(4) The amount of gross income for such taxable year from sources
within the Virgin Islands, excluding--
(i) The amount of gain or loss from the sale or exchange of any
security, as defined in section 165(g)(2);
(ii) The amount of gross income received for services performed as
an employee of the United States or any agency thereof.
(5) Any amounts excluded from gross income from sources within the
Virgin Islands under subparagraph (4)(i) and (ii) of this paragraph.
(g) Time and place for filing statement. The statement, in
duplicate, providing the information required under section 934(d) and
paragraphs (d), (e), and (f) of
[[Page 135]]
this section shall be attached to the income tax return filed with the
Government of the Virgin Islands for the taxable year with respect to
which an exception is claimed under section 934 (b) or (c). If an
exception is claimed with respect to any taxable year for which the time
prescribed by law for filing the return expires prior to 30 days from
the publication of these regulations, the required statement must be
filed in duplicate on or before 90 days from the publication of these
regulations. The return and statement must be available for examination
by the Director of International Operations.
(h) Effective date. The provisions of this section shall apply to
taxable years beginning after December 31, 1959.
[T.D. 6629, 27 FR 12791, Dec. 28, 1962]
Sec. 1.935-1 Coordination of U.S. and Guam individual income taxes.
(a) Application of section--(1) Scope. Section 935 and this section
set forth the special rules relating to the filing of income tax
returns, income tax liabilities, and estimated income tax of individuals
described in subparagraph (2) of this paragraph. For additional rules
relating to the collection of income tax at source on the wages of
certain individuals, the furnishing of certain information with the
returns of certain individuals, and the covering over to the treasury of
Guam of net collections of income taxes imposed on certain individuals,
see section 7654 and Sec. 301.7654-1 of this chapter (Regulations on
Procedure and Administration).
(2) Individuals covered. This section shall apply for a taxable year
to any individual who--
(i) Is a resident of Guam, whether or not he is a citizen of the
United States,
(ii) Is a citizen of Guam but not otherwise a citizen of the United
States,
(iii) Has income derived from Guam for the taxable year and is a
citizen or resident of the United States, or
(iv) Files a joint return for the taxable year with any individual
described in subdivision (i), (ii), or (iii) of this subparagraph.
(3) Determination of residence and citizenship. For purposes of this
section, determinations of residence and citizenship for a taxable year
shall be made (except as provided to the contrary in paragraphs (d)(1)
and (2) of this section) as of the close of the taxable year. A citizen
of the United States is any individual who is a citizen within the
meaning of paragraph (c) of Sec. 1.1-1, except that the term does not
include an individual who is a citizen of Guam but not otherwise a
citizen of the United States. An individual who is a citizen of Guam but
not otherwise a citizen of the United States is any individual who has
become a citizen of the United States by birth or naturalization in
Guam. Whether an individual is a resident of Guam or a resident of the
United States shall generally be determined by applying to the facts and
circumstances in each case the principles of Sec. Sec. 1.871-2 through
1.871-5 relating to what constitutes residence or nonresidence, as the
case may be, in the United States in the case of an alien individual.
However, for special rules for determining the residence for tax
purposes of individuals under military or naval orders, see section 514
of the Soldiers' and Sailors' Civil Relief Act of 1940, 50 App. U.S.C.
574. The residence of an individual, and, therefore, the jurisdiction
with which he is required to file an income tax return under paragraph
(b) of this section, may change from year to year.
(b) Filing requirement--(1) Tax jurisdiction. An individual
described in paragraph (a)(2) of this section shall file his return of
income tax for the taxable year--
(i) With the United States if he is a resident of the United States,
whether or not he is a citizen of the United States,
(ii) With Guam if he is a resident of Guam, whether or not he is a
citizen of Guam, or
(iii) If neither subdivision (i) nor (ii) of this subparagraph
applies,
(A) With Guam if he is a citizen of Guam but not otherwise a citizen
of the United States, as defined in paragraph (a)(3) of this section, or
(B) With the United States if he is a citizen of the United States,
as defined in paragraph (a)(3) of this section. Thus, for example, if a
U.S. citizen employed by the United States in Guam becomes a resident of
Guam for the taxable year, he must file his return of
[[Page 136]]
income tax for such year with Guam. The tax shown on the return shall be
paid to the jurisdiction with which such return is required to be filed
and shall be determined by taking into account any credit under section
31 for tax withheld by Guam or the United States on wages, any credit
under section 6402(b) for an overpayment of income tax to Guam or the
United States, and any payments under section 6315 of estimated income
tax paid to Guam or the United States. See paragraph (a)(3) of this
section for the rule that determinations of residence and citizenship
are to be made as of the close of the taxable year.
(2) Joint returns. In the case of married persons, if one or both
spouses is an individual described in paragraph (a)(2) of this section
and they file a joint return of income tax, the spouses shall file their
joint return with, and pay the tax due on such return to, the
jurisdiction where the spouse who has the greater adjusted gross income
for the taxable year would be required under subparagraph (1) of this
paragraph to file his return if separate returns were filed. For this
purpose, adjusted gross income of each spouse is determined under
section 62 and the regulations thereunder but without regard to
community property laws; and, if one of the spouses dies, the taxable
year of the surviving spouse shall be treated as ending on the date of
such death.
(3) Place for filing returns--(i) U.S. returns. A return required
under this paragraph to be filed with the United States shall be filed
in accordance with Sec. 1.6091-2, except that such return of a citizen
or resident of the United States who is described in Sec. 301.7654-
1(a)(2) of this chapter (Regulations on Procedure and Administration)
shall be filed with the Internal Revenue Service Center, 11601 Roosevelt
Boulevard, Philadelphia, Pennsylvania 19155.
(ii) Guam returns. A return required under this paragraph to be
filed with Guam shall be filed with the Commissioner of Revenue and
Taxation, Agana, Guam 96910.
(4) Tax accounting standards. A taxpayer who has filed his return
with one of the jurisdictions named in subparagraph (1) of this
paragraph for a prior taxable year and is required to file his return
for a later taxable year with the other such jurisdiction may not, for
such later taxable year, change his accounting period, method of
accounting, or any election to which he is bound with respect to his
reporting of taxable income to the first jurisdiction unless he obtains
the consent of the second jurisdiction to make such change. However,
such change will not be effective for returns filed thereafter with the
first jurisdiction unless before such later date of filing he also
obtains the consent of the first jurisdiction to make such change. Any
request for consent to make a change pursuant to this subparagraph must
be made to the office where the return is required to be filed under
subparagraph (3) of this paragraph and in sufficient time to permit a
copy of the consent to be attached to the return for the taxable year.
(c) Extent of liability for income tax--(1) Extension of territory--
(i) General rule. With respect to an individual who, for a taxable year,
is described in paragraph (a)(2) of this section--
(A) For purposes of so much of the Internal Revenue Code of 1954 as
relates to the normal taxes and the surtaxes imposed by chapter 1
thereof, the United States shall be treated, in a geographical and
governmental sense, as including Guam, and
(B) For purposes of the Guam Territorial income tax (48 U.S.C.
1421i), Guam shall be treated, in a geographical and governmental sense,
as including the United States except that this subdivision shall not
apply for purposes of this section, section 7651, and section 7654.
(ii) Application of general rule. (A) The significance of the
application of the rule of subdivision (i) of this subparagraph will
depend upon the facts and circumstances of the particular case. The rule
will not be applied where its application would be manifestly
inapplicable or incompatible with the intent thereof. Thus, the rule
will not be applied for purposes of section 3401, relating to definition
of wages. Also, the rule will not be applied in determining the sources
of dividends and interest
[[Page 137]]
from a domestic corporation. For example, if less than 20 percent of a
domestic corporation's gross income is from U.S. sources for the period
described in section 861(a)(1)(B) and (2)(A), but more than 20 percent
of its gross income is from U.S. and Guam sources taken together for
such period, the dividends and interest derived from it will be treated
as derived from sources without the United States. In addition, for
purposes of section 1372(e)(4), relating to whether an election of a
small business corporation has been terminated because it derived more
than 80 percent of its gross receipts from sources outside the United
States, gross receipts from sources within Guam will be treated as gross
receipts from sources outside the United States. On the other hand, some
of the conclusions which may be reached as a result of the application
of subdivision (i) of this subparagraph to a U.S. taxpayer (that is, an
individual described in paragraph (b)(1)(i) or (iii)(B) of this section)
are as follows. A U.S. taxpayer may not claim a foreign tax credit based
upon his income from sources within Guam. Income tax paid to Guam may be
taken into account under sections 31, 6315, and 6402(b) as payments to
the United States. For purposes of section 116(a), relating to the
partial exclusion of dividends received by individuals, dividends paid
to a U.S. taxpayer by a corporation created or organized in Guam or
under the law of Guam will be treated as dividends paid by a domestic
corporation. Taxes paid to Guam and otherwise satisfying the
requirements of section 164(a) will be allowed as a deduction under that
section, but income taxes paid to Guam will be disallowed as a deduction
under section 275(a).
(B) If a U.S. taxpayer has a net operating loss carryback or
carryover under section 172, a foreign tax credit carryback or carryover
under section 904, an investment credit carryback or carryover under
section 46, a capital loss carryover under section 1212, or a charitable
contributions carryover under section 170, the United States will take
such carryback or carryover into account for a taxable year for which
the taxpayer's return is required to be filed with the United States,
and make a refund to the extent required under section 6402, even though
the return of the taxpayer for the taxable year (whether beginning on,
before, or after December 31, 1972) giving rise to the carryback or
carryover was required to be filed with Guam.
(C) For purposes of income averaging of a U.S. taxpayer under
sections 1301 through 1305, the taxpayer will not be denied status as an
``eligible individual'' merely because he was during the base period
defined in section 1302(c)(2) treated under section 932 as a nonresident
alien individual because he was a citizen of Guam but not otherwise a
citizen of the United States. See section 1303(b). Furthermore, in
determining the base period of such a U.S. taxpayer under section
1302(c)(2), taxable years for which a return was required to be filed
with Guam shall be taken into account.
(D) In applying the Guam Territorial income tax the converse of the
preceding rules under this subdivision will apply. Thus, for example,
income tax paid to the United States may be taken into account under
sections 31, 6315, and 6402(b) as payments to Guam. Moreover, a citizen
of the United States (as defined in paragraph (a)(3) of this section)
not a resident of Guam will not be treated as a nonresident alien
individual for purposes of the Guam Territorial income tax. Thus, for
example, a citizen of the United States (as so defined), or a resident
of the United States, will not be treated as a nonresident alien
individual for purposes of section 1371(a)(3) of the Guamanian
Territorial income tax.
(2) Liability to other jurisdiction--(i) Filing with Guam. If for a
taxable year an individual is required under paragraph (b)(1) of this
section to file a return with Guam, he is relieved of liability to file
an income tax return with, and to pay an income tax to, the United
States for the taxable year.
(ii) Filing with the United States. If for a taxable year an
individual is required under paragraph (b)(1) of this section to file a
return with the United States, he is relieved of liability to file an
income tax return with, and to pay an income tax to, Guam for the
taxable year.
[[Page 138]]
(d) Special rules for estimated income tax--(1) Declaration of
estimated income tax. If, under all the facts and circumstances existing
at the date an individual is required to file a declaration of estimated
income tax, there is reason to believe that he will, for the taxable
year, be an individual described in paragraph (a)(2) of this section, he
must file his declaration of estimated income tax (and all amendments
thereof) with the jurisdiction with which he would be required to file a
return under paragraph (b)(1) of this section if his taxable year had
closed on the date he is first required to file a declaration of
estimated income tax for the taxable year. Except as provided in
paragraph (6) of this section (relating to underpayments of estimated
income tax), payments of estimated income tax shall be made to the
jurisdiction with which he is required to file the declaration even
though for the taxable year he is required under paragraph (b)(1) of
this section to file his return with the other jurisdiction. In
determining the amount of such estimated income tax, income tax paid to
Guam may be taken into account under sections 31 and 6402(b) as payments
to the United States, and vice versa. For rules relating to the
determination of, and time for filing, declarations of estimated tax,
see sections 6015 and 6073; for rules relating to the time for paying
installments of the tax, see section 6153.
(2) Joint declaration of estimated income tax. In the case of
married persons, if, under all the facts and circumstances existing at
the date a spouse is required to file a declaration of estimated income
tax, there is reason to believe that he will, for the taxable year, be
an individual described in paragraph (a)(2) of this section and the
spouses file a joint declaration of estimated income tax, the spouses
must file their joint declaration of estimated income tax (and all
amendments thereof) with the jurisdiction where the spouse who has the
greater estimated adjusted gross income for the taxable year would be
required under subparagraph (1) of this paragraph to file his
declaration of estimated income tax if separate declarations were filed.
For this purpose, estimated adjusted gross income of each spouse for the
taxable year is determined without regard to community property laws.
Except as provided in paragraph (6) of this section, payments of
estimated income tax shall be made to the jurisdiction with which the
spouses are required to file the joint declaration.
(3) Early filing of declarations. If the individual or spouses have
in fact filed a declaration or joint declaration of estimated income tax
earlier than the time he or they are first required to file the
declaration and such declaration was not filed where it is required to
be filed under paragraph (d)(1) or (2) of this section, as the case may
be, of this paragraph, only subsequent amendments of the declaration are
required to be filed pursuant to such paragraph (d)(1) or (2) of this
section with the other jurisdiction and only subsequent installments of
the estimated income tax are required to be paid to the other
jurisdiction.
(4) Place for filing declarations. A declaration of estimated income
tax required under subparagraph (1) of this paragraph to be filed with
Guam, shall be filed as prescribed in paragraph (b)(3)(ii) of this
section. A declaration of estimated income tax required under
subparagraph (1) of this paragraph to be filed with the United States
shall be filed at the place prescribed by Sec. 1.6073-1(c).
(5) Liability to other jurisdiction--(i) Filing with Guam. If, for a
taxable year, an individual is required under this paragraph to file a
declaration of estimated income tax with Guam, he is relieved of
liability to file a declaration of estimated income tax (and any
amendments thereof) with, and to make payments of estimated income tax
to, the United States for the taxable year.
(ii) Filing with the United States. If, for a taxable year, an
individual is required under this paragraph to file a declaration of
estimated income tax with the United States, he is relieved of liability
to file a declaration of estimated income tax (and any amendments
thereof) with, and to make payments of estimated income tax to, Guam for
the taxable year.
(6) Underpayments. The liability of an individual described in
paragraph (a)(2)
[[Page 139]]
of this section for underpayments of estimated income tax for a taxable
year, as determined under section 6654 and the regulations thereunder,
shall be to the jurisdiction with which he is required under paragraph
(b) of this section to file his return for the taxable year.
(e) Illustration. The application of this section may be illustrated
by the following examples:
Example 1. B, and individual, files returns on a calendar year
basis. B is a resident of the United States at the time he is required
to file his declaration of estimated income tax for 1974. If, under the
facts and circumstances, B does not reasonably expect at the time he
files his declaration of estimated income tax that he will be a resident
of Guam at the close of 1974, he will not be subject to this section at
the time of such filing. However, B subsequently receives Guam source
income which necessitates an amendment of his declaration, and some time
later in 1974 he becomes a resident of Guam for the remainder of the
year. B is required under paragraph (d)(1) of this section to file his
amended declaration with the United States and to make payments of the
estimated tax to the United States. However, B is required to file his
income tax return for 1974 with Guam and to make any underpayments of
estimated tax to Guam, pursuant to paragraphs (b)(1) and (d)(6) of this
section.
Example 2. C, an individual, files returns on a calendar year basis.
On March 1, 1974, C is a resident of the United States, files his
declaration of estimated income tax for 1974 with the United States, and
pays his first installment of estimated tax to the United States. Prior
to the date C would otherwise be required to file his declaration of
estimated income tax for 1974 (April 15, 1974), C becomes a resident of
Guam for the remainder of the year. C is required under paragraph (d)(1)
of this section to make only his remaining payments of installments of
estimated tax to Guam. C is also required to file his income tax return
for 1974 with Guam and to make any underpayments of estimated tax to
Guam, pursuant to paragraphs (b)(1) and (d)(6) of this section.
Example 3. D, an individual, files returns on a calendar year basis.
On August 1, 1974, D ceases to be a resident of the United States for
the year and becomes a resident of Guam for the remainder of the year. D
is first required to file a declaration of estimated income tax for 1974
on September 15, 1974, because of his receipt of an extraordinary item
of income after June 15, 1974. D is required under paragraph (d)(1) of
this section to file his declaration with Guam and to make payments of
the estimated tax to Guam. D is also required to file his income tax
return for 1974 with Guam and to make any underpayments of estimated tax
to Guam, pursuant to paragraphs (b)(1) and (d)(6) of this section.
(f) Effective date. This section shall apply for taxable years
beginning after December 31, 1972.
(Secs. 7805 (68A Stat. 917; 26 U.S.C. 7805) and 7654(e) (86 Stat. 1496;
26 U.S.C. 7654 (e)) of the Internal Revenue Code of 1954)
[T.D. 7385, 40 FR 50261, Oct. 29, 1975]
Sec. 1.936-1 Elections.
(a) Making an election. A domestic corporation shall make an
election under section 936(e), for any taxable year beginning after
December 31, 1975, by filing Form 5712 on or before the later of--
(1) The date on which such corporation is required, pursuant to
sections 6072(b) and 6081, to file its Federal income tax return for the
first taxable year for which the election is made; or
(2) April 8, 1980.
Form 5712 shall be filed with the Internal Revenue Service Center, 11601
Roosevelt Boulevard, Philadelphia, Pennsylvania 19155 (Philadelphia
Center).
(b) Revoking an election. Any corporation to which an election under
section 936 (e) applies on February 8, 1980 is hereby granted the
consent of the Secretary to revoke that election for the first taxable
year to which the election applied. (The corporation may make a new
election under Sec. 1.936-1 (a) for any subsequent taxable year.) The
corporation shall make this revocation by sending to the Philadelphia
Center a written statement of revocation on or before April 8, 1980.
(Secs. 7805 and 936(e) of the Internal Revenue Code of 1954 (68A Stat.
917 and 90 Stat. 1644; 26 U.S.C. 7805 and 936(e)))
[T.D. 7673, 45 FR 8588, Feb. 8, 1980; T.D. 7673, 45 FR 16174, Mar. 13,
1980]
Sec. 1.936-4 Intangible property income in the absence of an election out.
The rules in this section apply for purposes of section 936(h) and
also for purposes of section 934(e), where applicable.
Q. 1: If a possessions corporation and its affiliates do not make an
election under either the cost sharing or 50/50
[[Page 140]]
profit split option, what rules will govern the treatment of income
attributable to intangible property owned or leased by the possessions
corporation?
A. 1: Intangible property income will be allocated to the
possessions corporation's U.S. shareholders with the proration of income
based on shareholdings. If a shareholder of the possessions corporation
is a foreign person or a tax-exempt person, the possessions corporation
will be taxable on that shareholder's pro rata amount of the intangible
property income. If any class of the stock of a possessions corporation
is regularly traded on an established securities market, then the
intangible property income will be taxable to the possessions
corporation rather than the corporation's U.S. shareholders. For these
purposes, a United States shareholder includes any shareholder who is a
United States person as described under section 7701(a)(30). The term
``intangible property income'' means the gross income of a possessions
corporation attributable to any intangible property other than
intangible property which has been licensed to such corporation since
prior to 1948 and which was in use by such corporation on September 3,
1982.
Q. 2: What is the source of the intangible property income described
in question 1?
A. 2: The intangible property income is U.S. source, whether taxed
to U.S. shareholders or taxed to the possessions corporation. Such
intangible property income, if treated as income of the possessions
corporation, does not enter into the calculation of the 80-percent
possessions source test or the 65-percent active trade or business test
of section 936(a)(2)(A) and (B).
Q. 3: How will the amount of income attributable to intangible
property be measured?
A. 3: Income attributable to intangible property includes the amount
received by a possessions corporation from the sale, exchange, or other
disposition of any product or from the rendering of a service which is
in excess of the reasonable costs it incurs in manufacturing the product
or rendering the service (other than costs incurred in connection with
intangibles) plus a reasonable profit margin. A reasonable profit margin
shall be computed with respect to direct and indirect costs other than
(i) costs incurred in connection with intangibles, (ii) interest
expense, and (iii) the cost of materials which are subject to processing
or which are components in a product manufactured by the possessions
corporation. Notwithstanding the above, certain taxpayers who have been
permitted by the Internal Revenue Service in taxable years beginning
before January 1, 1983, to use the cost-plus method of pricing without
reflecting a return from intangibles, but including the cost of
materials in the cost base, will not be precluded from doing so. (Sec.
3.02(3), Rev. Proc. 63-10, 1963-1 C.B. 490.) Thus, the Internal Revenue
Service may continue in appropriate cases to permit such taxpayers to
continue to report their income as they have been under existing
procedures described in the previous sentence if it is appropriate under
all the facts and circumstances and does not distort the income of the
taxpayer.
Q. 4: If there is no intangible property related to a product
produced in whole or in part by a possessions corporation, what method
may the possessions corporation use to compute its income?
A. 4: The taxpayer may compute its income using the appropriate
method as provided under section 482 and the regulations thereunder. The
taxpayer may also elect the cost sharing or profit split method.
[T.D. 8090, 51 FR 21524, June 13, 1986]
Sec. 1.936-5 Intangible property income when an election out is made:
Product, business presence, and contract manufacturing.
The rules in this section apply for purposes of section 936(h) and
also for purposes of section 934(e), where applicable.
(a) Definition of product.
Q. 1: What does the term ``product'' mean?
A. 1: The term ``product'' means an item of property which is the
result of a production process. The term ``product'' includes component
products, integrated products, and end-product
[[Page 141]]
forms. A component product is a product which is subject to further
processing before sale to an unrelated party. A component product may be
produced from other items of property, and if it is so produced, may be
treated as including or not including (at the choice of the possessions
corporation) one or more of such other items of property for all
purposes of section 936(h)(5). An integrated product is a product which
is not subject to any further processing before sale to an unrelated
party and which includes all component products from which it is
produced. An end-product form is a product which--
(1) Is not subject to any further processing before sale to an
unrelated party;
(2) Is produced from a component product or products; and
(3) Is treated as not including certain component products for all
purposes of section 936(h)(5).
A possessions corporation may treat a component product, integrated
product, or end-product form as its possession product even though the
final stage or stages of production occur outside the possession.
Further processing includes transformation, incorporation, assembly, or
packaging.
Q. 2: If a possessions corporation produces both a component product
and an integrated product (which by definition includes the end-product
form), may the possessions corporation use the options under section
936(h)(5) to compute its income with respect to either the component
product, the integrated product or the end-product form?
A. 2: Yes. The possessions corporation may choose to treat the
component product, the integrated product, or the end-product form as
the product for purposes of determining whether the possessions
corporation satisfies the significant business presence test. The
possessions corporation must treat the same item of property as its
product (the possession product) for all purposes of section 936(h)(5)
for that taxable year, including the significant business presence test
under section 936(h)(5)(B)(ii), the possessions sales calculation under
section 936(h)(5)(C)(i)(I), the determination of income under section
936(h)(5)(C)(i)(II), and the combined taxable income computations under
section 936(h)(5)(C)(ii). Although the possessions corporation must
treat the same item of property as its product for all purposes of
section 936(h)(5) in a particular taxable year, its choice of the
component product, integrated product or end-product form may be
different from year to year. The possessions corporation must specify
the possession product on a statement attached to its return (Schedule P
of Form 5735). The possessions corporation may specify its choice by
either listing the components that are included in the possession
product or the components that are excluded from the possession product.
The possessions corporation must file a separate Schedule P with respect
to each possession product. The possessions corporation must attach to
each Schedule P detailed computations indicating how the significant
business presence test is satisfied with respect to the possession
product identified in that Schedule P.
Q. 3: A possessions corporation produces a product that is sometimes
sold to unrelated parties without further processing and is sometimes
sold to unrelated parties after further processing. May the possessions
corporation choose to treat the same item of property as the possession
product even though in some cases it is an integrated product and in
some cases it is a component product?
A. 3: Yes. Except as provided in questions and answers 4 and 5, the
possessions corporation must designate a single possession product even
though it is sometimes a component product and sometimes an integrated
product.
Q. 4: A possessions corporation produces a product that is sometimes
sold without further processing by any member of the affiliated group to
unrelated parties or to related parties for their own consumption and is
sometimes sold after further processing by any member of the affiliated
group to unrelated parties or to related parties for their own
consumption. May the possessions corporation designate two products as
possession products?
A. 4: The possessions corporation may designate two or more
possession products. The possessions corporation
[[Page 142]]
must use a consistent definition of the possession product for all items
of property that are sold to unrelated parties or consumed by related
parties at the same stage in the production process. The significant
business presence test shall apply separately to each product designated
by the possessions corporation. The possessions corporation shall
compute its income separately with respect to each product.
Q. 5: A possessions corporation produces a product in one taxable
year and does not sell all of the units that it produced. In the next
taxable year the possessions corporation produces a product which
includes the product produced in the prior year. The possessions
corporation could not have satisfied the significant business presence
test with respect to the units produced the first taxable year if the
larger possession product had been designated. May the possessions
corporation designate two possession products in the second year?
A. 5: Yes. The possessions corporation may designate two possession
products. However, once a product has been designated for a particular
year all sales of units produced in that year must be defined in the
same manner. In addition, the taxpayer must maintain a significant
business presence in a possession with respect to that product. Sales
shall be deemed made first out of the current year's production. If all
of the current year's production is sold and some inventory is
liquidated, then the taxpayer's method of inventory accounting shall be
applied to determine what year's layer of inventory is liquidated.
Example 1. A possessions corporation S, manufactures a bulk
pharmaceutical in a possession. S transfers the bulk pharmaceutical to
its U.S. parent, P, for encapsulation and sale by P to customers. S
satisifes the significant business presence test with respect to the
bulk pharmaceutical (the component product) and the combination of the
bulk pharmaceutical and the capsule (the integrated product). S may use
the cost sharing or profit split method to compute its income with
respect to either the component product or the integrated product.
Example 2. The facts are the same as in example 1 except that S does
not satisfy the significant business presence test with respect to the
integrated product. S may use the cost sharing or profit split method to
compute its income only with respect to the component product. However,
if in a later taxable year S satisfies the significant business presence
test with respect to the integrated product, then S may use the cost
sharing or profit split method to compute its income with respect to
that integrated product for that later taxable year.
Example 3. P, a domestic corporation, produces in bulk form in the
United States the active ingredient for a pharmaceutical product, P
transfers the bulk form to S, a wholly owned possessions corporation. S
uses the bulk form to produce in Puerto Rico the finished dosage form
drug. S transfers the drug in finished dosage form to P, which sells the
drug to unrelated customers in the U.S. The direct labor costs incurred
in Puerto Rico by S during its taxable year in formulating, filling and
finishing the dosage form are at least 65 percent of the total direct
labor costs incurred by the affiliated group in producing the bulk and
finished forms during that period. S manufactures (within the meaning of
section 954(d)(1)(A)) the finished dosage form. S has elected out under
section 936(h)(5) under the profit split option for the drug product
area (SIC 283). P and S may treat the bulk and finished dosage forms as
parts of an integrated product. Since S satisfies the significant
business presence requirement with respect to the integrated product, it
is entitled to 50 percent of the combined taxable income on the
integrated product.
Example 4. A possessions corporation, S. produces the keyboard of an
electric typewriter and incorporates the keyboard with components
acquired from a related corporation into finished typewriters. S does
not satisfy the significant business presence test with respect to the
typewriters (the integrated product). Therefore, S may use the cost
sharing or profit split method to compute its income only with respect
to a component product or end-product form. For taxable year 1983, S
specifies on a statement attached to its return (Schedule P of Form
5735) that the possession product is the end-product form. The statement
indentifies the components--for example, the keyboard structure and
frame--which are included in the possession product. S's definition of
the possession product will apply to all units of the electric
typewriters which S produces in whole or in part in the possession and
which are sold in 1983. Thus, all units of a given component
incorporated into such typewriters will be treated in the same way. For
example, all keyboards and all frames will be included in the possession
product, and all electric drive mechanisms and rollers will be excluded
from the possession product.
Example 5. Possessions corporation A produces printed circuit boards
in a possession. The printed circuit boards are sold to unrelated
parties. A also uses the boards to
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produce personal computers in the possession. A may designate two
possession products: printed circuit boards and personal computers. The
significant business presence test applies separately with respect to
each of these products. Thus, for those printed circuit boards that are
sold to unrelated parties, only the costs of the possessions corporation
and the other members of the affiliated group that are incurred with
respect to units of the printed circuit boards which are produced in
whole or in part in the possessions and sold to third parties shall be
taken into account. Conversely, with respect to personal computers, only
the costs incurred with respect to the personal computers shall be taken
into account. This would include the costs with respect to printed
circuit boards that are incorporated into personal computers but not the
costs incurred with respect to printed circuit boards that are sold
without further processing to unrelated parties.
Example 6. Possessions corporation S produces integrated circuits in
a possession. P, an affilate of S, produces circuit boards in the United
States. P transfers the circuit boards to S. S assembles the integrated
circuits and the circuit boards. S sells some of the loaded circuit
boards to third parties. S retains some of the loaded circuit boards and
incorporates them into central processing units. The central processing
units are then sold to third parties. S may designate two possession
products. S must use a consistent definition of the possession product
for all units that are sold at the same stage in the production process.
Thus, with respect to those units sold after assembly of the integrated
circuits and the printed circuits boards, if S cannot satisfy the
significant business presence test with respect to all the loaded
circuit boards (the integrated product), then S must designate a lesser
product, either the integrated circuit (the component product) or the
loaded circuit board less the printed circuit board (the end-product
form) as its possession product. With respect to the central processing
units sold the same rule would apply. Thus, if S cannot satisfy the
significant business presence test with respect to the entire central
processing unit for all of the central processing units sold, S must
designate some lesser product as its possession product.
Example 7. S is a possession corporation. In 1985, S produced 100
units of product X. Those units were finished into product Y in 1985 by
affiliates of S. Product X is a component of product Y. In 1985, S
satisfies the direct labor test with respect to product X but not with
respect to product Y. S designates the component product X as its
possession product. In 1986 S produces 100 units of product X and
finishes those units into product Y. S would have satisfied the
significant business presence test with respect to product X if S had
designated product X as its possession product in 1986. In addition, in
1986 S satisfies the significant business presence test with respect to
the integrated product Y. In 1986, S sells 150 units of Y. One hundred
of those units would be deemed to be produced in 1986. With respect to
those units S may designate the integrated product Y as its possession
product. Under S's method of inventory accounting the remaining 50 units
were determined to have been produced in 1985. With respect to those
units S must define its possession product as it did for the taxable
year in which those units were produced. Thus, S's possession product
would be the component product X.
Q. 6: May an affiliated group establish groupings of possession
products and treat the groupings as single products?
A. 6: An affiliated group may establish reasonable groupings of
possession products based on similarities in the production processes of
the possession products. Possession products that are grouped shall be
treated as a single product. The determination of whether the production
processes involved in producing the products that are to be grouped are
similar is based on the production processes of the components that are
included in the possession product. The affiliated group may establish
new groupings each year. Any grouping which materially distorts a
taxpayer's income or the application of the significant business
presence test may be disallowed by the Commissioner. The mere fact that
a grouping results in an increased allocation of income to the
possessions corporation does not, of itself, create a material
distortion of income. If the Commissioner determines that the taxpayer's
grouping is improper with respect to one or more products in a group,
then those products shall be excluded from the group. The effect of
excluding a product or products from the group is that the taxpayer must
demonstrate that the group without the excluded products (and each
excluded product itself) satisfies the significant business presence
test. If the group without the excluded products, or any of the excluded
products themselves, fails to satisfy the significant business presence
test, then the possessions corporation's income from those products
shall be determined under section 936(h)(1)
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through (4) and the regulations thereunder.
Example 1. The following are examples of possession products the
processes of production of which are sufficiently similar that they may
be grouped and treated as a single product:
(A) Beverage bases or concentrates for different soft drinks or soft
drink syrups, regardless of whether some include sweeteners and some do
not:
(B) Different styles of clothing;
(C) Different styles of shoes;
(D) Equipment which relies on gravity to deliver solutions to
patients intravenously;
(E) Equipment which relies on machines to deliver solutions to
patients intravenously;
(F) Video game cartridges, even though the concept and design of
each game title is, in part, protected against infringement by separate
copyrights;
(G) All integrated circuits;
(H) All printed circuit boards; and
(I) Hardware and software if the software is one of several
alternative types of software offered by the manufacturer and sold only
with the hardware, and a purchaser of the hardware would ordinarily
purchase one or more of the manufacturer-provided alternative types of
software. In all other cases, hardware and software may not be grouped
and treated as a single product.
Groupings (D) and (E) do not include any solutions which are delivered
through the equipment described therein.
Example 2. A possessions corporation produces in Puerto Rico non-
programmable, interactive cathode ray tube computer terminals that vary
in price. These terminals all interact with a computer or controller to
perform their functions of data entry, graphics word processing, and
program development. The terminals can be purchased with options that
include a built-in printer, different language keyboards, specialized
cathode ray tubes, and different power supply features. All terminals
are produced in one integrated process requiring the same skills and
operations. The differences in the production of the terminals include
differences in the number of printed circuit boards incorporated in each
terminal, the use of unique keyboards, and the installation and testing
of the built-in printer. Some difference in direct labor time to
manufacture the terminals occurs, primarily due to the differing number
and complexity of printed circuit boards incorporated into each
terminal. Different model numbers are assigned to various computer
terminals. A grouping by the taxpayer of all of the terminals as one
product will be respected by the Service, unless the Service establishes
that substantial distortion results. This grouping is proper because the
processes of producing each of the terminals are similar.
Example 3. A possessions corporation, S produces several models of
serial matrix impact printers and teleprinters. These products have
differing performance standards based on such factors as speed (in
characters per second), numbers of columns, and cost. The production
process for all types of printers involves production of three basic
elements: electronic circuitry, the printing head, and the mechanical
parts. The process of producing all the printers is similar. Thus, all
printers could be grouped and treated as a single product. S purchases
electronic circuitry and mechanical parts from a U.S. affiliate. S
performs manufacturing functions relative to the printing head and
assembles and tests the finished printers. S does not satisfy the
significant business presence test with respect to the integrated
products. S therefore specifies on a statement attached to its return
(Schedule P of Form 5735) that the possession product for both the
serial matrix printers and the teleprinters is the end-product form. The
statement identifies the components which are included in each
possession product. S may group and treat as a single product the serial
matrix printers and the teleprinters if both end-product forms include
and exclude similar components. Thus, if the end-product form for both
the serial matrix printers and the teleprinters includes the mechanical
parts and excludes the electronic circuitry, then S may group and treat
as a single product the two end-product forms. If, however, the end-
product forms for the two items of property contain components that are
not similar and as a result of this definition of the end-product forms
the production processes involved in producing the two end-product forms
are not similar, then S may not group the end-product forms.
Q. 7: Is the affiliated group permitted to include in a group an
item of property that is not produced in whole or in part in a
possession?
A. 7: No.
Example 1. Possessions corporation S produces 70 units of product A
in a possession. P, an affiliate of S, produces 30 units of product A
entirely in the United States. All of the units are sold to unrelated
parties. The affiliated group is not permitted to group the 30 units of
product A produced in the United States with the 70 units produced in
the possession because those units are not produced in whole or in part
in a possession.
Example 2. The facts are the same as in example 1 except that the 30
units of product A are transferred to possessions corporation S. S
incorporates the 100 units of product A into product B. This
incorporation takes place in the possession. S may group and treat as a
single product all of the units of product B even though some of those
units
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contain units of product A that were produced in the possession and some
that were produced in the United States.
Q. 8: What factors should be disregarded in determining whether a
particular grouping of similar items of property is reasonable?
A. 8: In general, differences in the following factors will be
disregarded in determining whether a particular grouping of items of
property is reasonable:
(1) Differences in testing requirements (e.g., some products sold
for military use may require more extensive or different testing than
products sold for commercial use);
(2) Differences in the product specifications that are designed to
accommodate the product to its area of use or for conditions under which
used (e.g., electrical products designed for ultimate use in the United
States differ from electrical products designed for ultimate use in
Europe);
(3) Differences in packaging or labeling (e.g., differences in the
number of units of the items shipped in one package); and
(4) Minor differences in the operations of the items of property.
Q. 9: What rules apply for purposes of determining whether
pharmaceutical products are properly grouped and treated as a single
product?
A. 9: The rules contained in questions and answers 6 through 8 of
this section shall apply. Thus, an affiliated group may establish
reasonable groupings based on similarities in the production processes
of two or more possession products. In establishing a group the
affiliated group may only compare the production processes involved in
producing the possession products. The fact that two pharmaceutical
products contain different active or inert ingredients is not relevant
to the determination of whether the pharmaceutical products may be
grouped. For example, if the possession products are bulk chemicals and
the production processes involved in producing the bulk chemicals are
similar, those bulk chemicals may be grouped and treated as a single
product even though they contain different active or inert ingredients.
The affiliated group may also group and treat as a single product the
finished dosage form drug as long as the production processes involved
in producing the finished dosage forms are similar. For these purposes,
the production processes involved in producing the following classes of
items shall be considered to be sufficiently similar that possession
products delivered in a form described in one of the categories may be
grouped with other possession products delivered in a form described in
the same category.
The categories are:
(1) Capsules, tablets, and pills;
(2) Liquids, ointments, and creams; or
(3) Injectable and intravenous preparations.
No distinctions should be based on packaging, list numbers, or size of
dosage. The affiliated group may group and treat as a single product the
integrated product (combination of the bulk and the delivery form) only
if all the production processes involved in producing the integrated
products are similar. The rules of this question and answer are
illustrated by the following examples.
Example 1. Possessions corporation S produces two chemical active
ingredients X and Y. Both chemical ingredients are produced through the
process of fermentation. The affiliated group is permitted to group and
treat as a single product the two chemical ingredients.
Example 2. The facts are the same as in example 1 and possessions
corporation S finishes chemical ingredient X into tablets and chemical
ingredient Y into capsules. The affiliated group is permitted to group
and treat as a single product the combination of the bulk pharmaceutical
and the finishing because the production processes involved in producing
the integrated products are similar.
Example 3. Possessions corporation S produces in a possession a bulk
chemical X by fermentation. A United States affiliate, P, produces in
the United States a bulk chemical, Y, by fermentation. Both bulk
chemicals are finished by S in the possession. The finished dosage form
of X is in pill form. The finished dosage form of Y is in injectable
form. If S's possession product is the integrated product or the end-
product form then S may not group X and Y because the production
processes involved in producing the finished dosage form of X and Y are
not similar. If S's possession product is the component then S may not
group X and Y because
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the bulk chemical Y is not produced in whole or in part in a possession.
Q. 10: Will the fact that a manufacturer of a drug must submit a New
Drug Application (``NDA'') or a supplemental NDA to the Food and Drug
Administration have any effect on the definition or grouping of a
product?
A. 10: No.
Q. 11: A possessions corporation which produced a product or
rendered a type of service in a possession on or before September 3,
1982, is not required to meet the significant business presence test in
a possession with respect to such product or type of service for its
taxable years beginning before January 1, 1986 (the interim period).
During such interim period, how will the term ``product'' be defined for
purposes of allocating income under the cost sharing or profit split
methods?
A. 11: During the interim period the product will be determined
based on the activities performed by the possessions corporation within
a possession on September 3, 1982. During the interim period the
possessions corporation may compute its income under the cost sharing or
profit split method only with respect to the product that is produced or
manufactured within the meaning of section 954(d)(1)(A) within the
possession. If the product is manufactured from a component or
components produced by an affiliated corporation or a contract
manufacturer, then the product will not be treated as including such
component or components for purposes of the computation of income under
the cost sharing or profit split methods. Thus, the possessions
corporation is not entitled to any return on the intangibles associated
with the component or components. Notwithstanding the preceding
sentences, for taxable years beginning before January 1, 1986, a
possessions corporation may compute its income under the cost sharing or
profit split method with respect to a product which includes a component
or components produced by an affiliated corporation or contract
manufacturer if the possessions corporation satisfies with respect to
such product the significant business presence test described in section
936(h)(5)(B)(ii) and the regulations thereunder.
Example 1. A possessions corporation, S, was manufacturing (within
the meaning of section 954(d)(1)(A)) integrated circuits in a possession
on September 3, 1982. S transferred those integrated circuits to related
corporation P. P incorporated the integrated circuits into central
processing units (CPUs in the United States) and sold the CPUs to
unrelated parties. S continued to manufacture integrated circuits in the
possession through Juanuary 1, 1986. For taxable years beginning before
January 1, 1986, S may compute its income under the cost sharing or
profit split method with respect to the integrated circuits regardless
of whether S satisfies the significant business presence test. However,
unless S satisfies the significant business presence test with respect
to the central processing units, S may not compute its income under the
cost sharing or profit split methods with respect to the CPUs, and thus,
S is not entitled to any return on manufacturing intangibles associated
with CPUs to the extent that they are not related to the integrated
circuits produced by S, nor (except as provided in the profit split
methods) to any return on marketing intangibles.
Example 2. A possessions corporation, S, was engaged on September 3,
1982, in the manufacture (within the meaning of section 954(d)(1)(A)) of
a bulk pharmaceutical in Puerto Rico from raw materials. S sold the bulk
pharmaceutical to its U.S. parent, P, for encapsulation and sale by P to
customers as the product X. Because S was not engaged in the
encapsulation of X, S is not considered to have manufactured the
integrated product, X, in Puerto Rico. During the interim period, S may
compute its income under the cost sharing or profit split methods with
respect to the integrated product, X, only if S satisfies the
significant business presence test with respect to X. S may compute its
income under the cost sharing or profit split methods with respect to
the component product (the bulk pharmaceutical).
Example 3. P is a domestic corporation that is not a possessions
corporation. P manufactures a bulk pharmaceutical in the United States.
P transfers the bulk pharmaceutical to its wholly owned subsidiary, S, a
possessions corporation. On September 3, 1982, S was engaged in the
encapsulation of the bulk pharmaceutical in Puerto Rico in a manner
which satisfies the test of section 954(d)(1)(A). For taxable years
beginning before January 1, 1986, S may compute its income under the
cost sharing or profit split methods with respect to the end-product
form the (the encapsulated drug) regardless of whether S meets the
significant business presence test. However, unless S satisfies the
significant business presence test with respect to the integrated
product, S may not compute its income under the cost sharing or profit
split methods with respect to the
[[Page 147]]
integrated product, and thus, S is not entitled to any return on the
intangibles associated with the bulk pharmaceutical.
Q. 12: On September 3, 1982, a possessions corporation, S was
engaged in the manufacture (within the meaning of section 954(d)(1)(A))
of X in a possession. During the interim period, after September 3,
1982, but before January 1, 1986, S produced Y, which differs from X in
terms of minor design features. S did not produce Y in a possession on
September 3, 1982. Will S be considered to have commenced production of
a new product after September 3, 1982, for purposes of the application
of the significant business presence test for the interim period?
A. 12: No. X and Y will be considered to be a single product, and
therefore S will not be required to satisfy the business presence test
separately with respect to Y during the interim period. In all cases in
which the items of property produced on or before September 3, 1982 and
the items of property produced after that date could have been grouped
together under the guidelines provided in Sec. 1.936-5(a) questions and
answers 6 through 10, the possessions corporation will not be considered
to manufacture a new product after September 3, 1982.
Q. 13: May the term ``product'' be defined differently for export
sales than for domestic sales?
A. 13: Yes. For rules concerning the application of the separate
election for export sales see Sec. 1.936-7(b).
(b) Requirement of significant business presence--(1) General rules.
Q. 1: In general, a possessions corporation may compute its income
under the cost sharing or profit split methods with respect to a product
only if the possessions corporation has a significant business presence
in a possession with respect to that product. When will a possession
corporation be considered to have a significant business presence in a
possession?
A. 1: For purposes of the cost sharing method, the significant
business presence test is met if the possessions corporation satisfies
either a value added test or a direct labor test. For purposes of the
profit split method, the significant business presence test is met if
the possessions corporation satisfies either a value added test or a
direct labor test and also manufactures the product in the possession
within the meaning of section 954(d)(1)(A).
Q. 2: How may a possessions corporation satisfy the direct labor
test with respect to a product?
A. 2: The possessions corporation will satisfy the direct labor test
with respect to a product if the direct labor costs incurred by the
possessions corporation as compensation for services performed in a
possession are greater than or equal to 65 percent of the direct labor
costs of the affiliated group for units of the possession product
produced during the taxable year in whole or in part by the possessions
corporation.
Q. 3: How may a possessions corporation satisfy the value added
test?
A. 3: In order to satisfy the value added test, the production costs
of the possessions corporation incurred in the possession with respect
to units of the possession product produced in whole or in part by the
possessions corporation in the possession and sold or otherwise disposed
of during the taxable year by the affiliated group to unrelated parties
must be greater than or equal to twenty-five percent of the difference
between gross receipts from such sales or other dispositions and the
direct material costs of the affilated group for materials purchased for
such units from unrelated parties.
Q. 4: Must the significant business presence test be met with
respect to all units of the product produced during the taxable year by
the affiliated group?
A. 4: No. The significant business presence test must be met with
respect to only those units of the product produced during the taxable
year in whole or in part by the possessions corporation in a possession.
Q. 5: For purposes of determining whether a possessions corporation
satisfies the significant business presence test, how shall the
possessions corporation treat the cost of components transferred to the
possessions corporation by a member of the affiliated group?
A. 5: The treatment of the cost of components transferred from an
affiliate depends on whether the possession
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product is treated as including the components for purposes of section
936(h). If it is, then for purposes of the value added test, the
production costs associated with the component shall be treated as
production costs of the affiliated group that are not incurred by the
possessions corporation. Those production costs, other than the cost of
materials, shall not be treated as a cost of materials. For purposes of
the direct labor test and the alternative significant business presence
test, the direct labor costs associated with such components shall be
treated as direct labor costs of the affiliated group that are not
incurred by the possessions corporation. If the possession product is
treated as not including such component for purposes of section 936(h),
then, solely for purposes of determining whether the possessions
corporation satisfies the value added test, the cost of the component
shall not be treated as either a cost of materials or as a production
cost. For purposes of the direct labor test and the alternative
significant business presence test, the direct labor costs associated
with such component shall not be treated as direct labor costs of the
affiliated group. If the possession product is treated as not including
such component, then the possessions corporation shall not be entitled
to any return on the intangibles associated with the manufacturing or
marketing of the component.
Q. 6: May two or more related possessions corporations aggregate
their production or direct labor costs for purposes of determining
whether they satisfy the significant business presence test with respect
to a single product?
A. 6: No.
Q. 7: A possessions corporation, S, purchases raw materials and
components from an unrelated corporation which conducts business outside
of a possession. The unrelated corporation is not a contract
manufacturer. What is the treatment of such raw materials and components
for purposes of the significant business presence test?
A. 7: Where Company S purchases raw materials or components from an
unrelated corporation which is not a contract manufacturer, the raw
materials and components are treated as materials, and the costs related
thereto are treated as a cost of materials.
(2) Direct labor costs.
Q. 1: How is the term ``direct labor costs'' to be defined?
A. 1: The term ``direct labor costs'' has the same meaning which it
has for purposes of Sec. 1.471-11(b)(2)(i). Thus, direct labor costs
include the cost of labor which can be identified or associated with
particular units or groups of units of a specific product. The elements
of direct labor include such items as basic compensation, overtime pay,
vacation and holiday pay, sick leave pay (other than payments pursuant
to a wage continuation plan under section 105(d)), shift differential,
payroll taxes, and payments to a supplemental unemployment benefit plan
paid or incurred on behalf of employees engaged in direct labor.
Q. 2: May a taxpayer treat a cost as a direct labor cost if it is
not included in inventoriable costs under section 471 and the
regulations thereunder?
A. 2: No. A cost may be treated as a direct labor cost only if it is
included in inventoriable costs. However, a cost may be considered a
direct labor cost even though the activity to which it relates would not
constitute manufacturing under section 954(d)(1)(A) as long as the cost
is included in inventoriable costs.
Q. 3: May the members of the affiliated group include as direct
labor costs the labor element in indirect production costs?
A. 3: No. The labor element of indirect production costs may not be
considered as part of direct labor costs.
Q. 4: Do direct labor costs include the costs which can be
identified or associated with particular units or groups of units of a
specific product if those costs could also be described as quality
control and inspection?
A. 4: Yes. Direct labor costs include costs which can be identified
or associated with particular units or groups of units of a specific
product. Thus, if quality control and inspection is an integral part of
the production process, then the labor associated with that quality
control and inspection shall be considered direct labor. For example,
integrated circuits are soldered to printed circuit boards by passing
the
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boards over liquid solder. Employees inspect each of the boards and
repair any imperfectly soldered joints discovered on that inspection.
The labor associated with this process is direct labor. However, if a
person performs random inspections on limited numbers of products, then
that labor associated with those inspections shall be considered quality
control and therefore indirect labor.
Q. 5: Do direct labor costs of the possessions corporation include
only the costs which were actually incurred or do they take into
account, in addition, any labor savings which result because the
activities were performed in a possession rather than in the United
States?
A. 5: Direct labor costs include only the costs which were actually
incurred.
Q. 6: For purposes of determining whether a possessions corporation
satisfies the significant business presence test for a taxable year with
respect to a product, how shall the possessions corporation compute its
direct labor costs of units of the product?
A. 6: The direct labor test shall be applied separately to products
produced in whole or in part by the possessions corporation in the
possession during each taxable year. Sales shall be deemed to be made
first out of the current year's production. If sales are made only out
of the current year's production, then the direct labor costs of
producing those units that are sold shall be the pro rata portion of the
total direct labor costs of producing all the units that are produced in
whole or in part in the possession by the possessions corporation during
the current year. If all of the current year's production is sold and
some inventory is liquidated, then the direct labor test shall be
applied separately to the current year's production and the liquidated
inventory. The direct labor costs of producing the liquidated inventory
shall be the pro rata portion of the total direct labor costs that were
incurred in producing all the units that were produced in whole or in
part by the possessions corporation in the possessions in the layer of
liquidated inventory determined under the member's method of inventory
accounting.
Example. S is a cash basis calendar year taxpayer that has made an
election under section 936(a). In 1985 S produced 100 units of product
X. Fifty percent of the direct labor costs of the affiliated group were
incurred by S and were compensation for services performed in the
possession. Thus, S did not satisfy the significant business presence
test with respect to product X in taxable year 1985. During 1986 S
produced 100 units of product X. One hundred percent of the direct labor
costs of the affiliated group were incurred by S and were compensation
for services performed in the possession. In 1986 S sells 150 units of
product X. One hundred of those units are deemed to be from the units
produced in 1986. With respect to those units S satisfies the
significant business presence test. Under S's method of inventory
accounting the remaining 50 units were determined to be produced in
1985. With respect to those units S does not satisfy the significant
business presence test because only 50% of the direct labor costs
incurred in producing those units were incurred by S and were
compensation for services performed in the possession.
Q. 7: What is the result if in a particular taxable year the
possessions corporation satisfies the significant business presence test
with respect to units of the product produced in one year and fails the
significant business with respect to units produced in another year?
A. 7: For those units of the product with respect to which the
possession corporation satisfies the significant business presence test,
the possessions corporation may compute its income under the provisions
of section 936(h)(5). For those units of the product with respect to
which the possessions corporations fails the significant business
presence test, the possessions corporation must compute its income under
section 936(h)(1) through (4).
Q. 8: Do direct labor costs include costs incurred in a prior
taxable year with respect to units of the possession product that are
finished in a later taxable year?
A. 8: Yes.
(3) Direct material costs.
Q. 1: How is the term ``direct material costs'' to be defined?
A. 1: Direct material costs include the cost of those materials
which become an integral part of the specific product and those
materials which are consumed in the ordinary course of manufacturing and
can be identified or
[[Page 150]]
associated with particular units or groups of units of that product. See
Sec. 1.471-3 for the elements of direct material costs.
Q. 2: May a taxpayer treat a cost as a direct material cost if it is
not included in inventoriable costs under section 471 and the
regulations thereunder?
A. 2: A taxpayer may not treat such costs as direct material costs.
(4) Production costs.
Q. 1: How is the term ``production costs'' defined?
A. 1: The term ``production costs'' has the same meaning which it
has for purposes of Sec. 1.471-11(b) except that the term does not
include direct material costs and interest. Thus, production costs
include direct labor costs and fixed and variable indirect production
costs (other than interest).
Q. 2: With respect to indirect production costs described in Sec.
1.471-11(c)(2) (ii) and (iii), may a possessions corporation include
these costs in production costs for purposes of section 936, if they are
not included in inventoriable costs under section 471 and the
regulations thereunder?
A. 2: No. A possessions corporation may include these costs only if
they are included for purposes of section 471 and the regulations
thereunder. If a possessions corporation and the other members of the
affiliated group include and exclude different indirect production costs
in their inventoriable costs, then, for purposes of the significant
business presence test, the possessions corporation shall compute its
production costs and the production costs of the other members of the
affiliated group by subtracting from the production costs of each member
all indirect costs included by that member that are not included in
production costs by all other members of the affiliated group.
Q. 3: Does a change in a taxpayer's method of accounting for
purposes of section 471 affect the taxpayer's computation of production
costs for purposes of section 936?
A. 3: Yes. If a taxpayer changes its method of accounting for
purposes of section 471, then the same change shall apply for purposes
of section 936.
Q. 4: For purposes of determining whether a possessions corporation
satisfies the significant business presence test for a taxable year with
respect to a product, how shall the possessions corporation compute its
costs of producing units of the product sold or otherwise disposed to
unrelated parties during the taxable year?
A. 4: All members of the affiliated group may elect to use their
current year production costs regardless of whether the members use the
FIFO or LIFO method of inventory accounting. If some or all of the
current year's production of a product is sold, then the production
costs of producing those units sold shall be the pro rata portion of the
total production costs of producing all the units produced in the
current year. If all of the current year's production of a product is
sold and some inventory is liquidated, then the production costs of
producing the liquidated inventory shall be the pro rata portion of the
production costs incurred in producing the layer of liquidated inventory
as determined under the member's method of inventory accounting.
Q. 5: How should the members of the affiliated group determine the
portion of their production costs that is allocable to units of the
product sold or otherwise disposed of during the taxable year?
A. 5: The members of the affiliated group may use either standard
production costs (so long as variances are not material), average
production costs, or FIFO production costs to determine the production
costs that will be considered to be attributable to units of the product
sold or otherwise disposed of during the taxable year. However, all
members of the affiliated group must use the same method.
Q. 6: When is the quality control and inspection of a product
considered to be part of the production activity for that product?
A. 6: Quality control and inspection of a manufactured product
before its sale or other disposition by the manufacturer, or before its
incorporation into other products, is considered to be part of the
indirect production activity for that initial product. Subsequent
testing of a product to ensure that the
[[Page 151]]
product is compatible with other products is not a part of the
production activity for the initial product.
When a component is incorporated into an end-product form and the end-
product form is then tested, the latter testing will be considered to be
a part of the indirect production activity for the end-product form and
will not be considered to be a part of the production activity for the
component.
Q. 7: For purposes of the significant business presence test and the
allocation of income to a possessions corporation, what is the treatment
of the cost of installation of a product?
A. 7: For purposes of the significant business presence test and the
allocation of income to a possessions corporation, product installation
costs need not be taken into account as costs incurred in the
manufacture of that product, if the taxpayer keeps such permanent books
of account or records as are sufficient to establish the fair market
price of the uninstalled product. In such a case, the cost of
installation materials, the cost of the labor for installation, and a
reasonable profit for installation will not be included in the costs and
income associated with the possession product. If the taxpayer does not
keep such permanent books of account or records, then the cost of
installation materials and the cost of labor for installation shall be
treated as costs associated with the possession product and income will
be allocated to the possessions corporation and its affiliates under the
rules provided in these regulations.
Q. 8: For purposes of the significant business presence test and the
allocation of income to a product or service, what is the treatment of
the cost of servicing and maintaining a possession product that is sold
to an unrelated party?
A. 8: The cost of servicing and maintaining a possession product
after it is sold is not associated with the production of that product.
Q. 9: For purposes of the significant business presence test and the
allocation of income to a possessions corporation, what is the treatment
of the cost of samples?
A. 9: The cost of producing samples will be treated as a marketing
expense and not as inventoriable costs for these purposes. However, for
taxable years beginning prior to January 1, 1986, the cost of producing
samples may be treated as either a marketing expense or as inventoriable
costs.
(5) Gross receipts.
Q. 1: How shall the affiliated group determine gross receipts from
sales or other dispositions by the affiliated group to unrelated parties
of the possession product?
A. 1: Gross receipts shall be determined in the same manner as
possession sales under the rules contained in Sec. 1.936-6(a)(2).
(6) Manufacturing within the meaning of section 954(d)(1)(A).
Q. 1: What is the test for determining, within the meaning of
section 954(d)(1)(A), whether a product is manufactured or produced by a
possessions corporation in a possession?
A. 1: A product is considered to have been manufactured or produced
by a possessions corporation in a possession within the meaning of
section 954(d)(1)(A) and Sec. 1.954-3(a)(4) if--
(i) The property has been substantially transformed by the
possessions corporation in the possession;
(ii) The operations conducted by the possessions corporation in the
possession in connection with the property are substantial in nature and
are generally considered to constitute the manufacture or production of
property; or
(iii) The conversion costs sustained by the possessions corporation
in the possession, including direct labor, factory burden, testing of
components before incorporation into an end product and testing of the
manufactured product before sales account for 20 percent or more of the
total cost of goods sold of the possessions corporation.
In no event, however, will packaging, repackaging, labeling, or minor
assembly operations constitute manufacture or production of property.
See particularly examples 2 and 3 of Sec. 1.954-3(a)(4)(iii).
Q. 2: Does the requirement that a possession product be produced or
manufactured in a possession within the meaning of section 954(d)(1)(A)
apply to taxable years beginning before January 1, 1986?
[[Page 152]]
A. 2: A possessions corporation must satisfy this requirement for
taxable years beginning before January 1, 1986, in the following cases:
(i) If the possessions corporation makes a separate election under
section 936(h)(5)(F)(iv)(II) with respect to export sales;
(ii) If the possessions corporation is electing as its possession
product a product that is subject to the interim period rules of Sec.
1.936-5(a) question and answer (10); or
(iii) If the possessions corporation is electing as its possession
product a product that is not subject to the interim period rules of
Sec. 1.936-5 (a) question and answer (10) and the possessions
corporation computes its income under the profit split method with
respect to that product.
For rules concerning products first produced in a possession after
September 3, 1982, see Sec. 1.936-5(b)(7) question and answer (2).
(7) Start-up operations.
Q. 1: With respect to products not produced (and types of services
not rendered) in the possession on or before September 3, 1982, when
must a possessions corporation first satisfy the 25 percent value added
test or the 65 percent direct labor test?
A. 1: A transitional period is established such that a possessions
corporation engaged in start-up operations with respect to a product or
service need not satisfy the 25 percent value added test or the 65
percent labor test until the third taxable year following the taxable
year in which such product is first sold by the possessions corporation
or such service is first rendered by the possessions corporation. During
the transitional period, the applicable percentages for these tests will
be as follows:
------------------------------------------------------------------------
Any year after 1982
--------------------------
1 2 3
------------------------------------------------------------------------
Value added test............................. 10 15 20
Labor test................................... 35 45 55
------------------------------------------------------------------------
Q. 2: Does the requirement that a possession product be produced or
manufactured in a possessions within the meaning of section 954(d)(1)(A)
apply to a product if the possessions corporation is engaged in start-up
operations with respect to that product?
A. 2: The possessions corporation must produce or manufacture the
possessions product within the meaning of section 954(d)(1)(A) if the
possessions corporation computes its income with respect to that product
under the profit split method.
Q. 3: When will a possessions corporation be considered to be
engaged in start-up operations?
A. 3: A possessions corporation is engaged in start-up operations if
it begins operations in a possession with respect to a product or type
of service after September 3, 1982. Subject to the further provisions of
this answer, a possessions corporation will be considered to begin
operations with respect to a product if, under the rules of Sec. 1.936-
5(a) questions and answers (6) through (10), such product could not be
grouped with any other item of property manufactured in whole or in part
in the possessions by any member of the affiliated group in any
preceding taxable year. Any improvement or other change in a possession
product which does not substantially change the production process would
not be deemed to create a new product. A change in the division of
manufacturing activity between the possessions corporation and its
affiliates with respect to an item of property will not give rise to a
new product. If a possessions corporation was producing a possession
product that was either a component product or an end-product form and
the possessions corporation expands its operations in the same
possession so that it is now producing a product that includes the
earlier possession product, the possessions corporation will not be
entitled to use the start-up significant business presence test unless
the production costs incurred by the possessions corporation in the
possession in producing a unit of its new possession product are at
least double the production costs incurred by the possessions
corporation in the possession in producing a unit of the earlier
possession product. If any member of an affiliated group actually groups
two or more items of property then, solely for the purposes of
determining whether any item of property in that group is a new product,
that
[[Page 153]]
grouping shall be respected. However, the fact that an affiliated group
does not actually group two or more items of property shall be
disregarded in determining whether any item of property is a new
product. Notwithstanding the above, if a possessions corporation is
producing a possession product in one possession and such corporation or
a member of its affiliated group begins operations in a different
possession, regardless of whether the items of property could be
grouped, the affiliated group may treat the units of the item of
property produced at the new site of operations in the different
possession as a new product.
(8) Alternative significant business presence test.
Q. 1: Will the Secretary adopt a significant business presence test
other than those set forth in section 936(h)(5)(B)(ii)?
A. 1: Yes. The following significant business presence test is
adopted both for the transitional period and thereafter. A possessions
corporation will have a significant business presence in a possession
for a taxable year with respect to a product or type of service if--
(i) No less than 50 percent of the direct labor costs of the
affiliated group for units of the product produced, in whole or in part,
during the taxable year by the possessions corporation or for the type
of service rendered by the possessions corporation during the taxable
year are incurred by the possessions corporation as compensation for
services performed in the possession; and
(ii) The direct labor costs of the possessions corporation for units
of the product produced or the type of service rendered plus the base
period construction costs are no less than 70 percent of the sum of such
base period construction costs and the direct labor costs of the
affiliated group for such units of the product produced or the type of
service rendered.
Notwithstanding satisfaction of the above test, for purposes of
determining whether a possessions corporation may compute its income
under the profit split method, a possessions corporation will not be
treated as having a significant business presence in a possession with
respect to a product unless the possessions corporation manufactures the
product in the possession within the meaning of section 954(d)(1)(A).
Q. 2: How is the term ``base period construction costs'' defined?
A. 2: The term ``base period construction costs'' means the average
construction costs incurred by or on behalf of the possessions
corporation for services in the possession during the taxable year and
the preceding four taxable years for section 1250 property (as defined
in section 1250(c) and the regulations thereunder) that is used for the
production of the product or the rendering of the service in the
possession, and which represents the original use of the section 1250
property. For purposes of the preceding sentence, if the possessions
corporation was not in existence during one or more of the four
preceding taxable years, its construction costs for that year or years
shall be deemed to be zero. Construction costs include architects' and
engineers' fees, labor costs, and overhead and profit (if the
construction is performed by a person that is not a member of the
affiliated group).
(c) Definition and treatment of contract manufacturing.
Q. 1: For purposes of determining whether a possessions corporation
satisfies the significant business presence test with respect to a
product, the costs incurred by the possessions corporation or by any of
its affiliates in connection with contract manufacturing which is
related to that product and is performed outside the possession shall be
treated as direct labor costs of the affiliated group and shall not be
treated as production costs of the possessions corporation or as
material costs. How is the term ``contract manufacturing'' to be
defined?
A. 1: The term ``contract manufacturing'' includes any arrangement
between a possessions corporation (or another member of the affiliated
group) and an unrelated person if the unrelated person:
(1) Performs work on inventory owned by a member of the affiliated
group for a fee without the passage of title;
(2) Performs production activities (including manufacturing,
assembling,
[[Page 154]]
finishing, or packaging) under the direct supervision and control of a
member of the affiliated group; or
(3) Does not undertake any significant risk in manufacturing its
product (e.g., it is paid by the hour).
Q. 2: Does an arrangement between a member of the affiliated group
and an unrelated party constitute contract manufacturing if the
unrelated party uses an intangible owned or licensed by a member of the
affiliated group?
A. 2: Such an arrangement will be treated as contract manufacturing
if the unrelated party makes use of a patent owned or licensed by a
member of the affiliated group in producing the product which becomes
part of the possession product of the possessions corporation. In
addition, such use of manufacturing intangibles other than patents may
be treated as contract manufacturing if it is established that the
arrangement has the effect of materially distorting the application of
the significant business presence test. However, the preceding sentence
shall not apply if the possessions corporation establishes that the
arrangement was entered into for a substantial business purpose (e.g.,
to obtain the benefit of special expertise of the manufacturer or
economies of scale). These rules shall not apply to such contract
manufacturing performed in taxable years beginning before January 1,
1986, nor shall the rules apply to binding contracts for the performance
of such contract manufacturing entered into before June 13, 1986.
Q. 3: For purposes of the significant business presence test, how
shall a possessions corporation treat the cost of contract manufacturing
performed within a possession?
A. 3: If the possessions corporation uses the value added test, it
will be permitted to treat the cost of the contract manufacturing
performed in a possession, not including material costs, as a production
cost of the possessions corporation. If it uses the direct labor test or
the alternative significant business presence test set forth in Sec.
1.936-5(b)(8), it is permitted to treat the direct labor costs of the
contract manufacturer associated with such contract manufacturing as a
cost of direct labor of the possessions corporation. The allowable
amount of the direct labor cost shall be determined in accordance with
question and answer 4 below.
Q. 4: How are the amounts paid by a possessions corporation to a
contract manufacturer for services rendered in a possession to be
treated by the possessions corporation in computing the direct labor
cost of the product to which such contract manufacturing relates?
A. 4: If the possessions corporation can establish the contract
manufacturer's direct labor cost which was incurred in the possession,
such cost will be treated as incurred by the possessions corporation as
compensation for services performed in the possession. If the
possessions corporation cannot establish such cost, then 50 percent of
the amount paid to such contract manufacturer may be treated as incurred
by the possessions corporation as compensation for services performed in
the possession: provided, that not more than 50 percent of the fair
market value of the product manufactured by the contract manufacturer is
attributable to articles shipped into the possession, and the
possessions corporation receives a statement from the contract
manufacturer that this test has been satisfied. If this fair market
value test is not satisfied, then the cost of contract manufacturing
performed within a possession shall not be treated as a production cost
or a direct labor cost of either the possessions corporation or the
affiliated group.
Q. 5: For purposes of the significant business presence test, what
is the treatment of costs which are incurred by a member of the
affiliated group (including the possessions corporation) for contract
manufacturing performed outside of the possession with respect to an
item of property which is a component of the possession product?
A. 5: If the possession product is treated as including such
component, the cost of the contract manufacturing shall be treated as a
direct labor cost of members of the affiliated group other than the
possessions corporation for purposes of the direct labor test and the
alternative significant business presence test, and shall not be treated
as a production cost of the possessions corporation or as a cost of
materials
[[Page 155]]
for purposes of the value added test. If the possession product is
treated as not including such component, the cost of the contract
manufacturing shall not be treated as a direct labor cost of any member
of the affiliated group for purposes of the direct labor test and the
alternative significant business presence test, and shall not be treated
as a production cost of the possessions corporation or as a cost of
materials for purposes of the value added test.
[T.D. 8090, 51 FR 21524, June 13, 1986; 51 FR 27174, July 30, 1986]
Sec. 1.936-6 Intangible property income when an election out is made:
Cost sharing and profit split options; covered intangibles.
The rules in this section apply for purposes of section 936(h) and
also for purposes of section 934(e) where applicable.
(a) Cost sharing option--(1) Product area research.
Q. 1: Cost sharing payments are based on research undertaken by the
affiliated group in the ``product area'' which includes the possession
product. The term ``product area'' is defined by reference to the three-
digit classification under the Standard Industrial Classification (SIC)
code. Which governmental agency has jurisdiction to decide the proper
SIC category for any specfic product?
A. 1: Solely for the purpose of determining the tax consequences of
operating in a possession, the Secretary or his delegate has exclusive
jurisdiction to decide the proper SIC category under which a product is
classified. For this purpose, the product area under which a product is
classified will be determined according to the 1972 edition of the SIC
code. From time to time and in appropriate cases, the Secretary may
prescribe regulations or issue rulings determining the proper SIC
category under which a particular product is to be classified, and may
prescribe regulations for aggregating two or more three-digit
classifications of the SIC code and for classifying product areas
according to a system other than under the SIC code.
Q. 2: How is the term ``affiliated group'' defined for purposes of
the cost sharing option?
A. 2: For purposes of the cost sharing option, the term ``affiliated
group'' means the possessions corporation and all other organizations,
trades or businesses (whether or not incorporated, whether or not
organized in the United States, and whether or not affiliated) owned or
controlled directly or indirectly by the same interests, within the
meaning of section 482.
Q. 3: Are research and development expenditures that are included in
product area research limited to research and development expenditures
that are deductible under section 174 or that are incurred by U.S.
affiliates?
A. 3: No, product area research is not limited to product area
research expenditures deductible under section 174 or to expenses
incurred by U.S. affiliates. Product area research also includes
deductions permitted under section 168 with respect to research property
which are not deductible under section 174; qualified research expenses
within the meaning of section 30(b); payments (such as royalities) for
the use of, or right to use, a patent, invention, formula, process,
design, pattern or know-how; and a proper allowance for amounts incurred
in the acquisition of manufacturing intangible property. In the case of
an acquisition of depreciable or amortizable manufacturing intangible
property, the annual amount of product area research shall be be equal
to the allowable depreciation or amortization on the intangible property
for the taxable year. In the case of an acquisition of nondepreciable or
nonamortizable manufacturing intangible property, the amount expended
for the acquisition shall be deemed to be amortized over a five year
period and included in product area research in the year of the deemed
amortization. Any contingent payment made with respect to the
acquisition of nonamortizable manufacturing intangible property shall be
treated as amounts incurred in the acquisition of nonamortizable
manufacturing intangible property when paid or accrued.
Q. 4: Does royalty income from a person outside the affiliated group
with respect to the manufacturing intangibles within a product area
reduce the product area research pool within the same product area?
[[Page 156]]
A. 4: Yes.
Q. 5: Does income received from a person outside the affiliated
group from the sale of a manufacturing intangible reduce the product
area research pool within the same product area?
A. 5: In determining product area research, the income from the sale
attributable to noncontingent payments will reduce product area research
ratably over the remaining useful life of the property in the case of an
amortizable intangible and ratably over a 5-year period in the case of a
nonamortizable intangible. Any income attributable to contingent amounts
received with respect to the sale of manufacturing intangible property
shall be treated as amounts received from the sale of the manufacturing
intangible property in the year in which such contingent amounts are
received or accrued.
Q. 6: If a member of an affiliated group incurs research and
development expenses pursuant to a contract with an unrelated person who
is entitled to exclusive ownership of all the technology resulting from
the expenditures, is the amount of product area research reduced by the
amount of such expenditures?
A. 6: To the extent that the product area research expenditures can
be allocated solely to the technology produced for the unrelated person,
such expenditures will not be included in product area research
expenditures provided, however, that the unrelated person has exclusive
ownership of all the technology resulting from these expenditures, and
further that no member of the affiliated group has a right to use any of
the technology.
Q. 7: What is the treatment of product area research expenditures
attributable to a component where the component and the integrated
product fall within different product areas?
A. 7: For purposes of the computation of product area research
expenditures in the product area by the affiliated group, the product
area in which the component falls is aggregated with the product area in
which the integrated product falls. However, if the component product
and integrated product are in separate SIC codes and if the component
product is not included in the definition of the possession product,
then the product area research expenditures are not aggregated. The same
rule applies where the taxpayer elects a component product which
encompasses another component product and the two component products
fall into separate SIC codes. In such case, the product area in which
the first component falls is aggregated with the product area in which
the second component falls.
(2) Possession sales and total sales.
Q. 1: The cost sharing payment is the same proportion of the total
cost of product area research which the amount of ``possession sales''
of the affiliated group bears to the ``total sales'' of the affiliated
group within the product area. How are ``possession sales'' defined for
purposes of the cost sharing fraction?
A. 1: The term ``possession sales'' means the aggregate sales or
other dispositions of the possession product, to persons who are not
members of the affiliated group, less returns and allowances and less
indirect taxes imposed on the production of the product, for the taxable
year. Except as otherwise indicated in Sec. 1.936-6(a)(2), the sales
price to be used is the sales price received by the affiliated group
from persons who are not members of the affiliated group.
Q. 2: For purposes of the numerator of the cost sharing fraction,
how are possession sales computed where the possession product is a
component product or an end-product form?
A. 2: (i) The sales price of the component product or end-product
form is determined as follows. With respect to a component product, an
independent sales price from comparable uncontrolled transactions must
be used if such price can be determined in accordance with Sec. 1.482-
2(e)(2). If an independent sales price of the component product from
comparable uncontrolled transactions cannot be determined, then the
sales price of the component product shall be deemed to be equal to the
transfer price, determined under the appropriate section 482 method,
which the possessions corporation uses under the cost sharing method in
computing the income it derives from the
[[Page 157]]
active conduct of a trade or business in the possession with respect to
the component product. The possessions corporation in lieu of using the
transfer price determined under the preceding sentence may treat the
sales price for the component product as equal to the same proportion of
the third party sales price of the integrated product which the
production costs attributable to the component product bear to the total
production cost for the integrated product. Production cost will be the
sum of direct and indirect production costs as defined in Sec. 1.936-
5(b)(4). If the possessions corporation determines the sales price of
the component product using the production cost ratio, the transfer
price used by the possessions corporation in computing its income from
the component product under the cost sharing method may not be greater
than such sales price.
(ii) With respect to an end-product form, the sales price of the
end-product form is equal to the difference between the third party
sales price of the integrated product and the independent sales price of
the excluded component(s) from comparable uncontrolled transactions, if
such price can be determined under Sec. 1.482-2(e)(2). If an
independent sales price of the excluded component(s) from uncontrolled
transactions cannot be determined, then the sales price of the end-
product form shall be deemed to be equal to the transfer price,
determined under the appropriate section 482 method, which the
possessions corporation uses under the cost sharing method in computing
the income it derives from the active conduct of a trade or business in
the possession with respect to such end-product form. The possessions
corporation in lieu of using the transfer price determined under the
preceding sentence may use the production cost ratio method described
above to determine the sales price of the end-product form (i.e., the
same proportion of the third party sales price of the integrated product
which the production costs attributable to the end-product form bear to
the total production costs for the integrated product). If the
possessions corporation determines the sales price of the end-product
form using the production cost ratio, the transfer price used by the
possessions corporation in computing its income from the end-product
form under the cost sharing method may not be greater than such sales
price. For similar rules applicable to the profit split option see Sec.
1.936-6(b)(1), question and answer 12.
Q. 3: For purposes of determining possessions sales in the numerator
of the cost sharing fraction, will the replacement part price of the
product be treated as a price from comparable uncontrolled transactions?
A. 3: Prices for replacement parts are generally higher than prices
for equipment sold as part of an original system. Thus, prices for
replacement parts cannot generally be used directly as prices for
comparable uncontrolled transactions. However, replacement part prices
may be used for estimating comparable uncontrolled prices where the
price differential can be reasonably determined and taken into account
under Sec. 1.482-2(e)(2).
Q. 4: For purposes of determining possession sales in the cost
sharing fraction, what is the treatment of components that are purchased
by one possessions corporation from an affiliated possessions
corporation and which are incorporated into a possession product where
the transferor possessions corporation treats the transferred component
as a possession product?
A. 4: When one possessions corporation purchases components from a
second possessions corporation which is an affiliated corporation, the
purchase price of the components paid to the second possessions
corporation shall be subtracted from the sales proceeds of the product
produced in the possession by the first possessions corporation, and
only the remainder is included in the numerator of the cost sharing
formula for the first corporation. For example, assume that N
corporation manufactures a component for sale to O corporation for $100
(a price which reflects prices in comparable uncontrolled transactions).
Both N and O are affiliated possessions corporations. N has designated
that component product as its possession product. O then incorporates
that product into a second product which is sold to customers for
[[Page 158]]
$300 N and O must make separate cost sharing payments. The cost sharing
payment of N corporation is determined by including $100 as possession
sales, and the payment of O is determined by subtracting that $100
purchase price from the $300 received from customers. Thus, the
possessions sales amount of O is $200. This rule is intended to prevent
the double counting of the sales of a component produced by one
possessions corporation and incorporated into another product by an
affiliated possessions corporation.
Q. 5: Are pre-TEFRA sales included in the cost sharing fraction?
A. 5: No. Pre-TEFRA sales are sales of products produced by the
possessions corporation and transferred to an affiliate prior to a
possessions corporation's first taxable year beginning after December
31, 1982. Pre-TEFRA sales are not included in either the numerator or
denominator of the cost sharing fraction. If the U.S. affiliate uses the
FIFO method of costing inventory, the pre-TEFRA inventory will be
treated as the first inventory sold by the U.S. affiliate during the
first year in which section 936(h) applies. If the U.S. affiliate uses
the LIFO method of costing inventory (either dollar-value or specific
goods LIFO), pre-TEFRA inventor will be treated as inventory sold by the
U.S. affiliate in the year in which the U.S. afiliate's LIFO layer
containing pre-TEFRA LIFO inventory is liquidated.
Q. 6: How are ``possession sales'' determined under the cost sharing
formula if members of the affiliated group (other than the possessions
corporation) include purchases of the possession product, X, in a
dollar-value LIFO inventory pool (as provided under Sec. 1.472-8)?
A. 6: Possession sales may be determined by applying the revenue
identification method provided under paragraph (b)(1) Question and
Answer 18 of this section.
Q. 7: Do possession sales include excise taxes paid by the
possessions corporation when the product is sold for ultimate use or
consumption in the possession?
A. 7: No. The amount of excise taxes is excluded from both the
numerator and denominator of the cost sharing fraction.
Q. 8: How are ``total sales'' defined for purposes of the cost
sharing fraction?
A. 8: The term ``total sales'' means aggregate sales or other
dispositions of products in the same product area as the possession
product, less returns and allowances and less indirect taxes imposed on
the production of the product, for the taxable year to persons who are
not members of the affiliated group. The sales price to be used is the
sales price received by the affiliated group from persons who are not
members of the affiliated group.
Q. 9: In computing that cost sharing payment, how are ``total
sales'' computed if the dollar-value LIFO inventory pool includes some
products which are not included in the product area (determined under
the 3-digit SIC code) on which the denominator of the cost sharing
fraction is based?
A. 9: In such case, the amount of the total sales within the product
area to persons who are not members of the affiliated group by persons
who are members of the affiliated group is determined by multiplying the
total sales of the products within the dollar-value LIFO inventory pool
by a fraction. The numerator of the fraction includes the dollar-value
of purchases by members of the affiliated group (including the
possessions corporation) of products within the product area made during
the year, plus any added production costs (as defined in Sec. 1.471-
11(b), (c), and (d) but not including the costs of materials) incurred
by the affiliates during the same period. The denominator of the
fraction includes the dollar-value of purchases by members of the
affiliated group (including the possessions corporation) of products
within the dollar-value LIFO inventory pool made during the same period
(including any production costs, as described above, incurred by the
affiliate during the same period). For these purposes, purchases of a
possession product are determined on the basis of the possessions
corporation's cost for its inventory purposes.
Q. 10: May a possessions corporation compute its income under the
cost
[[Page 159]]
sharing method with respect to a possession product which the
possessions corporation sells to a member of its affiliated group and
which that member then leases to an unrelated person or uses in its own
trade or business?
A. 10: Yes, provided that an independent sales price for the
possession product from comparable uncontrolled transactions can be
determined in accordance with Sec. 1.482-2(e)(2), and, provided
further, that such member complies with the requirements of Sec. 1.936-
6(a)(2), question and answer 14. If, however, there is a comparable
uncontrolled price for an integrated product and the possession product
is a component product or end-product form thereof, the possessions
corporation may, if such member complies with the requirements of Sec.
1.936-6(a)(2), question and answer 14, compute its income under the cost
sharing method with respect to such possession product. In that case,
the cost sharing payment shall be computed under the following question
and answer.
Q. 11: How are possession sales and total sales to be determined for
purposes of computing the cost sharing payment with respect to a
possession product which the possessions corporation sells to a member
of its affiliated group where that member then leases the possession
product to unrelated persons or uses it in its own trade or business?
A. 11: If the possessions corporation is entitled to compute its
income from such sales of the possession product under the cost sharing
method, both possession sales and total sales shall be determined as if
the possession product had been sold by the affiliate to an unrelated
person at the time the possession product was first leased or otherwise
placed in service by the affiliate. The sales price on such deemed sale
shall be equal to the independent sales price from comparable
uncontrolled transactions determined in accordance with Sec. 1.482-
2(e)(2), if any. If the possession product is a component product or an
end-product form for which there is no such independent sales price but
there is a comparable uncontrolled price for the integrated product
which includes the possession product, the deemed sales price of the
possession product shall be computed under the rules of Sec. 1.936-
6(a)(2) question and answer 2. The full amount of income received under
the lease shall be treated as income of (and taxed to) the affiliate and
not the possessions corporation.
Q. 12: When may a possessions corporation take into account in
computing total sales under the cost sharing method products in the same
product area as the possession product (other than the possession
product itself) where such products are leased by members of the
affiliated group to unrelated persons or used by any such member in its
own trade or business?
A. 12: For purposes of computing total sales under the cost sharing
method, the possessions corporation may take into account products in
the same product area as the possession product itself where such
products are leased by members of the affiliated group to unrelated
persons or used in the trade or business of any such member, but only if
an independent sales price of such products from comparable uncontrolled
transactions may be determined under Sec. 1.482-2(e)(2). In such cases,
the units of such products which are leased or otherwise used internally
by members of the affiliated group may be treated as sold to unrelated
persons for such independent sales price for purposes of computing total
sales.
Q. 13: Assuming that a possessions corporation is entitled to
compute its income under the cost sharing method with respect to sales
of a possession product to affiliates in cases where those affiliates
lease units of the possession product to unrelated persons or use them
internally, is the possessions corporation's income from the possession
product any different than if the affiliates had sold the product to
unrelated parties?
A. 13: No.
Q. 14: If a possessions corporation sells units of a possession
product to a member of its affiliated group and that affiliate then
leases those units to an unrelated person or uses the units in its own
trade or business, what requirements must the affilate meet in order for
the possessions corporation to be entitled to the benefits of the cost
sharing method with respect to such units?
[[Page 160]]
A. 14: (i) For taxable years of the possessions corporation
beginning on or before June 13, 1986, the affiliate need not meet any
special requirements in order for the possessions corporation to be
entitled to the beneifts of the cost sharing method with respect to such
units. Thus, the affiliate's basis in such units shall be equal to the
transfer price used for computing the possessions corporation's gross
income with respect to such units under section 936(h)(5)(C)(i)(II), and
the income derived by the affiliate from such lease or internal use
shall be reported by the affiliate when and to the extent actually
derived. The affiliate shall not be deemed to have sold such units to an
unrelated party at the time they were first leased or otherwise placed
in service for any purpose other than the computation of possession
sales and total sales. A similar rule applies to other products in the
same product area as the possession product which are sold by any member
in its own trade or business and which the possessions corporation takes
into account in computing total sales under the cost sharing method.
(ii) For taxable years of the possessions corporations beginning
after June 13, 1986, a possessions corporations will not be entitled to
the benefits of the cost sharing method with respect to units of the
possession product which the possessions corporation sells to an
affiliate where the affiliate then leases such units to an unrelated
person or uses them in its own trade or business, unless the affiliate
agrees to be treated for all tax purposes as having sold such units to
an unrelated party at the time they were first leased or otherwise
placed in service by such affiliate. The affiliate must demonstrate such
agreement by reporting its income from such units as if:
(A) It had sold such units to an unrelated person at such time at a
price equal to the price used to compute possessions sales under Sec.
1.936-6(a)(2), question and answer 11;
(B) It had immediately repurchased such units for the same price;
and
(C) Its basis in such units for all subsequent purposes was equal to
its cost basis from such deemed repurchase.
For treatment of other products in the same product area as the
possession product see Sec. 1.936-6(a)(2), question and answer 12.
(iii) The principles contained in questions and answers 11, 12, 13,
and 14 are illustrated by the following example:
Example. Possessions corporation S and its affiliate A are calendar
year taxpayers. In 1985, S manufactures 100 units of possession product
X. S sells 50 units of X to unrelated persons in arm's length
transactions for $10 per unit. In applying the cost sharing method to
determine the portion of its gross income from such sales which
qualifies for the possessions tax credit, S determines that $8 of the
$10 sales price may be taken into account. S sells the remaining 50
units of X to A, and A then leases such units to unrelated persons. In
1985, A also manufacturers 100 units of product Y, the only other
product in the same product area as X manufactured or sold by any member
of the affiliated group. A manufactured the 100 units of Y at a cost of
$15 per unit, sold 50 units of Y to unrelated persons in arm's length
transactions for $20 per unit, and leased the remaining 50 units of Y to
unrelated persons.
S may compute its income under the cost sharing method with respect
to the 50 units of X it sold to A because S can determine an independent
sales price of X from comparable uncontrolled transactions under Sec.
1.482-2(e)(2). For purposes of computing both possessions sales and
total sales, the 50 units of X sold to A will be deemed to have been
sold by A to an unrelated person for $10 per unit. The income of S
qualifying for the possessions tax credit from the sale of those 50
units of X to A, and A's basis in those units, will both be determined
using the $8 transfer price determined under section 936
(h)(5)(C)(i)(II). For purposes of computing total sales in the
denominator of the cost sharing fraction, S may also take into account
the 50 units of Y leased by A to unrelated persons, as if A had sold
those units for $20 per unit. A's basis in those units of Y will
continue to be its actual cost basis of $15 per unit.
If all of the above transactions had occurred in 1987, S would be
entitled to compute its income under the cost sharing method with
respect to the 50 units of X it sold to A only if A agreed to be treated
for all tax purposes as if it had sold such units for $10 per unit,
realized income on such deemed sale of $2 per unit, repurchased such
units immediately for $10 per unit, and then leased such units, which
would then have a $10 per unit basis in A's hands. For purposes of
computing total sales, S would be entitled to take into account the 50
units of X leased by A to unrelated persons as if A had sold such units
for $20 per unit.
[[Page 161]]
(3) Credits against cost sharing payments.
Q. 1: Is the cost of product area research paid or accrued by the
possessions corporation in a taxable year creditable against the cost
sharing payment?
A. 1: Yes, if the cost of the product area research is paid or
accrued solely by the possessions corporation. Thus, payments by the
possessions corporation under cost sharing arrangements with, or
royalties paid to, unrelated persons are so creditable. Amounts (such as
royalties) paid directly or indirectly to, or on behalf of, related
persons and amounts paid under any cost sharing agreements with related
persons are not creditable against the cost sharing payment.
Q. 2: Do royalties or other payments made by an affiliate of the
possessions corporation to another member of the affiliated group reduce
the cost sharing payment if such royalties or other payments are based,
in part, on activity of the possessions corporation?
A. 2: No. Payments made between affiliated corporations do not
reduce the cost sharing payment. Thus, for example, if a possessions
corporation sells a component to a foreign affiliate for incorporation
by the foreign affiliate into an integrated product sold to unrelated
persons, and the foreign affiliate pays a royalty to the U.S. parent of
the possessions corporation based on the total value of the integrated
product, the cost sharing payment of the possessions corporation is not
reduced.
(4) Computation of cost sharing payment.
Q. 1: S is a possessions corporation engaged in the manufacture and
sale of four products (A, B, C, and D) all of which are classified under
the same three-digit SIC code. S sells its production to a U.S.
affiliate, P, which resells it to unrelated parties in the United
States. P's third party sales of each of these products produced in
whole or in part by S (computed as provided under paragraph (a)(2) of
Sec. 1.936-6) are $1 million or a total of $4 million for A, B, C, and
D. P's other sales of products in the same SIC code are $3,000,000; and
the defined worldwide product area research of the affiliated group is
$350,000. How should S compute the cost sharing amount for products A,
B, C, and D?
A. 1: The cost sharing amount is computed separately for each
product on Schedule P of Form 5735. S should use the following formula
for each of the products A, B, C, and D:
[GRAPHIC] [TIFF OMITTED] TC09OC91.006
[GRAPHIC] [TIFF OMITTED] TC09OC91.007
Q. 2: The facts are the same as in question 1 except that S
manufactures product D under a license from an unrelated person. S pays
the unrelated party an annual license fee of $20,000. Thus, the
worldwide product area research expense of the affiliated group is
$370,000. How should the cost sharing payment be adjusted?
A. 2: The cost sharing fee should be reduced by the $20,000 license
fee made as a direct annual payment to a third party on account of
product D. The cost sharing payment with respect to product D in this
example will be adjusted as follows:
[[Page 162]]
[GRAPHIC] [TIFF OMITTED] TC09OC91.008
[GRAPHIC] [TIFF OMITTED] TC09OC91.009
Q. 3: The facts are the same as in question 1 except that S also
manufactures and exports product E to a foreign affiliate, which resells
it to unrelated persons for $1 million. S makes a separate election for
its export sales. How should S compute the cost sharing amount for
product E?
A. 3: The numerator of the cost sharing fraction is the aggregate
sales or other dispositions by members of the affiliated group of the
units of product E produced in whole or in part in the possession to
persons who are not members of the affiliated group. The cost sharing
amount for product E would be computed as follows:
[GRAPHIC] [TIFF OMITTED] TC09OC91.010
or
[GRAPHIC] [TIFF OMITTED] TC09OC91.011
Q. 4: The facts are the same as in question 1, except that S also
receives $10,000 in royalty income from unrelated persons for the
licensing of certain manufacturing intangible property rights. What is
the amount of the product area research that must be allocated in
determining the cost sharing amount?
A. 4: If the affiliated group receives royalty income from unrelated
persons with respect to manufacturing intangibles in the same product
area, then the product area research to be considered shall be first
reduced by such royalty income. In this case, the amount of product area
research to be used in determining S's cost sharing payment should be
reduced by the $10,000 royalty payment received to $340,000.
Q. 5: May a possessions corporation redetermine the amount of its
required cost sharing payment after filing its tax return?
A. 5: If after filing its tax return, a possessions corporation
files an amended return, or if an adjustment is made on audit, either of
which affects the amount of the cost sharing payment required, then a
redetermination of the cost sharing payment must be made. See, however,
section 936(h)(5)(C)(i)(III)(a) with respect to the increase in the cost
sharing payment due to interest imposed under section 6601(a).
(5) Effect of election under the cost sharing method.
Q. 1: What is the effect of the cost sharing method?
[[Page 163]]
A. 1: The cost sharing payment reduces the amount of deductions (and
the amount of reductions in earnings and profits) otherwise allowable to
the U.S. affiliates (other than tax-exempt affiliates) within the
affiliated group as determined under section 936(h)(5)(C)(i)(I)(b) which
have incurred research expenditures (as defined in Sec. 1.936-6(a)(1),
question and answer (3) in the same product area for which the cost
sharing option is elected, during the taxable year in which the cost
sharing payment accrues. If there are no such U.S. affiliates, the
reductions with respect to deductions and earnings and profits, as the
case may be, are made with respect to foreign affiliates within the same
affiliated group which have incurred product area research expenditures
in such product area attributable to a U.S. trade or business. If there
are no affiliates which have incurred research expenditures in such
product area, the reductions are then made with respect to any other
U.S. affiliate and, if there is no such U.S. affiliate, then to any
other foreign affiliate. The allocations of these reductions in each
case shall be made in proportion to the gross income of the affiliates.
In the case of foreign affiliates, the allocation shall be made in
proportion to gross income attributable to the U.S. trade or business or
worldwide gross income, as the case may be. With respect to each group
above, the reduction of deductions shall be applied first to deductions
under section 174, then to deductions under section 162, and finally to
any other deductions on a pro rata basis.
Q. 2: For purposes of estimated tax payments, when is the cost
sharing amount deemed to accrue?
A. 2: The cost sharing amount is deemed to accrue to the appropriate
affiliate on the last day of the taxable year of each such affiliate in
which or with which the taxable year of the possessions corporation
ends.
Q. 3: If the cost sharing method is elected and the year of accrual
of the cost sharing payment to the appropriate affiliate (described in
question and answer 1 of this paragraph (a)(5)) differs from the year of
actual payment by the possessions corporation, in what year are the
deductions of the recipients reduced?
A. 3: In the year the cost sharing payment has accrued.
Q. 4: What is the treatment of income from intangibles under the
cost sharing method?
A. 4: Under the cost sharing method, a possessions corporation is
treated as the owner, for purposes of obtaining a return thereon, of
manufacturing intangibles related to a possession product. The term
``manufacturing intangible'' means any patent, invention, formula,
process, design, pattern, or know-how. The possessions corporation will
not be treated as the owner, for purposes of obtaining a return thereon,
of any manufacturing intangibles related to a component product produced
by an affiliated corporation and transferred to the possessions
corporation for incorporation into the possession product, except in the
case that the possession product is treated as including such component
product for all purposes of section 936(h)(5). Further, the possessions
corporation will not be treated as the owner, for purposes of obtaining
a return thereon, of any marketing intangibles except ``covered
intangibles.'' (See Sec. 1.936-6(c).)
Q. 5: If the cost sharing option is elected, is it necessary for the
possessions corporation to be the legal owner of the manufacturing
intangibles related to the possession product in order for the
possessions corporation to receive a full return with respect to such
intangibles?
A. 5: No. There is no requirement that manufacturing intangibles be
owned by the possessions corporation.
Q. 6: How is income attributable to marketing intangibles treated
under the cost sharing method?
A. 6: Except in the case of ``covered intangibles'' (see Sec.
1.936-6(c)), the possessions corporation is not treated as the owner of
any marketing intangibles, and income attributable to marketing
intangible of the possessions corporation will be allocated to the
possessions corporation's U.S. shareholders with the proration of income
based on shareholdings. If a shareholder of the possessions corporation
is a foreign, person or is otherwise tax exempt, the possessions
corporation is
[[Page 164]]
taxable on that shareholder's pro rata amount of the intangible property
income. If the possessions corporation is a corporation any class of the
stock of which is regularly traded on an established securities market,
then the income attributable to marketing intangibles will be taxable to
the possessions corporation rather than the corporation's U.S.
shareholders.
Q. 7: What is the source of the intangible property income described
in question and answer 6?
A. 7: The intangible property income is U.S. source whether taxed to
the U.S. shareholder or taxed to the possessions corporation and section
863 (b) does not apply for this purpose. However, such intangible
property income, if treated as income of the possessions corporation,
does not enter into the calculation of the 80-percent possession source
test or the 65-percent active trade or business test.
Q.7a: What is the source of the taxpayer's gross income derived from
a sale in the United States of a possession product purchased by the
taxpayer (or an affiliate) from a corporation that has an election in
effect under section 936, if the income from such sale is taken into
account to determine benefits under cost sharing for the section 936
corporation? Is the result different if the taxpayer (or an affiliate)
derives gross income from a sale in the United States of an integrated
product incorporating a possession product purchased by the taxpayer (or
an affiliate) from the section 936 corporation, if the taxpayer (or an
affiliate) processes the possession product or an excluded component in
the United States?
A.7a: Under either scenario, the income is U.S. source, without
regard to whether the possession product is a component, end-product, or
integrated product. Section 863 does not apply in determining the source
of the taxpayer's income. This Q&A 7a is applicable for taxable years
beginning on or after November 13, 1998.
Q. 8: May marketing intangible income, if any, be allocated to the
possessions corporation with respect to custom-made products?
A. 8: No. If the cost sharing option is elected, then income
attributable to marketing intangibles (other than ``covered
intangibles'' described in Sec. 1.936-6(c)) will be taxed as discussed
in questions and answers 6 and 7 of paragraph (a)(5) of this section. It
is immaterial whether the product is custom-made.
Q. 9: In order to sell a pharmaceutical product in the United
States, a New Drug Application (``NDA'') for the product must be
approved by the U.S. Food and Drug Administration. Is an NDA considered
a manufacturing or marketing intangible for purposes of the allocation
of income under the cost sharing method?
A. 9: A manufacturing intangible.
Q. 10: Can a copyright be, in whole or in part, a manufacturing
intangible for purposes of the allocation of income under the cost
sharing method?
A. 10: In general, a copyright is a marketing intangible. See
section 936(h)(3)(B)(ii). However, copyrights may be treated either as
manufacturing intangibles or nonmanufacturing intangibles (or as partly
each) depending upon the function or the use of the copyright. If the
copyright is used in manufacturing, it will be treated as a
manufacturing intangible; but if it is used in marketing, even if it is
also classified as know-how, it will be treated as a marketing
intangible.
Q. 11: If the cost sharing option is elected and a patent is related
to the product produced by the possessions corporation, does the return
to the possessions corporation with respect to the manufacturing
intangible include the make, use, and sell elements of the patent?
A. 11: Yes. A patent confers an exclusive right for 17 years to sell
a product covered by the patent. During this period, the return to the
possessions corporation includes the make, use and sell elements of the
patent.
Q. 12: For purposes of the cost sharing option, may a safe haven
rule be applied to determine the amount of marketing intangible income?
A. 12: No. The amount of marketing intangible income is determined
on the basis of all relevant facts and circumstances. The section 482
regulations will continue to apply except to the extent modified by the
election. Rev. Proc. 63-10 and Rev. Proc. 68-22 do not apply for this
purpose.
[[Page 165]]
Q. 13: If a product covered by the cost sharing election is sold by
a possessions corporation to an affiliated corporation for resale to an
unrelated party, may the resale price method under section 482 be used
to determine the intercompany price of the possessions corporation?
A. 13: In general, the resale price method may be used if (a) no
comparable uncontrolled price for the product exists, and (b) the
affiliated corporation does not add a substantial amount of value to the
product by manufacturing or by the provision of services which are
reflected in the sales price of the product to the customer. The
possessions corporation will not be denied use of the resale price
method for purposes of such inter-company pricing merely because the
reseller adds more than an insubstantial amount to the value of the
product by the use of intangible property.
Q. 14: If a possessions corporation makes the cost sharing election
and uses the cost-plus method under section 482 to determine the arm's-
length price of a possession product, will the cost base include the
cost of materials which are subject to processing or which are
components in the possession product?
A. 14: A taxpayer may include the cost of materials in the cost base
if it is appropriate under the regulations under Sec. 1.482-2(e)(4).
Q. 15: If the possessions corporation computes its income with
respect to a product under the cost sharing method, and the price of the
product is determined under the cost-plus method under section 482, does
the cost base used in computing cost-plus under section 482 include the
amount of the cost sharing payment?
A. 15: The amount of the cost sharing payment is included in the
cost base. However, no profit with respect to the cost sharing payment
will be allowed.
Q. 16: If a member of the affiliated group transfers to a
possessions corporation a component which is incorporated into a
possession product, how will the transfer price for the component be
determined?
A. 16: The transfer price for the component will be determined under
section 482, and as follows. If the possession product is treated as not
including such component for purposes of section 936(h)(5), the transfer
price paid for the component will include a return on all intangibles
related to the component product. If the posssession product is treated
as including such component for purposes of section 936(h)(5), then the
transfer price paid for the component by the possessions corporation
will not include a return on any manufacturing intangible related to the
component product, and the possessions corporation will obtain the
return on the manufacturing intangibles associated with the component.
Q. 17: If the possessions corporation computes its income with
respect to a product under the cost sharing method, with respect to
which units of the product shall the possessions corporation be treated
as owning intangible property as a result of having made the cost
sharing election?
A. 17: The possessions corporation shall not be treated as owning
intangible property, as a result of having made the cost sharing
election, with respect to any units of a possession product which were
not taken into account by the possessions corporation in applying the
significant business presence test for the current taxable year or for
any prior taxable year in which the possessions corporation also had a
significant business presence in the possession with respect to such
product.
(b) Profit split option--(1) Computation of combined taxable income.
Q. 1: In determining combined taxable income from sales of a
possession product, how are the allocations and apportionments of
expenses, losses, and other deductions to be determined?
A. 1: (i) Expenses, losses, and other deductions are to be allocated
and apportioned on a ``fully-loaded'' basis under Sec. 1.861-8 to the
combined gross income of the possessions corporation and other members
of the affiliated group (other than foreign affiliates). For purposes of
the profit split option, the term ``affiliated group'' is defined the
same as under Sec. 1.936-6 (a)(1) question and answer 2. The amount of
research, development, and experimental expenses allocated and
apportioned to
[[Page 166]]
combined gross income is to be determined under Sec. 1.861-8(e)(3). The
amount of research, development and experimental expenses and related
deductions (such as royalties paid or accrued with respect to
manufacturing intangibles by the possessions corporation or other
domestic members of the affiliated group to unrelated persons or to
foreign affiliates) allocated and apportioned to combined gross income
shall in no event be less than the amount of the cost sharing payment
that would have been required under the rules set forth in section
936(h)(5)(C)(i)(II) and paragraph (a) of this section if the cost
sharing option had been elected. Other expenses which are subject to
Sec. 1.861-8(e) are to be allocated and apportioned in accordance with
that section. For example, interest expense (including payments made
with respect to bonds issued by the Puerto Rican Industrial, Medical and
Environmental Control Facilities Authority (AFICA)) is to be allocated
and apportioned under Sec. 1.861-8(e)(2). With the exception of
marketing and distribution expenses discussed below, the other remaining
expenses which are definitely related to a class of gross income shall
be allocated to that class of gross income and shall be apportioned on
the basis of any reasonable method, as described in Sec. 1.861-8 (b)(3)
and (c)(1). Examples of such methods may include, but are not limited
to, those specified in Sec. 1.861-8(c)(1)(i) through (vi).
(ii) The class of gross income to which marketing and distribution
expenses relate and shall be allocated is generally to be defined by the
same ``product area'' as is determined for the relevant research,
development, and experimental expenses (i.e., the appropriate 3-digit
SIC code), but shall include only gross income generated or reasonably
expected to be generated from the geographic area or areas to which the
expenses relate. It shall be presumed that marketing and distribution
expenses relate to all product sales within the same product area. If,
however, it can be established that any of these expenses are separately
identifiable expenses, such as advertising, and relate, directly or
indirectly, solely to a specific product or a specific group of
products, such expenses shall be allocated to the class of gross income
defined by the specific product or group of products. Thus, advertising
and other separately identifiable marketing expenses which relate
specifically and exclusively to a particular product must be allocated
entirely to the gross income from that product, even though the taxpayer
or other members of an affiliated group which includes the taxpayer
produce and market other products in the same 3-digit SIC code
classification. The mere display of a company logo or mention of a
company name solely in the context of identifying the manufacturer shall
not prevent an advertisement from relating specifically and exclusively
to a particular product or group of products.
(iii) If marketing and distribution expenses are allocated to a
class of gross income which consists both of income from sales of
possession products (the statutory grouping) and other income such as
from sale by U.S. affiliates of products not produced in the possession
(the residual grouping), then these marketing and distribution expenses
shall be apportioned on a ``fully loaded'' basis which reflects, to a
reasonably close extent, the factual relationship between these
deductions and the statutory and residual groupings of gross income.
Apportionment methods based upon comparisons of amounts incurred before
ultimate sale of a product (including apportionment on a comparison of
costs of goods sold, other expenses incurred, or other comparisons set
forth in Sec. 1.861-8 (c)(1)(v), such as time spent) are not on a
``fully-loaded'' basis and do not reflect this required factual
relationship. These deductions shall be apportioned on a basis of
comparison of the amount of gross sales or receipts or another method if
it is established that such method similarly reflects the required
factual relationship. Thus, for example, a comparison of units sold may
be used only where the units are of the same or similar value and are,
thus, in fact comparable.
(iv) The rules for allocation and apportionment of marketing and
distribution expenses may be illustrated by the following examples:
[[Page 167]]
Example 1. Assume that possessions corporation A manufacturers
prescription pharmaceutical product 1 for resale by P, its U.S.
parent corporation, in the United States. Additionally, assume that P
manufactures prescription pharmaceutical products 2 and
3 in the United States for sale there. Further, assume that all
three products are within the same product area, and that marketing and
distribution expenses are internally divided by P among the three
products on the basis of time spent by sales persons of P on marketing
of the three products, as follows:
Product 1............................................. 50X
Product 2............................................. 80X
Product 3............................................. 110X
--------
Total...................................................... 240X
These expenses of 240X are allocated to gross income generated by all
three products and shall be apportioned on the basis of gross sales or
receipts of product 1 as compared to products 2 and
3 or another method which similarly reflects the factual
relationship between these expenses and gross income derived from
product 1 and products 2 and 3. Thus, if a
sales method were used and sales of product 1 accounted for
one-third of sales receipts from the three products, 80X (240 / 3) of
marketing and distribution expenses would be apportioned to the combined
gross income from product 1.
Example 2. Corporation B produces and sells Brand W whiskey, in the
United States. B's subsidiary, S, which is a possessions corporation,
produces soft drink extract in Puerto Rico which it sells to independent
bottlers to produce Brand S soft drinks for sale in the United States.
Corporation B's advertisements and other promotional materials for Brand
W whiskey make no reference to Brand S soft drinks (or any other
Corporation B products), and Brand S soft drink advertisements and other
promotional materials make no reference to Brand W whiskey (or any other
corporation B products). For purposes of section 936(h), the advertising
and other promotional expenses for Brand W whiskey must be allocated
entirely to the gross income from sales of Brand W whiskey and the
advertising and other promotional expenses for Brand S soft drink must
be allocated entirely to the gross income from the sales of soft drink
extract, notwithstanding the fact that whiskey and soft drink extract
are both included in SIC code 208. A similar result would apply, for
example, to separately identifiable advertising and other marketing
expenses which relate specifically and exclusively to one or the other
of the following pairs of products: chewing gum and granulated sugar
(SIC code 206); canned tuna fish and freeze-dried coffee (SIC code 209);
children's underwear and ladies' brassieres (SIC code 234); aspirin
tablets and prescription antibiotic tablets (SIC code 283); floor wax
and perfume (SIC code 284); adhesives and inks (SIC code 289); semi-
conductors and cathode-ray tubes (SIC code 367); batteries and extension
cords (SIC code 369); bandages and dental supplies (SIC code 384);
stainless steel flatware and jewelry parts (SIC code 391); children's
toys and sporting goods (SIC code 394); hair curlers and zippers (SIC
code 396); and paint brushes and linoleum tiles (SIC code 399).
Example 3. Assume the same facts as in Example 1 and that
possessions corporation A also manufactures aspirin, a non-prescription
product, for resale by its U.S. parent corporation, P. Further, assume
that the advertising and separately identifiable marketing expenses
which relate specifically and exclusively to aspirin sales total $100
and that these expenses are allocable solely to gross income derived
from aspirin sales. The sales method continues to be used to apportion
the marketing and distribution expenses related, directly or indirectly,
to products 1, 2, and 3, and the
apportionment of such expenses to product 1 for purposes of
determining combined taxable income from product 1 will remain
as stated in Example 1. None of the advertising and other separately
identifiable marketing expenses which relate specifically and
exclusively to aspirin will be taken into account in allocating and
apportioning the marketing and distribution expenses relating to the
gross income attributable to products 1, 2, and
3. Gross income attributable to aspirin will be considered as a
separate class of gross income, and all the advertising and separately
identifiable marketing expenses which relate specifically and
exclusively to aspirin sales of $100 will be allocated to the class of
gross income derived from aspirin sales. Similarly, none of the
marketing and distribution expenses, directly or indirectly, related
solely to the group of products 1, 2, and 3
will be taken into account in determining the combined taxable income
from aspirin sales. the remaining marketing and distribution expenses
which do not, directly or indirectly, relate solely to any specific
product or group of products (e.g., the salaries of a Vice-President of
Marketing who has responsibility for marketing all products and his
staff) shall be allocated and apportioned on the basis of the gross
receipts from the sales of all of the products (or a similar method) in
determining combined taxable income of any product.
Q. 2: How may the allocation and apportionment of expenses to
combined gross income be verified?
A. 2: Substantiation of the allocation and apportionment of expenses
will be required upon audit of the possessions corporation and
affiliates. Detailed
[[Page 168]]
substantiation may be necessary, particularly where the entities are
engaged in multiple lines of business involving distinct product areas.
Sources of substantiation may include certified financial reports. Form
10-K's, annual reports, internal production reports, product line
assembly work papers, and other relevant materials. In this regard, see
Sec. 1.861-8(f)(5).
Q. 3: Does section 936(h) override the moratorium provided by
section 223 of the Economic Recovery Tax Act of 1981 and any subsequent
similar moratorium?
A. 3: Yes. Thus, the allocation and apportionment of product area
research described in question and answer 1 must be made without regard
to the moratorium.
Q. 4: Is the cost of samples treated as a marketing expense?
A. 4: Yes. The cost of producing samples will be treated as a
marketing expense and not as inventoriable costs for purposes of
determining combined taxable income (and compliance with the significant
business presence test). However, for taxable years beginning prior to
January 1, 1986, the cost of producing samples may be treated as either
a marketing expense or as inventoriable costs.
Q. 5: If a possessions corporation uses the profit split method to
determine its taxable income from sales of a product, how does it
determine its gross income for purposes of the 80-percent possession
source test and the 65-percent active trade or business test of section
936(a)(2)?
A. 5: One-half of the deductions of the affiliated group (other than
foreign affiliates) which are used in determining the combined taxable
income from sales of the product are added to the portion of the
combined taxable income allocated to the possessions corporation in
order to determine the possessions corporation's gross income from sales
of such product.
Q. 6: How will income from intangibles related to a possession
product be treated under the profit split method?
A. 6: Combined taxable income of the possessions corporation and
affiliates from the sale of the possession product will include income
attributable to all intangibles, including both manufacturing and
marketing intangibles, associated with the product.
Q. 7: Can a possessions corporation apply the profit split option to
a possession product if no U.S. affiliates derive income from the sale
of the possession product?
A. 7: Yes.
Q. 8: With respect to the factual situation discussed in question
and answer 7 how is combined taxable income computed?
A. 8: The profit split option is applied to the taxable income of
the possessions corporation from sales of the possession product to
foreign affiliates and unrelated persons. Fifty percent of that income
is allocated to the possessions corporation, and the remainder is
allocated to the appropriate affiliates as described in question and
answer 13 of this paragraph (b)(1).
Q. 9: May a possessions corporation compute its income under the
profit split method with respect to units of a possession product which
it sells to a U.S. affiliate if the U.S. affiliate leases such units to
unrelated persons or to foreign affiliates or uses such units in its own
trade or business?
A. 9: Yes, provided that an independent sales price for the
possession product from comparable uncontrolled transactions can be
determined in accordance with Sec. 1.482-2 (e)(2). If, however, there
is a comparable uncontrolled price for an integrated product and the
possession product is a component product or end-product form thereof,
the possessions corporation may compute its income under the profit
split method with respect to such units. In either case, the possessions
corporation shall compute combined taxable income with respect to such
units under the following question and answer.
Q. 10: If the possessions corporation is entitled to use the profit
split method in the situation described in Q. 9 (leasing units of the
possession product or use of such units in the taxpayer's own trade or
business), how should it compute combined taxable income with respect to
such units?
A. 10: (i) Combined taxable income shall be computed as if the U.S.
affiliate had sold the units to an unrelated person (or to a foreign
affiliate) at the
[[Page 169]]
time the units were first leased or otherwise placed in service by the
U.S. affiliate. The sales price on such deemed sale shall be equal to
the independent sales price from comparable uncontrolled transactions
determined in accordance with Sec. 1.482-2(e)(2), if any.
(ii) If the possession product is a component product or an end-
product form, the combined taxable income with respect to the possession
product shall be determined under Q&A. 12 of this paragraph (b)(1).
(iii) For purposes of determining the basis of a component product
or an end-product form, the deemed sales price of such product must be
determined. The deemed sales price of the component product shall be
determined by multiplying the deemed sales price of the integrated
product that includes the component product by a ratio, the numerator of
which is the production costs of the component product and the
denominator of which is the production costs of the integrated product
that includes the component product. The deemed sales price of an end-
product form shall be determined by multiplying the deemed sales price
of the integrated product that includes the end-product form by a ratio,
the numerator of which is the production costs of the end-product form
and the denominator of which is the production costs of the integrated
product that includes the end-product form. For the definition of
production costs, see Q&A. 12 of this paragraph (b)(1).
(iv)(A) If combined taxable income is determined under paragraph (v)
of A. 12 of this paragraph (b)(1), in the case of a component product,
the deemed sales price shall be determined by using the actual sales
price of that product when sold as an integrated product (as adjusted
under the rules of the fourth sentence of Sec. 1.482-3(b)(2)(ii)(A)).
(B) If combined taxable income is determined under paragraph (v) of
A. 12 of this paragraph (b)(1), in the case of an end-product form, the
deemed sales price shall be determined by subtracting from the deemed
sales price of the integrated product that includes the end-product form
(e.g., the leased property) the actual sales price of the excluded
component when sold as an integrated product to an unrelated person (as
adjusted under the rules of the fourth sentence of Sec. 1.482-
3(b)(2)(ii)(A)).
(v) The full amount of income received under the lease shall be
treated as income of (and be taxed to) the U.S. affiliate and not the
possessions corporation.
Q. 11: In the situation described in question 9, how does the U.S.
affiliate determine its basis in such units for purposes of computing
depreciation and similar items?
A. 11: The U.S. affiliate shall be treated, for purposes of
computing its basis in such units, as if it had repurchased such units
immediately following the deemed sale and at the deemed sales price as
provided in Q&A. 10 of this paragraph (b)(1).
The principles of questions and answers 10 and 11 are illustrated by the
following example:
Example: Possessions corporation S manufactures 100 units of
possession product X. S sells 50 units of X to an unrelated person in an
arm's length transaction for $10 per unit. S sells the remaining 50
units to its U.S. affiliate, A, which leases such units to unrelated
persons. The combined taxable income for the 100 units of X is computed
below on the basis of the given production, sales, and cost data:
Sales:
1. Total sales by S to unrelated persons (50 x $10).......... $500
2. Total deemed sales by A to unrelated persons (50 x $10)... 500
3. Total gross receipts (line 1 plus line 2)................. 1,000
Total costs:
4. Material costs............................................ 200
5. Production costs.......................................... 300
6. Research expenses......................................... 0
7. Other expenses............................................ 100
8. Total (add lines 4 through 7)............................. 600
Combined taxable income attributable to the 100 units of X:
9. Combined taxable income (line 3 minus line 8)............. 400
10. Share of combined taxable income apportioned to S (50% of 200
line 9).....................................................
11. Share of combined taxable income apportioned to A (line 9 200
minus line 10)..............................................
A's basis in 50 units of X leased by it to unrelated persons:
12. 50 units times $10 deemed repurchase price............... 500
Subsequent leasing income is entirely taxed to A.
[[Page 170]]
Q. 12: If the possession product is a component product or an end-
product form, how is the combined taxable income for such product to be
determined?
A. 12: (i) Except as provided in paragraph (v) of this A. 12,
combined taxable income for a component product or an end-product form
is computed under the production cost ratio (PCR) method.
(ii) Under the PCR method, the combined taxable income for a
component product will be the same proportion of the combined taxable
income for the integrated product that includes the component product
that the production costs attributable to the component product bear to
the total production costs (including costs incurred by the U.S.
affiliates) for the integrated product that includes the component
product. Production costs will be the sum of the direct and indirect
production costs as defined under Sec. 1.936-5(b)(4) except that the
costs will not include any costs of materials. If the possession product
is a component product that is transformed into an integrated product in
whole or in part by a contract manufacturer outside of the possession,
within the meaning of Sec. 1.936-5(c), the denominator of the PCR shall
be computed by including the same amount paid to the contract
manufacturer, less the costs of materials of the contract manufacturer,
as is taken into account for purposes of the significant business
presence test under Sec. 1.936-5(c) Q&A. 5.
(iii) Under the PCR method the combined taxable income for an end-
product form will be the same proportion of the combined taxable income
for the integrated product that includes the end-product form that the
production costs attributable to the end-product form bear to the total
production costs (including costs incurred by the U.S. affiliates) for
the integrated product that includes the end-product form. Production
costs will be the sum of the direct and indirect production costs as
defined under Sec. 1.936-5(b)(4) except that the costs will not include
any costs of materials. If the possession product is an end-product form
and an excluded component is contract manufactured outside of the
possession, within the meaning of Sec. 1.936-5(c), the denominator
shall be computed by including the same amount paid to the contract
manufacturer, less cost of materials of the contract manufacturer, as is
also taken into account for purposes of the significant business
presence test under Sec. 1.936-5(c) Q&A. 5.
(iv) This paragraph (iv) of A. 12 illustrates the computation of
combined taxable income for a component product or end-product form
under the PCR method. S, a possessions corporation, is engaged in the
manufacture of microprocessors. S obtains a component from a U.S.
affiliate, O. S sells its production to another U.S. affiliate, P, which
incorporates the microprocessors into central processing units (CPUs). P
transfers the CPUs to a U.S. affiliate, Q, which incorporates the CPUs
into computers for sale to unrelated persons. S chooses to define the
possession product as the CPUs. The combined taxable income for the sale
of the possession product on the basis of the given production, sales,
and cost data is computed as follows:
Production costs (excluding costs of materials):
1. O's costs for the component......................... 100
2. S's costs for the microprocessors................... 500
3. P's costs for the CPUs (the possession product)..... 200
4. Q's costs for the computers......................... 400
5. Total production costs for the computer (Add lines 1 1,200
through 4)............................................
6. Combined production costs for the CPU (the 800
possession product) (Add lines 1 through 3)...........
7. Ratio of production costs for the CPUs (the 0.667
possession product) to the production costs for the
computer..............................................
Determination of combined taxable income for computers:
Sales:
8. Total possession sales of computers to unrelated 7,500
customers and foreign affiliates......................
Total costs of O, S, P, and Q incurred in production of a
computer:
9. Production costs (enter from line 5)................ 1,200
10. Material costs..................................... 100
[[Page 171]]
11. Total costs (line 9 plus line 10).................. 1,300
12. Combined gross income from sale of computers (line 6,200
8 minus line 11)......................................
Expenses of the affiliated group (other than foreign
affiliates) allocable and apportionable to the computers
or any component thereof under the rules of Sec. Sec.
1.861-8 through 1.861-14T and 1.936-6 (b)(1), Q&A. 1:
13. Expenses (other than research expenses)............ 980
Research expenses of the affiliated group allocable and
apportionable to the computers:
14. Total sales in the 3-digit SIC Code................ 12,500
15. Possession sales of the computers (enter from line 7,500
8)....................................................
16. Cost sharing fraction (divide line 15 by line 14).. 0.6
17. Research expenses incurred by the affiliated group 700
in 3-digit SIC Code multiplied by 120 percent.........
18. Cost sharing amount (multiply line 16 by line 17).. 420
19. Research of the affiliated group (other than 300
foreign affiliates) allocable and apportionable under
Sec. Sec. 1.861-17 and 1.861-14T(e)(2) to the
computers.............................................
20. Enter the greater of line 18 or line 19............ 420
Computation of combined taxable income of the computer and
the CPU:
21. Combined taxable income attributable to the 4,800
computer (line 12 minus line 13 and line 20)..........
22. Combined taxable income attributable to CPUs 3,200
(multiply line 21 by line 7) (production cost ratio)..
23. Share of combined taxable income apportioned to S 1,600
(50 percent of line 22)...............................
Share of combined taxable income apportioned to U.S.
affiliate(s) of S:
24. Adjustments for research expenses (line 18 minus 80
line 19 multiplied by line 7).........................
25. Adjusted combined taxable income (line 22 plus line 3,280
24)...................................................
26. Share of combined taxable income apportioned to 1,680
affiliates of S (line 25 minus line 23)...............
(v)(A) If a possession product is sold by a taxpayer or its
affiliate to unrelated persons in covered sales both as an integrated
product and as a component product and the conditions of paragraph
(v)(C) of this A. 12 are satisfied, the taxpayer may elect to determine
the combined taxable income derived from covered sales of the component
product under this paragraph (v). In that case, the combined taxable
income derived from covered sales of the component product shall be
determined by using the same per unit combined taxable income as is
derived from covered sales of the product as an integrated product, but
subject to the limitation of paragraph (v)(D) of this A. 12.
(B) In the case of a possession product that is an end-product form,
if all of the excluded components are also separately sold by the
taxpayer or its affiliate to unrelated persons in uncontrolled
transactions and the conditions of paragraph (v)(C) of this A. 12 are
satisfied, the taxpayer may elect to determine the combined taxable
income of such end-product form under this paragraph (v). In that case,
the combined taxable income derived from covered sales of the end-
product form shall be determined by reducing the per unit combined
taxable income from the integrated product that includes the end-product
form by the per unit combined taxable income for excluded components
determined under the rules of this paragraph (v), but subject to the
limitation of paragraph (v)(D) of this A. 12. For this purpose, combined
taxable income of the excluded components must be determined under
section 936 as if the excluded components were possession products.
(C) In the case of component products, this paragraph (v) applies
only if the sales price of the possession product sold in covered sales
as an integrated product (i.e., in uncontrolled transactions) would be
the most direct and reliable measure of an arm's length price within the
meaning of the fourth sentence of Sec. 1.482-3(b)(2)(ii)(A) for the
component product. For purposes of applying the fourth sentence of Sec.
1.482-3(b)(2)(ii)(A), the sale of the integrated product that includes
the component product is treated as being immediately preceded by a sale
of the component (i.e. without further processing) in a controlled
transaction. In the case of end-product forms, this paragraph
[[Page 172]]
(v) applies only if the sales price of excluded components separately
sold in uncontrolled transactions would be the most direct and reliable
measure of an arm's length price within the meaning of the fourth
sentence of Sec. 1.482-3(b)(2)(ii)(A) for all excluded components of an
integrated product that includes an end-product form. For purposes of
applying the fourth sentence of Sec. 1.482-3(b)(2)(ii)(A), the sale of
the integrated product that includes excluded components is treated as
being immediately preceded by a sale of the excluded components (i.e.
without further processing) in a controlled transaction. Under the
fourth sentence of Sec. 1.482-3(b)(2)(ii)(A), the uncontrolled
transactions referred to in this paragraph (v)(C) must have no
differences with the controlled transactions that would affect price, or
have only minor differences that have a definite and reasonably
ascertainable effect on price and for which appropriate adjustments are
made (resulting in appropriate adjustments to the computation of
combined taxable income). If such adjustments cannot be made, or if
there are more than minor differences between the controlled and
uncontrolled transactions, the method provided by this paragraph (v)(C)
cannot be used. Thus, for example, these uncontrolled transactions must
involve substantially identical property in the same or a substantially
identical geographic market, and must be substantially identical to the
controlled transaction in terms of their volumes, contractual terms, and
market level. See Sec. 1.482-3(b)(2)(ii)(B).
(D) In no case can the per unit combined taxable income as
determined under paragraph (v)(A) or (B) of this A. 12 be greater than
the per unit combined taxable income of the integrated product that
includes the component product or end-product form.
(E) The provisions of this paragraph (v) are illustrated by the
following example. Taxpayer manufactures product A in a U.S. possession.
Some portion of product A is sold to unrelated persons as an integrated
product and the remainder is sold to related persons for transformation
into product AB. The combined taxable income of integrated product A is
$400 per unit and the combined taxable income of product AB is $300 per
unit. The production cost ratio with respect to product A when sold as a
component of product AB, is 2/3. Unless the taxpayer elects and
satisfies the conditions of this paragraph (v), the combined taxable
income with respect to A will be $200 per unit (combined taxable income
for AB of $300 x the production cost ratio of 2/3). If, however, the
comparability standards of paragraph (v)(C) of this A. 12 are met, the
taxpayer may elect to determine combined taxable income of product A
when sold as a component of product AB using the same per unit combined
taxable income as product A when sold as an integrated product. However,
the per unit combined taxable income from sales of product A as a
component product may not exceed the per unit combined taxable income on
the sale of product AB. Therefore, the combined taxable income of
component product A may not exceed $300 per unit.
(vi) Taxpayers that have not elected the percentage limitation under
section 936(a)(1) for the first taxable year beginning after December
31, 1993, may do so if the taxpayer has elected the profit split method
and computation of combined taxable income is affected by Q&A.12 of this
paragraph (b)(1).
(vii) The rules of Q&A. 12 of this paragraph (b)(1) apply for
taxable years ending after June 9, 1996. If, however, the election under
paragraph (v) of A. 12 of Sec. 1.936-6(b)(1) is made, this election
must be made for the taxpayer's first taxable year beginning after
December 31, 1993, and if not made effective for that year, the election
cannot be made for any later taxable year. A successor corporation that
makes the same or substantially similar products as its predecessor
corporation cannot make an election under paragraph (v) of A.12 of Sec.
1.936-6(b)(1) unless the election was made by its predecessor
corporation for its first taxable year beginning after December 31,
1993.
Q. 13: If the profit split option is elected, how is the portion of
combined taxable income not allocated to the possessions corporation to
be treated?
A. 13: (i) The income shall be allocated to affiliates in the
following order, but no allocations will be made
[[Page 173]]
to affiliates described in a later category if there are any affiliates
in a prior category--
(A) First, to U.S. affiliates (other than tax exempt affiliates)
within the group (as determined under section 482) that derive income
with respect to the product produced in whole or in part in the
possession;
(B) Second, to U.S. affiliates (other than tax exempt affiliates)
that derive income from the active conduct of a trade or business in the
same product area as the possession product;
(C) Third, to other U.S. affiliates (other than tax-exempt
affiliates);
(D) Fourth, to foreign affiliates that derive income from the active
conduct of a U.S. trade or business in the same product area as the
possession product (or, if the foreign members are resident in a country
with which the U.S. has an income tax convention, then to those foreign
members that have a permanent establishment in the United States that
derives income in the same product area as the possession product); and
(E) Fifth, to all other affiliates.
(ii) The allocations made under paragraph (i)(A) of this A. 13 shall
be made on the basis of the relative gross income derived by each such
affiliate with respect to the product produced in whole or in part in
the possession. For this purpose, gross income must be determined
consistently for each affiliate and consistently from year to year.
(iii) The allocations made under paragraphs (i)(B) and (i)(D) of
this A. 13 shall be made on the basis of the relative gross income
derived by each such affiliate from the active conduct of the trade or
business in the same product area.
(iv) The allocations made under paragraphs (i)(C) and (i)(E) of this
A. 13 shall be made on the basis of the relative total gross income of
each such affiliate before allocating income under this section.
(v) Income allocated to affiliates shall be treated as U.S. source
and section 863(b) does not apply for this purpose.
(vi) For purposes of determining an affiliate's estimated tax
liability for income thus allocated for taxable years beginning prior to
January 1, 1995, the income shall be deemed to be received on the last
day of the taxable year of each such affiliate in which or with which
the taxable year of the possessions corporation ends. For taxable years
beginning after December 31, 1994, quarterly estimated tax payments will
be required as provided under section 711 of the Uruguay Round
Agreements, Public Law 103-465 (1994), page 230, and any administrative
guidance issued by the Internal Revenue Service thereunder.
Q. 14: What is the source of the portion of combined taxable income
allocated to the possessions corporation?
A. 14: Income allocated to the possessions corporation shall be
treated as possession source income and as derived from the active
conduct of a trade or business within the possession.
Q. 15: How is the profit split option to be applied to properly
account for costs incurred in a year with respect to products which are
sold by the possessions corporation to a U.S. affiliate during such
year, but are not resold by the U.S. affiliate to persons who are not
members of the affiliated group or to foreign affiliates until a later
year?
A. 15: The rules under Sec. 1.994-1(c)(5) are to be applied.
Incomplete transactions will not be taken into consideration in
computing combined taxable income. Thus, for example, if in 1983, A, a
possessions corporation, sells units of a product with a cost to A of
$5000 to B corporation, its U.S. affiliate, which use the dollar-value
LIFO method of costing inventory, and B sells units with a cost of $4000
(representing A's cost) to C corporation, a foreign affiliate, only
$4000 of such costs shall be taken into consideration in computing the
combined taxable income of the possessions corporation and U.S.
affiliates for 1983. If a specific goods LIFO inventory method is used
by B, the determination of whether A's goods remain in B's inventory
shall be based on whether B's specific goods LIFO grouping has
experienced an increment or decrement for the year on the specific LIFO
cost of such units, rather than on an average unit cost of such units.
If the FIFO method of costing inventory is used by B, transfers may be
based on
[[Page 174]]
the cost of the specific units transferred or on the average unit
production cost of the units transferred, but in each case a FIFO flow
assumption shall be used to identify the units transferred. For a
determination of which goods are sold by taxpayers using the LIFO
method, see question and answer 19.
Q. 16: If a possessions corporation purchases materials from an
affiliate and computes combined taxable income for a possession product
which includes such materials, how are those materials to be treated in
the possessions corporation's inventory?
A. 16: The cost of those materials is considered to be equal to the
affiliate's cost using the affiliate's method of costing inventory.
Q. 17: If the possessions corporation uses the FIFO method of
costing inventory and the U.S. affiliate uses the LIFO method of costing
inventory, or vice versa, what method of costing inventory should be
used in computing combined taxable income?
A. 17: The transferor corporation's method of costing inventory
determines the cost of inventory for purposes of combined taxable income
while the transferee corporation's method of costing inventory
determines the flow. Assume, for example, that X corporation, a
possessions corporation, using the FIFO method of costing inventory
purchases materials from Y corporation, U.S. affiliate, also using the
FIFO method. X corporation produces a product which it transfers to Z
corporation, another U.S. affiliate using the LIFO method. Assume also
that the final product satisfies the significant business presence test.
Under the facts, the cost of the materials purchased by X from Y is Y's
FIFO cost. The costs of the inventory transferred by X to Z are
determined under X's FIFO method of accounting as is the flow of the
inventory from X to Z. The costs added by Z are determined under Z's
LIFO method of inventory, as is the flow of the inventory from Z to
unrelated persons or foreign affiliates.
Q. 18: How are the costs of a possession product and the revenues
derived from the sale of a possession product determined if the U.S.
affiliate includes purchases of the possessions product in a dollar-
value LIFO inventory pool (as provided under Sec. 1.472-8)?
A. 18: The following method will be accepted in determining the
revenues derived from the sale of a possession product and the costs of
a possession product if the U.S. affiliate includes purchases of the
possession product in a dollar-value LIFO inventory pool. The rules
apply solely for the cost sharing and profit split options under section
936(h).
(i) Revenue identification. The identification of revenues derived
from sales of a possession product must generally be made on a specific
identification basis. The particular method employed by a taxpayer for
valuing its inventory will have no impact on the determination of what
units are sold or how much revenue is derived from such sales. Thus, if
a U.S. affiliate sells both item A (a possession product) and item B (a
non-possession product), the actual sales revenues received by the U.S.
affiliate from item A sales would constitute possession product revenue
for purposes of the profit split option and possession sales for
purposes of the cost sharing option regardless of whether the U.S.
affiliate values its inventories on the FIFO or the LIFO method. In
instances where sales of item A (i.e., the possession product) cannot be
determined by use of specific identification (for example, in cases
where items A and B are identical except that one is produced in the
possession (item A) and the other (item B) is produced outside of the
possession and it is not possible to segregate these items in the hands
of the U.S. affiliate), it will be necessary to identify the portion of
the combined sales of items A and B (which together can be identified on
a specific identification basis) which is attributed to item A sales and
the portion which is attributed to item B sales. The determination of
the portion of aggregated sales attributable to item A and item B is
independent of the LIFO method used to determine the cost of such sales
and may be made under the following approach. A taxpayer may, for
purposes of this section of the regulations, use the relative purchases
(in units) of
[[Page 175]]
items A and B by the U.S. affiliate during the taxable year (or other
appropriate measuring period such as the period during the taxable year
used to determine current-year costs, i.e., earliest acquisitions
period, latest acquisitions period, etc.) in determining the ratio to
apply against the combined items A and B sales revenue. If the sales
exceed current purchases, the taxpayer can use a FIFO unit approach
which identifies actual unit sales on a first-in, first-out basis.
Revenue determination where specific identification is not possible is
illustrated by the following example:
Example. At the end of year 1, there are 600 units of combined items
A and B which are to be allocated between A and B on the basis of annual
purchases of A and B units during year 1. During year 1, 1,000 units of
item A, a possession product, and 2,000 units of item B, a non-
possession product, were purchased. Thus, the 600 units in year 1 ending
inventory are allocated 200 (i.e. \1/3\) to item A units and 400 (i.e.
\2/3\) to item B units based on the relative purchases of A (1,000) and
B (2,000) in year 1. These units appear as beginning inventory in year
2.
In year 2, 1,500 units of item A are purchased and 1,500 units of
item B are purchased. However, 3,300 units of items A and B in the
aggregate are sold for $600,000. The relative proportion of the $600,000
attributable to item A and to item B sales would be determined as
follows:
------------------------------------------------------------------------
Year 2 sales Item A Item B
------------------------------------------------------------------------
Unit sales from opening inventory....................... 200 400
Unit sale from current-year purchases................... 1,350 1,350
---------------
Total unit sales (3,300)............................ 1,550 1,750
Percentage.......................................... 47 53
------------------------------------------------------------------------
[GRAPHIC] [TIFF OMITTED] TC14NO91.144
------------------------------------------------------------------------
Year 2 Closing Inventory Units
------------------------------------------------------------------------
Item A.......................................................... 150
Item B.......................................................... 150
------------------------------------------------------------------------
Thus, revenues from Item A sales for purposes of computing possession
sales for the cost sharing option and revenues for the profit split
option are $281,818.
(ii) Cost identification. The determination of the cost of
possession product sales by the U.S. affiliate must be based on the LIFO
inventory method of the U.S. affiliate. The LIFO cost of possession
product sales will, for purposes of this section of the regulations, be
determined by maintaining a separate LIFO cost for possession products
in a taxpayer's opening and closing LIFO inventory and using this cost
to calculate an independent cost of possession product sales. This
separate LIFO cost for possession products in the LIFO pool of a
taxpayer is to be determined as follows:
(A) Determine the base-year cost of possession products in ending
inventory in a LIFO pool.
(B) Determine the percentage of the base-year cost of possession
products in the pool as compared to the total base-year cost of all
items in the pool.
(C) Multiply the percentage determined in step (B) of this
subdivision (ii) by the ending LIFO inventory value of the pool to
determine the deemed LIFO cost attributable to possession products in
the pool.
(D) Subtract the LIFO cost of possession products in ending
inventory in the pool (as calculated in step (C) of this subdivision
(ii)) from the sum of:
(1) Possession product purchases for the year, plus
(2) The portion of the opening LIFO inventory value of the pool
attributed to possession products (i.e., the result obtained in step (C)
of this subdivision (ii) for the prior year).
The number determined by this calculation is the LIFO cost of possession
[[Page 176]]
product sales from the taxpayer's LIFO pool.
Example: Assume that item A is a possession product and item B is a
non-possession product and also assume the inventory and purchases with
respect to the LIFO pool as provided below:
Year 1--Ending Inventory
------------------------------------------------------------------------
No. of Base-year Base-year
units cost/unit cost Percent
------------------------------------------------------------------------
Item A...................... 100 $2.00 $200 20
Item B...................... 200 4.00 800 80
------------------------------------------------------------------------
Year 1--LIFO Value
------------------------------------------------------------------------
Base-year
cost Index LIFO cost
------------------------------------------------------------------------
Increment layer 2...................... $300 3.0 $900
Increment layer 1...................... 400 2.0 800
Base layer............................. 300 1.0 300
----------- ----------
Pool total....................... $1,000 ......... $2,000
------------------------------------------------------------------------
Year 1--LIFO Value Per Item
------------------------------------------------------------------------
Base-year LIFO
cost value
------------------------------------------------------------------------
Total pool.................................. $1,000 $2,000
------------
Item A............................................ 200 400
Item B............................................ 800 1,600
------------------------------------------------------------------------
Year 2--Purchases
------------------------------------------------------------------------
Total
purchases
------------------------------------------------------------------------
Item A....................................................... $6,000
Item B....................................................... 4,000
------------------------------------------------------------------------
Year 2--Ending Inventory
------------------------------------------------------------------------
No. of Base-year Base-year
units cost/unit cost Percent
------------------------------------------------------------------------
Item A...................... 200 $2.00 $400 50
Item B...................... 100 4.00 400 50
------------------------------------------------------------------------
Year 2--LIFO Value
------------------------------------------------------------------------
Base-year
cost Index LIFO cost
------------------------------------------------------------------------
Increment layer 2...................... $100 3.0 $300
Increment layer 1...................... 400 2.0 800
Base layer............................. $300 1.0 300
----------- ----------
Pool total............................. 800 ......... 1,400
------------------------------------------------------------------------
The year 2 LIFO cost of possession product A sales will be calculated as
follows:
(1) Base-year cost of item in year 2 ending inventory=$400
(2) Percentage of item A base-year cost to total base-year cost ($400 /
$800) = 50%
(3) LIFO value of item A ($1,400 x 50%) = $700
(4) LIFO cost of item A sales is determined by adding to the beginning
inventory in year 2 the purchases of item A in year 2 and subtracting
from this amount the ending inventory in year 2 ($400 + $6000 - $700 =
$5700). The beginning inventory in year 2 is determined by multiplying
the LIFO cost of the year 1 ending inventory by a percentage of item A
base year cost to the total base-year cost in year 1. The ending
inventory in year 2 is determined under (3) above.
Q. 19: If a possession product is purchased from a possessions
corporation by a U.S. affiliate using the dollar-value LIFO method of
costing its inventory and is included in a LIFO pool of the U.S.
affiliate which includes products purchased from the possessions
corporation in pre-TEFRA years, how should the LIFO index computation of
the U.S. affiliate be made in the first year in which section 936(h)
applies and in subsequent taxable years?
A. 19: The U.S. affiliate should treat the first taxable year for
which section 936(h) applies as a new base year in accordance with
procedures provided by regulations under section 472. Thus, the opening
inventory for the first year for which section 936(h) applies (valuing
possession products purchased from the possessions corporation on the
basis of the cost of such possession products), would equal the new base
year cost of the inventory of such pool of the U.S. affiliate.
Increments and decrements at new base year cost would be valued for LIFO
purposes pursuant to the procedures provided by regulations under
section 472.
Q. 20: If the possessions corporation computes its income with
respect to a product under the profit split method, with respect to
which units of the product shall the profit split method apply?
A. 20: The profit split method shall apply to units of the
possession product produced in whole or in part by the possessions
corporation in the possession and sold during the taxable year by
members of the affiliated group (other than foreign affiliates) to
unrelated parties or to foreign affiliates. In no event shall the profit
split method apply to units of the product which were not taken into
account by the possessions corporation in applying the significant
business presence test for the current taxable year or for any prior
taxable year in which the possessions corporation also had a significant
business presence in the possession with respect to such product.
(2) Pre-TEFRA inventory.
[[Page 177]]
Q. 1: How is pre-TEFRA inventory to be determined if the profit
split option is elected and the FIFO method of costing inventory is used
by the U.S. affiliate?
A. 1: Pre-TEFRA inventory is inventory which was produced by the
possessions corporation and transferred to a U.S. affiliate prior to the
possessions corporation's first taxable year beginning after December
31, 1982. Pre-TEFRA inventory will not be included for purposes of the
profit split option. If the U.S. affiliate uses the FIFO method of
costing inventory, the pre-TEFRA inventory will be treated as the first
inventory sold by the U.S. affiliate during the first year in which
section 936(h) applies and will not be included in the computation of
combined taxable income for purposes of the profit split option. The
treatment of pre-TEFRA inventory when FIFO costing is used by both the
U.S. affiliate and the possessions corporation is illustrated by the
following example in which FIFO unit costing is used:
Example. Assume the following:
------------------------------------------------------------------------
X Y
-----------------------------------
Possessions U.S. affiliate
corporation -----------------
------------------
Number Cost Number Cost
of per of per
units unit units unit
------------------------------------------------------------------------
Beginning inventory................. 500 $150 200 $225
Units produced during 1983.......... 1,000 200 ....... .......
Ending inventory.................... 400 200 300 .......
------------------------------------------------------------------------
In 1983, the beginning inventory of X, a possessions corporation, is
500 units with a unit cost of $150 and the beginning inventory of Y, the
U.S. affiliate, is 200 units with a unit cost of $225, which represents
the section 482 price paid by Y. Y's beginning inventory in 1983
represents purchases made in 1982 of products produced by X in that
year. Y sells all the units it purchases from X to Z, a foreign
affiliate. In 1983, X produces 1000 units at a unit cost of $200 and
sells 1100 units to Y (the difference between 1500 units, representing
X's 1983 beginning inventory (500) and the units produced by X in 1983
(1000), and X's ending inventory of 400 units). Of the 1100 units sold
by X to Y in 1983 only 800 units (and not 1000 units) which were sold by
Y to Z are taken into consideration in computing combined taxable income
for 1983. Since FIFO costing by the possessions corporation is used, the
cost is $150 per unit for the first 500 units and $200 per unit for the
remaining 300 units. The 200 units sold by X to Y in 1982 are pre-TEFRA
inventory and are not included in the computation of combined taxable
income for 1983. They are also treated as the first units sold by Y to Z
in 1983. This inventory has a unit cost of $225, which reflects the
section 482 transfer price from X to Y in 1982. Y's 1983 ending
inventory of 300 units will not be taken into consideration in computing
the combined taxable income of X and Y for 1983 because the units have
not been sold to a foreign affiliate or to persons who are not members
of the affiliated group. In a subsequent year when the units are sold to
Z, the cost to X and selling price to Z of these units will enter into
the computation of combined taxable income for that year.
(c) Covered Intangibles.
Q. 1: What are ``covered intangibles'' under section
936(h)(5)(C)(i)(II)?
A. 1: The term ``covered intangibles'' means (1) intangible property
developed in a possession solely by the possessions corporation and
owned by it, (2) manufacturing intangible property (described in section
936(h)(3)(B)(i)) which is acquired by the possessions corporation from
unrelated persons, and (3) any other intangible property (described in
section 936(h)(3)(B) (ii) through (v), to the extent not described in
section 936(h)(3)(B)(i)) which relates to sales of products or services
to unrelated persons for ultimate consumption or use in the possession
in which the possessions corporation conducts its business. The
possessions corporation is treated as the owner of covered intangibles
for purposes of obtaining a return thereon.
Q. 2: Do covered intangibles include manufacturing intangible
property which is acquired by an affiliate and subsequently transferred
to the possessions corporation?
A. 2: No. In order for a manufacturing intangible to be treated as a
covered intangible, the intangible property must be acquired directly by
the possessions corporation from an unrelated person unless the
manufacturing intangible was acquired by an affiliate from an unrelated
person and was transferred to the possessions corporation by the
affiliate prior to September 3, 1982.
Q. 3: If a possessions corporation licenses a manufacturing
intangible
[[Page 178]]
from an unrelated party, will the licensed intangible be treated as a
covered intangible?
A. 3: No.
Q. 4: How is ultimate consumption or use determined for purposes of
the definition of covered intangibles?
A. 4: A product will be treated as having its ultimate use or
consumption in a possession if it is sold by the possessions corporation
to a related or unrelated person in a possession and is not resold or
used or consumed outside of the possession within one year after the
date of the sale.
Q. 5: Are sales of products that relate to covered intangibles
excluded from the cost sharing fraction?
A. 5: If no manufacturing intangibles other than covered intangibles
are associated with the possession product, then sales of such product
will be excluded from the cost sharing fraction. If both covered and
non-covered manufacturing intangibles are associated with the possession
product, then sales of such product will be included in the cost sharing
fraction.
Q. 6: If the cost sharing option is elected, is it necessary for the
possessions corporation to be the legal owner of covered intangibles
described in section 936(h)(5)(C)(i)(II)(c) related to the product in
order for the possessions corporation to receive a full return with
respect to such intangibles?
A. 6: No. For purposes of section 936(h), it is immaterial whether
such covered intangibles are owned by the possessions corporation or by
another member of the affiliated group. Moreover, if the legal owner of
such covered intangibles which are subject to section 936(h)(5) is an
affiliate of the possessions corporation, such person will not be
required to charge an arm's-length royalty under section 482 to the
possessions corporation.
[T.D. 8090, 51 FR 21532, June 13, 1986; 51 FR 27174, July 30, 1986, as
amended by T.D. 8669, 61 FR 21367, May 10, 1996; 61 FR 39072, July 26,
1996; T.D. 8786, 63 FR 55025, Oct. 14, 1998]
Sec. 1.936-7 Manner of making election under section 936 (h)(5);
special election for export sales; revocation of election under section 936(a).
(a) The rules in this section apply for purposes of section 936(h)
and also for purposes of section 934(e), where applicable.
(b) Manner of making election.
Q. 1. [Reserved]. For further guidance, see Sec. 1.936-7T(b) Q. 1.
A. 1. [Reserved]. For further guidance, see Sec. 1.936-7T(b) A. 1.
Q. 2: May the ``election out'' under section 936(h)(5) be made on a
product-by-product basis, or must it be made on a wide basis?
A. 2: An electing corporation is required to treat products in the
same product area in the same manner. Similarly, all possessions
corporations in the same affiliated group that produce any products or
render any services in the same product area must make the same election
for all products that fall within the same product area. However, Sec.
1.936-7(b) provides that the electing corporation may make a different
election for export sales than for domestic sales. The electing
corporation or corporations may also make different elections for
products that fall within different product areas.
Q. 3: May the possessions corporation elect to define product area
more narrowly than the 3-digit SIC code?
A. 3: No. Certain alternatives, such as the 4-digit SIC code, would
not be permitted under the statute. However, other methods for defining
product area may be considered by the Commissioner in the future.
Q. 4: May a possessions corporation make an election out under the
cost sharing method with respect to a product area if the affiliated
group incurs no research, development or experimental costs in the
product area?
A. 4: Yes. In that case the cost sharing payment will be zero.
Q. 5: If the significant business presence test is not satisfied for
a product or type of service within the product area covered by the
election out under section 936(h)(5) what rules will apply with respect
to that product?
A. 5: With respect to the product which does not satisfy the
significant business presence test, the provisions of section 936 (h)(1)
through (h)(4) will apply to the allocation of income. However, if a
cost sharing or a profit split election has been made with respect to
the product area, the cost sharing payment or the research and
development
[[Page 179]]
floor under section 936(h)(5)(C)(ii)(II) will not be reduced.
Q. 6: Is a taxpayer permitted to make a change of election with
respect to the cost sharing and profit split methods?
A. 6: In general, once the election is properly made, it is binding
for the first year in which it applies and all subsequent years
(including upon any later created or acquired affiliates), and
revocation is only permitted with the consent of the Commissioner of
Internal Revenue. However, a taxpayer will be permitted to change its
election once from the cost sharing method to the profit split method or
vice versa, or from the method permitted under section 936 (h)(1)
through (h)(4) to cost sharing or profit split or vice versa, without
the consent of the Commissioner if the change is made on the taxpayer's
return for its first taxable year ending after June 13, 1986. Such
change will apply to such taxable year and all subsequent taxable years,
and, at the taxpayer's option, may also apply to all prior taxable years
for which section 936(h) was in effect. A change of election will be
treated as an election subject to the procedures set forth above and to
section 481 of the Internal Revenue Code.
Q. 7: If the Commissioner determines that a possessions corporation
does not meet the 80-percent possession source test or the 65-percent
active trade or business test (the ``qualification tests'') for any
taxable year beginning after 1982, under what circumstances is the
possessions corporation permitted to make a distribution of property
after the close of its taxable year to meet the qualification tests?
A. 7: A possessions corporation may make a pro rata distribution of
property to its shareholders after the close of the taxable year if the
Commissioner determines that the possessions corporation does not
satisfy the qualification tests (a) by reason of the exclusion from
gross income of intangible income under section 936(h)(1)(B) or section
936(h)(5)(C)(i)(II) or (b) by reason of the allocation to the
shareholders of the possessions corporation of income under section
936(h)(5)(C)(ii)(III); provided, however, that the determination of the
Commissioner does not contain a finding that the failure of such
corporation to satisfy the qualification tests was due, in whole or in
part, to fraud with intent to evade tax or willful neglect on the part
of the possessions corporation. The possessions corporation must
designate the distribution at the time the distribution is made as a
distribution to meet qualification requirements, and it will be subject
to the provisions of section 936(h)(4). Such distributions will not
qualify for the dividends received deduction.
Q. 8: If a possessions corporation owns stock in a subsidiary
possessions corporation, any intangible property income allocated to the
parent possessions corporation under section 936(h) will be treated as
U.S. source income and taxable to the parent possessions corporation. Is
the intangible property income taken into consideration in determining
whether the parent possessions corporation meets the income tests of
section 936(a)(2)?
A. 8: While taxable to the parent possessions corporation, the
intangible property income does not enter into the calculation of the
80-percent possession source test or the 65-percent active trade or
business test of section 936(a)(2)(A) and (B). This would also be the
case if the subsidiary possessions corporation made a qualifying
distribution under section 936(h)(4).
(c) Separate election for export sales.
Q. 1: What methods of computing income can a possessions corporation
use under the separate election for export sales?
A. 1: The only two methods which are available under the separate
election for export sales are the cost sharing method and the profit
split method.
Q. 2: What is the definition of export sales for purposes of the
separate election for export sales?
A. 2: The determination of export sales is based upon the
destination of the product, i.e., where it is to be used or consumed. If
the product is sold to a U.S. affiliate, it will be treated as an export
sale only if resold or otherwise transferred abroad to a foreign person
(including a foreign affiliate or foreign branch of a U.S. affiliate)
within one year from the date of sale to the U.S.
[[Page 180]]
affiliate for ultimate use or consumption outside the United States as
provided under Sec. 1.954-3(a)(3)(ii).
Q. 3: Assume that a possessions corporation sells a product to both
foreign affiliates and foreign branches of U.S. affiliates. In addition,
it sells the product to its U.S. parent for resale in the U.S. The
possessions corporation makes a profit split election for domestic sales
and a cost sharing election of export sales. Will the sales to foreign
branches of U.S. affiliates be treated as exports subject to the cost
sharing method or as domestic sales subject to the profit split method?
A. 3: The sales to a foreign branch of a U.S. corporation are
exports if for ultimate use or consumption outside of the United States
as provided under Sec. 1.954-3(a)(3)(ii).
Q. 4: Under what circumstances may a possessions corporation make
the separate election under section 936(h)(5)(F)(iv)(II) for computing
its income from products exported to a foreign person when the income
derived by such foreign person on the resale of such products is
included in foreign base company income under section 954(a)?
A. 4: If the income derived by a foreign person on the resale of
products manufactured, in whole or in part, by a possessions corporation
is included in foreign base company income under section 954(a), then
the possessions corporation may make the separate export election under
section 936(h)(5)(F)(iv)(II) for computing its income from such products
only if such foreign person has been formed or is availed of for
substantial business reasons that are unrelated to an affiliated
corporation's U.S. tax liability. For purposes of the proceding
sentence, a foreign person will be considered to be formed or availed of
for such substantial business reasons if the foreign person in the
normal course of business purchases substantial quantities of products
from both the possessions corporation and its affiliates for resale,
and, in addition provides support services for affiliated companies such
as centralized testing, marketing of products, management of local
currency exposures, or other similar services. However, a foreign person
that purchases and resells products only from a possessions corporation
is presumed to be formed or availed of for other than such substantial
business reasons, even if the foreign person provides additional
services.
Q. 5: When will the ``manufacturing'' test set forth in subsection
(d)(1)(A) of section 954 be applicable to the export sales of a product
of a possessions corporation which makes a separate election for export
sales?
A. 5: An electing corporation will be required to meet the
``manufacturing'' test set forth in subsection (d)(1)(A) of section 954
with respect to export sales of its product in each taxable year in
which the separate election for export sales is in effect.
(d) Revocation of election under section 936(a).
Q. 1: When may an election under section 936(a) be revoked?
A. 1: An election under section 936(a) may be revoked during the
first ten years of section 936 status only with the consent of the
Commissioner, and without the Commissioner's consent after that time.
The Commissioner hereby consents to all requests for revocation that are
made with respect to the taxapayer's first taxable year beginning after
December 31, 1982 provided that the section 936(a) election was in
effect for the corporation's last taxable year beginning before January
1, 1983, if the taxpayer agrees not to re-elect section 936(a) prior to
its first taxable year beginning after December 31, 1988. A taxpayer
that wishes to revoke a section 936(a) election under the terms of the
blanket revocation must attach a ``Statement of Revocation--Section
936'' to the taxpayer's timely filed return (including extensions) and
must state that in revoking the election the taxpayer agrees not to re-
elect section 936(a) prior to its first taxable year beginning after
December 31, 1988. Other requests to revoke not covered by the
Commissioner's blanket consent should be addressed to the District
Director having jurisdiction over the taxpayer's tax return.
[T.D. 8090, 51 FR 21545, June 13, 1986, as amended by T.D. 9100, 68 FR
70705, Dec. 19, 2003]
[[Page 181]]
Sec. 1.936-7T Manner of making election under section 936(h)(5);
special election for export sales; revocation of election under
section 936(a) (temporary).
(a) [Reserved]. For further guidance, see Sec. 1.936-7 (a).
(b) Manner of making election.
Q. 1: How does a possessions corporation make an election to use the
cost sharing method or profit split method?
A.1: A possessions corporation makes an election to use the cost
sharing or profit split method by filing Form 5712-A (``Election and
Verification of the Cost Sharing or Profit Split Method Under Section
936(h)(5)'') and attaching it to its tax return. Form 5712-A must be
filed on or before the due date (including extensions) of the tax return
of the possessions corporation for its first taxable year beginning
after December 31, 1982. The electing corporation must set forth on the
form the name and the taxpayer identification number or address of all
members of the affiliated group (including foreign affiliates not
required to file a U.S. tax return). All members of the affiliated group
must consent to the election. For elections filed with respect to
taxable years beginning before January 1, 2003, an authorized officer of
the electing corporation must sign the statement of election and must
declare that he has received a signed statement of consent from an
authorized officer, director, or other appropriate official of each
member of the affiliated group. Elections filed for taxable years
beginning after December 31, 2002, will incorporate a declaration by the
electing corporation that it has received a signed consent from an
authorized officer, director, or other appropriate official of each
member of the affiliated group and will be verified by signing the
return. The election is not valid for a taxable year unless all
affiliates consent. A failure to obtain an affiliate's written consent
will not invalidate the election out if the possessions corporation made
a good faith effort to obtain all the necessary consents or the failure
to obtain the missing consent was inadvertent. Subsequently created or
acquired affiliates are bound by the election. If an election out is
revoked under section 936(h)(5)(F)(iii), a new election out with respect
to that product area cannot be made without the consent of the
Commissioner. The possessions corporation shall file an amended Form
5712-A with its timely filed income tax return to reflect any changes in
the names or number of the members of the affiliated group for any
taxable year after the first taxable year to which the election out
applies. By consenting to the election out, all affiliates agree to
provide information necessary to compute the cost sharing payment under
the cost sharing method or combined taxable income under the profit
split method, and failure to provide such information shall be treated
as a request to revoke the election out under section 936(h)(5)(F)(iii).
Q. & A. 2 through 8 [Reserved]. For further guidance, see Sec.
1.936-7(b), Q. & A. 2 through 8.
(c) and (d) [Reserved]. For further guidance, see Sec. 1.936-7(c)
and (d).
[T.D. 9100, 68 FR 70705, Dec. 19, 2003]
Sec. 1.936-8T Qualified possession source investment income (temporary). [Reserved]
Sec. 1.936-9T Source of qualified possession source investment income (temporary). [Reserved]
Sec. 1.936-10 Qualified investments.
(a) In general. [Reserved]
(b) Qualified investments in Puerto Rico. [Reserved]
(c) Qualified investment in certain Caribbean Basin countries--(1)
General rule. An investment of qualified funds described in this section
shall be treated as a qualified investment of funds for use in Puerto
Rico if the funds are used for a qualified investment in a qualified
Caribbean Basin country. A qualified investment in a qualified Caribbean
Basin country is a loan of qualified funds by a qualified financial
institution (described in paragraph (c)(3) of this section) directly to
a qualified recipient (described in paragraph (c)(9) of this section) or
indirectly through a single financial intermediary for investment in
active busines assets (as defined in paragraph (c)(4) of this section)
in a qualified Caribbean Basin country (described in paragraph
[[Page 182]]
(c)(10)(ii) of this section) or for investment in development projects
(as defined in paragraph (c)(5) of this section) in a qualified
Caribbean Basin country, provided--
(i) The investment is authorized, prior to disbursement of the
funds, by the Commissioner of Financial Institutions of Puerto Rico (or
his delegate) pursuant to regulations issued by such Commissioner; and
(ii) The agreement, certification, and due diligency requirements
under paragraphs (c)(11), (12), and (13) of this section are met.
A loan by a qualified financial institution shall not be disqualified
merely because the loan transaction is processed by the central bank of
issue of the country into which the loan is made pursuant to, and solely
for purposes of complying with, the exchange control laws or regulations
of such country. Further, a loan by a qualified financial institution
shall not be disqualified merely because the loan is acquired by another
person, provided such other person is also a qualified financial
institution.
(2) Termination of qualification--(i) In general. An investment
that, at any time after having met the requirements for a qualified
investment in a qualified Caribbean Basin country under the terms of
this paragraph (c), fails to meet any of the conditions enumerated in
this paragraph (c) shall no longer be considered a qualified investment
in a qualified Caribbean Basin country from the time of such failure,
unless the investment satisfies the requirements for a timely cure
described in paragraph (c)(2)(ii) of this section. Such a failure
includes, but is not limited to, the occurrence of any of the following
events:
(A) Active business assets cease to qualify as such;
(B) Proceeds from the investment are diverted for the financing of
assets, projects, or operations that are not active business assets or
development projects or are not the assests or the project of the
qualified recipient;
(C) The holder of the qualified recipient's obligation is not a
qualified financial institution;
(D) The qualified recipient's qualified business activity ceases to
qualify as such; or
(E) The qualified Caribbean Basin country ceases to be a country
described in paragraph (c)(10)(ii) of this section.
(ii) Timely cure--(A) In general. A timely cure shall be considered
to have been made if the event or events that cause disqualification of
the investment are corrected within a reasonable period of time. For
purposes of this section, a reasonable period of time shall not exceed
60 days after such event or events come to the attention of the
qualified recipient or the qualified financial institution or should
have some to their attention by the exercise of reasonable diligence.
(B) Due diligence requirements. A time cure of a failure to comply
with the due diligence requirements of paragraphs (c)(11), (12), and
(13) of this section shall be considered to be made if the failure to
comply is due to reasonable cause and, upon request of the Commissioner
of Financial Institutions of Puerto Rico (or his delegate) or of the
Assistant Commissioner (International) (or his authorized
representative), the qualified financial institution (and its trustee or
agent), if any), the financial intermediary, or the qualified recipient
establishes to the satisfaction of the Commissioner of Financial
Institutions of Puerto Rico (or his delegate) or of the Assistant
Commissioner (International) (or his authorized representative) that it
has exercised due diligence in ensuring that the funds were property
disbursed to a qualified recipient and applied by or on behalf of such
qualified recipient to uses that qualify the investment as an investment
in qualified business assets or a development project under the
provisions of this paragraph (c).
(iii) Assumption of qualified recipient's obligation. An investment
shall not cease to qualify merely because the qualified recipient's
obligation to the qualified financial institution (or to a financial
intermediary, if any) is assumed by another person, provided such other
person assumes the qualified recipient's agreement and certification
requirements under paragraph (c)(11)(i) of this section and is either--
[[Page 183]]
(A) A qualified recipient on the date of assumption, in which case
such person shall be treated for purposes of this section as the
original qualified recipient and shall be subject to all the
requirements of this section for continued qualification of the loan as
a qualified investment in a qualified Caribbean Basin country; or
(B) An international organization, the principal purpose of which is
to foster economic development in developing countries and which is
described in section 1 of the International Organizations Immunities Act
(22 U.S.C. 288), if the assumption of the obligation is pursuant to a
bona fide guarantee agreement.
(3) Qualified financial institution--(i) General rule. For purposes
of section 936(d)(4)(A) and this section, a qualified financial
institution includes only--
(A) A banking, financing, or similar business defined in Sec.
1.864-4(c)(5)(i) that is an eligible institution described in paragraph
(c)(3)(ii) of this section, but not including branches of such
institution outside of Puerto Rico;
(B) A single-purpose entity described in paragraph (c)(3)(iii) of
this section;
(C) The Government Development Bank for Puerto Rico;
(D) The Puerto Rico Economic Development Bank; and
(E) Such other entity as may be determined by the Commissioner by
Revenue Procedure or other guidance published in the Internal Revenue
Bulletin.
(ii) Eligible institution. An eligible institution means an
institution--
(A) That is an entity organized under the laws of the Commonwealth
of Puerto Rico or is the Puerto Rican branch of an entity organized
under the laws of another jurisdiction, if such entity is engaged in a
banking, financing, or similar business defined in Sec. 1.864-
4(c)(5)(i), and
(B) That is licensed as an eligible institution under Regulation No.
3582 (or any successor regulation) issued by the Commissioner of
Financial Institutions of Puerto Rico (hereinafter ``Puerto Rican
Regulation No. 3582'').
(iii) Single-purpose entity. A single-purpose entity is an entity
that meets all of the following conditions:
(A) The entity is organized under the laws of the Commonwealth of
Puerto Rico and is a corporation, a partnership or a trust, which
conducts substantially all of its activities in Puerto Rico.
(B) The sole purpose of the entity is to use qualified funds from
possessions corporations to make one or more qualified investments in a
qualified Caribbean Basin country and the entity actually uses such
funds only for such purpose.
(C) In the case of an entity that is a trust, one of the trustees is
a qualified financial institution described in paragraph (c)(3)(i) of
this section.
(D) The entity is licensed as an eligible institution under Puerto
Rican Regulation No. 3582 (or any successor regulation).
(E) Any temporary investment by the entity for its own account of
funds received from a possessions corporation, and the income from the
investment thereof, and any temporary investment by the entity for its
own account of principal and interest paid by a borrower to the entity,
and the income from the investment thereof, are limited to investments
in eligible activities, as described in section 6.2.4 of Puerto Rican
Regulation No. 3582, as in effect on September 22, 1989.
(4) Investments in active business assets--(i) In general. For
purposes of section 936(d)(4)(A)(i)(I) and this section and subject to
the provisions of paragraph (c)(8) of this section, a loan qualifies as
an investment in active business assets if--
(A) The amounts disbursed to a qualified recipient under the loan or
bond issue are promptly applied (as defined in paragraphs (c)(6) and (7)
of this section) by (or on behalf of) the qualified recipient solely for
capital expenditures for the construction, rehabilitation (including
demolition associated therewith), improvement, or upgrading of qualified
assets described in paragraphs (c)(4)(ii)(A), (B), (E), and (F) of this
section, for the acquisition of qualified assets described in paragraphs
(c)(4)(ii)(B), (C), (E), and (F) of this section, for the expenditures
described in paragraphs (c)(4)(ii)(D), (E),
[[Page 184]]
and (F) of this section, and, if applicable, for the financing of
incidental expenditures described in paragraph (c)(4)(iii) of this
section;
(B) The qualified recipient owns the assets for United States income
tax purposes and uses them in a qualified business activity (as defined
in paragraph (c)(4)(iv)); and
(C) The requirements of paragraph (c)(6) of this section (regarding
temporary investments and time periods within which the funds must be
invested) and of paragraph (c)(7) of this section (regarding the
refinancing of existing funding and the time periods within which
funding for investments must be secured) are satisfied.
(ii) Definition of qualified assets. For purposes of this paragraph
(c), qualified assets mean--
(A) Real property;
(B) Tangible personal property (such as furniture, machinery, or
equipment) that is not property described in section 1221(1) and that is
either new property or property which at no time during the period
specified in paragraph (c)(4)(v) of this section was used in a business
activity in the qualified Caribbean Basin country in which the property
is to be used;
(C) Rights to intangible property that is a patent, invention,
formula, process, design, pattern, know-how, or similar item, or rights
under a franchise agreement, provided that such rights--
(1) Were not at any time during the period specified in paragraph
(c)(4)(v) of this section used in a business activity in the qualified
Caribbean Basin country in which the rights are to be used,
(2) Are not rights the use of which gives rise, or would give rise
if used, to United States source income, and
(3) Are not rights acquired by the qualified recipient from a person
related (within the meaning of section 267(b), using ``10 percent''
instead of ``50 percent'' in the places where it appears) to the
qualified recipient;
(D) Exploration and development expenditures incurred by a qualified
recipient for the purpose of ascertaining the existence, location,
extent or quality of any deposit of ore, oil, gas, or other mineral in a
qualified Caribbean Basin country, as well as for purposes of developing
such deposit (within the meaning of section 616 of the Code and the
regulations thereunder);
(E) Living plants and animals (other than crops, plants, and animals
that are acquired primarily to hold as inventory by the qualified
recipient for resale in the ordinary course of trade or business)
acquired in connection with a farming business (as defined in Sec.
1.263-1T(c)(4)(i)), expenditures of a preparatory nature to prepare the
land or area for farming (such as planting trees, drilling wells,
clearing brush, leveling land, laying pipes, building roads,
constructing tanks and reservoirs), expenditures for soil and water
conservation of a type described in section 175(c)(1), and expenditures
of a development nature incurred in connection with, and during, the
preproductive period of property produced in a farming business (as
defined in Sec. 1.263-1T(c)(4)(ii));
(F) Other assets or expenditures that are not described in
paragraphs (c)(4)(ii)(A) through (E) of this section and that the
Commissioner may, by Revenue Procedure or other guidance published in
the Internal Revenue Bulletin or by ruling issued to a qualified
financial institution or qualified recipient upon its request, determine
to be qualified assets.
(iii) Incidental expenditures. An amount in addition to the loan
proceeds borrowed to make an investment in active business assets shall
be considered an investment in active business assets if such amount is
applied to finance expenditures that are incidental to making the
investment in active business assets, provided such amount is disbursed
at or about the same time the proceeds for making the investment in
active business assets are disbursed. For purposes of this section,
expenditures incidental to an investment in active business assets
include only the following items:
(A) A reasonable amount of costs (other than the cost of credit
enhancement or bond insurance premiums) associated with arranging the
financing of an investment in active business assets, not to exceed 3.5
percent of the proceeds of the loan or bond issue.
[[Page 185]]
(B) A reasonable amount of installation costs and other reasonable
costs associated with placing an active business asset in service in the
qualified business activity.
(C) An amount not in excess of 10 percent of the total amount of
investment in qualified assets to finance the acquisition of inventory,
and other working capital requirements, but if an investment is in
connection with a manufacturing or farming business, the percentage
limitation shall be 50 percent rather than 10 percent provided the
excess over the 10 percent limitation is used to finance inventory
property. For purposes of this paragraph (c), whether a business is a
manufacturing business shall be determined under principles similar to
those described in section 954(d)(1)(A) and the regulations thereunder;
whether a business is a farming business shall be determined under Sec.
1.263-1T(c)(4)(i).
(D) An amount not in excess of 5 percent of the sum of the
investment in active business assets and the costs described in
paragraphs (c)(4)(iii)(A), (B), and (C) of this section for the
refinancing of an existing debt of the qualified recipient if such
refinancing is incidental to an investment in active business assets.
For this purpose, the replacement of an existing loan arrangement shall
not be considered the refinancing of an existing indebtedness to the
extent that the funds under such loan arrangement have not yet been
disbursed to the qualified recipient.
(iv) Qualified business activity. A qualified business activity is a
lawful industrial or commercial activity that is conducted as an active
trade or business (under principles similar to those described in Sec.
1.367(a)-2T(b) (2) and (3)) in a qualified Caribbean Basin country. A
trade or business for purposes of this paragraph (c)(4)(iv) is any
business activity meeting the principles of section 367 of the Code and
described in Divisions A through I (excluding group 43 in Division E
(relating to the United States Postal Service) and groups 84 (relating
to museums, art galleries, and botanical and zoological gardens), 86
(relating to membership organizations), and 88 (relating to private
households in Division I) of the 1987 Standard Industrial Classification
Manual issued by the Executive Office of the President, Office of
Management and Budget, or in the comparable provisions of any successor
Standard Industrial Classification Manual that is adopted by the
Commissioner of Internal Revenue in a notice, regulation, or other
document published in the Internal Revenue Cumulative Bulletin.
(v) Period of use. The period referred to in paragraphs
(c)(4)(ii)(B) and (C) of this section shall be a five year period
preceding the date of acquisition with the loan proceeds, if the date of
acquisition is on or before May 13, 1991. If the date of acquisition is
after May 13, 1991, then the period specified in this paragraph
(c)(4)(v) shall be three years preceding the date of acquisition with
the loan proceeds.
(5) Investments in development projects--(i) In general. Subject to
the provisions of paragraph (c)(8) of this section, this paragraph
(c)(5)(i) describes the requirements in order for a loan by a qualified
financial institution to qualify as an investment in a development
project for purposes of section 936(d)(4)(A)(i)(II) and for this
section.
(A) The amounts disbursed under the loan or bond issue must be
promptly applied (as defined in paragraphs (c)(6) and (7) of this
section) by (or on behalf of) the qualified recipient solely for one or
more investments described in paragraph (c)(4)(i)(A) of this section and
in any land, buildings, or other property functionally related and
subordinate to a facility described in paragraph (c)(5)(ii) of this
section (determined under principles similar to those described in Sec.
1.103-8(a)(3)), for use (under principles similar to those described in
Sec. 1.367(a)-2T(b)(5)) in connection with one or more activities
described in paragraph (c)(5)(i)(B) of this section.
(B) The activities referred to in paragraph (c)(5)(i)(A) of this
section are--
(1) A development project described in paragraph (c)(5)(ii) of this
section in a qualified Caribbean Basin country; or
(2) The performance in a qualified Caribbean Basin country of a non-
commercial governmental function described in paragraph (c)(5)(iv) of
this section;
[[Page 186]]
(C) The qualified recipient must own the assets for United States
income tax purposes;
(D) The requirements of paragraph (c)(6) of this section (regarding
temporary investments and time periods within which the funds must be
invested) and of paragraph (c)(7) of this section (regarding the
refinancing of existing funding and time periods within which funding
for investments must be secured) must be satisfied.
(ii) Development project. For purposes of this paragraph (c), a
development project is one or more facilities in a qualified Caribbean
Basin country that support economic development in that country and that
satisfy the public use requirement of paragraph (c)(5)(iii) of this
section. Examples of facilities that may meet the public use requirement
include, but are not limited to--
(A) Transportation systems and equipment, including sea, surface,
and air, such as roads, railways, air terminals, runways, harbor
facilities, and ships and aircraft;
(B) Communications facilities;
(C) Training and education facilities related to qualified business
activities;
(D) Industrial parks, including necessary support facilities such as
roads; transmission lines for water, gas, electricity, and sewage;
docks; plant sites preparations; power generation; sewage disposal; and
water treatment;
(E) Sports facilities;
(F) Convention or trade show facilities;
(G) Sewage, solid waste, water, and electric facilities;
(H) Housing projects pursuant to a government program designed to
provide affordable housing to low or moderate income families, based
upon local standards; and
(I) Hydroelectric generating facilities.
(iii) Public use requirement. To satisfy the public use requirement
in paragraph (c)(5)(ii) of this section, a facility must serve or be
available on a regular basis for general public use, as contrasted with
similar types of facilities which are constructed for the exclusive use
of a limited number of persons as determined under principles similar to
those described in Sec. 1.103-8(a)(2).
(iv) Non-commercial governmental functions. For purposes of
paragraph (c)(5)(i)(B) of this section, the term ``non-commercial
governmental functions'' refers to activities that, under U.S.
standards, are not customarily attributable to or carried on by private
enterprises for profit and are performed for the general public with
respect to the common welfare or which relate to the administration of
some phase of government. For example, the operation of libraries, toll
bridges, or local transportation services, and activities substantially
equivalent to those carried out by the Federal Aviation Authority,
Interstate Commerce Commission, or United States Postal Service, are
considered non-commercial governmental functions. For purposes of this
section, non-commercial government functions shall not include military
activities.
(v) [Reserved]
(6) Prompt application of borrowed proceeds. This paragraph (c)(6)
provides rules for determining whether amounts disbursed to a qualified
recipient by a qualified financial institution (or a financial
intermediary) shall be considered to have been promptly applied for the
purpose of paragraphs (c)(4)(i)(A) and (c)(5)(i)(A) of this section.
(i) In general. Except as otherwise provided in paragraphs
(c)(6)(ii) and (c)(7)(iii)(B) of this section, amounts disbursed to a
qualified recipient by a qualified financial institution (or a financial
intermediary) shall be considered to have been promptly applied for the
purpose of paragraphs (c)(4)(i)(A) and (c)(5)(i)(A) of this section if
the amounts are fully expended for any of the purposes described in
paragraphs (c)(4)(i)(A) or (c)(5)(i)(A) of this section no later than
six months from the date of such disbursement and any temporary
investment of such funds by the qualified recipient during such period
complies with the rules of paragraph (c)(6)(iii)(A) of this section.
Where the amounts disbursed are bond proceeds described in paragraph
(c)(6)(iv)(A) of this section, the six-month period shall begin on the
date of issuance of the bonds. In the event the qualified financial
institution (or financial intermediary) invests any part of the bond
proceeds before disbursement of those
[[Page 187]]
proceeds to the qualified recipient, all earnings from any such
investment shall be paid to the qualified recipient or applied for its
benefit.
(ii) Special rules for long term projects financed out of bond
proceeds. In the case of a long term project described in paragraph
(c)(6)(iv)(B) of this section that is financed out of bond proceeds, the
six-month period described in paragraph (c)(6)(i) of this section shall
be extended with respect to the amount of bond proceeds used to fund the
project for such reasonable period of time as shall be necessary until
completion of the project or until beginning of production (in the case
of a farming business), but, in any event, not to exceed three years
from the date of issuance of the bonds, and only if--
(A) The project that is financed out of bond proceeds was identified
as of the date of issue;
(B) A construction and expenditure plan certified by an independent
expert (such as an engineer, an architect, or a farming expert) is filed
with, and approved by, the Commissioner of Financial Institutions of
Puerto Rico (or his delegate) prior to the date of issue, which makes a
reasonable estimate, as of the date of filing of the plan, of the
amounts and uses of the bond proceeds and the time of completion or
production, and includes a schedule of progress payments until such
time;
(C) The terms of the construction and expenditure plan are disclosed
in the public offering memorandum, private placement memorandum, or
similar document prepared for information or disclosure purposes in
relation to the issuance of bonds; and
(D) Any temporary investment of the bond proceeds complies with the
rules of paragraph (c)(6)(iii)(A) and (B) of this section.
(iii) Temporary investments--(A) During six-month period. During the
six-month period described in paragraph (c)(6)(i) of this section,
during the first six months of the period described in paragraph
(c)(6)(ii) of this section, and during the 30-day period described in
paragraph (c)(7)(iii)(A) of this section, loan proceeds disbursed to a
qualified recipient, bond proceeds, and income from the investment
thereof, may be held in unrestricted yield investments, provided such
yield reflects normal market yield for such type of investments and
provided the income from such investments, if any, is or would be
sourced either in Puerto Rico or in a country in which the investment in
active business assets or development project is to be made.
(B) During other periods. During any other period, any temporary
investment of bond proceeds, and of income from such investments, shall
be limited to investments in eligible activities. For purposes of this
paragraph (c)(6)(iii)(B), the term ``eligible activities'' shall mean
those investments described in section 6.2.4 of Puerto Rican Regulation
No. 3582, as in effect on September 22, 1989.
(iv) Definitions--(A) Bond proceeds. For purposes of this paragraph
(c), bond proceeds shall mean the proceeds from the issuance of
obligations by way of a public offering or a private placement by a
qualified financial institution for investment in active business assets
or a development project that has been identified at the time of issue
and is described in a public offering memorandum, private placement
memorandum, or similar document prepared for information or disclosure
purposes in relation to the issuance of the bonds.
(B) Long term project. For purposes of this section, the term long
term project means--
(1) A project, whether or not under a contract, for the
construction, rehabilitation, improvement, upgrading, or production of
qualified assets, or for expenditures, described in paragraph (c)(4)(ii)
of this section (other than paragraph (c)(4)(ii)(C) of this section),
which is reasonably expected to require more than 12 months to complete;
or
(2) The production of property in a farming business referred to in
paragraph (c)(4)(ii)(E) of this section, which is reasonably expected to
require a preproductive period in excess of 12 months.
(7) Financing of previously incurred costs. Loan or bond proceeds
which are disbursed after a qualified recipient has paid or incurred
part or all of the costs of acquiring active business assets or
investing in a development project shall be considered to have
[[Page 188]]
been applied for such purposes only as provided in this paragraph
(c)(7).
(i) Replacement of temporary non-section 936 financing of a
qualified investment. This paragraph (c)(7)(i) prescribes the maximum
time limits within which temporary non-section 936 financing of
qualified investments may be replaced with section 936 funds without
being considered a prohibited refinancing transaction. This paragraph
(c)(7)(i) applies to the refinancing of costs incurred with respect to
investments that, at the time the costs were first incurred, were either
qualified investments in a qualified Caribbean Basin country or were
investments by a qualified recipient in active business assets or a
development project in a qualified Caribbean Basin country. This
paragraph (c)(7)(i) applies also to the refinancing of costs incurred
with respect to any other investment. However, in the latter case, the
amount of costs that may be refinanced with section 936 funds is limited
to the amount of costs that are incurred with respect to the investment
after the investment becomes a qualified investment in a qualified
Caribbean Basin country. For purposes of this paragraph (c)(7)(i), the
time when costs are incurred shall be determined under principles
similar to those applicable under section 461(h) dealing with the
economic performance test for the accrual of deductible liabilities.
This paragraph (c)(7)(i) applies only to the situations described in
this paragraph (c)(7)(i).
(A) In the case of an investment in active business assets or a
development project, a loan shall be a qualified investment for purposes
of this paragraph (c) if the loan proceeds are disbursed, or the
obligations are issued, no later than six months after the date on which
the qualified recipient takes possession of the asset or the facility
or, if earlier, places the asset or the facility in service. However, in
the case of a small project described in paragraph (c)(8)(v) of this
section, the six-month period shall be one year.
(B) In the case of an investment in active business assets or a
development project that is part of a long term project described in
paragraph (c)(6)(iv)(B) of this section, a loan shall also be a
qualified investment for purposes of this paragraph (c) if the loan
proceeds are disbursed, or the obligations are issued, no later than six
months after completion of the project or, in the case of a farming
business, after the beginning of production, and in any event, no later
than three years after the date on which the first payment is made
toward the eligible costs of the project. The amount of the qualified
investment may not exceed the sum of--
(1) The eligible costs relating to investments described in
paragraph (c)(4)(i)(A) in the case of an investment in active business
assets, or the eligible costs relating to investments described in
paragraph (c)(5)(i) of this section in the case of a development
project, but only to the extent of the costs that are incurred after the
date described in paragraph (c)(7)(i)(D) of this section, and
(2) The portion of unpaid interest that would be required to be
capitalized under U.S. tax rules and that accrued on prior temporary
non-section 936 financing from the date described in paragraph
(c)(7)(i)(D) of this section through the date the section 936 loan
proceeds are disbursed or the section 936 obligations are issued.
(C) In order to qualify for the special rules of this paragraph
(c)(7)(i), a plan must be filed with the Commissioner of Financial
Institutions of Puerto Rico (or his delegate) stating the qualified
recipient's intention to refinance the costs of the long term project
with section funds.
(D) The date referred to in paragraph (c)(7)(i)(B) (1) and (2) of
this section is a date that is the later of--
(1) The date the plan described in paragraph (c)(7)(i)(C) is filed,
or
(2) The date the investment becomes a qualified investment by a
qualified recipient in active business assets or a development project
in a qualified Caribbean Basin country.
(ii) Refinancing of section 936 financing. A section 936 loan or
bond issue used to finance a qualified investment described in paragraph
(c)(1) of this section may be refinanced with section 936 funds through
a new loan or bond issue to the extent of the remaining principal
balance on such existing qualified financing, increased by the
[[Page 189]]
amount of unpaid interest accrued through the date the new loan proceeds
are disbursed or the new obligations are issued and that would be
required to be capitalized under U.S. tax rules.
(iii) Prompt application of borrowed proceeds--(A) In general. In
the case of a loan or bond issue described in paragraph (c)(7)(i) or
(ii) of this section, the rules of paragraph (c)(6) of this section
shall apply but the six-month period described in paragraph (c)(6)(i) of
this section shall be limited to 30 days from the date of disbursement
of loan proceeds to the qualified recipient or from the date of issuance
in the case of a bond issue.
(B) Special rules for long term projects financed out of bond
proceeds. In the case of a long term project described in paragraph
(c)(6)(iv)(B) of this section that is financed out of bond proceeds, the
30-day period described in paragraph (c)(7)(iii)(A) of this section
shall be extended with respect to the amount of bond proceeds used for
the permanent financing of the long term project for such reasonable
period of time as shall be necessary until completion of the project or
beginning of production (in the case of a farming business), but, in any
event, not to exceed three years from the date of issuance of the bonds.
For purposes of this paragraph (c)(7)(iii)(B), the period of time shall
be considered reasonable only if--
(1) A construction and expenditure plan certified by an independent
expert (such as an engineer, an architect, or a farming expert) is filed
with, and approved by, the Commissioner of Financial Institutions of
Puerto Rico (or his delegate) prior to the date of issue, which makes a
reasonable estimate, as of the date of issue, of the amounts and uses of
the bond proceeds and the time of completion or production, and includes
a schedule of progress payments until such time; and
(2) The terms of the construction and expenditure plan are disclosed
in the public offering memorandum, private placement memorandum, or
similar document prepared for information or disclosure purposes in
relation to the bond issue.
(8) Miscellaneous operating rules--(i) Sale and leaseback. An asset
that is acquired and leased back to the person from whom acquired does
not constitute an investment in an active business asset or an
investment in a development project.
(ii) Use of asset in qualified business activity. For purposes of
paragraph (c)(4)(i)(B), an asset shall be considered used or held for
use in a qualified business activity if it is used or held for use in
such activity under principles similar to those described in Sec.
1.367(a)-2T(b)(5), or a successor provision.
(iii) Definition of capital expenditures. For purposes of this
paragraph (c), capital expenditures mean those expenditures described in
section 263(a) of the Code (without regard to paragraphs (A) through (G)
of section 263(a)(1)), and those costs required to be capitalized under
section 263A with respect to property described in section 263A(b)(1),
relating to self-constructed assets.
(iv) Loans through certain financial intermediaries. A loan by a
qualified financial institution shall not be disqualified from being an
investment in active business assets or in a development project merely
because the proceeds are first lent to a financial intermediary (as
defined in paragraph (c)(8)(iv)(H) of this section) which, in turn, on-
lends the proceeds directly to a qualified recipient, provided the
requirements of this paragraph (c)(8)(iv) are satisfied.
(A) The loan to the qualified recipient must satisfy the
requirements of paragraph (c)(4)(i) of this section in the case of an
investment in active business assets, or of paragraph (c)(5)(i) of this
section in the case of an investment in a development project.
(B) The qualified recipient and the active business assets or
development project in which the proceeds are to be invested must be
identified prior to disbursement of any part of the proceeds by the
qualified financial institution to the financial intermediary.
(C) The effective interest rate charged by the qualified financial
institution to the financial intermediary must not exceed the average
interest rate paid by the qualified financial institution with respect
to its eligible funds, increased by such number of basis points as is
required to provide
[[Page 190]]
reasonable compensation to the qualified financial institution for
services performed and risks assumed with respect to the loan to the
financial intermediary that are not ordinarily required to be performed
or assumed with respect to a deposit, loan, repurchase agreement or
other transfer of eligible funds with another qualified financial
institution. The average interest rate shall be the average rate,
determined on a daily basis, paid by the qualified financial institution
on its eligible funds over the most recent quarter preceding the date on
which the rate on the loan to the financial intermediary is committed.
(D) The effective interest rate charged by the financial
intermediary to the qualified recipient must not exceed the effective
interest rate charged to the financial intermediary by the qualified
financial institution, increased by such number of basis points as is
required to provide reasonable compensation to the financial
intermediary for services performed and risks assumed with respect to
the loan to the qualified recipient.
(E) The financial intermediary must borrow from the qualified
financial institution under substantially the same terms as it lends to
the qualified recipient. In particular, both loans must have
disbursement terms, repayment schedules and maturity dates for interest
and principal amounts such that the financial intermediary does not
retain for more than 48 hours any of the funds disbursed by the
qualified financial institution nor any of the funds paid by the
qualified recipient in repayment of principal or interest on the loan.
(F) The financial institution and the financial intermediary must
agree to comply with the due diligence requirements described in
paragraphs (c)(11), (12), and (13) of this section;
(G) The time periods and temporary investments rules in paragraphs
(c)(6) and (7) of this section must be complied with; and
(H) For purposes of this paragraph (c), the financial intermediary
must be--
(1) An active trade or business which a person maintains in a
qualified Caribbean Basin country and which consists of a banking,
financing or similar business as defined in Sec. 1.864-4(c)(5)(i)
(other than a central bank of issue); or
(2) A public international organization, the principal purpose of
which is to foster economic development in developing countries and
which is described in section 1 of the International Organizations
Immunities Act (22 U.S.C. 288).
For purposes of paragraphs (c)(8)(iv)(C) and (D) of this section, the
determination of whether compensation is reasonable shall be made in
relation to normal commercial practices for comparable transactions
carrying a similar degree of commercial, currency and political risk.
Reasonable credit enhancement fees and other reasonable fees and amounts
charged to the financial intermediary or the qualified recipient with
respect to the loan transaction in addition to interest shall be added
to the interest cost in determining the effective interest rate.
(v) Small project. For purposes of this paragraph (c), a small
project shall be a project (including the acquisition of an asset) for
which the total amount of section 936 funds used for its financing does
not exceed $1,000,000 in the aggregate, or such other amount as the
Commissioner may publish, from time to time, in the Internal Revenue
Bulletin.
(9) Qualified recipient. For purposes of this section, a qualified
recipient is any person described in paragraph (c)(9)(i) or (ii) of this
section. The term ``person'' means a person described in section
7701(a)(1) or a government (within the meaning of Sec. 1.892-2T(a)(1))
of a qualified Caribbean Basin country.
(i) In the case of an investment described in paragraph (c)(4) of
this section (relating to investments in active business assets), a
qualified recipient is a person that carries on a qualified business
activity in a qualified Caribbean Basin country, and complies with the
agreement and certification requirements described in paragraph
(c)(11)(i) of this section at all times during the period in which the
investment remains outstanding.
(ii) In the case of an investment described in pargraph (c)(5) of
this section (relating to investments in development projects), a
qualified recipient
[[Page 191]]
is the borrower (including a person empowered by the borrower to
authorize expenditures for the investment in the development project)
that has authority to comply, and complies, with the agreement and
certification requirements described in paragraph (c)(11)(i) of this
section at all times during the period in which the investment remains
outstanding.
(10) Investments in a qualified Caribbean Basin country--(i) Rules
for determining the place of an investment. The rules of this paragraph
(c)(10)(i) shall apply to determine the extent to which an investment in
an active business asset or a development project will be considered
made in qualified Caribbean Basin Country.
(A) An investment in real property is considered made in the
qualified Caribbean Basin country in which the real property is located.
(B) Except as otherwise provided in this paragraph (c)(10)(i)(B), an
investment in tangible personal property is considered made in a
qualified Caribbean Basin Country so long as the tangible personal
property is predominantly used in that country. Whether property is used
predominantly in a qualified Caribbean Basin country shall be determined
under principles similar to those described in Sec. 1.48-1(g)(1),
(g)(2)(ii), (g)(2)(iv), (g)(2)(vi), (g)(2)(viii), and (g)(2)(x)
(relating to investment tax credits for property used outside the United
States) as in effect on December 31, 1985. A vessel, container, or
aircraft shall be considered for use predominantly in a qualified
Caribbean Basin country in any year if it is used for transport to and
from such country with some degree of frequency during that year and at
least 30 percent of the income from the use of such vessel, container or
aircraft for that year is sourced in such country under principles
similar to those described in section 863(c)(1) and (2) (relating to
source rules for certain transportation income). Cables and pipelines
which are premanently installed as part of a communication or
transportation system between a qualified Caribbean Basin country and
another country or among several countries which include a qualified
Caribbean Basin country shall be considered used in a qualified
Caribbean Basin country to the extent of 50 percent of the portion of
the facility that directly links the qualified country to another
country or to a hub, unless it is established by notice or other
guidance published in the Internal Revenue Bulletin or by ruling issued
to a qualified institution or qualified recipient upon request that it
is appropriate to attribute a greater portion of the cost of the
facility to the qualified Caribbean Basin country.
(C) An investment in rights to intangible property is considered
made in a qualified Caribbean Basin country to the extent such rights
are used in that country. Where rights to intangible property are used
shall be determined under principles similar to those described in Sec.
1.954-2T(b)(3)(vii) or a successor provision.
(ii) Qualified Caribbean Basin country. For purposes of this
section, the term ``qualified Caribbean Basin country'' means any
beneficiary country (within the meaning of section 212(a)(1)(A) of the
Caribbean Basin Economic Recovery Act, Public Law 98-67 (Aug. 5, 1983),
97 Stat. 384, 19 U.S.C. 2702(a)(1)(A)), which meets the requirements of
section 274(h)(6)(A)(i) and (ii) and the U.S. Virgin Islands, and
includes the territorial waters and continental shelf thereof.
(11) Agreements and certifications by qualified recipients and
financial intermediaries--(i) In general. In order for an investment to
be considered a qualified investment under section 936(d)(4) and
paragraph (c)(1) of this section, a qualified recipient must certify to
the qualified financial institution (or to the financial intermediary,
if the loan is made through a financial intermediary) on the date of
closing of the loan agreement and on each anniversary date thereof, that
it is a qualified recipient described in paragraph (c)(9) of this
section. In addition, the qualified recipient must agree in the loan
agreement with the qualified financial institution (or with the
financial intermediary, if the loan is made through a financial
intermediary)--
(A) To use the funds at all times during the period the loan is
outstanding solely for the purposes and in the manner described in
paragraph (c)(4) of this section (regarding investment in active
[[Page 192]]
business assets) or in paragraph (c)(5) of this section (regarding
investment in development projects);
(B) To comply with the requirements of paragraph (c)(6) of this
section (regarding temporary investments and time periods within which
the funds must be invested) and paragraph (c)(7) of this section
(regarding the refinancing of existing funding and the time periods
within which funding for investments must be secured);
(C) To notify the Assistant Commissioner (International), the
qualified financial institution (or the financial intermediary, if the
loan is made through a financial intermediary), and the Commissioner of
Financial Institutions of Puerto Rico (or his delegate) pursuant to
paragraph (c)(14) of this section if it no longer is a qualified
recipient or if, for any other reason, the investment has ceased to
qualify as a qualified investment described in paragraph (c)(1) of this
section, promptly upon the occurrence of such disqualifying event; and
(D) To permit examination by the office of the Assistant
Commissioner (International) (or by the office of any District Director
authorized by the Assistant Commissioner (International)) and the
Commissioner of Financial Institutions of Puerto Rico (or his delegate)
of all necessary books and records that are sufficient to verify that
the funds were used for investments in active business assets or
development projects in conformity with the terms of the loan agreement.
(ii) Certification by a financial intermediary. In the case of a
loan by a qualified financial institution to a financial intermediary,
the financial intermediary must certify to the qualified financial
institution (using the procedures described in paragraph (c)(11)(i) of
this section) that it is a financial intermediary described in paragraph
(c)(8)(iv)(H) of this section, and must furnish to the qualified
financial institution a copy of the qualified recipient's certification
described in paragraph (c)(11)(i) of this section and of its loan
agreement with the qualified recipient. In addition, the financial
intermediary must agree in the loan agreement with the qualified
financial institution:
(A) To comply with the requirements of paragraph (c)(8)(iv) of this
section; and
(B) To permit examination by the office of the Assistant
Commissioner (International) (or by the office of any District Director
authorized by the Assistant Commissioner (International)) and the
Commissioner of Financial Institutions of Puerto Rico (or his delegate)
of all its necessary books and records that are sufficient to verify
that the funds were used in conformity with the terms of the loan
agreements.
(12) Certification requirements. In order for an investment to be
considered a qualified investment under section 936(d)(4), section
936(d)(4)(C)(i) requires that both the person in whose trade or business
such investment is made and the financial institution certify to the
Secretary of the Treasury and the Commissioner of Financial Institutions
of Puerto Rico that the proceeds of the loan will be promptly used to
acquire active business assets or to make other authorized expenditures.
This certification requirement is satisfied as to the qualified
financial institution, the financial intermediary (if any), and the
qualified recipient if the qualified financial institution submits a
certificate to both the Assistant Commissioner (International) and to
the Commissioner of Financial Institutions of Puerto Rico (or his
delegate) pursuant to paragraph (c)(14) of this section upon
authorization of the investment by the Commissioner of Financial
Institutions and, in any event, prior to the first disbursement of the
loan proceeds to the qualified recipient or to the financial
intermediary (if any), in which the qualified financial institution--
(i) Represents that, as of the date of the certification, the
qualified recipient and the financial intermediary (if any) have
complied with the requirements described in paragraph (c)(11) of this
section;
(ii) Describes the important terms of the loan to the financial
intermediary (if any) and to the qualified recipient, including the
amount of the loan, the nature of the investment, the basis for its
qualification as an investment in active business assets or a
development project under this section, the identity
[[Page 193]]
of the financial intermediary (if any) and of the qualified recipient,
the qualified Caribbean Basin country involved, and the nature of the
collateral or other security used, including any guarantee;
(iii) Agrees to permit examination by the Assistant Commissioner
(International) (or by the office of any District Director authorized by
the Assistant Commissioner (International)) and the Commissioner of
Financial Institutions of Puerto Rico (or his delegate) of all its
necessary books and records that are sufficient to verify that the funds
were used for investments in active business assets or development
projects in conformity with the terms of the loan agreement or
agreements with the financial intermediary (if any) and with the
qualified recipient; and
(iv) In the case of a single-purpose entity that is a qualified
financial institution, discloses the name and address of the entity's
trustee or agent, if any, that assists the qualified financial
institution in the performance of its due diligence requirement under
paragraph (c) of this section, and represents that the trustee or agent
has agreed with the qualified financial institution to permit
examination by the Assistant Commissioner (International) (or by the
office of any District Director authorized by the Assistant Commissioner
(International)) and the Commissioner of Financial Institutions of
Puerto Rico (or his delegate) of all necessary books and records of such
trustee or agent that are sufficient to verify that the funds were used
for investments in active business assets or development projects in
conformity with the terms of the loan agreement or agreements with the
financial intermediary (if any) and with the qualified recipient.
(13) Continuing due diligence requirements. In order to maintain the
qualification for an investment under paragraph (c)(1) of this section,
the continuing due diligence requirements described in this paragraph
(c)(13) must be satisfied.
(i) Requirements of qualified recipient. A qualified recipient
must--
(A) Submit annually to the qualified financial institution or to the
financial intermediary from which its qualified funds were obtained a
copy of its most recent annual financial statement accompanied by an
opinion of an independent accountant familiar with the financials of the
qualified recipient disclosing the amount of the loan, the current
outstanding balance of the loan, describing the assets financed with
such loan and the qualified business activity in which such assets are
used or the development project for which the loan is used, and stating
that there are no reasons to doubt that the loan proceeds have been
properly used and continue to be properly used, and
(B) Act in a manner consistent with its representations and
agreements described in paragraph (c)(11) of this section.
(ii) Requirements of qualified financial institutions. Except as
otherwise provided in paragraph (c)(13)(iii) of this section, a
qualified financial institution described in paragraph (c)(3) of this
section must maintain in its records and have available for inspection
the documentation described in paragraph (c)(13)(ii)(A) or (B) of this
section. In addition, the qualified financial institution is required to
notify the Assistant Commissioner (International) and the Commissioner
of Financial Institutions of Puerto Rico (or his delegate) pursuant to
paragraph (c)(14) of this section upon becoming aware that a loan has
ceased to be an investment in active business assets or a development
project under this section. For purposes of this paragraph (c)(13)(ii),
multiple loans for investment in a single qualified business activity or
development project will be aggregated in determining what due diligence
requirements apply.
(A) In the case of a small project described in paragraph (c)(8)(v)
of this section, the following documents must be maintained and
available for inspection:
(1) The loan application or other similar document;
(2) The financial statements of the qualified recipient filed as
part of the loan application;
(3) The statement required by section 6.4.3(a)(iii) of Puerto Rican
Regulation No. 3582 or any successor thereof, signed by the qualified
recipient (or its
[[Page 194]]
duly authorized representative), acknowledging the receipt of the loan
proceeds, describing the assets financed with such loan and the business
activity in which such assets are to be used or the development project
for which the funds will be utilized, the collateral to be provided for
the transaction including any guarantee, and the basis for its
qualification as a qualified recipient;
(4) The loan documents; and
(5) In the case of a qualified financial institution that is a
single-purpose entity, a copy of the agreement with the entity's trustee
or agent, if any, described in paragraph (c)(12)(iv) of this section.
(B) In the case of a disbursement concerning a project that is not a
small project described in paragraph (c)(8)(v) of this section, the
following documents must be maintained and available for inspection, in
addition to the documents required by paragraph (c)(13)(ii)(A) of this
section:
(1) A memorandum of credit prepared by an officer of the qualified
financial institution (or, in the case of a single purpose entity, an
agent of the entity or a trustee for the entity, if any) and signed by
the officer of the qualified financial institution, containing the
details of the investigation and review that the qualified financial
institution, or its trustee or agent, if any, conducted in order to
evaluate whether the investment is qualified under paragraph (c)(1) of
this section and the opinion of the officer of the qualified financial
institution, or the opinion of an officer of the agent of, or of the
trustee for, the qualified financial institution, if any, that there is
no reasonable ground for belief that the qualified funds will be
diverted to a use that is not permitted under the provisions of this
section; in making this investigation and review, factors that must be
utilized are ones similar to those listed in Puerto Rico Regulation No.
3582, section 6.4.2;
(2) The annual financial statement of the qualified recipient; and
(3) The written report of an officer of the qualified financial
institution, or of an officer of an agent of, or of the trustee for, the
qualified financial institution, if any, documenting discussions, both
before and after the disbursement of the loan proceeds, with each
recipient's accounting, financial and executive personnel with respect
to the proposed and actual use of the loan proceeds and his analysis of
the annual financial statements of the qualified recipient including an
analysis of the statement of sources and uses of funds. After the loan
disbursement, such discussions and review shall occur annually during
the term of the loan. Such report shall include the conclusion that in
such officer's opinion there is no reasonable ground for belief that the
qualified recipient is improperly utilizing the funds.
(iii) Requirements in the case of a financial intermediary. Where a
qualified financial institution lends funds to a financial intermediary
which are on-lent to a qualified recipient--
(A) The obligation to maintain the documentation described in
paragraph (c)(13)(ii)(A) or (B) of this section shall apply only to the
financial intermediary and not to the qualified financial institution
and the provisions of paragraph (c)(13)(ii)(A) or (B) of this section
shall be read so as to impose on the financial intermediary any
obligation imposed on the qualified financial institution.
(B) The financial intermediary shall forward annually to the
qualified financial institution a copy of the documentation it is
required to maintain in its records pursuant to the provisions of this
paragraph (c)(13)(iii) and shall notify the Assistant Commissioner
(International), the Commissioner of Financial Institutions of Puerto
Rico (or his delegate) and the qualified financial institution pursuant
to paragraph (c)(14) of this section upon becoming aware that a loan has
ceased to be an investment in active business assets or a development
project under this section. The qualified financial institution must
maintain in its records and have available for inspection the
documentation furnished by the financial intermediary pursuant to this
paragraph (c)(13)(iii)(B).
(C) The qualified financial institution shall cause one of its
officers (or one of the officers of its agent or trustee, if any) to
prepare a written report
[[Page 195]]
documenting his analysis of the documentation furnished by the financial
intermediary pursuant to paragraph (c)(13)(iii)(B) of this section, his
discussions, both before and after the disbursement of the loan
proceeds, with the financial intermediary's accounting, financial and
executive personnel with respect to the proposed and actual use of the
loan proceeds, and his analysis of the annual financial statements of
the qualified recipient including an analysis of the statement of
sources and uses of funds. After the loan disbursement, such discussions
and review shall occur annually during the term of the loan. Such report
shall include the conclusion that in such officer's opinion there is no
reasonable ground for belief that the qualified recipient is improperly
utilizing the funds.
(14) Procedures for notices and certifications. Notices and
certifications to the Assistant Commissioner (International) required
under paragraphs (c)(11), (12) and (13) of this section shall be
addressed to the attention of the Assistant Commissioner
(International), Office of Taxpayer Service and Compliance, IN:C, 950
L'Enfant Plaza South, SW., Washington, DC 20024. Notices and
certifications to the Commissioner of Financial Institutions of Puerto
Rico required under paragraphs (c)(11), (12), and (13) of this section
shall be addressed as follows: Commissioner of Financial Institutions,
GPO Box 70324, San Juan, Puerto Rico 00936.
(15) Effective date. This paragraph (c) is effective May 13, 1991.
It is applicable to investments by a possessions corporation in a
financial institution that are used by a financial institution for
investments in accordance with a specific authorization granted by the
Commissioner of Financial Institutions of Puerto Rico (or his delegate)
after September 22, 1989. However, the taxpayer may choose to apply
Sec. 1.936-10T(c) for periods before June 12, 1991.
[T.D. 8350, 56 FR 21927, May 13, 1991]
Sec. 1.936-11 New lines of business prohibited.
(a) In general. A possessions corporation that is an existing credit
claimant, as defined in section 936(j)(9)(A) and this section, that adds
a substantial new line of business during a taxable year, or that has a
new line of business that becomes substantial during the taxable year,
loses its status as an existing credit claimant for that year and all
years subsequent.
(b) New line of business--(1) In general. A new line of business is
any business activity of the possessions corporation that is not closely
related to a pre-existing business of the possessions corporation. The
term closely related is defined in paragraph (b)(2) of this section. The
term pre-existing business is defined in paragraph (b)(3) of this
section.
(2) Closely related. To determine whether a new activity is closely
related to a pre-existing business of the possessions corporation all
the facts and circumstances must be considered, including those set
forth in paragraphs (b)(2)(i)(A) through (G) of this section.
(i) Factors. The following factors will help to establish that a new
activity is closely related to a pre-existing business activity of the
possessions corporation--
(A) The new activity provides products or services very similar to
the products or services provided by the pre-existing business;
(B) The new activity markets products and services to the same class
of customers;
(C) The new activity is of a type that is normally conducted in the
same business location;
(D) The new activity requires the use of similar operating assets;
(E) The new activity's economic success depends on the success of
the pre-existing business;
(F) The new activity is of a type that would normally be treated as
a unit with the pre-existing business' in the business accounting
records; and
(G) The new activity and the pre-existing business are regulated or
licensed by the same or similar governmental authority.
(ii) Safe harbors. An activity is not a new line of business if--
(A) If the activity is within the same six-digit North American
Industry Classification System (NAICS) code (or four-digit Standard
Industrial Classification (SIC) code). The similarity of
[[Page 196]]
the NAICS or SIC codes may not be relied upon to determine whether the
activity is closely related to a pre-existing business where the code
indicates a miscellaneous category;
(B) If the new activity is within the same five-digit NAICS code (or
three-digit SIC code) and the facts relating to the new activity also
satisfy at least three of the factors listed in paragraphs (b)(2)(i)(A)
through (G) of this section; or
(C) If the pre-existing business is making a component product or
end-product form, as defined in Sec. 1.936-5(a)(1),Q&A1, and the new
business activity is making an integrated product, or an end-product
form with fewer excluded components, that is not within the same six-
digit NAICS code (or four-digit SIC code) as the pre-existing business
solely because the component product and the integrated product (or two
end-product forms) have different end-uses.
(3) Pre-existing business--(i) In general. Except as provided in
paragraph (b)(3)(ii) of this section, a business activity is a pre-
existing business of the existing credit claimant if--
(A) The existing credit claimant was actively engaged in the
activity within the possession on or before October 13, 1995; and
(B) The existing credit claimant had elected the benefits of the
Puerto Rico and possession tax credit pursuant to an election which was
in effect for the taxable year that included October 13, 1995.
(ii) Acquisition of an existing credit claimant. (A) If all the
assets of one or more trades or businesses of a corporation of an
existing credit claimant are acquired by an affiliated or non-affiliated
existing credit claimant which carries on the business activity of the
predecessor existing credit claimant, the acquired business activity
will be treated as a pre-existing business of the acquiring corporation.
A non-affiliated acquiring corporation will not be bound by any section
936(h) election made by the predecessor existing credit claimant with
respect to that business activity.
(B) Where all of the assets of one or more trades or businesses of a
corporation of an existing credit claimant are acquired by a corporation
that is not an existing credit claimant, the acquiring corporation may
make a section 936(e) election for the taxable year in which the assets
are acquired with the following effects--
(1) The acquiring corporation will be treated as an existing
(2) The activity will be considered a pre-existing business of the
acquiring corporation;
(3) The acquiring corporation will be deemed to satisfy the rules of
section 936(a)(2) for the year of acquisition; and
(4) After making an election under section 936(e), a non-affiliated
acquiring corporation will not be bound by elections under sections
936(a)(4) and (h) made by the predecessor existing credit claimant.
(C) For purposes of this section the assets of a trade or business
are determined at the time of acquisition provided that the transferee
actively conducts the trade or business acquired.
(D) A mere change in the stock ownership of a possessions
corporation will not affect its status as an existing credit claimant
for purposes of this section.
(4) Leasing of Assets. (i) The leasing of assets (and employees to
operate leased assets) will not, for purposes of this section, be
considered a new line of business of the existing credit claimant if--
(A) the existing credit claimant used the leased assets in an active
trade or business for at least five years;
(B) the existing credit claimant does not through its own officers
or staff of employees perform management or operational functions (but
not including operational functions performed through leased employees)
with respect to the leased assets; and
(C) the existing credit claimant does not perform marketing
functions with respect to the leasing of the assets.
(ii) Any income from the leasing of assets not considered a new line
of business pursuant to paragraph (b)(4)(i) of this section will not be
income from the active conduct of a trade or business (and, therefore,
the existing credit claimant may not receive a possession tax credit
with respect to such income).
[[Page 197]]
(5) Timing rule. The tests for a new line of business in this
paragraph (whether the new activity is closely related to a pre-existing
business) are applied only at the end of the taxable year during which
the new activity is added.
(c) Substantial--(1) In general. A new line of business is
considered to be substantial as of the earlier of--
(i) The taxable year in which the possessions corporation derives
more than 15 percent of its gross income from that new line of business
(gross income test); or
(ii) The taxable year in which the possessions corporation directly
uses in that new line of business more than 15 percent of its assets
(assets test).
(2) Gross income test. The denominator in the gross income test is
the amount that is the gross income of the possessions corporation for
the current taxable year, while the numerator is the amount that is the
gross income of the new line of business for the current taxable year.
The gross income test is applied at the end of each taxable year. For
purposes of this test, if a new line of business is added late in the
taxable year, the income is not to be annualized in that year. In the
case of a new line of business acquired through the purchase of assets,
the gross income of such new line of business for the taxable year of
the acquiring corporation that includes the date of acquisition is
determined from the date of acquisition through the end of the taxable
year. In the case of a consolidated group election made pursuant to
section 936(i)(5), the test applies on a company by company basis and
not on a consolidated basis.
(3) Assets test--(i) Computation. The denominator is the adjusted
tax basis of the total assets of the possessions corporation for the
current taxable year. The numerator is the adjusted tax basis of the
total assets utilized in the new line of business for the current
taxable year. The assets test is computed annually using all assets
including cash and receivables.
(ii) Exception. A new line of business of a possessions corporation
will not be treated as substantial as a result of meeting the assets
test if an event that is not reasonably anticipated causes assets used
in the new line of business of the possessions corporation to exceed 15
percent of the adjusted tax basis of the possessions corporation's total
assets. For example, an event that is not reasonably anticipated would
include the destruction of plant and equipment of the pre-existing
business due to a hurricane or other natural disaster, or other similar
circumstances beyond the control of the possessions corporation. The
expiration of a patent is not such an event and will not permit use of
this exception.
(d) Examples. The following examples illustrate the rules described
in paragraphs (a), (b), and (c) of this section. In the following
examples, X Corp. is an existing credit claimant unless otherwise
indicated:
Example 1. X Corp. is a pharmaceutical corporation which
manufactured bulk chemicals (a component product). In March 1997, X
Corp. began to also manufacture pills (e.g., finished dosages or an
integrated product). The new activity provides products very similar to
the products provided by the pre-existing business. The new activity is
of a type that is normally conducted in the same business location as
the pre-existing business. The activity's economic success depends on
the success of the pre-existing business. The manufacture of bulk
chemicals is in NAICS code 325411, Medicinal and Botanical
Manufacturing, while the manufacture of the pills is in NAICS code
325412, Pharmaceutical Preparation Manufacturing. Although the products
have a different end-use, may be marketed to a different class of
customers, and may not use similar operating assets, they are within the
same five-digit NAICS code and the activity also satisfies paragraphs
(b)(2)(i)(A), (C), and (E) of this section. The manufacture of the pills
by X Corp. will be considered closely related to the manufacture of the
bulk chemicals. Therefore, X Corp. will not be considered to have added
a new line of business for purposes of paragraph (b) of this section
because it falls within the safe harbor rule of (b)(2)(ii)(B).
Example 2. X Corp. currently manufactures printed circuit boards in
a possession. As a result of a technological breakthrough, X Corp. could
produce the printed circuit boards more efficiently if it modified its
existing production methods. Because demand for its products was high, X
Corp. expanded when it modified its production methods. After these
modifications to the facilities and production methods, the products
produced through the new technology were in the same six-digit NAICS
code as products
[[Page 198]]
produced previously by X Corp. See paragraph (b)(2)(ii)(A) of this
section. Therefore, X Corp. will not be considered to have added a new
line of business for purposes of paragraph (b) of this section because
it falls within the safe harbor rule of (b)(2)(ii)(A).
Example 3. X Corp. has manufactured Device A in Puerto Rico for a
number of years and began to manufacture Device B in Puerto Rico in
1997. Device A and Device B are both used to conduct electrical current
to the heart and are both sold to cardiologists. There is no significant
change in the type of activity conducted in Puerto Rico after the
transfer of the manufacturing of Device B to Puerto Rico. Similar
manufacturing equipment, manufacturing processes and skills are used in
the manufacture of both devices. Both are regulated and licensed by the
Food and Drug Administration. The economic success of Device B is
dependent upon the success of Device A only to the extent that the
liability and manufacturing prowess with respect to one reflects
favorably on the other. Depending upon the heart abnormality, the
cardiologist may choose to use Device A, Device B or both on a patient.
The manufacture of Device B is treated as a unit with the manufacture of
Device A in X Corp.'s accounting records. The manufacture of Device A is
in the six-digit NAICS code 339112, Surgical and Medical Instrument
Manufacturing. The manufacture of Device B is in the six-digit NAICS
code 334510, Electromedical and Electrotherapeutic Apparatus
Manufacturing. (The manufacture of Device A is in the four-digit SIC
code 3845, Electromedical and Electrotherapeutic Apparatus. The
manufacture of Device B is in the four-digit SIC code 3841, Surgical and
Medical Instruments and Apparatus.) The safe harbor of paragraph
(b)(2)(ii)(B) of this section applies because the two activities are
within the same three-digit SIC code and Corp. X satisfies paragraphs
(b)(2)(i)(A), (B), (C), (D), (F), and (G) of this section.
Example 4. X Corp. has been manufacturing house slippers in Puerto
Rico since 1990. Y Corp. is a U.S. corporation that is not affiliated
with X Corp. and is not an existing credit claimant. Y Corp. has been
manufacturing snack food in the United States. In 1997, X Corp.
purchased the assets of Y Corp. and began to manufacture snack food in
Puerto Rico. House slipper manufacturing is in the six-digit NAICS code
316212 (Four-digit SIC code 3142, House Slippers). The manufacture of
snack foods falls under the six-digit NAICS code 311919, Other Snack
Food Manufacturing (four-digit SIC code 2052, Cookies and Crackers
(pretzels)). Because these activities are not within the same five or
six digit NAICS code (or the same three or four-digit SIC code), and
because snack food is not an integrated product that contains house
slippers, the safe harbor of paragraph (b)(2)(ii) of this section cannot
apply. Considering all the facts and circumstances, including the seven
factors of paragraph (b)(2)(i) of this section, the snack food
manufacturing activity is not closely related to the manufacture of
house slippers, and is a new line of business, within the meaning of
paragraph (b) of this section.
Example 5. X Corp., a calendar year taxpayer, is an existing credit
claimant that has elected the profit-split method for computing taxable
income. P Corp. was not an existing credit claimant and manufactured a
product in a different five-digit NAICS code than the product
manufactured by X Corp. In 1997, X Corp. acquired the stock of P Corp.
and liquidated P Corp. in a tax-free liquidation under section 332, but
continued the business activity of P Corp. as a new business segment.
Assume that this new business segment is a new line of business within
the meaning of paragraph (c) of this section. In 1997, X Corp. has gross
income from the active conduct of a trade or business in a possession
computed under section 936(a)(2) of $500 million and the adjusted tax
basis of its assets is $200 million. The new business segment had gross
income of $60 million, or 12 percent of the X Corp. gross income, and
the adjusted basis of the new segment's assets was $20 million, or 10
percent of the X Corp. total assets. In 1997, X Corp. does not derive
more than 15 percent of its gross income, or directly use more that 15
percent of its total assets, from the new business segment. Thus, the
new line of business acquired from P Corp. is not a substantial new line
of business within the meaning of paragraph (c) of this section, and the
new activity will not cause X Corp. to lose its status as an existing
credit claimant during 1997. In 1998, however, the gross income of X
Corp. grew to $750 million while the gross income of the new line of
business grew to $150 million, or 20% of the X Corp. 1998 gross income.
Thus, in 1998, the new line of business is substantial within the
meaning of paragraph (c) of this section, and X Corp. loses its status
as an existing credit claimant for 1998 and all years subsequent.
(e) Loss of status as existing credit claimant. An existing credit
claimant that adds a substantial new line of business in a taxable year,
or that has a new line of business that becomes substantial in a taxable
year, loses its status as an existing credit claimant for that year and
all years subsequent.
(f) Effective date--(1) General rule. This section applies to
taxable years of a possessions corporation beginning on or after January
25, 2000.
[[Page 199]]
(2) Election for retroactive application. Taxpayers may elect to
apply retroactively all the provisions of this section for any open
taxable year beginning after December 31, 1995. Such election will be
effective for the year of the election and all subsequent taxable years.
This section will not apply to activities of pre-existing businesses for
taxable years beginning before January 1, 1996.
[T.D. 8868, 65 FR 3815, Jan. 25, 2000]
china trade act corporations
Sec. 1.941-1 Special deduction for China Trade Act corporations.
In addition to the deductions from taxable income otherwise allowed
such a corporation, a China Trade Act corporation is, under certain
conditions, allowed an additional deduction in computing taxable income.
This special deduction is an amount equal to the proportion of the
taxable income derived from sources within Formosa and Hong Kong
(determined without regard to this section and determined in a manner
similar to that provided in part I (section 861 and following),
subchapter N, chapter 1 of the Code, and the regulations thereunder)
which the par value of the shares of stock of the corporation, owned on
the last day of the taxable year by (a) persons resident in Formosa,
Hong Kong, the United States, or possessions of the United States, and
(b) individual citizens of the United States wherever resident, bears to
the par value of the whole number of shares of stock of the corporation
outstanding on that date. The decrease, by reason of such deduction, in
the tax imposed by section 11 must not, however, exceed the amount of
the special dividend referred to in section 941 (b), and is not
allowable unless the special dividend has been certified to the
Commissioner by the Secretary of Commerce.
Sec. 1.941-2 Meaning of terms used in connection with China Trade
Act corporations.
(a) A China Trade Act corporation is one organized under the
provisions of the China Trade Act, 1922 (15 U.S.C. chapter 4).
(b) The term ``special dividend'' means the amount which is
distributed as a dividend to or for the benefit of such persons as on
the last day of the taxable year were resident in Formosa, Hong Kong,
the United States, or possessions of the United States, or were
individual citizens of the United States, and owned shares of stock of
the corporation. Such dividend must be distributed prior to or at the
time fixed by law for filing the return of the corporation, including
the period of any extension of time granted under rules and regulations
prescribed by the Commissioner with the approval of the Secretary or his
delegate. Such special dividend does not include any other amounts
payable or to be payable to such persons or for their benefit by reason
of their interest in the corporation and must be made in proportion to
the par value of the shares of stock of the corporation owned by each.
(c) For the purposes of section 941, the shares of stock of a China
Trade Act corporation are considered to be owned by the person in whom
the equitable right to the income from such shares is in good faith
vested.
(d) ``Taxable income derived from sources within Formosa and Hong
Kong'' is the sum of the taxable income from sources wholly within
Formosa and Hong Kong and that portion of the taxable income from
sources partly within and partly without Formosa and Hong Kong which may
be allocated to sources within Formosa and Hong Kong. The method of
computing this income is similar to that described in part I (section
861 and following), subchapter N, chapter 1 of the Code, and the
regulations thereunder.
Sec. 1.941-3 Illustration of principles.
The application of section 941 may be illustrated by the following
example:
Example. (1) The A Company, a China Trade Act corporation, has
taxable income (computed without regard to the deduction under section
941) for the calendar year 1954 of $200,000 and receives no dividends
from domestic corporations. All of its stock on December 31, 1954, is
owned on that date by persons resident in Formosa, Hong Kong, the United
States, or possessions of the United States, or individual citizens of
the United States. It distributes a special dividend amounting to
$100,000 on February 15, 1955,
[[Page 200]]
which is certified by the Secretary of Commerce as provided in section
941(b). For the purpose of the tax imposed by section 11, it is
necessary in this example to make two computations, first, without
allowing the special deduction from taxable income on account of income
derived from sources within Formosa and Hong Kong, and, second, allowing
such deduction. The computations are as follows:
(2) First computation; without allowing the special deduction from
taxable income.
Taxable income............................................... $200,000
Normal tax (section 11 (b)).................................. 60,000
Surtax (section 11 (c))...................................... 38,500
Total income tax............................................. 98,500
(3) Second computation; allowing the special deduction from taxable
income.
Taxable income............................................. $200,000
Since the total taxable income is derived from sources within Formosa
and Hong Kong and since the par value of the shares of stock of the
corporation owned on the last day of the taxable year by (a) persons
resident in Formosa, Hong Kong, the United States, or possessions of the
United States, and (b) individual citizens of the United States wherever
resident, is 100 percent of the par value of the total number of shares
of stock of the corporation outstanding on that day, 100 percent of such
taxable income is deductible.
Special deduction from taxable income...................... $200,000
Amount of income subject to tax under section 11........... None
(4) Since the special dividend ($100,000) exceeds the diminution of
the tax ($98,500) on account of the allowance of the special deduction
from taxable income, the entire amount of the special deduction is
allowable and the corporation has no income tax liability for 1954.
Sec. 1.943-1 Withholding by a China Trade Act corporation.
Dividends paid by a China Trade Act corporation to a nonresident
alien individual, foreign partnership, or foreign corporation are
subject to withholding of tax at source under Sec. 1.1441-1. However,
see paragraph (c) of Sec. 1.1441-4 for exemption applicable to
dividends paid to residents of Formosa or Hong Kong.
[T.D. 6908, 31 FR 16769, Dec. 31, 1966]
controlled foreign corporations
Sec. 1.951-1 Amounts included in gross income of United States shareholders.
(a) In general. If a foreign corporation is a controlled foreign
corporation (within the meaning of section 957) for an uninterrupted
period of 30 days or more (determined under paragraph (f) of this
section) during any taxable year of such corporation beginning after
December 31, 1962, every person--
(1) Who is a United States shareholder (as defined in section 951(b)
and paragraph (g) of this section) of such corporation at any time
during such taxable year, and
(2) Who owns (within the meaning of section 958(a)) stock in such
corporation on the last day, in such year, on which such corporation is
a controlled foreign corporation shall include in his gross income for
his taxable year in which or with which such taxable year of the
corporation ends, the sum of--
(i) Except as provided in section 963, such shareholder's pro rata
share (determined under paragraph (b) of this section) of the
corporation's subpart F income (as defined in section 952) for such
taxable year of the corporation,
(ii) Such shareholder's pro rata share (determined under paragraph
(c)(1) of this section) of the corporation's previously excluded subpart
F income withdrawn from investment in less developed countries for such
taxable year of the corporation,
(iii) Such shareholder's pro rata share (determined under paragraph
(c)(2) of this section) of the corporation's previously excluded subpart
F income withdrawn from investment in foreign base company shipping
operations for such taxable year of the corporation, and
(iv) Such shareholder's pro rata share (determined under paragraph
(d) of this section) of the corporation's increase in earnings invested
in United States property for such taxable year of the corporation (but
only to the extent such pro rata share is not excluded from such
shareholder's gross income for his taxable year under section
959(a)(2)).
For purposes of determining whether a United States shareholder which is
a domestic corporation is a personal holding company under section 542
and Sec. 1.542-1, the character of the amount includible in gross
income of such domestic corporation under this paragraph shall be
determined as if such amount were realized directly by such corporation
from the source from which it is realized by the controlled
[[Page 201]]
foreign corporation. See paragraph (a) of Sec. 1.957-2 for special
limitation on the amount of subpart F income in the case of a controlled
foreign corporation described in section 957(b). See section 970(a) and
Sec. 1.970-1 which provides for the reduction of subpart F income of
export trade corporations.
(b) Limitation on a United States shareholder's pro rata share of
subpart F income--(1) In general. For purposes of paragraph (a)(2)(i) of
this section, a United States shareholder's pro rata share (determined
in accordance with the rules of paragraph (e) of this section) of the
foreign corporation's subpart F income for the taxable year of such
corporation is--
(i) The amount which would have been distributed with respect to the
stock which such shareholder owns (within the meaning of section 958(a))
in such corporation if on the last day, in such corporation's taxable
year, on which such corporation is a controlled foreign corporation it
had distributed pro rata to its shareholders an amount which bears the
same ratio to its subpart F income for such taxable year as the part of
such year during which such corporation is a controlled foreign
corporation bears to the entire taxable year, reduced by--
(ii) The amount of distributions received by any other person during
such taxable year as a dividend with respect to such stock, but only to
the extent that such distributions do not exceed the dividend which
would have been received by such other person if the distributions by
such corporation to all its shareholders had been the amount which bears
the same ratio to the subpart F income of such corporation for the
taxable year as the part of such year during which such shareholder did
not own (within the meaning of section 958(a)) such stock bears to the
entire taxable year.
(2) Illustrations. The application of this paragraph may be
illustrated by the following examples:
Example 1. A, a United States shareholder, owns 100 percent of the
only class of stock of M, a controlled foreign corporation throughout
1963. Both A and M Corporation use the calendar year as a taxable year.
For 1963, M Corporation derives $100 of subpart F income, has $100 of
earnings and profits, and makes no distributions. A must include $100 in
his gross income for 1963 under section 951(a)(1)(A)(i).
Example 2. The facts are the same as in example 1, except that
instead of holding 100 percent of the stock of M Corporation for the
entire year, A sells 60 percent of such stock to B, a nonresident alien,
on May 26, 1963. Thus, M Corporation is a controlled foreign corporation
for the period January 1, 1963, through May 26, 1963. A must include $40
($100x146/365) in his gross income for 1963 under section
951(a)(1)(A)(i).
Example 3. The facts are the same as in example 1, except that
instead of holding 100 percent of the stock of M Corporation for the
entire year, A holds 60 percent of such stock on December 31, 1963,
having acquired such interest on May 26, 1963, from B, a nonresident
alien, who owned such interest from January 1, 1963. Before A's
acquisition of such stock, M Corporation had distributed a dividend of
$15 to B in 1963 with respect to such stock. A must include $21 in his
gross income for 1963 under section 951(a)(1)(A)(i), such amount being
determined as follows:
Corporation M's Subpart F income for 1963....................... $100
Less: Reduction under section 951(a)(2)(A) for period (1-1-63 40
through 5-26-63) during which M Corporation is not a controlled
foreign corporation ($100x146/365).............................
---------
Subpart F income for 1963 as limited by section 951(a)(2)(A).... 60
A's pro rata share of subpart F income as determined under 36
section 951 (a)(2)(A) (60 percent of $60)......................
Less: Reduction under section 951(a)(2)(B) for dividends
received by B during 1963 with respect to the stock acquired by
A in M Corporation:
(i) Dividend received by B............................ 15 ......
(ii) B's pro rata share of the amount which bears the 24 ......
same ratio to M Corporation's subpart F income for
1963 ($100) as the period during which A did not own
(within the meaning of section 958(a)) his stock (146
days) bears to the entire taxable year (365 days) (60
percent of ($100x146/365))...........................
(iii) Amount of reduction (lesser of (i) or (ii))..... ...... 15
-------
A's pro rata share of Subpart F income as determined under 21
section 951(a)(2)..............................................
Example 4. A, a United States shareholder, owns 100 percent of the
only class of stock of P, a controlled foreign corporation throughout
1963, and P owns 100 percent of the only class of stock of R, a
controlled foreign corporation throughout 1963. A and Corporations P and
R each use the calendar year as a taxable year. For 1963, R Corporation
derives $100 of subpart F income, has $100 of earnings and profits, and
distributes a dividend of $20 to P Corporation. Corporation P has no
income for 1963 other than the dividend received from R Corporation. A
must include $100 in his gross income for 1963 under section
951(a)(1)(A)(i) as subpart F income of R Corporation for such year. Such
[[Page 202]]
subpart F income is not reduced under section 951(a)(2)(B) for the
dividend of $20 paid to P Corporation because there was no part of the
year 1963 during which A did not own (within the meaning of section
958(a)) the stock of R Corporation. By reason of the application of
section 959(b), the $20 distribution from R Corporation to P Corporation
is not again includible in the gross income of A under section 951(a).
Example 5. The facts are the same as in example 4, except that
instead of holding the stock of R Corporation for the entire year, P
Corporation acquires 60 percent of the only class of stock of R
Corporation on March 14, 1963, from C, a nonresident alien, after R
Corporation distributes in 1963 a dividend of $35 to C with respect to
the stock so acquired by P Corporation. The stock interest so acquired
by P Corporation was owned by C from January 1, 1963, until acquired by
P Corporation. A must include $36 in his gross income for 1963 under
section 951(a)(1)(A)(i), such amount being determined as follows:
Corporation R's Subpart F income for 1963...................... $100
Less: Reduction under section 951(a)(2)(A) for period (1-1-63 20
through 3-14-63) during which R Corporation is not a
controlled foreign corporation ($100x73/365)..................
----------
Subpart F income for 1963 as limited by section 951(a)(2)(A)... 80
A's pro rata share of subpart F income as determined under 48
section 951 (a)(2)(A) (60 percent of $80).....................
Less: Reduction under section 951(a)(2)(B) for dividends
received by C during 1963 with respect to the stock indirectly
acquired by A in R Corporation:
(i) Dividend received by C.......................... 35 .......
(ii) C's pro rata share of the amount which bears 12 .......
the same ratio to R Corporation's Subpart F income
for 1963 ($100) as the period during which A did
not indirectly own (within the meaning of section
958(a)(2)) his stock (73 days) bears to the entire
taxable year (365 days) (60 percent of ($100x73/
365))..............................................
----------
(iii) Amount of reduction (lesser of (i) or (ii))... ....... 12
--------
A's pro rata share of Subpart F income as determined under 36
section 951 (a)(2)............................................
(c) Limitation on a United States shareholder's pro rata share of
previously excluded subpart F income withdrawn from investments--(1)
Investments in less developed countries. For purposes of paragraph
(a)(2)(ii) of this section, a United States shareholder's pro rata share
(determined in accordance with the rules of paragraph (e) of this
section) of the foreign corporation's previously excluded subpart F
income withdrawn from investment in less developed countries for the
taxable year of such corporation shall not exceed an amount which bears
the same ratio to such shareholder's pro rata share of such income
withdrawn (as determined under section 955(a)(3), as in effect before
the enactment of the Tax Reduction Act of 1975, and paragraph (c) of
Sec. 1.955-1) for such taxable year as the part of such year during
which such corporation is a controlled foreign corporation bears to the
entire taxable year. See paragraph (c)(2) of Sec. 1.955-1 for a special
rule applicable to exclusions and withdrawals occurring before the date
on which the United States shareholder acquires his stock.
(2) Investments in foreign base company shipping operations. For
purposes of paragraph (a)(2)(iii) of this section, a United States
shareholder's pro rata share (determined in accordance with the rules of
paragraph (e) of this section) of the foreign corporation's previously
excluded subpart F income withdrawn from investment in foreign base
company shipping operations for the taxable year of such corporation
shall not exceed an amount which bears the same ratio to such
shareholder's pro rata share of such income withdrawn (as determined
under section 955(a)(3) and paragraph (c) of Sec. 1.955A-1) for such
taxable year as the part of such year during which such corporation is a
controlled foreign corporation bears to the entire taxable year. See
paragraph (c)(2) of Sec. 1.955A-1 for a special rule applicable to
exclusions and withdrawals occurring before the date on which the United
States shareholder acquires his stock.
(d) Limitation on a United States shareholder's pro rata share of
increase in investment in United States property. For purposes of
paragraph (a)(2)(iv) of this section, a United States shareholder's pro
rata share (determined in accordance with the rules of paragraph (e) of
this section) of the foreign corporation's increase in earnings invested
in United States property for the taxable year of such corporation shall
not exceed an amount which bears the same ratio to such shareholder's
pro rata share of such increase (as determined under section 956(a)(2)
and paragraph (c) of Sec. 1.956-1) for such taxable year as the part of
such year during which such
[[Page 203]]
corporation is a controlled foreign corporation bears to the entire
taxable year. The amount determined under the preceding sentence,
however, shall be taken into account under paragraph (a)(2)(iv) of this
section only to the extent such amount is not excluded from such
shareholder's gross income for his taxable year under section 959(a)(2)
and the regulations thereunder.
(e) ``Pro rata share'' defined--(1) In general. For purposes of
paragraphs (b), (c), and (d) of this section, a United States
shareholder's pro rata share of a controlled foreign corporation's
subpart F income, previously excluded subpart F income withdrawn from
investment in less developed countries, previously excluded subpart F
income withdrawn from investment in foreign base company shipping
operations, or increase in earnings invested in United States property,
respectively, for any taxable year is his pro rata share determined
under paragraph (a) of Sec. 1.952-1, paragraph (c) of Sec. 1.955-1,
paragraph (c) of Sec. 1.955A-1, or paragraph (c) of Sec. 1.956-1,
respectively.
(2) More than one class of stock. If a controlled foreign
corporation for a taxable year has more than one class of stock
outstanding, the amount of such corporation's subpart F income,
withdrawal, or increase in investment, for the taxable year which shall
be taken into account with respect to any one class of such stock for
purposes of subparagraph (1) of this paragraph shall be that amount
which bears the same ratio to the total of such subpart F income,
withdrawal, or increase in investment for such year as the earnings and
profits which would be distributed with respect to such class of stock
if all earnings and profits of such corporation for such year were
distributed on the last day of such corporation's taxable year on which
such corporation is a controlled foreign corporation bear to the total
earnings and profits of such corporation for such taxable year. For
purposes of the preceding sentence, if an arrearage in dividends for
prior taxable years exists with respect to a class of preferred stock of
such corporation, the earnings and profits for the taxable year shall be
attributed to such arrearage only to the extent such arrearage exceeds
the earnings and profits of such corporation remaining from prior
taxable years beginning after December 31, 1962.
(3) Discretionary power to allocate earnings to different classes of
stock. If the allocation of a foreign corporation's earnings and profits
for the taxable year between two or more classes of stock depends upon
the exercise of discretion by that body of persons which exercises with
respect to such corporation the powers ordinarily exercised by the board
of directors of a domestic corporation, the allocation of earnings and
profits to such classes shall be made for purposes of this paragraph as
if such classes constituted one class of stock in which each share has
the same rights to dividends as any other share, unless a different
method of allocation of earnings and profits is established as proper by
the United States shareholder.
(4) Illustrations. The application of this paragraph may be
illustrated by the following examples:
Example 1. Throughout its taxable year 1964, controlled foreign
corporation A has outstanding 40 shares of common stock and 60 shares of
6-percent, nonparticipating, nonvoting, preferred stock with a par value
of $100 per share. D, a United States citizen who uses the calendar year
as a taxable year, owns 30 shares of the common, and 15 shares of the
preferred, stock during 1964: Corporation A for 1964 has earnings and
profits of $1,000, and income of $500 with respect to which amounts are
required to be included in gross income of United States shareholders
under section 951(a). In such case, if the total $1,000 of earnings and
profits were distributed on December 31, 1964, $360 (0.06x$100x60) would
be distributed with respect to A Corporation's preferred stock and $640
($1,000 minus $360) would be distributed with respect to its common
stock. Accordingly, of the $500 with respect to which amounts are
required to be included in gross income of United States shareholders
under section 951(a), $180 ($360/$1,000x $500) is allocated to the
outstanding preferred stock and $320 ($640/$1,000x$500) is allocated to
the outstanding common stock. D's pro rata share of such amounts for
1964 is $285 [($180x15/60)+($320x 30/40)].
Example 2. The facts are the same as in example 1, except that the
preferred stock is cumulative and there is an arrearage in dividends
with respect to such stock of $900; on December 31, 1963, Corporation A
has accumulated earnings and profits for 1963 of $700; therefore, for
purposes of this paragraph, Corporation A's earnings and profits for
1964
[[Page 204]]
attributable to such arrearage may not exceed $200 ($900 minus $700). In
such case, for purposes of this paragraph, if the $1,000 earnings and
profits for 1964 were distributed on December 31, 1964, $560
[(0.06x$100x60)+$200] would be distributed with respect to A
Corporation's preferred stock and $440 ($1,000 minus $560) would be
distributed with respect to its common stock. Accordingly, of the $500
with respect to which amounts are required to be included in gross
income of United States shareholders under section 951 (a), $280 ($560/
$1,000x$500) is allocated to the outstanding preferred stock and $220
($440/ $1,000x$500) is allocated to the outstanding common stock. D's
pro rata share of such amounts for 1964 is $235 [($280x15/ 60)+($220x30/
40)].
(f) Determination of holding period. For purposes of sections 951
through 964, the holding period of an asset (including stock of a
controlled foreign corporation) shall be determined by excluding the day
on which such asset is acquired and including the day on which such
asset is disposed of. The application of this paragraph may be
illustrated by the following example:
Example. On June 30, 1963, United States person E acquires 70 of the
100 shares of the only class of stock of foreign corporation A from
nonresident alien B, who until such time owns all such 100 shares. E
sells 10 shares of stock of such corporation on November 30, 1963, and
60 shares on December 31, 1963, to nonresident alien F. Corporation A is
a controlled foreign corporation for the period beginning with July 1,
1963, and extending through December 31, 1963. As to the 10 shares of
stock sold on November 30, 1963, E is treated as not owning such shares
at any time after November 30, 1963, nor before July 1, 1963. As to the
remaining 60 shares of stock, E is treated as not owning them before
July 1, 1963, or after December 31, 1963.
(g) United States shareholder defined-- (1) In general. For purposes
of sections 951 through 964, the term ``United States shareholder''
means, with respect to a foreign corporation, a United States person (as
defined in section 957(d)) who owns within the meaning of section
958(a), or is considered as owning by applying the rules of ownership of
section 958(b), 10 percent or more of the total combined voting power of
all classes of stock entitled to vote of such foreign corporation.
(2) Percentage of total combined voting power owned by United States
person--(i) Meaning of combined voting power. In determining for
purposes of subparagraph (1) of this paragraph whether a United States
person owns the requisite percentage of voting power of all classes of
stock entitled to vote, consideration will be given to all the facts and
circumstances in each case. In any case where--
(a) A foreign corporation has more than one class of stock
outstanding, and
(b) One or more United States persons own (within the meaning of
section 958) shares of any one class of stock which possesses the power
to elect, appoint, or replace a person, or persons, who with respect to
such corporation, exercise the powers ordinarily exercised by a member
of the board of directors of a domestic corporation,
the percentage of the total combined voting power with respect to such
corporation owned by any such United States person shall be his
proportionate share of the percentage of the persons exercising the
powers ordinarily exercised by members of the board of directors of a
domestic corporation (described in (b) of this subdivision) which such
class of stock (as a class) possesses the power to elect, appoint, or
replace. In all cases, however, a United States person will be deemed to
own 10 percent or more of the total combined voting power with respect
to a foreign corporation if such person owns (within the meaning of
section 958) 20 percent or more of the total number of shares of a class
of stock of such corporation possessing one or more powers enumerated in
paragraph (b)(1) of Sec. 1.957-1. Whether a foreign corporation is a
controlled foreign corporation for purposes of sections 951 through 964
shall be determined by applying the rules of section 957 and Sec. Sec.
1.957-1 through 1.957-4.
(ii) Illustration. The application of this paragraph may be
illustrated by the following examples:
Example 1. Foreign corporation S has two classes of capital stock
outstanding, consisting of 60 shares of class A stock and 40 shares of
class B stock. Each class of the outstanding stock is entitled to
participate on a share for share basis in any dividend distributions by
S Corporation. The owners of a majority of the class A stock are
entitled to elect 7 of the 10 corporate directors, and the owners of a
majority of the class B
[[Page 205]]
stock are entitled to elect the other 3 of the 10 directors. Thus, the
class A stock (as a class) possesses 70 percent of the total combined
voting power of all classes of stock entitled to vote of S Corporation,
and the class B stock (as a class) possesses 30 percent of such voting
power. D, a United States person, owns 31 shares of the class A stock
and thus owns 36,167 percent (31/60x70 percent) of the total combined
voting power of all classes of stock entitled to vote of S Corporation.
By reason of the ownership of such voting power, D is a United States
shareholder of S Corporation under section 951(b). For purposes of
section 957, S Corporation is a controlled foreign corporation by reason
of D's ownership of a majority of the class A stock, as illustrated in
example 2 of paragraph (c) of Sec. 1.957-1. E, a United States person,
owns eight shares of the class A stock and thus owns 9.333 percent (8/
60x70 percent) of the total combined voting power of all classes of
stock entitled to vote of S Corporation. Since E owns only 9.333 percent
of such voting power and less than 20 percent of the number of shares of
the class A stock, he is not a United States shareholder of S
Corporation under section 951(b). F, a United States person, owns 14
shares of the class B stock and thus owns 10.5 percent (14/40x30
percent) of the total combined voting power of all classes of stock
entitled to vote of S Corporation. By reason of the ownership of such
voting power, F is a United States shareholder of S Corporation under
section 951(b).
Example 2. Foreign corporation R has three classes of stock
outstanding, consisting of 10 shares of class A stock, 20 shares of
class B stock, and 300 shares of class C stock. Each class of the
outstanding stock is entitled to participate on a share for share basis
in any distribution by R Corporation. The owners of a majority of the
class A stock are entitled to elect 6 of the 10 corporate directors, and
the owners of a majority of the class B stock are entitled to elect the
other 4 of the 10 directors. The class C stock is not entitled to vote.
D, E, and F, United States persons, each own 2 shares of the class A
stock and 100 shares of the class C stock. As owners of a majority of
the class A stock, D, E, and F elect 6 members of the board of
directors. D, E, and F are United States shareholders of R Corporation
under section 951(b) since each owns 20 percent of the total number of
shares of the class A stock which possesses the power to elect a
majority of the board of directors of R Corporation. For purposes of
section 957, R Corporation is a controlled foreign corporation by reason
of the ownership by D, E, and F of a majority of the class A stock, as
illustrated in example 2 of paragraph (c) of Sec. 1.957-1.
[T.D. 6795, 30 FR 935, Jan. 29, 1965, as amended by T.D. 7893, 48 FR
22507, May 19, 1983]
Sec. 1.951-2 Coordination of subpart F with election of a foreign
investment company to distribute income.
A United States shareholder who for his taxable year is a qualified
shareholder (within the meaning of section 1247(c)) of a foreign
investment company with respect to which an election under section
1247(a) and the regulations thereunder is in effect for the taxable year
of such company which ends with or within such taxable year of such
shareholder shall not be required to include any amount in his gross
income for his taxable year under paragraph (a) of Sec. 1.951-1 with
respect to such company for that taxable year of such company.
[T.D. 6795, 30 FR 937, Jan. 29, 1965]
Sec. 1.951-3 Coordination of subpart F with foreign personal holding
company provisions.
A United States shareholder (as defined in section 951(b)) who is
required under section 551(b) to include in his gross income for his
taxable year his share of the undistributed foreign personal holding
company income for the taxable year of a foreign personal holding
company (as defined in section 552) which for that taxable year is a
controlled foreign corporation (as defined in section 957) shall not be
required to include in his gross income for his taxable year under
section 951(a) and paragraph (a) of Sec. 1.951-1 any amount
attributable to the earnings and profits of such corporation for that
taxable year of such corporation. If a foreign corporation is both a
foreign personal holding company and a controlled foreign corporation
for the same period which is only a part of its taxable year, then, for
purposes of applying the immediately preceding sentence, such
corporation shall be deemed to be, for such part of such year, a foreign
personal holding company and not a controlled foreign corporation and
the earnings and profits of such corporation for the taxable year shall
be deemed to be that amount which bears the same ratio to its earnings
and profits for the taxable year as such part of the taxable year bears
to the entire taxable year. The application of this section may be
illustrated by the following examples:
[[Page 206]]
Example 1. A, a United States shareholder, owns 100 percent of the
only class of stock of controlled foreign corporation M which, in turn,
owns 100 percent of the only class of stock of controlled foreign
corporation N. A and Corporations M and N use the calendar year as a
taxable year. During 1963, N Corporation derives $40,000 of gross income
all of which is foreign personal holding company income within the
meaning of section 553; thus, N Corporation is a foreign personal
holding company for such year within the meaning of section 552(a). For
1963, N Corporation has undistributed foreign personal holding company
income (as defined in section 556(a)) of $30,000, derives $25,000 of
subpart F income, and has earnings and profits of $32,000. During 1963,
M Corporation derives $100,000 of gross income (including as a dividend
under section 555(c)(2) the $30,000 of N Corporation's undistributed
foreign personal holding company income), 65 percent of which is foreign
personal holding company income within the meaning of section 553.
Therefore, M Corporation is a foreign personal holding company for such
year. For 1963, M Corporation has undistributed foreign personal holding
company income (as defined in section 556(a)) of $90,000, determined by
taking into account under section 552(c)(1) N Corporation's $30,000 of
undistributed foreign personal holding company income for such year; in
addition, M Corporation derives $50,000 of subpart F income and has
earnings and profits of $92,000. Neither M Corporation nor N Corporation
makes any actual distributions during 1963. A is required under section
551(b) to include in his gross income for 1963 as a dividend the $90,000
of M Corporation's undistributed foreign personal holding company income
for such year. For 1963, A is not required to include in his gross
income under section 951(a) any of the $50,000 subpart F income of M
Corporation or of the $25,000 subpart F income of N Corporation.
Example 2. The facts are the same as in example 1, except that only
45 percent of M Corporation's gross income (determined by including
under section 555(c)(2) the $30,000 of N Corporation's undistributed
foreign personal holding company income) is foreign personal holding
company income within the meaning of section 553; accordingly, M
Corporation is not a foreign personal holding company for 1963. Since
for such year M Corporation is not a foreign personal holding company,
the undistributed foreign personal holding company income ($30,000) of N
Corporation is not required under section 555(b) to be included in the
gross income of M Corporation for 1963; as a result, such income is not
required under section 551(b) to be included in the gross income of A
for such year even though N Corporation is a foreign personal holding
company for that year. For 1963, A is required to include $75,000 in his
gross income under section 951(a)(1)(A)(i) and paragraph (a) of Sec.
1.951-1, consisting of the $50,000 subpart F income of M Corporation and
the $25,000 subpart F income of N Corporation.
Example 3. The facts are the same as in example 1, except that in
1963 N Corporation actually distributes $30,000 to M Corporation and M
Corporation, in turn, actually distributes $90,000 to A. Under section
556 the undistributed foreign personal holding company income of both M
corporation and N Corporation is thus reduced to zero; accordingly, no
amount is included in the gross income of A under section 551(b) by
reason of his interest in corporations M and N. A must include $75,000
in his gross income for 1963 under section 951(a)(1)(A)(i) and paragraph
(a) of Sec. 1.951-1, consisting of the $50,000 subpart F income of M
Corporation and the $25,000 subpart F income of N Corporation. Of the
$90,000 distribution received by A from M Corporation, $75,000 is
excludable from his gross income under section 959(a)(1) as previously
taxed earnings and profits; the remaining $15,000 is includible in his
gross income for 1963 as a dividend.
Example 4. (a) A, a United States shareholder, owns 100 percent of
the only class of stock of controlled foreign corporation P, organized
on January 1, 1963. Both A and P Corporation use the calendar year as a
taxable year. During 1963, 1964, and 1965, P Corporation is not a
foreign personal holding company as defined in section 552(a); in each
of such years, P Corporation derives dividend income of $10,000 which
constitutes foreign personal holding company income (within the meaning
of Sec. 1.954-2) but under 26 CFR 1.954-1(b)(1) (Revised as of April 1,
1975) excludes such amounts from foreign base company income as
dividends received from, and reinvested in, qualified investments in
less developed countries. Corporation P's earnings and profits
accumulated for 1963, 1964, and 1965 and determined under paragraph
(b)(2) of Sec. 1.955-1 are $40,000. For 1966, P Corporation is a
foreign personal holding company, has predistribution earnings and
profits of $10,000, derives $10,000 of income which is both foreign
personal holding company income within the meaning of section 553 and
subpart F income within the meaning of section 952, distributes $8,000
to A, and has undistributed foreign personal holding company income of
$2,000 within the meaning of section 556. In addition, for 1966 P
Corporation has a withdrawal (determined under section 955(a) as in
effect before the enactment of the Tax Reduction Act of 1975 but without
regard to its earnings and profits for such year) of $25,000 of
previously excluded subpart F income from investment in less developed
countries. A is required under section 551(b) to include in his gross
income for 1966 as a dividend the $2,000 undistributed foreign personal
holding company income. The $8,000
[[Page 207]]
distribution is includible in A's gross income for 1966 under sections
61(a)(7) and 301 as a distribution to which section 316(a)(2) applies.
Corporation P's $25,000 withdrawal of previously excluded subpart F
income from investment in less developed countries is includible in A's
gross income for 1966 under section 951(a)(1)(A)(ii) and paragraph
(a)(2) of Sec. 1.951-1.
(b) If P Corporation's earnings and profits accumulated for 1963,
1964, and 1965 were $15,000, instead of $40,000, the result would be the
same as in paragraph (a) of this example, except that a withdrawal of
only $15,000 of previously excluded subpart F income from investment in
less developed countries would be includible in A's gross income for
1966 under section 951(a)(1)(A)(ii) and paragraph (a)(2) of Sec. 1.951-
1.
(c) The principles of this example also apply to withdrawals
(determined under section 955(a), as in effect before the enactment of
the Tax Reduction Act of 1975) of previously excluded subpart F income
from investment in less developed countries effected after the effective
date of such Act, and to withdrawals (determined under section 955(a),
as amended by such Act) of previously excluded subpart F income from
investment in foreign base company shipping operations.
Example 5. (a) The facts are the same as in paragraph (a) of example
4, except that, instead of having a $25,000 decrease in qualified
investments in less developed countries for 1966, P Corporation invests
$20,000 in tangible property (not described in section 956(b)(2))
located in the United States and such investment constitutes an increase
(determined under section 956(a) but without regard to the earnings and
profits of P Corporation for 1966) in earnings invested in United States
property. Corporation P's earnings and profits accumulated for 1963,
1964, and 1965 and determined under paragraph (b)(1) of Sec. 1.956-1
are $22,000. The result is the same as in paragraph (a) of example 4,
except that instead of including the $25,000 withdrawal, A must include
$20,000 in his gross income for 1966 under section 951(a)(1)(B) and
paragraph (a)(2)(iv) of Sec. 1.951-1 as an investment of earnings in
United States property.
(b) If P Corporation's earnings and profits accumulated for 1963,
1964, and 1965 were $9,000 instead of $22,000, the result would be the
same as in paragraph (a) of this example, except that only $9,000 would
be includible in A's gross income for 1966 under section 951(a)(1)(B)
and paragraph (a)(2)(iv) of Sec. 1.951-1 as an investment of earnings
in United States property.
[T.D. 6795, 30 FR 937, Jan. 29, 1965, as amended by T.D. 7893, 48 FR
22508, May 19, 1983]
Sec. 1.952-1 Subpart F income defined.
(a) In general. For purposes of sections 951 through 964, a
controlled foreign corporation's subpart F income for any taxable year
shall, except as provided in paragraph (b) of this section and subject
to the limitations of paragraphs (c) and (d) of this section, consist of
the sum of--
(1) The income derived by such corporation for such year from the
insurance of United States risks (determined in accordance with the
provisions of section 953 and Sec. Sec. 1.953-1 through 1.953-6),
(2) The income derived by such corporation for such year which
constitutes foreign base company income (determined in accordance with
the provisions of section 954 and Sec. Sec. 1.954-1 through 1.954-8),
(3)(i) An amount equal to the product of--
(A) The income of such corporation other than income which--
(1) Is attributable to earnings and profits of the foreign
corporation included in the gross income of a United States person under
section 951 (other than by reason of this paragraph) (determined in
accordance with the provisions of section 951 and Sec. 1.951-1), or
(2) Is described in section 952(b),
multiplied by
(B) The international boycott factor determined in accordance with
the provisions of section 999(c)(1), or
(ii) In lieu of the amount determined under paragraph (a)(3)(i) of
this section, the amount described under section 999(c)(2) of such
international boycott income, and
(4) The sum of the amount of any illegal bribes, kickbacks, or other
payments paid after November 3, 1976, by or on behalf of the corporation
during the taxable year of the corporation directly or indirectly to an
official, employee, or agent in fact of a government. An amount is paid
by a controlled foreign corporation where it is paid by an officer,
director, employee, shareholder or agent of such corporation for the
benefit of such corporation. For purposes of this section, the
principles of section 162(c) and the regulations thereunder shall apply.
In the case of payments made after September 3, 1982, a payment is
illegal if the payment would be unlawful under the Foreign Corrupt
Practices Act of 1977 if the payor were a United States
[[Page 208]]
person. The fair market value of an illegal payment made in the form of
property or services shall be considered the amount of such illegal
payment.
Pursuant to section 951(a)(1)(A)(i) and Sec. 1.951-1, a United States
shareholder of such controlled foreign corporation must include his pro
rata share of such subpart F income in his gross income for his taxable
year in which or with which such taxable year of the foreign corporation
ends. See section 952(a). However, see paragraph (a) of Sec. 1.957-2
for special rule limiting the subpart F income to the income derived
from the insurance of United States risks in the case of certain
controlled foreign corporations described in section 957(b).
(b) Exclusion of U.S. income--(1) Taxable years beginning before
January 1, 1967. For rules applicable to taxable years beginning before
January 1, 1967, see 26 CFR 1.952-1(b)(1) (Revisedof April 1, 1975).
(2) Taxable years beginning after December 31, 1966. Notwithstanding
paragraph (a) of this section, a controlled foreign corporation's
subpart F income for any taxable year beginning after December 31, 1966,
shall not include any item of income from sources within the United
States which is effectively connected for that year with the conduct by
such corporation of a trade or business in the United States unless,
pursuant to a treaty to which the United States is a party, such item of
income either is exempt from the income tax imposed by chapter 1
(relating to normal taxes and surtaxes) of the Code or is subject to
such tax at a reduced rate.
Thus, for example, dividends received from sources within the United
States by a foreign corporation engaged in business in the United States
during the taxable year, which are not effectively connected for that
year with the conduct of a trade or business in the United States by
that corporation, shall not be excluded from subpart F income under
section 952(b) and this subparagraph even though such dividends are
subject to the tax of 30 percent imposed by section 881 (a). Also, for
example, if, by reason of an income tax convention to which the United
States is a party, an amount of interest from sources within the United
States which is effectively connected for the taxable year with the
conduct of a business in the United States by a foreign corporation is
subject to tax under chapter 1 at a flat rate of 15 percent, as provided
in Sec. 1.871-12, such interest is not excluded from subpart F income
under section 952(b) and this subparagraph. The deductions attributable
to items of income which are excluded from subpart F income under this
subparagraph shall not be taken into account for purposes of section
952.
(3) Rule applicable under section 956 (b)(2). For purposes only of
paragraph (b)(1))(viii) of Sec. 1.956-2, an item of income derived by a
controlled foreign corporation from sources within the United States
with respect to which for the taxable year a tax is imposed in
accordance with section 882(a) shall be considered described in section
952(b) whether or not such item of income would have constituted subpart
F income for such year.
(c) Limitation on a controlled foreign corporation's subpart F
income--(1) In general. A United States shareholder's pro rata share
(determined in accordance with the rules of paragraph (e) of Sec.
1.951-1) of a controlled foreign corporation's subpart F income for any
taxable year shall not exceed his pro rata share of the earnings and
profits (as defined in section 964(a) and Sec. 1.964-1) of such
corporation for such taxable year, computed as of the close of such
taxable year without diminution by reason of any distributions made
during such taxable year, minus the sum of--
(i) The amount, if any, by which such shareholder's pro rata share
of--
(a) The sum of such corporation's deficits in earnings and profits
for prior taxable years beginning after December 31, 1962, plus
(b) The sum of such corporation's deficits in earnings and profits
for taxable years beginning after December 31, 1959, and before January
1, 1963 (reduced by the sum of the earnings and profits (as so defined)
of such corporation for any of such taxable years) exceeds
(c) The sum of such corporation's earnings and profits for prior
taxable years beginning after December 31,
[[Page 209]]
1962, which, with respect to such shareholder, are allocated to other
earnings and profits under section 959(c)(3) and Sec. 1.959-3; and
(ii) Such shareholder's pro rata share of any deficits in earnings
and profits of other foreign corporations for a taxable year beginning
after December 31, 1962, which are attributable to stock of such other
foreign corporations owned by such shareholder within the meaning of
section 958(a) and which, in accordance with section 952(d) and
paragraph (d) of this section, are taken into account as a reduction in
the controlled foreign corporation's earnings and profits for such
taxable year.
For purposes of applying this subparagraph, the reduction (if any)
provided by subdivision (i) of this subparagraph in a United States
shareholder's pro rata share of the earnings and profits of a controlled
foreign corporation shall be taken into account before the reduction
provided by subdivision (ii) of this subparagraph. See section 952(c).
(2) Special rules. For purposes only of determining the limitation
under subparagraph (1) of this paragraph on a United States
shareholder's pro rata share of a controlled foreign corporation's
subpart F income for any taxable year--
(i) Status of foreign corporation. The earnings and profits, or
deficit in earnings and profits, of a foreign corporation for any
taxable year shall be taken into account whether or not such foreign
corporation is a controlled foreign corporation at the time such
earnings and profits are derived or such deficit in earnings and profits
is incurred.
(ii) Deficits in earnings and profits taken into account only once.
A controlled foreign corporation's deficit in earnings and profits for
any taxable year preceding the taxable year shall be taken into account
for the taxable year only to the extent such deficit has not been taken
into account under this paragraph, paragraph (d) of this section, or
paragraph (d)(2)(ii) of Sec. 1.963-2 (applied as if section 963 had not
been repealed by the Tax Reduction Act of 1975) in computing a minimum
distribution, for any taxable year preceding the taxable year, to reduce
earnings and profits of such preceding year of such controlled foreign
corporation or of any other controlled foreign corporation. To the
extent a controlled foreign corporation's (the ``first corporation'')
excess foreign base company shipping deductions for any taxable year
(determined under Sec. 1.955A-3(c)(2)(i)) reduce the foreign base
company shipping income of another member of a related group (as defined
in Sec. 1.955A-2(b)), such deductions shall not be taken into account
in determining the earnings and profits or deficits in earnings and
profits of such first corporation for such taxable year for purposes of
this paragraph (c) and paragraph (d) of this section. The rule of the
preceding sentence shall not apply to the extent the excess foreign base
company shipping deductions of the first corporation reduce the foreign
base company shipping income of another member of a related group below
zero.
(iii) Determination of pro rata share. A United States shareholder's
pro rata share of a controlled foreign corporation's earnings and
profits, or deficit in earnings and profits, for any taxable year shall
be determined in accordance with the principles of paragraph (e) of
Sec. 1.951-1 and paragraph (d)(2)(ii) of Sec. 1.963-2.
(3) Illustrations. The application of this paragraph may be
illustrated by the following examples:
Example 1. (a) A is a United States shareholder who owns 100 percent
of the only class of stock of M Corporation, a controlled foreign
corporation organized on January 1, 1963. Both A and M Corporation use
the calandar year as a taxable year.
(b) During 1963, M Corporation derives $20,000 of subpart F income
and has earnings and profits of $30,000. Corporation M makes no
distributions to A during such year. The limitation under section 952(c)
on M Corporation's subpart F income for 1963 is $30,000; and $20,000 is
includible in A's gross income for such year under section
951(a)(1)(A)(i).
(c) On January 1, 1964, M Corporation acquires 100 percent of the
only class of stock of N Corporation, a controlled foreign corporation
which uses the calendar year as a taxable year. During 1964, N
Corporation derives $6,000 of subpart F income, has $7,000 of earnings
and profits, and distributes $5,000 to M Corporation. The limitation
under section 952(c) on N Corporation's subpart F income
[[Page 210]]
for 1964 is $7,000; and $6,000 of subpart F income is includible in A's
gross income for such year under section 951(a)(1)(A)(i).
(d) During 1964, M Corporation derives $8,000 of rents which
constitute subpart F income, makes a $10,000 distribution to A, and has
earnings and profits of $12,000 (including the $5,000 dividend received
from N Corporation). The limitation under section 952(c) on M
Corporation's subpart F income for 1964 is $7,000, determined as
follows:
Corporation M's earnings and profits for 1964 (determined $12,000
under section 964(a) and Sec. 1.964-1 as of the close of
such year without diminution for any distributions made
during such year).........................................
Less: Corporation M's earnings and profits for 1964 5,000
described in section 959(b)...............................
------------
Limitation on M Corporation's Subpart F income for 1964.... 7,000
Thus, for 1964 with respect to A's interest in M Corporation, $7,000 of
subpart F income is includible in his gross income under section
951(a)(1)(A)(i). The $10,000 dividend received from M Corporation is
excludible from A's gross income for 1964 under section 959(a)(1) and
paragraph (b) of Sec. 1.959-1.
Example 2. A is a United States shareholder who owns 100 percent of
the only class of stock of R Corporation which was organized on January
1, 1961. R Corporation is a controlled foreign corporation for the
entire period after December 31, 1962, here involved. Both A and R
Corporation use the calendar year as a taxable year. During 1963, R
Corporation derives $25,000 of subpart F income and has $50,000 of
earnings and profits. Corporation R has $15,000 of earnings and profits
for 1961, and a deficit in earnings and profits of $45,000 for 1962.
Thus, R Corporation has as of December 31, 1963, a net deficit in
earnings and profits of $30,000 for the years 1961 and 1962. Corporation
R makes no distributions to A during 1963. The limitation under section
952(c) on R Corporation's subpart F income for 1963 is $20,000 ($50,000
minus $30,000), and $20,000 of subpart F income is includible in A's
gross income for 1963 under section 951(a)(1)(A)(i). During 1964, R
Corporation derives $18,000 of subpart F income and has $30,000 of
earnings and profits. Corporation R makes no distributions to A during
1964. The entire $18,000 of subpart F income is includible in A's gross
income for 1964 under section 951(a)(1)(A)(i).
(d) Treatment of deficits in earnings and profits attributable to
stock of other foreign corporation indirectly owned by a United States
shareholder--(1) In general. For purposes of paragraph (c)(1)(ii) of
this section, if--
(i) A United States shareholder owns (within the meaning of section
958(a)) stock in two or more foreign corporations in a chain of foreign
corporations (as defined in subparagraph (2)(ii) of this paragraph), and
(ii) Any of the corporations in such chain has a deficit in earnings
and profits for a taxable year beginning after December 31, 1962,
then, with respect to such shareholder and only for purposes of
determining the limitation on subpart F income under paragraph (c) of
this section, the earnings and profits for the taxable year of each such
foreign corporation which is a controlled foreign corporation shall, in
accordance with the rules of subparagraph (2) of this paragraph, be
reduced to take into account any deficit in earnings and profits
referred to in subdivision (ii) of this subparagraph. See section
952(d).
(2) Special rules. For purposes of this paragraph--
(i) Applicable rules. The special rules set forth in paragraph
(c)(2) of this section shall apply.
(ii) ``Chain'' defined. A chain of foreign corporations shall, with
respect to a United States shareholder, include--
(a) Any foreign corporation in which such shareholder owns (within
the meaning of section 958(a)(1)(A)) stock but, only to the extent of
the stock so owned and
(b) All foreign corporations in which such shareholder owns (within
the meaning of section 958(a)(2)) stock, but only to the extent of the
stock so owned by reason of his ownership of the stock referred to in
(a) of this subdivision.
(iii) Allocation of deficit. If one or more foreign corporations
(whether or not a controlled foreign corporation) includible in a chain
of foreign corporations has a deficit in earnings and profits
(determined under section 964(a) and Sec. 1.964-1) for the taxable
year, the amount of deficit taken into account under section 952(d) with
respect to a United States shareholder in such chain as a reduction in
earnings and profits for the taxable year of a controlled foreign
corporation includible in such chain shall be an amount which bears the
same ratio to such shareholder's pro rata share of the total deficit in
earnings and profits for the taxable year of all includible foreign
corporations as his pro rata share of the
[[Page 211]]
earnings and profits (determined under paragraph (c) of this section but
without regard to the provisions of subparagraph (1)(ii) of such
paragraph) for the taxable year of such includible controlled foreign
corporation bears to his pro rata share of the total earnings and
profits (as so determined under paragraph (c) of this section) for the
taxable year of all includible controlled foreign corporations. The
amount of deficit taken into account under this subdivision with respect
to any controlled foreign corporation includible in a chain of foreign
corporations shall not exceed the United States shareholder's pro rata
share of the controlled foreign corporation's earnings and profits for
the taxable year.
(iv) Taxable year. The taxable year from which a deficit is
allocated under this paragraph, and the taxable year to which such
deficit is allocated to reduce earnings and profits, shall be the
taxable year of the foreign corporation ending with or within the
taxable year of the United States shareholder described in subparagraph
(1)(i) of this paragraph.
(3) Illustration. The application of this paragraph may be
illustrated by the following examples:
Example 1. (a) Domestic corporation M owns 100 percent, 20 percent,
and 100 percent, respectively, of the only class of stock of foreign
corporations A, B, and F, respectively. Corporation A owns 80 percent of
the only class of stock of each of foreign corporations B and C,
respectively. Corporation F owns 20 percent of such stock of C
Corporation. Corporation B owns 75 percent of the only class of stock of
foreign corporation D, and 50 percent of the only class of stock of each
of foreign corporations G and H, respectively. C Corporation owns 75
percent of the only class of stock of foreign corporation E. All the
corporations use the calendar year as a taxable year, and all of the
foreign corporations, except corporations G and H, are controlled
foreign corporations throughout the period here involved.
(b) The subpart F income, and the earnings and profits (determined
under paragraph (c) of this section but without regard to subparagraph
(1)(ii) of such paragraph) or deficit in earnings and profits
(determined under section 964(a) and Sec. 1.964-1), of each of the
foreign corporations for 1963 are as follows, the deficits being set
forth in parentheses:
------------------------------------------------------------------------
Earnings
Subpart F and
income profits
(deficits)
------------------------------------------------------------------------
A Corporation................................... $6,000 $18,000
B Corporation................................... .......... (7,500)
C Corporation................................... .......... (2,500)
D Corporation................................... 4,000 5,000
E Corporation................................... 12,000 15,000
F Corporation................................... 8,000 20,250
G Corporation................................... .......... (10,000)
H Corporation................................... .......... 7,000
------------------------------------------------------------------------
(c) The chains of foreign corporations (within the meaning of
subparagraph (2)(ii) of this paragraph) for 1963 are the ``A'' chain,
consisting of corporations, A, B, C, D, E, G, and H, but only to the
extent of M Corporation's stock interest in such corporations under
section 958(a) by reason of its ownership of stock in A Corporation; the
``B'' chain, consisting of corporations B, D, G, and H, but only to the
extent of M Corporation's stock interest in such corporations under
section 958(a) by reason of its ownership of stock in B Corporation; and
the ``F'' chain, consisting of corporations F, C, and E, but only to the
extent of M Corporation's stock interest in such corporations under
section 958(a) by reason of its ownership of stock in F Corporation.
(d) Corporation M's stock interest under section 958(a) in each of
the chains of foreign corporations is as follows for 1963:
[In percent]
----------------------------------------------------------------------------------------------------------------
A B C D E F G H
----------------------------------------------------------------------------------------------------------------
A chain:
Direct interest............................... 100 ...... ...... ...... ...... ...... ...... ......
(100%x80%).................................... ...... 80 ...... ...... ...... ...... ...... ......
(100%x80%).................................... ...... ...... 80 ...... ...... ...... ...... ......
(80%x75%)..................................... ...... ...... ...... 60 ...... ...... ...... ......
(80%x75%)..................................... ...... ...... ...... ...... 60 ...... ...... ......
(80%x50%)..................................... ...... ...... ...... ...... ...... ...... 40 ......
(80%x50%)..................................... ...... ...... ...... ...... ...... ...... ...... 40
B chain:
Direct interest............................... ...... 20 ...... ...... ...... ...... ...... ......
(20%x75%)..................................... ...... ...... ...... 15 ...... ...... ...... ......
(20%x50%)..................................... ...... ...... ...... ...... ...... ...... 10 ......
(20%x50%)..................................... ...... ...... ...... ...... ...... ...... ...... 10
F chain:
Direct interest............................... ...... ...... ...... ...... ...... 100 ...... ......
(100%x20%).................................... ...... ...... 20 ...... ...... ...... ...... ......
[[Page 212]]
(20%x75%)..................................... ...... ...... ...... ...... 15 ...... ...... ......
---------
Total interests.............................. 100 100 100 75 75 100 50 50
----------------------------------------------------------------------------------------------------------------
(e) Corporation M's pro rata share of the earnings and profits
(determined under paragraph (c) of this section but without regard to
subparagraph (1)(ii) of such paragraph), or of the deficit, of each
controlled foreign corporation of each foreign corporation,
respectively, includible in the respective chains for 1963 is as
follows:
------------------------------------------------------------------------
Earnings
and profits Deficit
------------------------------------------------------------------------
A chain:
A Corporation (100%)........................ $18,000 ...........
B Corporation (80%)......................... ........... ($6,000)
C Corporation (80%)......................... ........... (2,000)
D Corporation (60%)......................... 3,000 ...........
E Corporation (60%)......................... 9,000 ...........
G Corporation (40%)......................... ........... (4,000)
H Corporation (40%)......................... (\1\) ...........
--------------
Total...................................... 30,000 (12,000)
==============
B chain:
B Corporation (20%)......................... ........... ($1,500)
D Corporation (15%)......................... $750 ...........
G Corporation (10%)......................... ........... (1,000)
H Corporation (10%)......................... (\1\) ...........
--------------
Total...................................... $750 ($2,500)
==============
F chain:
F Corporation (100%)........................ 20,250 ...........
C Corporation (20%)......................... ........... (500)
E Corporation (15%)......................... 2,250 ...........
--------------
Total...................................... $22,500 (500)
------------------------------------------------------------------------
\1\ The earnings and profits of H Corporation are not included in the
total earnings and profits for the chain because H Corporation is not
a controlled foreign corporation.
(f) The amount by which M Corporation's pro rata share of the
earnings and profits for 1963 of the controlled foreign corporations in
each respective chain shall be reduced under section 952(d) by M
Corporation's pro rata share of the deficits of corporations B, C, and G
for 1963 is determined as follows:
Amount of
reduction
A chain:
A Corporation ($12,000x$18,000/$30,000).................. $7,200
D Corporation ($12,000x$3,000/$30,000)................... 1,200
E Corporation ($12,000x$9,000/$30,000)................... 3,600
--------------
Total................................................... 12,000
==============
B chain:
D Corporation ($2,500x$750/$750)............ $2,500 ...........
Limitation: M Corporation's pro-rata share 750 ...........
of D Corporation's earnings and profits....
Allocation of used deficit ($750) to M
Corporation's pro rata share of the
deficits of corporations B and G:
B Corporation ($750x ($1,500/$2,500))..... $450 ...........
G Corporation ($750x ($1,000/$2,500))..... 300 ...........
-------------
Total.................................... 750 $750
==============
F chain:
F Corporation ($500x$20,250/$22,500)..................... 450
E Corporation ($500x$2,250/$22,500)...................... 50
--------------
Total................................................... 500
(g) Corporation M's pro rata share of the earnings and profits
(determined after reduction for deficits under section 952(d)) for 1963
of each controlled foreign corporation in the respective chains,
determined on a chain-by-chain basis, is determined as follows:
------------------------------------------------------------------------
Earnings
and Reduction Reduced
profits (sec. earnings
before 952(d)) and
reduction profits
------------------------------------------------------------------------
A chain:
A Corporation........................ $18,000 $7,200 $10,800
D Corporation........................ 3,000 1,200 1,800
E Corporation........................ 9,000 3,600 5,400
B chain: D Corporation................. 750 750 .........
F chain:
F Corporation........................ 20,250 450 19,800
E Corporation........................ 2,250 50 2,200
------------------------------------------------------------------------
(h) Corporation M's pro rata share of each controlled foreign
corporation's subpart F income, limited as provided by section 952(c)
and paragraph (c) of this section, for 1963 which is includible in its
gross income for such year under section 951(a)(1)(A)(i) and Sec.
1.951-1 is determined as follows:
------------------------------------------------------------------------
Earnings
Subpart F and Amount
income profit includible
(before (sec. 952 in income
limitation) (c))
------------------------------------------------------------------------
A Corporation (100%)................ $6,000 $10,800 $6,000
D Corporation (75%) 3,000 1,800 1,800
E Corporation (75%) 9,000 7,600 7,600
F Corporation (100%) 8,000 19,800 8,000
--------------
[[Page 213]]
Total includible under sec. ........... ......... 23,400
951(a)(1)(A)(i)..................
------------------------------------------------------------------------
Example 2. The facts are the same as in example 1 except that, in
addition, for 1964, foreign corporations C, D, and E have no subpart F
income and no earnings and profits and foreign corporations G and H have
no earnings and profits. For 1964, B Corporation has subpart F income of
$1,000 and earnings and profits (determined in accordance with section
964(a) and Sec. 1.964-1) of $1,500; A Corporation has subpart F income
of $800 and earnings and profits of $1,000; and F Corporation has
subpart F income of $500 and earnings and profits of $1,000. Such
earnings and profits are determined without regard to distributions for
1964. Corporation B has an unused deficit in earnings and profits of
$1,050 for 1963 ($1,500 minus $450) applicable to M Corporation's
interest in such corporation (paragraph (f) of example 1), and, under
paragraph (c)(1)(i)(a) of this section, with respect to M Corporation,
such deficit reduces B Corporation's earnings and profits for 1964 to
$450. Inasmuch as G Corporation is not a controlled foreign corporation
for 1964, such corporation's unused deficit in earnings and profits of
$700 for 1963 ($1,000 minus $300) applicable to M Corporation's interest
in such corporation (paragraph (f) of example 1) may be used under
paragraph (c)(1)(i)(a) of this section to reduce M Corporation's
interest in G Corporation's earnings and profits in a later year or
years for which G Corporation is a controlled foreign corporation.
Corporation M's pro rata share of each controlled foreign corporation's
subpart F income, limited as provided by section 952(c) and paragraph
(c) of this section, for 1964 which is includible in its gross income
for such year under section 951(a)(1)(A)(i) and Sec. 1.951-1 is
determined as follows:
------------------------------------------------------------------------
Earnings
Subpart F and Amount
income profits includible
(before (sec. in income
limitation) 952(c))
------------------------------------------------------------------------
A Corporation....................... $800 $1,000 $800
B Corporation....................... 1,000 450 450
F Corporation....................... 500 1,000 500
------------------------------------------------------------------------
Example 3. The facts are the same as in example 2, except that for
1964 B Corporation has subpart F income of $550 and earnings and profits
(determined in accordance with section 964(a) and Sec. 1.964-1) of
$550; such earnings and profits are determined without regard to
distributions for 1964. Under paragraph (c)(1)(i)(a) of this section, B
Corporation's unused deficit of $1,050 for 1963 reduces its earnings and
profits for 1964 with respect to M Corporation to zero. The remaining
$500 of the unused deficit for 1963 applicable to M Corporation's
interest in B Corporation may be used under paragraph (c)(1)(i)(a) of
this section in later years to reduce M Corporation's interest in B
Corporation's earnings and profits.
(e) Application of current earnings and profits limitation--(1) In
general. If the subpart F income (as defined in section 952(a)) of a
controlled foreign corporation exceeds the foreign corporation's
earnings and profits for the taxable year, the subpart F income
includible in the income of the corporation's United States shareholders
is reduced under section 952(c)(1)(A) in accordance with the following
rules. The excess of subpart F income over current year earnings and
profits shall--
(i) First, proportionately reduce subpart F income in each separate
category of the controlled foreign corporation, as defined in Sec.
1.904-5(a)(1), in which current earnings and profits are zero or less
than zero;
(ii) Second, proportionately reduce subpart F income in each
separate category in which subpart F income exceeds current earnings and
profits; and
(iii) Third, proportionately reduce subpart F income in other
separate categories.
(2) Allocation to a category of subpart F income. An excess amount
that is allocated under paragraph (e)(1) of this section to a separate
category must be further allocated to a category of subpart F income if
the separate category contains more than one category of subpart F
income described in section 952(a) or, in the case of foreign base
company income, described in Sec. 1.954-1(c)(1)(iii)(A) (1) or (2). In
such case, the excess amount that is allocated to the separate category
must be allocated to the various categories of subpart F income within
that separate category on a proportionate basis.
(3) Recapture of subpart F income reduced by operation of earnings
and profits limitation. Any amount in a category of subpart F income
described in section 952(a) or, in the case of foreign base company
income, described in Sec. 1.954-1(c)(1)(iii)(A) (1) or (2) that is
reduced by operation of the current year earnings and profits limitation
of section 952(c)(1)(A) and this paragraph (e)
[[Page 214]]
shall be subject to recapture in a subsequent year under the rules of
section 952(c)(2) and paragraph (f) of this section.
(4) Coordination with sections 953 and 954. The rules of this
paragraph (e) shall be applied after the application of sections 953 and
954 and the regulations under those sections, except as provided in
Sec. 1.954-1(d)(4)(ii).
(5) Earnings and deficits retain separate limitation character. The
income reduction rules of paragraph (e)(1) of this section shall apply
only for purposes of determining the amount of an inclusion under
section 951(a)(1)(A) from each separate category as defined in Sec.
1.904-5(a)(1) and the separate categories in which recapture accounts
are established under section 952(c)(2) and paragraph (f) of this
section. For rules applicable in computing post-1986 undistributed
earnings, see generally section 902 and the regulations under that
section. For rules relating to the allocation of deficits for purposes
of computing foreign taxes deemed paid under section 960 with respect to
an inclusion under section 951(a)(1)(A), see Sec. 1.960-1(i).
(f) Recapture of subpart F income in subsequent taxable year--(1) In
general. If a controlled foreign corporation's subpart F income for a
taxable year is reduced under the current year earnings and profits
limitation of section 952(c)(1)(A) and paragraph (e) of this section,
recapture accounts will be established and subject to recharacterization
in any subsequent taxable year to the extent the recapture accounts were
not previously recharacterized or distributed, as provided in paragraphs
(f)(2) and (3) of this section.
(2) Rules of recapture--(i) Recapture account. If a category of
subpart F income described in section 952(a) or, in the case of foreign
base company income, described in Sec. 1.954-1(c)(1)(iii)(A) (1) or (2)
is reduced under the current year earnings and profits limitation of
section 952(c)(1)(A) and paragraph (e) of this section for a taxable
year, the amount of such reduction shall constitute a recapture account.
(ii) Recapture. Each recapture account of the controlled foreign
corporation will be recharacterized, on a proportionate basis, as
subpart F income in the same separate category (as defined in Sec.
1.904-5(a)(1)) as the recapture account to the extent that current year
earnings and profits exceed subpart F income in a taxable year. The
United States shareholder must include his pro rata share (determined
under the rules of Sec. 1.951-1(e)) of each recharacterized amount in
income as subpart F income in such separate category for the taxable
year.
(iii) Reduction of recapture account and corresponding earnings.
Each recapture account, and post-1986 undistributed earnings in the
separate category containing the recapture account, will be reduced in
any taxable year by the amount which is recharacterized under paragraph
(f)(2)(ii) of this section. In addition, each recapture account, and
post-1986 undistributed earnings in the separate category containing the
recapture account, will be reduced in the amount of any distribution out
of that account (as determined under the ordering rules of section
959(c) and paragraph (f)(3)(ii) of this section).
(3) Distribution ordering rules--(i) Coordination of recapture and
distribution rules. If a controlled foreign corporation distributes an
amount out of earnings and profits described in section 959(c)(3) in a
year in which current year earnings and profits exceed subpart F income
and there is an amount in a recapture account for such year, the
recapture rules will apply first.
(ii) Distributions reduce recapture accounts first. Any distribution
made by a controlled foreign corporation out of earnings and profits
described in section 959(c)(3) shall be treated as made first on a
proportionate basis out of the recapture accounts in each separate
category to the extent thereof (even if the amount in the recapture
account exceeds post-1986 undistributed earnings in the separate
category containing the recapture account). Any remaining distribution
shall be treated as made on a proportionate basis out of the remaining
earnings and profits of the controlled foreign corporation in each
separate category. See section 904(d)(3)(D).
(4) Examples. The application of paragraphs (e) and (f) of this
section may be illustrated by the following examples:
[[Page 215]]
Example 1. (i) A, a U.S. person, is the sole shareholder of CFC, a
controlled foreign corporation formed on January 1, 1998, whose
functional currency is the u. In 1998, CFC earns 100u of foreign base
company sales income that is general limitation income described in
section 904(d)(1)(I) and incurs a (200u) loss attributable to activities
that would have produced general limitation income that is not subpart F
income. In 1998 CFC also earns 100u of foreign personal holding company
income that is passive income described in section 904(d)(1)(A), and
100u of foreign personal holding company income that is dividend income
subject to a separate limitation described in section 904(d)(1)(E) for
dividends from a noncontrolled section 902 corporation. CFC's subpart F
income for 1998, 300u, exceeds CFC's current earnings and profits, 100u,
by 200u. Under section 952(c)(1)(A) and paragraph (e) of this section,
subpart F income is limited to CFC's current earnings and profits of
100u, all of which is included in A's gross income under section
951(a)(1)(A). The 200u of CFC's 1998 subpart F income that is not
included in A's income in 1998 by reason of section 952(c)(1)(A) is
subject to recapture under section 952(c)(2) and paragraph (f) of this
section.
(ii) For purposes of determining the amount and type of income
included in A's gross income and the amount and type of income in CFC's
recapture account, the rules of paragraphs (e)(1) and (2) of this
section apply. Under paragraph (e)(1)(i) of this section, the amount by
which CFC's subpart F income exceeds its earnings and profits for 1998,
200u, first reduces from 100u to 0 CFC's subpart F income in the general
limitation category, which has a current year deficit of (100u) in
earnings and profits. Next, under paragraph (e)(1)(iii) of this section,
the remaining 100u by which CFC's 1998 subpart F income exceeds earnings
and profits is applied proportionately to reduce CFC's subpart F income
in the separate categories for passive income (100u) and dividends from
the noncontrolled section 902 corporation (100u). Thus, A includes 50u
of passive limitation/foreign personal holding company income and 50u of
dividends from the noncontrolled section 902 corporation/foreign
personal holding company income in gross income in 1998. CFC has 100u in
its general limitation/foreign base company sales income recapture
account attributable to the 100u of foreign base company sales income
that is not included in A's income by reason of the earnings and profits
limitation of section 952(c)(1)(A). CFC also has 50u in its passive
limitation recapture account, all of which is attributable to foreign
personal holding company income, and 50u in its recapture account for
dividends from the noncontrolled section 902 corporation, all of which
is attributable to foreign personal holding company income.
(iii) For purposes of computing post-1986 undistributed earnings,
the rules of sections 902 and 960, including the rules of Sec. 1.960-
1(i), apply. Under Sec. 1.960-1(i), the general limitation deficit of
(100u) is allocated proportionately to reduce passive limitation
earnings of 100u and noncontrolled section 902 dividend earnings of
100u. Thus, passive limitation earnings are reduced by 50u to 50u (100u
passive limitation earnings/200u total earnings in positive separate
categories x (100u) general limitation deficit=50u reduction), and the
noncontrolled section 902 corporation earnings are reduced by 50u to 50u
(100u noncontrolled section 902 corporation earnings/200u total earnings
in positive separate categories x (100u) general limitation deficit=50u
reduction). All of CFC's post-1986 foreign income taxes with respect to
passive limitation income and dividends from the noncontrolled section
902 corporation are deemed paid by A under section 960 with respect to
the subpart F inclusions (50u inclusion/50u earnings in each separate
category). After the inclusion and deemed-paid taxes are computed, at
the close of 1998 CFC has a (100u) deficit in general limitation
earnings (100u subpart F earnings + (200u) nonsubpart F loss), 50u of
passive limitation earnings (100u of earnings attributable to foreign
personal holding company income -50u inclusion) with a corresponding
passive limitation/foreign personal holding company income recapture
account of 50u, and 50u of earnings subject to a separate limitation for
dividends from the noncontrolled section 902 corporation (100u earnings
-50u inclusion) with a corresponding noncontrolled section 902
corporation/foreign personal holding company income recapture account of
50u.
Example 2. (i) The facts are the same as in Example 1 with the
addition of the following facts. In 1999, CFC earns 100u of foreign base
company sales income that is general limitation income and 100u of
foreign personal holding company income that is passive limitation
income. In addition, CFC incurs (10u) of expenses that are allocable to
its separate limitation for dividends from the noncontrolled section 902
corporation. Thus, CFC's subpart F income for 1999, 200u, exceeds CFC's
current earnings and profits, 190u, by 10u. Under section 952(c)(1)(A)
and paragraph (e) of this section, subpart F income is limited to CFC's
current earnings and profits of 190u, all of which is included in A's
gross income under section 951(a)(1)(A).
(ii) For purposes of determining the amount and type of income
included in A's gross income and the amount and type of income in CFC's
recapture accounts, the rules of paragraphs (e)(1) and (2) of this
section apply. While CFC's general limitation post-1986 undistributed
earnings for 1999 are 0 ((100u) opening balance + 100u subpart F
income), CFC's general limitation subpart F income (100u) does not
exceed its general
[[Page 216]]
limitation current earnings and profits (100u) for 1999. Accordingly,
under paragraph (e)(1)(iii) of this section, the amount by which CFC's
subpart F income exceeds its earnings and profits for 1999, 10u, is
applied proportionately to reduce CFC's subpart F income in the separate
categories for general limitation income, 100u, and passive income,
100u. Thus, A includes 95u of general limitation foreign base company
sales income and 95u of passive limitation foreign personal holding
company income in gross income in 1999. At the close of 1999 CFC has
105u in its general limitation/foreign base company sales income
recapture account (100u from 1998 + 5u from 1999), 55u in its passive
limitation/foreign personal holding company income recapture account
(50u from 1998 + 5u from 1999), and 50u in its dividends from the
noncontrolled section 902 corporation/foreign personal holding company
income recapture account (all from 1998).
(iii) For purposes of computing post-1986 undistributed earnings in
each separate category, the rules of sections 902 and 960, including the
rules of Sec. 1.960-1(i), apply. Thus, post-1986 undistributed earnings
(or an accumulated deficit) in each separate category are increased (or
reduced) by current earnings and profits or current deficits in each
separate category. The accumulated deficit in CFC's general limitation
earnings and profits (100u) is reduced to 0 by the addition of 100u of
1999 earnings and profits. CFC's passive limitation earnings of 50u are
increased by 100u to 150u, and CFC's noncontrolled section 902
corporation earnings of 50u are decreased by (10u) to 40u. After the
addition of current year earnings and profits and deficits to the
separate categories there are no deficits remaining in any separate
category. Thus, the allocation rules of Sec. 1.960-1(i)(4) do not apply
in 1999. Accordingly, in determining the post-1986 foreign income taxes
deemed paid by A, post-1986 undistributed earnings in each separate
category are unaffected by earnings in the other categories. Foreign
taxes deemed paid under section 960 for 1999 would be determined as
follows for each separate category: with respect to the inclusion of 95u
of foreign base company sales income out of general limitation earnings,
the section 960 fraction is 95u inclusion/0 total earnings; with respect
to the inclusion of 95u of passive limitation income the section 960
fraction is 95u inclusion/150u passive earnings. Thus, no general
limitation taxes would be associated with the inclusion of the general
limitation earnings because there are no accumulated earnings in the
general limitation category. After the deemed-paid taxes are computed,
at the close of 1999 CFC has a (95u) deficit in general limitation
earnings and profits ((100u) opening balance + 100u current earnings -
95u inclusion), 55u of passive limitation earnings and profits (50u
opening balance + 100u current foreign personal holding company income -
95u inclusion), and 40u of earnings and profits subject to the separate
limitation for dividends from the noncontrolled section 902 corporation
(50u opening balance + (10u) expense).
Example 3. (i) A, a U.S. person, is the sole shareholder of CFC, a
controlled foreign corporation whose functional currency is the u. At
the beginning of 1998, CFC has post-1986 undistributed earnings of 275u,
all of which are general limitation earnings described in section
904(d)(1)(I). CFC has no previously-taxed earnings and profits described
in section 959(c)(1) or (c)(2). In 1998, CFC has a (200u) loss in the
shipping category described in section 904(d)(1)(D), 100u of foreign
personal holding company income that is passive income described in
section 904(d)(1)(A), and 125u of general limitation manufacturing
earnings that are not subpart F income. CFC's subpart F income for 1998,
100u, exceeds CFC's current earnings and profits, 25u, by 75u. Under
section 952(c)(1)(A) and paragraph (e) of this section, subpart F income
is limited to CFC's current earnings and profits of 25u, all of which is
included in A's gross income under section 951(a)(1)(A). The 75u of
CFC's 1998 subpart F income that is not included in A's income in 1998
by reason of section 952(c)(1)(A) is subject to recapture under section
952(c)(2) and paragraph (f) of this section.
(ii) For purposes of determining the amount and type of income
included in A's gross income and the amount and type of income in CFC's
recapture account, the rules of paragraphs (e)(1) and (2) of this
section apply. Under paragraph (e)(1) of this section, the amount of
CFC's subpart F income in excess of earnings and profits for 1998, 75u,
reduces the 100u of passive limitation foreign personal holding company
income. Thus, A includes 25u of passive limitation foreign personal
holding company income in gross income, and CFC has 75u in its passive
limitation/foreign personal holding company income recapture account.
(iii) For purposes of computing post-1986 undistributed earnings in
each separate category the rules of sections 902 and 960, including the
rules of Sec. 1.960-1(i), apply. Under Sec. 1.960-1(i), the shipping
limitation deficit of (200u) is allocated proportionately to reduce
general limitation earnings of 400u and passive limitation earnings of
100u. Thus, general limitation earnings are reduced by 160u to 240u
(400u general limitation earnings/500u total earnings in positive
separate categories x (200u) shipping deficit=160u reduction), and
passive limitation earnings are reduced by 40u to 60u (100u passive
earnings/500u total earnings in positive separate categories x (200u)
shipping deficit=40u reduction). Five-twelfths of CFC's post-1986
foreign income taxes with respect to passive limitation earnings are
deemed paid by A under section
[[Page 217]]
960 with respect to the subpart F inclusion (25u inclusion/60u passive
earnings). After the inclusion and deemed-paid taxes are computed, at
the close of 1998 CFC has 400u of general limitation earnings (275u
opening balance + 125u current earnings), 75u of passive limitation
earnings (100u of foreign personal holding company income -25u
inclusion), and a (200u) deficit in shipping limitation earnings.
Example 4. (i) The facts are the same as in Example 3 with the
addition of the following facts. In 1999, CFC earns 50u of general
limitation earnings that are not subpart F income and 75u of passive
limitation income that is foreign personal holding company income. Thus,
CFC has 125u of current earnings and profits. CFC distributes 200u to A.
Under paragraph (f)(3)(i) of this section, the recapture rules are
applied first. Thus, the amount by which 1999 current earnings and
profits exceed subpart F income, 50u, is recharacterized as passive
limitation foreign personal holding company income. CFC's total subpart
F income for 1999 is 125u of passive limitation foreign personal holding
company income (75u current earnings plus 50u recapture account), and
the passive limitation/foreign personal holding company income recapture
account is reduced from 75u to 25u.
(ii) CFC has 150u of previously-taxed earnings and profits described
in section 959(c)(2) (25u attributable to 1998 and 125u attributable to
1999), all of which is passive limitation earnings and profits. Under
section 959(c), 150u of the 200u distribution is deemed to be made from
earnings and profits described in section 959(c)(2). The remaining 50u
is deemed to be made from earnings and profits described in section
959(c)(3). Under paragraph (f)(3)(ii) of this section, the dividend
distribution is deemed to be made first out of the passive limitation
recapture account to the extent thereof (25u). Under paragraph
(f)(2)(iii) of this section, the passive limitation recapture account is
reduced from 25u to 0. The remaining distribution of 25u is treated as
made out of CFC's general limitation earnings and profits.
(iii) For purposes of computing post-1986 undistributed earnings,
the rules of section 902 and 960, including the rules of Sec. 1.960-
1(i), apply. Thus, the shipping limitation accumulated deficit of (200u)
reduces general limitation earnings and profits of 450u and passive
limitation earnings and profits of 150u on a proportionate basis. Thus,
100% of CFC's post-1986 foreign income taxes with respect to passive
limitation earnings are deemed paid by A under section 960 with respect
to the 1999 subpart F inclusion of 125u (100u inclusion (numerator
limited to denominator)/100u passive earnings). No post-1986 foreign
income taxes remain to be deemed paid under section 902 in connection
with the 25u distribution from the passive limitation/foreign personal
holding company income recapture account. One-twelfth of CFC's post-1986
foreign income taxes with respect to general limitation earnings are
deemed paid by A under section 902 with respect to the distribution of
25u general limitation earnings and profits described in section
959(c)(3) (25u inclusion/300u general limitation earnings). After the
deemed-paid taxes are computed, at the close of 1999 CFC has 425u of
general limitation earnings and profits (400u opening balance + 50u
current earnings--25u distribution), 0 of passive limitation earnings
(75u recapture account + 75u current foreign personal holding company
income--125u inclusion--25u distribution), and a (200u) deficit in
shipping limitation earnings.
(5) Effective date. Paragraph (e) of this section and this paragraph
(f) apply to taxable years of a controlled foreign corporation beginning
after March 3, 1997.
(g) Treatment of distributive share of partnership income--(1) In
general. A controlled foreign corporation's distributive share of any
item of income of a partnership is income that falls within a category
of subpart F income described in section 952(a) to the extent the item
of income would have been income in such category if received by the
controlled foreign corporation directly. For specific rules regarding
the treatment of a distributive share of partnership income under
certain provisions of subpart F, see Sec. Sec. 1.954-1(g), 1.954-
2(a)(5), 1.954-3(a)(6), and 1.954-4(b)(2)(iii).
(2) Example. The application of this paragraph (g) may be
illustrated by the following example:
Example. CFC, a controlled foreign corporation, is an 80-percent
partner in PRS, a foreign partnership. PRS earns $100 of interest income
that is not export financing interest as defined in section
954(c)(2)(B), or qualified banking or financing income as defined in
section 954(h)(3)(A), from a person unrelated to CFC. This interest
income would have been foreign personal holding company income to CFC,
under section 954(c), if it had received this income directly.
Accordingly, CFC's distributive share of this interest income, $80, is
foreign personal holding company income.
(3) Effective date. This paragraph (g) applies to taxable years of a
controlled
[[Page 218]]
foreign corporation beginning on or after July 23, 2002.
[T.D. 6795, 30 FR 938, Jan. 29, 1965, as amended by T.D. 6892, 31 FR
11144, Aug. 23, 1966; T.D. 7293, 38 FR 32802, Nov. 28, 1973; T.D. 7545,
43 FR 19652, May 8, 1978; T.D. 7862, 47 FR 56490, Dec. 17, 1982; T.D.
7893, 48 FR 22508, May 19, 1983; T.D. 7894, 48 FR 22516, May 19, 1983;
T.D. 8331, 56 FR 2846, Jan. 25, 1991; T.D. 8704, 62 FR 18, Jan. 2, 1997;
T.D. 9008, 67 FR 48023, July 23, 2002]
Sec. 1.952-2 Determination of gross income and taxable income of
a foreign corporation.
(a) Determination of gross income--(1) In general. Except as
provided in subparagraph (2) of this paragraph, the gross income of a
foreign corporation for any taxable year shall, subject to the special
rules of paragraph (c) of this section, be determined by treating such
foreign corporation as a domestic corporation taxable under section 11
and by applying the principles of section 61 and the regulations
thereunder.
(2) Insurance gross income--(i) Life insurance gross income. The
gross income for any taxable year of a controlled foreign corporation
which is engaged in the business of reinsuring or issuing insurance or
annuity contracts and which, if it were a domestic corporation engaged
only in such business, would be taxable as a life insurance company to
which part I (sections 801 through 820) of subchapter L of chapter 1 of
the Code applies, shall, subject to the special rules of paragraph (c)
of this section, be the sum of--
(a) The gross investment income, as defined under section 804(b),
except that interest which is excluded from gross income under section
103 shall not be taken into account;
(b) The sum of the items taken into account under section 809(c),
except that advance premiums shall not be taken into account; and
(c) The amount by which the net long-term capital gain exceeds the
net short-term capital loss.
(ii) Mutual and other insurance gross income. The gross income for
any taxable year of a controlled foreign corporation which is engaged in
the business of reinsuring or issuing insurance or annuity contracts and
which, if it were a domestic corporation engaged only in such business,
would be taxable as a mutual insurance company to which part II
(sections 821 through 826) of subchapter L of chapter 1 of the Code
applies or as a mutual marine insurance or other insurance company to
which part III (sections 831 and 832) of subchapter L of chapter 1 of
the Code applies, shall, subject to the special rules of paragraph (c)
of this section, be--
(a) The sum of--
(1) The gross income, as defined in section 832(b)(1);
(2) The amount of losses incurred, as defined in section 832(b)(5);
and
(3) The amount of expenses incurred, as defined in section
832(b)(6); reduced by
(b) The amount of interest which under section 103 is excluded from
gross income.
(b) Determination of taxable income--(1) In general. Except as
provided in subparagraph (2) of this paragraph, the taxable income of a
foreign corporation for any taxable year shall, subject to the special
rules of paragraph (c) of this section, be determined by treating such
foreign corporation as a domestic corporation taxable under section 11
and by applying the principles of section 63.
(2) Insurance taxable income. The taxable income for any taxable
year of a controlled foreign corporation which is engaged in the
business of reinsuring or issuing insurance or annuity contracts and
which, if it were a domestic corporation engaged only in such business,
would be taxable as an insurance company to which subchapter L of
chapter 1 of the Code applies shall, subject to the special rules of
paragraph (c) of this section, be determined by treating such
corporation as a domestic corporation taxable under subchapter L of
chapter 1 of the Code and by applying the principles of Sec. Sec.
1.953-4 and 1.953-5 for determining taxable income.
(c) Special rules for purposes of this section--(1) Nonapplication
of certain provisions. Except where otherwise distinctly expressed, the
provisions of subchapters F, G, H, L, M, N, S, and T of chapter 1 of the
Internal Revenue Code shall not apply and, for taxable years of a
controlled foreign corporation beginning after March 3, 1997, the
[[Page 219]]
provisions of section 103 of the Internal Revenue Code shall not apply.
(2) Application of principles of Sec. 1.964-1. The determinations
with respect to a foreign corporation shall be made as follows:
(i) Books of account. The books of account to be used shall be those
regularly maintained by the corporation for the purpose of accounting to
its shareholders.
(ii) Accounting principles. Except as provided in subparagraphs (3)
and (4) of this paragraph, the accounting principles to be employed are
those described in paragraph (b) of Sec. 1.964-1. Thus, in applying
accounting principles generally accepted in the United States for
purposes of reflecting in the financial statements of a domestic
corporation the operations of foreign affiliates, no adjustment need be
made unless such adjustment will have a material effect, within the
meaning of paragraph (a) of Sec. 1.964-1.
(iii) Translation into United States dollars--(a) In general. Except
as provided in (b) of this subdivision, the amounts determined in
accordance with subdivision (ii) of this subparagraph shall be
translated into United States dollars in accordance with the principles
of paragraph (d) of Sec. 1.964-1.
(b) Special rule. In any case in which the value of the foreign
currency in relation to the United States dollar fluctuates more than 10
percent during any translation period (within the meaning of paragraph
(d)(6) of Sec. 1.964-1), the subpart F income and non-subpart F income
shall be separately translated as if each constituted all the income of
the controlled foreign corporation for the translation period.
(iv) Tax accounting methods. The tax accounting methods to be
employed are those established or adopted by or on behalf of the foreign
corporation under paragraph (c) of Sec. 1.964-1. Thus, such accounting
methods must be consistent with the manner of treating inventories,
depreciation, and elections referred to in subdivisions (ii), (iii), and
(iv) of paragraph (c)(1) of Sec. 1.964-1 and used for purposes of such
paragraph; however, if, in accordance with paragraph (c)(6) of Sec.
1.964-1, a foreign corporation receives foreign base company income
before any elections are made or before an accounting method is adopted
by or on behalf of such corporation under paragraph (c)(3) of Sec.
1.964-1, the determinations of whether an exclusion set forth in section
954(b) applies shall be made as if no elections had been made and no
accounting method had been adopted.
(v) Exchange gain or loss--(a) Exchange gain or loss, determined in
accordance with the principles of Sec. 1.964-1(e), shall be taken into
account for purposes of determining gross income and taxable income.
(b) Exchange gain or loss shall be treated as foreign base company
shipping income (or as a deduction allocable thereto) to the extent that
it is attributable to foreign base company shipping operations. The
extent to which exchange gain or loss is attributable to foreign base
company shipping operations may be determined under any reasonable
method which is consistently applied from year to year. For example, the
extent to which the exchange gain or loss is attributable to foreign
base company shipping operations may be determined on the basis of the
ratio which the foreign based company shipping income of the corporation
for the taxable year bears to its total gross income for the taxable
year, such ratio to be determined without regard to this subdivision
(v).
(c) The remainder of the exchange gain or loss shall be allocated
between subpart F income and non-subpart F income under any reasonable
method which is consistently applied from year to year. For example,
such remainder may be allocated to subpart F income in the same ratio
that the gross subpart F income (exclusive of foreign base company
shipping income) of the corporation for the taxable year bears to its
total gross income (exclusive of foreign base company shipping income)
for the taxable year, such ratio to be determined without regard to this
subdivision (v).
(3) Necessity for recognition of gain or loss. Gross income of a
foreign corporation (including an insurance company) includes gain or
loss only if such gain or loss would be recognized under the provisions
of the Internal Revenue Code if the foreign corporation were a domestic
corporation taxable under
[[Page 220]]
section 11 (subject to the modifications of subparagraph (1) of this
paragraph). See section 1002. However, a foreign corporation shall not
be treated as a domestic corporation for purposes of determining whether
section 367 applies.
(4) Gross income and gross receipts. The term ``gross income'' may
not have the same meaning as the term ``gross receipts''. For example,
in a manufacturing, merchandising, or mining business, gross income
means the total sales less the cost of goods sold, plus any income from
investments and from incidental or outside operations or sources.
(5) Treatment of capital loss and net operating loss. In determining
taxable income of a foreign corporation for any taxable year--
(i) Capital loss carryback and carryover. The capital loss carryback
and carryover provided by section 1212(a) shall not be allowed.
(ii) Net operating loss deduction. The net operating loss deduction
under section 172(a) or the operations loss deduction under section 812
shall not be allowed.
(6) Corporations which have insurance income. For purposes of
paragraphs (a)(2) and (b)(2) of this section, in determining whether a
controlled foreign corporation which is engaged in the business of
reinsuring or issuing insurance or annuity contracts and which, if it
were a domestic corporation engaged only in such business, would be
taxable as an insurance company to which subchapter L of chapter 1 of
the Code applies, it is immaterial that--
(i) The corporation would be exempt from taxation as an organization
described in section 501(a),
(ii) The corporation would not be taxable as an insurance company to
which subchapter L of the Code applies, or
(iii) The corporation would be subject to the alternative tax for
small mutual insurance companies provided by section 821(c).
[T.D. 6795, 30 FR 941, Jan. 29, 1965, as amended by T.D. 7893, 48 FR
22508, May 19, 1983; T.D. 7894, 48 FR 22516, May 19, 1983; T.D. 8704, 62
FR 20, Jan. 2, 1997]
Sec. 1.953-1 Income from insurance of United States risks.
(a) In general. The subpart F income of a controlled foreign
corporation for any taxable year includes its income derived from the
insurance of United States risks for such taxable year. See section
952(a)(1). A controlled foreign corporation shall have income derived
from the insurance of United States risks for such purpose of it has
taxable income, as determined under Sec. 1.953-4 or Sec. 1.953-5,
which is attributable to the reinsuring or the issuing of any insurance
or annuity contract in connection with United States risks, as defined
in Sec. 1.953-2 or Sec. 1.953-3, and if it satisfies the 5-percent
minimum premium requirement prescribed in paragraph (b) of this section.
It is immaterial for purposes of this section whether the person insured
or the beneficiary of any insurance, annuity, or reinsurance contract
is, as to such corporation, a related person or a United States
shareholder. For definition of the term ``controlled foreign
corporation'' for purposes of taking into account income derived from
the insurance of United States risks under section 953, see section 957
(a) and (b) and Sec. Sec. 1.957-1 and 1.957-2.
(b) 5-percent minimum premium requirement. A controlled foreign
corporation shall not have income derived from the insurance of United
States risks for purposes of this section unless the premiums received
by such corporation during the taxable year which are attributable to
the reinsuring and the issuing of insurance and annuity contracts in
connection with the United States risks exceed 5 percent of the total
premiums which are received by such corporation during such taxable year
and which are attributable to the reinsuring and the issuing of
insurance and annuity contracts in connection with all risks.
(c) General definitions. For purposes of Sec. Sec. 1.953-1 to
1.953-6, inclusive--
(1) Reinsurance, etc. The terms ``reinsurance'', ``insurance'', and
``annuity contract'' have the same meaning which they have for purposes
of applying section 809(c)(1) or section 832(b)(4), as the case may be.
(2) Premiums. The term ``premiums'' means the items taken into
account for
[[Page 221]]
the taxable year under section 809(c)(1), or the amount computed for the
taxable year under section 832(b)(4) without the application of
subparagraph (B) thereof, as the case may be; except that, for purposes
of determining the amount of premiums received in applying paragraph (b)
of this section or paragraph (a) of Sec. 1.953-3, advance premiums and
deposits shall not be taken into account.
(3) Insurance company. The term ``insurance company'' has the same
meaning which it has for purposes of applying section 801(a), determined
by applying the principles of paragraph (a) of Sec. 1.801-3.
(4) Related person. The term ``related person'', when used with
respect to a controlled foreign corporation, shall have the meaning
assigned to it by paragraph (e) of Sec. 1.954-1.
(5) Policy period. With respect to any insurance or annuity contract
under which a corporation is potentially liable at any time during its
taxable year, the term ``policy period'' means with respect to such year
each period of coverage under the contract if such period begins or ends
with or within the taxable year, except that, if such period of coverage
is more than one year, such term means such of the following periods as
are applicable, each one of which is a policy period with respect to the
taxable year:
(i) The one-year period which begins with the effective date of the
contract and begins or ends with or within the taxable year,
(ii) The one-year period which begins with an anniversary of the
contract and begins or ends with or within the taxable year, and
(iii) The period of less than one year if such period begins with an
anniversary of the contract, ends with the date on which coverage under
the contract terminates, and begins or ends with or within the taxable
year.
For such purposes, the effective date of the contract is the date on
which coverage under the contract begins, and the anniversary of the
contract is the annual return of the effective date. The period of
coverage under a contract is the period beginning with the effective
date of the contract and ending with the date on which the coverage
under the contract expires; except that, if the risk under the contract
has been transferred by assumption reinsurance, the period of coverage
shall end with the effective date of such transfer or, if the contract
is canceled, with the effective date of cancellation. For this purpose,
the term ``assumption reinsurance'' shall have the meaning provided by
paragraph (a)(7)(ii) of Sec. 1.809-5. The application of this
subparagraph may be illustrated by the following examples:
Example 1. Controlled foreign corporation A issues to domestic
corporation M an insurance contract which provides coverage for the 2\1/
2\ year period beginning on July 1, 1963. Corporation A uses the
calendar year as the taxable year. For 1963, the policy period under
such contract as to A Corporation is July 1, 1963, to June 30, 1964. For
1964, the policy periods under such contract as to A Corporation are
July 1, 1963, to June 30, 1964, and July 1, 1964, to June 30, 1965. For
1965, the policy periods under such contract as to A Corporation are
July 1, 1964, to June 30, 1965, and July 1, 1965, to December 31, 1965.
Example 2. The facts are the same as in example 1 except that M
Corporation cancels the contract on August 31, 1963. For 1963, the
policy period under such contract as to A Corporation is July 1, 1963,
to August 31, 1963.
Example 3. The facts are the same as in example 1 except that on
January 15, 1965, A Corporation cedes insurance under the contract to
controlled foreign corporation B, which also uses the calendar year as
the taxable year. For 1964, the policy periods under such contract as to
A Corporation are July 1, 1963, to June 30, 1964, and July 1, 1964, to
June 30, 1965. For 1965, the policy periods under such contract as to
both A Corporation and B Corporation are July 1, 1964, to June 30, 1965,
and July 1, 1965, to December 31, 1965.
Example 4. Controlled foreign corporation C, which uses the calendar
year as the taxable year, issues to domestic corporation N an insurance
contract which covers the marine risks in connection with shipping a
machine to Europe. The contract does not specify the dates during which
the machine is covered, but provides coverage from the time the machine
is delivered alongside a named vessel in Hoboken, New Jersey, until the
machine is delivered alongside such vessel in Liverpool, England. Such
deliveries in New Jersey and England take place on February 1, and
February 28, 1963, respectively. For 1963, the policy period under such
contract as to C Corporation is February 1, to February 28, 1963.
(6) Foreign country. The term ``foreign country'' includes, where
not otherwise
[[Page 222]]
expressly provided, a possession of the United States.
[T.D. 6781, 29 FR 18201, Dec. 23, 1964]
Sec. 1.953-2 Actual United States risks.
(a) In general. For purposes of paragraph (a) of Sec. 1.953-1, the
term ``United States risks'' means risks described in section
953(a)(1)(A)--
(1) In connection with property in the United States (as defined in
paragraph (b) of this section),
(2) In connection with liability arising out of activity in the
United States (as defined in paragraph (c) of this section), or
(3) In connection with the lives or health of residents of the
United States (as defined in paragraph (d) of this section).
For purposes of section 953(a), the term ``United States'' is used in a
geographical sense and includes only the States and the District of
Columbia. Therefore, the reinsuring or the issuing of insurance or
annuity contracts by a controlled foreign corporation in connection with
property located in a foreign country or a possession of the United
States, in connection with activity in a foreign country or a
possession, or in connection with the lives or health of citizens of the
United States who are not residents of the United States will not give
rise to income to which paragraph (a) of Sec. 1.953-1 applies, unless
the income derived by the controlled foreign corporation from such
contracts constitutes income derived in connection with risks which are
deemed to be United States risks, as defined in Sec. 1.953-3.
(b) Property in the United States. The term ``property in the United
States'' means property, as defined in subparagraph (1) of this
paragraph, which is in the United States, within the meaning of
subparagraph (2) of this paragraph.
(1) Property defined. The term ``property'' means any interest of an
insured in tangible (including real and personal) or intangible
property. Such interests include, but are not limited to, those of an
owner, landlord, tenant, mortgagor, mortgagee, trustee, beneficiary, or
partner. Thus, for example, if insurance is issued against loss from
fire and theft with respect to an insured's home and its contents, such
risks are risks in connection with property, whether the insured is the
owner or lessee and whether the contents include furniture or cash and
securities. Furthermore, if insurance is issued against all risks of
damage or loss with respect to the automobile of an insured, such risks
are risks in connection with property, whether the risks insured against
may be caused by the insured, another person, or natural forces.
(2) United States location--(i) In general. Property will be
considered property in the United States when it is exclusively located
in the United States. Conversely, property will be considered property
not in the United States when it is exclusively located outside the
United States. In addition, property which is ordinarily located in, but
temporarily located outside, the United States will be considered
property in the United States both when it is ordinarily located in, and
when it is temporarily located outside, the United States if the premium
which is attributable to the reinsuring or issuing of any insurance
contract in connection with such property cannot be allocated to, or
apportioned between, risks incurred when such property is actually
located in the United States and risks incurred when it is actually
located outside the United States. If such premium can be so allocated
or apportioned on a reasonable basis, however, such property will be
considered property not in the United States when it is actually located
outside the United States. However, property will not be considered
property in the United States if it is neither property which is
exclusively located in the United States nor property which is
ordinarily located in, but temporarily located outside, the United
States. The rules prescribed in subdivision (ii) of this subparagraph
shall apply in determining whether a premium can be allocated or
apportioned on a reasonable basis to or between risks incurred when
property is actually located in the United States and risks incurred
when such property is actually located outside the United States. The
rules prescribed in subdivisions (iii) through (x)
[[Page 223]]
of this subparagraph shall apply in determining whether property is, or
will be considered, exclusively located in or outside the United States
and whether property is, or will be considered, ordinarily located in
the United States; such rules also limit the rule of premium allocation
and apportionment prescribed in this subdivision and subdivision (ii) of
this subparagraph. The determinations required by this subparagraph
shall be made with respect to the location of property during the policy
period applicable to the taxable year of the insuring or reinsuring
corporation, or, if more than one policy period exists with respect to
such taxable year, such determinations shall be made separately with
respect to the location of property during each such policy period.
(ii) Premium allocation or apportionment. Whether a premium can be
allocated or apportioned on a reasonable basis to or between risks
incurred when property is actually located in the United States and
risks incurred when such property is actually located outside the United
States shall depend on the intention of the parties to the insurance
contract, as determined from its provisions and the facts and
circumstances preceding its execution. Contract provisions on the basis
of which the premium reasonably may be so allocated or apportioned
include, but are not limited to, provisions which separately describe
each risk covered, the period of coverage of each risk, the special
warranties for each risk, the premium for each risk (or the basis for
determining such premium), and the conditions of paying the premium for
each risk. For purposes of this subdivision, it shall be unnecessary
formally to make a separate policy with respect to each risk covered or
with respect to each clause attached to the policy, provided that the
intention of the parties to the contract is reasonably clear. For
example, if in the ordinary course of carrying on an insurance business
an insurance policy is issued which covers fire, theft, and water damage
risks incurred when property is actually located in the United States
and marine risks incurred when such property is actually located outside
the United States and which, pursuant to accepted insurance principles,
properly describes the premium rates as percentages of the amount of
coverage as ``.825% plus .3% fire, etc. risks plus .12% water risks =
1.245%'', a reasonable basis exists to allocate a $124.50 premium paid
for $10,000 of such coverage to $82.50 for foreign risks and $42.00
($30.00+ $12.00) to United States risks.
(iii) Property in general--(a) Ordinary and temporary location.
Except as otherwise provided in subdivisions (iv) through (x) of this
subparagraph, the determination of whether property is ordinarily
located in the United States will depend on all the facts and
circumstances in each case. Property is ordinarily located in the United
States if its location in the United States is regular, usual, or often
occurring. However, in all cases property will be considered ordinarily
located in the United States if it is actually located in the United
States for an aggregate of more than 50 percent of the days in the
applicable policy period whereas property will, under no circumstances,
be considered ordinarily located in the United States if it is actually
located in the United States for an aggregate of not more than 30
percent of the days in the applicable policy period. Property which is
ordinarily located in the United States is temporarily located outside
the United States when it is actually located outside the United States.
For purposes of determining the number and percent of the days in an
applicable policy period, the term ``day'' means, not any 24-
consecutive-hour period, but a continuous period of twenty-four hours
commencing from midnight and ending with the following midnight; in
determining the location of property for such purposes, an amount of
time which is at least one-half of such a day, but less than the entire
day, shall be considered a day, and an amount of time which is less than
one-half of such a day shall not be considered a day.
(b) Illustrations. The application of this subdivision may be
illustrated by the following examples:
Example 1. Controlled foreign corporation A issues to domestic
corporation M a comprehensive blanket or floater insurance policy which,
for one year, covers inventory
[[Page 224]]
samples which M Corporation regularly ships from the United States in
order to encourage sales. Such shipments are made on the condition that
they be returned to the United States within 5 days after they are
received. During the one-year policy period, such samples are sent from,
and returned to, the United States 50 times, and during such one-year
period are actually located in the United States for an aggregate of 120
days. Since the location of the samples in the United States during such
one-year period is often recurring, they are property ordinarily located
in, but temporarily located outside, the United States. Therefore, they
will be considered property in the United States even though for such
one-year period their location in the United States is not regular or
usual and is not for an aggregate of more than 50 percent of the days in
the policy period. However, if, by considering such factors as the terms
and premium schedule of the insurance contract as well as the number,
value, and duration of the location in and outside the United States, of
such samples, the premium which is attributable to the issuing of such
contract can be allocated to, or apportioned between, risks occurring
when such samples are actually located in the United States and risks
occurring when they are actually located outside the United States, such
samples will be considered property not in the United States when they
are actually located outside the United States.
Example 2. A machine, located for several years in a foreign branch
of a United States manufacturer, is permanently transferred to the home
office of such manufacturer, where it arrives on January 1, 1963, and
remains for the remainder of 1963. Under a separate insurance contract
issued by a controlled foreign corporation, which uses the calendar year
as the taxable year, such machine is insured against damage for the
three-year period commencing on May 1, 1962. Because of the change in
location of the machine, the premiums are increased as of January 1,
1963. Since the machine is in the United States from January 1, 1963, to
April 30, 1963, its location in the United States is regular and usual
during the policy period of May 1, 1962, to April 30, 1963. Accordingly,
the machine is ordinarily located in the United States for such policy
period. However, since the premium which is attributable to the issuing
of such contract is allocable to risks occurring when the machine is
actually located in, and when it is actually located outside, the United
States, such machine will be considered property not in the United
States from May 1, 1962, through December 31, 1962.
(iv) Commercial motor vehicles, ships, aircraft, railroad rolling
stock, and containers. Any motor vehicle, ship, aircraft, railroad
rolling stock, or any container transported thereby, which is used
exclusively in the commercial transportation of persons or property to
or from the United States (including such transportation from one place
to another in the United States) and is ordinarily located in the United
States will be considered property in the United States both when such
property is ordinarily located in, and when such property is temporarily
located outside, the United States. Whether such property is used in the
transportation of persons or property to or from the United States and
is ordinarily located in the United States are issues to be determined
from all the facts and circumstances in each case. However, in all cases
such transportation property will be considered ordinarily located in
the United States if either more than 50 percent of the miles traversed
during the applicable policy period in the use of such property are
traversed within the United States or such property is located in the
United States more than 50 percent of the time during such period.
Further, such transportation property will not at any time be considered
property in the United States if either not more than 30 percent of the
miles traversed during the applicable policy period in the use of such
property are traversed within the United States or such property is
located in the United States for not more than 30 percent of the time
during such period. Nevertheless, if not more than 30 percent of the
miles traversed during the applicable policy period in the use of such
transportation property are traversed within the United States, such
property will be considered ordinarily located in the United States if
it is located in the United States more than 50 percent of the time
during such period Moreover, if such transportation property is located
in the United States for not more than 30 percent of the time during the
applicable policy period, such property will be considered ordinarily
located in the United States if more than 50 percent of the miles
traversed during such period in the use of such property are traversed
within the United States. If such transportation property is considered
property in the United States because more than 50 percent of the miles
traversed during the applicable policy period in
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the use of such property are traversed within the United States, the
apportionment of premium provided in subdivision (i) of this
subparagraph shall be made on a mileage basis. If, however, such
property is considered property in the United States because such
property is located in the United States more than 50 percent of the
time during the applicable policy period, the apportionment of premium
provided in subdivision (i) of this subparagraph shall be made on a time
basis.
(v) Noncommercial motor vehicles, ships, aircraft, and railroad
rolling stock. Except as provided in subdivision (iv) of this
subparagraph, any motor vehicle, ship or boat, aircraft, or railroad
rolling stock which at any time is actually located in the United States
and which either (a) is registered with the United States, a State
(including any political subdivision thereof), or any agency thereof or
(b), if not so registered, is owned by a citizen, resident, or
corporation of the United States will be considered property which is
ordinarily located in the United States. Unless the premium which is
attributable to the reinsuring or issuing of any insurance contract in
connection with such property considered ordinarily located in the
United States is specifically allocated under the contract to risks
incurred when such property is actually located in the United States and
to risks incurred when it is actually located outside the United States,
such property will be considered property in the United States both when
it is ordinarily located in, and when it is temporarily located outside,
the United States; under no circumstances will such property be
considered outside the United States on the basis of any apportionment
of such premium.
(vi) Property exported or imported by railroad or motor vehicle. Any
property which is exported from, or imported to, the United States by
railroad or motor vehicle will be considered property ordinarily located
in the United States which, when such property is not actually located
in the United States, is temporarily located outside the United States.
For example, if an insurance contract reinsured or issued in connection
with property exported from the United States by motor vehicle covers
risks commencing when such property is loaded on the motor vehicle at
the United States warehouse and terminating when such property is
unloaded at the foreign warehouse, and if the premium payable with
respect to risks incurred when the property is in the United States and
risks incurred when the property is in the foreign country is not
separately stated, such property will be considered property in the
United States only until such property is actually located outside the
United States, provided that the premium can be properly apportioned
(for example) on the basis of time or mileage, between risks incurred
when the property is actually located in the United States and risks
incurred when it is actually located outside the United States. If in
such case the premium is not so apportionable, such property will be
considered property in the United States both when such property is
ordinarily located in, and when it is temporarily located outside, the
United States.
(vii) Property exported by ship or aircraft. If an insurance
contract which is reinsured or issued in connection with property which
is exported from the United States by ship or aircraft covers risks all
of which terminate when such property is placed aboard a ship or
aircraft at the United States port of exit for shipment from the United
States, such property will be considered property in the United States.
If such insurance contract covers risks all of which commence when such
property is placed aboard a ship or aircraft at the United States port
of exit for shipment from the United States, such property will be
considered property not in the United States. If such insurance contract
covers risks commencing before, and terminating after, such property is
placed aboard a ship or aircraft at the United States port of exit for
shipment from the United States, such property will be considered
property ordinarily located in the United States which, after such
property is placed aboard such ship or aircraft at the United States
port of exit, is temporarily located outside the United States. The
[[Page 226]]
application of this subdivision may be illustrated by the following
example:
Example. A controlled foreign corporation issues an insurance
contract in connection with property exported from the United States by
ship. The contract covers risks commencing after such property is
removed from the United States warehouse and terminating when such
property is unloaded at the foreign port of entry. Assuming that the
premium payable with respect to the risks incurred before and the risks
incurred after the property is placed aboard the ship at the United
States port of exit for shipment from the United States or with respect
to the steps in handling such property during such coverage, such as
transporting the property to the United States port of exit, unloading
the property there, placing the property aboard the ship, holding the
property aboard the ship in port, the actual voyage, and unloading the
property at the foreign port of entry, is separately stated in, or is
determinable from, such contract, the property will be considered
property in the United States only until such property is placed aboard
the ship at the United States port of exit for shipment from the United
States. Assuming, however, that the premiums payable with respect to
such steps, or with respect to the risks incurred before and the risks
incurred after the property is placed aboard the ship at the United
States port of exit, are not allocable or apportionable under the
contract, such property will be considered property in the United States
both before and after such property is placed aboard the ship at the
United States port of exit.
(viii) Property imported by ship or aircraft. If an insurance
contract which is reinsured or issued in connection with property which
is imported to the United States by ship or aircraft covers risks all of
which terminate when such property is unloaded at the United States port
of entry, such property will be considered property not in the United
States. If such insurance contract covers risks all of which commence
after such property is unloaded at the United States port of entry, such
property will be considered property in the United States. If such
insurance contract covers risks commencing before, and terminating
after, such property is unloaded at the United States port of entry,
such property will be considered property ordinarily located in the
United States which, before such property is unloaded at the United
States port of entry, is temporarily located outside the United States.
For an illustration pertaining to the allocation or apportionment of the
premium, see the example in subdivision (vii) of this subparagraph.
(ix) Shipments originating and terminating in the United States. Any
property which is shipped from one place in the United States to another
place in the United States, on or over a foreign country, the high seas,
or the coastal waters of the United States will be considered property
actually located at all times in the United States. For example,
property which is shipped from New York City to Los Angeles via the
Panama Canal or from San Francisco to Hawaii or Alaska will be
considered property actually located at all times in the United States.
(x) Shipments originating and terminating in a foreign country. Any
property which is shipped by any means, or a combination of means, of
transportation from one foreign country to another foreign country, or
from a contiguous foreign country to the same contiguous foreign
country, on or over the United States will be considered property
exclusively located outside the United States. Notwithstanding the
foregoing, any property which is shipped by any means, or a combination
of means, of transportation from one contiguous foreign country to
another contiguous foreign country on or over the United States will be
considered property ordinarily located in the United States which, when
such property is not actually located in the United States, is
temporarily located outside the United States.
(c) Liability from United States activity. The term ``liability
arising out of activity in the United States'' means a loss, as
described in subparagraph (1) of this paragraph, or a liability, as
described in subparagraph (2) of this paragraph, which could arise from
activity performed in the United States, as defined in subparagraph (3)
of this paragraph.
(1) Loss described. The term ``loss'' includes all loss of an
insured which could arise from the occurrence of the event insured
against except that such term does not include any loss in connection
with property described in
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paragraph (b) of this section. For example, such term includes, in the
case of a promoter of outdoor sporting events, the loss which could
arise from the cancellation of such an event because of inclement
weather.
(2) Liability described. The term ``liability'' includes all
liability of an insured in tort, contract, property, or otherwise. It
includes, for example, the liability of a principal for the acts of his
agent, of a husband for the acts of his spouse, and of a parent for the
acts of his child. The term not only includes the direct liability which
may be incurred, for example, by a tortfeasor to the person harmed, but
also the indirect liability which may be incurred, for example, by a
manufacturer to the purchaser at retail for a breach of warranty.
(3) Activity in the United States--(i) In general. A loss or
liability will be considered a loss or liability which could arise from
activity performed in the United States if the loss or liability would
result, if at all, from an activity exclusively carried on in the United
States. Conversely, a loss or liability will be considered a loss or
liability which could not arise from activity performed in the United
States if the loss or liability would result, if at all, from an
activity exclusively carried on outside the United States. In addition,
a loss or liability will be considered a loss or liability which could
arise from activity performed in the United States if the loss or
liability would result, if at all, from an activity ordinarily carried
on in, but partly carried on outside, the United States. If the premium
which is attributable to the reinsuring or issuing of any insurance
contract in connection with an activity ordinarily carried on in, but
partly carried on outside, the United States can, on a reasonable basis,
be allocated to, or apportioned between, the risks incurred with respect
to the activity carried on in, and the risks incurred with respect to
the activity carried on outside, the United States, such loss or
liability will be considered a loss or liability which could not arise
from activity performed in the United States to the extent the loss or
liability would result, if at all, from that activity carried on outside
the United States. However, a loss or liability will not be considered a
loss or liability which could arise from an activity performed in the
United States if such loss or liability would result, if at all, from an
activity which is neither exclusively carried on in the United States
nor ordinarily carried on in, but partly carried on outside, the United
States. The principles of paragraph (b)(2)(ii) of this section for
allocating or apportioning a premium on a reasonable basis to or between
risks incurred when property is actually located in the United States
and risks incurred when such property is actually located outside the
United States shall apply for allocating or apportioning a premium on a
reasonable basis to or between the risks incurred with respect to the
activity carried on in, and the risks incurred with respect to the
activity carried on outside, the United States. The rules prescribed in
subdivisions (ii) through (vi) of this subparagraph shall apply in
determining whether an activity is, or will be considered, exclusively
carried on in or outside the United States and whether an activity is,
or will be considered, ordinarily carried on in the United States and in
determining what is the activity which is performed by the insured from
which a loss or liability results or could result; such rules also limit
the rule of premium allocation and apportionment prescribed in this
subdivision. The determinations required by this subparagraph shall be
made with respect to the location of an activity of the insured
performed during the policy period applicable to the taxable year of the
insuring or reinsuring corporation, or, if more than one policy period
exists with respect to such taxable year, such determinations shall be
made separately with respect to the location of the activity during each
such policy period.
(ii) Substantial activity carried on in the United States. The term
``activity'' is used in its broadest sense and includes the performance
of an act unlawfully undertaken, the wrongful performance of an act
lawfully undertaken, and the wrongful failure to perform an act lawfully
required to be undertaken. With respect to a loss described in
subparagraph (1) of this
[[Page 228]]
paragraph, the term ``activity'' includes the occurrence of the event
insured against. The determination of whether an activity ordinarily is
carried on in, but is partly carried on outside, the United States will
depend on all the facts and circumstances in each case. An activity
ordinarily is carried on in the United States if a substantial amount of
such activity is carried on in the United States. Factors which will be
taken into account in determining whether a substantial amount of
activity is carried on in the United States are those which are
connected with the activity and include, but are not limited to, the
location of the insured's assets, the place where personal services are
performed, and the place where sales occur, but only if such assets,
services, and sales are connected with the activity. In all cases an
activity will be considered substantially carried on in the United
States if more than 50 percent of the insured's total assets, personal
services, and sales, if any, connected with such activity are located,
performed, or occur in the United States. On the other hand, an activity
will, under no circumstances, be considered substantially carried on in
the United States if not more than 30 percent of the insured's total
assets, personal services, and sales, if any, connected with such
activity are located, performed, or occur in the United States. For this
purpose, the mean of the value of the total assets at the beginning and
end of the policy period shall be used, determined by taking assets into
account at their actual value (not reduced by liabilities), which, in
the absence of affirmative evidence to the contrary, shall be deemed to
be (a) face value in the case of bills receivable, accounts receivable,
notes receivable, and open accounts held by an insured using the cash
receipts and disbursements method of accounting and (b) adjusted basis
in the case of all other assets. Personal services shall be measured by
the amount of compensation paid or accrued for such services, and sales
shall be measured by the volume of gross sales. An activity is carried
on partly outside the United States if it is carried on, whether
substantially or in substantially, outside the United States.
(iii) Manufacturing, producing, constructing, or assembling
activity. If a person who manufactures, produces, constructs, or
assembles property is liable with regard to the consumption or use of
such property, such liability will be considered to result from the
activity performed of manufacturing, producing, constructing, or
assembling such property. If such person manufactures, produces,
constructs, or assembles more than one type of product, the liability
with regard to the consumption or use of one of such products will be
considered to result from the activity performed of manufacturing,
producing, constructing, or assembling that particular product. For
example, the liability of a building contractor, which constructs
apartment buildings only in the United States, for the improper
construction of, or the failure to construct, an apartment building,
will be considered to result from an activity exclusively carried on in
the United States and will be considered a liability which could arise
from activity performed in the United States. In further illustration,
the liability (which is covered by a single policy of insurance) of a
domestic corporation, which assembles refrigerators exclusively in the
United States and manufactures automobiles both in a foreign country and
in the United States through substantial activity carried on in each of
such countries, for the negligent manufacturing of a part for one of the
automobiles by the foreign branch, will be considered to result from an
activity ordinarily carried on in, but partly carried on outside, the
United States and will be considered a liability which could arise from
activity performed in the United States.
(iv) Selling activity. If a person is liable with regard to selling
activity performed, such liability will be considered, except as
provided in subdivisions (iii), (v), and (vi) of this subparagraph, to
result from such selling activity. A person will be considered to be
engaged in selling activity if such person engages in an activity
resulting in the sale of property. Thus, it is immaterial that, under
the Code, such activity would not constitute engaging in or carrying on
a trade or business in the
[[Page 229]]
country in which such activity is carried on, the property in the goods
does not pass in such country, or delivery of the property is not made
in such country. For example, if a foreign wholesale distributor, which
manages its entire business operations in a foreign country and sells
its inventory exclusively in the United States--its only contact in the
United States being the promotion of such sales to United States retail
outlets by advertising in trade publications and distributing sales
catalogues--is liable for a breach of warranty with regard to the sale
of property to a United States retail outlet, such liability will be
considered to result from an activity exclusively carried on in the
United States and will be considered a liability which could arise from
activity performed in the United States.
(v) Liability from service or driving activity--(a) In general. If a
person is liable with regard to any service activity performed, or is
liable with regard to driving activity performed in connection with a
motor vehicle, ship or boat, aircraft, or railroad rolling stock,
whether or not exclusively used in the commercial transportation of
persons or property, such liability will be considered to result from
such service or driving activity. For example, if an oil company which
drills for oil exclusively in a foreign country is liable with regard to
the negligent handling by its employees of explosives in the course of
such drilling there, such liability will be considered to result from an
activity exclusively carried on outside the United States and will be
considered a liability which could not arise from activity performed in
the United States. In further illustration, if a corporation which
services machinery exclusively in a foreign country under servicing
contracts is liable with regard to the negligent repairing of a machine
under such a contract, such liability will be considered to result from
an activity exclusively carried on outside the United States and will be
considered a liability which could not arise from activity performed in
the United States.
(b) Location of activities in connection with transportation
property. For purposes of (a) of this subdivision, service or driving
activity performed in connection with a motor vehicle, ship or boat,
aircraft, or railroad rolling stock, whether or not exclusively used in
the commercial transportation of persons or property, will be considered
activity performed in the United States if the activity is carried on at
a time when such property is or will be considered, in accordance with
subdivision (iv) or (v) of paragraph (b)(2) of this section, actually in
the United States or ordinarily located in the United States. However,
if the premium which is attributable to the reinsuring or issuing of any
insurance contract in connection with such service or driving activity
which is carried on at a time when such property is, or will be
considered, ordinarily located in the United States can be allocated to,
or apportioned between, the risks incurred when such property is
actually located in the United States and risks incurred when it is
actually located outside the United States, such liability will be
considered a liability which could arise from activity performed in the
United States only when such property is actually located in the United
States. Any allocation or apportionment of premium under the preceding
sentence shall be made in accordance with the rules of allocation and
apportionment provided in subdivision (iv) or (v) of paragraph (b)(2) of
this section. For example, if a person is liable with regard to the
performance of services outside the United States in the operation of a
motor vehicle which is used exclusively in the commercial transportation
of persons to and from the United States and which, because more than 50
percent of the miles traversed during the applicable policy period in
the use of such property are traversed within the United States, is
considered ordinarily located in the United States, such liability will
be considered to be a liability which could not arise from activity
performed in the United States only to the extent that the premium which
is attributable to the reinsuring or issuing of any insurance contract
in connection with such service activity is apportioned on a mileage
basis between the risks incurred when such motor vehicle is actually
located in the United States and when such vehicle is
[[Page 230]]
actually located outside the United States. See paragraph (b)(2)(iv) of
this section. In further illustration, if a person is liable with regard
to his negligent driving of a motor vehicle which is not used
exclusively in the commercial transportation of persons or property,
which is registered with any State, and which is driven both in the
United States and a foreign country, such liability will be considered a
liability which could arise from activity performed in the United
States, unless the premium which is attributable to the reinsuring or
issuing of an insurance contract in connection with such driving
performed in such motor vehicle ordinarily located in the United States
is specifically allocated under the contract to risks incurred with
respect to driving performed in, and to risks incurred with respect to
driving performed outside, the United States. See paragraph (b)(2)(v) of
this section.
(c) Illustration. The application of this subdivision may be further
illustrated by the following example:
Example. Controlled foreign corporation A is a wholly owned
subsidiary of domestic corporation M. Both corporations are insurance
companies and use the calendar year as the taxable year. Corporation M
is exclusively engaged in issuing to owners of commercial rental
property which is located in the United States insurance contracts which
cover any harm which may be caused in 1963 by the tortious conduct of
the owners' employees in managing and maintaining such property. The
owners insured under such contracts include both residents and
nonresidents of the United States. In 1963, M Corporation cedes to A
Corporation one-half of the insurance contracts issued by M Corporation
in that year, including the contracts issued to nonresidents. Income of
A Corporation derived in 1963 from reinsuring the risks of M Corporation
is income from the insurance of United States risks since all the
insurance contracts reinsured by it are in connection with a liability
which could arise from service activity performed in the United States.
(vi) Liability from delivery of property. If the person who is
obligated to deliver property is liable with regard to such delivery,
such liability will be considered to result from the activity performed
of delivering such property. For example, if a corporation which exports
all of its inventory from the United States to foreign countries or
possessions of the United States is liable with regard to its failure to
make delivery outside the United States of inventory it has sold, such
liability will be considered to result from an activity exclusively
carried on outside the United States and will be considered a liability
which could not arise from activity performed in the United States. In
further illustration, if a corporation which exports all of its
inventory from a foreign country to the United States is liable with
regard to its improper delivery in the United States of inventory it has
sold, such liability will be considered to result from an activity
exclusively carried on in the United States and will be considered a
liability which could arise from activity performed in the United
States.
(d) Lives or health of United States residents. Risks in connection
with the lives or health of residents of the United States include those
risks which are the subject of insurance contracts referred to in
section 801(a), relating to the definition of a life insurance company.
If the insured is a resident of the United States at the time the
insurance contract is approved, the risk is in connection with the life
or health of a resident of the United States for the period of coverage
under the contract. However, if during such period of coverage the
insured notifies the insurer, or circumstances known to the insurer
indicate, that the insured is no longer a resident of the United States,
the risk shall cease to be a risk in connection with the life or health
of a resident of the United States for the policy period in which the
insured gives such notice or such circumstances are known to the
insurer, and for each subsequent policy period. Conversely, if the
insured is a resident of a particular foreign country at the time the
insurance contract is approved, the risk is in connection with the life
or health of a resident of such foreign country for the period of
coverage under the contract. However, if during such period of coverage
the insured notifies the insurer, or circumstances known to the insurer
indicate, that the insured is no longer a resident of such foreign
country, the
[[Page 231]]
risk shall cease to be a risk in connection with the life or health of a
resident of such particular foreign country for the policy period in
which the insured gives such notice or such circumstances are known to
the insurer, and for each subsequent policy period. In determining the
country of residence of an insured, the principles of Sec. Sec.
301.7701(b)-1 through 301.7701(b)-9 of this chapter, relating to the
determination of residence and nonresidence in the United States and of
foreign residence, shall apply. Citizens of the United States are not
residents of the United States merely because of their citizenship. The
application of this paragraph may be illustrated by the following
example:
Example. Controlled foreign corporation A is a wholly owned
subsidiary of domestic corporation M. Corporation A uses the calendar
year as the taxable year and is engaged in the life insurance business
in foreign country X. In 1963, A Corporation issues ordinary life
insurance contracts on the lives of residents of the United States,
including one issued on February 1, 1963, to R, a citizen of foreign
country Y and a resident of the United States on such date. All activity
in connection with the issuing of such contracts is transacted by mail.
On May 1, 1963, R abandons his United States residence and establishes
residence in foreign country Z. There are no circumstances known to A
Corporation that R has changed his residence until R, on March 1, 1964,
actually notifies A Corporation of that change. Income of A Corporation
for the policy period of February 1, 1963, to January 31, 1964, from
issuing such insurance contracts is income derived from the insurance of
United States risks. However, income of A Corporation derived for the
policy period of February 1, 1964, to January 31, 1965, from R's
insurance contract is not income derived from the insurance of United
States risks.
(Secs. 913(m) (92 Stat. 3106; 26 U.S.C. 913(m)), and 7805 (68A Stat.
917; 26 U.S.C. 7805), Internal Revenue Code of 1954)
[T.D. 6781, 29 FR 18202, Dec. 23, 1964, as amended by T.D. 7736, 45 FR
76143, Nov. 18, 1980; T.D. 8411, 57 FR 15241, Apr. 27, 1992]
Sec. 1.953-3 Risks deemed to be United States risks.
(a) Artificial arrangements. For purposes of paragraph (a) of Sec.
1.953-1, the term ``United States risks'' also includes under section
953(a)(1)(B) risks which are deemed to be United States risks. They are
risks (other than United States risks described in section 953(a)(1)(A)
and Sec. 1.953-2) which a controlled foreign corporation reinsures
under an insurance or annuity contract, or with respect to which a
controlled foreign corporation issues any insurance or annuity contract,
in accordance with any arrangement whereby another corporation which is
not a controlled foreign corporation receives an amount of premiums (for
reinsuring or issuing any insurance or annuity contract in connection
with the United States risks described in section 953(a)(1)(A) and Sec.
1.953-2) which is substantially equal to the amount of premiums which
the controlled foreign corporation receives under its contracts.
Arrangements to which this rule applies include those entered into by
the controlled foreign corporation, by its United States shareholders,
or by a related person.
(b) Evidence of arrangements. The determination of the existence of
an arrangement referred to in paragraph (a) of this section shall depend
on all the facts and circumstances in each case. In making this
determination, it will be recognized that arrangements of this type
generally are orally entered into outside the United States and that
direct evidence of such an arrangement is not ordinarily available.
Therefore, in determining the existence of such an arrangement,
consideration will be given to whether or not there is substantial
similarity between the type, location, profit margin expected, and loss
experience of the risks which the corporation which is not a controlled
foreign corporation insures or reinsures and the risks which the
controlled foreign corporation insures or reinsures. Further,
consideration will be given to the existence of prior similar
arrangements between, and the identity of the directors or shareholders
of, the corporation which is not a controlled foreign corporation, its
shareholders, or related persons and the controlled foreign corporation,
its shareholders, or related persons. However, the absence of such prior
arrangements or identity of directors or shareholders will not of itself
establish the nonexistence of an arrangement referred to in paragraph
(a) of this section. In determining whether the
[[Page 232]]
amounts received by the controlled foreign corporation and the
corporation which is not a controlled foreign corporation are
substantially equal, the period in which the controlled foreign
corporation receives premiums need not be the same as, or identical in
length with, that of the corporation which is not a controlled foreign
corporation nor limited to a taxable year of the controlled foreign
corporation.
(c) Illustrations. The application of this section may be
illustrated by the following examples:
Example 1. Controlled foreign corporation A is a wholly owned
subsidiary of domestic corporation M. Foreign corporation B is a wholly
owned subsidiary of foreign corporation R. All corporations use the
calendar year as the taxable year. Corporations M and R, which are not
related persons, agree that from July 1, 1963, through December 31,
1963, B Corporation will reinsure all risks of M Corporation which are
United States risks described in section 953(a)(1)(A), and that from
January 1, 1964, through June 30, 1964, A Corporation will reinsure all
risks of R Corporation which are not United States risks described in
section 953(a)(1)(A). The amount of premiums received by A Corporation
and B Corporation, respectively, as a result of the agreement are
substantially equal. The income of A Corporation derived in 1964 from
reinsuring the risks of R Corporation is income derived from the
insurance of United States risks described in section 953(a)(1)(B).
Example 2. Assume the same facts as in example 1, except that M and
R Corporations also agree, as part of their arrangement, that from July
1, 1964, through December 31, 1964, B Corporation will reinsure all
risks of M Corporation which are United States risks described in
section 953(a)(1)(A), and that from January 1, 1965, through June 30,
1965, A Corporation will reinsure all risks of R Corporation which are
not United States risks described in section 953(a)(1)(A). The amount of
premiums derived by B Corporation from July 1, 1963, through December
31, 1963, under the agreement is not substantially equal to the amount
of premiums derived by A Corporation from January 1, 1964, through June
30, 1964, and the amount of premiums derived by B Corporation from July
1, 1964, through December 31, 1964, is not substantially equal to the
amount of premiums derived by A Corporation from January 1, 1965,
through June 30, 1965. However, the aggregate amount of premiums
received by B Corporation under the arrangement is substantially equal
to the aggregate amount of premiums received by A Corporation. The
income of A Corporation derived in 1964 and 1965 from reinsuring the
risks of R Corporation is income derived from the insurance of United
States risks described in section 953(a)(1)(B).
Example 3. Assume the same facts as in example 1, except that
foreign corporation C is also a wholly owned subsidiary of R
Corporation. Assume that C Corporation uses the calendar year as its
taxable year. Assume further that M Corporation and R Corporation agree
that from July 1, 1963, through December 31, 1963, B Corporation and C
Corporation together will reinsure the United States risks described in
section 953(a)(1)(A) of M Corporation. The amount of premiums received
by B Corporation in respect of such United States risks is equal to one-
third of the amount received by A Corporation in respect of the risks
which are not United States risks described in section 953(a)(1)(A), and
the amount of premiums received by C Corporation in respect of such
United States risks is equal to two-thirds of the amount so received by
A Corporation. The income of A Corporation derived in 1964 from
reinsuring the risks of R Corporation is income derived from the
insurance of United States risks described in section 953(a)(1)(B).
Example 4. Assume the same facts as in example 3, except that
controlled foreign corporation D is also a wholly owned subsidiary of M
Corporation and uses the calendar year as its taxable year. Assume
further that M Corporation and R Corporation agree that in 1964 R
Corporation will pay premiums of $300,000 to A Corporation and $700,000
to D Corporation to reinsure all risks of R Corporation which are not
United States risks described in section 953(a)(1)(A), and that in 1963
M Corporation will pay premiums of $400,000 to B Corporation and
$600,000 to C Corporation to reinsure all risks of M Corporation which
are United States risks described in section 953(a)(1)(A). The income of
A Corporation and D Corporation derived in 1964 from reinsuring the
risks of R Corporation is income derived from the insurance of United
States risks described in section 953(a)(1)(B).
Example 5. Controlled foreign corporation A is a wholly owned
subsidiary of domestic insurance corporation M. Controlled foreign
corporation B is a wholly owned subsidiary of domestic insurance
corporation N. All corporations use the calendar year as the taxable
year. As a result of an arrangement between M Corporation and N
Corporation, in 1963 A Corporation reinsures all the United States risks
described in section 953(a)(1)(A) of N Corporation, and B Corporation
reinsures all the United States risks described in section 953(a)(1)(A)
of M Corporation. The premiums and other consideration received by A
Corporation and B Corporation in respect of such reinsurance are not
substantially equal. The income of A Corporation and B Corporation in
1962 from reinsuring the risks of N Corporation and M Corporation,
respectively, is income derived from
[[Page 233]]
the insurance of United States risks described in section 953(a)(1)(A)
and is not income derived from the insurance or United States risks
described in section 953(a)(1)(B).
Example 6. Assume the same facts as in example 5, except that B
Corporation is not a controlled foreign corporation. The income of A
Corporation in 1963 from reinsuring the risks of N Corporation is income
derived from the insurance of United States risks described in section
953(a)(1)(A) and is not income derived from the insurance of United
States risks described in section 953(a)(1)(B).
[T.D. 6781, 29 FR 18207, Dec. 23, 1964]
Sec. 1.953-4 Taxable income to which section 953 applies.
(a) Taxable income defined--(1) Life insurance taxable income. For a
controlled foreign corporation which is engaged in the business of
reinsuring or issuing insurance or annuity contracts and which, if it
were a domestic corporation engaged only in such business, would be
taxable as a life insurance company to which part I (sections 801
through 820) of subchapter L of the Code applies, the term ``taxable
income'' means for purposes of paragraph (a) of Sec. 1.953-1 the gain
from operations, as defined in section 809(b) and as modified by this
section, derived from, and attributable to, the insurance of United
States risks. For purposes of determining such taxable income, the
provisions of section 802(b) (relating to the definition of life
insurance company taxable income) shall not apply. Determinations for
purposes of this subparagraph shall be made without regard to section
501(a).
(2) Mutual and other insurance taxable income. For a controlled
foreign corporation which is engaged in the business of reinsuring or
issuing insurance or annuity contracts and which, if it were a domestic
corporation engaged only in such business, would be taxable as a mutual
insurance company to which part II (sections 821 through 826) of
subchapter L of the Code applies or a mutual marine insurance or other
insurance company to which part III (sections 831 and 832) of subchapter
L of the Code applies, the term ``taxable income'' means for purposes of
paragraph (a) of Sec. 1.953-1 taxable income, as defined in section
832(a) and as modified by this section, derived from, and attributable
to, the insurance of United States risks. Determinations for purposes of
this subparagraph shall be made without regard to section 501(a).
(3) Corporations not qualifying as insurance companies. For special
rules applicable under this section in the case of a controlled foreign
corporation which, if it were a domestic corporation, would not qualify
as an insurance company, see Sec. 1.953-5.
(b) Certain provisions inapplicable. In determining taxable income
under this section, the following provisions of subchapter L of the Code
shall not apply:
(1) Section 809(d)(4), relating to the operations loss deduction;
(2) Section 809(d)(5), relating to certain nonparticipating
contracts;
(3) Section 809(d)(6), relating to certain accident and health
insurance and group life insurance;
(4) Section 809(d)(10), relating to small business deduction;
(5) Section 817(b), relating to gain on property held on December
31, 1958, and certain substituted property acquired after 1958; and
(6) Section 832(c)(5), relating to capital losses.
(c) Computation of reserves required by law--(1) Law applicable in
determining reserves. The reserves which will be taken into account as
reserves required by law under section 801(b)(2), both in determining
for any taxable year whether a controlled foreign corporation is a
controlled foreign corporation described in paragraph (a)(1) or (2) of
this section and in determining taxable income of such corporation for
the taxable year under paragraph (a) of this section, shall be the
following reserves:
(i) Reserves required by the law of a State. The reserves which are
required by the law of the State or States to which the insurance
business of the controlled foreign corporation is subject, but only with
respect to its United States business, if any, which is taxable under
section 819(a).
(ii) Reserves deemed to be required. To the extent of such
controlled foreign corporation's insurance business not taxable under
section 819(a)--
(a) Except as provided in (b) of this subdivision (ii), the reserves
which would result if such reserves were determined by applying the
minimum
[[Page 234]]
standards of the law of New York as if such controlled foreign
corporation were an insurance company transacting all of its insurance
business (other than its United States business which is taxable under
section 819(a)) for such taxable year in such State, and
(b) With respect to all risks covered by insurance ceded to such
controlled foreign corporation by an insurance company to which apply
the provisions of subchapter L of the Code (determined without regard to
section 501(a)) and in respect of which an election is made by or on
behalf of such controlled foreign corporation to determine its reserves
in accordance with this subdivision (b), the amount of reserves against
such risks which would result if all of such reserves were determined by
applying the law of the State, to which the risks in the hands of such
insurance company are subject, as if such controlled foreign corporation
were an insurance company engaged in reinsuring such risks in such
State.
(2) Rules of application. For purposes of subparagraph (1) of this
paragraph, the following rules shall apply:
(i) Life insurance reserves computed on preliminary term basis. For
purposes of determining under paragraph (a) of this section the taxable
income of a controlled foreign corporation, an election may be made by
or on behalf of such corporation that the amount of reserves which are
taken into account as life insurance reserves with respect to contracts
for which reserves are computed on a preliminary term basis shall be
determined as provided in section 818(c). This election shall apply,
subject to section 818(c), to all life insurance reserves of the
controlled foreign corporation, whether or not reserves applicable to
the United States business taxable under section 819(a). However,
reserves determined as provided in section 818(c) shall not be taken
into account in determining whether a controlled foreign corporation is
a controlled foreign corporation described in paragraph (a)(1) or (2) of
this section.
(ii) Actual reserves required. (a) A controlled foreign corporation
will be considered to have a reserve only to the extent the reserve has
been actually held during the taxable year for which such reserve is
claimed.
(b) For determining when reserves are required by the law of a
State, see paragraph (b) of Sec. 1.801-5 of this chapter.
(iii) Total reserves to be taken into account. The total reserves of
a controlled foreign corporation shall be taken into account in
determining whether such corporation is a controlled foreign corporation
described in paragraph (a)(1) or (2) of this section. Therefore, in
making such determination, the reserves which, under subparagraph (1)(i)
of this paragraph, are required by the law of any State shall be taken
into account together with the reserves which, under subparagraph
(1)(ii) of this paragraph, are deemed to be required. Moreover, reserves
applicable to the reinsuring or the issuing of insurance or annuity
contracts of both United States risks and foreign risks shall be taken
into account. Finally, except as provided in subdivision (i) of this
subparagraph, the reserves which are taken into account in determining
whether a controlled foreign corporation is a controlled foreign
corporation described in paragraph (a)(1) or (2) of this section shall
be the same reserves which are taken into account in determining under
paragraph (a) of this section the taxable income of such corporation.
(iv) Method of comparing reserves when subject to more than one
State. If the insurance business of a controlled foreign corporation is
subject to the law of more than one State, the amount of reserves taken
into account under subparagraph (1)(i) of this paragraph shall be the
amount of the highest aggregate reserve required by any State,
determined as provided in paragraph (a) of Sec. 1.801-5 of this
chapter.
(d) Domestic corporation tax attributes. In determining taxable
income of a controlled foreign corporation under this section there
shall be allowed, except as provided in section 953(b), this section,
and Sec. 1.953-5, the exclusions and deductions from gross income which
would be allowed if such corporation were a domestic insurance company
engaged in the business of only reinsuring or issuing the insurance or
annuity contracts which have
[[Page 235]]
been reinsured or issued by such corporation. For this purpose, the
provisions of sections 819, 821(e), 822(e), 831(b), and 832(d), relating
to foreign insurance companies, shall not apply; however, for the
exclusion from the taxable income determined under section 953 of
amounts derived from sources within the United States, see section
952(b) and paragraph (b) of Sec. 1.952-1. Furthermore, taxable income
shall be determined under this section without regard to section 882 (b)
and (c), relating to gross income and deductions of a foreign
corporation, and without regard to whether the controlled foreign
corporation is carrying on an insurance business in the United States.
For other rules relating to the determination of gross income and
taxable income of a foreign corporation for purposes of subpart F, see
Sec. 1.952-2.
(e) Limitation on certain amounts in respect of United States risks.
In determining taxable income under this section the following amounts
shall not, in accordance with section 953(b)(4), be taken into account
except to the extent they are attributable to the reinsuring or issuing
of any insurance or annuity contract in connection with United States
risks described in Sec. 1.953-2 or Sec. 1.953-3:
(1) The amount of premiums determined under section 809(c)(1);
(2) The net decrease in reserves determined under section 809(c)(2);
(3) The net increase in reserves determined under section 809(d)(2);
and
(4) The premiums earned on insurance contracts during the taxable
year, as determined under section 832(b)(4). For the allocation and
apportionment of such amounts to income from the insurance of United
States risks, see paragraphs (f) and (g) of this section.
(f) Items allocated or apportioned--(1) Rules of allocation or
apportionment. In determining taxable income under this section, first
determine all items of income, expenses, losses, and other deductions
which directly relate to the premiums received for the reinsuring or the
issuing of any insurance or annuity contract in connection with United
States risks, as defined in Sec. Sec. 1.953-2 and 1.953-3, and allocate
such items to the insurance of United States risks. For example, the
deductions allowed by section 809(d)(1), relating to death benefits,
section 809(d)(3), relating to dividends to policyholders, and section
809(d)(7), relating to the assumption by another person of liabilities
under insurance contracts, shall be allocated to the insurance of United
States risks to the extent they relate directly to the premiums received
for reinsuring or issuing insurance or annuity contracts in connection
with United States risks. Next, determine all items of income, expenses,
losses, and other deductions which directly relate to the premiums
received for the reinsuring or the issuing of any insurance or annuity
contract in connection with foreign risks and allocate such items to the
reinsuring of foreign risks. Finally, determine all items of income,
expenses, losses, and other deductions which relate to the premiums
received for the reinsuring or the issuing of any insurance or annuity
contract in connection with both United States risks and foreign risks,
and, except as provided in paragraph (g) of this section, apportion such
items between the insurance of United States risks and the insurance of
foreign risks in the manner prescribed in subparagraph (2) or (3) of
this paragraph, as the case may be. As used in this section, the term
``foreign risks'' means risks which are not United States risks as
defined in Sec. 1.953-2 or Sec. 1.953-3.
(2) Method of apportionment in determination of life insurance
taxable income--(i) Investment yield and net long-term capital gain.
Unless they can be allocated to the insurance of United States risks, as
provided in subparagraph (1) of this paragraph, in determining a
controlled foreign corporation's taxable income for any taxable year
under paragraph (a)(1) of this section--
(a) The investment yield under section 804(c),
(b) The amount (if any) under section 809(b)(1)(B) by which the net
long-term capital gain exceeds the net short-term capital loss, and
(c) Those deductions allowed under section 809(d)(8), (9), and (12)
which relate to gross investment income shall be apportioned to the
reinsuring and issuing of insurance and annuity contracts in connection
with United
[[Page 236]]
States risks in an amount which bears the same ratio to each of such
amounts of investment yield, excess gain, and deductions as the sum of
the mean of each of the items described in section 810(c) at the
beginning and end of the taxable year attributable to reinsuring and
issuing any insurance and annuity contracts in connection with United
States risks bears to the sum of the mean of each of the items described
in section 810(c) at the beginning and end of the taxable year
attributable to reinsuring and issuing all insurance and annuity
contracts. Thus, for example, if the ratio which the sum of the mean of
each of the items described in section 810(c) at the beginning and end
of the taxable year attributable to reinsuring and issuing insurance and
annuity contracts in connection with United States risks bears to the
sum of the mean of each of the items described in section 810(c) at the
beginning and end of the taxable year attributable to reinsuring and
issuing all insurance and annuity contracts in one to three, then,
unless an allocation to the insurance of United States risks can be made
as provided in subparagraph (1) of this paragraph, one-third of each of
such amounts of investment yield, excess gain, and deductions shall be
apportioned to the reinsuring and issuing of insurance and annuity
contracts in connection with United States risks, and two-thirds of each
of such amounts shall be apportioned to the reinsuring and issuing of
insurance and annuity contracts in connection with foreign risks.
(ii) Other income and deductions--(a) Amount taken into account. In
determining a controlled foreign corporation's taxable income for any
taxable year under paragraph (a)(1) of this section, all items of income
taken into account under section 809(c)(3), relating to other amounts of
gross income, and the other deductions allowed under section 809(d)(12)
to the extent that such other deductions do not relate to gross
investment income shall be apportioned to the reinsuring and issuing of
insurance and annuity contracts in connection with United States risks
in an amount which bears the same ratio to each of such items of income
or of such other deductions as the numerator determined under (b) of
this subdivision bears to the denominator determined under (c) of this
subdivision.
(b) Numerator. The numerator used for purposes of the apportionment
under (a) of this subdivision shall be an amount which equals the amount
determined under (c) of this subdivision, but only to the extent that
the amount so determined is taken into account under paragraph (e) of
this section in determining taxable income for the taxable year.
(c) Denominator. The denominator used for purposes of the
apportionment under (a) of this subdivision shall be an amount which
equals--
(1) The amount of premiums determined under section 809(c)(1) for
the taxable year, plus
(2) The net decrease in reserves determined under section 809(c)(2)
for such year, minus
(3) The net increase in reserves determined under section 809(d)(2)
for such year.
(iii) Reserves used in apportionment formula. The rules for
determining which reserves are taken into account in determining the
taxable income of a controlled foreign corporation under paragraph (a)
of this section shall also apply under subdivision (ii) (b) and (c) of
this subparagraph in determining the net decrease in reserves under
section 809(c)(2) or the net increase in reserves under section
809(d)(2). See paragraph (c) of this section.
(3) Method of apportionment in determination of mutual and other
insurance income--(i) In general. In determining a controlled foreign
corporation's taxable income for any taxable year under paragraph (a)(2)
of this section, any item which is required to be apportioned under
subparagraph (1) of this paragraph shall be apportioned to the
reinsuring and issuing of insurance and annuity contracts in connection
with United States risks in an amount which bears the same ratio to the
total amount of such item as the amount of premiums earned on insurance
contracts during the taxable year which is required to be taken into
account by such corporation under paragraph (e)(4) of this section in
determining such taxable income bears to the total amount
[[Page 237]]
of all its premiums earned (as determined under section 832(b)(4)) on
insurance contracts during the taxable year.
(ii) Reserves used in apportionment formula. The principles of
subparagraph (2)(iii) of this paragraph shall apply in determining the
reserves included in premiums earned on insurance contracts during the
taxable year for purposes of subdivision (i) of this subparagraph.
(g) Separate accounting. The methods of apportionment prescribed in
subparagraphs (2) and (3) of paragraph (f) of this section for
determining taxable income under this section shall not apply if the
district director determines that the controlled foreign corporation, in
good faith and unaffected by considerations of tax liability, regularly
employs in its books of account a detailed segregation of receipts,
expenditures, assets, liabilities, and net worth which clearly reflects
the income derived from the reinsuring or issuing of insurance or
annuity contracts in connection with United States risks. The district
director, in making such determination, shall give effect to any foreign
law, satisfactory evidence of which is presented by the United States
shareholder to the district, director, which requires a reasonable
segregation of those items of income, expense, losses, and other
deductions which relate to determining such taxable income.
(h) Illustration. The application of paragraphs (e) and (f) of this
section may be illustrated by the following example:
Example. Controlled foreign corporation A, incorporated under, and
engaged in an insurance business subject to, the laws of foreign country
X, is a wholly owned subsidiary of domestic corporation M. Both
corporations use the calendar year as the taxable year. Corporation M is
a life insurance company as defined in section 801(a); A Corporation
would, if it were a domestic corporation, be taxable under part I of
subchapter L of the Code. In 1963, A Corporation derives income from the
insurance of United States risks as a result of reinsuring the life
insurance policies issued by M Corporation on lives of residents of the
United States. In 1963, A Corporation also issues policies of life
insurance on individuals who are not residents of the United States, but
its premiums from the reinsuring of United States risks exceed he 5-
percent minimum premium requirement prescribed in paragraph (b) of Sec.
1.953-1. Based upon the facts set forth in paragraph (a) of this
example, A Corporation for 1963 has taxable income under this section of
$40,200, which is attributable to the reinsuring of life insurance
contracts in connection with United States risks, determined in the
manner provided in paragraphs (b), (c), and (d) of this example.
(a) A summary of the entire operations of A Corporation for 1963,
determined under this section as though such corporation were a domestic
life insurance company but without applying paragraph (f) of this
section, is as follows:
------------------------------------------------------------------------
Attributable Attributable
Attributable to to insuring
Item to all reinsuring foreign
insurance U.S. risks risks
------------------------------------------------------------------------
Investment Income:
(1) Investment yield under $90,000 Unallocable Unallocable
section 804(c).............
(2) Sum of the mean of each 2,500,000 $1,000,000 $1,500,000
of the items described in
section 810(c) at beginning
and end of 1963............
(3) Required interest under 60,000 25,000 35,000
section 809(a)(2)..........
(4) Deductions allowed under 10,000 Unallocable Unallocable
section 809(d)(8), (9), and
(12) which relate to gross
investment income..........
Underwriting Income:
(5) Premiums under section 600,000 200,000 400,000
809(c)(1)..................
(6) Net decrease in reserves 10,000 None 10,000
under section 809(c)(2)....
(7) Net increase in reserves 40,000 40,000 None
under section 809(d)(2)....
(8) Deductions allowed under
section 809(d) (other than
deduction allowed under
section 809(d)(2) and other
than those deductions
allowed under section
809(d)(8), (9), and (12)
which relate to gross
investment income):
(i) Allocable............. 330,000 110,000 220,000
(ii) Unallocable.......... 60,000 Unallocable Unallocable
------------------------------------------------------------------------
(b) The unallocable investment yield ($90,000) under paragraph
(a)(1) of this example and the unallocable deductions ($10,000) under
paragraph (a)(4) relating to gross investment income are apportioned to
the reinsuring of United States risks under paragraph (f)(1)(i) of this
section in the amounts
[[Page 238]]
of $36,000, and $4,000, respectively, determined as follows:
(1) Sum of the mean of each of the items described in $1,000,000
section 810(c) at beginning and end of 1963, attributable
to reinsuring U.S. risks (paragraph (a)(2))................
(2) Sum of the mean of each of the items described in $2,500,000
section 810(c) at beginning and end of 1963, attributable
to all insurance (paragraph (a)(2))........................
(3) Ratio of amount under subparagraph (1) to amount under 40%
subparagraph (2) ($1,000,000/$2,500,000)...................
(4) Amount of investment yield attributable to reinsuring of $36,000
U.S. risks (40% of $90,000)................................
(5) Amount of such deductions attributable to reinsuring of $4,000
U.S. risks (40% of $10,000)................................
(c) The unallocable deductions ($60,000) under paragraph (a)(8)(ii)
of this example which do not relate to gross investment income are
apportioned to the reinsuring of United States risks under paragraph
(f)(2)(ii) of this section in the amount of $16,800, determined as
follows:
(1) The numerator determined under paragraph (f)(2)(ii)(b) of this
section is $160,000, determined as follows:
(i) Premiums under section 809(c)(1) $200,000 ...........
attributable to reinsuring U.S. risks
(paragraph (a)(5))...........................
(ii) Plus: Net decrease in reserves under ........... $200,000
section 809(c)(2) attributable to reinsuring
U.S. risks (paragraph (a)(6))................
------------
(iii) Less: Net increase in reserves under section $40,000
809(d)(2) attributable to reinsuring U.S. risks (paragraph
(a)(7))...................................................
------------
........... $160,000
(2) The denominator determined under paragraph (f)(2)(ii)(c) of this
section is $570,000, determined as follows:
(i) Premiums under section 809(c)(1) $600,000 ...........
attributable to all insurance (paragraph
(a)(5))......................................
(ii) Plus: Net decrease in reserves under 10,000 ...........
section 809(c)(2) attributable to all
insurance (paragraph (a)(6)).................
--------------
........... $610,000
(iii) Less: Net increase in reserves under section 40,000
809(d)(2) attributable to all insurance (paragraph (a)(7))
------------
........... $570,000
(3) Ratio which the numerator determined under subparagraph (1)
bears to the denominator determined under subparagraph (2) ($160,000/
$570,000)--28%.
(4) Amount of deductions attributable to reinsuring of U.S. risks
(28% of $60,000)-- $16,800.
(d) The taxable income of A Corporation for 1963 which constitutes
its income derived from the insurance of United States risks for
purposes of paragraph (a) of Sec. 1.953-1 is $40,200, determined as
follows:
----------------------------------------------------------------------------------------------------------------
Attributable to all Attributable to Attributable to
insurance reinsuring U.S. insuring foreign
---------------------- risks risks
-------------------------------------------
----------------------------------------------------------------------------------------------------------------
Item:
(1) Investment yield under section 804(c) $90,000 ......... $36,000 ......... $54,000 .........
(paragraph (a)(1), unallocable but as
apportioned under paragraph (b)(4).........
(2) Less: Required interest under section 60,000 ......... 25,000 ......... 35,000 .........
809(a)(2) (paragraph (a)(3))...............
----------- ----------- -----------
(3) Life insurance company's share of ......... $30,000 ......... $11,000 ......... $19,000
investment yield under section 809(b)(1)(A)
Plus sum of:
(4) Premiums under section 809(c)(1) 600,000 ......... 200,000 ......... 400,000 .........
(paragraph (a)(5)).........................
(5) Net decrease in reserves under section 10,000 610,000 None 200,000 10,000 410,000
809(c)(2) (paragraph (a)(6))...............
------------
Sum determined under section 809(b)(1)... ......... 640,000 ......... 211,000 ......... 429,000
Less sum of:
(6) Net increase in reserves under section 40,000 ......... 40,000 ......... None .........
809(d)(2) (paragraph (a)(7))...............
(7) Deductions allowed under section 10,000 ......... 4,000 ......... 6,000 .........
809(d)(8), (9), and (12) which relate to
gross investment income (paragraph (a)(4)),
unallocable but as apportioned under
paragraph (b)(5)...........................
(8) Deductions allowed under section 809(d)
(other than deduction allowed under section
809(d)(2) and other than those deductions
allowed under section 809(d)(8), (9), and
(12) which relate to gross investment
income) (paragraph (a)(8)):................
(i) Allocable............................. 330,000 ......... 110,000 ......... 220,000 .........
[[Page 239]]
(ii) Unallocable, but as apportioned under 60,000 440,000 16,800 170,800 43,200 269,200
paragraph (c)(4).........................
------------
Gain from operations..................... ......... 200,000 ......... 40,200 ......... 159,800
----------------------------------------------------------------------------------------------------------------
[T.D. 6781, 29 FR 18207, Dec. 23, 1964]
Sec. 1.953-5 Corporations not qualifying as insurance companies.
(a) In general. A controlled foreign corporation is not excluded
from the application of paragraph (a) of Sec. 1.953-1 because such
corporation, if it were a domestic corporation, would not be taxable as
an insurance company to which subchapter L of the Code applies. Thus, if
a controlled foreign corporation reinsures or issues insurance or
annuity contracts in connection with United States risks, as defined in
Sec. 1.953-2 or Sec. 1.953-3, and satisfies the 5-percent minimum
premium requirement prescribed in paragraph (b) of Sec. 1.953-1, such
corporation may derive income from the insurance of United States risks
even though the primary and predominant business activity of such
corporation during the taxable year is not the issuing of insurance or
annuity contracts or the reinsuring of risks underwritten by insurance
companies.
(b) Income from insurance of United States risks by noninsurance
company. For purposes of paragraph (a) of Sec. 1.953-1, the taxable
income derived from the reinsuring or the issuing of any insurance or
annuity contract in connection with United States risks by a controlled
foreign corporation which, if it were a domestic corporation, would not
be taxable as an insurance company to which subchapter L of the Code
applies shall be determined under Sec. 1.953-4, subject to, and to the
extent not inconsistent with, the special rules prescribed in paragraph
(c) or (d) of this section, whichever applies.
(c) Special rules in determining taxable income--(1) In general. The
rules prescribed in this paragraph apply in order to exclude from the
determination under Sec. 1.953-4 of the taxable income described in
paragraph (b) of this section those items of the controlled foreign
corporation's gross income and deductions which are not attributable to
the reinsuring and issuing of insurance and annuity contracts.
(2) Life insurance taxable income--(i) Amount of investment yield
taken into account. For purposes of determining the taxable income of a
controlled foreign corporation which would not be taxable as an
insurance company to which subchapter L of the Code applies if it were a
domestic corporation but would be taxable as an insurance company to
which part I of such subchapter applies if it were a domestic insurance
company engaged in the business of only reinsuring or issuing the
insurance or annuity contracts which have been reinsured or issued by
such corporation, the investment yield under section 804(c), the amount
(if any) by which the net long-term capital gain exceeds the net short-
term capital loss, and all items of income taken into account under
section 809(c)(3) shall be taken into account, subject to the provisions
of paragraphs (e) and (f) of Sec. 1.953-4, in an amount which bears the
same ratio to each of such amounts of investment yield, excess gain, and
income items, as the case may be, as the numerator determined under
subdivision (ii) of this subparagraph bears to the denominator
determined under subdivision (iii) of this subparagraph.
(ii) Numerator. The numerator used for purposes of the apportionment
under subdivision (i) of this subparagraph shall be the sum of--
(a) The mean of each of the items described in section 810(c) at the
beginning and end of the taxable year, determined in accordance with the
rules prescribed in paragraph (c) of Sec. 1.953-4 for purposes of
determining taxable income of a controlled foreign corporation under
paragraph (a) of Sec. 1.953-4,
[[Page 240]]
(b) The mean of other liabilities at the beginning and end of the
taxable year which are attributable to the reinsuring and issuing of
insurance and annuity contracts, and
(c) The mean of the earnings and profits accumulated by the
controlled foreign corporation at the beginning and end of the taxable
year (determined without diminution by reason of any distributions made
during the taxable year) which are attributable to the reinsuring and
issuing of insurance and annuity contracts.
(iii) Denominator. The denominator used for purposes of the
apportionment under subdivision (i) of this subparagraph shall be the
mean of the value of the total assets held by the controlled foreign
corporation at the beginning and end of the taxable year, determined by
taking assets into account at their actual value (not reduced by
liabilities), which, in the absence of affirmative evidence to the
contrary, shall be deemed to be (a) face value in the case of bills
receivable, accounts receivable, notes receivable, and open accounts
held by a controlled foreign corporation using the cash receipts and
disbursements method of accounting and (b) adjusted basis in the case of
all other assets.
(3) Mutual and other insurance taxable income--(i) Amount of
insurance income taken into account. For purposes of determining the
taxable income of a controlled foreign corporation which, if it were a
domestic corporation, would not be taxable as an insurance company to
which subchapter L of the Code applies but which if it were a domestic
insurance company engaged in the business of only reinsuring or issuing
the insurance or annuity contracts which have been reinsured or issued
by such corporation, would be taxable as a mutual insurance company to
which part II of subchapter L of the Code applies, or would be taxable
as a mutual marine insurance or other insurance company to which part
III of subchapter L of the Code applies, the sum of the items of gross
income referred to in section 832(b)(1) (except the gross amount earned
during the taxable year from underwriting income described in section
832(b)(1)(A)) reduced by the deductions allowable under section 832(c)
which are related to such items of gross income shall be taken into
account, subject to the provisions of paragraphs (e) and (f) of Sec.
1.953-4, in an amount which bears the same proportion to the sum of such
items of gross income reduced by such deductions as the numerator
determined under subdivision (ii) of this subparagraph bears to the
denominator determined under subdivision (iii) of this subparagraph.
(ii) Numerator. The numerator used for purposes of the apportionment
under subdivision (i) of this subparagraph shall be the sum of--
(a) The mean of the controlled foreign corporation's unearned
premiums at the beginning and end of the taxable year, determined under
section 832(b)(4)(B) and in accordance with the rules prescribed in
paragraph (c) of Sec. 1.953-4 for purposes of determining taxable
income of a controlled foreign corporation under paragraph (a) of Sec.
1.953-4,
(b) The mean of such corporation's unpaid losses at the beginning
and end of the taxable year, determined under section 832(b)(5)(B),
(c) The mean of the items described in section 810(c)(4) at the
beginning and end of the taxable year, to the extent allowable to such
corporation under section 832(c)(11),
(d) The mean of other liabilities at the beginning and end of the
taxable year which are attributable to the reinsuring and issuing of
insurance and annuity contracts, and
(e) The mean of the earnings and profits accumulated by such
corporation at the beginning and end of the taxable year (determined
without diminution by reason of any distributions made during the
taxable year) which are attributable to the reinsuring and issuing of
insurance and annuity contracts.
(iii) Denominator. The denominator used for purposes of the
apportionment under subdivision (i) of this subparagraph shall be the
mean of the value of the total assets held by the controlled foreign
corporation at the beginning and end of the taxable year, determined in
the manner prescribed in subparagraph (2)(iii) of this paragraph.
(d) Separate accounting. The special rules prescribed in paragraph
(c) of this
[[Page 241]]
section shall not apply if the district director determines that the
controlled foreign corporation, in good faith and unaffected by
considerations of tax liability, regularly employs in its books of
account a detailed segregation of receipts, expenditures, assets,
liabilities, and net worth which clearly reflects the income derived
from the reinsuring or issuing of insurance or annuity contracts. The
district director, in making such determination, shall give effect to
any foreign law, satisfactory evidence of which is presented by the
United States shareholder to the district director, which requires a
reasonable segregation of the insurance assets of the controlled foreign
corporation.
[T.D. 6781, 29 FR 18211, Dec. 23, 1964]
Sec. 1.953-6 Relationship of sections 953 and 954.
(a) Priority of application. For purposes of determining the subpart
F income of a controlled foreign corporation under section 952 for any
taxable year, the provisions of section 954, relating to foreign base
company income, shall be applied, after first applying section 953, only
with respect to income which is not income derived from the insurance of
United States risks under section 953. For example, the provisions of
section 954 may be applied with respect to the income of a controlled
foreign corporation which is not income derived from the insurance of
United States risks under section 953 because such corporation does not
satisfy the 5-percent minimum premium requirement prescribed in
paragraph (b) of Sec. 1.953-1, even though such corporation has taxable
income, as determined under Sec. 1.953-4, which is attributable to the
reinsuring or the issuing of any insurance or annuity contracts in
connection with United States risks. In addition, the provisions of
section 954 may apply with respect to the income of a controlled foreign
corporation to the extent such income is not allocated or apportioned
under Sec. 1.953-4 to the insurance of United States risks.
(b) Decrease in income not material. It is not material that the
income of a controlled foreign corporation is decreased as a result of
the application of paragraph (a) of this section. Thus, in applying
Sec. 1.953-4 to the income of a controlled foreign corporation
described in paragraph (c)(2) of Sec. 1.953-5 which would, but for
paragraph (a) of this section, be subject to the provisions of section
954, there shall be allowed, in determining the taxable income derived
from the insurance of United States risks under Sec. 1.953-4, a
deduction under section 809(a)(1) for the share of each and every item
of investment yield set aside for policyholders; it is not material that
in determining foreign base company income such deduction would not be
allowed under section 954(b)(5). Further, income of a controlled foreign
corporation which is required to be taken into account under section 953
in determining income derived from the insurance of United States risks
and would, but for the provisions of paragraph (a) of this section,
constitute foreign base company income under section 954 shall not be
taken into account under section 954(b)(3)(B) in determining whether
foreign base company income exceeds 70 percent of gross income for the
taxable year.
(c) Increase in income not material. It is not material that the
income of a controlled foreign corporation is increased as a result of
the application of paragraph (a) of this section. Thus, in applying
Sec. 1.953-4 to income of a controlled foreign corporation which would,
but for paragraph (a) of this section, be subject to the provisions of
section 954, it is not material that the dividends, interest, and gains
from the sale or exchange of stock or securities derived from certain
investments which would not be included in foreign personal holding
company income under section 954(c)(3)(B) are included under section 953
in income derived from the insurance of United States risks. Further,
income of a controlled foreign corporation which is required to be taken
into account under section 953 in determining income derived from the
insurance of United States risks and would, but for paragraph (a) of
this section, constitute foreign base company income shall not be
excluded under section 954(b)(3)(A) for the taxable year.
[T.D. 6781, 29 FR 18212, Dec. 23, 1964]
[[Page 242]]
Sec. 1.954-0 Introduction.
(a) Effective dates--(1) Final regulations--(i) In general. Except
as otherwise specifically provided, the provisions of Sec. Sec. 1.954-1
and 1.954-2 apply to taxable years of a controlled foreign corporation
beginning after November 6, 1995. If any of the rules described in
Sec. Sec. 1.954-1 and 1.954-2 are inconsistent with provisions of other
regulations under subpart F, these final regulations are intended to
apply instead of such other regulations.
(ii) Election to apply final regulations retroactively--(A) Scope of
election. An election may be made to apply the final regulations
retroactively with respect to any taxable year of the controlled foreign
corporation beginning on or after January 1, 1987. If such an election
is made, these final regulations must be applied in their entirety for
such taxable year and all subsequent taxable years. All references to
section 11 in the final regulations shall be deemed to include section
15, where applicable.
(B) Manner of making election. An election under this paragraph
(a)(1)(ii) is binding on all United States shareholders of the
controlled foreign corporation and must be made--
(1) By the controlling United States shareholders, as defined in
Sec. 1.964-1(c)(5), by attaching a statement to such effect with their
original or amended income tax returns for the taxable year of such
United States shareholders in which or with which the taxable year of
the CFC ends, and including any additional information required by
applicable administrative pronouncements, or
(2) In such other manner as may be prescribed in applicable
administrative pronouncements.
(C) Time for making election. An election may be made under this
paragraph (a)(1)(ii) with respect to a taxable year of the controlled
foreign corporation beginning on or after January 1, 1987 only if the
time for filing a return or claim for refund has not expired for the
taxable year of any United States shareholder of the controlled foreign
corporation in which or with which such taxable year of the controlled
foreign corporation ends.
(D) Revocation of election. An election made under this paragraph
(a)(1)(ii) may not be revoked.
(2) Temporary regulations. The provisions of Sec. Sec. 4.954-1 and
4.954-2 of this chapter apply to taxable years of a controlled foreign
corporation beginning after December 31, 1986 and on or before November
6, 1995. However, the provisions of Sec. 4.954-2(b)(6) of this chapter
continue to apply. For transactions entered into on or before October
10, 1995, taxpayers may rely on Notice 89-90, 1989-2 C.B. 407, in
applying the temporary regulations.
(3) Sec. Sec. 1.954A-1 and 1.954A-2. The provisions of Sec. Sec.
1.954A-1 and 1.954A-2 (as contained in 26 CFR part 1 edition revised
April 1, 1995) apply to taxable years of a controlled foreign
corporation beginning before January 1, 1987. All references therein to
sections of the Code are to the Internal Revenue Code of 1954 prior to
the amendments made by the Tax Reform Act of 1986.
(b) Outline of Sec. Sec. 1.954-0, 1.954-1 and 1.954-2.
Sec. 1.954-0 Introduction.
(a) Effective dates.
(1) Final regulations.
(i) In general.
(ii) Election to apply final regulations retroactively.
(A) Scope of election.
(B) Manner of making election.
(C) Time for making election.
(D) Revocation of election.
(2) Temporary regulations.
(3) Sec. Sec. 1.954A-1 and 1.954A-2.
(b) Outline of Sec. Sec. 1.954-0, 1.954-1, and 1.954-2.
Sec. 1.954-1 Foreign base company income.
(a) In general.
(1) Purpose and scope.
(2) Gross foreign base company income.
(3) Adjusted gross foreign base company income.
(4) Net foreign base company income.
(5) Adjusted net foreign base company income.
(6) Insurance income.
(7) Additional items of adjusted net foreign base company income or
adjusted net insurance income by reason of section 952(c).
(b) Computation of adjusted gross foreign base company income and
adjusted gross insurance income.
(1) De minimis and full inclusion tests.
(i) De minimis test.
(A) In general.
(B) Currency translation.
[[Page 243]]
(C) Coordination with sections 864(d) and 881(c).
(ii) Seventy percent full inclusion test.
(2) Character of gross income included in adjusted gross foreign
base company income.
(3) Coordination with section 952(c).
(4) Anti-abuse rule.
(i) In general.
(ii) Presumption.
(iii) Related persons.
(iv) Example.
(c) Computation of net foreign base company income.
(1) General rule.
(i) Deductions against gross foreign base company income.
(ii) Losses reduce subpart F income by operation of earnings and
profits limitation.
(iii) Items of income.
(A) Income other than passive foreign personal holding company
income.
(B) Passive foreign personal holding company income.
(2) Computation of net foreign base company income derived from same
country insurance income.
(d) Computation of adjusted net foreign base company income or
adjusted net insurance income.
(1) Application of high tax exception.
(2) Effective rate at which taxes are imposed.
(3) Taxes paid or accrued with respect to an item of income.
(i) Income other than passive foreign personal holding company
income.
(ii) Passive foreign personal holding company income.
(4) Special rules.
(i) Consistency rule.
(ii) Coordination with earnings and profits limitation.
(iii) Example.
(5) Procedure.
(6) Coordination of full inclusion and high tax exception rules.
(7) Examples.
(e) Character of income.
(1) Substance of the transaction.
(2) Separable character.
(3) Predominant character.
(4) Coordination of categories of gross foreign base company income
or gross insurance income.
(i) In general.
(ii) Income excluded from other categories of gross foreign base
company income.
(f) Definition of related person.
(1) Persons related to controlled foreign corporation.
(i) Individuals.
(ii) Other persons.
(2) Control.
(i) Corporations.
(ii) Partnerships.
(iii) Trusts and estates.
(iv) Direct or indirect ownership.
Sec. 1.954-2 Foreign personal holding company income.
(a) Computation of foreign personal holding company income.
(1) Categories of foreign personal holding company income.
(2) Coordination of overlapping categories under foreign personal
holding company provisions.
(i) In general.
(ii) Priority of categories.
(3) Changes in the use or purpose for which property is held.
(i) In general.
(ii) Special rules.
(A) Anti-abuse rule.
(B) Hedging transactions.
(iii) Example.
(4) Definitions and special rules.
(i) Interest.
(ii) Bona fide hedging transaction.
(A) Definition.
(B) Identification.
(C) Effect of identification and non-identification.
(1) Transactions identified.
(2) Inadvertent identification.
(3) Transactions not identified.
(4) Inadvertent error.
(5) Anti-abuse rule.
(iii) Inventory and similar property.
(A) Definition.
(B) Hedging transactions.
(iv) Regular dealer.
(v) Dealer property.
(A) Definition.
(B) Securities dealers.
(C) Hedging transactions.
(vi) Examples.
(vii) Debt instrument.
(b) Dividends, interest, rents, royalties and annuities.
(1) In general.
(2) Exclusion of certain export financing interest.
(i) In general.
(ii) Exceptions.
(iii) Conduct of a banking business.
(iv) Examples.
(3) Treatment of tax-exempt interest. [Reserved]
(4) Exclusion of dividends or interest from related persons.
(i) In general.
(A) Corporate payor.
(B) Payment by a partnership.
(ii) Exceptions.
(A) Dividends.
(B) Interest paid out of adjusted foreign base company income or
insurance income.
(1) In general.
(2) Rule for corporations that are both recipients and payors of
interest.
(C) Coordination with sections 864(d) and 881(c).
(iii) Trade or business requirement.
[[Page 244]]
(iv) Substantial assets test.
(v) Valuation of assets.
(vi) Location of tangible property.
(A) In general.
(B) Exception.
(vii) Location of intangible property.
(A) In general.
(B) Exception for property located in part in the payor's country of
incorporation.
(viii) Location of inventory and dealer property.
(A) In general.
(B) Inventory and dealer property located in part in the payor's
country of incorporation.
(ix) Location of debt instruments.
(x) Treatment of certain stock interests.
(xi) Treatment of banks and insurance companies. [Reserved]
(5) Exclusion of rents and royalties derived from related persons.
(i) In general.
(A) Corporate payor.
(B) Payment by a partnership.
(ii) Exceptions.
(A) Rents or royalties paid out of adjusted foreign base company
income or insurance income.
(B) Property used in part in the controlled foreign corporation's
country of incorporation.
(6) Exclusion of rents and royalties derived in the active conduct
of a trade or business.
(c) Excluded rents.
(1) Active conduct of a trade or business.
(2) Special rules.
(i) Adding substantial value.
(ii) Substantiality of foreign organization.
(iii) Active leasing expenses.
(iv) Adjusted leasing profit.
(3) Examples.
(d) Excluded royalties.
(1) Active conduct of a trade or business.
(2) Special rules.
(i) Adding substantial value.
(ii) Substantiality of foreign organization.
(iii) Active licensing expenses.
(iv) Adjusted licensing profit.
(3) Examples.
(e) Certain property transactions.
(1) In general.
(i) Inclusions.
(ii) Exceptions.
(iii) Treatment of losses.
(iv) Dual character property.
(2) Property that gives rise to certain income.
(i) In general.
(ii) Gain or loss from the disposition of a debt instrument.
(3) Property that does not give rise to income.
(f) Commodities transactions.
(1) In general.
(i) Inclusion in foreign personal holding company income.
(ii) Exception.
(iii) Treatment of losses.
(2) Definitions.
(i) Commodity.
(ii) Commodities transaction.
(iii) Qualified active sale.
(A) In general.
(B) Active conduct of a commodities business.
(C) Substantially all.
(D) Activities of employees of a related entity.
(iv) Qualified hedging transaction entered into prior to January 31,
2003.
(A) In general.
(B) Exception.
(C) Effective date.
(v) Qualified hedging transaction entered into on or after January
31, 2003.
(A) In general.
(B) Exception.
(C) Examples.
(D) Effective date.
(vi) Financial institutions not a producer, etc.
(g) Foreign currency gain or loss.
(1) Scope and purpose.
(2) In general.
(i) Inclusion.
(ii) Exclusion for business needs.
(A) General rule.
(B) Business needs.
(C) Regular dealers.
(1) General rule.
(2) Certain interest-bearing liabilities treated as dealer property.
(i) In general.
(ii) Failure to identify certain liabilities.
(iii) Effective date.
(D) Example.
(iii) Special rule for foreign currency gain or loss from an
interest-bearing liability.
(3) Election to characterize foreign currency gain or loss that
arises from a specific category of subpart F income as gain or loss in
that category.
(i) In general.
(ii) Time and manner of election.
(iii) Revocation of election.
(iv) Example.
(4) Election to treat all foreign currency gains or losses as
foreign personal holding company income.
(i) In general.
(ii) Time and manner of election.
(iii) Revocation of election.
(5) Gains and losses not subject to this paragraph.
(i) Capital gains and losses.
(ii) Income not subject to section 988.
(iii) Qualified business units using the dollar approximate separate
transactions method.
(iv) Gain or loss allocated under Sec. 1.861-9. [Reserved]
(h) Income equivalent to interest.
(1) In general.
[[Page 245]]
(i) Inclusion in foreign personal holding company income.
(ii) Exceptions.
(A) Liability hedging transactions.
(B) Interest.
(2) Definition of income equivalent to interest.
(i) In general.
(ii) Income from the sale of property.
(3) Notional principal contracts.
(i) In general.
(ii) Regular dealers.
(4) Income equivalent to interest from factoring.
(i) General rule.
(ii) Exceptions.
(iii) Factored receivable.
(iv) Examples.
(5) Receivables arising from performance of services.
(6) Examples.
[T.D. 8618, 60 FR 46508, Sept. 7, 1995; T.D. 8618, 60 FR 62024, Dec. 4,
1995; T.D. 8767, 63 FR 14615, Mar. 26, 1998; T.D. 9039, 68 FR 4917, Jan.
31, 2003]
Sec. 1.954-1 Foreign base company income.
(a) In general--(1) Purpose and scope. Section 954 and Sec. Sec.
1.954-1 and 1.954-2 provide rules for computing the foreign base company
income of a controlled foreign corporation. Foreign base company income
is included in the subpart F income of a controlled foreign corporation
under the rules of section 952. Subpart F income is included in the
gross income of a United States shareholder of a controlled foreign
corporation under the rules of section 951 and thus is subject to
current taxation under section 1, 11 or 55 of the Internal Revenue Code.
The determination of whether a foreign corporation is a controlled
foreign corporation, the subpart F income of which is included currently
in the gross income of its United States shareholders, is made under the
rules of section 957.
(2) Gross foreign base company income. The gross foreign base
company income of a controlled foreign corporation consists of the
following categories of gross income (determined after the application
of section 952(b))--
(i) Foreign personal holding company income, as defined in section
954(c);
(ii) Foreign base company sales income, as defined in section
954(d);
(iii) Foreign base company services income, as defined in section
954(e);
(iv) Foreign base company shipping income, as defined in section
954(f); and
(v) Foreign base company oil related income, as defined in section
954(g).
(3) Adjusted gross foreign base company income. The term adjusted
gross foreign base company income means the gross foreign base company
income of a controlled foreign corporation as adjusted by the de minimis
and full inclusion rules of paragraph (b) of this section.
(4) Net foreign base company income. The term net foreign base
company income means the adjusted gross foreign base company income of a
controlled foreign corporation reduced so as to take account of
deductions (including taxes) properly allocable or apportionable to such
income under the rules of section 954(b)(5) and paragraph (c) of this
section.
(5) Adjusted net foreign base company income. The term adjusted net
foreign base company income means the net foreign base company income of
a controlled foreign corporation reduced, first, by any items of net
foreign base company income excluded from subpart F income pursuant to
section 952(c) and, second, by any items excluded from subpart F income
pursuant to the high tax exception of section 954(b). See paragraph
(d)(4)(ii) of this section. The term foreign base company income as used
in the Internal Revenue Code and elsewhere in the Income Tax Regulations
means adjusted net foreign base company income, unless otherwise
provided.
(6) Insurance income. The term gross insurance income includes all
gross income taken into account in determining insurance income under
section 953. The term adjusted gross insurance income means gross
insurance income as adjusted by the de minimis and full inclusion rules
of paragraph (b) of this section. The term net insurance income means
adjusted gross insurance income reduced under section 953 so as to take
into account deductions (including taxes) properly allocable or
apportionable to such income. The term adjusted net insurance income
means net insurance income reduced by any items of net insurance income
[[Page 246]]
that are excluded from subpart F income pursuant to section 952(b) or
pursuant to the high tax exception of section 954(b). The term insurance
income as used in subpart F of the Internal Revenue Code and in the
regulations under that subpart means adjusted net insurance income,
unless otherwise provided.
(7) Additional items of adjusted net foreign base company income or
adjusted net insurance income by reason of section 952(c). Earnings and
profits of the controlled foreign corporation that are recharacterized
as foreign base company income or insurance income under section 952(c)
are items of adjusted net foreign base company income or adjusted net
insurance income, respectively. Amounts subject to recharacterization
under section 952(c) are determined after adjusted net foreign base
company income and adjusted net insurance income are otherwise
determined under subpart F and are not again subject to any exceptions
or special rules that would affect the amount of subpart F income. Thus,
for example, items of gross foreign base company income or gross
insurance income that are excluded from adjusted gross foreign base
company income or adjusted gross insurance income because the de minimis
test is met are subject to recharacterization under section 952(c).
Further, the de minimis and full inclusion tests of paragraph (b) of
this section, and the high tax exception of paragraph (d) of this
section, for example, do not apply to such amounts.
(b) Computation of adjusted gross foreign base company income and
adjusted gross insurance income--(1) De minimis and full inclusion
tests--(i) De minimis test--(A) In general. Except as provided in
paragraph (b)(1)(i)(C) of this section, adjusted gross foreign base
company income and adjusted gross insurance income are equal to zero if
the sum of the gross foreign base company income and the gross insurance
income of a controlled foreign corporation is less than the lesser of--
(1) 5 percent of gross income; or
(2) $1,000,000.
(B) Currency translation. Controlled foreign corporations having a
functional currency other than the United States dollar shall translate
the $1,000,000 threshold using the exchange rate provided under section
989(b)(3) for amounts included in income under section 951(a).
(C) Coordination with sections 864(d) and 881(c). Adjusted gross
foreign base company income or adjusted gross insurance income of a
controlled foreign corporation always includes income from trade or
service receivables described in section 864(d)(1) or (6), and portfolio
interest described in section 881(c), even if the de minimis test of
this paragraph (b)(1)(i) is otherwise satisfied.
(ii) Seventy percent full inclusion test. Except as provided in
section 953, adjusted gross foreign base company income consists of all
gross income of the controlled foreign corporation other than gross
insurance income and amounts described in section 952(b), and adjusted
gross insurance income consists of all gross insurance income other than
amounts described in section 952(b), if the sum of the gross foreign
base company income and the gross insurance income for the taxable year
exceeds 70 percent of gross income. See paragraph (d)(6) of this
section, under which certain items of full inclusion foreign base
company income may nevertheless be excluded from subpart F income.
(2) Character of gross income included in adjusted gross foreign
base company income. The gross income included in the adjusted gross
foreign base company income of a controlled foreign corporation
generally retains its character as foreign personal holding company
income, foreign base company sales income, foreign base company services
income, foreign base company shipping income, or foreign base company
oil related income. However, gross income included in adjusted gross
foreign base company income because the full inclusion test of paragraph
(b)(1)(ii) of this section is met is termed full inclusion foreign base
company income, and constitutes a separate category of adjusted gross
foreign base company income for purposes of allocating and apportioning
deductions under paragraph (c) of this section.
[[Page 247]]
(3) Coordination with section 952(c). Income that is included in
subpart F income because the full inclusion test of paragraph (b)(1)(ii)
of this section is met does not reduce amounts that, under section
952(c), are subject to recharacterization.
(4) Anti-abuse rule--(i) In general. For purposes of applying the de
minimis test of paragraph (b)(1)(i) of this section, the income of two
or more controlled foreign corporations shall be aggregated and treated
as the income of a single corporation if a principal purpose for
separately organizing, acquiring, or maintaining such multiple
corporations is to prevent income from being treated as foreign base
company income or insurance income under the de minimis test. A purpose
may be a principal purpose even though it is outweighed by other
purposes (taken together or separately).
(ii) Presumption. Two or more controlled foreign corporations are
presumed to have been organized, acquired or maintained to prevent
income from being treated as foreign base company income or insurance
income under the de minimis test of paragraph (b)(1)(i) of this section
if the corporations are related persons, as defined in paragraph
(b)(4)(iii) of this section, and the corporations are described in
paragraph (b)(4)(ii)(A), (B), or (C) of this section. This presumption
may be rebutted by proof to the contrary.
(A) The activities carried on by the controlled foreign
corporations, or the assets used in those activities, are substantially
the same activities that were previously carried on, or assets that were
previously held, by a single controlled foreign corporation. Further,
the United States shareholders of the controlled foreign corporations or
related persons (as determined under paragraph (b)(4)(iii) of this
section) are substantially the same as the United States shareholders of
the one controlled foreign corporation in a prior taxable year. A
presumption made in connection with the requirements of this paragraph
(b)(4)(ii)(A) may be rebutted by proof that the activities carried on by
each controlled foreign corporation would constitute a separate branch
under the principles of Sec. 1.367(a)-6T(g)(2) if carried on directly
by a United States person.
(B) The controlled foreign corporations carry on a business,
financial operation, or venture as partners directly or indirectly in a
partnership (as defined in section 7701(a)(2) and Sec. 301.7701-3 of
this chapter) that is a related person (as defined in paragraph
(b)(4)(iii) of this section) with respect to each such controlled
foreign corporation.
(C) The activities carried on by the controlled foreign corporations
would constitute a single branch operation under Sec. 1.367(a)-6T(g)(2)
if carried on directly by a United States person.
(iii) Related persons. For purposes of this paragraph (b), two or
more persons are related persons if they are in a relationship described
in section 267(b). In determining for purposes of this paragraph (b)
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 with the application of section
1563(e)(1), and stock owned with the application of section 267(c). In
determining for purposes of this paragraph (b) 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).
(iv) Example. The following example illustrates the application of
this paragraph (b)(4).
Example. (i)(1) USP is the sole United States shareholder of three
controlled foreign corporations: CFC1, CFC2 and CFC3. The three
controlled foreign corporations all have the same taxable year. The
three controlled foreign corporations are partners in FP, a foreign
entity classified as a partnership under section 7701(a)(2) and Sec.
301.7701-3 of the regulations. For their current taxable years, each of
the controlled foreign corporations derives all of its income other than
foreign base company income from activities conducted through FP, and
its foreign base company income from activities conducted both jointly
through FP and separately without FP. Based on the facts in the table
below, the foreign base company income derived by each controlled
foreign corporation for its current taxable year, including income
derived from FP, is less than five percent of the gross income of each
controlled
[[Page 248]]
foreign corporation and is less than $1,000,000:
----------------------------------------------------------------------------------------------------------------
CFC1 CFC2 CFC3
----------------------------------------------------------------------------------------------------------------
Gross income.................................................... $4,000,000 $8,000,000 $12,000,000
Five percent of gross income.................................... 200,000 400,000 600,000
Foreign base company income..................................... 199,000 398,000 597,000
----------------------------------------------------------------------------------------------------------------
(2) Thus, without the application of the anti-abuse rule of this
paragraph (b)(4), each controlled foreign corporation would be treated
as having no foreign base company income after the application of the de
minimis test of section 954(b)(3)(A) and paragraph (b)(1)(i) of this
section.
(ii) However, under these facts, the requirements of paragraph
(b)(4)(i) of this section are met unless the presumption of paragraph
(b)(4)(ii) of this section is successfully rebutted. The sum of the
foreign base company income of the controlled foreign corporations is
$1,194,000. Thus, the amount of gross foreign base company income of
each controlled foreign corporation will not be reduced by reason of the
de minimis rule of section 954(b)(3)(A) and this paragraph (b).
(c) Computation of net foreign base company income--(1) General
rule. The net foreign base company income of a controlled foreign
corporation (as defined in paragraph (a)(4) of this section) is computed
under the rules of this paragraph (c)(1). The principles of Sec. 1.904-
5(k) shall apply where payments are made between controlled foreign
corporations that are related persons (within the meaning of section
954(d)(3)). Consistent with these principles, only payments described in
Sec. 1.954-2(b)(4)(ii)(B)(2) may be offset as provided in Sec. 1.904-
5(k)(2).
(i) Deductions against gross foreign base company income. The net
foreign base company income of a controlled foreign corporation is
computed first by taking into account deductions in the following
manner:
(A) First, the gross amount of each item of income described in
paragraph (c)(1)(iii) of this section is determined.
(B) Second, any expenses definitely related to less than all gross
income as a class shall be allocated and apportioned under the
principles of sections 861, 864 and 904(d) to the gross income described
in paragraph (c)(1)(i)(A) of this section.
(C) Third, foreign personal holding company income that is passive
within the meaning of section 904 (determined before the application of
the high-taxed income rule of Sec. 1.904-4(c)) is reduced by related
person interest expense allocable to passive income under Sec. 1.904-
5(c)(2); such interest must be further allocated and apportioned to
items described in paragraph (c)(1)(iii)(B) of this section.
(D) Fourth, the amount of each item of income described in paragraph
(c)(1)(iii) of this section is reduced by other expenses allocable and
apportionable to such income under the principles of sections 861, 864
and 904(d).
(ii) Losses reduce subpart F income by operation of earnings and
profits limitation. Except as otherwise provided in Sec. 1.954-2(g)(4),
if after applying the rules of paragraph (c)(1)(i) of this section, the
amount remaining in any category of foreign base company income or
foreign personal holding company income is less than zero, the loss in
that category may not reduce any other category of foreign base company
income or foreign personal holding company income except by operation of
the earnings and profits limitation of section 952(c)(1).
(iii) Items of income--(A) Income other than passive foreign
personal holding company income. A single item of income (other than
foreign personal holding company income that is passive) is the
aggregate amount from all transactions that falls within a single
separate category (as defined in Sec. 1.904-5(a)(1)), and either--
(1) Falls within a single category of foreign personal holding
company income as--
(i) Dividends, interest, rents, royalties and annuities;
(ii) Gain from certain property transactions;
(iii) Gain from commodities transactions;
(iv) Foreign currency gain; or
(v) Income equivalent to interest; or
[[Page 249]]
(2) Falls within a single category of foreign base company income,
other than foreign personal holding company income, as--
(i) Foreign base company sales income;
(ii) Foreign base company services income;
(iii) Foreign base company shipping income;
(iv) Foreign base company oil related income; or
(v) Full inclusion foreign base company income.
(B) Passive foreign personal holding company income. A single item
of foreign personal holding company income that is passive is an amount
of income that falls within a single group of passive income under the
grouping rules of Sec. 1.904-4(c)(3), (4) and (5) and a single category
of foreign personal holding company income described in paragraphs
(c)(1)(iii)(A)(1) (i) through (v).
(2) Computation of net foreign base company income derived from same
country insurance income. Deductions relating to foreign base company
income attributable to the issuing (or reinsuring) of any insurance or
annuity contract in connection with risks located in the country under
the laws of which the controlled foreign corporation is created or
organized shall be allocated and apportioned in accordance with the
rules set forth in section 953.
(d) Computation of adjusted net foreign base company income or
adjusted net insurance income--(1) Application of high tax exception.
Adjusted net foreign base company income (or adjusted net insurance
income) equals the net foreign base company income (or net insurance
income) of a controlled foreign corporation, reduced by any net item of
such income that qualifies for the high tax exception provided by
section 954(b)(4) and this paragraph (d). Any item of income that is
foreign base company oil related income, as defined in section 954(g),
or portfolio interest, as described in section 881(c), does not qualify
for the high tax exception. See paragraph (c)(1)(iii) of this section
for the definition of the term item of income. For rules concerning the
treatment for foreign tax credit purposes of amounts excluded from
subpart F under section 954(b)(4), see Sec. 1.904-4(c). A net item of
income qualifies for the high tax exception only if--
(i) An election is made under section 954(b)(4) and paragraph (d)(5)
of this section to exclude the income from the computation of subpart F
income; and
(ii) It is established that the net item of income was subject to
foreign income taxes imposed by a foreign country or countries at an
effective rate that is greater than 90 percent of the maximum rate of
tax specified in section 11 for the taxable year of the controlled
foreign corporation.
(2) Effective rate at which taxes are imposed. The effective rate
with respect to a net item of income shall be determined separately for
each controlled foreign corporation in a chain of corporations through
which a distribution is made. The effective rate at which taxes are
imposed on a net item of income is--
(i) The United States dollar amount of foreign income taxes paid or
accrued (or deemed paid or accrued) with respect to the net item of
income, determined under paragraph (d)(3) of this section; divided by
(ii) The United States dollar amount of the net item of foreign base
company income or insurance income, described in paragraph (c)(1)(iii)
of this section, increased by the amount of foreign income taxes
referred to in paragraph (d)(2)(i) of this section.
(3) Taxes paid or accrued with respect to an item of income--(i)
Income other than passive foreign personal holding company income. The
amount of foreign income taxes paid or accrued with respect to a net
item of income (other than an item of foreign personal holding company
income that is passive) for purposes of section 954(b)(4) and this
paragraph (d) is the United States dollar amount of foreign income taxes
that would be deemed paid under section 960 with respect to that item if
that item were included in the gross income of a United States
shareholder under section 951(a)(1)(A) (determined, in the case of a
United States shareholder that is an individual, as if an election under
section 962 has been made, whether or not such election is actually
made). For this purpose, in accordance with the regulations under
section 960, the amounts that would be
[[Page 250]]
deemed paid under section 960 shall be determined separately with
respect to each controlled foreign corporation and without regard to the
limitation applicable under section 904(a). 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), will not be affected by a
subsequent reduction in foreign income taxes attributable to a
distribution to shareholders of all or part of such income.
(ii) Passive foreign personal holding company income. The amount of
income taxes paid or accrued with respect to a net item of foreign
personal holding company income that is passive for purposes of section
954(b)(4) and this paragraph (d) is the United States dollar amount of
foreign income taxes that would be deemed paid under section 960 and
that would be taken into account for purposes applying the provisions of
Sec. 1.904-4(c) with respect to that net item of income.
(4) Special rules--(i) Consistency rule. An election to exclude
income from the computation of subpart F income for a taxable year must
be made consistently with respect to all items of passive foreign
personal holding company income eligible to be excluded for the taxable
year. Thus, high-taxed passive foreign personal holding company income
of a controlled foreign corporation must either be excluded in its
entirety, or remain subject to subpart F in its entirety.
(ii) Coordination with earnings and profits limitation. If the
amount of income included in subpart F income for the taxable year is
reduced by the earnings and profits limitation of section 952(c)(1), the
amount of income that is a net item of income, within the meaning of
paragraph (c)(1)(iii) of this section, is determined after the
application of the rules of section 952(c)(1).
(iii) Example. The following example illustrates the provisions of
paragraph (d)(4)(ii) of this section. All of the taxes referred to in
the following example are foreign income taxes. For simplicity, this
example assumes that the amount of taxes that are taken into account as
a deduction under section 954(b)(5) and the amount of the gross-up
required under sections 960 and 78 are equal. Therefore, this example
does not separately illustrate the deduction for taxes and gross-up.
Example. During its 1995 taxable year, CFC, a controlled foreign
corporation, earns royalty income, net of taxes, of $100 that is foreign
personal holding company income. CFC has no expenses associated with
this royalty income. CFC pays $50 of foreign income taxes with respect
to the royalty income. For 1995, CFC has current earnings and profits of
$50. CFC's subpart F income, as determined prior to the application of
this paragraph (d), exceeds its current earnings and profits. Thus,
under paragraph (d)(4)(ii) of this section, the amount of CFC's only net
item of income, the royalty income, will be limited to $50. The
remaining $50 will be subject to recharacterization in a subsequent
taxable year under section 952(c)(2). Because the amount of foreign
income taxes paid with respect to this net item of income is $50, the
effective rate of tax on the item, for purposes of this paragraph (d),
is 50 percent ($50 of taxes/$50 net item + $50 of taxes). Accordingly,
an election under paragraph (d)(5) of this section may be made to
exclude the item of income from the computation of subpart F income.
(5) Procedure. An election made under the procedure provided by this
paragraph (d)(5) is binding on all United States shareholders of the
controlled foreign corporation and must be made--
(i) By the controlling United States shareholders, as defined in
Sec. 1.964-1(c)(5), by attaching a statement to such effect with their
original or amended income tax returns, and including any additional
information required by applicable administrative pronouncements; or
(ii) In such other manner as may be prescribed in applicable
administrative pronouncements.
(6) Coordination of full inclusion and high tax exception rules.
Notwithstanding paragraph (b)(1)(ii) of this section, full inclusion
foreign base company income will be excluded from subpart F income if
more than 90 percent of the adjusted gross foreign base company income
and adjusted gross insurance company income of a controlled foreign
corporation (determined without regard to the full inclusion test of
paragraph (b)(1) of this section) is attributable to net amounts
excluded from subpart F income pursuant to an election to have the high
tax exception
[[Page 251]]
described in section 954(b)(4) and this paragraph (d) apply.
(7) Examples. (i) The following examples illustrate the rules of
this paragraph (d). All of the taxes referred to in the following
examples are foreign income taxes. For simplicity, these examples assume
that the amount of taxes that are taken into account as a deduction
under section 954(b)(5) and the amount of the gross-up required under
sections 960 and 78 are equal. Therefore, these examples do not
separately illustrate the deduction for taxes and gross-up. Except as
otherwise stated, these examples assume there are no earnings, deficits,
or foreign income taxes in the post-1986 pools of earnings and profits
or foreign income taxes.
Example 1. (i) Items of income. During its 1995 taxable year,
controlled foreign corporation CFC earns from outside its country of
operation portfolio dividend income of $100 and interest income, net of
taxes, of $100 (consisting of a gross payment of $150 reduced by a
third-country withholding tax of $50). For purposes of illustration,
assume that CFC incurs no expenses. None of the income is taxed in CFC's
country of operation. The dividend income was not subject to third-
country withholding taxes. Pursuant to the operation of section 904, the
interest income is high withholding tax interest and the dividend income
is passive income. Accordingly, pursuant to paragraph (c)(1)(iii) of
this section, CFC has two net items of income--
(1) $100 of foreign personal holding company (FPHC)/passive income
(the dividends); and
(2) $100 of FPHC/high withholding tax income (the interest).
(ii) Effective rates of tax. No foreign tax would be deemed paid
under section 960 with respect to the net item of income described in
paragraph (i)(1) of this Example 1. Therefore, the effective rate of
foreign tax is 0, and the item may not be excluded from subpart F income
under the rules of this paragraph (d). Foreign tax of $50 would be
deemed paid under section 960 with respect to the net item of income
described in paragraph (i)(2) of this Example 1. Therefore, the
effective rate of foreign tax is 33 percent ($50 of creditable taxes
paid, divided by $150, consisting of the net item of foreign base
company income ($100) plus creditable taxes paid thereon ($50)). The
highest rate of tax specified in section 11 for the 1995 taxable year is
35 percent. Accordingly, the net item of income described in paragraph
(i)(2) of this Example 1 may be excluded from subpart F income if an
election under paragraph (d)(5) of this section is made, since it is
subject to foreign tax at an effective rate that is greater than 31.5
percent (90 percent of 35 percent). However, for purposes of section
904(d), it remains high withholding tax interest.
Example 2. (i) The facts are the same as in Example 1, except that
CFC's country of operation imposes a tax of $50 with respect to CFC's
dividend income (and thus CFC earns portfolio dividend income, net of
taxes, of only $50). The interest income is still high withholding tax
interest. The dividend income is still passive income (without regard to
the possible applicability of the high tax exception of section
904(d)(2)). Accordingly, CFC has two items of income for purposes of
this paragraph (d)--
(1) $50 of FPHC/passive income (net of the $50 foreign tax); and
(2) $100 of FPHC/high withholding tax interest income.
(ii) Each item is taxed at an effective rate greater than 31.5
percent. The net item of income described in paragraph (i)(1) of this
Example 2: foreign tax ($50) divided by sum ($100) of net item of income
($50) plus creditable tax thereon ($50) equals 50 percent. The net item
of income described in paragraph (i)(2) of this Example 2: foreign tax
($50) divided by sum ($150) of income item ($100) plus creditable tax
thereon ($50) equals 33 percent. Accordingly, an election may be made
under paragraph (d)(5) of this section to exclude either or both of the
net items of income described in paragraphs (i)(1) and (2) of this
Example 2 from subpart F income. If no election is made the items would
be included in the subpart F income of CFC.
Example 3. (i) The facts are the same as in Example 1, except that
the $100 of portfolio dividend income is subject to a third-country
withholding tax of $50, and the $150 of interest income is from sources
within CFC's country of operation, is subject to a $10 income tax
therein, and is not subject to a withholding tax. Although the interest
income and the dividend income are both passive income, under paragraph
(c)(1)(iii)(B) of this section they constitute separate items of income
pursuant to the application of the grouping rules of Sec. 1.904-4(c).
Accordingly, CFC has two net items of income for purposes of this
paragraph (d)--
(1) $50 (net of $50 tax) of FPHC/non-country of operation/greater
than 15 percent withholding tax income; and
(2) $140 (net of $10 tax) of FPHC/country of operation income.
(ii) The item described in paragraph (i)(1) of this Example 3 is
taxed at an effective rate greater than 31.5 percent, but Item 2 is not.
The net item of income described in paragraph (i)(1) of this Example 3:
foreign tax ($50) divided by sum ($100) of net item of income ($50) plus
creditable tax thereon ($50) equals 50 percent. The net item of income
described in paragraph (i)(2) of this Example 3: foreign
[[Page 252]]
tax ($10) divided by sum ($150) of net item of income ($140) plus
creditable tax thereon ($10) equals 6.67 percent. Therefore, an election
may be made under paragraph (d)(5) of this section to exclude the net
item of income described in paragraph (i)(1) of this Example 3 but not
the net item of income described in paragraph (i)(2) of this Example 3
from subpart F income.
Example 4. The facts are the same as in Example 3, except that the
$150 of interest income is subject to an income tax of $50 in CFC's
country of operation. Accordingly, CFC's items of income are the same as
in Example 3, but both items are taxed at an effective rate greater than
31.5 percent. The net item of income described in paragraph (i)(1) of
Example 3: foreign tax ($50) divided by sum ($100) of net item of income
($50) plus creditable tax thereon ($50) equals 50 percent. The net item
of income described in paragraph (i)(2) of Example 3: foreign tax ($50)
divided by sum ($150) of net item of income ($100) plus creditable tax
thereon ($50) equals 33 percent. Pursuant to the consistency rule of
paragraph (d)(4)(i) of this section, an election made by CFC's
controlling United States shareholders must exclude from subpart F
income both items of FPHC income under the high tax exception of section
954(b)(4) and this paragraph (d). The election may not be made only with
respect to one item.
Example 5. The facts are the same as in Example 1, except that CFC
earns $5 of portfolio dividend income and $150 of interest income. In
addition, CFC earns $45 for performing consulting services within its
country of operation for unrelated persons. CFC's gross foreign base
company income for 1995 of $155 ($150 of gross interest income and $5 of
portfolio dividend income) is greater than 70 percent of its gross
income of $200. Therefore, under the full inclusion test of paragraph
(b)(1)(ii) of this section, CFC's adjusted gross foreign base company
income is $200, and under paragraph (b)(2) of this section, the $45 of
consulting income is full inclusion foreign base company income. If CFC
elects, under paragraph (d)(5) of this section, to exclude the interest
income from subpart F income pursuant to the high tax exception, the $45
of full inclusion foreign base company income will be excluded from
subpart F income under paragraph (d)(6) of this section because the $150
of gross interest income excluded under the high tax exception is more
than 90 percent of CFC's adjusted gross foreign base company income of
$155.
(ii) The following examples generally illustrate the application of
paragraph (c) of this section and this paragraph (d). Example 1
illustrates the order of computations. Example 2 illustrates the
computations required by sections 952 and 954 and this Sec. 1.954-1 if
the full inclusion test of paragraph (b)(1)(ii) of this section is met
and the income is not excluded from subpart F income under section
952(b). Computations in these examples involving the operation of
section 952(c) are included for purposes of illustration only and do not
provide substantive rules concerning the operation of that section. For
simplicity, these examples assume that the amount of taxes that are
taken into account as a deduction under section 954(b)(5) and the amount
of the gross-up required under sections 960 and 78 are equal. Therefore,
these examples do not separately illustrate the deduction for taxes and
gross-up.
Example 1. (i) Gross income. CFC, a controlled foreign corporation,
has gross income of $1000 for the current taxable year. Of that $1000 of
income, $100 is interest income that is included in the definition of
foreign personal holding company income under section 954(c)(1)(A) and
Sec. 1.954-2(b)(1)(ii), is not income from a trade or service
receivable described in section 864(d)(1) or (6), or portfolio interest
described in section 881(c), and is not excluded from foreign personal
holding company income under any provision of section 952(b) or section
954(c). Another $50 is foreign base company sales income under section
954(d). The remaining $850 of gross income is not included in the
definition of foreign base company income or insurance income under
sections 954 (c), (d), (e), (f) or (g) or 953, and is foreign source
general limitation income described in section 904(d)(1)(I).
(ii) Expenses. For the current taxable year, CFC has expenses of
$500. This amount includes $8 of interest paid to a related person that
is allocable to foreign personal holding company income under section
904, and $2 of other expense that is directly related to foreign
personal holding company income. Another $20 of expense is directly
related to foreign base company sales. The remaining $470 of expenses is
allocable to general limitation income that is not foreign base company
income or insurance income.
(iii) Earnings and losses. CFC has earnings and profits for the
current taxable year of $500. In the prior taxable year, CFC had losses
with respect to income other than gross foreign base company income or
gross insurance income. By reason of the limitation provided under
section 952(c)(1)(A), those losses reduced the subpart F income
(consisting entirely of foreign source general limitation income) of CFC
by $600 for the prior taxable year.
(iv) Taxes. Foreign income tax of $30 is considered imposed on the
interest income
[[Page 253]]
under the rules of section 954(b)(4), this paragraph (d), and Sec.
1.904-6. Foreign income tax of $14 is considered imposed on the foreign
base company sales income under the rules of section 954(b)(4),
paragraph (d) of this section, and Sec. 1.904-6. Foreign income tax of
$177 is considered imposed on the remaining foreign source general
limitation income under the rules of section 954(b)(4), this paragraph
(d), and Sec. 1.904-6. For the taxable year of CFC, the maximum United
States rate of taxation under section 11 is 35 percent.
(v) Conclusion. Based on these facts, if CFC elects to exclude all
items of income subject to a high foreign tax under section 954(b)(4)
and this paragraph (d), it will have $500 of subpart F income as defined
in section 952(a) (consisting entirely of foreign source general
limitation income) determined as follows:
Step 1--Determine gross income:
(1) Gross income............................................. $1000
Step 2--Determine gross foreign base company income and gross
insurance income:
(2) Interest income included in gross foreign personal 100
holding company income under section 954(c).................
(3) Gross foreign base company sales income under section 50
954(d)......................................................
(4) Total gross foreign base company income and gross 150
insurance income as defined in sections 954 (c), (d), (e),
(f) and (g) and 953 (line (2) plus line (3))................
Step 3--Compute adjusted gross foreign base company income and
adjusted gross insurance income:
(5) Five percent of gross income (.05 x line (1))............ 50
(6) Seventy percent of gross income (.70 x line (1))......... 700
(7) Adjusted gross foreign base company income and adjusted 150
gross insurance income after the application of the de
minimis test of paragraph (b) (line (4), or zero if line (4)
is less than the lesser of line (5) or $1,000,000) (if the
amount on this line 7 is zero, proceed to Step 8)...........
(8) Adjusted gross foreign base company income and adjusted 150
gross insurance income after the application of the full
inclusion test of paragraph (b) (line (4), or line (1) if
line (4) is greater than line (6))..........................
Step 4--Compute net foreign base company income:
(9) Expenses directly related to adjusted gross foreign base 20
company sales income........................................
(10) Expenses (other than related person interest expense) 2
directly related to adjusted gross foreign personal holding
company income..............................................
(11) Related person interest expense allocable to adjusted 8
gross foreign personal holding company income under section
904.........................................................
(12) Net foreign personal holding company income after 90
allocating deductions under section 954(b)(5) and paragraph
(c) of this section (line (2) reduced by lines (10) and
(11)).......................................................
(13) Net foreign base company sales income after allocating 30
deductions under section 954(b)(5) and paragraph (c) of this
section (line (3) reduced by line (9))......................
(14) Total net foreign base company income after allocating 120
deductions under section 954(b)(5) and paragraph (c) of this
section (line (12) plus line (13))..........................
Step 5--Compute net insurance income:
(15) Net insurance income under section 953.................. 0
Step 6--Compute adjusted net foreign base company income:
(16) Foreign income tax imposed on net foreign personal 30
holding company income (as determined under section
954(b)(4) and this paragraph (d))...........................
(17) Foreign income tax imposed on net foreign base company 14
sales income (as determined under section 954(b)(4) and this
paragraph (d))..............................................
(18) Ninety percent of the maximum United States corporate 31.5%
tax rate....................................................
(19) Effective rate of foreign income tax imposed on net 33%
foreign personal holding company income ($90 of interest)
under section 954(b)(4) and this paragraph (d) (line (16)
divided by line (12)).......................................
(20) Effective rate of foreign income tax imposed on $30 of 47%
net foreign base company sales income under section
954(b)(4) and this paragraph (d) (line (17) divided by line
(13)).......................................................
(21) Net foreign personal holding company income subject to a 90
high foreign tax under section 954(b)(4) and this paragraph
(d) (zero, or line (12) if line (19) is greater than line
(18)).......................................................
[[Page 254]]
(22) Net foreign base company sales income subject to a high 30
foreign tax under section 954(b)(4) and this paragraph (d)
(zero, or line (13) if line (20) is greater than line (18)).
(23) Adjusted net foreign base company income after applying 0
section 954(b)(4) and this paragraph (d) (line (14), reduced
by the sum of line (21) and line (22))......................
Step 7--Compute adjusted net insurance income:
(24) Adjusted net insurance income........................... 0
Step 8--Additions to or reduction of adjusted net foreign base
company income by reason of section 952(c):
(25) Earnings and profits for the current year............... 500
(26) Amount subject to being recharacterized as subpart F 500
income under section 952(c)(2) (excess of line (25) over the
sum of lines (23) and (24)); if there is a deficit, then the
limitation of section 952(c)(1) may apply for the current
year........................................................
(27) Amount of reduction in subpart F income for prior 600
taxable years by reason of the limitation of section
952(c)(1)...................................................
(28) Subpart F income as defined in section 952(a), assuming 500
section 952(a)(3), (4), and (5) do not apply (the sum of
line (23), line (24), and the lesser of line (26) or line
(27)).......................................................
(29) Amount of prior year's deficit to be recharacterized as 100
subpart F income in later years under section 952(c) (excess
of line (27) over line (26))................................
Example 2. (i) Gross income. CFC, a controlled foreign corporation,
has gross income of $1000 for the current taxable year. Of that $1000 of
income, $720 is interest income that is included in the definition of
foreign personal holding company income under section 954(c)(1)(A) and
Sec. 1.954-2(b)(1)(ii), is not income from trade or service receivables
described in section 864(d)(1) or (6), or portfolio interest described
in section 881(c), and is not excluded from foreign personal holding
company income under any provision of section 954(c) and Sec. 1.954-2
or section 952(b). The remaining $280 is services income that is not
included in the definition of foreign base company income or insurance
income under sections 954 (c), (d), (e), (f), or (g) or 953, and is
foreign source general limitation income for purposes of section
904(d)(1)(I).
(ii) Expenses. For the current taxable year, CFC has expenses of
$650. This amount includes $350 of interest paid to related persons that
is allocable to foreign personal holding company income under section
904, and $50 of other expense that is directly related to foreign
personal holding company income. The remaining $250 of expenses is
allocable to services income other than foreign base company income or
insurance income.
(iii) Earnings and losses. CFC has earnings and profits for the
current taxable year of $350. In the prior taxable year, CFC had losses
with respect to income other than foreign base company income or
insurance income. By reason of the limitation provided under section
952(c)(1)(A), those losses reduced the subpart F income of CFC
(consisting entirely of foreign source general limitation income) by
$600 for the prior taxable year.
(iv) Taxes. Foreign income tax of $120 is considered imposed on the
$720 of interest income under the rules of section 954(b)(4), paragraph
(d) of this section, and Sec. 1.904-6. Foreign income tax of $2 is
considered imposed on the services income under the rules of section
954(b)(4), paragraph (d) of this section, and Sec. 1.904-6. For the
taxable year of CFC, the maximum United States rate of taxation under
section 11 is 35 percent.
(v) Conclusion. Based on these facts, if CFC elects to exclude all
items of income subject to a high foreign tax under section 954(b)(4)
and this paragraph (d), it will have $350 of subpart F income as defined
in section 952(a), determined as follows.
Step 1--Determine gross income:
(1) Gross income............................................. $1000
Step 2--Determine gross foreign base company income and gross
insurance income:
(2) Gross foreign base company income and gross insurance 720
income as defined in sections 954 (c), (d), (e), (f) and (g)
and 953 (interest income)...................................
Step 3--Compute adjusted gross foreign base company income and
adjusted gross insurance income:
(3) Seventy percent of gross income (.70 x line (1))......... 700
(4) Adjusted gross foreign base company income and adjusted 1000
gross insurance income after the application of the full
inclusion rule of this paragraph (b)(1) (line (2), or line
(1) if line (2) is greater than line (3))...................
(5) Full inclusion foreign base company income under 280
paragraph (b)(1)(ii) (line (4) minus line (2))..............
Step 4--Compute net foreign base company income:
(6) Expenses (other than related person interest expense) 50
directly related to adjusted gross foreign personal holding
company income..............................................
[[Page 255]]
(7) Related person interest expense allocable to adjusted 350
gross foreign personal holding company income under section
904.........................................................
(8) Deductions allocable to full inclusion foreign base 250
company income under section 954(b)(5) and paragraph (c) of
this section................................................
(9) Net foreign personal holding company income after 320
allocating deductions under section 954(b)(5) and paragraph
(c) of this section (line (2) reduced by line (6) and line
(7))........................................................
(10) Full inclusion foreign base company income after 30
allocating deductions under section 954(b)(5) and paragraph
(c) of this section (line (5) reduced by line (8))..........
(11) Total net foreign base company income after allocating 350
deductions under section 954(b)(5) and paragraph (c) of this
section (line (9) plus line (10))...........................
Step 5--Compute net insurance income:
(12) Net insurance income under section 953.................. 0
Step 6--Compute adjusted net foreign base company income:
(13) Foreign income tax imposed on net foreign personal 120
holding company income (interest)...........................
(14) Foreign income tax imposed on net full inclusion foreign 2
base company income.........................................
(15) Ninety percent of the maximum United States corporate 31.5%
tax rate....................................................
(16) Effective rate of foreign income tax imposed on $320 of 38%
net foreign personal holding company income under section
954(b)(4) and this paragraph (d) (line (13) divided by line
(9))........................................................
(17) Effective rate of foreign income tax imposed on $30 of 7%
net full inclusion foreign base company income under section
954(b)(4) and this paragraph (d) (line (14) divided by line
(10)).......................................................
(18) Net foreign personal holding company income subject to a 320
high foreign tax under section 954(b)(4) and this paragraph
(d) (zero, or line (9) if line (16) is greater than line
(15)).......................................................
(19) Net full inclusion foreign base company income subject 0
to a high foreign tax under section 954(b)(4) and this
paragraph (d) (zero, or line (10) if line (17) is greater
than line (15)).............................................
(20) Adjusted net foreign base company income after applying 30
section 954(b)(4) and this paragraph (d) (line (11) reduced
by the sum of line (18) and line (19))......................
Step 7--Compute adjusted net insurance income:
(21) Adjusted net insurance income........................... 0
Step 8--Reduction of adjusted net foreign base company income
or adjusted net insurance income by reason of paragraph (d)(6)
of this section:
(22) Adjusted gross foreign base company income and adjusted 720
gross insurance income (determined without regard to the
full inclusion test of paragraph (b)(1) of this section)
(line (4) reduced by line (5))..............................
(23) Ninety percent of adjusted gross foreign base company 648
income and adjusted gross insurance income (determined
without regard to the full inclusion test of paragraph
(b)(1)(ii) of this section) (90% of the amount on line (22))
(24) Net foreign base company income and net insurance income 720
excluded from subpart F income under section 954(b)(4),
increased by the amount of expenses that reduced this income
under section 954(b)(5) and paragraph (c) of this section
(line (18) increased by the sum of line (6) and line (7))...
(25) Adjusted net full inclusion foreign base company income 30
excluded from subpart F income under paragraph (d)(6) of
this section (zero, or line (10) reduced by line (19) if
line (24) is greater than line (23))........................
(26) Adjusted net foreign base company income after 0
application of paragraph (d)(6) of this section (line (20)
reduced by line (25)).......................................
Step 9--Additions to or reduction of subpart F income by reason
of section 952(c):
(27) Earnings and profits for the current year............... 350
(28) Amount subject to being recharacterized as subpart F 350
income under section 952(c)(2) (excess of line (27) over the
sum of line (21) and line (26)); if there is a deficit, then
the limitation of 952(c)(1) may apply for the current year..
(29) Amount of reduction in subpart F income for prior 600
taxable years by reason of the limitation of section
952(c)(1)...................................................
[[Page 256]]
(30) Subpart F income as defined in section 952(a), assuming 350
section 952(a)(3), (4), and (5) do not apply (the sum of
line (21) and line (26) plus the lesser of line (28) or line
(29)).......................................................
(31) Amount of prior years' deficit remaining to be 250
recharacterized as subpart F income in later years under
section 952(c) (excess of line (29) over line (28)).........
(e) Character of income--(1) Substance of the transaction. For
purposes of section 954, income shall be characterized in accordance
with the substance of the transaction, and not in accordance with the
designation applied by the parties to the transaction. For example, an
amount that is designated as rent by the taxpayer but actually
constitutes income from the sale of property, royalties, or income from
services shall not be characterized as rent but shall be characterized
as income from the sale of property, royalties or income from services,
as the case may be. Local law shall not be controlling in characterizing
income.
(2) Separable character. To the extent the definitional provisions
of section 953 or 954 describe the income or gain derived from a
transaction, or any portion or portions thereof, that income or gain, or
portion or portions thereof, is so characterized for purposes of subpart
F. Thus, a single transaction may give rise to income in more than one
category of foreign base company income described in paragraph (a)(2) of
this section. For example, if a controlled foreign corporation, in its
business of purchasing personal property and selling it to related
persons outside its country of incorporation, also performs services
outside its country of incorporation with respect to the property it
sells, the sales income will be treated as foreign base company sales
income and the services income will be treated as foreign base company
services income for purposes of these rules.
(3) Predominant character. The portion of income or gain derived
from a transaction that is included in the computation of foreign
personal holding company income is always separately determinable and
thus must always be segregated from other income and separately
classified under paragraph (e)(2) of this section. However, the portion
of income or gain derived from a transaction that would meet a
particular definitional provision under section 954 or 953 (other than
the definition of foreign personal holding company income) in unusual
circumstances may not be separately determinable. If such portion is not
separately determinable, it must be classified in accordance with the
predominant character of the transaction. For example, if a controlled
foreign corporation engineers, fabricates, and installs a fixed offshore
drilling platform as part of an integrated transaction, and the portion
of income that relates to services is not accounted for separately from
the portion that relates to sales, and is otherwise not separately
determinable, then the classification of income from the transaction
shall be made in accordance with the predominant character of the
arrangement.
(4) Coordination of categories of gross foreign base company income
or gross insurance income--(i) In general. The computations of gross
foreign base company income and gross insurance income are limited by
the following rules:
(A) If income is foreign base company shipping income, pursuant to
section 954(f), it shall not be considered insurance income or income in
any other category of foreign base company income.
(B) If income is foreign base company oil related income, pursuant
to section 954(g), it shall not be considered insurance income or income
in any other category of foreign base company income, except as provided
in paragraph (e)(4)(i)(A) of this section.
(C) If income is insurance income, pursuant to section 953, it shall
not be considered income in any category of foreign base company income
except as provided in paragraph (e)(4)(i)(A) or (B) of this section.
(D) If income is foreign personal holding company income, pursuant
to section 954(c), it shall not be considered income in any other
category of foreign base company income, other than as provided in
paragraph (e)(4)(i)(A), (B) or (C) of this section.
[[Page 257]]
(ii) Income excluded from other categories of gross foreign base
company income. Income shall not be excluded from a category of gross
foreign base company income or gross insurance income under this
paragraph (e)(4) by reason of being included in another category of
gross foreign base company income or gross insurance income, if the
income is excluded from that other category by a more specific provision
of section 953 or 954. For example, income derived from a commodity
transaction that is excluded from foreign personal holding company
income under Sec. 1.954-2(f) as income from a qualified active sale may
be included in gross foreign base company income if it also meets the
definition of foreign base company sales income. See Sec. 1.954-2(a)(2)
for the coordination of overlapping categories within the definition of
foreign personal holding company income.
(f) Definition of related person--(1) Persons related to controlled
foreign corporation. Unless otherwise provided, for purposes of section
954 and Sec. Sec. 1.954-1 through 1.954-8 inclusive, the following
persons are considered under section 954(d)(3) to be related persons
with respect to a controlled foreign corporation:
(i) Individuals. An individual, whether or not a citizen or resident
of the United States, who controls the controlled foreign corporation.
(ii) Other persons. A foreign or domestic corporation, partnership,
trust or estate that controls or is controlled by the controlled foreign
corporation, or is controlled by the same person or persons that control
the controlled foreign corporation.
(2) Control--(i) Corporations. With respect to a corporation,
control means the ownership, directly or indirectly, of stock possessing
more than 50 percent of the total voting power of all classes of stock
entitled to vote or of the total value of the stock of the corporation.
(ii) Partnerships. With respect to a partnership, control means the
ownership, directly or indirectly, of more than 50 percent (by value) of
the capital or profits interest in the partnership.
(iii) Trusts and estates. With respect to a trust or estate, control
means the ownership, directly or indirectly, of more than 50 percent (by
value) of the beneficial interest in the trust or estate.
(iv) Direct or indirect ownership. For purposes of this paragraph
(f), to determine direct or indirect ownership, the principles of
section 958 shall be applied without regard to whether a corporation,
partnership, trust or estate is foreign or domestic or whether or not an
individual is a citizen or resident of the United States.
(g) Distributive share of partnership income--(1) Application of
related person and country of organization tests. Unless otherwise
provided, to determine the extent to which a controlled foreign
corporation's distributive share of any item of gross income of a
partnership would have been subpart F income if received by it directly,
under Sec. 1.952-1(g), if a provision of subpart F requires a
determination of whether an entity is a related person, within the
meaning of section 954(d)(3), or whether an activity occurred within or
outside the country under the laws of which the controlled foreign
corporation is created or organized, this determination shall be made by
reference to such controlled foreign corporation and not by reference to
the partnership.
(2) Application of related person test for sales and purchase
transactions between a partnership and its controlled foreign
corporation partner. For purposes of determining whether a controlled
foreign corporation's distributive share of any item of gross income of
a partnership is foreign base company sales income under section
954(d)(1) when the item of income is derived from the sale by the
partnership of personal property purchased by the partnership from (or
sold by the partnership on behalf of) the controlled foreign
corporation; or the sale by the partnership of personal property to (or
the purchase of personal property by the partnership on behalf of) the
controlled foreign corporation (CFC-partnership transaction), the CFC-
partnership transaction will be treated as a transaction with an entity
that is a related person, within the meaning of section 954(d)(3), under
paragraph (g)(1) of this section, if--
[[Page 258]]
(i) The controlled foreign corporation purchased such personal
property from (or sold it to the partnership on behalf of), or sells
such personal property to (or purchases it from the partnership on
behalf of), a related person with respect to the controlled foreign
corporation (other than the partnership), within the meaning of section
954(d)(3); or
(ii) The branch rule of section 954(d)(2) applies to treat as
foreign base company sales income the income of the controlled foreign
corporation from selling to the partnership (or a third party) personal
property that the controlled foreign corporation has manufactured, in
the case where the partnership purchases personal property from (or
sells personal property on behalf of) the controlled foreign
corporation.
(3) Examples. The application of this paragraph (g) is illustrated
by the following examples:
Example 1. CFC, a controlled foreign corporation organized in
Country A, is an 80-percent partner in Partnership, a partnership
organized in Country A. All of the stock of CFC is owned by USP, a U.S.
corporation. Partnership earns commission income from purchasing Product
O on behalf of USP, from unrelated manufacturers in Country B, for sale
in the United States. To determine whether CFC's distributive share of
Partnership's commission income is foreign base company sales income
under section 954(d), CFC is treated as if it purchased Product O on
behalf of USP. Under section 954(d)(3), USP is a related person with
respect to CFC. Thus, with respect to CFC, the sales income is deemed to
be derived from the purchase of personal property on behalf of a related
person. Because the property purchased is both manufactured and sold for
use outside of Country A, CFC's country of organization, CFC's
distributive share of the sales income is foreign base company sales
income.
Example 2. (i) CFC1, a controlled foreign corporation organized in
Country A, is an 80-percent partner in Partnership, a partnership
organized in Country B. CFC2, a controlled foreign corporation organized
in Country B, owns the remaining 20 percent interest in Partnership.
CFC1 and CFC2 are owned by a common U.S. parent, USP. CFC2 manufactures
Product A in Country B. Partnership earns sales income from purchasing
Product A from CFC2 and selling it to third parties located in Country B
that are not related persons with respect to CFC1 or CFC2. To determine
whether CFC1's distributive share of Partnership's sales income is
foreign base company sales income under section 954(d), CFC1 is treated
as if it purchased Product A from CFC2 and sold it to third parties in
Country B. Under section 954(d)(3), CFC2 is a related person with
respect to CFC1. Thus, with respect to CFC1, the sales income is deemed
to be derived from the purchase of personal property from a related
person. Because the property purchased is both manufactured and sold for
use outside of Country A, CFC1's country of organization, CFC1's
distributive share of the sales income is foreign base company sales
income.
(ii) Because Product A is both manufactured and sold for use within
CFC2's country of organization, CFC2's distributive share of
Partnership's sales income is not foreign base company sales income.
Example 3. CFC, a controlled foreign corporation organized in
Country A, is an 80 percent partner in MJK Partnership, a Country B
partnership. CFC purchased goods from J Corp, a Country C corporation
that is a related person with respect to CFC. CFC sold the goods to MJK
Partnership. In turn, MJK Partnership sold the goods to P Corp, a
Country D corporation that is unrelated to CFC. P Corp sold the goods to
unrelated customers in Country D. The goods were manufactured in Country
C by persons unrelated to J Corp . CFC's distributive share of the
income of MJK Partnership from the sale of goods to P Corp will be
treated as income from the sale of goods purchased from a related person
for purposes of section 954(d)(1) because CFC purchased the goods from J
Corp, a related person. Because the goods were both manufactured and
sold for use outside of Country A, CFC's distributive share of the
income attributable to the sale of the goods is foreign base company
sales income. Further, CFC's income from the sale of the goods to MJK
Partnership will also be foreign base company sales income.
Example 4. The facts are the same as Example 3, except that MJK
Partnership purchased the goods from P Corp and sold those goods to CFC.
CFC sold the goods to J Corp. J Corp sold the goods to unrelated
customers in Country C. CFC's distributive share of the income of MJK
Partnership from the sale of the goods by the partnership to itself will
be treated as income from the sale of goods to a related person, for
purposes of section 954(d)(1). Because the goods were both manufactured
and sold for use outside of Country A, CFC's distributive share of
income attributable to the sale of the goods is foreign base company
sales income. Further, CFC's income from the sale of the goods to J Corp
is also foreign base company sales income.
(4) Effective date. This paragraph (g) applies to taxable years of a
controlled
[[Page 259]]
foreign corporation beginning on or after July 23, 2002.
[T.D. 8618, 60 FR 46509, Sept. 7, 1995; 60 FR 62024, 62025, Dec. 4,
1995, as amended by T.D. 8704, 62 FR 20, Jan. 2, 1997; T.D. 8767, 63 FR
14615, Mar. 26, 1998; T.D. 8827, 64 FR 37677, July 13, 1999; T.D. 9008,
67 FR 48023, July 23, 2002]
Sec. 1.954-2 Foreign personal holding company income.
(a) Computation of foreign personal holding company income--(1)
Categories of foreign personal holding company income. For purposes of
subpart F and the regulations under that subpart, foreign personal
holding company income consists of the following categories of income--
(i) Dividends, interest, rents, royalties, and annuities as
described in paragraph (b) of this section;
(ii) Gain from certain property transactions as described in
paragraph (e) of this section;
(iii) Gain from commodities transactions as described in paragraph
(f) of this section;
(iv) Foreign currency gain as described in paragraph (g) of this
section; and
(v) Income equivalent to interest as described in paragraph (h) of
this section.
(2) Coordination of overlapping categories under foreign personal
holding company provisions--(i) In general. If any portion of income,
gain or loss from a transaction is described in more than one category
of foreign personal holding company income (as described in paragraph
(a)(2)(ii) of this section), that portion of income, gain or loss is
treated solely as income, gain or loss from the category of foreign
personal holding company income with the highest priority.
(ii) Priority of categories. The categories of foreign personal
holding company income, listed from highest priority (paragraph
(a)(2)(ii)(A) of this section) to lowest priority (paragraph
(a)(2)(ii)(E) of this section), are--
(A) Dividends, interest, rents, royalties, and annuities, as
described in paragraph (b) of this section;
(B) Income equivalent to interest, as described in paragraph (h) of
this section without regard to the exceptions in paragraph (h)(1)(ii)(A)
of this section;
(C) Foreign currency gain or loss, as described in paragraph (g) of
this section without regard to the exclusion in paragraph (g)(2)(ii) of
this section;
(D) Gain or loss from commodities transactions, as described in
paragraph (f) of this section without regard to the exclusion in
paragraph (f)(1)(ii) of this section; and
(E) Gain or loss from certain property transactions, as described in
paragraph (e) of this section without regard to the exceptions in
paragraph (e)(1)(ii) of this section.
(3) Changes in the use or purpose for which property is held--(i) In
general. Under paragraphs (e), (f), (g) and (h) of this section,
transactions in certain property give rise to gain or loss included in
the computation of foreign personal holding company income if the
controlled foreign corporation holds that property for a particular use
or purpose. The use or purpose for which property is held is that use or
purpose for which it was held for more than one- half of the period
during which the controlled foreign corporation held the property prior
to the disposition.
(ii) Special rules--(A) Anti-abuse rule. If a principal purpose of a
change in use or purpose of property was to avoid including gain or loss
in the computation of foreign personal holding company income, all the
gain or loss from the disposition of the property is treated as foreign
personal holding company income. A purpose may be a principal purpose
even though it is outweighed by other purposes (taken together or
separately).
(B) Hedging transactions. The provisions of paragraph (a)(3)(i) of
this section shall not apply to bona fide hedging transactions, as
defined in paragraph (a)(4)(ii) of this section. A transaction will be
treated as a bona fide hedging transaction only so long as it satisfies
the requirements of paragraph (a)(4)(ii) of this section.
(iii) Example. The following example illustrates the application of
this paragraph (a)(3).
[[Page 260]]
Example. At the beginning of taxable year 1, CFC, a controlled
foreign corporation, purchases a building for investment. During taxable
years 1 and 2, CFC derives rents from the building that are included in
the computation of foreign personal holding company income under
paragraph (b)(1)(iii) of this section. At the beginning of taxable year
3, CFC changes the use of the building by terminating all leases and
using it in an active trade or business. At the beginning of taxable
year 4, CFC sells the building at a gain. The building was not used in
an active trade or business of CFC for more than one-half of the period
during which it was held by CFC. Therefore, the building is considered
to be property that gives rise to rents, as described in paragraph
(e)(2) of this section, and gain from the sale is included in the
computation of CFC's foreign personal holding company income under
paragraph (e) of this section.
(4) Definitions and special rules. The following definitions and
special rules apply for purposes of computing foreign personal holding
company income under this section.
(i) Interest. The term interest includes all amounts that are
treated as interest income (including interest on a tax-exempt
obligation) by reason of the Internal Revenue Code or Income Tax
Regulations or any other provision of law. For example, interest
includes stated interest, acquisition discount, original issue discount,
de minimis original issue discount, market discount, de minimis market
discount, and unstated interest, as adjusted by any amortizable bond
premium or acquisition premium.
(ii) Bona fide hedging transaction--(A) Definition. The term bona
fide hedging transaction means a transaction that meets the requirements
of Sec. 1.1221-2 (a) through (d) and that is identified in accordance
with the requirements of paragraph (a)(4)(ii)(B) of this section, except
that in applying Sec. 1.1221-2(b)(1), the risk being hedged may be with
respect to ordinary property, section 1231 property, or a section 988
transaction. A transaction that hedges the liabilities, inventory or
other assets of a related person (as defined in section 954(d)(3)), that
is entered into to assume or reduce risks of a related person, or that
is entered into by a person other than a person acting in its capacity
as a regular dealer (as defined in paragraph (a)(4)(iv) of this section)
to reduce risks assumed from a related person, will not be treated as a
bona fide hedging transaction. For an illustration of how this rule
applies with respect to foreign currency transactions, see paragraph
(g)(2)(ii)(D) of this section.
(B) Identification. The identification requirements of this section
shall be satisfied if the taxpayer meets the identification and
recordkeeping requirements of Sec. 1.1221-2(f). However, for bona fide
hedging transactions entered into prior to March 7, 1996 the
identification and recordkeeping requirements of Sec. 1.1221-2 shall
not apply. Rather, for bona fide hedging transactions entered into on or
after July 22, 1988 and prior to March 7, 1996 the identification and
recordkeeping requirements shall be satisfied if such transactions are
identified by the close of the fifth day after the day on which they are
entered into. For bona fide hedging transactions entered into prior to
July 22, 1988, the identification and recordkeeping requirements shall
be satisfied if such transactions are identified reasonably
contemporaneously with the date they are entered into, but no later than
within the normal period prescribed under the method of accounting of
the controlled foreign corporation used for financial reporting
purposes.
(C) Effect of identification and non-identification--(1)
Transactions identified. If a taxpayer identifies a transaction as a
bona fide hedging transaction for purposes of this section, the
identification is binding with respect to any loss arising from such
transaction whether or not all of the requirements of paragraph
(a)(4)(ii)(A) of this section are satisfied. Accordingly, such loss will
be allocated against income that is not subpart F income (or, in the
case of an election under paragraph (g)(3) of this section, against the
category of subpart F income to which it relates) and apportioned among
the categories of income described in section 904(d)(1). If the
transaction is not in fact a bona fide hedging transaction described in
paragraph (a)(4)(ii)(A) of this section, however, then any gain realized
with respect to such transaction shall not be considered as gain from a
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bona fide hedging transaction. Accordingly, such gain shall be treated
as gain from the appropriate category of foreign personal holding
company income. Thus, the taxpayer's identification of the transaction
as a hedging transaction does not itself operate to exclude gain from
the appropriate category of foreign personal holding company income.
(2) Inadvertent identification. Notwithstanding paragraph
(a)(4)(ii)(C)(1) of this section, if the taxpayer identifies a
transaction as a bona fide hedging transaction for purposes of this
section, the characterization of the loss is determined as if the
transaction had not been identified as a bona fide hedging transaction
if--
(i) The transaction is not a bona fide hedging transaction (as
defined in paragraph (a)(4)(ii)(A) of this section);
(ii) The identification of the transaction as a bona fide hedging
transaction was due to inadvertent error; and
(iii) All of the taxpayer's transactions in all open years are being
treated on either original or, if necessary, amended returns in a manner
consistent with the principles of this section.
(3) Transactions not identified. Except as provided in paragraphs
(a)(4)(ii)(C)(4) and (5) of this section, the absence of an
identification that satisfies the requirements of paragraph
(a)(4)(ii)(B) of this section is binding and establishes that a
transaction is not a bona fide hedging transaction. Thus, subject to the
exceptions, the characterization of gain or loss is determined without
reference to whether the transaction is a bona fide hedging transaction.
(4) Inadvertent error. If a taxpayer does not make an identification
that satisfies the requirements of paragraph (a)(4)(ii)(B) of this
section, the taxpayer may treat gain or loss from the transaction as
gain or loss from a bona fide hedging transaction if--
(i) The transaction is a bona fide hedging transaction (as defined
in paragraph (a)(4)(ii)(A) of this section);
(ii) The failure to identify the transaction was due to inadvertent
error; and
(iii) All of the taxpayer's bona fide hedging transactions in all
open years are being treated on either original or, if necessary,
amended returns as bona fide hedging transactions in accordance with the
rules of this section.
(5) Anti-abuse rule. If a taxpayer does not make an identification
that satisfies all the requirements of paragraph (a)(4)(ii)(B) of this
section but the taxpayer has no reasonable grounds for treating the
transaction as other than a bona fide hedging transaction, then loss
from the transaction shall be treated as realized with respect to a bona
fide hedging transaction. Thus, a taxpayer may not elect to exclude loss
from its proper characterization as a bona fide hedging transaction. The
reasonableness of the taxpayer's failure to identify a transaction is
determined by taking into consideration not only the requirements of
paragraph (a)(4)(ii)(A) of this section but also the taxpayer's
treatment of the transaction for financial accounting or other purposes
and the taxpayer's identification of similar transactions as hedging
transactions.
(iii) Inventory and similar property--(A) Definition. The term
inventory and similar property (or inventory or similar property) means
property that is stock in trade of the controlled foreign corporation or
other property of a kind that would properly be included in the
inventory of the controlled foreign corporation if on hand at the close
of the taxable year (if the controlled foreign corporation were a
domestic corporation), or property held by the controlled foreign
corporation primarily for sale to customers in the ordinary course of
its trade or business.
(B) Hedging transactions. A bona fide hedging transaction with
respect to inventory or similar property (other than a transaction
described in section 988(c)(1) without regard to section
988(c)(1)(D)(i)) shall be treated as a transaction in inventory or
similar property.
(iv) Regular dealer. The term regular dealer means a controlled
foreign corporation that--
(A) Regularly and actively offers to, and in fact does, purchase
property from and sell property to customers who are not related persons
(as defined in section 954(d)(3)) with respect to the controlled foreign
corporation in the ordinary course of a trade or business; or
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(B) Regularly and actively offers to, and in fact does, enter into,
assume, offset, assign or otherwise terminate positions in property with
customers who are not related persons (as defined in section 954(d)(3))
with respect to the controlled foreign corporation in the ordinary
course of a trade or business.
(v) Dealer property--(A) Definition. Property held by a controlled
foreign corporation is dealer property if--
(1) The controlled foreign corporation is a regular dealer in
property of such kind (determined under paragraph (a)(4)(iv) of this
section); and
(2) The property is held by the controlled foreign corporation in
its capacity as a dealer in property of such kind without regard to
whether the property arises from a transaction with a related person (as
defined in section 954(d)(3)) with respect to the controlled foreign
corporation. The property is not held by the controlled foreign
corporation in its capacity as a dealer if the property is held for
investment or speculation on its own behalf or on behalf of a related
person (as defined in section 954(d)(3)).
(B) Securities dealers. If a controlled foreign corporation is a
licensed securities dealer, only the securities that it has identified
as held for investment in accordance with the provisions of section
475(b) or section 1236 will be considered to be property held for
investment or speculation under this section. A licensed securities
dealer is a controlled foreign corporation that is both a securities
dealer, as defined in section 475, and a regular dealer, as defined in
paragraph (a)(4)(iv) of this section, and that is either--
(1) Registered as a securities dealer under section 15(a) of the
Securities Exchange Act of 1934 or as a Government securities dealer
under section 15C(a) of such Act; or
(2) Licensed or authorized in the country in which it is chartered,
incorporated, or organized to purchase and sell securities from or to
customers who are residents of that country. The conduct of such
securities activities must be subject to bona fide regulation, including
appropriate reporting, monitoring, and prudential (including capital
adequacy) requirements, by a securities regulatory authority in that
country that regularly enforces compliance with such requirements and
prudential standards.
(C) Hedging transactions. A bona fide hedging transaction with
respect to dealer property shall be treated as a transaction in dealer
property.
(vi) Examples. The following examples illustrate the application of
paragraphs (a)(4)(ii), (iv) and (v) of this section.
Example 1. (i) CFC1 and CFC2 are related controlled foreign
corporations (within the meaning of section 954(d)(3)) located in
Countries F and G, respectively. CFC1 and CFC2 regularly purchase
securities from and sell securities to customers who are not related
persons with respect to CFC1 or CFC2 (within the meaning of section
954(d)(3)) in the ordinary course of their businesses and regularly and
actively hold themselves out as being willing to, and in fact do, enter
into either side of options, forward contracts, or other financial
instruments. CFC1 uses securities that are traded in securities markets
in Country G to hedge positions that it enters into with customers
located in Country F. CFC1 is not a member of a securities exchange in
Country G, so it purchases such securities from CFC2 and unrelated
persons that are registered as securities dealers in Country G and that
are members of Country G securities exchanges. Such hedging transactions
qualify as bona fide hedging transactions under paragraph (a)(4)(ii) of
this section.
(ii) Transactions that CFC1 and CFC2 enter into with each other do
not affect the determination of whether they are regular dealers.
Because CFC1 and CFC2 regularly purchase securities from and sell
securities to customers who are not related persons within the meaning
of section 954(d)(3) in the ordinary course of their businesses and
regularly and actively hold themselves out as being willing to, and in
fact do, enter into either side of options, forward contracts, or other
financial instruments, however, they qualify as regular dealers in such
property within the meaning of paragraph (a)(4)(iv) of this section.
Moreover, because CFC1 purchases securities from CFC2 as bona fide
hedging transactions with respect to dealer property, the securities are
dealer property under paragraph (a)(4)(v)(C) of this section. Similarly,
because CFC2 sells securities to CFC1 in the ordinary course of its
business as a dealer, the securities are dealer property under paragraph
(a)(4)(v)(A) of this section.
Example 2. (i) CFC is a controlled foreign corporation located in
Country B. CFC serves as the currency coordination center for the
controlled group, aggregating currency risks incurred by the group and
entering into hedging transactions that transfer those risks outside of
the group. CFC regularly and
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actively holds itself out as being willing to, and in fact does, enter
into either side of options, forward contracts, or other financial
instruments with other members of the same controlled group. CFC hedges
risks arising from such transactions by entering into transactions with
persons who are not related persons (within the meaning of section
954(d)(3)) with respect to CFC. However, CFC does not regularly and
actively hold itself out as being willing to, and does not, enter into
either side of transactions with unrelated persons.
(ii) CFC is not a regular dealer in property under paragraph
(a)(4)(iv) of this section and its options, forwards, and other
financial instruments are not dealer property within the meaning of
paragraph (a)(4)(v) of this section.
(vii) Debt instrument. The term debt instrument includes bonds,
debentures, notes, certificates, accounts receivable, and other
evidences of indebtedness.
(5) Special rules applicable to distributive share of partnership
income--(i) [Reserved]
(ii) Certain other exceptions applicable to foreign personal holding
company income. To determine the extent to which a controlled foreign
corporation's distributive share of an item of income of a partnership
is foreign personal holding company income --
(A) The exceptions contained in section 954(c) that are based on
whether the controlled foreign corporation is engaged in the active
conduct of a trade or business, including section 954(c)(2) and
paragraphs (b)(2) and (6), (e)(1)(ii) and (3)(ii), (iii) and (iv),
(f)(1)(ii), (g)(2)(ii), and (h)(3)(ii) of this section, shall apply only
if any such exception would have applied to exclude the income from
foreign personal holding company income if the controlled foreign
corporation had earned the income directly, determined by taking into
account only the activities of, and property owned by, the partnership
and not the separate activities or property of the controlled foreign
corporation or any other person;
(B) A controlled foreign corporation's distributive share of
partnership income will not be excluded from foreign personal holding
company income under the exception contained in section 954(h) unless
the controlled foreign corporation is an eligible controlled foreign
corporation within the meaning of section 954(h)(2) (taking into account
the income of the controlled foreign corporation and any partnerships or
other qualified business units, within the meaning of section 989(a), of
the controlled foreign corporation, including the controlled foreign
corporation's distributive share of partnership income) and the
partnership, of which the controlled foreign corporation is a partner,
generates qualified banking or financing income within the meaning of
section 954(h)(3) (taking into account only the income of the
partnership);
(C) A controlled foreign corporation's distributive share of
partnership income will not be excluded from foreign personal holding
company income under the exception contained in section 954(i) unless
the controlled foreign corporation partner is a qualifying insurance
company, as defined in section 953(e)(3) (determined by examining
premiums written by the controlled foreign corporation and any
partnerships or other qualified business units, within the meaning of
section 989(a), of the CFC partner), and the partnership, of which the
controlled foreign corporation is a partner, generates qualified
insurance income within the meaning of section 954(i)(2) (taking into
account only the income of the partnership).
(iii) Examples. The application of paragraph (a)(5)(ii) is
demonstrated by the following examples:
Example 1. B Corp, a Country C corporation, is a controlled foreign
corporation within the meaning of section 957(a). B Corp is an 80
percent partner of RKS Partnership, a Country D partnership whose
principal office is located in Country D. RKS Partnership is a qualified
business unit of B Corp, within the meaning of section 989(a). B Corp,
including income earned through RKS Partnership, derives more than 70
percent of its gross income directly from the active and regular conduct
of a lending or finance business, within the meaning of section
954(h)(4), from transactions in various countries with customers which
are not related persons. Thus, B Corp is predominantly engaged in the
active conduct of a banking, financing, or similar business within the
meaning of section 954(h)(2)(A)(i). B Corp conducts substantial activity
with respect to such business within the meaning of section
954(h)(2)(A)(ii). RKS Partnership derives more than 30 percent of its
income from the active and regular conduct of a lending or finance
business, within the meaning of section 954(h)(4), from transactions
with customers which are not related persons and
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which are located solely within the home country of RKS Partnership,
Country D. B Corp's distributive share of RKS Partnership's income from
its lending or finance business will satisfy the special rule for income
derived in the active conduct of banking, financing, or similar business
of section 954(h). B Corp is an eligible controlled foreign corporation
within the meaning of section 954(h)(2) and RKS Partnership generates
qualified banking or financing income within the meaning of section
954(h)(3). B Corp does not have any foreign personal holding company
income with respect to its distributive share of RKS Partnership income
attributable to its lending or finance business income earned in Country
D.
Example 2. D Corp, a Country F corporation, is a controlled foreign
corporation within the meaning of section 957(a). D Corp satisfies the
requirements of section 953(e)(3) and is a qualifying insurance company.
D Corp is a 40 percent partner of DJ Partnership, a Country G
partnership. DJ Partnership is a qualified business unit of D Corp,
within the meaning of section 989(a), and is licensed by the applicable
insurance regulatory body for Country G to sell insurance to persons
other than related persons in its home country within the meaning of
section 953(e)(4)(A). DJ Partnership receives income from persons who
are not related persons, within the meaning of section 954(d)(3), from
investments that satisfy the requirements of section 954(i)(2). D Corp's
distributive share of DJ Partnership's income from investments that
satisfy the requirements of section 954(i)(2) will not be treated as
foreign personal holding company income because D Corp will satisfy the
special rule of section 954(i) for income derived in the active conduct
of insurance business. DJ Partnership is a qualifying insurance company
branch within the meaning of section 953(e)(4) and its income is
qualified insurance income within the meaning of section 954(i)(2). D
Corp does not have any foreign personal holding company income as a
result of its distributive share of DJ Partnership income that is
attributable to the partnership's qualifying insurance income.
(iv) [Reserved]
(v) Effective date. This paragraph (a)(5) applies to taxable years
of a controlled foreign corporation beginning on or after July 23, 2002.
(b) Dividends, interest, rents, royalties, and annuities--(1) In
general. Foreign personal holding company income includes--
(i) Dividends, except certain dividends from related persons as
described in paragraph (b)(4) of this section and distributions of
previously taxed income under section 959(b);
(ii) Interest, except export financing interest as defined in
paragraph (b)(2) of this section and certain interest received from
related persons as described in paragraph (b)(4) of this section;
(iii) Rents and royalties, except certain rents and royalties
received from related persons as described in paragraph (b)(5) of this
section and rents and royalties derived in the active conduct of a trade
or business as defined in paragraph (b)(6) of this section; and
(iv) Annuities.
(2) Exclusion of certain export financing interest--(i) In general.
Foreign personal holding company income does not include interest that
is export financing interest. The term export financing interest means
interest that is derived in the conduct of a banking business and is
export financing interest as defined in section 904(d)(2)(G). Solely for
purposes of determining whether interest is export financing interest,
property is treated as manufactured, produced, grown, or extracted in
the United States if it is so treated under Sec. 1.927(a)-1T(c).
(ii) Exceptions. Export financing interest does not include income
from related party factoring that is treated as interest under section
864(d)(1) or (6) after the application of section 864(d)(7).
(iii) Conduct of a banking business. For purposes of this section,
export financing interest is considered derived in the conduct of a
banking business if, in connection with the financing from which the
interest is derived, the corporation, through its own officers or staff
of employees, engages in all the activities in which banks customarily
engage in issuing and servicing a loan.
(iv) Examples. The following examples illustrate the application of
this paragraph (b)(2).
Example 1. (i) DS, a domestic corporation, manufactures property in
the United States. In addition to selling inventory (property described
in section 1221(1)), DS occasionally sells depreciable equipment it
manufactures for use in its trade or business, which is property
described in section 1221(2). Less than 50 percent of the fair market
value, determined in accordance with section 904(d)(2)(G), of each item
of inventory or
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equipment sold by DS is attributable to products imported into the
United States. CFC, a controlled foreign corporation with respect to
which DS is a related person (within the meaning of section 954(d)(3)),
provides loans described in section 864(d)(6) to unrelated persons for
the purchase of property from DS. This property is purchased exclusively
for use or consumption outside the United States and outside CFC's
country of incorporation.
(ii) If, in issuing and servicing loans made with respect to
purchases from DS of depreciable equipment used in its trade or
business, which is property described in section 1221(2) in the hands of
DS, CFC engages in all the activities in which banks customarily engage
in issuing and servicing loans, the interest accrued from these loans
would be export financing interest meeting the requirements of this
paragraph (b)(2) and, thus, not included in foreign personal holding
company income. However, interest from the loans made with respect to
purchases from DS of property that is inventory in the hands of DS
cannot be export financing interest because it is treated as income from
a trade or service receivable under section 864(d)(6) and the exception
under section 864(d)(7) does not apply. Thus the interest from loans
made with respect to this inventory is included in foreign personal
holding company income under paragraph (b)(1)(ii) of this section.
Example 2. (i) DS, a domestic corporation manufactures property in
the United States. DS wholly owns two controlled foreign corporations
organized in Country A, CFC1 and CFC2. CFC1 has a substantial part of
its assets used in its trade or business in Country A. CFC1 purchases
the property that DS manufactures and sells it without further
manufacture for use or consumption within Country A. This property is
inventory property, as described in section 1221(1), in the hands of
CFC1. Less than 50 percent of the fair market value, determined in
accordance with section 904(d)(2)(G), of each item of inventory sold by
CFC1 is attributable to products imported into the United States. CFC2
provides loans described in section 864(d)(6) to unrelated persons in
Country A for the purchase of the property from CFC1.
(ii) If, in issuing and servicing loans made with respect to
purchases from CFC1 of the inventory property, CFC2 engages in all the
activities in which banks customarily engage in issuing and servicing
loans, the interest accrued from these loans would be export financing
interest meeting the requirements of paragraph (b)(2) of this section.
It is not treated as income from a trade or service receivable under
section 864(d)(6) because the exception under section 864(d)(7) applies.
Thus the interest is excluded from foreign personal holding company
income.
Example 3. The facts are the same as in Example 2 except that the
property sold by CFC1 is manufactured by CFC1 in Country A from
component parts that were manufactured by DS in the United States. The
interest accrued from the loans by CFC2 is not export financing interest
as defined in section 904(d)(2)(G) because the property is not
manufactured in the United States under Sec. 1.927(a)-1T(c). No portion
of the interest is export financing interest as defined in this
paragraph (b)(2). The full amount of the interest is, therefore,
included in foreign personal holding company income under paragraph
(b)(1)(ii) of this section.
(3) Treatment of tax exempt interest. For taxable years of a
controlled foreign corporation beginning after March 3, 1997, foreign
personal holding company income includes all interest income, including
interest that is described in section 103 (see Sec. 1.952-2(c)(1)).
(4) Exclusion of dividends or interest from related persons--(i) In
general--(A) Corporate payor. Foreign personal holding company income
received by a controlled foreign corporation does not include dividends
or interest if the payor--
(1) Is a corporation that is a related person with respect to the
controlled foreign corporation, as defined in section 954(d)(3);
(2) Is created or organized under the laws of the same foreign
country (the country of incorporation) as is the controlled foreign
corporation; and
(3) Uses a substantial part of its assets in a trade or business in
its country of incorporation, as determined under this paragraph (b)(4).
(B) Payment by a partnership. For purposes of this paragraph (b)(4),
if a partnership with one or more corporate partners makes a payment of
interest, a corporate partner will be treated as the payor of the
interest--
(1) If the interest payment gives rise to a partnership item of
deduction under the Internal Revenue Code or Income Tax Regulations, to
the extent that the item of deduction is allocable to the corporate
partner under section 704(b); or
(2) If the interest payment does not give rise to a partnership item
of deduction under the Internal Revenue Code or Income Tax Regulations,
to the extent that a partnership item reasonably related to the payment
would be allocated to that partner under an
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existing allocation under the partnership agreement (made pursuant to
section 704(b)).
(ii) Exceptions--(A) Dividends. Dividends are excluded from foreign
personal holding company income under this paragraph (b)(4) only to the
extent that they are paid out of earnings and profits that are earned or
accumulated during a period in which--
(1) The stock on which dividends are paid with respect to which the
exclusion is claimed was owned by the recipient controlled foreign
corporation directly, or indirectly through a chain of one or more
subsidiaries each of which meets the requirements of paragraph
(b)(4)(i)(A) of this section; and
(2) Each of the requirements of paragraph (b)(4)(i)(A) of this
section is satisfied or, to the extent earned or accumulated during a
taxable year of the related foreign corporation ending on or before
December 31, 1962, during a period in which the payor was a related
corporation as to the controlled foreign corporation and the other
requirements of paragraph (b)(4)(i)(A) of this section were
substantially satisfied.
(3) This paragraph (b)(4)(ii)(A) is illustrated by the following
example:
Example. A, a domestic corporation, owns all of the stock of B, a
corporation created and organized under the laws of Country Y, and C, a
corporation created and organized under the laws of Country X. The
taxable year of each of the corporations is the calendar year. In Year
1, B earns $100 of income from the sale of products in Country Y that it
manufactured in Country Y. C had no earnings and profits in Year 1. On
January 1 of Year 2, A contributes all of the stock of B and C to Newco,
a Country Y corporation, in exchange for all of the stock of Newco.
Neither B nor C earns any income in Year 2, but at the end of Year 2 B
distributes the $100 accumulated earnings and profits to Newco. Newco's
income from the distribution, $100, is foreign personal holding company
income because the earnings and profits distributed by B were not earned
or accumulated during a period in which the stock of B was owned by
Newco and in which each of the requirements of paragraph (b)(4)(i)(A) of
this section was satisfied.
(B) Interest paid out of adjusted foreign base company income or
insurance income--(1) In general. Interest may not be excluded from the
foreign personal holding company income of the recipient under this
paragraph (b)(4) to the extent that the deduction for the interest is
allocated under Sec. 1.954-1(a)(4) and (c) to the payor's adjusted
gross foreign base company income (as defined in Sec. 1.954-1(a)(3)),
adjusted gross insurance income (as defined in Sec. 1.954-1(a)(6)), or
any other category of income included in the computation of subpart F
income under section 952(a).
(2) Rule for corporations that are both recipients and payors of
interest. If a controlled foreign corporation is both a recipient and
payor of interest, the interest that is received will be characterized
before the interest that is paid. In addition, the amount of interest
paid or accrued, directly or indirectly, by the controlled foreign
corporation to a related person (as defined in section 954(d)(3)) shall
be offset against and eliminate any interest received or accrued,
directly or indirectly, by the controlled foreign corporation from that
related person. In a case in which the controlled foreign corporation
pays or accrues interest to a related person, as defined in section
954(d)(3), and also receives or accrues interest indirectly from the
related person, the smallest interest payment is eliminated and the
amounts of all other interest payments are reduced by the amount of the
smallest interest payment.
(C) Coordination with sections 864(d) and 881(c). Income of a
controlled foreign corporation that is treated as interest under section
864(d)(1) or (6), or that is portfolio interest, as defined by section
881(c), is not excluded from foreign personal holding company income
under section 954(c)(3)(A)(i) and this paragraph (b)(4).
(iii) Trade or business requirement. Except as otherwise provided
under this paragraph (b)(4), the principles of section 367(a) apply for
purposes of determining whether the payor has a trade or business in its
country of incorporation and whether its assets are used in that trade
or business. Property purchased or produced for use in a trade or
business is not considered used in a trade or business before it is
placed in service or after it is retired from service as determined in
accordance with the principles of sections 167 and 168.
(iv) Substantial assets test. A substantial part of the assets of
the payor will be considered to be used in a trade or
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business located in the payor's country of incorporation for a taxable
year only if the average value of the payor's assets for such year that
are used in the trade or business and are located in such country equals
more than 50 percent of the average value of all the assets of the payor
(including assets not used in a trade or business). The average value of
assets for the taxable year is determined by averaging the values of
assets at the close of each quarter of the taxable year. The value of
assets is determined under paragraph (b)(4)(v) of this section, and the
location of assets used in a trade or business of the payor is
determined under paragraphs (b)(4)(vi) through (xi) of this section.
(v) Valuation of assets. For purposes of determining whether a
substantial part of the assets of the payor are used in a trade or
business in its country of incorporation, the value of assets shall be
their fair market value (not reduced by liabilities), which, in the
absence of affirmative evidence to the contrary, shall be deemed to be
their adjusted basis.
(vi) Location of tangible property--(A) In general. Tangible
property (other than inventory and similar property as defined in
paragraph (a)(4)(iii) of this section, and dealer property as defined in
paragraph (a)(4)(v) of this section) used in a trade or business is
considered located in the country in which it is physically located.
(B) Exception. An item of tangible personal property that is used in
the trade or business of a payor in the payor's country of incorporation
is considered located within the payor's country of incorporation while
it is temporarily located elsewhere for inspection or repair if the
property is not placed in service in a country other than the payor's
country of incorporation and is not to be so placed in service following
the inspection or repair.
(vii) Location of intangible property--(A) In general. Intangible
property (other than inventory and similar property as defined in
paragraph (a)(4)(iii) of this section, dealer property as defined in
paragraph (a)(4)(v) of this section, and debt instruments) is considered
located entirely in the payor's country of incorporation for a quarter
of the taxable year only if the payor conducts all of its activities in
connection with the use or exploitation of the property in that country
during that entire quarter. For this purpose, the country in which the
activities connected to the use or exploitation of the property are
conducted is the country in which the expenses associated with these
activities are incurred. Expenses incurred in connection with the use or
exploitation of an item of intangible property are included in the
computation provided by this paragraph (b)(4) if they would be
deductible under section 162 or includible in inventory costs or the
cost of goods sold if the payor were a domestic corporation. If the
payor conducts such activities through an agent or independent
contractor, then the expenses incurred by the payor with respect to the
agent or independent contractor shall be deemed to be incurred by the
payor in the country in which the expenses of the agent or independent
contractor were incurred by the agent or independent contractor.
(B) Exception for property located in part in the payor's country of
incorporation. If the payor conducts its activities in connection with
the use or exploitation of an item of intangible property, including
goodwill (other than inventory and similar property, dealer property and
debt instruments) during a quarter of the taxable year both in its
country of incorporation and elsewhere, then the value of the intangible
considered located in the payor's country of incorporation during that
quarter is a percentage of the value of the item as of the close of the
quarter. That percentage equals the ratio that the expenses incurred by
the payor (described in paragraph (b)(4)(vii)(A) of this section) during
the entire quarter by reason of activities that are connected with the
use or exploitation of the item of intangible property and are conducted
in the payor's country of incorporation bear to all expenses incurred by
the payor during the entire quarter by reason of all such activities
worldwide.
(viii) Location of inventory and dealer property--(A) In general.
Inventory and similar property, as defined in paragraph (a)(4)(iii) of
this section, and
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dealer property, as defined in paragraph (a)(4)(v) of this section, are
considered located entirely in the payor's country of incorporation for
a quarter of the taxable year only if the payor conducts all of its
activities in connection with the production and sale, or purchase and
resale, of such property in its country of incorporation during that
entire quarter. If the payor conducts such activities through an agent
or independent contractor, then the location of such activities is the
place in which they are conducted by the agent or independent
contractor.
(B) Inventory and dealer property located in part in the payor's
country of incorporation. If the payor conducts its activities in
connection with the production and sale, or purchase and resale, of
inventory or similar property or dealer property during a quarter of the
taxable year both in its country of incorporation and elsewhere, then
the value of the inventory or similar property or dealer property
considered located in the payor's country of incorporation during each
quarter is a percentage of the value of the inventory or similar
property or dealer property as of the close of the quarter. That
percentage equals the ratio that the costs and expenses incurred by the
payor during the entire quarter by reason of activities connected with
the production and sale, or purchase and resale, of inventory or similar
property or dealer property that are conducted in the payor's country of
incorporation bear to all costs or expenses incurred by the payor during
the entire quarter by reason of all such activities worldwide. A cost
incurred in connection with the production and sale or purchase and
resale of inventory or similar property or dealer property is included
in this computation if it--
(1) Would be included in inventory costs or otherwise capitalized
with respect to inventory or similar property or dealer property under
section 61, 263A, 471, or 472 if the payor were a domestic corporation;
or
(2) Would be deductible under section 162 if the payor were a
domestic corporation and is definitely related to gross income derived
from such property (but not to all classes of gross income derived by
the payor) under the principles of Sec. 1.861-8.
(ix) Location of debt instruments. For purposes of this paragraph
(b)(4), debt instruments, other than debt instruments that are inventory
or similar property (as defined in paragraph (a)(4)(iii) of this
section) or dealer property (as defined in paragraph (a)(4)(v) of this
section) are considered to be used in a trade or business only if they
arise from the sale of inventory or similar property or dealer property
by the payor or from the rendition of services by the payor in the
ordinary course of a trade or business of the payor, and only until such
time as interest is required to be charged under section 482. Debt
instruments that arise from the sale of inventory or similar property or
dealer property during a quarter are treated as having the same
location, proportionately, as the inventory or similar property or
dealer property held during that quarter. Debt instruments arising from
the rendition of services in the ordinary course of a trade or business
are considered located on a proportionate basis in the countries in
which the services to which they relate are performed.
(x) Treatment of certain stock interests. Stock in a controlled
foreign corporation (lower-tier corporation) that is incorporated in the
same country as the payor and that is more than 50-percent owned,
directly or indirectly, by the payor within the meaning of section
958(a) shall be considered located in the payor's country of
incorporation and, solely for purposes of section 954(c)(3), used in a
trade or business of the payor in proportion to the value of the assets
of the lower-tier corporation that are used in a trade or business in
the country of incorporation. The location of assets used in a trade or
business of the lower-tier corporation shall be determined under the
rules of this paragraph (b)(4).
(xi) Treatment of banks and insurance companies. [Reserved]
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(5) Exclusion of rents and royalties derived from related persons--
(i) In general--(A) Corporate payor. Foreign personal holding company
income received by a controlled foreign corporation does not include
rents or royalties if--
(1) The payor is a corporation that is a related person with respect
to the controlled foreign corporation, as defined in section 954(d)(3);
and
(2) The rents or royalties are for the use of, or the privilege of
using, property within the country under the laws of which the
controlled foreign corporation receiving the payments is created or
organized (the country of incorporation).
(B) Payment by a partnership. For purposes of this paragraph (b)(5),
if a partnership with one or more corporate partners makes a payment of
rents or royalties, a corporate partner will be treated as the payor of
the rents or royalties--
(1) If the rent or royalty payment gives rise to a partnership item
of deduction under the Internal Revenue Code or Income Tax Regulations,
to the extent the item of deduction is allocable to the corporate
partner under section 704(b); or
(2) If the rent or royalty payment does not give rise to a
partnership item of deduction under the Internal Revenue Code or Income
Tax Regulations, to the extent that a partnership item reasonably
related to the payment would be allocated to that partner under an
existing allocation under the partnership agreement (made pursuant to
section 704(b)).
(ii) Exceptions--(A) Rents or royalties paid out of adjusted foreign
base company income or insurance income. Rents or royalties may not be
excluded from the foreign personal holding company income of the
recipient under this paragraph (b)(5) to the extent that deductions for
the payments are allocated under section 954(b)(5) and Sec. 1.954-
1(a)(4) and (c) to the payor's adjusted gross foreign base company
income (as defined in Sec. 1.954-1(a)(3)), adjusted gross insurance
income (as defined in Sec. 1.954-1(a)(6)), or any other category of
income included in the computation of subpart F income under section
952(a).
(B) Property used in part in the controlled foreign corporation's
country of incorporation. If the payor uses the property both in the
controlled foreign corporation's country of incorporation and elsewhere,
the part of the rent or royalty attributable (determined under the
principles of section 482) to the use of, or the privilege of using, the
property outside such country of incorporation is included in the
computation of foreign personal holding company income under this
paragraph (b).
(6) Exclusion of rents and royalties derived in the active conduct
of a trade or business. Foreign personal holding company income shall
not include rents or royalties that are derived in the active conduct of
a trade or business and received from a person that is not a related
person (as defined in section 954(d)(3)) with respect to the controlled
foreign corporation. For purposes of this section, rents or royalties
are derived in the active conduct of a trade or business only if the
provisions of paragraph (c) or (d) of this section are satisfied.
(c) Excluded rents--(1) Active conduct of a trade or business. Rents
will be considered for purposes of paragraph (b)(6) of this section to
be derived in the active conduct of a trade or business if such rents
are derived by the controlled foreign corporation (the lessor) from
leasing any of the following--
(i) Property that the lessor has manufactured or produced, or has
acquired and added substantial value to, but only if the lessor is
regularly engaged in the manufacture or production of, or in the
acquisition and addition of substantial value to, property of such kind;
(ii) Real property with respect to which the lessor, through its own
officers or staff of employees, regularly performs active and
substantial management and operational functions while the property is
leased;
(iii) Personal property ordinarily used by the lessor in the active
conduct of a trade or business, leased temporarily during a period when
the property would, but for such leasing, be idle; or
(iv) Property that is leased as a result of the performance of
marketing functions by such lessor if the lessor,
[[Page 270]]
through its own officers or staff of employees located in a foreign
country, maintains and operates an organization in such country that is
regularly engaged in the business of marketing, or of marketing and
servicing, the leased property and that is substantial in relation to
the amount of rents derived from the leasing of such property.
(2) Special rules--(i) Adding substantial value. For purposes of
paragraph (c)(1)(i) of this section, the performance of marketing
functions will not be considered to add substantial value to property.
(ii) Substantiality of foreign organization. For purposes of
paragraph (c)(1)(iv) of this section, whether an organization in a
foreign country is substantial in relation to the amount of rents is
determined based on all of the facts and circumstances. However, such an
organization will be considered substantial in relation to the amount of
rents if active leasing expenses, as defined in paragraph (c)(2)(iii) of
this section, equal or exceed 25 percent of the adjusted leasing profit,
as defined in paragraph (c)(2)(iv) of this section.
(iii) Active leasing expenses. The term active leasing expenses
means the deductions incurred by an organization of the lessor in a
foreign country that are properly allocable to rental income and that
would be allowable under section 162 to the lessor if it were a domestic
corporation, other than--
(A) Deductions for compensation for personal services rendered by
shareholders of, or related persons (as defined in section 954(d)(3))
with respect to, the lessor;
(B) Deductions for rents paid or accrued;
(C) Deductions that, although generally allowable under section 162,
would be specifically allowable to the lessor (if the lessor were a
domestic corporation) under any section of the Internal Revenue Code
other than section 162; and
(D) Deductions for payments made to agents or independent
contractors with respect to the leased property other than payments for
insurance, utilities and other expenses for like services, or for
capitalized repairs.
(iv) Adjusted leasing profit. The term adjusted leasing profit means
the gross income of the lessor from rents, reduced by the sum of--
(A) The rents paid or incurred by the lessor with respect to such
rental income;
(B) The amounts that would be allowable to such lessor (if the
lessor were a domestic corporation) as deductions under sections 167 or
168 with respect to such rental income; and
(C) The amounts paid by the lessor to agents or independent
contractors with respect to such rental income other than payments for
insurance, utilities and other expenses for like services, or for
capitalized repairs.
(3) Examples. The application of this paragraph (c) is illustrated
by the following examples.
Example 1. Controlled foreign corporation A is regularly engaged in
the production of office machines which it sells or leases to others and
services. Under paragraph (c)(1)(i) of this section, the rental income
of Corporation A from these leases is derived in the active conduct of a
trade or business for purposes of section 954(c)(2)(A).
Example 2. Controlled foreign corporation D purchases motor vehicles
which it leases to others. In the conduct of its short-term leasing of
such vehicles in foreign country X, Corporation D owns a large number of
motor vehicles in country X which it services and repairs, leases motor
vehicles to customers on an hourly, daily, or weekly basis, maintains
offices and service facilities in country X from which to lease and
service such vehicles, and maintains therein a sizable staff of its own
administrative, sales, and service personnel. Corporation D also leases
in country X on a long-term basis, generally for a term of one year,
motor vehicles that it owns. Under the terms of the long-term leases,
Corporation D is required to repair and service, during the term of the
lease, the leased motor vehicles without cost to the lessee. By the
maintenance in country X of office, sales, and service facilities and
its complete staff of administrative, sales, and service personnel,
Corporation D maintains and operates an organization therein that is
regularly engaged in the business of marketing and servicing the motor
vehicles that are leased. The deductions incurred by such organization
satisfy the 25-percent test of paragraph (c)(2)(ii) of this section;
thus, such organization is substantial in relation to the rents
Corporation D receives from leasing the motor vehicles. Therefore, under
paragraph (c)(1)(iv) of this section, such rents are derived in the
active conduct of a trade or business for purposes of section
954(c)(2)(A).
Example 3. Controlled foreign corporation E owns a complex of
apartment buildings that
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it has acquired by purchase. Corporation E engages a real estate
management firm to lease the apartments, manage the buildings and pay
over the net rents to Corporation E. The rental income of Corporation E
from such leases is not derived in the active conduct of a trade or
business for purposes of section 954(c)(2)(A).
Example 4. Controlled foreign corporation F acquired by purchase a
twenty-story office building in a foreign country, three floors of which
it occupies and the rest of which it leases. Corporation F acts as
rental agent for the leasing of offices in the building and employs a
substantial staff to perform other management and maintenance functions.
Under paragraph (c)(1)(ii) of this section, the rents received by
Corporation F from such leasing operations are derived in the active
conduct of a trade or business for purposes of section 954(c)(2)(A).
Example 5. Controlled foreign corporation G owns equipment that it
ordinarily uses to perform contracts in foreign countries to drill oil
wells. For occasional brief and irregular periods it is unable to obtain
contracts requiring immediate performance sufficient to employ all such
equipment. During such a period it sometimes leases such idle equipment
temporarily. After the expiration of such temporary leasing of the
property, Corporation G continues the use of such equipment in the
performance of its own drilling contracts. Under paragraph (c)(1)(iii)
of this section, rents Corporation G receives from such leasing of idle
equipment are derived in the active conduct of a trade or business for
purposes of section 954(c)(2)(A).
(d) Excluded royalties--(1) Active conduct of a trade or business.
Royalties will be considered for purposes of paragraph (b)(6) of this
section to be derived in the active conduct of a trade or business if
such royalties are derived by the controlled foreign corporation (the
licensor) from licensing--
(i) Property that the licensor has developed, created, or produced,
or has acquired and added substantial value to, but only so long as the
licensor is regularly engaged in the development, creation or production
of, or in the acquisition of and addition of substantial value to,
property of such kind; or
(ii) Property that is licensed as a result of the performance of
marketing functions by such licensor if the licensor, through its own
officers or staff of employees located in a foreign country, maintains
and operates an organization in such country that is regularly engaged
in the business of marketing, or of marketing and servicing, the
licensed property and that is substantial in relation to the amount of
royalties derived from the licensing of such property.
(2) Special rules--(i) Adding substantial value. For purposes of
paragraph (d)(1)(i) of this section, the performance of marketing
functions will not be considered to add substantial value to property.
(ii) Substantiality of foreign organization. For purposes of
paragraph (d)(1)(ii) of this section, whether an organization in a
foreign country is substantial in relation to the amount of royalties is
determined based on all of the facts and circumstances. However, such an
organization will be considered substantial in relation to the amount of
royalties if active licensing expenses, as defined in paragraph
(d)(2)(iii) of this section, equal or exceed 25 percent of the adjusted
licensing profit, as defined in paragraph (d)(2)(iv) of this section.
(iii) Active licensing expenses. The term active licensing expenses
means the deductions incurred by an organization of the licensor in a
foreign country that are properly allocable to royalty income and that
would be allowable under section 162 to the licensor if it were a
domestic corporation, other than--
(A) Deductions for compensation for personal services rendered by
shareholders of, or related persons (as defined in section 954(d)(3))
with respect to, the licensor;
(B) Deductions for royalties paid or incurred;
(C) Deductions that, although generally allowable under section 162,
would be specifically allowable to the licensor (if the controlled
foreign corporation were a domestic corporation) under any section of
the Internal Revenue Code other than section 162; and
(D) Deductions for payments made to agents or independent
contractors with respect to the licensed property.
(iv) Adjusted licensing profit. The term adjusted licensing profit
means the gross income of the licensor from royalties, reduced by the
sum of--
(A) The royalties paid or incurred by the licensor with respect to
such royalty income;
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(B) The amounts that would be allowable to such licensor as
deductions under section 167 or 197 (if the licensor were a domestic
corporation) with respect to such royalty income; and
(C) The amounts paid by the licensor to agents or independent
contractors with respect to such royalty income.
(3) Examples. The application of this paragraph (d) is illustrated
by the following examples.
Example 1. Controlled foreign corporation A, through its own staff
of employees, owns and operates a research facility in foreign country
X. At the research facility, employees of Corporation A who are
scientists, engineers, and technicians regularly perform experiments,
tests, and other technical activities, that ultimately result in the
issuance of patents that it sells or licenses. Under paragraph (d)(1)(i)
of this section, royalties received by Corporation A for the privilege
of using patented rights that it develops as a result of such research
activity are derived in the active conduct of a trade or business for
purposes of section 954(c)(2)(A), but only so long as the licensor is
regularly engaged in the development, creation or production of, or in
the acquisition of and addition of substantial value to, property of
such kind.
Example 2. Assume that Corporation A in Example 1, in addition to
receiving royalties for the use of patents that it develops, receives
royalties for the use of patents that it acquires by purchase and
licenses to others without adding any value thereto. Corporation A
generally consummates royalty agreements on such purchased patents as
the result of inquiries received by it from prospective licensees when
the fact becomes known in the business community, as a result of the
filing of a patent, advertisements in trade journals, announcements, and
contacts by employees of Corporation A, that Corporation A has acquired
rights under a patent and is interested in licensing its rights.
Corporation A does not, however, maintain and operate an organization in
a foreign country that is regularly engaged in the business of marketing
the purchased patents. The royalties received by Corporation A for the
use of the purchased patents are not derived in the active conduct of a
trade or business for purposes of section 954(c)(2)(A).
Example 3. Controlled foreign corporation B receives royalties for
the use of patents that it acquires by purchase. The primary business of
Corporation B, operated on a regular basis, consists of licensing
patents that it has purchased raw from inventors and, through the
efforts of a substantial staff of employees consisting of scientists,
engineers, and technicians, made susceptible to commercial application.
For example, Corporation B, after purchasing patent rights covering a
chemical process, designs specialized production equipment required for
the commercial adaptation of the process and, by so doing, substantially
increases the value of the patent. Under paragraph (d)(1)(i) of this
section, royalties received by Corporation B from the use of such patent
are derived in the active conduct of a trade or business for purposes of
section 954(c)(2)(A).
Example 4. Controlled foreign corporation C receives royalties for
the use of a patent that it developed through its own staff of employees
at its facility in country X. Corporation C has developed no other
patents. It does not regularly employ a staff of scientists, engineers
or technicians to create new products to be patented. Further, it does
not purchase and license patents developed by others to which it has
added substantial value. The royalties received by Corporation C are not
derived from the active conduct of a trade or business for purposes of
section 954(c)(2)(A).
Example 5. Controlled foreign corporation D finances independent
persons in the development of patented items in return for an ownership
interest in such items from which it derives a percentage of royalty
income, if any, subsequently derived from the use by others of the
protected right. Corporation D also attempts to increase its royalty
income from such patents by contacting prospective licensees and
rendering to licensees advice that is intended to promote the use of the
patented property. Corporation D does not, however, maintain and operate
an organization in a foreign country that is regularly engaged in the
business of marketing the patents. Royalties received by Corporation D
for the use of such patents are not derived in the active conduct of a
trade or business for purposes of section 954(c)(2)(A).
(e) Certain property transactions--(1) In general--(i) Inclusions.
Gain from certain property transactions described in section
954(c)(1)(B) includes the excess of gains over losses from the sale or
exchange of--
(A) Property that gives rise to dividends, interest, rents,
royalties or annuities, as described in paragraph (e)(2) of this
section;
(B) Property that is an interest in a partnership, trust or REMIC;
and
(C) Property that does not give rise to income, as described in
paragraph (e)(3) of this section.
(ii) Exceptions. Gain or loss from certain property transactions
described in section 954(c)(1)(B) and paragraph (e)(1)(i) of this
section does not include gain or loss from the sale or exchange of--
[[Page 273]]
(A) Inventory or similar property, as defined in paragraph
(a)(4)(iii) of this section;
(B) Dealer property, as defined in paragraph (a)(4)(v) of this
section; or
(C) Property that gives rise to rents or royalties described in
paragraph (b)(6) of this section that are derived in the active conduct
of a trade or business from persons that are not related persons (as
defined in section 954(d)(3)) with respect to the controlled foreign
corporation.
(iii) Treatment of losses. Section 1.954-1(c)(1)(ii) provides for
the treatment of losses in excess of gains from the sale or exchange of
property described in paragraph (e)(1)(i) of this section.
(iv) Dual character property. Property may, in part, constitute
property that gives rise to certain income as described in paragraph
(e)(2) of this section or, in part, constitute property that does not
give rise to any income as described in paragraph (e)(3) of this
section. However, property that is described in paragraph (e)(1)(i)(B)
of this section cannot be dual character property. Dual character
property must be treated as two separate properties for purposes of
paragraph (e)(2) or (3) of this section. Accordingly, the sale or
exchange of such dual character property will give rise to gain or loss
that in part must be included in the computation of foreign personal
holding company income under paragraph (e)(2) or (3) of this section,
and in part is excluded from such computation. Gain or loss from the
disposition of dual character property must be bifurcated under this
paragraph (e)(1)(iv) pursuant to the method that most reasonably
reflects the relative uses of the property. Reasonable methods may
include comparisons in terms of gross income generated or the physical
division of the property. In the case of real property, the physical
division of the property will in most cases be the most reasonable
method available. For example, if a controlled foreign corporation owns
an office building, uses 60 percent of the building in its trade or
business, and rents out the other 40 percent, then 40 percent of the
gain recognized on the disposition of the property would reasonably be
treated as gain that is included in the computation of foreign personal
holding company income under this paragraph (e)(1). This paragraph
(e)(1)(iv) addresses the contemporaneous use of property for dual
purposes. For rules concerning changes in the use of property affecting
its classification for purposes of this paragraph (e), see paragraph
(a)(3) of this section.
(2) Property that gives rise to certain income--(i) In general.
Property the sale or exchange of which gives rise to foreign personal
holding company income under this paragraph (e)(2) includes property
that gives rise to dividends, interest, rents, royalties or annuities
described in paragraph (b) of this section, including--
(A) Property that gives rise to export financing interest described
in paragraph (b)(2) of this section; and
(B) Property that gives rise to income from related persons
described in paragraph (b)(4) or (5) of this section.
(ii) Gain or loss from the disposition of a debt instrument. Gain or
loss from the sale, exchange or retirement of a debt instrument is
included in the computation of foreign personal holding company income
under this paragraph (e) unless--
(A) In the case of gain--
(1) It is interest (as defined in paragraph (a)(4)(i) of this
section); or
(2) It is income equivalent to interest (as described in paragraph
(h) of this section); and
(B) In the case of loss--
(1) It is directly allocated to, or treated as an adjustment to,
interest income (as described in paragraph (a)(4)(i) of this section) or
income equivalent to interest (as defined in paragraph (h) of this
section) under any provision of the Internal Revenue Code or Income Tax
Regulations; or
(2) It is required to be apportioned in the same manner as interest
expense under section 864(e) or any other provision of the Internal
Revenue Code or Income Tax Regulations.
(3) Property that does not give rise to income. Except as otherwise
provided in this paragraph (e)(3), for purposes of this section, the
term property that does not give rise to income includes all rights and
interests in property (whether or not a capital asset) including, for
example, forwards, futures and options.
[[Page 274]]
Property that does not give rise to income shall not include--
(i) Property that gives rise to dividends, interest, rents,
royalties or annuities described in paragraph (e)(2) of this section;
(ii) Tangible property (other than real property) used or held for
use in the controlled foreign corporation's trade or business that is of
a character that would be subject to the allowance for depreciation
under section 167 or 168 and the regulations under those sections
(including tangible property described in Sec. 1.167(a)-2);
(iii) Real property that does not give rise to rental or similar
income, to the extent used or held for use in the controlled foreign
corporation's trade or business;
(iv) Intangible property (as defined in section 936(h)(3)(B)),
goodwill or going concern value, to the extent used or held for use in
the controlled foreign corporation's trade or business;
(v) Notional principal contracts (but see paragraphs (f)(2), (g)(2)
and (h)(3) of this section for rules that include income from certain
notional principal contracts in gains from commodities transactions,
foreign currency gains and income equivalent to interest, respectively);
or
(vi) Other property that is excepted from the general rule of this
paragraph (e)(3) by the Commissioner in published guidance. See Sec.
601.601(d)(2) of this chapter.
(f) Commodities transactions--(1) In general--(i) Inclusion in
foreign personal holding company income. Foreign personal holding
company income includes the excess of gains over losses from commodities
transactions.
(ii) Exception. Gains and losses from qualified active sales and
qualified hedging transactions are excluded from the computation of
foreign personal holding company income under this paragraph (f).
(iii) Treatment of losses. Section 1.954-1(c)(1)(ii) provides for
the treatment of losses in excess of gains from commodities
transactions.
(2) Definitions--(i) Commodity. For purposes of this section, the
term commodity includes tangible personal property of a kind that is
actively traded or with respect to which contractual interests are
actively traded.
(ii) Commodities transaction. The term commodities transaction means
the purchase or sale of a commodity for immediate (spot) delivery or
deferred (forward) delivery, or the right to purchase, sell, receive, or
transfer a commodity, or any other right or obligation with respect to a
commodity accomplished through a cash or off-exchange market, an
interbank market, an organized exchange or board of trade, or an over-
the-counter market, or in a transaction effected between private parties
outside of any market. Commodities transactions include, but are not
limited to--
(A) A futures or forward contract in a commodity;
(B) A leverage contract in a commodity purchased from a leverage
transaction merchant;
(C) An exchange of futures for physical transaction;
(D) A transaction, including a notional principal contract, in which
the income or loss to the parties is measured by reference to the price
of a commodity, a pool of commodities, or an index of commodities;
(E) The purchase or sale of an option or other right to acquire or
transfer a commodity, a futures contract in a commodity, or an index of
commodities; and
(F) The delivery of one commodity in exchange for the delivery of
another commodity, the same commodity at another time, cash, or
nonfunctional currency.
(iii) Qualified active sale--(A) In general. The term qualified
active sale means the sale of commodities in the active conduct of a
commodities business as a producer, processor, merchant or handler of
commodities if substantially all of the controlled foreign corporation's
business is as an active producer, processor, merchant or handler of
commodities. The sale of commodities held by a controlled foreign
corporation other than in its capacity as an active producer, processor,
merchant or handler of commodities is not a qualified active sale. For
example, the sale by a controlled foreign corporation of commodities
that were held
[[Page 275]]
for investment or speculation would not be a qualified active sale.
(B) Active conduct of a commodities business. For purposes of this
paragraph, a controlled foreign corporation is engaged in the active
conduct of a commodities business as a producer, processor, merchant or
handler of commodities only with respect to commodities for which each
of the following conditions is satisfied--
(1) It holds the commodities directly, and not through an agent or
independent contractor, as inventory or similar property (as defined in
paragraph (a)(4)(iii) of this section) or as dealer property (as defined
in paragraph (a)(4)(v) of this section); and
(2) With respect to such commodities, it incurs substantial expenses
in the ordinary course of a commodities business from engaging in one or
more of the following activities directly, and not through an
independent contractor--
(i) Substantial activities in the production of the commodities,
including planting, tending or harvesting crops, raising or slaughtering
livestock, or extracting minerals;
(ii) Substantial processing activities prior to the sale of the
commodities, including the blending and drying of agricultural
commodities, or the concentrating, refining, mixing, crushing, aerating
or milling of commodities; or
(iii) Significant activities as described in paragraph
(f)(2)(iii)(B)(3) of this section.
(3) For purposes of paragraph (f)(2)(iii)(B)(2)(iii) of this
section, the significant activities must relate to--
(i) The physical movement, handling and storage of the commodities,
including preparation of contracts and invoices, arranging freight,
insurance and credit, arranging for receipt, transfer or negotiation of
shipping documents, arranging storage or warehousing, and dealing with
quality claims;
(ii) Owning and operating facilities for storage or warehousing; or
(iii) Owning or chartering vessels or vehicles for the
transportation of the commodities.
(C) Substantially all. Substantially all of the controlled foreign
corporation's business is as an active producer, processor, merchant or
handler of commodities if the sum of its gross receipts from all of its
qualified active sales (as defined in this paragraph (f)(2)(iii) without
regard to the substantially all requirement) of commodities and its
gross receipts from all of its qualified hedging transactions (as
defined in paragraph (f)(2)(iv) of this section, applied without regard
to the substantially all requirement of this paragraph (f)(2)(iii)(C))
equals or exceeds 85 percent of its total gross receipts for the taxable
year (computed as though the corporation were a domestic corporation).
In computing gross receipts, the District Director may disregard any
sale or hedging transaction that has as a principal purpose manipulation
of the 85 percent gross receipts test. A purpose may be a principal
purpose even though it is outweighed by other purposes (taken together
or separately).
(D) Activities of employees of a related entity. For purposes of
this paragraph (f), activities of employees of an entity related to the
controlled foreign corporation, who are made available to and supervised
on a day-to-day basis by, and whose salaries are paid by (or reimbursed
to the related entity by), the controlled foreign corporation, are
treated as activities engaged in directly by the controlled foreign
corporation.
(iv) Qualified hedging transaction entered into prior to January 31,
2003(A) In general. The term qualified hedging transaction means a bona
fide hedging transaction, as defined in paragraph (a)(4)(ii) of this
section, with respect to qualified active sales (other than transactions
described in section 988(c)(1) without regard to section
988(c)(1)(D)(i)).
(B) Exception. The term qualified hedging transaction does not
include transactions that are not reasonably necessary to the conduct of
business of the controlled foreign corporation as a producer, processor,
merchant or handler of a commodity in the manner in which such business
is customarily and usually conducted by others.
(C) Effective date. This paragraph (f)(2)(iv) applies to gain or
loss realized by a controlled foreign corporation with respect to a
qualified hedging
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transaction entered into prior to January 31, 2003.
(v) Qualified hedging transaction entered into on or after January
31, 2003--(A) In general. The term qualified hedging transaction means a
bona fide hedging transaction, as defined in paragraph (a)(4)(ii) of
this section, with respect to one or more commodities transactions
reasonably necessary to the conduct of any business by a producer,
processor, merchant or handler of commodities in a manner in which such
business is customarily and usually conducted by others. For purposes of
this paragraph (f)(2)(v), a producer, processor, merchant or handler of
commodities includes a controlled foreign corporation that regularly
uses commodities in a manufacturing, construction, utilities, or
transportation business.
(B) Exception. The term qualified hedging transaction does not
include a transaction described in section 988(c)(1) (without regard to
section 988(c)(1)(D)(i)).
(C) Examples. The following examples illustrate the provisions of
this paragraph (f)(2)(v):
Example 1. CFC1 is a controlled foreign corporation located in
country A. CFC1 manufactures and sells machinery in country B using
aluminum and component parts purchased from third parties that contain
significant amounts of aluminum. CFC1 conducts its manufacturing
business in a manner in which such business is customarily and usually
conducted by others. To protect itself against increases in the price of
aluminum used in the machinery it manufactures, CFC1 enters into futures
purchase contracts for the delivery of aluminum. These futures purchase
contracts are bona fide hedging transactions. As CFC1 purchases aluminum
and component parts containing significant amounts of aluminum in the
spot market for use in its business, it closes out an equivalent amount
of aluminum futures purchase contracts by entering into offsetting
aluminum futures sales contracts. The aluminum futures purchase
contracts are qualified hedging transactions as defined in paragraph
(f)(2)(v)(A) of this section. Accordingly, any gain or loss on such
aluminum futures purchase contracts is excluded from the computation of
foreign personal holding company income.
Example 2. CFC2 is a controlled foreign corporation located in
country B. CFC2 operates an airline business within country B in a
manner in which such business is customarily and usually conducted by
others. To protect itself against increases in the price of aviation
fuel, CFC2 enters into forward contracts for the purchase of aviation
fuel. These forward purchase contracts are bona fide hedging
transactions. As CFC2 purchases aviation fuel in the spot market for use
in its business, it closes out an equivalent amount of its forward
purchase contracts for cash pursuant to a contractual provision that
permits CFC2 to terminate the contract and make or receive a one-time
payment representing the contract's fair market value. The aviation fuel
forward purchase contracts are qualified hedging transactions as defined
in paragraph (f)(2)(v)(A) of this section. Accordingly, any gain or loss
on such aviation fuel forward purchase contracts is excluded from the
computation of foreign personal holding company income.
(D) Effective date. This paragraph (f)(2)(v) applies to gain or loss
realized by a controlled foreign corporation with respect to a qualified
hedging transaction entered into on or after January 31, 2003.
(vi) Financial institutions not a producer, etc. For purposes of
this paragraph (f), a corporation is not a producer, processor, merchant
or handler of commodities if its business is primarily financial. For
example, the business of a controlled foreign corporation is primarily
financial if its principal business is making a market in notional
principal contracts based on a commodities index.
(g) Foreign currency gain or loss--(1) Scope and purpose. This
paragraph (g) provides rules for the treatment of foreign currency gains
and losses. Paragraph (g)(2) of this section provides the general rule.
Paragraph (g)(3) of this section provides an election to include foreign
currency gains or losses that would otherwise be treated as foreign
personal holding company income under this paragraph (g) in the
computation of another category of subpart F income. Paragraph (g)(4) of
this section provides an alternative election to treat any net foreign
currency gain or loss as foreign personal holding company income.
Paragraph (g)(5) of this section provides rules for certain gains and
losses not subject to this paragraph (g).
(2) In general--(i) Inclusion. Except as otherwise provided in this
paragraph (g), foreign personal holding company income includes the
excess of foreign
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currency gains over foreign currency losses attributable to any section
988 transactions (foreign currency gain or loss). Section 1.954-
1(c)(1)(ii) provides rules for the treatment of foreign currency losses
in excess of foreign currency gains. However, if an election is made
under paragraph (g)(4) of this section, the excess of foreign currency
losses over foreign currency gains to which the election would apply may
be apportioned to, and offset, other categories of foreign personal
holding company income.
(ii) Exclusion for business needs--(A) General rule. Foreign
currency gain or loss directly related to the business needs of the
controlled foreign corporation is excluded from foreign personal holding
company income.
(B) Business needs. Foreign currency gain or loss is directly
related to the business needs of a controlled foreign corporation if--
(1) The foreign currency gain or loss--
(i) Arises from a transaction (other than a hedging transaction)
entered into, or property used or held for use, in the normal course of
the controlled foreign corporation's trade or business, other than the
trade or business of trading foreign currency;
(ii) Arises from a transaction or property that does not itself (and
could not reasonably be expected to) give rise to subpart F income other
than foreign currency gain or loss;
(iii) Does not arise from a transaction described in section
988(c)(1)(B)(iii); and
(iv) Is clearly determinable from the records of the controlled
foreign corporation as being derived from such transaction or property;
or
(2) The foreign currency gain or loss arises from a bona fide
hedging transaction, as defined in paragraph (a)(4)(ii) of this section,
with respect to a transaction or property that satisfies the
requirements of paragraphs (g)(2)(ii)(B)(1) (i) through (iii) of this
section, provided that any gain or loss arising from such transaction or
property that is attributable to changes in exchange rates is clearly
determinable from the records of the CFC as being derived from such
transaction or property. For purposes of this paragraph
(g)(2)(ii)(B)(2), a hedging transaction will satisfy the aggregate
hedging rules of Sec. 1.1221-2(c)(3) only if all (or all but a de
minimis amount) of the aggregate risk being hedged arises in connection
with transactions or property that satisfy the requirements of
paragraphs (g)(2)(ii)(B)(1) (i) through (iii) of this section, provided
that any gain or loss arising from such transactions or property that is
attributable to changes in exchange rates is clearly determinable from
the records of the CFC as being derived from such transactions or
property.
(C) Regular dealers--(1) General rule. Transactions in dealer
property (as defined in paragraph (a)(4)(v) of this section) described
in section 988(c)(1)(B) or (C) that are entered into by a controlled
foreign corporation that is a regular dealer (as defined in paragraph
(a)(4)(iv) of this section) in such property in its capacity as a dealer
will be treated as directly related to the business needs of the
controlled foreign corporation under paragraph (g)(2)(ii)(A) of this
section.
(2) Certain interest-bearing liabilities treated as dealer
property--(i) In general. For purposes of this paragraph (g)(2)(ii)(C),
an interest-bearing liability incurred by a controlled foreign
corporation that is denominated in (or determined by reference to) a
non-functional currency shall be treated as dealer property of the type
described in paragraph (g)(2)(ii)(C)(1) of this section if the
liability, by being denominated in such currency, reduces the controlled
foreign corporation's currency risk with respect to dealer property, and
the liability is identified on the controlled foreign corporation's
records as a liability treated as dealer property before the close of
the day on which the liability is incurred.
(ii) Failure to identify certain liabilities. If a controlled
foreign corporation identifies certain interest-bearing liabilities as
liabilities treated as dealer property under paragraph
(g)(2)(ii)(C)(2)(i) of this section but fails to so identify other
interest-bearing liabilities that manage its currency risk with respect
to assets held that constitute dealer property, the Commissioner may
treat such other liabilities as properly identified as dealer property
under paragraph (g)(2)(ii)(C)(2)(i)
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of this section if the Commissioner determines that the failure to
identify such other liabilities had as one of its principal purposes the
avoidance of Federal income tax.
(iii) Effective date. This paragraph (g)(2)(ii)(C)(2) applies only
to gain or loss from an interest-bearing liability entered into by a
controlled foreign corporation on or after January 31, 2003.
(D) Example. The following example illustrates the provisions of
this paragraph (g)(2).
Example. (i) CFC1 and CFC2 are controlled foreign corporations
located in Country B, and are members of the same controlled group. CFC1
is engaged in the active conduct of a trade or business that does not
produce any subpart F income. CFC2 serves as the currency coordination
center for the controlled group, aggregating currency risks incurred by
the group and entering into hedging transactions that transfer those
risks outside of the group. Pursuant to this arrangement, and to hedge
the currency risk on a non-interest bearing receivable incurred by CFC1
in the normal course of its business, on Day 1 CFC1 enters into a
forward contract to sell Japanese Yen to CFC2 in 30 days. Also on Day 1,
CFC2 enters into a forward contract to sell Yen to unrelated Bank X on
Day 30. CFC2 is not a regular dealer in Yen spot and forward contracts,
and the Yen is not the functional currency for either CFC1 or CFC2.
(ii) Because the forward contract entered into by CFC1 to sell Yen
hedges a transaction entered into in the normal course of CFC1's
business that does not give rise to subpart F income, it qualifies as a
bona fide hedging transaction as defined in paragraph (a)(4)(ii) of this
section. Therefore, CFC1's foreign exchange gain or loss from that
forward contract will not be treated as foreign personal holding company
income or loss under this paragraph (g).
(iii) Because the forward contract to purchase Yen was entered into
by CFC2 in order to assume currency risks incurred by CFC1 it does not
qualify as a bona fide hedging transaction, as defined in paragraph
(a)(4)(ii) of this section. Thus, foreign exchange gain or loss
recognized by CFC2 from that forward contract will be foreign personal
holding company income. Because CFC2 entered into the forward contract
to sell Yen in order to hedge currency risks of CFC1, that forward
contract also does not qualify as a bona fide hedging transaction. Thus,
CFC2's foreign currency gain or loss arising from that forward contract
will be foreign personal holding company income.
(iii) Special rule for foreign currency gain or loss from an
interest-bearing liability. Except as provided in paragraph
(g)(2)(ii)(C)(2) or (g)(5)(iv) of this section, foreign currency gain or
loss arising from an interest-bearing liability is characterized as
subpart F income and non-subpart F income in the same manner that
interest expense associated with the liability would be allocated and
apportioned between subpart F income and non-subpart F income under
Sec. Sec. 1.861-9T and 1.861-12T.
(3) Election to characterize foreign currency gain or loss that
arises from a specific category of subpart F income as gain or loss in
that category--(i) In general. For taxable years of a controlled foreign
corporation beginning on or after November 6, 1995, the controlling
United States shareholders of the controlled foreign corporation may
elect, under this paragraph (g)(3), to exclude foreign currency gain or
loss otherwise includible in the computation of foreign personal holding
company income under this paragraph (g) from the computation of foreign
personal holding company income under this paragraph (g) and include
such foreign currency gain or loss in the category (or categories) of
subpart F income (described in section 952(a), or, in the case of
foreign base company income, described in Sec. 1.954-1(c)(1)(iii)(A)
(1) or (2)) to which such gain or loss relates. If an election is made
under this paragraph (g)(3) with respect to a category (or categories)
of subpart F income described in section 952(a), or, in the case of
foreign base company income, described in Sec. 1.954-1(c)(1)(iii)(A)
(1) or (2), the election shall apply to all foreign currency gain or
loss that arises from--
(A) A transaction (other than a hedging transaction) entered into,
or property used or held for use, in the normal course of the controlled
foreign corporation's trade or business that gives rise to income in
that category (or categories) and that is clearly determinable from the
records of the controlled foreign corporation as being derived from such
transaction or property; and
(B) A bona fide hedging transaction, as defined in paragraph
(a)(4)(ii) of this section, with respect to a transaction or property
described in paragraph
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(g)(3)(i)(A) of this section. For purposes of this paragraph
(g)(3)(i)(B), a hedging transaction will satisfy the aggregate hedging
rules of Sec. 1.1221-2(c)(3) only if all (or all but a de minimus
amount) of the aggregate risk being hedged arises in connection with
transactions or property that generate the same category of subpart F
income described in section 952(a), or, in the case of foreign base
company income, described in Sec. 1.954-1(c)(1)(iii)(A) (1) or (2).
(ii) Time and manner of election. The controlling United States
shareholders, as defined in Sec. 1.964-1(c)(5), make the election on
behalf of the controlled foreign corporation by filing a statement with
their original income tax returns for the taxable year of such United
States shareholders ending with or within the taxable year of the
controlled foreign corporation for which the election is made, clearly
indicating that such election has been made. If the controlling United
States shareholders elect to apply these regulations retroactively,
under Sec. 1.954-0(a)(1)(ii), the election under this paragraph (g)(3)
may be made by the amended return filed pursuant to the election under
Sec. 1.954-0(a)(1)(ii). The controlling United States shareholders
filing the election statement described in this paragraph (g)(3)(ii)
must provide copies of the election statement to all other United States
shareholders of the electing controlled foreign corporation. Failure to
provide copies of such statement will not cause an election under this
paragraph (g)(3) to be voidable by the controlled foreign corporation or
the controlling United States shareholders. However, the District
Director has discretion to void the election if it is determined that
three was no reasonable cause for the failure to provide copies of such
statement. The statement shall include the following information--
(A) The name, address, taxpayer identification number, and taxable
year of such United States shareholder;
(B) The name, address, and taxable year of the controlled foreign
corporation for which the election is effective; and
(C) Any additional information required by the Commission by
administrative pronouncement.
(iii) Revocation of election. This election is effective for the
taxable year of the controlled foreign corporation for which it is made
and all subsequent taxable years of such corporation unless revoked by
or with the consent of the Commissioner.
(iv) Example. The following example illustrates the provisions of
this paragraph (g)(3).
Example. (i) CFC, a controlled foreign corporation, is a sales
company that earns foreign base company sales income under section
954(d). CFC makes an election under this paragraph (g)(3) to treat
foreign currency gains or losses that arise from a specific category (or
categories) of subpart F income (as described in section 952(a), or, in
the case of foreign base company income, as described in Sec. 1.954-
1(c)(1)(iii)(A) (1) or (2)) as that type of income. CFC aggregates the
currency risk on all of its transactions that generate foreign base
company sales income and hedges this net currency exposure.
(ii) Assuming no more than a de minimus amount of risk in the pool
of risks being hedged arises from transactions or property that generate
income other than foreign base company sales income, pursuant to its
election under (g)(3), CFC's net foreign currency gain from the pool and
the hedging transactions will be treated as foreign base company sales
income under section 954(d), rather than as foreign personal holding
company income under section 954(c)(1)(D). If the pool of risks and the
hedging transactions generate a net foreign base company sales loss,
however, CFC must apply the rules of Sec. 1.954-1(c)(1)(ii).
(4) Election to treat all foreign currency gains or losses as
foreign personal holding company income--(i) In general. If the
controlling United States shareholders make an election under this
paragraph (g)(4), the controlled foreign corporation shall include in
its computation of foreign personal holding company income the excess of
foreign currency gains over losses or the excess of foreign currency
losses over gains attributable to any section 988 transaction (except
those described in paragraph (g)(5) of this section) and any section
1256 contract that would be a section 988 transaction but for section
988(c)(1)(D). Separate elections for section 1256 contracts and section
988 transactions are not permitted. An election under this paragraph
(g)(4) supersedes an election under paragraph (g)(3) of this section.
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(ii) Time and manner of election. The controlling United States
shareholders, as defined in Sec. 1.964-1(c)(5), make the election on
behalf of the controlled foreign corporation in the same time and manner
as provided in paragraph (g)(3)(ii) of this section.
(iii) Revocation of election. This election is effective for the
taxable year of the controlled foreign corporation for which it is made
and all subsequent taxable years of such corporation unless revoked by
or with the consent of the Commissioner.
(5) Gains and losses not subject to this paragraph--(i) Capital
gains and losses. Gain or loss that is treated as capital gain or loss
under section 988(a)(1)(B) is not foreign currency gain or loss for
purposes of this paragraph (g). Such gain or loss is treated as gain or
loss from the sale or exchange of property that is included in the
computation of foreign personal holding company income under paragraph
(e)(1) of this section. Paragraph (a)(2) of this section provides other
rules concerning income described in more than one category of foreign
personal holding company income.
(ii) Income not subject to section 988. Gain or loss that is not
treated as foreign currency gain or loss by reason of section 988 (a)(2)
or (d) is not foreign currency gain or loss for purposes of this
paragraph (g). However, such gain or loss may be included in the
computation of other categories of foreign personal holding company
income in accordance with its characterization under section 988 (a)(2)
or (d) (for example, foreign currency gain that is treated as interest
income under section 988(a)(2) will be included in the computation of
foreign personal holding company income under paragraph (b)(ii) of this
section).
(iii) Qualified business units using the dollar approximate separate
transactions method. This paragraph (g) does not apply to any DASTM gain
or loss computed under Sec. 1.985-3(d). Such gain or loss is allocated
under the rules of Sec. 1.985-3 (e)(2)(iv) or (e)(3). However, the
provisions of this paragraph (g) do apply to section 988 transactions
denominated in a currency other than the United States dollar or the
currency that would be the qualified business unit's functional currency
were it not hyperinflationary.
(iv) Gain or loss allocated under Sec. 1.861-9. [Reserved]
(h) Income equivalent to interest--(1) In general--(i) Inclusion in
foreign personal holding company income. Except as provided in this
paragraph (h), foreign personal holding company income includes income
equivalent to interest as defined in paragraph (h)(2) of this section.
(ii) Exceptions--(A) Liability hedging transactions. Income, gain,
deduction or loss that is allocated and apportioned in the same manner
as interest expense under the provisions of Sec. 1.861-9T is not income
equivalent to interest for purposes of this paragraph (h).
(B) Interest. Amounts treated as interest under section 954(c)(1)(A)
and paragraph (b) of this section are not income equivalent to interest
for purposes of this paragraph (h).
(2) Definition of income equivalent to interest--(i) In general. The
term income equivalent to interest includes income that is derived
from--
(A) A transaction or series of related transactions in which the
payments, net payments, cash flows or return predominantly reflect the
time value of money;
(B) Transactions in which the payments (or a predominant portion
thereof) are, in substance, for the use or forbearance of money;
(C) Notional principal contracts, to the extent provided in
paragraph (h)(3) of this section;
(D) Factoring, to the extent provided in paragraph (h)(4) of this
section;
(E) Conversion transactions, but only to the extent that gain
realized with respect to such a transaction is treated as ordinary
income under section 1258;
(F) The performance of services, to the extent provided in paragraph
(h)(5) of this section;
(G) The commitment by a lender to provide financing, if any portion
of such financing is actually provided;
(H) Transfers of debt securities subject to section 1058; and
(I) Other transactions, as provided by the Commissioner in published
guidance. See Sec. 601.601(d)(2) of this chapter.
(ii) Income from the sale of property. Income from the sale of
property will
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not be treated as income equivalent to interest by reason of paragraph
(h)(2)(i)(A) or (B) of this section. Income derived by a controlled
foreign corporation will be treated as arising from the sale of property
only if the corporation in substance carries out sales activities.
Accordingly, an arrangement that is designed to lend the form of a sales
transaction to a transaction that in substance constitutes an advance of
funds will be disregarded. For example, if a controlled foreign
corporation acquires property on 30-day payment terms from one person
and sells that property to another person on 90-day payment terms and at
prearranged prices and terms such that the foreign corporation bears no
substantial economic risk with respect to the purchase and sale other
than the risk of non-payment, the foreign corporation has not in
substance derived income from the sale of property.
(3) Notional principal contracts--(i) In general. Income equivalent
to interest includes income from notional principal contracts
denominated in the functional currency of the taxpayer (or a qualified
business unit of the taxpayer, as defined in section 989(a)), the value
of which is determined solely by reference to interest rates or interest
rate indices, to the extent that the income from such transactions
accrues on or after August 14, 1989.
(ii) Regular dealers. Income equivalent to interest does not include
income earned by a regular dealer (as defined in paragraph (a)(4)(iv) of
this section) from notional principal contracts that are dealer property
(as defined in paragraph (a)(4)(v) of this section).
(4) Income equivalent to interest from factoring--(i) General rule.
Income equivalent to interest includes factoring income. Except as
provided in paragraph (h)(4)(ii) of this section, the term factoring
income includes any income (including any discount income or service
fee, but excluding any stated interest) derived from the acquisition and
collection or disposition of a factored receivable. The amount of income
equivalent to interest realized with respect to a factored receivable is
the difference (if a positive number) between the amount paid for the
receivable by the foreign corporation and the amount that it collects on
the receivable (or realizes upon its sale of the receivable). The rules
of this paragraph (h)(4) apply only with respect to the tax treatment of
factoring income derived from the acquisition and collection or
disposition of a factored receivable and shall not affect the
characterization of an expense or loss of either the person whose goods
or services gave rise to a factored receivable or the obligor under a
receivable.
(ii) Exceptions. Factoring income shall not include--
(A) Income treated as interest under section 864(d)(1) or (6)
(relating to income derived from trade or service receivables of related
persons), even if such income is treated as not described in section
864(d)(1) by reason of the same-country exception of section 864(d)(7);
(B) Income derived from a factored receivable if payment for the
acquisition of the receivable is made on or after the date on which
stated interest begins to accrue, but only if the rate of stated
interest equals or exceeds 120 percent of the Federal short-term rate
(as defined under section 1274) (or the analogous rate for a currency
other than the dollar) as of the date on which the receivable is
acquired by the foreign corporation; or
(C) Income derived from a factored receivable if payment for the
acquisition of the receivable by the foreign corporation is made only on
or after the anticipated date of payment of all principal by the obligor
(or the anticipated weighted average date of payment of a pool of
purchased receivables).
(iii) Factored receivable. For purposes of this paragraph (h)(4),
the term factored receivable includes any account receivable or other
evidence of indebtedness, whether or not issued at a discount and
whether or not bearing stated interest, arising out of the disposition
of property or the performance of services by any person, if such
account receivable or evidence of indebtedness is acquired by a person
other than the person who disposed of the property or provided the
services that gave rise to the account receivable or evidence of
indebtedness. For purposes of this paragraph (h)(4), it is immaterial
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whether the person providing the property or services agrees to transfer
the receivable at the time of sale (as by accepting a third-party charge
or credit card) or at a later time.
(iv) Examples. The following examples illustrate the application of
this paragraph (h)(4).
Example 1. DP, a domestic corporation, owns all of the outstanding
stock of FS, a controlled foreign corporation. FS acquires accounts
receivable arising from the sale of property by unrelated corporation X.
The receivables have a face amount of $100, and after 30 days bear
stated interest equal to at least 120 percent of the applicable Federal
short-term rate (determined as of the date the receivables are acquired
by FS). FS purchases the receivables from X for $95 on Day 1 and
collects $100 plus stated interest from the obligor under the
receivables on Day 40. Income (other than stated interest) derived by FS
from the factored receivables is factoring income within the meaning of
paragraph (h)(4)(i) of this section and, therefore, is income equivalent
to interest.
Example 2. The facts are the same as in Example 1, except that,
rather than collecting $100 plus stated interest from the obligor under
the factored receivables on Day 40, FS sells the receivables to
controlled foreign corporation Y on Day 15 for $97. Both the income
derived by FS on the factored receivables and the income derived by Y
(other than stated interest) on the receivables are factoring income
within the meaning of paragraph (h)(4)(i) of this section, and
therefore, constitute income equivalent to interest.
Example 3. The facts are the same as in Example 1, except that FS
purchases the receivables from X for $98 on Day 30. Income derived by FS
from the factored receivables is excluded from factoring income under
paragraph (h)(4)(ii)(B) of this section and, therefore, does not give
rise to income equivalent to interest.
Example 4. The facts are the same as in Example 3, except that it is
anticipated that all principal will be paid by the obligor of the
receivables by Day 30. Income derived by FS from this maturity factoring
of the receivables is excluded from factoring income under paragraph
(h)(4)(ii)(C) of this section and, therefore, does not give rise to
income equivalent to interest.
Example 5. The facts are the same as in Example 4, except that FS
sells the factored receivables to Y for $99 on Day 45, at which time
stated interest is accruing on the unpaid balance of $100. Because
interest was accruing at the time Y acquired the receivables at a rate
equal to at least 120 percent of the applicable Federal short-term rate,
income derived by Y from the factored receivables is excluded from
factoring income under paragraph (h)(4)(ii)(B) of this section and,
therefore, does not give rise to income equivalent to interest.
Example 6. DP, a domestic corporation engaged in an integrated
credit card business, owns all of the outstanding stock of FS, a
controlled foreign corporation. On Day 1, individual A uses a credit
card issued by DP to purchase shoes priced at $100 from X, a foreign
corporation unrelated to DP, FS, or A. On Day 7, X transfers the
receivable (which does not bear stated interest) arising from A's
purchase to FS in exchange for $95. FS collects $100 from A on Day 45.
Income derived by FS on the factored receivable is factoring income
within the meaning of paragraph (h)(4)(i) of this section and,
therefore, is income equivalent to interest.
(5) Receivables arising from performance of services. If payment for
services performed by a controlled foreign corporation is not made until
more than 120 days after the date on which such services are performed,
then the income derived by the controlled foreign corporation
constitutes income equivalent to interest to the extent that interest
income would be imputed under the principles of section 483 or the
original issue discount provisions (sections 1271 through 1275), if--
(i) Such provisions applied to contracts for the performance of
services;
(ii) The time period referred to in sections 483(c)(1) and
1274(c)(1)(B) were 120 days rather than six months; and
(iii) The time period referred to in section 483(c)(1)(A) were 120
days rather than one year.
(6) Examples. The following examples illustrate the application of
this paragraph (h).
Example 1. CFC, a controlled foreign corporation, promises that
Corporation A may borrow up to $500 in principal for one year beginning
at any time during the next three months at an interest rate of 10
percent. In exchange, Corporation A pays CFC a commitment fee of $2.
Pursuant to this agreement, CFC lends $80 to Corporation A. As a result,
the entire $2 fee is included in the computation of CFC' s foreign
personal holding company income under paragraph (h)(2)(i)(G) of this
section.
Example 2. (i) At the beginning of its current taxable year, CFC, a
controlled foreign corporation, purchases at face value a one-year debt
instrument issued by Corporation A having a $100 principal amount and
bearing a floating rate of interest set at the London Interbank Offered
Rate (LIBOR) plus one percentage point. Contemporaneously, CFC
[[Page 283]]
borrows $100 from Corporation B for one year at a fixed interest rate of
10 percent, using the debt instrument as security.
(ii) During its current taxable year, CFC accrues $11 of interest
from Corporation A on the bond. Because interest is excluded from the
definition of income equivalent to interest under paragraph
(h)(1)(ii)(B) of this section, the $11 is not income equivalent to
interest.
(iii) During its current taxable year, CFC incurs $10 of interest
expense with respect to the borrowing from Corporation B. That expense
is allocated and apportioned to, and reduces, subpart F income to the
extent provided in section 954(b)(5) and Sec. Sec. 1.861-9T through
1.861-12T and 1.954-1(c).
Example 3. (i) On January 1, 1994, CFC, a controlled foreign
corporation with the United States dollar as its functional currency,
purchases at face value a 10-year debt instrument issued by Corporation
A having a $100 principal amount and bearing a floating rate of interest
set at LIBOR plus one percentage point payable on December 31st of each
year. CFC subsequently determines that it would prefer receiving a fixed
rate of return. Accordingly, on January 1, 1995, CFC enters into a 9-
year interest rate swap agreement with Corporation B whereby Corporation
B promises to pay CFC on December 31st of each year an amount equal to
10 percent on a notional principal amount of $100. In exchange, CFC
promises to pay Corporation B an amount equal to LIBOR plus one
percentage point on the notional principal amount.
(ii) On December 31, 1995, CFC receives $9 of interest income from
Corporation A with respect to the debt instrument. On the same day, CFC
receives a total of $10 from Corporation B and pays $9 to Corporation B
with respect to the interest rate swap.
(iii) The $9 of interest income is foreign personal holding income
under section 954(c)(1). Pursuant to Sec. 1.446-3(d), CFC recognizes $1
of swap income for its 1995 taxable year that is also foreign personal
holding company income because it is income equivalent to interest under
paragraph (h)(2)(i)(C) of this section.
Example 4. (i) CFC, a controlled foreign corporation, purchases
commodity X on the spot market for $100 and, contemporaneously, enter
into a 3-month forward contract to sell commodity X for $104, a price
set by the forward market.
(ii) Assuming that substantially all of CFC's expected return is
attributable to the time value of the net investment, as described in
section 1258(c)(1), the transaction is a conversion transaction under
section 1258(c). Accordingly, any gain treated as ordinary income under
section 1258(a) will be foreign personal holding company income because
it is income equivalent to interest under paragraph (h)(2)(i)(E) of this
section.
[T.D. 8618, 60 FR 46517, Sept. 7, 1995; 60 FR 58731, Nov. 28, 1995; 60
FR 62025, 62026, Dec. 4, 1995, as amended by T.D. 8704, 62 FR 21, Jan.
2, 1997; T.D. 8985, 67 FR 12866, Mar. 20, 2002; T.D. 9008, 67 FR 48024,
July 23, 2002; T.D. 9039, 68 FR 4917, Jan. 31, 2003]
Sec. 1.954-3 Foreign base company sales income.
(a) Income included--(1) In general--(i) General rules. Foreign base
company sales income of a controlled foreign corporation shall, except
as provided in subparagraphs (2), (3), and (4) of this paragraph,
consist of gross income (whether in the form of profits, commissions,
fees, or otherwise) derived in connection with (a) the purchase of
personal property from a related person and its sale to any person, (b)
the sale of personal property to any person on behalf of a related
person, (c) the purchase of personal property from any person and its
sale to a related person, or (d) the purchase of personal property from
any person on behalf of a related person. See section 954(d)(1). This
section shall apply to the purchase and/or sale of personal property,
whether or not such property was purchased and/or sold in the ordinary
course of trade or business, except that income derived in connection
with the sale of tangible personal property will not be considered to be
foreign base company sales income if such property is sold to an
unrelated person, as defined in paragraph (e)(2) of Sec. 1.954-1, after
substantial use has been made of the property by the controlled foreign
corporation in its trade or business. This section shall not apply to
the excess of gains over losses from sales or exchanges of securities or
from futures transactions, to the extent such excess gains are
includible in foreign personal holding company income of the controlled
foreign corporation under Sec. 1.954-2 or foreign base company shipping
income under Sec. 1.954-6; nor shall it apply to the sale of the
controlled foreign corporation's property (other than its stock in trade
or other property of a kind which would properly be included in its
inventory if on hand at the close of the taxable year, or property held
primarily for sale to customers in the ordinary
[[Page 284]]
course of its trade or business) if substantially all the property of
such corporation is sold pursuant to the discontinuation of the trade or
business previously carried on by such corporation. The term ``any
person'' as used in this subparagraph includes a related person, as
defined in paragraph (e)(1) of Sec. 1.954-1.
(ii) Special rule--(a) In general. The term ``personal property'' as
used in section 954(d) and this section shall not include agricultural
commodities which are not grown in the United States (within the meaning
of section 7701(a)(9)) in commercially marketable quantities. All of the
agricultural commodities listed in table I shall be considered grown in
the United States in commercially marketable quantities. Bananas, black
pepper, cocoa, coconut, coffee, crude rubber, and tea shall not be
considered grown in the United States in commercially marketable
quantities. All other agricultural commodities shall not be considered
grown in the United States in commercially marketable quantities when,
in consideration of all of the facts and circumstances of the individual
case, such commodities are shown to be produced in the United States in
insufficient quantity and quality to be marketed commercially. The term
``agricultural commodities'' includes, but is not limited to, livestock,
poultry, fish produced in fish farms, fruit, furbearing animals as well
as the products of truck farms, ranches, nurseries, ranges, and
orchards. A fish farm is an area where fish are grown or raised
(artificially protected and cared for), as opposed to merely caught or
harvested. However, the term ``agricultural commodities'' shall not
include timber (either standing or felled), or any commodity at least 50
percent of the fair market value of which is attributable to
manufacturing or processing, determined in a manner consistent with the
regulations under section 993(c) (relating to the definition of export
property). For purposes of applying such regulations, the term
``processing'' shall be deemed not to include handling, packing,
packaging, grading, storing, transporting, slaughtering, and harvesting.
Subdivision (ii) shall apply in the computation of foreign base company
sales income for taxable years of controlled foreign corporations
beginning after December 31, 1975, and to taxable years of U.S.
shareholders (within the meaning of section 951(b)) within which or with
which such taxable years of such foreign corporations end.
(b) Table.
Table I--Agricultural Commodities Grown in the United States in
Commercially Marketable Quantities
Livestock and Products
Beeswax Horses
Cattle and calves Milk
Chickens Mink
Chicken eggs Mohair
Ducks Rabbits
Geese Sheep and lambs
Goats Turkeys
Hogs Wool
Honey
Crops
Alfalfa Lettuce
Almonds Lime
Apples Macadamia nuts
Apricots Maple syrup and
Artichokes sugar
Asparagus Mint
Avocadoes Mushrooms
Barley Nectarines
Beans Oats
Beets Olives
Blackberries Onions
Blueberries Oranges
Brussel sprouts Papayas
Broccoli Pecans
Bulbs Peaches
Cabbage Peanuts
Cantaloupes Pears
Carrots Peas
Cauliflower Peppers
Celery Plums and prunes
Cherries Potatoes
Corn Potted plants
Cotton Raspberries
Cranberries Rice
Cucumbers Rhubarb
Cut flowers Rye
Dates Sorghum grain
Eggplant Soybeans
Escarole Spinach
Figs Strawberries
Filberts Sugar beets
Flaxseed Sugarcane
Garlic Sweet potatoes
Grapes Tangelos
Grapefruit Tangerines
Grass seed Tobacco
Hay Tomatoes
Honeydew melons Walnuts
Hops Watermelons
Lemons Wheat
(iii) The application of this subparagraph may be illustrated by the
following examples:
Example 1. Controlled foreign corporation A, incorporated under the
laws of foreign
[[Page 285]]
country X, is a wholly owned subsidiary of domestic corporation M.
Corporation A purchases from M Corporation, a related person, articles
manufactured in the United States and sells the articles in the form in
which purchased to P, not a related person, for delivery and use in
foreign country Y. Gross income of A Corporation derived from the
purchase and sale of the personal property is foreign base company sales
income.
Example 2. Corporation A in example 1 also purchases from P, not a
related person, articles manufactured in country Y and sells the
articles in the form in which purchased to foreign corporation B, a
related person, for use in foreign country Z. Gross income of A
Corporation derived from the purchase and sale of the personal property
is foreign base company sales income.
Example 3. Controlled foreign corporation C, incorporated under the
laws of foreign country X, is a wholly owned subsidiary of domestic
corporation N. By contract, N Corporation agrees to pay C Corporation, a
related person, a commission equal to 6 percent of the gross selling
price of all personal property shipped by N Corporation as the result of
orders solicited by C Corporation in foreign countries Y and Z. In
fulfillment of such orders, N Corporation ships products manufactured by
it in the United States. Corporation C does not assume title to the
property sold. Gross commissions received by C Corporation from N
Corporation in connection with the sale of such property for use in
countries Y and Z constitute foreign base company sales income.
Example 4. Controlled foreign corporation D, incorporated under the
laws of foreign country Y, is a wholly owned subsidiary of domestic
corporation R. In 1964, D Corporation acquires a United States
manufactured lathe from R Corporation. In 1972, after having made
substantial use of the lathe in its manufacturing business, D
Corporation sells the lathe to an unrelated person for use in foreign
country Z. Gross income from the sale of the lathe is not foreign base
company sales income since it is sold to an unrelated person after
substantial use has been made of it by D Corporation in its business.
Example 5. Controlled foreign corporation E, incorporated under the
laws of foreign country Y, is a wholly owned subsidiary of domestic
corporation P. Corporation E purchases from P Corporation articles
manufactured by P Corporation outside of country Y and sells the
articles to F Corporation, an unrelated person, for use in foreign
country Z. Corporation E finances the purchase of the articles by F
Corporation by agreeing to accept payment over an extended period of
time and receives not only the purchase price but also interest and
service fees. All gross income of E Corporation derived in connection
with the purchase and sale of the personal property, including interest
and service fees derived from financing the sale to F Corporation,
constitutes foreign base company sales income.
(2) Property manufactured, produced, constructed, grown, or
extracted within the country in which the controlled foreign corporation
is created or organized. Foreign base company sales income does not
include income derived in connection with the purchase and sale of
personal property (or purchase or sale of personal property on behalf of
a related person) in a transaction described in subparagraph (1) of this
paragraph if the property is manufactured, produced, constructed, grown,
or extracted in the country under the laws of which the controlled
foreign corporation which purchases and sells the property (or acts on
behalf of a related person) is created or organized. See section
954(d)(1)(A). The principles set forth in subparagraph (4) of this
paragraph with respect to the manufacture, production, or construction
of personal property shall apply under this subparagraph in determining
what constitutes manufacture, production, or construction of property.
The application of this subparagraph may be illustrated by the following
examples:
Example 1. Controlled foreign corporation A, incorporated under the
laws of foreign country X, is a wholly owned subsidiary of domestic
corporation M. Corporation A purchases coffee beans grown in country X
from foreign corporation P, a related person, and sells the beans to M
Corporation, a related person, for use in the United States. Income from
the purchase and sale of the coffee beans by A Corporation is not
foreign base company sales income since the beans were grown in country
X.
Example 2. Controlled foreign corporation B, incorporated under the
laws of foreign country X, is a wholly owned subsidiary of controlled
foreign corporation C, also incorporated under the laws of country X.
Corporation B purchases and imports into country X rough diamonds mined
in foreign country Y; in country X it cuts, polishes, and shapes the
diamonds in a process which constitutes manufacturing within the meaning
of subparagraph (4) of this paragraph. Corporation B sells the finished
diamonds to C Corporation, a related person, which in turn sells them
for use in foreign country Z. Since for purposes of this subparagraph
the finished diamonds are manufactured in country X, gross income
derived by C Corporation from their sale is not foreign base company
sales income.
[[Page 286]]
(3) Property sold for use, consumption, or disposition within the
country in which the controlled foreign corporation is created or
organized--(i) In general. Foreign base company sales income does not
include income derived in connection with the purchase and sale of
personal property (or purchase or sale of personal property on behalf of
a related person) in a transaction described in subparagraph (1) of this
paragraph, (a) if the property is sold for use, consumption, or
disposition in the country under the laws of which the controlled
foreign corporation which purchases and sells the property (or sells on
behalf of a related person) is created or organized or (b), where the
property is purchased by the controlled foreign corporation on behalf of
a related person, if such property is purchased for use, consumption, or
disposition in the country under the laws of which such controlled
foreign corporation is created or organized. See section 954(d)(1)(B).
(ii) Rules for determining country of use, consumption, or
disposition. As a general rule, personal property which is sold to an
unrelated person will be presumed for purposes of this subparagraph to
have been sold for use, consumption, or disposition in the country of
destination of the property sold; for such purpose, the occurrence in a
country of a temporary interruption in shipment of goods shall not
constitute such country the country of destination. However, if at the
time of a sale of personal property to an unrelated person the
controlled foreign corporation knew, or should have known from the facts
and circumstances surrounding the transaction, that the property
probably would not be used, consumed, or disposed of in the country of
destination, the controlled foreign corporation must determine the
country of ultimate use, consumption, or disposition of the property or
the property will be presumed to have been used, consumed, or disposed
of outside the country under the laws of which the controlled foreign
corporation is created or organized. A controlled foreign corporation
which sells personal property to a related person is presumed to sell
such property for use, consumption, or disposition outside the country
under the laws of which the controlled foreign corporation is created or
organized unless such corporation establishes the use made of the
property by the related person; once it has established that the related
person has disposed of the property, the rules in the two preceding
sentences relating to sales by a controlled foreign corporation to an
unrelated person will apply at the first stage in the chain of
distribution at which a sale is made by a related person to an unrelated
person. Notwithstanding the preceding provisions of this subdivision, a
controlled foreign corporation which sells personal property to any
person all of whose business except for an insubstantial part consists
of selling from inventory to retail customers at retail outlets all
within one country may assume at the time of such sale to such person
that such property will be used, consumed, or disposed of within such
country.
(iii) Fungible goods. For purposes of this subparagraph, a
controlled foreign corporation which sells to a purchaser personal
property which because of its fungible nature cannot reasonable be
specifically traced to other purchasers and to the countries of ultimate
use, consumption, or disposition shall, unless such corporation
establishes a different disposition as being proper, treat such property
as being sold, for ultimate use, consumption, or disposition in those
countries, and to those other purchasers, in the same proportions in
which property from the fungible mass of the first purchaser is sold in
the regular course of business by such first purchaser. No apportionment
need be made, however, on the basis of sporadic sales by the first
purchaser. This subdivision shall apply only in a case where the
controlled foreign corporation knew, or should have known from the facts
and circumstances surrounding the transaction, the manner in which the
first purchaser disposes of goods from the fungible mass.
(iv) Illustrations. The application of this subparagraph may be
illustrated by the following examples:
Example 1. Controlled foreign corporation A, incorporated under the
laws of foreign
[[Page 287]]
country X, and controlled foreign corporation B, incorporated under the
laws of foreign country Y, are related persons. Corporation A purchases
from B Corporation electric transformers produced by B Corporation in
country Y and sells the transformers to D Corporation, an unrelated
person, for installation in a factory building being constructed in
country X. Since the personal property purchased and sold by A
Corporation is to be used within the country in which A Corporation is
incorporated, income of A Corporation derived from the purchase and sale
of the electric transformers is not foreign base company sales income.
Example 2. Controlled foreign corporation C, incorporated under the
laws of foreign country X, is a wholly owned subsidiary of domestic
corporation N. Corporation C purchases from N Corporation sewing
machines manufactured in the United States by N Corporation and sells
the sewing machines to retail department stores, unrelated persons,
located in foreign country X. The entire activities of the department
stores to which C Corporation sells the machines consist of selling
goods from inventory to retail customers at retail outlets in country X.
Under these circumstances, at the time of sale C Corporation may assume
the sewing machines will be used, consumed, or disposed of in country X,
and no attempt need be made by C Corporation to determine where the
sewing machines will ultimately be used by the customers of the retail
department stores. Gross income of C Corporation derived from the sales
to the department stores located in country X is not foreign base
company sales income.
Example 3. Controlled foreign corporation D, incorporated under the
laws of foreign country Y, and controlled foreign corporation E,
incorporated under the laws of foreign country X, are related persons.
Corporation D purchases from E Corporation sulphur extracted by E
Corporation from deposits located in country X. Corporation D sells the
sulphur to F Corporation, an unrelated person, for delivery to F
Corporation's storage facilities located in country Y. At the time of
the sale of the sulphur from D Corporation to F Corporation, D
Corporation knows that F Corporation is actively engaged in the business
of selling a large amount of sulphur in country Y but also that F
Corporation sells, in the normal course of its business, 25 percent of
its sulphur for ultimate consumption in foreign country Z. However, D
Corporation has no knowledge at the time of sale whether any portion of
the particular shipment it sells to F Corporation will be resold by F
Corporation for ultimate use, consumption, or disposition outside
country Y. Moreover, delivery of the sulphur to F Corporation's storage
facilities constitutes more than a temporary interruption in the
shipment of the sulphur. Under such circumstances, D Corporation may,
but is not required to, trace the ultimate disposition by F Corporation
of the personal property sold to F Corporation; however, if D
Corporation does not trace the ultimate disposition and if it does not
establish a different disposition as being proper, 25 percent of the
sulphur sold by D Corporation to F Corporation will be treated as being
sold for consumption in country Z and 25 percent of the gross income
from the sale of sulphur by D Corporation to F Corporation will be
treated as foreign base company sales income.
Example 4. Controlled foreign corporation G, incorporated under the
laws of foreign country X, is a wholly owned subsidiary of domestic
corporation P. Corporation G purchases from P Corporation toys
manufactured in the United States by P Corporation and sells the toys to
R, an unrelated person, for delivery to a duty-free port in country X.
Instructions for the assembly and operation of the toys are printed in a
language which is not commonly used in country X. From the facts and
circumstances surrounding the sales to R, G Corporation knows, or should
know, that the toys will probably not be used, consumed, or disposed of
within country X. Therefore, unless G Corporation determines the use to
be made of the toys by R, such property will be presumed to have been
sold by R for use, consumption, or disposition outside of country X, and
the entire gross income of G Corporation derived from the sales will be
considered foreign base company sales income.
(4) Property manufactured or produced by the controlled foreign
corporation--(i) In general. Foreign base company sales income does not
include income of a controlled foreign corporation derived in connection
with the sale of personal property manufactured, produced, or
constructed by such corporation in whole or in part from personal
property which it has purchased. A foreign corporation will be
considered, for purposes of this subparagraph, to have manufactured,
produced, or constructed personal property which it sells if the
property sold is in effect not the property which it purchased. In the
case of the manufacture, production, or construction of personal
property, the property sold will be considered, for purposes of this
subparagraph, as not being the property which is purchased if the
provisions of subdivision (ii) or (iii) of this subparagraph are
satisfied. For rules of apportionment in determining foreign base
company sales income derived from the sale of personal
[[Page 288]]
property purchased and used as a component part of property which is not
manufactured, produced, or constructed, see subparagraph (5) of this
paragraph.
(ii) Substantial transformation of property. If purchased personal
property is substantially transformed prior to sale, the property sold
will be treated as having been manufactured, produced, or constructed by
the selling corporation. The application of this subdivision may be
illustrated by the following examples:
Example 1. Controlled foreign corporation A, incorporated under the
laws of foreign country X, operates a paper factory in foreign country
Y. Corporation A purchases from a related person wood pulp grown in
country Y. Corporation A, by a series of processes, converts the wood
pulp to paper which it sells for use in foreign country Z. The
transformation of wood pulp to paper constitutes the manufacture or
production of property for purposes of this subparagraph.
Example 2. Controlled foreign corporation B, incorporated under the
laws of foreign country X, purchases steel rods from a related person
which produces the steel in foreign country Y. Corporation B operates a
machining plant in country X in which it utilizes the purchased steel
rods to make screws and bolts. The transformation of steel rods to
screws and bolts constitutes the manufacture or production of property
for purposes of this subparagraph.
Example 3. Controlled foreign corporation C, incorporated under the
laws of foreign country X, purchases tuna fish from unrelated persons
who own fishing boats which catch such fish on the high seas.
Corporation C receives such fish in country X in the condition in which
taken from the fishing boats and in such country processes, cans, and
sells the fish to related person D, incorporated under the laws of
foreign country Y, for consumption in foreign country Z. The
transformation of such fish into canned fish constitutes the manufacture
or production of property for purposes of this subparagraph.
(iii) Manufacture of a product when purchased components constitute
part of the property sold. If purchased property is used as a component
part of personal property which is sold, the sale of the property will
be treated as the sale of a manufactured product, rather than the sale
of component parts, if the operations conducted by the selling
corporation in connection with the property purchased and sold are
substantial in nature and are generally considered to constitute the
manufacture, production, or construction of property. Without limiting
this substantive test, which is dependent on the facts and circumstances
of each case, the operations of the selling corporation in connection
with the use of the purchased property as a component part of the
personal property which is sold will be considered to constitute the
manufacture of a product if in connection with such property conversion
costs (direct labor and factory burden) of such corporation account for
20 percent or more of the total cost of goods sold. In no event,
however, will packaging, repackaging, labeling, or minor assembly
operations constitute the manufacture, production, or construction of
property for purposes of section 954(d)(1). The application of this
subdivision may be illustrated by the following examples:
Example 1. Controlled foreign corporation A, incorporated under the
laws of foreign country X, sells industrial engines for use,
consumption, and disposition outside country X. Corporation A, in
connection with the assembly of such engines, performs machining and
assembly operations. In addition, A Corporation purchases, from related
and unrelated persons, components manufactured in foreign country Y. On
a per unit basis, A Corporation's selling price and costs of such
engines are as follows:
Selling price................................... ...... ...... $400
Cost of goods sold:
Material--
Acquired from related persons............... $100 ...... ......
Acquired from others........................ 40 ...... ......
--------
Total material............................. ...... $140 ......
Conversion costs (direct labor and factory burden)...... 70 ......
--------
Total cost of goods sold........................ ...... 210
---------
Gross profit.................................... ...... 190
Administrative and selling expenses............. ...... 50
=========
Taxable income.................................. ...... 140
The conversion costs incurred by A Corporation are more than 20 percent
of total costs of goods sold ($70/$210 or 33 percent). Although the
product sold, an engine, is not sufficiently distinguishable from the
components to constitute a substantial transformation of the purchased
parts within the meaning of subdivision (ii) of this subparagraph, A
Corporation will be considered under this subdivision to have
manufactured the product it sells.
Example 2. Controlled foreign corporation B, incorporated under the
laws of foreign
[[Page 289]]
country X, operates an automobile assembly plant. In connection with
such activity, B Corporation purchases from related persons assembled
engines, transmissions, and certain other components, all of which are
manufactured outside of country X; purchases additional components from
unrelated persons; conducts stamping, machining, and subassembly
operations; and has a substantial investment in tools, jigs, welding
equipment, and other machinery and equipment used in the assembly of an
automobile. On a per unit basis, B Corporation's selling price and costs
of such automobiles are as follows:
Selling price.......................... ......... ......... $2,500
Cost of goods sold:
Material--
Acquired from related persons...... $1,200 ......... .........
Acquired from others............... 275 ......... .........
-----------
Total material.................... ......... $1,475 .........
Conversion costs (direct labor and factory burden) 25 .........
-----------
Total cost of goods sold..................... ......... 1,800
------------
Gross profit...................................... ......... 700
Administrative and selling expenses............... ......... 300
------------
Taxable income............................... ......... 400
============
The product sold, an automobile, is not sufficiently distinguishable
from the components purchased (the engine, transmission, etc.) to
constitute a substantial transformation of purchased parts within the
meaning of subdivision (ii) of this subparagraph. Although conversion
costs of B Corporation are less than 20 percent of total cost of goods
sold ($325/$1800 or 18 percent), the operations conducted by B
Corporation in connection with the property purchased and sold are
substantial in nature and are generally considered to constitute the
manufacture of a product. Corporation B will be considered under this
subdivision to have manufactured the product it sells.
Example 3. Controlled foreign corporation C, incorporated under the
laws of foreign country X, purchases from related persons radio parts
manufactured in foreign country Y. Corporation C designs radio kits,
packages component parts required for assembly of such kits, and sells
the parts in a knocked-down condition to unrelated persons for use
outside country X. These packaging operations of C Corporation do not
constitute the manufacture, production, or construction of personal
property for purposes of section 954(d)(1).
(5) Rules for apportionment of income derived from the sale of
purchased components used in property not manufactured, produced, or
constructed. The foreign base company sales income derived by a
controlled foreign corporation for the taxable year from sales of
personal property purchased and used as a component part of property
which is not manufactured, produced, or constructed by such corporation
within the meaning of subparagraph (4) of this paragraph shall, unless
the records of the controlled foreign corporation show that a different
apportionment of income is proper or unless all the income from such
sales is treated as foreign base company sales income, be determined by
first making for such year the following separate classifications and
subclassifications with respect to the property which is sold and then
by apportioning the income for such year from such sales in accordance
with the rules of this subparagraph:
(i) A classification of the cost of components used in the property
which is sold into two classes consisting of the cost of components
manufactured, produced, constructed, grown, or extracted--
(a) Within the country under the laws of which the controlled
foreign corporation is created or organized, and
(b) Outside such country;
(ii) A subclassification of the class described in subdivision (i)
(b) of this subparagraph into--
(a) The cost of such components purchased from unrelated persons,
and
(b) The cost of such components purchased from related persons;
(iii) A classification of the income derived from such sales into
two classes consisting of income derived from sales for use,
consumption, or disposition--
(a) Within the country under the laws of which the controlled
foreign corporation is created or organized, and
(b) Outside such country; and
(iv) A subclassification of the class described in subdivision (iii)
(b) of this subparagraph into income from--
(a) Sales to unrelated persons, and
(b) Sales to related persons.
The foreign base company sales income for the taxable year from
purchases of the property from related persons and sales to unrelated
persons shall be the amount which bears to the amount described in
subdivision (iv) (a) of this
[[Page 290]]
subparagraph the same ratio that the amount described in subdivision
(ii) (b) of this subparagraph bears to the total cost of components used
in the product which is sold. The foreign base company sales income for
the taxable year from purchases of the property from related persons and
sales to related persons is the amount which bears to the amount
described in subdivision (iv) (b) of this subparagraph the same ratio
that the amount described in subdivision (ii) (b) of this subparagraph
bears to the total cost of components used in the product which is sold.
The foreign base company sales income for the taxable year from
purchases of the property from unrelated persons and sales to related
persons is the amount which bears to the amount described in subdivision
(iv) (b) of this subparagraph the same ratio that the amount described
in subdivision (ii) (a) of this subparagraph bears to the total cost of
components used in the product which is sold. The application of this
subparagraph may be illustrated by the following examples:
Example 1. Controlled foreign corporation C, which is incorporated
under the laws of foreign country X, uses the calendar year as the
taxable year. For 1964, C Corporation purchases radio parts of which
some are manufactured in foreign country Y; and others, in country X.
Some of the parts manufactured in country Y are purchased from related
persons. Corporation C uses the purchased parts in radio kits which it
designs and sells for assembly by its customers, unrelated persons, some
of whom use the kits outside country X. Unless the records of C
Corporation show that a different apportionment of income is proper, the
foreign base company sales income for 1964 is determined in the
following manner upon the basis of the following factual classifications
for such year:
Cost of components purchased from all persons:
Manufactured within country X.................................. $20
Manufactured outside country X................................. 40
--------
Total cost.................................................... 60
========
Cost of components manufactured outside country X:
Purchased from unrelated persons............................... 10
Purchased from related persons................................. 30
--------
Total cost.................................................... 40
========
Gross income from sales:
Gross receipts from sales...................................... 120
Cost of goods sold:
Components............................................ $60 .....
Direct labor and factory burden....................... 10 70
-------------
Gross income................................................ 50
========
Gross income from sales:
For use within country X....................................... 26
For use outside country X...................................... 24
--------
Gross income.................................................. 50
========
Foreign base company sales income from purchases from related 12
persons and sales to unrelated persons ($24x$30/$60)............
========
Example 2. The facts are the same as in example 1 except that none
of the purchases are from related persons and some of the sales for use
outside country X are to related persons. Unless the records of C
Corporation show that a different apportionment of income is proper, the
foreign base company sales income for 1964 is determined in the
following manner upon the basis of the following additional factual
classification for such year:
Gross income from sales for use outside country X--
To unrelated persons........................................ $8
To related persons.......................................... 16
---------
Total gross income......................................... 24
=========
Foreign base company sales income from purchases from 10.67
unrelated persons and sales to related persons ($16x$40/$60).
=========
Example 3. The facts are the same as in example 1 except that some
of the sales for use outside country X are to related persons as in
example 2. Unless the records of C Corporation show that a different
apportionment of income is proper, the foreign base company sales income
for 1964 is determined in the following manner:
Foreign base company sales income from purchases from related $4.00
persons and sales to unrelated persons ($8x$30/$60)..........
Foreign base company sales income from purchases from related 8.00
persons and sales to related persons ($16x$30/$60)...........
Foreign base company sales income from purchases from 2.67
unrelated persons and sales to related persons ($16x$10/$60).
---------
Total foreign base company sales income..................... 14.67
=========
(6) Special rule applicable to distributive share of partnership
income--(i) In general. To determine the extent to which a controlled
foreign corporation's distributive share of any item of gross income of
a partnership would have been foreign base company sales income if
received by it directly, under Sec. 1.952-1(g), the property sold will
be considered to be manufactured, produced or constructed by the
controlled foreign corporation, within the meaning of paragraph (a)(4)
of this section, only if
[[Page 291]]
the manufacturing exception of paragraph (a)(4) of this section would
have applied to exclude the income from foreign base company sales
income if the controlled foreign corporation had earned the income
directly, determined by taking into account only the activities of, and
property owned by, the partnership and not the separate activities or
property of the controlled foreign corporation or any other person.
(ii) Example. The application of paragraph (a)(6)(i) of this section
is illustrated by the following example:
Example. CFC, a controlled foreign corporation organized under the
laws of Country A, is an 80 percent partner in Partnership X, a
partnership organized under the laws of Country B. Partnership X
performs activities in Country B that would constitute the manufacture
of Product O, within the meaning of paragraph (a)(4) of this section, if
performed directly by CFC. Partnership X, through its sales offices in
Country B, then sells Product O to Corp D, a corporation that is a
related person with respect to CFC, within the meaning of section
954(d)(3), for use within Country B. CFC's distributive share of
Partnership X's sales income is not foreign base company sales income
because the manufacturing exception of paragraph (a)(4) of this section
would have applied to exclude the income from foreign base company sales
income if CFC had earned the income directly.
(iii) Effective date. This paragraph (a)(6) applies to taxable years
of a controlled foreign corporation beginning on or after July 23, 2002.
(b) Branches of controlled foreign corporation treated as separate
corporations--(1) General rules for determining when to apply separate
treatment--(i) Sales or purchase branch--(a) In general. If a controlled
foreign corporation carries on purchasing or selling activities by or
through a branch or similar establishment located outside the country
under the laws of which such corporation is created or organized and the
use of the branch or similar establishment for such activities has
substantially the same tax effect as if the branch or similar
establishment were a wholly owned subsidiary corporation of such
controlled foreign corporation, the branch or similar establishment and
the remainder of the controlled foreign corporation will be treated as
separate corporations for purposes of determining foreign base company
sales income of such corporation. See section 954(d)(2).
(b) Allocation of income and comparison of effective rates of tax.
The determination as to whether such use of the branch or similar
establishment has the same tax effect as if it were a wholly owned
subsidiary corporation of the controlled foreign corporation shall be
made by allocating to such branch or similar establishment only that
income derived by the branch or establishment which, when the special
rules of subparagraph (2)(i) of this paragraph are applied, is described
in paragraph (a) of this section (but determined without applying
subparagraphs (2), (3), and (4) of such paragraph). The use of the
branch or similar establishment for such activities will be considered
to have substantially the same tax effect as if it were a wholly owned
subsidiary corporation of the controlled foreign corporation if the
income allocated to the branch or similar establishment under the
immediately preceding sentence is, by statute, treaty obligation, or
otherwise, taxed in the year when earned at an effective rate of tax
that is less than 90 percent of, and at least 5 percentage points less
than, the effective rate of tax which would apply to such income under
the laws of the country in which the controlled foreign corporation is
created or organized, if, under the laws of such country, the entire
income of the controlled foreign corporation were considered derived by
the corporation from sources within such country from doing business
through a permanent establishment therein, received in such country, and
allocable to such permanent establishment, and the corporation were
managed and controlled in such country.
(c) Use of more than one branch. If a controlled foreign corporation
carries on purchasing or selling activities by or through more than one
branch or similar establishment located outside the country under the
laws of which such corporation is created or organized, or by or through
one or more such branches or similar establishments in a case where
subdivision (ii) of this subparagraph also applies, then (b) of this
subdivision shall be applied separately to the income derived by
[[Page 292]]
each such branch or similar establishment (by treating such purchasing
or selling branch or similar establishment as if it were the only branch
or similar establishment of the controlled foreign corporation and as if
any such other branches or similar establishments were separate
corporations) in determining whether the use of such branch or similar
establishment has substantially the same tax effect as if such branch or
similar establishment were a wholly owned subsidiary corporation of the
controlled foreign corporation.
(ii) Manufacturing branch--(a) In general. If a controlled foreign
corporation carries on manufacturing, producing, constructing, growing,
or extracting activities by or through a branch or similar establishment
located outside the country under the laws of which such corporation is
created or organized and the use of the branch or similar establishment
for such activities with respect to personal property purchased or sold
by or through the remainder of the controlled foreign corporation has
substantially the same tax effect as if the branch or similar
establishment were a wholly owned subsidiary corporation of such
controlled foreign corporation, the branch or similar establishment and
the remainder of the controlled foreign corporation will be treated as
separate corporations for purposes of determining foreign base company
sales income of such corporation. See section 954(d)(2).
(b) Allocation of income and comparison of effective rates of tax.
The determination as to whether such use of the branch or similar
establishment has substantially the same tax effect as if the branch or
similar establishment were a wholly owned subsidiary corporation of the
controlled foreign corporation shall be made by allocating to the
remainder of such controlled foreign corporation only that income
derived by the remainder of such corporation, which, when the special
rules of subparagraph (2)(i) of this paragraph are applied, is described
in paragraph (a) of this section (but determined without applying
subparagraphs (2), (3), and (4) of such paragraph). The use of the
branch or similar establishment for such activities will be considered
to have substantially the same tax effect as if it were a wholly owned
subsidiary corporation of the controlled foreign corporation if income
allocated to the remainder of the controlled foreign corporation under
the immediately preceding sentence is, by statute, treaty obligation, or
otherwise, taxed in the year when earned at an effective rate of tax
that is less than 90 percent of, and at least 5 percentage points less
than, the effective rate of tax which would apply to such income under
the laws of the country in which the branch or similar establishment is
located, if, under the laws of such country, the entire income of the
controlled foreign corporation were considered derived by such
corporation from sources within such country from doing business through
a permanent establishment therein, received in such country, and
allocable to such permanent establishment, and the corporation were
created or organized under the laws of, and managed and controlled in,
such country.
(c) Use of one or more sales or purchase branches in addition to a
manufacturing branch. If, with respect to personal property
manufactured, produced, constructed, grown, or extracted by or through a
branch or similar establishment located outside the country under the
laws of which the controlled foreign corporation is created or
organized, purchasing or selling activities are carried on by or through
more than one branch or similar establishment, or by or through one or
more branches or similar establishments located outside such country, of
such corporation, then (b) of this subdivision shall be applied
separately to the income derived by each such purchasing or selling
branch or similar establishment (by treating such purchasing or selling
branch or similar establishment as though it alone were the remainder of
the controlled foreign corporation) for purposes of determining whether
the use of such manufacturing, producing, constructing, growing, or
extracting branch or similar establishment has substantially the same
tax effect as if such branch or similar establishment were a wholly
owned subsidiary corporation of the controlled foreign corporation.
[[Page 293]]
(2) Special rules--(i) Determination of treatment as a wholly owned
subsidiary corporation. For purposes of determining under this paragraph
whether the use of a branch or similar establishment which is treated as
a separate corporation has substantially the same tax effect as if the
branch or similar establishment were a wholly owned subsidiary
corporation of a controlled foreign corporation--
(a) Treatment as separate corporations. The branch or similar
establishment will be treated as a wholly owned subsidiary corporation
of the controlled foreign corporation, and such branch or similar
establishment will be deemed to be incorporated in the country in which
it is located.
(b) Activities treated as performed on behalf of remainder of
corporation. With respect to purchasing or selling activities performed
by or through the branch or similar establishment, such purchasing or
selling activities shall--
(1) With respect to personal property manufactured, produced,
constructed, grown, or extracted by the controlled foreign corporation,
or
(2) With respect to personal property (other than property described
in (1) of this subdivision (b)) purchased or sold, or purchased and
sold, by the controlled foreign corporation,
be treated as performed on behalf of the controlled foreign corporation.
(c) Activities treated as performed on behalf of branch. With
respect to manufacturing, producing, constructing, growing, or
extracting activities performed by or through the branch or similar
establishment, purchasing or selling activities performed by or through
the remainder of the controlled foreign corporation with respect to the
personal property manufactured, produced, constructed, grown, or
extracted by or through the branch or similar establishment shall be
treated as performed on behalf of the branch or similar establishment.
(d) Determination of hypothetical tax. To the extent applicable, the
principles of paragraph (b)(4)(ii) of Sec. 1.954-1 shall be used in
determining, under subdivision (i) of subparagraph (1) of this
paragraph, the effective rate of tax which would apply to the income of
the branch or similar establishment under the laws of the country in
which the controlled foreign corporation is created or organized, or in
determining, under subdivision (ii) of such subparagraph, the effective
rate of tax which would apply to the income of the branch or similar
establishment under the laws of the country in which the manufacturing,
producing, constructing, growing, or extracting branch or similar
establishment is located.
(e) Tax laws to be taken into account. Tax determinations shall be
made by taking into account only the income, war profits, excess
profits, or similar tax laws (or the absence of such laws) of the
countries involved.
(ii) Determination of foreign base company sales income. Once it has
been determined under subparagraph (1) of this paragraph that a branch
or similar establishment and the remainder of the controlled foreign
corporation are to be treated as separate corporations, the
determination of whether such branch or similar establishment, or the
remainder of the controlled foreign corporation, as the case may be, has
foreign base company sales income shall be made by applying the
following rules:
(a) Treatment as separate corporations. The branch or similar
establishment will be treated as a wholly owned subsidiary corporation
of the controlled foreign corporation, and such branch or similar
establishment will be deemed to be incorporated in the country in which
it is located.
(b) Activities treated as performed on behalf of remainder of
corporation. With respect to purchasing or selling activities performed
by or through the branch or similar establishment, such purchasing or
selling activities shall--
(1) With respect to personal property manufactured, produced,
constructed, grown, or extracted by the controlled foreign corporation,
or
(2) With respect to personal property (other than property described
in (1) of this subdivision (b)) purchased or sold, or purchased and
sold, by the controlled foreign corporation,
be treated as performed on behalf of the controlled foreign corporation.
[[Page 294]]
(c) Activities treated as performed on behalf of branch. With
respect to manufacturing, producing, constructing, growing, or
extracting activities performed by or through the branch or similar
establishment, purchasing or selling activities performed by or through
the remainder of the controlled foreign corporation with respect to the
personal property manufactured, produced, constructed, grown, or
extracted by or through the branch or similar establishment shall be
treated as performed on behalf of the branch or similar establishment.
(d) Items not to be twice included in income. Income which is
classified as foreign base company sales income as a result of the
application of subdivision (i) of subparagraph (1) of this paragraph
shall not be again classified as foreign base company sales income as a
result of the application of subdivision (ii) of such subparagraph.
(e) Comparison with ordinary treatment. Income derived by the branch
or similar establishment, or by the remainder of the controlled foreign
corporation, shall not be considered foreign base company sales income
if the income would not be so considered if it were derived by a
separate controlled foreign corporation under like circumstances.
(f) Priority of application. If income derived by the branch or
similar establishment, or by the remainder of the controlled foreign
corporation, from a transaction would be classified as foreign base
company sales income of such controlled foreign corporation under
section 954(d)(1) and paragraph (a) of this section, the income shall,
notwithstanding this paragraph, be treated as foreign base company sales
income under paragraph (a) of this section and the branch or similar
establishment shall not be treated as a separate corporation with
respect to such income.
(3) Inclusion of amounts in gross income of United States
shareholders. A branch or similar establishment of a controlled foreign
corporation and the remainder of such corporation shall be treated as
separate corporations under this paragraph solely for purposes of
determining the foreign base company sales income of each such
corporation and for purposes of including an amount in subpart F income
of the controlled foreign corporation under section 953(a). See section
954(b)(3) and paragraph (d)(4) of Sec. 1.954-1 for rules relating to
the treatment of a branch or similar establishment of a controlled
foreign corporation and the remainder of such corporation as separate
corporations for purposes of independently determining if the foreign
base company income of each such corporation is less than 10 percent, or
more than 70 percent, of its gross income. For all other purposes,
however, a branch or similar establishment of a controlled foreign
corporation and the remainder of such corporation shall not be treated
as separate corporations. For example, if the controlled foreign
corporation has a deficit in earnings and profits to which section
952(c) applies, the limitation of such section on the amount includable
in the subpart F income of such corporation will apply. Moreover,
income, war profits, or excess profits taxes paid by a branch or similar
establishment to a foreign country will be treated as having been paid
by the controlled foreign corporation for purposes of section 960
(relating to special rules for foreign tax credit) and the regulations
thereunder. Also, income of a branch or similar establishment, treated
as a separate corporation under this paragraph, will not be treated as
dividend income of the controlled foreign corporation of which it is a
branch or similar establishment.
(4) Illustrations. The application of this paragraph may be
illustrated by the following examples:
Example 1. Controlled foreign corporation A, incorporated under the
laws of foreign country X, is engaged in the manufacturing business in
such country. Corporation A negotiates sales of its products for use
outside of country X through a sales office, branch B, maintained in
foreign country Y. These activities constitute the only activities of A
Corporation. Country X levies an income tax at an effective rate of 50
percent on the income of A Corporation derived by the manufacturing
plant in country X but does not tax the sales income of A Corporation
derived by branch B in country Y. Country Y levies an income tax at an
effective rate of 10 percent on the sales income derived by branch B but
does not tax the income of A Corporation derived by the manufacturing
plant in country X. If the sales income derived by branch B
[[Page 295]]
were, under the laws of country X, derived from sources within country X
by A Corporation, such income would be taxed by such country at an
effective rate of 50 percent. In determining foreign base company sales
income of A Corporation, branch B is treated as a separate wholly owned
subsidiary corporation of A Corporation, the 10 percent rate of tax on
branch B's income being less than 90 percent of, and at least 5
percentage points less than, the 50 percent rate. Income derived by
branch B, treated as a separate corporation, from the sale by or through
it for use, consumption, or disposition outside country Y of the
personal property produced in country X is treated as income from the
sale of personal property on behalf of A Corporation, a related person,
and constitutes foreign base company sales income. The remainder of A
Corporation, treated as a separate corporation, derives no foreign base
company sales income since it produces the product which is sold.
Example 2. Controlled foreign corporation C is incorporated under
the laws of foreign country X. Corporation C maintains branch B in
foreign country Y. Branch B manufactures articles in country Y which are
sold through the sales offices of C Corporation located in country X.
These activities constitute the only activities of C Corporation.
Country Y levies an income tax at an effective rate of 30 percent on the
manufacturing profit of C Corporation derived by branch B but does not
tax the sales income of C Corporation derived by the sales offices in
country X. Country X does not impose an income, war profits, excess
profits, or similar tax, and no tax is paid to any foreign country with
respect to income of C Corporation which is not derived by branch B. If
C Corporation were incorporated under the laws of country Y, the sales
income of the sales offices in country X would be taxed by country Y at
an effective rate of 30 percent. In determining foreign base company
sales income of C Corporation, branch B is treated as a separate wholly
owned subsidiary corporation of C Corporation, the zero rate of tax on
the income derived by the remainder of C Corporation being less than 90
percent of, and at least 5 percentage points less than, the 30 percent
rate. Branch B, treated as a separate corporation, derives no foreign
base company sales income since it produces the product which is sold.
Income derived by the remainder of C Corporation, treated as a separate
corporation, from the sale by or through it for use, consumption, or
disposition outside country X of the personal property produced in
country Y is treated as income from the sale of personal property on
behalf of branch B, a related person, and constitutes foreign base
company sales income.
Example 3. Controlled foreign corporation E, incorporated under the
laws of foreign country X, is a wholly owned subsidiary of controlled
foreign corporation D, also incorporated under the laws of country X.
Corporation E maintains branch B in foreign country Y. Both corporations
use the calendar year as the taxable year. In 1964, E Corporation's sole
activity, carried on through branch B, consists of the purchase of
articles manufactured in country X by D Corporation, a related person,
and the sale of the articles through branch B for use outside country X.
The income of E Corporation derived by branch B from such transactions
is taxed to E Corporation by country X only at the time E Corporation
distributes such income to D Corporation and is then taxed on the basis
of what the tax (a 40 percent effective rate) would have been if the
income had been derived in 1964 by E Corporation from sources within
country X from doing business through a permanent establishment therein.
Country Y levies an income tax at an effective rate of 50 percent on
income derived from sources within such country, but the income of
branch B for 1964 is effectively taxed by country Y at a 5 percent rate
since, under the laws of such country, only 10 percent of branch B's
income is derived from sources within such country. Corporation E makes
no distributions to D Corporation in 1964. In determining foreign base
company sales income of E Corporation for 1964, branch B is treated as a
separate wholly owned subsidiary corporation of E Corporation, the 5
percent rate of tax on branch B's income being less than 90 percent of,
and at least 5 percentage points less than, the 40 percent rate. Income
derived by branch B, treated as a separate corporation, from the sale by
or through it for use, consumption, or disposition outside country Y of
the personal property produced in country X is treated as income from
the sale of personal property on behalf of E Corporation, a related
person, and constitutes foreign base company sales income.
Example 4. Controlled foreign corporation F, incorporated under the
laws of foreign country X, is a wholly owned subsidiary of domestic
corporation M. Corporation F, through its branch B in foreign country Y,
purchases from controlled foreign corporation G, a wholly owned
subsidiary of M Corporation incorporated under the laws of foreign
country Z, personal property which G Corporation manufactures in country
Z. Corporation F sells such property for use in foreign country W. Since
the income of F Corporation from such purchases and sales is classified
as foreign base company sales income under section 954(d)(1) and
paragraph (a) of this section, branch B will not be treated as a
separate corporation with respect to such income even if the tax
differential between countries X and Y would otherwise justify such
treatment.
Example 5. Controlled foreign corporation A, incorporated under the
laws of foreign
[[Page 296]]
country X, is engaged in manufacturing articles through its home office,
located in country X, and selling such articles through branch B,
located in foreign country Y, and through branch C, located in foreign
country Z, for use outside country X. These activities constitute the
only activities of A Corporation for its taxable year 1963. Each such
country levies an income tax on only the income derived from sources
within such country, and all income derived in 1963 by the home office,
branch B, and branch C, respectively, is derived from sources within
countries X, Y, and Z, respectively. The income and income taxes of A
Corporation for 1963 are as follows:
------------------------------------------------------------------------
X Country Y Country Z Country
------------------------------------------------------------------------
Income of:
Home office.................... $200,000 ........... ...........
Branch B....................... ........... $100,000 ...........
Branch C....................... ........... ........... $100,000
Income tax....................... $100,000 $20,000 $20,000
Effective rate of tax............ 50% 20% 20%
------------------------------------------------------------------------
By applying subparagraph (1)(i) of this paragraph and by treating branch
B as though it were the only branch of A Corporation, branch B is
treated as a separate wholly owned subsidiary corporation of A
Corporation in determining foreign base company sales income of A
Corporation for 1963, the 20 percent rate of tax on the income of such
branch being less than 90 percent of, and at least 5 percentage points
less than, the 50 percent rate of tax which would apply to the income of
branch B under the laws of country X if, under the laws of such country,
all the income of A Corporation for 1963 derived through the home office
and branch B were derived from sources within country X. Moreover, by
applying subparagraph (1)(i) of this paragraph and by treating branch C
as though it were the only branch of A Corporation, branch C is treated
as a separate wholly owned subsidiary corporation of A Corporation, the
20 percent rate of tax on the income of such branch being less than 90
percent of, and at least 5 percentage points less than, the 50 percent
rate of tax which would apply to the income of branch C under the laws
of country X if, under the laws of such country, all the income of A
Corporation for 1963 derived through the home office and branch C were
derived from sources within country X. The income derived by branch B
and branch C, respectively, each treated as a separate corporation, from
the sale by or through each of them for use, consumption, or disposition
outside country Y and country Z, respectively, is treated as income from
the sale of personal property on behalf of A Corporation, a related
person, and constitutes foreign base company sales income for 1963. The
home office of A Corporation, treated as a separate corporation, derives
no foreign base company sales income for 1963 since it produces the
articles which are sold.
Example 6. Controlled foreign corporation A, incorporated under the
laws of foreign country X is engaged in manufacturing articles through
branch B, located in foreign country Y, and selling such articles
through branch C, located in foreign country Z, and through its home
office, located in country X, for use outside country X. These
activities constitute the only activities of A Corporation for its
taxable year 1963. Each such country levies an income tax on only the
income derived from sources within such country, and all income derived
in 1963 by the home office, branch B, and branch C, respectively, is
derived from sources within countries X, Y, and Z, respectively. The
income and income taxes of A Corporation for 1963 are as follows:
------------------------------------------------------------------------
X Country Y Country Z Country
------------------------------------------------------------------------
Income of:
Home office.................... $100,000 ........... ...........
Branch B....................... ........... $200,000 ...........
Branch C....................... ........... ........... $100,000
Income tax....................... $20,000 $100,000 $20,000
Effective rate of tax............ 20% 50% 20%
------------------------------------------------------------------------
In determining foreign base company sales income of A Corporation for
1963 neither branch B nor branch C is treated, by applying subparagraph
(1)(i) of this paragraph, as a separate wholly owned subsidiary
corporation of A Corporation since branch B derives no income from the
purchase or sale of personal property and since, in the case of branch C
treated as though it were the only branch of A Corporation, the 20
percent rate of tax on the income of branch C is not less than 90
percent of, and not as much as 5 percentage points less than, the 20
percent rate of tax which would apply to the income of branch C under
the laws of country X if, under the laws of such country, all the income
of A Corporation for 1963 derived through the home office and branch C
were derived from sources within country X. However, by applying
subparagraph (1)(ii) of this paragraph and by treating the home office
in country X as though it alone were the remainder of A Corporation,
branch B is treated as a separate wholly owned subsidiary corporation of
A Corporation, the 20 percent rate of tax on the income of the home
office
being less than 90 percent of, and at least 5 percentage points less
than, the 50 percent rate of tax which would apply to the income of the
home office under the laws of country Y if, under the laws of such
country, all the income of A Corporation for 1963 derived through the
home office and branch B were derived from sources within country Y.
Moreover, by applying subparagraph (1)(ii) of this paragraph and by
treating branch C as
[[Page 297]]
though it alone were the remainder of A Corporation, branch B and branch
C are treated as separate wholly owned subsidiary corporations of A
Corporation, the 20 percent rate of tax on the income of branch C being
less than 90 percent of, and at least 5 percentage points less than, the
50 percent rate of tax which would apply to the income of branch C under
the laws of country Y if, under the laws of such country, all the income
of A Corporation for 1963 derived through branch B and branch C were
derived from sources within country Y. The income derived by the home
office and branch C, respectively, each treated as a separate
corporation, from the sale by or through each of them for use,
consumption, or disposition outside country X and country Z,
respectively, is treated as income from the sale of personal property on
behalf of branch B, a related person, and constitutes foreign base
company sales income for 1963. Branch B, treated as a separate
corporation, derives no foreign base company sales income since it
produces the articles which are sold.
Example 7. Controlled foreign corporation A, incorporated under the
laws of foreign country X, is engaged in manufacturing articles through
branch B, located in foreign country Y, and selling such articles
through the home office, located in country X, and through branch C,
located in foreign country Z, for use outside country X. These
activities constitute the only activities of A Corporation for its
taxable year 1963. Each such country levies an income tax on only the
income derived from sources within such country, and all income derived
in 1963 by the home office, branch B, and branch C, respectively, is
derived from sources within countries X, Y, and Z, respectively. The
income and income taxes of A Corporation for 1963 are as follows:
------------------------------------------------------------------------
X Country Y Country Z Country
------------------------------------------------------------------------
Income of:
Home office.................... $100,000 ........... ...........
Branch B....................... ........... $200,000 ...........
Branch C....................... ........... ........... $100,000
Income tax....................... $40,000 $100,000 $20,000
Effective rate of tax............ 40% 50% 20%
------------------------------------------------------------------------
By applying subparagraph (1)(i) of this paragraph and by treating branch
C as though it were the only branch of A Corporation, branch C is
treated as a separate wholly owned subsidiary corporation of A
Corporation in determining foreign base company sales income of A
Corporation for 1963, the 20 percent rate of tax on the income of branch
C being less than 90 percent of, and at least 5 percentage points less
than, the 40 percent rate of tax which would apply to the income of
branch C under the laws of country X if, under the laws of such country,
all the income of A Corporation for 1963 derived through the home office
and branch C were derived from sources within country X. In addition, by
applying subparagraph (1)(ii) of this paragraph and by treating the home
office in country X as though it alone were the remainder of A
Corporation, branch B is treated as a separate wholly owned subsidiary
corporation of A Corporation, the 40 percent rate of tax on the income
of the home office being less than 90 percent of, and at least 5
percentage points less than, the 50 percent rate of tax which would
apply to the income of the home office under the laws of country Y if,
under the laws of such country, all the income of A Corporation for 1963
derived through the home office and branch B were derived from sources
within country Y. Moreover, by applying subparagraph (1)(ii) of this
paragraph and by treating branch C as though it alone were the remainder
of A Corporation, branch B and branch C would again be treated as
separate wholly owned subsidiary corporations of A Corporation, the 20
percent rate of tax on the income of branch C being less than 90 percent
of, and at least 5 percentage points less than, the 50 percent rate of
tax which would apply to the income of branch C under the laws of
country Y if, under the laws of such country, all the income of A
Corporation for 1963 derived through branch B and branch C were derived
from sources within country Y; however, for purposes of determining
foreign base company sales income of A Corporation for 1963, only the
classification under subparagraph (1)(i) of this paragraph shall, by
reason of the application of subparagraph (2)(ii)(d) of this paragraph,
be applied with respect to the income derived by branch C. The income
derived by the home office and branch C, respectively, each treated as a
separate corporation, from the sale by or through each of them for use,
consumption, or disposition outside country X and country Z,
respectively, is treated as income from the sale of personal property on
behalf of branch B, a related person, and constitutes foreign base
company sales income for 1963. Branch B, treated as a separate
corporation, derives no foreign base company sales income since it
produces the articles which are sold.
(c) Shipping income for taxable years beginning after December 31,
1975. For taxable years beginning after December 31, 1975, foreign base
company shipping income (as determined under Sec. 1.954-6) of a
controlled foreign corporation shall not also be considered
[[Page 298]]
foreign base company sales income of that controlled foreign
corporation.
[T.D. 6734, 29 FR 6392, May 15, 1964, as amended by T.D. 7545, 43 FR
32754, May 8, 1978; T.D. 7893, 48 FR 22508, May 19, 1983; T.D. 7894, 48
FR 22523, May 19, 1983; T.D. 9008, 67 FR 48025, July 23, 2002]
Sec. 1.954-4 Foreign base company services income.
(a) Items included. Except as provided in paragraph (d) of this
section, foreign base company services income means income of a
controlled foreign corporation, whether in the form of compensation,
commissions, fees, or otherwise, derived in connection with the
performance of technical, managerial, engineering, architectural,
scientific, skilled, industrial, commercial, or like services which--
(1) Are performed for, or on behalf of a related person, as defined
in paragraph (e)(1) of Sec. 1.954-1, and
(2) Are performed outside the country under the laws of which the
controlled foreign corporation is created or organized.
(b) Services performed for, or on behalf of, a related person--(1)
Specific cases. For purposes of paragraph (a)(1) of this section,
``services which are performed for, or on behalf of, a related person''
include (but are not limited to) services performed by a controlled
foreign corporation in a case where--
(i) The controlled foreign corporation is paid or reimbursed by, is
released from an obligation to, or otherwise receives substantial
financial benefit from, a related person for performing such services;
(ii) The controlled foreign corporation performs services (whether
or not with respect to property sold by a related person) which a
related person is, or has been, obligated to perform;
(iii) The controlled foreign corporation performs services with
respect to property sold by a related person and the performance of such
services constitutes a condition or a material term of such sale; or
(iv) Substantial assistance contributing to the performance of such
services has been furnished by a related person or persons.
(2) Special rules--(i) Guaranty of performance. Subparagraph (1)(ii)
of this paragraph shall not apply with respect to services performed by
a controlled foreign corporation pursuant to a contract the performance
of which is guaranteed by a related person, if (a) the related person's
sole obligation with respect to the contract is to guarantee performance
of such services, (b) the controlled foreign corporation is fully
obligated to perform the services under the contract, and (c) the
related person (or any other person related to the controlled foreign
corporation) does not in fact (1) pay for performance of, or perform,
any of such services the performance of which is so guaranteed or (2)
pay for performance of, or perform, any significant services related to
such services. If the related person (or any other person related to the
controlled foreign corporation) does in fact pay for performance of, or
perform, any of such services or any significant services related to
such services, subparagraph (1)(ii) of this paragraph shall apply with
respect to the services performed by the controlled foreign corporation
pursuant to the contract the performance of which is guaranteed by the
related person, even though such payment or performance is not
considered to be substantial assistance for purposes of subparagraph
(1)(iv) of this paragraph. For purposes of this subdivision, a related
person shall be considered to guarantee performance of the services by
the controlled foreign corporation whether it guarantees performance of
such services by a separate contract of guaranty or enters into a
service contract solely for purposes of guaranteeing performance of such
services and immediately thereafter assigns the entire contract to the
controlled foreign corporation for execution.
(ii) Application of substantial assistance test. For purposes of
subparagraph (1)(iv) of this paragraph--
(a) Assistance furnished by a related person or persons to the
controlled foreign corporation shall include, but shall not be limited
to, direction, supervision, services, know-how, financial assistance
(other than contributions to capital), and equipment, material, or
supplies.
[[Page 299]]
(b) Assistance furnished by a related person or persons to a
controlled foreign corporation in the form of direction, supervision,
services, or know-how shall not be considered substantial unless either
(1) the assistance so furnished provides the controlled foreign
corporation with skills which are a principal element in producing the
income from the performance of such services by such corporation or (2)
the cost to the controlled foreign corporation of the assistance so
furnished equals 50 percent or more of the total cost to the controlled
foreign corporation of performing the services performed by such
corporation. The term ``cost'', as used in this subdivision (b), shall
be determined after taking into account adjustments, if any, made under
section 482.
(c) Financial assistance (other than contributions to capital),
equipment, material, or supplies furnished by a related person to a
controlled foreign corporation shall be considered assistance only in
that amount by which the consideration actually paid by the controlled
foreign corporation for the purchase or use of such item is less than
the arm's length charge for such purchase or use. The total of such
amounts so considered to be assistance in the case of financial
assistance, equipment, material, and supplies furnished by all related
persons shall be compared with the profits derived by the controlled
foreign corporation from the performance of the services to determine
whether the financial assistance, equipment, material, and supplies
furnished by a related person or persons are by themselves substantial
assistance contributing to the performance of such services. For
purposes of this subdivision (c), determinations shall be made after
taking into account adjustments, if any, made under section 482 and the
term ``consideration actually paid'' shall include any amount which is
deemed paid by the controlled foreign corporation pursuant to such an
adjustment.
(d) Even though assistance furnished by a related person or persons
to a controlled foreign corporation in the form of direction,
supervision, services, or know-how is not considered to be substantial
under (b) of this subdivision and assistance furnished by a related
person or persons in the form of financial assistance (other than
contributions to capital), equipment, material, or supplies is not
considered to be substantial under (c) of this subdivision, such
assistance may nevertheless constitute substantial assistance when taken
together or in combination with other assistance furnished by a related
person or persons which in itself is not considered to be substantial.
(e) Assistance furnished by a related person or persons to a
controlled foreign corporation in the form of direction, supervision,
services, or know-how shall not be taken into account under (b) or (d)
of this subdivision unless the assistance so furnished assists the
controlled foreign corporation directly in the performance of the
services performed by such corporation.
(iii) Special rule applicable to distributive share of partnership
income. A controlled foreign corporation's distributive share of a
partnership's services income will be deemed to be derived from services
performed for or on behalf of a related person, within the meaning of
section 954(e)(1)(A), if the partnership is a related person with
respect to the controlled foreign corporation, under section 954(d)(3),
and, in connection with the services performed by the partnership, the
controlled foreign corporation, or a person that is a related person
with respect to the controlled foreign corporation, provided assistance
that would have constituted substantial assistance contributing to the
performance of such services, under paragraph (b)(2)(ii) of this
section, if furnished to the controlled foreign corporation by a related
person. This paragraph (b)(2)(iii) applies to taxable years of a
controlled foreign corporation beginning on or after July 23, 2002.
(3) Illustrations. The application of this paragraph may be
illustrated by the following examples:
Example 1. Controlled foreign corporation A is paid by related
corporation M for the installation and maintenance of industrial
machines which M Corporation manufactures and sells to B Corporation.
Such installation and maintenance services by A Corporation are
performed for, or on behalf of, M Corporation for purposes of section
954(e).
[[Page 300]]
Example 2. Controlled foreign corporation B enters into a contract
with an unrelated person to drill an oil well in a foreign country.
Domestic corporation M owns all the outstanding stock of B Corporation.
Corporation B employs a relatively small clerical and administrative
staff and owns the necessary well-drilling equipment. Most of the
technical and supervisory personnel who oversee the drilling of the oil
well by B Corporation are regular employees of M Corporation who are
temporarily employed by B Corporation. In addition, B Corporation hires
on the open market unskilled and semiskilled laborers to work on the
drilling project. The services performed by B Corporation under the
well-drilling contract are performed for, or on behalf of, a related
person for purposes of section 954(e) because the services of the
technical and supervisory personnel which are provided by M Corporation
are of substantial assistance in the performance of such contract in
that they assist B Corporation directly in the execution of the contract
and provide B Corporation with skills which are a principal element in
producing the income from the performance of such contract.
Example 3. Controlled foreign corporation F enters into a contract
with an unrelated person to construct a dam in a foreign country.
Domestic corporation M owns all the outstanding stock of F Corporation.
Corporation F leases or buys from M Corporation, on an arm's length
basis, the equipment and material necessary for the construction of the
dam. The technical and supervisory personnel who design and oversee the
construction of the dam are regular full-time employees of F Corporation
who are not on loan from any related person. The principal clerical
work, and the financial accounting, required in connection with the
construction of the dam by F Corporation are performed, on a remunerated
basis, by full-time employees of M Corporation. All other assistance F
Corporation requires in completing the construction of the dam is paid
for by that corporation and furnished by unrelated persons. The services
performed by F Corporation under the contract for the construction of
the dam are not performed for, or on behalf of, a related person for
purposes of section 954(e) because the clerical and accounting services
furnished by M Corporation do not assist F Corporation directly in the
performance of the contract.
Example 4. Controlled foreign corporation D, a wholly owned
subsidiary of domestic corporation M, procures and enters a contract
with an unrelated person to construct a superhighway in a foreign
country, but such person enters the contract only on the condition that
M Corporation agrees to perform, or to pay for the performance by some
person other than D Corporation of, the services called for by the
contract if D Corporation should fail to complete their performance.
Corporation D is capable of performing such contract. No related person
as to D Corporation pays for, or performs, any services called for by
the contract, or pays for, or performs, any significant services related
to such services. The construction of the superhighway by D Corporation
is not considered for purposes of section 954(e) to be the performance
of services for, or on behalf of M Corporation.
Example 5. Domestic corporation M is obligated under a contract with
an unrelated person to construct a superhighway in a foreign country. At
a later date M Corporation assigns the entire contract to its wholly
owned subsidiary, controlled foreign corporation C, and the unrelated
person releases M Corporation from any obligation under the contract.
The construction of such highway by C Corporation is considered for
purposes of section 954(e) to be the performance of services for, or on
behalf of, M Corporation.
Example 6. Domestic corporation M enters a contract with an
unrelated person to construct a superhighway in a foreign country.
Corporation M immediately assigns the entire contract to its wholly
owned subsidiary, controlled foreign corporation C. The unrelated person
does not release M Corporation of its obligation under the contract, the
sole purpose of these arrangements being to have M Corporation guarantee
performance of the contract by C Corporation. Corporation C is capable
of performing the construction contract. Neither M Corporation nor any
other person related to C Corporation pays for, or performs, any
services called for by the construction contract or at any time pays
for, or performs, any significant services related to the services
performed under such contract. The construction of the superhighway by C
Corporation is not considered for purposes of section 954(e) to be the
performance of services for, or on behalf of, M Corporation.
Example 7. The facts are the same as in example 6 except that M
Corporation, preparatory to entering the construction contract, prepares
plans and specifications which enable the submission of bids for the
contract. Since M Corporation has performed significant services related
to the services the performance of which it has guaranteed, the
construction of such highway by C Corporation is considered for purposes
of section 954(e) to be the performance of services for, or on behalf
of, M Corporation.
Example 8. Domestic corporation M manufactures an industrial machine
which requires specialized installation. Corporation M sells the
machines for a basic price if the contract of sale contains no provision
for installation. If, however, the customer agrees to employ controlled
foreign corporation E, a wholly owned subsidiary of M Corporation,
[[Page 301]]
to install the machine and to pay E Corporation a specified installation
charge, M Corporation sells the machine at a price which is less than
the basic price. The installation services performed by E Corporation
for customers of M Corporation purchasing the machine at the reduced
price are considered for purposes of section 954(e) to be performed for,
or on behalf of, M Corporation.
Example 9. Domestic corporation M manufactures and sells industrial
machines with a warranty as to their performance conditional upon their
installation and maintenance by a factory-authorized service agency.
Controlled foreign corporation F, a wholly owned subsidiary of M
Corporation, is the only authorized service agency. Any installation or
maintenance services performed by F Corporation on such machines are
considered for purposes of section 954(e) to be performed for, or on
behalf of, M Corporation.
Example 10. Domestic corporation M manufactures electric office
machines which it sells at a basic price without any provision for, or
understanding as to, adjustment or maintenance of the machines. The
machines require constant adjustment and maintenance services which M
Corporation, certain wholly owned subsidiaries of M Corporation, and
certain unrelated persons throughout the world are qualified to perform.
From among the numerous persons qualified and available to perform
adjustment and maintenance services with respect to such office
machines, foreign corporation B, a customer of M Corporation, employs
controlled foreign corporation G, a wholly owned subsidiary of M
Corporation, to adjust and maintain the office machines which B
Corporation purchases from M Corporation. The adjustment and maintenance
services performed by G Corporation for B Corporation are not considered
for purposes of section 954(e) to be performed for, or on behalf of, M
Corporation.
(c) Place where services are performed. The place where services
will be considered to have been performed for purposes of paragraph
(a)(2) of this section will depend on the facts and circumstances of
each case. As a general rule, services will be considered performed
where the persons performing services for the controlled foreign
corporation which derives income in connection with the performance of
technical, managerial, architectural, engineering, scientific, skilled,
industrial, commercial, or like services are physically located when
they perform their duties in the execution of the service activity
resulting in such income. Therefore, in many cases, total gross income
of a controlled foreign corporation derived in connection with each
service contract or arrangement performed for or on behalf of a related
person must be apportioned, between income which is not foreign base
company services income and that which is foreign base company services
income, on a basis of employee-time spent within the foreign country
under the laws of which the controlled foreign corporation is created or
organized and employee-time spent without the foreign country under the
laws of which such corporation is created or organized. In allocating
time spent within and without the foreign country under the laws of
which the controlled foreign corporation is created or organized,
relative weight must also be given to the value of the various functions
performed by persons in fulfillment of the service contract or
arrangement. For example, clerical work will ordinarily be assigned
little value, while services performed by technical, highly skilled, and
managerial personnel will be assigned greater values in relation to the
type of function performed by each individual.
(d) Items excluded. Foreign base company services income does not
include--
(1) Income derived in connection with the performance of services by
a controlled foreign corporation if--
(i) The services directly relate to the sale or exchange of personal
property by the controlled foreign corporation,
(ii) The property sold or exchanged was manufactured, produced,
grown, or extracted by such controlled foreign corporation, and
(iii) The services were performed before the sale or exchange of
such property by the controlled foreign corporation;
(2) Income derived in connection with the performance of services by
a controlled foreign corporation if the services directly relate to an
offer or effort to sell or exchange personal property which was, or
would have been, manufactured, produced, grown, or extracted by such
controlled foreign corporation whether or not a sale or exchange of such
property was in fact consummated; or
[[Page 302]]
(3) For taxable years beginning after December 31, 1975, foreign
base company shipping income (as determined under Sec. 1.954-6).
[T.D. 6734, 29 FR 6399, May 15, 1964, as amended by T.D. 6981, 33 FR
16497, Nov. 13, 1968; T.D. 7893, 48 FR 22523, May 19, 1983; T.D. 9008,
67 FR 48025, July 23, 2002]
Sec. 1.954-5 Increase in qualified investments in less developed
countries; taxable years of controlled foreign corporations beginning
before January 1, 1976.
For rules applicable to taxable years of controlled foreign
corporations beginning before January 1, 1976, see section 954(b)(1) (as
in effect before the enactment of the Tax Reduction Act of 1975) and 26
CFR 1.954-5 (Revised as of April 1, 1975).
[T.D. 7893, 48 FR 22508, May 19, 1983]
Sec. 1.954-6 Foreign base company shipping income.
(a) Scope--(1) In general. This section prescribes rules for
determining foreign base company shipping income under the provisions of
section 954(f), as amended by the Tax Reduction Act of 1975.
(2) Effective date. (i) The rules prescribed in this section apply
to taxable years of foreign corporations beginning after December 31,
1975, and to taxable years of United States shareholders (as defined in
section 951 (b)) within which or with which such taxable years of such
foreign corporations end.
(ii) Except as described in paragraph (b)(1)(viii) of this section,
foreign base company shipping income does not include amounts earned by
a foreign corporation in a taxable year of such corporation beginning
before January 1, 1976. See example 1 of paragraph (g)(2) of this
section for an illustration of the effect of this subparagraph on
partnership income. See example 3 of paragraph (f)(4)(ii) of this
section for an illustration of the effect of this subparagraph on
certain dividend income. See paragraph (f)(5)(iii) of this section for
the effect of this subparagraph on certain interest and gains.
(b) Definitions--(1) Foreign base company shipping income. The term
``foreign base company shipping income'' means--
(i) Gross income derived from, or in connection with, the use (or
hiring or leasing for use) of any aircraft or vessel in foreign commerce
(see paragraph (c) of this section),
(ii) Gross income derived from, or in connection with, the
performance of services directly related to the use of any aircraft or
vessel in foreign commerce (see paragraph (d) of this section),
(iii) Gross income incidental to income described in subdivisions
(i) and (ii) of this subparagraph, as provided in paragraph (e) of this
section,
(iv) Gross income derived from the sale, exchange, or other
disposition of any aircraft or vessel used or held for use (by the
seller or by a person related to the seller) in foreign commerce,
(v) In the case of a controlled foreign corporation, dividends,
interest, and gains described in paragraph (f) of this section,
(vi) Income described in paragraph (g) of this section (relating to
partnerships, trusts, etc.),
(vii) Exchange gain, to the extent allocable to foreign base company
shipping income (see Sec. 1.952-2(c)(2)(v)(b), and
(viii) In the case of a controlled foreign corporation and at its
option, dividends, interest, and gains attributable to income derived
from aircraft and vessels (as defined in 26 CFR 1.954-1(b)(2) (Revised
as of April 1, 1975)) by a less developed country shipping company
(described in Sec. 1.955-5(b)) in taxable years beginning after
December 31, 1962, and before January 1, 1976. The portion of a
dividend, interest, or gain attributable to such income shall be
determined by the same method as that for determining the portion of a
dividend, interest, or gain attributable to foreign base company
shipping income under paragraphs (f)(4), (5), and (6) of this section,
but without regard to paragraphs (f)(6)(ii) and (iv)(B).
(2) Foreign base company shipping operations. For purposes of
sections 951 through 964, the term ``foreign base company shipping
operations'' means the trade or business from which gross income
described in subparagraph (1)(i) and (ii) of this paragraph is derived.
(3) Foreign commerce. For purposes of sections 951 through 964--
[[Page 303]]
(i) An aircraft or vessel is used in foreign commerce to the extent
it is used in transportation of property or passengers--
(A) Between a port (or airport) in the United States or possession
of the United States and a port (or airport) in a foreign country, or
(B) Between a port (or airport) in a foreign country and another in
the same country or between a port (or airport) in a foreign country and
one in another foreign country.
Thus, for example, a trawler, a factory ship, and an oil drilling ship
are not considered to be used in foreign commerce. On the other hand, a
cruise ship which visits one or more foreign ports is considered to be
so used. Notwithstanding subdivision (i)(B) of this paragraph (b)(3),
foreign base company income does not include income derived from, or in
connection with, the use of an aircraft or vessel in transportation of
property or passengers between a port (or airport) in a foreign country
and another port (or airport) in the same country if both the foreign
corporation is created or organized and the aircraft or vessel is
registered in that country.
(ii) The term vessel includes all water craft and other artificial
contrivances of whatever description and at whatever stage of
construction, whether on the stocks or launched, which are used or are
capable of being used or are intended to be used as a means of
transportation on water. This definition does not apply for purposes of
section 956(b)(2)(G) and Sec. 1.956-2(b)(1)(ix).
(iii) The term port means any place (whether on or off shore) where
aircraft or vessels are accustomed to load or unload goods or to take on
or let off passengers.
(iv) Any vessel (such as a lighter or beacon lightship) which serves
other vessels used in foreign commerce (within the meaning of
subdivision (i) of this subparagraph) shall, to the extent so used, also
be considered to be used in foreign commerce.
(v) For the meaning of the term ``foreign country'', see section
638(2).
(4) Use in foreign commerce. For purposes of sections 951 through
964, the use of an aircraft or vessel in foreign commerce includes the
hiring or leasing (or subleasing) of an aircraft or vessel to another
for use in foreign commerce. Thus, for example, an aircraft or vessel is
``used in foreign commerce'' within the meaning of section 955(b)(1)(A)
if such aircraft or vessel is chartered (whether pursuant to a bareboat
charter, time charter, or otherwise) to another for use in foreign
commerce.
(5) Related person. With respect to a controlled foreign
corporation, the term ``related person'' means a related person as
defined in Sec. 1.954-1(e)(1), and the term ``unrelated person'' means
an unrelated person as defined in Sec. 1.954-1(e)(2).
(c) Aircraft or vessel income--(1) In general. The term ``income
derived from, or in connection with, the use (or hiring or leasing for
use) of any aircraft or vessel in foreign commerce'' as used in
paragraph (b)(1)(i) of this section means--
(i) Income derived from transporting passengers or property by
aircraft or vessel in foreign commerce and
(ii) Income derived from hiring or leasing an aircraft or vessel to
another for use in foreign commerce.
(2) Illustrations. The application of this paragraph may be
illustrated by the following examples:
Example 1. Foreign corporation C owns a foreign flag vessel which it
charters under a long-term charter to foreign corporation D. The vessel
is used by D as a tramp which has no fixed or regular schedule. The
vessel carries bulk and packaged cargoes, as well as occasional
passengers, under charter parties, contracts of affreightment, or other
contracts of carriage. The carriage of cargoes and passengers is between
a port in the United States and a port in a foreign country or between a
port in one foreign country and another port in the same or a different
foreign country. The charter hire paid to C by D constitutes income
derived from the use of the vessel in foreign commerce, but is not
foreign base company income to the extent the charter hire is allocable
to income derived from the use of the vessel between ports in the same
foreign country in which both C is incorporated and the vessel is
registered. The charter hire and freight and passenger revenue
(including demurrage and dead freight) derived by D also constitute
income derived from the use of the vessel in foreign commerce, but is
not foreign base company income to the extent the charter hire and
freight and passenger revenue are allocable to the use of the vessel
between
[[Page 304]]
ports in the same foreign country in which both D is incorporated and
the vessel is registered.
Example 2. (a) Foreign corporation E owns a foreign flag tanker
which it charters under a long-term bareboat charter to foreign
corporation F for use in foreign commerce. F produces oil in a foreign
country and ships the oil to other foreign countries and to the United
States. The vessel, when not engaged in carrying F's oil, is used to
carry bulk cargoes for unrelated persons in foreign commerce as
opportunity offers. The charger hire received by E constitutes income
derived from the use of the vessel in foreign commerce. The income
derived by F from carrying bulk cargoes for unrelated persons also
constitutes income derived from the use of the vessel in foreign
commerce.
(b) F is forced to lay up the vessel as a result of adverse market
developments. Pursuant to the terms of the charter, F continues to pay
charter hire to E during the period of lay-up. The charter hire received
by E during the period of lay-up constitutes income derived from the use
of the vessel in foreign commerce.
Example 3. (a) A shipment of cheese is loaded into a container owned
by controlled foreign corporation S at the consignor's place of business
in Hamar, Norway. The cheese is transported to Milan, Italy, by the
following routings:
(1) Overland by road from Hamar, Norway, to Gothenburg, Sweden, by
unrelated motor carriers via Oslo, Norway,
(2) By sea from Gothenburg to Rotterdam, Netherlands, by feeder
vessel under foreign flag, time chartered to S by unrelated owner,
(3) By sea from Rotterdam to Algeciras, Spain, by feeder vessel
under foreign flag, time chartered to S by unrelated owner.
(4) By sea from Algeciras to Genoa, Italy, by line-haul vessel under
U.S. flag, chartered by S from related company, and
(5) Overland from Genoa to Milan, Italy, by unrelated motor carrier.
(b) The consignor pays S total charges of $1,710, and S pays $676 to
unrelated third parties, which amounts may be broken down as follows:
------------------------------------------------------------------------
Revenue Costs
Amount collected paid to
billed to by S on unrelated
Description of charges customer behalf of 3d party
and an and
collected unrelated absorbed
by S party by S
------------------------------------------------------------------------
Ocean freight.......................... $1,420 ......... .........
Trucking charge of empty equipment to 50 $50 .........
shipper's facility....................
Trucking charges Hamar to Oslo......... 60 60 .........
Trucking charges Oslo to Gothenburg.... ......... ......... $315
Trucking charges Genoa to Milan........ 180 180 .........
Brokerage Commission in Europe......... ......... ......... 71
------------
Total.............................. 1,710 290 386
------------------------------------------------------------------------
(c) Of the $1,710 amount billed to the consignor and collected by S,
$290 is collected by S on behalf of unrelated third parties. This $290
amount is not includable in S's gross income, and is therefore not
includable in S's foreign base company shipping income. The remaining
$1,420 amount (i.e., $1,710-$290) is includable in S's foreign base
company shipping income. The $386 amount paid by S to unrelated third
parties and absorbed by S is deductible from foreign base company
shipping income under Sec. 1.954-1(c).
(d) Services directly related--(1) In general. The term ``income
derived from, or in connection with, the performance of services
directly related to the use of an aircraft or vessel in foreign
commerce'', as used in paragraph (b)(1)(ii) of this section, means--
(i) Income derived from, or in connection with, the performance of
services described in subparagraph (2) or (3) of this paragraph, and
(ii) Income treated as foreign base company shipping income under
subparagraph (4) of this paragraph.
(2) Intragroup services. The services described in this subparagraph
are services performed for a person who is the owner, lessor, lessee or
operator of an aircraft or vessel used in foreign commerce, by such
person or by a person related to such person, and which fall into one or
more of the following categories:
(i) Terminal services, such as dockage, wharfage, storage, lights,
water, refrigeration, and similar services;
(ii) Stevedoring and other cargo handling services;
(iii) Container related services (including the rental of containers
and related equipment) performed either in connection with the local
drayage or inland haulage of cargo or in the course of transportation in
foreign commerce;
[[Page 305]]
(iv) Services performed by tugs, lighters, barges, scows, launches,
floating cranes, and other similar equipment;
(v) Maintenance and repairs;
(vi) Training of pilots and crews;
(vii) Licensing of patents, know-how, and similar intangible
property developed and used in the course of foreign base company
shipping operations;
(viii) Services performed by a booking, operating, or managing
agent; and
(ix) Any service performed in the course of the actual
transportation of passengers or property.
(3) Services for passenger, consignor, or consignee. The services
described in this subparagraph are services provided by the operator (or
person related to the operator) of an aircraft or vessel in foreign
commerce for the passenger, consignor, or consignee, such as--
(i) Services described in one or more of the categories set out in
subparagraphs (2)(i) through (iv) and (ix) of this paragraph,
(ii) The rental of staterooms, berths, or living accommodations and
the furnishing of meals,
(iii) Barber shop and other services to passengers aboard vessels,
(iv) Excess baggage, and
(v) Demurrage, dispatch, and dead freight.
(4) The 70-percent test. At the option of the foreign corporation
all the gross income for a taxable year derived by a foreign corporation
from any facility used in connection with the performance of services
described in one or more of the categories set out in subparagraph
(2)(i) through (ix) of this paragraph is foreign base company shipping
income if more than 70 percent of such gross income for either--
(i) Such taxable year, or
(ii) Such taxable year and the two preceding taxable years,
is foreign base company shipping income (determined without regard to
this subparagraph). Thus, for example, if 80 percent of the gross income
derived by a controlled foreign corporation at a stevedoring facility is
treated as foreign base company shipping income under subparagraph (2)
of this paragraph, then the remaining 20 percent is treated as foreign
base company shipping income under this subparagraph.
(5) Rules for applying subparagraph (4). (i) Solely for purposes of
applying subparagraphs (4) of this paragraph, foreign base company
shipping income and gross income shall be deemed to include an arm's
length charge (see paragraph (h)(5) of this section) for services
performed by the foreign corporation for itself.
(ii) In determining whether services performed by a foreign
corporation are performed at a single facility or at two or more
different facilities, all of the facts and circumstances involved will
be taken into account. Ordinarily, all services performed by a foreign
corporation within a single port area will be considered performed at a
single facility.
(iii) The application of this subparagraph and subparagraph (4) of
this paragraph may be illustrated by the following example in which it
is assumed that the foreign corporation has chosen to apply the 70-
percent test of subparagraph (4):
Example. (a) Controlled foreign corporation X uses the calendar year
as the taxable year. For 1976, X is divided into two operating
divisions, A and B. Division A operates a number of vessels in foreign
commerce. Division B operates a terminal facility at which it performs
services described in subparagraph (2)(i) of this paragraph for vessels
some of which are operated by division A, some of which are operated by
persons related to X, and some of which are operated by persons
unrelated to X. For 1976, X includes under subparagraph (5) as foreign
base company shipping income and gross income, for purposes of
subparagraph (4), an arm's length charge for services performed for
itself. For 1976, the gross income derived by division B is
reconstructed for purposes of subparagraph (4) of this paragraph as
follows, based on the facts shown in the following table:
(1) Gross income derived from persons unrelated to X........... $20
(2) Gross income derived from persons related to X............. 10
--------
(3) Actual gross income (line (1) plus line (2))............... 30
(4) Hypothetical gross income derived from division A 70
(determined by the application of subdivision (i) of this
subparagraph).................................................
--------
[[Page 306]]
(5) Total reconstructed gross income (line (3) plus line (4)).. 100
========
(b) Since 80 percent of the reconstructed gross income derived by
division B would be treated as foreign base company shipping income
under subparagraph (2) of this paragraph, the entire $30 amount of the
gross income actually derived by division B is treated as foreign base
company shipping income under subparagraph (4) of this paragraph.
(6) Arm's length charge. For purposes of this section, the arm's
length charge for services performed by a foreign corporation for itself
shall be determined by applying the principles of section 482 and the
regulations thereunder as if the party for whom the services are
performed and the party by whom the services are performed were not the
same person, but were controlled taxpayers within the meaning of Sec.
1.482-1(a)(4).
(7) Illustrations. The application of this paragraph may be
illustrated by the following examples:
Example 1. Controlled foreign corporation A acts as a managing agent
for foreign corporation B, a related person which contracts to construct
and charter a foreign flag vessel for use in foreign commerce. As
managing agent for B, A performs a broad range of services relating to
the use of the vessel, including arranging for, and supervising of,
construction and chartering of the vessel, and handling of operating
services after construction is completed. The income derived by A from
its management and operating services constitutes income derived in
connection with the performance of services directly related to the use
of the vessel in foreign commerce.
Example 2. Controlled foreign corporation C uses the calendar year
as the taxable year. During 1976, C is engaged in the trade or business
of acting as a steamship agent solely for unrelated persons. C's
activities as steamship agent range from ``husbanding'' (i.e., arranging
for fuel, supplies and port services, and attending to crew and customs
matters) to the solicitation and booking of cargo at a number of foreign
ports. None of C's other gross income for 1976 is foreign base company
shipping income. Under these circumstances, C's gross income derived
from its steamship agency does not constitute foreign base company
shipping income.
(e) Incidental income--(1) In general. Foreign base company shipping
income includes all incidental income derived by a foreign corporation
in the course of its active conduct of foreign base company shipping
operations.
(2) Examples. Examples of incidental income derived in the course of
the active conduct of foreign base company shipping operations include--
(i) Gain from the sale, exchange or other disposition of assets
which are related shipping assets within the meaning of Sec. 1.955A-
2(b),
(ii) Income derived from temporary investments described in Sec.
1.955A-2(b)(2)(i) and (iii),
(iii) Interest on accounts receivable and evidences of indebtedness
described in Sec. 1.955A-2(b)(2)(ii),
(iv) Income derived from granting concessions to others aboard
aircraft or vessels used in foreign commerce,
(v) Income derived from stock and currency futures described in
Sec. 1.955A-2(b)(2)(vii) and (viii),
(vi) Income derived by the lessor of an aircraft or vessel used in
foreign commerce from additional rentals for the use of related
equipment (such as a complement of containers), and
(vii) Interest derived by the seller from a purchase money mortgage
loan in respect of the sale of an aircraft or vessel described in Sec.
1.955A-2(a)(1)(i).
(f) Certain dividends, interest, and gain--(1) In general. (i) The
foreign base company shipping income of a controlled foreign corporation
(referred to in subdivision (ii)(A) of this paragraph (f)(1) as ``first
corporation'') includes--
(A) Dividends and interest received from foreign corporations listed
in subdivision (ii) of this paragraph (f)(1), and
(B) Gain recognized from the sale, exchange, or other disposition of
stock or obligations of foreign corporations listed in subdivision (ii)
of this paragraph (f)(1),
but only to the extent that such dividends, interest, and gains are
attributable to foreign base company shipping income of the foreign
corporations listed in subdivision (ii) of this paragraph (f)(1).
(ii) The foreign corporations referred to in subdivision (i) of this
paragraph (f)(1) are--
(A) Foreign corporations with respect to which the first corporation
(see subdivision (i) of this paragraph (f)(1)) would be deemed under
section 902(b) to pay taxes,
[[Page 307]]
(B) Controlled foreign corporations which are related persons
(within the meaning of section 954(d)(3)), and
(C) Less developed country shipping companies described in Sec.
1.955-5(b).
(2) Corporation deemed to pay taxes. (i) For purposes of this
paragraph, a controlled foreign corporation would be deemed under
section 902(b) to pay taxes in respect of any other foreign corporation
if such controlled foreign corporation would be deemed, for purposes of
applying section 902(a) to any United States shareholder of such
controlled foreign corporation, to pay taxes in respect of dividends
which were received from such other foreign corporation (whether or not
such other foreign corporation actually pays any taxes or dividends).
Solely for purposes of this subdivision, each United States shareholder
(within the meaning of section 951(b)) shall be deemed to be a domestic
corporation.
(ii) The application of subdivision (i) of this subparagraph may be
illustrated by the following examples:
Example 1. Domestic corporation M owns 100 percent of the one class
of stock of controlled foreign corporation X, which in turn owns 40
percent of the one class of stock of foreign corporation Y. Y is not a
controlled foreign corporation. For purposes of subdivision (1) of this
subparagraph, X is deemed to pay taxes in respect of Y.
Example 2. The facts are the same as in example 1, except that
United States shareholder A, an individual, owns 80 percent of the stock
of corporation X, and United States shareholders B and C, parent and
child, own the other 20 percent in equal shares. For purposes of
applying this paragraph to all three United States shareholders (A, B,
and C), X is deemed to pay taxes in respect of Y.
(3) Obligation defined. For purposes of this section, the term
``obligation'' means any bond, note, debenture, certificate, or other
evidence of indebtedness, and a debt recorded in the books of account of
both the creditor and the debtor. In the absence of legal, governmental,
or business reasons to the contrary, the indebtedness must bear interest
or be issued at a discount.
(4) Dividends. (i) For purposes of this paragraph and Sec. 1.954-
1(b)(2), the portion of a dividend which is attributable to foreign base
company shipping income is that amount which bears the same ratio to the
total dividend received as the earnings and profits out of which such
dividend is paid that are attributable to foreign base company shipping
income bears to the total earnings and profits out of which such
dividend is paid. For purposes of this subdivision, the source of the
earnings and profits out of which a distribution is made shall be
determined under section 316(a), except that the source of the earnings
and profits out of which a distribution is made by a controlled foreign
corporation with respect to stock owned (within the meaning of section
958(a)) by a United States shareholder of such controlled foreign
corporation shall be determined under Sec. 1.959-3.
(ii) The application of this subparagraph may be illustrated by the
following examples:
Example 1. Domestic corporation M owns 100 percent of the one class
of stock of controlled foreign corporation X, which in turn owns 40
percent of the one class of stock of foreign corporation Y. Y, which is
not (and has not been) either a controlled foreign corporation or a less
developed country shipping company, makes a distribution of $100 to X.
Under section 316(a), such distribution is made out of Y's earnings and
profits for 1978. Sixty percent of Y's earnings and profits for 1978 are
attributable to foreign base company shipping income. As a result, $60
of the $100 distribution constitutes foreign base company shipping
income to X under subdivision (i) of this subparagraph.
Example 2. The facts are the same as in example 1, except that under
section 316(a) $20 of the $100 dividend is paid out of Y's earnings and
profits for 1979, and the other $80 is paid out of Y's earnings and
profits for 1978. Thirty percent of Y's earnings and profits for 1979
are attributable to foreign base company shipping income. Since 60
percent of Y's earnings and profits for 1978 are also attributable to
foreign base company shipping income, $54, i.e. (.60x$80)+(.30x$20), of
the $100 distribution constitutes foreign base company shipping income
to X under subdivision (i) of this subparagraph.
Example 3. The facts are the same as in example 1 except that under
section 316(a) the $100 dividend is made out of Y's earnings and profits
for 1972. Since under paragraph (a)(2)(ii) of this section foreign base
company shipping income does not include amounts earned by a foreign
corporation (not a less developed country shipping company) in a taxable
year beginning before January 1,
[[Page 308]]
1978, no amount of such $100 distribution constitutes foreign base
company shipping income to X under subdivision (i) of this subparagraph.
Example 4. Domestic corporation N owns 100 percent of the one class
of stock of controlled foreign corporation S, which in turn owns 100
percent of the one class of stock of controlled foreign corporation T. T
makes a distribution of $100 to S, of which $80 is allocable under Sec.
1.959-3 to earnings and profits for 1977 which are described in Sec.
1.959-3(b)(2), and $20 is allocable to earnings and profits for 1978
which are described in Sec. 1.959-3(b)(3). The $80 amount is excluded
from S's gross income under section 959(b) and therefore is not included
in S's foreign base company shipping income. One hundred percent of T's
earnings and profits for 1978 described in Sec. 1.959-3(b)(3) were
attributable to reinvested foreign base company shipping income. As a
result, the entire $20 amount is included in S's foreign base company
shipping income under this paragraph. See Sec. 1.954-1(b)(2) for the
rule that such $20 amount may be excluded from the foreign base company
income of S.
(5) Interest and gain. (i) Except as provided in subdivisions (ii)
and (iii) of this subparagraph, the portion of any interest paid by a
foreign corporation, or gain recognized from the sale, exchange, or
other disposition of stock or obligations of a foreign corporation,
which is attributable to the foreign base company shipping income of
such foreign corporation is that amount which bears the same ratio to
such interest or gain as the foreign base company shipping income of
such corporation for the period described in subparagraph (6) of this
paragraph bears to its gross income for such period.
(ii) Interest which is paid by a controlled foreign corporation is
attributable to such corporation's foreign base company shipping income
to the same extent that such interest is allocable (under the principles
of Sec. 1.954-1(c)) to its foreign base company shipping income.
(iii) If interest is paid by a foreign corporation, or if stock
obligations of a foreign corporation are sold, exchanged, or otherwise
disposed of, during a taxable year of such foreign corporation beginning
before January 1, 1976, then no portion of such interest or gain is
attributable to foreign base company shipping income.
(iv) Solely for purposes of subdivision (i) of this subparagraph, if
a controlled foreign corporation (the ``first corporation'') owns more
than 10 percent of the stock of another controlled foreign corporation
(the ``second corporation''), then
(A) The gross income of the first corporation for any taxable year
shall be--
(1) Increased by its pro rata share of the gross income of the
second corporation for the taxable year which ends with or within such
taxable year of the first corporation, and
(2) Decreased by the amount of any dividends received from the
second corporation; and
(B) The foreign base company shipping income of the first
corporation for any taxable year shall be--
(1) Increased by its pro rata share of the foreign base company
shipping income of the second corporation for the taxable year which
ends with or within such taxable year of the first corporation, and
(2) Decreased by the amount of any dividends received from the
second corporation which constitute foreign base company income.
(v) Solely for purposes of applying subdivision (i) of this
subparagraph, the district director shall make such other adjustments to
the gross income and the foreign base company shipping income of any
foreign corporation as are necessary to properly determine the extent to
which any interest or gain is attributable to foreign base company
shipping income, including proper adjustments to reflect any transaction
during the test period described in subparagraph (6) of this paragraph
to which section 332, 351, 354, 355, 356, or 361 applies.
(6) Test period. (i) Except as provided in subdivisions (ii) and
(iii) of this subparagraph the period described in this subparagraph
with respect to any foreign corporation is the 3-year period ending with
the close of such corporation's taxable year preceding the year during
which interest was paid or stock or obligations were sold, exchanged, or
otherwise disposed of, or such part of such period as such corporation
was in existence.
(ii) The period described in this paragraph shall not include any
part of a taxable year beginning before January 1, 1976.
[[Page 309]]
(iii) If interest is paid by a foreign corporation, or if stock or
obligations of a foreign corporation are sold, exchanged, or otherwise
disposed of during its first taxable year, then the period described in
this paragraph shall be such first taxable year.
(iv) For purposes of subdivision (iii) of this subparagraph, the
first taxable year of a foreign corporation is the later of--
(A) The first taxable year of its existence, or
(B) Its first taxable year beginning after December 31, 1975.
(g) Income from partnerships, trusts, etc.--(1) In general. The
foreign base company shipping income of any foreign corporation
includes--
(i) Its distributive share of the gross income of any partnership,
and
(ii) Any amounts includible in its gross income under section
652(a), 662(a), 671, or 691(a),
to the extent that such items would have been includible in its foreign
base company shipping income had they been realized by it directly.
(2) Illustrations. The application of subparagraph (1) of this
paragraph may be illustrated by the following examples:
Example 1. Controlled foreign corporations X and Y are equal
partners in partnership P. The taxable years end on December 31 for X,
June 30 for Y, and March 31 for P. In the fiscal year ending March 31,
1976, P's sole business activity is the use of a vessel in foreign
commerce. P derives gross income of $200 from the use of the vessel, and
incurs expenses, taxes, and other deductions of $160. Assume X's
distributive share of such
$200 of P's gross income is $100, all of which is includible in X's
gross income. If X had realized its distributive share of $100 directly,
then the amount which would have been includible in X's foreign base
company shipping income under this paragraph is the portion allocable to
the months of January, February, and March of 1976. Such amount, $25
(i.e., \1/2\ x $200 x 3 months/12 months), is included in X's foreign
base company shipping income for its taxable year ending December 31,
1976. Similarly, X is entitled under this paragraph to a deduction from
foreign base company shipping income of $20 (i.e., \1/2\ x $160 x 3
months/12 months). Since foreign base company shipping income does not
include amounts earned by a foreign corporation (not a less developed
country shipping corporation) in a taxable year beginning before January
1, 1976, Y has no foreign base company shipping income (under this
paragraph or otherwise) for its taxable year beginning on July 1, 1975.
Example 2. The facts are the same as in example 1, except that P
incurs expenses, taxes, and deductions of $240 in its taxable year
ending on March 31, 1976. Accordingly, $25 is includible in X's foreign
base company shipping income, and the amount deductible therefrom under
this paragraph is $30 (i.e., \1/2\ x $240 x 3 months/12 months).
(3) Other income. Except as expressly provided in subparagraph (1)
of this paragraph, foreign base company shipping income does not include
any amount includible in the gross income of a controlled foreign
corporation under part I of subchapter J (section 641 and following,
relating to estates, trusts, and beneficiaries), and gains from the sale
or other disposition of any interest in an estate or trust.
(h) Additional rules--(1) Gross income. For purposes of this section
and Sec. 1.955A-2, the gross income of a foreign corporation (whether
or not a controlled foreign corporation) shall be determined in
accordance with the provisions of section 952 and Sec. 1.952-2. Thus,
for example, section 883 (relating to exclusions from gross income of
foreign corporations) is inapplicable under Sec. 1.952-2 (a)(1) and
(c)(1). In addition, the gross income of a controlled foreign
corporation shall be determined, with respect to a United States
shareholder of such controlled foreign corporation, by excluding
distributions received by such corporation which are excluded from gross
income under section 959(b) with respect to such shareholder.
(2) Earnings and profits. For purposes of this section, the earnings
and profits of a foreign corporation (whether or not a controlled
foreign corporation) shall be determined in accordance with the
provisions of section 964 and the regulations thereunder.
(3) No double counting. No item of gross income shall be counted as
foreign base company shipping income under more than one provision of
this section. For example, If $200 of gross income derived from the use
of a lighter is treated as foreign base company shipping income under
both paragraphs (b)(1)(i) and (ii) of this section, then such $200 is
counted only once as foreign base company shipping income. A
[[Page 310]]
taxpayer may choose under which provision to include an item of income.
(4) Losses. (i) Generally, if a controlled foreign corporation has
losses which are properly allocable to foreign base company shipping
income, the extent to which such losses are deductible from such income
shall be determined by treating such foreign corporation as a domestic
corporation and applying the principles of section 63. See Sec. Sec.
1.954-1(c) and 1.952-2(b). Thus for example, losses from sales or
exchanges of capital assets are allowable only to the extent of gains
from such sales or exchanges.
(ii) If gain from the sale, exchange, or other disposition of any
stock or obligation would be treated (to any extent) as foreign base
company shipping income, then loss from such sale, exchange, or other
disposition is properly allocable to foreign base company shipping
income (to the same extent).
(iii) In determining the extent to which any loss on the disposition
of a qualified investment in foreign base company shipping operations is
deductible from foreign base company shipping income, it is immaterial
that such loss is taken into account under Sec. 1.955A-1(b)(1)(ii) as a
reduction in the amount of the decrease in (withdrawal from) qualified
investments in foreign base company shipping operations.
(5) Hypothetical charges. Under paragraph (d)(5)(i) of this section
and Sec. 1.955A-2(a)(4)(ii)(A), gross income may be deemed to include
hypothetical arm's length charges for services performed by a controlled
foreign corporation for itself. Under paragraph (d)(2) of this section,
certain of these hypothetical charges may be treated as foreign based
company shipping income. Such hypothetical charges are deemed to be
income solely for purposes of applying the ``extent of use'' tests
prescribed by paragraph (d)(4) of this section and Sec. 1.955A-2(a)(4).
Charges for services performed by a controlled foreign corporation for
itself shall in no event be included in income for any other purposes.
[T.D. 7894, 48 FR 22523, May 19, 1983]
Sec. 1.954-7 Increase in qualified investments in foreign base
company shipping operations.
(a) Determination of investments at close of taxable year--(1) In
general. Under section 954(g), the increase in qualified investments in
foreign base company shipping operations, for purposes of section
954(b)(2) and paragraph (b)(1) of Sec. 1.954-1, of any controlled
foreign corporation for any taxable year is, except as provided in
paragraph (b) of this section, the amount by which--
(i) The controlled foreign corporation's qualified investments in
foreign base company shipping operations at the close of the taxable
year, exceed
(ii) Its qualified investments in foreign base company shipping
operations at the close of the preceding taxable year.
(2) Preceding taxable year. For purposes of this section, a taxable
year which begins before January 1, 1976, may be a preceding taxable
year.
(3) Cross-reference. See section 955 (b) and Sec. 1.955A-2 for the
definition of the term ``qualified investments in foreign base company
shipping operations''.
(b) Election to determine investments at close of following taxable
year--(1) General rule. In lieu of determining an increase in qualified
investments in foreign base company shipping operations for a taxable
year in the manner provided in paragraph (a) of this section, a United
States shareholder of a controlled foreign corporation may make an
election under section 955(b)(3) to determine the increase for the
corporation's taxable year by ascertaining the amount by which--
(i) Such corporation's qualified investments in foreign base company
shipping operations at the close of the taxable year immediately
following such taxable year, exceed
(ii) Its qualified investments in foreign base company shipping
operations at the close of the taxable year immediately preceding such
following taxable year.
(2) Election with respect to first taxable year. Notwithstanding
subparagraph (1) of this paragraph, if an election is made without
consent by a United States shareholder under Sec. 1.955A-4 (b)(1) with
respect to a controlled foreign corporation, the increase in such
[[Page 311]]
controlled foreign corporation's qualified investments in foreign base
company shipping operations for the first taxable year to which such
election applies shall be the amount by which--
(i) Such corporation's qualified investments in foreign base company
shipping operations at the close of the taxable year immediately
following such first taxable year, exceed
(ii) Its qualified investments in foreign base company shipping
operations at the close of the taxable year immediately preceding such
first taxable year.
(3) Manner of making election. For the manner of making an election
under section 955(b)(3), and for rules pertaining to the revocation of
such an election, see Sec. 1.955A-4.
(4) Coordination with prior law. If a United States shareholder
makes an election without consent under Sec. 1.955A-4(b)(1) with
respect to a controlled foreign corporation, then such corporation's
increase in qualified investments in foreign base company shipping
operations for the first taxable year to which such election applies
shall be determined by disregarding any change which occurs during such
taxable year in the amount of such corporation's investments in stock or
obligations of a less developed country shipping company described in
Sec. 1.955-5 (b) if both of the following conditions exist:
(i) Such taxable year is the first taxable year of such corporation
which begins after December 31, 1975, and
(ii) Such United States shareholder has elected to determine the
change in such corporation's qualified investments in less developed
countries for its last taxable year beginning before January 1, 1976,
under Sec. 1.954-5(b) or Sec. 1.955-3.
(5) Illustrations. The application of this paragraph may be
illustrated by the following examples:
Example 1. (a) Controlled foreign corporation X is a wholly owned
subsidiary of domestic corporation M. X uses the calendar year as the
taxable year. The amounts of X's qualified investments in foreign base
company shipping operations at the close of 1975 through 1979 are as
follows:
Qualified investments at December 31, 1975................. $16,000
Qualified investments at December 31, 1976................. 17,000
Qualified investments at December 31, 1977................. 23,000
Qualified investments at December 31, 1978................. 28,000
Qualified investments at December 31, 1979................. 30,000
(b) Assume that M properly files without consent a timely election
under Sec. 1.955A-4(b)(1) to determine X's increase for 1976 in
qualified investments in foreign base company shipping operations
pursuant to this paragraph, and that the election remains in force
through 1978. Then X's increases for 1976 through 1978 in qualified
investments in foreign base company shipping operations are as follows:
Increase for 1976 ($23,000 minus $16,000)..................... $7,000
Increase for 1977 ($28,000 minus $23,000)..................... 5,000
Increase for 1978 ($30,000 minus $28,000)..................... 2,000
Example 2. Assume the same facts as in example 1, except that M
never files an election under Sec. 1.955A-4(b)(1). X's increases for
1976 through 1978 in qualified investments in foreign base company
shipping operations are as follows:
Increase for 1976 ($17,000 minus $16,000)..................... $1,000
Increase for 1977 ($23,000 minus $17,000)..................... 6,000
Increase for 1978 ($28,000 minus $23,000)..................... 5,000
Example 3. The facts are the same as in example 1, except that X's
qualified investments in foreign base company shipping operations
include an investment in less developed country shipping companies
described in Sec. 1.955-5(b) of $500 on December 31, 1975, and $750 on
December 31, 1976. Assume further that M has made an election under
section 955(b)(3) (as in effect before the enactment of the Tax
Reduction Act of 1975) with respect to X's taxable year 1975. Then X's
increase in qualified investments in foreign base company shipping
operations for 1976 is $6,750 (i.e., $7,000-$250).
(c) Illustration. The application of this section may be illustrated
by the following example:
Example. (a) Controlled foreign corporation X uses the calendar year
as the taxable year. On December 31, 1975, X's qualified investments in
foreign base company shipping operations (determined as provided in
Sec. 1.955A-2(g)) consist of the following amounts:
Cash......................................................... $6,000
Readily marketable securities................................ 1,000
Stock of related controlled foreign corporations............. 4,000
Traffic and other receivables................................ 14,000
Marine insurance claims receivables.......................... 1,000
Foreign income tax refunds receivable........................ 1,000
Prepaid shipping expenses and shipping inventories ashore.... 1,000
Vessel construction funds.................................... 0
Vessels...................................................... 123,000
Vessel plans and construction in progress.................... 3,000
Containers and chassis....................................... 0
Terminal property and equipment.............................. 2,000
Shipping office (land and building).......................... 1,000
Vessel spare parts ashore.................................... 1,000
Performance deposits......................................... 2,000
Deferred charges............................................. 2,000
Stock of less developed country shipping company described in 10,000
Sec. 1-955-5(b)...........................................
----------
[[Page 312]]
172,000
==========
(b) On December 31, 1976, X's qualified investments in foreign base
company shipping operations (determined as provided in Sec. 1.955A-
2(g)) consists of the following amounts:
Cash......................................................... $5,000
Readily marketable securities................................ 2,000
Stock of related controlled foreign corporations............. 4,000
Traffic and other receivables................................ 16,000
Foreign income tax refunds receivable........................ 3,000
Prepaid shipping expenses and shipping inventories ashore.... 2,000
Vessel construction funds.................................... 1,000
Vessels...................................................... 117,000
Vessel plans and construction in progress.................... 12,000
Containers and chassis....................................... 4,000
Terminal property and equipment.............................. 2,000
Shipping office (land and building).......................... 1,000
Vessel spare parts ashore.................................... 1,000
Performance deposits......................................... 2,000
Deferred charges............................................. 2,000
Stock of less developed country shipping company described in 0
Sec. 1.955-5(b)...........................................
----------
174,000
==========
(c) For 1976, X's increase in qualified investments in foreign base
company shipping operations is $2,000, which amount is determined as
follows:
Qualified investments at Dec. 31, 1976....................... $174,000
Qualified investments at Dec. 31, 1975....................... 172,000
----------
Increase for 1976........................................ 2,000
[T.D. 7894, 48 FR 22528, May 19, 1983]
Sec. 1.954-8 Foreign base company oil related income.
(a) Foreign base company oil related income--(1) In general. Under
section 954(g), the foreign base company oil related income of a
controlled foreign corporation (except as provided under paragraph (b)
of this section) consists of the items of foreign oil related income
(``FORI'') described in section 907(c)(2) and (3), other than such
income derived from a source within a foreign country in connection
with--
(i) Oil or gas which was extracted from an oil or gas well located
in that foreign country (``extraction exception''), or
(ii) Oil, gas, or a primary product of oil or gas which is sold by
the controlled foreign corporation or a related person for use or
consumption within that country or is loaded in that country on a vessel
or aircraft as fuel for the vessel or aircraft (``use or consumption
exception'').
A taxpayer claiming the use or consumption exception must establish its
applicability on the basis of facts and circumstances. For special rules
for applying the extraction exception, see paragraph (c) of this
section.
(2) Source of income. The source of foreign base company oil related
income is determined generally under the principles of Sec. Sec. 1.861-
1 to 1.863-5. See Sec. 1.863-6. Thus, income from the performance of a
service generally is sourced in the country where the service is
performed. See Sec. 1.861-4. Underwriting income from insuring a
foreign oil related activity is sourced at the location of the risk. See
section 861(a)(7) and Sec. 1.953-2.
(3) Primary product. The term ``primary product'' of oil or gas has
the meaning given this term by Sec. 1.907(c)-1(d)(5) and (6).
(4) Vessel. For the definition of the term ``vessel'', see Sec.
1.954-6(b)(3)(ii).
(5) Foreign country. For purposes of this section, the term
``foreign country'' has the same meaning as in section 638 (relating to
continental shelf areas). Thus, for example, oil or gas extracted from a
sea area will be deemed to be extracted in the country which has
exclusive rights of exploitation of natural resources with respect to
that area if the other conditions of section 638 are met.
(6) Country of use or consumption. For rules for determining the
country of use or consumption, see Sec. 1.954-3(a)(3)(ii).
(7) Insurance income. For purposes of this section, income derived
from or attributable to insurance of section 907(c)(2) activities means
taxable income as defined in section 832(a) and as modified by the
principles of Sec. 1.953-4 (other than as the section is applied to
life insurance).
(8) Fuel product. For purposes of this section, the term ``fuel
product'' means oil, gas or a primary product of oil or gas.
(9) Effective date. The provisions of section 954(g) and this
section are applicable to taxable years of foreign corporations
beginning on or after January 1, 1983, and to taxable years of United
States shareholders in which or with which those taxable years of
foreign corporations end.
[[Page 313]]
(b) Exemption for small oil producers--(1) In general. Foreign base
company oil related income does not include any income of a foreign
corporation which is not a large oil producer.
(2) Large oil producer. A corporation is a large oil producer
(within the meaning of section 954(g)(2)) if the average daily
production (extraction) of foreign crude oil and natural gas by the
related group which includes the corporation and related persons (within
the meaning of section 954(d)(3)) for the taxable year or immediately
preceding taxable year is 1,000 or more barrels. The average daily
production of foreign crude oil or natural gas for any taxable year (and
the conversion of cubic feet of natural gas into barrels) is determined
under rules similar to the rules of section 613A, except that only crude
oil or natural gas from a well located outside the United States is
taken into account.
(c) Special rules for applying the extraction exception of paragraph
(a)(1)(i) of this section--(1) Refining income described in section
907(c)(2)(A). With regard to a controlled foreign corporation's refining
income from the processing of minerals extracted (by the taxpayer or by
any other person) from oil or gas wells into their primary products, as
described in section 907(c)(2)(A), a pro rata method will be applied for
purposes of determining the part of the refining income that qualifies
for the extraction exception of paragraph (a)(1)(i) of this section. The
pro rata method will be based on the proportion that the barrels of the
fuel product extracted in the country of processing bears to the total
barrels of the fuel product processed in that country and will apply
regardless of the country of sale of the primary product.
(2) Marketing income described in section 907(c)(2)(C). With regard
to a controlled foreign corporation's marketing income from the
distribution or sale of minerals extracted from oil or gas wells or of
primary products, as described in section 907(c)(2)(C), a pro rata
method will be applied for purposes of determining the part of the
marketing income that qualifies for the extraction exception of
paragraph (a)(1)(i) of this section. When applying the pro rata method
to the sale of a fuel product other than a primary product, the pro rata
method will be based on the proportion that the barrels of the fuel
product extracted in the country of sale bears to the total barrels of
the fuel product sold in that country. When applying the pro rata method
to the sale of primary products, the method will be based on the
proportion that the barrels of the fuel product extracted in the country
of sale bears to the total barrels of the fuel product processed. For
purposes of applying the pro rata method, data of the controlled foreign
corporation's related group (as defined in section 954(g)(2)(C)) will be
taken into account. The pro rata method will not apply, however, if the
mineral or primary product is purchased by the controlled foreign
corporation from a person not within the controlled foreign
corporation's related group. In that situation, the marketing income
will be presumed to qualify for the extraction exception if the country
of the source of the marketing income is a net exporter of crude oil or
gas, whichever is relevant. If the country of the source of the
marketing income is not a net exporter of crude oil or gas, whichever is
relevant, the marketing income will be presumed not to qualify for the
extraction exception. The controlled foreign corporation may, however,
rebut this latter presumption by demonstrating on the basis of all the
facts and circumstances that its marketing income does qualify for the
extraction exception. If a primary product that is acquired from a
person within the controlled foreign corporation's related group is
commingled with like products acquired from persons not within that
related group, the pro rata method based on the proportion that the
barrels of the fuel product extracted in the country of sale bears to
the total barrels of the fuel product processed will be applied to that
portion of the total products sold that was purchased from persons
within the related group, to the extent that that person did not sell
product purchased from an unrelated person, and either the presumption
or facts and circumstances will determine the characterization of the
remainder.
[[Page 314]]
(3) Transportation income described in section 907(c)(2)(B). With
regard to a controlled foreign corporation's income from the
transportation of minerals from oil and gas wells or of primary
products, as described in section 907(c)(2)(B), the rules set forth in
paragraph (c)(2) of this section will apply for purposes of determining
the part of the transportation income that qualifies for the extraction
exception of paragraph (a)(1)(i) of this section.
(4) Illustrations. The following examples illustrate the application
of this paragraph.
Example 1. Controlled foreign corporation M has a refinery in
foreign country A that refines 250x barrels of oil during its taxable
year beginning in 1984. It is determined that 125x barrels of its 250x
barrels were extracted in country A. M sold 150x barrels of its 250x
barrels in country A for consumption in country A which resulted in
$225x of income from refining and $225x of marketing income, as
described in section 907(c)(2)(C). M also sold within foreign country B,
for consumption in country B, 100x barrels of its 250x barrels which
resulted in an additional $150x of income from refining for M and $170x
of marketing income for M. The 100x barrels sold by M within country B,
a contiguous country, were transported from M's refinery in country A to
country B by a pipeline which is owned by M, and M recognized a total of
$10x of income from the transportation of the 100x barrels. Of this
$10x, $8x was recognized in country A and $2x was recognized in country
B. Under the source of income rules of paragraph (a)(2) of this section,
income from refining is considered derived from the country in which the
refining occurs and not from the country where the sale of the refined
product occurs.
(i) M's refining income. M has $75x of foreign base company oil
related income with respect to its refining of the 250x barrels,
determined as follows:
(A) Total amount of income from refining attributable to oil refined in
country A by M$375x.....................................................
(B) Amount of income from refining with respect to oil sold for
consumption ($225x) in country A (use or consumption exception under
paragraph (a)(1)(ii) of this section(225x)..............................
(C) Pro rate amount of income from refining attributable to sales in
country B considered extracted from country A ($150x times 125x barrels/
250x barrels) (extraction exception under paragraph (a)(1)(i) of this
section(75x)............................................................
(D) Foreign base company oil related income$75x.........................
(ii) M's marketing income. M does not have foreign base company oil
related income with respect to its sale of the 100x barrels in country B
and 150x barrels in country A because the $170x and $225x, respectively,
of marketing income was derived from the country in which the oil was
sold for consumption (an exception under paragraph (a)(1)(ii) of this
section).
(iii) M's transportation income. M does not have foreign base
company oil related income with respect to its $2x of pipeline
transportation income recognized in country B because the income was
derived from the country in which the 100x barrels were sold for
consumption, an exception under paragraph (a)(1)(ii) of this section.
With regard to the $8x of pipeline transportation income recognized in
country A, however, M has $4x of foreign base company oil related income
since of the total barrels refined in country A (250x) only one-half
were extracted in that country. Therefore, only one-half of the
transportation income qualifies for the extraction exception of
paragraph (a)(1)(i) of this section.
(iv) M's extraction income. M does not have foreign base company oil
related income for its extraction activity because extraction income is
excluded in all events. See section 954(g)(1)(A).
Example 2. Assume the same facts as in Example 1 except that M sold
all of the 250x barrels of refined oil in country A. In addition, assume
that country A is a net exporter of crude oil. As in Example 1, M sold
150x barrels for consumption in country A with the same resulting
income. M sold in country A the remaining 100x barrels to unrelated
controlled foreign corporation N which resulted in an additional $150x
of income from refining for M and $170x of marketing income for M. N
immediately resold in country A for export those 100x barrels. N did not
commingle the 100x barrels with any other refined oil. N earned $10x of
marketing income on that sale.
(i) M's refining income. M has $75x foreign base company oil related
income with respect to its refining of the 250x barrels determined as
follows:
(A) Total amount of income from refining attributable to oil refined in
country A by M$375x.....................................................
(B) Amount of income from refining with respect to oil sold for
consumption ($225x) in country A (use or consumption exception under
paragraph (a)(1)(ii) of this section)(225x).............................
(C) Pro rata amount of income from refining attributable to sales in
country A (for consumption outside of country A) considered extracted
from country A ($150x
[[Page 315]]
times 125x barrels/250x barrels) (extraction exception under paragraph
(a)(1)(i) of this section)(75x).........................................
(D) Foreign base company oil related income$75x.........................
(ii) M's marketing income. M does not have foreign base company oil
related income with respect to its marketing income from the sale of the
150x barrels in country A because the $225x of marketing income was
derived from the country in which the oil was sold for consumption (an
exception under paragraph (a)(1)(ii) of this section). M has $85x of
foreign base company oil related income with respect to its marketing
income from sale to N of the 100x barrels, determined as follows:
(A) Total amount of marketing income from the sale$170x.................
(B) Pro rata amount of marketing income attributable to oil product
considered extracted in country A ($170x times 125x barrels/250x
barrels) (extraction exception under paragraph (a)(1)(i) of this
section)(85x)...........................................................
(C) Foreign base company oil related income$85x.........................
(iii) N's marketing income. N is not related to M. Therefore, since
N sold the 100x barrels in country A, a net exporter of crude oil, and
since N did not commingle the 100x barrels with other refined products,
it is presumed that all of the 100x barrels were extracted in country A.
Accordingly, all of N's $10x of marketing income is excepted under
paragraph (a)(1)(i) of this section.
Example 3. Assume the same facts as in Example 2 except that N is
related to M. Characterization of M's income remains the same as in
Example 2. N will have, however, $5x of foreign base company oil related
income with regard to its marketing income, determined as follows:
(i) Total amount of marketing income from the sale$10x..................
(ii) Pro rata amount of marketing income considered extracted from
country A ($10x times 125x barrels/250x barrels) (extraction exception
under paragraph (a)(1)(i) of this section)5x............................
(iii) Foreign base company oil related income$5x........................
Example 4. Assume that controlled foreign corporation M has a
refinery in foreign country A that refines 200x barrels of oil during
its taxable year beginning in 1984. It is determined that 100x barrels
of that oil were extracted in country A and that the other 100x barrels
were extracted in country B. Neither country A nor country B is a net
exporter of crude oil. In addition, M purchased from an unrelated
country A refiner 100x barrels of already refined oil. M does not know
where this oil was extracted. These 100x barrels of purchased refined
oil were commingled with the 200x barrels of refined oil from M's
refinery. M sold 225x barrels of refined oil in country A for
consumption in country A which resulted in $250x of income from refining
and $225x of marketing income. M sold within foreign country B for
consumption outside of country B 75x barrels of refined oil which
resulted in $100x of income from refining and $75x of marketing income.
The refined product was transported between country A and country B by
an unrelated person.
(i) M's refining income. With regard to the sales in country A, M
has $50x of foreign base company oil related income with respect to its
refining of the 100x barrels, determined as follows:
(A) Total amount of income from refining attributable to oil refined in
country A by M$350x.....................................................
(B) Amount of income from refining with respect to oil sold for
consumption in country A ($250x) (use or consumption exception under
paragraph (a)(1)(ii) of this section)(250x).............................
(C) Pro rata amount of income from refining attributable to sales in
country B considered extracted from country A ($100x times 100x barrels/
200x barrels) (extraction exception under paragraph (a)(1)(i) of this
section)(50x)...........................................................
(D) Foreign base company oil related income$50x.........................
(ii) M's marketing income. Since the barrels from M's refinery and
those that M purchased were commingled, a portion, as follows, of the
marketing income is deemed to derive from both purchased and refined
products. Since M refined 200x barrels and purchased 100x barrels, its
marketing income of $225x from the sale of the 225x barrels in country A
for consumption in country A will be deemed to consist of $150x (200x/
300x x $225x) from the sale of products refined by M and $75x (100x/300x
x $225x) from the sale of purchased products. Likewise, its marketing
income of $75x from the sale of the 75x barrels in country B for
consumption outside of country B will be deemed to consist of $50x
(200x/300x x $75x) from the sale of products refined by M and $25x
(100x/300x x $75x) from the sale of purchased products.
(A) Purchased products. M is considered as having $75x of marketing
income from the sale of purchased products in country A for consumption
in country A. None of this marketing income is foreign base company oil
related income since the marketing income is earned in country A, the
country of consumption. See paragraph (a)(1)(ii) of this section. All of
the $25x of M's marketing income from the sale of purchased products in
country B will be foreign base company oil related income. The exception
at paragraph (a)(1)(ii) of this section does not apply since
[[Page 316]]
the refined oil is not sold for use or consumption in country B.
Likewise, the extraction exception under paragraph (a)(1)(i) of this
section does not apply. The purchased product cannot be presumed to be
extracted in country B since country B is not a net exporter of crude
oil. In addition, M cannot show, on a facts and circumstances basis,
that purchased products were refined from crude oil extracted in country
B.
(B) Products refined by M. With regard to M's marketing income
attributable to the sale of products refined by M, M does not have any
foreign base company oil related income with regard to its $150x of
marketing income in country A since that income was derived from the
country in which the oil was sold for consumption (the use or
consumption exception under paragraph (a)(1)(ii) of this section). M has
$25x of foreign base company oil related income with regard to its $50x
of marketing income in country B determined as follows:
(1) Total amount of income from marketing attributable to oil refined by
M and sold in country B$50x.............................................
(2) Pro rata amount of income from marketing attributable to sales in
country B considered extracted from country B ($50x times 100x barrels/
200x barrels) (extraction exception under paragraph (a)(1)(i) of this
section)(25x)...........................................................
(3) Foreign base company oil related income$25x.........................
[T.D. 8331, 56 FR 2847, Jan. 25, 1991; 56 FR 11511, Mar. 19, 1991]
Sec. 1.955-0 Effective dates.
(a) Section 955 as in effect before the enactment of the Tax
Reduction Act of 1975--(1) In general. In general, Sec. Sec. 1.955-1
through 1.955-6 are applicable with respect to withdrawals of previously
excluded subpart F income from qualified investment in less developed
countries for taxable years of foreign corporations beginning after
December 31, 1962, and to taxable years of United States shareholders
(as defined in section 951(b)) within which or with which such taxable
years of such foreign corporations end. However, such sections are
effective with respect to withdrawals of amounts invested in less
developed country shipping companies described in section 955(c)(2) (as
in effect before the enactment of the Tax Reduction Act of 1975) only
for taxable years of foreign corporations beginning before January 1,
1976, and for taxable years of United States shareholders (as defined in
section 951(b)) within which or with which such taxable years of such
foreign corporations end. For rules applicable to withdrawals of amounts
invested in less developed country shipping companies described in
section 955(c)(2) (as in effect before such enactment), in taxable years
of foreign corporations beginning after December 31, 1975, see section
955(b)(5) (as amended by such Act) and Sec. Sec. 1.955A-1 through
1.955A-4.
(2) References. Except as otherwise provided therein, all references
contained in Sec. Sec. 1.955-1 through 1.955-6 to section 954 or 955 or
to the regulations under section 954 are to those sections and
regulations as in effect before the enactment of the Tax Reduction Act
of 1975. For regulations under section 954 (as in effect before such
enactment), see 26 CFR Sec. 1.954-1 through 1.954-5 (Revised as of
April 1, 1975). For taxable years of foreign corporations beginning
after December 31, 1975, and for taxable years of United States
shareholders (as described in section 951(b)) within which or with which
such taxable years of such foreign corporations end, the definitions of
less developed countries and less developed country corporations
contained in section 902(d) (as amended by such Act) and Sec. 1.902-2
apply for purposes of determining the credit for corporate stockholders
in foreign corporations under section 902.
(b) Section 955 as amended by the Tax Reduction Act of 1975. Except
as otherwise provided therein, Sec. Sec. 1.955A-1 through 1.955A-4 are
applicable to taxable years of foreign corporations beginning after
December 31, 1975, and to taxable years of United States shareholders
(as defined in section 951(b)) within which or with which such taxable
years of such foreign corporations end.
[T.D. 7893, 48 FR 22508, May 19, 1983, as amended by T.D. 7894, 48 FR
22529, May 19, 1983]
Sec. 1.955-1 Shareholder's pro rata share of amount of previously
excluded subpart F income withdrawn from investment in less developed
countries.
(a) In general. Pursuant to section 951(a)(1)(A)(ii) and the
regulations
[[Page 317]]
thereunder, a United States shareholder of a controlled foreign
corporation must include in its gross income its pro rata share (as
determined in accordance with paragraph (c) of this section) of the
amount of such controlled foreign corporation's previously excluded
subpart F income which is withdrawn for any taxable year from investment
in less developed countries. Section 955 provides rules for determining
the amount of a controlled foreign corporation's previously excluded
subpart F income for any taxable year of the corporation beginning after
December 31, 1962, that is withdrawn from investment in less developed
countries for any taxable year of the corporation beginning before
January 1, 1976. Except for investment in less developed country
shipping companies, section 955 also provides rules for determining the
amount of a controlled foreign corporation's previously excluded subpart
F income for any taxable year of the corporation beginning after
December 31, 1962, which is withdrawn from investment in less developed
countries in taxable years of the corporation beginning after December
31, 1975. To determine the amount of a controlled foreign corporation's
previously excluded subpart F income withdrawn from investment in less
developed country shipping companies described in section 955(c)(2) in
taxable years of a controlled foreign corporation beginning after
December 31, 1975, see section 955(b)(5) (as in effect after amendment
by the Tax Reduction Act of 1975) and Sec. Sec. 1.955A-1 through
1.955A-4. For effective dates, see Sec. 1.955-0.
(b) Amount withdrawn by controlled foreign corporation--(1) In
general. For purposes of sections 951 through 964, the amount of a
controlled foreign corporation's previously excluded subpart F income
which is withdrawn for any taxable year from investment in less
developed countries is an amount equal to the decrease for such year in
such corporation's qualified investments in less developed countries.
Such decrease is, except as provided in Sec. 1.955-3--
(i) An amount equal to the excess of the amount of its qualified
investments in less developed countries at the close of the preceding
taxable year over the amount of its qualified investments in less
developed countries at the close of the taxable year, minus
(ii) The amount (if any) by which recognized losses on sales or
exchanges by such corporation during the taxable year of qualified
investments in less developed countries exceed its recognized gains on
sales or exchanges during such year of qualified investments in less
developed countries,
but only to the extent that the net amount so determined does not exceed
the limitation determined under subparagraph (2) of this paragraph. See
Sec. 1.955-2 for determining the amount of qualified investments in
less developed countries.
(2) Limitations applicable in determining decreases--(i) General.
The limitation referred to in subparagraph (1) of this paragraph for any
taxable year of a controlled foreign corporation shall be the lesser of
the following two limitations:
(a) The sum of the controlled foreign corporation's earnings and
profits (or deficit in earnings and profits) for the taxable year,
computed as of the close of the taxable year without diminution by
reason of any distributions made during the taxable year, plus the sum
of its earnings and profits (or deficits in earnings and profits)
accumulated for prior taxable years beginning after December 31, 1962,
(including prior taxable years beginning after December 31, 1975) or,
(b) The sum of the amounts excluded under section 954(b)(1) and
paragraph (b)(1) of Sec. 1.954-1 from the foreign base company income
of such corporation for all prior taxable years, minus the sum of the
amounts (determined under this paragraph) of its previously excluded
subpart F income withdrawn from investment in less developed countries
for all prior taxable years.
(ii) Treatment of earnings and profits. For purposes of determining
earnings and profits of a controlled foreign corporation under
subdivision (i)(a) of this subparagraph, such earnings and profits shall
be considered not to include any amounts which are attributable to--
(a)(1) Amounts which, for the current taxable year, are included in
the gross income of a United States shareholder
[[Page 318]]
of such controlled foreign corporation under section 951(a)(1)(A)(i) or
(iii), or
(2) Amounts which, for any prior taxable year, have been included in
the gross income of a United States shareholder of such controlled
foreign corporation under section 951(a) and have not been distributed;
or
(b)(1) Amounts which, for the current taxable year, are included in
the gross income of a United States shareholder of such controlled
foreign corporation under section 551(b) or would be so included under
such section but for the fact that such amounts were distributed to such
shareholder during the taxable year, or
(2) Amounts which, for any prior taxable year, have been included in
the gross income of a United States shareholder of such controlled
foreign corporation under section 551(b) and have not been distributed.
The rules of this subdivision apply only in determining the limitation
on a controlled foreign corporation's decrease in qualified investments
in less developed countries. See section 959 and the regulations
thereunder for limitations on the exclusion from gross income of
previously taxed earnings and profits.
(3) Taxable years beginning after December 31, 1975. (i) In the case
of a taxable year of a controlled foreign corporation beginning after
December 31, 1975, Sec. 1.955-2(b)(5) must be applied in determining
the amount of its qualified investments in less developed countries on
both of the determination dates applicable to such taxable year.
(ii) The application of this subparagraph may be illustrated by the
following examples:
Example 1. (a) Controlled foreign corporation M uses the calendar
year as the taxable year. Throughout 1974 through 1976, M owns 100
percent of the only class of stock of foreign corporation N, a less
developed country shipping company described in Sec. 1.955-5(b), and M
owns no other stock or obligations. The amount taken into account under
Sec. 1.955-2(d) with respect to the stock of N is $10,000 at the close
of 1974, 1975, and 1976. The amount of M's previously excluded subpart F
income which is withdrawn for 1975 (a year to which Sec. 1.955-2(b)(5)
does not apply) from investment in less developed countries is zero,
determined as follows:
(1) Qualified investments in less developed countries at the $10,000
close of 1974...............................................
(2) Less: qualified investments in less developed countries 10,000
at the close of 1975........................................
----------
(3) Balance.................................................. 0
==========
(Further computations similar to those set out in lines (iv) through
(ix) of example 1 of paragraph (d) of this section are unnecessary
because the balance in line (3) of this example is zero.)
(b) As a result of Sec. 1.955-2(b)(5)(ii), the amount of M's
previously excluded subpart F income which is withdrawn for 1976 from
investment in less developed countries is zero, determined as follows:
(1) Qualified investments in less developed countries at the close $0
of 1975...........................................................
(2) Less: qualified investments in less developed countries at the 0
close of 1976.....................................................
----
(3) Balance........................................................ 0
====
Example 2. The facts are the same as in example 1, except that
foreign corporation N is a less developed country corporation described
in Sec. 1.955-5(a). The amount of M's previously excluded subpart F
income withdrawn for 1976 from investment in less developed countries is
zero, determined as follows:
(1) Qualified investments in less developed countries at the $10,000
close of 1975...............................................
(2) Less: qualified investments in less developed countries 10,000
at the close of 1976........................................
----------
(3) Balance.................................................. 0
==========
(c) Shareholder's pro rata share of amount withdrawn by controlled
foreign corporation--(1) In general. A United States shareholder's pro
rata share of a controlled foreign corporation's previously excluded
subpart F income withdrawn for any taxable year from investment in less
developed countries is his pro rata share of the amount withdrawn for
such year by such corporation, as determined under paragraph (b) of this
section. See section 955(a)(3).
(2) Special rule. A United States shareholder's pro rata share of
the net amount determined under paragraph (b)(2)(i)(b) of this section
with respect to any stock of the controlled foreign corporation owned by
such shareholder
[[Page 319]]
shall be determined without taking into account any amount attributable
to a period prior to the date on which such shareholder acquired such
stock. See section 1248 and the regulations thereunder for rules
governing treatment of gain from sales or exchanges of stock in certain
foreign corporations.
(d) Illustrations. The application of this section may be
illustrated by the following examples:
Example 1. A, a United States shareholder, owns 60 percent of the
only class of stock of M Corporation, a controlled foreign corporation
throughout the entire period here involved. Both A and M Corporation use
the calendar year as a taxable year. Corporation M's qualified
investments in less developed countries at the close of 1964 amount to
$125,000; and, at the close of 1965, to $75,000. During 1965, M
Corporation realizes recognized gains of $5,000 and recognized losses of
$15,000, on sales of qualified investments in less developed countries.
Corporation M's earnings and profits for 1965 and its accumulated
earnings and profits for 1963 and 1964 amount to $45,000, as determined
under paragraph (b)(2) of this section. The amount excluded under
section 954(b)(1) for 1963 from its foreign base company income is
$75,000, and the amount of its previously excluded subpart F income
withdrawn for 1964 from investment in less developed countries is
$25,000. The amount of M Corporation's previously excluded subpart F
income withdrawn for 1965 from investment in less developed countries is
$40,000, and A's pro rata share of such amount is $24,000, determined as
follows:
(i) Qualified investments in less developed countries at the $125,000
close of 1964...............................................
(ii) Less: Qualified investments in less developed countries 75,000
at the close of 1965........................................
----------
(iii) Balance................................................ 50,000
(iv) Less: Excess of recognized losses over recognized gains 10,000
on sales during 1965 of qualified investments in less
developed countries ($15,000 less $5,000)...................
----------
(v) Tentative decrease in qualified investments in less 40,000
developed countries for 1965................................
==========
(vi) Earnings and profits for 1963, 1964, and 1965........... 45,000
----------
(vii) Excess of amount excluded under section 954(b)(1) from 50,000
foreign base company income for 1963 ($75,000 over amount of
previously excluded subpart F income withdrawn for 1964 from
investment in less developed countries ($25,000)............
----------
(viii) M Corporation's amount of previously excluded subpart 40,000
F income withdrawn for 1965 from investment in less
developed countries (item (v), but not to exceed the lesser
of item (vi) or item (vii)).................................
----------
(ix) A's pro rata share of M Corporation's amount of $24,000
previously excluded subpart F income withdrawn for 1965 from
investment in less developed countries (60 percent of
$40,000)....................................................
==========
Example 2. The facts are the same as in example 1, except that M
Corporation's earnings and profits (determined under paragraph (b)(2) of
this section) for 1963, 1964, and 1965 (item (vi)) are $30,000 instead
of $45,000. Corporation M's amount of previously excluded subpart F
income withdrawn for 1965 from investment in less developed countries is
$30,000. A's pro rata share of such amount is $18,000 (60 percent of
$30,000).
Example 3. The facts are the same as in example 1, except that the
excess of the amount excluded under section 954(b)(1) for 1963 from M
Corporation's foreign base company income over the amount of its
previously excluded subpart F income withdrawn for 1964 from investment
in less developed countries (item (vii)) is $20,000 instead of $50,000.
Corporation M's amount of previously excluded subpart F income withdrawn
for 1965 from investment in less developed countries is $20,000. A's pro
rata share of such amount is $12,000 (60 percent of $20,000).
[T.D. 6683, 28 FR 11178, Oct. 18, 1963, as amended by T.D. 6795, 30 FR
942, Jan. 29, 1965; T.D. 7893, 48 FR 22509, May 19, 1983; T.D. 7894, 48
FR 22529, May 19, 1983]
Sec. 1.955-2 Amount of a controlled foreign corporation's qualified
investments in less developed countries.
(a) Included property. For purposes of sections 951 through 964, a
controlled foreign corporation's ``qualified investments in less
developed countries'' are items of property (other than property
excluded under paragraph (b)(1) of this section) owned directly by such
corporation on the applicable determination date for purposes of section
954(f) or section 955(a)(2) and consisting of one or more of the
following:
(1) Stock of a less developed country corporation if the controlled
foreign corporation owns (within the meaning of paragraph (b)(2) of this
section) on the applicable determination date 10 percent or more of the
total combined voting power of all classes of stock of such less
developed country corporation;
[[Page 320]]
(2) An obligation (as defined in paragraph (b)(3) of this section)
of a less developed country corporation which, at the time of
acquisition (as defined in paragraph (b)(4) of this section) of such
obligation by the controlled foreign corporation, has a maturity of one
year or more, but only if the controlled foreign corporation owns
(within the meaning of paragraph (b)(2) of this section) on the
applicable determination date 10 percent or more of the total combined
voting power of all classes of stock of such less developed country
corporation; and
(3) An obligation (as defined in paragraph (b)(3) of this section)
of a less developed country, including obligations issued or guaranteed
by the government of such country or of a political subdivision thereof
and obligations of any agency or instrumentality of such country, in
which such country is financially committed. The application of this
subparagraph may be illustrated by the following example:
Example. A, a political subdivision of foreign country X, constructs
and operates a toll bridge. Country X is a less developed country
throughout the period here involved. A issues bonds under an indenture
which provides for amortization of the principal and interest of such
bonds only out of the net revenues derived from operation of the bridge.
The bonds of A are obligations in which X country is financially
committed and, in the hands of a controlled foreign corporation, are
qualified investments in less developed countries.
(b) Special rules--(1) Excluded property. For purposes of paragraph
(a) of this section, property which is disposed of within 6 months after
the date of its acquisition shall be excluded from a controlled foreign
corporation's qualified investments in less developed countries.
However, the fact that property acquired by a controlled foreign
corporation has not been held on an applicable determination date for
more than 6 months after the date of its acquisition shall not prevent
such property from being included in the controlled foreign
corporation's qualified investments in less developed countries on such
date. Proper adjustments shall be made subsequently, however, to exclude
any item of property so included, if the property is in fact disposed of
within 6 months after the date of its acquisition. See section
955(b)(4).
(2) Determination of stock ownership. In determining for purposes of
paragraphs (a)(1) and (2) of this section whether a controlled foreign
corporation owns 10 percent or more of the total combined voting power
of all classes of stock of a less developed country corporation, only
stock owned directly by such controlled foreign corporation shall be
taken into account and the provisions of section 958 and the regulations
thereunder shall not apply. See section 958(a)(1).
(3) Obligation defined. For purposes of paragraphs (a)(2) and (3) of
this section, the term ``obligation'' means any bond, note, debenture,
certificate, or other evidence of indebtedness. In the absence of legal,
governmental, or business reasons to the contrary, the indebtedness must
bear interest or be issued at a discount.
(4) Date of acquisition. For purposes of paragraphs (a)(2) and
(b)(5)(i) of this section, stock or an obligation shall be considered
acquired by a foreign corporation as of the date such corporation
acquires an adjusted basis in the stock or obligation. For this purpose,
in a case in which a foreign corporation acquires stock or an obligation
in a transaction (other than a reorganization of the type described in
section 368(a)(1)(E) or (F)) in which no gain or loss would be
recognized had the transaction been between two domestic corporations,
such corporation will be considered to have acquired an adjusted basis
in such stock or obligation as of the date such transaction occurs.
(5) Taxable years beginning after December 31, 1975. For taxable
years beginning after December 31, 1975, qualified investments in less
developed countries do not include--
(i) Any property acquired after the latest determination date
applicable to a taxable year beginning before December 31, 1975,
(ii) Stock or obligations of a less developed country shipping
company described in Sec. 1.955-5(b), and
(iii) Stock or obligations which were not treated as qualified
investments in less developed countries on the later of the two
determination dates applicable to the preceding taxable year.
[[Page 321]]
See Sec. 1.955-1(b)(3) for rules relating to the application of this
subparagraph. See Sec. 1.955A-2(h) for rules relating to the treatment
of investments in stock or obligations described in subdivision (ii) of
this subparagraph as qualified investments in foreign base company
shipping operations.
(6) Determination dates. For purposes of subparagraph (5) of this
paragraph and Sec. 1.955-1(b)(3), the determination dates applicable to
a taxable year of a controlled foreign corporation are--
(i) Except as provided in subdivision (ii) of this subparagraph, the
close of such taxable year and the close of the preceding taxable year,
and
(ii) With respect to a United States shareholder who has made an
election under section 955(b)(3) to determine such corporation's
increase in qualified investments in less developed countries at the
close of the following taxable year, the close of such taxable year and
the close of the taxable year immediately following such taxable year.
(c) Termination of designation as a less developed country. For
purposes of sections 951 through 964, property which would constitute a
qualified investment in a less developed country but for the fact that a
foreign country or United States possession has, after the acquisition
of such property by the controlled foreign corporation, ceased to be a
less developed country shall be treated as a qualified investment in a
less developed country. The application of this paragraph may be
illustrated by the following example:
Example. On December 31, 1969, in accordance with the provisions of
Sec. 1.955-4, the designation of the foreign country X as an
economically less developed country is terminated. Corporation M, a
controlled foreign corporation, has $50,000 of qualified investments in
country X acquired before December 31, 1969. After 1969 such investments
are treated as qualified investments in a less developed country
notwithstanding the termination of the status of X Country as an
economically less developed country. However, if such qualified
investments of M Corporation are reduced to $40,000, each United States
shareholder of M Corporation is required, subject to the provisions of
Sec. 1.955-1, to include his pro rata share of the $10,000 decrease in
his gross income under section 951(a)(1)(A)(ii) and the regulations
thereunder.
(d) Amount attributable to property--(1) General rule. For purposes
of this section, the amount taken into account with respect to any
property which constitutes a qualified investment in a less developed
country shall be its adjusted basis as of the applicable determination
date, reduced by any liability (other than a liability described in
subparagraph (2) of this paragraph) to which such property is subject on
such date. To be taken into account under this subparagraph, a liability
must constitute a specific charge against the property involved. Thus, a
liability evidenced by an open account or a liability secured only by
the general credit of the controlled foreign corporation will not be
taken into account. On the other hand, if a liability constitutes a
specific charge against several items of property and cannot definitely
be allocated to any single item of property, the liability shall be
apportioned against each of such items of property in that ratio which
the adjusted basis of such item on the applicable determination date
bears to the adjusted basis of all such items at such time. A liability
in excess of the adjusted basis of the property which is subject to such
liability shall not be taken into account for the purpose of reducing
the adjusted basis of other property which is not subject to such
liability.
(2) Excluded charges. For purposes of subparagraph (1) of this
paragraph, a specific charge created with respect to any item of
property principally for the purpose of artificially increasing or
decreasing the amount of a controlled foreign corporation's qualified
investments in less developed countries will not be recognized; whether
a specific charge is created principally for such purpose will depend
upon all the facts and circumstances of each case. One of the factors
that will be considered in making such a determination with respect to a
loan is whether the loan is from a related person, as defined in section
954(d)(3) and paragraph (e) of Sec. 1.954-1.
(3) Statement required. If for purposes of this section a United
States shareholder of a controlled foreign corporation reduces the
adjusted basis of property which constitutes a qualified investment in a
less developed country
[[Page 322]]
on the ground that such property is subject to a liability, he shall
attach to his return a statement setting forth the adjusted basis of the
property before the reduction and the amount and nature of the
reduction.
(4) Taxable years beginning after December 31, 1975. For taxable
years beginning after December 31, 1975, the amount taken into account
under subparagraph (1) of this paragraph with respect to any property
which constitutes a qualified investment in less developed countries
shall not exceed the amount taken into account with respect to such
property at the close of the preceding taxable year.
[T.D. 6683, 28 FR 11179, Oct. 18, 1963, as amended by T.D. 7894, 48 FR
22529, May 19, 1983]
Sec. 1.955-3 Election as to date of determining qualified investments
in less developed countries.
(a) Nature of election. In lieu of determining the increase for a
taxable year of a foreign corporation beginning before January 1, 1976,
under the provisions of section 954(f) and paragraph (a) of Sec. 1.954-
5, or the decrease under the provisions of section 955(a)(2) and
paragraph (b) of Sec. 1.955-1, in a controlled foreign corporation's
qualified investments in less developed countries for a taxable year in
the manner provided in such provisions, a United States shareholder of
such controlled foreign corporation may elect, under the provisions of
section 955(b)(3) and this section, to determine such increase in
accordance with the provisions of paragraph (b) of Sec. 1.954-5 and to
determine such decrease by ascertaining the amount by which--
(1) Such controlled foreign corporation's qualified investments in
less developed countries at the close of such taxable year exceed its
qualified investments in less developed countries at the close of the
taxable year immediately following such taxable year, and reducing such
excess by
(2) The amount determined under paragraph (b)(1)(ii) of Sec. 1.955-
1 for such taxable year,
subject to the limitation provided in paragraph (b)(2) of Sec. 1.955-1
for such taxable year. An election under this section may be made with
respect to each controlled foreign corporation with respect to which a
person is a United States shareholder within the meaning of section
951(b), but the election may not be exercised separately with respect to
the increases and the decreases of such controlled foreign corporation.
If an election is made under this section to determine the increase of a
controlled foreign corporation in accordance with the provisions of
paragraph (b) of Sec. 1.954-5, subsequent decreases of such controlled
foreign corporation shall be determined in accordance with this
paragraph and not in accordance with paragraph (b) of Sec. 1.955-1.
(b) Time and manner of making election--(1) Without consent. An
election under this section with respect to a controlled foreign
corporation shall be made without the consent of the Commissioner by a
United States shareholder's filing a statement to such effect with his
return for his taxable year in which or with which ends the first
taxable year of such controlled foreign corporation in which--
(i) Such shareholder owns, within the meaning of section 958(a), or
is considered as owning by applying the rules of ownership of section
958(b), 10 percent or more of the total combined voting power of all
classes of stock entitled to vote of such controlled foreign
corporation, and
(ii) Such controlled foreign corporation realizes foreign base
company income from which amounts are excluded under section 954(b)(1)
and paragraph (b)(1) of Sec. 1.954-1.
The statement shall contain the name and address of the controlled
foreign corporation and identification of such first taxable year of
such corporation. For taxable years of a foreign corporation beginning
after December 31, 1975, no election under this section with respect to
a controlled foreign corporation may be made without the consent of the
Commissioner.
(2) With consent. An election under this section with respect to a
controlled foreign corporation may be made by a United States
shareholder at any time with the consent of the Commissioner. Consent
will not be granted unless the United States shareholder and the
Commissioner agree to the
[[Page 323]]
terms, conditions, and adjustments under which the election will be
effected. Consent will not be granted if the first taxable year of the
controlled foreign corporation with respect to which the shareholder
desires to compute an amount described in section 954(b)(1) in
accordance with the election provided in this section begins after
December 31, 1975. The application for consent to elect shall be made by
the United States shareholder's mailing a letter for such purpose to the
Commissioner of Internal Revenue, Washington, DC 20224. The application
shall be mailed before the close of the first taxable year of the
controlled foreign corporation with respect to which the shareholder
desires to compute an amount described in section 954(b)(1) in
accordance with the election provided in this section. The application
shall include the following information:
(i) The name, address, and taxable year of the United States
shareholder;
(ii) The name and address of the controlled foreign corporation;
(iii) The first taxable year of the controlled foreign corporation
for which income is to be computed under the election;
(iv) The amount of the controlled foreign corporation's qualified
investments in less developed countries at the close of its preceding
taxable year; and
(v) The sum of the amounts excluded under section 954(b)(1) and
paragraph (b)(1) of Sec. 1.954-1 from the foreign base company income
of the controlled foreign corporation for all prior taxable years during
which such shareholder was a United States shareholder of such
corporation and the sum of the amounts of its previously excluded
subpart F income withdrawn from investment in less developed countries
for all prior taxable years during which such shareholder was a United
States shareholder of such corporation.
(c) Effect of election--(1) General. Except as provided in
subparagraphs (3) and (4) of this paragraph, an election under this
section with respect to a controlled foreign corporation shall be
binding on the United States shareholder and shall apply to all
qualified investments in less developed countries acquired, or disposed
of, by such controlled foreign corporation during the taxable year
following its taxable year for which income is first computed under the
election and during all succeeding taxable years of such corporation.
(2) Returns. Any return of a United States shareholder required to
be filed before the completion of a period with respect to which
determinations are to be made as to a controlled foreign corporation's
qualified investments in less developed countries for purposes of
computing such shareholder's taxable income shall be filed on the basis
of an estimate of the amount of the controlled foreign corporation's
qualified investments in less developed countries at the close of the
period. If the actual amount of such investments is not the same as the
amount of the estimate, the United States shareholder shall immediately
notify the Commissioner. The Commissioner will thereupon redetermine the
amount of tax of such United States shareholder for the year or years
with respect to which the incorrect amount was taken into account. The
amount of tax, if any, due upon such redetermination shall be paid by
the United States shareholder upon notice and demand by the district
director. The amount of tax, if any, shown by such redetermination to
have been overpaid shall be credited or refunded to the United States
shareholder in accordance with the provisions of sections 6402 and 6511
and the regulations thereunder.
(3) Revocation. Upon application by the United States shareholder,
the election made under this section may, subject to the approval of the
Commissioner, be revoked. Approval will not be granted unless the United
States shareholder and the Commissioner agree to the terms, conditions,
and adjustments under which the rev- ocation will be effected. Unless
such agreement provides otherwise, the change in the controlled foreign
corporation's qualified investments in less developed countries for its
first taxable year for which income is computed without regard to the
election previously made will be considered to be zero for purposes of
effectuating the revocation. The application for consent to revocation
shall be made by the United
[[Page 324]]
States shareholder's mailing a letter for such purpose to the
Commissioner of Internal Revenue, Washington, DC 20224. The application
shall be mailed before the close of the first taxable year of the
controlled foreign corporation with respect to which the shareholder
desires to compute the amounts described in section 954(b)(1) or 955(a)
without regard to the election provided in this section. The application
may also be filed in a taxable year beginning after December 31, 1975.
The application shall include the following information:
(i) The name, address, and taxpayer identification number of the
United States shareholder;
(ii) The name and address of the controlled foreign corporation;
(iii) The taxable year of the controlled foreign corporation for
which such amounts are to be so computed;
(iv) The amount of the controlled foreign corporation's qualified
investments in less developed countries at the close of its preceding
taxable year;
(v) The sum of the amounts excluded under section 954(b)(1) and
paragraph (b)(1) of Sec. 1.954-1 from the foreign base company income
of the controlled foreign corporation for all prior taxable years during
which such shareholder was a United States shareholder of such
corporation and the sum of the amounts of its previously excluded
subpart F income withdrawn from investment in less developed countries
for all prior taxable years during which such shareholder was a United
States shareholder of such corporation; and
(vi) The reasons for the request for consent to revocation.
(4) Transfer of stock. If during any taxable year of a controlled
foreign corporation--
(i) A United States shareholder who has made an election under this
section with respect to such controlled foreign corporation sells,
exchanges, or otherwise disposes of all or part of his stock in such
controlled foreign corporation, and
(ii) The foreign corporation is a controlled foreign corporation
immediately after the sale, exchange, or other disposition,
then, with respect to the stock so sold, exchanged, or disposed of, the
controlled foreign corporation's acquisitions and dispositions of
qualified investments in less developed countries for such taxable year
shall be considered to be zero. If the United States shareholder's
successor in interest is entitled to and does make an election under
paragraph (b)(1) of this section to determine the controlled foreign
corporation's increase in qualified investments in less developed
countries for the taxable year in which he acquires such stock, such
increase with respect to the stock so acquired shall be determined in
accordance with the provisions of paragraph (b)(1) of Sec. 1.954-5. If
the controlled foreign corporation realizes no foreign base company
income from which amounts are excluded under section 954(b)(1) and
paragraph (b)(1) of Sec. 1.954-1 for the taxable year in which the
United States shareholder's successor in interest acquires such stock
and such successor in interest makes an election under paragraph (b)(1)
of this section with respect to a subsequent taxable year of such
controlled foreign corporation, the increase in the controlled foreign
corporation's qualified investments in less developed countries for such
subsequent taxable year shall be determined in accordance with the
provisions of paragraph (b)(2) of Sec. 1.954-5.
(d) Illustrations. The application of this section may be
illustrated by the following examples:
Example 1. Foreign corporation A is a wholly owned subsidiary of
domestic corporation M. Both corporations use the calendar year as a
taxable year. In a statement filed with its return for 1963, M
Corporation makes an election under section 955(b)(3) and the election
remains in force for the taxable year 1964. At December 31, 1964, A
Corporation's qualified investments in less developed countries amount
to $100,000; and, at December 31, 1965, to $80,000. For purposes of
paragraph (a)(1) of this section, A Corporation's decrease in qualified
investments in less developed countries for the taxable year 1964 is
$20,000 and is determined by ascertaining the amount by which A
Corporation's qualified investments in less developed countries at
December 31, 1964 ($100,000) exceed its qualified investments in less
developed countries at December 31, 1965 ($80,000).
Example 2. The facts are the same as in example 1 except that A
Corporation experiences no changes in qualified investments in less
developed countries during its taxable
[[Page 325]]
years 1966 and 1967. If M Corporation's election were to remain in
force, A Corporation's acquisitions and dispositions of qualified
investments in less developed countries during A Corporation's taxable
year 1968 would be taken into account in determining whether A
Corporation has experienced an increase or a decrease in qualified
investments in less developed countries for its taxable year 1967.
However, M Corporation duly files before the close of A Corporation's
taxable year 1967 an application for consent to revocation of M
Corporation's election under section 955(b)(3), and, pursuant to an
agreement between the Commissioner and M Corporation, consent is granted
by the Commissioner. Assuming such agreement does not provide otherwise,
A Corporation's change in qualified investments in less developed
countries for its taxable year 1967 is zero because the effect of the
revocation of the election is to treat acquisitions and dispositions of
qualified investments in less developed countries actually occurring in
1968 as having occurred in such year rather than in 1967.
Example 3. The facts are the same as in example 2 except that A
Corporation's qualified investments in less developed countries at
December 31, 1968, amount to $70,000. For purposes of paragraph
(b)(1)(i) of Sec. 1.955-1, the decrease in A Corporation's qualified
investments in less developed countries for the taxable year 1968 is
$10,000 and is determined by ascertaining the amount by which A
Corporation's qualified investments in less developed countries at
December 31, 1967 ($80,000) exceed its qualified investments in less
developed countries at December 31, 1968 ($70,000).
Example 4. The facts are the same as in example 1 except that on
September 30, 1965, M Corporation sells 40 percent of the only class of
stock of A Corporation to N Corporation, a domestic corporation.
Corporation N uses the calendar year as a taxable year. Corporation A
remains a controlled foreign corporation immediately after such sale of
its stock. Corporation A's qualified investments in less developed
countries at December 31, 1966, amount to $90,000. The changes in A
Corporation's qualified investments in less developed countries
occurring in its taxable year 1965 are considered to be zero with
respect to the 40-percent stock interest acquired by N Corporation. The
entire $20,000 reduction in A Corporation's qualified investments in
less developed countries which occurs during the taxable year 1965 is
taken into account by M Corporation for purposes of paragraph (a)(1) of
this section in determining its tax liability for the taxable year 1964.
Corporation A's increase in qualified investments in less developed
countries for the taxable year 1965 with respect to the 60-percent stock
interest retained by M Corporation is $6,000 and is determined by
ascertaining M Corporation's pro rata share (60 percent) of the amount
by which A Corporation's qualified investments in less developed
countries at December 31, 1968 ($90,000) exceed its qualified
investments in less developed countries at December 31, 1965 ($80,000).
Corporation N does not make an election under section 955(b)(3) in its
return for its taxable year 1966. Corporation A's increase in qualified
investments in less developed countries for the taxable year 1966 with
respect to the 40-percent stock interest acquired by N Corporation is
$4,000.
[T.D. 6683, 28 FR 11180, Oct. 18, 1963, as amended by T.D. 7893, 48 FR
22509, May 19, 1983; T.D. 7894, 48 FR 22530, May 19, 1983]
Sec. 1.955-4 Definition of less developed country.
(a) Designation by Executive order. For purposes of sections 951
through 964, the term ``less developed country'' means any foreign
country (other than an area within the Sino-Soviet bloc) or any
possession of the United States with respect to which, on the first day
of the foreign corporation's taxable year, there is in effect an
Executive order by the President of the United States designating such
country or possession as an economically less developed country for
purposes of such sections. Each territory, department, province, or
possession of any foreign country other than a country within the Sino-
Soviet bloc may be treated as a separate foreign country for purposes of
such designation if the territory, department, province, or possession
is overseas from the country of which it is a territory, department,
province, or possession. Thus, for example, an overseas possession of a
foreign country may be designated by Executive order as an economically
less developed country even though the foreign country itself has not
been designated as an economically less developed country; or the
foreign country may be so designated even though the overseas
possessions of such country have not been designated as economically
less developed countries. The term ``possession of the United States'',
for purposes of section 955(c)(3) and this section, shall be construed
to have the same meaning as that contained in paragraph (b)(2) of Sec.
1.957-3.
(b) Countries not eligible for designation. Section 955(c)(3)
provides that no designation by Executive order may be
[[Page 326]]
made under section 955(c)(3) and paragraph (a) of this section with
respect to--
Australia
Austria
Belgium
CanadaDenmark
France
Germany(Federal Republic)
Hong Kong
Italy
Japan
Liechtenstein
Luxembourg
Monaco
Netherlands
New Zealand
Norway
Union of South Africa
San Marino
Sweden
Switzerland
United Kingdom.
(c) Termination of designation. Section 955(c)(3) provides that,
after the President has designated any foreign country or possession of
the United States as an economically less developed country for purposes
of sections 951 through 964, he may not terminate such designation
(either by issuing an Executive order for the purpose of terminating
such designation or by issuing an Executive order which has the effect
of terminating such designation) unless, at least 30 days prior to such
termination, he has notified the Senate and the House of Representatives
of his intention to terminate such designation. If such 30-day notice is
given, no action by the Congress of the United States is necessary to
effectuate the termination. The requirement for giving 30-day notice to
the Senate and House of Representatives applies also to the termination
of a designation with respect to an overseas territory, department,
province, or possession of a foreign country. See paragraph (c) of Sec.
1.955-2 for the effect of a termination of a Presidential designation
upon property which would be a qualified investment in a less developed
country but for the fact of such termination.
[T.D. 6683, 28 FR 11182, Oct. 18, 1963]
Sec. 1.955-5 Definition of less developed country corporation.
(a) Less developed country corporation--(1) In general. For purposes
of sections 951 through 964, the term ``less developed country
corporation'' means a foreign corporation described in paragraph (b) of
this section and also any foreign corporation--
(i) Which is engaged in the active conduct of one or more trades or
businesses during the entire taxable year;
(ii) Which derives 80 percent or more of its gross income, if any,
for such taxable year from sources within less developed countries, as
determined under the provisions of Sec. 1.955-6; and
(iii) Which has 80 percent or more in value (within the meaning of
paragraph (d) of this section) of its assets on each day of such taxable
year consisting of one or more of the following items of property:
(a) Property (other than property described in (b) through (h) of
this subdivision) which is used, or held for use, in such trades or
businesses and is located in one or more less developed countries;
(b) Money;
(c) Deposits with persons carrying on the banking business;
(d) Stock of any other less developed country corporation;
(e) Obligations (within the meaning of paragraph (b)(3) of Sec.
1.955-2) of another less developed country corporation which at the time
of their acquisition (within the meaning of paragraph (b)(4) of Sec.
1.955-2) by the foreign corporation have a maturity of one year or more;
(f) Obligations (within the meaning of paragraph (b)(3) of Sec.
1.955-2) of any less developed country;
(g) Investments which are required to be made or held because of
restrictions imposed by the government of any less developed country;
and
(h) Property described in section 956(b)(2).
For purposes of this subparagraph, if a foreign corporation is a partner
in a foreign partnership, as defined in section 7701(a)(2) and (5) and
the regulations thereunder, such corporation will be considered to be
engaged in the active conduct of a trade or business to the extent and
in the manner in which the partnership is so engaged and to own directly
its proportionate share of each of the assets of the partnership. For
purposes of subdivision (i) of this subparagraph, a newly-organized
foreign corporation will be considered engaged in the active conduct of
a trade or business from the date of its organization if such
corporation commences
[[Page 327]]
business operations as soon as practicable after such organization. In
the absence of affirmative evidence showing that the 80-percent
requirement of subdivision (iii) of this subparagraph has not been
satisfied on each day of the taxable year, such requirement will be
considered satisfied if it is established to the satisfaction of the
district director that such requirement has been satisfied on the last
day of each quarter of the taxable year of the foreign corporation. For
purposes of subdivision (iii) of this subparagraph, property (other than
stock in trade or other property of a kind which would properly be
included in inventory of the foreign corporation if on hand at the close
of the taxable year, or property held primarily for sale to customers in
the ordinary course of the trade or business of the foreign corporation)
purchased for use in a trade or business and temporarily located outside
less developed countries will be considered located in less developed
countries if, but only if, such property is shipped to and received in
less developed countries promptly after such purchase.
(2) Special rules. For purposes of subparagraph (1)(iii)(a) of this
paragraph--
(i) Treatment of receivables. Bills receivable, accounts receivable,
notes receivable and open accounts shall be considered to be used in the
trade or business and located in less developed countries if, but only
if--
(a) Such obligations arise out of the rental of property located in
less developed countries, the performance of services within less
developed countries, or the sale of property manufactured, produced,
grown, or extracted in less developed countries, but only to the extent
that the aggregate amount of such obligations at any time during the
taxable year does not exceed an amount which is ordinary and necessary
to carry on the business of both parties to the transactions if such
transactions are between unrelated persons or, if such transactions are
between related persons, an amount which would be ordinary and necessary
to carry on the business of both parties to the transactions if such
transactions were between unrelated persons;
(b) In the case of bills receivable, accounts receivable, notes
receivable, and open accounts arising out of transactions other than
those referred to in (a) of this subdivision--
(1) If the obligor is an individual such individual is a resident of
one or more less developed countries and of no other country which is
not a less developed country;
(2) If the obligor is a corporation which as to the foreign
corporation is a related person as defined in section 954(d)(3) and
paragraph (e) of Sec. 1.954-1, such obligor meets, with respect to the
period ending with the close of its annual accounting period in which
occurs the date on which the obligation is incurred, the 80-percent
gross income requirement of paragraph (b)(1)(ii) of Sec. 1.955-6.
(3) If the obligor is a corporation which as to the foreign
corporation is not a related person as defined in section 954(d)(3) and
paragraph (e) of Sec. 1.954-1, it is reasonable, on the basis of
ascertainable facts, for the obligee to believe that the obligor meets,
with respect to such period, the 80-percent gross income requirement of
paragraph (b)(1)(ii) of Sec. 1.955-6.
(ii) Location of interests in real estate. Interests in real estate
such as leaseholds of land or improvements thereon, mortgages on real
property (including interests in mortgages on leaseholds of land or
improvements thereon), and mineral, oil, or gas interests shall be
considered located in less developed countries if, but only if, the
underlying real estate is located in less developed countries.
(iii) Location of certain other intangibles. Intangible property
(other than any such property described in subdivision (i) or (ii) of
this subparagraph) used in the trade or business of the foreign
corporation shall be considered to be located in less developed
countries in the same ratio that the amount of the foreign corporation's
tangible property and property described in subdivision (i) or (ii) of
this subparagraph used in its trades or businesses and located or deemed
located in less developed countries bears to the total amount of its
tangible property and property described in subdivision (i) or (ii) of
this
[[Page 328]]
subparagraph used in its trades or businesses.
(3) Illustration. The provisions of subparagraph (1) of this
paragraph may be illustrated by the following example:
Example. Foreign corporation A is formed on November 1, 1963, to
engage in the business of manufacturing and selling radios in Brazil, a
less developed country as of November 1, 1963. Corporation A uses the
calendar year as a taxable year. Shortly after it is formed, A
Corporation acquires a plant site and begins construction of a plant
which is completed on August 1, 1964. Corporation A commences business
operations as soon as practicable and continues such operations through
December 31, 1964, and thereafter. Corporation A will be considered for
purposes of subparagraph (1)(i) of this paragraph to be engaged in the
active conduct of a trade or business for its entire taxable years
ending on December 31, 1963, and 1964. The plant site and the plant
(while under construction and after completion) will be considered to be
property held during such taxable years for use in A Corporation's trade
or business.
(b) Shipping companies. For purposes of sections 951 through 964,
the term ``less developed country corporation'' also means any foreign
corporation--
(1) Which has 80 percent or more of its gross income, if any, for
the taxable year consisting of one or more of--
(i) Gross income derived--
(a) From, or in connection with, the using (or hiring or leasing for
use) in foreign commerce of aircraft or vessels registered under the
laws of a less developed country,
(b) From, or in connection with, the performance of services
directly related to the use in foreign commerce of aircraft or vessels
registered under the laws of a less developed country, or
(c) From the sale or exchange of aircraft or vessels registered
under the laws of a less developed country and used in foreign commerce
by such foreign corporation;
(ii) Dividends and interest received or accrued from other foreign
corporations which are less developed country corporations within the
meaning of this paragraph and 10 percent or more of the total combined
voting power of all classes of stock of which is owned at the time such
dividends and interest are so received or accrued by such foreign
corporation; and
(iii) Gain from the sale or exchange of stock or obligations of
other foreign corporations which are less developed country corporations
within the meaning of this paragraph and 10 percent or more of the total
combined voting power of all classes of stock of which is owned by such
foreign corporation immediately before such sale or exchange; and
(2) Which has 80 percent or more in value (within the meaning of
paragraph (d) of this section) of its assets on each day of the taxable
year consisting of--
(i) Assets used, or held for use, for the production of income
described in subparagraph (1) of this paragraph, or in connection with
the production of such income, whether or not such income is received
during the taxable year, and
(ii) Property described in section 956(b)(2).
In the absence of affirmative evidence showing that the 80-percent
requirement of this subparagraph has not been satisfied on each day of
the taxable year such requirement will be considered satisfied if it is
established to the satisfaction of the district director that such
requirement has been satisfied on the last day of each quarter of the
taxable year of the foreign corporation. The provisions of this
subparagraph may be illustrated by the following example:
Example. Foreign corporation A is formed on November 1, 1963, for
the purpose of constructing and operating a vessel and, on that date,
enters a charter agreement which provides that such vessel will be
registered under the laws of Liberia, a less developed country as of
November 1, 1963, and operated between South American and European
ports. Corporation A uses the calendar year as a taxable year.
Construction of the vessel is completed on September 1, 1965, and the
vessel is registered under the laws of Liberia and operated between
South American and European ports through December 31, 1965, and
thereafter. The charter and the vessel (while under construction and
after completion), or any interest of A Corporation in such assets, will
be considered assets which are held by A Corporation during its taxable
years ending on December 31, 1963, 1964, and 1965, for use in the
production of income described in subparagraph (1) of this paragraph.
(c) Determination of stock ownership. In determining for purposes of
paragraph (b)(1)(ii) and (iii) of this section
[[Page 329]]
whether a foreign corporation owns 10 percent or more of the total
combined voting power of all classes of stock of a less developed
country corporation, only stock owned directly by such foreign
corporation shall be taken into account and the provisions of section
958 and the regulations thereunder shall not apply. See section
958(a)(1).
(d) Determination of value. For purposes of paragraphs (a)(1)(iii)
and (b)(2) of this section--
(1) General. Except as provided in subparagraph (2) of this
paragraph, the value at which property shall be taken into account is
its actual value (not reduced by liabilities) which, in the absence of
affirmative evidence to the contrary, shall be deemed to be its adjusted
basis.
(2) Treatment of certain receivables. The value at which receivables
described in paragraph (a)(2)(i) of this section and held by a foreign
corporation using the cash receipts and disbursements method of
accounting shall be taken into account is their actual value (not
reduced by liabilities) which, in the absence of affirmative evidence to
the contrary, shall be deemed to be their face value.
[T.D. 6683, 28 FR 11182, Oct. 18, 1963]
Sec. 1.955-6 Gross income from sources within less developed countries.
(a) General. For purposes of paragraph (a)(1)(ii) of Sec. 1.955.5,
the determination whether a foreign corporation has derived 80 percent
or more of its gross income from sources within less developed countries
for any taxable year shall be made by the application of the provisions
of sections 861 through 864, and Sec. Sec. 1.861-1 through 1.863-5, in
application of which the name of a less developed country shall be
substituted for ``the United States'', except that if income is derived
by the foreign corporation from--
(1) Interest (other than interest to which subparagraph (3) of this
paragraph applies), the rules set forth in paragraph (b) of this section
shall apply;
(2) Dividends, the rules set forth in paragraph (c) of this section
shall apply; or
(3) Income (including interest) derived in connection with the sale
of tangible personal property, the rules set forth in paragraph (d) of
this section shall apply.
The source of income described in subparagraph (1), (2), or (3) of this
paragraph shall be determined solely under the rules of this section and
without regard to the rules of sections 861 through 864, and the
regulations thereunder.
(b) Interest--(1) In general. Except as provided in subparagraph (2)
of this paragraph and paragraph (d) of this section, gross income
derived by the foreign corporation from interest on any indebtedness--
(i) Of an individual shall be treated as income from sources within
a less developed country if, but only if, such individual is a resident
of one or more less developed countries and of no other country which is
not a less developed country.
(ii) Of a corporation shall be treated as income from sources within
less developed countries if, but only if, 80 percent or more of the
gross income of the payer corporation for the 3-year period ending with
the close of its annual accounting period in which such interest is
paid, or for such part of such 3-year period as such corporation has
been in existence, or for such part of such 3-year period as occurs on
and after the beginning of such corporation's first annual accounting
period beginning after December 31, 1962, whichever period is shortest,
was derived from sources within less developed countries as determined
in accordance with the principles of this section; or
(iii) Of a less developed country, including obligations issued or
guaranteed by the government of such country or of a political
subdivision thereof and obligations of any agency or instrumentality of
such country, in which such country is financially committed shall be
treated as income from sources within such country.
(2) Special rule. Gross income derived by the foreign corporation
from interest on obligations of the United States shall be treated as
income from sources within less developed countries without regard to
the provisions of subparagraph (1) of this paragraph.
(3) Payers other than related persons. For purposes of subparagraph
(1)(ii) of
[[Page 330]]
this paragraph, a payer corporation which as to the recipient
corporation is not a related person as defined in section 954(d)(3) and
paragraph (e) of Sec. 1.954-1 shall be deemed to have satisfied the 80-
percent gross income requirement if, on the basis of ascertainable
facts, it is reasonable for the recipient corporation to believe that
such requirement is satisfied.
(c) Dividends--(1) In general. Gross income derived by the foreign
corporation from dividends, as defined in section 316 and the
regulations thereunder, shall be treated as income from sources within
less developed countries if, but only if, 80 percent or more of the
gross income of the payer corporation for the 3-year period ending with
the close of its annual accounting period in which such dividends are
distributed, or for such part of such 3-year period as such corporation
has been in existence, or for such part of such 3-year period as occurs
on and after the beginning of such corporation's first annual accounting
period beginning after December 31, 1962, whichever period is shortest,
was derived from sources within less developed countries as determined
in accordance with the principles of this section.
(2) Payers other than related persons. See paragraph (b)(3) of this
section for rule governing satisfaction of the 80-percent gross income
requirement by payers other than related persons.
(d) Sale of tangible personal property--(1) In general. Income
(whether in the form of profits, commissions, fees, interest, or
otherwise) derived by the foreign corporation in connection with the
sale of tangible personal property shall be treated as income from
sources within less developed countries if, but only if--
(i) Such property is produced (within the meaning of subparagraph
(2) of this paragraph) within less developed countries; or
(ii) Such property is sold for use, consumption, or disposition
within less developed countries even though produced outside less
developed countries and the selling corporation is engaged within less
developed countries, in connection with sales of such property, in
continuous operational activities which are substantial in relation to
such sales, as evidenced, for example, by the maintenance within less
developed countries of a substantial sales or service organization or
substantial facilities for the storage, handling, transportation,
assembly, packaging, or servicing of such property.
(2) Production defined. For purposes of this paragraph, the term
``produced'' means manufactured, grown, extracted, or constructed and
includes a substantial transformation of property purchased for resale
or the manufacture of a product when purchased components constitute
part of the property which is sold. See paragraph (a)(4)(ii) and (iii)
of Sec. 1.954-3 for a statement and illustration of the principles set
forth in the preceding sentence.
[T.D. 6683, 28 FR 11183, Oct. 18, 1963, as amended by T.D. 6688, 28 FR
11632, Oct. 31, 1963]
Sec. 1.955A-1 Shareholder's pro rata share of amount of previously
excluded subpart F income withdrawn from investment in foreign base
company shipping operations.
(a) In general. Section 955 provides rules for determining the
amount of a controlled foreign corporation's previously excluded subpart
F income which is withdrawn for any taxable year beginning after
December 31, 1975, from investment in foreign base company shipping
operations. Pursuant to section 951(a)(1)(A)(iii) and the regulations
thereunder, a United States shareholder of such controlled foreign
corporation must include in his gross income his pro rata share of such
amount as determined in accordance with paragraph (c) of this section.
(b) Amount withdrawn by controlled foreign corporation--(1) In
general. For purposes of sections 951 through 964, the amount of a
controlled foreign corporation's previously excluded subpart F income
which is withdrawn for any taxable year from investment in foreign base
company shipping operations is an amount equal to the decrease for such
year in such corporation's qualified investments in foreign base company
shipping operations. Such decrease is, except as provided in Sec.
1.955A-4--
(i) An amount equal to the excess of the amount of its qualified
investments
[[Page 331]]
in foreign base company shipping operations at the close of the
preceding taxable year over the amount of its qualified investments in
foreign base company shipping operations at the close of the taxable
year, minus
(ii) The amount (if any) by which recognized losses on sales or
exchanges by such corporation during the taxable year of qualified
investments in foreign base company shipping operations exceed its
recognized gains on sales or exchanges during such year of qualified
investments in foreign base company shipping operations,
but only to the extent that the net amount so determined does not exceed
the limitation determined under subparagraph (2) of this paragraph. See
Sec. 1.955A-2 for determining the amount of qualified investments in
foreign base company shipping operations.
(2) Limitation applicable in determining decreases--(i) In general.
The limitation referred to in subparagraph (i) of this paragraph for any
taxable year of a controlled foreign corporation shall be the lesser of
the following two limitations:
(A) The sum of (1) the controlled foreign corporation's earnings and
profits (or deficit in earnings and profits) for the taxable year,
computed as of the close of the taxable year without diminution by
reason of any distribution made during the taxable year, (2) the sum of
its earnings and profits (or deficits in earnings and profits)
accumulated for prior taxable years beginning after December 31, 1975,
and (3) the amount described in subparagraph (3) of this paragraph; or
(B) The sum of the amounts excluded under section 954(b)(2) (see
subparagraph (4) of this paragraph) from the foreign base company income
of such corporation for all prior taxable years beginning after December
31, 1975, minus the sum of the amounts (determined under this paragraph)
of its previously excluded subpart F income withdrawn from investment in
foreign base company shipping operations for all such prior taxable
years.
(C) For purposes of the immediately preceding subparagrah (B), the
amount excluded under section 954(b)(2) for a taxable year of a
controlled foreign corporation (the ``first corporation'') includes (1)
an amount excluded under section 954(b)(2) by another corporation which
is a member of a related group (as defined in Sec. 1.955A-3(b)(1))
attributable to the first corporation's excess investment (see Sec.
1.955A-3(c)(4)) for a taxable year beginning after December 31, 1983,
(2) an amount excluded by a corporation under Sec. 1.954-1(b)(4)(ii)(b)
by reason of the application of the carryover rule there set forth, and
(3) an amount equal to the first corporation's pro rata share of a group
excess deduction (see Sec. 1.955A-3(c)(2)) of a related group for a
taxable year beginning after December 31, 1983 (but not in excess of
that portion of such pro rata share which would reduce the first
corporation's foreign base company shipping income to zero). Such
amounts will not be treated as excluded under section 954(b)(2) by any
other corporation.
(ii) Certain exclusions from earnings and profits. For purposes of
determining the earnings and profits of a controlled foreign corporation
under subdivision (i)(A)(1) and (2) of this subparagraph, such earnings
and profits shall be considered not to include any amounts which are
attributable to--
(A)(1) Amounts which, for the current taxable year, are included in
the gross income of a United States shareholder of such controlled
foreign corporation under section 951(a)(1)(A)(i), or
(2) Amounts which, for any prior taxable year, have been included in
the gross income of a United States shareholder of such controlled
foreign corporation under section 951(a) and have not been distributed;
or
(B)(1) Amounts which, for the current taxable year, are included in
the gross income of a United States shareholder of such controlled
foreign corporation under section 551(b) or would be so included under
such section but for the fact that such amounts were distributed to such
shareholder during the taxable year, or
(2) Amounts which, for any prior taxable year, have been included in
the gross income of a United States shareholder of such controlled
foreign corporation under section 551(b) and have not been distributed.
[[Page 332]]
The rules of this subdivision apply only in determining the limitation
on a controlled foreign corporation's decrease in qualified investments
in foreign base company shipping operations. See section 959 and the
regulations thereunder for rules relating to the exclusion from gross
income of previously taxed earnings and profits.
(3) Carryover of amounts relating to investments in less developed
country shipping companies--(i) In general. The amount described in this
subparagraph for any taxable year of a controlled foreign corporation
beginning after December 31, 1975, is the lesser of--
(A) The excess of the amount described in subdivision (ii) of this
subparagraph, over the amount described in subdivision (iii) of this
subparagraph, or
(B) The limitation determined under subdivision (iv) of this
subparagraph.
(ii) Previously excluded subpart F income invested in less developed
country shipping companies. The amount described in this subdivision for
all taxable years of a controlled foreign corporation beginning after
December 31, 1975, is the lesser of--
(A) The amount of such corporation's qualified investments
(determined under Sec. 1.955-2 other than paragraph (b)(5) thereof) in
less developed country shipping companies described in Sec. 1.955-5(b)
at the close of the last taxable year of such corporation beginning
before January 1, 1976, or
(B) The limitation determined under Sec. 1.955-1(b)(2)(i)(b)
(relating to previously excluded subpart F income) for the first taxable
year of such corporation beginning after January 1, 1976.
(iii) Amounts previously carried over. The amount described in this
subdivision for any taxable year of a controlled foreign corporation
shall be the sum of the excesses determined for each prior taxable year
beginning after December 31, 1976, of--
(A) The amount (determined under this paragraph) of such
corporation's previously excluded subpart F income withdrawn from
investment in foreign base company shipping operations, over
(B) The sum of the earnings and profits determined under
subparagraph (2)(i)(A)(1) and (2) of this paragraph.
(iv) Extent attributable to accumulated earnings and profits. The
limitation determined under this subdivision for any taxable year of a
controlled foreign corporation is the sum of such controlled foreign
corporation's earnings and profits (or deficits in earnings and profits)
accumulated for taxable years beginning after December 31, 1962, and
before January 1, 1976. For purposes of the preceding sentence, earnings
and profits shall be determined by excluding the amounts described in
subparagraph (2)(ii)(A) and (B) of this paragraph.
(v) Illustration. The application of this subparagraph may be
illustrated by the following example:
Example. (a) Throughout the period here involved, A is a United
States shareholder of controlled foreign corporation M. M is not a
foreign personal holding company, and M uses the calendar year as the
taxable year.
(b) The amount described in this subparagraph for M's taxable year
1978 with respect to A is determined as follows, based on the facts
shown in the following table:
(1) Investment in less developed country shipping companies $10,000
on December 31, 1975 (subdivision (ii)(A) amount).........
(2) Sec. 1.955-1(b)(2)(i)(b) limitation for 1976 50,000
(previously excluded subpart F income not withdrawn from
investment in less developed countries) (subdivision
(ii)(B) amount)...........................................
(3) Subdivision (ii) amount (lesser of lines (1) and (2)).. 10,000
(4) Subdivision (iii) amount: Excess for 1977 of M's 2,000
previously excluded subpart F income withdrawn from
investment in foreign base country shipping operations,
$3,000, over the sum of the amounts determined under
subparagraphs (2)(i)(A)(1) and (2) of this paragraph,
$1,000....................................................
------------
(5) Excess of line (3) over line (4)....................... 8,000
============
(6) Sum of M's earnings and profits accumulated for 1962 26,000
through 1975, determined on December 31, 1978.............
(7) Amount described in this subparagraph for 1978 (lesser 8,000
of line (5) and line (6)).................................
============
(c) For 1978, M's earnings and profits (reduced as provided in Sec.
1.955-1(b)(2)(ii)(a)(1)) are $19,000, and the amount of M's previously
excluded subpart F income withdrawn from investment in less developed
countries determined under Sec. 1.955-1(b)) is $42,000. Consequently,
$23,000 of M's earnings and profits accumulated for 1962 through 1975
are attributable to such $42,000 amount, and will therefore be excluded
under subparagraph (2)(ii))(A)(2) of this paragraph from M's earnings
and profits accumulated for 1962 through 1975, determined as of December
31, 1979. No other portion of M's earnings and
[[Page 333]]
profits accumulated for 1962 through 1975 is distributed or included in
the gross income of a United States shareholder in 1978.
(d) The amount described in this subparagraph for M's taxable year
1979 with respect to A is determined as follows, based on the additional
facts shown in the following table:
(1) Subdivision (ii) amount (line (3) from paragraph (b) of $10,000
this example).............................................
(2) Subdivision (iii) amount: (i) Excess for 1977 from line 2,000
(4) of paragraph (b) of this example......................
(ii) Plus: excess for 1978 of M's previously excluded 0
subpart F income withdrawn from investment in foreign
base country shipping operations, $6,000, over the
sum of the amounts determined under subparagraphs
(2)(i)(A)(1) and (2) of this paragraph, $25,000......
-------
(iii) Subdivision (iii) amount........................... 2,000
------------
(3) Excess of line (1) over line (2)(iii).................. 8,000
============
(4) Sum of M's earnings and profits accumulated for 1962 3,000
through 1975, determined on December 31, 1979 ($26,000
minus $23,000)............................................
(5) Amount described in this subparagraph for 1979 (lesser 3,000
of line (3) and line (4)).................................
============
(4) Amount excluded. For purposes of subparagraph (2)(i)(B) of this
paragraph, the amount excluded under section 954(b)(2) from the foreign
base company income of a controlled foreign corporation for any taxable
year beginning after December 31, 1975, is the excess of--
(i) The amount which would have been equal to the subpart F income
of such corporation for such taxable year if such corporation had had no
increase in qualified investments in foreign base company shipping
operations for such taxable year, over
(ii) The subpart F income of such corporation for such taxable year.
(c) Shareholder's pro rata share of amount withdrawn by controlled
foreign corporation--(1) In general. A United States shareholder's pro
rata share of a controlled foreign corporation's previously excluded
subpart F income withdrawn for any taxable year from investment in
foreign base company shipping operations is his pro rata share of the
amount withdrawn for such year by such corporation, as determined under
paragraph (b) of this section. See section 955(a)(3). Such pro rata
share shall be determined in accordance with the principles of Sec.
1.195-1(e).
(2) Special rule. A United States shareholder's pro rata share of
the net amount determined under paragraph (b)(2)(i)(B) of this section
with respect to any stock of the controlled foreign corporation owned by
such shareholder shall be determined without taking into account any
amount attributable to a period prior to the date on which such
shareholder acquired such stock. See section 1248 and the regulations
thereunder for rules governing treatment of gain from sales or exchanges
of stock in certain foreign corporations.
(d) Illustrations. The application of this section may be
illustrated by the following examples:
Example 1. A, a United States shareholder, owns 60 percent of the
only class of stock of M Corporation, a controlled foreign coporation
throughout the entire period here involved. Both A and M use the
calendar year as a taxable year. The amount of M's previously excluded
subpart F income withdrawn for 1978 from investment in foreign base
company shipping operations is $40,000, and A's pro rata share of such
amount is $24,000 determined as follows based on the facts shown in the
following table:
(a) Qualified investments in foreign base company shipping $125,000
operations at the close of 1977...........................
(b) Less: qualified investments in foreign base company 75,000
shipping operations at the close of 1978..................
------------
(c) Balance................................................ 50,000
(d) Less: excess of recognized losses ($15,000) over 10,000
recognized gains ($5,000) on sales during 1978 of
qualified investments in foreign base company shipping
operations................................................
------------
(e) Tentative decrease in qualified investment in foreign 40,000
base company shipping operations for 1978.................
============
(f) Earnings and profits for 1976, 1977, and 1978.......... 45,000
(g) Plus: amount determined under paragraph (b)(3) of this 0
section...................................................
------------
(h) Earnings and profits limitation........................ 45,000
============
[[Page 334]]
(i) Excess of amount excluded under section 954(b)(2) from 50,000
foreign base company income for 1976 ($75,000) over amount
of previously excluded subpart F income withdrawn for 1977
from investment in foreign base company shipping
operations ($25,000)......................................
(j) M's amount of previously excluded subpart F income 40,000
withdrawn for 1978 from investment in foreign base company
shipping operations (item (e), but not to exceed the
lesser of item (h) or item (i)............................
(k) A's pro rata share of M Corporation's amount of 24,000
previously excluded subpart F in come withdrawn for 1978
from investment in foreign base company shipping
operations (60 percent of $40,000)........................
============
Example 2. The facts are the same as in example 1, except that M's
earnings and profits (determined under paragraph (b)(2) of this section)
for 1976, 1977, and 1978 (item (f)) are $30,000 instead of $45,000. M's
amount of previously excluded subpart F income withdrawn for 1978 from
investment in foreign base company shipping operations is $30,000. A's
pro rata share of such amount is $18,000 (60 percent of $30,000).
Example 3. The facts are the same as in example 1, except that the
excess of the amount excluded under section 954(b)(2) for 1976 from M
Corporation's foreign base company income over the amount of its
previously excluded subpart F income withdrawn for 1977 from investment
in foreign base company shipping operations (item (i)) is $20,000
instead of $50,000. M's amount of previously excluded subpart F income
withdrawn for 1978 from investment in foreign base company shipping
operations is $20,000. A's pro rata share of such amount is $12,000 (60
percent of $20,000).
[T.D. 7894, 48 FR 22530, May 19, 1983; 48 FR 40888, Sept. 12, 1983]
Sec. 1.955A-2 Amount of a controlled foreign corporation's qualified
investments in foreign base company shipping operations.
(a) Qualified investments--(1) In general. Under section 955(b), for
purposes of sections 951 through 964, a controlled foreign corporation's
``qualified investments in foreign base company shipping operations''
are investments in--
(i) Any aircraft or vessel, to the extent that such aircraft or
vessel is used (or hired or leased for use) in foreign commerce,
(ii) Related shipping assets (within the meaning of paragraph (b) of
this section),
(iii) Stock or obligations of a related controlled foreign
corporation, to the extent provided in paragraph (c) of this section,
(iv) A partnership, to the extent provided in paragraph (d) of this
section, and
(v) Stock or obligations of a less developed country shipping
company described in Sec. 1.955-5(b), as provided in paragraph (h) of
this section.
(2) Coordination of provisions. No amount shall be counted as a
qualified investment in foreign base company shipping operations under
more than one provision of this section. Thus, for example, if a $10,000
investment in stock of a controlled foreign corporation is treated as a
qualified investment in foreign base company shipping operations under
both subparagraphs (1)(iii) and (v) of this paragraph, then such $10,000
is counted only once as a qualified investment in foreign base company
shipping operations.
(3) Definitions. If the meaning of any term is defined or explained
in Sec. 1.954-6, then such term shall have the same meaning when used
in this section.
(4) Extent of use. (i) For purposes of subparagraph (1)(i) of this
paragraph and paragraph (b)(1) of this section, the extent to which an
asset of a controlled foreign corporation is used during a taxable year
in foreign base company shipping operations shall be determined on the
basis of the proportion for such year which the foreign base company
shipping income derived from the use of such asset bears to the total
gross income derived from the use of such asset.
(ii) For purposes of determining under subdivision (i) of this
subparagraph the amounts of foreign base company shipping income and
gross income of a controlled foreign corporation--
(A) Such amounts shall be deemed to include an arm's length charge
(see Sec. 1.954-6(h)(5)) for services performed by such corporation for
itself,
(B) Such amounts shall be deemed to include an arm's length charge
for the use of an asset (such as a vessel under
[[Page 335]]
construction or laid up for repairs) which is held for use in foreign
base company shipping operations, but is not actually so used,
(C) Foreign base company shipping income shall be deemed to include
amounts earned in taxable years beginning before January 1, 1976, and
(D) The district director shall make such other adjustments to such
amounts as are necessary to properly determine the extent to which any
asset is used in foreign base company shipping operations.
(b) Related shipping assets--(1) In general. For purposes of this
section, the term ``related shipping asset'' means any asset which is
used (or held for use) for or in connection with the production of
income described in Sec. 1.954-6(b)(1)(i) or (ii), but only to the
extent that such asset is so used (or is so held for use).
(2) Examples. Examples of assets of a controlled foreign corporation
which are used (or held for use) for or in connection with the
production of income described in subparagraph (1) of this paragraph
include--
(i) Money, bank deposits, and other temporary investments which are
reasonably necessary to meet the working capital requirements of such
corporation in its conduct of foreign base company shipping operations,
(ii) Accounts receivable and evidences of indebtedness which arise
from the conduct of foreign base company shipping operations by such
corporation or by a related person,
(iii) Amounts (other than amounts described in subdivision (i) of
this subparagraph) deposited in bank accounts or invested in readily
marketable securities pursuant to a specific, definite, and feasible
plan to purchase any tangible asset for use in foreign base company
shipping operations,
(iv) Amounts paid into escrow to secure the payment of (A) charter
hire for an aircraft, vessel, or other asset used in foreign base
company shipping operations or (B) a debt which constitutes a specific
charge against such an asset,
(v) Capitalized expenditures (such as progress payments) made under
a contract to purchase any asset for use in foreign base company
shipping operations,
(vi) Prepaid expense and deferred charges incurred in the course of
foreign base company shipping operations,
(vii) Stock acquired and retained to insure a source of supplies or
services used in the conduct of foreign base company shipping
operations, and
(viii) Currency futures acquired and retained as a hedge against
international currency fluctuations in connection with foreign base
company shipping operations.
(3) Limitations--(i) Vessels generally. Notwithstanding any other
provision of this paragraph, the term ``related shipping assets'' does
not include any money or other intangible assets of a controlled foreign
corporation, to the extent that such assets are permitted to accumulate
in excess of the reasonably anticipated needs of the business.
(ii) Safe harbor. If a controlled foreign corporation accumulates
money or other intangible assets pursuant to a plan to purchase one or
more vessels for use in foreign commerce, and if--
(A) The amount so accumulated, plus
(B) The sum of the amounts accumulated by other controlled foreign
corporations which are related persons (within the meaning of section
954(d)(3)) pursuant to similar plans, does not exceed 110 percent of a
reasonable down payment on each vessel planned to be purchased within a
reasonable period, then such plan will be considered to be feasible. For
purposes of the preceding sentence, a reasonable down payment shall not
exceed 28 percent of the total cost of acquisition. The determination
dates applicable to the taxable year of a controlled foreign corporation
are those set forth in paragraph (c)(2)(ii) of this section. In the case
of accumulation of assets which do not come within the safe harbor
limitation of this subdivision (ii), in determining whether such assets
have accumulated beyond the reasonably anticipated needs of the
business, factors to be taken into account include, but are not limited
to, the availability of financing to purchase a vessel and the
availability of a vessel suitable for the purposes to which the vessel
is to be put.
[[Page 336]]
(iii) Other assets. In determining whether a plan to purchase any
asset other than a vessel for use in foreign base company shipping
operations is feasible, principles similar to those stated in
subdivision (ii) of this subparagraph shall be applied.
(4) Cross-reference. See Sec. 1.954-7(c) for additional
illustrations bearing on the application of this paragraph.
(c) Stock and obligations--(1) In general. Investments by a
controlled foreign corporation (the ``first corporation'') in stock or
obligations of a second controlled foreign corporation which is a
related person (within the meaning of section 954(d)(3) are considered
to be qualified investments in foreign base company shipping operations
to the extent that the assets of such second corporation are used (or
held for use) in foreign base company shipping operations. See
subparagraph (2) of this paragraph. However, an investment in an
obligation of the second corporation will not be considered a qualified
investment in foreign base company shipping operations if the obligation
represents a liability which constitutes a specific charge (nonrecourse
or otherwise) against an asset of the second corporation which is not
either--
(i) An aircraft or vessel used (or held for use) to some extent in
foreign commerce, or
(ii) An asset described in paragraphs (a)(1)(ii) through (v) of this
section.
(2) Extent of use. On any determination date applicable to a taxable
year of the first corporation, the extent to which the assets of the
second corporation are used in foreign base company shipping operations
shall be determined on the basis of the proportion which the amount of
such second corporation's qualified investments in foreign base company
shipping operations bears to its net worth, such proportion to be
determined at the close of the second corporation's last taxable year
which ends on or before such determination date. For purposes of the
preceding sentence--
(i) A controlled foreign corporation's net worth is the total
adjusted basis of the corporate assets reduced by the total outstanding
principal amount of the corporate liabilities, and
(ii) The determination dates applicable to a taxable year of a
controlled foreign corporation are--
(A) Except as provided in (B) of this subdivision, the close of such
taxable year and the close of the preceding taxable year, and
(B) With respect to a United States shareholder who has made an
election under section 955(b)(3) to determine such corporation's
increase in qualified investments in foreign base company shipping
operations at the close of the following taxable year, the close of such
taxable year and the close of the taxable year immediately following
such taxable year.
(3) Illustrations. The application of this paragraph may be
illustrated by the following examples:
Example 1. On December 31, 1976, controlled foreign corporation X
owns 100 percent of the single class of stock of controlled foreign
corporation Y. X and Y both use the calendar year as the taxable year.
On December 31, 1976, Y's assets consist of a vessel used in foreign
commerce, related shipping assets, and other assets unrelated to its
foreign base company shipping operations. On such date Y has qualified
investments in foreign base company shipping operations (determined
under paragraph (g) of this section) of $60,000, and a net worth of
$100,000. If X's investment in the stock of Y is $50,000, then $30,000
of such amount, i.e.,
[GRAPHIC] [TIFF OMITTED] TC09OC91.012
is a qualified investment in foreign base company shipping operations.
Example 2. The facts are the same as in example 1, except that on
December 31, 1976, Y's assets consist entirely of a vessel used in
foreign commerce and related shipping assets, Y has qualified
investments in foreign base company shipping operations (determined
under paragraph (g) of this section) of $16,000 and (therefore) a net
worth of $16,000. If X's investment in the stock of Y is $50,000, then
the entire $50,000, i.e.,
[GRAPHIC] [TIFF OMITTED] TC09OC91.013
is a qualified investment in foreign base company shipping operations.
Example 3. On December 31, 1980, controlled foreign corporation J
owns two notes of controlled foreign corporation K, which is a related
person (within the meaning of section 954(d)(3)). Both J and K use the
calendar year as the taxable year. J's adjusted basis in
[[Page 337]]
each of the two notes is $100,000. The first note is secured only by the
general credit of K. The second note is secured by (and, therefore,
constitutes a specific charge on) a hotel owned by K in a foreign
country. On December 31, 1980, K has qualified investments in foreign
base company shipping operation with an adjusted basis of $500,000
(before applying the rules of paragraph (g) of this section). The
adjusted basis of all of K's corporate assets is $1,100,000. K's only
liabilities are the two notes. The amount of K's qualified investments
in foreign base company shipping operations (determined under paragraph
(g) of this section) is $450,000. K's net worth is $900,000. The amount
of J's qualified investment in foreign base company shipping operations
in respect of the first note is $50,000, i.e.,
[GRAPHIC] [TIFF OMITTED] TC09OC91.014
The amount of J's qualified investment in respect of the second note is
zero (see the last sentence of paragraph (c)(1) of this section).
(d) Partnerships--(1) In general. A controlled foreign corporation's
investment in a partnership at the close of any taxable year of such
corporation shall be considered a qualified investment in foreign base
company shipping operations to the extent of the proportion which such
corporation's foreign base company shipping income for such taxable year
would bear to its gross income for such taxable year if--
(i) Such corporation had realized no income other than its
distributive share of the partnership gross income, and
(ii) Such corporation's income were adjusted in accordance with the
rules stated in paragraphs (a)(4)(ii)(B) and (D) of this section.
(2) Transitional rule. For purposes of subparagraph (1)(i) of this
paragraph, the controlled foreign corporation's distributive share of
the partnership gross income shall not include any amount attributable
to income earned by the partnership before the first day of such
corporation's first taxable year beginning after December 31, 1975.
(3) Cross-reference. See paragraph (g)(4) of this section for rules
relating to the determination of the amount of a controlled foreign
corporation's investment in a partnership.
(e) Trusts--(1) In general. An investment in a trust is not a
qualified investment in a foreign base company shipping operations.
(2) Grantor trusts. Notwithstanding subparagraph (1) of this
pargraph, if a controlled foreign corporation is treated as the owner of
any portion of a trust under subpart E of part I of subchapter J
(relating to grantors and others treated as substantial owners), then
for purposes of this section such controlled foreign corporation is
deemed to be the actual owner of such portion of the assets of the
trust. Accordingly, its investments in such assets (as determined under
paragraph (g)(5) of this section) may be treated as a qualified
investment in foreign base company shipping operations.
(3) Definitions. For purposes of this section, the term ``trust''
means a trust as defined in Sec. 301.7701-4.
(f) Excluded property. For purposes of paragraph (a) of this
section, property acquired principally for the purpose of artificially
increasing the amount of a controlled foreign corporation's qualified
investments in foreign base company shipping operations will not be
recognized; whether an item of property is acquired principally for such
purpose will depend upon all the facts and circumstances of each case.
One of the factors that will be considered in making such a
determination with respect to an item of property is whether the item is
disposed of within 6 months after the date of its acquisition.
(g) Amount attributable to property--(1) General rule. For purposes
of this section, the amount taken into account under section 955(b)(4)
with respect to any property which constitutes a qualified investment in
foreign base company shipping operations shall be its adjusted basis as
of the applicable determination date, reduced by the outstanding
principal amount of any liability (other than a liability described in
subparagraph (2) of this paragraph) to which such property is subject on
such date including a liability secured only by the general credit of
the controlled foreign corporation. Liabilities shall be taken into
account in the following order:
(i) The adjusted basis of each and every item of corporate property
shall
[[Page 338]]
be reduced by any specific charge (non-recourse or otherwise) to which
such item is subject. For this purpose, if a liability constitutes a
specific charge against several items of property and cannot definitely
be allocated to any single item of property, the specific charge shall
be apportioned against each of such items of property in that ratio
which the adjusted basis of such item on the applicable determination
date bears to the adjusted basis of all such items on such date. The
excess against property over the adjusted basis of such property shall
be taken into account as a liability secured only by the general credit
of the corporation.
(ii) A liability which is evidenced by an open account or which is
secured only by the general credit of the controlled foreign corporation
shall be apportioned against each and every item of corporate property
in that ratio which the adjusted basis of such item on the applicable
determination date (reduced as provided in subdivision (i) of this
subparagraph) bears to the adjusted basis of all the corporate property
on such date (reduced as provided in subdivision (i) of this
subparagraph); provided that no liability shall be apportioned under
this subdivision against any stock or obligations described in paragraph
(h)(1) of this section.
(2) Excluded charges. For purposes of subparagraph (1) of this
paragraph, a liability created principally for the purpose of
artificially increasing or decreasing the amount of a controlled foreign
corporation's qualified investments in foreign base company shipping
operations will not be recognized. Whether a liability is created
principally for such purpose will depend upon all the facts and
circumstances of each case. One of the factors that will be considered
in making such a determination with respect to a loan is whether the
loan was both created after November 20, 1974, and is from a related
person, as defined in section 954(d)(3) and paragraph (e) of Sec.
1.954-1. Another such factor is whether the liability was created after
March 29, 1975, in a taxable year beginning before January 1, 1976. For
purposes of this paragraph (g)(2), payments on liabilities which are
represented by an open account are credited against the account
transactions arising earliest in time.
(3) Statement required. If for purposes of this section the adjusted
basis of property which constitutes a qualified investment in foreign
base company shipping operations by a controlled foreign corporation is
reduced on the ground that such property is subject to a liability, each
United States shareholder shall attach to his return a statement setting
forth the adjusted basis of the property before the reduction and the
amount and nature of the reduction.
(4) Partnership interest. If a controlled foreign corporation is a
partner in a partnership, its investment in the partnership taken into
account under section 955(b)(4) shall be its adjusted basis in the
partnership determined under section 722 or 742, adjusted as provided in
section 705, and reduced as provided in subparagraph (1) of this
paragraph. (However, if the partnership is not engaged solely in the
conduct of foreign base company shipping operations, such amount shall
be taken into account only to the extent provided in paragraph (d)(1) of
this section).
(5) Grantor trust. If a controlled foreign corporation is deemed to
own a portion of the assets of a trust under paragraph (e)(2) of this
section then the amount taken into account under section 955 (b)(4) with
respect to such assets shall be determined as provided in subparagraph
(1) of this paragraph by the application of the following rules:
(i) Such controlled foreign corporation's adjusted basis in such
assets shall be deemed to be a proportionate share of the trust's
adjusted basis in such assets, and
(ii) A proportionate share of the liabilities of the trust shall be
deemed to be liabilities of such controlled foreign corporation and to
constitute specific charges against such assets.
(6) Translation into United States dollars. The amounts determined
in accordance with this paragraph shall be translated into United States
dollars in accordance with the principles of Sec. 1.964-1(e)(4).
(h) Investments in shipping companies under prior law--(1) In
general. If an
[[Page 339]]
amount invested in stock or obligations of a less developed country
shipping company described in Sec. 1.955-5(b) is treated as a qualified
investment in less developed countries under Sec. 1.955-2 (applied
without regard to paragraph (b)(5)(ii) thereof) on the applicable
determination date for purposes of section 954(g) or section 955(a)(2)
with respect to a taxable year beginning after December 31, 1975, then
such amount shall be treated as a qualified investment in foreign base
company shipping operations on such determination date. See section
955(b)(5).
(2) Effect on prior law. See Sec. 1.955-2(b)(5)(ii) for the rule
that investments which are treated as qualified investments in foreign
base company shipping operations under subparagraph (1) of this
paragraph shall not be treated as qualified investments in less
developed countries for purposes of section 951(a)(1)(A)(ii).
(3) Illustration. The application of this paragraph may be
illustrated by the following example:
Example. (a) Throughout the period here involved, controlled foreign
corporation X owns 100 percent of the single class of stock of
controlled foreign corporation Y, X and Y each use the calendar years as
the taxable year. At the close of 1975, X's $50,000 investment in the
stock of Y is treated as a qualified investment in less developed
countries under Sec. 1.955-2 (applied without regard to Sec. 1.955-
2(b)(5)(ii), and Y is a less developed country shipping company
described in Sec. 1.955-5(b).
(b) On December 31, 1976, Y is still a less developed country
shipping company and X's $50,000 investment in the stock of Y is still
treated as a qualified investment in less developed countries under
Sec. 1.955-2 (applied without regard to Sec. 1.955-2(b)(5)(ii). Under
subparagraph (1) of this paragraph X's entire $50,000 investment in the
stock of Y is treated as a qualified investment in foreign base company
shipping operations.
(c) For 1977, Y's gross income is $10,000 and Y's foreign base
company shipping income is $7,500. Since Y fails to meet the 80-percent
income test of Sec. 1.955-5(b)(1), Y is no longer a less developed
country shipping company described in Sec. 1-955-5(b), and X's
investment in the stock of Y is no longer treated as a qualified
investment in less developed countries under Sec. 1.955-2 (applied
without regard to Sec. 1.955-2(b)(5)(ii). However, assume that on
December 31, 1977, Y's net worth (as defined in paragraph (c)(2)(1) of
this section) is $100,000, that Y's qualified investments in foreign
base company shipping operations (determined under this section) on
December 31, 1977, are $75,000, and that X's investment in the stock of
Y (as determined under paragraph (g) of this section) continues to be
$50,000. Then $67,500, i.e.,
[GRAPHIC] [TIFF OMITTED] TC09OC91.015
of X's $50.000 investment in the stock of Y is treated as a qualified
investment in foreign company shipping operations under paragraph (c) of
this section.
(d) For 1978, all of Y's gross income is foreign base company
shipping income. Although Y is again a less developed country shipping
company described in Sec. 1.955-5(b), X's investment in the stock of Y
is no longer treated as a qualified investment in less developed
countries under Sec. 1.955-2(b)(5)(iii). Thus, X's investment in the
stock of Y is not treated as a qualified investment in foreign base
company shipping operations under subparagraph (1) of this paragraph.
However, X's investment in the stock of Y may be so treated under
another provision of this section, as was the case in item (c) of this
example.
(Secs. 955 (b)(2) and 7805 of the Internal Revenue Code of 1954 (89
Stat. 63; 26 U.S.C. 955(b)(2), and 68A Stat. 917; 26 U.S.C. 7805))
[T.D. 7894, 48 FR 22532, May 19, 1983; 48 FR 40888, Sept. 12, 1983, as
amended by T.D. 7959, 49 FR 22280, May 29, 1984]
Sec. 1.955A-3 Election as to qualified investments by related persons.
(a) In general. If a United States shareholder elects the benefits
of section 955(b) 2 with respect to a related group (as defined in
paragraph (b)(1) of this section) of controlled foreign corporations,
then an investment in foreign base company shipping operation made by
one member of such group will be treated as having been made by another
member to the extent provided in paragraph (c)(4) of this section, and
each member will be subject to the other provisions of paragraph (c) of
this section. An election once made shall apply for the taxable year for
which it is made and for all subsequent years unless the election is
revoked or a new election is made to add one or more controlled foreign
corporations to election coverage. For the manner of making an election
under section 955(b)(2), and for rules relating to the revocation of
such an election, see paragraph (d) of this section. For rules
[[Page 340]]
relating to the coordination of sections 955(b)(2) and 955(b)(3), see
paragraph (e) of this section.
(b) Related group--(1) Related group defined. The term ``related
group'' means two or more controlled foreign corporations, but only if
all of the following requirements are met:
(i) All such corporations use the same taxable year.
(ii) The same United States shareholder controls each such
corporation within the meaning of section 954(d)(3) at the end of such
taxable year, and
(iii) Such United States shareholder elects to treat such
corporations as a related group.
(iv) If any of the corporations is on a 52-53 week taxable year and
if all of the taxable years of the corporations end within the same 7-
day period, the rule of paragraph (b)(1)(i) of this section shall be
deemed satisfied.
(v) An election under paragraph (b)(1)(iii) of this section will not
be valid in the case of an election by a U.S. shareholder (the ``first
U.S. shareholder'') if--
(A) The first U.S. shareholder controls a second U.S. shareholder,
(B) The second U.S. shareholder controls one or more controlled
foreign corporations, and
(C) Any of the controlled foreign corporations are the subject of
the election by the first U.S. shareholder,
unless the second U.S. shareholder consents to the election by the first
U.S. shareholder.
(2) Group taxable years defined. The ``group taxable year'' is the
common taxable year of a related group.
(3) Limitation. If a United States shareholder elects to treat two
or more corporations as a related group for a group taxable year (the
``first group taxable year''), then such United States shareholder (and
any other United States shareholder which is controlled by such
shareholder) may not also elect to treat two or more other corporations
as a related group for a group taxable year any day of which falls
within the first group taxable year.
(4) Illustrations. The application of this paragraph may be
illustrated by the following examples:
Example 1. Domestic corporation M owns 100 percent of the only class
of stock of controlled foreign corporations A, B, C, D, and E. A, B, and
C use the calendar year as the taxable year. D and E use the fiscal year
ending on June 30 as the taxable year. M may elect to treat A, B and C
as a related group. However, M may not elect to treat C, D, and E as a
related group.
Example 2. The facts are the same as in example 1. In addition, M
elects to treat A, B, and C as a related group for the group taxable
year which ends on December 31, 1976. M may not also elect to treat D
and E as a related group for the group taxable year ending on June 30,
1977.
Example 3. United States shareholder A owns 60 percent of the only
class of stock of controlled foreign corporation X and 40 percent of the
only class of stock of controlled foreign corporation Y. United States
shareholder B owns the other 40 percent of the stock of X and the other
60 percent of the stock of Y. Neither A nor B (nor both together) may
elect to treat X and Y as a related group.
(c) Effect of election. If a United States shareholder elects to
treat two or more controlled foreign corporations as a related group for
any group taxable year then, for purposes of determining the foreign
base company income (see Sec. 1.954-1) and the increase or decrease in
qualified investments in foreign base company shipping operations (see
Sec. Sec. 1.954-7. 1.955A-1, and 1.955A-4) of each member of such group
for such year, the following rules shall apply:
(1) Intragroup dividends. The gross income of each member of the
related group shall be deemed not to include dividends received from any
other member of such group, to the extent that such dividends are
attributable (within the meaning of Sec. 1.954-6(f)(4)) to foreign base
company shipping income. In determining net foreign base company
shipping income, deductions allocable to intragroup dividends
attributable to foreign base company shipping income shall not be
allowed.
(2) Group excess deduction. (i) The deductions allocable under Sec.
1.954-1(c) to the foreign base company shipping income of each member of
the related group shall be deemed to include such member's pro rata
share of the group excess deduction.
(ii) The group excess deduction for the group taxable year is the
sum of
[[Page 341]]
the excesses for each member of the related group (having an excess)
of--
(A) The member's deductions (determined without regard to this
subparagraph) allocable to foreign base company shipping income for such
year, over
(B) The member's foreign base company shipping income for such year.
(iii) A member's pro rata share of the group excess deduction is the
amount which bears the same ratio to such group excess deduction as--
(A) The excess of such member's foreign base company shipping income
over the deductions (so determined) allocable thereto, bears to
(B) The sum of such excesses for each member of the related group
having an excess.
(iv) For purposes of this subparagraph, ``foreign base company
shipping income'' means foreign base company shipping income (as defined
in Sec. 1.954-6), reduced by excluding therefrom all amounts which
are--
(A) Excluded from subpart F income under section 952(b) (relating to
exclusion of United States income) or
(B) Excluded from foreign base company income under section
954(b)(4) (relating to exception for foreign corporation not availed of
to reduce taxes).
(v) The application of this subparagraph may be illustrated by the
following example:
Example. Controlled foreign corporations X, Y, and Z are a related
group for calendar year 1976. The excess group deduction for 1976 is $9,
X's pro rata share of the group excess deduction is $6, and Y's pro rata
share is $3, determined as follows on the basis of the facts shown in
the following table:
------------------------------------------------------------------------
X Y Z Group
------------------------------------------------------------------------
(1) Gross shipping income................. $100 $90 $90 ......
(2) Shipping deductions................... 60 70 80 ......
(3) Net shipping income................... 40 20 (9) ......
(4) Group excess deduction................ ...... ..... ..... 80
(5) X's pro rata share of group excess 6 ..... ..... ......
deduction ($9x$40/$60)...................
(6) Y's pro rata share of group excess ...... 3 ..... ......
deduction ($9x$20/$60)...................
------------------------------------------------------------------------
(3) Intragroup investments. On both of the determination dates
applicable to the group taxable year for purposes of section 954(g) or
section 955(a)(2), the qualified investments in foreign base company
shipping operations of each member of the related group shall be deemed
not to include stock of any other member of the related group. In
addition, neither the gains nor the losses on dispositions of such stock
during the group taxable year shall be taken into account under Sec.
1.955A-1(b)(1)(ii) in determining the decrease in qualified investments
in foreign base company shipping operations of any member of such
related group.
(4) Group excess investment. (i) On the later (and only the later)
of the two determination dates applicable to the group taxable year for
purposes of section 954(g) or section 955(a)(2), the qualified
investments in foreign base company shipping operations of each member
of the related group shall be deemed to include such member's pro rata
share of the group excess investment.
(ii) The group excess investment for the group taxable year is the
sum of the excess for each member of the related group (having an
excess) of--
(A) The member's increase in qualified investments in foreign base
company shipping operations (determined under Sec. 1.954-7 after the
application of subparagraph (3) of this paragraph) for such year, over
(B) The member's foreign base company shipping income for such year.
(iii) A member's pro rata share of the group excess investment is
the amount which bears the same ratio to such group excess investment
as--
(A) Such member's shortfall, in qualified investments bears to
(B) the sum of the shortfalls in qualified investments of each
member of such related group having a shortfall.
(iv) If a member has an increase in qualified investments in foreign
base company shipping operations (determined as provided in Sec. 1.954-
7 after the application of subparagraph (3) of this paragraph) for the
group taxable year, then such member's ``shortfall in qualified
investments'' is the excess of--
(A) Such member's foreign base company shipping income for such
year, over
(B) Such increase.
(v) If a member has a decrease in qualified investments in foreign
base company shipping operations (determined under Sec. 1.955A-1(b)(1)
or Sec. 1.955A-
[[Page 342]]
4(a), whichever is applicable, after the application of subparagraph (3)
of this paragraph) for the group taxable year, then such member's
``shortfall in qualified investments'' is the sum of--
(A) Such member's foreign base company shipping income for such year
and
(B) Such decrease.
(vi) For purposes of this subparagraph, ``foreign base company
shipping income'' means foreign base company shipping income (as defined
in subparagraph (2)(iv) of this paragraph), reduced by the deductions
allocable thereto under Sec. 1.954-1(c) (including the additional
deductions described in subparagraph (2) of this paragraph).
(vii) The application of paragraphs (c)(1), (3), and (4) of this
section may be illustrated by the following example:
Example. (a) Controlled foreign corporations R, S, and T are a
related group for calendar year 1977. R and S do not own the stock of
any member of the related group.
(b) On December 31, 1977, T has qualified investments in foreign
base company shipping operations (determined without regard to
paragraphs (c)(3) and (4)) of $105, of which $15 consists of stock of S.
After application of paragraph (c)(3) (but before application of
paragraph (c)(4)), on December 31, 1977, T has qualified investments in
foreign base company shipping operations of $90, determined as follows:
(1) Qualified investments (determined without regard to $105
paragraph (c)(3)) on December 31, 1977.........................
(2) Less: Qualified investments in stock of another member of a 15
related group (as required by paragraph (c)(3))................
-------
(3) Balance..................................................... 90
(c) During 1977, T's foreign base company shipping income is $180,
determined without regard to paragraph (c)(1). Included in the $180 is
$5 in dividends in respect of T's stock in S. During 1977, T has
shipping deductions of $91. Of T's shipping deductions, $1 is allocable
to the dividends from S. After application of paragraph (c)(1), T's net
shipping income during 1977 is $85, determined as follows:
(1) Foreign base company shipping income................. ..... $180
(2) Less: intragroup dividends (as required by paragraph ..... 5
(c)(1)).................................................
-------
(3) Balance.............................................. ..... 175
(4) Shipping deductions.................................. $91 ......
(5) Less: deductions allocable to intragroup dividends 1 ......
(as required by paragraph (c)(1)).......................
-------
(6) Balance.............................................. 90 ......
(7) Net shipping income (line (3) minus line (6))........ ..... 85
(d) During 1977 (without regard to paragraph (c)(4)), R's increase
in qualified investments in foreign base company shipping operations is
$120; S's decrease is $55; and T's increase is $35, determined on the
basis of the facts shown in the following table. In all cases, the
listed amounts of qualified investments on December 31, 1976, reflect
any adjustments required by paragraph (c)(3) for 1976, but not any
adjustment required by paragraph (c)(4) for 1976 (see Sec. Sec. 1.955A-
3 (c)(3) and (4)(i)).
------------------------------------------------------------------------
R S T
------------------------------------------------------------------------
(1) Qualified investments on December 31, 1977 (in $220 $150 $90
the case of T, taken from line (3) of part (b) of
this example).....................................
(2) Qualified investments on December 31, 1976..... 100 205 55
--------
(3) Increase (decrease) (line (1) minus line (2)).. 120 (55) 35
------------------------------------------------------------------------
(e) In 1977, R's net shipping income is $100; S's is $95; and T's is
$85, determined as follows:
------------------------------------------------------------------------
R S T
------------------------------------------------------------------------
(1) Gross foreign base company shipping income (in $200 $180 $175
the case of T, taken from line (3) of part (c) of
this example).....................................
(2) Shipping deductions (in the case of T, taken 100 85 90
from line (6) of part (c) of this example)........
--------
(3) Net shipping income (line (1) minus line (2)).. 100 95 85
------------------------------------------------------------------------
(f) By application of paragraph (c)(4) for 1977, S's pro rata share
of the group excess investment is $15, and T's pro rata share is $5,
determined as follows:
------------------------------------------------------------------------
R S T Group
------------------------------------------------------------------------
(1) Net shipping income (taken from line $100 $95 $85 ......
(3) of part (e) of this example).........
(2) Increase (decrease) in qualified 120 (55) 35 ......
investments (taken from line (3) of part
(d) of this example).....................
(3) Excess investment..................... 20 ..... ..... $20
(4) Shortfall............................. ...... 150 50 200
(5) S's pro rata share of group excess ...... 15 ..... ......
investment ($20x$150/$200)...............
(6) T's pro rata share of group excess ...... ..... 5 ......
investment ($20x$50/$200)................
------------------------------------------------------------------------
(g) After application of paragraph (c)(4), for purposes of
determining their increase or decrease in qualified investments in
foreign base company shipping operations for 1977, on December 31, 1977,
the amount of R's qualified investments is $200; the amount of S's is
$165; and the amount of T's is $95, determined as follows:
[[Page 343]]
------------------------------------------------------------------------
R S T
------------------------------------------------------------------------
(1) Qualified investments on December 31, 1977 $220 $150 $90
(taken from line (1) of part (d) of this example).
(2) Plus: pro rata share of group excess investment ..... 15 5
(as required by paragraph (c)(4)) (taken from
lines (5) and (6) of part (f) of this example)....
(3) Minus: Excess investment treated as investments 20 ..... .....
of related group members (taken from line (3) of
part (f) of this example).........................
--------
(4) Total qualified investments.................... 200 165 95
------------------------------------------------------------------------
(h) After application of paragraph (c)(1), (3), and (4), during
1977, R's increase in qualified investments in foreign base company
shipping operations is $100; S's decrease is $40; and T's increase is
$40, determined as set forth in the table below. In all cases, the
listed amounts of qualified investments on December 31, 1976, reflect
any similar adjustments required by paragraph (c)(3) for 1976, but not
any adjustment required by paragraph (c)(4) for 1976 (see Sec. 1.955A-
3(c)(3) and (4)(i)).
------------------------------------------------------------------------
R S T
------------------------------------------------------------------------
(1) Qualified investments on December 31, 1977 $200 $165 $95
(taken from line (4) of part (g) of this example).
(2) Qualified investments on December 31, 1976 (see 100 205 55
line (2) of part (d) of this example).............
--------
(3) Increase (decrease) (line (1) minus line (2)).. 100 (40) 40
------------------------------------------------------------------------
(5) Collateral effect. (i) An election under this section by a
United States shareholder to treat two or more controlled foreign
corporations as a related group for a group taxable year shall have no
effect on--
(A) Any other United States shareholder (including a minority
shareholder of a member of such related group).
(B) Any other controlled foreign corporation, and
(C) The foreign personal holding company income, foreign base
company sales income, and foreign base company services income, and the
deductions allocable under Sec. 1.954-1(c) thereto, of any member of
such related group.
(ii) See Sec. 1.952-1(c)(2)(ii) for the effect of an election under
this section on the computation of earnings and profits and deficits in
earnings and profits under section 952 (c) and (d).
(iii) The application of this subparagraph may be illustrated by the
following example:
Example. United States shareholder A owns 80 percent of the only
class of stock of controlled foreign corporations X and Y. United States
shareholder B owns the other 20 percent of the stock of X and Y. X and Y
both use the calendar year as the taxable year. A elects to treat X and
Y as a related group for 1977. For purposes of determining the amounts
includible in B's gross income under section 951(a) in respect of X and
Y, the election made by A shall be disregarded and all of B's
computations shall be made without regard to this section, as
illustrated in Sec. 1.952-3(d).
(d) Procedure--(1) Time and manner of making election. A United
States shareholder shall make an election under this section to treat
two or more controlled foreign corporations as a related group for a
group taxable year and subsequent years by filing a statement to such
effect with the return for the taxable year within which or with which
such group taxable year ends. The statement shall include the following
information:
(i) The name, address, taxpayer identification number, and taxable
year of the United States shareholder;
(ii) The name, address, and taxable year of each controlled foreign
corporation which is a member of the related group and is to be subject
to the election; and
(iii) A schedule showing the calculations by which the amounts
described in this section have been determined for the taxable year for
which the election is first effective. With respect to each subsequent
taxable year to which the election applies, a new schedule showing
calculations of such amounts for that taxable year must be filed with
the return for that taxable year. A consent to an election required by
paragraph (b)(1)(v) of this section shall include the same information
required for the election statement.
(2) Revocation. (i) Except as provided in subdivision (ii) of this
subparagraph, an election under this section by a United States
shareholder shall be binding for the group taxable year for which it is
made and for subsequent years.
(ii) Upon application by the United States shareholder (and any
other
[[Page 344]]
United States shareholder controlled by such shareholder which consented
under paragraph (b)(1)(v) of this section to the election), an election
made under this section may, subject to the approval of the
Commissioner, be revoked. An application to revoke the election, as of a
specified group taxable year, with respect to one or more (but not all)
controlled foreign corporations, subject to an election shall be deemed
to be an application to revoke the election. Approval will not be
granted unless a material and substantial change in circumstances occurs
which could not have been anticipated when the election was made. The
application for consent to revocation shall be made by mailing a letter
for such purpose to Commissioner of Internal Revenue, Attention: T:C:C,
Washington, DC 20224, containing a statement of the facts which justify
such consent. If a member of a related group subject to an election
ceases to meet the requirements of paragraph (b) of this section for
membership in the group by reason of any action taken by it or any
member of the group or the electing United States shareholder, then the
election will be deemed to be revoked as of the beginning of the taxable
year in which such action occurred. If such action is taken principally
for the purpose of revoking the election without applying for and
obtaining the approval of the Commissioner to the revocation, then no
further election covering any member of that related group may be made
by any United States shareholder for the remainder of the taxable year
in which the action occurred and the five succeeding taxable years.
(e) Coordination with section 955(b)(). If a United States
shareholder elects under this section to treat two or more controlled
foreign corporations as a related group for any taxable year, and if
such United States shareholder is required under Sec. 1.955A-4(c)(2)
for purposes of filing any return to estimate the qualified investments
in foreign base company shipping operations of any member of such group,
then such United States shareholder shall, for purposes of filing such
return, determine the amount includible in his gross income in respect
of each member of such related group on the basis of such estimate. If
the actual amount of such investments is not the same as the amount of
the estimate, the United States shareholder shall immediately notify the
Commissioner. The Commissioner will thereupon redetermine the amount of
tax of such United States shareholder for the year or years with respect
to which the incorrect amount was taken into account. The amount of tax,
if any, due upon such redetermination shall be paid by the United States
shareholder upon notice and demand by the district director. The amount
of tax, if any, shown by such redetermination to have been overpaid
shall be credited or refunded to the United States shareholder in
accordance with the provisions of sections 6402 and 6511 and the
regulations thereunder. If a United States shareholder elects under this
section and if the United States shareholder has made an election under
section 955(b)(3) as to at least one member of the related group, then
the qualified investment amounts necessary for the calculations of
paragraphs (c)(3) and (4) of this section shall be obtained, for each
member of the related group, as of the determination dates applicable to
each of the members.
(f) Illustrations. The application of this section may be
illustrated by the following examples:
Example 1. (a) Controlled foreign corporations X and Y are wholly
owned subsidiaries of domestic corporation M, X and Y use the calendar
year as the taxable year. For 1977, X and Y are not export trade
corporations (as defined in section 971(a)), nor have they any income
derived from the insurance of United States risks (within the meaning of
section 963(a)). M does not elect to treat X and Y as a related group
for 1977.
(b) For 1977, X and Y each have gross income (determined as provided
in Sec. 1.951-6(h)(1)) of $1,000. X's foreign base company income is
$20 and Y's foreign base company imcome is $0, determined as follows,
based on the facts shown in the following table:
------------------------------------------------------------------------
X Y
------------------------------------------------------------------------
(1) Foreign lease company shipping income........... $1,000 $1,000
[[Page 345]]
(2) Less: amounts excluded from subpart F income 0 0
under section 952(b) (relating to U.S. income) and
amounts excluded from foreign base company income
under section 945(b)(4) (relating to corporation
not availed of to reduce taxes)....................
-----------
(3) Balance......................................... 1,000 1,000
(4) Less: deductions allocable under Sec. 1.954- 800 1,040
1(c) to balance....................................
-------------------
(5) Remaining balance............................... 200 0
===========
(6) Less: Increase in qualified investments in 180 ........
foreign base company shipping operations...........
-----------
(7) Foreign base company income..................... 20 ........
------------------------------------------------------------------------
(c) For 1977, Y has a withdrawal of previously excluded Subpart F
income from investment in foreign base company shipping operations of
$20, determined as follows, on the basis of the facts shown in the
following table:
(1) Qualified investments in foreign base company shipping $1,210
operations at December 31, 1976..............................
(2) Less: qualified investments in foreign base company 1,170
shipping operations at December 31, 1977.....................
---------
(3) Balance................................................... 40
(4) Less: excess of recognized losses over recognized gains on 20
sales during 1977 of qualified investments in foreign base
company shipping operations..................................
---------
(5) Tentative decrease in qualified investments in foreign 20
base company shipping operations for 1977....................
=========
(6) Limitation described in Sec. 1.955A-1(b)(2)............. 160
(7) Y's amount of previously excluded subpart F income 20
withdrawn from investment in foreign base company shipping
operations (lesser of lines (5) and (6)).....................
=========
Example 2. (a) The facts are the same as in example 1, except that M
does elect to treat X and Y as a related group for 1977.
(b) The group excess deduction, which is solely attributable to Y's
net shipping loss, is $40 (i.e., $1,040-$1,000). Since X is the only
member of the related group with net shipping income, X's pro rata share
of the group excess deduction is the entire $40 amount.
(c) X's foreign base company income for 1977 is zero, determined as
follows:
(1) Preliminary net foreign base company shipping income (line $200
(b)(5) of example 1).........................................
(2) Less: X's pro rata share of group excess deduction........ 40
---------
(3) Remaining balance......................................... 160
(4) Less: increase in qualified investments in foreign base 180
company shipping operations..................................
---------
(5) Foreign base company income............................... 0
=========
(d) The group excess investment, which is solely attributable to X's
excess investment, is $20 (i.e., $180 minus $160). Since Y is the only
member of the related group with a shortfall in qualified investments,
Y's share of the group excess investment is the entire $20 amount.
(e) During 1976 and 1977, Y owns no stock of X. Y's withdrawal of
previously excluded subpart F income from investment in foreign base
company shipping operations for 1977 is zero, determined as follows:
(1) Qualified investments at December 31, 1976................ $1,210
(2)(i) Qualified investments at December 31, 1977 (determined 1,170
without regard to paragraph (c)(4) of this section)..........
(ii) Y's pro rata share of group excess investment.......... 20
---------
(iii) Total qualified investments at December 31, 1977 (Line 1,190
(i) plus line (ii).........................................
---------
(3) Balance (line (1) minus line (2)(iii)..................... 20
(4) Less: excess of recognized losses over recognized gains on 20
sales during 1977 of qualified investments in foreign base
company shipping operations..................................
---------
(5) Decrease in qualified investments for 1977................ 0
=========
(Secs. 955 (b)(2) and 7805 of the Internal Revenue Code of 1954 (89
Stat. 63; 26 U.S.C. 955(b)(2), and 68A Stat. 917; 26 U.S.C. 7805))
[T.D. 7894, 48 FR 22535, May 19, 1983; 48 FR 40888, Sept. 12, 1983, as
amended by T.D. 7959, 49 FR 22280, May 29, 1984]
Sec. 1.955A-4 Election as to date of determining qualified investment in
foreign base company shipping operations.
(a) Nature of election. In lieu of determining the increase under
the provisions of section 954(g) and Sec. 1.954-7(a) or the decrease
under the provisions of section 955(a)(2) and Sec. 1.955A-1(b) in a
controlled foreign corporation's qualified investments in foreign base
company shipping operations for a taxable year in the manner provided in
such provisions, a United States shareholder of such controlled foreign
corporation may elect, under the provisions of section 955(b)(3) and
this section, to determine such increase in accordance with the
provisions of Sec. 1.954-7(b) and to determine such decrease by
ascertaining the amount by which--
(1) Such controlled foreign corporation's qualified investments in
foreign base company shipping operations at the close of such taxable
year exceed its qualified investments in foreign base company shipping
operations at
[[Page 346]]
the close of the taxable year immediately following such taxable year,
and reducing such excess by
(2) The amount determined under Sec. 1.955A-1(b)(1)(ii) for such
taxable year subject to the limitation provided in Sec. 1.995A-1(b)(2)
for such taxable year. An election under this section may be made with
respect to each controlled foreign corporation with respect to which a
person is a United States shareholder within the meaning of section
951(b), but the election may not be exercised separately with respect to
the increases and the decreases of such controlled foreign corporation.
If an election is made under this section to determine the increase of a
controlled foreign corporation in accordance with the provisions of
Sec. 1.954-7(b), subsequent decreases of such controlled foreign
corporation shall be determined in accordance with this paragraph and
not in accordance with Sec. 1.955A-1(b).
(b) Time and manner of making election--(1) Without consent. An
election under this section with respect to a controlled foreign
corporation shall be made without the consent of the Commissioner by a
United States shareholder's filing a statement to such effect with his
return for his taxable year in which or with which ends the first
taxable year of such controlled foreign corporation in which--
(i) Such shareholder is a United States shareholder, and
(ii) Such controlled foreign corporation realizes foreign base
company shipping income, as defined in Sec. 1.954-6.
The statement shall contain the name and address of the controlled
foreign corporation and identification of such first taxable year of
such corporation.
(2) With consent. An election under this section with respect to a
controlled foreign corporation may be made by a United States
shareholder at any time with the consent of the Commissioner. Consent
will not be granted unless the United States shareholder and the
Commissioner agree to the terms, conditions, and adjustments under which
the election will be effected. The application for consent to elect
shall be made by the United States shareholder's mailing a letter for
such purpose to the Commissioner of Internal Revenue, Washington, DC
20224. The application shall be mailed before the close of the first
taxable year of the controlled foreign corporation with respect to which
the shareholder desires to compute an amount described in section
954(b)(2) in accordance with the election provided in this section. The
application shall include the following information.
(i) The name, address, and taxpayer identification number, and
taxable year of the United States shareholder;
(ii) The name and address of the controlled foreign corporation;
(iii) The first taxable year of the controlled foreign corporation
for which income is to be computed under the election;
(iv) The amount of the controlled foreign corporation's qualified
investments in foreign base company shipping operations at the close of
its preceding taxable year; and
(v) The sum of the amounts excluded under section 954(b)(2) and
Sec. 1.954-1(b)(1) from the foreign base company income of the
controlled foreign corporation for all prior taxable years during which
such shareholder was a United States shareholder of such corporation and
the sum of the amounts of its previously excluded subpart F income
withdrawn from investment in foreign base company shipping operations
for all prior taxable years during which such shareholder was a United
States shareholder of such corporation.
(c) Effect of election--(1) General. Except as provided in
subparagraphs (3) and (4) of this paragraph, an election under this
section with respect to a controlled foreign corporation shall be
binding on the United States shareholder and shall apply to all
qualified investments in foreign base company shipping operations
acquired, or disposed of, by such controlled foreign corporation during
the taxable year following its taxable year for which income is first
computed under the election and during all succeeding taxable years of
such corporation.
(2) Returns. Any return of a United States shareholder required to
be filed before the completion of a period with respect to which
determinations are to be made as to a controlled foreign corporation's
qualified investments in foreign base company shipping operations
[[Page 347]]
for purposes of computing such shareholder's taxable income shall be
filed on the basis of an estimate of the amount of the controlled
foreign corporation's qualified investments in foreign base company
shipping operations at the close of the period. If the actual amount of
such investments is not the same as the amount of the estimate, the
United States shareholder shall immediately notify the Commissioner. The
Commissioner will thereupon redetermine the amount of tax of such United
States shareholder for the year or years with respect to which the
incorrect amount was taken into account. The amount of tax, if any, due
upon such redetermination shall be paid by the United States shareholder
upon notice and demand by the district director. The amount of tax, if
any, shown by such redetermination to have been overpaid shall be
credited or refunded to the United States shareholder in accordance with
the provisions of sections 6402 and 6511 and the regulations thereunder.
(3) Revocation. Upon application by the United States shareholder,
the election made under this section may, subject to the approval of the
Commissioner, be revoked. Approval will not be granted unless the United
States shareholder and the Commissioner agree to the terms, conditions,
and adjustments under which the revocation will be effected. Unless such
agreement provides otherwise, the change in the controlled foreign
corporation's qualified investments in foreign base company shipping
operations for its first taxable year for which income is computed
without regard to the election previously made will be considered to be
zero for purposes of effectuating the revocation. The application for
consent to revocation shall be made by the United States shareholder's
mailing a letter for such purpose to the Commissioner of Internal
Revenue, Washington, DC 20224. The application shall be mailed before
the close of the first taxable year of the controlled foreign
corporation with respect to which the shareholder desires to compute the
amounts described in section 954(b)(2) or 955(a) without regard to the
election provided in this section. The application shall include the
following information:
(i) The name, address, and taxpayer identification number of the
United States shareholder:
(ii) The name and address of the controlled foreign corporation;
(iii) The taxable year of the controlled foreign corporation for
which such amounts are to be computed;
(iv) The amount of the controlled foreign corporation's qualified
investments in foreign base company shipping operations at the close of
its preceding taxable year;
(v) The sum of the amounts excluded under section 954(b)(2) and
Sec. 1.954-1(b)(1) from the foreign base company income of the
controlled foreign corporation for all prior taxable years during which
such shareholder was a United States shareholder of such corporation and
the sum of the amounts of its previously excluded subpart F income
withdrawn from investment in foreign base company shipping operations
for all prior taxable years during which such shareholder was a United
States shareholder of such corporation; and
(vi) The reasons for the request for consent to revocation.
(4) Transfer of stock. If during any taxable year of a controlled
foreign corporation--
(i) A United States shareholder who has made an election under this
section with respect to such controlled foreign corporation sells,
exchanges, or otherwise disposes of all or part of his stock in such
controlled foreign corporation, and
(ii) The foreign corporation is a controlled foreign corporation
immediately after the sale, exchange, or other disposition,
then, with respect to the stock so sold, exchanged, or disposed of, the
change in the controlled foreign corporation's qualified investments in
foreign base company shipping operations for such taxable year shall be
considered to be zero. If the United States shareholder's successor in
interest is entitled to and does make an election under paragraph (b)(1)
of this section to determine the controlled foreign corporation's
increase in qualified investments in foreign base company shipping
operations
[[Page 348]]
for the taxable year in which he acquires such stock, such increase with
respect to the stock so acquired shall be determined in accordance with
the provisions of Sec. 1.954-7(b)(1). If the controlled foreign
corporation realizes no foreign base company income from which amounts
are excluded under section 954(b)(2) and Sec. 1.954-1(b)(1) for the
taxable year in which the United States shareholder's successor in
interest acquires such stock and such successor in interest makes an
election under paragraph (b)(1) of this section with respect to a
subsequent taxable year of such controlled foreign corporation, the
increase in the controlled foreign corporation's qualified investments
in foreign base company shipping operations for such subsequent taxable
year shall be determined in accordance with the provisions of Sec.
1.954-7(b)(2).
(d) Illustrations. The application of this section may be
illustrated by the following examples:
Example 1. Foreign corporation A is a wholly owned subsidiary of
domestic corporation M. Both corporations use the calendar year as a
taxable year. In a statement filed with its return for 1977, M makes an
election under section 955(b)(3) and the election remains in force for
the taxable year 1978. At December 31, 1978, A's qualified investments
in foreign base company shipping operations amount to $100,000; and, at
December 31, 1979, to $80,000. For purposes of paragraph (a)(1) of this
section, A Corporation's decrease in qualified investments in foreign
base company shipping operations for the taxable year 1978 is $20,000
and is determined by ascertaining the amount by which A Corporation's
qualified investments in foreign base company shipping operations at
December 31, 1978 ($100,000) exceed its qualified investments in foreign
base company shipping operations at December 31, 1979 ($80,000).
Example 2. The facts are the same as in example 1 except that A
experiences no changes in qualified investments in foreign base company
shipping operations during its taxable years 1980 and 1981. If M's
election were to remain in force, A's acquisitions and dispositions of
qualified investments in foreign base company shipping operations during
A's taxable year 1982 would be taken into account in determining whether
A has experienced an increase or a decrease in qualified investments in
foreign base company shipping operations for its taxable year 1981.
However, M duly files before the close of A's taxable year 1981 as
application for consent to revocation of M Corporation's election under
section 955(b)(3), and, pursuant to an agreement between the
Commissioner and M, consent is granted by the Commissioner. Assuming
such agreement does not provide otherwise, A's change in qualifed
investments in foreign base company shipping operations for its taxable
year 1981 is zero because the effect of the revocation of the election
is to treat acquisitions and dispositions of qualified investments in
foreign base company shipping operations actually occurring in 1982 as
having occurred in such year rather than in 1981.
Example 3. The facts are the same as in example 2 except that A's
qualified investments in foreign base company shipping operations at
December 31, 1982, amount to $70,000. For purposes of paragraph
(b)(1)(i) of Sec. 1.955A-1, the decrease in A's qualified investments
in foreign base company shipping operations for the taxable year 1982 is
$10,000 and is determined by ascertaining the amount by which A's
qualified investments in foreign base company shipping operations at
December 31, 1981 ($80,000) exceed its qualified investments in foreign
base company shipping operations at December 31, 1982 ($70,000).
Example 4. The facts are the same as in example 1. Assume further
that on September 30, 1979, M sells 40 percent of the only class of
stock of A to N Corporation, a domestic corporation. N uses the calendar
year as a taxable year. A remains a controlled foreign corporation
immediately after such sale of its stock. A's qualified investments in
foreign base company shipping operations at December 31, 1980, amount to
$90,000. The changes in A Corporation's qualified investments in foreign
base company shipping operations occurring in its taxable year 1979 are
considered to be zero with respect to the 40-percent stock interest
acquired by N Corporation. The entire $20,000 reduction in A
Corporation's qualified investments in foreign base company shipping
operations which occurs during the taxable year 1979 is taken into
account by M for purposes of paragraph (c)(1) of this section in
determining its tax liability for the taxable year 1978. A's increase in
qualified investments in foreign base company shipping operations for
the taxable year 1979 with respect to the 60-percent stock interest
retained by M is $6,000 and is determined by ascertaining M's pro rata
share (60 percent) of the amount by which A's qualified investments in
foreign base company shipping operations at December 31, 1980 ($90,000)
exceed its qualified investments in foreign base company shipping
operations at December 31, 1979 ($80,000). N does not make an election
under section 955(b)(3) in its return for its taxable year 1980.
Corporation A's increase in qualified investments in foreign base
company shipping
[[Page 349]]
operations for the taxable year 1980 with respect to the 40-percent
stock interest acquired by N is $4,000.
[T.D. 7894, 48 FR 22539, May 19, 1983]
Sec. 1.956-1 Shareholder's pro rata share of a controlled foreign
corporation's increase in earnings invested in United States property.
(a) In general. Section 956(a)(1) and paragraph (b) of this section
provide rules for determining the amount of a controlled foreign
corporation's earnings invested in United States property at the close
of any taxable year. Such amount is the aggregate amount invested in
United States property to the extent such amount would have constituted
a dividend if it had been distributed on such date. Subject to the
provisions of section 951(a)(4) and the regulations thereunder, a United
States shareholder of a controlled foreign corporation is required to
include in his gross income his pro rata share, as determined in
accordance with paragraph (c) of this section, of the controlled foreign
corporation's increase for any taxable year in earnings invested in
United States property but only to the extent such share is not
excludable from his gross income under the provisions of section
959(a)(2) and the regulations thereunder.
(b) Amount of a controlled foreign corporation's investment of
earnings in United States property--(1) Dividend limitation. The amount
of a controlled foreign corporation's earnings invested at the close of
its taxable year in United States property is the aggregate amount of
such property held, directly or indirectly, by such corporation at the
close of its taxable year to the extent such amount would have
constituted a dividend under section 316 and Sec. Sec. 1.316-1 and
1.316-2 (determined after the application of section 955(a)) if it had
been distributed on such closing day. For purposes of this subparagraph,
the determination of whether an amount would have constituted a dividend
if distributed shall be made without regard to the provisions of section
959(d) and the regulations thereunder.
(2) Aggregate amount of United States property. For purposes of
determining an increase in earnings invested in United States property
for any taxable year beginning after December 31, 1975, the aggregate
amount of United States property held by a controlled foreign
corporation at the close of--
(i) Any taxable year beginning after December 31, 1975, and
(ii) The last taxable year beginning before January 1, 1976 does not
include stock or obligations of a domestic corporation described in
section 956(b)(2)(F) or movable property described in section
956(b)(2)(G).
(3) Treatment of earnings and profits. For purposes of making the
determination under subparagraph (1) of this paragraph as to whether an
amount of investment would have constituted a dividend if distributed at
the close of any taxable year of a controlled foreign corporation,
earnings and profits of the controlled foreign corporation shall be
considered not to include any amounts which are attributable to--
(i) Amounts which have been included in the gross income of a United
States shareholder of such controlled foreign corporation under section
951(a)(1)(B) (or which would have been so included but for section
959(a)(2)) and have not been distributed, or
(ii)(a) Amounts which are included in the gross income of a United
States shareholder of such controlled foreign corporation under section
551(b) or would be so included under such section but for the fact that
such amounts were distributed to such shareholder during the taxable
year, or
(b) Amounts which, for any prior taxable year, have been included in
the gross income of a United States shareholder of such controlled
foreign corporation under section 551(b) and have not been distributed.
The rules of this subparagraph apply only in determining the limitation
on a controlled foreign corporation's increase in earnings invested in
United States property. See section 959 and the regulations thereunder
for limitations on the exclusion from gross income of previously taxed
earnings and profits.
(4) [Reserved]
(c) Shareholder's pro rata share of increase--(1) General rule. A
United States shareholder's pro rata share of a controlled foreign
corporation's increase
[[Page 350]]
for any taxable year in earnings invested in United States property is
the amount determined by subtracting the shareholder's pro rata share
of--
(i) The controlled foreign corporation's earnings invested in United
States property at the close of its preceding taxable year, as
determined under paragraph (b) of this section, reduced by amounts paid
by such corporation during such preceding taxable year to which section
959(c)(1) and the regulations thereunder apply, from his pro rata share
of
(ii) The controlled foreign corporation's earnings invested in
United States property at the close of its current taxable year, as
determined under paragraph (b) of this section.
(2) Illustration. The application of this paragraph may be
illustrated by the following examples:
Example 1. A is a United States shareholder and direct owner of 60
percent of the only class of stock of R Corporation, a controlled
foreign corporation during the entire period here involved. Both A and R
Corporation use the calendar year as a taxable year. Corporation R's
aggregate investment in United States property on December 31, 1964,
which would constitute a dividend (as determined under paragraph (b) of
this section) if distributed on such date is $150,000. During the
taxable year 1964, R Corporation distributed $50,000 to which section
959(c)(1) applies. Corporation R's aggregate investment in United States
property on December 31, 1965, is $250,000; and R Corporation's current
and accumulated earnings and profits on such date (determined as
provided in paragraph (b) of this section) are $225,000. A's pro rata
share of R Corporation's increase for 1965 in earnings invested in
United States property is $75,000, determined as follows:
(i) Aggregate investment in United States property on $250,000
December 31, 1965...........................................
------------
(ii) Current and accumulated earnings and profits on December 225,000
31, 1965....................................................
------------
(iii) Amount of earnings invested in United States property 225,000
on December 31, 1965, which would constitute a dividend if
distributed on such date (lesser of item (i) or item (ii))..
(iv) Aggregate investment in United States $150,000 .........
property on December 31, 1964, which would
constitute a dividend if distributed on such date
Less: Amounts distributed during 1964 to which 50,000 100,000
section 959(c)(1) applies......................
------------
(v) R Corporation's increase for 1965 in earnings invested in 125,000
United States property (item (iii) minus item (iv)).........
============
(vi) A's pro rata share of R Corporation's increase for 1965 75,000
in earnings invested in United States property (item (v)
times 60 percent)...........................................
Example 2. The facts are the same as in example 1, except that R
Corporation's current and accumulated earnings and profits on December
31, 1965, are $100,000 instead of $225,000. Accordingly, even through R
Corporation's aggregate investment in United States property on December
31, 1965, of $250,000 exceeds the net amount ($100,000) taken into
account under subparagraph (1)(i) of this paragraph as of December 31,
1964, by $150,000, there is no increase for taxable year 1965 in
earnings invested in United States property because of the dividend
limitation of paragraph (b)(1) of this section. Corporation R's
aggregate investment in United States property on December 31, 1966, is
unchanged ($250,000) Corporation R's current and accumulated earnings
and profits on December 31, 1966, are $175,000, and, as a consequence,
its aggregate investment in United States property which would
constitute a dividend if distributed on that date is $175,000.
Corporation R pays no amount during 1965 to which section 959(c)(1)
applies. Corporation R's increase for the taxable year 1966 in earnings
invested in United States property is $75,000, and A's pro rata share of
that amount is $45,000 ($75,000 times 60 percent).
(d) Date and basis of determinations. The determinations made under
paragraph (c)(1)(i) of this section with respect to the close of the
preceding taxable year of a controlled foreign corporation and under
paragraph (c)(1)(ii) with respect to the close of the current taxable
year of such controlled foreign corporation, for purposes of determining
the United States shareholder's pro rata share of such corporation's
increased investment of earnings in United States property for the
current taxable year, shall be made as of the last day of the current
taxable year of such corporation but on the basis of stock owned, within
the meaning of section 958(a) and the regulations thereunder, by such
United States shareholder on the last day of the current taxable year of
the foreign corporation on which such corporation is a controlled
foreign corporation. See the last sentence of section 956(a)(2). The
application of this paragraph may be illustrated from the following
example:
Example. Domestic corporation M owns 60 percent of the only class of
stock of A Corporation, a controlled foreign corporation
[[Page 351]]
during the entire period here involved. Both M Corporation and A
Corporation use the calendar year as a taxable year. Corporation A's
investment of earnings in United States property at the close of the
taxable year 1963 is $100,000, as determined under paragraph (b) of this
section, and M Corporation includes its pro rata share of such amount
($60,000) in gross income for its taxable year 1963. On June 1, 1964, M
Corporation acquires an additional 25 percent of A Corporation's
outstanding stock from a person who is not a United States person as
defined in section 957(d). Corporation A's investment of earnings in
United States property at the close of the taxable year 1964, as
determined under paragraph (b) of this section, is unchanged ($100,000).
Corporation A pays no amount during 1963 to which section 959(c)(1)
applies. Corporation M is not required, by reason of the acquisition in
1964 of A Corporation's stock, to include an additional amount in its
gross income with respect to A Corporation's investment of earnings in
United States property even though the earnings invested in United
States property by A Corporation attributable to the stock acquired by M
Corporation were not previously taxed. The determination made under
paragraph (c)(1)(i) of this section as well as the determination made
under paragraph (c)(1)(ii) of this section with respect to A
Corporation's investment for 1964 of earnings in United States property
are made on the basis of stock owned by M Corporation (85 percent) at
the close of 1964.
(e) Amount attributable to property--(1) General rule. Except as
provided in subparagraph (2) of this paragraph, for purposes of
paragraph (b)(1) of this section the amount taken into account with
respect to any United States property shall be its adjusted basis, as of
the applicable determination date, reduced by any liability (other than
a liability described in subparagraph (3) of this paragraph) to which
such property is subject on such date. To be taken into account under
this subparagraph, a liability must constitute a specific charge against
the property involved. Thus, a liability evidenced by an open account or
a liability secured only by the general credit of the controlled foreign
corporation will not be taken into account. On the other hand, if a
liability constitutes a specific charge against several items of
property and cannot definitely be allocated to any single item of
property, the liability shall be apportioned against each of such items
of property in that ratio which the adjusted basis of such item on the
applicable determination date bears to the adjusted basis of all such
items at such time. A liability in excess of the adjusted basis of the
property which is subject to such liability shall not be taken into
account for the purpose of reducing the adjusted basis of other property
which is not subject to such liability.
(2) Rule for pledges and guarantees. For purposes of this section
the amount taken into account with respect to any pledge or guarantee
described in paragraph (c)(1) of Sec. 1.956-2 shall be the unpaid
principal amount on the applicable determination date of the obligation
with respect to which the controlled foreign corporation is a pledgor or
guarantor.
(3) Excluded charges. For purposes of subparagraph (1) of this
paragraph, a specific charge created with respect to any item of
property principally for the purpose of artificially increasing or
decreasing the amount of a controlled foreign corporation's investment
of earnings in United States property will not be recognized; whether a
specific charge is created principally for such purpose will depend upon
all the facts and circumstances of each case. One of the factors that
will be considered in making such a determination with respect to a loan
is whether the loan is from a related person, as defined in section 954
(d)(3) and paragraph (e) of Sec. 1.954-1.
(4) Statement required. If for purposes of this section a United
States shareholder of a controlled foreign corporation reduces the
adjusted basis of property which constitutes United States property on
the ground that such property is subject to a liability, he shall attach
to his return a statement setting forth the adjusted basis of the
property before the reduction and the amount and nature of the
reduction.
(Secs. 956(c), 7805, Internal Revenue Code of 1954 (76 Stat. 1017, 68A
Stat. 917; (26 U.S.C. 956(c) and 7805 respectively)))
[T.D. 6704, 29 FR 2600, Feb. 20, 1964, as amended by T.D. 6795, 30 FR
942, Jan. 29, 1965; T.D. 7712, 45 FR 52374, Aug. 7, 1980; T.D. 8209, 53
FR 22171, June 14, 1988]
[[Page 352]]
Sec. 1.956-1T Shareholder's pro rata share of a controlled foreign
corporation's increase in earnings invested in United States property
(temporary).
(a) [Reserved]
(b)(1)-(3) [Reserved]
(4) Treatment of certain investments of earnings in United States
Property--(i) Special rule. For purposes of Sec. 1.956-1(b)(1) of the
regulations, a controlled foreign corporation will be considered to hold
indirectly (A) the investments in United States property held on its
behalf by a trustee or a nominee or (B) at the discretion of the
District Director, investments in U.S. property acquired by any other
foreign corporation that is controlled by the controlled foreign
corporation, if one of the principal purposes for creating, organizing,
or funding (through capital contributions or debt) such other foreign
corporation is to avoid the application of section 956 with respect to
the controlled foreign corporation. For purposes of this paragraph (b),
a foreign corporation will be controlled by the controlled foreign
corporation if the foreign corporation and the controlled foreign
corporation are related parties under section 267(b). In determining for
purposes of this paragraph (b) 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
with the application of section 1563(e)(1), and stock owned with the
application of section 267(c). The following examples illustrate the
application of this paragraph.
Example 1. P, a domestic corporation, owns all of the outstanding
stock of FS1, a controlled foreign corporation, and all of the
outstanding stock of FS2, also a controlled foreign corporation. FS1
sells products to FS2 in exchange for trade receivables due in 60 days.
FS2 has no earnings and profits. FS1 has substantial accumulated
earnings and profits. FS2 loans to P an amount equal to the debt it owes
FS1. FS2 pays the trade receivables according to the terms of the
receivables. FS1 will not be considered to hold indirectly the
investment in United States property under this paragraph (b)(4),
because there was no transfer of funds to FS2.
Example 2. The facts are the same as in Example 1, except that FS2
does not pay the receivables. FS1 is considered to hold indirectly the
investment in United States property under this paragraph (b)(4),
because there was a transfer of funds to FS2, a principal purpose of
which was to avoid the application of section 956 to FS1.
(ii) Effective date. This section is effective June 14, 1988, with
respect to investments made on or after June 14, 1988.
(c)-(d) [Reserved]
(e)(1)-(4) [Reserved]
(e)(5) Excluded charges--(i) Special rule. For purposes of Sec.
1.956-1(e)(1) of the regulations, in the case of an investment in United
States property consisting of an obligation of a related person, as
defined in section 954(d)(3) and paragraph (e) of Sec. 1.954-1, a
liability will not be recognized as a specific charge if the liability
representing the charge is with recourse with respect to the general
credit or other assets of the investing controlled foreign corporation.
(ii) Effective date. This section is effective June 14, 1988, with
respect to investments made on or after June 14, 1988.
[T.D. 8209, 53 FR 22171, June 14, 1988]
Sec. 1.956-2 Definition of United States property.
(a) Included property--(1) In general. For purposes of section
956(a) and Sec. 1.956-1, United States property is (except as provided
in paragraph (b) of this section) any property acquired (within the
meaning of paragraph (d)(1) of this section) by a foreign corporation
(whether or not a controlled foreign corporation at the time) during any
taxable year of such foreign corporation beginning after December 31,
1962, which is--
(i) Tangible property (real or personal) located in the United
States;
(ii) Stock of a domestic corporation;
(iii) An obligation (as defined in paragraph (d)(2) of this section)
of a United States person (as defined in section 957(d)); or
(iv) Any right to the use in the United States of--
(a) A patent or copyright,
(b) An invention, model, or design (whether or not patented),
(c) A secret formula or process, or
(d) Any other similar property right, which is acquired or developed
by the
[[Page 353]]
foreign corporation for use in the United States by any person. Whether
a right described in this subdivision has been acquired or developed for
use in the United States by any person is to be determined from all the
facts and circumstances of each case. As a general rule, a right
actually used principally in the United States will be considered to
have been acquired or developed for use in the United States in the
absence of affirmative evidence showing that the right was not so
acquired or developed for such use.
(2) Illustrations. The application of the provisions of this
paragraph may be illustrated by the following examples:
Example 1. Foreign corporation R uses as a taxable year a fiscal
year ending on June 30. Corporation R acquires on June 1, 1963, and
holds on June 30, 1963, $100,000 of tangible property (not described in
section 956(b)(2)) located in the United States. Corporation R's
aggregate investment in United States property at the close of its
taxable year ending June 30, 1963, is zero since the property which is
acquired on June 1, 1963, is not acquired during a taxable year of R
Corporation beginning after December 31, 1962. Assuming no change in R
Corporation's aggregate investment in United States property during its
taxable year ending June 30, 1964, R Corporation's increase in earnings
invested in United States property for such taxable year is zero.
Example 2. Foreign corporation S uses the calendar year as a taxable
year and is a controlled foreign corporation for its entire taxable year
1965. Corporation S is not a controlled foreign corporation at any time
during its taxable years 1963 and 1964. Corporation S owns on December
31, 1964, $100,000 of tangible property (not described in section
956(b)(2)) located in the United States which it acquires during taxable
years beginning after December 31, 1962. Corporation S's aggregate
investment in United States property on December 31, 1964, is $100,000.
Corporation S's current and accumulated earnings and profits (determined
as provided in paragraph (b) of Sec. 1.956-1) as of December 31, 1964,
are in excess of $100,000. Assuming no change in S Corporation's
aggregate investment in United States property during its taxable year
1965, S Corporation's increase in earnings invested in United States
property for such taxable year is zero.
Example 3. Foreign corporation T uses the calendar year as a taxable
year and is a controlled foreign corporation for its entire taxable
years 1963, 1964, and 1966. At December 31, 1964, T Corporation's
investment in United States property is $100,000. Corporation T is not a
controlled foreign corporation at any time during its taxable year 1965
in which it acquires $25,000 of tangible property (not described in
section 956(b)(2)) located in the United States. On December 31, 1965, T
Corporation holds the United States property of $100,000 which it held
on December 31, 1964, and, in addition, the United States property
acquired in 1965. Corporation T's aggregate investment in United States
property at December 31, 1965, is $125,000. Corporation T's current and
accumulated earnings and profits (determined as provided in paragraph
(b) of Sec. 1.956-1) as of December 31, 1965, are in excess of
$125,000, and T Corporation pays no amount during 1965 to which section
959 (c)(1) applies. Assuming no change in T Corporation's aggregate
investment in United States property during its taxable year 1966, T
Corporation's increase in earnings invested in United States property
for such taxable year is zero.
(3) Property owned through partnership. For purposes of section 956,
if a controlled foreign corporation is a partner in a partnership that
owns property that would be United States property, within the meaning
of paragraph (a)(1) of this section, if owned directly by the controlled
foreign corporation, the controlled foreign corporation will be treated
as holding an interest in the property equal to its interest in the
partnership and such interest will be treated as an interest in United
States property. This paragraph (a)(3) applies to taxable years of a
controlled foreign corporation beginning on or after July 23, 2002.
(b) Exceptions--(1) Excluded property. For purposes of section
956(a) and paragraph (a) of this section, United States property does
not include the following types of property held by a foreign
corporation:
(i) Obligations of the United States.
(ii) Money.
(iii) Deposits with persons carrying on the banking business, unless
the deposits serve directly or indirectly as a pledge or guarantee
within the meaning of paragraph (c) of this section. See paragraph
(e)(2) of Sec. 1.956-1.
(iv) Property located in the United States which is purchased in the
United States for export to, or use in, foreign countries. For purposes
of this subdivision, property to be used outside the United States will
be considered property to be used in a foreign country. Whether property
is of a type
[[Page 354]]
described in this subdivision is to be determined from all the facts and
circumstances in each case. Property which constitutes export trade
assets within the meaning of section 971(c)(2) and paragraph (c)(3) of
Sec. 1.971-1 will be considered property of a type described in this
subdivision.
(v) Any obligation (as defined in paragraph (d)(2) of this section)
of a United States person (as defined in section 957(d)) arising in
connection with the sale or processing of property if the amount of such
obligation outstanding at any time during the taxable year of the
foreign corporation does not exceed an amount which is ordinary and
necessary to carry on the trade or business of both the other party to
the sale or processing transaction and the United States person, or, if
the sale or processing transaction occurs between related persons, would
be ordinary and necessary to carry on the trade or business of both the
other party to the sale or processing transaction and the United States
person if such persons were unrelated persons. Whether the amount of an
obligation described in this subdivision is ordinary and necessary is to
be determined from all the facts and circumstances in each case.
(vi) Any aircraft, railroad rolling stock, vessel, motor vehicle, or
container used in the transportation of persons or property in foreign
commerce and used predominantly outside the United States. Whether
transportation property described in this subdivision is used in foreign
commerce and predominantly outside the United States is to be determined
from all the facts and circumstances in each case. As a general rule,
such transportation property will be considered to be used predominantly
outside the United States if 70 percent or more of the miles traversed
(during the taxable year at the close of which a determination is made
under section 956(a)(2)) in the use of such property are traversed
outside the United States or if such property is located outside the
United States 70 percent of the time during such taxable year.
(vii) An amount of assets described in paragraph (a) of this section
of an insurance company equivalent to the unearned premiums or reserves
which are ordinary and necessary for the proper conduct of that part of
its insurance business which is attributable to contracts other than
those described in section 953(a)(1) and the regulations thereunder. For
purposes of this subdivision, a reserve will be considered ordinary and
necessary for the proper conduct of an insurance business if, under the
principles of paragraph (c) of Sec. 1.953-4, such reserve would qualify
as a reserve required by law. See paragraph (d)(3) of Sec. 1.954-2 for
determining, for purposes of this subdivision, the meaning of insurance
company and of unearned premiums.
(viii) For taxable years beginning after December 31, 1975, the
voting or nonvoting stock or obligations of an unrelated domestic
corporation. For purposes of this subdivision, an unrelated domestic
corporation is a domestic corporation which is neither a United States
shareholder (as defined in section 951(b)) of the controlled foreign
corporation making the investment, nor a corporation 25 percent or more
of whose total combined voting power of all classes of stock entitled to
vote is owned or considered as owned (within the meaning of section 958
(b)) by United States shareholders of the controlled foreign corporation
making the investment. The determination of whether a domestic
corporation is an unrelated corporation is made immediately after each
acquisition of stock or obligations by the controlled foreign
corporations.
(ix) For taxable years beginning after December 31, 1975, movable
drilling rigs or barges and other movable exploration and exploitation
equipment (other than a vessel or an aircraft) when used on the
Continental Shelf (as defined in section 638) of the United States in
the exploration for, development, removal, or transportation of natural
resources from or under ocean waters. Property used on the Continental
Shelf includes property located in the United States which is being
constructed or is in storage or in transit within the United States for
use on the Continental Shelf. In general, the type of property which
qualifies for the exception under this subdivision includes any movable
property which would be entitled to the investment
[[Page 355]]
credit if used outside the United States in certain geographical areas
of the Western Hemisphere pursuant to section 48(a)(2)(B)(x) (without
reference to sections 49 and 50).
(x) An amount of--
(a) A controlled foreign corporation's assets described in paragraph
(a) of this section equivalent to its earnings and profits which are
accumulated after December 31, 1962, and are attributable to items of
income described in section 952(b) and the regulations thereunder,
reduced by the amount of
(b) The earnings and profits of such corporation which are applied
in a taxable year of such corporation beginning after December 31, 1962,
to discharge a liability on property, but only if the liability was in
existence at the close of such corporation's taxable year immediately
preceding its first taxable year beginning after December 31, 1962, and
the property would have been United States property if it had been
acquired by such corporation immediately before such discharge.
For purposes of this subdivision, distributions made by such corporation
for any taxable year shall be considered first made out of earnings and
profits for such year other than earnings and profits referred to in (a)
of this subdivision.
(2) Statement required. If a United States shareholder of a
controlled foreign corporation excludes any property from the United
States property of such controlled foreign corporation on the ground
that section 956(b)(2) applies to such excluded property, he shall
attach to his return a statement setting forth, by categories described
in paragraph (a)(1) of this section, the amount of United States
property of the controlled foreign corporation and, by categories
described in subparagraph (1) of this paragraph, the amount of such
property which is excluded.
(c) Treatment of pledges and guarantees--(1) General rule. Except as
provided in subparagraph (4) of this paragraph, any obligation (as
defined in paragraph (d)(2) of this section) of a United States person
(as defined in section 957(d)) with respect to which a controlled
foreign corporation is a pledgor or guarantor shall be considered for
purposes of section 956(a) and paragraph (a) of this section to be
United States property held by such controlled foreign corporation.
(2) Indirect pledge or guarantee. If the assets of a controlled
foreign corporation serve at any time, even though indirectly, as
security for the performance of an obligation of a United States person,
then, for purposes of paragraph (c)(1) of this section, the controlled
foreign corporation will be considered a pledgor or guarantor of that
obligation. For this purpose the pledge of stock of a controlled foreign
corporation will be considered as the indirect pledge of the assets of
the corporation if at least 66 2/3 percent of the total combined voting
power of all classes of stock entitled to vote is pledged and if the
pledge of stock is accompanied by one or more negative covenants or
similar restrictions on the shareholder effectively limiting the
corporation's discretion with respect to the disposition of assets and
the incurrence of liabilities other than in the ordinary course of
business. This paragraph (c)(2) applies only to pledges and guarantees
which are made after September 8, 1980. For purposes of this paragraph
(c)(2) a refinancing shall be considered as a new pledge or guarantee.
(3) Illustrations. The following examples illustrate the application
of this paragraph (c):
Example 1. A, a United States person, borrows $100,000 from a bank
in foreign country X on December 31, 1964. On the same date controlled
foreign corporation R pledges its assets as security for A's performance
of A's obligation to repay such loan. The place at which or manner in
which A uses the money is not material. For purposes of paragraph (b) of
Sec. 1.956-1, R Corporation will be considered to hold A's obligation
to repay the bank $100,000, and, under the provisions of paragraph
(e)(2) of Sec. 1.956-1, the amount taken into account in computing R
Corporation's aggregate investment in United States property on December
31, 1964, is the unpaid principal amount of the obligation on that date
($100,000).
Example 2. The facts are the same as in example 1, except that R
Corporation participates in the transaction, not by pledging its assets
as security for A's performance of A's obligation to repay the loan, but
by agreeing to buy for $1,00,000 at maturity the note representing A's
obligation if A does not repay the loan. Separate arrangements are made
with respect to the payment of the interest
[[Page 356]]
on the loan. The agreement of R Corporation to buy the note constitutes
a guarantee of A's obligation. For purposes of paragraph (b) of Sec.
1.956-1, R Corporation will be considered to hold A's obligation to
repay the bank $100,000, and, under the provisions of paragraph (e)(2)
of Sec. 1.956-1, the amount taken into account in computing R
Corporation's aggregate investment in United States property on December
31, 1964, is the unpaid principal amount of the obligation on that date
($100,000).
Example 3. A, a United States person, borrows $100,000 from a bank
on December 10, 1981, pledging 70 percent of the stock of X, a
controlled foreign corporation, as collateral for the loan. A and X use
the calendar year as their taxable year. in the loan agreement, among
other things, A agrees not to cause or permit X Corporation to do any of
the following without the consent of the bank:
(a) Borrow money or pledge assets, except as to borrowings in the
ordinary course of business of X Corporation;
(b) Guarantee, assume, or become liable on the obligation of
another, or invest in or lend funds to another;
(c) Merge or consolidate with any other corporation or transfer
shares of any controlled subsidiary;
(d) Sell or lease (other than in the ordinary course of business) or
otherwise dispose of any substantial part of its assets;
(e) Pay or secure any debt owing by X Corporation to A; and
(f) Pay any dividends, except in such amounts as may be required to
make interest or principal payments on A's loan from the bank.
A retains the right to vote the stock unless a default occurs by A.
Under paragraph (c)(2) of this section, the assets of X Corporation
serve indirectly as security for A's performance of A's obligation to
repay the loan and X Corporation will be considered a pledgor or
guarantor with respect to that obligation. For purposes of paragraph (b)
of Sec. 1.956-1, X Corporation will be considered to hold A's
obligation to repay the bank $100,000 and under paragraph (e)(2) of
Sec. 1.956-1, the amount taken into account in computing X
Corporation's aggregate investment in United States property on December
31, 1981, is the unpaid principal amount of the obligation on that date.
(4) Special rule for certain conduit financing arrangements. The
rule contained in subparagraph (1) of this paragraph shall not apply to
a pledge or a guarantee by a controlled foreign corporation to secure
the obligation of a United States person if such United States person is
a mere conduit in a financing arrangement. Whether the United States
person is a mere conduit in a financing arrangement will depend upon all
the facts and circumstances in each case. A United States person will be
considered a mere conduit in a financing arrangement in a case in which
a controlled foreign corporation pledges stock of its subsidiary
corporation, which is also a controlled foreign corporation, to secure
the obligation of such United States person, where the following
conditions are satisfied:
(i) Such United States person is a domestic corporation which is not
engaged in the active conduct of a trade or business and has no
substantial assets other than those arising out of its relending of the
funds borrowed by it on such obligation to the controlled foreign
corporation whose stock is pledged; and
(ii) The assets of such United States person are at all times
substantially offset by its obligation to the lender.
(d) Definitions--(1) Meaning of ``acquired''--(i) Applicable rules.
For purposes of this section--
(a) Property shall be considered acquired by a foreign corporation
when such corporation acquires an adjusted basis in the property;
(b) Property which is an obligation of a United States person with
respect to which a controlled foreign corporation is a pledgor or
guarantor (within the meaning of paragraph (c) of this section) shall be
considered acquired when the corporation becomes liable as a pledgor or
guarantor or is otherwise considered a pledgor or guarantor (within the
meaning of paragraph (c)(2) of this section); and
(c) Property shall not be considered acquired by a foreign
corporation if--
(1) Such property is acquired in a transaction in which gain or loss
would not be recognized under this chapter to such corporation if such
corporation were a domestic corporation;
(2) The basis of the property acquired by the foreign corporation is
the same as the basis of the property exchanged by such corporation; and
(3) The property exchanged by the foreign corporation was not United
States property (as defined in paragraph (a)(1) of this section) but
would have been such property if it had been acquired by such
corporation immediately before such exchange.
[[Page 357]]
(ii) Illustrations. The application of this subparagraph may be
illustrated by the following examples:
Example 1. Foreign corporation R uses the calendar year as a taxable
year and acquires before January 1, 1963, stock of domestic corporation
M having as to R Corporation an adjusted basis of $10,000. The stock of
M Corporation is not United States property of R Corporation on December
31, 1962, since it is not acquired in a taxable year of R Corporation
beginning on or after Janury 1, 1963. On June 30, 1963, R Corporation
sells the M Corporation stock for $15,000 in cash and expends such
amount in acquiring stock of domestic corporation N which has as to R
Corporation an adjusted basis of $15,000. For purposes of determining R
Corporation's aggregate investment in United States property on December
31, 1963, R Corporation has, by virtue of acquiring the stock of N
Corporation, acquired $15,000 of United States property.
Example 2. Foreign corporation S, a controlled foreign corporation
for the entire period here involved, uses the calendar year as a taxable
year and purchases for $100,000 on December 31, 1963, tangible property
(not described in section 956(b)(2)) located in the United States and
having a remaining estimated useful life of 10 years, subject to a
mortgage of $80,000 payable in 5 annual installments. The property
constitutes United States property as of December 31, 1963, and the
amount taken into account for purposes of determining the aggregate
amount of S Corporation's investment in United States property under
paragraph (b) of Sec. 1.956-1 is $20,000. No depreciation is sustained
with respect to the property during the taxable year 1963. During the
taxable year 1964, S Corporation pays $16,000 on the mortgage and
sustains $10,000 of depreciation with respect to the property. As of
December 31, 1964, the amount taken into account with respect to the
property for purposes of determining the aggregate amount of S
Corporation's investment in United States property under paragraph (b)
of Sec. 1.956-1 is $26,000, computed as follows:
Cost of property............................................. $100,000
Less: Reserve for depreciation............................. 10,000
-----------
Adjusted basis of property................................ 90,000
Less: Liability to which property is subject:
Gross amount of mortgage....................... $80,000 .........
Payment during 1964............................ 16,000 .........
----------
........ 64,000
----------
Amount taken into account (12-31-64)......................... 26,000
Example 3. Controlled foreign corporation T uses the calendar year
as a taxable year and acquires on December 31, 1963, $10,000 of United
States property not described in section 956(b)(2); no depreciation is
sustained with respect to the property during 1963. Corporation T's
current and accumulated earnings and profits (determined as provided in
paragraph (b) of Sec. 1.956-1) as of December 31, 1963, are in excess
of $10,000, and T Corporation's United States shareholders include in
their gross income under section 951(a)(1)(B) their pro rata share of T
Corporation's increase ($10,000) for 1963 in earnings invested in United
States property. On January 1, 1964, T Corporation acquires an
additional $10,000 of United States property not described in section
956(b)(2). Each of the two items of property has an estimated useful
life of 5 years, and T Corporation sustains $4,000 of depreciation with
respect to such properties during its taxable year 1964. Corporation T's
current and accumulated earnings and profits as of December 31, 1964,
exceed $16,000, determined as provided in paragraph (b) of Sec. 1.956-
1. Corporation T pays no amounts during 1963 to which section 959(c)(1)
applies. Corporation T's investment of earnings in United States
property at December 31, 1964, is $16,000, and its increase for 1964 in
earnings invested in United States property is $6,000.
Example 4. Foreign corporation U uses the calendar year as a taxable
year and acquires before January 1, 1963, stock in domestic corporation
M having as to U Corporation an adjusted basis of $10,000. On December
1, 1964, pursuant to a statutory merger described in section 368(a)(1),
M Corporation merges into domestic corporation N, and U Corporation
receives on such date one share of stock in N Corporation, the surviving
corporation, for each share of stock it held in M Corporation. Pursuant
to section 354 no gain or loss is recognized to U Corporation, and
pursuant to section 358 the basis of the property received (stock of N
Corporation) is the same as that of the property exchanged (stock of M
Corporation). Corporation U is not considered for purposes of section
956 to have acquired United States property by reason of its receipt of
the stock in N Corporation.
Example 5. The facts are the same as in example 4, except that U
Corporation acquires the stock of M Corporation on February 1, 1963,
rather than before January 1, 1963. For purposes of determining U
Corporation's aggregate investment in United States property on December
31, 1963, U Corporation has, by virtue of acquiring the stock of M
Corporation, acquired $10,000 of United States property. Corporation U
pays no amount during 1963 to which section 959(c)(1) applies. The
reorganization and resulting acquisition on December 1, 1964, by U
Corporation of N Corporation's stock also represents an acquisition of
United States property; however, assuming no other change in U
Corporation's aggregate investment in United States property during
1964, U Corporation's increase for such year in earnings invested in
United States property is zero.
[[Page 358]]
(2) [Reserved]
(Secs. 956(c), 7805, Internal Revenue Code of 1954 (76 Stat. 1017, 68A
Stat. 917; (26 U.S.C. 956(c) and 7805 respectively)))
[T.D. 6704, 29 FR 2601, Feb. 20, 1964, as amended by T.D. 7712, 45 FR
52374, Aug. 7, 1980; T.D. 7797, 46 FR 57675, Nov. 25, 1981; T.D. 8209,
53 FR 22171, June 14, 1988; T.D. 9008, 67 FR 48025, July 23, 2002]
Sec. 1.956-2T Definition of United States Property (temporary).
(a)-(c) [Reserved]
(d)(1) [Reserved]
(2) Obligation defined--(i) Rule. For purposes of Sec. 1.956-2 of
the regulations, the term ``obligation'' includes any bond, note,
debenture, certificate, bill receivable, account receivable, note
receivable, open account, or other indebtedness, whether or not issued
at a discount and whether or not bearing interest, except that such term
shall not include:
(A) Any indebtedness arising out of the involuntary conversion of
property which is not United States property within the meaning of
paragraph (a)(1) of Sec. 1.956-2, or
(B) Any obligation of a United States person (as defined in section
957(c)) arising in connection with the provision of services by a
controlled foreign corporation to the United States person if the amount
of such obligation outstanding at any time during the taxable year of
the controlled foreign corporation does not exceed an amount which would
be ordinary and necessary to carry on the trade or business of the
controlled foreign corporation and the United States person if they were
unrelated. The amount of such obligations shall be considered to be
ordinary and necessary to the extent of such receivables that are paid
within 60 days.
See Sec. 1.956-2(b)(1)(v) for the exclusion from United States property
of obligations arising in connection with the sale or processing of
property where such obligations are ordinary and necessary as to amount.
(ii) Effective date. This section is effective June 14, 1988, with
respect to investments made on or after June 14, 1988.
[T.D. 8209, 53 FR 22171, June 14, 1988]
Sec. 1.956-3T Certain trade or service receivables acquired from United
States persons (temporary).
(a) In general. For purposes of section 956(a) and Sec. 1.956-1,
the term ``United States property'' also includes any trade or service
receivable if the trade or service receivable is acquired (directly or
indirectly) after March 1, 1984, from a related person who is a United
States person (as defined in section 7701(a)(30)) (hereinafter referred
to as a ``related United States person'') and the obligor under the
receivable is a United States person. A trade or service receivable
described in this paragraph shall be considered to be United States
property notwithstanding the exceptions (other than subparagraph (H))
contained in section 956(b)(2). The terms ``trade or service
receivable'' and ``related person'' have the respective meanings given
to such terms by section 864(d) and the regulations thereunder. For
purposes of this section, the exception contained in Sec. 1.956-
2T(d)(2)(i)(B) for short-term obligations shall not apply to service
receivables described in this paragraph.
(b) Acquisition of a trade or service receivable--(1) General rule.
The rules of Sec. 1.864-8T(c)(1) shall be applied to determine whether
a controlled foreign corporation has acquired a trade or service
receivable.
(2) Indirect acquisitions--(i) Acquisition through unrelated person.
A trade or service receivable will be considered to be acquired from a
related person if it is acquired from an unrelated person who acquired
(directly or indirectly) such receivable from a person who is a related
person to the acquiring person.
(ii) Acquisition by nominee or pass-through entity. A controlled
foreign corporation will be considered to have acquired a trade or
service receivable of a related United States person held on its behalf:
(A) By a nominee or by a partnership, simple trust, S corporation or
other pass-through entity to the extent the controlled foreign
corporation owns (directly or indirectly) a beneficial interest in such
partnership or other pass-through entity; or
(B) By another foreign corporation that is controlled by the
controlled foreign corporation, if one of the principal
[[Page 359]]
purposes for creating, organizing, or funding such other foreign
corporation (through capital contributions or debt) is to avoid the
application of section 956. See Sec. 1.956-1T.
The rule of this paragraph (b)(2)(ii) does not limit the application of
paragraph (b)(2)(iii) of this section regarding the characterization of
trade or service receivables of unrelated persons acquired pursuant to
certain swap or pooling arrangements. The following examples illustrate
the application of this paragraph (b)(2)(ii).
Example 1. FS1, a controlled foreign corporation with substantial
accumulated earnings and profits, contributes $2,000,000 to PS, a
partnership, in exchange for a 20 percent limited partnership interest
in PS. PS purchases trade or service receivables of FS1's domestic
parent, P. The obligors under the receivables are United States persons.
PS does not purchase receivables of any person who is related to any
other partner in PS. Under paragraph (b)(2)(ii)(A) of this section,
there is an investment of the earnings of FS1 in United States property
equal to 20 percent of PS's basis in the receivables of P.
Example 2. FS1, a controlled foreign corporation, has accumulated
more than $3,000,000 in earnings and profits. It organizes a wholly-
owned foreign corporation, FS2, with a $2,000,000 equity contribution.
FS2 has no earnings and profits. FS2 uses the funds to purchase trade or
service receivables of FS1's domestic parent, P. The obligors under the
receivables are United States persons. Under paragraph (b)(2)(ii)(B) of
this section, there is an investment of the earnings of FS1 in United
States property equal to $2,000,000.
(iii) Swap or pooling arrangements. A trade or service receivable of
an unrelated person will be considered to be a trade or service
receivable acquired from a related United States person and subject to
the rules of this section if it is acquired in accordance with an
arrangement that involves two or more groups of related persons that are
unrelated to each other and the effect of the arrangement is that one or
more related persons in each group acquire (directly or indirectly)
trade or service receivables of one or more unrelated United States
persons who are also parties to the arrangement, in exchange for
reciprocal purchases of receivables of United States persons in the
first group. The following example illustrates the application of this
paragraph (b)(2)(iii).
Example. Controlled foreign corporations A, B, C, and D are wholly-
owned subsidiaries of domestic corporations M, N, O, and P,
respectively. M, N, O, and P are not re lated persons. According to a
prearranged plan, A, B, C, and D each acquire trade or service
receivables of M, N, O, and/or P. The obligors under some or all of the
re ceivables acquired by each of A, B, C, and D are United States
persons. Because the effect of this arrange ment is that the unrelated
groups acquire each other's trade or service receivables of United
States persons pursuant to the ar rangement, there is an investment of
the earnings of each of A, B, C, and D in United States property to the
extent of the purchase price of those receivables under which the
obligors are United States persons.
(iv) Financing arrangements. If a con trolled foreign corporation
participates (directly or indirectly) in a lending transaction that
results in a loan to a United States person who purchases property
described in section 1221(1) (hereinafter referred to as ``inventory
property'') or services of a related United States person, or to any
person who purchases trade or service receiv ables of a related United
States person under which the obligor is a United States person, or to a
person who is re lated to any such purchaser, and if the loan would not
have been made or maintained on the same terms but for the corresponding
purchase, then the controlled foreign corporation shall be considered to
have indirectly acquired a trade or service receivable described in
paragraph (a) of this section. For purposes of this paragraph
(b)(2)(iv), it is immaterial that the sums lent are not, in fact, the
sums used to finance the purchase of the inventory property or services
or trade or service receiv ables of a related United States person. The
amount to be taken into account with respect to the controlled foreign
corporation's investment in United States property (resulting from
application of this paragraph (b)(2)(iv)) shall be the amount lent
pursuant to a lend ing transaction described in this para graph
(b)(2)(iv), if the amount lent is equal to or less than the pur chase
price of the inventory property, services, or trade or service
receivables. If the amount lent is greater than the purchase price of
the inventory property, services or receivables, the amount to
[[Page 360]]
be taken into account shall be the pur chase price. The following
examples il lustrate the application of this para graph (b)(2)(iv).
Example 1. P, a domestic corporation, owns all of the outstanding
stock of FS1, a con trolled foreign corporation. P sells equip ment for
$2,000,000 to X, an unrelated United States person. FS1 makes a
$1,000,000 short-term loan to X, which loan would not have been made or
maintained on the same terms but for X's purchase of P's equipment. Be
cause FS1 directly participates in a lending transaction described in
this paragraph (b)(2)(iv), FS1 is considered to have acquired the
receivable of a related United States per son. Thus, there is an
investment of FS1's earnings and profits in United States prop erty in
the amount of $1,000,000.
Example 2. The facts are the same as in Ex ample 1, except that
instead of loaning money to X directly, FS1 deposits $3,000,000 with an
unrelated financial institution that loans $2,000,000 to X in order for
X to pur chase P's equipment. The loan would not have been made or
maintained on the same terms but for the corresponding deposit. Ac
cordingly, the deposit and the loan are treat ed as a direct loan from
FS1 to X. See Rev. Rul. 87-89, 1987-37 I.R.B. 16. Because FS1 indi
rectly participates in a lending transaction described in this paragraph
(b)(2)(iv), FS1 is considered to have acquired the receivable of a
related United States person. Thus, there is an investment of FS1's
earnings and prof its in United States property in the amount of
$2,000,000.
Example 3. P, a domestic corporation, owns all of the outstanding
stock of FS1, a con trolled foreign corporation. FS1 makes a $3,000,000
loan to U, an unrelated foreign cor poration, in connection with U's
purchase for $2,000,000 of receivables from the sale of in ventory
property by P to United States obli gors. Because FS1 directly
participates in a lending transaction described in this para graph
(b)(2)(iv), FS1 is considered to have ac quired receivables of a related
United States person. Thus, there is an investment of FS1's earnings and
profits in United States prop erty in the amount of $2,000,000.
(c) Substitution of obligor. For pur poses of this section, the
substitution of another person for a United States obligor may be
disregarded. Thus, if a purchaser who is a United States per son
arranges for a foreign person to pay a United States seller of inventory
property or services and the seller transfers by sale or otherwise to
its own controlled foreign corporation the foreign person's obligation
for pay ment, then the acquisition of the for eign person's obligation
shall con stitute an investment in United States property by the
seller's controlled foreign corporation, unless it can be demonstrated
by the parties to the transaction that the primary purpose for the
arrangement was not the avoidance of section 956. The following example
illustrates the application of this paragraph.
Example. P, a domestic corporation, owns all of the outstanding
stock of FS1, a controlled foreign corporation with substantial
accumulated earnings and profits. P sells equipment to X, a domestic
corporation unrelated to P. To pay for the equipment, X arranges for a
foreign financing entity to issue a note to P. P then sells the note to
FS1. FS1 has made an investment in United States property in the amount
of the purchase price of the note.
[T.D. 8209, 53 FR 22169, June 14, 1988]
Sec. 1.957-1 Definition of controlled foreign corporation.
(a) In general. The term controlled foreign corporation means any
foreign corporation of which more than 50 percent (or such lesser amount
as is provided in section 957(b) or section 953(c)) of either--
(1) The total combined voting power of all classes of stock of the
corporation entitled to vote; or
(2) The total value of the stock of the corporation, is owned within
the meaning of section 958(a), or (except for purposes of section
953(c)) is considered as owned by applying the rules of section 958(b)
and Sec. 1.958-2, by United States shareholders on any day during the
taxable year of such foreign corporation. For the definition of the term
United States shareholder, see sections 951(b) and 953(c)(1)(A). For the
definition of the term foreign corporation, see Sec. 301.7701-5 of this
chapter (Procedure and Administration Regulations). For the treatment of
associations as corporations, see section 7701(a)(3) and Sec. Sec.
301.7701-1 and 301.7701-2 of this chapter. For the definition of the
term stock, see sections 958(a)(3) and 7701(a)(7). For the
classification of a member in an association, joint stock company or
insurance company as a shareholder, see section 7701(a)(8).
(b) Percentage of total combined voting power owned by United States
shareholders--(1) Meaning of combined voting
[[Page 361]]
power. In determining for purposes of paragraph (a) of this section
whether United States shareholders own the requisite percentage of total
combined voting power of all classes of stock entitled to vote,
consideration will be given to all the facts and circumstances of each
case. In all cases, however, United States shareholders of a foreign
corporation will be deemed to own the requisite percentage of total
combined voting power with respect to such corporation--
(i) If they have the power to elect, appoint, or replace a majority
of that body of persons exercising, with respect to such corporation,
the powers ordinarily exercised by the board of directors of a domestic
corporation;
(ii) If any person or persons elected or designated by such
shareholders have the power, where such shareholders have the power to
elect exactly one-half of the members of such governing body of such
foreign corporation, either to cast a vote deciding an evenly divided
vote of such body or, for the duration of any deadlock which may arise,
to exercise the powers ordinarily exercised by such governing body; or
(iii) If the powers which would ordinarily be exercised by the board
of directors of a domestic corporation are exercised with respect to
such foreign corporation by a person whom such shareholders have the
power to elect, appoint, or replace.
(2) Shifting of formal voting power. Any arrangement to shift formal
voting power away from United States shareholders of a foreign
corporation will not be given effect if in reality voting power is
retained. The mere ownership of stock entitled to vote does not by
itself mean that the shareholder owning such stock has the voting power
of such stock for purposes of section 957. For example, if there is any
agreement, whether express or implied, that any shareholder will not
vote his stock or will vote it only in a specified manner, or that
shareholders owning stock having not more than 50 percent of the total
combined voting power will exercise voting power normally possessed by a
majority of stockholders, then the nominal ownership of the voting power
will be disregarded in determining which shareholders actually hold such
voting power, and this determination will be made on the basis of such
agreement. Moreover, where United States shareholders own shares of one
or more classes of stock of a foreign corporation which has another
class of stock outstanding, the voting power ostensibly provided such
other class of stock will be deemed owned by any person or persons on
whose behalf it is exercised or, if not exercised, will be disregarded
if the percentage of voting power of such other class of stock is
substantially greater than its proportionate share of the corporate
earnings, if the facts indicate that the shareholders of such other
class of stock do not exercise their voting rights independently or fail
to exercise such voting rights, and if a principal purpose of the
arrangement is to avoid the classification of such foreign corporation
as a controlled foreign corporation under section 957.
(c) Illustrations. The application of this section may be
illustrated by the following examples:
Example 1. Foreign corporation R has two classes of capital stock
outstanding, 60 shares of class A stock, and 40 shares of class B stock.
Each share of each class of stock has one vote for all purposes. E, a
United States person, owns 51 shares of class A stock. Corporation R is
a controlled foreign corporation.
Example 2. Foreign corporation S has three classes of capital stock
outstanding, consisting of 60 shares of class A stock, 40 shares of
class B stock, and 200 shares of class C stock. The owners of a majority
of class A stock are entitled to elect 6 of the 10 corporate directors,
and the owners of a majority of the class B stock are entitled to elect
the other 4 of the 10 directors. Class C stock has no voting rights. D,
a United States person, owns all of the shares of the class C stock. He
also owns 31 shares of class A stock and as such an owner can elect 6
members of the board of directors. None of the remaining shares of class
A stock, or the 40 shares of class B stock, is owned, or considered as
owned, within the meaning of section 958, by a United States person.
Since, as owner of 31 shares of the class A stock, D has sufficient
voting power to elect 6 directors, D has more than 50 percent of the
total combined voting power of all classes of stock entitled to vote,
and S Corporation is a controlled foreign corporation.
Example 3. M, a United States person, owns a 51-percent interest in
R Company, a foreign
[[Page 362]]
company of which he is a member. The company, if it were domestic, would
be taxable as a corporation. The remaining interest of 49 percent in the
company is owned by seven other members none of whom is a United States
person. The memorandum of association of R Company provides for only one
manager, who with respect to the company exercises the powers ordinarily
exercised by a board of directors of a domestic corporation. The manager
is to be elected by unanimous agreement of all the members. Since M owns
51 percent of the company, he will be deemed to own more than 50 percent
of the total combined voting power of all classes of stock of R Company
entitled to vote, notwithstanding that he has power to elect a manager
only with the agreement of the other members. Company R is a controlled
foreign corporation.
Example 4. Domestic corporation M owns a 49-percent interest in S
Company, a foreign company of which it is a member. The company, if it
were domestic, would be taxable as a corporation. Company S is formed
under the laws of foreign country Y. The remaining interest of 51
percent in S Company is owned by persons who are not United States
persons. The organization contract of S Company provides for one
manager, B, a citizen and resident of country Y who is an officer of M
Corporation in charge of its foreign operations in such country, or any
person M Corporation may at any time appoint to succeed B in such
capacity. The manager has the sole authority with respect to S Company
to exercise powers ordinarily exercised by a board of directors of a
domestic corporation. Since M Corporation has the discretionary power to
replace B and to appoint his successor as manager of S Company, the
company is a controlled foreign corporation.
Example 5. N, a United States person, owns 50 percent of the
outstanding shares of the only class of capital stock of foreign
corporation R. An additional 48 percent of the outstanding shares is
owned by foreign corporation S. The remaining 2 percent of shares is
owned by P, a citizen and resident of foreign country T, who regularly
acts as attorney for N in the conduct of N's business affairs in country
T. All of the shares of the outstanding capital stock of R Corporation
are bearer shares. At the time of the issuance of the shares to him, P
places the certificates for such shares in a depository to which N has
access. On several occasions N, with P's acquiescence, has taken such
shares from the depository and, on one such occasion, used the shares as
collateral in borrowing funds on a loan. Although dividends, when paid,
are paid to P on his shares, his charges to N for legal fees are reduced
by the amount of the dividends paid on such shares. Although P votes his
shares at meetings of shareholders, the facts set forth above indicate
an implied agreement between P and N that N is really to retain dominion
over the stock. N is deemed to own the voting rights ostensibly attached
to the stock owned by P, and R Corporation is a controlled foreign
corporation.
Example 6. M, a domestic corporation which manufactures in the
United States and distributes all of its production for foreign
consumption through N, a person other than a related person or a United
States person, forms foreign corporation S to purchase products from M
Corporation and sell them to N. Corporations S and M have common
directors. The outstanding capital stock of S Corporation consists of
10,000 shares of $100 par value class A stock, which has no voting
rights except to vote for dissolution of the corporation on a share-for-
share basis, and 500 shares of no par class B stock which has full
voting rights. Each class of the outstanding stock is to participate on
a share for share basis in any dividend. The class A stock has a
preference as to assets on dissolution of the corporation to the extent
of its par value as well as the right to participate with the class B
stock in all other assets on a share for share basis. All of the shares
of class A stock are issued to M Corporation in return for property
having a value of $1 million. Of the class B stock, 300 of the shares
are issued to N in return for $3,000 in cash and 200 shares are issued
to M Corporation for $2,000 in cash. At stockholder meetings N never
votes in opposition to M Corporation on important issues. Corporation S
has average annual earnings of $200,000, all of which will be subpart F
income if S Corporation is held to be a controlled foreign corporation.
All such earnings are accumulated. Although N ostensibly has 60 percent
of the voting power of S Corporation by virtue of his ownership of 300
shares of class B stock, he has the right to only approximately 3
percent of any dividends which may be paid by S Corporation; in
addition, upon liquidation of S Corporation, N is entitled to share in
the assets only after M Corporation has received the par value of its
10,000 shares of class A stock, or $1 million. Thus, the voting power
owned by N is substantially greater than its proportionate share of the
earnings of S Corporation. In addition, the facts set forth above
indicate that N is not exercising his voting rights independently and
that a principal purpose of the capitalization arrangement is to avoid
classification of S Corporation as a controlled foreign corporation. For
these reasons, the voting power ostensibly provided the class B stock
will be deemed owned by M Corporation, and S Corporation is a controlled
foreign corporation.
Example 7. Foreign corporation A, authorized to issue 100 shares of
one class of capital stock, issues, for $1,000 per share, 45 shares to
domestic corporation M, 45 shares to foreign
[[Page 363]]
corporation B, and 10 shares to foreign corporation C. Corporation C, a
bank, lends $3 million to finance the operations of A Corporation. In
the course of negotiating these financial arrangements, D, an officer of
C Corporation, and E, an officer of M Corporation, orally agree that C
Corporation will vote its stock as M Corporation directs. By virtue of
such oral agreement M Corporation possesses the voting power ostensibly
owned by C Corporation, and A Corporation is a controlled foreign
corporation.
Example 8. For its prior taxable year, JV, a foreign corporation,
had outstanding 1000 shares of class A stock, which is voting common,
and 1000 shares of class B stock, which is nonvoting preferred. DP, a
domestic corporation, and FP, a foreign corporation, each owned
precisely 500 shares of both class A and class B stock, and each elected
5 of the 10 members of JV's board of directors. The other facts and
circumstances were such that JV was not a controlled foreign corporation
on any day of the prior taxable year. On the first day of the current
taxable year, DP purchased one share of class B stock from FP. JV was a
controlled foreign corporation on the following day because over 50
percent of the total value in the corporation was held by a person that
was a United States shareholder under section 951(b). See Sec. 1.951-
1(f).
Example 9. The facts are the same as in Example 8 except that the
stock of FP was publicly traded, FP had one class of stock, and on the
first day of the current taxable year DP purchased one share of FP stock
on the foreign stock exchange instead of purchasing one share of JV
stock from FP. JV became a controlled foreign corporation on the
following day because over 50 percent of the total value in the
corporation was held by a person that was a United States shareholder
under section 951(b).
Example 10. X, a foreign corporation, is incorporated under the laws
of country Y. Under the laws of country Y, X is considered a mutual
insurance company. X issues insurance policies that provide the
policyholder with the right to vote for directors of the corporation,
the right to a share of the assets upon liquidation in proportion to
premiums paid, and the right to receive policyholder dividends in
proportion to premiums paid. Only policyholders are provided with the
right to vote for directors, share in assets upon liquidation, and
receive distributions. United States policyholders contribute 25 percent
of the premiums and have 25 percent of the outstanding rights to vote
for the board of directors. Based on these facts, the United States
policyholders are United States shareholders owning the requisite
combined voting power and value. Thus, X is a controlled foreign
corporation for purposes of taking into account related person insurance
income under section 953(c).
(d) Effective date. Paragraphs (a) and (c) Examples 8 through 10 of
this section are effective for taxable years of a controlled foreign
corporation beginning after November 6, 1995.
[T.D. 6688, 28 FR 11631, Oct. 31, 1963, as amended by T.D. 8216, 53 FR
27510, July 21, 1988; T.D. 8618, 60 FR 46529, Sept. 7, 1995; 60 FR
62026, Dec. 4, 1995; T.D. 8704, 62 FR 21, Jan. 2, 1997]
Sec. 1.957-2 Controlled foreign corporation deriving income from
insurance of United States risks.
(a) In general. For purposes of taking into account only the income
derived from the insurance of United States risks under Sec. 1.953-1,
the term ``controlled foreign corporation'' means any foreign
corporation of which more than 25 percent, but not more than 50 percent,
of the total combined voting power of all classes of stock entitled to
vote is owned within the meaning of section 958(a), or is considered as
owned by applying the rules of ownership of section 958(b), by United
States shareholders on any day of the taxable year of such foreign
corporation, but only if the gross amount of premiums received by such
foreign corporation during such taxable year which are attributable to
the reinsuring and the issuing of insurance and annuity contracts in
connection with United States risks, as defined in Sec. 1.953-2 or
1.953-3, exceeds 75 percent of the gross amount of all premiums received
by such foreign corporation during such year which are attributable to
the reinsuring and the issuing of insurance and annuity contracts in
connection with all risks. The subpart F income for a taxable year of a
foreign corporation which is a controlled foreign corporation for such
taxable year within the meaning of this paragraph shall, subject to the
provisions of section 952(b), (c), and (d), and Sec. 1.952-1, include
only the income derived from the insurance of United States risks, as
determined under Sec. 1.953-1.
(b) Gross amount of premiums defined. For a foreign corporation
which is engaged in the business of reinsuring or issuing insurance or
annuity contracts and which, if it were a domestic corporation engaged
only in such business, would be taxable as--
[[Page 364]]
(1) A life insurance company to which part I (sections 801 through
820) of subchapter L of the Code applies,
(2) A mutual insurance company to which part II (sections 821
through 826) of subchapter L of the Code applies, or
(3) A mutual marine insurance or other insurance company to which
part III (sections 831 and 832) of subchapter L of the Code applies,
the term ``gross amount of premiums'' means, for purposes of paragraph
(a) of this section, the gross amount of premiums and other
consideration which are taken into account by a life insurance company
under section 809(c)(1). Determinations for purposes of this paragraph
shall be made without regard to section 501(a).
[T.D. 6795, 30 FR 942, Jan. 29, 1965]
Sec. 1.957-3 Corporations organized in United States possessions.
(a) General rule. For purposes of sections 951 through 964, a
corporation created or organized in a possession of the United States or
under the laws of a possession of the United States shall not be treated
as a controlled foreign corporation for any taxable year if--
(1) 80 percent or more of the gross income of such corporation for
the 3-year period immediately preceding the close of the taxable year or
for such part of such 3-year period as such corporation was in existence
or for such part of such 3-year period as occurs on and after the
beginning of such corporation's first annual accounting period beginning
after December 31, 1962, whichever period is shortest, was derived from
sources within a possession of the United States; and
(2) 50 percent or more of the gross income of such corporation for
such period, or for such part of such period, was derived from the
active conduct within a possession of the United States of one or more
trades or businesses constituting--
(i) The manufacture or processing of goods, wares, merchandise, or
other tangible personal property;
(ii) The processing of agricultural or horticultural products or
commodities (including but not limited to livestock, poultry, or fur-
bearing animals);
(iii) The catching or taking of any kind of fish, or any
manufacturing or processing of any products or commodities obtained from
such activities;
(iv) The mining or extraction of natural resources, or any
manufacturing or processing of any products or commodities obtained from
such activities; or
(v) The ownership or operation of hotels.
(b) Special provisions. For purposes of section 957(c) and this
section--
(1) United States defined. The term ``United States'' includes only
the States and the District of Columbia.
(2) Possession of the United States defined. The term ``possession
of the United States'' includes Guam, the Midway Islands, the Panama
Canal Zone, the Commonwealth of Puerto Rico, American Samoa, the Virgin
Islands, and Wake Island.
(3) Determination of source of gross income. Whether gross income of
a corporation referred to in paragraph (a) of this section is derived
from sources within a possession of the United States shall be
determined by the application of the provisions of Sec. 1.955-6 except
that, for purposes of making such determination, the term ``produced'',
as used in paragraph (d)(2) of Sec. 1.955-6, shall also include the
activities described in paragraph (a)(2)(i) through (iv) of this section
and the activities considered, under subparagraph (4) of this paragraph,
to be qualifying trades or businesses.
(4) Manufacturing or processing. The trades or businesses which
qualify under the provisions of paragraph (a)(2) of this section shall
include, but not be limited to, the manufacture of tabulating cards,
paper tablets or pads, facial tissues, and paper napkins from rolls of
paper; the manufacture of such household products as liquid starch by
mixing quantities of the ingredients which are used to produce liquid
starch; and the manufacture of juices and drinks from fruit
concentrates. In the application of paragraph (a)(2) of this section,
proper regard shall be given to the classification of a trade or
business as a manufacturing or processing activity under the applicable
economic incentive law of the possession involved. The fact that an
activity of a corporation qualifies as a trade or business for purposes
of paragraph (a)
[[Page 365]]
of this section does not necessarily mean that such activity constitutes
a substantial transformation of property within the meaning of paragraph
(a)(4) of Sec. 1.954-3 for purposes of determining any foreign base
company income of such corporation.
[T.D. 6683, 28 FR 11184, Oct. 18, 1963]
Sec. 1.957-4 United States person defined.
(a) Basic rule--(1) In general. The term ``United States person''
has the same meaning for purposes of sections 951 through 964 which it
has under section 7701(a)(30) and in the regulations thereunder, except
as provided in section 957(d) and paragraphs (b), (c), and (d) of this
section which provide, with respect to corporations organized in
possessions of the United States, that certain residents of such
possessions are not United States persons. The effect of determining
that an individual is not a United States person for such purposes is to
exclude such individual in determining whether a foreign corporation
created or organized in, or under the laws of, Puerto Rico, the Virgin
Islands, or any possession of the United States (other than Puerto Rico
or the Virgin Islands) is a controlled foreign corporation. See Sec.
1.957-1 for definition of the term ``controlled foreign corporation'';
Sec. 1.957-2 for a special limitation on the amount of subpart F income
of certain controlled foreign corporations deriving income from the
insurance of United States risks; and Sec. 1.957-3 for the exclusion of
certain corporations organized in United States possessions from the
definition of controlled foreign corporation.
(2) Special provisions applicable to possessions of the United
States. For purposes of section 957(d) and this section--
(i) Possession of the United States defined. The term ``possession
of the United States'' has the same meaning which it has under paragraph
(b)(2) of Sec. 1.957-3.
(ii) Determination of residence in a possession. Whether an
individual is a bona fide resident of Puerto Rico, the Virgin Islands,
or any other possession of the United States, shall be determined in
general by applying to the facts and circumstances in each case the
principles of Sec. Sec. 1.871-2 through 1.871-5, relating to the
determination of residence in the United States.
(b) Puerto Rico corporation and resident. With respect only to a
foreign corporation created or organized in, or under the laws of,
Puerto Rico--
(1) If an individual (who, without regard to this paragraph, is a
United States person) is a bona fide resident of Puerto Rico during his
entire taxable year in which or with which the taxable year of such
foreign corporation ends, and
(2) If 50 percent or more of the gross income of such foreign
corporation is derived from sources within Puerto Rico, as determined
under Sec. 1.863-6, for the 3-year period (or for such part of such 3-
year period as such foreign corporation has been in existence) ending
with the close of the taxable year of such foreign corporation which--
(i) Ends with or within the taxable year next preceding such taxable
year of such individual and at any time, during the period beginning
with the beginning of such latter taxable year of such individual and
ending not later than one year after the close of such taxable year of
such foreign corporation, such individual directly owns stock in such
foreign corporation, or
(ii) Ends within such taxable year of such individual and at any
time, during the period beginning after the close of such taxable year
of such foreign corporation and ending with the close of such taxable
year of such individual, such individual directly owns stock in such
foreign corporation,
then, such individual shall not be considered a United States person
with respect to such corporation for the taxable year of such
corporation which ends with or within the taxable year of such person.
The application of this paragraph may be illustrated by the following
examples:
Example 1. Foreign corporation R, incorporated under the laws of
Puerto Rico, is wholly owned by D, a United States citizen. D and
corporation R use the calendar year as the taxable year. For 1961, 1962,
and 1963, 60 percent of the gross income of R Corporation is derived
from sources within Puerto Rico and 40 percent of the gross income of R
Corporation is derived from sources within Panama, as determined under
Sec. 1.863-6. During all of 1964, D is a bona fide resident of Puerto
Rico. D is not a United States person with
[[Page 366]]
respect to R Corporation for 1964. Accordingly, R Corporation is not a
controlled foreign corporation at any time in 1964.
Example 2. Foreign corporation R is incorporated on January 1, 1962,
under the laws of Puerto Rico. D, a United States citizen, owns all the
one class of stock of R Corporation throughout 1962 and 1963. D and
corporation R use the calendar year as the taxable year. For 1962, 55
percent of the gross income of R Corporation is derived from sources
within Puerto Rico and 45 percent of the gross income of R Corporation
is derived from sources within the Netherlands Antilles, as determined
under Sec. 1.863-6. For 1963, 40 percent of the gross income of R
Corporation is derived from sources within Puerto Rico and 60 percent of
the gross income of R Corporation is derived from sources within the
Netherlands Antilles, as determined under Sec. 1.863-6. During all of
1963 D is a bona fide resident of Puerto Rico. With respect to R
Corporation, D is not a United States person for 1963 because D is a
bona fide resident of Puerto Rico for all of 1963; 55 percent of the
gross income of R Corporation for 1962 is derived from sources within
Puerto Rico; and D owns stock in R Corporation at some time during 1963.
Accordingly, R Corporation is not a controlled foreign corporation at
any time in 1963. In making this determination, it is immaterial that R
Corporation does not satisfy the 50-percent gross income test for 1963,
the taxable year during all of which D is a resident of Puerto Rico.
Example 3. Foreign corporation R is incorporated on January 1, 1962,
under the laws of Puerto Rico. D, a United States citizen, owns all the
one class of stock of R Corporation throughout 1962 and 1963. D and
corporation R use the calendar year as the taxable year. For 1962, 45
percent of the gross income of R Corporation is derived from sources
within Puerto Rico and 55 percent of the gross income of R Corporation
is derived from sources within the Netherlands Antilles, as determined
under Sec. 1.863-6. For 1963, 60 percent of the gross income of R
Corporation is derived from sources within Puerto Rico and 40 percent of
the gross income of R Corporation is derived from sources within the
Netherlands Antilles, as determined under Sec. 1.863-6. With respect to
R Corporation, D is a United States person for 1963, since R Corporation
does not satisfy the 50-percent gross income test for 1962. Accordingly,
R Corporation is a controlled foreign corporation for all of 1963.
Example 4. Foreign corporation S is incorporated on July 1, 1962,
under the laws of Puerto Rico. Corporation S uses the fiscal year ending
on June 30 as the taxable year. For its fiscal year ending on June 30,
1963, 55 percent of the gross income of S Corporation is derived from
sources within Puerto Rico and 45 percent of the gross income of S
Corporation is derived from sources within Switzerland, as determined
under Sec. 1.863-6. For its fiscal years ending on June 30, 1964, and
June 30, 1965, respectively, 40 percent of the gross income of S
Corporation is derived from sources within Puerto Rico and 60 percent of
the gross income of S Corporation is derived from sources within
Switzerland, as determined under Sec. 1.863-6. B, a United States
citizen, who uses the calendar year as the taxable year, is a bona fide
resident of Puerto Rico for all of 1964. On July 1, 1964, B acquires,
and holds throughout the remainder of 1964, all of the one class of
stock of S Corporation. With respect to S Corporation for its taxable
year ending June 30, 1964, B is a United States person because--
(a) Although B is a bona fide resident of Puerto Rico for his entire
year 1964 in which ends S Corporation's taxable year ending June 30,
1964, and S Corporation meets the 50-percent gross income test for the
applicable part of the 3-year period ending June 30, 1963, B does not
own stock in S Corporation during the period beginning January 1, 1964,
and ending June 30, 1964, and
(b) Although B owns stock in S Corporation during the period
beginning July 1, 1964, and ending December 31, 1964, S Corporation does
not meet the 50-percent gross income test for the applicable part of the
3-year period ending June 30, 1964.
Accordingly, with respect to B, S Corporation is a controlled foreign
corporation for its entire taxable year ending June 30, 1964.
Example 5. The facts are the same as in example 4, except B buys all
of the stock of S Corporation on June 1, 1964, rather than on July 1,
1964. With respect to S Corporation for its taxable year ending June 30,
1964, B is not a United States person because B is a bona fide resident
of Puerto Rico for his entire taxable year 1964 in which ends S
Corporation's taxable year ending June 30, 1964; S Corporation meets the
50-percent gross income test for the applicable part of the 3-year
period ending June 30, 1963; and B owns stock in S Corporation during
the period beginning January 1, 1964, and ending June 30, 1964.
Accordingly, with respect to B, S Corporation is not a controlled
foreign corporation at any time during its taxable year ending June 30,
1964.
(c) Virgin Islands corporation and President. With respect only to a
foreign corporation created or organized in, or under the laws of, the
Virgin Islands--
(1) If an individual (who, without regard to this paragraph, is a
United States person) is a bona fide resident of the Virgin Islands as
of the last day of his taxable year in which or with which the taxable
year of such foreign corporation ends, and
[[Page 367]]
(2) Such individual's income tax obligations under subtitle A
(relating to income taxes) of the Code for his taxable year are
satisfied, in accordance with section 28(a) of the Revised Organic Act
of the Virgin Islands (48 U.S.C. 1642), by paying the tax on his income
derived from all sources, both within and outside the Virgin Islands,
into the treasury of the Virgin Islands, then, such individual shall not
be considered a United States person with respect to such corporation
for the taxable year of such corporation which ends with or within the
taxable year of such person. The application of this paragraph may be
illustrated by the following examples:
Example 1. Foreign corporation S, incorporated under the laws of the
Virgin Islands, is wholly owned by D, a United States citizen.
Corporation S uses the fiscal year ending on June 30 as the taxable
year, and D uses the calendar year as the taxable year. From September
1, 1963, to December 31, 1964, inclusive, D is a bona fide resident of
the Virgin Islands. For 1963 and 1964, D satisfies his income tax
obligations under section 28(a) of the Revised Organic Act of the Virgin
Islands by paying the tax on his income derived from all sources, both
within and outside the Virgin Islands, into the treasury of the Virgin
Islands. With respect to S Corporation for its taxable years ending June
30, 1963, and 1964, D is not a United States person. Accordingly, S
Corporation is not a controlled foreign corporation for such taxable
years of such corporation.
Example 2. The facts are the same as in example 1, except that from
August 15, 1964, to December 31, 1964, inclusive, D is a bona fide
resident of the United States. Thus, D does not satisfy his income tax
obligations for 1964 under section 28(a) of the Revised Organic Act of
the Virgin Islands. The result is the same as in example 1, except that
with respect to S Corporation for its taxable year ending June 30, 1964,
D is a United States person and, accordingly, S Corporation is a
controlled foreign corporation for such taxable year of such
corporation.
(d) Corporation and resident of other United States possessions.
With respect only to a foreign corporation created or organized in, or
under the laws of, any possession of the United States (other than
Puerto Rico or the Virgin Islands)--
(1) If an individual (who, without regard to this paragraph, is a
United States person) is a bona fide resident of such possession during
his entire taxable year in which or with which the taxable year of such
foreign corporation ends, and
(2) Any part or all of such individual's income (other than amounts
includible in his gross income under section 951(a)) for his taxable
year derived, in accordance with Sec. 1.863-6, from sources within any
possession of the United States (whether or not the possession of which
such individual is a resident) is not, as a result of the application of
section 931, included in his gross income for his taxable year,
then, such individual shall not be considered a United States person
with respect to such corporation for the taxable year of such
corporation which ends with or within the taxable year of such person.
Subparagraph (2) of this paragraph shall apply only for purposes of
determining whether an individual is a United States person; after such
determination has been made, section 931 shall be applied to the gross
income (including amounts includible in gross income under section
951(a)) of such individual to determine the amount to be excluded from
such individual's gross income under section 931. The application of
this paragraph may be illustrated by the following examples:
Example 1. Foreign corporation R, incorporated under the laws of
Guam, is wholly owned by D, a United States citizen. D and corporation R
use the calendar year as the taxable year and the cash receipts and
disbursements method of accounting. D is a bona fide resident of Guam
for all of 1963 and all of his income of $30,000 (determined without
taking into account amounts includible in his gross income under section
951(a)) is derived from sources within Guam. Of such income, $24,000 is
received in Guam and $6,000 is erceived in the United States. It meets
the 3-year test of section 931(a) and, but for the application of
section 931(b), all of his income of $30,000 would be excluded from
gross income for 1963 under section 931. However, in accordance with
section 931(b) and paragraph (c) of Sec. 1.931-1, the $6,000 received
in the United States is included in gross income. Nevertheless, since
part ($24,000) of his income of $30,000 for 1963 derived, in accordance
with Sec. 1.863-6, from sources within Guam is not, as a result of the
application of section 931, included in his gross income, D is not a
United States person with respect to R Corporation for its taxable year
1963. Accordingly, R Corporation is not a controlled foreign corporation
for its taxable year 1963.
[[Page 368]]
Example 2. The facts are the same as in example 1, except that,
instead of receiving the $6,000 in the United States, D receives $10,000
of the $30,000 in Guam for services performed for an agency of the
United States. Under Sec. 1.863-6, all of D's income for 1963 is income
derived from sources within Guam. However, since D's income of $10,000
from the agency of the United States is deemed under section 931 (i) to
be derived from sources within the United States for purposes of section
931, at least 80 percent of his gross income for 1963, determined
without the application of section 931, is not derived from sources
within Guam. Accordingly, since no part of D's gross income of $30,000
for 1963 derived, in accordance with Sec. 1.863-6, from sources within
Guam is, as a result of the application of section 931, excluded from
gross income for 1963, D is a United States person with respect to R
Corporation for R Corporation's taxable year 1963. Accordingly, R
Corporation is a controlled foreign corporation for its taxable year
1963.
[T.D. 6775, 29 FR 16082, Dec. 2, 1964]
Sec. 1.958-1 Direct and indirect ownership of stock.
(a) In general. Section 958(a) provides that, for purposes of
sections 951 to 964 (other than sections 955(b)(1)(A) and (B) and
955(c)(2)(A)(ii) (as in effect before the enactment of the Tax Reduction
Act of 1975), and 960(a)(1)), stock owned means--
(1) Stock owned directly; and
(2) Stock owned with the application of paragraph (b) of this
section.
The rules of section 958(a) and this section provide a limited form of
stock attribution primarily for use in determining the amount taxable to
a United States shareholder under section 951(a). These rules also apply
for purposes of other provisions of the Code and regulations which make
express reference to section 958(a).
(b) Stock ownership through foreign entities. For purposes of
paragraph (a)(2) of this section, stock owned, directly or indirectly,
by or for a foreign corporation, foreign partnership, foreign trust
(within the meaning of section 7701(a)(31)) described in sections 671
through 679, or other foreign trust or foreign estate (within the
meaning of section 7701(a)(31)) shall be considered as being owned
proportionately by its shareholders, partners, grantors or other persons
treated as owners under sections 671 through 679 of any portion of the
trust that includes the stock, or beneficiaries, respectively. Stock
considered to be owned by reason of the application of this paragraph
shall, for purposes of reapplying this paragraph, be treated as actually
owned by such person. Thus, this rule creates a chain of ownership;
however, since the rule applies only to stock owned by a foreign entity,
attribution under the rule stops with the first United States person in
the chain of ownership running from the foreign entity. The application
of this paragraph may be illustrated by the following example:
Example. Domestic corporation M owns 75 percent of the one class of
stock in foreign corporation R, which in turn owns 80 percent of the one
class of stock in foreign corporation S, which in turn owns 90 percent
of the one class of stock in foreign corporation T. Under this
paragraph, R Corporation is considered as owning 80 percent of the 90
percent of the stock which S Corporation owns in T Corporation, or 72
percent. Corporation M is considered as owning 75 percent of such 72
percent of the stock in T Corporation, or 54 percent. Since M
Corporation is a domestic corporation, the attribution under this
paragraph stops with M Corporation, even though, illustratively, such
corporation is wholly owned by domestic corporation N.
(c) Rules of application--(1) Special rule for mutual insurance
companies. For purposes of applying paragraph (a) of this section in the
case of a foreign mutual insurance company, the term ``stock'' shall
include any certificate entitling the holder to voting power in the
corporation.
(2) Amount of interest in foreign corporation, foreign partnership,
foreign trust, or foreign estate. The determination of a person's
proportionate interest in a foreign corporation, foreign partnership,
foreign trust, or foreign estate will be made on the basis of all the
facts and circumstances in each case. Generally, in determining a
person's proportionate interest in a foreign corporation, the purpose
for which the rules of section 958(a) and this section are being applied
will be taken into account. Thus, if the rules of section 958(a) are
being applied to determine the amount of stock owned for purposes of
section 951(a), a person's proportionate interest in a foreign
corporation will generally be determined with reference to such person's
interest
[[Page 369]]
in the income of such corporation. If the rules of section 958(a) are
being applied to determine the amount of voting power owned for purposes
of section 951(b) or 957, a person's proportionate interest in a foreign
corporation will generally be determined with reference to the amount of
voting power in such corporation owned by such person. However, any
arrangement which artificially decreases a United States person's
proportionate interest will not be recognized. See Sec. Sec. 1.951-1
and 1.957-1.
(d) Illustration. The application of this section may be illustrated
by the following examples:
Example 1. United States persons A and B own 25 percent and 50
percent, respectively, of the one class of stock in foreign corporation
M. Corporation M owns 80 percent of the one class of stock in foreign
corporation N, and N Corporation owns 60 percent of the one class of
stock in foreign corporation P. Under paragraph (b) of this section, M
Corporation is considered to own 48 percent (80 percent of 60 percent)
of the stock in P Corporation; such 48 percent is treated as actually
owned by M Corporation for the purpose of again applying paragraph (b)
of this section. Thus, A and B are considered to own 12 percent (25
percent of 48 percent) and 24 percent (50 percent of 48 percent),
respectively, of the stock in P Corporation.
Example 2. United States person C is a 60-percent partner in foreign
partnership X. Partnership X owns 40 percent of the one class of stock
in foreign corporation Q. Corporation Q is a 50-percent partner in
foreign partnership Y, and partnership Y owns 100 percent of the one
class of stock in foreign corporation R. By the application of paragraph
(b) of this section, C is considered to own 12 percent (60 percent of 40
percent of 50 percent of 100 percent) of the stock in R Corporation.
Example 3. Foreign trust Z was created for the benefit of United
States persons D, E, and F. Under the terms of the trust instrument, the
trust income is required to be divided into three equal shares. Each
beneficiary's share of the income may either be accumulated for him or
distributed to him in the discretion of the trustee. In 1970, the trust
is to terminate and there is to be paid over to each beneficiary the
accumulated income applicable to his share and one-third of the corpus.
The corpus of trust Z is composed of 90 percent of the one class of
stock in foreign corporation S. By the application of this section, each
of D, E, and F is considered to own 30 percent (\1/3\ of 90 percent) of
the stock in S Corporation.
Example 4. Among the assets of foreign estate W are Blackacre and a
block of stock, consisting of 75 percent of the one class of stock of
foreign corporation T. Under the terms of the will governing estate W,
Blackacre is left to G, a nonresident alien, for life, remainder to H, a
nonresident alien, and the block of stock is left to United States
person K. By the application of this section, K is considered to own the
75 percent of the stock of T Corporation, and G and H are not considered
to own any of such stock.
[T.D. 6889, 31 FR 9455, July 12, 1966, as amended by T.D. 7893, 48 FR
22509, May 19, 1983; T.D. 8955, 66 FR 37897, July 20, 2001]
Sec. 1.958-2 Constructive ownership of stock.
(a) In general. Section 958(b) provides that, for purposes of
sections 951(b), 954(d)(3), 956(b)(2), and 957, the rules of section
318(a) as modified by section 958(b) and this section shall apply to the
extent that the effect is to treat a United States person as a United
States shareholder within the meaning of section 951(b), to treat a
person as a related person within the meaning of section 954(d)(3), to
treat the stock of a domestic corporation as owned by a United States
shareholder of a controlled foreign corporation under section 956(b)(2),
or to treat a foreign corporation as a controlled foreign corporation
under section 957. The rules contained in this section also apply for
purposes of other provisions of the Code and regulations which make
express reference to section 958(b).
(b) Members of family--(1) In general. Except as provided in
subparagraph (3) of this paragraph, an individual shall be considered as
owning the stock owned, directly or indirectly, by or for--
(i) His spouse (other than a spouse who is legally separated from
the individual under a decree of divorce or separate maintenance); and
(ii) His children, grandchildren, and parents.
(2) Effect of adoption. For purposes of subparagraph (1)(ii) of this
paragraph, a legally adopted child of an individual shall be treated as
a child of such individual by blood.
(3) Stock owned by nonresident alien individual. For purposes of
this paragraph, stock owned by a nonresident alien individual (other
than a foreign trust or foreign estate) shall not be
[[Page 370]]
considered as owned by a United States citizen or a resident alien
individual. However, this limitation does not apply for purposes of
determining whether the stock of a domestic corporation is owned or
considered as owned by a United States shareholder under section
956(b)(2) and Sec. 1.956-2(b)(1)(viii). See section 958(b)(1).
(c) Attribution from partnerships, estates, trusts, and
corporations--(1) In general. Except as provided in subparagraph (2) of
this paragraph--
(i) From partnerships and estates. Stock owned, directly or
indirectly, by or for a partnership or estate shall be considered as
owned proportionately by its partners or beneficiaries.
(ii) From trusts--(a) To beneficiaries. Stock owned, directly or
indirectly, by or for a trust (other than an employees' trust described
in section 401(a) which is exempt from tax under section 501(a)) shall
be considered as owned by its beneficiaries in proportion to the
actuarial interest of such beneficiaries in such trust.
(b) To owner. Stock owned, directly or indirectly, by or for any
portion of a trust of which a person is considered the owner under
sections 671 to 679 (relating to grantors and others treated as
substantial owners) shall be considered as owned by such person.
(iii) From corporations. If 10 percent or more in value of the stock
in a corporation is owned, directly or indirectly, by or for any person,
such person shall be considered as owning the stock owned, directly or
indirectly, by or for such corporation, in that proportion which the
value of the stock which such person so owns bears to the value of all
the stock in such corporation. See section 958(b)(3).
(2) Rules of application. For purposes of subparagraph (1) of this
paragraph, if a partnership, estate, trust, or corporation owns,
directly or indirectly, more than 50 percent of the total combined
voting power of all classes of stock entitled to vote in a corporation,
it shall be considered as owning all the stock entitled to vote. See
section 958(b)(2).
(d) Attribution to partnerships, estates, trusts, and corporations--
(1) In general. Except as provided in subparagraph (2) of this
paragraph--
(i) To partnerships and estates. Stock owned, directly or
indirectly, by or for a partner or a beneficiary of an estate shall be
considered as owned by the partnership or estate.
(ii) To trusts--(a) From beneficiaries. Stock owned, directly or
indirectly, by or for a beneficiary of a trust (other than an employees'
trust described in section 401(a) which is exempt from tax under section
501(a)) shall be considered as owned by the trust, unless such
beneficiary's interest in the trust is a remote contingent interest. For
purposes of the preceding sentence, a contingent interest of a
beneficiary in a trust shall be considered remote if, under the maximum
exercise of discretion by the trustee in favor of such beneficiary, the
value of such interest, computed actuarially, is 5 percent or less of
the value of the trust property.
(b) From owner. Stock owned, directly or indirectly, by or for a
person who is considered the owner of any portion of a trust under
sections 671 to 678 (relating to grantors and others treated as
substantial owners) shall be considered as owned by the trust.
(iii) To corporations. If 50 percent or more in value of the stock
in a corporation is owned, directly or indirectly, by or for any person,
such corporation shall be considered as owning the stock owned, directly
or indirectly, by or for such person. This subdivision shall not be
applied so as to consider a corporation as owning its own stock.
(2) Limitation. Subparagraph (1) of this paragraph shall not be
applied so as to consider a United States person as owning stock which
is owned by a person who is not a United States person. This limitation
does not apply for purposes of determining whether the stock of a
domestic corporation is owned or considered as owned by a United States
shareholder under section 956(b)(2) and Sec. 1.956-2(b)(1)(viii). See
section 958(b)(4).
(e) Options. If any person has an option to acquire stock, such
stock shall be considered as owned by such person. For purposes of the
preceding sentence, an option to acquire such an option, and each one of
a series of such options, shall be considered as an option to acquire
such stock.
[[Page 371]]
(f) Rules of application. For purposes of this section--
(1) Stock treated as actually owned-- (i) In general. Except as
provided in subdivisions (ii) and (iii) of this subparagraph, stock
constructively owned by a person by reason of the application of
paragraphs (b), (c), (d), and (e) of this section shall, for purposes of
applying such paragraphs, be considered as actually owned by such
person.
(ii) Members of family. Stock constructively owned by an individual
by reason of the application of paragraph (b) of this section shall not
be considered as owned by him for purposes of again applying such
paragraph in order to make another the constructive owner of such stock.
(iii) Partnerships, estates, trusts, and corporation. Stock
constructively owned by a partnership, estate, trust, or corporation by
reason of the application of paragraph (d) of this section shall not be
considered as owned by it for purposes of applying paragraph (c) of this
section in order to make another the constructive owner of such stock.
(iv) Option rule in lieu of family rule. For purposes of this
subparagraph, if stock may be considered as owned by an individual under
paragraph (b) or (e) of this section, it shall be considered as owned by
him under paragraph (e).
(2) Coordination of different attribution rules. For purposes of any
one determination, stock which may be owned under more than one of the
rules of Sec. 1.958-1 and this section, or by more than one person,
shall be owned under that attribution rule which imputes to the person,
or persons, concerned the largest total percentage of such stock. The
application of this subparagraph may be illustrated by the following
examples:
Example 1. (a) United States persons A and B, and domestic
corporation M, own 9 percent, 32 percent, and 10 percent, respectively,
of the one class of stock in foreign corporation R. A also owns 10
percent of the one class of stock in M Corporation. For purposes of
determining whether A is a United States shareholder with respect to R
Corporation, 10 percent of the 10-percent interest of M Corporation in R
Corporation is considered as owned by A. See paragraph (c)(1)(iii) of
this section. Thus, A owns 10 percent (9 percent plus 10 percent of 10
percent) of the stock in R Corporation and is a United States
shareholder with respect to such corporation. Corporation M and B, by
reason of owning 10 percent and 32 percent, respectively, of the stock
in R Corporation are United States shareholders with respect to such
corporation.
(b) For purposes of determining whether R Corporation is a
controlled foreign corporation, the 1 percent of the stock in R
Corporation directly owned by M Corporation and considered as owned by A
cannot be counted twice. Therefore, the total amount of stock in R
Corporation owned by United States shareholders is 51 percent,
determined as follows:
Stock Ownership in R Corporation
[percent]
A.............................................................. 9
B.............................................................. 32
M Corporation.................................................. 10
--------
Total........................................................ 51
Example 2. United States person C owns 10 percent of the one class
of stock in foreign corporation N, which owns 60 percent of the one
class of stock in foreign corporation S. Under paragraph (a)(2) of Sec.
1.958-1, C is considered as owning 6 percent (10 percent of 60 percent)
of the stock in S Corporation. Under paragraph (c)(1)(iii) and (2) of
this section N Corporation is considered as owning 100 percent of the
stock in S Corporation and C is considered as owning 10 percent of such
100 percent, or 10 percent of the stock in S Corporation. Thus, for
purposes of determining whether C is a United States shareholder with
respect to S Corporation, the attribution rules of paragraph (c)(1)(iii)
and (2) of this section are used inasmuch as C owns a larger total
percentage of the stock of S Corporation under such rules.
(g) Illustration. The application of this section may be illustrated
by the following examples:
Example 1. United States persons A and B own 5 percent and 25
percent, respectively, of the one class of stock in foreign corporation
M. Corporation M owns 60 percent of the one class of stock in foreign
corporation N. Under paragraph (a)(2) of Sec. 1.958-1, A and B are
considered as owning 3 percent (5 percent of 60 percent) and 15 percent
(25 percent of 60 percent), respectively, of the stock in N Corporation.
Under paragraph (c)(2) of this section, M Corporation is treated as
owning all the stock in N Corporation, and, under paragraph (c)(1)(iii)
of this section, B is considered as owning 25 percent of such 100
percent, or 25 percent of the stock in N Corporation. Inasmuch as A owns
less than 10 percent of the stock in M Corporation, he is not considered
as owning, under paragraph (c)(1)(iii) of
[[Page 372]]
this section, any of the stock in N Corporation owned by M Corporation.
Thus, the attribution rules of paragraph (a)(2) of Sec. 1.958-1 are
used with respect to A inasmuch as he owns a larger total percentage of
the stock of N Corporation under such rules; and the attribution rules
of paragraph (c)(1)(iii) and (2) of this section are used with respect
to B inasmuch as he owns a larger total percentage of the stock of N
Corporation under such rules.
Example 2. United States person C owns 60 percent of the one class
of stock in domestic corporation P; corporation P owns 60 percent of the
one class of stock in foreign corporation Q; and corporation Q owns 60
percent of the one class of stock in foreign corporation R. Under
paragraph (a)(2) of Sec. 1.958-1, P Corporation is considered as owning
36 percent (60 percent of 60 percent) of the stock in R Corporation, and
C is considered as owning none of the stock in R Corporation inasmuch as
the chain of ownership stops at the first United States person and P
Corporation is such a person. Under paragraph (c)(2) of this section, Q
Corporation is treated as owning 100 percent of the stock in R
Corporation, and under paragraph (c)(1)(iii) of this section, P
Corporation is considered as owning 60 percent of such 100 percent, or
60 percent of the stock in R Corporation. For purposes of determining
the amount of stock in R Corporation which C is considered as owning, P
Corporation is treated under paragraph (c)(2) of this section as owning
100 percent of the stock in R Corporation; therefore, C is considered as
owning 60 percent of the stock in R Corporation. Thus, the attribution
rules of paragraph (c)(1)(iii) and (2) of this section are used with
respect to C and P Corporation inasmuch as they each own a larger total
percentage of the stock of R Corporation under such rules.
Example 3. United States person D owns 25 percent of the one class
of stock in foreign corporation S. D is also a 40-percent partner in
domestic partnership X, which owns 50 percent of the one class of stock
in domestic corporation T. Under paragraph (d)(1)(i) of this section,
the 25 percent of the stock in S Corporation owned by D is considered as
being owned by partnership X; since such stock is treated as actually
owned by partnership X under paragraph (f)(1)(i) of this section, such
stock is in turn considered as being owned by T Corporation under
paragraph (d)(1)(iii) of this section. Thus, under paragraphs (d)(1) and
(f)(1)(i) of this section, T Corporation is considered as owning 25
percent of the stock in S Corporation.
Example 4. Foreign corporation U owns 100 percent of the one class
of stock in domestic corporation V and also 100 percent of the one class
of stock in foreign corporation W. By virtue of paragraph (d)(2) of this
section, V Corporation may not be considered under paragraph (d)(1) of
this section as owning the stock owned by its sole shareholder, U
Corporation, in W Corporation.
Example 5. United States citizen E owns 15 percent of the one class
of stock in foreign corporation Y, and United States citizen F, E's
spouse, owns 5 percent of such stock. E and F's four nonresident alien
grandchildren each own 20 percent of the stock in Y Corporation. Under
paragraph (b)(1) of this section, E is considered as owning the stock
owned by F in Y Corporation; however, by virtue of paragraph (b)(3) of
this section, E may not be considered under paragraph (b)(1) of this
section as owning any of the stock in Y Corporation owned by such
grandchildren.
Example 6. United States person F owns 10 percent of the one class
of stock in foreign corporation Z; corporation Z owns 10 percent of the
one class of stock in foreign corporation K; and corporation K owns 100
percent of the one class of stock in foreign corporation L. United
States person G, F's spouse, owns 9 percent of the stock in K
Corporation. Under paragraph (c)(1)(iii) of this section or paragraph
(a)(2) of Sec. 1.958-1, F is considered as owning 1 percent (10 percent
of 10 percent of 100 percent) of the stock in L Corporation by reason of
his ownership of stock in Z Corporation, and, under paragraph (b)(1) of
this section, G is considered as owning such 1 percent of the stock in L
Corporation. Under paragraph (a)(2) of Sec. 1.958-1, G is considered as
owning 9 percent (9 percent of 100 percent) of the stock in L
Corporation by reason of her ownership of stock in K Corporation, and,
under paragraph (b)(1) of this section, F is considered as owning such 9
percent of the stock in L Corporation. Thus, for the purpose of
determining whether F or G is a United States shareholder with respect
to L Corporation, each of F and G is considered as owning a total of 10
percent of the stock in L Corporation by applying the rules of paragraph
(a)(2) of Sec. 1.958-1 and paragraphs (b)(1) and (c)(1)(iii) of this
section.
(Secs. 956(c), 7805, Internal Revenue Code of 1954 (76 Stat. 1017, 68A
Stat. 917; (26 U.S.C. 956(c) and 7805 respectively)))
[T.D. 6889, 31 FR 9455, July 12, 1966, as amended by T.D. 7712, 45 FR
52375, Aug. 7, 1980; T.D. 8955, 66 FR 37897, July 20, 2001]
Sec. 1.959-1 Exclusion from gross income of United States persons of
previously taxed earnings and profits.
(a) In general. Sections 951 through 964 provide that certain types
of income of controlled foreign corporations will be subject to United
States income tax even though such amounts are not currently distributed
to the United States shareholders of such corporations. The amounts so
taxed to certain
[[Page 373]]
United States shareholders are described as subpart F income, previously
excluded subpart F income withdrawn from investment in less developed
countries, previously excluded subpart F income withdrawn from
investment in foreign base company shipping operations, and increases in
earnings invested in United States property. Section 959 provides that
amounts taxed as subpart F income, as previously excluded subpart F
income withdrawn from investment in less developed countries, or as
previously excluded subpart F income withdrawn from investment in
foreign base company shipping operations are not taxed again as
increases in earnings invested in United States property. Section 959
also provides an exclusion whereby none of the amounts so taxed are
taxed again when actually distributed directly, or indirectly through a
chain of ownership described in section 958(a), to United States
shareholders or to such shareholders' successors in interest. The
exclusion also applies to amounts taxed to United States shareholders as
income of one controlled foreign corporation and later distributed to
another controlled foreign corporation in such a chain of ownership
where such amounts would otherwise be again included in the income of
such shareholders or their successors in interest as subpart F income of
the controlled foreign corporation to which they are distributed.
Section 959 also provides rules for the allocation of distributions to
earnings and profits and for the non-dividend treatment of actual
distributions which are excluded from gross income.
(b) Actual distributions to United States persons. The earnings and
profits for a taxable year of a foreign corporation attributable to
amounts which are, or have been, included in the gross income of a
United States shareholder of such corporation under section 951(a) shall
not, when such amounts are distributed to such shareholder directly, or
indirectly through a chain of ownership described in section 958(a), be
again included in the gross income of such United States shareholder.
See section 959(a)(1). Thus, earnings and profits attributable to
amounts which are, or have been, included in the gross income of a
United States shareholder of a foreign corporation under section 951
(a)(1)(A)(i) as subpart F income, under section 951(a)(1)(A)(ii) as
previously excluded subpart F income withdrawn from investment in less
developed countries, under section 951(a)(1)(A)(iii) as previously
excluded subpart F income withdrawn from investment in foreign base
company shipping operations, or under section 951(a)(1)(B) as earnings
invested in United States property, shall not be again included in the
gross income of such shareholder when such amounts are actually
distributed, directly or indirectly, to such shareholder. See paragraph
(d) of this section for exclusion applicable to such shareholder's
successor in interest. The application of this paragraph may be
illustrated by the following example:
Example. (a) A, a United States shareholder, owns 100 percent of the
only class of stock of R Corporation, a corporation organized on January
1, 1963, which is a controlled foreign corporation throughout the period
here involved. Both A and R Corporation use the calendar year as a
taxable year.
(b) During 1964, R Corporation derives $100 of subpart F income, and
A includes such amount in his gross income under section
951(a)(1)(A)(i). Corporation R's current and accumulated earnings and
profits (before taking into account distributions made during 1964) are
$150. Also, during 1964, R Corporation distributes $50 to A. The $50
distribution is excludable from A's gross income for 1964 under this
paragraph and Sec. 1.959-3 because such distribution represents
earnings and profits attributable to amounts which are included in A's
gross income for such year under section 951(a).
(c) If instead of deriving the $100 of subpart F income in 1964, R
Corporation derives such amount during 1963 and has earnings and profits
for 1963 in excess of $100, A must include $100 in his gross income for
1963 under section 951(a)(1)(A)(i). However, the $50 distribution made
by R Corporation to A during 1964 is excludable from A's gross income
for such year under this paragraph and Sec. 1.959-3 because such
distribution represents earnings and profits attributable to amounts
which have been included in A's gross income for 1963 under section
951(a).
(d) If, with respect to 1964--
(1) Instead of owning the stock of R Corporation directly, A owns
such stock through a chain of ownership described in section
[[Page 374]]
958(a), that is, A owns 100 percent of M Corporation which owns 100
percent of N Corporation which owns 100 percent of R Corporation,
(2) Both M and N Corporations use the calendar year as a taxable
year and are controlled foreign corporations throughout the period here
involved,
(3) Corporation R derives $100 of subpart F income and has earnings
and profits in excess of $100,
(4) Neither M Corporation nor N Corporation has earnings and profits
or a deficit in earnings and profits, and
(5) The $50 distribution is from R Corporation to N Corporation to M
Corporation to A,
A must include $100 in his gross income for 1964 under section
951(a)(1)(A)(i) by reason of his indirect ownership of R Corporation.
However, the $50 distribution is excludable from A's gross income for
1964 under this paragraph and Sec. 1.959-3 because such distribution
represents earnings and profits attributable to amounts which are
included in A's gross income for such year under section 951(a) and are
distributed indirectly to A through a chain of ownership described in
section 958(a).
(c) Excludable investment of earnings in United States property. The
earnings and profits for a taxable year of a foreign corporation
attributable to amounts which are, or have been, included in the gross
income of a United States shareholder of such corporation under section
951(a)(1)(A) shall not, when such amounts would, but for section
959(a)(2) and this paragraph, be included under section 951(a)(1)(B) in
the gross income of such shareholder directly, or indirectly through a
chain of ownership described in section 958(a), be again included in the
gross income of such United States shareholder. Thus, earnings and
profits attributable to amounts which are, or have been, included in the
gross income of a United States shareholder of a foreign corporation
under section 951(a)(1)(A)(i) as subpart F income, under section
951(a)(1)(A)(ii) as previously excluded subpart F income withdrawn from
investment in less developed countries, or under section
951(a)(1)(A)(iii) as previously excluded subpart F income withdrawn from
investment in foreign base company shipping operations, may be invested
in United States property without being again included in such
shareholder's income under section 951 (a). Moreover, the first amount
deemed invested in United States property are amounts previously
included in the gross income of a United States shareholder under
section 951(a)(1)(A). See paragraph (d) of this section for exclusion
applicable to such shareholder's successor in interest. The application
of this paragraph may be illustrated by the following example:
Example. (a) A, a United States shareholder, owns 100 percent of the
only class of stock of R Corporation, a corporation organized on January
1, 1963, which is a controlled foreign corporation throughout the period
here involved. Both A and R Corporation use the calendar year as a
taxable year.
(b) During 1964, R Corporation derives $35 of subpart F income, and
A includes such amount in his gross income under section
951(a)(1)(A)(i). During 1964, R Corporation also invests $50 in tangible
property (other than property described in section 956(b)(2)) located in
the United States. Corporation R makes no distributions during the year,
and its current earnings and profits are in excess of $50. Of the $50
investment of earnings in United States property, $35 is excludable from
A's gross income for 1964 under section 959(a)(2) because such amount
represents earnings and profits which are attributable to amounts which
are included in A's gross income for such year under section
951(a)(1)(A)(i) and therefore may be invested in United States property
without again being included in A's gross income. The remaining $15 is
includible in A's gross income for 1964 under section 951(a)(1)(B).
(c) If, instead of deriving $35 of subpart F income in 1964, R
Corporation has no subpart F income for 1964 but derives the $35 of
subpart F income during 1963 and has earnings and profits for such year
in excess of $35, A must include $35 in his gross income for 1963 under
section 951(a)(1)(A)(i). However, of the $50 investment of earnings in
United States property made by R Corporation during 1964, $35 is
excludable from A's gross income for 1964 under section 959(a)(2)
because such amount represents earnings and profits attributable to
amounts which have been included in A's gross income for 1963 under
section 951(a)(1)(A)(i). The remaining $15 is includible in A's gross
income for 1964 under section 951(a)(1)(B).
(d) Application of exclusions to shareholder's successor in
interest. If a United States person (as defined in Sec. 1.957-4)
acquires from any person any portion of the interest in the foreign
corporation of a United States shareholder referred to in paragraph (b)
or (c) of this section, the rules of such paragraph shall apply to such
acquiring person
[[Page 375]]
but only to the extent that the acquiring person establishes to the
satisfaction of the district director his right to the exclusion
provided by such paragraph. The information to be furnished by the
acquiring person to the district director with his return for the
taxable year to support such exclusion shall include:
(1) The name, address, and taxable year of the foreign corporation
from which the distribution is received and of all other corporations,
partnerships, trusts, or estates in any applicable chain of ownership
described in section 958(a);
(2) The name, address, and (in the case of information required to
be furnished after June 20, 1983) taxpayer identification number of the
person from whom the stock interest was acquired;
(3) A description of the stock interest acquired and its relation,
if any, to a chain of ownership described in section 958(a);
(4) The amount for which an exclusion under section 959(a) is
claimed; and
(5) Evidence showing that the earnings and profits for which an
exclusion is claimed are attributable to amounts which were included in
the gross income of a United States shareholder under section 951(a),
that such amounts were not previously excluded from the gross income of
a United States person, and the identity of the United States
shareholder including such amounts.
The acquiring person shall also furnish to the district director such
other information as may be required by the district director in support
of the exclusion.
Example. (a) A, a United States shareholder, owns 100 percent of the
only class of stock of R Corporation, a corporation organized on January
1, 1964, and a controlled foreign corporation throughout the period here
involved. Both A and R Corporation use the calendar year as a taxable
year.
(b) During 1964, R Corporation has $100 of subpart F income and
earnings and profits in excess of $100. A includes $100 in his gross
income for 1964 under section 951(a)(1)(A)(i). During 1965, A sells 40
percent of his stock in R Corporation to B, a United States person who
uses the calendar year as a taxable year. In 1965, R Corporation has no
earnings and profits and experiences no increase in earnings invested in
United States property. Corporation R distributes $40 to B on December
1, 1965. If B establishes his right to the exclusion to the satisfaction
of the district director, he may exclude $40 from his gross income for
1965 under section 959(a)(1).
(c) If, instead of selling his 40-percent interest directly to B, A
sells on February 1, 1965, 40 percent of his stock in R Corporation to
C, a nonresident alien, and on October 1, 1965, B acquires the 40-
percent interest in R Corporation from C, the result is the same as in
paragraph (b) of this example, if B establishes his right to the
exclusion to the satisfaction of the district director.
(d) If, instead of acquiring 40 percent, B acquires only 5 percent
of A's stock in R Corporation and R Corporation distributes $5 to B
during 1965, B is not a United States shareholder (within the meaning of
section 951(b)) with respect to R Corporation since he owns only 5
percent of the stock of R Corporation. Notwithstanding, B may exclude
the $5 distribution from his gross income for 1965 under section
959(a)(1) if he establishes his right to the exclusion to the
satisfaction of the district director.
(e) If the facts are assumed to be the same as in paragraphs (a) and
(b) of this example except that--
(1) A owns the stock of R Corporation indirectly through a chain of
ownership described in section 958(a), that is, A owns 100 percent of M
Corporation which owns 100 percent of N Corporation which owns 100
percent of R Corporation,
(2) B acquires from N Corporation 40 percent of the stock in R
Corporation,
(3) Both M Corporation and N Corporation are controlled foreign
corporations which use the calendar year as a taxable year,
(4) Neither M Corporation nor N Corporation has any amount in 1964
or 1965 which is includible in gross income of United States
shareholders under section 951(a), and
(5) Neither M Corporation nor N Corporation has a deficit in
earnings and profits for 1964;
the result is the same as in paragraph (b) of this example if B
establishes his right to the exclusion to the satisfaction of the
district director.
[T.D. 6795, 30 FR 943, Jan. 29, 1965, as amended by T.D. 7893, 48 FR
22509, May 19, 1983]
Sec. 1.959-2 Exclusion from gross income of controlled foreign
corporations of previously taxed earnings and profits.
(a) Applicable rule. The earnings and profits for a taxable year of
a controlled foreign corporation attributable to amounts which are, or
have been, included in the gross income of a
[[Page 376]]
United States shareholder under section 951(a) shall not, when
distributed through a chain of ownership described in section 958(a), be
also included in the gross income of another controlled foreign
corporation in such chain for purposes of the application of section
951(a) to such other controlled foreign corporation with respect to such
United States shareholder. See section 959(b). The exclusion from the
income of such other foreign corporation also applies with respect to
any other United States shareholder who acquires from such United States
shareholder or any other person any portion of the interest of such
United States shareholder in the controlled foreign corporation, but
only to the extent the acquiring shareholder establishes to the
satisfaction of the district director his right to such exclusion. An
acquiring shareholder claiming the exclusion under section 959(b) shall
furnish to the district director with his return for the taxable year
the information required under paragraph (d) of Sec. 1.959-1 to support
the exclusion under this paragraph.
(b) Illustration. The application of this section may be illustrated
by the following example:
Example. (a) A, a United States shareholder, owns 100 percent of the
only class of stock of M Corporation which in turn owns 100 percent of
the only class of stock of N Corporation. A and corporations M and N use
the calendar year as a taxable year and corporations M and N are
controlled foreign corporations throughout the period here involved.
(b) During 1963, N Corporation invests $100 in tangible property
(other than property described in section 956(b)(2)) located in the
United States and has earnings and profits in excess of $100. A is
required to include $100 in his gross income for 1963 under section
951(a)(1)(B) by reason of his indirect ownership of the stock of N
Corporation. During 1963, M Corporation has no income or investments
other than the income derived from a distribution of $100 from N
Corporation. Corporation M has earnings and profits of $100 for 1963.
Under paragraph (a) of Sec. 1.954-2, the $100 distribution received by
M Corporation from N Corporation would otherwise constitute subpart F
income of M Corporation; however, by reason of section 959(b) and this
section, this amount does not constitute gross income of M Corporation
for purposes of determining amounts includible in A's gross income under
section 951(a)(1)(A)(i).
(c) During 1964, N Corporation derives $100 of subpart F income and
distributes $100 to M Corporation which has no subpart F income for 1964
but which invests the $100 distribution in tangible property (other than
property described in section 956(b)(2)) located in the United States.
Corporation N's earnings and profits for 1964 are in excess of $100, and
M Corporation's current and accumulated earnings and profits (before
taking into account distributions made during 1964) are in excess of
$100. A is required with respect to N Corporation to include $100 in his
gross income for 1964 under section 951(a)(1)(A)(i) by reason of his
indirect ownership of the stock of N Corporation. The investment by M
Corporation in United States property would otherwise constitute an
investment of earnings in United States property to which section 956
applies; however, by reason of section 959(b) and this section, such
amount does not constitute gross income of M Corporation for purposes of
determining amounts includible in A's gross income under section
951(a)(1)(B).
(d) If during 1965, N Corporation invests $100 in tangible property
(other than property described in section 956(b)(2)) located in the
United States and has earnings and profits in excess of $100, A will be
required with respect to N Corporation to include $100 in his gross
income for 1965 under section 951(a)(1)(B), because the $100 of earnings
and profits for 1964 attributable to N Corporation's subpart F income
which was taxed to A in 1964 was distributed to M Corporation in such
year.
(e) If, with respect to 1966--
(1) Corporation N owns 100 percent of the only class of stock of R
Corporation,
(2) Corporation R derives $100 of subpart F income, has earnings and
profits in excess of $100, and makes no distributions to N Corporation,
(3) Corporation N invests $25 in tangible property (other than
property described in section 956(b)(2)) located in the United States
and has current and accumulated earnings and profits in excess of $25,
and
(4) Corporation M has no income or investments and does not have a
deficit in earnings and profits,
the $100 of subpart F income derived by R Corporation is includible in
A's gross income for 1966 under section 951(a)(1)(A)(i) and the $25
investment of earnings in United States property by N Corporation is
includible in A's gross income for 1966 under section 951(a)(1)(B).
(f) If, however, the facts are the same as in paragraph (e) of this
example except that--
(1) During 1966, R Corporation distributes $20 to N Corporation, and
(2) Corporation N makes no distributions during such year to M
Corporation,
of the $25 investment in United States property by N Corporation, $20 is
not includible
[[Page 377]]
in A's gross income for 1966 because such amount represents earnings and
profits which are attributable to amounts included in A's gross income
for such year under section 951(a)(1)(A)(i) with respect to R
Corporation and which have been distributed to N Corporation by R
Corporation. By reason of section 959(B) and this section, such $20
distribution to N Corporation does not constitute gross income of N
Corporation for purposes of determining amounts includible in A's gross
income under section 951(a)(1)(B); however, the remaining $5 of
investment of earnings in United States property by N Corporation in
1966 is includible in A's gross income for such year under section
951(a)(1)(B).
[T.D. 6795, 30 FR 944, Jan. 29, 1965]
Sec. 1.959-3 Allocation of distributions to earnings and profits of
foreign corporations.
(a) In general. For purposes of Sec. Sec. 1.959-1 and 1.959-2, the
source of the earnings and profits from which distributions are made by
a foreign corporation as between earnings and profits attributable to
increases in earnings invested in United States property, previously
taxed subpart F income, previously excluded subpart F income withdrawn
from investment in less developed countries, previously excluded subpart
F income withdrawn from investment in foreign base company shipping
operations, and other amounts shall be determined in accordance with
section 959(c) and paragraphs (b) through (e) of this section.
(b) Applicability of section 316(a). For purposes of this section,
section 316(a) shall be applied, in determining the source of
distributions from the earnings and profits of a foreign corporation, by
first applying section 316(a)(2) and then by applying section
316(a)(1)--
(1) First, as provided by section 959 (c)(1), to earnings and
profits attributable to amounts included in gross income of a United
States shareholder under section 951(a)(1)(B) (or which would have been
so included but for section 959(a)(2) and paragraph (c) of Sec. 1.959-
1),
(2) Secondly, as provided by section 959(c)(2), to earnings and
profits attributable to amounts included in gross income of a United
States shareholder under section 951(a)(1)(A) (but reduced by amounts
not included in such gross income under section 951(a)(1)(B) because of
the exclusion provided by section 959(a)(2) and paragraph (c) of Sec.
1.959-1), and
(3) Finally, as provided by section 959(c)(3), to other earnings and
profits. Thus, distributions shall be considered first attributable to
amounts, if any, described in subparagraph (1) of this paragraph (first
for the current taxable year and then for prior taxable years beginning
with the most recent prior taxable year), secondly to amounts, if any,
described in subparagraph (2) of this paragraph (first for the current
taxable year and then for prior taxable years beginning with the most
recent prior taxable year), and finally to the amounts, if any,
described in subparagraph (3) of this paragraph (first for the current
taxable year and then for prior taxable years beginning with the most
recent prior taxable year). See, however, paragraph (e) of Sec. 1.963-3
(applied as if section 963 had not been repealed by the Tax Reduction
Act of 1975) for a special rule for determination of the source of
distributions counting as minimum distributions. Earnings and profits
are classified as to year and as to section 959(c) amount in the year in
which such amounts are included in gross income of a United States
shareholder under section 951(a) and are reclassified as to section
959(c) amount in the year in which such amounts would be so included but
for the provisions of section 959(a)(2); any subsequent distribution of
such amounts to a higher tier in a chain of ownership described in
section 958(a) does not of itself change such classifications. For
example, earnings and profits of a foreign corporation attributable to
amounts of previously excluded subpart F income withdrawn from
investment in less developed countries (or from investments in export
trade assets or foreign base company shipping operations) shall be
reclassified as amounts to which subparagraph (2), rather than
subparagraph (3), of this paragraph applies for purposes of determining
priority of distribution, and such earnings and profits shall be
considered attributable to the taxable year in which the withdrawal
occurs. This paragraph shall apply to distributions by one foreign
corporation to another foreign corporation and by a foreign corporation
to a
[[Page 378]]
United States person. The application of this paragraph may be
illustrated by the following example:
Example. (a) M, a controlled foreign corporation, is organized on
January 1, 1963, and is 100-percent owned by A, a United States
shareholder. Both A and M Corporation use the calendar year as a taxable
year, and M Corporation is a controlled foreign corporation throughout
the period here involved. As of December 31, 1966, M Corporation's
accumulated earnings and profits of $450 (before taking into account
distributions made in 1966) applicable to A's interest in such
corporation are classified for purposes of section 959(c) as follows:
------------------------------------------------------------------------
Classification of earnings and
profits for purposes of section
Year 959
-----------------------------------
(c)(1) (c)(2) (c)(3)
------------------------------------------------------------------------
1963................................ $100 .......... ..........
1964................................ 100 $75 ..........
1965................................ .......... 75 $50
1966................................ .......... .......... 50
------------------------------------------------------------------------
(b) During 1966, M Corporation makes three separate distributions to
A of $150 each, and the source of such distributions under section
959(c) is as follows:
------------------------------------------------------------------------
Allocation of
distributions
Amount Year under section
959
------------------------------------------------------------------------
Distribution No. 1................... $100 1964 (c)(1)
50 1963 (c)(1)
-----------
150 ....... .............
===========
Distribution No. 2................... 50 1963 (c)(1)
75 1965 (c)(2)
25 1964 (c)(2)
-----------
150 ....... .............
===========
Distribution No. 3................... 50 1964 (c)(2)
50 1966 (c)(3)
50 1965 (c)(3)
-----------
150 ....... .............
------------------------------------------------------------------------
(c) If, in addition to the above facts--
(1) M Corporation owns throughout the period here involved 100
percent of the only class of stock of N Corporation, a controlled
foreign corporation which uses the calendar year as a taxable year,
(2) Corporation N derives $60 of subpart F income for 1963 which A
includes in his gross income for such year under section
951(a)(1)(A)(i),
(3) Corporation N has earnings and profits for 1963 of $60 but has
neither earnings or profits nor a deficit in earnings and profits for
1964, 1965, or 1966, and
(4) During 1966, N Corporation invests $20 in tangible property (not
described in section 956(b)(2)) located in the United States and
distributes $45 to M Corporation,
the $20 investment of earnings in United States property is excludable
from A's gross income for 1966, under section 959(a)(2) and paragraph
(c) of Sec. 1.959-1, with respect to N Corporation and the $45 dividend
received by M Corporation does not, under section 959(b) and Sec.
1.959-2, constitute gross income of M Corporation for 1966 for purposes
of determining amounts includible in A's gross income under section
951(a)(1)(A)(i) with respect to M Corporation. However, the $45 dividend
paid by N Corporation to M Corporation is allocated under section 959(c)
and this paragraph to the earnings and profits of N Corporation as
follows: $20 to 1963 earnings described in section 959(c)(1) and $25 to
1963 earnings described in section 959(c)(2). In such case, M
Corporation's earnings and profits of $495 (before taking into account
distributions made in 1966) would be classified as follows for purposes
of section 959(c):
------------------------------------------------------------------------
Classification of earnings and
profits for purposes of section
Year 959
-----------------------------------
(c)(1) (c)(2) (c)(3)
------------------------------------------------------------------------
1963................................ $120 $25 ..........
1964................................ 100 75 ..........
1965................................ .......... 75 $50
1966................................ .......... .......... 50
------------------------------------------------------------------------
(d) The three distributions to A in 1966 of $150 each would then
have the following source under section 959(c):
------------------------------------------------------------------------
Allocation of
distributions
Amount Year under section
959
------------------------------------------------------------------------
Distribution No. 1................... $100 1964 (c)(1)
50 1963 (c)(1)
-----------
150 ....... .............
===========
Distribution No. 2................... 70 1963 (c)(1)
75 1965 (c)(2)
5 1964 (c)(2)
-----------
150 ....... .............
===========
Distribution No. 3................... 70 1964 (c)(2)
25 1963 (c)(2)
50 1966 (c)(3)
5 1965 (c)(3)
-----------
150 ....... .............
------------------------------------------------------------------------
(c) Treatment of deficits in earnings and profits. For purposes of
this section, a United States shareholder's pro rata share (determined
in accordance with the principles of paragraph (e) of Sec. 1.951-1) of
a foreign corporation's deficit in earnings and profits, determined
under section 964(a) and Sec. 1.964-1, for
[[Page 379]]
any taxable year shall be applied only to earnings and profits described
in paragraph (b)(3) of this section.
(d) Treatment of certain foreign taxes. For purposes of this
section, any amount described in subparagraph (1), (2), or (3) of
paragraph (b) of this section which is distributed by a foreign
corporation through a chain of ownership described in section 958(a)(2)
shall be reduced by any income, war profits, or excess profits taxes
imposed on or with respect to such distribution by any foreign country
or possession of the United States.
Example. (a) Domestic corporation M owns 100 percent of the only
class of stock of foreign corporation A, which is incorporated under the
laws of foreign country X and which, in turn, owns 100 percent of the
only class of stock of foreign corporation B, which is incorporated
under the laws of foreign country Y. All corporations use the calendar
year as a taxable year and corporations A and B are controlled foreign
corporations throughout the period here involved.
(b) During 1963, B Corporation (a less developed country corporation
for 1963 within the meaning of Sec. 1.955-5) derives $90 of subpart F
income, after incurring $10 of foreign income tax allocable to such
income under paragraph (c) of Sec. 1.954-1, has earnings and profits in
excess of $90, and makes no distributions. Corporation M must include
$90 in its gross income for 1963 under section 951(a)(1)(A)(i). As of
December 31, 1963, with respect to M Corporation, B Corporation has
earnings and profits for 1963 described in section 959(c)(2) of $90.
(c) During 1964, B Corporation has neither earnings and profits nor
a deficit in earnings and profits but distributes $90 to A Corporation,
and, by reason of section 959(b) and Sec. 1.959-2, such amount is not
includible in the gross income of M Corporation for 1964 under section
951(a) with respect to A Corporation. Corporation A incurs a withholding
tax of $13.50 on the $90 dividend distributed from B Corporation (15
percent of $90) and an additional foreign income tax of 10 percent or
$7.65 by reason of the inclusion of the net distribution of $76.50 ($90
minus $13.50) in its taxable income for 1964. As of December 31, 1964,
with respect to M Corporation, B Corporation's earnings and profits for
1963 described in section 959(c)(2) amount to zero ($90 minus $90); and
A Corporation's earnings and profits for 1963 described in section
959(c)(2) amount to $68.85 ($90 minus $13.50 minus $7.65).
(e) Determination of foreign tax credit. For purposes of applying
section 902 and section 960 in determining the foreign tax credit
allowable under section 901 in a case in which distributions are made by
a second-tier corporation or a first-tier corporation, as the case may
be, from its earnings and profits for a taxable year which are
attributable to an amount included in the gross income of a U.S.
shareholder under section 951(a) or which are attributable to amounts
excluded from the gross income of such foreign corporation under section
959(b) and Sec. 1.959-2 with respect to a U.S. shareholder, the rules
of paragraph (b) of this section shall apply except that in applying
subparagraph (1) or (2) of such paragraph--
(1) Distributions from the earnings and profits for such taxable
year of the second-tier corporation shall be considered first
attributable to its earnings and profits attributable to distributions
from the earnings and profits of the foreign corporation, if any, next
lower in the chain of ownership described in section 958(a), to the
extent of such earnings and profits of the second-tier corporation, and
then to the other earnings and profits of such second-tier corporation,
and
(2) Distributions from the earnings and profits for such taxable
year of the first-tier corporation shall be considered first
attributable to its earnings and profits attributable to distributions
from the earnings and profits of the second-tier corporation, to the
extent of such earnings and profits of the first-tier corporation, and
then to the other earnings and profits of such first-tier corporation.
For purposes of this paragraph, a second-tier corporation is a foreign
corporation referred to in section 960(a)(1)(B), and a first-tier
corporation is a foreign corporation referred to in section 960
(a)(1)(A). The application of this paragraph may be illustrated by the
following examples:
Example 1. (a) Domestic corporation A, a United States shareholder,
owns 100 percent of the only class of stock of foreign corporation R
which, in turn, owns 100 percent of the only class of stock of foreign
corporation S. All corporations use the calendar year as a taxable year,
and corporations R and S are controlled foreign corporations throughout
the period here involved.
(b) Neither R Corporation nor S Corporation has subpart F income for
1963. During 1963, S Corporation increases by $100 its investment in
tangible property (not described
[[Page 380]]
in section 956(b)(2)) located in the United States, makes no
distributions, and has earnings and profits of $100. Corporation A must
include $100 in its gross income for 1963 under section 951(a)(1)(B)
with respect to S Corporation. During 1963, R Corporation also increases
by $100 its investment in tangible property (not described in section
956(b)(2)) located in the United States, makes no distributions, and has
earnings and profits of $100. Corporation A must include $100 in its
gross income for 1963 under section 951(a)(1)(B) with respect to R
Corporation.
(c) During 1964, S Corporation distributes $100 to R Corporation,
and R Corporation distributes $100 to A Corporation. Neither corporation
has any earnings or profits or deficit in earnings and profits for such
year. On December 31, 1964, R Corporation has earnings and profits
(computed before distributions to A Corporation made for the year) of
$200, consisting of $100 of section 959(c)(1) amounts of R Corporation
for 1963 and of $100 of section 959(c)(1) amounts of S Corporation for
1963. For purposes of determining the foreign tax credit under section
960 and the regulations thereunder, the $100 distribution by R
Corporation shall be considered attributable to S Corporation's earnings
and profits for 1963 described in section 959(c)(1).
Example 2. (a) Domestic corporation A, a United States shareholder,
owns 100 percent of the only class of stock of foreign corporation T
which, in turn, owns 100 percent of the only class of stock of foreign
corporation U. All corporations use the calendar year as a taxable year,
and corporations T and U are controlled foreign corporations throughout
the period here involved.
(b) During 1964, T Corporation invests $100 in tangible property
(not described in section 956(b)(2)) located in the United States. For
1964, T Corporation has no subpart F income and makes no distributions;
A must include $100 in its gross income for 1964 under section
951(a)(1)(B) with respect to T Corporation. For 1964, U Corporation has
no subpart F income or investment of earnings in United States property
but U Corporation has $100 of earnings and profits which it distributes
to T Corporation. At December 31, 1964, T Corporation has earnings and
profits of $300, consisting of operating income of $100 for each of the
years 1963 and 1964 and $100 in dividends received from the earnings and
profits of U Corporation for 1964. These earnings and profits are
classified as follows under section 959(c): $100 of section 959(c)(1)
amounts of T Corporation for 1964, $100 of section 959(c)(3) amounts of
U Corporation for 1964, and $100 of section 959(c)(3) amounts of T
Corporation for 1963.
(c) During 1965 neither T Corporation nor U Corporation has any
earnings and profits or deficit in earnings and profits or investment of
earnings in U.S. property, but T Corporation distributes $100 to A
Corporation. For purposes of determining the foreign tax credit under
section 960 and the regulations thereunder, the $100 distribution of T
Corporation shall be considered attributable to T Corporation's earnings
and profits for 1964 described in section 959(c)(1).
(f) Illustration. The application of this section may be illustrated
by the following example:
Example. (a) M, a controlled foreign corporation is organized on
January 1, 1963, and is wholly owned by A, a United States shareholder.
Both A and Corporation M use the calendar year as a taxable year.
(b) Corporation M's earnings and profits (before distributions) for
1963 are $200, $100, of which is attributable to subpart F income.
Corporation M's earnings and profits for such year also include $25
attributable to subpart F income which is excluded from M Corporation's
foreign base company income under section 954(b)(1) as dividends,
interest, and gains invested in qualified investments in less developed
countries. Corporation M's increase in earnings invested in tangible
property (not described in section 956(b)(2)) located in the United
States for 1963, is $50, and M Corporation makes a distribution of such
property during such year of $20. For purposes of section 959, A's
interest in M Corporation's earnings and profits as of December 31,
1963, determined after the distributions of $20, is classified as
follows:
Section 959(c)(1) amounts:
Earnings for 1963 attributable to increased $50 .......
investment in U.S. property which would have been
included in A's gross income but for application of
section 959(a)(2) and Sec. 1.959-1(c)............
Less: Distribution for 1963 allocated under section 20 $30
959(c)(1) and paragraph (b)(1) of this section to
such amounts.......................................
---------
Section 959(c)(2) amounts:
Earnings for 1963 attributable to subpart F income 100 .......
included in A's gross income under section
951(a)(1)(A)(i)....................................
Less: Earnings for 1963 attributable to increased 50 50
investment in U.S. property which would have been
included in A's gross income but for application of
section 959(a)(2) and Sec. 1.959-1(c)............
---------
Section 959(c)(3) amounts:
Predistribution earnings for 1963................... 200 .......
Less: Earnings for 1963 classified as:
Section 959(c)(1) amounts................ $50 ....... .......
[[Page 381]]
Section 959(c)(2) amounts................ 50 100 100
----------
A's total interest in M Corporation's ....... ....... 180
earnings and profits........................
----------------------------------------------
For 1963, A is required to include $100 of subpart F income in his gross
income under section 951(a)(1)(A)(i). He would have been required to
include $50 in his gross income under section 951(a)(1)(B) as M
Corporation's increase in earnings invested in United States property,
except that section 959(a)(2) and paragraph (c) of Sec. 1.959-1 provide
in effect that earnings and profits taxed to A under section
951(a)(1)(A) with respect to M Corporation (whether in the current
taxable year or in prior years) may be invested in United States
property without again being included in gross income under section
951(a). The $20 dividend from M Corporation is excluded from A's gross
income under section 959(a)(1) and paragraph (b) of Sec. 1.959-1, since
such distribution is allocated under section 959(c)(1) and paragraph
(b)(1) of this section to amounts described in section 959(c)(1).
(c) During 1964, M Corporation's earnings and profits (before
distributions) are $300, $75 of which is attributable to subpart F
income. Corporation M has no change in investments in United States
property during such year and withdraws $15 of previously excluded
subpart F income from investment in less developed countries.
Corporation M makes a cash distribution of $250 to A during 1964. For
purposes of section 959, A's interest in M Corporation's earnings and
profits as of December 31, 1964, determined after the distribution of
$250, is classified as follows:
Section 959 (c)(1) amounts:
Section 959(c)(1) net amount for 1963 (as determined $30 .......
under paragraph (b) of this example)...............
Less: Distribution for 1964 allocated under section 30 .......
959(c)(1) and paragraph (b)(1) of this section to
such amount........................................
=========
Section 959(c)(2) amounts:
Section 959(c)(2) net amount for 1963 (as determined 50 .......
under paragraph (b) of this example)...............
Plus: Earnings for 1964 attributable to:
Subpart F income for 1964 included in A's gross 75 .......
income under section 951(a)(1)(A)(i).............
Previously excluded subpart F income withdrawn in 15 .......
1964 from investment in less developed countries
and included in A's gross income under section
951(a)(1)(A)(ii).................................
---------
140 .......
Less: Distribution for 1964 allocated under section 140 .......
959(c)(2) and paragraph (b)(2) of this section to
such amounts.......................................
=========
Section 959(c)(3) amounts:
Section 959(c)(3) net amount for 1963 (as determined 100 .......
under paragraph (b) of this example)...............
Plus: Section 959(c)(3) net amount
for 1964:
Predistribution earnings for ....... $300 ....... .......
1964...........................
Less:
Earnings for 1964 classified $90 ....... ....... .......
as section 959(c)(1) amounts
($0) and as section 959(c)(2)
amounts ($75+$15)............
Distributions for 1964 80 170 130 $230
allocated under section
959(c)(3) and paragraph
(b)(3) of this section.......
----------
A's total interest in M ....... ....... ....... 230
Corporation's earnings and profits.
-------------------------------------
For 1964, A is required to include in his gross income under section
951(a)(1)(A)(i) $75 of subpart F income, and under section 951
(a)(1)(A)(ii) $15 of previously excluded subpart F income withdrawn from
investment in less developed countries. Of the $250 cash distribution, A
may exclude $170 from his gross income under section 959(a)(1) and
paragraph (b) of Sec. 1.959-1 and $80 is includible in his gross income
as a dividend.
(d) The source under section 959(c) of the 1964 distribution of $250
to A is as follows:
------------------------------------------------------------------------
Allocation of
distribution
Year Amount under section
959
------------------------------------------------------------------------
1963.................................... $30 (c)(1).
1964.................................... 90 (c)(2).
1963.................................... 50 (c)(2).
1964.................................... 80 (c)(3).
----------------
250 ..............
------------------------------------------------------------------------
[T.D. 6795, 30 FR 945, Jan. 29, 1965, as amended by T.D. 7334, 39 FR
44211, Dec. 23, 1974; T. D. 7545, 43 FR 19652, May 8, 1978; T.D. 7893,
48 FR 22510, May 19, 1983]
[[Page 382]]
Sec. 1.959-4 Distributions to United States persons not counting as
dividends.
Except as provided in section 960(a)(3) and Sec. 1.960-2, any
distribution to a United States person which is excluded from the gross
income of such person under section 959(a)(1) and Sec. 1.959-1 shall be
treated for purposes of chapter 1 (relating to normal taxes and
surtaxes) of subtitle A (relating to income taxes) of the Code as a
distribution which is not a dividend. However, see paragraph (b)(1) of
Sec. 1.956-1, relating to the dividend limitation on the amount of a
controlled foreign corporation's investment of earnings in United States
property.
[T.D. 7120, 36 FR 10860, June 4, 1971]
Sec. 1.960-1 Foreign tax credit with respect to taxes paid on earnings
and profits of controlled foreign corporations.
(a) Scope of regulations under section 960. This section prescribes
rules for determining the foreign income taxes deemed paid under section
960(a)(1) by a domestic corporation which is required under section 951
to include in gross income an amount attributable to a first-, second-,
or third-tier corporation's earnings and profits. Section 1.960-2
prescribes rules for applying section 902 to dividends paid by a third-,
second-, or first-tier corporation from earnings and profits
attributable to an amount which is, or has been, included in gross
income under section 951. Section 1.960-3 provides special rules for the
application of the gross-up provisions of section 78 where an amount is
included in gross income under section 951. Section 1.960-4 prescribes
rules for increasing the applicable foreign tax credit limitation under
section 904(a) of the domestic corporation for the taxable year in which
it receives a distribution of earnings and profits in respect of which
it was required under section 951 to include an amount in its gross
income for a prior taxable year. Section 1.960-5 prescribes rules for
disallowing a deduction for foreign income taxes for such taxable year
of receipt where the domestic corporation received the benefits of the
foreign tax credit for such previous taxable year of inclusion. Section
1.960-6 provides that the excess of such an increase in the applicable
limitation under section 904(a) over the tax liability of the domestic
corporation for such taxable year of receipt results in an overpayment
of tax. Section 1.960-7 prescribes the effective dates for application
of these rules.
(b) Definitions. For purposes of section 960 and Sec. Sec. 1.960-1
through 1.960-7--
(1) First-tier corporation. The term ``first-tier corporation''
means a foreign corporation at least 10 percent of the voting stock of
which is owned by the domestic corporation described in paragraph (a) of
this section.
(2) Second-tier corporation. In the case of amounts included in the
gross income of the taxpayer under section 951--
(i) For taxable years beginning before January 1, 1977, the term
``second-tier corporation'' means a foreign corporation at least 50
percent of the voting stock of which is owned by such first-tier
corporation.
(ii) For taxable years beginning after December 31, 1976, the term
``second-tier corporation'' means a foreign corporation as least 10
percent of the voting stock of which is owned by such first-tier
corporation.
(3) Third-tier corporation. In the case of amounts included in the
gross income of a domestic shareholder under section 951 for taxable
years beginning after December 31, 1976, the term ``third-tier
corporation'' means a foreign corporation at least 10 percent of the
voting stock of which is owned by such second-tier corporation.
(4) Immediately lower-tier corporation. In the case of a first-tier
corporation the term ``immediately lower-tier corporation'' means a
second-tier corporation. In the case of a second-tier corporation, the
term ``immediately lower-tier corporation'' means a third-tier
corporation. In the case of a third-tier corporation, the term
``immediately lower-tier corporation'' means a fourth-tier corporation.
(5) Foreign income taxes. The term ``foreign income taxes'' means
income, war profits, and excess profits taxes, and taxes included in the
term ``income, war profits, and excess profits
[[Page 383]]
taxes'' by reason of section 903, imposed by a foreign country or a
possession of the United States.
(c) Amount of foreign income taxes deemed paid by domestic
corporation in respect of earnings and profits of foreign corporation
attributable to amount included in income under section 951--(1) In
general. For purposes of section 901--
(i) If for the taxable year there is included in the gross income of
a domestic corporation under section 951 an amount attributable to the
earnings and profits of a first- or second-tier corporation for any
taxable year, the domestic corporation shall be deemed to have paid the
same proportion of the total foreign income taxes paid, accrued, or
deemed (in accordance with paragraph (b) of Sec. 1.960-2) to be paid by
such foreign corporation on or with respect to its earnings and profits
for its taxable year as the amount (in the case of a first-tier
corporation, determined without regard to section 958(a)(2); in the case
of a second-tier corporation, determined without regard to section
958(a)(1)(A) and, to the extent that stock of such second-tier
corporation is owned by the domestic corporation through a foreign
corporation other than the first-tier corporation, determined without
regard to section 958(a)(2)) so included in the gross income of the
domestic corporation under section 951 with respect to such foreign
corporation bears to the total earnings and profits of such foreign
corporation for its taxable year. This paragraph (c)(1)(i) shall not
apply to amounts included in the gross income of the domestic
corporation under section 951 with respect to the second-tier
corporation unless the percentage-of-voting-stock requirement of section
902(b)(3)(A) is satisfied.
(ii) If for the taxable year there is included in the gross income
of a domestic corporation under section 951 an amount attributable to
the earnings and profits of a third-tier corporation for any taxable
year, the domestic corporation shall be deemed to have paid the same
proportion of the total foreign income taxes paid or accrued by such
foreign corporation on or with respect to its earnings and profits for
its taxable year as the amount (determined without regard to section
958(a)(1)(A) and, to the extent that stock of such third-tier
corporation is owned by the domestic corporation through a foreign
corporation other than the second-tier corporation, determined without
regard to section 958(a)(2)) so included in the gross income of the
domestic corporation under section 951 with respect to such foreign
corporation bears to the total earnings and profits of such foreign
corporation. This paragraph (c)(1)(ii) shall not apply unless the
percentage-of-voting-stock requirement of section 902(b)(3)(B) is
satisfied.
(iii) In applying paragraph (c)(1)(i) or (c)(1)(ii) of this section
to a first-, second-, or third-tier corporation which for the taxable
year has income excluded under section 959(b), paragraph (c)(3) of this
section shall apply for purposes of excluding certain earnings and
profits of such foreign corporation and foreign income taxes, if any,
attributable to such excluded income.
(iv) This paragraph (c)(1) applies whether or not the first-,
second-, or third-tier corporation makes a distribution for the taxable
year of its earnings and profits which are attributable to the amount
included in the gross income of the domestic corporation under section
951.
(v) This paragraph (c)(1) does not apply to an increase in current
earnings invested in United States property which, but for paragraph (e)
of Sec. 1.963-3 (applied as if section 963 had not been repealed by the
Tax Reduction Act of 1975), would be included in the gross income of the
domestic corporation under section 951(a)(1)(B) but which, pursuant to
such paragraph, counts toward a minimum distribution for the taxable
year. This subdivision shall apply in taxable years subsequent to the
Tax Reduction Act of 1975 only in those cases where an adjustment is
required as a result of an election made under section 963 prior to the
Act.
(2) Taxes paid or accrued on or with respect to earnings and profits
of foreign corporation. For purposes of paragraph (c)(1) of this
section, the foreign income taxes paid or accrued by a first-, second-
or third-tier corporation on or with respect to its earnings and profits
for its taxable years shall be the total amount of the foreign income
taxes
[[Page 384]]
paid or accrued by such foreign corporation for such taxable year.
(3) Exclusion of earnings and profits and taxes of a first-, second-
, or third-tier corporation having income excluded under section 959(b).
If in the case of a first-, second-, or third-tier corporation to which
paragraph (c)(1)(i) or (c)(1)(ii) of this section is applied--
(i) The earnings and profits of such foreign corporation for its
taxable year consist of (A) earnings and profits attributable to
dividends received from an immediately lower-tier corporation which are
attributable to amounts included in the gross income of a domestic
corporation under section 951 with respect to the immediately lower- or
lower-tier corporations, and (B) other earnings and profits, and
(ii) The effective rate of foreign income taxes paid or accrued by
such foreign corporation in respect to the dividends to which its
earnings and profits described in paragraph (c)(3)(i)(A) of this section
are attributable is higher or lower than the effective rate of foreign
income taxes paid or accrued by such foreign corporation in respect to
the income to which its earnings and profits described in paragraph
(c)(3)(i)(B) of this section are attributable,
then, for the purposes of applying paragraph (c)(1)(i) or (c)(1)(ii) of
this section to the foreign income taxes paid, accrued, or deemed to be
paid, by such foreign corporation on or with respect to its earnings and
profits for such taxable year, the earnings and profits of such foreign
corporation for such taxable year shall be considered not to include the
earnings and profits described in paragraph (c)(3)(i)(A) of this section
and only the foreign income taxes paid, accrued, or deemed to be paid,
by such foreign corporation in respect to the income to which its
earnings and profits described in paragraph (c)(3)(i)(B) of this section
are attributable shall be taken into account. For purposes of applying
this paragraph (c)(3), the effective rate of foreign income taxes paid
or accrued in respect to income shall be determined consistently with
the principles of paragraphs (b)(3)(iv) and (viii) and (c) of Sec.
1.954-1. Thus, for example, the effective rate of foreign income taxes
paid or accrued in respect to dividends received by such foreign
corporation shall be determined by taking into account any
intercorporate dividends received deduction allowed to such corporation
for such dividends.
(4) Illustrations. The application of this paragraph may be
illustrated by the following examples:
Example 1. Domestic corporation N owns all the one class of stock of
controlled foreign corporation A. Both corporations use the calendar
year as the taxable year. For 1978, N Corporation is required under
section 951 to include in gross income $50 attributable to the earnings
and profits of A Corporation for such year, but A Corporation does not
distribute any earnings and profits for such year. The foreign income
taxes paid by A Corporation for 1978 which are deemed paid by N
Corporation for such year under section 960(a)(1) are determined as
follows upon the basis of the facts assumed:
Pretax earnings and profits of A Corporation.................. $100.00
Foreign income taxes (20%).................................... 20.00
Earnings and profits.......................................... 80.00
Amount required to be included in N Corporation's gross income 50.00
under section 951............................................
Dividends paid to N Corporation............................... 0
Foreign income taxes paid on or with respect to earnings and 20.00
profits of A Corporation.....................................
Foreign income taxes of A Corporation deemed paid by N 12.50
Corporation under section 960(a)(1) ($50/$80x$20)............
Example 2. Domestic corporation N owns all the one class of stock of
controlled foreign corporation A, which owns all the one class of stock
of controlled foreign corporation B. All such corporations use the
calendar year as the taxable year. For 1978, N Corporation is required
under section 951 to include in gross income $45 attributable to the
earnings and profits of B Corporation for such year, but is not required
to include any amount in gross income under section 951 attributable to
the earnings and profits of A Corporation for such year. Neither B
Corporation nor A Corporation distributes any earnings and profits for
1978. The foreign income taxes paid by B Corporation for 1978 which are
deemed paid by N Corporation for such year under section 960(a)(1) are
determined as follows upon the basis of the facts assumed:
Pretax earnings and profits of B Corporation.................. $100.00
Foreign income taxes (40%).................................... 40.00
Earnings and profits.......................................... 60.00
Amounts required to be included in N Corporation's gross 45.00
income under section 951 with respect to B Corporation.......
Dividends paid................................................ 0
Foreign income taxes paid on or with respect to earnings and 40.00
profits of B Corporation.....................................
Foreign income taxes of B Corporation deemed paid by N 30.00
Corporation under section 960(a)(1) ($45/$60x$40)............
[[Page 385]]
Example 3. Domestic corporation N owns all the one class of stock of
controlled foreign corporation A, which owns all the one class of stock
of controlled foreign corporation B, which owns all the one class of
stock of foreign corporation C. All such corporations use the calendar
year as the taxable year. For 1978, N Corporation is required under
section 951 to include in gross income $80 attributable to the earnings
and profits of C Corporation for such year, $45 attributable to the
earnings and profits of B Corporation for such year and $50 attributable
to the earnings and profits of A Corporation for such year. Neither C
Corporation nor B corporation distributes any earnings and profits for
1978. The foreign income taxes which are deemed paid by N Corporation
for such year under section 960(a)(1) are determined as follows upon the
basis of the facts assumed:
C Corporation (third-tier corporation):
Pretax earnings of C Corporation.............................. $150.00
Foreign income taxes (40%).................................... 60.00
Earnings and profits.......................................... 90.00
Amounts required to be included in N Corporation's gross 80.00
income under section 951.....................................
Dividends paid to B Corporation............................... 0
Foreign income taxes paid on or with respect to earnings and 60.00
profits of C Corporation.....................................
B Corporation (second-tier corporation):
Pretax earnings of B Corporation.............................. $100.00
Foreign income taxes (40%).................................... 40.00
Earnings and profits.......................................... 60.00
Amount required to be included in N Corporation's gross income 45.00
under section 951............................................
Dividends paid to A Corporation............................... 0
Foreign income taxes paid on or with respect to earnings and 40.00
profits of B Corporation.....................................
A Corporation (first-tier corporation):
Pretax earnings and profits of A Corporation.................. $100.00
Foreign income taxes (20%).................................... 20.00
Earnings and profits.......................................... 80.00
Amount required to be included in N Corporation's gross income 50.00
under section 951............................................
Dividends paid to N Corporation............................... 0
Foreign income taxes paid on or with respect to earnings and 20.00
profits of A Corporation.....................................
N Corporation (domestic corporation):
Foreign income taxes deemed paid by N Corporation under
section 960(a)(1):
Taxes of C Corporation $80/$90x$60.......................... $53.33
Taxes of B Corporation $45/$60x$40.......................... 30.00
Taxes of A Corporation $50/$80x$20.......................... 12.50
---------
Total taxes deemed paid under section 960(a)(1)........... $95.83
Example 4. Domestic corporation N owns all the one class of stock of
controlled foreign corporation A, which owns 5 percent of the one class
of stock of controlled foreign corporation B. N Corporation also
directly owns 95 percent of the one class of stock of B Corporation.
(Under these facts, B Corporation is only a first-tier corporation with
respect to N Corporation) all such corporations use the calendar year as
the taxable year. For 1978, N Corporation is required under section 951
to include in gross income $60 attributable to the earnings and profits
of B Corporation and $79.20 attributable to the earnings and profits of
A Corporation. For 1978, B Corporation distributes $19 to N Corporation
and $1 to A Corporation, but A Corporation makes no distribution to N
Corporation. The foreign income taxes paid by N Corporation for such
year under section 960(a)(1) are determined as follows upon the basis of
the facts assumed in accordance with Sec. 1.960-1(c)(1)(i):
B Corporation (first-tier corporation):
Pretax earnings and profits................................... $100.00
Foreign income taxes (40%).................................... 40.00
Earnings and profits.......................................... 60.00
Amount required to be included in N Corporation's gross income 60.00
under section 951 with respect to B Corporation..............
A Corporation (first-tier corporation):
Pretax earnings and profits (including $1 dividend from B $100.00
Corporation).................................................
Foreign income taxes (20%).................................... 20.00
Earnings and profits.......................................... 80.00
Amount required to be included in N Corporation's gross income 79.20
with respect to A Corporation ($99-[$99x0.20]................
N Corporation (domestic corporation):
Foreign income taxes deemed paid by N Corporation under
section 960(a)(1) with respect to--
B Corporation ([$60x0.95/$60]x$40).......................... $38.00
A Corporation ($79.20/$80x$20).............................. 19.80
---------
Total taxes deemed paid under section 960(a)(1)........... $57.80
Example 5. Domestic corporation N owns all the one class of stock of
controlled foreign corporation A, which owns all the one class of stock
of controlled foreign corporation B. All such corporations use the
calendar year as the taxable year. For 1978, N Corporation is required
under section 951 to include in gross income $175 attributable to the
earnings and profits of A Corporation for such year. For 1978, B
Corporation has earnings and profits of $225, on which it pays foreign
income taxes of $75. In 1978, B Corporation distributes $150, which,
under paragraph (b) of Sec. 1.960-2, consists of $100 to which section
902(b)(1) does not apply (from B Corporation's earnings and profits
attributable to an amount required under section 951 to be included in N
Corporation's gross income with respect to B Corporation) and $50 to
which section 902(b)(1) applies (from B Corporation's other earnings and
profits). The country under the laws of which A Corporation is
incorporated imposes an income tax of 40 percent on all income but
exempts from tax dividends received from a subsidiary corporation. A
Corporation makes no distribution for 1978. Under paragraph (b) of Sec.
1.960-2, A Corporation is deemed to have paid $25 ($50/$150x$75) of the
$75 foreign income taxes paid by B Corporation on its pretax earnings
and profits of $225. The foreign income taxes deemed paid by N
Corporation for 1978 under
[[Page 386]]
section 960(a)(1) with respect to A Corporation are determined as
follows upon the basis of the following assumed facts:
Pretax earnings and profits of A Corporation:
Dividends received from B Corporation....................... $150.00
Other income................................................ 250.00
-----------
Total pretax earnings and profits......................... $400.00
Foreign income taxes:
On dividends received from B Corporation.......... 0
On other income ($250x0.40)....................... 100.00
-----------
Total foreign income taxes................................ 100.00
Earnings and profits:
Attributable to dividends received from B 100.00
Corporation which are attributable to amounts
included in N Corporation's gross income under
section 951 with respect to B Corporation........
Attributable to other income:
Attributable to dividends received $50.00
from B Corporation which are
attributable to amounts not included
in N Corporation's gross income under
951 with respect to B Corporation....
Attributable to other income ($250- 150.00 $200.00
$100 [$250x0.40])....................
-----------
Total earnings and profits.............................. $300.00
-----------
Foreign income taxes deemed paid by N Corporation under
section 960(a)(1) with respect to A Corporation:
Tax paid by A Corporation in respect to its income other 87.50
than dividends received from B Corporation attributable to
amounts included in N Corporation's gross income under
section 951 with respect to B Corporation ($175/$200x$100).
Tax of B Corporation deemed paid by A Corporation under 21.88
section 902(b)(1) in respect to such income ($175/$200x$25)
-----------
Total foreign income taxes deemed paid by N Corporation $109.38
under section 960(a)(1) with respect to A Corporation....
===========
(d) Time for meeting stock ownership requirements--(1) In general.
For the purposes of applying paragraph (c) of this section to amounts
included in the gross income of a domestic corporation attributable to
the earnings and profits of a first-, second-, or third-tier
corporation, the stock ownership requirements of paragraph (b)(1), (2),
and (3) of this section and the percentage of voting stock requirements
of paragraph (c)(1)(i) and (ii) of this section, if applicable, must be
satisfied on the last day in the taxable year of such first-, second-,
or third-tier corporation, as the case may be, on which such foreign
corporation is a controlled foreign corporation. For paragraph (c) to
apply to amounts included in a domestic corporation's gross income
attributable to the earnings and profits of a second-tier corporation,
the requirements of paragraph (b)(1) and (2) of this section and the
percentage of voting stock requirement of paragraph (c)(1)(i) of this
section must be met on such date. For paragraph (c) to apply to amounts
included in a domestic corporation's gross income attributable to the
earnings and profits of a third-tier corporation, the requirements of
paragraph (b)(1), (2), and (3) of this section and the percentage of
voting stock requirement of paragraph (c)(1)(ii) of this section must be
met on such date.
(2) Illustrations. The application of this paragraph may be
illustrated by the following examples:
Example 1. Domestic corporation N is required for its taxable year
ending June 30, 1978, to include in gross income under section 951 an
amount attributable to the earnings and profits of controlled foreign
corporation A for 1977 and another amount attributable to the earnings
and profits of controlled foreign corporation B for such year.
Corporations A and B use the calendar year as the taxable year. Such
amounts are required to be included in N Corporation's gross income by
reason of its ownership of stock in A Corporation and in turn by A
Corporation's ownership of stock in B Corporation. Corporation A is a
controlled foreign corporation throughout 1977, but B Corporation is a
controlled foreign corporation only from January 1, 1977, through
September 30, 1977. Corporation N may obtain credit under section
960(a)(1) for the year ending June 30, 1978, for foreign income taxes
paid by A Corporation for 1977, only if N Corporation owns at least 10
percent of the voting stock of A Corporation on December 31, 1977.
Corporation N may obtain credit under section 960(a)(1) for the year
ending June 30, 1978, for foreign income taxes paid by B Corporation for
1977, only if on September 30, 1977, N Corporation owns at least 10
percent of the voting stock of A Corporation, A Corporation owns at
least 10 percent of the voting stock of B Corporation, and the
percentage of voting stock requirement of paragraph (c)(1)(i) of this
section is met.
Example 2. The facts are the same as in example 1, except that A
Corporation is a controlled foreign corporation only from January 1,
1977, through March 31, 1977. Corporation N may obtain credit under
section
[[Page 387]]
960(a)(1) for the year ending June 30, 1978, for foreign income taxes
paid by A Corporation for 1977, only if N Corporation owns at least 10
percent of the voting stock of A Corporation on March 31, 1977.
Corporation N may obtain credit under section 960(a)(1) for the year
ending June 30, 1978, for foreign income taxes paid by B Corporation for
1977, only if on September 30, 1977, N Corporation owns at least 10
percent of the voting stock of A Corporation, A Corporation owns at
least 10 percent of the voting stock of B Corporation, and the
percentage of voting stock requirement of paragraph (c)(1)(i) of this
section is met.
Example 3. Domestic Corporation N owns 100 percent of the stock of
controlled foreign corporation A. A Corporation owns 20 percent of the
stock of controlled foreign corporation B. B Corporation owns 10 percent
of the voting stock of controlled foreign corporation C. For calendar
year 1983, N Corporation is required to include amounts in its gross
income attributable to the earnings and profits of A, B, and C
Corporations. A, B, and C Corporations were all controlled foreign
corporations throughout their respective taxable years ending as
follows: A Corporation, December 31, 1983; B Corporation, November 31,
1983; and C Corporation, August 31, 1983. Paragraph (c) of this section
applies to amounts included in gross income of N Corporation with
respect to the earnings and profits of A Corporation because the 10
percent ownership requirement of paragraph (b)(1) of this section is met
on December 31, 1983. Paragraph (c) of this section applies to amounts
included in the gross income of N Corporation with respect to the
earnings and profits of B Corporation because the 10 percent stock
ownership requirements of paragraphs (b)(1) and (2) of this section are
met on November 30, 1983, and the percentage of voting stock requirement
of paragraph (c)(1)(i) of this section (5 percent) is also met on such
date. The percentage of voting stock in A Corporation owned by N
Corporation (100 percent) multiplied by the percentage of voting stock
in B Corporation owned by A Corporation (20 percent) is 20 percent.
Paragraph (c) of this section will not apply to amounts included in N
Corporation's gross income attributable to the earnings and profits of C
Corporation even though on August 31, 1983, the 10 percent stock
ownership requirements of paragraphs (b)(1), (2), and (3) of this
section are met, because the percentage of voting stock requirement of
paragraph (c)(1)(ii) of this section (5 percent) is not met on such
date. The percentage of voting stock of C Corporation owned by B
Corporation (10 percent) multiplied by 20 percent (the percentage of
voting stock of A Corporation owned by N Corporation multiplied by the
percentage of voting stock of B Corporation owned by A Corporation) is 2
percent.
(e) Information to be furnished. If the credit for foreign income
taxes claimed under section 901 includes taxes deemed paid under section
960(a)(1), the domestic corporation must furnish the same information
with respect to the taxes so deemed paid as it is required to furnish
with respect to the taxes actually paid or accrued by it and for which
credit is claimed. See Sec. 1.905-2. For other information required to
be furnished by the domestic corporation for the annual accounting
period of certain foreign corporations ending with or within such
corporation's taxable year, see section 6038(a) and the regulations
thereunder.
(f) Reduction of foreign income taxes paid or deemed paid. For
reduction of the amount of foreign income taxes paid or deemed paid by a
foreign corporation for purposes of section 960, see section 6038(c) (as
amended by section 338 of the Tax Equity and Fiscal Responsibility Act
of 1982) and the regulations thereunder, relating to failure to furnish
information with respect to certain foreign corporations. For reduction
of the foreign income taxes deemed paid by a domestic corporation under
section 960 with respect to foreign oil and gas extraction income, see
section 907(a).
(g) Amounts under section 951 treated as distributions for purposes
of applying effective dates. For purposes of applying section 902 in
determining the amount of credit allowed under section 960(a)(1) and
paragraph (c) of this section, the effective date provisions of the
regulations under section 902 shall apply, and for purposes of so
applying the regulations under section 902, any amount attributable to
the earnings and profits for the taxable year of a first-, second-, or
third-tier corporation which is included in the gross income of a
domestic corporation under section 951 shall be treated as a
distribution received by such domestic corporation on the last day in
such taxable year on which such foreign corporation is a controlled
foreign corporation.
(h) Source of income and country to which tax is deemed paid--(1)
Source of income. For purposes of section 904--
(i) The amount included in gross income of a domestic corporation
under
[[Page 388]]
section 951 for the taxable year with respect to a first-, second-, or
third-tier corporation, plus
(ii) Any section 78 dividend to which such section 951 amount gives
rise by reason of taxes deemed paid by such domestic corporation under
section 960(a)(1),
shall be deemed to be derived from sources within the foreign country or
possession of the United States under the laws of which such first-tier
corporation, or the first-tier corporation in the same chain of
ownership as such second- or third-tier corporation, is created or
organized.
(2) Country to which taxes deemed paid. For purposes of section 904,
the foreign income taxes paid by the first-, second-, or third-tier
corporation and deemed to be paid by the domestic corporation under
section 960(a)(1) by reason of the inclusion of the amount described in
paragraph (h)(1)(i) of this section in the gross income of such domestic
corporation shall be deemed to be paid to the foreign country or
possession of the United States under the laws of which such first-tier
corporation, or the first-tier corporation in the same chain of
ownership as such second- or third-tier corporation, is created or
organized.
(3) Illustration. The application of this paragraph may be
illustrated by the following example:
Example. Domestic corporation N owns all the one class of stock of
controlled foreign corporation A, incorporated under the laws of foreign
country X, which owns all the one class of stock of controlled foreign
corporation B, incorporated under the laws of foreign country Y. All
such corporations use the calendar year as the taxable year. For 1978, N
Corporation is required under section 951 to include in gross income $45
attributable to the earnings and profits of B Corporation for such year
and $50 attributable to the earnings and profits of A Corporation for
such year. For 1978, because of the inclusion of such amounts in gross
income, N Corporation is deemed under section 960(a)(1) and paragraph
(c) of this section to have paid $15 of foreign income taxes paid by B
Corporation for such year and $10 of foreign income taxes paid by A
Corporation for such year. For purposes of section 904, the amount ($95)
included in N Corporation's gross income under section 951 attributable
to the earnings and profits of corporations A and B is deemed to be
derived from sources within country X, and the section 78 dividend
consisting of the foreign income taxes ($25) deemed paid by N
Corporation under section 960(a)(1) with respect to such $95 is deemed
to be derived from sources within country X. The $25 of foreign income
taxes so deemed paid by N Corporation are deemed to be paid to country X
for purposes of section 904.
(i) Computation of deemed-paid taxes in post-1986 taxable years--(1)
General rule. If a domestic corporation is eligible to compute deemed-
paid taxes under section 960(a)(1) with respect to an amount included in
gross income under section 951(a), then, such domestic corporation shall
be deemed to have paid a portion of the foreign corporation's post-1986
foreign income taxes determined under section 902 and the regulations
under that section in the same manner as if the amount so included were
a dividend paid by such foreign corporation (determined by applying
section 902(c) in accordance with section 904(d)(3)(B)).
(2) Ordering rule for computing deemed-paid taxes under sections 902
and 960. If a domestic corporation computes deemed-paid taxes under both
sections 902 and 960 in the same taxable year, section 960 shall be
applied first. After the deemed-paid taxes are computed under section
960 with respect to a deemed income inclusion, post-1986 undistributed
earnings and post-1986 foreign income taxes in each separate category
shall be reduced by the appropriate amounts before deemed-paid taxes are
computed under section 902 with respect to a dividend distribution.
(3) Computation of post-1986 undistributed earnings. Post-1986
undistributed earnings (or an accumulated deficit in post-1986
undistributed earnings) are computed under section 902 and the
regulations under that section.
(4) Allocation of accumulated deficits. For purposes of computing
post-1986 undistributed earnings under sections 902 and 960, a post-1986
accumulated deficit in a separate category shall be allocated
proportionately to reduce post-1986 undistributed earnings in the other
separate categories. However, a deficit in any separate category shall
not permanently reduce earnings in other separate categories, but after
the deemed-paid taxes are computed the
[[Page 389]]
separate limitation deficit shall be carried forward in the same
separate category in which it was incurred. In addition, because deemed-
paid taxes may not exceed taxes paid or accrued by the controlled
foreign corporation, in computing deemed-paid taxes with respect to an
inclusion out of a separate category that exceeds post-1986
undistributed earnings in that separate category, the numerator of the
deemed-paid credit fraction (deemed inclusion from the separate
category) may not exceed the denominator (post-1986 undistributed
earnings in the separate category).
(5) Examples. The application of this paragraph (i) may be
illustrated by the following examples. See Sec. 1.952-1(f)(4) for
additional illustrations of these rules.
Example 1. (i) A, a U.S. person, is the sole shareholder of CFC, a
controlled foreign corporation formed on January 1, 1998, whose
functional currency is the u. In 1998 CFC earns 100u of general
limitation income described in section 904(d)(1)(I) that is not subpart
F income and 100u of foreign personal holding company income that is
passive income described in section 904(d)(1)(A). In 1998 CFC also
incurs a (50u) loss in the shipping category described in section
904(d)(1)(D). CFC's subpart F income for 1998, 100u, does not exceed
CFC's current earnings and profits of 150u. Accordingly, all 100u of
CFC's subpart F income is included in A's gross income under section
951(a)(1)(A). Under section 904(d)(3)(B) of the Internal Revenue Code
and paragraph (i)(1) of this section, A includes 100u of passive
limitation income in gross income for 1998.
(ii) For purposes of computing post-1986 undistributed earnings
under sections 902, 904(d) and 960 with respect to the subpart F
inclusion, the shipping limitation deficit of (50u) is allocated
proportionately to reduce general limitation earnings of 100u and
passive limitation earnings of 100u. Thus, general limitation earnings
are reduced by 25u to 75u (100u general limitation earnings/200u total
earnings in positive separate categories x (50u) shipping deficit = 25u
reduction), and passive limitation earnings are reduced by 25u to 75u
(100u passive earnings/200u total earnings in positive separate
categories x (50u) shipping deficit = 25u reduction). All of CFC's post-
1986 foreign income taxes with respect to passive limitation earnings
are deemed paid by A under section 960 with respect to the 100u subpart
F inclusion of passive income (75u inclusion (numerator limited to
denominator under paragraph (i)(4) of this section)/75u passive
earnings). After the inclusion and deemed-paid taxes are computed, at
the close of 1998 CFC has 100u of general limitation earnings, 0 of
passive limitation earnings (100u of foreign personal holding company
income -- 100u inclusion), and a (50u) deficit in shipping limitation
earnings.
Example 2. (i) The facts are the same as in Example 1 with the
addition of the following facts. In 1999, CFC distributes 150u to A. CFC
has 100u of previously-taxed earnings and profits described in section
959(c)(2) attributable to 1998, all of which is passive limitation
earnings and profits. Under section 959(c), 100u of the 150u
distribution is deemed to be made from earnings and profits described in
section 959(c)(2). The remaining 50u is deemed to be made from earnings
and profits described in section 959(c)(3). The entire dividend
distribution of 50u is treated as made out of CFC's general limitation
earnings and profits. See section 904(d)(3)(D).
(ii) For purposes of computing post-1986 undistributed earnings
under section 902 with respect to the 1999 dividend of 50u, the shipping
limitation accumulated deficit of (50u) reduces general limitation
earnings and profits of 100u to 50u. Thus, 100% of CFC's post-1986
foreign income taxes with respect to general limitation earnings are
deemed paid by A under section 902 with respect to the 1999 dividend of
50u (50u dividend/50u general limitation earnings). After the deemed-
paid taxes are computed, at the close of 1999 CFC has 50u of general
limitation earnings (100u opening balance--50u distribution), 0 of
passive limitation earnings, and a (50u) deficit in shipping limitation
earnings.
(6) Effective date. This paragraph (i) applies to taxable years of a
controlled foreign corporation beginning after March 3, 1997.
[T.D. 7120, 36 FR 10852, June 4, 1971; 36 FR 11924, June 23, 1971, as
amended by T.D. 7334, 39 FR 44211, Dec. 23, 1974; 40 FR 1014, Jan. 6,
1975; T.D. 7649, 44 FR 60088, 60089, Oct. 18, 1979; T.D. 7843, 47 FR
50472, Nov. 8, 1982; 47 FR 55477, Dec. 10, 1982; T.D. 7961, 49 FR 26225,
June 27, 1984; T.D. 8704, 62 FR 21, Jan. 2, 1997]
Sec. 1.960-2 Interrelation of section 902 and section 960 when dividends
are paid by third-, second-, or first-tier corporation.
(a) Scope of this section. This section prescribes rules for the
application of section 902 in a case where dividends are paid by a
third-, second-, or first-tier corporation, as the case may be, from its
earnings and profits for a taxable year when an amount attributable to
such earnings and profits is included
[[Page 390]]
in the gross income of a domestic corporation under section 951, or when
such earnings and profits are attributable to an amount excluded from
the gross income of such foreign corporation under section 959(b) and
Sec. 1.959-2, with respect to the domestic corporation. In making
determinations under this section, any portion of a distribution
received from a first-tier corporation by the domestic corporation which
is excluded from the domestic corporation's gross income under section
959(a) and Sec. 1.959-1, or any portion of a distribution received from
an immediately lower-tier corporation by the third-, second-, or first-
tier corporation which is excluded from such foreign corporation's gross
income under section 959(b) and Sec. 1.959-2, shall be treated as a
dividend for purposes of taking into account under section 902 any
foreign income taxes paid by such third-, second-, or first-tier
corporation which are not deemed paid by the domestic corporation under
section 960(a)(1) and Sec. 1.960-1.
(b) Application of section 902(b) to dividends received from an
immediately lower-tier corporation. For purposes of paragraph (a) of
this section and paragraph (c)(1)(i) of Sec. 1.960-1, section 902(b)
shall apply to all dividends received by the first- or second-tier
corporation from the immediately lower-tier corporation other than
dividends attributable to earnings and profits of such immediately
lower-tier corporation in respect of which an amount is, or has been,
included in the gross income of a domestic corporation under section 951
with respect to such immediately lower-tier corporation.
(c) Application of section 902(a) to dividends received by domestic
corporation from first-tier corporation. For purposes of paragraph (a)
of this section, section 902 (a) shall apply to all dividends received
by the domestic corporation for its taxable year from the first-tier
corporation other than dividends attributable to earnings and profits of
such first-tier corporation in respect of which an amount is, or has
been, included in the gross income of a domestic corporation under
section 951 with respect to such first-tier corporation.
(d) Allocation of earnings and profits of a first- or second-tier
corporation having income excluded under section 959(b)--(1) First-tier
corporations. If the first-tier corporation for its taxable year
receives dividends from the second-tier corporation to which in
accordance with paragraph (b) of this section 902(b)(1) or section
902(b)(2) applies and other dividends from the second-tier corporation
to which such sections do not apply, then in applying section 902(a)
pursuant to this section and in applying section 960(a)(1) pursuant to
Sec. 1.960-1(c)(1)(i), with respect to the foreign income taxes paid
and deemed paid by the second-tier corporation which are deemed paid by
the first-tier corporation for such taxable year under section
902(b)(1)--
(i) The earnings and profits of the first-tier corporation for such
taxable year shall be considered not to include its earnings and profits
which are attributable to the dividends to which section 902(b)(1) does
not apply (in determining the domestic corporation's credit for the
taxes paid by the second-tier corporation) or which are attributable to
the dividends to which sections 902(b)(1) and 902(b)(2) do not apply (in
determining the domestic corporation's credit for taxes deemed paid by
the second-tier corporation) and
(ii) For the purposes of so applying section 902(a), distributions
to the domestic corporation from such earnings and profits which are
attributable to the dividends to which section 902(b)(1) does not apply
(in determining the domestic corporation's credit for taxes paid by the
second-tier corporation) or which are attributable to the dividends to
which sections 902(b)(1) and 902(b)(2) do not apply (in determining the
domestic corporation's credit for taxes deemed paid by the second-tier
corporation) shall not be treated as a dividend.
(2) Second-tier corporations. If the second-tier corporation for its
taxable year receives dividends from the third-tier corporation to
which, in accordance with paragraph (b) of this section, section
902(b)(2) applies and other dividends from the third-tier corporation to
which such section does not apply, then in applying section 902(b)(1)
pursuant to this section, and in applying section 960(a)(1) pursuant to
paragraph (c)(1)(i) of Sec. 1.960-1, with respect to the
[[Page 391]]
foreign taxes deemed paid by the second-tier corporation for such
taxable year under section 902(b)(2)--
(i) The earnings and profits of the second-tier corporation for such
taxable year shall be considered not to include its earnings and profits
which are attributable to such other dividends from the third-tier
corporation, and
(ii) For the purposes of so applying section 902(b)(1),
distributions to the first-tier corporation from such earnings and
profits which are attributable to such other dividends from the third-
tier corporation shall not be treated as a dividend.
(e) Separate determinations under sections 902(a), 902(b)(1), and
902(b)(2) in the case of a first-, second-, or third-tier corporation
having income excluded under section 956(b). If in the case of a first-,
second-, or third-tier corporation to which paragraph (b) or (c) of this
section is applied--
(1) The earnings and profits of such foreign corporation for its
taxable year consist of--
(i) Dividends received from an immediately lower-tier corporation
which are attributable to amounts included in the gross income of a
domestic corporation under section 951 with respect to the immediately
lower- or lower-tier corporations, and
(ii) Other earnings and profits, and
(2) The effective rate of foreign income taxes paid or accrued by
such foreign corporation on the dividends described in paragraph
(e)(1)(i) of this section is higher or lower than the effective rate of
foreign income taxes attributable to its earnings and profits described
in paragraph (e)(1)(ii) of this section,
then, for purposes of applying paragraph (b) or (c) of this section to
dividends paid by such foreign corporation to the domestic corporation
or the first- or second-tier corporation, sections 902(a), 902(b)(1),
and 902(b)(2) shall be applied separately to the portion of the dividend
which is attributable to the earnings and profits described in paragraph
(e)(1)(i) of this section and separately to the portion of the dividend
which is attributable to the earnings and profits described in paragraph
(e)(1)(ii) of this section. In making a separate determination with
respect to the earnings and profits described in paragraph (e)(1)(i) or
(e)(1)(ii) of this section, only the foreign income taxes paid or
accrued (or, in the case of earnings and profits of a first- or second-
tier corporation described in paragraph (e)(1)(ii) of this section,
deemed to be paid) by such foreign corporation on the income
attributable to such earnings and profits shall be taken into account.
For purposes of applying this paragraph (e), no part of the foreign
income taxes paid, accrued, or deemed to be paid which are attributable
to the earnings and profits described in paragraph (e)(1)(ii) of this
section shall be attributed to the dividend described in paragraph
(e)(1)(i) of this section; and no part of the foreign income taxes paid
or accrued on the dividend described in paragraph (e)(1)(i) of this
section shall be attributed to the earnings and profits described in
paragraph (e)(1)(ii) of this section. Furthermore, the effective rate of
foreign income taxes paid or accrued shall be determined consistently
with the principles of paragraphs (b)(3)(iv) and (viii) and (c) of Sec.
1.954-1. Thus, for example, the effective rate of foreign income taxes
on dividends received by such foreign corporation shall be determined by
taking into account any intercorporate dividends received deduction
allowed to such corporation for such dividends.
(f) Illustrations. The application of this section may be
illustrated by the following examples. In all of the examples other than
examples 6, 7, 9 and 10, it is assumed that the effective rate of
foreign income taxes paid or accrued by the first- or second-tier
corporation, as the case may be, in respect to dividends received from
the immediately lower-tier corporation, is the same as the effective
rate of foreign income taxes paid or accrued by the first- or second-
tier corporation with respect to its other income:
Example 1. Domestic corporation N owns all the one class of stock of
controlled foreign corporation A, which owns all the one class of stock
of controlled foreign corporation B. All such corporations use the
calendar year as the taxable year. For 1978, N Corporation is required
under section 951 to include $50 in gross income attributable to the
earnings and profits of A Corporation for such year, but is not required
to include any
[[Page 392]]
amount in gross income under section 951 attributable to the earnings
and profits of B Corporation. For such year, B Corporation distributes a
dividend of $45, but A Corporation does not make any distributions. The
foreign income taxes deemed paid by N Corporation for 1978 under section
960(a)(1), after applying section 902(b)(1) for such year of A
Corporation, are determined as follows upon the basis of the facts
assumed:
B Corporation (second-tier corporation):
Pretax earnings and profits................................. $100.00
Foreign income taxes (40%).................................. 40.00
Earnings and profits........................................ 60.00
Dividends paid to A Corporation............................. $45.00
Foreign income taxes paid by B Corporation on or with 40.00
respect to its accumulated profits.........................
Foreign income taxes of B Corporation deemed paid by A 30.00
Corporation for 1978 under section 902(b)(1) ($45/$60x$40).
A Corporation (first-tier corporation):
Pretax earnings and profits:
Dividends from B Corporation..................... $45.00 ........
Other income..................................... 100.00 ........
---------
Total pretax earnings and profits............... ....... 145.00
Foreign income taxes (20%)......................... ....... 29.00
Earnings and profits............................... ....... 116.00
Foreign income taxes paid, and deemed to be paid, by A 59.00
Corporation on or with respect to its earnings and profits
($29+$30)..................................................
Amount required to be included in N Corporation's gross 50.00
income under section 951 with respect to A Corporation.....
Dividends paid to N Corporation............................. 0
N Corporation (domestic corporation):
Foreign income taxes of A Corporation deemed paid by N 25.43
Corporation for 1978 under section 960(a)(1) ($50/$116x$59)
Example 2. Domestic corporation N owns all the one class of stock of
controlled foreign corporation A, which owns all the one class of stock
of controlled foreign corporation B. All such corporations use the
calendar year as the taxable year. For 1978, N Corporation is required
under section 951 to include in gross income $150 attributable to the
earnings and profits of B Corporation for such year, which B Corporation
distributes during such year. Corporation N is not required for 1978 to
include any amount in gross income under section 951 attributable to the
earnings and profits of A Corporation, but A Corporation distributes for
such year $135 from its earnings and profits attributable to B
Corporation's dividend. The foreign income taxes deemed paid by N
Corporation for 1978 under section 960(a)(1)(C) and section 902(a) are
determined as follows upon the basis of the facts assumed:
B Corporation (second-tier corporation):
Pretax earnings and profits................................. $250.00
Foreign income taxes (20%).................................. 50.00
Earnings and profits........................................ 200.00
Amounts required to be included in N Corporation's gross 150.00
income under section 951 with respect to B Corporation.....
Dividends paid to A Corporation............................. 150.00
Foreign income taxes paid on or with respect to earnings and 50.00
profits of B Corporation...................................
A Corporation (first-tier corporation):
Pretax earnings and profits:
Dividends from B Corporation.................... $150.00 ........
Other income.................................... 200.00 ........
----------
Total pretax earnings and profits........................ 350.00
Foreign income taxes (10%).................................. 35.00
Earnings and profits........................................ 315.00
Dividends paid to N Corporation............................. 135.00
Foreign income taxes paid by A Corporation on or with 35.00
respect to its accumulated profits.........................
N Corporation (domestic corporation):
Foreign income taxes of B Corporation deemed paid by N 37.50
Corporation for 1978 under section 960(a)(1) ($150/
$200x$50)..................................................
Foreign income taxes of A Corporation deemed paid by N 15.00
Corporation for 1978 under section 902(a) ($135/$315x$35)..
-----------
Total foreign income taxes deemed paid by N Corporation 52.50
under section 901........................................
Example 3. Domestic corporation N owns all the one class of stock of
controlled foreign corporation A, which owns all the one class of stock
of controlled foreign corporation B. All such corporations use the
calendar year as the taxable year. For 1978, N Corporation is required
under section 951 to include $180 in gross income attributable to the
earnings and profits of A Corporation for such year, but is not required
to include any amount in gross income under section 951 attributable to
the earnings and profits of B Corporation. Corporation B distributes
from its earnings and profits for 1978 a dividend of $50. For 1978, A
Corporation distributes $180 from its earnings and profits attributable
to the amount required under section 951 to be included in N
Corporation's gross income for such year with respect to A Corporation
and $20 from its other earnings and profits. The foreign income taxes
deemed paid by N Corporation for 1978 under section 960(a)(1) and
section 902(a) are determined as follows upon the basis of the facts
assumed:
B Corporation (second-tier corporation):
Pretax earnings and profits................................. $100.00
Foreign income taxes (40%).................................. 40.00
Earnings and profits........................................ 60.00
Dividends paid to A Corporation............................. 50.00
Foreign income taxes paid by B Corporation on or with 40.00
respect to its accumulated profits.........................
Foreign income taxes of B Corporation deemed paid by A 33.33
Corporation for 1978 under section 902(b)(1) ($50/$60x$40).
A Corporation (first-tier corporation):
Pretax earnings and profits:
Dividends from B Corporation.................... $50.00 ........
Other income.................................... 200.00 ........
----------
Total pretax earnings and profits......................... 250.00
Foreign income taxes (10%).................................. 25.00
Earnings and profits........................................ 225.00
Foreign income taxes paid, and deemed to be paid, by A 58.33
Corporation on or with respect to its earnings and profits
($25.00+$33.33)............................................
Amounts required to be included in N Corporation's gross 180.00
income for 1978 under section 951 with respect to A
Corporation................................................
[[Page 393]]
Dividends paid to N Corporation:
Dividends to which section 902(a) does not apply 180.00 ........
(from A Corporation's earnings and profits in
respect of which an amount is required under
section 951 to be included in N Corporation's
gross income with respect to A Corporation)....
Dividends to which section 902(a) applies (from 20.00 ........
A Corporation's other earnings and profits)....
----------
Total dividends paid to N Corporation..................... $200.00
N Corporation (domestic corporation):
Foreign income taxes of corporations A and B deemed paid by 46.66
N Corporation under section 960(a)(1) ($180/$225x$58.33)...
Foreign income taxes of corporations A and B deemed paid by 5.18
N Corporation under section 902(a) ($20/$225x$58.33).......
-----------
Total foreign income taxes deemed paid by N Corporation 51.84
under section 901........................................
Example 4. Domestic corporation N owns all the one class of stock of
controlled foreign corporation A, which owns all the one class of stock
of controlled foreign corporation B. All such corporations use the
calendar year as the taxable year. For 1978, N Corporation is required
under section 951 to include in gross income $150 attributable to the
earnings and profits of B Corporation for such year and $22.50
attributable to the earnings and profits of A Corporation for such year.
For 1978, B Corporation distributes $175, consisting of $150 from its
earnings and profits attributable to amounts required under section 951
to be included in N Corporation's gross income with respect to B
Corporation and $25 from its other earnings and profits. Corporation A
does not distribute any dividends for 1978. The foreign income taxes
deemed paid by N Corporation for 1978 under section 960(a)(1) are
determined as follows upon the basis of the facts assumed:
B Corporation (second-tier corporation):
Pretax earnings and profits................................. $250.00
Foreign income taxes (20%).................................. 50.00
Earnings and profits........................................ 200.00
Amounts required to be included in N Corporation's gross 150.00
income under section 951 for 1978 with respect to B
Corporation................................................
Dividends paid by B Corporation:
Dividends to which section 902(b) does not apply $150.00 ........
(from B Corporation's earnings and profits in
respect of which an amount is required under
section 951 to be included in N Corporation's
gross income with respect to B Corporation)....
Dividends to which section 902(b)(1) applies 25.00 ........
(from B Corporation's other earnings and
profits).......................................
----------
Total dividends paid to A Corporation.................... 175.00
Foreign income taxes paid by B Corporation on or with 50.50
respect to its accumulated profits.........................
Foreign income taxes of B Corporation deemed paid by A 6.25
Corporation for 1978 under section 902(b)(1) ($25/$200x$50)
A Corporation (first-tier corporation):
Pretax earnings and profits................................. 175.00
Foreign income tax (10 percent)............................. 17.50
Earnings and profits........................................ 157.50
Earnings and profits after exclusion of amounts attributable 22.50
to dividends to which section 902(b) does not apply
($157.50 less [$150- ($150x0.10)]).........................
Amount required to be included in N Corporation's gross 22.50
income for 1978 under section 951 with respect to A
Corporation................................................
Dividends paid to N Corporation............................. 0
N Corporation (domestic corporation):
Foreign income taxes deemed paid by N Corporation
under section 960(a)(1)(C) with respect to A
Corporation:
Tax actually paid by A Corporation ($22.50/ 2.50 ........
$157.50x$17.50)................................
Tax of B Corporation deemed paid by A 6.25 ........
Corporation under section 902(b)(1) ($22.50/
$22.50x$6.25)..................................
-----------
........ 8.75
Foreign income taxes deemed paid by N Corporation under 37.50
section 960(a)(1)(C) with respect to B Corporation ($150/
$200x$50)..................................................
-----------
Total taxes deemed paid under section 960(a)(1)(C)...... 46.20
Example 5. Domestic corporation N owns all the one class of stock of
controlled foreign corporation A, which owns all the one class of stock
of controlled foreign corporation B. All such corporations use the
calendar year as the taxable year. For 1978, N Corporation is required
under section 951 to include in gross income $150 attributable to the
earnings and profits of B Corporation for such year and $22.50
attributable to the earnings and profits of A Corporation for such year.
For 1978, B Corporation distributes $175, consisting of $150 from its
earnings and profits attributable to amounts required under section 951
to be included in N Corporation's gross income with respect to B
Corporation and $25 from its other earnings and profits. For 1978, A
Corporation distributes $225, consisting of $135 from its earnings and
profits attributable to the amount required under section 951 to be
included in N Corporation's gross, income with respect to B Corporation,
$22.50 from its earnings and profits attributable to the amount required
under section 951 to be included in N Corporation's gross income with
respect to A Corporation, and $67.50 from its other earnings and
profits. The foreign income taxes deemed paid by N Corporation for 1978
under section 960(a)(1) and section 902(a)(1) are determined as follows
upon the basis of the facts assumed:
[[Page 394]]
B Corporation (second-tier corporation):
Pretax earnings and profits................................. $250.00
Foreign income taxes (20%).................................. 50.00
Earnings and profits........................................ 200.00
Amounts required to be included in N Corporation's gross 150.00
income for 1978 under section 951 with respect to B
Corporation................................................
Dividends paid by B Corporation:
Dividends to which section 902(b) does not apply $150.00 ........
(from B Corporation's earnings and profits in
respect of which an amount is required under
section 951 to be included in N Corporation's
gross income with respect to B Corporation)....
Dividends to which section 902(b) applies (from $25.00 ........
B Corporation's other earnings and profits)....
----------
Total dividends paid to A Corporation.................... $175.00
Foreign income taxes paid by B Corporation on or with 50.00
respect to its accumulated profits.........................
Foreign income taxes of B Corporation deemed paid by A 6.25
Corporation for 1978 under section 902(b)(1) ($25/$200x$50)
A Corporation (first-tier corporation):
Pretax earnings and profits:
Dividends received from B Corporation........... 175.00 ........
Other income.................................... 100.00 ........
----------
Total pretax earnings and profits........................ 275.00
Foreign income taxes (10 percent)........................... 27.50
Earnings and profits........................................ 247.50
Earnings and profits after exclusion of amounts attributable 112.50
to dividends to which section 902(b) does not apply
($247.50 less [$150 -($150x0.10)]).........................
Amount required to be included in N Corporation's gross 22.50
income for 1978 under section 951 with respect to A
Corporation................................................
Distributions paid by A Corporation:
Dividends to which section 902(a) does not apply 22.50 ........
(From A Corporation's earnings and profits in
respect of which an amount is required under
section 951 to be included in N Corporation's
gross income with respect to A Corporation)......
Dividends to which section 902(a) applies (from A 202.50 ........
Corporation's other earnings and profits)........
----------
Total dividends paid to N Corporation........... 225.00 ........
N Corporation (domestic corporation):
Foreign income taxes deemed paid by N Corporation
under section 960(a)(1) with respect to--
B Corporation ($150/$200x$50)................... ........ 37.50
A Corporation:
Tax paid by A Corporation ($22.50/ 2.50 ........
$247.50x$27.50)..............................
Tax of B Corporation deemed paid by A 1.25 3.75
Corporation under section 902(b)(1) ($22.50/
$112.50x$6.25)...............................
-----------
Total taxes deemed paid under section 960(a)(1)....... 41.25
Foreign income taxes deemed paid by N Corporation
under section 902(a)(1) with respect to A
Corporation:
Tax paid by A Corporation ($200.50/ 22.50 ........
$247.50x$27.50)................................
Tax of B Corporation deemed paid by A 3.75 ........
Corporation ($67.50/ $112.50x$6.25)............
----------
Total taxes deemed paid under section 902(a)(1)......... 26.52
-----------
Total foreign income taxes deemed paid by N Corporation 67.05
under section 901........................................
Example 6. Domestic corporation N owns all the one class of stock of
controlled foreign corporation A, which owns all the one class of stock
of controlled foreign corporation B. All such corporations use the
calendar year as the taxable year. A and B corporations are organized
under the laws of foreign country X. All of B corporation's assets used
in a trade or business are located in country X. Country X imposes an
income tax of 20 percent on B corporation's income. For 1978, N
Corporation is required under section 951 to include in gross income
$100 attributable to the earnings and profits of B Corporation for such
year. For 1978, B Corporation distributes $150, consisting of $100 from
its earnings and profits attributable to the amount required under
section 951 to be included in N Corporation's gross income with respect
to B Corporation and $50 from its other earnings and profits. Country X
imposes an income tax of 10 percent on A Corporation's income but
exempts from tax dividends received from B Corporation. N is not
required to include any amount in gross income under section 951 for
1978 attributable to the earnings and profits of A Corporation for such
year. For 1978, A Corporation distributes $175, consisting of $100 from
its earnings and profits attributable to the amount required under
section 951 to be included in N Corporation's gross income with respect
to B Corporation, and $75 from its other earnings and profits. The
foreign income taxes deemed paid by N Corporation for 1978 under section
960(a)(1) and section 902(a) are determined as follows on the basis of
the facts assumed:
B Corporation (2d-tier corporation):
Pretax earnings and profits................................. $200.00
Foreign income taxes (20%).................................. 40.00
Earnings and profits........................................ 160.00
Amount required to be included in N Corporation's gross 100.00
income for 1978 under section 951 with respect to B
Corporation................................................
[[Page 395]]
Dividends paid by B Corporation:
Dividends to which section 902(b) does not apply $100.00 ........
(from B corporation's earnings and profits in
respect of which an amount is required under
section 951 to be included in N corporation's
gross income with respect to B corporation)......
Dividends to which section 902(b)(1) applies (from 50.00 ........
B corporation's other earnings and profits)......
----------
Total dividends paid to A corporation...................... 150.00
Foreign income taxes of B corporation deemed paid 12.50 ........
by A corporation for 1978 under section 902(b)(1)
($50/$100x $40)..................................
A corporation (1st-tier corporation):
Pretax earnings and profits:
Dividends received from B corporation........... 150.00 ........
Other income.................................... 100.00 ........
----------
Total pretax earnings and profits............. ........ 250.00
Foreign income taxes:
On dividends received from B corporation........ None ........
On other income ($100x0.10)..................... 10.00 ........
Total foreign income taxes..................... ........ 10.00
Earnings and profits:
Attributable to dividends received from B corporation to 100.00
which section 902(b) does not apply........................
Attributable to other income:
Attributable to dividends received from B 50.00 ........
Corporation to which section 902(b)(1) applies...
Attributable to other income ($100-$10)........... 90.00 ........
----------
Subtotal................................................... 140.00
Total earnings and profits................................. 240.00
Earnings and profits after exclusion of amounts attributable 140.00
to dividends to which section 902(b) does not apply ($240-
$100)......................................................
Amount required to be included in N corporation's gross None
income for 1978 under section 951 with respect to A
corporation................................................
Dividends paid by A corporation:
Dividends to which section 902(a) does not apply None ........
(from A corporation's earnings and profits in
respect of which an amount is required under
section 951 to be included in N corporation's
gross income with respect to A corporation)....
Dividends to which section 902(a) applies (from $175.00 ........
A corporation's other earnings and profits)....
----------
Total dividends paid to N corporation.................... $175.00
N corporation (domestic corporation):
Foreign income taxes deemed paid by N corporation under 25.00
section 960(a)(1) with respect to B corporation ($100/
$160x$40)..................................................
Foreign income taxes deemed paid by N corporation
under section 902(a) with respect to A
corporation (allocation of earnings and profits
being made under pars. (c)(2) and (d) of this
section):
Tax paid by A corporation in respect to None ........
dividends received from B Corporation to which
section 902(b) does not apply ($100/ $100x$0)..
Tax paid by A corporation in respect to its 5.36 ........
other income ($75/ $140x$10)...................
Tax paid by B corporation deemed paid by A 6.70 ........
corporation in respect to such other income
($75/$140x$12.50)..............................
----------
Total taxes deemed paid under section 902(a)............ 12.06
Total foreign income taxes deemed paid by N 37.06 ........
corporation under section 901..................
Example 7. Domestic corporation N owns all the one class of stock of
controlled foreign corporation A, which owns all the one class of stock
of controlled foreign corporation B. All such corporations use the
calendar year as the taxable year. For 1978, N Corporation is required
under section 951 to include in gross income $150 attributable to the
earnings and profits of B Corporation for such year and $47.50
attributable to the earnings and profits of A Corporation for such year.
For 1978, B Corporation distributes $200, consisting of $150 from its
earnings and profits attributable to the amount required under section
951 to be included in N Corporation's gross income with respect to B
Corporation and $50 from its other earnings and profits. The country
under the laws of which A Corporation is incorporated imposes an income
tax of 5 percent on dividends received from a subsidiary corporation and
20 percent on other income. For 1978, A Corporation distributes $100
from its earnings and profits to N Corporation, such amount being
attributable under paragraph (e) of Sec. 1.959-3 to the amount required
under section 951 to be included in N Corporation's gross income with
respect to B Corporation. The foreign income taxes deemed paid by N
Corporation for 1978 under section 960(a)(1) and section 902(a) are
determined as follows on the basis of the facts assumed:
B Corporation (2d-tier corporation):
Pretax earnings and profits................................. $250.00
Foreign income taxes (20 percent)........................... 150.00
Earnings and profits........................................ 200.00
Amount required to be included in N Corporation's gross 150.00
income for 1978 under section 951 with respect to B
corporation................................................
[[Page 396]]
Dividends paid by B corporation:
Dividends to which section 902(b) does not apply $150.00 ........
(from B corporation's earnings and profits in
respect of which an amount is required under
section 951 to be included in N corporation's
gross income with respect to B corporation)....
Dividends to which section 902(b)(1) applies 50.00 ........
(from B corporation's other earnings and
profits).......................................
----------
Total dividends paid to A corporation...................... 200.00
Foreign income taxes of B corporation deemed paid by A 12.50
corporation for 1978 under section 902(b)(1) ($50/$200x$50)
A corporation (1st-tier corporation):
Pretax earnings and profits:
Dividends received from B corporation........... 200.00 ........
Other income.................................... 100.00 ........
----------
Total pretax earnings and profits........................ 300.00
Foreign income taxes:
On dividends received from B corporation to which section 7.50
902(b) does not apply ($150x 0.05).......................
On other income:
Dividends received from B corporation to which 2.50 ........
section 902(b)(1) applies ($50x 0.05)........
Other income of A corporation ($100x0.20)..... 20.00 ........
----------
Total.................................................... 22.50
-----------
Total foreign income taxes................................ 30.00
Earnings and profits:
Attributable to dividends received from B corporation to 142.50
which section 902(b) does not apply ($150-$7.50)...........
Attributable to other income:
Attributable to dividends received from B 47.50 ........
corporation to which section 902(b)(1) applies
($50-$2.50)....................................
Attributable to other income ($100-$20.......... 80.00 ........
----------
Total.................................................... 127.50
-----------
Total earnings and profits............................... 270.00
Earnings and profits after exclusion of amounts attributable 127.50
to dividends to which section 902(b) does not apply ($270
less $142.50)................................................
Amount required to be included in N corporation's gross income 47.50
for 1978 under section 951 with respect to A corporation.....
Dividends paid by A Corporation:
Dividends to which section 902(a) does not apply None ........
(from A corporation's earnings and profits in
respect of which an amount is required under
section 951 to be included in N corporation's
gross income with respect to A corporation)......
Dividends to which section 902(a)(1) applies (from $100.00 ........
A corporation's other earnings and profits)......
----------
Total dividends paid to N corporation.................... $100.00
N Corporation (domestic corporation):
Foreign income taxes deemed paid by N corporation under 37.50
section 960(a)(1) with respect to--B corporation ($150/
$200x$50)
A corporation (allocation of earnings and profits being made
under Sec. 1.960-1(c)(3) and par. (d) of this section):
Tax paid by A corporation ($47.50/ 8.38 ........
$127.50x$22.50)................................
Tax of B corporation deemed paid by A 4.66 ........
corporation under section 902(b)(1) ($47.50/
$127.50x$12.50)................................
----------
Total.......................................... ........ 13.04
=========
Total taxes deemed paid under section 960(a)(1) ........ 50.54
Foreign income taxes deemed paid by N corporation 5.26 ........
under section 902(a) with respect to A
corporation (allocations of earnings and profits
being made under pars. (c)(2) and (d) of this
section) ($100/$142.50x$7.50)....................
----------
Total foreign income taxes deemed paid by N Corporation 55.80
under section 901........................................
Example 8. Domestic corporation N owns all the one class of stock of
controlled foreign corporation A, which owns all the one class of stock
of controlled foreign corporation B, which owns all the one class of
stock of controlled foreign corporation C. All such corporations use the
calendar year as the taxable year. For 1978, N Corporation is required
under section 951 to include $50 attributable to the earnings and
profits of C Corporation and $15 attributable to the earnings and
profits of B Corporation in its gross income. N Corporation is not
required to include any amount in its gross income with respect to A
Corporation under section 951 in 1978. For such year, C Corporation
distributes $75 to B Corporation. B Corporation in turn distributes $60
of its earnings and profits to A Corporation. A Corporation has no other
earnings and profits for 1978 and distributes $45 of its earnings and
profits to N Corporation. The foreign income taxes deemed paid by N
Corporation under section 960(a)(1) and section 902(a) are determined as
follows on the basis of the facts assumed:
C Corporation (third-tier corporation):
Pretax earnings and profits................................... $150.00
Foreign taxes paid by C Corporation (30%)..................... 45.00
Earnings and profits.......................................... 105.00
Amount required to be included in gross income of N 50.00
Corporation under section 951 with respect to C Corporation..
Dividend to B Corporation..................................... 75.00
Dividend from earnings and profits to which 50.00
section 902(b)(2) does not apply (attributable to
amounts included in N Corporation's gross income
under section 951 with respect to C Corporation).
[[Page 397]]
Dividend from earnings and profits to which $25.00
section 902(b)(2) applies (attributable to
amounts not included in N Corporation's gross
income with respect to C Corporation)............
Amount of foreign income taxes of C Corporation deemed paid by
B Corporation under section 902(b)(2) and Sec. 1.960-2(b):
[GRAPHIC] [TIFF OMITTED] TC09OC91.016
($25/$105x$45).............................................. $10.71
B Corporation (second-tier corporation):
Pretax earnings and profits:
Dividend from C Corporation....................... $75.00
Other earnings and profits........................ 225.00
-----------
Total pretax earnings and profits......................... $300.00
Foreign income taxes paid by B Corporation (40%).............. 120.00
Earnings and profits.......................................... 180.00
Earnings and profits attributable to amounts to 30.00
which section 902(b)(2) does not apply (amounts
included in N Corporation's gross income under
section 951 with respect to C Corporation ($50-
($50x.40)).......................................
Other earnings and profits........................ 150.00
Earnings and profits of B Corporation after exclusion for 150.00
amounts to which section 902(b)(2) does not apply (amounts
attributable to earnings and profits which are included in N
Corporation's gross income under section 951 with respect to
C Corporation) ($180-$30)....................................
Amount to be included in gross income under section 951 of N 15.00
Corporation with respect to B Corporation....................
Amount of dividend to A Corporation........................... 60.00
Dividend from earnings and profits to which 30.00
section 902(b)(2) does not apply (attributable to
amounts included in N Corporation's gross income
under section 951 with respect to C Corporation).
Dividend from earnings and profits to which 15.00
section 902(b)(1) does not apply (attributable to
amounts included in N Corporation's gross income
under section 951 with respect to B Corporation).
Dividend from other earnings and profits 15.00
(attributable to amounts not included in N
Corporation's gross income under section 951 with
respect to B or C Corporation)...................
Foreign income taxes of B Corporation deemed paid by A
Corporation under section 902(b)(1) and Sec. 1.960-2(b):
[GRAPHIC] [TIFF OMITTED] TC09OC91.017
($45/$180x120).............................................. $30.00
Foreign income taxes (of C Corporation) deemed paid by B
Corporation deemed paid by A Corporation under section
902(b)(1) in accordance with Sec. 1.960-2(b) and Sec.
1.960-2(d)(2)(i) and (ii):
[[Page 398]]
[GRAPHIC] [TIFF OMITTED] TC09OC91.018
($15/$150x$10.71)........................................... 1.07
A Corporation (first-tier corporation):
Pretax earnings and profits:
Dividend from B Corporation....................... $60.00
Other earnings and profits........................ 0
-----------
Total pretax earnings and profits......................... $60.00
Foreign income taxes paid by A Corporation (10%).............. 6.00
Earnings and profits.......................................... 54.00
Earnings and profits attributable to amounts to 27.00
which section 902(b)(2) does not apply
(attributable to amounts previously included in N
Corporation's gross income under section 951 with
respect to C Corporation) ($30-($30X.10))........
Earnings and profits attributable to amounts to 13.50
which section 902(b)(1) does not apply
(attributable to amounts included in N
Corporation's gross income under section 951 with
respect to B Corporation) ($15- ($15X.10)).......
Other earnings and profits ($15--($15X.10))....... 13.50
Earnings and profits of A Corporation after exclusion for 40.50
amounts to which section 902(b)(1) does not apply
(attributable to amounts included in N Corporation's gross
income under section 951 with respect to B Corporation)
($54.00-$13.50)..............................................
Earnings and profits of A Corporation after exclusion for 13.50
amounts to which sections 902(b)(1) and (2) do not apply
(attributable to amounts included in N Corporation's gross
income under section 951 with respect to B or C Corporation)
($40.50-$27.00)..............................................
Dividend to N Corporation..................................... 45.00
Dividend from earnings and profits to which $27.00
section 902(b)(2) does not apply (attributable to
amounts included in N Corporation's gross income
under section 951 with respect to C Corporation).
Dividend from earnings and profits to which 13.50
section 902(b)(1) does not apply (attributable to
amounts included in N Corporation's gross income
under section 951 with respect to B Corporation).
Dividend from earnings and profits to which 0
section 902(a) does not apply (attributable to
amounts included in N Corporation's gross income
under section 951 with respect to A Corporation).
Dividend from other earnings and profits 4.50
(attributable to amounts not included in N
Corporation's gross income under section 951 with
respect to A, B, or C Corporation)...............
N Corporation (domestic corporation):
Foreign income taxes deemed paid by N Corporation under
section 960(a)(1) and Sec. 1.960-1(c)(1)(ii) with respect
to C Corporation:
[GRAPHIC] [TIFF OMITTED] TC09OC91.019
($50/$105x$45.00)........................................... $21.43
Foreign income taxes deemed paid by N Corporation under 11.07
section 960(a)(1) and Sec. 1.960-1(c)(1)(i) with respect to
B Corporation................................................
Taxes paid by B Corporation:
[[Page 399]]
[GRAPHIC] [TIFF OMITTED] TC09OC91.020
($15/$180x$120)................................... $10.00
Taxes deemed paid by B Corporation in accordance with Sec. 1.960-
2(d)(2)(i):
[GRAPHIC] [TIFF OMITTED] TC09OC91.021
($15/$150x$10.71)................................. $1.07
-----------
Total taxes deemed paid by N Corporation under section $32.50
960(a)(1)................................................
Foreign income taxes deemed paid by N Corporation under
section 902(a):
Taxes paid by A Corporation in accordance with Sec. 1.960-2(c):
[GRAPHIC] [TIFF OMITTED] TC09OC91.022
($45/$54x$6)...................................... $5.00
Taxes paid by B Corporation deemed paid by A
Corporation in accordance with Sec. Sec. 1.960-
2(c) and 1.960-2(d)(1)(i) and (ii):
[GRAPHIC] [TIFF OMITTED] TC09OC91.023
($31.50/$40.50x$30.00)............................ 23.33
Taxes (of C Corporation) deemed paid by B Corporation deemed paid by
A Corporation in accordance with Sec. Sec. 1.960-2(c) and 1.960-
2(d)(1)(i) and (ii):
[[Page 400]]
[GRAPHIC] [TIFF OMITTED] TC09OC91.024
($4.50/$13.50x$1.07).............................. .36
-----------
Total taxes deemed paid by N Corporation under section $28.69
902(a)...................................................
---------
Total foreign income taxes deemed paid by N $61.19
Corporation under section 901..................
===========
Example 9. Domestic corporation N owns all the one class of stock of
controlled foreign corporation A, which owns all the one class of stock
of controlled foreign corporation B, which owns all the one class of
stock of controlled foreign corporation C. A and B Corporations are
organized under the laws of foreign country X. C Corporation is
organized under the laws of foreign country Y. All of B Corporation's
assets used in a trade or business are located in country X. All such
corporations use the calendar year as the taxable year. For 1978, N
Corporation is required to include in its gross income under section
951, $50 attributable to the earnings and profits of C Corporation and
$100 attributable to the earnings and profits of B Corporation. N
Corporation is not required to include any amount in its gross income
under section 951 with respect to A Corporation. Country X imposes an
income tax of 10 percent on dividends from foreign subsidiaries, 20
percent on dividends from domestic subsidiaries, and 40 percent on other
earnings and profits. For 1978, C Corporation distributes $75 to B
Corporation. For such year, B Corporation distributes $175 of its
earnings and profits to A Corporation. A Corporation has no other
earnings and profits for 1978 and distributes $130 of its earnings and
profits to N Corporation. The foreign income taxes deemed paid by N
Corporation under sections 960(a)(1) and 902(a) are determined as
follows on the basis of the facts assumed:
C Corporation (third-tier corporation):
Pretax earnings and profits................................... $150.00
Foreign income taxes paid by C Corporation (30%).............. 45.00
Earnings and profits.......................................... 105.00
Amount required to be included in gross income of N 50.00
Corporation under section 951 with respect to C Corporation..
Dividend to B Corporation..................................... 75.00
Dividend to which section 902(b)(2) does not apply $50.00
(attributable to amounts included in N
Corporation's gross income under section 951 with
respect to C Corporation)........................
Dividend to which section 902(b)(2) applies 25.00
(attributable to amounts not included in N
Corporation's gross income under section 951 with
respect to C Corporation)........................
Amount of foreign income taxes of C Corporation deemed paid by 10.71
B Corporation under section 902(b)(2) and Sec. 1.960-2(b)
($25/$105x$45)...............................................
(For formula see Sec. 1.960-2(g)(1)(i)(A))
B Corporation (second-tier corporation):
Pretax earnings and profits:
Dividend from C Corporation....................... $75.00
Other earnings and profits........................ 225.00
-----------
Total pretax earnings and profits......................... $300.00
Foreign income taxes paid by B Corporation.................... 97.50
On dividends received from C Corporation to which $5.00
section 902(b)(2) does not apply (attributable to
amounts included in N Corporation's gross income
under section 951 with respect to C Corporation)
($50x.10)........................................
On dividend from C Corporation to which section 2.50
902(b)(2) applies (attributable to amounts not
included in N Corporation's gross income under
section 951 with respect to C Corporation)
($25x.10)........................................
On other income of B Corporation ($225x.40)....... 90.00
Earnings and profits.......................................... 202.50
Attributable to dividend to which section 45.00
902(b)(2) does not apply (attributable to amounts
included in N Corporation's gross income under
section 951 with respect to C Corporation) ($50-
$5)..............................................
Attributable to dividend from C Corporation to $22.50
which section 902(b)(2) applies (attributable to
amounts not included in N Corporation's gross
income under section 951 with respect to C
Corporation) ($25-$2.50).........................
Attributable to other income of B Corporation 135.00
($225-$90).......................................
[[Page 401]]
Earnings and profits after exclusion of amounts attributable $157.50
to dividend to which section 902(b)(2) does not apply
(attributable to amounts included in N Corporation's gross
income under section 951 with respect to C Corporation)
($202.50-$45)................................................
Amount required to be included in N Corporation's gross income 100.00
under section 951 with respect to B Corporation..............
Dividend paid by B Corporation................................ 175.00
Dividend to which section 902(b)(2) does not apply $45.00
(attributable to amounts included in N
Corporation's gross income under section 951 with
respect to C Corporation)........................
Dividend to which section 902(b)(1) does not apply 100.00
(attributable to amounts included in N
Corporation's gross income under section 951 with
respect to B Corporation)........................
Dividend from other earnings and profits 30.00
(attributable to amounts not included in N
Corporation's gross income with respect to B or C
Corporation).....................................
Foreign income taxes of B Corporation deemed paid by A
Corporation under section 902(b)(1) (separate tax rate
applicable to dividend received by B Corporation allocation
in accordance with Sec. 1.960-2(e)) (for formula see Sec.
1.960-2(g)(1)(ii)(A)(2) (i) and (ii)):
Tax paid by B Corporation on earnings previously taxed with respect
to C Corporation or lower-tiers which is deemed paid by A Corporation:
[GRAPHIC] [TIFF OMITTED] TC09OC91.025
($45/$45x$5)................................................ $5.00
Tax paid by B Corporation on earnings not previously taxed with
respect to C Corporation or lower-tiers which is deemed paid by A
Corporation:
[GRAPHIC] [TIFF OMITTED] TC09OC91.026
($30/157.50x$92.50)......................................... $17.62
Foreign income taxes (of C Corporation) deemed paid by B 2.04
Corporation deemed paid by A Corporation under section
902(b)(1) ($30/$157.50x$10.71)...............................
(For formula see Sec. 1.960-2(g)(1)(ii)(B)(1))
A Corporation (first-tier corporation):
Pretax earnings and profits:
Dividend from B Corporation....................... $175.00
Other income...................................... 0
-----------
Total pretax earnings and profits......................... $175.00
Foreign income taxes paid by A Corporation (20%).............. 35.00
Earnings and profits.......................................... 140.00
Attributable to dividend to which section $36.00
902(b)(2) does not apply (attributable to amounts
included in N Corporation's gross income under
section 951 with respect to C Corporation) ($45-
($45x.20)).......................................
Attributable to amounts to which section 902(b)(1) 80.00
does not apply (Attributable to amounts included
in N Corporation's gross income under section 951
with respect to B Corporation) ($100-($100x.20)).
[[Page 402]]
Attributable to other earnings and profits 24.00
(attributable to amounts not included in N
Corporation's gross income with respect to B or C
Corporation).....................................
Earnings and profits after exclusion for amounts to which $60.00
section 902(b)(1) does not apply (attributable to amounts
included in N Corporation's gross income under section 951
with respect to B Corporation) ($140-$80)....................
Earnings and profits after exclusion for amounts to which 24.00
sections 902(b)(1) and 902(b)(2) do not apply (attributable
to amounts included in N Corporation's gross income under
section 951 with respect to B or C Corporation) ($60-$36)....
Amount required to be included in N Corporation's gross income None
under section 1951 with respect to A Corporation.............
Dividend to N Corporation..................................... $130.00
Dividend to which section 902(b)(2) does not apply $36.00
(attributable to amounts included in N
Corporation's gross income under section 951 with
respect to C Corporation)........................
Dividend to which section 902(b)(1) does not apply 80.00
(attributable to amounts included in N
Corporation's gross income under section 951 with
respect to B Corporation)........................
Dividend to which section 902(a) does not apply 0
(attributable to amounts included in N
Corporation's gross income under section 951 with
respect to A Corporation)........................
Dividend from other earnings and profits 14.00
(attributable to amounts not included in N
Corporation's gross income with respect to A, B,
or C Corporation)................................
N Corporation (domestic corporation):
Foreign income taxes deemed paid by N Corporation under $21.43
section 960(a)(1) and Sec. 1.960-1(c) with respect to C
Corporation ($50/$105x$45)...................................
(for formula see Sec. 1.960-2(g)(2)(i)(A))
Foreign income taxes deemed paid by N Corporation under 65.53
section 960(a)(1) with respect to B Corporation (allocation
of earnings and profits being made in accordance with Sec.
1.960-1(c)(3) and Sec. 1.960-2(e)) (Separate tax rate
applicable to dividend received by B Corporation)............
Taxes paid by B corporation (for formula see Sec. 1.960-2(g)(2)(ii)
(A)(2)):
[GRAPHIC] [TIFF OMITTED] TC09OC91.027
($100/$157.50x$92.50)............................. $58.73
Taxes (of C Corporation) deemed paid by B 6.80
Corporation under section 902(b)(2) which are
deemed paid by N Corporation under section
960(a)(1) ($100/$157.50x$10.71)..................
(for formula see Sec. 1.960-2(g)(2)(ii)(B)(1))
-----------
Total taxes deemed paid by N Corporation under section $86.96
960(a)(1)................................................
Foreign income taxes deemed paid by N Corporation under
section 902(a):
Taxes paid by A Corporation ($130/$140x$35)....... $32.50
(for formula see Sec. 1.960-2(g)(1)(iii)(A)(1))
Taxes paid by B Corporation deemed paid by A Corporation
(Separate tax rate applicable to dividend received by B
Corporation allocation required by Sec. 1.960-2(e)) (for
formula see Sec. 1.960-2(g)(1)(iii)(B)(2) (i) and (ii)):
Tax paid by B Corporation on earnings previously
taxed with respect to C Corporation or lower
tiers which is deemed paid by N Corporation:
[[Page 403]]
[GRAPHIC] [TIFF OMITTED] TC09OC91.028
($36/$36x$5)...................................... $5.00
Tax paid by B Corporation on earnings not
previously taxed with respect to C Corporation or
lower tiers which is deemed paid by N
Corporation:
[GRAPHIC] [TIFF OMITTED] TC09OC91.029
($14/$24x$17.62).................................. $10.28
Taxes (of C Corporation) deemed paid by B 1.19
Corporation deemed paid by A Corporation ($14/
$24x$2.04).......................................
-----------
(for formula see Sec. 1.960-2(g)(1)(iii)(C)(1))
Total taxes deemed paid by N Corporation under section $48.97
902(a)...................................................
-----------
Total foreign income taxes deemed paid by N Corporation 135.93
under section 901........................................
===========
Example 10. The facts are the same as in example 9 except that A
Corporation has other earnings and profits of $200 in 1978 and country X
imposes a tax of 50 percent on A Corporation's other earnings and
profits. A Corporation distributes $200 of its earnings and profits to N
Corporation in 1978. The foreign income taxes paid by N Corporation
under sections 960 (a)(1) and 902 (a) are determined as follows on the
basis of the facts assumed:
C Corporation (third-tier corporation):
Pretax earnings and profits................................... $150.00
Foreign income taxes paid by C Corporation (30%).............. 45.00
Earnings and profits.......................................... 105.00
Amount required to be included in gross income of N $50.00
Corporation under section 951 with respect to C Corporation..
Dividend to B Corporation..................................... 75.00
Dividend to which section 902(b)(2) does not apply 50.00
(attributable to amounts included in N
Corporation's gross income under section 951 with
respect to C Corporation)........................
Dividend to which section 902(b)(2) applies 25.00
(attributable to amounts not included in N
Corporation's gross income under section 951 with
respect to C Corporation)........................
Amount of foreign income taxes of C Corporation deemed paid by 10.71
B Corporation under section 902(b)(2) and Sec. 1.960-2(b)
($25/$105x$45)...............................................
(for formula see Sec. 1.960-2(g)(1)(i)(A))
B Corporation (second-tier corporation):
Pretax earnings and profits:
Dividend from C Corporation....................... $75.00
Other earnings and profits........................ 225.00
-----------
Total pretax earnings and profits......................... $300.00
Foreign income taxes of B Corporation......................... $97.50
On dividends received from C Corporation to which $5.00
section 902(b)(2) does not apply (attributable to
amounts included in N Corporation's gross income
under section 951 with respect to C Corporation)
($50x.10)........................................
On dividend from C Corporation to which section 2.50
902(b)(2) applies (attributable to amounts not
included in N Corporation's gross income under
section 951 with respect to C Corporation)
($25x.10)........................................
[[Page 404]]
On other income of B Corporation ($225x.40)....... 90.00
Earnings and profits.......................................... $202.50
Attributable to dividend to which section $45.00
902(b)(2) does not apply (attributable to amounts
included in N Corporation's gross income under
section 951 with respect to C Corporation) ($50-
$5)..............................................
Attributable to dividend from C Corporation to 22.50
which section 902(b)(2) applies (attributable to
amounts not included in N Corporation's gross
income under section 951 with respect to C
Corporation) ($25-$2.50).........................
Attributable to other income of B Corporation 135.00
($225-$90).......................................
Earnings and profits after exclusion of amounts attributable 157.50
to dividend to which section 902(b)(2) does not apply
(attributable to amounts included in N Corporation's gross
income under section 951 with respect to C Corporation)
($202.50-$45)................................................
Amount required to be included in N Corporation's gross income 100.00
under section 951 with respect to B Corporation..............
Dividend paid by B Corporation................................ 175.00
Dividend to which section 902(b)(2) does not apply $45.00
(attributable to amounts included in N
Corporation's gross income under section 951 with
respect to C Corporation)........................
Dividend to which section 902(b)(1) does not apply 100.00
(attributable to amounts included in N
Corporation's gross income under section 951 with
respect to B Corporation)........................
Dividend from other earnings and profits 30.00
(attributable to amounts not included in N
Corporation's gross income with respect to B or C
Corporation).....................................
Foreign income taxes of B Corporation deemed paid by A
Corporation under section 902(b)(1) with allocation required
by Sec. 1.960-2 (e):
($45/$45x$5)................................................ 5.00
($30/$157.50x$92.50)........................................ 17.62
(for formula see Sec. 1.960-2(g)(1)(ii)(A)(2) (i) and
(ii))
Foreign income taxes (of C Corporation) deemed paid by B 2.04
Corporation deemed paid by A Corporation under section
902(b)(1): ($30/$157.50 x $10.71)
(for formula see Sec. 1.960-2(g)(1)(ii)(B)(1))
A Corporation (first-tier corporation):
Pretax earnings and profits:
Dividend from B Corporation....................... $175.00
Other earnings and profits........................ 200.00
-----------
Total pretax earnings and profits......................... $375.00
Foreign income taxes paid by A Corporation.................... 135.00
On dividend received from B Corporation to which 9.00
section 902(b)(2) does not apply (attributable to
amounts included in N Corporation's gross income
under section 951 with respect to C Corporation)
($45x.20)........................................
On dividend received from B Corporation to which 20.00
section 902(b)(1) does not apply (attributable to
amounts included in N Corporation's gross income
under section 951 with respect to B Corporation)
($100x.20).......................................
On dividend from B Corporation attributable to B 6.00
Corporation's other earnings and profits
(attributable to amounts not included in N
Corporation's gross income with respect to B or C
Corporation) ($30x.20)...........................
On other income of A Corporation ($200x.50)....... 100.00
Earnings and profits.......................................... 240.00
Attributable to dividend to which section 36.00
902(b)(2) does not apply (attributable to amounts
included in N Corporation's gross income under
section 951 with respect to C Corporation) ($45-
$9)..............................................
Attributable to dividend to which section 80.00
902(b)(1) does not apply (attributable to amounts
included in N Corporation's gross income with
respect to B Corporation) ($100-$20).............
Attributable to other earnings and profits of A 124.00
Corporation (attributable to amounts not included
in N Corporation's gross income with respect to
A, B, or C Corporation) [($30-$6)+($200-$100)]...
Amount required to be included in N Corporation's gross income None
under section 951 with respect to A Corporation..............
Earnings and profits after exclusion of amounts attributable 160.00
to dividend to which section 902(b)(1) does not apply
(attributable to amounts included in N Corporation's gross
income under section 951 with respect to B Corporation)......
Earnings and profits after exclusion of amounts attributable 124.00
to dividend to which sections 902(b)(1) and 902(b)(2) do not
apply (attributable to amounts included in N Corporation's
gross income under section 951 with respect to B and C
Corporation).................................................
Dividend to N Corporation..................................... 200.00
Dividend attributable to amounts to which section $36.00
902(b)(2) does not apply (attributable to amounts
included in N Corporation's gross income under
section 951 with respect to C Corporation).......
Dividend attributable to amounts to which section 80.00
902(b)(1) does not apply (attributable to amounts
included in N Corporation's gross income with
respect to B Corporation)........................
Dividend attributable to amounts to which section 0
902(a) does not apply (attributable to amounts
included in N Corporation's gross income under
section 951 with respect to A Corporation).......
Dividend attributable to A Corporation's other $84.00
earnings and profits (attributable to amounts not
included in N Corporation's gross income under
section 951 with respect to A, B, or C
Corporation).....................................
[[Page 405]]
N Corporation (domestic corporation).
Foreign income taxes deemed paid by N Corporation under $21.43
section 960(a)(1) and Sec. 1.960-1(c) with respect to C
Corporation ($50/$150x$45)...................................
(for formula see Sec. 1.960-2(g)(2)(i)(A))
Foreign income taxes deemed paid by N Corporation under 65.53
section 960(a)(1) with respect to B Corporation (allocation
of earning and profits being made in accordance with Sec.
1.960-1(c)(3) and Sec. 1.960-2(e)).........................
Taxes paid by B Corporation ($100/$157.50x$92.50). $58.73
(for formula see Sec. 1.960-2(g)(2)(ii)(A)(2))
Taxes deemed paid by B Corporation 6.80
($100x$157.50x$10.71)............................
(for formula see Sec. 1.960-2(g)(2)(ii)(B)(1))
----------
Total taxes deemed paid by N Corporation under section 86.96
960(a)(1)................................................
Foreign income taxes deemed paid by N Corporation under
section 902(a) (separate tax rate applicable to dividends
received by A Corporation allocation required by Sec. 1.960-
2(e)) (for formula see Sec. 1.960-2(g)(1)(iii)(A)(2) (i)
and (ii)):
Tax paid by A Corporation on earnings previously taxed with respect
to B Corporation or lower tiers which is deemed paid by N Corporation:
[GRAPHIC] [TIFF OMITTED] TC09OC91.030
($116/$116x$29)................................... $29.00
Tax paid by A Corporation on earnings not
previously taxed with respect to B Corporation or
lower tiers which is deemed paid by N
Corporation:
[GRAPHIC] [TIFF OMITTED] TC09OC91.031
($84/$124x$106)................................... $71.81
Taxes (paid by B Corporation) deemed paid by A
Corporation allocation required by Sec. 1.960-
2(e):
($36/$36x$5)...................................... 5.00
($84/$124x$17.62)................................. 11.94
(for formula see Sec. 1.960-2(g)(1)(iii)(B)(2)
(i) and (ii))
Taxes (of C Corporation) deemed paid by B 1.38
Corporation deemed paid by A Corporation ($84/
$124x$2.04)......................................
-----------
(for formula see Sec. 1.960-2(g)(1)(iii)(C)(1))
Total taxes deemed paid by N Corporation under section $119.13
902(a) credit............................................
-----------
Total foreign income taxes deemed paid by N Corporation 206.09
under section 901........................................
===========
(g) Formulas. This paragraph contains formulas for determining a
domestic corporation's section 902 and 960 credits when amounts
distributed through a chain of ownership have been included in whole or
in part in the gross income of a domestic corporation
[[Page 406]]
under section 951 with respect to first-, second-, third-, or lower-tier
corporations.
(1) Determination of the section 902 credit--(i) Section 902(b)(2)
credit. If the second-tier corporation receives a dividend from a third-
tier corporation attributable in whole or in part to amounts included in
a domestic corporation's gross income under section 951 with respect to
the third- or lower-tier corporations, the second-tier corporation's
credit for taxes paid by the third-tier corporation under section
902(b)(2) is determined as follows:
(A) If the effective rate of tax on dividends received by the third-
tier corporation is the same as the effective rate of tax on its other
earnings and profits--
[GRAPHIC] [TIFF OMITTED] TC09OC91.032
(B) If the effective rate of tax on dividends received by the third-
tier corporation is higher or lower than the effective rate of tax on
its other earnings and profits--
(1) Credit for tax paid by third-tier corporation on earnings
included in domestic corporation's gross income with respect to fourth-
or lower-tier corporations--
[GRAPHIC] [TIFF OMITTED] TC09OC91.033
(2) Credit for tax paid by third-tier corporation on earnings not
included in domestic corporation's gross income with respect to fourth-
or lower-tier corporations--
[GRAPHIC] [TIFF OMITTED] TC09OC91.034
[[Page 407]]
(ii) Section 902(b)(1) credit. If the first-tier corporation
receives a dividend from a second-tier corporation attributable in a
whole or in part to amounts included in a domestic corporation's gross
income under section 951 with respect to the second- or lower-tier
corporations, the first-tier corporation's credit for taxes paid and
deemed paid by the second-tier corporation under section 902(b)(1) is
determined as follows:
(A) Taxes paid by the second-tier corporation which are deemed paid
by the first-tier corporation--(1) If the effective rate of tax on
dividends received by the second-tier corporation is the same as the
effective rate of tax on its other earnings and profits--
[GRAPHIC] [TIFF OMITTED] TC09OC91.035
(2) If the effective rate of tax on dividends received by the
second-tier corporation is higher or lower than the effective rate of
tax on its other earnings and profits--
(i) Credit for tax paid by second-tier corporation on earnings
previously taxed with respect to third- or lower-tier corporations--
[GRAPHIC] [TIFF OMITTED] TC09OC91.036
(ii) Credit for tax paid by second-tier corporation on earnings not
previously taxed with respect to third- or lower-tier corporations--
[GRAPHIC] [TIFF OMITTED] TC09OC91.037
[[Page 408]]
(B) Taxes deemed paid by the second-tier corporation which are
deemed paid by the first-tier corporation-- (1) If the effective rate of
tax dividends received by the third-tier corporation is the same as the
effective rate of tax on its other earnings and profits--
[GRAPHIC] [TIFF OMITTED] TC09OC91.038
(2) If the effective rate of tax on dividends received by the third-
tier corporation is higher or lower than the effective rate of tax on
its other earnings and profits--
(i) Credit for tax paid by third-tier corporation on earnings
previously taxed with respect to fourth- or lower-tier corporations--
[GRAPHIC] [TIFF OMITTED] TC09OC91.039
(ii) Credit for tax paid by third-tier corporation on earnings not
previously taxed with respect to fourth- or lower-tier corporations--
[GRAPHIC] [TIFF OMITTED] TC09OC91.040
[[Page 409]]
(iii) Section 902(a) credit. If the domestic corporation receives a
dividend from a first-tier corporation attributable in whole or in part
to amounts included in a domestic corporation's gross income under
section 951 with respect to the first- or lower-tier corporations, the
domestic corporation's credit for taxes paid and deemed paid by the
first-tier corporation under section 902(a) is determined as follows:
(A) Taxes paid by the first-tier corporation which are deemed paid
by domestic corporation--(1) If the effective rate of tax on dividends
received by the first-tier corporation is the same as the effective rate
of tax on its other earnings and profits--
[GRAPHIC] [TIFF OMITTED] TC09OC91.041
(2) If the effective rate of tax on dividends received by the first-
tier corporation is higher or lower than the effective rate of tax on
its other earnings and profits--
(i) Credit for tax paid by first-tier corporation on earnings
previously taxed with respect to second- or lower-tier corporations--
[GRAPHIC] [TIFF OMITTED] TC09OC91.042
(ii) Credit for tax paid by first-tier corporation on earnings not
previously taxed with respect to second- or lower-tier corporations--
[[Page 410]]
[GRAPHIC] [TIFF OMITTED] TC09OC91.043
(B) Taxes (paid by second-tier corporation) deemed paid by first-
tier corporation which are deemed paid by domestic corporation--(1) If
the effective rate of tax on dividends received by the second-tier
corporation is the same as its tax rate on other earnings and profits--
[GRAPHIC] [TIFF OMITTED] TC09OC91.044
(2) If the effective rate of tax on dividends received by the
second-tier corporation is higher or lower than the effective rate of
tax on its other earnings and profits--
(i) Credit for tax paid by second-tier corporation on earnings
previously taxed with respect to third-tier or lower-tier corporations--
[GRAPHIC] [TIFF OMITTED] TC09OC91.045
(ii) Credit for tax paid by second-tier corporation on earnings not
previously taxed with respect to third- or lower-tier corporations--
[[Page 411]]
[GRAPHIC] [TIFF OMITTED] TC09OC91.046
(C) Taxes (of third-tier corporation) deemed paid by first-tier
corporation which are deemed paid by domestic corporation--(1) If the
effective rate of tax on dividends received by the third-tier
corporation is the same as the effective rate of tax on its other
earnings and profits--
[GRAPHIC] [TIFF OMITTED] TC09OC91.047
(2) If the effective rate of tax on dividends received by the third-
tier corporation is higher or lower than the effective rate of tax on
its other earnings and profits--
(i) Credit for tax (of third-tier corporation) deemed paid by
second-tier corporation on earnings previously taxed with respect to
fourth- or lower-tier corporations--
[GRAPHIC] [TIFF OMITTED] TC09OC91.048
[[Page 412]]
(ii) Credit for tax (of third-tier corporation) deemed paid by
second-tier on earnings not previously taxed with respect to fourth- or
lower-tier corporations--
[GRAPHIC] [TIFF OMITTED] TC09OC91.049
(2) Determination of domestic corporation's section 960 credit for
amounts included in its gross income with respect to a first-, second-,
or third-tier corporation which has received a distribution previously
included in the gross income of a domestic corporation under section
951--(i) Third-tier credit. If a domestic corporation is required to
include an amount in its gross income under section 951 with respect to
a third-tier corporation which has received a distribution from a
fourth-tier corporation of amounts included in a domestic corporation's
gross income under section 951 with respect to the fourth- or lower-tier
corporations, the domestic corporation's credit for taxes paid by the
third-tier corporation under section 960(a)(1) is determined as follows:
(A) If the effective rate of tax on dividends received by the third-
tier corporation is the same as the effective rate of tax on its other
earnings and profits--
[GRAPHIC] [TIFF OMITTED] TC09OC91.050
(B) If the effective rate of tax on dividends received by the third-
tier corporation is higher or lower than the effective rate of tax on
its other earnings and profits--
[GRAPHIC] [TIFF OMITTED] TC09OC91.051
[[Page 413]]
(ii) Second-tier credit. If a domestic corporation is required to
include an amount in its gross income under section 951 with respect to
a second-tier corporation which has received a distribution from a
third-tier corporation of amounts included in a domestic corporation's
gross income under section 951 with respect to the third- or lower-tier
corporations, the domestic corporation's credit for taxes paid and
deemed paid by the second-tier corporation under section 960(a)(1) is
determined as follows:
(A) Credit for taxes paid by the second-tier corporation which are
deemed paid by the domestic corporation.
(1) If the effective rate of tax on dividends received by the
second-tier corporation is the same as the effective rate of tax on its
other earnings and profits--
[GRAPHIC] [TIFF OMITTED] TC09OC91.052
(2) If the effective rate of tax on dividends received by the
second-tier is higher or lower than the effective rate of tax on its
other earnings and profits--
[GRAPHIC] [TIFF OMITTED] TC09OC91.053
(B) Credit for taxes (of the third-tier corporation) deemed paid by
the second-tier corporation under section 902(b)(2)--(1) If the
effective rate of tax on dividends received by the third-tier
corporation is the same as the effective rate of tax on its other
earnings and profits--
[GRAPHIC] [TIFF OMITTED] TC09OC91.054
[[Page 414]]
(2) If the effective rate of tax on dividends received by the third-
tier corporation is higher or lower than the effective rate of tax on
its other earnings and profits--
[GRAPHIC] [TIFF OMITTED] TC09OC91.055
(iii) First-tier credit. If a domestic corporation is required to
include amounts in its gross income under section 951 with respect to a
first-tier corporation which has received a distribution from a second-
tier corporation of amounts included in a domestic corporation's gross
income under section 951 with respect to the second- or lower-tier
corporations, the domestic corporation's credit for taxes paid and
deemed paid by the first-tier corporation under section 960(a)(1) shall
be determined as follows:
(A) Credit for taxes paid by the first-tier corporation.
(1) If the effective rate of tax on dividends received by the first-
tier corporation is the same as the effective rate of tax on its other
earnings and profits--
[GRAPHIC] [TIFF OMITTED] TC09OC91.056
(2) If the effective rate of tax on dividends received by the first-
tier corporation is higher or lower than the effective rate of tax on
its other earnings and profits--
[GRAPHIC] [TIFF OMITTED] TC09OC91.057
(B) Credit for taxes paid by the second-tier corporation deemed paid
by the first-tier corporation under section 902(b)(1).
(1) If the effective rate of tax on dividends received by the
second-tier corporation is the same as the effective
[[Page 415]]
rate of tax on its other earnings and profits--
[GRAPHIC] [TIFF OMITTED] TC09OC91.058
(2) If the effective rate of tax on dividends received by the
second-tier corporation is higher or lower than the effective rate of
tax on its other earnings and profits--
[GRAPHIC] [TIFF OMITTED] TC09OC91.059
(C) Credit for taxes (of the third-tier corporation) deemed paid by
the second-tier corporation which are deemed paid by first-tier
corporation under section 902(b)(1).
(1) If the effective rate of tax on dividends received by the third-
tier corporation is the same as the effective rate of tax on its other
earnings and profits--
[GRAPHIC] [TIFF OMITTED] TC09OC91.060
(2) If the effective rate of tax on dividends received by the third-
tier corporation is higher or lower than the effective rate of tax on
its other earnings and profits--
[[Page 416]]
[GRAPHIC] [TIFF OMITTED] TC09OC91.061
[T.D. 7120, 36 FR 10854, June 4, 1971; 36 FR 11924, June 23, 1971, as
amended by T.D. 7334, 39 FR 44212, Dec. 23, 1974; 40 FR 1014, Jan. 6,
1975; 40 FR 2802, Jan. 16, 1975; T.D. 7649, 44 FR 60089, Oct. 18, 1979;
T.D. 7843, 47 FR 50476, Nov. 8, 1982; 47 FR 55477, Dec. 10, 1982]
Sec. 1.960-3 Gross-up of amounts included in income under section 951.
(a) General rule for including taxes in income. Any taxes deemed
paid by a domestic corporation for the taxable year pursuant to section
960(a)(1) shall, except as provided in paragraph (b) of this section, be
included in the gross income of such corporation for such year as a
dividend pursuant to section 78 and Sec. 1.78-1.
(b) Certain taxes not included in income. Any taxes deemed paid by a
domestic corporation for the taxable year pursuant to section 902(a) or
section 960(a)(1) shall not be included in the gross income of such
corporation for such year as a dividend pursuant to section 78 and Sec.
1.78-1 to the extent that such taxes are paid or accrued by the first-,
second-, or third-tier corporation, as the case may be, on or with
respect to an amount which is excluded from the gross income of such
foreign corporation under section 959(b) and Sec. 1.959-2 as
distributions from the earnings and profits of another controlled
foreign corporation attributable to an amount which is, or has been,
required to be included in the gross income of the domestic corporation
under section 951.
(c) Illustrations. The application of this section may be
illustrated by the following examples:
Example 1. Domestic corporation N owns all the one class of stock of
controlled foreign corporation A, which owns all the one class of stock
of controlled foreign corporation B. All such corporations use the
calendar year as the taxable year. For 1978, B Corporation, after having
paid $20 of foreign income taxes, has $80 in earnings and profits, which
are attributable to the amount required to be included in N
Corporation's gross income for such year under section 951 with respect
to B Corporation and all of which are distributed to A Corporation in
such year. The dividend so received from B Corporation is excluded from
A Corporation's gross income under section 959(b) and Sec. 1.959-2. An
income tax of 10 percent is required to be withheld from such dividend
by the foreign country under the laws of which B Corporation is created,
and the foreign country under the laws of which A Corporation is created
imposes an income tax of $22 on the dividend received from B
Corporation. For 1978, A Corporation's earnings and profits are $50
($80-[0.10x$80]-$22), which it distributes in such year to N
Corporation. For 1978, N Corporation is required under section 951 to
include $80 in gross income with respect to B Corporation and also is
required under the gross-up provisions of section 78 to include in gross
income $20 ($80/$80x$20), the amount equal to the foreign income taxes
of B Corporation which are deemed paid by N Corporation under section
960(a)(1). Under paragraph (b) of this section N Corporation is not
required to include in gross income the $30 ($8+$22) of foreign income
taxes which are paid by A Corporation in connection with the dividend
received from B Corporation and which are deemed paid by N Corporation
under section 902(a) and paragraph (c) of Sec. 1.960-2.
Example 2. Domestic corporation N owns all the one class of stock of
controlled foreign corporation A, which owns all the one class of stock
of controlled foreign corporation B, which in turn owns all the one
class of stock of controlled foreign corporation C. All such
corporations use the calendar year as the taxable year. For 1978, C
Corporation, after having paid $20 of foreign income taxes, has $80 in
earnings and profits, which are attributable to the amount required to
be included in N Corporation's gross income for such year under section
951 with respect to C Corporation and all of which are distributed to B
Corporation in such year. After having
[[Page 417]]
paid foreign income taxes of $10 on the dividend received from C
Corporation, B Corporation distributes the balance of $70 to A
Corporation. After having paid foreign income taxes of $5 on the
dividend received from B Corporation, A Corporation distributes the
balance of $65 to N Corporation. The dividend so received by B
Corporation, and in turn by A Corporation, is excluded from the gross
income of such corporations under section 959(b) and Sec. 1.959-2.
Under paragraph (b) of this section N Corporation is not required to
include in gross income the $15 ($10+$5) of foreign income taxes which
are paid by corporations B and A, respectively, in connection with the
dividend so received and which are deemed paid by N Corporation under
section 902(a) and paragraphs (b) and (c) of Sec. 1.960-2.
[T.D. 7120, 36 FR 10856, June 4, 1971, as amended by T.D. 7481, 42 FR
20130, Apr. 18, 1977; T.D. 7649, 44 FR 60089, Oct. 18, 1979; T.D. 7843,
47 FR 50484, Nov. 8, 1982]
Sec. 1.960-4 Additional foreign tax credit in year of receipt of
previously taxed earnings and profits.
(a) Increase in section 904(a) limitation for the taxable year of
exclusion--(1) In general. The applicable limitation under section
904(a) for a taxpayer's taxable year (hereinafter in this section
referred to as the ``taxable year of exclusion'') in which he receives
an amount which is excluded from gross income under section 959(a)(1)
and which is attributable to a controlled foreign corporation's earnings
and profits in respect of which an amount was required to be included in
the gross income of such taxpayer under section 951(a) for a taxable
year (hereinafter in this section referred to as the ``taxable year of
inclusion'') previous to the taxable year of exclusion shall be
increased under section 960(b)(1) by the amount described in paragraph
(b) of this section if the conditions described in subparagraph (2) of
this paragraph are satisfied.
(2) Conditions under which increase in limitation is allowed for the
taxable year of exclusion. The increase in limitation described in
subparagraph (1) of this paragraph for the taxable year of exclusion
shall be made only if the taxpayer--
(i) For the taxable year of inclusion either chose to claim a
foreign tax credit as provided in section 901 or did not pay or accrue
any foreign income taxes,
(ii) Chooses to claim a foreign tax credit as provided in section
901 for the taxable year of exclusion, and
(iii) For the taxable year of exclusion pays, accrues, or is deemed
to have paid foreign income taxes with respect to the amount, described
in subparagraph (1) of this paragraph, which is excluded from his gross
income for such year under section 959(a)(1).
(b) Amount of increase in limitation for the taxable year of
exclusion. The amount of increase under section 960 (b)(1) in the
applicable limitation under section 904(a) for the taxable year of
exclusion shall be--
(1) The amount by which the applicable section 904(a) limitation for
the taxable year of inclusion was increased, determined as provided in
paragraph (c) of this section, by reason of the inclusion of the amount
in the taxpayer's income for such year under section 951(a), reduced by
(2) The amount of foreign income taxes allowed as a credit under
section 901 for such taxable year of inclusion and which were allowable
to such taxpayer solely by reason of the inclusion of such amount in his
gross income under section 951(a), as determined under paragraph (d) of
this section, and then by
(3) The additional reduction for such taxable year of inclusion
arising by reason of increases in limitation under section 960(b)(1) for
taxable years intervening between such taxable year of inclusion and
such taxable year of exclusion, as determined under paragraph (e) of
this section in respect of such inclusion under section 951(a),
except that the amount of increase determined under this paragraph for
the taxable year of exclusion shall in no case exceed the amount of
foreign income taxes paid, accrued, or deemed to be paid by such
taxpayer for such taxable year of exclusion with respect to the amount,
described in paragraph (a)(1) of this section, which is excluded from
gross income for such year under section 959(a)(1).
(c) Determination of increase in limitation for the taxable year of
inclusion. The amount of the increase in the applicable limitation under
section 904(a) for
[[Page 418]]
the taxable year of inclusion which arises by reason of the inclusion of
the amount in gross income under section 951(a) shall be the amount of
the applicable limitation under section 904(a) for such year reduced by
the amount which would have been the applicable limitation under section
904(a) for such year if the amount had not been included in gross income
for such year under section 951(a).
(d) Determination of foreign income taxes allowed for taxable year
of inclusion by reason of section 951(a) amount. The amount of foreign
income taxes allowed as a credit under section 901 for the taxable year
of inclusion which were allowable solely by reason of the inclusion of
the amount in gross income for such year under section 951(a) shall be
the amount of foreign income taxes allowed as a credit under section 901
for such year reduced by the amount of foreign income taxes which would
have been allowed as a credit under section 901 for such year if the
amount had not been included in gross income for such year under section
951(a). For purposes of this paragraph, the term ``foreign income
taxes'' includes foreign income taxes paid or accrued, and foreign
income taxes deemed paid under section 902, section 904(d), and section
960(a), for the taxable year of inclusion.
(e) Additional reduction for the taxable year of inclusion arising
by reason of increases in limitation for intervening years. The amount
of increase in the applicable limitation under section 904(a) for the
taxable year of inclusion shall also be reduced, after first deducting
the foreign income taxes described in paragraph (b)(2) of this section,
by any increases in limitation which arise under section 960(b)(1)--by
reason of any earlier exclusions under section 959(a)(1) in respect of
the same inclusion under section 951(a) for such taxable year of
inclusion--for the first, second, third, fourth, etc., succeeding
taxable years of exclusion, in that order, which follow such taxable
year of inclusion and precede the taxable year of exclusion in respect
of which the increase in limitation under section 960(b)(1) and
paragraph (b) of this section is being determined. The amount of any
increase in limitation which arises under section 960(b)(1) for any such
succeeding taxable year of exclusion shall be the amount of foreign
income taxes allowed as a credit under section 901 for each such taxable
year reduced by the amount of foreign income taxes which would have been
allowed as a credit under section 901 for each such year if the
limitation for each such year were not increased under section
960(b)(1). For any such succeeding taxable year of exclusion for which
the taxpayer does not choose to claim a foreign tax credit as provided
in section 901, the same increase in limitation under section 960(b)(1)
shall be treated as having been made, for purposes of this paragraph,
which would have been made for such taxable year if the taxpayer had
chosen to claim the foreign tax credit for such year.
(f) Illustrations. The application of this section may be
illustrated by the following examples:
Example 1. Domestic corporation N owns all of the one class of stock
of controlled foreign corporation A. Corporation A, after paying foreign
income taxes of $30, has earnings and profits for 1978 of $70, all of
which are attributable to an amount required under section 951(a) to be
included in N Corporation's gross income for 1978. Both corporations use
the calendar year as the taxable year. For 1979 and 1980, A Corporation
has no earnings and profits attributable to an amount required to be
included in N Corporation's gross income under section 951(a); for each
such year it makes a distribution of $35 (from its earnings and profits
for 1978) from which a foreign income tax of $6 is withheld. For each of
1978, 1979, and 1980, N Corporation derives taxable income of $50 from
sources within the United States and claims a foreign tax credit under
section 901, determined by applying the overall limitation under section
904(a)(2).
The United States tax payable by N Corporation is determined as follows,
assuming a corporate tax rate of 48 percent:
1978
Taxable income of N Corporation:
U.S. sources............................................... $50.00
Sources without the U.S.:
Amount required to be included in N $70.00 .........
Corporation's gross income under section
951(a).......................................
[[Page 419]]
Foreign income taxes deemed paid by N 30.00 100.00
Corporation under section 960(a)(1) and
included in N Corporation's gross income
under section 78 ($30x$70/$70)...............
------------
Total taxable income.......................... ......... 150.00
==========
U.S. tax payable for 1978:
U.S. tax before credit ($150x0.48)......................... 72.00
Credit: Foreign income taxes of $30, but not to exceed 30.00
overall limitation of $48 for 1978 ($100/$150x$72)........
------------
U.S. tax payable........................................... 42.00
============
1979
Taxable income of N Corporation, consisting of income from $50.00
U.S. sources................................................
U.S. tax before credit ($50x0.48)............................ 24.00
Section 904(a)(2) overall limitation for 1979:
Limitation for 1979 before increase under section 960(b)(1) 0
($24x$0/$50)..............................................
Plus: Increase in overall limitation for 1979
under section 960(b)(1):
Amount by which 1978 overall limitation was $48.00 .........
increased by reason of inclusion in N
Corporation's gross income under section
951(a) for 1978 ($48-[($50x0.48)x$0/$50])....
Less: Foreign income taxes allowed as a credit 30.00 .........
for 1978 which were allowable solely by
reason of such section 951(a) inclusion ($30-
$0)..........................................
-----------
Balance....................................... 18.00 .........
But: Such balance not to exceed foreign income 6.00 6.00
taxes paid by N Corporation for 1979 with
respect to $35 distribution excluded under
section 959(a)(1) ($6 tax withheld)..........
------------
Overall limitation for 1979................................ 6.00
============
U.S. tax payable for 1979:
U.S. tax before credit ($50x0.48).......................... 24.00
Credit: Foreign income taxes of $6, but not to exceed 6.00
overall limitation of $6 for 1966.........................
------------
U.S. tax payable........................................... 18.00
============
1980
Taxable income of N Corporation, consisting of income from U.S. $50.00
sources.......................................................
U.S. tax before credit ($50x0.48).............................. 24.00
==========
Section 904(a)(2) overall limitation for 1980:
Limitation for 1980 before increase under section 960(b)(1) 0
($24x$0/$50)................................................
Plus: Increase in overall limitation for 1980 under
section 960(b)(1):
Amount by which 1978 overall limitation was $48.00 .......
increased by reason of inclusion in N
Corporation's gross income under section 951(a)
for 1978 ($48-[($50x0.48)x$0/$50])...............
Less: Foreign income taxes allowed as a credit for 30.00 .......
1978 which were allowable solely by reason of
such section 951(a) inclusion ($30-$0)...........
---------
Tentative balance................................. 18.00 .......
Less: Increase in overall limitation under section $6.00 .......
960(b)(1) for 1979 by reason of such section
951(a) inclusion.................................
---------
Balance........................................... 12.00
But: Such balance not to exceed foreign income taxes 6.00 $6.00
paid by N Corporation for 1980 with respect to $35
distribution excluded under section 959(a)(1) ($6
tax withheld)......................................
----------
Overall limitation for 1980.................................. 6.00
==========
U.S. tax payable for 1980:
U.S. tax before credit ($50x0.48)............................ 24.00
Credit: Foreign income taxes of $6, but not to exceed overall 6.00
limitation of $6 for 1967...................................
----------
U.S. tax payable............................................. 18.00
Example 2. The facts for 1978, 1979, and 1980, are the same as in
example 1, except that in 1977, to which the section 904(a)(2) overall
limitation applies, N Corporation pays $18 of foreign income taxes in
excess of the overall limitation and that such excess is not absorbed as
a carryback to 1975 or 1976 under section 904(c). Therefore, there is no
increase under section 960(b)(1) in the overall limitation for 1979 or
1980 since the amount ($48) by which the 1978 overall limitation was
increased by reason of the inclusion in N Corporation's gross income for
1978 under section 951(a), less the foreign income taxes ($48) 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 1978 which
were allowable solely by reason of such section 951(a) inclusion consist
of the $30 of foreign income taxes deemed paid for 1978 under section
960(a)(1) and the $18 of foreign income taxes for 1977 carried over and
deemed paid for 1978 under section 904(c).
Example 3. (a) Domestic corporation N owns all the one class of
stock of controlled foreign corporation A, which in turn owns all the
one class of stock of controlled foreign corporation B. All corporations
use the calendar years as the taxable year. Corporation B, after paying
foreign income taxes of $30, has earnings and profits for 1978 of $70,
all of which is attributable to an amount required under section 951(a)
to be included in N Corporation's gross income for 1978, and $35 of
[[Page 420]]
which it distributes in such year to A Corporation. For 1978, A
Corporation, after paying foreign income taxes of $5 on such dividend
from B Corporation, has total earnings and profits of $30, all of which
it distributes in such year to N Corporation, a foreign income tax of $3
being withheld therefrom.
(b) For 1979, B Corporation has no earnings and profits, but
distributes in such year to A Corporation the $35 remaining of its
earnings and profits for 1965. For 1979, A Corporation, after paying
foreign income taxes of $5 on such dividend from B Corporation, has
total earnings and profits of $30, all of which it distributes to N
Corporation, a foreign income tax of $3 being withheld therefrom.
(c) For each of 1978 and 1979, N Corporation has taxable income of
$100 from United States sources and claims a foreign tax credit under
section 901, determined by applying the overall limitation under section
904(a)(2). The United States tax payable by N Corporation is determined
as follows, assuming a corporate tax rate of 48 percent:
1978
Taxable income of N Corporation:
U.S. sources.................................................. $100
Sources without the U.S.:
Amount required to be included in N Corporation's $70 ......
gross income under section 951(a) with respect to B
Corporation.........................................
Foreign income taxes deemed paid by N Corporation 30 100
under section 960(a)(1) and included in N
Corporation's gross income under section 78 ($30x$70/
$70)................................................
--------
Total taxable income................................... ..... 200
=======
U.S. tax payable for 1978:
U.S. tax before credit ($200x0.48)............................ 96
Credit: Foreign income taxes of $38 ([$30x$70/$70]+$3), but 38
not to exceed overall limitation of $48 ($96x$100/$200)......
--------
U.S. tax payable.............................................. 58
========
1979
Taxable income of N Corporation, consisting of income from U.S. $100
sources.......................................................
U.S. tax before credit ($100x0.48)............................. 48
Section 904(a)(2) overall limitation for 1979:
Limitation for 1979 before increase under section 960(b)(1) 0
($48x$0/$100)...............................................
Plus: Increase in overall limitation for 1979 under
section 960(b)(1):
Amount by which 1978 overall limitation was $48 .......
increased by reason of inclusion in N
Corporation's gross income under section 951(a)
for 1978 ($48-[($100x0.48)x$0/$100])..............
Less: Foreign income taxes allowed as a credit for 38 .......
1978 which were allowable solely by reason of such
section 951(a) inclusion ($38-$0).................
--------
Balance........................................... 10 .......
But: Such balance not to exceed foreign income 8 8
taxes paid and deemed paid by N Corporation for
1979 with respect to $30 distribution excluded
under section 959(a)(1) ([$5x$30/$30]+$3).........
---------
Overall limitation for 1979.......................... ...... 8
========
U.S. tax payable for 1979:
U.S. tax before credit ($100x0.48)........................... 48
Credit: Foreign income taxes of $8 ($3+$5), but not to exceed 8
overall limitation of $8 for 1979...........................
---------
U.S. tax payable............................................. 40
[T.D. 7120, 36 FR 10859, June 4, 1971, as amended by T.D. 7649, 44 FR
60089, Oct. 18, 1979]
Sec. 1.960-5 Credit for taxable year of inclusion binding for taxable
year of exclusion.
(a) Taxes not allowed as a deduction for taxable year of exclusion.
In the case of any taxpayer who--
(1) Chooses to claim a foreign tax credit as provided in section 901
for the taxable year for which he is required to include in gross income
under section 951(a) an amount attributable to the earnings and profits
of a controlled foreign corporation, and
(2) Does not choose to claim a foreign tax credit as provided in
section 901 for a taxable year in which he receives an amount which is
excluded from gross income under section 959(a)(1) and which is
attributable to such earnings and profits of such controlled foreign
corporation,
No deduction shall be allowed under section 164 for the taxable year of
such exclusion for any foreign income taxes paid or accrued on or with
respect to such excluded amount.
(b) Illustration. The application of this section may be illustrated
by the following example:
Example. Domestic Corporation N owns all the one class of stock of
controlled foreign corporation A. Both corporations use the calendar
year as the taxable year. All of A Corporation's earnings and profits of
$80 for 1978 (after payment of foreign income taxes of $20 on its total
income of $100 for such year) are attributable to amount required under
section 951(a) to be included in N Corporation's gross income for 1978.
For 1978, N Corporation chooses to claim a foreign tax credit for the
$20 of foreign income taxes which for such year are paid by A
Corporation and deemed paid by N Corporation
[[Page 421]]
under section 960(a)(1) and paragraph (c)(1) of Sec. 1.960-1. For 1979,
A Corporation distributes the entire $80 of 1978 earnings and profits, a
foreign income tax of $8 being withheld therefrom. Although N
Corporation does not choose to claim a foreign tax credit for 1979, it
may not deduct such $8 of foreign income taxes under section 164.
Corporation N may, however, deduct under such section a foreign income
tax of $4 which is withheld from a distribution of $40 by A Corporation
during 1979 from its 1979 earnings and profits.
[T.D. 7120, 36 FR 10859, June 4, 1971, as amended by T.D. 7649, 44 FR
60089, Oct. 18, 1979]
Sec. 1.960-6 Overpayments resulting from increase in limitation for
taxable year of exclusion.
(a) Amount of overpayment. If an increase in the limitation under
section 960(b)(1) and Sec. 1.960-4 for a taxable year of exclusion
exceeds the tax (determined before allowance of any credits against tax)
imposed by chapter 1 of the Code for such year, the amount of such
excess shall be deemed an overpayment of tax for such year and shall be
refunded or credited to the taxpayer in accordance with chapter 65
(section 6401 and following) of the Code.
(b) Illustration. The application of this section may be illustrated
by the following example:
Example. Domestic corporation N owns all the one class of stock of
controlled foreign corporation A. Both corporations use the calendar
year as the taxable year. For 1978, A Corporation has total income of
$100,000 on which it pays foreign income taxes of $20,000. All of A
Corporation's earnings and profits for 1978 of $80,000 are attributable
to an amount which is required under section 951(a) to be included in N
Corporation's gross income for 1978. By reason of such income inclusion
N Corporation is deemed for 1978 to have paid under section 960(a)(1),
and is required under section 78 to include in gross income for such
year, the $20,000 ($20,000x$80,000/$80,000) of foreign income taxes paid
by A Corporation for such year. Corporation N also derives $100,000
taxable income from sources within the United States for 1978. For 1979,
N Corporation has $25,000 of taxable income, all of which is derived
from sources within the United States. No part of A Corporation's
earnings and profits for 1979 is attributable to an amount required
under section 951(a) to be included in N Corporation's gross income.
During 1979, A Corporation makes one distribution consisting of its
$80,000 earnings and profits for 1978, all of which is excluded under
section 959(a)(1) from N Corporation's gross income for 1979, and from
which distribution foreign income taxes of $10,000 are withheld. For
1978 and 1979, N Corporation claims the foreign tax credit under section
901, determined by applying the overall limitation under section
904(a)(2). The United States tax of N Corporation is determined as
follows for such years, assuming a corporate tax rate of 22 percent, a
surtax of 26 percent and a surtax exemption of $25,000:
1978
Taxable income of N Corporation:
U.S. sources............................................. $100,000
Sources without the U.S.:
Amount required to be included in N $80,000 ...........
Corporation's gross income under section
951(a)...................................
Foreign income taxes deemed paid by N 20,000 100,000
Corporation under section 960(a)(1) and
included in N Corporation's gross income
under section 78 ($20,000x$80,000/
$80,000).................................
--------------
Total taxable income..................... ........... 200,000
============
U.S. tax payable for 1978:
U.S. tax before credit ([$200,000x 0.22]+[$175,000x0.26]) 89,500
Credit: Foreign income taxes of $20,000, but not to 20,000
exceed overall limitation of $44,750 ($89,500x$100,000/
$200,000)...............................................
--------------
U.S. tax payable......................................... 69,500
==============
1979
Taxable income of N Corporation, consisting of income from $25,000
U.S. sources..............................................
U.S. tax before credit ($25,000x0.22)...................... 5,500
Section 904(a)(2) overall limitation for 1979:
Limitation for 1979 before increase under section 0
960(b)(1) ($5,500x$0/$25,000)...........................
Plus: Increase in overall limitation for
1979 under section 960(b)(1):
Amount by which 1978 overall limitation $44,750 ...........
was increased by reason of inclusion in N
Corporation's gross income under section
951(a) for 1978 ($44,750 - [$41,500 x $0/
$100,000])...............................
Less: Foreign income taxes allowed as a 20,000 ...........
credit for 1978 which were allowable
solely by reason of such section 951(a)
inclusion ($20,000-$0)...................
-------------
Balance.................................. 24,750 ...........
[[Page 422]]
But: Such balance not to exceed foreign 10,000 10,000
income taxes paid by N Corporation for
1979 with respect to $80,000 distribution
excluded under section 959(a)(1) ($10,000
tax withheld)............................
--------------
Overall limitation for 1979.............................. 10,000
==============
U.S. tax payable for 1979:
U.S. tax before credit ($25,000x0.22).................... 5,500
Credit: Foreign income taxes of $10,000, but not to 10,000
exceed overall limitation of $10,000 for 1979...........
--------------
U.S. tax payable......................................... None
==============
Overpayment of tax for 1979:
Increase in limitation under section 960(b)(1) for 1979.. 10,000
Less: Tax imposed for 1979 under chapter 1 of the Code... 5,500
--------------
Excess treated as overpayment............................ 4,500
[T.D. 7120, 36 FR 10859, June 4, 1971, as amended by T.D. 7649, 44 FR
60089, Oct. 18, 1979]
Sec. 1.960-7 Effective dates.
(a) General rule. Except as provided in paragraph (b), the rules
contained in Sec. Sec. 1.960-1--1.960-6 shall apply to taxable years of
foreign corporations beginning after December 31, 1962, and taxable
years of U.S. corporate shareholders within which or with which the
taxable year of such foreign corporation ends.
(b) Exception for less developed country corporations. If for any
taxable year beginning after December 31, 1962, and before January 1,
1976, a first-tier foreign corporation qualified as a less developed
country corporation as defined in 26 CFR 1.902-2 revised as of April 1,
1978, the rules pertaining to less developed country corporations
contained in 26 CFR 1.960-1--1.960-6 revised as of April 1, 1978, shall
apply to any amounts required to be included in gross income under
section 951 for such taxable year.
(c) Third-tier credit. The rules contained in Sec. Sec. 1.960-1--
1.960-6 shall apply to amounts included in the gross income of a
domestic corporation under section 951 with respect to the earnings and
profits of third-tier corporations (as defined in Sec. 1.960-1) in
taxable years beginning after December 31, 1976.
[T.D. 7649, 44 FR 60089, Oct. 18, 1979, as amended by T.D. 7843, 47 FR
50484, Nov. 8, 1982]
Sec. 1.961-1 Increase in basis of stock in controlled foreign
corporations and of other property.
(a) Increase in basis--(1) In general. Except as provided in
subparagraph (2) of this paragraph, the basis of a United States
shareholder's--
(i) Stock in a controlled foreign corporation; or
(ii) Property (as defined in paragraph (b)(1) of this section) by
reason of the ownership of which he is considered under section
958(a)(2) as owning stock in a controlled foreign corporation shall be
increased under section 961(a), as of the last day in the taxable year
of such corporation on which it is a controlled foreign corporation, by
the amount required to be included with respect to such stock or such
property in such shareholder's gross income under section 951(a) for his
taxable year in which or with which such taxable year of such
corporation ends. The increase in basis provided by the preceding
sentence shall be made only to the extent to which such amount required
to be included in gross income under section 951(a) was so included in
gross income.
(2) Limitation on amount of increase in case of election under
section 962. In the case of a United States shareholder who makes the
election under section 962 for the taxable year, the amount of the
increase in basis provided by subparagraph (1) of this paragraph shall
not exceed the amount of United States tax paid in accordance with such
election with respect to the amounts included in such shareholder's
gross income under section 951(a) for such year (as determined under
Sec. 1.962-1).
(b) Rules of application--(1) Property defined. The property of a
United States shareholder referred to in paragraph (a)(1)(ii) of this
section shall consist of--
(i) Stock in a foreign corporation;
(ii) An interest in a foreign partnership; or
[[Page 423]]
(iii) A beneficial interest in a foreign estate or trust (as defined
in section 7701(a)(31)).
(2) Increase with respect to each share of stock. Any increase under
paragraph (a) of this section in the basis of a United States
shareholder's stock in a foreign corporation shall be made in the amount
included in gross income under section 951(a) or in the amount of United
States tax paid in accordance with an election under section 962, as the
case may be, with respect to each share of such stock.
(c) Illustration. The application of this section may be illustrated
by the following examples:
Example 1. Domestic corporation M owns 800 of the 1,000 shares of
the one class of stock in controlled foreign corporation R which owns
all of the one class of stock in controlled foreign corporation S.
Corporations M, R, and S use the calendar year as a taxable year. In
1964, S Corporation has $100,000 of earnings and profits after the
payment of $11,250 of foreign income taxes, and $100,000 of subpart F
income. Corporation R has no earnings and profits. With respect to S
Corporation, M Corporation is required to include in gross income
$80,000 (800/1,000x$100,000) under section 951(a), and $9,000 ($80,000/
$100,000x$11,250) under section 78. On December 31, 1964, M Corporation
must increase the basis of each share of its stock in R Corporation by
$100 ($80,000/800).
Example 2. A, an individual United States shareholder, owns all of
the 1,000 shares of the one class of stock in controlled foreign
corporation T. Corporation T and A use the calendar year as a taxable
year. In 1964, T Corporation has $80,000 of earnings and profits after
the payment of $20,000 of foreign income taxes, and $80,000 of subpart F
income. A makes the election under section 962 for 1964 and in
accordance with such election pays a United States tax of $23,000 with
respect to the $80,000 included in his gross income under section
951(a). On December 31, 1964, A must increase the basis of each share of
his stock in T Corporation by $23 ($23,000/1,000).
[T.D. 6850, 30 FR 11854, Sept. 16, 1978]
Sec. 1.961-2 Reduction in basis of stock in foreign corporations and
of other property.
(a) Reduction in basis--(1) In general. Except as provided in
subparagraph (2) of this paragraph, the adjusted basis of a United
States person's--
(i) Stock in a foreign corporation;
(ii) Interest in a foreign partnership; or
(iii) Beneficial interest in a foreign estate or trust (as defined
in section 7701(a)(31)),
with respect to which such United States person receives an amount which
is excluded from gross income under section 959(a), shall be reduced
under section 961(b), as of the time such person receives such excluded
amount, by the sum of the amount so excluded and any income, war
profits, or excess profits taxes imposed by any foreign country or
possession of the United States on or with respect to the earnings and
profits attributable to such excluded amount when such earnings and
profits were actually distributed directly or indirectly through a chain
of ownership described in section 958(a)(2).
(2) Limitation on amount of reduction in case of election under
section 962. In the case of a distribution of earnings and profits
attributable to amounts with respect to which an election under section
962 has been made, the amount of the reduction in basis provided by
subparagraph (1) of this paragraph shall not exceed the sum of--
(i) The amount of such distribution which is excluded from gross
income under section 959(a) after the application of section 962(d) and
Sec. 1.962-3; and
(ii) Any income, war profits, or excess profits taxes imposed by any
foreign country or possession of the United States on or with respect to
the earnings and profits attributable to such excluded amount when such
earnings and profits were actually distributed directly or indirectly
through a chain of ownership described in section 958(a)(2).
(b) Reduction with respect to each share of stock. Any reduction
under paragraph (a) of this section in the adjusted basis of a United
States person's stock in a foreign corporation shall be made with
respect to each share of such stock in the sum of--
(1)(i) The amount excluded from gross income under section 959(a);
or
(ii) The amount excluded from gross income under section 959(a)
after the application of section 962(d) and Sec. 1.962-3; and
[[Page 424]]
(2) The amount of any income, war profits, or excess profits taxes
imposed by any foreign country or possession of the United States on or
with respect to the earnings and profits attributable to such excluded
amount when such earnings and profits were actually distributed directly
or indirectly through a chain of ownership described in section
958(a)(2).
(c) Amount in excess of basis. To the extent that the amount of the
reduction in the adjusted basis of property provided by paragraph (a) of
this section exceeds such adjusted basis, the amount shall be treated as
gain from the sale or exchange of property.
(d) Illustration. The application of this section may be illustrated
by the following examples:
Example 1. (a) Domestic corporation M owns all of the 1,000 shares
of the one class of stock in controlled foreign corporation R, which
owns all of the 500 shares of the one class of stock in controlled
foreign corporation S. Each share of M Corporation's stock in R
Corporation has a basis of $200. Corporations M, R, and S use the
calendar year as a taxable year. In 1963, S Corporation has $100,000 of
earnings and profits after the payment of $50,000 of foreign income
taxes and $100,000 of subpart F income. For 1963, M Corporation includes
$100,000 in gross income under section 951(a) with respect to S
Corporation. In accordance with the provisions of Sec. 1.961-1, M
Corporation increases the basis of each of its 1,000 shares of stock in
R Corporation to $300 ($200+$100,000/1,000) as of December 31, 1963.
(b) On July 31, 1964, M Corporation sells 250 of its shares of stock
in R Corporation to domestic corporation N at a price of $350 per share.
Corporation N satisfies the requirements of paragraph (d) of Sec.
1.959-1 so as to qualify as M Corporation's successor in interest. On
September 30, 1964, the earnings and profits attributable to the
$100,000 included in M Corporation's gross income under section 951(a)
for 1963 are distributed to R Corporation which incurs a withholding tax
of $10,000 on such distribution (10 percent of $100,000) and an
additional foreign income tax of 33\1/3\ percent or $30,000 by reason of
the inclusion of the net distribution of $90,000 ($100,000 minus
$10,000) in its taxable income for 1964. On June 30, 1965, R Corporation
distributes the remaining $60,000 of such earnings and profits to
corporations M and N: Corporation M receives $45,000 (750/1,000x$60,000)
and excludes such amount from gross income under section 959(a);
Corporation N receives $15,000 (250/1,000x$60,000) and, as M
Corporation's successor in interest, excludes such amount from gross
income under section 959(a). As of June 30, 1965, M Corporation must
reduce the adjusted basis of each of its 750 shares of stock in R
Corporation to $200 ($300 minus ($45,000/750+$10,000/1,000+$30,000/
1,000)); and N Corporation must reduce the basis of each of its 250
shares of stock in R Corporation to $250 ($350 minus ($15,000/
250+$10,000/1,000+$30,000/1,000)).
Example 2. The facts are the same as in paragraph (a) of example 1,
except that in addition, on July 31, 1964, R Corporation sells its 500
shares of stock in S Corporation to domestic corporation P at a price of
$600 per share. Corporation P satisfies the requirements of paragraph
(d) of Sec. 1.959-1 so as to qualify as M Corporation's successor in
interest. On September 30, 1964, S Corporation distributes $100,000 of
earnings and profits to P Corporation, which earnings and profits are
attributable to the $100,000 included in M Corporation's gross income
under section 951(a) for 1963. Corporation P incurs a withholding tax of
$10,000 on the distribution from S Corporation (10 percent of $100,000).
As M Corporation's successor in interest, P Corporation excludes the
$90,000 it receives from gross income under section 959(a). As of
September 30, 1964, P Corporation must reduce the basis of each of its
500 shares of stock in S Corporation to $400 ($600 minus ($90,000/
500+$10,000/500)).
[T.D. 6850, 30 FR 11854, Sept. 16, 1965]
Sec. 1.962-1 Limitation of tax for individuals on amounts included in
gross income under section 951(a).
(a) In general. An individual United States shareholder may, in
accordance with Sec. 1.962-2, elect to have the provisions of section
962 apply for his taxable year. In such case--
(1) The tax imposed under chapter 1 of the Internal Revenue Code on
all amounts which are included in his gross income for such taxable year
under section 951(a) shall (in lieu of the tax determined under section
1) be an amount equal to the tax which would be imposed under section 11
if such amounts were received by a domestic corporation (determined in
accordance with paragraph (b)(1) of this section), and
(2) For purposes of applying section 960(a)(1) (relating to foreign
tax credit) such amounts shall be treated as if received by a domestic
corporation (as provided in paragraph (b)(2) of this section).
Thus, an individual United States shareholder may elect to be subject to
[[Page 425]]
tax at corporate rates on amounts included in his gross income under
section 951(a) and to have the benefit of a credit for certain foreign
taxes paid with respect to the earnings and profits attributable to such
amounts. Section 962 also provides rules for the treatment of an actual
distribution of earnings and profits previously taxed in accordance with
an election of the benefits of this section. See Sec. 1.962-3. For
transitional rules for certain taxable years, see Sec. 1.962-4.
(b) Rules of application. For purposes of this section--
(1) Application of section 11. For purposes of applying section 11
for a taxable year as provided in paragraph (a)(1) of this section in
the case of an electing United States shareholder--
(i) Determination of taxable income. The term ``taxable income'' as
used in section 11 shall mean the sum of--
(a) All amounts required to be included in his gross income under
section 951(a) for such taxable year; plus
(b) All amounts which would be required to be included in his gross
income under section 78 for such taxable year with respect to the
amounts referred to in (a) of this subdivision if such shareholder were
a domestic corporation.
For purposes of this section, such sum shall not be reduced by any
deduction of the United States shareholder even if such shareholder's
deductions exceed his gross income.
(ii) Limitation on surtax exemption. The surtax exemption provided
by section 11(c) shall not exceed an amount which bears the same ratio
to $25,000 ($50,000 in the case of a taxable year ending after December
31, 1974, and before January 1, 1976) as the amounts included in his
gross income under section 951(a) for the taxable year bear to his pro
rata share of the earnings and profits for the taxable year of all
controlled foreign corporations with respect to which such United States
shareholder includes any amount in his gross income under section 951(a)
for the taxable year.
(2) Allowance of foreign tax credit--(i) In general. Subject to the
applicable limitation of section 904 and to the provisions of this
subparagraph, there shall be allowed as a credit against the United
States tax on the amounts described in subparagraph (1)(i) of this
paragraph the foreign income, war profits, and excess profits taxes
deemed paid under section 960(a)(1) by the electing United States
shareholder with respect to such amounts.
(ii) Application of section 960(a)(1). In applying section 960(a)(1)
for purposes of this subparagraph in the case of an electing United
States shareholder, the term ``domestic corporation'' as used in
sections 960(a)(1) and 78, and the term ``corporation'' as used in
section 901, shall be treated as referring to such shareholder with
respect to the amounts described in subparagraph (1)(i) of this
paragraph.
(iii) Carryback and carryover of excess tax deemed paid. For
purposes of this subparagraph, any amount by which the foreign income,
war profits, and excess profits taxes deemed paid by the electing United
States shareholder for any taxable year under section 960(a)(1) exceed
the limitation determined under subdivision (iv)(a) of this subparagraph
shall be treated as a carryback and carryover of excess tax paid under
section 904(d), except that in no case shall excess tax paid be deemed
paid in a taxable year if an election under section 962 by such
shareholder does not apply for such taxable year. Such carrybacks and
carryovers shall be applied only against the United States tax on
amounts described in subparagraph (1)(i) of this paragraph.
(iv) Limitation on credit. For purposes of determining the
limitation under section 904 on the amount of the credit for foreign
income, war profits, and excess profits taxes--
(a) Deemed paid with respect to amounts described in subparagraph
(1)(i) of this paragraph, the electing United States shareholder's
taxable income shall be considered to consist only of the amounts
described in such subparagraph (1)(i), and
(b) Paid with respect to amounts other than amounts described in
subparagraph (1)(i) of this paragraph, the electing United States
shareholder's taxable income shall be considered to consist only of
amounts other than the amounts described in such subparagraph (1)(i).
[[Page 426]]
(v) Effect of choosing benefits of sections 901 to 905. The
provisions of this subparagraph shall apply for a taxable year whether
or not the electing United States shareholder chooses the benefits of
subpart A of part III of subchapter N of chapter 1 (sections 901 to 905)
of the Internal Revenue Code for such year.
(c) Illustration. The application of this section may be illustrated
by the following example:
Example. Throughout his taxable year ending December 31, 1964, A, an
unmarried individual who is not the head of a household, owns 60 of the
100 shares of the one class of stock in foreign corporation M and 80 of
the 100 shares of the one class of stock in foreign corporation N. A and
corporations M and N use the calendar year as a taxable year,
corporations M and N are controlled foreign corporations throughout the
period here involved, and neither corporation is a less developed
country corporation. The earnings and profits and subpart F income of,
and the foreign income taxes paid by, such corporations for 1964 are as
follows:
------------------------------------------------------------------------
M N
------------------------------------------------------------------------
Pretax earnings and profits..................... $500,000 $1,200,000
Foreign income taxes............................ 200,000 400,000
Earnings and profits............................ 300,000 800,000
Subpart F income................................ 150,000 750,000
------------------------------------------------------------------------
Apart from his section 951(a) income, A has gross income of $200,600 and
$100,000 of deductions attributable to such income. He is required to
include $90,000 (0.60x$150,000) in gross income under section 951(a)
with respect to M Corporation and $600,000 (0.80x$750,000) with respect
to N Corporation. A elects to have the provisions of section 962 apply
for 1964 and computes his tax as follows:
----------------------------------------------------------------------------------------------------------------
Tax on amounts included under section 951(a):
Income under section 951(a) from M Corporation................ $90,000
Gross-up under sections 960(a)(1) and 78 ($90,000/ 60,000
$300,000x$200,000)...........................................
Income under section 951(a) from N Corporation................ 600,000
Gross-up under sections 960(a)(1) and 78 ($600,000/ 300,000
$800,000x$400,000)...........................................
----------------
Taxable income under section 11............................... 1,050,000
Normal tax (0.22x$1,050,000).................................................. $231,000
Surtax exemption ([$90,000+$600,000]/ 21,036
[0.60x$300,000+(0.80x$800,000)]x$25,000).....................
Subject to surtax under section 11 ($1,050,000-$21,036)....... 1,028,964
Surtax (0.28x$1,028,964)...................................................... 288,110
----------------
Tentative U.S. tax............................................................ 519,110
Foreign tax credit ($60,000+$300,000)......................... 360,000
----------------
Total U.S. tax payable on amounts included under section 951(a)............................. $159,110
Tax with respect to other income:
Gross income.................................................................. 200,600
Less:
Personal exemption.......................................... 600
Deductions.................................................. 100,000
-----------------
100,600
----------------
Taxable income................................................................ 100,000
Tax with respect to such other taxable income................. .............. 59,340
-----------------
Total tax ($159,110+$59,340)................................................................ 218,450
----------------------------------------------------------------------------------------------------------------
[T.D. 6858, 30 FR 13695, Oct. 28, 1965, as amended by T.D. 7413, 41 FR
12640, Mar. 26, 1976]
Sec. 1.962-2 Election of limitation of tax for individuals.
(a) Who may elect. The election under section 962 may be made only
by a United States shareholder who is an individual (including a trust
or estate).
(b) Time and manner of making election. Except as provided in Sec.
1.962-4, a United States shareholder shall make an election under this
section by filing a statement to such effect with his return for the
taxable year with respect to which the election is made. The statement
shall include the following information:
(1) The name, address, and taxable year of each controlled foreign
corporation with respect to which the electing shareholder is a United
States
[[Page 427]]
shareholder and of all other corporations, partnerships, trusts, or
estates in any applicable chain of ownership described in section
958(a);
(2) The amounts, on a corporation-by-corporation basis, which are
included in such shareholder's gross income for his taxable year under
section 951(a);
(3) Such shareholder's pro rata share of the earnings and profits
(determined under Sec. 1.964-1) of each such controlled foreign
corporation with respect to which such shareholder includes any amount
in gross income for his taxable year under section 951(a) and the
foreign income, war profits, excess profits, and similar taxes paid on
or with respect to such earnings and profits;
(4) The amount of distributions received by such shareholder during
his taxable year from each controlled foreign corporation referred to in
subparagraph (1) of this paragraph from excludable section 962 earnings
and profits (as defined in paragraph (b)(1)(i) of Sec. 1.962-3), from
taxable section 962 earnings and profits (as defined in paragraph
(b)(1)(ii) of Sec. 1.962-3), and from earnings and profits other than
section 962 earnings and profits, showing the source of such amounts by
taxable year; and
(5) Such further information as the Commissioner may prescribe by
forms and accompanying instructions relating to such election.
(c) Effect of election--(1) In general. Except as provided in
subparagraph (2) of this paragraph and Sec. 1.962-4, an election under
this section by a United States shareholder for a taxable year shall be
applicable to all controlled foreign corporations with respect to which
such shareholder includes any amount in gross income for his taxable
year under section 951(a) and shall be binding for the taxable year for
which such election is made.
(2) Revocation. Upon application by the United States shareholder,
an election made under this section may, subject to the approval of the
Commissioner, be revoked. Approval will not be granted unless a material
and substantial change in circumstances occurs which could not have been
anticipated when the election was made. The application for consent to
revocation shall be made by the United States shareholder's mailing a
letter for such purpose to Commissioner of Internal Revenue, Attention:
T:R, Washington, DC 20224, containing a statement of the facts upon
which such shareholder relies in requesting such consent.
[T.D. 6858, 30 FR 13696, Oct. 28, 1965]
Sec. 1.962-3 Treatment of actual distributions.
(a) In general. Section 962(d) provides that the earnings and
profits of a foreign corporation attributable to amounts which are, or
have been, included in the gross income of an individual United States
shareholder under section 951(a) by reason of such shareholder's
ownership (within the meaning of section 958(a)) of stock in such
corporation and with respect to which amounts an election under Sec.
1.962-2 applies or applied shall, when such earnings and profits are
distributed to such shareholder with respect to such stock,
notwithstanding the provisions of section 959(a)(1), be included in his
gross income to the extent that such earnings and profits exceed the
amount of income tax paid by such shareholder under this chapter on the
amounts to which such election applies or applied. Thus, when such
shareholder receives an actual distribution of section 962 earnings and
profits (as defined in paragraph (b)(1) of this section) from a foreign
corporation, only the excludable section 962 earnings and profits (as
defined in paragraph (b)(1)(i) of this section) may be excluded from his
gross income.
(b) Rules of application. For purposes of this section--
(1) Section 962 earnings and profits defined. With respect to an
individual United States shareholder, the term ``section 962 earnings
and profits'' means the earnings and profits of a foreign corporation
referred to in paragraph (a) of this section. Such earnings and profits
include--
(i) Excludable section 962 earnings and profits. Excludable section
962 earnings and profits which are the amount of the section 962
earnings and profits equal to the amount of income tax paid under this
chapter by such shareholder on the amounts included in his gross income
under section 951(a); and
[[Page 428]]
(ii) Taxable section 962 earnings and profits. Taxable section 962
earnings and profits which are the excess of section 962 earnings and
profits over the amount described in subdivision (i) of this
subparagraph.
(2) Determinations made separately for each taxable year. If section
962 earnings and profits attributable to more than one taxable year are
distributed by a foreign corporation the determinations under this
section shall be made separately with respect to each such taxable year.
(3) Source of distributions--(i) In general. Except as otherwise
provided in this subparagraph, the provisions of paragraphs (a) through
(d) of Sec. 1.959-3 shall apply in determining the source of
distributions of earnings and profits by a foreign corporation.
(ii) Treatment of section 962 earnings and profits under Sec.
1.959-3. For purposes of a section 959(c) amount and year classification
under paragraph (b) of Sec. 1.959-3, a distribution of earnings and
profits by a foreign corporation shall be first allocated to earnings
and profits other than section 962 earnings and profits (as defined in
subparagraph (1) of this paragraph) and then to section 962 earnings and
profits. Thus distributions shall be considered first attributable to
amounts described in paragraph (b)(1) of Sec. 1.959-3 which are not
section 962 earnings and profits and then to amounts described in such
paragraph (b)(1) which are section 962 earnings and profits (first for
the current taxable year and then for prior taxable years beginning with
the most recent prior taxable year), secondly to amounts described in
paragraph (b)(2) of Sec. 1.959-3 which are not section 962 earnings and
profits and then to amounts described in such paragraph (b)(2) which are
section 962 earnings and profits (first for the current taxable year and
then for prior taxable years beginning with the most recent prior
taxable year), and finally to the amounts described in paragraph (b)(3)
of Sec. 1.959-3 (first for the current taxable year and then for prior
taxable years beginning with the most recent prior taxable year).
(iii) Allocation to excludable section 962 earnings and profits. A
distribution of section 962 earnings and profits by a foreign
corporation for any taxable year shall be considered first attributable
to the excludable section 962 earnings and profits (as defined in
subparagraph (1)(i) of this paragraph) and then to taxable section 962
earnings and profits.
(iv) Allocation of deficits in earnings and profits. A United States
shareholder's pro rata share (determined in accordance with the
principles of paragraph (e) of Sec. 1.951-1) of a foreign corporation's
deficit in earnings and profits (determined under Sec. 1.964-1) for any
taxable year shall be applied in accordance with the provisions of
paragraph (c) of Sec. 1.959-3 except that such deficit shall also be
applied to taxable section 962 earnings and profits (as defined in
subparagraph (1)(ii) of this paragraph).
(4) Distribution in exchange for stock. The provisions of this
section shall not apply to a distribution of section 962 earnings and
profits which is treated as in part or full payment in exchange for
stock under subchapter C of chapter 1 of the Internal Revenue Code. The
application of this subparagraph may be illustrated by the following
example:
Example. Individual United States shareholder A owns 60 percent of
the only class of stock in foreign corporation M, the basis of which is
$10,000. Both A and M Corporation use the calendar year as a taxable
year. In each of the taxable years 1964, 1965, and 1966, M Corporation
has $1,000 of earnings and profits and $1,000 of subpart F income. With
respect to each such amount, A includes $600 in gross income under
section 951(a), makes the election under section 962, and pays a United
States tax of $132 (22 percent of $600). Accordingly, A increases the
basis of his stock in M corporation under section 961(a) by $132 in each
of the years 1964, 1965, and 1966, and thus on December 31, 1966, the
adjusted basis for A's stock in M Corporation is $10,396. In 1967, M
Corporation is completely liquidated (in a transaction described in
section 331) and A receives $13,800, consisting of $1,800 of earnings
and profits attributable to the amounts which A included in gross income
under section 951(a) in 1964, 1965, and 1966, and $12,000 attributable
to the other assets of M Corporation. No amount of the $3,404 gain
realized by A on such distribution ($13,800 minus $10,396) may be
excluded from gross income under section 959(a)(1). However, section
962(d) will not prevent any part of such $3,404 from being treated as a
capital gain under section 331.
[[Page 429]]
(5) Illustration. The application of this paragraph may be
illustrated by the following example:
Example. (a) M, a controlled foreign corporation is organized on
January 1, 1963; A and B, individual United States shareholders, own 50
percent and 25 percent, respectively, of the only class of stock in M
Corporation. Corporation M, A, and B use the calendar year as a taxable
year, and M Corporation is a controlled foreign corporation throughout
the period here involved. For the taxable years 1963, 1964, 1965, and
1966, A and B must include amounts in gross income under section 951(a)
with respect to M Corporation. For the years 1963, 1965, and 1966, A
makes the election under section 962. On January 1, 1967, B sells his
25-percent interest in M Corporation to A; A satisfies the requirements
of paragraph (d) of Sec. 1.959-1 so as to qualify as B's successor in
interest. As of December 31, 1967, M Corporation's accumulated earnings
and profits of $675 (before taking into account distributions made in
1967) applicable to A's interest (including his interest as B's
successor in interest) in such corporation are classified under Sec.
1.959-3 and this section for purposes of section 962(d) as follows:
Classification of Earnings and Profits for Purposes of Sec. 1.962-3
----------------------------------------------------------------------------------------------------------------
Section 959(c)(1) Section 959(c)(2)
--------------------------------------------------------------------
Non- Excludable Taxable Non- Excludable Taxable
section section section section section section Section
Year 962 962 962, 962 962 962 959
earnings earnings earnings earnings earnings earnings (c)(3)
and and and and and and
profits profits profits profits profits profits
----------------------------------------------------------------------------------------------------------------
1963............................. $25 $11 $39 ......... .......... ......... .........
1964............................. 75 .......... ......... $60 .......... ......... $15
1965............................. ......... .......... ......... 75 $33 $117 .........
1966............................. ......... .......... ......... 50 22 78 .........
1967............................. ......... .......... ......... ......... .......... ......... 75
----------------------------------------------------------------------------------------------------------------
(b) During 1967, M Corporation makes three separate distributions to
A of $200, $208, and $267. The source of such distributions under Sec.
1.959-3 and this section is as follows:
------------------------------------------------------------------------
Classification of
distributions under
Distribution Amount Year sections 959 and
962(d)
------------------------------------------------------------------------
No. 1............................ $75 1964 (c)(1) non-section
25 1963 962.
11 1963 Do.
39 1963 (c)(1) excludable
50 1966 section 962.
(c)(1) taxable
section 962.
(c)(2) non-section
962.
----------
Total.......................... 200
----------------------------------
No. 2............................ 22 1966 (c)(2) excludable
78 1966 section 962
75 1965 (c)(2) taxable
33 1965 section 962.
(c)(2) non-section
962.
(c)(2) excludable
section 962.
Total.......................... 208
----------------------------------
No. 3............................ 117 1965 (c)(2) taxable
60 1964 section 962.
75 1967 (c)(2) non-section
15 1964 962.
(c)(3).
Do.
----------
Total.......................... 267
------------------------------------------------------------------------
(c) A must include $324 in his gross income for 1967. The source of
these amounts is as follows:
------------------------------------------------------------------------
Distribution Amount Year Classification
------------------------------------------------------------------------
No. 1............................ $39 1963 (c)(1) taxable
section 962.
No. 2............................ 78 1966 (c)(2) taxable
section 962.
No. 3............................ 117 1965 Do.
75 1967 (c)(3).
15 1964 Do.
----------
Total.......................... 324
------------------------------------------------------------------------
(c) Treatment of shareholder's successor in interest--(1) In
general. If a United States person (as defined in Sec. 1.957-4)
acquires from any person any portion of the interest in the foreign
corporation of a United States shareholder referred to in this section,
the rules of paragraphs (a) and (b) of this section shall apply to such
acquiring person. However, no exclusion of section 962 earnings and
profits under paragraph (a) of this section shall be allowed unless such
acquiring person establishes to the satisfaction of the district
director his right to such exclusion. The information to be furnished by
the acquiring person to the district director with his return for the
taxable year to support such exclusion shall include:
(i) The name, address, and taxable year of the foreign corporation
from which a distribution of section 962 earnings and profits is
received and of
[[Page 430]]
all other corporations, partnerships, trusts, or estates in any
applicable chain of ownership described in section 958(a);
(ii) The name and address of the person from whom the stock interest
was acquired;
(iii) A description of the stock interest acquired and its relation,
if any, to a chain of ownership described in section 958(a);
(iv) The amount for which an exclusion under paragraph (a) of this
section is claimed; and
(v) Evidence showing that the section 962 earnings and profits for
which an exclusion is claimed are attributable to amounts which were
included in the gross income of a United States shareholder under
section 951(a) subject to an election under Sec. 1.962-2, that such
amounts were not previously excluded from the gross income of a United
States person, and the identity of the United States shareholder
including such amount.
The acquiring person shall also furnish to the district director such
other information as may be required by the district director in support
of the exclusion.
(2) Taxes previously deemed paid by an individual United States
shareholder. If a corporate successor in interest of an individual
United States shareholder receives a distribution of section 962
earnings and profits, the income, war profits, and excess profits taxes
paid to any foreign country or to any possession of the United States in
connection with such earnings and profits shall not be taken into
account for purposes of section 902, to the extent such taxes were
deemed paid by such individual United States shareholder under paragraph
(b)(2) of Sec. 1.962-1 and section 960(a)(1) for any prior taxable
year.
[T.D. 6858, 30 FR 13696, Oct. 28, 1965]
Sec. 1.962-4 Transitional rules for certain taxable years.
(a) Extension of time for making or revoking election. Paragraphs
(b) and (c) of this section provide additional rules with respect to
making or revoking an election under section 962 which apply only to a
taxable year of a United States shareholder for which the last day
prescribed by law for filing his return (including any extensions of
time under section 6081) occurs or occurred on or before January 31,
1966.
(b) Manner of making election not previously made. If a United
States shareholder who has not previously made an election under section
962 for any taxable year referred to in paragraph (a) of this section
desires to make such an election, he may do so by filing his return or
an amended return for such taxable year together with a statement
setting forth the information required under paragraph (b) of Sec.
1.962-2. Such return or amended return and statement shall be filed on
or before January 31, 1966.
(c) Revocation of election previously made. If a United States
shareholder who has made an election under section 962 on or before
November 1, 1965, for any taxable year referred to in paragraph (a) of
this section desires to revoke such election, he may do so by filing an
amended return to which is attached a statement that the election
previously made is revoked. Such amended return and statement shall be
filed on or before January 31, 1966.
[T.D. 6858, 30 FR 13698, Oct. 28, 1965]
Sec. 1.963-0 Repeal of section 963; effective dates.
(a) Repeal of section 963. Except as provided in paragraphs (b) and
(c) of this section, the provisions of section 963 and Sec. Sec. 1.963-
1 through 1.963-7 are repealed for taxable years of foreign corporations
beginning after December 31, 1975, and for taxable years of United
States shareholders (within the meaning of section 951(b), within which
or with which such taxable years of such foreign corporations end.
(b) Transitional rules for chain or group election--(1) In general.
If a United States shareholder (within the meaning of section 951(b)
makes either a chain election pursuant to Sec. 1.963-1(e) or a group
election pursuant to Sec. 1.963-1(f) for a taxable year of such
shareholder beginning after December 31, 1975, then a foreign
corporation shall be includible in such election only if--
(i) It has a taxable year beginning before January 1, 1976, which
ends within such taxable year of the United States shareholder, and
(ii) It is either--
[[Page 431]]
(A) A controlled foreign corporation or
(B) A foreign corporation by reason of ownership of stock in which
such shareholder indirectly owns (within the meaning of section
958(a)(2)) stock in a controlled foreign corporation to which this
subparagraph applies.
(2) Series rule. If any foreign corporation in a series of foreign
corporations is excluded by subparagraph (i) of this paragraph from a
chain or group election of a United States shareholder for its taxable
year, then any foreign corporation in which the United States
shareholder owns stock indirectly by reason of ownership of stock in
such excluded corporation shall also be excluded from such election to
the extent of such indirect ownership regardless of when its taxable
year begins.
(3) Illustration. The application of this paragraph may be
illustrated by the following example:
Example. (a) M is a domestic corporation, A, B, D, and E are
controlled foreign corporations, and C is a foreign corporation other
than a controlled foreign corporation. All five foreign corporations,
each have only one class of stock outstanding. M owns directly all of
the stock of A, which in turn owns directly all of the stock of B, which
in turn owns directly 60 percent of the stock of D, which in turn owns
directly all of the stock of E. M also owns directly 40 percent of the
stock of C, which in turn owns directly the remaining 40 percent of the
stock of D. M is a United States shareholder with respect to no other
foreign corporation. M and B each use the calendar year as the taxable
year. A, C, D, and E each use a fiscal year ending on November 30 as the
taxable year. For calendar year 1976, M may make either a first-tier
election with respect to A, a chain election with respect to C and D (to
the extent of M's indirect 16-percent stock interest in D by reason of
its direct ownership of 40 percent of the stock of C) or a group
election with respect to A, C, D (to the extent of such 16-percent stock
interest) and E (to the extent of M's indirect 16-percent stock interest
in E).
(b) M's indirect 100 percent stock interest in B will be excluded
from any chain or group election made by M for calendar year 1976 since
B is a controlled foreign corporation which does not have a taxable year
beginning before January 1, 1976, which ends within the taxable year of
M beginning after December 31, 1975, for which M has made either a chain
or group election.
(c) M's indirect 60 percent stock interest through A and B in D and
E will be excluded from any chain or group election made by M for
calendar year 1976 since such 60 percent interests are indirectly owned
by M by reason of its indirect ownership of stock in B, which is a
foreign corporation which does not have a taxable year beginning before
January 1, 1976, which ends within the taxable year of M beginning after
December 31, 1975, for which M has made either a chain or group
election.
(d) If C used the calendar year as its taxable year and was
therefore excluded from a chain election made with respect to it and D,
then D would also be excluded from such an election, since D would then
be a foreign corporation in which M owns stock indirectly by reason of
ownership of stock in C, which is excluded from such election.
(c) Deficiency distributions. The rules relating to deficiency
distributions under section 963(e)(2) and Sec. 1.963-6 shall continue
to apply to a taxable year beginning after the effective date of the
repeal of section 963 in which it is determined that a deficiency
distribution must be made for an earlier taxable year for which a United
States shareholder made an election to secure the exclusion under
section 963 but failed to receive a minimum distribution.
(d) Special adjustments pursuant to section 963 to be taken into
account for taxable years subsequent to the repeal of section 963. If a
United States shareholder of a controlled foreign corporation elects to
receive a minimum distribution under section 963 for a taxable year,
section 963 and the regulations thereunder may require certain elections
and adjustments to be made in subsequent taxable years. These elections
and adjustments shall be taken into account for subsequent taxable years
as if section 963 were still in effect and no election to receive a
minimum distribution were made after the effective date of the repeal of
section 963. Examples of these elections and special adjustments
include, but are not limited to, the election which may be made pursuant
to Sec. 1.963-3(g)(2), relating to the special extended distribution
period, and the special adjustments to be made pursuant to Sec. 1.963-
4, relating to the minimum overall tax burden test.
[T.D. 7545, 43 FR 19652, May 8, 1978]
[[Page 432]]
Sec. 1.963-1 Exclusion of subpart F income upon receipt of minimum
distribution.
(a) In general--(1) Purpose of section 963. Section 963 sets forth
an exception to section 951(a)(1)(A)(i) by providing that a United
States corporate shareholder may exclude from its gross income the
subpart F income of a controlled foreign corporation if for the taxable
year such shareholder elects such exclusion and, where necessary,
receives a distribution of the earnings and profits of such foreign
corporation sufficient to bring the aggregate U.S. and foreign income
taxes on the pretax earnings and profits of that corporation to a
percentage level approaching the U.S. tax rate for such year on the
income of a domestic corporation. The election to secure an exclusion
under section 963 may be made with respect to a ``single first-tier
corporation'' or a ``chain'' or ``group'' of controlled foreign
corporations. This section defines the terms ``single first-tier
corporations,'' ``chains,'' ``group,'' and certain other terms and
prescribes the manner in which such an election is to be made. Section
1.963-2 describes the manner in which the amount of the minimum
distribution for any taxable year is to be determined. Section 1.963-3
specifies the distributions counting toward a minimum distribution.
Section 1.963-4 sets forth the requirement with respect to a minimum
distribution from a chain or group that the overall U.S. and foreign
income tax must equal either 90 percent of the U.S. corporate tax rate
applied against consolidated pretax and predistribution earnings and
profits or, with the application of the special rules set forth in that
section, the total U.S. and foreign income taxes which would have been
incurred in respect of a pro rata minimum distribution from the chain or
group. Section 1.963-5 provides special rules for applying section 963
in certain cases in which the rate of foreign income tax incurred by a
foreign corporation varies with the amount of distributions it makes for
the taxable year. Section 1.963-6 outlines the deficiency distribution
procedure that may be followed if for reasonable cause a U.S. corporate
shareholder fails to receive a complete minimum distribution for a
taxable year for which it elects the exclusion under section 963.
Section 1.963-7 provides transitional rules for the application of
section 963 for certain taxable years of U.S. shareholders ending on or
before the 90th day after September 30, 1964. Section 1.963-8 provides
rules for the determination of the required minimum distribution during
the period the Sec. surcharge imposed by section 51 is in effect.
(2) Conditions for exclusion of subpart F income. To qualify for an
exclusion under section 963 for any taxable year with respect to the
subpart F income of a controlled foreign corporation, a corporate United
States shareholder must--
(i) Elect such exclusion on or before the last day (including any
extensions of time under section 6081) prescribed by law for filing its
return of the tax imposed by chapter 1 of the Code for the taxable year;
(ii) Receive, if and to the extent necessary, distributions of the
type described in paragraph (a) of Sec. 1.963-3 sufficient in amount to
constitute a minimum distribution;
(iii) Incur, in the case of a chain or group election, income tax
with respect to such minimum distribution sufficient to satisfy the
requirements of paragraph (a) of Sec. 1.963-4, relating to the minimum
overall tax burden; and
(iv) Consent, on or before such last day for making the election, to
the regulations under section 963 applicable to such taxable year and to
any amendments thereof duly prescribed before such last day.
The making of the election under section 963 by filing the return on or
before such last day shall constitute the consent to the regulations
under such section prescribed before such last day. For an extension of
the time for receiving a minimum distribution and making the consent for
certain taxable years ending on or before the 90th day after September
30, 1964, see Sec. 1.963-7.
(3) Subpart F income excluded. An exclusion under section 963 for a
taxable year of a United States shareholder for which the election is
made under such section shall apply only to the subpart F income for the
taxable year of the single first-tier corporation to which
[[Page 433]]
the election applies or of each controlled foreign corporation in the
chain or group to which the election applies. Only those amounts
attributable to the stock interest to which the election relates may be
excluded. Thus, in case of a first-tier election with respect to stock
of a controlled foreign corporation owned directly within the meaning of
section 958(a)(1)(A), the corporate United States shareholder may not
exclude any subpart F income of such foreign corporation which is
includible in its gross income under section 951(a)(1)(A)(i) by virtue
of its indirect ownership of stock in such foreign corporation through
the operation of section 958(a)(2). Subpart F income of a controlled
foreign corporation which is excluded from the gross income of a United
States shareholder by reason of the receipt of a minimum distribution to
which section 963 applies shall not be considered to be excluded under
section 954(b)(1) or section 970(a).
(4) Affiliated group of corporations. An affiliated group of
domestic corporations which makes a consolidated return under section
1501 for the taxable year shall be treated as a single United States
shareholder for purposes of applying section 963 for such year if the
common parent corporation in its return for such affiliated group makes
any first-tier election, chain election, or group election under section
963 for such affiliated group; in such case, no member of such
affiliated group may separately make any first-tier election, chain
election, or group election under section 963 for the taxable year. If
the common parent of such an affiliated group so making a consolidated
return makes no first-tier election, chain election, or group election
for such affiliated group, then any member may make a first-tier
election, chain election, or group election to the same extent that it
could so elect if such affiliated group had not filed a consolidated
return; in such case, the affiliated group will not be treated as a
single United States shareholder.
(b) Definitions. For purposes of section 963 and Sec. Sec. 1.963-1
through 1.963-8--
(1) Controlled foreign corporation. The term ``Controlled foreign
corporation'' shall have the meaning accorded to it by section 957 and
the regulations thereunder but shall not include any foreign corporation
for a taxable year beginning before January 1, 1963.
(2) Single first-tier corporation. The term ``single first-tier
corporation'' means a controlled foreign corporation described in
paragraph (d) of this section with respect to which a first-tier
election has been made for the taxable year.
(3) Chain. The term ``chain'' means collectively the foreign
corporations described in paragraph (e) of this section with respect to
which a chain election has been made for the taxable year.
(4) Group. The term ``group'' means collectively the foreign
corporations described in paragraph (f) of this section with respect to
which a group election has been made for the taxable year.
(5) First-tier election, etc. The term ``first-tier election'' means
an election described in paragraph (c)(1)(i)(a) of this section; the
term ``chain election'' means an election described in paragraph
(c)(1)(i)(b) of this section; and the term ``group election'' means an
election described in paragraph (c)(1)(ii) of this section.
(6) Taxable year. (i) The term ``taxable year of a single first-tier
corporation,'' ``taxable year of a corporation in a chain,'' or
``taxable year of a corporation in a group,'' means, respectively, the
taxable year of such corporation ending with or within the taxable year
of the electing United States shareholder for which is made under
paragraph (c)(1) of this section the election establishing it as a
single first-tier corporation, a corporation in a chain, or corporation
in a group, as the case may be.
(ii) The term ``taxable year'' when used in reference to a chain or
group refers collectively to the respective taxable years of the foreign
corporations in such chain or group to which applies the election
establishing such chain or group status, such taxable year being, in the
case of each respective corporation in the chain or group, such
corporation's taxable year ending with or within the taxable year of the
electing United States shareholder, whether or not such taxable year of
the corporation is the same as that of any
[[Page 434]]
other foreign corporation in the chain or group.
(7) Foreign income tax. The term ``foreign income tax'' means
income, war profits, and excess profits taxes, and taxes included in the
term ``income, war profits, and excess profits taxes'' by reason of
section 903, paid or accrued to a foreign country or possession of the
United States and taken into account for purposes of sections 901
through 905. Except in determining the foreign tax credit under section
901, the term shall not include any tax which is deemed paid by a
foreign corporation under section 902(b).
(c) Election to exclude subpart F income--(1) Foreign corporations
included in election. A corporate United States shareholder may for any
taxable year exercise the election to secure an exclusion under section
963 either--
(i)(a) Separately with respect to any foreign corporation which as
to such shareholder is described in paragraph (d) of this section, and/
or
(b) Separately with respect to the foreign corporation or
corporations which as to such shareholder are in a series described in
paragraph (e) of this section, except to the extent of any interest (of
such shareholder in any such corporation) with respect to which an
election has otherwise been made under this subdivision (i); or
(ii) With respect to all foreign corporations which as to such
shareholder are described in paragraph (f) of this section.
(2) Manner of making election. An election under subparagraph (1) of
this paragraph to secure an exclusion under section 963 and the consent
to the regulations under such section shall be made for a taxable year
by filing with the return for such taxable year--
(i) A written statement stating that such election is made for such
taxable year,
(ii) The names of the foreign corporations to which the election
applies, the taxable year, country or incorporation, earnings and
profits (as determined under paragraph (d) of Sec. 1.963-2), foreign
income tax taken into account under paragraph (e) of Sec. 1.963-2, and
outstanding capital stock, of each such corporation,
(iii) In case of a group election, the names of all foreign
corporations excluded from such group under paragraph (f)(2) and (3) of
this section and identifying characterizations for all foreign branches
included in, and excluded from, such group under paragraph (f)(4) of
this section, together with the authority for such exclusion or
inclusion, and
(iv) Such other information relating to the election made as the
Commissioner may prescribe by instructions or schedules to support such
return.
(3) Duration of election--(i) Year-by-year requirement. An election
under subparagraph (1) of this paragraph to secure an exclusion under
section 963 may be made for each taxable year of the United States
shareholder but shall be effective only with respect to the taxable year
for which made. An election made for any taxable year shall be
irrevocable with respect to that taxable year once the period for the
making of such election has expired, except to the extent provided by
subdivision (ii) of this subparagraph.
(ii) Revocation or modification of election for reasonable cause--
(a) Conditions under which allowed. If, after the making of an election
under subparagraph (1) of this paragraph, the United States shareholder
establishes to the satisfaction of the Commissioner that reasonable
cause exists for revocation or modification of such election, it may
withdraw that election; change from a group election to first-tier
elections and/or chain elections or from a chain election to a first-
tier election: change from a first-tier election to a chain election or
from first-tier elections and/or chain elections to a group election;
or, in the case of a chain or group election, alter the composition of
the chain or group by adding or eliminating corporations. The United
States shareholder shall be allowed to revoke or modify elections
pursuant to this subdivision only once for any taxable year of such
shareholder and then only at a time prior to the expiration of the
period prescribed by law for making an assessment of the tax imposed by
chapter 1 of the Code for such taxable year and for any subsequent
taxable year for
[[Page 435]]
which the tax liability of such shareholder would be affected by such
revocation or modification of election. The Commissioner may, as a
condition to such revocation or modification of the election, require a
consent by the United States shareholder under section 6501 to extend,
for the taxable year and such subsequent years affected by the
revocation or modification, the period for the making of assessments,
and the bringing of distraint or a proceeding in court for collection,
in respect of a deficiency and all interest, additional amounts, and
assessable penalties.
(b) Nature of reasonable cause. Reasonable cause shall be deemed to
exist for the revocation or modification of an election only if, after
the making of such election, a material and substantial change in
circumstances affecting the election occurs which reasonably could not
have been anticipated when the election was made and which, to a
significant degree, was beyond the control of the electing United States
shareholder. For example, reasonable cause would exist if the minimum
distribution were computed on the basis of a contested foreign income
tax asserted by a foreign tax authority which, as a consequence of
litigation occurring after the filing of the United States shareholder's
return, is refunded, with the result that the United States shareholder
is not entitled under the election which was made to an exclusion under
section 963.
(c) Request for revocation or modification. A United States
shareholder desiring to revoke or modify the election shall mail to the
Commissioner of Internal Revenue, Attention: T:R, Washington, DC, 20224,
a letter requesting such revocation or modification; such letter shall
set forth the information required by subparagraph (2) of this paragraph
with respect to any new election and the facts and circumstances which
the shareholder considers reasonable cause for such revocation or
modification. The shareholder shall also consent, if required, to the
extension of assessment period referred to in (a) of this subdivision
and shall furnish such other information as may be required by the
Commissioner in support of such request. If the Commissioner is
satisfied that reasonable cause exists for the revocation or
modification, the United States shareholder shall file an amended return
consistent with any new election which is made.
(d) Corporations to which a first-tier election may apply--(1)
Includible interest. A corporate United States shareholder may make a
first-tier election for the taxable year only with respect to a single
controlled foreign corporation in which it owns stock directly within
the meaning of section 958(a)(1)(A) and only with respect to the stock
so owned. The election must apply to all of the stock so owned by such
shareholder and shall relate only to the subpart F income of such
corporation which would otherwise be required to be included in gross
income by reason of owning such stock. The shareholder may for the same
taxable year make a first-tier election with respect to one or more
controlled foreign corporations in which it directly owns stock and not
with respect to other controlled foreign corporations in which it
directly owns stock.
(2) Illustrations. The application of this paragraph may be
illustrated by the following examples:
Example 1. Domestic corporation M directly owns all the one class of
stock in each of the controlled foreign corporations A, B, and C.
Corporation M may make a first-tier election for a taxable year with
respect to any one of corporations A, B, and C; with respect to
corporations A and B, respectively; with respect to corporations A and
C, respectively; with respect to corporations B and C, respectively; or
with respect to corporations A, B, and C, respectively.
Example 2. Domestic corporation M directly owns all the one class of
stock of controlled foreign corporation A and 20 percent of the one
class of stock of controlled foreign corporation B. Corporation A
directly owns 80 percent of the stock of B Corporation. All such
corporations use the calendar year as the taxable year. For 1964, M
Corporation makes a first-tier election with respect to corporations A
and B, respectively, and receives a minimum distribution from each. An
exclusion under section 963 for 1964 will be allowed for all of A
Corporation's subpart F income for such year but only for the amount of
B Corporation's subpart F income which M Corporation would (without
regard to section 963) be required to include in gross income for such
year under section 951(a)(1)(A)(i) by reason of directly owning 20
[[Page 436]]
percent of the stock of B Corporation. Corporation M may not exclude any
amount which it would be required (without regard to section 963) to
include in gross income under section 951(a)(1)(A)(i) for such year with
respect to the subpart F income of B Corporation by reason of its
indirect ownership (through the operation of section 958(a)(2)) of 80
percent of the stock of B Corporation, unless M Corporation separately
elects such exclusion and receives a minimum distribution with respect
to such interest. See paragraph (e) of this section relating to chain
elections.
(e) Corporations to which a chain election may apply--(1) Includible
interests. A Corporate United States shareholder may make a chain
election for the taxable year with respect to one or more controlled
foreign corporations in any series which includes only one foreign
corporation described in subdivision (i), any one or more controlled
foreign corporations described in subdivision (ii), and all foreign
corporations described in subdivision (iii) of this subparagraph:
(i) A foreign corporation, whether or not a controlled foreign
corporation, to the extent of stock owned by such shareholder--
(a) Directly (within the meaning of section 958(a)(1)(A)) in such
corporation, or
(b) Indirectly (through the operation of section 958(a)(2)) by
virtue of the direct ownership (within the meaning of section
958(a)(1)(A)) of stock in such corporation by a foreign trust, foreign
estate, or foreign partnership, in which such shareholder is a
beneficiary or partner;
(ii) To the extent that such shareholder so elects, any controlled
foreign corporation to the extent that, by reason of its ownership of
stock described in subdivision (i) of this subparagraph, such
shareholder indirectly owns within the meaning of section 958(a)(2)
stock in such controlled foreign corporation; and
(iii) All foreign corporations, whether or not controlled foreign
corporations, by reason (and to the extent) of ownership of stock in
which such shareholder indirectly owns within the meaning of section
958(a)(2) stock in a controlled foreign corporation included in the
series by reason of subdivision (ii) of this subparagraph.
Notwithstanding the preceding sentence, a corporate United States
shareholder may make a chain election for the taxable year with respect
to a single foreign corporation, but only if such foreign corporation is
a controlled foreign corporation described in subdivision (i)(b) of this
subparagraph. The shareholder may for the same taxable year make a chain
election with respect to one or more series, and not with respect to
other series, to which this subparagraph applies.
(2) Illustrations. The application of this paragraph may be
illustrated by the following examples:
Example 1. Domestic corporation M directly owns all the one class of
stock of controlled foreign corporation A, which in turn directly owns
80 percent of the one class of stock of controlled foreign corporation
B. Corporation M may make a chain election with respect to corporations
A and B.
Example 2. Domestic corporation M directly owns all the one class of
stock of controlled foreign corporation A, which in turn directly owns
80 percent of the one class of stock of controlled foreign corporation
B, which in turn directly owns all the one class of stock of controlled
foreign corporation C. Corporation M also directly owns 20 percent of
the stock of B Corporation. Corporation M may make a chain election
either with respect to corporations A and B or with respect to
corporations A, B, and C. In either case corporations B and C can be
included in the chain only to the extent of M Corporation's indirect 80-
percent stock interest in such corporations by reason of its direct
ownership of 100 percent of the stock of A Corporation. Corporation M
may also make a chain election with respect to corporations B and C, in
which case the chain would include corporations B and C to the extent of
the 20-percent stock interest which M Corporation owns directly in B
Corporation, and indirectly owns in C Corporation by reason of its
direct ownership of such stock interest in B Corporation.
Example 3. Domestic corporation M directly owns all the one class of
stock of controlled foreign corporation A, which in turn directly owns
all the one class of stock of controlled foreign corporations B and C.
Corporation M may make a chain election either with respect to
corporations A, B, and C; or with respect to corporations A and B; or
with respect to corporations A and C.
Example 4. Domestic corporation M directly owns all the one class of
stock of controlled foreign corporation A and 40 percent of the one
class of stock of foreign corporation B, not a controlled foreign
corporation. Corporation A directly owns 30 percent of
[[Page 437]]
the one class of stock of controlled foreign corporation C, and B
Corporation directly owns the remaining 70 percent of the stock of C
Corporation. Corporation M may make a chain election with respect to
corporations A and C, but in such case C Corporation can be included in
the chain only to the extent of M Corporation's indirect 30-percent
stock interest in such corporation by reason of its direct ownership of
100 percent of the stock of A Corporation. Corporation M may instead
make a chain election with respect to corporations B and C, but in such
case C Corporation can be included in the chain only to the extent of M
Corporation's indirect 28-percent stock interest in such corporation by
reason of its direct ownership of 40 percent of the stock of B
Corporation. In the latter case, B Corporation must be included in the
chain even though it is not a controlled foreign corporation.
Corporation M may also make two chain elections, one with respect to
corporations A and C, and the other with respect to corporations B and
C, as described above.
Example 5. Domestic corporation M directly owns all the one class of
stock of controlled foreign corporation A, which in turn directly owns
all the one class of stock of controlled foreign corporation B and 40
percent of the one class of stock of foreign corporation C, not a
controlled foreign corporation. Corporation M may make a chain election
with respect to corporations A and B. Corporation C may not be included
in the chain since M Corporation does not, by reason of its indirect
ownership of stock in C Corporation, own stock in any controlled foreign
corporation.
Example 6. Domestic corporation M directly owns a 60-percent
partnership interest in foreign partnership D and by reason of such
interest owns indirectly, within the meaning of section 958(a)(2), 60
percent of the one class of stock of controlled foreign corporation E
(all of the stock of which is directly owned by D Partnership) and 60
percent of the one class of stock of controlled foreign corporation F
(all the stock of which is also directly owned by D Partnership). By
virtue of its direct interest in D Partnership, M Corporation may make a
chain election with respect to E Corporation alone or with respect to F
Corporation alone. Corporation M may also make two chain elections, one
with respect to E Corporation, the other with respect to F Corporation.
(f) Corporations to which a group election may apply--(1) Includible
interests. A corporate United States shareholder may make a group
election for the taxable year with respect to a group of foreign
corporations which includes, except as provided in subparagraphs (2) and
(3) of this paragraph, all of the following corporations:
(i) All controlled foreign corporations in which such shareholder
owns stock either directly within the meaning of section 958(a)(1)(A) or
indirectly within the meaning of section 958(a)(2), and
(ii) All foreign corporations, whether or not controlled foreign
corporations, by reason (and to the extent) of ownership of stock in
which such shareholder, indirectly owns within the meaning of section
958(a)(2) stock in a controlled foreign corporation described in
subdivision (i) of this subparagraph.
A first-tier election or chain election may not be made for any taxable
year with respect to any foreign corporation which for such taxable year
has been excluded under subparagraph (2) or (3) of this paragraph from a
group with respect to which a group election has been made for such
year. The application of this subparagraph may be illustrated by the
following examples:
Example 1. Domestic corporation M directly owns all the one class of
stock of controlled foreign corporations A and B and is a United States
shareholder with respect to no other foreign corporation. M Corporation
may make a group election with respect to corporations A and B.
Example 2. Domestic corporation M directly owns all the one class of
stock of controlled foreign corporations A and B, and B Corporation
directly owns 80 percent of the one class of stock of controlled foreign
corporation C. Corporation M is a United States shareholder only with
respect to corporations A, B, and C. If M Corporation makes a group
election, it must make the election with respect to corporations A, B,
and C.
Example 3. Domestic corporation M directly owns all the one class of
stock of controlled foreign corporations A and B. Corporation A directly
owns 70 percent of the one class of stock of controlled foreign
corporation C. Corporation B directly owns 40 percent of the one class
of stock of foreign corporation D, not a controlled foreign corporation,
and D Corporation directly owns 30 percent of the stock of C
Corporation. Corporation M is a United States shareholder with respect
to no other foreign corporation. If M Corporation makes a group
election, it must make the election with respect to corporations A, B,
C, and D. Corporation D must be included in the group even though it is
not a controlled foreign corporation.
[[Page 438]]
(2) Less developed country corporations. If the United States
shareholder so elects, it may for any taxable year exclude from a group
for purposes of a group election every controlled foreign corporation
which is a less developed country corporation as defined in section
955(c) and Sec. 1.955-5 for the taxable year of such foreign
corporation ending with or within such taxable year of the shareholder
but only if, by reason of ownership of stock in such foreign
corporation, the shareholder does not indirectly own within the meaning
of section 958(a)(2) stock in any other controlled foreign corporation
which is not a less developed country corporation for its taxable year
ending with or within such taxable year of the shareholder. The election
under this subparagraph to exclude a less developed country corporation
is required to be made with respect to all less developed country
corporations of which the electing shareholder is a United States
shareholder and which, under the preceding sentence, are eligible to be
excluded.
Example. Domestic corporation M directly owns all the one class of
stock of controlled foreign corporations A and B, not less developed
country corporations. Corporation A directly owns all of the one class
of stock of controlled foreign corporation C, B Corporation directly
owns all the one class of stock of controlled foreign corporation D, and
D Corporation directly owns all the one class of stock of controlled
foreign corporation E. Corporations C, D, and E are less developed
country corporations under section 955(c). Corporation M may make a
group election with respect to corporations A, B, C, D, and E; it may
also exclude the less developed country corporations and make a group
election with respect to corporations A and B only. If E Corporation
were not a less developed country corporation, however, neither D
Corporation nor E Corporation could be excluded since, by reason of
ownership of stock in D Corporation, M Corporation would indirectly own
stock in E Corporation, a controlled foreign corporation which is not a
less developed country corporation.
(3) Foreign corporations with blocked foreign income. If the United
States shareholder so elects, it may for any taxable year exclude from a
group for purposes of a group election any foreign corporation with
respect to which it is established to the satisfaction of the
Commissioner that an amount of earnings and profits of such corporation
sufficient to constitute its share of a pro rata minimum distribution
(as defined in paragraph (a)(2)(i) of Sec. 1.963-4) by the group cannot
be distributed to such United States shareholder because of currency or
other restrictions or limitations imposed under the laws of any foreign
country. If, by reason of ownership of stock in a foreign corporation
which is excluded from the group under the preceding sentence, a United
States shareholder owns stock in another foreign corporation an amount
of whose earnings and profits sufficient to constitute its share of a
pro rata minimum distribution by the group cannot be distributed to such
United States shareholder through such excluded foreign corporation
because of currency or other restrictions or limitations imposed under
the laws of any foreign country, such other foreign corporation must
also be excluded from the group for purposes of the group election. For
purposes of this subparagraph, the determination as to whether earnings
and profits cannot be distributed because of currency or other
restrictions or limitations imposed under the laws of a foreign country
shall be made in accordance with the regulations under section 964(b),
except that such restrictions or limitations shall be considered to
exist notwithstanding that distributions are made by the foreign
corporation in a foreign currency if, assuming the distributee to be the
United States shareholder, the distributed amounts would be excludable
from the distributee's gross income for the taxable year of receipt
under a method of accounting in which the reporting of blocked foreign
income is deferred until the income ceases to be blocked.
(4) Treatment of foreign branches of domestic corporation as foreign
subsidiary corporations--(i) In general. If the United States
shareholder so elects, all branches (other than a branch excluded under
subdivision (iii) of this subparagraph) maintained by such shareholder
in foreign countries and possessions of the United States shall be
treated, for purposes of applying subparagraph (1) of this paragraph, as
wholly owned foreign subsidiary corporations of such shareholder
organized under the laws
[[Page 439]]
of such respective foreign countries or possessions of the United
States. Each branch treated as such a foreign subsidiary corporation
shall be included in the group by the United States shareholder making
the group election and shall be regarded, for purposes of section 963,
as having distributed to such shareholder all of its earnings and
profits for the taxable year, irrespective of the statutory percentage
applied for the taxable year under paragraph (b) of Sec. 1.963-2. As
used in this subparagraph, the term ``branch'' shall mean a permanent
organization maintained in a foreign country or a possession of the
United States to engage in the active conduct of a trade or business.
Whether a permanent organization is maintained in a foreign country or
possession of the United States shall depend upon the facts and
circumstances of the particular case. As a general rule, a permanent
organization shall be considered to be maintained in such country or
possession if the United States shareholder maintains therein a
significant work force or significant manufacturing, mining,
warehousing, sales, office, or similar business facilities of a fixed or
permanent nature. If a United States shareholder so operates that it
satisfies the branch test with respect to each of several foreign
countries or possessions, each such branch shall be treated as a
separate wholly owned foreign subsidiary corporation organized under the
laws of such country or possession in respect of which it satisfies such
test. In no event shall a branch which is treated as a wholly owned
foreign subsidiary corporation under this subparagraph be also treated
as a less developed country corporation. The term ``possession of the
United States,'' as used in this subparagraph, shall be construed to
have the same meaning as that contained in paragraph (b)(2) of Sec.
1.957-3.
(ii) Earnings and profits and taxes of a foreign branch. The
earnings and profits (or deficit in earnings and profits) for a taxable
year of a branch treated as a wholly owned foreign subsidiary
corporation under this subparagraph shall be determined by applying
against the gross income (as defined in section 61) of the branch its
allowable deductions other than any net operating loss deduction. Any
excess of gross income over such deductions shall constitute earnings
and profits. Any excess of such deductions over gross income shall
constitute a deficit in earnings and profits. For purposes of this
subparagraph, the gross income of a branch is that which is produced by
the trade or business activities separately conducted by it outside the
United States and which is derived from sources without the United
States under the provisions of sections 861 through 864 and the
regulations thereunder; the allowable deductions of a branch are those
which are properly allocable to or chargeable against its gross income
and which are allowable under chapter 1 of the Code to the corporation
of which it is a branch. Only the foreign income tax allocable to the
gross income of the branch shall be considered paid or accrued by such
branch. Solely for the purpose of determining under paragraph (c)(2) of
Sec. 1.963-2 the effective foreign tax rate of a group which includes a
branch treated as a wholly owned foreign subsidiary corporation, the
foreign income tax considered paid or accrued by the branch shall be
treated as an allowable deduction of such branch even though the United
States shareholder chooses to take the benefits of section 901 for the
taxable year.
(iii) Excluded branches. For purposes of subdivision (i) of this
subparagraph, a branch maintained by the United States shareholder in a
possession of the United States shall not be treated as a wholly owned
foreign subsidiary corporation of the United States shareholder for the
taxable year unless such branch would be a controlled foreign
corporation (as defined in section 957 and the regulations thereunder)
for such taxable year if it were incorporated under the laws of such
possession and unless the gross income of such shareholder for such
taxable year includes for purposes of the tax imposed by Chapter 1 of
the Code the income, if any, derived by such shareholder from sources
within possessions of the United States, as determined under the
provisions of sections 861 through 864 and the regulations thereunder.
[[Page 440]]
(iv) Illustrations. The application of this subparagraph may be
illustrated by the following examples:
Example 1. Throughout 1964, domestic corporation M directly owns all
of the one class of stock of controlled foreign corporations A and B.
All corporations use the calendar year as the taxable year. During 1964,
M Corporation engages in foreign country X in the manufacture and sale
of steel tubing and rods, maintaining therein a significant work force
and significant manufacturing and sales facilities for such purpose.
Corporation M also engages in foreign country Y in the mining and sale
of iron ore, maintaining therein a significant work force and
substantial mining and sales facilities for such purpose. For 1964, M
Corporation may make a group election with respect to corporations A and
B and the branches operated in country X and country Y, treating such
branches as wholly owned foreign subsidiary corporations. If corporation
M elects to include one such branch in the group election, it must
include both.
Example 2. Throughout 1964, domestic corporation M directly owns all
the one class of stock of controlled foreign corporations A and B. All
corporations use the calendar year as the taxable year. During 1964, M
Corporation exports tractors to foreign country Z, in which country its
sole activities consist of arranging for title to the tractors to pass
to the purchasers in that country. Corporation M's only facility in
country Z in 1964 is a small rented office, and its work force therein
consists only of a few clerical employees. The activities of M
Corporation in country Z do not constitute the maintenance of a branch
therein for purposes of this subparagraph. Corporation M may make a
group election, only with respect to corporations A and B.
[T.D. 6759, 29 FR 13325, Sept. 25, 1964; 29 FR 13896, Oct. 8, 1964, as
amended by T.D. 6767, 29 FR 14877, Nov. 3, 1964; T.D. 7100, 36 FR 5335,
Mar. 20, 1971]
Sec. 1.963-2 Determination of the amount of the minimum distribution.
(a) Application of statutory percentage to earnings and profits. The
amount of the minimum distribution required to be received by a United
States shareholder with respect to stock to which the election under
paragraph (c) of Sec. 1.963-1 applies for the taxable year in order to
qualify for a section 963 exclusion for such year shall be the amount,
if any, determined by the multiplication of the statutory percentage
applicable for the taxable year by--
(1) In the case of a first-tier election, such shareholder's
proportionate share (as determined under paragraph (d)(2) of this
section) of the earnings and profits for the taxable year of the single
first-tier corporation to which the election relates,
(2) In the case of a chain election, the consolidated earnings and
profits (as determined under paragraph (d)(3) of this section) with
respect to such shareholder for the taxable year of the chain to which
the election relates, or
(3) In the case of a group election, the consolidated earnings and
profits (as determined under paragraph (d)(3) of this section) with
respect to such shareholder for the taxable year of the group to which
the election relates.
For the requirement that the overall United States and foreign income
tax incurred in respect of a minimum distribution from a chain or group
must equal or exceed either 90 percent of the United States corporate
tax rate applied against pretax and predistribution consolidated
earnings and profits or, with the application of the special rules set
forth therein, must equal or exceed the overall United States and
foreign income tax which would have resulted from a pro rata minimum
distribution, see paragraph (a)(1) of Sec. 1.963-4.
(b) Statutory percentage. The statutory percentage (referred to in
paragraph (a) of this section) for the taxable year shall be determined
by applying the effective foreign tax rate (as defined in paragraph (c)
of this section) for such year with respect to the single first-tier
corporation, chain, or group, as the case may be, against--
(1) The table set forth in section 963(b)(1) in the case of an
election to secure an exclusion under section 963 for a taxable year of
the United States shareholder beginning in 1963 and a taxable year
entirely within the surcharge period ending before January 1, 1970.
(2) The table set forth in section 963(b)(2) in the case of an
election to secure an exclusion under section 963 for a taxable year of
the U.S. shareholder beginning in 1964 or for a taxable year of such
shareholder beginning in 1969
[[Page 441]]
and ending in 1970 to the extent subparagraph (B) of section 963(b)(3)
applies,
(3) The table set forth in section 963(b)(3) in the case of an
election to secure an exclusion under section 963 for a taxable year of
the U.S. shareholder beginning after December 31, 1964 except a taxable
year which includes any part of the surcharge period, or
(4) The table set forth in paragraph (b) of Sec. 1.963-8 in the
case of an election to secure an exclusion under section 963 for the
calendar year 1970.
Example. Domestic corporation M owns all the one class of stock in
controlled foreign corporation A. Corporation M uses the calendar year
as its taxable year, and A Corporation uses a fiscal year ending August
31. For 1964, M Corporation makes a first-tier election in order to
exclude from gross income for such year the subpart F income of A
Corporation for its taxable year ending on August 31, 1964. Although,
such election applies to the taxable year of A Corporation beginning on
September 1, 1963, the applicable table, for purposes of determining the
statutory percentages to be used under paragraph (a) of this section for
the taxable year, is that set forth in section 963(b)(2), which relates
to taxable years of United States shareholders beginning in 1964. Thus,
if for the taxable year of A Corporation ending August 31, 1964, the
effective foreign tax rate is 30 percent, A Corporation would have to
distribute 72 percent of its earnings and profits for such year in order
for M Corporation to be entitled to an exclusion under section 963 for
1964.
(c) Effective foreign tax rate--(1) Single first-tier corporation.
For purposes of section 963 the term ``effective foreign tax rate'' for
a taxable year means, with respect to a single first-tier corporation,
the percentage which--
(i) The United States shareholder's proportionate share (as
determined under paragraph (e)(1) of this section) of the foreign income
tax of such corporation for such taxable year is of--
(ii) The sum of--
(a) The United States shareholder's proportionate share (as
determined under paragraph (d)(2) of this section) of the earnings and
profits of such corporation for such taxable year, and
(b) The amount referred to in subdivision (i) of this subparagraph.
(2) Chain or group of corporations. For purposes of section 963, the
term ``effective foreign tax rate'' for a taxable year means, with
respect to a chain or group, the percentage which--
(i) The consolidated foreign income taxes (as determined under
paragraph (e)(2) of this section) of such chain or group with respect to
the United States shareholder for such taxable year is of--
(ii) The sum of--
(a) The consolidated earnings and profits (as determined under
paragraph (d)(3) of this section) of such chain or group with respect to
such United States shareholder for such taxable year, and
(b) The amount referred to in subdivision (i) of this subparagraph.
(3) Treatment of United States tax as foreign tax. For the purpose
solely of determining the effective foreign tax rate under this
paragraph, if a foreign corporation has pretax earnings and profits
attributable to income from sources within the United States for the
taxable year upon which it pays United States income tax and if
distributions from the earnings and profits of such corporation for such
year to the electing United States shareholder with respect to stock to
which the election to secure an exclusion under section 963 relates do
not entitled such shareholder to the dividends-received deduction under
section 245, the amount of the United States income tax shall be taken
into account as though such tax were foreign income tax. The amount so
treated as foreign income tax shall not exceed 90 percent of an amount
determined by multiplying such pretax earnings and profits attributable
to income from sources within the United States by a percentage which is
the sum of the normal tax rate and the surtax rate (determined without
regard to the surtax exemption) prescribed by section 11 for the taxable
year of the United States shareholder.
(d) Determination of proportionate share of earnings and profits and
consolidated earnings and profits--(1) Earnings and profits of foreign
corporations. For purposes of Sec. Sec. 1.963-1 through 1.963-8, the
earnings and profits, or deficit in earnings and profits, for the
taxable year, of a single first-tier corporation or of a foreign
corporation in a chain or group shall be the amount of its
[[Page 442]]
earnings and profits for such year, determined under section 964(a) and
Sec. 1.964-1 but without reduction for foreign income tax or for
distributions made by such corporation, less--
(i) In the case of a foreign corporation included in a chain or
group, the amount of any distributions received (computed without
reduction for any income tax paid or accrued by such corporation with
respect to such distributions) by such corporation during its taxable
year from the earnings and profits (whether or not from earnings and
profits of the taxable year to which the election under section 963
applies) of another foreign corporation in the chain or group.
(ii) In the case of every foreign corporation, the amount of foreign
income tax paid or accrued by such corporation during its taxable year
other than foreign income tax referred to in subdivision (i) and (iii)
of this subparagraph, and
(iii) In the case of a foreign corporation included in a chain or
group, the foreign income tax paid or accrued by such corporation with
respect to distributions from the earnings and profits of any other
foreign corporation in the chain or group for the taxable year of such
other corporation to which the election under section 963 applies, but
only if the U.S. shareholder chooses under this subdivision to take such
tax into account in determining the effective foreign tax rate rather
than count it toward the amount of the minimum distribution as provided
in paragraph (b)(2) of Sec. 1.963-3.
In the event that the foreign income tax of a corporation included in a
chain or group depends upon the extent to which distributions are made
by such corporation, the amount of foreign income tax referred to in
subdivision (ii) of this subparagraph shall, only for purposes of
determining the effective foreign tax rate, be the amount which would
have been paid or accrued if no distributions had been made. For the
rules in other cases involving corporations whose foreign income tax
varies with distributions, see Sec. 1.963-5. For the manner of
computing the earnings and profits of a foreign branch treated as a
wholly owned foreign subsidiary corporation see paragraph (f)(4)(ii) of
Sec. 1.963-1.
(2) Shareholder's proportionate share of earnings and profits--(i)
Corporation with earnings and profits--(a) In general. A United States
shareholder's proportionate share, with respect to stock to which the
election to secure an exclusion under section 963 relates, of the
earnings and profits of a foreign corporation (not including a foreign
branch described in (b) of this subdivision) for its taxable year shall
be the share which such shareholder would receive if the total amount of
such corporation's earnings and profits, as determined under
subparagraph (1) of this paragraph, for such year were distributed on
the last day of such corporation's taxable year on which such
corporation is a controlled foreign corporation or is a foreign
corporation by reason of the ownership of stock in which the United
States shareholder indirectly owns within the meaning of section
958(a)(2) stock in a controlled foreign corporation.
(b) Foreign branch treated as a foreign subsidiary corporation. A
United States shareholder's proportionate share of the earnings and
profits, for the taxable year, of a branch treated as a wholly owned
foreign subsidiary corporation and included in a group under paragraph
(f)(4) of Sec. 1.963-1 shall be the total earnings and profits of such
branch for the taxable year, as determined under paragraph (f)(4)(ii) of
such section.
(c) Indirectly held foreign corporations. If the proportionate share
to be determined is of earnings and profits of a foreign corporation the
stock of which is owned by the United States shareholder by reason of
its ownership of stock (with respect to which the election relates) in
another corporation, such shareholder's proportionate share of such
earnings and profits for the taxable year shall be determined on the
basis of the amount such shareholder would receive from such foreign
corporation with respect to stock in such foreign corporation if there
were distributed for the taxable year all such earnings and profits, as
determined under subparagraph (1) of this paragraph, and of all the
earnings and profits of all other corporations through
[[Page 443]]
which such earnings and profits must pass in order to be received by
such shareholder with respect to the stock to which the election
relates. For purposes of the preceding sentence, the amount received by
the shareholder from the earnings and profits of a foreign corporation
shall be determined without taking into account deductions (whether or
not allowable under chapter 1 of the Code) of other foreign corporations
through which such earnings and profits are distributed.
(d) More than one class of stock. If a foreign corporation for a
taxable year has more than one class of stock outstanding, the earnings
and profits of such corporation for such year which shall be taken into
account with respect to any one class of such stock shall be the
earnings and profits which would be distributed with respect to such
class if all earnings and profits of such corporation for such year were
distributed on the last day of such corporation's taxable year, on which
such corporation is a controlled foreign corporation or is a foreign
corporation by reason of the ownership of stock in which the United
States shareholder indirectly owns within the meaning of section
958(a)(2) stock in a controlled foreign corporation. If an arrearage in
dividends for prior taxable years exists with respect to a class of
preferred stock of such corporation, the earnings and profits for the
taxable year shall be attributed to such arrearage only to the extent
such arrearage exceeds the earnings and profits of such corporation
remaining from prior taxable years beginning after December 31, 1962.
For example, if a controlled foreign corporation, using the calendar
year as its taxable year, has earnings and profits for 1963 of $100
accumulated at December 31, 1963, and an arrearage of $150 for such year
in respect of preferred stock, the earnings and profits for 1964
attributable to such arrearage may not exceed $50 ($150-$100).
(e) Discretionary power to allocate earnings to different classes of
stock. If the allocation of a foreign corporation's earnings and profits
for the taxable year between two or more classes of stock depends upon
the exercise of discretion by that body of persons which exercises with
respect to such corporation the power ordinarily exercised by the board
of directors of a domestic corporation, the allocation of such earnings
and profits to such classes shall be made for purposes of this
subdivision as if such classes constituted one class of stock in which
each share has the same rights to dividends as any other share, unless a
different method of allocation of such earnings and profits is made by
such body not later than 90 days after the close of such taxable year.
(f) Illustrations. The application of this subdivision may be
illustrated by the following examples:
Example 1. Domestic corporation M directly owns 80 percent of the
one class of stock of controlled foreign corporation A, which directly
owns 60 percent of the one class of stock of controlled foreign
corporation B. Each such corporation has earnings and profits of $70 for
the taxable year, as determined under subparagraph (1) of this
paragraph. Corporation M's proportionate share of the earnings and
profits is $56 (0.80x$70) as to A Corporation and $33.60 (0.80x0.60x$70)
as to B Corporation.
Example 2. Throughout 1964 controlled foreign corporation A, which
uses the calendar year as the taxable year, has outstanding 40 shares of
common stock and 60 shares of 6-percent, nonparticipating, noncumulative
preferred stock with a par value of $100 per share. Corporation A has
earnings and profits of $1,000, for 1964, as determined under
subparagraph (1) of this paragraph. In such case, $360 (0.06x$100x60) of
earnings and profits would be taken into account with respect to the
preferred stock and $640 ($1,000-$360), with respect to the common
stock. Thus, if a United States shareholder owns 10 shares of common
stock and 30 shares of preferred stock for 1964, its proportionate share
of the earnings and profits for such year is $340 ([10/40x$640]+[30/
60x$360]).
(ii) Deficit in earnings and profits of a corporation in a chain or
group. A United States shareholder's proportionate share, with respect
to stock to which the election to secure an exclusion under section 963
relates, of a deficit in earnings and profits of a foreign corporation
in a chain or group for a taxable year shall be the portion of such
deficit which, if such corporation had earnings and profits for such
year as determined under subparagraph (1) of this paragraph and all of
such earnings and profits were distributed on the date described in
subdivision (i)(a) of this subparagraph, the share of such
[[Page 444]]
earnings and profits such shareholder would receive bears to the total
of the earnings and profits which would be so distributed on such date.
For the determination of the deficit of a foreign branch treated as a
wholly owned foreign subsidiary corporation and included in a group, see
paragraph (f)(4)(ii) of Sec. 1.963-1. A United States shareholder's
proportionate share of the deficit of such a branch shall be the total
deficit of such branch for the taxable year.
(iii) Controlled foreign corporation for part of year. If--
(a) Stock in a foreign corporation is owned within the meaning of
section 958(a) by a United States shareholder on the last day in the
taxable year of such corporation for which such corporation is a
controlled foreign corporation to which applies an election by such
shareholder to secure an exclusion under section 963 with respect to
such stock, or
(b) Stock in a foreign corporation which is not a controlled foreign
corporation is owned within the meaning of section 958(a) by a United
States shareholder on the last day in the taxable year of such
corporation on which another foreign corporation (which, by reason of
the stock so owned, is owned by such shareholder within the meaning of
section 958(a)) is a controlled foreign corporation to which applies an
election by such shareholder to secure an exclusion under section 963
with respect to such stock,
the earnings and profits of such foreign corporation for the taxable
year which are taken into account in determining such shareholder's
proportionate share thereof shall be an amount of such earnings and
profits, determined as provided in subparagraph (1) of this paragraph,
which bears to the total of such earnings and profits the same ratio
which the part (computed on a daily basis) of such year during which
such corporation is a controlled foreign corporation (or, in case such
corporation is not a controlled foreign corporation, during which such
other corporation is a controlled foreign corporation) bears to the
total taxable year. If the United States shareholder by sufficient
records and accounts establishes to the satisfaction of the district
director the gross income received or accrued, and the deductions paid
or accrued, for the part of such year during which such corporation is a
controlled foreign corporation (or, in case such corporation is not a
controlled foreign corporation, during which such other corporation is a
controlled foreign corporation), the amount of earnings and profits
based on such records and accounts may be used in lieu of the amount
determined under the preceding sentence. The application of this
subdivision may be illustrated by the following examples:
Example 1. Domestic corporation M on June 30, 1963, purchases 60
percent of the one class of stock of A Corporation which on July 1
becomes a controlled foreign corporation and remains such throughout the
remainder of 1963. Both corporations use the calendar year as the
taxable year. Corporation M makes a first-tier election with respect to
A Corporation. For 1963, A Corporation has $100 of earnings and profits,
as determined under subparagraph (1) of this paragraph. Corporation M's
proportionate share of such earnings and profits for 1963 is $30.25
(0.60x[184/365x$100]).
Example 2. (a) Throughout 1963 domestic corporation M directly owns
20 percent of the one class of stock of foreign corporation A, not a
controlled foreign corporation at any time, which directly owns 50
percent of the one class of stock of foreign corporation B, which
becomes a controlled foreign corporation on July 1, 1963, and remains
such throughout the remainder of 1963. All such corporations use the
calendar year as the taxable year. Each of corporations A and B has
earnings and profits for 1963 of $100, as determined under subparagraph
(1) of this paragraph. Corporation M makes a chain election for 1963
with respect to corporations A and B. Corporation M's proportionate
share of the earnings and profits of A Corporation for 1963 is $10.08
(0.20x[184/365x$100]). Corporation M's proportionate share of the
earnings and profits of B Corporation for 1963 is $5.04 (0.20x0.50x[184/
365x$100]).
(b) If B Corporation had been a controlled foreign corporation
throughout 1963, M Corporation's proportionate share of the earnings and
profits of corporations A and B for 1963 would have been $20 (0.20x$100)
and $10 (0.20x0.50x$100), respectively.
(c) If corporations A and B had each been a controlled foreign
corporation only for the period of January 1, 1963, through June 30,
1963, M Corporation's proportionate share of the earnings and profits of
such corporations would have been $9.92 (0.20x[181/365x$100]) and $4.98
(0.20x0.50x[181/365x $100]), respectively.
[[Page 445]]
(d) If A Corporation had been a controlled foreign corporation
throughout 1963 or during the period of July 1, 1963, through December
31, 1963, but B Corporation had been a controlled foreign corporation
only during the period of January 1, 1963, through June 30, 1963, M
Corporation's proportionate share of the earnings and profits of such
corporations would have been $20 (0.20x$100) and $4.96 (0.20x0.50x[181/
365x$100]), respectively.
(3) Consolidated earnings and profits with respect to United States
shareholder. The consolidated earnings and profits of a chain or group
with respect to any United States shareholder for the taxable year shall
be the sum of such shareholder's proportionate shares of the earnings
and profits, and of the deficit in earnings and profits, determined
under subparagraph (2) of this paragraph, for such year of all foreign
corporations, whether or not controlled foreign corporations, in such
chain or group.
(e) Foreign income taxes used in determining effective foreign tax
rate. For purposes of determining the effective foreign tax rate under
paragraph (c) of this section--
(1) Shareholder's proportionate share of taxes of a foreign
corporation. The foreign income tax of a foreign corporation for a
taxable year shall consist of the foreign income tax referred to in
paragraph (d)(1)(ii) of this section with respect to such year and, if
the United States shareholder chooses to take the foreign income tax
described in paragraph (d)(1)(iii) of this section into account in
determining the effective foreign tax rate of a chain or group which
includes such foreign corporation, the foreign income tax referred to in
such paragraph with respect to such year. A United States shareholder's
proportionate share, with respect to stock to which the election to
secure an exclusion under section 963 applies, of the foreign income tax
of such foreign corporation for a taxable year shall be the same
proportion of such foreign income tax that such shareholder's
proportionate share (as determined under paragraph (d)(2)(i) of this
section) of the earnings and profits of such corporation for such year
bears to the total earnings and profits of such corporation for such
year. A United States shareholder's proportionate share of the foreign
income tax, for the taxable year, of a branch treated as a wholly owned
foreign subsidiary corporation and included in a group under paragraph
(f)(4) of Sec. 1.963-1 shall be the total foreign income tax of such
branch for the taxable year.
(2) Consolidated foreign income taxes with respect to United States
shareholder. The consolidated foreign income taxes of a chain or group
with respect to a United States shareholder for the taxable year of such
chain or group shall be the sum of such shareholder's proportionate
shares (as determined under subparagraph (1) of this paragraph) of the
foreign income tax of all foreign corporations, whether or not
controlled foreign corporations, in such chain or group.
(3) Taxes paid by foreign corporation on distributions received
during its distribution period. If a distribution received by a foreign
corporation in a chain or group from another foreign corporation in such
chain or group after the close of the recipient's taxable year but
during its distribution period for such year is allocated to the
earnings and profits of such recipient corporation for such year under
paragraph (c)(2) of Sec. 1.963-3, then any foreign income tax paid or
accrued by such recipient corporation on such distribution shall be
treated as paid or accrued for such taxable year.
(f) Illustrations. The application of this section may be
illustrated by the following examples:
Example 1. For 1966, domestic corporation M makes a first-tier
election with respect to controlled foreign corporation A, 80 percent of
the one class of stock of which M Corporation owns directly. Both
corporations use the calendar year as the taxable year. For 1966, A
Corporation has earnings and profits (before reduction for foreign
income tax) of $100 with respect to which it pays foreign income tax of
$30. Its earnings and profits are $70 ($100-$30). Corporation M's
proportionate share of such earnings and profits is $56 (0.80x$70), and
its proportionate share of the foreign income tax is $24 ($56/$70x$30).
The effective foreign tax rate is 30 percent ($24/[$56+$24]). Based on
such effective foreign tax rate, the statutory percentage under section
963(b)(3) for 1966 is 69 percent. Thus, the amount of the minimum
distribution which M Corporation must receive from A Corporation's 1966
earnings and profits is a dividend of $38.64 (0.69x$56).
Example 2. For 1966, domestic corporation M makes a first-tier
election with respect to
[[Page 446]]
controlled foreign corporation A, all of whose one class of stock M
Corporation owns directly. Both corporations use the calendar year as
the taxable year. For 1966, A Corporation has earnings and profits
(before reduction for income tax) of $100, of which $40 is attributable
to income from sources within the United States on which $12 United
States income tax is paid. The foreign country in which A Corporation is
incorporated imposes an income tax at 30 percent on the $100 but allows
a credit against its tax for the $12 of United States income tax, so
that it imposes a net foreign income tax of $18 for 1966. In determining
the effective foreign tax rate of A Corporation for 1966, such $12 of
United States income tax may be treated as foreign income tax to the
extent it does not exceed $17.28 ($40x0.90x0.48). Corporation A has
earnings and profits of $70 for 1966. Although A Corporation's effective
foreign tax rate for 1966 is 30 percent, determined by dividing $30 by
the sum of $70 plus $30, none of the United States tax which is taken
into account in determining such rate shall be treated as foreign income
tax for purposes of determining the foreign tax credit of M Corporation
under section 902. Based on such effective foreign tax rate, the
statutory percentage under section 963(b)(3) for 1966 is 69 percent.
Thus, the amount of the minimum distribution which M Corporation must
receive from A Corporation's 1966 earnings and profits is a dividend of
$48.30 (0.69x$70).
Example 3. Domestic corporation M directly owns throughout 1966, 60
percent of the one class of stock of controlled foreign corporation A,
not a less developed country corporation under section 902(d), which has
for 1966 earnings and profits of $70 (all of which is attributable to
subpart F income) after having paid foreign income tax of $30. Both
corporations use the calendar year as the taxable year. Corporation A is
created under the laws of a foreign country which imposes a 6-percent
dividend withholding tax. Corporation M would be required, but for
section 963, to include $42 (0.60x$70) of A Corporation's subpart F
income in gross income under section 951(a)(1)(A)(i). For 1966, however,
M Corporation makes a first-tier election with respect to A Corporation.
Since the tax withheld on distributions made by A Corporation is
considered to have been paid by M Corporation, the effective foreign tax
rate applicable to A Corporation for 1966 is only 30 percent, the
percentage which such $30 of foreign income tax is of $100 (the sum of
$30 plus $70). Thus, the statutory percentage under section 963(b) for
1966 is 69 percent. The amount of the minimum distribution which M
Corporation must receive from A Corporation's 1966 earnings and profits
is the distribution M Corporation will receive if A Corporation
distributes 69 percent of its earnings and profits for 1966. Thus, if M
Corporation receives a distribution of 69 percent of its proportionate
share of such earnings and profits or $28.98 (0.69x0.60x$70), it may
exclude from gross income for 1966 $42 otherwise required to be included
in gross income under section 951(a)(1)(A)(i) and will determine its
income tax, assuming no other income and no surtax exemption under
section 11(c), as follows:
Dividend....................................................... $28.98
Gross-up under section 78 ($28.98/ $70x$30).................... 12.42
Taxable income................................................. 41.40
U.S. tax before foreign tax credit ($41.40x0.48)............... 19.87
Foreign tax credit ($12.42+[0.06 x$28.98])..................... 14.16
U.S. tax payable............................................... 5.71
Example 4. (a) For 1966 domestic corporation M makes a chain
election with respect to controlled foreign corporation A, all of whose
one class of stock it directly owns, and controlled foreign corporation
B, all of whose one class of stock is directly owned by A Corporation.
Both foreign corporations are subject to a foreign income tax at a flat
rate of 30 percent, and all corporations use the calendar year as a
taxable year. For 1966, B Corporation has pretax earnings and profits of
$100 and distributes $51.50. For 1966, A Corporation has pretax earnings
and profits of $151.50, consisting of $100 from selling activities and
$51.50 received as a distribution from B Corporation, upon which it pays
a foreign income tax of $45.45 (i.e., 30 percent of $151.50).
(b) Corporation M chooses under paragraph (d)(1)(iii) of this
section to take the foreign tax paid by A Corporation on the dividend
received from B Corporation into account in determining the effective
foreign tax rate of the chain rather than count it toward the amount of
the minimum distribution. Thus, to determine consolidated earnings and
profits of the chain for 1966, A Corporation's pretax earnings and
profits of $151.50 are first reduced by the intercorporate dividend of
$51.50 received from B Corporation so that A Corporation has pretax and
predistribution earnings and profits of $100 ($151.50 less $51.50).
Corporation A's pretax and predistribution earnings and profits of $100
are then reduced by the foreign income tax of $30 (30 percent of $100)
paid on such earnings and profits, resulting in predistribution earnings
and profits of $70 ($100 less $30). Since M Corporation chooses to count
toward the effective foreign tax rate, rather than toward the minimum
distribution, A Corporation's foreign income tax of $15.45 (0.30x51.50)
imposed on the dividend received from B Corporation, such
predistribution earnings and profits of $70 of A Corporation are further
reduced by such $15.45 of tax to $54.55 ($70-$15.45). Corporation B,
having received no dividends from any other corporation in the chain,
has predistribution earnings and profits of $70 ($100 less foreign
income tax of $30).
(c) The consolidated earnings and profits of the chain for 1966 are
$124.55 ($54.55+$70). The
[[Page 447]]
consolidated foreign income taxes for such year are $75.45
($30+$15.45+$30). The effective foreign tax rate of the chain for 1966
is 37.73 percent ($75.45/[$124.55+$75.45]). The statutory percentage for
1966 under section 963(b)(3) is 51 percent. Thus, the amount of the
minimum distribution which M Corporation must receive from the 1966
consolidated earnings and profits of the chain is $63.52 (0.51x$124.55).
Example 5. The facts are the same as in example 4 except that M
Corporation does not choose under paragraph (d)(1)(iii) of this section
to take into account, in determining the effective foreign tax rate, the
foreign income tax of $15.45 paid by A Corporation on the distribution
of $51.50 received from B Corporation. In such case, the consolidated
earnings and profits of the chain are $140 ($70+$70) and the
consolidated foreign income taxes are $60 ($30+$30), the latter amount
being determined without taking into account A Corporation's foreign
income tax of $15.45 on the distribution of $51.50 received from B
Corporation. The effective foreign tax rate for 1966 is 30 percent ($60/
[$140+$60]), and the statutory percentage under section 963(b) is 69
percent. Thus, the amount of the minimum distribution which must be made
from the 1966 consolidated earnings and profits of the chain is $96.60
(0.69x$140). For the counting of such $15.45 of A Corporation's tax
toward the $96.60 amount of the minimum distribution, see paragraph
(b)(2) of Sec. 1.963-3.
Example 6. For 1966 domestic corporation M directly owns the
following percentages of the one class of stock of the following
controlled foreign corporations in respect of which it makes a group
election: 80 percent of A Corporation, 60 percent of B Corporation, and
70 percent of C Corporation. All corporations use the calendar year as
the taxable year; none of the foreign corporations is a less developed
country corporation under section 902(d). Each foreign corporation makes
distributions during 1966. The consolidated earnings and profits, and
the consolidated foreign income taxes, of the group for 1966 with
respect to M Corporation, and the amount of the minimum distribution
which M Corporation must receive, are determined as follows, based on
the earnings and profits and foreign income tax shown in the following
table:
------------------------------------------------------------------------
Controlled foreign
corporations
-----------------------
A B C
------------------------------------------------------------------------
Predistribution and pretax earnings and profits. $100 $100 $100.00
Foreign income tax.............................. 15 25 35.00
Predistribution earnings and profits............ 85 75 65.00
M Corporation's proportionate share of earnings
and profits:
(0.80x$85).................................... 68 ..... ........
(0.60x$75).................................... ..... 45 ........
(0.70x$65).................................... ..... ..... 45.50
Consolidated earnings and profits with respect ..... ..... 158.50
to M Corporation ($68+$45+$45.50)..............
M Corporation's proportionate share of foreign
income tax:
($15x[$68/$85])............................... 12 ..... ........
($25x[$45/$75])............................... ..... 15 ........
($35x[$45.50/$65])............................ ..... ..... 24.50
Consolidated foreign income taxes with respect ..... ..... 51.50
to M Corporation ($12+$15+$24.50)..............
------------------------------------------------------------------------
The effective foreign tax rate for 1966 is 24.5 percent ($51.50/
[$158.50+$51.50]) and the statutory percentage under section 963(b)(3)
for such year is 76 percent. Thus, the amount of the minimum
distribution which M Corporation must receive from the 1966 consolidated
earnings and profits of the group is $120.46 (0.76x$158.50).
Example 7. (a) For 1966 domestic corporation M makes a chain
election with respect to the following controlled foreign corporations:
A Corporation, 80 percent of whose one class of stock M Corporation owns
directly; B Corporation, 60 percent of whose one class of stock is
directly owned by A Corporation; and C Corporation, 70 percent of whose
one class of stock is directly owned by B Corporation. All corporations
use the calendar year as the taxable year; none of the foreign
corporations is a less developed country corporation under section
902(d). The predistribution and pretax earnings and profits of each
foreign corporation are $100. Each foreign corporation pays a flat rate
of foreign income tax on all income computed without reduction for
dividends paid and determined by including dividends received. Such rate
is 15 percent for A Corporation, 25 percent for B Corporation, and 35
percent for C Corporation. Corporation C distributes $65, and B
Corporation distributes $100, for 1966. Corporation M chooses under
paragraph (d)(1)(iii) of this section to count toward the effective
foreign tax rate, rather than toward the amount of the minimum
distribution, the foreign income tax paid by corporations A and B,
respectively, on distributions received from corporations B and C,
respectively.
(b) The consolidated earnings and profits, and the consolidated
foreign income taxes, of the chain, and the amount of the minimum
distribution for 1966, with respect to M Corporation are determined as
follows:
[[Page 448]]
------------------------------------------------------------------------
Controlled foreign corporations
---------------------------------------
A B C Total
------------------------------------------------------------------------
Pretax earnings and profits..... $160.00 $145.50 $100.00 ........
Reduction for intercorporate
dividends:
(0.60x$100)................... 60.00 ........ ........ ........
(0.70x$65).................... ........ 45.50 ........ ........
------------------------------
Pretax and predistribution 100.00 100.00 100.00 ........
earnings and profits...........
Reduction for foreign income tax
on such pretax and
predistribution earnings and
profits:
(0.15x$100)................... 15.00 ........ ........ ........
(0.25x$100)................... ........ 25.00 ........ ........
(0.35x$100)................... ........ ........ 35.00 ........
------------------------------
Predistribution earnings and 85.00 75.00 65.00 ........
profits........................
Reduction for foreign income tax
on intercorporate distributions
of 1966 earnings and profits:
(0.15x$60).................... 9.00 ........ ........ ........
(0.25x$45.50)................. ........ 11.38 ........ ........
------------------------------
76.00 63.62 65.00
==============================
Consolidated earnings and
profits with respect to M
Corporation:
(0.80x$76).................... 60.80 ........ ........ ........
(0.80x0.60x$63.62)............ ........ 30.54 ........ ........
(0.80x0.60x0.70x$65).......... ........ ........ 21.84 $113.18
Consolidated foreign income
taxes with respect to M
Corporation:
($60.80/$76x[$15+$9])......... 19.20 ........ ........ ........
($30.54/$63.62x[$25+$11.38]).. ........ 17.46 ........ ........
($21.84/$65x$35).............. ........ ........ 11.76 $48.42
Effective foreign tax rate ........ ........ ........ 29.96%
($48.42/[$113.18+$48.42])......
Statutory percentage under ........ ........ ........ 69%
section 963(b).................
Amount of minimum distribution ........ ........ ........ $78.0
which M Corporation must
receive from 1966 consolidated
earnings and profits
(0.69x$113.18), no amount of
the tax on intercorporate
distributions being counted
toward the minimum distribution
------------------------------------------------------------------------
Example 8. The facts are the same as in example 7 except that M
Corporation does not choose under paragraph (d)(1)(iii) of this section
to take into account, in determining the effective foreign tax rate, the
foreign income tax paid by the recipient corporations on the
intercorporate distributions. The consolidated earnings and profits, the
consolidated foreign income taxes, of the chain, and the amount of the
minimum distribution which M Corporation must receive, for 1966 are
determined as follows:
------------------------------------------------------------------------
Controlled foreign corporations
---------------------------------------
A B C Total
------------------------------------------------------------------------
Pretax earnings and profits..... $160.00 $145.50 $100.00 ........
Reduction for intercorporate
dividends:
(0.60x$100)................... 60.00 ........ ........ ........
(0.70x$65).................... ........ 45.50 ........ ........
------------------------------
Pretax and predistribution 100.00 100.00 100.00 ........
earnings and profits...........
Reduction for foreign income tax
on such pretax and
predistribution earnings and
profits:
(0.15x$100)................... 15.00 ........ ........ ........
(0.25x$100)................... ........ 25.00 ........ ........
(0.35x$100)................... ........ ........ 35.00 ........
---------------------------------
Predistribution earnings and 85.00 75.00 65.00 ........
profits........................
Consolidated earnings and
profits with respect to M
Corporation:
(0.80x$85).................... 68.00 ........ ........ ........
(0.80x0.60x$75)............... ........ 36.00 ........ ........
(0.80x0.60x0.70x$65).......... ........ ........ 21.84 $125.84
Consolidated foreign income
taxes with respect to M
Corporation:
($68/$85x$15)................. 12.00 ........ ........ ........
($36/$75x$25)................. ........ 12.00 ........ ........
($21.84/$65x$35).............. ........ ........ 11.76 $35.76
Effective foreign tax rate ........ ........ ........ 22.13%
($35.76/[$125.84+$35.76])......
Statutory percentage under ........ ........ ........ 76%
section 963(b).................
Amount of minimum distribution ........ ........ ........ $95.64
to be made from 1966
consolidated earnings and
profits with respect to M
Corporation: (0.76x$125.84)....
[[Page 449]]
Foreign income tax on
intercorporate distributions of
1966 earnings and profits which
is counted toward the minimum
distribution (see Sec. 1.963-
3(b)(2)):
($68/$85x[0.15x$60]).......... 7.20 ........ ........ ........
($36/$75x[0.25x$45.50])....... ........ 5.46 ........ $12.66
Amount of minimum distribution ........ ........ ........ $82.98
which M Corporation must
actually receive from the chain
($95.64-$12.66)................
------------------------------------------------------------------------
[T.D. 6759, 29 FR 13329, Sept. 25, 1964, as amended by T.D. 6767, 29 FR
14877, Nov. 3, 1964; T.D. 7100, 36 FR 5335, Mar. 20, 1971]
Sec. 1.963-3 Distributions counting toward a minimum distribution.
(a) Conditions under which earnings and profits are counted toward a
minimum distribution--(1) In general. A distribution to the United
States shareholder by a single first-tier corporation or by a foreign
corporation included in a chain or group shall count toward a minimum
distribution for the taxable year of such shareholder to which the
election under section 963 relates only to the extent that--
(i) It is received by such shareholder during such year or within
180 days thereafter,
(ii) It is a distribution of the type described in paragraph (b) of
this section,
(iii) Under paragraph (c) of this section, it is deemed to be
distributed from the earnings and profits of the foreign corporations
for the taxable year of such corporation to which the election relates,
and
(iv) Such shareholder chooses to include it in gross income for the
taxable year of such shareholder to which the election relates
notwithstanding that such distribution, by reason of its receipt after
the close of such year, would ordinarily be includible in the gross
income of a subsequent year.
Amounts taken into account under this subparagraph as gross income of
the United States shareholder for the taxable year to which the election
relates shall not be considered to be includible in the gross income of
such shareholder for a subsequent taxable year. For purposes of
determining the foreign tax credit under sections 901 through 905,
foreign income tax paid or accrued by such shareholder on or with
respect to such amounts shall be treated as paid or accrued during the
taxable year of such election.
(2) Distributions made prior to acquisition of stock. A United
States shareholder which owns within the meaning of section 958(a) stock
in a foreign corporation with respect to which such shareholder elects
to secure an exclusion under section 963 for the taxable year may count
toward the minimum distribution any distribution made with respect to
such stock, and before its acquisition by the United States shareholder,
to any other domestic corporation not exempt from income tax under
chapter 1 of the Code, to the extent that such distribution is made out
of the United States shareholder's proportionate share, as determined
under paragraph (d)(2) of Sec. 1.963-2, of such corporation's earnings
and profits for the taxable year and would have counted toward a minimum
distribution if it had been distributed to such United States
shareholder. The application of this subparagraph may be illustrated by
the following examples:
Example 1. Controlled foreign corporation A, which uses the calendar
year as the taxable year, has for 1963 $100 of earnings and profits and
100 shares of only one class of stock outstanding. Domestic corporation
M, not exempt from income tax under chapter 1 of the Code, directly owns
all of such shares during the period from January 1, 1963, through June
30, 1963. On June 30, 1963, M Corporation transfers all of such shares
to domestic corporation N, which owns them throughout the remainder of
1963 and elects to secure an exclusion under section 963 for such year
with respect to the subpart F income of A Corporation. During June 1963,
M Corporation receives a dividend of $75 from A Corporation, which would
count toward a minimum distribution if it had been distributed to N
Corporation for such year. Corporation N's proportionate share of the
earnings and profits of A Corporation for 1963 is
[[Page 450]]
$100; N Corporation may count toward a minimum distribution for 1963 the
entire dividend of $75 paid to M Corporation.
Example 2. The facts are the same as in example 1 except that M is a
nonresident alien individual. Since A Corporation is not a controlled
foreign corporation from January 1, 1963, through June 30, 1963, N
Corporation's proportionate share of the earnings and profits of A
Corporation for 1963 is $50.41 ($100x184/365), as determined under
paragraph (d)(2)(iii) of Sec. 1.963-2. Although $25.41 ($75-$49.59) of
the $75 distribution to M is paid from N Corporation's proportionate
share of A Corporation's 1963 earnings and profits, N Corporation may
not count toward a minimum distribution any part of the $75 dividend
distributed to M, since M is not a domestic corporation.
(b) Qualifying distributions--(1) Amounts not counted toward a
minimum distribution. No distribution received by a United States
shareholder shall count toward a minimum distribution for the taxable
year with respect to such shareholder to the extent the distribution is
excludable from gross income to the extent gain on the distribution is
not recognized, or to the extent the distribution is treated as a
distribution in part or full payment in exchange for stock.
Undistributed amounts required to be included in gross income under
section 551 as undistributed foreign personal holding company income or
under section 951 as undistributed amounts of a controlled foreign
corporation shall not count toward a minimum distribution under section
963. An amount received by a United States shareholder as a distribution
which under section 302 or section 331 is treated as a distribution in
part or full payment in exchange for stock shall not count toward a
minimum distribution even though such amount is includible in gross
income under section 1248 as a dividend. For purposes of this
subparagraph, any portion of a distribution of earnings and profits
which is attributable to an increase in current earnings, invested in
United States property which, but for paragraph (e) of this section,
would be included in the gross income of the United States shareholder
under section 951(a)(1)(B) shall not be treated as an amount excludable
from gross income.
(2) Inclusion of tax on intercorporate distributions. In the case of
a chain or group election, the United States shareholder's proportionate
share of the amount of the foreign income tax paid or accrued for the
taxable year by a foreign corporation in the chain or group with respect
to distributions received by such corporation from the earnings and
profits, of another foreign corporation in such chain or group, for the
taxable year of such other corporation to which the election relates
shall count toward a minimum distribution from such chain or group for
the taxable year, but only if the United States shareholder does not
choose under paragraph (d)(1)(iii) of Sec. 1.963-2 to take such tax
into account in determining the effective foreign tax rate of such chain
or group for the taxable year. To the extent that foreign income tax
counts toward a minimum distribution under this subparagraph, it shall
be applied against and reduce the amount of the minimum distribution
required to be received by the United States shareholder, determined
without regard to this paragraph.
(c) Rules for allocation of distributions to earnings and profits
for a taxable year. To determine whether a distribution to the United
States shareholder by a single first-tier corporation or by a foreign
corporation in a chain or group is made from the earnings and profits of
such corporation for the taxable year to which the election under
section 963 relates, the following subparagraphs shall apply:
(1) Exception to section 316. Section 316 shall apply except that a
distribution of earnings and profits made by a foreign corporation
either to another foreign corporation or to the United States
shareholder shall be treated as having been paid from the earnings and
profits of the distributing corporation for the taxable year of such
corporation to which the election relates only if it is made during its
distribution period (described in paragraph (g) of this section) for
such year.
(2) Distributions from other corporations. The earnings and profits
of a foreign corporation shall be determined in accordance with
paragraph (d)(1) of Sec. 1.963-2 (applied as though the United States
shareholder had chosen under subparagraph (1)(iii) of such paragraph to
take the tax described therein into
[[Page 451]]
account in determining the effective foreign tax rate) except that, in
the case of a chain or group election, a distribution received by a
foreign corporation in the chain or group from another foreign
corporation in such chain or group shall be taken into account as
earnings and profits of the recipient corporation for the taxable year
of such recipient corporation to which the election relates but only to
the extent that--
(i) The distribution is received by the recipient corporation during
the distribution period for the taxable year of such recipient
corporation to which the election relates,
(ii) If the distribution had been received by the United States
shareholder, it would have constituted a distribution of the type
described in paragraph (b) of this section, and
(iii) The distribution is made from the earnings and profits of the
distributing corporation for the taxable year of such distributing
corporation to which the election relates.
(d) Year of inclusion in income of foreign corporation and effect
upon subpart F income. To the extent that a distribution to the United
States shareholder counting toward a minimum distribution from a chain
or group consists of earnings and profits distributed to a foreign
corporation in the chain or group after the close of the recipient
corporation's taxable year but during its distribution period for such
year by another foreign corporation in such chain or group, such amount
shall be treated as received by the recipient corporation on the last
day of such taxable year and shall not be regarded as foreign personal
holding company income (within the meaning of section 553(a) or 954(c))
of such corporation for the taxable year in which such amount is
actually received. The extent to which a distribution counting toward a
minimum distribution consists of earnings and profits distributed to a
foreign corporation in a chain or group shall be determined under the
ordering rules of paragraph (b)(3) of Sec. 1.963-4 (applied in each
instance as though the United States shareholder had not chosen under
paragraph (d)(1)(iii) of Sec. 1.963-2 to take the tax described therein
into account in determining the effective foreign tax rate). However,
for such purpose, the amount of foreign income tax, if any, which counts
toward the minimum distribution shall be determined without regard to
paragraph (b)(2) of this section but in accordance with paragraph
(b)(3)(iii) of Sec. 1.963-4.
(e) Distribution of current earnings invested in United States
property. A distribution made by a foreign corporation during its
distribution period for a taxable year shall, notwithstanding section
959(c), first be attributed to earnings and profits for such year
described in section 959(c)(3) and then to other earnings and profits.
For such purposes, earnings and profits of such foreign corporation for
such year attributable to amounts which would otherwise be included in
gross income of the United States shareholder under section 951(a)(1)(B)
for such year shall be treated as earnings and profits to which section
959(c)(3) applies, shall not be excluded from gross income under section
959 (a) or (b), and shall count toward a minimum distribution for such
year. See paragraph (c)(1)(v) of Sec. 1.960-1 and paragraph (a) of
Sec. 1.960-2.
(f) Cumulative dividends in arrears. A distribution in satisfaction
of arrearages shall be treated as being made out of earnings and profits
of the foreign corporation for the taxable year to which the election
under section 963 applies only to the extent the dividend is not
attributed, under paragraph (d)(2)(i)(d) of Sec. 1.963-2, to the
earnings and profits of such corporation remaining from prior taxable
years beginning after December 31, 1962. The application of this
paragraph may be illustrated by the following example:
Example. For 1963, single first-tier corporation A, which uses the
calendar year as the taxable year, has earnings and profits of $50; for
1964, a deficit in earnings and profits of $20; for 1965, earnings and
profits of $100; and for 1966, earnings and profits of $240. For each of
such years preferred dividends accumulate at the rate of $60; but no
dividend is paid until 1966 during which year the current dividend is
paid and $180 is distributed toward the arrearages. Of this $180, only
$50 ($180-$130) shall be treated as paid from 1966 earnings and profits.
(g) Distribution period of a foreign corporation--(1) General
distribution period. Except as provided by subparagraph (2)
[[Page 452]]
of this paragraph, the distribution period with respect to a foreign
corporation for its taxable year shall begin immediately after the close
of the distribution period for the preceding taxable year and shall end
with the close of the 60th day of the next succeeding taxable year. If
no election to secure an exclusion under section 963 applied to the
preceding taxable year, the distribution period for the taxable year
shall begin with the 61st day of the taxable year.
(2) Special extended distribution period. If the United States
shareholder of the foreign corporation so elects in statement filed with
its return for the taxable year for which the election to secure the
exclusion under section 963 is made, the distribution period with
respect to such foreign corporation for its taxable year to which the
election to secure the exclusion applies shall end with any day which
occurs no earlier than the last day of such taxable year of such foreign
corporation and no later than the 180th day after the close of such
taxable year. The statement shall designate the day so elected as the
end of the distribution period.
(h) Illustrations. The application of this section may be
illustrated by the following examples:
Example 1. For 1963 domestic corporation M makes a chain election
with respect to controlled foreign corporation A, all of whose one class
of stock M Corporation directly owns, and controlled foreign corporation
B, all of whose one class of stock is directly owned by A Corporation.
All such corporations use the calendar year as the taxable year, and the
distribution periods of corporations A and B for 1963 coincide.
Corporations A and B each have earnings and profits (before
distributions) of $100 for 1963. On June 1, 1963, B Corporation
distributes earnings and profits of $120, of which $100 is from its
earnings and profits for 1963 and $20 is from prior earnings. For 1963,
A Corporation pays no income tax and distributes earnings and profits of
$150 to M Corporation. Under paragraph (c) of this section, such $150 is
allocated to A Corporation's earnings and profits of $200 for 1963,
consisting of its total earnings and profits for that year of $220 less
the $20 received as a distribution from B Corporation's prior earnings.
Example 2. Domestic corporation M directly owns all of the one class
of stock of controlled foreign corporation A. Both corporations use the
calendar year as the taxable year, and A Corporation's taxable year and
its distribution period for 1963 coincide. For 1963, $50 is included in
the gross income of M Corporation under section 951(a)(1)(B) as A
Corporation's increase in earnings invested for such year in United
States property. For 1964, M Corporation makes a first-tier election
with respect to A Corporation. For 1964, A Corporation has earnings and
profits of $100, including $10 attributable to an increase in earnings
invested for such year in United States property. During 1964, A
Corporation distributes earnings and profits of $80 to M Corporation.
Without regard to paragraph (e) of this section, $10 of this
distribution is attributable under section 959(c)(1) to A Corporation's
1964 earnings and profits required to be included in M Corporation's
gross income under section 951(a)(1)(D). Pursuant to paragraph (e) of
this section, however, the entire distribution of $80 counts toward a
minimum distribution for 1964 and is considered to be from earnings and
profits of A Corporation for 1964 described in section 959(c)(3). Thus
the entire distribution of $80 is included in M Corporation's gross
income as a dividend and the foreign tax credit in respect of such
amount is determined in accordance with section 902 as modified by the
regulations under section 963. On the other hand, if A Corporation made
no distributions for 1964, no part of the $10 of A Corporation's
increase in earnings invested in United States property for such year
would count toward a minimum distribution for any other year but would
be included in the gross income for M Corporation for 1964 under section
951(a)(1)(B), and the foreign tax credit in respect of such amount would
be determined in accordance with Sec. 1.960-1.
Example 3. For 1964 domestic corporation M makes a chain election
with respect to controlled foreign corporation A, all the one class of
stock of which is owned directly by M Corporation, and controlled
foreign corporation B, all the one class of stock of which is owned
directly by A Corporation. Corporation M makes no election under section
963 for 1963 or 1965. Corporations M and B use the calendar year as the
taxable year, and A Corporation uses for its taxable year a fiscal year
ending on September 30. Corporation M elects to have the distribution
period for each controlled foreign corporation end on March 29, 1965,
such date being the 180th day after the close of A Corporation's taxable
year ending on September 30, 1964. Corporation A's distribution period
for its taxable year ending on September 30, 1964, begins on November
30, 1963, the 61st day of such taxable year. The distribution period of
B Corporation for 1964 begins on March 1, 1964, the 61st day of such
taxable year. A distribution counting toward a minimum distribution for
1964 may be made from the earnings and profits of B Corporation only if
[[Page 453]]
the amount thereof is distributed by B Corporation to A Corporation, and
in turn by A Corporation to M Corporation, during the period of March 1,
1964, through March 29, 1965.
Example 4. The facts are the same as in example 3, except that for
their taxable years ending in 1964, corporations A and B each have
earnings and profits (before distributions) of $100. On March 10, 1965,
B Corporation distributes to A Corporation a dividend of $80 upon which
A Corporation incurs foreign income tax at the rate of 10 percent. On
March 15, 1965, A Corporation distributes to M Corporation a dividend of
$50. Corporation M chooses to take into account as gross income for 1964
from such distribution only $40. For purposes of applying this section,
the distribution counting toward a minimum distribution is $44.44,
consisting of the $40 of earnings and profits actually received by M
Corporation plus the $4.44 ($40/$72x$8) of foreign income tax incurred
by A Corporation attributable thereto; A Corporation is deemed to have
received $44.44 ($40/0.90) of the distribution from B Corporation on
September 30, 1964, the last day of the taxable year of A Corporation to
which the election relates; and the foreign personal holding company
income derived by A Corporation for its taxable year ending in 1965 from
the distribution from B is only $35.56 ($80-$44.44). Assuming that no
exceptions, exclusions, or exemptions were applicable, subpart F income
would be realized by A Corporation for its taxable year ending on
September 30, 1965, upon the distribution by B Corporation to A
Corporation, but only in the amount of $32 ($35.56 less a deduction
under section 954(b)(5) for taxes of $3.56).
[T.D. 7100, 36 FR 10860, June 4, 1971; 36 FR 11924, June 23, 1971, as
amended by T.D. 7334, 39 FR 44214, Dec. 23, 1974]
Sec. 1.963-4 Limitations on minimum distribution from a chain or group.
(a) Minimum overall tax burden--(1) In general. Notwithstanding the
fact that distributions of the type described in paragraph (a) of Sec.
1.963-3 are made by a chain or group to the United States shareholder in
an amount sufficient to constitute a minimum distribution for the
taxable year of such shareholder to which the chain or group election
relates, no exclusion shall be allowable under section 963 to such
shareholder with respect to such chain or group for such year unless--
(i) Without applying the special rules set forth in paragraphs (b)
and (c) of this section, the overall United States and foreign income
tax (as defined in subparagraph (2)(ii) of this paragraph) for the
taxable year with respect to the distribution which is made equals or
exceeds 90 percent of an amount determined by multiplying the sum of the
consolidated earnings and profits (as determined under paragraph (d)(3)
of Sec. 1.963-2) and the consolidated foreign income taxes (as
determined under paragraph (e)(2) of Sec. 1.963-2) of such chain or
group for the taxable year with respect to such shareholder by a
percentage which equals the sum of the normal tax rate and the surtax
rate (determined without regard to the surtax exemption) prescribed by
section 11 for the taxable year of the shareholder, or
(ii) With the application of the special rules set forth in
paragraphs (b) and (c) of this section--
(a) Such shareholder receives a pro rata minimum distribution (as
defined in subparagraph (2)(i) of this paragraph) from such chain or
group for such taxable year, or
(b) To the extent necessary, the amount of the foreign income tax
allowable as a credit for such year under section 901 with respect to
the distribution which is made is reduced and credit for the reduction
is deferred, as provided in paragraph (c)(3) of this section, so that
the overall United States and foreign income tax for the taxable year
with respect to such distribution equals or exceeds the lesser of--
(1) The overall United States and foreign income tax which would be
paid or accrued for such year with respect to a pro rata minimum
distribution received by such shareholder from such chain or group for
such year, and
(2) Ninety percent of an amount determined by multiplying the sum of
the consolidated earnings and profits (as determined under paragraph
(b)(1) of this section) and the consolidated foreign income taxes (as
determined under paragraph (b)(1) of this section) of such chain or
group for the taxable year with respect to such shareholder by a
percentage which equals the sum of the normal tax rate and the surtax
rate (determined without regard to the surtax exemption) prescribed by
section 11 for the taxable year of the shareholder.
(2) Definitions. For purposes of Sec. Sec. 1.963-1 through
1.963.8--
[[Page 454]]
(i) Pro rata minimum distribution. A pro rata minimum distribution
from a chain or group for the taxable year is a distribution of earnings
and profits to the United States shareholder, with respect to stock to
which the chain or group election relates, which is the statutory
percentage (applicable with respect to such chain or group as determined
under paragraph (b) of Sec. 1.963-2) of the United States shareholder's
proportionate share of the taxable year's earnings and profits of each
foreign corporation in such chain or group (determined in accordance
with paragraph (d)(2) of Sec. 1.963-2 but without making any deduction
under paragraph (d)(1)(iii) of such section).
(ii) Overall United States and foreign income tax. The overall
United States and foreign income tax for any taxable year of a chain or
group with respect to a minimum distribution is the sum of--
(a) The consolidated foreign income taxes of the chain or group for
such year with respect to the United States shareholder making the chain
or group election,
(b) Any other foreign income tax paid or accrued by a foreign
corporation in the chain or group by reason of the receipt of any
distributions counting toward such minimum distribution from such chain
or group for that year, and
(c) The foreign income tax, if any, and United States income tax
paid or accrued by such shareholder upon amounts counting toward such
minimum distribution from such chain or group for such year.
Such overall United States and foreign income tax shall be determined
with respect to such minimum distribution without taking into account
any foreign income tax which is deemed paid for such year under section
904(d), relating to carryback and carryover of excess tax paid. For
purposes of this subdivision, the consolidated foreign income taxes of
the chain or group shall be determined under paragraph (e)(2) of Sec.
1.963-2, applied without regard to the second sentence of paragraph
(d)(1) of that section.
(3) Taxes paid by foreign corporation on distributions received
during its distribution period. For purposes of determining foreign
income tax deemed paid by the United States shareholder for the taxable
year under section 902, if a distribution received by a foreign
corporation in a chain or group from another foreign corporation in such
chain or group after the close of the recipient's taxable year but
during its distribution period for such year is allocated to the
earnings and profits of such recipient corporation for such year under
paragraph (c)(2) of Sec. 1.963-3, any foreign income tax paid or
accrued by such recipient corporation on such distribution shall be
treated as paid or accrued for such taxable year.
(4) Illustration. The application of this paragraph may be
illustrated by the following example:
Example. (a) Domestic corporation M directly owns all of the one
class of stock of foreign corporation A, which in turn directly owns all
of the one class of stock of foreign corporation B. Corporation M makes
a chain election with respect to A Corporation and B Corporation. All
such corporations use the calendar year as the taxable year. Assuming
that A Corporation does not incur foreign tax on amounts distributed by
B Corporation, the foreign income tax and earnings and profits of
corporations A and B, the effective foreign tax rate, and the statutory
percentage for 1966, are as follows:
------------------------------------------------------------------------
A B Consolidated
------------------------------------------------------------------------
Pretax and predistribution earnings and $100 $100 $200
profits....................................
Foreign income tax.......................... 20 40 60
--------
Earnings and profits........................ 80 60 140
========
Effective foreign tax rate ($60/[$140+$60]). ..... ..... 30%
Statutory percentage under section 963(b)... ..... ..... 69%
------------------------------------------------------------------------
(b) Corporation M is entitled for 1966 to exclude its pro rata share
of the subpart F income of corporations A and B for such year if it
receives from the 1966 consolidated earnings and profits of the chain
distributions totaling at least $96.60 (0.69x$140) and if--
(1) The sum of the consolidated foreign income taxes ($60) of the
chain for 1966 and of the United States income tax for 1966 (determined
by taking into account the foreign tax credit under section 901 without
regard to paragraph (c) of this section) imposed on such distributions
equals at least $86.40 (0.90x0.48x$200);
(2) Under the special rules of paragraphs (b) and (c) of this
section, the distributions received consist of a distribution from each
of corporations A and B which is 69 percent of the earnings and profits
for 1966 of such corporation, that is, a distribution of $55.20
[[Page 455]]
(0.69x$80) from A Corporation and of $41.40 (0.69x$60) from B
Corporation; or
(3) Under the special rules of paragraphs (b) and (c) of this
section, the foreign tax credit is reduced and deferred to such an
extent that the sum of the consolidated foreign income taxes ($60) of
the chain for 1966 and of the United States income tax for 1966
(determined by taking into account the foreign tax credit under section
901 as modified by paragraph (c) of this section) imposed on such
distributions equals the lesser of $86.40 (0.90x0.48x$200) and the
amount which the sum of such taxes would be if M Corporation were to
receive a distribution of $55.20 (0.69x$80) from the 1966 earnings and
profits of A Corporation and $41.40 (0.69x$60) from the 1966 earnings
and profits of B Corporation.
(b) Special rules for determining earnings and profits and foreign
income taxes. For purposes of determining the minimum overall tax burden
under paragraph (a)(1)(ii) of this section, Sec. Sec. 1.963-2 and
1.963-3 shall apply as modified by the following subparagraphs:
(1) Exclusion of tax on intercorporate distributions. The
consolidated earnings and profits and consolidated foreign income taxes
of a chain or group for the taxable year shall be determined in
accordance with Sec. 1.963-2, except that foreign income tax referred
to in paragraph (d)(1)(iii) of such section may be taken into account in
determining the effective foreign tax rate only--
(i) To the extent that such tax is not deemed paid by the United
States shareholder under section 902 (as modified by paragraph (c) of
this section) for its taxable year to which the chain or group election
relates, or
(ii) If, by taking the tax into account, the effective foreign tax
rate with respect to such chain or group, as determined under paragraph
(c)(2) of Sec. 1.963-2, exceeds the highest effective foreign tax rate
requiring a distribution under section 963(b) for such year of the
shareholder.
(2) Allocation of deficits. For purposes of determining the amount
of each foreign corporation's share of a pro rata minimum distribution
from a chain or group for the taxable year and for purposes of
determining the foreign tax credit under paragraph (c) of this section
of the United States shareholder with respect to any minimum
distribution from a chain or group for the taxable year--
(i) Deficits of foreign corporations. The total of the United States
shareholder's proportionate shares, as determined under paragraph
(d)(2)(ii) of Sec. 1.963-2, of the deficit of every foreign corporation
in the chain or group having a deficit for the taxable year shall be
allocated against and shall reduce such shareholder's proportionate
share, as determined under paragraph (d)(2)(i) of Sec. 1.963-2, of the
earnings and profits for the taxable year of each other foreign
corporation in the chain or group having earnings and profits for such
year in an amount which bears to such total of shares of deficit the
same ratio which such share of earnings and profits bears to the total
of such shareholder's proportionate shares, as so determined, of the
earnings and profits of all foreign corporations in the chain or group
having earnings and profits for the taxable year.
(ii) Deficits of foreign branches. If for the taxable year a group
includes under paragraph (f)(4) of Sec. 1.963-1 foreign branches the
aggregate of whose allowable deductions (other than any net operating
loss deduction) exceeds the aggregate of their gross incomes for the
taxable year, determined as provided in paragraph (f)(4)(ii) of such
section, the amount of such excess shall be allocated as provided by
subdivision (i) of this subparagraph.
(3) Distributions through a chain or group. In determining whether
and to what extent a distribution for any taxable year has been made out
of the earnings and profits of a foreign corporation included in a chain
of ownership described in section 958(a) consisting of two or more
corporations in a chain or group for the taxable year, the following
subdivisions shall apply:
(i) Allocation first to income received as a distribution. If any
foreign corporation included in the chain or group for the taxable year
receives a distribution for such year from another foreign corporation
in the chain or group and in turn makes a distribution for the taxable
year, the distribution so made shall first be allocated to the earnings
and profits, to the extent thereof, attributable to the distribution so
received; if distributions are received from more than one other
corporation in the chain or group, the distribution
[[Page 456]]
made by the recipient corporation shall be apportioned among all such
amounts. For purposes of determining whether a distribution is made or
received for the taxable year, see paragraph (c) of Sec. 1.963-3.
(ii) Successive distributions through a chain or group. If any
foreign corporation included in the chain or group for the taxable year
distributes an amount from its earnings and profits of such year, the
amount so distributed shall be considered to be received from such
earnings and profits by the United States shareholder to the extent the
amount is distributed by successive distributions made by each other
foreign corporation in the chain or group for the taxable year through
the chain of ownership described in section 958(a) into the hands of
such shareholder.
(iii) Distribution determined without reduction by taxes of
intervening corporations. If, for the taxable year to which the election
to secure an exclusion under section 963 applies, the United States
shareholder receives a distribution to which subdivision (ii) of this
subparagraph applies, the entire amount distributed by the foreign
corporation from such shareholder's proportionate share of its earnings
and profits for the taxable year shall, except where taxes referred to
in paragraph (d)(1)(iii) of Sec. 1.963-2 are taken into account as
provided by subparagraph (1) of this paragraph, count toward a minimum
distribution and shall not be reduced for such purpose by an foreign
income tax paid or accrued on such amount by another foreign corporation
in the chain or group through which such amount is distributed by
successive distributions into the hands of such shareholder. The
application of this subdivision may be illustrated by the following
examples:
Example 1. For 1966, domestic corporation M makes a chain election
with respect to controlled foreign corporation A, all the one class of
stock of which is directly owned by M Corporation, and controlled
foreign corporation B, all the one class of stock of which is directly
owned by A Corporation. All corporations use the calendar year as the
taxable year. Corporation M complies with the special rules of this
paragraph and paragraph (c) of this section for the taxable year.
Corporation A's only income for 1966 is a dividend of $52.50 distributed
in such year by B Corporation, on which A Corporation is subject to an
income tax of $10.50. The remaining $42 ($52.50 less $10.50) is
distributed by A Corporation for 1966 to M Corporation. The full $52.50
distributed by B Corporation counts toward a minimum distribution by the
chain for 1966.
Example 2. For 1966, domestic corporation M makes a chain election
with respect to controlled foreign corporation A, all the one class of
stock of which it owns directly, and controlled foreign corporation B,
all the one class of stock of which A Corporation own directly. All
corporations use the calendar year as the taxable year. Corporation M
complies with the special rules of this paragraph and paragraph (c) of
this section for the taxable year. The predistribution and pretax
earnings and profits for 1966 of B Corporation are $100, and of A
Corporation, $0. Corporation B pays foreign income tax of $30 and during
the year distributes $70. On such $70, A Corporation pays foreign income
tax of $14. By applying paragraph (d)(1)(iii) of Sec. 1.963-2, the
consolidated foreign income taxes of the chain for 1966 are $44
($30+$14) and the consolidated earnings and profits of the chain are $56
($70-$14); in such case, the effective foreign tax rate of the chain for
1966 is 44 percent ($44/[$56+$44]) and thus in excess of the highest
effective foreign tax rate requiring a distribution for such year under
section 963(b). Since M Corporation may thus take A Corporation's tax of
$14 into account, the statutory percentage under section 963(b) for 1966
is zero percent and the amount of the minimum distribution required to
be made by the chain is $0.
(c) Special foreign tax credit rules--(1) In general. In determining
the minimum overall tax burden under paragraph (a)(1)(ii) of this
section, the foreign tax credit of the United States shareholder with
respect to a minimum distribution received for the taxable year from the
chain or group shall be determined under the provisions of sections 901
through 905 as modified by Sec. 1.963-3 except that--
(i) Under subparagraph (2) of this paragraph--
(a) Taxes of a second-tier corporation making a distribution through
a first-tier corporation shall not be averaged with taxes of such first-
tier corporation,
(b) Taxes of a first-tier corporation or a second-tier corporation
on a distribution made through such corporation shall not be averaged
with such corporation's taxes on its other income; and
[[Page 457]]
(c) Taxes of a first-tier corporation or a second-tier corporation
shall not be deemed paid with respect to distributions from the earnings
and profits of such corporation which are offset by a deficit allocated
under paragraph (b)(2) of this section to the United States
shareholder's proportionate share of the earnings and profits of such
corporation; and
(ii) The foreign tax credit may be reduced and the reduction
deferred under subparagraph (3) of this paragraph to another taxable
year of the United States shareholder.
(2) Nonaveraging of tax--(i) Year of minimum distribution--(a) Taxes
deemed paid by a first-tier corporation and taxes actually paid by such
corporation. If, by successive distributions through a chain or group, a
United States shareholder receives for a taxable year a distribution of
the earnings and profits for such year of any corporation in such chain
or group, and if both section 902(a) and section 902(b) apply with
respect to such distribution, all the taxes deemed paid under section
902(b) by the first-tier corporation described in section 902(a) with
respect to such distribution of such earnings and profits shall be
deemed paid by the United States shareholder for such taxable year under
section 902(a) with respect to the earnings and profits so distributed
and, notwithstanding the rules otherwise applicable under section 902,
no part of the taxes so deemed paid by such first-tier corporation shall
be attributed to other earnings and profits of such first-tier
corporation for such year and no part of the taxes paid or accrued with
respect to such other earnings and profits shall be attributed to the
earnings and profits so received as a distribution.
(b) Taxes of a foreign corporation paid on intercorporate
distributions and on other income. If, by successive distributions
through a chain or group, a United States shareholder receives for a
taxable year a distribution of the earnings and profits for such year of
any corporation in such chain or group, then in applying section 902(a)
with respect to such distribution through a first-tier corporation
described in section 902(a), or in applying section 902(b) with respect
to such distribution through a second-tier corporation described in
section 902(b), as the case may be, the taxes of such corporation which
shall be taken into account in determining taxes deemed paid under such
section shall be the foreign income tax actually paid or accrued for the
taxable year by such first-tier or second-tier corporation, as the case
may be, with respect to such distribution; and, notwithstanding the
rules otherwise applicable under section 902, no part of the taxes so
paid by such first-tier or second-tier corporation shall be attributed
to other earnings and profits of such corporation for such year and no
part of the taxes paid or accrued with respect to such other earnings
and profits shall be attributed to the earnings and profits so received
as a distribution.
(c) Corporation with earnings and profits reduced by allocated
deficits. In the application of section 902, a United States
shareholder's proportionate share of the earnings and profits for the
taxable year of a foreign corporation to which the chain or group
election applies shall reflect the reduction of such earnings and
profits by deficits allocated thereto under paragraph (b)(2) of this
section. No taxes paid or accrued by such corporation shall be deemed
paid under section 902 with respect to a distribution to such
shareholder from the earnings and profits of such corporation for such
year to the extent that such distribution exceeds the shareholder's
proportionate share as so reduced.
(ii) Year of distribution of remaining earnings and profits. If for
a taxable year in respect of which a United States shareholder receives
a minimum distribution pursuant to an election under section 963 and in
respect of which the provisions of this subparagraph are applied--
(a) The foreign income tax which is paid or accrued by a foreign
corporation for such year, by reason of the receipt and payment of
earnings and profits counting toward such minimum distribution, is
deemed paid under subdivision (i) (a) or (b) of this subparagraph,
(b) The pretax and predistribution earnings and profits for such
year of a foreign corporation in a chain or group
[[Page 458]]
with respect to stock on which such minimum distribution is received are
reduced by reason of the deduction under paragraph (d)(1)(i) of Sec.
1.963-2 of distributions received from other corporations in such chain
or group, or
(c) Such shareholder's proportionate share of the earnings and
profits for such year of a foreign corporation in a chain or group
making a distribution counting toward such minimum distribution is
reduced by the allocation thereto under paragraph (b)(2) of this section
of a portion of the deficits of foreign branches or other foreign
corporations in such chain or group,
the pretax and predistribution earnings and profits of such foreign
corporation for such year to which such minimum distribution is
attributable and the foreign income tax which is taken into account in
determining tax deemed paid under section 902 on such pretax and
predistribution earnings and profits shall not be taken into account in
the application of section 902 when other earnings and profits of such
foreign corporation for such year are distributed in a subsequent
taxable year of such foreign corporation to such shareholder. For the
purpose of applying the preceding sentence to a case in which (c) of
this subdivision applies, the pretax and predistribution earnings and
profits of the foreign corporation for such year to which the minimum
distributed is attributable shall be the amount of such corporation's
earnings and profits which are distributed and count toward the minimum
distribution plus the foreign income tax of such foreign corporation
allocated thereto in determining the taxes deemed paid under section 902
for the taxable year of the minimum distribution.
(iii) Illustrations. The application of this subparagraph may be
illustrated by the following examples:
Example 1. Domestic corporation M makes a chain election for 1966
with respect to controlled foreign corporation A, which is wholly owned
directly by M Corporation, and controlled foreign corporation B, which
is wholly owned directly by A Corporation. Each corporation uses the
calendar year as the taxable year. In 1966, corporations A and B are
subject to foreign income tax at the rates of 20 percent and 30 percent,
respectively, with no deduction being allowed for dividends received or
paid; each such corporation has pretax and predistribution earnings and
profits of $100. Corporation M receives from the chain a pro rata
minimum distribution for such year and applies thereto the special rules
of this paragraph and paragraph (b) of this section. Corporation A is
not a less developed country corporation under section 902(d). The 1966
foreign income tax of corporations A and B which is deemed paid by M
Corporation under section 902(a) for 1966, and the remaining tax which
is allocated to earnings and profits to be distributed to M Corporation
in future years, are determined as follows:
------------------------------------------------------------------------
A B Total
------------------------------------------------------------------------
Pretax and predistribution $100.00 $100.00 $200.00
earnings and profits............
Foreign income tax............... 20.00 30.00 50.00
Consolidated earnings and profits 80.00 70.00 150.00
Effective foreign tax rate ($50/ ........... ........... 25%
[$150+$50]).....................
Statutory percentage under ........... ........... 76%
section 963(b)..................
Amount distributed as pro rata
minimum distribution for 1966:
(0.76x$80)..................... 60.80 ........... ...........
(0.76x$70)..................... ........... 53.20 114.00
Amount received by M Corporation
as pro rata minimum
distribution:
A Corporation's distribution... $60.80 ........... ...........
B Corporation's distribution ........... $42.56 $103.36
($53.20 - [0.20 x $53.20]), or
($53.20 - $10.64).............
Amount of tax counted toward ........... ........... 10.64
minimum distribution............
Tax deemed paid by M Corporation
for 1966 for purposes of gross-
up under section 78 and foreign
tax credit:
($60.80/$80x$20)............... 15.20 ........... ...........
([$42.56/$42.56x$10.64] ........... 33.44 48.64
+[$53.20/$70x$30]) or
($10.64+$22.80)...............
Remaining 1966 earnings and
profits for future distribution
to M Corporation:
($80-$60.80)................... 19.20 ........... ...........
($70-$53.20)................... ........... 16.80 36.00
Foreign income tax attributable
to 1966 earnings and profits
remaining for future
distribution to M Corporation:
($19.20/$80x$20)............... 4.80 ........... ...........
($16.80/$70x$30)............... ........... 7.20 12.00
------------------------------------------------------------------------
[[Page 459]]
Example 2. The facts are the same as in example 1 except that A
Corporation pays foreign income tax at the rate of 30 percent and B
Corporation, at the rate of 20 percent; and A Corporation is allowed a
deduction, in computing its income subject to tax, for the full amount
of dividends received. The determination of tax deemed paid for 1966 is
as follows:
------------------------------------------------------------------------
A B Total
------------------------------------------------------------------------
Pretax and predistribution earnings and $100.00 $100.00 $200.00
profits..................................
Foreign income tax........................ 30.00 20.00 50.00
Consolidated earnings and profits......... 70.00 80.00 50.00
Effective foreign tax rate ($50/ ........ ........ 25%
[$150+$50])..............................
Statutory percentage under section 963(b). ........ ........ 76%
Amount distributed by foreign corporations
as a pro rata minimum distribution for
1966 and amount received by M
Corporation:
(0.76x$70).............................. $53.20 ........ ........
(0.76x$80).............................. ........ $60.80 $114.00
Tax deemed paid by M Corporation for 1966
for purposes of gross-up under section 78
and foreign tax credit:
($53.20/$70x$30)........................ 22.80 ........ ........
($60.80/$80x$20)........................ ........ 15.20 38.00
Remaining 1966 earnings and profits for
future distribution to M Corporation:
($70-$53.20)............................ 16.80 ........ ........
($80-$60.80)............................ ........ 19.20 36.00
Foreign income tax attributable to 1966
earnings and profits remaining for future
distribution to M Corporation:
($16.80/$70x$30)........................ 7.20 ........ ........
($19.20/$80x$20)........................ ........ 4.80 12.00
------------------------------------------------------------------------
Example 3. For 1966, domestic corporation M makes a group election
with respect to controlled foreign corporations A and B, both of which
are wholly owned directly by M Corporation, and foreign branch C of M
Corporation. All such corporations use the calendar year as the taxable
year. Corporation M receives a pro rata minimum distribution from the
group for 1966 and applies thereto the special rules of this paragraph
and paragraph (b) of this section. Neither foreign corporation is a less
developed country corporation under section 902(d). Corporations A and B
pay foreign income tax at a flat rate of 20 percent and 30 percent,
respectively. The 1966 foreign income tax of corporations A and B which
is deemed paid by M Corporation under section 902(a) for 1966, and the
remaining tax which is allocated to earnings and profits to be
distributed to M Corporation in future years, are determined as follows:
------------------------------------------------------------------------
A B Branch C Total
------------------------------------------------------------------------
Pretax and predistribution $60.00 $60.00 ($20) $100.00
earnings and profits (and
deficit) of the group.........
Foreign income tax............. 12.00 18.00 ......... 30.00
Earnings and profits (and 48.00 42.00 (20) 70.00
deficit)......................
Allocation of deficit of Branch
C:
($48/[$48+$42]x$20).......... (10.67) ........ ......... ........
($42/[$48+$42]x$20).......... ........ (9.33) ......... ........
Consolidated earnings and 37.33 32.67 ......... 70.00
profits of the group..........
Effective foreign tax rate ($30/ ........ ........ ......... 30%
$100).........................
Statutory percentage under ........ ........ ......... 69%
section 963(b)................
Amount received by M
Corporation as pro rata
minimum distribution for 1966:
(0.69x$37.33)................ 25.76 ........ ......... ........
(0.69x$32.67)................ ........ 22.54 ......... $48.30
Tax deemed paid by M
Corporation for 1966 for
purposes of gross-up under
section 78 and foreign tax
credit:
($25.76/$37.33x$12).......... 8.28 ........ ......... ........
($22.54/$32.67x$18).......... ........ 12.42 ......... 20.70
Remaining 1966 earnings and
profits for future
distribution to M Corporation:
($48-$25.76)................. 22.24 ........ ......... ........
($42-$22.54)................. ........ 19.46 ......... 41.70
Foreign income tax attributable
to 1966 earnings and profits
remaining for future
distribution to M Corporation:
($12-$8.28).................. 3.72 ........ ......... ........
($18-$12.42)................. ........ 5.58 ......... 9.30
------------------------------------------------------------------------
Example 4. The facts are the same as in example 3 except that the
group does not make a pro rata minimum distribution but distributes
$48.30, consisting of $40 distributed by A Corporation and $8.30
distributed by B Corporation. Corporation M complies with the special
rules of this paragraph and paragraph (b) of this section. The 1966
foreign income tax of corporations A and B which is deemed paid by M
Corporation under section 902(a)
[[Page 460]]
for 1966, and the remaining tax which is allocated to earnings and
profits to be distributed to M Corporation in future years, are
determined as follows, the minimum overall tax burden for 1966 being
such as to satisfy the requirement of paragraph (a)(1)(ii)(b) of this
section:
------------------------------------------------------------------------
A B Branch C Total
------------------------------------------------------------------------
Amount received by M $40.00 $8.30 ......... $48.30
Corporation...................
Tax deemed paid by M
Corporation for 1966 for
purposes of gross-up under
section 78 and foreign tax
credit:
($37.33/$37.33x$12).......... 12.00 ........ ......... ........
($8.30/$32.67x$18)........... ........ 4.57 ......... 16.57
Remaining 1966 earnings and
profits for future
distribution to M Corporation:
($48-$40).................... 8.00 ........ ......... ........
($42-$8.30).................. ........ 33.70 ......... 41.70
------------------------------------------------------------------------
------------------------------------------------------------------------
A B Branch C Total
------------------------------------------------------------------------
Foreign income tax attributable
to 1966 earnings and profits
remaining for future
distribution to M Corporation:
($12-$12).................... 0 ........ ......... ........
($18-$4.57).................. ........ 13.43 ......... 13.43
------------------------------------------------------------------------
(3) Reduction and deferral of the foreign tax credit--(i) In
general. To the extent specified in paragraph (a)(1)(ii)(b) of this
section a reduction shall be made in the foreign tax credit allowable
under section 901 for the taxable year with respect to distributions
counting toward a minimum distribution for such year from the chain or
group; and such reduction in credit shall be allocated, as provided in
subdivision (ii) of this subparagraph, to foreign corporations in such
chain or group and deferred, as provided in subdivision (iii) of this
subparagraph, to subsequent taxable years of the United States
shareholder.
(ii) Allocation of reduction in foreign tax credit. The amount of
any reduction in foreign tax credit for the taxable year which is made
under subdivision (i) of this subparagraph with respect to a minimum
distribution for any taxable year from the chain or group shall be
allocated among any first-tier and second-tier corporations described in
section 902 (a) and (b), respectively, which are in such chain or group.
The amount of any such reduction in foreign tax credit shall be
allocated among such first-tier and second-tier corporations in the
ratio which the United States shareholder's proportionate share of
undistributed earnings and profits of each such corporation for the
taxable year bears to the total of such shareholder's proportionate
shares of the undistributed earnings and profits of all such
corporations for such year. None of such reduction shall be allocated to
any other corporations in the chain or group or to any foreign branches
included under paragraph (f)(4) of Sec. 1.963-1 in the group as wholly
owned foreign subsidiary corporations.
(iii) Deferral of allocated credit--(a) Allowance of credit in
subsequent years. The reduction in foreign tax credit allocated to a
first-tier or second-tier corporation in the chain or group for a
taxable year under subdivision (ii) of this subparagraph shall be deemed
paid under the principles of section 902 (applicable to foreign
corporations which are not less developed country corporations) with
respect to distributions, to the extent made by such corporation to the
United States shareholder referred to in subdivision (ii) of this
subparagraph, in a subsequent taxable year from the undistributed
earnings and profits of such corporation for such year of allocation.
Thus, for example, in the case of a distribution in the subsequent year
from such earnings and profits by a first-tier corporation, the tax
deemed paid shall be an amount which bears to the total of such
reduction in foreign tax credit the same ratio that the distribution to
the shareholder in the subsequent year bears to such shareholder's
proportionate share of such undistributed earnings and profits for the
year of allocation.
(b) Limitations on use of deferred credit. The deferred tax so
deemed paid shall be deemed paid for such subsequent
[[Page 461]]
taxable year and shall be allowed under section 901 (without regard to
the limitations under section 904) as a credit against the income tax
imposed for such year by chapter 1 of the Code, but the amount of such
credit shall not exceed the excess of the tax so imposed for such year
over the credit (determined without regard to this subdivision (iii)
allowed under sections 901 through 905 for such year. Any amount by
which the deferred tax so deemed paid in such subsequent taxable year
exceeds the limitation under the preceding sentence shall not be carried
back or carried over under section 904(d) to another taxable year of the
United States shareholder. No credit shall be allowed under this
subdivision for the subsequent taxable year to the extent that the
credit would reduce the tax of the United States shareholder under
chapter 1 of the Code on any minimum distribution for such year to which
section 963 applies.
(c) Gross-up not applicable. Any amount allowed as a credit for a
subsequent taxable year under this subdivision shall not be included in
the gross income of the United States shareholder for such year under
section 78.
(d) Illustrations. The application of this section may be
illustrated by the following examples, in which the surtax exemption
provided by section 11(c) is disregarded:
Example 1. (a) For 1966, domestic corporation M makes a chain
election with respect to controlled foreign corporation A, which it
wholly owns directly, and controlled foreign corporation B, which A
Corporation wholly owns directly. Corporation A is not a less developed
country corporation under section 902(d). All corporations use the
calendar year as the taxable year. For 1966, M Corporation complies with
the special rules of paragraphs (b) and (c) of this section. Corporation
A has pretax and predistribution earnings and profits for 1966 of $40
and is subject to foreign income tax at a flat rate of 36 percent, with
no deduction being allowed for dividends received or paid. B Corporation
has pretax and predistribution earnings and profits of $60 for 1966 and
is subject to a foreign income tax at a flat rate of 20 percent, with no
deduction being allowed for dividends received or paid. For 1967, B
Corporation has no earnings and profits, A Corporation has no earnings
and profits other than a dividend of $21.22 from B Corporation, and M
Corporation has taxable income of $20.98 from United States sources.
Corporation M uses the overall limitation under section 904(a)(2) on the
foreign tax credit.
(b) If a pro rata minimum distribution were made for 1966, the
overall United States and foreign income tax for such year with respect
to such distribution would be $41.30, determined as follows:
------------------------------------------------------------------------
A B Total
------------------------------------------------------------------------
Pretax and predistribution earnings and $40.00 $60.00 $100.00
profits..................................
Foreign income tax:
(0.36x$40).............................. 14.40 ........ ........
(0.20x$60).............................. ........ 12.00 $26.40
Consolidated earnings and profits......... 25.60 48.00 73.60
Effective foreign tax rate ($26.40/ ........ ........ 26.4%
[$73.60+$26.40]).........................
Statutory percentage under section 963(b). ........ ........ 69%
Amount distributed as pro rata minimum
distribution:
(0.69x$25.60)........................... 17.66 ........ ........
(0.69x$48).............................. ........ 33.12 $50.78
Amount received by M Corporation as pro
rata minimum distribution:
Corporation's distribution.............. 17.66 ........ ........
B Corporation's distribution ($33.12- ........ 21.20 38.86
[0.36x $33.12]), or ($33.12-$11.92)....
Gross-up under section 78:
($17.66/$25.60x$14.40).................. 9.94 ........ ........
($21.20 / $21.20 x [$11.92 + ($33.12 / ........ 20.20 30.14
$48 x $12)]), or ($11.92+$8.28)........
---------
Taxable income of M Corporation........... ........ ........ 69.00
---------
U.S. tax before foreign tax credit ........ ........ 33.12
($69x0.48)...............................
Foreign tax credit (as determined under ........ ........ 30.14
gross-up above)..........................
---------
U.S. tax payable.......................... ........ ........ 2.98
=========
Overall U.S. and foreign income tax with ........ ........ 41.30
respect to pro rata minimum distribution
($26.40+$11.92+$2.98)....................
=========
------------------------------------------------------------------------
(c) The chain, however, does not make a pro rata distribution for
1966, but distributes $24 from A Corporation's earnings and profits and
$26.78 from B Corporation's earnings and profits, the total distribution
of $50.78 being equal to the statutory percentage of the consolidated
earnings and profits (0.69x$73.60) of the chain with respect to M
Corporation. Thus, M Corporation must make such a reduction in its
foreign tax credit that the overall United States and foreign income tax
for 1966 with respect to the distribution equals the lesser of $41.30
(the overall United States and foreign income tax which would be paid
with respect to a pro rata minimum
[[Page 462]]
distribution) and $43.20 (90 percent of 48 percent of pretax and
predistribution consolidated earnings and profits of $100). The
remaining 1956 earnings and profits of the chain are distributed late in
1967. Corporation M determines its tax as follows for such years:
1966
------------------------------------------------------------------------
A B Total
------------------------------------------------------------------------
Distributions made........................ $24.00 $26.78 $50.78
Amount received by M Corporation:
A Corporation's distribution.......... 24.00 ........ ........
B Corporation's distribution ($26.78- ........ 17.14 41.14
[0.36x 26.78]), or ($26.78-$9.64)....
Gross-up under section 78:
($24/$25.60x$14.40)..................... 13.50 ........ ........
($17.14 / $17.14 x [$9.64 + ($26.78 / ........ 16.34 29.84
$48 x $12)]), or ($9.64+$6.70).........
---------
Taxable income of M Corporation........... ........ ........ $70.98
=========
Tentative U.S. tax before foreign tax ........ ........ 34.07
credit ($70.98x.48)......................
Less: Tentative foreign tax credit (as ........ ........ 29.84
computed under gross-up above)...........
---------
Tentative U.S. tax payable................ ........ ........ 4.23
=========
Tentative overall U.S. and foreign income ........ ........ 40.27
tax ($26.40+$9.64+$4.23).................
Overall U.S. and foreign tax which would ........ ........ 41.30
be paid with respect to a pro rata
minimum distribution (part (b) of this
example).................................
Insufficient overall U.S. and foreign ........ ........ 1.03
income tax ($41.30-$40.27)...............
Reduced foreign tax credit ($29.84-$1.03). ........ ........ 28.81
U.S. tax payable ($34.07-$28.81).......... ........ ........ 5.26
Overall U.S. and foreign income tax ........ ........ 41.30
($26.40+$9.64+$5.26).....................
Reduction in foreign tax credit to be ........ ........ 1.03
deferred ($29.84-$28.81).................
Remaining 1966 earnings and profits of:
A Corporation ($25.60-$24).............. $1.60 ........ ........
B Corporation ($48-$26.78).............. ........ $21.22 22.82
Allocation of reduction in foreign tax
credit to remaining 1966 earnings and
profits of:
A Corporation ($1.60/22.82x$1.03)....... .07 ........ ........
B Corporation ($21.22/$22.82x$1.03)..... ........ .96 1.03
Foreign income tax attributable to
remaining 1966 earnings and profits of:
A Corporation ($1.60/$25.60x$14.40)..... .90 ........ ........
B Corporation ($21.22/$48x$12).......... ........ 5.30 6.20
-------------------------------------------
1967
------------------------------------------------------------------------
Taxable income of M Corporation consisting
of distributions from:
A Corporation's remaining 1966 earnings 1.60 ........ ........
and profits............................
B Corporation's remaining 1966 earnings ........ 13.58 15.18
and profits ($21.22-[.36x21.22]), or
($21.22-$7.64).........................
Gross-up under section 78:
($1.60/$1.60x$0.90)..................... .90 ........ ........
($13.58/$13.58x [$7.64+($21.22/ ........ 12.94 13.84
21.22x$5.30)]).........................
---------
Taxable income from sources without the ........ ........ 29.02
U.S......................................
Taxable income from sources within the ........ ........ 20.98
U.S......................................
---------
Total taxable income of M Corporation... ........ ........ 50.00
=========
U.S. tax before foreign tax credit ........ ........ 24.00
(0.48x$50)...............................
Foreign tax credit:
Tax deemed paid under section 902:
$13.84, but not to exceed section 904 ........ ........ 13.84
limitation of $13.93 ($29.02/$50x$24)
(see gross-up above).................
Tax deemed paid under the principles of
section 902:
($1.60/$1.60x$0.07)................... .07 ........ ........
($21.22/$21.22x 0.96)................. ........ .96 1.03
U.S. tax payable ($24-[$13.84+$1.03])..... ........ ........ 9.13
------------------------------------------------------------------------
Example 2. (a) For 1963, domestic corporation M makes a group
election with respect to controlled foreign corporations A and B, both
of which M Corporation wholly owns directly. All such corporations use
the calendar year as the taxable year. Corporation A is created under
the laws of foreign country X, and B Corporation is created under the
laws of foreign country Y; neither of such corporations is a less
developed country corporation under section 902(d). Corporation
[[Page 463]]
M complies with the special rules of paragraphs (b) and (c) of this
section. Each foreign corporation has pretax earnings and profits of
$100 for 1963. The income of A Corporation is subject to a foreign
income tax rate of 20 percent, and the income of B Corporation is
subject to a foreign income tax rate of 30 percent. Corporation M uses
the per-country limitation under section 904(a)(1) on the foreign tax
credit.
(b) If a pro rata minimum distribution were made for 1963, the group
would distribute $123 based upon an effective foreign tax rate of 25
percent ($50/[$50+$150]) and a statutory percentage of 82 percent under
section 963(b); of this amount $57.40 (0.82x$70) would be distributed
from B Corporation's earnings and profits and $65.60 (0.82x$80) would be
distributed from A Corporation's earnings and profits. In such case, the
overall United States and foreign income tax for 1963 with respect to
the pro rata minimum distribution would be determined as follows, using
the 52 percent United States corporate income tax rate applicable for
such year:
Taxable income of M Corporation from sources in--
Y Country:
B Corporation dividend.......................... $57.40 ........
Gross-up under section 78 ($57.40/$70x$30)........ 24.60 $82.00
----------
X Country:
A Corporation dividend............................ 65.60 ........
Gross-up under section 78 ($65.60/$80x$20)........ 16.40 82.00
-----------
Taxable income.................................. ........ 164.00
=========
U.S. tax before tax credit (0.52x$164).............. ........ 85.28
Foreign tax credit:
Y Country tax..................................... 24.60 ........
X Country tax..................................... 16.40 41.00
-----------
U.S. tax payable.................................... ........ 44.28
=========
Overall U.S. and foreign income tax with respect to ........ 94.28
pro rata minimum distribution ($44.28+ $50)........
(c) The group, however, does not make a pro rata minimum
distribution for 1963 but distributes $123, consisting of $70 from B
Corporation's earnings and profits and $53 from A Corporation's earnings
and profits. Thus, M Corporation must make such a reduction in its
foreign tax credit that the overall United States and foreign income tax
for 1963 with respect to the distribution equals the lesser of $94.28
(the overall United States and foreign income tax which would be paid
with respect to a pro rata minimum distribution) and $93.60 (90 percent
of 52 percent of pretax and predistribution consolidated earnings and
profits of $200). The remaining 1963 earnings and profits of the group
are distributed late in 1964. Neither A Corporation nor B Corporation
has earnings and profits for 1964. Corporation M determines its tax as
follows for such years, assuming a 52 percent (instead of 50 percent)
United States corporate income tax rate for 1964:
1963
Taxable income of M Corporation from sources in--
Y Country:
B Corporation dividend.......................... $70.00 ........
Gross-up under section 78 ($70/$70x$30)......... 30.00 $100.00
----------
X Country:
A Corporation dividend............................ 53.00 ........
Gross-up under section 78 ($53/$80x$20)......... 13.25 66.25
-------------------
Taxable income for 1963....................... ........ 166.25
=========
U.S. tax before foreign tax credit (0.52x$166.25)... ........ 86.45
Less: Tentative foreign tax credit:
Y Country tax ($30.00 but not to exceed ($100.00/ 30.00 ........
$166.25x$86.45))...............................
X Country tax ($13.25 but not to exceed ($66.25/ 13.24 43.25
$166.25x$86.45))...............................
-------------------
Tentative U.S. tax payable.......................... ........ 43.20
=========
Tentative overall U.S. and foreign income tax ........ 93.60
($50+$43.20).......................................
Insufficient overall U.S. and foreign income tax ........ .40
($93.60-$93.20)....................................
Reduced foreign tax credit ($43.25-$0.40)........... ........ 42.85
U.S. tax payable for 1963 ($86.45-$42.85)........... ........ 43.00
Overall U.S. and foreign income tax ($50+$43.60).... ........ 93.60
Reduction in foreign tax credit to be deferred ........ .40
($43.25-$42.85)....................................
Remaining 1963 earnings and profits of:
A Corporation ($80-$53)........................... 27.00 ........
B Corporation ($70-$70)........................... 0 27.00
----------
Allocation of reduction in foreign tax credit to ........ .40
remaining 1963 earnings and profits of A
Corporation ($27/$27x $0.40).......................
Foreign income tax attributable to remaining 1963
earnings and profits of:
A Corporation ($20-$13.25)........................ 6.75 ........
B Corporation ($30-$30)........................... 0 6.75
----------
1964
Taxable income of M Corporation from sources in X
Country:
A Corporation dividend............................ ........ 27.00
Gross-up under section 78 ($27/$27x $6.75)........ ........ 6.75
---------
Taxable income for 1964......................... ........ 33.75
=========
U.S. tax before foreign tax credit ($33.75x0.52).... ........ 17.55
Less: Foreign tax credit:
Tax deemed paid under section 902 (as computed 6.75 ........
under gross-up, but not to exceed $33.75/$33.75
x $17.55)......................................
Tax deemed paid under the principles of section .40 7.15
902 ($27/$27x$0.40)............................
-------------------
U.S. tax payable for 1964........................... ........ 10.40
=========
[[Page 464]]
Example 3. (a) For 1966, domestic corporation M makes a chain
election with respect to controlled foreign corporation A, which it
wholly owns directly, and controlled foreign corporation B, which A
Corporation wholly owns directly. Corporation A is a less developed
country corporation under section 902(d). All corporations use the
calendar year as the taxable year. For 1966, each of the foreign
corporations has pretax and predistribution earnings and profits of
$100. The income of A Corporation is subject to a foreign income tax
rate of 20 percent, with no deduction being allowed for dividends
received or paid; and the income of B Corporation is subject to a
foreign income tax rate of 30 percent on such basis. During 1966, B
Corporation distributes $50 to A Corporation, and A Corporation
distributes $104 to M Corporation. During 1967 the remaining 1966
earnings and profits of such corporations are distributed to M
Corporation.
(b) If M Corporation were not to comply with the special rules of
paragraphs (b) and (c) of this section and were to deduct foreign income
tax on intercorporate distributions under paragraph (d)(1)(iii) of Sec.
1.963-2, the chain would not be considered to make a minimum
distribution for 1966 because, although it makes a distribution which is
sufficient in amount to constitute a minimum distribution, the overall
United States and foreign income tax for such year with respect to such
distribution would be insufficient under paragraph (a)(1)(i) of this
section. The determination that M Corporation would not be entitled to
the section 963 exclusion for 1966 by reason of such distribution in
such circumstances is made as follows:
------------------------------------------------------------------------
A B Total
------------------------------------------------------------------------
Pretax earnings and profits................... $150 $100 ........
Reduction for intercorporate dividends........ 50 ...... ........
----------------
Pretax and predistribution earnings and 100 100 $200.00
profits......................................
Reduction for foreign income tax on such 20 30 50.00
pretax and predistribution earnings and
profits......................................
---------
Predistribution earnings and profits.......... 80 70 150.00
Reduction for foreign income tax on 10 ...... 10.00
intercorporate distributions of 1966 earnings
and profits ($50x0.20).......................
---------
Consolidated earnings and profits of the chain 70 70 140.00
---------
Consolidated foreign income taxes ...... ...... 60.00
($30+$20+$10)................................
Effective foreign tax rate ($60/ [$140+$60]).. ...... ...... 30%
Statutory percentage under section 963(b)..... ...... ...... 69%
Amount of a minimum distribution ($140x0.69).. ...... ...... 96.60
Overall United States and foreign income tax ...... ...... 86.40
required to be paid (part (a)(1)(i) of this
section) (0.90x [0.22+0.26]x$200)............
Tentative taxable income of M Corporation..... ...... ...... $104.00
Tentative U.S. tax before foreign tax credit ...... ...... 49.92
(0.48x$104)..................................
Tentative foreign tax credit ($104/ ...... ...... 33.80
$120x[($120/$150x$30)+($50/ $100x$30)] or
($104/$120x$39)..............................
Tentative U.S. tax payable ($49.92- $33.80)... ...... ...... 16.12
Overall U.S. and foreign income tax ...... ...... 76.12
($60+$16.12).................................
Insufficient overall U.S. and foreign income ...... ...... 10.28
tax ($86.40-$76.12)..........................
------------------------------------------------------------------------
(c) By complying with the special rules of paragraphs (b) and (c) of
this section, however, M Corporation will receive a minimum distribution
for 1966 if it receives the statutory percentage of consolidated
earnings and profits and if the overall United States and foreign income
tax with respect to the distribution which is made is at least the
lesser of $86.40 (0.90x0.48x$200) and of the overall United States and
foreign income tax which would be paid with respect to a pro rata
minimum distribution from the chain. If a pro rata minimum distribution
were made for 1966, the chain would be required to distribute earnings
and profits of $114, based upon an effective foreign tax rate of 25
percent ($50/[$50+$150]) and a statutory percentage of 76 percent under
section 963(b); of this amount $53.20 (0.76x$70) would be distributed
from B Corporation's earnings and profits and $60.80 (0.76x$80) would be
distributed from A Corporation's earnings and profits. The overall
United States and foreign income tax with respect to such a pro rata
minimum distribution would be $73.62, determined as follows:
Taxable income of M Corporation ($60.80+[$53.20- ........ $103.36
($53.20x0.20)])....................................
U.S. tax before foreign tax credit (0.48 x$103.36).. ........ 49.61
Foreign tax credit:
B Corporation's distribution ($53.20/ $24.47 ........
[$70+$30]x$30)+ ($42.56+ $10.64]x$10.64).........
A Corporation's distribution ($60.80/[$80+20]x$20) 12.16 36.63
-----------
U.S. tax payable.................................... ........ 12.98
=========
Overall U.S. and foreign income tax with respect to ........ 73.62
pro rata minimum distribution ($50+ $10.64+$12.98).
(d) The United States income tax of M Corporation for 1966 and 1967
is determined as follows, assuming that the minimum overall tax burden
is determined under paragraph (a)(1)(ii)(b) of this section:
[[Page 465]]
1966
Dividend from earnings and profits of--
B Corporation ($50 minus tax of $10 on A ........ $40.00
Corporation at the rate of 20 percent)...........
A Corporation..................................... ........ 64.00
---------
Taxable income of M Corporation..................... ........ 104.00
=========
U.S. tax before foreign tax credit (0.48x$104)...... ........ $49.92
Less: Foreign tax credit:
B Corporation's distribution ($50/ $23.00 ........
[$70+$30]x$30+($40/[$40+$10]x$10), or ($15+$8)...
A Corporation's distribution ($64/$80+$20]x$20)... 12.80 35.80
-----------
U.S. tax payable.................................... ........ $14.12
=========
Overall U.S. and foreign income tax with respect to ........ 74.12
actual distribution ($50+$10+$14.12)...............
Overall U.S. and foreign income tax that would be ........ 73.62
paid with respect to a pro rata minimum
distribution (part (c) of this example)............
Remaining 1966 earnings and profits for future
distribution by:
B Corporation ($70-$50)........................... ........ 20.00
A Corporation ($80-$64)........................... ........ 16.00
---------
Total............................................ ........ 36.00
=========
Foreign income tax attributable to remaining 1966
earnings and profits of:
B Corporation ($20/$70x$30)....................... ........ 8.57
A Corporation ($16/$80x$20)....................... ........ 4.00
1967
Dividend from remaining 1966 earnings and profits
of--
B Corporation ($20 minus tax of $4 on A ........ 16.00
Corporation at the rate of 20 percent)...........
A Corporation..................................... ........ 16.00
---------
Taxable income of M Corporation..................... ........ 32.00
=========
U.S. tax before foreign tax credit (0.48x$32)....... ........ 15.36
Less: Foreign tax credit:
B Corporation's distribution ($20/ $9.20 ........
[$20+$8.57]x$8.57)+($16/[$16+$4] x$4), or
($6+$3.20).......................................
A Corporation's distribution ($16/ [$16+$4]x$4)... 3.20 12.40
-----------
U.S. tax payable.................................... ........ 2.96
---------
Example 4. (a) Domestic corporation M directly owns 90 percent of
the one class of stock of controlled foreign corporation A, which
directly owns 80 percent of the one class of stock of controlled foreign
corporation B, which in turn directly owns 60 percent of the one class
of stock of controlled foreign corporation C. None of the foreign
corporations are less developed country corporations under section
902(d); all corporations use the calendar year as the taxable year. For
1963, M Corporation makes a chain election with respect to corporations
A, B, and C and receives a distribution from the consolidated earnings
and profits of the chain which does not constitute a pro rata minimum
distribution. The remaining 1963 consolidated earnings and profits of
the chain are distributed late in 1964, for which year it is assumed
that the United States corporate income tax rate is the same (52
percent) as for 1963. No corporation in the chain has earnings and
profits for 1964 other than from distributions received from remaining
1963 earnings and profits of another corporation in the chain. The
foreign country under the laws of which A Corporation is created does
not tax dividends which are received by such corporation from B
Corporation, but B Corporation is taxed on dividends received from C
Corporation. Corporation M complies with the special rules of paragraphs
(b) and (c) of this section and determines the minimum overall tax
burden under paragraph (a)(1)(ii)(b) of this section with respect to the
distribution which is made. Corporation M uses the overall limitation
under section 904(a)(2) on the foreign tax credit. The distribution
received by M Corporation for 1963 from the consolidated earnings and
profits of the chain is sufficient in amount to constitute a minimum
distribution. The overall United States and foreign income tax for 1963
with respect to the distribution which is made must be at least equal to
the lesser of $32.21 (the amount payable, as determined under paragraph
(b) of this example, with respect to a pro rata minimum distribution)
and $31.34 (90 percent of 52 percent of pretax and predistribution
consolidated earnings and profits of $66.96).
(b) If the chain were to make a pro rata minimum distribution, the
distributions and the overall United States and foreign income tax for
1963 with respect to the minimum distribution would be determined as
follows, based upon the facts assumed:
----------------------------------------------------------------------------------------------------------------
A B C Total
----------------------------------------------------------------------------------------------------------------
Pretax and predistribution earnings and profits..................... $20.00 $50.00 $30.00
Reduction for foreign income tax on such earnings and profits (10%, 2.00 20.00 3.00
40%, and 10%, respectively)........................................
---------------------------------
Predistribution earnings and profits................................ 18.00 30.00 27.00
=================================
Consolidated earnings and profits with respect to M Corporation:
(0.90x$18)........................................................ 16.20
(0.90x0.80x$30) or (0.72x$30)..................................... ......... 21.60
(0.90x0.80x0.60x$27) or (0.432x$27)............................... ......... ......... 11.66 $49.46
[[Page 466]]
Consolidated foreign income taxes with respect to M Corporation:
($16.20/$18x$2)................................................... 1.80
($21.60/$30x$20).................................................. ......... 14.40
($11.66/$27x$3)................................................... ......... ......... 1.30 17.50
Effective foreign tax rate of the chain for 1963 ($17.50/ ......... ......... ......... 26.14%
[$49.46+$17.50]), or ($17.50/ $66.96)..............................
Statutory percentage under section 963(b)........................... ......... ......... ......... 82%
Pro rata minimum distribution (before reduction of dividend from C
Corporation's share by B Corporation tax paid on such amount):
(0.82x$16.20)..................................................... 13.28
(0.82x$21.60)..................................................... ......... 17.71
(0.82x$11.66)..................................................... ......... ......... 9.56
(0.82x$49.46)..................................................... ......... ......... ......... 40.56
Such amounts as reduced by further foreign income tax imposed on
distributions through the chain:
No further foreign tax............................................ 13.28
No further foreign tax............................................ ......... 17.71
B Corporation tax ($9.56-[0.40x$9.56]), or ($9.56-$3.82).......... ......... ......... 5.74 36.73
Gross-up under section 78:
($13.28/$16.20x$1.80)............................................. 1.48
($17.71/$21.60x$14.40)............................................ ......... 11.81
($5.74/$5.74x$3.82)............................................... ......... 3.82 ......... 17.11
M Corporation's taxable income for 1963 attributable to minimum ......... ......... ......... 53.84
distribution ($36.73+$17.11).......................................
U.S. tax before foreign tax credit ($53.84x0.52).................... ......... ......... ......... 28.00
Foreign tax credit (as determined under gross-up above)............. ......... ......... ......... 17.11
U.S. tax payable for 1963 ($28-$17.11).............................. ......... ......... ......... 10.89
Overall U.S. and foreign income tax with respect to pro rata minimum ......... ......... ......... 32.21
distribution ($17.50+$3.82+$10.89).................................
----------------------------------------------------------------------------------------------------------------
(c) Based upon the distributions which are made by corporations A,
B, and C, M. Corporation pays United States tax as follows for 1963 and
1964:
1963
----------------------------------------------------------------------------------------------------------------
A B C Total
----------------------------------------------------------------------------------------------------------------
Distribution made from consolidated earnings and profits of the $9.36 $21.60 $9.60 $40.56
chain..............................................................
Excess of distribution over statutory percentage of consolidated ......... ......... ......... None
earnings and profits for 1963 ($40.56-[0.82x$49.46])...............
Determination of whether the overall U.S. and foreign income tax
with respect to the actual distribution is equal to, or exceeds,
the lesser of $32.21 (paragraph (b) of example) and $31.34
(paragraph (a) of example):
Amount received by M Corporation after reduction by further
foreign income tax imposed on distributions through the chain:
No further foreign tax.......................................... 9.36
No further foreign tax.......................................... ......... 21.60
B Corporation tax ($9.60-[0.40x$9.60]), or ($9.60-$3.84)........ ......... ......... 5.76 36.72
Gross-up under section 78:
($9.36/$16.20x$1.80)............................................ 1.04
($21.60/$21.60x$14.40).......................................... ......... 14.40
($5.76/$5.76x$3.84)............................................. ......... 3.84 ......... 19.28
Taxable income of M Corporation for 1963 attributable to actual ......... ......... ......... 56.00
distribution ($36.72+$19.28).......................................
U.S. tax before foreign tax credit ($56x0.52)..................... ......... ......... ......... 29.12
Tentative foreign tax credit (as determined under gross-up above). ......... ......... ......... 19.28
Tentative U.S. tax payable ($29.12-$19.28)........................ ......... ......... ......... 9.84
Overall U.S. and foreign income tax with respect to actual ......... ......... ......... 31.18
distribution ($17.50+ $3.84+$9.84)...............................
Insufficient overall U.S. and foreign income tax ($31.34 [i.e., ......... ......... ......... .16
0.90x0.52x$66.96]- 31,18)........................................
Reduced foreign tax credit ($19.28-$0.16)........................... ......... ......... ......... 19.12
U.S. tax payable for 1963 ($29.12-$19.12)........................... ......... ......... ......... 10.00
Overall U.S. and foreign income tax with respect to actual ......... ......... ......... 31.34
distribution ($17.50+$3.84+$10)....................................
Allocation of reduction in foreign tax credit to undistributed
consolidated 1963 earnings and profits of A and B Corporations to
be deemed paid by M Corporation in future years:
Reduction in foreign tax credit ($19.28-$19.12)................... ......... ......... ......... .16
Undistributed 1963 consolidated earnings and profits of the chain:
($16.20-$9.36).................................................. 6.84
($21.60-$21.00)................................................. ......... 0
[[Page 467]]
($11.66-$9.60).................................................. ......... ......... $2.06 8.90
Allocation of reduction in credit:
($6.84/$6.84x$0.16)............................................. .16 ......... ......... .16
Foreign income tax attributable to undistributed 1963 earnings and
profits of the chain to be taken into account in determining tax
deemed paid under section 902:
($1.80-$1.04)................................................... .76 ......... ......... .........
($14.40-$14.40)................................................. ......... ......... ......... .7
1964
Distribution from remaining 1963 consolidated earnings and profits
of the chain:
($16.20-$9.36).................................................... 6.84
($21.60-$21.60)................................................... ......... 0
($11.66-$9.60).................................................... ......... ......... 2.06 8.90
Such amounts as reduced by further foreign income tax imposed on
distributions through the chain:
No further foreign tax............................................ 6.84
B Corporation tax ($2.06-[0.40x$2.06]), or ($2.06-$0.82).......... ......... 1.24 ......... 8.08
Gross-up under section 78:
($6.84/$6.84x$0.76)............................................... 0.76
($1.24/$1.24x$0.82)............................................... ......... 0.82 ......... 1.58
Taxable income of M Corporation for 1964 attributable to 1964 ......... ......... ......... 9.66
distribution ($8.08+$1.58).........................................
U.S. tax before foreign tax credit ($9.66x0.52)..................... ......... ......... ......... 5.02
Foreign tax credit:
Deferred credit in accordance with principles of section 902 0.16 ......... ......... 0.16
($6.84/$6.84x$0.16)..............................................
Tax deemed paid under section 902 (computed under gross-up above). ......... ......... ......... 1.58
U.S. tax payable for 1964 ($5.02-[$0.16+$1.58])..................... ......... ......... ......... 3.28
----------------------------------------------------------------------------------------------------------------
Example 5. (a) Domestic corporation M directly owns all the one
class of stock of each of controlled foreign corporations A, B, C, and
D. All such corporations use the calendar year as the taxable year. None
of the foreign corporations is a less developed country corporation
under section 902(d). For 1963, M Corporation makes a group election
with respect to corporations A, B, C, and D and receives from the 1963
consolidated earnings and profits of the group a distribution which is
not a pro rata minimum distribution. None of the foreign corporations
has earnings and profits for 1964, but the remaining 1963 earnings and
profits of the group are distributed late in 1964, for which year it is
assumed that the United States corporate income tax rate is the same (52
percent) as for 1963. The overall limitation under section 904(a)(2) on
the foreign tax credit applies for both years.
(b) Assume that M Corporation does not comply with the special rules
of paragraphs (b) and (c) of this section and that for 1963 it draws a
distribution of all of B Corporation's earnings and profits and enough
of C Corporation's earnings and profits to receive the amount of a
minimum distribution and to assure that the overall United States and
foreign income tax for such year with respect to the distribution from
the group satisfies the overall minimum tax requirement of paragraph
(a)(1)(i) of this section. In such case, the overall United States and
foreign income tax for 1963 with respect to the distribution which is
made, determined by using the foreign tax credit under section 901
without applying the special credit rules of paragraph (c) of this
section, must at least equal $37.44 (90 percent of 52 percent of pretax
and predistribution consolidated earnings and profits of $80).
Corporation M's United States income tax for 1963 and 1964 with respect
to the distribution of the 1963 earnings and profits of the group is
determined as follows, based upon the facts assumed:
1963
----------------------------------------------------------------------------------------------------------------
A B C D Total
----------------------------------------------------------------------------------------------------------------
Pretax and predistribution earnings and profits (and $25.00 $25.00 $50.00 ($20.00) $80.00
deficits) of the group..................................
Consolidated foreign income taxes........................ 2.50 12.50 15.00 ......... 30.00
Consolidated earnings and profits........................ 22.50 12.50 35.00 (20.00) 50.00
Effective foreign tax rate ($30/[$50+$30])............... ......... ......... ......... ......... 37.5%
Statutory percentage under section 963(b)................ ......... ......... ......... ......... 68%
[[Page 468]]
Amount of a minimum distribution (0.68x$50).............. ......... ......... ......... ......... 34.00
Tentative distribution................................... ......... 12.50 21.50 ......... 34.00
Tentative gross-up under section 78:
($12.50/$12.50x$12.50) ......... 12.50 ......... ......... .........
($21.50/$35x$15) ......... ......... 9.21 ......... 21.71
Tentative taxable income of M Corporation ($34+$21.71)... ......... ......... ......... ......... 55.71
Tentative U.S. tax before foreign tax credit ......... ......... ......... ......... 28.97
(0.52x$55.71)...........................................
Tentative foreign tax credit (as computed under gross-up ......... ......... ......... ......... 21.71
above)..................................................
Tentative U.S. tax payable ($28.97-$21.71)............... ......... ......... ......... ......... 7.26
Tentative overall U.S. and foreign income tax ($30+$7.26) ......... ......... ......... ......... 37.26
Minimum overall U.S. and foreign income tax required to ......... ......... ......... ......... 37.44
be paid (0.90x .52x$80).................................
Insufficient overall U.S. and foreign income tax ($37.44- ......... ......... ......... ......... .18
$37.26).................................................
Revised distribution..................................... ......... 12.50 22.07 ......... 34.57
Gross-up under section 78:
($12.50/$12.50x$12.50)................................. ......... 12.50 ......... ......... .........
($22.07/$35x$15)....................................... ......... ......... 9.46 ......... 21.96
Taxable income of M Corporation ($34.57+$21.96).......... ......... ......... ......... ......... 56.53
U.S. tax before foreign tax credit (.52x$56.53).......... ......... ......... ......... ......... 29.40
Foreign tax credit (as computed under gross-up above).... ......... ......... ......... ......... 21.96
U.S. tax payable ($29.40-$21.96)......................... ......... ......... ......... ......... 7.44
Overall U.S. and foreign income tax on actual ......... ......... ......... ......... 37.44
distribution ($30+$7.44)................................
----------------------------------------------------------
1964
----------------------------------------------------------------------------------------------------------------
Distribution of remaining 1963 consolidated earnings and
profits:
($22.50-$0)............................................ 22.50
($12.50-$12.50)........................................ .........
($35-$22.07)........................................... ......... ......... 12.93 ......... 35.43
Gross-up under section 78:
($22.50/$22.50x$2.50).................................. 2.50
($12.93/$35x$15)....................................... ......... ......... 5.54 ......... 8.04
Taxable income of M Corporation ($35.43+$8.04)........... ......... ......... ......... ......... 43.47
U.S. tax before foreign tax credit ($43.47x0.52)......... ......... ......... ......... ......... 22.60
Foreign tax credit (as computed under gross-up above).... ......... ......... ......... ......... 8.04
U.S. tax payable ($22.60-$8.04).......................... ......... ......... ......... ......... 14.56
----------------------------------------------------------------------------------------------------------------
(c) Assume that M Corporation does comply with the special rules of
paragraphs (b) and (c) of this section and for 1963 receives a minimum
distribution consisting of $20 from A Corporation and $14 from C
Corporation. In such case, the overall United States and foreign income
tax for 1963 with respect to the minimum distribution must at least
equal the lesser of $37.44 (0.90 x 0.52 x $80) and the overall United
States and foreign income tax of $37.89 that would be paid with respect
to a pro rata minimum distribution from the group for such year. In such
case, the determinations would be made pursuant to subparagraphs (1) and
(2) of this paragraph.
(1) If a pro rata minimum distribution were made for 1963 by the
group, the overall United States and foreign income tax for such year
with respect to such distribution would be $37.89, determined as
follows:
----------------------------------------------------------------------------------------------------------------
A B C D Total
----------------------------------------------------------------------------------------------------------------
Pretax and predistribution earnings and profits (and $25.00 $25.00 $50.00 ($20) $80.00
deficits) of the group..................................
Consolidated foreign income taxes........................ 2.50 12.50 15.00 ......... 30.00
Consolidated earnings and profits before allocation of 22.50 12.50 35.00 ......... 70.00
deficits................................................
Allocation of deficit of D Corporation:
($22.50/$70x$20)....................................... (6.43)
($12.50/$70x$20)....................................... ......... (3.57) ......... ......... .........
($35/$70x$20).......................................... ......... ......... (10.00) ......... (20.00)
Consolidated earnings and profits........................ 16.07 8.93 25.00 ......... 50.00
Effective foreign tax rate ($30/$80)..................... ......... ......... ......... ......... 37.50%
Statutory percentage under section 963(b)................ ......... ......... ......... ......... 68%
Pro rata minimum distribution:
(0.68x$16.07).......................................... 10.93
(0.68x$8.93)........................................... ......... 6.07 ......... ......... .........
(0.68x$25)............................................. ......... ......... 17.00 ......... 34.00
Gross-up under section 78:
($10.93/$16.07x$2.50).................................. 1.70
[[Page 469]]
($6.07/$8.93x$12.50)................................... ......... 8.50 ......... ......... .........
($17/$25x$15).......................................... ......... ......... 10.20 ......... 20.40
Taxable income of M Corporation ($34+$20.40)............. ......... ......... ......... ......... 54.40
U.S. tax before foreign tax credit (0.52x$54.40)......... ......... ......... ......... ......... 28.29
Foreign tax credit (as computed under the gross-up above) ......... ......... ......... ......... 20.40
U.S. tax payable ($28.29-$20.40)......................... ......... ......... ......... ......... 7.89
Overall U.S. and foreign income tax with respect to pro ......... ......... ......... ......... 37.89
rata minimum distribution ($30+$7.89)...................
----------------------------------------------------------------------------------------------------------------
(2) Corporation M's United States income tax for 1963 and 1964 with
respect to the distribution of the 1963 earnings and profits of the
group is determined as follows:
1963
----------------------------------------------------------------------------------------------------------------
A B C D Total
----------------------------------------------------------------------------------------------------------------
Distributions actually made.............................. $20.00 ......... $14.00 ......... $34.00
Gross-up under section 78:
($16.07/$16.07x$2.50).................................. 2.50 ......... ......... ......... .........
($14/$25x$15).......................................... ......... ......... 8.40 ......... 10.90
Taxable income of M Corporation ($34+$10.90)............. ......... ......... ......... ......... 44.90
U.S. tax before foreign tax credit (0.52x$44.90)......... ......... ......... ......... ......... 23.35
Foreign tax credit (as computed under gross-up above).... ......... ......... ......... ......... 10.90
U.S. tax payable ($23.35-$10.90)......................... ......... ......... ......... ......... 12.45
Overall U.S. and foreign income tax with respect to the ......... ......... ......... ......... 42.45
distribution actually made ($30+$12.45), such amount
being in excess of the minimum overall tax burden of
$37.44..................................................
----------------------------------------------------------
1964
----------------------------------------------------------------------------------------------------------------
Earnings and profits for 1963 to which minimum
distribution for such year was not attributable:
($22.50-$20)........................................... $2.50 ......... ......... ......... .........
($12.50-$0)............................................ ......... $12.50 ......... ......... .........
($35.00-$14)........................................... ......... ......... $21.00 ......... $36.00
Foreign income tax for 1963 not taken into account in
determining tax deemed paid for such year on pretax
earnings and profits to which the minimum distribution
for such year was attributable:
([$16.07-$16.07]/$16.07x$2.50)......................... 0 ......... ......... ......... .........
([$8.93-$0]/$8.93x$12.50).............................. ......... 12.50 ......... ......... .........
([$25-$14]/$25x$15).................................... ......... ......... 6.60 ......... 19.10
Distributions to M Corporation in 1964................... 2.50 12.50 21.00 ......... 36.00
Gross-up under section 78:
($2.50/$2.50x$0)....................................... 0 ......... ......... ......... .........
($12.50/$12.50x$12.50)................................. ......... 12.50 ......... ......... .........
($21/$21x$6.60)........................................ ......... ......... 6.60 ......... 19.10
Taxable income of M Corporation ($36+$19.10)............. ......... ......... ......... ......... 55.10
U.S. tax before foreign tax credit (0.52x$55.10)......... ......... ......... ......... ......... 28.65
Foreign tax credit (as computed under gross-up above).... ......... ......... ......... ......... 19.10
U.S. tax payable ($28.65-$19.10)......................... ......... ......... ......... ......... 9.55
----------------------------------------------------------------------------------------------------------------
Example 6. Throughout 1963, domestic corporation M directly owns all
the one class of stock of controlled foreign corporations A, B, and C,
and maintains in a foreign country a branch which qualifies under
paragraph (f)(4) of Sec. 1.963-1 for inclusion in a group as a wholly
owned foreign subsidiary corporation. For 1963, a year for which the
overall limitation under section 904(a)(2) on the foreign tax credit
applies, M Corporation makes a group election with respect to A, B, and
C Corporations and the foreign branch. All such corporations use the
calendar year as the taxable year. The foreign branch has pretax and
predistribution earnings and profits of $40 for 1963, as determined
under paragraph (f)(4)(ii) of Sec. 1.963-1. None of the foreign
corporations is a less developed country corporation under section
902(d). Corporation M complies with the special rules of paragraphs (b)
and (c) of this section. The United States income tax of M Corporation
for 1963 is as follows, based upon the facts assumed:
[[Page 470]]
----------------------------------------------------------------------------------------------------------------
A B C Branch Total
----------------------------------------------------------------------------------------------------------------
Pretax and predistribution consolidated earnings and $20.00 $30.00 $10 $40 $100.00
profits of the group....................................
Consolidated income taxes................................ 2.00 15.00 5 20 42.00
Effective foreign tax rate ($42/$100).................... ......... ......... ......... ......... 42%
Statutory percentage under section 963(b)................ ......... ......... ......... ......... 40%
Posttax and predistribution consolidated earnings and 18.00 15.00 5 20 58.00
profits of the group....................................
U.S. tax which would be paid on a pro rata minimum
distribution from consolidated earnings and profits of
the group:
Pro rata minimum distribution (and amount which would
be received by M Corporation):
(0.40x$18)........................................... 7.20 ......... ......... ......... .........
(0.40x$15)........................................... ......... 6.00 ......... ......... .........
(0.40x$5)............................................ ......... ......... 2 ......... .........
(0.40x$40)........................................... ......... ......... ......... 16 31.20
Gross-up under section 78:
($7.20/$18x$2)....................................... .80 ......... ......... ......... .........
($6/$15x$15)......................................... ......... 6.00 ......... ......... .........
($2/$5x$5)........................................... ......... ......... 2 ......... 8.80
Taxable income of M Corporation ($31.20+$8.80)......... ......... ......... ......... ......... 40.00
U.S. tax before foreign tax credit (0.52x$40).......... ......... ......... ......... ......... 20.80
Foreign tax credit ($8.80, as computed under the gross- ......... ......... ......... ......... 16.80
up, plus 40 percent of $20)...........................
U.S. tax payable ($20.80-$16.80)....................... ......... ......... ......... ......... 4.00
Overall U.S. and foreign income tax with respect to a pro ......... ......... ......... ......... 46.00
rata minimum distribution for 1963 ($4+$42).............
Tentative tax on distribution actually received by M
Corporation:
Actual distribution received........................... ......... ......... $5 $40 $45.00
Gross-up under section 78 ($5/$5x$5)................... ......... ......... 5 ......... 5.00
Taxable income of M Corporation ($45+$5)............... ......... ......... ......... ......... 50.00
U.S. tax before foreign tax credit (0.52x$50).......... ......... ......... ......... ......... 26.00
Tentative foreign tax credit ($5, as computed under the ......... ......... ......... ......... 25.00
gross-up above, plus 100 percent of $20)..............
Tentative U.S. tax payable ($26-$25)................... ......... ......... ......... ......... 1.00
Insufficient overall U.S. and foreign income tax (the ......... ......... ......... ......... 3.00
lesser of $46 or $46.80 [0.90x0.52x$100] minus $43
[$1+$42])...............................................
Reduced foreign tax credit ($25-$3)...................... ......... ......... ......... ......... 22.00
U.S. tax payable ($26-$22)............................... ......... ......... ......... ......... 4.00
Overall U.S. and foreign income tax with respect to ......... ......... ......... ......... 46.00
actual distribution for 1963 ($4+$42)...................
Reduction in foreign tax credit for 1963 ($25-$22)....... ......... ......... ......... ......... 3.00
Allocation of reduction in foreign tax credit to
undistributed 1963 consolidated earnings and profits of
the group:
($18/[$18+$15]x$3.00).................................. 1.64 ......... ......... ......... .........
($15/[$18+$15]x$3.00).................................. ......... 1.36 ......... ......... 3.00
----------------------------------------------------------------------------------------------------------------
Example 7. Domestic group M, an affiliated group of domestic
corporations filing a consolidated return under section 1501, makes a
group election for 1963 with respect to a group consisting of two
controlled foreign corporations C and D, all of whose one class of stock
is directly owned by group M, and foreign branch B, a foreign branch of
a Western Hemisphere trade corporation (as defined in section 921)
included in group M. No distributions are received for the taxable year
from corporations C and D, but the foreign group makes a minimum
distribution by reason of the deemed distribution of all of branch B's
earnings and profits. Group M complies with the special rules of
paragraphs (b) and (c) of this section. For 1963, a year for which the
United States corporate income tax rate is 52 percent, the overall
limitation under section 904(a)(2) on the foreign tax credit applies.
All corporations use the calendar year as the taxable year. None of the
foreign corporations is a less developed country corporation under
section 902(d) for 1963. The income, and the United States and foreign
income tax for 1963, are determined as follows, based upon the facts
assumed:
----------------------------------------------------------------------------------------------------------------
Branch C D Total
----------------------------------------------------------------------------------------------------------------
Pretax and predistribution consolidated earnings and profits of the $100.00 $10.00 $10.00 $120.00
foreign group (before Western Hemisphere trade corporation
deduction).........................................................
Western Hemisphere trade corporation deduction ($100x0.14/0.52)..... 26.92 ......... ......... 26.92
Pretax and predistribution consolidated earnings and profits of the 73.08 10.00 10.00 93.08
foreign group (after Western Hemisphere trade corporation
deduction).........................................................
[[Page 471]]
Consolidated foreign income taxes (38%, 20%, and zero rate,
respectively):
(0.38x$100)....................................................... 38.00 ......... ......... .........
(0.20x$10)........................................................ ......... 2.00 ......... 40.00
Consolidated earnings and profits of the foreign group............ 35.08 8.00 10.00 53.08
Effective foreign tax rate ($40/$93.08)............................. ......... ......... ......... 43%
Statutory percentage under section 963(b)........................... ......... ......... ......... 40%
Tax which would be paid with respect to a pro rata minimum
distribution from consolidated earnings and profits of the foreign
group:
Pro rata minimum distribution:
(0.40x$73.08)................................................... 29.23 ......... ......... .........
(0.40x$8.00).................................................... ......... 3.20 ......... .........
(0.40x$10.00)................................................... ......... ......... 4.00 36.43
Gross-up under section 78: ($3.20/$8.00x$2)....................... ......... .80 ......... .80
Taxable income of group M......................................... 29.23 4.00 4.00 37.23
U.S. tax before foreign tax credit:
(0.52x$29.23)................................................... 15.20 ......... ......... .........
(0.54x$4.00).................................................... ......... 2.16 ......... .........
(0.54x$4.00).................................................... ......... ......... 2.16 19.52
Foreign tax credit ($0.80, as computed under the gross-up above, 15.20 .80 ......... 16.00
plus 40 percent of $38)..........................................
U.S. tax payable.................................................. ......... 1.36 2.16 3.52
Overall U.S. and foreign income tax with respect to pro rata ......... ......... ......... 43.52
minimum distribution ($3.52+$40).................................
Tentative tax on distribution actually received by group M:
Taxable income of branch.......................................... 73.08 ......... ......... 73.08
U.S. tax before foreign tax credit (0.52x$73.08).................. 38.00 ......... ......... 38.00
Tentative foreign tax credit...................................... 38.00 ......... ......... 38.00
Tentative U.S. tax payable........................................ ......... ......... ......... 0
Insufficient overall U.S. and foreign income tax (the lesser of ......... ......... ......... 3.52
$43.52 or $43.56 [0.90x0.52x$93.08] minus $40).....................
Reduced foreign tax credit ($38-$3.52).............................. ......... ......... ......... 34.48
U.S. tax payable ($38-$34.48)....................................... ......... ......... ......... 3.52
Overall U.S. and foreign income tax ($3.52+$40.00).................. ......... ......... ......... 43.52
Reduction in foreign tax credit for 1963 ($38-$34.48)............... ......... ......... ......... 3.52
Allocation of reduction in foreign tax credit to 1963 undistributed
consolidated earnings and profits of the foreign group:
($8/[$8+$10]x$3.52)............................................... ......... 1.56 ......... .........
($10/[$8+$10]x$3.52).............................................. ......... ......... 1.96 3.52
----------------------------------------------------------------------------------------------------------------
[T.D. 6759, 29 FR 13335, Sept. 25, 1964; 29 FR 13896, Oct. 8, 1964, as
amended by T.D. 6767, 29 FR 14878, Nov. 3, 1964; T.D. 7100, 36 FR 5336,
Mar. 20, 1971]
Sec. 1.963-5 Foreign corporations with variation in foreign tax rate
because of distributions.
(a) Limited application of section. The rules of this section shall
apply to a foreign corporation only if--
(1) Under the laws of a foreign country or possession of the United
States the foreign income tax of the corporation for the taxable year
depends upon the extent to which distributions are made by such
corporation from its earnings and profits for the taxable year, so that
the rate of such tax for the taxable year on income which is distributed
differs from the rate of such tax for such year on the income which is
not distributed, and
(2) The corporation--
(i) Is a single first-tier corporation, or
(ii) Is for the taxable year in a chain or group from which the
United States shareholder receives a minimum distribution in respect of
which the minimum overall tax burden is determined in accordance with
paragraph (a)(1)(ii) of Sec. 1.963-4.
(b) Foreign income tax determined as though no distributions were
made. The foreign income tax on the pretax and predistribution earnings
and profits of the foreign corporation for the taxable year shall
(solely for the purpose of determining the effective foreign tax rate
under paragraph (c) of Sec. 1.963-2) be determined as if the foreign
corporation made no distributions for the taxable year. However,
notwithstanding the second sentence of paragraph (d)(1) of Sec. 1.963-
2, where the United States shareholder owns the stock (with respect to
which the election under section 963 is
[[Page 472]]
made) in such corporation by reason of stock owned through a chain of
ownership described in section 958(a) and the foreign income tax of such
corporation for the taxable year decreases as distributions are made
from its earnings and profits, the rule in the preceding sentence shall
not apply if the electing United States shareholder does not actually
receive for the taxable year its proportionate share of the earnings and
profits which are actually distributed. In such case, the foreign income
tax on pretax and predistribution earnings and profits shall be the
actual foreign income tax of such corporation, computed on the basis of
the distributions which are made. For example, assume that a second-tier
foreign corporation in a chain has pretax and predistribution earnings
of $100 for the taxable year and that foreign law imposes on such
corporation a foreign income tax of 50 percent of the pretax earnings
and profits minus dividends for such year and of 20 percent of such
dividends. If the second-tier foreign corporation distributes $20 of
earnings and profits to a first-tier foreign corporation which is part
of the same chain, and if the first-tier corporation retains the
dividend so received, the foreign income tax of the second-tier foreign
corporation shall be considered to be the tax actually paid for the
taxable year, that is, $44 (50 percent of $80 plus 20 percent of $20).
If the first-tier foreign corporation distributes the dividend so
received, the foreign income tax of the second-tier foreign corporation
shall be considered to be $50 (50 percent of $100). For purposes of this
paragraph, the principles of paragraph (b)(3) of Sec. 1.963-4 shall
apply.
(c) Minimum distribution--(1) Single first-tier corporation. A
minimum distribution for a taxable year by a single first-tier
corporation described in paragraph (a)(1) of this section shall be a
distribution which is equal to--
(i) The amount resulting from the multiplication of the statutory
percentage specified in paragraph (b) of Sec. 1.963-2 for such year by
the United States shareholder's proportionate share of the earnings and
profits of such corporation, as determined under paragraph (d)(2)(i) of
Sec. 1.963-2 but without the deduction for foreign income tax provided
by paragraph (d)(1)(ii) and (iii) of such section, reduced by
(ii) The foreign income tax on the pretax amount determined under
subdivision (i) of this subparagraph which would be paid or accrued by
such corporation by reason of distributing such amount, less such tax,
for such taxable year.
(2) Corporation in a chain or group making a pro rata minimum
distribution. In case of a corporation described in paragraph (a)(2)(ii)
of this section in a chain or group, such corporation's share of a pro
rata minimum distribution by the chain or group for the taxable year
shall be--
(i) The amount resulting from the multiplication of the statutory
percentage specified in paragraph (b) of Sec. 1.963-2 for the taxable
year by the United States shareholder's proportionate share of the
earnings and profits of such corporation, as determined under paragraph
(d)(3) of Sec. 1.963-2 but without the deduction for foreign income tax
provided by paragraph (d)(1)(ii) and (iii) of such section, reduced by
(ii) The foreign income tax on the pretax amount determined under
subdivision (i) of this subparagraph which would be paid or accrued by
such corporation by reason of distributing such amount, less such tax,
for such taxable year.
(3) A chain or group making a distribution other than a pro rata
minimum distribution. If a chain or group contains one or more foreign
corporations described in paragraph (a)(2)(ii) of this section and such
chain or group makes a minimum distribution other than a pro rata
minimum distribution for the taxable year, the amount of such minimum
distribution to the electing United States shareholder shall be at
least--
(i) The amount resulting from the multiplication of the statutory
percentage specified in paragraph (b) of Sec. 1.963-2 for the taxable
year by the consolidated earnings and profits of such chain or group
with respect to such shareholder, as determined under paragraph (d)(3)
of such section but without any deduction for foreign income tax
provided by paragraph
[[Page 473]]
(d)(1)(ii) and (iii) of such section, reduced by
(ii) The foreign income tax on the pretax amount determined under
subdivision (i) of this subparagraph which would be paid or accrued by
the foreign corporations in the chain or group by reason of distributing
such amount, less such tax, for such taxable year.
(4) Illustrations. The application of this paragraph may be
illustrated by the following examples:
Example 1. Domestic corporation M directly owns 80 percent of the
one class of stock of single first-tier corporation B, which for 1964
has $100 of pretax earnings and profits on which is imposed a foreign
income tax of 40 percent of pretax earnings and profits minus dividends
for the taxable year and of 20 percent of the amount of such dividends.
Both corporations use the calendar year as the taxable year. The
effective foreign tax rate applicable to B Corporation, as determined
under paragraph (c) of Sec. 1.963-2, is 40 percent, and the statutory
percentage under paragraph (b) of Sec. 1.963-2 for 1964 is 38 percent.
Corporation M receives a minimum distribution for 1964 if it receives
from B Corporation's earnings and profits for such year $22.80, that is,
80 percent of $28.50, the distribution which would be made if there were
distributed that amount of earnings and profits which, together with the
foreign income tax at the rate effectively applicable to pretax earnings
and profits to which such distribution is attributable, equals 38
percent of $100. Such distribution may be determined by solving for
``d'' in the following formula:
d=$38-0.20d-0.40($38-d)
d=$38-0.20d-$15.20+0.40d
d=$22.80+0.20d
0.80 d=$22.80
d=$22.80/0.80
d=$28.50
Example 2. Domestic corporation M directly owns 80 percent of the
one class of stock of each of controlled foreign corporations A and B,
which constitute a group and each of which for 1964 has pretax earnings
and profits of $100. All corporations use the calendar year as the
taxable year. Corporation A is subject to foreign income tax at a flat
rate of 40 percent; and B Corporation is subject to a foreign income tax
of 40 percent of $100 minus dividends for the taxable year and of 20
percent of the amount of such dividends. The effective foreign tax rate
with respect to the group, as determined under paragraph (c) of Sec.
1.963-2, is 40 percent, and the statutory percentage under paragraph (b)
of Sec. 1.963-2 for 1964 is 38 percent. Corporation B distributes $25
for 1964 toward a minimum distribution from the group which is not a pro
rata minimum distribution. The minimum distribution by the group for
1964 with respect to M Corporation is determined as follows:
M Corporation's proportionate share of B Corporation's $20.00
distribution (0.80x$25).......................................
--------
Pretax and predistribution consolidated earnings and profits of 160.00
the group (0.80x$200).........................................
--------
Statutory percentage of pretax and predistribution consolidated 60.80
earnings and profits (0.33x$160)..............................
--------
Less: portion of such statutory percentage to which the $20 25.00
dividend received from B Corporation is attributable: Total
dividend paid by B Corporation
Plus: Foreign income tax on B Corporation's pretax and
predistribution earnings and profits to which such dividend is
attributable, letting ``t'' represent such tax:
t=0.20 ($25)+0.40t......................................... .......
t=$5+0.40t................................................. .......
0.60t=$5..................................................... .......
t=$5/0.60.................................................. 8.33
--------
B Corporation's pretax and predistribution earnings and profits 33.33
to which such dividend is attributable........................
========
M Corporation's proportionate share of B Corporation's pretax 26.67
and predistribution earnings and profits to which the dividend
is attributable (0.80x$33.33).................................
--------
The statutory percentage of the pretax and predistribution 34.13
consolidated earnings and profits of the group to which A
Corporation's distribution must be attributable...............
========
Dividend required to be received from A Corporation ($34.13- 20.48
[0.40x$34.13])................................................
--------
Minimum distribution to M Corporation of the taxable year's 40.48
consolidated earnings and profits of the group ($20+$20.48)...
--------
Example 3. The facts are the same as in example 2 except that the
$25 distribution of earnings and profits is made by A Corporation. The
amount of the minimum distribution for 1964 is determined as follows:
M Corporation's proportionate share of A Corporation's $20.00
distribution (0.80x$25).......................................
--------
Pretax and predistribution consolidated earnings and profits of 160.00
the group (0.80x$200).........................................
--------
Statutory percentage of pretax and predistribution consolidated 60.80
earnings and profits (0.38x$160)..............................
--------
Less: Portion of such statutory percentage to which the $20 25.00
dividend received from A Corporation is attributable: Total
dividend paid by A Corporation................................
Plus: Foreign income tax on A Corporation's pretax and 16.67
predistribution earnings and profits to which such dividend is
attributable (0.40x[$25/0.60])................................
--------
A Corporation's pretax and predistribution earnings and profits 41.67
to which such dividend is attributable........................
========
M Corporation's proportionate share of A Corporation's pretax 33.34
and predistribution earnings and profits to which dividend is
attributable ($41.67x0.80)....................................
--------
[[Page 474]]
Portion of the statutory percentage of the pretax and 27.46
predistribution consolidated earnings and profits of the group
to which B Corporation's distribution must be attributable....
========
Dividend received from B Corporation, letting ``d'' represent
the dividend:
d=$27.46-0.20d-0.40 ($27.46-d)............................. .......
d=$27.46-0.20d-$10.98+0.40d................................ .......
d=$16.48+0.20d............................................. .......
0.80d=$16.48................................................. .......
d=$16.48/0.80.............................................. 20.60
--------
Minimum distribution to M Corporation of the taxable year's 40.60
consolidated earnings and profits of the group ($20+$20.60)...
(d) Distributions through a chain or group. In the application of
paragraph (b)(3)(i) of Sec. 1.963-4, relating to the allocation of
dividend payments first to income received as a distribution from other
foreign corporations in the chain or group, if one or more of such other
foreign corporations is a corporation whose foreign income tax rate
decreases as the distributions are made, the allocation under such
paragraph shall be made first to such corporations' distributions.
(e) Foreign tax credit--(1) Year of minimum distribution. If a
United States shareholder receives for a taxable year a distribution of
the earnings and profits for the taxable year of a foreign corporation
described in paragraph (a) of this section and if for such year such
corporation is a first-tier corporation, or a second-tier corporation
described in section 902 (a) or (b), as the case may be, then, in
applying paragraph (c)(2)(i) of Sec. 1.963-4, only the foreign income
tax which is effectively applicable to pretax earnings and profits to
which are attributable the earnings and profits which are distributed
shall be deemed paid for such year under section 902 (a) or (b), as the
case may be, and the foreign income tax so paid or accrued by such
corporation shall not be averaged, for purposes of such section, with
its foreign income tax paid or accrued for such year on its pretax
earnings and profits to which are attributable the earnings and profits
which are not distributed.
(2) Year of distribution of remaining earnings and profits. If for a
taxable year a United States shareholder receives a minimum distribution
from a corporation described in paragraph (a) of this section, the
pretax and predistribution earnings and profits of such corporation for
the taxable year to which such minimum distribution is attributable and
the foreign income tax which is taken into account, in accordance with
paragraph (c)(2)(i) of Sec. 1.963-4, in determining tax deemed paid
under section 902 on such pretax and predistribution earnings and
profits shall not be taken into account in the application of section
902 when other earnings and profits of such foreign corporation for such
year are distributed in a subsequent taxable year of such foreign
corporation to such shareholder.
(3) Illustration. The application of this paragraph may be
illustrated by the following examples:
Example 1. (a) All the income of controlled foreign corporation B,
wholly owned directly by domestic corporation M, is taxed by foreign
country Y, the tax laws of which impose at the local level a corporate
income tax of 10 percent of earnings and profits (before reduction for
income taxes) and, at the national level, an income tax of 30 percent of
such earnings and profits reduced by the local tax and by any profits
which are distributed. Also, at the national level, a tax of 20 percent
is imposed on B Corporation on the dividends which are paid for the
taxable year. Both corporations use the calendar year as the taxable
year. For 1963, B Corporation has earnings and profits (before reduction
by income taxes) of $100. B Corporation is not a less developed country
corporation under section 902(d). For 1963, M Corporation makes a first-
tier election with respect to B Corporation and receives a minimum
distribution. Corporation B has no 1964 earnings and profits, and its
remaining 1963 earnings and profits are distributed late in 1964. The
amount of the minimum distribution required to be received by M
Corporation for 1963 and the United States tax with respect to the 1963
earnings and profits of B Corporation are determined as follows,
assuming a United States corporate income tax rate of 52 percent
(instead of 50 percent) for 1964 and no surtax exemption under section
11(c) for either year:
1963
Effective foreign tax rate which obtains if no 37%
earnings and profits of B Corporation are
distributed [($100x0.10)+ ([$100-
($100x0.10)]x0.30)]/$100...........................
Minimum percentage of earnings and profits required 68%
under section 963(b) to be distributed, given a 37
percent effective foreign tax rate.................
[[Page 475]]
Amount of earnings and profits (before reduction by $68.00
foreign income tax) to which minimum distribution
would be attributable if the effective foreign tax
rate of 37 percent obtained (0.68x$100)............
Minimum distribution required to be received by M
Corporation, i.e., such an amount that is $68 less
the foreign income tax on such $68, determined by
letting ``d'' equal the dividend in the algebraic
equation:
d=$68 - (0.10 x $68) - 0.30 ($68 - [0.10 x $68] - ..................
d) - 0.20d....................................
d=$68 - $6.80 - ($20.40 - $2.04 - 0.30d) - 0.20d ..................
d=$61.20 - $20.40 + $2.04 + 0.30d - 0.20d....... ..................
d=$42.84 + 0.10d................................ ..................
0.90d=$42.84...................................... ..................
d=$42.84/0.90, or............................... $47.60
Gross-up under section 78, using the actual foreign $20.40
income tax imposed on pretax profits to which are
attributable the earnings and profits distributed
($6.80+0.30 [$61.20-$47.60]+0.20 [$47.60]).........
Taxable income of M Corporation for 1963 $68.00
($47.60+$20.40)....................................
U.S. tax before foreign tax credit ($68x0.52)....... $35.36
Foreign tax credit ($47.60/$47.60x $20.40).......... $20.40
U.S. tax payable for 1963 ($35.36- $20.40).......... $14.96
Overall U.S. and foreign income tax rate 47.20%
[$14.96+$20.40+($32x0.37)]/$100....................
1964
Dividend received by M Corporation ($32-[0.37x$32]). $20.16
Gross-up under section 78, using the foreign income $11.84
tax paid or accrued on pretax earnings and profits
to which are attributable 1963 earnings and profits
distributed during 1964 ($20.16/$20.16x[$32x 0.37])
Taxable income of M Corporation for 1964 $32.00
($20.16+$11.84)....................................
U.S. tax before foreign tax credit ($32x0.52)....... $16.64
Foreign tax credit ($20.16/$20.16x $11.84).......... $11.84
U.S. tax payable ($16.64-$11.84).................... $4.80
(b) If B Corporation were a less developed country corporation under
section 902(d), there would be no gross-up under section 78 and the
foreign tax credit of M Corporation would be $14.28 for 1963 ($47.60/
[47.60+ $20.40]x$20.40), and $7.46 for 1964 ($20.16/
[$20.16+$11.84]x$11.84).
Example 2. For 1963, domestic corporation M receives a dividend of
$21 from B Corporation which counts toward a minimum distribution from a
group, determined by applying the special rules of paragraphs (b) and
(c) of Sec. 1.963-4. Both corporations use the calendar year as the
taxable year. Foreign law imposes on B Corporation an income tax of 40
percent of the year's pretax earnings and profits, less dividends paid
for such year, and of 20 percent of such dividends. Corporation M
directly owns 70 percent of the one class of stock of B Corporation,
which for 1963 has pretax and predistribution earnings and profits of
$100. Corporation B is not a less developed country corporation under
section 902(d). In late 1964, M Corporation receives a distribution of
all of B Corporation's 1964 earnings and profits and of $25.20 from its
1963 earnings and profits. The foreign income tax of B Corporation
deemed paid for 1963 by M Corporation under section 902(a) is based on
the foreign income tax actually paid by B Corporation on an amount of
pretax earnings and profits which, when reduced by the tax so paid,
equals the total dividend which is paid. The determination of tax deemed
paid by M Corporation with respect to distributions from 1963 earnings
and profits of B Corporation is as follows:
1963
Pretax and predistribution earnings and profits of B $100
Corporation for 1963..........................................
Total dividend paid by B Corporation in 1963 ($21/0.70)........ 30
Total foreign income tax paid by B Corporation for 1963 34
(0.40[$100- $30]+[0.20x$30]) or ($28+$6)......................
Foreign income tax, represented by ``t'' in the following
equation, to be taken into account with respect to total
dividend in determining tax deemed paid under section 902(a)
by M Corporation:
t=(0.20x$30)+0.40t......................................... .......
t=$6+0.40t................................................. .......
0.60t=$6..................................................... .......
t=$6/0.60, or.............................................. $10
Foreign income tax deemed paid by M Corporation for 1963 ($21/ 7
$30x$10)......................................................
1964
Remaining 1963 earnings and profits of B Corporation ([$100- 36
$34]-$30) or ($66-$30)........................................
Dividend received by M Corporation for 1964 (0.70x$36)......... 25.20
Foreign income tax deemed paid by M Corporation for 1964 16.80
($25.20/$36x [$34-$10]) or ($25.20/$36x$24)...................
[T.D. 6759, 29 Sept. 25, 1964; 29 FR 13896, Oct. 8, 1964, as amended by
T.D. 6767, 29 FR 14879, Nov. 3, 1964]
Sec. 1.963-6 Deficiency distribution.
(a) In general. Section 963(e)(2) and this section provide a method
under which, by virtue of a deficiency distribution, a United States
shareholder may be relieved from the payment of a deficiency in tax for
any taxable year arising by reason of failure to include subpart F
income in gross income under section 951(a)(1)(A)(i), when it has been
determined that such shareholder has failed to receive a minimum
distribution for such year in respect of which it elected to secure the
exclusion
[[Page 476]]
under section 963. In addition, this section provides rules with respect
to a credit or refund of part or all of any such deficiency which has
been paid. Under the method provided, the benefit of the exclusion of
subpart F income from gross income of the United States shareholder is
allowed retroactively for the taxable year in respect of which the
election under section 963 applied, but only if the subsequent
deficiency distribution meets the requirements of this section. The
benefits of the retroactive exclusion will not, however, prevent the
assessment of interest, additional amounts, and assessable penalties.
(b) Requirements for deficiency distribution--(1) Distribution made
on or after date of determination. If--
(i) A United States shareholder, in making its return of the tax
imposed by chapter 1 of the Code for any taxable year, elects to secure
an exclusion under section 963 for such year,
(ii) It is subsequently determined (within the meaning of paragraph
(c) of this section) that an exclusion under section 963 of subpart F
income with respect to stock to which such election relates does not
apply for such taxable year because of the failure of such shareholder
to receive a minimum distribution for such year with respect to such
stock, and
(iii) Such failure is due to reasonable cause, a deficiency
distribution which is received by such shareholder with respect to such
stock from a foreign corporation which was the single first-tier
corporation, or a corporation in the chain or group, as the case may be,
with respect to which the election was made, shall count toward a
minimum distribution under section 963 for such year of election if such
deficiency distribution is received (except as provided by subparagraph
(2) of this paragraph) on, or within 90 days after, the date of such
determination and prior to the filing of a claim under paragraph (d)(1)
of this section. Such claim must be filed within 120 days after the date
of such determination, and the deficiency distribution must be a
dividend of such a nature (except as otherwise provided in this section)
as would have permitted it to count toward a minimum distribution for
the taxable year of the election if it had been received by the United
States shareholder during such year. No distribution shall count as a
deficiency distribution under this subparagraph unless a claim therefor
is filed under paragraph (d)(1) of this section.
(2) Distribution made before date of determination. A deficiency
distribution may also be received by a United States shareholder at any
time prior to the date on which the determination required by
subparagraph (1) of this paragraph is made. A distribution will count as
a deficiency distribution under this subparagraph--
(i) To the extent that such distribution otherwise satisfies the
requirements of this section;
(ii) If the United States shareholder files within 90 days after
such distribution but before the determination date an advance claim
described in paragraph (d)(2) of this section for treatment of such
distribution as a deficiency distribution;
(iii) If such shareholder consents in such claim to include such
deficiency distribution in gross income for the taxable year of the
election to the extent necessary to complete a minimum distribution for
such year and under section 6501 to extend the period for the making of
assessments, and the bringing of distraint or a proceeding in court for
collection, in respect of a deficiency and all interest, additional
amounts, and assessable penalties for such taxable year;
(iv) If, when requested by the district director, such shareholder
consents under section 6501 in such claim to extend the period for the
making of assessments, and the bringing of distraint or a proceeding in
court for collection, in respect of a deficiency and all interest,
additional amounts and assessable penalties for the year of receipt of
such distribution; and
(v) To the extent that such shareholder makes advance payment of tax
which would result from the inclusion of such distribution in gross
income as a minimum distribution for the year of such deficiency.
To the extent that such distribution is not necesasry under the
determination (when made under paragraph (c) of this section) for a
deficiency distribution, it
[[Page 477]]
shall be included in the United States shareholder's gross income for
the taxable year of receipt of such distribution and paragraph (g) of
this section shall not apply.
(3) Earnings and profits of year of election to be first
distributed. If--
(i) In the case of a first-tier election, the United States
shareholder's proportionate share of the earnings and profits of the
foreign corporation which was the single first-tier corporation, or
(ii) In the case of a chain or group election, any portion of the
share of any corporation or corporations (which were in the chain or
group) of the consolidated earnings and profits with respect to the
United States shareholder,
for the taxable year of the election has not been distributed on the
stock with respect to which the election was made, then a distribution,
in order to be counted toward a deficiency distribution, must be made by
such corporation or corporations and from such earnings and profits to
the extent thereof. Once all such earnings and profits of such
corporation or corporations have been completely distributed, a
deficiency distribution may be made from other earnings and profits of
such foreign corporation which was a single first-tier corporation, or
of such corporation or corporations which were in such chain or group,
as the case may be.
(4) Proof of reasonable cause. Reasonable cause for failure to
receive a minimum distribution shall be deemed to exist, in the absence
of circumstances demonstrating bad faith, if the electing United States
shareholder receives, within the period prescribed by paragraph
(a)(1)(i) of Sec. 1.963-3 with respect to the year of election, at
least 80 percent of the amount of a minimum distribution (from the
earnings and profits to which the election for such year relates) which
if received during such period would have satisfied the conditions for
the section 963 exclusion to apply to such year. If less than 80 percent
of the amount of a minimum distribution is received during such period,
the existence of a reasonable cause for failure to receive a minimum
distribution must be established by clear and convincing evidence;
however, the preceding sentence shall not be taken as a limitation on
the establishment of reasonable cause by any other proof of reasonable
cause. For example, reasonable cause will exist if a single first-tier
corporation for its taxable year makes a distribution which would be a
minimum distribution but for a refund of foreign income tax which it has
paid in good faith under foreign law but which is found not to be due
after the United States income tax return of the United States
shareholder has been filed.
(c) Nature and details of determination. (1) A determination that
the section 963 exclusion does not apply to a United States shareholder
for a taxable year due to its failure to receive a minimum distribution
for such year shall, for the purposes of this section, be established
by--
(i) A decision by the Tax Court or a judgment, decree, or other
order by any court of competent jurisdiction, which has become final;
(ii) A closing agreement made under section 7121; or,
(iii) An agreement which is signed by the district director, or such
other official to whom authority to sign the agreement is delegated, and
by, or on behalf of, such shareholder and which relates to the liability
of such shareholder for the tax under chapter 1 of the Code for such
year.
(2) The date of determination by a decision of the Tax Court shall
be the date upon which such decision becomes final, as prescribed in
section 7481.
(3) The date upon which a judgment of a court becomes final shall be
determined upon the basis of the facts in the particular case.
Ordinarily, a judgment of a United States district court shall become
final upon the expiration of the time allowed for taking an appeal, if
no such appeal is duly taken within such time; and a judgment of the
United States Court of Claims shall become final upon the expiration of
the time allowed for filing a petition for certiorari, if no such
petition is duly filed within such time.
(4) The date of determination by a closing agreement made under
section 7121 shall be the date such agreement is approved by the
Commissioner.
(5) The date of a determination made by an agreement which is signed
by the
[[Page 478]]
district director, or such other official to whom authority to sign the
agreement is delegated, shall be the date prescribed by this
subparagraph. The agreement shall be sent to the United States
shareholder at his last known address by either registered or certified
mail. For further guidance regarding the definition of last known
address, see Sec. 301.6212-2 of this chapter. If registered mail is
used for such purpose, the date of registration shall be treated as the
date of determination; if certified mail is used for such purpose, the
date of the postmark on the sender's receipt for such mail shall be
treated as the date of determination. However, if the deficiency
distribution is received by such shareholder before such registration or
postmark date but on or after the date the agreement is signed by the
district director or such other official to whom authority to sign the
agreement is delegated, the date of determination shall be the date on
which the agreement is so signed.
(6) The determination under this paragraph shall find that, due to
the United States shareholder's failure to receive a minimum
distribution, the section 963 exclusion does not apply for the taxable
year with respect to stock to which the election under such section
relates. A determination described in subdivision (ii) or (iii) of
subparagraph (1) of this paragraph shall set forth the amount of the
deficiency distribution and the amount of additional income tax for
which the United States shareholder is liable under Chapter 1 of the
Code by reason of not including in gross income for such year the amount
of the deficiency distribution. If a determination described in
subdivision (i) of subparagraph (1) of this paragraph does not establish
the amount of the deficiency distribution and such amount of additional
tax, such amounts may be established by an agreement which is signed by
the district director, or such other official to whom authority to sign
the agreement is delegated.
(d) Claim for treatment of distribution as a deficiency
distribution--(1) Claim filed after date of determination. A claim
(including any amendments thereof) for treatment of a deficiency
distribution as counting toward a minimum distribution for the taxable
year of election shall be filed in duplicate, within 120 days after the
date of the determination described in paragraph (c) of this section,
with the requisite declaration prescribed by the Commissioner on the
appropriate claim form and shall be accompanied by--
(i) A copy of such determination and a description of how it became
final;
(ii) If requested by the district director, or by such other
official to whom authority to sign the agreement referred to in
paragraph (c)(1) or (6) of this section is delegated, a consent by the
United States shareholder under section 6501 to extend the period for
the making of assessments, and the bringing of distraint or a proceeding
in court for collection, in respect of a deficiency and all interest,
additional amounts, and assessable penalties for the taxable year of
election; and
(iii) Such other information as may be required by the claim form or
the district director, or other official, in support of the claim.
(2) Advance claim. An advance claim for treatment of a deficiency
distribution as counting toward a minimum distribution for the taxable
year of election shall be filed in duplicate, within 90 days after such
distribution but before the date of determination described in paragraph
(c) of this section, and shall satisfy all requirements of subparagraph
(1) of this paragraph other than subdivision (i) of such subparagraph.
However, within 120 days after the date of the determination described
in paragraph (c) of this section, the advance claim shall be completed
so that it satisfies all requirements of subparagraph (1) of this
paragraph.
(e) Computation of interest on deficiencies in tax. If a United
States shareholder, for the taxable year of the election under section
963, completes a minimum distribution for such year by receiving a
deficiency distribution to which this section applies, the interest on
the deficiency in tax due by reason of the failure to include the amount
of such deficiency distribution in such shareholder's gross income for
such year shall be computed for the period from the last date prescribed
for payment of the tax for such year to the date such deficiency in tax
is paid. No
[[Page 479]]
interest shall be due by reason of the failure to include Subpart F
income in gross income for a taxable year in respect of which a minimum
distribution under section 963 is completed by a deficiency distribution
to which this section applies.
(f) Claim for credit or refund. If a deficiency in tax is asserted
for any taxable year by reason of failure to include Subpart F income in
gross income under section 951(a)(1)(A)(i) and the United States
shareholder has paid any portion of such asserted deficiency, such
shareholder is entitled to a credit or refund of such payment to the
extent that such payment constitutes an overpayment of tax as the result
of the receipt of a deficiency distribution to which this section
applies. To secure credit or refund of such overpayment of tax, the
United States shareholder must file a claim for refund in accordance
with Sec. 301.6402-3, in addition to the claim form required under
paragraph (d) of this section. No interest shall be allowed on such
credit or refund. For other rules applicable to the filing of claims for
credit or refund of an overpayment of tax, see section 6402 and the
regulations thereunder. For the limitations applicable to the credit or
refund for an overpayment of tax, see section 6511 and the regulations
thereunder.
(g) Effect of deficiency distribution--(1) Allocation of
distributions. The deficiency distribution shall be allocated, by
applying the rules of Sec. 1.963-3 (and paragraph (b) of Sec. 1.963-4,
if applicable for the year of election), as a distribution first from
the earnings and profits (to the extent thereof) of the foreign
corporation which was the single first-tier corporation, or of the
distributing corporation or corporations which were in the chain or
group, as the case may be, for the taxable year in respect of which the
election was made, and then from earnings and profits (to the extent
thereof) described in section 959(c)(3) and determined as provided in
section 959 for the most recent taxable year and the first, second,
etc., taxable years preceding such recent taxable years, in that order,
of the distributing corporation or corporations. In applying the
preceding sentence to taxable years other than the taxable year in
respect of which the election was made, the deficiency distribution
shall first be allocated, in the order of allocation prescribed by such
sentence, first to taxable years in respect of which no election under
section 963 was made with respect to the stock on which such
distribution is received and then to taxable years in respect of which
an election under such section was made.
(2) Year of receipt. Any deficiency distribution made with respect
to a taxable year of the United States shareholder shall be treated,
except as provided in paragraph (b)(2) of this section, as having been
received by the shareholder in that year for which such shareholder
elected to secure an exclusion under section 963; and, for purposes of
the foreign tax credit under section 901, the foreign income taxes paid
or accrued, or deemed paid, by the United States shareholder by reason
of a distribution of any amount treated as a deficiency distribution for
such year shall be treated as paid or accrued, or deemed paid, for such
year.
(3) Year of payment. A distribution counting toward a deficiency
distribution for a taxable year of election shall, except as provided in
paragraph (b)(2) of this section, be treated for purposes of applying
paragraph (a) of Sec. 1.963-3, relating to conditions under which
earnings and profits are counted toward a minimum distribution, and
paragraph (b)(3) of Sec. 1.963-4, relating to rules for distributing
through a chain or group, as if it were distributed during the
distribution period (as defined in paragraph (g) of Sec. 1.963-3) with
respect to the distributing corporation and each foreign corporation
through which such distribution is made to the United States
shareholder, for the taxable year to which the election under section
963 applies; and the foreign income taxes paid by any foreign
corporation by reason of such distribution shall, in the application of
section 902 and of the special rules of paragraph (c) of Sec. 1.963-4,
be treated as paid or accrued by such foreign corporation for its
taxable year to which such election applies. The distribution shall not
count toward a minimum distribution for any other taxable year.
[[Page 480]]
(4) Allocation of reduction in tax credit. If any portion of a
deficiency distribution from a corporation which was in a chain or group
is paid from earnings and profits of a taxable year other than that in
respect of which the election was made, then the minimum distribution
toward which such deficiency distribution counts may not be treated as a
pro rata minimum distribution for purposes of Sec. 1.963-4. Moreover,
the amount of the overall United States and foreign income tax with
respect to such minimum distribution must satisfy the minimum tax
requirements of paragraph (a)(1)(i), or paragraph (ii), of Sec. 1.963-
4, but, if the latter applies, without any reduction and deferral under
paragraph (c)(3) of such section of the foreign tax credit allowable
under section 901 with respect to the deficiency distribution.
[T.D. 6759, 29 FR 13346, Sept. 25, 1964, as amended by T.D. 6767, 29 FR
14879, Nov. 3, 1964; T.D. 7410, 41 FR 11020, Mar. 16, 1976; T.D. 8939,
66 FR 2819, Jan. 12, 2001]
Sec. 1.963-7 Transitional rules for certain taxable years.
(a) Extension of time for making, revoking, or changing election--
(1) In general. Subparagraphs (2) and (3) of this paragraph provide
additional rules which apply only to a taxable year of a United States
shareholder for which the last day prescribed by law for filing its
return (including any extensions of time under section 6081) occurs on
or before the 90th day after September 30, 1964.
(2) Manner of making the election. The election of the United States
shareholder to secure the exclusion under section 963 and the consent to
the regulations under such section may be made for the taxable year--
(i) By filing with the return (or with an amended return filed on or
before such 90th day) for such taxable year--
(a) A written statement stating that such election is made for such
taxable year, and
(b) The names of the foreign corporations to which such election
applies, the taxable year, country of incorporation, pretax earnings and
profits, foreign income taxes, earnings and profits, and outstanding
capital stock, of each such corporation, and such other information
relating to the election made as the Commissioner may prescribe, on or
before the date of filing, by instructions or schedules to support such
return; or
(ii) In case of any extension of time under section 6081 with
respect to such taxable year where the last day prescribed by law for
filing the return by the electing United States shareholder (not
including any extensions thereof) occurs on or before September 30,
1964, by filing with the request for the first such extension of time a
written statement stating that such election is made for such taxable
year and setting forth the names of the foreign corporations to which
each election applies.
(3) Revocation or change of election. An election made in the manner
provided by subparagraph (2) of this paragraph may be revoked or
changed--
(i) By filing with the return on or before the 90th day after
September 30, 1964, a written statement that such election is revoked or
changed, as the case may be, and by setting forth with respect to any
such modified election the information prescribed by subparagraph
(2)(i)(b) of this paragraph, or
(ii) Where the return has been filed on or before such 90th day, by
filing on or before such 90th day an amended return and an accompanying
statement that such election is revoked or changed, as the case may be,
and by setting forth with respect to any such modified election the
information prescribed by subparagraph (2)(i)(b) of this paragraph.
(b) Extension of time for making a minimum distribution--(1) In
general. This paragraph applies only with respect to a taxable year of a
United States shareholder ending on or before September 30, 1964, for
which an election to secure an exclusion under section 963 is made
where, in case of a first-tier election, the distribution period of such
first-tier corporation with respect to its taxable year to which such
election applies ends on or before the 90th day after such date, and
where, in the case of a chain or group election, the distribution period
ends on or before such 90th day with respect to the taxable year to
which the election applies of any of the foreign corporations in such
chain or group.
[[Page 481]]
(2) Conditions for obtaining extension of time. A distribution on
stock with respect to which the election under section 963 was made
which is received by the United States shareholder from a foreign
corporation which was the single first-tier corporation, or a
corporation in the chain or group, as the case may be, with respect to
which the election was made, shall count toward a minimum distribution
under section 963 for such year of election if--
(i) The distribution is made on or before such 90th day,
(ii) The shareholder, in a statement attached to its return or
amended return for such year (which is filed on or before such 90th day)
indicates the foreign corporation or corporations from which the
distribution is made and states that, and the extent to which, the
distribution is to count toward such minimum distribution,
(iii) The distribution is of such a nature as would have permitted
it to count toward a minimum distribution for such taxable year of the
United States shareholder if it had been made on the last day of such
year, and
(iv) The United States shareholder includes the distribution in
gross income as if it were received on the last day of such taxable year
of election.
The distribution shall be applied against the earnings and profits of
the single first-tier corporation or the foreign corporations in the
chain or group for the taxable year of such corporation or corporations
to which the election applies.
(3) Year of receipt. To the extent that a distribution counts toward
a minimum distribution under this paragraph with respect to a taxable
year of the United States shareholder, it shall be treated as having
been received by the shareholder in that year for the purpose of
determining gross income and the assessment of interest, additional
amounts, and assessable penalties; and, for purposes of the foreign tax
credit under section 901, the foreign income taxes paid or accrued, or
deemed paid, by the United States shareholder by reason of a
distribution of any amount treated as a distribution for such year under
this paragraph shall be treated as paid or accrued, or deemed paid, for
such year.
(4) Year of payment. The distribution shall be treated for purposes
of applying paragraph (a) of Sec. 1.963-3, relating to conditions under
which earnings and profits are counted toward a minimum distribution,
and paragraph (b)(3) of Sec. 1.963-4, relating to rules for
distributing through a chain or group, as if it were distributed during
the distribution period (as defined in paragraph (g) of Sec. 1.963-3)
with respect to the distributing corporation and each foreign
corporation through which such distribution is made to the United States
shareholder, for the taxable year to which the election under section
963 applies; and the foreign income taxes paid by any foreign
corporation by reason of such distribution shall, in the application of
section 902 and of the special rules of paragraph (c) of Sec. 1.963-4,
be treated as paid or accrued by such foreign corporation for its
taxable year to which such election applies. The distribution shall not
count toward a minimum distribution for any other taxable year.
[T.D. 6759, 29 FR 13348, Sept. 25, 1964, as amended by T.D. 6767, 29 FR
14879, Nov. 3, 1964]
Sec. 1.963-8 Determination of minimum distribution during the surcharge
period.
(a) Taxable years not wholly within the surcharge period. In the
case of a taxable year beginning before the surcharge period and ending
within the surcharge period, or beginning within the surcharge period
and ending after the surcharge period, or beginning before January 1,
1970, and ending after December 31, 1969, section 963(b) provides the
method for determining the required minimum distribution. Under the
method prescribed in section 963(b) for such years, the required minimum
distribution is an amount equal to the sums of:
(1) That portion of the minimum distribution which would be required
if the provisions of section 963(b)(1) were applicable to the taxable
year, which the number of days in such taxable year which are within the
surcharge period and before January 1, 1970, bears to the total number
of days in such taxable year.
[[Page 482]]
(2) That portion of the minimum distribution which would be required
if the provisions of section 963(b)(2) were applicable to such taxable
year, which the number of days in such taxable year which are within the
surcharge period and after December 31, 1969, bears to the total number
of days in such taxable year, and
(3) That portion of the minimum distribution which would be required
if the provisions of section 963(b)(3) were applicable to such taxable
year, which the number of days in such taxable year which are not within
the surcharge period bears to the total number of days in such taxable
year.
(b) Calendar year 1970. For calendar year 1970, the required minimum
distribution shall be an amount determined in accordance with the
following table:
------------------------------------------------------------------------
The required
minimum
distribution
If the effective foreign tax rate is (percentage)-- of earnings
and profits is
(percentage)--
------------------------------------------------------------------------
Under 9................................................. 84.983562
9 or over but less than 10.............................. 82.967123
10 or over but less than 18............................. 80.983562
18 or over but less than 19............................. 79.471233
19 or over but less than 26............................. 77.487671
26 or over but less than 27............................. 73.958904
27 or over but less than 32............................. 70.487671
32 or over but less than 33............................. 67.463014
33 or over but less than 36............................. 63.991781
36 or over but less than 37............................. 57.942466
37 or over but less than 39............................. 51.991781
39 or over but less than 40............................. 44.934247
40 or over but less than 41............................. 37.495890
41 or over but less than 42............................. 31.446575
42 or over but less than 43............................. 19.446575
43 or over but less than 44............................. 12.893151
44 or over but less than 45............................. 6.446575
45 or over.............................................. 0
------------------------------------------------------------------------
(c) Surcharge period. For purposes of this section the term
``surcharge period'' means the period beginning January 1, 1968, and
ending June 30, 1970.
(d) Illustration of principles. The application of the rules set
forth in paragraphs (a), (b), and (c) of this section may be illustrated
by the following example. It is assumed that all computations are
carried to sufficient accuracy:
Example. (a) M, a domestic corporation, and A, its controlled
corporation (the one class of stock of which is wholly owned by M), both
have a taxable year beginning December 1, 1969, and ending November 30,
1970. For such taxable year M makes a first-tier election with respect
to A corporation. The effective foreign tax rate for such year is 30
percent.
(b) Under section 963(b) and paragraph (b) of this section the
surcharge period ends June 30, 1970. Therefore, of the 365 days in the
taxable year, 153 days are not within the surcharge period. Of the
remaining 212 days, 31 are within the surcharge period and before
January 1, 1970 and 181 days are within the surcharge period and after
December 31, 1969. If section 963(b)(1) were applicable to the entire
taxable year, the required minimum distribution of earnings and profits
would be 75 percent. If section 963(b)(2) were applicable to the entire
taxable year, the required minimum distribution would be 72 percent. If
section 963(b)(3) were applicable to the entire taxable year, the
required minimum distribution would be 69 percent.
(c) Under section 963(b) and this section the required minimum
distribution of earnings and profits is 71 percent, computed as follows:
(75%x31/365)+(72%x181/365) +(69%x153/365)=71%.
[T.D. 7100, 36 FR 5336, Mar. 20, 1971]
Sec. 1.964-1 Determination of the earnings and profits of a foreign
corporation.
(a) In general. For purposes of sections 951 through 964, the
earnings and profits (or deficit in earnings and profits) of a foreign
corporation for its taxable year shall, except as provided in paragraph
(f) of this section, be computed substantially as if such corporation
were a domestic corporation by--
(1) Preparing a profit and loss statement with respect to such year
from the books of account regularly maintained by the corporation for
the purpose of accounting to its shareholders;
(2) Making the adjustments necessary to conform such statement to
the accounting principles described in paragraph (b) of this section;
(3) Making the further adjustments necessary to conform such
statement to the tax accounting standards described in paragraph (c) of
this section;
(4) Translating the amounts shown on such adjusted statement into
United States dollars in accordance with paragraph (d) of this section,
and
(5) Adjusting the amount of profit or loss shown on such translated
and adjusted statement in accordance with paragraph (e) of this section
to reflect any exchange gain or loss determined thereunder.
[[Page 483]]
The computation described in the preceding sentence may be made by
following the procedures described in paragraphs (a)(1) through (5) of
this section in an order other than the one listed, as long as the
result so obtained would be the same. In determining earnings and
profits, or the deficit in earnings and profits, of a foreign
corporation under section 964, the amount of any illegal bribe,
kickback, or other payment (within the meaning of section 162(c), as
amended by section 288 of the Tax Equity and Fiscal Responsibility Act
of 1982 in the case of payments made after September 3, 1982, and the
regulations thereunder) paid after November 3, 1976, by or on behalf of
the corporation during the taxable year of the corporation directly or
indirectly to an official, employee, or agent in fact of a government
shall not be taken into account to decrease such earnings and profits or
to increase such deficit. No adjustment shall be required under
subparagraph (2) or (3) of this paragraph unless it is material. Whether
an adjustment is material depends on the facts and circumstances of the
particular case, including the amount of the adjustment, its size
relative to the general level of the corporation's total assets and
annual profit or loss, the consistency with which the practice has been
applied, and whether the item to which the adjustment relates is of a
recurring or merely a nonrecurring nature. For the treatment of earnings
and profits whose distribution is prevented by restrictions and
limitations imposed by a foreign government, see section 964(b) and the
regulations thereunder.
(b) Accounting adjustments--(1) In general. The accounting
principles to be applied in making the adjustments required by paragraph
(a)(2) of this section shall be those accounting principles generally
accepted in the United States for purposes of reflecting in the
financial statements of a domestic corporation the operations of its
foreign affiliates, including the following:
(i) Clear reflection of income. Any accounting practice designed for
purposes other than the clear reflection on a current basis of income
and expense for the taxable year shall not be given effect. For example,
an adjustment will be required where an allocation is made to an
arbitrary reserve out of current income.
(ii) Physical assets, depreciation, etc. All physical assets (as
defined in paragraph (e)(5)(ii) of this section), including inventory
when reflected at cost, shall be taken into account at historical cost
computed either for individual assets or groups of similar assets. The
historical cost of such an asset shall not reflect any appreciation or
depreciation in its value or in the relative value of the currency in
which its cost was incurred. Depreciation, depletion, and amortization
allowances shall be based on the historical cost of the underlying asset
and no effect shall be given to any such allowance determined on the
basis of a factor other than historical cost. For special rules for
determining historical cost where assets are acquired during a taxable
year beginning before January 1, 1950, or a majority interest in the
foreign corporation is acquired after December 31, 1949, but before
October 27, 1964, see subparagraph (2) of this paragraph.
(iii) Valuation of assets and liabilities. Any accounting practice
which results in the systematic undervaluation of assets or
overvaluation of liabilities shall not be given effect, even though
expressly permitted or required under foreign law, except to the extent
allowable under paragraph (c) of this section. For example, an
adjustment will be required where inventory is written down below market
value. For the definition of market value, see paragraph (a) of Sec.
1.471-4.
(iv) Income equalization. Income and expense shall be taken into
account without regard to equalization over more than one accounting
period; and any equalization reserve or similar provision affecting
income or expense shall not be given effect, even though expressly
permitted or required under foreign law, except to the extent allowable
under paragraph (c) of this section.
(v) Foreign currency. If transactions effected in a foreign currency
other than that in which the books of the corporation are kept are
translated into the foreign currency reflected in the books, such
translation shall be made in a manner substantially similar
[[Page 484]]
to that prescribed by paragraph (d) of this section for the translation
of foreign currency amounts into United States dollars.
(2) Historical cost. For purposes of this section, the historical
cost of an asset acquired by the foreign corporation during a taxable
year beginning before January 1, 1963, shall be determined, if it is so
elected by or on behalf of such corporation--
(i) In the event that the foreign corporation became a majority
owned subsidiary of a United States person (within the meaning of
section 7701(a)(30)) after December 31, 1949, but before October 27,
1964, and the asset was held by such foreign corporation at that time,
as though the asset was purchased on the date during such period the
foreign corporation first became a majority owned subsidiary at a price
equal to its then fair market value, or
(ii) In the event that subdivision (i) of this subparagraph is
inapplicable but the asset was acquired by the foreign corporation
during a taxable year beginning before January 1, 1950, as though the
asset were purchased on the first day of the first taxable year of the
foreign corporation beginning after December 31, 1949, at a price equal
to the undepreciated cost (cost or other basis minus book depreciation)
of that asset as of that date as shown on the books of account of such
corporation regularly maintained for the purpose of accounting to its
shareholders.
For purposes of this subparagraph, a foreign corporation shall be
considered a majority owned subsidiary of a United States person if,
taking into account only stock acquired by purchase (as defined in
section 334(b)(3)), the United States person owns (within the meaning of
section 958(a)) more than 50 percent of the total combined voting power
of all classes of stock of the foreign corporation entitled to vote. The
election under this subparagraph shall be made for the first taxable
year beginning after December 31, 1962, in which the foreign corporation
is a controlled foreign corporation (within the meaning of section 957),
or for which it is included in a chain or group under section
963(c)(2)(B) or (3)(B) (applied as if section 963 had not been repealed
by the Tax Reduction Act of 1975), or has a deficit in earnings and
profits sought to be taken into account under section 952(d) or pays a
dividend that is included in the foreign base company shipping income of
a controlled foreign corporation under Sec. 1.954-6(f). Once made, such
an election shall be irrevocable. For the time and manner in which an
election may be made on behalf of a foreign corporation, see paragraph
(c)(3) of this section.
(3) Illustrations. The application of this paragraph may be
illustrated by the following examples:
Example 1. Corporation M is a controlled foreign corporation which
regularly maintains books of account for the purpose of accounting to
its shareholders in accordance with the accounting practices prevalent
in country X, the country in which it operates. As a consequence of
those practices, the profit and loss statement prepared from these books
of account reflects an allocation to an arbitrary reserve out of current
income and depreciation allowances based on replacement values which are
greater than historical cost. Adjustments are necessary to conform such
statement to accounting principles generally accepted in the United
States. Assuming these adjustments to be material, the unacceptable
practices, will have to be eliminated from the statement, an increase in
the amount of profit (or a decrease in the amount of loss) thereby
resulting.
Example 2. In 1973, Corporation N is a foreign corporation which is
not a controlled foreign corporation but which is included in a chain,
for minimum distribution purposes, under section 963(c)(2)(B).
Corporation N regularly maintains books of account for the purpose of
accounting to its shareholders in accordance with the accounting
practices of country Y, the country in which it operates. As a
consequence of those practices, the profit and loss statement prepared
from these books of account reflects the inclusion in income of stock
dividends and of corporate distributions representing a return of
capital. Adjustments are necessary to conform such statement to
accounting principles generally accepted in the United States. Assuming
these adjustments to be material, the unacceptable practices will have
to be eliminated from the statement, a decrease in the amount of profit
(or increase in the amount of loss) thereby resulting.
(c) Tax adjustments--(1) In general. The tax accounting standards to
be applied in making the adjustments required by paragraph (a)(3) of
this section shall be the following:
[[Page 485]]
(i) Accounting methods. The method of accounting shall reflect the
provisions of section 446 and the regulations thereunder.
(ii) Inventories. Inventories shall be taken into account in
accordance with the provisions of sections 471 and 472 and the
regulations thereunder.
(iii) Depreciation. Depreciation shall be computed as follows:
(a) For any taxable year beginning before July 1, 1972; depreciation
shall be computed in accordance with section 167 and the regulations
thereunder.
(b) If, for any taxable year beginning after June 30, 1972, 20
percent or more of the gross income from all sources of the corporation
is derived from sources within the United States, then depreciation
shall be computed in accordance with the provisions of Sec. 1.312-15.
(c) If, for any taxable year beginning after June 30, 1972, less
than 20 percent of the gross income from all sources of the corporation
is derived from sources within the United States, then depreciation
shall be computed in accordance with section 167 and the regulations
thereunder.
(iv) Elections. Effect shall be given to any election made in
accordance with an applicable provision of the Code and the regulations
thereunder and these regulations.
Except as provided in subparagraphs (2) and (3) of this paragraph, any
requirements imposed by the Code or applicable regulations with respect
to making an election or adopting or changing a method of accounting
must be satisfied by or on behalf of the foreign corporation just as
though it were a domestic corporation if such election or such adoption
or change of method is to be taken into account in the computation of
its earnings and profits.
(2) Adoption of method. For the first taxable year beginning after
December 31, 1962, in which the foreign corporation is a controlled
foreign corporation (within the meaning of section 957), or for which it
is included in a chain or group under section 963(c)(2)(B) or (3)(B)
(applied as if section 963 had not been repealed by the Tax Reduction
Act of 1975), or has a deficit in earnings and profits sought to be
taken into account under section 952(d), or pays a dividend that is
included in the foreign base company shipping income of a controlled
foreign corporation under Sec. 1.954-6(f), there may be adopted or made
by such corporation or on its behalf any method of accounting or
election allowable under this section notwithstanding that, in previous
years, its earnings and profits were computed, or its books or financial
statements prepared, on a different basis and notwithstanding that such
election is required by the Code or regulations to be made in a prior
taxable year. For purposes of determining the amount of a deficit in
earnings and profits taken into account pursuant to section
952(c)(1)(B), if a different basis is used in previous years, ratable
adjustments shall be made in the earnings and profits attributable to
such previous years to prevent any duplication or omission of amounts
that would otherwise result from the adoption of such method or the
making of such election. See subparagraph (3) of this paragraph for the
manner in which a method of accounting or an election may be adopted or
made on behalf of the foreign corporation.
(3) Action on behalf of corporation--(i) In general. An election
shall be deemed made, or an adoption or change in method of accounting
deemed effectuated, on behalf of the foreign corporation only if its
controlling United States shareholders (as defined in subparagraph (5)
of this paragraph)--
(a) Satisfy for such corporation any requirements imposed by the
Code or applicable regulations with respect to such election or such
adoption or change in method, such as the filing of forms, the execution
of consents, securing the permission of the Commissioner, or maintaining
books and records in a particular manner,
(b) File the written statement described in subdivision (ii) of this
subparagraph at the time and in the manner prescribed therein, and
(c) Provide the written notice required by subdivision (iii) of this
subparagraph at the time and in the manner prescribed therein.
For purposes of the preceding sentence, the books of the foreign
corporation shall be considered to be maintained in a particular manner
if the controlling
[[Page 486]]
United States shareholders or the foreign corporation regularly keep the
records and accounts required by section 964(c) and the regulations
thereunder in that manner. Any election required to be made or
information required to be filed with a tax return shall be deemed made
or furnished on behalf of the foreign corporation if its controlling
United States shareholders file the written statement described in
subdivision (ii) of this subparagraph with respect to such election
within the period specified therein. For a special rule postponing the
time for taking action by or on behalf of a foreign corporation until
the amount of its earnings and profits becomes significant, see
subparagraph (6) of this paragraph.
(ii) Written statement. The written statement required by
subdivision (i) of this subparagraph shall be jointly executed by the
controlling United States shareholders, shall be filed with the Director
of the Internal Revenue Service Center, 11601 Roosevelt Blvd.,
Philadelphia, Pennsylvania 19155, within 180 days after the close of the
taxable year of the foreign corporation with respect to which the
election is made or the adoption or change of method effected, or before
May 1, 1965, whichever is later, and shall set forth the name and
country or organization of the foreign corporation, the names,
addresses, taxpayer identification numbers (in the case of statements
required to be filed after June 20, 1983), and stock interests of the
controlling United States shareholders, the nature of the action taken,
the names, addresses, and (in the case of statements required to be
filed after June 20, 1983) taxpayer identification numbers of all other
United States shareholders notified of the election or adoption or
change of method, and such other information as the Commissioner may by
forms require.
(iii) Notice. Prior to the filing of the written statement described
in subdivision (ii) of this subparagraph, the controlling United States
shareholders shall provide written notice of the election made or the
adoption or change of method effected to all other persons known by them
to be United States shareholders who own (within the meaning of section
958(a)) stock of the foreign corporation. Such notice shall set forth
the name and country of organization of the foreign corporation, the
names, addresses, and stock interests of the controlling United States
shareholders, the nature of the action taken, and such other information
as the Commissioner may by forms require. However, the failure of the
controlling United States shareholders to provide such notice to a
person required to be notified thereunder shall not invalidate the
election made or the adoption or change of method effected, if it is
established to the satisfaction of the Commissioner that reasonable
cause existed for such failure.
(4) Effect of action by controlling United States shareholders. Any
action taken by the controlling United States shareholders on behalf of
the foreign corporation pursuant to subparagraph (3) of this paragraph
shall be reflected in the computation of the earnings and profits of
such corporation under this section to the extent that it bears upon the
tax liability of a United States shareholder who either--
(i) Was a controlling United States shareholder with respect to the
action taken;
(ii) Received the written notice provided by subparagraph (3)(iii)
of this paragraph;
(iii) Failed to file any of the returns required by section 6046 and
the regulations thereunder within the period prescribed by section
6046(d); or
(iv) Was notified by the Director of the Philadelphia Service Center
of the action taken--
(a) Within 61 days after the last day (including extensions of time)
prescribed with respect to the taxable year of the foreign corporation
by subparagraph (3)(ii) of this paragraph for filing the written
statement described in such subparagraph, or
(b) Within 180 days after the close of the first taxable year in
which such shareholder becomes a United States shareholder, whichever is
later.
To the extent that the computation of the earnings and profits of the
foreign corporation bears upon the tax liability of any United States
shareholder other than those enumerated in the preceding sentence, the
computation shall reflect the action taken only if
[[Page 487]]
such shareholder assents to such treatment. Such assent may be given at
any time, but not later than 90 days after the shareholder is first
apprised of such action by the Director of the Philadelphia Service
Center. The shareholder shall signify his assent by filing a written
statement with the Director of the Internal Revenue Service Center,
11601 Roosevelt Blvd., Philadelphia, Pennsylvania, 19155, setting forth
the name and country of organization of the foreign corporation, his own
name, address, and stock interest in the corporation, the nature of the
action being assented to, and such other information as the Commissioner
may by forms require.
(5) Controlling United States shareholders. For purposes of this
paragraph the controlling United States shareholders of a foreign
corporation shall be those United States shareholders (as defined in
section 951(b)), who, in the aggregate, own (within the meaning of
section 958(a)) more than 50 percent of the total combined voting power
of all classes of the stock of such corporation entitled to vote and who
undertake to act on its behalf. In the event that the foreign
corporation is not a controlled foreign corporation but is included in a
chain or group under section 963(c)(2)(B) or (3)(B), the controlling
United States shareholder with respect to such foreign corporation shall
be deemed to be the domestic corporation which elects to receive the
minimum distribution from such chain or group. In the event that the
foreign corporation is neither a controlled foreign corporation nor
included in a chain or group under section 963(c)(2)(B) or (3)(B) but
has a deficit in earnings and profits sought to be taken into account
under section 952(d), the controlling United States shareholder with
respect to such foreign corporation shall be the shareholder seeking to
take such deficit into account. In the event that the foreign
corporation is a controlled foreign corporation but the United States
shareholders (as defined in section 951(b)) do not, in the aggregate,
own (within the meaning of section 958(a)) more than 50 percent of the
total combined voting power of all classes of the stock of such
corporation entitled to vote, the controlling United States shareholders
of the foreign corporation shall be all those United States shareholders
who own (within the meaning of section 958(a)) stock of such
corporation. In the event that a foreign corporation is not a controlled
foreign corporation but pays a dividend to a controlled foreign
corporation that is attributable to foreign base company shipping income
under Sec. 1.954-6(f), the controlling United States shareholders (as
defined in this subparagraph) of the controlled foreign corporation
shall be considered the controlling United States shareholders of the
foreign corporation.
(6) Action not required until significant. Notwithstanding any other
provision of this paragraph, action by or on behalf of a foreign
corporation (other than a foreign corporation subject to tax under
section 882) to make an election or to adopt a method of accounting
shall not be required until 180 days after the close of the first
taxable year for which--
(i) An amount is includible in gross income with respect to such
corporation under section 951(a);
(ii) It is sought to be established that such corporation is a less
developed country corporation (within the meaning of section 955(c), as
in effect before the enactment of the Tax Reduction Act of 1975);
(iii) An amount is excluded from Subpart F income (within the
meaning of section 952) by section 952(c), section 952(d), or section
970(a);
(iv) Such corporation is the subject of an election to secure an
exclusion under section 963 (applied as if section 963 had not been
repealed by the Tax Reduction Act of 1975); or
(v) It is sought to be established that the corporation has foreign
base company shipping income (within the meaning of section 954(f)).
In the event that action by or on behalf of the foreign corporation is
not undertaken by the time specified in the preceding sentence and such
failure is shown to the satisfaction of the Commissioner to be due to
inadvertence or a reasonable cause, such action may be undertaken during
any period of at least 30 days occurring after such showing is made
which the Commissioner may specify as appropriate for
[[Page 488]]
this purpose. Where the action necessary to make an election or to adopt
a method of accounting is undertaken by or on behalf of the foreign
corporation in accordance with this subparagraph, such election shall be
deemed to have been made, or such adoption of accounting method
effected, for the first taxable year of the foreign corporation
beginning after December 31, 1962, in which such corporation is a
controlled foreign corporation (within the meaning of section 957) or
for which it is included in a chain or group under section 963(c)(2)(B)
or (3)(B) (applied as if section 963 had not been repealed by the Tax
Reduction Act of 1975) or has a deficit in earnings and profits sought
to be taken into account under section 952(d) or pays a dividend that is
included in the foreign base company shipping income of a controlled
foreign corporation under Sec. 1.954-6(f). For special rules for
computing earnings and profits for purposes of section 1248 or income
for purposes of applying an exclusion set forth in section 954(b) where
the taxable year of the foreign corporation occurs prior to the making
of elections or the adoption of methods of accounting under this
subparagraph, see the regulations under section 952 and section 1248.
(7) Revocation of election. Notwithstanding any other provision of
this section, any election made by or on behalf of a foreign corporation
(other than a foreign corporation subject to tax under section 882) may
be modified or revoked by or on behalf of such corporation for the
taxable year for which made whenever the consent of the Commissioner is
secured for such modification or revocation, even though such election
would be irrevocable but for this subparagraph.
(8) Illustrations. The application of this paragraph may be
illustrated by the following examples:
Example 1. X Corporation is a controlled foreign corporation which
maintains its books, in accordance with the laws of the country in which
it operates, by taking inventoriable items into account under the
``first-in, first-out'' method. A, B, and C, the United States
shareholders of X Corporation, own 45 percent, 30 percent, and 25
percent of its voting stock, respectively. For the first taxable year of
X Corporation beginning after December 31, 1962, B and C adopt on its
behalf the ``last-in, first-out'' inventory method, notifying A of the
action taken. Even though A may object to such action, adjustments must
be made to reflect the use of the LIFO method of inventorying in the
computation of the earnings and profits of X Corporation with respect to
him as well as with respect to B and C.
Example 2. Y Corporation is a controlled foreign corporation which
maintains its books, in accordance with the laws of the country in which
it operates, by employing the straight-line method of depreciation. D
and E, the United States shareholders of Y Corporation, own 51 percent
and 10 percent of its voting stock, respectively. For the first taxable
year of Y Corporation beginning after December 31, 1962, D adopts on its
behalf the declining balance method of depreciation. However, not
knowing that E is a United States shareholder of the company, D fails to
provide him with notice of the action taken. Assuming that E has filed
the return required by section 6046 and the regulations thereunder
within the period prescribed by section 6046(d), adjustments in the
computation of earnings and profits will not be required with respect to
him unless the Director of International Operations notifies him of the
action taken within 240 days after the close of Y's taxable year. If
notice is not provided to E within this period, he will not be compelled
to make the adjustments. At his option, however, he may accept the
action taken by assenting thereto not later than 90 days after he is
first apprised of such action by the Director of International
Operations.
(d) Translation into United States dollars--(1) In general--(i)
General rule. Except as provided in subdivisions (ii), (iii), and (iv)
of this subparagraph, the amounts to be shown on the profit and loss
statement, adjusted pursuant to paragraphs (b) and (c) of this section,
shall be translated into United States dollars (as required by paragraph
(a)(4) of this section) at the appropriate exchange rate for the
translation period (as defined in subparagraph (6) of this paragraph) to
which they relate.
(ii) Cost of goods sold. Amounts representing items of inventory
reflected in the cost of goods sold shall be translated--
(a) To the extent that such amounts represent items included in the
opening inventory balance, so as to obtain the same amount of United
States dollars which represented (after translation and adjustment) such
items in the closing inventory balance for the preceding taxable year,
[[Page 489]]
(b) To the extent that such amounts represent items purchased or
otherwise first included in inventory during the taxable year, at the
appropriate exchange rate for the translation period in which the
historical cost of such items was incurred, and
(c) To the extent that such amounts represent items included in the
closing inventory balance, at the appropriate exchange rate for the
translation period in which the historical cost of such items was
incurred, except that, if such amounts are written down to market value,
such market value shall be determined at the year-end rate.
Notwithstanding the preceding sentence, amounts representing items of
inventory included in the closing inventory balance may be translated at
the year-end rate even though not written down to market value; however,
once such a rate is employed under those circumstances, translation may
not be made for subsequent taxable years at the appropriate exchange
rate for the translation period in which the historical cost of the
items of inventory was incurred unless the permission of the
Commissioner is secured.
(iii) Depreciation, depletion, and amortization. Amounts
representing allowances for depreciation, depletion, or amortization
shall be translated at the appropriate exchange rate for the translation
period in which the historical cost of the underlying asset was incurred
or is deemed to have been incurred. For purposes of this subdivision, if
the historical cost of an asset is determined under paragraph (b)(2) of
this section, such cost shall be deemed to have been incurred on the
date the asset is considered to have been purchased under that
paragraph.
(iv) Prepaid expenses or income. Amounts representing expenses or
income paid or received in a prior taxable year shall be translated at
the appropriate exchange rate for the translation period during which
they were paid or received. Notwithstanding the preceding sentence,
amounts representing such prepaid income or expenses may be translated
at the year-end rate; however, once such a rate is employed, translation
may not be made for subsequent taxable years at the appropriate exchange
rate for the translation period during which such income or expenses
were paid or received unless the permission of the Commissioner is
secured.
(2) Appropriate exchange rate--(i) In general. Where the value of
the foreign currency relative to the United States dollar does not
fluctuate substantially during a translation period, a single exchange
rate shall be appropriate for all amounts representing classes of items
which relate to such period, such rate to be a simple average determined
by dividing the sum of the closing rates for each of the calendar months
ending with or within such period by the number of such months. On the
other hand, where the value of the foreign currency relative to the
United States dollar does fluctuate substantially during a translation
period, the exchange rate appropriate to an amount representing a class
of items which relates to such period shall be either (a) a simple
average determined in accordance with the preceding sentence, or (b) a
weighted average taking into account the volume of transactions
(reflected by the amount being translated) for the calendar months
ending with or within such period, depending upon which average would
produce a result more representative of that which would have been
obtained by translating the individual transactions reflected by that
amount at the closing rate for the month to which each such transaction
relates. Whether the value of the foreign currency relative to the
United States dollar fluctuates substantially during the translation
period is a question of fact, depending upon, among other things, the
extent to which the volume of transactions varies from month to month.
In general, however, the degree of fluctuation will be considered
substantial if the closing rate for any calendar month ending with or
within the translation period varies by more than 10 percent from the
closing rate for any preceding calendar month ending within that period.
(ii) Monthly rate. Notwithstanding subdivision (i) of this
subparagraph, if it is so elected by or on behalf of the foreign
corporation, and if the closing rate for any calendar month ending with
or within a translation period does not vary by more than 3 percent
[[Page 490]]
from the closing rate for any preceding calendar month ending within
that period, the appropriate exchange rate for amounts representing all
classes of items relating to such period shall be any exchange rate
which is designated in the election and which does not vary by more than
3 percent from the closing rate for any calendar month ending with or
within such period. An election under this subdivision may be made with
respect to any translation period of any taxable year of the foreign
corporation beginning after December 31, 1962. Such election shall be
effective only with respect to the translation period for which it is
made, and once made shall be irrevocable with respect to that period.
See paragraph (c)(3) of this section for the time and manner in which an
election may be made on behalf of the foreign corporation.
(iii) Class of items. For purposes of this subparagraph, the term
``class of items'' means any category which is reflected separately on
books of account or financial statements. For example, sales is a class
of items which is reflected separately on the profit and loss statement,
and accounts receivable is a class of items which is reflected
separately on the balance sheet.
(3) Closing rate. The closing rate for any calendar month shall be
the exchange rate on the last day of that month determined by reference
to a qualified source of exchange rates within the meaning of
subparagraph (5) of this paragraph.
(4) Year-end rate. The year-end rate shall be the closing rate for
the last calendar month of the taxable year.
(5) Qualified source of exchange rates. A qualified source of
exchange rates shall be any source which is demonstrated to the
satisfaction of the district director to reflect actual transactions
conducted in a free market and involving representative amounts. In the
absence of such a demonstration, the exchange rates taken into account
in the computation of the earnings and profits of the foreign
corporation shall be determined by reference to the free market rate set
forth in the pertinent monthly issue of ``International Financial
Statistics'' or a successor publication of the International Monetary
Fund, or such other source of exchange rates reflecting actual
transactions conducted in a free market and involving representative
amounts as the Commissioner may designate as appropriate for this
purpose.
(6) Translation period--(i) In general. Except as provided in
subdivision (ii) of this subparagraph, the translation period shall be a
taxable year.
(ii) Currency fluctuations. If it is so elected by or on behalf of
the foreign corporation, the taxable year shall be divided into groups
consisting of a calendar month or consecutive calendar months as
specified in the election, each such group constituting a separate
translation period. Where the value of the foreign currency relative to
the United States dollar fluctuates substantially during the taxable
year, the use of the weighted average referred to in subparagraph (2)(i)
of this paragraph ordinarily may be avoided by dividing the taxable year
into translation periods so that the first translation period begins
with the first day of such year and each subsequent translation period
begins with the first day of the first calendar month thereafter ending
with or within such year for which the closing rate varies by more than
10 percent from the closing rate for any month in the preceding
translation period. An election under this subdivision may be made with
respect to any taxable year of the foreign corporation beginning after
December 31, 1962. Such election shall be effective only with respect to
the taxable year for which it is made, and once made shall be
irrevocable with respect to such year. For the time and manner in which
an election may be made on behalf of the foreign corporation, see
paragraph (c)(3) of this section.
(7) Actual transactions. Notwithstanding any other provisions of
this paragraph--
(i) Dollar transactions. Any transaction involving the payment or
receipt of United States dollars shall be reflected in the profit and
loss statement by the amount of United States dollars involved in such
transaction.
(ii) Conversion transactions. Any transaction involving the
conversion of a foreign currency into United States dollars, or the
conversion of United States dollars into a foreign currency,
[[Page 491]]
shall be reflected in the profit and loss statement by an amount
expressed in United States dollars and determined by translation at the
exchange rate at which conversion was effected if the foreign
corporation knows, or reasonably should know, that exchange rate.
(iii) Daily rate. Any transaction other than one described in
subdivision (i) or (ii) may be translated into United States dollars at
the exchange rate for the day on which that transaction occurred, such
rate to be determined by reference to a qualified source of exchange
rates within the meaning of subparagraph (5) of this paragraph.
No transaction shall be required to be taken into account under
subdivision (i) or (ii) unless the United States dollars involved are
material in amount.
(8) Other methods. Notwithstanding the other provisions of this
paragraph, translation into United States dollars may be made in
accordance with a system or method not otherwise described in this
paragraph, provided that such system or method (i) was employed by the
corporation for purposes of accounting to its shareholders prior to
January 1, 1963, and (ii) is shown to the satisfaction of the
Commissioner to clearly reflect the earnings and profits of the
corporation.
(9) Illustrations. The application of this paragraph may be
illustrated by the following examples:
Example 1. M Corporation, a controlled foreign corporation organized
on January 1, 1963, employs the calendar year as its taxable year and
maintains its books of account in abbas, the currency of the country in
which it operates. During 1963 M Corporation's monthly sales amounted to
100,000 abbas per month, its total payroll and other expenses for the
year amounted to 180,000 abbas, and its total inventory purchases
amounted to 1,050,000 abbas. Also during 1963, M Corporation purchased
depreciable assets for 1,000,000 abbas. The value of the abba relative
to the United States dollar fluctuated only slightly in 1963; the
monthly closing rate moved between 19.8 abbas and 20.2 abbas per United
States dollar and stood at 19.9 abbas per United States dollar for most
of the year and at yearend. An election under subparagraph (2)(ii) of
this paragraph is made on behalf of M Corporation to use the par rate of
20 abbas per United States dollar as the exchange rate appropriate for
1963. Assuming that none of the amounts shown therein reflects a
transaction described in subparagraph (7) of this paragraph, M
Corporation's adjusted profit and loss statement for 1963 would be
translated into United States dollars as follows:
------------------------------------------------------------------------
Local Exchange U.S.
currency rate dollars
------------------------------------------------------------------------
Sales................................... 1,200,000 20:1 60,000
----------- ---------
Cost of goods sold:
Purchases............................. 1,050,000 20:1 52,500
Less: Closing inventory............... (350,000) 20:1 (17,500)
----------- ---------
700,000 ......... 35,000
Wages and other expenses................ 180,000 20:1 9,000
Depreciation............................ 200,000 20:1 10,000
----------- ---------
Total costs and expenses............ 1,080,000 ......... 54,000
----------- ---------
Operating profit..................... 120,000 ......... 6,000
------------------------------------------------------------------------
Example 2. The facts are the same as in example 1 and in addition
during 1964 M Corporation had annual sales of 1,470,000 abbas, annual
wages and other expenses of 252,000 abbas, and inventory purchases of
910,000 abbas. Also during 1964, M Corporation purchased additional
depreciable assets for 430,000 abbas, the bulk of such purchases being
made in the last half of the year. The value of the abba relative to the
United States dollar gradually declined in 1964, the monthly closing
rate moving from 19.9 abbas per United States dollar down to 22 abbas
per United States dollar. For most classes of items, the appropriate
exchange rate is a simple average of monthly closing rates or 21 abbas
per United States dollar. However, since the bulk of the depreciable
asset purchases were made in the last half of the year, the rate
representative of those transactions is a weighted average of 21.5 abbas
per United States dollar. Assuming that none of the amounts shown
therein reflects a transaction described in subparagraph (7) of this
paragraph and that closing inventory is translated at historical rates,
M Corporation's adjusted profit and loss statement for 1964 would be
translated into United States dollars as follows:
------------------------------------------------------------------------
Local Exchange U.S.
currency rate dollars
------------------------------------------------------------------------
Sales................................... 1,470,000 21:1 70,000
------------
Cost of goods sold:
Opening inventory..................... 350,000 20:1 17,500
Purchases............................. 910,000 21:1 43,333
Less: Closing inventory............... (418,000) 21:1 (19,905)
----------- ---------
842,000 ......... 40,928
Wages and other expenses................ 252,000 21:1 12,000
Depreciation:
1963 assets........................... 150,000 20:1 7,500
1964 assets........................... 86,000 21.5:1 4,000
----------- ---------
[[Page 492]]
Total costs and expenses............ 1,330,000 ......... 64,428
----------- ---------
Operating profit..................... 140,000 ......... 5,572
------------------------------------------------------------------------
Example 3. The facts are the same as in examples 1 and 2 except that
the 1964 sales of M Corporation amounted to 1,260,000 abbas plus $10,500
in United States dollars. Assuming that closing inventory is translated
at historical rates, M Corporation's adjusted profit and loss statement
for 1964 would be translated as follows:
------------------------------------------------------------------------
Local Exchange U.S.
currency rate dollars
------------------------------------------------------------------------
Sales--Abbas............................ 1,260,000 21:1 60,000
Sales--U.S. dollars..................... 215,250 (\1\) 10,500
----------- ---------
Total sales.......................... 1,475,250 ......... 70,500
----------- ---------
Cost of goods sold:
Opening inventory..................... 350,000 20:1 17,500
Purchases............................. 910,000 21:1 43,333
Less: Closing inventory............... (418,000) 21:1 19,905
----------- ---------
842,000 ......... 40,928
Wages and other expenses................ 252,000 21:1 12,000
Depreciation:
1963 assets........................... 150,000 20:1 7,500
1964 assets........................... 86,000 21.5:1 4,000
----------- ---------
Total costs and expenses............ 1,330,000 ......... 64,428
----------- ---------
Operating profit..................... 145,250 ......... 6,072
------------------------------------------------------------------------
\1\ Transaction.
Example 4. The facts are the same as in examples 1 and 2. M
Corporation continues to operate during 1965 and the value of the abba
relative to the United States dollar declines materially during that
year; the monthly closing rate drops from 22 abbas per United States
dollar to 26 abbas per United States dollar, a decrease of more than 10
percent. An election under subparagraph (6)(ii) of this paragraph is
made on behalf of M Corporation to divide the year into translation
periods, the applicable periods being January 1 through July 31 and
August 1 through December 31. For most classes of items, the appropriate
exchange rate for each of these translation periods is a simple average
of monthly closing rates, or 23 abbas and 25 abbas per United States
dollar, respectively. However, all of the depreciable asset purchases
were made at the end of the first translation period--January 1 through
July 31--and, therefore, the rate representative of those transactions
is a weighted average of 24 abbas per United States dollar. The classes
of items reflecting M Corporation's 1965 financial transactions and the
representative rates of exchange for such classes of items are as
follows:
------------------------------------------------------------------------
Local Exchange
currency rate
------------------------------------------------------------------------
Sales:
Jan. 1-July 31.................................. 1,000,000 23:1
Aug. 1-Dec. 31.................................. 500,000 25:1
Inventory purchases:
Jan. 1-July 31.................................. 559,000 23:1
Aug. 1-Dec. 31.................................. 361,000 25:1
Expenses:
Jan. 1-July 31.................................. 115,000 23:1
Aug. 1-Dec. 31.................................. 145,000 25:1
Fixed asset purchases............................. 216,000 24:1
Closing inventory................................. 430,000 (\1\)
------------------------------------------------------------------------
\1\ Historical.
Assuming that M Corporation uses the first-in, first-out method of
inventory valuation, the closing inventory is assumed in normal
circumstances to consist of purchases made during the most recent
translation period as follows:
------------------------------------------------------------------------
Local Exchange U.S.
currency rate dollars
------------------------------------------------------------------------
All of the August-December purchases..... 361,000 25:1 14,440
Balance from January- July purchases..... 69,000 23:1 3,000
---------- ---------
Total closing inventory............... 430,000 ......... 17,440
------------------------------------------------------------------------
Assuming that none of the amounts shown therein reflects a transaction
described in subparagraph (7) of this paragraph, and that closing
inventory is translated at historical rates, M Corporation's adjusted
profit and loss statement for 1965 would be translated into United
States dollars as follows:
------------------------------------------------------------------------
Local Exchange U.S.
currency rate dollars
------------------------------------------------------------------------
Sales:
Jan. 1-July 31........................ 1,000,000 23:1 43,478
Aug. 1-Dec. 31........................ 500,000 25:1 20,000
----------- ---------
1,500,000 ......... 63,478
----------- ---------
Cost of goods sold:
Opening inventory purchases........... 418,000 21:1 19,905
Jan. 1-July 31........................ 559,000 23:1 24,304
Aug. 1-Dec. 31........................ 361,000 25:1 14,440
Less: Closing inventory................. (430,000) (\1\) (17,440)
----------- ---------
908,000 ......... 41,209
Wages and other expenses:
Jan. 1-July 31........................ 115,000 23:1 5,000
Aug. 1-Dec. 31........................ 145,000 25:1 5,800
Depreciation:
1963 assets........................... 120,000 20:1 6,000
1964 assets........................... 64,500 21.5:1 3,000
1965 assets........................... 43,200 24:1 1,800
----------- ---------
Total costs and expenses.............. 1,395,700 ......... 62,809
----------- ---------
Operating profit...................... 104,300 ......... 669
------------------------------------------------------------------------
\1\ Historical.
[[Page 493]]
(e) Exchange gain or loss--(1) In general. The exchange gain or loss
determined in accordance with subparagraph (2) of this paragraph shall
be applied against and reduce, or applied to and increase, as the case
may be, the amount of profit or loss shown on the profit and loss
statement prepared pursuant to paragraph (a)(1) of this section, as
adjusted and translated pursuant to paragraph (a)(2), (3), and (4) of
this section. For the manner in which the exchange gain or loss is to be
allocated to or applied against Subpart F income, see section 952 and
the regulations thereunder.
(2) Determination of exchange gain or loss. The exchange gain (or
loss) for the taxable year shall be the amount which equals--
(i) The retained earnings for the taxable year as determined under
subparagraph (3) of this paragraph, plus
(ii) The amount of any distributions made during the taxable year
translated at the exchange rate appropriate to the translation period
during which such distributions were made (or taken into account) in
accordance with paragraph (d)(7) of this section, if applicable, minus
(iii) The amount representing retained earnings for the preceding
taxable year as determined under subparagraph (3) of this paragraph,
minus
(iv) The amount of profit (or plus the amount of any loss) shown on
the profit and loss statement for the taxable year prepared pursuant to
paragraph (a)(1) of this section and adjusted and translated pursuant to
paragraph (a)(2), (3), and (4) of this section.
(3) Retained earnings. The retained earnings for any taxable year
shall be determined by first--
(i) Preparing a balance sheet as of the end of such year from the
books of account regularly maintained by the foreign corporation for the
purpose of accounting to its shareholders;
(ii) Making the adjustments necessary to conform such balance sheet
to the accounting principles described in paragraph (b) of this section;
(iii) Making the further adjustments necessary to conform such
balance sheet to the tax accounting standards described in paragraph (c)
of this section; and
(iv) Translating the amounts shown on the balance sheet (other than
amounts representing retained earnings) into United States dollars in
accordance with subparagraph (4) of this paragraph.
The retained earnings shall be an amount equal to the excess of the
aggregate amount representing assets on the balance sheet (as adjusted
and translated under this subparagraph) over the aggregate amount
representing liabilities, reserves (other than reserves out of current
or accumulated earnings), and paid- in capital on the balance sheet (as
adjusted and translated under this subparagraph).
(4) Translation of balance sheet. Amounts shown on the balance sheet
as adjusted pursuant to subparagraphs (3)(ii) and (iii) of this
paragraph (other than amounts representing retained earnings) shall be
translated into United States dollars as follows:
(i) Financial assets. Amounts representing financial assets shall be
translated at the year-end rate.
(ii) Physical assets. Amounts representing physical assets (other
than inventory) shall be translated at the appropriate exchange rate for
the translation period in which the historical cost of the asset was
incurred or is deemed to have been incurred. For special rules for
determining date on which the historical cost of certain assets acquired
during taxable years beginning before January 1, 1950, or owned at the
time a majority interest in the corporation was acquired after December
31, 1949, but before October 27, 1964, is deemed to have been incurred,
see paragraph (b)(2) of this section.
(iii) Depreciation and similar reserves. Amounts representing
depreciation, depletion, and amortization reserves shall be translated
at the appropriate exchange rate for the translation period in which the
historical cost of the underlying asset was incurred or is deemed to
have been incurred.
(iv) Inventory. Amounts representing items of inventory included in
the closing inventory balance shall be translated in accordance with
paragraph (d)(1)(ii) of this section.
[[Page 494]]
(v) Bad debt reserves. Amounts representing bad debts reserves shall
be translated at the year-end rate.
(vi) Prepaid income or expense. Amounts representing expenses or
income paid or received in a prior taxable year shall be translated in
accordance with paragraph (d)(1)(iv) of this section.
(vii) Short-term liabilities. Amounts representing short-term
liabilities shall be translated at the year-end rate.
(viii) Long-term liabilities. Amounts representing long-term
liabilities shall be translated at the appropriate exchange rate for the
translation period in which such liabilities were incurred.
(ix) Paid-in capital. Amounts representing paid-in capital shall be
translated at the appropriate exchange rate for the translation period
in which such capital was paid in.
Notwithstanding any other provisions of this subparagraph, where the
amount representing an item shown on the balance sheet reflects a
transaction described in paragraph (d)(7) of this section, such
transaction shall be taken into account in accordance with that
paragraph.
(5) Definitions. For purposes of this paragraph--
(i) Financial assets. A financial asset shall be any asset
reflecting a fixed amount of foreign currency, such as cash on hand,
bank deposits, and loans and accounts receivable. Securities (within the
meaning of section 1236(c)) shall be considered physical assets if they
have been or are reasonably expected to be held for at least six months;
if not they shall be considered financial assets whether or not they
reflect a fixed amount of foreign currency. Moreover, advances on open
account to any corporation in which the foreign corporation and any
related persons (within the meaning of section 954(d)(3) and the
regulations thereunder) with respect thereto own at least 10 percent of
the combined voting power of all classes of stock entitled to vote shall
not be considered financial assets if such advances have remained open
for more than one year.
(ii) Physical assets. A physical asset shall be any asset other than
a financial asset and shall include goodwill, patents, and other
intangibles.
(iii) Short-term liabilities. A short-term liability shall be any
indebtedness of the foreign corporation which is due or overdue as of
the date of the balance sheet or which will become due within 1 year
thereafter.
(iv) Long-term liabilities. A long- term liability is any
indebtedness of the foreign corporation other than a short- term
liability.
For the definition of ``appropriate exchange rate'', ``year-end rate'',
and ``translation period'', see paragraphs (d)(2), (4), and (6),
respectively, of this section.
(6) Illustrations. The application of this paragraph may be
illustrated by the following examples:
Example 1. N Corporation is a controlled foreign corporation which
uses the calendar year as its taxable year and which maintains its books
in yuccas, the currency of the country in which it operates. For 1963,
its operating profit is 140,000 yuccas or $55,720. At the end of the
year, its balance sheet, as translated and adjusted pursuant to
subparagraph (3) of this paragraph, is as follows:
------------------------------------------------------------------------
Local Exchange U.S.
currency rate dollars
------------------------------------------------------------------------
Cash................................... 77,000 2.20:1 35,000
Accounts receivable.................... 209,000 2.20:1 95,000
Inventory.............................. 418,000 (\1\) 199,050
Fixed assets........................... 1,430,000 (\1\) 700,000
Less: Accumulated depreciation......... (436,000) (\1\) (215,000)
----------- ----------
Total assets........................ 1,698,000 ......... 814,050
=========== ==========
Current liabilities.................... 338,000 2.20:1 153,640
Long-term liabilities.................. 300,000 (\1\) 150,000
Paid-in capital........................ 800,000 (\1\) 400,000
Retained earnings...................... 260,000 ......... 110,410
----------- ----------
Total liabilities and net worth..... 1,698,000 ......... 814,050
------------------------------------------------------------------------
\1\ Historical.
N Corporation's retained earnings for 1962 are determined on the basis
of its balance sheet as of the end of that year, translated as follows:
------------------------------------------------------------------------
Local Exchange U.S.
currency rate dollars
------------------------------------------------------------------------
Cash................................... 70,000 2.00:1 35,000
Accounts receivable.................... 180,000 2.00:1 90,000
Inventory.............................. 350,000 (\1\) 175,000
Fixed assets........................... 1,000,000 (\1\) 500,000
Less: Accumulated depreciation......... (200,000) (\1\) (100,000)
----------- ----------
Total assets........................ 1,400,000 ......... 700,000
=========== ==========
[[Page 495]]
Current liabilities.................... 180,000 2.00:1 90,000
Long-term liabilities.................. 300,000 (\1\) 150,000
Paid-in capital........................ 800,000 (\1\) 400,000
Retained earnings...................... 120,000 ......... 60,000
----------- ----------
Total liabilities and net worth..... 1,400,000 ......... 700,000
------------------------------------------------------------------------
\1\ Historical.
The exchange gain or loss of N Corporation for 1963 may be computed
as follows:
Retained earnings--1963............................ ........ $110,410
Less:
Retained earnings--1962.......................... $60,000 .........
Operating profit--1963........................... 55,720 115,720
-----------
Exchange loss...................................... ........ (5,310)
-----------
Example 2. Assume the same facts as in example 1. For 1964, N
Corporation's operating profit is 104,300 yuccas or $15,740. It pays a
dividend of 26,000 yuccas during a translation period when the
appropriate exchange rate is 2.60 yuccas per United States dollar. At
yearend, its balance sheet, as translated and adjusted pursuant to
subparagraph (3) of this paragraph, is as follows:
------------------------------------------------------------------------
Local Exchange U.S.
currency rate dollars
------------------------------------------------------------------------
Cash................................... 91,000 2.60:1 35,000
Accounts receivable.................... 260,000 2.60:1 100,000
Inventory.............................. 430,000 (\1\) 174,400
Fixed assets........................... 1,646,000 (\1\) 790,000
Less: Accumulated depreciation......... (663,700) (\1\) (323,000)
----------- ----------
Total assets........................ 1,763,300 ......... 776,400
=========== ==========
Current liabilities.................... 325,000 2.60:1 125,000
Long-term liabilities.................. 300,000 (\1\) 150,000
Paid-in capital........................ 800,000 (\1\) 400,000
Retained earnings...................... 338,300 ......... 101,400
----------- ----------
Total liabilities and net worth..... 1,763,300 ......... 776,400
------------------------------------------------------------------------
\1\ Historical.
The exchange gain or loss of N Corporation for 1964 would be
computed as follows:
Retained earnings--1964........................... ......... $101,400
Add:
Dividends--1964................................. ......... 10,000
------------
Predistribution earnings........................ ......... 111,400
Less:
Retained earnings--1963......................... $110,410 .........
Operating profit--1964.......................... 15,740 126,150
------------
Exchange loss..................................... ......... (14,750)
------------
(f) Determination of earnings and profits as if a domestic
corporation--(1) In general. If the books of account regularly
maintained by a foreign corporation for the purpose of accounting to its
shareholders are kept in U.S. dollars and in accordance with accounting
principles generally accepted in the United States, and if it is so
elected by or on behalf of such corporation, the earnings and profits of
the foreign corporation for a taxable year shall, except as otherwise
provided in paragraph (f)(2) of this section, be determined in every
respect as if it were a domestic corporation. Such election shall be
effective only for the taxable year with respect to which the election
is made. Once made, such election shall be irrevocable. See paragraph
(c)(3) of this section for the time and manner in which an election may
be made on behalf of a foreign corporation.
(2) Illegal payments. The amount of any illegal bribe, kickback, or
other payment (within the meaning of section 162(c), as amended by
section 288 of the Tax Equity and Fiscal Responsibility Act of 1982 in
the case of payments made after September 3, 1982, and the regulations
thereunder) paid after November 3, 1976, by or on behalf of the
corporation during the taxable year of the corporation directly or
indirectly to an official, employee, or agent in fact of a government
shall not be taken into account to decrease earnings and profits or
increase the deficit in earnings and profits otherwise determined under
paragraph (f)(1) of this section.
[T.D. 6764, 29 FR 14628, Oct. 27, 1964; 29 FR 15204, Nov. 11, 1964, as
amended by T.D. 6787, 29 FR 18502, Dec. 29, 1964; T.D. 6995, 34 FR 832,
Jan. 18, 1969; T.D. 7221, 37 FR 24747, Nov. 21, 1972; T.D. 7322, 39 FR
30931, Aug. 27, 1974; T.D. 7545, 43 FR 19652, May 8, 1978; T.D. 7862, 47
FR 56491, Dec. 17, 1982; T.D. 7893, 48 FR 22510, May 19, 1983]
Sec. 1.964-1T Special rules for computing earnings and profits of
controlled foreign corporations in taxable years beginning after
December 31, 1986 (temporary).
(a)-(f) [Reserved]
(g)(1) Earnings and profits computed in functional currency--(i)
Rule. For taxable years of a controlled foreign corporation (within the
meaning of section 957) beginning after December 31, 1986, earnings and
profits shall be computed in the controlled foreign corporation's
functional currency (determined under section 985 and the regulations
thereunder) in accordance with Sec. 1.964-1
[[Page 496]]
as modified by this paragraph (g). Accordingly, Sec. 1.964-1 (d), (e),
and (f) and (to the extent inconsistent with this paragraph (g)) Sec.
1.964-1(c) do not apply for taxable years of a controlled foreign
corporation beginning after December 31, 1986. For purposes of this
section, the term ``earnings and profits'' includes a deficit in
earnings and profits.
(ii) Cross reference. In the case of a controlled foreign
corporation with a functional currency other than the United States
dollar (dollar), see sections 986(b) and 989(b) for rules regarding the
time and manner of translating distributions or inclusions of the
controlled foreign corporation's earnings and profits into dollars.
(2) Election required when first significant. Tax accounting methods
or elections may be adopted or made by, or on behalf of, a controlled
foreign corporation in the manner prescribed by the Code and regulations
no later than 180 days after the close of the first taxable year of the
controlled foreign corporation in which the computation of its earnings
and profits is significant for United States income tax purposes with
respect to its controlling United States shareholders (as defined in
Sec. 1.964-1(c)(5)). For taxable years of a controlled foreign
corporation beginning before January 1, 1989, only the events listed in
Sec. 1.964-1(c)(6) are considered to cause a controlled foreign
corporation's earnings and profits to have United States tax
significance. For taxable years of a controlled foreign corporation
beginning after December 31, 1988, events that cause a controlled
foreign corporation's earnings and profits to have United States tax
significance include, without limitation--
(i) The events listed in Sec. 1.964-1(c)(6),
(ii) A distribution from the controlled foreign corporation to its
shareholders with respect to their stock,
(iii) Any event making the controlled foreign corporation subject to
tax under section 882,
(iv) An election by the controlled foreign corporation's controlling
United States shareholders to use the tax book value method of
allocating interest expense under section 864(e)(4), and
(v) A sale or exchange of the controlled foreign corporation's stock
by the controlling United States shareholders.
The filing of the information return required by section 6038 shall not
itself constitute a significant event.
(3) Effect of failure to make required election. If an accounting
method or election is not timely adopted or made by, or on behalf of, a
controlled foreign corporation, and such failure is not shown to the
satisfaction of the Commissioner to be due to reasonable cause under
Sec. 1.964-1(c)(6), earnings and profits shall be computed in
accordance with this section. Such computation shall be made as if no
elections had been made and any permissible accounting methods not
requiring an election and reflected in the books of account regularly
maintained by the controlled foreign corporation for the purpose of
accounting to its shareholders had been adopted. Thereafter, any change
in a particular accounting method or methods may be made by, or on
behalf of, the controlled foreign corporation only with the Commission's
consent.
(4) Computation of earnings and profits by a minority shareholder
prior to majority election or significant event. A minority United
States shareholder (as defined in section 951(b)) of a controlled
foreign corporation may be required to compute a controlled foreign
corporation's earnings and profits before the controlled foreign
corporation or its controlling United States shareholders make, or are
required under this section to make, an election or adopt a method of
accounting for United States tax purposes. In such a case, the minority
United States shareholder must compute earnings and profits in
accordance with this section. Such computation shall be made as if no
elections had been made and any permissible accounting methods not
requiring an election and reflected in the books of account regularly
maintained by the controlled foreign corporation for the purpose of
accounting to its shareholders had been adopted. However, a later,
properly filed, and timely election or adoption of method by, or on
[[Page 497]]
behalf of, the controlled foreign corporation shall not be treated as a
change in accounting method.
(5) Binding effect. For taxable years beginning after December 31,
1986, except as otherwise provided in the Code or regulations, earnings
and profits of a controlled foreign corporation shall be computed
consistently under the rules of sections 964(a) and 986(b) for all
federal income tax purposes. An election or adoption of a method of
accounting for United States tax purposes by a controlled foreign
corporation, or on its behalf pursuant to Sec. 1.964-1(c) or any other
provision of the regulations (e.g., Sec. 1.985-2(c)(3)), shall bind
both the controlled foreign corporation and its United States
shareholders as to the computation of the controlled foreign
corporation's earnings and profits under section 964(a) for the year of
the election or adoption and in subsequent taxable years unless the
Commissioner consents to a change. The preceding sentence shall apply
regardless of--
(i) Whether the election or adoption of a method of accounting was
made in a pre-1987 or a post-1986 taxable year;
(ii) Whether the controlled foreign corporation was a controlled
foreign corporation at the time of the election or adoption of method;
(iii) When ownership was acquired; or
(iv) Whether the United States shareholder received the written
notice required by Sec. 1.964-1(c)(3).
Adjustments to the appropriate separate category (as defined in Sec.
1.904-5(a)(1)) of earnings and profits and income of the controlled
foreign corporation shall be required using the principles of section
481 to prevent any duplication or omission of amounts attributable to
previous years that would otherwise result from any such election or
adoption.
(6) Examples. The following examples illustrate the rules of this
section.
Example 1: (i) P, a calendar year domestic corporation, owns all of
the outstanding stock of FX, a calendar year controlled foreign
corporation. None of the significant events specified in Sec. 1.964-
1(c)(6) or this section has occurred. In addition, neither P nor FX has
ever made or adopted, or been required to make or adopt, an election or
method of accounting for United States tax purposes with respect to FX.
On June 1, 1990, FX makes a distribution to P. FX does not act to make
any election or adopt a method of accounting for United States tax
purposes.
(ii) P must compute FX's earnings and profits in order to determine
if any portion of the distribution is taxable as a dividend and to
determine P's foreign tax credit on such portion under section 902. P
must satisfy the requirements of Sec. 1.964-1(c)(3) and file the
written statement and notice described therein within 180 days after the
close of FX's 1990 taxable year in order to make an election or to adopt
a method of accounting on behalf of FX. Any such election or adoption
will govern the computation of earnings and profits of FX for all
federal income tax purposes (including, e.g., the determination of
foreign tax credits on subpart F inclusions) in 1990 and subsequent
taxable years unless the Commissioner consents to a change.
(iii) If P fails to satisfy the regulatory requirements in a timely
manner and such failure is not shown to the satisfaction of the
Commissioner to be due to reasonable cause, the earnings and profits of
FX shall be computed as if no elections were made and any permissible
methods of accounting not requiring an election and reflected in its
books were adopted. Any subsequent attempt by FX or P to change an
accounting method shall be effective only if the Commissioner consents
to the change.
Example 2: (i) The facts are the same as in Example 1, except that P
elects to allocate its interest expense under section 864(e)(4) for its
1989 taxable year under the tax book value method of Sec. 1.861-12T(c)
of the Temporary Income Tax Regulations.
(ii) P must compute the earnings and profits of FX in order to
determine the adjustment to P's basis in the stock of FX for P's 1989
taxable year. P must satisfy the requirements of Sec. 1.964-1(c)(3) and
file the written statement and notice described therein within 180 days
after the close of FX's 1989 taxable year in order to make an election
or to adopt a method of accounting on behalf of FX. Any such election or
adoption will govern the computation of FX's earnings and profits in
1989 and subsequent taxable years for all federal income tax purposes
(including, e.g., the characterization of the June 1, 1990 distribution
and the determination of P's foreign tax credit, if any, with respect
thereto) unless the Commissioner consents to a change.
(iii) If P fails to satisfy the regulatory requirements in a timely
manner and such failure is not shown to the satisfaction of the
Commissioner to be due to reasonable cause, the earnings and profits of
FX shall be computed as if no elections were made and any permissible
methods of accounting not requiring an election and reflected in its
books were adopted. Any subsequent attempt by FX or P to change an
accounting method
[[Page 498]]
shall be effective only if the Commissioner consents to the change.
Example 3: (i) The facts are the same as in Example 2, except that P
elects to allocate its interest expense under section 864(e)(4) for its
1988 taxable year under the tax book value method of Sec. 1.861-12T (c)
of the Temporary Income Tax Regulations.
(ii) P must compute the earnings and profits of FX in order to
determine the adjustment to P's basis in the stock of FX for P's 1988
taxable year. P must satisfy the requirements of Sec. 1.964-1(c)(3) and
file the written statement and notice described therein within 180 days
after the close of FX's 1988 taxable year in order to make an election
or to adopt a method of accounting on behalf of FX. Any such election or
adoption will govern the computation of FX's earnings and profits in
1988 and subsequent taxable years for all federal income tax purposes
(including, e.g., P's basis adjustment for purposes of section 864(e)(4)
in 1989 and the characterization of the June 1, 1990 distribution and
the determination of P's foreign tax credit, if any, with respect
thereto) unless the Commissioner consents to a change.
(iii) If P fails to satisfy the regulatory requirements in a timely
manner and such failure is not shown to the satisfaction of the
Commissioner to be due to reasonable cause, the earnings and profits of
FX for 1988 shall be computed as if no elections were made and any
permissible methods of accounting not requiring an election and
reflected in its books were adopted. However, a properly filed, timely
election or adoption of method by, or on behalf of, FX with respect to
its 1989 taxable year, when P's basis adjustment for purposes of section
864(e)(4) first constitutes a significant event, shall not be treated as
a change in accounting method. No recomputation of P's basis adjustment
for 1988 shall be required by reason of any such election or adoption of
method with respect to FX's 1989 taxable year, but prospective
adjustments to FX's earnings and profits and income shall be made to the
extent required by Sec. 1.964-1T(g)(5).
Example 4: (i) The facts are the same as in Example 3, except that
FX had subpart F income taxable to P in 1986, and P computed FX's
earnings and profits for purposes of determining the amount of the
inclusion and the foreign taxes deemed paid by P in 1986 under section
960 pursuant to Sec. 1.964-1 (a) through (e).
(ii) Any election made or method of accounting adopted on behalf of
FX by P pursuant to Sec. 1.964-1(c) in 1986 is binding on P and FX for
purposes of computing FX's earnings and profits in 1986 and subsequent
taxable years. Thus, in determining P's basis adjustment for purposes of
section 864(e)(4) in 1988 and 1989 and its deemed-paid credit with
respect to the 1990 dividend, FX's earnings and profits must be computed
consistently with the method used by P with regard to the 1986 subpart F
inclusion. (However, Sec. 1.964-1 (d), (e), and (f) do not apply in
computing FX's earnings and profits in post-1986 taxable years.)
Example 5: (i) The facts are the same as in Example 4, except that
FX made a dividend distribution to P on June 1, 1985, and P computed
FX's earnings and profits for purposes of computing the foreign taxes
deemed paid by P in 1985 under section 902 with respect to the
distribution under Sec. 1.964-1 exclusive of paragraphs (d), (e), and
(f) pursuant to a timely election under Sec. 1.902-1(g)(1).
(ii) Any election made or method of accounting adopted on behalf of
FX by P pursuant to Sec. 1.964-1(c) in 1985 is binding on P and FX for
purposes of computing FX's earnings and profits in 1985 and subsequent
taxable years. Thus, in determining P's basis adjustment for purposes of
section 864(e)(4) in 1988 and 1989 and its deemed-paid credit with
respect to the 1986 subpart F inclusion and the 1990 dividend, FX's
earnings and profits must be computed consistently with the method used
by P with regard to the 1985 dividend. If, rather than choosing under
Sec. 1.902-1(g)(1) to use the section 964 rules, P computed FX's
earnings and profits for purposes of section 902 in 1985 in all respects
as if FX were a domestic corporation, then P would have been free to
make elections or adopt a method of accounting on behalf of FX under
Sec. 1.964-1(c) with respect to the subpart F inclusion in 1986. Any
such election or adoption would be binding on P and FX as to the
computation of FX's earnings and profits in 1986 and subsequent taxable
years.
[T.D. 8283, 55 FR 2516, Jan. 25, 1990; 55 FR 7711, Mar. 5, 1990]
Sec. 1.964-2 Treatment of blocked earnings and profits.
(a) General rule. If, in accordance with paragraph (d) of this
section, it is established to the satisfaction of the district director
that any amount of the earnings and profits of a controlled foreign
corporation for the taxable year (determined under Sec. 1.964-1) was
subject to a currency or other restriction or limitation imposed under
the laws of any foreign country (within the meaning of paragraph (b) of
this section) on its distribution to United States shareholders who own
(within the meaning of section 958(a)) stock of such corporation, such
amount shall not be included in earnings and profits for purposes of
sections 952, 955 (as in effect both before and after the enactment of
the Tax Reduction Act of 1975), and 956 for such taxable year. For rules
[[Page 499]]
governing the treatment of amounts with respect to which such
restriction or limitation is removed, see paragraph (c) of this section.
(b) Rules of application. For purposes of paragraph (a) of this
section--
(1) Period of restriction or limitation. An amount of earnings and
profits of a controlled foreign corporation for any taxable year shall
not be included in earnings and profits for purposes of sections 952,
955 (as in effect both before and after the enactment of the Tax
Reduction Act of 1975), and 956 only if such amount of earnings and
profits is subject to a currency or other restriction or limitation
(within the meaning of subparagraph (2) of this paragraph) throughout
the 150-day period beginning 90 days before the close of the taxable
year and ending 60 days after the close of such taxable year.
(2) Restriction or limitation defined. Whether earnings and profits
of a controlled foreign corporation are subject to a currency or other
restriction or limitation imposed under the laws of a foreign country
must be determined on the basis of all the facts and circumstances in
each case. Generally, such a restriction or limitation must prevent--
(i) The ready conversion (directly or indirectly) of such currency
into United States dollars, or into property of a type normally owned by
such corporation in the operation of its business or other money which
is readily convertible into United States dollars; or
(ii) The distribution of dividends by such corporation to its United
States shareholders.
For purposes of this subparagraph, if a United States shareholder owns
(within the meaning of section 958(a)), or is considered as owning by
applying the rules of ownership of section 958(b), 80 percent or more of
the total combined voting power of all classes of stock of a foreign
corporation in a chain of ownership described in section 958(a), the
distribution of dividends by such corporation to such shareholder will
not be considered prevented solely by reason of the existence of a
currency or other restriction or limitation at an intermediate tier in
such chain if dividends may be distributed directly to such
shareholders.
(3) Foreign laws. A currency or other restriction or limitation on
the distribution of earnings and profits may be imposed in a foreign
country by express statutory provisions, executive orders or decrees,
rules or regulations of a governmental agency, court decisions, the
actions of appropriate officials who are acting within the scope of
their authority, or by any similar official action. A currency
restriction will not be considered to exist unless export restrictions
are also imposed which prevent the exportation of property of a type
normally owned by the controlled foreign corporation in the operation of
its business which could be readily converted into United States
dollars.
(4) Voluntary restriction or limitation. A currency or other
restriction or limitation arising from the voluntary act of the
controlled foreign corporation or its United States shareholders during
a taxable year beginning after December 31, 1962, will not be taken into
account. For example, if a controlled foreign corporation--
(i) Issues a stock dividend which has the effect of capitalizing
earnings and profits;
(ii) Elects to restrict its earnings and profits or to make certain
investments as a means of avoiding current tax or securing a reduced
rate of tax; or
(iii) Allocates earnings and profits to an optional or arbitrary
reserve; such restriction is voluntary and will not be taken into
account.
(5) Treatment of earnings and profits in cases of certain mandatory
reserves--(i) In general. If a controlled foreign corporation is
required under the laws of a foreign country to establish a reserve out
of earnings and profits for the taxable year, such earnings and profits
shall be considered subject to a restriction or limitation by reason of
such requirement only to the extent that the amount required to be
included in such reserve at the close of the taxable year exceeds the
accumulated earnings and profits (determined in accordance with
subdivision (ii) of this subparagraph) of such corporation at the close
of the preceding taxable year.
[[Page 500]]
(ii) Determination of earnings and profits. For purposes of
determining the accumulated earnings and profits of a controlled foreign
corporation under subdivision (i) of this subparagraph, such earnings
and profits shall not include any amounts which are attributable to--
(a) Amounts which, for any prior taxable year, have been included in
the gross income of a United States shareholder under section 951(a) and
have not been distributed;
(b) Amounts which, for any prior taxable year, have been included in
the gross income of a United States shareholder of such foreign
corporation under section 551(b) and have not been distributed; or
(c) Amounts which become subject to a voluntary restriction or
limitation (within the meaning of subparagraph (4) of this paragraph)
during a taxable year beginning before January 1, 1963.
The rules of this subdivision apply only in determining the accumulated
earnings and profits of a controlled foreign corporation for purposes of
this subparagraph. See section 959 and the regulations thereunder for
limitations on the exclusion from gross income of previously taxed
earnings and profits.
(6) Exhaustion of procedures for distributing earnings and profits.
Earnings and profits of a controlled foreign corporation for a taxable
year will not be considered subject to a currency or other restriction
or limitation on their distribution unless the United States
shareholders of such corporation demonstrate either that the available
procedures for distributing such earnings and profits have been
exhausted or that the use of such procedures will be futile. As a
general rule, such procedures will be considered to have been exhausted
if the foreign corporation applies for dollars (or foreign currency
readily convertible into dollars) at the appropriate rate of exchange
and complies with the applicable laws and regulations governing the
acquisition and transfer of such currency including submission of the
necessary documentation to the exchange authority. The fact that
available procedures for distributing earnings and profits were
exhausted without success with respect to a prior year is not, of
itself, sufficient evidence that such procedures would not be successful
with respect to the current taxable year.
(c) Removal of restriction or limitation--(1) In general. If, during
any taxable year, a currency or other restriction or limitation (within
the meaning of paragraph (b) of this section) imposed under the laws of
a foreign country on the distribution of earnings and profits of a
controlled foreign corporation to its United States shareholders is
removed--
(i) Treatment of deferred income. Each United States shareholder of
such corporation on the last day in such year that such corporation is a
controlled foreign corporation shall include in his gross income for
such taxable year the amounts attributable to such earnings and profits
which would have been includible in his gross income under section
951(a) for prior taxable years but for the existence of the currency or
other restriction or limitation except that the amounts included under
this subdivision (i) shall not exceed his pro rata share of--
(a) The earnings and profits upon which the restriction was removed
determined on the basis of his stock ownership on the last day of the
immediately preceding taxable year, and
(b) The applicable limitations under paragraph (c) of Sec. 1.952-1,
paragraph (b)(2) of Sec. 1.955-1, paragraph (b)(2) of Sec. 1.955A-1,
or paragraph (b) of Sec. 1.956-1, determined as of the last day of the
immediately preceding taxable year, taking into account the provisions
of subdivision (ii) of this subparagraph.
(ii) Treatment of earnings and profits. For purposes of sections
952, 955 (as in effect both before and after the enactment of the Tax
Reduction Act of 1975), and 956, the earnings and profits which are no
longer subject to a currency or other restriction or limitation shall be
treated as included in the corporation's earnings and profits for the
year in which such earnings and profits were derived.
Amounts with respect to which a currency or other restriction or
limitation is removed shall be translated into United States dollars at
the appropriate exchange rate for the translation period during which
such currency or other restriction or limitation
[[Page 501]]
is removed. See paragraph (d) of Sec. 1.964-1. Amounts with respect to
which a currency or other restriction or limitation is removed shall not
be taken into account in determining whether a deficiency distribution
(within the meaning of Sec. 1.963-6 (applied as if section 963 had not
been repealed by the Tax Reduction Act of 1975)) is required to be made
for the year in which such earnings and profits were derived.
(2) Removal of restriction or limitation defined. An amount of
earnings and profits shall be considered no longer subject to a
limitation or restriction if and to the extent that--
(i) Money or property in such foreign country is readily convertible
into United States dollars, or into other money or property of a type
normally owned by such corporation in the operation of its business
which is readily convertible into United States dollars;
(ii) Notwithstanding the existence of any laws or regulations
forbidding the exchange of money or property into United States dollars,
conversion is actually made into United States dollars, or other money
or property of a type normally owned by such corporation in the
operation of its business which is readily convertible into United
States dollars; or
(iii) A mandatory reserve requirement (described in paragraph (b)(5)
of this section) is removed either by a change in law of the foreign
country imposing such requirement or by an accumulation of earnings and
profits not subject to such requirement.
(3) Distribution in foreign country. If, during any taxable year,
earnings and profits previously subject to a currency or other
restriction or limitation are distributed in a foreign country to one or
more United States shareholders of a controlled foreign corporation
directly, or indirectly through a chain of ownership described in
section 958(a), such earnings and profits shall be considered no longer
subject to a restriction or limitation. However, distributed amounts may
be excluded from such shareholder's gross income for the taxable year of
receipt if such shareholder elects a method of accounting under which
the reporting of blocked foreign income is deferred until the income
ceases to be blocked.
(4) Source of distribution. If, during any taxable year, earnings
and profits previously subject to a currency or other restriction or
limitation is distributed to one or more United States shareholders of a
controlled foreign corporation directly, or indirectly through a chain
of ownership described in section 958(a), the source of such
distribution shall be determined in accordance with the rules of Sec.
1.959-3.
(5) Illustration. The provisions of this paragraph may be
illustrated by the following example:
Example. (a) M, a United States person, owns all of the only class
of stock of A Corporation, a foreign corporation incorporated under the
laws of foreign country X on January 1, 1963. Both M and A Corporations
use the calendar year as a taxable year and A Corporation is a
controlled foreign corporation throughout the period here involved.
(b) During 1963, A Corporation derives income of $100,000 all of
which is subpart F income and has earnings and profits of $100,000.
Under the laws of X Country, currency cannot be exported without a
license. During the last 90 days of 1963 and the first 60 days of 1964,
A Corporation can obtain a license to distribute only an amount
equivalent to $10,000. M must include $10,000 in his gross income for
1963 under section 951(a)(1)(A)(i) and $90,000 of A Corporation's
earnings and profits for 1963 are not taken into account for purposes of
sections 952, 955, and 956.
(c) During 1964, A Corporation has no income and no earnings and
profits. On June 1, 1964, A Corporation converts an amount equivalent to
$20,000 into property of a type normally owned by such corporation in
the operation of its business which is readily convertible into United
States dollars but does not distribute such amount. Corporation A must
include $20,000 in its earnings and profits for 1963 for purposes of
sections 952, 955, and 956. M must include $20,000 in his gross income
for 1964.
(d) During 1965, A Corporation has no income and no earnings and
profits. On December 15, 1965, A Corporation distributes an amount
equivalent to $15,000 to M in X Country. Neither M nor A Corporation can
obtain a license to export currency from X Country. In his return for
the taxable year 1965, M elects a method of accounting under which the
reporting of blocked foreign income is deferred until the income ceases
to be blocked. Accordingly, M does not include the $15,000 in his gross
income for 1965.
(e) During 1966, A Corporation has no income and no earnings and
profits. On February 1, 1966, notwithstanding the laws and regulations
of X Country which forbid the exchange of X Country's currency into
[[Page 502]]
United States dollars, M converts an amount equivalent to $15,000 into a
currency which is readily convertible into United States dollars. Since
the income has ceased to be blocked, M must include $15,000 in his gross
income for 1966.
(d) Manner of claiming existence of restriction or limitation on
distribution of earnings and profits. A United States shareholder
claiming that an amount of the earnings and profits of a controlled
foreign corporation for the taxable year was subject to a currency or
other restriction or limitation imposed under the laws of a foreign
country on its distribution shall file a statement with his return for
the taxable year with or within which the taxable year of the foreign
corporation ends which shall include--
(1) The name and address of the foreign corporation,
(2) A description of the classes of stock of the foreign corporation
and a statement of the number of shares of each class owned (within the
meaning of section 958(a)) or considered as owned (by applying the rules
of ownership of section 958(b)) by the United States shareholder,
(3) A description of the currency or other restriction or limitation
on the distribution of earnings and profits,
(4) The total earnings and profits of the foreign corporation for
the taxable year (before any amount is excluded from earnings and
profits under this section) and the United States shareholder's pro rata
share of such total earnings and profits,
(5) The United States shareholder's pro rata share of the amount of
earnings and profits subject to a restriction or limitation on
distribution,
(6) The amounts which would be includible in the United States
shareholder's gross income under section 951(a) but for the existence of
the currency or other restriction or limitation,
(7) A description of the available procedures for distributing
earnings and profits and a statement setting forth the steps taken to
exhaust such procedures or a statement setting forth the reasons that
the use of such procedures would be futile, and
(8) The amount of distributions made in a foreign country and a
statement as to whether a method of accounting has been elected under
which the reporting of blocked income is deferred until such income
ceases to be blocked, including an identification of the taxable year
and place of filing of such election.
In addition, such United States shareholder shall furnish to the
district director such other information as he may require to verify the
status of a currency or other restriction or limitation.
[T.D. 6892, 31 FR 11142, Aug. 23, 1966, as amended by T.D. 7545, 43 FR
19652, May 8, 1978; T.D. 7893, 48 FR 22510, May 19, 1983]
Sec. 1.964-3 Records to be provided by United States shareholders.
(a) Shareholder's responsibility for providing records. For purposes
of verifying his income tax liability in respect of amounts includible
in income under section 951 for the taxable year of a controlled foreign
corporation each United State shareholder (as defined in section 951(b))
who owns (within the meaning of section 958(a)) stock of such
corporation shall, within a reasonable time after demand by the district
director, provide the district director--
(1) Such permanent books of account or records as are sufficient to
satisfy the requirements of section 6001 and section 964(c), or true
copies thereof, as are reasonably demanded, and
(2) If such books or records are not maintained in the English
language, either (i) an accurate English translation of such books or
records or (ii) the services of a qualified interpreter satisfactory to
the district director.
If such books or records are being used by another district director,
the United States shareholder upon whom the district director has made a
demand to provide such books or records shall file a statement of such
fact with his district director, indicating the location of such books
or records. For the length of time the United States shareholder of a
controlled foreign corporation must cause such books or records as are
under his control to be retained, see paragraph (e) of Sec. 1.6001-1.
(b) Records to be provided. Except as otherwise provided in
paragraph (c) of this section, the requirements of section 6001 and
section 964(c) for record
[[Page 503]]
keeping shall be considered satisfied if the books or records produced
are sufficient to verify for the taxable year--
(1) The subpart F income of the controlled foreign corporation and,
if any part of such income is excluded from the income of the United
States shareholder under section 963 or section 970(a), the application
of such exclusion,
(2) The previously excluded subpart F income of such corporation
withdrawn from investment in less developed countries,
(3) The previously excluded subpart F income of such corporation
withdrawn from investment in foreign base company shipping operations,
(4) The previously excluded export trade income of such corporation
withdrawn from investment, and
(5) The increase in earnings invested by such corporation in United
States property.
(c) Special rules. Verification of the subpart F income of the
controlled foreign corporation for the taxable year shall not be
required if--
(1) It can be demonstrated to the satisfaction of the district
director that--
(i) The locus and nature of such corporation's activities were such
as to make it unlikely that the foreign base company income of such
corporation (determined in accordance with paragraph (c)(3) of Sec.
1.952-3) exceeded 5 percent of its gross income (determined in
accordance with paragraph (b)(1) of Sec. 1.952-3) for the taxable year.
(For taxable years to which Sec. 1.952-3 does not apply, such amounts
shall be determined under 26 CFR Sec. 1.954-1(d)(3)(i) and (ii)
(Revised as of April 1, 1975))), and
(ii) If such corporation reinsures or issues insurance or annuity
contracts in connection with United States risks, the 5-percent minimum
premium requirement prescribed in paragraph (b) of Sec. 1.953-1 has not
been exceeded for the taxable year, or
(2) The United States shareholder's pro rata share of such subpart F
income is excluded in full from his income under section 963 and the
books or records verify the application of such exclusion.
[T.D. 6824, 30 FR 6480, May 11, 1965, as amended by T.D. 7893, 48 FR
22510, May 19, 1983]
Sec. 1.964-4 Verification of certain classes of income.
(a) In general. The provisions of this section shall apply for
purposes of determining when books or records are sufficient for
purposes of Sec. 1.964-3 to verify the classes of income described in
such section.
(b) Subpart F income. Books or rec ords sufficient to verify the
subpart F income of a controlled foreign corporation must establish for
the taxable year--
(1) Its gross income and deductions,
(2) The income derived from the insurance of United States risks (as
provided in paragraph (c) of this section),
(3) The foreign base company income (as provided in paragraph (d) of
this section), and
(4) In the case of a United States shareholder claiming the benefit
of the exclusion provided in section 952(b) or the limitation provided
in section 952(c)--
(i) The items of income excluded from subpart F income by paragraph
(b) of Sec. 1.952-1 as income derived from sources within the United
States, the United States income tax incurred with respect thereto, and
the deductions properly allocable thereto and connected therewith, and
(ii) The earnings and profits, or deficit in earnings and profits,
of any foreign corporation necessary for the determinations provided in
paragraphs (c) and (d) of Sec. 1.952-1.
(c) Income from insurance of United States risks. Books or records
sufficient to verify the income of a controlled foreign corporation from
the insurance of United States risks must establish for the taxable
year--
(1) That the 5-percent minimum premium requirement prescribed in
paragraph (b) of Sec. 1.953-1 has not been exceeded, or
(2) The taxable income, as determined under Sec. 1.953-4 or Sec.
1.953-5, which is attributable to the reinsuring or the issuing of any
insurance or annuity contracts in connection with United States risks,
as defined in Sec. 1.953-2 or Sec. 1.953-3.
(d) Foreign base company income and exclusions therefrom. Books or
records sufficient to verify the income of a controlled foreign
corporation which is
[[Page 504]]
foreign base company income must establish for the taxable year the
following items:
(1) Foreign personal holding company income. The foreign personal
holding company income to which section 954(c) and Sec. 1.954-2 apply,
for which purpose there must be established the gross income from--
(i) All rents and royalties,
(ii) Rents and royalties received in the active conduct of a trade
or business from an unrelated person, as determined under section
954(c)(3)(A) and paragraph (d)(1) of Sec. 1.954-2,
(iii) Rents and royalties received from a related person for the use
of property in the country of incorporation of the controlled foreign
corporation, as determined under section 954(c)(4)(C) and paragraph
(e)(3) of Sec. 1.954-2,
(iv) All dividends, interest, and except where the controlled
foreign corporation is a regular dealer in stock or securities, all
gains and losses from the sale or exchange of stock or securities,
(v) Dividends, interest, and gains from the sale or exchange of
stock or securities, received in the conduct of a banking, financing, or
insurance business from an unrelated person, as determined under section
954(c)(3)(B) and paragraph (d)(2) and (3) of Sec. 1.954-2,
(vi) Dividends and interest received from a related corporation
organized in the country of incorporation of the controlled foreign
corporation, as determined under section 954(c)(4)(A) and paragraph
(e)(1) of Sec. 1.954-2,
(vii) Interest received in the conduct of a banking or other
financing business from a related person, as determined under section
954(c)(4)(B) and paragraph (e)(2) of Sec. 1.954-2,
(viii) All annuities,
(ix) All gains from commodities transactions described in section
553(a)(3),
(x) All income from estates and trusts described in section
553(a)(4),
(xi) All income from personal service contracts described in section
553(a)(5), and
(xii) All compensation for the use of corporate property by
shareholders described in section 553(a)(6).
(2) Foreign base company sales income. The foreign base company
sales income to which section 954(d) and Sec. 1.954-3 apply, for which
purpose there must be established the gross income from--
(i) All sales by the controlled foreign corporation of its personal
property and all purchases or sales of personal property by such
corporation on behalf of another person,
(ii) Purchases and/or sales of personal property in connection with
transactions not involving related persons (as defined in paragraph
(e)(2) of Sec. 1.954-1),
(iii) Purchases and/or sales of personal property manufactured,
produced, etc., in the country of incorporation of the controlled
foreign corporation, as determined under paragraph (a)(2) of Sec.
1.954-3,
(iv) Purchases and/or sales of personal property for use, etc., in
the country of incorporation of the controlled foreign corporation, as
determined under paragraph (a)(3) of Sec. 1.954-3, and
(v) Sales of personal property manufactured or produced by the
controlled foreign corporation, as determined under paragraph (a)(4) of
Sec. 1.954-3.
Where an item of income falls within more than one of subdivisions (ii)
through (v) of this subparagraph, it shall be sufficient to establish
that it falls within any one of them. If a branch or similar
establishment is treated as a wholly owned subsidiary corporation
through the application of section 954(d)(2) and paragraph (b) of Sec.
1.954-3, the requirements of this subparagraph shall be satisfied
separately for each branch or similar establishment so treated and for
the remainder of the controlled foreign corporation.
(3) Foreign base company services income. The foreign base company
services income to which section 954(e) and Sec. 1.954-4 apply, for
which purpose there must be established the gross income from--
(i) All services performed by the controlled foreign corporation,
(ii) Services other than those (as determined under paragraph (b) of
Sec. 1.954-4) performed for, or on behalf of, a related person,
(iii) Services performed in the country of incorporation of the
controlled foreign corporation, as determined under paragraph (c) of
Sec. 1.954-4, and
[[Page 505]]
(iv) Services performed in connection with the sale or exchange of,
or with an offer or effort to sell or exchange, personal property
manufactured, produced, etc., by the controlled foreign corporation, as
determined under paragraph (d) of Sec. 1.954-4.
Where an item of income falls within more than one of subdivisions (ii)
through (iv) of this subparagraph, it shall be sufficient to establish
that it falls within any one of them.
(4) Foreign base company oil related income. (i) The foreign base
company oil related income described in section 954(g) and Sec. 1.954-
8, for which purpose there must be established, with respect to each
foreign country, the gross income derived from--
(A) The processing of minerals extracted (by the taxpayer or by any
other person) from oil or gas wells into their primary products, as
determined under section 907(c)(2)(A),
(B) The transportation of such minerals or primary products, as
determined under section 907(c)(2)(B),
(C) The distribution or sale of such minerals or primary products,
as determined under section 907(c)(2)(C),
(D) The disposition of assets used by the taxpayer in a trade or
business described in subdivision (A), (B) or (C), as determined under
section 907(c)(2)(D),
(E) Dividends, interests, partnership distributions, and other
amounts, as determined under section 907(c)(3).
Where an item of income falls within more than one of the listings in
paragraphs (d)(4)(i)(A) through (E) of this section, it shall be
sufficient to establish that it falls within any one of them.
(ii) If any of the items of income listed in paragraph (d)(4)(i) of
this section arising from sources within a foreign country relates to
oil, gas, or a primary product thereof and is described in section
954(g)(1)(A) or (B) and Sec. 1.954-8(a)(1)(i) or (ii) (and, hence, is
not foreign base company oil related income), then there must be
established facts sufficient to verify the amount of such item of income
which is not foreign base company oil related income. In this regard,
the total quantities of oil, gas and primary products thereof which gave
rise to such item of income and the portions of such quantities which
were extracted or sold within the foreign country must be established.
(5) Qualified investments in less developed countries. For rules in
effect for taxable years of foreign corporations beginning before
January 1, 1976, see 26 CFR 1.964-4(d)(4) (Revised as of April 1, 1975).
(6) Income derived from aircraft or ships. For rules in effect for
taxable years of foreign corporations beginning before January 1, 1976,
see CFR Sec. 1.964-4(d)(5) (Revised as of April 1, 1975).
(7) Foreign base company shipping income. The foreign base company
shipping income to which section 954(f) and Sec. 1.954-6 apply, for
which purpose there must be established--
(i) Gross income derived from, or in connection with, the use (or
hiring or leasing for use) of any aircraft or vessel in foreign
commerce, as determined under Sec. 1.954-6(c),
(ii) Gross income derived from, or in connection with, the
performance of services directly related to the use of any aircraft or
vessel in foreign commerce, as determined under Sec. 1.954-6(d),
(iii) Gross income incidental to income described in subdivisions
(i) and (ii) of this subparagraph, as determined under Sec. 1.954-6(e),
(iv) Gross income derived from the sale, exchange, or other
disposition of any aircraft or vessel used (by the seller or by a person
related to the seller) in foreign commerce,
(v) Dividends, interest, and gains described in Sec. Sec. 1.954-
6(f) and 1.954(b) (1)(viii),
(vi) Income described in Sec. 1.954-6(g) (relating to partnerships,
trusts, etc.), and
(vii) Exchange gain, to the extent allocable to foreign base company
shipping income, as determined under Sec. 1.952-2(c)(2)(v)(b).
If the controlled foreign corporation has income derived from or in
connection with, the use (or hiring or leasing for use) of any aircraft
or vessel in foreign commerce, or derived from, or in connection with,
the performance of services directly related to the use of any aircraft
or vessel in foreign commerce, it shall be necessary to establish, from
the books and records of the controlled foreign corporation, that
[[Page 506]]
such aircraft or vessel was used in foreign commerce within the meaning
of subparagraphs (3) and (4) of Sec. 1.954-6(b).
(8) Income on which taxes are not substantially reduced. The gross
income excluded from foreign base company income under section 954(b)(4)
and paragraph (b)(3) or (4) of Sec. 1.954-1 in the case of a controlled
foreign corporation not availed of to substantially reduce income taxes,
the income or similar taxes incurred with respect thereto, and all other
factors necessary to verify the application of such exclusion.
(9) Qualified investments in foreign base company shipping
operations. The foreign base company shipping income that is excluded
from foreign base company income under section 954(b)(2) and Sec.
1.954-1(b)(1).
(10) Special rule for shipping income. The distributions received
through a chain of ownership described in section 958(a) which are
excluded from foreign base company income under section 954(b)(6)(B) and
Sec. 1.954-1(b)(2).
(11) Deductions. The deductions allocable, under paragraph (c) of
Sec. 1.954-1, to each of the classes and subclasses of gross income
described in subparagraphs (1) through (9) of this paragraph.
(e) Exclusion under section 963. Books or records sufficient to
verify the application of the exclusion provided by section 963 with
respect to the subpart F income for the taxable year of a controlled
foreign corporation must establish that the conditions set forth in
paragraph (a)(2) of Sec. 1.963-1 have been met.
(f) Exclusion under section 970(a). Books or records sufficient to
verify the application for the taxable year of the exclusion provided by
section 970(a) in respect of export trade income which is foreign base
company income must establish for such year--
(1) That the controlled foreign corporation is an export trade
corporation, as defined in section 971(a) and paragraph (a) of Sec.
1.971-1,
(2) The export trade income, as determined under section 971(b) and
paragraph (b) of Sec. 1.971-1, which constitutes foreign base company
income,
(3) The export promotion expenses, as determined under section
971(d) and paragraph (d) of Sec. 1.971-1, which are allocable to the
excludable export trade income,
(4) The gross receipts, and the gross amount on which is computed
compensation included in gross receipts, from property in respect of
which the excludable export trade income is derived, as described in
section 970(a)(1)(B) and paragraph (b)(2)(ii) of Sec. 1.970-1, and
(5) The increase in investments in export trade assets, as
determined under section 970(c)(2) and paragraph (d)(2) of Sec. 1.970-
1.
(g-1) Withdrawal of previously excluded subpart F income from
qualified investment in less developed countries. Books or records
sufficient to verify the previously excluded subpart F income of the
controlled foreign corporation withdrawn from investment in less
developed countries for the taxable year must establish--
(1) The sum of the amounts of income excluded from foreign base
company income under section 954(b)(1) and paragraph (b)(1) of Sec.
1.954-1 (as in effect for taxable years beginning before January 1,
1976; see 26 CFR 1.954-1(b)(1) (Revised as of April 1, 1975)) for all
prior taxable years,
(2) The sum of the amounts of previously excluded subpart F income
withdrawn from investment in less developed countries for all prior
taxable years, as determined under section 955(a) (as in effect before
the enactment of the Tax Reduction Act of 1975) and paragraph (b) of
Sec. 1.955-1, and
(3) The amount withdrawn from investment in less developed countries
for the taxable year as determined under section 955(a) (as in effect
before the enactment of the Tax Reduction Act of 1975) and paragraph (b)
of Sec. 1.955-1.
(g-2) Withdrawal of previously excluded subpart F income from
investment in foreign base company shipping operations. Books or records
sufficient to verify the previously excluded subpart F income of the
controlled foreign corporation withdrawn from investment in foreign base
company shipping operations for the taxable year must establish--
(1) The sum of the amounts of income excluded from foreign base
company income under section 954(b)(2) and
[[Page 507]]
paragraph (b)(1) of Sec. 1.954-1 for all prior taxable years,
(2) The sum of the amounts of previously excluded subpart F income
withdrawn from investment in foreign base company shipping operations
for all prior taxable years, as determined under section 955(a) and
paragraph (b) of Sec. 1.955A-1,
(3) The amount withdrawn from investment in foreign base company
shipping operations for the taxable year as determined under section
955(a) and paragraph (b) of Sec. 1.955A-1, and
(4) If the carryover (as described in Sec. 1.955A-1(b)(3)) of
amounts relating to investments in less developed country shipping
companies (as described in Sec. 1.995-5(b)) is applicable, (i) the
amount of the corporation's qualified investments (determined under
Sec. 1.955-2 other than paragraph (b)(5) thereof) in less developed
country shipping companies at the close of the last taxable year of the
corporation beginning before January 1, 1976, and (ii) the amount of the
limitation with respect to previously excluded subpart F income
(determined under Sec. 1.955-1(b)(1)(i)(b)) for the first taxable year
of the corporation beginning after December 31, 1975.
(h) Withdrawal of previously excluded export trade income from
investment. Books or records sufficient to verify the previously
excluded export trade income of the controlled foreign corporation
withdrawn from investment for the taxable year must establish the United
States shareholder's proportionate share of--
(1) The sum of the amounts by which the subpart F income of such
corporation was reduced for all prior taxable years under section 970(a)
and paragraph (b) of Sec. 1.970-1,
(2) The sum of the amounts described in section 970(b)(1)(B),
(3) The sum of the amounts of previously excluded export trade
income of such corporation withdrawn from investment under section
970(b) and paragraph (c) of Sec. 1.970-1 for all prior taxable years,
and
(4) The amount withdrawn from investment under section 970(b) and
paragraph (c) of Sec. 1.970-1 for the taxable year.
(i) Increase in earnings invested in United States property. Books
or rec ords sufficient to verify the increase for the taxable year in
earnings invested by the controlled foreign corporations in United
States property must establish--
(1) The amount of such corporation's earnings invested in United
States property (as defined in section 956(b)(1) and paragraph (a) of
Sec. 1.956-2) at the close of the current and preceding taxable years,
as determined under paragraph (b) of Sec. 1.956-1,
(2) The amount of excluded property described in section 956(b)(2)
and paragraph (b) of Sec. 1.956-2 held by such corporation at the close
of such years,
(3) The earnings and profits, to which section 959(c)(1) and
paragraph (b)(1) of Sec. 1.959-3 apply, distributed by such corporation
during the preceding taxable year, and
(4) The amount of increase in earnings invested by such corporation
in United States property which is excluded from the United States
shareholder's gross income for the taxable year under section 959(a)(2)
and paragraph (c) of Sec. 1.959-1.
[T.D. 6824, 30 FR 6481, May 11, 1965, as amended by T.D. 7211, 37 FR
21436, Oct. 11, 1972; T.D. 7893, 48 FR 22511, May 19, 1983; T.D. 8331,
56 FR 2849, Jan. 25, 1991]
Sec. 1.964-5 Effective date of subpart F.
Sections 951 through 964 and Sec. Sec. 1.951 through 1.964-4 shall
apply with respect to taxable years of foreign corporations beginning
after December 31, 1962, and to taxable years of United States
shareholders within which or with which such taxable years of such
corporations end.
[T.D. 7120, 36 FR 10862, June 4, 1971
export trade corporations
Sec. 1.970-1 Export trade corporations.
(a) In general. Sections 970 through 972 provide in general that if
a controlled foreign corporation is an export trade corporation for any
taxable year, the subpart F income of such corporation shall, subject to
limitations provided by section 970(a) and paragraph (b) of this
section, be reduced by so much of such corporation's export trade income
as constitutes foreign
[[Page 508]]
base company income. To the extent subpart F income of an export trade
corporation is reduced under section 970 and this section, an amount is
required by section 970(b) and paragraph (c) of this section to be
included in gross income of United States shareholders of the
corporation if there is a subsequent decrease in such corporation's
investments in export trade assets. See section 971(a) and paragraph (a)
of Sec. 1.971-1 for definition of the term ``export trade
corporation'', section 971(b) and paragraph (b) of Sec. 1.971-1 for
definition of the term ``export trade income'', and section 971(c) and
paragraph (c) of Sec. 1.971-1 for definition of the term ``export trade
assets''.
(b) Amount by which export trade income shall reduce subpart F
income--(1) Deductible amount. The subpart F income, determined as
provided in section 952 and the regulations thereunder but without
regard to section 970 and this paragraph, of a controlled foreign
corporation which is an export trade corporation for its taxable year
shall be reduced by an amount equal to so much of its export trade
income as constitutes foreign base company income for such taxable year,
but only to the extent that such amount of export trade income does not
exceed the limitation determined under subparagraph (2) of this
paragraph for such taxable year. See section 972 and Sec. 1.972-1 for
rules relating to the consolidation of export trade corporations for
purposes of determining the limitations described in subparagraph (2) of
this paragraph.
(2) Limitation on the amount of export trade income deductible from
subpart F income. The amount by which subpart F income of an export
trade corporation may be reduced for any taxable year under subparagraph
(1) of this paragraph may not exceed whichever of the following
limitations is the smallest:
(i) The amount which is equal to 150 percent of the export promotion
expenses, as defined in section 971(d) and paragraph (d) of Sec. 1.971-
1, of the export trade corporation paid or incurred during the taxable
year which are properly allocable to the receipt or the production of so
much of its export trade income as constitutes foreign base company
income for such taxable year;
(ii) The amount which is equal to 10 percent of the gross receipts
(other than from commissions, fees, or other compensation for services),
plus 10 percent of the gross amount upon the basis of which are computed
commissions, fees, or other compensation for services included in gross
receipts, of the export trade corporation received or accrued during the
taxable year from, or in connection with, the sale, installation,
operation, maintenance, or use of property in respect of which such
corporation derives export trade income which constitutes foreign base
company income for such taxable year; or
(iii) The amount which bears the same ratio to the increase in
investments in export trade assets, as defined in section 970(c)(2) and
paragraph (d)(2) of this section, of the export trade corporation for
its taxable year as the export trade income which constitutes foreign
base company income of such corporation for such taxable year bears to
the entire export trade income of the corporation for such year.
Under subdivision (ii) of this subparagraph, in the case of minimum or
maximum fee arrangements, the determination shall be made on the basis
of the actual gross amounts with respect to which such fees are paid,
rather than on the basis of the amounts upon which such minimum or
maximum fees are computed. All determinations of limitations under this
subparagraph shall be made on an aggregate basis and not with respect to
separate items or categories of income described in paragraph (b)(1) of
Sec. 1.971-1.
(3) Determination of export promotion expense limitation. For
purposes of determining the limitation contained in subparagraph (2)(i)
of this paragraph for any taxable year of the export trade corporation,
there shall be taken into account with respect to those items or
categories of export trade income which constitute foreign base company
income the entire amount of those export promotion expenses which are
directly related to such items or categories of income and a ratable
part of any other export promotion expenses which are indirectly related
to such items or categories of income, except that no export promotion
expense shall
[[Page 509]]
be allocated to an item or category of income to which it clearly does
not apply and no deduction allowable to such corporation under section
882(c) and the regulations thereunder shall be taken into account.
(4) Application of section 482. The limitations provided in section
970(a) and subparagraph (2) of this paragraph shall not affect the
authority of the district director to apply the provisions of section
482 and the regulations thereunder, relating to allocation of income and
deductions among taxpayers.
(5) Illustrations. The application of this paragraph may be
illustrated by the following examples:
Example 1. Foreign corporation A is a wholly owned subsidiary of
domestic corporation M. Both corporations use the calendar year as the
taxable year. For 1963, A Corporation's subpart F income determined
under section 952 and the regulations thereunder is $35, the total of
its gross receipts and gross amounts referred to in subparagraph (2)(ii)
of this paragraph is $310, its export promotion expenses properly
allocable to its export trade income which constitutes foreign base
company income are $18, its increase in investments in export trade
assets is $32, and its export trade income is $40, of which $30
constitutes foreign base company income and $10 does not constitute
foreign base company income. The subpart F income of A Corporation for
1963 as reduced under section 970(a) is $11, determined as follows:
(i) Subpart F income.................................... ...... $35
(ii) Less: $30 export trade income which constitutes
foreign base company income, but deduction not to
exceed the smallest of the following limitations
(smallest of (a), (b), or (c)):
(a) 150 percent of allocable export promotion $27 ......
expenses referred to in subparagraph (2)(i) of this
paragraph (150% of $18)............................
(b) 10 percent of gross receipts and gross amounts $31 ......
referred to in subparagraph (2)(ii) of this
paragraph (10% of $310)............................
(c) Amount which bears to the increase in $24 $24
investments in export trade assets ($32) the same
ratio as the export trade income which constitutes
foreign base company income ($30) bears to total
export trade income ($40) (75% [$30/$40] of $32)...
=======
(iii) Subpart F income as reduced under section 970(a).. ...... 11
Example 2. The facts are the same as in example 1, except that A
Corporation's export promotion expenses properly allocable to export
trade income which constitutes foreign base company income are $14
instead of $18. The applicable limitation on the amount deductible from
A Corporation's subpart F income for 1963 is $21 (150% of $14) instead
of $24. The subpart F income as reduced under section 970(a) is $14 ($35
less $21).
Example 3. The facts are the same as in example 1, except that the
total amount of A Corporation's gross receipts and gross amounts
referred to in subparagraph (2)(ii) of this paragraph is $200 instead of
$310. The applicable limitation on the amount deductible from A
Corporation's subpart F income for 1963 is $20 (10 percent of $200)
instead of $24. The subpart F income as reduced under section 970(a) is
$15 ($35 less $20).
Example 4. The facts are the same as in example 1, except that A
Corporation derives its export trade income which constitutes foreign
base company income of $30 in a service arrangement with M Corporation
under which it receives as a fee 5 percent of the gross receipts from M
Corporation's sales or a minimum fee of $30. Such gross receipts are
$220. The gross amounts taken into account in determining the limitation
under subparagraph (2)(ii) of this paragraph are $220. The applicable
limitation on the amount deductible from A Corporation's subpart F
income for 1963 is $22 (10 percent of $220) instead of $24. The subpart
F income as reduced under section 970(a) is $13 ($35 minus $22).
Example 5. The facts are the same as in example 1, except that A
Corporation derives its export trade income which constitutes foreign
base company income of $30 in a service arrangement with M Corporation
under which it receives as a fee 9 percent of the gross receipts from M
Corporation's sales or a maximum fee of $30. Such gross receipts are
$400. In such instance, the limitation under (ii)(b) of example 1 is $40
(10 percent of $400) instead of $31. The applicable limitation on the
amount deductible from A Corporation's subpart F income for 1963 is $24,
the smallest of the three limitations. The subpart F income as reduced
under section 970(a) is $11 ($35 less $24).
(c) Withdrawal of previously excluded export trade income--(1)
Inclusion of withdrawal in income of United States shareholders. If--
(i) A controlled foreign corporation was an export trade corporation
for any taxable year,
(ii) Such corporation in any such taxable year derived subpart F
income which, under the provisions of section 970(a) and paragraph (b)
of this section, was reduced, and
(iii) Such corporation has in a subsequent taxable year a decrease
in investments in export trade assets,
every person who is a United States shareholder, as defined in section
[[Page 510]]
951(b), of such corporation on the last day of such subsequent taxable
year on which such corporation is a controlled foreign corporation shall
include in his gross income, under section 951(a)(1)(A)(ii) and the
regulations thereunder as an amount to which section 955 (as in effect
before the enactment of the Tax Reduction Act of 1975) applies, his pro
rata share of the amount of such decrease in investments but only to the
extent that such pro rata share does not exceed the limitations
determined under subparagraph (2) of this paragraph. A United States
shareholder's pro rata share of a controlled foreign corporation's
decrease for any taxable year in investments in export trade assets
shall be his pro rata share of such corporation's decrease for such year
determined under section 970(c)(3) and paragraph (d)(3) of this section.
(2) Limitations applicable in determining amount includible in
income--(i) General. A United States shareholder's pro rata share of a
controlled foreign corporation's decrease in investments in export trade
assets for any taxable year of such corporation shall, for purposes of
determining an amount to be included in the gross income for any taxable
year of such shareholder, not exceed the lesser of the limitations
determined under (a) and (b) of this subdivision:
(a) Such shareholder's pro rata share of the sum of the controlled
foreign corporation's earnings and profits (or deficit in earnings and
profits) for the taxable year, computed as of the close of the taxable
year without diminution by reason of any distributions made during the
taxable year, plus his pro rata share of the sum of its earnings and
profits (or deficits in earnings and profits) accumulated for prior
taxable years beginning after December 31, 1962, or
(b)(1) Such shareholder's pro rata share of the sum of the amounts
by which the subpart F income of such controlled foreign corporation for
prior taxable years was reduced under section 970(a) and paragraph (b)
of this section, plus
(2) Such shareholder's pro rata share of the sum of the amounts
which were not included in the subpart F income of such controlled
foreign corporation for such prior taxable years by reason of the
application of section 972 and Sec. 1.972-1, minus
(3) Such shareholder's pro rata share of the sum of the amounts
which were previously included in his gross income for prior taxable
years under section 951(a)(1)(A)(ii) by reason of the application of
section 970(b) and this paragraph with respect to such controlled
foreign corporation.
The net amount determined under (b) of this subdivision with respect to
any stock owned by the United States shareholder shall be determined
without taking into account any amount attributable to a period prior to
the date on which such shareholder acquired such stock. See section 1248
and the regulations thereunder for rules governing the treatment of gain
from sales or exchanges of stock in certain foreign corporations.
(ii) Treatment of earnings and profits. For purposes of determining
earnings and profits of a controlled foreign corporation under
subdivision (i) (a) of this subparagraph, such earnings and profits
shall be considered not to include any amounts which are attributable
to--
(a) Amounts which are, or have been, included in the gross income of
a United States shareholder of such controlled foreign corporation under
section 951(a) (other than an amount included in the gross income of a
United States shareholder under section 951(a)(1)(A)(ii) or section
951(a)(1)(B) for the taxable year) and have not been distributed, or
(b)(1) Amounts which for the current taxable year, are included in
the gross income of a United States shareholder of such controlled
foreign corporation under section 551(b) or would be so included under
such section but for the fact that such amounts were distributed to such
shareholder during the taxable year, or
(2) Amounts which, for any prior taxable year, have been included in
the gross income of a United States shareholder of such controlled
foreign corporation under section 551(b) and have not been distributed.
The rules of this subdivision apply only in determining the limitation
on a
[[Page 511]]
United States shareholder's pro rata share of a controlled foreign
corporation's decrease in investments in export trade assets. See
section 959 and the regulations thereunder for limitations on the
exclusion of previously taxed earnings and profits.
(iii) Rules of application. The determinations made under
subdivision (i) of this subparagraph for purposes of determining the
United States shareholder's pro rata share of a controlled foreign
corporation's decrease in investments in export trade assets for any
taxable year shall be made on the basis of the stock such shareholder
owns, within the meaning of section 958(a) and the regulations
thereunder, in the controlled foreign corporation on the last day in the
taxable year on which such corporation is a controlled foreign
corporation even though such shareholder owned more or less stock in
such corporation prior to that date. See section 972 and paragraph
(b)(3) of Sec. 1.972-1 for rules relating to the allocation of a
decrease in investments in export trade assets of export trade
corporations in a consolidated chain of such corporations. See section
951(a)(3) and the regulations thereunder for an additional limitation
upon the amount of a United States shareholder's pro rata share
determined under this paragraph.
(3) Illustrations. The application of this paragraph may be
illustrated by the following examples:
Example 1. Foreign corporation A, which has one class of stock
outstanding, is a wholly owned subsidiary of domestic corporation M
throughout 1963 and 1964. Both corporations use the calendar year as the
taxable year. For 1963, A Corporation qualifies as an export trade
corporation and its subpart F income, determined in accordance with the
provisions of section 952 and the regulations thereunder, is reduced by
$20 under the provisions of section 970(a) and paragraph (b) of this
section. Section 972 is assumed not to apply to A Corporation. For 1964,
A Corporation has a decrease of $8 in investments in export trade
assets. For 1963 and 1964, A Corporation has earnings and profits of $30
(determined under the provisions of subparagraph (2) of this paragraph).
Corporation M's pro rata share of A Corporation's decrease in
investments in export trade assets for 1964 which is includible in M
Corporation's gross income for 1964 under section 951(a)(1)(A)(ii) by
reason of the application of section 970(b) is $8, determined as
follows:
(i) Corporation M's pro rata share of A ..... ..... $8
Corporation's decrease in investments in export
trade assets for 1964 (100% of $8)................
(ii) Limitation on amount includible in gross
income of M Corporation for 1964 (smaller of (a)
or (b)):
(a) Corporation M's pro rata share of A ..... $30 .....
Corporation's earnings and profits for 1963 and
1964 determined under subparagraph (2) of this
paragraph (100% of $30).........................
(b) Corporation M's pro rata share of amounts by $20 ..... .....
which the subpart F income of A Corporation for
1963 was reduced under section 970(a) (100% of
$20)............................................
Plus: Corporation M's pro rata share of amounts 0 ..... .....
which were not included in subpart F income of A
Corporation for 1963 by reason of the
application of section 972......................
-------
Total........................................ 20 ..... .....
Less: Corporation M's pro rata share of the sum 0 20 .....
of amounts which were previously included in
gross income of M Corporation under section
951(a)(1)(A)(ii) by reason of the application of
section 970(b) with respect to A Corporation....
--------------
(iii) Corporation M's pro rata share includible in ..... ..... 8
gross income for 1964 under section
951(a)(1)(A)(ii) by reason of the application of
section 970(b) (smaller of (i) or (ii))...........
Example 2. Assume the same facts as in example 1, except that on
February 14, 1965, M Corporation sells 25 percent of its stock in A
Corporation to N Corporation. Corporation N is a domestic corporation
which also uses the calendar year as a taxable year. For 1965, A
Corporation has a decrease of $16 in investments in export trade assets.
Corporation A's earnings and profits for 1963 and 1964 (determined under
the provisions of subparagraph (2) of this paragraph) are $22 ($30 minus
$8). Corporation A's earnings and profits for 1965 are $6 (determined
under the provisions of subparagraph (2) of this paragraph). For 1965, M
Corporation's pro rata share of A Corporation's decrease in investments
in export trade assets which is includible in M Corporation's gross
income under section 951(a)(1)(A)(ii) is $9, and N Corporation's pro
rata share includible in gross income under such section is $0,
determined as follows:
M Corporation
(i) Corporation M's pro rata share of A ..... ..... $12
Corporation's decrease in investments in export
trade assets for 1965 (75% of $16)................
[[Page 512]]
(ii) Limitation on amount includible in gross
income of M Corporation for 1965 (smaller of (a)
or (b)):
(a) Corporation M's pro rata share of A ..... $21 .....
Corporation's earnings and profits for 1963,
1964, and 1965 determined under subparagraph (2)
of this paragraph (75% of $28)..................
(b) Corporation M's pro rata share of amounts by $15 ..... .....
which the subpart F income of A Corporation for
1963 was reduced under section 970(a) (75% of
$20)............................................
Plus: Corporation M's pro rata share of amounts 0 ..... .....
which were not included in subpart F income of
A Corporation for 1963 and 1964 by reason of
the application of section 972................
-------
Total........................................ $15 ..... .....
Less: Corporation M's pro rata share of the sum 6 9 .....
of amounts which were previously included in
gross income of M Corporation under section
951(a)(1)(A)(ii) by reason of the application of
section 970(b) with respect to A Corporation
(75% of $8).....................................
-------
(iii) Corporation M's pro rata share includible in ..... ..... 9
gross income for 1965 under section
951(a)(1)(A)(ii) by reason of the application of
section 970(b) (smaller of (i) or (ii))...........
N Corporation
(i) Corporation N's pro rata share of A ..... ..... 0
Corporation's decrease in investments in export
trade assets for 1965 (25% of $16)................
(ii) Limitation on amount includible in gross
income of N Corporation for 1965 (smaller of (a)
or (b)):
(a) Corporation N's pro rata share of A ..... 07 .....
Corporation's earnings and profits for 1963,
1964, and 1965 determined under subparagraph (2)
of this paragraph (25% of $28)..................
(b) Corporation N's pro rata share of amounts by 0 ..... .....
which the subpart F income of A Corporation for
1963 was reduced under section 970(a) (amounts
prior to 2/14/65 not being taken into account)..
Plus: Corporation N's pro rata share of amounts 0 ..... .....
which were not included in subpart F income of
A Corporation for 1963 and 1964 by reason of
the application of section 972 (amounts prior
to 2/14/65 not being taken into account)......
-------
Total........................................ 0 ..... .....
Less: Corporation N's pro rata share of the sum 0 0 .....
of amounts which were previously included in
gross income of N Corporation under section
951(a)(1)(A)(ii) by reason of the application of
section 970(b) with respect to A Corporation
(amounts prior to 2/14/65 not being taken into
account)........................................
(iii) Corporation N's pro rata share includible in ..... ..... 0
gross income for 1965 under section
951(a)(1)(A)(ii) by reason of the application of
section 970(b) (smaller of (i) or (ii))...........
(d) Investments in export trade assets--(1) Amount of investments.
For purposes of sections 970 through 972 and Sec. Sec. 1.970-1 to
1.972-1, inclusive, export trade assets shall be taken into account on
the following bases:
(i) Working capital. Working capital to which section 971(c)(1)
applies shall be taken into account at the adjusted basis of current
assets, determined as of the applicable determination date, less any
current liabilities (except as provided in subdivision (iii) of this
subparagraph).
(ii) Other export trade assets. Inventory to which section 971(c)(2)
applies, facilities to which section 971(c)(3) applies, and evidences of
indebtedness to which section 971(c)(4) applies, shall be taken into
account at their adjusted bases as of the applicable determination date,
reduced by any liabilities (except as provided in subdivision (iii) of
this subparagraph) to which such property is subject on such date. To be
taken into account under this subparagraph, a liability must constitute
a specific charge against the property involved. Thus, a liability
evidenced by an open account or a liability secured only by the general
credit of the controlled foreign corporation will not be taken into
account. On the other hand, if a liability constitutes a specific charge
against several items of property and cannot definitely be allocated to
any single item of property, the liability shall be apportioned against
each of such items of property in that ratio which the adjusted basis of
such item on the applicable determination date bears to the adjusted
basis of all such items on such date. A liability in excess of the
adjusted basis of the property which is subject to such liability will
not be taken into account for the purpose of reducing the adjusted basis
[[Page 513]]
of other property which is not subject to such liability. See paragraph
(c)(6) of Sec. 1.971-1 for treatment of export trade assets which
constitute working capital to which section 971(c)(1) applies and which
also constitute inventory to which section 971(c)(2) applies or
evidences of indebtedness to which section 971(c)(4) applies.
(iii) Treatment of certain liabilities. For purposes of subdivisions
(i) and (ii) of this subparagraph, a current liability, or a specific
charge created with respect to any item of property, principally for the
purpose of artificially increasing or decreasing the amount of a
controlled foreign corporation's investments in export trade assets
shall be taken into account in such a manner as to properly reflect the
controlled foreign corporation's investments in export trade assets;
whether a specific charge or current liability is created principally
for such purpose will depend upon all the facts and circumstances of
each case. One of the factors that will be considered in making such a
determination with respect to a loan is whether the loan is from a
related person, as defined in section 954(d)(3) and paragraph (e) of
Sec. 1.954-1.
(iv) Statement required. If for purposes of this section a United
States shareholder of a controlled foreign corporation reduces the
adjusted basis of property which constitutes an export trade asset on
the ground that such property is subject to a liability, he shall attach
to his return a statement setting forth the adjusted basis of the
property before the reduction and the amount and nature of the
reduction.
(2) Increase in investments in export trade assets. For purposes of
section 970(a) and paragraph (b) of this section, the amount of increase
in investments in export trade assets of a controlled foreign
corporation for a taxable year shall be, except as provided in Sec.
1.970-2, the amount by which--
(i) The amount of its investments in export trade assets at the
close of such taxable year, exceeds
(ii) The amount of its investments in export trade assets at the
close of the preceding taxable year.
(3) Decrease in investments in export trade assets. For purposes of
section 970(b) and paragraph (c) of this section, the amount of the
decrease in investments in export trade assets of a controlled foreign
corporation for a taxable year shall be, except as provided in Sec.
1.970-2, the amount by which--
(i) The amount of its investments in export trade assets at the
close of the preceding taxable year, minus
(ii) An amount equal to the excess of recognized losses over
recognized gains on sales, exchanges, involuntary conversions, assets or
other dispositions, of export trade during the taxable year, exceeds
(iii) The amount of its investments in export trade assets at the
close of the taxable year.
For purposes of subdivision (ii) of this subparagraph, recognized losses
include a write-down of inventory to lower of cost or market in
accordance with a method of inventory valuation established or adopted
by or on behalf of such foreign corporation under paragraph (c) of Sec.
1.964-1.
[T.D. 6755, 29 FR 12704, Sept. 9, 1964, as amended by T.D. 6795, 30 FR
947, Jan. 29, 1965; T.D. 6892, 31 FR 11144, Aug. 23, 1966; T.D. 7293, 38
FR 32802, Nov. 28, 1973; T.D. 7893, 48 FR 22511, May 19, 1983]
Sec. 1.970-2 Elections as to date of determining investments in export
trade assets.
(a) Nature of elections--(1) In general. In lieu of determining the
increase under the provisions of paragraph (d)(2) of Sec. 1.970-1, or
the decrease under the provisions of paragraph (d)(3) of Sec. 1.970-1,
in a controlled foreign corporation's investments in export trade assets
for a taxable year in the manner provided in such provisions, a United
States shareholder of such corporation may elect, under the provisions
of section 970(c)(4) and this section, to determine such increase or
decrease in accordance with the provisions of subparagraph (2) of this
paragraph or, in the case of export trade assets which are facilities
described in section 971(c)(3), in accordance with the provisions of
subparagraph (3) of this paragraph. Separate elections may be made under
subparagraph (2) and/or (3) of this paragraph with respect to each
controlled foreign corporation with respect to which a person is a
United States shareholder, within the meaning of section 951(b).
[[Page 514]]
(2) Election of 75-day rule. A United States shareholder of a
controlled foreign corporation may elect with respect to a taxable year
of such corporation to make the determinations under subparagraphs
(2)(i) and (3)(iii) of paragraph (d) of Sec. 1.970-1 of the amount of
such corporation's investments in export trade assets as of the 75th day
after the close of the taxable year referred to in such subparagraphs of
paragraph (d) of Sec. 1.970-1. The election provided by this
subparagraph may be made with respect to export trade assets other than
facilities described in section 971(c)(3) or with respect to export
trade assets which are facilities or with respect to both types of
export trade assets (but the election under this paragraph with respect
to export trade assets which are facilities or with respect to both
types of export trade assets may be made only if the election provided
by subparagraph (3) of this paragraph is not made). If the election
provided by this subparagraph is made, the amount of export trade assets
with respect to which such election is made at the close of the
preceding taxable year which is described in subparagraphs (2)(ii) and
(3)(i) of paragraph (d) of Sec. 1.970-1 shall be the amount of export
trade assets which was considered by application of the 75-day rule to
be the amount of export trade assets at the close of such preceding
taxable year; except that for the first taxable year of the controlled
foreign corporation for which the 75-day rule is elected the amount of
investments in export trade assets with respect to which such election
is made at the close of such preceding year described in subparagraphs
(2)(ii) and (3)(i) of paragraph (d) of Sec. 1.970-1 shall be the amount
of investments in export trade assets at the actual close of such
preceding year. In the case of a taxable year of such corporation
beginning after December 31, 1962, and before December 31, 1963, the
amount of investments in export trade assets with respect to which such
election is made alternatively may be determined by the United States
shareholder as of the 75th day after the close of the preceding taxable
year referred to in subparagraphs (2)(ii) and (3)(i) of paragraph (d) of
Sec. 1.970-1 rather than as of the close of such preceding taxable
year.
(3) Election for export trade assets which are facilities. A United
States shareholder of a controlled foreign corporation may elect with
respect to a taxable year of such corporation to make the determinations
under subparagraphs (2)(i) and (3)(iii) of paragraph (d) of Sec. 1.970-
1 of the amount of such corporation's investments in export trade assets
which are facilities described in section 971(c)(3) as of the close of
such corporation's taxable year following the taxable year referred to
in such subparagraphs of paragraph (d) of Sec. 1.970-1. The election
provided by this subparagraph may be made only if the United States
shareholder does not elect the 75-day rule of subparagraph (2) of this
paragraph with respect to export trade assets which are facilities. If
the election provided by this subparagraph is made, the amount of
investments in export trade assets which are facilities at the close of
the preceding taxable year which is described in subparagraphs (2)(ii)
and (3)(i) of paragraph (d) of Sec. 1.970-1 shall be the amount of
export trade assets which are facilities which was considered, by reason
of the application of the following-year rule provided in this
subparagraph with respect to such preceding taxable year, to be the
amount of export trade assets which are facilities at the close of such
preceding taxable year; except that for the first taxable year of the
controlled foreign corporation for which such following-year rule is
elected the amount of investments in export trade assets which are
facilities at the close of the preceding taxable year described in
subparagraphs (2)(ii) and (3)(i) of paragraph (d) of Sec. 1.970-1 shall
be the amount of investments in export trade assets which are facilities
at the actual close of such preceding taxable year.
(b) Time and manner of making elections--(1) Without consent. A
United States shareholder may, with respect to any controlled foreign
corporation, make one or both of the elections described in paragraph
(a)(2) or (3) of this section without the consent of the Commissioner by
filing a statement to such effect with his return for his taxable year
in which or with which ends
[[Page 515]]
the first taxable year of such corporation in which--
(i) Such shareholder owns, within the meaning of section 958(a), or
is considered as owning, by applying the rules of section 958(b), 10
percent or more of the total combined voting power of all classes of
stock entitled to vote of such corporation, and
(ii) Such corporation realizes subpart F income which is reduced
under section 970(a) and paragraph (b) of Sec. 1.970-1.
The statement shall contain the name and address of the controlled
foreign corporation, identification of such first taxable year of such
corporation, and an indication as to which election or elections
described in paragraph (a) of this section the United States shareholder
is making. If such return has been filed on or before the 90th day after
the date these regulations are published in the Federal Register, such
United States shareholder shall file such statement with the district
director with which the return was filed on or before such 90th day.
(2) With consent. A United States shareholder may make one or both
of the elections described in paragraph (a)(2) or (3) of this section
with respect to any controlled foreign corporation at any time with the
consent of the Commissioner. Consent will not be granted unless the
shareholder and the Commissioner agree to the terms, conditions, and
adjustments under which the election will be effected. The application
for consent to elect shall be made by the shareholder's mailing a letter
for such purpose to the Commissioner of Internal Revenue, Washington, DC
20224. The application shall be mailed before the close of the first
taxable year of the controlled foreign corporation with respect to which
the shareholder desires to determine an exclusion under section 970(a)
in accordance with one or both of the elections provided in paragraph
(a) of this section. The application shall include the following
information:
(i) The name, address, and taxable year of the United States
shareholder;
(ii) The name, address, and taxable year of the controlled foreign
corporation;
(iii) A statement indicating which of the elections the shareholder
desires to make;
(iv) The amount of the foreign corporation's investments in export
trade assets (by a category which includes export trade assets other
than facilities and a category which includes only export trade assets
which are facilities) at the close of its preceding taxable year;
(v) The shareholder's pro rata share of the sum of the amounts by
which the subpart F income of the foreign corporation, for all prior
taxable years during which such shareholder was a United States
shareholder of such corporation, was reduced under section 970(a) and
paragraph (b) of Sec. 1.970-1;
(vi) The shareholder's pro rata share of the sum of the amounts
which were not included in the subpart F income of the foreign
corporation, for all prior taxable years during which such shareholder
was a United States shareholder of such corporation, by reason of the
application of section 972 and Sec. 1.972-1; and
(vii) The shareholder's pro rata share of the sum of the amounts
which were previously included in his gross income, for all prior
taxable years during which such shareholder was a United States
shareholder of such corporation, under section 951(a)(1)(A)(ii) by
reason of the application of section 970(b) and paragraph (b) of Sec.
1.970-1 to the foreign corporation.
(c) Effect of elections--(1) In general. Except as provided in
subparagraphs (3) and (4) of this paragraph, an election made under
paragraph (a) of this section with respect to a controlled foreign
corporation shall be binding on the United States shareholder and--
(i) In the case of the election described in paragraph (a)(2) of
this section, shall apply to all investments in export trade assets with
respect to which such election is made acquired, or disposed of, by such
corporation during the 75-day period following its taxable year for
which subpart F income is first computed under the election and during
all succeeding corresponding 75-day periods of such corporation, or
(ii) In the case of the election described in paragraph (a)(3) of
this section, shall apply to all investments in
[[Page 516]]
export trade assets which are facilities acquired, or disposed of, by
such corporation during the taxable year following its taxable year for
which subpart F income is first computed under the election and during
all succeeding corresponding taxable years of such corporation.
(2) Returns. Any return of a United States shareholder required to
be filed before the completion of a period with respect to which
determinations are to be made as to a controlled foreign corporation's
investments in export trade assets for purposes of computing such
shareholder's taxable income shall be filed on the basis of an estimate
of the amount of such corporation's investments in export trade assets
at the close of the period. If the actual amount of such investments is
not the same as the amount of the estimate, the shareholder shall
immediately notify the Commissioner. The Commissioner will thereupon
redetermine the amount of such shareholder's tax for the year or years
with respect to which the incorrect amount was taken into account. The
amount of tax, if any, due upon such redetermination shall be paid by
the shareholder upon notice and demand by the district director. The
amount of tax, if any, shown by such redetermination to have been
overpaid shall be credited or refunded to the shareholder in accordance
with the provisions of sections 6402 and 6511 and the regulations
thereunder.
(3) Revocation--(i) In general--(a) Consent required. Upon
application by the United States shareholder, an election made under
paragraph (a) of this section may, subject to the approval of the
Commissioner, be revoked. Approval will not be granted unless the
shareholder and the Commissioner agree to the terms, conditions, and
adjustments under which the revocation will be effected.
(b) Revocation of 75-day rule. In the case of the revocation of an
election described in paragraph (a)(2) of this section, the change in
the controlled foreign corporation's investments in export trade assets
with respect to which such election was made for its first taxable year
for which subpart F income or a decrease in investments in export trade
assets is computed without regard to the election previously made shall,
unless the agreement with the Commissioner provides otherwise, be
considered to be the amount by which--
(1) Such corporation's investments in export trade assets with
respect to which such election was made at the close of such taxable
year exceeds or, if applicable, is exceeded by
(2) Such corporation's investments in export trade assets with
respect to which such election was made at the close of the 75th day
after the close of the preceding taxable year of such corporation.
(c) Revocation of following-year rule. In the case of the revocation
of an election described in paragraph (a)(3) of this section, the change
in the controlled foreign corporation's investments in export trade
assets which are facilities for its first taxable year for which subpart
F income or a decrease in investments in export trade assets is computed
without regard to the election previously made shall, unless the
agreement with the Commissioner provides otherwise, be considered to be
zero.
(ii) Time and manner of applying for consent to revocation--(a)
Application to Commissioner. The application for consent to revocation
of an election shall be made by the United States shareholder's mailing
a letter for such purpose to the Commissioner of Internal Revenue,
Washington, DC, 20224. The application shall be mailed before the close
of the first taxable year of the controlled foreign corporation with
respect to which the shareholder desires to determine an exclusion under
section 970(a) or an inclusion under section 970(b) without regard to
such election.
(b) Information required. The application shall include the
following information:
(1) The name, address, and taxable year of the United States
shareholder;
(2) The name, address, and taxable year of the controlled foreign
corporation;
(3) A statement indicating the election the shareholder desires to
revoke under this subparagraph;
[[Page 517]]
(4) The information required under subdivisions (iv) through (vii)
of paragraph (b)(2) of this section;
(5) In the case of an application for consent to revocation of an
election made under paragraph (a)(2) of this section, the amount of the
foreign corporation's investments in export trade assets with respect to
which such election was made at the close of the 75th day after the
close of such corporation's taxable year immediately preceding the
taxable year of such corporation; and
(6) The reasons for the request for consent to revocation.
(4) Transfer of stock--(i) Election of 75-day rule in force. (a) If
during any taxable year of a controlled foreign corporation--
(1) A United States shareholder who has made the election described
in paragraph (a)(2) of this section with respect to such corporation
sells, exchanges, or otherwise disposes of all or part of his stock in
such corporation, and
(2) The foreign corporation is a controlled foreign corporation
immediately after the sale, exchange, or other disposition,
then, with respect to the stock so sold, exchanged, or disposed of, the
successor in interest shall consider the controlled foreign
corporation's change during the first 75 days of such taxable year in
investments in export trade assets with respect to which such election
is made to be zero.
(b) If the United States shareholder's successor in interest makes
an election under paragraph (a)(2) of this section in order to determine
an exclusion under section 970(a) for the taxable year of such
corporation in which the acquires such stock, the amount of the
controlled foreign corporation's investments in export trade assets with
respect to which such election is made at the close of its preceding
taxable year shall be considered, with respect to the stock so acquired,
to be the amount of such corporation's investments in export trade
assets with respect to which such election is made at the close of the
75th day after the close of such preceding taxable year.
(c) If the United States shareholder's successor in interest makes
an election under paragraph (a)(2) of this section in order to determine
an exclusion under section 970(a) for a taxable year of such corporation
subsequent to the taxable year in which he acquired the stock, the
amount of the controlled foreign corporation's investments in export
trade assets with respect to which such election is made at the close of
its taxable year immediately preceding such subsequent taxable year
shall, with respect to the stock so acquired, be the amount of such
corporation's investments in such assets at the actual close of such
preceding taxable year.
(ii) Election in force with respect to export trade assets which are
facilities--(a) If during any taxable year of a controlled foreign
corporation--
(1) A United States shareholder who has made the election described
in paragraph (a)(3) of this section with respect to such corporation
sells, exchanges, or otherwise disposes of all or part of his stock in
such corporation, and
(2) The foreign corporation is a controlled foreign corporation
immediately after the sale, exchange or other disposition,
then, with respect to the stock so sold, exchanged, or disposed of, the
successor in interest shall consider the controlled foreign
corporation's change for such taxable year in investments in export
trade assets which are facilities to be zero.
(b) If the United States shareholder's successor in interest makes
an election under paragraph (a)(3) of this section in order to determine
an exclusion under section 970(a) for the taxable year of such
corporation in which he acquires such stock, the amount of the
controlled foreign corporation's investments in export trade assets
which are facilities at the close of its preceding taxable year shall be
considered, with respect to the stock so acquired, to be the amount of
such corporation's investments in export trade assets which are
facilities at the close of the taxable year in which such stock is
acquired.
(c) If the United States shareholder's successor in interest makes
an election under paragraph (a)(3) of this section in order to determine
an exclusion under section 970(a) for a taxable year of such corporation
subsequent to the taxable
[[Page 518]]
year in which he acquired the stock, the amount of the controlled
foreign corporation's investments in export trade assets which are
facilities at the close of its taxable year immediately preceding such
subsequent taxable year shall, with respect to the stock so acquired, be
the amount of such corporation's investments in such assets at the
actual close of such preceding taxable year.
(d) Illustrations. The principles contained in this section are
illustrated by the examples set forth in paragraph (d) of Sec. 1.955.3.
[T.D. 6755, 29 FR 12707, Sept. 9, 1964]
Sec. 1.970-3 Effective date of subpart G.
Sections 970 through 972 and Sec. Sec. 1.970-1 through 1.972-1
shall apply with respect to taxable years of foreign corporations
beginning after December 31, 1962, and to taxable years of United States
shareholders within which or with which such taxable years of such
corporations end.
[T.D. 6755, 29 FR 12709, Sept. 9, 1964]
Sec. 1.971-1 Definitions with respect to export trade corporations.
(a) Export trade corporations--(1) In general. For purposes of
sections 970 through 972 and Sec. Sec. 1.970-1 to 1.972-1, inclusive,
the term ``export trade corporation'' means a controlled foreign
corporation which for the period specified in subparagraph (2) of this
paragraph satisfies the conditions specified in subparagraph (3) of this
paragraph. However, no controlled foreign corporation may qualify as an
export trade corporation for any taxable year beginning after October
31, 1971, unless it qualified as an export trade corporation for any
taxable year beginning before such date. In addition, if a corporation
fails to qualify as an export trade corporation for a period of any 3
consecutive taxable years beginning after October 31, 1971, then for any
taxable year beginning after such 3-year period, such corporation shall
not be included within the term ``export trade corporation''.
(2) Three-year period. The period referred to in subparagraph (1) of
this paragraph is the 3-year period ending with the close of the
controlled foreign corporation's current taxable year, or such part of
such 3-year period as occurs on and after the beginning of the
corporation's first taxable year beginning after December 31, 1962,
whichever period is shorter.
(3) Gross income requirements. The conditions referred to in
subparagraph (1) of this paragraph are that the controlled foreign
corporation derives--
(i) 90 percent or more of its gross income from sources without the
United States, and
(ii)(a) 75 percent of more of its gross income from transactions,
activities, or interest described in section 971(b) and paragraph (b) of
this section, or
(b) 50 percent or more of its gross income from transactions,
activities, or interest described in section 971(b) and paragraph (b) of
this section in respect of agricultural products grown in the United
States.
(4) Determination of sources of gross income. The sources of gross
income of a controlled foreign corporation shall be determined for
purposes of subparagraph (3)(i) of this paragraph in accordance with the
rules for determining sources of gross income set forth in sections 861
through 864 and the regulations thereunder.
(b) Export trade income--(1) General rule. For purposes of sections
970 through 972 and Sec. Sec. 1.970-1 to 1.972-1, inclusive, the term
``export trade income'' means the gross export trade income of a
controlled foreign corporation derived from transactions, activities, or
interest described in subdivisions (i) through (vii) of this
subparagraph, less deductions allowed under subdivision (viii) of this
subparagraph.
(i) Sale of export property. Gross export trade income of a
controlled foreign corporation includes gross income it derives from the
sale of export property (as defined in paragraph (e) of this section)
which it purchases, if the sale is made to an unrelated person for use,
consumption, or disposition outside the United States. See section
971(b)(1). As a general rule, property will be presumed to have been
sold for use, consumption, or disposition in the country of destination
of the sale. However, if at the time of the sale the controlled foreign
corporation knows, or should
[[Page 519]]
have known from the facts and circumstances surrounding the sales
transaction, that the property will probably be used, consumed, or
disposed of in the United States, such property will be presumed to have
been sold for use, consumption, or disposition in the United States
unless the controlled foreign corporation establishes that such property
was used, consumed, or disposed of outside the United States. For
purposes of this subdivision, export property must be sold by a
controlled foreign corporation in essentially the same form in which
such property is purchased. Whether export property sold is in
essentially the same form in which such property is purchased shall be
determined on the basis of all the facts and circumstances in each case.
Storage, handling, transportation, packaging, or servicing of property
will be considered not to alter the form in which property is purchased.
However, manufacture or production, within the meaning of paragraph
(a)(4) of Sec. 1.954-3, will be considered to alter the form in which
property is purchased and no part of the gross income from the sale of
such property will be treated as export trade income. The application of
this subdivision may be illustrated by the following example:
Example. Controlled foreign corporation A, incorporated under the
laws of foreign country Y, purchases articles manufactured in the United
States from domestic corporation M and sells them in the form in which
purchased to foreign corporation B, unrelated to A Corporation, for use
in foreign countries, X, Y, and Z. The gross income of A Corporation
from the purchase and sale of the articles constitutes gross export
trade income.
(ii) Commissions and other income derived in connection with the
sale of export property. Gross export trade income of a controlled
foreign corporation includes gross commissions, fees, compensation, or
other income derived by such corporation from the performance for any
person of commercial, industrial, financial, technical, scientific,
managerial, engineering, architectural, skilled, or other services in
respect of a sale by such corporation in a transaction described in
subdivision (i) of this subparagraph or in respect of the sale by any
other person of export property to a person unrelated to the controlled
foreign corporation for use, consumption, or disposition outside the
United States. Such gross export trade income includes payments received
for surveys made prior to, and in connection with, the sale of such
export property (whether or not such sales are ultimately consummated).
See section 971(b)(1). The term ``any person'' or ``any other person''
as used in this subdivision includes a related person as defined in
section 954(d)(3) and paragraph (e) of Sec. 1.954-1. The application of
this subdivision may be illustrated by the following examples:
Example 1. Controlled foreign corporation A, incorporated under the
laws of foreign country X, receives from M Corporation a commission
equal to 6 percent of the gross selling price of all personal property
shipped by M Corporation as a result of services performed by A
Corporation in soliciting orders in foreign countries X, Y, and Z. In
fulfillment of such orders, M Corporation ships products manufactured by
it in the United States. Corporation A does not assume title to the
property sold. Gross commissions received by A Corporation from M
Corporation in connection with the sale of such property to persons
unrelated to A Corporation for use, consumption, or disposition outside
the United States constitute gross export trade income.
Example 2. Foreign corporation B, incorporated under the laws of
foreign country X, is a wholly owned subsidiary of domestic corporation
N. Corporation N, is engaged in the business of manufacturing heavy duty
electrical equipment in the United States. By contract, N Corporation
engages B Corporation for the purpose of conducting engineering,
technical, and financial studies required by N Corporation in the
preparation of bids to supply foreign country Y with electrical
equipment for a construction project to be undertaken by such country.
Corporation N pays B Corporation a fee for the services, all of which
are performed in country Y, which is based upon the number of hours of
work performed without regard to whether a sale is ultimately
consummated. Corporation N does not receive a contract from country Y on
its bid to supply equipment. Income derived by B Corporation from
performance of the service contract constitutes gross export trade
income.
(iii) Commissions and other income derived in connection with the
installation or maintenance of export property. Gross export trade
income of a controlled foreign corporation includes gross commissions,
fees, compensation, or other
[[Page 520]]
income derived by such corporation from the performance for any person
of commercial, industrial, financial, technical, scientific, managerial,
engineering, architectural, skilled, or other services in respect of the
installation or maintenance of export property which has been sold by
such corporation in a transaction described in subdivision (i) of this
subparagraph or by any other person to a person unrelated to the
controlled foreign corporation for use, consumption, or disposition
outside the United States. See section 971(b)(1). The term ``any
person'' or ``any other person'' as used in this subdivision includes a
related person as defined in section 954(d)(3) and paragraph (e) of
Sec. 1.954-1.
(iv) Commissions and other income derived in connection with the use
of patents, copyrights, and other like property. Gross export trade
income of a controlled foreign corporation includes gross commissions,
fees, compensation, or other income derived by such corporation from the
performance for any person of commercial, industrial, financial,
technical, scientific, managerial, engineering, architectural, skilled,
or other services in connection with the use outside of the United
States by an unrelated person of patents, copyrights, secret processes
and formulas, goodwill, trademarks, trade brands, franchises, and other
like property, including gross income derived from obtaining licensees
for patents, but only if the patent, copyright, or other like property
is acquired, or developed, and owned by the manufacturer, producer,
grower, or extractor of any export property, in respect of which the
controlled foreign corporation also derives gross export trade income
within the meaning of subdivision (i), (ii), or (iii) of this
subparagraph. See section 971(b)(2). The application of this subdivision
may be illustrated by the following example:
Example. Foreign corporation A incorporated under the laws of
foreign country X, is a wholly owned subsidiary of domestic corporation
M. Corporation M, the owner of a patent registered in foreign country X,
grants B Corporation, a corporation unrelated to A Corporation, the
right to use such patent in foreign country Y in exchange for payment of
a royalty. By a separate contract with B Corporation, A Corporation
agrees for a gross fee of $100,000 to furnish, by maintaining a staff of
technical representatives at the offices of B Corporation, technical
services to B Corporation in connection with B Corporation's use of the
patent. Corporation A also derives export trade income from the sale of
export property which it purchases from M Corporation, the manufacturer
of such property, and sells to C Corporation, an unrelated person, for
use in country Y by C Corporation. The gross fee of $100,000 received by
A Corporation for the furnishing of technical services in connection
with B Corporation's use of M Corporation's patent constitutes gross
export trade income since the service for which the fee is paid is
performed in connection with the use outside the United States by an
unrelated person (B Corporation) of a patent owned by a manufacturer (M
Corporation) of export property in respect of which the controlled
foreign corporation (A Corporation) derives gross export trade income
from the sale to an unrelated person (C Corporation) for use outside the
United States of export property purchased by it from the manufacturer
(M Corporation).
(v) Income attributable to use of export property by an unrelated
person. Gross export trade income of a controlled foreign corporation
includes gross commissions, fees, rents, compensation, or other income
which is received by such corporation from an unrelated person and is
attributable to the use of export property by such unrelated person. See
section 971(b)(3). The application of this subdivision may be
illustrated by the following example:
Example. Foreign corporation A, incorporated under the laws of
foreign country X, is a wholly owned subsidiary of domestic corporation
M. Corporation A acquires by purchase bottling machines manufactured in
the United States and leases the machines to B Corporation, a
corporation unrelated to A Corporation, for use by B Corporation in
foreign country Y. Gross rental income of A Corporation from the lease
of the machines to B Corporation constitutes gross export trade income.
(vi) Income attributable to the use of export property in the
rendition of technical, scientific, or engineering services--(a)
General. Gross export trade income of a controlled foreign corporation
includes gross commissions, fees, compensation, or other income which is
received by such corporation from an unrelated person and is
attributable to
[[Page 521]]
the use of export property in the performance of technical, scientific,
or engineering services to such unrelated person. See section 971(b)(3).
(b) Rule of apportionment. If a commission, fee, or other income
received by a controlled foreign corporation from an unrelated person
under a contract or arrangement for the performance of technical,
scientific, or engineering services is not solely attributable to the
use of export property in the performance of such services and the
amount of the gross income attributable to such use of export property
cannot be established by reference to transactions between other
unrelated persons, such gross income shall be an amount which bears the
same ratio to total gross income from the contract or arrangement as the
cost of the export property consumed in the performance of such
services, including a reasonable allowance for depreciation with respect
to the export property so used, bears to the total costs and expenses
attributable to the production of income under the contract or
arrangement.
(c) Illustration. The application of this subdivision may be
illustrated by the following example:
Example. Foreign corporation A, incorporated under the laws of
foreign country X, is a wholly owned subsidiary of domestic corporation
M. Corporation A is engaged in the seismograph service business in
foreign country X. In an effort to establish the probable existence of
oil in a concession area it owns in foreign country Y, B Corporation
which is unrelated to A Corporation enters into a contract with A
Corporation whereby A Corporation is required to make seismographic
tests of the area in country Y for a fixed fee of $100,000. In
performance of the contract, A Corporation hires a skilled crew to carry
out the contract and utilizes equipment and supplies (for example,
trucks, seismographic equipment, etc.) which constitute export property.
Corporation A cannot establish by reference to transactions between
other unrelated persons, the income attributable to the use of the
export property in the performance of the contract. Corporation A's
total costs and expenses (for example, salaries of the crew,
administrative expenses, all supplies, total depreciation on property
used in performance of the contract, etc.) incurred in performance of
the contract are $80,000. The cost of export property consumed in
performance of the contract (for example, dynamite, motor oil, and other
supplies which were produced in the United States, reasonable
depreciation on trucks and seismographic equipment manufactured in the
United States and used in performance of the contract, etc.) is $30,000.
Corporation A's gross export trade income from the contract is $37,500,
that is, the amount which bears the same ratio to total gross income
from the contract ($100,000) as the cost of the export property consumed
in the rendition of the services ($30,000) bears to total costs and
expenses attributable to the contract ($80,000).
(vii) Interest from export trade assets. Gross export trade income
of a controlled foreign corporation includes interest derived by it from
export trade assets described in section 971(c)(4) and paragraph (c)(5)
of this section. See section 971(b)(4).
(viii) Deductions to be taken into account. Export trade income of a
controlled foreign corporation for any taxable year shall be the amount
determined by deducting from the items or categories of gross income
described in subdivisions (i) through (vii) of this subparagraph the
entire amount of those expenses, taxes, and other deductions properly
allocable to such items or categories of income. For purposes of this
section, expenses, taxes, and other deductions shall first be allocated
to items or categories of gross income to which they directly relate;
then, expenses, taxes, and other deductions which cannot definitely be
allocated to some item or category of gross income shall be ratably
apportioned among all items or categories of gross income, except that
no expense, tax, or other deduction shall be allocated to an item or
category of income to which it clearly does not apply and no deduction
allowable to such controlled foreign corporation under section 882(c)
and the regulations thereunder shall be taken into account.
(2) Cross reference. For rules governing the determination of gross
income and taxable income of a foreign corporation, see Sec. 1.952-2.
(c) Export trade assets--(1) In general. For purposes of sections
970 through 972 and Sec. Sec. 1.970-1 to 1.972-1, inclusive, the term
``export trade assets'' means--
(i) Working capital reasonably necessary for the production of
export trade income,
[[Page 522]]
(ii) Inventory of export property held for use, consumption, or
disposition outside the United States,
(iii) Facilities located outside the United States for the storage,
handling, transportation, packaging, servicing, sale, or distribution of
export property, and
(iv) Evidences of indebtedness executed by unrelated persons in
connection with payment for purchases of export property for use,
consumption, or disposition outside the United States, or in connection
with the payment for services described in section 971(b)(2) or (3) and
paragraph (b)(1)(iv), (v), or (vi) of this section.
(2) Working capital. For purposes of subparagraph (1)(i) of this
paragraph, working capital of a controlled foreign corporation is the
excess of its current assets over its current liabilities. Liabilities
maturing in one year or less shall be considered current liabilities. A
determination of the amount of working capital of a controlled foreign
corporation which is reasonably necessary for the production of export
trade income will depend upon the nature and volume of the activities of
the controlled foreign corporation which produce export trade income as
they exist on the applicable determination date. In determining working
capital which is reasonably necessary for the production of export trade
income, the anticipated future needs of the business will be taken into
account to the extent that such needs relate to the year of the
controlled foreign corporation following the applicable determination
date; anticipated future needs relating to a later period will not be
taken into account unless it is clearly established that such needs are
reasonably related to the production of export trade income as of the
applicable determination date.
(3) Inventory of export property. For purposes of subparagraph
(1)(ii) of this paragraph, the inclusion of items in inventory shall be
determined in accordance with rules applicable to domestic corporations.
See Sec. Sec. 1.471-1 through 1.471-9. Inventory of export property of
a controlled foreign corporation includes export property held for use,
consumption, or disposition outside the United States regardless of
where it is located on the applicable determination date. Thus, such
property may be physically located in the United States on such date.
However, for property physically located in the United States to
constitute export property, it must have been acquired by the controlled
foreign corporation with a clear intent that it would dispose of the
property for use, consumption, or disposition outside the United States.
As a general rule, if during the year following the applicable
determination date export property which was physically located in the
United States on such date is actually exported for use, consumption, or
disposition outside the United States, such property will be deemed held
for such purpose on the applicable determination date. On the other
hand, the indefinite ware housing of export property in the United
States by the controlled foreign corporation, or the subsequent sale of
export property by such corporation for use, consumption, or disposition
in the United States, will evidence a lack of intent by such corporation
on the applicable determination date to hold such property for use,
consumption, or disposition outside the United States.
(4) Facilities located outside the United States--(i) In general.
For purposes of subparagraph (1)(iii) of this paragraph, a facility, as
defined in subdivision (ii)(a) of this subparagraph, will be considered
an export trade asset only--
(a) If such facility is located outside the United States, and
(b) To the extent that such facility is used, within the meaning of
subdivision (ii)(c) of this subparagraph, by the controlled foreign
corporation for the storage, handling, transportation, packaging,
servicing, sale, or distribution of export property in essentially the
same form in which such property is acquired by such corporation.
Thus, a facility in which property is manufactured or produced, even
though export property is used or consumed in the production or becomes
a component part of the manufactured article, will not qualify as an
export trade asset.
(ii) Special rules--(a) Facility defined. For purposes of
subdivision (i) of this subparagraph, the term ``facility'' includes any
asset or group of assets used
[[Page 523]]
for the storage, handling, transportation, packaging, servicing, sale,
or distribution of export property. Thus, such term includes warehouse,
storage, or sales facilities (for example, sales office equipment),
transportation equipment (for example, motor trucks, vessels, etc.), and
machinery and equipment (for example, packaging equipment, servicing
equipment, cranes, forklift trucks used in warehouses, etc.).
(b) Determination of location of transportation facilities. A
transportation facility shall be considered to be located outside the
United States for purposes of subdivision (i)(a) of this subparagraph if
such property is predominantly located outside the United States. As a
general rule, on an applicable determination date a transportation
facility will be considered to be predominantly located outside the
United States if 70 percent or more of the miles traversed (during the
12-month period immediately preceding such determination date or for
such part of such period as such facility is owned by the controlled
foreign corporation) in the use of such facility are traversed outside
the United States or if such facility is located outside the United
States at least 70 percent of the time during such period or such part
thereof.
(c) Determination of use. For purposes of subdivision (i)(b) of this
subparagraph, the extent to which a facility is used in carrying on the
activities described in such subdivision depends on the use made of the
facility for the 12-month period immediately preceding the applicable
determination date or for such part of such period as such facility is
owned by the controlled foreign corporation. The method of measuring
such use will depend upon the facts and circumstances in each case.
However, such determinations of use will generally be made for a
facility as a whole and not on the basis of individual items used in the
operation of a facility. Thus, a determination as to the use of a
warehouse facility will generally be made with respect to the entire
facility and not separately for the items used in such warehouse, such
as forklift trucks, storage bins, etc.
(5) Evidences of indebtedness. For purposes of subparagraph (1)(iv)
of this paragraph, the term ``evidence of indebtedness'' shall mean a
note, installment sales contract, a time bill of exchange evidencing a
sale on credit, or similar written instrument executed by an unrelated
person which evidences the obligation of an unrelated person to pay for
export property which an unrelated person purchases for use,
consumption, or disposition outside the United States or to pay for
services described in section 971(b)(2) or (3) and paragraph (b)(1)(iv),
(v), or (vi) of this section which are performed for an unrelated
person. Receivables which arise out of the delivery of export property,
or the performance of services, which are evidenced by invoices, bills
of lading, bills of exchange which do not evidence a sale on credit,
sales slips, and similar documents created by the unilateral act of a
creditor shall not be considered evidences of indebtedness for purposes
of section 971(c)(4).
(6) Duplication of treatment and priority of application. No asset
which constitutes an export trade asset shall be taken into account more
than once in determining the investments in export trade assets of a
controlled foreign corporation. Assets which constitute working capital
and also constitute inventory to which section 971(c)(2) applies or
evidences of indebtedness to which section 971(c)(4) applies shall be
taken into account in determining whether the amount of working capital
of the controlled foreign corporation is reasonably necessary for the
production of export trade income. However, to the extent that the
amount of inventory to which section 971(c)(2) applies or evidences of
indebtedness to which section 971(c)(4) applies is not included in
working capital to which section 971(c)(1) applies on the ground that
such amount is not reasonably necessary for the production of export
trade income, the amount shall be included under section 971(c)(2) or
971(c)(4), as the case may be, in a controlled foreign corporation's
investments in export trade assets.
(d) Export promotion expenses--(1) In general. For purposes of
sections 970 through 972 and Sec. Sec. 1.970-1 to 1.972-1, inclusive,
the term ``export promotion
[[Page 524]]
expenses'' means, subject to the provisions of subparagraph (2) of this
paragraph, all the ordinary and necessary expenses paid or incurred
during the taxable year by the controlled foreign corporation which are
reasonably allocable to the receipt or production of export trade income
including--
(i) A reasonable allowance for salaries or other compensation for
personal services actually rendered for such purpose,
(ii) Rentals or other payments for the use of property actually used
for such purpose, and
(iii) A reasonable allowance for the exhaustion, wear and tear, or
obsolescence of property actually used for such purpose.
In determining for purposes of this subparagraph whether expenses are
reasonably allocable to the receipt or production of export trade
income, consideration shall be given to the facts and circumstances of
each case. As a general rule, if export trade income results from the
sale of export property, export promotion expenses allocable to such
income shall include warehousing, advertising, selling, billing,
collection, other administrative, and similar costs properly allocable
to the marketing activity, but shall not include cost of goods sold,
income or similar tax, any expense which does not advance the
distribution or sale of export property for use, consumption, or
disposition outside the United States, or any expense for which the
controlled foreign corporation is reimbursed. If export trade income
results from the rental of export property, export promotion expenses
allocable to such income shall include a reasonable allowance for
depreciation and servicing of such property, and the administrative and
similar costs properly allocable to the rental activity. If export trade
income results from the performance of services, export promotion
expenses shall include a reasonable allowance for compensation of the
persons performing services for the controlled foreign corporation in
the execution of the service contract or arrangement and administrative
expenses reasonably allocable to the service activity. In no case shall
income taxes be included in export promotion expenses.
(2) Expenses incurred within the United States. No expense incurred
within the United States shall be treated as an export promotion expense
for purposes of section 971(d) and subparagraph (1) of this paragraph
unless at least--
(i) 90 percent of all salaries and other personal service
compensation incurred in the receipt or the production of export trade
income,
(ii) 90 percent of rents and other payments for the use of property
used in the receipt or the production of export trade income,
(iii) 90 percent of the allowances for the exhaustion, wear and
tear, or obsolescence of property used in the receipt or the production
of export trade income, and
(iv) 90 percent of all other ordinary and necessary expenses
reasonably allocable to the receipt or the production of export trade
income,
is incurred outside the United States. For this purpose, personal
service compensation will be considered incurred at the place where the
service is performed (for example, salaries will be considered incurred
at the place where the employee works; payments for art work will be
considered incurred at the place where the art work is prepared, etc.);
rent, depreciation, and other expenses related to real or personal
property will be considered incurred at the place where the property is
located; and expenses for media advertising will be considered incurred
at the place where the advertising is consumed. For such purpose,
newspaper or periodical advertising will be considered consumed where
the newspaper or periodical is principally distributed, and television
and radio advertising will be considered consumed at the place where the
audience is primarily located. Technicalities of contract or payment,
for example, the place where a contract is executed or the location of a
bank account from which payment is made, shall not be determinative of
the place where an expense is incurred.
(e) Export property. For purposes of sections 970 through 972 and
Sec. Sec. 1.970-1 to 1.972-1, inclusive, the term ``export property''
means property, or any interest in property, which is manufactured,
produced, grown, or extracted in the United States. Whether property
[[Page 525]]
will be considered manufactured or produced in the United States will
depend on the facts and circumstances of each case. As a general rule,
if--
(1) The property sold, serviced, used, or rented by the controlled
foreign corporation is substantially transformed in the United States
prior to its export from the United States, or
(2) The operations conducted in the United States with respect to
the property sold, serviced, used, or rented by the controlled foreign
corporation, whether performed in the United States by one person or a
series of persons in a chain of distribution, are substantial in nature
and are generally considered to constitute the manufacture or production
of property,
then the property sold, serviced, used, or rented will be considered to
have been manufactured or produced in the United States. The rules under
paragraph (a)(4)(ii) of Sec. 1.954-3, relating to the substantial
transformation of property, and paragraph (a)(4)(iii) of such section,
dealing with a substantive test for determining whether property will be
treated as having been manufactured or produced, shall apply for
purposes of making determinations under this paragraph.
(f) Unrelated person. For purposes of sections 970 through 972 and
Sec. Sec. 1.970-1 to 1.972-1, inclusive, the term ``unrelated person''
means a person other than a related person as defined in section
954(d)(3) and paragraph (e) of Sec. 1.954-1.
[T.D. 6755, 29 FR 12710, Sept. 9, 1964, as amended by T.D. 7293, 38 FR
32802, Nov. 28, 1973; T.D. 7533, 43 FR 6603, Feb. 15, 1978]
Sec. 1.972-1 Consolidation of group of export trade corporations.
(a) Election to consolidate--(1) In general. One or more United
States shareholders (as defined in section 951(b)) owning (within the
meaning of section 958(a)) or who are considered as owning by applying
the rules of ownership of section 958(b) more than 50 percent of the
total combined voting power of all classes of stock entitled to vote of
an export trade corporation, which is the top-tier corporation in a
chain (within the meaning of subparagraph (2) of this paragraph) of
export trade corporations, may, subject to the provisions of this
section, elect to consolidate such chain for purposes of determining--
(i) The limitations, described in section 970(a) and paragraph
(b)(2) of Sec. 1.970-1, on the amount by which subpart F income of an
export trade corporation in such chain shall be reduced as provided in
section 970(a) and paragraph (b)(1) of Sec. 1.970-1, and
(ii) The amount includible in gross income of such shareholders
under section 951(a)(1)(A)(ii) with respect to such a corporation's
decrease in investments in export trade assets to which section 970(b)
applies as described in paragraph (c) of Sec. 1.970-1.
(2) ``Chain'' defined. A chain of export trade corporations shall
include--
(i) The top-tier export trade corporation referred to in
subparagraph (1) of this paragraph which is the first export trade
corporation in a chain of ownership described in section 958(a);
(ii) All export trade corporations 80 percent or more of the total
combined voting power of all classes of stock entitled to vote of which
is owned directly by such top-tier export trade corporation on the last
day of its taxable year; and
(iii) All export trade corporations 80 percent or more of the total
combined voting power of all classes of stock entitled to vote of which
is owned directly by the export trade corporations described in
subdivision (ii) of this subparagraph on the last day of the taxable
year of the export trade corporation described in subdivision (i) of
this subparagraph.
For purposes of this section, a reference to a top-tier corporation
shall mean an export trade corporation described in subdivision (i) of
this subparagraph, a reference to a second-tier corporation shall mean
an export trade corporation described in subdivision (ii) of this
subparagraph, and a reference to a third-tier corporation shall mean an
export trade corporation described in subdivision (iii) of this
subparagraph.
(3) Inclusion requirement. If an election is made by a United States
shareholder under this paragraph with respect to a chain of export trade
corporations (as defined in subparagraph (2) of this paragraph), all
export trade corporations which are included in the
[[Page 526]]
chain must be included in the consolidation. If such an election is
made, the determinations under section 970 shall be made on a
consolidated basis with respect to the entire interest which the
electing United States shareholder owns in each of the export trade
corporations in the chain, including any minority interests owned
directly or indirectly by such shareholder in second-tier and third-tier
corporations in the chain. A United States shareholder may elect to
consolidate his interest in export trade corporations in one chain of
such corporations without electing to consolidate his interest in export
trade corporations in other chains.
(4) Conditions for making initial election--(i) Without consent. The
initial election to consolidate a chain of export trade corporations may
be made without the consent of the Commissioner only if, immediately
before the election to consolidate, each of the export trade
corporations to be included in the consolidation is using the same
taxable year and has the same elections under section 970(c)(4) and
Sec. 1.970-2 in force, or not in force, as the case may be. The
election shall be made by the electing shareholder or shareholders with
respect to the taxable year in which or with which ends the first
taxable year of the top-tier corporation to which the election to
consolidate applies and at the time of filing such shareholders' returns
for such taxable year or within 90 days after final regulations under
this section are published in the Federal Register, whichever date
occurs later. Each United States shareholder making such an election
shall attach to his return a statement showing:
(a) The name, address, and taxable year of each export trade
corporation in the chain of such corporations for which an election is
made,
(b) The amount and percentage of each class of stock owned by such
shareholder (within the meaning of section 958), corporation by
corporation, in each of such export trade corporations, and
(c) A list of the names and addresses, and a description of the
ownership interests, of all other United States shareholders, if any,
who are making the same election to consolidate and a statement that
such shareholders are also making the election.
(ii) With consent. If, immediately before the election to
consolidate, each of the export trade corporations in a chain of such
corporations does not use the same taxable year or does not have the
same elections under section 970(c)(4) and Sec. 1.970-2 in force, or
not in force, as the case may be, the initial election to consolidate
such chain may be exercised by the electing shareholder or shareholders
only with the consent of the Commissioner. Consent will not be granted
unless each electing United States shareholder and the Commissioner
agree to the terms, conditions, and adjustments under which such
consolidation is to be effected and unless, subject to such terms,
conditions, and adjustments as the Commissioner may prescribe, each of
the export trade corporations in the chain adopts a common taxable year
and has the same elections under section 970(c)(4) and Sec. 1.970-2 in
force, or not in force, as the case may be. The application for consent
to consolidate shall be made by mailing a letter, signed by each of the
electing United States shareholders, to the Commissioner of Internal
Revenue, Washington, DC 20224. The application shall be mailed before
the close of the first taxable year of the top-tier corporation with
respect to which the electing shareholder or shareholders desire to make
a consolidation or before the close of the 90th day after final
regulations under this section are published in the Federal Register,
whichever date occurs later, and shall include the statement described
in subdivision (i) of this subparagraph.
(5) Effect of election. If an election to consolidate a chain of
export trade corporations is made for a taxable year of a United States
shareholder, such election shall, except as provided in subparagraph (6)
of this paragraph, be binding on such shareholder for such taxable year
and for all succeeding taxable years. If, in a subsequent taxable year
of the United States shareholder, an export trade corporation for the
first time qualifies as a second-tier or third-tier corporation in such
chain on the last day of the taxable year of the top-tier corporation
which ends in or
[[Page 527]]
with the subsequent taxable year of such shareholder, the shareholder's
interest in such export trade corporation shall be included in the
consolidation to which the election applies, but only if such export
trade corporation as of such last day uses the same taxable year and has
the same elections under section 970(c)(4) and Sec. 1.970-2 in force,
or not in force, as the case may be, as such top-tier corporation. The
United States shareholder shall, with respect to such additional export
trade corporation, submit with his return for such subsequent taxable
year the statement described in subparagraph (4)(i) of this paragraph.
(6) Termination of election. An election under this paragraph to
consolidate a chain of export trade corporations shall terminate for the
first taxable year of the foreign corporation which during the period of
consolidation is a top-tier corporation--
(i) At the close of which any foreign corporation which was included
in such consolidation for the preceding taxable year ceases to qualify
as an export trade corporation or to be eligible under this paragraph
for inclusion in such chain,
(ii) At the close of which an export trade corporation for the first
time qualifies as a second-tier or third-tier corporation in such chain
but does not as of such close of the year use the same taxable year or
have the same elections under section 970(c)(4) and Sec. 1.970-2 in
force, or not in force, as the case may be, as such top-tier
corporation, or
(iii)(a) In respect of which the Commissioner, upon application made
by a United States shareholder who made the election to consolidate, or
his successor in interest, consents to a termination of the election.
Approval will not be granted unless the United States shareholder and
the Commissioner agree to the terms, conditions, and adjustments under
which the termination will be effected.
(b) The application for consent to termination shall be made by the
United States shareholder's mailing a letter for such purpose to the
Commissioner of Internal Revenue, Washington, DC 20224. The application
shall be mailed before the close of the taxable year of the foreign
corporations with respect to which the shareholder desires to terminate
the consolidation and shall include the following information:
(1) The name, address, and taxable year of each export trade
corporation in the chain of such corporations for which the election was
made,
(2) The amount and percentage of each class of stock owned by such
shareholder (within the meaning of section 958), corporation by
corporation, in each of such export trade corporations, and
(3) A list of the names and addresses, and a description of the
ownership interests, of all other United States shareholders, if any,
who participated in making the election with such United States
shareholder, or their successors in interest, and a statement whether
such other persons are or are not terminating the election.
(7) Election subsequent to initial election. If a United States
shareholder elects under subparagraph (4) of this paragraph to
consolidate his interest in a chain of export trade corporations and the
election to consolidate such corporations terminates under the
provisions of subparagraph (6) of this paragraph, such shareholder may
not thereafter elect under this section to consolidate his interest in
any corporation which was in that chain of export trade corporations
unless he receives the consent of the Commissioner to do so. Application
to obtain such consent of the Commissioner shall be made by a letter
mailed to the Commissioner of Internal Revenue, Washington, DC, 20224,
before the close of the first taxable year of the top-tier corporation
of the chain of export trade corporations in which the election to
include such interest is to apply. Such application for consent shall
include a statement showing:
(i) With respect to such chain, the information required to be shown
in the statement described in subparagraph (4)(i) of this paragraph, and
(ii) The United States shareholder's interest in such chain which
was previously included in a consolidation, the taxable years of such
previous consolidation, and the manner in which such previous
consolidation was terminated.
[[Page 528]]
(8) Illustration. The application of this paragraph may be
illustrated by the following example:
Example. Domestic corporation M owns 60 percent of the only class of
stock of foreign corporation A, and 100 percent of the only class of
stock of foreign corporation F, respectively. Corporation A owns 80
percent of the only class of stock of foreign corporations B and C,
respectively. Corporation M also owns 20 percent of the stock of B
Corporation. Corporation B owns 80 percent of the only class of stock of
foreign corporation D. Corporations B and C each own 50 percent of the
only class of stock of foreign corporation E. Corporation F owns 100
percent of the only class of stock of foreign corporation G, which owns
100 percent of the only class of stock of foreign corporation H.
Corporation F also owns 20 percent of the stock of C Corporation.
Domestic corporations N and R own 30 percent and 10 percent,
respectively, of the stock of A Corporation. All corporations use the
calendar year as a taxable year, and all foreign corporations qualify as
export trade corporations for 1963. Corporation M may elect for 1963 to
consolidate its interest in the chain (the ``A'' chain) of export trade
corporations which includes corporations A, B, C, D, and E; and
Corporation M need not, but may, elect to consolidate its interest in
the chain (the ``F'' chain) of export trade corporations which includes
corporations F, G, and H. Consolidation of M Corporation's interest in
the ``A'' chain with its interest in the ``F'' chain is not permitted.
If M Corporation elects to consolidate the ``A'' chain, M Corporation
must include in the consolidation its 20 percent directly owned interest
in B Corporation and its 20 percent indirectly owned (through F
Corporation) interest in C Corporation. Either N Corporation or R
Corporation, or both, may join M Corporation in electing to consolidate
their interests in the ``A'' chain. However, neither N Corporation nor R
Corporation may elect to consolidate the ``A'' chain unless M
Corporation also agrees to so elect, because corporations N and R,
neither jointly nor separately, own more than 50 percent of the total
combined voting power of all classes of stock entitled to vote of A
Corporation. If corporations M, N, and R elect to consolidate the ``A''
chain, the determinations specified in subparagraph (1) of this
paragraph will be made on a consolidated basis with respect to such
corporations' respective interest in the chain as shown in the following
tabulation:
------------------------------------------------------------------------
A % B % C % D % E %
------------------------------------------------------------------------
M Corporation's interest:
Direct interest............................ 60
(60%x80%)+20% direct interest.............. ... 68
(60%x80%)+20% indirect interest............ ... ... 68
(68%x80%).................................. ... ... ... 54.4
(68%x50%)+(68%x50%)........................ ... ... ... ..... 68
N Corporation's interest:
Direct interest............................ 30
(30%x80%).................................. ... 24
(30%x80%).................................. ... ... 24
(24%x80%).................................. ... ... ... 19.2
(24%x50%)+(24%x50%)........................ ... ... ... ..... 24
R Corporation's interest:
Direct interest............................ 10
(10%x80%).................................. ... 8
(10%x80%).................................. ... ... 8
(8%x80%)................................... ... ... ... 6.4
(8%x50%)+(8%x50%).......................... ... ... ... ..... 8
------
Total interests to which consolidation 100 100 100 80 100
applies.................................
------------------------------------------------------------------------
(b) Effect of consolidation--(1) Determination of subpart F income,
export trade income, etc. An election under paragraph (a) of this
section to consolidate export trade corporations in a chain of such
corporations shall have no effect on the determination of the character
of income as subpart F income or on the determination of export trade
income, export trade income which constitutes foreign base company
income, or earnings and profits of the individual export trade
corporations in the chain. Thus, the consolidation of export trade
corporations under this section shall not have the effect of reducing
earnings and profits of such corporations or of changing the
characterization of income from that which is, for example, foreign base
company
[[Page 529]]
income to that which is not. The application of this paragraph may be
illustrated by the following example:
Example. Corporation A, incorporated under the laws of foreign
country X, and corporation B, incorporated under the laws of foreign
country Y, are both wholly owned subsidiaries of domestic corporation M.
Corporations A and B both qualify under section 971(a) as export trade
corporations. Corporation A purchases personal property produced in the
United States from an unrelated person and sells the property to B
Corporation for use outside of country X. Corporation B resells the
property to an unrelated person for use in foreign country Z.
Corporations A and B each derive foreign base company sales income
described in Sec. 1.954-3 from the purchase and sale transactions.
Consolidation of Corporations A and B under this section does not result
in the two transactions being treated as one transaction which is a
purchase of property from an unrelated person and a sale of property to
an unrelated person or the nonrecognition of gain on the sale of export
property by A Corporation to B Corporation.
(2) Determination of amount by which consolidated subpart F income
is reduced--(i) In general. In determining the amount by which the
subpart F income of each export trade corporation includible in a
consolidation of export trade corporations shall be reduced as provided
in section 970(a) and paragraph (b)(1) of Sec. 1.970-1 for any taxable
year of consolidation, the limitations provided by section 970(a) and
paragraph (b)(2) of Sec. 1.970-1 on such amount for each such export
trade corporation shall be determined on the basis of such corporation's
separate share of--
(a) Amounts included in the total export promotion expense,
(b) The total gross receipts from the sale, installation, operation,
maintenance, or use of property in respect of which each such
corporation derives such export trade income as is properly allocable to
the export trade income which constitutes foreign base company income,
and
(c) The total increase in investments in export trade assets,
of all export trade corporations to which the consolidation applies for
the taxable year.
(ii) Limitations not effective. If for any taxable year each of the
limitations under paragraph (b)(2) of Sec. 1.970-1, determined on a
consolidated basis, equals or exceeds the total export trade income
which constitutes foreign base company income of all corporations
includible in the consolidation of export trade corporations, the
subpart F income of each includible corporation shall be reduced under
section 970(a) for such year by its separate export trade income which
constitutes foreign base company income.
(iii) Limitation effective. If for any taxable year one of the
limitations under paragraph (b)(2) of Sec. 1.970-1, determined on a
consolidated basis, is less than the total export trade income which
constitutes foreign base company income of all corporations includible
in the consolidation of export trade corporations, the amount by which
the subpart F income of each includible corporation shall be reduced
under section 970(a) for such year shall be an amount which bears the
same ratio to the amount by which the subpart F income may be reduced on
a consolidated basis as the export trade income which constitutes
foreign base company income of each includible corporation bears to the
total export trade income which constitutes foreign base company income
of all export trade corporations includible in the consolidation of
export trade corporations.
(iv) Illustration. The application of this subparagraph may be
illustrated by the following example:
Example. (a) Domestic corporation M owns 100 percent of the only
class of stock of controlled foreign corporation A, which, in turn, owns
100 percent of the only class of stock of controlled foreign corporation
B. All corporations use the calendar year as the taxable year, and
corporations A and B are export trade corporations throughout the period
here involved. Corporation M elects under this section to consolidate
corporations A and B for the entire period here involved. Corporation M
elects under paragraph (a)(2) of Sec. 1.970-2 for 1963 to determine
both A Corporation's and B Corporation's investments in export trade
assets as of the close of the 75th day after the close of such
corporations' taxable year.
(b) The following amounts are applicable to corporations A and B for
1964:
------------------------------------------------------------------------
Corporation Corporation
A B
------------------------------------------------------------------------
Subpart F income.............................. $100 $200
[[Page 530]]
Export trade income which constitutes foreign 25 75
base company income..........................
Other export trade income..................... 10 15
Export promotion expenses allocable to export 10 80
trade income which constitutes foreign base
company income...............................
Gross receipts from the sale of property in 400 600
respect of which export trade income which
constitutes foreign base company income is
derived......................................
Increase in investments in export trade assets 35 120
for period beginning with March 16, 1964, and
ending with March 16, 1965...................
------------------------------------------------------------------------
(c) The amount by which subpart F income of corporations A and B is
reduced for 1964 on a separate-company basis without regard to section
972 may be determined as set forth in items (i) through (vii) below, and
the results of the consolidation of corporations A and B for 1964 are
set forth in items (viii) through (x). Assuming an alternative case in
which for 1964 the facts are the same as set forth in paragraphs (a) and
(b) of this example except that B Corporation incurs export promotion
expenses of $50 (rather than $80) which are allocable to the export
trade income which constitutes foreign base company income, the results
of the consolidation of corporations A and B for such year (a case where
one of the limitations under paragraph (b)(2) of Sec. 1.970-1 is
effective) are set forth in items (xi) through (xiii):
------------------------------------------------------------------------
A B
Corporation Corporation Total
(1) (2) (3)
------------------------------------------------------------------------
(i) Subpart F income................. $100 $200 $300
==============
(ii) Export trade income which 25 75 100
constitutes foreign base company
income..............................
(iii) Other export trade income...... 10 15 25
--------------
(iv) Total export trade income....... 35 90 125
==============
(v) Limitations under Sec. 1.970-
1(b)(2):
(a) Increase in export trade assets
limitation:
($35x$25/$35).................... 25 ........... .......
($120x$75/$90)................... ........... 100 .......
([$35+$120]x$100/ $125).......... ........... ........... 124
(b) Gross receipts limitation:
(10% of $400).................... 40 ........... .......
(10% of $600).................... ........... 60 .......
(10% of $1,000).................. ........... ........... 100
(c) Export promotion expenses
limitation:
(150% of $10).................... 15 ........... .......
(150% of $80).................... ........... 120 .......
(150% of $90).................... ........... ........... 135
(d) Export promotion expenses
limitation (alternative case):
(150% of $10).................... 15 ........... .......
(150% of $50).................... ........... 75 .......
(150% of $60).................... ........... ........... 90
--------------
(vi) Reduction in subpart F income on 15 60 75
a separate company basis determined
without regard to section 972 (item
(ii), but not to exceed smallest of
items (v) (a), (b), and (c), in
columns (1) and (2))................
--------------
(vii) Subpart F income as reduced on 85 140 225
a separate company basis (item (i)
minus item (vi))....................
==============
(viii) Reduction in subpart F income ........... ........... 100
on a consolidated basis determined
under section 972 (item (ii), but
not to exceed smallest of items (v)
(a), (b), and (c), in column (3))...
--------------
(ix) Apportionment of reduction in 25 75 100
subpart F income (item (ii))........
(x) Subpart F income as reduced on a 75 125 200
consolidated basis (item (i) minus
item (ix))..........................
==============
Alternative Case
(xi) Reduction in subpart F income on ........... ........... 9
a consolidated basis determined
under section 972 (item (ii) but not
to exceed smallest of items (v) (a),
(b), and (d), in column (3))........
--------
(xii) Apportionment of reduction in $22.50 ........... .......
subpart F income (item (xi) times
[item (ii) of column (1) over item
(ii) of column (3)] and item (xi)
times [item (ii) of column (2) over
item (ii) of column (3)]); ($90 x
$25/$100)...........................
($90 x $75/$100)................... ........... $67.50 90
---------------------
(xiii) Subpart F income as reduced on 77.50 132.50 210
a consolidated basis (item (i) minus
item (xii)).........................
------------------------------------------------------------------------
(3) Determination of pro rata share of consolidated withdrawal of
previously excluded export trade income--(i) In general. If, for any
taxable year, there is a decrease in investments in export trade assets
under section 970(b) and paragraph (c)(1) of Sec. 1.970-1, determined
on a consolidated basis, of export trade corporations includible in a
consolidated chain of such corporations, each United States shareholder
who has elected under paragraph (a) of this section to
[[Page 531]]
consolidate his interest in such chain of corporations shall include in
his gross income, under section 951(a)(1)(A)(ii) and the regulations
thereunder as an amount to which section 955 (as in effect before the
enactment of the Tax Reduction Act of 1975) applies, his pro rata share
of the amount of such consolidated decrease in investments but only to
the extent such pro rata share does not exceed the lesser of the
limitations provided by section 970(b) and paragraph (c)(2) of Sec.
1.970-1 with respect to such shareholder determined on a consolidated
basis. The consolidated decrease in investments and the consolidated
limitations shall be determined by aggregating the applicable amounts
determined under paragraph (c) of Sec. 1.970-1 with respect to such
shareholder's interest in each corporation includible in the
consolidation.
(ii) Allocation of pro rata share of consolidated decrease in
investments in export trade assets. For purposes of determining the
amount referred to in paragraph (c)(2)(i)(b)(3) of Sec. 1.970-1 for a
subsequent taxable year, a United States shareholder's pro rata share of
a consolidated decrease in investments determined under subdivision (i)
of this subparagraph for the current taxable year shall be allocated to
such shareholder's interest in each of the export trade corporations
includible in the consolidation in that ratio which--
(a) The net amount determined under paragraph (c)(2)(i)(b) of Sec.
1.970-1 with respect to such shareholder's interest in such corporation
for all prior taxable years (whether or not a taxable year occurring
during the period of consolidation) bears to
(b) The total of the net amounts determined under paragraph
(c)(2)(i) (b) of Sec. 1.970-1 with respect to such shareholder's
interests in all export trade corporations includible in such
consolidation for all prior taxable years (whether or not a taxable year
occurring during the period of consolidation).
(iii) Illustration. The application of this subparagraph may be
illustrated by the following example:
Example. (a) Domestic corporation M owns 60 percent of the only
class of stock of controlled foreign corporation A, which, in turn, owns
100 percent of the only class of stock of controlled foreign corporation
B. All corporations use the calendar year as a taxable year, and
corporations A and B are export trade corporations throughout the period
here involved. Corporation M elects to consolidate corporations A and B
for the entire period here involved.
(b) The following amounts are applicable to corporations A and B for
1964:
------------------------------------------------------------------------
Consolidated
A (1) B (2) (3)
------------------------------------------------------------------------
(i) Consolidated decrease in investments in ..... ..... $100
export trade assets (determined before
application of Sec. 1.970-1(c)(2)).......
(ii) M Corporation's pro rata share of ..... ..... 60
consolidated decrease (60%)................
(iii) M Corporation's pro rata share of $120 $90 210
earnings and profits for 1963 and 1964
(Sec. 1.970-1(c) (2)(i)(a)...............
(iv) M Corporation's pro rata share of net 180 60 240
amount determined under Sec. 1.970-
1(c)(2)(i)(b) for 1963.....................
(v) Amount includible in M Corporation's ..... ..... 60
gross income for 1964 (smallest of items
(ii), (iii), and (iv) in column (3)).......
------------------------------------------------------------------------
Corporation M must include $60 in its gross income for 1964 under
section 951(a)(1)(A)(ii) by reason of the application of section 970(b)
as its pro rata share of the consolidated decrease in investments in
export trade assets; and, for purposes of determining the amount under
paragraph (c)(2)(i)(b)(3) of Sec. 1.970-1 with respect to M
Corporation's interest in each of corporations A and B for a subsequent
taxable year, such consolidated decrease for 1964 is allocated as
follows: to M Corporation's interest in A Corporation, $45 ($60 times
$180/$240); and to its interest in B Corporation, $15 ($60 times $60/
$240).
(c) The following amounts are applicable to corporations A and B for
1965:
------------------------------------------------------------------------
Consolidated
A(1) B(2) (3)
------------------------------------------------------------------------
(i) Consolidated decrease in ......... ......... $150
investments in export trade assets
(determined before application of
Sec. 1.970-1(c)(2))..............
(ii) M Corporation's pro rata share ......... ......... 90
of consolidated decrease (60%).....
(iii) M Corporation's pro rata share $100 ($20) 80
of earnings and profits (and
deficits in earnings and profits)
for 1963, 1964, and 1965 (Sec.
1.970-1(c)(2)(i)(a))...............
[[Page 532]]
(iv) M Corporation's pro rata share ......... ......... ............
of the net amount determined under
Sec. 1.970-1(c)(2)(i)(b) for 1963
and 1964...........................
($180-$45)........................ 135 ......... ............
($60-$15)......................... ......... 45 ............
Total........................... ......... ......... 180
(v) Amount includible in M ......... ......... 80
Corporation's gross income for 1965
(smallest of items (ii), (iii), and
(iv) in column (3))................
------------------------------------------------------------------------
Corporation M must include $80 in its gross income for 1965 under
section 951(a)(1)(A)(ii) by reason of the application of section 970(b)
as its pro rata share of the consolidated decrease in investments in
export trade assets; and, for purposes of determining the amount under
paragraph (c)(2)(i)(b)(3) of Sec. 1.970-1 with respect to M
Corporation's interest in each of corporations A and B for a subsequent
taxable year, such consolidated decrease for 1965 is allocated as
follows: to M Corporation's interest in A Corporation, $60 ($80 times
$135/$180); and to its interest in B Corporation, $20 ($80 times $45/
$180).
(d) The following amounts are applicable to corporations A and B for
1966:
------------------------------------------------------------------------
Consolidated
A(1) B(2) (3)
------------------------------------------------------------------------
(i) Consolidated decrease in investments in ..... ..... $200
export trade assets (determined before
application of Sec. 1.970-1(c)(2)).......
(ii) M Corporation's pro rata share of ..... ..... 120
consolidated decrease (60%)................
(iii) M Corporation's pro rata share of $120 $50 170
earnings and profits (and deficits in
earnings and profits) for 1963, 1964, 1965,
and 1966 (Sec. 1.970-1(c)(2)(i)(a))......
(iv) M Corporation's pro rata share of the ..... ..... ............
net amount determined under Sec. 1.970-
1(c)(2)(i)(b) for 1963, 1964, and 1965.....
($180 minus [$45+$60]).................... 75 ..... ............
($60-[$15+$20])........................... ..... 25 ............
Total................................... ..... ..... 100
(v) Amount includible in M Corporation's ..... ..... 100
gross income for 1966 (smallest of items
(ii), (iii), and (iv) in column (3)).......
------------------------------------------------------------------------
Corporation M must include $100 in its gross income for 1966 under
section 951(a)(1)(A)(ii) by reason of the application of section 970(b)
as its pro rata share of the consolidated decrease in investments in
export trade assets; and, for purposes of determining the amount under
paragraph (c)(2)(i)(b)(3) of Sec. 1.970-1 with respect to M
Corporation's interest in each of corporations A and B for a subsequent
taxable year, such consolidated decrease for 1966 is allocated as
follows: to M Corporation's interest in A Corporation, $75 ($100 times
$75/$100); and to its interest in B Corporation, $25 ($100 times $25/
$100).
[T.D. 6754, 29 FR 12714, Sept. 9, 1964, as amended by T.D. 7893, 48 FR
22512, May 19, 1983]
Sec. 1.981-0 Repeal of section 981; effective dates.
The provisions of section 981 are not effective for taxable years
beginning after December 31, 1976. For the treatment of the community
income of aliens and their spouses for taxable years beginning after
December 31, 1976, see section 879 and the regulations thereunder.
[T.D. 7670, 45 FR 6929, Jan. 31, 1980]
Sec. 1.981-1 Foreign law community income for taxable years beginning
after December 31, 1966, and before January 1, 1977.
(a) Election for special treatment--(1) In general. An individual
citizen of the United States who meets the requirements of section
981(a)(1) and subparagraph (2) of this paragraph for any open taxable
year beginning after December 31, 1966, and before January 1, 1977, may
make a binding election with his nonresident alien spouse to have
section 981(b) and paragraph (b) of this section apply to their income
for such year which is treated as community income under the applicable
community property laws of a foreign country or countries. Generally,
the community property laws of a foreign country operate upon land
situated within its jurisdiction and upon personal property owned by
spouses domiciled therein. If the election is made for any taxable year,
it shall also apply for all subsequent open taxable years of such
citizen and his nonresident alien spouse for which all the requirements
of section 981(a)(1) and subparagraph (2) of this paragraph are met,
unless the Director of International Operations consents, in accordance
with paragraph (c)(2) of this section, to a termination of the election.
An election under section 981(a) and this section has no effect for any
taxable year beginning before January 1, 1967, for which a separate
election, if made, must be made under section
[[Page 533]]
981(c)(1) and Sec. 1.981-2. For the definition of ``open taxable year''
see section 981(e)(2) and paragraph (a) of Sec. 1.981-3. If the citizen
and his nonresident alien spouse have different taxable years, see
paragraph (c) of Sec. 1.981-3. If one of the spouses is deceased, see
paragraph (d) of Sec. 1.981-3.
(2) Requirements to be met. In order for a U.S. citizen and his
nonresident alien spouse to make an election under section 981(a) and
this section for any taxable year and in order for the election to apply
for any subsequent taxable year it is required under section 981(a)(1)
that, for each such taxable year, such citizen be (i) a citizen of the
United States, (ii) a bona fide resident of a foreign country or
countries during the entire taxable year, and (iii) married at the close
of the taxable year to an individual who is (a) a nonresident alien
during the entire taxable year and (b), in the case of any such
subsequent taxable year, the same nonresident alien individual to whom
the citizen was married at the close of the earliest of such taxable
years. If either spouse dies during a taxable year, the taxable year of
the surviving spouse shall be treated, solely for purposes of making the
determination under subdivision (iii) of this subparagraph, as ending on
the date of such death. A citizen of the United States shall be
considered as not married at the close of his taxable year if he is
legally separated from his spouse under a decree of divorce or of
separate maintenance. However, the mere fact that spouses have not lived
together during the course of the taxable year shall not cause them to
be considered as not married at the close of the taxable year. A husband
and wife who are separated under an interlocutory decree of divorce
retain the relationship of husband and wife until the decree becomes
final.
(3) Determination of residence. The principles of paragraphs (a)(2)
and (b)(7) of Sec. 1.911-1 (26 CFR 1.911-1 (1978)) shall apply in order
to determine for purposes of this paragraph whether a U.S. citizen is a
bona fide resident of a foreign country or countries during the entire
taxable year. The principles of Sec. Sec. 1.871.2 through 1.871-5 shall
apply in order to determine whether the alien spouse of a U.S. citizen
is a nonresident during the entire taxable year.
(4) Manner of electing. The election under section 981(a) and this
section shall be made in accordance with the applicable rules set forth
in paragraph (c) of this section.
(b) Treatment of community income--(1) In general. Community income
for any taxable year to which an election under section 981(a) and this
section applies, and the deductions properly allocable to such income,
shall be divided between the electing U.S. citizen and nonresident alien
spouses in accordance with the rules set forth in section 981(b) and
subparagraphs (2) through (6) of this paragraph. Community income for
this purpose means all gross income, whether derived from sources within
or without the United States, which is treated as community income of
the spouses under the community property laws of the foreign country
having jurisdiction to determine the legal ownership of the income. A
spouse has ownership of the income for this purpose if under the
applicable foreign law he has a proprietary vested interest in the
income.
(2) Earned income. Wages, salaries, or professional fees, and other
amounts received as compensation for personal services actually
performed, which are community income for the taxable year, shall be
treated as the income of the spouse who actually performed the personal
services. This subparagraph does not apply, however, to community income
(i) derived from any trade or business carried on by the husband or the
wife, (ii) attributable to a spouse's distributive share of the income
of a partnership to which subparagraph (4) of this paragraph applies,
(iii) consisting of compensation for personal services rendered to a
corporation which represents a distribution of the earnings and profits
of the corporation rather than a reasonable allowance as compensation
for the personal services actually performed, or (iv) derived from
property which is acquired as consideration for personal services
performed.
(3) Trade or business income. If any income derived from a trade or
business carried on by the husband or wife is community income for the
taxable
[[Page 534]]
year, all of the gross income, and the deductions attributable to such
income, shall be treated as the gross income and deductions of the
husband unless the wife exercises substantially all of the management
and control of the trade or business, in which case all of the gross
income and deductions shall be treated as the gross income and
deductions of the wife. This subparagraph does not apply to any income
derived from a trade or business carried on by a partnership of which
both or one of the spouses is a member. For purposes of this
subparagraph, income derived from a trade or business includes any
income derived from a trade or business in which both personal services
and capital are material income producing factors. The term ``management
and control'' means management and control in fact, not the management
and control imputed to the husband under the community property laws of
a foreign country. For example, a wife who operates a beauty parlor
without any appreciable collaboration on the part of a husband is
considered as having substantially all of the management and control of
the business despite the provisions of any community property laws of a
foreign country vesting in the husband the right of management and
control of community property; and the income and deductions
attributable to the operation of the beauty parlor are considered the
income and deductions of the wife.
(4) Partnership income. If any portion of a spouse's distributive
share of the income of a partnership of which such spouse is a member is
community income for the taxable year, all of that distributive share
shall be treated as the income of that spouse and shall not be taken
into account in determining the income of the other spouse. If both
spouses are members of the same partnership, the distributive share of
the income of each spouse which is community income shall be treated as
the income of that spouse. A spouse's distributive share of such income
of a partnership shall be determined as provided in section 704, and the
regulations thereunder.
(5) Income from separate property. Any community income for the
taxable year, other than income described in section 981(b)(1) or (2)
and subparagraph (2), (3), or (4) of this paragraph, which is derived
from the separate property of one of the spouses shall be treated as the
income of that spouse. The determination of what property is separate
property for this purpose shall be made in accordance with the laws of
the foreign country which, in accordance with subparagraph (1) of this
paragraph, has jurisdiction to determine that the income from such
property is community income.
(6) Other community income. Any community income for the taxable
year, other than income described in section 981(b)(1), (2), or (3), and
subparagraph (2), (3), (4), or (5) of this paragraph, shall be treated
as the income of that spouse who has a proprietary vested interest in
that income under the laws of the foreign country which, in accordance
with subparagraph (1) of this paragraph, has jurisdiction to determine
that such income is community income. Thus, for example, this
subparagraph applies to community income not described in subparagraph
(2), (3), (4), or (5) of this paragraph which consists of dividends,
interest, rents, royalties, or gains, from community property or of the
earnings of unemancipated minor children.
(7) Illustrations. The application of this paragraph may be
illustrated by the following examples:
Example 1. H, a nonresident alien individual and W, a U.S. citizen,
each of whose taxable years is the calendar year, were married
throughout 1967. H and W were residents of, and domiciled in, foreign
country Z during the entire taxable year. During 1967, H earned $10,000
from the performance of personal services as an employee. H also
received $500 in dividend income from stock which under the community
property laws of country Z is considered to be the separate property of
H. W had no separate income for 1967. Under the community property laws
of country Z all income earned by either spouse is considered to be
community income, and one-half of such income is considered to belong to
the other spouse. In addition, such laws of country Z provide that all
income derived from property held separately by either spouse is to be
treated as community income and treated as belonging one-half to each
spouse. Thus, under the community property laws of country Z, H and W
are both considered to have realized income of $5,250 during
[[Page 535]]
1967, even though such laws recognize the stock as the separate property
of H. If the election under this section is in effect for 1967, under
the rules of subparagraphs (2) and (5) of this paragraph all of the
income of $10,500 derived during 1967 shall be treated, for U.S. income
tax purposes, as the income of H.
Example 2. The facts are the same as in example 1 except that H is
the sole proprietor of a retail merchandising company and such company
has a $10,000 profit during 1967. W exercises no management and control
over the business. In addition, H is a partner in a wholesale
distributing company, and his distributive share of the partnership
profit is $5,000. Both of these amounts of income are treated as
community income under the community property laws of country Z, and
under such laws both H and W are treated as realizing $7,500 of such
income. If the election under this section is in effect for 1967, under
the rule of subparagraphs (3) and (4) of this paragraph all $15,000 of
such income shall be treated as the income of H for U.S. income tax
purposes.
Example 3. The facts are the same as in example 1 except that H also
received $1,000 in dividends on stock held separately in his name. Under
the community property laws of country Z the stock is considered to be
community property; and the dividends, to be community income, one-half
of such income being treated as the income of each spouse. If the
election under this section is in effect for 1967, under the rule of
subparagraph (6) of this paragraph, $500 of the dividend income shall be
treated, for U.S. income tax purposes, as the income of each spouse.
(c) Time and manner of making or terminating an election--(1) In
general. A citizen of the United States and his nonresident alien spouse
shall, for the first taxable year beginning after December 31, 1966, for
which an election under section 981(a) and this section is to apply,
make the election by filing a return, an amended return, or a claim for
refund, whichever is proper, for such taxable year and attaching thereto
a statement that the election is being made and that the requirements of
paragraph (a)(2) of this section are met for such taxable year. The
statement must show the name, address, and account number, if any, of
each spouse, the name and address of the executor, administrator, or
other person making the election for a deceased spouse, the taxable year
to which the election applies, and the name of the foreign country or
countries having jurisdiction to determine the ownership of any income
being treated in accordance with section 981(b) and paragraph (b) of
this section. The statement must be signed by both persons making the
election. An election under this section may be made only for a taxable
year which, on the date of the election, as defined in paragraph (b) of
Sec. 1.981-3, is open within the meaning of section 981(e)(2) and
paragraph (a) of Sec. 1.981-3.
(2) Termination only with consent of Director of International
Operations--(i) In general. An election under this section for any
taxable year is binding and may not be revoked. The election shall also
remain in effect for all subsequent taxable years of the spouses for
which the requirements of paragraph (a)(2) of this section are met and
which on the date of the election are open, within the meaning of
paragraph (a) of Sec. 1.981-3, unless the election is terminated for
any such subsequent taxable year or years in accordance with subdivision
(ii) of this subparagraph. Any return, amended return, or claim for
refund in respect of any such subsequent taxable year for which the
election is in effect shall have attached thereto a copy of the
statement filed in accordance with subparagraph (1) of this paragraph
and an additional signed statement that for such subsequent taxable year
the requirements of paragraph (a)(2) of this section are met.
(ii) Written request to terminate required. A request to terminate
an election under this section for a subsequent taxable year or years
shall be made in writing by the persons who made the election and shall
be addressed to the Director of International Operations, Internal
Revenue Service, Washington, DC 20225. The request must include the
name, address, and account number, if any, of each spouse and must be
signed by the persons making the request. It must specify the taxable
year or years for which the termination is to be effective and the
grounds which justify the termination. The request shall be filed not
later than 90 days before the close of the period for assessing a
deficiency against the U.S. citizen for the earliest taxable
[[Page 536]]
year of such citizen for which the termination is to be effective. The
Director of International Operations may require such other information
as may be necessary in order to determine whether the termination will
be permitted. A copy of the consent by the Director of International
Operations to terminate must be attached to an amended income tax return
for each taxable year for which the termination is effective and for
which a return has previously been filed.
(Secs. 913(m) (92 Stat. 3106; 26 U.S.C. 913(m)), and 7805 (68A Stat.
917; 26 U.S.C. 7805), Internal Revenue Code of 1954)
[T.D. 7330, 39 FR 38372, Oct. 31, 1974, as amended by T.D. 7670, 45 FR
6929, Jan. 31, 1980; T.D. 7736, 45 FR 76143, Nov. 18, 1980]
Sec. 1.981-2 Foreign law community income for taxable years beginning
before January 1, 1967.
(a) Election for special treatment--(1) In general. For all open
taxable years beginning before January 1, 1967, for which an individual
citizen of the United States meets the requirements of subparagraphs (A)
and (C) of section 981(a)(1) and subparagraph (2) of this paragraph,
such citizen and his nonresident alien spouse may make a joint election
to have section 981(c)(2) and paragraph (b) of this section apply to
their income which is treated as community income under the applicable
community property laws of a foreign country or countries. However, if
the conditions prescribed by section 981(d)(3) and subparagraph (3) of
this paragraph are met, the nonresident alien spouse is not required to
join in the election and such citizen may make a separate election to
have section 981(c)(2) and paragraph (b) of this section apply to such
income for such taxable years. An election under section 981(c)(1) and
this section shall apply to every open taxable year of such citizen and
his nonresident alien spouse beginning before January 1, 1967, for which
all the requirements of subparagraphs (A) and (C) of section 981(a)(1)
and subparagraph (2) of this paragraph are met. It is immaterial whether
such open taxable year is a taxable year subject to the provisions of
the 1954 Code, the 1939 Code, or any other internal revenue law in
effect before the 1939 Code. An election under section 981(c)(1) and
this section has no effect for any taxable year beginning after December
31, 1966. For the definition of ``open taxable year'' see section
981(e)(2) and paragraph (a) of Sec. 1.981-3. If the citizen and his
nonresident alien spouse have different taxable years, see paragraph (c)
of Sec. 1.981-3. If one of the spouses is deceased, see paragraph (d)
of Sec. 1.981-3. An election under section 981(c)(1) and this section
is binding and may not be revoked.
(2) Requirements to be met. In order for the citizen of the United
States to make an election under this section, whether required to be
made jointly with his nonresident alien spouse or permitted to be made
separately, it is required under section 981(c)(1) that, for each
taxable year to which the election applies, the citizen making the
election be (i) a citizen of the United States and (ii) married at the
close of the taxable year to an individual who is (a) a nonresident
alien during the entire taxable year and (b), in the case of any such
taxable years subsequent to the first, the same nonresident alien
individual to whom the citizen was married at the close of such first
taxable year. The provisions of paragraph (a)(2) of Sec. 1.981-1 apply
to determine whether a U.S. citizen making an election under section
981(c)(1) and this section is married at the close of a taxable year to
an individual who is a nonresident alien during the entire taxable year.
(3) Cases where joint election is not required. A nonresident alien
spouse is not required to join in an election under section 981(c)(1)
and this section if the Director of International Operations determines
in accordance with paragraph (c)(4) of this section--
(i) That an election under section 981(c)(1) and this section would
not affect the liability for Federal income tax of the nonresident alien
spouse for any taxable year, whether beginning on, before, or after
January 1, 1967, or
(ii) That the effect of the election on the liability of the
nonresident alien spouse for Federal income tax for any such taxable
year cannot be ascertained and that to deny the election to the U.S.
citizen spouse would be
[[Page 537]]
inequitable and cause undue hardship to the U.S. citizen.
If in accordance with this subparagraph the nonresident alien spouse is
not required to join in the election by the U.S. citizen, the provisions
of section 981(d)(2) and paragraph (e) of Sec. 1.981-3 shall not apply
so as to extend the period for assessing deficiencies or filing a claim
for credit or refund for any taxable year of the nonresident alien
spouse.
(4) Manner of electing. The election under section 981(c)(1) and
this section shall be made in accordance with the applicable rules set
forth in paragraph (c) of this section.
(b) Treatment of community income--(1) In general. Community income,
as defined in paragraph (b)(1) of Sec. 1.981-1, for any taxable year
beginning before January 1, 1967, to which an election under section
981(c)(1) and this section applies, and the deductions properly
allocable to such income, shall be divided between the U.S. citizen and
his nonresident alien spouse in accordance with the rules set forth in
section 981(c)(2) and subparagraphs (2) and (3) of this paragraph. The
income shall be divided in such manner even though the nonresident alien
spouse is not required, in accordance with paragraph (a)(3) of this
section, to join in the election by the U.S. citizen.
(2) Earned income, business income, partnership income, and income
from separate property. All community income for any taxable year to
which this paragraph applies which is treated as the income of one of
the spouses in accordance with section 981(b)(1), (2), or (3) and
paragraph (b)(2), (3), (4), or (5) of Sec. 1.981-1 shall be treated as
the income of that spouse for purposes of this paragraph.
(3) Other community income. All community income for any taxable
year to which this paragraph applies, other than income described in
subparagraph (2) of this paragraph, shall be treated as the income of
the spouse who, for such taxable year, has a greater amount of gross
income than the other spouse, determined by adding to the amount of
gross income which is treated as the gross income of that spouse in
accordance with subparagraph (2) of this paragraph the amount of the
gross income for the taxable year which is treated as the separate
income of that spouse under the community property laws of the foreign
country having jurisdiction to determine the legal ownership of the
income. If either spouse dies during a taxable year, the taxable year of
the surviving spouse shall be treated as ending on the date of such
death for the purpose of determining which spouse has the greater amount
of gross income for such taxable year. Moreover, if the U.S. citizen and
his nonresident alien spouse do not have the same taxable year, as
defined in section 441(b) and the regulations thereunder, the periods
for which the amounts of gross income are to be compared under this
subparagraph are (i) the taxable year of the citizen and (ii) that
period falling within the consecutive taxable years of the nonresident
alien spouse which coincides with the period covered by such taxable
year of the citizen. See paragraph (c) of Sec. 1.981-3.
(c) Time and manner of making election--(1) In general. A citizen of
the United States and his nonresident alien spouse or, if subparagraph
(4) of this paragraph applies, such citizen alone may make an election
under section 981(c)(1) and this section at any time on or after
November 13, 1966, for each and every taxable year beginning before
January 1, 1967, which on the date of the election, as defined in
paragraph (b) of Sec. 1.981-3, is open within the meaning of section
981(e)(2) and paragraph (a) of Sec. 1.981-3. The election shall be made
by filing a return, an amended return, or a claim for refund, whichever
is proper, for each taxable year to which the election applies and
attaching thereto a statement that the election is being made and that
the requirements of paragraph (a)(2) of this section are met for each
such taxable year. The statement must also show the information required
by subparagraph (2) of this paragraph and must, where applicable, be
signed by both persons making the election.
(2) Information required. The statement described in subparagraph
(1) of this paragraph must show--
(i) The name, address, and account number, if any, of each spouse,
[[Page 538]]
(ii) The name and address of the executor, administrator, or other
person making the election for a deceased spouse,
(iii) The taxable years to which the election applies,
(iv) The office of the district director, or the service center,
where the return or returns, if any, for such taxable year or years were
filed,
(v) The dates on which such return or returns, if any, were filed
and on which the tax for such taxable year or years was paid, if the tax
has been paid, and
(vi) The name of the foreign country or countries having
jurisdiction to determine the ownership of any income being treated in
accordance with section 981(c)(2) and paragraph (b) of this section.
(3) Place for filing. Any return, amended return, or claim for
refund filed under subparagraph (1) of this paragraph in respect of any
taxable year shall be filed with the Director of International
Operations, Internal Revenue Service, Washington, DC 20225. (See Sec.
1.6091-3.)
(4) Determination that joint election is not required. A U.S.
citizen spouse entitled to make an election under section 981(c)(1) and
this section for open taxable years beginning before January 1, 1967,
may apply to the Director of International Operations for a
determination under section 981(d)(3) that the nonresident alien spouse
is not required to join in the election by such citizen. This
application shall be made by filing with the Director of International
Operations, Internal Revenue Service, Washington, DC 20225, a statement
setting forth the same information required by subparagraph (2) of this
paragraph and such other information as is required by the Director of
International Operations to justify a claim that the requirements of
section 981(d)(3) and paragraph (a)(3) of this section are met. The
Director of International Operations shall notify the U.S. citizen by
letter of his determination with respect to the application. If the
determination is that the nonresident alien spouse is not required to
join in the election, a copy of the letter of determination shall be
attached to each return, amended return, or claim for refund, to be
filed pursuant to subparagraph (1) of this paragraph.
[T.D. 7330, 39 FR 38373, Oct. 31, 1974]
Sec. 1.981-3 Definitions and other special rules.
(a) Open taxable years. (1) For purposes of paragraph (a) of Sec.
1.981-1, and paragraph (a) of Sec. 1.981-2, a taxable year of the U.S.
citizen, and the taxable year or years of his nonresident alien spouse
ending or beginning within such taxable year of such citizen, shall be
treated as open if the period prescribed by section 6501(a) (or section
6501(c)(4) if the period is extended by agreement) for assessing a
deficiency against the citizen for his taxable year has not expired
before the date of the election, determined under paragraph (b) of this
section. Thus, for example, a taxable year of a U.S. citizen beginning
before January 1, 1967, is open for purposes of this subparagraph if,
before the election under section 981(c)(1) and Sec. 1.981-2, such
citizen has never filed a return for such year and a return was required
under section 6012 without reference to section 981. For example, if a
U.S. citizen spouse on a calendar year basis who has never filed a
return for 1960 decides in 1975 that he wishes to make the election
under section 981(c)(1) and Sec. 1.981-2 in order to avoid being
subject to tax for 1960 on his share of the community income for that
year, he may in 1975 elect the benefits of section 981(c)(2) by filing
an election in accordance with paragraph (c) of Sec. 1.981-2. In such
case, a taxable year or years of the nonresident alien spouse of such
citizen ending or beginning within 1960 shall be treated in 1975 as an
open taxable year.
(2) Subparagraph (1) of this paragraph shall apply even though the
period prescribed by section 6501 for assessing a deficiency against the
nonresident alien spouse for his taxable year or years ending or
beginning within the taxable year of the U.S. citizen has expired before
the election is made.
(3) If either spouse dies during a taxable year to which an election
under Sec. 1.981-1 or Sec. 1.981-2 applies, the taxable year of the
decedent and the surviving spouse shall be determined under this
paragraph without regard to section 981(e)(4), relating to death of
spouse
[[Page 539]]
during the taxable year. See paragraph (a)(2) of Sec. 1.443-1.
(4) For definition of the term ``taxable year'', see section 441(b)
and the regulations thereunder.
(b) Date of election. (1) For purposes of Sec. 1.981-1 and this
section the date of an election made under section 981(a) and Sec.
1.981-1 is the date on which the return, amended return, or claim for
refund required by paragraph (c)(1) of Sec. 1.981-1 is filed.
(2) For purposes of Sec. 1.981-2 and this section the date of an
election made under section 981(c)(1) and Sec. 1.981-2 is the date on
which the returns, amended returns, or claims for refund, required by
paragraph (c)(1) of Sec. 1.981-2 are filed.
(3) For provisions treating timely mailing as timely filing, see
section 7502 and the regulations thereunder.
(c) Spouses with different taxable years. If the U.S. citizen and
his nonresident alien spouse do not have the same taxable year, as
defined in section 441(b) and the regulations thereunder, the election
under Sec. 1.981-1 or Sec. 1.981-2 shall apply to each taxable year of
such citizen in respect of which the election is made and to that period
falling within the consecutive taxable years of the nonresident alien
spouse which coincides with the period covered by such taxable year of
the citizen.
(d) Election on behalf of deceased spouse. Any election, statement,
or request, required to be made under paragraph (c) of Sec. 1.981-1, or
paragraph (c) of Sec. 1.981-2, by one of the spouses may, if such
spouse is deceased, be made by the executor, administrator, or other
person charged with the property of such deceased spouse.
(e) Extension of period of limitations on assessment or refund--(1)
Assessment of deficiency. Except as provided in subparagraph (3) of this
paragraph, if an election under section 981(a) and Sec. 1.981-1, or
under section 981(c)(1) and Sec. 1.981-2, is properly made, the period
within which a deficiency may be assessed for any taxable year to which
the election applies shall, to the extent the deficiency is attributable
to the application of such election, not expire before one year after
the date of the election, determined under paragraph (b) of this
section.
(2) Refund of tax. Except as provided in subparagraph (3) of this
paragraph, if an election under section 981(a) and Sec. 1.981-1, or
under section 981(c)(1) and Sec. 1.981-2, is properly made, the period
within which a claim for credit or refund of an overpayment for any
taxable year to which the election applies may be filed shall, to the
extent the overpayment is attributable to the application of the
election, not expire before one year after the date of the election,
determined under paragraph (b) of this section.
(3) Exception in case of nonelecting alien. Subparagraphs (1) and
(2) of this paragraph shall not apply to any taxable year of a
nonresident alien spouse who, in accordance with paragraph (a)(3) of
Sec. 1.981-2, is not required to join in the election by the U.S.
citizen spouse under section 981(c)(1) and Sec. 1.981-2.
(f) Payment of interest for extension period. To the extent that an
overpayment or deficiency for any taxable year is attributable to an
election made under Sec. 1.981-1 or Sec. 1.981-2, no interest shall be
allowed or paid for any period ending with the day before the date which
is one year after the date of the election, determined under paragraph
(b) of this section.
[T.D. 7330, 39 FR 38374, Oct. 31, 1974]
Sec. 1.985-0 Outline of regulation.
This section lists the paragraphs contained in Sec. Sec. 1.985-1
through 1.985-6.
Sec. 1.985-1 Functional currency.
(a) Applicability and effective date.
(b) Dollar functional currency.
(c) Functional currency of a QBU that is not required to use the
dollar.
(d) Single functional currency for a foreign corporation.
(e) Translation of nonfunctional currency transactions.
(f) Examples.
Sec. 1.985-2 Election to use the United States dollar as the functional
currency of a QBU.
(a) Background and scope.
(b) Eligible QBU.
(c) Time and manner for dollar election.
(d) Effect of dollar election.
Sec. 1.985-3 United States dollar approximate separate transactions
method.
(a) Scope and effective date.
(b) Statement of method.
[[Page 540]]
(c) Translation into United States dollars.
(d) Computation of DASTM gain or loss.
(e) Effect of DASTM gain or loss on gross income, taxable income, or
earnings and profits.
Sec. 1.985-4 Method of accounting.
(a) Adoption or election.
(b) Condition for changing functional currencies.
(c) Relationship to certain other sections of the Code.
Sec. 1.985-5 Adjustments required upon change in functional currency.
(a) In general.
(b) Step 1--Taking into account exchange gain or loss on certain
section 988 transactions.
(c) Step 2--Determining the new functional currency basis of
property and the new functional currency amount of liabilities and any
other relevant items.
(d) Step 3A--Additional adjustments that are necessary when a branch
changes functional currency.
(e) Step 3B--Additional adjustments that are necessary when a
taxpayer changes functional currency.
(f) Examples.
Section 1.985-6 Transition rules for a QBU that uses the dollar
approximate separate transactions method for its first taxable year
beginning in 1987.
(a) In general.
(b) Certain controlled foreign corporations.
(c) All other foreign corporations.
(d) Pre-1987 section 902 amounts.
(e) Net worth branch.
(f) Profit and loss branch.
[T.D. 8263, 54 FR 38653, Sept. 20, 1989, as amended by T.D. 8464, 58 FR
232, Jan. 5, 1993; T.D. 8556, 59 FR 37672, July 25, 1994]
Sec. 1.985-1 Functional currency.
(a) Applicability and effective date--(1) Purpose and scope. These
regulations provide guidance with respect to defining the functional
currency of a taxpayer and each qualified business unit (QBU), as
defined in section 989(a). Generally, a taxpayer and each QBU must make
all determinations under subtitle A of the Code (relating to income
taxes) in its respective functional currency. This section sets forth
rules for determining when the functional currency is the United States
dollar (dollar) or a currency other than the dollar. Section 1.985-2
provides an election to use the dollar as the functional currency for
certain QBUs that absent the election would have a functional currency
that is a hyperinflationary currency, and explains the effect of making
the election. Section 1.985-3 sets forth the dollar approximate separate
transactions method that certain QBUs must use to compute their income
or loss or earnings and profits. Section 1.985-4 provides that the
adoption of a functional currency is a method of accounting and sets
forth conditions for a change in functional currency. Section 1.985-5
provides adjustments that are required to be made upon a change in
functional currency. Finally, Sec. 1.985-6 provides transition rules
for a QBU that uses the dollar approximate separate transactions method
for its first taxable year beginning after December 31, 1986.
(2) Effective date. These regulations apply to taxable years
beginning after December 31, 1986. However, any taxpayer desiring to
apply temporary Income Tax Regulations Sec. 1.985-0T through Sec.
1.985-4T in lieu of these regulations to all taxable years beginning
after December 31, 1986, and on or before October 20, 1989 may (on a
consistent basis) so choose. For the text of the temporary regulations,
see 53 FR 20308 (1988).
(b) Dollar functional currency--(1) In general. The dollar shall be
the functional currency of a taxpayer or QBU described in paragraph
(b)(1)(i) through (v) of this section regardless of the currency used in
keeping its books and records (as defined in Sec. 1.989(a)-1(d)). The
dollar shall be the functional currency of--
(i) A taxpayer that is not a QBU (e.g., an individual);
(ii) A QBU that conducts its activities primarily in dollars. A QBU
conducts its activities primarily in dollars if the currency of the
economic environment in which the QBU conducts its activities is
primarily the dollar. The facts and circumstances test set forth in
paragraph (c)(2) of this section shall apply in making this
determination;
(iii) Except as otherwise provided by ruling or administrative
pronouncement, a QBU that has the United States, or any possession or
territory of the United States where the dollar is the standard
currency, as its residence (as defined in section 988(a)(3)(B));
[[Page 541]]
(iv) A QBU that does not keep books and records in the currency of
any economic environment in which a significant part of its activities
is conducted. Whether a QBU keeps such books and records is determined
in accordance with paragraph (c)(3) of this section; or
(v) A QBU that produces income or loss that is, or is treated as,
effectively connected with the conduct of a trade or business within the
United States.
(2) QBUs operating in a hyperinflationary environment--(i) Taxable
years beginning on or before August 24, 1994. For taxable years
beginning on or before August 24, 1994, see Sec. 1.985-2 with respect
to a QBU that elects to use, or is otherwise required to use, the dollar
as its functional currency.
(ii) Taxable years beginning after August 24, 1994--(A) In general.
For taxable years beginning after August 24, 1994, except as otherwise
provided in paragraph (b)(2)(ii)(B) of this section, any QBU that
otherwise would be required to use a hyperinflationary currency as its
functional currency must use the dollar as its functional currency and
compute income or loss or earnings and profits under the rules of Sec.
1.985-3.
(B) Exceptions--(1)--Certain QBU branches. The functional currency
of a QBU that otherwise would be required to use a hyperinflationary
currency as its functional currency and that is a branch of a foreign
corporation having a non-dollar functional currency that is not
hyperinflationary shall be the functional currency of the foreign
corporation. Such QBU's income or loss or earnings and profits shall be
determined under Sec. 1.985-3 by substituting the functional currency
of the foreign corporation for the dollar.
(2) Corporation that is not a controlled foreign corporation. A
foreign corporation (or its QBU branch) operating in a hyperinflationary
environment is not required to use the dollar as its functional currency
pursuant to paragraph (b)(2)(ii)(A) of this section if that foreign
corporation is not a controlled foreign corporation as defined in
section 957 or 953(c)(1)(B). However, a noncontrolled section 902
corporation, as defined in section 904(d)(2)(E), may elect to use the
dollar (or, if appropriate, the currency specified in paragraph
(b)(2)(ii)(B)(1) of this section) as its (or its QBU branch's)
functional currency under the procedures set forth in Sec. 1.985-
2(c)(3).
(C) Change in functional currency. (1) In general. If a QBU is
required to change its functional currency to the dollar under paragraph
(b)(2)(ii)(A) of this section, or chooses or is required to change its
functional currency to the dollar for any open taxable year (and all
subsequent taxable years) under Sec. 1.985-3(a)(2)(ii), the change is
considered to be made with the consent of the Commissioner for purposes
of Sec. 1.985-4. A QBU changing functional currency must make
adjustments described in Sec. 1.985-7 if the year of change (as defined
in Sec. 1.481-1(a)(1)) begins after 1987, or the adjustments described
in Sec. 1.985-6 if the year of change begins in 1987. No adjustments
under section 481 are required solely because of a change in functional
currency described in this paragraph (b)(2)(ii)(C).
(2) Effective date. This paragraph (b)(2)(ii)(C) applies to taxable
years beginning after April 6, 1998. However, a taxpayer may choose to
apply this paragraph (b)(2)(ii)(C) to all open years after December 31,
1986, provided each person, and each QBU branch of a person, that is
related (within the meaning of Sec. 1.985-2(d)(3)) also applies to this
paragraph (b)(2)(ii)(C).
(D) Hyperinflationary currency. For purposes of sections 985 through
989, the term hyperinflationary currency means the currency of a country
in which there is cumulative inflation during the base period of at
least 100 percent as determined by reference to the consumer price index
of the country listed in the monthly issues of the ``International
Financial Statistics'' or a successor publication of the International
Monetary Fund. If a country's currency is not listed in the monthly
issues of ``International Financial Statistics,'' a QBU may use any
other reasonable method consistently applied for determining the
country's consumer price index. Base period means, with respect to any
taxable year, the thirty-six calendar months immediately preceding the
first day of the current calendar year. For this purpose, the cumulative
inflation rate for the base period is based on compounded inflation
rates. Thus, if for 1991, 1992,
[[Page 542]]
and 1993, a country's annual inflation rates are 29 percent, 25 percent,
and 30 percent, respectively, the cumulative inflation rate for the
three-year base period is 110 percent [((1.29 x 1.25 x 1.3)-1.0 x
1.10)x100=110%] and the currency of the country for the QBU's 1994 year
is considered hyperinflationary. In making the determination whether a
currency is hyperinflationary, the determination for purposes of United
States generally accepted accounting principles may be used for income
tax purposes provided the determination is based on criteria that is
substantially similar to the rules previously set forth in this
paragraph (b)(2)(ii)(D), the method of determination is applied
consistently from year to year, and the same method is applied to all
related persons as defined in Sec. 1.985-3(e)(2)(vi).
(E) Change in functional currency when currency ceases to be
hyperinflationary--(1) In general. A QBU that has been required to use
the dollar as its functional currency under paragraph (b)(2) of this
section, or has elected to use the dollar as its functional currency
under paragraph (b)(2)(ii)(B)(2) of this section or Sec. 1.985-2, must
change its functional currency as of the first day of the first taxable
year that follows three consecutive taxable years in which the currency
of its economic environment, determined under paragraph (c)(2) of this
section, is not a hyperinflationary currency. The functional currency of
the QBU for such year shall be determined in accordance with paragraph
(c) of this section. For purposes of Sec. 1.985-4, the change is
considered to be made with the consent of the Commissioner. See Sec.
1.985-5 for adjustments that are required upon a change in functional
currency.
(2) Effective Date. This paragraph (b)(2)(ii)(E) of this section
applies to taxable years beginning after April 6, 1998.
(c) Functional currency of a QBU that is not required to use the
dollar--(1) General rule. The functional currency of a QBU that is not
required to use the dollar under paragraph (b) of this section shall be
the currency of the economic environment in which a significant part of
the QBU's activities is conducted, if the QBU keeps, or is presumed
under paragraph (c)(3) of this section to keep, its books and records in
such currency.
(2) Economic environment. For purposes of section 985 and the
regulations thereunder, the economic environment in which a significant
part of a QBU's activities is conducted shall be determined by taking
into account all the facts and circumstances.
(i) Facts and circumstances. The facts and circumstances that are
considered in determining the economic environment in which a
significant part of a QBU's activities is conducted include, but are not
limited to, the following:
(A) The currency of the country in which the QBU is a resident as
determined under section 988(a)(3)(B);
(B) The currencies of the QBU's cash flows;
(C) The currencies in which the QBU generates revenues and incurs
expenses;
(D) The currencies in which the QBU borrows and lends;
(E) The currencies of the QBU's sales markets;
(F) The currencies in which pricing and other financial decisions
are made;
(G) The duration of the QBU's business operations; and
(H) The significance and/or volume of the QBU's independent
activities.
(ii) Rate of inflation. The rate of inflation (regardless of how it
is determined) shall not be a factor used to determine a QBU's economic
environment.
(iii) Consistency. A taxpayer must consistently apply the facts and
circumstances test set forth in this paragraph (c)(2) in evaluating the
economic environment of its QBUs, e.g., its branches, that engage in the
same or similar trades or businesses.
(3) Books and records presumption. A QBU shall be presumed to keep
books and records in the currency of the economic environment in which a
significant part of its activities are conducted. The presumption may be
overcome only if the QBU can demonstrate to the satisfaction of the
district director that a substantial nontax purpose exists for not
keeping any books and records in such currency. A taxpayer
[[Page 543]]
may not use this presumption affirmatively in determining a QBU's
functional currency.
(4) Multiple currencies. If a QBU has more than one currency that
satisfies the requirements of paragraph (c)(1) of this section, the QBU
may choose any such currency as its functional currency.
(5) Relationship of United States accounting principles. In making
the functional currency determination under this paragraph (c), the
currency of the QBU for purposes of United States generally accepted
accounting principles (GAAP) will ordinarily be accepted as the
functional currency of the QBU for income tax purposes, provided that
the GAAP determination is based on facts and circumstances substantially
similar to those set forth in paragraph (c)(2) of this section.
(6) Effect of changed circumstances. Regardless of any change in
circumstances, a QBU may change its functional currency determined under
this paragraph (c) only if the QBU complies with Sec. 1.985-4 or the
Commissioner's consent is considered to have been granted under Sec.
1.985-2(d)(4) or Sec. 1.985-3(a)(2)(ii). For special rules relating to
the conversion to the euro, see Sec. 1.985-8.
(d) Single functional currency for a foreign corporation--(1)
General rule. This paragraph (d) applies to a foreign corporation that
has two or more QBUs that do not have the same functional currency. The
foreign corporation shall be treated as having a single functional
currency for the corporation as a whole that is different from the
functional currency of one or more of its QBUs. The determination of a
foreign corporation's functional currency shall be made by first
applying paragraph (d)(1)(i) and then paragraph (d)(l)(ii) of this
section.
(i) Step 1. Each QBU of the foreign corporation determines its
functional currency in accordance with the rules set forth in paragraphs
(b) and (c) of this section and Sec. 1.985-2.
(ii) Step 2. The foreign corporation determines its functional
currency applying the principles of paragraphs (b) and (c) of this
section to the corporation's activities as a whole. Thus, if a foreign
corporation has two branches, the corporation shall determine its
functional currency by applying the principles of paragraphs (b) and (c)
of this section to the combined activities of the corporation and the
branches. For purposes of this paragraph (d)(1), if a QBU of a foreign
corporation has the dollar as its functional currency under paragraph
(b)(2) of this section, the QBU's activities shall be considered dollar
activities of the corporation.
(2) Translation of income or loss of QBUs having different
functional currencies than the foreign corporation as a whole. Where the
functional currency of a foreign corporation as a whole differs from the
functional currency of one or more of its QBUs, each such QBU shall
determine the amount of its income or loss or earnings and profits (or
deficit in earnings and profits) in its functional currency under the
principles of section 987 (relating to branch transactions). The amount
of income or loss or earnings and profits (or deficit in earnings and
profits) of each QBU in its functional currency shall then be translated
into the foreign corporation's functional currency using the appropriate
exchange rate as defined in section 989(b)(4) for purposes of
determining the corporation's income or loss or earnings and profits (or
deficit in earnings and profits).
(e) Translation of nonfunctional currency transactions. Except for a
QBU using the dollar approximate separate transactions method described
in Sec. 1.985-3, see section 988 and the regulations thereunder for the
treatment of nonfunctional currency transactions.
(f) Examples. The provisions of this section are illustrated by the
following examples:
Example 1. P, a domestic corporation, operates exclusively through
foreign branch X in Country A. X is a QBU within the meaning of section
989(a) and its residence is Country A as determined under section 988
(a)(3)(B). The currency of Country A is the LC. All of X's purchases,
sales, and expenses are in the LC. The laws of A require X to keep books
and records in the LC. It is determined that the LC is the currency of X
under United States generally accepted accounting principles. This
determination is based on facts and circumstances substantially similar
to those set forth in paragraph (c)(2) of this section. Under these
facts, while the functional currency of P is the dollar since its
residence
[[Page 544]]
is the United States, the functional currency of X is the LC.
Example 2. P, a publicly-held domestic regulated investment company
(as defined under section 851), operates exclusively through foreign
branch B in Country R. B is a QBU within the meaning of section 989(a)
and its residence is Country R as determined under section 988(a)(3)(B).
The currency of Country R is the LC. B's principal activities consist of
purchasing and selling stock and securities of Country R companies and
securities issued by Country R. It is determined that the dollar is the
currency of B under United States generally accepted accounting
principles. This determination is not based on facts and circumstances
substantially similar to those set forth in paragraph (c)(2) of this
section. Under these facts, while the functional currency of P is the
dollar since its residence is the United States, B may choose the LC as
its functional currency because it has significant activities in the LC
provided it keeps books and records in the LC. The fact that the dollar
is the currency of B under generally accepted accounting principles is
irrelevant for purposes of determining B's functional currency because
the GAAP determination was not based on factors similar to those set
forth in paragraph (c)(2) of this section.
Example 3. P, a domestic bank, operates through foreign branch X in
Country R. X is a QBU within the meaning of section 989(a) and its
residence is Country R as determined under section 988(a)(3)(B). The
currency of Country R is the LC. The laws of R require X to keep books
and records in the LC. The branch customarily loans dollars and LCs. In
the case of its LC loans, X ordinarily fixes the terms of the loans by
reference to a contemporary London Inter-Bank Offered Rate (LIBOR) on
dollar deposits. For instance, the interest on the amount of the
outstanding LC loan principal might equal LIBOR plus 2 percent and the
amount of the outstanding LC loan principal would be adjusted to reflect
changes in the dollar value of the LC. X is primarily funded with
dollar-denominated funds borrowed from related and unrelated parties.
X's only LC activities are paying local taxes, employee wages, and local
expenses such as rent and electricity. Under these facts, X's activities
are primarily conducted in dollars. Thus, although X keeps its books and
records in LCs, X's functional currency is the dollar.
Example 4. S, a foreign corporation organized in Country U, is
wholly-owned by P, a domestic corporation. The currency of Country U is
the LC. S's sole function is acting as a financing vehicle for P and
domestic corporations that are affiliated with P. All borrowing and
lending transactions between S and P and its domestic affiliates are in
dollars. Furthermore, primarily all of S's other borrowings are dollar-
denominated or based on a dollar index. S's only LC activities are
paying local taxes, employee wages, and local expenses such as rent and
electricity. S keeps its books and records in the LC. Under these facts,
S's activities are primarily conducted in dollars. Thus, although S
keeps its books and records in LCs, S's functional currency is the
dollar.
Example 5. D is a domestic corporation whose primary activity is the
extraction of natural gas and oil through foreign branch X in Country Y.
X is a QBU within the meaning of section 989(a) and its residence is
Country Y as determined under section 988(a)(3)(B). The currency of
Country Y is the LC. X bills a significant amount of its natural gas and
oil sales in dollars and a significant amount in LCs. X also incurs
significant LC and dollar expenses and liabilities. The laws of Country
Y require X to keep its books and records in the LC. It is determined
that the LC is the currency of X under United States generally accepted
accounting principles. This determination is based on facts and
circumstances substantially similar to those set forth in paragraph
(c)(2) of this section. Absent other factors indicating that X primarily
conducts its activities in the dollar, D could choose either the dollar
or the LC as X's functional currency because X has significant
activities in both the dollar and the LC, provided the books and records
requirement is satisfied. If, instead, X's activities were determined to
be primarily in the dollar, then X would have to use the dollar as its
functional currency.
Example 6. S, a foreign corporation organized in Country U, is
wholly-owned by P, a domestic corporation. The currency of U is the LC.
S purchases the products it sells from related and unrelated parties,
including P. These purchases are made in the LC. In addition, most of
S's gross receipts are generated by transactions denominated in the LC.
S attempts to determine its LC price for goods sold in such a manner as
to obtain an LC equivalent of a certain dollar amount after reduction
for all LC costs. However, local market conditions sometimes result in
pricing adjustments. Thus, changes in the LC-dollar exchange rate from
period to period generally result in corresponding changes in the LC
price of S's products. S pays local taxes, employee wages, and other
local expenses in the LC. It is determined that the dollar is the
currency of S under United States generally accepted accounting
principles. This determination is not based on facts and circumstances
substantially similar to those set forth in paragraph (c)(2) of this
section. Under these facts, S could choose either the dollar or the LC
as its functional currency because S has significant activities in both
the dollar and the LC, provided that the books and records requirement
is satisfied.
[[Page 545]]
Example 7. S, a foreign corporation organized in Country X, is
wholly-owned by P, a domestic corporation. S conducts all of its
operations through two branches. Branch A is located in Country F and
branch B is located in Country G. S, A, and B are QBUs within the
meaning of section 989(a). Branch A's and branch B's residences are
Country F and Country G respectively as determined under section
988(a)(3)(B). The currency of Country F is the FC and the currency of
Country G is the LC. The functional currencies of S, A, and B are
determined in a two step procedure.
Step 1: The functional currency of branches A and B. Branch A and
branch B both conduct all activities in their respective local
currencies. The FC is the currency of branch A and the LC is the
currency of branch B under United States generally accepted accounting
principles. This determination is based on facts and circumstances
substantially similar to those set forth in paragraph (c)(2) of this
section. Under these facts, the functional currency of branch A is the
FC and the functional currency of branch B is the LC.
Step 2: The functional currency of S. S's functional currency is
determined by disregarding the fact that A and B are branches. When A's
activities and B's activities are viewed as a whole, S determines that
it only conducts significant activities in the LC. Therefore, S's
functional currency is the LC. See Examples 9, 10, and 11 for how the
earnings and profits of a foreign corporation, which has branches with
different functional currencies, are determined.
Example 8. Assume the same facts as in Example 7, except that S does
not exist and P conducts all of its operations through branch A and
branch B. In this instance P's functional currency in Step 2 is the
dollar, regardless of the fact that its branches' activities viewed as a
whole are in the LC, because P is a taxpayer whose residence is the
United States under section 988(a)(3)(B)(i). Therefore, while the
functional currency of branch A is the FC and the functional currency of
branch B is the LC, the functional currency of P is the dollar because
its residence is the United States.
Example 9. The facts are the same as in Example 7. ln addition,
assume that in 1987 branch A has earnings of 100 FC and branch B has
earnings of 100 LC as determined under section 987. The weighted average
exchange rate for the year is 1 FC/2 LC. Branch A's earnings are
translated into 200 LC for purposes of computing S's earnings and
profits in 1987. Thus, the total earnings and profits of S from branch A
and branch B for 1987 is 300 LC.
Example 10. (i) X, a foreign corporation organized in Country W, is
wholly-owned by P, a domestic corporation. Both X and P are calendar
year taxpayers that began business during 1987. X operates exclusively
through two branches, A and B both of which are located outside of
Country W. The functional currency of X and A is the LC, while the
functional currency of B is the DC as determined under section 985 and
Sec. 1.985-1. The earnings of B must be computed under section 987,
relating to branch transactions. In 1987, A earns 900 LCs of nonsubpart
F income and B earns 200 DCs of nonsubpart F income. Under section
904(d)(2), A's income is financial service income and B's income is
general limitation income. In order to determine X's earnings and
profits, B's income must be translated into LCs (the functional currency
of X). The weighted average exchange rate for 1987 is 1 LC/2 DC. Thus,
in 1987 X's current earnings and profits (and its post-1986
undistributed earnings) are 1000 LCs consisting of 900 LCs of financial
services income earned by A and 100 LCs (200 DC/2) of general limitation
income earned by B. Neither A nor B makes any remittances during 1987.
(ii) In 1988, neither A nor B earns any income or generates any
loss. On December 31, 1988, A remits 50 LCs directly to P. The
remittance to P is considered to be remitted by A to X and then
immediately distributed by X as a dividend. The 50 LC remittance does
not result in an exchange gain or loss under section 987 to X because
the functional currency of X and A is the LC. See section 987(3). Under
section 904(d)(3)(D), the 50 LC dividend is treated as income in a
separate category to the extent of the dividend's pro rata share of X's
earnings and profits in each separate limitation category. Thus, 90
percent, or 45 LCs, is treated as financial services income, and 10
percent, or 5 LCs, is treated as general limitation income. After the
dividend distribution, X has 950 LCs of accumulated earnings and profits
(and post-1986 undistributed earnings) consisting of 855 LCs of
financial service limitation income and 95 LCs of general limitation
income.
Example 11. The facts are the same as in Example 10, except that A
makes no remittance during 1988 but B remits 120 DCs to X on December
31, 1988, which X immediately converts into LCs, and X makes no dividend
distribution during 1988. Assume that the appropriate exchange rate for
the remittance is 1 LC/3 DCs. B's remittance triggers exchange loss to
X. See section 987(3). Under section 987, the exchange loss on the
remittance is 20 LCs calculated as follows: 40 LCs, which is the LC
value of the 120 DC remittance (120 DCs/3), less 60 LCs, their LC basis
(120 DCs/2). This loss is sourced and characterized under section 987
and regulations thereunder.
Example 12. F, a foreign corporation, has gain from the disposition
of a United States real property interest (as defined in section
897(c)). The gain is taken into account as if F were engaged in a trade
or business within the United States during the taxable year
[[Page 546]]
and as if such gain were effectively connected with such trade or
business. F's disposition activity shall be treated as a separate QBU
with a dollar functional currency because such activity produced income
that is treated as effectively connected with a trade or business within
the United States. Therefore, F must compute its gain from the
disposition by giving the United States real property interest an
historic dollar basis.
[T.D. 8263, 54 FR 38653, Sept. 20, 1989, as amended by T.D. 8556, 59 FR
37672, July 25, 1994; T.D. 8765, 63 FR 10774, Mar. 5, 1998; 63 FR 15760,
Apr. 1, 1998; T.D. 8776, 63 FR 40368, July 29, 1998; T.D. 8927, 66 FR
2216, Jan. 11, 2001]
Sec. 1.985-2 Election to use the United States dollar as the functional
currency of a QBU.
(a) Background and scope--(1) In general. This section permits an
eligible QBU to elect to use the dollar as its functional currency for
taxable years beginning on or before August 24, 1994. An election to use
a dollar functional currency is not permitted for a QBU other than an
eligible QBU. Paragraph (b) of this section defines an eligible QBU.
Paragraph (c) of this section describes the time and manner for making
the dollar election and paragraph (d) of this section describes the
effect of making the election. For the definition of a QBU, see section
989(a). See Sec. 1.985-1(b)(2)(ii) for rules requiring a QBU to use the
dollar as its functional currency in taxable years beginning after
August 24, 1994.
(2) Exception. Pursuant to Sec. 1.985-1(b)(2)(ii)(B)(2), the rules
of paragraph (c)(3) of this section shall apply with respect to the
procedure required to be followed by a noncontrolled section 902
corporation as defined in section 904(d)(2)(E) to elect the dollar as
its (or its QBU branch's) functional currency and the application of
Sec. 1.985-3.
(b) Eligible QBU--(1) In general. The term ``eligible QBU'' means a
QBU that could have used a hyperinflationary currency as its functional
currency absent the dollar election. See Sec. 1.985-1 for how a QBU
determines its functional currency absent the dollar election.
(2) Hyperinflationary currency. See Sec. 1.985-1(b)(2)(ii)(D) for
the definition of hyperinflationary currency.
(c) Time and manner for dollar election--(1) QBUs that are branches
of United States persons--(i) Rule. If an eligible QBU is a branch of a
United States person, the dollar election shall be made by attaching a
completed Form 8819 to the United States person's timely filed (taking
extensions into account) tax return for the first taxable year for which
the election is to be effective.
(ii) Procedure prior to the issuance of Form 8819. In the absence of
Form 8819, the election shall be made in accordance with Sec. 1.985-
2T(c)(1). Failure to file an amended return within the time period
prescribed in Sec. 1.985-2T(c)(1) shall not invalidate the dollar
election if it is established to the satisfaction of the district
director that reasonable cause existed for such failure. A subsequent
election for 1988 will not prejudice the taxpayer with respect to such
reasonable cause determination. Nevertheless, each United States person
making an election under the Sec. 1.985-2T(c)(1) must file a Form 8819
in the time and manner provided in the Form's instructions.
(2) Eligible QBUs that are controlled foreign corporations or
branches of controlled foreign corporations--(i) Rule. If an eligible
QBU is a controlled foreign corporation (as described in section 957),
or a branch of a controlled foreign corporation, the election may be
made either by the foreign corporation or by the controlling United
States shareholders on behalf of the foreign corporation by--
(A) Filing a completed Form 8819 in the time and manner provided in
the Form's instructions, and
(B) Providing the written notice required by paragraph (c)(2)(ii) of
this section at the time and in the manner prescribed therein.
The term controlling United States shareholders means those United
States shareholders (as defined in section 951(b)) who, in the
aggregate, own (within the meaning of section 958(a)) greater than 50
percent of the total combined voting power of all classes of stock of
the foreign corporation entitled to vote. If the foreign corporation is
a controlled foreign corporation (as described in section 957) but the
United States shareholders do not, in the aggregate, own the requisite
voting power, the term ``controlling United States shareholders'' means
all the United States shareholders (as defined
[[Page 547]]
in section 951(b)) who own (within the meaning of section 958(a)) stock
of the controlled foreign corporation.
(ii) Notice. Prior to filing Form 8819, the controlling United
States shareholders (or the foreign corporation, if the dollar election
is made by the corporation) shall provide written notice that the dollar
election will be made to all United States persons known to be
shareholders who own (within the meaning of section 958(a)) stock of the
foreign corporation. Such notice shall also include all information
required in Form 8819.
(iii) Reasonable cause exception. Failure of the controlling United
States shareholders (or the foreign corporation, if the dollar election
is made by the corporation) to timely file Form 8819 or provide written
notice to a United States person required to be notified by paragraph
(c)(2)(ii) of this section shall not invalidate the dollar election, if
it is established to the satisfaction of the district director that
reasonable cause existed for such failure.
(iv) Procedure prior to the issuance of Form 8819. In the absence of
Form 8819, an eligible QBU described in paragraph (c)(2)(i) of this
section shall make the dollar election in accordance with Sec. 1.985-
2T(c)(2). Nevertheless, the person or persons that made such election
must file a Form 8819 in the time and manner provided in the Form's
instructions.
(3) Eligible QBUs that are noncontrolled foreign corporations or
branches of noncontrolled foreign corporations--(i) Rule. If an eligible
QBU is a noncontrolled foreign corporation (a foreign corporation not
described in section 957), or a branch of a noncontrolled foreign
corporation, the dollar election must be made by the corporation or the
majority domestic corporate shareholders on behalf of the corporation by
applying the rules provided in paragraph (c)(2)(i)(A) and (B), (ii),
(iii), and (iv) of this section substituting ``majority domestic
corporate shareholders'' for ``controlling United States shareholders''
wherever it appears therein. The term ``majority domestic corporate
shareholders'' means those domestic corporate shareholders (as described
in section 902(a)) who, in the aggregate, own (within the meaning of
section 958(a)) greater than 50 percent of the total combined voting
stock of all classes of stock of the noncontrolled foreign corporation
entitled to vote that is owned (within the meaning of section 958(a)) by
all the domestic corporate shareholders.
(ii) Procedure prior to the issuance of Form 8819. In the absence of
Form 8819, an eligible QBU described in paragraph (c)(3)(i) of this
section shall make the dollar election in accordance with Sec. 1.985-
2T(c)(3). Nevertheless, the person or persons that made such election
must file a Form 8819 in the time and manner provided in the Form's
instructions.
(4) Others. Any other person making a dollar election under this
section shall elect by filing Form 8819 and fulfilling any other notice
requirements that may be required by the Commissioner.
(d) Effect of dollar election--(1) General rule. If a dollar
election is made (or considered made under paragraph (d)(3) of this
section) by or on behalf of an eligible QBU, the QBU shall be deemed to
have the dollar as its functional currency. Each United States person
that owns (within the meaning of section 958(a)) stock of a foreign
corporation which has the dollar as its functional currency under Sec.
1.985-2 must make all of its federal income tax calculations with
respect to the foreign corporation using the dollar as the corporation's
functional currency (regardless of when ownership was acquired or
whether the United States person received the written notice required by
paragraph (c)(2)(i)(B) of this section).
(2) Computation--(i) In general. Except as provided in paragraph
(d)(2)(ii) of this section, any eligible QBU that pursuant to this Sec.
1.985-2 has a dollar functional currency must compute income or loss or
earnings and profits (or deficit in earnings and profits) in dollars
using the dollar approximate separate transactions method described in
Sec. 1.985-3.
(ii) Alternative method. An eligible QBU that has a dollar
functional currency pursuant to this Sec. 1.985-2 may use a method
other than the dollar approximate separate transactions method described
in Sec. 1.985-3 only if the QBU
[[Page 548]]
demonstrates to the satisfaction of the Commissioner that it can
properly employ such method. Generally, the QBU must show that it could
compute foreign currency gain or loss under the principles of section
988 with respect to each of its section 988 transactions. If
subsequently the QBU can no longer demonstrate to the satisfaction of
the district director that it can properly employ such an alternative
method, then the QBU will be deemed to have changed its method of
accounting to the dollar approximate separate transactions method
described in Sec. 1.985-3. This change in accounting will be treated as
having been made with the consent of the Commissioner. No adjustments
under either Sec. 1.985-5T (or any succeeding final regulation) or
section 481(a) shall be required solely because of the change. Rather
the QBU shall begin accounting for its operations under Sec. 1.985-3
based on its dollar books and records as of the time of the change.
(3) Conformity--(i) General rule. If a dollar election is made under
this Sec. 1.985-2 for an eligible QBU (``electing QBU''), then the
dollar shall be the functional currency of any related person
(regardless of when such person became related to the electing QBU) that
is an eligible QBU, or any branch of any such related person that is an
eligible QBU. For purposes of the preceding sentence, the term ``related
person'' means any person with a relationship defined in section 267 (b)
to the electing QBU (or to the United States or foreign person of which
the electing QBU is a part). 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 with the application of section 1563(e)(1), and
stock owned with the application of section 267(c).
(ii) Branches of United States and foreign persons. If a dollar
election is made for a QBU branch of any person, each eligible QBU
branch of such person shall have the dollar as its functional currency.
(4) Required adjustments. If an eligible QBU's functional currency
changes due to a dollar election, or due to the conformity requirements
of paragraph (d)(3) of this section, such change shall be deemed for
purposes of Sec. 1.9B5-4 to be consented to by the Commissioner. No
adjustments under section 481(a) shall be required solely because of the
change. However, the QBU must make those adjustments required by Sec.
1.985-5T (or any succeeding final regulation).
(5) Taxable year conformity required. Generally, the adjustments
required by paragraph (d)(4) of this section shall be made for a related
person's taxable year--
(i) That includes the date in which the electing QBU made the dollar
election if the person was related to such electing QBU at any time
during the QBU's taxable year that includes such date, or
(ii) During which the person first becomes related to any electing
QBU, in all other cases.
For purposes of this paragraph (d)(5), the date in which the electing
QBU makes the dollar election shall be the last day of the electing
QBU's taxable year. The district director may permit the related party
to make such adjustments beginning one taxable year later if, in the
district director's sole judgment, reasonable cause exists for the
related party not being able to make the required adjustments for the
earlier year.
(6) Availability of election. A dollar election may be made by or on
behalf of a QBU, or considered made under the conformity rule of
paragraph (d)(3), in any year in which the QBU is an eligible QBU. If a
dollar election is not made by or on behalf of a QBU for its first
taxable year beginning after December 31, 1986 in which it is an
eligible QBU, then any dollar election made by or on behalf of the QBU,
or considered made under the conformity rules of paragraph (d)(3) of
this section, that results in a change in the QBU's functional currency
shall be treated as having been made with the consent of the
Commissioner. In such a case, however, the taxpayer must make those
adjustments required by Sec. 1.985-5T (or any succeeding final
regulation).
(7) Effect of changed circumstances. Regardless of any change in
circumstances (e.g., a currency ceases to qualify as hyperinflationary),
a QBU whose functional currency is the dollar
[[Page 549]]
under this section may change its functional currency only if the QBU
complies with Sec. 1.985-4.
(8) Examples. The provisions of this section are illustrated by the
following examples.
Example 1. X is a calendar year domestic corporation that in 1987
establishes a branch, A, in Country Z. A's functional currency under
sections 985(b)(1) and (2) and Sec. 1.985-1 is the ``h'', the currency
of Country Z. The cumulative inflation in Country Z exceeds 100 percent
for the thirty-six months prior to January 1987, as measured by the
consumer price index of Country Z listed in the monthly issues of the
``International Financial Statistics''. Accordingly, A is an eligible
QBU in 1987 because the h is a hyperinflationary currency. Thus, X may
elect the dollar as the functional currency of A for 1987.
Example 2. The facts are the same as in Example (1). X does not
elect the dollar as the functional currency of A for 1987. Rather, X
elects the dollar as the functional currency of A for l991, a year A is
an eligible QBU. The election constitutes a change in A's functional
currency that is made with the consent of the Commissioner. However, A
must make the adjustments required under Sec. 1.985-5T (or any
succeeding final regulation).
Example 3. X is a domestic corporation that establishes A, an
eligible QBU branch. X is wholly owned by domestic corporation Y. Y has
an eligible QBU branch, B. Both X and Y are calendar year taxpayers. X
makes a dollar election for A in 1987. Thus, A is an electing QBU. X and
Y are related persons as defined in section 267(b) (i.e., Y has a
relationship under section 267(b)(3) to X, the corporation of which A is
a part). Therefore, the dollar election by X for A in 1987 results in B,
the eligible QBU branch of Y, also having the dollar as its functional
currency for 1987.
Example 4. The facts are the same as in Example 3, except that Y
does not have an eligible QBU branch but owns all the stock of C, a
calendar year controlled foreign corporation, which is not itself an
eligible QBU but which has an eligible QBU branch, D. X and C are
related persons as defined in section 267(b) (i.e., C has a relationship
under section 267(b)(3) to X, the corporation of which A is a part).
Therefore, the dollar election by X for A in 1987 results in D, the
eligible QBU branch of C, also having the dollar as its functional
currency for 1987.
Example 5. X, whose taxable year ends September 30, is an eligible
QBU that does not use the dollar as its functional currency. X is
wholly-owned by domestic corporation W. On January 1, 1989, X acquires
all the stock of Y, an unrelated eligible QBU that made the dollar
election under Sec. 1.985-2. Y is a calendar year taxpayer. After the
stock purchase, X and Y are related persons as defined in section
267(b). Under Sec. Sec. 1.985-2(d)(3) and (5), the dollar shall be the
functional currency of X, any person related to X, and any branch of
such related person that is an eligible QBU beginning with the taxable
year that includes December 31, 1989. Thus, X must change to the dollar
for its taxable year beginning October 1, 1988. However, the district
director may allow X to change to the dollar for its taxable year
beginning October 1, 1989, provided reasonable cause exists. Those QBUs
changing to the dollar as their functional currency as the result of the
conformity requirements must make the adjustments required under Sec.
1.985-5T (or any succeeding final regulation).
Example 6. The facts are the same as in Example 5, except that
before X purchased the Y stock, X made the dollar election under Sec.
1.985-2 but Y did not use the dollar as its functional currency. Under
Sec. Sec. 1.985-2(d)(3) and (5) the dollar shall be the functional
currency of Y, any person related to Y, and any branch of such related
person that is an eligible QBU beginning with the taxable year that
includes September 30, 1989. Thus, Y must change to the dollar for its
taxable year beginning January 1, 1989. However the district director
may allow Y to change to the dollar for its taxable year beginning
January 1, 1990, provided reasonable cause exists. Those QBUs changing
to the dollar as their functional currency as the result of the
conformity requirements must make the adjustments required under Sec.
1.985-5T (or any succeeding final regulation).
[T.D. 8263, 54 FR 38656, Sept. 20, 1989, as amended by T.D. 8556, 59 FR
37673, July 25, 1994]
Sec. 1.985-3 United States dollar approximate separate transactions method.
(a) Scope and effective date--(1) Scope. This section describes the
United States dollar (dollar) approximate separate transactions method
of accounting (DASTM). For all purposes of subtitle A, this method of
accounting must be used to compute the gross income, taxable income or
loss, or earnings and profits (or deficit in earnings and profits) of a
QBU (as defined in section 989(a)) that has the dollar as its functional
currency pursuant to Sec. 1.985-1(b)(2).
(2) Effective date--(i) In general. This section is effective for
taxable years beginning after August 24, 1994.
(ii) DASTM prior-year election. A taxpayer may elect to apply this
section to any open taxable year beginning after December 31, 1986
(whether or not
[[Page 550]]
DASTM has been previously elected for some or all of those years). In
order to make this election, the taxpayer must apply Sec. 1.985-3 to
that year and all subsequent years. In addition, each person that is
related (within the meaning of Sec. 1.985-3(e)(2)(vi)) to the taxpayer
on the last day of any taxable year for which the election is effective
and that would have been eligible to elect DASTM must also apply these
rules to that year and all subsequent years. A taxpayer that has not
previously elected to apply DASTM to its prior taxable years may make
the DASTM election for the pertinent years by filing amended returns and
complying with the applicable election procedures of Sec. 1.985-2. Form
8819 shall be attached to the return for the first year for which the
election is to be effective. A taxpayer that has elected DASTM for prior
taxable years and applied the rules under Sec. 1.985-3 (as contained in
the April 1, 1994 edition of 26 CFR part 1 (1.908 to 1.1000)) may amend
its returns to apply the rules of this Sec. 1.985-3. In either case,
the DASTM election for prior taxable years shall be deemed to be made
with the consent of the Commissioner.
(b) Statement of method. Under DASTM, income or loss or earnings and
profits (or a deficit in earnings and profits) of a QBU for its taxable
year shall be determined in dollars by--
(1) Preparing an income or loss statement from the QBU's books and
records (within the meaning of Sec. 1.989(a)-1(d)) as recorded in the
QBU's hyperinflationary currency (as defined in Sec. 1.985-
1(b)(2)(ii)(D));
(2) Making the adjustments necessary to conform such statement to
United States generally accepted accounting principles and tax
accounting principles (including reversing monetary correction
adjustments required by local accounting principles);
(3) Translating the amounts of hyperinflationary currency as shown
on such adjusted statement into dollars in accordance with paragraph (c)
of this section; and
(4) Adjusting the resulting dollar income or loss or earnings and
profits (or deficit in earnings and profits) and, where necessary,
particular items of gross income, deductible expense or other amounts,
in accordance with paragraph (e) of this section to reflect the amount
of DASTM gain or loss as determined under paragraph (d) of this section.
(c) Translation into United States dollars--(1) In general. Except
as otherwise provided in this paragraph (c), the amounts shown on the
income or loss statement, as adjusted under paragraph (b)(2) of this
section, shall be translated into dollars at the exchange rate (as
defined in paragraph (c)(6) of this section) for the translation period
(as defined in paragraph (c)(7) of this section) to which they relate.
However, if the QBU previously changed its functional currency to the
dollar, and the rules of Sec. 1.985-5 (or, if applicable, Sec. 1.985-
5T, as contained in the April 1, 1993 edition of 26 CFR part 1 (1.908 to
1.1000)) applied in translating its balance sheet amounts into dollars,
then the spot exchange rate applied under those rules shall be used to
translate any amount that would otherwise be translated at a rate
determined by reference to a translation period prior to the change in
functional currency. For example, depreciation with respect to an asset
acquired while the QBU had a nondollar functional currency shall be
translated into dollars at the spot rate on the last day of the taxable
year before the year of change to a dollar functional currency, rather
than at the rate for the period in which the asset was acquired.
(2) Cost of goods sold. The dollar value of cost of goods sold shall
equal the sum of the dollar values of beginning inventory and purchases
less the dollar value of closing inventory as these amounts are
determined under paragraph (c)(3) of this section.
(3) Beginning inventory, purchases, and closing inventory--(i)
Beginning inventory. Amounts representing beginning inventory shall be
translated so as to obtain the same amount of dollars which represented
such items in the closing inventory balance for the preceding taxable
year.
(ii) Purchases. Amounts representing items purchased or otherwise
first included in inventory during the taxable year shall be translated
at the exchange rate for the translation period
[[Page 551]]
in which the cost of such items was incurred.
(iii) Closing inventory--(A) In general. Amounts representing items
included in the closing inventory balance shall be translated at the
exchange rate for the translation period in which the cost of such items
was incurred. However, if amounts representing items included in the
closing inventory balance are either valued at market or written down to
market value, they shall be translated at the exchange rate existing on
the last day of the taxable year. For purposes of determining lower of
cost or market, items of inventory included in the closing inventory
balance shall be translated into dollars at the exchange rate for the
translation period in which the cost of such items was incurred and
compared with market as determined in the QBU's hyperinflationary
currency translated into dollars at the exchange rate existing on the
last day of the taxable year.
(B) Determination of translation period. The method used to
determine the translation period of amounts representing items of
closing inventory for purposes of paragraph (c)(3)(iii)(A) of this
section may be based upon reasonable approximations and averages,
including rates of turnover, provided that the method is used
consistently from year to year.
(4) Depreciation, depletion, and amortization. Amounts representing
allowances for depreciation, depletion, or amortization shall be
translated at the exchange rate for the translation period in which the
cost of the underlying asset was incurred, except as provided in
paragraph (c)(1) of this section.
(5) Prepaid expenses or income. Amounts representing expense or
income paid or received in a prior taxable year shall be translated at
the exchange rate for the translation period during which they were paid
or received.
(6) Exchange rate. The exchange rate for a translation period may be
determined under any reasonable method, provided that the method is
consistently applied to all translation periods and conforms to the
taxpayer's method of financial accounting. Reasonable methods include
the average of beginning and ending exchange rates for the translation
period and the spot rate on the last day of the translation period. Once
chosen, a method for determining an exchange rate can be changed only
with the consent of the district director.
(7) Translation period--(i) In general. Except as provided in
paragraphs (c)(3)(iii)(B) and (c)(7)(ii) of this section, a translation
period shall be each month within a QBU's taxable year.
(ii) Exception. A taxpayer may divide its taxable year into
translation periods of equal length (with not more than one short period
annually) that are less than one month. Once such a translation period
is established, it may not be changed without the consent of the
district director.
(8) Dollar transactions--(i) In general. Except as provided in
paragraph (c)(8)(ii) of this section, no DASTM gain or loss is realized
with respect to dollar transactions since the dollar is the functional
currency of the QBU. Thus, the amount of any payment or receipt of
dollars shall be reflected in the income or loss statement by the amount
of such dollars. Also, the income or loss attributable to any
transaction in which the amount that a QBU is entitled to receive (or is
required to pay) by reason of such transaction is denominated in terms
of the dollar, or is determined by reference to the value of the dollar,
must be computed transaction by transaction. For example, if a foreign
corporation lends 20 LC when 20 LC=$20 and is entitled to receive the LC
equivalent of $20 at maturity plus a market rate of interest in dollars
(or its LC equivalent), the loan is a dollar transaction. Similarly,
this paragraph applies to any transaction that is determined to be a
dollar transaction under section 988.
(ii) Non-dollar functional currency. If pursuant to Sec. 1.985-
1(b)(2)(ii)(B)(1), a QBU is required to use a functional currency other
than the dollar, then that currency shall be substituted for the dollar
in applying paragraph (c)(8)(i) of this section.
(9) Third currency transactions.--A taxpayer may use any reasonable
method of accounting for transactions described in sections 988(c)(1)(B)
and
[[Page 552]]
(C) that are denominated in, or determined by reference to, a currency
other than the QBU's hyperinflationary currency or the dollar (third
currency transactions) so long as such method is consistent with its
method of financial accounting.
(10) Examples. The provisions of this paragraph (c) are illustrated
by the following examples:
Example 1. S is an accrual basis QBU that is required to use the
dollar as its functional currency for its first taxable year beginning
in 1994. S's hyperinflationary currency is the ``h.'' During 1994, S
accrues 100 dollars attributable to dollar-denominated sales. Because
this is a dollar transaction under paragraph (c)(8) of this section, S's
income or loss for 1994 shall reflect the 100 dollars (not the
hyperinflationary value of such dollars when accrued).
Example 2. (i) S is an accrual basis QBU that is required to use the
dollar as its functional currency for its first taxable year beginning
in 1994. S's hyperinflationary currency is the ``h.'' During 1994, S's
sales amounted to 240,000,000h, its currently deductible expenses were
26,000,000h, and its total inventory purchases amounted to 100,000,000h.
During January and February of 1994, S purchased depreciable assets for
80,000,000h and was allowed depreciation of 4,000,000h. At the end of
1994, S's closing inventory was 23,000,000h. No election to use a
translation period other than the month is made, S had no transactions
described in paragraph (c)(8) or (c)(9) of this section, and S's closing
inventory was computed on the first-in, first-out inventory method. S's
adjusted income or loss statement for 1994 is translated into dollars as
follows:
----------------------------------------------------------------------------------------------------------------
Hyperinflationary Exchange United States
currency rate dollars
----------------------------------------------------------------------------------------------------------------
Sales
(Jan.-Feb.)..................................................... 10,000,000h \1\ 20:1 $500,000
(Mar.-Apr.)..................................................... 20,000,000 21:1 952,381
(May.-June.).................................................... 50,000,000 22:1 2,272,727
(July).......................................................... 50,000,000 23:1 2,173,913
(August)........................................................ 20,000,000 26:1 769,231
(Sept.)......................................................... 20,000,000 28:1 714,286
(Oct.).......................................................... 20,000,000 29:1 689,655
(Nov.).......................................................... 20,000,000 30:1 666,667
(Dec.).......................................................... 30,000,000 31:1 967,742
------------------- ----------------
Total..................................................... 240,000,000h .......... 9,706,602
Cost of Goods Sold
Opening Inventory Purchases: 0 .......... 0
(Jan.-Feb.)................................................. 15,000,000h 20:1 750,000
(Mar.-Apr.)................................................. 10,000,000 21:1 476,190
(May-June).................................................. 30,000,000 22:1 1,363,636
(July)...................................................... 20,000,000 23:1 869,565
(August).................................................... 10,000,000 26:1 384,615
(Sept.)..................................................... 5,000,000 28:1 178,571
(Oct.)...................................................... 5,000,000 29:1 172,414
(Nov.)...................................................... 2,500,000 30:1 83,333
(Dec.)...................................................... 2,500,000 31:1 80,645
Less Closing Inventory.......................................... (23,000,000) (\2\) (822,655)
------------------- ----------------
77,000,000h .......... 3,536,314
----------------------------------------------------------------------------------------------------------------
\1\ Where multiple months are indicated, the exchange rate applies for all months.
\2\ See paragraph (ii) of this Example.
(ii) Since S uses the first-in, first-out inventory method, the
closing inventory is assumed to consist of purchases made during the
most recent translation period as follows:
----------------------------------------------------------------------------------------------------------------
Hyperinflationary United States
currency Exchange rate dollars
----------------------------------------------------------------------------------------------------------------
December..................................................... 2,500,000h 31:1 $ 80,645
November..................................................... 2,500,000 30:1 83,333
October...................................................... 5,000,000 29:1 172,414
September.................................................... 5,000,000 28:1 178,571
August....................................................... 8,000,000 26:1 307,692
------------------- ---------------
Total.................................................. 23,000,000h .............. 822,655
=================== ===============
[[Page 553]]
Non-Capitalized Expenses
(Jan.-Feb.).................................................. 4,000,000h 20:1 200,000
(Mar.-Apr.).................................................. 2,500,000 21:1 119,048
(May-June)................................................... 2,500,000 22:1 113,636
(July)....................................................... 2,000,000 23:1 86,957
(August)..................................................... 3,000,000 26:1 115,385
(Sept.)...................................................... 3,000,000 28:1 107,143
(Oct.)....................................................... 2,000,000 29:1 68,966
(Nov.)....................................................... 3,000,000 30:1 100,000
(Dec.)....................................................... 4,000,000 31:1 129,032
------------------- ---------------
Total.................................................. 26,000,000h .............. 1,040,167
Depreciation................................................. 4,000,000h 20:1 200,000
Total Cost & Expenses.................................. 107,000,000h .............. 4,776,481
------------------- ---------------
Operating Profit............................................. 133,000,000h .............. 4,930,121
=================== ===============
----------------------------------------------------------------------------------------------------------------
(d) Computation of DASTM gain or loss--(1) Rule. DASTM gain or loss
of a QBU equals--
(i) The net worth of the QBU (as determined under paragraph (d)(2)
of this section) at the end of the taxable year minus the net worth of
the QBU at the end of the preceding taxable year; plus
(ii) The dollar amount of the items described in paragraph (d)(3) of
this section and minus the dollar amount of the items described in
paragraph (d)(4) of this section; minus
(iii) The amount of dollar income or earnings and profits (or plus
the amount of any dollar loss or deficit in earnings and profits) as
determined for the taxable year pursuant to paragraphs (b)(1) through
(b)(3) of this section.
(2) Net worth. Net worth of a QBU at the end of any taxable year
equals the aggregate dollar amount representing assets on the QBU's
balance sheet at the end of the taxable year less the aggregate dollar
amount representing liabilities on the balance sheet. Notwithstanding
any other provision in this paragraph (d)(2), the district director may
adjust the amount of any asset or liability if a purpose for acquiring
(or disposing of) the asset or incurring (or discharging) the liability
is to manipulate the composition of the balance sheet for any period
during the taxable year in order to avoid tax. The taxpayer shall
determine net worth by--
(i) Preparing a balance sheet as of the end of the taxable year from
the QBU's books and records (within the meaning of Sec. 1.989(a)-1(d))
as recorded in the QBU's hyperinflationary currency;
(ii) Making adjustments necessary to conform such balance sheet to
United States generally accepted accounting principles and tax
accounting principles (including reversing monetary correction
adjustments required by local accounting principles); and
(iii) Translating the asset and liability amounts shown on the
balance sheet into United States dollars in accordance with paragraph
(d)(5) of this section.
(3) Positive adjustments. The items described in this paragraph
(d)(3) are dividend distributions for the taxable year and any items
that decrease net worth for the taxable year but that generally do not
affect income or loss or earnings and profits (or a deficit in earnings
and profits). Such items include a transfer to the home office of a QBU
branch and a return of capital. Except as otherwise provided by ruling
or administrative pronouncement, the amount of a transfer to the home
office of a QBU branch, a dividend, or a distribution that is a return
of capital shall be translated into dollars at the exchange rate on the
date the amount is paid.
(4) Negative adjustments. The items described in this paragraph
(d)(4) are items that increase net worth for the taxable year but that
generally do not affect income or loss or earnings and profits (or a
deficit in earnings and profits). Such items include a capital
contribution or a transfer from a home
[[Page 554]]
office to a QBU branch. Except as otherwise provided by ruling or
administrative pronouncement, if the contribution or transfer is not in
dollars, the amount of a capital contribution or transfer shall be
translated into dollars at the exchange rate on the date made.
(5) Translation of balance sheet. Asset and liability amounts shown
on the balance sheet in hyperinflationary currency (adjusted pursuant to
paragraph (d)(2)(ii) of this section) shall be translated into dollars
as provided in this paragraph (d)(5). However, if the QBU previously
changed its functional currency to the dollar and the rules of Sec.
1.985-5 (or, if applicable, Sec. 1.985-5T, as contained in the April 1,
1993 edition of 26 CFR part 1 (1.908 to 1.1000)) applied in translating
its balance sheet amounts into dollars, then the spot exchange rate
applied under those rules shall be used to translate any amount that
would otherwise be translated at a rate determined by reference to a
translation period prior to the change in functional currency. For
example, the basis of real property acquired while the QBU had a
nondollar functional currency shall be translated into dollars at the
spot rate on the last day of the taxable year before the year of change
to a dollar functional currency, rather than at the rate for the period
in which the cost was incurred.
(i) Closing inventory. Amounts representing items of inventory
included in the closing inventory balance shall be translated in
accordance with paragraph (c)(3)(iii) of this section.
(ii) Bad debt reserves. Amounts representing bad debt reserves shall
be translated at the exchange rate for the last translation period for
the taxable year.
(iii) Prepaid income or expense. Amounts representing expenses or
income paid or received in a prior taxable year shall be translated in
accordance with paragraph (c)(5) of this section.
(iv) Hyperinflationary currency. Amounts of the hyperinflationary
currency and hyperinflationary demand deposit balances shall be
translated at the exchange rate for the last translation period of the
taxable year.
(v) Certain assets--(A) In general. Amounts representing plant, real
property, equipment, goodwill, and patents and other intangibles shall
be translated at the exchange rate for the translation period in which
the cost of the asset was incurred.
(B) Adjustment to certain assets. Amounts representing depreciation,
depletion, and amortization reserves shall be translated in accordance
with paragraph (c)(4) of this section.
(vi) Hyperinflationary debt obligations. Except as provided in
paragraph (d)(5)(vii) of this section, amounts representing a
hyperinflationary debt obligation (including accounts receivable and
payable) shall be translated at the exchange rate for the last
translation period for the taxable year.
(vii) Accrued foreign income taxes. Amounts representing an accrued
but unpaid foreign income tax shall be translated at the exchange rate
on the last day of the last translation period of the taxable year of
accrual.
(viii) Certain hyperinflationary financial instruments. Amounts
representing any item described in section 988(c)(1)(B)(iii) (relating
to forward contracts, futures contracts, options, or similar financial
instruments) denominated in or determined by reference to the
hyperinflationary currency shall be translated at the exchange rate for
the last translation period for the taxable year.
(ix) Other assets and liabilities. Amounts representing assets and
liabilities, other than those described in paragraphs (d)(5)(i) through
(viii) of this section, shall be translated at the exchange rate for the
translation period in which the cost of the asset or the amount of the
liability was incurred.
(6) Dollar transactions. Notwithstanding any other provisions of
this paragraph (d), where the amount representing an item shown on the
balance sheet reflects a dollar transaction (described in paragraph
(c)(8) of this section), the transaction shall be taken into account in
accordance with that paragraph.
(7) Third currency transactions. A taxpayer may use any reasonable
method of accounting for transactions described in section 988(c)(1)(B)
and (C) that are denominated in, or determined by reference to, a
currency other than
[[Page 555]]
the QBU's hyperinflationary currency or the dollar (third currency
transactions), so long as such method is consistent with its method of
financial accounting.
(8) Character. The amount of DASTM gain or loss determined under
paragraph (d)(1) of this section shall be ordinary income or loss.
(9) Example. The provisions of this paragraph (d) are illustrated by
the following example:
Example. (i) S, an accrual method calendar year foreign corporation,
uses DASTM. S's hyperinflationary currency is the ``h.'' S's net worth
at December 31, 1993 was $3,246,495. For 1994, S's operating profit is
81,340,000h, or $2,038,200. S made a 5,000,000h distribution in April
and again in December of 1994. S's translation period is the month. None
of S's assets or liabilities reflect a dollar or third currency
transaction described in paragraph (c)(8) or (c)(9) of this section,
respectively. The exchange rate for each month in 1994 is as follows:
January 32h:$1
Feb.-Mar. 33:1
April-May 34:1
June 35:1
July 36:1
Aug.-Sept. 37:1
Oct. 38:1
Nov. 39:1
Dec. 40:1
(ii) At the end of 1994, S's assets and liabilities, as adjusted and
translated pursuant to paragraphs (d)(2) and (d)(5) of this section, are
as follows:
----------------------------------------------------------------------------------------------------------------
Hyperin-
flationary Exchange rate U.S. dollar
----------------------------------------------------------------------------------------------------------------
Hyperinflationary cash on hand.................................. 40,000h 40:1 $1,000
Checking account.............................................. 400,000 40:1 10,000
Accounts Receivable- 30 Day Accounts............................ 20,000,000 \1\ 40:1 500,000
60 Day Accounts............................................. 25,000,000 40:1 625,000
Inventory....................................................... 65,000,000 (\2\) 2,500,000
Fixed assets--Property.......................................... 90,000,000 27:1 3,333,333
Plant....................................................... 190,000,000 (\3\) 6,785,714
Accumulated Depreciation................................ (600,000) (\3\) (21,428)
Equipment................................................... 10,000,000 (\4\) 340,000
Accumulated Depreciation................................ (400,000) (\4\) (13,333)
Common Stock--Stock A........................................... 500,000 34:1 14,706
Stock B................................................... 400,000 26:1 15,385
Preferred Stock................................................. 1,000,000 32:1 31,250
C.D.s........................................................... 5,000,000 40:1 125,000
Total Assets.............................................. 406,340,000 .............. 14,246,627
Accounts Payable Long-term liabilities: 35,000,000 40:1 875,000
Liability A................................................. 150,000,000 40:1 3,750,000
Liability B................................................. 80,000,000 40:1 2,000,000
Liability C................................................. 30,000,000 40:1 750,000
---------------- ---------------
Total Liabilities......................................... 295,000,000h .............. $7,375,000
----------------------------------------------------------------------------------------------------------------
\1\ S ages its accounts receivable and groups them into two categories--those outstanding for 30 days and those
outstanding for 60 days.
\2\ Translated the same as closing inventory under paragraph (c)(3)(iii).
\3\ The cost of S's plant was incurred in several translation periods. Therefore, the dollar cost and dollar
depreciation reflect several translation rates.
\4\ S has a variety of equipment. Therefore, S's dollar basis represents the sum of the hyperinflationary cost
of each, translated according to the exchange rate for the translation period incurred.
(iii) The DASTM gain of S for 1994 is computed as follows:
Net worth--1994 .............. $6,871,627
Less--Net worth--1993 .............. $3,246,495
Plus--1994 Dividends:
April $149,254
December \1\ 126,582 275,836
Less Operating Profit-- .............. 2,038,200
1994
DASTM Gain .............. $1,862,768
===============
\1\ The exchange rates on the date of the April and December dividends
were 33.5h:$1 and 39.5h:$1, respectively.
[[Page 556]]
(iv) Thus, total profit = $2,038,200 + $1,862,768 = $3,900,968
(e) Effect of DASTM gain or loss on gross income, taxable income, or
earnings and profits--(1) In general. For all purposes of subtitle A,
the amount of DASTM gain or loss of a QBU determined under paragraph (d)
of this section is taken into account by the QBU for purposes of
determining the amount of its gross income, taxable income or loss,
earnings and profits (or deficit in earnings and profits), and, where
necessary, particular items of income, expense or other amounts. DASTM
gain or loss is allocated under one of two methods. Certain small QBUs
may elect the small QBU DASTM allocation described in paragraph (e)(2)
of this section. All other QBUs must use the 9-step procedure described
in paragraph (e)(3) of this section.
(2) Small QBU DASTM allocation--(i) Election threshold. A taxpayer
may elect to use the small QBU DASTM allocation described in paragraph
(e)(2)(iv) of this section with respect to a QBU that has an adjusted
basis in assets (translated as provided in paragraph (d)(5) of this
section) of $10 million or less at the end of any taxable year. In
calculating the $10 million threshold, a QBU shall be treated as owning
all of the assets of each related QBU (as defined in paragraph
(e)(2)(vi) of this section) having its residence (as defined in section
988(a)(3)(B)) in the QBU's country of residence (related same- country
QBU). For this purpose, appropriate adjustment shall be made to
eliminate the double counting of assets created in transactions between
related QBUs resident in the same country. For example, assume QBU-1,
resident in country X, sells inventory to related QBU-2, also resident
in country X, in exchange for an account receivable. For purposes of
determining the assets of QBU-1 under this paragraph (e)(2)(i), the
taxpayer shall take into account either the inventory shown on the books
of QBU-2 or QBU-1's receivable from QBU-2 (but not both).
(ii) Consent to election. The election of the small QBU DASTM
allocation or subsequent application of the rules of paragraph (e)(3) of
this section due to an increase in the adjusted basis of the QBU's
assets shall be deemed to have been made with the consent of the
Commissioner. Once the election under paragraph (e)(2)(iii) of this
section is made, it shall apply for all years in which the adjusted
basis of the assets of the QBU (and any related same-country QBU) is $10
million or less, unless revoked with the Commissioner's consent. If the
adjusted basis of the assets of the QBU (and any related same- country
QBU) exceeds $10 million at the end of any taxable year, the rules of
paragraph (e)(3) of this section shall apply to that QBU (and any
related same-country QBU) for such year and each subsequent year unless
such QBU again qualifies, and applies for and obtains the Commissioner's
consent, to use the small QBU DASTM allocation. However, if a QBU
acquires assets with a principal purpose of avoiding the application of
paragraph (e)(2)(iv) of this section, the Commissioner may disregard the
acquisition of such assets.
(iii) Manner of making election--(A) QBUs that are branches of
United States persons. For the first year in which this election is
effective, in the case of a QBU branch of a United States person, a
statement shall be attached to the United States person's timely filed
Federal income tax return (taking extensions into account). The
statement shall identify the QBU (or QBUs) for which the election is
being made by describing its business and its country of residence,
state the adjusted basis of the assets of the QBU (and any related same-
country QBUs) to which the election applies, and include a statement
that the election is being made pursuant to Sec. 1.985-3(e)(2).
(B) Other QBUs. In the case of a QBU other than one described in
paragraph (e)(2)(iii)(A) of this section, an election must be made in
the manner prescribed in Sec. 1.964-1. The statement filed with the
Internal Revenue Service as required under Sec. 1.964-1 must include
the information required under paragraph (e)(2)(iii)(A) of this section.
(iv) Effect of election. If a taxpayer elects under this paragraph
(e)(2) to use the small QBU DASTM allocation, DASTM gain or loss, as
determined under paragraph (d) of this section, of a small QBU shall be
allocated ratably to all items of the QBU's gross income
[[Page 557]]
(determined prior to adjustment for DASTM gain or loss). Therefore, for
purposes of the foreign tax credit, DASTM gain or loss shall be
allocated on the basis of the relative amounts of gross income in each
separate category as defined in Sec. 1.904-5(a)(1). In the case of a
controlled foreign corporation (within the meaning of section 957 or
953(c)(1)(B)), for purposes of section 952, DASTM gain or loss shall be
allocated to subpart F income in a separate category in the same ratio
that the gross subpart F income in that category for the taxable year
bears to its total gross income in that category for the taxable year.
(v) Conformity. If a person (or a QBU of such person) makes an
election under this paragraph (e)(2) to use the small QBU DASTM
allocation, then each QBU of any related person (as defined in paragraph
(e)(2)(vi) of this section) that satisfies the threshold requirement of
paragraph (e)(2)(i) of this section (after application of the
aggregation rule of paragraph (e)(2)(i) of this section) shall be deemed
to have made the election.
(vi) Related person. The term related person means any person with a
relationship to the QBU (or to the United States or foreign person of
which the electing QBU is a part) that is defined in section 267(b) or
section 707(b).
(3) DASTM 9-step procedure--(i) Step 1--prepare balance sheets. The
taxpayer shall prepare an opening and a closing balance sheet for the
QBU for each balance sheet period during the taxable year. The balance
sheet period is the most frequent period for which balance sheet data
are reasonably available (but in no event less frequently than
quarterly). The balance sheet period may not be changed without the
consent of the district director. The balance sheets must be prepared
under the principles of paragraph (d)(2) of this section.
(ii) Step 2--identify certain assets and liabilities. The taxpayer
shall identify each item on the balance sheet that is described in
section 988(c)(1)(B) or (C) and that would have been translated under
paragraph (d)(5) of this section into dollars at the exchange rate for
the last translation period for the taxable year (or the exchange rate
on the last day of the last translation period of the taxable year in
the case of an accrued foreign income tax liability).
(iii) Step 3--characterize the assets. The taxpayer shall
characterize and group the assets identified in paragraph (e)(3)(ii) of
this section (Step 2) according to the source and the type of income
that they generate, have generated, or may reasonably be expected to
generate by applying the principles of Sec. 1.861-9T(g)(3) or its
successor regulation (relating to characterization of assets for
purposes of interest expense allocation). If a purpose for a taxpayer's
business practices is to manipulate asset characterization or groupings,
the district director may allocate or apportion DASTM gain or loss
attributable to the assets. Thus, if a taxpayer that previously did not
separately state interest on accounts receivable begins to impose an
interest charge and a purpose for the change was to manipulate tax
characterizations or groupings, then the district director may require
that none of the DASTM gain or loss attributable to those receivables be
allocated or apportioned to interest income.
(iv) Step 4--determine DASTM gain or loss attributable to certain
assets--(A) General rule. The taxpayer shall determine the dollar amount
of DASTM gain or loss attributable to assets in each group identified in
paragraph (e)(3)(iii) of this section (Step 3) as follows:
[GRAPHIC] [TIFF OMITTED] TC09OC91.062
where
bb = the hyperinflationary currency adjusted basis of the assets in the
group at the beginning of the balance sheet period.
eb = the hyperinflationary currency adjusted basis of the assets in the
group at the end of the balance sheet period.
er = one dollar divided by the number of hyperinflationary currency
units that equal one dollar at the end of the balance sheet period.
br = one dollar divided by the number of hyperinflationary currency
units that equal one dollar at the beginning of the balance sheet
period.
(B) Weighting to prevent distortion. If averaging the adjusted basis
of assets in a group at the beginning and end of
[[Page 558]]
a balance sheet period results in an allocation of DASTM gain or loss
that does not clearly reflect income, as might be the case in the event
of a purchase or disposition of an asset that is not in the normal
course of business, the taxpayer must use a weighting method that
reflects the time the assets are held by the QBU during the translation
period.
(C) Example. The provisions of this paragraph (e)(3)(iv) are
illustrated by the following example:
Example. S is a foreign corporation that operates in the
hyperinflationary currency ``h'' and computes its income or loss or
earnings and profits under DASTM. S's adjusted basis in a group of
assets described in section 988(c)(1)(B) or (C) that generate general
limitation foreign source income (as characterized under paragraph
(e)(3)(iii) of this section) at the beginning of the balance sheet
period is 750,000h. S's basis in such assets at the end of the balance
sheet period is 1,250,000h. The exchange rate at the beginning of the
balance sheet period is $1 = 200h. The exchange rate at the end of the
balance sheet period is $1 = 500h. The DASTM loss attributable to the
assets described above is $3,000, determined as follows:
[(750,000h+1,250,000h)/2]x [($1/500h)-($1/200h)]=($3000)
(v) Step 5--adjust dollar gross income by DASTM gain or loss from
assets. The taxpayer shall adjust the dollar amount of the QBU's gross
income (computed under paragraphs (b)(1) through (b)(3) of this section)
generated by each group of assets characterized in paragraph (e)(3)(iii)
of this section (Step 3) by the amount of DASTM gain or loss
attributable to those assets computed under paragraph (e)(3)(iv) of this
section (Step 4). Thus, if a group of assets, such as accounts
receivable, generates both a category of income described in section
904(d)(1)(I) (relating to general limitation income) that is not foreign
base company income as defined in section 954 and a DASTM loss under
paragraph (e)(3)(iv) of this section (Step 4), the amount of the DASTM
loss would reduce the amount of the QBU's gross income in that category.
Similarly, if a group of assets, such as short-term bank deposits,
generates both foreign personal holding company income that is passive
income (described in sections 954(c)(1)(A) and 904(d)(1)(A)) and a DASTM
loss under paragraph (e)(3)(iv) of this section (Step 4), the amount of
the DASTM loss would reduce the amount of the QBU's foreign personal
holding company income and passive income. See section 904(f) and the
regulations thereunder in the case where that section would apply and
DASTM loss attributable to a group of assets exceeds the income
generated by such assets.
(vi) Step 6--determine DASTM gain or loss attributable to
liabilities--(A) General rule. The taxpayer shall determine the dollar
amount of DASTM gain or loss attributable to liabilities identified in
paragraph (e)(3)(ii) of this section (Step 2), and described in
paragraph (e)(3)(vi)(B) of this section as follows:
[GRAPHIC] [TIFF OMITTED] TC09OC91.063
where
bl = the hyperinflationary currency amount of liabilities at the
beginning of the balance sheet period.
el = the hyperinflationary currency amount of liabilities at the end of
the balance sheet translation period.
br = one dollar divided by the number of hyperinflationary currency
units that equal one dollar at the beginning of the balance sheet
period.
er = one dollar divided by the number of hyperinflationary currency
units that equal one dollar at the end of the balance sheet period.
(B) Separate calculation. The calculation shall be made separately
for interest-bearing liabilities described in paragraph (e)(3)(vii) of
this section (Step 7) and for each of the classes of non-interest-
bearing liabilities described in paragraph (e)(3)(viii) of this section
(Step 8).
(C) Weighting to prevent distortion. Where a distortion would result
from averaging the amount of liabilities at the beginning and end of a
balance sheet period, as might be the case where a taxpayer incurs or
retires a substantial liability, the taxpayer must use a different
method that more clearly reflects the average amount of liabilities
weighted to reflect the time the liability was outstanding during the
balance sheet period.
(vii) Step 7--adjust dollar income and expense by DASTM gain or loss
from interest-bearing liabilities--(A) In general.
[[Page 559]]
The taxpayer shall apply the amount of DASTM gain on interest-bearing
liabilities computed under paragraph (e)(3)(vi) of this section (Step 6)
to reduce interest expense generated by such liabilities (e.g., prior to
the application of Sec. 1.861-9T or its successor regulation). To the
extent DASTM gain on such liabilities exceeds interest expense, it shall
be sourced or otherwise classified in the same manner that interest
expense is allocated and apportioned under Sec. 1.861-9T or its
successor regulation. The amount of DASTM loss on interest-bearing
liabilities computed under paragraph (e)(3)(vi) of this section (Step 6)
shall be allocated and apportioned in the same manner that interest
expense is allocated and apportioned under Sec. 1.861-9T or its
successor regulation (without regard to the exceptions to fungibility in
Sec. 1.861-10T or its successor regulation). For purposes of this
section, an interest-bearing liability is a liability that requires
payment of periodic interest (whether fixed or variable), has original
issue discount, or would have interest imputed under subtitle A.
(B) Allocation of DASTM gain or loss from interest-bearing
liabilities that generate related person interest expense. DASTM gain or
loss from interest-bearing liabilities that generate related person
interest expense (as provided in section 954(b)(5)) shall be allocated
for purposes of subtitle A (including sections 904 and 952) in the same
manner that the related person interest expense of that debt is required
to be allocated under the rules of section 954(b)(5) and Sec. 1.904-
5(c)(2).
(C) Modified gross income method. In applying the modified gross
income method described in Sec. 1.861-9T(j) or its successor
regulation, gross income shall be adjusted for any DASTM gain or loss
from assets as provided in paragraph (e)(3)(v) of this section (Step 5)
and any DASTM gain or loss with respect to short-term, non-interest-
bearing trade payables as provided in paragraph (e)(3)(viii)(A) of this
section.
(viii) Step 8--adjust dollar income and expense by DASTM gain or
loss from non-interest bearing liabilities--(A) Short-term, non-
interest-bearing trade payables. The taxpayer shall allocate DASTM gain
or loss on short-term non-interest-bearing trade payables for purposes
of subtitle A (including sections 904 and 952) to the same category or
type of gross income as the cost or expense to which the trade payable
relates. For this purpose, a short-term, non-interest-bearing trade
payable is a non-interest-bearing liability with a term of 183 days or
less that is incurred to purchase property or services to be used by the
obligor in an active trade or business.
(B) Excise tax payables. The taxpayer shall allocate DASTM gain or
loss on excise tax payables for purposes of subtitle A (including
sections 904 and 952) to the same category or type of gross income as
would be derived from the activity to which the excise tax relates.
(C) Other non-interest-bearing liabilities--(1) In general. Except
as provided in paragraphs (e)(3)(viii)(A), (e)(3)(viii)(B), and
(e)(3)(viii)(C)(2) of this section, DASTM gain or loss on non-interest-
bearing liabilities shall be allocated under paragraph (e)(3)(ix) of
this section (Step 9).
(2) Tracing if substantial distortion of income. DASTM gains and
losses on liabilities described in paragraph (e)(3)(viii)(C)(1) of this
section may be attributed to the same section 904(d) separate category
or subpart F category as the transaction to which the liability relates
if the taxpayer demonstrates to the satisfaction of the district
director, or it is determined by the district director, that application
of paragraph (e)(3)(viii)(C)(1) of this section results in a substantial
distortion of income.
(ix) Step 9--allocate residual DASTM gain or loss. If there is a
difference between the net DASTM gain or loss determined under
paragraphs (e)(3)(i) through (viii) of this section (Steps 1 through 8)
and the DASTM gain or loss determined under paragraph (d) of this
section, the amount of the difference must be allocated for purposes of
subtitle A (including sections 904 and 952) to the QBU's gross income
(computed under paragraphs (b)(1) through (3) of this section, as
adjusted under paragraphs (e)(3)(i) through (viii) of this section
(Steps 1 through 8)) on the
[[Page 560]]
basis of the relative amounts of each category or type of gross income.
[T.D. 8556, 59 FR 37673, July 25, 1994]
Sec. 1.985-4 Method of accounting.
(a) Adoption of election. The adoption of, or the election to use, a
functional currency shall be treated as a method of accounting. The
functional currency shall be used for the year of adoption (or election)
and for all subsequent taxable years unless permission to change is
granted, or considered to be granted under Sec. 1.985-2 or 1.985-8, by
the Commissioner.
(b) Condition for changing functional currencies. Generally,
permission to change functional currencies shall not be granted unless
significant changes in the facts and circumstances of the QBU's economic
environment occur. If the determination of the functional currency of
the QBU for purposes of United States generally accepted accounting
principles (GAAP) is based on facts and circumstances substantially
similar to those set forth in Sec. 1.985-1(c)(2), then ordinarily the
Commissioner will grant a taxpayer's request to change its functional
currency (or the functional currency of its branch that is a QBU) to a
new functional currency only if the taxpayer (or its QBU) also changes
to the new functional currency for purposes of GAAP. However, permission
to change will not necessarily be granted merely because the new
functional currency will conform to the taxpayer's GAAP functional
currency.
(c) Relationship to certain other sections of the Code. Nothing in
this section shall be construed to override the provisions of any other
sections of the Code of regulations that require the use of consistent
accounting methods. Such provisions must be independently satisfied
separate and apart from the identification of a functional currency. For
instance, while separate geographical divisions of a taxpayer's trade or
business may have different functional currencies, such geographical
divisions may nevertheless be required to consistently use other methods
of accounting.
[T.D. 8263, 54 FR 38661, Sept. 20, 1989, as amended by T.D. 8776, 63 FR
40368, July 29, 1998; T.D. 8927, Jan. 11, 2001]
Sec. 1.985-5 Adjustments required upon change in functional currency.
(a) In general. This section applies in the case of a QBU that
changes from one functional currency (old functional currency) to
another functional currency (new functional currency). A taxpayer or QBU
subject to the rules of this section shall make the adjustments set
forth in the 3-step procedure described in paragraphs (b) through (e) of
this section. The adjustments shall be made on the last day of the
taxable year ending before the year of change as defined in Sec. 1.481-
1(a)(1). Gain or loss required to be recognized under paragraphs (b),
(d)(2), and (e)(2) of this section is not subject to section 481 and,
therefore, the full amount of the gain or loss must be included in
income or earnings and profits on the last day of the taxable year
ending before the year of change. Except as provided in Sec. 1.985-6, a
QBU with a functional currency for its first taxable year beginning in
1987 that is different from the currency in which it had kept its books
and records for United States accounting and tax accounting purposes for
its prior taxable year shall apply the principles of this Sec. 1.985-5
for purposes of computing the relevant functional currency items, such
as earnings and profits, basis of an asset, and amount of a liability,
as of the first day of a taxpayer's first taxable year beginning in
1987. However, a QBU that changes to the dollar pursuant to Sec. 1.985-
1(b)(2) after 1987 shall apply Sec. 1.985-7.
(b) Step 1--Taking into account exchange gain or loss on certain
section 988 transactions. The QBU shall recognize or otherwise take into
account for all purposes of the Code the amount of any unrealized
exchange gain or loss attributable to a section 988 transaction (as
defined in section 988(c)(1)(A), (B), and (C)) that, after applying
section 988(d), is denominated in terms of or determined by reference to
the new functional currency. The amount of such gain or loss shall be
determined without regard to the limitations of section
[[Page 561]]
988(b) (i.e., whether any gain or loss would be realized on the
transaction as a whole). The character and source of such gain or loss
shall be determined under section 988.
(c) Step 2--Determining the new functional currency basis of
property and the new functional currency amount of liabilities and any
other relevant items. The new functional currency adjusted basis of
property and the new functional currency amount of liabilities and any
other relevant items (e.g., items described in section
988(c)(1)(B)(iii)) shall equal the product of the amount of the old
functional currency adjusted basis or amount multiplied by the new
functional currency/old functional currency spot exchange rate on the
last day of the taxable year ending before the year of change (spot
rate).
(d) Step 3A--Additional adjustments that are necessary when a branch
changes functional currency--(1) Branch changing to a functional
currency other than the taxpayer's functional currency--(i) Rule. If a
QBU that is a branch of a taxpayer changes to a functional currency
other than the taxpayer's functional currency, the branch shall make the
adjustments set forth in either paragraph (d)(1)(ii) or (d)(1)(iii) of
this section for purposes of section 987. See Sec. 1.987-5(d) for rules
for computing the branch's equity pool and basis pool.
(ii) Where prior to the change the branch and taxpayer had different
functional currencies. If the branch and the taxpayer had different
functional currencies prior to the change, the branch's new functional
currency equity pool shall equal the product of the old functional
currency amount of the equity pool multiplied by the spot rate. No
adjustment to the basis pool is necessary.
(iii) Where prior to the change the branch and taxpayer had the same
functional currency. If the branch and the taxpayer had the same
functional currency prior to the change, the branch's basis pool shall
equal the difference between the branch's total old functional currency
basis of its assets and its total old functional currency amount of its
liabilities. The branch's equity pool shall equal the product of the
basis pool multiplied by the spot rate.
(2) Branch changing to the taxpayer's functional currency. If a
branch changes its functional currency to the taxpayer's functional
currency, the branch shall be treated as if it terminated on the last
day of the taxable year ending before the year of change. In such a
case, the taxpayer shall realize gain or loss attributable to the
branch's equity pool under the principles of section 987.
(e) Step 3B--Additional adjustments that are necessary when a
taxpayer changes functional currency--(1) Corporations. The amount of a
corporation's new functional currency earnings and profits and the
amount of its new functional currency paid-in capital shall equal the
product of the old functional currency amounts of such items multiplied
by the spot rate. The foreign income taxes and accumulated profits or
deficits in accumulated profits of a foreign corporation that were
maintained in foreign currency for purposes of section 902 and that are
attributable to taxable years of the foreign corporation beginning
before January 1, 1987, also shall be translated into the new functional
currency at the spot rate.
(2) Collateral consequences to a United States shareholder of a
corporation changing to the United States dollar as its functional
currency. A United States shareholder (within the meaning of section
951(b) or section 953(c)(1)(A)) of a controlled foreign corporation
(within the meaning of section 957 or section 953(c)(1)(B)) changing its
functional currency to the dollar shall recognize foreign currency gain
or loss computed under section 986(c) as if all previously taxed
earnings and profits, if any, (including amounts attributable to pre-
1987 taxable years that were translated from dollars into functional
currency in the foreign corporation's first post-1986 taxable year) were
distributed immediately prior to the change. Such a shareholder shall
also recognize gain or loss attributable to the corporation's paid-in
capital to the same extent, if any, that such gain or loss would be
recognized under the regulations under section 367(b) if the corporation
was liquidated completely.
(3) Taxpayers that are not corporations. [Reserved]
[[Page 562]]
(4) Adjustments to a branch's accounts when a taxpayer changes
functional currency--(i) Taxpayer changing to a functional currency
other than the branch's functional currency. If a taxpayer changes to a
functional currency that differs from the functional currency of a
branch of the taxpayer, the branch shall adjust its basis pool in the
manner prescribed in paragraph (d)(1)(ii) of this section for adjusting
the equity pool, if the taxpayer's old functional currency was different
from the branch's functional currency. If the taxpayer's old functional
currency was the same as the branch's functional currency, the branch
shall determine its equity pool and basis pool in the manner set forth
in paragraph (d)(1)(iii) of this section for determining the basis pool
and equity pool, respectively.
(ii) Taxpayer changing to the same functional currency as the
branch. If a taxpayer changes to the same functional currency as a
branch of the taxpayer, the taxpayer shall realize gain or loss as set
forth in paragraph (d)(2) of this section.
(f) Examples. The provisions of this section are illustrated by the
following examples.
Example 1. S, a calendar year foreign corporation, is wholly owned
by domestic corporation P. The Commissioner granted permission to change
S's functional currency from the LC to the FC beginning January 1, 1993.
The LC/FC exchange rate on December 31, 1992 is 1 LC/2 FC. The following
shows how S must convert the items on its balance sheet from the LC to
the FC.
------------------------------------------------------------------------
1:2
-----------------------
LC FC
------------------------------------------------------------------------
Assets:
Cash on hand.................................. 40,000 80,000
Accounts Receivable........................... 10,000 20,000
Inventory..................................... 100,000 200,000
100,000 FC Bond (100,000 LC historical basis). \1\50,000 100,000
Fixed assets:
Property.................................... 200,000 400,000
Plant....................................... 500,000 1,000,000
Accumulated Depreciation.................. (200,000) (400,000)
Equipment................................... 1,000,000 2,000,000
Accumulated Depreciation.................. (400,000) (800,000)
-------------
Total Assets................................ 1,300,000 2,600,000
=============
Liabilities:
Accounts Payable.............................. 50,000 100,000
Long-term Liabilities......................... 400,000 800,000
Paid-in-Capital............................... 800,000 1,600,000
Retained Earnings............................. \2\ 50,000 100,000
-------------
Total Liabilities and Equity................ 1,300,000 2,600,000
------------------------------------------------------------------------
\1\ Under Sec. 1.985-5(b), S will recognize a 50,000 LC loss (100,000
LC basis-50,000 LC value) on the bond resulting from the change in
functional currency. Thus, immediately before the change, S's basis in
the FC bond (taking into account the loss) is 50,000 LC.
\2\ The amount of S's LC retained earnings reflects the 50,000 LC loss
on the bond.
Example 2. P, a domestic corporation, operates a foreign branch, S.
The Commissioner granted permission to change S's functional currency
from the LC to the FC beginning January 1, 1993. As of December 31,
1992, S's equity pool was 2,000 LC and its basis pool was $4,000. The
LC/FC exchange rate on December 31, 1992 is 1 LC/2 FC. On January 1,
1993, the new functional currency amount of S's equity pool is 4,000 FC.
The basis pool is not affected.
[T.D. 8464, 58 FR 233, Jan. 5, 1993; 58 FR 11099, Feb. 23, 1993, as
amended by T.D. 8765, 63 FR 10774, Mar. 5, 1998]
Sec. 1.985-6 Transition rules for a QBU that uses the dollar approximate
separate transactions method for its first taxable year beginning in 1987.
(a) In general. This section sets forth transition rules for a QBU
that used the dollar approximate separate transactions method of
accounting set forth in Sec. 1.985-3 or Sec. 1.985-3T (as contained in
the April 1, 1989 edition of 26 CFR part 1 (1.908 to 1.1000)) for its
first taxable year beginning in 1987 (DASTM QBU). A DASTM QBU must
determine the dollar and hyperinflationary currency basis of its assets
and the dollar and hyperinflationary currency amount of its liabilities
that were acquired or incurred in taxable years beginning before January
1, 1987. In addition, a DASTM QBU must determine its net worth,
including its retained earnings, at the end of the QBU's last taxable
year beginning before January 1, 1987. This section provides rules for
controlled foreign corporations (as defined in section 957 or section
953(c)(1)(B)), other foreign corporations, and branches of United States
persons that must make these determinations.
(b) Certain controlled foreign corporations. If a DASTM QBU was a
controlled foreign corporation for its last
[[Page 563]]
taxable year beginning before January 1, 1987, and it had a significant
event as described in Sec. 1.964-1(c)(6) in a taxable year beginning
before January 1, 1987, then the rules of this paragraph (b) shall
apply.
(1) Basis in assets and amount of liabilities. The hyperinflationary
currency adjusted basis of the QBU's assets and the hyperinflationary
currency amount of the QBU's liabilities acquired or incurred by the QBU
in a taxable year beginning before January 1, 1987, shall be the basis
or the amount as determined under Sec. 1.964-1(e) prior to translation
under Sec. 1.964-1(e)(4). The dollar adjusted basis of such assets and
the dollar amount of such liabilities shall be the adjusted basis or the
amount as determined under the rules of Sec. 1.964-1(e) after
translation under Sec. 1.964-1(e)(4).
(2) Retained earnings. The dollar amount of the QBU's retained
earnings at the end of its last taxable year beginning before January 1,
1987, shall be the dollar amount determined under Sec. 1.964-1(e)(3).
(c) All other foreign corporations. If a foreign corporation is a
DASTM QBU that is not described in paragraph (b) of this section, then
the hyperinflationary currency and dollar adjusted basis in the QBU's
assets acquired in taxable years beginning before January 1, 1987, the
hyperinflationary currency and dollar amount of the QBU's liabilities
acquired or incurred in taxable years beginning before January 1, 1987,
and the dollar amount of the QBU's net worth, including its retained
earnings, at the end of its last taxable year beginning before January
1, 1987, shall be determined by applying the principles of Sec. 1.985-
3T or Sec. 1.985-3. Thus, for example, the dollar basis of plant and
equipment shall be determined using the appropriate historical exchange
rate.
(d) Pre-1987 section 902 amounts--(1) Translation of pre-1987
section 902 accumulated profits and taxes into United States dollars.
The foreign income taxes and accumulated profits or deficits in
accumulated profits of a foreign corporation that were maintained in
foreign currency for purposes of section 902 and that are attributable
to taxable years of the foreign corporation beginning before January 1,
1987, shall be translated into dollars at the spot exchange rate on the
first day of its first taxable year beginning after December 31, 1986.
Once translated into dollars, these accumulated profits and taxes shall
(absent a change in functional currency) remain in dollars for all
federal income tax purposes.
(2) Carryforward of accumulated deficits in accumulated profits from
pre-1987 taxable years to post-1986 taxable years. For purposes of
sections 902 and 960, the post-1986 undistributed earnings of a foreign
corporation that is subject to the rules of this section shall be
reduced by the dollar amount of the corporation's deficit in accumulated
profits, if any, determined under section 902 and the regulations
thereunder, that was accumulated at the end of the corporation's last
taxable year beginning before January 1, 1987. The dollar amount of the
accumulated deficit shall be determined by multiplying the foreign
currency amount of such deficit by the spot exchange rate on the last
day of the corporation's last taxable year beginning before January 1,
1987, and shall be taken into account on the first day of the
corporation's first taxable year beginning after December 31, 1986.
Post-1986 undistributed earnings may not be reduced by the dollar amount
of a pre-1987 deficit in retained earnings determined under Sec. 1.964-
1(e).
(e) Net worth branch. If a DASTM QBU is a branch of a United States
person and the QBU used a net worth method of accounting for its last
taxable year beginning before January 1, 1987, then the rules of this
paragraph (e) shall apply. A net worth method of accounting is any
method of accounting under which the taxpayer calculates the taxable
income of a QBU based on the net change in the dollar value of the QBU's
equity (assets minus liabilities) during the course of a taxable year,
taking into account any contributions or remittances made during the
year. See, e.g., Rev. Rul. 75-106, 1975-1 C.B. 31. (See Sec.
601.601(d)(2)(ii)(b) of this chapter).
(1) Basis in assets and amount of liabilities--(i) Hyperinflationary
amounts. For the first taxable year beginning in 1987, the
hyperinflationary currency adjusted basis of a QBU's assets or the
hyperinflationary currency amounts of
[[Page 564]]
its liabilities acquired or incurred in a taxable year beginning before
January 1, 1987 is the hyperinflationary currency basis or amount at the
date when acquired or incurred, as adjusted according to United States
generally accepted accounting and tax accounting principles. If a
hyperinflationary currency basis or amount was not determined at such
date, the dollar basis or amount, as adjusted according to United States
generally accepted accounting and tax accounting principles, shall be
translated into hyperinflationary currency at the spot exchange rate on
the date when the asset or liability was acquired or incurred.
(ii) Dollar amounts. For the first taxable year beginning in 1987,
the dollar adjusted basis of the QBU's assets and the amounts of its
liabilities shall be those amounts reflected on the QBU's dollar books
and records at the end of the taxpayer's last taxable year beginning
before January 1, 1987, after adjusting the books and records according
to United States generally accepted accounting and tax accounting
principles.
(2) Ending net worth. The dollar amount of the QBU's net worth at
the end of its last taxable year beginning before January 1, 1987 shall
equal the QBU's net worth at that date as determined under paragraph
(e)(1)(ii) of this section.
(f) Profit and loss branch. If a DASTM QBU is a branch of a United
States person and the QBU used a profit and loss method of accounting
for its last taxable year beginning before January 1, 1987, then the
United States person shall first apply the transition rules of Sec.
1.987-5 in order to determine the beginning amount and dollar basis of
the branch's EQ pool, the hyperinflationary currency basis of the
branch's assets, and the hyperinflationary currency amounts of its
liabilities. A profit and loss method of accounting is any method of
accounting under which the taxpayer calculates the profits of a QBU by
computing the QBU's profits in its functional currency and translating
the net result into dollars. See e.g., Rev. Rul. 75-107, 1975-1 C.B. 32.
(See Sec. 601.601(d)(2)(ii)(b) of this chapter). The QBU and the
taxpayer must then make the adjustments required by Sec. 1.985-5, e.g.,
the QBU must take into account unrealized exchange gain or loss on
dollar-denominated section 988 transactions, the taxpayer must account
for the deemed termination of the branch, and the taxpayer must
translate the QBU's balance sheet items from hyperinflationary currency
into dollars at the spot rate.
[T.D. 8464, 58 FR 234, Jan. 5, 1993]
Sec. 1.985-7 Adjustments required in connection with a change to DASTM.
(a) In general. If a QBU begins to use the dollar approximate
separate transactions method of accounting set forth in Sec. 1.985-3
(DASTM) in a taxable year beginning after April 6, 1998, adjustments
shall be made as provided by this section. For the rules with respect to
foreign corporations, see paragraph (b) of this section. For the rules
with respect to adjustments to the income of United States shareholders
of controlled foreign corporations, see paragraph (c) of this section.
For the rules with respect to adjustments relating to QBU branches, see
paragraph (d) of this section. For the effective date of this section,
see paragraph (e). For purposes of applying this section, the look-back
period shall be the period beginning with the first taxable year after
the transition date and ending on the last day prior to the taxable year
of change. The term transition date means the later of the last day of
the last taxable year ending before the base period as defined in Sec.
1.985-1(b)(2)(ii)(D) or the last day of the taxable year in which the
QBU last applied DASTM. The taxable year of change shall mean the
taxable year of change as defined in Sec. 1.481-1(a)(1). The
application of this paragraph may be illustrated by the following
examples:
Example 1. A calendar year QBU that has not previously used DASTM
operates in a country in which the functional currency of the country is
hyperinflationary as defined under Sec. 1.985-1(b)(2)(ii)(D) for the
QBU's 1999 tax year. The look-back period is the period from January 1,
1996 through December 31, 1998, the transition date is December 31,
1995, and the taxable year of change is the taxable year beginning
January 1, 1999.
Example 2. A QBU that has not previously used DASTM with a taxable
year ending
[[Page 565]]
June 30, operates in a country in which the functional currency of the
country is hyperinflationary for the QBU's tax year beginning July 1,
1999 as defined under Sec. 1.985-1(b)(2)(ii)(D) (where the base period
is the thirty-six calendar months immediately preceding the first day of
the current calendar year 1999). The look-back period is the period from
July 1, 1995 through June 30, 1999, the transition date is June 30,
1995, and the taxable year of change is the taxable year beginning July
1, 1999.
(b) Adjustments to foreign corporations--(1) In general. In the case
of a foreign corporation, the corporation shall make the adjustments set
forth in paragraphs (b)(2) through (4) of this section. The adjustments
shall be made on the first day of the taxable year of change.
(2) Treatment of certain section 988 transactions--(i) Exchange gain
or loss from section 988 transactions unrealized as of the transition
date. A foreign corporation shall adjust earnings and profits by the
amount of any unrealized exchange gain or loss that was attributable to
a section 988 transaction (as defined in sections 988(c)(1)(A), (B), and
(C)) that was denominated in terms of (or determined by reference to)
the dollar and was held by the corporation on the transition date. Such
gain or loss shall be computed as if recognized on the transition date
and shall be reduced by any gain and increased by any loss recognized by
the corporation with respect to such transaction during the look-back
period. The amount of such gain or loss shall be determined without
regard to the limitations of section 988(b) (i.e., whether any gain or
loss would be realized on the transaction as a whole). The character and
source of such gain or loss shall be determined under section 988.
Proper adjustments shall be made to account for gain or loss taken into
account by reason of this paragraph (b)(2). See Sec. 1.985-5(f) Example
1, footnote 1.
(ii) Treatment of a section 988 transaction entered into and
terminated during the look-back period. A foreign corporation shall
reduce earnings and profits by the amount of any gain, and increase
earnings and profits by the amount of any loss, that was recognized with
respect to any dollar denominated section 988 transactions entered into
and terminated during the look-back period.
(3) Opening balance sheet. The opening balance sheet of a foreign
corporation for the taxable year of change shall be determined as if the
corporation had changed its functional currency to the dollar by
applying Sec. 1.985-5(c) on the transition date and had translated its
assets and liabilities acquired and incurred during the look-back period
under Sec. 1.985-3.
(4) Earnings and profits adjustments--(i) Pre-1987 accumulated
profits. The foreign income taxes and accumulated profits or deficits in
accumulated profits of a foreign corporation that are attributable to
taxable years beginning before January 1, 1987, as stated on the
transition date, and that were maintained for purposes of section 902 in
the old functional currency, shall be translated into dollars at the
spot rate in effect on the transition date. The applicable accumulated
profits shall be reduced on a last-in, first-out basis by the aggregate
dollar amount (translated from functional currency in accordance with
the rules of section 989(b)) attributable to earnings and profits that
were distributed (or treated as distributed) during the look-back period
to the extent such amounts distributed exceed the earnings and profits
calculated under (b)(4)(ii) or (b)(4)(iii), as applicable. See Sec.
1.902-1(b)(2)(ii). Once translated into dollars, these pre-1987 taxes
and accumulated profits or deficits in accumulated profits shall (absent
a change in functional currency) remain in dollars for all federal
income tax purposes.
(ii) Post-1986 undistributed earnings of a CFC. In the case of a
controlled foreign corporation (within the meaning of section 957 or
section 953(c)(1)(B))(CFC) or a foreign corporation subject to the rules
of Sec. 1.904-6(a)(2), the corporation's post-1986 undistributed
earnings in each separate category as defined in Sec. 1.904-5(a)(1) as
of the first day of the taxable year of change (and prior to adjustment
under paragraph (c)(1) of this section) shall equal the sum of--
(A) The corporation's post-1986 undistributed earnings and profits
(or deficit in earnings and profits) in each separate category as
defined in Sec. 1.904-
[[Page 566]]
5(a)(1) as stated on the transition date translated into dollars at the
spot rate in effect on the transition date; and
(B) The sum of the earnings and profits (or deficit in earnings and
profits) in each separate category determined under Sec. 1.985-3 for
each post-transition date taxable year prior to the taxable year of
change.
Such amount shall be reduced by the aggregate dollar amount
(translated from functional currency in accordance with the rules of
section 989(b)) attributable to earnings and profits that were
distributed (or treated as distributed) during the look-back period out
of post-1986 earnings and profits in such separate category. For
purposes of applying this paragraph (b)(4)(ii)(B), the opening balance
sheet for calculating earnings and profits under Sec. 1.985-3 for the
first post-transition year shall be translated into dollars pursuant to
Sec. 1.985-5(c).
(iii) Post-1986 undistributed earnings of other foreign
corporations. In the case of a foreign corporation that is not a CFC or
subject to the rules of Sec. 1.904-6(a)(2), the corporation's post-1986
undistributed earnings shall equal the sum of--
(A) The corporation's post-1986 undistributed earnings (or deficit)
on the transition date translated into dollars at the spot rate in
effect on the transition date; and
(B) The sum of the earnings and profits (or deficit in earnings and
profits) determined under Sec. 1.985-3 for each post-transition date
taxable year (or such later year determined under section 902(c)(3)(A))
prior to the taxable year of change.
Such amount shall be reduced by the aggregate dollar amount
(translated from functional currency in accordance with the rules of
section 989(b)) that was distributed (or treated as distributed) during
the look-back period out of post-1986 earnings and profits. For purposes
of applying this paragraph (b)(4)(iii)(B), the opening balance sheet for
calculating earnings and profits under Sec. 1.985-3 for the first post-
transition year shall be translated into dollars pursuant to Sec.
1.985-5(c).
(c) United States shareholders of controlled foreign corporations--
(1) In general. A United States shareholder (within the meaning of
section 951(b) or section 953(c)(1)(B)) of a CFC that changes to DASTM
shall make the adjustments set forth in paragraphs (c) (2) through (5)
of this section on the first day of the taxable year of change.
Adjustments under this section shall be taken into account by the
shareholder (or such shareholder s successor in interest) ratably over
four taxable years beginning with the taxable year of change. Similar
rules shall apply in determining adjustments to income of United States
persons who have made an election under section 1295 to treat a passive
foreign investment company as a qualified electing fund.
(2) Treatment under subpart F of income recognized on section 988
transactions. The character of amounts taken into account under
paragraph (b)(2) of this section for purposes of sections 951 through
964, shall be determined on the transition date and to the extent
characterized as subpart F income shall be taken into account in
accordance with the rules of paragraph (c)(1) of this section. Such
amounts shall retain their character for all federal income tax purposes
(including sections 902, 959, 960, 961, 1248, and 6038).
(3) Recognition of foreign currency gain or loss on previously taxed
earnings and profits on the transition date. Gain or loss is recognized
under section 986(c) as if all previously taxed earnings and profits as
determined on the transition date, if any, were distributed on such
date. Such gain or loss shall be reduced by any foreign currency gain
and increased by any foreign currency loss that was recognized under
section 986(c) with respect to distributions of previously taxed
earnings and profits during the look-back period. Such amount shall be
characterized in accordance with section 986(c) and taken into account
in accordance with the rules of paragraph (c)(1) of this section.
(4) Subpart F income adjustment. Subpart F income in a separate
category shall be determined under Sec. 1.985-3 for each look-back
year. For this purpose, the opening DASTM balance sheet shall be
determined under Sec. 1.985-5. The sum of the difference (positive or
negative) between the amount computed pursuant to Sec. 1.985-3 and
amount that was included in income for each year
[[Page 567]]
shall be taken into account in the taxable year of change pursuant to
paragraph (c)(1) of this section. Such amounts shall retain their
character for all federal income tax purposes (including sections 902,
959, 960, 961, 1248, and 6038). For rules applicable if an adjustment
under this section results in a loss for the taxable year in a separate
category, see section 904(f) and the regulations thereunder. The amount
of previously taxed earnings and profits as determined under section
959(c)(2) shall be adjusted (positively or negatively) by the amount
taken into account under this paragraph (c)(4) as of the first day of
the taxable year of change.
(5) Foreign tax credit. A United States shareholder of a CFC shall
compute an amount of foreign taxes deemed paid under section 960 with
respect to any positive adjustments determined under paragraph (c) of
this section. The amount of foreign tax deemed paid shall be computed
with reference to the full amount of the adjustment and to the post-1986
undistributed earnings determined under paragraph (b)(4) (i) and (ii) of
this section and the post-1986 foreign income taxes of the CFC on the
first day of the taxable year of change (i.e., without taking into
account earnings and taxes for the taxable year of change). For purposes
of section 960, the associated taxes in each separate category shall be
allocated pro rata among, and deemed paid in, the shareholder's taxable
years in which the income is taken into account. (No adjustment to
foreign taxes deemed paid in prior years is required solely by reason of
a negative adjustment to income under paragraph (c)(1) of this section).
(d) QBU branches--(1) In general. In the case of a QBU branch, the
taxpayer shall make the adjustments set forth in paragraphs (d)(2)
through (d)(4) of this section. Adjustments under this section shall be
taken into account by the taxpayer ratably over four taxable years
beginning with the taxable year of change.
(2) Treatment of certain section 988 transactions--(i) Exchange gain
or loss from section 988 transactions unrealized as of the transition
date. A QBU branch shall adjust income by the amount of any unrealized
exchange gain or loss that was attributable to a section 988 transaction
(as defined in sections 988(c)(1) (A), (B), and (C)) that was
denominated in terms of (or determined by reference to) the dollar and
was held by the QBU branch on the transition date. Such gain or loss
shall be computed as if recognized on the transition date and shall be
reduced by any gain and increased by any loss recognized by the QBU
branch with respect to such transaction during the look-back period. The
amount of such gain or loss shall be determined without regard to the
limitations of section 988(b) (i.e., whether any gain or loss would be
realized on the transaction as a whole). The character and source of
such gain or loss shall be determined under section 988. Proper
adjustments shall be made to account for gain or loss taken into account
by reason of this paragraph (d)(2). See Sec. 1.985-5(f) Example 1,
footnote 1.
(ii) Treatment of a section 988 transaction entered into and
terminated during the look-back period. A QBU branch shall reduce income
by the amount of any gain, and increase income by the amount of any
loss, that was recognized with respect to any dollar denominated section
988 transactions entered into and terminated during the look-back
period.
(3) Deemed termination income adjustment. The taxpayer shall realize
gain or loss attributable to the QBU branch's equity pool (as stated on
the transition date) under the principles of section 987, computed as if
the branch terminated on the transition date. Such amount shall be
reduced by section 987 gain and increased by section 987 loss that was
recognized by such taxpayer with respect to remittances during the look-
back period.
(4) Branch income adjustment. Branch income in a separate category
shall be determined under Sec. 1.985-3 for each look-back year. For
this purpose, the opening DASTM balance sheet shall be determined under
Sec. 1.985-5. The sum of the difference (positive or negative) between
the amount computed pursuant to Sec. 1.985-3 and amount taken into
account for each year shall be taken into account in the taxable year of
change pursuant to paragraph (d)(1) of this section. Such amounts shall
retain their
[[Page 568]]
character for all federal income tax purposes.
(5) Opening balance sheet. The opening balance sheet of a QBU branch
for the taxable year of change shall be determined as if the branch had
changed its functional currency to the dollar by applying Sec. 1.985-
5(c) on the transition date and had translated its assets and
liabilities acquired and incurred during the look-back period under
Sec. 1.985-3.
(e) Effective date. This section is effective for taxable years
beginning after April 6, 1998. However, a taxpayer may choose to apply
this section to all open taxable years beginning after December 31,
1986, provided each person, and each QBU branch of a person, that is
related (within the meaning of Sec. 1.985-2(d)(3)) to the taxpayer also
applies this section.
[T.D. 8765, 63 FR 10774, Mar. 5, 1998]
Sec. 1.985-8 Special rules applicable to the European Monetary Union
(conversion to euro).
(a) Definitions--(1) Legacy currency. A legacy currency is the
former currency of a Member State of the European Community which is
substituted for the euro in accordance with the Treaty establishing the
European Community signed February 7, 1992. The term legacy currency
shall also include the European Currency Unit.
(2) Conversion rate. The conversion rate is the rate at which the
euro is substituted for a legacy currency.
(b) Operative rules--(1) Initial adoption. A QBU (as defined in
Sec. 1.989(a)-1(b)) whose first taxable year begins after the euro has
been substituted for a legacy currency may not adopt a legacy currency
as its functional currency.
(2) QBU with a legacy currency as its functional currency--(i)
Required change. A QBU with a legacy currency as its functional currency
is required to change its functional currency to the euro beginning the
first day of the first taxable year--
(A) That begins on or after the day that the euro is substituted for
that legacy currency (in accordance with the Treaty on European Union);
and
(B) In which the QBU begins to maintain its books and records (as
described in Sec. 1.989(a)-1(d)) in the euro.
(ii) Notwithstanding paragraph (b)(2)(i) of this section, a QBU with
a legacy currency as its functional currency is required to change its
functional currency to the euro no later than the last taxable year
beginning on or before the first day such legacy currency is no longer
valid legal tender.
(3) QBU with a non-legacy currency as its functional currency --(i)
In general. A QBU with a non-legacy currency as its functional currency
may change its functional currency to the euro pursuant to this Sec.
1.985-8 if--
(A) Under the rules set forth in Sec. 1.985-1(c), the euro is the
currency of the economic environment in which a significant part of the
QBU's activities are conducted;
(B) After conversion, the QBU maintains its books and records (as
described in Sec. 1.989(a)-1(d)) in the euro; and
(C) The QBU is not required to use the dollar as its functional
currency under Sec. 1.985-1(b).
(ii) Time period for change. A QBU with a non-legacy currency as its
functional currency may change its functional currency to the euro under
this section only if it does so within the period set forth in paragraph
(b)(2) of this section as if the functional currency of the QBU was a
legacy currency.
(4) Consent of Commissioner. A change made pursuant to paragraph (b)
of this section shall be deemed to be made with the consent of the
Commissioner for purposes of Sec. 1.985-4. A QBU changing its
functional currency to the euro pursuant to paragraph (b)(2) of this
section must make adjustments as provided in paragraph (c) of this
section. A QBU changing its functional currency to the euro pursuant to
paragraph (b)(3) must make adjustments as provided in Sec. 1.985-5.
(5) Statement to file upon change. With respect to a QBU that
changes its functional currency to the euro under paragraph (b) of this
section, an affected taxpayer shall attach to its return for the taxable
year of change a statement that includes the following: ``TAXPAYER
CERTIFIES THAT A QBU OF THE TAXPAYER HAS CHANGED ITS FUNCTIONAL CURRENCY
TO THE EURO PURSUANT TO TREAS. REG.
[[Page 569]]
Sec. 1.985-8.'' For purposes of this paragraph (b)(5), an affected
taxpayer shall be in the case where the QBU is: a QBU of an individual
U.S. resident (as a result of the activities of such individual), the
individual; a QBU branch of a U.S. corporation, the corporation; a
controlled foreign corporation (as described in section 957)(or QBU
branch thereof), each United States shareholder (as described in section
951(b)); a partnership, each partner separately; a noncontrolled section
902 corporation (as described in section 904(d)(2)(E)) (or branch
thereof), each domestic shareholder as described in Sec. 1.902-1(a)(1);
or a trust or estate, the fiduciary of such trust or estate.
(c) Adjustments required when a QBU changes its functional currency
from a legacy currency to the euro pursuant to paragraph (b)(2) of this
section--(1) In general. A QBU that changes its functional currency from
a legacy currency to the euro pursuant to paragraph (b)(2) of this
section must make the adjustments described in paragraphs (c)(2) through
(5) of this section. Section 1.985-5 shall not apply.
(2) Determining the euro basis of property and the euro amount of
liabilities and other relevant items. The euro basis in property and the
euro amount of liabilities and other relevant items shall equal the
product of the legacy functional currency adjusted basis or amount of
liabilities multiplied by the applicable conversion rate.
(3) Taking into account exchange gain or loss on legacy currency
section 988 transactions--(i) In general. Except as provided in
paragraphs (c)(3)(iii) and (iv) of this section, a legacy currency
denominated section 988 transaction (determined after applying section
988(d)) outstanding on the last day of the taxable year immediately
prior to the year of change shall continue to be treated as a section
988 transaction after the change and the principles of section 988 shall
apply.
(ii) Examples. The application of this paragraph (c)(3) may be
illustrated by the following examples:
Example 1. X, a calendar year QBU on the cash method of accounting,
uses the deutschmark as its functional currency. X is not described in
section 1281(b). On July 1, 1998, X converts 10,000 deutschmarks (DM)
into Dutch guilders (fl) at the spot rate of fl1 = DM1 and loans the
10,000 guilders to Y (an unrelated party) for one year at a rate of 10%
with principal and interest to be paid on June 30, 1999. On January 1,
1999, X changes its functional currency to the euro pursuant to this
section. Assume that the euro/deutschmark conversion rate is set by the
European Council at [euro]1= DM2. Assume further that the euro/guilder
conversion rate is set at [euro]1 = fl2.25. Accordingly, under the terms
of the note, on June 30, 1999, X will receive [euro]4444.44 (fl10,000/
2.25) of principal and [euro]444.44 (fl1,000/2.25) of interest. Pursuant
to this paragraph (c)(3), X will realize an exchange loss on the
principal computed under the principles of Sec. 1.988-2(b)(5). For this
purpose, the exchange rate used under Sec. 1.988-2(b)(5)(i) shall be
the guilder/euro conversion rate. The amount under Sec. 1.988-
2(b)(5)(ii) is determined by translating the fl10,000 at the guilder/
deutschmark spot rate on July 1, 1998, and translating that deutschmark
amount into euros at the deutschmark/euro conversion rate. Thus, X will
compute an exchange loss for 1999 of [euro]555.56 determined as follows:
[[euro]4444.44 (fl10,000/2.25)-5000 ((fl10,000/1)/2) = - [euro]555.56].
Pursuant to this paragraph (c)(3), the character and source of the loss
are determined pursuant to section 988 and regulations thereunder.
Because X uses the cash method of accounting for the interest on this
debt instrument, X does not realize exchange gain or loss on the receipt
of that interest.
Example 2. (i) X, a calendar year QBU on the accrual method of
accounting, uses the deutschmark as its functional currency. On February
1, 1998, X converts 12,000 deutschmarks into Dutch guilders at the spot
rate of fl1 = DM1 and loans the 12,000 guilders to Y (an unrelated
party) for one year at a rate of 10% with principal and interest to be
paid on January 31, 1999. In addition, assume the average rate
(deutschmark/guilder) for the period from February 1, 1998, through
December 31, 1998 is fl1.07 = DM1. Pursuant to Sec. 1.988-
2(b)(2)(ii)(C), X will accrue eleven months of interest on the note and
recognize interest income of DM1028.04 (fl1100/1.07) in the 1998 taxable
year.
(ii) On January 1, 1999, the euro will replace the deutschmark as
the national currency of Germany pursuant to the Treaty on European
Union signed February 7, 1992. Assume that on January 1, 1999, X changes
its functional currency to the euro pursuant to this section. Assume
that the euro/deutschmark conversion rate is set by the European Council
at [euro]1 = DM2. Assume further that the euro/guilder conversion rate
is set at [euro]1 = fl2.25. In 1999, X will accrue one month of interest
equal to [euro]44.44 (fl100/2.25). On January 31, 1999, pursuant to the
note, X will receive interest denominated in euros of [euro]533.33
(fl1200/2.25). Pursuant to this paragraph (c)(3), X will realize an
exchange loss
[[Page 570]]
in the 1999 taxable year with respect to accrued interest computed under
the principles of Sec. 1.988-2(b)(3). For this purpose, the exchange
rate used under Sec. 1.988-2(b)(3)(i) is the guilder/euro conversion
rate and the exchange rate used under Sec. 1.988-2(b)(3)(ii) is the
deutschmark/euro conversion rate. Thus, with respect to the interest
accrued in 1998, X will realize exchange loss of [euro]25.13 under Sec.
1.988-2(b)(3) as follows: [[euro]488.89 (fl1100/2.25)- [euro]514.02
(DM1028.04/2) =- [euro]25.13]. With respect to the one month of interest
accrued in 1999, X will realize no exchange gain or loss since the
exchange rate when the interest accrued and the spot rate on the payment
date are the same.
(iii) X will realize exchange loss of [euro]666.67 on repayment of
the loan principal computed in the same manner as in Example 1
[[euro]5333.33 (fl12,000/2.25)- [euro]6000 fl12,000/1)/2)]. The losses
with respect to accrued interest and principal are characterized and
sourced under the rules of section 988.
(iii) Special rule for legacy nonfunctional currency. The QBU shall
realize or otherwise take into account for all purposes of the Internal
Revenue Code the amount of any unrealized exchange gain or loss
attributable to nonfunctional currency (as described in section
988(c)(1)(C)(ii)) that is denominated in a legacy currency as if the
currency were disposed of on the last day of the taxable year
immediately prior to the year of change. The character and source of the
gain or loss are determined under section 988.
(iv) Legacy currency denominated accounts receivable and payable--
(A) In general. A QBU may elect to realize or otherwise take into
account for all purposes of the Internal Revenue Code the amount of any
unrealized exchange gain or loss attributable to a legacy currency
denominated item described in section 988(c)(1)(B)(ii) as if the item
were terminated on the last day of the taxable year ending prior to the
year of change.
(B) Time and manner of election. With respect to a QBU that makes an
election described in paragraph (c)(3)(iv)(A) of this section, an
affected taxpayer (as described in paragraph (b)(5) of this section)
shall attach a statement to its tax return for the taxable year ending
immediately prior to the year of change which includes the following:
``TAXPAYER CERTIFIES THAT A QBU OF THE TAXPAYER HAS ELECTED TO REALIZE
CURRENCY GAIN OR LOSS ON LEGACY CURRENCY DENOMINATED ACCOUNTS RECEIVABLE
AND PAYABLE UPON CHANGE OF FUNCTIONAL CURRENCY TO THE EURO.'' A QBU
making the election must do so for all legacy currency denominated items
described in section 988(c)(1)(B)(ii).
(4) Adjustments when a branch changes its functional currency to the
euro--(i) Branch changing from a legacy currency to the euro in a
taxable year during which taxpayer's functional currency is other than
the euro. If a branch changes its functional currency from a legacy
currency to the euro for a taxable year during which the taxpayer's
functional currency is other than the euro, the branch's euro equity
pool shall equal the product of the legacy currency amount of the equity
pool multiplied by the applicable conversion rate. No adjustment to the
basis pool is required.
(ii) Branch changing from a legacy currency to the euro in a taxable
year during which taxpayer's functional currency is the euro. If a
branch changes its functional currency from a legacy currency to the
euro for a taxable year during which the taxpayer's functional currency
is the euro, the taxpayer shall realize gain or loss attributable to the
branch's equity pool under the principles of section 987, computed as if
the branch terminated on the last day prior to the year of change.
Adjustments under this paragraph (c)(4)(ii) shall be taken into account
by the taxpayer ratably over four taxable years beginning with the
taxable year of change.
(5) Adjustments to a branch's accounts when a taxpayer changes to
the euro--(i) Taxpayer changing from a legacy currency to the euro in a
taxable year during which a branch's functional currency is other than
the euro. If a taxpayer changes its functional currency to the euro for
a taxable year during which the functional currency of a branch of the
taxpayer is other than the euro, the basis pool shall equal the product
of the legacy currency amount of the basis pool multiplied by the
applicable conversion rate. No adjustment to the equity pool is
required.
(ii) Taxpayer changing from a legacy currency to the euro in a
taxable year
[[Page 571]]
during which a branch's functional currency is the euro. If a taxpayer
changes its functional currency from a legacy currency to the euro for a
taxable year during which the functional currency of a branch of the
taxpayer is the euro, the taxpayer shall take into account gain or loss
as determined under paragraph (c)(4)(ii) of this section.
(6) Additional adjustments that are necessary when a corporation
changes its functional currency to the euro. The amount of a
corporation's euro currency earnings and profits and the amount of its
euro paid-in capital shall equal the product of the legacy currency
amounts of these items multiplied by the applicable conversion rate. The
foreign income taxes and accumulated profits or deficits in accumulated
profits of a foreign corporation that were maintained in foreign
currency for purposes of section 902 and that are attributable to
taxable years of the foreign corporation beginning before January 1,
1987, also shall be translated into the euro at the conversion rate.
(d) Treatment of legacy currency section 988 transactions with
respect to a QBU that has the euro as its functional currency--(1) In
general. This Sec. 1.985-8(d) applies to a QBU that has the euro as its
functional currency and that holds a section 988 transaction denominated
in, or determined by reference to, a currency that is substituted by the
euro. For example, this paragraph (d) will apply to a German QBU with
the euro as its functional currency if the QBU is holding Country X
currency or other section 988 transactions denominated in such currency
on the day in the year 2005 when the euro is substituted for the Country
X currency.
(2) Principles of paragraph (c)(3) of this section shall apply. With
respect to a QBU described in paragraph (d) of this section, the
principles of paragraph (c)(3) of this section shall apply. For example,
if a German QBU with the euro as its functional currency is holding a
Country X currency denominated debt instrument on the day in the year
2005 when the euro is substituted for the Country X currency, the
instrument shall continue to be treated as a section 988 transaction
pursuant to the principles of paragraph (c)(3)(i) of this section.
However, if such QBU holds Country X currency, the QBU shall take into
account any unrealized exchange gain or loss pursuant to the principles
of paragraph (c)(3)(iii) of this section as if the currency was disposed
of on the day prior to the day the euro is substituted for the Country X
currency. Similarly, if the QBU makes an election under the principles
of paragraph (c)(3)(iv) of this section, the QBU shall take into account
for all purposes of the Internal Revenue Code the amount of any
unrealized exchange gain or loss attributable to a legacy currency
denominated item described in section 988(c)(1)(B)(ii) as if the item
were terminated on the day prior to the day the euro is substituted for
the Country X currency.
(e) Effective date. This section applies to tax years ending after
July 29, 1998.
[T.D. 8927, 66 FR 2216, Jan. 11, 2001; T.D. 8927, 66 FR 21447, Apr. 30,
2001]
Sec. 1.987-1 Profit and loss method of accounting for a qualified
business unit of a taxpayer having a different functional currency
from the taxpayer.
[Reserved]
Sec. 1.987-2 Accounting for gain or loss on certain transfers of
property. [Reserved]
Sec. 1.987-3 Termination. [Reserved]
Sec. 1.987-4 Special rules relating to QBU branches of foreign
taxpayers. [Reserved]
Sec. 1.987-5 Transition rules for certain qualified business units
using a profit and loss method of accounting for taxable years
beginning before January 1, 1987.
(a) Applicability--(1) In general. This section applies to qualified
business unit (QBU) branches of United States persons, whose functional
currency (as defined in section 985 of the Code and the regulations
thereunder) is other than the United States dollar (dollar) and that
used a profit and loss method of accounting for their last taxable year
beginning before January 1, 1987. Generally, a profit and loss method of
accounting is any method of accounting under which the taxpayer
calculates the profits of a QBU branch in its functional currency and
translates
[[Page 572]]
the net result into dollars. For all taxable years beginning after
December 31, 1986, such QBU branches must use the profit and loss method
of accounting as described in section 987, except to the extent
otherwise provided in regulations under section 985 or any other
provision of the Code. See Sec. 1.989(c)-1 regarding transition rules
for QBU branches of United States persons that have a nondollar
functional currency and that used a net worth method of accounting for
their last taxable year beginning before January 1, 1987.
(2) Insolvent QBU branches. A taxpayer may apply the principles of
this section to a QBU branch that used a profit and loss method of
accounting for its last taxable year beginning before January 1, 1987,
whose $E pool (as defined in paragraph (d)(3)(i) of this section) is
negative. For taxable years beginning on or after October 25, 1991, the
principles of this section shall apply to insolvent QBU branches.
(b) General rules. Generally, section 987 gain or loss occurs when a
QBU branch makes a remittance. A remittance is considered to be made
from one or more functional currency pools under rules provided in
paragraph (c) of this section. In general, the amount of section 987
gain or loss from a remittance equals the difference between the dollar
value of the functional currency adjusted basis of the property remitted
and the portion of the dollar basis in the applicable pool. Section 987
gain or loss is calculated under a 4-step procedure described in
paragraph (d) of this section. Section 987 gain or loss attributable to
a remittance is realized and must be recognized in the taxable year of
the remittance except to the extent otherwise provided in regulations.
(c) Determining the pool(s) from which a remittance is made--(1)
Remittances made during taxable years beginning after December 31, 1986,
and before October 25, 1991. A remittance made during taxable years
beginning after December 31, 1986 and before October 25, 1991, first
represents an amount of the QBU branch's post-86 profits pool (including
functional currency profits for the current taxable year determined
without regard to remittances made during the current year). To the
extent the functional currency amount of the remittance exceeds the
post-86 profits pool, it is considered to come out of the EQ pool.
Paragraph (d)(2) of this section describes the EQ pool and the post-86
profits pool.
(2) Remittances made in taxable years beginning on or after October
25, 1991. For remittances made in taxable years beginning on or after
October 25, 1991, the post-86 profits and EQ pools are combined into one
pool called the equity pool. Therefore, remittances made during those
taxable years will only come from the equity pool. The dollar basis of,
and section 987 gain or loss on, such remittances shall be calculated
utilizing the principles set forth in paragraphs (d)(4) and (5) of this
section.
(d) Calculation of section 987 gain or loss--(1) In general. This
paragraph (d) describes the 4-step procedure for calculating section 987
gain or loss.
(2) Step 1--Calculate the amount of the functional currency pools--
(i) EQ pool-- (A) Beginning pool. The beginning amount of the EQ pool is
equal to the functional currency adjusted bases of a QBU branch's assets
less the functional currency amount of the QBU branch's liabilities at
the end of the taxpayer's last taxable year beginning before January 1,
1987, as these amounts are determined under the rules of paragraphs (e)
and (f) of the section. The district director may allow for additional
adjustments to the beginning amount of the EQ pool to prevent the
recognition of section 987 gain or loss due to factors unrelated to the
movement of exchange rates.
(B) Adjusting the EQ pool. The EQ pool is increased by the
functional currency amount of any transfer (as determined under section
987) to the QBU branch made during the current taxable year or any prior
taxable year beginning after December 31, 1986. If the transfer is made
in a nonfunctional currency, this amount is translated into the QBU
branch's functional currency at the spot rate (determined under the
principles of section 988 and the regulations thereunder) on the date of
the transfer. The method for determining the rate must be applied
consistently each quarter. The EQ pool is decreased by the functional
currency amount of any remittance (as determined under section 987) made
during a
[[Page 573]]
prior taxable year beginning after December 31, 1986, that is considered
remitted from the EQ pool under paragraph (c) of this section. The EQ
pool must also be decreased by any transfer from the QBU branch that is
not a remittance.
(ii) Post-86 profits pool. The amount of a QBU branch's post-86
profits pool is calculated at the end of each taxable year beginning
after December 31, 1986. The opening balance of the post-86 profits pool
at the beginning of the first taxable year beginning after December 31,
1986, is zero. The post-86 profits pool is increased by the functional
currency amount of the QBU branch's profits (determined under section
987) for the taxable year. The post-86 profits pool is decreased by the
functional currency amount of the QBU branch's losses (determined under
section 987) for the taxable year and the amount of any remittances by
the QBU branch during the taxable year from the post-86 profits pool as
provided under paragraph (c) of this section.
(iii) Adjustments to the equity pool. For remittances made in
taxable years beginning on or after October 25, 1991 under paragraph
(c)(2) of this section, the post-86 profits and EQ pools are combined
into one pool called the equity pool. Additions to and subtractions from
the equity pool shall be made utilizing the principles of paragraphs
(d)(2)(i)(B) and (ii) of this section. For example, remittances shall
reduce the equity pool.
(3) Step 2--Calculate the dollar basis of the pools--(i) Dollar
basis of the EQ pool--(A) Beginning dollar basis. The beginning dollar
basis of the EQ pool (hereinafter referred to as the $E pool) equals:
(1) The dollar amount of all the QBU branch's profits reported on
the taxpayer's income tax returns for taxable years beginning before
January 1, 1987, plus the total dollar amount of all transfers to the
QBU branch during that period (properly reflected on the taxpayer's
books), less
(2) The dollar amount of all the QBU branch's losses reported on the
taxpayer's income tax returns for such years, and the total dollar basis
of all remittances and all transfers made by the QBU branch during that
period (properly reflected on the taxpayer's books).
A QBU branch's profits and losses shall be properly adjusted for foreign
taxes of the QBU branch.
(B) Adjusting the $E pool. The $E pool is increased by the dollar
amount of any transfers to the QBU branch made during the current
taxable year or any prior taxable year beginning after December 31,
1986. If a transfer is made in a currency other than the dollar, the
amount of the currency is translated into dollars at the spot rate
(determined under the principles of section 988 and the regulations
thereunder) on the date of the transfer. The $E pool is decreased by the
dollar basis of any remittance made during a prior taxable year
beginning after December 31, 1986, that is considered remitted from the
$E pool under paragraphs (c) and (d)(4) of these section. The $E pool is
also reduced by the amount of a transfer (other than a remittance) from
the QBU branch translated into dollars at the spot rate (determined
under the principles of section 988 and the regulations thereunder) on
the date of the transfer. The method for determining the spot rate must
be applied consistently to all transfers to and from a QBU branch.
(ii) Dollar basis of the post-86 profits pool. The amount of a QBU
branch's dollar basis in the post-86 profits pool (the $P pool) is
calculated at the end of each taxable year beginning after December 31,
1986. The opening balance of the $P pool at the beginning of the first
taxable year beginning after December 31, 1986, is zero. The $P pool is
increased by the functional currency amount of the QBU branch's profits
(determined under section 987) for the taxable year translated into
dollars at the weighted average exchange rate (as defined in Sec. 1.989
(b)-1) for the year. The $P pool is decreased by the functional currency
amount of the QBU branch's losses (determined under section 987) for the
taxable year translated into dollars at the weighted average exchange
rate for the year and by the dollar basis of any remittances made by the
QBU branch during the taxable year from the post-86 profits pool under
paragraph (c)(1) of this section.
[[Page 574]]
(iii) Combination of the $E and the $P pools. For taxable years
beginning on or after October 25, 1991 the $P and the $E pools are
combined into one pool called the basis pool. Additions to and
subtractions from the basis pool shall be made utilizing the principles
set forth in paragraphs (d)(3)(i) and (ii) of this section.
(4) Step 3--Calculation of the dollar basis of a remittance. For all
taxable years beginning after December 31, 1986, the dollar basis of a
remittance is calculated using the following formula:
[GRAPHIC] [TIFF OMITTED] TC09OC91.064
(5) Step 4--Calculation of the section 987 gain or loss on a
remittance. Section 987 gains or loss equals the difference between--
(i) The dollar amount of the remittance, and
(ii) The dollar basis of the remittance as calculated under
paragraph (d)(4) of this section.
(e) Functional currency adjusted basis of QBU branch assets acquired
in taxable years beginning before January 1, 1987--(1) Basis of asset.
For taxable years beginning after December 31, 1986, the functional
currency adjusted basis of a QBU branch asset acquired in a taxable year
beginning before January 1, 1987, is the functional currency basis of
the asset at the date of acquisition, as adjusted according to United
States tax principles. The functional currency adjusted basis of an
asset for which a functional currency basis was not determined at the
date of acquisition is the nonfunctional currency basis of the asset at
the date of acquisition multiplied by the spot exchange rate on the date
of acquisition, as adjusted according to United States tax principles.
(2) Adjustment to basis of asset. Any future adjustments to the
functional currency adjusted basis of such an asset are determined with
respect to the appropriate functional currency adjusted basis of the
asset as determined under this paragraph (e).
(f) Functional currency amount of QBU branch liabilities acquired in
taxable years beginning before January 1, 1987. For the first taxable
year beginning after December 31, 1986, the amount of a QBU branch
liability incurred in a taxable year beginning before January 1, 1987,
is the functional currency amount of the liability at the date incurred,
as adjusted according to United States tax principles. The functional
currency amount of a liability for which a functional currency amount
was not determined at the date incurred is the nonfunctional currency
amount of the liability at the date incurred multiplied by the spot
exchange rate on the date incurred, as adjusted according to the United
States tax principles.
(g) Examples. The provisions of this section are illustrated by the
following examples.
Example 1: (i) Facts. U.S. is a domestic corporation. B, a QBU
branch of U.S., operates in country X and was established in 1985. B's
functional currency is the FC. U.S. is on a calendar taxable year and,
prior to January 1, 1987, accounted for the operations of B by the
profit and loss method of accounting as set forth in Rev. Rul. 75-107,
1975-1 C.B. 32. B's books and records were kept according to United
States tax principles. B received a transfer of $2,000 in 1985, and had
profits of $3,000 in 1985 and $5,000 in 1986. B made a remittance in
1986, the dollar basis of which was $1,000. As of December 31, 1986, the
adjusted basis of B's functional currency assets exceeded the functional
currency amount of its liabilities by 15,000 FC (the beginning pool of
EQ). Under section 987, B has profits of 8,000 FC in 1987, which are
worth $1,000 when translated at the weighted average exchange rate for
1987 as required by sections 987(2) and 989(b)(4). B has no profits or
loss in 1988. There are no transfers to B in 1987 and 1988. B remits
18,000 FC in 1988. Under section 987, the appropriate exchange rate for
the 1988 remittance is 10 FC/$1.
[[Page 575]]
(ii) Calculation of section 987 loss on remittance--(A) Post-86
profits. Under paragraph (c)(i) of this section, the 18,000 FC
remittance comes first out of the post-86 profits pool (8,000 FC) and
second out of EQ (10,000 FC). The loss on the 1988 remittance out of the
post-86 profits pool equals:
Dollar value of post-86 profits remitted - Dollar basis of post-86
profits remitted=
(8,000 FC x 10 FC/$1) - $1,000 = $800 - $1,000 = <=$200 loss.
(B) EQ. Under paragraph (d) of this section, U.S. calculates 987
gain or loss on the 10,000 FC remittance of EQ from B as follows:
Step 1. The total EQ pool equals 15,000 FC (the functional currency
adjusted bases of its assets less the functional currency amount of its
liabilities as of December 31, 1986). There are no adjustments necessary
under paragraph (d)(2)(i)(B) of this section.
Step 2. The $E pool is $9,000 (the $2,000 transfer in 1985 plus
profits of $3,000 in 1985 and $5,000 in 1986 and less than $1,000 basis
of the 1986 remittance). There are no adjustments necessary under
paragraph (d)(3)(i)(B) of this section.
Step 3. The entire 10,000 FC remittance is deemed to come out of EQ.
Step 4. The dollar basis of the EQ remitted equals: N x $E
determined under paragraph (d)(3)(i)=
[GRAPHIC] [TIFF OMITTED] TC09OC91.065
Where:
[GRAPHIC] [TIFF OMITTED] TC09OC91.066
Step 5. Section 987 loss of U.S. on remittance equals:
Dollar value of the EQ remitted - Dollar basis of the EQ remitted =
(10,000 FC x 10 FC/$1) - $6,000 = $1,000 - $6,000 = <=$5,000
loss.
(C) Total loss on remittance. The total combined loss on the
remittance is '$5,200. The total of amounts determined in
paragraphs (ii)(A) and (B) of this Example 1.
Example 2: (i) Facts. D is a domestic corporation. B, a QBU branch
of D, operates in country X. B's functional currency is the FC. At the
end of B's last taxable year beginning before October 25, 1991, B's EQ
pool equals 15,000 FC and B's post-86 profits pool equals 8,000 FC. B's
$E amount equals $9,000, and the $P pool equals $1,000. In B's first
taxable year beginning on or after October 25, 1991, B remits 18,000 FC.
Under section 987, the appropriate exchange rate for this remittance is
10FC:$1.
(ii) Computation of the equity pool.
15,000 FC (EQ pool) + 8,000 FC (post-86 profits pool) = 23,000 FC
(equity pool)
(iii) Computation of the basis pool.
[GRAPHIC] [TIFF OMITTED] TC09OC91.067
(iv) Dollar basis in remittance.
[GRAPHIC] [TIFF OMITTED] TC09OC91.068
(v) Computation of section 987 loss by U.S. on remittance.
[GRAPHIC] [TIFF OMITTED] TC09OC91.069
[[Page 576]]
(h) Character and source of section 987 gain or loss. Section 987
gain or loss is sourced and characterized as provided by section 987 and
regulations issued under that section.
[T.D. 8367, 56 FR 48434, Sept. 25, 1991; 56 FR 65684, Dec. 18, 1991]
Sec. 1.988-0 Taxation of gain or loss from a section 988 transaction; Table of Contents.
This section lists captioned paragraphs contained in Sec. Sec.
1.988-1 through 1.988-5.
Sec. 1.988-1 Certain definitions and special rules.
(a) Section 988 transaction.
(1) In general.
(2) Description of transactions.
(3)-(5) [Reserved]
(6) Examples.
(7) Special rules for regulated futures contracts and non-equity
options.
(8) Special rules for qualified funds.
(9) Exception for certain transactions entered into by an
individual.
(10) Intra-taxpayer transactions.
(11) Authority of Commissioner to include or exclude transactions
from section 988.
(b) Spot contract.
(c) Nonfunctional currency.
(d) Spot rate.
(1) In general.
(2) Consistency required in valuing transactions subject to section
988.
(3) Use of certain spot rate conventions for payables and
receivables denominated in nonfunctional currency.
(4) Currency where an official government established rate differs
from a free market rate.
(e) Exchange gain or loss.
(f) Hyperinflationary currency.
(g) Fair market value.
(h) Interaction with sections 1092 and 1256 in examples.
(i) Effective date.
Sec. 1.988-2 Recognition and computation of exchange gain or loss.
(a) Disposition of nonfunctional currency.
(1) Recognition of exchange gain or loss.
(2) Computation of exchange gain or loss.
(b) Translation of interest income or expense and determination of
exchange gain or loss with respect to debt instruments.
(1) Translation of interest income received with respect to a
nonfunctional currency demand account.
(2) Translation of nonfunctional currency interest income or expense
received or paid with respect to a debt instrument described in Sec.
1.988-1(a)(1)(ii) and (2)(i).
(3) Exchange gain or loss recognized by the holder with respect to
accrued interest income.
(4) Exchange gain or loss recognized by the obligor with respect to
accrued interest expense.
(5) Exchange gain or loss recognized by the holder of a debt
instrument with respect to principal.
(6) Exchange gain or loss recognized by the obligor of a debt
instrument with respect to principal.
(7) Payment ordering rules.
(8) Limitation of exchange gain or loss on payment or disposition of
a debt instrument.
(9) Examples.
(10) Treatment of bond premium.
(11) Market discount.
(12) Tax exempt bonds.
(13) Nonfunctional currency debt exchanged for stock of obligor.
(14) [Reserved]
(15) Debt instruments and deposits denominated in hyperinflationary
currencies.
(16) Coordination with section 267 regarding debt instruments.
(17) Coordination with installment method under section 453.
(c) Item of expense or gross income or receipts which is to be paid
or received after the date accrued.
(1) In general.
(2) Determination of exchange gain or loss with respect to an item
of gross income or receipts.
(3) Determination of exchange gain or loss with respect to an item
of expense.
(4) Examples.
(d) Exchange gain or loss with respect to forward contracts, futures
contracts and option contracts.
(1) Scope.
(2) Realization of exchange gain or loss.
(3) Recognition of exchange gain or loss.
(4) Determination of exchange gain or loss.
(5) Hyperinflationary contracts.
(e) Currency swaps and notional principal contracts.
(1) Notional principal contract denominated in a single
nonfunctional currency.
(2) Special rules for currency swaps.
(3) Amortization of swap premium or discount in the case of off
market swaps.
(4) Treatment of taxpayer disposing of a currency swap.
(5) Examples.
(6) Special effective date for rules regarding currency swaps.
(7) Special rules for currency swap contracts in hyperinflationary
currencies.
(f) Substance over form.
(1) In general.
(2) Example.
(g) Effective date.
Sec. 1.988-3 Character of exchange gain or loss.
(a) In general.
[[Page 577]]
(b) Election to characterize exchange gain or loss on certain
identified forward contracts, futures contracts and option contracts as
capital gain or loss.
(1) In general.
(2) Special rule for contracts that become part of a straddle after
the election is made.
(3) Requirements for making the election.
(4) Verification.
(5) Independent verification.
(6) Effective date.
(c) Exchange gain or loss treated as interest.
(1) In general.
(2) Exchange loss realized by the holder on nonfunctional currency
tax exempt bonds.
(d) Effective date.
Sec. 1.988-4 Source of gain or loss realized on a section 988
transaction.
(a) In general.
(b) Qualified business unit.
(1) In general.
(2) Proper reflection on the books of the taxpayer or qualified
business unit.
(c) Effectively connected exchange gain or loss.
(d) Residence.
(1) In general.
(2) Exception.
(3) Partner in a partnership not engaged in a U.S. trade or business
under section 864(b)(2).
(e) Special rule for certain related party loans.
(1) In general.
(2) United States person.
(3) Loans by related person.
(4) 10 percent owned foreign corporation.
(f) Exchange gain or loss treated as interest under Sec. 1.988-3.
(g) Exchange gain or loss allocated in the same manner as interest
under Sec. 1.861-9T.
(h) Effective date.
Sec. 1.988-5 Section 988(d) hedging transactions.
(a) Integration of a nonfunctional currency debt instrument and a
Sec. 1.988-5(a) hedge.
(1) In general.
(2) Exception.
(3) Qualifying debt instrument.
(4) Section 1.988-5(a) hedge.
(5) Definition of integrated economic transaction.
(6) Special rules for legging in and legging out of integrated
treatment.
(7) Transactions part of a straddle.
(8) Identification requirements.
(9) Taxation of qualified hedging transactions.
(10) Transition rules and effective dates.
(b) Hedged executory contracts.
(1) In general.
(2) Definitions.
(3) Identification rules.
(4) Effect of hedged executory contract.
(5) References to this paragraph (b).
(c) Hedges of period between trade date and settlement date on
purchase or sale of publicly traded stock or security.
(d) [Reserved]
(e) Advance rulings regarding net hedging and anticipatory hedging
systems.
(f) [Reserved]
(g) General effective date.
[T.D. 8400, 57 FR 9177, Mar. 17, 1992, as amended by T.D. 8860, 65 FR
2028, Jan. 13, 2000]
Sec. 1.988-1 Certain definitions and special rules.
(a) Section 988 transaction--(1) In general. The term ``section 988
transaction'' means any of the following transactions--
(i) A disposition of nonfunctional currency as defined in paragraph
(c) of this section;
(ii) Any transaction described in paragraph (a)(2) of this section
if any amount which the taxpayer is entitled to receive or is required
to pay by reason of such transaction is denominated in terms of a
nonfunctional currency or is determined by reference to the value of one
or more nonfunctional currencies.
A transaction described in this paragraph (a) need not require or permit
payment with a nonfunctional currency as long as any amount paid or
received is determined by reference to the value of one or more
nonfunctional currencies. The acquisition of nonfunctional currency is
treated as a section 988 transaction for purposes of establishing the
taxpayer's basis in such currency and determining exchange gain or loss
thereon.
(2) Description of transactions. The following transactions are
described in this paragraph (a)(2).
(i) Debt instruments. Acquiring a debt instrument or becoming an
obligor under a debt instrument. The term ``debt instrument'' means a
bond, debenture, note, certificate or other evidence of indebtedness.
(ii) Payables, receivables, etc. Accruing, or otherwise taking into
account, for purposes of subtitle A of the Internal Revenue Code, any
item of expense or gross income or receipts which is to be paid or
received after the date on which so accrued or taken into account. A
payable relating to cost of
[[Page 578]]
goods sold, or a payable or receivable relating to a capital expenditure
or receipt, is within the meaning of this paragraph (a)(2)(ii).
Generally, a payable relating to foreign taxes (whether or not claimed
as a credit under section 901) is within the meaning of this paragraph
(a)(2)(ii). However, a payable of a domestic person relating to accrued
foreign taxes of its qualified business unit (QBU branch) is not within
the meaning of this paragraph (a)(2)(ii) if the QBU branch's functional
currency is the U.S. dollar and the foreign taxes are claimed as a
credit under section 901.
(iii) Forward contract, futures contract, option contract, or
similar financial instrument. Except as otherwise provided in this
paragraph (a)(2)(iii) and paragraph (a)(4)(i) of this section, entering
into or acquiring any forward contract, futures contract, option,
warrant, or similar financial instrument.
(A) Limitation for certain derivative instruments. A forward
contract, futures contract, option, warrant, or similar financial
instrument is within this paragraph (a)(2)(iii) only if the underlying
property to which the instrument ultimately relates is a nonfunctional
currency or is otherwise described in paragraph (a)(1)(ii) of this
section. Thus, if the underlying property of an instrument is another
financial instrument (e.g., an option on a futures contract), then the
underlying property to which such other instrument (e.g., the futures
contract) ultimately relates must be a nonfunctional currency. For
example, a forward contract to purchase wheat denominated in a
nonfunctional currency, an option to enter into a forward contract to
purchase wheat denominated in a nonfunctional currency, or a warrant to
purchase stock denominated in a nonfunctional currency is not described
in this paragraph (a)(2)(iii). On the other hand, a forward contract to
purchase a nonfunctional currency, an option to enter into a forward
contract to purchase a nonfunctional currency, an option to purchase a
bond denominated in or the payments of which are determined by reference
to the value of a nonfunctional currency, or a warrant to purchase
nonfunctional currency is described in this paragraph (a)(2)(iii).
(B) Nonfunctional currency notional principal contracts--(1) In
general. The term ``similar financial instrument'' includes a notional
principal contract only if the payments required to be made or received
under the contract are determined with reference to a nonfunctional
currency.
(2) Definition of notional principal contract. The term ``notional
principal contract'' means a contract (e.g., a swap, cap, floor or
collar) that provides for the payment of amounts by one party to another
at specified intervals calculated by reference to a specified index upon
a notional principal amount in exchange for specified consideration or a
promise to pay similar amounts. For this purpose, a ``notional principal
contract'' shall only include an instrument where the underlying
property to which the instrument ultimately relates is money (e.g.,
functional currency), nonfunctional currency, or property the value of
which is determined by reference to an interest rate. Thus, the term
``notional principal contract'' includes a currency swap as defined in
Sec. 1.988-2(e)(2)(ii), but does not include a swap referenced to a
commodity or equity index.
(C) Effective date with respect to certain contracts. This paragraph
(a)(2)(iii) does not apply to any forward contract, futures contract,
option, warrant, or similar financial instrument entered into or
acquired on or before October 21, 1988, if such instrument would have
been marked to market under section 1256 if held on the last day of the
taxable year.
(3)-(5) [Reserved]
(6) Examples. The following examples illustrate the application of
paragraph (a) of this section. The examples assume that X is a U.S.
corporation on an accrual method with the calendar year as its taxable
year. Because X is a U.S. corporation the U.S. dollar is its functional
currency under section 985. The examples also assume that section 988(d)
does not apply.
Example 1. On January 1, 1989, X acquires 10,000 Canadian dollars.
On January 15, 1989, X uses the 10,000 Canadian dollars to purchase
inventory. The acquisition of the 10,000 Canadian dollars is a section
988 transaction for purposes of establishing X's basis in such Canadian
dollars. The disposition of the
[[Page 579]]
10,000 Canadian dollars is a section 988 transaction pursuant to
paragraph (a)(1) of this section.
Example 2. On January 1, 1989, X acquires 10,000 Canadian dollars.
On January 15, 1989, X converts the 10,000 Canadian dollars to U.S.
dollars. The acquisition of the 10,000 Canadian dollars is a section 988
transaction for purposes of establishing X's basis in such Canadian
dollars. The conversion of the 10,000 Canadian dollars to U.S. dollars
is a section 988 transaction pursuant to paragraph (a)(1) of this
section.
Example 3. On January 1, 1989, X borrows 100,000 British pounds
([pound]) for a period of 10 years and issues a note to the lender with
a face amount of [pound]100,000. The note provides for payments of
interest at an annual rate of 10% paid quarterly in pounds and has a
stated redemption price at maturity of [pound]100,000. X's becoming the
obligor under the note is a section 988 transaction pursuant to
paragraphs (a)(1)(ii) and (2)(i) of this section. Because X is an
accrual basis taxpayer, the accrual of interest expense under X's note
is a section 988 transaction pursuant to paragraphs (a)(1)(ii) and
(2)(ii) of this section. In addition, the acquisition of the British
pounds to make payments under the note is a section 988 transaction for
purposes of establishing X's basis in such pounds, and the disposition
of such pounds is a section 988 transaction under paragraph (a)(1)(i) of
this section. See Sec. 1.988-2(b) with respect to the translation of
accrued interest expense and the determination of exchange gain or loss
upon payment of accrued interest expense.
Example 4. On January 1, 1989, X purchases an original issue for
74,621.54 British pounds ([pound]) a 3-year bond maturing on December
31, 1991, at a stated redemption price of [pound]100,000. The bond
provides for no stated interest. The bond has a yield to maturity of 10%
compounded semiannually and has [pound]25,378.46 of original issue
discount. The acquisition of the bond is a section 988 transaction as
provided in paragraphs (a)(1)(ii) and (2)(i) of this section. The
accrual of original issue discount with respect to the bond is a section
988 transaction under paragraphs (a)(1)(ii) and (2)(ii) of this section.
See Sec. 1.988-2(b) with respect to the translation of original issue
discount and the determination of exchange gain or loss upon receipt of
such amounts.
Example 5. On January 1, 1989, X sells and delivers inventory to Y
for 10,000,000 Italian lira for payment on April 1, 1989. Under X's
method of accounting, January 1, 1989 is the accrual date. Because X is
an accrual basis taxpayer, the accrual of a nonfunctional currency
denominated item of gross receipts on January 1, 1989, for payment after
the date of accrual is a section 988 transaction under paragraphs
(a)(1)(ii) and (2)(ii) of this section.
Example 6. On January 1, 1989, X agrees to purchase a machine from Y
for delivery on March 1, 1990 for 1,000,000 yen. The agreement calls for
X to pay Y for the machine on June 1, 1990. Under X's method of
accounting, the expenditure for the machine does not accrue until
delivery on March 1, 1990. The agreement to purchase the machine is not
a section 988 transaction. In particular, the agreement to purchase the
machine is not described in paragraph (a)(2)(ii) of this section because
the agreement is not an item of expense taken into account under
subtitle A (but rather is an agreement to purchase a capital asset in
the future). However, the payable that will arise on the delivery date
is a section 988 transaction under paragraphs (a)(1)(ii) and (2)(ii) of
this section even though the payable relates to a capital expenditure.
In addition, the disposition of yen to satisfy the payable on June 1,
1990, is a section 988 transaction under paragraph (a)(1)(i) of this
section.
Example 7. On January 1, 1989, X purchases and takes delivery of
inventory for 10,000 French francs with payment to be made on April 1,
1989. Under X's method of accounting, the expense accrues on January 1,
1989. On January 1, 1989, X also enters into a forward contract with a
bank to purchase 10,000 French francs for $2,000 on April 1, 1989.
Because X is an accrual basis taxpayer, the accrual of a nonfunctional
currency denominated item of expense on January 1, 1989, for payment
after the date of accrual is a section 988 transaction under paragraphs
(a)(1)(ii) and (2)(ii) of this section. Entering into the forward
contract to purchase the 10,000 French francs is a section 988
transaction under paragraphs (a)(1)(ii) and (2)(iii) of this section.
Example 8. On January 1, 1989, X acquires 100,000 Norwegian krone.
On January 15, 1989, X purchases and takes delivery of 1,000 shares of
common stock with the 100,000 krone acquired on January 1, 1989. On
August 1, 1989, X sells the 1,000 shares of common stock and receives
120,000 krone in payment. On August 30, 1989, X converts the 120,000
krone to U.S. dollars. The acquisition of the 100,000 krone on January
1, 1989, and the acquisition of the 120,000 krone on August 1, 1989, are
section 988 transactions for purposes of establishing the basis of such
krone. The disposition of the 100,000 krone on January 15, 1989, and the
120,000 krone on August 30, 1989, are section 988 transactions as
provided in paragraph (a)(1)(i) of this section. Neither the acquisition
on January 15, 1989, nor the disposition on August 1, 1989, of the stock
is a section 988 transaction.
Example 9. On May 11, 1989, X purchases a one year note at original
issue for its issue price of $1,000. The note pays interest in dollars
at the rate of 4 percent compounded semiannually. The amount of
principal received by X upon maturity is equal to $1,000 plus the
equivalent of the excess, if any, of (a) the Financial Times One Hundred
Stock
[[Page 580]]
Index (an index of stocks traded on the London Stock Exchange hereafter
referred to as the FT100) determined and translated into dollars on the
last business day prior to the maturity date, over (b) [pound]2,150, the
``stated value'' of the FT100, which is equal to 110% of the average
value of the index for the six months prior to the issue date,
translated at the exchange rate of [pound]1=$1.50. The purchase by X of
the instrument described above is not a section 988 transaction because
the index used to compute the principal amount received upon maturity is
determined with reference to the value of stock and not nonfunctional
currency.
Example 10. On April 9, 1989, X enters into an interest rate swap
that provides for the payment of amounts by X to its counterparty based
on 4% of a 10,000 yen principal amount in exchange for amounts based on
yen LIBOR rates. Pursuant to paragraphs (a)(1)(ii) and (2)(iii) of this
section, this yen for yen interest rate swap is a section 988
transaction.
Example 11. On August 11, 1989, X enters into an option contract for
sale of a group of stocks traded on the Japanese Nikkei exchange. The
contract is not a section 988 transaction within the meaning of Sec.
1.988-1(a)(2)(iii) because the underlying property to which the option
relates is a group of stocks and not nonfunctional currency.
(7) Special rules for regulated futures contracts and non-equity
options--(i) In general. Except as provided in paragraph (a)(7)(ii) of
this section, paragraph (a)(2)(iii) of this section shall not apply to
any regulated futures contract or non-equity option which would be
marked to market under section 1256 if held on the last day of the
taxable year.
(ii) Election to have paragraph (a)(2)(iii) of this section apply.
Notwithstanding paragraph (a)(7)(i) of this section, a taxpayer may
elect to have paragraph (a)(2)(iii) of this section apply to regulated
futures contracts and non-equity options as provided in paragraphs
(a)(7)(iii) and (iv) of this section.
(iii) Procedure for making the election. A taxpayer shall make the
election provided in paragraph (a)(7)(ii) of this section by sending to
the Internal Revenue Service Center, Examination Branch, Stop Number 92,
Kansas City, MO 64999 a statement titled ``Election to Treat Regulated
Futures Contracts and Non-Equity Options as Section 988 Transactions
Under Section 988 (c)(1)(D)(ii)'' that contains the following:
(A) The taxpayer's name, address, and taxpayer identification
number;
(B) The date the notice is mailed or otherwise delivered to the
Internal Revenue Service Center;
(C) A statement that the taxpayer (including all members of such
person's affiliated group as defined in section 1504 or in the case of
an individual all persons filing a joint return with such individual)
elects to have section 988(c)(1)(D)(i) and Sec. 1.988-1(a)(7)(i) not
apply;
(D) The date of the beginning of the taxable year for which the
election is being made;
(E) If the election is filed after the first day of the taxable
year, a statement regarding whether the taxpayer has previously held a
contract described in section 988(c)(1)(D)(i) or Sec. 1.988-1(a)(7)(i)
during such taxable year, and if so, the first date during the taxable
year on which such contract was held; and
(F) The signature of the person making the election (in the case of
individuals filing a joint return, the signature of all persons filing
such return).
The election shall be made by the following persons: in the case of an
individual, by such individual; in the case of a partnership, by each
partner separately; effective for taxable years beginning after March
17, 1992, in the case of tiered partnerships, each ultimate partner; in
the case of an S corporation, by each shareholder separately; in the
case of a trust (other than a grantor trust) or estate, by the fiduciary
of such trust or estate; in the case of any corporation other than an S
corporation, by such corporation (in the case of a corporation that is a
member of an affiliated group that files a consolidated return, such
election shall be valid and binding only if made by the common parent,
as that term is used in Sec. 1.1502-77(a)); in the case of a controlled
foreign corporation, by its controlling United States shareholders under
Sec. 1.964-1(c)(3). With respect to a corporation (other than an S
corporation), the election, when made by the common parent, shall be
binding on all members of such corporation's affiliated group as defined
in section 1504
[[Page 581]]
that file a consolidated return. The election shall be binding on any
income or loss derived from the partner's share (determined under the
principles of section 702(a)) of all contracts described in section
988(c)(1)(D)(i) or paragraph (a)(7)(i) of this section in which the
taxpayer holds a direct interest or indirect interest through a
partnership or S corporation; however, the election shall not apply to
any income or loss of a partnership for any taxable year if such
partnership made an election under section 988(c)(1)(E)(iii)(V) for such
year or any preceding year. Generally, a copy of the election must be
attached to the taxpayer's income tax return for the first year it is
effective. It is not required to be attached to subsequent returns.
However, in the case of a partner, a copy of the election must be
attached to the taxpayer's income tax return for every year during which
the taxpayer is a partner in a partnership that engages in a transaction
that is subject to the election.
(iv) Time for making the election--(A) In general. Unless the
requirements for making a late election described in paragraph
(a)(7)(iv)(B) of this section are satisfied, an election under section
988 (c)(1)(D)(ii) and paragraph (a)(7)(ii) of this section for any
taxable year shall be made on or before the first day of the taxable
year or, if later, on or before the first day during such taxable year
on which the taxpayer holds a contract described in section
988(c)(1)(D)(ii) and paragraph (a)(7)(ii) of this section. The election
under section 988(c)(1)(D)(ii) and paragraph (a)(7)(ii) of this section
shall apply to contracts entered into or acquired after October 21,
1988, and held on or after the effective date of the election. The
election shall be effective as of the beginning of the taxable year and
shall be binding with respect to all succeeding taxable years unless
revoked with the prior consent of the Commissioner. In determining
whether to grant revocation of the election, recapture of the tax
benefit derived from the election in previous taxable years will be
considered.
(B) Late elections. A taxpayer may make an election under section
988(c)(1)(D)(ii) and paragraph (a)(7)(ii) of this section within 30 days
after the time prescribed in the first sentence of paragraph
(a)(7)(iv)(A) of this section. Such a late election shall be effective
as of the beginning of the taxable year; however, any losses recognized
during the taxable year with respect to contracts described in section
988(c)(1)(D)(ii) or paragraph (a)(7)(ii) of this section which were
entered into or acquired after October 21, 1988, and held on or before
the date on which the late election is mailed or otherwise delivered to
the Internal Revenue Service Center shall not be treated as derived from
a section 988 transaction. A late election must comply with the
procedures set forth in paragraph (a)(7)(iii) of this section.
(v) Transition rule. An election made prior to September 21, 1989
which satisfied the requirements of Notice 88-124, 1988-51 I.R.B. 6,
shall be deemed to satisfy the requirements of paragraphs (a)(7)(iii)
and (iv) of this section.
(vi) General effective date provision. This paragraph (a)(7) shall
apply with respect to futures contracts and options entered into or
acquired after October 21, 1988.
(8) Special rules for qualified funds--(i) Definition of qualified
fund. The term ``qualified fund'' means any partnership if--
(A) At all times during the taxable year (and during each preceding
taxable year to which an election under section 988(c)(1)(E)(iii)(V)
applied) such partnership has at least 20 partners and no single partner
owns more than 20 percent of the interests in the capital or profits of
the partnership;
(B) The principa1 activity of such partnership for such taxable year
(and each such preceding taxable year) consists of buying and selling
options, futures, or forwards with respect to commodities;
(C) At least 90 percent of the gross income of the partnership for
the taxable year (and each such preceding year) consists of income or
gains described in subparagraph (A), (B), or (G) of section 7704(d)(1)
or gain from the sale or disposition of capital assets held for the
production of interest or dividends;
(D) No more than a de minimis amount of the gross income of the
partnership for the taxable year (and
[[Page 582]]
each such preceding taxable year) was derived from buying and selling
commodities; and
(E) An election under section 988 (c)(1)(E)(iii)(V) as provided in
paragraph (a)(8)(iv) of this section applies to the taxable year.
(ii) Special rules relating to paragraph (a)(8)(i)(A) of this
section--(A) Certain general partners. The interest of a general partner
in the partnership shall not be treated as failing to meet the 20
percent ownership requirement of paragraph (a)(8)(i)(A) of this section
for any taxable year of the partnership if, for the taxable year of the
partner in which such partnership's taxable year ends, such partner (and
each corporation filing a consolidated return with such partner) had no
ordinary income or loss from a section 988 transaction (other than
income from the partnership) which is exchange gain or loss (as the case
may be).
(B) Treatment of incentive compensation. For purposes of paragraph
(a)(8)(i)(A) of this section, any income allocable to a general partner
as incentive compensation based on profits rather than capital shall not
be taken into account in determining such partner's interest in the
profits of the partnership.
(C) Treatment of tax exempt partners. The interest of a partner in
the partnership shall not be treated as failing to meet the 20 percent
ownership requirements of paragraph (a)(5)(8)(A) of this section if none
of the income of such partner from such partnership is subject to tax
under chapter 1 of subtitle A of the Internal Revenue Code (whether
directly or through one or more pass-through entities).
(D) Look-through rule. In determining whether the 20 percent
ownership requirement of paragraph (a)(8)(i)(A) of this section is met
with respect to any partnership, any interest in such partnership held
by another partnership shall be treated as held proportionately by the
partners in such other partnership.
(iii) Other special rules--(A) Related persons. Interests in the
partnership held by persons related to each other (within the meaning of
section 267(b) or 707(b)) shall be treated as held by one person.
(B) Predecessors. Reference to any partnership shall include a
reference to any predecessor thereof.
(C) Treatment of certain debt instruments. Solely for purposes of
paragraph (a)(8)(i)(D) of this section, any debt instrument which is
described in both paragraphs (a)(1)(ii) and (2)(i) of this section shall
be treated as a commodity.
(iv) Procedure for making the election provided in section
988(c)(1)(E)(iii)(V). A partnership shall make the election provided in
section 988(c)(1)(E)(iii)(V) by sending to the Internal Revenue Service
Center, Examination Branch, Stop Number 92, Kansas City, MO 64999 a
statement titled ``QUALIFIED FUND ELECTION UNDER SECTION
988(c)(1)(E)(iii)(V)'' that contains the following:
(A) The partnership's name, address, and taxpayer identification
number;
(B) The name, address and taxpayer identification number of the
general partner making the election on behalf of the partnership;
(C) The date the notice is mailed or otherwise delivered to the
Internal Revenue Service Center;
(D) A brief description of the activity of the partnership;
(E) A statement that the partnership is making the election provided
in section 988(c)(1)(E)(iii)(V);
(F) The date of the beginning of the taxable year for which the
election is being made;
(G) If the election is filed after the first day of the taxable
year, then a statement regarding whether the partnership previously held
an instrument referred to in section 988(c)(1)(E)(i) during such taxable
year and, if so, the first date during the taxable year on which such
contract was held; and
(H) The signature of the general partner making the election.
The election shall be made by a general partner with management
responsibility of the partnership's activities and a copy of such
election shall be attached to the partnership's income tax return (Form
1065) for the first taxable year it is effective. It is not required to
be attached to subsequent returns.
(v) Time for making the election. The election under section
988(c)(1)(E)(iii)(V) for any taxable year
[[Page 583]]
shall be made on or before the first day of the taxable year or, if
later, on or before the first day during such year on which the
partnership holds an instrument described in section 988(c)(1)(E)(i).
The election under section 988(c)(1)(E)(iii)(V) shall apply to the
taxable year for which made and all succeeding taxable years. Such
election may only be revoked with the consent of the Commissioner. In
determining whether to grant revocation of the election, recapture by
the partners of the tax benefit derived from the election in previous
taxable years will be considered.
(vi) Operative rules applicable to qualified funds--(A) In general.
In the case of a qualified fund, any bank forward contract or any
foreign currency futures contract traded on a foreign exchange which is
not otherwise a section 1256 contract shall be treated as a section 1256
contract for purposes of section 1256.
(B) Gains and losses treated as short-term. In the case of any
instrument treated as a section 1256 contract under paragraph
(a)(8)(vi)(A) of this section, subparagraph (A) of section 1256(a)(3)
shall be applied by substituting ``100 percent'' for ``40 percent'' (and
subparagraph (B) of such section shall not apply).
(vii) Transition rule. An election made prior to September 21, 1989,
which satisfied the requirements of Notice 88-124, 1988-51 I.R.B. 6,
shall be deemed to satisfy the requirements of Sec. 1.988-1(a)(8)(iv)
and (v).
(viii) General effective date rules--(A) The requirements of
subclause (IV) of section 988(c)(1)(E)(iii) shall not apply to contracts
entered into or acquired on or before October 21, 1988.
(B) In the case of any partner in an existing partnership, the 20
percent ownership requirements of subclause (I) of section
988(c)(1)(E)(iii) shall be treated as met during any period during which
such partner does not own a percentage interest in the capital or
profits of such partnership greater than 33\1/3\ percent (or, if lower,
the lowest such percentage interest of such partner during any period
after October 21, 1988, during which such partnership is in existence).
For purposes of the preceding sentence, the term ``existing
partnership'' means any partnership if--
(1) Such partnership was in existence on October 21, 1988, and
principally engaged on such date in buying and selling options, futures,
or forwards with respect to commodities; or
(2) A registration statement was filed with respect to such
partnership with the Securities and Exchange Commission on or before
such date and such registration statement indicated that the principal
activity of such partnership will consist of buying and selling
instruments referred to in paragraph (a)(8)(viii)(B)(1) of this section.
(9) Exception for certain transactions entered into by an
individual--(i) In general. A transaction entered into by an individual
which otherwise qualifies as a section 988 transaction shall be
considered a section 988 transaction only to the extent expenses
properly allocable to such transaction meet the requirements of section
162 or 212 (other than the part of section 212 dealing with expenses
incurred in connection with taxes).
(ii) Examples. The following examples illustrate the application of
paragraph (a)(9) of this section.
Example 1. X is a U.S. citizen who therefore has the U.S. dollar as
his functional currency. On January 1, 1990, X enters into a spot
contract to purchase 10,000 British pounds ([pound]) for $15,000 for
delivery on January 3, 1990. Immediately upon delivery, X acquires at
original issue a pound denominated bond with an issue price of
[pound]10,000. The bond matures on January 3, 1993, pays interest in
pounds at a rate of 10% compounded semiannually, and has no original
issue discount. Assume that all expenses properly allocable to these
transactions would meet the requirements of section 212. Under Sec.
1.988-2(d)(1)(ii), entering into the spot contract on January 1, 1990,
is not a section 988 transaction. The acquisition of the pounds on
January 3, 1990, under the spot contract is a section 988 transaction
for purposes of establishing X's basis in the pounds. The disposition of
the pounds and the acquisition of the bond by X are section 988
transactions. These transactions are not excluded from the definition of
a section 988 transaction under paragraph (a)(9) of this section because
expenses properly allocable to such transactions meet the requirements
of section 212.
Example 2. X is a U.S. citizen who therefore has the dollar as his
functional currency. In preparation for X's vacation, X purchases 1,000
British pounds ([pound]) from a bank on June
[[Page 584]]
1, 1989. During the period of X's vacation in the United Kingdom
beginning June 10, 1989, and ending June 20, 1989, X spends [pound]500
for hotel rooms, [pound]300 for food and [pound]200 for miscellaneous
vacation expenses. The expenses properly allocable to such dispositions
do not meet the requirements of section 162 or 212. Thus, the
disposition of the pounds by X on his vacation are not section 988
transactions.
(10) Intra-taxpayer transactions--(i) In general. Except as provided
in paragraph (a)(10)(ii) of this section, transactions between or among
the taxpayer and/or qualified business units of that taxpayer (``intra-
taxpayer transactions'') are not section 988 transactions. See section
987 and the regulations thereunder.
(ii) Certain transfers. Exchange gain or loss with respect to
nonfunctional currency or any item described in paragraph (a)(2) of this
section entered into with another taxpayer shall be realized upon an
intra-taxpayer transfer of such currency or item where as the result of
the transfer the currency or other such item--
(A) Loses its character as nonfunctional currency or an item
described in paragraph (a)(2) of this section; or
(B) Where the source of the exchange gain or loss could be altered
absent the application of this paragraph (a)(10)(ii).
Such exchange gain or loss shall be computed in accordance with Sec.
1.988-2 (without regard to Sec. 1.988-2(b)(8)) as if the nonfunctional
currency or item described in paragraph (a)(2) of this section had been
sold or otherwise transferred at fair market value between unrelated
taxpayers. For purposes of the preceding sentence, a taxpayer must use
the translation rate that it uses for purposes of computing section 987
gain or loss with respect to the QBU branch that makes the transfer. In
the case of a gain or loss incurred in a transaction described in this
paragraph (a)(10)(ii) that does not have a significant business purpose,
the Commissioner, may defer such gain or loss.
(iii) Example. The following example illustrates the provisions of
this paragraph (a)(10).
Example. (A) X, a corporation with the U.S. dollar as its functional
currency, operates through foreign branches Y and Z. Y and Z are
qualified business units as defined in section 989(a) with the LC as
their functional currency. X computes Y's and Z's income under section
987 (relating to branch transactions). On November 12, 1988, Y transfers
$25 to the home office of X when the fair market value of such amount
equals LC120. Y has a basis of LC100 in the $25. Under paragraph
(a)(10)(ii) of this section, Y realizes foreign source exchange gain of
LC20 (LC120--LC100) as the result of the $25 transfer. For purposes of
determining whether the transfer is a remittance resulting in additional
gain or loss, see section 987 and the regulations thereunder.
(B) If instead Y transfers the $25 to Z, exchange gain is not
realized because the $25 is nonfunctional currency with respect to Z and
if Z were to immediately convert the $25 into LCs, the gain would be
foreign source. For purposes of determining whether the transfer is a
remittance resulting in additional gain or loss, see section 987 and the
regulations thereunder.
(11) Authority to include or exclude transactions from section 988--
(i) In general. The Commissioner may recharacterize a transaction (or
series of transactions) in whole or in part as a section 988 transaction
if the effect of such transaction (or series of transactions) is to
avoid section 988. In addition, the Commissioner may exclude a
transaction (or series of transactions) which in form is a section 988
transaction from the provisions of section 988 if the substance of the
transaction (or series of transactions) indicates that it is not
properly considered a section 988 transaction.
(ii) Example. The following example illustrates the provisions of
this paragraph (a)(11).
Example. B is an individual with the U.S. dollar as its functional
currency. B holds 500,000 Swiss francs which have a basis of $100,000
and a fair market value of $400,000 as of October 15, 1989. On October
16, 1989, B transfers the 500,000 Swiss francs to a newly formed U.S.
corporation, X, with the dollar as its functional currency. On October
16, 1989, B sells the stock of X for $400,000. Assume the transfer to X
qualified for nonrecognition under section 351. Because the sale of the
stock of X is a substitute for the disposition of an asset subject to
section 988, the Commissioner may recharacterize the sale of the stock
as a section 988 transaction. The same result would obtain if B
transferred the Swiss francs to a partnership and then sold the
partnership interest.
(b) Spot contract. A spot contract is a contract to buy or sell
nonfunctional currency on or before two business
[[Page 585]]
days following the date of the execution of the contract. See Sec.
1.988-2 (d)(1)(ii) for operative rules regarding spot contracts.
(c) Nonfunctional currency. The term ``nonfunctional currency''
means with respect to a taxpayer or a qualified business unit (as
defined in section 989 (a)) a currency (including the European Currency
Unit) other than the taxpayer's or the qualified business unit's
functional currency as defined in section 985 and the regulations
thereunder. For rules relating to nonrecognition of exchange gain or
loss with respect to certain dispositions of nonfunctional currency, see
Sec. 1.988-2 (a)(1)(iii).
(d) Spot rate--(1) In general. Except as otherwise provided in this
paragraph, the term ``spot rate'' means a rate demonstrated to the
satisfaction of the District Director or the Assistant Commissioner
(International) to reflect a fair market rate of exchange available to
the public for currency under a spot contract in a free market and
involving representative amounts. In the absence of such a
demonstration, the District Director or the Assistant Commissioner
(International), in his or her sole discretion, shall determine the spot
rate from a source of exchange rate information reflecting actual
transactions conducted in a free market. For example, the taxpayer or
the District Director or the Assistant Commissioner (International) may
determine the spot rate by reference to exchange rates published in the
pertinent monthly issue of ``International Financial Statistics'' or a
successor publication of the International Monetary Fund; exchange rates
published by the Board of Governors of the Federal Reserve System
pursuant to 31 U.S.C. section 5151; exchange rates published in
newspapers, financial journals or other daily financial news sources; or
exchange rates quoted by electronic financial news services.
(2) Consistency required in valuing transactions subject to section
988. If the use of inconsistent sources of spot rate quotations results
in the distortion of income, the District Director or the Assistant
Commissioner (International) may determine the appropriate spot rate.
(3) Use of certain spot rate conventions for payables and
receivables denominated in nonfunctional currency. If consistent with
the taxpayer's financial accounting, a taxpayer may utilize a spot rate
convention determined at intervals of one quarter year or less for
purposes of computing exchange gain or loss with respect to payables and
receivables denominated in a nonfunctional currency that are incurred in
the ordinary course of business with respect to the acquisition or sale
of goods or the obtaining or performance of services. For example, if
consistent with the taxpayer's financial accounting, a taxpayer may
accrue all payables and receivables incurred during the month of January
at the spot rate on December 31 or January 31 (or at an average of any
spot rates occurring between these two dates) and record the payment or
receipt of amounts in satisfaction of such payables and receivables
consistent with such convention. The use of a spot rate convention
cannot be changed without the consent of the Commissioner.
(4) Currency where an official government established rate differs
from a free market rate--(i) In general. If a currency has an official
government established rate that differs from a free market rate, the
spot rate shall be the rate which most clearly reflects the taxpayer's
income. Generally, this shall be the free market rate.
(ii) Examples. The following examples illustrate the application of
this paragraph (d)(4).
Example 1. X is an accrual method U.S. corporation with the dollar
as its functional currency. X owns all the stock of a Country L
subsidiary, CFC. CFC has the currency of Country L, the LC, as its
functional currency. Country L imposes restrictions on the remittance of
dividends. On April 1, 1990, CFC pays a dividend to X in the amount of
LC100. Assume that the official governnent established rate is $1=LC1
and the free market rate, which takes into account the remittance
restrictions and which is the rate that most clearly reflects income, is
$1=LC4. On April 1, 1990, X donates the LC100 in a transaction that
otherwise qualifies as a charitable contribution under section 170 (c).
Both the amount of the dividend income and the deduction under section
170 is $25 (LC100 x the free market rate, $.25).
Example 2. X, a corporation with the U.S. dollar as its functional
currency, operates in
[[Page 586]]
foreign country L through branch Y. Y is a qualified business unit as
defined in section 989 (a). X computes Y's income under the dollar
approximate separate transactions method as described in Sec. 1.985-3.
The currency of L is the LC. X can purchase legally United States
dollars ($) in L only from the L government. In order to take advantage
of an arbitrage between the official and secondary dollar to LC exchange
rates in L:
(i) X purchases LC100 for $60 in L on the secondary market when the
official exchange rate is S1=LC1;
(ii) X transfers the LC100 to Y;
(iii) Y purchases $100 for LC100; and
(iv) Y transfers $65 ($100 less an L tax withheld of $35 on the
transfer) to the home office of X.
Under paragraph (a)(7) of this section, the transfer of the LC100 by X
to Y is a realization event. X has a basis of $60 in the LC100. Under
these facts, the appropriate dollar to LC exchange rate for computing
the amount realized by X is the official exchange rate. Therefore, X
realizes $40 ($100-$60) of U.S. source gain from the transfer to Y. The
same result would obtain if Y rather than X purchased the LC100 on the
secondary market in L with $60 supplied by X, because the substance of
this transaction is that X is performing the arbitrage.
(e) Exchange gain or loss. The term ``exchange gain or loss'' means
the amount of gain or loss realized as determined in Sec. 1.988-2 with
respect to a section 988 transaction. Except as otherwise provided in
these regulations (e.g., Sec. 1.98B-5), the amount of exchange gain or
loss from a section 988 transaction shall be separately computed for
each section 988 transaction, and such amount shall not be integrated
with gain or loss recognized on another transaction (whether or not such
transaction is economically related to the section 988 transaction). See
Sec. 1.988-2 (b)(8) for a special rule with respect to debt
instruments.
(f) Hyperinflationary currency--(1) Definition--(i) General rule.
For purposes of section 988, a hyperinflationary currency means a
currency described in Sec. 1.985-1(b)(2)(ii)(D). Unless otherwise
provided, the currency in any example used in Sec. Sec. 1.988-1 through
1.988-5 is not a hyperinflationary currency.
(ii) Special rules for determining base period. In determining
whether a currency is hyperinflationary under Sec. 1.985-1(b)(2)(ii)(D)
for purposes of this paragraph (f), the following rules will apply:
(A) The base period means the thirty-six calendar month period
ending on the last day of the taxpayer's (or qualified business unit's)
current taxable year. Thus, for example, if for 1996, 1997, and 1998, a
country's annual inflation rates are 6 percent, 11 percent, and 90
percent, respectively, the cumulative inflation rate for the three-year
base period is 124% [((1.06 x 1.11 x 1.90) - 1.0 = 1.24) x 100 = 124%].
Accordingly, assuming the QBU has a calendar year as its taxable year,
the currency of the country is hyperinflationary for the 1998 taxable
year. This change in the Sec. 1.985-1(b)(2)(ii)(D) base period shall
not apply to any section 988 transaction of an entity described in
section 851 (regulated investment company (RIC)) or section 856 (real
estate investment trust (REIT)). The Service may, by notice, provide
that the foregoing change in the Sec. 1.985-1(b)(2)(ii)(D) base period
does not apply to any section 988 transaction of an entity with
distribution requirements similar to a RIC or REIT.
(B) The last sentence of Sec. 1.985-1(b)(2)(ii)(D) shall not apply
to alter the base period for purposes of this paragraph (f) in
determining whether a currency is hyperinflationary for purposes of
section 988. Accordingly, generally accepted accounting principles may
not apply to alter the base period for purposes of this paragraph (f).
(2) Effective date. Paragraph (f)(1) of this section shall apply to
transactions entered into after February 14, 2000.
(g) Fair market value. The fair market value of an item shall, where
relevant, reflect an appropriate premium or discount for the time value
of money (e.g., the fair market value of a forward contract to buy or
sell nonfunctional currency shall reflect the present value of the
difference between the units of nonfunctional currency times the market
forward rate at the time of valuation and the units of nonfunctional
currency times the forward rate set forth in the contract). However, if
consistent with the taxpayer's method of financial accounting (and
consistently applied from year to year), the preceding sentence shall
not apply to a financial instrument that matures within one year from
the date of issuance
[[Page 587]]
or acquisition. Unless otherwise provided, the fair market value given
in any example used in Sec. Sec. 1.988-1 through 1.988-5 is deemed to
reflect appropriately the time value of money. If the use of
inconsistent sources of forward or other market rate quotations results
in the distortion of income, the District Director or the Assistant
Commissioner (International) may determine the appropriate rate.
(h) Interaction with sections 1092 and 1256. Unless otherwise
provided, it is assumed for purposes of Sec. Sec. 1.988-1 through
1.988-5 that any contract used in any example is not a section 1256
contract and is not part of a straddle as defined in section 1092. No
inference is intended regarding the application of section 1092 or 1256
unless expressly stated.
(i) Effective date. Except as otherwise provided in this section,
this section shall be effective for taxable years beginning after
December 31, 1986. Thus, except as otherwise provided in this section,
any payments made or received with respect to a section 988 transaction
in taxable years beginning after December 31, 1986, are subject to this
section.
[T.D. 8400, 57 FR 9178, Mar. 17, 1992, as amended by T.D. 8914, 66 FR
280, Jan. 3, 2001]
Sec. 1.988-2 Recognition and computation of exchange gain or loss.
(a) Disposition of nonfunctional currency--(1) Recognition of
exchange gain or loss--(i) In general. Except as otherwise provided in
this section, Sec. 1.988-1(a)(7)(ii), and Sec. 1.988-5, the
recognition of exchange gain or loss upon the sale or other disposition
of nonfunctional currency shall be governed by the recognition
provisions of the Internal Revenue Code which apply to the sale or
disposition of property (e.g., section 1001 or, to the extent provided
in regulations, section 1092). The disposition of nonfunctional currency
in settlement of a forward contract, futures contract, option contract,
or similar financial instrument is considered to be a sale or
disposition of the nonfunctional currency for purposes of the preceding
sentence.
(ii) Clarification of section 1031. An amount of one nonfunctional
currency is not ``property of like kind'' with respect to an amount of a
different nonfunctional currency.
(iii) Coordination with section 988(c)(1)(C)(ii). No exchange gain
or loss is recognized with respect to the following transactions--
(A) An exchange of units of nonfunctional currency for different
units of the same nonfunctional currency;
(B) The deposit of nonfunctional currency in a demand or time
deposit or similar instrument (including a certificate of deposit)
issued by a bank or other financial institution if such instrument is
denominated in such currency;
(C) The withdrawal of nonfunctional currency from a demand or time
deposit or similar instrument issued by a bank or other financial
institution if such instrument is denominated in such currency;
(D) The receipt of nonfunctional currency from a bank or other
financial institution from which the taxpayer purchased a certificate of
deposit or similar instrument denominated in such currency by reason of
the maturing or other termination of such instrument; and
(E) The transfer of nonfunctional currency from a demand or time
deposit or similar instrument issued by a bank or other financial
institution to another demand or time deposit or similar instrument
denominated in the same nonfunctional currency issued by a bank or other
financial institution.
The taxpayer's basis in the units of nonfunctional currency or other
property received in the transaction shall be the adjusted basis of the
units of nonfunctional currency or other property transferred. See
paragraph (b) of this section with respect to the timing of interest
income or expense and the determination of exchange gain or loss
thereon.
(iv) Example. The following example illustrates the provisions of
paragraph (a)(1)(iii) of this section.
Example. X is a corporation on the accrual method of accounting with
the U.S. dollar as its functional currency. On January 1, 1989, X
acquires 1,500 British pounds ([pound]) for $2,250 ([pound]1 = $1.50).
On January 3, 1989, when the spot rate is [pound]1 = $1.49, X deposits
the [pound]1,500 with a British financial institution in a non-interest
bearing demand account. On February 1,
[[Page 588]]
1989, when the spot rate is [pound]1 = $1.45, X withdraws the
[pound]1,500. On February 5, 1989, when the spot rate is [pound]1 =
$1.42, X purchases inventory in the amount of [pound]1,500. Pursuant to
paragraph (a)(1)(iii) of this section, no exchange loss is realized
until February 5, 1989, when X disposes of the [pound]1,500 for
inventory. At that time, X realizes exchange loss in the amount of $120
computed under paragraph (a)(2) of this section. The loss is not an
adjustment to the cost of the inventory.
(2) Computation of gain or loss--(i) In general. Exchange gain
realized from the sale or other disposition of nonfunctional currency
shall be the excess of the amount realized over the adjusted basis of
such currency, and exchange loss realized shall be the excess of the
adjusted basis of such currency over the amount realized.
(ii) Amount realized--(A) In general. The amount realized from the
disposition of nonfunctional currency shall be determined under section
1001(b). A taxpayer that uses a spot rate convention under Sec. 1.988-
1(d)(3) to determine exchange gain or loss with respect to a payable
shall determine the amount realized upon the disposition of
nonfunctional currency paid in satisfaction of the payable in a manner
consistent with such convention.
(B) Exchange of nonfunctional currency for property. For purpose of
paragraph (a)(2) of this section, the exchange of nonfunctional currency
for property (other than nonfunctional currency) shall be treated as--
(1) An exchange of the units of nonfunctional currency for units of
functional currency at the spot rate on the date of the exchange, and
(2) The purchase or sale of the property for such units of
functional currency.
(C) Example. The following example illustrates the provisions of
paragraph (a)(2)(ii)(B) of this section.
Example. G is a U.S. corporation with the U.S. dollar as its
functional currency. On January 1, 1989, G enters into a contract to
purchase a paper manufacturing machine for 10,000,000 British pounds
([pound]) for delivery on January 1, 1991. On January 1, 1991, when G
exchanges [pound]10,000,000 (which G purchased for $12,000,000) for the
machine, the fair market value of the machine is [pound]17,000,000. On
January 1, 1991, the spot exchange rate is [pound]1 = $1.50. Under
paragraph (a)(2)(ii)(B) of this section, the transaction is treated as
an exchange of [pound]10,000,000 for $15,000,000 and the purchase of the
machine for $15,000,000. Accordingly, in computing G's exchange gain of
$3,000,000 on the disposition of the [pound]10,000,000, the amount
realized is $15,000,000. G's basis in the machine is $15,000,000. No
gain is recognized on the bargain purchase of the machine.
(iii) Adjusted basis--(A) In general. Except as provided in
paragraph (a)(2)(iii)(B) of this section, the adjusted basis of
nonfunctional currency is determined under the applicable provisions of
the Internal Revenue Code (e.g., sections 1011 through 1023). A taxpayer
that uses a spot rate convention under Sec. 1.988-1 (d)(3) to determine
exchange gain or loss with respect to a receivable shall determine the
basis of nonfunctional currency received in satisfaction of such
receivable in a manner consistent with such convention.
(B) Determination of the basis of nonfunctional currency withdrawn
from an account with a bank or other financial institution--(1) In
general. The basis of nonfunctional currency withdrawn from an account
with a bank or other financial institution shall be determined under any
reasonable method that is consistently applied from year to year by the
taxpayer to all accounts denominated in a nonfunctional currency. For
example, a taxpayer may use a first in first out method, a last in first
out method, a pro rata method (as illustrated in the example below), or
any other reasonable method that is consistently applied. However, a
method that consistently results in units of nonfunctional currency with
the highest basis being withdrawn first shall not be considered
reasonable.
(2) Example. The following example illustrates the provisions of
this paragraph (a)(2)(iii)(B).
Example. (i) X, a cash basis individual with the dollar as his
functional currency, opens a demand account with a Swiss bank. Assume
expenses associated with the demand account are deductible under section
212. The following chart indicates Swiss franc deposits to the account,
Swiss franc interest credited to the account, the dollar basis of each
deposit, and the determination of the aggregate dollar basis of all
Swiss francs in the account. Assume that the taxpayer has properly
translated all the amounts specified in the chart and that all
transactions are subject to section 988.
[[Page 589]]
----------------------------------------------------------------------------------------------------------------
Aggregate
Date Swiss francs deposited Interest received U.S. dollar U.S. dollar
basis basis
----------------------------------------------------------------------------------------------------------------
1/01/89.......................... 1000 Sf ........................ $500 $500
3/31/89.......................... ......................... 50 Sf 25 525
6/30/89.......................... ......................... 50 Sf 24 549
9/30/89.......................... ......................... 50 Sf 25 574
12/31/89......................... ......................... 50 Sf 26 600
----------------------------------------------------------------------------------------------------------------
(ii) On January 1, 1990, X withdraws 500 Swiss francs from the
account. X may determine his basis in the Swiss francs by multiplying
the aggregate U.S. dollar basis of Swiss francs in the account by a
fraction the numerator of which is the number of Swiss francs withdrawn
from the account and the denominator is the total number of Swiss francs
in the account. Under this method, X's basis in the 500 Swiss francs is
$250 computed as follows:
[GRAPHIC] [TIFF OMITTED] TC09OC91.070
(iii) X's basis in the Swiss francs remaining in the account is $350
($600-$250). X must use this method consistently from year to year with
respect to withdrawals of nonfunctional currency from all of X's
accounts.
(iv) Purchase and sale of stock or securities traded on an
established securities market by cash basis taxpayer--
(A) Amount realized. If stock or securities traded on an established
securities market are sold by a cash basis taxpayer for nonfunctional
currency, the amount realized with respect to the stock or securities
(as determined on the trade date) shall be computed by translating the
units of nonfunctional currency received into functional currency at the
spot rate on the settlement date of the sale. This rule applies
notwithstanding that the stock or securities are treated as disposed of
on a date other than the settlement date under another section of the
Code. See section 453(k).
(B) Basis. If stock or securities traded on an established
securities market are purchased by a cash basis taxpayer for
nonfunctional currency, the basis of the stock or securities shall be
determined by translating the units of nonfunctional currency paid into
functional currency at the spot rate on the settlement date of the
purchase.
(C) Example. The following example illustrates the provisions of
this paragraph (a)(2)(iv).
Example. On November 1, 1989 (the trade date), X, a calendar year
cash basis U.S. individual, purchases stock for [pound]100 for
settlement on November 5, 1989. On November 1, 1989, the spot value of
the [pound]100 is $140. On November 5, 1989, X purchases [pound]100 for
$141 which X uses to pay for the stock. X's basis in the stock is $141.
On December 30, 1990 (the trade date), X sells the stock for [pound]110
for settlement on January 5, 1991. On December 30, 1990, the spot value
of [pound]110 is $165. On January 5, 1991, X transfers the stock and
receives [pound]110 which, translated at the spot rate, equal $166.
Under section 453(k), the stock is considered disposed of on December
30, 1990. The amount realized with respect to such disposition is the
value of the [pound]110 on January 5, 1991 ($166). Accordingly, X's gain
realized on December 30, 1990, from the disposition of the stock is $25
($166 amount realized less $141 basis). X's basis in the [pound]110
received from the sale of the stock is $166.
(v) Purchase and sale of stock or securities traded on an
established securities market by accrual basis taxpayer. For taxable
years beginning after March 17, 1992, an accrual basis taxpayer may
elect to apply the rules of paragraph (a)(2)(iv) of this section. The
election shall be made by filing a statement with the taxpayer's first
return in which the election is effective clearly indicating that the
election has been made. A method so elected must be applied consistently
from year to year and cannot be changed without the consent of the
Commissioner.
(b) Translation of interest income or expense and determination of
exchange gain or loss with respect to debt instruments--(1) Translation
of interest income received with respect to a nonfunctional currency
demand account. Interest income received with respect to a demand
account with a bank or other financial institution which is denominated
in (or the payments of which are determined by reference to) a
nonfunctional currency shall be translated into functional currency at
the spot rate on the date received or accrued or pursuant to any
reasonable spot rate convention consistently applied by the taxpayer to
all taxable years and to all accounts denominated in nonfunctional
currency in the same financial institution. For
[[Page 590]]
example, a taxpayer may translate interest income received with respect
to a demand account on the last day of each month of the taxable year,
on the last day of each quarter of the taxable year, on the last day of
each half of the taxable year, or on the last day of the taxable year.
No exchange gain or loss is realized upon the receipt or accrual of
interest income with respect to a demand account subject to this
paragraph (b)(1).
(2) Translation of nonfunctional currency interest income or expense
received or paid with respect to a debt instrument described in Sec.
1.988-1(a)(1)(ii) and (2)(i)--(i) Scope--(A) In general. Paragraph (b)
of this section only applies to debt instruments described in Sec.
1.988-1(a)(1)(ii) and (2)(i) where all payments are denominated in, or
determined with reference to, a single nonfunctional currency. Except as
provided in paragraph (b)(2)(i)(B) of this section, this paragraph (b)
shall not apply to contingent payment debt instruments.
(B) Nonfunctional currency contingent payment debt instruments--(1)
Operative rules. [Reserved]
(2) Certain instruments are not contingent payment debt instruments.
For purposes of section 1275(d), a debt instrument denominated in, or
all payments of which are determined with reference to, a single
nonfunctional currency (with no contingencies) is not a contingent
payment debt instrument. See Sec. 1.988-1(a)(4) and (5) for the
treatment of dual currency and multi-currency debt instruments.
(ii) Determination and translation of interest income or expense--
(A) In general. Interest income or expense on a debt instrument
described in paragraph (b)(2)(i) of this section (including original
issue discount determined in accordance with sections 1271 through 1275
and 163(e) as adjusted for acquisition premium under section 1272(a)(7),
and acquisition discount determined in accordance with sections 1281
through 1283) shall be determined in units of nonfunctional currency and
translated into functional currency as provided in paragraphs
(b)(2)(ii)(B) and (C) of this section. For purposes of sections 483,
1273(b)(5) and 1274, the nonfunctional currency in which an instrument
is denominated (or by reference to which payments are determined) shall
be considered money.
(B) Translation of interest income or expense that is not required
to be accrued prior to receipt or payment. With respect to an instrument
described in paragraph (b)(2)(i) of this section, interest income or
expense received or paid that is not required to be accrued by the
taxpayer prior to receipt or payment shall be translated at the spot
rate on the date of receipt or payment. No exchange gain or loss is
realized with respect to the receipt or payment of such interest income
or expense (other than the exchange gain or loss that might be realized
under paragraph (a) of this section upon the disposition of the
nonfunctional currency so received or paid).
(C) Translation of interest income or expense that is required to be
accrued prior to receipt or payment. With respect to an instrument
described in paragraph (b)(2)(i) of this section, interest income or
expense that is required to be accrued prior to receipt or payment
(e.g., under section 1272, 1281 or 163(e) or because the taxpayer uses
an accrual method of accounting) shall be translated at the average rate
(or other rate specified in paragraph (b)(2)(iii)(B) of this section)
for the interest accrual period or, with respect to an interest accrual
period that spans two taxable years, at the average rate (or other rate
specified in paragraph (b)(2)(iii)(B) of this section) for the partial
period within the taxable year. See paragraphs (b)(3) and (4) of this
section for the determination of exchange gain or loss on the receipt or
payment of accrued interest income or expense.
(iii) Determination of average rate or other accrual convention--(A)
In general. For purposes of this paragraph (b), the average rate for an
accrual period (or partial period) shall be a simple average of the spot
exchange rates for each business day of such period or other average
exchange rate for the period reasonably derived and consistently applied
by the taxpayer.
(B) Election to use spot accrual convention. For taxable years
beginning after March 17, 1992, a taxpayer may elect to translate
interest income and expense at the spot rate on the last day of the
interest accrual period (and in the case
[[Page 591]]
of a partial accrual period, the spot rate on the last day of the
taxable year). If the last day of the interest accrual period is within
five business days of the date of receipt or payment, the taxpayer may
translate interest income or expense at the spot rate on the date of
receipt or payment. The election shall be made by filing a statement
with the taxpayer's first return in which the election is effective
clearly indicating that the election has been made. A method so elected
must be applied consistently to all debt instruments from year to year
and cannot be changed without the consent of the Commissioner.
(3) Exchange gain or loss recognized by the holder with respect to
accrued interest income. The holder of a debt instrument described in
paragraph (b)(2)(i) of this section shall realize exchange gain or loss
with respect to accrued interest income on the date such accrued
interest income is received or the instrument is disposed of (including
a deemed disposition under section 1001 that results from a material
change in terms of the instrument). Except as otherwise provided in this
paragraph (b) (e.g., paragraph (b)(8) of this section), exchange gain or
loss realized with respect to accrued interest income shall be
recognized in accordance with the applicable recognition provisions of
the Internal Revenue Code. The amount of exchange gain or loss so
realized with respect to accrued interest income is determined for each
accrual period by--
(i) Translating the units of nonfunctional currency interest income
received with respect to such accrual period (as determined under the
ordering rules of paragraph (b)(7) of this section) into functional
currency at the spot rate on the date the interest income is received or
the instrument is disposed of (or deemed disposed of), and
(ii) Subtracting from such amount the amount computed by translating
the units of nonfunctional currency interest income accrued with respect
to such income received at the average rate (or other rate specified in
paragraph (b)(2)(iii)(B) of this section) for the accrual period.
(4) Exchange gain or loss recognized by the obligor with respect to
accrued interest expense. The obligor under a debt instrument described
in paragraph (b)(2)(i) of this section shall realize exchange gain or
loss with respect to accrued interest expense on the date such accrued
interest expense is paid or the obligation to make payments is
transferred or extinguished (including a deemed disposition under
section 1001 that results from a material change in terms of the
instrument). Except as otherwise provided in this paragraph (b) (e.g.,
paragraph (b)(8) of this section), exchange gain or loss realized with
respect to accrued interest expense shall be recognized in accordance
with the applicable recognition provisions of the Internal Revenue Code.
The amount of exchange gain or loss so realized with respect to accrued
interest expense is determined for each accrual period by--
(i) Translating the units of nonfunctional currency interest expense
accrued with respect to the amount of interest paid into functional
currency at the average rate (or other rate specified in paragraph
(b)(2)(iii)(B) of this section) for such accrual period; and
(ii) Subtracting from such amount the amount computed by translating
the units of nonfunctional currency interest paid (or, if the obligation
to make payments is extinguished or transferred, the units accrued) with
respect to such accrual period (as determined under the ordering rules
in paragraph (b)(7) of this section) into functional currency at the
spot rate on the date payment is made or the obligation is transferred
or extinguished (or deemed extinguished).
(5) Exchange gain or loss recognized by the holder of a debt
instrument with respect to principal. The holder of a debt instrument
described in paragraph (b)(2)(i) of this section shall realize exchange
gain or loss with respect to the principal amount of such instrument on
the date principal (determined under the ordering rules of paragraph
(b)(7) of this section) is received from the obligor or the instrument
is disposed of (including a deemed disposition under section 1001 that
results from a material change in terms of the instrument). For purposes
of computing exchange gain or loss, the principal amount of a debt
instrument is
[[Page 592]]
the holder's purchase price in units of nonfunctional currency. See
paragraph (b)(10) of this section for rules regarding the amortization
of that part of the principal amount that represents bond premium and
the computation of exchange gain or loss thereon. If, however, the
holder acquired the instrument in a transaction in which exchange gain
or loss was realized but not recognized by the transferor, the
nonfunctional currency principal amount of the instrument with respect
to the holder shall be the same as that of the transferor. Except as
otherwise provided in this paragraph (b) (e.g., paragraph (b)(8) of this
section), exchange gain or loss realized with respect to such principal
amount shall be recognized in accordance with the applicable recognition
provisions of the Internal Revenue Code. The amount of exchange gain or
loss so realized by the holder with respect to principal is determined
by--
(i) Translating the units of nonfunctional currency principal at the
spot rate on the date payment is received or the instrument is disposed
of (or deemed disposed of); and
(ii) Subtracting from such amount the amount computed by translating
the units of nonfunctional currency principal at the spot rate on the
date the holder (or a transferor from whom the nonfunctional principal
amount is carried over) acquired the instrument (is deemed to acquire
the instrument).
(6) Exchange gain or loss recognized by the obligor of a debt
instrument with respect to principal. The obligor under a debt
instrument described in paragraph (b)(2)(i) of this section shall
realize exchange gain or loss with respect to the principal amount of
such instrument on the date principal (determined under the ordering
rules of paragraph (b)(7) of this section) is paid or the obligation to
make payments is transferred or extinguished (including a deemed
disposition under section 1001 that results from a material change in
terms of the instrument). For purposes of computing exchange gain or
loss, the principal amount of a debt instrument is the amount received
by the obligor for the debt instrument in units of nonfunctional
currency. See paragraph (b)(10) of this section for rules regarding the
amortization of that part of the principal amount that represents bond
premium and the computation of exchange gain or loss thereon. If,
however, the obligor became the obligor in a transaction in which
exchange gain or loss was realized but not recognized by the transferor,
the nonfunctional currency principal amount of the instrument with
respect to such obligor shall be the same as that of the transferor.
Except as otherwise provided in this paragraph (b) (e.g., paragraph
(b)(8) of this section), exchange gain or loss realized with respect to
such principal shall be recognized in accordance with the applicable
recognition provisions of the Internal Revenue Code. The amount of
exchange gain or loss so realized by the obligor is determined by--
(i) Translating the units of nonfunctional currency principal at the
spot rate on the date the obligor (or a transferor from whom the
principal amount is carried over) became the obligor (or is deemed to
have become the obligor); and
(ii) Subtracting from such amount the amount computed by translating
the units of nonfunctional currency principal at the spot rate on the
date payment is made or the obligation is transferred or extinguished
(or deemed extinguished).
(7) Payment ordering rules--(i) Debt instruments subject to the
rules of sections 163(e), or 1271 through 1288. In the case of a debt
instrument described in paragraph (b)(2)(i) of this section that is
subject to the rules of sections 163(e), or 1272 through 1288, units of
nonfunctional currency (or an amount determined with reference to
nonfunctional currency) received or paid with respect to such debt
instrument shall be treated first as a receipt or payment of periodic
interest under the principles of section 1273 and the regulations
thereunder, second as a receipt or payment of original issue discount to
the extent accrued as of the date of the receipt or payment, and finally
as a receipt or payment of principal. Units of nonfunctional currency
(or an amount determined with reference to nonfunctional currency)
treated as a receipt or payment of original issue discount under the
preceding sentence are attributed to the earliest accrual period in
which
[[Page 593]]
original issue discount has accrued and to which prior receipts or
payments have not been attributed. No portion thereof shall be treated
as prepaid interest. These rules are illustrated by Example 10 of
paragraph (b)(9) of this section.
(ii) Other debt instruments. In the case of a debt instrument
described in paragraph (b)(2)(i) of this section that is not subject to
the rules of section 163(e) or 1272 through 1288, whether units of
nonfunctional currency (or an amount determined with reference to
nonfunctional currency) received or paid with respect to such debt
instrument are treated as interest or principal shall be determined
under section 163 or other applicable section of the Code.
(8) Limitation of exchange gain or loss on payment or disposition of
a debt instrument. When a debt instrument described in paragraph
(b)(2)(i) of this section is paid or disposed of, or when the obligation
to make payments thereunder is satisfied by another person, or
extinguished or assumed by another person, exchange gain or loss is
computed with respect to both principal and any accrued interest
(including original issue discount), as provided in paragraph (b)(3)
through (7) of this section. However, pursuant to section 988(b)(1) and
(2), the sum of any exchange gain or loss with respect to the principal
and interest of any such debt instrument shall be realized only to the
extent of the total gain or loss realized on the transaction. The gain
or loss realized shall be recognized in accordance with the general
principles of the Code. See Examples 3, 4 and 6 of paragraph (b)(9) of
this section.
(9) Examples. The preceding provisions are illustrated in the
following examples. The examples assume that any transaction involving
an individual is a section 988 transaction.
Example 1. (i) X is an individual on the cash method of accounting
with the dollar as his functional currency. On January 1, 1992, X
converts $13,000 to 10,000 British pounds ([pound]) at the spot rate of
[pound]1 = $1.30 and loans the [pound]10,000 to Y for 3 years. The terms
of the loan provide that Y will make interest payments of [pound]1,000
on December 31 of 1992, 1993, and 1994, and will repay X's [pound]10,000
principal on December 31, 1994. Assume the spot rates for the pertinent
dates are as follows:
------------------------------------------------------------------------
Spot rate
Date (pounds to
dollars)
------------------------------------------------------------------------
Jan. 1, 1992............................................... [pound]1=$1
.30
Dec. 31, 1992.............................................. [pound]1=$1
.35
Dec. 31, 1993.............................................. [pound]1=$1
.40
Dec. 31, 1994.............................................. [pound]1=$1
.45
------------------------------------------------------------------------
(ii) Under paragraph (b)(2)(ii)(B) of this section, X will trans1ate
the [pound]1,000 interest payments at the spot rate on the date
received. Accordingly, X will have interest income of $1,350 in 1992,
$1,400 in 1993, and $1,450 in 1994. Because X is a cash basis taxpayer,
X does not realize exchange gain or loss on the receipt of interest
income.
(iii) Under paragraph (b)(5) of this section, X will realize
exchange gain upon repayment of the [pound]10,000 principal amount
determined by translating the [pound]10,000 at the spot rate on the date
it is received ([pound]10,000x$1.45 = $14,500) and subtracting from such
amount, the amount determined by translating the [pound]10,000 at the
spot rate on the date the loan was made ([pound]10,000x$1.30 = $13,000).
Accordingly, X will realize an exchange gain of $1,500 on the repayment
of the loan on December 31, 1994.
Example 2. (i) Assume the same facts as in Example 1 except that X
is an accrual method taxpayer and that average rates are as follows:
------------------------------------------------------------------------
Average rate (pounds to
Accrual period dollars)
------------------------------------------------------------------------
1992...................................... [pound]1=$1.32
1993...................................... [pound]1=$1.37
1994...................................... [pound]1=$1.42
------------------------------------------------------------------------
(ii) Under paragraph (b)(2)(ii)(C) of this section, X will accrue
the [pound]1,000 interest payments at the average rate for the accrual
period. Accordingly, X will have interest income of $1,320 in 1992,
$1,370 in 1993, and $1,420 in 1994. Because X is an accrual basis
taxpayer, X determines exchange gain or loss for each interest accrual
period by translating the units of nonfunctional currency interest
income received with respect to such accrual period at the spot rate on
the date received and subtracting the amounts of interest income accrued
for such period. Thus, X will realize $90 of exchange gain with respect
to interest received under the loan, computed as follows:
------------------------------------------------------------------------
Spot Accrued
value interest Exch.
Year interest @ average gain
received rate
------------------------------------------------------------------------
1992................................... $1,350 $1,320 $30
1993................................... 1,400 1,370 30
1994................................... 1,450 1,420 30
----------
Total................................ ......... ......... $90
------------------------------------------------------------------------
(iii) Under paragraph (b)(5) of this section, X will realize
exchange gain upon repayment
[[Page 594]]
of the [pound]10,000 loan principal determined in the same manner as in
Example 1. Accordingly, X will realize an exchange gain of $1,500 on the
repayment of the loan principal on December 31, 1994.
Example 3. Assume the same facts as in Example 1 except that X is a
calendar year taxpayer on the accrual method of accounting that elects
to use a spot rate convention to translate interest income as provided
in Sec. 1.988-2(b)(2)(iii)(B). Interest income is received by X on the
last day of each accrual period. Under paragraph (b)(2)(ii)(C), X will
translate the interest income at the spot rate on the last day of each
interest accrual period. Accordingly, X will have interest income of
$1,350 in 1992, and $1,400 in 1993, $1,450 in 1994. Because the rate at
which the interest income is translated is the same as the rate on the
day of receipt, X will not realize any exchange gain or loss with
respect to the interest income. Under paragraph (b)(5) of this section,
X will realize exchange gain upon repayment of the [pound]10,000 loan
principal determined in the same manner as in Example 1. Accordingly, X
will realize an exchange gain of $1,500 on the repayment of the loan
principal on December 31, 1994.
Example 4. Assume the same facts as in Example 1 except that on
December 31, 1993, X sells Y's note for 9,821.13 British pounds
([pound]) after the interest payment. Under paragraph (b)(8) of this
section, X will compute exchange gain on the [pound]10,000 principal.
The exchange gain is $1,000 [([pound]10,000x$1.40)-
([pound]10,000x$1.30)]. This exchange gain, however, is only realized to
the extent of the total gain on the disposition. X's total gain is
$749.58 [([pound]9,821.13x$1.40)-([pound]10,000x$1.30)]. Thus, X will
realize $749.58 of exchange gain (and will realize no market loss).
Example 5. (i) The facts are the same as in Example 1 except that Y
becomes insolvent and fails to repay the full [pound]10,000 principal
when due. Instead, X and Y agree to compromise the debt for a payment of
[pound]8,000 on December 31, 1994. Under paragraph (b)(8) of this
section, X will compute exchange gain on the [pound]10,000 originally
booked. The exchange gain is $1,500 [([pound]10,000x$1.45)-
([pound]10,000x$1.30) = $1,500]. This exchange gain, however, is only
realized to the extent of the total gain on the disposition. X realizes
an overall loss on the disposition of $1,400 [([pound]8,000x$1.45)-
([pound]10,000x$1.30) = ($1,400)]. Thus, X will realize no exchange gain
(and a $1400 market loss).
(ii) If the exchange rate on December 31, 1994, were [pound]1 =
$1.25, rather than [pound]1 = $1.45, X would compute exchange loss under
paragraph (b)(8) of this section, on the [pound]10,000 originally
booked. The exchange loss would be $500 [([pound]10,000x$1.25)-
([pound]10,000x $1.30) = ($500)]. X's total loss on the disposition
would be $3,000 [([pound]8,000x$1.25)-([pound]10,000x$1.30) = ($3,000)].
Thus, X would realize $500 of exchange loss and a $2,500 market loss on
the disposition.
Example 6. (i) X is an individual with the dollar as his functional
currency. X is on the cash method of accounting. On January 1, 1989, X
borrows 10,000 British pounds ([pound]) from Y, an unrelated person. The
terms of the loan provide that X will make interest payments of
[pound]1,200 on December 31 of 1989 and 1990 and will repay Y's
[pound]10,000 principal on December 31, 1990. The spot rates for the
pertinent dates are as follows:
------------------------------------------------------------------------
Spot rate
Date \1\
------------------------------------------------------------------------
Jan. 1, 1989............................................... 1=$1.50
Dec. 31, 1989.............................................. 1=1.60
Dec. 31, 1990.............................................. 1=1.70
------------------------------------------------------------------------
\1\ Pounds to dollars.
Assume that the basis of the [pound]1,200 paid as interest by X on
December 31, 1989, is $2,000, the basis of the [pound]1,200 paid as
interest by X on December 31, 1990, is $2,020 and the basis of the
[pound]10,000 principal paid by X on December 31, 1990, is $16,000.
(ii) Under paragraph (b)(2)(ii)(B) of this section, X translates the
[pound]1,200 interest payments at the spot rate on the day paid. Thus, X
paid $1,920 ([pound]1,200x$1.60) of interest on December 31, 1989, and
$2,040 ([pound]1,200x$1.70) of interest on December 31, 1990. In
addition, X will realize exchange gain or loss on the disposition of the
[pound]1,200 on December 31, 1989 and 1990, under paragraph (a) of this
section. Pursuant to paragraph (a)(2) of this section, X will realize an
exchange loss of $80 [([pound]1,200x$1.60)-$2,000] on December 31, 1989,
and exchange gain of $20 [([pound]1,200x$1.70)-$2,020] on December 31,
1990.
(iii) Under paragraph (b)(6) of this section, X will realize
exchange loss on December 31, 1990, upon repayment of the [pound]10,000
principal amount determined by translating the [pound]10,000 received at
the spot rate on January 1, 1989 ([pound]10,000x$1.50 = $15,000) and
subtracting from such amount, the amount determined by translating the
[pound]10,000 paid at the spot rate on December 31, 1990
([pound]10,000x$1.70 = $17,000). Thus, under paragraph (b)(6) of this
section, X has an exchange loss with respect to the [pound]10,000
principal of $2,000. Further, under paragraph (a)(2) of this section, X
will realize an exchange gain upon disposition of the [pound]10,000 on
December 31, 1990. Under paragraph (a)(2) of this section, X will
subtract his adjusted basis in the [pound]10,000 ($16,000) from the
amount realized upon the disposition of the [pound]10,000
([pound]10,000x$1.70 = $17,000) resulting in a gain of $1,000.
Accordingly, X's combined exchange gain and loss realized on December
31, 1990, with respect to the repayment of the [pound]10,000 is a $1,000
exchange loss.
Example 7. (i) X is a calendar year corporation on the accrual
method of accounting
[[Page 595]]
and with the dollar as its functional currency. On January 1, 1989, X
purchases at original issue for 82.64 Canadian dollars (C$) M
corporation's 2 year note maturing on December 31, 1990, at a stated
redemption price of C$100. The yield to maturity in Canadian dollars is
10 percent and the accrual period is the one year period beginning
January 1 and ending December 31. The note has C$17.36 of original issue
discount. Assume that the spot rates are as follows: C$1 = U.S.$.72 on
January 1, 1989; C$1 = U.S.$.80 on January 1, 1990; C$1 = U.S.$ .82 on
December 31, 1990. Assume further that the average rate for 1989 is C$1
= U.S.$ .76 and for 1990 is C$1 = U.S. $.81.
(ii) Under paragraph (b)(2)(ii)(A) of this section, X will determine
its interest income in Canadian dollars. Accordingly, under section
1272, X must take into account original issue discount in the amount of
C$8.26 on December 31, 1989, and C$9.10 on December 31, 1990. Pursuant
to paragraph (b)(2)(ii)(C) of this section, X will translate these
amounts into U.S. dollars at the average exchange rate for the relevant
accrual period. Thus, the amount of interest income taken into account
in 1989 is U.S.$6.28 (C$8.26xU.S.$.76) and in 1990 is U.S.$7.37
(C$9.10xU.S.$.81). Pursuant to paragraph (b)(3)(ii) of this section, X
will realize exchange gain or loss with respect to the accrued interest
determined for each accrual period by translating the Canadian dollars
received with respect to such accrual period into U.S. dollars at the
spot rate on the date the interest is received and subtracting from that
amount the amount accrued in U.S. dollars. Thus, the amount of exchange
gain realized on December 31, 1990, is U.S.$.58 (U.S.$.49 from
1989+U.S.$.09 from 1990). Pursuant to paragraph (b)(5) of this section,
X shall realize exchange gain or loss with respect to the principal
(C$82.64) on December 31, 1990, computed by translating the C$82.64 at
the spot rate on December 31, 1990 (U.S.$67.76) and subtracting the
C$82.64 translated at the spot rate on January 1, 1989 (U.S.$59.50) for
an exchange gain of U.S.$8.26. Thus, X's combined exchange gain is
U.S.$8.84 (U.S.$.49+U.S.$.09+U.S.$8.26).
(iii) Assume instead that on January 1, 1990, X sells the note for
C$86.95, which it immediately converts to U.S. dollars. X's exchange
gain is computed under paragraph (b)(8) of this section with reference
to the nonfunctional currency denominated principal amount (C$82.64) and
the nonfunctional currency denominated accrued original issue discount
(C$8.26). X will compute an exchange gain of U.S.$6.61 with respect to
the issue price [(C$82.64xU.S. $ .80)-(C$82.64xU.S.$.72)] and an
exchange gain of U.S.$.33 with respect to the accrued original issue
discount [(C$8.26xU.S.$.80)- (C$8.26xU.S.$ .76)]. Accordingly, prior to
the application of paragraph (b)(8) of this section, X's total exchange
gain is U.S.$6.94 (U.S.$6.61+U.S.$.33), and X's market loss is U.S.$3.16
[(C$90.90-C$86.95)xU.S.$.80]. Pursuant to paragraph (b)(8) of this
section, however, X's market loss on the note of U.S.$3.16 is netted
against X's exchange gain of U.S.$6.94, resulting in a realized exchange
gain of U.S.$3.78 and no market loss.
Example 8. (i) The facts are the same as in Example 7 (i) except
that on January 1, 1990, X contributes the M corporation note to Y, a
wholly-owned U.S. subsidiary of X with the dollar as its functional
currency, and Y collects C$100 from M corporation at maturity on
December 31, 1990, when the spot rate is C$1 = U.S.$.82. The transfer of
the note from X to Y qualifies for nonrecognition of gain under section
351(a). On December 31, 1990, Y includes C$9.10 of accrued interest in
income which translated at the average exchange rate of C$1 = U.S.$.81
for the year results in U.S.$7.37 of interest income.
(ii) Y's exchange gain is computed under paragraph (b)(3) of this
section with respect to accrued interest income and paragraph (b)(5) of
this section with respect to the nonfunctional currency principal
amount. Under paragraph (b)(3) of this section, Y will realize exchange
gain or loss for each accrual period computed by translating the units
of nonfunctional currency interest income received with respect to such
accrual period at the spot rate on the day received and subtracting the
amounts of interest income accrued for such period. Thus, Y will realize
$.49 of exchange gain with respect to original issue discount accrued in
1989 [(C$8.26xU.S.$.82)-(C$8.26xU.S.$.76) = U.S. $.49] and $.09 of
exchange gain with respect to original issue discount accrued in 1990
[(C$9.10xU.S.$.82)-(C$9.10xU.S.$.81) = $.09].
(iii) Pursuant to paragraph (b)(5) of this section, the
nonfunctional currency principal amount of the M bond in the hands of Y
is C$82.64, the amount carried over from X, the transferor. Y's exchange
gain with respect to the nonfunctional currency principal amount is
$8.26 [(C$82.64xU.S.$.82)- (C$82.64xU.S.$.72) = U.S. $8.26].
Accordingly, Y's combined exchange gain is U.S. $8.84 ($.49+$.09+$8.26).
Because the amount realized in Canadian dollars equals the adjusted
issue price (C$100) on retirement of the M note, there is no market
loss, and the netting rule of paragraph (b)(8) of this section does not
limit realization of the exchange gain.
Example 9. (i) X is a calendar year corporation on the accrual
method of accounting and with the dollar as its functional currency. X
elects to use the spot rate convention to translate interest income as
provided in paragraph (b)(2)(iii)(B) of this section. On January 31,
1992, X loans [pound]1000 to Y, an unrelated person. Under the terms of
the loan, Y will pay X interest of [pound]50 on July 31, 1992, and
January 31, 1993, and will repay the [pound]1000 principal on January
31, 1993. Assume the following spot exchange rates:
[[Page 596]]
------------------------------------------------------------------------
Spot rate
Date \1\
------------------------------------------------------------------------
Jan. 31, 1992.............................................. [pound]1=$1
.50
July 31, 1992.............................................. [pound]1=1.
55
Dec. 31, 1992.............................................. [pound]1=1.
60
Jan. 31, 1993.............................................. [pound]1=1.
61
------------------------------------------------------------------------
\1\ Pounds to dollars.
(ii) Under paragraph (b)(2)(ii)(C) of this section, X will translate
the interest income at the spot rate on the last day of each interest
accrual period (and in the case of a partial accrual period, at the spot
rate on the last day of the taxable year). Accordingly, X will have
interest income of $77.50 ([pound]50x$1.55) on July 31, 1992. Assuming
under X's method of accounting that interest is accrued daily, X will
accrue $66.50 (153/184x[pound]50)x$1.60) of interest income on December
31, 1992. On January 31, 1993, X will have interest income of $13.60
((31/184x[pound]50)x$1.61). Because the rate at which the interest
income is translated is the same as the rate on the day of receipt, X
will not realize any exchange gain or loss with respect to the interest
income received on July 31, 1992. However, X will realize exchange gain
on the [pound]41.50 (153/184x[pound]50) of accrued interest income of
$.41 [([pound]41.50x$1.61)-([pound]41.50x$1.60) = $.41].
(iii) Under paragraph (b)(5) of this section, X will realize
exchange gain upon repayment of the [pound]100 principal amount
determined by translating the [pound]100 at the spot rate on the date it
is received ([pound]100x$1.61 = $161.00) and subtracting from such
amount, the amount determined by translating the [pound]100 at the spot
rate on the date the loan was made ([pound]100x$1.50 = $150.00).
Accordingly, X will realize an exchange gain of $11 on the repayment of
the loan on January 31, 1993.
Example 10. (i) X, a cash basis taxpayer with the dollar as its
functional currency, has the calendar year as its taxable year. On
January 1, 1992, X purchases at original issue for 65.88 British pounds
([pound]) M corporation's 5-year bond maturing on December 31, 1996,
having a stated redemption price at maturity of [pound]100. The bond
provides for annual payments of interest in pounds of 1 pound per year
on December 31 of each year. The bond has 34.12 British pounds of
original issue discount. The yield to maturity is 10 percent in British
pounds and the accrual period is the one year period beginning January 1
and ending December 31 of each calendar year. The amount of original
issue discount is determined in pounds for each accrual period by
multiplying the adjusted issue price expressed in pounds by the yield
and subtracting from such amount the periodic interest payments
expressed in pounds for such period. The periodic interest payments are
translated at the spot rate on the payment date (December 31 of each
year). The original issue discount is translated at the average rate for
the accrual period (January 1 through December 31). The following chart
describes the determination of interest income with respect to the facts
presented and provides other pertinent information.
[[Page 597]]
Table 1
--------------------------------------------------------------------------------------------------------------------------------------------------------
Original
Periodic issue
interest discount in
Assumed payments in pounds Total
Periodic Original Assumed average pounds multiplied interest
interest issue Issue price spot rate rate for multiplied by the income in Adjusted
Year (Dec. 31) payments in discount in or adjusted on Dec. 31 accrual by spot average dollars issue price
pounds for pounds for issue price (pounds to period rate on the rate for (column 7 in dollars
the accrual the accrual in pounds dollars) (pounds to date of the accrual plus column
period period dollars) payment period 8)
(column 2 (column 3
times times
column 5) column 6)
1 2 3 4 5 6 7 8 9 10
------------------------------------
Issue Date:
........... ........... 65.88 1=$1.20 ........... ........... ........... ........... $79.06
1992 1 5.59 71.47 1=1.30 1=$1.25 $1.30 $6.99 $8.29 86.05
1993 1 6.15 77.62 1=1.40 1=1.35 1.40 8.30 9.70 94.35
1994 1 6.76 84.38 1=1.50 1=1.45 1.50 9.80 11.30 104.15
1995 1 7.44 91.82 1=1.60 1=1.55 1.60 11.53 13.13 115.68
1996 1 8.18 100.00 1=1.70 1=1.65 1.70 13.50 15.20 129.18
--------------------------------------------------------------------------------------------------------------------------------------------------------
[[Page 598]]
(ii) Because X is a cash basis taxpayer, X does not realize exchange
gain or loss on the receipt of the [pound]1 periodic interest payments.
However, X will realize exchange gain on December 31, 1996 totaling
$7.88 with respect to the original issue discount. Exchange gain is
determined for each interest accrual period by translating the units of
nonfunctional currency interest income received with respect to such
accrual period at the spot rate on the date received and subtracting
from such amount, the amount computed by translating the units of
nonfunctional currency interest income accrued for such period at the
average rate for the period. The following chart illustrates this
computation:
Table 2
----------------------------------------------------------------------------------------------------------------
IOD in
Interest pounds
Assumed received Assumed times the
OID accrued spot rate times spot average average Exchange
in pounds on date rate on the rate for rate for gain or
Year for each payment date accrual the accrual loss (col.
accrual received received period period 4 less col.
period (pounds to (col. 2 (pounds to (col. 2 6)
dollars) times col. dollars) times col.
3) 5)
1 2 3 4 5 6 7
-----------------------------------
1992.............................. 5.59 1=$1.70 $9.50 1=$1.25 $6.99 $2.51
1993.............................. 6.15 1=1.70 10.46 1=1.35 8.30 2.16
1994.............................. 6.76 1=1.70 11.49 1=1.45 9.80 1.69
1995.............................. 7.44 1=1.70 12.65 1=1.55 11.53 1.12
1996.............................. 8.18 1=1.70 13.90 1=1.65 13.50 .40
------------
Total........................... ........... ........... ........... ........... ........... $7.88
----------------------------------------------------------------------------------------------------------------
(iii) X will also realize exchange gain with respect to the
principal of the loan (i.e., the issue price of 65.88 British pounds) on
December 31, 1996 computed by translating the units of nonfunctional
currency principal received at the spot rate on the date principal is
received (65.88 British pounds x $1.70 = $112.00) and subtracting from
such amount, the units of nonfunctional currency principal received
translated at the spot rate on the date the instrument was acquired
(65.88 British pounds x $1.20 = $79.06). Accordingly, X's exchange gain
on the principal is $32.94 and X's total exchange gain with respect to
the accrued interest and principal is $40.82. It should be noted that,
under this fact pattern, the total exchange gain may be determined in an
alternative fashion. Exchange gain may be computed by subtracting the
adjusted issue price in dollars at maturity ($129.18--see column 10 of
Table 1) from the amount computed by multiplying the stated redemption
price at maturity in pounds times the spot rate on the maturity date
([pound]100x$1.70 = $170), which equals $40.82.
Example 11. (i) The facts are the same as in Example 10 except that
X makes an election under paragraph (b)(2)(iii) of this section to
translate accrued interest on the last day of the accrual period.
Accordingly, columns 8, 9 and 10 in Table 1 would change as follows:
------------------------------------------------------------------------
Original
issue
discount in Total
pounds interest
multiplied income in Adjusted
Year (Dec. 31) by the spot dollars issue price
rate on (column 7 in dollars
last day of plus column
accrual 8)
period
(Dec. 31)
1 8 9 10
----------------------------------
$79.06
1992............................. $7.27 $8.57 87.63
1993............................. 8.61 10.01 97.64
1994............................. 10.14 11.64 109.28
1995............................. 11.90 13.50 122.78
1996............................. 13.91 15.61 138.39
------------------------------------------------------------------------
(ii) Because X is a cash basis taxpayer, X does not realize exchange
gain or loss on the receipt of the [pound]1 periodic interest payments.
However, X will realize exchange gain on December 31, 1993 totaling
$6.18 with respect to the original issue discount. Exchange gain is
determined for each interest accrual period by translating the units of
nonfunctional currency interest income received with respect to such
accrual period at the spot rate on the date received and subtracting
from such amount, the amount computed by translating the units of
nonfunctional currency interest income accrued for such period at the
spot rate on the last day of the accrual period. Accordingly, columns 5,
6 and 7 of Table 2 would change as follows:
[[Page 599]]
------------------------------------------------------------------------
OID in
pounds
times the
Spot rate spot rate Exchange
on last day on the last gain or
Year of accrual day of the loss (col.
period accrual 4 less col.
period (col 6)
2 times
col. 3)
1 5 6 7
----------------------------------
1992............................. $1.30 $7.27 $2.23
1993............................. 1.40 8.61 1.85
1994............................. 1.50 10.14 1.35
1995............................. 1.60 11.90 0.75
1996............................. 1.70 13.90 0.00
------------
6.18
------------------------------------------------------------------------
(iii) X will realize exchange gain with respect to the principal
amount of the loan as provided in the preceding example.
Example 12. (i) C is a corporation that is a calendar year accrual
method taxpayer with the dollar as its functional currency. On January
1, 1989, C lends 100 British pounds ([pound]) in exchange for a note
under the terms of which C will receive two equal payments of
[pound]57.62 on December 31, 1989, and December 31, 1990. Each payment
of [pound]57.62 represents the annual payment necessary to amortize the
[pound]100 principal amount at a rate of 10% compounded annually over a
two year period. The following tables reflect the amounts of principal
and interest that compose each payment and assumptions as to the
relevant exchange rates:
------------------------------------------------------------------------
Date Principal Interest
------------------------------------------------------------------------
Dec. 31, 1989................................. [pound]47.6 [pound]10.0
2 0
Dec. 12, 1990................................. [pound]52.3 [pound]5.24
8
------------------------------------------------------------------------
------------------------------------------------------------------------
Average
Date Spot rate rate for
[pound]1= year ending
------------------------------------------------------------------------
Jan. 1, 1989.................................. $1.30
Dec. 31, 1989................................. 1.40 1.35
Dec. 31, 1990................................. 1.50 1.45
------------------------------------------------------------------------
(ii) Because each interest payment is equal to the product of the
outstanding principal balance of the obligation and a single fixed rate
of interest, each stated interest payment constitutes periodic interest
under the principles of section 1273. Accordingly, there is no original
issue discount.
(iii) Because C is an accrual basis taxpayer, C will translate the
interest income at the average rate for the annual accrual period
pursuant to paragraph (b)(2)(ii)(C) of this section. Thus, C's interest
income is $13.50 ([pound]10.00x$1.35) in 1989, and $7.60
([pound]5.24x$1.45) in 1990. C will realize exchange gain or loss upon
receipt of accrued interest computed in accordance with paragraph (b)(3)
of this section. Thus, C will realize exchange gain in the amount of
$.50 [([pound]10.00x$1.40)-$13.50] in 1989, and $.26
[([pound]5.24x$1.50)-$7.60] in 1990.
(iv) In addition, C will realize exchange gain or loss upon the
receipt of principal each year computed under paragraph (b)(5) of this
section. Thus, C will realize exchange gain in the amount of $4.76
[([pound]47.62x$1.40)-([pound]47.62x$1.30)] in 1989, and $10.48
[([pound]52.38x$1.50)-([pound]52.38x$1.30)] in 1990.
(10) Treatment of bond premium--(i) In general. Amortizable bond
premium on a bond described in paragraph (b)(2)(i) of this section shall
be computed in the units of nonfunctional currency in which the bond is
denominated (or in which the payments are determined). Amortizable bond
premium properly taken into account under section 171 or Sec. 1.61-12
(or the successor provision thereof) shall reduce interest income or
expense in units of nonfunctional currency. Exchange gain or loss is
realized with respect to bond premium described in the preceding
sentence by treating the portion of premium amortized with respect to
any period as a return of principal. With respect to a holder that does
not elect to amortize bond premium under section 171, the amount of bond
premium will constitute a market loss when the bond matures. See
paragraph (b)(8) of this section. The principles set forth in this
paragraph (b)(10) shall apply to determine the treatment of acquisition
premium described in section 1272(a)(7).
(ii) Example. The following example illustrates the provisions of
this paragraph (b)(10).
Example. (A) X is an individual on the cash method of accounting
with the dollar as his functional currency. On January 1, 1989, X
purchases Y corporation's note for 107.99 British pounds ([pound]) from
Z, an unrelated party. The note has an issue price of [pound]100, a
stated redemption price at maturity of [pound]100, pays interest in
pounds at the rate of 10% compounded annually, and matures on December
31, 1993. X elects to amortize the bond premium of [pound]7.99 under the
rules of section 171. Pursuant to paragraph (b)(10)(i) of this section,
bond premium is determined and amortized in British pounds. Assume the
amortization schedule is as follows:
------------------------------------------------------------------------
Unamortized
Bond premium
Year ending 12/31 premium plus Interest
amortized principal
------------------------------------------------------------------------
[pound]107.
99
1989............................. [pound]1.36 [pound]106. [pound]8.64
63
1990............................. [pound]1.47 [pound]105. [pound]8.53
16
1991............................. [pound]1.59 [pound]103. [pound]8.41
57
1992............................. [pound]1.71 [pound]101. [pound]8.29
86
[[Page 600]]
1993............................. [pound]1.85 [pound]100. [pound]8.15
00
------------------------------------------------------------------------
(B) The bond premium reduces X's pound interest income under the
note. For example, the [pound]10 stated interest payment made in 1989 is
reduced by [pound]1.36 of bond premium, and the resulting [pound]8.64
interest income is translated into dollars at the spot rate on December
31, 1989. Exchange gain or loss is realized on the [pound]1.36 bond
premium based on the difference between the spot rates on January 1,
1989, the date the premium is paid to acquire the bond, and December 31,
1989, the date the bond premium is returned as part of the stated
interest. The [pound]1.36 bond premium reduces the unamortized premium
plus principal to [pound]106.63 ([pound]107.99-[pound]1.36). On December
31, 1993, when the bond matures and the [pound]7.99 of bond premium has
been fully amortized, X will realize exchange gain or loss with respect
to the remaining purchase price of [pound]100.
(11) Market discount--(i) In general. Market discount as defined in
section 1278(a)(2) shall be determined in units of nonfunctional
currency in which the market discount bond is denominated (or in which
the payments are determined). Accrued market discount (other than market
discount currently included in income pursuant to section 1278(b)) shall
be translated into functional currency at the spot rate on the date the
market discount bond is disposed of. No part of such accrued market
discount is treated as exchange gain or loss. Accrued market discount
currently includible in income pursuant to section 1278(b) shall be
translated into functional currency at the average exchange rate for the
accrual period. Exchange gain or loss with respect to accrued market
discount currently includible in income under section 1278(b) shall be
determined in accordance with paragraph (b)(3) of this section relating
to accrued interest income.
(ii) Example. The following example illustrates the provisions of
this paragraph (b)(11).
Example. (A) X is a calendar year corporation with the U.S. dollar
as its functional currency. On January 1, 1990, X purchases a bond of M
corporation for 96,530 British pounds ([pound]). The bond, which was
issued on January 1, 1989, has an issue price of [pound]100,000, a
stated redemption price at maturity of [pound]100,000, and provides for
annual pound payments of interest at 8 percent. The bond matures on
December 31, 1991. X purchased the bond at a market discount of 3,470
pounds and did not elect to include the market discount currently in
income under section 1278(b). X holds the bond to maturity and on
December 31, 1991, receives payment of [pound]100,000 (plus [pound]8,000
interest) when the exchange rate is [pound]1 = $1.50.
(B) Pursuant to paragraph (b)(11) of this section, X computes market
discount in units of nonfunctional currency. Thus, the market discount
as defined under section 1278(a)(2) is [pound]3,470. Accrued market
discount (other than market discount currently included in income
pursuant to section 1278(b)) is translated at the spot rate on the date
the market discount bond is disposed of. Accordingly, X will translate
the accrued market discount of [pound]3,470 at the spot rate on December
31, 1991 ([pound]3,470x$1.50 = $5,205). No exchange gain or loss is
realized with respect to the [pound]3,470 of accrued market discount.
See paragraphs (b)(3) and (5) of this section for the realization and
recognition of exchange gain or loss with respect to accrued interest
and principal.
(12) Tax exempt bonds. See Sec. 1.988-3(c)(2), which characterizes
exchange loss realized with respect to a nonfunctional currency tax
exempt bond as a reduction of interest income.
(13) Nonfunctional currency debt exchanged for stock of obligor--(i)
In general. Notwithstanding any other section of the Code other than
section 267, 1091 or 1092, exchange gain or loss shall be realized and
recognized by the holder and the obligor in accordance with the rules of
paragraphs (b)(3) through (7) of this section with respect to the
principal and accrued interest of a debt instrument described in
paragraph (b)(2)(i) of this section that is acquired by the obligor in
exchange for its stock, provided however, that such gain or loss shall
be recognized only to the extent of the total gain or loss on the
exchange (regardless of whether such gain or loss would otherwise be
recognized). This rule shall apply whether the debt instrument is
converted into stock according to its terms or exchanged pursuant to a
separate agreement between the obligor and the holder. A debt instrument
that is acquired by the obligor from a shareholder as a contribution to
capital shall be treated for purposes of this section as exchanged for
stock, whether or not additional stock is issued.
[[Page 601]]
(ii) Coordination with section 108. Section 988 and this section
shall apply before section 108. Exchange gain realized by the obligor on
an exchange described in paragraph (b)(13)(i) of this section shall not
be treated as discharge of indebtedness income, but shall be considered
to reduce the amount of the liability for purposes of computing the
obligor's income on the exchange under section 108(e)(4), section
108(e)(6) or section 108(e)(10).
(iii) Effective date. This paragraph (b)(13) shall be effective for
exchanges of debt for stock effected after September 21, 1989.
(iv) Examples. The following examples illustrate the operation of
this paragraph (b)(13). In each such example, assume that sections 267,
1091 and 1092 do not apply.
Example 1. (i) X is a calendar year U.S. corporation with the U.S.
dollar as its functional currency. On January 1, 1990 (the issue date),
X acquired a convertible bond maturing on December 31, 1998, issued by Y
corporation, a U.K. corporation with the British pound ([pound]) as its
functional currency. The issue price of the bond is [pound]100,000, the
stated redemption price at maturity is [pound]100,000, and the bond
provides for annual pound interest payments at the rate of 10%. The
terms of the bond also provide that at any time prior to December 31,
1998, the holder may surrender all of his interest in the bond in
exchange for 20 shares of Y common stock. On January 1, 1994, X
surrenders his interest in the bond for 20 shares of Y common stock.
Assume the following: (a) The spot rate on January 1, 1990, is [pound]1
= $1.30, (b) The spot rate on January 1, 1994, is [pound]1 = $1.50, and
(c) The 20 shares of Y common stock have a market value of
[pound]200,000 on January 1, 1994.
(ii) Pursuant to paragraph (b)(13) of this section, X will realize
and recognize exchange gain with respect to the issue price
([pound]100,000) of the bond on January 1, 1994, when the bond is
converted to stock. X will compute exchange gain pursuant to paragraph
(b)(5) of this section by translating the issue price at the spot rate
on the conversion date ([pound]100.000x$1.50 = $150,000) and subtracting
from such amount the issue price translated at the spot rate on the date
X acquired the bond ([pound]100,000x$1.30 = $130,000). Thus, X will
realize and recognize $20,000 of exchange gain. X's basis in the 20
shares of Y common stock is $150,000 ($130,000 substituted basis +
$20,000 recognized gain).
Example 2. (i) X, a foreign corporation with the British pound
([pound]) as its functional currency, lends [pound]100 at a market rate
of interest to Y, its wholly-owned U.S. subsidiary, on January 1, 1990,
on which date the spot exchange rate is [pound]1 = $1. Y's functional
currency is the U.S. dollar. On January 1, 1992, when the spot exchange
rate is [pound]1 = $.50, X cancels the debt as a contribution to
capital. Pursuant to paragraph (b)(13) of this section, Y will realize
and recognize exchange gain with respect to the [pound]100 issue price
of the debt instrument on January 1, 1992. Y will compute exchange gain
pursuant to paragraph (b)(6) of this section by translating the issue
price at the spot rate on the date Y became the obligor ([pound]100x$1 =
$100) and subtracting from such amount the issue price translated at the
spot rate on the date of extinguishment ([pound]100x$.50 = $50). Thus, Y
will realize and recognize $50 of exchange gain.
(ii) Under section 108(e)(6), on the acquisition of its indebtedness
from X as a contribution to capital Y is treated as having satisfied the
debt with an amount of money equal to X's adjusted basis in the debt
([pound]100). For purposes of section 108(e)(6), X's adjusted basis is
translated into United States dollars at the spot rate on the date Y
acquires the debt ([pound]1 = $.50). Therefore, Y is treated as having
satisfied the debt for $50. Pursuant to paragraph (b)(13) of this
section, for purposes of section 108 the amount of the indebtedness is
considered to be reduced by the exchange gain from $100 to $50.
Accordingly, Y recognizes $50 of exchange gain and no discharge of
indebtedness income on the extinguishment of its debt to X.
(iii) If X were a United States taxpayer with a dollar functional
currency and a $100 basis in Y's obligation. X would realize and
recognize an exchange loss of $50 under paragraph (b)(5) of this section
on the contribution of the debt to Y. The recognized loss would reduce
X's adjusted basis in the debt from $100 to $50, so that for purposes of
applying section 108(e)(6) Y is treated as having satisfied the debt for
$50. Accordingly, under these facts as well Y would recognize $50 of
exchange gain and no discharge of indebtedness income.
Example 3. (i) X and Y are unrelated calendar year U.S. corporations
with the U.S. dollar as their functional currency. On January 1, 1990
(the issue date), X acquires Y's bond maturing on December 31, 1999. The
issue price of the bond is [pound]100,000, the stated redemption price
at maturity is [pound]100,000, and the bond provides for annual pound
interest payments at the rate of 10%. On January 1, 1994, X and Y agree
that Y will redeem its bond from X in exchange for 20 shares of Y common
stock. Assume the following:
(a) The spot rate on January 1, 1990, is [pound]1 = $1.00,
(b) The spot rate on January 1, 1994, is [pound]1 = $.50,
(c) Interest rates on equivalent bonds have increased so that as of
January 1, 1994, the value of Y's bond has declined to [pound]90,000,
and
[[Page 602]]
(d) The 20 shares of Y common stock have a market value of
[pound]90,000 as of January 1, 1994.
(ii) Pursuant to paragraph (b)(13) of this section, X will realize
and recognize exchange loss with respect to the issue price
([pound]100,000) of the bond on January 1, 1994, when the bond is
exchanged for stock. X will compute exchange loss pursuant to paragraph
(b)(5) of this section by translating the issue price at the spot rate
on the exchange date ([pound]100,000x$.50 = $50,000) and subtracting
from such amount the issue price translated at the spot rate on the date
X acquired the bond ([pound]100,000x$1.00 = $100,000). Thus, X will
compute $50,000 of exchange loss, all of which will be realized and
recognized because it does not exceed the total $55,000 realized loss on
the exchange ($45,000 worth of stock received less $100,000 basis in the
exchanged bond).
(iii) Pursuant to paragraph (b)(13) of this section, Y will realize
and recognize exchange gain with respect to the issue price, computed
under paragraph (b)(6) of this section by translating the issue price at
the spot rate on the date Y became the obligor ([pound]100,000x$1.00 =
$100,000) and subtracting from such amount the issue price translated at
the spot rate on the exchange date ([pound]100,000x$.50 = $50,000).
Thus, Y will realize and recognize $50,000 of exchange gain. Under
section 108(e)(10), on the transfer of stock to X in satisfaction of its
indebtedness Y is treated as having satisfied the indebtedness with an
amount of money equal to the fair market value of the stock
([pound]90,000x$.50 = $45,000). Pursuant to paragraph (b)(13) of this
section, for purposes of section 108 the amount of the indebtedness is
considered to be reduced by the recognized exchange gain from $100,000
to $50,000. Accordingly, Y recognizes an additional $5,000 of discharge
of indebtedness income on the exchange.
Example 4. (i) The facts are the same as in Example 3 except that
interest rates on equivalent bonds have declined, rather than increased,
so that the value of Y's bond on January 1, 1994, has risen to
[pound]112,500; and X and Y agree that Y will redeem its bond from X on
that date in exchange for 25 shares of Y common stock worth
[pound]112,500. Pursuant to paragraphs (b)(13) and (b)(5) of this
section, X will compute $50,000 of exchange loss on the exchange with
respect to the [pound]100,000 issue price of the bond. See Example 3.
However, because X's total loss on the exchange is only $43,750 ($56,250
worth of stock received less $100,000 basis in the exchanged bond),
under the netting rule of paragraph (b)(13) of this section the realized
exchange loss is limited to $43,750.
(ii) Pursuant to paragraphs (b)(13) and (b)(6) of this section, Y
will compute $50,000 of exchange gain with respect to the issue price.
See Example 3. Under section 108(e)(10), Y is treated as having
satisfied the $100,000 indebtedness with an amount of money equal to the
fair market value of the stock ([pound]112,500x$.50 = $56,250),
resulting in a total gain on the exchange of $43,750. Accordingly, under
paragraph (b)(13) of this section Y's realized (and recognized) exchange
gain on the exchange is limited to $43,750. Also pursuant to paragraph
(b)(13) of this section, for purposes of section 108 the amount of the
indebtedness is considered to be reduced by the recognized exchange gain
from $100,000 to $56,250. Accordingly, Y recognizes no discharge of
indebtedness income on the exchange.
(14) [Reserved]
(15) Debt instruments and deposits denominated in hyperinflationary
currencies--(i) In general. If a taxpayer issues, acquires, or otherwise
enters into or holds a hyperinflationary debt instrument (as defined in
paragraph (b)(15)(vi)(A) of this section) or a hyperinflationary deposit
(as defined in paragraph (b)(15)(vi)(B) of this section) on which
interest is paid or accrued that is denominated in (or determined by
reference to) a nonfunctional currency of the taxpayer, then the
taxpayer shall realize exchange gain or loss with respect to such
instrument or deposit for its taxable year determined by reference to
the change in exchange rates between--
(A) The later of the first day of the taxable year, or the date the
instrument was entered into (or an amount deposited); and
(B) The earlier of the last day of the taxable year, or the date the
instrument (or deposit) is disposed of or otherwise terminated.
(ii) Only exchange gain or loss is realized. No gain or loss is
realized under paragraph (b)(15)(i) by reason of factors other than
movement in exchange rates, such as the creditworthiness of the debtor.
(iii) Special rule for synthetic, non-hyperinflationary currency
debt instruments--(A) General rule. Paragraph (b)(15)(i) does not apply
to a debt instrument that has interest and principal payments that are
to be made by reference to a currency or item that does not reflect
hyperinflationary conditions in a country (within the meaning of Sec.
1.988-1(f)).
(B) Example. Paragraph (b)(15)(iii)(A) is illustrated by the
following example:
[[Page 603]]
Example. When the Turkish lira (TL) is a hyperinflationary currency,
A, a U.S. corporation with the U.S. dollar as its functional currency,
makes a 5 year, 100,000 TL-denominated loan to B, an unrelated
corporation, at a 10% interest rate when 1,000 TL equals $1. Under the
terms of the debt instrument, B must pay interest annually to A in
amount of Turkish lira that is equal to $100. Also under the terms of
the debt instrument, B must pay A upon maturity of the debt instrument
an amount of Turkish lira that is equal to $1,000. Although the
principal and interest are payable in a hyperinflationary currency, the
debt instrument is a synthetic dollar debt instrument and is not subject
to paragraph (b)(15)(i) of this section.
(iv) Source and character of gain or loss--(A) General rule for
hyperinflationary conditions. The rules of this paragraph (b)(15)(iv)(A)
shall apply to any taxpayer that is either an issuer of (or obligor
under) a hyperinflationary debt instrument or deposit and has currency
gain on such debt instrument or deposit, or a holder of a
hyperinflationary debt instrument or deposit and has currency loss on
such debt instrument or deposit. For purposes of subtitle A of the
Internal Revenue Code, any exchange gain or loss realized under
paragraph (b)(15)(i) of this section is directly allocable to the
interest expense or interest income, respectively, from the debt
instrument or deposit (computed under this paragraph (b)), and therefore
reduces or increases the amount of interest income or interest expense
paid or accrued during that year with respect to that instrument or
deposit. With respect to a debt instrument or deposit during a taxable
year, to the extent exchange gain realized under paragraph (b)(15)(i) of
this section exceeds interest expense of an issuer, or exchange loss
realized under paragraph (b)(15)(i) of this section exceeds interest
income of a holder or depositor, the character and source of such excess
amount shall be determined under Sec. Sec. 1.988-3 and 1.988-4.
(B) Special rule for subsiding hyperinflationary conditions. If the
taxpayer is an issuer of (or obligor under) a hyperinflationary debt
instrument or deposit and has currency loss, or if the taxpayer is a
holder of a hyperinflationary debt instrument or deposit and has
currency gain, then for purposes of subtitle A of the Internal Revenue
Code, the character and source of the currency gain or loss is
determined under Sec. Sec. 1.988-3 and 1.988-4. Thus, if an issuer has
both interest expense and currency loss, the currency loss is sourced
and characterized under section 988, and does not affect the
determination of interest expense.
(v) Adjustment to principal or basis. Any exchange gain or loss
realized under paragraph (b)(15)(i) of this section is an adjustment to
the functional currency principal amount of the issuer, functional
currency basis of the holder, or the functional currency amount of the
deposit. This adjusted amount or basis is used in making subsequent
computations of exchange gain or loss, computing the basis of assets for
purposes of allocating interest under Sec. Sec. 1.861-9T through 1.861-
12T and 1.882-5, or making other determinations that may be relevant for
computing taxable income or loss.
(vi) Definitions--(A) Hyperinflationary debt instrument. A
hyperinflationary debt instrument is a debt instrument that provides
for--
(1) Payments denominated in or determined by reference to a currency
that is hyperinflationary (as defined in Sec. 1.988-1(f)) at the time
the taxpayer enters into or otherwise acquires the debt instrument; or
(2) Payments denominated in or determined by reference to a currency
that is hyperinflationary (as defined in Sec. 1.988-1(f)) during the
taxable year, and the terms of the instrument provide for the adjustment
of principal or interest payments in a manner that reflects
hyperinflation. For example, a debt instrument providing for a variable
interest rate based on local conditions and generally responding to
changes in the local consumer price index will reflect hyperinflation.
(B) Hyperinflationary deposit. A hyperinflationary deposit is a
demand or time deposit or similar instrument issued by a bank or other
financial institution that provides for--
(1) Payments denominated in or determined by reference to a currency
that is hyperinflationary (as defined in Sec. 1.988-1(f)) at the time
the taxpayer enters into or otherwise acquires the deposit; or
[[Page 604]]
(2) Payments denominated in or determined by reference to a currency
that is hyperinflationary (as defined in Sec. 1.988-1(f)) during the
taxable year, and the terms of the deposit provide for the adjustment of
the deposit amount or interest payments in a manner that reflects
hyperinflation.
(vii) Interaction with other provisions--(A) Interest allocation
rules. In determining the amount of interest expense, this paragraph
(b)(15) applies before Sec. Sec. 1.861-9T through 1.861-12T, and 1.882-
5.
(B) DASTM. With respect to a qualified business unit that uses the
United States dollar approximate separate transactions method of
accounting described in Sec. 1.985-3, paragraph (b)(15)(i) of this
section does not apply.
(C) Interaction with section 988(a)(3)(C). Section 988(a)(3)(C) does
not apply to a debt instrument subject to the rules of paragraph
(b)(15)(i) of this section.
(D) Hedging rules. To the extent Sec. 1.446-4 or 1.988-5 apply, the
rules of paragraph (b)(15)(i) of this section will not apply. This
paragraph (b)(15)(vii)(D) does not apply if the application of Sec.
1.988-5 results in hyperinflationary debt instrument or deposit
described in paragraph (b)(15)(vi)(A) or (B) of this section.
(viii) Effective date. This paragraph (b)(15) applies to
transactions entered into after February 14, 2000.
(16) Coordination with section 267 regarding debt instruments--(i)
Treatment of a creditor. For rules applicable to a corporation included
in a controlled group that is a creditor under a debt instrument see
Sec. 1.267(f)--1(h).
(ii) Treatment of a debtor. [Reserved]
(17) Coordination with installment method under section 453.
[Reserved]
(c) Item of expense or gross income or receipts which is to be paid
or received after the date accrued--(1) In general. Except as provided
in Sec. 1.988-5, exchange gain or loss with respect to an item
described in Sec. 1.988-1(a)(1)(ii) and (2)(ii) (other than accrued
interest income or expense subject to paragraph (b) of this section)
shall be realized on the date payment is made or received. Except as
provided in the succeeding sentence, such exchange gain or loss shall be
recognized in accordance with the applicable recognition provisions of
the Internal Revenue Code. If the taxpayer's right to receive income, or
obligation to pay an expense, is transferred or modified in a
transaction in which gain or loss would otherwise be recognized,
exchange gain or loss shall be realized and recognized only to the
extent of the total gain or loss on the transaction.
(2) Determination of exchange gain or loss with respect to an item
of gross income or receipts. Exchange gain or loss realized on an item
of gross income or receipts described in paragraph (c)(1) of this
section shall be determined by multiplying the units of nonfunctional
currency received by the spot rate on the payment date, and subtracting
from such amount the amount determined by multiplying the units of
nonfunctional currency received by the spot rate on the booking date.
The term ``spot rate on the payment date'' means the spot rate
determined under Sec. 1.988-1(d) on the date payment is received or
otherwise taken into account. Pursuant to Sec. 1.988-1(d)(3), a
taxpayer may use a spot rate convention for purposes of determining the
spot rate on the payment date. The term ``spot rate on the booking
date'' means the spot rate determined under Sec. 1.988-1(d) on the date
the item of gross income or receipts is accrued or otherwise taken into
account. Pursuant to Sec. 1.988-1(d)(3), a taxpayer may use a spot rate
convention for purposes of determining the spot rate on the booking
date.
(3) Determination of exchange gain or loss with respect to an item
of expense. Exchange gain or loss realized on an item of expense
described in paragraph (c)(1) of this section shall be determined by
multiplying the units of nonfunctional currency paid by the spot rate on
the booking date and subtracting from such amount the amount determined
by multiplying the units of nonfunctional currency paid by the spot rate
on the payment date. The term ``spot rate on the booking date'' means
the spot rate determined under Sec. 1.988-1(d) on the date the item of
expense is accrued or otherwise taken into account. Pursuant to Sec.
1.988-1(d)(3), a taxpayer may use a spot rate convention for purposes of
determining the spot rate on the booking date. The
[[Page 605]]
term ``spot rate on the payment date'' means the spot rate determined
under Sec. 1.988-1(d) on the date payment is made or otherwise taken
into account. Pursuant to Sec. 1.988-1(d)(3), a taxpayer may use a spot
rate convention for purposes of determining the spot rate on the date.
(4) Examples. The following examples illustrate the application of
paragraph (c) of this section.
Example 1. X is a calendar year corporation with the dollar as its
functional currency. X is on the accrual method of accounting. On
January 15, 1989, X sells inventory for 10,000 Canadian dollars (C$).
The spot rate on January 15, 1989, is C$1 = U.S. $.55. On February 23,
1989, when X receives payment of the C$10,000, the spot rate is C$1 =
U.S. $.50. On February 23, 1989, X will realize exchange loss. X's loss
is computed by multiplying the C$10,000 by the spot rate on the date the
C$10,000 are received (C$10,000x.50 = U.S. $5,000) and subtracting from
such amount, the amount computed by multiplying the C$10,000 by the spot
rate on the booking date (C$10,000x.55 = U.S. $5,500). Thus, X's
exchange loss on the transaction is U.S. $500 (U.S. $5,000-U.S. $5,500).
Example 2. The facts are the same as in Example 1 except that X uses
a spot rate convention to determine the spot rate as provided in Sec.
1.988-1(d)(3). Pursuant to X's spot rate convention, the spot rate at
which a payable or receivable is booked is determined monthly for each
nonfunctional currency payable or receivable by adding the spot rate at
the beginning of the month and the spot rate at the end of the month and
dividing by two. All payables and receivables in a nonfunctional
currency booked during the month are translated into functional currency
at the rate described in the preceding sentence. Further, the
translation of nonfunctional currency paid with respect to a payable,
and nonfunctional currency received with respect to a receivable, is
also performed pursuant to the spot rate convention. Assume the spot
rate determined under the spot rate convention for the month of January
is C$1 = U.S. $.54 and for the month of February is C$1 = U.S. $.51. On
the last date in February, X will realize exchange loss. X's loss is
computed by multiplying the C$10,000 by the spot rate convention for the
month of February (C$10,000xU.S. $.51 = U.S. $5,100) and subtracting
from such amount, the amount computed by multiplying the C$10,000 by the
spot rate convention for the month of January (C$10,000xU.S. $.54 =
$5,400). Thus, X's exchange loss on the transaction is U.S. $300 (U.S.
$5,100-U.S. $5,400). X's basis in the C$10,000 is U.S. $5,400.
Example 3. The facts are the same as in Example 2 except that X has
a standing order with X's bank for the bank to convert any nonfunctional
currency received in satisfaction of a receivable into U.S. dollars on
the day received and to deposit those U.S. dollars in X's U.S. dollar
bank account. X may use its convention to translate the amount booked
into U.S. dollars, but must use the U.S. dollar amounts received from
the bank with respect to such receivables to determine X's exchange gain
or loss. Thus, if X receives payment of the C$10,000 on February 23,
1989, when the spot rate is C$1 = U.S.$ .50, X determines exchange gain
or loss by subtracting the amount booked under X's convention
(U.S.$5,400) from the amount of U.S. dollars received from the bank
under the standing conversion order (assume $5,000). X's exchange loss
is U.S.$400.
(d) Exchange gain or loss with respect to forward contracts, futures
contracts and option contracts--(1) Scope--(i) In general. This
paragraph (d) applies to forward contracts, futures contracts and option
contracts described in Sec. 1.988-1(a)(1)(ii) and (2)(iii). For rules
applicable to currency swaps and notional principal contracts described
in Sec. 1.988-1(a) (1)(ii) and (2)(iii), see paragraph (e) of this
section.
(ii) Treatment of spot contracts. Solely for purposes of this
paragraph (d), a spot contract as defined in Sec. 1.988-1(b) to buy or
sell nonfunctional currency is not considered a forward contract or
similar transaction described in Sec. 1.988-1(a)(2)(iii) unless such
spot contract is disposed of (or otherwise terminated) prior to making
or taking delivery of the currency. For example, if a taxpayer with the
dollar as its functional currency enters into a spot contract to
purchase British pounds, and takes delivery of such pounds under the
contract, the delivery of the pounds is not a realization event under
section 988(c)(5) and paragraph (e)(4)(ii) of this section because the
contract is not considered a forward contract or similar transaction
described in Sec. 1.988-1(a)(2)(iii). However, if the taxpayer sells or
otherwise terminates the contract before taking delivery of the pounds,
exchange gain or loss shall be realized and recognized in accordance
with paragraphs (d)(2) and (3) of this section.
(2) Realization of exchange gain or loss--(i) In general. Except as
provided in Sec. 1.988-5, exchange gain or loss on a contract described
in Sec. 1.988-2(d)(1) shall be realized in accordance with the
[[Page 606]]
applicable realization section of the Internal Revenue Code (e.g.,
sections 1001, 1092, and 1256). See also section 988(c)(5). For purposes
of determining the timing of the realization of exchange gain or loss,
sections 1092 and 1256 shall take precedence over section 988(c)(5).
(ii) Realization by offset--(A) In general. Except as provided in
paragraphs (d)(2)(ii)(B) and (C) of this section, exchange gain or loss
with respect to a transaction described in Sec. 1.988-1(a)(1)(ii) and
(2)(iii) shall not be realized solely because such transaction is offset
by another transaction (or transactions).
(B) Exception where economic benefit is derived. If a transaction
described in Sec. 1.988-1(a)(1)(ii) and (2)(iii) is offset by another
transaction or transactions, exchange gain shall be realized to the
extent the taxpayer derives, by pledge or otherwise, an economic benefit
(e.g., cash, property or the proceeds from a borrowing) from any gain
inherent in such offsetting positions. Proper adjustment shall be made
in the amount of any gain or loss subsequently realized for gain taken
into account by reason of the preceding sentence. This paragraph
(d)(2)(ii)(B) shall apply to transactions creating an offset after
September 21, 1989.
(C) Certain contracts traded on an exchange. If a transaction
described in Sec. 1.988-1(a)(1)(ii) and (2)(iii) is traded on an
exchange and it is the general practice of the exchange to terminate
offsetting contracts, entering into an offsetting contract shall be
considered a termination of the contract being offset.
(iii) Clarification of section 988(c)(5). If the delivery date of a
contract subject to section 988(c)(5) and paragraph (d)(4)(ii) of this
section is different than the date the contract expires, then for
purposes of determining the date exchange gain or loss is realized, the
term delivery date shall mean expiration date.
(iv) Examples. The following examples illustrate the rules of this
paragraph (d)(1) and (2).
Example 1. On August 1, 1989, X, a calendar year corporation with
the dollar as its functional currency, enters into a forward contract
with Bank A to buy 100 New Zealand dollars for $80 for delivery on
January 31, 1990. (The forward purchase contract is not a section 1256
contract.) On November 1, 1989, the market price for the purchase of 100
New Zealand dollars for delivery on January 31, 1990, is $76. On
November 1, 1989, X cancels its obligation under the forward purchase
contract and pays Bank A $3.95 (the present value of $4 discounted at
12% for the period) in cancellation of such contract. Under section 1001
(a), X realizes an exchange loss of $3.95 on November 1, 1989, because
cancellation of the forward purchase contract for cash results in the
termination of X's contract.
Example 2. X is a corporation with the dollar as its functional
currency. On January 1, 1989, X enters into a currency swap contract
with Bank A under which X is obligated to make a series of Japanese yen
payments in exchange for a series of dollar payments. On February 21,
1992, X has a gain of $100,000 inherent in such contract as a result of
interest rate and exchange rate movements. Also on February 21, 1992, X
enters into an offsetting swap with Bank A to lock in such gain. If on
February 21, 1992, X pledges the gain inherent in such offsetting
positions as collateral for a loan, X's initial swap contract is treated
as being terminated on February 21, 1992, under paragraph (d)(2)(ii)(B)
of this section. Proper adjustment is made in the amount of any gain or
loss subsequently realized for the gain taken into account by reason of
paragraph (d)(2)(ii)(B) of this section.
Example 3. X is a calendar year corporation with the dollar as its
functional currency. On October 1, 1989, X enters into a forward
contract to buy 100,000 Swiss francs (Sf) for delivery on March l, 1990,
for $51,220. Assume that the contract is a section 1256 contract under
section 1256(g)(2) and that section 1256(e) does not apply. Pursuant to
section 1256(a)(1), the forward contract is treated as sold for its fair
market value on December 31, 1989. Assume that the fair market value of
the contract is $1,000 determined under Sec. 1.988-1(g). Thus X will
realize an exchange gain of $1,000 on December 31, 1989. Such gain is
subject to the character rules of Sec. 1.988-3 and the source rules of
Sec. 1.988-4.
(v) Extension of the maturity date of certain contracts. An
extension of time for making or taking delivery under a contract
described in paragraph (d)(1) of this section (e.g., a historical rate
rollover as defined in Sec. 1.988-5(b)(2)(iii)(C)) shall be considered
a sale or exchange of the contract for its fair market value on the date
of the extension and the establishment of a new contract on such date.
If, under the terms of the extension, the time value of any gain or loss
recognized pursuant
[[Page 607]]
to the preceding sentence adjusts the price of the currency to be bought
or sold under the new contract, the amount attributable to such time
value shall be treated as interest income or expense for all purposes of
the Code. However, the preceding sentence shall not apply and the amount
attributable to the time value of any gain or loss recognized shall be
treated as exchange gain or loss if the period beginning on the first
date the contract is rolled over and ending on the date payment is
ultimately made or received with respect to such contract does not
exceed 183 days.
(3) Recognition of exchange gain or loss. Except as provided in
Sec. 1.988-5 (relating to section 988 hedging transactions), exchange
gain or loss realized with respect to a contract described in paragraph
(d)(1) of this section shall be recognized in accordance with the
applicable recognition provisions of the Internal Revenue Code. For
example, a loss realized with respect to a contract described in
paragraph (d)(1) of this section which is part of a straddle shall be
recognized in accordance with the provisions of section 1092 to the
extent such section is applicable.
(4) Determination of exchange gain or loss--(i) In general. Exchange
gain or loss with respect to a contract described in Sec. 1.988-2(d)(1)
shall be determined by subtracting the amount paid (or deemed paid), if
any, for or with respect to the contract (including any amount paid upon
termination of the contract) from the amount received (or deemed
received), if any, for or with respect to the contract (including any
amount received upon termination of the contract). Any gain or loss
determined according to the preceding sentence shall be treated as
exchange gain or loss.
(ii) Special rules where taxpayer makes or takes delivery. If the
taxpayer makes or takes delivery in connection with a contract described
in paragraph (d)(1) of this section, any gain or loss shall be realized
and recognized in the same manner as if the taxpayer sold the contract
(or paid another person to assume the contract) on the date on which he
took or made delivery for its fair market value on such date. See
paragraph (d)(2)(iii) of this section regarding the definition of the
term ``delivery date.'' This paragraph (d)(4)(ii) shall not apply in any
case in which the taxpayer makes or takes delivery before June 11, 1987.
(iii) Examples. The following examples illustrate the application of
paragraph (d)(4) of this section.
Example 1. X is a calendar year corporation with the dollar as its
functional currency. On October 1, 1989, when the six month forward rate
is $.4907, X enters into a forward contract to buy 100,000 New Zealand
dollars (NZD) for delivery on March 1, 1990. On March 1, 1990, when X
takes delivery of the 100,000 NZD, the spot rate is 1NZD equals $.48.
Pursuant to section 988(c)(5) and paragraph (d)(4)(ii) of this section,
a taxpayer that takes delivery of nonfunctional currency under a forward
contract that is subject to section 988 is treated as if the taxpayer
sold the contract for its fair market value on the date delivery is
taken. If X sold the contract on March 1, 1990, the transferee would
require a payment of $1,070 [($.48x100,000NZD)-($.4907x100,000NZD)] to
compensate him for the loss in value of the 100,000NZD. Therefore, X
realizes an exchange loss of $1,070. X has a basis in the 100,000NZD of
$48,000.
Example 2. Assume the same facts as in Example 1 except that the
contract is for Swiss francs and is a section 1256 contract. Assume
further that on December 31, 1989, the value to X of the contract as
marked to market is $1,000. Pursuant to section 1256(a), X realizes an
exchange gain of $1,000. Such gain, however, is characterized as
ordinary income under Sec. 1.988-3 and will be sourced under Sec.
1.988-4.
Example 3. X is a calendar year corporation with the dollar as its
functional currency. On May 2, 1989, X enters into an option contract
with Bank A to purchase 50,000 Canadian dollars (C$) for U.S. $42,500
(C$1 = U.S. $.85) for delivery on or before September 18, 1989. X pays a
$285 premium to Bank A to obtain the option contract. On September 18,
1989, when X exercises the option and takes delivery of the C$50,000,
the spot rate is C$1 equals U.S. $.90. Pursuant to section 988(c)(5) and
paragraph (d)(4)(ii) of this section, a taxpayer that takes delivery
under an option contract that is subject to section 988 is treated as if
the taxpayer sold the contract for its fair market value on the date
delivery is taken. If X sold the contract for its fair market value on
September 18, 1989, X would receive U.S. $2,500 [(C$50,000xU.S. $.90)-
(C$50,000xU.S. $.85)]. Accordingly, X is deemed to have received U.S.
$2,500 on the sale of the contract at its fair market value. X will
realize U.S. $2,215 ($2,500 deemed received less $285 paid) of exchange
gain with respect to the delivery of Canadian dollars
[[Page 608]]
under the option contract. X's basis in the 50,000 Canadian dollars is
U.S. $45,000.
(5) Hyperinflationary contracts--(i) In general. If a taxpayer
acquires or otherwise enters into a hyperinflationary contract (as
defined in paragraph (d)(5)(ii) of this section) that has payments to be
made or received that are denominated in (or determined by reference to)
a nonfunctional currency of the taxpayer, then the taxpayer shall
realize exchange gain or loss with respect to such contract for its
taxable year determined by reference to the change in exchange rates
between--
(A) The later of the first day of the taxable year, or the date the
contract was acquired or entered into; and
(B) The earlier of the last day of the taxable year, or the date the
contract is disposed of or otherwise terminated.
(ii) Definition of hyperinflationary contract. A hyperinflationary
contract is a contract described in paragraph (d)(1) of this section
that provides for payments denominated in or determined by reference to
a currency that is hyperinflationary (as defined in Sec. 1.988-1(f)) at
the time the taxpayer acquires or otherwise enters into the contract.
(iii) Interaction with other provisions--(A) DASTM. With respect to
a qualified business unit that uses the United States dollar approximate
separate transactions method of accounting described in Sec. 1.985-3,
this paragraph (d)(5) does not apply.
(B) Hedging rules. To the extent Sec. 1.446-4 or 1.988-5 apply,
this paragraph (d)(5) does not apply.
(C) Adjustment for subsequent transactions. Proper adjustments must
be made in the amount of any gain or loss subsequently realized for gain
or loss taken into account by reason of this paragraph (d)(5).
(iv) Effective date. This paragraph (d) (5) is applicable to
transactions acquired or otherwise entered into after February 14, 2000.
(e) Currency swaps and other notional principal contracts--(1) In
general. Except as provided in paragraph (e)(2) of this section or in
Sec. 1.988-5, the timing of income, deduction and loss with respect to
a notional principal contract that is a section 988 transaction shall be
governed by section 446 and the regulations thereunder. Such income,
deduction and loss is characterized as exchange gain or loss (except as
provided in another section of the Internal Revenue Code (or regulations
thereunder), Sec. 1.988-5, or in paragraph (f) of this section).
(2) Special rules for currency swaps--(i) In general. Except as
provided in paragraph (e)(2)(iii)(B) of this section, the provisions of
this paragraph (e)(2) shall apply solely for purposes of determining the
realization, recognition and amount of exchange gain or loss with
respect to a currency swap contract, and not for purposes of determining
the source of such gain or loss, or characterizing such gain or loss as
interest. Except as provided in Sec. 1.988-3(c), any income or loss
realized with respect to a currency swap contract shall be characterized
as exchange gain or loss (and not as interest income or expense). Any
exchange gain or loss realized in accordance with this paragraph (e)(2)
shall be recognized unless otherwise provided in an applicable section
of the Code. For purposes of this paragraph (e)(2), a currency swap
contract is a contract defined in paragraph (e)(2)(ii) of this section.
With respect to a contract which requires the payment of swap principal
prior to maturity of such contract, see paragraph (f) of this section.
For purposes of this paragraph (e), the rules of paragraph (d)(2)(ii) of
this section (regarding realization by offset) apply. See Example 2 of
paragraph (d)(2)(iv) of this section.
(ii) Definition of currency swap contract--(A) In general. A
currency swap contract is a contract involving different currencies
between two or more parties to--
(1) Exchange periodic interim payments, as defined in paragraph
(e)(2)(ii)(C) of this section, on or prior to maturity of the contract;
and
(2) Exchange the swap principal amount upon maturity of the
contract.
A currency swap contract may also require an exchange of the swap
principal amount upon commencement of the agreement.
(B) Swap principal amount. The swap principal amount is an amount of
two different currencies which, under the terms of the currency swap
contract, is used to determine the periodic interim payments in each
currency and which
[[Page 609]]
is exchanged upon maturity of the contract. If such amount is not
clearly set forth in the contract, the Commissioner may determine the
swap principal amount.
(C) Exchange of periodic interim payments. An exchange of periodic
interim payments is an exchange of one or more payments in one currency
specified by the contract for one or more payments in a different
currency specified by the contract where the payments in each currency
are computed by reference to an interest index applied to the swap
principal amount. A currency swap contract must clearly indicate the
periodic interim payments, or the interest index used to compute the
periodic interim payments, in each currency.
(iii) Timing and computation of periodic interim payments--(A) In
general. Except as provided in paragraph (e)(2)(iii)(B) of this section
and Sec. 1.988-5, the timing and computation of the periodic interim
payments provided in a currency swap agreement shall be determined by
treating--
(1) Payments made under the swap as payments made pursuant to a
hypothetical borrowing that is denominated in the currency in which
payments are required to be made (or are determined with reference to)
under the swap, and
(2) Payments received under the swap as payments received pursuant
to a hypothetical loan that is denominated in the currency in which
payments are received (or are determined with reference to) under the
swap.
Except as provided in paragraph (e)(2)(v) of this section, the
hypothetical issue price of such hypothetical borrowing and loan shall
be the swap principal amount. The hypothetical stated redemption price
at maturity is the total of all payments (excluding any exchange of the
swap principal amount at the inception of the contract) provided under
the hypothetical borrowing or loan other than periodic interest payments
under the principles of section 1273. For purposes of determining
economic accrual under the currency swap, the number of hypothetical
interest compounding periods of such hypothetical borrowing and loan
shall be determined pursuant to a semiannual compounding convention
unless the currency swap contract indicates otherwise. For purposes of
determining the timing and amount of the periodic interim payments, the
principles regarding the amortization of interest (see generally,
sections 1272 through 1275 and 163(e)) shall apply to the hypothetical
interest expense and income of such hypothetical borrowing and loan.
However, such principles shall not apply to determine the time when
principal is deemed to be paid on the hypothetical borrowing and loan.
See paragraph (d)(2)(iii) of this section and Example 2 of paragraph
(d)(5) of this section with respect to the time when principal is deemed
to be paid. With respect to the translation and computation of exchange
gain or loss on any hypothetical interest income or expense, see Sec.
1.988-2(b). The amount treated as exchange gain or loss by the taxpayer
with respect to the periodic interim payments for the taxable year shall
be the amount of hypothetical interest income and exchange gain or loss
attributable to such interest income from the hypothetical borrowing and
loan for such year less the amount of hypothetical interest expense and
exchange gain or loss attributable to the interest expense from such
hypothetical borrowing and loan for such year.
(B) Effect of prepayment for purposes of section 956. For purposes
of section 956, the Commissioner may treat any prepayment of a currency
swap as a loan.
(iv) Timing and determination of exchange gain or loss with respect
to the swap principal amount. Exchange gain or loss with respect to the
swap principal amount shall be realized on the day the units of swap
principal in each currency are exchanged. (See paragraph
(e)(2)(ii)(A)(2) of this section which requires that the entire swap
principal amount be exchanged upon maturity of the contract.) Such gain
or loss shall be determined on the date of the exchange by subtracting
the value (on such date) of the units of swap principal paid from the
value of the units of swap principal received. This paragraph (e)(2)(iv)
does not apply to an equal exchange of the swap principal amount at the
commencement of the agreement at a market exchange rate.
[[Page 610]]
(v) Anti-abuse rules--(A) Method of accounting does not clearly
reflect income. If the taxpayer's method of accounting for income,
expense, gain or loss attributable to a currency swap does not clearly
reflect income, or if the present value of the payments to be made is
not equivalent to that of the payments to be received (including the
swap premium or discount, as defined in paragraph (e)(3)(ii) of this
section) on the day the taxpayer enters into or acquires the contract,
the Commissioner may apply principles analogous to those of section 1274
or such other rules as the Commissioner deems appropriate to clearly
reflect income. For example, in order to clearly reflect income the
Commissioner may determine the hypothetical issue price, the
hypothetical stated redemption price at maturity, and the amounts
required to be taken into account within a taxable year. Further, if the
present value of the payments to be made is not equivalent to that of
the payments to be received (including the swap premium or discount, as
defined in paragraph (e)(3)(ii) of this section) on the day the taxpayer
enters into or acquires the contract, the Commissioner may integrate the
swap with another transaction (or transactions) in order to clearly
reflect income.
(B) Terms must be clearly stated. If the currency swap contract does
not clearly set forth the swap principal amount in each currency, and
the periodic interim payments in each currency (or the interest index
used to compute the periodic interim payments in each currency), the
Commissioner may defer any income, deduction, gain or loss with respect
to such contract until termination of the contract.
(3) Amortization of swap premium or discount in the case of off-
market currency swaps--(i) In general. An ``off-market currency swap''
is a currency swap contract under which the present value of the
payments to be made is not equal to that of the payments to be received
on the day the taxpayer enters into or acquires the contract (absent the
swap premium or discount, as defined in paragraph (e)(3)(ii) of this
section). Generally, such present values may not be equal if the swap
exchange rate (as defined in paragraph (e)(3)(iii) of this section) is
not the spot rate, or the interest indices used to compute the periodic
interim payments do not reflect current values, on the day the taxpayer
enters into or acquires the currency swap.
(ii) Treatment of taxpayer entering into or acquiring an off-market
currency swap. If a taxpayer that enters into or acquires a currency
swap makes a payment (that is, the taxpayer pays a premium, ``swap
premium,'' to enter into or acquire the currency swap) or receives a
payment (that is, the taxpayer enters into or acquires the currency swap
at a discount, ``swap discount'') in order to make the present value of
the amounts to be paid equal the amounts to be received, such payment
shall be amortized in a manner which places the taxpayer in the same
position it would have been in had the taxpayer entered into a currency
swap contract under which the present value of the amounts to be paid
equal the amounts to be received (absent any swap premium or discount).
Thus, swap premium or discount shall be amortized as follows--
(A) The amount of swap premium or discount that is attributable to
the difference between the swap exchange rate (as defined in paragraph
(e)(3)(iii) of this section) and the spot rate on the date the contract
is entered into or acquired shall be taken into account as income or
expense on the date the swap principal amounts are taken into account;
and
(B) The amount of swap premium or discount attributable to the
difference in values of the periodic interim payments shall be amortized
in a manner consistent with the principles of economic accrual. Cf.,
section 171.
Any amount taken into account pursuant to this paragraph (e)(3)(ii)
shall be treated as exchange gain or loss.
(iii) Definition of swap exchange rate. The swap exchange rate is
the single exchange rate set forth in the contract at which the swap
principal amounts are determined. If the swap exchange rate is not
clearly set forth in the contract, the Commissioner may determine such
rate.
(iv) Coordination with Sec. 1.446-3(g)(4) regarding swaps with
significant nonperiodic payments. The rules of Sec. 1.446-3(g)(4)
[[Page 611]]
apply to any currency swap with a significant nonperiodic payment.
Section 1.446-3(g)(4) applies before this paragraph (e)(3). Thus, if
Sec. 1.446-3(g)(4) applies, currency gain or loss may be realized on
the loan. This paragraph (e)(3)(iv) applies to transactions entered into
after February 14, 2000.
(4) Treatment of taxpayer disposing of a currency swap. Any gain or
loss realized on the disposition or the termination of a currency swap
is exchange gain or loss.
(5) Examples. The following examples illustrate the application of
this paragraph (e).
Example 1. (i) C is an accrual method calendar year corporation with
the dollar as its functional currency. On January 1, 1989, C enters into
a currency swap with J with the following terms:
(1) the principal amount is $150 and 100 British pounds ([pound])
(the equivalent of $150 on the effective date of the contract assuming a
spot rate of [pound]1 = $1.50 on January 1, 1989);
(2) C will make payments equal to 10% of the dollar principal amount
on December 31, 1989, and December 31, 1990;
(3) J will make payments equal to 12% of the pound principal amount
on December 31, 1989, and December 31, 1990; and
(4) on December 31, 1990, C will pay to J the $150 principal amount
and J will pay to C the [pound]100 principal amount.
Assume that the spot rate is [pound]1 = $1.50 on January 1, 1989,
[pound]1 = $1.40 on December 31, 1989, and [pound]1 = $1.30 on December
31, 1990. Assume further that the average rate for 1989 is [pound]1 =
$1.45 and for 1990 is [pound]1 = $1.35.
(ii) Solely for determining the realization of gain or loss in
accordance with paragraph (e)(2) of this section (and not for purposes
of determining whether any payments are treated as interest), C will
treat the dollar payments made by C as payments made pursuant to a
dollar borrowing with an issue price of $150, a stated redemption price
at maturity of $150, and yield to maturity of 10%. C will treat the
pound payments received as payments received pursuant to a pound loan
with an issue price of [pound]100, a stated redemption price at maturity
of [pound]100, and a yield of 12% to maturity. Pursuant to Sec. 1.988-
2(b), C is required to compute hypothetical accrued pound interest
income at the average rate for the accrual period and then determine
exchange gain or loss on the day payment is received with respect to
such accrued amount. Accordingly, C will accrue $17.40 ([pound]12x$1.45)
in 1989 and $16.20 ([pound]12x$1.35) in 1990. C also will compute
hypothetical exchange loss of $.60 on December 31, 1989
[([pound]12x$1.40)- ([pound]12x$1.45)] and hypothetical exchange loss of
$.60 on December 31, 1990 [([pound]12x$1.30)- ([pound]12x$1.35)]. All
such hypothetical interest income and exchange loss are characterized
and sourced as exchange gain and loss. Further, C is treated as having
paid $15 ($150x10%) of hypothetical interest on December 31, 1989, and
again on December 31, 1990. Such hypothetical interest expense is
characterized and sourced as exchange loss. Thus, C will have a net
exchange gain of $1.80 ($17.40-$.60-$15.00) with respect to the periodic
interim payments in 1989 and a net exchange gain of $.60 ($16.20-$.60-
$15.00) with respect to the periodic interim payments in 1990. Finally,
C will realize an exchange loss on December 31, 1990, with respect to
the exchange of the swap principal amount. This loss is determined by
subtracting the value of the units of swap principal paid ($150) from
the value of the units of swap principal received ([pound]100x$1.30 =
$130) resulting in a $20 exchange loss.
Example 2. (i) C is an accrual method calendar year corporation with
the dollar as its functional currency. On January 1, 1989, when the spot
rate is [pound]1 = $1.50, C enters into a currency swap contract with J
under which C agrees to make and receive the following payments:
------------------------------------------------------------------------
Date C pays J pays
------------------------------------------------------------------------
December 31, 1989............................. $15.00 [pound]12.0
0
December 31, 1990............................. 41.04 12.00
December 31, 1991............................. 0.00 12.00
December 31, 1992............................. 150.00 112.00
------------------------------------------------------------------------
(ii) Under paragraph (e)(2)(iii) of this section, C must treat the
dollar periodic interim payments under the swap as made pursuant to a
hypothetical dollar borrowing. The hypothetical issue price is $150 and
the stated redemption price at maturity is $206.04. The amount of
hypothetical interest expense must be amortized in accordance with
economic accrual. Thus J must include and C must deduct periodic interim
payment amounts as follows:
------------------------------------------------------------------------
Amount
taken into Adjusted
account issue price
------------------------------------------------------------------------
December 31, 1989............................. $15.00 150.00
December 31, 1990............................. $15.00 123.96
December 31, 1991............................. $12.40 136.36
December 31, 1992............................. $13.64
------------------------------------------------------------------------
(iii) Gain or loss with respect to the periodic interim payments of
the currency swap is determined under paragraph (e)(2)(iii)(A) of this
section with respect to the dollar cash flow amortized as set forth
above and the corresponding pound cash flow as stated in the currency
swap contract. Gain or loss with respect to the principal payments
(i.e., $150 and [pound]100) exchanged on December 31, 1992, is
determined under paragraph (e)(2)(iv) of this section on December 31,
1992, notwithstanding that under the principles regarding
[[Page 612]]
amortization of interest $26.04 would have been regarded as a payment of
principal on December 31, 1990.
Example 3. (i) X is a corporation on the accrual method of
accounting with the dollar as its functional currency and the calendar
year as its taxable year. On January 1, 1989, X enters into a three year
currency swap contract with Y with the following terms. The swap
principal amount is $100 and the Swiss franc (Sf) equivalent of such
amount which equals Sf200 translated at the swap exchange rate of $1 =
Sf2. There is no initial exchange of the swap principal amount. The
interest rates used to compute the periodic interim payments are 10%
compounded annually for U.S. dollar payments and 5% compounded annually
for Swiss franc payments. Thus, under the currency swap, X agrees to pay
Y $10 (10%x$100) on December 31st of 1989, 1990 and 1991 and to pay Y
the swap principal amount of $100 on December 31, 1991. Y agrees to pay
X Sf10 (5%xSf200) on December 31st of 1989, 1990 and 1991 and to pay X
the swap principal amount of Sf200 on December 31, 1991. Assume that the
average rate for 1989 and the spot rate on December 31, 1989, is $1 =
Sf2.5.
(ii) Under paragraph (e)(2)(iii) of this section, on December 31,
1989, X will realize an exchange loss of $6 (the sum of $10 of loss by
reason of the $10 periodic interim payment paid to Y and $4.00 of gain,
the value of Sf10 on December 31, 1989, from the receipt of Sf10 on such
date).
(iii) On January 1, 1990, X transfers its rights and obligations
under the swap contract to Z, an unrelated corporation. Z has the dollar
as its functional currency, is on the accrual method of accounting, and
has the calendar year as its taxable year. On January 1, 1990, the
exchange rate is $1 = Sf2.50. The relevant dollar interest rate is 8%
compounded annually and the relevant Swiss franc interest rate is 5%
compounded annually. Because of the movement in exchange and interest
rates, the agreement between X and Z to transfer the currency swap
requires X to pay Z $23.56 (the swap discount as determined under
paragraph (e)(3) of this section).
(iv) Pursuant to paragraph (e)(4) of this section, X may deduct the
loss of $23.56 in 1990. The loss is characterized under Sec. 1.988-3
and sourced under Sec. 1.988-4.
(v) Pursuant to paragraph (e)(3)(ii) of this section, Z is required
to amortize the $23.56 received as follows. The amount of the $23.56
payment that is attributable to movements in exchange rates ($20) is
taken into account on December 31, 1991, the date the swap principal
amounts are exchanged, under paragraph (e)(3)(ii)(A) of this section.
This amount is the present value (discounted at 10%, the rate under the
currency swap contract used to compute the dollar periodic interim
payments) of the financial asset required to compensate Z for the loss
in value of the hypothetical Swiss franc loan resulting from movements
in exchange rates between January 1, 1989, and January 1, 1990. This
amount is determined by assuming that interest rates did not change from
the date the swap originally was entered into (January 1, 1989), but
that the exchange rate is $1 = Sf2.50. Under this assumption, a taxpayer
undertaking the obligation to pay dollars under the currency swap on
January 1, 1990, would only agree to pay $8 for Sf10 on December 31,
1990, and $88 for Sf210 on December 31, 1991, because the exchange rates
have moved from $1 = Sf2 to $1 = Sf2.50. Thus, Z requires $2 on December
31, 1990, and $22 on December 31, 1991, to compensate for the amount of
dollar payments Z is required to make in exchange for the Swiss francs
received on December 31, 1990 and 1991. The present value of $2 on
December 31, 1990, and $22 on December 31, 1991, discounted at the rate
for U.S. dollar payments of 10% is $20 ($1.82+$18.18). This amount is
discounted at the rate for U.S. dollar payments (i.e., at the historic
rate) because the amount of the $23.56 payment received by Z that is
attributable to movements in interest rates is computed and amortized
separately as provided in the following paragraph.
(vi) Pursuant to paragraph (e)(3)(ii)(B) of this section, Z is
required to amortize the portion of the $23.56 payment attributable to
movements in interest rates under principles of economic accrual over
the term of the currency swap agreement. The amount of the $23.56
payment that is attributable to movements in interest rates (assuming
that exchange rates have not changed) is the present value ($3.56) of
the excess ($2.00 in 1990 and $2.00 in 1991) of the periodic interim
payments Z is required to pay under the currency swap agreement ($10 in
1990 and $10 in 1991) over the amount Z would be required to pay if the
currency swap agreement reflected current interest rates on the day Z
acquired the swap contract ($8 in 1990 and $8 in 1991) discounted at the
appropriate dollar interest rate on January 1, 1990. Thus, under
principles of economic accrual (e.g., see section 171 of the Code), Z
will include in income $1.72 on December 31, 1990, the amount that, when
added to the interest ($.28) on the $3.56 computed at the 8% rate on the
date Z acquired the currency swap contract, will equal the $2.00 needed
to compensate Z for the movement in interest rates between January 1,
1989, and January 1, 1990. Z also will include in income $1.85 on
December 31, 1991, the amount that, when added to the interest ($.15) on
the $1.85 (the remaining balance of the $3.56 payment) computed at the
8% rate on the date Z acquired the currency swap contract, will equal
the $2.00 needed to compensate Z for the movement in interest rates
between January 1, 1990, and January 1, 1991. This amount is computed
assuming exchange rates have not changed because the amount
[[Page 613]]
attributable to movements in exchange rates is computed and amortized
separately under the preceding paragraph.
(6) Special effective date for rules regarding currency swaps.
Paragraph (e)(3) of this section regarding amortization of swap premium
or discount in the case of off-market currency swaps shall be effective
for transactions entered into after September 21, 1989, unless such swap
premium or discount was paid or received pursuant to a binding contract
with an unrelated party that was entered into prior to such date. For
transactions entered into prior to this date, see Notice 89-21, 1989-8
I.R.B. 23.
(7) Special rules for currency swap contracts in hyperinflationary
currencies--(i) In general. If a taxpayer enters into a
hyperinflationary currency swap (as defined in paragraph (e)(7)(iv) of
this section), then the taxpayer realizes exchange gain or loss for its
taxable year with respect to such instrument determined by reference to
the change in exchange rates between--
(A) The later of the first day of the taxable year, or the date the
instrument was entered into (by the taxpayer); and
(B) The earlier of the last day of the taxable year, or the date the
instrument is disposed of or otherwise terminated.
(ii) Adjustment to principal or basis. Proper adjustments are made
in the amount of any gain or loss subsequently realized for gain or loss
taken into account by reason of this paragraph (e)(7).
(iii) Interaction with DASTM. With respect to a qualified business
unit that uses the United States dollar approximate separate
transactions method of accounting described in Sec. 1.985-3, this
paragraph (e)(7) does not apply.
(iv) Definition of hyperinflationary currency swap contract. A
hyperinflationary currency swap contract is a currency swap contract
that provides for--
(A) Payments denominated in or determined by reference to a currency
that is hyperinflationary (as defined in Sec. 1.988-1(f)) at the time
the taxpayer enters into or otherwise acquires the currency swap; or
(B) Payments that are adjusted to take into account the fact that
the currency is hyperinflationary (as defined in Sec. 1.988-1(f))
during the current taxable year. A currency swap contract that provides
for periodic payments determined by reference to a variable interest
rate based on local conditions and generally responding to changes in
the local consumer price index is an example of this latter type of
currency swap contract.
(v) Special effective date for nonfunctional hyperinflationary
currency swap contracts. This paragraph (e)(7) applies to transactions
entered into after February 14, 2000.
(f) Substance over form--(1) In general. If the substance of a
transaction described in Sec. 1.988-1(a)(1) differs from its form, the
timing, source, and character of gains or losses with respect to such
transaction may be recharacterized by the Commissioner in accordance
with its substance. For example, if a taxpayer enters into a transaction
that it designates a ``currency swap contract'' that requires the
prepayment of all payments to be made or to be received (but not both),
the Commissioner may recharacterize the contract as a loan. In applying
the substance over form principle, separate transactions may be
integrated where appropriate. See also Sec. 1.861-9T(b)(1).
(2) Example. The following example illustrates the provisions of
this paragraph (f).
Example. (i) On January 1, 1990, X, a U.S. corporation with the
dollar as its functional currency, enters into a contract with Y under
which X will pay Y $100 and Y will pay X LC100 on January 1, 1990, and X
will pay Y LC109.3 and Y will pay X $133 on December 31, 1992. On
January 1, 1990, the spot exchange rate is LC1 = $1 and the 3 year
forward rate is LC1 = $.8218. X's cash flows are summarized below:
------------------------------------------------------------------------
Date Dollar LC
------------------------------------------------------------------------
1/1/90................................................ (100) 100
12/31/90.............................................. 0 0
12/31/91.............................................. 0 0
12/31/92.............................................. 133 (109.3)
------------------------------------------------------------------------
(ii) X and Y designate this contract as a ``currency swap.''
Notwithstanding this designation, for purposes of determining the
timing, source, and character with respect to the transaction, the
transaction is characterized by the Commissioner in accordance
[[Page 614]]
with its substance. Thus, the January 1, 1990, exchange by X of $100 for
LC 100 is treated as a spot purchase of LCs by X and the December 31,
1992, exchange by X at 109.3LC for $133 is treated as a forward sale of
LCs by X. Under such treatment there would be no tax consequences to X
under paragraph (e)(2) of this section in 1990, 1991, and 1992 with
respect to this transaction other than the realization of exchange gain
or loss on the sale of the LC109.3 on December 31, 1992. Calculation of
such gain or loss would be governed by the rules of paragraph (d) of
this section.
(g) Effective date. Except as otherwise provided in this section,
this section shall be effective for taxable years beginning after
December 31, 1986. Thus, except as otherwise provided in this section,
any payments made or received with respect to a section 988 transaction
in taxable years beginning after December 31, 1986, are subject to this
section.
(h) Timing of income and deductions from notional principal
contracts. Except as otherwise provided (e.g., in Sec. 1.988-5 or
1.446-3(g)), income or loss from a notional principal contract described
in Sec. 1.988-1(a)(2)(iii)(B) (other than a currency swap) is exchange
gain or loss. For the rules governing the timing of income and
deductions with respect to notional principal contracts, see Sec.
1.446-3. See paragraph (e)(2) of this section with respect to currency
swaps.
[T.D. 8400, 57 FR 9183, Mar. 17, 1992, as amended by T.D. 8491, 58 FR
53135, Oct. 14, 1993; T.D. 8860, 65 FR 2028, Jan. 13, 2000]
Sec. 1.988-3 Character of exchange gain or loss.
(a) In general. The character of exchange gain or loss recognized on
a section 988 transaction is governed by section 988 and this section.
Except as otherwise provided in section 988(c)(1)(E), section 1092,
Sec. 1.988-5 and this section, exchange gain or loss realized with
respect to a section 988 transaction (including a section 1256 contract
that is also a section 988 transaction) shall be characterized as
ordinary gain or loss. Accordingly, unless a valid election is made
under paragraph (b) of this section, any section providing special rules
for capital gain or loss treatment, such as sections 1233, 1234, 1234A,
1236 and 1256(f)(3), shall not apply.
(b) Election to characterize exchange gain or loss on certain
identified forward contracts, futures contracts and option contracts as
capital gain or loss--(1) In general. Except as provided in paragraph
(b)(2) of this section, a taxpayer may elect, subject to the
requirements of paragraph (b)(3) of this section, to treat any gain or
loss recognized on a contract described in Sec. 1.988-2(d)(1) as
capital gain or loss, but only if the contract--
(i) Is a capital asset in the hands of the taxpayer;
(ii) Is not part of a straddle within the meaning of section 1092(c)
(without regard to subsections (c)(4) or (e)); and
(iii) Is not a regulated futures contract or nonequity option with
respect to which an election under section 988(c)(1)(D)(ii) is in
effect.
If a valid election under this paragraph (b) is made with respect to a
section 1256 contract, section 1256 shall govern the character of any
gain or loss recognized on such contract.
(2) Special rule for contracts that become part of a straddle after
an election is made. If a contract which is the subject of an election
under paragraph (b)(1) of this section becomes part of a straddle within
the meaning of section 1092(c) (without regard to subsections (c)(4) or
(e)) after the date of the election, the election shall be invalid with
respect to gains from such contract and the Commissioner, in his sole
discretion, may invalidate the election with respect to losses.
(3) Requirements for making the election. A taxpayer elects to treat
gain or loss on a transaction described in paragraph (b)(1) of this
section as capital gain or loss by clearly identifying such transaction
on its books and records on the date the transaction is entered into. No
specific language or account is necessary for identifying a transaction
referred to in the preceding sentence. However, the method of
identification must be consistently applied and must clearly identify
the pertinent transaction as subject to the section 988(a)(1)(B)
election. The Commissioner, in his sole discretion, may invalidate any
purported election that does not comply with the preceding sentence.
[[Page 615]]
(4) Verification. A taxpayer that has made an election under Sec.
1.988-3(b)(3) must attach to his income tax return a statement which
sets forth the following:
(i) A description and the date of each election made by the taxpayer
during the taxpayer's taxable year;
(ii) A statement that each election made during the taxable year was
made before the close of the date the transaction was entered into;
(iii) A description of any contract for which an election was in
effect and the date such contract expired or was otherwise sold or
exchanged during the taxable year;
(iv) A statement that the contract was never part of a straddle as
defined in section 1092; and
(v) A statement that all transactions subject to the election are
included on the statement attached to the taxpayer's income tax return.
In addition to any penalty that may otherwise apply, the Commissioner,
in his sole discretion, may invalidate any or all elections made during
the taxable year under Sec. 1.988-3(b)(1) if the taxpayer fails to
verify each election as provided in this Sec. 1.988-3(b)(4). The
preceding sentence shall not apply if the taxpayer's failure to verify
each election was due to reasonable cause or bona fide mistake. The
burden of proof to show reasonable cause or bona fide mistake made in
good faith is on the taxpayer.
(5) Independent verification--(i) Effect of independent
verification. If the taxpayer receives independent verification of the
election in paragraph (b)(3) of this section, the taxpayer shall be
presumed to have satisfied the requirements of paragraphs (b)(3) and (4)
of this section. A contract that is a part of a straddle as defined in
section 1092 may not be independently verified and shall be subject to
the rules of paragraph (b)(2) of this section.
(ii) Requirements for independent verification. A taxpayer receives
independent verification of the election in paragraph (b)(3) of this
section if--
(A) The taxpayer establishes a separate account(s) with an unrelated
broker(s) or dealer(s) through which all transactions to be
independently verified pursuant to this paragraph (b)(5) are conducted
and reported.
(B) Only transactions entered into on or after the date the taxpayer
establishes such account may be recorded in the account.
(C) Transactions subject to the election of paragraph (b)(3) of this
section are entered into such account on the date such transactions are
entered into.
(D) The broker or dealer provides the taxpayer a statement detailing
the transactions conducted through such account and includes on such
statement the following: ``Each transaction identified in this account
is subject to the election set forth in section 988(a)(1)(B).''
(iii) Special effective date for independent verification. The rules
of this paragraph (b)(5) shall be effective for transactions entered
into after March 17, 1992.
(6) Effective date. Except as otherwise provided, this paragraph (b)
is effective for taxable years beginning on or after September 21, 1989.
For prior taxable years, any reasonable contemporaneous election meeting
the requirements of section 988(a)(1)(B) shall satisfy this paragraph
(b).
(c) Exchange gain or loss treated as interest--(1) In general.
Except as provided in this paragraph (c)(1), exchange gain or loss
realized on a section 988 transaction shall not be treated as interest
income or expense. Exchange gain or loss realized on a section 988
transaction shall be treated as interest income or expense as provided
in paragraph (c)(2) of this section with regard to tax exempt bonds,
Sec. 1.988-2(e)(2)(ii)(B), Sec. 1.988-5, and in administrative
pronouncements. See Sec. 1.861-9T(b), providing rules for the
allocation of certain items of exchange gain or loss in the same manner
as interest expense.
(2) Exchange loss realized by the holder on nonfunctional currency
tax exempt bonds. Exchange loss realized by the holder of a debt
instrument the interest on which is excluded from gross income under
section 103(a) or any similar provision of law shall be treated as an
offset to and reduce total interest income received or accrued with
respect to such instrument. Therefore, to
[[Page 616]]
the extent of total interest income, no exchange loss shall be
recognized. This paragraph (c)(2) shall be effective with respect to
debt instruments acquired on or after June 24, 1987.
(d) Effective date. Except as otherwise provided in this section,
this section shall be effective for taxable years beginning after
December 31, 1986. Thus, except as otherwise provided in this section,
any payments made or received with respect to a section 988 transaction
in taxable years beginning after December 31, 1986, are subject to this
section. Thus, for example, a payment made prior to January 1, 1987,
under a forward contract that results in the deferral of a loss under
section 1092 to a taxable year beginning after December 31, 1986, is not
characterized as an ordinary loss by virtue of paragraph (a) of this
section because payment was made prior to January 1, 1987.
[T.D. 8400, 57 FR 9197, Mar. 17, 1992]
Sec. 1.988-4 Source of gain or loss realized on a section 988 transaction.
(a) In general. Except as otherwise provided in Sec. 1.988-5 and
this section, the source of exchange gain or loss shall be determined by
reference to the residence of the taxpayer. This rule applies even if
the taxpayer has made an election under Sec. 1.988-3(b) to characterize
exchange gain or loss as capital gain or loss. This section takes
precedence over section 865.
(b) Qualified business unit--(1) In general. The source of exchange
gain or loss shall be determined by reference to the residence of the
qualified business unit of the taxpayer on whose books the asset,
liability, or item of income or expense giving rise to such gain or loss
is properly reflected.
(2) Proper reflection on the books of the taxpayer or qualified
business unit--(i) In general. Whether an asset, liability, or item of
income or expense is properly reflected on the books of a qualified
business unit is a question of fact.
(ii) Presumption if booking practices are inconsistent. It shall be
presumed that an asset, liability, or item of income or expense is not
properly reflected on the books of the qualified business unit if the
taxpayer and its qualified business units employ inconsistent booking
practices with respect to the same or similar assets, liabilities, or
items of income or expense. If not properly reflected on the books, the
Commissioner may allocate any asset, liability, or item of income or
expense between or among the taxpayer and its qualified business units
to properly reflect the source (or realization) of exchange gain or
loss.
(c) Effectively connected exchange gain or loss. Notwithstanding
paragraphs (a) and (b) of this section, exchange gain or loss that under
principles similar to those set forth in Sec. 1.864-4(c) arises from
the conduct of a United States trade or business shall be sourced in the
United States and such gain or loss shall be treated as effectively
connected to the conduct of a United States trade or business for
purposes of sections 871(b) and 882 (a)(1).
(d) Residence--(1) In general. Except as otherwise provided in this
paragraph (d), for purposes of sections 985 through 989, the residence
of any person shall be--
(i) In the case of an individual, the country in which such
individual's tax home (as defined in section 911(d)(3)) is located;
(ii) In the case of a corporation, partnership, trust or estate
which is a United States person (as defined in section 7701(a)(30)), the
United States; and
(iii) In the case of a corporation, partnership, trust or estate
which is not a United States person, a country other than the United
States.
If an individual does not have a tax home (as defined in section
911(d)(3)), the residence of such individual shall be the United States
if such individual is a United States citizen or a resident alien and
shall be a country other than the United States if such individual is
not a United States citizen or resident alien. If the taxpayer is a U.S.
person and has no principal place of business outside the United States,
the residence of the taxpayer is the United States. Notwithstanding
paragraph (d)(1)(ii) of this section, if a partnership is formed or
availed of to avoid tax by altering the source of exchange gain or loss,
the source of such gain or loss shall be determined by reference to the
residence of the partners rather than the partnership.
[[Page 617]]
(2) Exception. In the case of a qualified business unit of any
taxpayer (including an individual), the residence of such unit shall be
the country in which the principal place of business of such qualified
business unit is located.
(3) Partner in a partnership not engaged in a U.S. trade or business
under section 864(b)(2). The determination of residence shall be made at
the partner level (without regard to whether the partnership is a
qualified business unit of the partners) in the case of partners in a
partnership that are not engaged in a U.S. trade or business by reason
of section 864(b)(2).
(e) Special rule for certain related party loans--(1) In general. In
the case of a loan by a United States person or a related person to a 10
percent owned foreign corporation, or a corporation that meets the 80
percent foreign business requirements test of section 861(c)(1), other
than a corporation subject to Sec. 1.861-11T(e)(2)(i), which is
denominated in, or determined by reference to, a currency other than the
U.S. dollar and bears interest at a rate at least 10 percentage points
higher than the Federal mid-term rate (as determined under section
1274(d)) at the time such loan is entered into, the following rules
shall apply--
(i) For purposes of section 904 only, such loan shall be marked to
market annually on the earlier of the last business day of the United
States person's (or related person's) taxable year or the date the loan
matures; and
(ii) Any interest income earned with respect to such loan for the
taxable year shall be treated as income from sources within the United
States to the extent of any notional loss attributable to such loan
under paragraph (d)(1)(i) of this section.
(2) United States person. For purposes of this paragraph (e), the
term ``United States person'' means a person described in section
7701(a)(30).
(3) Loans by related foreign persons--(i) In general. [Reserved]
(ii) Definition of related person. For purposes of this paragraph
(e), the term ``related person'' has the meaning given such term by
section 954(d)(3) except that such section shall be applied by
substituting ``United States person'' for ``controlled foreign
corporation'' each place such term appears.
(4) 10 percent owned foreign corporation. For purposes of this
paragraph (e), the term ``10 percent owned foreign corporation'' means
any foreign corporation in which the United States person owns directly
or indirectly (within the meaning of section 318(a)) at least 10 percent
of the voting stock.
(f) Exchange gain or loss treated as interest under Sec. 1.988-3.
Notwithstanding the provisions of this section, any gain or loss
realized on a section 988 transaction that is treated as interest income
or expense under Sec. 1.988-3(c)(1) shall be sourced or allocated and
apportioned pursuant to section 861(a)(1), 862(a)(1), or 864(e) as the
case may be.
(g) Exchange gain or loss allocated in the same manner as interest
under Sec. 1.861-9T. The allocation and apportionment of exchange gain
or loss under Sec. 1.861-9T shall not affect the source of exchange
gain or loss for purposes of sections 871(a), 881, 1441, 1442 and 6049.
(h) Effective date. This section shall be effective for taxable
years beginning after December 31, 1986. Thus, any payments made or
received with respect to a section 988 transaction in taxable years
beginning after December 31, 1986, are subject to this section.
[T.D. 8400, 57 FR 9199, Mar. 17, 1992]
Sec. 1.988-5 Section 988(d) hedging transactions.
(a) Integration of a nonfunctional currency debt instrument and a
Sec. 1.988-5(a) hedge--(1) In general. This paragraph (a) applies to a
qualified hedging transaction as defined in this paragraph (a)(1). A
qualified hedging transaction is an integrated economic transaction, as
provided in paragraph (a)(5) of this section, consisting of a qualifying
debt instrument as defined in paragraph (a)(3) of this section and a
Sec. 1.988-5(a) hedge as defined in paragraph (a)(4) of this section.
If a taxpayer enters into a transaction that is a qualified hedging
transaction, no exchange gain or loss is recognized by the taxpayer on
the qualifying debt instrument or on the Sec. 1.988-5(a) hedge for the
period that either is part of a qualified hedging transaction, and the
transactions shall be integrated as provided in paragraph (a)(9) of this
section. However, if the
[[Page 618]]
qualified hedging transaction results in a synthetic nonfunctional
currency denominated debt instrument, such instrument shall be subject
to the rules of Sec. 1.988-2(b).
(2) Exception. This paragraph (a) does not apply with respect to a
qualified hedging transaction that creates a synthetic asset or
liability denominated in, or determined by reference to, a currency
other than the U.S. dollar if the rate that approximates the Federal
short-term rate in such currency is at least 20 percentage points higher
than the Federal short term rate (determined under section 1274(d)) on
the date the taxpayer identifies the transaction as a qualified hedging
transaction.
(3) Qualifying debt instrument--(i) In general. A qualifying debt
instrument is a debt instrument described in Sec. 1.988-1(a)(2)(i),
regardless of whether denominated in, or determined by reference to,
nonfunctional currency (including dual currency debt instruments, multi-
currency debt instruments and contingent payment debt instruments). A
qualifying debt instrument does not include accounts payable, accounts
receivable or similar items of expense or income.
(ii) Special rule for debt instrument of which all payments are
proportionately hedged. If a debt instrument satisfies the requirements
of paragraph (a)(3)(i) of this section, and all principal and interest
payments under the instrument are hedged in the same proportion, then
for purposes of this paragraph (a), that portion of the instrument that
is hedged is eligible to be treated as a qualifying debt instrument, and
the rules of this paragraph (a) shall apply separately to such
qualifying debt instrument. See Example 8 in paragraph (a)(9)(iv) of
this section.
(4) Section 1.988-5(a) hedge--(i) In general. A Sec. 1.988-5(a)
hedge (hereinafter referred to in this paragraph (a) as a ``hedge'') is
a spot contract, futures contract, forward contract, option contract,
notional principal contract, currency swap contract, similar financial
instrument, or series or combination thereof, that when integrated with
a qualifying debt instrument permits the calculation of a yield to
maturity (under principles of section 1272) in the currency in which the
synthetic debt instrument is denominated (as determined under paragraph
(a)(9)(ii)(A) of this section).
(ii) Retroactive application of definition of currency swap
contract. A taxpayer may apply the definition of currency swap contract
set forth in Sec. 1.988-2(e)(2)(ii) in lieu of the definition of swap
agreement in section 2(e)(5) of Notice 87-11, 1987-1 C.B. 423 to
transactions entered into after December 31, 1986 and before September
21, 1989.
(5) Definition of integrated economic transaction. A qualifying debt
instrument and a hedge are an integrated economic transaction if all of
the following requirements are satisfied--
(i) All payments to be made or received under the qualifying debt
instrument (or amounts determined by reference to a nonfunctional
currency) are fully hedged on the date the taxpayer identifies the
transaction under paragraph (a) of this section as a qualified hedging
transaction such that a yield to maturity (under principles of section
1272) in the currency in which the synthetic debt instrument is
denominated (as determined under paragraph (a)(9)(ii)(A) of this
section) can be calculated. Any contingent payment features of the
qualifying debt instrument must be fully offset by the hedge such that
the synthetic debt instrument is not classified as a contingent payment
debt instrument. See Examples 6 and 7 of paragraph (a)(9)(iv) of this
section.
(ii) The hedge is identified in accordance with paragraph (a)(8) of
this section on or before the date the acquisition of the financial
instrument (or instruments) constituting the hedge is settled or closed.
(iii) None of the parties to the hedge are related. The term
``related'' means the relationships defined in section 267(b) or section
707(b).
(iv) In the case of a qualified business unit with a residence, as
defined in section 988(a)(3)(B), outside of the United States, both the
qualifying debt instrument and the hedge are properly reflected on the
books of such qualified business unit throughout the term of the
qualified hedging transaction.
(v) Subject to the limitations of paragraph (a)(5) of this section,
both
[[Page 619]]
the qualifying debt instrument and the hedge are entered into by the
same individual, partnership, trust, estate, or corporation. With
respect to a corporation, the same corporation must enter into both the
qualifying debt instrument and the hedge whether or not such corporation
is a member of an affiliated group of corporations that files a
consolidated return.
(vi) With respect to a foreign person engaged in a U.S. trade or
business that enters into a qualifying debt instrument or hedge through
such trade or business, all items of income and expense associated with
the qualifying debt instrument and the hedge (other than interest
expense that is subject to Sec. 1.882-5), would have been effectively
connected with such U.S. trade or business throughout the term of the
qualified hedging transaction had this paragraph (a) not applied.
(6) Special rules for legging in and legging out of integrated
treatment--(i) Legging in. ``Legging in'' to integrated treatment under
this paragraph (a) means that a hedge is entered into after the date the
qualifying debt instrument is entered into or acquired, and the
requirements of this paragraph (a) are satisfied on the date the hedge
is entered into (``leg in date''). If a taxpayer legs into integrated
treatment, the following rules shall apply--
(A) Exchange gain or loss shall be realized with respect to the
qualifying debt instrument determined solely by reference to changes in
exchange rates between--
(1) The date the instrument was acquired by the holder, or the date
the obligor assumed the obligation to make payments under the
instrument; and
(2) The leg in date.
(B) The recognition of such gain or loss will be deferred until the
date the qualifying debt instrument matures or is otherwise disposed of.
(C) The source and character of such gain or loss shall be
determined on the leg in date as if the qualifying debt instrument was
actually sold or otherwise terminated by the taxpayer.
(ii) Legging out. With respect to a qualifying debt instrument and
hedge that are properly identified as a qualified hedging transaction,
``legging out'' of integrated treatment under this paragraph (a) means
that the taxpayer disposes of or otherwise terminates all or a part of
the qualifying debt instrument or hedge prior to maturity of the
qualified hedging transaction, or the taxpayer changes a material term
of the qualifying debt instrument (e.g., exercises an option to change
the interest rate or index, or the maturity date) or hedge (e.g.,
changes the interest or exchange rates underlying the hedge, or the
expiration date) prior to maturity of the qualified hedging transaction.
A taxpayer that disposes of or terminates a qualified hedging
transaction (i.e., disposes of or terminates both the qualifying
transaction and the hedge on the same day) shall be considered to have
disposed of or otherwise terminated the synthetic debt instrument rather
than as legging out. If a taxpayer legs out of integrated treatment, the
following rules shall apply--
(A) The transaction will be treated as a qualified hedging
transaction during the time the requirements of this paragraph (a) were
satisfied.
(B) If the hedge is disposed of or otherwise terminated, the
qualifying debt instrument shall be treated as sold for its fair market
value on the date the hedge is disposed of or otherwise terminated (the
``leg-out date''), and any gain or loss (including gain or loss
resulting from factors other than movements in exchange rates) from the
identification date to the leg-out date is realized and recognized on
the leg-out date. The spot rate on the leg-out date shall be used to
determine exchange gain or loss on the debt instrument for the period
beginning on the leg-out date and ending on the date such instrument
matures or is disposed of or otherwise terminated. Proper adjustment to
the principal amount of the debt instrument must be made to reflect any
gain or loss taken into account. The netting rule of Sec. 1.988-2(b)(8)
shall apply.
(C) If the qualifying debt instrument is disposed of or otherwise
terminated, the hedge shall be treated as sold for its fair market value
on the date the qualifying debt instrument is disposed of or otherwise
terminated (the ``leg-out date''), and any gain or loss from the
identification date to the leg-out
[[Page 620]]
date is realized and recognized on the leg-out date. The spot rate on
the leg-out date shall be used to determine exchange gain or loss on the
hedge for the period beginning on the leg-out date and ending on the
date such hedge is disposed of or otherwise terminated.
(D) Except as provided in paragraph (a)(8)(iii) of this section
(regarding identification by the Commissioner), that part of the
qualified hedging transaction that has not been terminated (i.e., the
remaining debt instrument in its entirety even if partially hedged, or
hedge) cannot be part of a qualified hedging transaction for any period
subsequent to the leg out date.
(E) If a taxpayer legs out of a qualified hedging transaction and
realizes a gain with respect to the terminated instrument, then
paragraph (a)(6)(ii)(B) or (C) of this section, as appropriate, shall
not apply if during the period beginning 30 days before the leg-out date
and ending 30 days after that date the taxpayer enters into another
transaction that hedges at least 50% of the remaining currency flow with
respect to the qualifying debt instrument which was part of the
qualified hedging transaction (or, if appropriate, an equivalent amount
under the Sec. 1.988-5 hedge which was part of the qualified hedging
transaction).
(7) Transactions part of a straddle. At the discretion of the
Commissioner, a transaction shall not satisfy the requirements of
paragraph (a)(5) of this section if the debt instrument making up the
qualified hedging transaction is part of a straddle as defined in
section 1092(c) prior to the time the qualified hedging transaction is
identified.
(8) Identification requirements--(i) Identification by the taxpayer.
A taxpayer must establish a record and before the close of the date the
hedge is entered into, the taxpayer must enter into the record for each
qualified hedging transaction the following information--
(A) The date the qualifying debt instrument and hedge were entered
into;
(B) The date the qualifying debt instrument and the hedge are
identified as constituting a qualified hedging transaction;
(C) The amount that must be deferred, if any, under paragraph (a)(6)
of this section and the source and character of such deferred amount;
(D) A description of the qualifying debt instrument and the hedge;
and
(E) A summary of the cash flow resulting from treating the
qualifying debt instrument and the hedge as a qualified hedging
transaction.
(ii) Identification by trustee on behalf of beneficiary. A trustee
of a trust that enters into a qualified hedging transaction may satisfy
the identification requirements described in paragraph (a)(8)(i) of this
section on behalf of a beneficiary of such trust.
(iii) Identification by the Commissioner. If--
(A) A taxpayer enters into a qualifying debt instrument and a hedge
but fails to comply with one or more of the requirements of this
paragraph (a), and
(B) On the basis of all the facts and circumstances, the
Commissioner concludes that the qualifying debt instrument and the hedge
are, in substance, a qualified hedging transaction,
then the Commissioner may treat the qualifying debt instrument and the
hedge as a qualified hedging transaction. The Commissioner may identify
a qualifying debt instrument and a hedge as a qualified hedging
transaction regardless of whether the qualifying debt instrument and the
hedge are held by the same taxpayer.
(9) Taxation of qualified hedging transactions--(i) In general--(A)
General rule. If a transaction constitutes a qualified hedging
transaction, the qualifying debt instrument and the hedge are integrated
and treated as a single transaction with respect to the taxpayer that
has entered into the qualified hedging transaction during the period
that the transaction qualifies as a qualified hedging transaction.
Neither the qualifying debt instrument nor the hedge that makes up the
qualified hedging transaction shall be subject to section 263(g), 1092
or 1256 for the period such transactions are integrated. However, the
qualified hedging transaction may be subject to section 263(g) or 1092
if such transaction is part of a straddle.
(B) Special rule for income or expense of foreign persons
effectively connected with a U.S. trade or business. Interest income of
a foreign person resulting from a
[[Page 621]]
qualified hedging transaction entered into by such foreign person that
satisfies the requirements of paragraph (a)(5)(vii) of this section
shall be treated as effectively connected with a U.S. trade or business.
Interest expense of a foreign person resulting from a qualified hedging
transaction entered into by such foreign person that satisfies the
requirements of paragraph (a)(5)(vii) of this section shall be allocated
and apportioned under Sec. 1.882-5 of the regulations.
(C) Special rule for foreign persons that enter into qualified
hedging transactions giving rise to U.S. source income not effectively
connected with a U.S. trade or business. If a foreign person enters into
a qualified hedging transaction that gives rise to U.S. source interest
income (determined under the source rules for synthetic asset
transactions as provided in this section) not effectively connected with
a U.S. trade or business of such foreign person, for purposes of
sections 871(a), 881, 1441, 1442 and 6049, the provisions of this
paragraph (a) shall not apply and such sections of the Internal Revenue
Code shall be applied separately to the qualifying debt instrument and
the hedge. To the extent relevant to any foreign person, if the
requirements of this paragraph (a) are otherwise met, the provisions of
this paragraph (a) shall apply for all other purposes of the Internal
Revenue Code (e.g., for purposes of calculating the earnings and profits
of a controlled foreign corporation that enters into a qualified hedging
transaction through a qualified business unit resident outside the
United States, income or expense with respect to such qualified hedging
transaction shall be calculated under the provisions of this paragraph
(a)).
(ii) Income tax effects of integration. The effect of integrating
and treating a transaction as a single transaction is to create a
synthetic debt instrument for income tax purposes, which is subject to
the original issue discount provisions of sections 1272 through 1288 and
163(e), the terms of which are determined as follows:
(A) Denomination of synthetic debt instrument. In the case where the
qualifying debt instrument is a borrowing, the denomination of the
synthetic debt instrument is the same as the currency paid under the
terms of the hedge to acquire the currency used to make payments under
the qualifying debt instrument. In the case where the qualifying debt
instrument is a lending, the denomination of the synthetic debt
instrument is the same as the currency received under the terms of the
hedge in exchange for amounts received under the qualifying debt
instrument. For example, if the hedge is a forward contract to acquire
British pounds for dollars, and the qualifying debt instrument is a
borrowing denominated in British pounds, the synthetic debt instrument
is considered a borrowing in dollars.
(B) Term and accrual periods. The term of the synthetic debt
instrument shall be the period beginning on the identification date and
ending on the date the qualifying debt instrument matures or such
earlier date that the qualifying debt instrument or hedge is disposed of
or otherwise terminated. Unless otherwise clearly indicated by the
payment interval under the hedge, the accrual period shall be a six
month period which ends on the dates determined under section
1272(a)(5).
(C) Issue price. The issue price of the synthetic debt instrument is
the adjusted issue price of the qualifying debt instrument translated
into the currency in which the synthetic debt instrument is denominated
at the spot rate on the identification date.
(D) Stated redemption price at maturity. In the case where the
qualifying debt instrument is a borrowing, the stated redemption price
at maturity shall be determined under section 1273(a)(2) on the
identification date by reference to the amounts to be paid under the
hedge to acquire the currency necessary to make interest and principal
payments on the qualifying debt instrument. In the case where the
qualifying debt instrument is a lending, the stated redemption price at
maturity shall be determined under section 1273(a)(2) on the
identification date by reference to the amounts to be received under the
hedge in exchange for the interest and principal payments received
pursuant to the terms of the qualifying debt instrument.
[[Page 622]]
(iii) Source of interest income and allocation of expense. Interest
income from a synthetic debt instrument described in paragraph
(a)(9)(ii) of this section shall be sourced by reference to the source
of income under sections 861 (a)(1) and 862(a)(1) of the qualifying debt
instrument. The character for purposes of section 904 of interest income
from a synthetic debt instrument shall be determined by reference to the
character of the interest income from qualifying debt instrument.
Interest expense from a synthetic debt instrument described in paragraph
(a)(9)(ii) of this section shall be allocated and apportioned under
Sec. Sec. 1.861-8T through 1.861-12T or the successor sections thereof
or under Sec. 1.882-5.
(iv) Examples. The following examples illustrate the application of
this paragraph (a)(9).
Example 1. (i) K is a U.S. corporation with the U.S. dollar as its
functional currency. On December 24, 1989, K agrees to close the
following transaction on December 31, 1989. K will borrow from an
unrelated party on December 31, 1989, 100 British pounds ([pound]) for 3
years at a 10 percent rate of interest, payable annually, with no
principal payment due until the final installment. K will also enter
into a currency swap contract with an unrelated counterparty under the
terms of which--
(a) K will swap, on December 31, 1989, the [pound]100 obtained from
the borrowing for $100; and
(b) K will exchange dollars for pounds pursuant to the following
table in order to obtain the pounds necessary to make payments on the
pound borrowing:
------------------------------------------------------------------------
U.S.
Date dollars Pounds
------------------------------------------------------------------------
December 31, 1990............................. 8 10
December 31, 1991............................. 8 10
December 31, 1992............................. 108 110
------------------------------------------------------------------------
(ii) The interest rate on the borrowing is set and the exchange
rates on the swap are fixed on December 24, 1989. On December 31, 1989,
K borrows the [pound]100 and swaps such pounds for $100. Assume x has
satisfied the identification requirements of paragraph (a)(8) of this
section.
(iii) The pound borrowing (which constitutes a qualifying debt
instrument under paragraph (a)(3) of this section) and the currency swap
contract (which constitutes a hedge under paragraph (a)(4) of this
section) are a qualified hedging transaction as defined in paragraph
(a)(1) of this section. Accordingly, the pound borrowing and the swap
are integrated and treated as one transaction with the following
consequences:
(A) The integration of the pound borrowing and the swap results in a
synthetic dollar borrowing with an issue price of $100 under section
1273(b)(2).
(B) The total amount of interest and principal of the synthetic
dollar borrowing is equal to the dollar payments made by K under the
currency swap contract (i.e., $8 in 1990, $8 in 1991, and $108 in 1992).
(C) The stated redemption price at maturity (defined in section
1273(a)(2)) is $100. Because the stated redemption price equals the
issue price, there is no OID on the synthetic dollar borrowing.
(D) K may deduct the annual interest payments of $8 under section
163(a) (subject to any limitations on deductibility imposed by other
provisions of the Code) according to its regular method of accounting. K
has also paid $100 as a return of principal in 1992.
(E) K must allocate and apportion its interest expense with respect
to the synthetic dollar borrowing under the rules of Sec. Sec. 1.861-8T
through 1.861-12T.
Example 2. (i) K, a U.S. corporation, has the U.S. dollar as its
functional currency. On December 24, 1989, when the spot rate for Swiss
francs (Sf) is Sf1 = $1, K enters into a forward contract to purchase
Sf100 in exchange for $100.04 for delivery on December 31, 1989. The
Sf100 are to be used for the purchase of a franc denominated debt
instrument on December 31, 1989. The instrument will have a term of 3
years, an issue price of Sf100, and will bear interest at 6 percent,
payable annually, with no repayment of principal until the final
installment. On December 24, 1989, K also enters into a series of
forward contracts to sell the franc interest and principal payments that
will be received under the terms of the franc denominated debt
instrument for dollars according to the following schedule:
------------------------------------------------------------------------
U.S.
Date dollars Francs
------------------------------------------------------------------------
December 31, 1990............................. 6.12 6
December 31, 1991............................. 6.23 6
December 31, 1992............................. 112.16 106
------------------------------------------------------------------------
(ii) On December 31, 1989, K takes delivery of the Sf100 and
purchases the franc denominated debt instrument. Assume K satisfies the
identification requirements of paragraph (a)(8) of this section. The
purchase of the franc debt instrument (which constitutes a qualifying
debt instrument under paragraph (a)(3) of this section) and the series
of forward contracts (which constitute a hedge under paragraph (a)(4) of
this section) are a qualified hedging transaction under paragraph (a)(1)
of this section. Accordingly, the franc debt instrument and all the
forward contracts are integrated and treated as one transaction with the
following consequences:
[[Page 623]]
(A) The integration of the franc debt instrument and the forward
contracts results in a synthetic dollar debt instrument in an amount
equal to the dollars exchanged under the forward contract to purchase
the francs necessary to acquire the franc debt instrument. Accordingly,
the issue price is $100.04 (section 1273(b)(2) of the Code).
(B) The total amount of interest and principal received by K with
respect to the synthetic dollar debt instrument is equal to the dollars
received under the forward sales contracts (i.e., $6.12 in 1990, $6.23
in 1991, and $112.16 in 1992).
(C) The synthetic dollar debt instrument is an installment
obligation and its stated redemption price at maturity is $106.15 (i.e.,
$6.12 of the payments in 1990, 1991, and 1992 are treated as periodic
interest payments under the principles of section 1273). Because the
stated redemption price at maturity exceeds the issue price, under
section 1273(a)(1) the synthetic dollar debt instrument has OID of
$6.11.
(D) The yield to maturity of the synthetic dollar debt instrument is
8.00 percent, compounded annually. Assuming K is a calendar year
taxpayer, it must include interest income of $8.00 in 1990 (of which
$1.88 constitutes OID), $8.15 in 1991 (of which $2.03 constitutes OID),
and $8.32 in 1992 (of which $2.20 constitutes OID). The amount of the
final payment received by K in excess of the interest income includible
is a return of principal and a payment of previously accrued OID.
(E) The source of the interest income shall be determined by
applying sections 861(a)(1) and 862(a)(1) with reference to the franc
interest income that would have been received had the transaction not
been integrated.
Example 3. (i) K is an accrual method U.S. corporation with the U.S.
dollar as its functional currency. On January 1, 1992, K borrows 100
British pounds ([pound]) for 3 years at a 10% rate of interest payable
on December 31 of each year with no principal payment due until the
final installment. The spot rate on January 1, 1992, is [pound]1 =
$1.50. On January 1, 1993, when the spot rate is [pound]1 = $1.60, K
enters into a currency swap contract with an unrelated counterparty
under the terms of which K will exchange dollars for pounds pursuant to
the following table in order to obtain the pounds necessary to make the
remaining payments on the pound borrowing:
------------------------------------------------------------------------
U.S.
Date dollars Pounds
------------------------------------------------------------------------
December 31, 1993............................. 12.80 10
December 31, 1994............................. 12.80 10
December 31, 1994............................. 160.00 100
------------------------------------------------------------------------
(ii) Assume that British pound interest rates are still 10% and that
K properly identifies the pound borrowing and the currency swap contract
as a qualified hedging transaction as provided in paragraph (a)(8) of
this section. Under paragraph (a)(6)(i) of this section, K must realize
exchange gain or loss with respect to the pound borrowing determined
solely by reference to changes in exchange rates between January 1, 1992
and January 1, 1993. (Thus, gain or loss from other factors such as
movements in interest rates or changes in credit quality of K are not
taken into account). Recognition of such gain or loss is deferred until
K terminates its pound borrowing. Accordingly, K must defer exchange
loss in the amount of $10 [([pound]100x1.50)-([pound]100x1.60)].
(iii) Additionally, the qualified hedging transaction is treated as
a synthetic U.S. dollar debt instrument with an issue date of January 1,
1993, and a maturity date of December 31, 1994. The issue price of the
synthetic debt instrument is $160 ([pound]100x1.60, the spot rate on
January 1, 1993) and the total amount of interest and principal is
$185.60. The accrual period is the one year period beginning on January
1 and ending December 31 of each year. The stated redemption price at
maturity is $160. Thus, K is treated as paying $12.80 of interest in
1993, $12.80 of interest in 1994, and $160 of principal in 1994. The
interest expense from the synthetic instrument is allocated and
apportioned in accordance with the rules of Sec. Sec. 1.861-8T through
1.861-12T. Sections 263(g), 1092, and 1256 do not apply to the positions
comprising the synthetic dollar borrowing.
Example 4. (i) K is an accrual method U.S. corporation with the U.S.
dollar as its functional currency. On January 1, 1990, K borrows 100
British pounds ([pound]) for 3 years at a 10% rate of interest payable
on December 31 of each year with no principal payment due until the
final installment. The spot rate on January 1, 1990, is [pound]1 =
$1.50. Also on January 1, 1990, K enters into a currency swap contract
with an unrelated counterparty under the terms of which K will exchange
dollars for pounds pursuant to the following table in order to obtain
the pounds necessary to make the remaining payments on the pound
borrowing:
------------------------------------------------------------------------
U.S.
Date dollars Pounds
------------------------------------------------------------------------
December 31, 1990............................. 12.00 10
December 31, 1991............................. 12.00 10
December 31, 1992............................. 162.00 110
------------------------------------------------------------------------
(ii) Assume that K properly identifies the pound borrowing and the
currency swap contract as a qualified hedging transaction as provided in
paragraph (a)(1) of this section.
(iii) The pound borrowing (which constitutes a qualifying debt
instrument under paragraph (a)(3) of this section) and the currency swap
contract (which constitutes a hedge under paragraph (a)(4) of this
section) are a qualified hedging transaction as defined in paragraph
(a)(1) of this section. Accordingly, the pound borrowing and the swap
[[Page 624]]
are integrated and treated as one transaction with the following
consequences:
(A) The integration of the pound borrowing and the swap results in a
synthetic dollar borrowing with an issue price of $150 under section
1273(b)(2).
(B) The total amount of interest and principal of the synthetic
dollar borrowing is equal to the dollar payments made by K under the
currency swap contract (i.e., $12 in 1990, $12 in 1991, and $162 in
1992).
(C) The stated redemption price at maturity (defined in section
1273(a)(2)) is $150. Because the stated redemption price equals the
issue price, there is no OID on the synthetic dollar borrowing.
(D) K may deduct the annual interest payments of $12 under section
163(a) (subject to any limitations on deductibility imposed by other
provisions of the Code) according to its regular method of accounting. K
has also paid $150 as a return of principal in 1992.
(E) K must allocate and apportion its interest expense from the
synthetic instrument under the rules of Sec. Sec. 1.861-8T through
1.861-12T.
(iv) Assume that on January 1, 1991, the spot exchange rate is
[pound]1 = $1.60, interest rates have not changed since January 1, 1990,
(accordingly, assume that the market value of K's bond in pounds has not
changed) and that K transfers its rights and obligations under the
currency swap contract in exchange for $10. Under Sec. 1.988-
2(e)(3)(iii), K will include in income as exchange gain $10 on January
1, 1991. Pursuant to paragraph (a)(6)(ii) of this section, the pound
borrowing and the currency swap contract are treated as a qualified
hedging transaction for 1990. The loss inherent in the pound borrowing
from January 1, 1990, to January 1, 1991, is realized and recognized on
January 1, 1991. Such loss is exchange loss in the amount of $10.00
[([pound]100x$1.50, the spot rate on January 1, 1990)--
([pound]100x$1.60, the spot rate on January 1, 1991)]. For purposes of
determining exchange gain or loss on the [pound]100 principal amount of
the debt instrument for the period January 1, 1991, to December 31,
1992, the spot rate on January 1, 1991 is used rather than the spot rate
on the issue date. Thus, assuming that the spot rate on December 31,
1992, the maturity date, is [pound]1 = $1.80, K realizes exchange loss
in the amount of $20 [([pound]100x$1.60)-([pound]100x$1.80)]. Except as
provided in paragraph (a)(8)(iii) (regarding identification by the
Commissioner), the pound borrowing cannot be part of a qualified hedging
transaction for any period subsequent to the leg out date.
Example 5. (i) K, a U.S. corporation, has the U.S. dollar as its
functional currency. On January 1, 1990, when the spot rate for Swiss
francs (Sf) is Sf1 = $.50, K converts $100 to Sf200 and purchases a
franc denominated debt instrument. The instrument has a term of 3 years,
an adjusted issue price of Sf200, and will bear interest at 5 percent,
payable annually, with no repayment of principal until the final
installment. The U.S. dollar interest rate on an equivalent instrument
is 8% on January 1, 1990, compounded annually. On January 1, 1990, K
also enters into a series of forward contracts to sell the franc
interest and principal payments that will be received under the terms of
the franc denominated debt instrument for dollars according to the
following schedule:
------------------------------------------------------------------------
U.S.
Date dollars Francs
------------------------------------------------------------------------
December 31, 1990............................. 5.14 10
December 31, 1991............................. 5.29 10
December 31, 1992............................. 114.26 210
------------------------------------------------------------------------
(ii) Assume K satisfies the identification requirements of paragraph
(a)(8) of this section. Assume further that on January 1, 1991, the spot
exchange rate is Sf1 = U.S.$.5143, the U.S. dollar interest rate is 10%,
compounded annually, and the Swiss franc interest rate is the same as on
January 1, 1990 (5%, compounded annually). On January 1, 1991, K
disposes of the forward contracts that were to mature on December 31,
1991, and December 31, 1992 and incurs a loss of $3.62 (the present
value of $.10 with respect to the 1991 contract and $4.27 with respect
to the 1992 contract).
(iii) The purchase of the franc debt instrument (which constitutes a
qualifying debt instrument under paragraph (a)(3) of this section) and
the series of forward contracts (which constitute a hedge under
paragraph (a)(4) of this section) are a qualified hedging transaction
under paragraph (a)(1) of this section. Accordingly, the franc debt
instrument and all the forward contracts are integrated for the period
beginning January 1, 1990, and ending January 1, 1991.
(A) The integration of the franc debt instrument and the forward
contracts results in a synthetic dollar debt instrument with an issue
price of $100.
(B) The total amount of interest and principal to be received by K
with respect to the synthetic dollar debt instrument is equal to the
dollars to be received under the forward sales contracts (i.e., $5.14 in
1990, $5.29 in 1991, and $114.26 in 1992).
(C) The synthetic dollar debt instrument is an installment
obligation and its stated redemption price at maturity is $109.27 (i.e.,
$5.14 of the payments in 1990, 1991, and 1992 is treated as periodic
interest payments under the principles of section 1273). Because the
stated redemption price at maturity exceeds the issue price, under
section 1273(a)(1) the synthetic dollar debt instrument has OID of
$9.27.
(D) The yield to maturity of the synthetic dollar debt instrument is
8.00 percent, compounded annually. Assuming K is a calendar year
taxpayer, it must include interest income of $8.00 in 1990 (of which
$2.86 constitutes OID).
[[Page 625]]
(E) The source of the interest income is determined by applying
sections 861(a)(1) and 862(a)(1) with reference to the franc interest
income that would have been received had the transaction not been
integrated.
(iv) Because K disposed of the forward contracts on January 1, 1991,
the rules of paragraph (a)(6)(ii) of this section shall apply.
Accordingly, the $3.62 loss from the disposition of the forward
contracts is realized and recognized on January 1, 1991. Additionally, K
is deemed to have sold the franc debt instrument for $102.86, its fair
market value in dollars on January 1, 1991. K will compute gain or loss
with respect to the deemed sale of the franc debt instrument by
subtracting its adjusted basis in the instrument ($102.86--the value of
the Sf200 issue price at the spot rate on the identification date plus
$2.86 of original issue discount accrued on the synthetic dollar debt
instrument for 1990) from the amount realized on the deemed sale of
$102.86. Thus K realizes and recognizes no gain or loss from the deemed
sale of the debt instrument. The dollar amount used to determine
exchange gain or loss with respect to the franc debt instrument is the
Sf200 issue price on January 1, 1991, translated into dollars at the
spot rate on January 1, 1991, of Sf1 = U.S.$.5143. Except as provided in
paragraph (a)(8)(iii) of this section (regarding identification by the
Commissioner), the franc borrowing cannot be part of a qualified hedging
transaction for any period subsequent to the leg out date.
Example 6. (i) K is a U.S. corporation with the dollar as its
functional currency. On January 1, 1992, K issues a debt instrument with
the following terms: the issue price is $1,000, the instrument pays
interest annually at a rate of 8% on the $1,000 principal amount, the
instrument matures on December 31, 1996, and the amount paid at maturity
is the greater of zero or $2,000 less the U.S. dollar value (determined
on December 31, 1996) of 150,000 Japanese yen.
(ii) Also on January 1, 1992, K enters into the following hedges
with respect to the instrument described in the preceding paragraph: a
forward contract under which K will sell 150,000 yen for $1,000 on
December 31, 1996 (note that this forward rate assumes that interest
rates in yen and dollars are equal); and an option contract that expires
on December 31, 1996, under which K has the right (but not the
obligation) to acquire 150,000 yen for $2,000. K will pay for the option
by making payments to the writer of the option equal to $5 each December
31 from 1992 through 1996.
(iii) The net economic effect of these transactions is that K has
created a liability with a principal amount and amount paid at maturity
of $1,000, with an interest cost of 8.5% (8% on debt instrument, 0.5%
option price) compounded annually. For example, if on December 31, 1996,
the spot exchange rate is $1 = 100 yen, K pays $500 on the bond [$2,000-
(150,000 yen/$100)], and $500 in satisfaction of the forward contract
[$1,000-(150,000 yen/$100)]. If instead the spot exchange rate on
December 31, 1996 is $1 = 200 yen, K pays $1,250 on the bond [$2,000-
(150,000 yen/$200)] and K receives $250 in satisfaction of the forward
contract [$1,000-(150,000 yen/$200)]. Finally, if the spot exchange rate
on December 31, 1996 is $1 = 50 yen, K pays $0 on the bond [$2,000-
(150,000 yen/$50), but the bond holder is not required under the terms
of the instrument to pay additional principal]; K exercises the option
to buy 150,000 yen for $2,000; and K then delivers the 150,000 yen as
required by the forward contract in exchange for $1,000.
(iv) Assume K satisfies the identification requirements of paragraph
(a)(8) of this section. The debt instrument described in paragraph (i)
of this Example 6 (which constitutes a qualifying debt instrument under
paragraph (a)(3) of this section) and the forward contract and option
contract described in paragraph (ii) of this example (which constitute a
hedge under paragraph (a)(4) of this section and are collectively
referred to hereafter as ``the contracts'') together are a qualified
hedging transaction under paragraph (a)(1) of this section. Accordingly,
with respect to K, the debt instrument and the contracts are integrated,
resulting in a synthetic dollar debt instrument with an issue price of
$1000, a stated redemption price at maturity of $1000 and a yield to
maturity of 8.5% compounded annually (with no original issue discount).
K must allocate and apportion its annual interest expense of $85 under
the rules of Sec. Sec. 1.861-8T through 1.861-12T.
Example 7. (i) R is a U.S. corporation with the dollar as its
functional currency. On January 1, 1995, R issues a debt instrument with
the following terms: the issue price is 504 British pounds ([pound]),
the instrument pays interest at a rate of 3.7% (compounded semi-
annually) on the [pound]504 principal amount, the instrument matures on
December 31, 1999, with a repayment at maturity of the [pound]504
principal plus the proportional gain, if any, in the ``Financial Times''
100 Stock Exchange (FTSE) index (determined by the excess of the value
of the FTSE index on the maturity date over the value of the FTSE on the
issue date, divided by the value of the FTSE index on the issue date,
multiplied by the number of FTSE index contracts that could be purchased
on the issue date for [pound]504).
(ii) Also on January 1, 1995, R enters into a contract with a bank
under which on January 1, 1995, R will swap the [pound]504 for $1,000
(at the current spot rate). R will make U.S. dollar payments to the bank
equal to 8.15% on the notional principal amount of $1,000 (compounded
semi-annually) for the period beginning January 1, 1995 and ending
December 31,
[[Page 626]]
1999. R will receive pound payments from the bank equal to 3.7% on the
notional principal amount of [pound]504 (compounded semi-annually) for
the period beginning January 1, 1995 and ending December 31, 1999. On
December 31, 1999, R will swap with the bank $1,000 for [pound]504 plus
the proportional gain, if any, in the FTSE index (computed as provided
above).
(iii) Economically, both the indexed debt instrument and the hedging
contract are hybrid instruments with the following components. The
indexed debt instrument is composed of a par pound debt instrument that
is assumed to have a 10.85% coupon (compounded semi-annually) plus an
embedded FTSE equity index option for which the investor pays a premium
of 7.15% (amortized semi-annually) on the pound principal amount. The
combined effect is that the premium paid by the investor partially
offsets the coupon payments resulting in a return of 3.7% (10.85%-
7.15%). Similarly, the dollar payments under the hedging contract to be
made by R are computed by multiplying the dollar notional principal
amount by an 8.00% rate (compounded semi-annually) which the facts
assume would be the rate paid on a conventional currency swap plus a
premium of 0.15% (amortized semi-annually) on the dollar notional
principal amount for an embedded FTSE equity index option.
(iv) Assume R satisfies the identification requirements of paragraph
(a)(8) of this section. The indexed debt instrument described in
paragraph (i) of this Example 7 constitutes a qualifying debt instrument
under paragraph (a)(3) of this section. The hedging contract described
in paragraph (ii) of this Example 7 constitutes a hedge under paragraph
(a)(4) of this section. Since both the pound exposure of the indexed
debt instrument and the exposure to movements of the FTSE embedded in
the indexed debt instrument are hedged such that a yield to maturity can
be determined in dollars, the transaction satisfies the requirement of
paragraph (a)(5)(i) of this section. Assuming the transactions satisfy
the other requirements of paragraph (a)(5) of this section, the indexed
debt instrument and hedge are a qualified hedging transaction under
paragraph (a)(1) of this section. Accordingly, with respect to R, the
debt instrument and the contracts are integrated, resulting in a
synthetic dollar debt instrument with an issue price of $1000, a stated
redemption price at maturity of $1000 and a yield to maturity of 8.15%
compounded semi-annually (with no original issue discount). K must
allocate and apportion its interest expense from the synthetic
instrument under the rules Sec. Sec. 1.861-8T through 1.861-12T.
Example 8. (i) K is a U.S. corporation with the U.S. dollar as its
functional currency. On December 24, 1992, K agrees to close the
following transaction on December 31, 1992. K will borrow from an
unrelated party on December 31, 1992, 200 British pounds ([pound]) for 3
years at a 10 percent rate of interest, payable annually, with no
principal payment due until the final installment. K will also enter
into a currency swap contract with an unrelated counterparty under the
terms of which--
(A) K will swap, on December 31, 1992, [pound]100 obtained from the
borrowing for $100; and
(B) K will exchange dollars for pounds pursuant to the following
table:
------------------------------------------------------------------------
U.S.
Date dollars Pounds
------------------------------------------------------------------------
December 31, 1993............................. 8 10
December 31, 1994............................. 8 10
December 31, 1995............................. 108 110
------------------------------------------------------------------------
(ii) The interest rate on the borrowing is set and the exchange
rates on the swap are fixed on December 24, 1992. On December 31, 1992,
K borrows the [pound]200 and swaps [pound]100 for $100. Assume K has
satisfied the identification requirements of paragraph (a)(8) of this
section.
(iii) The [pound]200 debt instrument satisfies the requirements of
paragraph (a)(3)(i) of this section. Because all principal and interest
payments under the instrument are hedged in the same proportion (50% of
all interest and principal payments are hedged), 50% of the payments
under the [pound]200 instrument (principal amount of [pound]100 and
annual interest of [pound]10) are treated as a qualifying debt
instrument for purposes of paragraph (a) of this section. Thus, the
distinct [pound]100 borrowing and the currency swap contract (which
constitutes a hedge under paragraph (a)(4) of this section) are a
qualified hedging transaction as defined in paragraph (a)(1) of this
section. Accordingly, [pound]100 of the pound borrowing and the swap are
integrated and treated as one synthetic dollar transaction with the
following consequences:
(A) The integration of [pound]100 of the pound borrowing and the
swap results in a synthetic dollar borrowing with an issue price of $100
under section 1273(b)(2).
(B) The total amount of interest and principal of the synthetic
dollar borrowing is equal to the dollar payments made by K under the
currency swap contract (i.e., $8 in 1993, $8 in 1994, and $108 in 1995).
(C) The stated redemption price at maturity (defined in section
1273(a)(2)) is $100. Because the stated redemption price equals the
issue price, there is no OID on the synthetic dollar borrowing.
(D) K may deduct the annual interest payments of $8 under section
163(a) (subject to any limitations on deductibility imposed by other
provisions of the Code) according to its regular method of accounting. K
has also paid $100 as a return of principal in 1995.
(E) K must allocate and apportion its interest expense from the
synthetic instrument under the rules of Sec. Sec. l.861-8T through
1.861-12T.
[[Page 627]]
That portion of the [pound]200 pound debt instrument that is not hedged
(i.e., [pound]100) is treated as a separate debt instrument subject to
the rules of Sec. 1.988-2 (b) and Sec. Sec. l.861-8T through 1.861-
12T.
Example 9. (i) K is an accrual method U.S. corporation with the U.S.
dollar as its functional currency. On January 1, 1992, K borrows 100
British pounds ([pound]) for 3 years at a 10% rate of interest payable
on December 31 of each year with no principal payment due until the
final installment. On the same day, K enters into a currency swap
agreement with an unrelated bank under which K agrees to the following:
(A) On January 1, 1992, K will exchange the [pound]100 borrowed for
$150.
(B) For the period beginning January 1, 1992 and ending December 31,
1994, K will pay at the end of each month an amount determined by
multiplying $150 by one month LIBOR less 65 basis points and receive
from the bank on December 31st of 1992, 1993, and 1994, [pound]10.
(C) On December 31, 1994, K will exchange $150 for [pound]100.
Assume K satisfies the identification requirements of paragraph (a)(8)
of this section.
(ii) The pound borrowing (which constitutes a qualifying debt
instrument under paragraph (a)(3) of this section) and the currency swap
contract (which constitutes a hedge under paragraph (a)(4) of this
section) are a qualified hedging transaction as defined in paragraph
(a)(1) of this section. Accordingly, the pound borrowing and the swap
are integrated and treated as one transaction with the following
consequences:
(A) The integration of the pound borrowing and the swap results in a
synthetic dollar borrowing with an issue price of $150 under section
1273(b)(2).
(B) The total amount of interest and principal of the synthetic
dollar borrowing is equal to the dollar payments made by K under the
currency swap contract.
(C) The stated redemption price at maturity (defined in section
1273(a)(2)) is $150. Because the stated redemption price equals the
issue price, there is no OID on the synthetic dollar borrowing.
(D) K may deduct the monthly variable interest payments under
section 163(a) (subject to any limitations on deductibility imposed by
other provisions of the Code) according to its regular method of
accounting. K has also paid $150 as a return of principal in 1994.
(E) K must allocate and apportion its interest expense from the
synthetic instrument under the rules of Sec. Sec. 1.861-8T through
1.861-12T.
Example 10. (i) K is an accrual method U.S. corporation with the
U.S. dollar as its functional currency. On January 1, 1992, K loans 100
British pounds ([pound]) for 3 years at a 10% rate of interest payable
on December 31 of each year with no principal payment due until the
final installment. The spot rate on January 1, 1992, is [pound]1 =
$1.50. Also on January 1, 1992, K enters into a currency swap contract
with an unrelated counterparty under the terms of which K will exchange
pounds for dollars pursuant to the following table:
------------------------------------------------------------------------
Date Pounds Dollars
------------------------------------------------------------------------
December 31, 1992............................. 10 12
December 31, 1993............................. 10 12
December 31, 1994............................. 110 162
------------------------------------------------------------------------
(ii) Assume that K properly identifies the pound borrowing and the
currency swap contract as a qualified hedging transaction as provided in
paragraph (a)(1) of this section.
(iii) The pound loan (which constitutes a qualifying debt instrument
under paragraph (a)(3) of this section) and the currency swap contract
(which constitutes a hedge under paragraph (a)(4) of this section) are a
qualified hedging transaction as defined in paragraph (a)(1) of this
section. Accordingly, the pound loan and the swap are integrated and
treated as one transaction with the following consequences:
(A) The integration of the pound loan and the swap results in a
synthetic dollar loan with an issue price of $150 under section
1273(b)(2).
(B) The total amount of interest and principal of the synthetic
dollar loan is equal to the dollar payments received by K under the
currency swap contract (i.e., $12 in 1992, $12 in 1993, and $162 in
1994).
(C) The stated redemption price at maturity (defined in section
1273(a)(2)) is $150. Because the stated redemption price equals the
issue price, there is no OID on the synthetic dollar loan.
(D) K must include in income as interest $12 in 1992, 1993, and
1994.
(E) The source of the interest income shall be determined by
applying sections 861(a)(1) and 862(a)(1) with reference to the pound
interest income that would have been received had the transaction not
been integrated.
(iv) On January 1, 1993, K transfers both the pound loan and the
currency swap to B, its wholly owned U.S. subsidiary, in exchange for B
stock in a transfer that satisfies the requirements of section 351.
Under paragraph (a)(6) of this section, the transfer of both instruments
is not ``legging out.'' Rather, K is considered to have transferred the
synthetic dollar loan to B in a transaction in which gain or loss is not
recognized. B's basis in the loan under section 362 is $100.
(10) Transition rules and effective dates for certain provisions--
(i) Coordination with Notice 87-11. Any transaction entered into prior
to September 21, 1989,
[[Page 628]]
which satisfied the requirements of Notice 87-11, 1987-1 C.B. 423, shall
be deemed to satisfy the requirements of paragraph (a) of this section.
(ii) Prospective application to contingent payment debt instruments.
In the case of a contingent payment debt instrument, the definition of
qualifying debt instrument set forth in paragraph (a)(3)(i) of this
section applies to transactions entered into after March 17, 1992.
(iii) Prospective application of partial hedging rule. Paragraph
(a)(3)(ii) of this section is effective for transactions entered into
after March 17, 1992.
(iv) Effective date for paragraph (a)(6)(i) of this section. The
rules of paragraph (a)(6)(i) of this section are effective for qualified
hedging transactions that are legged into after March 17, 1992.
(b) Hedged executory contracts--(1) In general. If the taxpayer
enters into a hedged executory contract as defined in paragraph (b)(2)
of this section, the executory contract and the hedge shall be
integrated as provided in paragraph (b)(4) of this section.
(2) Definitions--(i) Hedged executory contract. A hedged executory
contract is an executory contract as defined in paragraph (b)(2)(ii) of
this section that is the subject of a hedge as defined in paragraph
(b)(2)(iii) of this section, provided that the following requirements
are satisfied--
(A) The executory contract and the hedge are identified as a hedged
executory contract as provided in paragraph (b)(3) of this section.
(B) The hedge is entered into (i.e., settled or closed, or in the
case of nonfunctional currency deposited in an account with a bank or
other financial institution, such currency is acquired and deposited) on
or after the date the executory contract is entered into and before the
accrual date as defined in paragraph (b)(2)(iv) of this section.
(C) The executory contract is hedged in whole or in part throughout
the period beginning with the date the hedge is identified in accordance
with paragraph (b)(3) of this section and ending on or after the accrual
date.
(D) None of the parties to the hedge are related. The term related
means the relationships defined in section 267(b) and section 707(c)(1).
(E) In the case of a qualified business unit with a residence, as
defined in section 988(a)(3)(B), outside of the United States, both the
executory contract and the hedge are properly reflected on the books of
the same qualified business unit.
(F) Subject to the limitations of paragraph (b)(2)(i)(E) of this
section, both the executory contract and the hedge are entered into by
the same individual, partnership, trust, estate, or corporation. With
respect to a corporation, the same corporation must enter into both the
executory contract and the hedge whether or not such corporation is a
member of an affiliated group of corporations that files a consolidated
return.
(G) With respect to a foreign person engaged in a U.S. trade or
business that enters into an executory contract or hedge through such
trade or business, all items of income and expense associated with the
executory contract and the hedge would have been effectively connected
with such U.S. trade or business throughout the term of the hedged
executory contract had this paragraph (b) not applied.
(ii) Executory contract--(A) In general. Except as provided in
paragraph (b)(2)(ii)(B) of this section, an executory contract is an
agreement entered into before the accrual date to pay nonfunctional
currency (or an amount determined with reference thereto) in the future
with respect to the purchase of property used in the ordinary course of
the taxpayer's business, or the acquisition of a service (or services),
in the future, or to receive nonfunctional currency (or an amount
determined with reference thereto) in the future with respect to the
sale of property used or held for sale in the ordinary course of the
taxpayer's business, or the performance of a service (or services), in
the future. Notwithstanding the preceding sentence, a contract to buy or
sell stock shall be considered an executory contract. (Thus, for
example, a contract to sell stock of an affiliate
[[Page 629]]
is an executory contract for this purpose.) On the accrual date, such
agreement ceases to be considered an executory contract and is treated
as an account payable or receivable.
(B) Exceptions. An executory contract does not include a section 988
transaction. For example, a forward contract to purchase nonfunctional
currency is not an executory contract. An executory contract also does
not include a transaction described in paragraph (c) of this section.
(C) Effective date for contracts to buy or sell stock. That part of
paragraph (b)(2)(ii)(A) of this section which provides that a contract
to buy or sell stock shall be considered an executory contract applies
to contracts to buy or sell stock entered into on or after March 17,
1992.
(iii) Hedge--(A) In general. For purposes of this paragraph (b), the
term hedge means a deposit of nonfunctional currency in a hedging
account (as defined paragraph (b)(3)(iii)(D) of this section), a forward
or futures contract described in Sec. 1.988-1(a)(1)(ii) and (2)(iii),
or combination thereof, which reduces the risk of exchange rate
fluctuations by reference to the taxpayer's functional currency with
respect to nonfunctional currency payments made or received under an
executory contract. The term hedge also includes an option contract
described in Sec. 1.988-1(a)(1)(ii) and (2)(iii), but only if the
option's expiration date is on or before the accrual date. The premium
paid for an option that lapses shall be integrated with the executory
contract.
(B) Special rule for series of hedges. A series of hedges as defined
in paragraph (b)(3)(iii)(A) of this section shall be considered a hedge
if the executory contract is hedged in whole or in part throughout the
period beginning with the date the hedge is identified in accordance
with paragraph (b)(3)(i) of this section and ending on or after the
accrual date. A taxpayer that enters into a series of hedges will be
deemed to have satisfied the preceding sentence if the hedge that
succeeds a hedge that has been terminated is entered into no later than
the business day following such termination.
(C) Special rules for historical rate rollovers--(1) Definition. A
historical rate rollover is an extension of the maturity date of a
forward contract where the new forward rate is adjusted on the rollover
date to reflect the taxpayer's gain or loss on the contract as of the
rollover date plus the time value of such gain or loss through the new
maturity date.
(2) Certain historical rate rollovers considered a hedge. A
historical rate rollover is considered a hedge if the rollover date is
before the accrual date.
(3) Treatment of time value component of certain historical rate
rollovers that are hedges. Interest income or expense determined under
Sec. 1.988-2(d)(2)(v) with respect to a historical rate rollover shall
be considered part of a hedge if the period beginning on the first date
a hedging contract is rolled over and ending on the date payment is made
or received under the executory contract does not exceed 183 days. Such
interest income or expense shall not be recognized and shall be an
adjustment to the income from, or expense of, the services performed or
received under the executory contract, or to the amount realized or
basis of the property sold or purchased under the executory contract.
For the treatment of such interest income or expense that is not
considered part of a hedge, see Sec. 1.988-2(d)(2)(v).
(D) Special rules regarding deposits of nonfunctional currency in a
hedging account. A hedging account is an account with a bank or other
financial institution used exclusively for deposits of nonfunctional
currency used to hedge executory contracts. For purposes of determining
the basis of units in such account that comprise the hedge, only those
units in the account as of the accrual date shall be taken into
consideration. A taxpayer may adopt any reasonable convention
(consistently applied to all hedging accounts) to determine which units
comprise the hedge as of the accrual date and the basis of the units as
of such date.
(E) Interest income on deposit of nonfunctional currency in a
hedging account. Interest income on a deposit of nonfunctional currency
in a hedging account may be taken into account for purposes of
determining the amount of a hedge if such interest is accrued on or
before the accrual date. However,
[[Page 630]]
such interest income shall be included in income as provided in section
61. For example, if a taxpayer with the dollar as its functional
currency enters into an executory contract for the purchase and delivery
of a machine in one year for 100 British pounds ([pound]), and on such
date deposits [pound]90.91 in a properly identified bank account that
bears interest at the rate of 10%, the interest that accrues prior to
the accrual date shall be included in income and may be considered a
hedge.
(iv) Accrual date. The accrual date is the date when the item of
income or expense (including a capital expenditure) that relates to an
executory contract is required to be accrued under the taxpayer's method
of accounting.
(v) Payment date. The payment date is the date when payment is made
or received with respect to an executory contract or the subsequent
corresponding account payable or receivable.
(3) Identification rules--(i) Identification by the taxpayer. A
taxpayer must establish a record and before the close of the date the
hedge is entered into, the taxpayer must enter into the record a clear
description of the executory contract and the hedge and indicate that
the transaction is being identified in accordance with paragraph (b)(3)
of this section.
(ii) Identification by the Commissioner. If a taxpayer enters into
an executory contract and a hedge but fails to satisfy one or more of
the requirements of paragraph (b) of this section and, based on the
facts and circumstances, the Commissioner concludes that the executory
contract in substance is hedged, then the Commissioner may apply the
provisions of paragraph (b) of this section as if the taxpayer had
satisfied all of the requirements therein, and may make appropriate
adjustments. The Commissioner may apply the provisions of paragraph (b)
of this section regardless of whether the executory contract and the
hedge are held by the same taxpayer.
(4) Effect of hedged executory contract--(i) In general. If a
taxpayer enters into a hedged executory contract, amounts paid or
received under the hedge by the taxpayer are treated as paid or received
by the taxpayer under the executory contract, or any subsequent account
payable or receivable, or that portion to which the hedge relates. Also,
the taxpayer recognizes no exchange gain or loss on the hedge. If an
executory contract, on the accrual date, becomes an account payable or
receivable, the taxpayer recognizes no exchange gain or loss on such
payable or receivable for the period covered by the hedge.
(ii) Partially hedged executory contracts. The effect of integrating
an executory contract and a hedge that partially hedges such contract is
to treat the amounts paid or received under the hedge as paid or
received under the portion of the executory contract being hedged, or
any subsequent account payable or receivable. The income or expense of
services performed or received under the executory contract, or the
amount realized or basis of property sold or purchased under the
executory contract, that is attributable to that portion of the
executory contract that is not hedged shall be translated into
functional currency on the accrual date. Exchange gain or loss shall be
realized when payment is made or received with respect to any payable or
receivable arising on the accrual date with respect to such unhedged
amount.
(iii) Disposition of a hedge or executory contract prior to the
accrual date--(A) In general. If a taxpayer identifies an executory
contract as part of a hedged executory contract as defined in paragraph
(b)(2) of this section, and disposes of (or otherwise terminates) the
executory contract prior to the accrual date, the hedge shall be treated
as sold for its fair market value on the date the executory contract is
disposed of and any gain or loss shall be realized and recognized on
such date. Such gain or loss shall be an adjustment to the amount
received or expended with respect to the disposition or termination, if
any. The spot rate on the date the hedge is treated as sold shall be
used to determine subsequent exchange gain or loss on the hedge. If a
taxpayer identifies a hedge as part of a hedged executory contract as
defined in paragraph (b)(2) of this section, and disposes of the hedge
prior to the accrual date, any gain or loss realized on such disposition
shall not be recognized and
[[Page 631]]
shall be an adjustment to the income from, or expense of, the services
performed or received under the executory contract, or to the amount
realized or basis of the property sold or purchased under the executory
contract.
(B) Certain events in a series of hedges treated as a termination of
the hedged executory contract. If the rules of paragraph (b)(2)(iii)(B)
of this section are not satisfied, the hedged executory contract shall
be terminated and the provisions of paragraph (b)(4)(iii)(A) of this
section shall apply to any gain or loss previously realized with respect
to such hedge. Any subsequent hedging contracts entered into to reduce
the risk of exchange rate movements with respect to such executory
contract shall not be considered a hedge as defined in paragraph
(b)(2)(iii) of this section.
(C) Executory contracts between related persons. If an executory
contract is between related persons as defined in sections 267(b) and
707(b), and the taxpayer disposes of the hedge or terminates the
executory contract prior to the accrual date, the Commissioner may
redetermine the timing, source, and character of gain or loss from the
hedge or the executory contract if he determines that a significant
purpose for disposing of the hedge or terminating the executory contract
prior to the accrual date was to affect the timing, source, or character
of income, gain, expense, or loss for Federal income tax purposes.
(iv) Disposition of a hedge on or after the accrual date. If a
taxpayer identifies a hedge as part of a hedged executory contract as
defined in paragraph (b)(2) of this section, and disposes of the hedge
on or after the accrual date, no gain or loss is recognized on the hedge
and the booking date as defined in Sec. 1.988-2(c)(2) of the payable or
receivable for purposes of computing exchange gain or loss shall be the
date such hedge is disposed of. See Example 3 of paragraph (b)(4)(iv) of
this section.
(v) Sections 263(g), 1092, and 1256 do not apply. Sections 263(g),
1092, and 1256 do not apply with respect to an executory contract or
hedge which comprise a hedged executory contract as defined in paragraph
(b)(2) of this section. However, sections 263(g), 1092 and 1256 may
apply to the hedged executory contract if such transaction is part of a
straddle.
(vi) Examples. The principles set forth in paragraph (b) of this
section are illustrated in the following examples. The examples assume
that K is an accrual method, calendar year U.S. corporation with the
dollar as its functional currency.
Example 1. (i) On January 1, 1992, K enters into a contract with
JPF, a Swiss machine manufacturer, to pay 500,000 Swiss francs for
delivery of a machine on June 1, 1993. Also on January 1, 1992, K enters
into a foreign currency forward agreement to purchase 500,000 Swiss
francs for $250,000 for delivery on June 1, 1993. K properly identifies
the executory contract and the hedge in accordance with paragraph
(b)(3)(i) of this section. On June 1, 1993, K takes delivery of the
500,000 Swiss francs (in exchange for $250,000) under the forward
contract and makes payment of 500,000 Swiss francs to JPF in exchange
for the machine. Assume that the accrual date is June 1, 1993.
(ii) Under paragraph (b)(1) of this section, the hedge is integrated
with the executory contract. Therefore, K is deemed to have paid
$250,000 for the machine and there is no exchange gain or loss on the
foreign currency forward contract. K's basis in the machine is $250,000.
Section 1256 does not apply to the forward contract.
Example 2. (i) On January 1, 1992, K enters into a contract with S,
a Swiss machine manufacturer, to pay 500,000 Swiss francs for delivery
of a machine on June 1, 1993. Under the contract, K is not obligated to
pay for the machine until September 1, 1993. On February 1, 1992, K
enters into a foreign currency forward agreement to purchase 500,000
Swiss francs for $250,000 for delivery on September 1, 1993. K properly
identifies the executory contract and the hedge in accordance with
paragraph (b)(3) of this section. On June 1, 1993, K takes delivery of
machine. Assume that under K's method of accounting the delivery date is
the accrual date. On September 1, 1993, K takes delivery of the 500,000
Swiss francs (in exchange for $250,000) under the forward contract and
makes payment of 500,000 Swiss francs to S.
(ii) Under paragraph (b)(1) of this section, the hedge is integrated
with the executory contract. Therefore K is deemed to have paid $250,000
for the machine and there is no exchange gain or loss on the foreign
currency forward contract. Thus K's basis in the machine is $250,000. In
addition, no exchange gain or loss is recognized on the payable in
existence from June 1, 1993, to September 1, 1993. Section 1256 does not
apply to the forward contract.
[[Page 632]]
Example 3. The facts are the same as in Example 2 except that K
disposed of the forward contract on August 1, 1993 for $10,000. Pursuant
to paragraph (b)(4)(iv) of this section, K does not recognize the
$10,000 gain. K's basis in the machine is $250,000 (the amount fixed by
the forward contract), regardless of the amount in dollars that K
actually pays to acquire the Sf500,000 when K pays for the machine. K
has a payable with a booking date of August 1, 1993, payable on
September 1, 1993 for 500,000 Swiss francs. Thus, K will realize
exchange gain or loss on the difference between the amount booked on
August 1, 1993 and the amount paid on September 1, 1993 under Sec.
1.988-2(c).
Example 4. (i) On January 1, 1992, K enters into a contract with S,
a Swiss machine repair firm, to pay 500,000 Swiss francs for repairs to
be performed on June 1, 1992. Under the contract, K is not obligated to
pay for the repairs until September 1, 1992. On February 1, 1992, K
enters into a foreign currency forward agreement to purchase 500,000
Swiss francs for $250,000 for delivery on August 1, 1992. K properly
identifies the executory contract and the hedge in accordance with
paragraph (b)(3) of this section. On June 1, 1992, S performs the repair
services. Assume that under K's method of accounting this date is the
accrual date. On August 1, 1992, K takes delivery of the 500,000 Swiss
francs (in exchange for $250,000) under the forward contract. On the
same day, K deposits the Sf500,000 in a separate account with a bank and
properly identifies the transaction as a continuation of the hedged
executory contract. On September 1, 1992, K makes payment of the
Sf500,000 in the account to S.
(ii) Under paragraph (b)(1) of this section, the hedge is integrated
with the executory contract. Therefore K is deemed to have paid $250,000
for the services and there is no exchange gain or loss on the foreign
currency forward contract or on the disposition of Sf500,000 in the
account. Any interest on the Swiss francs in the account is included in
income but is not considered part of the hedge (because the amount paid
for the services must be set on or before the accrual date). In
addition, no exchange gain or loss is recognized on the payable in
existence from June 1, 1992, to September 1, 1992. Section 1256 does not
apply to the forward contract.
Example 5. (i) On January 1, 1992, K enters into a contract with S,
a Swiss machine manufacturer, to pay 500,000 Swiss francs for delivery
of a machine on June 1, 1993. Under the contract, K is not obligated to
pay for the machine until September 1, 1993. On February 1, 1992, K
enters into a foreign currency forward agreement to purchase 250,000
Swiss francs for $125,000 for delivery on September 1, 1993. K properly
identifies the executory contract and the hedge in accordance with
paragraph (b)(3) of this section. On June 1, 1993, K takes delivery of
the machine. Assume that under K's method of accounting the delivery
date is the accrual date. Assume further that the exchange rate is Sf1 =
$.50 on June 1, 1993. On August 30, 1993, K purchases Sf250,000 for
$135,000. On September 1, 1993, K takes delivery of the 250,000 Swiss
francs (in exchange for $125,000) under the forward contract and makes
payment of 500,000 Swiss francs (the Sf250,000 received under the
contract plus the Sf250,000 purchased on August 30, 1993) to S. Assume
the spot rate on September 1, 1993, is 1 Sf = $.5420 (Sf250,000 equal
$135,500).
(ii) Under paragraph (b)(1) of this section, the partial hedge is
integrated with the executory contract. K is deemed to have paid
$250,000 for the machine [$125,000 on the hedged portion of the
Sf500,000 and $125,000 ($.50, the spot rate on June 1, 1993, times
Sf250,000) on the unhedged portion of the Sf500,000]. K's basis in the
machine therefore is $250,000. K recognizes no exchange gain or loss on
the foreign currency forward contract but K will realize exchange gain
of $500 on the disposition of the Sf250,000 purchased on August 30, 1993
under Sec. 1.988-2(a). In addition, exchange loss is realized on the
unhedged portion of the payable in existence from June 1, 1993, to
September 1, 1993. Thus, K will realize exchange loss of $10,500
($125,000 booked less $135,500 paid) under Sec. 1.988-2(c) on the
payable. Section 1256 does not apply to the forward contract.
Example 6. (i) On January 1, 1990, K enters into a contract with S,
a Swiss steel manufacturer, to buy steel for 1,000,000 Swiss francs (Sf)
for delivery and payment on December 31, 1990. On January 1, 1990, the
spot rate is Sf1 = $.50, the U.S. dollar interest rate is 10% compounded
annually, and the Swiss franc rate is 5% compounded annually. Under K's
method of accounting, the delivery date is the accrual date.
(ii) Assume that on January 1, 1990, K enters into a foreign
currency forward contract to buy Sf1,000,000 for $523,800 for delivery
on December 31, 1990. K properly identifies the executory contract and
the hedge in accordance with paragraph (b)(3) of this section. Pursuant
to paragraph (b)(2)(iii) of this section, the forward contract
constitutes a hedge. Assuming that the requirements of paragraph
(b)(2)(i) of this section are satisfied, the executory contract to buy
steel and the forward contract are integrated under paragraph (b)(1) of
this section. Thus, K is deemed to have paid $523,800 for the steel and
will have a basis in the steel of $523,800. No gain or loss is realized
with respect to the forward contract and section 1256 does not apply to
such contract.
(iii) Assume instead that on January 1, 1990, K enters into a
foreign currency forward contract to buy Sf1,000,000 for $512,200 for
delivery on July 1, 1990. K properly identifies the executory contract
and the hedge in accordance with paragraph (b)(3) of this
[[Page 633]]
section. On July 1, 1990, when the spot rate is Sf1 = $.53, K cancels
the forward contract in exchange for $17,800 ($530,000-$512,200). On
July 1, 1990, K enters into a second forward agreement to buy
Sf1,000,000 for $542,900 for delivery on December 31, 1990. K properly
identifies the second forward agreement as a hedge in accordance with
paragraph (b)(3) of this section. Pursuant to paragraph (b)(2)(iii) of
this section, the forward contract entered into on January 1, 1990, and
the forward contract entered into on July 1, 1990, constitute a hedge.
Assuming that the requirements of paragraph (b)(2)(i) of this section
are satisfied, the executory contract to buy steel and the forward
agreements are integrated under paragraph (b)(1) of this section. Thus,
K is deemed to have paid $525,100 for the steel (the forward price in
the second forward agreement of $542,900 less the gain on the first
forward agreement of $17,800) and will have a basis in the steel of
$525,100. No gain is realized with respect to the forward contracts and
section 1256 does not apply to such contracts.
(iv) Assume instead that on January 1, 1990, K enters into a foreign
currency forward contract to buy Sf1,000,000 for $512,200 for delivery
on July 1, 1990. K properly identifies the executory contract and the
hedge in accordance with paragraph (b)(3) of this section. On July 1,
1990, when the spot rate is Sf1 = $.53, K enters into a historical rate
rollover of its $17,800 gain ($530,000-$512,200) on the forward
agreement. Thus, K enters into a second foreign currency forward
agreement to buy Sf1,000,000 for $524,210 for delivery on December 31,
1990. (The forward price of $524,210 is the market forward price on July
1, 1990, for the purchase of Sf1,000,000 for delivery on December 31,
1990, of $542,900 less the $17,800 gain on January 1, 1990, contract and
less the time value of such gain of $890.) K properly identifies the
second forward agreement as a hedge in accordance with paragraph (b)(3)
of this section. On December 31, 1990, when the spot rate is Sf1 = $.54,
K takes delivery of the Sf1,000,000 (in exchange for $524,210) and
purchases the steel for Sf1,000,000. Pursuant to paragraph (b)(2)(iii)
of this section, the forward contract entered into on January 1, 1990,
and the forward contract entered into on July 1, 1990, which
incorporates the rollover of K's gain on the January 1, 1990, contract,
constitute a hedge. Assuming that the requirements of paragraph
(b)(2)(i) of this section are satisfied, the executory contract to buy
steel and the forward agreements are integrated under paragraph (b)(1)
of this section. Because the period from the rollover date to the date
payment is made under the executory contract does not exceed 183 days,
the $890 of interest income is considered part of the hedge and is not
recognized. Thus, K is deemed to have paid $524,210 for the steel and
will have a basis in the steel of $524,210. No gain is realized with
respect to the forward contracts and section 1256 does not apply to such
contracts.
(v) Assume instead that on January 1, 1990, K purchases Sf952,380.95
(the present value of Sf1,000,000 to be paid on December 31, 1990) for
$476,190.48 and on the same day deposits the Swiss francs in a separate
bank account that bears interest at a rate of 5%, compounded annually. K
properly identifies the transaction as a hedged executory contract. Over
the period beginning January 1, 1990, and ending December 31, 1990, K
receives Sf47,619.05 in interest on the account that is included in
income and that has a basis of $25,714.29. (Assume that under Sec.
1.988-2(b)(1), K uses the spot rate of Sf1 = $.54 to translate the
interest income). On December 31, 1990, K makes payment of the
Sf1,000,000 principal and accrued interest in the account to S. Pursuant
to paragraph (b)(2)(iii) of this section, the principal in the bank
account and the interest constitute a hedge. Under paragraph (b)(1) of
this section, the hedge is integrated with the executory contract.
Therefore K is deemed to have paid $501,904.77 (the basis of the
principal deposited plus the basis of the interest) for the steel and
there is no exchange gain or loss on the disposition of the Sf1,000,000.
K's basis in the steel therefore is $501,904.77.
(5) References to this paragraph (b). If the rules of this paragraph
(b) are referred to in another paragraph of this section (e.g.,
paragraph (c) of this section), then the rules of this paragraph (b)
shall be applied for purposes of such other paragraph by substituting
terms appropriate for such other paragraph. For example, paragraph
(c)(2) of this section refers to the identification rules of paragraph
(b)(3) of this section. Accordingly, for purposes of paragraph (c)(2),
the rules of paragraph (b)(3) will be applied by substituting the term
``stock or security'' for ``executory contract''.
(c) Hedges of period between trade date and settlement date on
purchase or sale of publicly traded stock or security. If a taxpayer
purchases or sells stocks or securities which are traded on an
established securities market and--
(1) Hedges all or part of such purchase or sale for any part of the
period beginning on the trade date and ending on the settlement date;
and
(2) Identifies the hedge and the underlying stock or securities as
an integrated transaction under the rules of paragraph (b)(3) of this
section;
[[Page 634]]
then any gain or loss on the hedge shall be an adjustment to the amount
realized or the adjusted basis of the stock or securities sold or
purchased (and shall not be taken into account as exchange gain or
loss). The term hedge means a deposit of nonfunctional currency in a
hedging account (within the meaning of paragraph (b)(2)(iii)(D) of this
section), or a forward or futures contract described in Sec. 1.988-
1(a)(1)(ii) and (2)(iii), or combination thereof, which reduces the risk
of exchange rate fluctuations for any portion of the period beginning on
the trade date and ending on the settlement date. The provisions of
paragraphs (b)(2)(i)(D) through (G), and (b)(2)(iii)(D) and (E) of this
section shall apply. Sections 263(g), 1092, and 1256 do not apply with
respect to stock or securities and a hedge which are subject to this
paragraph (c).
(d) [Reserved]
(e) Advance rulings regarding net hedging and anticipatory hedging
systems. In his sole discretion, the Commissioner may issue an advance
ruling addressing the income tax consequences of a taxpayer's system of
hedging either its net nonfunctional currency exposure or anticipated
nonfunctional currency exposure. The ruling may address the character,
source, and timing of both the section 988 transaction(s) making up the
hedge and the underlying transactions being hedged. The procedures for
obtaining a ruling shall be governed by such pertinent revenue
procedures and revenue rulings as the Commissioner may provide. The
Commissioner will not issue a ruling regarding hedges of a taxpayer's
investment in a foreign subsidiary.
(f) [Reserved]
(g) General effective date. Except as otherwise provided in this
section, the rules of this section shall apply to qualified hedging
transactions, hedged executory contracts and transactions described in
paragraph (c) of this section entered into on or after September 21,
1989. This section shall apply even if the transaction being hedged
(e.g., the debt instrument) was entered into or acquired prior to such
date. The effective date regarding advance rulings for net and
anticipatory hedging shall be governed by such revenue procedures that
the Commissioner may publish.
[T.D. 8400, 57 FR 9199, Mar. 17, 1992]
Sec. 1.989(a)-1 Definition of a qualified business unit.
(a) Applicability--(1) In general. This section provides rules
relating to the definition of the term ``qualified business unit'' (QBU)
within the meaning of section 989.
(2) Effective date. These rules shall apply to taxable years
beginning after December 31, 1986. However, any person may apply on a
consistent basis Sec. 1.989(a)-1T (c) of the Temporary Income Tax
Regulations in lieu of Sec. 1.989(a)-1 (c) to all taxable years
beginning after December 31, 1986, and on or before February 5, 1990.
For the text of the temporary regulation, see 53 FR 20612 (June 8,
1988).
(b) Definition of a qualified business unit--(1) In general. A QBU
is any separate and clearly identified unit of a trade or business of a
taxpayer provided that separate books and records are maintained.
(2) Application of the QBU definition--(i) Persons. A corporation is
QBU. An individual is not a QBU. A partnership, trust, or estate is a
QBU of a partner or beneficiary.
(ii) Activities. Activities of a corporation, partnership, trust,
estate, or individual qualify as a QBU if--
(A) The activities constitute a trade or business; and
(B) A separate set of books and records is maintained with respect
to the activities.
(3) Special rule. Any activity (wherever conducted and regardless of
its frequency) that produces income or loss that is, or is treated as,
effectively connected with the conduct of a trade or business within the
United States shall be treated as a separate QBU, provided the books and
records requirement of paragraph (d)(2) of this section is satisfied.
(c) Trade or business. The determination as to whether activities
constitute a trade or business is ultimately dependent upon an
examination of all the facts and circumstances. Generally, a trade or
business for purposes of section 989(a) is a specific unified group of
activities that constitutes (or could
[[Page 635]]
constitute) an independent economic enterprise carried on for profit,
the expenses related to which are deductible under section 162 or 212
(other than that part of section 212 dealing with expenses incurred in
connection with taxes). To constitute a trade or business, a group of
activities must ordinarily include every operation which forms a part
of, or a step in, a process by which an enterprise may earn income or
profit. Such group of activities must ordinarily include the collection
of income and the payment of expenses. It is not necessary that the
activities carried out by a QBU constitute a different trade or business
from those carried out by other QBUs of the taxpayer. A vertical,
functional, or geographic division of the same trade or business may be
a trade or business for this purpose provided that the activities
otherwise qualify as trade or business under this paragraph (c).
However, activities that are merely ancillary to a trade or business
will not constitute a trade or business under this paragraph (c).
Activities of an individual as an employee are not considered by
themselves to constitute a trade or business under this paragraph (c).
(d) Separate books and records--(1) General rule. Except as provided
in paragraph (d)(2) of this section, a separate set of books and records
shall include books of original entry and ledger accounts, both general
and subsidiary, or similar records. For example, in the case of a
taxpayer using the cash receipts and disbursements method of accounting,
the books of original entry include a cash receipts and disbursements
journal where each receipt and each disbursement is recorded. Similarly,
in the case of a taxpayer using an accrual method of accounting, the
books of original entry include a journal to record sales (accounts
receivable) and a journal to record expenses incurred (accounts
payable). In general, a journal represents a chronological account of
all transactions entered into by an entity for an accounting period. A
ledger account, on the other hand, chronicles the impact during an
accounting period of the specific transactions recorded in the journal
for that period upon the various items shown on the entity's balance
sheet (i.e., assets, liabilities, and capital accounts) and income
statement (i.e., revenues and expenses).
(2) Special rule. For purposes of paragraph (b)(3) of this section,
books and records include books and records used to determine income or
loss that is, or is treated as, effectively connected with the conduct
of a trade or business within the United States.
(e) Examples. The provisions of this section may be illustrated by
the following examples:
Example 1. Corporation X is a domestic corporation. Corporation X
manufactures widgets in the U.S. for export. Corporation X sells widgets
in the United Kingdom through a branch office in London. The London
office has its own employees and solicits and processes orders.
Corporation X maintains in the U.S. a separate set of books and records
for all transactions conducted by the London office. Corporation X is a
QBU under paragraph (b)(2)(i) of this section because of its corporate
status. The London branch office is a QBU under paragraph (b)(2)(ii) of
this section because (1) the sale of widgets is a trade or business as
defined in paragraph (c) of this section; and (2) a complete and
separate set of books and records (as described in paragraph (d) of this
section) is maintained with respect to its sales operations.
Example 2. A domestic corporation incorporates a wholly-owned
subsidiary in Switzerland. The domestic corporation is a manufacturer
that markets its product abroad primarily through the Swiss subsidiary.
To facilitate sales of the parent's product in Europe, the Swiss
subsidiary has branch offices in France and West Germany that are
responsible for all marketing operations in those countries. Each branch
has its own employees, solicits and processes orders, and maintains a
separate set of books and records. The domestic corporation and the
Swiss subsidiary are both QBUs under paragraph (b)(2)(i) of this section
because of their corporate status. The French and West German branches
are QBUs of the Swiss subsidiary. They satisfy paragraph (b)(2)(ii)
because each constitutes a trade or business (as defined in paragraph
(c) of this section) and because separate sets of books and records (as
described in paragraph (d) of this section) of their respective
operations is maintained. Each branch is considered to have a trade or
business although each is a geographical division of the same trade or
business.
Example 3. W is a domestic corporation that manufactures product X
in the United States for sale worldwide. All of W's sales functions are
conducted exclusively in the United States. W employs individual Q to
[[Page 636]]
work in France. Q's sole function is to act as a courier to deliver
sales documents to customers in France. With respect to Q's activities
in France, a separate set of books and records as described in paragraph
(d) is maintained. Under paragraph (c) of this section, Q's activities
in France do not constitute a QBU since they are merely ancillary to W's
manufacturing and selling business. Q is not considered to have a QBU
because an individual's activities as an employee are not considered to
constitute a trade or business of the individual under paragraph (c).
Example 4. The facts are the same as in example (3) except that the
courier function is the sole activity of a wholly-owned French
subsidiary of W. Under paragraph (b)(2)(i) of this section, the French
subsidiary is considered to be a QBU.
Example 5. A corporation incorporated in the Netherlands is a
subsidiary of a domestic corporation and a holding company for the stock
of one or more subsidiaries incorporated in other countries. The Dutch
corporation's activities are limited to paying its directors and its
administrative expenses, receiving capital contributions from its United
States parent corporation, contributing capital to its subsidiaries,
receiving dividend distributions from its subsidiaries, and distributing
dividends to its domestic parent corporation. Under paragraph (b)(2)(i)
of this section, the Netherlands corporation is considered to be a QBU.
Example 6. Taxpayer A, an individual resident of the United States,
is engaged in a trade or business wholly unrelated to any type of
investment activity. A also maintains a portfolio of foreign currency-
denominated investments through a foreign broker. The broker is
responsible for all activities necessary to the management of A's
investments and maintains books and records as described in paragraph
(d) of this section, with respect to all investment activities of A. A's
investment activities qualify as a QBU under paragraph (b)(2)(ii) of
this section to the extent the activities engaged in by A generate
expenses that are deductible under section 212 (other than that part of
section 212 dealing with expenses incurred in connection with taxes).
Example 7. Taxpayer A, an individual resident of the United States,
is the sole shareholder of foreign corporation (FC) whose activities are
limited to trading in stocks and securities. FC is a QBU under paragraph
(b)(2)(i) of this section.
Example 8. Taxpayer A, an individual resident of the United States,
markets and sells in Spain and in the United States various products
produced by other United States manufacturers. A has an office and
employs a salesman to manage A's activities in Spain, maintains a
separate set of books and records with respect to his activities in
Spain, and is engaged in a trade or business as defined in paragraph (c)
of this section. Therefore, under paragraph (b)(2)(ii) of this section,
the activities of A in Spain are considered to be a QBU.
Example 9. Foreign corporation FX is incorporated in Mexico and is
wholly owned by a domestic corporation. The domestic corporation elects
to treat FX as a domestic corporation under section 1504(d). FX operates
entirely in Mexico and maintains a separate set of books and records
with respect to its activities in Mexico. FX is a QBU under paragraph
(b)(2)(i) of this section. The activities of FX in Mexico also
constitute a QBU under paragraph (b)(2)(ii) of this section.
Example 10. F, a foreign corporation, computes a gain of $100 from
the disposition of a United States real property interest (as defined in
section 897(c)). The gain is taken into account as if F were engaged in
a trade or business in the United States and as if such gain were
effectively connected with such trade or business. F is a QBU under
paragraph (b)(2)(i) of this section because of its corporate status. F's
disposition activity constitutes a separate QBU under paragraph (b)(3)
of this section.
[T.D. 8279, 55 FR 284, Jan. 4, 1990]
Sec. 1.989(b)-1 Definition of weighted average exchange rate.
For purposes of section 989(b)(3) and (4), the term ``weighted
average exchange rate'' means the simple average of the daily exchange
rates (determined by reference to a qualified source of exchange rates
within the meaning of Sec. 1.964-1(d)(5)), excluding weekends, holidays
and any other nonbusiness days for the taxable year.
[T.D. 8263, 54 FR 38664, Sept. 20, 1989. Redesignated by T.D. 8367, 56
FR 48437, Sept. 25, 1991; 57 FR 6060, Feb. 18, 1992]
Sec. 1.989(c)-1 Transition rules for certain branches of United States
persons using a net worth method of accounting for taxable years beginning
before January 1, 1987.
(a) Applicability--(1) In general. This section applies to qualified
business units (QBU) branches of United States persons, whose functional
currency (as defined in section 985 of the Code and regulations issued
thereunder) is other than the United States dollar (dollar) and that
used a net worth method of accounting for their last taxable year
beginning before January 1, 1987. Generally, a net worth method of
accounting is any method of accounting under
[[Page 637]]
which the taxpayer calculates the taxable income of a QBU branch based
on the net change in the dollar value of the QBU branch's equity over
the course of a taxable year, taking into account any remittance made
during the year. QBU branch equity is the excess of QBU branch assets
over QBU branch liabilities. For all taxable years beginning after
December 31, 1986, such QBU branches must use the profit and loss method
of accounting as described in section 987, except to the extent
otherwise provided in regulations under section 985 or any other
provision of the Code.
(2) Insolvent QBU branches. A taxpayer may apply the principles of
this section to a QBU branch that used a net worth method of accounting
for its last taxable year beginning before January 1, 1987, whose $E
pool (as defined in paragraph (d)(3)(i) of this section) is negative.
For taxable years beginning on or after October 25, 1991, the principles
of this section shall apply to insolvent QBU branches.
(b) General rules. For the general rules, see Sec. 1.987-5(b).
(c) Determining the pool(s) from which a remittance is made. To
determine from which pool(s) a remittance is made, see Sec. 1.987-5(c).
(d) Calculation of section 987 gain or loss--(1) In general. See
Sec. 1.987-5(d)(1) for rules to make this calculation.
(2) Step 1--Calculate the amount of the functional currency pools.
For calculation of the amount of the functional currency pools, see
Sec. 1.987-5(d)(2).
(3) Step 2--Calculate the dollar basis pools--(i) Dollar basis of
the EQ pool--(A) Beginning dollar basis. The beginning dollar basis of
the EQ pool (hereinafter referred to as the $E pool) equals the final
net worth of the QBU branch. Final net worth of the QBU branch equals
the QBU branch's equity value (assets less liabilities) measured in
dollars at the end of the taxpayer's last taxable year beginning before
January 1, 1987, determined on the basis of the QBU branch's books and
records as adjusted according to United States tax principles.
(B) Adjusting the $E pool. For adjustments to be made to the $E
pool, see Sec. 1.987-5(d)(3)(i)(B).
(ii) Dollar basis of the post-86 profits pool. To calculate the
dollar basis of the post-86 profits pool, see Sec. 1.987-5(d)(3)(ii).
(iii) Dollar basis of the equity pool. To calculate the dollar basis
of the equity pool, see Sec. 1.987-5(d)(3)(iii).
(4) Step 3--Calculation of the dollar basis of a remittance. To
calculate the dollar basis of the EQ remitted, see Sec. 1.987-5(d)(4).
(5) Step 4--Calculation of the section 987 gain or loss on a
remittance. To calculate 987 gain or loss determined on a remittance,
see Sec. 1.987-5(d)(5).
(e) Functional currency adjusted basis of QBU branch assets acquired
in taxable years beginning before January 1, 1987. To determine the
functional currency adjusted basis of QBU branch assets acquired in
taxable years beginning before January 1, 1987, see Sec. 1.987-5(e).
(f) Functional currency amount of QBU branch liabilities acquired in
taxable years beginning before January 1, 1987. To determine the
functional currency amount of QBU branch liabilities acquired in taxable
years beginning before January 1, 1987, see Sec. 1.987-5(f).
[T.D. 8367, 56 FR 48437, Sept. 25, 1991]
Domestic International Sales Corporations
Sec. 1.991-1 Taxation of a domestic international sales corporation.
(a) In general. A corporation which is a DISC for a taxable year is
not subject to any tax imposed by subtitle A of the Code (sections 1
through 1564) for such taxable year, except for the tax imposed by
chapter 5 thereof (sections 1491 through 1494) on certain transfers to
avoid tax. Thus, for example, a corporation which is a DISC for a
taxable year is not subject for such year to the corporate income tax
(section 11), the minimum tax on tax preferences (sections 56 through
58), or the accumulated earnings tax (sections 531 through 537). A DISC
is liable for the payment of all taxes payable by corporations under
other subtitles of the Code, such as, for example, income taxes withheld
at the source and other employment taxes under subtitle C and the
interest equalization tax and other miscellaneous excise taxes imposed
by
[[Page 638]]
subtitle D. In addition, a DISC is subject to the provisions of chapter
3 of subtitle A (including section 1461), relating to withholding of tax
on nonresident aliens and foreign corporations and tax-free covenant
bonds. See Sec. 1.992-1 for the definition of the term ``DISC.''
(b) Determination of taxable income--(1) In general. Although a DISC
is not subject to tax under subtitle A of the Code (other than chapter 5
thereof), a DISC's taxable income shall be determined for each taxable
year in order to determine, for example, the amount deemed distributed
for that taxable year to its shareholders pursuant to Sec. 1.995-2.
Except as otherwise provided in the Code and the regulations thereunder,
the taxable income of a DISC shall be determined in the same manner as
if the DISC were a domestic corporation which had not elected to be
treated as a DISC. Thus, for example, a DISC chooses its method of
depreciation, inventory method, and annual accounting period in the same
manner as if it were a corporation which had not elected to be treated
as a DISC. Any elections affecting the determination of taxable income
shall be made by the DISC. Thus, as a further example, a DISC which
makes an installment sale described in section 453 is able to avail
itself of the benefits of section 453: Provided, The DISC complies with
the election requirements of such section. See Sec. 1.995-2(e) and
Sec. 1.996-8 and the regulations thereunder for rules relating to the
application for a taxable year of a DISC of a deduction under section
172 for a net operating loss carryback or carryover or of a capital loss
carryback or carryover under section 1212.
(2) Choice of method of accounting. A DISC may, generally, choose
any method of accounting permissible under section 446(c) and the
regulations thereunder. However, if a DISC is a member of a controlled
group (as defined in Sec. 1.993-1(k)), the DISC may not choose a method
of accounting which, when applied to transactions between the DISC and
other members of the controlled group, will result in a material
distortion of the income of the DISC or any other member of the
controlled group. Such a material distortion of income would occur, for
example, if a DISC chooses to use the cash method of accounting where
the DISC acts as commission agent in a substantial volume of sales of
property by a related corporation which uses the accrual method of
accounting and which customarily pays commissions to the DISC more than
2 months after such sales. As a further example, a material distortion
of income would occur if a DISC chooses to use the accrual method of
accounting where the DISC leases a substantial amount of property from a
related corporation which uses the cash method of accounting, if the
DISC customarily accrues any portion of the rent on such property more
than 2 months before the rent is paid. Changes in the method of
accounting of a DISC are subject to the requirements of section 446(e)
and the regulations thereunder.
(3) Choice of annual accounting period--(i) In general. A DISC may
choose its annual accounting period without regard to the annual
accounting period of any of its stockholders. In general, changes in the
annual accounting period of a DISC are subject to the requirements of
section 442 and the regulations thereunder.
(ii) Transition rule for change in taxable year in order to become a
DISC. A corporation may, without the consent of the Commissioner, change
its annual accounting period and adopt a new taxable year beginning on
the first day of any month in 1972: Provided, That--
(a) Such change has the effect of accelerating the time as of which
such corporation can become a DISC,
(b) The Commissioner is notified of such change by means of a
statement filed (with the regional service center with which such
corporation files its election to be treated as a DISC) not later than
the end of the period during which such corporation may file an election
to be treated as a DISC for such new taxable year, and
(c) The short period required to effect such change is not a taxable
year in which such corporation has a net operating loss as defined in
section 172.
Thus, for example, if a corporation which uses the calendar year for its
taxable year does not complete arrangements to become a DISC until
[[Page 639]]
May 15, 1972, such corporation can, pursuant to this subdivision, change
its annual accounting period and adopt a taxable year beginning on the
first day of any month in 1972 after May. A change to a new annual
accounting period made pursuant to this subdivision is effective only if
the corporation which makes such change qualifies as a DISC for such new
period. A corporation may change its annual accounting period and adopt
a new taxable year pursuant to this subdivision without regard to the
provisions of Sec. 1.1502-76 (relating to the taxable year of members
of a group). A copy of the statement described in (b) of this
subdivision shall be attached to the return of a corporation for the new
taxable year to which such corporation changes pursuant to this
subdivision. A corporation which changes its annual accounting period
pursuant to this subparagraph will not be permitted under section 442 to
change its annual accounting period at any time before 1982, except with
the consent of the Commissioner as provided in Sec. 1.442-1(b)(1) or
pursuant to subparagraph (4) of this paragraph.
(4) Transition rule for change of taxable year of certain DISC's. In
the case of a DISC all of the shares of which are held by a single
shareholder or by members of a group who file a consolidated return,
such DISC may (without the consent of the Commissioner) change its
annual accounting period and adopt a taxable year beginning in 1972
which is the same as the taxable year of such shareholder or the members
of such group. A change to a new annual accounting period may be made by
a DISC pursuant to this subparagraph even if such DISC has changed its
annual accounting period pursuant to subparagraph (3)(ii) of this
paragraph.
(5) Transition rule for beginning of first taxable year of certain
corporations. If a corporation organized before January 1, 1972, neither
acquires assets (other than cash or other property acquired as
consideration for the issuance of stock) nor begins doing business prior
to January 1, 1972, the first taxable year of such corporation is deemed
to begin at the time such corporation acquires any asset (other than
cash or other property acquired as consideration for the issuance of
stock) or begins doing business, whichever is earlier: Provided, That
such corporation is a DISC for such first taxable year. For purposes of
Sec. 1.6012-2(a), such corporation is treated as not coming into
existence until the beginning of such first taxable year.
(c) Effective date. The provisions of this section and the
regulations under sections 992 through 997 apply with respect to taxable
years ending after December 31, 1971, except that a corporation may not
be a DISC for any taxable year beginning before January 1, 1972.
(d) Related statutes. For rules relating to the transfer, during a
taxable year beginning before January 1, 1976, to a DISC of assets of an
export trade corporation (as defined in section 971), where a parent
owns all the outstanding stock of both such DISC and such export trade
corporation, see section 505(b) of the Revenue Act of 1971 (85 Stat.
551). For rules regarding limitations on the qualification of a
corporation as an export trade corporation for any taxable year
beginning after October 31, 1971, see section 971(a)(3).
[T.D. 7323, 39 FR 34402, Sept. 25, 1974, as amended by T.D. 7854, 47 FR
51738, Nov. 17, 1982]
Sec. 1.992-1 Requirements of a DISC.
(a) ``DISC'' defined. The term ``DISC'' refers to a domestic
international sales corporation. The term ``DISC'' means a corporation
which, for a taxable year--
(1) Is duly incorporated and existing under the laws of any State or
the District of Columbia,
(2) Satisfies the gross receipts test described in paragraph (b) of
this section,
(3) Satisfies the assets test described in paragraph (c) of this
section,
(4) Satisfies the capitalization requirement described in paragraph
(d) of this section,
(5) Satisfies the requirement that an election to be treated as a
DISC be in effect for such year, as described in paragraph (e) of this
section,
(6) [Reserved]
(7) Maintains separate books and records, and
(8) Is not an ineligible corporation described in paragraph (f) of
this section.
[[Page 640]]
A corporation which satisfies the requirements described in
subparagraphs (1) through (8) of this paragraph for a taxable year is
treated as a separate corporation for Federal tax purposes and qualifies
as a DISC, even though such corporation would not be treated (if it were
not a DISC) as a corporate entity for Federal income tax purposes. An
association cannot qualify as a DISC even if such association is taxable
as a corporation pursuant to section 7701(a)(3). In addition, a
corporation created or organized in, or under the law of, a possession
of the United States cannot qualify as a DISC. The rules contained in
this paragraph constitute a relaxation of the general rules of corporate
substance otherwise applicable under the Code. The separate
incorporation of a DISC is required under section 992(a)(1) to make it
possible to keep a better record of the income which is subject to the
special treatment provided by sections 991 through 996, but this does
not necessitate in all other respects the separate relationships which
otherwise would be required between a parent corporation and its
subsidiary. However, this relaxation of the general rules of corporate
substance does not apply with respect to other corporations in other
contexts. In the case of a transaction between a DISC and a person
related to such DISC for purposes of section 482, see Sec. 1.993-1(l)
for rules for determining whether income is income of a DISC to which
the intercompany pricing rules authorized by section 994 apply.
(b) Gross receipts test. In order for a corporation described in
paragraph (a)(1) of this section to be a DISC for a taxable year, 95
percent or more of its gross receipts (as defined in Sec. 1.993-6) for
such year must consist of qualified export receipts (as defined in Sec.
1.993-1). Gross receipts for a taxable year are determined in accordance
with the method of accounting adopted by the corporation pursuant to
Sec. 1.991-1(b)(2). However, for rules regarding gross receipts in the
case of a commission sale by such corporation, see Sec. 1.993-6.
(c) Assets test--(1) In general. In order for a corporation
described in paragraph (a)(1) of this section to be a DISC for a taxable
year, the adjusted basis (determined under section 1011) of its
qualified export assets at the close of such year must equal or exceed
95 percent of the sum of the adjusted bases (determined under section
1011) of all assets of such corporation at the close of such year.
(2) Assets acquired to meet assets test. For purposes of determining
whether the requirements of subparagraph (1) of this paragraph are
satisfied by a corporation at the end of a taxable year, an asset which
is a qualified export asset is treated as not being an asset of such
corporation at such time if such asset is held for a total of 60 days or
less and is acquired directly or indirectly through borrowing, unless
the acquisition of such asset is established to the satisfaction of the
Commissioner or his delegate to have been for bona fide purposes. Such
acquisition is deemed to have been for bona fide purposes if, for
example, it is made in the usual course of the corporation's trade or
business.
(d) Capitalization requirement--(1) In general. To qualify as a DISC
for a taxable year, a corporation must have, on each day of that taxable
year, only one class of stock. The par value (or, in the case of stock
without par value, the stated value) of the corporation's outstanding
stock must be on each day of the taxable year at least $2,500. In the
case of a corporation which elects to be treated as a DISC for its first
taxable year, the requirements of this paragraph (d)(1) are satisfied if
the corporation has no more than one class of stock at any time during
the year and if the par value (or, in the case of stock without par
value, the stated value) of the corporation's outstanding stock is at
least $2,500 on the last day of the period within which the election
must be made and on each succeeding day of the year. For purposes of
this paragraph (d)(1), the stated value of shares is the aggregate
amount of the consideration paid for such shares which is not allotted
to paid in surplus, or other surplus. The law of the State of
incorporation of the DISC determines what consideration may be used to
capitalize the DISC. A corporation will not be a qualified DISC unless
at least $2,500 of valid consideration was used for this purpose. If a
corporation has a realized or unrealized loss during a taxable year
[[Page 641]]
which results in the impairment of all or part of the capital required
under this paragraph (d)(1), that impairment does not result in
disqualification under this paragraph (d)(1), provided that the
corporation does not take any legal or formal action under State law to
reduce capital for that year below the amount required under this
paragraph (d)(1).
(2) Treatment of debt payable to shareholders--(i) In general.
Purported debt of a DISC payable to any person, whether or not such
person is a shareholder or a member of a controlled group (as defined in
Sec. 1.993-1(k)) of which such DISC is a member, is treated as debt for
all purposes of the Code, provided that such purported debt--
(a) Would qualify as debt for purposes of the Code if the DISC were
a corporation which did not qualify as a DISC,
(b) Qualifies under subdivision (ii) of this subparagraph, or
(c) Are trade accounts payable described in subdivision (iii) of
this subparagraph.
Such debt is not treated as stock, and interest payable by the DISC on
such debt is treated as interest by both the DISC and the holder of such
debt. Payment of the principal of such debt by a DISC does not
constitute the payment of a dividend by such DISC. The provisions of
this subparagraph apply for a taxable year of a DISC, even though debt
described in this subparagraph would be treated as stock of the
corporation if such corporation did not qualify as a DISC for such year.
(ii) Safe harbor rule. Purported debt of a DISC will in no event be
treated as other than debt for purposes of subdivision (i) of this
subparagraph if--
(a) It is a written obligation to pay a sum certain on or before a
fixed maturity date,
(b) Interest is payable on such purported debt at an arm's length
interest rate (as determined under Sec. 1.482-2(a)(2)), expressed as a
fixed dollar amount or a fixed percentage of principal,
(c) Such purported debt is not convertible into stock or into other
purported debt unless such other purported debt qualifies under this
subparagraph as debt of the DISC,
(d) Such purported debt does not confer voting rights upon its
holder, except in the event of default thereon, and
(e) Interest and principal are paid in accordance with the terms of
such purported debt or with any modification of such terms consistent
with (a) through (d) of this subdivision.
The determination of whether purported debt of a DISC constitutes debt
described in this subdivision is made without regard to the proportion
of debt of the DISC held by any of its shareholders, to the ratio of the
outstanding debt of the DISC to its equity, or to the amount of
outstanding debt of such DISC. The provisions of (e) of this subdivision
do not prevent the modification of the terms of debt of a DISC where,
for example, a DISC becomes unable to make timely payments of principal
required under such terms, provided that such modification is consistent
with (a) through (d) of this subdivision.
(iii) Trade accounts payable. Trade accounts payable of a DISC which
arise in the normal course of its trade or business (such as in
consideration for inventory or supplies) constitute debt of the DISC
(whether or not such accounts payable are debt described in subdivision
(i) (a) or (b) of this subparagraph), provided that such accounts are
payable within 15 months after they arise. If such accounts are payable
more than 15 months after they arise, they are debt of such DISC only if
they are debt described in subdivision (i) (a) or (b) of this
subparagraph.
(iv) Relation of subparagraph to other corporations. The provisions
of this subparagraph generally constitute a relaxation of the ordinary
rules used in determining whether purported debt of a corporation is
debt or equity. This relaxation is in recognition of the principle that
a corporation may qualify as a DISC even though it has relatively little
capital. This relaxation does not apply with respect to purported debt
of other corporations in other contexts. The provisions of subdivisions
(i), (ii), and (iii) of this subparagraph apply only for taxable years
for which a corporation qualifies (or is treated) as a DISC.
(3) Classes of stock. [Reserved]
[[Page 642]]
(e) Election in effect. In order for a corporation to be a DISC for
a taxable year, an election to be treated as a DISC must be made by such
corporation pursuant to Sec. 1.992-2 and must be in effect for such
taxable year. A corporation does not become or remain a DISC solely by
making such an election. A corporation is a DISC for a taxable year only
if such an election is in effect for that year and the corporation also
satisfies the requirements of paragraphs (a) through (d) of this
section. See Sec. 1.992-2 for rules regarding the time and manner of
making such an election.
(f) Ineligible corporations. The following corporations shall not be
eligible to be treated as a DISC--
(1) A corporation exempt from tax by reason of section 501,
(2) A personal holding company (as defined in section 542),
(3) A financial institution to which section 581 or 593 applies,
(4) An insurance company subject to the tax imposed by subchapter L,
(5) A regulated investment company (as defined in section 851(a)),
(6) A China Trade Act corporation receiving the special deduction
provided in section 941(a), or
(7) An electing small business corporation (as defined in section
1371(b)).
(g) Status as DISC after having filed return as a DISC. Under
section 992(a)(2), notwithstanding the failure of a corporation to meet
the requirements of paragraph (a) of this section for a taxable year,
such corporation will be treated as a DISC for purposes of the Code for
such taxable year (and, thus, will not be able to claim that it is not
eligible to be a DISC) if--
(1) Such corporation files a return as a DISC for such taxable year,
(2) Such corporation does not notify the district director, more
than 30 days before the expiration of the period of limitation
(including extensions thereof) on assessment for underpayment of tax for
such taxable year (as determined under section 6501 and the regulations
thereunder), that it is not a DISC for such taxable year, and
(3) The Internal Revenue Service has not issued, within such period
of limitation (including extensions thereof) on assessment for
underpayment of tax for such taxable year, a notice of deficiency based
on a determination that such corporation is not a DISC for such taxable
year.
A corporation is treated as a DISC, for all purposes, pursuant to the
provisions of this paragraph for any taxable year for which it meets the
requirements of this paragraph, even if such corporation is an
ineligible corporation described in paragraph (f) of this section for
such taxable year. Thus, for example, a corporation which is treated as
a DISC for a taxable year pursuant to this paragraph is treated as a
DISC for that taxable year for purposes of Sec. 1.992-2(e)(3) (relating
to the termination of a DISC election if a corporation is not a DISC for
each of any 5 consecutive taxable years). If a corporation is treated as
a DISC for a taxable year pursuant to this paragraph, persons who held
stock of such corporation at any time during such taxable year are
treated, with respect to such stock, as holders of stock in a DISC for
the period or periods during which they held such stock within such
taxable year.
(h) Definition of ``former DISC''. Under section 992(a)(3), the term
``former DISC'' refers to a corporation which is not a DISC for a
taxable year but which was (or was treated as) a DISC for a prior
taxable year. However, a corporation is not a former DISC for a taxable
year unless such corporation has, at the beginning of such taxable year,
undistributed previously taxed income (as defined in Sec. 1.996-3(c) or
accumulated DISC income (as defined in Sec. 1.996-3(b)). A corporation
which is a former DISC for a taxable year is a former DISC for all
purposes of the Code.
(Secs. 385 and 7805 of the Internal Revenue Code of 1954 (83 Stat. 613
and 68A Stat. 917; 26 U.S.C. 385 and 7805))
[T.D. 7323, 39 FR 34403, Sept. 25, 1974, as amended by T.D. 7420, 41 FR
20654, May 20, 1976; 41 FR 22267, June 2, 1976; T.D. 7747, 45 FR 86459,
Dec. 31, 1980; T.D. 7920, 48 FR 50712, Nov. 3, 1983; T.D. 8371, 56 FR
55234, Oct. 25, 1991]
Sec. 1.992-2 Election to be treated as a DISC.
(a) Manner and time of election--(1) Manner--(i) In general. A
corporation
[[Page 643]]
can elect to be treated as a DISC for a taxable year beginning after
December 31, 1971. Except as provided in paragraph (a)(1)(ii) of this
section, the election is made by the corporation filing Form 4876 with
the service center with which it would file its income tax return if it
were subject for such taxable year to all the taxes imposed by subtitle
A of the Internal Revenue Code of 1954. The form shall be signed by any
person authorized to sign a corporation return under section 6062, and
shall contain the information required by such form. Except as provided
in paragraphs (b)(3) and (c) of this section, such election to be
treated as a DISC shall be valid only if the consent of every person who
is a shareholder of the corporation as of the beginning of the first
taxable year for which such election is effective is on or attached to
such Form 4876 when filed with the service center.
(ii) Transitional rule for corporations electing during 1972. If the
first taxable year for which an election by a corporation to be treated
as a DISC is a taxable year beginning after December 31, 1971, and on or
before December 31, 1972, such election may be made either in the manner
prescribed in subdivision (i) of this subparagraph or by filing, at the
place prescribed in subdivision (i) of this subparagraph, a statement
captioned ``Election to be Treated as a DISC.'' Such statement of
election shall be valid only if the consent of each shareholder is filed
with the service center in the form, and at the time, prescribed in
paragraph (b) of this section. Such statement shall be signed by any
person authorized to sign a corporation return under section 6062 and
shall include the name, address, and employer identification number (if
known) of the corporation, the beginning date of the first taxable year
for which the election is effective, the number of shares of stock of
the corporation issued and outstanding as of the earlier of the
beginning of the first taxable year for which the election is effective
or the time the statement is filed, the number of shares held by each
shareholder as of the earlier of such dates, and the date and place of
incorporation. As a condition of the election being effective, a
corporation which elects to become a DISC by filing a statement in
accordance with this subdivision must furnish (to the service center
with which the statement was filed) such additional information as is
required by Form 4876 by March 31, 1973.
(2) Time of making election--(i) In general. In the case of a
corporation making an election to be treated as a DISC for its first
taxable year, such election shall be made within 90 days after the
beginning of such taxable year. In the case of a corporation which makes
an election to be treated as a DISC for any taxable year beginning after
March 31, 1972 (other than the first taxable year of such corporation),
the election shall be made during the 90-day period immediately
preceding the first day of such taxable year.
(ii) Transitional rules for certain corporations electing during
1972. In the case of a corporation which makes an election to be treated
as a DISC for a taxable year beginning after December 31, 1971, and on
or before March 31, 1972 (other than its first taxable year), the
election shall be made within 90 days after the beginning of such
taxable year.
(b) Consent by shareholders--(1) In general--(i) Time and manner of
consent. Under paragraph (a)(1)(i) of this section, subject to certain
exceptions, the election to be treated as a DISC is not valid unless
each person who is a shareholder as of the beginning of the first
taxable year for which the election is effective signs either the
statement of consent on Form 4876 or a separate statement of consent
attached to such form. A shareholder's consent is binding on such
shareholder and all transferees of his shares and may not be withdrawn
after a valid election is made by the corporation. In the case of a
corporation which files an election to become a DISC for a taxable year
beginning after December 31, 1972, if a person who is a shareholder as
of the beginning of the first taxable year for which the election is
effective does not consent by signing the statement of consent set forth
on Form 4876, such election shall be valid (except in the case of an
extension of the time for filing granted under the provisions of
subparagraph (3) of this paragraph or
[[Page 644]]
paragraph (c) of this section) only if the consent of such shareholder
is attached to the Form 4876 upon which such election is made.
(ii) Form of consent. A consent other than the statement of consent
set forth on Form 4876 shall be in the form of a statement which is
signed by the shareholder and which sets forth (a) the name and address
of the corporation and of the shareholder and (b) the number of shares
held by each such shareholder as of the time the consent is made and (if
the consent is made after the beginning of the corporation's taxable
year for which the election is effective) as of the beginning of such
year. If the consent is made by a recipient of transferred shares
pursuant to paragraph (c) of this section, the statement of consent
shall also set forth the name and address of the person who held such
shares as of the beginning of such taxable year and the number of such
shares. Consent shall be made in the following form: ``I (insert name of
shareholder), a shareholder of (insert name of corporation seeking to
make the election) consent to the election of (insert name of
corporation seeking to make the election) to be treated as a DISC under
section 992(b) of the Internal Revenue Code. The consent so made by me
is irrevocable and is binding upon all transferees of my shares in
(insert name of corporation seeking to make the election).'' The
consents of all shareholders may be incorporated in one statement.
(iii) Who may consent. Where stock of the corporation is owned by a
husband and wife as community property (or the income from such stock is
community property), or is owned by tenants in common, joint tenants, or
tenants by the entirety, each person having a community interest in such
stock or the income therefrom and each tenant in common, joint tenant,
and tenant by the entirety must consent to the election. The consent of
a minor shall be made by his legal guardian or by his natural guardian
if no legal guardian has been appointed. The consent of an estate shall
be made by the executor or administrator thereof. The consent of a trust
shall be made by the trustee thereof. The consent of an estate or trust
having more than one executor, administrator, or trustee, may be made by
any executor, administrator, or trustee, authorized to make a return of
such estate or trust pursuant to section 6012(b)(5). The consent of a
corporation or partnership shall be made by an officer or partner
authorized pursuant to section 6062 or 6063, as the case may be, to sign
the return of such corporation or partnership. In the case of a foreign
person, the consent may be signed by any individual (whether or not a
U.S. person) who would be authorized under sections 6061 through 6063 to
sign the return of such foreign person if he were a U.S. person.
(2) Transitional rule for corporations electing during 1972. In the
case of a corporation which files an election to be treated as a DISC
for a taxable year beginning after December 31, 1971, and on or before
December 31, 1972, such election shall be valid only if the consent of
each person who is a shareholder as of the beginning of the first
taxable year for which such election is effective is filed with the
service center with which the election was filed within 90 days after
the first day of such taxable year or within the time granted for an
extension of time for filing such consent. The form of such consent
shall be the same as that prescribed in subparagraph (1) of this
paragraph. Such consent shall be attached to the statement of election
or shall be filed separately (with such service center) with a copy of
the statement of election. An extension of time for filing a consent may
be granted in the manner, and subject to the conditions, described in
subparagraph (3) of this paragraph.
(3) Extension of time to consent. An election which is timely filed
and would be valid except for the failure to attach the consent of any
shareholder to the Form 4876 upon which the election was made or to
comply with the 90-day requirement in subparagraph (2) of this paragraph
or paragraph (c)(1) of this section, as the case may be, will not be
invalid for such reason if it is shown to the satisfaction of the
service center that there was reasonable cause for the failure to file
such consent, and if such shareholder files a proper consent to the
election within such extended period of time as may be granted by the
Internal Revenue Service. In
[[Page 645]]
the case of a late filing of a consent, a copy of the Form 4876 or
statement of election shall be attached to such consent and shall be
filed with the same service center as the election. The form of such
consent shall be the same as that set forth in paragraph (b)(1)(ii) of
this section. In no event can any consent be made pursuant to this
paragraph on or after the last day of the first taxable year for which a
corporation elects to be treated as a DISC.
(c) Consent by holder of transferred shares--(1) In general. If a
shareholder of a corporation transfers--
(i) Prior to the first day of the first taxable year for which such
corporation elects to be treated as a DISC, some or all of the shares
held by him without having consented to such election, or
(ii) On or before the 90th day after the first day of the first
taxable year for which such corporation elects to be treated as a DISC,
some or all of the shares held by him as of the first day of such year
(or if later, held by him as of the time such shares are issued) without
having consented to such election, then consent may be made by any
recipient of such shares on or before the 90th day after the first day
of such first taxable year. If such recipient fails to file his consent
on or before such 90th day, an extension of time for filing such consent
may be granted in the manner, and subject to the conditions, described
in paragraph (b)(3) of this section. In addition, if the transfer occurs
more than 90 days after the first day of such taxable year, an extension
of time for filing such consent may be granted to such recipient only if
it is determined under paragraph (b)(3) of this section that an
extension of time would have been granted the transferor for the filing
of such consent if the transfer had not occurred. A consent which is not
attached to the original Form 4876 or statement of election (as the case
may be) shall be filed with the same service center as the original Form
4876 or statement of election and shall have attached a copy of such
original form or statement of election. The form of such consent shall
be the same as that set forth in paragraph (b)(1)(ii) of this section.
For the purposes of this paragraph, a transfer of shares includes any
sale, exchange, or other disposition, including a transfer by gift or at
death.
(2) Requirement for the filing of an amended Form 4876 or statement
of election. In any case in which a consent to a corporation's election
to be treated as a DISC is made pursuant to subparagraph (1) of this
paragraph, such corporation must file an amended Form 4876 or statement
of election (as the case may be) reflecting all changes in ownership of
shares. Such form must be filed with the same service center with which
the original Form 4876 or statement of election was filed by such
corporation.
(d) Effect of election--(1) Effect on corporation. A valid election
to be treated as a DISC remains in effect (without regard to whether the
electing corporation qualifies as a DISC for a particular year) until
terminated by any of the methods provided in paragraph (e) of this
section. While such election is in effect, the electing corporation is
subject to sections 991 through 997 and other provisions of the Code
applicable to DISC's for any taxable year for which it qualifies as a
DISC (or is treated as qualifying as a DISC pursuant to Sec. 1.992-
1(g)). Such corporation is also subject to such provisions for any
taxable year for which it is treated as a former DISC as a result of
qualifying or being treated as a DISC for any taxable year for which
such election was in effect.
(2) Effect on shareholders. A valid election by a corporation to be
treated as a DISC subjects the shareholders of such corporation to the
provisions of section 995 (relating to the taxation of the shareholders
of a DISC or former DISC) and to all other provisions of the Code
relating to the shareholders of a DISC or former DISC. Such provisions
of the Code apply to any person who is a shareholder of a DISC or former
DISC whether or not such person was a shareholder at the time the
corporation elected to become a DISC.
(e) Termination of election--(1) In general. An election to be
treated as a DISC is terminated only as provided in subparagraph (2) or
(3) of this paragraph.
[[Page 646]]
(2) Revocation of election--(i) Manner of revocation. An election by
a corporation to be treated as a DISC may be revoked by the corporation
for any taxable year of the corporation after the first taxable year for
which the election is effective. Such revocation shall be made by the
corporation filing a statement that the corporation revokes its election
under section 992(b) to be treated as a DISC. Such statement shall
indicate the corporation's name, address, employer identification
number, and the first taxable year of the corporation for which the
revocation is to be effective. The statement shall be signed by any
person authorized to sign a corporation return under section 6062. Such
revocation shall be filed with the service center with which the
corporation filed its election, except that, if it filed an annual
information return under section 6011(e)(2), the revocation shall be
filed with the service center with which it filed its last such return.
(ii) Years for which revocation is effective. If a corporation files
a statement revoking its election to be treated as a DISC during the
first 90 days of a taxable year (other than the first taxable year for
which such election is effective), such revocation will be effective for
such taxable year and all taxable years thereafter. If the corporation
files a statement revoking its election to be treated as a DISC after
the first 90 days of a taxable year, the revocation will be effective
for all taxable years following such taxable year.
(3) Continued failure to be a DISC. If a corporation which has
elected to be treated as a DISC does not qualify as a DISC (and is not
treated as a DISC pursuant to Sec. 1.992-1(g)) for each of any 5
consecutive taxable years, such election terminates and will not be
effective for any taxable year after such fifth taxable year. Such
termination will be effective automatically, without notice to such
corporation or to the Internal Revenue Service. If, during any 5-year
period for which an election is effective, the corporation should
qualify as a DISC (or be treated as a DISC pursuant to Sec. 1.992-1(g))
for a taxable year, a new 5-year period shall automatically start at the
beginning of the following taxable year.
(4) Election after termination. If a corporation has made a valid
election to be treated as a DISC and such election terminates in either
manner described in subparagraph (2) or (3) of this paragraph, such
corporation is eligible to reelect to be treated as a DISC at any time
by following the procedures described in paragraphs (a) through (c) of
this section. If a corporation terminates its election and subsequently
reelects to be treated as a DISC, the corporation and its shareholders
continue to be subject to sections 995 and 996 with respect to the
period during which its first election was in effect. Thus, for example,
distributions upon disqualification includible in the gross incomes of
shareholders of a corporation pursuant to section 995(b)(2) continue to
be so includible for taxable years for which a second election of such
corporation is in effect without regard to the second election.
[T.D. 7323, 39 FR 34405, Sept. 25, 1974, as amended by T.D. 7420, 41 FR
20655, May 20, 1976]
Sec. 1.992-3 Deficiency distributions to meet qualification requirements.
(a) In general. A corporation which meets the requirements described
in Sec. 1.992-1 for treatment as a DISC for a taxable year, other than
the 95 percent of gross receipts test described in Sec. 1.992-1(b) or
the 95-percent assets test described in Sec. 1.992-1(c), or both tests,
may nevertheless qualify as a DISC for such year by making deficiency
distributions (attributable to its gross receipts other than qualified
export receipts and its assets other than qualified export assets) if
all of the following requirements are satisfied:
(1) The corporation distributes the amount determined under
paragraph (b) of this section as a deficiency distribution. The amount
of a deficiency distribution is determined without regard to the amount
by which the corporation fails to meet either test.
(2) The reasonable cause requirements prescribed in paragraph (c)(1)
of this section are satisfied with respect to both the corporation's
failure to meet either test and its failure to make a deficiency
distribution prior to the time the distribution is made.
[[Page 647]]
(3) The corporation makes such deficiency distribution pro rata to
all its shareholders.
(4) The corporation designates the distribution, at the time of the
distribution, as a deficiency distribution, pursuant to section 992(c),
to meet the qualification requirements to be a DISC. Such designation
shall be in the form of a communication sent at the time of such
distribution to each shareholder and to the service center with which
the corporation has filed or will file its return for the taxable year
to which the distribution relates. A corporation may not retroactively
designate a prior distribution as a deficiency distribution to meet
qualification requirements. Subject to the limitation described in
paragraph (c)(3) of this section, a corporation may make a deficiency
distribution with respect to a taxable year at any time after the close
of such taxable year or, in the case of a deficiency distribution made
on or before September 29, 1975, at any time during or after such
taxable year.
See sections 246(d), 904(f), 995, and 996 for rules regarding the
treatment of a deficiency distribution to meet qualification
requirements by the shareholders and the corporation.
(b) Amount of deficiency distribution--(1) In general. In order to
meet the requirements of paragraph (a) of this section, the amount of a
deficiency distribution must be, if the corporation fails to meet--
(i) The 95 percent of gross receipts test, the amount determined in
subparagraph (2) of this paragraph,
(ii) The 95-percent assets test, the amount determined in
subparagraph (3) of this paragraph, and
(iii) Both such tests, except as provided in subparagraph (4) of
this paragraph, the sum of the amounts determined in subparagraphs (2)
and (3) of this paragraph.
(2) Computation of deficiency distribution to meet 95 percent of
gross receipts test--(i) In general. If a corporation fails to meet the
95 percent of gross receipts test described in Sec. 1.992-1(b) for its
taxable year, the amount of the deficiency distribution required by this
subparagraph is an amount equal to the sum of its taxable income (if
any) from each transaction giving rise to gross receipts (as defined in
Sec. 1.993-6) which are not qualified export receipts (as defined in
Sec. 1.993-1). A corporation's taxable income from a transaction shall
be the amount of such gross receipts from such transaction reduced only
by (a) its cost of goods sold attributable to such gross receipts, and
by (b) its expenses, losses, and other deductions properly apportioned
or allocated thereto in a manner consistent with the rules set forth in
Sec. 1.861-8. For purposes of this subdivision, however, any expenses,
losses, or other deductions which cannot definitely be allocated to some
item or class of gross income in such manner shall not reduce such gross
receipts. If the corporation is a commission agent for a principal in a
transaction, the corporation's taxable income is the amount of the
commission from such transaction reduced only by the amounts described
in (b) of this subdivision.
(ii) Example. The provisions of this subparagraph may be illustrated
by the following example:
Example. (a) X and Y are calendar year taxpayers. X, a domestic
manufacturing company, owns all the stock of Y, which seeks to qualify
as a DISC for 1973. During 1973, X manufactures a machine which is
eligible to be export property as defined in Sec. 1.993-3. Y is made a
commission agent with respect to exporting such machine. Thereafter,
during 1973 Y is considered to receive gross receipts of $100,000, as
determined under section 993(f), attributable to X's sale of the machine
in a manner which causes the gross receipts to be excluded receipts
pursuant to section 993(a)(2) and, therefore, not qualified export
receipts. Y's total gross receipts for 1973 are $1 million of which
$900,000 (i.e., 90 percent) are qualified export receipts. Therefore, Y
does not satisfy the 95 percent of gross receipts test for 1973 because
less than 95 percent of its gross receipts are qualified export
receipts. Y has $9,000 of expenses properly apportioned or allocated to
its gross income from such sale and $1,000 of other expenses which
cannot definitely be allocated to some item or class of gross income,
determined in a manner consistent with the rules set forth in Sec.
1.861-8. In order to satisfy the 95 percent of gross receipts test for
1973, if the commission due from X to Y were $15,000, Y must make a
deficiency distribution of $6,000 computed as follows:
Y's commission (gross income) from the transaction......... $15,000
Less: Y's expenses apportioned or allocated to its gross 9,000
income from the transaction...............................
------------
[[Page 648]]
Required deficiency distribution by reason of $100,000 of 6,000
gross receipts which are not qualified export receipts....
(b) If the commission due from X to Y were $9,400, resulting in a
net loss of $600 to Y ($9,400 to $10,000), Y must make a deficiency
distribution of $400 computed as follows:
Y's commissions (gross income) from the transaction........ $9,400
Less: Y's expenses apportioned or allocated to its gross 9,000
income from the transaction...............................
------------
Required deficiency distribution by reason of $100,000 of 400
gross receipts which are not qualified export receipts....
(c) If the commission due from X to Y were $8,500, Y would not be
required to make a deficiency distribution since, under this
subparagraph, there would be no taxable income attributable to gross
receipts from the sale.
(3) Computation of deficiency distribution to meet 95 percent assets
test--(i) In general. If a corporation fails to meet the 95 percent
assets test described in Sec. 1.992-1(c) for its taxable year, the
amount of the deficiency distribution required by this subparagraph is
an amount equal to the fair market value as of the last day of such
taxable year of the assets which are not qualified export assets held by
such corporation on such last day.
(ii) Asset held for more than 1 year. In the case of a corporation
which holds continuously an asset which is not a qualified export asset
at the close of more than 1 taxable year, it must distribute an amount
equal to its fair market value (or, if greater, the amount determined
under subparagraph (4) of this paragraph) only once if, at the close of
the first such taxable year, such corporation reasonably believed that
such asset was a qualified export asset. This subdivision shall not
apply for any taxable year beginning after the date the corporation
knows (or a reasonable man would have known) that an asset is not a
qualified export asset and in order to qualify for each such year, the
corporation must distribute the fair market value of such asset for each
such year.
(4) Computation in the case of a failure to meet both tests as a
result of a single transaction. If a corporation fails to meet both the
95 percent of gross receipts test and the 95 percent assets test for a
taxable year, and if the corporation holds at the end of such year
assets (other than cash or qualified export assets) which were received
as proceeds of a sale or exchange during such year which resulted in
gross receipts other than qualified export receipts, then the amount of
the deficiency distribution required by this paragraph with respect to
such sale or exchange and assets held is the larger of the amount
required by subparagraph (2) of this paragraph with respect to the sale
or exchange or the amount required by subparagraph (3) of this paragraph
with respect to such assets held. Thus, for example, if a corporation
sells property which is not a qualified export asset for $100, receives
$85 in cash and a note for $15, and derives $25 of taxable income from
the sale as determined under subparagraph (2) of this paragraph, it must
distribute $25. If the provisions of this subparagraph are applied with
respect to assets of a DISC (other than qualified export assets), such
provisions do not apply to any property received as proceeds from a sale
or exchange of such assets.
(c) Reasonable cause for failure--(1) In general. If for a taxable
year, a corporation has failed to meet the 95 percent of gross receipts
test, the 95 percent assets test, or both tests, such corporation may
satisfy any such test for such year by means of a deficiency
distribution in the amount determined under paragraph (b) of this
section only if the reasonable cause requirements of this subparagraph
are satisfied. Such reasonable cause requirements are satisfied if--
(i) There is reasonable cause (as determined in accordance with
subparagraph (2) of this paragraph) for such corporation's failure to
satisfy such test and to make such distribution prior to the date on
which it was made, the time limit in subparagraph (3) of this paragraph
for making the distribution is satisfied, and interest (if required) is
paid in the amount and in the manner prescribed by subparagraph (4) of
this paragraph, or
(ii) The time and ``70-percent'' requirements of the reasonable
cause test of paragraph (d) of this section are satisfied.
(2) Determination of reasonable cause. In general, whether a
corporation's failure to meet the 95 percent of gross receipts test, the
95 percent assets test,
[[Page 649]]
or both tests for a taxable year and its failure to make a pro rata
distribution prior to the date on which it was made will be considered
for reasonable cause where the action or inaction which resulted in such
failure occurred in good faith, such as failure to meet the 95 percent
assets test resulting from blocked currency or expropriation, or failure
to meet either test because of reasonable uncertainty as to what
constitutes a qualified export receipt or a qualified export asset. For
further examples, if a corporation's reasonable determination of the
percentage of its total gross receipts that are qualified export
receipts is subsequently redetermined to be less than 95 percent as a
result of a price adjustment by the Internal Revenue Service under
section 482, or if the corporation has a casualty loss for which it
receives an unanticipated insurance recovery which causes its qualified
export receipts to be less than 95 percent of its total gross receipts,
then the failure to satisfy the 95 percent of gross receipts test is
considered to be due to reasonable cause.
(3) Time limit for deficiency distribution. Except as otherwise
provided in this subparagraph, the time limit prescribed by this
subparagraph for making a deficiency distribution is satisfied if the
amount of the distribution required by paragraph (b) of this section is
made within 90 days from the date of the first written notification to
the corporation by the Internal Revenue Service that it had not
satisfied the 95 percent of gross receipts test or the 95 percent assets
test or both tests, for a taxable year. Upon a showing by the
corporation that an extension of the 90-day time limit is reasonable and
necessary, the Commissioner may grant such extension of such time limit.
In any case in which a corporation contests the decision of the Internal
Revenue Service that such corporation has not met the 95 percent of
gross receipts test, the 95 percent assets test, or both tests, an
extension of the 90-day time limit will be allowed until 30 days after
the final determination of such contest. The date of the final
determination of such contest shall, for purposes of section 992(c), be
established in the manner specified in subdivisions (i) through (iv) of
this subparagraph:
(i) The date of final determination by a decision of the United
States Tax Court is the date upon which such decision becomes final, as
prescribed in section 7481.
(ii) The date of final determination in a case which is contested in
a court (and upon which there is a judgment) other than the Tax Court is
the date upon which the judgment becomes final and will be determined on
the basis of the facts and circumstances of each particular case. For
example, ordinarily a judgment of a United States district court becomes
final upon the expiration of the time allowed for taking an appeal, if
no such appeal is duly taken within such time; and a judgment of the
United States Court of Claims becomes final upon the expiration of the
time allowed for filing a petition for certiorari if no such petition is
duly filed within such time.
(iii) The date of a final determination by a closing agreement, made
under section 7121, is the date such agreement is approved by the
Commissioner.
(iv) A final determination under section 992(c) may be made by an
agreement signed by the district director or director of the service
center with which the corporation files its annual return or by such
other official to which authority to sign has been delegated, and by or
on behalf of the taxpayer. The agreement shall set forth the total
amount of the deficiency distribution to be paid to the shareholders of
the DISC for the taxable year or years. An agreement under this
subdivision shall be sent to the taxpayer at his last known address by
either registered or certified mail. For further guidance regarding the
definition of last known address, see Sec. 301.6212-2 of this
chapter.If registered mail is used for such purpose, the date of
registration is considered the date of final determination; if certified
mail is used for such purpose, the date of postmark on the sender's
receipt for such mail is considered the date of final determination. If
the corporation makes a deficiency distribution before such registration
or postmark date but on or after the date the district director or
director of the service center or other
[[Page 650]]
official has signed the agreement, the date of signature by the district
director or director of the service center or other official is
considered the date of final determination. If the corporation makes a
deficiency distribution before the district director or director of the
service center or other official signs the agreement, the date of final
determination is considered to be the date of the making of the
deficiency distribution. During any extension of time the interest
charge provided in subparagraph (4) of this paragraph will continue to
accrue at the rate provided for in such subparagraph.
(4) Payment of interest for delayed distribution--(i) In general. If
a corporation makes a deficiency distribution after the 15th day of the
ninth month after the close of the taxable year with respect to which
such distribution is made, such distribution will not be deemed to
satisfy the 95 percent of gross receipts test or the 95 percent assets
test for such year unless such corporation pays to the Internal Revenue
Service a charge determined by multiplying (a) an amount equal to 4\1/2\
percent of such distribution by (b) the number of its taxable years
which begin (1) after the taxable year with respect to which the
distribution is made and (2) before such distribution is made. Such
charge must be paid, within the 30-day period beginning with the day on
which such distribution is made, to the service center with which the
corporation files its annual information return for its taxable year in
which the distribution is made. For purposes of the Internal Revenue
Code, such charge is considered interest.
(ii) Example. The provisions of subdivision (i) of this subparagraph
may be illustrated by the following example:
Example. X corporation, which uses the calendar year as its taxable
year, meets the 95 percent assets test but fails to meet the 95 percent
of gross receipts test for 1972 and does not by September 15, 1973, make
the deficiency distribution required by reason of its failure to meet
such test. Assume that reasonable cause exists for the corporation's
failure to meet the 95 percent of gross receipts test and failure to
make the required deficiency distribution. If X makes the required
deficiency distribution, in the amount of $10,000, on April 1, 1976, X
must pay on or before April 30, 1976, to the service center with which
it files its annual information return a charge of $1,800, computed as
follows:
Deficiency distribution made by X.......................... $10,000
Multiplied by 4\1/2\ percent............................... .045
------------
Intermediate product....................................... 450
Multiplied by: Number of X's taxable years beginning after 4
1972 and before April 1, 1976.............................
------------
Charge to be paid service center because of late deficiency 1,800
distribution (which is considered interest)...............
(d) Certain distributions deemed for reasonable cause. If a
corporation makes a distribution in the amount required by paragraph (b)
of this section with respect to a taxable year on or before the 15th day
of the ninth month after the close of such year, it will be deemed to
have acted with reasonable cause with respect to its failure to satisfy
the 95 percent of gross receipts test, the 95 percent assets test, or
both tests, for such year and its failure to make such distribution
prior to the date on which the distribution was made if--
(1) At least 70 percent of the gross receipts of such corporation
for such taxable year consist of qualified export receipts, and
(2) The sum of the adjusted bases of the qualified export assets
held by such corporation on the last day of each month of the taxable
year equals or exceeds 70 percent of the sum of the adjusted bases of
all assets held by the corporation on each such day.
[T.D. 7323, 39 FR 34407, Sept. 25, 1974; 39 FR 36009, Oct. 7, 1974, as
amended by T.D. 7420, 41 FR 20655, May 20, 1976; T.D. 7854, 47 FR 51739,
Nov. 17, 1982; T.D. 8939, 66 FR 2819, Jan. 12, 2001]
Sec. 1.992-4 Coordination with personal holding company provisions in
case of certain produced film rents.
(a) In general. Section 992(d)(2) provides that a personal holding
company is not eligible to be treated as a DISC. Section 543(a)(5)(B)
provides that, for purposes of section 543, the term ``produced film
rents'' means payments received with respect to an interest in a film
for the use of, or the right to use, such film, but only to the extent
that such interest was acquired before substantial completion of
production of such film. Under section 992(e), if such produced film
rents are included in the ordinary gross income (as defined in
[[Page 651]]
section 543(b)(1)) of a qualified subsidiary for a taxable year of such
subsidiary, and such interest was acquired by such subsidiary from its
parent, such interest is deemed (for purposes of the application of
sections 541, 543(b)(1), and 992(d)(2), and Sec. 1.992-1(f) for such
taxable year) to have been acquired by such subsidiary at the time such
interest was acquired by such parent. Thus, for example, if a parent
acquires an interest in a film before it is substantially completed,
then substantially completes such film prior to transferring an interest
in such motion picture to a qualified subsidiary, the qualified
subsidiary is considered as having acquired such interest prior to
substantial completion of such motion picture for purposes of
determining whether payments from the rental of such motion picture will
be classified as produced film rents of such subsidiary. The provisions
of section 992(e) and this section are not applicable in determining
whether payments received with respect to an interest in a film are
included in the ordinary gross income of a parent or a qualified
subsidiary. Thus, even though a qualified subsidiary is treated pursuant
to this section as having acquired an interest in a film at the time
such interest was acquired by such subsidiary's parent, payments
received by such parent with respect to such interest prior to the
transfer of such interest to such subsidiary are includible in the
ordinary gross income of such parent and not includible in the ordinary
gross income of such subsidiary.
(b) Definitions--(1) Qualified subsidiary. For purposes of this
section, a corporation is a qualified subsidiary for a taxable year if--
(i) Such corporation was established for the purpose of becoming a
DISC,
(ii) Such corporation would qualify (or be treated) as a DISC for
such taxable year if it is not a personal holding company, and
(iii) On every day of such taxable year on which shares of such
corporation are outstanding, at least 80 percent of such shares are held
directly by a second corporation.
(2) Parent. For purposes of this section, the term ``parent'' means
a second corporation referred to in subparagraph (1)(iii) of this
paragraph.
[T.D. 7323, 39 FR 34409, Sept. 25, 1974]
Sec. 1.993-1 Definition of qualified export receipts.
(a) In general. For a corporation to qualify as a DISC, at least 95
percent of its gross receipts for a taxable year must consist of
qualified export receipts. Under section 993(a), the term ``qualified
export receipts'' means any of the eight amounts described in paragraphs
(b) through (i) of this section, except to the extent that any of the
eight amounts is an excluded receipt within the meaning of paragraph (j)
of this section. For purposes of this section and Sec. Sec. 1.993-2
through 1.993-6--
(1) DISC. All references to a DISC mean a DISC, except when the
context indicates that such term means a corporation in the process of
meeting the conditions necessary for that corporation to become a DISC,
or a corporation being tested as to whether it qualifies as a DISC.
(2) Sale, lease, and license. The term ``sale'' includes an exchange
or other disposition and the term ``lease'' includes a rental or a
sublease. The term ``license'' includes a sublicense. All rules under
this section and Sec. Sec. 1.993-2 through 1.993-6 applicable to leases
of export property apply in the same manner to licenses of export
property. See Sec. 1.993-3(f)(3) for a description of intangible
property which cannot be export property.
(3) Gross receipts. The term ``gross receipts'' is defined by
section 993(f) and Sec. 1.993-6.
(4) Qualified export assets. The term ``qualified export assests''
is defined by section 993(b) and Sec. 1.993-2.
(5) Export property. The term ``export property'' is defined by
section 993(c) and Sec. 1.993-3.
(6) Related person. The term ``related person'' means a person who
is related to another person if either immediately before or after a
transaction--
(i) The relationship between such persons would result in a
disallowance of losses under section 267 (relating to
[[Page 652]]
disallowance of losses, etc., between related taxpayers), or section
707(b) (relating to losses disallowed, etc., between partners and
controlled partnerships), and the regulations thereunder, or
(ii) Such persons are members of the same controlled group of
corporations, as defined in section 1563(a) (relating to definition of
controlled group of corporations), except that (a) ``more than 50
percent'' shall be substituted for ``at least 80 percent'' each place it
appears in section 1563(a) and the regulations thereunder, and (b) the
provisions of section 1563(b) shall not apply in determining whether
such persons are members of the same controlled group.
(7) Related supplier. The term ``related supplier'' is defined by
Sec. 1.994-1(a)(3)(ii).
(8) Controlled group. The term ``controlled group'' is defined by
paragraph (k) of this section.
(b) Sales of export property. Qualified export receipts of a DISC
include gross receipts from the sale of export property by such DISC, or
by any principal for whom such DISC acts as a commission agent (whether
or not such principal is a related supplier), pursuant to the terms of a
contract entered into with a purchaser by such DISC or by such principal
at any time or by any other person and assigned to such DISC or such
principal at any time prior to the shipment of such property to the
purchaser. Any agreement, oral or written, which constitutes a contract
at law, satisfies the contractual requirement of this paragraph. Gross
receipts from the sale of export property, whenever received, do not
constitute qualified export receipts unless the seller (or the
corporation acting as commission agent for the seller) is a DISC at the
time of the shipment of such property to the purchaser. For example, if
a corporation which sells export property under the installment method
is not a DISC for the taxable year in which the property is shipped to
the purchaser, gross receipts from such sale do not constitute qualified
export receipts for any taxable year of the corporation.
(c) Leases of export property--(1) In general. Qualified export
receipts of a DISC include gross receipts from the lease of export
property provided that--
(i) Such property is held by such DISC (or by a principal for whom
such DISC acts as commission agent with respect to the lease) either as
an owner or lessee at the beginning of the term of such lease, and
(ii) Such DISC qualified (or was treated) as a DISC for its taxable
year in which the term of such lease began.
(2) Prepayment of lease receipts. If part or all of the gross
receipts from a lease of property are prepaid, then--
(i) All such prepaid gross receipts are qualified export receipts of
a DISC if it is reasonably expected at the time of such prepayment that
throughout the term of such lease they would be qualified export
receipts if received not as a prepayment; or
(ii) If it is reasonably expected at the time of such prepayment
that throughout the term of such lease they would not be qualified
export receipts if received not as a prepayment, then only those prepaid
receipts, for the taxable years of the DISC for which they would be
qualified export receipts, are qualified export receipts.
Thus, for example, if a lessee makes a prepayment of the first and last
years' rent, and it is reasonably expected that the leased property will
be export property for the first half of the lease period but not the
second half of such period, the amount of the prepayment which
represents the first year's rent will be considered qualified export
receipts if it would otherwise qualify, whereas the amount of the
prepayment which represents the last year's rent will not be considered
qualified export receipts.
(d) Related and subsidiary services--(1) In general. Qualified
export receipts of a DISC include gross receipts from services furnished
by such DISC which are related and subsidiary to any sale or lease (as
described in paragraph (b) or (c) of this section) of export property by
such DISC or with respect to which such DISC acts as a commission agent,
provided that such DISC derives qualified export receipts from such sale
or lease. Such services may be performed within or without the United
States.
[[Page 653]]
(2) Services furnished by DISC. Services are considered to be
furnished by a DISC for purposes of this paragraph if such services are
provided by--
(i) The person who sold or lease the export property to which such
services are related and subsidiary, provided that the DISC acts as a
commission agent with respect to the sale or lease of such property and
with respect to such services,
(ii) The DISC as principal, or any other person pursuant to a
contract between such person and such DISC, provided the DISC acted as
principal or commission agent with respect to the sale or lease of such
property, or
(iii) A member of the same controlled group as the DISC where the
sale or lease of the export property is made by another member of such
controlled group provided, however, that the DISC act as principal or
commission agent with respect to such sale or lease and as commission
agent with respect to such services.
(3) Related services. A service is related to a sale or lease of
export property if--
(i) Such service is of the type customarily and usually furnished
with the type of transaction in the trade or business in which such sale
or lease arose and
(ii) The contract to furnish such service--
(a) Is expressly provided for in or is provided for by implied
warranty under the contract of sale or lease,
(b) Is entered into on or before the date which is 2 years after the
date on which the contract under which such sale or lease was entered
into, provided that the person described in subparagraph (2) of this
paragraph which is to furnish such service delivers to the purchaser or
lessor a written offer or option to furnish such services on or before
the date on which the first shipment of goods with respect to which the
service is to be performed is delivered, or
(c) Is a renewal of the services contract described in (a) or (b) of
this subdivision. Services which may be related to a sale or lease of
export property include but are not limited to warranty service,
maintenance service, repair service, and installation service.
Transportation (including insurance related to such transportation) may
be related to a sale or lease of export property, provided that the cost
of such transportation is included in the sale price or rental of the
property or, if such cost is separately stated, is paid by the DISC (or
its principal) which sold or leased the property to the person
furnishing the transportation service. Financing or the obtaining of
financing for a sale or lease is not a related service for purposes of
this paragraph.
(4) Subsidiary services--(i) In general. Services related to a sale
or lease of export property are subsidiary to such sale or lease only if
it is reasonably expected at the time of such sale or lease that the
gross receipts from all related services furnished by the DISC (as
defined in subparagraphs (2) and (3) of this paragraph) will not exceed
50 percent of the sum of (a) the gross receipts from such sale or lease
and (b) the gross receipts from related services furnished by the DISC
(as described in subparagraph (2) of this paragraph). In the case of a
sale, reasonable expectations at the time of the sale are based on the
gross receipts from all related services which may reasonably be
expected to be performed at any time before the end of the 10-year
period following the date of such-sale. In the case of a lease,
reasonable expectations at the time of the lease are based on the gross
receipts from all related services which may reasonably be expected to
be performed at any time before the end of the term of such lease
(determined without regard to renewal options).
(ii) Allocation of gross receipts from services. In determining
whether the services related to a sale or lease of export property are
subsidiary to such sale or lease, the gross receipts to be treated as
derived from the furnishing of services may not be less than the amount
of gross receipts reasonably allocated to such services as determined
under the facts and circumstances of each case without regard to
whether--
(a) Such services are furnished under a separate contract or under
the same contract pursuant to which such sale or lease occurs or
(b) The cost of such services is specified in the contract of sale
or lease.
[[Page 654]]
(iii) Transactions involving more than one item of export property.
If more than one item of export property is sold or leased in a single
transaction pursuant to one contract, the total gross receipts from such
transaction and the total gross receipts from all services related to
such transaction are each taken into account in determining whether such
services are subsidiary to such transaction. However, the provisions of
this subdivision apply only if such items could be included in the same
product line, as determined under Sec. 1.994-1(c)(7).
(iv) Renewed service contracts. If under the terms of a contract for
related services, such contract is renewable within 10 years after a
sale of export property, or during the term of a lease of export
property, related services to be performed under the renewed contract
are subsidiary to such sale or lease if it is reasonably expected at the
time of such renewal that the gross receipts from all related services
which have been and which are to be furnished by the DISC (as described
in subparagraph (2) of this paragraph) will not exceed 50 percent of the
sum of (a) the gross receipts from such sale or lease and (b) the gross
receipts from related services furnished by the DISC (as so described).
Reasonable expectations are determined as provided in subdivision (i) of
this subparagraph.
(v) Parts used in services. In a services contract described in
subparagraph (3) of this paragraph provides for the furnishing of parts
in connection with the furnishing of related services, gross receipts
from the furnishing of such parts are not taken into account in
determining whether under this subparagraph the services are subsidiary.
See paragraph (b) or (c) of this section to determine whether the gross
receipts from the furnishing of parts consitute qualified export
receipts. See Sec. 1.993-3(c)(2)(iv) and (e)(3) for rules regarding the
treatment of such parts with respect to the manufacture of export
property and the foreign content of such property, respectively.
(5) Relation to leases. If the gross receipts for services which are
related and subsidiary to a lease of property have been prepaid at any
time for all such services which are to be performed before the end of
the term of such lease, then as of the time of the prepayment the rules
in paragraph (c)(2) of this section (relating to prepayment of lease
receipts) will determine whether prepaid services under this subdivision
are qualified export receipts. Thus, for example if it is reasonably
expected that leased property will be export property for the first year
of the term of the lease but will not be export property for the second
year of the term, prepaid gross receipts for related and subsidiary
services to be furnished in the first year may be qualified export
receipts. However, any prepaid gross receipts for such services to be
furnished in the second year cannot be qualified export receipts.
(6) Relation with export property determination. The determination
as to whether gross receipts from the sale or lease of export property
constitute qualified export receipts does not depend upon whether
services connected with such sale or lease are related and subsidiary to
such sale or lease. Thus, for example, assume that a DISC receives gross
receipts of $1,000 from the sale of export property and gross, receipts
of $1,100 from installation and maintenance services which are to be
furnished by such DISC within 10 years after the sale and which are
related to such sale. The $1,100 which the DISC receives for such
services would not be qualified export receipts since the gross receipts
from the services exceed 50 percent of the sum of the gross receipts
from the sale and the gross receipts from the related services furnished
by such DISC. The $1,000 which the DISC receives from the sale of export
property would, however, be a qualified export receipt if the sale met
the requirements of paragraph (b) of this section.
(e) Gains from sales of certain qualified export assets. Qualified
export receipts of a DISC include gross receipts from the sale by such
DISC of any assets (wherever located) which, as of the date of such
sale, are qualified export assets as defined in Sec. 1.993-2 even
though such assets are not export property (as defined in Sec. 1.993-
3). Gross receipts are derived from the sale of such assets only where
such sale results in recognized gain (see Sec. 1.993-6(a)). For
[[Page 655]]
purposes of this paragraph, losses from the sale of such qualified
export assets shall not be taken into account for purposes of
determining the DISC's qualified export receipts.
(f) Dividends. Qualified export receipts of a DISC for a taxable
year include all dividends includible in the gross income of such DISC
for such taxable year with respect to the stock of related foreign
export corporations (as defined in Sec. 1.993-5) and all amounts
includible in the gross income of such DISC with respect to such
corporations pursuant to section 951 (relating to amounts included in
the gross income of U.S. shareholders of controlled foreign
corporations).
(g) Interest on obligations which are qualified export assets.
Qualified export receipts of a DISC include interest on any obligation
which is a qualified export asset of such DISC, including any amount
includible in gross income as interest (such as, for example, an amount
treated as original issue discount pursuant to section 1232) or as
imputed interest under section 483. Gain from the sale of obligations
described in this paragraph is treated (to the extent such gain is not
treated as interest on such obligations) as qualified export receipts
pursuant to paragraph (e) of this section.
(h) Engineering and architectural services--(1) In general.
Qualified export receipts of a DISC include gross receipts from
engineering services (as described in subparagraph (5) of this
paragraph) or architectural services (as described in subparagraph (5)
of this paragraph) or architectural services (as described in
subparagraph (6) of this paragraph) furnished by such DISC (as described
in subparagraph (7) of this paragraph) for a construction project (as
defined in subparagraph (8) of this paragraph) located, or proposed for
location, outside the United States. Such services may be performed
within or without the United States.
(2) Services included. Engineering and architectural services
include feasibility studies for a proposed construction project whether
or not such project is ultimately initiated.
(3) Excluded services. Engineering and architectural services do not
include--
(i) Services connected with the exploration for minerals or
(ii) Technical assistance or knowhow.
For purposes of this paragraph, the term ``technical assistance or
knowhow'' includes activities or programs designed to enable business,
commerce, industrial establishments, and governmental organizations to
acquire or use scientific, architectural, or engineering information.
(4) Other services. Receipts from the performance of construction
activities other than engineering and architectural services constitute
qualified export receipts to the extent that such activities are related
and subsidiary services (within the meaning of paragraph (d) of this
section) with respect to a sale or lease of export property.
(5) Engineering services. For purposes of this paragraph,
engineering services in connection with any construction project (within
the meaning of subparagraph (8) of this paragraph) include any
professional services requiring engineering education, training, and
experience and the application of special knowledge of the mathematical,
physical, or engineering sciences to such professional services as
consultation, investigation, evaluation, planning, design, or
responsible supervision of construction for the purpose of assuring
compliance with plans, specifications, and design.
(6) Architectural services. For purposes of this paragraph,
architectural services include the offering or furnishing of any
professional services such as consultation, planning, aesthetic, and
structural design, drawings and specifications, or responsible
supervision of construction (for the purpose of assuring compliance with
plans, specifications, and design) or erection, in connection with any
construction project (within the meaning of subparagraph (8) of this
paragraph).
(7) Definition of ``furnished by such DISC''. For purposes of this
paragraph, architectural and engineering services are considered
furnished by a DISC if such services are provided--
(i) By the DISC,
(ii) By another person (whether or not a United States person)
pursuant to a contract entered into by such person with the DISC at any
time prior to
[[Page 656]]
the furnishing of such services, provided that the DISC acts as
principal with respect to the furnishing of such services, or
(iii) By another person (whether or not a United States person)
pursuant to a contract for the furnishing of such services entered into
at any time prior to the furnishing of such services provided that the
DISC acts as commission agent with respect to such services.
(8) Definition of ``construction project''. For purposes of this
paragraph, the term ``construction project'' includes the erection,
expansion, or repair (but not including minor remodeling or minor
repairs) of new or existing buildings or other physical facilities
including, for example, roads, dams, canals, bridges, tunnels, railroad,
tracks, and pipelines. The term also includes site grading and
improvement and installation of equipment necessary for the
construction. Gross receipts from the sale or lease of construction
equipment are not qualified export receipts unless such equipment is
export property (as defined in Sec. 1.993-3).
(i) Managerial services--(1) In general. Qualified export receipts
of a first DISC for its taxable year include gross receipts from the
furnishing of managerial services provided for another DISC, which is
not a related person, to aid such unrelated DISC in deriving qualified
export receipts, provided that at least 50 percent of the gross receipts
of the first DISC for such year consists of qualified export receipts
derived from the sale or lease of export property and the furnishing of
related and subsidiary services, as described in paragraph (b), (c), and
(d) of this section, respectively.
For purposes of this paragraph, managerial services are considered
furnished by a DISC if such services are provided--
(i) By the first DISC,
(ii) By another person (whether or not a United States person)
pursuant to a contract entered into by such person with the first DISC
at any time prior to the furnishing of such services, provided that the
first DISC acts as principal with respect to the furnishing of such
services, or
(iii) By another person (whether or not a United States person)
pursuant to a contract for the furnishing of such services entered into
at any time prior to the furnishing of such services provided that the
DISC acts as commission agent with respect to such services.
(2) Definition of ``managerial services.'' The term ``managerial
services'' as used in this paragraph means activities relating to the
operation of another unrelated DISC which derives qualified export
receipts from the sale or lease of export property and from the
furnishing of services related and subsidiary to such sales or leases.
Such term includes staffing and operational services necessary to
operate such other DISC, but does not include legal, accounting,
scientific, or technical services. Examples of managerial services are:
(i) Export market studies, (ii) making shipping arrangements, and (iii)
contracting potential foreign purchasers.
(3) Status of recipient of managerial services--(i) In general.
Qualified export receipts of a first DISC include receipts from the
furnishing of managerial services during any taxable year of a recipient
if such recipient qualifies as a DISC (within the meaning of Sec.
1.992-1(a) for such taxable year.
(ii) Recipient deemed to qualify as a DISC. For purposes of
subdivision (i) of this subparagraph, a recipient is deemed to qualify
as a DISC for its taxable year if the first DISC obtains from such
recipient a copy of such recipient's election to be treated as a DISC as
described in Sec. 1.992-2(a) together with such recipient's sworn
statement that such election has been filed with the Internal Revenue
Service Center. The recipient may mark out the names of its shareholders
on a copy of its election to be treated as a DISC before submitting it
to the first DISC. The copy of the election and the sworn statement of
such recipient must be received by the first DISC within 6 months after
the beginning of the first taxable year of the recipient during which
such first DISC furnishes managerial services for such recipient. The
copy of the election and the sworn statement of the recipient need not
be
[[Page 657]]
obtained by the first DISC for subsequent taxable years of the
recipient.
(iii) Recipient not treated as a DISC. For purposes of subdivision
(i) of this subparagraph, a recipient of managerial services is not
treated as a DISC with respect to such services performed during a
taxable year for which such recipient does not qualify as a DISC if the
DISC performing such services does not believe or if a reasonable person
would not believe (taking into account the furnishing DISC's managerial
relationship with such recipient DISC) at the beginning of such taxable
year that the recipient will qualify as a DISC for such taxable year.
(j) Excluded receipts--(1) In general. Notwithstanding the
provisions of paragraphs (b) through (i) of this section, qualified
export receipts of a DISC do not include any of the five amounts
described in subparagraphs (2) through (6) of this paragraph.
(2) Sales and leases of property for ultimate use in the United
States. Property which is sold or leased for ultimate use in the United
States does not constitute export property. See Sec. 1.993-3(d)(4)
(relating to determination of where the ultimate use of the property
occurs). Thus, qualified export receipts of a DISC described in
paragraph (b) or (c) of this section do not include gross receipts of
the DISC from the sale or lease of such property.
(3) Sales of export property accomplished by subsidy. Qualified
export receipts of a DISC do not include gross receipts described in
paragraph (b) of this section if the sale of export property (whether or
not such property consists of agricultural products) is pursuant to any
of the following:
(i) The development loan program, or grants under the technical
cooperation and development grants program of the Agency for
International Development, or grants under the military assistance
program administered by the Department of Defense, pursuant to the
Foreign Assistance Act of 1961, as amended (22 U.S.C. 2151), unless the
DISC shows to the satisfaction of the district director that, under the
conditions existing at the time of the sale, the purchaser had a
reasonable opportunity to purchase, on competitive terms and from a
seller who was not a U.S. person, goods which were substantially
identical to such property and which were not manufactured, produced,
grown, or extracted (as described in Sec. 1.993-3(c)) in the United
States,
(ii) The Pub. L. 480 program authorized under title I of the
Agricultural Trade Development and Assistance Act of 1954, as amended (7
U.S.C. 1691, 1701-1710),
(iii) For taxable years ending before January 1, 1974, the Barter
program of the Commodity Credit Corporation authorized by section 4(h)
of the Commodity Credit Corporation Charter Act, as amended (15 U.S.C.
714b(h)), and section 303 of the Agricultural Trade Development and
Assistance Act of 1954, as amended (7 U.S.C. 1692) but only if the
taxpayer treats such sales as sales giving rise to excluded receipts,
(iv) The Export Payment program of the Commodity Credit Corporation
authorized by sections 5(d) and (f) of the Commodity Credit Corporation
Charter Act, as amended (15 U.S.C. 714c (d) and (f)),
(v) The section 32 export payment programs authorized by section 32
of the Act of August 24, 1935, as amended (7 U.S.C. 612c), and
(vi) For taxable years beginning after November 3, 1972, the Export
Sales program of the Commodity Credit Corporation authorized by sections
5 (d) and (f) of the Commodity Credit Corporation Charter Act, as
amended (15 U.S.C. 714c (d) and (f)), other than the GSM-4 program
provided under 7 CFR part 1488, and section 407 of the Agricultural Act
of 1949, as amended (7 U.S.C. 1427), for the purpose of disposing of
surplus agricultural commodities and exporting or causing to be exported
agricultural commodities, except that for taxable years beginning on or
before November 3, 1972, the taxpayer may treat such sales as sales
giving rise to excluded receipts.
(4) Sales or lease of export property and furnishing of engineering
or architectural services for use by the United States--(i) In general.
Qualified export receipts of a DISC do not include gross receipts
described in paragraph (b), (c), or (h) of this section if a sale or
lease of export property, or the furnishing of engineering or
architectural services, is for use
[[Page 658]]
by the United States or an instrumentality thereof in any case in which
any law or regulation requires in any manner the purchase or lease of
property manufactured, produced, grown, or extracted in the United
States or requires the use of engineering or architectural services
performed by a U.S. person. For example, a sale by a DISC of export
property to the Department of Defense for use outside the United States
would not produce qualified export receipts for such DISC if the
Department of Defense purchased such property from appropriated funds
subject to any provisions of the Armed Services Procurement Regulations
(32 CFR subchapter A, part 6, subpart A) or any appropriations act for
the Department of Defense for the applicable year which restricts the
availability of such appropriated funds to the procurement of items
which are grown, reprocessed, reused, or produced in the United States.
(ii) Direct or indirect sales or leases. Any sale or lease of export
property is for use by the United States or an instrumentality thereof
is such property is sold or leased by a DISC (or by a principal for whom
such DISC acts as commission agent) to--
(a) A person who is a related person with respect to such DISC or
such principal and who sells or leases such property for use by the
United States or an instrumentality thereof or
(b) A person who is not a related person with respect to such DISC
or such principal if, at the time of such sale or lease, there is an
agreement or understanding that such property will be sold or leased for
use by the United States or an instrumentality thereof (or if a
reasonable person would have known at the time of such sale or lease
that such property would be sold or leased for use by the United States
or an instrumentality thereof) within 3 years after such sale or lease.
(iii) Excluded programs. The provisions of subdivisions (i) and (ii)
of this subparagraph do not apply in the case of a purchase by the
United States or an instrumentality thereof if such purchase is pursuant
to--
(a) The Foreign Military Sales Act, as amended (22 U.S.C. 2751 et
seq.), or a program under which the U.S. Government purchases property
for resale, on commercial terms, to a foreign government or agency or
instrumentality thereof, or
(b) A program (whether bilateral or multilateral) under which sales
to the U.S. Government are open to international competitive bidding.
(5) Services. Qualified export receipts of a DISC do not include
gross receipts described in paragraph (d) of this section (concerning
related and subsidiary services) if the services from which such gross
receipts are derived are related and subsidiary to the sale or lease of
property which results in excluded receipts pursuant to this paragraph.
(6) Receipts within controlled group--(i) In general. Gross receipts
of a corporation do not constitute qualified export receipts for any
taxable year of such corporation if--
(a) At the time of the sale, lease, or other transaction resulting
in such gross receipts, such corporation and the person from whom such
receipts are directly or indirectly derived (whether or not such
corporation and such person are the same person) are members of the same
controlled group (as defined in paragraph (k) of this section) and
(b) Such corporation and such person each qualifies (or is treated
under section 992(a)(2)) as a DISC for its taxable year in which its
receipts arise.
Thus, for example, assume that R, S, X, and Y are members of the same
controlled group and that X and Y are DISC's. If R sells property to S
and pays X a commission relating to that sale and if S sells the same
property to an unrelated foreign party and pays Y a commission relating
to that sale, the receipts received by X from the sale of such property
by R to S will be considered to be derived from Y, a DISC which is a
member of the same controlled group as X, and thus will not result in
qualified export receipts to X. The receipts received by Y from the sale
to an unrelated foreign party may, however, result in qualified export
receipts to Y. For another example, if R and S both assign the
commissions to X, receipts derived from the sale from R to S will be
considered to be derived from X acting as commission agent for
[[Page 659]]
S and will not result in qualified export receipts to X. Receipts
derived by X from the sale of property by S to an unrelated foreign
party, may, however, constitute qualified export receipts.
(ii) Leased property. See Sec. 1.993-3(f)(2) regarding property not
constituting export property in certain cases where such property is
leased to any corporation which is a member of the same controlled group
as the lessor.
(k) Definition of ``controlled group''. For purposes of sections 991
through 996 and the regulations thereunder, the term ``controlled
group'' has the same meaning as is assigned to the term ``controlled
group of corporations'' by section 1563(a), except that (1) the phrase
``more than 50 percent'' is substituted for the phrase ``at least 80
percent'' each place the latter phrase appears in section 1563(a), and
(2) section 1563(b) shall not apply. Thus, for example, a foreign
corporation subject to tax under section 881 may be a member of a
controlled group. Furthermore, two or more corporations (including a
foreign corporation) are members of a controlled group at any time such
corporations meet the requirements of section 1563(a) (as modified by
this paragraph).
(l) DISC's entitlement to income--(1) Application of section 994. A
corporation which meets the requirements of Sec. 1.992-1(a) to be
treated as a DISC for a taxable year is entitled to income, and the
intercompany pricing rules of section 994(a)(1) or (2) apply, in the
case of any transactions described in Sec. 1.994-1(b) between such DISC
and its related supplier (as defined in Sec. 1.994-1(a)(3)). For
purposes of this subparagraph, such DISC need not have employees or
perform any specific function.
(2) Other transactions. In the case of a transaction to which the
provisions of subparagraph (1) of this paragraph do not apply but from
which a DISC derives gross receipts, the income to which the DISC is
entitled as a result of the transaction is determined pursuant to the
terms of the contract for such transaction and, if applicable, section
482 and the regulations thereunder.
(3) Examples. The provisions of this paragraph may be illustrated by
the following examples:
Example 1. P Corporation forms S Corporation as a wholly-owned
subsidiary. S qualifies as a DISC for its taxable year. S has no
employees on its payroll. S is granted a franchise with respect to
specified exports of P. P will sell such exports to S for resale by S.
Such exports are of a type which produce qualified export receipts as
defined in paragraph (b) of this section. P's sales force will solicit
orders in the name of S using S's order forms. S places orders with P
only when S itself has received orders. No inventory is maintained by S.
P makes shipments directly to customers of S. Employees of P will act
for S and billings and collections will be handled by P in the name of
S. Under these facts, the income derived by S for such taxable year from
the purchase and resale of the specified export is treated for Federal
income tax purposes as the income of S, and the amount of income
allocable to S will be determined under section 994 of the Code.
Example 2. P Corporation forms S Corporation as a wholly-owned
subsidiary. S qualifies as a DISC for its taxable year. S has no
employees on its payroll. S is granted a sales franchise with respect to
specified exports of P and will receive commissions with respect to such
exports. Such exports are of a type which will produce gross receipts
for S which are qualified export receipts as defined in paragraph (b) of
this section. P's sales force will solicit orders in the name of P.
Billings and collections are handled directly by P. Under these facts,
the commissions paid to S for such taxable year with respect to the
specified exports shall be treated for Federal income tax purposes as
the income of S, and the amount of income allocable to S is determined
under section 994 of the Code.
[T.D. 7514, 42 FR 55454, Oct. 17, 1977; 42 FR 60910, Nov. 30, 1977, as
amended by T.D. 7854, 47 FR 51739, Nov. 17, 1982]
Sec. 1.993-2 Definition of qualified export assets.
(a) In general. For a corporation to qualify as a DISC, at the close
of its taxable year it must have qualified export assets with adjusted
bases equal to at least 95 percent of the sum of the adjusted bases of
all its assets. An asset which is a qualified export asset under more
than one paragraph of this section shall be taken into account only once
in determining the sum of the adjusted bases of all qualified export
assets. Under section 993(b), the qualified export assets held by a
corporation are--
(1) Export property as defined in Sec. 1.993-3 (see paragraph (b)
of this section),
[[Page 660]]
(2) Business assets described in paragraph (c) of this section,
(3) Trade receivables described in paragraph (d) of this section,
(4) Temporary investments to the extent described in paragraph (e)
of this section,
(5) Producer's loans as defined in Sec. 1.993-4 (see paragraph (f)
of this section),
(6) Stock or securities (described in paragraph (g) of this section)
of related foreign export corporations as defined in Sec. 1.993-5,
(7) Export-Import Bank and other obligations described in paragraph
(h) of this section,
(8) Financing obligations described in paragraph (i) of this
section, and
(9) Funds awaiting investment described in paragraph (j) of this
section.
(b) Export property. In general, export property is certain property
held for sale or lease which meets the requirements of Sec. 1.993-3.
(c) Business assets. For purposes of this section, business assets
are assets used by a DISC (other than as a lessor) primarily in
connection with--
(1) The sale, lease, storage, handling, transportation, packaging,
assembly, or servicing of export property, or
(2) The performance of engineering or architectural services
(described in Sec. 1.993-1(h)) or managerial services (described in
Sec. 1.993-1(i)) in furtherance of the production of qualified export
receipts.
Assets used primarily in the manufacture, production, growth, or
extraction (within the meaning of Sec. 1.993-3(c)) of property are not
business assets.
(d) Trade receivables--(1) In general. For purposes of this section,
trade receivables are accounts receivable and evidences of indebtedness
which arise by reason of transactions of such corporation or of another
corporation which is a DISC and which is a member of a controlled group
which includes such corporation described in subparagraph (A), (B), (C),
(D), (G), or (H), of section 993(a)(1) and which are due the DISC (or,
if it acts as an agent, due its principal) and held by the DISC.
(2) Trade receivables representing commissions. If a DISC acts as
commission agent for a principal in a transaction described in Sec.
1.993-1 (b), (c), (d), (e), (h), or (i) which results in qualified
export receipts for the DISC, and if an account receivable or evidence
of indebtedness held by the DISC and representing the commission payable
to the DISC as a result of the transaction arises (and, in the case of
an evidence of indebtedness, designated on its face as representing such
commission), such account receivable or evidence of indebtedness shall
be treated as a trade receiveable. If, however, the principal is a
related supplier (as defined in Sec. 1.994-1(a)(3)) with respect to the
DISC, such account receivable or evidence of indebtedness will not be
treated as a trade receivable unless it is payable and paid in a time
and manner which satisfy the requirements of Sec. 1.994-1(e)(3) or (5)
(relating to initial payment of transfer price or commission and
procedure for adjustments to transfer price or commission,
respectively), as the case may be. However, see subparagraph (3) of this
paragraph for rules regarding certain accounts receivable representing
commissions payable to a DISC by its related supplier.
(3) Indebtedness arising under Sec. 1.994-1(e). An indebtedness
arising under Sec. 1.994-1(e)(3)(iii) (relating to initial payment of
transfer price or commission) in favor of a DISC is not a qualified
export asset. An indebtedness arising under Sec. 1.994-1(e)(5)(i)
(relating to procedure for adjustments to transfer price or commission)
in favor of a DISC is a trade receivable if it is paid in the time and
manner described in Sec. 1.994-1(e)(5)(i) and (ii) and if it otherwise
satisfies the requirements of subparagraph (2) of this paragraph. If
such an indebtedness is not paid in the time and manner described in
Sec. 1.994-1(e)(5)(i) and (ii), it is not a qualified export asset.
(e) Temporary investments--(1) In general. For purposes of this
section, temporary investments are money, bank deposits (not including
time deposits of more than 1 year), and other similar temporary
investments to the extent maintained by a DISC as reasonably necessary
to meet its requirements for working capital. For purposes of this
paragraph, a temporary investment is an obligation, including an
evidence of indebtedness as defined in paragraph (d)(1) of this section,
which is a demand obligation or has a period remaining to
[[Page 661]]
maturity of not more than 1 year at the date it is acquired by the DISC.
A temporary investment does not include trade receivables.
(2) Determination of amount of working capital maintained. For
purposes of this paragraph--
(i) The working capital of a DISC is the excess of its current
assets over current liabilities.
(ii) Current assets are cash and other assets (other than trade
receivables) which may reasonably be expected to be converted into cash
or sold or consumed during the current normal operating cycle of the
DISC's trade or business.
(iii) Current liabilities are obligations (or portions of
obligations) due within the current normal operating cycle of the trade
or business of the DISC whose satisfaction when due is reasonably
expected to require the use of current assets.
(iv) Generally accepted financial accounting treatments will be
accepted, and
(v) Current assets (other than temporary investments) are taken into
account before temporary investments, and trade receivables are never
taken into account, in determining whether such temporary investments
are maintained by the DISC as reasonably necessary to meet his current
liabilities and its requirements for working capital.
(3) Determination of amount of working capital reasonably required.
For purposes of this paragraph, a determination of the amount of money,
bank deposits, and other similar temporary investments reasonably
necessary to meet the requirements of the DISC for working capital will
depend upon the nature and volume of the activities of the DISC existing
at the end of the DISC's taxable year for which such determination is
made, such as, for example--
(i) In the case of a DISC which purchases and sells inventory, the
amount of working capital reasonably required is limited to an amount
reasonably necessary to meet the ordinary operating expenses during the
current normal operating cycle of the trade or business of the DISC, an
amount reasonably needed to meet specific and definite plans for
expansion and any amounts necessary for reasonably anticipated
extraordinary business expenses.
(ii) In the case of a DISC which actively conducts a trade or
business (including the employment of a sales force) and receives
commissions in respect of goods to which such DISC does not have title,
the amount of working capital required will depend upon the nature and
volume of the activities of the DISC which produce such income as they
exist on the applicable determination date. In determining the amount of
working capital which is reasonably required for the production of such
income, the anticipated future needs of the business will be taken into
account to the extent that such needs relate to the year of the DISC
following the applicable determination date. Anticipated future needs
relating to a later period will not be taken into account unless it is
clearly established that such needs are reasonably related to the
production of such income as of the applicable determination date.
(iii) In the case of a DISC which does not actively conduct a trade
or business, and which receives commissions solely by reason of section
994(a)(1), (a)(2), or (b) with respect to goods to which such DISC does
not have title, no working capital would be required beyond a de minimis
amount unless it appears from the facts and circumstances that
additional working capital will be required.
(iv) In the case of a DISC deriving income from the leasing of
property, the amount of working capital required will be determined on
the basis of the facts and circumstances in such case.
(4) Relationship of working capital to other qualified export
assets. If a temporary investment is a qualified export asset under any
provision of this section (other than this paragraph), this paragraph
shall not affect its status as a qualified export asset. However, any
such temporary investment is taken into account before other temporary
investments in determining whether such other temporary investments are
maintained by a DISC as reasonably necessary to meet its requirements
for working capital. Current assets (other than temporary investments)
are taken
[[Page 662]]
into account before temporary investments, and trade receivables are
never taken into account, in determining whether such temporary
investments are maintained by the DISC as reasonably necessary
requirements for working capital. An obligation issued or incurred by a
member of a controlled group (as defined in Sec. 1.993-1(k)) of which
the DISC is a member is not a qualified export asset under this
paragraph. For rules regarding working capital as of the end of each
month of a taxable year for purposes of the 70-percent reasonableness
standard with respect to certain deficiency distributions, see paragraph
(j)(3) of this section.
(f) Producer's loans. For purposes of this section, a producer's
loan is an evidence of indebtedness arising in connection with
producer's loans which are made by a DISC and which meet the
requirements of Sec. 1.993-4. If a producer's loan is a qualified
export asset, interest accrued with respect to the producer's loan will
also be treated as a qualified export asset provided that payment is
made in the form of money, property (valued at its fair market value on
its date of transfer and including accounts receivable for sales by or
through a DISC), a written obligation which qualifies as a debt under
the safe harbor rule of Sec. 1.992-1(d)(2)(ii), or an accounting entry
offsetting the account receivable against an existing debt owed by the
person in whose favor the account receivable was established to the
person with whom it engaged in the transaction and that payment is made
no later than 60 days following the close of the taxable year of accrual
of the interest. This paragraph (f) is effective for taxable years
beginning after January 10, 1985 except that the taxpayer may at its
option apply the provisions of this paragraph to taxable years ending
after December 31, 1971.
(g) Stock or securities of related foreign corporations. For
purposes of this section, the term ``stock or securities'', with respect
to a related foreign export corporation (as defined in Sec. 1.993-5),
has the same meaning as such term has as used in section 351 (relating
to transfers to controlled corporations), except that the term
``securities'' does not include obligations which are repaid, in whole
or in part, at any time during the taxable year of the DISC following
the taxable year of the DISC during which such obligations were acquired
by the DISC or were issued, unless the DISC demonstrates to the
satisfaction of the district director that the repayment was for bona
fide business purposes and not for the purpose of avoidance of Federal
income taxes.
(h) Export-Import Bank obligations. For purposes of this section,
the term ``Export-Import Bank obligations'' means obligations issued,
guaranteed, insured, or reinsured (in whole or in part) by the Export-
Import Bank of the United States or by the Foreign Credit Insurance
Association, but only if such obligations are acquired by the DISC--
(1) From the Export-Import Bank of the United States,
(2) From the Foreign Credit Insurance Association, or
(3) From the person selling or purchasing the goods or services by
reason of which such obligations arose, or from any corporation which is
a member of the same controlled group (as defined in Sec. 1.993-1(k))
as such person.
For purposes of this paragraph, obligations issued by a person described
in subparagraphs (1), (2), and (3) of this paragraph are treated as
acquired from such person by the DISC if acquired from any person not
more than 90 days after the date of original issue (as defined in Sec.
1.1232-3(b)(3)). Examples of specific types of Export-Import Bank
obligations include debentures issued by such bank and certificates of
loan participation.
(i) Financing obligations. For purposes of this section, financing
obligations are obligations (held by a DISC) of a domestic corporation
organized solely for the purpose of financing sales of export property
pursuant to an agreement with the Export-Import Bank of the United
States under which such corporation makes export loans guaranteed by
such Bank.
(j) Funds awaiting investment--(1) In general. For purposes of this
section, subject to the limitation descibed in subparagraph (2) of this
paragraph, if, at the close of a DISC's taxable year,
[[Page 663]]
the sum of the DISC's money, bank deposits, and other similar temporary
investments is determined under paragraph (e) of this section to exceed
an amount reasonably necessary to meet the DISC's requirements for
working capital, the amount of the DISC's bank deposits in the United
States to the extent of the amount of this excess are funds awaiting
investment at the close of such taxable year.
(2) Limitation. Bank deposits described in subparagraph (1) of this
paragraph are funds awaiting investment only if, by the last day of each
of the sixth, seventh, and eighth months after the close of such taxable
year, the sum of the adjusted bases of the qualified export assets of
the DISC (other than such bank deposits) equals or exceeds 95 percent of
the sum of the adjusted bases of all assets of the DISC (including such
bank deposits) it held on the last day of such taxable year. For
purposes of this subparagraph, the adjusted bases of assets of a DISC
are determined as of the end of each of the months referred to in this
subparagraph. Funds awaiting investment as described in this paragraph
need not be traceable to any of the qualified export assets held by the
DISC at the end of any of the months referred to in this subparagraph.
(3) Coordination with certain deficiency distribution provisions.
Under section 992(c)(3) and Sec. 1.992-3(d) a deficiency distribution
made on or before the 15th day of the ninth month after the end of a
corporation's taxable year is deemed to be for reasonable cause if
certain requirements are met, including the requirement (described in
section 992(c)(3)(B) and Sec. 1.992-3(d)(2)) that the sum of the
adjusted bases of the qualified export assets held by the corporation on
the last day of each month of such year equals or exceeds 70 percent of
the sum of the adjusted bases of all assets held by the corporation on
each such last day. If, on any such last day, the sum or a DISC's money,
bank deposits, and other similar temporary investments is determined
under paragraph (e) of this section to exceed an amount reasonably
necessary to meet the DISC's requirements for working capital, the
amount of the DISC's bank deposits to the extent of the amount of this
excess are funds awaiting investment on such last day, if either--
(i) The requirements of subparagraph (2) of this paragraph are
satisfied with respect to the taxable year of the DISC which includes
such month or
(ii) At the close of such taxable year the sum of the DISC's money,
bank deposits, and other similar temporary investments is determined
under paragraph (e) of this section not to exceed an amount reasonably
necessary to meet the DISC's requirements for working capital.
(Secs. 995(e)(7), (8) and (10), 995(g) and 7805 of the Internal Revenue
Code of 1954 (90 Stat. 1655, 26 U.S.C. 995 (e)(7), (8) and (10); 90
Stat. 1659, 26 U.S.C. 995(g); and 68A Stat 917, 26 U.S.C. 7805))
[T.D. 7514, 42 FR 55459, Oct. 17, 1977; 42 FR 60910, Nov. 30, 1977, as
amended by T.D. 7854, 47 FR 51740, Nov. 17, 1982; T.D. 7984, 49 FR
40018, Oct. 12, 1984]
Sec. 1.993-3 Definition of export property.
(a) General rule. Under section 993(c), except as otherwise provided
with respect to excluded property in paragraph (f) of this section and
with respect to certain short supply property in paragraph (i) of this
section, export property is property in the hands of any person (whether
or not a DISC)--
(1) Manufactured, produced, grown, or extracted in the United States
by any person or persons other than a DISC (see paragraph (c) of this
section),
(2) Held primarily for sale or lease in the ordinary course of a
trade or business to any person for direct use, consumption, or
disposition outside the United States (see paragraph (d) of this
section),
(3) Not more than 50 percent of the fair market value of which is
attributable to articles imported into the United States (see paragraph
(e) of this section), and
(4) Which is not sold or leased by a DISC, or with a DISC as
commission agent, to another DISC which is a member of the same
controlled group (as defined in Sec. 1.993-1(k)) as the DISC.
(b) Services. For purposes of this section, services (including the
written communication of services in any form) are not export property.
Whether an item is property or services shall be
[[Page 664]]
determined on the basis of the facts and circumstances attending the
development and disposition of the item. Thus, for example, the
preparation of a map of a particular construction site would constitute
services and not export property, but standard maps prepared for sale to
customers generally would not constitute services and would be export
property if the requirements of this section were otherwise met.
(c) Manufacture, production, growth, or extraction of property--(1)
By a person other than a DISC. Export property may be manufactured,
produced, grown, or extracted in the United States by any person,
provided that such person does not qualify (and is not treated) as a
DISC. Property held by a DISC which was manufactured, produced, grown,
or extracted by it at a time when it did not qualify (and was not
treated) as a DISC is not export property of the DISC. Property which
sustains further manufacture or production outside the United States
prior to sale or lease by a person but after manufacture or production
in the United States will not be considered as manufactured, produced,
grown, or extracted in the United States by such person.
(2) Manufactured or produced--(i) In general. For purposes of this
section, property which is sold or leased by a person is considered to
be manufactured or produced by such person if such property is
manufactured or produced (within the meaning of either subdivision (ii),
(iii), or (iv) of this subparagraph) by such person or by another person
pursuant to a contract with such person. Except as provided in
subdivision (iv) of this subparagraph, manufacture or production of
property does not include assembly or packaging operations with respect
to property.
(ii) Substantial transformation. Property is manufactured or
produced by a person if such property is substantially transformed by
such person. Examples of substantial transformation of property would
include the conversion of woodpulp to paper, steel rods to screws and
bolts, and the canning of fish.
(iii) Operations generally considered to constitute manufacturing.
Property is manufactured or produced by a person if the operations
performed by such person in connection with such property are
substantial in nature and are generally considered to constitute the
manufacture or production of property.
(iv) Value added to property. Property is manufactured or produced
by a person if with respect to such property conversion costs (direct
labor and factory burden including packaging or assembly) of such person
account for 20 percent of more of--
(a) The cost of goods sold or inventory amount of such person for
such property is such property is sold or held for sale, or
(b) The adjusted basis of such person for such property, as
determined in accordance with the provisions of section 1011, if such
property is held for lease or leased.
The value of parts provided pursuant to a services contract, as
described in Sec. 1.993-1 (d)(4)(v), is not taken into account in
applying this subdivision.
(d) Primary purpose of which property is held--(1) In general--(i)
General rule. Under paragraph (a)(2) of this section, export property
(a) must be held primarily for the purpose of sale or lease in the
ordinary course of trade or business to a DISC, or to any other person,
and (b) such sale or lease must be for direct use, consumption, or
disposition outside the United States. Thus, property cannot qualify as
export property unless it is sold or leased for direct use, consumption
or disposition outside the United States. Property is sold or leased for
direct use, consumption, or disposition outside the United States if
such sale or lease satisfies the destination test described in
subparagraph (2) of this paragraph, the proof of compliance requirements
described in subparagraph (3) of this paragraph, and the use outside the
United States test described in subparagraph (4) of this paragraph.
(ii) Factors not taken into account. In determining whether property
which is sold or leased to a DISC is sold or leased for direct use
consumption, or disposition outside the United States, the fact that the
acquiring DISC holds the property in inventory or for lease prior to the
time it sells or leases it for direct use, consumption, or disposition
[[Page 665]]
outside the United States will not affect the characterization of the
property as export property. Export property need not be physically
segregated from other property.
(2) Destination test. (i) For purposes of subparagraph (1) of this
paragraph the destination test in this subparagraph is satisfied with
respect to property sold or leased by a seller or lessor only if it is
delivered by such seller or lessor (or an agent of such seller or
lessor) regardless of the F.O.B. point or the place at which title
passes or risk of loss shifts from the seller or lessor--
(a) Within the United States to a carrier or freight forwarder for
ultimate delivery outside the United States to a purchaser or lessee (or
to a subsequent purchaser or sublessee),
(b) Within the United States to a purchaser or lessee, if such
property is ultimately delivered, directly used, or directly consumed
outside the United States (including delivery to a carrier or freight
forwarder for delivery outside the United States) by the purchaser or
lessee (or a subsequent purchaser or sublessee) within 1 year after such
sale or lease,
(c) Within or outside the United States to a purchaser or lessee
which, at the time of the sale or lease, is a DISC and is not a member
of the same controlled group (as defined in Sec. 1.993-1(k)) as the
seller or lessor,
(d) From the United States to the purchaser or lessee (or a
subsequent purchaser or sublessee) at a point outside the United States
by means of a ship, aircraft, or other delivery vehicle, owned, leased,
or chartered by the seller or lessor,
(e) Outside the United States to a purchaser or lessee from a
warehouse, a storage facility, or assembly site located outside the
United States, if such property was previously shipped by such seller or
lessor from the United States, or
(f) Outside the United States to a purchaser or lessee if such
property was previously shipped by such seller or lessor from the United
States and if such property is located outside the United States
pursuant to a prior lease by the seller or lessor, and either (1) such
prior lease terminated at the expiration of its term (or by the action
of the prior lessee acting alone), (2) the sale occurred or the term of
the subsequent lease began after the time at which the term of the prior
lease would have expired, or (3) the lessee under the subsequent lease
is not a related person (as defined in Sec. 1.993-1(a)(6)) with respect
to the lessor and the prior lease was terminated by the action of the
lessor (acting alone or together with the lessee).
(ii) For purposes of this subparagraph (other than (c) and (f)(3) of
subdivision (i) thereof), any relationship between the seller or lessor
and any purchaser, subsequent purchaser, lessee, or sublessee is
immaterial.
(iii) In no event is the destination test of this subparagraph
satisfied with respect to property which is subject to any use (other
than a resale or sublease), manufacture, assembly, or other processing
(other than packaging) by any person between the time of the sale or
lease by such seller or lessor and the delivery or ultimate delivery
outside the United States described in this subparagraph.
(iv) If property is located outside the United States at the time it
is purchased by a person or leased by a person as lessee, such property
may be export property in the hands of such purchaser or lessee only if
it is imported into the United States prior to its further sale or lease
(including a sublease) outside the United States. Paragraphs (a)(3) and
(e) of this section (relating to 50 percent foreign content test) are
applicable in determining whether such property is export property.
Thus, for example, if such property is not subjected to manufacturing or
production (as defined in paragraph (c) of this section) within the
United States after such importation, it does not qualify as export
property.
(3) Proof of compliance with destination test--(i) Delivery outside
the United States. For purposes of subparagraph (2) of this paragraph
(other than subdivision (i)(c) thereof), a seller or lessor shall
establish ultimate delivery, use, or consumption of property outside the
United States by providing--
(a) A facsimile or carbon copy of the export bill of lading issued
by the carrier who delivers the property,
[[Page 666]]
(b) A certificate of an agent or representative of the carrier
disclosing delivery of the property outside the United States,
(c) A facsimile or carbon copy of the certificate of lading for the
property executed by a customs officer of the country to which the
property is delivered,
(d) If such country has no customs administration, a written
statement by the person to whom delivery outside the United States was
made,
(e) A facsimile or carbon copy of the shipper's export declaration,
a monthly shipper's summary declaration filed with the Bureau of
Customs, or a magnetic tape filed in lieu of the Shipper's Export
Declaration, covering the property,
(f) Any other proof (including evidence as to the nature of the
property or the nature of the transaction) which establishes to the
satisfaction of the Commissioner that the property was ultimately
delivered, or directly sold, or directly consumed outside the United
States within 1 year after the sale or lease.
(ii) The requirements of subdivision (i) (a), (b), (c), or (e) of
this subparagraph will be considered satisfied even though the name of
the ultimate consignee and the price paid for the goods is marked out
provided that, in the case of a Shipper's Export Declaration or other
document listed in such subdivision (e) or a document such as an export
bill of lading such document still indicates the country in which
delivery to the ultimate consignee is to be made and, in the case of a
certificate of an agent or representative of the carrier, that such
document indicates that the property was delivered outside the United
States.
(iii) A seller or lessor shall also establish the meeting of the
requirement of subparagraph (2)(i) of this paragraph (other than
subdivision (c) thereof), that the property was delivered outside the
United States without further use, manufacture, assembly, or other
processing within the United States.
(iv) Sale or lease to an unrelated DISC. For purposes of
subparagraph (2)(i)(c) of this paragraph, a purchaser or lessee of
property is deemed to qualify as a DISC for its taxable year if the
seller or lessor obtains from such purchaser or lessee a copy of such
purchaser's or lessee's election to be treated as a DISC as described in
Sec. 1.992-2(a) together with such purchaser's or lessee's sworn
statement that such election has been filed with the Internal Revenue
Service Center. The copy of the election and the sworn statement of such
purchaser or lessee must be received by the seller or lessor within 6
months after the sale or lease. A purchaser or lessee is not treated as
a DISC with respect to a sale or lease during a taxable year for which
such purchaser or lessee does not qualify as a DISC if the seller or
lessor does not believe or if a reasonable person would not believe at
the time such sale or lease is made that the purchaser or lessee will
qualify as a DISC for such taxable year.
(v) Failure of proof. If a seller or lessor fails to provide proof
of compliance with the destination test as required by this
subparagraph, the property sold or leased is not export property.
(4) Sales and leases of property for ultimate use in the United
States--(i) In general. For purposes of subparagraph (1) of this
paragraph, the use test in this subparagraph is satisfied with respect
to property which--
(a) Under subdivisions (ii) through (iv) of this subparagraph is not
sold for ultimate use in the United States or
(b) Under subdivision (v) of this subparagraph is leased for
ultimate use outside the United States.
(ii) Sales of property for ultimate use in the United States. For
purposes of subdivision (i) of this subparagraph, a purchaser of
property (including components, as defined in subdivision (vii) of this
subparagraph) is deemed to use such property ultimately in the United
States if any of the following conditions exists:
(a) Such purchaser is a related person (as defined in Sec. 1.993-
1(a)(6)) with respect to the seller and such purchaser ultimately uses
such property, or a second product into which such property is
incorporated as a component, in the United States.
(b) At the time of the sale, there is an agreement or understanding
that such property, or a second product into which such property is
incorporated as
[[Page 667]]
a component, will be ultimately used by the purchaser in the United
States.
(c) At the time of the sale, a reasonable person would have believed
that such property or such second product would be ultimately used by
such purchaser in the United States unless, in the case of a sale of
components, the fair market value of such components at the time of
delivery to the purchaser constitutes less than 20 percent of the fair
market value of the second product into which such components are
incorporated (determined at the time of completion of the production,
manufacture or assembly of such second product).
For purposes of (b) of this subdivision, there is an agreement or
understanding that property will ultimately be used in the United States
if, for example, a component is sold abroad under an express agreement
with the foreign purchaser that the component is to be incorporated into
a product to be sold back to the United States. As a further example
there would also be such an agreement or understanding if the foreign
purchaser indicated at the time of the sale or previously that the
component is to be incorporated into a product which is designed
principally for the United States market. However, such an agreement or
understanding does not result from the mere fact that a second product,
into which components exported from the United States have been
incorporated and which is sold on the world market, is sold in
substantial quantities in the United States.
(iii) Use in the United States. For purposes of subdivision (ii) of
this subparagraph, property (including components incorporated into a
second product) is or would be ultimately used in the United States by
such purchaser if, at any time within 3 years after the purchase of such
property or components, either such property or components (or the
second product into which such components are incorporated) is resold by
such purchaser for use by a subsequent purchaser within the United
States or such purchaser or subsequent purchaser fails, for any period
of 365 consecutive days, to use such property or second product
predominantly outside the United States as defined in subdivision (vi)
of this subparagraph).
(iv) Sales to retailers. For purposes of subdivision (ii)(c) of this
subparagraph, property sold to any person whose principal business
consists of selling from inventory to retail customers at retail outlets
ouside the United States will be considered as property for ultimate use
outside the United States.
(v) Leases of property for ultimate use outside the United States.
For purposes of subdivision (i) of this subparagraph a lessee of
property is deemed to use such property ultimately outside the United
States during a taxable year of the lessor if such property is used
predominantly outside the United States (as defined in subdivision (vi)
of this subparagraph) by the lessee during the portion of the lessor's
taxable year which is included within the term of the lease. A
determination as to whether the ultimate use of leased property
satisfies the requirements of this subdivision is made for each taxable
year of the lessor. Thus, leased property may be used predominantly
outside the United States for a taxable year of the lessor (and thus,
constitute export property if the remaining requirements of this section
are met) even if the property is not used predominantly outside the
United States in earlier taxable years or later taxable years of the
lessor.
(vi) Predominant use outside the United States. For purposes of this
subparagraph, property is used predominantly outside the United States
for any period if, during such period, such property is located outside
the United States more than 50 percent of the time. An aircraft,
railroad rolling stock, vessel, motor vehicle, container, or other
property used for transportation purposes in deemed to be used
predominantly outside the United States for any period if, during such
period, either such property is located outside the United States more
than 50 percent of the time or more than 50 percent of the miles
traversed in the use of such property are traversed in outside the
United States. However, any such property is deemed to be within the
United States at all times during which it is engaged in transport
between any two points within the
[[Page 668]]
United States, except where such transport constitutes uninterrupted
international air transportation within the meaning of section
4262(c)(3) and the regulations thereunder (relating to tax on air
transportation of persons). For purposes of applying section 4262(c)(3)
to this subdivision, the term ``United States'' has the same meaning as
in Sec. 1.993-7.
(vii) Component. For purposes of this subparagraph, a component is
property which is (or is reasonably expected to be) incorporated into a
second product by the purchaser of such component by means of
production, manufacture, or assembly.
(e) Foreign content of property--(1) The 50 percent test. Under
paragraph (a)(3) of this section, no more than 50 percent of the fair
market value of export property may be attributable to the fair market
value of articles which were imported into the United States. For
purposes of this paragraph, articles imported into the United States are
referred to as ``foreign content''. The fair market value of the foreign
content of export property is computed in accordance with subparagraph
(4) of this paragraph. The fair market value of export property which is
sold to a person who is not a related person with respect to the seller
is the sale price for such property (not including interest finance or
carrying charges, or similar charges)
(2) Application of 50 percent test. The 50 percent test described in
subparagraph (1) of this paragraph is applied on an item-by-item basis
If, however, a person sells or leases a substantial volume of
substantially identical export property in a taxable year and if all of
such property contains substantially identical foreign content is
substantially the same proportion, such person may determine the portion
of foreign content contained in such property on an aggregate basis.
(3) Parts and services. If, at the time property is sold or leased
the seller or lessor agrees to furnish parts pursuant to a services
contract (as provided in Sec. 1.993-1(d)(4)(v)) and the price for the
parts is not separately stated, the 50 percent test described in
subparagraph (1) of this paragraph is applied on an aggregate basis to
the property and parts. If the price for the parts is described in
subparagraph (1) of this paragraph is applied separately to the property
and to the parts.
(4) Computation of foreign content-- (i) Valuation. For purposes of
applying the 50 percent test described in subparagraph (1) of this
paragraph, it is necessary to determine the fair market value of all
articles which constitute foreign content of the property being tested
to determine if it is export property. The fair market value of such
imported articles is determined as of the time such articles are
imported into the United States. With respect to articles imported into
the United States before July 1, 1980, the fair market value of such
articles is their appraised value as determined under section 402 or
402a of the Tariff Act of 1930 (19 U.S.C. 1401a or 1402) in connection
with their importation. With respect to articles imported into the
United States on or after July 1, 1980, the fair market value of such
articles is their appraised value as determined under section 402 of the
Tariff Act of 1930 (19 U.S.C. 1401a) in connection with their
importation. The appraised value of such articles is the full dutiable
value of such articles, determined, however, without regard to any
special provision in the United States tariff laws which would result in
a lower dutiable value. Thus, an article which is imported into the
United States is treated as entirely imported even if all or a portion
of such article was originally manufactured, produced, grown, or
extracted in the United States.
(ii) Evidence of fair market value. For purposes of subdivision (i)
of this subparagraph, the fair market value of imported articles
constituting foreign content may be evidenced by the customs invoice
issued on the importation of such articles into the United States. If
the holder of such articles is not the importer (or a related person
with respect to the importer), the fair market value of such articles
may be evidenced by a certificate based upon information contained in
the customs invoice and furnished to the holder by the person from whom
such articles (or property
[[Page 669]]
incorporating such articles) were purchased. If a customs invoice or
certificate described in the preceding sentence is not available to a
person purchasing property, such person shall establish that no more
than 50 percent of the fair market value of such property is
attributable to the fair market value of articles which were imported
into the United States.
(iii) Interchangeable component articles--(a) Where identical or
similar component articles can be incorporated interchangeably into
property and a person acquires some such component articles that are
imported into the United States and other such component articles that
are not imported into the United States, the determination whether
imported component articles were incorporated in such property as is
exported from the United States shall be made on a substitution basis as
in the case of the rules relating to drawback accounts under the customs
laws. See section 313(b) of the Tariff Act of 1930, as amended (19
U.S.C. 1313(b)).
(b) The provisions of (a) of this subdivision may be illustrated by
the following example:
Example. Assume that a manufacturer produces a total of 20,000
electronic devices. The manufacturer exports 5,000 of the devices and
subsequently sells 11,000 of the devices to a DISC which exports the
11,000 devices. The major single component article in each device is a
tube which represents 60 percent of the fair market value of the device
at the time the device is sold by the manufacturer. The manufacturer
imports 8,000 of the tubes and produces the remaining 12,000 tubes. For
purposes of this subdivision, in accordance with the substitution
principle used in the customs drawback laws, the 5,000 devices exported
by the manufacturer are each treated as containing an imported tube
because the devices were exported prior to the sale to the DISC. The
remaining 3,000 imported tubes are treated as being contained in the
first 3,000 devices purchased and exported by the DISC. Thus, since the
50 percent test is not met with respect to the first 3,000 devices
purchased and exported by the DISC, those devices are not export
property. The remaining 8,000 devices purchased and exported by the DISC
are treated as containing tubes produced in United States, and those
devices are export property (if they otherwise meet the requirements of
this section).
(f) Excluded property--(1) In general. Notwithstanding any other
provision of this section, the following property is not export
property--
(i) Property described in subparagraph (2) of this paragraph
(relating to property leased to a member of a controlled group),
(ii) Property described in subparagraph (3) of this paragraph
(relating to certain types of intangible property),
(iii) Products described in paragraph (g) of this section (relating
to depletable products), and
(iv) Products described in paragraph (h) of this section (relating
to certain export controlled products).
(2) Property leased to member of controlled group--(i) In general.
Property leased to a person (whether or not a DISC) which is a member of
the same controlled group (as defined in Sec. 1.993-1(k)) as the lessor
constitutes export property for any period of time only if during the
period--
(a) Such property is held for sublease, or is subleased, by such
person to a third person for the ultimate use of such third person;
(b) Such third person is not a member of the same controlled group;
and
(c) Such property is used predominantly outside the United States by
such third person.
(ii) Predominant use. The provisions of paragraph (d)(4)(vi) of this
section apply in determining under subdivision (i)(c) of this
subparagraph whether such property is used predominently outside the
United States by such third person.
(iii) Leasing rule. For purposes of this subparagraph, leased
property is deemed to be ultimately used by a member of the same
controlled group as the lessor if such property is leased to a person
which is not a member of such controlled group but which subleases such
property to a person which is a member of such controlled group. Thus,
for example, if X, a DISC for the taxable year, leases a movie film to
Y, a foreign corporation which is not a member of the same controlled
group as X, and Y then subleases the film to persons which are members
of such group for showing to the general public, the film is not export
property. On the other hand, if X, a DISC for the
[[Page 670]]
taxable year, leases a movie film to Z, a foreign corporation which is a
member of the same controlled group as X, and Z then subleases the film
to Y, another foreign corporation, which is not a member of the same
controlled group for showing to the general public, the film is not
disqualified under this subparagraph from being export property.
(iv) Certain copyrights. With respect to a copyright which is not
excluded by subparagraph (3) of this paragraph from being export
property, the ultimate use of such property is the sale or exhibition of
such property to the general public. Thus, if A, a DISC for the taxable
year, leases recording tapes to B, a foreign corporation which is a
member of the same controlled group as A, and if B makes records from
the recording tape and sells the records to C, another foreign
corporation, which is not a member of the same controlled group, for
sale by C to the general public, the recording tape is not disqualified
under this subparagraph from being export property, notwithstanding the
leasing of the recording tape by A to a member of the same controlled
group, since the ultimate use of the tape is the sale of the records
(i.e., property produced from the recording tape).
(3) Intangible property. Export property does not include any
patent, invention, model, design, formula, or process, whether or not
patented, or any copyright (other than films, tapes, records, or similar
reproductions, for commercial or home use), goodwill, trademark,
tradebrand, franchise, or other like property. Although a copyright such
as a copyright on a book does not constitute export property, a
copyrighted article (such as a book) if not accompanied by a right to
reproduce it is export property if the requirements of this section are
otherwise satisfied. However, a license of a master recording tape for
reproduction outside the United States is not disqualified under this
subparagraph from being export property.
(g) Depletable products--(1) In general. Under section 993(c)(2)(C),
a product or commodity which is a depletable product (as defined in
subparagraph (2) of this paragraph) or contains a depletable product is
not export property if--
(i) It is a primary product from oil, gas, coal, or uranium (as
described in subparagraph (3) of this paragraph), or
(ii) It does not qualify as a 50-percent manufactured or processed
product (as described in subparagraph (4) of this paragraph).
(2) Definition of ``depletable product''. For purposes of this
paragraph, the term ``depletable product'' means any product or
commodity of a character with respect to which a deduction for depletion
is allowable under section 613 or 613A. Thus, the term depletable
product includes any mineral extracted from a mine, an oil or gas well,
or any other natural deposit, whether or not the DISC or related
supplier is allowed a deduction, or is eligible to take a deduction, for
depletion with respect to the mineral in computing its taxable income.
Thus, for example, iron ore purchased by a DISC from a broker is a
depletable product in the hands of the DISC for purposes of this
paragraph even though the DISC is not eligible to take a deduction for
depletion under section 613 or 613A.
(3) Primary product from oil, gas, coal, or uranium. A primary
product from oil, gas, coal, or uranium is not export property. For
purposes of this paragraph--
(i) Primary product from oil. The term ``primary product from oil''
means crude oil and all products derived from the destructive
distillation of crude oil, including--
(a) Volatile products,
(b) Light oils such as motor fuel and kerosene,
(c) Distillates such as naphtha,
(d) Lubricating oils,
(e) Greases and waxes, and
(f) Residues such as fuel oil.
For purposes of this paragraph, a product or commodity derived from
shale oil which would be a primary product from oil if derived from
crude oil is considered a primary product from oil.
(ii) Primary product from gas. The term ``primary product from gas''
means all gas and associated hydrocarbon components from gas wells or
oil wells, whether recovered at the lease or upon further processing,
including--
(a) Natural gas,
(b) Condensates,
[[Page 671]]
(c) Liquefied petroleum gases such as ethane, propane, and butane,
and
(d) Liquid products such as natural gasoline.
(iii) Primary product from coal. The term ``primary product from
coal'' means coal and all products recovered from the carbonization of
coal including--
(a) Coke,
(b) Coke-oven gas,
(c) Gas liquor,
(d) Crude light oil, and
(e) Coal tar.
(iv) Primary product from uranium. The term ``primary product from
uranium'' means uranium ore and uranium concentrates (known in the
industry as ``yellow cake''), and nuclear fuel materials derived from
the refining of uranium ore and uranium concentrates, or produced in a
nuclear reaction, including--
(a) Uranium hexafluoride,
(b) Enriched uranium hexafluoride,
(c) Uranium metal,
(d) Uranium compounds, such as uranium carbide,
(e) Uranium dioxide, and
(f) Plutonium fuels.
(v) Primary products and changing technology. The primary products
from oil, gas, coal, or uranium described in subdivisions (i) through
(iv) of this subparagraph and the processes described in those
subdivisions are not intended to represent either the only primary
products from oil, gas, coal, or uranium, or the only processes from
which primary products may be derived under existing and future
technologies, such as the gasification and liquefaction of coal.
(vi) Petrochemicals. For purposes of this paragraph, petrochemicals
are not considered primary products from oil, gas, or coal.
(4) 50-percent manufactured or processed product--(i) In general. A
product or commodity (other than a primary product from oil, gas, coal,
or uranium) which is or contains a depletable product is not excluded
from the term ``export property'' by reason of section 993(c)(2)(C) if
it is a 50-percent manufactured or processed product. Such a product or
commodity is a ``50-percent manufactured or processed product'' if,
after the cutoff point of the depletable product, it is manufactured or
processed (as defined in subdivision (ii) of this subparagraph) and
either the cost test described in subdivision (iv) of this subparagraph
or the fair market value test described in subdivision (v) of this
subparagraph is satisfied. To determine cutoff point, see subdivisions
(vi) and (vii) of this subparagraph.
(ii) Manufactured or processed. A product is manufactured or
processed if it is manufactured or produced within the meaning of
paragraph (c)(2) of this section, except that for purposes of this
subdivision the term manufacturing or processing does not include any
excluded process (as defined in subdivision (iii) of this subparagraph)
and the term conversion costs (as used in subdivision (iv) of such
paragraph (c)(2)) does not include any costs attributable to any
excluded process.
(iii) Excluded processes. For purposes of this paragraph, excluded
processes are extracting (i.e., all processes which are applied before
the cutoff point of the mineral to which such processes are applied),
and handling, packing, packaging, grading, storing, and transporting.
(iv) Cost test. A product or commodity will qualify as a 50-percent
manufactured or processed product if--
(a) Its manufacturing and processing costs (that is, the portion of
the cost of goods sold or inventory amount of the product or commodity
attributable to the aggregate cost of manufacturing or processing each
mineral contained therein) equal or exceed--
(b) An amount equal to either of the following:
(1) 50 percent of its cost of goods sold or inventory amount
(decreased, at the DISC's option, by the portion of such cost or amount
the DISC establishes is allocable to the difference between each prior
owner's selling price for each depletable product contained in such
product or commodity and such prior owner's cost of goods sold with
respect thereto).
(2) The aggregate of the cost at the cutoff point (see subdivisions
(vi) and (vii) of this subparagraph) properly attributable to each
mineral contained in such product or commodity. However, if this
subdivision (2) is applied, then the amount in (a) of this subparagraph
[[Page 672]]
(iv) shall be decreased and the amount in this subdivision (2) shall be
increased, by so much of the cost of goods sold or inventory amount of
the product or commodity as is properly allocable to any process other
than transportation applied after the cutoff point of such mineral which
would be a mining process (within the meaning of Sec. 1.613-4) were it
applied before such point.
(v) Fair market value test. A product or commodity will qualify as a
50-percent manufactured or processed product if--
(a) The excess of its fair market value on the date it is sold,
exchanged, or otherwise disposed of (or, if not sold, exchanged, or
otherwise disposed of, the last day of the DISC's taxable year) over the
portion thereof properly allocable to excluded processes other than
extracting is equal to or greater than
(b) Twice the aggregate of the fair market value at the cutoff point
for each mineral contained in such product or commodity.
For purposes of this subdivision (v), the fair market value of a product
or commodity on the date it is sold, exchanged, or otherwise disposed of
is the price at which it is disposed of, subject to any adjustment that
may be required under the arm's length standard of section 482 and the
regulations thereunder. If such product or commodity is not sold,
exchanged, or otherwise disposed of, then, for purposes of section
992(a)(1)(B) (relating to the 95-percent test with respect to qualified
export assets), the fair market value of a product or commodity on the
last day of the DISC's taxable year is the arm's length price at which
such product or commodity would have been sold on such date, determined
by applying the principles of section 482 and the regulations
thereunder.
(vi) Cutoff point of a mineral. For purposes of this subparagraph:
(a) The cutoff point is the point at which gross income from the
property (within the meaning of section 613(a)) was in fact determined.
(b) The cost at the cutoff point is deemed to be the amount of the
gross income from the property of the taxpayer eligible for a depletion
deduction with respect to the mineral.
(c) The fair market value at the cutoff point is deemed to be the
amount of the gross income from the property of the taxpayer eligible
for a depletion deduction with respect to the mineral, except that, if
(1) the fair market value of a product or commodity on the date
specified in subdivision (v)(a) of this subparagraph exceeds the
aggregate of the fair market value at the cutoff point for each mineral
contained therein and (2) 10 percent or more of such excess is
attributable to a net increase in the fair market values of such
minerals by reason of factors other than manufacturing or processing or
the application of excluded processes (such as, for example, increases
in the fair market values of some minerals by reason of inflation or
speculation exceed decreases in such values of other minerals by reason
of deflation or speculation), then the aggregate of the fair market
value at the cutoff point for each such mineral shall be increased to
reflect the net excess so attributable.
(d) The provisions of this subdivision (vi) are illustrated by the
following example.
Example. An integrated manufacturer, X, on February 1, 1976, had
gross income from the property (within the meaning of section 613(a)) of
$50 with respect to a specified volume of a mineral. Thus, the cost at
the cutoff point of the mineral was $50. X converted the mineral into a
product which it sold on July 15, 1976, for $75. Of the $25 excess of
the selling price over the gross income from the property, $23 was
attributable to manufacturing, processing, and the application or
excluded processes, and $2 was attributable to an increase in the fair
market value of the mineral due to inflation between February 1 and July
15, 1976. Since only 8 percent of such excess ($2/$25) was attributable
to factors other than manufacturing, processing, and the application of
excluded processes, the fair market value at the cutoff point of the
mineral is $50. However, had $3 of the $25 excess, or 12 percent, been
attributable to an increase in the fair market value of the mineral due
to inflation, then the fair market value at the cutoff point of the
mineral would be $53.
(vii) [Reserved]
(viii) Special rule for certain used products and scrap products. If
a product or commodity is a used 50-percent manufactured or processed
product, or is recovered as scrap from a 50-percent manufactured or
processed product,
[[Page 673]]
such product or commodity will be treated as a 50-percent manufactured
or processed product.
(ix) Special rule for byproducts and waste products. For purposes of
applying the cost test or fair market value test of subdivision (iv) or
(v) of this subparagraph if a depletable product is recovered from a
manufacturing process as a byproduct or waste product, then the cost and
fair market value at the cutoff point are each deemed to be the lesser
of--
(a) The fair market value of the waste product or byproduct
containing the depletable product, determined as of the date the
byproduct or waste product is recovered, or
(b) The amount the cost at the cut-off point would be for a
depletable product of like kind and grade which is extracted, determined
as of the date the byproduct or waste product is recovered.
For purposes of (b) of this subdivision the cutoff point for the
depletable product of like kind and grade is deemed to be the point at
which gross income from the property would be determined if such
depletable product were sold by the taxpayer eligible to take a
deduction for depletion after the completion of all mining processes
applied to the depletable product and before the application of any
nonmining process.
(x) Proof of satisfaction of 50-percent manufactured or processed
test. (a) No substantiation is required to establish that either the
cost test or the fair market value test of subdivisions (iv) or (v) of
this subparagraph is satisfied or that a product or commodity qualifies
under (viii) of this subdivision as either a used 50-percent
manufactured or processed product or as scrap from a 50-percent
manufactured or processed product as long as it is reasonably obvious,
on the basis of all relevant facts and circumstances, that either the
cost test or fair market value test is satisfied, or that the product or
commodity qualifies as either as used 50-percent manufactured or
processed product or as scrap from a 50-percent manufactured or
processed product. Thus, for example, in the case of a DISC exporting a
high precision lens at least 50 percent of the fair market value of
which is obviously attributable to grinding, no substantiation of gross
income from the property properly allocable to the depletable products
contained in the lens, cost, or fair market values will be required.
(b) In cases in which satisfaction of either the cost test or the
fair market value test is not reasonably obvious, a DISC will be
required to substantiate the gross income from the property properly
allocable to each depletable product in a product or commodity and
either all costs or fair market values relied upon the DISC.
(c) For purposes of substantiating (1) gross income from the
property properly allocable to a depletable product, (2) costs, and (3)
fair market values, the DISC and related supplier shall each identify
items in (or that were in) inventory in the same manner each used to
identify items in inventory for purposes of computing Federal income
tax.
(xi) Application of 50-percent test. The 50-percent test described
in this subparagraph is applied on an item-by-item basis. If, however, a
DISC sells a substantial volume of substantially identical products or
commodities and if all or a group of such products or commodities
contain substantially identical depletable products in substantially the
same proportions and have cost or fair market value relationships (as
the case may be) that are in substantially the same proportions, such
DISC may apply the 50-percent test on an aggregate basis with respect to
all such products or commodities, or group, as the case may be.
(5) Effective dates. Except as provided in subparagraph (6) of this
paragraph, section 993(c)(2)(C) applies--
(i) With respect to any product or commodity not owned by a DISC, to
sales, exchanges, or other dispositions made after March 18, 1975, with
respect to which the DISC derives gross receipts.
(ii) With respect to any product or commodity acquired by a DISC
after March 18, 1975.
(iii) With respect to any product or commodity owned by a DISC on
March 18, 1975, to sales, exchanges, or other dispositions made after
March 18, 1976,
[[Page 674]]
and to owning such product or commodity after such date.
For purposes of this paragraph and subparagraph (6) of this paragraph,
the date of a sale, exchange, or other disposition of a product or
commodity is the date as of which title to such product or commodity
passes. The accounting method of a person is not determinative of the
date of a sale, exchange, or other disposition.
(6) Fixed contracts. Section 1101(f) of the Tax Reform Act of 1976
provides an exception to the effective date rules in this paragraph and
in paragraph (h) of this section. Section 1101(f)(2) of the Act provides
that section 993(c)(2)(C) and (D) shall not apply to sales, exchanges,
and other dispositions made after March 18, 1975, but before March 19,
1980, if they are made pursuant to a fixed contract. Section 1101(f)(2)
also defines fixed contract. Under that definition, if the seller can
vary the price of the product for unspecified cost increases (which
could include tax cost increases), or if the quantity of products or
commodities to be sold can be increased or decreased under the contract
by the seller without penalty, the contract is not to be considered a
fixed contract with respect to the amount over which the seller has
discretion. For example, if a contract calls for a minimum delivery of x
amount of a product but allows the seller to refuse to deliver goods
beyond that minimum amount (or allows a renegotiation of the sales price
of goods beyond that amount), then with respect to the amount above the
minimum the contract is not a fixed quantity contract.
(h) Export controlled products--(1) In general. An export controlled
product is not export property. A product or commodity may be an export
controlled product at one time but not an export controlled product at
another time. For purposes of this paragraph, a product or commodity is
an ``export controlled product'' at a particular time if at that time
the export of such product or commodity is prohibited or curtailed under
section 4(b) of the Export Administration Act of 1969 or section 7(a) of
the Export Administration Act of 1979, to effectuate the policy relating
to the protection of the domestic economy set forth in such Acts
(paragraph (2)(A) of section 3 of the Export Administration Act of 1969
and paragraph (2)(C) of section 3 of the Export Administration Act of
1979). Such policy is to use export controls to the extent necessary
``to protect the domestic economy from the excessive drain of scarce
materials and to reduce the serious inflationary impact of foreign
demand.''
(2) Products considered export controlled products--(i) In general.
For purposes of this paragraph, an export controlled product is a
product or commodity which is subject to short supply export controls
under 15 CFR part 377. A product or commodity is considered an export
controlled product for the duration of each control period which applies
to such product or commodity. A control period of a product or commodity
begins on and includes the initial control date (as defined in
subdivision (ii) of this subparagraph) and ends on and includes the
final control date (as defined in subdivision (iii) of this
subparagraph).
(ii) Initial control date. The initial control date of a product or
commodity which was subject to short supply export controls on March 19,
1975, is March 19, 1975. The initial control date of a product or
commodity which is subject to short supply export controls after March
19, 1975, is the effective date stated in the regulations to 15 CFR part
377 which subjects such product or commodity to short supply export
controls. If there is no effective date stated in such regulations, the
initial control date of such product or commodity is the date on which
such regulations are filed for publications in the Federal Register.
(iii) Final control date. The final control date of a product or
commodity is the effective date stated in the regulations to 15 CFR part
377 which removes such product or commodity from short supply export
controls. If there is no effective date stated in such regulations, the
final control date of such product or commodity is the date on which
such regulations are filed for publication in the Federal Register.
(iv) Expiration of Export Administration Act. An initial control
date and a final control date cannot occur after the expiration date of
the Export Administration Act under the authority
[[Page 675]]
of which the short supply export controls were issued.
(3) Effective dates--(i) Products controlled on March 19, 1975.
Except as provided in paragraph (g)(6) of this section, if a product or
commodity was subject to short supply export controls on March 19, 1975,
this paragraph applies--
(a) With respect to any such product or commodity not owned by a
DISC, to sales, exchanges, other dispositions, or leases made after
March 18, 1975, with respect to which the DISC derives gross receipts.
(b) With respect to any such product or commodity acquired by a DISC
after March 18, 1975, and
(c) With respect to any such product or commodity owned by a DISC on
March 18, 1975, to sales, exchanges, other dispositions, and leases made
after March 18, 1976, and to owning such product or commodity after such
date.
(ii) Products first controlled after March 19, 1975. If a product or
commodity becomes subject to short supply export controls after March
19, 1975, this paragraph applies to sales, exchanges, other
dispositions, or leases of such product or commodity made on or after
the initial control date of such product or commodity, and to owning
such product or commodity on or after such date.
(iii) Date of sale, exchange, lease, or other disposition. For
purposes of this subparagraph, the date of sale, exchange, or other
disposition of a product or commodity is the date as of which title to
such product or commodity passes. The date of a lease is the date as of
which the lessee takes possession of a product or commodity. The
accounting method of a person is not determinative of the date of sale,
exchange, other disposition, or lease.
(iv) Property in short supply. If the President determines that the
supply of any property which is otherwise export property as defined in
this section is insufficient to meet the requirements of the domestic
economy, he may by Executive order designate such property as in short
supply. Any property so designated will be treated as property which is
not export property during the period beginning with the date specified
in such Executive order and ending with the date specified in an
Executive order setting forth the President's determination that such
property is no longer in short supply.
[T.D. 7514, 42 FR 55461, Oct. 17, 1977, as amended by T.D. 7513, 42 FR
57309, Nov. 2, 1977; T.D. 7854, 47 FR 51740, Nov. 17, 1982]
Sec. 1.993-4 Definition of producer's loans.
(a) General rule--(1) Definition. Under section 993(d), a loan made
by a DISC to a person, referred to in this section as the ``borrower,''
is a producer's loan if--
(i) The loan is made out of accumulated DISC income within the
meaning of subparagraph (3) of this paragraph.
(ii) The loan is evidenced by an obligation described in
subparagraph (4) of this paragraph.
(iii) The requirement as to the trade or business of the borrower
described in subparagraph (5) of this paragraph is satisfied.
(iv) At the time the loan is made, the obligation referred to in
subdivision (ii) of this subparagraph bears a legend stating ``This
Obligation Is Designated A Producer's Loan Within The Meaning of section
993(d) of the Internal Revenue Code'' or words of substantially the same
meaning.
(v) The limitation as to the export-related assets of the borrower
described in paragraph (b) of this section is satisfied.
(vi) The requirement as to the increased investment of the borrower
in export-related assets described in paragraph (c) of this section is
satisfied, and
(vii) The requirement of paragraph (d) of this section as to proof
of compliance with paragraphs (b) and (c) of this section is satisfied.
(2) Application of this section--(i) In general. A loan which is a
producer's loan is a qualified export asset of the DISC (see Sec.
1.993-2(a)(5) and (F)). The interest on a producer's loan is a qualified
export receipt of the DISC (see Sec. 1.993-1(g)). A producer's loan is
not a dividend to a borrower which is also a shareholder of the DISC
making the loan. For rules with respect to deemed distributions by
reason of the amount of foreign investment attributable to
[[Page 676]]
producer's loans, see section 995(b)(1)(G) and (d) and the regulations
thereunder.
(ii) No tracing of loan proceeds. For purposes of applying this
section, in order to qualify as a producer's loan, the proceeds of the
loan need not be traced to an investment in any specific asset.
(iii) Unrelated borrower. For purposes of applying this section, it
is not necessary for a borrower to be a related person with respect to
the DISC from which it receives a producer's loan, or a member of the
same controlled group as the DISC.
(iv) Unpaid balance of producer's loans. For purposes of applying
this section, the unpaid balance of producer's loans does not include
the unpaid balance of any producer's loan to the extent the loan has
been deducted or charged off by the DISC as totally or partially
worthless under section 165 or 166.
(v) Refinancing, renewal, and extension. For purposes of applying
this section, the refinancing, renewal, or extension of a producer's
loan shall be treated as the making of a new loan which may qualify as a
producer's loan only if the requirements of subparagraph (1) of this
paragraph are met.
(vi) Events subsequent to time loan is made. The determination as to
whether a loan qualifies as a producer's loan is made on the basis of
the relevant facts taken into account for purposes of determining
whether the loan was a producer's loan when made. Thus, for example, if
the accumulated DISC income of the lender is later reduced below the
unpaid balance of all producer's loans previously made by the DISC, such
subsequent decrease in the amount of accumulated DISC income will not
result in later disqualification of such loan (or part thereof) as a
producer's loan. Similarly, if a loan (or part of a loan) does not
qualify as a producer's loan because of an insufficient amount of
accumulated DISC income at the time the loan is made, a subsequent
increase in the amount of accumulated DISC income will not result in
later qualification of such loan (or part thereof) as a producer's loan.
As a further example, for purposes of applying the borrower's export
related assets limitation described in paragraph (b) of this section, a
loan which qualifies as a producer's loan when made will not later be
disqualified if property, the gross receipts from the sale or lease of
which were includible in the numerator of the fraction described in
paragraph (b)(3)(i) of this section at the time of sale or lease by the
borrower, is later characterized as excluded property (as defined in
Sec. 1.993-3(f)).
(vii) Application of tests under paragraphs (b) and (c) on
controlled group bases. If the borrower is a member of a controlled
group (as defined in Sec. 1.993-1(k)) at the time a loan is made, all
amounts that must be determined for purposes of applying the limitation
and increased investment requirement with respect to the export-related
assets of the borrower (described in paragraphs (b) and (c),
respectively, of this section) may be determined at the election of the
borrower by aggregating such amounts for all members of the controlled
group, determined for the taxable year of each member of the controlled
group during which the loan is made, excluding only such members of the
group as are DISC's or foreign corporations for such year. However, such
amounts may be included only to the extent that such amounts have not
already been taken into account in applying the limitation and increased
investment requirement with respect to any other borrower. Amounts to be
aggregated for all such members if such election is made include, for
example, gross receipts (described in paragraphs (b)(3)(i) and (ii) of
this section) and export-related assets (described in paragraph (b)(2)
of this section). The borrower may make such election by causing its
written statement of election to be attached to the lending DISC's
return under section 6011(e)(2) for the first taxable year of the
lending DISC within which or with which the borrower's taxable year for
which the election is to apply ends. An election once made is binding on
all members of the controlled group which includes the borrower with
respect to all taxable years of the borrower beginning with its first
taxable year for which the election is made. A borrower who makes such
election may revoke it only if it secures the consent of the
[[Page 677]]
Commissioner to such revocation upon application made through the
lending DISC.
(3) Loan out of accumulated DISC income--(i) In general. A loan is a
producer's loan only to the extent that it is made out of accumulated
DISC income. A loan is made out of accumulated DISC income only if the
amount of the loan, when added to the unpaid balance at the time such
loan is made of all other producer's loans made by a DISC, does not
exceed the amount of accumulated DISC income of the DISC at the
beginning of the month in which the loan is made. The amount of
accumulated DISC income at the beginning of any month is determined as
if the DISC's taxable year closed at the end of the immediately
preceding month.
(ii) Presumption. A loan made during a taxable year shall be deemed
under subdivision (i) of this subparagraph to have been made out of
accumulated DISC income if the balance of producer's loans at the
beginning of the year and those made during the year do not exceed
accumulated DISC income at the end of the year.
(iii) Deemed distributions. For purposes of this subparagraph,
accumulated DISC income as of the end of any taxable year (or month)
shall be determined without regard to deemed distributions under section
995(b)(1)(G) for the amount of foreign investment attributable to
producer's loans for such year (or for the taxable year for which such
month is a part) but actual distributions shall be taken into account.
(4) Evidence and terms of obligation. A loan is a producer's loan
only if the loan is evidenced by a note or other evidence of
indebtedness which is made by the borrower and which has a stated
maturity date not more than 5 years from the date the loan is made.
Accordingly, a loan which does not have a stated maturity date or which
has a stated maturity date more than 5 years from the date such loan is
made can never meet the 5-year requirement of this subparagraph. Thus,
for example, even if there is a period of less than 5 years remaining to
the stated maturity date of a loan, the loan can never be a producer's
loan if it had a stated maturity date more than 5 years from the date it
was made. For a further example, if a loan having a period remaining to
maturity of 2 years is extended for a further period of 3 years (making
a total of 5 years to maturity from the date of the extension), the
extension of the loan would under subparagraph (2)(v) of this paragraph
constitute the making of a new producer's loan and the original
producer's loan would terminate. If, however, a loan having a period
remaining to maturity of 2 years is extended for a further period of 4
years (making a total of 6 years to maturity from the date of the
extension), the original producer's loan will terminate and the new loan
will not be a producer's loan. If a producer's loan is not paid in full
at its maturity date and is not formally refinanced, renewed, or
extended, such loan shall be deemed to be a new loan which does not have
a stated maturity date and, thus, will not be a producer's loan. For
purposes of this subparagraph, an evidence of indebtedness is a written
instrument of indebtedness. Section 482 and the regulations thereunder
are applicable to determine, in the case of a loan by the DISC to a
borrower which is owned or controlled directly or indirectly by the same
interests as the DISC within the meaning of section 482, whether the
interest charged on such loan is at an arm's length rate.
(5) Borrower's trade or business. A loan is a producer's loan only
if the loan is made to a person engaged in the United States in the
manufacture, production, growth, or extraction (within the meaning of
Sec. 1.993-3(c)) of export property determined without regard to Sec.
1.993-3(f)(1)(iii) and (iv). The borrower may also be engaged in other
trades or businesses and the loan need not be traceable to specific
investments in export property.
(b) Borrower's export related assets limitation--(1) General rule. A
loan to a borrower is a producer's loan only to the extent that the
amount of the loan, when added to the unpaid balance of all other
producer's loans made by all DISC's to the borrower which are
outstanding at the time the loan is made, does not exceed an amount
equal to the
[[Page 678]]
amount of the borrower's export-related assets (determined under
subparagraph (2) of this paragraph) multiplied by the fraction set forth
in subparagraph (3) of this paragraph.
(2) Amount of export-related assets--(i) In general. For purposes of
subparagraph (1) of this paragraph, the amount of the borrower's export-
related assets is the sum of the amounts described in subdivisions (ii),
(iii), and (iv) of this subparagraph.
(ii) Borrower's plant and equipment. The amount described in this
subdivision is the sum of the borrower's adjusted bases (determined as
of the beginning of the borrower's taxable year in which a loan is made
to it) for plant, machinery, equipment, and supporting production
facilities, which are located in the United States. Supporting
production facilities are all property used primarily in connection with
the manufacture, production, growth, or extraction (within the meaning
of Sec. 1.993-3(c)) or storage, handling, transportation, or assembly
of property by the borrower.
(iii) Borrower's property held primarily for sale or lease. The
amount described in this subdivision is the amount of the borrower's
property (at the beginning of the taxable year of the borrower in which
a loan is made to it) held primarily for sale or lease to customers in
the ordinary course of its trade or business. The amount of such
property held for sale is determined under the methods of identifying
and valuing inventory normally used by the borrower. The amount of such
property held for lease or leased is the borrower's adjusted bases,
determined under section 1011, for such property.
(iv) Borrower's research and experimental expenditures. The amount
described in this subdivision is the aggregate amount, whether or not
charged to capital account, of research and experimental expenditures
(within the meaning of section 174) incurred in the United States by the
borrower during each of its taxable years which begin after December 31,
1971, and precede the taxable year in which the loan is made to the
borrower. Such research and experimental expenditures need bear no
relationship to export property (as defined in Sec. 1.993-3) of the
borrower. The aggregate amount of all such expenditures for each of such
preceding taxable years is taken into account for purposes of this
subparagraph, regardless of whether all or any portion of the aggregate
amount has been taken into account with respect to producer's loans made
to the borrower by any DISC in preceding taxable years. The aggregate
amount of all such expenditures shall include such expenditures of a
corporation, the assets of which were acquired by the borrower in a
distribution or a transfer described in section 381(a)(1) or (2)
(relating to carryovers in certain corporate acquisitions).
(3) Fraction referred to in subparagraph (1) of this paragraph--(i)
Numerator of fraction. The numerator of the fraction set forth in this
subparagraph is the sum of the borrower's gross receipts for each of its
3 taxable years immediately preceding the taxable year in which the loan
is made (but not including any taxable year beginning before January 1,
1972) from the sale or lease of export property (determined without
regard to Sec. 1.993-3(f)(1)(iii) and (iv)) which is manufactured,
produced, grown, or extracted (within the meaning of Sec. 1.993-3(c))
by the borrower whether or not sold or leased directly or through a
related domestic person (notwithstanding Sec. 1.993-3(a)(4) and
(f)(2)). For purposes of the preceding sentence, with respect to a sale
or lease to a related DISC in which the transfer price is determined
under section 994(a)(1) or (2), the rules under Sec. 1.994-1(c)(5)
(relating to incomplete transactions) shall be applied, and with respect
to all other sales and leases the rules under Sec. 1.994-1(c)(5) other
than subdivision (i)(d) thereof shall be applied.
(ii) Denominator of fraction. The denominator of the fraction set
forth in this subparagraph is the sum of the amount included in the
numerator and all other gross receipts of the borrower, for each of its
taxable years for which gross receipts are included in the numerator of
the fraction, from all sales or leases of all property held by the
borrower primarily for sale or lease to customers in the ordinary course
of its trade or business. For purposes of subdivision (i) of this
subparagraph and this subdivision, if such property is sold or leased to
a domestic related
[[Page 679]]
person which resells or subleases such property, the borrower's gross
receipts shall be the gross receipts derived by the domestic related
person from the resale or sublease of the export property.
(iii) Taxable years. If the borrower has not engaged in the sale or
lease of property (as described in this subparagraph) for the 3
immediately preceding taxable years, or if 3 taxable years beginning
after December 31, 1971, have not elapsed, the fraction will be computed
on the basis of such gross receipts for its taxable years immediately
preceding the loan and beginning after December 31, 1971, during which
the borrower has so engaged. No producer's loans can be made to a
borrower until after the end of the first taxable year of the borrower
beginning after December 31, 1971.
(c) Requirement for increased investment in export-related assets--
(1) In general. A loan to a borrower is a producer's loan only to the
extent that the amount of the loan, when added to the unpaid balance of
all other producer's loans made by all DISC's to the borrower during the
borrower's taxable year during which such loan is made, does not exceed
the amount of the borrower's increase for the year in investment in
export-related assets. Such increase for any taxable year is the sum
of--
(i) The increase (if any) in the borrowers adjusted basis of certain
types of assets as determined under subparagraph (2) of this paragraph
and
(ii) The amount (if any) during the year of its research and
experimental expenditures as determined under paragraph (b)(2)(iv) of
this section.
(2) Increase in adjusted basis. The amount under this subparagraph
is the amount (not less than zero) by which--
(i) The borrower's adjusted basis (determined as of the end of its
taxable year in which the producer's loan is made) in all of its
property which is described in paragraph (b)(2)(ii) (plant and
equipment), and (iii) (property held primarily for sale or lease) of
this section, including any such property acquired by it during such
taxable year, exceeds
(ii) Its adjusted bases in all such property (determined as of the
beginning of such year).
(3) Ordering rule. If during the borrower's taxable year the amount
of increase in investment in export-related assets determined under this
subparagraph is exceeded by amounts loaned to the borrower during such
year that would otherwise qualify as producer's loans, such loans shall
be applied in the order made against the amount of such increase in
order to determine which loans qualify as producer's loans.
(d) Proof of borrower's compliance with paragraphs (b) and (c) of
this section. For purposes of paragraphs (b) and (c) of this section, a
DISC shall be prepared to establish initially the compliance of the
borrower with the requirements of such paragraphs by providing the
written statement of the borrower, certified by a certified public
accountant, stating that the borrower has complied with the limitation
and increased investment requirement in section 993(d)(2) and (3) of the
Internal Revenue Code of 1954. In lieu of certification by a certified
public accountant, the DISC may attach to its return a statement signed
by the borrower under penalties of perjury on a form provided by the
Internal Revenue Service certifying that the borrower has complied with
the limitation and increased investment requirement in section 993(d)(2)
and (3) of the Internal Revenue Code of 1954. For taxable years ending
after October 17, 1977, the DISC must attach either the certification by
the certified public accountant or the certification by the borrower to
its return. Additional full substantiation of the borrower's compliance
with the requirements of such paragraphs may be required by the district
director. If full substantiation of such compliance is not provided by
the DISC (or the borrower) when required, the loan shall be deemed not
to be a producer's loan.
(e) Special limitation in the case of domestic film maker--(1)
General rule. The limitation of paragraph (b) of this section as to the
export-related assets of the borrower will be considered satisfied if
the DISC--
[[Page 680]]
(i) Is engaged in the trade or business of selling or leasing films
which are export property, or is acting as a commission agent for a
person who is so engaged,
(ii) Makes a loan to a borrower which is a domestic film maker (as
defined in subparagraph (5) of this paragraph) for the purpose of making
a film, and
(iii) The amount of such loan, when added to the unpaid balance of
all other producer's loans made by all DISC's to the borrower which are
outstanding at the time the loan is made, does not exceed an amount
determined by multiplying--
(a) The sum of (1) the amount of the export-related assets of the
borrower (determined under paragraph (b)(2)(i) of this section as of the
beginning of the borrower's taxable year in which the loan is made),
plus (2) the amount of a reasonable estimate of the amount of such
export related assets obtained or to be obtained by the borrower during
such year and subsequent years with respect to films as to which filming
begins within such year by
(b) The percentage which, based on the experience of other film
makers of similar films for the 5 calendar years preceding the calendar
year in which the loan is made, the annual gross receipts (as described
in Sec. 1.993-6(a)(1), whether or not such films constitute property
described therein) of such other film makers from the sale or lease of
such films outside the United States is of the annual gross receipts of
such other film makers from all sales or leases of such films.
(2) Purpose of loan. A loan by a DISC will be deemed to be for the
making of a film if there exists a written agreement between the DISC
and the borrower, executed at or before the time the loan is made,
stating that the loan is made or to be made to enable the borrower to
make such film.
(3) Reasonable estimate of amounts. For purposes of subparagraph
(1)(iii)(a)(2) of this paragraph, a reasonable estimate shall be based
on the conditions known by the DISC and borrower to exist at the time a
loan is made (or which the DISC and borrower have reason to know to
exist at such time).
(4) Experience of film makers. For purposes of subparagraph
(1)(iii)(b) of this paragraph, the experience of other film makers of
similar films for the 5 calendar years preceding the calendar year in
which the loan is made shall be derived from such records and statistics
as are acknowledged in the trade as reasonably reliable.
(5) Domestic film maker. For purposes of this section, a borrower is
a domestic film maker with respect to a film if--
(i) The borrower is a U.S. person within the meaning of section
7701(a)(30), except that (a) with respect to a partnership all of the
partners must be U.S. persons and (b) with respect to a corporation all
of its officers and at least a majority of its directors must be U.S.
persons,
(ii) The borrower is engaged in the trade or business of making the
film with respect to which the loan is made,
(iii) Each studio, if any, used or to be used for filming or for
recording sound incorporated into such film is located in the United
States (as defined in section 7701(a)(9)),
(iv) At least 80 percent of the aggregate playing time of the film
is or will be photographed within the United States (as defined in
section 7701(a)(9)), and
(v) At least 80 percent of the total amount (not including any
amount which is contingent upon receipts or profits of such film and
which is fully taxable by the United States) paid or to be paid for
services performed in the making of the film is either paid or to be
paid to persons who are U.S. persons at the time such services are
performed or consists of amounts which are fully taxable by the United
States.
(6) Amounts as fully taxable. For purposes of subparagraph (5)(v) of
this paragraph, an amount is considered fully taxable by the United
States if the entire amount is included in gross income under section 61
or is subject to withholding under any provision of U.S. law or treaty
to which the U.S. is a party and is not exempt from taxation under any
provision of such law or treaty. Where a nonresident alien individual is
engaged for the making of a film or where a foreign corporation is
engaged to furnish the services of one of its officers or employees for
the making of a film, the amount paid such
[[Page 681]]
individual or corporation will be considered as fully taxable by the
United States only if it meets the test of this subparagraph.
[T.D. 7514, 42 FR 55464, Oct. 17, 1977, as amended by T.D. 7513, 42 FR
57311, Nov. 2, 1977; T.D. 7514, 42 FR 60910, Nov. 30, 1977; T.D. 7854,
47 FR 51741, Nov. 17, 1982]
Sec. 1.993-5 Definition of related foreign export corporation.
(a) General rule--(1) Definition. Under section 993(e), a foreign
corporation is a related foreign export corporation with respect to a
DISC if--
(i) It is a foreign international sales corporation described in
paragraph (b) of this section,
(ii) It is a real property holding company described in paragraph
(c) of this section, or
(iii) It is an associated foreign corporation described in paragraph
(d) of this section.
(2) Application of this section. It is necessary to determine
whether a foreign corporation is a related foreign export corporation
with respect to a DISC for the following two purposes:
(i) Qualified export assets. Under Sec. 1.993-2(g), the stock or
securities of a related foreign export corporation held by the DISC are
qualified export assets.
(ii) Qualified export receipts. Under Sec. 1.993-1 (e), (f), and
(g), certain receipts of the DISC with respect to stock or securities of
a related foreign export corporation held by the DISC are qualified
export receipts.
(b) Foreign international sales corporation--(1) In general. A
foreign corporation is a foreign international sales corporation with
respect to a taxable year of a DISC if--
(i) On each day during such taxable year of the DISC on which the
foreign corporation has stock issued and outstanding, the DISC owns
directly stock of the foreign corporation possessing more than 50
percent of the total combined voting power of all classes of stock of
the foreign corporation entitled to vote as determined under the
principles of Sec. 1.957-1(b) (relating to definition of controlled
foreign corporation),
(ii) 95 percent or more of such foreign corporation's gross receipts
(as defined in Sec. 1.993-6) for its taxable year ending with or within
such taxable year of the DISC consists of qualified export receipts
described in Sec. 1.993-1 (b) through (e) or interest described in
Sec. 1.993-1(g) derived from any obligations described in Sec. 1.993-2
(d) or (e), and
(iii) The sum of the adjusted bases of the assets of the foreign
corporation which are qualified export assets described in Sec. 1.993-2
(b) through (e) and which are held by the foreign corporation at the
close of its taxable year which ends with or within such taxable year of
the DISC equals or exceeds 95 percent of the sum of the adjusted bases
of all assets held by the foreign corporation at the close of such
taxable year.
(2) Certain determinations. The determinations as to whether gross
receipts are qualified export receipts described in subparagraph (1)(ii)
of this paragraph and as to whether assets are qualified export assets
described in subparagraph (1)(iii) of this paragraph are made by
applying the requirements of Sec. Sec. 1.993-1 and 1.993-2 to the
foreign corporation as if it were a domestic corporation being tested to
determine whether it is a DISC. For purposes of making either of such
determinations, the principles of accounting applicable for purposes of
computing earnings and profits under Sec. 1.964-1 (relating to a
controlled foreign corporation's earnings and profits) shall apply.
(c) Real property holding company--(1) In general. A foreign
corporation is a real property holding company with respect to a taxable
year of a DISC if--
(i) On each day during such taxable year of the DISC on which the
foreign corporation has stock issued and outstanding, the DISC owns
directly stock of the foreign corporation possessing more than 50
percent of the total combined voting power of all classes of stock of
the foreign corporation entitled to vote as determined under the
principles of Sec. 1.957-1(b) and
(ii) The sole function of the foreign corporation is to hold title
to real property situated outside the United States for the exclusive
use of the DISC, title to which may not be held by the DISC (and, if the
DISC subleases such property to a related supplier, as described in
subparagraph (3) of this paragraph, by such related supplier)
[[Page 682]]
under the law of the country in which such property is situated.
(2) Activities of the foreign corporation. For purposes of
subparagraph (1)(ii) of this paragraph, a foreign corporation which
holds title to real property situated outside the United States may also
perform activities with respect to such property (such as management,
maintenance, and payment of taxes) which are ancillary to its function
of holding title to such property.
(3) Exclusive use by the DISC. Real property held by the foreign
corporation must be used exclusively by the DISC whether under a lease
or any other arrangement. Real property is not so used by the DISC if
the DISC subleases such property to any other person. If, however,
during a taxable year of the DISC--
(i) 90 percent or more of the qualified export receipts of the DISC
for such year are derived from transactions with respect to which it is
a commission agent for a related supplier (as defined in Sec. 1.994-
1(a)(3)(ii)), and
(ii) The DISC subleases such property to such related supplier
then such property will be considered as used exclusively by the DISC
during such year if such related supplier does not sublease such
property.
(d) Associated foreign corporation--(1) In general. A foreign
corporation is an associated foreign corporation with respect to a
taxable year of the DISC if--
(i) On each day during such taxable year of the DISC on which the
foreign corporation has stock issued and outstanding, the DISC, or one
or more members of the same controlled group of corporations (as defined
in subparagraph (2) of this paragraph) as the DISC, owns (within the
meaning of section 1563 (d) and (e)) stock of the foreign corporation
possessing less than 10 percent of the total combined voting power of
all classes of stock of the foreign corporation entitled to vote, as
determined under the principles of Sec. 1.957-1(b), or owns no stock of
such corporation, and
(ii) The ownership of stock, or of securities (as defined in Sec.
1.993-2(g)), of the foreign corporation by the DISC or by one or more
members of such controlled group of corporations reasonably furthers a
transaction or transactions giving rise to qualified export receipts for
the DISC.
(2) Controlled group of corporations. For purposes of this
paragraph, the term ``controlled group of corporations'' has the same
meaning assigned to the term in section 1563(a) and not section
993(a)(3) and Sec. 1.993-1(k). Thus, for purposes of this paragraph,
the test of control is 80 percent control and, since the rules of
section 1563(b) apply, only domestic members are considered to be
members of the controlled group.
(3) Furtherance of qualified export receipts. Ownership of stock or
securities of a foreign corporation will be considered as reasonably
furthering a transaction or transactions giving rise to qualified export
receipts for a DISC if--
(i) The ownership is necessary to obtain or maintain the foreign
corporation as a customer of the DISC or of a related supplier, as
defined in Sec. 1.994-1(a)(3)(ii) of the DISC or to aid the sales
distribution system of the DISC or of such related supplier, and
(ii) The amount of the investment in the foreign corporation bears a
reasonable relationship to the amount of the DISC's annual net profit
from transactions in its trade or business which it may reasonably
expect to derive on account of such ownership.
In determining whether the amount of the investment is reasonable, there
shall be taken into account any stock or securities of the foreign
corporation owned by any other foreign corporation which, if it were a
domestic corporation, would be a member of the same controlled group of
corporations as the DISC.
[T.D. 7514, 42 FR 55467, Oct. 17, 1977; 42 FR 60910, Nov. 30, 1977]
Sec. 1.993-6 Definition of gross receipts.
(a) General rule. Under section 993(f), for purposes of sections 991
through 996, the gross receipts of a person for a taxable year are--
(1) The total amounts received or accrued by the person from the
sale or lease of property held primarily for sale or lease in the
ordinary course of a trade or business, and
(2) Gross income recognized from all other sources, such as, for
example, from--
[[Page 683]]
(i) The furnishing of services (whether or not related to the sale
or lease of property described in subparagraph (1) of this paragraph),
(ii) Dividends and interest,
(iii) The sale at a gain of any property not described in
subparagraph (1) of this paragraph, and
(iv) Commission transactions as and to the extent described in
paragraph (e) of this section.
(b) Nongross receipts items. For purposes of paragraph (a) of this
section, gross receipts do not include amounts received or accrued by a
person from--
(1) The proceeds of a loan or of the repayment of a loan, or
(2) A receipt of property in a transaction to which section 118
(relating to contribution to capital) or 1032 (relating to exchange of
stock for property) applies.
(c) Nonreduction of total amounts. For purposes of paragraph (a) of
this section, the total amounts received or accrued by a person are not
reduced by returns and allowances, costs of goods sold, expenses,
losses, a deduction for dividends received under section 243, or any
other deductible amounts.
(d) Method of accounting. For purposes of paragraph (a) of this
section, the total amounts received or accrued by a person shall be
determined under the method of accounting used in computing its taxable
income. If, for example, a DISC receives advance or installment payments
for the sale or lease of property described in paragraph (a)(1) of this
section, for the furnishing of services, or which represent recognized
gain from the sale of property not described in paragraph (a)(1) of this
section, any amount of such advance payments is considered to be gross
receipts of the DISC for the taxable year for which such amount is
included in the gross income of the DISC.
(e) Commission transactions. (1) In the case of transactions which
give rise to a commission on the sale or lease of property or the
furnishing of services by a principal, the amount recognized by the
commission agent as gross income from all such transactions shall be the
gross receipts derived by the principal from the sale or lease of the
property, or the gross income derived by the principal from the
furnishing of services, with respect to which the commissions are
derived. In the case of a commission agent for a related supplier (as
defined in Sec. 1.994-1(a)(3)(ii)), the gross receipts or gross income
of such agent shall be determined as if it used the same method of
accounting as its related supplier. In the case of a commission agent
for a principal other than a related supplier, the gross receipts or
gross income of such principal shall be determined as if such principal
used the same method of accounting as its agent.
(2) If the commission arrangement provides that the commission agent
will receive a commission only with respect to sales or leases of export
property, or the furnishing of services, which result in qualified
export receipts, the commission agent will not take into account the
gross receipts or gross income, as the case may be, derived by the
principal from any transaction for which the commission agent would not
be entitled to a commission under the commission arrangement.
(f) Example. The provisions of this section may be illustrated by
the following example:
Example. During 1973, M, a related supplier (as defined in Sec.
1.994-1(a)(3)(ii)) of N, is engaged in the manufacture of machines in
the United States. N, a calendar year taxpayer, is engaged in the sale
and lease of such machines in foreign countries. N furnishes services
which are related and subsidiary to its sale and lease of such machines.
N also acts as a commission agent in foreign countries for Z, an
unrelated supplier, with respect to Z's sale of products. N receives
dividends on stock owned by it in a related foreign export corporation
(as defined in Sec. 1.993-5), interest on producer's loans made to M,
and proceeds from sales of business assets located outside the United
States resulting in a recognized gains and losses. N's gross receipts
for 1973 are $3,550, computed on the basis of the additional facts
assumed in the table below:
(1) N's sales receipts for machines manufactured by M (without $1,500
reduction for cost of goods sold and selling expenses)........
(2) N's lease receipts for machines manufactured by M (without 500
reduction for depreciation and leasing expenses)..............
(3) N's gross income from services for machines manufactured by 400
M (without reduction for service expenses)....................
(4) Z's sale receipts for products manufactured by Z (without 550
reduction for Z's cost of goods sold, commissions on sales,
and commission sales expenses)................................
(5) Dividends received by N.................................... 150
(6) Interest received by N on producer's loans................. 200
[[Page 684]]
(7) Proceeds received by N representing recognized gain (but 250
not losses) from sales of business assets located outside the
United States.................................................
--------
(8) N's gross receipts......................................... 3,550
========
[T.D. 7514, 42 FR 55468, Oct. 17, 1977]
Sec. 1.993-7 Definition of United States.
Under section 993(g), the term ``United States'' includes the
States, the District of Columbia, the Commonwealth of Puerto Rico, and
possessions of the United States. For the requirement that a DISC must
be incorporated and existing under the laws of a State or the District
of Columbia, see Sec. 1.992-1(a)(1).
[T.D. 7514, 42 FR 55468, Oct. 17, 1977]
Sec. 1.994-1 Inter-company pricing rules for DISC's.
(a) In general--(1) Scope. In the case of a transaction described in
paragraph (b) of this section, section 994 permits a person related to a
DISC to determine the allowable transfer price charged the DISC (or
commission paid the DISC) by its choice of three methods described in
paragraph (c)(2), (3), and (4) of this section: The ``4 percent'' gross
receipts method, the ``50-50'' combined taxable income method, and the
section 482 method. Under the first two methods, the DISC is entitled to
10 percent of its export promotion expenses as additional taxable
income. When the gross receipts method or combined taxable income method
is applied to a transaction, the Commissioner may not make
distributions, apportionments, or allocations as provided by section 482
and the regulations thereunder. For rules as to certain ``incomplete
transactions'' and for computing combined taxable income, see paragraph
(c)(5) and (6) of this section. Grouping of transactions for purposes of
applying the method chosen is provided by paragraph (c)(7) of this
section. The rules in paragraph (c) of this section are directly
applicable only in the case of sales or exchanges of export property to
a DISC for resale, and are applicable by analogy to leases, commissions,
and services as provided in paragraph (d) of this section. For rules
limiting the application of the gross receipts method and combined
taxable income method so that the supplier related to the DISC will not
incur a loss on transactions, see paragraph (e)(1) of this section.
Paragraph (e)(2) of this section provides for the applicability of
section 482 to resales by the DISC to related persons. Paragraph (e)(3)
of this section provides for the time by which a reasonable estimate of
the transfer price (including commissions and other payments) should be
paid. The subsequent determination and further adjustments to transfer
prices are set forth in paragraph (e)(4) of this section. Export
promotion expenses are defined in paragraph (f) of this section.
Paragraph (g) of this section has several examples illustrating the
provisions of this section. Section 1.994-2 prescribes the marginal
costing rules authorized by section 994(b)(2).
(2) Performance of substantial economic functions. The application
of section 994(a)(1) or (2) does not depend on the extent to which the
DISC performs substantial economic functions (except with respect to
export promotion expenses). See paragraph (l) of Sec. 1.993-1.
(3) Related party and related supplier. For the purposes of this
section--
(i) The term ``related party'' means a person which is owned or
controlled directly or indirectly by the same interests as the DISC
within the meaning of section 482 and Sec. 1.482-1(a).
(ii) The term ``related supplier'' means a related party which
singly engages in a transaction directly with the DISC which is subject
to the rules of section 994 and this section. However, a DISC may have
different related suppliers with respect to different transactions. If,
for example, X owns all the stock of Y, a corporation, and of Z, a DISC,
and sells a product to Y which is resold to Z, only Y is the related
supplier of Z, and, thus, only the resale from Y to Z is subject to
section 994 and this section. If, however, X sells directly to Z and Y
also sells directly to Z, then, as to the transactions involving direct
sales to Z, each of X and Y is a related supplier of Z.
(b) Transactions to which section 994 applies. Section 994(a)(3) may
be applied, as described in paragraph (a) of this section, to any
transaction between a related supplier and a DISC. Section 994(a)(1) or
(2) may be applied,
[[Page 685]]
as described in paragraph (a) of this section, to a transaction between
a related supplier and a DISC only in the following cases:
(1) Where the related supplier sells export property to the DISC for
resale or where the DISC is commission agent for the related supplier on
sales by the related supplier of export property to third parties
whether or not related parties. For purposes of this section, references
to sales include exchanges.
(2) Where the related supplier leases export property to the DISC
for sublease for a comparable period with comparable terms of payment or
where the DISC is commission agent for the related supplier on leases by
the related supplier of export property to third parties whether or not
related parties.
(3) Where services are furnished by a related supplier which are
related and subsidiary to any sale or lease by the DISC, acting as
principal or commission agent, of export property under subparagraph (1)
or (2) of this paragraph.
(4) Where engineering or architectural services for construction
projects located (or proposed for location) outside of the United States
are furnished by a related supplier where the DISC is acting as
principal or commission agent with respect to the furnishing of such
services to a third party whether or not a related party.
(5) Where the related supplier furnishes managerial services in
furtherance of the production of qualified export receipts of an
unrelated DISC where the related DISC is acting as principal or
commission agent with respect to the furnishing of such services to an
unrelated DISC.
Transactions are included, for purposes of this paragraph, only if they
give rise to qualified export receipts (within the meaning of section
993(a)) in the hands of the related DISC. If a transaction is not
included in subparagraph (1), (2), (3), (4), or (5) of this paragraph,
the rules of section 994(a)(1) or (2) do not apply. Thus, for example,
the rules of sectoin 994(a)(1) or (2) would not apply if a DISC
purchased export property from its related supplier and leased such
property to a third party.
(c) Transfer price for sales of export property--(1) In general.
Under this paragraph, rules are prescribed for computing the allowable
price for a transfer from a related supplier to a DISC in the case of a
sale of export property described in paragraph (b)(1) of this section.
(2) The ``4-percent'' gross receipts method. Under the gross
receipts method of pricing, the transfer price for a sale by the related
supplier to the DISC is the price as a result of which the taxable
income derived by the DISC from the sale will not exceed the sum of (i)
4 percent of the qualified export receipts of the DISC derived from the
sale of the export property (as defined in section 993 (c)) and (ii) 10
percent of the export promotion expenses (as defined in paragraph (f) of
this section) of the DISC attributable to such qualified export
receipts.
(3) The ``50-50'' combined taxable income method. Under the combined
taxable income method of pricing, the transfer price for a sale by the
related supplier to the DISC is the price as a result of which the
taxable income derived by the DISC from the sale will not exceed the sum
of (i) 50 percent of the combined taxable income (as defined in
subparagraph (6) of this paragraph) of the DISC and its related supplier
attributable to the qualified export receipts from such sale and (ii) 10
percent of the export promotion expenses (as defined in paragraph (f) of
this section) of the DISC attributable to such qualified export
receipts.
(4) Section 482 method. If the rules of subparagraphs (2) and (3) of
this paragraph are inapplicable to a sale or a taxpayer does not choose
to use them, the transfer price for a sale by the related supplier to
the DISC is to be determined on the basis of the sale price actually
charged but subject to the rules provided by section 482 and the
regulations thereunder.
(5) Incomplete transactions. (i) For purposes of the gross receipts
and combined taxable income methods, where property (encompassed within
a transaction or group chosen under subparagraph (7) of this paragraph)
is transferred by a related supplier to a DISC during a taxable year of
either the DISC or related supplier, but some or
[[Page 686]]
all of such property is not sold by the DISC during such year--
(a) The transfer price of such property sold by the DISC during such
year shall be computed separately from the transfer price of the
property not sold by the DISC during such year,
(b) With respect to such property not sold by the DISC during such
year, the transfer price paid by the DISC for such year shall be the
related supplier's cost of goods sold (see subparagraph (6)(ii) of this
paragraph) with respect to the property, except that, with respect to
such taxable years ending on or before August 15, 1975, the transfer
price paid by the DISC shall be at least (but need not exceed) the
related supplier's cost of goods sold with respect to the property.
(c) For the subsequent taxable year during which such property is
resold by the DISC, an additional amount shall be paid by the DISC (to
be treated as income for such year by the related supplier) equal to the
excess of the amount which would have been the transfer price under this
section had the transfer to the DISC by the related supplier and the
resale by the DISC taken place during the taxable year of the DISC
during which it resold the property over the amount already paid under
(b) of this subdivision.
(d) The time and manner of payment of transfer prices required by
(b) and (c) of this subdivision shall be determined under paragraphs
(e)(3), (4), and (5) of this section.
(ii) For purposes of this paragraph, a DISC may determine the year
in which it receives property from a related supplier and the year in
which it sells property in accordance with the method of identifying
goods in its inventory properly used under section 471 or 472 (relating
respectively to general rule for inventories and to LIFO inventories).
Transportation expense of the related supplier in connection with a
transaction to which this subparagraph applies shall be treated as an
item of cost of goods sold with respect to the property if the related
supplier includes the cost of intracompany transportation between its
branches, divisions, plants, or other units in its cost of goods sold
(see subparagraph (6)(ii) of this paragraph).
(6) Combined taxable income. For purposes of this section, the
combined taxable income of a DISC and its related supplier from a sale
of export property is the excess of the gross receipts (as defined in
section 993(f)) of the DISC from such sale over the total costs of the
DISC and related supplier which relate to such gross receipts. Gross
receipts from a sale do not include interest with respect to the sale.
Combined taxable income under this paragraph shall be determined after
taking into account under paragraph (e)(2) of this section all
adjustments required by section 482 with respect to transactions to
which such section is applicable. In determining the gross receipts of
the DISC and the total costs of the DISC and related supplier which
relate to such gross receipts, the following rules shall be applied:
(i) Subject to subdivisions (ii) through (v) of this subparagraph,
the taxpayer's method of accounting used in computing taxable income
will be accepted for purposes of determining amounts and the taxable
year for which items of income and expense (including depreciation) are
taken into account. See Sec. 1.991-1(b)(2) with respect to the method
of accounting which may be used by a DISC.
(ii) Cost of goods sold shall be determined in accordance with the
provisions of Sec. 1.61-3. See sections 471 and 472 and the regulations
thereunder with respect to inventories. With respect to property to
which an election under section 631 applies (relating to cutting of
timber considered as a sale or exchange), cost of goods sold shall be
determined by applying Sec. 1.631-1(d)(3) and (e) (relating to fair
market value as of the beginning of the taxable year of the standing
timber cut during the year considered as its cost).
(iii) Costs (other than cost of goods sold) which shall be treated
as relating to gross receipts from sales of export property are (a) the
expenses, losses, and other deductions definitely related, and therefore
allocated and apportioned, thereto, and (b) a ratable part of any other
expenses, losses, or
[[Page 687]]
other deductions which are not definitely related to a class of gross
income, determined in a manner consistent with the rules set forth in
Sec. 1.861-8.
(iv) The taxpayer's choice in accordance with subparagraph (7) of
this paragraph as to the grouping of transactions shall be controlling,
and costs deductible in a taxable year shall be allocated and
apportioned to the items or classes of gross income of such taxable year
resulting from such grouping.
(v) If an account receivable arising with respect to a sale of
export property is transferred by the related supplier to a DISC which
is a member of the same controlled group within the meaning of Sec.
1.993-1(k) for an amount reflecting a discount from the selling price
taken into account in computing (without regard to this subdivision)
combined taxable income of the DISC and its related supplier, then the
combined taxable income from such sale shall be reduced by the amount of
the discount.
(7) Grouping transactions. (i) Generally, the determinations under
this section are to be made on a transaction-by-transaction basis.
However, at the annual choice of the taxpayer some or all of these
determinations may be made on the basis of groups consisting of products
or product lines.
(ii) A determination by a taxpayer as to a product or a product line
will be accepted by a district director if such determination conforms
to any one of the following standards: (a) A recognized industry or
trade usage, or (b) the 2-digit major groups (or any inferior
classifications or combinations thereof, within a major group) of the
Standard Industrial Classification as prepared by the Statistical Policy
Division of the Office of Management and Budget, Executive Office of the
President.
(iii) A choice by the taxpayer to group transactions for a taxable
year on a product or product line basis shall apply to all transactions
with respect to that product or product line consummated during the
taxable year. However, the choice of a product or product line grouping
applies only to transactions covered by the grouping and, as to
transactions not encompassed by the grouping, the determinations are
made on a transaction-by-transaction basis. For example, the taxpayer
may choose a product grouping with respect to one product and use the
transaction-by-transaction method for another product within the same
taxable year.
(iv) For rules as to grouping certain related and subsidiary
services, see paragraph (d)(3)(ii) of this section.
(d) Rules under section 994(a)(1) and (2) for transactions other
than sales. The following rules are prescribed for purposes of applying
the gross receipts method or combined taxable income method to
transactions other than sales:
(1) Leases. In the case of a lease of export property by a related
supplier to a DISC for sublease by the DISC to produce gross receipts,
for any taxable year the amount of rent the DISC must pay to the related
supplier shall be determined under the DISC's lease with its related
supplier but must be computed in a manner consistent with the rules in
paragraph (c) of this section for computing the transfer price in the
case of sales and resales of export property under the gross receipts
method or combined taxable income method. For purposes of applying this
subparagraph, transactions may not be so grouped on a product or product
line basis under the rules of paragraph (c)(7) of this section as to
combine in any one group of transactions both lease transactions and
sale transactions involving the same product or product line.
(2) Commissions. If any transaction to which section 994 applies is
handled on a commission basis for a related supplier by a DISC and such
commissions give rise to qualified export receipts under section
993(a)--
(i) The amount of the income that may be earned by the DISC in any
year is the amount, computed in a manner consistent with paragraph (c)
of this section, which the DISC would have been permitted to earn under
the gross receipts method, the combined taxable income method, or
section 482 method if the related supplier had sold (or leased) the
property or service to the DISC and the DISC in turn sold (or subleased)
to a third party, whether or not a related party, and
[[Page 688]]
(ii) The maximum commission the DISC may charge the related supplier
is the sum of the amount of income determined under subdivision (i) of
this subparagraph plus the DISC's total costs for the transaction as
determined under paragraph (c)(6) of this section.
(3) Receipts from services--(i) Related and subsidiary services
attributable to the year of the export transaction. The gross receipts
for related and subsidiary services described in paragraph (b)(3) of
this section shall be treated as part of the receipts from the export
transaction to which such services are related and subsidiary, but only
if, under the arrangement between the DISC and its related supplier and
the accounting method otherwise employed by the DISC, the income from
such services is includible for the same taxable year as income from
such export transaction.
(ii) Other services. In the case of related and subsidiary services
to which subdivision (i) of this subparagraph does not apply and other
services described in paragraph (b)(4) or (5) of this section performed
by a related supplier (relating respectively to engineering and
architectural services and certain managerial services), the amount of
taxable income which the DISC may derive for any taxable year shall be
determined under the arrangement between the DISC and its related
supplier and shall be computed in a manner consistent with the rules in
paragraph (c) of this section for computing the transfer price in the
case of sales for resale of export property under the gross receipts
method or combined taxable income method. Related and subsidiary
services to which subdivision (i) of this subparagraph does not apply
may be grouped, under the rules for grouping of transactions in
paragraph (c)(7) of this section, with the products or product lines to
which they are related and subsidiary, so long as the grouping of
services chosen is consistent with the grouping of products or product
lines chosen for the taxable year in which either the product or product
lines were sold or in which payment for such services is received or
accrued. The rules for grouping of transactions in paragraph (c)(7) of
this section shall not apply with respect to the determination of
taxable income which the DISC may derive from other services described
in paragraph (b)(4) or (5) of this section performed by a related
supplier or commissions on such services, and such determination shall
be made only on a transaction-by-transaction basis.
(e) Methods of applying paragraphs (c) and (d) of this section--(1)
Limitation on DISC income (``no loss'' rule)--(i) In general. Except as
otherwise provided in this subparagraph, neither the gross receipts
method nor the combined taxable income method may be applied to cause in
any taxable year a loss to the related supplier, but either method may
be applied to the extent it does not cause a loss. A loss to a related
supplier would result if the taxable income of the DISC would exceed the
combined taxable income of the related supplier and the DISC. If,
however, there is no combined taxable income of the DISC and the related
supplier (because, for example, a combined loss is incurred), a transfer
price (or commission) will not be deemed to cause a loss to the related
supplier if it allows the DISC to recover an amount not in excess of its
costs (if any).
(ii) Special rule for applying ``4 percent'' gross receipts method
to sales. A transfer price or commission, determined under the ``4
percent'' gross receipts method (determined without regard to
subdivision (i) of this subparagraph), for a sale of export property
referred to in paragraph (b)(1) of this section, will not be considered
to cause a loss for the related supplier if for the DISC's taxable year,
the ratio that (a) the taxable income of the DISC derived from such sale
by using such price or commission bears to (b) the DISC's gross receipts
from such sale is not greater than the ratio that (c) all of the taxable
income of the related supplier and the DISC from all sales of the same
product or product line (domestic and foreign) to third parties whether
or not related parties bears to (d) the total gross receipts of the
related supplier and the DISC from such sales. For purposes of the
preceding sentence, sales between the DISC and its related suppliers
shall not be taken into account under (c) or (d) of this subdivision.
For example, assume that for a taxable year of a DISC the total costs
[[Page 689]]
of the related supplier and the DISC with respect to all sales ($150 for
domestic and $44 for foreign) of a product line are $194 and the total
gross receipts of the related supplier and the DISC with respect to such
sales are $200 so that the total taxable income of the related supplier
and the DISC with respect to such sales is $6. The parties would thus be
entitled to compute a transfer price determined under the gross receipts
method on any given sale of product A of such product line by the
related supplier to the DISC which would allocate to the DISC taxable
income equal to not more than 3 percent (i.e., $6/$200) of its gross
receipts derived from its resale of such product. If the DISC were to
resell an item of product A for $10, the transfer price paid by the DISC
to the related supplier determined under the gross receipts method could
be as low as $9.70.
(iii) Grouping transactions. For purposes of subdivision (i) of this
subparagraph, the basis for grouping transactions chosen by the taxpayer
under paragraph (c)(7) of this section for the taxable year shall be
applied. For purposes of making the computations of subdivision (ii) (c)
and (d) of this subparagraph, however, the taxpayer may choose any basis
for grouping transactions permissible under paragraph (c)(7) of this
section, even though it may not be the same basis as that already chosen
under paragraph (c)(7) of this section for computing transfer prices or
commissions to a DISC. If, for example, the taxpayer has chosen to group
transactions on a product basis for computing transfer prices or
commissions to a DISC for a taxable year, the taxpayer may still group
transactions on a product line basis for purposes of computing taxable
income and total gross receipts under subdivision (ii) (c) and (d) of
this subparagraph. For a further example, if the taxpayer computes
taxable income for one group of transactions under the gross receipts
method and computes taxable income for a second group of transactions
under the combined taxable income method, the taxpayer may aggregate
these transactions for purposes of computing taxable income and total
gross receipts under subdivision (ii) (c) and (d) of this subparagraph.
(2) Relationship to section 482. In applying the rules under section
994, it may be necessary to first take into account the price of a
transfer (or other transaction) between the DISC (or related supplier)
and a related party which is subject to the arm's length standard of
section 482. Thus, for example, where a related supplier sells export
property to a DISC which the related supplier purchased from related
parties, the costs taken into account in computing the combined taxable
income of the DISC and the related supplier are determined after any
necessary adjustment under section 482 of the price paid by the related
supplier to the related parties. In applying section 482 to a transfer
by a DISC, however, the DISC and its related supplier are treated as if
they were a single entity carrying on all the functions performed by the
DISC and the related supplier with respect to the transaction and the
DISC shall be allowed to receive under the section 482 standard the
amount the related supplier would have received had there been no DISC.
(3) Initial payment of transfer price or commission. (i) The amount
of a transfer price (or reasonable estimate thereof) actually charged by
a related supplier to a DISC, or a sales commission (or reasonable
estimate thereof) actually charged by a DISC to a related supplier, in a
transaction to which section 994 applies must be paid no later than 60
days following the close of the taxable year of the DISC during which
the transaction occurred.
(ii) Payment must be in the form of money, property (including
accounts receivable from sales by or through the DISC), a written
obligation which qualifies as debt under the safe harbor rule of Sec.
1.992-1(d)(2)(ii), or an accounting entry offsetting the account
receivable against an existing debt owed by the person in whose favor
the account receivable was established to the person with whom it
engaged in the transaction. The form of the payment to a DISC need not
be a qualified export asset under Sec. 1.993-2. However, for the
requirement that the adjusted basis of the qualified export assets of
the DISC at the close of its taxable year must equal or exceed 95
percent of the sum of the adjusted bases of all assets of the
[[Page 690]]
DISC at the close of its taxable year, see section 992(a)(1)(B).
(iii) If the district director can demonstrate, based upon the data
available as of the 60th day after the close of such taxable year, that
the amount actually paid did not represent a reasonable estimate of the
transfer price or commission (as the case may be) to be determined under
section 994 and this section, an indebtedness will be deemed to arise,
from the person required to make the payment in favor of the person to
whom the payment is required to be made, in an amount equal to the
difference between the amount of the transfer price or commission
determined under section 994 and this section and the amount (if any)
actually paid and received. Such indebtedness will be deemed to arise as
of the date the transaction occurred which gave rise to the
indebtedness, except that, if such transaction occurred in a taxable
year of the DISC ending on or before August 15, 1975, at the taxpayer's
option, the indebtedness will be deemed to arise as of the date by which
payment was required under subdivision (i) of this paragraph (e)(3).
Such indebtedness owed to a DISC shall be treated as an asset but shall
not be treated as a trade receivable or other qualified export asset
(see Sec. 1.993-2(d)(3)) as of the end of the taxable year of the DISC
in which the indebtedness is deemed to arise.
(iv)(a) Except with respect to incomplete transactions to which
paragraph (c)(5)(i)(b) of this section applies, if the amount actually
paid results in the DISC realizing at least 50 percent of the DISC's
taxable income from the transaction as reported in its tax return for
the taxable year the transaction is completed, then the amount actually
paid shall be deemed to be a reasonable estimate of such transfer price
or commission.
(b) With respect to incomplete transactions to which paragraph
(c)(5)(i)(b) of this section applies and which were initiated during a
taxable year ending after August 15, 1975, the amount actually paid
shall be deemed to be a reasonable estimate of such transfer price if
any one of the following three tests is met:
(1) The amount actually paid by the DISC to the related supplier in
respect of the property does not exceed the related supplier's cost of
goods sold (see paragraph (c)(6)(ii) of this section) with respect to
the property.
(2) If the transaction is completed by the date on which the DISC's
return is required to be filed for the year in which the transaction was
initiated, the amount actually paid by the DISC to the related supplier
in respect of the property results in the DISC realizing at least 50
percent of the DISC's taxable income from the transaction when
completed.
(3) The percentage that (i) an amount equal to (a) the amount
actually paid by the DISC to the related supplier in respect of the
property minus (b) the related supplier's cost of goods sold with
respect to the property, bears to (ii) the related supplier's cost of
goods sold in respect of the property, is not greater than 50 percent of
the percentage that (iii) the combined taxable income for completed
transactions of the same group as the property during the DISC's taxable
year in which the incomplete transaction was initiated, bears to (iv)
the cost of goods sold of the related supplier and DISC with respect to
such transactions.
(c) For purposes of this subdivision (iv), whether the transfer
price or commission actually paid is deemed a reasonable estimate may be
determined on the basis for grouping transactions chosen by the taxpayer
under paragraph (c)(5) and (7) of this section.
(v) An indebtedness arising under subdivision (iii) of this
subparagraph shall bear interest at an arm's length rate, computed in
the manner provided by Sec. 1.482-2(a)(2) from the 61st day after the
close of the DISC's taxable year in which the transaction occurred which
gave rise to the indebtedness to the date of payment. The interest so
computed shall be accrued and included in the taxable income of the
person to whom the indebtedness is owed for each taxable year during
which the indebtedness is unpaid.
(4) Subsequent determination of transfer price or commission. The
DISC and its related supplier would ordinarily determine under section
994 and this section the transfer price payable by the DISC
[[Page 691]]
(or the commission payable to the DISC) for a transaction before the
DISC files its return for the taxable year of the transaction. After the
DISC has filed its return, a redetermination of the transfer price (or
commission) may only be made if permitted by the Code and the
regulations thereunder. Such a redetermination would include a
redetermination by reason of an adjustment under section 482 and the
regulations thereunder or section 861 and Sec. 1.861-8 which affects
the amounts which entered into the determination of the transfer price
or commission.
(5) Procedure for adjustments to transfer price or commission--
(i)(a) If the transfer price (or commission) for a transaction
determined under section 994 is different from the price (or commission)
actually charged, the person who received too small a transfer price (or
commission) or paid too large a transfer price (or commission) shall
establish (or be deemed to have established), at the date of the
determination or redetermination under subparagraph (4) of this
paragraph of the transfer price (or commission) under section 994, an
account receivable due the DISC from the person with whom it engaged in
the transaction equal to the difference in amount between the transfer
price (or commission) so determined and the transfer price (or
commission) previously paid and received. If the account receivable is
paid within 90 days after the date it is established (or deemed
established), then as of the end of the taxable year of the DISC in
which the transaction occurred which gave rise to the indebtedness, the
account receivable shall be treated as an asset and, under Sec. 1.993-
2(d)(3) as a trade receivable, and thus as a qualified export asset.
(b) If, for example, during 1972, a DISC which uses the calendar
year as its taxable year sold a product which it purchased that year
from its related supplier and paid a price of $10,000 which price is a
reasonable estimate under subparagraph (3)(iii) of this paragraph but is
later determined under section 994 to be $8,000 immediately before the
DISC filed its return for 1972, the DISC must be paid $2,000 (i.e.,
$10,000-$8,000) by its related supplier or establish an account
receivable from its related supplier of $2,000. The account receivable
may be paid without tax consequences, provided that such account
receivable is paid within 90 days after the date it is established (or
deemed established). Such account receivable paid within such 90 days
will be considered to relate to the taxable year in which the
transaction occurred which gave rise thereto rather than the taxable
year during which it is established or paid.
(ii) Payment must be in a form specified in subparagraph (3) of this
paragraph.
(iii) If an account receivable of a DISC described in subdivision
(i) of this paragraph (e)(5) is not paid within 90 days of the date it
is established (or deemed established), then, as of the end of the
taxable year of the DISC in which the transaction occurred which gives
rise to the indebtedness, the account receivable shall be treated as an
asset except that, if the account receivable is established (or deemed
established) in a taxable year of the DISC ending on or before August
15, 1975, at the taxpayer's option, the account receivable shall be
treated as an asset as of the end of such taxable year. However, under
Sec. 1.993-2(d)(3), an account receivable referred to in the preceding
sentence shall not be treated as a trade receivable or other qualified
export asset.
(iv) An account receivable established in accordance with
subdivision (i) of this subparagraph shall bear interest at an arm's
length rate, computed in the manner provided by Sec. 1.482-2(a)(2) from
the day after the date the account receivable is deemed established to
the date of payment. The interest so computed shall be accrued and
included in the taxpayer's taxable income for each taxable year during
which the account receivable is outstanding.
(v)(a) In lieu of establishing an account receivable in accordance
with subdivision (i) of this subparagraph for all or part of an amount
due a related supplier, the related supplier and DISC are permitted to
treat all or part of any distribution which was made by the DISC out of
its previously taxed income with respect to the year to which the
determination or redetermination
[[Page 692]]
relates as an additional payment of transfer price or repayment of
commission (and not as a distribution) made as of the date the
distribution was made. Any additional amount arising on the
determination or redetermination due the related supplier after this
treatment shall be represented by an account receivable established
under subdivision (i) of this subparagraph. To the extent that a
distribution is so treated under this subdivision (v), it shall cease to
qualify as distribution for any Federal income tax purpose, and the
DISC's account for previously taxed income shall be adjusted
accordingly. If all or part of any distribution made to a shareholder
other than the related supplier is recharacterized under this
subdivision (v), the related supplier shall establish an account
receivable from that shareholder for the amount so recharacterized. Such
account receivable shall be paid in the time and manner set forth in
this paragraph (e)(5). In order to obtain the relief provided by this
subdivision (v), the conditions and procedures prescribed by Revenue
Procedure 84-3 must be met. The provisions of this paragraph (e)(5)(v)
shall apply to all open taxable years ending after December 31, 1971.
(b) If, for example, during 1982, a DISC commission from a related
supplier with respect to a transaction completed in 1980 was
redetermined to be $1,000 less than the commission actually charged by,
and paid to, the DISC, the amount of any distribution previously made by
the DISC from its 1980 previously taxed income to the related supplies
as a shareholder may, to the extent of $1,000, be treated not as a
distribution but as a repayment of the commission.
(vi) The procedure for adjustments to transfer price provided by
this subparagraph does not apply to incomplete transactions described in
paragraph (c)(5)(i)(b) of this section. Such procedure will, however, be
applied to any such transaction with respect to the taxable year in
which the transaction is completed.
(6) Examples. The provisions of this paragraph may be illustrated by
the following examples:
Example 1. (i) During 1975, a DISC which uses the calendar year as
its taxable year purchased a product from its related supplier and made
an initial payment of $8,500. If $8,500 were determined to be the
transfer price under section 994, the DISC's taxable income from the
transaction would be $1,000. Immediately before the DISC filed its
return for 1975, under section 994 it is determined that the transfer
price is $8,000 and the DISC's taxable income is $1,500. Thus, the
requirement of a reasonable estimate under subparagraph (3) of this
paragraph was met because the amount ($8,500) actually paid resulted in
the DISC realizing taxable income of $1,000 which is not less than 50
percent of the DISC's taxable income ($1,500) from the transaction as
determined under section 994.
(ii) Pursuant to subparagraph (5) of this paragraph, an account
receivable due the DISC for $500, i.e., $8,500-$8,000, is established on
September 15, 1976, the date the DISC files its return for 1975, and is
paid on December 1, 1976. The account receivable for $500 will be
considered to relate to the taxable year (1975) in which the transaction
occurred which gave rise thereto and will be a qualified export asset
under Sec. 1.993-2(d)(3) for the last day of such year.
Example 2. Assume the same facts as in example 1 except that the
account receivable for $500 is paid on January 1, 1977. The account
receivable for $500 will still be considered to relate to the taxable
year (1975) in which the transaction occurred which gave rise thereto.
However, such account receivable will be treated as an asset which is
not a qualified export asset under Sec. 1.993-2(d)(3) for the last day
of such year.
(f) Export promotion expenses--(1) Purpose of expense. (i) In order
for an expense or cost of a type described in subparagraph (2) of this
paragraph to be an export promotion expense, the expense or cost must be
incurred or treated as incurred by the DISC (under subparagraph (7) of
this paragraph) to advance the sale, lease, or other distribution of
export property for use, consumption, or distribution outside the United
States. Costs of services in performing installation (but not assembly)
on the site and for meeting warranty commitments if such services are
related and subsidiary (within the meaning of Sec. 1.993-1(d)) to any
qualified sale, lease, or other distribution of export property by the
DISC (or with respect to which the DISC received a commission) will be
considered to advance the sale, lease, or other distribution of export
property. General and administrative
[[Page 693]]
expenses attributable to billing customers, other clerical functions of
the DISC, or generally operating the DISC, will also be considered to
advance the sale, lease, or other distribution of export property.
(ii) Where an expense or cost incurred or treated as incurred by the
DISC qualifies only in part as an export promotion expense, such expense
or cost must be allocated between the qualified portion and such other
portion on a reasonable basis. See Sec. 1.994-2(b)(2) for the option of
the related supplier not to claim expenses as export promotion expenses.
(2) Types of expenses. The only expenses or costs which may be
export promotion expenses are those expenses or costs meeting the test
of subparagraph (1) of this paragraph which constitute--
(i) Ordinary and necessary expenses of the DISC paid or incurred
during the DISC's taxable year in carrying on any trade or business,
allowable as deductions under section 162, such as expenses for market
studies, advertising, salaries and wages (including contributions or
compensations deductible under section 404) of sales, clerical, and
other personnel, rentals on property, sales commissions, warehousing,
and other selling expenses,
(ii) A reasonable allowance under section 167 for exhaustion, wear
and tear, or obsolescence of the property of the DISC,
(iii) Costs of freight (subject to the limitations of subparagraph
(4) of this paragraph),
(iv) Costs of packaging for export (as defined in subparagraph (5)
of this paragraph), or
(v) Costs of designing and labeling packages exclusively for export
markets (under subparagraph (6) of this paragraph).
(3) Ineligible expenses. Items ineligible to be export promotion
expenses include, for example, interest expenses, bad debt expenses,
freight insurance, State and local income and franchise taxes, the cost
of manufacture or assembly operations, and items of cost of goods sold
(except as otherwise provided in this paragraph in the case of certain
freight, packaging, and designing and labeling expenses). Income or
similar taxes eligible for a foreign tax credit under sections 901 and
903 are also not eligible to be export promotion expenses.
(4) Freight expenses--(i) In general. Export promotion expenses
include one-half of the freight expense (not including insurance) for
shipping export property aboard a U.S.-flag carrier in those cases where
law or regulation of the United States or of any State or political
subdivision thereof or of any agency or instrumentality of any of these
does not require that the export property be shipped aboard a U.S.-flag
carrier. For purposes of this paragraph, the term ``freight expense''
includes charges paid for c.o.d. service, miscellaneous ground charges,
such as charges incurred for services normally performed by U.S.-flag
carriers, charges for services of loading aboard U.S.-flag carriers
normally performed by such carriers, freight forwarders, or independent
contractors engaged in loading property, and charges attributable to a
freight consolidation function normally performed by freight forwarders.
In order for one-half of freight expenses paid to the owner (or the
agent of the owner) of a U.S.-flag carrier to be claimed as an export
promotion expense, the DISC must obtain a written statement (such as,
for example, a bill of lading) from the owner (or the agent) disclosing
that the export property was shipped aboard the owner's U.S.-flag
carrier or another U.S.-flag carrier, and the DISC must have no
reasonable basis for disbelieving such statement of the owner (or the
agent). For the requirement of a written statement from a freight
forwarder, see subdivision (iv) of this subparagraph.
(ii) U.S.-flag carrier defined. For purposes of this paragraph, the
term ``U.S.-flag carrier'' is an airplane owned and operated by a U.S.
person or persons (as defined in section 7701(a)(30)) or a ship
documented under the laws of the United States. Shipment initiated by
delivery to the U.S. Postal Service shall be considered shipment aboard
a U.S.-flag carrier, but not if shipped to a place to which mail
shipments from the United States are
[[Page 694]]
ordinarily accomplished by land transportation, such as to Canada or
Mexico, unless airmail is specified.
(iii) Shipment pursuant to law or regulation. Shipment pursuant to
law or regulation includes instances where a U.S.-flag carrier must be
used in order to obtain permission from the Government to make the
export. If the law or regulation requires a fixed portion of the export
property to be shipped aboard a U.S.-flag carrier, the freight expense
on that portion of such export property that was so shipped in order to
satisfy such requirement cannot qualify as an export promotion expense.
(iv) Freight forwarders. A payment to a freight forwarder shall be
considered freight expense within the meaning of this paragraph to the
extent the forwarder utilizes a U.S.-flag carrier. For purposes of this
paragraph, the term ``freight forwarder'' includes air freight
consolidators and carriers owned and operated by U.S. persons utilizing
U.S.- flag carriers such as non-vessel-owning common carriers. In order
for one-half of freight expenses paid to a freight forwarder to be
claimed as export promotion expenses, the DISC must obtain a written
statement (such as, for example, a bill of lading) from the freight
forwarder disclosing that the export property was shipped aboard a U.S.-
flag carrier, and the DISC must have no reasonable basis for
disbelieving such statement of the freight forwarder.
(v) Freight within the United States. A DISC may not claim as export
promotion expense any amount that is attributable to carriage of export
property between points within the United States. If, however, export
property is carried from the United States to a foreign country on a
through shipment pursuant to a single bill of lading or similar document
aboard one or more U.S.-flag carriers, the freight expense of such
carriage shall not be apportioned between the domestic and foreign
portions of such carriage, even though a carrier may stop en route
within the United States or the export property may be shifted from one
carrier to another, and one-half of such freight expense may be claimed
as an export promotion expense. Freight expense does not include the
cost of transporting the export property to the depot of the U.S.-flag
carrier or freight forwarder for shipment abroad. The expense of
shipment of export property initiated by delivery to the U.S. Postal
Service for ultimate delivery outside the United States shall be
considered as attributable entirely to carriage of such property outside
the United States.
(5) Packaging for export. (i) Export promotion expenses include the
direct and indirect cost of packaging export property (including the
cost of the package) for export whether or not the packaging is the same
as domestic packaging. Such packaging costs do not include costs of
manufacturing (as defined in the regulations under section 993) and
assembly. Thus, if a DISC buys and packages export property for resale,
its costs of packaging the export property are export promotion
expenses. If, however, the process of such packaging by the DISC is
physically integrated with the process of manufacturing the export
property by the related supplier, the costs of such packaging are not
export promotion expenses.
(ii) The cost of containers leased from a shipping company to which
the DISC also pays freight for the property packaged is not a cost of
packaging. However, in such circumstances, one-half of the rental charge
may be allowable as a freight expense if permitted under subparagraph
(4) of this paragraph.
(6) Designing and labeling packages. Export promotion expenses
include the direct and indirect costs of designing and labeling
packages, including bottles, cans, jars, boxes, cartons, or containers,
to the extent incurred for export markets. Thus, for example, to the
extent incurred for supplying export markets, the cost of designing
labels in a foreign language and the cost of printing such labels are
export promotion expenses.
(7) DISC must incur export promotion expenses--(i) In general. In
order for an expense to be an export promotion expense it must be
incurred or treated as incurred under this subparagraph by the DISC. For
example, an expense is incurred by a DISC if the expense results from
(a) the DISC incurring an
[[Page 695]]
obligation to pay compensation to its employees, (b) depreciation of
property owned by the DISC and used by its employees, (c) the DISC
incurring an obligation to pay for office supplies used by its
employees, (d) the DISC incurring an obligation to pay space costs for
use by its employees, or (e) the DISC incurring an obligation to pay
other costs supporting efforts by its employees.
(ii) Payments to independent contractors. A payment to an
independent contractor, directly or indirectly, is treated as incurred
by the DISC if the cost of performing the function performed by the
independent contractor would be considered an export promotion expense
described in subparagraphs (1) and (2) of this paragraph if performed by
the DISC, and if, in a case where the services of the independent
contractor were engaged by a party related to the DISC, such related
party and such DISC agreed in writing before the contract was entered
into that a specified portion or all of the contract was for the benefit
of the DISC and that all of the expenses of the contract (eligible to be
considered as export promotion expenses) with respect to such portion
would be borne by the DISC.
(iii) Expenses incurred by related parties. Reimbursements or other
payments by a DISC to a related party are export promotion expenses only
if the expenses of the related party for which reimbursement is made are
for space in a building actually used by employees of the DISC or for
export property owned by the DISC. Except as otherwise provided in the
preceding sentence, expenses incurred by a foreign international sales
corporation (FISC) or a real property holding company (as defined in
section 993(e)(1) and (2), respectively) shall not be treated as export
promotion expenses of its DISC.
(iv) Selling commissions paid by a DISC. A commission paid by a DISC
to a person other than a related person, with respect to a transaction
which gives rise to qualified export receipts of the DISC, is an export
promotion expense of the DISC. A commission paid by a DISC to a related
person is not an export promotion expense.
(v) Sales of promotional material. If a DISC sells promotional
material to a buyer of export property from the DISC at a price which is
greater than the costs of the DISC for such material, such costs are not
export promotion expenses. If, however, the DISC sells promotional
material at a price which is less than its costs for such material, the
excess of such costs over such price is an export promotion expense. For
rules relating to the status of promotional material as qualified export
assets and export property, see Sec. Sec. 1.993-2 and 1.993-3,
respectively.
(vi) An expense may be incurred by the DISC under subdivisions (i)
through (v) of this subparagraph even if the accounting for and payment
of such expense is handled by a related party and the DISC reimburses
the related party for such expenses.
(8) Incomplete transactions. Expenses eligible to be treated as
export promotion expenses which are attributable to the sale, lease, or
other distribution of export property and which are incurred prior to
the taxable year of sale, lease, or other distribution by the DISC are
not treated as export promotion expenses until the taxable year of sale,
lease, or other distribution or until the taxable year in which it is
first determined that no transaction is reasonably expected to result
from the expense incurred (whether or not a transaction subsequently
results). Thus, for example, if a DISC incurs a packaging cost which is
otherwise eligible to be treated as an export promotion expense, the
DISC may not include such charge as an export promotion expense until
the year in which the export property with respect to which the
packaging cost was incurred is actually sold by the DISC. If no
transaction is reasonably expected to result from the packaging cost,
such cost should be allocated as an export promotion expense to the
group of transactions to which such cost is most closely related.
(g) Examples. The provisions of this section may be illustrated by
the following examples:
Example 1. J and K are calendar year taxpayers. J, a domestic
manufacturing company, owns all the stock of K, a DISC for the taxable
year. During 1972, J manufactures only 100 units of a product (which is
eligible to be export property as defined in section
[[Page 696]]
993(c)). J enters into a written agreement with K whereby K is granted a
sales franchise with respect to exporting such property and K will
receive commissions with respect to such exports equal to the maximum
amount permitted to be received under the intercompany pricing rules of
section 994. Thereafter, the 100 units are sold for $1,000. J's cost of
goods sold attributable to the 100 units is $650. J's direct selling
expenses so attributable are $100. Although J has other deductible
expenses, for purposes of this example assume that J has no other
deductible expenses. K pays $230 to independent contractors which
qualify as export promotion expenses under paragraph (f)(7)(ii) of this
section. K does not perform functions substantial enough to entitle it
to an allocation of income which meets the arm's length standard of
section 482. The income which K may earn under section 994 under the
franchise is $20, computed as follows:
(1) Combined taxable income:
(a) K's sales price................................. ....... $1,000
(b) Less deductions:
J's cost of goods sold............................ $650
J's direct selling expenses....................... 100
K's export promotion expenses..................... 230
---------
Total deductions.............................. ....... 980
--------
(c) Combined taxable income......................... ....... 20
========
(2) K's profit under combined taxable income method (before
application of loss limitation):
(a) 50 percent of combined taxable income.................... 10
(b) Plus: 10 percent of K's export promotion expenses (10% of 23
$230).......................................................
----------
(c) K's profit............................................... 33
==========
(3) K's profit under gross receipts method (before application
of loss limitation):
(a) 4 percent of K's sales price (4% of $1,000).............. 40
(b) Plus: 10 percent of K's export promotion expenses (10% of 23
$230).......................................................
----------
(c) K's profit............................................... 63
========
Since combined taxable income ($20) is lower than both K's profit
under the combined taxable income method ($33) and under the gross
receipts method ($63), the maximum income K may earn is $20.
Accordingly, the commissions K may receive from J are $250, i.e., K's
expenses ($230) plus K's profit ($20).
Example 2. M and N are calendar year taxpayers. M, a domestic
manufacturing company, owns all the stock of N, a DISC for the taxable
year. During 1972, M produces and sells a particular product line of
export property to N for $75, a price which can be justified as
satisfying the standard of arm's length price of section 482. N performs
substantial functions with respect to the transaction and resells the
export property for $100. M's cost of goods sold attributable to the
export property is $60. M's direct selling expenses so attributable
(relating to advertising of the product line in foreign markets) are
$12. Although M has other deductible expenses, for purposes of this
example, assume that M has no other deductible expenses. N's expenses
attributable to resale of the export property are $22 of which $20 are
export promotion expenses. The maximum profit which N may earn with
respect to the product line is $6, computed as follows:
(1) Combined taxable income:
(a) N's sales price................................. ....... $100
(b) Less deductions:
M's cost of goods sold............................ $60
M's direct selling expenses....................... 12
N's expenses...................................... 22
--------
Total deductions................................ ....... 94
--------
(c) Combined taxable income......................... ....... 6
========
(2) N's profit under combined taxable income method (before
application of loss limitation):
(a) 50 percent of combined taxable income.................... 3
(b) Plus: 10 percent of N's export promotion expenses (10% of 2
$20)........................................................
----------
(c) N's profit............................................... 5
==========
(3) N's profit under gross receipts method (before application
of loss limitation):
(a) 4 percent of N's sales price (4% of $100)................ 4
(b) Plus: 10 percent of N's export promotion expenses (10% of 2
$20)........................................................
----------
(c) N's profit............................................... 6
==========
(4) N's profit under section 482 method:
(a) N's sales price.......................................... 100
(b) Less deductions:
N's cost of goods sold (price paid by N to M)..... 75
N's expenses...................................... 22
--------
Total deductions................................ ....... 97
--------
(c) N's profit...................................... ....... 3
========
Since the gross receipts method results in greater profit to N ($6)
than does the combined taxable income method ($5) or section 482 method
($3), and does not exceed combined taxable income ($6), N may earn a
maximum profit of $6. Accordingly, the transfer price from M to N may be
readjusted as long as the transfer price is not readjusted below $72,
computed as follows:
(5) Transfer price from M to N:
(a) N's sales price................................... ...... $100
(b) Less:
N's expenses........................................ $22
N's profit.......................................... 6
--------
Total subtractions................................ ...... 28
-------
(c) Transfer price.................................... ...... 72
Example 3. Q and R are calendar year taxpayers. Q, a domestic
manufacturing company, owns all the stock of R, a DISC for the taxable
year. During 1972, Q produces and sells a product line of export
property to R for $170, a price which can be justified as satisfying the
standards of arm's length price of
[[Page 697]]
section 482, and R resells the export property for $200. Q's cost of
goods sold attributable to the export property is $115 so that the
combined gross income from the sale of the export property is $85 (i.e.,
$200 minus $115). Q's expenses incurred in connection with the property
sold are $35. Q's deductible overhead and other supportive expenses
allocable to all gross income are $6. Apportionment of these supportive
expenses on the basis of gross income does not result in a material
distortion of income and is a reasonable method of apportionment. Q's
gross income from sources other than the transaction is $170 making
total gross income of Q and R (excluding the transfer price paid by R)
$255 (i.e., $85 plus $170). R's expenses attributable to resale of the
export property are $20, all of which are export promotion expenses. The
maximum profit which R may earn with respect to the product line is $16,
computed as follows:
(1) Combined taxable income:
(a) R's sales price................................... ...... $200
(b) Less deductions:
(i) Q's cost of goods sold.......................... 115
(ii) Q's expenses incurred in connection with the 35
property sold......................................
(iii) Apportionment of Q's supportive
expenses:
Q's supportive expenses................. $6
Combined gross income from sale of 85
export property........................
Total gross income of Q and R........... 255
Apportionment........................... (6x85)/ 2
255
(iv) R's expenses......................... ........ 20
--------
Total deductions........................ ........ ...... 172
-------
(c) Combined taxable income................................... 28
===========
(2) R's profit under combined taxable income method (before
application of loss limitation):
(a) 50 percent of combined taxable income..................... 14
(b) Plus: 10 percent of R's export promotion expenses (10% of 2
$20).........................................................
-----------
(c) R's profit................................................ 16
===========
(3) R's profit under gross receipts method (before application
of loss limitation):
(a) 4 percent of R's sales price (4% of $200)................. 8
(b) Plus: 10 percent of R's export promotion expenses (10% of 2
$20).........................................................
-----------
(c) R's profit................................................ 10
===========
(4) R's profit under section 482 method:
(a) R's sales price........................................... 200
(b) Less deductions:
R's cost of goods sold (price paid by R to Q)....... 170
R's expenses........................................ 20
----------
Total deductions.................................. ...... 190
---------
(c) R's profit........................................ ...... 10
=======
Since the combined taxable income method results in greater profit
to R ($16) than does the gross receipts method ($10) or section 482
method ($10), and does not exceed combined taxable income ($28), R may
earn a maximum profit of $16. Accordingly, the transfer price from Q to
R may be readjusted as long as the transfer price is not readjusted
below $164 computed as follows:
(5) Transfer price from Q to R:
(a) R's sales price................................... ...... $200
(b) Less:
R's expenses........................................ $20
R's profit.......................................... 16
--------
Total............................................. ...... 36
-------
(c) Transfer price.................................... ...... 164
=======
Example 4. S and T are calendar year taxpayers. S, a domestic
manufacturing company, owns all the stock of T, a DISC for the taxable
year. During 1972, S produces and sells 100 units of a particular
product to T under a written agreement which provides that the transfer
price between S and T shall be that price which allocates to T the
maximum permitted to be received under the intercompany pricing rules of
section 994. Thereafter, the 100 units are sold by T for $950. S's cost
of goods sold attributable to the 100 units is $650. S's other
deductible expenses so attributable are $300. Although S has other
deductible expenses, for purposes of this example, assume that S has no
deductible expenses not definitely allocable to any item of gross
income. T's expenses attributable to the resale of the 100 units are
$50. S chooses not to apply the section 482 method. T may not earn any
income under the gross receipts or combined taxable income method with
respect to resale of the 100 units because combined taxable income is a
negative figure, computed as follows:
(1) Combined taxable income:
(a) T's sales price................................... ...... $950
(b) Less deductions:
S's cost of goods sold.............................. $650
S's expenses........................................ 300
T's expenses........................................ 50
--------
Total deductions.................................. ...... 1,000
-------
(c) Combined taxable income (loss).................... ...... ($50)
=======
Under paragraph (e)(1)(i) of this section, T is permitted to recover
its expenses attributable to the 100 units ($50) even though such
recovery results in a loss or increased loss to the related supplier.
Accordingly, the transfer price from S to T may be readjusted as long as
the transfer price is not readjusted below $900, computed as follows:
(2) Transfer price from S to T:
(a) T's sales price........................................... $950
(b) Less: T's expenses........................................ 50
-------
(c) Transfer price............................................ 900
=======
[[Page 698]]
Example 5. Assume the same facts as in example 4 except that S
chooses to apply the section 482 method and that under arm's length
dealings T would have derived $10 of income. Accordingly, the transfer
price from S to T may be set at an amount not less than $890, computed
as follows:
(1) Transfer price from S to T:
(a) T's sales price................................... ...... $950
(b) Less:
T's expenses........................................ $50
T's profit.......................................... 10
--------
Total deductions.................................. ...... 60
-------
(c) Transfer price.................................... ...... 890
=======
Example 6. X and Y are calendar year taxpayers. X, a domestic
manufacturing company, owns all the stock of Y, a DISC for the taxable
year. During March 1972, X manufactures a particular product of export
property which it leases on April 1, 1972, to Y for a term of 1 year at
a monthly rental of $1,000, a rent which satisfies the standard of arm's
length rental under section 482. Y subleases the product on April 1,
1972, for a term of 1 year at a monthly rental of $1,200. X's cost for
the product leased is $40,000. X's other deductible expenses
attributable to the product are $900, all of which are incurred in 1972.
Although X has other deductible expenses, for purposes of this example,
assume that X has no other deductible expenses. Y's expenses
attributable to sublease of the export property are $450, all of which
are incurred in 1972 and are export promotion expenses. X depreciates
the property on a straight line basis without the use of an averaging
convention, assuming a useful life of 8 years and no salvage value. The
profit which Y may earn with respect to the transaction is $2,895 for
1972 and $1,175 for 1973, computed as follows:
computation for 1972
(1) Combined taxable income:
(a) Y's sublease rental receipts for year ........ $10,800
($1,200x9 months)................................
(b) Less deductions:
X's depreciation ($40,000x1/8x9/12)............. $3,750
X's other expenses.............................. 900
Y's expenses.................................... 450
----------
Total deductions.............................. ........ 5,100
---------
(c) Combined taxable income....................... ........ 5,700
=========
(2) Y's profit under combined taxable income method (before
application of loss limitation):
(a) 50 percent of combined taxable income................... 2,850
(b) Plus: 10 percent of Y's export promotion expenses (10% 45
of $450)...................................................
-----------
(c) Y's profit.............................................. 2,895
===========
(3) Y's profit under gross receipts method (before application
of loss limitation):
(a) 4 percent of Y's sublease rental receipts for year (4% 432
of $10,800)................................................
(b) Plus: 10 percent of Y's export promotion expenses (10% 45
of $450)...................................................
-----------
(c) Y's profit.............................................. 477
===========
(4) Y's profit under section 482 method:
(a) Y's sublease rental receipts for year................... $10,800
(b) Less deductions:
Y's lease rental payments for year.............. $9,000
Y's expenses.................................... 450
----------
Total deductions.................................. ........ 9,450
---------
(c) Y's profit.................................... ........ 1,350
Since the combined taxable income method results in greater profit
to Y ($2,895) than does the gross receipts method ($477) or section 482
method ($1,350), Y may earn a profit of $2,895 for 1972. Accordingly,
the monthly rental payable by Y to X for 1972 may be readjusted as long
as the monthly rental payable is not readjusted below $828.33, computed
as follows:
(5) Monthly rental payable by Y to X for 1972:
(a) Y's sublease rental receipts for year................. $10,800.00
(b) Less:
Y's expenses.................................. 450.00
Y's profit.................................... 2,895.00
----------
Total....................................... ........ 3,345.00
-----------
(c) Rental payable for 1972............................... 7,455.00
-----------
(d) Rental payable each month ($7,455/9 months)........... 828.33
===========
computation for 1973
(1) Combined taxable income:
(a) Y's sublease rental receipts for year ($1,200x3 $3,600
months)..................................................
(b) Less: X's depreciation ($40,000x1/8x3/12)............. 1,250
-----------
(c) Combined taxable income............................... 2,350
===========
(2) Y's profit under combined taxable income method (before
application of loss limitation):
(a) 50 percent of combined taxable income................. $1,175
-----------
(b) Y's profit............................................ 1,175
===========
(3) Y's profit under gross receipts method (before
application of loss limitation):
(a) 4 percent of Y's sublease rental receipts for year (4% 144
of $3,600)...............................................
===========
(b) Y's profit............................................ 144
===========
(4) Y's profit under section 482 method:
(a) Y's sublease rental receipts for year................. 3,600
(b) Less: Y's lease rental payments for year.............. 3,000
-----------
(c) Y's profit............................................ 600
Since the combined taxable income method results in greater profit
to Y ($1,175) than does the gross receipts method ($144) or section 482
method ($600), Y may earn a profit of $1,175 for 1973. Accordingly, the
monthly rental payable by Y to X for 1973 may be readjusted as long as
the monthly rental payable is not readjusted below $808.33, computed as
follows:
[[Page 699]]
(5) Monthly rental payable by Y to X for 1973:
(a) Y's sublease rental receipts for year................. $3,600.00
(b) Less: Y's profit...................................... 1,175.00
-----------
(c) Rental payable for 1973............................... 2,425.00
===========
(d) Rental payable for each month ($2,425/3 months)....... 808.33
===========
(Secs. 995(e)(7), (8) and (10), 995(g) and 7805 of the Internal Revenue
Code of 1954 (90 Stat. 1655, 26 U.S.C. 995 (e)(7), (8) and (10); 90
Stat. 1659, 26 U.S.C. 995(g); and 68A Stat 917, 26 U.S.C. 7805))
[T.D. 7364, 40 FR 29827, July 16, 1975, as amended by T.D. 7435, 41 FR
43142, Sept. 30, 1976; T.D. 7854, 47 FR 51741, Nov. 17, 1982; T.D. 7984,
49 FR 40018, Oct. 12, 1984]
Sec. 1.994-2 Marginal costing rules.
(a) In general. This section prescribes the marginal costing rules
authorized by section 994(b)(2). If under paragraph (c)(1) of this
section a DISC is treated for its taxable year as seeking to establish
or maintain a foreign market for sales of an item, product, or product
line of export property (as defined in Sec. 1.993-3) from which
qualified export receipts are derived, the marginal costing rules
prescribed in paragraph (b) of this section may be applied to allocate
costs between gross receipts derived from such sales and other gross
receipts for purposes of computing, under the ``50-50'' combined taxable
income method of Sec. 1.994-1(c)(3), the combined taxable income of the
DISC and related supplier derived from such sales. Such marginal costing
rules may be applied whether or not the related supplier manufactures,
produces, grows, or extracts (within the meaning of Sec. 1.993-3(c))
the export property sold. Such marginal costing rules do not apply to
sales of export property which in the hands of a purchaser related under
section 954(d)(3) to the seller give rise to foreign base company sales
income as described in section 954(d) unless, for the purchaser's year
in which it resells the export property, section 954(b)(3)(A) is
applicable or such income is under the exceptions in section 954(b)(4).
Such marginal costing rules do not apply to leases of property or the
performance of any services whether or not related and subsidiary
services (as defined in Sec. 1.994-1(b)(3).
(b) Marginal costing rules for allocations of costs--(1) In general.
Marginal costing is a method under which only marginal or variable costs
of producing and selling a particular item, product, or product line are
taken into account for purposes of section 994. Where this section is
applicable, costs attributable to deriving qualified export receipts for
the DISC's taxable year from sales of an item, product, or product line
may be determined in any manner the related supplier (as defined in
Sec. 1.994-1(a)(3)(ii)) chooses, provided that the requirements of both
subparagraphs (2) and (3) of this paragraph are met.
(2) Variable costs taken into account. There are taken into account
in computing the combined taxable income of the DISC and its related
supplier from sales of an item, product, or product line the following
costs:
(i) Direct production costs (as defined in Sec. 1.471-11(b)(2)(i))
and
(ii) Costs which are export promotion expenses, but only if they are
claimed as export promotion expenses in determining taxable income
derived by the DISC under the combined taxable income method of Sec.
1.994-1(c)(3).
At the taxpayer's option, all, a part, or none of the costs which
qualify as export promotion expenses may be so claimed as export
promotion expenses.
(3) Overall profit percentage limitation. As a result of such
determination of costs attributable to such qualified export receipts
for the DISC's taxable year, the combined taxable income of the DISC and
its related supplier from sales of such item, product, or product line
for the DISC's taxable year does not exceed gross receipts (determined
under Sec. 1.993-6) of the DISC derived from such sales, multiplied by
the overall profit percentage (determined under paragraph (c)(2) of this
section).
(c) Definitions--(1) Establishing or maintaining a foreign market. A
DISC shall be treated for its taxable year as seeking to establish or
maintain a foreign market with respect to sales of an item, product, or
product line of export property from which qualified export receipts are
derived if the combined taxable income computed under paragraph (b) of
this section is greater than the combined taxable income computed under
Sec. 1.994-1(c)(6).
(2) Overall profit percentage. (i) For purposes of this section, the
overall
[[Page 700]]
profit percentage for a taxable year of the DISC for a product or
product line is the percentage which--
(a) The combined taxable income of the DISC and its related supplier
plus all other taxable income of its related supplier from all sales
(domestic and foreign) of such product or product line during the DISC's
taxable year, computed under the full costing method, is of
(b) The total gross receipts (determined under Sec. 1.993-6) from
all such sales.
(ii) At the annual option of the related supplier, the overall
profit percentage for the DISC's taxable year for all products and
product lines may be determined by aggregating the amounts described in
subdivision (i) (a) and (b) of this subparagraph of the DISC, and all
domestic members of the controlled group (as defined in Sec. 1.993-
1(k)) of which the DISC is a member, for the DISC's taxable year and for
taxable years of such members ending with or within the DISC's taxable
year.
(iii) For purposes of determining the amounts in subdivisions (i)
(b) and (ii) of this subparagraph, a sale of property between a DISC and
its related supplier or between domestic members of the controlled group
shall be taken into account only during the DISC's taxable year (or
taxable year of the member ending within the DISC's taxable year) during
which the property is ultimately sold to a person which is neither the
DISC nor such a domestic member.
(3) Grouping of transactions. (i) In general, for purposes of this
section, an item, product, or product line is the item or group
consisting of the product or product line pursuant to Sec. 1.994-
1(c)(7) used by the taxpayer for purposes of applying the intercompany
pricing rules of Sec. 1.994-1.
(ii) However, for purposes of determining the overall profit
percentage under subparagraph (2) of this paragraph, any product or
product line grouping permissible under Sec. 1.994-1(c)(7) may be used
at the annual choice of the taxpayer, even though it may not be the same
item or grouping referred to in subdivision (i) of this subparagraph, as
long as the grouping chosen for determining the overall profit
percentage is at least as broad as the grouping referred to in such
subdivision (i).
(4) Full costing method. For purposes of this section, the term
``full costing method'' is the method for determining combined taxable
income set forth in Sec. 1.994-1(c)(6).
(d) Application of limitation on DISC income (``no loss'' rule). If
the marginal costing rules of this section are applied, the combined
taxable income method of Sec. 1.994-1(c)(3) may not be applied to cause
in any taxable year a loss to the related supplier, but such method may
be applied to the extent it does not cause a loss. For purposes of the
preceding sentence, a loss to a related supplier would result if the
taxable income of the DISC would exceed the combined taxable income of
the related supplier and the DISC determined in accordance with
paragraph (b) of this section. If, however, there is no combined taxable
income (so determined), see the last sentence of Sec. 1.994-1(e)(1)(i).
(e) Examples. The provisions of this section may be illustrated by
the following examples:
Example 1. X and Y are calendar year taxpayers. X, a domestic
manufacturing company, owns all the stock of Y, a DISC for the taxable
year. During 1973, X manufactures a product line which is eligible to be
export property (as defined in Sec. 1.993-3). X enters into a written
agreement with Y whereby Y is granted a sales franchise with respect to
exporting such product line from which qualified export receipts will be
derived and Y will receive commissions with respect to such exports
equal to the maximum amount permitted to be received under the
intercompany pricing rules of section 994. Commissions are computed
using the combined taxable income method under Sec. 1.994-1(c)(3). For
purposes of applying the combined taxable income method, X and Y compute
their combined taxable income attributable to the product line of export
property under the marginal costing rules in accordance with the
additional facts assumed in the table below:
(1) Maximum combined taxable income (determined under
paragraph (b)(2) of this section):
(a) Y's gross receipts from export sales.................... $95.00
(b) Less:
(i) Direct materials............................ 40.00 ........
(ii) Direct labor............................... 20.00 ........
(iii) Y's export promotion expenses claimed in 5.00 ........
determining Y's DISC taxable income............
[[Page 701]]
(iv) Total deductions........................... 65.00 ........
----------
(c) Maximum combined taxable income......................... 30.00
===========
(2) Overall profit percentage limitation (determined under
paragraph (b)(3) of this section):
(a) Gross receipts of X and Y from all domestic and foreign 400.00
sales......................................................
(b) Less deductions:
(i) Direct materials............................ 160.00 ........
(ii) Direct labor............................... 80.00 ........
(iii) Other costs (of which $8 are costs of the 40.00 ........
DISC including $5 of export promotion expenses
claimed in determining Y's taxable income).....
----------
(c) Total deductions........................................ 280.00
-----------
(d) Total taxable income from all sales computed on a full 120.00
costing method.............................................
===========
(e) Overall profit percentage (line (d) ($120) divided by 30%
line (a) ($400)) (percent).................................
(f) Multiply by gross receipts from Y's export sales (line $95.00
(1)(a))....................................................
===========
(g) Overall profit percentage limitations................... 28.50
Since the overall profit percentage limitation under line (2)(g)
($28.50) is less than maximum combined taxable income under line (1)(c)
($30), combined taxable income under marginal costing is limited to
$28.50. Since under the franchise agreement Y is to earn the maximum
commission permitted under the intercompany pricing rules of section
994, combined taxable income on the transactions is $28.50. Accordingly,
the costs attributable to export sales (other than for direct material,
direct labor, and export promotion expenses) are $1.50, i.e., line
(1)(c) ($30) minus line (2)(g) ($28.50). Under the combined taxable
income method of Sec. 1.994-1 (c)(3), Y will have taxable income
attributable to the sales of $14.75, i.e., the sum of 1/2 of combined
taxable income (1/2 of $28.50) and 10 percent of Y's export promotion
expenses claimed in determining Y's taxable income (10 percent of $5).
Accordingly, the commissions Y receives from X are $22.75, i.e., Y's
costs ($8, see line (2)(b)(iii)) plus Y's profit ($14.75).
Example 2. (1) Assume the same facts as in example 1, except that
gross receipts from export sales are only $85 and gross receipts from
all sales remain at $400. For purposes of applying the combined taxable
income method, X and Y may compute their combined taxable income
attributable to the product line of export property under the marginal
costing rules as follows:
(1) Maximum combined taxable income (determined under paragraph
(b)(2) of this section):
(a) Y's gross receipts from export sales..................... $85.00
(b) Less:
(i) Direct materials.............................. 40.00 .......
(ii) Direct labor................................. 20.00 .......
(iii) Y's export promotion expenses claimed in 5.00 .......
determining Y's taxable income...................
---------
(iv) Total deductions...................................... 65.00
----------
(c) Maximum combined taxable income.......................... 20.00
==========
(2) Overall profit percentage limitation (determined under
paragraph (b)(3) of this section):
(a) Gross receipts from Y's export sales (line (1)(a))....... 85.00
(b) Multiply by overall profit percentage (as determined in 30%
example 1) (percent)........................................
----------
(c) Overall profit percentage limitation..................... 25.50
========
Since maximum combined taxable income under line (1)(c) ($20) is less
than the overall profit percentage limitation under line (2)(c)
($25.50), combined taxable income under marginal costing is limited to
$20. Since under the franchise agreement Y is to earn the maximum
commission permitted under the intercompany pricing rules of section
994, combined taxable income on the transactions is $20. Accordingly, no
costs (other than for direct material, direct labor, and export
promotion expenses) will be attributed to export sales. Under the
combined taxable income method of Sec. 1.994-1(c)(3), Y will have
taxable income attributable to the sales of $10.50, i.e., the sum of 1/2
of combined taxable income (1/2 of $20) and 10 percent of Y's export
promotion expenses claimed in determining Y's taxable income (10 percent
of $5). Accordingly, the Commissions Y receives from X are $18.50, i.e.,
Y's costs ($8, see line (2)(b)(iii) of example 1) plus Y's profit
($10.50).
(2) If export promotion expenses are not claimed in determining
taxable income of Y under the combined taxable income method, the
taxable income of Y would be increased to $12.50 and commissions payable
to Y would be increased to $20.50, computed as follows:
(3) Maximum combined taxable income (determined under
paragraph (b)(2) of this section):
(a) Y's gross receipts from export sales............ $85.00
(b) Less:
(i) Direct materials.............................. 40.00
(ii) Direct labor................................. 20.00
---------
(iii) Total deductions............................ ....... 60.00
--------
(c) Maximum combined taxable income.......................... 25.00
==========
(4) Overall profit percentage limitation (line (2)(c))......... 25.50
========
Since maximum combined taxable income under line (3)(c) ($25) is less
than the overall profit percentage under line (4) ($25.50), combined
taxable income under marginal costing is limited to $25. Since under the
franchise agreement Y is to earn the maximum commission permitted under
the intercompany pricing rules of section 994, combined taxable income
on the transactions is $25. Accordingly, no costs (other than for direct
material and direct labor) will be attributed to
[[Page 702]]
export sales. Under the combined taxable income method of Sec. 1.994-
1(c)(3), Y will have taxable income attributable to the sales of $12.50,
i.e., 1/2 of combined taxable income (1/2 of $25). Accordingly, the
commissions Y receives from X are $20.50, i.e., Y's costs ($8, see line
(2)(b)(iii) of example 1) plus Y's profit ($12.50).
Example 3. (1) Assume the same facts as in example 1, except that
gross receipts from export sales are only $85, gross receipts from all
sales remain at $400, and Y has costs of $40 consisting of Y's export
promotion expenses of $35 and costs of $5 other than for direct
material, direct labor, or export promotion expenses. For purposes of
applying the combined taxable income method, X and Y may compute their
combined taxable income attributable to the product line of export
property under the marginal costing rules as follows:
(1) Maximum combined taxable income (determined under
paragraph (b)(2) of this section):
(a) Y's gross receipts from export sales............ $85.00
(b) Less:
(i) Direct materials.............................. 40.00 .......
(ii) Direct labor................................. 20.00 .......
(iii) Y's export promotion expenses claimed in 35.00 .......
determining Y's taxable income...................
---------
(iv) Total deductions............................. ....... 95.00
--------
(c) Maximum combined taxable income (loss)................... (10.00)
==========
(2) Overall profit percentage limitation (as determined in 25.50
example 2)....................................................
========
Since maximum combined taxable income under line (1)(c) (which is a loss
of $10) is less than the overall profit percentage limitation under line
(2)(c) ($25.50), combined taxable income under marginal costing is a
loss of $10 and, under the combined taxable income method of Sec.
1.994-1(c)(3), Y will have no taxable income or loss attributable to the
sales. Accordingly, the commissions Y receives from X are $40, i.e., Y's
costs ($40).
(2) If export promotion expenses are not claimed in determining Y's
taxable income under the combined taxable income method, the taxable
income of Y would be increased to $12.50 and commissions payable to Y
would be increased to $52.50 computed as follows:
(3) Maximum combined taxable income (determined under paragraph $25.00
(b)(2) of this section) (line (3)(c) of example 2)............
(4) Overall profit percentage limitation (as determined in 25.50
example 2)....................................................
The results would be the same as in part (2) of example 2, except that
the commissions Y receives from X are $52.50, i.e., Y's costs ($40) plus
Y's profit ($12.50).
[T.D. 7364, 40 FR 29836, July 16, 1975; 40 FR 33972, Aug. 13, 1975]
Sec. 1.995-1 Taxation of DISC income to shareholders.
(a) In general. (1) Under Sec. 1.991-1(a), a corporation which is a
DISC for a taxable year is not subject to any tax imposed by subtitle A
of the Code (sections 1 through 1564) for the taxable year, except for
the tax imposed by chapter 5 thereof (sections 1491 through 1494) on
certain transfers to avoid tax.
(2) Under section 995(a), the shareholders of a DISC, or a former
DISC, are subject to taxation on the earnings and profits of the DISC in
accordance with the provisions of chapter 1 of the Code generally
applicable to shareholders, but subject to the modifications provided in
sections 995, 996, and 997.
(3) Under Sec. 1.996-3, three divisions of earnings and profits of
a DISC, or former DISC, are defined: ``accumulated DISC income'',
``previously taxed income'', and ``other earnings and profits''. Under
Sec. 1.995-2, certain amounts of the DISC's earnings and profits are
deemed to be distributed as dividends to shareholders of the DISC at the
close of the DISC's taxable year in which such earnings were derived.
Such deemed distributions do not cause a reduction in the DISC's
earnings and profits, but are taken into account in Sec. 1.996-3(c) as
an increase in previously taxed income. To the extent the DISC's
earnings and profits are paid out in a subsequent distribution which is,
under Sec. 1.996-1, treated as made out of such ``previously taxed
income,'' they will not be taxable to the shareholders a second time.
(4) In general, ``accumulated DISC income'' is the earnings and
profits of the DISC which have not been deemed distributed and which may
be deferred from taxation so long as they are not actually distributed
with respect to its stock. However, deferral of taxation on
``accumulated DISC income'' may be terminated, in whole or in part, in
the event of: (i) Certain foreign investment attributable to producer's
loans (see Sec. 1.995-2(a)(5) and Sec. 1.995-5); (ii) revocation of
the election to be treated as a DISC or other disqualification (see
Sec. 1.995-3); and (iii) certain dispositions of DISC stock in which
gain is realized (see Sec. 1.995-4).
[[Page 703]]
(5) Since a DISC is not taxed on its taxable income, section 246(d)
and Sec. 1.246-4 provide that the deduction otherwise allowed under
section 243 shall not be allowed with respect to a dividend from a DISC,
or former DISC, paid or treated as paid out of accumulated DISC income
or previously taxed income or with respect to a deemed distribution in a
qualified year under Sec. 1.995-2(a).
(b) Amounts and character of amounts includible in shareholder's
gross income. Each shareholder of a corporation which is a DISC, or
former DISC, shall include in his gross income--
(1) Amounts actually distributed to him that are includible in his
gross income in accordance with paragraph (c) of this section.
(2) Amounts which, pursuant to Sec. 1.995-2, he is deemed to
receive as a distribution taxable as a dividend on the last day of each
of the corporation's taxable years for which it qualifies as a DISC,
(3) Amounts which, pursuant to Sec. 1.995-3, he is deemed to
receive as a distribution taxable as a dividend in the event the
corporation revokes its election to be treated as a DISC or otherwise is
disqualified as a DISC, and
(4) Gain realized on certain dispositions of stock in the
corporation which, under Sec. 1.995-4, is includible in his gross
income as a dividend.
(c) Treatment of actual distributions. (1) Except as provided in
subparagraph (3) of this paragraph, amounts actually distributed to a
shareholder of a DISC, or former DISC, with respect to his stock are
includible in his gross income in accordance with section 301.
(2) Since a deemed distribution does not reduce the earnings and
profits of a DISC, it does not affect the determination as to whether a
subsequent actual distribution is a ``dividend'' under section 316(a).
Since, however, the amount of a deemed distribution increases
``previously taxed income'', it does affect the determination as to
whether a subsequent actual distribution is excluded (as described in
subparagraph (3) of this paragraph) from gross income.
(3) Under Sec. 1.996-1(c), the amount of any actual distribution
(including a deficiency distribution made pursuant to Sec. 1.992-3),
with respect to stock in a DISC, or former DISC, which is treated under
Sec. 1.996-1 as made out of previously taxed income, is excluded by the
distributee from gross income, but only to the extent that such amount
does not exceed the adjusted basis of the distributee's stock. Under
Sec. 1.996-5(b), that portion of any actual distribution which is
treated as made out of previously taxed income shall be applied against
and reduce the adjusted basis of the stock and, to the extent that it
exceeds the adjusted basis of the stock, it shall be treated as gain
from the sale or exchange of property.
(4) A deficiency distribution pursuant to Sec. 1.992-3 may be made
after the close of the DISC's taxable year with respect to which it is
made. The determinations as to whether such deficiency distribution is a
dividend under section 301 and as to which division of earnings and
profits is the source thereof depend upon the status of the DISC's
earnings and profits account and divisions thereof at the time the
distribution is actually made. See Sec. 1.996-1(d) for the priority of
such deficiency distribution over other actual distributions made during
the same taxable year.
(d) Personal holding company income. (1) Any amount includible in a
shareholder's gross income as a dividend with respect to the stock of a
DISC, or former DISC, pursuant to paragraph (b) of this section shall be
treated as a dividend for all purposes of the Code, except that for
purposes of determining whether such shareholder is a personal holding
company within the meaning of section 542 any amount deemed distributed
for qualified years under Sec. 1.995-2 or upon disqualification under
Sec. 1.995-3, any amount of gain on certain dispositions of DISC stock
to which Sec. 1.995-4 applies, and any amount treated under Sec.
1.996-1 as distributed out of accumulated DISC income or previously
taxed income shall not be treated as a dividend or any other kind of
income described in section 543(a).
(2) Notwithstanding subparagraph (1) of this paragraph, the
shareholder may treat as an item of income described under section 543
(for example, rents) any amount to which the exception in
[[Page 704]]
such subparagraph (1) applies, if it establishes to the satisfaction of
the district director that such amount is attributable to earnings and
profits derived from such item of income.
[T.D. 7324, 39 FR 35109, Sept. 30, 1974]
Sec. 1.995-2 Deemed distributions in qualified years.
(a) General rule. Under section 995 (b)(1), each shareholder of a
DISC shall be treated as having received a distribution taxable as a
dividend with respect to his stock on the last day of each taxable year
of the DISC, in an amount which is equal to his pro rata share of the
sum (as limited by paragraph (b) of this section), of the following
seven items:
(1) An amount equal to the gross interest derived by the DISC during
such year from producer's loans (as defined in Sec. 1.993-4).
(2) An amount equal to the lower of--
(i) Any gain recognized by the DISC during such year on the sale or
exchange of property (other than property which in the hands of the DISC
is a qualified export asset) which was previously transferred to it in a
transaction in which the transferor realized gain which was not
recognized in whole or in part, or
(ii) The amount of the transferor's gain which was not recognized on
the previous transfer of the property to the DISC.
For purposes of this subparagraph, each item of property shall be
considered separately. See paragraph (d) of this section for special
rules with respect to certain tax-free acquisitions of property by the
DISC.
(3) An amount equal to the lower of--
(i) Any gain recognized by the DISC during such year on the sale or
exchange of property which in the hands of the DISC is a qualified
export asset (other than stock in trade or property described in section
1221(1)) and which was previously transferred to the DISC in a
transaction in which the transferor realized gain which was not
recognized in whole or in part, or
(ii) The amount of the transferor's gain which was not recognized on
the previous transfer of the property to the DISC and which would have
been includible in the transferor's gross income as ordinary income if
its entire realized gain had been recognized upon the transfer.
For purposes of this subparagraph, each item of property shall be
considered separately. See paragraph (d) of this section for special
rules with respect to certain tax-free acquisitions of property by the
DISC.
(4) For taxable years beginning after December 31, 1975, an amount
equal to 50 percent of the taxable income of the DISC for the taxable
years attributable to military property (as defined in Sec. 1.995-6).
(5) For taxable years beginning after December 31, 1975, the taxable
income for the taxable year attributable to base period export gross
receipts (as defined in Sec. 1.995-7).
(6) The sum of--
(i)(A) In the case of a corporate share holder, an amount equal to
57.5 percent of the excess (if any) (one-half for DISCs' taxable years
beginning before January 1, 1983) of the taxable income of the DISC for
such year (computed as provided in Sec. 1.991-1(b)(1)) over the sum of
the amounts deemed distributed for the taxable year in accordance with
subparagraphs (1), (2), (3), (4) and (5) of this paragraph, or
(B) In the case of a non-corporate share holder, an amount equal to
one-half of the excess (if any) of the taxable income of the DISC for
such year (computed as provided in Sec. 1.991-1(b)(1)) over the sum of
the amounts deemed distributed for the taxable year in accordance with
subparagraphs (1), (2), (3), (4), and (5) of this paragraph.
(ii)(A) An amount equal to the amount under subdivision (i) of
paragraph (a)(6) of this section multiplied by the international boycott
factor as determined under section 999 (c)(1) , or
(B) In lieu of the amount determined under subdivision (ii)(A) of
paragraph (a)(6) of this section, the amount described under section 999
(c)(2) of such international boycott income, and
(iii) An amount equal to the sum of any illegal bribes, kickbacks,
or other payments paid by or on behalf of the DISC directly or
indirectly to an official, employee, or agent in fact of a government.
An amount is paid by a DISC where it is paid by any officer, director,
employee, shareholder, or agent
[[Page 705]]
of the DISC for the benefit of such DISC. For purposes of this section,
the principles of section 162 (c) and the regulations thereunder shall
apply. The fair market value of an illegal payment made in the form of
property or services shall be considered the amount of such illegal
payment.
(7) The amount of foreign investment attributable to producer's
loans of the DISC, as of the close of the ``group taxable year'' ending
with such taxable year of the DISC, determined in accordance with Sec.
1.995-5. The amount of such foreign investment attributable to
producer's loans so determined for any taxable year of a former DISC
shall be deemed distributed as a dividend to the shareholders of such
former DISC on the last day of such taxable year. See Sec. 1.995-3(e)
for the effect that such deemed distribution has on scheduled
installments of deemed distributions of accumulated DISC income under
Sec. 1.995-3(a) upon disqualification.
(b) Limitation on amount of deemed distributions under section
995(b)(1). (1) The sum of the amounts described in paragraph (a)(1)
through (a)(6) of this section which is deemed distributed pro rata to
the DISC's shareholders a dividend for any taxable year of the
corporation shall not exceed the DISC's earnings and profits for such
year.
(2) The amount of foreign investment attributable to producer's
loans of the DISC (as described in paragraph (a)(7) of this section)
which is deemed to be distributed pro rata to the DISC's shareholders as
dividends for any taxable year of the corporation shall not exceed the
lower of the corporation's accumulated DISC income at the beginning of
such year or the corporation's accumulated earnings and profits at the
beginning of such year (but not less than zero)--
(i) Increased by any DISC income of the corporation for such year as
defined in Sec. 1.996-3(b)(2) (i.e., any excess of the DISC's earnings
and profits for such year over the sum of the amounts described in
paragraph (a)(1) through (a)(6) of this section), or
(ii) Decreased by any deficit in the corporation's earnings and
profits for such year.
Thus, for example, if a DISC has a deficit in accumulated earnings and
profits at the beginning of a taxable year of $10,000, current earnings
and profits of $12,000, no amounts described in paragraphs (a)(1)
through (a)(6) of this section for the year, and foreign investment
attributable to producer's loans for the taxable year of $5,000, the
DISC would have a deemed distribution described in paragraph (a)(7) of
this section of $5,000 for the taxable year. On the other hand, suppose
the DISC had accumulated earnings and profits of $13,000 at the
beginning of the taxable year, accumulated DISC income of $10,000 at the
beginning of the taxable year, a deficit in earnings and profits for the
taxable year of $12,000, no amounts described in paragraphs (a)(1)
through (a)(6) of this section for the taxable year, and foreign
investment attributable to producer's loans for the taxable year of
$5,000. Under these facts the DISC would have no deemed distribution
described in paragraph (a)(7) of this section because the corporation
had no DISC income for the taxable year and the current year's deficit
in earnings and profits subtracted from the DISC's accumulated DISC
income at the beginning of the year produces a negative amount. For
rules relating to the carryover to a subsequent year of the $5,000 of
foreign investment attributable to producer's loans, see Sec. 1.995-
5(a)(6).
(3) If, by reason of the limitation in subparagraph (1) of this
paragraph, less than the sum of the amounts described in paragraphs
(a)(1) through (a)(6) of this section is deemed distributed, then the
portion of such sum which is deemed distributed shall be attributed
first to the amount described in subparagraph (1) of such paragraph, to
the extent thereof; second to the amount described in subparagraph (2)
of such paragraph, to the extent thereof; third to the amount described
in subparagraph (3) of such paragraph, to the extent thereof; and so
forth, and finally to the amount described in paragraph (b)(6) of this
paragraph.
(c) Examples. Paragraphs (a) and (b) of this section may be
illustrated by the following examples:
Example 1. Y is a corporation which uses the calendar year as its
taxable year and which elects to be treated as a DISC beginning with
1972. X is its sole shareholder. In
[[Page 706]]
1972, X transfers certain property to Y in exchange for Y's stock in a
transaction in which X does not recognize gain or loss by reason of the
application of section 351(a). Included in the property transferred to Y
is depreciable property described in paragraph (a)(3) of this section on
which X realizes, but does not recognize by reason of the application of
section 1245(b)(3), a gain of $20,000. If X had sold such property for
cash, the $20,000 gain would have been recognized as ordinary income
under section 1245. Also included in the transfer to Y is 100 shares of
stock in a third corporation (which is not a related foreign export
corporation) on which X realizes, but does not recognize, a gain of
$5,000. In 1973, Y sells such property and recognizes a gain of $25,000
on the depreciable property and $8,000 on the 100 shares of stock. Y has
accumulated earnings and profits at the beginning of 1973 of $5,000,
earnings and profits for 1973 of $72,000, and taxable income for 1973 of
$100,000. At the beginning of 1973, Y has $6,000 of accumulated DISC
income, no previously taxed income, and a deficit of $1,000 of other
earnings and profits. Under these facts and the additional facts assumed
in the table below, X is treated as having received a deemed
distribution taxable as a dividend of $76,000 on December 31, 1973,
determined as follows:
(1) Gross interest derived by Y in 1973 from producer's loans.. $7,000
(2) Amount of gain on depreciable property (lower of Y's 20,000
recognized gain ($25,000) or X's gain not recognized on
section 1245 property ($20,000))..............................
(3) Amount of gain on stock (lower of X's gain not recognized 5,000
or Y's recognized gain ($8,000) ($5,000)).....................
(4) One-half excess of taxable income for 1973 over the sum of 34,000
lines (1), (2), and (3) (1/2 of ($100,000 minus $32,000)).....
--------
(5) Limitation on lines (1) through (4):
(a) Sum of lines (1) through (4)............................. 66,000
(b) Earnings and profits for 1973............................ 72,000
--------
(c) Lower of lines (a) and (b)............................... 66,000
--------
(6) Amount under paragraph (a)(5) of this section:
(a) Foreign investment attributable to producer's loans 10,000
under Sec. 1.995-5......................................
(b) Sum of the lower of accumulated earnings and profits at 11,000
beginning of 1973 ($5,000) or accumulated DISC income at
beginning of 1973 ($6,000) and excess of earnings and
profits for 1973 over line (5)(c) ($72,000 minus $66,000).
--------
(c) Lower of lines (a) and (b)............................. 10,000
--------
(7) Total deemed distribution (sum of lines (5)(c) and (6)(c)). 76,000
========
Example 2. Assume the facts are the same as in example 1, except
that earnings and profits for 1973 amount to only $60,000. Under these
facts, X is treated as receiving a deemed distribution taxable as a
dividend of $65,000 on December 31, 1973, determined as follows:
(5) Limitation on lines (1) through (4):
(a) Line (5)(a) of example 1.............................. $66,000
(b) Earnings and profits for 1973......................... 60,000
---------
(c) Lower of lines (a) and (b)............................ 60,000
---------
(6) Amount under paragraph (a)(5) of this section:
(a) Line (6)(a) of example 1.............................. 10,000
(b) Sum of the lower of accumulated earnings and profits 5,000
at beginning of 1973 ($5,000) or accumulated DISC income
at beginning of 1973 ($6,000) plus excess of earnings and
profits for 1973 over line (5)(c) ($60,000 minus $60,000)
---------
(c) Lower of lines (a) and (b)............................ 5,000
---------
(7) Total deemed distribution (sum of lines (5)(c) and (6)(c)) 65,000
=========
Example 3. Assume the facts are the same as in example 1, except
that Y has a deficit in accumulated earnings and profits at the
beginning of 1973 of $4,000. Such deficit is comprised of accumulated
DISC income of $1,000, no previously taxed income, and a deficit in
other earnings and profits of $5,000. Under these facts, X is treated as
receiving a deemed distribution taxable as a dividend in the amount of
$72,000 on December 31, 1973, determined as follows:
(5) Limitation on lines (1) through (4):
(a) Line (5)(a) of example 1................................ $66,000
(b) Earnings and profits for 1973........................... 72,000
---------
(c) Lower of lines (a) and (b).............................. 66,000
---------
(6) Amount under paragraph (a)(5) of this section:
(a) Line (6)(a) of example 1................................ 10,000
(b) Sum of accumulated earnings and profits at beginning of 6,000
1973 (not less than $0), and excess of earnings and profits
for 1973 over amount in line (5)(c) ($72,000 minus $66,000)
---------
(c) Lower of lines (a) and (b).............................. 6,000
---------
(7) Total deemed distribution sum of lines (5)(c) and (6)(c).. 72,000
=========
(d) Special rules for certain tax-free acquisitions of property by
the DISC. (1) For purposes of paragraph (a)(2)(i) and (3)(i) of this
section, if--
(i) A DISC acquires property in a first transaction and in a second
transaction it disposes of such property in exchange for other property,
and
(ii) By reason of the application of section 1031 (relating to like-
kind exchanges) or section 1033 (relating to involuntary conversions),
the basis in the
[[Page 707]]
DISC's hands of the other property acquired in such second transaction
is determined in whole or in part with reference to the basis of the
property acquired in the first transaction,
then upon a disposition of such other property in a third transaction by
the DISC such other property shall be treated as though it had been
transferred to the DISC in the first transaction. Thus, if the first
transaction is a purchase of the property for cash, then paragraphs
(a)(2) and (3) of this section will not apply to a sale by the DISC of
the other property acquired in the second transaction.
(2) For purposes of paragraphs (a)(2)(i) and (3)(i) of this section,
if a DISC acquires property in a first transaction and it transfers such
property to a transferee DISC in a second transaction in which the
transferor DISC's gain is not recognized in whole or in part, then such
property shall be treated as though it had been transferred to the
transferee DISC in the same manner in which it was acquired in the first
transaction by the transferor DISC. For example, if X and Y both qualify
as DISC's and X transfers property to Y in a second transaction in which
gain or loss is not recognized, paragraph (a)(2) or (3) of this section
does not apply to a sale of such property by Y in a third transaction if
X had acquired the property in a first transaction by a purchase for
cash. If, however, X acquired the property from a transferor other than
a DISC in the first transaction in which the transferor's realized gain
was not recognized, then paragraph (a)(2) or (3) of this section may
apply to the sale by Y if the other conditions of such paragraph (a)(2)
or (3) are met.
(3) If a DISC acquires property in a second transaction described in
subparagraph (1) or (2) of this paragraph in which it (or, in the case
of a second transaction described in subparagraph (2) of this paragraph,
the transferor DISC) recognizes a portion (but not all) of the realized
gain, then the amount described in paragraph (a)(2)(ii) or (a)(3)(ii) of
this section with respect to a disposition by the DISC of such acquired
property in a third transaction shall not exceed the transferor's gain
which was not recognized on the first transaction minus the amount of
gain recognized by the DISC (or transferor DISC) on the second
transaction.
(4) The provisions of this paragraph may be illustrated by the
following examples:
Example 1. X and Y are corporations each of which qualifies as a
DISC and uses the calendar year as its taxable year. In 1972, X acquires
section 1245 property in a first transaction in which the transferor's
entire realized gain of $17 is not recognized. In 1973, X transfers such
property to Y in a second transaction in which X realizes a gain of $20
of which only $4 is recognized. (On December 31, 1973, X's shareholders
are treated as having received a deemed distribution of a dividend which
includes such $4 under paragraph (a)(3) of this section, provided the
limitation in paragraph (b) of this section is met.) In a third
transaction in 1974, Y sells such property and recognizes a gain of $25.
With respect to Y's shareholders on December 31, 1974, the amount
described in paragraph (a)(3)(ii) of this section would be limited to
$13, which is the amount of the transferor's gain which was not
recognized on the first transaction ($17) minus the amount of gain
recognized by X on the second transaction ($4).
Example 2. Z is a DISC using the calendar year as its taxable year.
In a first transaction in 1972, in exchange for its stock, Z acquires
section 1245 property from A, an individual who is its sole shareholder,
in a transaction in which A's realized gain of $30 is not recognized by
reason of the application of section 351(a). In a second transaction in
1973, Z exchanges such property for other property in a like-kind
exchange to which section 1031(b) applies and recognizes $10 of a
realized gain of $35. (On December 31, 1973, A is treated as having
received a deemed distribution of a dividend which includes such $10
under paragraph (a)(3) of this section, provided the limitation in
paragraph (b) of this section is met.) In a third transaction in 1974, Z
sells the property acquired in the like-kind exchange and recognizes a
gain of $25. With respect to A on December 31, 1974, the amount
described in paragraph (a)(3)(ii) of this section is limited to $20,
which is the amount of A's gain which was not recognized on the first
transaction ($30) minus the amount of gain recognized by Z on the second
transaction ($10).
(e) Carry back of net operating loss and capital loss to prior DISC
taxable year. For purposes of sections 991, 995, and 996, the amount of
the deduction for the taxable year under section 172 for a net operating
loss carryback or carryover or under section 1212 for a capital
[[Page 708]]
loss carryback or carryover shall be determined in the same manner as if
the DISC were a domestic corporation which had not elected to be treated
as a DISC. Thus, the amount of the deduction will be the same whether or
not the corporation was a DISC in the year of the loss or in the year to
which the loss is carried. For provisions setting forth adjustments to
the DISC's, or former DISC's, deemed distributions, adjustments to its
divisions of earnings and profits, and other tax consequences arising
from such carrybacks, see Sec. 1.996-8.
(Secs. 995(e)(7), (8) and (10), 995(g) and 7805 of the Internal Revenue
Code of 1954 (90 Stat. 1655, 26 U.S.C. 995 (e)(7), (8) and (10); 90
Stat. 1659, 26 U.S.C. 995(g); and 68A Stat 917, 26 U.S.C. 7805))
[T.D. 7324, 39 FR 35110, Sept. 30, 1974, as amended by T.D. 7862, 47 FR
56492, Dec. 17, 1982; T.D. 7984, 49 FR 40018, Oct. 12, 1984]
Sec. 1.995-3 Distributions upon disqualification.
(a) General rule. Under section 995 (b)(2), a shareholder of a
corporation which is disqualified from being a DISC, either because
pursuant to Sec. 1.992-2(e)(2) it revoked its election to be treated as
a DISC or because it has failed to satisfy the requirements as set forth
in Sec. 1.992-1 to be a DISC for a taxable year, shall be deemed to
have received (at the times specified in paragraph (b) of this section)
distributions taxable as dividends aggregating an amount equal to his
pro rata share of the accumulated DISC income (as defined in Sec.
1.996-3(b)) of such corporation which was accumulated during the
immediately preceding consecutive taxable years for which the
corporation was a DISC. The pro rata share referred to in the preceding
sentence shall be determined as of the close of the last of such
consecutive taxable years for which the corporation was a DISC. See
Sec. 1.996-7(c) for rules relating to the carryover of, and maintaining
a separate account for, such accumulated DISC income in certain
reorganizations.
(b) Time of receipt of deemed distributions. Distributions described
in paragraph (a) of this section shall be deemed to be received in equal
installments on the last day of each of the 10 taxable years of the
corporation following the year of the disqualification described in
paragraph (a) of this section, except that in no case may the number of
equal installments exceed the number of the immediately preceding
consecutive taxable years for which the corporation was a DISC.
(c) Transfer of shares. Deemed distributions are includible under
paragraphs (a) and (b) of this section in a shareholder's gross income
as a dividend only so long as he continues to hold the shares with
respect to which the distribution is deemed made. Thus, the transferee
of such shareholder will include in his gross income under paragraphs
(a) and (b) of this section the remaining installments of the deemed
distribution which the transferor would have included in his gross
income as a dividend had he not transferred the shares. However, if the
transferee acquires the shares in a transaction in which the
transferor's gain is treated under Sec. 1.995-4 in whole or in part as
a dividend, then under Sec. 1.996-4(a) such transferee does not include
subsequent installments in his gross income to the extent that the
transferee treats such subsequent installments as made out of previously
taxed income.
(d) Effect of requalification. Deemed distributions under paragraphs
(a) and (b) of this section continue and are includible in gross income
as dividends by the shareholders whether or not the corporation
subsequently requalifies and is treated as a DISC.
(e) Effect of actual distributions and deemed distributions under
section 995(b)(1)(G). If, during the period a shareholder of a DISC, or
former DISC, is taking into account deemed distributions under
paragraphs (a) and (b) of this section, an actual distribution is made
to him out of accumulated DISC income or a deemed distribution because
of foreign investment attributable to producer's loans is made under
Sec. 1.995-2(a)(5) out of accumulated DISC income, such actual or
deemed distribution shall first reduce the last installment of the
deemed distributions scheduled to be included in the shareholder's gross
income as a dividend, and then the preceding scheduled installments in
reverse order. If deemed distributions are scheduled to
[[Page 709]]
be included in gross income for two or more disqualifications, an actual
distribution or a deemed distribution under Sec. 1.995-2 (a)(5) which
is treated as made out of accumulated DISC income reduces the deemed
distributions resulting from the earlier disqualification first.
(f) Examples. This section may be illustrated by the following
examples:
Example 1. X Corporation, which uses the calendar year as its
taxable year, elects to be treated as a DISC beginning with 1972. X
qualifies as a DISC for taxable years 1972 through 1975, but, pursuant
to Sec. 1.992-2(e)(2), revokes its election as of January 1, 1976, and
is disqualified as a DISC. On that date, X has $24,000 of accumulated
DISC income. X's shareholders will be deemed to receive $6,000 in
distributions taxable as a dividend on the last day of each of X's four
succeeding taxable years (1977, 1978, 1979, and 1980).
Example 2. Assume the same facts as in example 1, except that in
1978 X makes an actual distribution of $22,000 to its shareholders of
which $10,000 is treated under Sec. 1.996-1 as made out of accumulated
DISC income. (The remaining $12,000 of such distribution is treated as
made out of previously taxed income.) The actual distribution would
first reduce the $6,000 deemed distribution scheduled for 1980 to zero
and then reduce the $6,000 deemed distribution scheduled for 1979 to
$2,000. Thus, X's shareholders include in 1978 $16,000 is gross income
as dividends ($10,000 of actual distributions and the $6,000 deemed
distribution scheduled for that year) and $2,000 as a dividend in 1979.
Example 3. Assume the same facts as in example 2, except that X
requalifies as a DISC for taxable year 1977 during which it derives
$7,000 of DISC income (computed after taking into account a deemed
distribution under Sec. 1.995-2(a)(4) of $7,000), but is again
disqualified in 1978. In addition X makes an actual distribution in 1977
equal to the deemed distribution of $7,000. Such actual distribution is
excluded from gross income under Sec. 1.996-1(c). In 1977. X's
shareholders include in gross income as dividends the $6,000 deemed
distribution upon disqualification (in addition to the deemed
distributions of $7,000 under Sec. 1.995-2 for 1977 when it was treated
as a DISC). The actual distribution in 1978 still reduces the
installments resulting from the earlier disqualification. Thus, in 1978,
X's shareholders include $16,000 in gross income as dividends. In 1979,
X's shareholders include $9,000 in gross income as dividends (the final
installment of $2,000 from the earlier disqualification plus the single
deemed distribution of $7,000 resulting from the later
disqualification).
[T.D. 7324, 39 FR 35112, Sept. 30, 1974, as amended by T.D. 7854, 47 FR
51741, Nov. 17, 1982]
Sec. 1.995-4 Gain on disposition of stock in a DISC.
(a) Disposition in which gain is recognized--(1) In general. If a
shareholder disposes, or is treated as disposing, of stock in a DISC, or
former DISC, then any gain recognized on such disposition shall be
included in the shareholder's gross income as a dividend,
notwithstanding any other provision of the Code, to the extent of the
accumulated DISC income amount (described in paragraph (d) of this
section). To the extent the recognized gain exceeds the accumulated DISC
income amount, it is taxable as gain from the sale or exchange of the
stock.
(2) Nonapplication of subparagraph (1). The provisions of
subparagraph (1) of this paragraph do not apply (i) to the extent gain
is not recognized (such as, for example, in the case of a gift or an
exchange of stock to which section 354 applies) and (ii) to the amount
of any recognized gain which is taxable as a dividend (such as, for
example, under section 301 or 356(a)(2)) or as gain from the sale or
exchange of property which is not a capital asset. The amount taxable as
a dividend under section 301 or 356(a)(2) is subject to the rules
provided in Sec. 1.995-1(c) for the treatment of actual distributions
by a DISC.
(b) Disposition in which separate corporate existence of DISC is
terminated--(1) General. If stock in a corporation that is a DISC, or
former DISC, is disposed of in a transaction in which its separate
corporate existence as a DISC, or former DISC, is terminated, then,
notwithstanding any other provision of the Code, an amount of realized
gain shall be recognized and included in the transferor's gross income
as a dividend. The realized gain shall be recognized to the extent that
such gain--
(i) Would not have been recognized but for the provisions of this
paragraph, and
(ii) Does not exceed the accumulated DISC income amount (described
in paragraph (d) of this section).
[[Page 710]]
(2) Cessation of separate corporate existence as a DISC, or former
DISC. For purposes of subparagraph (1) of this paragraph, separate
corporate existence as a DISC, or former DISC, will be treated as having
ceased if, as a result of the transaction, there is no separate entity
which is a DISC and to which is carried over the accumulated DISC income
and other tax attributes of the DISC, or former DISC, the stock of which
is disposed of. Thus, for example, if stock in a DISC, or former DISC,
is exchanged in a transaction described in section 381(a) (relating to
carryovers in certain corporate acquisitions), the gain realized on the
transfer of such stock will not be recognized under subparagraph (1) of
this paragraph if the assets of such DISC, or former DISC, are acquired
by a corporation which immediately after the acquisition qualifies as a
DISC. For a further example, if a DISC, or former DISC, is liquidated in
a transaction to which section 332 (relating to complete liquidations of
subsidiaries) applies, the transaction will be subject to subparagraph
(1) of this paragraph if the basis to the transferee corporation of the
assets acquired on the liquidation is determined under section 334(b)(2)
(as in effect prior to amendment by the Tax Equity and Fiscal
Responsibility Act of 1982) or if immediately after such liquidation the
transferee of such assets does not qualify as a DISC. However, separate
corporate existence as a DISC, or former DISC, will not be treated as
having ceased in the case of a mere change in place of organization,
however effected. See Sec. 1.996-7 for rules for the carryover of the
divisions of a DISC's earnings and profits to one or more DISC's.
(c) Disposition to which section 311, 336, or 337 applies--(1) In
general. If, after December 31, 1976, a shareholder distributes, sells,
or exchanges stock in a DISC, or former DISC, in a transaction to which
section 311, 336, or 337 applies, then an amount equal to the excess of
the fair market value of such stock over its adjusted basis in the hands
of the shareholder shall, notwithstanding any other provision of the
Code, be included in gross income of the shareholder as a dividend to
the extent of the accumulated DISC income amount (described in paragraph
(d) of this section).
(2) Nonapplication of subparagraph (1). Subparagraph (1) shall not
apply if the person receiving the stock in the disposition has a holding
period for the stock which includes the period for which the stock was
held by the shareholder disposing of such stock.
(d) Accumulated DISC income amount--(1) General. For purposes of
this section, the accumulated DISC income amount is the accumulated DISC
income of the DISC or former DISC which is attributable to the stock
disposed of and which was accumulated in taxable years of such DISC or
former DISC during the period or periods such stock was held by the
shareholder who disposed of such stock.
(2) Period during which a shareholder has held stock. For purposes
of this section, the period during which a shareholder has held stock
includes the period he is considered to have held it by reason of the
application of section 1223 and, if his basis is determined in whole or
in part under the provisions of section 1014(d) (relating to special
rule for DISC stock acquired from decedent), the holding period of the
decedent. Such holding period is to exclude the day of acquisition but
include the day of disposition. Thus, for example, if A purchases stock
in a DISC on December 31, 1972, and makes a gift of such stock to B on
June 30, 1973, then on December 31, 1974, B will be treated as having
held the stock for 2 full years. If the basis of the stock in C's hands
is determined under section 1014(d) upon a transfer from B's estate on
December 31, 1976, by reason of B's death on June 30, 1974, then on
December 31, 1976, C will be treated as having held the stock for 4 full
years.
(e) Accumulated DISC income allocable to shareholder under section
995(c)(2)--(1) In general. Under this paragraph, rules are prescribed
for purposes of paragraph (d) of this section as to the manner of
determining, with respect to the stock of a DISC, or former DISC,
disposed of, the amount of accumulated DISC income which is attributable
to such stock and which was accumulated in taxable years of the
corporation during the period or periods the stock disposed of was held
or treated under
[[Page 711]]
paragraph (d)(2) of this section as held by the transferor.
Subparagraphs (2), (3), and (4) of this paragraph set forth a method of
computation which may be employed to determine such amount. Any other
method may be employed so long as the result obtained would be the same
as the result obtained under such method.
(2) Step 1. Determine the increase (or decrease) in accumulated DISC
income for each taxable year of the DISC, or former DISC, by subtracting
from the amount of accumulated DISC income (as defined in Sec. 1.996-
3(b)) at the close of each taxable year the amount thereof as of the
close of the immediately preceding taxable year.
(3) Step 2. (i) Determine for each taxable year of the DISC, or
former DISC, the increase (or decrease) in accumulated DISC income per
share by dividing such increase (or decrease) for the year by the number
of shares outstanding or deemed outstanding on each day of such year.
(ii) If the number of shares of stock in the corporation outstanding
on each day of a taxable year of the DISC, or former DISC, is not
constant, then the number of such shares deemed outstanding on each day
of such year shall be the sum of the fractional amounts in respect of
each share which was outstanding on any day of the taxable year. The
fractional amount in respect of a share shall be determined by dividing
the number of days in the taxable year on which such share was
outstanding (excluding the day the share became outstanding, but
including the day the share ceased to be outstanding), by the total
number of days in such taxable year.
(iii) If for any taxable year of a DISC, or former DISC, the share
disposed of was not held (or treated under paragraph (d)(2) of this
section as held) by the disposing shareholder for the entire year, then
the amount of increase (or decrease) in accumulated DISC income
attributable to such share for such year is the amount determined as if
he held the share until the end of such year multiplied by a fraction
the numerator of which is the number of days in the taxable year on
which the shareholder held (or under paragraph (d)(2) of this section is
treated as having held) such share and the denominator of which is the
total number of days in the taxable year.
(4) Step 3. Add the amounts computed in step 2 for each taxable year
of the DISC, or former DISC, in which the shareholder held such share of
stock.
(5) Examples. This paragraph may be illustrated by the following
examples:
Example 1. X Corporation uses the calendar year as its taxable year
and elects to be a DISC for the first time for 1973. On January 1, 1973,
X has 20 shares issued and outstanding. A and B each own 10 shares. On
July 1, 1976, X issues 10 shares to C. On December 31, 1977, A sells his
10 shares to D and recognizes a gain of $120. Under these facts and
other facts assumed in the table below, A includes in his gross income
for 1977 a dividend under paragraph (b) of this section of $61.30 and
long-term capital gain of $58.70.
----------------------------------------------------------------------------------------------------------------
(d)--Increase
(a)--Year (b)--Increase (decrease)
end (decrease) in (c)--Shares per share
Year accumulated accumulated outstanding (column (b)
DISC income DISC income divided by
column (c))
----------------------------------------------------------------------------------------------------------------
1973.................................................... $80 $80 20 $4.00
1974.................................................... 50 (30) 20 (1.50)
1975.................................................... 80 30 20 1.50
1976.................................................... 100 20 \1\ 25 .80
1977.................................................... 140 40 30 1.33
--------------
(1) Total increase in accumulated DISC income for each ........... ............. ........... 6.13
share disposed of (sum of amounts in column (d)).......
Multiply by number of shares disposed of................ ........... ............. ........... 10
--------------
(2) Total amount of accumulated DISC income attributable ........... ............. ........... 61.30
to A's shares disposed of..............................
(3) A's gain............................................ ........... ............. ........... 120.00
(4) Portion of A's gain taxable as a dividend (lower of ........... ............. ........... 61.30
lines (2) and (3)).....................................
[[Page 712]]
(5) Portion of A's gain taxable as long-term capital ........... ............. ........... 58.70
gain (line (3) minus line (4)).........................
----------------------------------------------------------------------------------------------------------------
\1\ Under subparagraph (3)(ii) of this paragraph, the aggregate fractional amounts of the 10 shares issued on
July 1, 1976, is 5 shares, i.e., 10 shares, multiplied by (183 days/366 days). Thus, the number of shares
deemed outstanding for 1976 is 25 shares, i.e., 20 shares plus 5 shares.
Example 2. Assume the same facts as in example 1, except that A
sells his 10 shares to D on July 1, 1977. Under subparagraph (3)(iii) of
this paragraph, the amount of increase in accumulated DISC income for
1977 which is attributable to each share disposed of is limited to $.67,
i.e., $1.33 multiplied by 182 days/365 days. Therefore, the sum of the
yearly increases (and decreases) in accumulated DISC income for each
share is reduced by $.66 (i.e., $1.33 minus $.67). The total increase in
accumulated DISC income for each share disposed of is $5.47 (i.e., $6.13
minus $.66). Under these facts, A would include in his gross income for
1977 a dividend of $54.70 and long-term capital gain of $65.30
determined as follows:
(1) Total increase in accumulated DISC income for each $5.47
share disposed of.........................................
Multiplied by number of shares disposed of................. 10
------------
(2) Total amount of accumulated DISC income attributable of 54.70
to all shares disposed of.................................
(3) A's gain............................................... 120.00
(4) Portion of A's gain taxable as a dividend (lower of 54.70
lines (2) and (3))........................................
(5) Portion of A's gain taxable as long-term capital gain 65.30
(line (3) minus line (4)).................................
[T.D. 7324, 39 FR 35112, Sept. 30, 1974, as amended by T.D. 7854, 47 FR
51741, Nov. 17, 1982]
Sec. 1.995-5 Foreign investment attributable to producer's loans.
(a) In general--(1) Limitation. Under section 995(d), the amount as
of the close of a ``group taxable year'' (as defined in subparagraph (3)
of this paragraph) of foreign investment attributable to producer's
loans of a DISC for purposes of section 995(b)(1)(G) shall be the excess
(as of the close of such year) of--
(i) The smallest of--
(a) The amount of the net increase in foreign assets (as defined in
paragraph (b) of this section) by domestic and foreign members of the
controlled group which includes the DISC,
(b) The amount of the actual foreign investment by the domestic
members of such group (as determined under paragraph (c) of this
section), or
(c) The amount of outstanding producer's loans (as determined under
Sec. 1.993-4) by such DISC to members of such controlled group, over
(ii) The amount (determined under Sec. 1.995-2 (a)(5) and (b)(2))
of foreign investment attributable to producer's loans treated under
section 995(b)(1)(G) as deemed distributions by the particular DISC
taxable as dividends for prior taxable years of that particular DISC.
Thus, for example, if the shareholders of a DISC which uses the calendar
year as its taxable year (and which is a member of a controlled group in
which all of the members use the calendar year as their taxable year)
are treated under section 995(b)(1)(G) as receiving foreign investment
attributable to producer's loans of a DISC of $0 in 1972, $10 in 1973,
and $30 in 1974, or a total of $40, and if the smallest of the amounts
described in subdivision (i) of this subparagraph at the end of 1975 is
$90, then the amount of the foreign investment attributable to
producer's loans of a DISC at the end of 1975 is $50, i.e., the excess
(as of the close of 1975) of the smallest of the amounts described in
subdivision (i) of this subparagraph ($90) over the sum of the amounts
of foreign investment attributable to producer's loans treated under
section 995(b)(1)(G) as deemed distributions by the DISC taxable as
dividends for prior taxable years of the DISC ($40). If the separate
corporate existence of the DISC as to which the amount described in
subdivision (ii) of this subparagraph
[[Page 713]]
relates ceases to exist within the meaning of Sec. 1.995-4(c)(2), then
such amount shall no longer be taken into account by the group for any
purpose. For inclusion of amounts because of certain corporate
acquisitions, see paragraph (d) of this section.
(2) Controlled group; domestic and foreign member. For purposes of
this section--
(i) The term ``controlled group'' has the meaning assigned to such
term by Sec. 1.993-1(k).
(ii) The term domestic member means a domestic corporation which is
a member of a controlled group, and the term foreign member means a
foreign corporation which is a member of a controlled group.
(3) Group taxable year. (i) The term group taxable year refers
collectively to the taxable year of the DISC and to the taxable year of
each corporation in the controlled group which includes the DISC ending
with or within the taxable year of the DISC. Thus, for example, if a
corporation has a subsidiary which uses the calendar year as its taxable
year and which elects to be treated as a DISC, and if the parent has a
taxable year ending on October 31, the ``group taxable year'' for 1973
would refer to calendar year 1973 for the DISC and to the parent's
taxable year ending October 31, 1973.
(ii) In cases in which the DISC makes a return for a short taxable
year, that is, for a taxable year consisting of a period of less than 12
months, pursuant to section 443 and the regulations thereunder, or Sec.
1.991-1(b)(3), the following rules shall apply--
(a) In the case of a change in the annual accounting period of the
DISC resulting in a short taxable year, the group taxable year refers
collectively to the short taxable year and to the taxable year of each
corporation in the controlled group which includes the DISC ending with
or within the short taxable year.
(b) In the case of a DISC which is in existence during only part of
what would otherwise be its taxable year, the group taxable year refers
collectively to the short period during which the DISC was in existence
and to the taxable year of each corporation in the controlled group
which includes the DISC ending with or within the 12-month period ending
on the last day of the short period.
(iii) With respect to periods prior to the first taxable year for
which a member of the group qualified (or is treated) as a DISC, each
group taxable year shall be determined under subdivision (i) of this
subparagraph as if such member was in existence, it qualified as a DISC,
and its taxable year ended on that date corresponding to the date such
member's first taxable year ended after it qualified (or is treated) as
a DISC whether or not the corporation which qualifies (or is treated) as
a DISC used the same taxable year before it so qualified (or is so
treated). Thus, for example, if a corporation which is organized on
March 3, 1975, uses the calendar year as its taxable year, and is a
member of a controlled group which does not include a DISC, first
qualifies (or is treated) as a DISC for calendar year 1975, then the
term ``group taxable year'' with respect to years prior to 1975 refers
collectively to such prior calendar years and to the taxable year of
each corporation in the group ending with or within such prior calendar
years.
(iv) For special rules in the case of a group which includes more
than one DISC, see paragraph (g) of this section.
(4) Amounts determined for prior years. Unless the 3-year limitation
is properly elected under subparagraph (5) of this paragraph, the
amounts described in paragraphs (b) (relating to net increase in foreign
assets) and (c) (relating to actual foreign investments by domestic
members) of this section reflect, as of the close of a group taxable
year, amounts for all taxable years of members of the group beginning
after December 31, 1971 (and amounts arising after December 31, 1971, or
such other date prescribed in paragraph (b)(7) of this section),
provided that such amounts relate to such group taxable year and
preceding group taxable years. Thus, for example, if all members of a
controlled group use the calendar year as the taxable year, and 1980 is
the first taxable year for which any member of the group qualifies (or
is treated) as a DISC, then, unless the 3-year limitation is elected
under subparagraph (5) of this paragraph, the
[[Page 714]]
amounts described in paragraphs (b) and (c) of this section will be
taken into account beginning with the dates specified in the preceding
sentence. For rules as to carryovers on certain corporate acquisitions
and reorganizations, see paragraph (d) of this section.
(5) Three-year elective limitation. (i) A DISC may elect to take
into account only amounts described in paragraphs (b) (relating to net
increase in foreign assets) and (c) (relating to actual foreign
investment by domestic members) of this section for the 3 taxable years
of each member immediately preceding its taxable year included in that
first group taxable year which includes a member's first taxable year
during which it qualifies (or is treated) as a DISC. For purposes of the
preceding sentence, determinations shall be made by reference to the
taxable year of the issuer or transferor (as the case may be). If an
election is made under this subdivision, the offset for uncommitted
transitional funds under paragraph (b)(7) of this section is not
allowed. If an election is made under this subdivision, the 3-year
limitation applies to amounts described in paragraphs (b)(4) and (c)(1)
and (2) of this section.
(ii) An election under subdivision (i) of this subparagraph shall
not apply with respect to amounts which must be carried over under
paragraph (d) of this section in the case of certain corporate
acquisitions and reorganizations.
(iii) An election under subdivision (i) of this subparagraph shall
be made by the DISC attaching to its first return, filed under section
6011(e)(2), a statement to the effect that the 3-year limitation is
being elected under Sec. 1.995-5(a)(5)(i).
(6) Cumulative basis. Pursuant to section 995(d)(5), all
determinations of amounts specified in this section are to be made on a
cumulative basis from the 1st year (or date) provided for in this
section. Thus, each such determination shall take into account a net
increase or a net decrease during the year, as the case may be. However,
if the 3-year limitation is elected under subparagraph (5) of this
paragraph, then only amounts with respect to periods specified in such
subparagraph (5) are amounts taken into account for years before a
member of the group qualifies (or is treated) as a DISC. The
computations described in this section may be made in any way chosen by
the DISC (including a corporation being tested as to whether it
qualifies as a DISC), provided such method results in the amount
prescribed by this section.
(7) Example. The provisions of this paragraph may be illustrated by
the following example:
Example. X Corporation, which uses the calendar year as its taxable
year, is a member of a controlled group (within the meaning of
subparagraph (2) of this paragraph). X elects to be treated as a DISC
beginning with 1972. The amount of foreign investment attributable to
X's producer's loans treated under section 995(b)(1)(G) as a
distribution taxable as a dividend as of the close of each group taxable
year with respect to each taxable year of X from 1972 through 1975 are
set forth in the table below, computed on the basis of the facts assumed
(the amounts on lines (1), (2), (3), and (5) being running balances):
------------------------------------------------------------------------
Taxable year of X 1972 1973 1974 1975
------------------------------------------------------------------------
(1) Net increase (or decrease) in ($30) $10 $100 $150
foreign assets since January 1,
1972, at close of group taxable
year..............................
(2) Actual foreign investment at 20 60 80 140
close of group taxable year.......
(3) Outstanding producer's loans of 0 40 90 120
X (the DISC) as of the close of
group taxable year................
===========
(4) Smallest of lines (1), (2), or 0 10 80 120
(3) (not less than zero)..........
(5) Less section 995(b)(1)(G) 0 0 10 80
deemed distributions for prior
taxable years (sum of lines (5)
and (6) from prior year)..........
-----------
(6) Section 995(b)(1)(G) deemed 0 10 70 40
distribution as of close of
taxable year......................
------------------------------------------------------------------------
(b) Net increase in foreign assets--(1) In general. (i) The term net
increase in foreign assets when used in this section means the excess
for the controlled group (as of the close of the group taxable year) of
(a) the investment in foreign assets to be taken into account
[[Page 715]]
under subparagraph (2) of this paragraph over (b) the aggregate of the
five offsets allowed by subparagraphs (3) through (7) of this paragraph.
(ii) No amount described in this paragraph (other than amounts
described in subparagraphs (4) and (7) of this paragraph) with respect
to a member of the group (or foreign branch of a member) shall be taken
into account unless it is attributable to a taxable year of such member
beginning after December 31, 1971. For a 3-year elective limitation with
respect to the first taxable year for which a member qualifies (or is
treated) as a DISC, see paragraph (a)(5) of this section. For manner of
determining amounts on a cumulative basis, see paragraph (a)(6) of this
section.
(2) Investments made in foreign assets. (i) For purposes of
subparagraph (1) of this paragraph, there shall be taken into account as
investment in foreign assets the aggregate of the amounts expended
(within the meaning of subdivision (ii) of this subparagraph) during the
period described in subparagraph (1)(ii) of this paragraph by all
members of the controlled group which includes the DISC to acquire
assets described in section 1231(b) (determined without regard to any
holding period therein provided) which are located outside the United
States (as defined in Sec. 1.993-7) reduced by the aggregate of the
amounts received by all such members of the controlled group from the
sale, exchange, or involuntary conversion of such assets described in
section 1231(b) which are located outside the United States. For
purposes of this section, amounts expended for assets which are
qualified export assets (as defined in Sec. 1.993-2) of a DISC (or
which would be qualified export assets if owned by a DISC) shall not be
taken into account. Thus, for example, if a DISC acquires a qualified
export asset located outside the United States, the asset is not to be
taken into account for purposes of determining the net increase in
foreign assets.
(ii) As used in subdivision (i) of this subparagraph, the term
amounts expended (or amounts received) means the amount of any money or
the fair market value (on the date of acquisition, sale, exchange, or
involuntary conversion) of any property (other than money) used to
acquire (or received for) the assets described in such subdivision (i).
(iii) For purposes of this subparagraph, an asset (other than an
aircraft or vessel) is considered as located outside the United States
if it was used predominantly outside the United States during the group
taxable year. The determination as to whether such an asset is used
predominantly outside the United States during the group taxable year in
which it was acquired or sold, exchanged, or involuntarily converted
shall be made by applying the rules of Sec. 1.993-3(d) except that an
aircraft described in section 48(a)(2)(B)(i) or a vessel described in
section 48(a)(2)(B)(iii) shall be considered located in the United
States and all other aircraft or vessels shall be considered located
outside the United States. Thus, for example, if a member of a
controlled group which includes a DISC acquires a vessel which is
documented under the laws of a foreign country, the amount expended to
acquire that vessel is an amount described in subdivision (i) of this
subparagraph.
(iv) Examples. The provisions of this subparagraph may be
illustrated by the following examples:
Example 1. X Corporation, which uses the calendar year as its
taxable year, is a domestic member of a controlled group (within the
meaning of paragraph (a)(2) of this section). During 1972, in a
transaction to which section 1031 applies, X acquires a warehouse
located outside the United States and having a fair market value of
$100. As consideration, X transfers $20 in cash and a warehouse located
within the United States and having a fair market value of $80. Under
these facts, $100 will be taken into account as investment in foreign
assets.
Example 2. The facts are the same as in example 1, except that the
warehouse transferred by X as consideration is located outside the
United States. Under these facts, only $20 will be taken into account as
investment in foreign assets because the amount expended for such assets
(i.e., $100) is reduced by the fair market value of any property located
outside the United States received in exchange for such assets (i.e.,
$80).
(3) Depreciation with respect to all foreign assets of a controlled
group. (i) An offset allowed by this subparagraph is the depreciation
(determined under subdivision (ii) of this subparagraph) or
[[Page 716]]
depletion (determined under subdivision (iii) of this subparagraph)
attributable to taxable years of the member beginning after December 31,
1971, with respect to all of the group's foreign assets described in
subparagraph (2) of this paragraph including such assets acquired prior
to the date provided in such subparagraph (2), and without regard to
whether the 3-year election in paragraph (a)(5) of this section is made.
Thus, for example, depreciation for a taxable year of a member beginning
after December 31, 1971, with respect to an asset described in section
1231(b) which is located outside of the United States and which was
acquired during a taxable year of the member beginning before January 1,
1972, is an offset allowed by this subparagraph. For a further example,
depreciation with respect to a qualified export asset is not such an
offset.
(ii) The depreciation taken into account under subdivision (i) of
this subparagraph shall be--
(a) In the case of an asset owned by a domestic member, only the
amount allowed under section 167(b)(1) (relating to the allowance of the
straight-line method of depreciation) and Sec. 1.162-11 (b) (relating
to amortization in lieu of depreciation), but not the amount allowed
under section 179 (relating to the additional first-year depreciation
allowance).
(b) In the case of an asset owned by a foreign member, the
depreciation and amortization (referred to in (a) of this subdivision)
allowable for purposes of computing earnings and profits under
subparagraph (5)(i) of this paragraph.
(iii) The depletion taken into account under subdivision (i) of this
subparagraph shall be limited to cost depletion computed under sections
611 and 612 and the regulations thereunder. Thus, percentage depletion
is not to be taken into account in computing the offset under this
subparagraph.
(4) Amount of outstanding stock or debt. (i) An offset allowed by
this subparagraph is the outstanding amount of stock (including treasury
stock) or debt obligations of any member of the group issued, sold, or
exchanged after December 31, 1971, by any member (whether or not the
same member) to persons who (on the date of such issuance, sale, or
exchange) were neither United States persons (within the meaning of
section 7701(a)(30)) nor members of the group: Provided, That, in the
case of a debt obligation, such obligation is not repaid within 12
months after such issuance, sale, or exchange. Thus, for example, if
stock is issued to a member of the group before January 1, 1972, and
after December 31, 1971, it is sold to a person who is neither a United
States person nor a member of the group, an offset allowed by this
subparagraph includes the outstanding amount of such stock. For purposes
of this subparagraph, foreign branches of United States banks are not
considered to be United States persons.
(ii) The outstanding amount of stock or debt obligations shall be
determined in accordance with the following provisions:
(a) The outstanding amount of stock or debt obligations described in
subdivision (i) of this subparagraph is equal to the net amount
described in (b) of this subdivision reduced (but not below zero) by the
amount described in (c) of this subdivision.
(b) The net amount described in this subdivision (b) is the excess
of (1) the aggregate of the amount of money and the fair market value of
property (other than money) transferred by persons who are not members
of the group and who are not U.S. persons as consideration for such
stock and debt obligations over (2) fees and commission expenses borne
by the issuer or transferror with respect to their issuance, sale, or
exchange.
(c) The amount described in this subdivision (c) is the aggregate
amount of money and fair market value of property (other than money)
distributed to such persons on distributions in respect of such stock
from other than earnings and profits or on distributions in redemption
of such stock and the amount of principal paid pursuant to such debt
obligations.
(d) For purposes of this subdivision (ii), in the case of a
redemption, the stock or debt redeemed shall be charged against the
earliest of such stock or debt issued, sold, or exchanged in order to
determine the amount by which the balance of outstanding stock
[[Page 717]]
or debt is to be reduced. For purposes of this subparagraph, the fair
market value of property received as consideration shall be determined
as of the date the transaction occurs, and a contribution to capital
within the meaning of section 118 shall be treated as the issuance of
stock.
(iii) The provisions of subdivision (i) of this subparagraph apply
regardless of the treatment under the Code of the transaction in which
the stock or debt was issued, sold, or exchanged. Thus, for example, if
X Corporation, a member of a controlled group which includes a DISC,
acquires from a nonresident alien individual in exchange solely for X's
voting stock all of the stock of Y Corporation pursuant to a
reorganization as defined in section 368(a)(1)(B), the fair market value
of the Y stock on the date of the exchange would be an offset allowed by
this subparagraph.
(iv) The provisions of this subparagraph may be illustrated by the
following example:
Example. X Corporation is a member of a controlled group (within a
meaning of paragraph (a)(2) of this section) every member of which uses
the calendar year as its taxable year. On January 1, 1972, X issues in a
public offering its stock to persons described in subdivision (i) of
this subparagraph who, in the aggregate, pay $1,000 as consideration. X
pays $100 in underwriting fees. On the same date, X receives $425 upon
issuing a $500 debt obligation to such persons at a discount of $75 and
pays $25 in underwriting fees. On December 31, 1972, the offset allowed
under this subparagraph is $1,300, i.e., ($1,000 minus $100) plus ($425
minus $25). If, during 1973, X makes a distribution of $150 (not in
redemption) from other than earnings and profits with respect to such
stock, then the offset is reduced to $1,150.
(5) Earnings and profits. (i) An offset allowed by this subparagraph
is one-half the aggregate of the earnings and profits accumulated for
all taxable years beginning after December 31, 1971, computed (without
regard to any distributions from earnings and profits by a foreign
corporation to a domestic corporation in accordance with Sec. 1.964-1
(relating to a controlled foreign corporation's earnings and profits),
of each foreign member of the group which is controlled directly or
indirectly (as determined under the principles of section 958 and the
regulations thereunder) by a domestic member of the group and each
foreign branch of a domestic member of the group (computed as if the
branch were a foreign corporation). The DISC is bound by any action on
behalf of a foreign member that was taken pursuant to Sec. 1.964-
1(c)(3) or by any failure to take action by or on behalf of a foreign
member within the time specified in Sec. 1.964-1(c)(6). With respect to
a foreign member for which action was not previously required under
Sec. 1.964-1(c)(6) to be taken, the DISC may take action on behalf of
such member by attaching a statement to that effect to the return of the
DISC under section 6011(e)(2) for the first taxable year during which it
qualifies (or is treated) as a DISC and there is outstanding a
producer's loan made by such DISC to a member of the controlled group
which includes the DISC.
(ii) If the aggregate of the accumulated earnings and profits
described in subdivision (i) of this subparagraph is a deficit, the
amount allowable as an offset under this subparagraph is zero.
(6) Royalties and fees. An offset allowed by this subparagraph is
one-half the royalties and fees paid by foreign members of the group to
domestic members of the group and by foreign branches of domestic
members of the group to domestic members of the group during the taxable
years of such members beginning after December 31, 1971.
(7) Uncommitted transitional funds. (i) An offset allowed by this
subparagraph for the uncommitted transitional funds of the group is the
sum described in subdivision (ii) of this subparagraph of the amount of
certain capital raised under the foreign direct investment program and
the amounts described in subdivision (iv) of this subparagraph of
certain foreign excess working capital held on October 31, 1971.
(ii) The amount described in this subdivision of certain capital
raised under the foreign direct investment program is the excess (if
any) of--
(a) The amount of the offset allowed by subparagraph (4) of this
paragraph, determined, however, with respect to
[[Page 718]]
the stock and debt obligations of domestic members of the group
outstanding on December 31, 1971 (including amounts treated as stock
outstanding by reason of a contribution to capital), whether or not
outstanding after such date, which were issued, sold, or exchanged on or
after January 1, 1968, by any member (whether or not the same member) to
persons who (on the date of such issuance, sale, or exchange) were
neither United States persons (within the meaning of section
7701(a)(30)) nor members of the group, but only to the extent the
taxpayer establishes that such amount constitutes a long-term borrowing
(see 15 CFR 1000.324 \1\) for purposes of the foreign direct investment
program (see 15 CFR part 1000 \1\), over
---------------------------------------------------------------------------
\1\ Editorial Note: 15 CFR part 1000 was removed at 39 FR 30481,
Aug. 23, 1974.
---------------------------------------------------------------------------
(b) The amount (determined under paragraph (c) of this section) of
actual foreign investment by the domestic members of the group during
the portion of the period such stock or debt obligations have been
outstanding prior to January 1, 1972, such determination to be made by
substituting January 1, 1968, for the December 31, 1971, date specified
in such paragraph (c) and by not taking into account the earnings and
profits described in paragraph (c)(3) of this section.
For purposes of this subparagraph, foreign branches of United States
banks are not considered to be United States persons.
(iii)(a) A taxpayer may establish that an amount under subdivision
(ii) (a) of this subparagraph constitutes a long-term borrowing for
purposes of the foreign direct investment program by keeping records
sufficient to demonstrate that appropriate reports were filed with the
Office of Foreign Direct Investment of the Department of Commerce with
respect to the foreign borrowing or by any other method satisfactory to
the district director.
(b) The amounts described in subdivision (ii) (a) of this
subparagraph include amounts with respect to which an election under
section 4912(c), to subject certain obligations of a United States
person to the interest equalization tax, has been made: Provided, That
the obligations to which such amounts relate were issued by an
``overseas financing subsidiary'' described in 15 CFR part 1000 \1\ and
were assumed by a United States person from such overseas financing
subsidiary. Thus, for example, if an overseas financing subsidiary
issues its notes to a foreign person in 1968, and such notes are assumed
by its United States parent in 1973, which parent elects under section
4912(c) to have the notes subject to the interest equalization tax, then
the amount of money received by the subsidiary is an amount described in
subdivision (ii)(a) of this subparagraph.
(iv) The amount described in this subdivision of foreign excess
working capital is the amount of liquid assets held by the foreign
members of such group and foreign branches of domestic members of such
group on October 31, 1971 (whether or not so held after such date) in
excess of their reasonable working capital needs (as defined in Sec.
1.993-2 (e)) on that date, but only to the extent not included in
subdivision (ii) of this subparagraph. For purposes of this subdivision,
the term liquid assets means money, bank deposits (not including time
deposits), and indebtedness of any kind (including time deposits) which
on the day acquired had a maturity of 2 years or less.
(8) Example. The provisions of this paragraph may be illustrated by
the following example:
Example. X Corporation, which uses the calendar year as its taxable
year is a member of a controlled group (within the meaning of paragraph
(a)(2) of this section). X elects to be treated as a DISC beginning with
1972. The amount of net increase in foreign assets of the group at the
close of each group taxable year with respect to each taxable year of X
from 1972 through 1975 are set forth in the table below, computed on the
basis of the facts assumed (the amounts on each line being running
balances):
------------------------------------------------------------------------
Taxable year of X 1972 1973 1974 1975
------------------------------------------------------------------------
(1) Investment in foreign assets.... $150 $165 $260 $300
==========
(2) Depreciation with respect to 20 40 60 80
foreign assets of group............
(3) Amount of stock or debt 30 30 30 30
outstanding issued after December
31, 1971...........................
[[Page 719]]
(4) One-half earnings and profits of 40 70 100 130
foreign members....................
(5) Royalties and fees paid by 10 15 20 20
foreign members to domestic members
(6) Uncommitted transitional funds.. 10 10 10 10
----------
(7) Sum of lines (2) through (6).... 110 165 220 270
----------
(8) Net increase in foreign assets 40 0 40 30
(line (1) minus line (6))..........
------------------------------------------------------------------------
(c) Actual foreign investment by domestic members. For purposes of
determining the limitation in paragraph (a) of this section, the amount
of the actual foreign investment by domestic members of a controlled
group is the sum (as of the close of the group taxable year) determined
on a cumulative basis (see paragraph (a)(6) of this section) of--
(1) Outstanding stock or debt (including contributions to capital).
The outstanding amount (determined in accordance with the principles of
paragraph (b)(4)(ii) of this section, applied with respect to stock or
debt obligations described in this subparagraph) of stock (including
treasury stock) or debt obligations (other than normal trade
indebtedness) of foreign members of the group issued, sold, or exchanged
after December 31, 1971, by any person (whether or not a member) which
is not a domestic member to domestic members of the group: Provided,
That the outstanding amount of debt obligations of any foreign member
shall be the greater of such amount outstanding at the close of the
taxable year of such member or the highest such amount outstanding at
any time during the immediately preceding 90 days,
(2) Transfers to foreign branches. The amount of money or the fair
market value of property (other than money) transferred by domestic
members of the group after December 31, 1971, to foreign branches of
such members in transactions which would, if the branch were a
corporation, be in consideration for the sale of stock or debt
obligations of (or a contribution of capital to) such foreign branches
(as determined under subparagraph (1) of this paragraph), and
(3) Earnings and profits of foreign members. One-half of the
earnings and profits (computed in accordance with paragraph (b)(5) of
this section for purposes of computing net increase in foreign assets)
of foreign members of the group which are controlled directly or
indirectly (as determined under the principles of section 958 and the
regulations thereunder) by a domestic member of the group and foreign
branches (treated for this purpose as a corporation) of domestic members
of the group accumulated during the taxable years of such foreign
members (or branches) beginning after December 31, 1971, or, if later,
the taxable year referred to in paragraph (a)(5)(i) of this section if
the 3-year election provided for in such paragraph (a)(5)(i) is made.
(d) Carryovers on certain corporate acquisitions and
reorganizations--(1) Certain corporate acquisitions. (i) If--
(a) A member of a controlled group (``first controlled group'')
acquires in a transaction to which section 381 applies the assets of a
corporation which is a member of a second controlled group or acquires
stock in such a corporation pursuant to a reorganization as defined in
section 368(a)(1)(B) to which section 361 applies, or
(b) A member or combination of members of the first controlled group
acquire in a transaction not described in (a) of this subdivision a
majority interest (as defined in paragraph (e)(2) of this section) in
the stock of a corporation which is a member of a second controlled
group which includes a DISC so that such DISC after the acquisition is a
member of the new controlled group,
then, for purposes of computing foreign investment attributable to
producer's loans with respect to the new controlled group as constituted
after such acquisition, all amounts described in paragraphs (a) through
(c) of this section, including the amount specified in paragraph
(a)(1)(ii) of this section (relating to amounts treated under section
995(b)(1)(G) as deemed distributions by the DISC taxable as dividends
for prior taxable years of the DISC), with respect to members of the
second
[[Page 720]]
controlled group which become members of the new controlled group shall
carry over to such new controlled group. For purposes of this
subdivision (i), a controlled group may consist of only one member. With
respect to certain transactions involving foreign corporations, see
section 367.
(ii) If a member or combination of members of a controlled group,
immediately after an acquisition of stock to which subdivision (i) of
this subparagraph applies, do not control the total combined voting
power (determined under Sec. 1.957-1(b)) of the corporation whose stock
was acquired, proper apportionment consistent with the principles of
paragraph (e)(5) of this section shall be made with respect to amounts
to which paragraphs (a) through (c) of this section apply.
(iii)(a) If subdivision (i) of this subparagraph applies, then for
purposes of determining the application of the 3-year elective
limitation provided for in paragraph (a)(5) of this section, the rules
in (b), (c), and (d) of this subdivision (iii) apply.
(b) If both the ``first controlled group'' and the ``second
controlled group'' (as those terms are defined in subdivision (i) of
this subparagraph) include a DISC, and a DISC in either group has
elected the 3-year limitation provided in paragraph (a)(5) of this
section, then only those amounts taken into account under such paragraph
(a)(5) by the electing DISC or DISC's shall be taken into account.
(c) If one of the groups includes a DISC and the other does not, and
if the DISC has elected the 3-year limitation provided in paragraph
(a)(5) of this section, then, for purposes of computing foreign
investment attributable to producer's loans with respect to the new
controlled group as constituted after the acquisition, all amounts
described in paragraphs (a) through (c) of this section with respect to
members of the controlled group which did not include the DISC shall
carry over to such new controlled group, but only to the extent provided
in such paragraph (a)(5), computed as if the group taxable year in which
the acquisition occurred was the first group taxable year which includes
a member's first taxable year during which it qualifies (or is treated)
as a DISC.
(d) If (c) of this subdivision (iii) applies, except that the DISC
has not elected the 3-year limitation provided in paragraph (a)(5) of
this section, then the DISC in the new controlled group as constituted
after the acquisition may, with respect to members of the controlled
group which did not include the DISC, make the election provided in such
paragraph (a)(5), and treat the year in which the acquisition occurred
as if it were the first group taxable year which includes a member's
first taxable year during which it qualifies (or is treated) as a DISC.
(iv) If a majority interest, or an interest in addition to a
majority interest, is acquired in a transaction other than a transaction
described in subdivision (i) of this subparagraph, then the rules in
paragraph (e) of this section (relating to the acquisition of the
foreign assets of a corporation) apply.
(2) Corporation ceasing to be a member. As of the date a corporation
which is a member of a controlled group ceases to be a member of such
group, the amounts of such group described in paragraphs (a) through (c)
of this section will be reduced by such amounts which are attributable
to the corporation which is no longer a member of the group.
(e) Acquisition of a majority interest in a corporation--(1) In
general. If paragraph (d)(1)(i) of this section (relating to certain
corporate acquisitions in which all amounts described in paragraphs (a)
through (c) of this section carry over) does not apply, then, for
purposes of determining under paragraph (b)(2) of this section the
investments made in foreign assets by a controlled group, the
acquisition of a majority interest (as defined in subparagraph (2) of
this paragraph) or an interest in addition to a majority interest in a
corporation by any member or combination of members of the controlled
group is considered an acquisition of the assets (to the extent provided
in subparagraph (5) of this paragraph) of the acquired corporation by
the group, including the assets of any
[[Page 721]]
foreign corporation in which the acquired corporation owns a majority
interest (to the extent provided in subparagraph (5) of this paragraph).
For the rules concerning the date upon which an acquisition of a
majority interest is considered to have occurred, see subparagraph (3)
of this paragraph.
(2) Majority interest. For purposes of this section, a majority
interest is more than 50 percent of the total combined voting power of
all classes of a corporation's stock entitled to vote, as determined
under Sec. 1.957-1(b).
(3) Acquisition date. For purposes of this paragraph, an acquisition
of a majority interest shall be considered to have occurred on the day
on which the combined voting power of the group first reached the
percentage required in subparagraph (2) of this paragraph.
(4) Valuation of assets. For purposes of this section, the amount of
a corporation's assets deemed acquired is the fair market value of the
assets on the date a majority interest, or an interest in addition to a
previously held majority interest, is acquired.
(5) Apportionment in the case of the acquisition of less than all of
the voting stock. (i) If the acquisition described in subparagraph (1)
of this paragraph of a majority interest is of less than 100 percent of
the total combined voting power of all classes of stock of the acquired
corporation entitled to vote, then for purposes of subparagraph (1) of
this paragraph the amount of the foreign assets of the corporation
deemed acquired as of the day the majority interest is considered
acquired shall be an amount equal to the fair market value of all of the
corporation's foreign assets described in paragraph (b)(2) of this
section as of such day multiplied by the percentage of the total
combined voting power (determined under Sec. 1.957-1(b)) held by
members of the group on the day the majority interest is considered
acquired.
(ii) If any member or combination of members of the controlled group
hold a majority interest in a corporation, then for purposes of
subparagraph (1) of this paragraph the acquisition of additional
combined voting power by members of the controlled group shall be
considered an acquisition of its foreign assets described in paragraph
(b)(2) of this section in an amount equal to the fair market value of
all such assets held by the foreign corporation on the date of the
acquisition, multiplied by the increase (expressed in percentage points)
in total combined voting power (as determined under Sec. 1.957-1(b))
which occurred.
(6) Examples. The application of this paragraph may be illustrated
by the following examples:
Example 1. M Corporation uses the calendar year as its taxable year.
On November 18, 1973, M acquires from A, an individual United States
person, for $1 million cash all 10,000 shares of the voting stock of N,
a foreign corporation. N's only asset is a warehouse located in France
with a fair market value on the date of acquisition of $1 million. Under
subparagraph (1) of this paragraph, the controlled group of which M is a
member is considered to have expended $1 million for the acquisition of
foreign assets described in paragraph (b)(2) of this section.
Example 2. The facts are the same as in example 1, except that on
November 18, 1973, M acquires only 80 percent of N's voting stock. M is
considered to have expended $800,000 for the acquisition of assets
described in paragraph (b)(2) of this section, computed as follows:
(1) Fair market value of N's foreign assets described in $1,000,000
paragraph (b)(2) of this section..........................
(2) Multiply by percentage of total combined voting power .8
of all classes of N stock entitled to vote acquired by M..
------------
(3) Amount considered expended............................. $800,000
============
Example 3. The facts are the same as in example 2, except that
individual A is not a United States person, and M acquires the 80
percent of N voting stock in exchange for cash of $100,000 and M stock
having a fair market value on the date of the acquisition of $700,000. M
is considered to have acquired assets described in paragraph (b)(2) of
this section in the amount of $800,000 (see computations in example 2)
and to have an offset under paragraph (b)(4) of this section (relating
to outstanding stock or debt) of $700,000 (the fair market value of the
M stock transferred to A who is not a United States person). However,
the controlled group of which M is a member is not considered to have
acquired any other amounts described in paragraphs (a) through (c) of
this section with respect to N for taxable years prior to the taxable
year of N during which the acquisition occurred.
Example 4. P Corporation, which uses the calendar year as its
taxable year, is a member of a controlled group which includes a DISC.
During 1973, P acquires from B, an individual United States person, for
cash, 30
[[Page 722]]
percent of the total combined voting power of all classes of stock
entitled to vote of Q, a foreign corporation. All of Q's assets are
assets described in paragraph (b)(2) of this section. No additional
interest in Q is acquired by members of the group during 1973. The
controlled group of which Q is a member is not considered to have made
any investments in foreign assets described in such paragraph (b)(2) as
of the close of 1973.
Example 5. Assume the same facts as in example 4. Assume further
that during 1974, R Corporation, a member of the controlled group which
includes P, acquires for cash 40 percent of the total combined voting
power of all classes of stock of Q entitled to vote as follows: 20
percent on July 31, and 20 percent on December 31. Thus, on December 31,
1974, members of the controlled group own 70 percent of Q's voting power
(30+20+20) and on that date are considered to have acquired a majority
interest in Q. The fair market value of Q's assets on December 31, 1974,
is $5 million. The group is considered to have expended $3,500,000 for
the acquisition of assets described in paragraph (b)(2) of this section
computed as follows:
(1) Fair market value of Q's foreign assets described in $5,000,000
paragraph (b)(2) of this section as of the date the
acquisition is deemed to have occurred under subparagraph
(3) of this paragraph (December 31, 1974).................
(2) Multiply by percentage of total combined voting power .7
of all classes of Q stock entitled to vote held by members
of the group on such date.................................
------------
$3,500,000
============
Example 6. The facts are the same as in example 5. Assume further
that on July 15, 1975, P acquires the remaining 30 percent of the total
combined voting power of all classes of Q stock entitled to vote, and on
such date the fair market value of Q's assets is $5,500,000. The group
is considered to have expended $5,150,000 for the acquisition of assets
described in paragraph (b)(2) of this section as of the close of 1975,
computed as follows:
(1) Amount of prior years' investment...................... $3,500,000
============
(2) Investment during 1975:
(a) Fair market value of Q's foreign assets described in $5,500,000
paragraph (b)(2) of this section on July 15, 1975.......
(b) Multiply by additional percentage acquired of total .3
combined voting power of all classes of Q stock entitled
to vote.................................................
------------
(c) Investment during 1975............................... $1,650,000
============
(3) Amount considered expended for foreign assets described $5,150,000
in paragraph (b)(2) of this section by reason of the
acquisition of Q stock....................................
(f) Records. A DISC shall keep or be readily able to produce such
permanent books of account or records as are sufficient to establish the
transactions and amounts described in this section. Where applicable,
such books of account or records shall be cumulative and shall show
transactions and amounts of the members of the controlled group which
includes the DISC which occurred prior to the date the DISC qualified
(or is treated) as a DISC.
(g) Multiple DISC's--(1) Allocation among DISC's. In the case of a
controlled group which includes more than one DISC, the amounts
described in paragraphs (b) and (c) of this section shall be allocated
among the DISC's in order to determine the limitation in paragraph (a)
of this section. Each DISC's allocable portion of these amounts shall be
equal to the total of such amounts multiplied by a fraction the
numerator of which is the individual DISC's outstanding producer's loans
to members of the group, and the denominator of which is the aggregate
amounts of outstanding producer's loans to members of the group by all
DISC's which are members of the group.
(2) Different taxable years. If all of the DISC's which are members
of the controlled group do not have the same taxable year, then one such
DISC shall on behalf of all such DISC's elect to make all computations
under section 995(d) as if all DISC's that are members of the group use
the same taxable year as the actual taxable year of any one of the
DISC's. The election as to which DISC's taxable year is to be used shall
be made by the electing DISC attaching to its first return, filed under
section 6011(e)(2), a statement indicating which such taxable year will
be used. Once such an election is made it may not be revoked until such
time as all of the DISC's which are members of the group use the same
taxable year. If this subparagraph applies, books and records must be
kept by the group which are adequate to show the necessary computations
under section 995(d).
(3) This paragraph may be illustrated by the following example:
Example. Corporation X and corporation Y are members of the same
controlled group and each has elected to be treated as a DISC. X uses a
taxable year ending March 31, and Y
[[Page 723]]
uses a taxable year ending November 30. Notwithstanding the fact that
all other members of the group use the calendar year as their taxable
year, all computations for purposes of determining the amount of foreign
investment attributable to producer's loans under section 995(d) must be
made as if both DISC's use a taxable year ending either March 31 (X's
taxable year) or November 30 (Y's taxable year).
[T.D. 7324, 39 FR 35114, Sept. 30, 1974, as amended by T.D. 7420, 41 FR
20655, May 20, 1976; T.D. 7854, 47 FR 51742, Nov. 17, 1982]
Sec. 1.995-6 Taxable income attributable to military property.
(a) Gross income attributable to military property. For purposes of
section 995(b)(3)(A)(i), the term ``gross income which is attributable
to military property'' includes income from the sale, exchange, lease,
or rental of military property (as described in paragraph (c) of this
section). The term also includes gross income from the performance of
services which are related and subsidiary (as defined in Sec. 1.993-
1(d)) to any qualified sale, exchange, lease, or rental of military
property. Where gross income cannot be determined on an item by item
basis, the gross income with respect to those items not so determinable
shall be apportioned. Such apportionment shall be accomplished using
appropriate facts and circumstances, so that the gross income
apportioned to sale of military property bears a reasonably close
factual relationship to the actual gross income earned on such sales.
The apportionment shall be based on methods which include the fair
market value of property sold or exchanged, the fair rental value of any
leaseholds granted, the fair market value of any related or subsidiary
services performed in connection with such sale or leases or methods
based on gross receipts or costs of goods sold, where appropriate.
(b) Deductions. For purposes of section 995(b)(3)(A)(ii), deductions
shall be properly allocated and apportioned to gross income, described
in paragraph (a) of this section, in accordance with the rules of Sec.
1.861-8. These deductions include all applicable deductions from gross
income provided under part VI of subchapter B of chapter 1 of the Code.
(c) Military property. For purposes of this section, the term
military property means any property which is an arm, ammunition, or
implement of war designated in the munitions list published pursuant to
section 38 of the International Security Assistance and Arms Export
Control Act of 1976 (22 U.S.C. 2778 which superseded 22 U.S.C. 1934) and
the regulations thereunder (22 CFR 121.01).
(d) Illustration. The principles of this section may be illustrated
by the following example:
Example. X Corporation elects to be a DISC for the first time in
1976. X has taxable income of $50,000, of which $30,000 is attributable
to military property and $10,000 to interest on producer's loans. The
total deemed distributions with respect to X are as follows:
(1) Gross interest from Producer's loans in 1976............. $10,000
(2) 50 percent of the taxable income of the DISC attributable 15,000
to military property in 1976................................
(3) One-half of the excess of taxable income for 1976 over 12,500
the sum of lines (1) and (2) (\1/2\ of ($50,000 minus
$25,000))...................................................
(4) Total deemed distributions (sum of total lines (1), (2), 37,500
and (3))....................................................
(Secs. 995(e)(7), (8) and (10), 995(g) and 7805 of the Internal Revenue
Code of 1954 (90 Stat. 1655, 26 U.S.C. 995 (e)(7), (8) and (10); 90
Stat. 1659, 26 U.S.C. 995(g); and 68A Stat 917, 26 U.S.C. 7805))
[T.D. 7984, 49 FR 40019, Oct. 12, 1984]
Sec. 1.996-1 Rules for actual distributions and certain deemed distributions.
(a) General rule. Under section 996(a)(1), any actual distribution
(other than a distribution described in paragraph (b) of this section or
to which Sec. 1.995-4 applies) to a shareholder by a DISC, or former
DISC, which is made out of earnings and profits shall be treated as
made--
(1) First, out of ``previously taxed income'' (as defined in Sec.
1.996-3(c)) to the extent thereof,
(2) Second, out of ``accumulated DISC income'' (as defined in Sec.
1.996-3(b)) to the extent thereof, and
(3) Third, out of ``other earnings and profits'' (as defined in
Sec. 1.996-3(d)) to the extent thereof.
(b) Rules for qualifying distributions and deemed distributions
under section 995(b)(1)(G)--(1) In general. Except as
[[Page 724]]
provided in subparagraph (2), any actual distribution to meet
qualification requirements made pursuant to Sec. 1.992-3 and any deemed
distribution pursuant to Sec. 1.995-2(a)(5) (relating to foreign
investment attributable to producer's loans) which is made out of
earnings and profits shall be treated as made--
(i) First, out of ``accumulated DISC income'' (as defined in Sec.
1.996-3(b)) to the extent thereof.
(ii) Second, out of ``other earnings and profits'' (as defined in
Sec. 1.996-3(d)) to the extent thereof, and
(iii) Third, out of ``previously taxed income'' (as defined in Sec.
1.996-3(c)) to the extent thereof.
(2) Special rule. For taxable years beginning after December 31,
1975, paragraph (b)(1) of this section shall apply to one-half of the
amount of an actual distribution made pursuant to Sec. 1.992-3 to
satisfy the condition of Sec. 1.992-1(b) (the gross receipts test) and
paragraph (a) of this section shall apply to the remaining one-half of
such amount.
(c) Exclusion from gross income. Under section 996(a)(3), amounts
distributed out of previously taxed income shall be excluded by the
distrib utee from gross income. However, see Sec. 1.996-5(b) for
treatment as gain from the sale or exchange of property of the portion
of an actual distribution out of previously taxed income to the extent
it exceeds the adjusted basis of the stock with respect to which the
distribution is made.
(d) Priority of distributions. Under section 996(c), for purposes of
determining their treatment under paragraphs (a), (b), and (c) of this
section, distributions made during a taxable year shall be treated as
being made in the following order--
(1) Deemed distributions under Sec. Sec. 1.995-2 and 1.995-3.
(2) Actual distributions to meet qualification requirements made
pursuant to Sec. 1.992-3 in the order in which they are made, and
(3) Other actual distributions in the order in which they are made.
Thus, the treatment of any distribution shall be determined after the
divisions of earnings and profits have been properly adjusted by taking
into account distributions of higher priority which are made or deemed
made during the same taxable year.
(e) Examples. The provisions of this section may be illustrated by
the following examples:
Example 1. Y Corporation, which uses the calendar year as its
taxable year elects to be treated as a DISC beginning with 1972. During
1973, Y makes a cash distribution of $100 to X Corporation, Y's sole
shareholder. For 1973, Y has no earnings and profits. As of the
beginning of 1973, Y has $300 of accumulated earnings and profits, which
consist of $70 of accumulated DISC income, $40 of previously taxed
income, and $190 of other earnings and profits. The entire $100
distribution is a dividend under section 316. However, $40 thereof is
treated as made out of previously taxed income and is thus excluded from
gross income. Accordingly, only $60 is treated as distributed out of
accumulated DISC income and includible in gross income. See Sec. 1.246-
4 for the inapplicability of the dividend received deduction with
respect to the entire distribution of $100.
Example 2. Assume the same facts as in example 1, except that the
cash distribution is designated as a distribution to meet qualification
requirements made pursuant to Sec. 1.992-3. Under these facts, X
includes the entire distribution in its gross income as a dividend. Of
the $100 distributed, $70 is treated as made out of accumulated DISC
income and the remaining $30 is treated as made out of other earnings
and profits. The dividend received deduction under section 243 is
available only with respect to such $30.
Example 3. Y Corporation, which uses the calendar year as its
taxable year, elects to be treated as a DISC beginning with 1972. As of
the end of 1975, Y had failed to meet the gross receipts test for that
year. In 1975 Y had $100 of taxable income, $80 of which was
attributable to qualified export receipts and $20 of which was
attributable to receipts that did not qualify as qualified export
receipts. As of the beginning of 1976, Y had $300 of accumulated
earnings and profits, which consisted of $70 of accumulated DISC income,
$40 of previously taxed income, and $190 of other earnings and profits.
In 1976 Y makes a cash distribution of $20 pursuant to Sec. 1.992-3 in
order to satisfy the gross receipts test for 1975. For 1976 Y has no
earnings and profits and no deemed distributions. The entire $20
distribution is a dividend under section 316. Under Sec. 1.996-1(b)(2),
half of the $20 cash distribution is treated pursuant to Sec. 1.996-
1(b)(1) and half is treated pursuant to Sec. 1.996-1(a). Thus, $10 is
treated as distributed out of accumulated DISC income and is includible
in gross income. The other $10 is treated as made out of previously
taxed income and is thus excluded from gross income. As of the beginning
of 1977, Y has $280 of accumulated
[[Page 725]]
earnings and profits, which consists of $60 of accumulated DISC income,
$30 of previously taxed income, and $190 of other earnings and profits.
[T.D. 7324, 39 FR 35120, Sept. 30, 1974, as amended by T.D. 7854, 47 FR
51742, Nov. 17, 1982]
Sec. 1.996-2 Ordering rules for losses.
(a) In general. Under section 996(b), if for any taxable year a
DISC, or a former DISC, incurs a deficit in earnings and profits, such
deficit shall be charged--
(1) First, to other earnings and profits (as defined in Sec. 1.996-
3(d)) to the extent thereof,
(2) Second, to accumulated DISC income (as defined in Sec. 1.996-
3(b)) to the extent thereof, subject to the special rule in paragraph
(b) of this section,
(3) Third, to previously taxed income (as defined in Sec. 1.996-
3(c)) to the extent thereof, and
(4) To the extent that the amount of such deficit exceeds the sum of
the amounts charged in accordance with subparagraphs (1), (2), and (3)
of this paragraph, to other earnings and profits (as defined in Sec.
1.996-3(d)).
Thus, the excess deficit charged to other earnings and profits under
subparagraph (4) of this paragraph will create a deficit therein in the
amount of such excess. To determine the amount of any division of
earnings and profits for the purpose of determining under Sec. 1.996-1
the treatment of any actual and certain deemed distributions, the
portion of a deficit in earnings and profits chargeable under this
paragraph to such division prior to such distribution shall be
determined in a manner consistent with the rules in Sec. 1.316-2(b) for
determining the amount of earnings and profits available on the date of
any distribution.
(b) Deficits subsequent to a disqualification. A deficit in earnings
and profits of a DISC, or former DISC, shall not be charged to
accumulated DISC income which has been determined is to be deemed
distributed to the shareholders pursuant to Sec. 1.995-3 as a result of
a revocation of election or other disqualification. Thus, in accordance
with paragraph (a) of this section as modified by this paragraph, a
deficit incurred by a former DISC following such a revocation or
disqualification shall be charged first to other earnings and profits
and then to previously taxed income with any balance being charged to
other earnings and profits and creating a deficit therein. The preceding
sentence shall also apply in the case of a deficit incurred by a DISC
which has no accumulated DISC income accumulated during its current
taxable year and all immediately preceding consecutive taxable years for
which it was a DISC. If as a result of the application of this paragraph
the amount of a deficit in other earnings and profits exceeds the amount
of a deficit in accumulated earnings and profits, then upon any
subsequent actual distribution the deficit in other earnings and profits
shall be reduced by the lower of (1) the amount of such actual
distribution chargeable to accumulated DISC income or previously taxed
income or (2) the amount of such excess.
(c) Examples. The provisions of this section may be illustrated by
the following examples:
Example 1. X Corporation, which uses the calendar year as its
taxable year, becomes a DISC beginning with 1976. In addition to other
facts assumed in the table below, X incurs a deficit in earnings and
profits for 1979 of $70. Such deficit is charged to the divisions of X's
earnings and profits pursuant to paragraph (a) of this section in the
manner set forth in such table.
------------------------------------------------------------------------
Other
Accumulated Previously earnings
DISC income taxed and
income profits
------------------------------------------------------------------------
Balance January 1, 1976.............. ........... .......... $50
Increase for 1976.................... $10 $8 ........
Increase for 1977.................... 10 8 ........
Increase for 1978.................... 10 8 ........
--------------
Balance January 1, 1979............ 30 24 50
Deficit for 1979 of $70:
Charge No. 1....................... ........... .......... (50)
Charge No. 2....................... (20) .......... ........
--------------
Balance January 1, 1980.......... 10 .......... 0
------------------------------------------------------------------------
Example 2. Assume the same facts as in example 1, except that
effective for taxable years beginning with 1979, X revokes its election
to be treated as a DISC. Under Sec. 1.995-3, X has $30 of accumulated
DISC income which is to be deemed distributed $10 per year in 1980,
1981, and 1982. The deficit in earnings and profits for 1979 is charged
to the divisions of X's earnings and profits pursuant to
[[Page 726]]
paragraph (b) of this section in the manner set forth in the table
below:
------------------------------------------------------------------------
Other
Accumulated Previously earnings
DISC income taxed and
income profits
------------------------------------------------------------------------
Balance January 1, 1979.............. $30 $24 $50
Deficit for 1979 of $70:.............
Charge No. 1....................... ........... .......... (50)
Charge No. 2....................... ........... (20) ........
--------------
Balance January 1, 1980.......... 30 4 0
------------------------------------------------------------------------
Example 3. Assume the same facts as in example 2, except that the
deficit in earnings and profits for 1979 is $120. Assume further that
for 1980, 1981, and 1982, during which years X's shareholders are
receiving scheduled installments of the deemed distributions of
accumulated DISC income under Sec. 1.995-3, X, a former DISC, has
neither earnings and profits nor a deficit in earnings and profits. The
$120 deficit for 1979 is charged to the divisions of X's earnings and
profits pursuant to paragraph (b) of this section in the manner set
forth in the table below:
----------------------------------------------------------------------------------------------------------------
Other
Accumulated Previously earnings Accumulated
DISC income taxed and earnings
income profits and profits
----------------------------------------------------------------------------------------------------------------
Balance January 1, 1979......................................... $30 $24 $50 $104
Deficit for 1979 of $120........................................ ........... .......... ........ (120)
Charge No. 1.................................................. ........... .......... (50) ...........
Charge No. 2.................................................. ........... (24) ........ ...........
Charge No. 3.................................................. ........... .......... (46) ...........
--------------
Balance January 1, 1980..................................... 30 0 (46) (16)
Deemed distributions in 1980 under Sec. 1.995-3............... (10) 10 ........ ...........
--------------
Balance January 1, 1981..................................... 20 10 (46) (16)
----------------------------------------------------------------------------------------------------------------
Example 4. Assume the same facts as in example 3, except that on
December 31, 1980, X makes an actual distribution of $10 out of
previously taxed income. On January 1, 1981, X has $20 of accumulated
DISC income, no previously taxed income, and a deficit of $36 in other
earnings and profits. The deficit of $16 in accumulated earnings and
profits remains the same.
[T.D. 7324, 39 FR 35120, Sept. 30, 1974]
Sec. 1.996-3 Divisions of earnings and profits.
(a) In general. For purposes of sections 991 through 997, the
earnings and profits of a DISC, or former DISC, shall be treated as
composed of the following three divisions:
(1) Accumulated DISC income (as defined in paragraph (b) of this
section),
(2) Previously taxed income (as defined in paragraph (c) of this
section), and
(3) Other earnings and profits (as defined in paragraph (d) of this
section),
(b) Accumulated DISC income defined. (1) Accumulated DISC income is
that portion of a corporation's earnings and profits which were derived
during taxable years for which it qualified as a DISC and which were
deferred from taxation. Accumulated DISC income as of the close of each
taxable year of the corporation is--
(i) The amount of accumulated DISC income as of the close of the
immediately preceding taxable year increased by,
(ii) The amount of DISC income for the year (as determined in
subparagraph (2) of this paragraph) and reduced (but not below zero) by,
(iii) The items enumerated in subparagraph (3) of this paragraph.
(2) Under section 996(f)(1), DISC income is (i) the earnings and
profits derived by the corporation during a taxable year for which such
corporation is a DISC minus (ii) amounts deemed distributed under Sec.
1.995-2 other than the amount of foreign investment attributable to
producer's loans described in Sec. 1.995-2(a)(5). For example, the
earnings and profits of a DISC for a taxable year include any amounts
includible in such DISC's gross income pursuant to section 951(a)
(relating to controlled foreign corporations). Deemed distributions
under Sec. 1.995-2(a)(5) are taken into account under subparagraph (3)
of this paragraph as a reduction in computing accumulated DISC income.
(3) The accumulated DISC income (as increased by DISC income for the
year determined under subparagraph (2) of this paragraph) is reduced by
each of the following items in the following order:
(i) Any amount deemed distributed for such year under Sec. 1.995-3
(relating to deemed distributions upon disqualification),
(ii) Any amount of foreign investment attributable to producer's
loans deemed distributed for such year under Sec. 1.995-2(a)(5) to the
extent it is charged
[[Page 727]]
to accumulated DISC income under Sec. 1.996-1(b)(1)(i),
(iii) The amount of any adjustment to accumulated DISC income for
such year under Sec. 1.966-4(b)(1), and
(iv) To the extent they are treated, under Sec. 1.996-1 (a) or (b)
(relating to ordering rules for distributions), as made out of
accumulated DISC income, the amounts of any actual qualifying
distributions pursuant to Sec. 1.992-3 in the order in which they are
made, and thereafter by the amounts of any other actual distributions in
the order in which they are made, except that, prior to each actual
distribution, accumulated DISC income shall be reduced by the portion of
any deficit in earnings and profits for the taxable year chargeable at
that time under Sec. 1.996-2(a)(2) to accumulated DISC income.
(4) Every distribution or other reduction in accumulated DISC income
pursuant to subparagraph (3) of this paragraph shall be charged to the
most recently accumulated DISC income.
(c) Previously taxed income. Under section 996(f)(2), previously
taxed income as of the close of each taxable year of the corporation is
an amount equal to--
(1) The sum of--
(i) The amount of previously taxed income as of the close of the
immediately preceding taxable year,
(ii) Amounts deemed distributed for the current year under Sec.
1.995-2 (relating to deemed distributions in qualified years),
(iii) Amounts deemed distributed for the current year under Sec.
1.995-3 (relating to deemed distributions upon disqualification),
(iv) With respect to a distribution in redemption to which Sec.
1.996-4(b)(1) applies, an amount equal to the excess (if any) of (a) the
amount of the reduction under Sec. 1.996-4(b)(1) in accumulated DISC
income over (b) the reduction in the corporation's earnings and profits
(see section 312(e)), and
(v) Any amount by which accumulated DISC income is reduced under
paragraph (b)(3)(ii) of this section by reason of a deemed distribution
as a dividend, under Sec. 1.995-2(a)(5), of an amount of foreign
investment attributable to producer's loans,
(2) Decreased (but not below zero), to the extent they are treated,
under Sec. 1.996-1 (a) or (b) (relating to ordering rules for
distributions), as made out of previously taxed income, by the amounts
of any actual qualifying distributions pursuant to Sec. 1.992-3 in the
order in which they are made, and thereafter by the amounts of any other
actual distributions in the order in which they are made, except that,
prior to any actual distribution, previously taxed income shall be
reduced by the portion of any deficit in earnings and profits for the
taxable year chargeable at that time under Sec. 1.996-2(a)(3) to
previously taxed income.
(d) Other earnings and profits. Under section 996(f)(3), other
earnings and profits consist of earnings and profits other than
accumulated DISC income and previously taxed income described
respectively in paragraphs (b) and (c) of this section. Other earnings
and profits as of the close of each taxable year of the corporation is
(subject to paragraph (e) of this section) an amount equal to the amount
of other earnings and profits as of the close of the immediately
preceding taxable year decreased (if necessary, below zero) in the
following order by--
(1) To the extent they are treated, under Sec. 1.996-1 (a) or (b)
(relating to ordering rules for distributions), as made out of other
earnings and profits, the amounts of any actual qualifying distributions
pursuant to Sec. 1.992-3 in the order in which they are made, and
thereafter the amounts of any other actual distributions in the order in
which they are made, except that, prior to any actual distribution,
other earnings and profits shall be reduced by the portion of any
deficit in earnings and profits for the taxable year chargeable at that
time under Sec. 1.996-2(a)(1) to other earnings and profits, and
(2) With respect to a distribution in redemption to which Sec.
1.996-4(b)(1) applies, an amount equal to the excess (if any) of (a) the
reduction in the corporation's earnings and profits (see section 312(e))
over (b) the amount of the reduction under Sec. 1.996-4(b)(1) in
accumulated DISC income.
(e) Distributions in kind. (1) For purposes of determining, under
paragraphs (b), (c), and (d) of this section, the
[[Page 728]]
amount by which any division of earnings and profits is reduced by
reason of a distribution of property (other than money or the DISC's, or
former DISC's, own obligations), the amount of such distribution is the
fair market value of such property at the time of the distribution.
(2) For any taxable year in which the DISC makes a distribution of
such property, the amount of other earnings and profits determined under
paragraph (d) of this section (without regard to this subparagraph)
shall be--
(i) Increased by the excess (if any) of the amount of such
distribution treated as a dividend under section 316(a) over the
adjusted basis of such property, and
(ii) Decreased by the excess (if any) of the adjusted basis of such
property over the amount of such distribution treated as a dividend
under section 316 (a).
Each item of property shall be considered separately for purposes of
making the adjustment under this subparagraph.
(f) Examples. The provisions of Sec. Sec. 1.996-1, 1.996-2, and
this section may be illustrated by the following examples:
Example 1. M Corporation, which uses the calendar year as its
taxable year, elects to be treated as a DISC beginning with 1974. During
1975, M derives no earnings and profits and makes no deemed or actual
distributions, except that on December 31, 1975, M's shareholders are
treated as having received a dividend distribution of $100 under Sec.
1.995-2 (a)(5) (relating to foreign investment attributable to
producer's loans). M's earnings and profits are adjusted as shown on
line (2) of the table below on the basis of facts assumed therein.
----------------------------------------------------------------------------------------------------------------
Other
Accumulated Accumulated Previously earnings
earnings DISC income taxed and
and profits income profits
----------------------------------------------------------------------------------------------------------------
(1) Balance January 1, 1975................................... $450 $100 $250 $100
(2) Adjustments (see paragraphs (b)(3)(ii) and (c)(1)(v) of 0 (100) 100 0
this section)................................................
--------------
(3) Balance January 1, 1976................................... 450 0 350 100
----------------------------------------------------------------------------------------------------------------
Example 2. N Corporation, which uses the calendar year as its
taxable year, elects to be treated as a DISC beginning with 1972. During
1973, N derives no earnings and profits for the year and makes no deemed
or actual distributions, except that A, a shareholder, realized $200 of
gain upon receiving an actual cash distribution of $300 in redemption of
N stock having an adjusted basis of $100 in his hands. The redemption is
treated as an exchange under section 302(a) but, under section 995(c), A
includes the $200 of gain in his gross income as a dividend. Assuming
that, under section 312(e), $240 is properly chargeable to capital
account of N and that, under Sec. 1.996-4(b), accumulated DISC income
is reduced by $200, N's accounts are adjusted on line (2) of the table
below on the basis of facts assumed therein.
----------------------------------------------------------------------------------------------------------------
Other
Accumulated Accumulated Previously earnings
Capital earnings DISC income taxed and
and profits income profits
----------------------------------------------------------------------------------------------------------------
(1) Balance January 1, 1973......................... $2,000 $400 $300 $100 0
(2) Adjustments (see Sec. 1.996-4(b) and paragraph (240) (60) (200) 140 0
(c)(1)(iv) of this section)........................
-----------
(3) Balance January 1, 1974......................... 1,760 340 100 240 0
----------------------------------------------------------------------------------------------------------------
Example 3. P Corporation, which uses the calendar year as its
taxable year, elects to be treated as a DISC beginning with 1973. During
1974, P derives no earnings and profits for the year and makes no deemed
or actual distributions, except for a distribution to B, its sole
shareholder, of property with a fair market value of $100 and an
adjusted basis in P's hands of $40. Under Sec. 1.996-1(a)(1), B treats
the entire amount of the distribution as being made out of previously
taxed income and, under Sec. 1.996-1(c), excludes it from his gross
income. P's earnings and profits, divisions are adjusted on lines (2)
and (3) of the table below on the basis of facts assumed therein.
[[Page 729]]
----------------------------------------------------------------------------------------------------------------
Other
Accumulated Accumulated Previously earnings
earnings DISC income taxed and
and profits income profits
----------------------------------------------------------------------------------------------------------------
(1) Balance January 1, 1974................................... $200 $80 $120 0
(2) Adjustment under paragraphs (c)(2) and (e)(1) this section (40) 0 (100) 0
(3) Adjustment under paragraph (e)(2)(i) of this section...... 0 0 0 $60
--------------
(4) Balance January 1, 1975................................... 160 80 20 60
----------------------------------------------------------------------------------------------------------------
Example 4. Q Corporation, which uses the calendar year as its
taxable year, elects to be treated as a DISC beginning with 1974. On
January 1, 1975, Q has accumulated earnings and profits of $1,200 and,
during 1975, Q incurs a deficit in earnings and profits of $365. The
amount of such deficit incurred as of any date before the close of 1975
cannot be shown. On July 1, 1975, Q makes a cash distribution of $650,
with respect to its stock to C, Q's sole shareholder. C subsequently
transfers by gift all of his Q stock to D. On December 31, 1975, Q makes
a cash distribution of $650, with respect to its stock, to D. Under
these facts and additional facts assumed in the table below, C is
treated as having received a dividend of $650 of which $320 is treated
as distributed out of previously taxed income and excluded from gross
income. D is treated as receiving a dividend of $186. Adjustments to Q's
earnings and profits accounts are illustrated in the table below:
----------------------------------------------------------------------------------------------------------------
Other
Accumulated Accumulated Previously earnings
earnings DISC income taxed and
and profits income profits
----------------------------------------------------------------------------------------------------------------
(1) Balance January 1, 1975................................... $1,200 $800 $320 $80
(2) Portion of 1975 deficit of $365 chargeable as of June 30, (181) (101) 0 (80)
1975, pursuant to Sec. 1.996-2(a)..........................
--------------
(3) Balance July 1, 1975...................................... 1,019 699 320 0
(4) $650 distributed to C on July 1, 1975..................... (650) (330) (320) 0
(5) Portion of 1975 deficit of $365 chargeable as of December (183) (183) 0 0
30, 1975, pursuant to Sec. 1.996-2(a)......................
--------------
(6) Balance December 31, 1975................................. $186 $186 0 0
(7) $650 distributed to D on December 31, 1975 \1\............ (186) (186) 0 0
--------------
(8) Balance January 1, 1976................................... 0 0 0 0
----------------------------------------------------------------------------------------------------------------
\1\ $60 treated as return of capital pursuant to section 301(c)(2).
Examples 5: (1) Facts. R Corporation, which uses the calendar year
as its taxable year elects to be treated as a DISC beginning with 1972.
X Corporation is its sole shareholder. At the beginning of 1974, R has a
deficit in earnings and profits of $60 all of which is composed of
``other earnings and profits''. For 1974, R has earnings and profits of
$80 before reduction for any distributions and taxable income of $70. On
June 15, 1974, R makes a cash distribution to X of $60, with respect to
its stock, to which section 301 applies. On August 15, 1974, R makes a
cash distribution to X of $30 designated as a distribution to meet
qualification requirements pursuant to Sec. 1.992-3. Under Sec. 1.995-
2(a), X is deemed to receive, on December 31, 1974, a distribution of a
dividend of $35, i.e., one-half of R's taxable income of $70. The tax
consequences of these facts to X and their effect on R's earnings and
profits are set forth in the subsequent subparagraphs of this example.
(2) Dividend treatment of actual distributions. Since R had $80 of
earnings and profits for 1974 and a deficit in accumulated earnings and
profits at the beginning of 1974, only $80 of the actual distributions
($90) are treated as dividends under sections 301(c)(1) and 316(a)(2).
($10 of the actual distribution, which is not treated as a dividend is
treated in the manner specified in section 301(c) (2) and (3).) Thus,
under Sec. 1.316-2(b), $26.67 of the actual qualifying distribution
made on August 15, 1974 ($30x $80/$90), and $53.33 of the actual
distribution made on June 15, 1974 ($60x$80/$90), are considered made
out of earnings and profits.
(3) Priority of distributions. Under Sec. 1.996-1(d), for purposes
of adjusting the divisions of R's earnings and profits and determining
the treatment of subsequent distributions, the sequence in which each
distribution is treated as having been made is--
(i) First, the deemed distribution of $35,
(ii) Second, the actual qualifying distribution of $30 made on
August 15, 1974, pursuant to Sec. 1.992-3, and
[[Page 730]]
(iii) Finally, the actual distribution of $60 made on June 15, 1974.
(4) Treatment and effect of deemed distribution. Under Sec. 1.995-
2(a), on December 31, 1974, X includes the deemed distribution of $35 in
its gross income as a dividend. Under paragraph (c)(1)(ii) of this
section, R's previously taxed income is increased by $35 as shown on
line (3) of the table in subparagraph (7) of this example. Under
paragraph (b)(1)(ii) and (2) of this section, accumulated DISC income is
increased by $45 of DISC income, i.e., R's earnings and profits for
1974, $80, minus the deemed distribution of $35, as shown on line (4) of
the table.
(5) Treatment and effect of actual qualifying distribution of $30.
As indicated in subparagraph (2) of this example, $26.67 of the $30
qualifying distribution on August 15, 1974, is treated as made out of
earnings and profits for 1974. Under Sec. 1.996-1(b)(1)(i), the entire
$26.67 is treated as distributed out of accumulated DISC income. Thus,
on August 15, 1974, X includes $26.67 in its gross income as a dividend.
No deduction is allowable under section 243. Under paragraph (b)(3)(iv)
of this section, R's accumulated DISC income is reduced by $26.67 as
shown on line (6) of the table in subparagraph (7) of this example.
(6) Treatment and effect of actual distribution of $60. As indicated
in subparagraph (2) of this example, $53.33 of the $60 distribution on
June 15, 1974, is treated as made out of earnings and profits for 1974.
Under Sec. 1.996-1(a), the $53.33 is treated as distributed out of
previously taxed income to the extent thereof, $35, and then out of
accumulated DISC income, $18.33. Thus, on June 15, 1974, X includes
$18.33 in its gross income as a dividend. Under Sec. 1.996-1(c), the
distribution of $35 out of previously taxed income is excluded from
gross income. No deduction is allowable under section 243 with respect
to the actual distribution of $53.33. Under paragraph (b)(3)(iv) of this
section, accumulated DISC income is reduced by $18.33 and, under
paragraph (c)(2) of this section, previously taxed income is reduced by
$35, as shown on line (7) of the table in subparagraph (7) of this
example.
(7) Summary. The effects on earnings and profits and the divisions
of earnings and profits are summarized in the following table:
----------------------------------------------------------------------------------------------------------------
Earnings Accumulated Previously Other
and profits earnings Accumulated taxed earnings
for year and profits DISC income income and profits
----------------------------------------------------------------------------------------------------------------
(1) Balance January 1, 1974.................... ........... ($60.00) ........... ........... ($60.00)
(2) Earnings and profits for year before $80.00 ........... ........... ........... ...........
reduction for distributions...................
(3) Deemed distribution of $35 to X on December ........... ........... ........... $35.00 ...........
31, 1974, under Sec. 1.995-2(a).............
(4) DISC income for 1974 of $45 as defined in ........... ........... $45.00 ........... ...........
paragraph (b)(2) of this section (line 2 ($80)
minus line 3 ($35))...........................
--------------
(5) Balance before actual distributions........ 80.00 (60.00) 45.00 35.00 (60.00)
(6) Qualifying distribution of $30 to X on (26.67) ........... (26.67) ........... ...........
August 15, 1974, pursuant to Sec. 1.992-3...
(7) Actual distribution to P of $60 on June 15, (53.33) ........... (18.33) (35.00) ...........
1974..........................................
--------------
(8) Balance January 1, 1975.................... 0 (60.00) 0 ........... (60.00)
----------------------------------------------------------------------------------------------------------------
Example 6. Assume the facts are the same as in example 5, except
that at the beginning of 1974 R's accumulated earnings and profits
amount to $60 consisting of accumulated DISC income of $20, previously
taxed income of $10, and other earnings and profits of $30. In addition,
on August 1, 1974, X transfers all R's stock to Y Corporation in a
reorganization described in section 368(a)(1)(B) in which under section
354 X recognizes no gain or loss. Under these facts, X includes in its
gross income for 1974 a dividend of $15 which is attributable to the
actual distribution of $60 paid out of earnings and profits on June 15,
1974. X excludes from gross income the balance of the $60 distribution
($45) paid out of earnings and profits because, under Sec. 1.996-1(a),
it is treated as paid out of previously taxed income. Y includes in its
gross income for 1974 a dividend of $65 of which $35 is attributable to
the deemed distribution of a dividend to Y on December 31, 1974, under
Sec. 1.995-2(a) and $30 is attributable to the qualifying distribution
paid out of earnings and profits to Y on August 15, 1974. The
adjustments to R's earnings and profits are summarized in the following
table:
[[Page 731]]
----------------------------------------------------------------------------------------------------------------
Earnings Accumulated Previously Other
and profits earnings Accumulated taxed earnings
for year and profits DISC income income and profits
----------------------------------------------------------------------------------------------------------------
(1) Balance January 1, 1974.................... ........... $60 $20 $10 $30
(2) Earnings and profits for year before $80 ........... ........... ........... ...........
reduction for distributions...................
(3) Deemed distribution of $35 to Y on December ........... ........... ........... 35 ...........
31, 1974, under Sec. 1.995-2(a).............
(4) DISC income for 1974 of $45 as defined in ........... ........... 45 ........... ...........
paragraph (b)(2) of this section (line 2 ($80)
minus line 3 ($35))...........................
--------------
(5) Balance before actual distributions........ 80 60 65 45 30
(6) Qualifying distribution of $30 to Y on (26.67) (3.33) (30) ........... ...........
August 15, 1974, pursuant to Sec. 1.992-3...
(7) Actual distribution to X of $60 on June 15, (53.33) (6.67) (15) (45) ...........
1974..........................................
--------------
(8) Balance January 1, 1975.................... ........... 50 20 0 30
----------------------------------------------------------------------------------------------------------------
(g) DISCs having corporate and noncorporate shareholders. In the
case of a DISC having one or more corporate shareholders but less than
all of its shareholders subject to the special rules of section
291(a)(4), relating to certain deferred DISC income as a corporate
preference item, accumulated DISC income and previously taxed income of
the DISC are divided between the corporate shareholders, as a class, and
the other shareholders, as a class, in proportion to amounts of DISC
income not deemed distributed and amounts deemed distributed to each
class. Subsequent taxation of actual and qualifying distributions shall
be based upon this division. Thus, if a DISC is owned 50 percent by
corporate shareholders and 50 percent by individual shareholders and has
undistributed taxable income of $2,000 for its year, the division is
made as follows:
Corporate shareholders:
Previously taxed income (57.5% of $2,000/2)............ $575
Accumulated DISC income (42.5% of $2,000/2)............ 425
Individual shareholders:
Previously taxed income (50% of $2,000/2).............. 500
Accumulated DISC income (50% of $2,000/2).............. 500
(Secs. 995(e)(7), (8) and (10), 995(g) and 7805 of the Internal Revenue
Code of 1954 (90 Stat. 1655, 26 U.S.C. 995 (e)(7), (8) and (10); 90
Stat. 1659, 26 U.S.C. 995(g); and 68A Stat. 917, 26 U.S.C. 7805))
[T.D. 7324, 39 FR 35121, Sept. 30, 1974, as amended by T.D. 7854, 47 FR
51742, Nov. 17, 1982; T.D. 7984, 49 FR 40024, Oct. 12, 1984]
Sec. 1.996-4 Subsequent effect of previous disposition of DISC stock.
(a) Shareholder adjustment for previously taxed income. (1) Under
section 996(d)(1), except as provided in subparagraph (2) of this
paragraph, if--
(i) Gain with respect to a share of stock of a DISC, or former DISC,
is treated under Sec. 1.995-4 as a dividend, and
(ii) With respect to such share, any person subsequently receives an
actual distribution made out of accumulated DISC income, or a deemed
distribution made, pursuant to Sec. 1.995-3, by reason of
disqualification, out of accumulated DISC income,
then such person shall treat such distribution in the same manner as a
distribution from previously taxed income (and thus excludable from
gross income under Sec. 1.996-1(c)) to the extent that the gain
referred to in subdivision (i) of this subparagraph exceeds the
aggregate amount of any other distributions with respect to such share
which were treated under this subparagraph as made from previously taxed
income.
(2) In applying subparagraph (1) of this paragraph with respect to a
share of stock in a DISC, or former DISC, the gain referred to in
subparagraph (1)(i) of this paragraph does not include any gain to a
shareholder on a redemption of such share which qualifies as an exchange
under section 302(a) or any gain on a disposition of such share prior to
such redemption. Distributions described in subparagraph (1)(ii) of this
paragraph do not include a distribution in a redemption which qualifies
as an
[[Page 732]]
exchange under section 302(a). For adjustments to accumulated DISC
income by reason of dividend treatment under Sec. 1.995-4 with respect
to gain upon a redemption of DISC stock to which section 302(a) applies
and upon a prior disposition of such stock, see paragraph (b) of this
section.
(3) Example. The provisions of this paragraph may be illustrated by
the following example:
Example. In 1974, under Sec. 1.995-4, A, a shareholder of a DISC,
on the sale of his DISC stock to B, is required to treat $20 of his gain
as a dividend. The DISC has no previously taxed income and $40 of
accumulated DISC income. Subsequently in the same year, B, the purchaser
of the stock, receives an actual dividend distribution of $15 with
respect to such stock which, under Sec. 1.996-1(a), is treated as made
out of accumulated DISC income. The amounts of the DISC's previously
taxed income and accumulated DISC income were not adjusted by reason of
the $20 treated as a dividend on the prior sale. However, even though
the DISC had no previously taxed income, the purchaser would treat the
$15 as though it had been paid out of previously taxed income and,
therefore would not include the $15 in gross income. If in 1975, B
receives another actual distribution of $9 with respect to such stock,
$5 (i.e., $20 dividend on A's sale less the $15 distribution to B in
1974 which was treated under subparagraph (1) of this paragraph as made
from previously taxed income) is treated as made from previously taxed
income and excluded from gross income. The result would be the same if,
on January 1, 1975, B had transferred such stock to C by gift and the $9
distribution had been made to C.
(b) Corporate adjustment upon redemption. (1) Under section
996(d)(2), if by reason of Sec. 1.995-4 gain on a redemption of stock
in a DISC, or former DISC, is included in the shareholder's gross income
as a dividend, then the accumulated DISC income shall be reduced by an
amount equal to the sum of--
(i) The amount of gain on such redemption which, under Sec. 1.995-
4, is treated as a dividend, and
(ii) The amount of any gain with respect to such redeemed stock
which, under Sec. 1.995-4, was treated as a dividend on a disposition
prior to such redemption minus the amount of distributions with respect
to such stock which have been treated as made out of previously taxed
income by reason of the application of paragraph (a)(1) of this section.
(2) The provisions of this paragraph may be illustrated by the
following examples:
Example 1. The entire stock of a DISC, which uses the calendar year
as its taxable year, has been owned equally by A, B, C, and D since it
was organized. At the close of 1976, when the DISC has $100 of
accumulated DISC income, it redeems all of A's shares in a transaction
qualifying as an exchange under section 302(a) and A, under Sec. 1.995-
4, includes $25 in his gross income as a dividend. The redemption has
the effect of reducing accumulated DISC income by $25 to $75.
Example 2. Assume the same facts as in example 1 except that the
stock of the DISC has not been held equally by A, B, C, and D since its
organization. A purchased his shares from X in 1974 in a transaction in
which X, under Sec. 1.995-4, included in his gross income $30 as a
dividend. In 1975, A receives a distribution of $10 out of accumulated
DISC income which, under paragraph (a)(1) of this section, is treated as
made out of previously taxed income. Under these facts, the redemption
of A's stock in 1976 has the effect of reducing accumulated DISC income
by $45 to $55 determined as follows:
(a) Accumulated DISC income....................... ......... $100
(b) Minus sum of:
(1) Dividend on redemption of A's stock......... $25
(2) Excess of dividend on X's sale ($30) over $20
distribution to A treated as made out of
previously taxed income ($10)..................
Total......................................... ......... 45
----------
(c) Accumulated DISC income on 12/31/76...................... 55
[T.D. 7324, 39 FR 35121, Sept. 30, 1974]
Sec. 1.996-5 Adjustment to basis.
(a) Addition to basis. Under section 996(e)(1) amounts representing
deemed distributions as provided in section 995(b) shall increase the
basis of the stock with respect to which the distribution is made.
(b) Reductions of basis. Under section 996(e)(2), the portion of an
actual distribution treated as made out of previously taxed income shall
reduce the basis of the stock with respect to which it is made and, to
the extent that it exceeds the adjusted basis of such stock, shall be
treated as gain from the sale or exchange of property. In the case of
stock includible in the gross estate of a decedent for which an election
is made under section 2032 (relating to alternate valuation), this
paragraph shall not apply to any distribution made after the date of the
[[Page 733]]
decendent's death and before the alternate valuation date provided by
section 2032. See section 1014(d) for a special rule for determining the
basis of stock in a DISC, or former DISC, acquired from a decedent.
[T.D. 7324, 39 FR 35124, Sept. 30, 1974]
Sec. 1.996-6 Effectively connected income.
In the case of a shareholder who is a nonresident alien individual
or a foreign corporation, trust, or estate, amounts taxable as dividends
by reason of the application of Sec. 1.995-4 (relating to gain on
disposition of stock in a DISC), amounts treated under Sec. 1.996-1 as
distributed out of accumulated DISC income, and amounts deemed
distributed under Sec. 1.995-2(a) (1) through (4) shall be treated as
gains and distributions which are effectively connected with the conduct
of a trade or business conducted through a permanent establishment of
such shareholder within the United States, and shall be subject to tax
in accordance with the provisions of section 871(b) and the regulations
thereunder in the case of nonresident alien individuals, trusts, or
estates, or section 882 and the regulations thereunder in the case of
foreign corporations. In no case, however shall other income of such
shareholder be taxable as effectively connected with the conduct of a
trade or business through a permanent establishment in the United States
solely because of the application of this section.
[T.D. 7324, 39 FR 35124, Sept. 30, 1974]
Sec. 1.996-7 Carryover of DISC tax attributes.
(a) In general. Carryover of a DISC's divisions of earnings and
profits to acquiring corporations in nontaxable transactions shall be
subject to rules generally applicable to other corporate tax attributes.
For example, a DISC which acquires the assets of another DISC in a
transaction to which section 381(a) applies shall succeed to, and take
into account, the divisions of the earnings and profits of the
transferor DISC in accordance with section 381(c)(2).
(b) Allocation of divisions of earnings and profits in corporate
separations. (1) If one DISC transfers part of its assets to a
controlled DISC in a transaction to which section 368(a)(1)(D) applies
and immediately thereafter the stock of the controlled DISC is
distributed in a distribution or exchange to which section 355 (or so
much of section 356 as relates to section 355) applies, then--
(i) The earnings and profits of the distributing DISC immediately
before the transaction shall be allocated between the distributing DISC
and the controlled DISC in accordance with the provisions of Sec.
1.312-10.
(ii) Each of the divisions of such earnings and profits, namely
previously taxed income, accumulated DISC income, and other earnings and
profits, shall be allocated between the distributing DISC and the
controlled DISC on the same basis as the earnings and profits are
allocated.
(iii) Any assets of the distributing DISC whose status as qualified
export assets is limited by its accumulated DISC income (e.g.,
producer's loans described in Sec. 1.993-4, Export-Import Bank and
other obligations described in Sec. 1.993-2(h), and financing
obligations described in Sec. 1.993-2(i)) shall be treated as having
been allocated, for the purpose of determining the classification of
such assets in the hands of the distributing DISC or the controlled
DISC, on the same basis as the earnings and profits are allocated
regardless of how such assets are actually allocated.
(2) Example. The provisions of this paragraph may be illustrated by
the following example:
Example. On January 1, 1974, P Corporation transfers part of its
assets to S Corporation, a newly organized subsidiary of P, in a
transaction described in section 368(a)(1)(D) and distributes all the S
stock in a transaction which qualifies under section 355. Immediately
before such transfer, P had earnings and profits of $120,000 of which
$100,000 constitutes accumulated DISC income. The unpaid balance of P's
producer's loans is $80,000 all of which is retained by P. Pursuant to
Sec. 1.312-10, 25 percent of P's accumulated DISC income is allocated
to S (i.e., $25,000). P's producer's loans will be treated as allocated
to S in the same proportion. Accordingly, for purposes of determining,
under Sec. 1.993-4(a)(3), the amount of producer's loans which S is
entitled to make, S is treated as having an unpaid balance of producer's
loans of $20,000 (i.e., 25% x $80,000) and P is treated as having an
unpaid balance of $60,000 (i.e., 75% x $80,000).
[[Page 734]]
(c) Accumulated DISC income accounts of separate DISC's maintained
after corporate combination. If two or more DISC's combine to form a new
DISC, or if the assets of one DISC are acquired by another DISC, in a
transaction described in section 381(a), accumulated DISC income of the
acquired DISC or DISC's shall carry over and be taken into account by
the acquiring or new DISC, except that a separate account shall be
maintained for the accumulated DISC income of any DISC scheduled to be
received as a deemed distribution by its shareholders under Sec. 1.995-
3 (relating to deemed distributions upon disqualification). If, as a
part of such transaction, the stock of the DISC which has accumulated
DISC income scheduled to be deemed distributed is exchanged for stock of
the acquiring or new DISC to which such accumulated DISC income is
carried over and which maintains a separate account, then such
accumulated DISC income shall be deemed distributed pro rata to
shareholders of the acquiring or new DISC on the basis of stock
ownership immediately after the exchange.
[T.D. 7324, 39 FR 35125, Sept. 30, 1974]
Sec. 1.996-8 Effect of carryback of capital loss or net operating
loss to prior DISC taxable year.
(a) Under Sec. 1.995-2(e), the deduction under section 172 for a
net operating loss carryback or under section 1212 for a capital loss
carryback is determined as if the DISC were a domestic corporation which
had not elected to be treated as a DISC. A carryback of a net operating
loss or of a capital loss of any corporation which reduces its taxable
income for a preceding taxable year for which it qualified as a DISC
will have the consequences enumerated in paragraphs (b) through (e) of
this section.
(b) For such preceding taxable year, the amount of a deemed
distribution of one-half of certain taxable income described in Sec.
1.995-2(a)(4) will ordinarily be reduced in effect (but not below zero)
by one-half of the sum of the amount of the deduction under section 172
for such year for net operating loss carrybacks and the amount of the
deduction under section 1212 for such year for capital loss carrybacks.
(c) The amount of reduction in the deemed distribution under
paragraph (b) of this section will have the effect of increasing the
limitation, provided in Sec. 1.995-2(b)(2), on the amount of foreign
investment attributable to producer's loans which is deemed distributed
under Sec. 1.995-2(a)(5).
(d) If the amount of a deemed distribution for a preceding taxable
year is reduced as described in paragraph (b) of this section, then for
such preceding taxable year the previously taxed income (as defined in
Sec. 1.996-3(c)) shall be decreased by the amount of such reduction and
the accumulated DISC income (as defined in Sec. 1.996-3(b)) shall be
increased by the amount of such reduction. Such adjustments shall be
made as of the time the deemed distribution for such preceding taxable
year is treated as having occurred. See Sec. 1.996-1(d) for the
priority of such deemed distribution in relation to other distributions
made in that preceding taxable year.
(e) The amount and treatment of any actual distribution made in such
preceding taxable year or a year subsequent to such preceding year, and
the treatment of gain on a disposition (in any such year) of the DISC's
stock to which Sec. 1.995-4 applies, shall be properly adjusted to
reflect the adjustments to previously taxed income and accumulated DISC
income described in paragraph (d) of this section.
[T.D. 7324, 39 FR 35125, Sept. 30, 1974]
Sec. 1.997-1 Special rules for subchapter C of the Code.
(a) For purposes of applying the provisions of sections 301 through
395 of the Code, any distribution in property to a corporation by a
DISC, or former DISC, which is made out of previously taxed income or
accumulated DISC income shall be treated as a distribution in the same
amount as if such distribution of property were made to an individual,
and have a basis, in the hands of the recipient corporation, equal to
such amount treated as having been distributed.
(b) This section may be illustrated by the following example:
Example. X Corporation is the sole shareholder of Y Corporation
which is a DISC. Y makes an actual distribution of property to
[[Page 735]]
X with respect to X's stock in Y. The property has a basis of $50 and a
fair market value of $100. The distribution is treated as made out of
accumulated DISC income under section 996(a) and is taxable as a
dividend under section 301(c)(1). Even though X is a corporation, the
amount of the distribution is $100 notwithstanding the provisions of
section 301(b)(1)(B) and the basis the property in X's hands is $100
notwithstanding the provisions of section 301(d)(2).
[T.D. 7324, 39 FR 35125, Sept. 30 1974]
[[Page 737]]
FINDING AIDS
--------------------------------------------------------------------
A list of CFR titles, subtitles, chapters, subchapters and parts and
an alphabetical list of agencies publishing in the CFR are included in
the CFR Index and Finding Aids volume to the Code of Federal Regulations
which is published separately and revised annually.
Table of CFR Titles and Chapters
Alphabetical List of Agencies Appearing in the CFR
Table of OMB Control Numbers
List of CFR Sections Affected
[[Page 739]]
Table of CFR Titles and Chapters
(Revised as of April 1, 2004)
Title 1--General Provisions
I Administrative Committee of the Federal Register
(Parts 1--49)
II Office of the Federal Register (Parts 50--299)
IV Miscellaneous Agencies (Parts 400--500)
Title 2 [Reserved]
Title 3--The President
I Executive Office of the President (Parts 100--199)
Title 4--Accounts
I General Accounting Office (Parts 1--99)
Title 5--Administrative Personnel
I Office of Personnel Management (Parts 1--1199)
II Merit Systems Protection Board (Parts 1200--1299)
III Office of Management and Budget (Parts 1300--1399)
V The International Organizations Employees Loyalty
Board (Parts 1500--1599)
VI Federal Retirement Thrift Investment Board (Parts
1600--1699)
VIII Office of Special Counsel (Parts 1800--1899)
IX Appalachian Regional Commission (Parts 1900--1999)
XI Armed Forces Retirement Home (Part 2100)
XIV Federal Labor Relations Authority, General Counsel of
the Federal Labor Relations Authority and Federal
Service Impasses Panel (Parts 2400--2499)
XV Office of Administration, Executive Office of the
President (Parts 2500--2599)
XVI Office of Government Ethics (Parts 2600--2699)
XXI Department of the Treasury (Parts 3100--3199)
XXII Federal Deposit Insurance Corporation (Part 3201)
XXIII Department of Energy (Part 3301)
XXIV Federal Energy Regulatory Commission (Part 3401)
XXV Department of the Interior (Part 3501)
XXVI Department of Defense (Part 3601)
[[Page 740]]
XXVIII Department of Justice (Part 3801)
XXIX Federal Communications Commission (Parts 3900--3999)
XXX Farm Credit System Insurance Corporation (Parts 4000--
4099)
XXXI Farm Credit Administration (Parts 4100--4199)
XXXIII Overseas Private Investment Corporation (Part 4301)
XXXV Office of Personnel Management (Part 4501)
XL Interstate Commerce Commission (Part 5001)
XLI Commodity Futures Trading Commission (Part 5101)
XLII Department of Labor (Part 5201)
XLIII National Science Foundation (Part 5301)
XLV Department of Health and Human Services (Part 5501)
XLVI Postal Rate Commission (Part 5601)
XLVII Federal Trade Commission (Part 5701)
XLVIII Nuclear Regulatory Commission (Part 5801)
L Department of Transportation (Part 6001)
LII Export-Import Bank of the United States (Part 6201)
LIII Department of Education (Parts 6300--6399)
LIV Environmental Protection Agency (Part 6401)
LV National Endowment for the Arts (Part 6501)
LVI National Endowment for the Humanities (Part 6601)
LVII General Services Administration (Part 6701)
LVIII Board of Governors of the Federal Reserve System (Part
6801)
LIX National Aeronautics and Space Administration (Part
6901)
LX United States Postal Service (Part 7001)
LXI National Labor Relations Board (Part 7101)
LXII Equal Employment Opportunity Commission (Part 7201)
LXIII Inter-American Foundation (Part 7301)
LXV Department of Housing and Urban Development (Part
7501)
LXVI National Archives and Records Administration (Part
7601)
LXVII Institute of Museum and Library Services (Part 7701)
LXIX Tennessee Valley Authority (Part 7901)
LXXI Consumer Product Safety Commission (Part 8101)
LXXIII Department of Agriculture (Part 8301)
LXXIV Federal Mine Safety and Health Review Commission (Part
8401)
LXXVI Federal Retirement Thrift Investment Board (Part 8601)
LXXVII Office of Management and Budget (Part 8701)
Title 6--Homeland Security
I Department of Homeland Security, Office of the
Secretary (Parts 0--99)
[[Page 741]]
Title 7--Agriculture
Subtitle A--Office of the Secretary of Agriculture
(Parts 0--26)
Subtitle B--Regulations of the Department of
Agriculture
I Agricultural Marketing Service (Standards,
Inspections, Marketing Practices), Department of
Agriculture (Parts 27--209)
II Food and Nutrition Service, Department of Agriculture
(Parts 210--299)
III Animal and Plant Health Inspection Service, Department
of Agriculture (Parts 300--399)
IV Federal Crop Insurance Corporation, Department of
Agriculture (Parts 400--499)
V Agricultural Research Service, Department of
Agriculture (Parts 500--599)
VI Natural Resources Conservation Service, Department of
Agriculture (Parts 600--699)
VII Farm Service Agency, Department of Agriculture (Parts
700--799)
VIII Grain Inspection, Packers and Stockyards
Administration (Federal Grain Inspection Service),
Department of Agriculture (Parts 800--899)
IX Agricultural Marketing Service (Marketing Agreements
and Orders; Fruits, Vegetables, Nuts), Department
of Agriculture (Parts 900--999)
X Agricultural Marketing Service (Marketing Agreements
and Orders; Milk), Department of Agriculture
(Parts 1000--1199)
XI Agricultural Marketing Service (Marketing Agreements
and Orders; Miscellaneous Commodities), Department
of Agriculture (Parts 1200--1299)
XIV Commodity Credit Corporation, Department of
Agriculture (Parts 1400--1499)
XV Foreign Agricultural Service, Department of
Agriculture (Parts 1500--1599)
XVI Rural Telephone Bank, Department of Agriculture (Parts
1600--1699)
XVII Rural Utilities Service, Department of Agriculture
(Parts 1700--1799)
XVIII Rural Housing Service, Rural Business-Cooperative
Service, Rural Utilities Service, and Farm Service
Agency, Department of Agriculture (Parts 1800--
2099)
XX Local Television Loan Guarantee Board (Parts 2200--
2299)
XXVI Office of Inspector General, Department of Agriculture
(Parts 2600--2699)
XXVII Office of Information Resources Management, Department
of Agriculture (Parts 2700--2799)
XXVIII Office of Operations, Department of Agriculture (Parts
2800--2899)
XXIX Office of Energy, Department of Agriculture (Parts
2900--2999)
XXX Office of the Chief Financial Officer, Department of
Agriculture (Parts 3000--3099)
[[Page 742]]
XXXI Office of Environmental Quality, Department of
Agriculture (Parts 3100--3199)
XXXII Office of Procurement and Property Management,
Department of Agriculture (Parts 3200--3299)
XXXIII Office of Transportation, Department of Agriculture
(Parts 3300--3399)
XXXIV Cooperative State Research, Education, and Extension
Service, Department of Agriculture (Parts 3400--
3499)
XXXV Rural Housing Service, Department of Agriculture
(Parts 3500--3599)
XXXVI National Agricultural Statistics Service, Department
of Agriculture (Parts 3600--3699)
XXXVII Economic Research Service, Department of Agriculture
(Parts 3700--3799)
XXXVIII World Agricultural Outlook Board, Department of
Agriculture (Parts 3800--3899)
XLI [Reserved]
XLII Rural Business-Cooperative Service and Rural Utilities
Service, Department of Agriculture (Parts 4200--
4299)
Title 8--Aliens and Nationality
I Department of Homeland Security (Immigration and
Naturalization) (Parts 1--499)
V Executive Office for Immigration Review, Department of
Justice (Parts 1000--1399)
Title 9--Animals and Animal Products
I Animal and Plant Health Inspection Service, Department
of Agriculture (Parts 1--199)
II Grain Inspection, Packers and Stockyards
Administration (Packers and Stockyards Programs),
Department of Agriculture (Parts 200--299)
III Food Safety and Inspection Service, Department of
Agriculture (Parts 300--599)
Title 10--Energy
I Nuclear Regulatory Commission (Parts 0--199)
II Department of Energy (Parts 200--699)
III Department of Energy (Parts 700--999)
X Department of Energy (General Provisions) (Parts
1000--1099)
XVII Defense Nuclear Facilities Safety Board (Parts 1700--
1799)
XVIII Northeast Interstate Low-Level Radioactive Waste
Commission (Part 1800)
[[Page 743]]
Title 11--Federal Elections
I Federal Election Commission (Parts 1--9099)
Title 12--Banks and Banking
I Comptroller of the Currency, Department of the
Treasury (Parts 1--199)
II Federal Reserve System (Parts 200--299)
III Federal Deposit Insurance Corporation (Parts 300--399)
IV Export-Import Bank of the United States (Parts 400--
499)
V Office of Thrift Supervision, Department of the
Treasury (Parts 500--599)
VI Farm Credit Administration (Parts 600--699)
VII National Credit Union Administration (Parts 700--799)
VIII Federal Financing Bank (Parts 800--899)
IX Federal Housing Finance Board (Parts 900--999)
XI Federal Financial Institutions Examination Council
(Parts 1100--1199)
XIV Farm Credit System Insurance Corporation (Parts 1400--
1499)
XV Department of the Treasury (Parts 1500--1599)
XVII Office of Federal Housing Enterprise Oversight,
Department of Housing and Urban Development (Parts
1700--1799)
XVIII Community Development Financial Institutions Fund,
Department of the Treasury (Parts 1800--1899)
Title 13--Business Credit and Assistance
I Small Business Administration (Parts 1--199)
III Economic Development Administration, Department of
Commerce (Parts 300--399)
IV Emergency Steel Guarantee Loan Board, Department of
Commerce (Parts 400--499)
V Emergency Oil and Gas Guaranteed Loan Board,
Department of Commerce (Parts 500--599)
Title 14--Aeronautics and Space
I Federal Aviation Administration, Department of
Transportation (Parts 1--199)
II Office of the Secretary, Department of Transportation
(Aviation Proceedings) (Parts 200--399)
III Commercial Space Transportation, Federal Aviation
Administration, Department of Transportation
(Parts 400--499)
V National Aeronautics and Space Administration (Parts
1200--1299)
VI Air Transportation System Stabilization (Parts 1300--
1399)
[[Page 744]]
Title 15--Commerce and Foreign Trade
Subtitle A--Office of the Secretary of Commerce (Parts
0--29)
Subtitle B--Regulations Relating to Commerce and
Foreign Trade
I Bureau of the Census, Department of Commerce (Parts
30--199)
II National Institute of Standards and Technology,
Department of Commerce (Parts 200--299)
III International Trade Administration, Department of
Commerce (Parts 300--399)
IV Foreign-Trade Zones Board, Department of Commerce
(Parts 400--499)
VII Bureau of Industry and Security, Department of
Commerce (Parts 700--799)
VIII Bureau of Economic Analysis, Department of Commerce
(Parts 800--899)
IX National Oceanic and Atmospheric Administration,
Department of Commerce (Parts 900--999)
XI Technology Administration, Department of Commerce
(Parts 1100--1199)
XIII East-West Foreign Trade Board (Parts 1300--1399)
XIV Minority Business Development Agency (Parts 1400--
1499)
Subtitle C--Regulations Relating to Foreign Trade
Agreements
XX Office of the United States Trade Representative
(Parts 2000--2099)
Subtitle D--Regulations Relating to Telecommunications
and Information
XXIII National Telecommunications and Information
Administration, Department of Commerce (Parts
2300--2399)
Title 16--Commercial Practices
I Federal Trade Commission (Parts 0--999)
II Consumer Product Safety Commission (Parts 1000--1799)
Title 17--Commodity and Securities Exchanges
I Commodity Futures Trading Commission (Parts 1--199)
II Securities and Exchange Commission (Parts 200--399)
IV Department of the Treasury (Parts 400--499)
Title 18--Conservation of Power and Water Resources
I Federal Energy Regulatory Commission, Department of
Energy (Parts 1--399)
III Delaware River Basin Commission (Parts 400--499)
VI Water Resources Council (Parts 700--799)
[[Page 745]]
VIII Susquehanna River Basin Commission (Parts 800--899)
XIII Tennessee Valley Authority (Parts 1300--1399)
Title 19--Customs Duties
I Bureau of Customs and Border Protection, Department of
Homeland Security; Department of the Treasury
(Parts 0--199)
II United States International Trade Commission (Parts
200--299)
III International Trade Administration, Department of
Commerce (Parts 300--399)
IV Bureau of Immigration and Customs Enforcement,
Department of Homeland Security (Parts 400--599)
Title 20--Employees' Benefits
I Office of Workers' Compensation Programs, Department
of Labor (Parts 1--199)
II Railroad Retirement Board (Parts 200--399)
III Social Security Administration (Parts 400--499)
IV Employees Compensation Appeals Board, Department of
Labor (Parts 500--599)
V Employment and Training Administration, Department of
Labor (Parts 600--699)
VI Employment Standards Administration, Department of
Labor (Parts 700--799)
VII Benefits Review Board, Department of Labor (Parts
800--899)
VIII Joint Board for the Enrollment of Actuaries (Parts
900--999)
IX Office of the Assistant Secretary for Veterans'
Employment and Training, Department of Labor
(Parts 1000--1099)
Title 21--Food and Drugs
I Food and Drug Administration, Department of Health and
Human Services (Parts 1--1299)
II Drug Enforcement Administration, Department of Justice
(Parts 1300--1399)
III Office of National Drug Control Policy (Parts 1400--
1499)
Title 22--Foreign Relations
I Department of State (Parts 1--199)
II Agency for International Development (Parts 200--299)
III Peace Corps (Parts 300--399)
IV International Joint Commission, United States and
Canada (Parts 400--499)
V Broadcasting Board of Governors (Parts 500--599)
VII Overseas Private Investment Corporation (Parts 700--
799)
IX Foreign Service Grievance Board Regulations (Parts
900--999)
[[Page 746]]
X Inter-American Foundation (Parts 1000--1099)
XI International Boundary and Water Commission, United
States and Mexico, United States Section (Parts
1100--1199)
XII United States International Development Cooperation
Agency (Parts 1200--1299)
XIV Foreign Service Labor Relations Board; Federal Labor
Relations Authority; General Counsel of the
Federal Labor Relations Authority; and the Foreign
Service Impasse Disputes Panel (Parts 1400--1499)
XV African Development Foundation (Parts 1500--1599)
XVI Japan-United States Friendship Commission (Parts
1600--1699)
XVII United States Institute of Peace (Parts 1700--1799)
Title 23--Highways
I Federal Highway Administration, Department of
Transportation (Parts 1--999)
II National Highway Traffic Safety Administration and
Federal Highway Administration, Department of
Transportation (Parts 1200--1299)
III National Highway Traffic Safety Administration,
Department of Transportation (Parts 1300--1399)
Title 24--Housing and Urban Development
Subtitle A--Office of the Secretary, Department of
Housing and Urban Development (Parts 0--99)
Subtitle B--Regulations Relating to Housing and Urban
Development
I Office of Assistant Secretary for Equal Opportunity,
Department of Housing and Urban Development (Parts
100--199)
II Office of Assistant Secretary for Housing-Federal
Housing Commissioner, Department of Housing and
Urban Development (Parts 200--299)
III Government National Mortgage Association, Department
of Housing and Urban Development (Parts 300--399)
IV Office of Housing and Office of Multifamily Housing
Assistance Restructuring, Department of Housing
and Urban Development (Parts 400--499)
V Office of Assistant Secretary for Community Planning
and Development, Department of Housing and Urban
Development (Parts 500--599)
VI Office of Assistant Secretary for Community Planning
and Development, Department of Housing and Urban
Development (Parts 600--699) [Reserved]
VII Office of the Secretary, Department of Housing and
Urban Development (Housing Assistance Programs and
Public and Indian Housing Programs) (Parts 700--
799)
[[Page 747]]
VIII Office of the Assistant Secretary for Housing--Federal
Housing Commissioner, Department of Housing and
Urban Development (Section 8 Housing Assistance
Programs, Section 202 Direct Loan Program, Section
202 Supportive Housing for the Elderly Program and
Section 811 Supportive Housing for Persons With
Disabilities Program) (Parts 800--899)
IX Office of Assistant Secretary for Public and Indian
Housing, Department of Housing and Urban
Development (Parts 900--1699)
X Office of Assistant Secretary for Housing--Federal
Housing Commissioner, Department of Housing and
Urban Development (Interstate Land Sales
Registration Program) (Parts 1700--1799)
XII Office of Inspector General, Department of Housing and
Urban Development (Parts 2000--2099)
XX Office of Assistant Secretary for Housing--Federal
Housing Commissioner, Department of Housing and
Urban Development (Parts 3200--3899)
XXV Neighborhood Reinvestment Corporation (Parts 4100--
4199)
Title 25--Indians
I Bureau of Indian Affairs, Department of the Interior
(Parts 1--299)
II Indian Arts and Crafts Board, Department of the
Interior (Parts 300--399)
III National Indian Gaming Commission, Department of the
Interior (Parts 500--599)
IV Office of Navajo and Hopi Indian Relocation (Parts
700--799)
V Bureau of Indian Affairs, Department of the Interior,
and Indian Health Service, Department of Health
and Human Services (Part 900)
VI Office of the Assistant Secretary-Indian Affairs,
Department of the Interior (Parts 1000--1199)
VII Office of the Special Trustee for American Indians,
Department of the Interior (Part 1200)
Title 26--Internal Revenue
I Internal Revenue Service, Department of the Treasury
(Parts 1--899)
Title 27--Alcohol, Tobacco Products and Firearms
I Alcohol and Tobacco Tax and Trade Bureau, Department
of the Treasury (Parts 1--399)
II Bureau of Alcohol, Tobacco, Firearms, and Explosives,
Department of Justice (Parts 400--699)
Title 28--Judicial Administration
I Department of Justice (Parts 0--299)
[[Page 748]]
III Federal Prison Industries, Inc., Department of Justice
(Parts 300--399)
V Bureau of Prisons, Department of Justice (Parts 500--
599)
VI Offices of Independent Counsel, Department of Justice
(Parts 600--699)
VII Office of Independent Counsel (Parts 700--799)
VIII Court Services and Offender Supervision Agency for the
District of Columbia (Parts 800--899)
IX National Crime Prevention and Privacy Compact Council
(Parts 900--999)
XI Department of Justice and Department of State (Parts
1100--1199)
Title 29--Labor
Subtitle A--Office of the Secretary of Labor (Parts
0--99)
Subtitle B--Regulations Relating to Labor
I National Labor Relations Board (Parts 100--199)
II Office of Labor-Management Standards, Department of
Labor (Parts 200--299)
III National Railroad Adjustment Board (Parts 300--399)
IV Office of Labor-Management Standards, Department of
Labor (Parts 400--499)
V Wage and Hour Division, Department of Labor (Parts
500--899)
IX Construction Industry Collective Bargaining Commission
(Parts 900--999)
X National Mediation Board (Parts 1200--1299)
XII Federal Mediation and Conciliation Service (Parts
1400--1499)
XIV Equal Employment Opportunity Commission (Parts 1600--
1699)
XVII Occupational Safety and Health Administration,
Department of Labor (Parts 1900--1999)
XX Occupational Safety and Health Review Commission
(Parts 2200--2499)
XXV Employee Benefits Security Administration, Department
of Labor (Parts 2500--2599)
XXVII Federal Mine Safety and Health Review Commission
(Parts 2700--2799)
XL Pension Benefit Guaranty Corporation (Parts 4000--
4999)
Title 30--Mineral Resources
I Mine Safety and Health Administration, Department of
Labor (Parts 1--199)
II Minerals Management Service, Department of the
Interior (Parts 200--299)
III Board of Surface Mining and Reclamation Appeals,
Department of the Interior (Parts 300--399)
IV Geological Survey, Department of the Interior (Parts
400--499)
[[Page 749]]
VII Office of Surface Mining Reclamation and Enforcement,
Department of the Interior (Parts 700--999)
Title 31--Money and Finance: Treasury
Subtitle A--Office of the Secretary of the Treasury
(Parts 0--50)
Subtitle B--Regulations Relating to Money and Finance
I Monetary Offices, Department of the Treasury (Parts
51--199)
II Fiscal Service, Department of the Treasury (Parts
200--399)
IV Secret Service, Department of the Treasury (Parts
400--499)
V Office of Foreign Assets Control, Department of the
Treasury (Parts 500--599)
VI Bureau of Engraving and Printing, Department of the
Treasury (Parts 600--699)
VII Federal Law Enforcement Training Center, Department of
the Treasury (Parts 700--799)
VIII Office of International Investment, Department of the
Treasury (Parts 800--899)
IX Federal Claims Collection Standards (Department of the
Treasury--Department of Justice) (Parts 900--999)
Title 32--National Defense
Subtitle A--Department of Defense
I Office of the Secretary of Defense (Parts 1--399)
V Department of the Army (Parts 400--699)
VI Department of the Navy (Parts 700--799)
VII Department of the Air Force (Parts 800--1099)
Subtitle B--Other Regulations Relating to National
Defense
XII Defense Logistics Agency (Parts 1200--1299)
XVI Selective Service System (Parts 1600--1699)
XVIII National Counterintelligence Center (Parts 1800--1899)
XIX Central Intelligence Agency (Parts 1900--1999)
XX Information Security Oversight Office, National
Archives and Records Administration (Parts 2000--
2099)
XXI National Security Council (Parts 2100--2199)
XXIV Office of Science and Technology Policy (Parts 2400--
2499)
XXVII Office for Micronesian Status Negotiations (Parts
2700--2799)
XXVIII Office of the Vice President of the United States
(Parts 2800--2899)
Title 33--Navigation and Navigable Waters
I Coast Guard, Department of Homeland Security (Parts
1--199)
II Corps of Engineers, Department of the Army (Parts
200--399)
[[Page 750]]
IV Saint Lawrence Seaway Development Corporation,
Department of Transportation (Parts 400--499)
Title 34--Education
Subtitle A--Office of the Secretary, Department of
Education (Parts 1--99)
Subtitle B--Regulations of the Offices of the
Department of Education
I Office for Civil Rights, Department of Education
(Parts 100--199)
II Office of Elementary and Secondary Education,
Department of Education (Parts 200--299)
III Office of Special Education and Rehabilitative
Services, Department of Education (Parts 300--399)
IV Office of Vocational and Adult Education, Department
of Education (Parts 400--499)
V Office of Bilingual Education and Minority Languages
Affairs, Department of Education (Parts 500--599)
VI Office of Postsecondary Education, Department of
Education (Parts 600--699)
XI National Institute for Literacy (Parts 1100--1199)
Subtitle C--Regulations Relating to Education
XII National Council on Disability (Parts 1200--1299)
Title 35--Panama Canal
I Panama Canal Regulations (Parts 1--299)
Title 36--Parks, Forests, and Public Property
I National Park Service, Department of the Interior
(Parts 1--199)
II Forest Service, Department of Agriculture (Parts 200--
299)
III Corps of Engineers, Department of the Army (Parts
300--399)
IV American Battle Monuments Commission (Parts 400--499)
V Smithsonian Institution (Parts 500--599)
VII Library of Congress (Parts 700--799)
VIII Advisory Council on Historic Preservation (Parts 800--
899)
IX Pennsylvania Avenue Development Corporation (Parts
900--999)
X Presidio Trust (Parts 1000--1099)
XI Architectural and Transportation Barriers Compliance
Board (Parts 1100--1199)
XII National Archives and Records Administration (Parts
1200--1299)
XV Oklahoma City National Memorial Trust (Part 1501)
XVI Morris K. Udall Scholarship and Excellence in National
Environmental Policy Foundation (Parts 1600--1699)
[[Page 751]]
Title 37--Patents, Trademarks, and Copyrights
I United States Patent and Trademark Office, Department
of Commerce (Parts 1--199)
II Copyright Office, Library of Congress (Parts 200--299)
IV Assistant Secretary for Technology Policy, Department
of Commerce (Parts 400--499)
V Under Secretary for Technology, Department of Commerce
(Parts 500--599)
Title 38--Pensions, Bonuses, and Veterans' Relief
I Department of Veterans Affairs (Parts 0--99)
Title 39--Postal Service
I United States Postal Service (Parts 1--999)
III Postal Rate Commission (Parts 3000--3099)
Title 40--Protection of Environment
I Environmental Protection Agency (Parts 1--1099)
IV Environmental Protection Agency and Department of
Justice (Parts 1400--1499)
V Council on Environmental Quality (Parts 1500--1599)
VI Chemical Safety and Hazard Investigation Board (Parts
1600--1699)
VII Environmental Protection Agency and Department of
Defense; Uniform National Discharge Standards for
Vessels of the Armed Forces (Parts 1700--1799)
Title 41--Public Contracts and Property Management
Subtitle B--Other Provisions Relating to Public
Contracts
50 Public Contracts, Department of Labor (Parts 50-1--50-
999)
51 Committee for Purchase From People Who Are Blind or
Severely Disabled (Parts 51-1--51-99)
60 Office of Federal Contract Compliance Programs, Equal
Employment Opportunity, Department of Labor (Parts
60-1--60-999)
61 Office of the Assistant Secretary for Veterans'
Employment and Training Service, Department of
Labor (Parts 61-1--61-999)
Subtitle C--Federal Property Management Regulations
System
101 Federal Property Management Regulations (Parts 101-1--
101-99)
102 Federal Management Regulation (Parts 102-1--102-299)
105 General Services Administration (Parts 105-1--105-999)
109 Department of Energy Property Management Regulations
(Parts 109-1--109-99)
114 Department of the Interior (Parts 114-1--114-99)
115 Environmental Protection Agency (Parts 115-1--115-99)
[[Page 752]]
128 Department of Justice (Parts 128-1--128-99)
Subtitle D--Other Provisions Relating to Property
Management [Reserved]
Subtitle E--Federal Information Resources Management
Regulations System
201 Federal Information Resources Management Regulation
(Parts 201-1--201-99) [Reserved]
Subtitle F--Federal Travel Regulation System
300 General (Parts 300-1--300-99)
301 Temporary Duty (TDY) Travel Allowances (Parts 301-1--
301-99)
302 Relocation Allowances (Parts 302-1--302-99)
303 Payment of Expenses Connected with the Death of
Certain Employees (Part 303-70)
304 Payment of Travel Expenses from a Non-Federal Source
(Parts 304-1--304-99)
Title 42--Public Health
I Public Health Service, Department of Health and Human
Services (Parts 1--199)
IV Centers for Medicare & Medicaid Services, Department
of Health and Human Services (Parts 400--499)
V Office of Inspector General-Health Care, Department of
Health and Human Services (Parts 1000--1999)
Title 43--Public Lands: Interior
Subtitle A--Office of the Secretary of the Interior
(Parts 1--199)
Subtitle B--Regulations Relating to Public Lands
I Bureau of Reclamation, Department of the Interior
(Parts 200--499)
II Bureau of Land Management, Department of the Interior
(Parts 1000--9999)
III Utah Reclamation Mitigation and Conservation
Commission (Parts 10000--10010)
Title 44--Emergency Management and Assistance
I Federal Emergency Management Agency, Department of
Homeland Security (Parts 0--399)
IV Department of Commerce and Department of
Transportation (Parts 400--499)
Title 45--Public Welfare
Subtitle A--Department of Health and Human Services
(Parts 1--199)
Subtitle B--Regulations Relating to Public Welfare
[[Page 753]]
II Office of Family Assistance (Assistance Programs),
Administration for Children and Families,
Department of Health and Human Services (Parts
200--299)
III Office of Child Support Enforcement (Child Support
Enforcement Program), Administration for Children
and Families, Department of Health and Human
Services (Parts 300--399)
IV Office of Refugee Resettlement, Administration for
Children and Families, Department of Health and
Human Services (Parts 400--499)
V Foreign Claims Settlement Commission of the United
States, Department of Justice (Parts 500--599)
VI National Science Foundation (Parts 600--699)
VII Commission on Civil Rights (Parts 700--799)
VIII Office of Personnel Management (Parts 800--899)
X Office of Community Services, Administration for
Children and Families, Department of Health and
Human Services (Parts 1000--1099)
XI National Foundation on the Arts and the Humanities
(Parts 1100--1199)
XII Corporation for National and Community Service (Parts
1200--1299)
XIII Office of Human Development Services, Department of
Health and Human Services (Parts 1300--1399)
XVI Legal Services Corporation (Parts 1600--1699)
XVII National Commission on Libraries and Information
Science (Parts 1700--1799)
XVIII Harry S. Truman Scholarship Foundation (Parts 1800--
1899)
XXI Commission on Fine Arts (Parts 2100--2199)
XXIII Arctic Research Commission (Part 2301)
XXIV James Madison Memorial Fellowship Foundation (Parts
2400--2499)
XXV Corporation for National and Community Service (Parts
2500--2599)
Title 46--Shipping
I Coast Guard, Department of Homeland Security (Parts
1--199)
II Maritime Administration, Department of Transportation
(Parts 200--399)
III Coast Guard (Great Lakes Pilotage), Department of
Homeland Security (Parts 400--499)
IV Federal Maritime Commission (Parts 500--599)
Title 47--Telecommunication
I Federal Communications Commission (Parts 0--199)
II Office of Science and Technology Policy and National
Security Council (Parts 200--299)
[[Page 754]]
III National Telecommunications and Information
Administration, Department of Commerce (Parts
300--399)
Title 48--Federal Acquisition Regulations System
1 Federal Acquisition Regulation (Parts 1--99)
2 Department of Defense (Parts 200--299)
3 Department of Health and Human Services (Parts 300--
399)
4 Department of Agriculture (Parts 400--499)
5 General Services Administration (Parts 500--599)
6 Department of State (Parts 600--699)
7 United States Agency for International Development
(Parts 700--799)
8 Department of Veterans Affairs (Parts 800--899)
9 Department of Energy (Parts 900--999)
10 Department of the Treasury (Parts 1000--1099)
12 Department of Transportation (Parts 1200--1299)
13 Department of Commerce (Parts 1300--1399)
14 Department of the Interior (Parts 1400--1499)
15 Environmental Protection Agency (Parts 1500--1599)
16 Office of Personnel Management, Federal Employees
Health Benefits Acquisition Regulation (Parts
1600--1699)
17 Office of Personnel Management (Parts 1700--1799)
18 National Aeronautics and Space Administration (Parts
1800--1899)
19 Broadcasting Board of Governors (Parts 1900--1999)
20 Nuclear Regulatory Commission (Parts 2000--2099)
21 Office of Personnel Management, Federal Employees
Group Life Insurance Federal Acquisition
Regulation (Parts 2100--2199)
23 Social Security Administration (Parts 2300--2399)
24 Department of Housing and Urban Development (Parts
2400--2499)
25 National Science Foundation (Parts 2500--2599)
28 Department of Justice (Parts 2800--2899)
29 Department of Labor (Parts 2900--2999)
30 Department of Homeland Security, Homeland Security
Acquisition Regulation (HSAR) (Parts 3000--3099)
34 Department of Education Acquisition Regulation (Parts
3400--3499)
35 Panama Canal Commission (Parts 3500--3599)
44 Federal Emergency Management Agency (Parts 4400--4499)
51 Department of the Army Acquisition Regulations (Parts
5100--5199)
52 Department of the Navy Acquisition Regulations (Parts
5200--5299)
53 Department of the Air Force Federal Acquisition
Regulation Supplement (Parts 5300--5399)
[[Page 755]]
54 Defense Logistics Agency, Department of Defense (Parts
5400--5499)
57 African Development Foundation (Parts 5700--5799)
61 General Services Administration Board of Contract
Appeals (Parts 6100--6199)
63 Department of Transportation Board of Contract Appeals
(Parts 6300--6399)
99 Cost Accounting Standards Board, Office of Federal
Procurement Policy, Office of Management and
Budget (Parts 9900--9999)
Title 49--Transportation
Subtitle A--Office of the Secretary of Transportation
(Parts 1--99)
Subtitle B--Other Regulations Relating to
Transportation
I Research and Special Programs Administration,
Department of Transportation (Parts 100--199)
II Federal Railroad Administration, Department of
Transportation (Parts 200--299)
III Federal Motor Carrier Safety Administration,
Department of Transportation (Parts 300--399)
IV Coast Guard, Department of Homeland Security (Parts
400--499)
V National Highway Traffic Safety Administration,
Department of Transportation (Parts 500--599)
VI Federal Transit Administration, Department of
Transportation (Parts 600--699)
VII National Railroad Passenger Corporation (AMTRAK)
(Parts 700--799)
VIII National Transportation Safety Board (Parts 800--999)
X Surface Transportation Board, Department of
Transportation (Parts 1000--1399)
XI Bureau of Transportation Statistics, Department of
Transportation (Parts 1400--1499)
XII Transportation Security Administration, Department of
Homeland Security (Parts 1500--1599)
Title 50--Wildlife and Fisheries
I United States Fish and Wildlife Service, Department of
the Interior (Parts 1--199)
II National Marine Fisheries Service, National Oceanic
and Atmospheric Administration, Department of
Commerce (Parts 200--299)
III International Fishing and Related Activities (Parts
300--399)
IV Joint Regulations (United States Fish and Wildlife
Service, Department of the Interior and National
Marine Fisheries Service, National Oceanic and
Atmospheric Administration, Department of
Commerce); Endangered Species Committee
Regulations (Parts 400--499)
[[Page 756]]
V Marine Mammal Commission (Parts 500--599)
VI Fishery Conservation and Management, National Oceanic
and Atmospheric Administration, Department of
Commerce (Parts 600--699)
CFR Index and Finding Aids
Subject/Agency Index
List of Agency Prepared Indexes
Parallel Tables of Statutory Authorities and Rules
List of CFR Titles, Chapters, Subchapters, and Parts
Alphabetical List of Agencies Appearing in the CFR
[[Page 757]]
Alphabetical List of Agencies Appearing in the CFR
(Revised as of April 1, 2004)
CFR Title, Subtitle or
Agency Chapter
Administrative Committee of the Federal Register 1, I
Advanced Research Projects Agency 32, I
Advisory Council on Historic Preservation 36, VIII
African Development Foundation 22, XV
Federal Acquisition Regulation 48, 57
Agency for International Development, United 22, II
States
Federal Acquisition Regulation 48, 7
Agricultural Marketing Service 7, I, IX, X, XI
Agricultural Research Service 7, V
Agriculture Department 5, LXXIII
Agricultural Marketing Service 7, I, IX, X, XI
Agricultural Research Service 7, V
Animal and Plant Health Inspection Service 7, III; 9, I
Chief Financial Officer, Office of 7, XXX
Commodity Credit Corporation 7, XIV
Cooperative State Research, Education, and 7, XXXIV
Extension Service
Economic Research Service 7, XXXVII
Energy, Office of 7, XXIX
Environmental Quality, Office of 7, XXXI
Farm Service Agency 7, VII, XVIII
Federal Acquisition Regulation 48, 4
Federal Crop Insurance Corporation 7, IV
Food and Nutrition Service 7, II
Food Safety and Inspection Service 9, III
Foreign Agricultural Service 7, XV
Forest Service 36, II
Grain Inspection, Packers and Stockyards 7, VIII; 9, II
Administration
Information Resources Management, Office of 7, XXVII
Inspector General, Office of 7, XXVI
National Agricultural Library 7, XLI
National Agricultural Statistics Service 7, XXXVI
Natural Resources Conservation Service 7, VI
Operations, Office of 7, XXVIII
Procurement and Property Management, Office of 7, XXXII
Rural Business-Cooperative Service 7, XVIII, XLII
Rural Development Administration 7, XLII
Rural Housing Service 7, XVIII, XXXV
Rural Telephone Bank 7, XVI
Rural Utilities Service 7, XVII, XVIII, XLII
Secretary of Agriculture, Office of 7, Subtitle A
Transportation, Office of 7, XXXIII
World Agricultural Outlook Board 7, XXXVIII
Air Force Department 32, VII
Federal Acquisition Regulation Supplement 48, 53
Air Transportation Stabilization Board 14, VI
Alcohol and Tobacco Tax and Trade Bureau 27, I
Alcohol, Tobacco, Firearms, and Explosives, 27, II
Bureau of
AMTRAK 49, VII
American Battle Monuments Commission 36, IV
American Indians, Office of the Special Trustee 25, VII
Animal and Plant Health Inspection Service 7, III; 9, I
Appalachian Regional Commission 5, IX
[[Page 758]]
Architectural and Transportation Barriers 36, XI
Compliance Board
Arctic Research Commission 45, XXIII
Armed Forces Retirement Home 5, XI
Army Department 32, V
Engineers, Corps of 33, II; 36, III
Federal Acquisition Regulation 48, 51
Benefits Review Board 20, VII
Bilingual Education and Minority Languages 34, V
Affairs, Office of
Blind or Severely Disabled, Committee for 41, 51
Purchase From People Who Are
Broadcasting Board of Governors 22, V
Federal Acquisition Regulation 48, 19
Census Bureau 15, I
Centers for Medicare & Medicaid Services 42, IV
Central Intelligence Agency 32, XIX
Chief Financial Officer, Office of 7, XXX
Child Support Enforcement, Office of 45, III
Children and Families, Administration for 45, II, III, IV, X
Civil Rights, Commission on 45, VII
Civil Rights, Office for 34, I
Coast Guard 33, I; 46, I; 49, IV
Coast Guard (Great Lakes Pilotage) 46, III
Commerce Department 44, IV
Census Bureau 15, I
Economic Affairs, Under Secretary 37, V
Economic Analysis, Bureau of 15, VIII
Economic Development Administration 13, III
Emergency Management and Assistance 44, IV
Federal Acquisition Regulation 48, 13
Fishery Conservation and Management 50, VI
Foreign-Trade Zones Board 15, IV
Industry and Security, Bureau of 15, VII
International Trade Administration 15, III; 19, III
National Institute of Standards and Technology 15, II
National Marine Fisheries Service 50, II, IV, VI
National Oceanic and Atmospheric 15, IX; 50, II, III, IV,
Administration VI
National Telecommunications and Information 15, XXIII; 47, III
Administration
National Weather Service 15, IX
Patent and Trademark Office, United States 37, I
Productivity, Technology and Innovation, 37, IV
Assistant Secretary for
Secretary of Commerce, Office of 15, Subtitle A
Technology, Under Secretary for 37, V
Technology Administration 15, XI
Technology Policy, Assistant Secretary for 37, IV
Commercial Space Transportation 14, III
Commodity Credit Corporation 7, XIV
Commodity Futures Trading Commission 5, XLI; 17, I
Community Planning and Development, Office of 24, V, VI
Assistant Secretary for
Community Services, Office of 45, X
Comptroller of the Currency 12, I
Construction Industry Collective Bargaining 29, IX
Commission
Consumer Product Safety Commission 5, LXXI; 16, II
Cooperative State Research, Education, and 7, XXXIV
Extension Service
Copyright Office 37, II
Corporation for National and Community Service 45, XII, XXV
Cost Accounting Standards Board 48, 99
Council on Environmental Quality 40, V
Court Services and Offender Supervision Agency 28, VIII
for the District of Columbia
Customs and Border Protection Bureau 19, I
Defense Contract Audit Agency 32, I
Defense Department 5, XXVI; 32, Subtitle A;
40, VII
[[Page 759]]
Advanced Research Projects Agency 32, I
Air Force Department 32, VII
Army Department 32, V; 33, II; 36, III,
48, 51
Defense Intelligence Agency 32, I
Defense Logistics Agency 32, I, XII; 48, 54
Engineers, Corps of 33, II; 36, III
Federal Acquisition Regulation 48, 2
National Imagery and Mapping Agency 32, I
Navy Department 32, VI; 48, 52
Secretary of Defense, Office of 32, I
Defense Contract Audit Agency 32, I
Defense Intelligence Agency 32, I
Defense Logistics Agency 32, XII; 48, 54
Defense Nuclear Facilities Safety Board 10, XVII
Delaware River Basin Commission 18, III
District of Columbia, Court Services and 28, VIII
Offender Supervision Agency for the
Drug Enforcement Administration 21, II
East-West Foreign Trade Board 15, XIII
Economic Affairs, Under Secretary 37, V
Economic Analysis, Bureau of 15, VIII
Economic Development Administration 13, III
Economic Research Service 7, XXXVII
Education, Department of 5, LIII
Bilingual Education and Minority Languages 34, V
Affairs, Office of
Civil Rights, Office for 34, I
Educational Research and Improvement, Office 34, VII
of
Elementary and Secondary Education, Office of 34, II
Federal Acquisition Regulation 48, 34
Postsecondary Education, Office of 34, VI
Secretary of Education, Office of 34, Subtitle A
Special Education and Rehabilitative Services, 34, III
Office of
Vocational and Adult Education, Office of 34, IV
Educational Research and Improvement, Office of 34, VII
Elementary and Secondary Education, Office of 34, II
Emergency Oil and Gas Guaranteed Loan Board 13, V
Emergency Steel Guarantee Loan Board 13, IV
Employee Benefits Security Administration 29, XXV
Employees' Compensation Appeals Board 20, IV
Employees Loyalty Board 5, V
Employment and Training Administration 20, V
Employment Standards Administration 20, VI
Endangered Species Committee 50, IV
Energy, Department of 5, XXIII; 10, II, III, X
Federal Acquisition Regulation 48, 9
Federal Energy Regulatory Commission 5, XXIV; 18, I
Property Management Regulations 41, 109
Energy, Office of 7, XXIX
Engineers, Corps of 33, II; 36, III
Engraving and Printing, Bureau of 31, VI
Environmental Protection Agency 5, LIV; 40, I, IV, VII
Federal Acquisition Regulation 48, 15
Property Management Regulations 41, 115
Environmental Quality, Office of 7, XXXI
Equal Employment Opportunity Commission 5, LXII; 29, XIV
Equal Opportunity, Office of Assistant Secretary 24, I
for
Executive Office of the President 3, I
Administration, Office of 5, XV
Environmental Quality, Council on 40, V
Management and Budget, Office of 5, III, LXXVII; 14, VI;
48, 99
National Drug Control Policy, Office of 21, III
National Security Council 32, XXI; 47, 2
Presidential Documents 3
Science and Technology Policy, Office of 32, XXIV; 47, II
[[Page 760]]
Trade Representative, Office of the United 15, XX
States
Export-Import Bank of the United States 5, LII; 12, IV
Family Assistance, Office of 45, II
Farm Credit Administration 5, XXXI; 12, VI
Farm Credit System Insurance Corporation 5, XXX; 12, XIV
Farm Service Agency 7, VII, XVIII
Federal Acquisition Regulation 48, 1
Federal Aviation Administration 14, I
Commercial Space Transportation 14, III
Federal Claims Collection Standards 31, IX
Federal Communications Commission 5, XXIX; 47, I
Federal Contract Compliance Programs, Office of 41, 60
Federal Crop Insurance Corporation 7, IV
Federal Deposit Insurance Corporation 5, XXII; 12, III
Federal Election Commission 11, I
Federal Emergency Management Agency 44, I
Federal Acquisition Regulation 48, 44
Federal Employees Group Life Insurance Federal 48, 21
Acquisition Regulation
Federal Employees Health Benefits Acquisition 48, 16
Regulation
Federal Energy Regulatory Commission 5, XXIV; 18, I
Federal Financial Institutions Examination 12, XI
Council
Federal Financing Bank 12, VIII
Federal Highway Administration 23, I, II
Federal Home Loan Mortgage Corporation 1, IV
Federal Housing Enterprise Oversight Office 12, XVII
Federal Housing Finance Board 12, IX
Federal Labor Relations Authority, and General 5, XIV; 22, XIV
Counsel of the Federal Labor Relations
Authority
Federal Law Enforcement Training Center 31, VII
Federal Management Regulation 41, 102
Federal Maritime Commission 46, IV
Federal Mediation and Conciliation Service 29, XII
Federal Mine Safety and Health Review Commission 5, LXXIV; 29, XXVII
Federal Motor Carrier Safety Administration 49, III
Federal Prison Industries, Inc. 28, III
Federal Procurement Policy Office 48, 99
Federal Property Management Regulations 41, 101
Federal Railroad Administration 49, II
Federal Register, Administrative Committee of 1, I
Federal Register, Office of 1, II
Federal Reserve System 12, II
Board of Governors 5, LVIII
Federal Retirement Thrift Investment Board 5, VI, LXXVI
Federal Service Impasses Panel 5, XIV
Federal Trade Commission 5, XLVII; 16, I
Federal Transit Administration 49, VI
Federal Travel Regulation System 41, Subtitle F
Fine Arts, Commission on 45, XXI
Fiscal Service 31, II
Fish and Wildlife Service, United States 50, I, IV
Fishery Conservation and Management 50, VI
Food and Drug Administration 21, I
Food and Nutrition Service 7, II
Food Safety and Inspection Service 9, III
Foreign Agricultural Service 7, XV
Foreign Assets Control, Office of 31, V
Foreign Claims Settlement Commission of the 45, V
United States
Foreign Service Grievance Board 22, IX
Foreign Service Impasse Disputes Panel 22, XIV
Foreign Service Labor Relations Board 22, XIV
Foreign-Trade Zones Board 15, IV
Forest Service 36, II
General Accounting Office 4, I
General Services Administration 5, LVII; 41, 105
Contract Appeals, Board of 48, 61
Federal Acquisition Regulation 48, 5
[[Page 761]]
Federal Management Regulation 41, 102
Federal Property Management Regulations 41, 101
Federal Travel Regulation System 41, Subtitle F
General 41, 300
Payment From a Non-Federal Source for Travel 41, 304
Expenses
Payment of Expenses Connected With the Death 41, 303
of Certain Employees
Relocation Allowances 41, 302
Temporary Duty (TDY) Travel Allowances 41, 301
Geological Survey 30, IV
Government Ethics, Office of 5, XVI
Government National Mortgage Association 24, III
Grain Inspection, Packers and Stockyards 7, VIII; 9, II
Administration
Harry S. Truman Scholarship Foundation 45, XVIII
Health and Human Services, Department of 5, XLV; 45, Subtitle A
Centers for Medicare & Medicaid Services 42, IV
Child Support Enforcement, Office of 45, III
Children and Families, Administration for 45, II, III, IV, X
Community Services, Office of 45, X
Family Assistance, Office of 45, II
Federal Acquisition Regulation 48, 3
Food and Drug Administration 21, I
Human Development Services, Office of 45, XIII
Indian Health Service 25, V; 42, I
Inspector General (Health Care), Office of 42, V
Public Health Service 42, I
Refugee Resettlement, Office of 45, IV
Homeland Security, Department of 6, I
Coast Guard 33, I; 46, I; 49, IV
Coast Guard (Great Lakes Pilotage) 46, III
Customs and Border Protection Bureau 19, I
Federal Emergency Management Agency 44, I
Immigration and Customs Enforcement Bureau 19, IV
Immigration and Naturalization 8, I
Transportation Security Administration 49, XII
Housing and Urban Development, Department of 5, LXV; 24, Subtitle B
Community Planning and Development, Office of 24, V, VI
Assistant Secretary for
Equal Opportunity, Office of Assistant 24, I
Secretary for
Federal Acquisition Regulation 48, 24
Federal Housing Enterprise Oversight, Office 12, XVII
of
Government National Mortgage Association 24, III
Housing--Federal Housing Commissioner, Office 24, II, VIII, X, XX
of Assistant Secretary for
Housing, Office of, and Multifamily Housing 24, IV
Assistance Restructuring, Office of
Inspector General, Office of 24, XII
Public and Indian Housing, Office of Assistant 24, IX
Secretary for
Secretary, Office of 24, Subtitle A, VII
Housing--Federal Housing Commissioner, Office of 24, II, VIII, X, XX
Assistant Secretary for
Housing, Office of, and Multifamily Housing 24, IV
Assistance Restructuring, Office of
Human Development Services, Office of 45, XIII
Immigration and Customs Enforcement Bureau 19, IV
Immigration and Naturalization 8, I
Immigration Review, Executive Office for 8, V
Independent Counsel, Office of 28, VII
Indian Affairs, Bureau of 25, I, V
Indian Affairs, Office of the Assistant 25, VI
Secretary
Indian Arts and Crafts Board 25, II
Indian Health Service 25, V; 42, I
Industry and Security, Bureau of 15, VII
Information Resources Management, Office of 7, XXVII
Information Security Oversight Office, National 32, XX
Archives and Records Administration
Inspector General
[[Page 762]]
Agriculture Department 7, XXVI
Health and Human Services Department 42, V
Housing and Urban Development Department 24, XII
Institute of Peace, United States 22, XVII
Inter-American Foundation 5, LXIII; 22, X
Interior Department
American Indians, Office of the Special 25, VII
Trustee
Endangered Species Committee 50, IV
Federal Acquisition Regulation 48, 14
Federal Property Management Regulations System 41, 114
Fish and Wildlife Service, United States 50, I, IV
Geological Survey 30, IV
Indian Affairs, Bureau of 25, I, V
Indian Affairs, Office of the Assistant 25, VI
Secretary
Indian Arts and Crafts Board 25, II
Land Management, Bureau of 43, II
Minerals Management Service 30, II
National Indian Gaming Commission 25, III
National Park Service 36, I
Reclamation, Bureau of 43, I
Secretary of the Interior, Office of 43, Subtitle A
Surface Mining and Reclamation Appeals, Board 30, III
of
Surface Mining Reclamation and Enforcement, 30, VII
Office of
Internal Revenue Service 26, I
International Boundary and Water Commission, 22, XI
United States and Mexico, United States
Section
International Development, United States Agency 22, II
for
Federal Acquisition Regulation 48, 7
International Development Cooperation Agency, 22, XII
United States
International Fishing and Related Activities 50, III
International Investment, Office of 31, VIII
International Joint Commission, United States 22, IV
and Canada
International Organizations Employees Loyalty 5, V
Board
International Trade Administration 15, III; 19, III
International Trade Commission, United States 19, II
Interstate Commerce Commission 5, XL
James Madison Memorial Fellowship Foundation 45, XXIV
Japan-United States Friendship Commission 22, XVI
Joint Board for the Enrollment of Actuaries 20, VIII
Justice Department 5, XXVIII; 28, I, XI; 40,
IV
Alcohol, Tobacco, Firearms, and Explosives, 27, II
Bureau of
Drug Enforcement Administration 21, II
Federal Acquisition Regulation 48, 28
Federal Claims Collection Standards 31, IX
Federal Prison Industries, Inc. 28, III
Foreign Claims Settlement Commission of the 45, V
United States
Immigration Review, Executive Office for 8, V
Offices of Independent Counsel 28, VI
Prisons, Bureau of 28, V
Property Management Regulations 41, 128
Labor Department 5, XLII
Benefits Review Board 20, VII
Employee Benefits Security Administration 29, XXV
Employees' Compensation Appeals Board 20, IV
Employment and Training Administration 20, V
Employment Standards Administration 20, VI
Federal Acquisition Regulation 48, 29
Federal Contract Compliance Programs, Office 41, 60
of
Federal Procurement Regulations System 41, 50
Labor-Management Standards, Office of 29, II, IV
Mine Safety and Health Administration 30, I
Occupational Safety and Health Administration 29, XVII
Public Contracts 41, 50
Secretary of Labor, Office of 29, Subtitle A
[[Page 763]]
Veterans' Employment and Training Service, 41, 61; 20, IX
Office of the Assistant Secretary for
Wage and Hour Division 29, V
Workers' Compensation Programs, Office of 20, I
Labor-Management Standards, Office of 29, II, IV
Land Management, Bureau of 43, II
Legal Services Corporation 45, XVI
Library of Congress 36, VII
Copyright Office 37, II
Local Television Loan Guarantee Board 7, XX
Management and Budget, Office of 5, III, LXXVII; 14, VI;
48, 99
Marine Mammal Commission 50, V
Maritime Administration 46, II
Merit Systems Protection Board 5, II
Micronesian Status Negotiations, Office for 32, XXVII
Mine Safety and Health Administration 30, I
Minerals Management Service 30, II
Minority Business Development Agency 15, XIV
Miscellaneous Agencies 1, IV
Monetary Offices 31, I
Morris K. Udall Scholarship and Excellence in 36, XVI
National Environmental Policy Foundation
National Aeronautics and Space Administration 5, LIX; 14, V
Federal Acquisition Regulation 48, 18
National Agricultural Library 7, XLI
National Agricultural Statistics Service 7, XXXVI
National and Community Service, Corporation for 45, XII, XXV
National Archives and Records Administration 5, LXVI; 36, XII
Information Security Oversight Office 32, XX
National Bureau of Standards 15, II
National Capital Planning Commission 1, IV
National Commission for Employment Policy 1, IV
National Commission on Libraries and Information 45, XVII
Science
National Council on Disability 34, XII
National Counterintelligence Center 32, XVIII
National Credit Union Administration 12, VII
National Crime Prevention and Privacy Compact 28, IX
Council
National Drug Control Policy, Office of 21, III
National Foundation on the Arts and the 45, XI
Humanities
National Highway Traffic Safety Administration 23, II, III; 49, V
National Imagery and Mapping Agency 32, I
National Indian Gaming Commission 25, III
National Institute for Literacy 34, XI
National Institute of Standards and Technology 15, II
National Labor Relations Board 5, LXI; 29, I
National Marine Fisheries Service 50, II, IV, VI
National Mediation Board 29, X
National Oceanic and Atmospheric Administration 15, IX; 50, II, III, IV,
VI
National Park Service 36, I
National Railroad Adjustment Board 29, III
National Railroad Passenger Corporation (AMTRAK) 49, VII
National Science Foundation 5, XLIII; 45, VI
Federal Acquisition Regulation 48, 25
National Security Council 32, XXI
National Security Council and Office of Science 47, II
and Technology Policy
National Telecommunications and Information 15, XXIII; 47, III
Administration
National Transportation Safety Board 49, VIII
National Weather Service 15, IX
Natural Resources Conservation Service 7, VI
Navajo and Hopi Indian Relocation, Office of 25, IV
Navy Department 32, VI
Federal Acquisition Regulation 48, 52
Neighborhood Reinvestment Corporation 24, XXV
Northeast Interstate Low-Level Radioactive Waste 10, XVIII
Commission
[[Page 764]]
Nuclear Regulatory Commission 5, XLVIII; 10, I
Federal Acquisition Regulation 48, 20
Occupational Safety and Health Administration 29, XVII
Occupational Safety and Health Review Commission 29, XX
Offices of Independent Counsel 28, VI
Oklahoma City National Memorial Trust 36, XV
Operations Office 7, XXVIII
Overseas Private Investment Corporation 5, XXXIII; 22, VII
Panama Canal Commission 48, 35
Panama Canal Regulations 35, I
Patent and Trademark Office, United States 37, I
Payment From a Non-Federal Source for Travel 41, 304
Expenses
Payment of Expenses Connected With the Death of 41, 303
Certain Employees
Peace Corps 22, III
Pennsylvania Avenue Development Corporation 36, IX
Pension Benefit Guaranty Corporation 29, XL
Personnel Management, Office of 5, I, XXXV; 45, VIII
Federal Acquisition Regulation 48, 17
Federal Employees Group Life Insurance Federal 48, 21
Acquisition Regulation
Federal Employees Health Benefits Acquisition 48, 16
Regulation
Postal Rate Commission 5, XLVI; 39, III
Postal Service, United States 5, LX; 39, I
Postsecondary Education, Office of 34, VI
President's Commission on White House 1, IV
Fellowships
Presidential Documents 3
Presidio Trust 36, X
Prisons, Bureau of 28, V
Procurement and Property Management, Office of 7, XXXII
Productivity, Technology and Innovation, 37, IV
Assistant Secretary
Public Contracts, Department of Labor 41, 50
Public and Indian Housing, Office of Assistant 24, IX
Secretary for
Public Health Service 42, I
Railroad Retirement Board 20, II
Reclamation, Bureau of 43, I
Refugee Resettlement, Office of 45, IV
Regional Action Planning Commissions 13, V
Relocation Allowances 41, 302
Research and Special Programs Administration 49, I
Rural Business-Cooperative Service 7, XVIII, XLII
Rural Development Administration 7, XLII
Rural Housing Service 7, XVIII, XXXV
Rural Telephone Bank 7, XVI
Rural Utilities Service 7, XVII, XVIII, XLII
Saint Lawrence Seaway Development Corporation 33, IV
Science and Technology Policy, Office of 32, XXIV
Science and Technology Policy, Office of, and 47, II
National Security Council
Secret Service 31, IV
Securities and Exchange Commission 17, II
Selective Service System 32, XVI
Small Business Administration 13, I
Smithsonian Institution 36, V
Social Security Administration 20, III; 48, 23
Soldiers' and Airmen's Home, United States 5, XI
Special Counsel, Office of 5, VIII
Special Education and Rehabilitative Services, 34, III
Office of
State Department 22, I; 28, XI
Federal Acquisition Regulation 48, 6
Surface Mining and Reclamation Appeals, Board of 30, III
Surface Mining Reclamation and Enforcement, 30, VII
Office of
Surface Transportation Board 49, X
Susquehanna River Basin Commission 18, VIII
Technology Administration 15, XI
Technology Policy, Assistant Secretary for 37, IV
[[Page 765]]
Technology, Under Secretary for 37, V
Tennessee Valley Authority 5, LXIX; 18, XIII
Thrift Supervision Office, Department of the 12, V
Treasury
Trade Representative, United States, Office of 15, XX
Transportation, Department of 5, L
Commercial Space Transportation 14, III
Contract Appeals, Board of 48, 63
Emergency Management and Assistance 44, IV
Federal Acquisition Regulation 48, 12
Federal Aviation Administration 14, I
Federal Highway Administration 23, I, II
Federal Motor Carrier Safety Administration 49, III
Federal Railroad Administration 49, II
Federal Transit Administration 49, VI
Maritime Administration 46, II
National Highway Traffic Safety Administration 23, II, III; 49, V
Research and Special Programs Administration 49, I
Saint Lawrence Seaway Development Corporation 33, IV
Secretary of Transportation, Office of 14, II; 49, Subtitle A
Surface Transportation Board 49, X
Transportation Statistics Bureau 49, XI
Transportation, Office of 7, XXXIII
Transportation Security Administration 49, XII
Transportation Statistics Bureau 49, XI
Travel Allowances, Temporary Duty (TDY) 41, 301
Treasury Department 5, XXI; 12, XV; 17, IV;
31, IX
Alcohol and Tobacco Tax and Trade Bureau 27, I
Community Development Financial Institutions 12, XVIII
Fund
Comptroller of the Currency 12, I
Customs and Border Protection Bureau 19, I
Engraving and Printing, Bureau of 31, VI
Federal Acquisition Regulation 48, 10
Federal Law Enforcement Training Center 31, VII
Fiscal Service 31, II
Foreign Assets Control, Office of 31, V
Internal Revenue Service 26, I
International Investment, Office of 31, VIII
Monetary Offices 31, I
Secret Service 31, IV
Secretary of the Treasury, Office of 31, Subtitle A
Thrift Supervision, Office of 12, V
Truman, Harry S. Scholarship Foundation 45, XVIII
United States and Canada, International Joint 22, IV
Commission
United States and Mexico, International Boundary 22, XI
and Water Commission, United States Section
Utah Reclamation Mitigation and Conservation 43, III
Commission
Veterans Affairs Department 38, I
Federal Acquisition Regulation 48, 8
Veterans' Employment and Training Service, 41, 61; 20, IX
Office of the Assistant Secretary for
Vice President of the United States, Office of 32, XXVIII
Vocational and Adult Education, Office of 34, IV
Wage and Hour Division 29, V
Water Resources Council 18, VI
Workers' Compensation Programs, Office of 20, I
World Agricultural Outlook Board 7, XXXVIII
[[Page 767]]
Table Of OMB Control Numbers
The OMB control numbers for chapter I of title 26 were consolidated into
Sec. Sec. 601.9000 and 602.101 at 50 FR 10221, Mar. 14, 1985. At 61 FR
58008, Nov. 12, 1996, Sec. 601.9000 was removed. Section 602.101 is
reprinted below for the convenience of the user.
PART 602_OMB CONTROL NUMBERS UNDER THE PAPERWORK REDUCTION ACT
Sec. 602.101 OMB Control numbers.
(a) Purpose. This part collects and displays the controlnumbers
assigned to collections of information in Internal Revenue Service
regulations by the Office of Management and Budget (OMB) under the
Paperwork Reduction Act of 1980. The Internal Revenue Service intends
that this part comply with the requirements of Sec. Sec. 1320.7(f),
1320.12, 1320.13, and 1320.14 of 5 CFR part 1320 (OMB regulations
implementing the Paperwork Reduction Act), for the display of control
numbers assigned by OMB to collections of information in Internal
Revenue Service regulations. This part does not display control numbers
assigned by the Office of Management and Budget to collections of
information of the Bureau of Alcohol, Tobacco, and Firearms.
(b) Display.
------------------------------------------------------------------------
Current OMB
CFR part or section where identified and described control No.
------------------------------------------------------------------------
1.1(h)-1(e)................................................ 1545-1654
1.23-5..................................................... 1545-0074
1.25-1T.................................................... 1545-0922
1545-0930
1.25-2T.................................................... 1545-0922
1545-0930
1.25-3T.................................................... 1545-0922
1545-0930
1.25-4T.................................................... 1545-0922
1.25-5T.................................................... 1545-0922
1.25-6T.................................................... 1545-0922
1.25-7T.................................................... 1545-0922
1.25-8T.................................................... 1545-0922
1.25A-1.................................................... 1545-1630
1.28-1..................................................... 1545-0619
1.31-2..................................................... 1545-0074
1.32-2..................................................... 1545-0074
1.32-3..................................................... 1545-1575
1.37-1..................................................... 1545-0074
1.37-3..................................................... 1545-0074
1.41-2..................................................... 1545-0619
1.41-3..................................................... 1545-0619
1.41-4A.................................................... 1545-0074
1.41-4 (b) and (c)......................................... 1545-0074
1.41-8(b).................................................. 1545-1625
1.41-8(d).................................................. 1545-0732
1.41-9..................................................... 1545-0619
1.42-1T.................................................... 1545-0984
1545-0988
1.42-2..................................................... 1545-1005
1.42-5..................................................... 1545-1357
1.42-6..................................................... 1545-1102
1.42-8..................................................... 1545-1102
1.42-10.................................................... 1545-1102
1.42-13.................................................... 1545-1357
1.42-14.................................................... 1545-1423
1.42-17.................................................... 1545-1357
1.43-3(a)(3)............................................... 1545-1292
1.43-3(b)(3)............................................... 1545-1292
1.44A-1.................................................... 1545-0068
1.44A-3.................................................... 1545-0074
1.44B-1.................................................... 1545-0219
1.45D-1T................................................... 1545-1765
1.46-1..................................................... 1545-0123
1545-0155
1.46-3..................................................... 1545-0155
1.46-4..................................................... 1545-0155
1.46-5..................................................... 1545-0155
1.46-6..................................................... 1545-0155
1.46-8..................................................... 1545-0155
1.46-9..................................................... 1545-0155
1.46-10.................................................... 1545-0118
1.46-11.................................................... 1545-0155
1.47-1..................................................... 1545-0166
1545-0155
1.47-3..................................................... 1545-0166
1545-0155
1.47-4..................................................... 1545-0123
1.47-5..................................................... 1545-0092
1.47-6..................................................... 1545-0099
1.48-3..................................................... 1545-0155
1.48-4..................................................... 1545-0808
1545-0155
1.48-5..................................................... 1545-0155
1.48-6..................................................... 1545-0155
1.48-12.................................................... 1545-0155
1545-1783
1.50A-1.................................................... 1545-0895
1.50A-2.................................................... 1545-0895
1.50A-3.................................................... 1545-0895
1.50A-4.................................................... 1545-0895
1.50A-5.................................................... 1545-0895
1.50A-6.................................................... 1545-0895
1.50A-7.................................................... 1545-0895
1.50B-1.................................................... 1545-0895
1.50B-2.................................................... 1545-0895
1.50B-3.................................................... 1545-0895
[[Page 768]]
1.50B-4.................................................... 1545-0895
1.50B-5.................................................... 1545-0895
1.51-1..................................................... 1545-0219
1545-0241
1545-0244
1545-0797
1.52-2..................................................... 1545-0219
1.52-3..................................................... 1545-0219
1.56-1..................................................... 1545-0123
1.56(g)-1.................................................. 1545-1233
1.56A-1.................................................... 1545-0227
1.56A-2.................................................... 1545-0227
1.56A-3.................................................... 1545-0227
1.56A-4.................................................... 1545-0227
1.56A-5.................................................... 1545-0227
1.57-5..................................................... 1545-0227
1.58-1..................................................... 1545-0175
1.58-9(c)(5)(iii)(B)....................................... 1545-1093
1.58-9(e)(3)............................................... 1545-1093
1.61-2..................................................... 1545-0771
1.61-2T.................................................... 1545-0771
1.61-4..................................................... 1545-0187
1.61-15.................................................... 1545-0074
1.62-2..................................................... 1545-1148
1.63-1..................................................... 1545-0074
1.66-4..................................................... 1545-1770
1.67-2T.................................................... 1545-0110
1.67-3T.................................................... 1545-0118
1.67-3..................................................... 1545-1018
1.71-1T.................................................... 1545-0074
1.72-4..................................................... 1545-0074
1.72-6..................................................... 1545-0074
1.72-9..................................................... 1545-0074
1.72-17.................................................... 1545-0074
1.72-17A................................................... 1545-0074
1.72-18.................................................... 1545-0074
1.74-1..................................................... 1545-1100
1.79-2..................................................... 1545-0074
1.79-3..................................................... 1545-0074
1.83-2..................................................... 1545-0074
1.83-5..................................................... 1545-0074
1.83-6..................................................... 1545-1448
1.103-10................................................... 1545-0123
1545-0940
1.103-15AT................................................. 1545-0720
1.103-18................................................... 1545-1226
1.103(n)-2T................................................ 1545-0874
1.103(n)-4T................................................ 1545-0874
1.103A-2................................................... 1545-0720
1.105-4.................................................... 1545-0074
1.105-5.................................................... 1545-0074
1.105-6.................................................... 1545-0074
1.108-4.................................................... 1545-1539
1.108-5.................................................... 1545-1421
1.110-1.................................................... 1545-1661
1.117-5.................................................... 1545-0869
1.118-2.................................................... 1545-1639
1.119-1.................................................... 1545-0067
1.120-3.................................................... 1545-0057
1.121-1.................................................... 1545-0072
1.121-2.................................................... 1545-0072
1.121-3.................................................... 1545-0072
1.121-4.................................................... 1545-0072
1545-0091
1.121-5.................................................... 1545-0072
1.127-2.................................................... 1545-0768
1.132-1T................................................... 1545-0771
1.132-2.................................................... 1545-0771
1.132-2T................................................... 1545-0771
1.132-5.................................................... 1545-0771
1.132-5T................................................... 1545-0771
1545-1098
1.132-9(b)................................................. 1545-1676
1.141-1.................................................... 1545-1451
1.141-12................................................... 1545-1451
1.142-2.................................................... 1545-1451
1.142(f)(4)-1.............................................. 1545-1730
1.148-0.................................................... 1545-1098
1.148-1.................................................... 1545-1098
1.148-2.................................................... 1545-1098
1545-1347
1.148-3.................................................... 1545-1098
1545-1347
1.148-4.................................................... 1545-1098
1545-1347
1.148-5.................................................... 1545-1098
1545-1490
1.148-6.................................................... 1545-1098
1545-1451
1.148-7.................................................... 1545-1098
1545-1347
1.148-8.................................................... 1545-1098
1.148-11................................................... 1545-1098
1545-1347
1.149(e)-1................................................. 1545-0720
1.150-1.................................................... 1545-1347
1.151-1.................................................... 1545-0074
1.152-3.................................................... 1545-0071
1545-1783
1.152-4.................................................... 1545-0074
1.152-4T................................................... 1545-0074
1.162-1.................................................... 1545-0139
1.162-2.................................................... 1545-0139
1.162-3.................................................... 1545-0139
1.162-4.................................................... 1545-0139
1.162-5.................................................... 1545-0139
1.162-6.................................................... 1545-0139
1.162-7.................................................... 1545-0139
1.162-8.................................................... 1545-0139
1.162-9.................................................... 1545-0139
1.162-10................................................... 1545-0139
1.162-11................................................... 1545-0139
1.162-12................................................... 1545-0139
1.162-13................................................... 1545-0139
1.162-14................................................... 1545-0139
1.162-15................................................... 1545-0139
1.162-16................................................... 1545-0139
1.162-17................................................... 1545-0139
1.162-18................................................... 1545-0139
1.162-19................................................... 1545-0139
1.162-20................................................... 1545-0139
1.162-27................................................... 1545-1466
1.163-5.................................................... 1545-0786
1545-1132
1.163-8T................................................... 1545-0995
1.163-10T.................................................. 1545-0074
1.163-13................................................... 1545-1491
1.163(d)-1................................................. 1545-1421
1.165-1.................................................... 1545-0177
1.165-2.................................................... 1545-0177
1.165-3.................................................... 1545-0177
1.165-4.................................................... 1545-0177
1.165-5.................................................... 1545-0177
1.165-6.................................................... 1545-0177
1.165-7.................................................... 1545-0177
1.165-8.................................................... 1545-0177
1.165-9.................................................... 1545-0177
1.165-10................................................... 1545-0177
1.165-11................................................... 1545-0074
1545-0177
1545-0786
1.165-12................................................... 1545-0786
1.166-1.................................................... 1545-0123
1.166-2.................................................... 1545-1254
[[Page 769]]
1.166-4.................................................... 1545-0123
1.166-10................................................... 1545-0123
1.167(a)-5T................................................ 1545-1021
1.167(a)-7................................................. 1545-0172
1.167(a)-11................................................ 1545-0152
1545-0172
1.167(a)-12................................................ 1545-0172
1.167(d)-1................................................. 1545-0172
1.167(e)-1................................................. 1545-0172
1.167(f)-11................................................ 1545-0172
1.167(l)-1................................................. 1545-0172
1.168(d)-1................................................. 1545-1146
1.168(f)(8)-1T............................................. 1545-0923
1.168(i)-1................................................. 1545-1331
1.168-5.................................................... 1545-0172
1.169-4.................................................... 1545-0172
1.170-1.................................................... 1545-0074
1.170-2.................................................... 1545-0074
1.170-3.................................................... 1545-0123
1.170A-1................................................... 1545-0074
1.170A-2................................................... 1545-0074
1.170A-4(A)(b)............................................. 1545-0123
1.170A-8................................................... 1545-0074
1.170A-9................................................... 1545-0052
1545-0074
1.170A-11.................................................. 1545-0123
1545-0074
1.170A-11T................................................. 1545-1868
1.170A-12.................................................. 1545-0020
1545-0074
1.170A-13.................................................. 1545-0074
1545-0754
1545-0908
1545-1431
1.170A-13(f)............................................... 1545-1464
1.170A-14.................................................. 1545-0763
1.171-4.................................................... 1545-1491
1.171-5.................................................... 1545-1491
1.172-1.................................................... 1545-0172
1.172-13................................................... 1545-0863
1.173-1.................................................... 1545-0172
1.174-3.................................................... 1545-0152
1.174-4.................................................... 1545-0152
1.175-3.................................................... 1545-0187
1.175-6.................................................... 1545-0152
1.177-1.................................................... 1545-0172
1.179-2.................................................... 1545-1201
1.179-3.................................................... 1545-1201
1.179-5.................................................... 1545-0172
1.180-2.................................................... 1545-0074
1.182-6.................................................... 1545-0074
1.183-1.................................................... 1545-0195
1.183-2.................................................... 1545-0195
1.183-3.................................................... 1545-0195
1.183-4.................................................... 1545-0195
1.190-3.................................................... 1545-0074
1.194-2.................................................... 1545-0735
1.194-4.................................................... 1545-0735
1.195-1.................................................... 1545-1582
1.197-1T................................................... 1545-1425
1.197-2.................................................... 1545-1671
1.213-1.................................................... 1545-0074
1.215-1T................................................... 1545-0074
1.217-2.................................................... 1545-0182
1.243-3.................................................... 1545-0123
1.243-4.................................................... 1545-0123
1.243-5.................................................... 1545-0123
1.248-1.................................................... 1545-0172
1.261-1.................................................... 1545-1041
1.263(a)-5................................................. 1545-1870
1.263(e)-1................................................. 1545-0123
1.263A-1................................................... 1545-0987
1.263A-1T.................................................. 1545-0187
1.263A-2................................................... 1545-0987
1.263A-3................................................... 1545-0987
1545-0987
1.263A-8(b)(2)(iii)........................................ 1545-1265
1.263A-9(d)(1)............................................. 1545-1265
1.263A-9(f)(1)(ii)......................................... 1545-1265
1.263A-9(f)(2)(iv)......................................... 1545-1265
1.263A-9(g)(2)(iv)(C)...................................... 1545-1265
1.263A-9(g)(3)(iv)......................................... 1545-1265
1.265-1.................................................... 1545-0074
1.265-2.................................................... 1545-0123
1.266-1.................................................... 1545-0123
1.267(f)-1................................................. 1545-0885
1.268-1.................................................... 1545-0184
1.274-1.................................................... 1545-0139
1.274-2.................................................... 1545-0139
1.274-3.................................................... 1545-0139
1.274-4.................................................... 1545-0139
1.274-5.................................................... 1545-0771
1.274-5A................................................... 1545-0139
1545-0771
1.274-5T................................................... 1545-0074
1545-0172
1545-0771
1.274-6.................................................... 1545-0139
1545-0771
1.274-6T................................................... 1545-0074
1545-0771
1.274-7.................................................... 1545-0139
1.274-8.................................................... 1545-0139
1.279-6.................................................... 1545-0123
1.280C-4................................................... 1545-1155
1.280F-3T.................................................. 1545-0074
1.280G-1................................................... 1545-1851
1.281-4.................................................... 1545-0123
1.302-4.................................................... 1545-0074
1.305-3.................................................... 1545-0123
1.305-5.................................................... 1545-1438
1.307-2.................................................... 1545-0074
1.312-15................................................... 1545-0172
1.316-1.................................................... 1545-0123
1.331-1.................................................... 1545-0074
1.332-4.................................................... 1545-0123
1.332-6.................................................... 1545-0123
1.337(d)-1................................................. 1545-1160
1.337(d)-2................................................. 1545-1160
1.337(d)-2T................................................ 1545-1774
1.337(d)-4................................................. 1545-1633
1.337(d)-5................................................. 1545-1672
1.337(d)-6................................................. 1545-1672
1.337(d)-7................................................. 1545-1672
1.338-2.................................................... 1545-1658
1.338-5.................................................... 1545-1658
1.338-10................................................... 1545-1658
1.338(h)(10)-1............................................. 1545-1658
1.341-7.................................................... 1545-0123
1.351-3.................................................... 1545-0074
1.355-5.................................................... 1545-0123
1.362-2.................................................... 1545-0123
1.367(a)-1T................................................ 1545-0026
1.367(a)-2T................................................ 1545-0026
1.367(a)-3................................................. 1545-0026
1545-1478
1.367(a)-6T................................................ 1545-0026
1.367(a)-8................................................. 1545-1271
1.367(b)-1................................................. 1545-1271
1.367(b)-3T................................................ 1545-1666
1.367(d)-1T................................................ 1545-0026
1.367(e)-1................................................. 1545-1487
1.367(e)-2................................................. 1545-1487
1.368-1.................................................... 1545-1691
[[Page 770]]
1.368-3.................................................... 1545-0123
1.371-1.................................................... 1545-0123
1.371-2.................................................... 1545-0123
1.374-3.................................................... 1545-0123
1.381(b)-1................................................. 1545-0123
1.381(c)(4)-1.............................................. 1545-0123
1545-0152
1545-0879
1.381(c)(5)-1.............................................. 1545-0123
1545-0152
1.381(c)(6)-1.............................................. 1545-0123
1545-0152
1.381(c)(8)-1.............................................. 1545-0123
1.381(c)(10)-1............................................. 1545-0123
1.381(c)(11)-1(k).......................................... 1545-0123
1.381(c)(13)-1............................................. 1545-0123
1.381(c)(17)-1............................................. 1545-0045
1.381(c)(25)-1............................................. 1545-0045
1.382-1T................................................... 1545-0123
1.382-2.................................................... 1545-0123
1.382-2T................................................... 1545-0123
1.382-3.................................................... 1545-1281
1545-1345
1.382-4.................................................... 1545-1120
1.382-6.................................................... 1545-1381
1.382-8.................................................... 1545-1434
1.382-9.................................................... 1545-1260
1545-1120
1545-1275
1545-1324
1.382-91................................................... 1545-1260
1545-1324
1.383-1.................................................... 1545-0074
1545-1120
1.401(a)-11................................................ 1545-0710
1.401(a)-20................................................ 1545-0928
1.401(a)-31................................................ 1545-1341
1.401(a)-50................................................ 1545-0710
1.401(a)(31)-1............................................. 1545-1341
1.401(b)-1................................................. 1545-0197
1.401(f)-1................................................. 1545-0710
1.401(k)-1................................................. 1545-1039
1545-1069
1.401-1.................................................... 1545-0020
1545-0197
1545-0200
1545-0534
1545-0710
1.401(a)(9)-1.............................................. 1545-1573
1.401(a)(9)-3.............................................. 1545-1466
1.401(a)(9)-4.............................................. 1545-1573
1.401-12(n)................................................ 1545-0806
1.401-14................................................... 1545-0710
1.402(c)-2................................................. 1545-1341
1.402(f)-1................................................. 1545-1341
1545-1632
1.403(b)-1................................................. 1545-0710
1.403(b)-2................................................. 1545-1341
1.403(b)-3................................................. 1545-0996
1.404(a)-4................................................. 1545-0710
1.404(a)-12................................................ 1545-0710
1.404A-2................................................... 1545-0123
1.404A-6................................................... 1545-0123
1.408-2.................................................... 1545-0390
1.408-5.................................................... 1545-0747
1.408-6.................................................... 1545-0203
1545-0390
1.408-7.................................................... 1545-0119
1.408A-2................................................... 1545-1616
1.408A-4................................................... 1545-1616
1.408A-5................................................... 1545-1616
1.408A-7................................................... 1545-1616
1.410(a)-2................................................. 1545-0710
1.410(d)-1................................................. 1545-0710
1.411(a)-11................................................ 1545-1471
1545-1632
1.411(d)-4................................................. 1545-1545
1.411(d)-6................................................. 1545-1477
1.412(b)-5................................................. 1545-0710
1.412(c)(1)-2.............................................. 1545-0710
1.412(c)(2)-1.............................................. 1545-0710
1.412(c)(3)-2.............................................. 1545-0710
1.414(c)-5................................................. 1545-0797
1.414(r)-1................................................. 1545-1221
1.415-2.................................................... 1545-0710
1.415-6.................................................... 1545-0710
1.417(a)(3)-1.............................................. 1545-0928
1.417(e)-1................................................. 1545-1471
1545-1724
1.417(e)-1T................................................ 1545-1471
1.419A(f)(6)-1............................................. 1545-1795
1.441-2.................................................... 1545-1748
1.442-1.................................................... 1545-0074
1545-0123
1545-0134
1545-0152
1545-1748
1.443-1.................................................... 1545-0123
1.444-3T................................................... 1545-1036
1.444-4.................................................... 1545-1591
1.446-1.................................................... 1545-0074
1545-0152
1.446-4(d)................................................. 1545-1412
1.448-1(g)................................................. 1545-0152
1.448-1(h)................................................. 1545-0152
1.448-1(i)................................................. 1545-0152
1.448-2T................................................... 1545-0152
1545-1855
1.451-1.................................................... 1545-0091
1.451-4.................................................... 1545-0123
1.451-5.................................................... 1545-0074
1.451-6.................................................... 1545-0074
1.451-7.................................................... 1545-0074
1.453-1.................................................... 1545-0152
1.453-2.................................................... 1545-0152
1.453-8.................................................... 1545-0152
1545-0228
1.453-10................................................... 1545-0152
1.453A-1................................................... 1545-0152
1545-1134
1.453A-2................................................... 1545-0152
1545-1134
1.453A-3................................................... 1545-0963
1.454-1.................................................... 1545-0074
1.455-2.................................................... 1545-0152
1.455-6.................................................... 1545-0123
1.456-2.................................................... 1545-0123
1.456-6.................................................... 1545-0123
1.456-7.................................................... 1545-0123
1.457-8.................................................... 1545-1580
1.458-1.................................................... 1545-0879
1.458-2.................................................... 1545-0152
1.460-1.................................................... 1545-1650
1.460-6.................................................... 1545-1031
1545-1572
1545-1732
1.461-1.................................................... 1545-0074
1.461-2.................................................... 1545-0096
1.461-4.................................................... 1545-0917
1.461-5.................................................... 1545-0917
1.463-1T................................................... 1545-0916
1.465-1T................................................... 1545-0712
1.466-1T................................................... 1545-0152
1.466-4.................................................... 1545-0152
[[Page 771]]
1.468A-3................................................... 1545-1269
1545-1378
1545-1511
1.468A-4................................................... 1545-0954
1.468A-7................................................... 1545-0954
1.468A-8................................................... 1545-1269
1.468B-1(j)................................................ 1545-1299
1.468B-2(k)................................................ 1545-1299
1.468B-2(l)................................................ 1545-1299
1.468B-3(b)................................................ 1545-1299
1.468B-3(e)................................................ 1545-1299
1.468B-5(b)................................................ 1545-1299
1.469-1.................................................... 1545-1008
1.469-2T................................................... 1545-0712
1545-1091
1.469-4T................................................... 1545-0985
1545-1037
1.469-7.................................................... 1545-1244
1.471-2.................................................... 1545-0123
1.471-5.................................................... 1545-0123
1.471-6.................................................... 1545-0123
1.471-8.................................................... 1545-0123
1.471-11................................................... 1545-0123
1545-0152
1.472-1.................................................... 1545-0042
1545-0152
1.472-2.................................................... 1545-0152
1.472-3.................................................... 1545-0042
1.472-5.................................................... 1545-0152
1.472-8.................................................... 1545-0028
1545-0042
1545-1767
1.475(b)-4................................................. 1545-1496
1.481-4.................................................... 1545-0152
1.481-5.................................................... 1545-0152
1.482-1.................................................... 1545-1364
1.482-4.................................................... 1545-1364
1.482-7.................................................... 1545-1364
1545-1794
1.501(a)-1................................................. 1545-0056
1545-0057
1.501(c)(3)-1.............................................. 1545-0056
1.501(c)(9)-5.............................................. 1545-0047
1.501(c)(17)-3............................................. 1545-0047
1.501(e)-1................................................. 1545-0814
1.503(c)-1................................................. 1545-0047
1545-0052
1.505(c)-1T................................................ 1545-0916
1.507-1.................................................... 1545-0052
1.507-2.................................................... 1545-0052
1.508-1.................................................... 1545-0052
1545-0056
1.509(a)-3................................................. 1545-0047
1.509(a)-5................................................. 1545-0047
1.509(c)-1................................................. 1545-0052
1.512(a)-1................................................. 1545-0687
1.512(a)-4................................................. 1545-0047
1545-0687
1.521-1.................................................... 1545-0051
1545-0058
1.527-2.................................................... 1545-0129
1.527-5.................................................... 1545-0129
1.527-6.................................................... 1545-0129
1.527-9.................................................... 1545-0129
1.528-8.................................................... 1545-0127
1.533-2.................................................... 1545-0123
1.534-2.................................................... 1545-0123
1.542-3.................................................... 1545-0123
1.545-2.................................................... 1545-0123
1.545-3.................................................... 1545-0123
1.547-2.................................................... 1545-0045
1545-0123
1.547-3.................................................... 1545-0123
1.551-4.................................................... 1545-0074
1.552-3.................................................... 1545-0099
1.552-4.................................................... 1545-0099
1.552-5.................................................... 1545-0099
1.556-2.................................................... 1545-0704
1.561-1.................................................... 1545-0044
1.561-2.................................................... 1545-0123
1.562-3.................................................... 1545-0123
1.563-2.................................................... 1545-0123
1.564-1.................................................... 1545-0123
1.565-1.................................................... 1545-0043
1545-0123
1.565-2.................................................... 1545-0043
1.565-3.................................................... 1545-0043
1.565-5.................................................... 1545-0043
1.565-6.................................................... 1545-0043
1.585-1.................................................... 1545-0123
1.585-3.................................................... 1545-0123
1.585-8.................................................... 1545-1290
1.586-2.................................................... 1545-0123
1.593-1.................................................... 1545-0123
1.593-6.................................................... 1545-0123
1.593-6A................................................... 1545-0123
1.593-7.................................................... 1545-0123
1.595-1.................................................... 1545-0123
1.597-2.................................................... 1545-1300
1.597-4.................................................... 1545-1300
1.597-6.................................................... 1545-1300
1.597-7.................................................... 1545-1300
1.611-2.................................................... 1545-0099
1.611-3.................................................... 1545-0007
1545-0099
1545-1784
1.612-4.................................................... 1545-0074
1.612-5.................................................... 1545-0099
1.613-3.................................................... 1545-0099
1.613-4.................................................... 1545-0099
1.613-6.................................................... 1545-0099
1.613-7.................................................... 1545-0099
1.613A-3................................................... 1545-0919
1.613A-3(e)................................................ 1545-1251
1.613A-3(l)................................................ 1545-0919
1.613A-5................................................... 1545-0099
1.613A-6................................................... 1545-0099
1.614-2.................................................... 1545-0099
1.614-3.................................................... 1545-0099
1.614-5.................................................... 1545-0099
1.614-6.................................................... 1545-0099
1.614-8.................................................... 1545-0099
1.617-1.................................................... 1545-0099
1.617-3.................................................... 1545-0099
1.617-4.................................................... 1545-0099
1.631-1.................................................... 1545-0007
1.631-2.................................................... 1545-0007
1.641(b)-2................................................. 1545-0092
1.642(c)-1................................................. 1545-0092
1.642(c)-2................................................. 1545-0092
1.642(c)-5................................................. 1545-0074
1.642(c)-6................................................. 1545-0020
1545-0074
1545-0092
1.642(g)-1................................................. 1545-0092
1.642(i)-1................................................. 1545-0092
1.645-1.................................................... 1545-1578
1.663(b)-2................................................. 1545-0092
1.664-1.................................................... 1545-0196
1.664-1(a)(7).............................................. 1545-1536
1.664-2.................................................... 1545-0196
1.664-3.................................................... 1545-0196
1.664-4.................................................... 1545-0020
1545-0196
[[Page 772]]
1.665(a)-0A through1.665(g)-2A............................. 1545-0192
1.666(d)-1A................................................ 1545-0092
1.671-4.................................................... 1545-1442
1.701-1.................................................... 1545-0099
1.702-1.................................................... 1545-0074
1.703-1.................................................... 1545-0099
1.704-2.................................................... 1545-1090
1.706-1.................................................... 1545-0099
1545-0074
1545-0134
1.706-1T................................................... 1545-0099
1.707-3(c)(2).............................................. 1545-1243
1.707-5(a)(7)(ii).......................................... 1545-1243
1.707-6(c)................................................. 1545-1243
1.707-8.................................................... 1545-1243
1.708-1.................................................... 1545-0099
1.732-1.................................................... 1545-0099
1545-1588
1.736-1.................................................... 1545-0074
1.743-1.................................................... 1545-0074
1545-1588
1.751-1.................................................... 1545-0074
1545-0099
1545-0941
1.752-5.................................................... 1545-1090
1.754-1.................................................... 1545-0099
1.755-1.................................................... 1545-0099
1.761-2.................................................... 1545-1338
1.801-1.................................................... 1545-0123
1545-0128
1.801-3.................................................... 1545-0123
1.801-5.................................................... 1545-0128
1.801-8.................................................... 1545-0128
1.804-4.................................................... 1545-0128
1.811-2.................................................... 1545-0128
1.812-2.................................................... 1545-0128
1.815-6.................................................... 1545-0128
1.818-4.................................................... 1545-0128
1.818-5.................................................... 1545-0128
1.818-8.................................................... 1545-0128
1.819-2.................................................... 1545-0128
1.821-1.................................................... 1545-1027
1.821-3.................................................... 1545-1027
1.821-4.................................................... 1545-1027
1.822-5.................................................... 1545-1027
1.822-6.................................................... 1545-1027
1.822-8.................................................... 1545-1027
1.822-9.................................................... 1545-1027
1.823-2.................................................... 1545-1027
1.823-5.................................................... 1545-1027
1.823-6.................................................... 1545-1027
1.825-1.................................................... 1545-1027
1.826-1.................................................... 1545-1027
1.826-2.................................................... 1545-1027
1.826-3.................................................... 1545-1027
1.826-4.................................................... 1545-1027
1.826-6.................................................... 1545-1027
1.831-3.................................................... 1545-0123
1.831-4.................................................... 1545-0123
1.832-4.................................................... 1545-1227
1.832-5.................................................... 1545-0123
1.848-2(g)(8).............................................. 1545-1287
1.848-2(h)(3).............................................. 1545-1287
1.848-2(i)(4).............................................. 1545-1287
1.851-2.................................................... 1545-1010
1.851-4.................................................... 1545-0123
1.852-1.................................................... 1545-0123
1.852-4.................................................... 1545-0123
1545-0145
1.852-6.................................................... 1545-0123
1545-0144
1.852-7.................................................... 1545-0074
1.852-9.................................................... 1545-0074
1545-0123
1545-0144
1545-0145
1545-1783
1.852-11................................................... 1545-1094
1.853-3.................................................... 1545-0123
1.853-4.................................................... 1545-0123
1.854-2.................................................... 1545-0123
1.855-1.................................................... 1545-0123
1.856-2.................................................... 1545-0123
1545-1004
1.856-6.................................................... 1545-0123
1.856-7.................................................... 1545-0123
1.856-8.................................................... 1545-0123
1.857-8.................................................... 1545-0123
1.857-9.................................................... 1545-0074
1.858-1.................................................... 1545-0123
1.860-2.................................................... 1545-0045
1.860-4.................................................... 1545-0045
1545-1054
1545-1057
1.860E-1................................................... 1545-1675
1.860E-2(a)(5)............................................. 1545-1276
1.860E-2(a)(7)............................................. 1545-1276
1.860E-2(b)(2)............................................. 1545-1276
1.861-2.................................................... 1545-0089
1.861-3.................................................... 1545-0089
1.861-8.................................................... 1545-0126
1.861-8(e)(6) and (g)...................................... 1545-1224
1.861-9T................................................... 1545-0121
1545-1072
1.861-18................................................... 1545-1594
1.863-1.................................................... 1545-1476
1.863-3.................................................... 1545-1476
1545-1556
1.863-3A................................................... 1545-0126
1.863-4.................................................... 1545-0126
1.863-7.................................................... 1545-0132
1.864-4.................................................... 1545-0126
1.871-1.................................................... 1545-0096
1.871-6.................................................... 1545-0795
1.871-7.................................................... 1545-0089
1.871-10................................................... 1545-0089
1545-0165
1.874-1.................................................... 1545-0089
1.881-4.................................................... 1545-1440
1.882-4.................................................... 1545-0126
1.883-1.................................................... 1545-1677
1.883-2.................................................... 1545-1677
1.883-3.................................................... 1545-1677
1.883-4.................................................... 1545-1677
1.883-5.................................................... 1545-1677
1.884-0.................................................... 1545-1070
1.884-1.................................................... 1545-1070
1.884-2.................................................... 1545-1070
1.884-2T................................................... 1545-0126
1545-1070
1.884-4.................................................... 1545-1070
1.884-5.................................................... 1545-1070
1.892-1T................................................... 1545-1053
1.892-2T................................................... 1545-1053
1.892-3T................................................... 1545-1053
1.892-4T................................................... 1545-1053
1.892-5T................................................... 1545-1053
1.892-6T................................................... 1545-1053
1.892-7T................................................... 1545-1053
1.897-2.................................................... 1545-0123
1545-0902
1.897-3.................................................... 1545-0123
1.897-5T................................................... 1545-0902
1.897-6T................................................... 1545-0902
[[Page 773]]
1.901-2.................................................... 1545-0746
1.901-2A................................................... 1545-0746
1.901-3.................................................... 1545-0122
1.902-1.................................................... 1545-0122
1545-1458
1.904-1.................................................... 1545-0121
1545-0122
1.904-2.................................................... 1545-0121
1545-0122
1.904-3.................................................... 1545-0121
1.904-4.................................................... 1545-0121
1.904-5.................................................... 1545-0121
1.904(f)-1................................................. 1545-0121
1545-0122
1.904(f)-2................................................. 1545-0121
1.904(f)-3................................................. 1545-0121
1.904(f)-4................................................. 1545-0121
1.904(f)-5................................................. 1545-0121
1.904(f)-6................................................. 1545-0121
1.904(f)-7................................................. 1545-1127
1.905-2.................................................... 1545-0122
1.905-3T................................................... 1545-1056
1.905-4T................................................... 1545-1056
1.905-5T................................................... 1545-1056
1.911-1.................................................... 1545-0067
1545-0070
1.911-2.................................................... 1545-0067
1545-0070
1.911-3.................................................... 1545-0067
1545-0070
1.911-4.................................................... 1545-0067
1545-0070
1.911-5.................................................... 1545-0067
1545-0070
1.911-6.................................................... 1545-0067
1545-0070
1.911-7.................................................... 1545-0067
1545-0070
1.913-13................................................... 1545-0067
1.921-1T................................................... 1545-0190
1545-0884
1545-0935
1545-0939
1.921-2.................................................... 1545-0884
1.921-3T................................................... 1545-0935
1.923-1T................................................... 1545-0935
1.924(a)-1T................................................ 1545-0935
1.925(a)-1T................................................ 1545-0935
1.925(b)-1T................................................ 1545-0935
1.926(a)-1T................................................ 1545-0935
1.927(a)-1T................................................ 1545-0935
1.927(b)-1T................................................ 1545-0935
1.927(d)-1................................................. 1545-0884
1.927(d)-2T................................................ 1545-0935
1.927(e)-1T................................................ 1545-0935
1.927(e)-2T................................................ 1545-0935
1.927(f)-1................................................. 1545-0884
1.931-1.................................................... 1545-0074
1545-0123
1.934-1.................................................... 1545-0782
1.935-1.................................................... 1545-0074
1545-0087
1545-0803
1.936-1.................................................... 1545-0215
1545-0217
1.936-4.................................................... 1545-0215
1.936-5.................................................... 1545-0704
1.936-6.................................................... 1545-0215
1.936-7.................................................... 1545-0215
1.936-10(c)................................................ 1545-1138
1.952-2.................................................... 1545-0126
1.953-2.................................................... 1545-0126
1.954-1.................................................... 1545-1068
1.954-2.................................................... 1545-1068
1.955-2.................................................... 1545-0123
1.955-3.................................................... 1545-0123
1.955A-2................................................... 1545-0755
1.955A-3................................................... 1545-0755
1.956-1.................................................... 1545-0704
1.956-2.................................................... 1545-0704
1.959-1.................................................... 1545-0704
1.959-2.................................................... 1545-0704
1.960-1.................................................... 1545-0122
1.962-2.................................................... 1545-0704
1.962-3.................................................... 1545-0704
1.962-4.................................................... 1545-0704
1.964-1.................................................... 1545-0126
1545-0704
1545-1072
1.964-3.................................................... 1545-0126
1.970-2.................................................... 1545-0126
1.985-2.................................................... 1545-1051
1545-1131
1.985-3.................................................... 1545-1051
1.988-0.................................................... 1545-1131
1.988-1.................................................... 1545-1131
1.988-2.................................................... 1545-1131
1.988-3.................................................... 1545-1131
1.988-4.................................................... 1545-1131
1.988-5.................................................... 1545-1131
1.992-1.................................................... 1545-0190
1545-0938
1.992-2.................................................... 1545-0190
1545-0884
1545-0938
1.992-3.................................................... 1545-0190
1545-0938
1.992-4.................................................... 1545-0190
1545-0938
1.993-3.................................................... 1545-0938
1.993-4.................................................... 1545-0938
1.994-1.................................................... 1545-0938
1.995-5.................................................... 1545-0938
1.1012-1................................................... 1545-0074
1545-1139
1.1014-4................................................... 1545-0184
1.1015-1................................................... 1545-0020
1.1017-1................................................... 1545-1539
1.1031(d)-1T............................................... 1545-1021
1.1033(a)-2................................................ 1545-0184
1.1033(g)-1................................................ 1545-0184
1.1034-1................................................... 1545-0072
1.1039-1................................................... 1545-0184
1.1041-1T.................................................. 1545-0074
1.1041-2................................................... 1545-1751
1.1042-1T.................................................. 1545-0916
1.1044(a)-1................................................ 1545-1421
1.1060-1................................................... 1545-1658
1.1071-1................................................... 1545-0184
1.1071-4................................................... 1545-0184
1.1081-4................................................... 1545-0028
1545-0046
1545-0123
1.1081-11.................................................. 1545-0074
1545-0123
1.1082-1................................................... 1545-0046
1.1082-2................................................... 1545-0046
1.1082-3................................................... 1545-0046
1545-0184
1.1082-4................................................... 1545-0046
1.1082-5................................................... 1545-0046
1.1082-6................................................... 1545-0046
1.1083-1................................................... 1545-0123
1.1092(b)-1T............................................... 1545-0644
[[Page 774]]
1.1092(b)-2T............................................... 1545-0644
1.1092(b)-3T............................................... 1545-0644
1.1092(b)-4T............................................... 1545-0644
1.1092(b)-5T............................................... 1545-0644
1.1211-1................................................... 1545-0074
1.1212-1................................................... 1545-0074
1.1221-2................................................... 1545-1480
1.1231-1................................................... 1545-0177
1545-0184
1.1231-2................................................... 1545-0177
1545-0184
1545-0074
1.1232-3................................................... 1545-0074
1.1237-1................................................... 1545-0184
1.1239-1................................................... 1545-0091
1.1242-1................................................... 1545-0184
1.1243-1................................................... 1545-0123
1.1244(e)-1................................................ 1545-0123
1545-1447
1.1245-1................................................... 1545-0184
1.1245-2................................................... 1545-0184
1.1245-3................................................... 1545-0184
1.1245-4................................................... 1545-0184
1.1245-5................................................... 1545-0184
1.1245-6................................................... 1545-0184
1.1247-1................................................... 1545-0122
1.1247-2................................................... 1545-0122
1.1247-4................................................... 1545-0122
1.1247-5................................................... 1545-0122
1.1248-7................................................... 1545-0074
1.1250-1................................................... 1545-0184
1.1250-2................................................... 1545-0184
1.1250-3................................................... 1545-0184
1.1250-4................................................... 1545-0184
1.1250-5................................................... 1545-0184
1.1251-1................................................... 1545-0184
1.1251-2................................................... 1545-0074
1545-0184
1.1251-3................................................... 1545-0184
1.1251-4................................................... 1545-0184
1.1252-1................................................... 1545-0184
1.1252-2................................................... 1545-0184
1.1254-1(c)(3)............................................. 1545-1352
1.1254-4................................................... 1545-1493
1.1254-5(d)(2)............................................. 1545-1352
1.1258-1................................................... 1545-1452
1.1272-3................................................... 1545-1353
1.1273-2(h)(2)............................................. 1545-1353
1.1274-3(d)................................................ 1545-1353
1.1274-5(b)................................................ 1545-1353
1.1274A-1(c)............................................... 1545-1353
1.1275-2................................................... 1545-1450
1.1275-3................................................... 1545-0887
1545-1353
1545-1450
1.1275-4................................................... 1545-1450
1.1275-6................................................... 1545-1450
1.1287-1................................................... 1545-0786
1.1291-9................................................... 1545-1507
1.1291-10.................................................. 1545-1507
1545-1304
1.1294-1T.................................................. 1545-1002
1545-1028
1.1295-1................................................... 1545-1555
1.1295-3................................................... 1545-1555
1.1297-3T.................................................. 1545-1028
1.1301-1................................................... 1545-1662
1.1311(a)-1................................................ 1545-0074
1.1361-1................................................... 1545-0731
1545-1591
1.1361-3................................................... 1545-1590
1.1361-5................................................... 1545-1590
1.1362-1................................................... 1545-1308
1.1362-2................................................... 1545-1308
1.1362-3................................................... 1545-1308
1.1362-4................................................... 1545-1308
1.1362-5................................................... 1545-1308
1.1362-6................................................... 1545-1308
1.1362-7................................................... 1545-1308
1.1362-8................................................... 1545-1590
1.1366-1................................................... 1545-1613
1.1367-1(f)................................................ 1545-1139
1.1368-1(f)(2)............................................. 1545-1139
1.1368-1(f)(3)............................................. 1545-1139
1.1368-1(f)(4)............................................. 1545-1139
1.1368-1(g)(2)............................................. 1545-1139
1.1374-1A.................................................. 1545-0130
1.1377-1................................................... 1545-1462
1.1378-1................................................... 1545-1748
1.1383-1................................................... 1545-0074
1.1385-1................................................... 1545-0074
1545-0098
1.1388-1................................................... 1545-0118
1545-0123
1.1398-1................................................... 1545-1375
1.1398-2................................................... 1545-1375
1.1402(a)-2................................................ 1545-0074
1.1402(a)-5................................................ 1545-0074
1.1402(a)-11............................................... 1545-0074
1.1402(a)-15............................................... 1545-0074
1.1402(a)-16............................................... 1545-0074
1.1402(b)-1................................................ 1545-0171
1.1402(c)-2................................................ 1545-0074
1.1402(e)(1)-1............................................. 1545-0074
1.1402(e)(2)-1............................................. 1545-0074
1.1402(e)-1A............................................... 1545-0168
1.1402(e)-2A............................................... 1545-0168
1.1402(e)-3A............................................... 1545-0168
1.1402(e)-4A............................................... 1545-0168
1.1402(e)-5A............................................... 1545-0168
1.1402(f)-1................................................ 1545-0074
1.1402(h)-1................................................ 1545-0064
1.1441-1................................................... 1545-1484
1.1441-2................................................... 1545-0795
1.1441-3................................................... 1545-0165
1545-0795
1.1441-4................................................... 1545-1484
1.1441-5................................................... 1545-0096
1545-0795
1545-1484
1.1441-6................................................... 1545-0055
1545-0795
1545-1484
1.1441-7................................................... 1545-0795
1.1441-8................................................... 1545-1053
1545-1484
1.1441-9................................................... 1545-1484
1.1443-1................................................... 1545-0096
1.1445-1................................................... 1545-0902
1.1445-2................................................... 1545-0902
1545-1060
1545-1797
1.1445-3................................................... 1545-0902
1545-1060
1545-1797
1.1445-4................................................... 1545-0902
1.1445-5................................................... 1545-0902
1.1445-6................................................... 1545-0902
1545-1060
1.1445-7................................................... 1545-0902
1.1445-8................................................... 1545-0096
1.1445-9T.................................................. 1545-0902
1.1445-10T................................................. 1545-0902
1.1451-1................................................... 1545-0054
[[Page 775]]
1.1451-2................................................... 1545-0054
1.1461-1................................................... 1545-0054
1545-0055
1545-0795
1545-1484
1.1461-2................................................... 1545-0054
1545-0055
1545-0096
1545-0795
1.1462-1................................................... 1545-0795
1.1492-1................................................... 1545-0026
1.1494-1................................................... 1545-0026
1.1502-5................................................... 1545-0257
1.1502-9................................................... 1545-1634
1.1502-9A.................................................. 1545-0121
1.1502-13.................................................. 1545-0123
1545-0885
1545-1161
1545-1433
1.1502-16.................................................. 1545-0123
1.1502-18.................................................. 1545-0123
1.1502-19.................................................. 1545-0123
1.1502-20.................................................. 1545-1160
1545-1218
1.1502-20T................................................. 1545-1774
1.1502-21.................................................. 1545-1237
1.1502-21T................................................. 1545-1790
1.1502-31.................................................. 1545-1344
1.1502-32.................................................. 1545-1344
1.1502-32T................................................. 1545-1774
1.1502-33.................................................. 1545-1344
1.1502-35T................................................. 1545-1828
1.1502-47.................................................. 1545-0123
1.1502-75.................................................. 1545-0025
1545-0123
1545-0133
1545-0152
1.1502-76.................................................. 1545-1344
1.1502-77.................................................. 1545-1699
1.1502-77A................................................. 1545-0123
1545-1046
1.1502-78.................................................. 1545-0582
1.1502-95.................................................. 1545-1218
1.1502-95A................................................. 1545-1218
1.1502-96.................................................. 1545-1218
1.1503-2................................................... 1545-1583
1.1503-2A.................................................. 1545-1083
1.1552-1................................................... 1545-0123
1.1561-3................................................... 1545-0123
1.1563-1................................................... 1545-0123
1545-0797
1.1563-3................................................... 1545-0123
1.6001-1................................................... 1545-0058
1545-0074
1545-0099
1545-0123
1545-0865
1.6011-1................................................... 1545-0055
1545-0074
1545-0085
1545-0089
1545-0090
1545-0091
1545-0096
1545-0121
1545-0458
1545-0666
1545-0675
1545-0908
1.6011-2................................................... 1545-0055
1545-0938
1.6011-3................................................... 1545-0238
1545-0239
1.6011-4................................................... 1545-1685
1.6012-1................................................... 1545-0067
1545-0085
1545-0089
1545-0675
1545-0074
1.6012-2................................................... 1545-0047
1545-0051
1545-0067
1545-0123
1545-0126
1545-0130
1545-0128
1545-0175
1545-0687
1545-0890
1545-1023
1545-1027
1.6012-3................................................... 1545-0047
1545-0067
1545-0092
1545-0196
1545-0687
1.6012-4................................................... 1545-0067
1.6012-5................................................... 1545-0067
1545-0967
1545-0970
1545-0991
1545-0936
1545-1023
1545-1033
1545-1079
1.6012-6................................................... 1545-0067
1545-0089
1545-0129
1.6013-1................................................... 1545-0074
1.6013-2................................................... 1545-0091
1.6013-6................................................... 1545-0074
1.6013-7................................................... 1545-0074
1.6015-5................................................... 1545-1719
1.6015(a)-1................................................ 1545-0087
1.6015(b)-1................................................ 1545-0087
1.6015(d)-1................................................ 1545-0087
1.6015(e)-1................................................ 1545-0087
1.6015(f)-1................................................ 1545-0087
1.6015(g)-1................................................ 1545-0087
1.6015(h)-1................................................ 1545-0087
1.6015(i)-1................................................ 1545-0087
1.6017-1................................................... 1545-0074
1545-0087
1545-0090
1.6031(a)-1................................................ 1545-1583
1.6031(b)-1T............................................... 1545-0099
1.6031(c)-1T............................................... 1545-0099
1.6032-1................................................... 1545-0099
1.6033-2................................................... 1545-0047
1545-0049
1545-0052
1545-0092
1545-0687
1545-1150
1.6033-3................................................... 1545-0052
1.6034-1................................................... 1545-0092
1545-0094
1.6035-1................................................... 1545-0704
1.6035-2................................................... 1545-0704
1.6035-3................................................... 1545-0704
1.6037-1................................................... 1545-0130
1545-1023
1.6038-2................................................... 1545-1617
1.6038-3................................................... 1545-1617
[[Page 776]]
1.6038A-2.................................................. 1545-1191
1.6038A-3.................................................. 1545-1191
1545-1440
1.6038B-1.................................................. 1545-1617
1.6038B-1T................................................. 1545-0026
1.6038B-2.................................................. 1545-1617
1.6039-2................................................... 1545-0820
1.6041-1................................................... 1545-0008
1545-0108
1545-0112
1545-0115
1545-0120
1545-0295
1545-0350
1545-0367
1545-0387
1545-0441
1545-0957
1545-1705
1.6041-2................................................... 1545-0008
1545-0119
1545-0350
1545-0441
1545-1729
1.6041-3................................................... 1545-1148
1.6041-4................................................... 1545-0115
1545-0295
1545-0367
1545-0387
1545-0957
1.6041-5................................................... 1545-0295
1545-0367
1545-0387
1545-0957
1.6041-6................................................... 1545-0008
1545-0115
1.6041-7................................................... 1545-0112
1545-0295
1545-0350
1545-0367
1545-0387
1545-0441
1545-0957
1.6042-1................................................... 1545-0110
1.6042-2................................................... 1545-0110
1545-0295
1545-0367
1545-0387
1545-0957
1.6042-3................................................... 1545-0295
1545-0367
1545-0387
1545-0957
1.6042-4................................................... 1545-0110
1.6043-1................................................... 1545-0041
1.6043-2................................................... 1545-0041
1545-0110
1545-0295
1545-0387
1.6043-3................................................... 1545-0047
1.6044-1................................................... 1545-0118
1.6044-2................................................... 1545-0118
1.6044-3................................................... 1545-0118
1.6044-4................................................... 1545-0118
1.6044-5................................................... 1545-0118
1.6045-1................................................... 1545-0715
1545-1705
1.6045-2................................................... 1545-0115
1.6045-4................................................... 1545-1085
1.6046-1................................................... 1545-0704
1545-0794
1545-1317
1.6046-2................................................... 1545-0704
1.6046-3................................................... 1545-0704
1.6046A.................................................... 1545-1646
1.6047-1................................................... 1545-0119
1545-0295
1545-0387
1.6049-1................................................... 1545-0112
1545-0117
1545-0295
1545-0367
1545-0387
1545-0597
1545-0957
1.6049-2................................................... 1545-0117
1.6049-3................................................... 1545-0117
1.6049-4................................................... 1545-0096
1545-0112
1545-0117
1545-1018
1545-1050
1.6049-5................................................... 1545-0096
1545-0112
1545-0117
1.6049-6................................................... 1545-0096
1.6049-7................................................... 1545-1018
1.6049-7T.................................................. 1545-0112
1545-0117
1545-0118
1.6050A-1.................................................. 1545-0115
1.6050B-1.................................................. 1545-0120
1.6050D-1.................................................. 1545-0120
1545-0232
1.6050E-1.................................................. 1545-0120
1.6050H-1.................................................. 1545-0901
1545-1380
1.6050H-2.................................................. 1545-0901
1545-1339
1545-1380
1.6050H-1T................................................. 1545-0901
1.6050I-2.................................................. 1545-1449
1.6050J-1T................................................. 1545-0877
1.6050K-1.................................................. 1545-0941
1.6050P-1.................................................. 1545-1419
1.6050P-1T................................................. 1545-1419
1.6050S-1.................................................. 1545-1678
1.6050S-2.................................................. 1545-1729
1.6050S-3.................................................. 1545-1678
1.6050S-4.................................................. 1545-1729
1.6052-1................................................... 1545-0008
1.6052-2................................................... 1545-0008
1.6060-1................................................... 1545-0074
1.6061-1................................................... 1545-0123
1.6062-1................................................... 1545-0123
1.6063-1................................................... 1545-0123
1.6065-1................................................... 1545-0123
1.6071-1................................................... 1545-0123
1545-0810
1.6072-1................................................... 1545-0074
1.6072-2................................................... 1545-0123
1545-0807
1.6073-1................................................... 1545-0087
1.6073-2................................................... 1545-0087
1.6073-3................................................... 1545-0087
1.6073-4................................................... 1545-0087
1.6074-1................................................... 1545-0123
1.6074-2................................................... 1545-0123
1.6081-1................................................... 1545-0066
1545-0148
1545-0233
1545-1057
1545-1081
1.6081-2................................................... 1545-0148
[[Page 777]]
1545-1054
1545-1036
1.6081-3................................................... 1545-0233
1.6081-4................................................... 1545-0188
1545-1479
1.6081-6................................................... 1545-0148
1545-1054
1.6081-7................................................... 1545-0148
1545-1054
1.6081-8T.................................................. 1545-1840
1.6081-9T.................................................. 1545-1840
1.6091-3................................................... 1545-0089
1.6107-1................................................... 1545-0074
1.6109-1................................................... 1545-0074
1.6109-2................................................... 1545-0074
1.6115-1................................................... 1545-1464
1.6151-1................................................... 1545-0074
1.6153-1................................................... 1545-0087
1.6153-4................................................... 1545-0087
1.6154-2................................................... 1545-0257
1.6154-3................................................... 1545-0135
1.6154-5................................................... 1545-0976
1.6161-1................................................... 1545-0087
1.6162-1................................................... 1545-0087
1.6164-1................................................... 1545-0135
1.6164-2................................................... 1545-0135
1.6164-3................................................... 1545-0135
1.6164-5................................................... 1545-0135
1.6164-6................................................... 1545-0135
1.6164-7................................................... 1545-0135
1.6164-8................................................... 1545-0135
1.6164-9................................................... 1545-0135
1.6302-1................................................... 1545-0257
1.6302-2................................................... 1545-0098
1545-0257
1.6411-1................................................... 1545-0098
1545-0135
1545-0582
1.6411-2................................................... 1545-0098
1545-0582
1.6411-3................................................... 1545-0098
1545-0582
1.6411-4................................................... 1545-0582
1.6414-1................................................... 1545-0096
1.6425-1................................................... 1545-0170
1.6425-2................................................... 1545-0170
1.6425-3................................................... 1545-0170
1.6654-1................................................... 1545-0087
1545-0140
1.6654-2................................................... 1545-0087
1.6654-3................................................... 1545-0087
1.6654-4................................................... 1545-0087
1.6655-1................................................... 1545-0142
1.6655-2................................................... 1545-0142
1.6655-3................................................... 1545-0142
1.6655-7................................................... 1545-0123
1.6655(e)-1................................................ 1545-1421
1.6661-3................................................... 1545-0988
1545-1031
1.6661-4................................................... 1545-0739
1.6662-3(c)................................................ 1545-0889
1.6662-4(e) and (f)........................................ 1545-0889
1.6662-6................................................... 1545-1426
1.6694-1................................................... 1545-0074
1.6694-2................................................... 1545-0074
1.6694-2(c)................................................ 1545-1231
1.6694-3(e)................................................ 1545-1231
1.6695-1................................................... 1545-0074
1545-1385
1.6695-2................................................... 1545-1570
1.6696-1................................................... 1545-0074
1545-0240
1.6851-1................................................... 1545-0086
1545-0138
1.6851-2................................................... 1545-0086
1545-0138
1.7476-1................................................... 1545-0197
1.7476-2................................................... 1545-0197
1.7519-2T.................................................. 1545-1036
1.7520-1................................................... 1545-1343
1.7520-2................................................... 1545-1343
1.7520-3................................................... 1545-1343
1.7520-4................................................... 1545-1343
1.7701(l)-3................................................ 1545-1642
1.7872-15.................................................. 1545-1792
1.9100-1................................................... 1545-0074
1.9101-1................................................... 1545-0008
2.1-4...................................................... 1545-0123
2.1-5...................................................... 1545-0123
2.1-6...................................................... 1545-0123
2.1-10..................................................... 1545-0123
2.1-11..................................................... 1545-0123
2.1-12..................................................... 1545-0123
2.1-13..................................................... 1545-0123
2.1-20..................................................... 1545-0123
2.1-22..................................................... 1545-0123
2.1-26..................................................... 1545-0123
3.2........................................................ 1545-0123
4.954-1.................................................... 1545-1068
4.954-2.................................................... 1545-1068
5.6411-1................................................... 1545-0098
1545-0582
1545-0042
1545-0074
1545-0129
1545-0172
1545-0619
5c.44F-1................................................... 1545-0619
5c.128-1................................................... 1545-0123
5c.168(f)(8)-1............................................. 1545-0123
5c.168(f)(8)-2............................................. 1545-0123
5c.168(f)(8)-6............................................. 1545-0123
5c.168(f)(8)-8............................................. 1545-0123
5c.305-1................................................... 1545-0110
5c.442-1................................................... 1545-0152
5f.103-1................................................... 1545-0720
5f.103-3................................................... 1545-0720
5f.6045-1.................................................. 1545-0715
6a.103A-2.................................................. 1545-0123
1545-0720
6a.103A-3.................................................. 1545-0720
7.465-1.................................................... 1545-0712
7.465-2.................................................... 1545-0712
7.465-3.................................................... 1545-0712
7.465-4.................................................... 1545-0712
7.465-5.................................................... 1545-0712
7.936-1.................................................... 1545-0217
7.999-1.................................................... 1545-0216
7.6039A-1.................................................. 1545-0015
7.6041-1................................................... 1545-0115
11.410-1................................................... 1545-0710
11.412(c)-7................................................ 1545-0710
11.412(c)-11............................................... 1545-0710
12.7....................................................... 1545-0190
12.8....................................................... 1545-0191
12.9....................................................... 1545-0195
14a.422A-1................................................. 1545-0123
15A.453-1.................................................. 1545-0228
16.3-1..................................................... 1545-0159
16A.126-2.................................................. 1545-0074
16A.1255-1................................................. 1545-0184
16A.1255-2................................................. 1545-0184
18.1371-1.................................................. 1545-0130
18.1378-1.................................................. 1545-0130
[[Page 778]]
18.1379-1.................................................. 1545-0130
18.1379-2.................................................. 1545-0130
20.2011-1.................................................. 1545-0015
20.2014-5.................................................. 1545-0015
1545-0260
20.2014-6.................................................. 1545-0015
20.2016-1.................................................. 1545-0015
20.2031-2.................................................. 1545-0015
20.2031-3.................................................. 1545-0015
20.2031-4.................................................. 1545-0015
20.2031-6.................................................. 1545-0015
20.2031-7.................................................. 1545-0020
20.2031-10................................................. 1545-0015
20.2032-1.................................................. 1545-0015
20.2032A-3................................................. 1545-0015
20.2032A-4................................................. 1545-0015
20.2032A-8................................................. 1545-0015
20.2039-4.................................................. 1545-0015
20.2051-1.................................................. 1545-0015
20.2053-3.................................................. 1545-0015
20.2053-9.................................................. 1545-0015
20.2053-10................................................. 1545-0015
20.2055-1.................................................. 1545-0015
20.2055-2.................................................. 1545-0015
1545-0092
20.2055-3.................................................. 1545-0015
20.2056(b)-4............................................... 1545-0015
20.2056(b)-7............................................... 1545-0015
1545-1612
20.2056A-2................................................. 1545-1443
20.2056A-3................................................. 1545-1360
20.2056A-4................................................. 1545-1360
20.2056A-10................................................ 1545-1360
20.2106-1.................................................. 1545-0015
20.2106-2.................................................. 1545-0015
20.2204-1.................................................. 1545-0015
20.2204-2.................................................. 1545-0015
20.6001-1.................................................. 1545-0015
20.6011-1.................................................. 1545-0015
20.6018-1.................................................. 1545-0015
1545-0531
20.6018-2.................................................. 1545-0015
20.6018-3.................................................. 1545-0015
20.6018-4.................................................. 1545-0015
1545-0022
20.6036-2.................................................. 1545-0015
20.6061-1.................................................. 1545-0015
20.6065-1.................................................. 1545-0015
20.6075-1.................................................. 1545-0015
20.6081-1.................................................. 1545-0015
1545-0181
1545-1707
20.6091-1.................................................. 1545-0015
20.6161-1.................................................. 1545-0015
1545-0181
20.6161-2.................................................. 1545-0015
1545-0181
20.6163-1.................................................. 1545-0015
20.6166-1.................................................. 1545-0181
20.6166A-1................................................. 1545-0015
20.6166A-3................................................. 1545-0015
20.6324A-1................................................. 1545-0754
20.7520-1.................................................. 1545-1343
20.7520-2.................................................. 1545-1343
20.7520-3.................................................. 1545-1343
20.7520-4.................................................. 1545-1343
22.0....................................................... 1545-0015
25.2511-2.................................................. 1545-0020
25.2512-2.................................................. 1545-0020
25.2512-3.................................................. 1545-0020
25.2512-5.................................................. 1545-0020
25.2512-9.................................................. 1545-0020
25.2513-1.................................................. 1545-0020
25.2513-2.................................................. 1545-0020
1545-0021
25.2513-3.................................................. 1545-0020
25.2518-2.................................................. 1545-0959
25.2522(a)-1............................................... 1545-0196
25.2522(c)-3............................................... 1545-0020
1545-0196
25.2523(a)-1............................................... 1545-0020
1545-0196
25.2523(f)-1............................................... 1545-0015
25.2701-2.................................................. 1545-1241
25.2701-4.................................................. 1545-1241
25.2701-5.................................................. 1545-1273
25.2702-5.................................................. 1545-1485
25.2702-6.................................................. 1545-1273
25.6001-1.................................................. 1545-0020
1545-0022
25.6011-1.................................................. 1545-0020
25.6019-1.................................................. 1545-0020
25.6019-2.................................................. 1545-0020
25.6019-3.................................................. 1545-0020
25.6019-4.................................................. 1545-0020
25.6061-1.................................................. 1545-0020
25.6065-1.................................................. 1545-0020
25.6075-1.................................................. 1545-0020
25.6081-1.................................................. 1545-0020
25.6091-1.................................................. 1545-0020
25.6091-2.................................................. 1545-0020
25.6151-1.................................................. 1545-0020
25.6161-1.................................................. 1545-0020
25.7520-1.................................................. 1545-1343
25.7520-2.................................................. 1545-1343
25.7520-3.................................................. 1545-1343
25.7520-4.................................................. 1545-1343
26.2601-1.................................................. 1545-0985
26.2632-1.................................................. 1545-0985
26.2642-1.................................................. 1545-0985
26.2642-2.................................................. 1545-0985
26.2642-3.................................................. 1545-0985
26.2642-4.................................................. 1545-0985
26.2652-2.................................................. 1545-0985
26.2662-1.................................................. 1545-0015
1545-0985
26.2662-2.................................................. 1545-0985
31.3102-3.................................................. 1545-0029
1545-0059
1545-0065
31.3121(b)(19)-1........................................... 1545-0029
31.3121(d)-1............................................... 1545-0004
31.3121(i)-1............................................... 1545-0034
31.3121(k)-4............................................... 1545-0137
31.3121(r)-1............................................... 1545-0029
31.3121(s)-1............................................... 1545-0029
31.3121(v)(2)-1............................................ 1545-1643
31.3302(a)-2............................................... 1545-0028
31.3302(a)-3............................................... 1545-0028
31.3302(b)-2............................................... 1545-0028
31.3302(e)-1............................................... 1545-0028
31.3306(c)(18)-1........................................... 1545-0029
31.3401(a)-1............................................... 1545-0029
31.3401(a)(6).............................................. 1545-1484
31.3401(a)(6)-1............................................ 1545-0029
1545-0096
1545-0795
31.3401(a)(7)-1............................................ 1545-0029
31.3401(a)(8)(A)-1 ........................................ 1545-0029
1545-0666
31.3401(a)(8)(C)-1 ........................................ 1545-0029
31.3401(a)(15)-1........................................... 1545-0182
31.3401(c)-1............................................... 1545-0004
31.3402(b)-1............................................... 1545-0010
[[Page 779]]
31.3402(c)-1............................................... 1545-0010
31.3402(f)(1)-1............................................ 1545-0010
31.3402(f)(2)-1............................................ 1545-0010
1545-0410
31.3402(f)(3)-1............................................ 1545-0010
31.3402(f)(4)-1............................................ 1545-0010
31.3402(f)(4)-2............................................ 1545-0010
31.3402(f)(5)-1............................................ 1545-0010
1545-1435
31.3402(h)(1)-1............................................ 1545-0029
31.3402(h)(3)-1............................................ 1545-0010
31.3402(h)(3)-1............................................ 1545-0029
31.3402(h)(4)-1............................................ 1545-0010
31.3402(i)-(1)............................................. 1545-0010
31.3402(i)-(2)............................................. 1545-0010
31.3402(k)-1............................................... 1545-0065
31.3402(l)-(1)............................................. 1545-0010
31.3402(m)-(1)............................................. 1545-0010
31.3402(n)-(1)............................................. 1545-0010
31.3402(o)-2............................................... 1545-0415
31.3402(o)-3............................................... 1545-0008
1545-0010
1545-0415
1545-0717
31.3402(p)-1............................................... 1545-0415
1545-0717
31.3402(q)-1............................................... 1545-0238
1545-0239
31.3404-1.................................................. 1545-0029
31.3405(c)-1............................................... 1545-1341
31.3406(a)-1............................................... 1545-0112
31.3406(a)-2............................................... 1545-0112
31.3406(a)-3............................................... 1545-0112
31.3406(a)-4............................................... 1545-0112
31.3406(b)(2)-1............................................ 1545-0112
31.3406(b)(2)-2............................................ 1545-0112
31.3406(b)(2)-3............................................ 1545-0112
31.3406(b)(2)-4............................................ 1545-0112
31.3406(b)(2)-5............................................ 1545-0112
31.3406(b)(3)-1............................................ 1545-0112
31.3406(b)(3)-2............................................ 1545-0112
31.3406(b)(3)-3............................................ 1545-0112
31.3406(b)(3)-4............................................ 1545-0112
31.3406(b)(4)-1............................................ 1545-0112
31.3406(c)-1............................................... 1545-0112
31.3406(d)-1............................................... 1545-0112
31.3406(d)-2............................................... 1545-0112
31.3406(d)-3............................................... 1545-0112
31.3406(d)-4............................................... 1545-0112
31.3406(d)-5............................................... 1545-0112
31.3406(e)-1............................................... 1545-0112
31.3406(f)-1............................................... 1545-0112
31.3406(g)-1............................................... 1545-0096
1545-0112
31.3406(g)-2............................................... 1545-0112
31.3406(g)-3............................................... 1545-0112
31.3406(h)-1............................................... 1545-0112
31.3406(h)-2............................................... 1545-0112
31.3406(h)-3............................................... 1545-0112
31.3406(i)-1............................................... 1545-0112
31.3501(a)-1T.............................................. 1545-0771
31.3503-1.................................................. 1545-0024
31.3504-1.................................................. 1545-0029
31.6001-1.................................................. 1545-0798
31.6001-2.................................................. 1545-0034
1545-0798
31.6001-3.................................................. 1545-0798
31.6001-4.................................................. 1545-0028
31.6001-5.................................................. 1545-0798
31.6001-6.................................................. 1545-0029
1459-0798
31.6011(a)-1............................................... 1545-0029
1545-0034
1545-0035
1545-0059
1545-0074
1545-0718
1545-0256
31.6011(a)-2............................................... 1545-0001
1545-0002
31.6011(a)-3............................................... 1545-0028
31.6011(a)-3A.............................................. 1545-0955
31.6011(a)-4............................................... 1545-0034
1545-0035
1545-0718
1545-1413
31.6011(a)-5............................................... 1545-0718
1545-0028
31.6011(a)-6............................................... 1545-0028
31.6011(a)-7............................................... 1545-0074
31.6011(a)-8............................................... 1545-0028
31.6011(a)-9............................................... 1545-0028
31.6011(a)-10.............................................. 1545-0112
31.6011(b)-1............................................... 1545-0003
31.6011(b)-2............................................... 1545-0029
31.6051-1.................................................. 1545-0008
1545-0182
1545-0458
1545-1729
31.6051-2.................................................. 1545-0008
31.6051-3.................................................. 1545-0008
31.6053-1.................................................. 1545-0029
1545-0062
1545-0064
1545-0065
1545-1603
31.6053-2.................................................. 1545-0008
31.6053-3.................................................. 1545-0065
1545-0714
31.6053-4.................................................. 1545-0065
1545-1603
31.6065(a)-1............................................... 1545-0029
31.6071(a)-1............................................... 1545-0001
1545-0028
1545-0029
31.6071(a)-1A.............................................. 1545-0955
31.6081(a)-1............................................... 1545-0008
1545-0028
31.6091-1.................................................. 1545-0028
1545-0029
31.6157-1.................................................. 1545-0955
31.6205-1.................................................. 1545-0029
31.6301(c)-1AT............................................. 1545-0035
1545-0112
1545-0257
31.6302-1.................................................. 1545-1413
31.6302-2.................................................. 1545-1413
31.6302-3.................................................. 1545-1413
31.6302-4.................................................. 1545-1413
31.6302(c)-2............................................... 1545-0001
1545-0257
31.6302(c)-2A.............................................. 1545-0955
31.6302(c)-3............................................... 1545-0257
31.6402(a)-2............................................... 1545-0256
31.6413(a)-1............................................... 1545-0029
31.6413(a)-2............................................... 1545-0029
1545-0256
31.6413(c)-1............................................... 1545-0029
1545-0171
31.6414-1.................................................. 1545-0029
32.1....................................................... 1545-0029
1545-0415
32.2....................................................... 1545-0029
35a.3406-2................................................. 1545-0112
[[Page 780]]
35a.9999-5................................................. 1545-0029
36.3121(l)(1)-1............................................ 1545-0137
36.3121(l)(1)-2............................................ 1545-0137
36.3121(l)(3)-1............................................ 1545-0123
36.3121(1)(7)-1............................................ 1545-0123
36.3121(1)(10)-1........................................... 1545-0029
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40.6302(c)-3(b)(2)(ii)..................................... 1545-1296
40.6302(c)-3(b)(2)(iii).................................... 1545-1296
40.6302(c)-3(e)............................................ 1545-1296
40.6302(c)-3(f)(2)(ii)..................................... 1545-1296
41.4481-1.................................................. 1545-0143
41.4481-2.................................................. 1545-0143
41.4483-3.................................................. 1545-0143
41.6001-1.................................................. 1545-0143
41.6001-2.................................................. 1545-0143
41.6001-3.................................................. 1545-0143
41.6071(a)-1............................................... 1545-0143
41.6081(a)-1............................................... 1545-0143
41.6091-1.................................................. 1545-0143
41.6109-1.................................................. 1545-0143
41.6151(a)-1............................................... 1545-0143
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41.6161(a)(1)-1............................................ 1545-0143
44.4401-1.................................................. 1545-0235
44.4403-1.................................................. 1545-0235
44.4412-1.................................................. 1545-0236
44.4901-1.................................................. 1545-0236
44.4905-1.................................................. 1545-0236
44.4905-2.................................................. 1545-0236
44.6001-1.................................................. 1545-0235
44.6011(a)-1............................................... 1545-0235
1545-0236
44.6071-1.................................................. 1545-0235
44.6091-1.................................................. 1545-0235
44.6151-1.................................................. 1545-0235
44.6419-1.................................................. 1545-0235
44.6419-1.................................................. 1545-0235
44.6419-2.................................................. 1545-0235
46.4371-4.................................................. 1545-0023
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1545-0257
48.4041-4.................................................. 1545-0023
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48.4041-6.................................................. 1545-0023
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48.4052-1.................................................. 1545-1418
48.4061(a)-1............................................... 1545-0023
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48.4064-1.................................................. 1545-0014
1545-0242
48.4071-1.................................................. 1545-0023
48.4073-1.................................................. 1545-0023
48.4073-3.................................................. 1545-0023
1545-1074
1545-1087
48.4081-2.................................................. 1545-1270
1545-1418
48.4081-3.................................................. 1545-1270
1545-1418
48.4081-4(b)(2)(ii)........................................ 1545-1270
48.4081-4(b)(3)(i)......................................... 1545-1270
48.4081-4(c)............................................... 1545-1270
48.4081-6(c)(1)(ii)........................................ 1545-1270
48.4081-7.................................................. 1545-1270
1545-1418
48.4082-2.................................................. 1545-1418
48.4082-6.................................................. 1545-1418
48.4082-7.................................................. 1545-1418
48.4091-3.................................................. 1545-1418
48.4101-1.................................................. 1545-1418
48.4101-2.................................................. 1545-1418
48.4161(a)-1............................................... 1545-0723
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48.4161(a)-3............................................... 1545-0723
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1545-0723
48.4216(a)-2............................................... 1545-0023
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48.4221-1.................................................. 1545-0023
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48.4221-5.................................................. 1545-0023
48.4221-6.................................................. 1545-0023
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48.4222(a)-1............................................... 1545-0023
1545-0014
48.4223-1.................................................. 1545-0023
1545-0723
1545-0723
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1545-0257
48.6302(c)-1............................................... 1545-0023
1545-0257
48.6412-1.................................................. 1545-0723
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1545-0723
48.6416(a)-2............................................... 1545-0723
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48.6416(b)(1)-1............................................ 1545-0723
48.6416(b)(1)-2............................................ 1545-0723
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48.6416(b)(1)-4............................................ 1545-0723
48.6416(b)(2)-1............................................ 1545-0723
48.6416(b)(2)-2............................................ 1545-0723
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1545-1087
48.6416(b)(2)-4............................................ 1545-0723
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48.6416(b)(3)-2............................................ 1545-0723
48.6416(b)(3)-3............................................ 1545-0723
48.6416(b)(4)-1............................................ 1545-0723
48.6416(b)(5)-1............................................ 1545-0723
48.6416(c)-1............................................... 1545-0723
48.6416(e)-1............................................... 1545-0023
1545-0723
48.6416(f)-1............................................... 1545-0023
1545-0723
48.6416(g)-1............................................... 1545-0723
48.6416(h)-1............................................... 1545-0723
48.6420(c)-2............................................... 1545-0023
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48.6420-1.................................................. 1545-0162
1545-0723
48.6420-2.................................................. 1545-0162
1545-0723
48.6420-3.................................................. 1545-0162
1545-0723
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48.6427-0.................................................. 1545-0723
48.6427-1.................................................. 1545-0023
1545-0162
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1545-0723
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48.6427-8.................................................. 1545-1418
48.6427-9.................................................. 1545-1418
48.6427-10................................................. 1545-1418
48.6427-11................................................. 1545-1418
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49.4251-4(d)(2)............................................ 1545-1628
49.4253-3.................................................. 1545-0023
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1545-0912
1545-0257
1545-0230
1545-0224
1545-0225
1545-0224
1545-0230
49.4271-1(d)............................................... 1545-0685
52.4682-1(b)(2)(iii)....................................... 1545-1153
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1545-1361
52.4682-2(d)............................................... 1545-1153
1545-1361
52.4682-3(c)(2)............................................ 1545-1153
52.4682-3(g)............................................... 1545-1153
52.4682-4(f)............................................... 1545-1153
1545-0257
52.4682-5(d)............................................... 1545-1361
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53.4940-1.................................................. 1545-0052
1545-0196
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53.4947-2.................................................. 1545-0196
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53.4958-6.................................................. 1545-1623
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1545-0052
1545-0092
1545-0196
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145.4051-1................................................. 1545-0745
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1545-1076
1545-0745
1545-1076
145.4061-1................................................. 1545-0745
1545-0257
1545-0230
1545-0224
156.6001-1................................................. 1545-1049
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156.6081-1................................................. 1545-1049
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157.6001-1T................................................ 1545-1824
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157.6161-1T................................................ 1545-1824
301.6011-2................................................. 1545-0225
1545-0350
[[Page 782]]
1545-0387
1545-0441
1545-0957
301.6017-1................................................. 1545-0090
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301.6035-1................................................. 1545-0123
301.6036-1................................................. 1545-0013
1545-0773
301.6047-1................................................. 1545-0367
1545-0957
301.6057-1................................................. 1545-0710
301.6057-2................................................. 1545-0710
301.6058-1................................................. 1545-0710
301.6059-1................................................. 1545-0710
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301.6104(a)-5.............................................. 1545-0056
301.6104(a)-6.............................................. 1545-0056
301.6104(b)-1.............................................. 1545-0094
1545-0742
301.6104(d)-1.............................................. 1545-1655
301.6104(d)-2.............................................. 1545-1655
301.6104(d)-3.............................................. 1545-1655
301.6109-1................................................. 1545-0003
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1545-0367
1545-0387
1545-0957
1545-1461
301.6109-3................................................. 1545-1564
301.6110-3................................................. 1545-0074
301.6110-5................................................. 1545-0074
301.6111-1T................................................ 1545-0865
1545-0881
301.6111-2................................................. 1545-0865
1545-1687
301.6112-1................................................. 1545-0865
1545-1686
301.6112-1T................................................ 1545-0865
1545-1686
301.6114-1................................................. 1545-1126
1545-1484
301.6222(a)-2.............................................. 1545-0790
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301.6222(b)-2.............................................. 1545-0790
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301.6230(e)-1.............................................. 1545-0790
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301.6231(c)-2.............................................. 1545-0790
301.6241-1T................................................ 1545-0130
301.6316-4................................................. 1545-0074
301.6316-5................................................. 1545-0074
301.6316-6................................................. 1545-0074
301.6316-7................................................. 1545-0029
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301.6361-1................................................. 1545-0074
1545-0024
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301.6402-2................................................. 1545-0024
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1545-0091
301.6402-3................................................. 1545-0055
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1545-0091
1545-0132
1545-1484
301.6402-5................................................. 1545-0928
301.6404-1................................................. 1545-0024
301.6404-2T................................................ 1545-0024
301.6404-3................................................. 1545-0024
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1545-1637
301.6501(d)-1.............................................. 1545-0074
1545-0430
301.6501(o)-2.............................................. 1545-0728
301.6511(d)-1.............................................. 1545-0582
1545-0024
301.6511(d)-2.............................................. 1545-0582
1545-0024
301.6511(d)-3.............................................. 1545-0024
1545-0582
301.6652-2................................................. 1545-0092
301.6685-1................................................. 1545-0092
301.6689-1T................................................ 1545-1056
301.6707-1T................................................ 1545-0865
1545-0881
301.6708-1T................................................ 1545-0865
301.6712-1................................................. 1545-1126
301.6723-1A(d)............................................. 1545-0909
301.6903-1................................................. 1545-0013
1545-1783
301.6905-1................................................. 1545-0074
301.7001-1................................................. 1545-0123
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301.7430-2(c).............................................. 1545-1356
301.7507-8................................................. 1545-0123
301.7507-9................................................. 1545-0123
301.7513-1................................................. 1545-0429
301.7517-1................................................. 1545-0015
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301.7623-1................................................. 1545-0409
1545-1534
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301.7701-3................................................. 1545-1486
301.7701-4................................................. 1545-1465
301.7701-7................................................. 1545-1600
301.7701-16................................................ 1545-0795
301.7701(b)-1.............................................. 1545-0089
301.7701(b)-2.............................................. 1545-0089
301.7701(b)-3.............................................. 1545-0089
301.7701(b)-4.............................................. 1545-0089
301.7701(b)-5.............................................. 1545-0089
301.7701(b)-6.............................................. 1545-0089
301.7701(b)-7.............................................. 1545-0089
1545-1126
301.7701(b)-9.............................................. 1545-0089
301.7805-1................................................. 1545-0805
301.9001-1................................................. 1545-0220
301.9100-2................................................. 1545-1488
301.9100-3................................................. 1545-1488
301.9100-4T................................................ 1545-0016
1545-0042
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1545-0129
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301.9100-6T................................................ 1545-0872
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301.9100-11T............................................... 1545-0123
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1545-0074
1545-0172
1545-1027
301.9100-14T............................................... 1545-0046
301.9100-15T............................................... 1545-0046
301.9100-16T............................................... 1545-0152
302.1-7.................................................... 1545-0024
305.7701-1................................................. 1545-0823
305.7871-1................................................. 1545-0823
404.6048-1................................................. 1545-0160
420.0-1.................................................... 1545-0710
Part 509................................................... 1545-0846
Part 513................................................... 1545-0834
Part 514................................................... 1545-0845
Part 521................................................... 1545-0848
601.104.................................................... 1545-0233
601.105.................................................... 1545-0091
601.201.................................................... 1545-0019
1545-0819
601.204.................................................... 1545-0152
601.401.................................................... 1545-0257
601.504.................................................... 1545-0150
601.601.................................................... 1545-0800
601.602.................................................... 1545-0295
1545-0387
1545-0957
601.702.................................................... 1545-0429
------------------------------------------------------------------------
(26 U.S.C. 7805)
[T.D. 8011, 50 FR 10222, Mar. 14, 1985]
Editorial Note: For Federal Register citations affecting Sec.
602.101, see the List of CFR Sections Affected, which appears in the
Findings Aids section of the printed volume and on GPO Access.
[[Page 785]]
List of CFR Sections Affected
All changes to sections of part 1 (Sec. Sec. 1.851 to 1.1000) of title
26 of the Code of Federal Regulations which were made by documents
published in the Federal Register since January 1, 2001, are enumerated
in the following list. Entries indicate the nature of the changes
effected. Page numbers refer to Federal Register pages. The user should
consult the entries for chapters and parts as well as sections for
revisions.
For the period before January 1, 2001, see the ``List of CFR Sections
Affected, 1949-1963, 1964-1972, 1973-1985, and 1986-2000'' published in
11 separate volumes.
2001
26 CFR
66 FR
Page
Chapter I
1.921-1T (b)(1) amended9929.......................................
1.925(a)-1 Added amended13428.....................................
1.925(a)-1T (c)(8)(I) revised; (e)(4) amended13428................
1.925(b)-1T (b)(3)(I) amended13429................................
1.958-1 (b) amended37897..........................................
1.958-2 (c)(1)(ii)(b) amended37897................................
1.963-6 (c)(5) amended2819........................................
1.985-1 (c)(6) amended2216........................................
1.985-4 (a) amended2216...........................................
1.985-8 Added2216.................................................
(c)(3)(ii) Examples 1 and 2 correctly added21447..............
1.985-8T Removed2218..............................................
1.988-1 (f) revised280............................................
1.992-3 (c)(3)(iv) amended2819....................................
2002
26 CFR
67 FR
Page
Chapter I
1.952-1 (g) added48023............................................
1.954-1 (g) added48023............................................
1.954-2 (a)(4)(ii)(A), (B), (g)(2)(ii)(B)(2) and (3)(i)(B)
amended12866....................................................
(a)(5) added48024.............................................
1.954-3 (a)(6) added48025.........................................
1.954-4 (b)(2)(iii) added48025....................................
1.956-2 (a)(3) added48025.........................................
2003
26 CFR
68 FR
Page
Chapter I
1.936-7 Introductory text designated as (a); (a), (b) and (c)
redesignated as (b), (c) and (d); new (b) amended70705....
1.936-7T Added70705...............................................
1.954-0 (b) amended4917...........................................
1.954-2 (f)(2)(iii)(E) removed; (f)(2)(iv) heading and (g)(2)(iii)
revised; (f)(2)(iv)(C), (v) (vi), (g)(2)(ii)(C)(1) through
(2)(iii) added4917........................................
2004
(No regulations published from January 1, 2004, through April 1, 2004)
[all]