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Federal Register: June 11, 2009 (Volume 74, Number 111)

DOCID: fr11jn09-21 FR Doc E9-13521

DEPARTMENT OF THE TREASURY

U.S. Citizenship and Immigration Services

CFR Citation: 26 CFR Parts 1 and 602

RIN ID: RIN 1545-BB28

TD ID: [TD 9452]

NOTICE: Part II

DOCID: fr11jn09-21

DOCUMENT ACTION: Final regulations, temporary regulations, and removal of temporary regulations.

SUBJECT CATEGORY:

Application of Separate Limitations to Dividends From Noncontrolled Section 902 Corporations

DATES: Effective Date: These regulations are effective on June 11, 2009.

Applicability Dates: For dates of applicability, see Sec. Sec. 1.8619(k), 1.86112(c)(5), 1.9021(g), 1.9042(h)(1) and (2), 1.904 4(n), 1.9045(o)(2), 1.9047(f)(10), 1.904(f)12(g)(5), and 1.9641(d).

DOCUMENT SUMMARY:

This document contains final regulations regarding the application of separate foreign tax credit limitations to dividends received from noncontrolled section 902 corporations. The American Jobs Creation Act of 2004 (AJCA) modified the treatment of such dividends effective for taxable years beginning after December 31, 2002. The Gulf Opportunity Zone Act of 2005 (GOZA) permits taxpayers to elect to defer the effective date of the AJCA amendments until taxable years beginning after December 31, 2004. The final regulations provide guidance needed to comply with these changes and affect corporations claiming foreign tax credits.

SUMMARY:

Treasury Department, Internal Revenue Service

FOR FURTHER INFORMATION CONTACT

Richard Chewning at (202) 622-3850 (not a tollfree number).
SUPPLEMENTARY INFORMATION

Paperwork Reduction Act

The collections of information contained in the final regulations have been reviewed and approved by the Office of Management and Budget in accordance with the Paperwork and Reduction Act (44 U.S.C. 3507(d)) under control number 15452014. The collections of information in the final regulations are in Sec. Sec. 1.9047(f)(9)(ii)(C) and 1.964 1(c)(3). This information is required, with respect to Sec. 1.904 7(f)(9)(ii)(C), to notify the IRS that taxpayer has made the election to defer the applicability of the provisions of section 403 of the AJCA. With respect to Sec. 1.9641(c)(3), this information is required to notify the IRS and domestic shareholders of a foreign corporation of elections made to adopt or change a method of accounting or taxable year of the foreign corporation.

An agency may not conduct or sponsor, and a person is not required to respond to, a collection of information unless it displays a valid control number.

Books or records relating to these collections of information must be retained as long as their contents may become material in the administration of any internal revenue law. Generally, tax returns and tax return information are confidential, as required by 26 U.S.C. 6103. Background

On April 20, 2006, a notice of proposed rulemaking by cross reference to temporary regulations (REG14478402) under sections 861, 902, 904, and 964 of the Code and temporary regulations (TD 9260) (the 2006 temporary regulations) were filed with the Office of the Federal Register. On April 25, 2006, the notice of proposed rulemaking by crossreference to temporary regulations and the 2006 temporary regulations were published in the Federal Register (71 FR 24543 and 71 FR 24516, respectively). Corrections to the 2006 temporary regulations were published on August 21, 2006, and December 26, 2006, in the Federal Register (71 FR 48474 and 71 FR 77264, respectively). Comments were received. A public hearing was not requested and none was held. After consideration of the comments, the proposed regulations are adopted as amended by this Treasury decision.

Explanation and Summary of Comments

The IRS and the Treasury Department received written comments on the 2006 temporary regulations. Those comments are discussed in this preamble. These new regulations make several changes to the 2006 temporary regulations to take into account comments received, while adopting without amendment most of the temporary regulations. The significant comments and revisions are described in this preamble. I. Interest Expense Apportionment

A. Interest Expense of a 10/50 Corporation

Section 904(d)(4)(A), as amended by the AJCA, provides that any dividend paid by a noncontrolled section 902 corporation (10/50 corporation) shall be treated as income in a separate category based on the separate category of the underlying earnings and profits being distributed (lookthrough treatment), effective for taxable years beginning after December 31, 2002 (post2002 taxable years), without regard to when the distributed earnings were accumulated. For purposes of apportioning interest expense of a 10/50 corporation in order to apply the dividend lookthrough rule, Sec. 1.8619T(f)(4) of the 2006 temporary regulations generally applies the same principles as Sec. 1.8619T(f)(3) (apportionment of interest expense of a controlled foreign corporation). Under these rules, interest expense of a 10/50 corporation may be apportioned using either the asset method or the modified gross income method. Regardless of the interest expense apportionment methods used by its majority domestic corporate shareholders, the 10/50 corporation (or the majority domestic corporate shareholders on behalf of the 10/50 corporation) may elect to use any of the methods described in Sec. 1.8619T or Sec. 1.8619 (that is, the modified gross income, tax book value, alternative tax book value or fair market value method) to apportion the 10/50 corporation's interest expense.

Section 1.8619T(j)(1) provides a rule for ``tiering up'' the income of tiers of controlled foreign corporations (CFCs) that use the modified gross income method to apportion interest expense. Under that rule, the lowesttier CFC's interest expense is allocated and apportioned based on its gross income, and its gross income reduced by such allocated and apportioned interest expense is then treated as gross income of the nexthighertier CFC for purposes of apportioning the highertier CFC's interest expense. These steps are then essentially repeated, moving up the tiers. A commenter requested that the IRS and the Treasury Department clarify the mechanics of apportioning interest expense when tiered corporations elect different apportionment methods. This commenter raises issues that are beyond the scope of this regulation project and therefore are not addressed in this document.

B. Definition of ``10 Percent Owned Corporation''

Prior to revision by the 2006 temporary regulations, Sec. 1.861 12T(c)(2) required an affiliated group using the tax book value method in apportioning its interest expense to adjust the basis of stock in any ``10 percent owned corporation'' that is held directly by members of the group to reflect each member's pro rata share of such 10 percent owned corporation's earnings and profits (or deficit in earnings and profits). The rule, as revised by the 2006 temporary regulations, applies to stock
[[Page 27869]]
of a 10 percent owned corporation not only where its stock is held directly by members of the affiliated group, but also where its stock is held indirectly through a partnership or other passthrough entity. The revision was effective on April 25, 2006, and applied
prospectively. The IRS and the Treasury Department stated in the preamble to the 2006 temporary regulations that the revision was a clarification.

A commenter questioned why the regulations include a prospective, rather than a retroactive, effective date, if the revision clarified existing law. The IRS and the Treasury Department maintain that the revision is a clarification of existing law but continue to believe a prospective effective date is appropriate because the prior regulations were ambiguous.

II. Carryover of Unused Foreign Taxes Under Section 904(c)

In the case of unused foreign taxes attributable to dividends from a 10/50 corporation with respect to which the taxpayer was no longer a qualifying shareholder as of the first day of the taxpayer's first taxable year ending after the first day of the 10/50 corporation's first post2002 taxable year, Sec. 1.9042T(h)(1) provides that the unused foreign taxes are allocated among the taxpayer's separate categories in the same percentages as the earnings in the 10/50 corporation's nonlookthrough pool or pre1987 accumulated profits ``would have been assigned had they been distributed in the last taxable year in which the taxpayer was a domestic shareholder in such corporation.'' In response to a comment, Sec. 1.9042(h)(1) of the final regulations clarifies that such taxes will be allocated as if lookthrough treatment applied in the year of the hypothetical distribution.
III. LookThrough Rules as Applied to 10/50 Corporations

A. General Application of LookThrough

With respect to applying the lookthrough rule to any dividend paid by a 10/50 corporation in a post2002 taxable year, Sec. 1.904 5T(c)(4)(iii) of the 2006 temporary regulations provides that any dividends paid in a post2002 taxable year to a domestic corporation by a 10/50 corporation with respect to which the domestic corporation meets the stock ownership requirements of section 902(a) are treated as income in a separate category in proportion to the ratio of the portion of earnings and profits of the 10/50 corporation attributable to income in such category to the total amount of earnings and profits of the 10/ 50 corporation.

A commenter expressed concern that in some cases, where a domestic shareholder meets the stock ownership requirements of section 902(a) but has a relatively small ownership interest, the administrative burden on both the taxpayer and the IRS of applying lookthrough to earnings and foreign taxes in a 10/50 corporation's lookthrough pools could be significant. The commenter asserted that the process of obtaining and analyzing multiple years of historical financial data to ascertain the exact portion of distributions that relate to specific categories of income can be challenging, particularly where distributions relate to earnings from certain historical periods (for example, those during which the taxpayer did not own stock in the 10/50 corporation). The commenter indicated that the reconstruction and safe harbor methods provided in Sec. 1.9047T(f)(4)(i) and (ii) of the 2006 temporary regulations, respectively, reduce difficulties in reconstructing historical accumulated earnings and taxes accounts of a 10/50 corporation, but those rules apply only to undistributed earnings and taxes accumulated in nonlookthrough periods and do not apply to distributions of earnings accumulated in lookthrough pools. The commenter suggested that the IRS and the Treasury Department consider providing an elective safe harbor approach for domestic shareholders who own a relatively small interest, such as 15 percent or less, in the 10/50 corporation, which would characterize a dividend paid by a 10/50 corporation as income in a separate category by reference to the gross revenue of the 10/50 corporation for the last three years or a similar abbreviated period, with antiabuse rules to address distortions.

The IRS and the Treasury Department recognize that in some circumstances a domestic shareholder of a 10/50 corporation (as well as a noncontrolling shareholder of a controlled foreign corporation (CFC)) may face difficulties in substantiating accumulated earnings and taxes accounts of the 10/50 corporation (or CFC) on a lookthrough basis. However, the IRS and the Treasury Department believe use of a safe harbor is appropriate only as a limited rule for reconstructing earnings and taxes accumulated during prior year periods when the look through rules did not apply to dividends from 10/50 corporations. An ongoing safe harbor is not appropriate because the statutory look through rules, which apply to all domestic shareholders meeting the stock ownership requirements of section 902(a) (that is, 10 percent), generally require substantiation, and if the lookthrough treatment of a dividend from a 10/50 corporation has not been adequately substantiated, section 904(d)(4)(C)(ii) requires that such dividend be treated as passive income. See also Sec. 1.9045T(c)(4)(iii) of the 2006 temporary regulations.

B. Substantiation of LookThrough Treatment

Section 1.9045T(c)(4)(iii) of the 2006 temporary regulations provides that a dividend from a 10/50 corporation is treated as passive income if the lookthrough characterization of the dividend is not substantiated to the satisfaction of the Commissioner.

A commenter expressed concern that if a 10/50 corporation has high taxed income outside the general and passive categories a taxpayer may intentionally fail to substantiate the lookthrough characterization of a dividend from the 10/50 corporation in order to achieve cross crediting. The commenter suggested that the final regulations include an antiabuse rule for situations where the Commissioner determines that a taxpayer deliberately failed to substantiate the lookthrough characterization of the dividend. The commenter suggested that the antiabuse rule could provide that in such a situation the earnings and associated taxes would be placed in a separate subbasket to prevent crosscrediting. Alternatively, the commenter suggested that the final regulations could apply rules similar to the rules of section 907. Finally, the commenter suggested that the inadequate substantiation rule in Sec. 1.9045T(c)(4)(iii) should be revised to conform to the rule in Sec. 1.9047T(f)(4)(iii), which provides that the Commissioner will allocate the undistributed earnings and taxes in the nonlook through pools to the foreign corporation's passive category only if the Commissioner determines that the lookthrough characterization of such earnings and taxes cannot reasonably be determined based on the available information. The IRS and the Treasury Department agree with this latter suggestion, and the rule in Sec. 1.9045(c)(4)(iii) of the final regulations adopts this comment.

C. Application of Section 904(h) to 10/50 Corporations

For purposes of the section 904 foreign tax credit limitation, section 904(h) (section 904(g) prior to redesignation in the AJCA) provides that certain income derived from a United Statesowned foreign corporation which would be treated as foreign source income under other Code provisions is
[[Page 27870]]
treated as U.S. source income. This resourcing rule applies to certain payments of interest and dividends by a United Statesowned foreign corporation as well as inclusions in gross income under sections 951(a) and 1293 to the extent the payments or inclusions are attributable to income of the United Statesowned foreign corporation from sources within the United States. Section 904(h)(6) generally defines a United Statesowned foreign corporation as any foreign corporation if United States persons (as defined in section 7701(a)(30)) hold 50 percent or more of either the total combined voting power of all classes of voting stock or the total value of the stock.

Section 1.9045(m) provides rules for the resourcing of certain amounts received or accrued (or treated as received or accrued) by a United States shareholder (as defined in section 951(b)) from a United Statesowned foreign corporation. Section 1.9045T(m)(1) of the 2006 temporary regulations clarified that the resourcing rule applies not only to CFCs but also to 10/50 corporations that meet the definition of a United Statesowned foreign corporation, and Sec. 1.9045T(m)(2)(ii) and (4) provide rules for resourcing interest and dividend payments from 10/50 corporations.

In the preamble to the 2006 temporary regulations, the IRS and the Treasury Department stated that this revision clarified that the rules for resourcing interest and dividends also apply to a 10/50 corporation that meets the definition of a United Statesowned foreign corporation.

A commenter suggested that the inclusion of 10/50 corporations within the resourcing rule of Sec. 1.9045T(m) was not simply a clarification and that the combination of referring to this provision as only a clarification and the prospective application of the rule is confusing. In addition, the commenter requested guidance on the appropriate treatment of dividends from 10/50 corporations for 2003 through 2006 under section 904(h) (section 904(g) as applicable for those years). The commenter suggested that Sec. 1.9045T(m) be made retroactive to 2003 (or 2005 for taxpayers electing to apply the pre AJCA section 904(d) rules to assign dividends paid by 10/50 corporations in their 2003 and 2004 taxable years to a single separate category for dividends from all 10/50 corporations) to match the retroactive effective date of the statutory changes to the lookthrough rules for 10/50 corporations and of the Sec. 1.9047T rules for reconstructing nonlookthrough pools.

This comment is not adopted. The IRS and the Treasury Department continue to believe that the revision is a clarification of existing law. A retroactive effective date is unnecessary, however, because the statute provides the applicable rule.

A commenter suggested that, because section 904(h) applies exactly the same rule to both section 951(a) and section 1293 inclusions, Sec. 1.9045(m)(5) (other than the special rules for related person interest expense which are incorporated by crossreference) should also reference section 1293 inclusions from United Statesowned 10/50 corporations. The IRS and the Treasury Department agree, and Sec. 1.9045(m)(5) of the final regulations adopts this comment.
D. Treatment of Earnings and Taxes Accumulated During a NonLook Through Period

i. Reconstruction Method

Section 1.9047T(f)(2) of the 2006 temporary regulations provides that any undistributed earnings and foreign income taxes in the non lookthrough pools of a 10/50 corporation that were accumulated and paid as of the end of the 10/50 corporation's last pre2003 taxable year are treated as if they were accumulated and paid during a period in which a distribution would have been eligible for lookthrough treatment. Section 1.9047T(f)(4)(i) of the 2006 temporary regulations provides that in order to substantiate the lookthrough
characterization of the earnings and taxes in the nonlookthrough pools, the taxpayer must make a reasonable, goodfaith effort to reconstruct the nonlookthrough pools of earnings and taxes for each year in the nonlookthrough period, beginning with the first year in which earnings were accumulated in the nonlookthrough pool. Section 1.9047T(f)(4)(i) further provides that reconstruction will be based on reasonably available books and records and other relevant information, and must take into account earnings distributed and taxes deemed paid in the nonlookthrough period as if they were distributed and deemed paid pro rata from the amounts that were added to the nonlookthrough pools during the nonlookthrough period.

In recognition of the difficulty in reconstructing the pools, the IRS and the Treasury Department stated in the preamble to the 2006 temporary regulations that a reasonable approximation of the amounts properly included in the lookthrough pools, based on available records obtained through reasonable, goodfaith efforts by the taxpayer, will adequately substantiate the reconstruction required by the statute.

A commenter suggested that clarification of what constitutes other relevant information would be helpful. The IRS and the Treasury Department do not adopt this comment because the substantiation requirement requires evaluation of the facts and circumstances of each situation.

With respect to earnings accumulated and foreign taxes paid in the 2003 through 2006 taxable years, a commenter suggested that the rules in the 2006 temporary regulations concerning the lookthrough characterization and reconstruction of earnings and taxes in the non lookthrough pools need to be clarified to provide that taxpayers are required to determine the subcharacterization of earnings and taxes, if relevant. As an example, the commenter stated that if a 10/50 corporation conducts a financing business but does not itself qualify as a financial services entity within the meaning of Sec. 1.904 4(e)(3)(i), a qualifying shareholder of the 10/50 corporation must (if the shareholder does not elect the safe harbor method) determine what portion of the nonlookthrough earnings qualify as active financing income as defined in Sec. 1.9044(e)(2)(i). Such a determination would be necessary in order to determine whether the income would be placed in the separate category for financial services income upon distribution to an uppertier financial services entity. The IRS and the Treasury Department agree with this comment that sub
characterization of earnings and taxes is required, if relevant, in determining the lookthrough characterization of earnings and taxes in the nonlookthrough pools and in reconstructing such pools. However, the IRS and the Treasury Department believe that the 2006 temporary regulations already require reconstruction as if lookthrough applied for all section 904 purposes, including any relevant sub
characterization of the earnings and taxes pools. Accordingly, the final regulations adopt the rule in the 2006 temporary regulations without change.

ii. Safe Harbor

Section 1.9047T(f)(4)(ii) of the 2006 temporary regulations provides a safe harbor in reconstructing the nonlookthrough pools under which a taxpayer may allocate the earnings and taxes in the non lookthrough pools ratably to the lookthrough pools on the first day of the 10/50 corporation's first post2002 taxable year in the same percentages as the taxpayer (or the qualified group member that owns the
[[Page 27871]]
10/50 corporation) properly characterizes the stock of the 10/50 corporation in the separate categories for purposes of apportioning the taxpayer's (or qualified group member's) interest expense in its first taxable year ending after the first day of the 10/50 corporation's first post2002 taxable year. If a taxpayer elects to use the safe harbor method with respect to a 10/50 corporation that uses the modified gross income method to apportion interest expense for the 10/ 50 corporation's first post2002 taxable year, earnings and taxes in the nonlookthrough pools are allocated to the lookthrough pools based on an average of the 10/50 corporation's modified gross income ratios for its taxable years beginning in 2003 and 2004. The IRS and the Treasury Department stated in the preamble to the 2006 temporary regulations that the twoyear base period rule is necessary to avoid potential distortions associated with allocating earnings and taxes from the nonlookthrough pool to the lookthrough pools based on the 10/50 corporation's modified gross income for just one taxable year.

A commenter suggested that other potential distortions are not addressed in Sec. 1.9047T(f)(4)(ii), such as instances in which a material change in the foreign corporation's operations (or asset composition) would distort the characterization of the nonlookthrough earnings and taxes under the safe harbor method. The commenter suggested that conditioning the use of the safe harbor method on the lack of any material change in the foreign corporation's operations, structure, assets or income from the nonlookthrough period would reduce the likelihood of a distortion.

The IRS and the Treasury Department acknowledge that the safe harbor method does not address all potential distortions. However, the purpose of the safe harbor method is to provide certainty and to minimize administrative burdens. The IRS and the Treasury Department believe that revising the safe harbor method to reflect the commenter's suggestion would diminish these benefits of the safe harbor method.

A commenter also suggested that the regulations should include guidance on how the safe harbor method election is to be made and the time frame for making the election. The commenter suggested that taxpayers should be allowed to elect the safe harbor method retroactively, on an amended return or during audit.

The IRS and the Treasury Department agree with this comment. The final regulations provide that taxpayers may choose to use the safe harbor method on either timely filed or amended tax returns or during audit. However, if a taxpayer chooses to use the safe harbor method on an amended return or in the course of an audit, the taxpayer must make appropriate adjustments to eliminate any duplicate benefits arising from application of the safe harbor method to taxable years that are not open for assessment. A taxpayer's choice to use the safe harbor method is evidenced by simply employing the method. No separate statement need be filed.

In addition, the final regulations clarify that the safe harbor method is only available as a transition rule for taxpayers who were required to characterize the stock of the foreign corporation for purposes of apportioning interest expense in the taxpayer's first taxable year ending after the first day of the foreign corporation's first post2002 taxable year. The safe harbor is not available to determine the lookthrough treatment of earnings accumulated by a foreign corporation that did not have a shareholder that was entitled to lookthrough treatment in such a year.
iii. Treatment of a Deficit Accumulated in a NonLookThrough Period

Section 1.9047T(f)(5) of the 2006 temporary regulations provides that if there is an accumulated deficit in the nonlookthrough pool of a 10/50 corporation or a CFC as of the end of the foreign corporation's last pre2003 taxable year, the deficit and associated taxes, if any, are treated as if they had been accumulated and paid during a look through period. The earnings and deficits in earnings making up the accumulated deficit are assigned to the lookthrough pools based on where the foreign corporation's income and expenses or losses would have been assigned had they been incurred during a lookthrough period, or, if the taxpayer uses the safe harbor method, the deficit is allocated based on how the stock of the foreign corporation is properly characterized for interest expense apportionment purposes.

A commenter suggested that the regulations should clarify that, for shareholders not using the safe harbor method, one or more separate income categories could have positive earnings, while one or more separate income categories could have a greater deficit. Thus, for example, if a 10/50 corporation had a $100 deficit accumulated in its nonlookthrough pool as of the end of its last pre2003 taxable year, the deficit could consist of a $200 deficit in general limitation income and $100 earnings in the separate category for shipping income.

The IRS and the Treasury Department believe that Sec. 1.904 7T(f)(5) of the 2006 temporary regulations is clear that, as part of reconstruction of a nonlookthrough pool that contains an accumulated deficit, one or more separate income categories could have positive earnings, while one or more separate income categories could have a greater deficit, and that therefore, the rule does not need to be revised to reflect the comment.

iv. Section 952(c) Recapture Accounts

In response to a comment, Sec. 1.9047(f)(7) of the final regulations provides that section 952(c)(2) recapture accounts maintained by a CFC with respect to dividends received from a 10/50 corporation that were subject to the earnings and profits limitation of section 952(c)(1) are allocated to separate categories in the same manner as the associated post1986 undistributed earnings.

v. GOZA Election

Conforming changes are made to the transition rules at Sec. 1.904 7(f)(9) for taxpayers electing to defer the applicability of the look through rules for two years to reflect changes in response to comments made with respect to the general transition rules of Sec. 1.904 7(f)(7).

E. PreAcquisition E&P

Section 904(d)(4)(C)(i)(II), as amended by the AJCA, provides that the Secretary may prescribe regulations regarding the treatment of distributions out of earnings and profits of a 10/50 corporation for periods before the taxpayer's acquisition of the stock to which the distributions relate (preacquisition E&P). Such distributions may be out of post1986 undistributed earnings accumulated by a 10/50 corporation before the specific shareholder acquired its stock or out of pre1987 accumulated profits accumulated before the 10/50 corporation had any qualifying shareholder. The 2006 temporary regulations extend lookthrough treatment to dividends out of earnings and profits accumulated in nonlookthrough periods during which a 10/ 50 corporation or a CFC had no qualifying shareholder and do not restrict lookthrough treatment of dividends paid to a new qualifying shareholder of an existing 10/50 corporation. The preamble to the 2006 temporary regulations stated that the IRS and the Treasury Department believe that look
[[Page 27872]]
through treatment of preacquisition earnings is the more appropriate policy result than passive category treatment, if lookthrough characterization can be adequately substantiated under Sec. Sec. 1.9045T(c)(4)(iii) and 1.9047T(f)(4).

A commenter suggested that the extension of lookthrough treatment to preacquisition E&P is inappropriate because the liberalized cross crediting of foreign taxes permitted by this treatment may encourage taxmotivated acquisitions in order to traffic in excess foreign taxes. The commenter suggested that the IRS and the Treasury Department exercise the regulatory authority under section 904(d)(4)(C)(i)(II) to create new separate categories for preacquisition earnings and profits.

This comment is not adopted. The IRS and the Treasury Department continue to believe that lookthrough treatment of preacquisition earnings, where the earnings and taxes are substantiated, is the more appropriate policy result. Moreover, denying lookthrough treatment to dividends of earnings of a 10/50 corporation accumulated prior to a specific shareholder's acquisition of stock entails unacceptable administrative complexity associated with maintaining multiple sets of lookthrough pools starting on different dates for different shareholders. Accordingly, the final regulations adopt the rule in the 2006 temporary regulations without change.
IV. Recapture of an Overall Foreign Loss or Separate Limitation Loss Incurred in a Separate Category for Dividends From a 10/50 Corporation

Section 1.904(f)12T(g)(1) of the 2006 temporary regulations provides that where a taxpayer had an overall foreign loss (OFL) or separate limitation loss (SLL) in a separate category for dividends from a 10/50 corporation, the OFL or SLL account is recaptured in subsequent taxable years out of income in the same separate categories in which the stock of the 10/50 corporation is properly characterized for purposes of apportioning the taxpayer's interest expense in its first taxable year in which dividends from the 10/50 corporation are eligible for lookthrough treatment (that is, its first taxable year ending after the first day of the 10/50 corporation's first post2002 taxable year).

A commenter suggested that a rule providing for recapture of the OFL or SLL from the other separate categories in the same proportions that postOFL or SLL dividends from the 10/50 corporation would have been assigned to such other separate categories had lookthrough applied would be more consistent with Sec. 1.9042T(h)(1) and (2) (carryovers of excess foreign taxes from 10/50 baskets) and Sec. 1.9047T(f)(2) and (3) (characterization of nonlookthrough pools as if lookthrough had applied) that generally take the approach of following the consequences that would have applied if lookthrough had always been in effect. This comment is not adopted. The IRS and the Treasury Department stated in the preamble to the 2006 temporary regulations and continue to believe that recapturing losses from income earned in subsequent years is a forwardlooking concept, and that reallocating OFL and SLL accounts based on the interest expense apportionment ratio (as opposed to, for example, reallocating losses based on reconstructed nonlookthrough pools) is consistent with that concept.
V. Regulations Under Section 964
A. Tax Elections, Adoptions of Method of Accounting or Taxable Year, and Changes in Method of Accounting or Taxable Year Made on Behalf of a CFC or 10/50 Corporation

The 2006 temporary regulations at Sec. 1.9641T(c)(2) and (3) provide rules allowing the majority domestic corporate shareholders of a 10/50 corporation to make an election, adopt a method of accounting or taxable year, or change a method of accounting or taxable year on behalf of the 10/50 corporation. The 2006 temporary regulations also allow the controlling United States shareholders of a CFC to make an election, adopt a method of accounting or taxable year, or change a method of accounting or taxable year on behalf of the CFC. Section 1.9641T(c)(2) provides that for the first taxable year of a foreign corporation beginning after April 25, 2006, in which such foreign corporation first qualifies as a CFC or 10/50 corporation, any method of accounting or taxable year allowable under this section may be adopted or elected by such foreign corporation or on its behalf notwithstanding that, in previous years, its books or financial statements were 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. Section 1.9641T(c)(6) further provides that such actions may be deferred until the first year in which the computation of the foreign corporation's earnings and profits is significant for U.S. tax purposes, and includes a nonexclusive list of significant events for taxable years beginning after April 25, 2006.

Section 1.9641T(c)(4) of the 2006 temporary regulations acknowledges that a 10/50 corporation may have had a significant event in taxable years beginning on or before April 25, 2006, such as a distribution with respect to which the corporation's shareholder could claim a deemedpaid foreign tax credit under section 902. In order to determine the allowable foreign tax credit, at the time of the distribution the 10/50 corporation's domestic corporate shareholder would have had to compute the 10/50 corporation's earnings and profits, even though no procedure was then available for the controlling domestic shareholders to adopt or elect accounting methods on the 10/50 corporation's behalf. Section 1.9641T(c)(4) provides that in this situation the 10/50 corporation's earnings and profits shall be computed as if no accounting method elections were made and any permissible accounting method not requiring an election and reflected in the books of account regularly maintained by the 10/50 corporation for purposes of accounting to its shareholders had been adopted. Thereafter, in taxable years beginning after April 25, 2006, the 10/50 corporation, or its controlling domestic shareholders, must obtain the consent of the Commissioner in order to change a particular accounting method or methods (or its taxable year) pursuant to the applicable revenue procedure. A commenter suggested that in post2006 years the controlling domestic shareholders of a 10/50 corporation should be permitted to change accounting methods on its behalf without obtaining the consent of the Commissioner or making adjustments to the 10/50 corporation's earnings and profits under the principles of section 481 to prevent the duplication or omission of amounts attributable to previous years. This comment is not adopted. The IRS and the Treasury Department believe that it would be inappropriate to give the controlling domestic shareholders of a 10/50 corporation this type of ``fresh start.''

A commenter recommended simplifying the procedures in Sec. 1.964 1T(c)(3) of the 2006 temporary regulations by which controlling domestic shareholders may make an election or adopt or change a method of accounting or taxable year on behalf of a foreign corporation. Specifically, the commenter suggested that Sec. 1.9641T(c)(3)(i) and (ii) be revised to provide that where a United States shareholder changes a method of accounting on behalf of a CFC of which it is the sole shareholder, such shareholder need file
[[Page 27873]]
only the original Form 3115 with its tax return, and need not file the statement (described in Sec. 1.9641T(c)(3)(ii)) that is required to be filed with each controlling domestic shareholder's tax return. The IRS and the Treasury Department agree with the comment and believe it is equally applicable to changes in the taxable year of the CFC. Accordingly, Sec. 1.9641(c)(3)(ii) of the final regulations provides that in the case of a controlling domestic shareholder that is the sole shareholder of a CFC, no separate statement need be filed if the information described in Sec. 1.9641(c)(3)(ii) is included on Form 5471 (Information Return of U.S. Persons With Respect to Certain Foreign Corporations) and Form 3115 (Application for Change in Accounting Method) or Form 1128 (Application to Adopt, Change or Retain a Tax Year), as applicable, filed with respect to the CFC with the shareholder's return for such taxable year.

B. Section 481(a) Adjustments

Prior to its expiration, Sec. 1.9641T(g)(5) provided that adjustments to the appropriate separate category of earnings and profits and income of the controlled foreign corporation was required using the principles of section 481(a) to prevent any duplication or omission of amounts attributable to previous years that would otherwise result from any election or adoption of a method of accounting. This provision was crossreferenced in Sec. 1.9641T(c)(4) of the 2006 temporary regulations. Commenters requested clarification regarding the mechanics of making the adjustments according to the principles of section 481(a), such as the period over which the section 481(a) adjustment is spread and whether a correlative section 481(a) adjustment should be made at the domestic shareholder level in order to capture an increased subpart F inclusion that would have been generated had earnings and profits initially been determined using the method subsequently elected or adopted. One commenter suggested that the regulations state specifically that the applicable domestic principles should apply so that the section 481 adjustment would be taken into account in determining the current earnings and profits of the CFC or 10/50 corporation beginning with the year of change and for the same period as the adjustment is taken into account for purposes of computing taxable income.

In response to the comment, Sec. 1.9641(c)(2) of the final regulations provides that adjustments to the appropriate separate category (as defined in Sec. 1.9045(a)(1)) of earnings and profits and income of the foreign corporation shall be required under section 481 to prevent any duplication or omission of amounts attributable to previous years that would otherwise result from any change in a method of accounting. The details concerning the section 481 adjustment are addressed in applicable revenue procedures. See, for example, Rev. Proc. 200852, 200836 IRB 587.

C. Miscellaneous CrossReferences

The 2006 temporary regulations included in Sec. 1.9641T(c)(4) crossreferences to expired Sec. 1.9641T(g) that are updated in the final regulations. In addition, Sec. 1.9641(c)(2) of the final regulations adds crossreferences to Sec. Sec. 1.9855, 1.9856, and 1.9867, which provide that a qualified business unit must make adjustments to its earnings and profits when it changes its functional currency or begins to use the dollar approximate separate transactions method of accounting.

Section 1.9641(b)(1)(v) includes a crossreference to ``paragraph (d) of this section.'' Because of revisions to Sec. 1.9641, that crossreference and a similar crossreference in Sec. 1.989(b)1 were no longer effective. The final regulations replace the crossreferences to paragraph (d) with the appropriate crossreference to section 988 and the regulations under that section.

Special Analyses

It has been determined that this Treasury decision is not a significant regulatory action as defined in Executive Order 12866. Therefore, a regulatory assessment is not required. It has also been determined that section 553(b) of 5 U.S.C. chapter 5 does not apply to these regulations, and, because the regulations do not impose a collection of information on small entities, the Regulatory Flexibility Act, 5 U.S.C. chapter 6, does not apply. Pursuant to section 7805(f) of the Code, the notice of proposed rulemaking preceding this regulation and temporary regulations were submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on their impact on small businesses.

Drafting Information

The principal authors of the final regulations are Richard Chewning and Jeffrey Parry of the Office of Associate Chief Counsel (International). However, other personnel from the Treasury Department and the IRS participated in their development.
List of Subjects

26 CFR Part 1

Income taxes, Reporting and recordkeeping requirements. 26 CFR Part 602

Reporting and recordkeeping requirements.
Adoption of Amendments to the Regulations
Accordingly, 26 CFR parts 1 and 602 are amended as follows: PART 1INCOME TAXES
Paragraph 1. The authority for part 1 continues to read in part as follows:

Authority: 26 U.S.C. 7805 * * *
Par. 2. Section 1.8619 is amended by removing paragraphs (h)(5)(iii) and (i)(4), revising paragraphs (a), (b), (c), (d), (e), (f), and (g)(1)(i), and adding paragraph (k), to read as follows:
1.8619 Allocation and apportionment of interest expense.
(a) through (f)(3)(i) [Reserved]. For further guidance, see Sec. 1.8619T(a) through (f)(3)(i).
(f)(3)(ii) Manner of election. The election shall be made by filing the statement and providing the written notice described in Sec. 1.9641(c)(3)(ii) and (iii), respectively, at the time and in the manner described therein. For further guidance, see Sec. 1.861 9T(f)(3)(ii).
(f)(3)(iii) and (iv) [Reserved]. For further guidance, see Sec. 1.8619T(f)(3)(iii) and (iv).
(4) Noncontrolled section 902 corporations(i) In general. For purposes of computing earnings and profits of a noncontrolled section 902 corporation (as defined in section 904(d)(2)(E)) for Federal tax purposes, the interest expense of a noncontrolled section 902 corporation may be apportioned using either the asset method described in Sec. 1.8619T(g) or the modified gross income method described in Sec. 1.8619T(j). A noncontrolled section 902 corporation that is not a controlled foreign corporation may elect to use a different method of apportionment than that elected by one or more of its shareholders. A noncontrolled section 902 corporation must use the same method of apportionment with respect to all its domestic corporate shareholders. (ii) Manner of election. The election to use the asset method described in Sec. 1.8619T(g) or the modified gross income method described in Sec. 1.8619T(j) may be made either by the
[[Page 27874]]
noncontrolled section 902 corporation or by the majority domestic corporate shareholders (as defined in Sec. 1.9641(c)(5)(ii)) on behalf of the noncontrolled section 902 corporation. The election shall be made by filing the statement and providing the written notice described in Sec. 1.9641(c)(3)(ii) and (iii), respectively, at the time and in the manner described therein. For further guidance, see Sec. 1.8619T(f)(4)(ii).
(iii) Stock characterization. In general, the stock of a noncontrolled section 902 corporation shall be characterized in the hands of any domestic corporation that meets the ownership requirements of section 902(a) with respect to the noncontrolled section 902 corporation, or in the hands of any member of the same qualified group as defined in section 902(b)(2), using the same method that the noncontrolled section 902 corporation uses to apportion its interest expense. Stock in a noncontrolled section 902 corporation shall be characterized as a passive category asset in the hands of any such shareholder that fails to meet the substantiation requirements of Sec. 1.9045(c)(4)(iii), or in the hands of any shareholder that is not eligible to compute an amount of foreign taxes deemed paid with respect to a dividend from the noncontrolled section 902 corporation for the taxable year. See Sec. 1.86112(c)(4).
(f)(5) through (g)(1)(i) [Reserved]. For further guidance, see Sec. 1.8619T(f)(5) through (g)(1)(i).
* * * * *
(k) Effective/applicability date. Paragraph (h)(5) of this section applies to taxable years beginning after December 31, 1989. Paragraph (i) of this section applies to taxable years beginning on or after March 26, 2004. Paragraphs (f)(3)(ii) and (4) of this section apply to taxable years of shareholders ending on or after April 20, 2009. See 26 CFR 1.8619T(f)(3)(ii)(last sentence) and (4) (revised as of April 1, 2009) for rules applicable to taxable years of shareholders ending after the first day of the first taxable year of the noncontrolled section 902 corporation beginning after December 31, 2002, and ending before April 20, 2009.
Par. 3. Section 1.8619T is amended as follows:
1. Remove paragraph (b)(6)(viii).
2. Revise the last sentence of paragraph (f)(3)(ii) and paragraph (f)(4).
3. Add paragraph (k).

The revisions and additions read as follows:
Sec. 1.8619T Allocation and apportionment of interest expense (temporary).
* * * * *
(f) * * *
(3) * * *
(ii) * * * For guidance relating to the time and manner of this election, see Sec. 1.8619(f)(3)(ii).
* * * * *
(4) * * * For further guidance, see Sec. 1.8619(f)(4). * * * * *
(k) Effective/applicability dates. Paragraph (b)(6) of this section applies to losses on any transaction described in paragraph (b)(6)(i) of this section that was entered into after September 14, 1988. Paragraph (b)(6) of this section also applies to any gain that was realized on any transaction described in paragraph (b)(6)(i) of this section that was entered into after August 11, 1989. Taxpayers may also apply paragraph (b)(6) of this section to any gain that was realized on any transaction described in paragraph (b)(6)(i) of this section that was entered into after September 14, 1988, and on or before August 11, 1989, if the taxpayer can demonstrate to the satisfaction of the Commissioner that substantially all of the arrangements described in paragraph (b)(6)(i) of this section to which the taxpayer became a party during that interim period were identified on the taxpayer's books and records with the liabilities of the taxpayer in a substantially contemporaneous manner and that all losses and expenses that are subject to the rules of paragraph (b)(6) of this section were treated in the same manner as interest expense. For this purpose, arrangements that were identified in a substantially contemporaneous manner with the taxpayer's assets shall be ignored. For further guidance, see Sec. 1.8619(k).
Par. 4. Section 1.86112 is added as follows:
Sec. 1.86112 Characterization rules and adjustments for certain assets.
(a) through (c)(1) [Reserved]. For further guidance, see Sec. 1.86112T(a) through (c)(1).
(2) Basis adjustment for stock in nonaffiliated 10 percent owned corporations (i) Taxpayers using the tax book value method(A) General rule. For purposes of apportioning expenses on the basis of the tax book value of assets, the adjusted basis of any stock in a 10 percent owned corporation owned by the taxpayer either directly or, for taxable years beginning after April 25, 2006, indirectly through a partnership or other passthrough entity shall be
(1) Increased by the amount of the earnings and profits of such corporation (and of lowertier 10 percent owned corporations) attributable to such stock and accumulated during the period the taxpayer or other members of its affiliated group held 10 percent or more of such stock; or
(2) Reduced (but not below zero) by any deficit in earnings and profits of such corporation (and of lowertier 10 percent owned corporations) attributable to such stock for such period.
(c)(2)(i)(B) through (c)(3) [Reserved] For further guidance, see Sec. 1.86112T(c)(2)(i)(B) through (c)(3).
(4) Characterization of stock of noncontrolled section 902 corporations(i) General rule. The principles of Sec. 1.86112T(c)(3) shall apply to stock in a noncontrolled section 902 corporation (as defined in section 904(d)(2)(E)). Accordingly, stock in a noncontrolled section 902 corporation shall be characterized as an asset in the various separate limitation categories on the basis of either the asset method described in Sec. 1.86112T(c)(3)(ii) or the modified gross income method described in Sec. 1.86112T(c)(3)(iii). Stock in a noncontrolled section 902 corporation the interest expense of which is apportioned on the basis of assets shall be characterized in the hands of its domestic shareholders (as defined in Sec. 1.9021(a)(1)) under the asset method described in Sec. 1.86112T(c)(3)(ii). Stock in a noncontrolled section 902 corporation the interest expense of which is apportioned on the basis of gross income shall be characterized in the hands of its domestic shareholders under the gross income method described in Sec. 1.86112T(c)(3)(iii).
(ii) Nonqualifying shareholders. Stock in a noncontrolled section 902 corporation shall be characterized as a passive category asset in the hands of a shareholder that is not eligible to compute an amount of foreign taxes deemed paid with respect to a dividend from the noncontrolled section 902 corporation for the taxable year, and in the hands of any shareholder with respect to whom lookthrough treatment is not substantiated. See Sec. 1.9045(c)(4)(iii).
(5) Effective/applicability date. Paragraphs (c)(2)(i)(A) and (4) of this section apply to taxable years of shareholders ending on or after April 20, 2009. See 26 CFR Sec. 1.86112T(c)(2)(i) introductory text, (2)(i)(A), (2)(i)(B), and (4) (revised as of April 1, 2009) for rules applicable to taxable years of shareholders ending after the first day of the first taxable year of the
[[Page 27875]]
noncontrolled section 902 corporation beginning after December 31, 2002, and ending before April 20, 2009.
(d) through (j) [Reserved]. For further guidance, see Sec. 1.861 12T(d) through (j).
Par. 5. Section 1.86112T is amended as follows:
1. Paragraph (c)(2)(i) introductory text is removed.
2. Paragraph (c)(2)(i)(A) is revised.
3. Paragraph (c)(2)(i)(B) is removed.
4. A paragraph heading is added to the undesignated text following paragraph (c)(2), which is designated as new paragraph (c)(2)(i)(B). 5. Paragraph (c)(4) is revised.
6. A new paragraph (c)(5) is added.

The revisions and additions read as follows:
Sec. 1.86112T Characterization rules and adjustments for certain assets (temporary).
* * * * *
(c) * * *
(2)(i)(A) [Reserved]. For further guidance, see Sec. 1.861 12(c)(2)(i)(A).
(B) Computational rules. * * *
(4) [Reserved]. For further guidance, see Sec. 1.86112(c)(4). (5) [Reserved]. For further guidance, see Sec. 1.86112(c)(5). * * * * *
Par. 6. Section 1.9021 is amended by revising paragraphs (a)(4)(ii), (a)(6), (a)(7), (a)(8)(i), (c)(8), (d)(1), (d)(2)(i), and (g) to read as follows:
Sec. 1.9021 Credit for domestic corporate shareholder of a foreign corporation for foreign income taxes paid by the foreign corporation. (a) * * *
(4) * * *
(ii) Fourth, fifth, or sixthtier corporation. In the case of dividends paid to a third, fourth, or fifthtier corporation by a foreign corporation in a taxable year beginning after August 5, 1997, the foreign corporation is a fourth, fifth, or sixthtier
corporation, respectively, if at the time the dividend is paid, the corporation receiving the dividend owns at least 10 percent of the foreign corporation's voting stock, the chain of foreign corporations that includes the foreign corporation is connected through stock ownership of at least 10 percent of their voting stock, the domestic shareholder in the firsttier corporation in such chain indirectly owns at least 5 percent of the voting stock of the foreign corporation through such chain, such corporation is a controlled foreign corporation (as defined in section 957) and the domestic shareholder is a United States shareholder (as defined in section 951(b)) in the foreign corporation. Taxes paid by a fourth, fifth, or sixthtier corporation shall be taken into account in determining post1986 foreign income taxes only if such taxes are paid with respect to taxable years beginning after August 5, 1997, in which the corporation was a controlled foreign corporation.
* * * * *
(6) Upper and lowertier corporations. In the case of a sixthtier corporation, the term uppertier corporation means a first, second, third, fourth, or fifthtier corporation. In the case of a fifthtier corporation, the term uppertier corporation means a first, second, third, or fourthtier corporation. In the case of a fourthtier corporation, the term uppertier corporation means a first, second, or thirdtier corporation. In the case of a thirdtier corporation, the term uppertier corporation means a first or secondtier corporation. In the case of a secondtier corporation, the term uppertier corporation means a firsttier corporation. In the case of a firsttier corporation, the term lowertier corporation means a second, third, fourth, fifth, or sixthtier corporation. In the case of a second tier corporation, the term lowertier corporation means a third, fourth, fifth, or sixthtier corporation. In the case of a thirdtier corporation, the term lowertier corporation means a fourth, fifth, or sixthtier corporation. In the case of a fourthtier corporation, the term lowertier corporation means a fifth or sixthtier
corporation. In the case of a fifthtier corporation, the term lower tier corporation means a sixthtier corporation.
(7) Foreign income taxes. The term foreign income taxes means income, war profits, and excess profits taxes as defined in Sec. 1.9012(a), and taxes included in the term income, war profits, and excess profits taxes by reason of section 903, that are imposed by a foreign country or a possession of the United States, including any such taxes deemed paid by a foreign corporation under this section. Foreign income, war profits, and excess profits taxes shall not include amounts excluded from the definition of those taxes pursuant to section 901 and the regulations under that section. See section 901(f) and (i) and paragraph (c)(5) of this section. Foreign income, war profits, and excess profits taxes also shall not include taxes for which a credit is disallowed under section 901 and the regulations under section 901. See section 901(j), (k), and (l), and paragraphs (c)(4) and (8) of this section.
(8) Post1986 foreign income taxes(i) In general. Except as provided in paragraphs (a)(10) and (13) of this section, the term post 1986 foreign income taxes of a foreign corporation means the sum of the foreign income taxes paid, accrued, or deemed paid in the taxable year of the foreign corporation in which it distributes a dividend plus the foreign income taxes paid, accrued, or deemed paid in the foreign corporation's prior taxable years beginning after December 31, 1986, to the extent the foreign taxes were not attributable to dividends distributed to, or earnings otherwise included (for example, under section 304, 367(b), 551, 951(a), 1248, or 1293) in the income of, a foreign or domestic shareholder in prior taxable years. Except as provided in paragraph (b)(4) of this section, foreign taxes paid or deemed paid by the foreign corporation on or with respect to earnings that were distributed or otherwise removed from post1986 undistributed earnings in prior post1986 taxable years shall be removed from post 1986 foreign income taxes regardless of whether the shareholder is eligible to compute an amount of foreign taxes deemed paid under section 902, and regardless of whether the shareholder in fact chose to credit foreign income taxes under section 901 for the year of the distribution or inclusion. Thus, if an amount is distributed or deemed distributed by a foreign corporation to a United States person that is not a domestic shareholder within the meaning of paragraph (a)(1) of this section (for example, an individual or a corporation that owns less than 10% of the foreign corporation's voting stock), or to a foreign person that does not meet the definition of an uppertier corporation under paragraph (a)(6) of this section, then although no foreign income taxes shall be deemed paid under section 902, foreign income taxes attributable to the distribution or deemed distribution that would have been deemed paid had the shareholder met the ownership requirements of paragraphs (a)(1) through (4) of this section shall be removed from post1986 foreign income taxes. Further, if a domestic shareholder chooses to deduct foreign taxes paid or accrued for the taxable year of the distribution or inclusion, it shall nonetheless be deemed to have paid a proportionate share of the foreign corporation's post1986 foreign income taxes under section 902(a), and the foreign income taxes deemed paid must be removed from post1986 foreign income taxes. In the case of a foreign corporation the foreign income taxes of which are determined based on an accounting period of less than one year,
[[Page 27876]]
the term year means that accounting period. See sections 441(b)(3) and 443.
* * * * *
(c) * * *
(8) Effect of certain liquidations, reorganizations, or similar transactions on certain foreign taxes paid or accrued in taxable years beginning on or before August 5, 1997(i) General rule.
Notwithstanding the effect of any liquidation, reorganization, or similar transaction, foreign taxes paid or accrued by a member of a qualified group (as defined in section 902(b)(2)) shall not be eligible to be deemed paid if they were paid or accrued in a taxable year beginning on or before August 5, 1997, by a corporation that was a fourth, fifth or sixthtier corporation with respect to the taxpayer on the first day of the corporation's first taxable year beginning after August 5, 1997.
(ii) Example. The following examples illustrate the application of this paragraph (c)(8):

Example. P, a domestic corporation, has owned 100 percent of the voting stock of foreign corporation S at all times since January 1, 1987. Until June 30, 2002, S owned 100 percent of the voting stock of foreign corporation T, T owned 100 percent of the voting stock of foreign corporation U, and U owned 100 percent of the voting stock of foreign corporation V. P, S, T, U, and V each use the calendar year as their U.S. taxable year. Thus, beginning in 1998 V was a fourthtier controlled foreign corporation, and its foreign taxes paid or accrued in 1998 and later taxable years were eligible to be deemed paid. On June 30, 2002, T was liquidated, causing S to acquire 100 percent of the stock of U. As a result, V became a thirdtier controlled foreign corporation. In 2003, V paid a dividend to U. Under paragraph (c)(8) of this section, foreign taxes paid by V in taxable years beginning before 1998 are not taken into account in computing the foreign taxes deemed paid with respect to the dividend paid by V to U.
(d) Dividends from controlled foreign corporations and noncontrolled section 902 corporations(1) General rule. If a dividend is described in paragraphs (d)(1)(i) through (iv) of this section, the following rules apply. If a dividend is paid out of post1986 undistributed earnings or pre1987 accumulated profits of a foreign corporation attributable to more than one separate category, the amount of foreign income taxes deemed paid by the domestic shareholder or the uppertier corporation under section 902 and paragraph (b) of this section shall be computed separately with respect to the post1986 undistributed earnings or pre1987 accumulated profits in each separate category out of which the dividend is paid. See Sec. 1.9045(c)(4) and (i), and paragraph (d)(2) of this section. The separately computed deemedpaid taxes shall be added to other taxes paid by the domestic shareholder or uppertier corporation with respect to income in the appropriate separate category. The rules of this paragraph (d)(1) apply to dividends received by
(i) A domestic shareholder that is a United States shareholder (as defined in section 951(b) or section 953(c)) from a firsttier corporation that is a controlled foreign corporation;
(ii) A domestic shareholder from a firsttier corporation that is a noncontrolled section 902 corporation;
(iii) An uppertier controlled foreign corporation from a lower tier controlled foreign corporation if the corporations are related lookthrough entities within the meaning of Sec. 1.9045(i) (see Sec. 1.9045(i)(3)); or
(iv) A foreign corporation that is eligible to compute an amount of foreign taxes deemed paid under section 902(b)(1), from a controlled foreign corporation or a noncontrolled section 902 corporation (that is, both the payor and payee corporations are members of the same qualified group as defined in section 902(b)(2) (see Sec. 1.9045 (i)(4)).
(2) Lookthrough(i) Dividends. Any dividend distribution by a controlled foreign corporation or noncontrolled section 902 corporation to a domestic shareholder or a foreign corporation that is eligible to compute an amount of foreign taxes deemed paid under section 902(b)(1) shall be deemed paid pro rata out of each separate category of income. Any dividend distribution by a controlled foreign corporation to a controlled foreign corporation that is a related lookthrough entity within the meaning of Sec. 1.9045(i)(3) shall also be deemed to be paid pro rata out of each separate category of income. See Sec. Sec. 1.9045(c)(4) and (i), and 1.9047. The portion of the foreign income taxes attributable to a particular separate category that shall be deemed paid by the domestic shareholder or uppertier corporation must be computed under the following formula:
[GRAPHIC] [TIFF OMITTED] TR11JN09.004
(g) Effective/applicability dates. This section applies to any distribution made in and after a foreign corporation's first taxable year beginning on or after January 1, 1987, except that the provisions of paragraphs (a)(4)(ii), (a)(6), (a)(7), (a)(8)(i), and (c)(8) of this section and, except as provided in Sec. 1.9047(f)(9), the provisions of paragraph (d) of this section apply to distributions made in taxable years of foreign corporations ending on or after April 20, 2009. See 26 CFR 1.9021T(a)(4)(ii), (a)(6), (a)(7), (a)(8)(i), and (c)(8) (revised as of April 1, 2009) for rules applicable to distributions made in taxable years of foreign corporations beginning after April 25, 2006, and ending before April 20, 2009, and 26 CFR 1.9021T(d), except as provided in 26 CFR 1.9047T(f)(9) (revised as of April 1, 2009), for rules applicable to distributions made in taxable years of foreign corporations beginning after December 31, 2002, and ending before April 20, 2009.
Sec. 1.9021T [Removed]
Par. 7. Section 1.9021T is removed.
Par. 8. Section 1.9040 is amended by revising the section heading and the entries for Sec. Sec. 1.9045(m), (m)(5), and (n), and 1.9047(f) to read as follows:
Sec. 1.9040 Outline of regulation provisions for section 904. * * * * *
Sec. 1.9045 Lookthrough rules as applied to controlled foreign corporations and other entities.
* * * * *
(m) Application of section 904(h).
* * * * *
(5) Treatment of inclusions under sections 951(a)(1)(A) and 1293. * * * * *
(n) Order of application of sections 904(d) and (h).
[[Page 27877]]
Sec. 1.9047 Transition rules.
* * * * *
(f) * * *
(1) Definition of nonlookthrough pools.
(2) Treatment of nonlookthrough pools of a noncontrolled section 902 corporation.
(3) Treatment of nonlookthrough pools of a controlled foreign corporation.
(4) Substantiation of lookthrough character of undistributed earnings and taxes in a nonlookthrough pool.
(i) Reconstruction of earnings and taxes pools.
(ii) Safe harbor method.
(iii) Inadequate substantiation.
(iv) Examples.
(5) Treatment of a deficit accumulated in a nonlookthrough pool.
(6) Treatment of pre1987 accumulated profits.
(7) Treatment of post1986 undistributed earnings or a deficit of a controlled foreign corporation attributable to dividends from a noncontrolled section 902 corporation paid in taxable years beginning before January 1, 2003.
(i) Lookthrough treatment of post1986 undistributed earnings at controlled foreign corporation level.
(ii) Lookthrough treatment of deficit in post1986
undistributed earnings at controlled foreign corporation level. (iii) Substantiation required for lookthrough treatment. (8) Treatment of distributions received by an uppertier corporation from a lowertier noncontrolled section 902 corporation, including when the corporations do not have the same taxable years. (i) Rule.
(ii) Example.
(9) Election to apply preAJCA rules to 2003 and 2004 taxable years.
(i) Definition.
(ii) Time, manner, and form of election.
(iii) Treatment of nonlookthrough pools in taxable years beginning after December 31, 2004.
(iv) Carryover of unused foreign tax.
(v) Carryback of unused foreign tax.
(vi) Recapture of overall foreign loss or separate limitation loss in the single category for dividends from all noncontrolled section 902 corporations.
(vii) Recapture of separate li