[Federal Register Volume 70, Number 99 (Tuesday, May 24, 2005)]
[Proposed Rules]
[Pages 29868-29907]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 05-10160]



[[Page 29867]]

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Part III





Department of the Treasury





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Internal Revenue Service



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26 CFR Part 1



Dual Consolidated Loss Regulations; Proposed Rule

  Federal Register / Vol. 70, No. 99 / Tuesday, May 24, 2005 / Proposed 
Rules  

[[Page 29868]]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-102144-04]
RIN 1545-BD10


Dual Consolidated Loss Regulations

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rule making and notice of public hearing.

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SUMMARY: This document contains proposed regulations under section 
1503(d) of the Internal Revenue Code (Code) regarding dual consolidated 
losses. Section 1503(d) generally provides that a dual consolidated 
loss of a dual resident corporation cannot reduce the taxable income of 
any other member of the affiliated group unless, to the extent provided 
in regulations, such loss does not offset the income of any foreign 
corporation. Similar rules apply to losses of separate units of 
domestic corporations. The proposed regulations address various dual 
consolidated loss issues, including exceptions to the general 
prohibition against using a dual consolidated loss to reduce the 
taxable income of any other member of the affiliated group.

DATES: Written and electronic comments and outlines of topics to be 
discussed at the public hearing scheduled for September 7, 2005, at 10 
a.m., must be received by August 22, 2005.

ADDRESSES: Send submissions to CC:PA:LPD:PR (REG-102144-04), room 5203, 
Internal Revenue Service, P.O. Box 7604, Washington, DC 20044. 
Submissions may be hand delivered between the hours of 8 a.m. and 4 
p.m. to CC:PA:LPD:PR (REG-102144-04), Courier's Desk, Internal Revenue 
Service, 1111 Constitution Avenue, NW., Washington, DC, or sent 
electronically via the IRS Internet site at http://www.irs.gov/regs or 
via the Federal eRulemaking Portal at http://www.regulations.gov/ (IRS 
and REG-102144-04). The public hearing will be held in the Auditorium 
of the Internal Revenue Building, 1111 Constitution Avenue, NW., 
Washington, DC.

FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations, 
Kathryn T. Holman, (202) 622-3840 (not a toll-free number); concerning 
submissions and the hearing, Robin Jones, (202) 622-3521 (not a toll-
free number).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

    The collection of information contained in this notice of proposed 
rulemaking has been submitted to the Office of Management and Budget in 
accordance with the Paperwork Reduction Act of 1995 (44 U.S.C. 
3507(d)). Comments on the collection of information should be sent to 
the Office of Management and Budget, Attn: Desk Officer for the 
Department of the Treasury, Office of Information and Regulatory 
Affairs, Washington, DC 20503, with copies to the Internal Revenue 
Service, Attn: IRS Reports Clearance Officer, W:CAR:MP:FP:S Washington, 
DC 20224. Comments on the collection of information should be received 
by July 25, 2005. Comments are specifically requested concerning:
    Whether the proposed collection of information is necessary for the 
proper performance of the functions of the IRS, including whether the 
information will have practical utility;
    The accuracy of the estimated burden associated with the proposed 
collection of information (see below);
    How the quality, utility, and clarity of the information to be 
collected may be enhanced;
    How the burden of complying with the proposed collection of 
information may be minimized, including through the application of 
automated collection techniques or other forms of information 
technology; and
    Estimates of capital or start-up costs and costs of operation, 
maintenance, and purchase of service to provide information.
    The collections of information in these proposed regulations are in 
Sec. Sec.  (1.1503(d)-1(b)(14), 1.1503(d)-1(c)(1), 1.1503(d)-2(d), 
1.1503(d)-4(c)(2), 1.1503(d)-4(d), 1.1503(d)-4(e)(2), 1.1503(d)-
4(f)(2), 1.1503(d)-4(g), 1.1503(d)-4(h) and 1.1503(d)-4(i). The various 
information is required. First, it notifies the IRS when the taxpayer 
asserts that it had reasonable cause for failing to comply with certain 
filing requirements under the regulations. Second, it indicates when 
the taxpayer attempts to rebut the amount of presumed tainted income. 
Finally, it provides the IRS various information regarding exceptions 
to the domestic use limitation, including domestic use elections, 
domestic use agreements, triggering events and recapture.
    The collection of information is in certain cases required and in 
certain cases voluntary. The likely respondents will be domestic 
corporations with foreign operations that generate losses.
    Estimated total annual reporting and/or recordkeeping burden: 2,665 
hours.
    Estimated average annual burden hours per respondent and/or 
recordkeeper: 1.5 hours.
    Estimated number of respondents and/or recordkeepers: 1,765.
    Estimated annual frequency of responses: Annually.
    An agency may not conduct or sponsor, and a person is not required 
to respond to, a collection of information unless it displays a valid 
control number assigned by the Office of Management and Budget.
    Books or records relating to a collection 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

    The United States taxes the worldwide income of domestic 
corporations. A domestic corporation is a corporation created or 
organized in the United States or under the law of the United States or 
of any State. The United States allows certain domestic corporations to 
file consolidated returns with other affiliated domestic corporations. 
When two or more domestic corporations file a consolidated return, 
losses that one corporation incurs generally may reduce or eliminate 
tax on income that another corporation earns.
    Some countries use criteria other than place of incorporation or 
organization to determine whether corporations are residents for tax 
purposes. For example, some countries treat corporations as residents 
for tax purposes if they are managed or controlled in that country. If 
one of these countries determines a corporation to be a resident, the 
corporation is generally subject to income tax of that foreign country 
on a residence basis. As a result, if such a corporation is a domestic 
corporation for U.S. tax purposes, it is a dual resident corporation 
and is subject to the income tax of both the foreign country and the 
United States on a residence basis.
    Prior to the Tax Reform Act of 1986, if a corporation was a 
resident of both a foreign country and the United States, and the 
foreign country permitted the losses of the corporation to be used to 
offset the income of another person (for example, as a result of 
consolidation), then the dual resident corporation could use any losses 
it generated twice: once to offset income that was subject to U.S. tax, 
but not foreign tax, and a second time to offset income subject to 
foreign tax, but not U.S. tax (double-dip).

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    Congress was concerned that this double-dip of a single economic 
loss could result in an undue tax advantage to certain foreign 
investors that made investments in domestic corporations, and could 
create an undue incentive for certain foreign corporations to acquire 
domestic corporations and for domestic corporations to acquire foreign 
rather than domestic assets. Staff of Joint Committee on Taxation, 99th 
Cong., 2nd Sess., General Explanation of the Tax Reform Act of 1986, at 
1064-1065 (1987). Through such double-dipping, worldwide economic 
income could be rendered partially or fully exempt from current 
taxation. Moreover, even if the foreign income against which the loss 
was used would eventually be subject to U.S. tax (upon a repatriation 
of earnings), there were timing benefits of double dipping that the 
statute was intended to prevent. Congress responded to this concern by 
enacting section 1503(d) as part of the Tax Reform Act of 1986.
    Section 1503(d) provides that a dual consolidated loss of a 
corporation cannot reduce the taxable income of any other member of the 
corporation's affiliated group. The statute defines a dual consolidated 
loss as a net operating loss of a domestic corporation that is subject 
to an income tax of a foreign country on its income without regard to 
the source of its income, or is subject to tax on a residence basis. 
The statute authorizes the issuance of regulations permitting the use 
of a dual consolidated loss to offset the income of a domestic 
affiliate if the loss does not offset the income of a foreign 
corporation under foreign law.
    Section 1503(d) further states that, to the extent provided in 
regulations, similar rules apply to any loss of a separate unit of a 
domestic corporation as if such unit where a wholly owned subsidiary of 
the corporation. Although the statute does not define the term separate 
unit, the legislative history to the provision refers to the loss of 
any separate and clearly identifiable unit of a trade or business of a 
taxpayer and cites as an example a foreign branch of a domestic 
corporation. See H.R. Rep. No. 795, 100th Cong., 2d Sess. July 26, 
1988) at 293.
    The IRS and Treasury issued temporary regulations under section 
1503(d) in 1989 (TD 8261, 1989-2 C.B. 220). The temporary regulations 
generally provided that, unless one of three limited exceptions 
applied, a dual consolidated loss of a dual resident corporation could 
not offset the income of any other member of the dual resident 
corporation's affiliated group. The temporary regulations contained 
similar rules for losses incurred by separate units.
    In response to comments that the temporary regulations were 
unnecessarily restrictive, the IRS and Treasury issued final 
regulations under section 1503(d) in 1992 (TD 8434, 1992-2 C.B. 240). 
These final regulations were updated and amended over the next 11 years 
(current regulations). The current regulations apply the section 
1503(d) limitation more narrowly than the temporary regulations. The 
current regulations adopt an actual use standard for permitting a dual 
consolidated loss to offset income of members of the affiliated group. 
This standard, which applies to both dual resident corporations and 
separate units, requires taxpayers to certify that no portion of the 
dual consolidated loss has been or will be used to offset the income of 
any other person under the income tax laws of a foreign country. If 
such a certification is made and a subsequent triggering event occurs, 
the dual consolidated loss must be recaptured in the year of the event 
(plus an applicable interest charge).
    This document proposes amendments to the current regulations under 
section 1503(d). Conforming amendments are also proposed to related 
regulations under sections 1502 and 6043.

Overview

    In general, the proposed regulations address three fundamental 
concerns that arise in connection with the current regulations. First, 
the IRS and Treasury believe that the scope of application of the 
current regulations should be modified. For example, the current 
regulations may apply to certain structures where there is little 
likelihood of a double-dip. Moreover, the IRS and Treasury understand 
that some taxpayers have taken the position that the current 
regulations do not apply to certain structures that provide taxpayers 
the benefits of the type of double-dip that section 1503(d) is intended 
to deny. Accordingly, the proposed regulations are designed to minimize 
these cases of potential over- and under-application.
    Second, the IRS and Treasury recognize that there are many 
unresolved issues that arise when applying the current regulations, 
particularly in light of the adoption of the entity classification 
regulations under Sec. Sec.  301.7701-1 through 301.7701-3. Thus, the 
proposed regulations modernize the dual consolidated loss regime to 
take into account the entity classification regulations and to resolve 
the related issues so that the rules can be applied by taxpayers and 
the Commissioner with greater certainty.
    Finally, the IRS and Treasury believe that, in many cases, the 
current regulations are administratively burdensome to both taxpayers 
and the Commissioner. Accordingly, the proposed regulations reduce, to 
the extent possible, the administrative burden imposed on taxpayers and 
the Commissioner.

Explanation of Provisions

A. Structure of the Proposed Regulations

    The proposed regulations are set forth in six sections. Section 
1.1503(d)-1 contains definitions and special rules for filings. Section 
1.1503(d)-2 sets forth operating rules, which include the general rule 
that prohibits the domestic use of a dual consolidated loss (subject to 
certain exceptions discussed below), a rule that limits the use of dual 
consolidated losses following certain transactions, an anti-avoidance 
provision that prevents dual consolidated losses from offsetting income 
from assets acquired in certain nonrecognition transactions or 
contributions to capital, and rules for computing foreign tax credit 
limitations. Section 1.1503(d)-3 contains special rules for accounting 
for dual consolidated losses. These special rules determine the amount 
of a dual consolidated loss, determine the effect of a dual 
consolidated loss on domestic affiliates, and provide special basis 
adjustments. Section 1.1503(d)-4 provides exceptions to the general 
rule that prohibits the domestic use of a dual consolidated loss, 
including a domestic use election. Section 1.1503(d)-5 contains 
examples that illustrate the application of the proposed regulations. 
Finally, Sec.  1.1503(d)-6 contains the proposed effective date of the 
proposed regulations.
    In addition to the proposed regulatory amendments under section 
1503(d), the proposed regulations also include conforming proposed 
amendments to Sec.  1.1502-21 and Sec.  1.6043-4T.

B. Definitions and Special Rules for Filings Under Section 1503(d)--
Sec.  1.1503(d)-1

1. Treatment of a Separate Unit as a Domestic Corporation and a Dual 
Resident Corporation
    Section 1.1503-2(c)(3) and (4) of the current regulations defines a 
separate unit of a domestic corporation as a foreign branch, within the 
meaning of Sec.  1.367(a)-6T(g), (foreign branch separate unit) and an 
interest in a partnership, trust or hybrid entity. The

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current regulations also provide that any separate unit of a domestic 
corporation is treated as a separate domestic corporation for purposes 
of applying the dual consolidated loss rules. Section 1.1503-2(c)(2). 
In addition, the current regulations provide that, unless otherwise 
indicated, any reference to a dual resident corporation refers also to 
a separate unit. As a result of these rules, certain provisions of the 
current regulations only refer to dual resident corporations, and 
therefore apply to separate units because they are treated as domestic 
corporations and dual resident corporations. However, other provisions 
of the current regulations refer to both dual resident corporations and 
separate units (for example, see Sec.  1.1503-2(g)(2)(iii)(A)).
    The IRS and Treasury believe that, in certain cases, treating 
separate units as domestic corporations creates uncertainty in applying 
the current regulations. This may occur, for example, as a result of 
certain rules applying to separate units because they are treated as 
domestic corporations or dual resident corporations, while other rules 
apply explicitly to separate units themselves. Accordingly, the 
proposed regulations do not contain a general rule that treats separate 
units as domestic corporations or dual resident corporations for all 
purposes of applying the dual consolidated loss regulations. Instead, 
the proposed regulations explicitly refer to dual resident corporations 
and separate units where appropriate, treat separate units as domestic 
corporations only for limited purposes, and modify the operative rules 
where necessary to take into account differences between dual resident 
corporations and separate units.
2. Application of Section 1503(d) to S Corporations
    Section 1.1503-2(c)(2) of the current regulations provides that an 
S corporation, as defined in section 1361, is not a dual resident 
corporation. The preamble to the current regulations explains that S 
corporations are so excluded because an S corporation cannot have a 
domestic corporation as one of its shareholders. The current 
regulations do not, however, explicitly exclude separate units owned by 
an S corporation from the definition of a dual resident corporation. As 
a result, the current regulations can be read to provide that an S 
corporation, although it cannot itself be a dual resident corporation, 
could own a separate unit that would be a dual resident corporation.
    The IRS and Treasury believe that such a result is inappropriate 
because an S corporation cannot have a domestic corporation as one of 
its shareholders and generally is not taxable at the entity level. 
Accordingly, the proposed regulations provide that for purposes of the 
dual consolidated loss rules, an S corporation is not treated as a 
domestic corporation. This modification clarifies that the dual 
consolidated loss regulations do not apply to the S corporation itself, 
or to foreign branches or interests in certain flow-through entities 
owned by an S corporation.
    The IRS and Treasury request comments as to whether regulated 
investment companies (as defined in section 851) or real estate 
investment trusts (as defined in section 856) should be similarly 
excluded from the application of the dual consolidated loss rules.
3. Losses of a Foreign Insurance Company Treated as a Domestic 
Corporation
    Section 953(d) generally provides that a foreign corporation that 
would qualify to be taxed as an insurance company if it were a domestic 
corporation may, under certain circumstances, elect to be treated as a 
domestic corporation. Section 953(d)(3) provides that if a corporation 
elects to be treated as a domestic corporation pursuant to section 
953(d) and is treated as a member of an affiliated group, any loss of 
such corporation is treated as a dual consolidated loss for purposes of 
section 1503(d), without regard to section 1503(d)(2)(B) (grant of 
regulatory authority to exclude losses which do not offset the income 
of foreign corporations from the definition of a dual consolidated 
loss). Therefore, losses of such corporations are treated as dual 
consolidated losses regardless of whether the corporation is subject to 
an income tax of a foreign country on its worldwide income or on a 
residence basis.
    The current regulations do not address the application of section 
953(d)(3). However, the definition of a dual resident corporation 
contained in the proposed regulations includes a foreign insurance 
company that makes an election to be treated as a domestic corporation 
pursuant to section 953(d) and is a member of an affiliated group, 
regardless of how such entity is taxed by the foreign country.
4. Definition of a Separate Unit
(a) Interests in Non-Hybrid Entity Partnerships and Interests in Non-
Hybrid Entity Grantor Trusts
    Section 1.1503-2(c)(4) of the current regulations defines a 
separate unit to include an interest in a hybrid entity (hybrid entity 
separate unit). The current regulations define a hybrid entity as an 
entity that is not taxable as an association for U.S. income tax 
purposes, but is subject to income tax in a foreign jurisdiction as a 
corporation (or otherwise at the entity level) either on its worldwide 
income or on a residence basis. This definition includes an interest in 
such an entity that is treated for U.S. tax purposes as a partnership 
(hybrid entity partnership) or as a grantor trust (hybrid entity 
grantor trust). An interest in an entity that is treated as a 
partnership or a grantor trust for both U.S. and foreign tax purposes 
(non-hybrid entity partnership and non-hybrid entity grantor trust, 
respectively) also is treated as a separate unit under the current 
regulations. Sec.  1.1503-2(c)(3)(i).
    The current regulations also apply to a separate unit owned 
indirectly through a partnership or grantor trust. Thus, for example, 
if a partnership owns a foreign branch within the meaning of Sec.  
1.367(a)-6T(g), a domestic corporate partner's interest in such 
partnership, and its indirect interest in a portion of the foreign 
branch owned through the partnership, each constitutes a separate unit.
    Under the current regulations, an interest in a non-hybrid entity 
partnership or a non-hybrid entity grantor trust is also treated as a 
separate unit, regardless of whether the partnership or grantor trust 
has any nexus with a foreign jurisdiction. This rule can result in the 
application of the dual consolidated loss rules when there may be 
little opportunity for a double-dip. For example, if two domestic 
corporations each own 50 percent of a domestic partnership that 
generates losses attributable to activities conducted solely in the 
United States, the corporate partners would be technically subject to 
the dual consolidated loss rules and therefore would not be allowed to 
offset their income with such losses, unless an exception applied. In 
such a case, however, it may be unlikely that the losses would be 
available to offset income of another person under the income tax laws 
of a foreign country.
    The IRS and Treasury believe that including an interest in a non-
hybrid entity partnership and an interest in a non-hybrid entity 
grantor trust in the

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definition of a separate unit may not be necessary and is 
administratively burdensome. In such cases, it may be unlikely that 
deductions and losses solely attributable to activities of the 
partnership or grantor trust, that do not rise to the level of a 
taxable presence in a foreign jurisdiction, can be used to offset 
income of another person under the income tax laws of a foreign 
country. As a result, the proposed regulations eliminate from the 
definition of a separate unit an interest in a non-hybrid entity 
partnership and an interest in a non-hybrid entity grantor trust. It 
should be noted, however, that the proposed regulations retain the rule 
contained in the current regulations that a domestic corporation can 
own a separate unit indirectly through both hybrid entity and non-
hybrid entity partnerships, and through both hybrid entity and non-
hybrid entity grantor trusts.
(b) Separate Unit Combination Rule
    Section 1.1503-2(c)(3)(ii) of the current regulations provides that 
if two or more foreign branches located in the same foreign country are 
owned by a single domestic corporation and the losses of each branch 
are made available to offset the income of the other branches under the 
tax laws of the foreign country, then the branches are treated as one 
separate unit. The combination rule in the current regulations does not 
apply to interests in hybrid entity separate units or to dual resident 
corporations.
    Although a disregarded entity is treated as a branch of its owner 
for various purposes of the Code, the current regulations distinguish a 
hybrid entity separate unit that is disregarded as an entity separate 
from its owner from a foreign branch separate unit. Compare Sec.  
1.1503-2(c)(3)(i)(A) and (c)(4); see also Sec.  1.1503-2(g)(2)(vi)(C). 
Accordingly, the combination rule under the current regulations does 
not apply to an interest in a hybrid entity separate unit, even if the 
hybrid entity is disregarded as an entity separate from its owner.
    The combination rule in the current regulations also requires the 
foreign branches to be owned by a single domestic corporation. Thus, 
for example, the current regulations do not permit the combination of 
foreign branches owned by different domestic corporations, even if such 
corporations are members of the same consolidated group. In addition, 
in some cases the current regulations do not allow the combination of 
foreign branches that are owned indirectly by a single domestic 
corporation through other separate units because, as discussed above, 
such other separate units are generally treated as domestic 
corporations for purposes of applying the dual consolidated loss 
regulations. As a result, such foreign branches are not treated as 
being owned by a single domestic corporation.
    The IRS and Treasury believe that the application of the 
combination rule should not be restricted to foreign branch separate 
units. In addition, the IRS and Treasury believe that the combination 
rule should not be limited to those cases where the domestic 
corporation owns the separate units directly. Therefore, provided 
certain requirements are satisfied, the proposed regulations adopt a 
broader combination rule that combines all separate units that are 
directly or indirectly owned by a single domestic corporation.
    In order for separate units to be combined under the proposed 
regulations, the losses of each separate unit must be made available to 
offset the income of the other separate units under the tax laws of a 
single foreign country. In addition, if the separate unit is a foreign 
branch separate unit, it must be located in the foreign country that 
allows its losses to be made available to offset income of each 
separate unit; if the separate unit is a hybrid entity separate unit, 
the hybrid entity must be subject to tax in the foreign country that 
allows losses to be made available to each separate unit either on its 
worldwide income or on a residence basis.
    The combination rule in the proposed regulations does not combine 
separate units owned by different domestic corporations, even if the 
domestic corporations are included in the same consolidated group. The 
IRS and Treasury believe this approach is consistent with section 
1503(d)(3), which provides that, to the extent provided in regulations, 
a loss of a separate unit of a domestic corporation is subject to the 
dual consolidated loss rules as if it were a wholly owned subsidiary of 
such domestic corporation. In addition, the combination rule contained 
in the proposed regulations only applies to separate units and 
therefore does not apply to dual resident corporations.
    The IRS and Treasury, however, request comments as to whether there 
is authority to expand the combination rule and, if so, whether the 
combination rule should be expanded to include separate units that are 
owned directly or indirectly by domestic corporations that are members 
of the same consolidated group. Similarly, comments are requested as to 
whether the combination rule should be extended to apply to dual 
resident corporations. Further, the IRS and Treasury request comments 
on the application of the operative provisions of the proposed 
regulations to combined separate units owned by different domestic 
corporations (for example, the SRLY limitation under Sec.  1.1503(d)-
3(c)).
5. Exception to the Definition of a Dual Consolidated Loss
    Section 1.1503-2(c)(5)(ii)(A) of the current regulations provides a 
very limited exception to the definition of a dual consolidated loss 
where the income tax laws of a foreign country do not permit the dual 
resident corporation to either: (1) Use its losses, expenses, or 
deductions to offset the income of any other person in the same taxable 
year; or (2) carry over or carry back its losses, expenses, or 
deductions to be used, by any means, to offset the income of any other 
person in other taxable years. This exception only applies in rare and 
unusual cases where the income tax laws of the foreign country do not 
allow any portion of the dual consolidated loss to be used to offset 
income of another person under any circumstances.
    The IRS and Treasury understand that some taxpayers have improperly 
interpreted this provision in a manner inconsistent with the policies 
of the dual consolidated loss rules. As a result, the proposed 
regulations eliminate this exception to the definition of a dual 
consolidated loss. As discussed below, however, the proposed 
regulations contain a new exception to the general rule restricting the 
use of a dual consolidated loss to offset income of a domestic 
affiliate. In general, this new exception applies when there is no 
possibility that any portion of the dual consolidated loss can be 
double-dipped, and operates in a manner that is similar to the manner 
in which the exception to the definition of a dual consolidated loss 
contained in the current regulations operates.
6. Partnership Special Allocations
    Section 1.1503-2(c)(5)(iii) of the current regulations reserves on 
the treatment of dual consolidated losses of separate units that are 
partnership interests, including interests in hybrid entities. The 
preamble to the current regulations explains that the reservation was 
principally the result of concerns regarding partnership special 
allocations.
    The proposed regulations no longer reserve on the treatment of 
separate units that are partnership interests. However, the IRS will 
continue to challenge structures that attempt to use special 
allocations in a manner that is

[[Page 29872]]

inconsistent with the principles of section 1503(d).
7. Domestic Use of a Dual Consolidated Loss
    Section 1.1503-2(b)(1) of the current regulations states that, 
except as otherwise provided, a dual consolidated loss cannot offset 
the taxable income of any domestic affiliate, regardless of whether the 
loss offsets income of another person under the income tax laws of a 
foreign country, and regardless of whether the income that the loss may 
offset in the foreign country is, has been, or will be subject to tax 
in the United States. Section 1.1503-2(c)(13) defines the term domestic 
affiliate to mean any member of an affiliated group, without regard to 
exceptions contained in section 1504(b) (other than section 1504(b)(3)) 
relating to includible corporations.
    The proposed regulations retain the general prohibition against 
using a dual consolidated loss to offset income of domestic affiliates 
contained in the current regulations, with modifications, and refer to 
such usage as a domestic use of a dual consolidated loss. This general 
prohibition is subject to a number of exceptions, discussed below. In 
addition, because the proposed regulations do not treat separate units 
as domestic corporations and dual resident corporations (other than for 
limited purposes) the proposed regulations expand the definition of a 
domestic affiliate to include separate units. This expanded definition 
is necessary for purposes of applying the domestic use limitation rule.
8. Foreign use of a dual consolidated loss
(a) General Rule
    Section 1.1503-2T(g)(2)(i) of the current regulations provides 
that, in order to elect relief from the general limitation on the use 
of a dual consolidated loss to offset income of a domestic affiliate 
with respect to a dual consolidated loss ((g)(2)(i) election), the 
taxpayer must, among other things, certify that no portion of the 
losses, expenses, or deductions taken into account in computing the 
dual consolidated loss has been, or will be, used to offset the income 
of any other person under the income tax laws of a foreign country. If, 
contrary to this certification, there is such a use, the dual 
consolidated loss subject to the (g)(2)(i) election generally must be 
recaptured and reported as gross income.
    The IRS and Treasury understand that issues arise involving the 
application of the use rule contained in the current regulations. For 
example, issues may arise where items of income, gain, deduction and 
loss are treated as being generated or incurred by different persons 
under U.S. and foreign law. Similarly, issues may arise due to 
different definitions of a person under U.S. and foreign law. These 
issues have become more prevalent since the adoption of the entity 
classification regulations under Sec. Sec.  301.7701-1 through 
301.7701-3.
    The IRS and Treasury also understand that taxpayers have taken 
positions under the current regulations regarding the use of a dual 
consolidated loss that are inconsistent with the policies underlying 
section 1503(d). On the other hand, the IRS and Treasury believe that, 
under the current regulations, a use can be deemed to occur in certain 
cases where there may be little likelihood of the type of double-dip 
that section 1503(d) was intended to prevent.
    For the reasons discussed above, the proposed regulations modify 
the definition of use and provide a rule based on foreign use. These 
modifications are intended to minimize the potential over- and under-
application of the dual consolidated loss rules that can occur under 
the current regulations. Under the proposed regulations, the foreign 
use definition is intended to minimize the opportunity for a double-
dip. However, the new definition is also intended to minimize the 
situations in which a foreign use will occur in cases where there may 
be little likelihood of a double-dip.
    The proposed regulations provide that a foreign use is deemed to 
occur only if two conditions are satisfied. The first condition is 
satisfied if any portion of a loss or deduction taken into account in 
computing the dual consolidated loss is made available under the income 
tax laws of a foreign country to offset or reduce, directly or 
indirectly, any item that is recognized as income or gain under such 
laws (including items of income or gain generated by the dual resident 
corporation or separate unit itself), regardless of whether income or 
gain is actually offset, and regardless of whether such items are 
recognized under U.S. tax principles. This condition ensures that there 
will not be a foreign use unless all or a portion of the dual 
consolidated loss offsets or reduces, or is made available to offset or 
reduce, income or gain for foreign tax purposes.
    The second condition is satisfied if items that are (or could be) 
offset pursuant to the first condition are considered, under U.S. tax 
principles, to be items of: (1) A foreign corporation; or (2) a direct 
or indirect (for example, through a partnership) owner of an interest 
in a hybrid entity, provided such interest is not a separate unit. This 
condition is intended to limit a foreign use to situations where the 
foreign income that is (or could be) offset by the dual consolidated 
loss is not currently subject to U.S. corporate income tax. In general, 
if the foreign income that is offset is currently subject to U.S. 
corporate income tax, there is no double-dip of the dual consolidated 
loss.
(b) Exception to Foreign Use If No Dilution of an Interest in a 
Separate Unit
    Section 1.1503-2(c)(15) of the current regulations employs a so-
called actual use standard for determining whether there has been a use 
of a dual consolidated loss to offset the income of another person 
under the laws of a foreign country. Although referred to as an actual 
use standard, this rule provides that a use is considered to occur in 
the year in which a loss, expense or deduction taken into account in 
computing the dual consolidated loss is made available for such an 
offset, unless an exception applies. The fact that the other person 
does not have sufficient income in that year to benefit from such an 
offset is not taken into account.
    The available component of the actual use standard was adopted 
because of the administrative complexity that would result from having 
a use occur only when income is actually offset. For example, if in the 
year that a portion of the dual consolidated loss is made available to 
be used by another person, the other person itself generates a loss (or 
has a loss carryover), then in many cases the portion of the dual 
consolidated loss would become part of the loss carryover. Such loss 
therefore would be available to be carried forward or carried back to 
offset income in different taxable years. Under this approach, the 
portion of the loss carryforward or carryback that was taken into 
account in computing the dual consolidated loss would need to be 
identified and tracked, which would require detailed ordering rules for 
determining when such losses were used. Timing and base differences 
between the U.S. and foreign jurisdiction would further complicate such 
an approach.
    Because of the administrative complexities discussed above, the 
foreign use definition contained in the proposed regulations retains 
the available for use standard. However, because the available for use 
standard is

[[Page 29873]]

retained, there are many cases in which a foreign use of a dual 
consolidated loss attributable to interests in hybrid entity 
partnerships and hybrid entity grantor trusts, and separate units owned 
indirectly through partnerships and grantor trusts, occurs, even though 
no portion of any item of deduction or loss comprising the dual 
consolidated loss is double-dipped. In the case of interests in hybrid 
entity partnerships and hybrid entity grantor trusts, a portion of the 
dual consolidated loss attributable to an interest in such entity in 
many cases would be made available to offset income or gain of a direct 
or indirect owner of an interest in such hybrid entity, provided such 
interest is not a separate unit. This typically would occur because 
under foreign law the hybrid entity is taxed as a corporation (or 
otherwise at the entity level) and its net losses may be carried 
forward or carried back. A similar result may occur in the case of a 
separate unit owned indirectly through a non-hybrid entity partnership 
or a non-hybrid entity grantor trust because of timing and base 
differences between the laws of the United States and the foreign 
jurisdiction.
    The IRS and Treasury believe this is an inappropriate result in 
many cases. For example, the IRS and Treasury believe that if there is 
no dilution of the domestic owner's interest in the separate unit, it 
is unlikely that any portion of the dual consolidated loss attributable 
to such separate unit can be put to a foreign use (other than through 
an election to consolidate or similar method, discussed below). 
Therefore, the proposed regulations include three new exceptions to the 
definition of a foreign use where there is no dilution of an interest 
in a separate unit. The new exceptions to foreign use apply to dual 
consolidated losses attributable to two types of separate units: (1) 
Interests in hybrid entity partnerships and interests in hybrid entity 
grantor trusts; and (2) separate units owned indirectly through 
partnerships and grantor trusts.
    The first exception to foreign use provides that, in general, no 
foreign use shall be considered to occur with respect to a dual 
consolidated loss attributable to an interest in a hybrid entity 
partnership or a hybrid entity grantor trust, solely because an item of 
deduction or loss taken into account in computing such dual 
consolidated loss is made available, under the income tax laws of a 
foreign country, to offset or reduce, directly or indirectly, any item 
that is recognized as income or gain under such laws and is considered 
under U.S. tax principles to be an item of the direct or indirect owner 
of an interest in such hybrid entity that is not a separate unit.
    The second exception to foreign use provides that, in general, no 
foreign use shall be considered to occur with respect to a dual 
consolidated loss attributable to or taken into account by a separate 
unit owned indirectly through a partnership or grantor trust solely 
because an item of deduction or loss taken into account in computing 
such dual consolidated loss is made available, under the income tax 
laws of a foreign country, to offset or reduce, directly or indirectly, 
any item that is recognized as income or gain under such laws and is 
considered under U.S. tax principles to be an item of a direct or 
indirect owner of an interest in such partnership or trust.
    Finally, the proposed regulations provide a similar exception for 
combined separate units that include individual separate units to which 
one of the other dilution exceptions would apply, but for the separate 
unit combination rule.
    The new exceptions to foreign use are subject to certain 
limitations, however. First, the exceptions will not apply if there has 
been a dilution of the interest in the separate unit. That is, the 
exception will not apply if during any taxable year the domestic 
owner's percentage interest in the separate unit, as compared to its 
interest in the separate unit as of the last day of the taxable year in 
which such dual consolidated loss was incurred, is reduced as a result 
of another person acquiring through sale, exchange, contribution or 
other means an interest in such partnership or grantor trust, unless 
the taxpayer demonstrates, to the satisfaction of the Commissioner, 
that the other person that acquired the interest in the partnership or 
grantor trust was a domestic corporation. The exceptions to foreign use 
should not apply when a person (other than a domestic corporation) 
acquires an interest in the separate unit because the dilution would 
typically result in an actual foreign use.
    Second, the exceptions do not apply if the availability does not 
arise solely from the ownership in such partnership or trust and the 
allocation of the item of deduction or loss, or the offsetting by such 
deduction or loss, of an item of income or gain of the partnership or 
trust. For example, the exception does not apply in the case where the 
item of loss or deduction is made available through a foreign 
consolidation regime.
    The IRS and Treasury request comments on the issues discussed above 
in connection with the availability component of the foreign use 
definition. Comments are specifically requested as to whether the 
dilution rules are appropriate and, if so, whether a de minimis 
exception should be provided.
9. Mirror Legislation Rule
    Section 1.1503-2(c)(15)(iv) of the current regulations contains a 
mirror legislation rule that addresses legislation enacted by foreign 
jurisdictions that operates in a manner similar to the dual 
consolidated loss rules. This rule was designed to prevent the revenue 
gain resulting from the disallowance of the double-dip benefit of a 
dual consolidated loss from inuring solely to the foreign jurisdiction 
(to the detriment of the United States). Staff of the Joint Committee 
on Taxation, General Explanation of the Tax Reform Act of 1986, at 
1065-66 (J. Comm. Print 1987).
    Congress recognized that mirror legislation in a foreign 
jurisdiction, in conjunction with a mirror legislation rule such as 
that contained in the current regulations, could result in the 
disallowance of a dual consolidated loss in both the United States and 
in the foreign jurisdiction. In such a case, Congress intended that 
Treasury pursue with the appropriate authorities in the foreign 
jurisdiction a bilateral agreement that would allow the use of the loss 
of a dual resident corporation to offset income of an affiliate in only 
one country. Staff of the Joint Committee on Taxation, General 
Explanation of the Tax Reform Act of 1986, at 1066. The mirror rule was 
specifically held to be valid by the Court of Appeals for the Federal 
Circuit. British Car Auctions, Inc. v. United States, 35 Fed. Cl. 123 
(1996), aff'd without op., 116 F.3d 1497 (Fed. Cir. 1997).
    The mirror legislation rule contained in the current regulations 
provides that if the laws of a foreign country deny the use of a loss 
of a dual resident corporation (or separate unit) to offset the income 
of another person because the dual resident corporation (or separate 
unit) is also subject to tax by another country on its worldwide income 
or on a residence basis, the loss is deemed to be used against the 
income of another person in such foreign country such that no (g)(2)(i) 
election can be made with respect to such loss. This rule is intended 
to prevent the foreign jurisdiction from enacting legislation that 
gives taxpayers no choice but to use the dual consolidated loss to 
offset income in the United States. This result is contrary to the 
general policy underlying the structure of the current regulations that 
provides taxpayers the choice of using the dual consolidated loss to 
either offset income

[[Page 29874]]

in the United States or income in the foreign jurisdiction (but not 
both).
    As a result of the consistency rule (discussed below), the deemed 
use of a dual consolidated loss pursuant to the mirror legislation rule 
may also restrict the ability to use other dual consolidated losses to 
offset the income of domestic affiliates, even if such losses are not 
subject to the mirror legislation.
    Subsequent to the issuance of the current regulations, several 
foreign jurisdictions enacted various forms of mirror legislation that, 
absent the mirror legislation rule, would have the effect of forcing 
certain taxpayers to use dual consolidated losses to offset income of 
domestic affiliates.
    Given the relevant legislative history and British Car Auctions, 
the IRS and Treasury believe that the mirror legislation rule remains 
necessary. This is particularly true in light of the prevalence of 
mirror legislation in foreign jurisdictions. As a result, the proposed 
regulations retain the mirror legislation rule. The proposed 
regulations modify the mirror legislation rule, however, to address its 
proper application with respect to mirror legislation enacted 
subsequent to the issuance of the current regulations, and to modify 
its application to better take into account the policies underlying the 
consistency rule.
    In general, the mirror legislation rule contained in the proposed 
regulations applies when the opportunity for a foreign use is denied 
because: (1) The loss is incurred by a dual resident corporation that 
is subject to income taxation by another country on its worldwide 
income or on a residence basis; (2) the loss may be available to offset 
income other than income of the dual resident corporation or separate 
unit under the laws of another country; or (3) the deductibility of any 
portion of a loss or deduction taken into account in computing the dual 
consolidated loss depends on whether such amount is deductible under 
the laws of another country.
    The IRS and Treasury understand that there may be uncertainty as to 
the application of the mirror legislation rule in a given case when the 
mirror legislation is limited in its application. Mirror legislation 
may or may not apply to a particular dual resident corporation or 
separate unit depending on various factors, including the type of 
entity or structure that generates the loss, the ownership of the 
operation or entity that generates the loss, the manner in which the 
operation or entity is taxed in another jurisdiction, or the ability of 
the losses to be deducted in another jurisdiction. As a result, the 
proposed regulations clarify that the mere existence of mirror 
legislation, regardless of whether it applies to the particular dual 
resident corporation, may not result in a deemed foreign use. For 
example, see Sec.  1.1503(d)-5(c) Example 23.
    The proposed regulations also clarify that the absence of an 
affiliate in the foreign jurisdiction, or the failure to make an 
election to enable a foreign use, does not prevent the opportunity for 
a foreign use. Thus, for example, the mirror legislation rule may apply 
even if there are no affiliates of the dual resident corporation in the 
foreign jurisdiction or, even where there is such an affiliate, no 
election is made to consolidate.
    As discussed below, the consistency rule is intended to promote 
uniformity and reduce administrative burdens. The IRS and Treasury 
believe that these concerns may not be significant, however, where 
there is only a deemed foreign use of a dual consolidated loss as a 
result of the mirror legislation rule. Accordingly, the mirror 
legislation rule contained in the proposed regulations provides that a 
deemed foreign use is not treated as a foreign use for purposes of 
applying the consistency rule.
10. Reasonable Cause Exception
    The current regulations require various filings to be included on a 
timely filed tax return. In addition, taxpayers that fail to include 
such filings on a timely filed tax return must request an extension of 
time to file under Sec.  301.9100-3.
    The IRS and Treasury believe that requiring taxpayers to request 
relief for an extension of time to file under Sec.  301.9100-3 results 
in an unnecessary administrative burden on both taxpayers and the 
Commissioner. The IRS and Treasury believe that a reasonable cause 
standard, similar to that used in other international provisions of the 
Code (such as sections 367(a) and 6038B), is a more appropriate and 
less burdensome means for taxpayers to cure compliance defects under 
section 1503(d). As a result, the proposed regulations adopt a 
reasonable cause standard. Moreover, extensions of time under Sec.  
301.9100-3 will not be granted for filings under these proposed 
regulations. See Sec.  301.9100-1(d).
    Under the reasonable cause standard, if a person that is permitted 
or required to file an election, agreement, statement, rebuttal, 
computation, or other information under the regulations fails to make 
such a filing in a timely manner, such person shall be considered to 
have satisfied the timeliness requirement with respect to such filing 
if the person is able to demonstrate, to the satisfaction of the 
Director of Field Operations having jurisdiction of the taxpayer's tax 
return for the taxable year, that such failure was due to reasonable 
cause and not willful neglect. Once the person becomes aware of the 
failure, the person must make this demonstration and comply by 
attaching all the necessary filings to an amended tax return (that 
amends the tax return to which the filings should have been attached), 
and including a written statement explaining the reasons for the 
failure to comply.
    In determining whether the taxpayer has reasonable cause, the 
Director of Field Operations shall consider whether the taxpayer acted 
reasonably and in good faith. Whether the taxpayer acted reasonably and 
in good faith will be determined after considering all the facts and 
circumstances. The Director of Field Operations shall notify the person 
in writing within 120 days of the filing if it is determined that the 
failure to comply was not due to reasonable cause, or if additional 
time will be needed to make such determination.

C. Operating Rules--Sec.  1.1503(d)-2

1. Application of Rules to Multiple Tiers of Separate Units
    Section 1.1503-2(b)(3) of the current regulations provides that if 
a separate unit of a domestic corporation is owned indirectly through 
another separate unit, limitations on the dual consolidated losses of 
the separate units apply as if the upper-tier separate unit were a 
subsidiary of the domestic corporation, and the lower-tier separate 
unit were a lower-tier subsidiary. In light of changes made to other 
provisions of the proposed regulations, this rule is no longer 
necessary. As a result, the proposed regulations do not contain this 
provision.
2. Tainted Income
    Section 1.1503-2(e) of the current regulations prevents the dual 
consolidated loss of a dual resident corporation that ceases being a 
dual resident corporation from offsetting tainted income of such 
corporation. Subject to certain exceptions, tainted income is defined 
as income derived from assets that are acquired by a dual resident 
corporation in a nonrecognition transaction, or as a contribution to 
capital, at any time during the three taxable years immediately 
preceding the tax year in which the corporation ceases to be a dual 
resident corporation, or at any time thereafter. The current 
regulations also contain a rule that,

[[Page 29875]]

absent proof to the contrary, presumes an amount of income generated 
during a taxable year as being tainted income. Such amount is the 
corporation's taxable income for the year multiplied by a fraction, the 
numerator of which is the fair market value of the tainted assets at 
the end of the year, and the denominator of which is the fair market 
value of the total assets owned by each domestic corporation at the end 
of each year.
    The tainted income rule is intended to prevent taxpayers from 
obtaining a double-dip with respect to a dual consolidated loss by 
stuffing assets into a dual resident corporation after, or in certain 
cases before, it terminates its status as a dual resident corporation. 
A double-dip may be obtained in such case because the income that 
offsets the dual consolidated loss generally would not be subject to 
tax in the foreign jurisdiction after the dual resident status of the 
corporation terminates.
    The proposed regulations retain the tainted income rule, subject to 
the following modifications. The proposed regulations clarify that 
tainted income includes both income or gain recognized on the sale or 
other disposition of tainted assets and income derived as a result of 
holding tainted assets. The proposed regulations also modify the rule 
defining the amount of income presumed to be tainted income. The 
proposed regulations clarify that the presumptive rule only applies to 
income derived as a result of holding tainted assets; income or gain 
recognized on the sale or other disposition of tainted assets should be 
readily determinable such that the presumptive rule need not apply. The 
proposed regulations also provide that the numerator in the presumptive 
income fraction is the fair market value of tainted assets determined 
at the time such assets were acquired by the corporation, as opposed to 
being determined at the end of the taxable year. The IRS and Treasury 
believe that this approach is more administrable because value should 
be more readily determinable on the acquisition date. In addition, this 
approach does not require tainted assets to be traced over time.

D. Special Rules for Accounting for Dual Consolidated Losses--Sec.  
1.1503(d)-3

1. Items Attributable to a Separate Unit
(a) Overview
    Section 1.1503-2(d)(1)(ii) of the current regulations provides a 
rule for determining whether a separate unit has a dual consolidated 
loss. Under this rule, the separate unit must compute its taxable 
income as if it were a separate domestic corporation that is a dual 
resident corporation, using only those items of income, expense, 
deduction, and loss that are otherwise attributable to such separate 
unit.
    The current regulations do not provide any guidance for determining 
the items of income, gain, deduction and loss that are otherwise 
attributable to a separate unit. The IRS and Treasury understand that 
the absence of such guidance has resulted in considerable uncertainty. 
For example, commentators have questioned whether all or any portion of 
the interest expense of a domestic owner is attributable to a separate 
unit.
    It is also unclear the extent to which a separate unit is treated 
as a separate domestic corporation under this rule. For example, 
commentators have questioned whether a transaction between a separate 
unit and its owner that is generally disregarded for federal tax 
purposes (for example, interest paid by a disregarded entity on an 
obligation held by its owner) can create an item of income, gain, 
deduction or loss for purposes of calculating a dual consolidated loss.
    Commentators have also questioned whether each separate unit in a 
tiered separate unit structure (that is, where one separate unit owns 
another separate unit) must separately determine whether it has a dual 
consolidated loss, or whether such separate units are combined for this 
purpose.
    The proposed regulations provide more definitive rules for 
determining the amount of a dual consolidated loss (or income) of a 
separate unit. These rules apply solely for purposes of section 1503(d) 
and, therefore, do not apply for other purposes of the Code (for 
example, section 987). The proposed regulations first provide general 
rules that apply for purposes of calculating dual consolidated losses 
(or income) for both foreign branch separate units and hybrid entity 
separate units. The proposed regulations provide additional rules for 
calculating the dual consolidated losses (or income) of foreign branch 
separate units, hybrid entity separate units, and separate units owned 
indirectly through other separate units, non-hybrid entity 
partnerships, or non-hybrid entity grantor trusts. Finally, the 
proposed regulations provide special rules that apply to tiered 
separate units, combined separate units, dispositions of separate 
units, and the treatment of certain income inclusions on stock.
(b) General Rules
    The proposed regulations clarify that only existing tax accounting 
items of income, gain, deduction and loss (translated into U.S. 
dollars) should be taken into account for purposes of calculating the 
dual consolidated loss of a separate unit. In other words, treating a 
separate unit as a separate domestic corporation does not cause items 
that are disregarded for U.S. tax purposes (for example, interest paid 
by a disregarded entity on an obligation held by its owner) to be 
regarded for purposes of calculating a separate unit's dual 
consolidated loss.
    The proposed regulations also clarify that in the case of tiered 
separate units, each separate unit must calculate its own dual 
consolidated loss and no item of income, gain, deduction and loss may 
be taken into account in determining the taxable income or loss of more 
than one separate unit. Similarly, the proposed regulations clarify 
that items of one separate unit cannot offset or otherwise be taken 
into account by another separate unit for purposes of calculating a 
dual consolidated loss (unless the separate unit combination rule 
applies). These rules ensure that the dual consolidated loss 
calculation is computed separately for each separate unit, which is 
necessary to prevent deductions and losses from being double-dipped.
(c) Foreign Branch Separate Unit
    The proposed regulations provide that the asset use and business 
activities principles of section 864(c) apply for purposes of 
determining the items of income, gain, deduction (other than interest) 
and loss that are taken into account in determining the taxable income 
or loss of a foreign branch separate unit. For this purpose, the 
trading safe harbors of section 864(b) do not apply for purposes of 
determining whether a trade or business exists within a foreign country 
or whether income may be treated as effectively connected to a foreign 
branch separate unit. In addition, the limitations on effectively 
connected treatment of foreign source related-party income under 
section 864(c)(4)(D) do not apply.
    The proposed regulations further provide that the principles of 
Sec.  1.882-5, as modified, apply for purposes of determining the items 
of interest expense that are taken into account in determining the 
taxable income or loss of a foreign branch separate unit. The rules 
provide that a taxpayer must use U.S. tax principles to determine both 
the classification and amounts of the assets and liabilities when the 
actual worldwide ratio is used. The valuation of assets must be 
determined under the same methodology the taxpayer uses under Sec.  
1.861-9T(g) for purposes of

[[Page 29876]]

allocating and apportioning interest expense under section 864(e). 
Further, and solely for these purposes, the domestic owner of the 
foreign branch separate unit is treated as a foreign corporation, the 
foreign branch separate unit is treated as a trade or business within 
the United States, and assets other than those of the foreign branch 
separate unit are treated as assets that are not U.S. assets. 
Accordingly, only the interest expense of the domestic owner of the 
foreign branch separate unit is subject to allocation for purposes of 
computing the dual consolidated loss. The IRS and Treasury believe that 
the application of these principles will better harmonize the borrowing 
rate and effective interest costs that both the United States and the 
foreign country take into account in determining the dual consolidated 
loss, as compared to the use of Sec.  1.861-9T.
    The IRS and Treasury believe that taking items into account in 
determining the taxable income or loss of a foreign branch separate 
unit under these standards is administrable because of the existing 
guidance provided under these provisions. In addition, the IRS and 
Treasury believe that this approach furthers the policy underlying 
section 1503(d) because it serves as a reasonable approximation of the 
items that the foreign jurisdiction may recognize as being taken into 
account in determining the taxable income or loss of a branch or 
permanent establishment of a non-resident corporation in such 
jurisdiction. Nevertheless, the IRS and Treasury solicit comments on 
these provisions and whether other administrable approaches (that 
approximate the items taken into account by the foreign jurisdiction) 
should be considered.
(d) Hybrid Entity
    The proposed regulations provide rules for attributing items of 
income, gain, deduction and loss to a hybrid entity. These rules are 
necessary to determine the items that are attributable to an interest 
in a hybrid entity that constitutes a separate unit.
    The proposed regulations provide that, in general, the items of 
income, gain, deduction and loss that are attributable to a hybrid 
entity are those items that are properly reflected on its books and 
records, as adjusted to conform to U.S. tax principles. The principles 
of Sec.  1.988-4(b)(2) apply for purposes of making this determination. 
These principles generally provide that the determination is a question 
of fact and must be consistently applied. These principles also provide 
that the Commissioner may allocate items of income, gain, deduction and 
loss between the domestic corporation (and intervening entities, if 
any) that own the hybrid entity separate unit, and the hybrid entity 
separate unit, if such items are not properly reflected on the books 
and records of the hybrid entity.
    The proposed regulations also provide that if a hybrid entity owns 
an interest in either a non-hybrid entity partnership or a non-hybrid 
entity grantor trust, items of income, gain, deduction and loss that 
are properly reflected on the books and records of such partnership or 
grantor trust (under the principles of Sec.  1.988-4(b)(2), as adjusted 
to conform to U.S. tax principles), are treated as being properly 
reflected on the books and records of the hybrid entity. However, such 
items are treated as being properly reflected on the books and records 
of the hybrid entity only to the extent they are taken into account by 
the hybrid entity under principles of subchapter K, chapter 1 of the 
Code, or the principles of subpart E, subchapter J, chapter 1 of the 
Code, as the case may be.
    The IRS and Treasury believe that attributing items to a hybrid 
entity under this standard is administrable because it is generally 
consistent with the accounting treatment of the items. The IRS and 
Treasury also believe that this standard furthers the policy underlying 
section 1503(d) because the items that are properly reflected on the 
books and records of the hybrid entity (as adjusted to conform to U.S. 
tax principles) represent the best approximation of items that the 
foreign jurisdiction would recognize as being attributable to the 
entity. For example, it is likely that a foreign jurisdiction would 
recognize and take into account as being attributable to a hybrid 
entity the interest expense properly reflected on the books and records 
of the hybrid entity; however, it is unlikely that a foreign 
jurisdiction would recognize, and take into account as being 
attributable to a hybrid entity, interest expense of a domestic 
corporation that owns an interest in the hybrid entity.
(e) Interest in a Disregarded Hybrid Entity
    The proposed regulations provide that, except to the extent 
otherwise provided under special rules (discussed below), items that 
are attributable to an interest in a hybrid entity that is disregarded 
as an entity separate from its owner are those items that are 
attributable to such hybrid entity itself.
(f) Interests in Hybrid Entity Partnerships, Interests in Hybrid Entity 
Grantor Trusts, and Separate Units Owned Indirectly Through 
Partnerships and Grantor Trusts
    The proposed regulations provide rules for determining the extent 
to which: (1) Items of income, gain, deduction and loss that are 
attributable to a hybrid entity that is a partnership are attributable 
to an interest in such hybrid entity partnership; and (2) items of 
income, gain, deduction and loss of a separate unit that is owned 
indirectly through a partnership are taken into account by a partner in 
such partnership. These items are taken into account to the extent they 
are includible in the partner's distributive share of the partnership 
income, gain, deduction or loss, as determined under the rules and 
principles of subchapter K, chapter 1 of the Code.
    The proposed regulations also provide rules for determining the 
extent to which: (1) Items of income, gain, deduction and loss 
attributable to a hybrid entity that is a grantor trust are 
attributable to an interest in such hybrid entity grantor trust; and 
(2) the items of income, gain, deduction and loss of a separate unit 
owned indirectly through a grantor trust are taken into account by an 
owner of such grantor trust. These items are taken into account to the 
extent they are attributable to trust property that the holder of the 
trust interest is treated as owning under the rules and principles of 
subpart E, subchapter J, chapter 1 of the Code.
(g) Allocation of Items Between Certain Indirectly Owned Separate Units
    The proposed regulations provide special rules for allocating items 
of income, gain, deduction and loss to foreign branch separate units 
that are owned, directly or indirectly (other than through a hybrid 
entity separate unit) by hybrid entities. In such a case, only items 
that are attributable to the hybrid entity that owns such separate unit 
(and intervening entities, if any, that are not themselves separate 
units) are taken into account.
    This rule is intended to minimize the items taken into account by a 
foreign branch separate unit that the foreign jurisdiction would not 
recognize as being so taken into account. This may occur in these cases 
because the foreign jurisdiction taxes the hybrid entity as a 
corporation (or otherwise at the entity level) and therefore likely 
would not take into account items of its owner. For example, if a 
domestic corporation indirectly owns a Country X foreign branch 
separate unit through a Country

[[Page 29877]]

Y hybrid entity, Country X likely would take into account items of the 
Country Y hybrid entity as being items of the Country X branch. It is 
unlikely, however, that Country X would take into account items of the 
domestic corporation as items of the Country X branch because Country X 
views the owner of the Country X branch (the Country Y hybrid entity) 
as a corporation. Therefore, only the items of income, gain, deduction 
and loss of the Country Y hybrid entity (and not items of the domestic 
corporation) should be taken into account for purposes of determining 
the dual consolidated loss of the Country X branch.
    The proposed regulations also provide that only income and assets 
of such hybrid entity are taken into account for purposes of applying 
the principles of section 864(c) and Sec.  1.882-5, as modified, in 
determining the items taken into account by the foreign branch separate 
unit; thus, other income and assets of the domestic owner, for example, 
are not taken into account for these purposes. This rule is also 
intended to ensure that the principles under these provisions are 
applied in a way that best approximates the items that the foreign 
jurisdiction would recognize as being taken into account by a taxable 
presence in such jurisdiction.
    Finally, the proposed regulations provide that items generally 
attributable to an interest in a hybrid entity are not taken into 
account to the extent they are taken into account by a foreign branch 
separate unit owned, directly or indirectly (other than through a 
hybrid entity separate unit), by the hybrid entity. This rule prevents 
two or more separate units from taking into account the same item of 
income, gain, deduction or loss under different rules.
(h) Combined Separate Units
    As discussed above, the proposed regulations combine separate units 
owned, directly or indirectly, by a single domestic corporation, 
provided certain requirements are satisfied. Because different rules 
may apply for purposes of attributing items to individual separate 
units that may be combined into a single separate unit, special rules 
are necessary to attribute items to combined separate units.
    The proposed regulations provide that in the case of a combined 
separate unit, items are first attributable to, or otherwise taken into 
account by, the individual separate units composing the combined 
separate unit, without regard to the combination rule. The combined 
separate unit then takes into account all of the items attributable to, 
or taken into account by, the individual separate units that compose 
such combined separate unit.
(i) Gain or Loss Recognized on Dispositions of Separate Units
    The current regulations do not indicate whether items of income, 
gain, deduction and loss recognized on the sale or disposition of a 
separate unit, or of an interest in a partnership or grantor trust 
through which a separate unit is indirectly owned, is attributable to 
or taken into account by such separate unit for purposes of calculating 
the dual consolidated loss of the separate unit for the year of the 
sale (or for purposes of reducing the amount of recapture as a result 
of a triggering event).
    The IRS and Treasury believe that it is appropriate to take into 
account items of income, gain, deduction and loss recognized on these 
dispositions. Thus, the proposed regulations provide that items of 
income, gain, deduction and loss recognized on the disposition of a 
separate unit (or an interest in a partnership or grantor trust that 
directly or indirectly owns a separate unit), are attributable to or 
taken into account by the separate unit to the extent of the gain or 
loss that would have been recognized had such separate unit sold all 
its assets in a taxable exchange, immediately before the disposition of 
the separate unit, for an amount equal to their fair market value. The 
proposed regulations clarify that for this purpose items of income and 
gain include loss recapture income or gain under section 367(a)(3)(C) 
or 904(f)(3).
    The proposed regulations also address situations where more than 
one separate unit is disposed of in the same transaction and items of 
income, gain, deduction and loss recognized on such disposition are 
attributable to more than one separate unit. In such a case, items of 
income, gain, deduction and loss are attributable to or taken into 
account by each such separate unit based on the gain or loss that would 
have been recognized by each separate unit if it had sold all of its 
assets in a taxable exchange, immediately before the disposition of the 
separate unit, for an amount equal to their fair market value.
(j) Income Inclusion on Stock
    The current regulations do not indicate whether an amount included 
in income arising from the ownership of stock in a foreign corporation 
(income inclusion) is attributable to or taken into account by a 
separate unit that owns the stock that gave rise to the income 
inclusion. For example, if a domestic corporation has a section 951(a) 
inclusion attributable to stock of a controlled foreign corporation 
that is owned by a hybrid entity separate unit, it is not clear under 
the current regulations whether such income inclusion is taken into 
account for purposes of calculating the dual consolidated loss of the 
hybrid entity separate unit.
    The IRS and Treasury believe that, solely for purposes of applying 
the dual consolidated loss rules, it is appropriate to treat income 
inclusions arising from the ownership of stock in the same manner that 
dividend income is treated. Accordingly, the proposed regulations 
provide that income inclusions are taken into account for purposes of 
calculating the dual consolidated loss of a separate unit if an actual 
dividend from such foreign corporation would have been so taken into 
account.
(k) Section 987 Gain or Loss
    Section 987 provides that if a taxpayer has one or more qualified 
business units with a functional currency other than the dollar, the 
taxpayer must make proper adjustments to take into account foreign 
currency gain or loss on certain transfers of property between such 
qualified business units.
    In 1991, the IRS and Treasury issued proposed regulations under 
section 987 that included rules for determining the amount of foreign 
currency gain or loss recognized on certain transfers of property 
between qualified business units. On April 3, 2000, the IRS and 
Treasury issued Notice 2000-20 (2000-14 I.R.B. 851) announcing that the 
IRS and Treasury intend to review and possibly replace the proposed 
regulations issued under section 987. The IRS and Treasury have opened 
a regulations project under section 987 and expect to issue new section 
987 regulations in the future.
    The current regulations do not provide specific rules that indicate 
whether section 987 gains or losses of a domestic owner are 
attributable to, or taken into account by, a separate unit for purposes 
of calculating the separate unit's dual consolidated loss. Because the 
IRS and Treasury have an open regulations project under section 987 and 
expect to issue new regulations under section 987, the IRS and Treasury 
do not believe it is appropriate to address this issue in the proposed 
regulations. The IRS and Treasury request comments on whether section 
987 gains and losses of a domestic owner should be attributable to, or 
taken into account by, a separate unit, particularly with respect to 
section 987 gains and losses attributable to, or taken into account by, 
separate units owned indirectly through hybrid entity separate units.

[[Page 29878]]

2. Effect of a Dual Consolidated Loss
    Section 1.1503-2(d)(2) of the current regulations provides that if 
a dual resident corporation has a dual consolidated loss that is 
subject to the general rule restricting it from offsetting the income 
of a domestic affiliate, the consolidated group of which the dual 
resident corporation is a member must compute its taxable income 
without taking into account the items of income, gain, deduction or 
loss taken into account in computing the dual consolidated loss. The 
current regulations contain a similar rule for separate units.
    These rules do not exclude only the dual consolidated loss in 
computing taxable income, but instead provide that none of the gross 
tax accounting items that compose the dual consolidated loss are taken 
into account. While this approach has the same effect on net income as 
would excluding only the dual consolidated loss, removing all gross 
items of income, gain, deduction and loss may have a distortive effect 
on other federal tax calculations.
    The IRS and Treasury believe that this distortive effect will be 
minimized if only the dual consolidated loss itself is not taken into 
account. Accordingly, the proposed regulations provide that only a pro 
rata portion of each item of deduction and loss taken into account in 
computing the dual consolidated loss are excluded in computing taxable 
income. In addition, to the extent that a dual consolidated loss is 
carried over or carried back and, subject to Sec.  1.1502-21(c) (as 
modified in the proposed regulations), is made available to offset 
income generated by the dual resident corporation or separate unit, the 
proposed regulations treat items composing the dual consolidated loss 
as being used on a pro rata basis.
3. Basis Adjustments
    Section 1.1503-2(d)(3) of the current regulations contains special 
basis adjustment rules that override the normal investment adjustment 
rules under Sec.  1.1502-32 for stock of affiliated dual resident 
corporations or affiliated domestic owners owned by other members of 
the consolidated group. These rules provide that stock basis is reduced 
by a dual consolidated loss, even though such loss is subject to the 
general limitation on the use of a dual consolidated loss to offset 
income of a domestic affiliate. To avoid reducing the stock basis a 
second time for the same dual consolidated loss, the rules also provide 
that no negative adjustment shall be made for the amount of dual 
consolidated loss subject to the general limitation that is 
subsequently absorbed in a carryover or carryback year. Finally, the 
rules provide that there is no basis increase for recapture income 
recognized as a result of a triggering event. Similar rules apply to 
separate units arising from ownership of an interest in a partnership. 
These special basis adjustment rules are generally intended to prevent 
an indirect deduction of a dual consolidated loss.
    The proposed regulations retain the special stock basis adjustment 
rules, as modified, to prevent the indirect use of a dual consolidated 
loss. In addition, the proposed regulations retain the rules addressing 
the effect of a dual consolidated loss on a partner's adjusted basis in 
its partnership interest in cases where the partnership interest is a 
separate unit, or a separate unit is owned indirectly through a 
partnership. These rules require the partner to adjust its basis in 
accordance with the principles of section 705, subject to certain 
modifications.
    The IRS and Treasury recognize that these rules may lead to harsh 
results, particularly in light of the fact that the indirect use of the 
dual consolidated loss would only arise through the disposition of the 
stock of a dual resident corporation (or a partnership interest) that 
may not occur for many years after the dual consolidated loss is 
incurred. In addition, upon such subsequent disposition the resulting 
deduction or loss would generally be capital in nature, and the 
definition of a dual consolidated loss excludes capital losses incurred 
by the dual resident corporation or separate unit. As a result, the IRS 
and Treasury request comments regarding concerns over these types of 
indirect uses and whether the special basis rules should be retained. 
These comments should consider whether the policies underlying section 
1503(d) require basis adjustment rules that differ from other basis 
adjustment rules that apply to non-capital, non-deductible expenses 
(for example, rules under sections 705 and 1367, and Sec.  1.1502-
32(b))

E. Exceptions to the Domestic Use Limitation Rule--Sec.  1.1503(d)-4

1. No Possibility of Foreign Use
    The proposed regulations provide a new exception to the general 
rule prohibiting the domestic use of a dual consolidated loss. To 
qualify under this exception, the consolidated group, unaffiliated dual 
resident corporation, or unaffiliated domestic owner must: (1) 
Demonstrate, to the satisfaction of the Commissioner, that there can be 
no foreign use of the dual consolidated loss at any time; and (2) 
prepare a statement and attach it to its tax return for the taxable 
year in which the dual consolidated loss is incurred. This statement 
must include an analysis, in reasonable detail and specificity, 
supported with an official or certified English translation of the 
relevant provisions of foreign law, of the treatment of the losses and 
deductions composing the dual consolidated loss, and the reasons 
supporting the conclusion that there cannot be a foreign use of the 
dual consolidated loss by any means at any time.
    This exception is intended to replace the exception to the 
definition of a dual consolidated loss contained in Sec.  1.1503-
2(c)(5)(ii)(A) of the current regulations. Thus, under the proposed 
regulations the question of foreign use is not relevant to the 
definition of a dual consolidated loss; the issue will instead be 
whether an exception to the domestic use limitation applies. Consistent 
with the exception to the definition of a dual consolidated loss 
contained in the current regulations, the IRS and Treasury believe that 
this new exception to the domestic use limitation rule contained in the 
proposed regulations will apply only in rare and unusual circumstances 
due to the definition of foreign use and general principles of foreign 
law. For example, if the foreign jurisdiction recognizes any item of 
deduction or loss composing the dual consolidated loss (regardless of 
whether recognized currently or deferred, for example, by being 
reflected in the basis of assets), and such item is available for 
foreign use through a form of consolidation, carryover or carryback, or 
a transaction (for example, a merger, basis carryover transaction, or 
entity classification election), then the exception will not apply.
2. Domestic Use Election and Agreement
    As discussed above, the current regulations provide an exception to 
the general rule prohibiting the use of a dual consolidated loss to 
offset the income of a domestic affiliate if a (g)(2)(i) election is 
made. Under this exception, the consolidated group, unaffiliated dual 
resident corporation, or unaffiliated domestic owner must enter into an 
agreement ((g)(2)(i) agreement) certifying, among other things, that no 
portion of the deductions or losses taken into account in computing the 
dual consolidated loss have been, or will be, used to offset the income 
of any other person under the income tax laws of a foreign country.
    The proposed regulations retain this elective exception, with 
modifications,

[[Page 29879]]

and refer to it as a domestic use election. In addition, the proposed 
regulations refer to the consolidated group, unaffiliated dual resident 
corporation, or unaffiliated domestic owner, as the case may be, that 
makes a domestic use election as an elector. In order to elect relief 
under this exception, the proposed regulations require the elector to 
enter into a domestic use agreement, which is similar to the (g)(2)(i) 
agreement required by the current regulations.
3. Certification Period
    Under the current regulations, a (g)(2)(i) agreement generally 
provides that if there is a triggering event during the 15-year period 
following the year in which the dual consolidated loss was incurred 
(certification period), the taxpayer must recapture and report as 
income the amount of the dual consolidated loss, and pay an interest 
charge. See Sec.  1.1503-2(g)(2)(iii)(A).
    Commentators have questioned whether under the current regulations 
the 15-year certification period applies only to the use triggering 
event, or whether it applies to all triggering events. These 
commentators note that, under this interpretation, triggering events 
other than use could occur after the expiration of the certification 
period. The IRS and Treasury believe that the certification period 
applies to all triggering events. Accordingly, the proposed regulations 
clarify that all triggering events are subject to the certification 
period and, therefore, a triggering event cannot occur after the 
expiration of the certification period.
    The IRS and Treasury also believe that a 15-year certification 
period is not required to deter and monitor double-dipping of losses 
and deductions. Moreover, the IRS and Treasury believe that requiring 
taxpayers to comply with the dual consolidated loss regulations, 
including the need to monitor potential triggering events and to comply 
with the various filing requirements, for a 15-year period is 
unnecessarily burdensome to both taxpayers and the Commissioner. As a 
result, the proposed regulations reduce the certification period from 
15 years to seven years with respect to a domestic use election.
4. Consistency Rule
    Section 1.1503-2(g)(2)(ii) of the current regulations contains a 
consistency rule. Under this rule, if any losses, expenses, or 
deductions taken into account in computing the dual consolidated loss 
of a dual resident corporation or separate unit are used to offset the 
income of another person under the laws of a single foreign country 
while the dual resident corporation or separate unit is owned by the 
domestic owner or member of the consolidated group, the losses, 
expenses, or deductions taken into account in computing the dual 
consolidated losses of other dual resident corporations or separate 
units owned by the same consolidated group (or other separate units 
owned by the unaffiliated domestic owner of the first separate unit) in 
that year are deemed to offset income of another person in the same 
foreign country. This rule only applies, however, if such losses, 
expenses, or deductions are recognized in the foreign country in the 
same taxable year. Moreover, this rule does not apply if, under foreign 
law, the other dual resident corporation or separate unit cannot use 
its losses, expenses, or deductions to offset income of another person 
in such taxable year.
    The consistency rule is intended to ensure that a consolidated 
group or domestic owner treats uniformly all dual consolidated losses 
of dual resident corporations or separate units that it owns that are 
available for use in a foreign country in a given year. The rule is 
also intended to minimize the administrative burden associated with 
identifying the items of loss or deduction of a particular dual 
consolidated loss that are used to offset income of another person 
under the income tax laws of a foreign country.
    Commentators have questioned the need for the consistency rule, 
noting that it can lead to harsh results.
    The IRS and Treasury believe that, despite concerns raised by 
commentators, the consistency rule continues to be necessary to promote 
the uniform treatment of dual consolidated losses of dual resident 
corporations and separate units owned by the consolidated group or 
domestic owner, and to minimize administrative burdens. As a result, 
the proposed regulations retain the consistency rule, as modified.
    In addition, the proposed regulations clarify that the consistency 
rule only applies to a dual consolidated loss that is subject to a 
domestic use agreement (other than a new domestic use agreement). In 
other words, the proposed regulations clarify that the consistency rule 
does not apply to a foreign use of a dual consolidated loss that occurs 
subsequent to a triggering event that terminates the domestic use 
agreement filed with respect to such dual consolidated loss.
5. Restrictions on Domestic Use Elections
    The current regulations do not explicitly address situations where 
a triggering event (discussed below) with respect to a dual 
consolidated loss occurs in the year in which the dual consolidated 
loss is incurred. The proposed regulations, however, make clear that a 
domestic use election cannot be made for a dual consolidated loss 
incurred in the same year in which a triggering event with respect to 
such loss occurs.
    The current regulations also do not explicitly address the 
application of section 953(d)(3) (limiting losses of foreign insurance 
companies that elect to be treated as domestic corporations). The 
proposed regulations, however, provide that a foreign insurance company 
that has elected to be treated as a domestic corporation pursuant to 
section 953(d) may not make a domestic use election. This rule is 
consistent with section 953(d)(3), which broadly prohibits regulatory 
exceptions to the general prohibition on the domestic use of dual 
consolidated losses in such cases.
6. Triggering Events
(a) In General
    Section 1.1503-2(g)(2)(iii) of the current regulations provides 
rules relating to certain events which require the recapture of 
previously allowed dual consolidated losses. Under these rules, if a 
consolidated group, unaffiliated dual resident corporation, or 
unaffiliated domestic owner, as the case may be, makes a (g)(2)(i) 
election, the dual resident corporation or separate unit must 
recapture, and the consolidated group, unaffiliated dual resident 
corporation or unaffiliated domestic owner must report as income the 
amount of the dual consolidated loss (and pay an interest charge) if a 
triggering event occurs during the certification period. Taxpayers may, 
however, rebut these triggering events upon making certain showings to 
the satisfaction of the Commissioner.
    The proposed regulations generally retain the triggering event 
rules contained in the proposed regulations, as modified, if a taxpayer 
makes a domestic use election.
(b) Carryover of Losses, Deductions, and Basis
    Under the current regulations, certain asset transfers by a dual 
resident corporation that result, under the laws of a foreign country, 
in a carryover of losses, expenses, or deductions are triggering 
events. The current

[[Page 29880]]

regulations contain a similar rule for such transfers by separate 
units. See Sec.  1.1503-2(g)(2)(iii)(A)(4) and (5).
    The proposed regulations retain these triggering events, as 
modified, and combine them into a single triggering event. The proposed 
regulations also clarify that certain asset transfers that result in 
the carryover of basis in assets under the laws of a foreign country 
also qualify as triggering events. This is the case because asset basis 
generally will, at some point in the future, be converted into a loss 
or deduction as a result of the depreciation, amortization or 
disposition of the asset. Accordingly, under foreign law, a transaction 
that results in the carryover of asset basis generally has the same 
effect as a transaction that results in the carryover of losses or 
deductions and therefore should be treated similarly.
(c) Disposition by a Separate Unit or Dual Resident Corporation of an 
Interest in a Separate Unit or Stock of a Dual Resident Corporation
    The current regulations provide that certain sales or other 
dispositions of 50 percent or more of the assets of a separate unit or 
dual resident corporation are deemed to be triggering events. See Sec.  
1.1503-2(g)(2)(iii)(A)(4) and (5). For this purpose, an interest in a 
separate unit and stock of a dual resident corporation are treated as 
assets of the separate unit or dual resident corporation. One 
commentator stated that, as a result of this rule, the disposition of 
an interest in one separate unit by another separate unit may 
inappropriately result in a triggering event for both separate units. 
Accordingly, the commentator suggested that the disposition of the 
interest in the lower-tier separate unit should not result in a 
triggering event with respect to dual consolidated losses of the 
separate unit that disposed of such interest.
    The IRS and Treasury believe that the disposition of an interest in 
a lower-tier separate unit (or the shares of a dual resident 
corporation) by an upper-tier separate unit (or dual resident 
corporation) typically will not result in the carryover of the dual 
consolidated loss of the upper-tier separate unit (or dual resident 
corporation) under the laws of the foreign jurisdiction such that it 
could be put to a foreign use. Therefore, the proposed regulations 
provide that for purposes of determining whether 50 percent or more of 
the separate unit's or dual resident corporation's assets is disposed 
of, an interest in a separate unit and the stock of a dual resident 
corporation shall not be treated as assets of the separate unit or dual 
resident corporation making such disposition. The IRS and Treasury 
request comments as to other assets the disposition of which should be 
excluded from the 50 percent test under this triggering event.
(d) Fifty Percent Threshold for Asset Transfer Triggering Events
    Section 1.1503-2(g)(2)(iii)(A)(7) of the current regulations 
provides that a triggering event occurs if, within a 12-month period, 
the domestic owner of a separate unit disposes of 50 percent or more 
(by voting power or value) of the interest in the separate unit that 
was owned by the domestic owner on the last day of the taxable year in 
which the dual consolidated loss was incurred. As noted above, the 
current regulations also provide that a triggering event occurs if a 
domestic owner of a separate unit transfers assets of the separate unit 
in a transaction that results, under the laws of a foreign country, in 
a carryover of the separate unit's losses, expenses, or deductions. 
Section 1.1503-2(g)(2)(iii)(A)(5). Moreover, the current regulations 
deem such an asset transfer to be a triggering event if 50 percent or 
more of the separate unit's assets (measured by fair market value at 
the time of transfer) are disposed of within a 12-month period.
    One commentator noted that the two triggering events discussed 
above operate differently in that any transfer of assets of a separate 
unit may constitute a triggering event, while the transfer of an 
interest in a separate unit constitutes a triggering event only if a 50 
percent threshold is met.
    The IRS and Treasury believe that these two triggering events 
should operate in a consistent manner. As a result, the proposed 
regulations provide that both the asset transfer triggering event and 
the separate unit interest transfer triggering event occur only if a 50 
percent threshold is satisfied. It should be noted, however, that 
transfers of assets of a dual resident corporation or separate unit, 
and transfers of interests of separate units, in many cases will 
subsequently result in a foreign use triggering event, even though the 
50 percent threshold for the asset transfer triggering event and the 
separate unit interest transfer triggering event are not satisfied. For 
example, if a domestic owner of an interest in a hybrid entity separate 
unit transfers 25 percent of its interest in the hybrid entity separate 
unit to a foreign corporation, all or a portion of a dual consolidated 
loss attributable to such separate unit in a prior year may be 
available to offset subsequent income of the owner of the transferred 
interest (that is not a separate unit after such transfer because it is 
held by a foreign corporation) and therefore may result in a foreign 
use triggering event.
(e) S Corporation Conversion
    Under the current regulations, if either an affiliated dual 
resident corporation or an affiliated domestic owner that has filed a 
(g)(2)(i) agreement with respect to a dual consolidated loss elects to 
be an S corporation pursuant to section 1362(a), such election results 
in a triggering event because it terminates the consolidated group and 
the affiliated dual resident corporation or affiliated domestic owner 
ceases to be a member of a consolidated group. See Sec.  1.1503-
2(g)(2)(iii)(A)(2). The current regulations do not, however, address an 
election to be an S corporation by either an unaffiliated dual resident 
corporation or an unaffiliated domestic owner that has made a (g)(2)(i) 
election.
    The IRS and Treasury believe that the election by an unaffiliated 
dual resident corporation or unaffiliated domestic owner to be an S 
corporation should be treated in the same manner as an election by an 
affiliated dual resident corporation or affiliated domestic owner that 
is a member of a consolidated group. Accordingly, the proposed 
regulations add as a new triggering event the election of either an 
unaffiliated dual resident corporation or unaffiliated domestic owner 
to be an S corporation.
(f) Consolidated Group Remains in Existence
    As stated above, and subject to exceptions, the current regulations 
provide that a triggering event occurs with respect to a dual 
consolidated loss of an affiliated dual resident corporation or 
affiliated domestic owner if such dual resident corporation or 
affiliated domestic owner ceases to be a member of the consolidated 
group of which it was a member when the dual consolidated loss was 
incurred. The current regulations also provide that an affiliated dual 
resident corporation or affiliated domestic owner is considered to 
cease to be a member of a consolidated group if the consolidated group 
ceases to exist (group termination triggering event) because, for 
example, the common parent is no longer in existence. Section 1.1503-
2(g)(2)(iii)(A)(2).
    One commentator stated that language contained in Revenue Procedure 
2000-42 (2000-2 C.B. 394) may imply that there is a group termination 
triggering event if the common parent of a consolidated group that made 
a (g)(2)(i) election ceases to exist, or is a party to

[[Page 29881]]

a reverse acquisition, even though the consolidated group remains in 
existence. This interpretation is contrary to the principles underlying 
the triggering events. Accordingly, the proposed regulations clarify 
that such transactions do not constitute group termination triggering 
events. See Sec.  1.1503(d)-5(c) Example 47.
7. Rebuttal of Triggering Events
    Under the current regulations, taxpayers may rebut all but two of 
the triggering events such that there is no dual consolidated loss 
recapture (or related interest charge) as a result of a putative 
triggering event. In general, under the current regulations, a 
triggering event is rebutted if the taxpayer demonstrates to the 
satisfaction of the Commissioner that, depending on the triggering 
event, either: (1) The losses, expenses or deductions of the dual 
resident corporation (or separate unit) cannot be used to offset income 
of another person under the laws of a foreign country or; (2) the 
transfer of assets did not result in a carryover under foreign law of 
the losses, expenses, or deductions of the dual resident corporation 
(or separate unit) to the transferee of the assets. See Sec.  1.1503-
2(g)(2)(iii)(A)(2) through (7). The policies underpinning the dual 
consolidated loss rules do not require recapture or an interest charge 
in such cases because there is no opportunity for any portion of the 
dual consolidated loss to be used to offset income of any other person 
under the income tax laws of a foreign country.
    The rebuttal rules impose a standard of proof on taxpayers that in 
many cases is difficult and burdensome to meet, even though there may 
be little likelihood that any portion of the dual consolidated loss 
could be used to offset the income of any other person under the income 
tax laws of a foreign country. For example, demonstrating that no 
portion of the dual consolidated loss can be used by another person as 
a result of typical loss carryover transactions under foreign law may 
not satisfy the burden if there is some potential that any portion of 
losses or deductions composing the dual consolidated loss could be so 
used as a result of a transaction that is rare, commercially 
impractical, or not reasonably foreseeable. In addition, because there 
are often significant differences between U.S. and foreign law, ruling 
out the various types of transactions that under U.S. law would allow 
all or a portion of the dual consolidated loss to be used by another 
person also may not be sufficient to rebut a triggering event.
    Commentators have noted that under the current regulations it may 
not be possible to rebut certain triggering events if the tax basis of 
a single asset carries over to another person under foreign law, even 
though as a result of the transaction recognized losses and accrued 
deductions generally do not carry over to another person under foreign 
law. This is the case because the person that receives the carryover 
asset basis may at some point in the future enjoy the benefit of a loss 
or deduction as a result of the depreciation, amortization or 
disposition of the asset. As a result, the carryover of a nominal 
amount of asset tax basis causes the entire dual consolidated loss to 
be recaptured. Similar issues arise in connection with assumptions of 
liabilities that, for example, result in deductions for U.S. tax 
purposes on an accrual basis, but are deductible under the laws of the 
foreign jurisdiction at a later time when paid. This result is 
consistent with the all or nothing principle, discussed below.
    The IRS and Treasury recognize that in some of these cases the use 
of a portion of a dual consolidated loss may be denied in both the 
United States and the foreign jurisdiction. Further, commentators have 
stated that denying a loss or deduction from offsetting income in both 
the United States and the foreign jurisdiction generally is 
inconsistent with the principles underlying section 1503(d) because the 
statute's purpose is to prevent the use of the same loss or deduction 
to offset income in multiple jurisdictions.
    The proposed regulations retain the rebuttal standard contained in 
the current regulations, with modifications. Taxpayers may rebut a 
triggering event under the proposed regulations if it can be 
demonstrated, to the satisfaction of the Commissioner, that there can 
be no foreign use of the dual consolidated loss. In addition, unlike 
the current regulations that have different standards for different 
triggering events, the proposed regulations apply the same standard to 
all triggering events (other than a foreign use triggering event, which 
cannot be rebutted).
    The IRS and Treasury believe that when the proposed regulations are 
finalized the number of transactions undertaken by taxpayers that 
result in triggering events will be significantly reduced, as compared 
to the current regulations, because of the significant reduction in the 
term of the certification period. Nevertheless, the IRS and Treasury 
believe that the current rebuttal standard may exceed that required to 
address adequately the concern that all or a portion of a dual 
consolidated loss could be put to a foreign use. Moreover, the IRS and 
Treasury believe that more definitive and administrable rebuttal rules 
should be provided to assist taxpayers and the Commissioner in 
determining whether the triggering event has been rebutted, and to 
minimize situations where there is recapture of a dual consolidated 
loss even though it may be unlikely that a significant portion of the 
dual consolidated loss could be put to a foreign use. Therefore, it is 
anticipated that, prior to the finalization of these proposed 
regulations, a revenue procedure will be issued that will provide safe 
harbors whereby triggering events will be deemed to be rebutted if the 
taxpayer satisfies various conditions. The revenue procedure may be 
issued in proposed form and then made final contemporaneously with 
these regulations.
    It is anticipated that the conditions contained in the revenue 
procedure would include the requirement that taxpayers demonstrate, to 
the satisfaction of the Commissioner, that there can be no foreign use 
of any significant portion of the dual consolidated loss as a result of 
certain enumerated transactions. It is also anticipated that the 
revenue procedure will address, and in some cases provide relief for, 
transactions that result in a de minimis carry over of asset basis 
under foreign law and are difficult or impossible to rebut under the 
current regulations. Finally, the revenue procedure may provide relief 
for triggering events resulting from the assumption of liabilities in 
connection with the acquisition of a trade or business as a result of 
liabilities incurred in the ordinary course of business being 
deductible at different times under U.S. law and the law of the foreign 
jurisdiction.
    The IRS and Treasury request comments regarding the transactions 
that should be included in the revenue procedure, approaches to address 
basis carryover transactions and liabilities assumed in the ordinary 
course of business, and other ways to minimize the administrative 
burden associated with rebutting the triggering events, while ensuring 
that there is little or no likelihood that a significant portion of the 
dual consolidated loss can be put to a foreign use.
8. Triggering Event Exception for Acquisition by an Unaffiliated 
Domestic Corporation or a New Consolidated Group
    Section 1.1503-2(g)(2)(iv)(B)(1) of the current regulations 
provides that if certain requirements are satisfied, the

[[Page 29882]]

following events do not constitute triggering events: (1) An affiliated 
dual resident corporation or affiliated domestic owner becomes an 
unaffiliated domestic corporation or a member of a new consolidated 
group (unless such transaction also qualifies under another exception); 
(2) assets of a dual resident corporation or a separate unit are 
acquired by an unaffiliated domestic corporation or a member of a new 
consolidated group; or (3) a domestic owner of a separate unit 
transfers its interest in the separate unit to an unaffiliated domestic 
corporation or to a member of a new consolidated group.
    The first requirement necessary for this exception to apply is that 
the consolidated group, unaffiliated dual resident corporation, or 
unaffiliated domestic owner that made the (g)(2)(i) election, and the 
unaffiliated domestic corporation or new consolidated group must enter 
into a closing agreement with the IRS providing that both parties will 
be jointly and severally liable for the total amount of the recapture 
of the dual consolidated loss and interest charge upon a subsequent 
triggering event. Second, the unaffiliated domestic corporation or new 
consolidated group must agree to treat any potential recapture as 
unrealized built-in gain for purposes of section 384, subject to any 
applicable exceptions thereunder. Finally, the unaffiliated domestic 
corporation or new consolidated group must file with its timely filed 
income tax return for the year in which the event occurs a (g)(2)(i) 
agreement (new (g)(2)(i) agreement), whereby it assumes the same 
obligations with respect to the dual consolidated loss as the 
corporation or consolidated group that filed the original (g)(2)(i) 
agreement with respect to that loss.
    On July 30, 2003, the IRS and Treasury issued final regulations 
(2003 regulations), published in the Federal Register at 68 FR 44616, 
that limited the need for closing agreements to avoid triggering events 
to only those three transactions described above. The preamble to the 
2003 regulations explained that in certain cases the requirement for a 
closing agreement resulted in an unnecessary administrative burden 
because the several liability imposed by Sec.  1.1502-6, in conjunction 
with the original (g)(2)(i) agreement and a new (g)(2)(i) agreement, 
provided for liability sufficiently comparable to that imposed under a 
closing agreement. Accordingly, the 2003 regulations provided that if a 
new (g)(2)(i) agreement is filed by the unaffiliated domestic 
corporation or new consolidated group, a closing agreement is not 
required in the following two instances: (1) An unaffiliated dual 
resident corporation or unaffiliated domestic owner that filed a 
(g)(2)(i) agreement becomes a member of a consolidated group; and (2) a 
consolidated group that filed a (g)(2)(i) agreement ceases to exist as 
a result of a transaction described in Sec.  1.1502-13(j)(5)(i) (unless 
a member of the terminating group, or successor-in-interest of such 
member, is not a member of the surviving group immediately after the 
terminating group ceases to exist).
    The preamble to the 2003 regulations noted that the IRS and 
Treasury were continuing to consider other alternatives to further 
reduce the administrative and compliance burdens under section 1503(d). 
After further consideration, the IRS and Treasury believe that, as a 
result of various requirements contained in the proposed regulations, 
there are sufficient protections, independent of a closing agreement, 
in all cases in which a closing agreement is otherwise required under 
the current regulations. As a result, the proposed regulations 
eliminate the closing agreement requirement contained in the current 
regulations and provide an exception to triggering events in all such 
cases (subsequent elector events) if: (1) The unaffiliated domestic 
corporation or new consolidated group (subsequent elector) enters into 
a domestic use agreement (new domestic use agreement); and (2) the 
corporation or consolidated group that filed the original domestic use 
agreement (original elector) files a statement with its tax return for 
the year of the event.
    Pursuant to the new domestic use agreement, the subsequent elector 
must: (1) Agree to assume the same obligations with respect to the dual 
consolidated loss as the original elector had pursuant to its domestic 
use agreement; (2) agree to treat any potential recapture of the dual 
consolidated loss at issue as unrealized built-in gain pursuant to 
section 384, subject to any applicable exceptions thereunder; (3) agree 
to be subject to the successor elector rules, discussed below; and (4) 
identify the original elector (and subsequent electors, if any). 
Pursuant to the statement filed by the original elector, the original 
elector must agree to be subject to the subsequent elector rules and 
must identify the subsequent elector.
9. Triggering Event Exception--Private Letter Ruling and Closing 
Agreement Option
    Under the current regulations, only specific triggering events can 
qualify for an exception as a result of the parties entering into a 
closing agreement. Therefore, the IRS will not consider entering into a 
closing agreement in other circumstances, even though the government's 
interests may be adequately protected in such circumstances such that 
recapture may not be necessary.
    Although the proposed regulations eliminate the need for a closing 
agreement to qualify for an exception to triggering events, discussed 
above, the IRS and Treasury are considering whether in limited cases it 
may be appropriate for the Commissioner, in its sole discretion and 
subject to the taxpayer satisfying conditions specified by the 
Commissioner, to enter into closing agreements with taxpayers such that 
certain other events would not be triggering events. Comments are 
requested as to the specific and limited types of triggering events 
that may be suitable for this exception, taking into account the 
policies underlying section 1503(d), administrative burdens, and the 
general interests of the U.S. government.
10. Annual Certification Reporting Requirement
    Section 1.1503-2T(g)(2)(vi)(B) of the current regulations provides 
that if a (g)(2)(i) election is made with respect to a dual 
consolidated loss of a dual resident corporation or a hybrid entity 
separate unit, the consolidated group, unaffiliated dual resident 
corporation, or unaffiliated domestic owner, as the case may be, must 
file with its tax return an annual certification during the 
certification period. This filing certifies that the losses or 
deductions that make up the dual consolidated loss have not been used 
to offset the income of another person under the tax laws of a foreign 
country. The filing also warrants that arrangements have been made to 
ensure that there will be no such use of the dual consolidated loss and 
that the taxpayer will be informed if any such use were to occur. The 
current regulations do not, however, require annual certifications for 
dual consolidated losses of foreign branch separate units.
    The IRS and Treasury believe that annual certifications of dual 
consolidated losses improve taxpayer compliance with the dual 
consolidated loss rules and are beneficial to the Commissioner in 
monitoring such compliance. The IRS and Treasury also believe that 
foreign branch separate units, hybrid entity separate units, and dual 
resident corporations should, to the extent possible, be treated 
consistently to reduce complexity. As a result, the proposed 
regulations expand

[[Page 29883]]

the annual certification requirement to include dual consolidated 
losses of foreign branch separate units. However, the reduction in the 
certification period from 15 years to seven years should substantially 
reduce the overall compliance burden of this requirement.
11. Amount of Recapture
    As stated above, under the current regulations a triggering event 
(other than a foreign use) generally can be rebutted only if no portion 
of the dual consolidated loss can be used by (or carries over to) 
another person under foreign law. See Sec.  1.503-2(g)(2)(iii)(A)(2) 
through (7). Thus, if even a de minimis portion of the dual 
consolidated loss can be used by (or carries over to) another person, 
the triggering event cannot be rebutted. Similarly, Sec.  1.1503-
2(g)(2)(vii)(A) of the current regulations provides that if a 
triggering event occurs, the entire dual consolidated loss subject to 
the (g)(2)(i) agreement (reduced by income earned subsequently by the 
dual resident corporation or separate unit) is recaptured and reported 
as income, regardless of the amount of the dual consolidated loss used 
by the other person. Thus, even a de minimis foreign use will cause the 
entire amount of the dual consolidated loss to be recaptured and 
reported as income.
    This so-called all or nothing principle is included in the current 
regulations primarily due to administrative concerns. In many cases, 
the exact amount of the dual consolidated loss that is used by another 
person cannot be readily determined. This inability is due, in part, to 
differences between U.S. and foreign law. For example, there may be 
temporary and permanent differences in the treatment of items of 
income, gain, deduction and loss. There may also be differences in loss 
carryover provisions. These concerns are exacerbated by the principle 
that certain deductions are fungible and, therefore, cannot easily be 
traced to a particular loss incurred in a particular year.
    Commentators have noted that in some cases the all or nothing 
principle results in a disallowance of deductions in both the United 
States and the foreign jurisdiction. Nevertheless, the IRS and Treasury 
believe that making a precise determination as to the amount of the 
dual consolidated loss put to a foreign use would require the 
Commissioner and taxpayers to analyze foreign law in great detail and, 
in some cases, compare the treatment of items under foreign law with 
their treatment under U.S. law. Such an analysis, however, is 
inconsistent with the principle underlying the regulations that, to the 
extent possible, the Commissioner and taxpayers should not be required 
to analyze foreign law. Moreover, departing from the all or nothing 
principle would likely require detailed ordering, stacking, and tracing 
rules to determine the amount and nature of dual consolidated losses 
that are recaptured upon a use. Such rules would add considerable 
complexity to the regulations. As a result, the proposed regulations 
retain the all or nothing rule contained in the current regulations. 
However, the IRS and Treasury request comments regarding administrable 
alternatives to the all or nothing rule that would not involve 
substantial analyses of foreign law. For example, comments are 
requested as to whether a pro rata recapture rule with respect to 
dispositions of separate units would be consistent with the general 
framework of the proposed regulations and would be administrable.
12. Subsequent Elector Rules
    Neither the current regulations nor Rev. Proc. 2000-42 (2000-2 C.B. 
394) explicitly address the consequences resulting from a triggering 
event (to which no exception applies) with respect to a dual 
consolidated loss that was not recaptured due to an earlier triggering 
event as a result of the parties entering into a closing agreement. In 
such a case, both parties are jointly and severally liable for the 
total amount of the recapture of the dual consolidated loss and 
interest charge resulting from such a subsequent triggering event. 
However, it is unclear which taxpayer must report the recapture income 
(and related interest charge) on its tax return upon the subsequent 
triggering event. In addition, there is little or no procedural 
guidance outlining how, pursuant to a closing agreement, the IRS would 
collect recapture tax and the related interest charge from the parties 
to the closing agreement.
    Accordingly, the proposed regulations contain rules regarding 
subsequent electors. These rules apply when, subsequent to an event 
that is not a triggering event because the unaffiliated domestic 
corporation or new consolidated group enters into a new domestic use 
agreement and satisfies other requirements (excepted event), a 
triggering event occurs, and no exception applies to such event 
(subsequent triggering event). The proposed regulations also provide 
rules that apply in the case of multiple subsequent electors (when 
subsequent to an excepted event, another excepted event occurs).
    The proposed regulations first provide that, except to the extent 
provided under the subsequent elector rules, the original elector (and 
in the case of multiple excepted events, any prior subsequent elector) 
is not subject to the general recapture and interest charge rules 
provided under the regulations. As a result, only the subsequent 
elector that owns the dual resident corporation or separate unit at the 
time of the subsequent triggering event is subject to the general 
recapture and interest charge rules.
    The proposed regulations also provide that, upon a subsequent 
triggering event to which no exception applies, the subsequent elector 
must calculate the recapture tax amount with respect to the dual 
consolidated loss subject to the new domestic use agreement and include 
it, along with an identification of the dual consolidated losses at 
issue and the original elector, on a statement attached to its tax 
return. The subsequent elector calculates the recapture tax amount 
based on a with and without calculation. The recapture tax amount 
equals the excess (if any) of the income tax liability of the 
subsequent elector for the taxable year of the subsequent triggering 
event, over the income tax liability of the subsequent elector for such 
taxable year computed by excluding the amount of recapture and related 
interest charge with respect to the dual consolidated losses at issue.
    In addition, the proposed regulations provide rules regarding tax 
assessment and collection procedures. The proposed regulations provide 
that an assessment identifying an income tax liability of the 
subsequent elector is considered an assessment of the recapture tax 
amount where such amount is part of the income tax liability being 
assessed and the recapture tax amount is reflected in the statement 
attached to the subsequent elector's tax return. The recapture tax 
amount is considered to be properly assessed as an income tax liability 
of the original elector, and each prior subsequent elector, if any, on 
the same date the income tax liability of the subsequent elector was 
properly assessed. This liability is joint and several.
    The proposed regulations also provide procedures pursuant to which 
any unpaid balance of the recapture tax amount may be collected from 
the original elector and the prior subsequent elector, if any. Such 
amounts may be collected from the original elector, and/or any prior 
subsequent elector, if each of the following conditions is satisfied: 
(1) The Commissioner has properly assessed the recapture amount; (2) 
the Commissioner has issued a notice and

[[Page 29884]]

demand for payment of the recapture tax amount to the subsequent 
elector; (3) the subsequent elector has failed to pay all of the 
recapture tax amount by the date specified in such notice and demand; 
and (4) the Commissioner has issued a notice and demand for payment of 
the unpaid portion of the recapture tax amount to the original elector 
and prior subsequent electors, if any. If the subsequent elector's 
income tax liability for a taxable period includes a recapture amount, 
and if such income tax liability is satisfied in part by payment, 
credit, or offset, such amount shall be allocated first to that portion 
of the income tax liability that is not attributable to the recapture 
tax amount, and then to that portion of the income tax liability that 
is attributable to the recapture tax amount.
    Finally, the proposed regulations contain rules regarding the 
refund of an income tax liability that includes a recapture tax amount.
13. Character and Source of Recapture Income
    Section 1.1503-2(g)(2)(vii)(D) of the current regulations provides 
that recapture income is treated as ordinary income having the same 
source and falling within the same separate category under section 904 
as the dual consolidated loss being recaptured. The current regulations 
do not, however, provide an explicit rule to identify the items that 
compose the dual consolidated loss. As a result, it is unclear under 
the current regulations how to determine the source and separate 
category of recapture income. In addition, the current regulations do 
not explicitly state how the recapture income is treated for purposes 
of the Code other than section 904.
    The proposed regulations clarify that the character (to the extent 
consistent with the recapture income being ordinary income in all 
cases) and source of the recapture income is determined based on the 
character and source of a pro rata portion of the deductions that were 
taken into account in calculating the dual consolidated loss. As 
discussed above, the dual consolidated loss is composed of a pro rata 
portion of all items of deduction and loss that are taken into account 
in computing such dual consolidated loss. Moreover, the proposed 
regulations clarify that the determination of the character and source 
of such income is not limited to section 904, but applies for all 
purposes of the Code (for example, section 856(c)(2) and (3)).
    Under the proposed regulations, the character and source of losses 
and deductions composing the dual consolidated loss should be 
identified during the year in which they are incurred, rather than the 
year in which they are ultimately used to offset income or gain. This 
approach attempts to simplify the rules and make them more 
administrable, rather than providing comprehensive stacking, ordering, 
and tracing rules that track the ultimate use of such items, which 
would be complex.
14. Failure To Comply With Recapture Provisions
    Under the current regulations, if the taxpayer fails to comply with 
the recapture provisions upon the occurrence of a triggering event, the 
dual resident corporation or separate unit that incurred the dual 
consolidated loss (or successor-in-interest) is not eligible to enter 
into a (g)(2)(i) agreement with respect to any dual consolidated losses 
incurred in the five taxable years beginning with the taxable year in 
which recapture is required. The current regulations contain two 
exceptions to this rule that apply unless the triggering event is an 
actual use of the dual consolidated loss. Under the first exception, 
the rule does not apply if the failure to comply is due to reasonable 
cause. Under the second exception, the rule does not apply if the 
taxpayer unsuccessfully attempted to rebut the triggering event by 
timely filing a rebuttal statement with its tax return.
    This provision is intended to encourage taxpayers to carefully 
monitor potential triggering events and properly comply with the 
recapture provisions upon the occurrence of a triggering event.
    The IRS and Treasury believe that the failure to comply penalty 
contained in the current regulations often does not operate in a manner 
that encourages compliance with the dual consolidated loss regulations. 
For example, if a taxpayer sells a dual resident corporation to a third 
party that is treated as a triggering event, but the taxpayer fails to 
comply with the recapture rules, the rule contained in the current 
regulations prevents the purchaser of the dual resident corporation 
from entering into a (g)(2)(i) agreement with respect to dual 
consolidated losses of the dual resident corporation for five years; it 
does not adversely affect the taxpayer that failed to properly comply 
with the recapture provisions. As a result, the proposed regulations do 
not include this penalty provision.
    Although the proposed regulations do not retain this penalty 
provision, the Commissioner may consider applying other applicable 
penalty provisions in appropriate circumstances; for example, the 
Commissioner may consider applying the accuracy-related penalty of 
section 6662. In addition, the IRS and Treasury will continue to 
consider whether a penalty provision, similar to the one contained in 
the current regulations, is appropriate, especially in cases of 
repeated non-compliance.

F. Effective Date--Sec.  1.1503(d)-6

    The proposed regulations are proposed to apply to dual consolidated 
losses incurred in taxable years beginning after the date that these 
proposed regulations are published as final regulations in the Federal 
Register.
    The IRS and Treasury request comments on the application of the 
regulations, including comments as to whether the proposed regulations, 
when finalized, should contain an election that would allow taxpayers 
to apply all or a portion of the regulations retroactively. In 
addition, comments are requested as to possible transition rules that 
may apply, including the application of the proposed regulations, when 
finalized, to existing (g)(2)(i) agreements.

Effect on Other Documents

    When these proposed regulations are adopted as final regulations, 
Rev. Proc. 2000-42 (2000-2 C.B. 394), will be obsolete with respect to 
dual consolidated losses incurred in taxable years beginning after the 
date that these proposed regulations are published as final regulations 
in the Federal Register.

Special Analyses

    It has been determined that this notice of proposed rule making is 
not a significant regulatory action as defined in Executive Order 
12866. Therefore, a regulatory assessment is not required. It is hereby 
certified that these regulations will not have a significant economic 
impact on a substantial number of small entities. This certification is 
based on the fact that these regulations will primarily affect 
affiliated groups of corporations that also have a foreign affiliate, 
which tend to be larger businesses. Moreover, the number of taxpayers 
affected and the average burden are minimal. Therefore, a Regulatory 
Flexibility Analysis is not required. Pursuant to section 7805(f) of 
the Code, these regulations will be submitted to the Chief Counsel for 
Advocacy of the Small Business Administration for comment on their 
impact on small business.

[[Page 29885]]

Comments and Public Hearing

    A public hearing has been scheduled for September 7, 2005, at 10 
a.m., in the Auditorium of the Internal Revenue Building, 1111 
Constitution Avenue, NW., Washington, DC. Because of access 
restrictions, visitors must enter at the main entrance, located at 1111 
Constitution Avenue, NW. All visitors must present photo identification 
to enter the building. Because of access restrictions, visitors will 
not be admitted beyond the immediate entrance more than 30 minutes 
before the hearing starts. For information about having your name 
placed on the building access list to attend hearing, see the FOR 
FURTHER INFORMATION CONTACT portion of this preamble.
    The rules of 26 CFR 601.601(a)(3) apply to the hearing. Persons who 
wish to present oral comments must submit written or electronic 
comments and an outline of the topic to be discussed and time to be 
devoted to each topic (preferably a signed original and eight (8) 
copies) by August 22, 2005. A period of 10 minutes will be allotted to 
each person for making comments. An agenda showing the scheduling of 
the speakers will be prepared after the deadline for receiving outlines 
has passed. Copies of the agenda will be available free of charge at 
the hearing.

Drafting Information

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

List of Subjects in 26 CFR Part 1

    Income taxes, reporting and recordkeeping requirements.

Proposed Amendments to the Regulations

    Accordingly, 26 CFR part 1 is proposed to be amended as follows:

PART 1--INCOME TAXES

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

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

    Sec.  1.1503(d) also issued under 26 U.S.C. 953(d) and 26 U.S.C. 
1502.

    Par. 2. In Sec.  1.1502-21, paragraph (c)(2)(v) is amended by 
removing the language ``Sec.  1.1503-2'' and adding ``Sec. Sec.  
1.1503(d)-1 through 1.1503(d)-6'' in its place.
    Par. 3. New Sec. Sec.  1.1503(d)-0 through 1.1503(d)-6 are added to 
read as follows:


Sec.  1.1503(d)-0  Table of contents.

    This section lists the captions contained in Sec. Sec.  1.1503(d)-1 
through 1.1503(d)-6.

Sec.  1.1503(d)-1 Definitions and special rules for filings under 
section 1503(d).

    (a) In general.
    (b) Definitions.
    (1) Domestic corporation.
    (2) Dual resident corporation.
    (3) Hybrid entity.
    (4) Separate unit.
    (i) In general.
    (ii) Separate unit combination rule.
    (iii) Indirectly.
    (5) Dual consolidated loss.
    (6) Subject to tax.
    (7) Foreign country.
    (8) Consolidated group.
    (9) Domestic owner.
    (10) Affiliated dual resident corporation and affiliated 
domestic owner.
    (11) Unaffiliated dual resident corporation, unaffiliated 
domestic corporation, and unaffiliated domestic owner.
    (12) Domestic affiliate.
    (13) Domestic use.
    (14) Foreign use.
    (i) In general.
    (ii) Available for use.
    (iii) Exceptions.
    (A) No election to enable foreign use.
    (B) Presumed use where no foreign country rule for determining 
use.
    (C) No dilution of an interest in a separate unit.
    (1) General rules.
    (i) Interest in a hybrid entity partnership or hybrid entity 
grantor trust.
    (ii) Indirectly owned separate units.
    (iii) Combined separate unit.
    (2) Exceptions.
    (i) Dilution of an interest in a separate unit.
    (ii) Consolidation and other prohibited uses.
    (iv) Ordering rules for determining the foreign use of losses.
    (v) Mirror legislation rule.
    (15) Grantor trust.
    (c) Special rules for filings under section 1503(d).
    (1) Reasonable cause exception.
    (2) Signature requirement.

Sec.  1.1503(d)-2 Operating rules.

    (a) In general.
    (b) Limitation on domestic use of a dual consolidated loss.
    (c) Elimination of a dual consolidated loss after certain 
transactions.
    (1) General rules.
    (i) Dual resident corporation.
    (ii) Separate unit.
    (A) General rule.
    (B) Combined separate unit.
    (2) Exceptions.
    (i) Certain section 368(a)(1)(F) reorganizations.
    (ii) Acquisition of a dual resident corporation by another dual 
resident corporation.
    (iii) Acquisition of a separate unit by a domestic corporation.
    (d) Special rule denying the use of a dual consolidated loss to 
offset tainted income.
    (1) In general.
    (2) Tainted income.
    (i) Definition.
    (ii) Income presumed to be derived from holding tainted assets.
    (3) Tainted assets defined.
    (4) Exceptions.
    (e) Computation of foreign tax credit limitation.

Sec.  1.1503(d)-3 Special rules for accounting for dual 
consolidated losses.

    (a) In general.
    (b) Determination of amount of dual consolidated loss.
    (1) Affiliated dual resident corporation.
    (2) Separate unit.
    (i) General rules.
    (ii) Foreign branch separate unit.
    (A) In general.
    (B) Principles of Sec.  1.882-5.
    (iii) Hybrid entity.
    (A) General rule.
    (B) Interest in a non-hybrid partnership and a non-hybrid 
grantor trust.
    (iv) Interest in a disregarded hybrid entity.
    (v) Items attributable to an interest in a hybrid entity 
partnership and a separate unit owned indirectly through a 
partnership.
    (vi) Items attributable to an interest in a hybrid entity 
grantor trust and a separate unit owned indirectly through a grantor 
trust.
    (vii) Special rules.
    (A) Allocation of items between certain tiered separate units.
    (B) Combined separate unit.
    (C) Gain or loss on the direct or indirect disposition of a 
separate unit.
    (D) Income inclusion on stock.
    (3) Foreign tax treatment disregarded.
    (4) Items generated or incurred while a dual resident 
corporation or a separate unit.
    (c) Effect of a dual consolidated loss on a domestic affiliate.
    (1) Dual resident corporation.
    (2) Separate unit.
    (3) SRLY limitation.
    (4) Items of a dual consolidated loss used in other taxable 
years.
    (d) Special basis adjustments.
    (1) Affiliated dual resident corporation or affiliated domestic 
owner.
    (i) Dual consolidated loss subject to domestic use limitation.
    (ii) Dual consolidated loss absorbed in carryover or carryback 
year.
    (iii) Recapture income.
    (2) Interests in hybrid entities that are partnerships or 
interests in partnerships through which a separate unit is owned 
indirectly.
    (i) Scope.
    (ii) Determination of basis of partner's interest.
    (A) Dual consolidated loss subject to domestic use limitation.
    (B) Dual consolidated loss absorbed in carryover or carryback 
year.
    (C) Recapture income.
    (3) Examples.

[[Page 29886]]

Sec.  1.1503(d)-4 Exceptions to the domestic use limitation rule.

    (a) In general.
    (b) Elective agreement in place between the United States and a 
foreign country.
    (c) No possibility of foreign use.
    (1) In general.
    (2) Statement.
    (d) Domestic use election.
    (1) In general.
    (2) Consistency rule.
    (3) Restrictions on domestic use election.
    (i) Triggering event in year of dual consolidated loss.
    (ii) Losses of a foreign insurance company treated as a domestic 
corporation.
    (e) Triggering events requiring the recapture of a dual 
consolidated loss.
    (1) Events.
    (i) Foreign use.
    (ii) Disaffiliation.
    (iii) Affiliation.
    (iv) Transfer of assets.
    (v) Transfer of an interest in a separate unit.
    (vi) Conversion to a foreign corporation.
    (vii) Conversion to an S corporation.
    (viii) Failure to certify.
    (2) Rebuttal.
    (f) Exceptions.
    (1) Acquisition by a member of the consolidated group.
    (2) Acquisition by an unaffiliated domestic corporation or a new 
consolidated group.
    (i) Subsequent elector events.
    (ii) Non-subsequent elector events.
    (iii) Requirements.
    (A) New domestic use agreement.
    (B) Statement filed by original elector.
    (3) Subsequent triggering events.
    (g) Annual certification reporting requirement.
    (h) Recapture of dual consolidated loss and interest charge.
    (1) Presumptive rules.
    (i) Amount of recapture.
    (ii) Interest charge.
    (2) Reduction of presumptive recapture amount and presumptive 
interest charge.
    (i) Amount of recapture.
    (ii) Interest charge.
    (3) Rules regarding subsequent electors.
    (i) In general.
    (ii) Original elector and prior subsequent electors not subject 
to recapture or interest charge.
    (iii) Recapture tax amount and required statement.
    (A) In general.
    (B) Recapture tax amount.
    (iv) Tax assessment and collection procedures.
    (A) In general.
    (1) Subsequent elector.
    (2) Original elector and prior subsequent electors.
    (B) Collection from original elector and prior subsequent 
electors; joint and several liability.
    (C) Allocation of partial payments of tax.
    (D) Refund.
    (v) Definition of income tax liability.
    (vi) Example.
    (4) Computation of taxable income in year of recapture.
    (i) Presumptive rule.
    (ii) Rebuttal of presumptive rule.
    (5) Character and source of recapture income.
    (6) Reconstituted net operating loss.
    (i) Termination of domestic use agreement and annual 
certifications.
    (1) Rebuttal of triggering event.
    (2) Exception to triggering event.
    (3) Recapture of dual consolidated loss.
    (4) Termination of ability for foreign use.
    (i) In general.
    (ii) Statement.

Sec.  1.1503(d)-5 Examples.

    (a) In general.
    (b) Presumed facts for examples.
    (c) Examples.

Sec.  1.1503(d)-6 Effective date.


Sec.  1.1503(d)-1  Definitions and special rules for filings under 
section 1503(d).

    (a) In general. This section and Sec. Sec.  1.1503(d)-2 through 
1.1503(d)-6 provide general rules concerning the determination and use 
of dual consolidated losses pursuant to section 1503(d). This section 
provides definitions that apply for purposes of this section and 
Sec. Sec.  1.1503(d)-2 through 1.1503(d)-6. This section also provides 
a reasonable cause exception and a signature requirement for filings 
under this section and Sec. Sec.  1.1503(d)-2 through 1.1503(d)-4.
    (b) Definitions. The following definitions apply for purposes of 
this section and Sec. Sec.  1.1503(d)-2 through 1.1503(d)-6:
    (1) Domestic corporation. The term domestic corporation means an 
entity classified as a domestic corporation under section 7701(a)(3) 
and (4) or otherwise treated as a domestic corporation by the Internal 
Revenue Code, including, but not limited to, sections 269B, 953(d), and 
1504(d). However, solely for purposes of Section 1503(d), the term 
domestic corporation does not include an S corporation, as defined in 
section 1361.
    (2) Dual resident corporation. The term dual resident corporation 
means a domestic corporation that is subject to an income tax of a 
foreign country on its worldwide income or on a residence basis. A 
corporation is taxed on a residence basis if it is taxed as a resident 
under the laws of the foreign country. The term dual resident 
corporation also means a foreign insurance company that makes an 
election to be treated as a domestic corporation pursuant to section 
953(d) and is treated as a member of an affiliated group for purposes 
of chapter 6, even if such company is not subject to an income tax of a 
foreign country on its worldwide income or on a residence basis. See 
section 953(d)(3).
    (3) Hybrid entity. The term hybrid entity means an entity that is 
not taxable as an association for U.S. income tax purposes but is 
subject to an income tax of a foreign country as a corporation (or 
otherwise at the entity level) either on its worldwide income or on a 
residence basis.
    (4) Separate unit--(i) In general. The term separate unit means 
either of the following that is owned, directly or indirectly, by a 
domestic corporation--
    (A) A foreign branch, as defined in Sec.  1.367(a)-6T(g) (foreign 
branch separate unit); or
    (B) An interest in a hybrid entity (hybrid entity separate unit).
    (ii) Separate unit combination rule. If two or more separate units 
(individual separate units) are owned, directly or indirectly, by a 
single domestic corporation, and the losses of each individual separate 
unit are made available to offset the income of the other individual 
separate units under the income tax laws of a single foreign country, 
then such individual separate units shall be treated as one separate 
unit (combined separate unit), provided that--
    (A) If the individual separate unit is a foreign branch separate 
unit, it is located in such foreign country; and
    (B) If the individual separate unit is a hybrid entity separate 
unit, the hybrid entity (an interest in which is the hybrid entity 
separate unit) is subject to an income tax of such foreign country 
either on its worldwide income or on a residence basis. See Sec.  
1.1503(d)-5(c) Example 1.
    (iii) Indirectly. The term indirectly, when used in reference to 
ownership of a separate unit, means ownership through a separate unit, 
through an entity classified as a partnership under Sec. Sec.  
301.7701-1 through -3 of this chapter, or through a grantor trust (as 
defined in paragraph (b)(15) of this section), regardless of whether 
the partnership or grantor trust is a U.S. person.
    (5) Dual consolidated loss. The term dual consolidated loss means--
    (i) In the case of a dual resident corporation, the net operating 
loss (as defined in section 172(c) and the regulations thereunder) 
incurred in a year in which the corporation is a dual resident 
corporation; and
    (ii) In the case of a separate unit, the net loss attributable to, 
or taken into account by, the separate unit under Sec.  1.1503(d)-
3(b)(2).
    (6) Subject to tax. For purposes of determining whether a domestic 
corporation or hybrid entity is subject to an income tax of a foreign 
country on its income, the fact that it has no actual income tax 
liability to the foreign

[[Page 29887]]

country for a particular taxable year shall not be taken into account.
    (7) Foreign country. The term foreign country includes any 
possession of the United States.
    (8) Consolidated group. The term consolidated group means a 
consolidated group, as defined in Sec.  1.1502-1(h), that includes 
either a dual resident corporation or a domestic owner.
    (9) Domestic owner. The term domestic owner means a domestic 
corporation that owns, directly or indirectly, one or more separate 
units.
    (10) Affiliated dual resident corporation and affiliated domestic 
owner. The terms affiliated dual resident corporation and affiliated 
domestic owner mean a dual resident corporation and a domestic owner, 
respectively, that is a member of a consolidated group.
    (11) Unaffiliated dual resident corporation, unaffiliated domestic 
corporation, and unaffiliated domestic owner. The terms unaffiliated 
dual resident corporation, unaffiliated domestic corporation, and 
unaffiliated domestic owner mean a dual resident corporation, domestic 
corporation, and domestic owner, respectively, that is not a member of 
a consolidated group.
    (12) Domestic affiliate. The term domestic affiliate means--
    (i) A member of an affiliated group, without regard to the 
exceptions contained in section 1504(b) (other than section 1504(b)(3)) 
relating to includible corporations;
    (ii) A domestic owner; or
    (iii) A separate unit.
    (13) Domestic use. A domestic use of a dual consolidated loss shall 
be deemed to occur when the dual consolidated loss is made available to 
offset, directly or indirectly, the taxable income of any domestic 
affiliate of the dual resident corporation or separate unit (that 
incurred the dual consolidated loss) in the taxable year in which the 
dual consolidated loss is recognized, or in any other taxable year, 
regardless of whether the dual consolidated loss offsets income under 
the income tax laws of a foreign country and regardless of whether any 
income that the dual consolidated loss may offset in the foreign 
country is, has been, or will be subject to tax in the United States. A 
domestic use shall be deemed to occur in the year the dual consolidated 
loss is included in the computation of the taxable income of a 
consolidated group or an unaffiliated domestic owner, even if no tax 
benefit results from such inclusion in that year. See Sec.  1.1503(d)-
5(c) Examples 2 through 5.
    (14) Foreign use--(i) In general. A foreign use of a dual 
consolidated loss shall be deemed to occur when any portion of a loss 
or deduction taken into account in computing the dual consolidated loss 
is made available under the income tax laws of a foreign country to 
offset or reduce, directly or indirectly, any item that is recognized 
as income or gain under such laws and that is considered under U.S. tax 
principles to be an item of--
    (A) A foreign corporation as defined in section 7701(a)(3) and 
(a)(5); or
    (B) A direct or indirect owner of an interest in a hybrid entity, 
provided such interest is not a separate unit. See Sec.  1.1503(d)-5(c) 
Examples 6 through 11.
    (ii) Available for use. A foreign use shall be deemed to occur in 
the year in which any portion of a loss or deduction taken into account 
in computing the dual consolidated loss is made available for an offset 
described in paragraph (b)(14)(i) of this section, regardless of 
whether it actually offsets or reduces any items of income or gain 
under the income tax laws of the foreign country in such year and 
regardless of whether any of the items that may be so offset or reduced 
are regarded as income under U.S. tax principles.
    (iii) Exceptions--(A) No election to enable foreign use. Where the 
laws of a foreign country provide an election that would enable a 
foreign use, a foreign use shall be considered to occur only if the 
election is made.
    (B) Presumed use where no foreign country rule for determining use. 
If the losses or deductions composing the dual consolidated loss are 
made available under the laws of a foreign country both to offset 
income that would constitute a foreign use and to offset income that 
would not constitute a foreign use, and the laws of the foreign country 
do not provide applicable rules for determining which income is offset 
by the losses or deductions, then for purposes of paragraph (b)(14) of 
this section, the losses or deductions shall be deemed to be made 
available to offset income that does not constitute a foreign use, to 
the extent of such income, before being considered to be made available 
to offset the income that does constitute a foreign use. See Sec.  
1.1503(d)-5(c) Examples 12 and 14.
    (C) No dilution of an interest in a separate unit--(1) General 
rules--(i) Interest in a hybrid entity partnership or hybrid entity 
grantor trust. Except as provided in paragraph (b)(14)(iii)(C)(2) of 
this section, no foreign use shall be considered to occur with respect 
to a dual consolidated loss attributable to an interest in a hybrid 
entity partnership or a hybrid entity grantor trust, solely because an 
item of deduction or loss taken into account in computing such dual 
consolidated loss is made available, under the income tax laws of a 
foreign country, to offset or reduce, directly or indirectly, any item 
that is recognized as income or gain under such laws and, that is 
considered under U.S. tax principles, to be an item of the direct or 
indirect owner of an interest in such hybrid entity that is not a 
separate unit. See Sec.  1.1503(d)-5(c) Examples 8 and 14 through 16.
    (ii) Indirectly owned separate units. Except as provided in 
paragraph (b)(14)(iii)(C)(2) of this section, no foreign use shall be 
considered to occur with respect to a dual consolidated loss 
attributable to or taken into account by a separate unit owned 
indirectly through a partnership or grantor trust solely because an 
item of deduction or loss taken into account in computing such dual 
consolidated loss is made available, under the income tax laws of a 
foreign country, to offset or reduce, directly or indirectly, any item 
that is recognized as income or gain under such laws, and that is 
considered under U.S. tax principles, to be an item of a direct or 
indirect owner of an interest in such partnership or trust. See Sec.  
1.1503(d)-5(c) Examples 17 and 18.
    (iii) Combined separate unit. This paragraph 
(b)(14)(iii)(C)(1)(iii) applies to a dual consolidated loss 
attributable to or taken into account by a combined separate unit that 
includes an individual separate unit to which paragraph 
(b)(14)(iii)(C)(1)(i) or (ii) of this section would apply, but for the 
application of the separate unit combination rule provided under Sec.  
1.1503(d)-1(b)(4)(ii). Except as provided in paragraph 
(b)(14)(iii)(C)(2) of this section, paragraph (b)(14)(iii)(C)(1)(i) or 
(ii), as applicable, shall apply to the portion of the dual 
consolidated loss of such combined separate unit that is attributable, 
as provided under Sec.  1.1503(d)-3(b)(2)(vii)(B)(1), to the individual 
separate unit (otherwise described in paragraph (b)(14)(iii)(C)(1)(i) 
or (ii) of this section) that is a component of the combined separate 
unit. See Sec.  1.1503(d)-5(c) Example 19.
    (2) Exceptions--(i) Dilution of an interest in a separate unit. 
Paragraph (b)(14)(iii)(C)(1) of this section shall not apply with 
respect to any item of deduction or loss that is taken into account in 
computing a dual consolidated loss attributable to or taken into 
account by a separate unit if during any taxable year the domestic 
owner's percentage interest in such separate unit, as compared to its 
interest in the separate unit as of the last day of the

[[Page 29888]]

taxable year in which such dual consolidated loss was incurred, is 
reduced as a result of another person acquiring through sale, exchange, 
contribution or other means, an interest in the partnership or grantor 
trust. The previous sentence shall not apply, however, if the 
unaffiliated domestic owner or consolidated group, as the case may be, 
demonstrates, to the satisfaction of the Commissioner, that the other 
person that acquired the interest in the partnership or grantor trust 
was a domestic corporation. Such demonstration must be made on a 
statement that is attached to, and filed by the due date (including 
extensions) of, its U.S. income tax return for the taxable year in 
which the ownership interest of the domestic owner is reduced. See 
Sec.  1.1503(d)-5(c) Examples 14 through 16 and 19.
    (ii) Consolidation and other prohibited uses. Paragraph 
(b)(14)(iii)(C)(1) of this section shall not apply if the availability 
described in such section does not arise solely from the ownership in 
such partnership or grantor trust and the allocation of the item of 
deduction or loss, or the offsetting by such deduction or loss, of an 
item of income or gain of the partnership or trust. For example, 
paragraph (b)(14)(iii)(C)(1) of this section shall not apply in the 
case where the item of loss or deduction is made available through a 
foreign consolidation regime. See Sec.  1.1503(d)-5(c) Examples 17 and 
18.
    (iv) Ordering rules for determining the foreign use of losses. If 
the laws of a foreign country provide for the foreign use of a dual 
consolidated loss, but do not provide applicable rules for determining 
the order in which such losses are used in a taxable year, the 
following rules shall govern--
    (A) Any net loss, or net income, that the dual resident corporation 
or separate unit has in a taxable year shall first be used to offset 
net income, or loss, recognized by its affiliates in the same taxable 
year before any carryover of its losses is considered to be used to 
offset any income from the taxable year;
    (B) If under the laws of the foreign country the dual resident 
corporation or separate unit has losses from different taxable years, 
it shall be deemed to use first the losses from the earliest taxable 
year from which a loss may be carried forward or back for foreign law 
purposes; and
    (C) Where different losses or deductions (for example, capital 
losses and ordinary losses) of a dual resident corporation or separate 
unit incurred in the same taxable year are available for foreign use, 
the different losses shall be deemed to be used on a pro rata basis. 
See Sec.  1.1503(d)-5(c) Example 13.
    (v) Mirror legislation rule. Except to the extent Sec.  1.1503(d)-
4(b) applies, and other than for purposes of the consistency rule under 
Sec.  1.1503(d)-4(d)(2), a foreign use shall be deemed to occur if and 
when the income tax laws of a foreign country deny any opportunity for 
the foreign use of the dual consolidated loss for any of the following 
reasons--
    (A) The loss is incurred by a dual resident corporation or separate 
unit that is subject to income taxation by another country on its 
worldwide income or on a residence basis;
    (B) The loss may be available to offset income (other than income 
of the dual resident corporation or separate unit) under the laws of 
another country; or
    (C) The deductibility of any portion of a loss or deduction taken 
into account in computing the dual consolidated loss depends on whether 
such amount is deductible under the laws of another country. See Sec.  
1.1503(d)-5(c) Examples 20 through 23.
    (15) Grantor trust. The term grantor trust means a trust, any 
portion of which is treated as being owned by the grantor or another 
person under subpart E of subchapter J of this chapter.
    (c) Special rules for filings under section 1503(d)--(1) Reasonable 
cause exception. If a person that is permitted or required to file an 
election, agreement, statement, rebuttal, computation, or other 
information under the provisions of this section or Sec. Sec.  
1.1503(d)-2 through 1.1503(d)-4 and that fails to make such filing in a 
timely manner, shall be considered to have satisfied the timeliness 
requirement with respect to such filing if the person is able to 
demonstrate, to the Director of Field operations having jurisdiction of 
the taxpayer's tax return for the taxable year, that such failure was 
due to reasonable cause and not willful neglect. The previous sentence 
shall only apply if, once the person becomes aware of the failure, the 
person attaches all documents that should have been filed previously, 
as well as a written statement setting forth the reasons for the 
failure to timely comply, to an amended income tax return that amends 
the return to which the documents should have been attached under the 
rules of this section or Sec. Sec.  1.1503(d)-2 through 1.1503(d)-4. In 
determining whether the taxpayer has reasonable cause, the Director of 
Field Operations shall consider whether the taxpayer acted reasonably 
and in good faith. Whether the taxpayer acted reasonably and in good 
faith will be determined after considering all the facts and 
circumstances. The Director of Field Operations shall notify the person 
in writing within 120 days of the filing if it is determined that the 
failure to comply was not due to reasonable cause, or if additional 
time will be needed to make such determination.
    (2) Signature requirement. When an election, agreement, statement, 
rebuttal, computation, or other information is required under this 
section or Sec. Sec.  1.1503(d)-2 through 1.1503(d)-4 to be attached to 
and filed by the due date (including extensions) of a U.S. tax return 
and signed under penalties of perjury by the person who signs the 
return, the attachment and filing of an unsigned copy is considered to 
satisfy such requirement, provided the taxpayer retains the original in 
its records in the manner specified by Sec.  1.6001-1(e).


Sec.  1.1503(d)-2  Operating rules.

    (a) In general. This section provides operating rules relating to 
dual consolidated losses, including a general rule prohibiting the 
domestic use of a dual consolidated loss, a rule that eliminates a dual 
consolidated loss following certain transactions, an anti-abuse rule 
for tainted income, and rules for computing foreign tax credit 
limitations.
    (b) Limitation on domestic use of a dual consolidated loss. Except 
as provided in Sec.  1.1503(d)-4, the domestic use of a dual 
consolidated loss is not permitted. See Sec.  1.1503(d)-5(c) Examples 2 
through 4 and 5.
    (c) Elimination of a dual consolidated loss after certain 
transactions--(1) General rules--(i) Dual resident corporation. Except 
as provided in paragraph (c)(2) of this section, a dual consolidated 
loss of a dual resident corporation shall not carry over to another 
corporation in a transaction described in section 381(a) and, as a 
result, shall be eliminated. See Sec.  1.1503(d)-5(c) Example 24.
    (ii) Separate unit--(A) General rule. Except as provided in 
paragraph (c)(2) of this section, a dual consolidated loss of a 
separate unit shall not carry over as a result of a transaction in 
which the separate unit ceases to be a separate unit of its domestic 
owner (for example, as a result of a termination, dissolution, 
liquidation, sale or other disposition of the separate unit) and, as a 
result, shall be eliminated.
    (B) Combined separate unit. This paragraph (c)(1)(ii)(B) applies to 
an individual separate unit that is a component of a combined separate 
unit that would, but for the separate unit combination rule, cease to 
be a separate unit of its domestic owner. In such a

[[Page 29889]]

case, and except as provided in paragraph (c)(2) of this section, the 
portion of the dual consolidated loss of the combined separate unit 
that is attributable to, or taken into account by, as provided under 
Sec.  1.1503(d)-3(b)(2)(vii)(B)(1), such individual separate unit shall 
not carry over and, as a result, shall be eliminated.
    (2) Exceptions--(i) Certain section 368(a)(1)(F) reorganizations. 
Paragraph (c)(1)(i) of this section shall not apply to a reorganization 
described in section 368(a)(1)(F) in which the resulting corporation is 
a domestic corporation.
    (ii) Acquisition of a dual resident corporation by another dual 
resident corporation. If a dual resident corporation transfers its 
assets to another dual resident corporation in a transaction described 
in section 381(a), and the transferee corporation is a resident of (or 
is taxed on its worldwide income by) the same foreign country of which 
the transferor was a resident (or was taxed on its worldwide income), 
then income generated by the transferee may be offset by the carryover 
dual consolidated losses of the transferor, subject to the limitations 
of Sec.  1.1503(d)-3(c) applied as if the transferee generated the dual 
consolidated loss. Dual consolidated losses of the transferor may not, 
however, be used to offset income of separate units owned by the 
transferee because such separate units constitute domestic affiliates 
of the transferee as provided under Sec.  1.1503(d)-1(b)(12)(iii).
    (iii) Acquisition of a separate unit by a domestic corporation. If 
a domestic owner transfers ownership of a separate unit to a domestic 
corporation in a transaction described in section 381(a), and the 
transferee is a domestic owner of the separate unit immediately 
following the transfer, then income generated by the separate unit 
following the transfer may be offset by the carryover dual consolidated 
losses of the separate unit, subject to the limitations of Sec.  
1.1503(d)-3(c) applied as if the separate unit of the transferee 
generated the dual consolidated loss. In addition, if a domestic owner 
transfers ownership of a separate unit to a domestic corporation in a 
transaction described in section 381(a), the transferee is a domestic 
owner of the separate unit immediately following the transfer, and the 
transferred separate unit is combined with another separate unit of the 
transferee immediately after the transfer as provided under Sec.  
1.1503(d)-1(b)(4)(ii), then income generated by the combined separate 
unit may be offset by the carryover dual consolidated losses of the 
transferred separate unit, subject to the limitations of Sec.  
1.1503(d)-3(c) applied as if the combined separate unit of the 
transferee generated the dual consolidated loss. See Sec.  1.1503(d)-
5(c) Example 25.
    (d) Special rule denying the use of a dual consolidated loss to 
offset tainted income--(1) In general. Dual consolidated losses 
incurred by a dual resident corporation shall not be used to offset 
income it earns after it ceases to be a dual resident corporation to 
the extent that such income is tainted income.
    (2) Tainted income--(i) Definition. For purposes of paragraph 
(d)(1) of this section, the term tainted income means--
    (A) Income or gain recognized on the sale or other disposition of 
tainted assets; and
    (B) Income derived as a result of holding tainted assets.
    (ii) Income presumed to be derived from holding tainted assets. In 
the absence of evidence establishing the actual amount of income that 
is attributable to holding tainted assets, the portion of a 
corporation's income in a particular taxable year that is treated as 
tainted income derived as a result of holding tainted assets shall be 
an amount equal to the corporation's taxable income for the year (other 
than income described in paragraph (d)(2)(i)(A) of this section) 
multiplied by a fraction, the numerator of which is the fair market 
value of all tainted assets acquired by the corporation (determined at 
the time such assets were so acquired) and the denominator of which is 
the fair market value of the total assets owned by the corporation at 
the end of such taxable year. To establish the actual amount of income 
that is attributable to holding tainted assets, documentation must be 
attached to, and filed by the due date (including extensions) of, the 
domestic corporation's tax return or the consolidated tax return of an 
affiliated group of which it is a member, as the case may be, for the 
taxable year in which the income is generated. See Sec.  1.1503(d)-5(c) 
Example 26.
    (3) Tainted assets defined. For purposes of paragraph (d)(2) of 
this section, tainted assets are any assets acquired by a domestic 
corporation in a nonrecognition transaction, as defined in section 
7701(a)(45), or any assets otherwise transferred to the corporation as 
a contribution to capital, at any time during the three taxable years 
immediately preceding the taxable year in which the corporation ceases 
to be a dual resident corporation or at any time thereafter.
    (4) Exceptions. Income derived from assets acquired by a domestic 
corporation shall not be subject to the limitation described in 
paragraph (d)(1) of this section, if--
    (i) For the taxable year in which the assets were acquired, the 
corporation did not have a dual consolidated loss (or a carryforward of 
a dual consolidated loss to such year); or
    (ii) The assets were acquired as replacement property in the 
ordinary course of business.
    (e) Computation of foreign tax credit limitation. If a dual 
resident corporation or separate unit is subject to Sec.  1.1503(d)-
3(c) (addressing the effect of a dual consolidated loss on a domestic 
affiliate), the consolidated group or unaffiliated domestic owner shall 
compute its foreign tax credit limitation by applying the limitations 
of Sec.  1.1503(d)-3(c). Thus, the items constituting the dual 
consolidated loss are not taken into account until the year in which 
such items are absorbed.


Sec.  1.1503(d)-3  Special rules for accounting for dual consolidated 
losses.

    (a) In general. This section provides special rules for determining 
the amount of income or loss of a dual resident corporation or separate 
unit for purposes of section 1503(d). In addition, this section 
provides rules for determining the effect of a dual consolidated loss 
on domestic affiliates and for making special basis adjustments.
    (b) Determination of amount of dual consolidated loss--(1) 
Affiliated dual resident corporation. For purposes of determining 
whether an affiliated dual resident corporation has a dual consolidated 
loss for the taxable year, the dual resident corporation shall compute 
its taxable income (or loss) in accordance with the rules set forth in 
the regulations under section 1502 governing the computation of 
consolidated taxable income, taking into account only the dual resident 
corporation's items of income, gain, deduction, and loss for the year. 
However, for purposes of this computation, the following items shall 
not be taken into account--
    (i) Any net capital loss of the dual resident corporation; and
    (ii) Any carryover or carryback losses.
    (2) Separate unit--(i) General rules. Paragraph (b)(2) of this 
section applies for purposes of determining whether a separate unit has 
a dual consolidated loss for the taxable year. The taxable income (or 
loss) in U.S. dollars of a separate unit shall be computed as if it 
were a separate domestic corporation and a dual resident corporation in 
accordance with the provisions of paragraph (b)(1) of this section, 
using only those existing items of income,

[[Page 29890]]

gain, deduction, and loss (translated into U.S. dollars) that are 
attributable to or taken into account by such separate unit. Treating a 
separate unit as a separate domestic corporation of the domestic owner 
under this paragraph shall not cause items of income, gain, deduction 
and loss that are otherwise disregarded for U.S. Federal tax purposes 
to be regarded for purposes of calculating a dual consolidated loss. 
Paragraph (b)(2) of this section shall apply separately to each 
separate unit and an item of income, gain, deduction, or loss shall not 
be considered attributable to or taken into account by more than one 
separate unit. Items of income, gain, deduction, and loss of one 
separate unit shall not offset items of income, gain, deduction, and 
loss, or otherwise be taken into account by, another separate unit for 
purposes of calculating a dual consolidated loss. But see the separate 
unit combination rule in Sec.  1.1503(d)-1(b)(4)(ii). See also Sec.  
1.1503(d)-5(c) Example 27.
    (ii) Foreign branch separate unit--(A) In general. For purposes of 
determining the items of income, gain, deduction (other than interest), 
and loss that are taken into account in determining the taxable income 
or loss of a foreign branch separate unit, the principles of section 
864(c)(2) and (c)(4) as set forth in Sec.  1.864-4(c) and Sec.  1.864-6 
shall apply. The principles apply without regard to limitations imposed 
on the effectively connected treatment of income, gain or loss under 
the trade or business safe harbors in section 864(b) and the 
limitations for treating foreign source income as effectively connected 
under section 864(c)(4)(D). For purposes of determining the interest 
expense that is taken into account in determining the taxable income or 
loss of a foreign branch separate unit, the principles of Sec.  1.882-
5, subject to paragraph (b)(2)(ii)(B) of this section, shall apply. 
When applying the principles of section 864(c) and Sec.  1.882-5 
(subject to paragraph (b)(2)(ii)(B) of this section), the domestic 
corporation that owns, directly or indirectly, the foreign branch 
separate unit shall be treated as a foreign corporation, the foreign 
branch separate unit shall be treated as a trade or business within the 
United States, and the other assets of the domestic corporation shall 
be treated as assets that are not U.S. assets.
    (B) Principles of Sec.  1.882-5. For purposes of paragraph 
(b)(2)(ii)(A) of this section, the principles of Sec.  1.882-5 shall be 
applied subject to the following:
    (1) Except as otherwise provided in this section, only the assets, 
liabilities and interest expense of the domestic owner shall be taken 
into account in the Sec.  1.882-5 formula;
    (2) Except as provided under paragraph (b)(2)(ii)(B)(3) of this 
section, a taxpayer may use the alternative tax book value method under 
Sec.  1.861-9T(i) for purposes of determining the value of its U.S. 
assets pursuant to Sec.  1.882-5(b)(2) and its worldwide assets 
pursuant to Sec.  1.882-5(c)(2);
    (3) For purposes of determining the value of a U.S. asset pursuant 
to Sec.  1.882-5(b)(2), and worldwide assets pursuant to Sec.  1.882-
5(c)(2), the taxpayer must use the same methodology under Sec.  1.861-
9T(g) (that is, tax book value, alternative tax book value, or fair 
market value) that the taxpayer uses for purposes of allocating and 
apportioning interest expense for the taxable year under section 
864(e);
    (4) Asset values shall be determined pursuant to Sec.  1.861-
9T(g)(2); and
    (5) For purposes of determining the step-two U.S. connected 
liabilities, the amounts of worldwide assets and liabilities under 
Sec.  1.882-5(c)(2)(iii) and (iv), must be determined in accordance 
with U.S. tax principles rather than substantially in accordance with 
U.S. tax principles.
    (iii) Hybrid entity--(A) General rule. The items of income, gain, 
deduction and loss attributable to a hybrid entity are those items that 
are properly reflected on its books and records under the principles of 
Sec.  1.988-4(b)(2), to the extent consistent with U.S. tax principles. 
See Sec.  1.1503(d)-5(c) Example 28.
    (B) Interest in a non-hybrid partnership and a non-hybrid grantor 
trust. If a hybrid entity owns, directly or indirectly (other than 
through a hybrid entity separate unit), an interest in either a 
partnership that is not a hybrid entity or a grantor trust that is not 
a hybrid entity, items of income, gain, deduction or loss that are 
properly reflected on the books and records of such partnership or 
grantor trust (under the principles of Sec.  1.988-4(b)(2), to the 
extent consistent with U.S. tax principles), to the extent provided 
under paragraphs (b)(2)(v) or (b)(2)(vi) of this section, respectively, 
shall be treated as being properly reflected on the books and records 
of the hybrid entity for purposes of paragraph (b)(2)(iii)(A) of this 
section. See Sec.  1.1503(d)-5(c) Example 30.
    (iv) Interest in a disregarded hybrid entity. Except as provided in 
paragraph (b)(2)(vii) of this section, for purposes of determining the 
items of income, gain, deduction and loss that are attributable to an 
interest in a hybrid entity that is disregarded as an entity separate 
from its owner (for example, as a result of an election made pursuant 
to Sec.  301.7701-3(c) of this chapter), those items described in 
paragraph (b)(2)(iii) of this section shall be taken into account. See 
Sec.  1.1503(d)-5(c) Example 30.
    (v) Items attributable to an interest in a hybrid entity 
partnership and a separate unit owned indirectly through a 
partnership--(A) This paragraph (b)(2)(v) applies for purposes of 
determining--
    (1) The extent to which the items of income, gain, deduction and 
loss attributable to a hybrid entity that is a partnership (as provided 
in paragraph (b)(2)(iii) of this section) are attributable to an 
interest in such hybrid entity partnership; and
    (2) The extent to which items of income, gain, deduction and loss 
of a separate unit that is owned indirectly through a partnership are 
taken into account by a partner in such partnership.
    (B) Items of income, gain, deduction and loss are taken into 
account by the owner of such interest, or separate unit, to the extent 
such items are includible in the owner's distributive share of the 
partnership income, gain, deduction and loss, as determined under the 
rules and principles of subchapter K of this chapter. See Sec.  
1.1503(d)-5(c) Example 30.
    (vi) Items attributable to an interest in a hybrid entity grantor 
trust and a separate unit owned indirectly through a grantor trust--(A) 
This paragraph (b)(2)(vi) applies for purposes of determining--
    (1) The extent to which items of income, gain, deduction and loss 
attributable to a hybrid entity that is a grantor trust (as provided in 
paragraph (b)(2)(iii) of this section) are attributable to an interest 
in such grantor trust; and
    (2) The extent to which the items of income, gain, deduction and 
loss of a separate unit owned indirectly through a grantor trust are 
taken into account by an owner of such grantor trust.
    (B) Items of income, gain, deduction and loss are taken into 
account to the extent such items are attributable to trust property 
that the holder of the trust interest is treated as owning under the 
rules and principles of subpart E of subchapter J of this chapter.
    (vii) Special rules. The following special rules shall apply for 
purposes of attributing items under paragraphs (b)(2)(i) through (vi) 
of this section:
    (A) Allocation of items between certain tiered separate units--(1) 
When a hybrid entity owns, directly or indirectly (other than through a 
hybrid entity separate unit), a foreign branch separate unit, for 
purposes of determining items of income, gain,

[[Page 29891]]

deduction and loss that are taken into account in determining the 
taxable income or loss of such foreign branch separate unit, only items 
of income, gain, deduction and loss that are attributable to the hybrid 
entity as provided in paragraph (b)(2)(iii) of this section (and 
intervening entities, if any, that are not themselves separate units) 
shall be taken into account. Items of the hybrid entity (including 
assets and liabilities) are taken into account for purposes of 
determining the taxable income or loss of the foreign branch separate 
unit pursuant to paragraph (b)(2)(ii) of this section. See Sec.  
1.1503(d)-5(c) Example 30.
    (2) For purposes of determining items of income, gain, deduction 
and loss that are attributable to an interest in the hybrid entity 
described in paragraph (b)(2)(vii)(A)(1) of this section, the items 
attributable to the hybrid entity in paragraph (b)(2)(iii) of this 
section shall not be taken into account to the extent they are also 
taken into account in determining, under the rules of paragraph 
(b)(2)(ii) of this section, the taxable income or loss of a foreign 
branch separate unit that is owned, directly or indirectly (other than 
through a hybrid entity separate unit), by the hybrid entity separate 
unit. See Sec.  1.1503(d)-5(c) Example 30.
    (B) Combined separate unit. If two or more separate units defined 
in Sec.  1.1503(d)-1(b)(4)(i) are treated as one combined separate unit 
pursuant to Sec.  1.1503(d)-1(b)(4)(ii), the items of income, gain, 
deduction and loss that are attributable to or taken into account in 
determining the taxable income of the combined separate unit shall be 
determined as follows--
    (1) Items of income, gain, deduction and loss are first attributed 
to, or taken into account by, each individual separate unit, as defined 
in Sec.  1.1503(d)-1(b)(4)(i) without regard to Sec.  1.1503(d)-
1(b)(4)(ii), pursuant to the rules of paragraph (b)(2) of this section; 
and
    (2) The combined separate unit then takes into account all of the 
items of income, gain, deduction and loss attributable to, or taken 
into account by, the individual separate units pursuant to paragraph 
(b)(2)(vii)(B)(1) of this section. See Sec.  1.1503(d)-5(c) Example 30.
    (C) Gain or loss on the direct or indirect disposition of a 
separate unit. For purposes of calculating a dual consolidated loss of 
a separate unit, items of income or gain (including loss recapture 
income or gain under section 367(a)(3)(C) or 904(f)(3)), deduction and 
loss recognized on the sale, exchange or other disposition of a 
separate unit (or an interest in a partnership or grantor trust that 
owns, directly or indirectly, a separate unit), are attributable to or 
taken into account by the separate unit to the extent of the gain or 
loss that would have been recognized had such separate unit sold all 
its assets in a taxable exchange, immediately before the disposition of 
the separate unit, for an amount equal to their fair market value. If, 
as a result of the sale, exchange or other disposition of a separate 
unit (or interest in a partnership or grantor trust) more than one 
separate unit is, directly or indirectly, disposed of, items of income, 
gain, deduction, and loss recognized on such disposition are 
attributable to or taken into account by each such separate unit (under 
the rules of this paragraph (b)(2)(vii)(C)) based on the gain or loss 
that would have been recognized by each separate unit if it had sold 
all of its assets in a taxable exchange, immediately before the 
disposition of the separate unit, for an amount equal to their fair 
market value. See Sec.  1.1503(d)-5(c) Examples 31 through 34.
    (D) Income inclusion on stock. Any amount included in income of a 
U.S. person arising from ownership of stock in a foreign corporation 
(for example, under section 951) through a separate unit shall be taken 
into account for purposes of calculating the dual consolidated loss of 
the separate unit if an actual dividend from such foreign corporation 
would have been so taken into account. See Sec.  1.1503(d)-5(c) Example 
29.
    (3) Foreign tax treatment disregarded. The fact that a particular 
item taken into account in computing a dual resident corporation's net 
operating loss, or a separate unit's loss, is not taken into account in 
computing income subject to a foreign country's income tax shall not 
cause such item to be excluded from the calculation of the dual 
consolidated loss.
    (4) Items generated or incurred while a dual resident corporation 
or a separate unit. For purposes of determining the amount of the dual 
consolidated loss of a dual resident corporation or a separate unit for 
the taxable year, only the items of income, gain, deduction and loss 
generated or incurred during the period the dual resident corporation 
or separate unit qualified as such shall be taken into account. The 
allocation of items to such period shall be made under the principles 
of Sec.  1.1502-76(b).
    (c) Effect of a dual consolidated loss on a domestic affiliate. For 
any taxable year in which a dual resident corporation or separate unit 
has a dual consolidated loss to which Sec.  1.1503(d)-2(b) applies, the 
following rules shall apply:
    (1) Dual resident corporation. If the dual resident corporation is 
a member of a consolidated group, the group shall compute its 
consolidated taxable income (or loss) by taking into account the dual 
resident corporation's items of gross income, gain, deduction, or loss 
taken into account in computing the dual consolidated loss, other than 
those items of deduction and loss that compose the dual resident 
corporation's dual consolidated loss. The dual consolidated loss shall 
be treated as composed of a pro rata portion of each item of deduction 
and loss of the dual resident corporation taken into account in 
calculating the dual consolidated loss. The dual consolidated loss is 
subject to the limitations on its use contained in paragraph (c)(3) of 
this section and, subject to such limitation, may be carried over or 
back for use in other taxable years as a separate net operating loss 
carryover or carryback of the dual resident corporation arising in the 
year incurred.
    (2) Separate unit. The unaffiliated domestic owner of a separate 
unit, or the consolidated group of an affiliated domestic owner of a 
separate unit, shall compute its taxable income (or loss) by taking 
into account the separate unit's items of gross income, gain, deduction 
and loss taken into account in computing the dual consolidated loss, 
other than those items of deduction and loss that compose the separate 
unit's dual consolidated loss. The dual consolidated loss shall be 
treated as composed of a pro rata portion of each item of deduction and 
loss of the separate unit taken into account in calculating the dual 
consolidated loss. The dual consolidated loss is subject to the 
limitations contained in paragraph (c)(3) of this section as if the 
separate unit that generated the dual consolidated loss were a separate 
domestic corporation that filed a consolidated return with its 
unaffiliated domestic owner or with the consolidated group of its 
affiliated domestic owner. Subject to such limitation, the dual 
consolidated loss may be carried over or back for use in other taxable 
years as a separate net operating loss carryover or carryback of the 
separate unit arising in the year incurred.
    (3) SRLY limitation. The dual consolidated loss shall be treated as 
a loss incurred by the dual resident corporation or separate unit in a 
separate return limitation year and shall be subject to all of the 
limitations of Sec.  1.1502-21(c) (SRLY limitation), subject to the 
following:

[[Page 29892]]

    (i) Notwithstanding Sec.  1.1502-1(f)(2)(i), the SRLY limitation is 
applied to any dual consolidated loss of a common parent;
    (ii) The SRLY limitation is applied without regard to Sec.  1.1502-
21(c)(2) (SRLY subgroup limitation) and 1.1502-21(g) (overlap with 
section 382);
    (iii) For purposes of calculating the general SRLY limitation under 
Sec.  1.1502-21(c)(1)(i), the calculation of aggregate consolidated 
taxable income shall only include items of income, gain, deduction or 
loss generated--
    (A) In the case of a dual resident corporation or hybrid entity 
separate unit, in years in which the dual resident corporation or 
hybrid entity (whose interest constitutes the separate unit) is 
resident (or is taxed on its worldwide income) in the same foreign 
country in which it was resident (or was taxed on its worldwide income) 
during the year in which the dual consolidated loss was generated; and
    (B) In the case of a foreign branch separate unit, items of income, 
gain, deduction or loss generated in years in which the foreign branch 
qualified as a separate unit; and
    (iv) For purposes of calculating the general SRLY limitation under 
Sec.  1.1502-21(c)(1)(i), the calculation of aggregate consolidated 
taxable income shall not include any amount included in income pursuant 
to Sec.  1.1503(d)-4(h) (relating to the recapture of a dual 
consolidated loss).
    (4) Items of a dual consolidated loss used in other taxable years. 
A pro rata portion of each item of deduction or loss that composes the 
dual consolidated loss shall be considered to be used when the dual 
consolidated loss is used in other taxable years. See Sec.  1.1503(d)-
5(c) Example 35.
    (d) Special basis adjustments--(1) Affiliated dual resident 
corporation or affiliated domestic owner. If a dual resident 
corporation or domestic owner is a member of a consolidated group, each 
other member owning stock in the dual resident corporation or domestic 
owner shall adjust the basis of the stock in accordance with the 
principles of Sec.  1.1502-32(b), subject to the following:
    (i) Dual consolidated loss subject to domestic use limitation. 
There shall be a negative adjustment under Sec.  1.1502-32(b)(2) for 
any amount of a dual consolidated loss of the dual resident corporation 
(or, in the case of a domestic owner, of separate units of such 
domestic owner) that is not absorbed as a result of the application of 
Sec. Sec.  1.1503(d)-2(b) and 3(c).
    (ii) Dual consolidated loss absorbed in carryover or carryback 
year. There shall be no negative adjustment under Sec.  1.1502-32(b)(2) 
for the amount of a dual consolidated loss of the dual resident 
corporation (or, in the case of a domestic owner, of separate units of 
such domestic owner) subject to Sec. Sec.  1.1503(d)-2(b) and 
1.1503(d)-3(c) that is absorbed in a carryover or carryback taxable 
year.
    (iii) Recapture income. There shall be no positive adjustment under 
Sec.  1.1502-32(b)(2) for any amount included in income by the dual 
resident corporation or domestic owner pursuant to Sec.  1.1503(d)-
4(h).
    (2) Interests in hybrid entities that are partnerships or interests 
in partnerships through which a separate unit is owned indirectly--(i) 
Scope. This paragraph (d)(2) applies for purposes of determining the 
adjusted basis of an interest in:
    (A) A hybrid entity that is a partnership; and
    (B) A partnership through which a domestic owner indirectly owns a 
separate unit.
    (ii) Determination of basis of partner's interest. The adjusted 
basis of an interest in a hybrid entity that is a partnership, or a 
partnership through which a domestic owner indirectly owns a separate 
unit, shall be adjusted in accordance with section 705 of this chapter, 
except as otherwise provided in this paragraph (d)(2)(ii).
    (A) Dual consolidated loss subject to domestic use limitation. The 
adjusted basis shall be decreased for any amount of the dual 
consolidated loss that is not absorbed as a result of the application 
of Sec. Sec.  1.1503(d)-2(b) and 1.1503(d)-3(c).
    (B) Dual consolidated loss absorbed in carryover or carryback year. 
The adjusted basis shall not be decreased for the amount of a dual 
consolidated loss subject to Sec. Sec.  1.1503(d)-2(b) and 1.1503(d)-
3(c) that is absorbed in a carryover or carryback taxable year.
    (C) Recapture income. The adjusted basis shall not be increased for 
any amount included in income pursuant to Sec.  1.1503(d)-4(h).
    (3) Examples. See Sec.  1.1503(d)-5(c) Examples 36 and 37.


Sec.  1.1503(d)-4  Exceptions to the domestic use limitation rule.

    (a) In general. This section provides certain exceptions to the 
domestic use limitation rule of Sec.  1.1503(d)-2(b).
    (b) Elective agreement in place between the United States and a 
foreign country. The domestic use limitation rule of Sec.  1.1503(d)-
2(b) shall not apply to a dual consolidated loss to the extent the 
consolidated group, unaffiliated dual resident corporation, or 
unaffiliated domestic owner, as the case may be, elects to deduct the 
loss in the United States pursuant to an agreement entered into between 
the United States and a foreign country that puts into place an 
elective procedure through which losses offset income in only one 
country.
    (c) No possibility of foreign use--(1) In general. The domestic use 
limitation rule of Sec.  1.1503(d)-2(b) shall not apply to a dual 
consolidated loss if the consolidated group, unaffiliated dual resident 
corporation, or unaffiliated domestic owner, as the case may be--
    (i) Demonstrates, to the satisfaction of the Commissioner, that no 
foreign use of the dual consolidated loss occurred in the year in which 
it was incurred, and no such use can occur in any other year by any 
means; and
    (ii) Prepares a statement described in paragraph (c)(2) of this 
section that is attached to, and filed by the due date (including 
extensions) of, its U.S. income tax return for the taxable year in 
which the dual consolidated loss is incurred. See Sec.  1.1503(d)-5(c) 
Examples 38 through 40.
    (2) Statement. The statement described in this section must be 
signed under penalties of perjury by the person who signs the tax 
return. The statement must be labeled No Possibility of Foreign Use of 
Dual Consolidated Loss Statement at the top of the page and must 
include the following items, in paragraphs labeled to correspond with 
the items set forth in paragraphs (c)(2)(i) through (iv) of this 
section:
    (i) A statement that the document is submitted under the provisions 
of Sec.  1.1503(d)-4(c);
    (ii) The name, address, tax identification number, and place and 
date of incorporation of the dual resident corporation, and the country 
or countries that tax the dual resident corporation on its worldwide 
income or on a residence basis, or, in the case of a separate unit, 
identification of the separate unit, including the name under which it 
conducts business, its principal activity, and the country in which its 
principal place of business is located;
    (iii) A statement of the amount of the dual consolidated loss at 
issue; and
    (iv) An analysis, in reasonable detail and specificity, supported 
with official or certified English translations of the relevant 
provisions of foreign law, of the treatment of the losses and 
deductions composing the dual consolidated loss under the laws of the 
foreign jurisdiction and the reasons supporting the conclusion that no 
foreign use of the dual consolidated loss occurred in the year in which 
it was incurred, and no such use can occur in any other year by any 
means.

[[Page 29893]]

    (d) Domestic use election--(1) In general. The domestic use 
limitation rule of Sec.  1.1503(d)-2(b) shall not apply to a dual 
consolidated loss if an election to be bound by the provisions of this 
paragraph (d) of this section (domestic use election) is made by the 
consolidated group, unaffiliated dual resident corporation, or 
unaffiliated domestic owner, as the case may be (elector). In order to 
elect relief under this paragraph (d) of this section, an agreement 
described in this paragraph (d)(1) of this section (domestic use 
agreement) must be attached to, and filed by the due date (including 
extensions) of, the U.S. income tax return of the elector for the 
taxable year in which the dual consolidated loss is incurred. The 
domestic use agreement must be signed under penalties of perjury by the 
person who signs the return. If dual consolidated losses of more than 
one dual resident corporation or separate unit are subject to the rules 
of this paragraph (d) which requires the filing of domestic use 
agreements by the same elector, the agreements may be combined in a 
single document, but the information required by paragraphs (d)(1)(ii) 
and (iv) of this section must be provided separately with respect to 
each dual consolidated loss. The domestic use agreement must be labeled 
Domestic Use Election and Agreement at the top of the page and must 
include the following items, in paragraphs labeled to correspond with 
the following:
    (i) A statement that the document submitted is an election and an 
agreement under the provisions of Sec.  1.1503(d)-4(d);
    (ii) The name, address, tax identification number, and place and 
date of incorporation of the dual resident corporation, and the country 
or countries that tax the dual resident corporation on its worldwide 
income or on a residence basis, or, in the case of a separate unit, 
identification of the separate unit, including the name under which it 
conducts business, its principal activity, and the country in which its 
principal place of business is located;
    (iii) An agreement by the elector to comply with all of the 
provisions of paragraphs (d) through (h) of this section, as 
applicable;
    (iv) A statement of the amount of the dual consolidated loss 
covered by the agreement;
    (v) A certification that there has not been, and will not be, a 
foreign use of the dual consolidated loss in any taxable year up to and 
including the seventh taxable year following the year in which the dual 
consolidated loss that is the subject of the agreement filed under 
paragraph (d) of this section was incurred (certification period);
    (vi) A certification that arrangements have been made to ensure 
that there will be no foreign use of the dual consolidated loss during 
the certification period, and that the elector will be informed of any 
such foreign use of the dual consolidated loss during such period;
    (vii) If applicable, a notification that an excepted triggering 
event under paragraph (f)(2)(i) of this section has occurred with 
respect to the dual consolidated loss within the taxable year covered 
by the elector's tax return and providing the name, taxpayer 
identification number, and address of the subsequent elector (within 
the meaning of paragraph (f)(2)(iii)(A) of this section) that will be 
filing future certifications with respect to such dual consolidated 
loss.
    (2) Consistency rule. If under the laws of a particular foreign 
country there is a foreign use of a dual consolidated loss of a dual 
resident corporation or separate unit that is subject to a domestic use 
agreement (but not a new domestic use agreement, defined in paragraph 
(f)(2)(iii)(A) of this paragraph), then a foreign use shall be deemed 
to occur for the following other dual consolidated losses (if any), but 
only if the income tax laws of the foreign country permit a foreign use 
of such other dual consolidated losses in the same taxable year--
    (i) Any dual consolidated loss of a dual resident corporation that 
is a member of the same consolidated group of which the first dual 
resident corporation or domestic owner is a member, if any deduction or 
loss taken into account in computing such dual consolidated loss is 
recognized under the income tax laws of such foreign country in the 
same taxable year; and
    (ii) Any dual consolidated loss of a separate unit that is owned 
directly or indirectly by the same domestic owner that owns the first 
separate unit, or that is owned directly or indirectly by any member of 
the same consolidated group of which the first dual resident 
corporation or domestic owner is a member, if any deduction or loss 
taken into account in computing such dual consolidated loss is 
recognized under the income tax laws of such foreign country in the 
same taxable year. See Sec.  1.1503(d)-5(c) Examples 41 and 42.
    (3) Restrictions on domestic use election--(i) Triggering event in 
year of dual consolidated loss. Except as otherwise provided in this 
section, if an event described in paragraphs (e)(1)(i) through (vii) of 
this section occurs during the year in which a dual resident 
corporation or separate unit incurs a dual consolidated loss (including 
a dual consolidated loss resulting, in whole or in part, from the 
occurrence of the triggering event itself), the consolidated group, 
unaffiliated dual resident corporation, or unaffiliated domestic owner, 
as the case may be, may not make a domestic use election with respect 
to the dual consolidated loss and such loss therefore is subject to the 
domestic use limitation rule of Sec.  1.1503(d)-2(b). See Sec.  
1.1503(d)-5(c) Example 32. See also Sec.  1.1503(d)-2(c) for rules that 
eliminate a dual consolidated loss after certain transactions.
    (ii) Losses of a foreign insurance company treated as a domestic 
corporation. A foreign insurance company that has elected to be treated 
as a domestic corporation pursuant to section 953(d) may not make a 
domestic use election. See section 953(d)(3).
    (e) Triggering events requiring the recapture of a dual 
consolidated loss--(1) Events. The elector must agree that, except as 
provided under paragraphs (e)(2) and (f) of this section, if there is a 
triggering event described in this paragraph (e) during the 
certification period, the elector will recapture and report as income 
the amount of the dual consolidated loss as provided in paragraph (h) 
of this section on its tax return for the taxable year in which the 
triggering event occurs (or, when the triggering event is a foreign use 
of the dual consolidated loss, the taxable year that includes the last 
day of the foreign tax year during which such use occurs). In addition, 
the elector must pay any applicable interest charge required by 
paragraph (h) of this section. For purposes of this section, except as 
provided under paragraphs (e)(2) and (f) of this section, any of the 
following events shall constitute a triggering event:
    (i) Foreign use. A foreign use of the dual consolidated loss 
(including a deemed foreign use pursuant to the mirror legislation rule 
set forth in Sec.  1.1503(d)-1(b)(13)(ii)(D) or the consistency rule 
set forth in paragraph (d)(2) of this section).
    (ii) Disaffiliation. An affiliated dual resident corporation or 
affiliated domestic owner ceases to be a member of the consolidated 
group that made the domestic use election. For purposes of this 
paragraph (e)(1)(ii), a dual resident corporation or domestic owner 
shall be considered to cease to be a member of the consolidated group 
if it is no longer a member of the group within the meaning of Sec.  
1.1502-1(b), or if the group ceases to exist (for example, when the 
group no longer files a consolidated

[[Page 29894]]

return). See Sec.  1.1503(d)-5(c) Example 47.
    (iii) Affiliation. An unaffiliated dual resident corporation or 
unaffiliated domestic owner becomes a member of a consolidated group. 
Any consequences resulting from this triggering event (for example, 
recapture of a dual consolidated loss) shall be taken into account in 
the tax return of the unaffiliated dual resident corporation or 
unaffiliated domestic owner for the taxable year that ends immediately 
before the taxable year in which the unaffiliated dual resident 
corporation or unaffiliated domestic owner becomes a member of the 
consolidated group.
    (iv) Transfer of assets. Fifty percent or more of the dual resident 
corporation's or separate unit's gross assets (measured by the fair 
market value of the assets at the time of such transfer (or for 
multiple transactions, at the time of the first transfer)) are sold or 
otherwise disposed of in either a single transaction or a series of 
transactions within a twelve-month period. For purposes of this 
paragraph, the interest in a separate unit and the shares of a dual 
resident corporation shall not be treated as assets of a dual resident 
corporation or a separate unit.
    (v) Transfer of an interest in a separate unit. Fifty percent or 
more of the interest in a separate unit (measured by voting power or 
value) owned directly or indirectly by the domestic owner on the last 
day of the taxable year in which the dual consolidated loss was 
incurred is sold or otherwise disposed of either in a single 
transaction or a series of transactions within a twelve-month period.
    (vi) Conversion to a foreign corporation. An unaffiliated dual 
resident corporation, unaffiliated domestic owner, or hybrid entity an 
interest in which is a separate unit, becomes a foreign corporation by 
means of a transaction (for example, a reorganization, or an election 
to be classified as a corporation under Sec.  301.7701-3(c) of this 
chapter) that, for foreign tax purposes, is not treated as involving a 
transfer of assets (and carryover of losses) to a new entity.
    (vii) Conversion to an S corporation. An unaffiliated dual resident 
corporation or unaffiliated domestic owner elects to be an S 
corporation pursuant to section 1362(a).
    (viii) Failure to certify. The elector fails to file a 
certification required under paragraph (g) of this section.
    (2) Rebuttal. An event described in paragraphs (e)(1)(ii) through 
(viii) of this section shall not constitute a triggering event if the 
elector demonstrates, to the satisfaction of the Commissioner, that 
there can be no foreign use of the dual consolidated loss at any time 
during the remaining certification period. The elector must prepare a 
statement, labeled Rebuttal of Triggering Event at the top of the page, 
that indicates that it is submitted under the provisions of this 
section Sec.  1.1503(d)-4(e)(2). The statement must set forth an 
analysis, in reasonable detail and specificity, supported with official 
or certified English translations of the relevant provisions of foreign 
law, of the treatment of the losses and deductions composing the dual 
consolidated loss under the facts of the event in question. The 
statement must be attached to, and filed by the due date (including 
extensions) of, the elector's income tax return for the taxable year in 
which the presumed triggering event occurs. See Sec.  1.1503(d)-5(c) 
Examples 43 through 45.
    (f) Exceptions--(1) Acquisition by a member of the consolidated 
group. The following events shall not constitute triggering events, 
requiring the recapture of the dual consolidated loss under paragraph 
(h) of this section--
    (i) An affiliated dual resident corporation or affiliated domestic 
owner ceases to be a member of a consolidated group solely by reason of 
a transaction in which a member of the same consolidated group succeeds 
to the tax attributes of the dual resident corporation or domestic 
owner under the provisions of section 381.
    (ii) Assets of an affiliated dual resident corporation or assets of 
a separate unit owned by an affiliated domestic owner are acquired in 
any other transaction by--
    (A) One or more members of its consolidated group; or
    (B) A partnership, a grantor trust, or a hybrid entity, but only if 
100 percent of such entity's interests are owned, directly or 
indirectly, by such affiliated dual resident corporation or affiliated 
domestic owner, as the case may be, or by members of its consolidated 
group.
    (iii) Assets of a separate unit are acquired in any other 
transaction by its domestic owner or by a hybrid entity or grantor 
trust, but only if 100 percent of such entity's interest is owned by 
the domestic owner.
    (iv) The interest of a hybrid entity separate unit, or an 
indirectly owned separate unit, owned by an affiliated domestic owner, 
is transferred to--
    (A) A member of its consolidated group; or
    (B) A partnership, a grantor trust, or a hybrid entity, but only if 
100 percent of such entity's interests are owned, directly or 
indirectly, by such affiliated domestic owner, or by members of its 
consolidated group.
    (2) Acquisition by an unaffiliated domestic corporation or a new 
consolidated group--(i) Subsequent elector events. If all the 
requirements of paragraph (f)(2)(iii) of this section are met, the 
following events shall not constitute triggering events requiring the 
recapture of the dual consolidated loss under paragraph (h) of this 
section--
    (A) An affiliated dual resident corporation or affiliated domestic 
owner becomes an unaffiliated domestic corporation or a member of a new 
consolidated group (other than in a transaction described in paragraph 
(f)(2)(ii)(B) of this section);
    (B) Assets of a dual resident corporation or a separate unit are 
acquired by--
    (1) An unaffiliated domestic corporation;
    (2) One or more members of a new consolidated group; or
    (3) A partnership, a grantor trust, or a hybrid entity, but only if 
100 percent of such entity's interests are owned, directly or 
indirectly, by members of a new consolidated group.
    (C) The interest of a hybrid entity separate unit, or an indirectly 
owned separate unit, owned by a domestic owner is transferred to--
    (1) An unaffiliated domestic corporation;
    (2) One or more members of a new consolidated group; or
    (3) A partnership, a grantor trust, or a hybrid entity, but only if 
100 percent of such entity's interests is owned, directly or 
indirectly, by members of a new consolidated group.
    (ii) Non-subsequent elector events. If the requirements of 
paragraph (f)(2)(iii)(A) of this section are met, the following events 
also shall not constitute triggering events requiring the recapture of 
the dual consolidated loss under paragraph (h) of this section--
    (A) An unaffiliated dual resident corporation or unaffiliated 
domestic owner becomes a member of a consolidated group; or
    (B) A consolidated group that filed a domestic use agreement ceases 
to exist as a result of a transaction described in Sec.  1.1502-
13(j)(5)(i) (other than a transaction in which any member of the 
terminating group, or the successor-in-interest of such member, is not 
a member of the surviving group immediately after the terminating group 
ceases to exist). See Sec.  1.1503(d)-5(c) Example 46.
    (iii) Requirements--(A) New domestic use agreement. The 
unaffiliated domestic corporation or new consolidated group (subsequent 
elector)

[[Page 29895]]

must file an agreement described in paragraph (d)(1) of this section 
(new domestic use agreement). The new domestic use agreement must be 
labeled New Domestic Use Agreement at the top of the page, and must be 
attached to and filed by the due date (including extensions) of, the 
subsequent elector's income tax return for the taxable year in which 
the event described in paragraph (f)(2)(i) or (f)(2)(ii) of this 
section occurs. The new domestic use agreement must be signed under 
penalties of perjury by the person who signs the return and must 
include the following items--
    (1) A statement that the document submitted is an election and 
agreement under the provisions of Sec.  1.1503(d)-4(f)(2);
    (2) An agreement to assume the same obligations with respect to the 
dual consolidated loss as the corporation or consolidated group that 
filed the original domestic use agreement (original elector) with 
respect to that loss;
    (3) An agreement to treat any potential recapture amount under 
paragraph (h) of this section with respect to the dual consolidated 
loss as unrealized built-in gain for purposes of section 384(a), 
subject to any applicable exceptions thereunder;
    (4) An agreement to be subject to the successor elector rules as 
provided in paragraph (h)(3) of this section; and
    (5) The name, U.S. taxpayer identification number, and address of 
the original elector and prior subsequent electors with respect to the 
dual consolidated losses, if any.
    (B) Statement filed by original elector. The original elector must 
file a statement that is attached to and filed by the due date 
(including extensions) of its income tax return for the taxable year in 
which the event described in paragraph (f)(2)(i) of this section 
occurs. The statement must be labeled Original Elector Statement at the 
top of the page, must be signed under penalties of perjury by the 
person who signs the tax return, and must include the following items--
    (1) A statement that the document submitted is an election and 
agreement under the provisions of Sec.  1.1503(d)-4(f)(2);
    (2) An agreement to be subject to the successor elector rules as 
provided in paragraph (h)(3) of this section; and
    (3) The name, U.S. taxpayer identification number, and address of 
the subsequent elector.
    (3) Subsequent triggering events. Any triggering event described in 
paragraph (e) of this section that occurs subsequent to one of the 
transactions described in paragraph (f)(1) or (2) of this section, and 
that itself does not fall within the exceptions provided in paragraph 
(f)(1) or (2) of this section, shall require recapture under paragraph 
(h) of this section.
    (g) Annual certification reporting requirement. Except as provided 
in paragraph (i) of this section, the elector must file a 
certification, labeled Certification of Dual Consolidated Loss at the 
top of the page, that is attached to, and filed by the due date 
(including extensions) of, its income tax return for each taxable year 
during the certification period. The certification must certify that 
there has been no foreign use of such dual consolidated loss. The 
certification must identify the dual consolidated loss to which it 
pertains by setting forth the elector's year in which the loss was 
incurred and the amount of such loss. In addition, the certification 
must warrant that arrangements have been made to ensure that there will 
be no foreign use of the dual consolidated loss and that the elector 
will be informed of any such foreign use. If dual consolidated losses 
of more than one taxable year are subject to the rules of this 
paragraph (g) of this section, the certification for those years may be 
combined in a single document but each dual consolidated loss must be 
separately identified.
    (h) Recapture of dual consolidated loss and interest charge--(1) 
Presumptive rules--(i) Amount of recapture. Except as otherwise 
provided in this section, upon the occurrence of a triggering event 
described in paragraph (e)(1) of this section that falls outside the 
exceptions provided in paragraph (f)(1) or (2) of this section, the 
dual resident corporation or separate unit shall recapture, and the 
elector shall report, as gross income the total amount of the dual 
consolidated loss to which the triggering event applies on its income 
tax return for the taxable year in which the triggering event occurs 
(or, when the triggering event is a foreign use of the dual 
consolidated loss, the taxable year that includes the last day of the 
foreign tax year during which such foreign use occurs).
    (ii) Interest charge. In connection with the recapture, the elector 
shall pay an interest charge. Except as otherwise provided in this 
section, such interest shall be determined under the rules of section 
6601(a) as if the additional tax owed as a result of the recapture had 
accrued and been due and owing for the taxable year in which the losses 
or deductions taken into account in computing the dual consolidated 
loss gave rise to a tax benefit for U.S. income tax purposes. For 
purposes of this paragraph (h)(1)(ii), a tax benefit shall be 
considered to have arisen in a taxable year in which such losses or 
deductions reduced U.S. taxable income. See Sec.  1.1503(d)-5(c) 
Example 51.
    (2) Reduction of presumptive recapture amount and presumptive 
interest charge--(i) Amount of recapture. The amount of dual 
consolidated loss that must be recaptured under paragraph (h) of this 
section may be reduced if the elector demonstrates, to the satisfaction 
of the Commissioner, the offset permitted by this paragraph (h)(2)(i). 
The reduction in the amount of recapture is the amount by which the 
dual consolidated loss would have offset other taxable income reported 
on a timely filed U.S. income tax return for any taxable year up to and 
including the taxable year of the triggering event if such loss had 
been subject to the restrictions of Sec.  1.1503(d)-2(b) (and therefore 
subject to the limitation under Sec.  1.1503(d)-3(c)(3)). In the case 
of a separate unit, the prior sentence is applied as if the separate 
unit were a separate domestic corporation that filed a consolidated 
return with its unaffiliated domestic owner or with the consolidated 
group of its affiliated domestic owner. For purposes of determining the 
reduction in the amount of recapture pursuant to this paragraph, the 
rules under Sec.  1.1503(d)-3(b) shall apply. Any reduction to 
recapture pursuant to this paragraph that is attributable to income 
generated in taxable years prior to the year in which the dual 
consolidated loss was generated, subject to the restrictions of Sec.  
1.1503(d)-2(b) (and therefore subject to the limitation under Sec.  
1.1503(d)-3(c)(3)), shall be permitted only if the elector demonstrates 
to the satisfaction of the Commissioner that the dual resident 
corporation or separate unit, as the case may be, qualified as such 
(with respect to the same foreign country in which the dual 
consolidated loss was generated) in the taxable years such income was 
generated. An elector utilizing this rebuttal rule must prepare a 
separate accounting showing that the income for each year that offsets 
the dual resident corporation or separate unit's recapture amount is 
attributable only to the dual resident corporation or separate unit. 
The separate accounting must be signed under penalties of perjury by 
the person who signs the elector's tax return, must be labeled 
Reduction of Recapture Amount at the top of the page, and must indicate 
that it is submitted under the provisions of paragraph (h)(2)(i) of 
this section. The accounting must be attached to, and filed by the due 
date (including extensions) of, the elector's income tax

[[Page 29896]]

return for the taxable year in which the triggering event occurs.
    (ii) Interest charge. The interest charge imposed under this 
section may be appropriately reduced if the elector demonstrates, to 
the satisfaction of the Commissioner, that the net interest owed would 
have been less than that provided in paragraph (h)(1)(ii) of this 
section if the elector had filed an amended return for the taxable year 
in which the loss was incurred, and for any other affected taxable 
years up to and including the taxable year of recapture, treating the 
dual consolidated loss as a loss subject to the restrictions of Sec.  
1.1503(d)-2(b) (and therefore subject to the limitations under Sec.  
1.1503(d)-3(c)(3)). In the case of a separate unit, the prior sentence 
is applied as if the separate unit were a separate domestic corporation 
that filed a consolidated return with its unaffiliated domestic owner. 
An elector utilizing this rebuttal rule must prepare a computation 
demonstrating the reduction in the net interest owed as a result of 
treating the dual consolidated loss as a loss subject to the 
restrictions of Sec.  1.1503(d)-2(b) (and therefore subject to the 
limitations under Sec.  1.1503(d)-3(c)(3)). The computation must be 
labeled Reduction of Interest Charge at the top of the page and must 
indicate that it is submitted under the provisions of paragraph 
(h)(2)(ii) of this section. The computation must be signed under 
penalties of perjury by the person who signs the elector's tax return, 
and must be attached to, and filed by the due date (including 
extensions) of, the elector's income tax return for the taxable year in 
which the triggering event occurs. See Sec.  1.1503(d)-5(c) Examples 51 
and 52.
    (3) Rules regarding subsequent electors--(i) In general. The rules 
of this paragraph (h)(3) apply when, subsequent to an event described 
in paragraph (e)(1) of this section with respect to which the 
requirements of paragraph (f)(2)(i) of this section were met (excepted 
event), a triggering event under paragraph (e) of this section occurs, 
and no exception applies to such triggering event under paragraph (f) 
of this section (subsequent triggering event).
    (ii) Original elector and prior subsequent electors not subject to 
recapture or interest charge--(A) Except to the extent provided in 
paragraph (h)(3) of this section, neither the original elector nor any 
prior subsequent elector shall be subject to the rules of paragraph (h) 
of this section with respect to dual consolidated losses subject to the 
original domestic use agreement.
    (B) In the case of a dual consolidated loss with respect to which 
multiple excepted events have occurred, only the subsequent elector 
that owns the dual resident corporation or separate unit at the time of 
the subsequent triggering event shall be subject to the recapture rules 
of paragraph (h) of this section. For purposes of paragraph (h) of this 
section, the term prior subsequent elector refers to all other 
subsequent electors.
    (iii) Recapture tax amount and required statement--(A) In general. 
If a subsequent triggering event occurs, the subsequent elector must 
prepare a statement that computes the recapture tax amount, as provided 
under paragraph (h)(3)(iii)(B) of this section, with respect to the 
dual consolidated loss subject to the new domestic use agreement. This 
statement must be attached to, and filed by the due date (including 
extensions) of, the subsequent elector's income tax return for the 
taxable year in which the subsequent triggering event occurs. The 
statement must be signed under penalties of perjury by the person who 
signs the return. The statement must be labeled Statement Identifying 
Secondary Liability at the top and, in addition to the calculation of 
the recapture tax amount, must include the following items, in 
paragraphs labeled to correspond with the items set forth in paragraphs 
(h)(3)(iii)(A)(1) through (3) of this section:
    (1) A statement that the document is submitted under the provisions 
of Sec.  1.1503(d)-4(h)(3)(iii);
    (2) A statement identifying the amount of the dual consolidated 
losses at issue and the taxable year in which they were used;
    (3) The name, address, and tax identification number of the 
original elector and all prior subsequent electors.
    (B) Recapture tax amount. The recapture tax amount equals the 
excess (if any) of--
    (1) The income tax liability of the subsequent elector for the 
taxable year of the subsequent triggering event; over
    (2) The income tax liability of the subsequent elector for the 
taxable year of the subsequent triggering event, computed by excluding 
the amount of recapture and related interest charge with respect to the 
dual consolidated losses that are recaptured as a result of the 
subsequent triggering event, as provided under paragraphs (h)(1) and 
(h)(2) of this section.
    (iv) Tax assessment and collection procedures--(A) In general--(1) 
Subsequent elector. An assessment identifying an income tax liability 
of the subsequent elector is considered an assessment of the recapture 
tax amount where the recapture tax amount is part of the income tax 
liability being assessed and the recapture tax amount is reflected in a 
statement attached to the subsequent elector's income tax return as 
provided under paragraph (h)(3)(iii) of this section.
    (2) Original elector and prior subsequent electors. The assessment 
of the recapture tax amount as set forth in paragraph (h)(3)(iv)(A)(1) 
of this section shall be considered as having been properly assessed as 
an income tax liability of the original elector and of each prior 
subsequent elector, if any. The date of such assessment shall be the 
date the income tax liability of the subsequent elector was properly 
assessed. The Commissioner may collect all or a portion of such 
recapture tax amount from the original elector and/or the prior 
subsequent electors under the circumstances set forth in paragraph 
(h)(3)(iv)(B) of this section.
    (B) Collection from original elector and prior subsequent electors; 
joint and several liability. If the subsequent elector does not pay in 
full any of the income tax liability that includes a recapture tax 
amount, the Commissioner may collect that portion of the unpaid balance 
of such income tax liability attributable to the recapture tax amount 
in full or in part from the original elector and/or from any prior 
subsequent elector, provided that the following conditions are 
satisfied with respect to such elector--
    (1) The Commissioner properly has assessed the recapture tax amount 
pursuant to paragraph (h)(3)(iv)(A)(1) of this section;
    (2) The Commissioner has issued a notice and demand for payment of 
the recapture tax amount to the subsequent elector in accordance with 
Sec.  301.6303-1 of this chapter;
    (3) The subsequent elector has failed to pay all of the recapture 
tax amount by the date specified in such notice and demand; and
    (4) The Commissioner has issued a notice and demand for payment of 
the unpaid portion of the recapture tax amount to the original elector, 
or prior subsequent elector (as the case may be), in accordance with 
Sec.  301.6303-1 of this chapter. The liability imposed under this 
paragraph (h)(3)(iv)(B) on the original elector and each prior 
subsequent elector shall be joint and several.
    (C) Allocation of partial payments of tax. If the subsequent 
elector's income tax liability for a taxable period includes a 
recapture tax amount, and if such income tax liability is satisfied in 
part by payment, credit, or offset, such

[[Page 29897]]

payment, credit or offset shall be allocated first to that portion of 
the income tax liability that is not attributable to the recapture tax 
amount, and then to that portion of the income tax liability that is 
attributable to the recapture tax amount.
    (D) Refund. If the Commissioner makes a refund of any income tax 
liability that includes a recapture tax amount, the Commissioner shall 
allocate and pay the refund to each elector who paid a portion of such 
income tax liability as follows:
    (1) The Commissioner shall first determine the total amount of 
recapture tax paid by and/or collected from the original elector and 
from any prior subsequent elector(s). The Commissioner shall then 
allocate and pay such refund to the original elector and prior 
subsequent elector(s), with each such elector receiving an amount of 
such refund on a pro rata basis, not to exceed the amount of recapture 
tax paid by and/or collected from such elector.
    (2) The Commissioner shall pay any balance of such refund, if any, 
to the subsequent elector.
    (v) Definition of income tax liability. Solely for purposes of 
paragraph (h)(3) of this section, the term income tax liability means 
the income tax liability imposed on a domestic corporation under Title 
26 of the United States Code for a taxable year, including additions to 
tax, additional amounts, penalties, and any interest charge related to 
such income tax liability.
    (vi) Example. See Sec.  1.1503(d)-5(c) Example 49.
    (4) Computation of taxable income in year of recapture--(i) 
Presumptive rule. Except to the extent provided in paragraph (h)(4)(ii) 
of this section, for purposes of computing the taxable income for the 
year of recapture, no current, carryover or carryback losses of the 
dual resident corporation or separate unit, of other members of the 
consolidated group, or of the domestic owner that are not attributable 
to the separate unit, may offset and absorb the recapture amount.
    (ii) Rebuttal of presumptive rule. The recapture amount included in 
gross income may be offset and absorbed by that portion of the 
elector's (consolidated or separate) net operating loss carryover that 
is attributable to the dual consolidated loss being recaptured, if the 
elector demonstrates, to the satisfaction of the Commissioner, the 
amount of such portion of the carryover. An elector utilizing this 
rebuttal rule must prepare a computation demonstrating the amount of 
net operating loss carryover that, under paragraph (h)(4)(ii) of 
section, may absorb the recapture amount included in gross income. Such 
computation must be signed under penalties of perjury and attached to 
and filed by the due date (including extensions) of, the income tax 
return for the taxable year in which the triggering event occurs.
    (5) Character and source of recapture income. The amount recaptured 
under paragraph (h) of this section shall be treated as ordinary 
income. Except as provided in the prior sentence, such income shall be 
treated, as applicable, as income from the same source, having the same 
character, and falling within the same separate category, for all 
purposes of the Internal Revenue Code, including sections 856(c)(2) and 
(3), 904(d), and 907, to which the items of deduction or loss composing 
the dual consolidated loss were allocated and apportioned, as provided 
under sections 861(b), 862(b), 863(a), 864(e), 865 and the regulations 
thereunder. See Sec.  1.1503(d)-5(c) Example 50.
    (6) Reconstituted net operating loss. Commencing in the taxable 
year immediately following the year in which the dual consolidated loss 
is recaptured, the dual resident corporation or separate unit (but only 
if such separate unit is owned, directly or indirectly, by a domestic 
corporation) shall be treated as having a net operating loss in an 
amount equal to the amount actually recaptured under paragraph (h) of 
this section. This reconstituted net operating loss shall be subject to 
the restrictions of Sec.  1.1503(d)-2(b) (and therefore, the 
restrictions of Sec.  1.1503(d)-3(c)(3)), without regard to the 
exceptions contained in paragraphs (b) through (d) of this section. The 
net operating loss shall be available only for carryover, under section 
172(b), to taxable years following the taxable year of recapture. For 
purposes of determining the remaining carryover period, the loss shall 
be treated as if it had been recognized in the taxable year in which 
the dual consolidated loss that is the basis of the recapture amount 
was incurred. See Sec.  1.1503(d)-5(c) Example 52.
    (i) Termination of domestic use agreement and annual 
certifications--(1) Rebuttal of triggering event. If, pursuant to 
paragraph (e)(2) of this section, an elector is able to rebut the 
presumption of a triggering event described in paragraphs (e)(1)(ii) 
through (ix) of this section, including complying with the related 
reporting requirements, then the domestic use agreement filed with 
respect to any dual consolidated losses that would have been recaptured 
as a result of the event, but for the rebuttal, shall terminate and 
have no further effect. See Sec.  1.1503(d)-5(c) Example 43.
    (2) Exception to triggering event. If an event described in 
paragraph (e)(1) of this section is not a triggering event as a result 
of the application of paragraph (f)(2)(i) or (ii) of this section, then 
the domestic use agreement filed with respect to any dual consolidated 
losses that would have been recaptured as a result of the event, but 
for the application of paragraph (f)(2)(i) or (f)(2)(ii) of this 
section, shall terminate and have no further effect. See Sec.  
1.1503(d)-5(c) Examples 46 and 49.
    (3) Recapture of dual consolidated loss. If a dual consolidated 
loss is recaptured pursuant to paragraph (h) of this section, then the 
domestic use agreement filed with respect to such recaptured dual 
consolidated loss shall terminate and have no further effect. See Sec.  
1.1503(d)-5(c) Examples 49 through 52.
    (4) Termination of ability for foreign use--(i) In general. A 
domestic use agreement filed with respect to a dual consolidated loss 
shall terminate and have no further effect as of the end of a taxable 
year if the elector--
    (A) Demonstrates, to the satisfaction of the Commissioner, that as 
of the end of such taxable year no foreign use of the dual consolidated 
loss can occur in any year by any means; and
    (B) Prepares a statement described in paragraph (i)(4)(ii) of this 
section that is attached to, and filed by the due date (including 
extensions) of, its U.S. income tax return for such taxable year.
    (ii) Statement. The statement described in this paragraph 
(i)(4)(ii) must be signed under penalties of perjury by the person who 
signs the return. The statement must be labeled Termination of Ability 
for Foreign Use at the top of the page and must include the following 
items, in paragraphs labeled to correspond with the following:
    (A) A statement that the document is submitted under the provisions 
of Sec.  1.1503(d)-4(i)(4).
    (B) The name, address, tax identification number, and place and 
date of incorporation of the dual resident corporation, and the country 
or countries that tax the dual resident corporation on its worldwide 
income or on a residence basis, or, in the case of a separate unit, 
identification of the separate unit, including the name under which it 
conducts business, its principal activity, and the country in which its 
principal place of business is located.
    (C) A statement of the amount of the dual consolidated loss at 
issue and the year in which such dual consolidated loss was incurred.

[[Page 29898]]

    (D) An analysis, in reasonable detail and specificity, supported 
with official or certified English translations of the relevant 
provisions of foreign law, of the treatment of the losses and 
deductions composing the dual consolidated loss under the laws of the 
foreign jurisdiction and the reasons supporting the conclusion that no 
foreign use of the dual consolidated loss can occur in any year by any 
means.


Sec.  1.1503(d)-5  Examples.

    (a) In general. This section provides examples that illustrate the 
application of Sec. Sec.  1.1503(d)-1 through 1.1503(d)-4. This section 
also provides facts that are presumed for such examples.
    (b) Presumed facts for examples. For purposes of the examples in 
this section, unless otherwise indicated, the following facts are 
presumed:
    (1) Each entity has only a single class of equity outstanding, all 
of which is held by a single owner.
    (2) P, a domestic corporation and the common parent of the P 
consolidated group, owns S, a domestic corporation and a member of the 
P consolidated group.
    (3) DRCX, a domestic corporation, is subject to Country 
X tax on its worldwide income or on a residence basis, and is a dual 
resident corporation.
    (4) DE1X and DE2X are both Country X 
entities, subject to Country X tax on their worldwide income or on a 
residence basis, and disregarded as entities separate from their owners 
for U.S. tax purposes. DE3Y is a Country Y entity, subject 
to Country Y tax on its worldwide income or on a residence basis, and 
disregarded as an entity separate from its owner for U.S. tax purposes. 
The interests in DE1X, DE2X, and DE3Y 
constitute hybrid entity separate units.
    (5) FBX is a foreign branch, as defined in Sec.  
1.367(a)-6T(g), and is a Country X foreign branch separate unit.
    (6) Neither the assets nor the activities of an entity constitutes 
a foreign branch separate unit.
    (7) FSX is a Country X entity that is subject to Country 
X tax on its worldwide income or on a residence basis and is classified 
as a foreign corporation for U.S. tax purposes.
    (8) The applicable foreign jurisdiction has a consolidation regime 
that--
    (i) Includes as members of a consolidated group any commonly 
controlled branches and permanent establishments in such jurisdiction, 
and entities that are subject to tax in such jurisdiction on their 
worldwide income or on a residence basis; and
    (ii) Allows the losses of members of consolidated groups to offset 
income of other members.
    (9) There is no mirror legislation, within the meaning of Sec.  
1.1503(d)-1(b)(14)(v), in the applicable foreign jurisdiction.
    (10) There is no elective agreement described in Sec.  1.1503(d)-
4(b) between the United States and the applicable foreign jurisdiction.
    (11) If a domestic use election, within the meaning of Sec.  
1.1503(d)-4(d), is made, all the necessary filings related to such 
election are properly completed on a timely basis.
    (12) If there is a triggering event requiring recapture of a dual 
consolidated loss, the amount of recapture is not reduced pursuant to 
Sec.  1.1503(d)-4(h)(2).
    (c) Examples. The following examples illustrate the application of 
Sec. Sec.  1.1503(d)-1 through 1.1503(d)-4:

    Example 1. Separate unit combination rule. (i) Facts. P owns 
DE3Y which, in turn, owns DE1X. 
DE1X owns FBX. Domestic partnership PRS, owned 
50% by P and 50% by an unrelated foreign person, conducts operations 
in Country X that constitute a foreign branch within the meaning of 
Sec.  1.367(a)-6T(g). S owns DE2X.
    (ii) Result. Pursuant to Sec.  1.1503(d)-1(b)(4)(ii), the 
interest in DE1X, FBX, and P's share of the 
Country X branch owned by PRS, which is owned by P indirectly 
through its interest in PRS, are combined and treated as one 
separate unit owned by P. P's interest in DE3Y, however, 
is another separate unit because it is subject to tax in Country Y, 
rather than Country X. S's interest in DE2X also is 
another separate unit because it is owned by S, a different domestic 
corporation.

    Example 2. Domestic use limitation--foreign branch separate 
unit. (i) Facts. P conducts operations in Country X that constitute 
a permanent establishment under the Country X income tax laws. In 
Year 1, P's Country X permanent establishment has a loss, as 
determined under Sec.  1.1503(d)-3(b)(2).
    (ii) Result. Under Sec.  1.1503(d)-1(b)(4)(i) and Sec.  
1.367(a)-6T(g)(1), P's Country X permanent establishment constitutes 
a foreign branch separate unit. Therefore, the Year 1 loss of the 
foreign branch separate unit constitutes a dual consolidated loss 
pursuant to Sec.  1.1503(d)-1(b)(5)(ii). The dual consolidated loss 
rules apply even though there is no affiliate of the foreign branch 
separate unit in Country X because it is still possible that all or 
a portion of the dual consolidated loss can be put to a foreign use. 
For example, there may be a foreign use with respect to an affiliate 
acquired in a year subsequent to the year in which the dual 
consolidated loss was generated. Accordingly, unless an exception 
under Sec.  1.1503(d)-4 applies (such as a domestic use election), 
the Year 1 dual consolidated loss of P's Country X permanent 
establishment is subject to the domestic use limitation rule of 
Sec.  1.1503(d)-2(b). As a result, the Year 1 dual consolidated loss 
cannot offset income of P that is not from its Country X foreign 
branch separate unit, or income from any other domestic affiliate of 
such foreign branch separate unit.

    Example 3. Domestic use limitation--no foreign consolidation 
regime. (i) Facts. The facts are the same as in Example 2, except 
that Country X does not have a consolidation regime that includes as 
members of consolidated groups Country X branches or permanent 
establishments.
    (ii) Result. The result is the same as Example 2. The dual 
consolidated loss rules apply even in the absence of a consolidation 
regime in the foreign country because it is possible that all or a 
portion of a dual consolidated loss can be put to a foreign use by 
other means, such as through an acquisition or similar transaction.

    Example 4. Domestic use limitation--foreign branch separate unit 
owned through a partnership. (i) Facts. P and S organize a 
partnership, PRSX, under the laws of Country X. 
PRSX is treated as a partnership for both U.S. and 
Country X income tax purposes. PRSX owns FBX. 
PRSX earns U.S. source income that is unconnected with 
its FBX branch operations and such income, therefore, is 
not subject to tax by Country X.
    (ii) Result. Under Sec.  1.1503(d)-1(b)(4)(i), P's and S's 
shares of FBX owned indirectly through their interests in 
PRSX are foreign branch separate units. Unless an 
exception under Sec.  1.1503(d)-4 applies, any dual consolidated 
loss incurred by FBX cannot offset income of P or S 
(other than income attributable to FBX), including their 
distributive share of the U.S. source income earned through their 
interests in PRSX, or income of any other domestic 
affiliates of FBX.

    Example 5. Domestic use limitation--interest in hybrid entity 
partnership and indirectly owned foreign branch separate unit. (i) 
Facts. HPSX is a Country X entity that is subject to 
Country X tax on its worldwide income. HPSX is classified 
as a partnership for U.S. tax purposes. P, S, and FX, an 
unrelated Country X corporation, are the sole partners of 
HPSX. For U.S. tax purposes, P, S, and FX each 
has an equal interest in each item of HPSX's profit or 
loss. HPSX conduct operations in Country Y that, if 
carried on by a U.S. person, would constitute a foreign branch 
within the meaning of Sec.  1.367(a)-6T(g).
    (ii) Result. Under Sec.  1.1503(d)-1(b)(4)(i), the partnership 
interests in HPSX held by P and S are hybrid entity 
separate units. In addition, P's and S's share of the Country Y 
branch owned indirectly through their interests in HPSX 
are foreign branch separate units. Unless an exception under Sec.  
1.1503(d)-4 applies, dual consolidated losses attributable to P's 
and S's interests in HPSX can only be used to offset 
income attributable to their respective interests in HPSX 
(other than income of HPSX's Country Y foreign branch 
separate unit). Similarly, dual consolidated losses of P's and S's 
interests in the Country Y branch of HPSX can only be 
used to offset income attributable to their respective interests in 
the Country Y branch.

    Example 6. Foreign use--general rule. (i) Facts. P owns 
DE1X. DE1X owns FSX. In Year

[[Page 29899]]

1, DE1X incurs a $100x net operating loss for both U.S. 
and Country X tax purposes. The $100x Year 1 loss of 
DE1X is attributable to P's interest in DE1X 
and is a dual consolidated loss. FSX earns $200x of 
income in Year 1 for Country X tax purposes. DE1X and 
FSX file a Country X consolidated tax return. For Country 
X purposes, the Year 1 $100x loss of DE1X is used to 
offset $100x of Year 1 income generated by FSX.
    (ii) Result. DE1X's $100x loss offsets 
FSX's income under the laws of Country X. In addition, 
under U.S. tax principles, such income is an item of FSX, 
a foreign corporation. As a result, under Sec.  1.1503(d)-
1(b)(14)(i), there has been a foreign use of the Year 1 dual 
consolidated loss attributable to P's interest in DE1X. 
Therefore, P cannot make a domestic use election with respect to the 
Year 1 dual consolidated loss of DE1X as provided under 
Sec.  1.1503(d)-4(d)(3)(i), and such loss will be subject to the 
domestic use limitation rule of Sec.  1.1503(d)-2(b). The result 
would be the same even if FSX, under Country X laws, had 
no income against which the dual consolidated loss of 
DE1X could be offset (unless FSX's ability to 
use the loss under Country X laws require an election, and no such 
election is made).

    Example 7. Foreign use--foreign reverse hybrid structure. (i) 
Facts. P owns DE1X. DE1X owns 99% and S owns 
1% of FRHX, a Country X partnership that elected to be 
treated as a corporation for U.S. tax purposes. FRHX 
conducts an active business in Country X. The 99% interest in 
FRHX is the only asset owned by DE1X. 
DE1X's sole item of income, gain, deduction, or loss in 
Year 1 for purposes of calculating a dual consolidated loss 
attributable to P's interest in DE1X is interest expense 
incurred on a loan from an unrelated party. DE1X's Year 1 
interest expense constitutes a dual consolidated loss. In Year 1, 
for Country X income tax purposes, DE1X took into account 
its distributive share of income generated by FRHX and 
offset such income with its interest expense.
    (ii) Result. In year 1, the dual consolidated loss attributable 
to P's interest in DE1X, offsets income recognized in 
Country X and under U.S. tax principles the income is considered to 
be income of FRHX, a foreign corporation. Accordingly, 
pursuant to Sec.  1.1503(d)-1(b)(14)(i), there is a foreign use of 
the dual consolidated loss. Therefore, P cannot make a domestic use 
election with respect to DE1X's Year 1 dual consolidated 
loss, as provided under Sec.  1.1503(d)-4(d)(3)(i), and such loss 
will be subject to the domestic use limitation rule of Sec.  
1.1503(d)-2(b).

    Example 8. Foreign use--inapplicability of no dilution exception 
to foreign reverse hybrid structure. (i) Facts. The facts are the 
same as in Example 7, except as follows. Instead of owning 
DE1X, P owns 75% of HPSX, a Country X entity 
subject to Country X tax on its worldwide income. FX, an 
unrelated foreign corporation, owns the remaining 25% of 
HPSX. HPSX is classified as a partnership for 
U.S. income tax purposes. HPSX owns 99% and S owns 1% of 
FRHX. HPSX incurs the Year 1 interest expense 
and P's interest in HPSX, therefore, has a dual 
consolidated loss in Year 1.
    (ii) Result. In year 1, the dual consolidated loss attributable 
to P's interest in HPSX offsets income recognized under 
Country X law and under U.S. tax principles the income is considered 
to be income of FRHX, a foreign corporation. Accordingly, 
pursuant to Sec.  1.1503(d)-1(b)(14)(i), there is a foreign use of 
the dual consolidated loss. In addition, the exception to foreign 
use under Sec.  1.1503(d)-1(b)(14)(iii)(C)(1)(i) does not apply 
because the foreign use is not solely the result of the dual 
consolidated loss being made available under Country X laws to 
offset an item of income or gain recognized under Country X laws 
that is considered, under U.S. tax principles, to be an item of 
FX. Instead, the income that is offset is, under U.S. tax 
principles, income of FRHX, a foreign corporation. 
Therefore, P cannot make a domestic use election with respect to the 
Year 1 dual consolidated loss attributable to its interest in 
HPSX, and such loss will be subject to the domestic use 
limitation rule of Sec.  1.1503(d)-2(b).

    Example 9. Foreign use--dual resident corporation with hybrid 
entity joint venture. (i) Facts. P owns DRCX, a member of 
the P consolidated group. DRCX owns 80% of 
HPSX, a Country X entity that is subject to Country X tax 
on its worldwide income. HPSX is classified as a 
partnership for U.S. tax purposes. FX, an unrelated 
foreign corporation, owns the remaining 20% of HPSX. In 
Year 1, DRCX generates a $100x net operating loss. Also 
in Year 1, HPSX generates $100x of income for Country X 
tax purposes. DRCX and HPSX file a 
consolidated tax return for Country X tax purposes, and 
HPSX offsets its $100x of income with the $100x loss 
generated by DRCX.
    (ii) Result. The $100x Year 1 net operating loss incurred by 
DRCX is a dual consolidated loss. In addition, 
HPSX is a hybrid entity and DRCX's interest in 
HPSX is a hybrid entity separate unit; however, there is 
no dual consolidated loss attributable to such separate unit in Year 
1. DRC X's Year 1 dual consolidated loss offsets $100x of 
income for Country X purposes, and $20x of such amount is (under 
U.S. tax principles) income of FX, which owns an interest 
in HPSX that is not a separate unit. As a result, 
pursuant to Sec.  1.1503(d)-1(b)(14)(i), there is a foreign use of 
the Year 1 dual consolidated loss of DRCX, and P cannot 
make a domestic use election with respect to such loss pursuant to 
Sec.  1.1503(d)-4(d)(3)(i). Therefore, such loss will be subject to 
the domestic use limitation rule of Sec.  1.1503(d)-2(b).

    Example 10. Foreign use--foreign parent corporation. (i) Facts. 
F1 and F2, nonresident alien individuals, each own 50% of 
FPX, a Country X entity that is subject to Country X tax 
on its worldwide income. FPX is classified as a 
corporation for U.S. tax purposes. FPX owns 
DRCX. DRCX is the parent of a consolidated 
group that includes as a member DS, a domestic corporation. In Year 
1, DRCX generates a dual consolidated loss of $100x and, 
for Country X tax purposes, FPX generates $100x of 
income. In Year 1, FPX elects to consolidate with 
DRCX, and the $100x Year 1 loss of DRCX is 
used to offset the income of FPX under the laws of 
Country X. For U.S. tax purposes, the items of FPX do not 
constitute items of income in Year 1.
    (ii) Result. The Year 1 dual consolidated loss of 
DRCX offsets the income of FPX under the laws 
of Country X. Pursuant to Sec.  1.1503(d)-1(b)(14)(i), the offset 
constitutes a foreign use because the items constituting such income 
are considered under U.S. tax principles to be items of a foreign 
corporation. This is the case even though the United States does not 
recognize such items as income in Year 1. Therefore, DRCX 
cannot make a domestic use election with respect to its Year 1 dual 
consolidated loss pursuant to Sec.  1.1503(d)-4(d)(3)(i). As a 
result, such loss will be subject to the domestic use limitation 
rule of Sec.  1.1503(d)-2(b).

    Example 11. Foreign use--parent hybrid entity. (i) Facts. The 
facts are the same as Example 10, except that FPX is classified as a 
partnership for U.S. tax purposes.

    (ii) Result. The dual consolidated loss of DRCX 
offsets the income of FPX under the laws of Country X. 
Pursuant to Sec.  1.1503(d)-1(b)(14)(i), such offset constitutes a 
foreign use because the items constituting such income are 
considered under U.S. tax principles to be items of F1 and F2, the 
owners of interests in FPX (a hybrid entity), that are 
not separate units. Therefore, DRCX cannot make a 
domestic use election with respect to its Year 1 dual consolidated 
loss pursuant to Sec.  1.1503(d)-4(d)(3)(i). As a result, such loss 
will be subject to the domestic use limitation rule of Sec.  
1.1503(d)-2(b). The result would be the same if F1 and F2 owned 
their interests in FPX indirectly through another 
partnership.

    Example 12. No foreign use--absence of foreign loss allocation 
rules. (i) Facts. P owns DE1X and DRCX. 
DRCX is a member of the P consolidated group and owns 
FSX. In Year 1, DRCX incurs a $200x net 
operating loss for both U.S. and Country X tax purposes, while 
DE1X recognizes $200x of income in Year 1 under the tax 
laws of each country. The $200x loss of DRCX is a dual 
consolidated loss. FSX also earns $200x of income in Year 
1 for Country X tax purposes. DRCX, DE1X, and 
FSX file a Country X consolidated tax return. However, 
Country X has no applicable rules for determining which income is 
offset by DRCX's Year 1 $200x loss.
    (ii) Result. Under Sec.  1.1503(d)-1(b)(14)(iii)(B), 
DRCX's $200x loss shall be treated as having been made 
available to offset DE1X's $200x of income. 
DE1X is not, under U.S. tax principles, a foreign 
corporation, and there is no interest in DE1X that is not 
a separate unit. As a result, DRCX's loss being made 
available to offset the income of DE1X is not considered 
a foreign use of such loss. Therefore, P can make a domestic use 
election with respect to DRCX's Year 1 dual consolidated 
loss.

    Example 13. No foreign use--absence of foreign loss usage 
ordering rules. (i) Facts. (A) P owns DRCX, a member of 
the P consolidated group. DRCX owns FSX. Under 
the Country X consolidation regime, a consolidated group may elect 
in any given year to use all or a portion of the losses of one 
consolidated group member to offset income of other consolidated 
group members. If no such election is made in a year in which losses 
are generated by a consolidated member, such losses carry forward 
and are available, at the election of the consolidated group, to 
offset income of

[[Page 29900]]

consolidated group members in subsequent tax years. Country X law 
does not provide ordering rules for determining when a loss from a 
particular tax year is used because, under Country X law, losses 
never expire. Similarly, Country X law does not provide ordering 
rules for determining when a particular type of loss (for example, 
capital or ordinary) is used. The United States and Country X 
recognize the same items of income, gain, deduction and loss in each 
year. In addition, neither DRCX nor FSX has 
items of income or loss for the taxable year other than those stated 
below.
    (B) In Year 1, DRCX incurs a capital loss of $80x 
which, under Sec.  1.1503(d)-3(b)(1), is not a dual consolidated 
loss. DRCX also incurs a net operating loss of $80x in 
Year 1. FSX generates $60x of capital gain in Year 1 
which, for Country X purposes, can be offset by capital losses and 
net operating losses. DRCX elects to use $60x of its 
total Year 1 loss of $160x to offset the $60x of capital gain 
generated by FSX in Year 1; the remaining $100x of Year 1 
loss carries forward. In Year 2, DRCX incurs a net 
operating loss of $100x, while FSX incurs a net operating 
loss of $50x. DRCX's $100x loss is a dual consolidated 
loss. Because DRCX does not elect under the laws of 
Country X to use all or a portion of its Year 2 net operating loss 
of $100x to offset the income of other members of the Country X 
consolidated group, P is permitted to make (and in fact does make) a 
domestic use election with respect to the Year 2 dual consolidated 
loss of DRCX. In Year 3, DRCX has a net 
operating loss of $10x and FSX generates $60x of capital 
gains. Country X law permits, upon an election, FSX's 
$60x of capital gain generated in Year 3 to be offset by losses 
(including carryover losses from prior years) of other group 
members. Accordingly, in Year 3, DRCX elects to use $60x 
of its accumulated losses to offset the $60x of Year 3 capital gain 
generated by FSX.
    (ii) Result. (A) DRCX's $80x Year 1 net operating 
loss is a dual consolidated loss. Under the ordering rules of Sec.  
1.1503(d)-1(b)(14)(iv)(C), a pro rata amount of DRCX's 
Year 1 net operating loss ($30x) and capital loss ($30x) is 
considered to be used to offset FSX's Year 1 $60x capital 
gain. As a result, P will not be able to make a domestic use 
election with respect to DRCX's Year 1 $80x dual 
consolidated loss.
    (B) DRCX's $10x Year 3 net operating loss is also a 
dual consolidated loss. Under the ordering rules of Sec.  1.1503(d)-
1(b)(14)(iv)(A), such loss is considered to be used to offset $10x 
of FSX's Year 3 $60x capital gain. Consequently, P will 
not be able to make a domestic use election with respect to such 
loss. Under the ordering rules of Sec.  1.1503(d)-1(b)(14)(iv)(B), 
$50x of loss carryover from Year 1 will be considered to offset the 
remaining $50x of Year 3 income because the income is deemed to have 
been offset by losses from the earliest taxable year from which a 
loss can be carried forward or back for foreign law purposes. Thus, 
none of DRCX's $100x Year 2 net operating loss will be 
deemed to offset FSX's remaining $50x of Year 3 income. 
As a result, such offset will not constitute a foreign use of 
DRCX's Year 2 dual consolidated loss.

    Example 14. No foreign use--no dilution of an interest in a 
separate unit. (i) Facts. (A) P owns 50% of HPSX, a 
Country X entity subject to Country X tax on its worldwide income. 
FX, an unrelated foreign corporation, owns the remaining 
50% of HPSX. HPSX is classified as a 
partnership for U.S. income tax purposes.
    (B) The United States and Country X recognize the same items of 
income, gain, deduction and loss in Years 1 and 2. In Year 1, 
HPSX incurs a loss of $100x. Under Sec.  1.1503(d)-
1(b)(4)(i)(B), P's interest in HPSX is a separate unit 
and P's interest in HPSX has a dual consolidated loss of 
$50x in Year 1. P makes a domestic use election with respect to such 
dual consolidated loss. In Year 2, HPSX generates $50x of 
income. Under Country X income tax laws, the $100x of Year 1 loss 
incurred by HPSX is carried forward and offsets the $50x 
of income generated by HPSX in Year 2; the remaining $50x 
of loss is carried forward and is available to offset income 
generated by HPSX in subsequent years. P and 
FX maintain their 50% ownership interests in 
HPSX throughout Years 1 and 2.
    (ii) Result. In Year 2, under the laws of Country X, the $100x 
of Year 1 loss, which includes the $50x dual consolidated loss 
attributable to P's interest in HPSX, is made available 
to offset income of HPSX. Such income would be 
attributable to P's interest in HPSX, which is a separate 
unit. Such income would also be income of FX, an owner of 
an interest in HPSX, which is not a separate unit. Under 
Sec.  1.1503(d)-1(b)(14)(iii)(B), because Country X does not have 
applicable rules for determining which Year 2 income of 
HPSX is offset by the $100x loss carried forward from 
year 1, the $50x dual consolidated loss is deemed to first have been 
made available to offset the $25x of income attributable to P's 
interest in HPSX. However, because only $25x of income is 
attributable to P's interest in HPSX, a portion of the 
remaining $25x of the dual consolidated loss is made available 
(under U.S. tax principles) to offset income of FX. As a 
result, a portion of the $50x dual consolidated loss is made 
available to offset income of the owner of an interest in a hybrid 
entity that is not a separate unit and, under the general rule of 
Sec.  1.1503(d)-1(b)(14)(i), there would be a foreign use of P's 
$50x Year 1 dual consolidated loss (there would also be a foreign 
use in this case because FX is a foreign corporation). 
However, pursuant to the exception to foreign use under Sec.  
1.1503(d)-1(b)(14)(iii)(C)(1)(i), there is no foreign use of the 
Year 1 dual consolidated loss in Year 2. In addition, the exceptions 
under Sec.  1.1503(d)-1(b)(14)(iii)(C)(2) do not apply because P's 
interest in HPSX as of the end of Year 1 has not been 
reduced, and the portion of the $50x dual consolidated loss was made 
available for a foreign use in Year 2 solely as a result of 
FX's ownership in HPSX and by the offsetting 
of income attributable to HPSX, the partnership in which 
FX holds an interest. Therefore, there is no foreign use 
of the Year 1 dual consolidated loss in Year 2. The result would be 
the same if FX owned its interest in HPSX 
indirectly through a partnership.

    Example 15. Foreign use--dilution of an interest in a separate 
unit. (i) Facts. The facts are the same as Example 14, except that 
at the beginning of Year 2, FX contributes cash to 
HPSX in exchange for additional equity of 
HPSX. As a result of the contribution, FX's 
interest in HPSX increases from 50% to 60%, and P's 
interest in HPSX decreases from 50% to 40%.
    (ii) Result. At the beginning of Year 2, P's interest in 
HPSX has been reduced as a result of a person other than 
a domestic corporation acquiring an interest in HPSX. 
Accordingly, pursuant to Sec.  1.1503(d)-1(b)(14)(iii)(C)(2)(i), the 
exception to foreign use provided under Sec.  1.1503(d)-
1(b)(14)(iii)(C)(1)(i) does not apply. Therefore, in Year 2 there is 
a foreign use of the $50x Year 1 dual consolidated loss attributable 
to P's interest in HPSX. Such foreign use constitutes a 
triggering event and the $50x Year 1 dual consolidated loss is 
recaptured.

    Example 16. No foreign use--dilution by a domestic corporation. 
(i) Facts. The facts are the same as Example 14, except that at the 
beginning of Year 2, instead of FX contributing cash to 
HPSX, S purchases 20% of P's interest in HPSX. 
As a result of the purchase, P's interest in HPSX 
decreases from 50% to 40%.
    (ii) Result. At the beginning of Year 2, P's interest in 
HPSX has been reduced as a result of a person acquiring 
an interest in HPSX. Accordingly, Sec.  1.1503(d)-
1(b)(14)(iii)(C)(1)(i) generally does not apply, and there would be 
a foreign use of the $50x Year 1 dual consolidated loss attributable 
to P's interest in HPSX. However, if P demonstrates, to 
the satisfaction of the Commissioner, that S is a domestic 
corporation in a statement attached to, and filed by the due date 
(including extensions) of P's U.S. income tax return for the taxable 
year in which the ownership interest of P was reduced, the exception 
to foreign use under Sec.  1.1503-1(b)(14)(iii)(C)(1)(i) will apply. 
In such a case, there will be no foreign use of the $50x Year 1 dual 
consolidated loss attributable to P's interest in HPSX. 
The result would be the same if S were unrelated to P, or if S 
acquired its interest in HPSX through the contribution of 
property to HPSX in exchange for equity (rather than as a 
purchase of a portion of P's interest).

    Example 17. Foreign use--foreign consolidation. (i) Facts. (A) P 
and FX, an unrelated Country X corporation, organize 
HPSY. P owns 20% of HPSY and FX 
owns 80% of HPSY. HPSY is classified as a 
partnership for U.S. income tax purposes and is a Country Y entity 
subject to Country Y tax on its worldwide income. HPSY 
conducts operations in Country X that, if carried on by a U.S. 
person, would constitute a foreign branch within the meaning of 
Sec.  1.367(a)-6T(g).
    (B) In Year 1, the Country X branch of HPSY has a 
loss of $100x as determined under Sec.  1.1503(d)-3(b)(2). Under 
Sec.  1.1503(d)-1(b)(4)(i), P's interest in HPSY is a 
separate unit, and P's indirect interest in a portion of the Country 
X branch of HPSY is also a separate unit. As a result, P 
has a dual consolidated loss of $20x in Year 1 attributable to its 
interest in the Country X branch owned indirectly through 
HPSY.

[[Page 29901]]

HPSY conducts no other activities in Year 1 and has no 
other items of income, gain, deduction or loss. Accordingly, there 
is no dual consolidated loss attributable to P's interest in 
HPSY. Under Country X income tax laws, FX 
elects to consolidate with the Country X branch of HPSY. 
As a result, the $100x Year 1 loss of the Country X branch of 
HPSY is available to offset the income of FX 
under the laws of Country X through consolidation.
    (ii) Result. Pursuant to Sec.  1.1503(d)-
1(b)(14)(iii)(C)(1)(ii), P's Year 1 $20x dual consolidated loss 
attributable to its indirect ownership of the Country X branch of 
HPSY would not generally be considered to be made 
available, under the laws of Country X, to reduce or offset an item 
of income or gain that is considered under U.S. tax principles to be 
income of FX. However, FX elected to 
consolidate with the Country X branch under Country X law such that 
the $20x dual consolidated loss attributable to P's interest in such 
separate unit is available to offset income under the laws of 
Country X as described in Sec.  1.1503(d)-1(b)(14)(iii)(C)(2)(ii). 
As a result, the exception under Sec.  1.1503(d)-
1(b)(14)(iii)(C)(1)(ii) shall not apply and there is a foreign use 
of the $20x Year 1 dual consolidated loss attributable to P's 
interest in the Country X branch of HPSY.

    Example 18. No foreign use--no election to consolidate under 
foreign law. (i) Facts. The facts are the same as in Example 17, 
except that FX does not elect under Country X law to 
consolidate with the Country X branch of HPSY.
    (ii) Result. Because FX does not elect to consolidate 
under foreign law, P's dual consolidated loss of $20x is not made 
available to offset FX's income, other than as a result 
of FX's ownership of HPSY. Accordingly, 
because there has been no dilution of P's interest in the Country X 
branch of HPSY, there has been no foreign use of P's $20x 
Year 1 dual consolidated loss pursuant Sec.  1.1503(d)-
1(b)(14)(iii)(C)(1)(ii).

    Example 19. No foreign use--combination rule. (i) Facts. (A) P 
and FX, an unrelated foreign corporation, form 
PRSX. P and FX each own 50 percent of 
PRSX throughout Years 1 and 2. PRSX is treated 
as a partnership for both U.S. and Country X income tax purposes. 
PRSX owns DEY. DEY is a Country Y 
entity subject to Country Y tax on its worldwide income and 
disregarded as an entity separate from its owner for U.S. tax 
purposes. PRSX does not have any items of income, gain, 
deduction, or loss from sources other than DEY. P also 
owns FBY, a Country Y foreign branch separate unit. 
Pursuant to Country Y law, the losses of DEY are 
available to offset the income of FBY, and vice versa. 
Under Sec.  1.1503(d)-1(b)(4)(i), P's interest in DEY, 
owned indirectly through PRSX, is a hybrid entity 
separate unit. In addition, under Sec.  1.1503(d)-1(b)(4)(ii), 
FBY and P's indirect interest in DEY are 
treated as a combined separate unit.
    (B) The United States and Country Y recognize the same items of 
income, gain, deduction and loss in Years 1 and 2. In year 1, 
DEY incurs a $100x loss and FBY incurs a $200x 
loss. Under Sec.  1.1503(d)-3(b)(vii)(B), the dual consolidated loss 
attributable to P's combined separate unit is $250x ($50x loss 
attributable to P's indirect interest in DEY plus $200x 
loss of FBY). In Year 2, DEY generates no 
income or loss.
    (ii) Result. Under Country Y law, the $100x of Year 1 loss 
incurred by DEY is carried forward and is available to 
offset income of DEY in Year 2. As a result, a portion of 
such loss will be available to offset income of DEY that 
is attributable to P's interest in DEY owned indirectly 
through PRSX. A portion of such loss will also be 
available to offset income of DEY that is attributable to 
FX's indirect ownership of DEY. Accordingly, 
under Sec.  1.1503(d)-1(b)(14)(i), there would be a foreign use of a 
portion of P's $250x Year 1 dual consolidated loss because it is 
available to offset an item of income of the owner of an interest in 
a hybrid entity, which is not a separate unit (there would also be a 
foreign use in this case because FX is a foreign 
corporation). However, under Sec.  1.1503(d)-1(b)(14)(iii)(C)(1)(ii) 
and (iii), and because there has been no dilution of P's interest in 
DEY (and no consolidation of DEY), no foreign 
use occurs as a result of the carryforward.

    Example 20. Mirror legislation rule--dual resident corporation. 
(i) Facts. P owns DRCX, a member of the P consolidated 
group. DRCX owns FSX. In Year 1, 
DRCX generates a $100x net operating loss that is a dual 
consolidated loss. To prevent corporations like DRCX from 
offsetting losses both against income of affiliates in Country X and 
against income of foreign affiliates under the tax laws of another 
country, Country X mirror legislation prevents a corporation that is 
subject to the income tax of another country on its worldwide income 
or on a residence basis from using the Country X form of 
consolidation. Accordingly, the Country X mirror legislation 
prevents the loss of DRCX from being made available to 
offset income of FSX.
    (ii) Result. Under Sec.  1.1503(d)-1(b)(14)(v), because the 
losses of DRCX are subject to Country X's mirror 
legislation, there shall, other than for purposes of the consistency 
rule under Sec.  1.1503(d)-4(d)(2), be a deemed foreign use of 
DRCX's Year 1 dual consolidated loss. Therefore, P will 
not be able to make a domestic use election with respect to 
DRCX's Year 1 dual consolidated loss pursuant to Sec.  
1.1503(d)-4(d)(3)(i).

    Example 21. Mirror legislation rule--standalone foreign branch 
separate unit. (i) Facts. P owns FBX. In Year 1, 
FBX incurs a dual consolidated loss of $100x. Under 
Country X tax laws, FBX also generates a loss. Country X 
enacted mirror legislation to prevent Country X branches of 
nonresident corporations from offsetting losses both against income 
of Country X affiliates and against other income of its owner (or 
foreign affiliate thereof) under the tax laws of another country. 
The Country X mirror legislation prevents a Country X branch of a 
nonresident corporation from offsetting its losses against the 
income of Country X affiliates if such losses may be deductible 
against income (other than income of the Country X branch) under the 
laws of another country.
    (ii) Result. Under Sec.  1.1503(d)-1(b)(14)(v), because the 
losses of FBX are subject to Country X's mirror 
legislation, there shall, other than for purposes of the consistency 
rule under Sec.  1.1503(d)-4(d)(2), be a deemed foreign use of 
FBX's Year 1 dual consolidated loss. This is the result 
even though P has no Country X affiliates. Therefore, P cannot make 
a domestic use election with respect to the Year 1 dual consolidated 
loss of FBX pursuant to Sec.  1.1503(d)-4(d)(3)(i).

    Example 22. Mirror legislation rule--absence of election to file 
consolidated return under local law. (i) Facts. The facts are the 
same as in Example 21, except that P also owns FSX and no 
election is made under Country X law to consolidate FBX 
and FSX.
    (ii) Result. The result is the same as Example 21, even though 
FBX has a Country X affiliate and no election is made 
under Country X law to consolidate FBX and 
FSX.

    Example 23. Mirror legislation rule--inapplicability to 
particular dual resident corporation or separate unit. (i) Facts. 
The facts are the same as in Example 21, except as follows. Rather 
than conducting operations in Country X through a foreign branch, P 
owns DE1X. In Year 1, DE1X incurs a loss of 
$100x and also generates a loss for Country X tax purposes. The 
$100x Year 1 loss of DE1X is a dual consolidated loss 
attributable to P's interest in DE1X.
    (ii) Result. The Country X mirror legislation only applies to 
Country X branches owned by non-resident corporations and therefore 
does not apply to losses generated by DE1X. Thus, if 
DE1X had a Country X affiliate, it would be permitted 
under the laws of Country X to use its loss to offset income of such 
affiliate, notwithstanding the Country X mirror legislation. As a 
result, the mirror legislation rule under Sec.  1.1503(d)-
1(b)(14)(v) does not apply with respect to the Year 1 dual 
consolidated loss of P's interest in DE1X. Therefore, a 
domestic use election can be made with respect to such loss 
(provided the conditions for such an election are otherwise 
satisfied).

    Example 24. Dual consolidated loss limitation after section 381 
transaction--disposition of assets and subsequent liquidation of 
dual resident corporation. (i) Facts. P owns DRCX, a 
member of the P consolidated group. In Year 1, DRCX 
incurs a dual consolidated loss and P does not make a domestic use 
election with respect to such loss. Under Sec.  1.1503(d)-2(b), 
DRCX's Year 1 dual consolidated loss may not be used to 
offset the income of P or S (or the income of any other domestic 
affiliate of DRCX) on the group's consolidated U.S. 
income tax return. At the beginning of Year 2, DRCX sells 
all of its assets and discontinues its business operations. 
DRCX is then liquidated into P pursuant to section 332.
    (ii) Result. Typically, under section 381, P would succeed to, 
and be permitted to utilize, DRCX's net operating loss 
carryover. However, Sec.  1.1503(d)-2(c)(1)(i) prohibits the dual 
consolidated loss of DRCX from carrying over to P. 
Therefore, DRCX's Year 1 net operating loss carryover is 
eliminated.

    Example 25. Dual consolidated loss limitation after section 381 
transaction--liquidation of dual resident corporation. (i) Facts. 
The facts are the same as in Example 24, except as follows. 
DRCX's activities

[[Page 29902]]

constitute a foreign branch within the meaning of Sec.  1.367(a)-
6T(g) and therefore are a foreign branch separate unit. In addition, 
DRCX's foreign branch separate unit incurs the Year 1 
dual consolidated loss, rather than DRCX itself. Finally, 
DRCX does not sell its assets and, following the 
liquidation of DRCX, P continues to operate 
DRCX's business as a foreign branch separate unit.
    (ii) Result. Pursuant to Sec.  1.1503(d)-2(c)(2)(iii), 
DRCX's Year 1 loss carryover is available to offset P's 
income generated by the foreign branch separate unit previously 
owned by DRCX (and now owned by P), subject to the 
limitations of Sec.  1.1503(d)-3(c) applied as if the separate unit 
of P generated the dual consolidated loss.

    Example 26. Tainted income. (i) Facts. P owns 100% of 
DRCZ, a domestic corporation that is included as a member 
of the P consolidated group. The P consolidated group uses the 
calendar year as its taxable year. During Year 1, DRCZ 
was managed and controlled in Country Z and therefore was subject to 
tax as a resident of Country Z and was a dual resident corporation. 
In Year 1, DRCZ generated a dual consolidated loss of 
$200x, and P did not make a domestic use election with respect to 
such loss. As a result, such loss is subject to the domestic use 
limitation rule of Sec.  1.1503(d)-2(b). At the end of Year 1, 
DRCZ moved its management and control from Country Z to 
the United States and therefore ceased being a dual resident 
corporation. At the beginning of Year 2, P transferred asset A, a 
non-depreciable asset, to DRCZ in exchange for common 
stock in a transaction that qualified for nonrecognition under 
section 351. At the time of the transfer, P's tax basis in asset A 
equaled $50x and the fair market value of asset A equaled $100x. The 
tax basis of asset A in the hands of DRCZ immediately 
after the transfer equaled $50x pursuant to section 362. Asset A did 
not constitute replacement property acquired in the ordinary course 
of business. DRCZ did not generate income or gain during 
Years 2, 3 or 4. On June 30, Year 5, DRCZ sold asset A to 
a third party for $100x, its fair market value at the time of the 
sale, and recognized $50x of income on such sale. In addition to the 
$50x income generated on the sale of asset A, DRCZ 
generated $100x of operating income in Year 5. At the end of Year 5, 
the fair market value of all the assets of DRCZ was 
$400x.
    (ii) Result. DRCZ ceased being a dual resident 
corporation at the end of Year 1. Therefore, its Year 1 dual 
consolidated loss cannot be offset by tainted income. Asset A is a 
tainted asset because it was acquired in a nonrecognition 
transaction after DRCZ ceased being a dual resident 
corporation (and was not replacement property acquired in the 
ordinary course of business). As a result, the $50x of income 
recognized by DRCZ on the disposition of asset A is 
tainted income and cannot be offset by the Year 1 dual consolidated 
loss of DRCZ. In addition, absent evidence establishing 
the actual amount of tainted income, $25x of the $100x Year 5 
operating income of DRCZ (($100x/$400x) x $100x) also is 
treated as tainted income and cannot be offset by the Year 1 dual 
consolidated loss of DRCZ under Sec.  1.1503(d)-
2(d)(2)(ii). Therefore, $75x of the $150x Year 5 income of 
DRCZ constitutes tainted income and may not be offset by 
the Year 1 dual consolidated loss of DRCZ; however, the 
remaining $75x of Year 5 income of DRCZ may be offset by 
such dual consolidated loss.

    Example 27. Treatment of disregarded item. (i) Facts. P owns 
DE1X. In Year 1, DE1X incurs interest expense 
attributable to a loan made from P to DE1X. 
DE1X has no other items of income, gain, deduction, or 
loss in Year 1. Because DE1X is disregarded as an entity 
separate from its owner, however, the interest expense is 
disregarded for federal tax purposes.
    (ii) Result. Even though DE1X is treated as a 
separate domestic corporation for purposes of determining the amount 
of dual consolidated loss pursuant to Sec.  1.1503(d)-3 (b)(2)(i), 
such treatment does not cause the interest expense incurred on the 
loan from P to DE1X that is disregarded for federal tax 
purposes to be regarded for purposes of calculating the Year 1 dual 
consolidated loss, if any, of DE1X. Therefore, P's 
interest in DE1X does not have a dual consolidated loss 
in Year 1.

    Example 28. Hybrid entity books and records. (i) Facts. P owns 
DE1X. In Year 1, P incurs interest expense attributable 
to a loan from a third party. The third party loan and related 
interest expense are properly recorded on the books and records of P 
(and not on the books and records of DE1X).
    (ii) Result. The interest expense on P's loan from the third 
party is not properly recorded on the books and records of 
DE1X. No portion of the interest expense on such loan is 
attributable to DE1X pursuant to Sec.  1.1503(d)-
3(b)(2)(iii) and (iv). Therefore, no portion of the interest expense 
is taken into account for purposes of calculating the Year 1 dual 
consolidated loss, if any, attributable to P's interest in 
DE1X pursuant to Sec.  1.1503(d)-3(b)(2).

    Example 29. Dividend income attributable to a separate unit. (i) 
Facts. P owns DE1X. DE1X owns DE3Y. 
DE3Y owns CFC, a controlled foreign corporation. P's 
interest in DE1X would otherwise have a dual consolidated 
loss of $75x (without regard to Year 1 dividend income or section 78 
gross-up received from CFC) in Year 1. In Year 1, CFC distributes 
$50x to DE3Y that is taxable as a dividend. 
DE3Y distributes the same amount to DE1X. P 
computes foreign taxes deemed paid on the dividend under section 902 
of $25x and includes that amount in gross income under section 78 as 
a dividend.
    (ii) Result. The $75x of dividend income ($50x distribution plus 
$25x section 78 gross-up) is properly recorded on the books and 
records of DE3Y, as adjusted to conform to U.S. tax 
principles. Accordingly, for purposes of determining whether the 
interest in DE3Y has a dual consolidated loss, the $75x 
dividend income from CFC is an item of income attributable to 
DE3Y, a disregarded entity, and therefore is an item 
attributable to the interest in DE3Y. The distribution of 
$50x from DE3Y to DE1X is generally not 
regarded for tax purposes and therefore does not give rise to an 
item that is taken into account for purposes of calculating a dual 
consolidated loss. As a result, the dual consolidated loss of $75x 
attributable to P's interest in DE1X in Year 1 is not 
reduced by the amount of dividend income attributable to the 
interest in DE3Y.

    Example 30. Items attributable to a combined separate unit. (i) 
Facts. P owns DE1X. DE1X owns a 50% interest 
in PRSZ, a Country Z entity that is classified as a 
partnership both for Country Z tax purposes and for U.S. tax 
purposes. FZ, a Country Z corporation unrelated to P, 
owns the remaining 50% interest in PRSZ. PRSZ 
conducts operations in Country X that, if owned by a U.S. person, 
would constitute a foreign branch as defined in Sec.  1.367(a)-
6T(g). Therefore, P's share of the Country X branch owned by 
PRSZ constitutes a foreign branch separate unit. 
PRSZ also owns assets that do not constitute a part of 
its Country X branch.
    (ii) Result. (A) Pursuant to Sec.  1.1503(d)-1(b)(4)(ii), P's 
interest in DE1X, and P's indirect ownership of a portion 
of the Country X branch of PRSZ, are combined and treated 
as one Country X separate unit. Pursuant to Sec.  1.1503(d)-
3(b)(2)(vii)(B)(1), for purposes of determining P's items of income, 
gain, deduction and loss taken into account by its combined separate 
unit, the items of P are first attributed to each separate unit that 
compose the combined Country X separate unit.
    (B) Pursuant to Sec.  1.1503(d)-3(b)(2)(ii)(A), the principles 
of section 864(c)(2), as modified, apply for purposes of determining 
P's items of income, gain, deduction (other than interest expense) 
and loss that are taken into account in determining the taxable 
income or loss of P's indirect interest in the Country X foreign 
branch owned by PRSZ. For purposes of determining 
interest expense taken into account in determining the taxable 
income or loss of P's indirect interest in the Country X foreign 
branch owned by PRSZ, the principles of Sec.  1.882-5, 
subject to Sec. 1.1503(d)-3(b)(2)(ii)(B), shall apply. For purposes 
of applying the principles of section 864(c) and Sec.  1.882-5, P is 
treated as a foreign corporation, the Country X branch of 
PRSZ is treated as a trade or business within the United 
States, and the assets of P (other than those of FBX) are 
treated as assets that are not U.S. assets. In addition, pursuant to 
Sec.  1.1503(d)-3(b)(2)(vii)(A)(1), only the items of 
DE1X and PRSZ are taken into account for 
purposes of this determination.
    (C) For purposes of determining the items of income, gain, 
deduction and loss that are attributable to DE1X and, 
therefore, attributable to P's interest in DE1X, only 
those items that are properly reflected on the books and records of 
DE1X, as adjusted to conform to U.S. tax principles, are 
taken into account. For this purpose, DE1X's distributive 
share of the items of income, gain, deduction and loss that are 
properly reflected on the books and records of PRSZ, as 
adjusted to conform to U.S. tax principles, are treated as being 
reflected on the books and records of DE1X, except to the 
extent such items are taken into account by the Country X branch of 
PRSZ, as provided above.
    (D) Pursuant to Sec.  1.1503(d)-3(b)(2)(vii)(B)(2), the combined 
Country X separate unit of P calculates its dual consolidated loss 
by taking into account all the items of income, gain deduction and 
loss

[[Page 29903]]

that were separately taken into account by P's interest in 
DE1X and the Country X branch of PRSZ owned 
indirectly by P.

    Example 31. Sale of branch by domestic owner. (i) Facts. P owns 
FBX. FBX has a $100x dual consolidated loss in 
Year 1. P makes a domestic use election with respect to such dual 
consolidated loss. In Year 2, P sells FBX and recognizes 
$75x of gain as a result of such sale. The sale is a triggering 
event of the Year 1 dual consolidated loss under Sec.  1.1503(d)-
4(e)(1).
    (ii) Result. Pursuant to Sec.  1.1503(d)-3(b)(2)(vii)(C), the 
gain on the sale of FBX is attributable to FBX 
for purposes of calculating the Year 2 dual consolidated loss (if 
any) of FBX, and for purposes of determining 
FBX's Year 2 taxable income for purposes of rebutting the 
amount of the Year 1 dual consolidated loss to be recaptured 
pursuant to Sec.  1.1503(d)-4(h)(2)(i). Assuming FBX has 
no other items of income, gain, deduction and loss in Year 2, only 
$25x of the Year 1 dual consolidated loss must be recaptured.

    Example 32. Sale of separate unit by another separate unit. (i) 
Facts. P owns DE1X. DE1X owns DE3Y. 
DE1X sells its interest in DE3Y at the end of 
Year 1 to an unrelated third party. The sale resulted in an ordinary 
loss of $30x. Without regard to the sale of DE3Y, no 
items of income, gain, deduction or loss are attributable to the 
interest of DE3Y in Year 1.
    (ii) Result. Pursuant to Sec.  1.1503(d)-3(b)(2)(vii)(C), the 
$30x loss recognized on the sale is attributable to the interest in 
DE3Y, and not the interest in DE1X. In 
addition, the loss attributable to the sale creates a Year 1 dual 
consolidated loss attributable to the interest in DE3Y. 
Pursuant to Sec.  1.1503(d)-4(d)(3)(i), P cannot make a domestic use 
election with respect to the Year 1 dual consolidated loss 
attributable to the interest in DE3Y because the sale of 
the interest in DE3Y is described in Sec.  1.1503(d)-
4(e)(1). As a result, although the Year 1 dual consolidated loss 
would otherwise be subject to the domestic use limitation rule of 
Sec.  1.1503(d)-2(b), it is eliminated pursuant to Sec.  1.1503(d)-
2(c)(1)(ii).

    Example 33. Gain and loss on sale of tiered separate units. (i) 
Facts. P owns DE1X. DE1X owns DE3Y. 
P sells its interest in DE1X to an unrelated third party. 
As a result of this sale, P recognizes $25x of net gain, consisting 
of $75 of income and $50 of loss. If DE1X sold its assets 
in a taxable transaction immediately before the sale of P's interest 
in DE1X, DE1X would have recognized $75x of 
income. In addition, if DE3Y had sold its assets in a 
taxable transaction immediately before the sale of P's interest in 
DE1X, DE3Y would have recognized a $50x loss.
    (ii) Result. Pursuant to sect; 1.1503(d)-3(b)(2)(vii)(C), the 
$75x of income and $50x of loss must be allocated to the interests 
of DE1X and DE3Y based on the amount of gain 
or loss that would be recognized if such entities sold their assets 
in a taxable exchange for an amount equal to their fair market value 
immediately before P sold its interest in DE1X. 
Therefore, $75x of gain and $50x of loss recognized by P on the sale 
of its interest DE1X are attributable to the interests in 
DE1X and DE3Y, respectively. As a result, such 
items will be taken into account in determining whether an interest 
in either entity has a dual consolidated loss in the year of the 
sale and for purposes of rebutting the amount of recapture of any 
dual consolidated loss (for which a domestic use election was made) 
of DE1X from a prior year, if any, pursuant to Sec.  
1.1503(d)-4(h)(2)(i).

    Example 34. Gain on sale of tiered separate units. (i) Facts. P 
owns 75% of HPSX, a Country X entity subject to Country X 
tax on its worldwide income. FX, a an unrelated foreign 
corporation, owns the remaining 25% of HPSX. 
HPSX is classified as a partnership for U.S. income tax 
purposes. HPSX owns operations in Country Y that, if 
owned by a U.S. person, would constitute a foreign branch within the 
meaning of Sec.  1.367(a)-6T(g). HPSX also owns assets 
that do not constitute a part of its Country Y branch. P's indirect 
interest in the Country Y branch owned by HPSX, and P's 
interest in HPSX, are each separate units. P sells its 
interest in HPSX and recognizes a gain of $150x on such 
sale. Immediately prior to P's sale of its interest in 
HPSX, P's indirect interest in HPSX's Country 
Y branch had a net built-in gain of $200x, and P's pro rata portion 
of HPSX's other assets had a net built-in gain of $100x.
    (ii) Result. Pursuant to Sec.  1.1503(d)-3(b)(2)(vii)(C), $100x 
of the total $150x of gain recognized ($200x/$300x x $150x) is taken 
into account for purposes of determining the taxable income of P's 
indirect interest in its share of the Country Y branch owned by 
HPSX. Thus, such amount will be taken into account in 
determining whether it has a dual consolidated loss in the year of 
the sale and for purposes of rebutting the amount of dual 
consolidated loss recapture, if any, pursuant to Sec.  1.1503(d)-
4(h)(2)(i). Similarly, $50x of such gain ($100x/$300x x $150x) is 
attributable to P's interest in HPSX and will be taken 
into account in determining whether it has a dual consolidated loss 
in the year of sale, and for purposes of rebutting the amount of 
recapture, if any, pursuant to Sec.  1.1503(d)-4(h)(2)(i).

    Example 35. Effect on domestic affiliate. (i) Facts. (A) P owns 
DE1X. In Years 1 and 2, the items of income, gain, 
deduction, and loss that are attributable to P's interest in 
DE1X for purposes of determining whether such interest 
has a dual consolidated loss for each year, pursuant to Sec.  
1.1503(d)-3(b)(2), are as follows:

------------------------------------------------------------------------
                       Item                           Year 1     Year 2
------------------------------------------------------------------------
Sales income......................................     $100x      $160x
Salary expense....................................      (75x)      (75x)
Research and experimental expense.................      (50x)      (50x)
Interest expense..................................      (25x)      (25x)
                                                   ------------
    Income/(dual consolidated loss)...............      (50x)       10x
------------------------------------------------------------------------

    (B) P does not make a domestic use election with respect to 
DE1X's Year 1 dual consolidated loss. Pursuant to 
Sec. Sec.  1.1503(d)-2(b) and 1.1503(d)-3(c)(2), DE1X's 
Year 1 dual consolidated loss of $50x is treated as a loss incurred 
by a separate corporation and is subject to the limitations under 
Sec.  1.1503(d)-3(c)(3).
    (ii) Result. (A) P must compute its taxable income for Year 1 
without taking into account the $50x dual consolidated loss 
attributable to P's interest in DE1X. Such amount 
consists of a pro rata portion of the expenses that were taken into 
account by DE1X in calculating its Year 1 dual 
consolidated loss. Thus, the items of the dual consolidated loss 
that are not taken into account by P in computing its taxable income 
are as follows: $25x of salary expense ($75x/$150x x $50x); $16.67x 
of research and experimental expense ($50x/$150x x $50x); and $8.33x 
of interest expense ($25x/$150x x $50x). The remaining amounts of 
each of these items, together with the $100x of sales income, are 
taken into account by P in computing its taxable income for Year 1 
as follows: $50x of salary expense ($75x-$25x); $33.33x of research 
and experimental expense ($50x-$16.67x); and $16.67x of interest 
expense ($25x-$8.33x).
    (B) Subject to the limitations provided under Sec.  1.1503(d)-
3(c)(3), the $50x dual consolidated loss generated by 
DE1X in Year 1 is carried forward and is available to 
offset the $10x of income generated by DE1X in Year 2. A 
pro rata portion of each item of deduction or loss included in such 
dual consolidated loss is considered to be used to offset the $10x 
of income, as follows: $5x of salary expense ($25x/$50x x $10x); 
$3.33x of research and experimental expense ($16.67x/$50x x $10x); 
and $1.67x of interest expense ($8.33x/$50x x $10x). The remaining 
amount of each item shall continue to be subject to the limitations 
under Sec.  1.1503(d)-3(c)(3).

    Example 36. Basis adjustment rule--year of dual consolidated 
loss. (i) Facts. (A) In addition to S, P owns S1, a domestic 
corporation. S owns DRCX and DRCX, in turn, 
owns FSX. S, S1 and DRCX are each members of 
the P consolidated group. W and Y are unrelated corporations that 
are not members of the P consolidated group.
    (B) At the beginning of Year 1, P has a basis of $1,000x in the 
stock of S. S has a $500x basis in the stock of DRCX.
    (C) In Year 1, DRCX incurs interest expense in the 
amount of $100x. In addition, DRCX sells a noncapital 
asset, u, in which it has a basis of $10x, to S1 for $50x. 
DRCX also sells a noncapital asset, v, in which it has a 
basis of $200x, to S1 for $100x. The sales of u and v are 
intercompany transactions described in Sec.  1.1502-13. 
DRCX also sells a capital asset, z, in which it has a 
basis of $180x, to Y for $90x. In Year 1, S1 earns $200x of separate 
taxable income, calculated in accordance with Sec.  1.1502-12, as 
well as $90x of capital gain from a sale of an asset to W. P and S 
have no items of income, gain, deduction or loss for Year 1.
    (D) In Year 1, DRCX has a dual consolidated loss of 
$100x (attributable to its interest expense). The sale of non-
capital assets u and v to S1, which are intercompany transactions, 
are not taken into account in calculating DRCX's dual 
consolidated loss. Pursuant to Sec.  1.1503(d)-3(b)(1), 
DRCX's $90x capital loss also is not included in the 
computation of the dual consolidated loss. Instead, 
DRCX's capital loss is included in

[[Page 29904]]

the computation of the consolidated group's capital gain net income 
under Sec.  1.1502-22(c) and is used to offset S1's $90x capital 
gain.
    (E) For Country X tax purposes, DRCX's $100x loss is 
available to offset the income of FSX, a foreign 
corporation, and therefore constitutes a foreign use. As a result, 
DRCX is not eligible to make a domestic use election 
pursuant to Sec.  1.1503(d)-4(d), and the $100x Year 1 dual 
consolidated loss of DRCX is subject to the domestic use 
limitation rule of Sec.  1.1503(d)-2(b).
    (ii) Result. (A) Because DRCX has a dual consolidated 
loss for the year, the consolidated taxable income of the 
consolidated group is calculated without regard to DRCX's 
items of loss or deduction taken into account in computing its dual 
consolidated loss (that is, the $100x of interest expense). 
Therefore, the consolidated taxable income of the consolidated group 
is $200x (the sum of $200x of separate taxable income earned by S1, 
plus $90x of capital gain earned by S1, minus $90x of capital loss 
incurred by DRCX). The $40x gain of DRCX upon 
the sale of item u to S1, and the $100x loss of DRCX upon 
the sale of item v to S1, are deferred pursuant to Sec.  1.1502-
13(c).
    (B) Pursuant to Sec.  1.1503(d)-3(d)(1)(i), S must make a 
negative adjustment under Sec.  1.1502-32(b)(2) to its basis in the 
stock of DRCX for the $100x dual consolidated loss 
incurred by DRCX. In addition, S must make a negative 
adjustment under Sec.  1.1502-32(b)(2) in the basis of the 
DRCX stock for DRCX's $90x capital loss 
because the loss has been absorbed by the consolidated group. Thus, 
S must make a $190x net negative adjustment to its basis in the 
stock of DRCX, reducing its basis from $500x to $310x. As 
provided in Sec.  1.1502-32(a)(3)(iii), the adjustments in the 
DRCX stock made by S are taken into account in 
determining P's basis in its S stock. Since S has no items of 
income, gain, deduction or loss for the taxable year, P must only 
make a negative adjustment to its basis in the stock of S to account 
for the tiering-up of adjustments for the taxable year pursuant to 
Sec.  1.1502-32(a)(3)(iii). Thus, P must make a $190x net negative 
adjustment to its basis in S stock, reducing its basis from $1,000x 
to $810x.

    Example 37. Basis adjustment rule--subsequent income of dual 
resident corporation. (i) Facts. (A) The facts are the same as in 
Example 36, except as follows. In Year 2, S1 sells items u and v to 
W for no gain or loss. The disposition of items u and v outside of 
the P consolidated group causes the intercompany gain and loss of 
DRCX attributable to u and v to be taken into account 
pursuant to Sec.  1.1502-13(c). DRCX also incurs $100x of 
interest expense in Year 2. In addition, DRCX sells a 
noncapital asset, r, in which it has a basis of $100x, to Y for 
$300x. P and S have no items of income, loss, or deduction for Year 
2.
    (B) DRCX has $40x of separate taxable income in Year 
2, computed as follows:

 
 
 
Interest Expense.............................................    ($100x)
Sale of Item v to S1.........................................     (100x)
Sale of Item u to S1.........................................       40x
Sale of Item r to Y..........................................      200x
                                                              ----------
    Net Income/(Loss)........................................       40x
 

    (C) Since DRCX does not have a dual consolidated loss 
for Year 2, the group's consolidated taxable income for the year is 
calculated in accordance with the general rule of Sec.  1.1502-11, 
and not in accordance with Sec.  1.1503(d)-3(c). In addition, 
DRCX is the only member of the consolidated group that 
has any income or loss for the taxable year. Thus, the consolidated 
taxable income of the group, computed without regard to 
DRCX's dual consolidated loss carryover, is $40x.
    (ii) Result. (A) As provided under Sec.  1.1503(d)-3(c), the 
portion of the $100x dual consolidated loss arising in Year 1 that 
is included in the group's consolidated net operating loss deduction 
for Year 2 is $40x. Thus, the P group has no consolidated taxable 
income for the year.
    (B) Pursuant to Sec.  1.1503(d)-3(d)(1)(ii), S does not make a 
negative adjustment to its basis in DRCX stock for the 
$40x of Year 1 dual consolidated loss that is absorbed in Year 2. 
However, pursuant to Sec.  1.1502-32(b), S does make a $40x net 
positive adjustment to its basis in DRCX stock, 
increasing its basis from $310x to $350x. In addition, as provided 
in Sec.  1.1502-32(a)(3)(iii), the adjustments in the 
DRCX stock made by S are taken into account in 
determining P's basis in its S stock. Since S has no other items of 
income, gain, deduction or loss for the taxable year, P must only 
make a positive adjustment to its basis in the stock of S for to 
account for the tiering-up of adjustments for the taxable year 
pursuant to Sec.  1.1502-32(a)(3)(iii). Thus, P must make a $40x net 
positive adjustment to its basis in S stock, increasing its basis 
from $810x to $850x.

    Example 38. Exception to domestic use limitation--no possibility 
of foreign use because items are not deducted or capitalized under 
foreign law. (i) Facts. P owns DE1X. In Year 1, the sole 
item of income, gain, deduction or loss attributable to P's interest 
in DE1X as provided under Sec.  1.1503(d)-3(b)(2) is 
$100x of interest expense. For Country X tax purposes, the $100x 
interest expense attributable to P's interest in DE1X in 
Year 1 is treated as a repayment of principal and therefore cannot 
be deducted (at any time) or capitalized.
    (ii) Result. The $100x of interest expense attributable to P's 
interest in DE1X constitutes a dual consolidated loss. 
However, because the sole item constituting the dual consolidated 
loss cannot be deducted or capitalized for Country X tax purposes, P 
can demonstrate that there can be no foreign use of the dual 
consolidated loss at any time. As a result, pursuant to Sec.  
1.1503(d)-4(c)(1), if P prepares a statement described in Sec.  
1.1503(d)-4(c)(2) and attaches it to its timely filed tax return, 
the Year 1 dual consolidated loss of DE1X will not be 
subject to the domestic use limitation rule of Sec.  1.1503(d)-2(b).

    Example 39. No exception to domestic use limitation--inability 
to demonstrate no possibility of foreign use because items are 
deferred under foreign law. (i) Facts. P owns DE1X. In 
Year 1, the sole items of income, gain, deduction or loss 
attributable to P's interest in DE1X as provided under 
Sec.  1.1503(d)-3(b)(2) are $75x of sales income and $100x of 
depreciation expense. For Country X tax purposes, DE1X 
also generates $75x of sales income in Year 1, but the $100x of 
depreciation expense is not deductible in Year 1. Instead, for 
Country X tax purposes the $100x of depreciation expense is 
deductible in Year 2. P does not make a domestic use election with 
respect to the Year 1 dual consolidated loss attributable to P's 
interest in DE1X.
    (ii) Result. The Year 1 $25x net loss of DE1X 
constitutes a dual consolidated loss attributable to P's interest in 
DE1X. In addition, even though DE1X has 
positive income in Year 1 for Country X tax purposes, P cannot 
demonstrate that there is no possibility of foreign use of its dual 
consolidated loss as provided under Sec.  1.1503(d)-4(c)(1)(i). P 
cannot make such a demonstration because the depreciation expense, 
an item composing the Year 1 dual consolidated loss, is deductible 
(in a later year) for Country X tax purposes and, therefore, may be 
available to offset or reduce income for Country X purposes that 
would constitute a foreign use. For example, if DE1X 
elected to be classified as a corporation pursuant to Sec.  
301.7701-3(c) of this chapter effective as of the end of Year 1, and 
the deferred depreciation expense were available for Country X tax 
purposes to offset Year 2 income of DE1X, an entity 
treated as a foreign corporation in Year 2 for U.S. tax purposes, 
there would be a foreign use. P could, however, make a domestic use 
election pursuant to Sec.  1.1503(d)-4(d) with respect to the Year 1 
dual consolidated loss.

    Example 40. No exception to domestic use limitation--inability 
to demonstrate no possibility of foreign use because items are 
deferred and not deducted or capitalized under foreign law. (i) 
Facts. P owns DE1X. In Year 1, the sole items of income, 
gain, deduction or loss attributable to P's interest in 
DE1X as provided in Sec.  1.1503(d)-3(b)(2) are $75x of 
sales income, $100x of interest expense and $25x of depreciation 
expense. For Country X tax purposes, DE1X generates $75x 
of sales income in Year 1, but the $100x interest expense is treated 
as a repayment of principal and therefore cannot be deducted (at any 
time) or capitalized. In addition, for Country X tax purposes the 
$25x of depreciation expense is not deductible in Year 1, but is 
deductible in Year 2.
    (ii) Result. The Year 1 $50x net loss of DE1X 
constitutes a dual consolidated loss attributable to P's interest in 
DE1X. Even though the $100x interest expense, a 
nondeductible and noncapital item for Country X tax purposes, 
exceeds the $50x Year 1 dual consolidated loss of DE1X, P 
cannot demonstrate that there is no possibility of foreign use of 
the dual consolidated loss as provided under Sec.  1.1503(d)-
4(c)(1)(i). P cannot make such a demonstration because the $25x 
depreciation expense, an item of deduction or loss composing the 
Year 1 dual consolidated loss, is deductible under Country X law (in 
Year 2) and, therefore, may be available to offset or reduce income 
for Country X purposes that would constitute a foreign use. P could, 
however, make a domestic use election pursuant to Sec.  1.1503(d)-
4(d) with respect to the Year 1 dual consolidated loss.

    Example 41. Consistency rule--deemed foreign use. (i) Facts. P 
owns DRCX, a

[[Page 29905]]

member of the P consolidated group, FBX, and 
FSX. In Year 1, DRCX incurs a dual 
consolidated loss, which is used to offset the income of 
FSX under the Country X form of consolidation. 
FBX also incurs a dual consolidated loss in Year 1. 
However, P elects not to use the FBX loss on a Country X 
consolidated return to offset the income of Country X affiliates.
    (ii) Result. The use of DRCX's dual consolidated loss 
to offset the income of FSX for Country X purposes 
constitutes a foreign use. Pursuant to Sec.  1.1503(d)-4(d)(2), this 
foreign use results in a foreign use of the dual consolidated loss 
of FBX. Therefore, the dual consolidated loss 
attributable to FBX is subject to the domestic use 
limitation rule of Sec.  1.1503(d)-2(b), and P cannot make a 
domestic use election with respect to such loss.

    Example 42. Consistency rule--no foreign use permitted. (i) 
Facts. The facts are the same as in Example 41, except that the 
income tax laws of Country X do not permit Country X branches of 
foreign corporations to file consolidated income tax returns with 
Country X affiliates.
    (ii) Result. The consistency rule does not apply with respect to 
the dual consolidated loss of FBX because the income tax 
laws of Country X do not permit a foreign use for such dual 
consolidated loss. Therefore, P may make a domestic use election for 
the dual consolidated loss attributable to FBX.

    Example 43. Triggering event rebuttal--expiration of losses in 
foreign country. (i) Facts. P owns DRCX, a member of the 
P consolidated group. In Year 1, DRCX incurs a dual 
consolidated loss of $100x. P makes a domestic use election with 
respect to DRCX's Year 1 dual consolidated loss and such 
loss therefore is included in the computation of the P group's 
consolidated taxable income. DRCX has no income or loss 
in Year 2 through Year 6. In Year 7, P sells the stock of 
DRCX to an unrelated party. At the time of the sale of 
the stock of DRCX, all of the losses and deductions that 
were included in the computation of the Year 1 dual consolidated 
loss of DRCX had expired for Country X purposes because 
the laws of Country X only provide for a five year carryover period 
of such items.
    (ii) Result. The sale of DRCX to the unrelated party 
generally would be a triggering event under Sec.  1.1503(d)-
4(e)(1)(ii), which would require the recapture of the Year 1 dual 
consolidated loss (and an applicable interest charge). However, upon 
adequate documentation that the losses and deductions have expired 
for Country X purposes, P can rebut the presumption that a 
triggering event has occurred pursuant to Sec.  1.1503(d)-4(e)(2). 
Pursuant to Sec.  1.1503(d)-4(i)(1), if the triggering event 
presumption is rebutted, the domestic use agreement filed by the P 
consolidated group with respect to the Year 1 dual consolidated loss 
of DRCX is terminated and has no further effect (absent a 
rebuttal, the domestic use agreement would terminate pursuant to 
Sec.  1.1503(d)-4(i)(3)).

    Example 44. Inability to rebut triggering event--tax basis 
carryover transaction. (i) Facts. (A) P owns DE1X. 
DE1X's sole asset is A, which it acquired at the 
beginning of Year 1 for $100x. DE1X does not have any 
liabilities. For U.S. tax purposes, DE1X's tax basis in A 
at the beginning of Year 1 is $100x and DE1X's sole item 
of income, gain, deduction and loss for Year 1 is a $20x 
depreciation deduction attributable to A. As a result, 
DE1X's Year 1 $20x depreciation deduction constitutes a 
dual consolidated loss attributable to P's interest in 
DE1X. P makes a domestic use election with respect to 
DE1X's Year 1 dual consolidated loss.
    (B) For Country X tax purposes, DE1X has a $100x tax 
basis in A at the beginning of Year 1, but A is not a depreciable 
asset. As a result, DE1X does not have any items of 
income, gain, deduction or loss in Year 1 for Country X tax 
purposes.
    (C) At the beginning of Year 2, P sells its interest in 
DE1X to F, an unrelated foreign person, for $80x. P's 
disposition of its interest in DE1X constitutes a 
presumptive triggering event under Sec.  1.1503(d)-4(e)(1) requiring 
the recapture of the $20x dual consolidated loss (plus the 
applicable interest charge). For Country X tax purposes, 
DE1X retains its tax basis of $100x in A following the 
sale.
    (ii) Result. The Year 1 dual consolidated loss is a result of 
the $20x depreciation deduction attributable to A. Although no item 
of loss or deduction was recognized by DE1X by the time 
of the sale for Country X tax purposes, the deduction composing the 
dual consolidated loss was retained by DE1X after the 
sale in the form of tax basis in A. As a result, a portion of the 
dual consolidated loss may offset income for Country X purposes in a 
manner that would constitute a foreign use. For example, if 
DE1X were to dispose of A, the amount of gain recognized 
by DE1X would be reduced and, therefore, an item 
composing the dual consolidated loss would reduce foreign income of 
an owner of an interest in a hybrid entity that is not a separate 
unit. Thus, P cannot demonstrate pursuant to Sec.  1.1503(d)-4(e)(2) 
that there can be no foreign use of the Year 1 dual consolidated 
loss following the triggering event and must recapture the Year 1 
dual consolidated loss. Pursuant to Sec.  1.1503(d)-4(i)(3), the 
domestic use agreement filed by the P consolidated group with 
respect to the Year 1 dual consolidated loss of DE1X is 
terminated and has no further effect.

    Example 45. Ability to rebut triggering event--taxable asset 
sale. (i) Facts. The facts are the same as Example 44, except that 
instead of P selling its interests in DE1X to F, 
DE1X sells asset A to F for $80x. Such sale constitutes a 
presumptive triggering event under Sec.  1.1503(d)-4(e)(1). For 
Country X tax purposes, F's tax basis in A is $80x.
    (ii) Result. The Year 1 dual consolidated loss attributable to 
P's interest in DE1X is a result of the $20x depreciation 
deduction attributable to A. For Country X tax purposes, however, 
F's tax basis in A was not determined, in whole or in part, by 
reference to the basis of A in the hands of DE1X. As a 
result, the deduction composing the dual consolidated loss will not 
give rise to an item of deduction or loss in the form of tax basis 
for Country X purposes (for example, when F disposes of A). 
Therefore, P may be able to demonstrate pursuant to Sec.  1.1503(d)-
4(e)(2) that there can be no foreign use of the Year 1 dual 
consolidated loss and, thus, may not be required to recapture the 
Year 1 dual consolidated loss. Pursuant to Sec.  1.1503(d)-4(i)(1), 
if such a demonstration is made, the domestic use agreement filed by 
the P consolidated group with respect to the Year 1 dual 
consolidated loss of DE1X is terminated pursuant to Sec.  
1.1503(d)-4(i)(1) and has no further effect (absent a rebuttal, the 
domestic use agreement would terminate pursuant to Sec.  1.1503(d)-
4(i)(3)).

    Example 46. Termination of consolidated group not a triggering 
event if acquirer files a new domestic use agreement. (i) Facts. P 
owns DRCX, a member of the P consolidated group. The P 
consolidated group uses the calendar year as its taxable year. In 
Year 1, DRCX incurs a dual consolidated loss and P makes 
a domestic use election with respect to such loss. No member of the 
P consolidated group incurs a dual consolidated loss in Year 2. On 
December 31, Year 2, T, the parent of the T consolidated group 
acquires all the stock of P, and all the members of the P group, 
including DRCX, become members of a consolidated group of 
which T is the common parent.
    (ii) Result. (A) Under Sec.  1.1503(d)-4(f)(2)(ii)(B), the 
acquisition by T of the P consolidated group is not an event 
described in Sec.  1.1503(d)-4(e)(1) requiring the recapture of the 
Year 1 dual consolidated loss of DRCX (and the payment of 
an interest charge), provided that the T consolidated group files a 
new domestic use agreement described in Sec.  1.1503(d)-
4(f)(2)(iii)(A). If a new domestic use agreement is filed, then 
pursuant to Sec.  1.1503(d)-4(i)(2), the domestic use agreement 
filed by the P consolidated group with respect to the Year 1 dual 
consolidated loss of DRCX is terminated and has no 
further effect.
    (iii) If a triggering event occurs on December 31, Year 3, the T 
consolidated group must recapture the dual consolidated loss that 
DRCX incurred in Year 1 (and pay an interest charge), as 
provided in Sec.  1.1503(d)-4(h). Each member of the T consolidated 
group, including DRCX and any former members of the P 
consolidated group, is severally liable for the additional tax (and 
the interest charge) due upon the recapture of the dual consolidated 
loss of DRCX. In addition, pursuant to Sec.  1.1503(d)-
4(i)(3), the new domestic use agreement filed by the T group with 
respect to the Year 1 dual consolidated loss of DRCX is 
terminated and has no further effect.

    Example 47. No triggering event if consolidated group remains in 
existence in connection with a reverse acquisition. (i) Facts. S 
owns FBX. FBX incurs a dual consolidated loss 
of $100x in Year 1 and P makes a domestic use election with respect 
to such loss. At the end of Year 2, P merges into T, the common 
parent of the T consolidated group, which includes U as a member. 
The shareholders of P immediately before the merger, as a result of 
owning stock in P, own 60% of the fair market value of T's stock 
immediately after the merger.
    (ii) Result. The P group is treated as continuing in existence 
under Sec.  1.1502-75(d)(3) with T and U being added as members of 
the P group, and T taking the place of P as the common parent. The 
merger of P into T does not constitute a triggering

[[Page 29906]]

event with respect to the dual consolidated loss in Year 1 pursuant 
to Sec.  1.1503(d)-4(e)(1)(ii) because the P consolidated group, 
which owned FBX, continues to exist.

    Example 48. Triggering event exception--acquisition of assets by 
domestic owner. (i) Facts. P owns DE1X. In Year 1, 
DE1X incurs a loss of $100x and, as a result, P's 
interest in DE1X has a Year 1 dual consolidated loss of 
$100x. P makes a domestic use election with respect to the Year 1 
dual consolidated loss and such loss therefore is included in the 
computation of the P group's consolidated taxable income. In Year 3, 
DE1X dissolves and surrenders its Country X corporate 
charter. Pursuant to its dissolution, DE1X distributes 
its assets and liabilities to P and the shares of DE1X 
are cancelled.
    (ii) Result. The disposition of the assets of DE1X 
(and the disposition of P's interest in DE1X) as a result 
of the dissolution generally would be a triggering event under Sec.  
1.1503(d)-4(e)(1). However, because the assets of DE1X 
are acquired by P, its domestic owner, as a result of the 
dissolution, the dissolution does not constitute a triggering event 
under Sec.  1.1503(d)-4(f)(1).

    Example 49. Subsequent elector rules. (i) Facts. P owns 
DRCX, a member of the P consolidated group. The P 
consolidated group uses the calendar year as its taxable year. In 
Year 1, DRCX incurs a dual consolidated loss and P makes 
a domestic use election with respect to such loss. No member of the 
P consolidated group incurs a dual consolidated loss in Year 2. On 
December 31, Year 2, T, the parent of the T consolidated group that 
also uses the calendar year as its taxable year, acquires all the 
stock of DRCX for cash.
    (ii) Result. (A) Under Sec.  1.1503(d)-4(f)(2)(i)(A), the 
acquisition by T of DRCX is not an event described in 
Sec.  1.1503(d)-4(e)(1) requiring the recapture of the Year 1 dual 
consolidated loss of DRCX (and the payment of an interest 
charge), provided: (1) the T consolidated group files a new domestic 
use agreement described in Sec.  1.1503(d)-4 (f)(2)(iii)(A) with 
respect to the Year 1 dual consolidated loss of DRCX; and 
(2) the P consolidated group files a statement described in Sec.  
1.1503(d)-4(f)(2)(iii)(B) with respect to the Year 1 dual 
consolidated loss of DRCX. If these requirements are 
satisfied, then pursuant to Sec.  1.1503(d)-4(i)(2) the domestic use 
agreement filed by the P consolidated group with respect to the Year 
1 dual consolidated loss of DRCX is terminated and has no 
further effect (if such requirements are not satisfied, the domestic 
use agreement would terminate pursuant to Sec.  1.1503(d)-4(i)(3).
    (B) Assume a triggering event occurs on December 31, Year 3, 
that requires recapture by the T consolidated group of the dual 
consolidated loss that DRCX incurred in Year 1, as well 
as the payment of an interest charge, as provided in Sec.  
1.1503(d)-4(h). In that case, each member of the T consolidated 
group, including DRCX, is severally liable for the 
additional tax (and the interest charge) due upon the recapture of 
the Year 1 dual consolidated loss of DRCX. The T 
consolidated group must prepare a statement that computes the 
recapture tax amount as provided under Sec.  1.1503(d)-4(h)(3)(iii). 
Pursuant to Sec.  1.1503(d)-4(h)(3)(iv)(A), the recapture tax amount 
is assessed as an income tax liability of the T consolidated group 
and is considered as having been properly assessed as an income tax 
liability of the P consolidated group. If the T consolidated group 
does not pay in full the income tax liability attributable to the 
recapture tax amount, the unpaid balance of such recapture tax 
amount may be collected from the P consolidated group in accordance 
with the provisions of Sec.  1.1503(d)-4(h)(3)(iv)(B). Pursuant to 
Sec.  1.1503(d)-4(i)(3), the new domestic use agreement filed by the 
T consolidated group is terminated and has no further effect.

    Example 50. Character and source of recapture income. (i) Facts. 
(A) P owns DE1X. In Year 1, the items of income, gain, 
deduction, and loss that are attributable to P's interest in 
DE1X for purposes of determining whether such interest 
has a dual consolidated loss are as follows:

 
 
 
Sales income.................................................     $100x
Salary expense...............................................      (75x)
Interest expense.............................................      (50x)
                                                              ----------
    Dual consolidated loss...................................      (25x)
 

    (B) P makes a domestic use election with respect to the Year 1 
dual consolidated loss attributable to P's interest in 
DE1X and, thus, the $25x dual consolidated loss is 
included in the computation of P's taxable income.
    (C) Pursuant to Sec.  1.861-8, the $75x of salary expense 
incurred by DE1X is allocated and apportioned entirely to 
foreign source general limitation income. Pursuant to Sec.  1.861-
9T, $25x of the $50x interest expense attributable to 
DE1X is allocated and apportioned to domestic source 
income, $15x of such interest expense is allocated and apportioned 
to foreign source general limitation income, and the remaining $10x 
of such interest expense is allocated and apportioned to foreign 
source passive income.
    (D) During Year 2, DE1X generates $5x of income, an 
amount which the $25x dual consolidated loss generated by 
DE1X in Year 1 would have offset if such loss had been 
subject to the separate return limitation year restrictions as 
provided under Sec.  1.1503(d)-3(c)(3).
    (E) At the beginning of Year 3, DE1X undergoes a 
triggering event within the meaning of Sec.  1.1503(d)-4(e)(1). 
Pursuant to Sec.  1.1503(d)-4(h)(2)(i), P demonstrates, to the 
satisfaction of the Commissioner, that the $5x generated by 
DE1X in Year 2 qualifies to reduce the amount that P must 
recapture as a result of the triggering event.
    (ii) Result. P must recapture and report as income $20x ($25x-
$5x) of DE1X's Year 1 dual consolidated loss, plus 
applicable interest, on its Year 3 tax return. Pursuant to Sec.  
1.1503(d)-4(h)(5), the recapture income is treated as ordinary 
income whose source and character (including section 904 separate 
limitation character) is determined by reference to the manner in 
which the recaptured items of expense or loss taken into account in 
calculating the dual consolidated loss were allocated and 
apportioned. Accordingly, P's $20x of recapture income is 
characterized and sourced as follows: $4x of domestic source income 
(($25x/$125x) x $20x); $14.4x of foreign source general limitation 
income (($75x+$15x)/$125x)x$20x); and $1.6x of foreign source 
passive income (($10x/$125x) x $20x). Pursuant to Sec.  1.1503(d)-
4(i)(3), the domestic use agreement filed by the P consolidated 
group with respect to the Year 1 dual consolidated of 
DE1X is terminated and has no further effect.

    Example 51. Interest charge without recapture. (i) Facts. P owns 
DE1X. In Year 1, a dual consolidated loss of $100x is 
attributable to P's interest in DE1X. P makes a domestic 
use election with respect to the Year 1 dual consolidated loss and 
uses the loss to offset the P group's consolidated taxable income. 
DE1X earns income of $100x in Year 2. At the end of Year 
2, DE1X undergoes a triggering event within the meaning 
of Sec.  1.1503(d)-4(e)(1). P demonstrates, to the satisfaction of 
the Commissioner, that taking into the limitation of Sec.  
1.1503(d)-3(c)(3) (modified SRLY limitation), the Year 1 $100x dual 
consolidated loss would have been offset by the $100x Year 2 income.
    (ii) Result. There is no recapture of the Year 1 dual 
consolidated loss attributable to P's interest in DE1 because it is 
reduced to zero under Sec.  1.1503(d)-4(h)(2)(i). However, P is 
liable for one year of interest charge under Sec.  1.1503(d)-
4(h)(1)(ii), even though P's recapture amount is zero. Pursuant to 
Sec.  1.1503(d)-4(i)(3), the domestic use agreement filed by the P 
consolidated group with respect to the Year 1 dual consolidated of 
DE1X is terminated and has no further effect.

    Example 52. Reduced recapture and interest charge, and 
reconstituted dual consolidated loss. (i) Facts. P owns 
DRCX, a member of the P consolidated group. In Year 1, 
DRCX incurs a dual consolidated loss of $100x and P earns 
$100x. P makes a domestic use election with respect to 
DRCX's Year 1 dual consolidated loss. Therefore, the 
consolidated group is permitted to offset P's $100x of income with 
DRCX's $100x loss. In Year 2, DRCX earns $30x, 
which is completely offset by a $30x net operating loss incurred by 
P in Year 2. In Year 3, DRCX earns income of $25x, while 
P recognizes no income or loss. In addition, there is a triggering 
event at the end of Year 3.
    (ii) Result. (A) Under the presumptive rule of Sec.  1.1503(d)-
4(h)(1)(i), DRCX must recapture $100x. However, the $100x 
recapture amount may be reduced by the amount by which the dual 
consolidated loss would have offset other taxable income if it had 
been subject to the limitation under Sec.  1.1503(d)-3(c)(3), upon 
adequate documentation of such offset under Sec.  1.1503(d)-
4(h)(2)(i).
    (B) Although DRCX earned $30x of income in Year 2, 
there was no consolidated taxable income in such year. As a result, 
the $100x of recapture income cannot be reduced by the $30x earned 
in Year 2, but such amount can be carried forward to subsequent 
taxable years and be used to the extent of consolidated taxable 
income generated in such years. In Year 3, DRCX earns 
$25x of income and the P consolidated group has $25 of consolidated 
taxable income in such year.

[[Page 29907]]

As a result, the $100x of recapture income can be reduced by the 
$25x. The $30x generated in Year 2 cannot be used in Year 3 because 
there is insufficient consolidated taxable income in such year.
    (C) Commencing in Year 4, the $75x recapture amount ($100x-$25x) 
is reconstituted and treated as a loss incurred by DRCX 
in a separate return limitation year, subject to the limitation 
under Sec.  1.1503(d)-2(b) (and therefore subject to the 
restrictions of Sec.  1.1503(d)-3(c)(3)). The carryover period of 
the loss, for purposes of section 172(b), will start from Year 1, 
when the dual consolidated loss was incurred. Pursuant to Sec.  
1.1503(d)-4(i)(3), the domestic use agreement filed by the P 
consolidated group with respect to the Year 1 dual consolidated of 
DE1X is terminated and has no further effect.


Sec.  1.1503(d)-6  Effective date.

    Sections 1.1503(d)-1 through 1.1503(d)-5 shall apply to dual 
consolidated losses incurred in taxable years beginning after the date 
that these regulations are published as final regulations in the 
Federal Register.
    Par. 4. In Sec.  1.6043-4T, paragraph (a)(1)(iii) is amended by 
removing the language ``Sec.  1.1503-2(c)(2)'' and adding ``Sec.  
1.1503(d)-1(b)(2)'' in its place.

Mark E. Matthews,
Deputy Commissioner for Services and Enforcement.
[FR Doc. 05-10160 Filed 5-19-05; 9:47 am]
BILLING CODE 4830-01-P