[Title 26 CFR 1.963-1]
[Code of Federal Regulations (annual edition) - April 1, 2002 Edition]
[Title 26 - INTERNAL REVENUE]
[Chapter I - INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY]
[Subchapter A - INCOME TAX (CONTINUED)]
[Part 1 - INCOME TAXES]
[Sec. 1.963-1 - Exclusion of subpart F income upon receipt of minimum distribution.]
[From the U.S. Government Printing Office]


26INTERNAL REVENUE102002-04-012002-04-01false1.963-1Sec. 1.963-1INTERNAL REVENUEINTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURYINCOME TAX (CONTINUED)INCOME TAXES
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 428]]

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 Secs. 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

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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

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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 431]]

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

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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.


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    (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

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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 435]]

    (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]