[Federal Register Volume 60, Number 215 (Tuesday, November 7, 1995)]
[Rules and Regulations]
[Pages 56117-56120]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-27563]



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DEPARTMENT OF THE TREASURY
Internal Revenue Service

26 CFR Part 1

[TD 8627]
RIN 1545-AN87


Limitation on Use of Deconsolidation To Avoid Foreign Tax Credit 
Limitations

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

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SUMMARY: This document contains final regulations relating to certain 
limitations on the amount of the foreign tax credit under section 
904(i). The final regulations will affect the sourcing and foreign tax 
credit separate limitation character of income for purposes of the 
calculation of the foreign tax credit by certain related domestic 
corporations. The final regulations are necessary to prevent avoidance 
of the foreign tax credit limitations.

DATES: These regulations are effective January 1, 1994.
    For dates of applicability, see Sec. 1.904(i)-1(e) of these 
regulations.

FOR FURTHER INFORMATION CONTACT: Kenneth D. Allison, 202-622-3860 (not 
a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

    This document contains final Income Tax Regulations (26 CFR part 1) 
under section 904 of the Internal Revenue Code.
    On May 17, 1994, a notice of proposed rulemaking (INTL-0006-90) 
relating to the foreign tax credit limitation imposed under section 
904(i) was published in the Federal Register (59 FR 25584) (1994-1 C.B. 
816).
    Written comments responding to this notice were received. A public 
hearing was requested and held on October 17, 1994. After consideration 
of all the comments, the proposed regulations under section 904(i) are 
adopted as revised by this Treasury decision. The final regulations are 
substantially as proposed. The preamble to the proposed regulations 
contains a discussion of the provisions.

Explanation of Revisions and Summary of Comments

Common Parent of an Extended Affiliated Group

    Section 1.904(i)-1(b)(1)(i)(B)(1) of the proposed regulations 
defined affiliates to include certain domestic corporations ultimately 
owned 80 percent or more by entities that are not includible 

[[Page 56118]]
corporations. The final regulations are modified to require that the 
domestic corporations be ultimately owned by a common parent that is a 
corporation.
    Commentators suggested that Congress did not intend to apply the 
rules of this section to domestic subsidiaries of a common foreign 
parent. However, section 904(i)(1) states that domestic corporations 
are affiliates under section 904(i) if those corporations would be 
affiliates under section 1504(a) without the exclusions contained in 
section 1504(b). Without the exclusion of foreign corporations under 
section 1504(b)(3), multiple chains of domestic corporations owned 80% 
or more by a foreign common parent would be affiliates under section 
1504(a). Thus, it is clear that Congress intended broad application of 
this provision to structures such as those with foreign common parents. 
The examples in the legislative history using domestic common parents 
are merely illustrative. Therefore, no change to Sec. 1.904(i)-
1(b)(1)(i)(B)(1) was made in the final regulations in response to this 
comment.
    Commentators suggested that the final regulations should be 
effective only for taxable years beginning after May 17, 1994, the 
publication date of the proposed regulations, for structures with a 
foreign common parent. Commentators also suggested that final 
regulations should not be applied to foreign common parent structures 
in existence prior to the enactment of section 904(i). The statute 
provides authority to address all structures, including foreign common 
parent structures. Therefore, no change in the effective date was made 
and no grandfather clause added with respect to such foreign common 
parent structures.

Determination of Taxable Income

    Commentators requested clarification whether provisions such as 
Secs. 1.861-11T and 1.861-14T, as well as the consolidated return 
provisions, apply to determine the taxable income of an affiliate in a 
separate category.
    Section 1.904(i)-1(a)(1)(i) of the final regulations provides that 
each affiliate must determine its net taxable income or loss in each 
separate category, as defined in Sec. 1.904-5(a)(1) and treating U.S. 
source income or loss as a separate category. In general, an affiliate 
may not use the consolidated return regulations in computing net 
taxable income or loss in each separate category. However, a 
consolidated group is treated as one affiliate, and such affiliate must 
use the consolidated return regulations (without regard to sections 
904(f) and 907(c)(4)) in computing the affiliate's net taxable income 
or loss in each separate category. To the extent applicable in the 
absence of section 904(i) and these regulations, other provisions of 
the Code and regulations will be used in the determination of an 
affiliate's net taxable income or loss in a separate category under 
Sec. 1.904(i)-1(a)(1)(i).
    Section 1.904(i)-1(a)(1)(ii) of the final regulations states that 
each affiliate's net income in a separate category will be combined 
with net income of all other affiliates in the same separate category. 
However, net losses in a separate category are combined with other 
affiliates' income or loss in the same category, under Sec. 1.904(i)-
1(a)(1)(ii), only to the extent that the affiliate's net loss in the 
separate category offsets taxable income, whether U.S. or foreign 
source, of the affiliate with the net loss. The consolidated return 
provisions dealing with sections 904(f) and 907(c)(4) are then applied 
to the combined amounts in each separate category as if all affiliates 
were members of a single consolidated group.

Allocation Methods

    The proposed regulations required that allocation be accomplished 
under ``any consistently applied reasonable method.'' Several 
commentators raised questions about the appropriateness of certain 
allocation methods. The final regulations adopt the proposed standard 
but have been clarified to provide that the determination of the 
reasonableness of a method is based on all of the facts and 
circumstances.
    Section 1.904(i)-1(a) of the proposed regulations required 
consistent application of the allocation method chosen. Commentators 
requested clarification as to whether this consistency rule requires 
the same allocation method to be used by each affiliate or whether, 
instead, the rule requires consistency in the choice of an allocation 
method from year to year. The final regulations clarify that a method 
is consistently applied only if used by all affiliates from year to 
year. Once chosen, an allocation method may be changed only with the 
consent of the Commissioner.

Deemed Distributions

    One comment noted that if a domestic corporation, affiliated by 
virtue of section 904(i) with another domestic corporation, makes a 
payment to that other domestic corporation in order to compensate the 
other corporation for an increase in its U.S. income tax as a result of 
the application of section 904(i), the payment may be a constructive 
dividend to a foreign parent, followed by a contribution to capital to 
the other domestic corporation. It was suggested that the rules of 
Sec. 1.1502-33(d) be applied by the section 904(i) regulations to allow 
affiliates that have altered tax liabilities due to the effect of 
section 904(i) to allocate that liability among the expanded affiliated 
group without triggering a constructive dividend. The final regulations 
clarify that the consolidated return regulations, including 
Sec. 1.1502-33(d), generally are not applicable to the extended 
affiliated group.

Consistency in Choice of Taxable Year

    One commentator questioned whether year-to-year consistency in the 
choice of the base taxable year for the extended affiliated group is 
required under Sec. 1.904(i)-1(c) of the proposed regulations, and 
whether the taxpayer must secure the permission of the Service to alter 
that choice. Failure to require consistency would permit the matching 
of affiliates' taxable years in the most advantageous manner each year 
and allow an expanded group to delay the affiliation of each newly 
acquired corporation, under Sec. 1.904(i)-1(b)(1)(iii), for the maximum 
period of time. The final regulations clarify that the taxable year 
chosen must be used consistently from year to year, and may be changed 
only with the Commissioner's consent.

Consolidated Group Considered a Single Affiliate

    The final regulations, in Sec. 1.904(i)-1(b)(1)(ii), clarify that a 
consolidated group, the members of which are affiliates under this 
section, will be treated as a single affiliate for purposes of this 
section. Thus, for example, the computations under Sec. 1.904(i)-
1(a)(1)(i) by a consolidated group of affiliates will produce one set 
of calculations with respect to each separate category of foreign 
source taxable income or loss for the consolidated group.

Exception for Newly Acquired Affiliates

    Section 1.904(i)-1(b)(1)(ii) of the proposed regulations stated 
that ``[a]n includible corporation will not be considered an affiliate 
of another includible corporation during its taxable year beginning 
before the date on which the first includible corporation first becomes 
an affiliate with respect to that other includible 
corporation.''[emphasis added]. A commentator questioned the identity 
of the corporation referenced by the emphasized ``its''. The final 
regulations, in renumbered Sec. 1.904(i)-1(b)(1)(iii)(A), clarify that 
the reference is to the new affiliate. 

[[Page 56119]]

    Because of this ambiguity in Sec. 1.904(i)-1(b)(1)(ii) of the 
proposed regulations, taxpayers may have lacked sufficient notice of 
the Service's interpretation of that provision. For this reason, 
includible corporations acquired from unrelated third parties prior to 
the thirty-first day after the publication of the regulations will be 
considered an affiliate on a date that is consistent with any 
reasonable interpretation of Sec. 1.904(i)-1(b)(1)(ii) of the proposed 
regulations. Therefore, Sec. 1.904(i)-1(b)(1)(iii)(A) will only apply 
to acquisitions of affiliates after December 7, 1995. With respect to 
acquisitions on or before December 7, 1995, Sec. 1.904(i)-
1(b)(1)(iii)(B) will apply.
    It has also been clarified that the exception only applies to 
acquisitions from unrelated third parties and does not apply where the 
acquisition of the new affiliate is used to avoid the application of 
section 904(i). Both of these clarifications apply to any acquisition 
of an includible corporation after December 31, 1993.

Special Analyses

    It has been determined that this Treasury decision is not a 
significant regulatory action as defined in EO 12866. Therefore, a 
regulatory assessment is not required. It is hereby certified that 
these regulations will not have a significant economic impact on a 
substantial number of small entities. Accordingly, a regulatory 
flexibility analysis is not required. This certification is based on 
the information that follows. These regulations affect related domestic 
corporations not electing to file a consolidated return, or ineligible 
to file a consolidated return for all of the domestic corporations 
because of the existence of nonincludible entities. It is assumed that 
a substantial number of small entities do not operate in such 
structures. Pursuant to section 7805(f) of the Internal Revenue Code, 
the notice of proposed rulemaking preceding these regulations was 
submitted to the Small Business Administration for comment on its 
impact on small businesses.

Need for Final Regulations

    This regulation, when adopted, would apply to taxable years of 
affiliates beginning after December 31, 1993. The final regulations 
will clarify the law in this area and will provide taxpayers with 
needed immediate guidance. The effective date is also necessary to 
prevent avoidance of tax. This regulation is not being issued subject 
to the effective date limitation of section 553(d) of 5 U.S.C.

Drafting Information

    The principal author of these regulations is Kenneth D. Allison of 
the Office of Associate Chief Counsel (International), IRS. However, 
other personnel from the IRS and Treasury Department participated in 
their development.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

    Accordingly, 26 CFR part 1 is amended as follows:

PART 1--INCOME TAXES

    Paragraph 1. The authority citation for part 1 is amended by adding 
an entry in numerical order to read as follows:

    Authority: 26 U.S.C. 7805. * * *

    Section 1.904(i)-1 also issued under 26 U.S.C. 904(i). * * *

    Par. 2. Section 1.904-0 is amended by:
    1. Revising the introductory text.
    2. Adding an entry for Sec. 1.904(i)-1.
    The revision and addition read as follows:


Sec. 1.904-0  Outline of regulation provisions for section 904.

    This section lists the regulations under section 904 of the 
Internal Revenue Code of 1986.
* * * * *


Sec. 1.904(i)-1  Limitation on use of deconsolidation to avoid foreign 
tax credit limitations.

(a) General rule.
(1) Determination of taxable income.
(2) Allocation.
(b) Definitions and special rules.
(1) Affiliate.
(i) Generally.
(ii) Rules for consolidated groups.
(iii) Exception for newly acquired affiliates.
(2) Includible corporation.
(c) Taxable years.
(d) Consistent treatment of foreign taxes paid.
(e) Effective date.

    Par. 3. Section 1.904(i)-1 is added to read as follows:


Sec. 1.904(i)-1  Limitation on use of deconsolidation to avoid foreign 
tax credit limitations.

    (a) General rule. If two or more includible corporations are 
affiliates, within the meaning of paragraph (b)(1) of this section, at 
any time during their taxable years, then, solely for purposes of 
applying the foreign tax credit provisions of section 59(a), sections 
901 through 908, and section 960, the rules of this section will apply.
    (1) Determination of taxable income--(i) Each affiliate must 
compute its net taxable income or loss in each separate category (as 
defined in Sec. 1.904-5(a)(1), and treating U.S. source income or loss 
as a separate category) without regard to sections 904(f) and 
907(c)(4). Only affiliates that are members of the same consolidated 
group use the consolidated return regulations (other than those under 
sections 904(f) and 907(c)(4)) in computing such net taxable income or 
loss. To the extent otherwise applicable, other provisions of the Code 
and regulations must be used in the determination of an affiliate's net 
taxable income or loss in a separate category.
    (ii) The net taxable income amounts in each separate category 
determined under paragraph (a)(1)(i) of this section are combined for 
all affiliates to determine one amount for the group of affiliates in 
each separate category. However, a net loss of an affiliate (first 
affiliate) in a separate category determined under paragraph (a)(1)(i) 
of this section will be combined under this paragraph (a) with net 
income or loss amounts of other affiliates in the same category only 
if, and to the extent that, the net loss offsets taxable income, 
whether U.S. or foreign source, of the first affiliate. The 
consolidated return regulations that apply the principles of sections 
904(f) and 907(c)(4) to consolidated groups will then be applied to the 
combined amounts in each separate category as if all affiliates were 
members of a single consolidated group.
    (2) Allocation. Any net taxable income in a separate category 
calculated under paragraph (a)(1)(ii) of this section for purposes of 
the foreign tax credit provisions must then be allocated among the 
affiliates under any consistently applied reasonable method, taking 
into account all of the facts and circumstances. A method is 
consistently applied if used by all affiliates from year to year. Once 
chosen, an allocation method may be changed only with the consent of 
the Commissioner. This allocation will only affect the source and 
foreign tax credit separate limitation character of the income for 
purposes of the foreign tax credit separate limitation of each 
affiliate, and will not otherwise affect an affiliate's total net 
income or loss. This section applies whether the federal income tax 
consequences of its application favor, or are adverse to, the taxpayer.
    (b) Definitions and special rules--For purposes of this section 
only, the following terms will have the meanings specified. 

[[Page 56120]]

    (1) Affiliate--(i) Generally. Affiliates are includible 
corporations--
    (A) That are members of the same affiliated group, as defined in 
section 1504(a); or
    (B) That would be members of the same affiliated group, as defined 
in section 1504(a) if--
    (1) Any non-includible corporation meeting the ownership test of 
section 1504(a)(2) with respect to any such includible corporation was 
itself an includible corporation; or
    (2) The constructive ownership rules of section 1563(e) were 
applied for purposes of section 1504(a).
    (ii) Rules for consolidated groups. Affiliates that are members of 
the same consolidated group are treated as a single affiliate for 
purposes of this section. The provisions of paragraph (a) of this 
section shall not apply if the only affiliates under this definition 
are already members of the same consolidated group without operation of 
this section.
    (iii) Exception for newly acquired affiliates--(A) With respect to 
acquisitions after December 7, 1995, an includible corporation acquired 
from unrelated third parties (First Corporation) will not be considered 
an affiliate of another includible corporation (Second Corporation) 
during the taxable year of the First Corporation beginning before the 
date on which the First Corporation originally becomes an affiliate 
with respect to the Second Corporation.
    (B) With respect to acquisitions on or before December 7, 1995, an 
includible corporation acquired from unrelated third parties will not 
be considered an affiliate of another includible corporation during its 
taxable year beginning before the date on which the first includible 
corporation first becomes an affiliate with respect to that other 
includible corporation.
    (C) This exception does not apply where the acquisition of an 
includible corporation is used to avoid the application of this 
section.
    (2) Includible corporation. The term includible corporation has the 
same meaning it has in section 1504(b).
    (c) Taxable years. If all of the affiliates use the same U.S. 
taxable year, then that taxable year must be used for purposes of 
applying this section. If, however, the affiliates use more than one 
U.S. taxable year, then an appropriate taxable year must be used for 
applying this section. The determination whether a taxable year is 
appropriate must take into account all of the relevant facts and 
circumstances, including the U.S. taxable years used by the affiliates 
for general U.S. income tax purposes. The taxable year chosen by the 
affiliates for purposes of applying this section must be used 
consistently from year to year. The taxable year may be changed only 
with the prior consent of the Commissioner. Those affiliates that do 
not use the year determined under this paragraph (c) as their U.S. 
taxable year for general U.S. income tax purposes must, for purposes of 
this section, use their U.S. taxable year or years ending within the 
taxable year determined under this paragraph (c). If, however, the 
stock of an affiliate is disposed of so that it ceases to be an 
affiliate, then the taxable year of that affiliate will be considered 
to end on the disposition date for purposes of this section.
    (d) Consistent treatment of foreign taxes paid. All affiliates must 
consistently either elect under section 901(a) to claim a credit for 
foreign income taxes paid or accrued, or deemed paid or accrued, or 
deduct foreign taxes paid or accrued under section 164. See also 
Sec. 1.1502-4(a); Sec. 1.905-1(a).
    (e) Effective date. Except as provided in paragraph (b)(1)(iii) of 
this section (relating to newly acquired affiliates), this section is 
effective for taxable years of affiliates beginning after December 31, 
1993.

    Approved: September 27, 1995.
Margaret Milner Richardson,
Commissioner of Internal Revenue.
Leslie Samuels,
Assistant Secretary of the Treasury.
[FR Doc. 95-27563 Filed 11-6-95; 8:45 am]
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