[Federal Register Volume 62, Number 4 (Tuesday, January 7, 1997)]
[Rules and Regulations]
[Pages 923-941]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-153]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Parts 1 and 602

[TD 8708]
RIN 1545-AL98


Computation of Foreign Taxes Deemed Paid Under Section 902 
Pursuant to a Pooling Mechanism for Undistributed Earnings and Foreign 
Taxes

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

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SUMMARY: This document contains final income tax regulations relating 
to the computation of foreign taxes deemed paid under section 902. 
Changes to the applicable law were made by the Tax Reform Act of 1986 
and by the Technical and Miscellaneous Revenue Act of 1988 (TAMRA). 
These regulations provide guidance needed to comply with these changes 
and affect foreign corporations and their United States corporate 
shareholders.

DATES: These regulations are effective January 7, 1997.
    Applicability: For the specific dates of applicability of these 
regulations, see Secs. 1.902-1(g) and 1.902-3(l).

FOR FURTHER INFORMATION CONTACT: Caren S. Shein (202) 622-3850 (not a 
toll free number).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

    The collection of information contained in these final regulations 
has been reviewed and approved by the Office of Management and Budget 
in accordance with the Paperwork Reduction Act (44 U.S.C. 3507) under 
control number 15451458. Responses to these collections of information 
are required by the IRS to implement the section 902 pooling regime 
enacted in the Tax Reform Act of 1986.
    An agency may not conduct or sponsor, and a person is not required 
to respond to, a collection of information unless the collection of 
information displays a valid control number.

[[Page 924]]

    The burden for the collection of information is reflected in the 
burden for Form 1118.
    Comments concerning the accuracy of this burden estimate and 
suggestions for reducing this burden should be sent to the Internal 
Revenue Service, Attention: IRS Reports Clearance Officer T:FP, 
Washington, DC 20224, and to the Office of Management and Budget, 
Attention: Desk Officer for the Department of the Treasury, Office of 
Information and Regulatory Affairs, Washington, DC 20503.
    Books or records relating to the 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

    Section 902 (26 CFR part 1) was amended by section 1202(a) of the 
Tax Reform Act of 1986 (Public Law 99-514, 100 Stat. 1085), and section 
1012(b) of the Technical and Miscellaneous Revenue Act of 1988 (TAMRA) 
(Public Law 100-647, 102 Stat. 3242). On January 6, 1995, the IRS 
published a notice of proposed rulemaking in the Federal Register (60 
FR 2049 [INTL-933-86 (1995-1 C.B. 959)]). The proposed regulations 
provide guidance needed to comply with section 902 as amended in 1986 
and 1988. No public hearing was requested or held, but numerous written 
comments were received. The proposed regulations, with certain changes 
made in response to comments, are adopted in this Treasury decision as 
final regulations. The principal changes to the regulations, as well as 
the major comments and suggestions, are discussed below.

Explanation of Provisions

Section 1.902-1

    In the preamble to the proposed regulations, the IRS requested 
comments on whether the holding of Revenue Ruling 71-141 (1971-1 C.B. 
211) should be expanded to allow taxes paid by a foreign corporation to 
be considered deemed paid by domestic corporations that are partners in 
domestic limited partnerships or foreign partnerships, shareholders in 
limited liability companies, beneficiaries of domestic or foreign 
trusts and estates, or interest holders in other pass-through entities. 
The revenue ruling held that two 50-percent domestic corporate general 
partners of a domestic general partnership that owned 40 percent of a 
foreign corporation were entitled to compute an amount of foreign taxes 
deemed paid under section 902 with respect to dividends they received 
from the foreign corporation through the partnership.
    The IRS received numerous comments in response to the request in 
the preamble. The commenters uniformly argue that the aggregate theory 
of partnerships should apply to allow domestic corporate partners to 
compute an amount of foreign taxes deemed paid with respect to 
dividends paid to any partnership by a foreign corporation, provided 
that the partner owns at least 10 percent of the voting stock of the 
foreign corporation through the partnership.
    The final regulations do not resolve under what circumstances a 
domestic corporate partner may compute an amount of foreign taxes 
deemed paid with respect to dividends received from a foreign 
corporation by a partnership or other pass-through entity. That issue 
will be the subject of a future proposed regulations project. However, 
in recognition of the holding in Revenue Ruling 71-141 (1971-1 C.B. 
211) that a general partner of a domestic general partnership may 
compute an amount of foreign taxes deemed paid with respect to a 
dividend distribution from a foreign corporation to the partnership, 
Sec. 1.902-1(a)(1) is amended to define a domestic shareholder as a 
domestic corporation that ``owns'' the requisite voting stock in a 
foreign corporation rather than one that ``owns directly'' the voting 
stock. The IRS is still considering under what other circumstances the 
revenue ruling should apply.
    Section 1.902-1(a)(8) is amended to clarify under what 
circumstances the pool of post-1986 foreign income taxes must be 
reduced to account for distributions made in prior post-1986 taxable 
years. The regulations require a reduction in the taxes pool for taxes 
attributable to earnings distributed to shareholders ineligible for the 
deemed paid credit (for example, a foreign shareholder, a U.S. 
individual shareholder, or a domestic corporate shareholder that owns 
less than 10 percent of the foreign corporation's voting stock) and to 
shareholders that are eligible for the credit but that choose to deduct 
foreign taxes under section 164(a) in the year of the distribution 
rather than claim a credit.
    The IRS understands that some taxpayers have taken the position, 
contrary to the position taken in Sec. 1.902-1(a)(8) of the proposed 
regulations, that although post-1986 undistributed earnings must be 
reduced to account for all distributions out of current or accumulated 
earnings and profits, post-1986 foreign income taxes should be reduced 
only to account for taxes attributable to distributions with respect to 
which a shareholder both is eligible to claim a credit for foreign 
taxes deemed paid under section 902(a) and in fact elects to credit 
foreign taxes for the taxable year under section 901(a). These 
taxpayers argue that only in those circumstances are foreign taxes 
``deemed paid'' and thus required to be removed from the taxes pool 
under a literal reading of sections 902(a) and 902(c)(2)(B).
    The IRS has not changed its position as reflected in Sec. 1.902-
1(a)(8)(i) of the proposed regulations that the foreign taxes pool must 
be reduced to account for foreign taxes attributable to all 
distributions and deemed distributions or inclusions to all 
shareholders. However, the text of the final regulations has been 
amended to clarify the rule. The requirement that the foreign taxes 
pool must be reduced proportionately as the earnings pool is reduced is 
consistent with the legislative history of the Tax Reform Act of 1986 
(Public Law 99-514). The House Report states that under the pooling 
regime, ``[a] dividend or subpart F inclusion is considered to bring 
with it a pro rata share of the accumulated foreign taxes paid by the 
subsidiary.'' H.R. Rep. No. 426, 99th Cong., 1st Sess. 357 (1985). In 
addition, removing taxes attributable to distributions to ineligible 
shareholders and eligible shareholders that choose to deduct foreign 
taxes is supported by the general matching principles of section 902, 
which presume that a dividend distribution will carry with it a ratable 
share of the foreign corporation's taxes. If taxes paid with respect to 
distributed earnings remained in the pool, eligible shareholders 
eventually could receive credits for more than their ratable share of 
the foreign corporation's taxes, a result at odds with the statutory 
scheme.
    Section 1.902-1(a)(8)(i) is amended to correct an oversight in the 
proposed regulation. In the case of a distribution out of current 
earnings and profits that is treated as a ``nimble'' dividend under 
section 316(a)(2) when there is a deficit in accumulated earnings and 
profits, post-1986 foreign income taxes are not reduced. This rule is 
not inconsistent with the general rule of paragraph (a)(8)(i) that the 
foreign taxes pool must be reduced to account for taxes attributable to 
all distributions and deemed distributions out of post-1986 
undistributed earnings. Rather, it reflects the fact that under section 
902 and these regulations, no taxes are deemed paid with respect to a 
nimble

[[Page 925]]

dividend under section 316(a)(2) because the post-1986 undistributed 
earnings pool is zero or less than zero.
    Section 1.902-1(a)(9), defining post-1986 undistributed earnings, 
is amended to clarify that the earnings pool is reduced only to account 
for distributions or deemed distributions that reduce earnings and 
profits and inclusions that result in previously-taxed amounts 
described in sections 959(c)(1) and (c)(2) or 1293(c). Thus, for 
example, in the case of a controlled foreign corporation owned 60 
percent by a domestic corporate shareholder and 40 percent by a foreign 
shareholder, the earnings and taxes pools are reduced only to account 
for 60 percent of the foreign corporation's subpart F income.
    The rules precluding special allocations of earnings and taxes in 
Sec. 1.902-1(a)(9)(iv) and (10)(ii) of the proposed regulations have 
been retained in the final regulations. These regulations are intended 
to reverse the result in Vulcan v. Commissioner, 96 T.C. 410 (1991), 
aff'd per curiam, 959 F.2d 973 (11th Cir. 1992), nonacq. 1995-1 C.B. 1, 
for post-1986 taxable years. Several commenters argued that the Vulcan 
decision was correct and should be applied to both pre-1987 and post-
1986 taxable years, and the regulations should be revised to reflect 
the decision. For the reasons stated in the preamble to the proposed 
regulations, the IRS declines to do so.
    Commenters also argued that the rule precluding special allocations 
of earnings and taxes is inconsistent with Sec. 1.904-6(a)(2). Section 
1.904-6(a)(2) is an anti-abuse rule designed to prevent the use of 
accommodation parties to improve a United States taxpayer's foreign tax 
credit position. The rule states that if a taxpayer receives or accrues 
a dividend from a noncontrolled section 902 corporation and the 
Commissioner establishes the existence of an express or implied 
agreement that the dividend is paid out of the foreign corporation's 
passive or high withholding tax interest earnings, then only taxes 
imposed on passive or high withholding tax interest earnings will be 
considered related to the dividend. The IRS may invoke this rule to 
prevent a shareholder from sheltering investment income from tax by 
investing it through a noncontrolled section 902 corporation that 
distributes only the investment earnings to the shareholder, which then 
treats the distribution as a dividend sheltered by taxes paid on the 
corporation's hightaxed active business income. The IRS believes that 
this narrowly defined anti-abuse rule is an appropriate exception to 
the general rule of Sec. 1.902-1(a)(9)(iv) and (a)(10)(ii) barring 
special allocations of earnings and taxes.
    Section 1.902-1(a)(11) has been amended to clarify that the 
definition of a dividend in section 316(a) applies for purposes of 
section 902, and that the section 902 definition of a dividend also 
includes deemed dividends under sections 551 and 1248. Deemed 
inclusions under sections 951(a) and 1293 are not dividends for 
purposes of section 902. However, sections 960(a)(1) and 1293(f) 
provide that deemed paid taxes with respect to inclusions under 
sections 951(a) and 1293 are determined under section 902 in the same 
manner as if a dividend was paid.
    Paragraph (a)(11) also has been amended to add a crossreference to 
section 1291 and Sec. 1.1291-5 of the proposed regulations, which 
provide special rules for computing foreign taxes deemed paid with 
respect to distributions from section 1291 funds. These distributions 
are treated as dividends solely for foreign tax credit purposes, but 
the general section 902 computational rules do not apply.
    A commenter correctly pointed out that the regulation's inclusion 
of deemed distributions under section 551 as dividends for purposes of 
section 902 is contrary to the holding in Revenue Ruling 74-59 (1974-1 
C.B. 183) that an amount includible in gross income under section 551 
is not considered a dividend received for purposes of the allowance of 
a foreign tax credit under section 902. The holding of the revenue 
ruling is based on language in the 1937 legislative history of the 
foreign personal holding company provisions. The Report of the Joint 
Committee on Tax Evasion and Avoidance of the Congress of the United 
States, H.R. Doc. No. 337, 75th Cong., 1st Sess. 18 (1937), recommended 
that shareholders of foreign personal holding companies not be allowed 
a credit for foreign income taxes paid by the foreign corporation with 
respect to amounts deemed distributed. The Report goes on to state that 
the committee recommended against allowing a credit because ``it is not 
administratively feasible, although it might seem equitable under the 
circumstances.''
    Section 551(b) provides that amounts required to be included in the 
gross income of a U.S. shareholder under section 551(a) are treated as 
dividends, and under current law it is administratively feasible to 
allow deemed paid taxes to be computed with respect to deemed 
dividends. In addition, the Code now includes other anti-deferral 
regimes, e.g., the subpart F and passive foreign investment company 
provisions, the application of which may overlap with the foreign 
personal holding company rules. Shareholders are permitted to compute 
deemed paid taxes with respect to subpart F and passive foreign 
investment company inclusions.
    The IRS, therefore, has concluded the revenue ruling is not 
supported by current law. A shareholder of a foreign personal holding 
company should be entitled to compute deemed paid taxes with respect to 
amounts required to be included in gross income as dividends under 
section 551(a). Revenue Ruling 74-59 (1974-1 C.B. 183) is hereby 
revoked effective as of the date these regulations are published in the 
Federal Register.
    A commenter argued that the rule in Sec. 1.902-1(b)(4), providing 
that no taxes are deemed paid with respect to dividends out of current 
earnings and profits when the foreign corporation has no post-1986 
undistributed earnings and no accumulated earnings and profits (so-
called ``nimble'' dividends) conflicts with the general purpose of the 
foreign tax credit to prevent double taxation. The rule is retained in 
the final regulations for two reasons. First, the legislative history 
of the Tax Reform Act of 1986 (Public Law 99-514) clearly indicates 
that Congress was aware of the issue and agreed with the position 
stated in the regulation. See S. Rep. No. 313, 99th Cong., 2d Sess. 321 
(1986). Second, because no taxes can be deemed paid under the 
computational rules of section 902 when post-1986 undistributed 
earnings are zero or less than zero, no taxes are removed from the 
post-1986 foreign income taxes pool. Thus, all of the foreign 
corporation's taxes remain in its post-1986 foreign income taxes pool 
and are available to be credited if the corporation pays another 
dividend in a later year in which the post-1986 undistributed earnings 
pool is positive.
    Section 1.902-1(c)(8) of the proposed regulations reserved on the 
application of section 902 in section 304 exchanges. Commenters 
suggested that the regulations should address this area by 
incorporating the holdings in Revenue Ruling 91-5 (1991-1 C.B. 114), 
and Revenue Ruling 92-86 (1992-1 C.B. 199). In addition, the commenters 
argued that the regulations should state that a deemed paid credit is 
available in a section 304 exchange involving a foreign parent 
corporation. The IRS is still studying the area and the regulations 
thus continue to reserve on the application of section 902 in a section 
304 exchange.
    Section 1.902-1(c)(9) of the proposed regulations is reserved in 
these final regulations. The proposed regulation

[[Page 926]]

provided a cross-reference to regulations under section 905(c) with 
respect to adjustments to post-1986 undistributed earnings and taxes 
that result from a section 482 allocation of income. There currently 
are no regulations under section 905(c) addressing section 482 
allocations and the IRS, therefore, has reserved this paragraph pending 
issuance of final regulations under section 905(c).
    Section 1.902-1(d)(3) (ii) through (iv) of the proposed regulations 
is not included in the final regulations. Paragraph (d)(3) set out 
rules and examples exercising a grant of regulatory authority under the 
last sentence of section 904(d)(2)(E)(i) to limit beyond the statute 
the circumstances under which a dividend paid to a new U.S. shareholder 
by a controlled foreign corporation out of earnings accumulated while 
it was a controlled foreign corporation will be treated as dividends 
from a noncontrolled section 902 corporation. Identical rules were 
proposed in 1992 under section 904(d). See Sec. 1.904-4(g)(3) (ii) 
through (iv) of the proposed regulations. The rules address the 
character of a dividend distribution under section 904(d) and are more 
appropriately placed in the regulations under that section. After 
considering the comments received, the rule will be finalized as part 
of the section 904 regulations.

Section 1.902-2

    A commenter suggested that the deficit carryback rules in 
Sec. 1.902-2(a)(1) should be amended to provide that a deficit in post-
1986 undistributed earnings will not be carried back to pre-1987 years 
on a return of capital or capital gain distribution. The rule states 
that a deficit will be carried back when ``* * * a corporation makes a 
distribution to shareholders that is a dividend or would be a dividend 
if there were current or accumulated earnings and profits, * * * .'' 
The commenter suggests that the rule in the proposed regulation can 
result in ``locked-in'' taxes when earnings attributable to one or more 
pre-1987 years are eliminated by the deficit carryback. If the deficit 
stays in the post-1986 pool there is a chance it can be absorbed by 
future earnings, leaving the pre-1987 earnings and taxes intact. In 
support of its position, the commenter argues that section 902 
establishes rules that minimize double taxation by allowing a taxpayer 
to compute a deemed paid credit on a taxable dividend. The legislative 
history indicates that the pooling provisions of section 902 are to 
apply solely for purposes of computing the deemed paid credit. Because 
a return of capital or capital gain distribution is not a taxable 
dividend and no section 902 credit is allowable, the commenter argues 
that the pooling rules (including the deficit carryback rules) should 
not apply.
    The IRS declines to adopt the commenter's suggestion. When an 
amount is distributed in a post-1986 taxable year and there is a 
deficit in post-1986 undistributed earnings, the deficit must be 
carried back and reduce earnings and profits in pre-1987 years to 
determine whether any earnings remain to support treatment of the 
distribution as a dividend. To the extent there are earnings remaining 
in one or more pre-1987 years after a deficit is carried back, the 
distribution is a dividend. Any remaining amount is a return of capital 
and capital gain. It would be incongruous to adopt a rule providing a 
different result if a single dollar of pre-1987 accumulated profits 
remains in a pre-1987 year after a post-1986 deficit is carried back 
than if the deficit carryback eliminated all pre-1987 accumulated 
profits and the entire distribution were treated as a return of 
capital.
    Another commenter argued that the interplay among Sec. 1.902-
2(b)(1) (pre-1987 accumulated deficit carries over to become the 
opening balance of post-1986 undistributed earnings pool) and 
Sec. 1.902-1(b)(4) (no taxes deemed paid if a dividend is a nimble 
dividend) of the proposed regulations, and section 960 (incorporating 
the section 902 rules with respect to deemed inclusions under subpart 
F) results in a denial of deemed paid taxes to a U.S. shareholder if a 
controlled foreign corporation has both a pre-1987 accumulated deficit 
and post-1986 earnings and profits that are entirely subpart F income. 
The commenter suggests that regulations be issued under section 960 to 
provide, solely for purposes of that section, that accumulated deficits 
in pre-1987 accumulated profits will not carry over into the post-1986 
pool.
    The IRS cannot adopt the rule the commenter suggests. Congress 
amended sections 902 and 960 in 1986 specifically to eliminate 
different earnings and profits and deemed paid taxes computations for 
purposes of sections 902 and 960. Further, in the situation the 
commenter posits, the credits are deferred but not permanently 
disallowed. If the controlled foreign corporation earns enough post-
1986 income to eliminate the accumulated deficit, any distribution or 
deemed distribution will carry with it a ratable share of post-1986 
foreign income taxes.
    A commenter argued that Sec. 1.902-2(b)(2) and (3), Example 1, are 
incorrect because they imply that annual deficits in pre-1987 
accumulated profits were required to be carried back under pre-1987 
section 902 regardless of how foreign income taxes were determined. The 
commenter argues that pre-1987 section 902 requires a ``correlation'' 
between accumulated profits as determined under U.S. law and the 
foreign law method by which foreign taxes were determined.
    The IRS disagrees with the comment and the proposed regulation has 
not been amended. The regulation reflects the IRS' longstanding 
position that in the case of a deficit in accumulated profits of a 
foreign corporation for a particular pre-1987 year, the deficit first 
reduces prior years' accumulated profits on a LIFO basis to the extent 
thereof, and then the remaining deficit reduces accumulated profits in 
subsequent years. That rule applies regardless of whether foreign law 
permits or requires the carryback or carryforward of losses. See 
Revenue Ruling 74-550 (1974-2 C.B. 209) and Revenue Ruling 87-72 (1987-
2 C.B. 170).

Effect on Other Documents

    The following revenue ruling is revoked as of January 7, 1997:
    Revenue Ruling 74-59, 1974-1 C.B. 183.

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 also has been determined that 
section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) 
does not apply to these regulations, and because the notice of proposed 
rulemaking preceding the regulations was issued prior to March 29, 
1996, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not 
apply. 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 
business.

Drafting Information

    The principal author of these final regulations is Caren Silver 
Shein of the Office of Associate Chief Counsel (International), within 
the Office of Chief Counsel, IRS. However, other personnel from the IRS 
and Treasury Department participated in their development.

List of Subjects

26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

[[Page 927]]

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 1--INCOME TAXES

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

    Authority: 26 U.S.C. 7805 * * *
    Section 1.902-1 also issued under 26 U.S.C. 902(c)(7).
    Section 1.902-2 also issued under 26 U.S.C. 902(c)(7). * * *


Secs. 1.902-1 and 1.902-2  [Redesignated Secs. 1.902-3 and 1.902-4]

    Par. 2. Sections 1.902-1 and 1.902-2 are redesignated Secs. 1.902-3 
and 1.902-4, respectively.
    Par. 3. Sections 1.902-0, 1.902-1 and 1.902-2 are added to read as 
follows:


Sec. 1.902-0  Outline of regulations provisions for section 902.

    This section lists the provisions under section 902.

Sec. 1.902-1  Credit for domestic corporate shareholder of a 
foreign corporation for foreign income taxes paid by the foreign 
corporation.

(a) Definitions and special effective date.
    (1) Domestic shareholder.
    (2) First-tier corporation.
    (3) Second-tier corporation.
    (4) Third-tier corporation.
    (5) Example.
    (6) Upper- and lower-tier corporations.
    (7) Foreign income taxes.
    (8) Post-1986 foreign income taxes.
    (i) In general.
    (ii) Distributions out of earnings and profits accumulated by a 
lower-tier corporation in its taxable years beginning before January 
1, 1987, and included in the gross income of an upper-tier 
corporation in its taxable year beginning after December 31, 1986.
    (iii) Foreign income taxes paid or accrued with respect to high 
withholding tax interest.
    (9) Post-1986 undistributed earnings.
    (i) In general.
    (ii) Distributions out of earnings and profits accumulated by a 
lower-tier corporation in its taxable years beginning before January 
1, 1987, and included in the gross income of an upper-tier 
corporation in its taxable year beginning after December 31, 1986.
    (iii) Reduction for foreign income taxes paid or accrued.
    (iv) Special allocations.
    (10) Pre-1987 accumulated profits.
    (i) Definition.
    (ii) Computation of pre-1987 accumulated profits.
    (iii) Foreign income taxes attributable to pre-1987 accumulated 
profits.
    (11) Dividend.
    (12) Dividend received.
    (13) Special effective date.
    (i) Rule.
    (ii) Example.
(b) Computation of foreign income taxes deemed paid by a domestic 
shareholder, first-tier corporation, and second-tier corporation.
    (1) General rule.
    (2) Allocation rule for dividends attributable to post-1986 
undistributed earnings and pre-1987 accumulated profits.
    (i) Portion of dividend out of post-1986 undistributed earnings.
    (ii) Portion of dividend out of pre-1987 accumulated profits.
    (3) Dividends paid out of pre-1987 accumulated profits.
    (4) Deficits in accumulated earnings and profits.
    (5) Examples.
(c) Special rules.
    (1) Separate computations required for dividends from each 
first-tier and lower-tier corporation.
    (i) Rule.
    (ii) Example.
    (2) Section 78 gross-up.
    (i) Foreign income taxes deemed paid by a domestic shareholder.
    (ii) Foreign income taxes deemed paid by an upper-tier 
corporation.
    (iii) Example.
    (3) Creditable foreign income taxes.
    (4) Foreign mineral income.
    (5) Foreign taxes paid or accrued in connection with the 
purchase or sale of certain oil and gas.
    (6) Foreign oil and gas extraction income.
    (7) United States shareholders of controlled foreign 
corporations.
    (8) Credit for foreign taxes deemed paid in a section 304 
transaction.
    (9) Effect of section 482 adjustments on post-1986 foreign 
income taxes and post-1986 undistributed earnings.
(d) Dividends from controlled foreign corporations.
    (1) General rule.
    (2) Look-through.
    (i) Dividends.
    (ii) Coordination with section 960.
    (3) Dividends distributed out of earnings accumulated before a 
controlled foreign corporation became a controlled foreign 
corporation.
    (i) General rule.
    (ii) Dividend distributions out of earnings and profits for a 
year during which a shareholder that is currently a more-than-90-
percent United States shareholder of a controlled foreign 
corporation was not a United States shareholder of the controlled 
foreign corporation.
(e) Information to be furnished.
(f) Examples.
(g) Effective date.

Sec. 1.902-2  Treatment of deficits in post-1986 undistributed 
earnings and pre-1987 accumulated profits of a first-, second-, or 
third-tier corporation for purposes of computing an amount of 
foreign taxes deemed paid Sec. 1.902-1.

(a) Carryback of deficits in post-1986 undistributed earnings of a 
first-, second-, or third-tier corporation to pre-effective date 
taxable years.
    (1) Rule.
    (2) Examples.
(b) Carryforward of deficits in pre-1987 accumulated profits of a 
first-, second-, or third-tier corporation to post-1986 
undistributed earnings for purposes of section 902.
    (1) General rule.
    (2) Effect of pre-effective date deficit.
    (3) Examples.

Sec. 1.902-3  Credit for domestic corporate shareholder of a 
foreign corporation for foreign income taxes paid with respect to 
accumulated profits of taxable years of the foreign corporation 
beginning before January 1, 1987.

    (a) Definitions.
    (1) Domestic shareholder.
    (2) First-tier corporation.
    (3) Second-tier corporation.
    (4) Third-tier corporation.
    (5) Foreign income taxes.
    (6) Dividend.
    (7) Dividend received.
(b) Domestic shareholder owning stock in a first-tier corporation.
    (1) In general.
    (2) Amount of foreign taxes deemed paid by a domestic 
shareholder.
(c) First-tier corporation owning stock in a second-tier 
corporation.
    (1) In general.
    (2) Amount of foreign taxes deemed paid by a first-tier 
corporation.
(d) Second-tier corporation owning stock in a third-tier 
corporation.
    (1) In general.
    (2) Amount of foreign taxes deemed paid by a second-tier 
corporation.
(e) Determination of accumulated profits of a foreign corporation.
(f) Taxes paid on or with respect to accumulated profits of a 
foreign corporation.
(g) Determination of earnings and profits of a foreign corporation.
    (1) Taxable year to which section 963 does not apply.
    (2) Taxable year to which section 963 applies.
    (3) Time and manner of making choice.
    (4) Determination by district director.
(h) Source of income from first-tier corporation and country to 
which tax is deemed paid.
    (1) Source of income.
    (2) Country to which taxes deemed paid.
(i) United Kingdom income taxes paid with respect to royalties.
(j) Information to be furnished.
(k) Illustrations.
(l) Effective date.

[[Page 928]]

Sec. 1.902-4  Rules for distributions attributable to accumulated 
profits for taxable years in which a first-tier corporation was a 
less developed country corporation.

(a) In general.
(b) Combined distributions.
(c) Distributions of a first-tier corporation attributable to 
certain distributions from second- or third-tier corporations.
(d) Illustrations.


Sec. 1.902-1  Credit for domestic corporate shareholder of a foreign 
corporation for foreign income taxes paid by the foreign corporation.

    (a) Definitions and special effective date. For purposes of section 
902, this section, and Sec. 1.902-2, the definitions provided in 
paragraphs (a) (1) through (12) of this section and the special 
effective date of paragraph (a)(13) of this section apply.
    (1) Domestic shareholder. In the case of dividends received by a 
domestic corporation from a foreign corporation after December 31, 
1986, the term domestic shareholder means a domestic corporation, other 
than an S corporation as defined in section 1361(a), that owns at least 
10 percent of the voting stock of the foreign corporation at the time 
the domestic corporation receives a dividend from that foreign 
corporation.
    (2) First-tier corporation. In the case of dividends received by a 
domestic shareholder from a foreign corporation in a taxable year 
beginning after December 31, 1986, the term first-tier corporation 
means a foreign corporation, at least 10 percent of the voting stock of 
which is owned by a domestic shareholder at the time the domestic 
shareholder receives a dividend from that foreign corporation. The term 
first-tier corporation also includes a DISC or former DISC, but only 
with respect to dividends from the DISC or former DISC that are treated 
under sections 861(a)(2)(D) and 862(a)(2) as income from sources 
without the United States.
    (3) Second-tier corporation. In the case of dividends paid to a 
first-tier corporation by a foreign corporation in a taxable year 
beginning after December 31, 1986, the foreign corporation is a second-
tier corporation if, at the time a first-tier corporation receives a 
dividend from that foreign corporation, the first-tier corporation owns 
at least 10 percent of the foreign corporation's voting stock and the 
product of the following equals at least 5 percent--
    (i) The percentage of voting stock owned by the domestic 
shareholder in the first-tier corporation; multiplied by
    (ii) The percentage of voting stock owned by the first-tier 
corporation in the second-tier corporation.
    (4) Third-tier corporation. In the case of dividends paid to a 
second-tier corporation by a foreign corporation in a taxable year 
beginning after December 31, 1986, a foreign corporation is a third-
tier corporation if, at the time a second-tier corporation receives a 
dividend from that foreign corporation, the second-tier corporation 
owns at least 10 percent of the foreign corporation's voting stock and 
the product of the following equals at least 5 percent--
    (i) The percentage of voting stock owned by the domestic 
shareholder in the first-tier corporation; multiplied by
    (ii) The percentage of voting stock owned by the first-tier 
corporation in the second-tier corporation; multiplied by
    (iii) The percentage of voting stock owned by the second-tier 
corporation in the third-tier corporation.
    (5) Example. The following example illustrates the ownership 
requirements of paragraphs (a) (1) through (4) of this section:

    Example. (i) Domestic corporation M owns 30 percent of the 
voting stock of foreign corporation A on January 1, 1991, and for 
all periods thereafter. Corporation A owns 40 percent of the voting 
stock of foreign corporation B on January 1, 1991, and continues to 
own that stock until June 1, 1991, when Corporation A sells its 
stock in Corporation B. Both Corporation A and Corporation B use the 
calendar year as the taxable year. Corporation B pays a dividend out 
of its post-1986 undistributed earnings to Corporation A, which 
Corporation A receives on February 16, 1991. Corporation A pays a 
dividend out of its post-1986 undistributed earnings to Corporation 
M, which Corporation M receives on January 20, 1992. Corporation M 
uses a fiscal year ending on June 30 as the taxable year.
    (ii) On February 16, 1991, when Corporation B pays a dividend to 
Corporation A, Corporation M satisfies the 10 percent stock 
ownership requirement of paragraphs (a) (1) and (2) of this section 
with respect to Corporation A. Therefore, Corporation A is a first-
tier corporation within the meaning of paragraph (a)(2) of this 
section and Corporation M is a domestic shareholder of Corporation A 
within the meaning of paragraph (a)(1) of this section. Also on 
February 16, 1991, Corporation B is a second-tier corporation within 
the meaning of paragraph (a)(3) of this section because Corporation 
A owns at least 10 percent of its voting stock, and the percentage 
of voting stock owned by Corporation M in Corporation A on February 
16, 1991 (30 percent) multiplied by the percentage of voting stock 
owned by Corporation A in Corporation B on February 16, 1991 (40 
percent) equals 12 percent. Corporation A shall be deemed to have 
paid foreign income taxes of Corporation B with respect to the 
dividend received from Corporation B on February 16, 1991.
    (iii) On January 20, 1992, Corporation M satisfies the 10-
percent stock ownership requirement of paragraphs (a)(1) and (2) of 
this section with respect to Corporation A. Therefore, Corporation A 
is a first-tier corporation within the meaning of paragraph (a)(2) 
of this section and Corporation M is a domestic shareholder within 
the meaning of paragraph (a)(1) of this section. Accordingly, for 
its taxable year ending on June 30, 1992, Corporation M is deemed to 
have paid a portion of the post-1986 foreign income taxes paid, 
accrued, or deemed to be paid, by Corporation A. Those taxes will 
include taxes paid by Corporation B that were deemed paid by 
Corporation A with respect to the dividend paid by Corporation B to 
Corporation A on February 16, 1991, even though Corporation B is no 
longer a second-tier corporation with respect to Corporations A and 
M on January 20, 1992, and has not been a second-tier corporation 
with respect to Corporations A and M at any time during the taxable 
years of Corporations A and M that include January 20, 1992.

    (6) Upper- and lower-tier corporations. In the case of a third-tier 
corporation, the term upper-tier corporation means a first- or second-
tier corporation. In the case of a second-tier corporation, the term 
upper-tier corporation means a first-tier corporation. In the case of a 
first-tier corporation, the term lower-tier corporation means a second- 
or third-tier corporation. In the case of a second-tier corporation, 
the term lower-tier corporation means a third-tier corporation.
    (7) Foreign income taxes. The term foreign income taxes means 
income, war profits, and excess profits taxes as defined in Sec. 1.901-
2(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 also paragraphs (c)(4) and (5) 
of this section (concerning foreign taxes paid with respect to foreign 
mineral income and in connection with the purchase or sale of oil and 
gas).
    (8) Post-1986 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

[[Page 929]]

the extent the foreign taxes were not paid or deemed paid by the 
foreign corporation on or with respect to earnings that in prior 
taxable years were distributed to, or otherwise included (e.g., under 
sections 304, 367(b), 551, 951(a), 1248 or 1293) in the income of, a 
foreign or domestic shareholder. 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 post-1986 undistributed earnings in prior post-
1986 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 
(e.g., 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 a first- or second-tier corporation under 
paragraph (a)(2) or (3) 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 post-1986 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 
post-1986 foreign income taxes under section 902(a), and the foreign 
taxes deemed paid must be removed from post-1986 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, the 
term year means that accounting period. See sections 441(b)(3) and 443.
    (ii) Distributions out of earnings and profits accumulated by a 
lower-tier corporation in its taxable years beginning before January 1, 
1987, and included in the gross income of an upper-tier corporation in 
its taxable year beginning after December 31, 1986. Post-1986 foreign 
income taxes shall include foreign income taxes that are deemed paid by 
an upper-tier corporation with respect to distributions from a lower-
tier corporation out of nonpreviously taxed pre-1987 accumulated 
profits, as defined in paragraph (a)(10) of this section, that are 
received by an upper-tier corporation in any taxable year of the upper-
tier corporation beginning after December 31, 1986, provided the upper-
tier corporation's earnings and profits in that year are included in 
its post-1986 undistributed earnings under paragraph (a)(9) of this 
section. Foreign income taxes deemed paid with respect to a 
distribution of pre-1987 accumulated profits shall be translated from 
the functional currency of the lower-tier corporation into dollars at 
the spot exchange rate in effect on the date of the distribution. To 
determine the character of the earnings and profits and associated 
taxes for foreign tax credit limitation purposes, see section 904 and 
Sec. 1.904-7(a).
    (iii) Foreign income taxes paid or accrued with respect to high 
withholding tax interest. Post-1986 foreign income taxes shall not 
include foreign income taxes paid or accrued by a noncontrolled section 
902 corporation (as defined in section 904(d)(2)(E)(i)) with respect to 
high withholding tax interest (as defined in section 904(d)(2)(B)) to 
the extent the foreign tax rate imposed on such interest exceeds 5 
percent. See section 904(d)(2)(E)(ii) and Sec. 1.904-4(g)(2)(iii). The 
reduction in foreign income taxes paid or accrued by the amount of tax 
in excess of 5 percent imposed on high withholding tax interest income 
must be computed in functional currency before foreign income taxes are 
translated into U.S. dollars and included in post-1986 foreign income 
taxes.
    (9) Post-1986 undistributed earnings--(i) In general. Except as 
provided in paragraphs (a) (10) and (13) of this section, the term 
post-1986 undistributed earnings means the amount of the earnings and 
profits of a foreign corporation (computed in accordance with sections 
964(a) and 986) accumulated in taxable years of the foreign corporation 
beginning after December 31, 1986, determined as of the close of the 
taxable year of the foreign corporation in which it distributes a 
dividend. Post-1986 undistributed earnings shall not be reduced by 
reason of any earnings distributed or otherwise included in income, for 
example under section 304, 367(b), 551, 951(a), 1248 or 1293, during 
the taxable year. Post-1986 undistributed earnings shall be reduced to 
account for distributions or deemed distributions that reduced earnings 
and profits and inclusions that resulted in previously-taxed amounts 
described in section 959(c) (1) and (2) or section 1293(c) in prior 
taxable years beginning after December 31, 1986. Thus, post-1986 
undistributed earnings shall not be reduced to the extent of the 
ratable share of a controlled foreign corporation's subpart F income, 
as defined in section 952, attributable to a shareholder that is not a 
United States shareholder within the meaning of section 951(b) or 
section 953(c)(1)(A), because that amount has not been included in a 
shareholder's gross income. Post-1986 undistributed earnings shall be 
reduced as provided herein regardless of whether any shareholder is 
deemed to have paid any foreign taxes, and regardless of whether any 
domestic shareholder chose to claim a foreign tax credit under section 
901(a) for the year of the distribution. For rules on carrybacks and 
carryforwards of deficits and their effect on post-1986 undistributed 
earnings, see Sec. 1.902-2. In the case of a foreign corporation the 
foreign income taxes of which are computed based on an accounting 
period of less than one year, the term year means that accounting 
period. See sections 441(b)(3) and 443.
    (ii) Distributions out of earnings and profits accumulated by a 
lower-tier corporation in its taxable years beginning before January 1, 
1987, and included in the gross income of an upper-tier corporation in 
its taxable year beginning after December 31, 1986. Distributions by a 
lower-tier corporation out of non-previously taxed pre-1987 accumulated 
profits, as defined in paragraph (a)(10) of this section, that are 
received by an upper-tier corporation in any taxable year of the upper-
tier corporation beginning after December 31, 1986, shall be treated as 
post-1986 undistributed earnings of the upper-tier corporation, 
provided the upper-tier corporation's earnings and profits for that 
year are included in its post-1986 undistributed earnings under 
paragraph (a)(9)(i) of this section. To determine the character of the 
earnings and profits and associated taxes for foreign tax credit 
limitation purposes, see section 904 and Sec. 1.904-7(a).
    (iii) Reduction for foreign income taxes paid or accrued. In 
computing post-1986 undistributed earnings, earnings and profits shall 
be reduced by foreign income taxes paid or accrued regardless of 
whether the taxes are creditable. Thus, earnings and profits shall be 
reduced by foreign income taxes paid with respect to high withholding 
tax interest even though a portion of the taxes is not creditable

[[Page 930]]

pursuant to section 904(d)(2)(E)(ii) and is not included in post-1986 
foreign income taxes under paragraph (a)(8)(iii) of this section. 
Earnings and profits of an upper-tier corporation, however, shall not 
be reduced by foreign income taxes paid by a lower-tier corporation and 
deemed to have been paid by the upper-tier corporation.
    (iv) Special allocations. The term post-1986 undistributed earnings 
means the total amount of the earnings of the corporation determined at 
the corporate level. Special allocations of earnings and taxes to 
particular shareholders, whether required or permitted by foreign law 
or a shareholder agreement, shall be disregarded. If, however, the 
Commissioner establishes that there is an agreement to pay dividends 
only out of earnings in the separate categories for passive or high 
withholding tax interest income, then only taxes imposed on passive or 
high withholding tax interest earnings shall be treated as related to 
the dividend. See Sec. 1.904-6(a)(2).
    (10) Pre-1987 accumulated profits--(i) Definition. The term pre-
1987 accumulated profits means the amount of the earnings and profits 
of a foreign corporation computed in accordance with section 902 and 
attributable to its taxable years beginning before January 1, 1987. If 
the special effective date of paragraph (a)(13) of this section 
applies, pre-1987 accumulated profits also includes any earnings and 
profits (computed in accordance with sections 964(a) and 986) 
attributable to the foreign corporation's taxable years beginning after 
December 31, 1986, but before the first day of the first taxable year 
of the foreign corporation in which the ownership requirements of 
section 902(c)(3)(B) and paragraphs (a) (1) through (4) of this section 
are met with respect to that corporation.
    (ii) Computation of pre-1987 accumulated profits. Pre-1987 
accumulated profits must be computed under United States principles 
governing the computation of earnings and profits. Pre-1987 accumulated 
profits are determined at the corporate level. Special allocations of 
accumulated profits and taxes to particular shareholders with respect 
to distributions of pre-1987 accumulated profits in taxable years 
beginning after December 31, 1986, whether required or permitted by 
foreign law or a shareholder agreement, shall be disregarded. Pre-1987 
accumulated profits of a particular year shall be reduced by amounts 
distributed from those accumulated profits or otherwise included in 
income from those accumulated profits, for example under sections 304, 
367(b), 551, 951(a), 1248 or 1293. If a deficit in post-1986 
undistributed earnings is carried back to offset pre-1987 accumulated 
profits, pre-1987 accumulated profits of a particular taxable year 
shall be reduced by the amount of the deficit carried back to that 
year. See Sec. 1.902-2. The amount of a distribution out of pre-1987 
accumulated profits, and the amount of foreign income taxes deemed paid 
under section 902, shall be determined and translated into United 
States dollars by applying the law as in effect prior to the effective 
date of the Tax Reform Act of 1986. See Secs. 1.902-3, 1.902-4 and 
1.964-1.
    (iii) Foreign income taxes attributable to pre-1987 accumulated 
profits. The term pre-1987 foreign income taxes means any foreign 
income taxes paid, accrued, or deemed paid by a foreign corporation on 
or with respect to its pre-1987 accumulated profits. Pre-1987 foreign 
income taxes of a particular year shall be reduced by the amount of 
taxes paid or deemed paid by the foreign corporation on or with respect 
to amounts distributed or otherwise included in income from pre-1987 
accumulated profits of that year. Thus, pre-1987 foreign income taxes 
shall be reduced by the amount of taxes deemed paid by a domestic 
shareholder (regardless of whether the shareholder chose to credit 
foreign income taxes under section 901 for the year of the distribution 
or inclusion) or a first-tier or second-tier corporation, and by the 
amount of taxes that would have been deemed paid had any other 
shareholder been eligible to compute an amount of foreign taxes deemed 
paid under section 902. Foreign income taxes deemed paid with respect 
to a distribution of pre-1987 accumulated profits shall be translated 
from the functional currency of the distributing corporation into 
United States dollars at the spot exchange rate in effect on the date 
of the distribution.
    (11) Dividend. For purposes of section 902, the definition of the 
term dividend in section 316 and the regulations under that section 
applies. Thus, for example, distributions and deemed distributions 
under sections 302, 304, 305(b) and 367(b) that are treated as 
dividends within the meaning of section 301(c)(1) also are dividends 
for purposes of section 902. In addition, the term dividend includes 
deemed dividends under sections 551 and 1248, but not deemed inclusions 
under sections 951(a) and 1293. For rules concerning excess 
distributions from section 1291 funds that are treated as dividends 
solely for foreign tax credit purposes, (see Regulation Project INTL-
656-87 published in 1992-1 C.B. 1124; see Sec. 601.601(d)(2)(ii)(b) of 
this chapter).
    (12) Dividend received. A dividend shall be considered received for 
purposes of section 902 when the cash or other property is 
unqualifiedly made subject to the demands of the distributee. See 
Sec. 1.301-1(b). A dividend also is considered received for purposes of 
section 902 when it is deemed received under section 304, 367(b), 551, 
or 1248.
    (13) Special effective date--(i) Rule. If the first day on which 
the ownership requirements of section 902(c)(3)(B) and paragraphs 
(a)(1) through (4) of this section are met with respect to a foreign 
corporation, without regard to whether a dividend is distributed, is in 
a taxable year of the foreign corporation beginning after December 31, 
1986, then--
    (A) The post-1986 undistributed earnings and post-1986 foreign 
income taxes of the foreign corporation shall be determined by taking 
into account only taxable years beginning on and after the first day of 
the first taxable year of the foreign corporation in which the 
ownership requirements are met, including subsequent taxable years in 
which the ownership requirements of section 902(c)(3)(B) and paragraphs 
(a)(1) through (4) of this section are not met; and
    (B) Earnings and profits accumulated prior to the first day of the 
first taxable year of the foreign corporation in which the ownership 
requirements of section 902(c)(3)(B) and paragraphs (a)(1) through (4) 
of this section are met shall be considered pre-1987 accumulated 
profits.
    (ii) Example. The following example illustrates the special 
effective date rules of this paragraph (a)(13):

    Example. As of December 31, 1991, and since its incorporation, 
foreign corporation A has owned 100 percent of the stock of foreign 
corporation B. Corporation B is not a controlled foreign 
corporation. Corporation B uses the calendar year as its taxable 
year, and its functional currency is the u. Assume 1u equals $1 at 
all relevant times. On April 1, 1992, Corporation B pays a 200u 
dividend to Corporation A and the ownership requirements of section 
902(c)(3)(B) and paragraphs (a)(1) through (4) of this section are 
not met at that time. On July 1, 1992, domestic corporation M 
purchases 10 percent of the Corporation B stock from Corporation A 
and, for the first time, Corporation B meets the ownership 
requirements of section 902(c)(3)(B) and paragraph (a)(2) of this 
section. Corporation M uses the calendar year as its taxable year. 
Corporation B does not distribute any dividends to Corporation M 
during 1992. For its taxable year ending December 31, 1992, 
Corporation B has 500u of earnings and profits (after foreign taxes 
but before taking into account the 200u

[[Page 931]]

distribution to Corporation A) and pays 100u of foreign income taxes 
that is equal to $100. Pursuant to paragraph (a)(13)(i) of this 
section, Corporation B's post-1986 undistributed earnings and post-
1986 foreign income taxes will include earnings and profits and 
foreign income taxes attributable to Corporation B's entire 1992 
taxable year and all taxable years thereafter. Thus, the April 1, 
1992, dividend to Corporation A will reduce post-1986 undistributed 
earnings to 300u (500u-200u) under paragraph (a)(9)(i) of this 
section. The foreign income taxes attributable to the amount 
distributed as a dividend to Corporation A will not be creditable 
because Corporation A is not a domestic shareholder. Post-1986 
foreign income taxes, however, will be reduced by the amount of 
foreign taxes attributable to the dividend. Thus, as of the 
beginning of 1993, Corporation B has $60 ($100-[$100 x 40% (200u/
500u)]) of post-1986 foreign income taxes. See paragraphs (a)(8)(i) 
and (b)(1) of this section.

    (b) Computation of foreign income taxes deemed paid by a domestic 
shareholder, first-tier corporation, and second-tier corporation--(1) 
General rule. If a foreign corporation pays a dividend in any taxable 
year out of post-1986 undistributed earnings to a shareholder that is a 
domestic shareholder or an upper-tier corporation at the time it 
receives the dividend, the recipient shall be deemed to have paid the 
same proportion of any post-1986 foreign income taxes paid, accrued or 
deemed paid by the distributing corporation on or with respect to post-
1986 undistributed earnings which the amount of the dividend out of 
post-1986 undistributed earnings (determined without regard to the 
gross-up under section 78) bears to the amount of the distributing 
corporation's post-1986 undistributed earnings. An upper-tier 
corporation shall not be entitled to compute an amount of foreign taxes 
deemed paid on a dividend from a lower-tier corporation, however, 
unless the ownership requirements of paragraphs (a) (1) through (4) of 
this section are met at each tier at the time the upper-tier 
corporation receives the dividend. Foreign income taxes deemed paid by 
a domestic shareholder or an upper-tier corporation must be computed 
under the following formula:

                                                                                                                
                                                                                     Dividend paid to domestic  
                                                                                    shareholder (or upper-tier  
                                                                                    corporation) by first-tier  
                                                                                    corporation (or lower-tier  
  Foreign income taxes deemed paid by        Post-1986 foreign income taxes                corporation)         
  domestic shareholder (or upper-tier     =   of first-tier corporation (or   x  -------------------------------
              corporation)                       lower-tier corporation)              Post-1986 undistributed   
                                                                                      earnings of first-tier    
                                                                                    corporation (or lower-tier  
                                                                                           corporation)         
                                                                                                                

    (2) Allocation rule for dividends attributable to post-1986 
undistributed earnings and pre-1987 accumulated profits--(i) Portion of 
dividend out of post-1986 undistributed earnings. Dividends will be 
deemed to be paid first out of post-1986 undistributed earnings to the 
extent thereof. If dividends exceed post-1986 undistributed earnings 
and dividends are paid to more than one shareholder, then the dividend 
to each shareholder shall be deemed to be paid pro rata out of post-
1986 undistributed earnings, computed as follows:

                                                                                                                
                                                                                               Dividends to     
    Portion of Dividend to a                                                                    Shareholder     
  Shareholder Attributable to     =         Post-1986 Undistributed  Earnings         x  -----------------------
    Post-1986 Undistributed                                                                Total Dividends Paid 
            Earnings                                                                        To all Shareholders 
                                                                                                                

    (ii) Portion of dividend out of pre-1987 accumulated profits. After 
the portion of the dividend attributable to post-1986 undistributed 
earnings is determined under paragraph (b)(2)(i) of this section, the 
remainder of the dividend received by a shareholder is attributable to 
pre-1987 accumulated profits to the extent thereof. That part of the 
dividend attributable to pre-1987 accumulated profits will be treated 
as paid first from the most recently accumulated earnings and profits. 
See Sec. 1.902-3. If dividends paid out of pre-1987 accumulated profits 
are attributable to more than one pre-1987 taxable year and are paid to 
more than one shareholder, then the dividend to each shareholder 
attributable to earnings and profits accumulated in a particular pre-
1987 taxable year shall be deemed to be paid pro rata out of 
accumulated profits of that taxable year, computed as follows:

                                                                                                                
                                             (Dividend Paid Out of Pre-1987           Dividend to Shareholder   
  Portion of Dividend to a Shareholder          Accumulated Profits with         -------------------------------
 Attributable to Accumulated Profits of   =  Respect to the Particular Pre-   x     Total Dividends Paid to all 
   a Particular Pre-1987 Taxable Year               1987 Taxable Year                      Shareholders         
                                                                                                                

    (3) Dividends paid out of pre-1987 accumulated profits. If 
dividends are paid by a first-tier corporation or a lower-tier 
corporation out of pre-1987 accumulated profits, the domestic 
shareholder or upper-tier corporation that receives the dividends shall 
be deemed to have paid foreign income taxes to the extent provided 
under section 902 and the regulations thereunder as in effect prior to 
the effective date of the Tax Reform Act of 1986. See paragraphs (a) 
(10) and (13) of this section and Secs. 1.902-3 and 1.902-4.
    (4) Deficits in accumulated earnings and profits. No foreign income 
taxes shall be deemed paid with respect to a distribution from a 
foreign corporation out of current earnings and profits that is treated 
as a dividend under section 316(a)(2), and post-1986 foreign income 
taxes shall not be reduced, if as of the end of the taxable year in 
which the dividend is paid or accrued, the corporation has zero or a 
deficit in post-1986 undistributed earnings and the sum of current plus 
accumulated earnings and profits is zero or less than zero. The 
dividend shall reduce post-

[[Page 932]]

1986 undistributed earnings and accumulated earnings and profits.
    (5) Examples. The following examples illustrate the rules of this 
paragraph (b):

    Example 1. Domestic corporation M owns 100 percent of foreign 
corporation A. Both Corporation M and Corporation A use the calendar 
year as the taxable year, and Corporation A uses the u as its 
functional currency. Assume that 1u equals $1 at all relevant times. 
All of Corporation A's pre-1987 accumulated profits and post-1986 
undistributed earnings are non-subpart F general limitation earnings 
and profits under section 904(d)(1)(I). As of December 31, 1992, 
Corporation A has 100u of post-1986 undistributed earnings and $40 
of post-1986 foreign income taxes. For its 1986 taxable year, 
Corporation A has accumulated profits of 200u (net of foreign taxes) 
and paid 60u of foreign income taxes on those earnings. In 1992, 
Corporation A distributes 150u to Corporation M. Corporation A has 
100u of post-1986 undistributed earnings and the dividend, 
therefore, is treated as paid out of post-1986 undistributed 
earnings to the extent of 100u. The first 100u distribution is from 
post-1986 undistributed earnings, and, because the distribution 
exhausts those earnings, Corporation M is deemed to have paid the 
entire amount of post-1986 foreign income taxes of Corporation A 
($40). The remaining 50u dividend is treated as a dividend out of 
1986 accumulated profits under paragraph (b)(2) of this section. 
Corporation M is deemed to have paid $15 (60u x 50u/200u, translated 
at the appropriate exchange rates) of Corporation A's foreign income 
taxes for 1986. As of January 1, 1993, Corporation A's post-1986 
undistributed earnings and post-1986 foreign income taxes are 0. 
Corporation A has 150u of accumulated profits and 45u of foreign 
income taxes remaining in 1986.
    Example 2. Domestic corporation M (incorporated on January 1, 
1987) owns 100 percent of foreign corporation A (incorporated on 
January 1, 1987). Both Corporation M and Corporation A use the 
calendar year as the taxable year, and Corporation A uses the u as 
its functional currency. Assume that 1u equals $1 at all relevant 
times. Corporation A has no pre-1987 accumulated profits. All of 
Corporation A's post-1986 undistributed earnings are non-subpart F 
general limitation earnings and profits under section 904(d)(1)(I). 
On January 1, 1992, Corporation A has a deficit in accumulated 
earnings and profits and a deficit in post-1986 undistributed 
earnings of (200u). No foreign taxes have been paid with respect to 
post-1986 undistributed earnings. During 1992, Corporation A earns 
100u (net of foreign taxes), pays $40 of foreign taxes on those 
earnings and distributes 50u to Corporation M. As of the end of 
1992, Corporation A has a deficit of (100u) ((200u) post1986 
undistributed earnings + 100u current earnings and profits) in post-
1986 undistributed earnings. Corporation A, however, has current 
earnings and profits of 100u. Therefore, the 50u distribution is 
treated as a dividend in its entirety under section 316(a)(2). Under 
paragraph (b)(4) of this section, Corporation M is not deemed to 
have paid any of the foreign taxes paid by Corporation A because 
post-1986 undistributed earnings and the sum of current plus 
accumulated earnings and profits are (100u). The dividend reduces 
both post-1986 undistributed earnings and accumulated earnings and 
profits. Therefore, as of January 1, 1993, Corporation A's post-1986 
undistributed earnings are (150u) and its accumulated earnings and 
profits are (150u). Corporation A's post-1986 foreign income taxes 
at the start of 1993 are $40.

    (c) Special rules--(1) Separate computations required for dividends 
from each first-tier and lower-tier corporation--(i) Rule. If in a 
taxable year dividends are received by a domestic shareholder or an 
upper-tier corporation from two or more first-tier corporations or two 
or more lower-tier corporations, the foreign income taxes deemed paid 
by the domestic shareholder or the upper-tier corporation under 
sections 902 (a) and (b) and paragraph (b) of this section shall be 
computed separately with respect to the dividends received from each 
first-tier corporation or lower-tier corporation. If a domestic 
shareholder receives dividend distributions from one or more first-tier 
corporations and in the same taxable year the first-tier corporation 
receives dividends from one or more lower-tier corporations, then the 
amount of foreign income taxes deemed paid shall be computed by 
starting with the lowest-tier corporation and working upward.
    (ii) Example. The following example illustrates the application of 
this paragraph (c)(1):

    Example. P, a domestic corporation, owns 40 percent of the 
voting stock of foreign corporation S. S owns 30 percent of the 
voting stock of foreign corporation T, and 30 percent of the voting 
stock of foreign corporation U. Neither S, T, nor U is a controlled 
foreign corporation. P, S, T and U all use the calendar year as 
their taxable year. In 1993, T and U both pay dividends to S and S 
pays a dividend to P. To compute foreign taxes deemed paid, 
paragraph (c)(1) of this section requires P to start with the lowest 
tier corporations and to compute foreign taxes deemed paid 
separately for dividends from each first-tier and lower-tier 
corporation. Thus, S first will compute foreign taxes deemed paid 
separately on its dividends from T and U. The deemed paid taxes will 
be added to S's post-1986 foreign income taxes, and the dividends 
will be added to S's post-1986 undistributed earnings. Next, P will 
compute foreign taxes deemed paid with respect to the dividend from 
S. This computation will take into account the taxes paid by T and U 
and deemed paid by S.

    (2) Section 78 gross-up--(i) Foreign income taxes deemed paid by a 
domestic shareholder. Except as provided in section 960(b) and the 
regulations under that section (relating to amounts excluded from gross 
income under section 959(b)), any foreign income taxes deemed paid by a 
domestic shareholder in any taxable year under section 902(a) and 
paragraph (b) of this section shall be included in the gross income of 
the domestic shareholder for the year as a dividend under section 78. 
Amounts included in gross income under section 78 shall, for purposes 
of section 904, be deemed to be derived from sources within the United 
States to the extent the earnings and profits on which the taxes were 
paid are treated under section 904(g) as United States source earnings 
and profits. Section 1.904-5(m)(6). Amounts included in gross income 
under section 78 shall be treated for purposes of section 904 as income 
in a separate category to the extent that the foreign income taxes were 
allocated and apportioned to income in that separate category. See 
section 904(d)(3)(G) and Sec. 1.904-6(b)(3).
    (ii) Foreign income taxes deemed paid by an upper-tier corporation. 
Foreign income taxes deemed paid by an uppertier corporation on a 
distribution from a lower-tier corporation are not included in the 
earnings and profits of the upper-tier corporation. For purposes of 
section 904, foreign income taxes shall be allocated and apportioned to 
income in a separate category to the extent those taxes were allocated 
to the earnings and profits of the lower-tier corporation in that 
separate category. See section 904(d)(3)(G) and Sec. 1.904-6(b)(3). To 
the extent that section 904(g) treats the earnings of the lower-tier 
corporation on which those foreign income taxes were paid as United 
States source earnings and profits, the foreign income taxes deemed 
paid by the upper-tier corporation on the distribution from the lower-
tier corporation shall be treated as attributable to United States 
source earnings and profits. See section 904(g) and Sec. 1.904-5(m)(6).
    (iii) Example. The following example illustrates the rules of this 
paragraph (c)(2):

    Example. P, a domestic corporation, owns 100 percent of the 
voting stock of controlled foreign corporation S. Corporations P and 
S use the calendar year as their taxable year, and S uses the u as 
its functional currency. Assume that 1u equals $1 at all relevant 
times. As of January 1, 1992, S has -0- post-1986 undistributed 
earnings and -0- post-1986 foreign income taxes. In 1992, S earns 
150u of non-subpart F general limitation income net of foreign taxes 
and pays 60u of foreign income taxes. As of the end of 1992, but 
before dividend payments, S has 150u of post-1986 undistributed 
earnings and $60 of post-1986 foreign income taxes. Assume that 50u 
of S's earnings for 1992 are from United States sources. S pays P a 
dividend of 75u

[[Page 933]]

which P receives in 1992. Under Sec. 1.904-5(m)(4), one-third of the 
dividend, or 25u (75u x 50u/150u), is United States source income to 
P. P computes foreign taxes deemed paid on the dividend under 
paragraph (b)(1) of this section of $30 ($60 x 50%[75u/150u]) and 
includes that amount in gross income under section 78 as a dividend. 
Because 25u of the 75u dividend is United States source income to P, 
$10 ($30 x 33.33%[25u/75u]) of the section 78 dividend will be 
treated as United States source income to P under this paragraph 
(c)(2).

    (3) Creditable foreign income taxes. The amount of creditable 
foreign income taxes under section 901 shall include, subject to the 
limitations and conditions of sections 902 and 904, foreign income 
taxes actually paid and deemed paid by a domestic shareholder that 
receives a dividend from a first-tier corporation. Foreign income taxes 
deemed paid by a domestic shareholder under paragraph (b) of this 
section shall be deemed paid by the domestic shareholder only for 
purposes of computing the foreign tax credit allowed under section 901.
    (4) Foreign mineral income. Certain foreign income, war profits and 
excess profits taxes paid or accrued with respect to foreign mineral 
income will not be considered foreign income taxes for purposes of 
section 902. See section 901(e) and Sec. 1.901-3.
    (5) Foreign taxes paid or accrued in connection with the purchase 
or sale of certain oil and gas. Certain income, war profits, or excess 
profits taxes paid or accrued to a foreign country in connection with 
the purchase and sale of oil or gas extracted in that country will not 
be considered foreign income taxes for purposes of section 902. See 
section 901(f).
    (6) Foreign oil and gas extraction income. For rules relating to 
reduction of the amount of foreign income taxes deemed paid with 
respect to foreign oil and gas extraction income, see section 907(a) 
and the regulations under that section.
    (7) United States shareholders of controlled foreign corporations. 
See paragraph (d) of this section and sections 960 and 962 and the 
regulations under those sections for special rules relating to the 
application of section 902 in computing foreign income taxes deemed 
paid by United States shareholders of controlled foreign corporations.
    (8) Credit for foreign taxes deemed paid in a section 304 
transaction. [Reserved].
    (9) Effect of section 482 adjustments on post-1986 foreign income 
taxes and post-1986 undistributed earnings. [Reserved].
    (d) Dividends from controlled foreign corporations--(1) General 
rule. Except as provided in paragraph (d)(3) of this section, if a 
dividend is received by a domestic shareholder that is a United States 
shareholder (as defined in section 951(b) or section 953(c)(1)(A)) from 
a first-tier corporation that is a controlled foreign corporation (as 
defined in section 957(a) or section 953(c)(1)(B)), or by an upper-tier 
corporation from a lower-tier corporation if the corporations are 
related look-through entities within the meaning of Sec. 1.904-5(i), 
the following rule applies. If a dividend is paid out of post-1986 
undistributed earnings or pre-1987 accumulated profits of the upper- or 
lower-tier controlled foreign corporation attributable to more than one 
separate category under section 904(d), the amount of foreign income 
taxes deemed paid by the domestic shareholder or the upper-tier 
corporation under section 902 and paragraph (b) of this section shall 
be computed separately with respect to the post-1986 undistributed 
earnings or pre-1987 accumulated profits in each separate category out 
of which the dividend is paid. See Sec. 1.904-5(c)(4) and paragraph 
(d)(2) of this section. The separately computed deemed paid taxes shall 
be added to other taxes paid by the U.S. shareholder or upper-tier 
corporation with respect to income in the appropriate separate 
category.
    (2) Look-through--(i) Dividends. Except as otherwise provided in 
paragraph (d)(3) of this section, any dividend distribution out of 
post-1986 undistributed earnings of a look-through entity to a related 
look-through entity shall be deemed to be paid pro rata out of each 
separate category of income. See Secs. 1.904-5(c)(4) and 1.904-7. The 
portion of the foreign income taxes attributable to a particular 
separate category that shall be deemed paid by the domestic shareholder 
or upper-tier corporation must be computed under the following formula:

                                                                                                                
                                                                                                 Dividend amount
                                                                                                 attributable to
                                                                                                    a separate  
                                                                                                     category   
Foreign taxes deemed paid by                                                                    ----------------
   domestic shareholder or                                                                          Post-1986   
 upper-tier corporation with       Post-1986 foreign income taxes of first-tier or lower-         undistributed 
    respect to a separate      =  tier corporation allocated and apportioned to a separate   x     earnings of  
   category under section                       category under Sec.  1.904-6                      first-tier or 
           904(d)                                                                                   lower-tier  
                                                                                                   corporation  
                                                                                                 attributable to
                                                                                                   the separate 
                                                                                                     category   
                                                                                                                

    (ii) Coordination with section 960. For rules coordinating the 
computation of foreign taxes deemed paid with respect to amounts 
included in gross income under section 951(a) and dividends distributed 
by a controlled foreign corporation, see section 960 and the 
regulations under that section.
    (3) Dividends distributed out of earnings accumulated before a 
controlled foreign corporation became a controlled foreign 
corporation--(i) General rule. Any dividend distributed by a controlled 
foreign corporation out of earnings accumulated before the controlled 
foreign corporation became a controlled foreign corporation shall be 
treated as a dividend from a noncontrolled section 902 corporation 
regardless of whether the earnings were accumulated in a taxable year 
beginning before January 1, 1987, or after December 31, 1986.
    (ii) Dividend distributions out of earnings and profits for a year 
during which a shareholder that is currently a more-than-90-percent 
United States shareholder of a controlled foreign corporation was not a 
United States shareholder of the controlled foreign corporation.  
[Reserved].
    (e) Information to be furnished. If the credit for foreign income 
taxes claimed under section 901 includes foreign income taxes deemed 
paid under section 902 and paragraph (b) of this section, the domestic 
shareholder must furnish the same information with respect to the 
foreign income taxes deemed paid as it is required to furnish with 
respect to the foreign income taxes it directly paid or accrued and for 
which the credit is claimed. See Sec. 1.905-2. For other information 
required to be furnished by the domestic shareholder for the annual 
accounting period of certain foreign corporations ending with

[[Page 934]]

or within the shareholder's taxable year, and for reduction in the 
amount of foreign income taxes paid, accrued, or deemed paid for 
failure to furnish the required information, see section 6038 and the 
regulations under that section.
    (f) Examples. The following examples illustrate the application of 
this section:

    Example 1. Since 1987, domestic corporation M has owned 10 
percent of the one class of stock of foreign corporation A. The 
remaining 90 percent of Corporation A's stock is owned by Z, a 
foreign corporation. Corporation A is not a controlled foreign 
corporation. Corporation A uses the u as its functional currency, 
and 1u equals $1 at all relevant times. Both Corporation A and 
Corporation M use the calendar year as the taxable year. In 1992, 
Corporation A pays a 30u dividend out of post-1986 undistributed 
earnings, 3u to Corporation M and 27u to Corporation Z. Corporation 
M is deemed, under paragraph (b) of this section, to have paid a 
portion of the post-1986 foreign income taxes paid by Corporation A 
and includes the amount of foreign taxes deemed paid in gross income 
under section 78 as a dividend. Both the foreign taxes deemed paid 
and the dividend would be subject to a separate limitation for 
dividends from Corporation A, a noncontrolled section 902 
corporation. Under paragraph (a)(9)(i) of this section, Corporation 
A must reduce its post-1986 undistributed earnings as of January 1, 
1993, by the total amount of dividends paid to Corporation M and 
Corporation Z in 1992. Under paragraph (a)(8)(i) of this section, 
Corporation A must reduce its post-1986 foreign income taxes as of 
January 1, 1993, by the amount of foreign income taxes that were 
deemed paid by Corporation M and by the amount of foreign income 
taxes that would have been deemed paid by Corporation Z had 
Corporation Z been eligible to compute an amount of foreign income 
taxes deemed paid with respect to the dividend received from 
Corporation A. Foreign income taxes deemed paid by Corporation M and 
Corporation A's opening balances in post-1986 undistributed earnings 
and post-1986 foreign income taxes for 1993 are computed as follows:


1. Assumed post-1986 undistributed earnings of     25u                  
 Corporation A at start of 1992.                                        
2. Assumed post-1986 foreign income taxes of       $25                  
 Corporation A at start of 1992.                                        
3. Assumed pre-tax earnings and profits of         50u                  
 Corporation A for 1992.                                                
4. Assumed foreign income taxes paid or accrued    15u                  
 by Corporation A in 1992.                                              
5. Post-1986 undistributed earnings in             60u                  
 Corporation A for 1992 (pre-dividend) (Line 1                          
 plus Line 3 minus Line 4).                                             
6. Post-1986 foreign income taxes in Corporation   $40                  
 A for 1992 (pre-dividend) (Line 2 plus Line 4                          
 translated at the appropriate exchange rates).                         
7. Dividends paid out of post-1986 undistributed   3u                   
 earnings of Corporation A to Corporation M in                          
 1992.                                                                  
8. Percentage of Corporation A's post-1986         5%                   
 undistributed earnings paid to Corporation M                           
 (Line 7 divided by Line 5).                                            
9. Foreign income taxes of Corporation A deemed    $2                   
 paid by Corporation M under section 902(a) (Line                       
 6 multiplied by Line 8).                                               
10. Total dividends paid out of post-1986          30u                  
 undistributed earnings of Corporation A to all                         
 shareholders in 1992.                                                  
11. Percentage of Corporation A's post-1986        50%                  
 undistributed earnings paid to all shareholders                        
 in 1992 (Line 10 divided by Line 5).                                   
12. Post-1986 foreign income taxes paid with       $20                  
 respect to post-1986 undistributed earnings                            
 distributed to all shareholders in 1992 (Line 6                        
 multiplied by Line 11).                                                
13. Corporation A's post-1986 undistributed        30u                  
 earnings at the start of 1993 (Line 5 minus Line                       
 10).                                                                   
14. Corporation A's post-1986 foreign income       $20                  
 taxes at the start of 1993 (Line 6 minus Line                          
 12).                                                                   
                                                                        

    Example 2. (i) The facts are the same as in Example 1, except 
that Corporation M has also owned 10 percent of the one class of 
stock of foreign corporation B since 1987. Corporation B uses the 
calendar year as the taxable year. The remaining 90 percent of 
Corporation B's stock is owned by Corporation Z. Corporation B is 
not a controlled foreign corporation. Corporation B uses the u as 
its functional currency, and 1u equals $1 at all relevant times. In 
1992, Corporation B has earnings and profits and pays foreign income 
taxes, a portion of which are attributable to high withholding tax 
interest, as defined in section 904(d)(2)(B)(i). Corporation B must 
reduce its pool of post-1986 foreign income taxes by the amount of 
tax imposed on high withholding tax interest in excess of 5 percent 
because that amount is not treated as a tax for purposes of section 
902. See section 904(d)(2)(E)(ii) and paragraph (a)(8)(iii) of this 
section. Corporation B pays 50u in dividends in 1992, 5u to 
Corporation M and 45u to Corporation Z. Corporation M must compute 
its section 902(a) deemed paid taxes separately for the dividends it 
receives in 1992 from Corporation A (as computed in Example 1) and 
from Corporation B. Foreign income taxes of Corporation B deemed 
paid by Corporation M, and Corporation B's opening balances in post-
1986 undistributed earnings and post-1986 foreign income taxes for 
1993 are computed as follows:


1. Assumed post-1986 undistributed earnings of     (100u)               
 Corporation B at start of 1992.                                        
2. Assumed post-1986 foreign income taxes of       $0                   
 Corporation B at start of 1992.                                        
3. Assumed pre-tax earnings and profits of         302.50u              
 Corporation B for 1992 (including 50u of high                          
 withholding tax interest on which 5u of tax is                         
 withheld).                                                             
4. Assumed foreign income taxes paid or accrued    102.50u              
 by Corporation B in 1992.                                              
5. Post-1986 undistributed earnings in             100u                 
 Corporation B for 1992 (pre-dividend) (Line 1                          
 plus Line 3 minus Line 4).                                             
6. Amount of foreign income tax of Corporation B   2.50u                
 imposed on high withholding tax interest in                            
 excess of 5% (5u withholding tax--[5% x 50u high                       
 withholding tax interest]).                                            
7. Post-1986 foreign income taxes in Corporation   $100                 
 B for 1992 (pre-dividend) (Line 2 plus [Line 4                         
 minus Line 6 translated at the appropriate                             
 exchange rate]).                                                       
8. Dividends paid out of post-1986 undistributed   5u                   
 earnings to Corporation M in 1992.                                     
9. Percentage of Corporation B's post-1986         5%                   
 undistributed earnings paid to Corporation M                           
 (Line 8 divided by Line 5).                                            
10. Foreign income taxes of Corporation B deemed   $5                   
 paid by Corporation M under section 902(a) (Line                       
 7 multiplied by Line 9).                                               
11. Total dividends paid out of post-1986          50u                  
 undistributed earnings of Corporation B to all                         
 shareholders in 1992.                                                  
12. Percentage of Corporation B's post-1986        50%                  
 undistributed earnings paid to all shareholders                        
 in 1992 (Line 11 divided by Line 5).                                   
13. Post-1986 foreign income taxes of Corporation  $50                  
 B paid on or with respect to post-1986                                 
 undistributed earnings distributed to all                              
 shareholders in 1992 (Line 7 multiplied by Line                        
 12).                                                                   
14. Corporation B's post-1986 undistributed        50u                  
 earnings at start of 1993 (Line 5 minus Line 11).                      
15. Corporation B's post-1986 foreign income       $50                  
 taxes at start of 1993 (Line 7 minus Line 13).                         
                                                                        

    (ii) For 1992, as computed in Example 1, Corporation M is deemed 
to have paid $2 of the post-1986 foreign income taxes paid by 
Corporation A and includes $2 in gross income as a dividend under 
section 78. Both the income inclusion and the credit are subject to 
a separate limitation for dividends from Corporation A, a 
noncontrolled section 902 corporation. Corporation M also is deemed 
to have paid $5 of the post-1986 foreign income taxes paid by 
Corporation B and includes $5 in gross income as a deemed dividend 
under section 78. Both the income inclusion and the foreign taxes 
deemed paid are subject to a separate limitation for dividends from 
Corporation B, a noncontrolled section 902 corporation.

[[Page 935]]

    Example 3. (i) Since 1987, domestic corporation M has owned 50 
percent of the one class of stock of foreign corporation A. The 
remaining 50 percent of Corporation A is owned by foreign 
corporation Z. For the same time period, Corporation A has owned 40 
percent of the one class of stock of foreign corporation B, and 
Corporation B has owned 30 percent of the one class of stock of 
foreign corporation C. The remaining 60 percent of Corporation B is 
owned by foreign corporation Y, and the remaining 70 percent of 
Corporation C is owned by foreign corporation X. Corporations A, B, 
and C are not controlled foreign corporations. Corporations A, B, 
and C use the u as their functional currency, and 1u equals $1 at 
all relevant times. Corporation B uses a fiscal year ending June 30 
as its taxable year; all other corporations use the calendar year as 
the taxable year. On February 1, 1992, Corporation C pays a 500u 
dividend out of post-1986 undistributed earnings, 150u to 
Corporation B and 350u to Corporation X. On February 15, 1992, 
Corporation B pays a 300u dividend out of post-1986 undistributed 
earnings computed as of the close of Corporation B's fiscal year 
ended June 30, 1992, 120u to Corporation A and 180u to Corporation 
Y. On August 15, 1992, Corporation A pays a 200u dividend out of 
post-1986 undistributed earnings, 100u to Corporation M and 100u to 
Corporation Z. In computing foreign taxes deemed paid by 
Corporations B and A, section 78 does not apply and Corporations B 
and A thus do not have to include the foreign taxes deemed paid in 
earnings and profits. See paragraph (c)(2)(ii) of this section. 
Foreign income taxes deemed paid by Corporations B, A and M, and the 
foreign corporations' opening balances in post-1986 undistributed 
earnings and post-1986 foreign income taxes for Corporation B's 
fiscal year beginning July 1, 1992, and Corporation C's and 
Corporation A's 1993 calendar years are computed as follows:


A. Corporation C (third-tier corporation):                              
    1. Assumed post-1986 undistributed earnings    1300u                
     in Corporation C at start of 1992.                                 
    2. Assumed post-1986 foreign income taxes in   $500                 
     Corporation C at start of 1992.                                    
    3. Assumed pre-tax earnings and profits of     500u                 
     Corporation C for 1992.                                            
    4. Assumed foreign income taxes paid or        300u                 
     accrued in 1992.                                                   
    5. Post-1986 undistributed earnings in         1500u                
     Corporation C for 1992 (pre-dividend) (Line                        
     1 plus Line 3 minus Line 4).                                       
    6. Post-1986 foreign income taxes in           $800                 
     Corporation C for 1992 (pre-dividend) (Line                        
     2 plus Line 4 translated at the appropriate                        
     exchange rates).                                                   
    7. Dividends paid out of post-1986             150u                 
     undistributed earnings of Corporation C to                         
     Corporation B in 1992.                                             
    8. Percentage of Corporation C's post-1986     10%                  
     undistributed earnings paid to Corporation B                       
     (Line 7 divided by Line 5).                                        
    9. Foreign income taxes of Corporation C       $80                  
     deemed paid by Corporation B under section                         
     902(b)(2) (Line 6 multiplied by Line 8).                           
    10. Total dividends paid out of post-1986      500u                 
     undistributed earnings of Corporation C to                         
     all shareholders in 1992.                                          
    11. Percentage of Corporation C's post-1986    33.33%               
     undistributed earnings paid to all                                 
     shareholders in 1992 (Line 10 divided by                           
     Line 5).                                                           
    12. Post-1986 foreign income taxes paid with   $266.66              
     respect to post-1986 undistributed earnings                        
     distributed to all shareholders in 1992                            
     (Line 6 multiplied by Line 11).                                    
    13. Post-1986 undistributed earnings in        1000u                
     Corporation C at start of 1993 (Line 5 minus                       
     Line 10).                                                          
    14. Post-1986 foreign income taxes in          $533.34              
     Corporation C at start of 1993 (Line 6 minus                       
     Line 12).                                                          
B. Corporation B (second-tier corporation):                             
    1. Assumed post-1986 undistributed earnings    0                    
     in Corporation B as of July 1, 1991.                               
    2. Assumed post-1986 foreign income taxes in   0                    
     Corporation B as of July 1, 1991.                                  
    3. Assumed pre-tax earnings and profits of     1000u                
     Corporation B for fiscal year ended June 30,                       
     1992, (including 150u dividend from                                
     Corporation B).                                                    
    4. Assumed foreign income taxes paid or        200u                 
     accrued by Corporation B in fiscal year                            
     ended June 30, 1992.                                               
    5. Foreign income taxes of Corporation C       $80                  
     deemed paid by Corporation B in its fiscal                         
     year ended June 30, 1992 (Part A, Line 9 of                        
     paragraph (i) of this Example 3).                                  
    6. Post-1986 undistributed earnings in         800u                 
     Corporation B for fiscal year ended June 30,                       
     1992 (pre-dividend) (Line 1 plus Line 3                            
     minus Line 4).                                                     
    7. Post-1986 foreign income taxes in           $280                 
     Corporation B for fiscal year ended June 30,                       
     1992 (pre-dividend) (Line 2 plus Line 4                            
     translated at the appropriate exchange rates                       
     plus Line 5).                                                      
    8. Dividends paid out of post-1986             120u                 
     undistributed earnings of Corporation B to                         
     Corporation A on February 15, 1992.                                
    9. Percentage of Corporation B's post-1986     15%                  
     undistributed earnings for fiscal year ended                       
     June 30, 1992, paid to Corporation A (Line 8                       
     divided by Line 6).                                                
    10. Foreign income taxes paid and deemed paid  $42                  
     by Corporation B as of June 30, 1992, deemed                       
     paid by Corporation A under section                                
     902(b)(1) (Line 7 multiplied by Line 9).                           
    11. Total dividends paid out of post-1986      300u                 
     undistributed earnings of Corporation B for                        
     fiscal year ended June 30, 1992.                                   
    12. Percentage of Corporation B's post-1986    37.5%                
     undistributed earnings for fiscal year ended                       
     June 30, 1992, paid to all shareholders                            
     (Line 11 divided by Line 6).                                       
    13. Post-1986 foreign income taxes paid and    $105                 
     deemed paid with respect to post-1986                              
     undistributed earnings distributed to all                          
     shareholders during Corporation B's fiscal                         
     year ended June 30, 1992 (Line 7 multiplied                        
     by Line 12).                                                       
    14. Post-1986 undistributed earnings in        500u                 
     Corporation B as of July 1, 1992 (Line 6                           
     minus Line 11).                                                    
    15. Post-1986 foreign income taxes in          $175                 
     Corporation B as of July 1, 1992 (Line 7                           
     minus Line 13).                                                    
C. Corporation A (first-tier corporation):                              
    1. Assumed post-1986 undistributed earnings    250u                 
     in Corporation A at start of 1992.                                 
    2. Assumed post-1986 foreign income taxes in   $100                 
     Corporation A at start of 1992.                                    
    3. Assumed pre-tax earnings and profits of     250u                 
     Corporation A for 1992 (including 120u                             
     dividend from Corporation B).                                      
    4. Assumed foreign income taxes paid or        100u                 
     accrued by Corporation A in 1992.                                  
    5. Foreign income taxes paid or deemed paid    $42                  
     by Corporation B as of June 30, 1992, that                         
     are deemed paid by Corporation A in 1992                           
     (Part B, Line 10 of paragraph (i) of this                          
     Example 3).                                                        
    6. Post-1986 undistributed earnings in         400u                 
     Corporation A for 1992 (pre-dividend) (Line                        
     1 plus Line 3 minus Line 4).                                       
    7. Post-1986 foreign income taxes in           $242                 
     Corporation A for 1992 (pre-dividend) (Line                        
     2 plus Line 4 translated at the appropriate                        
     exchange rates plus Line 5).                                       
    8. Dividends paid out of post-1986             100u                 
     undistributed earnings of Corporation A to                         
     Corporation M on August 15, 1992.                                  
    9. Percentage of Corporation A's post-1986     25%                  
     undistributed earnings paid to Corporation M                       
     in 1992 (Line 8 divided by Line 6).                                
    10. Foreign income taxes paid and deemed paid  $60.50               
     by Corporation A in 1992 that are deemed                           
     paid by Corporation M under section 902(a)                         
     (Line 7 multiplied by Line 9).                                     
    11. Total dividends paid out of post-1986      200u                 
     undistributed earnings of Corporation A to                         
     all shareholders in 1992.                                          

[[Page 936]]

                                                                        
    12. Percentage of Corporation A's post-1986    50%                  
     undistributed earnings paid to all                                 
     shareholders in 1992 (Line 11 divided by                           
     Line 6).                                                           
    13. Post-1986 foreign income taxes paid and    $121                 
     deemed paid by Corporation A with respect to                       
     post-1986 undistributed earnings distributed                       
     to all shareholders in 1992 (Line 7                                
     multiplied by Line 12).                                            
    14. Post-1986 undistributed earnings in        200u                 
     Corporation A at start of 1993 (Line 6 minus                       
     Line 11).                                                          
    15. Post-1986 foreign income taxes in          $121                 
     Corporation A at start of 1993 (Line 7 minus                       
     Line 13).                                                          
                                                                        

    (ii) Corporation M is deemed, under section 902(a) and paragraph 
(b) of this section, to have paid $60.50 of post-1986 foreign income 
taxes paid, or deemed paid, by Corporation A on or with respect to 
its post-1986 undistributed earnings (Part C, Line 10) and 
Corporation M includes that amount in gross income as a dividend 
under section 78. Both the income inclusion and the credit are 
subject to a separate limitation for dividends from Corporation A, a 
noncontrolled section 902 corporation.
    Example 4. (i) Since 1987, domestic corporation M has owned 100 
percent of the voting stock of controlled foreign corporation A, and 
Corporation A has owned 100 percent of the voting stock of 
controlled foreign corporation B. Corporations M, A and B use the 
calendar year as the taxable year. Corporations A and B are 
organized in the same foreign country and use the u as their 
functional currency. 1u equals $1 at all relevant times. Assume that 
all of the earnings of Corporations A and B are general limitation 
earnings and profits within the meaning of section 904(d)(2)(I), and 
that neither Corporation A nor Corporation B has any previously 
taxed income accounts. In 1992, Corporation B pays a dividend of 
150u to Corporation A out of post-1986 undistributed earnings, and 
Corporation A computes an amount of foreign taxes deemed paid under 
section 902(b)(1). The dividend is not subpart F income to 
Corporation A because section 954(c)(3)(B)(i) (the same country 
dividend exception) applies. Pursuant to paragraph (c)(2)(ii) of 
this section, Corporation A is not required to include the deemed 
paid taxes in earnings and profits. Corporation A has no pre-1987 
accumulated profits and a deficit in post-1986 undistributed 
earnings for 1992. In 1992, Corporation A pays a dividend of 100u to 
Corporation M out of its earnings and profits for 1992 (current 
earnings and profits). Under paragraph (b)(4) of this section, 
Corporation M is not deemed to have paid any of the foreign income 
taxes paid or deemed paid by Corporation A because Corporation A has 
a deficit in post-1986 undistributed earnings as of December 31, 
1992, and the sum of its current plus accumulated profits is less 
than zero. Note that if instead of paying a dividend to Corporation 
A in 1992, Corporation B had made an additional investment of $150 
in United States property under section 956, that amount would have 
been included in gross income by Corporation M under section 
951(a)(1)(B) and Corporation M would have been deemed to have paid 
$50 of foreign income taxes paid by Corporation B. See sections 
951(a)(1)(B) and 960. Foreign income taxes of Corporation B deemed 
paid by Corporation A and the opening balances in post-1986 
undistributed earnings and post-1986 foreign income taxes for 
Corporation A and Corporation B for 1993 are computed as follows:


A. Corporation B (second-tier corporation):                             
    1. Assumed post-1986 undistributed earnings    200u                 
     in Corporation B at start of 1992.                                 
    2. Assumed post-1986 foreign income taxes in   $50                  
     Corporation B at start of 1992.                                    
    3. Assumed pre-tax earnings and profits of     150u                 
     Corporation B for 1992.                                            
    4. Assumed foreign income taxes paid or        50u                  
     accrued in 1992.                                                   
    5. Post-1986 undistributed earnings in         300u                 
     Corporation B for 1992 (pre-dividend) (Line                        
     1 plus Line 3 minus Line 4).                                       
    6. Post-1986 foreign income taxes in           $100                 
     Corporation B for 1992 (pre-dividend) (Line                        
     2 plus Line 4 translated at the appropriate                        
     exchange rates).                                                   
    7. Dividends paid out of post-1986             150u                 
     undistributed earnings of Corporation B to                         
     Corporation A in 1992.                                             
    8. Percentage of Corporation B's post-1986     50%                  
     undistributed earnings paid to Corporation A                       
     (Line 7 divided by Line 5).                                        
    9. Foreign income taxes of Corporation B       $50                  
     deemed paid by Corporation A under section                         
     902(b)(1) (Line 6 multiplied by Line 8).                           
    10. Post-1986 undistributed earnings in        150u                 
     Corporation B at start of 1993 (Line 5 minus                       
     Line 7).                                                           
    11. Post-1986 foreign income taxes in          $50                  
     Corporation B at start of 1993 (Line 6 minus                       
     Line 9).                                                           
B. Corporation A (first-tier corporation):                              
    1. Assumed post-1986 undistributed earnings    (200u)               
     in Corporation A at start of 1992.                                 
    2. Assumed post-1986 foreign income taxes in   0                    
     Corporation A at start of 1992.                                    
    3. Assumed pre-tax earnings and profits of     200u                 
     Corporation A for 1992 (including 150u                             
     dividend from Corporation B).                                      
    4. Assumed foreign income taxes paid or        40u                  
     accrued by Corporation A in 1992.                                  
    5. Foreign income taxes paid by Corporation B  $50                  
     in 1992 that are deemed paid by Corporation                        
     A (Part A, Line 9 of paragraph (i) of this                         
     Example 4).                                                        
    6. Post-1986 undistributed earnings in         (40u)                
     Corporation A for 1992 (pre-dividend) (Line                        
     1 plus Line 3 minus Line 4).                                       
    7. Post-1986 foreign income taxes in           $90                  
     Corporation A for 1992 (pre-dividend) (Line                        
     2 plus Line 4 translated at the appropriate                        
     exchange rates plus Line 5).                                       
    8. Dividends paid out of current earnings and  100u                 
     profits of Corporation A for 1992.                                 
    9. Percentage of post-1986 undistributed       0                    
     earnings of Corporation A paid to                                  
     Corporation M in 1992 (Line 8 divided by the                       
     greater of Line 6 or zero).                                        
    10. Foreign income taxes paid and deemed paid  0                    
     by Corporation A in 1992 that are deemed                           
     paid by Corporation M under section 902(a)                         
     (Line 7 multiplied by Line 9).                                     
    11. Post-1986 undistributed earnings in        (140u)               
     Corporation A at start of 1993 (line 6 minus                       
     line 8).                                                           
    12. Post-1986 foreign income taxes in          $90                  
     Corporation A at start of 1993 (Line 7 minus                       
     Line 10).                                                          
                                                                        

    (ii) For 1993, Corporation A has 500u of earnings and profits on 
which it pays 160u of foreign income taxes. Corporation A receives 
no dividends from Corporation B, and pays a 100u dividend to 
Corporation M. The 100u dividend to Corporation M carries with it 
some of the foreign income taxes paid and deemed paid by Corporation 
A in 1992, which were not deemed paid by Corporation M in 1992 
because Corporation A had no post-1986 undistributed earnings. Thus, 
for 1993, Corporation M is deemed to have paid $125 of post-1986 
foreign income taxes paid and deemed paid by Corporation A and 
includes that amount in gross income as a dividend under section 78, 
determined as follows:


1. Post-1986 undistributed earnings in             (140u)               
 Corporation A at start of 1993.                                        
2. Post-1986 foreign income taxes in Corporation   $90                  
 A at start of 1993.                                                    
3. Pre-tax earnings and profits of Corporation A   500u                 
 for 1993.                                                              
4. Foreign income taxes paid or accrued by         160u                 
 Corporation A in 1993.                                                 
5. Post-1986 undistributed earnings in             200u                 
 Corporation A for 1993 (pre-dividend) (Line 1                          
 plus Line 3 minus Line 4).                                             
6. Post-1986 foreign income taxes in Corporation   $250                 
 A for 1993 (pre-dividend) (Line 2 plus Line 4                          
 translated at the appropriate exchange rates).                         

[[Page 937]]

                                                                        
7. Dividends paid out of post-1986 undistributed   100u                 
 earnings of Corporation A to Corporation M in                          
 1993.                                                                  
8. Percentage of post-1986 undistributed earnings  50%                  
 of Corporation A paid to Corporation M in 1993                         
 (Line 7 divided by Line 5).                                            
9. Foreign income taxes paid and deemed paid by    $125                 
 Corporation A that are deemed paid by                                  
 Corporation M in 1993 (Line 6 multiplied by Line                       
 8).                                                                    
10. Post-1986 undistributed earnings in            100u                 
 Corporation A at start of 1994 (Line 5 minus                           
 Line 7).                                                               
11. Post-1986 foreign income taxes in Corporation  $125                 
 A at start of 1994 (Line 6 minus Line 9).                              
                                                                        

    Example 5. (i) Since 1987, domestic corporation M has owned 100 
percent of the voting stock of controlled foreign corporation A. 
Corporation M also conducts operations through a foreign branch. 
Both Corporation A and Corporation M use the calendar year as the 
taxable year. Corporation A uses the u as its functional currency 
and 1u equals $1 at all relevant times. Corporation A has no subpart 
F income, as defined in section 952, and no increase in earnings 
invested in United States property under section 956 for 1992. 
Corporation A also has no previously taxed income accounts. 
Corporation A has general limitation income and high withholding tax 
interest income that, by operation of section 954(b)(4), does not 
constitute foreign base company income under section 954(a). Because 
Corporation A is a controlled foreign corporation, it is not 
required to reduce post-1986 foreign income taxes by foreign taxes 
paid or accrued with respect to high withholding tax interest in 
excess of 5 percent. See Sec. 1.902-1(a)(8)(iii). Corporation A pays 
a 60u dividend to Corporation M in 1992. For 1992, Corporation M is 
deemed, under paragraph (b) of this section, to have paid $24 of the 
post-1986 foreign income taxes paid by Corporation A and includes 
that amount in gross income under section 78 as a dividend, 
determined as follows:


1. Assumed post-1986 undistributed earnings in                          
 Corporation A at start of 1992 attributable to:                        
    (a) Section 904(d)(1)(B) high withholding tax  20u                  
     interest.                                                          
    (b) Section 904(d)(1)(I) general limitation    55u                  
     income.                                                            
2. Assumed post-1986 foreign income taxes in                            
 Corporation A at start of 1992 attributable to:                        
    (a) Section 904(d)(1)(B) high withholding tax  $5                   
     interest.                                                          
    (b) Section 904(d)(1)(I) general limitation    $20                  
     income.                                                            
3. Assumed pre-tax earnings and profits of                              
 Corporation A for 1992 attributable to:                                
    (a) Section 904(d)(1)(B) high withholding tax  20u                  
     interest.                                                          
    (b) Section 904(d)(1)(I) general limitation    20u                  
     income.                                                            
4. Assumed foreign income taxes paid or accrued                         
 in 1992 on or with respect to:                                         
    (a) Section 904(d)(1)(B) high withholding tax  10u                  
     interest.                                                          
    (b) Section 904(d)(1)(I) general limitation    5u                   
     income.                                                            
5. Post-1986 undistributed earnings in                                  
 Corporation A for 1992 (pre-dividend)                                  
 attributable to:                                                       
    (a) Section 904(d)(1)(B) high withholding tax  30u                  
     interest (Line 1(a) + Line 3(a) minus Line                         
     4(a)).                                                             
    (b) Section 904(d)(1)(I) general limitation    70u                  
     income (Line 1(b) + Line 3(b) minus Line                           
     4(b)).                                                             
                                                  ----------------------
    (c) Total....................................  100u                 
6. Post-1986 foreign income taxes in Corporation                        
 A for 1992 (pre-dividend) attributable to:                             
    (a) Section 904(d)(1)(B) high withholding tax  $15                  
     interest (Line 2(a) + Line 4(a) translated                         
     at the appropriate exchange rates).                                
    (b) Section 904(d)(1)(I) general limitation    $25                  
     income (Line 2(b) + Line 4(b) translated at                        
     the appropriate exchange rates).                                   
7. Dividends paid to Corporation M in 1992.......  60u                  
8. Dividends paid to Corporation M in 1992                              
 attributable to section 904(d) separate                                
 categories pursuant to Sec.  1.904-5(d):                               
    (a) Dividends paid to Corporation M in 1992    18u                  
     attributable to section 904(d)(1)(B) high                          
     withholding tax interest (Line 7 multiplied                        
     by Line 5(a) divided by Line 5(c)).                                
    (b) Dividends paid to Corporation M in 1992    42u                  
     attributable to section 904(d)(1)(I) general                       
     limitation income (Line 7 multiplied by Line                       
     5(b) divided by Line 5(c)).                                        
9. Percentage of Corporation A's post-1986                              
 undistributed earnings for 1992 paid to                                
 Corporation M attributable to:                                         
    (a) Section 904(d)(1)(B) high withholding tax  60%                  
     interest (Line 8(a) divided by Line 5(a)).                         
    (b) Section 904(d)(1)(I) general limitation    60%                  
     income (Line 8(b) divided by Line 5(b)).                           
10. Foreign income taxes of Corporation A deemed                        
 paid by Corporation M under section 902(a)                             
 attributable to:                                                       
    (a) Foreign income taxes of Corporation A      $9                   
     deemed paid by Corporation M under section                         
     902(a) with respect to section 904(d)(1)(B)                        
     high withholding tax interest (Line 6(a)                           
     multiplied by Line 9(a)).                                          
    (b) Foreign income taxes of Corporation A      $15                  
     deemed paid by Corporation M under section                         
     902(a) with respect to section 904(d)(1)(I)                        
     general limitation income (Line 6(b)                               
     multiplied by Line 9(b)).                                          
11. Post-1986 undistributed earnings in                                 
 Corporation A at start of 1993 attributable to:                        
    (a) Section 904(d)(1)(B) high withholding tax  12u                  
     interest (Line 5(a) minus Line 8(a)).                              
    (b) Section 904(d)(1)(I) general limitation    28u                  
     income (Line 5(b) minus Line 8(b)).                                
12. Post-1986 foreign income taxes in Corporation                       
 A at start of 1989 allocable to:                                       
    (a) Section 904(d)(1)(B) high withholding tax  $6                   
     interest (Line 6(a) minus Line 10(a)).                             
    (b) Section 904(d)(1)(I) general limitation    $10                  
     income (Line 6(b) minus Line 10(b)).                               
                                                                        

    (ii) For purposes of computing Corporation M's foreign tax 
credit limitation, the post-1986 foreign income taxes of Corporation 
A deemed paid by Corporation M with respect to income in separate 
categories will be added to the foreign income taxes paid or accrued 
by Corporation M associated with income derived from Corporation M's 
branch operation in the same separate categories. The dividend (and 
the section 78 inclusion with respect to the dividend) will be 
treated as income in separate categories and added to Corporation 
M's other income, if any, attributable to the same separate 
categories. See section 904(d) and Sec. 1.904-6.

    (g) Effective date. This section applies to any distribution made 
in and after a foreign corporation's first taxable year beginning on or 
after January 1, 1987.


Sec. 1.902-2  Treatment of deficits in post-1986 undistributed earnings 
and pre-1987 accumulated profits of a first-, second-, or third-tier 
corporation for purposes of computing an amount of foreign taxes deemed 
paid under Sec. 1.902-1.

    (a) Carryback of deficits in post-1986 undistributed earnings of a 
first-, second-, or third-tier corporation to pre-effective date 
taxable years--(1) Rule. For purposes of computing foreign income taxes 
deemed paid under Sec. 1.902-1(b) with respect to dividends paid by a 
first-, second-, or third-tier corporation, when there is a deficit in 
the post-1986 undistributed earnings of that corporation and the 
corporation makes a distribution to shareholders that is a dividend or 
would be a dividend if there were current or accumulated earnings and 
profits, then the post-1986 deficit shall be carried

[[Page 938]]

back to the most recent pre-effective date taxable year of the first-, 
second-, or third-tier corporation with positive accumulated profits 
computed under section 902. See Sec. 1.902-3(e). For purposes of this 
Sec. 1.902-2, a pre-effective date taxable year is a taxable year 
beginning before January 1, 1987, or a taxable year beginning after 
December 31, 1986, if the special effective date of Sec. 1.902-1(a)(13) 
applies. The deficit shall reduce the section 902 accumulated profits 
in the most recent preeffective date year to the extent thereof, and 
any remaining deficit shall be carried back to the next preceding year 
or years until the deficit is completely allocated. The amount carried 
back shall reduce the deficit in post-1986 undistributed earnings. Any 
foreign income taxes paid in a post-effective date year will not be 
carried back to preeffective date taxable years or removed from post-
1986 foreign income taxes. See section 960 and the regulations under 
that section for rules governing the carryback of deficits and the 
computation of foreign income taxes deemed paid with respect to deemed 
income inclusions from controlled foreign corporations.
    (2) Examples. The following examples illustrate the rules of this 
paragraph (a):

    Example 1. (i) From 1985 through 1990, domestic corporation M 
owns 10 percent of the one class of stock of foreign corporation A. 
The remaining 90 percent of Corporation A's stock is owned by Z, a 
foreign corporation. Corporation A is not a controlled foreign 
corporation and uses the u as its functional currency. 1u equals $1 
at all relevant times. Both Corporation A and Corporation M use the 
calendar year as the taxable year. Corporation A has pre-1987 
accumulated profits and post-1986 undistributed earnings or deficits 
in post-1986 undistributed earnings, pays pre-1987 and post-1986 
foreign income taxes, and pays dividends as summarized below:


Taxable year.....................  1985..............  1986..............  1987..............  1988..............  1989..............  1990             
Current E & P (Deficits) of Corp.  150u..............  150u..............  (100u)............  100u..............  0.................  0                
 A.                                                                                                                                                     
Current Plus Accumulated E & P of  150u..............  300u..............  200u..............  250u..............  250u..............  200u             
 Corp. A.                                                                                                                                               
Post-'86 Undistributed Earnings    ..................  ..................  (100u)............  100u..............  100u..............  50u              
 of Corp. A.                                                                                                                                            
Post-'86 Undistributed Earnings    ..................  ..................  0.................  100u..............  50u...............  50u              
 of Corp. A Reduced By Current                                                                                                                          
 Year Dividend Distributions                                                                                                                            
 (increased by deficit carryback).                                                                                                                      
Foreign Income Taxes of Corp. A    120u..............  120u..............  $10...............  $50...............  0.................  0                
 (Annual).                                                                                                                                              
Post-'86 Foreign Income Taxes of   ..................  ..................  $10...............  $60...............  $60...............  $30              
 Corp. A.                                                                                                                                               
12/31 Distributions to Corp. M...  0.................  0.................  5u................  0.................  5u................  0                
12/31 Distributions to Corp. Z...  0.................  0.................  45u...............  0.................  45u...............  0                
                                                                                                                                                        

    (ii) On December 31, 1987, Corporation A distributes a 5u 
dividend to Corporation M and a 45u dividend to Corporation Z. At 
that time Corporation A has a deficit of (100u) in post-1986 
undistributed earnings and $10 of post-1986 foreign income taxes. 
The (100u) deficit (but not the post-1986 foreign income taxes) is 
carried back to offset the accumulated profits of 1986 and removed 
from post-1986 undistributed earnings. The accumulated profits for 
1986 are reduced to 50u (150u-100u). The dividend is paid out of the 
reduced 1986 accumulated profits. Foreign taxes deemed paid by 
Corporation M with respect to the 5u dividend are 12u (120u x (5u/
50u)). See Sec. 1.902-1(b)(3). Corporation M must include 12u in 
gross income (translated under the rule applicable to foreign income 
taxes paid on earnings accumulated in pre-effective date years) 
under section 78 as a dividend. Both the income inclusion and the 
foreign taxes deemed paid are subject to a separate limitation for 
dividends from Corporation A, a noncontrolled section 902 
corporation. No accumulated profits remain in Corporation A with 
respect to 1986 after the carryback of the 1987 deficit and the 
December 31, 1987, dividend distributions to Corporations M and Z.
    (iii) On December 31, 1989, Corporation A distributes a 5u 
dividend to Corporation M and a 45u dividend to Corporation Z. At 
that time Corporation A has 100u of post-1986 undistributed earnings 
and $60 of post-1986 foreign income taxes. Therefore, the dividend 
is considered paid out of Corporation A's post-1986 undistributed 
earnings. Foreign taxes deemed paid by Corporation M with respect to 
the 5u dividend are $3 ($60 x 5%[5u/100u]). Corporation M must 
include $3 in gross income under section 78 as a dividend. Both the 
income inclusion and the foreign taxes deemed paid are subject to a 
separate limitation for dividends from noncontrolled section 902 
corporation A. Corporation A's post-1986 undistributed earnings as 
of January 1, 1990, are 50u (100u-50u). Corporation A's post-1986 
foreign income taxes must be reduced by the amount of foreign taxes 
that would have been deemed paid if both Corporations M and Z were 
eligible to compute an amount of deemed paid taxes. Section 1.902-
1(a)(8)(i). The amount of foreign income taxes that would have been 
deemed paid if both Corporations M and Z were eligible to compute an 
amount of deemed paid taxes on the 50u dividend distributed by 
Corporation A is $30 ($60 x 50%[50u/100u]). Thus, post-1986 foreign 
income taxes as of January 1, 1990, are $30 ($60-$30).
    Example 2. The facts are the same as in Example 1, except that 
Corporation A has a deficit in its post-1986 undistributed earnings 
of (150u) on December 31, 1987. The deficit is carried back to 1986 
and reduces accumulated profits for that year to -0-. Thus, the 
foreign income taxes paid with respect to the 1986 accumulated 
profits will never be deemed paid. The 1987 dividend is deemed to be 
out of Corporation A's 1985 accumulated profits. Foreign taxes 
deemed paid by Corporation M under section 902 with respect to the 
5u dividend paid on December 31, 1987, are 4u (120u x 5u/150u). See 
Sec. 1.902-1(b)(3). As a result of the December 31, 1987, dividend 
distributions, 100u (150u-50u) of accumulated profits and 80u (120u 
reduced by 40u[120u x 50u/150u] of foreign taxes that would have 
been deemed paid had all of Corporation A's shareholders been 
eligible to compute an amount of foreign taxes deemed paid with 
respect to the dividend paid out of 1985 accumulated profits) remain 
in Corporation A with respect to 1985.
    Example 3. (i) From 1986 through 1991, domestic corporation M 
owns 10 percent of the one class of stock of foreign corporation A. 
The remaining 90 percent of Corporation A's stock is owned by 
Corporation Z, a foreign corporation. Corporation A is not a 
controlled foreign corporation and uses the u as its functional 
currency. 1u equals $1 at all relevant times. Both Corporation A and 
Corporation M use the calendar year as the taxable year. Corporation 
A has pre-1987 accumulated profits and post-1986 undistributed 
earnings or deficits in post-1986 undistributed earnings, pays pre-
1987 and post-1986 foreign income taxes, and pays dividends as 
summarized below:

Taxable year.....................  1986..............  1987..............  1988..............  1989..............  1990..............  1991             
Current E & P (Deficits) of Corp.  100u..............  (50u).............  150u..............  75u...............  25u...............  0                
 A.                                                                                                                                                     
Current Plus Accumulated E & P of  100u..............  50u...............  200u..............  175u..............  200u..............  80u              
 Corp. A.                                                                                                                                               
Post-'86 Undistributed Earnings    ..................  (50u).............  100u..............  75u...............  100u..............  0                
 of Corp. A.                                                                                                                                            
Post-'86 Undistributed Earnings    ..................  (50u).............  0.................  75u...............  0.................  0                
 of Corp. A Reduced By Current                                                                                                                          
 Year Dividend Distributions                                                                                                                            
 (increased by deficit carryback).                                                                                                                      
Foreign Income Taxes (Annual) of   80u...............  0.................  $120..............  $20...............  $20...............  0                
 Corp. A.                                                                                                                                               

[[Page 939]]

                                                                                                                                                        
Post-'86 Foreign Income Taxes of   ..................  0.................  $120..............  $20...............  $40...............  0                
 Corp. A.                                                                                                                                               
12/31 Distributions to Corp. M...  0.................  0.................  10u...............  0.................  12u...............  0                
12/31 Distributions to Corp. Z...  0.................  0.................  90u...............  0.................  108u..............  0                
                                                                                                                                                        

    (ii) On December 31, 1988, Corporation A distributes a 10u 
dividend to Corporation M and a 90u dividend to Corporation Z. At 
that time Corporation A has 100u in its post-1986 undistributed 
earnings and $120 in its post-1986 foreign income taxes. Corporation 
M is deemed, under Sec. 1.902-1(b)(1), to have paid $12 ($120  
x 10%[10u/100u]) of the post-1986 foreign income taxes paid by 
Corporation A and includes that amount in gross income under section 
78 as a dividend. Both the income inclusion and the foreign taxes 
deemed paid are subject to a separate limitation for dividends from 
noncontrolled section 902 corporation A. Corporation A's post-1986 
undistributed earnings as of January 1, 1989, are 0 (100u-100u). Its 
post-1986 foreign taxes as of January 1, 1989, also are 0, $120 
reduced by $120 of foreign income taxes paid that would have been 
deemed paid if both Corporations M and Z were eligible to compute an 
amount of foreign taxes deemed paid on the dividend from Corporation 
A ($120  x 100%[100u/100u]).
    (iii) On December 31, 1990, Corporation A distributes a 12u 
dividend to Corporation M and a 108u dividend to Corporation Z. At 
that time Corporation A has 100u in its post-1986 undistributed 
earnings and $40 in its post-1986 foreign income taxes. The dividend 
is paid out of post-1986 undistributed earnings to the extent 
thereof (100u), and the remainder of 20u is paid out of 1986 
accumulated profits. Under Sec. 1.902-1(b)(2), the 12u dividend to 
Corporation M is deemed to be paid out of post-1986 undistributed 
earnings to the extent of 10u (100u  x 12u/120u) and the remaining 
2u is deemed to be paid out of Corporation A's 1986 accumulated 
profits. Similarly, the 108u dividend to Corporation Z is deemed to 
be paid out of post-1986 undistributed earnings to the extent of 90u 
(100u  x 108u/120u) and the remaining 18u is deemed to be paid out 
of Corporation A's 1986 accumulated profits. Foreign income taxes 
deemed paid by Corporation M under section 902 with respect to the 
portion of the dividend paid out of post-1986 undistributed earnings 
are $4 ($40  x 10%[10u/100u]), and foreign taxes deemed paid by 
Corporation M with respect to the portion of the dividend deemed 
paid out of 1986 accumulated profits are 1.6u (80u  x 2u/100u). 
Corporation M must include $4 plus 1.6u translated under the rule 
applicable to foreign income taxes paid on earnings accumulated in 
taxable years prior to the effective date of the Tax Reform Act of 
1986 in gross income as a dividend under section 78. The income 
inclusion and the foreign income taxes deemed paid are subject to a 
separate limitation for dividends from noncontrolled section 902 
Corporation A. As of January 1, 1991, Corporation A's post-1986 
undistributed earnings are 0 (100u-100u). 80u (100u-20u) of 
accumulated profits remain with respect to 1986. Post-1986 foreign 
income taxes as of January 1, 1991, are 0, $40 reduced by $40 of 
foreign income taxes paid that would have been deemed paid if both 
Corporations M and Z were eligible to compute an amount of deemed 
paid taxes on the 100u dividend distributed by Corporation A out of 
post-1986 undistributed earnings ($40  x 100%[100u/100u]). 
Corporation A has 64u of foreign income taxes remaining with respect 
to 1986, 80u reduced by 16u [80u  x 20u/100u] of foreign income 
taxes that would have been deemed paid if Corporations M and Z both 
were eligible to compute an amount of deemed paid taxes on the 20u 
dividend distributed by Corporation A out of 1986 accumulated 
profits.

    (b) Carryforward of deficits in pre-1987 accumulated profits of a 
first-, second-, or third-tier corporation to post-1986 undistributed 
earnings for purposes of section 902--(1) General rule. For purposes of 
computing foreign income taxes deemed paid under Sec. 1.902-1(b) with 
respect to dividends paid by a first-, second-, or third-tier 
corporation out of post-1986 undistributed earnings, the amount of a 
deficit in accumulated profits of the foreign corporation determined 
under section 902 as of the end of its last pre-effective date taxable 
year is carried forward and reduces post-1986 undistributed earnings on 
the first day of the foreign corporation's first taxable year beginning 
after December 31, 1986, or on the first day of the first taxable year 
in which the ownership requirements of section 902(c)(3)(B) and 
Sec. 1.902-1(a)(1) through (4) are met if the special effective date of 
Sec. 1.902-1(a)(13) applies. Any foreign income taxes paid with respect 
to a pre-effective date year shall not be carried forward and included 
in post-1986 foreign income taxes. Post-1986 undistributed earnings may 
not be reduced by the amount of a pre-1987 deficit in earnings and 
profits computed under section 964(a). See section 960 and the 
regulations under that section for rules governing the carryforward of 
deficits and the computation of foreign income taxes deemed paid with 
respect to deemed income inclusions from controlled foreign 
corporations. For translation rules governing carryforwards of deficits 
in pre-1987 accumulated profits to post-1986 taxable years of a foreign 
corporation with a dollar functional currency, see Sec. 1.985-6(d)(2).
    (2) Effect of pre-effective date deficit. If a foreign corporation 
has a deficit in accumulated profits as of the end of its last pre-
effective date taxable year, then the foreign corporation cannot pay a 
dividend out of preeffective date years unless there is an adjustment 
made (for example, a refund of foreign taxes paid) that restores 
section 902 accumulated profits to a pre-effective date taxable year or 
years. Moreover, if a foreign corporation has a deficit in section 902 
accumulated profits as of the end of its last pre-effective date 
taxable year, then no deficit in post-1986 undistributed earnings will 
be carried back under paragraph (a) of this section. For rules 
concerning carrybacks of eligible deficits from post-1986 undistributed 
earnings to reduce pre-1987 earnings and profits computed under section 
964(a), see section 960 and the regulations under that section.
    (3) Examples. The following examples illustrate the rules of this 
paragraph (b):

    Example 1. (i) From 1984 through 1988, domestic corporation M 
owns 10 percent of the one class of stock of foreign corporation A. 
The remaining 90 percent of Corporation A's stock is owned by 
Corporation Z, a foreign corporation. Corporation A is not a 
controlled foreign corporation and uses the u as its functional 
currency. 1u equals $1 at all relevant times. Both Corporation A and 
Corporation M use the calendar year as the taxable year. Corporation 
A has pre-1987 accumulated profits or deficits in accumulated 
profits and post-1986 undistributed earnings, pays pre-1987 and 
post-1986 foreign income taxes, and pays dividends as summarized 
below:


Taxable year..................  1984...........  1985...........  1986..........  1987..........  1988          
Current E & P (Deficits) of     25u............  (100u).........  (25u).........  200u..........  100u          
 Corp. A.                                                                                                       
Current Plus Accumulated E & P  25u............  (75u)..........  (100u)........  100u..........  50u           
 (Deficits) of Corp. A.                                                                                         
Post-'86 Undistributed          ...............  ...............  ..............  100u..........  50u           
 Earnings of Corp. A.                                                                                           
Post-'86 Undistributed          ...............  ...............  ..............  (50u).........  50u           
 Earnings of Corp. A Reduced                                                                                    
 By Current Year Dividend                                                                                       
 Distributions (reduced by                                                                                      
 deficit carryforward).                                                                                         
Foreign Income Taxes (Annual)   20u............  5u.............  0.............  $100..........  $50           
 of Corp. A.                                                                                                    
Post-'86 Foreign Income Taxes   ...............  ...............  ..............  $100..........  $50           
 of Corp. A.                                                                                                    
12/31 Distributions to Corp. M  0..............  0..............  0.............  15u...........  0             
12/31 Distributions to Corp. Z  0..............  0..............  0.............  135u..........  0             
                                                                                                                


[[Page 940]]

    (ii) On December 31, 1987, Corporation A distributes a 150u 
dividend, 15u to Corporation M and 135u to Corporation Z. 
Corporation A has 200u of current earnings and profits for 1987, but 
its post-1986 undistributed earnings are only 100u as a result of 
the reduction for pre-1987 accumulated deficits required under 
paragraph (b)(1) of this section. Corporation A has $100 of post-
1986 foreign income taxes. Only 100u of the 150u distribution is a 
dividend out of post-1986 undistributed earnings. Foreign income 
taxes deemed paid by Corporation M in 1987 with respect to the 10u 
dividend attributable to post-1986 undistributed earnings, computed 
under Sec. 1.902-1(b), are $10 ($100  x 10%[10u/100u]). Corporation 
M includes this amount in gross income under section 78 as a 
dividend. Both the income inclusion and the foreign taxes deemed 
paid are subject to a separate limitation for dividends from 
noncontrolled section 902 corporation A. After the distribution, 
Corporation A has (50u) of post-1986 undistributed earnings (100u-
150u) and -0- post-1986 foreign income taxes, $100 reduced by $100 
of foreign income taxes paid that would have been deemed paid if 
both Corporations M and Z were eligible to compute an amount of 
deemed paid taxes on the 100u dividend distributed by Corporation A 
out of post-1986 undistributed earnings ($100  x 100%[100u/100u]).
    (iii) The remaining 50u of the 150u distribution cannot be 
deemed paid out of accumulated profits of a pre-1987 year because 
Corporation A has an accumulated deficit as of the end of 1986 that 
eliminated all pre-1987 accumulated profits. See paragraph (b)(2) of 
this section. The 50u is a dividend out of current earnings and 
profits under section 316(a)(2), but Corporation M is not deemed to 
have paid any additional foreign income taxes paid by Corporation A 
with respect to that 50u dividend out of current earnings and 
profits. See Sec. 1.902-1(b)(4).
    Example 2. (i) From 1986 through 1991, domestic corporation M 
owns 10 percent of the one class of stock of foreign corporation A. 
The remaining 90 percent of Corporation A's stock is owned by 
Corporation Z, a foreign corporation. Corporation A is not a 
controlled foreign corporation and uses the u as its functional 
currency. 1u equals $1 at all relevant times. Both Corporation A and 
Corporation M use the calendar year as the taxable year. Corporation 
A has pre-1987 accumulated profits or deficits in accumulated 
profits and post-1986 undistributed earnings, pays post-1986 foreign 
income taxes, and pays dividends as summarized below:


Taxable year..................  1986...........  1987...........  1988..........  1989..........  1990          
Current E & P (Deficits) of     (100u).........  150u...........  (150u)........  100u..........  250u          
 Corp. A.                                                                                                       
Current Plus Accumulated E & P  (100u).........  50u............  (200u)........  (100u)........  50u           
 (Deficits) of Corp. A.                                                                                         
Post-'86 Undistributed          ...............  50u............  (200u)........  (100u)........  50u           
 Earnings of Corp. A.                                                                                           
Post-'86 Undistributed          ...............  (50u)..........  (200u)........  (200u)........  0             
 Earnings of Corp. A Reduced                                                                                    
 By Current Year Dividend                                                                                       
 Distributions (reduced by                                                                                      
 deficit carryforward).                                                                                         
Foreign Income Taxes (Annual)   0..............  $120...........  0.............  $50...........  $100          
 of Corp. A.                                                                                                    
Post-'86 Foreign Income Taxes   ...............  $120...........  0.............  $50...........  $150          
 of Corp. A.                                                                                                    
12/31 Distributions to Corp. M  0..............  10u............  0.............  10u...........  5u            
12/31 Distributions to Corp. Z  0..............  90u............  0.............  90u...........  45u           
                                                                                                                

    (ii) On December 31, 1987, Corporation A distributes a 10u 
dividend to Corporation M and a 90u dividend to Corporation Z. At 
the time of the distribution, Corporation A has 50u of post-1986 
undistributed earnings and 150u of current earnings and profits. 
Thus, 50u of the dividend distribution (5u to Corporation M and 45u 
to Corporation Z) is a dividend out of post-1986 undistributed 
earnings. The remaining 50u is a dividend out of current earnings 
and profits under section 316(a)(2), but Corporation M is not deemed 
to have paid any additional foreign income taxes paid by Corporation 
A with respect to that 50u dividend out of current earnings and 
profits. See Sec. 1.902-1(b)(4). Note that even if there were no 
current earnings and profits in Corporation A, the remaining 50u of 
the 100u distribution cannot be deemed paid out of accumulated 
profits of a pre1987 year because Corporation A has an accumulated 
deficit as of the end of 1986 that eliminated all pre-1987 
accumulated profits. See paragraph (b)(2) of this section. 
Corporation A has $120 of post-1986 foreign income taxes. Foreign 
taxes deemed paid by Corporation M under section 902 with respect to 
the 5u dividend out of post-1986 undistributed earnings are $12 
($120  x 10%[5u/50u]). Corporation M includes this amount in gross 
income as a dividend under section 78. Both the foreign taxes deemed 
paid and the deemed dividend are subject to a separate limitation 
for dividends from noncontrolled section 902 corporation A. As of 
January 1, 1988, Corporation A has (50u) in its post-1986 
undistributed earnings (50u-100u) and -0- in its post-1986 foreign 
income taxes, $120 reduced by $120 of foreign taxes that would have 
been deemed paid if both Corporations M and Z were eligible to 
compute an amount of deemed paid taxes on the dividend distributed 
by Corporation A out of post-1986 undistributed earnings ($120  
x 100%[50u/50u]).
    (iii) On December 31, 1989, Corporation A distributes a 10u 
dividend to Corporation M and a 90u dividend to Corporation Z. 
Although the distribution is considered a dividend in its entirety 
out of 1989 earnings and profits pursuant to section 316(a)(2), 
post-1986 undistributed earnings are (100u). Accordingly, for 
purposes of section 902, Corporation M is deemed to have paid no 
post-1986 foreign income taxes. See Sec. 1.902-1(b)(4). Corporation 
A's post-1986 undistributed earnings as of January 1, 1990, are 
(200u) ((100u)-100u). Corporation A's post-1986 foreign income taxes 
are not reduced because no taxes were deemed paid.
    (iv) On December 31, 1990, Corporation A distributes a 5u 
dividend to Corporation M and a 45u dividend to Corporation Z. At 
that time Corporation A has 50u of post-1986 undistributed earnings, 
and $150 of post-1986 foreign income taxes. Foreign taxes deemed 
paid by Corporation M under section 902 with respect to the 5u 
dividend are $15 ($150  x 10%[5u/50u]). Post-1986 undistributed 
earnings as of January 1, 1991, are -0- (50u-50u). Post-1986 foreign 
income taxes as of January 1, 1991, also are -0-, $150 reduced by 
$150 ($150  x 100%[50u/50u]) of foreign income taxes that would have 
been deemed paid if both Corporations M and Z were eligible to 
compute an amount of deemed paid taxes on the 50u dividend.

    Par. 4. Newly designated Sec. 1.902-3 is amended by revising the 
section heading and paragraph (a) introductory text, and by designating 
the last paragraph as paragraph (l) and revising it to read as follows:


Sec. 1.902-3  Credit for domestic corporate shareholder of a foreign 
corporation for foreign income taxes paid with respect to accumulated 
profits of taxable years of the foreign corporation beginning before 
January 1, 1987.

    (a) Definitions. For purposes of section 902 and Secs. 1.902-3 and 
1.902-4:
* * * * *
    (l) Effective date. Except as provided in Sec. 1.902-4, this 
section applies to any distribution received from a first-tier 
corporation by its domestic shareholder after December 31, 1964, and 
before the beginning of the foreign corporation's first taxable year 
beginning after December 31, 1986. If, however, the first day on which 
the ownership requirements of section 902(c)(3)(B) and Sec. 1.902-
1(a)(1) through (4) are met with respect to the foreign corporation is 
in a taxable year of the foreign corporation beginning after December 
31, 1986, then this section shall apply to all taxable years beginning 
after December 31, 1964, and before the year in which the ownership 
requirements are first met. See Sec. 1.902-1(a)(13)(iii). For 
corresponding rules applicable to distributions received by the 
domestic shareholder prior to January 1, 1965, see Sec. 1.902-5 as 
contained in the 26 CFR part 1 edition revised April 1, 1976.


Sec. 1.902-4  [Amended]

    Par. 5. Newly designated Sec. 1.902-4, paragraph (b), in the last 
sentence, the

[[Page 941]]

language ``Sec. 1.902-1'' is removed and ``Sec. 1.902-3'' is added in 
its place.

PART 602--OMB CONTROL NUMBERS UNDER THE PAPERWORK REDUCTION ACT

    Par. 6. The authority citation for part 602 continues to read as 
follows:

    Authority: 26 U.S.C. 7805.

    Par. 7. In Sec. 602.101, paragraph (c) is amended by adding an 
entry in numerical order to the table to read as follows:


Sec. 602.101  OMB Control Numbers.

* * * * *
    (c) * * *

------------------------------------------------------------------------
                                                             Current OMB
     CFR part of section where identified and described      control No.
------------------------------------------------------------------------
                                                                        
                  *        *        *        *        *                 
1.902-1....................................................    1545-1458
                                                                        
                  *        *        *        *        *                 
------------------------------------------------------------------------

Margaret Milner Richardson,
Commissioner of Internal Revenue.

    Approved: December 12, 1996.
Donald C. Lubick,
Assistant Secretary of the Treasury.
[FR Doc. 97-153 Filed 1-6-97; 8:45 am]
BILLING CODE 4830-01-U