[Title 26 CFR 1.952-1]
[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. 1.952-1 - Subpart F income defined.]
[From the U.S. Government Printing Office]
26INTERNAL REVENUE102002-04-012002-04-01falseSubpart F income defined.1.952-1Sec. 1.952-1INTERNAL REVENUEINTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURYINCOME TAX (CONTINUED)INCOME TAXES
Sec. 1.952-1 Subpart F income defined.
(a) In general. For purposes of sections 951 through 964, a
controlled foreign corporation's subpart F income for any taxable year
shall, except as provided in paragraph (b) of this section and subject
to the limitations of paragraphs (c) and (d) of this section, consist of
the sum of--
(1) The income derived by such corporation for such year from the
insurance of United States risks (determined in accordance with the
provisions of section 953 and Secs. 1.953-1 through 1.953-6),
(2) The income derived by such corporation for such year which
constitutes foreign base company income (determined in accordance with
the provisions of section 954 and Secs. 1.954-1 through 1.954-8),
(3)(i) An amount equal to the product of--
(A) The income of such corporation other than income which--
(1) Is attributable to earnings and profits of the foreign
corporation included in the gross income of a United States person under
section 951 (other than by reason of this paragraph) (determined in
accordance with the provisions of section 951 and Sec. 1.951-1), or
(2) Is described in section 952(b),
multiplied by
(B) The international boycott factor determined in accordance with
the provisions of section 999(c)(1), or
(ii) In lieu of the amount determined under paragraph (a)(3)(i) of
this section, the amount described under section 999(c)(2) of such
international boycott income, and
[[Page 208]]
(4) The sum of the amount of any illegal bribes, kickbacks, or other
payments paid after November 3, 1976, by or on behalf of the corporation
during the taxable year of the corporation directly or indirectly to an
official, employee, or agent in fact of a government. An amount is paid
by a controlled foreign corporation where it is paid by an officer,
director, employee, shareholder or agent of such corporation for the
benefit of such corporation. For purposes of this section, the
principles of section 162(c) and the regulations thereunder shall apply.
In the case of payments made after September 3, 1982, a payment is
illegal if the payment would be unlawful under the Foreign Corrupt
Practices Act of 1977 if the payor were a United States person. The fair
market value of an illegal payment made in the form of property or
services shall be considered the amount of such illegal payment.
Pursuant to section 951(a)(1)(A)(i) and Sec. 1.951-1, a United States
shareholder of such controlled foreign corporation must include his pro
rata share of such subpart F income in his gross income for his taxable
year in which or with which such taxable year of the foreign corporation
ends. See section 952(a). However, see paragraph (a) of Sec. 1.957-2 for
special rule limiting the subpart F income to the income derived from
the insurance of United States risks in the case of certain controlled
foreign corporations described in section 957(b).
(b) Exclusion of U.S. income--(1) Taxable years beginning before
January 1, 1967. For rules applicable to taxable years beginning before
January 1, 1967, see 26 CFR 1.952-1(b)(1) (Revisedof April 1, 1975).
(2) Taxable years beginning after December 31, 1966. Notwithstanding
paragraph (a) of this section, a controlled foreign corporation's
subpart F income for any taxable year beginning after December 31, 1966,
shall not include any item of income from sources within the United
States which is effectively connected for that year with the conduct by
such corporation of a trade or business in the United States unless,
pursuant to a treaty to which the United States is a party, such item of
income either is exempt from the income tax imposed by chapter 1
(relating to normal taxes and surtaxes) of the Code or is subject to
such tax at a reduced rate.
Thus, for example, dividends received from sources within the United
States by a foreign corporation engaged in business in the United States
during the taxable year, which are not effectively connected for that
year with the conduct of a trade or business in the United States by
that corporation, shall not be excluded from subpart F income under
section 952(b) and this subparagraph even though such dividends are
subject to the tax of 30 percent imposed by section 881 (a). Also, for
example, if, by reason of an income tax convention to which the United
States is a party, an amount of interest from sources within the United
States which is effectively connected for the taxable year with the
conduct of a business in the United States by a foreign corporation is
subject to tax under chapter 1 at a flat rate of 15 percent, as provided
in Sec. 1.871-12, such interest is not excluded from subpart F income
under section 952(b) and this subparagraph. The deductions attributable
to items of income which are excluded from subpart F income under this
subparagraph shall not be taken into account for purposes of section
952.
(3) Rule applicable under section 956 (b)(2). For purposes only of
paragraph (b)(1))(viii) of Sec. 1.956-2, an item of income derived by a
controlled foreign corporation from sources within the United States
with respect to which for the taxable year a tax is imposed in
accordance with section 882(a) shall be considered described in section
952(b) whether or not such item of income would have constituted subpart
F income for such year.
(c) Limitation on a controlled foreign corporation's subpart F
income--(1) In general. A United States shareholder's pro rata share
(determined in accordance with the rules of paragraph (e) of Sec. 1.951-
1) of a controlled foreign corporation's subpart F income for any
taxable year shall not exceed his pro rata share of the earnings and
profits (as defined in section 964(a) and Sec. 1.964-1) of such
corporation for such taxable year, computed as of the close of such
taxable year without diminution by
[[Page 209]]
reason of any distributions made during such taxable year, minus the sum
of--
(i) The amount, if any, by which such shareholder's pro rata share
of--
(a) The sum of such corporation's deficits in earnings and profits
for prior taxable years beginning after December 31, 1962, plus
(b) The sum of such corporation's deficits in earnings and profits
for taxable years beginning after December 31, 1959, and before January
1, 1963 (reduced by the sum of the earnings and profits (as so defined)
of such corporation for any of such taxable years) exceeds
(c) The sum of such corporation's earnings and profits for prior
taxable years beginning after December 31, 1962, which, with respect to
such shareholder, are allocated to other earnings and profits under
section 959(c)(3) and Sec. 1.959-3; and
(ii) Such shareholder's pro rata share of any deficits in earnings
and profits of other foreign corporations for a taxable year beginning
after December 31, 1962, which are attributable to stock of such other
foreign corporations owned by such shareholder within the meaning of
section 958(a) and which, in accordance with section 952(d) and
paragraph (d) of this section, are taken into account as a reduction in
the controlled foreign corporation's earnings and profits for such
taxable year.
For purposes of applying this subparagraph, the reduction (if any)
provided by subdivision (i) of this subparagraph in a United States
shareholder's pro rata share of the earnings and profits of a controlled
foreign corporation shall be taken into account before the reduction
provided by subdivision (ii) of this subparagraph. See section 952(c).
(2) Special rules. For purposes only of determining the limitation
under subparagraph (1) of this paragraph on a United States
shareholder's pro rata share of a controlled foreign corporation's
subpart F income for any taxable year--
(i) Status of foreign corporation. The earnings and profits, or
deficit in earnings and profits, of a foreign corporation for any
taxable year shall be taken into account whether or not such foreign
corporation is a controlled foreign corporation at the time such
earnings and profits are derived or such deficit in earnings and profits
is incurred.
(ii) Deficits in earnings and profits taken into account only once.
A controlled foreign corporation's deficit in earnings and profits for
any taxable year preceding the taxable year shall be taken into account
for the taxable year only to the extent such deficit has not been taken
into account under this paragraph, paragraph (d) of this section, or
paragraph (d)(2)(ii) of Sec. 1.963-2 (applied as if section 963 had not
been repealed by the Tax Reduction Act of 1975) in computing a minimum
distribution, for any taxable year preceding the taxable year, to reduce
earnings and profits of such preceding year of such controlled foreign
corporation or of any other controlled foreign corporation. To the
extent a controlled foreign corporation's (the ``first corporation'')
excess foreign base company shipping deductions for any taxable year
(determined under Sec. 1.955A-3(c)(2)(i)) reduce the foreign base
company shipping income of another member of a related group (as defined
in Sec. 1.955A-2(b)), such deductions shall not be taken into account in
determining the earnings and profits or deficits in earnings and profits
of such first corporation for such taxable year for purposes of this
paragraph (c) and paragraph (d) of this section. The rule of the
preceding sentence shall not apply to the extent the excess foreign base
company shipping deductions of the first corporation reduce the foreign
base company shipping income of another member of a related group below
zero.
(iii) Determination of pro rata share. A United States shareholder's
pro rata share of a controlled foreign corporation's earnings and
profits, or deficit in earnings and profits, for any taxable year shall
be determined in accordance with the principles of paragraph (e) of
Sec. 1.951-1 and paragraph (d)(2)(ii) of Sec. 1.963-2.
(3) Illustrations. The application of this paragraph may be
illustrated by the following examples:
Example 1. (a) A is a United States shareholder who owns 100 percent
of the only class
[[Page 210]]
of stock of M Corporation, a controlled foreign corporation organized on
January 1, 1963. Both A and M Corporation use the calandar year as a
taxable year.
(b) During 1963, M Corporation derives $20,000 of subpart F income
and has earnings and profits of $30,000. Corporation M makes no
distributions to A during such year. The limitation under section 952(c)
on M Corporation's subpart F income for 1963 is $30,000; and $20,000 is
includible in A's gross income for such year under section
951(a)(1)(A)(i).
(c) On January 1, 1964, M Corporation acquires 100 percent of the
only class of stock of N Corporation, a controlled foreign corporation
which uses the calendar year as a taxable year. During 1964, N
Corporation derives $6,000 of subpart F income, has $7,000 of earnings
and profits, and distributes $5,000 to M Corporation. The limitation
under section 952(c) on N Corporation's subpart F income for 1964 is
$7,000; and $6,000 of subpart F income is includible in A's gross income
for such year under section 951(a)(1)(A)(i).
(d) During 1964, M Corporation derives $8,000 of rents which
constitute subpart F income, makes a $10,000 distribution to A, and has
earnings and profits of $12,000 (including the $5,000 dividend received
from N Corporation). The limitation under section 952(c) on M
Corporation's subpart F income for 1964 is $7,000, determined as
follows:
Corporation M's earnings and profits for 1964 (determined $12,000
under section 964(a) and Sec. 1.964-1 as of the close of
such year without diminution for any distributions made
during such year).........................................
Less: Corporation M's earnings and profits for 1964 5,000
described in section 959(b)...............................
------------
Limitation on M Corporation's Subpart F income for 1964.... 7,000
Thus, for 1964 with respect to A's interest in M Corporation, $7,000 of
subpart F income is includible in his gross income under section
951(a)(1)(A)(i). The $10,000 dividend received from M Corporation is
excludible from A's gross income for 1964 under section 959(a)(1) and
paragraph (b) of Sec. 1.959-1.
Example 2. A is a United States shareholder who owns 100 percent of
the only class of stock of R Corporation which was organized on January
1, 1961. R Corporation is a controlled foreign corporation for the
entire period after December 31, 1962, here involved. Both A and R
Corporation use the calendar year as a taxable year. During 1963, R
Corporation derives $25,000 of subpart F income and has $50,000 of
earnings and profits. Corporation R has $15,000 of earnings and profits
for 1961, and a deficit in earnings and profits of $45,000 for 1962.
Thus, R Corporation has as of December 31, 1963, a net deficit in
earnings and profits of $30,000 for the years 1961 and 1962. Corporation
R makes no distributions to A during 1963. The limitation under section
952(c) on R Corporation's subpart F income for 1963 is $20,000 ($50,000
minus $30,000), and $20,000 of subpart F income is includible in A's
gross income for 1963 under section 951(a)(1)(A)(i). During 1964, R
Corporation derives $18,000 of subpart F income and has $30,000 of
earnings and profits. Corporation R makes no distributions to A during
1964. The entire $18,000 of subpart F income is includible in A's gross
income for 1964 under section 951(a)(1)(A)(i).
(d) Treatment of deficits in earnings and profits attributable to
stock of other foreign corporation indirectly owned by a United States
shareholder--(1) In general. For purposes of paragraph (c)(1)(ii) of
this section, if--
(i) A United States shareholder owns (within the meaning of section
958(a)) stock in two or more foreign corporations in a chain of foreign
corporations (as defined in subparagraph (2)(ii) of this paragraph), and
(ii) Any of the corporations in such chain has a deficit in earnings
and profits for a taxable year beginning after December 31, 1962,
then, with respect to such shareholder and only for purposes of
determining the limitation on subpart F income under paragraph (c) of
this section, the earnings and profits for the taxable year of each such
foreign corporation which is a controlled foreign corporation shall, in
accordance with the rules of subparagraph (2) of this paragraph, be
reduced to take into account any deficit in earnings and profits
referred to in subdivision (ii) of this subparagraph. See section
952(d).
(2) Special rules. For purposes of this paragraph--
(i) Applicable rules. The special rules set forth in paragraph
(c)(2) of this section shall apply.
(ii) ``Chain'' defined. A chain of foreign corporations shall, with
respect to a United States shareholder, include--
(a) Any foreign corporation in which such shareholder owns (within
the meaning of section 958(a)(1)(A)) stock but, only to the extent of
the stock so owned and
(b) All foreign corporations in which such shareholder owns (within
the meaning of section 958(a)(2)) stock, but only to the extent of the
stock so owned by reason of his ownership of
[[Page 211]]
the stock referred to in (a) of this subdivision.
(iii) Allocation of deficit. If one or more foreign corporations
(whether or not a controlled foreign corporation) includible in a chain
of foreign corporations has a deficit in earnings and profits
(determined under section 964(a) and Sec. 1.964-1) for the taxable year,
the amount of deficit taken into account under section 952(d) with
respect to a United States shareholder in such chain as a reduction in
earnings and profits for the taxable year of a controlled foreign
corporation includible in such chain shall be an amount which bears the
same ratio to such shareholder's pro rata share of the total deficit in
earnings and profits for the taxable year of all includible foreign
corporations as his pro rata share of the earnings and profits
(determined under paragraph (c) of this section but without regard to
the provisions of subparagraph (1)(ii) of such paragraph) for the
taxable year of such includible controlled foreign corporation bears to
his pro rata share of the total earnings and profits (as so determined
under paragraph (c) of this section) for the taxable year of all
includible controlled foreign corporations. The amount of deficit taken
into account under this subdivision with respect to any controlled
foreign corporation includible in a chain of foreign corporations shall
not exceed the United States shareholder's pro rata share of the
controlled foreign corporation's earnings and profits for the taxable
year.
(iv) Taxable year. The taxable year from which a deficit is
allocated under this paragraph, and the taxable year to which such
deficit is allocated to reduce earnings and profits, shall be the
taxable year of the foreign corporation ending with or within the
taxable year of the United States shareholder described in subparagraph
(1)(i) of this paragraph.
(3) Illustration. The application of this paragraph may be
illustrated by the following examples:
Example 1. (a) Domestic corporation M owns 100 percent, 20 percent,
and 100 percent, respectively, of the only class of stock of foreign
corporations A, B, and F, respectively. Corporation A owns 80 percent of
the only class of stock of each of foreign corporations B and C,
respectively. Corporation F owns 20 percent of such stock of C
Corporation. Corporation B owns 75 percent of the only class of stock of
foreign corporation D, and 50 percent of the only class of stock of each
of foreign corporations G and H, respectively. C Corporation owns 75
percent of the only class of stock of foreign corporation E. All the
corporations use the calendar year as a taxable year, and all of the
foreign corporations, except corporations G and H, are controlled
foreign corporations throughout the period here involved.
(b) The subpart F income, and the earnings and profits (determined
under paragraph (c) of this section but without regard to subparagraph
(1)(ii) of such paragraph) or deficit in earnings and profits
(determined under section 964(a) and Sec. 1.964-1), of each of the
foreign corporations for 1963 are as follows, the deficits being set
forth in parentheses:
------------------------------------------------------------------------
Earnings
Subpart F and
income profits
(deficits)
------------------------------------------------------------------------
A Corporation................................... $6,000 $18,000
B Corporation................................... .......... (7,500)
C Corporation................................... .......... (2,500)
D Corporation................................... 4,000 5,000
E Corporation................................... 12,000 15,000
F Corporation................................... 8,000 20,250
G Corporation................................... .......... (10,000)
H Corporation................................... .......... 7,000
------------------------------------------------------------------------
(c) The chains of foreign corporations (within the meaning of
subparagraph (2)(ii) of this paragraph) for 1963 are the ``A'' chain,
consisting of corporations, A, B, C, D, E, G, and H, but only to the
extent of M Corporation's stock interest in such corporations under
section 958(a) by reason of its ownership of stock in A Corporation; the
``B'' chain, consisting of corporations B, D, G, and H, but only to the
extent of M Corporation's stock interest in such corporations under
section 958(a) by reason of its ownership of stock in B Corporation; and
the ``F'' chain, consisting of corporations F, C, and E, but only to the
extent of M Corporation's stock interest in such corporations under
section 958(a) by reason of its ownership of stock in F Corporation.
(d) Corporation M's stock interest under section 958(a) in each of
the chains of foreign corporations is as follows for 1963:
[In percent]
----------------------------------------------------------------------------------------------------------------
A B C D E F G H
----------------------------------------------------------------------------------------------------------------
A chain:
Direct interest............................... 100 ...... ...... ...... ...... ...... ...... ......
[[Page 212]]
(100%x80%).................................... ...... 80 ...... ...... ...... ...... ...... ......
(100%x80%).................................... ...... ...... 80 ...... ...... ...... ...... ......
(80%x75%)..................................... ...... ...... ...... 60 ...... ...... ...... ......
(80%x75%)..................................... ...... ...... ...... ...... 60 ...... ...... ......
(80%x50%)..................................... ...... ...... ...... ...... ...... ...... 40 ......
(80%x50%)..................................... ...... ...... ...... ...... ...... ...... ...... 40
B chain:
Direct interest............................... ...... 20 ...... ...... ...... ...... ...... ......
(20%x75%)..................................... ...... ...... ...... 15 ...... ...... ...... ......
(20%x50%)..................................... ...... ...... ...... ...... ...... ...... 10 ......
(20%x50%)..................................... ...... ...... ...... ...... ...... ...... ...... 10
F chain:
Direct interest............................... ...... ...... ...... ...... ...... 100 ...... ......
(100%x20%).................................... ...... ...... 20 ...... ...... ...... ...... ......
(20%x75%)..................................... ...... ...... ...... ...... 15 ...... ...... ......
---------------------------------------------------------------
Total interests............................. 100 100 100 75 75 100 50 50
----------------------------------------------------------------------------------------------------------------
(e) Corporation M's pro rata share of the earnings and profits
(determined under paragraph (c) of this section but without regard to
subparagraph (1)(ii) of such paragraph), or of the deficit, of each
controlled foreign corporation of each foreign corporation,
respectively, includible in the respective chains for 1963 is as
follows:
------------------------------------------------------------------------
Earnings
and profits Deficit
------------------------------------------------------------------------
A chain:
A Corporation (100%)........................ $18,000 ...........
B Corporation (80%)......................... ........... ($6,000)
C Corporation (80%)......................... ........... (2,000)
D Corporation (60%)......................... 3,000 ...........
E Corporation (60%)......................... 9,000 ...........
G Corporation (40%)......................... ........... (4,000)
H Corporation (40%)......................... (\1\) ...........
-------------------------
Total................................... 30,000 (12,000)
=========================
B chain:
B Corporation (20%)......................... ........... ($1,500)
D Corporation (15%)......................... $750 ...........
G Corporation (10%)......................... ........... (1,000)
H Corporation (10%)......................... (\1\) ...........
-------------------------
Total................................... $750 ($2,500)
=========================
F chain:
F Corporation (100%)........................ 20,250 ...........
C Corporation (20%)......................... ........... (500)
E Corporation (15%)......................... 2,250 ...........
-------------------------
Total..................................... $22,500 (500)
------------------------------------------------------------------------
\1\ The earnings and profits of H Corporation are not included in the
total earnings and profits for the chain because H Corporation is not
a controlled foreign corporation.
(f) The amount by which M Corporation's pro rata share of the
earnings and profits for 1963 of the controlled foreign corporations in
each respective chain shall be reduced under section 952(d) by M
Corporation's pro rata share of the deficits of corporations B, C, and G
for 1963 is determined as follows:
Amount of
reduction
A chain:
A Corporation ($12,000x$18,000/$30,000).................. $7,200
D Corporation ($12,000x$3,000/$30,000)................... 1,200
E Corporation ($12,000x$9,000/$30,000)................... 3,600
--------------
Total................................................ 12,000
==============
B chain:
D Corporation ($2,500x$750/$750)............ $2,500
Limitation: M Corporation's pro-rata share 750
of D Corporation's earnings and profits....
Allocation of used deficit ($750) to M
Corporation's pro rata share of the
deficits of corporations B and G:
B Corporation ($750x ($1,500/$2,500))..... $450
G Corporation ($750x ($1,000/$2,500))..... 300
-------------
Total................................... 750 $750
=========================
F chain:
F Corporation ($500x$20,250/$22,500)..................... 450
E Corporation ($500x$2,250/$22,500)...................... 50
--------------
Total.................................................. 500
(g) Corporation M's pro rata share of the earnings and profits
(determined after reduction for deficits under section 952(d)) for 1963
of each controlled foreign corporation in the respective chains,
determined on a chain-by-chain basis, is determined as follows:
------------------------------------------------------------------------
Earnings
and Reduction Reduced
profits (sec. earnings
before 952(d)) and
reduction profits
------------------------------------------------------------------------
A chain:
A Corporation........................ $18,000 $7,200 $10,800
D Corporation........................ 3,000 1,200 1,800
E Corporation........................ 9,000 3,600 5,400
B chain: D Corporation................. 750 750 .........
[[Page 213]]
F chain:
F Corporation........................ 20,250 450 19,800
E Corporation........................ 2,250 50 2,200
------------------------------------------------------------------------
(h) Corporation M's pro rata share of each controlled foreign
corporation's subpart F income, limited as provided by section 952(c)
and paragraph (c) of this section, for 1963 which is includible in its
gross income for such year under section 951(a)(1)(A)(i) and Sec. 1.951-
1 is determined as follows:
------------------------------------------------------------------------
Earnings
Subpart F and Amount
income profit includible
(before (sec. 952 in income
limitation) (c))
------------------------------------------------------------------------
A Corporation (100%)................ $6,000 $10,800 $6,000
D Corporation (75%) 3,000 1,800 1,800
E Corporation (75%) 9,000 7,600 7,600
F Corporation (100%) 8,000 19,800 8,000
-----------------------------------
Total includible under sec. ........... ......... 23,400
951(a)(1)(A)(i)..................
------------------------------------------------------------------------
Example 2. The facts are the same as in example 1 except that, in
addition, for 1964, foreign corporations C, D, and E have no subpart F
income and no earnings and profits and foreign corporations G and H have
no earnings and profits. For 1964, B Corporation has subpart F income of
$1,000 and earnings and profits (determined in accordance with section
964(a) and Sec. 1.964-1) of $1,500; A Corporation has subpart F income
of $800 and earnings and profits of $1,000; and F Corporation has
subpart F income of $500 and earnings and profits of $1,000. Such
earnings and profits are determined without regard to distributions for
1964. Corporation B has an unused deficit in earnings and profits of
$1,050 for 1963 ($1,500 minus $450) applicable to M Corporation's
interest in such corporation (paragraph (f) of example 1), and, under
paragraph (c)(1)(i)(a) of this section, with respect to M Corporation,
such deficit reduces B Corporation's earnings and profits for 1964 to
$450. Inasmuch as G Corporation is not a controlled foreign corporation
for 1964, such corporation's unused deficit in earnings and profits of
$700 for 1963 ($1,000 minus $300) applicable to M Corporation's interest
in such corporation (paragraph (f) of example 1) may be used under
paragraph (c)(1)(i)(a) of this section to reduce M Corporation's
interest in G Corporation's earnings and profits in a later year or
years for which G Corporation is a controlled foreign corporation.
Corporation M's pro rata share of each controlled foreign corporation's
subpart F income, limited as provided by section 952(c) and paragraph
(c) of this section, for 1964 which is includible in its gross income
for such year under section 951(a)(1)(A)(i) and Sec. 1.951-1 is
determined as follows:
------------------------------------------------------------------------
Earnings
Subpart F and Amount
income profits includible
(before (sec. in income
limitation) 952(c))
------------------------------------------------------------------------
A Corporation....................... $800 $1,000 $800
B Corporation....................... 1,000 450 450
F Corporation....................... 500 1,000 500
------------------------------------------------------------------------
Example 3. The facts are the same as in example 2, except that for
1964 B Corporation has subpart F income of $550 and earnings and profits
(determined in accordance with section 964(a) and Sec. 1.964-1) of $550;
such earnings and profits are determined without regard to distributions
for 1964. Under paragraph (c)(1)(i)(a) of this section, B Corporation's
unused deficit of $1,050 for 1963 reduces its earnings and profits for
1964 with respect to M Corporation to zero. The remaining $500 of the
unused deficit for 1963 applicable to M Corporation's interest in B
Corporation may be used under paragraph (c)(1)(i)(a) of this section in
later years to reduce M Corporation's interest in B Corporation's
earnings and profits.
(e) Application of current earnings and profits limitation--(1) In
general. If the subpart F income (as defined in section 952(a)) of a
controlled foreign corporation exceeds the foreign corporation's
earnings and profits for the taxable year, the subpart F income
includible in the income of the corporation's United States shareholders
is reduced under section 952(c)(1)(A) in accordance with the following
rules. The excess of subpart F income over current year earnings and
profits shall--
(i) First, proportionately reduce subpart F income in each separate
category of the controlled foreign corporation, as defined in
Sec. 1.904-5(a)(1), in which current earnings and profits are zero or
less than zero;
(ii) Second, proportionately reduce subpart F income in each
separate category in which subpart F income exceeds current earnings and
profits; and
(iii) Third, proportionately reduce subpart F income in other
separate categories.
(2) Allocation to a category of subpart F income. An excess amount
that is allocated under paragraph (e)(1) of this section to a separate
category must be further allocated to a category of subpart F income if
the separate category contains more than one category of subpart F
income described in section 952(a) or, in the case of foreign base
company income, described in Sec. 1.954-1(c)(1)(iii)(A) (1) or (2). In
such case, the
[[Page 214]]
excess amount that is allocated to the separate category must be
allocated to the various categories of subpart F income within that
separate category on a proportionate basis.
(3) Recapture of subpart F income reduced by operation of earnings
and profits limitation. Any amount in a category of subpart F income
described in section 952(a) or, in the case of foreign base company
income, described in Sec. 1.954-1(c)(1)(iii)(A) (1) or (2) that is
reduced by operation of the current year earnings and profits limitation
of section 952(c)(1)(A) and this paragraph (e) shall be subject to
recapture in a subsequent year under the rules of section 952(c)(2) and
paragraph (f) of this section.
(4) Coordination with sections 953 and 954. The rules of this
paragraph (e) shall be applied after the application of sections 953 and
954 and the regulations under those sections, except as provided in
Sec. 1.954-1(d)(4)(ii).
(5) Earnings and deficits retain separate limitation character. The
income reduction rules of paragraph (e)(1) of this section shall apply
only for purposes of determining the amount of an inclusion under
section 951(a)(1)(A) from each separate category as defined in
Sec. 1.904-5(a)(1) and the separate categories in which recapture
accounts are established under section 952(c)(2) and paragraph (f) of
this section. For rules applicable in computing post-1986 undistributed
earnings, see generally section 902 and the regulations under that
section. For rules relating to the allocation of deficits for purposes
of computing foreign taxes deemed paid under section 960 with respect to
an inclusion under section 951(a)(1)(A), see Sec. 1.960-1(i).
(f) Recapture of subpart F income in subsequent taxable year--(1) In
general. If a controlled foreign corporation's subpart F income for a
taxable year is reduced under the current year earnings and profits
limitation of section 952(c)(1)(A) and paragraph (e) of this section,
recapture accounts will be established and subject to recharacterization
in any subsequent taxable year to the extent the recapture accounts were
not previously recharacterized or distributed, as provided in paragraphs
(f)(2) and (3) of this section.
(2) Rules of recapture--(i) Recapture account. If a category of
subpart F income described in section 952(a) or, in the case of foreign
base company income, described in Sec. 1.954-1(c)(1)(iii)(A) (1) or (2)
is reduced under the current year earnings and profits limitation of
section 952(c)(1)(A) and paragraph (e) of this section for a taxable
year, the amount of such reduction shall constitute a recapture account.
(ii) Recapture. Each recapture account of the controlled foreign
corporation will be recharacterized, on a proportionate basis, as
subpart F income in the same separate category (as defined in
Sec. 1.904-5(a)(1)) as the recapture account to the extent that current
year earnings and profits exceed subpart F income in a taxable year. The
United States shareholder must include his pro rata share (determined
under the rules of Sec. 1.951-1(e)) of each recharacterized amount in
income as subpart F income in such separate category for the taxable
year.
(iii) Reduction of recapture account and corresponding earnings.
Each recapture account, and post-1986 undistributed earnings in the
separate category containing the recapture account, will be reduced in
any taxable year by the amount which is recharacterized under paragraph
(f)(2)(ii) of this section. In addition, each recapture account, and
post-1986 undistributed earnings in the separate category containing the
recapture account, will be reduced in the amount of any distribution out
of that account (as determined under the ordering rules of section
959(c) and paragraph (f)(3)(ii) of this section).
(3) Distribution ordering rules--(i) Coordination of recapture and
distribution rules. If a controlled foreign corporation distributes an
amount out of earnings and profits described in section 959(c)(3) in a
year in which current year earnings and profits exceed subpart F income
and there is an amount in a recapture account for such year, the
recapture rules will apply first.
(ii) Distributions reduce recapture accounts first. Any distribution
made by a controlled foreign corporation out of earnings and profits
described in section 959(c)(3) shall be treated as made first on a
proportionate basis out of the recapture accounts in each separate
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category to the extent thereof (even if the amount in the recapture
account exceeds post-1986 undistributed earnings in the separate
category containing the recapture account). Any remaining distribution
shall be treated as made on a proportionate basis out of the remaining
earnings and profits of the controlled foreign corporation in each
separate category. See section 904(d)(3)(D).
(4) Examples. The application of paragraphs (e) and (f) of this
section may be illustrated by the following examples:
Example 1. (i) A, a U.S. person, is the sole shareholder of CFC, a
controlled foreign corporation formed on January 1, 1998, whose
functional currency is the u. In 1998, CFC earns 100u of foreign base
company sales income that is general limitation income described in
section 904(d)(1)(I) and incurs a (200u) loss attributable to activities
that would have produced general limitation income that is not subpart F
income. In 1998 CFC also earns 100u of foreign personal holding company
income that is passive income described in section 904(d)(1)(A), and
100u of foreign personal holding company income that is dividend income
subject to a separate limitation described in section 904(d)(1)(E) for
dividends from a noncontrolled section 902 corporation. CFC's subpart F
income for 1998, 300u, exceeds CFC's current earnings and profits, 100u,
by 200u. Under section 952(c)(1)(A) and paragraph (e) of this section,
subpart F income is limited to CFC's current earnings and profits of
100u, all of which is included in A's gross income under section
951(a)(1)(A). The 200u of CFC's 1998 subpart F income that is not
included in A's income in 1998 by reason of section 952(c)(1)(A) is
subject to recapture under section 952(c)(2) and paragraph (f) of this
section.
(ii) For purposes of determining the amount and type of income
included in A's gross income and the amount and type of income in CFC's
recapture account, the rules of paragraphs (e)(1) and (2) of this
section apply. Under paragraph (e)(1)(i) of this section, the amount by
which CFC's subpart F income exceeds its earnings and profits for 1998,
200u, first reduces from 100u to 0 CFC's subpart F income in the general
limitation category, which has a current year deficit of (100u) in
earnings and profits. Next, under paragraph (e)(1)(iii) of this section,
the remaining 100u by which CFC's 1998 subpart F income exceeds earnings
and profits is applied proportionately to reduce CFC's subpart F income
in the separate categories for passive income (100u) and dividends from
the noncontrolled section 902 corporation (100u). Thus, A includes 50u
of passive limitation/foreign personal holding company income and 50u of
dividends from the noncontrolled section 902 corporation/foreign
personal holding company income in gross income in 1998. CFC has 100u in
its general limitation/foreign base company sales income recapture
account attributable to the 100u of foreign base company sales income
that is not included in A's income by reason of the earnings and profits
limitation of section 952(c)(1)(A). CFC also has 50u in its passive
limitation recapture account, all of which is attributable to foreign
personal holding company income, and 50u in its recapture account for
dividends from the noncontrolled section 902 corporation, all of which
is attributable to foreign personal holding company income.
(iii) For purposes of computing post-1986 undistributed earnings,
the rules of sections 902 and 960, including the rules of Sec. 1.960-
1(i), apply. Under Sec. 1.960-1(i), the general limitation deficit of
(100u) is allocated proportionately to reduce passive limitation
earnings of 100u and noncontrolled section 902 dividend earnings of
100u. Thus, passive limitation earnings are reduced by 50u to 50u (100u
passive limitation earnings/200u total earnings in positive separate
categories x (100u) general limitation deficit=50u reduction), and the
noncontrolled section 902 corporation earnings are reduced by 50u to 50u
(100u noncontrolled section 902 corporation earnings/200u total earnings
in positive separate categories x (100u) general limitation deficit=50u
reduction). All of CFC's post-1986 foreign income taxes with respect to
passive limitation income and dividends from the noncontrolled section
902 corporation are deemed paid by A under section 960 with respect to
the subpart F inclusions (50u inclusion/50u earnings in each separate
category). After the inclusion and deemed-paid taxes are computed, at
the close of 1998 CFC has a (100u) deficit in general limitation
earnings (100u subpart F earnings + (200u) nonsubpart F loss), 50u of
passive limitation earnings (100u of earnings attributable to foreign
personal holding company income -50u inclusion) with a corresponding
passive limitation/foreign personal holding company income recapture
account of 50u, and 50u of earnings subject to a separate limitation for
dividends from the noncontrolled section 902 corporation (100u earnings
-50u inclusion) with a corresponding noncontrolled section 902
corporation/foreign personal holding company income recapture account of
50u.
Example 2. (i) The facts are the same as in Example 1 with the
addition of the following facts. In 1999, CFC earns 100u of foreign base
company sales income that is general limitation income and 100u of
foreign personal holding company income that is passive limitation
income. In addition, CFC incurs (10u) of expenses that are allocable to
its separate limitation for dividends from the noncontrolled section 902
corporation. Thus, CFC's
[[Page 216]]
subpart F income for 1999, 200u, exceeds CFC's current earnings and
profits, 190u, by 10u. Under section 952(c)(1)(A) and paragraph (e) of
this section, subpart F income is limited to CFC's current earnings and
profits of 190u, all of which is included in A's gross income under
section 951(a)(1)(A).
(ii) For purposes of determining the amount and type of income
included in A's gross income and the amount and type of income in CFC's
recapture accounts, the rules of paragraphs (e)(1) and (2) of this
section apply. While CFC's general limitation post-1986 undistributed
earnings for 1999 are 0 ((100u) opening balance + 100u subpart F
income), CFC's general limitation subpart F income (100u) does not
exceed its general limitation current earnings and profits (100u) for
1999. Accordingly, under paragraph (e)(1)(iii) of this section, the
amount by which CFC's subpart F income exceeds its earnings and profits
for 1999, 10u, is applied proportionately to reduce CFC's subpart F
income in the separate categories for general limitation income, 100u,
and passive income, 100u. Thus, A includes 95u of general limitation
foreign base company sales income and 95u of passive limitation foreign
personal holding company income in gross income in 1999. At the close of
1999 CFC has 105u in its general limitation/foreign base company sales
income recapture account (100u from 1998 + 5u from 1999), 55u in its
passive limitation/foreign personal holding company income recapture
account (50u from 1998 + 5u from 1999), and 50u in its dividends from
the noncontrolled section 902 corporation/foreign personal holding
company income recapture account (all from 1998).
(iii) For purposes of computing post-1986 undistributed earnings in
each separate category, the rules of sections 902 and 960, including the
rules of Sec. 1.960-1(i), apply. Thus, post-1986 undistributed earnings
(or an accumulated deficit) in each separate category are increased (or
reduced) by current earnings and profits or current deficits in each
separate category. The accumulated deficit in CFC's general limitation
earnings and profits (100u) is reduced to 0 by the addition of 100u of
1999 earnings and profits. CFC's passive limitation earnings of 50u are
increased by 100u to 150u, and CFC's noncontrolled section 902
corporation earnings of 50u are decreased by (10u) to 40u. After the
addition of current year earnings and profits and deficits to the
separate categories there are no deficits remaining in any separate
category. Thus, the allocation rules of Sec. 1.960-1(i)(4) do not apply
in 1999. Accordingly, in determining the post-1986 foreign income taxes
deemed paid by A, post-1986 undistributed earnings in each separate
category are unaffected by earnings in the other categories. Foreign
taxes deemed paid under section 960 for 1999 would be determined as
follows for each separate category: with respect to the inclusion of 95u
of foreign base company sales income out of general limitation earnings,
the section 960 fraction is 95u inclusion/0 total earnings; with respect
to the inclusion of 95u of passive limitation income the section 960
fraction is 95u inclusion/150u passive earnings. Thus, no general
limitation taxes would be associated with the inclusion of the general
limitation earnings because there are no accumulated earnings in the
general limitation category. After the deemed-paid taxes are computed,
at the close of 1999 CFC has a (95u) deficit in general limitation
earnings and profits ((100u) opening balance + 100u current earnings -
95u inclusion), 55u of passive limitation earnings and profits (50u
opening balance + 100u current foreign personal holding company income -
95u inclusion), and 40u of earnings and profits subject to the separate
limitation for dividends from the noncontrolled section 902 corporation
(50u opening balance + (10u) expense).
Example 3. (i) A, a U.S. person, is the sole shareholder of CFC, a
controlled foreign corporation whose functional currency is the u. At
the beginning of 1998, CFC has post-1986 undistributed earnings of 275u,
all of which are general limitation earnings described in section
904(d)(1)(I). CFC has no previously-taxed earnings and profits described
in section 959(c)(1) or (c)(2). In 1998, CFC has a (200u) loss in the
shipping category described in section 904(d)(1)(D), 100u of foreign
personal holding company income that is passive income described in
section 904(d)(1)(A), and 125u of general limitation manufacturing
earnings that are not subpart F income. CFC's subpart F income for 1998,
100u, exceeds CFC's current earnings and profits, 25u, by 75u. Under
section 952(c)(1)(A) and paragraph (e) of this section, subpart F income
is limited to CFC's current earnings and profits of 25u, all of which is
included in A's gross income under section 951(a)(1)(A). The 75u of
CFC's 1998 subpart F income that is not included in A's income in 1998
by reason of section 952(c)(1)(A) is subject to recapture under section
952(c)(2) and paragraph (f) of this section.
(ii) For purposes of determining the amount and type of income
included in A's gross income and the amount and type of income in CFC's
recapture account, the rules of paragraphs (e)(1) and (2) of this
section apply. Under paragraph (e)(1) of this section, the amount of
CFC's subpart F income in excess of earnings and profits for 1998, 75u,
reduces the 100u of passive limitation foreign personal holding company
income. Thus, A includes 25u of passive limitation foreign personal
holding company income in gross income, and CFC has 75u in its passive
limitation/foreign personal holding company income recapture account.
[[Page 217]]
(iii) For purposes of computing post-1986 undistributed earnings in
each separate category the rules of sections 902 and 960, including the
rules of Sec. 1.960-1(i), apply. Under Sec. 1.960-1(i), the shipping
limitation deficit of (200u) is allocated proportionately to reduce
general limitation earnings of 400u and passive limitation earnings of
100u. Thus, general limitation earnings are reduced by 160u to 240u
(400u general limitation earnings/500u total earnings in positive
separate categories x (200u) shipping deficit=160u reduction), and
passive limitation earnings are reduced by 40u to 60u (100u passive
earnings/500u total earnings in positive separate categories x (200u)
shipping deficit=40u reduction). Five-twelfths of CFC's post-1986
foreign income taxes with respect to passive limitation earnings are
deemed paid by A under section 960 with respect to the subpart F
inclusion (25u inclusion/60u passive earnings). After the inclusion and
deemed-paid taxes are computed, at the close of 1998 CFC has 400u of
general limitation earnings (275u opening balance + 125u current
earnings), 75u of passive limitation earnings (100u of foreign personal
holding company income -25u inclusion), and a (200u) deficit in shipping
limitation earnings.
Example 4. (i) The facts are the same as in Example 3 with the
addition of the following facts. In 1999, CFC earns 50u of general
limitation earnings that are not subpart F income and 75u of passive
limitation income that is foreign personal holding company income. Thus,
CFC has 125u of current earnings and profits. CFC distributes 200u to A.
Under paragraph (f)(3)(i) of this section, the recapture rules are
applied first. Thus, the amount by which 1999 current earnings and
profits exceed subpart F income, 50u, is recharacterized as passive
limitation foreign personal holding company income. CFC's total subpart
F income for 1999 is 125u of passive limitation foreign personal holding
company income (75u current earnings plus 50u recapture account), and
the passive limitation/foreign personal holding company income recapture
account is reduced from 75u to 25u.
(ii) CFC has 150u of previously-taxed earnings and profits described
in section 959(c)(2) (25u attributable to 1998 and 125u attributable to
1999), all of which is passive limitation earnings and profits. Under
section 959(c), 150u of the 200u distribution is deemed to be made from
earnings and profits described in section 959(c)(2). The remaining 50u
is deemed to be made from earnings and profits described in section
959(c)(3). Under paragraph (f)(3)(ii) of this section, the dividend
distribution is deemed to be made first out of the passive limitation
recapture account to the extent thereof (25u). Under paragraph
(f)(2)(iii) of this section, the passive limitation recapture account is
reduced from 25u to 0. The remaining distribution of 25u is treated as
made out of CFC's general limitation earnings and profits.
(iii) For purposes of computing post-1986 undistributed earnings,
the rules of section 902 and 960, including the rules of Sec. 1.960-
1(i), apply. Thus, the shipping limitation accumulated deficit of (200u)
reduces general limitation earnings and profits of 450u and passive
limitation earnings and profits of 150u on a proportionate basis. Thus,
100% of CFC's post-1986 foreign income taxes with respect to passive
limitation earnings are deemed paid by A under section 960 with respect
to the 1999 subpart F inclusion of 125u (100u inclusion (numerator
limited to denominator)/100u passive earnings). No post-1986 foreign
income taxes remain to be deemed paid under section 902 in connection
with the 25u distribution from the passive limitation/foreign personal
holding company income recapture account. One-twelfth of CFC's post-1986
foreign income taxes with respect to general limitation earnings are
deemed paid by A under section 902 with respect to the distribution of
25u general limitation earnings and profits described in section
959(c)(3) (25u inclusion/300u general limitation earnings). After the
deemed-paid taxes are computed, at the close of 1999 CFC has 425u of
general limitation earnings and profits (400u opening balance + 50u
current earnings--25u distribution), 0 of passive limitation earnings
(75u recapture account + 75u current foreign personal holding company
income--125u inclusion--25u distribution), and a (200u) deficit in
shipping limitation earnings.
(5) Effective date. Paragraph (e) of this section and this paragraph
(f) apply to taxable years of a controlled foreign corporation beginning
after March 3, 1997.
[T.D. 6795, 30 FR 938, Jan. 29, 1965, as amended by T.D. 6892, 31 FR
11144, Aug. 23, 1966; T.D. 7293, 38 FR 32802, Nov. 28, 1973; T.D. 7545,
43 FR 19652, May 8, 1978; T.D. 7862, 47 FR 56490, Dec. 17, 1982; T.D.
7893, 48 FR 22508, May 19, 1983; T.D. 7894, 48 FR 22516, May 19, 1983;
T.D. 8331, 56 FR 2846, Jan. 25, 1991; T.D. 8704, 62 FR 18, Jan. 2, 1997]