[Federal Register Volume 71, Number 79 (Tuesday, April 25, 2006)]
[Rules and Regulations]
[Pages 24516-24542]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 06-3882]



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Part V





Department of the Treasury





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Internal Revenue Service



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26 CFR Parts 1 and 602



Application of Separate Limitations to Dividends From Noncontrolled 
Section 902 Corporations; Final Rule and Proposed Rule

  Federal Register / Vol. 71, No. 79 / Tuesday, April 25, 2006 / Rules 
and Regulations  

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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Parts 1 and 602

[TD 9260]
RIN 1545-BF46


Application of Separate Limitations to Dividends From 
Noncontrolled Section 902 Corporations

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Temporary regulations.

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SUMMARY: This document contains temporary regulations regarding the 
application of separate foreign tax credit limitations to dividends 
received from noncontrolled section 902 corporations under section 
904(d)(4). Section 403 of the American Jobs Creation Act of 2004, 
Public Law 108-357, 118 Stat. 1418 (October 22, 2004) (AJCA), modified 
the treatment of such dividends effective for taxable years beginning 
after December 31, 2002. Section 403(l) of the Gulf Opportunity Zone 
Act of 2005, Public Law 109-135, 119 Stat. 2577 (December 22, 2005) 
(GOZA), permits taxpayers to elect to defer the effective date of the 
AJCA amendments until taxable years beginning after December 31, 2004. 
The temporary regulations provide guidance needed to comply with these 
changes and affect corporations claiming foreign tax credits. The text 
of these temporary regulations also serves as the text of the proposed 
regulations (REG-144784-02) set forth in the notice of proposed 
rulemaking on this subject published elsewhere in this issue of the 
Federal Register.

DATES: Effective Date: These regulations are effective April 25, 2006. 
For dates of applicability, see Sec. Sec.  1.861-9T(f)(4)(iv), 1.861-
12T(c)(4)(iii), 1.902-1T(g), 1.904-2T(h)(1) and (2), 1.904-4T(c)(2)(i), 
1.904-5T(o)(2), 1.904-7T(f)(10), 1.904(f)-12T(g)(5), and 1.964-1T(c)(2) 
and (c)(6).
    Applicability Dates: These regulations generally apply to dividends 
paid in taxable years of noncontrolled section 902 corporations 
beginning after December 31, 2002.

FOR FURTHER INFORMATION CONTACT: Ginny Chung (202) 622-3850 (not a toll 
free call).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

    These temporary regulations are being issued without prior notice 
and public procedure pursuant to the Administrative Procedure Act (5 
U.S.C. 553). For this reason, the collections of information contained 
in these regulations have been reviewed and, pending receipt and 
evaluation of public comments, approved by the Office of Management and 
Budget under control number 1545-2014. Responses to these collections 
of information are required to obtain a tax benefit.
    An agency may not conduct or sponsor, and a person is not required 
to respond to, a collection of information unless the collection of 
information displays a valid OMB control number.
    For further information concerning these collections of 
information, and where to submit comments on the collections of 
information and the accuracy of the estimated burden, and suggestions 
for reducing this burden, please refer to the preamble of the cross-
referencing notice of proposed rulemaking published in this issue of 
the Federal Register.
    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

    This document contains amendments to the regulations under sections 
861, 902, 904, and 964 relating to the application of separate 
limitations to dividends from noncontrolled section 902 corporations 
(10/50 corporations) under section 904(d)(4), as amended by the AJCA 
and GOZA. Prior to the Taxpayer Relief Act of 1997, Public Law No. 105-
34, 111 Stat. 788, 971 (1997) (1997 Act), dividends from each 10/50 
corporation were subject to a separate foreign tax credit limitation (a 
separate category for dividends from each 10/50 corporation). The 1997 
Act modified these rules, effective for taxable years beginning after 
December 31, 2002. In lieu of the separate category treatment, the 1997 
Act provided that dividends paid by 10/50 corporations that are not 
passive foreign investment companies out of earnings and profits 
accumulated in taxable years beginning on or before December 31, 2002, 
(10/50 dividends out of pre-2003 earnings) would be included in a 
single separate category (the single category for dividends from all 
10/50 corporations), and dividends from 10/50 corporations out of 
earnings and profits accumulated in taxable years beginning after 
December 31, 2002, (10/50 dividends out of post-2002 earnings) would be 
treated as income in a separate category based on the separate category 
of the underlying earnings and profits being distributed (look-through 
treatment). On December 23, 2002, the IRS and the Treasury Department 
issued Notice 2003-5 (2003-1 C.B. 294), which provided guidance 
addressing the application of section 904 to dividends paid by 10/50 
corporations under the 1997 Act.
    The AJCA modified the 10/50 dividend rules in the 1997 Act and 
provided that dividends from 10/50 corporations would be eligible for 
look-through treatment effective for taxable years beginning after 
December 31, 2002, without regard to when the distributed earnings were 
accumulated. Section 403(l) of the GOZA provided a rule allowing a 
taxpayer to elect, for taxable years beginning after December 31, 2002, 
and before January 1, 2005, not to apply the expanded look-through 
rules enacted in the AJCA to 10/50 dividends out of pre-2003 earnings. 
Section 403(l) of the GOZA also provided, with respect to carrybacks 
and carryforwards under section 904(c) of excess foreign taxes 
allocable to a dividend from a 10/50 corporation, that a taxpayer that 
elects not to apply the expanded look-through rules enacted in the AJCA 
to taxable years beginning in 2003 and 2004 must defer the application 
of the look-through rules for carryovers of excess foreign taxes 
contained in section 904(d)(4)(C)(iv).
    The temporary regulations modify the section 902 and 904 
regulations to reflect the look-through treatment of dividends from 10/
50 corporations and provide transition rules for the treatment of 
overall foreign losses and separate limitation losses under section 
904(f) and the carryover of excess foreign taxes under section 904(c). 
The temporary regulations also modify the grouping rules of Sec.  
1.904-4(c) that apply for purposes of determining whether an item of 
income is considered high-taxed income, the rules under Sec.  1.861-9T 
governing the apportionment of interest expense of a 10/50 corporation, 
and the rules under Sec.  1.861-12T governing the characterization of 
stock of a 10/50 corporation for purposes of apportioning the 
shareholder's interest expense.
    In addition, the temporary regulations modify the regulations under 
section 964 to add rules permitting majority domestic corporate 
shareholders of a 10/50 corporation to make tax accounting elections on 
behalf of the 10/50 corporation. The temporary regulations also expand 
the section 964 regulations to allow controlling United States 
shareholders and majority domestic corporate shareholders to adopt or 
change the taxable year of a controlled foreign corporation or 10/50 
corporation (as the case may be) on behalf of the

[[Page 24517]]

foreign corporation. The temporary regulations also revise the 
regulations' procedural rules to permit statements evidencing the 
shareholders' action to be filed with the shareholders' tax returns 
instead of 183 days after the close of the foreign corporation's 
taxable year. Finally, the temporary regulations modify the section 964 
regulations to eliminate obsolete provisions and reorganize some of the 
rules contained in Sec.  1.964-1T(g).
    The IRS and the Treasury Department request comments on additional 
guidance that may be needed to implement section 403 of the AJCA and 
section 403(l) of the GOZA.

Explanation of Provisions

I. Interest Expense Apportionment

A. Interest Expense of a 10/50 Corporation
    For purposes of apportioning interest expense of a 10/50 
corporation in order to apply the dividend look-through rule, new Sec.  
1.861-9T(f)(4) generally applies the principles of Sec.  1.861-9T(f)(3) 
(apportionment of interest expense of a controlled foreign 
corporation). Under this rule, interest expense of a 10/50 corporation 
may be apportioned using either the asset method or the modified gross 
income method. Section 1.861-9T(f)(4) also provides that the election 
to use the asset method or modified gross income method may be made by 
either the 10/50 corporation itself or by the ``majority domestic 
corporate shareholders'' of the 10/50 corporation. The term majority 
domestic corporate shareholders means those domestic corporations that 
meet the ownership requirements of section 902(a) with respect to the 
10/50 corporation (or to a first-tier foreign corporation that is a 
member of the same qualified group as the 10/50 corporation) that, in 
the aggregate, own directly or indirectly more than 50 percent of the 
combined voting power of all of the voting stock of the 10/50 
corporation that is owned directly or indirectly by all domestic 
corporations that meet the ownership requirements of section 902(a) 
with respect to the 10/50 corporation (or a relevant first-tier 10/50 
corporation). Unlike a controlled foreign corporation (CFC), however, a 
10/50 corporation will not be required to use the asset method even 
though the majority domestic corporate shareholders elect the fair 
market value method of apportionment. Compare Sec.  1.861-9T(f)(3)(i) 
and Sec.  1.861-8T(c)(2) (requiring CFC to use fair market value method 
if controlling United States shareholders as defined in Sec.  1.861-
9T(f)(3)(ii) elect fair market value method). The IRS and the Treasury 
Department believe that the conformity rule of Sec.  1.861-8T(c)(2) 
should not apply to foreign corporations that are not controlled by 
domestic shareholders. Therefore, regardless of the methods used by the 
majority domestic corporate shareholders of a 10/50 corporation, the 
10/50 corporation (or the majority domestic corporate shareholders on 
behalf of the 10/50 corporation) may elect to use any of the methods 
described in Sec.  1.861-9T or Sec.  1.861-9 (e.g., the modified gross 
income, tax book value, alternative tax book value, or fair market 
value method) to apportion the 10/50 corporation's interest expense.
B. Characterization of Stock of a 10/50 Corporation
    For purposes of apportioning interest expense to income of a 
taxpayer in the various separate categories under section 904(d), Sec.  
1.861-12T(c)(4) currently treats stock of each 10/50 corporation owned 
by the taxpayer as an asset giving rise to income in a separate 
category. The temporary regulations are amended to reflect the repeal 
of separate categories for dividends from 10/50 corporations. Because 
dividends from 10/50 corporations are eligible for look-through 
treatment in the same manner as dividends from CFCs, the IRS and the 
Treasury Department believe that stock of a 10/50 corporation should be 
treated for interest expense apportionment purposes in the same manner 
as stock of a CFC, which is characterized based on the income produced 
in the current year, or expected to be produced in future years, by the 
assets of the CFC. See Sec.  1.861-12T(c)(3). Accordingly, Sec.  1.861-
12T(c)(4) is amended to provide that stock in a 10/50 corporation is 
characterized as an asset in the various separate categories on the 
basis of either the asset method (described in Sec.  1.861-
12T(c)(3)(ii)) or the modified gross income method (described in Sec.  
1.861-12T(c)(3)(iii)), depending on the method used by the 10/50 
corporation to apportion its interest expense. In addition, the 
temporary regulations eliminate the special rule in Sec.  1.861-
12T(c)(4)(ii) for separate limitation losses, which provided that a 
taxpayer could elect to reallocate interest expense that resulted in a 
loss in a separate category for dividends from a 10/50 corporation. 
This rule is no longer necessary due to the elimination of separate 
categories for dividends from 10/50 corporations.
C. Definition of ``10 Percent Owned Corporation''
    The current temporary regulations require an affiliated group using 
the tax book value method in apportioning its interest expense to 
adjust the basis of stock in any ``10 percent owned corporation'' that 
is held directly by members of the group to reflect the member's pro 
rata share of such corporation's earnings and profits (or deficit in 
earnings and profits). Sec.  1.861-12T(c)(1), (c)(2). The adjustment 
must take into account such corporation's pro rata share of the 
earnings and profits (or deficit) of any lower-tier 10 percent owned 
corporation. Sec.  1.861-12T(c)(2)(iii). In general, a corporation is a 
``10 percent owned corporation'' if members of the affiliated group own 
directly or indirectly 10 percent or more of the voting power of the 
corporation. Sec.  1.861-12T(c)(2)(ii). As amended by this Treasury 
Decision, the basis adjustment rule of Sec.  1.861-12T(c)(2)(i) is 
revised to clarify that it applies to stock of a 10 percent owned 
corporation not only where stock in a 10 percent owned corporation is 
held directly by members of the affiliated group, but also where the 
stock is held indirectly through a partnership or other pass-through 
entity. Thus, the basis adjustment is required whenever the stock 
(rather than the interest in the pass-through entity) is the relevant 
asset for purposes of interest expense apportionment.

II. Deemed Paid Credit Under Section 902

A. Extension of Look-Through Rules and Tier Limitation
    The 1997 Act and AJCA amendments expanded the look-through 
treatment of dividends from 10/50 corporations. The temporary 
regulations amend Sec.  1.902-1(d) to reflect these changes. The 
temporary regulations also reflect provisions of the 1997 Act amending 
section 902 to provide for the calculation of deemed-paid taxes with 
respect to distributions through up to six tiers of foreign 
corporations in a chain of corporations in a ``qualified group'' 
described in section 902(b)(2). Under section 902(b)(2), the term 
``qualified group'' does not include any foreign corporation below the 
third tier in the chain unless such corporation is a controlled foreign 
corporation of which the domestic corporation is a United States 
shareholder. For a member of the qualified group below the third tier, 
only foreign income taxes paid with respect to periods during which it 
was a controlled foreign corporation are eligible to be deemed paid. 
The temporary regulations modify

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Sec.  1.902-1 to reflect these statutory amendments, effective for 
taxes paid by fourth-, fifth-, and sixth-tier qualified group members 
with respect to taxable years beginning after August 5, 1997.
B. Amounts Included in Post-1986 Foreign Income Taxes
    Under Sec.  1.902-1(a)(7), foreign income taxes do not include 
amounts not treated as a tax or certain taxes for which credit is 
disallowed under various provisions of section 901. The temporary 
regulations update the definition of foreign income taxes in Sec.  
1.902-1(a)(7) to exclude taxes for which a credit is disallowed under 
sections 901(j) (relating to the disallowance of a credit for foreign 
taxes paid or accrued to certain countries), sections 901(k) and (l) 
(disallowing credit for certain withholding taxes paid with respect to 
dividends or other income if the recipient does not meet certain 
holding period requirements or is under an obligation to make related 
payments with respect to substantially similar or related property), or 
any similar provision. In addition, the temporary regulations modify 
Sec.  1.902-1(a)(8) to reflect the amendment of section 902(c)(2)(B) in 
1997, which clarified the definition of post-1986 foreign income taxes 
by substituting the phrase ``attributable to'' for the phrase ``deemed 
paid with respect to.''
    Section 1113(c)(2) of the 1997 Act provided that in the case of any 
chain of foreign corporations described in clauses (i) and (ii) of 
section 902(b)(2)(B), no liquidation, reorganization, or similar 
transaction in a taxable year beginning after August 5, 1997, can have 
the effect of permitting taxes to be taken into account under section 
902 which could not have been taken into account under section 902 but 
for the transaction. This rule was enacted as part of the effective 
date of the 1997 Act's extension of the deemed-paid credit rules from 
three to six tiers as discussed above. Accordingly, Sec.  1.902-
1T(c)(8) is added to clarify that foreign taxes paid or accrued by a 
qualified group member are not eligible to be deemed paid if they were 
paid or accrued in a taxable year beginning on or before August 5, 
1997, if such member was a fourth-, fifth- or sixth-tier corporation 
with respect to the taxpayer on the first day of its first taxable year 
beginning after August 5, 1997.

III. Carryovers and Carrybacks of Excess Foreign Taxes Under Section 
904(c)

    Section 904(d)(4)(C)(iv), as amended by the AJCA, provides that 
look-through treatment applies to the carryover of excess foreign taxes 
from pre-2003 taxable years to post-2002 taxable years to the extent 
that they are allocable to dividends from 10/50 corporations. 
Consistent with this statutory amendment, Sec.  1.904-2T(h)(1) provides 
that to the extent that a taxpayer has paid, accrued, or deemed paid 
excess taxes in a separate category for dividends from a 10/50 
corporation paid in a pre-2003 taxable year and these excess taxes are 
carried over to taxable years beginning on or after the first day of 
the 10/50 corporation's first post-2002 taxable year, the excess taxes 
are assigned to the appropriate separate category as if the associated 
dividends had been eligible for look-through treatment when paid, based 
on the reconstruction of the 10/50 corporation's pre-2003 earnings in 
accordance with Sec.  1.904-7T(f) (discussed below in section V.E., 
``Treatment of earnings and taxes accumulated during a non-look-through 
period''). In the case of excess taxes attributable to dividends from a 
10/50 corporation with respect to which the taxpayer is no longer a 
qualifying shareholder as of the first day of its first post-2002 
taxable year, Sec.  1.904-2T(h)(1) provides that the excess taxes are 
assigned pro rata to the separate categories to which the foreign 
corporation's pre-2003 earnings would have been assigned had they been 
distributed in the last year that the taxpayer was a qualifying 
shareholder.
    If the Commissioner determines that the look-through 
characterization of the excess taxes cannot be reasonably determined 
under one of the methods described in Sec.  1.904-7T(f)(4), the 
Commissioner will assign such taxes to the general limitation category. 
Section 1.904-2T(h)(1) also provides that any excess taxes carried over 
from pre-2003 taxable years to post-2002 taxable years that would 
otherwise be assigned to the passive category are assigned to the 
general limitation category. The IRS and the Treasury Department 
believe that these rules are appropriate because to the extent the pre-
2003 dividend paid by the 10/50 corporation that generated the excess 
credits would have been treated as passive income, such income and 
associated taxes would have been considered high-taxed income under 
section 904(d)(2)(A)(iii)(III) and generally would have been 
recharacterized as general limitation income and taxes.
    Section 904(d)(4)(C)(iv), as amended by the AJCA, authorizes the 
Secretary to issue regulations for allocating carrybacks of excess 
taxes allocable to a dividend paid by a 10/50 corporation in a post-
2002 taxable year to a pre-2003 taxable year for purposes of allocating 
such dividend among the separate categories in effect for the taxable 
year to which carried. The IRS and the Treasury Department determined 
that the regulations should not provide for the carryback of post-2002 
excess taxes attributable to look-through dividends paid by a 10/50 
corporation to a separate limitation category for dividends from each 
10/50 corporation in pre-2003 years. Such a rule would be 
administratively burdensome because it would require taxpayers to 
maintain multiple sets of section 904(c) accounts for separate 
categories for the 2003 and 2004 taxable years and because it would 
necessitate complex stacking rules to determine the amount of excess 
taxes in a separate category that were attributable to dividends paid 
by specific 10/50 corporations. Accordingly, Sec.  1.904-2T(h)(2) 
provides that excess taxes that are allocable to dividends from 10/50 
corporations paid in post-2002 taxable years that are attributable to 
one or more separate categories are carried back to prior taxable years 
in the same separate categories to which the dividends were assigned.

IV. High-Taxed Income of a 10/50 Corporation

    In general, income received or accrued by a United States person 
that would otherwise be passive income is treated as general limitation 
income if the income is determined to be high-taxed income within the 
meaning of section 904(d)(2)(F). In determining whether passive income 
is high-taxed income, the grouping rules of Sec.  1.904-4(c) apply 
separately to dividends and subpart F inclusions from each controlled 
foreign corporation, income of a qualified business unit (QBU), and 
income of a QBU of a controlled foreign corporation and any other look-
through entity as defined in Sec.  1.904-5(i). Sec. Sec.  1.904-4(c)(4) 
and (c)(5)(iv). The temporary regulations at Sec.  1.904-4T(c)(3) and 
(c)(4) provide that the grouping rules similarly apply separately to 
dividends from each 10/50 corporation, which includes dividends that 
are treated as passive income either on a look-through basis or due to 
inadequate substantiation. The IRS and the Treasury Department believe 
that this rule is consistent with the intent of the existing separate 
grouping rules as well as legislative intent that ``the high-tax income 
rules apply appropriately to dividends treated as passive category 
income because of inadequate substantiation.'' H.R. Conf. Rep. No. 755, 
108th Cong. 2d Sess. 386 n.222 (2004). Consistent with the changes to 
the look-through rules enacted in the

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AJCA, this rule is effective for dividends paid in post-2002 taxable 
years of 10/50 corporations.

V. Look-Through Rules as Applied to 10/50 Corporations

A. Treatment of Dividends Paid by a 10/50 Corporation in General
    Section 904(d)(4)(A), as amended by the AJCA, provides that look-
through treatment applies to any dividend paid by a 10/50 corporation 
in a post-2002 taxable year, regardless of the year in which the 
earnings were accumulated. Accordingly, Sec.  1.904-5T(c)(4)(iii) 
provides that any dividends paid in a post-2002 taxable year to a 
domestic corporation by a 10/50 corporation with respect to which the 
domestic corporation meets the stock ownership requirements of section 
902(a) are treated as income in a separate category in proportion to 
the ratio of the portion of earnings and profits attributable to income 
in such category to the total amount of earnings and profits of the 10/
50 corporation. Interest, rents, and royalties paid by a 10/50 
corporation to a domestic corporation are not eligible for look-through 
treatment and are treated as passive income except as otherwise 
provided in section 904(d)(2)(A) and the regulations thereunder. Any 
dividend distribution by a 10/50 corporation to a shareholder that is 
not a corporation meeting the stock ownership requirements of section 
902(a) or (b) is also treated as passive income. Finally, as provided 
in section 904(d)(4)(C)(ii), Sec.  1.904-5T(c)(4)(iii) provides that a 
dividend from a 10/50 corporation is treated as passive income if the 
look-through characterization of the dividend is not substantiated to 
the satisfaction of the Commissioner. These rules are generally 
applicable to dividends paid by a 10/50 corporation during its first 
post-2002 taxable year and thereafter, without regard to whether the 
corresponding taxable year of the dividend recipient is a post-2002 
taxable year.
B. Allocation and Apportionment of Expenses of a 10/50 Corporation
    In applying look-through to dividends from 10/50 corporations, 
expenses of the 10/50 corporation (such as payments of interest, rents, 
and royalties) must be allocated and apportioned to the 10/50 
corporation's pools of post-1986 undistributed earnings. Sec.  1.904-
5T(c)(2)(iii) provides that expenses of a 10/50 corporation are 
allocated and apportioned to the income of the 10/50 corporation in the 
same manner as expenses of a CFC. See, e.g., section 954(b)(5); Sec.  
1.904-5(c)(2)(ii)).
    The temporary regulations, however, do not extend the special 
allocation rule for related person interest expense under section 
954(b)(5) and Sec.  1.904-5(c)(2)(ii) (providing that interest paid by 
a CFC to a U.S. shareholder or any related look-through entity is first 
allocated to reduce foreign personal holding company income which is 
passive income) to interest paid by 10/50 corporations. The AJCA did 
not extend look-through treatment to interest paid by a 10/50 
corporation to a domestic shareholder or to a related entity, and 10/50 
corporations are not subject to subpart F. Accordingly, interest paid 
by a 10/50 corporation to a domestic shareholder, CFC, or another 10/50 
corporation is treated as passive income (or high withholding tax 
interest, financial services income, or high-taxed general limitation 
income, as appropriate) and is apportioned to reduce the payor's pools 
of post-1986 undistributed earnings under the rules applicable to 
unrelated person interest expense, even though the generally applicable 
expense allocation rules of Sec.  1.904-5 apply to determine which 
earnings are reduced at the payor 10/50 corporation level.
C. Treatment of Dividends Paid Between Lower-Tier Look-Through Entities
    To reflect the extension of look-through treatment to dividends 
paid by 10/50 corporations and the repeal of separate categories for 
dividends from each 10/50 corporation, the temporary regulations remove 
the rules of Sec.  1.904-4(g) and amend the relevant provisions of 
Sec. Sec.  1.902-1 and 1.904-5. In order for a dividend from a 10/50 
corporation to qualify for look-through treatment, the shareholder must 
be a domestic corporation meeting the stock ownership requirements of 
section 902(a) with respect to the 10/50 corporation. Sections 
904(d)(2)(E) and 904(d)(4).
    In determining whether dividends paid by lower-tier corporations 
are eligible for look-through treatment, the eligibility requirements 
for dividends from 10/50 corporations and CFCs cannot be precisely 
conformed, because a taxpayer's eligibility for look-through treatment 
of a dividend from a 10/50 corporation is based on whether the taxpayer 
meets the stock ownership requirements of section 902, whereas a 
taxpayer's eligibility for look-through treatment of a dividend from a 
CFC is based on whether the taxpayer is a United States shareholder 
with respect to the CFC under section 951(b). See sections 
904(d)(2)(E)(i), 904(d)(3)(A), 904(d)(3)(D), and 904(d)(4)(A). However, 
the IRS and the Treasury Department believe that the eligibility 
requirements for look-through treatment of dividends from 10/50 
corporations and CFCs should be conformed to the greatest extent 
possible.
    Accordingly, Sec.  1.902-1T(d)(1) provides that the amount of 
foreign taxes deemed paid is computed separately with respect to post-
1986 undistributed earnings or pre-1987 accumulated profits in each 
separate category out of which a look-through dividend is paid in the 
following situations: (1) A dividend from a CFC to a domestic 
corporation meeting the stock ownership requirements of section 902(a) 
that is a United States shareholder (as defined in section 951(b) or 
section 953(c)) of the CFC; (2) a dividend from a 10/50 corporation to 
a domestic corporation meeting the stock ownership requirements of 
section 902(a); (3) a dividend received by an upper-tier CFC from a 
lower-tier CFC where the CFCs are related look-through entities under 
Sec.  1.904-5(i)(3); and (4) a dividend from a CFC or 10/50 corporation 
to a foreign corporation that is eligible to compute an amount of 
foreign taxes deemed paid under section 902(b)(1) (i.e., both the payor 
and payee corporations are members of the same qualified group as 
defined in section 902(b)(2)). Similarly, the temporary regulations at 
Sec.  1.904-5T(i)(4) apply look-through treatment to any dividend paid 
by a CFC or 10/50 corporation to another member of the same qualified 
group (as defined in section 902(b)(2)) that is eligible to compute an 
amount of foreign taxes deemed paid under section 902(b)(1), and retain 
the current rule of Sec.  1.904-5(i)(3) to the extent that it applies 
look-through treatment to dividends between CFCs that have a common 10 
percent U.S. shareholder but do not meet the requirements of section 
902(b).
D. Application of Section 904(g) to 10/50 Corporations
    Section 904(g) (redesignated under the AJCA as section 904(h) for 
taxable years beginning after 2006) provides that certain inclusions, 
including dividends and interest paid or accrued by a United States-
owned foreign corporation to a United States shareholder or a related 
person and which would be treated as foreign source income, are treated 
as U.S. source income. Section 904(g)(6) defines a United States-owned 
foreign corporation as any foreign corporation if United States persons 
(as defined in section 7701(a)(30) hold 50 percent or more of either 
the total combined voting power of all classes of voting stock or the 
total value of the stock. Section

[[Page 24520]]

1.904-5(m) provides rules concerning the resourcing of certain amounts 
received or accrued (or treated as received or accrued) by a United 
States shareholder from a CFC. The temporary regulations at Sec.  
1.904-5T(m) clarify that the rules for resourcing interest and 
dividends also apply to a 10/50 corporation that meets the definition 
of a United States-owned foreign corporation. These temporary 
regulations apply to amounts paid by a 10/50 corporation in taxable 
years of such corporation beginning after April 25, 2006.
E. Treatment of Earnings and Taxes Accumulated During a Non-Look-
Through Period
    Section 1.904-7T(f)(2) provides that earnings accumulated and 
foreign income taxes paid after a 10/50 corporation had a domestic 
corporate shareholder that met the stock ownership requirements of 
section 902(a) but before any such shareholder was eligible for look-
through treatment of dividends (non-look-through pool) that exist as of 
the end of the 10/50 corporation's last pre-2003 taxable year are 
treated as if they were accumulated and paid during a period in which 
the distribution would have been eligible for look-through treatment 
(look-through period). These earnings and taxes are treated as the 
opening balance of the post-1986 undistributed earnings and taxes pools 
in the 10/50 corporation's other separate categories on the first day 
of the 10/50 corporation's first post-2002 taxable year. Dividends that 
were paid in pre-2003 taxable years out of earnings accumulated in a 
non-look-through pool are not eligible for look-through treatment.
    Section 1.904-7T(f)(4)(i) provides that in order to substantiate 
the look-through characterization of the earnings and taxes in the non-
look-through pools, the taxpayer must reconstruct the non-look-through 
pools of earnings and taxes for each year in the non-look-through 
period, beginning with the first year in which earnings were 
accumulated in the non-look-through pool. Earnings and taxes are 
treated as if they were accumulated during a look-through period, 
taking into account earnings distributed and taxes deemed paid in the 
non-look-through period as if they were distributed and deemed paid pro 
rata from the amounts that were added to the non-look-through pools 
during the non-look-through period. As reconstructed, earnings and 
taxes in the non-look-through pools as of the last day of the 10/50 
corporation's last pre-2003 taxable year are assigned to the look-
through pools on the first day of the 10/50 corporation's first post-
2002 taxable year.
    The IRS and the Treasury Department recognize that shareholders may 
face difficulties in reconstructing historical accumulated earnings and 
taxes accounts of a 10/50 corporation on a look-through basis, because 
noncontrolling shareholders may have difficulty obtaining detailed 
records for prior periods from the 10/50 corporation. Therefore, the 
IRS and the Treasury Department anticipate that a reasonable 
approximation of the amounts properly included in the look-through 
pools, based on available records obtained through reasonable, good-
faith efforts by the taxpayer, will adequately substantiate the 
reconstruction required by the statute.
    Alternatively, Sec.  1.904-7T(f)(4)(ii) provides a safe harbor in 
reconstructing the non-look-through pools. Under the safe harbor, a 
taxpayer may allocate the earnings and taxes in the non-look-through 
pools ratably to the look-through pools on the first day of the 10/50 
corporation's first post-2002 taxable year in the same percentages as 
the taxpayer (or the qualified group member that owns the 10/50 
corporation) properly characterizes the stock of the 10/50 corporation 
in the separate categories for purposes of apportioning the taxpayer's 
(or qualified group member's) interest expense in its first taxable 
year ending after the first day of the 10/50 corporation's first post-
2002 taxable year. Under Sec.  1.861-12T(c)(3) and (4), this 
characterization generally is based on how the assets or income of the 
10/50 corporation are characterized in the separate categories for 
purposes of apportioning interest expense of the 10/50 corporation in 
the 10/50 corporation's first post-2002 taxable year. However, Sec.  
1.904-7T(f)(4)(ii) provides that if a taxpayer elects to use the safe 
harbor rule with respect to a 10/50 corporation that uses the modified 
gross income method to apportion interest expense for the 10/50 
corporation's first post-2002 taxable year, earnings and taxes in the 
non-look-through pools are allocated to the look-through pools based on 
an average of the 10/50 corporation's modified gross income ratios for 
its taxable years beginning in 2003 and 2004. The IRS and the Treasury 
Department believe that the two-year base period rule is necessary to 
avoid potential distortions associated with allocating earnings and 
taxes from the non-look-through pool to the look-through pools based on 
the 10/50 corporation's modified gross income for just one taxable 
year.
    Section 904(d)(4)(C)(ii), as amended by the AJCA, provides that if 
the Secretary determines that look-through treatment of a dividend out 
of earnings formerly accumulated in the non-look-through pool has not 
been adequately substantiated, the dividend is treated as passive 
income for purposes of section 904(d). Section 1.904-7T(f)(4)(iii) 
provides that in the case where a taxpayer does not elect the safe 
harbor rule of Sec.  1.904-7T(f)(4)(ii) and the Commissioner determines 
that the look-through characterization of earnings and taxes in the 
non-look-through pools cannot reasonably be determined based on the 
available information, the Commissioner will assign the earnings and 
associated taxes to the passive category for purposes of section 
904(d).
    As provided in Sec.  1.904-7T(f)(3), rules similar to Sec.  1.904-
7T(f)(2) will apply in assigning to separate categories earnings and 
taxes of a CFC that were accumulated during a non-look-through period. 
As reconstructed, earnings and taxes in a CFC's non-look-through pools 
as of the last day of the CFC's last pre-2003 taxable year will be 
added to the opening balance of the CFC's look-through pools of 
earnings and taxes on the first day of the CFC's first post-2002 
taxable year. The taxpayer must substantiate the look-through 
characterization of such earnings and taxes in accordance with Sec.  
1.904-7T(f)(4) by either reconstructing the non-look-through pools or 
electing the safe harbor.
    In addition, as provided in Sec.  1.904-7T(f)(6), the rules of 
Sec.  1.904-7T(f)(2) will apply to assign to separate categories pre-
1987 accumulated profits and pre-1987 foreign income taxes of a foreign 
corporation that were accumulated during a non-look-through period and, 
prior to the AJCA amendments, would have been assigned to a separate 
category for dividends from a 10/50 corporation. Accordingly, pre-1987 
accumulated profits and pre-1987 foreign income taxes accumulated 
during a non-look-through period will be treated as if they were 
accumulated during a look-through period. The taxpayer must 
substantiate the look-through characterization of such earnings and 
taxes in accordance with Sec.  1.904-7T(f)(4) by either reconstructing 
the annual layers of pre-1987 accumulated profits or electing the safe 
harbor.
F. Treatment of a Deficit Accumulated in a Non-Look-Through Period
    Section 1.904-7T(f)(5) provides that if there is an accumulated 
deficit in the non-look-through pool as of the end of a 10/50 
corporation's last pre-2003

[[Page 24521]]

taxable year, the deficit and associated taxes are treated in the same 
manner as earnings and taxes in a positive non-look-through pool, i.e., 
the deficit and taxes are treated as if they had been accumulated and 
paid during a look-through period. The earnings and deficits in 
earnings making up the accumulated deficit are assigned to the look-
through pools based on where the 10/50 corporation's income and 
expenses or losses would have been assigned had they been incurred 
during a look-through period, or, if the taxpayer elects the safe 
harbor, the deficit is allocated based on how the stock of the 10/50 
corporation is properly characterized for interest expense 
apportionment purposes. If the taxpayer does not elect the safe harbor 
and the Commissioner determines that the look-through characterization 
of the deficit in the non-look-through pool cannot be reasonably 
determined based on the available information, the Commissioner will 
assign the deficit and any associated taxes to the 10/50 corporation's 
passive category.
    The temporary regulations treat the deficit in the non-look-through 
pool as the opening balance of the post-1986 undistributed earnings 
pools in the 10/50 corporation's other separate categories on the first 
day of the 10/50 corporation's first post-2002 taxable year. If the 10/
50 corporation makes a distribution in a post-2002 taxable year in 
which there is a deficit balance in the aggregate of the look-through 
pools (as increased or reduced by earnings or a deficit in the non-
look-through pool), the deficit balance is carried back, on a look-
through basis, to reduce pre-1987 accumulated profits on a last in-
first out basis, and the deficit is removed from post-1986 
undistributed earnings. See Sec.  1.902-2(a)(1). If the deficit reduces 
to zero all of the pre-1987 accumulated profits, no foreign taxes in 
any of the pre-1987 annual layers are deemed paid with respect to the 
dividend. See Sec.  1.902-1(b)(4).
    In the case of a CFC that was formerly a 10/50 corporation and has 
a deficit in the non-look-through pool that was accumulated while it 
was a 10/50 corporation, any deficit that was not absorbed by earnings 
in the look-through pools and that remains at the end of the CFC's last 
pre-2003 taxable year is assigned to the look-through pools on the 
first day of the CFC's first post-2002 taxable year based on the 
reconstruction or safe harbor rules of Sec.  1.904-7T(f)(4). Foreign 
income taxes associated with this deficit pool that were previously not 
creditable are also assigned to the look-through pools on the first day 
of the CFC's first post-2002 taxable year based on the same method. To 
the extent that the portion of the deficit in the non-look-through pool 
that is assigned to a separate category exceeds post-1986 undistributed 
earnings in that category as of the end of the CFC's last pre-2003 
taxable year, the deficit will carry forward into the CFC's post-1986 
undistributed earnings pools for 2003. Under Sec.  1.904-7T(f)(6), 
similar rules apply to recharacterize a deficit in pre-1987 accumulated 
profits and any associated pre-1987 foreign income taxes that were 
accumulated during a non-look-through period.
G. Pre-Acquisition E&P of a 10/50 Corporation
    Section 904(d)(4)(C)(i)(II), as amended by the AJCA, provides that 
the Secretary may prescribe regulations regarding the treatment of 
distributions out of earnings and profits of a 10/50 corporation for 
periods before the taxpayer's acquisition of the stock to which the 
distributions relate (pre-acquisition E&P). Such distributions may be 
out of post-1986 undistributed earnings accumulated by a 10/50 
corporation before the specific shareholder acquired its stock or out 
of pre-1987 accumulated profits accumulated before the 10/50 
corporation had any qualifying shareholder. Prior to the AJCA 
amendments, such distributions, as well as distributions by a CFC out 
of earnings and profits for periods during which it was not a CFC, were 
subject to a separate foreign tax credit limitation for dividends from 
a 10/50 corporation. See section 904(d)(1)(E), section 904(d)(2)(E), 
and Sec.  1.904-4(g)(3).
    The temporary regulations do not limit look-through treatment for 
dividends out of earnings and profits accumulated in non-look-through 
periods during which a 10/50 corporation or CFC had no qualifying 
shareholder. The IRS and the Treasury Department believe that look-
through treatment of pre-acquisition earnings is the more appropriate 
policy result than passive category treatment, if look-through 
characterization can be adequately substantiated under the rules of 
Sec. Sec.  1.904-5T(c)(4)(iii) and 1.904-7T(f)(4). In addition, the 
temporary regulations do not limit look-through treatment for dividends 
out of pre-acquisition E&P accumulated in periods during which the 
distributing corporation was a 10/50 corporation, because any such 
restriction would create administrative complexities associated with 
maintaining multiple sets of look-through pools starting on different 
dates for different U.S. shareholders. Accordingly, distributions of 
earnings and profits from 10/50 corporations and CFCs in post-2002 
taxable years are generally eligible for look-through treatment, 
regardless of whether the distributing corporation was a look-through 
entity when the earnings were accumulated, and regardless of when the 
taxpayer acquired its stock.
H. Post-1986 Undistributed Earnings of a CFC Attributable to Dividends 
From Lower-Tier 10/50 Corporations
    Where a CFC has a separate category for dividends from each 10/50 
corporation containing earnings attributable to pre-2003 distributions 
from the lower-tier 10/50 corporation, Sec.  1.904-7T(f)(7) provides 
that the CFC's look-through pools of earnings and taxes will be 
adjusted to account for accumulated earnings and taxes attributable to 
dividends from the lower-tier 10/50 corporation as if the earnings and 
taxes were accumulated and deemed paid during a look-through period. 
Therefore, the earnings and taxes are recharacterized on the same basis 
used by the taxpayer to reconstruct the non-look-through pools of the 
lower-tier 10/50 corporation under Sec.  1.904-7T(f)(4). Taxes in each 
separate category for dividends from a lower-tier 10/50 corporation are 
assigned to the upper-tier CFC's look-through pools based on where the 
associated earnings distributed by the lower-tier foreign corporation 
(prior to being reduced by, for example, expense apportionment or 
payment of foreign income taxes at the CFC level) would have been 
assigned had such earnings been eligible for look-through treatment 
when received by the CFC.
    If a CFC has a deficit in a separate category for dividends from a 
lower-tier 10/50 corporation (due to, for example, expense 
apportionment or the payment of foreign income taxes by the CFC with 
respect to the lower-tier 10/50 corporation), the deficit and any 
associated taxes are treated as if they had been accumulated and deemed 
paid during a look-through period. Accordingly, the deficit is assigned 
to the upper-tier CFC's look-through pools based on where the upper-
tier CFC's income and expenses or losses would have been assigned had 
dividends from the lower-tier 10/50 corporation been eligible for look-
through treatment in the year such dividends were paid or such expenses 
and losses were incurred by the CFC.
    Similar to Sec.  1.904-7T(f)(4)(ii) (which provides a safe harbor 
in reconstructing the non-look-through pools to account for 
undistributed earnings (or a deficit) and taxes in the non-look-through 
pool

[[Page 24522]]

of a 10/50 corporation or CFC), Sec.  1.904-7T(f)(7)(iii) provides a 
safe harbor in reconstructing the look-through pools at the CFC level 
to account for undistributed earnings (or a deficit) and taxes in a 
CFC-level separate category for dividends from a lower-tier 10/50 
corporation. The taxpayer may allocate the earnings (or deficit) and 
taxes to the look-through pools at the CFC level by applying the safe 
harbor at the level of the CFC. Thus, if the taxpayer elects the safe 
harbor, the earnings (or deficit) and taxes are allocated based on how 
the CFC would properly characterize the stock of the lower-tier 10/50 
corporation for purposes of apportioning the CFC's interest expense, 
which in turn is based on the apportionment ratios properly used by the 
10/50 corporation to apportion its interest expense in its first post-
2002 taxable year. In the case of a taxpayer that elects to use the 
safe harbor rule where the 10/50 corporation uses the modified gross 
income method to apportion interest expense for its first post-2002 
taxable year, undistributed earnings (or a deficit) and taxes in a CFC-
level separate category for dividends from a 10/50 corporation are 
allocated to the look-through pools based on the average of the 10/50 
corporation's modified gross income ratios for its taxable years 
beginning in 2003 and 2004.
    In the case of a CFC that has in its qualified group a chain of 10/
50 corporations, the safe harbor applies first to the stock of the 
third-tier 10/50 corporation and then to the stock of the second-tier 
10/50 corporation. In the case of a taxpayer that elects the safe 
harbor with respect to a lower-tier 10/50 corporation of which the 
taxpayer was no longer a qualifying shareholder as of the end of the 
upper-tier CFC's last pre-2003 taxable year (e.g., because the 10/50 
corporation was no longer a member of the CFC's qualified group), the 
earnings (or deficit) and taxes in the separate category for dividends 
from the lower-tier 10/50 corporation are assigned to the CFC's look-
through pools in the same percentages as the stock of the 10/50 
corporation would have been characterized had the look-through rules 
applied in the last year the taxpayer was a qualifying shareholder of 
the 10/50 corporation.
    If the taxpayer does not elect the safe harbor and the Commissioner 
determines that the look-through characterization of the undistributed 
earnings (or deficit) and taxes in a CFC's separate category for 
dividends from a lower-tier 10/50 corporation cannot reasonably be 
determined based on the available information, the Commissioner will 
assign the earnings (or deficit) and taxes to the CFC's passive 
category.
I. Treatment of Distributions Received by a 10/50 Corporation From a 
Lower-Tier 10/50 Corporation When the Corporations Do Not Have The Same 
Taxable Years
    Section 1.904-7T(f)(8) provides guidance concerning when a dividend 
paid by a lower-tier corporation to an upper-tier corporation that is a 
member of the same qualified group is eligible for look-through 
treatment when the corporations' first post-2002 taxable years begin on 
different dates. In the case of a dividend paid during the upper-tier 
corporation's post-2002 taxable year but during the lower-tier 
corporation's pre-2003 taxable year, the dividend will be included in a 
separate category in the year received. However, any earnings of the 
upper-tier corporation attributable to such dividends are treated, 
beginning on the first day of the upper-tier corporation's next taxable 
year, as if they were accumulated during a look-through period. 
Dividends paid during the upper-tier corporation's pre-2003 taxable 
year but during the lower-tier corporation's post-2002 taxable year are 
eligible for look-through treatment in the year received.

VI. Separate Limitation Losses and Overall Foreign Losses

    Because the 1997 Act and the AJCA eliminated separate categories 
for dividends from 10/50 corporations for post-2002 taxable years, the 
temporary regulations provide transition rules for recapture in a post-
2002 taxable year of (1) an overall foreign loss (OFL) or separate 
limitation loss (SLL) in a separate category for dividends from each 
10/50 corporation that offset U.S. source income or income in other 
separate categories, respectively, in a pre-2003 taxable year; and (2) 
an SLL in another separate category (e.g., the general limitation or 
passive category) that offset income in a separate category for 
dividends from each 10/50 corporation in a pre-2003 taxable year.
A. Recapture of an OFL or SLL Incurred in a Separate Category for 
Dividends From a 10/50 Corporation
    Section 1.904(f)-12T(g)(1) provides that where a taxpayer had an 
OFL or SLL in a separate category for dividends from a 10/50 
corporation (i.e., an OFL, or SLL, in the separate category that offset 
U.S. source income, or income in other separate categories, in a pre-
2003 taxable year, or a later year in which the taxpayer received a 
dividend in the separate category, and the OFL or SLL would have been 
recaptured out of income in the separate category for dividends from 
that 10/50 corporation), the OFL or SLL account is recaptured out of 
income in the taxpayer's other separate categories in the same 
percentages as the income generated by the assets of the 10/50 
corporation. Specifically, the loss account will be recaptured in 
subsequent taxable years out of income in the same separate categories 
in which the stock of the 10/50 corporation is properly characterized 
for purposes of apportioning the taxpayer's interest expense in its 
first taxable year in which dividends from the 10/50 corporation are 
eligible for look-through treatment (i.e., its first taxable year 
ending after the first day of the 10/50 corporation's first post-2002 
taxable year). Any SLL account in a separate category for dividends 
from a 10/50 corporation with respect to another category that would be 
assigned to that other category under this rule will be eliminated, 
since ``recapture'' to and from the same category would be meaningless. 
See Sec.  1.904(f)-12T(g)(4) Example 1.
    The IRS and the Treasury Department determined that it is 
appropriate to reallocate OFL and SLL accounts based on how the 
taxpayer characterizes the stock of the 10/50 corporation for interest 
expense apportionment purposes in its first taxable year ending after 
the first day of the 10/50 corporation's first post-2002 taxable year. 
The IRS and the Treasury Department believe that recapturing losses 
from income earned in subsequent years is a forward-looking concept. 
Reallocating losses that were incurred in a separate category for 
dividends from each 10/50 corporation to the appropriate separate 
category based on the interest expense apportionment ratio (as opposed 
to, for example, reallocating losses based on reconstructed non-look-
through pools) is consistent with that concept.
    In the case of a taxpayer that has an OFL or SLL account in a 
separate category for dividends from a 10/50 corporation but no longer 
is a qualifying shareholder with respect to the foreign corporation, 
the IRS and the Treasury Department determined that reallocating OFLs 
and SLLs incurred in separate categories for dividends from 10/50 
corporations to the other separate categories may be inappropriate. In 
pre-2003 taxable years, recapture of the OFL or SLL would not have 
occurred because the taxpayer would not have received any additional 
dividends from the corporation that would be treated as income in the 
separate 10/50 loss category (unless the former shareholder

[[Page 24523]]

reacquired a sufficient interest in the corporation to become a 
qualifying shareholder). Accordingly, Sec.  1.904(f)-12T(g)(3) provides 
that where a taxpayer was not a qualifying shareholder with respect to 
a foreign corporation on December 20, 2002 (or was not a qualifying 
shareholder on the first day of the taxpayer's first post-2002 taxable 
year, pursuant to a transaction that was the subject of a binding 
contract which was in effect on December 20, 2002), any OFL or SLL 
accounts in the taxpayer's separate category for dividends from that 
corporation will not be reallocated. See Notice 2003-5 (announcing 
regulations would provide that OFL and SLL accounts in a separate 
category for dividends from each 10/50 corporation where the taxpayer 
was no longer a qualifying shareholder of as of December 20, 2002, will 
not be consolidated into the OFL and SLL accounts of the single 
category for dividends from 10/50 corporations).
    Section 1.904(f)-12T(g)(3) also provides that where an OFL or SLL 
account in a separate category for dividends from each 10/50 
corporation is not reallocated because the taxpayer is no longer a 
qualifying shareholder of that foreign corporation, the taxpayer may 
not carry over any excess foreign taxes in that separate category to 
another separate category on a look-through basis. However, the 
temporary regulations allow the taxpayer to elect to carry over all 
excess taxes in its separate categories for dividends from 10/50 
corporations to the other separate categories, provided that the 
taxpayer also reallocates the OFL and SLL accounts of such separate 
categories for dividends from 10/50 corporations into the OFL and SLL 
accounts of the appropriate separate categories.
B. Recapture of an SLL Incurred in Other Categories
    To the extent that an SLL in another separate category (e.g., the 
general limitation or passive category) offset income in a separate 
category for dividends from each 10/50 corporation in a pre-2003 
taxable year (or later year with or within which the 10/50 
corporation's last pre-2003 taxable year ends), income subsequently 
earned in the loss category will be recaptured as income in the same 
separate categories in which the taxpayer properly characterizes the 
stock of the 10/50 corporation on a look-through basis for purposes of 
apportioning the taxpayer's interest expense. See Sec. Sec.  1.904(f)-
12T(g)(2). Section 1.904(f)-12T(g)(4), Example 2, illustrates how the 
apportionment rule applies to SLLs in the general limitation and 
passive categories that previously offset income in a separate category 
for dividends from a 10/50 corporation, where the taxpayer 
characterizes the stock of the 10/50 corporation as a multiple category 
asset.

VII. Tax Elections, Adoptions of Method of Accounting or Taxable Year, 
and Changes in Method of Accounting or Taxable Year Made on Behalf of a 
CFC or 10/50 Corporation

    Section 1.964-1T(c)(2) and (3) add rules allowing the majority 
domestic corporate shareholders of a 10/50 corporation to make an 
election, adopt a method of accounting or taxable year, or change a 
method of accounting or taxable year on behalf of the 10/50 
corporation. Under Sec.  1.964-1T(c)(5), the term majority domestic 
corporate shareholders is defined as those domestic corporations that 
meet the ownership requirements of section 902(a) with respect to the 
10/50 corporation (or to a first-tier foreign corporation that is a 
member of the same qualified group as the 10/50 corporation), that, in 
the aggregate, own directly or indirectly more than 50 percent of the 
combined voting power of all the voting stock of the 10/50 corporation 
that is owned directly or indirectly by all domestic corporations that 
meet the ownership requirements of section 902(a) with respect to the 
10/50 corporation (or a relevant first-tier foreign corporation).
    Section 1.964-1(c)(3) of the current final regulations permits 
controlling United States shareholders of a CFC to make an election, or 
to adopt or change a method of accounting, on behalf of the CFC. 
Subject to the rules of section 898, the temporary regulations at Sec.  
1.964-1T(c)(3) extend this rule to permit controlling United States 
shareholders of a CFC to adopt or change the taxable year of a CFC. 
Finally, the temporary regulations revise the requirement that the 
controlling shareholders file a written statement executed by each of 
the controlling shareholders with the IRS within 180 days of the close 
of the foreign corporation's taxable year for which the adoption or 
change in method of accounting is to be effective. In lieu of the 
written statement, Sec.  1.964-1T(c)(3)(i)(B) requires that the jointly 
executed statement evidencing the controlling shareholders' consent to 
the adoption or change be retained by one or more of the shareholders, 
and that each shareholder file a separate statement with its tax return 
for the taxable year with or within which the foreign corporation's 
taxable year ends. This change will facilitate e-filing by eliminating 
the signature requirement and will facilitate compliance by conforming 
the dates on which the election statement and the shareholder's tax 
return must be filed.

VIII. Election To Defer Effective Date of 10/50 Look-Through Rules

A. Time, Form, and Manner of Election
    As discussed in the Background section of this document, section 
403(l) of the GOZA provides a rule under which a taxpayer may elect not 
to apply the extended look-through rules enacted in the AJCA for 
taxable years of 10/50 corporations beginning after December 31, 2002, 
and before January 1, 2005 (2003 and 2004 taxable years). In order to 
make the election, a taxpayer must attach a statement notifying the IRS 
of such election to its next tax return for which the due date (with 
extensions) is more than 90 days after April 25, 2006. The electing 
taxpayer's tax liability as shown on its original or amended tax 
returns for its affected taxable years generally must be consistent 
with the guidance set forth in Notice 2003-5, 2003-1 C.B. 294, and the 
rules of Sec.  1.861-12T(c)(4) (characterizing the stock of a 10/50 
corporation as an asset in the various separate categories). The 
electing taxpayer must also make appropriate adjustments to eliminate 
any double benefit arising from the election in years that are not open 
for assessment. Sec.  1.904-7T(f)(9).
B. Transition Rules
    Taxpayers that elect to apply the pre-AJCA look-through rules for 
the 2003 and 2004 taxable years must assign dividends paid by 10/50 
corporations in their 2003 and 2004 taxable years out of pre-2003 
earnings to a single separate category for dividends from all 10/50 
corporations (see Notice 2003-5). The temporary regulations provide 
transition rules for applying the AJCA look-through rules in taxable 
years of 10/50 corporations beginning after December 31, 2004.
    Under Sec.  1.904-7T(f)(9)(iii), pre-2003 earnings (or a deficit) 
and taxes in the non-look-through pool that existed as of the end of 
the foreign corporation's last pre-2005 taxable year are treated as if 
they were accumulated and paid during a period in which a distribution 
from that corporation would have been eligible for look-through 
treatment. These earnings (or deficits) and taxes are added to the 
foreign corporation's post-1986 undistributed earnings and taxes pools 
in the appropriate separate categories on the first day of the foreign 
corporation's first post-2004 taxable year. In accordance with the 
principles of Sec.  1.904-7T(f)(4), the taxpayer must

[[Page 24524]]

reconstruct the non-look-through pools or, if the taxpayer elects the 
safe harbor, allocate the earnings and taxes in the foreign 
corporation's non-look-through pools to the foreign corporation's look-
through pools on the first day of the foreign corporation's first post-
2004 taxable year. Under the safe harbor, this allocation is made in 
the same percentages as the taxpayer properly characterized the stock 
of the foreign corporation for purposes of interest expense 
apportionment in the taxpayer's first taxable year ending after the 
first day of the foreign corporation's first post-2002 taxable year. If 
the taxpayer does not elect the safe harbor and the Commissioner 
determines that the look-through characterization of the earnings (or 
deficit) and taxes cannot reasonably be determined, the Commissioner 
will allocate the earnings (or deficit) and taxes to the passive 
category.
    To the extent that a taxpayer had excess foreign taxes in the 
single category for dividends from all 10/50 corporations (regardless 
of whether they were carried forward from separate categories for 
dividends from each 10/50 corporation in pre-2003 taxable years under 
Notice 2003-5 or resulted from dividends paid in 2003 and 2004 taxable 
years), they will be carried forward to the appropriate separate 
categories in the same manner as excess taxes in the separate 
categories for dividends from each 10/50 corporation are carried over 
in the case of a non-electing taxpayer. See Sec.  1.904-2T(h)(1). The 
taxpayer must determine which 10/50 corporations paid the dividends to 
which the excess taxes are attributable and then assign the taxes to 
the appropriate separate categories as if such dividends had been 
eligible for look-through treatment when paid. Accordingly, Sec.  
1.904-7T(f)(9)(iv) provides that excess taxes in the single category 
for dividends from 10/50 corporations are assigned to the appropriate 
separate categories by reconstructing the non-look-through pools or, if 
the taxpayer elects the safe harbor, by allocating the taxes in the 
same percentages as the taxpayer properly characterized the stock of 
the foreign corporation for purposes of apportioning the taxpayer's 
interest expense for its first taxable year with or within which the 
10/50 corporation's first post-2002 taxable year began. This transition 
rule applies only to excess taxes attributable to dividends out of pre-
2003 earnings, because only these taxes are included in the single 
category for dividends from all 10/50 corporations.
    To the extent that excess taxes carried forward to the single 
category for dividends from 10/50 corporations under the rules of 
Notice 2003-5 were absorbed by low-taxed dividends paid by 10/50 
corporations in 2003 or 2004 taxable years out of pre-2003 earnings, or 
expired unused, the amount of excess taxes carried forward to a 
separate category on a look-through basis will be smaller than the 
aggregate amount of excess taxes initially carried forward to the 
single category for dividends from 10/50 corporations. To simplify the 
process of determining which 10/50 corporations paid the dividends to 
which the remaining excess taxes are attributable, Sec.  1.904-
7T(f)(9)(iv) treats the remaining excess taxes as attributable pro rata 
to the dividends paid by all 10/50 corporations out of non-look-through 
pools in a particular taxable year that resulted in excess taxes that 
were eligible to be carried forward. Such excess taxes are then carried 
forward to the separate categories based on how the non-look-through 
pools are recharacterized under the rules of Sec.  1.904-7T(f)(4).
    Excess taxes that would otherwise be assigned to the passive 
category and excess taxes with respect to which neither the IRS nor the 
taxpayer can substantiate look-through character are assigned to the 
general limitation category. This rule, previously discussed in section 
III above, applies regardless of whether a taxpayer elects to apply the 
pre-AJCA look-through rules to dividends paid in taxable years of its 
10/50 corporations beginning in 2003 and 2004.
    To the extent that a taxpayer has excess foreign taxes attributable 
to a look-through dividend paid by a 10/50 corporation in post-2002 
taxable years and such taxes are eligible for carryback, the taxes will 
be carried back within the same separate category and not to the 
separate categories or single category for dividends from 10/50 
corporations. See Sec.  1.904-7T(f)(9)(v).
    For taxpayers that maintained OFL and SLL recapture accounts in the 
single category for dividends from all 10/50 corporations (for example, 
as the result of consolidating OFL and SLL accounts of separate 
categories for dividends from each 10/50 corporation into one set of 
OFL and SLL accounts of the single category for dividends from all 10/
50 corporations under Notice 2003-5), the temporary regulations provide 
a transition rule for recapture in a post-2004 taxable year of an OFL 
and SLL in the single category for dividends from all 10/50 
corporations. Section 1.904-7T(f)(9)(vi) provides that the OFL and SLL 
accounts are assigned to the appropriate separate categories, on the 
first day of the taxpayer's first post-2004 taxable year following the 
last taxable year in which it received a dividend in this category. The 
assignment is based on how the stock of each 10/50 corporation giving 
rise to the OFL or SLL is properly characterized for purposes of 
apportioning the taxpayer's interest expense for its first taxable year 
with or within which the 10/50 corporation's first post-2002 taxable 
year began.
    For taxpayers that maintained an SLL recapture account in another 
separate category (e.g., the general or passive category) with respect 
to the single category for dividends from all 10/50 corporations, Sec.  
1.904-7T(f)(9)(vii) provides that the SLL will be recaptured as income 
in the appropriate separate categories in post-2004 taxable years. 
Income is recaptured in the separate categories in the same percentages 
as the taxpayer properly characterized the stock of the 10/50 
corporations with respect to which the loss account was established for 
purposes of apportioning the taxpayer's interest expense for its first 
taxable year with or within which the 10/50 corporation's first post-
2002 taxable year began.
    Where a CFC or 10/50 corporation had a single category for 
dividends from all 10/50 corporations containing earnings attributable 
to dividends paid in 2003 or 2004 taxable years of a lower-tier 10/50 
corporation, the undistributed earnings, previously-taxed earnings, and 
associated taxes are treated in post-2004 taxable years in the same 
manner as pre-2003 undistributed earnings and taxes in a separate 
category for dividends from each 10/50 corporation maintained at the 
CFC or 10/50 corporation level. Accordingly, Sec.  1.904-7T(f)(9)(viii) 
provides that the undistributed earnings and associated taxes in the 
single category for dividends from all 10/50 corporations are assigned 
to the appropriate separate categories based on the taxpayer's 
reconstruction of the non-look-through pools of the lower-tier foreign 
corporation, or, if the taxpayer elects the safe harbor, by allocating 
the earnings and taxes in the same percentages as the taxpayer properly 
characterized (or would have characterized) the stock of the lower-tier 
10/50 corporation for purposes of apportioning the upper-tier 
corporation's interest expense for its first post-2002 taxable year.
    Where a CFC or 10/50 corporation had an aggregate deficit in the 
single category for dividends from all 10/50 corporations as of the end 
of the foreign corporation's 2004 taxable year, the deficit and 
associated taxes are treated

[[Page 24525]]

in the same manner as a deficit in post-1986 undistributed earnings 
attributable to dividends from a lower-tier 10/50 corporation. 
Accordingly, Sec.  1.904-7T(f)(9)(ix) provides that the deficit is 
assigned to the look-through pools based on where the upper-tier 
corporation's income and expenses or losses would have been assigned 
had they been incurred during a look-through period, or, if the 
taxpayer elects the safe harbor, the deficit is allocated based on how 
the taxpayer properly characterized the stock of the lower-tier 
corporation for purposes of apportioning the upper-tier corporation's 
interest expense in its first taxable year with or within which the 
lower-tier corporation's first post-2002 taxable year began. Where the 
taxpayer does not elect the safe harbor and the Commissioner determines 
that the look-through characterization of the deficit cannot reasonably 
be determined based on the available information, the Commissioner will 
assign the deficit and taxes to the upper-tier corporation's passive 
category.

IX. Effective Date

    Section 403 of the AJCA provides that the amendments apply to 
taxable years beginning after December 31, 2002. The statutory language 
and legislative history of the AJCA do not specifically state whether 
the effective date refers to the taxable year of the foreign 
corporation or that of the U.S. shareholder. The temporary regulations 
clarify that the effective date of the amendments refers to the foreign 
corporation's taxable year, thereby eliminating the separate category 
for dividends from each 10/50 corporation as of the beginning of the 
foreign corporation's first post-2002 taxable year. Thus, dividends 
paid by the foreign corporation on and after that date (including 
dividends paid in a U.S. shareholder's pre-2003 taxable year) are 
eligible for look-through treatment. Basing the effective date on the 
foreign corporation's taxable year eliminates the need to create and 
maintain multiple sets of look-through pools of a single foreign 
corporation that begin on different dates for different shareholders. 
Accordingly, the temporary regulations are effective for dividends paid 
in taxable years of 10/50 corporations beginning after December 31, 
2002.
    As discussed in the Background section of this document, section 
403(l) of the GOZA provides a rule allowing taxpayers to elect not to 
apply the expanded look-through rules enacted in the AJCA to taxable 
years beginning in 2003 and 2004. As discussed in section VIII above, 
the temporary regulations provide guidance on the time, form, and 
manner of the election as well as transition rules applicable to 
taxpayers that elect to apply the pre-AJCA rules governing 10/50 
dividends to 2003 and 2004 taxable years.

Special Analyses

    It has been determined that this Treasury decision is not a 
significant regulatory action as defined in Executive Order 12866. 
Therefore, a regulatory assessment is not required. It also has been 
determined that section 553(b) of the Administrative Procedure Act (5 
U.S.C. chapter 5) does not apply to these regulations. For the 
applicability of the Regulatory Flexibility Act (5 U.S.C. chapter 6), 
refer to the Special Analyses section of the preamble of the cross-
referenced notice of proposed rulemaking published in this issue of the 
Federal Register. Pursuant to section 7805(f) of the Internal Revenue 
Code, these temporary regulations will be submitted to the Chief 
Counsel for Advocacy of the Small Business Administration for comment 
on their impact on small businesses.

Drafting Information

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

List of Subjects

26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

26 CFR Part 602

    Reporting and recordkeeping requirements.

Amendments to the Regulations

0
Accordingly, 26 CFR parts 1 and 602 are amended as follows:

PART 1--INCOME TAXES

0
Paragraph 1. The authority for part 1 continues to read in part:

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


0
Par. 2. Section 1.861-9T is amended as follows:
0
1. Revise the last sentence of paragraph (f)(3)(ii).
0
2. Redesignate paragraph (f)(4) as paragraph (f)(5) and add a new 
paragraph (f)(4).
    The revision and addition read as follows:


Sec.  1.861-9T  Allocation and apportionment of interest expense 
(temporary).

* * * * *
    (f) * * *
    (3) * * *
    (ii) * * * The election shall be made by filing a statement 
described in Sec.  1.964-1T(c)(3)(ii) at the time and in the manner 
described therein and providing a written notice described in Sec.  
1.964-1T(c)(3)(iii), except that no such statement or notice is 
required to be filed or sent before July 24, 2006.
* * * * *
    (4) Noncontrolled section 902 corporations--(i) In general. For 
purposes of computing earnings and profits of a noncontrolled section 
902 corporation (as defined in section 904(d)(2)(E)) for federal tax 
purposes, the interest expense of a noncontrolled section 902 
corporation may be apportioned using either the asset method described 
in paragraph (g) of this section or the modified gross income method 
described in paragraph (j) of this section. A noncontrolled section 902 
corporation that is not a controlled foreign corporation may elect to 
use a different method of apportionment than that elected by one or 
more of its shareholders. A noncontrolled section 902 corporation must 
use the same method of apportionment with respect to all its domestic 
corporate shareholders.
    (ii) Manner of election. The election to use the asset method 
described in paragraph (g) of this section or the modified gross income 
method described in paragraph (j) of this section may be made either by 
the noncontrolled section 902 corporation or by the majority domestic 
corporate shareholders (as defined in Sec.  1.964-1T(c)(5)(ii)) on 
behalf of the noncontrolled section 902 corporation. The election shall 
be made by filing a statement described in Sec.  1.964-1T(c)(3)(ii) at 
the time and in the manner described therein and providing a written 
notice described in Sec.  1.964-1T(c)(3)(iii), except that no such 
statement or notice is required to be filed or sent before July 24, 
2006.
    (iii) Stock characterization. In general, the stock of a 
noncontrolled section 902 corporation shall be characterized in the 
hands of any domestic corporation that meets the ownership requirements 
of section 902(a) with respect to the noncontrolled section 902 
corporation, or in the hands of any member of the same qualified group 
as defined in section 902(b)(2), using the same method that the 
noncontrolled section 902 corporation uses to apportion its interest 
expense. Stock in a

[[Page 24526]]

noncontrolled section 902 corporation shall be characterized as a 
passive category asset in the hands of any such shareholder that fails 
to meet the substantiation requirements of Sec.  1.904-5T(c)(4)(iii), 
or in the hands of any shareholder that is not eligible to compute an 
amount of foreign taxes deemed paid with respect to a dividend from the 
noncontrolled section 902 corporation for the taxable year. See Sec.  
1.861-12T(c)(4).
    (iv) Effective date. This paragraph (f)(4) applies for taxable 
years of shareholders ending after the first day of the first taxable 
year of the noncontrolled section 902 corporation beginning after 
December 31, 2002.
* * * * *

0
Par. 3. Section 1.861-12T is amended as follows:
0
1. Remove the language ``directly by the taxpayer'' from paragraph 
(c)(2)(i) introductory text and add the language ``by the taxpayer 
either directly or, for taxable years beginning after April 25, 2006, 
indirectly through a partnership or other pass-through entity'' in its 
place.
0
2. Revise paragraph (c)(4).
    The revision reads as follows:


Sec.  1.861-12T  Characterization rules and adjustment for certain 
assets (temporary regulations.)

* * * * *
    (c) * * *
    (4) Characterization of stock of noncontrolled section 902 
corporations--(i) General rule. The principles of paragraph (c)(3) of 
this section shall apply to stock in a noncontrolled section 902 
corporation (as defined in section 904(d)(2)(E)). Accordingly, stock in 
a noncontrolled section 902 corporation shall be characterized as an 
asset in the various separate limitation categories on the basis of 
either the asset method described in (c)(3)(ii) of this section or the 
modified gross income method described in (c)(3)(iii) of this section. 
Stock in a noncontrolled section 902 corporation the interest expense 
of which is apportioned on the basis of assets shall be characterized 
in the hands of its domestic shareholders (as defined in Sec.  1.902-
1(a)(1)) under the asset method described in paragraph (c)(3)(ii). 
Stock in a noncontrolled section 902 corporation the interest expense 
of which is apportioned on the basis of gross income shall be 
characterized in the hands of its domestic shareholders under the gross 
income method described in paragraph (c)(3)(iii).
    (ii) Nonqualifying shareholders. Stock in a noncontrolled section 
902 corporation shall be characterized as a passive category asset in 
the hands of a shareholder that is not eligible to compute an amount of 
foreign taxes deemed paid with respect to a dividend from the 
noncontrolled section 902 corporation for the taxable year, and in the 
hands of any shareholder with respect to whom look-through treatment is 
not substantiated. See Sec.  1.904-5T(c)(4)(iii).
    (iii) Effective date. This paragraph (c)(4) applies for taxable 
years of shareholders ending after the first day of the first taxable 
year of the noncontrolled section 902 corporation beginning after 
December 31, 2002.
* * * * *

0
Par. 4. Section 1.902-0 is amended as follows:
0
1. Revise the entry for Sec.  1.902-1(a)(4) and add entries for Sec.  
1.902-1(a)(4)(i) and (a)(4)(ii) .
0
2. Revise the entry for Sec.  1.902-1(b).
0
3. Revise the entry for Sec.  1.902-1(c)(8), and add entries for 
Sec. Sec.  1.902-1(c)(8)(i) and (ii).
0
4. Remove the entry for Sec.  1.902-1(c)(9).
0
5. Revise the entry for Sec.  1.902-1(d).
0
6. Remove the entries for Sec.  1.902-1(d)(3), (d)(3)(i), and 
(d)(3)(ii).
0
7. Revise the entries for Sec. Sec.  1.902-2, 1.902-2(a), and 1.902-
2(b).
    The revisions and additions read as follows:


1.902-0  Outline of regulations provisions for section 902.

* * * * *

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

    (a) * * *
    (4) Third- or lower-tier corporation.
    (i) Third-tier corporation.
    (ii) Fourth-, fifth-, or sixth-tier corporation.
* * * * *
    (b) Computation of foreign income taxes deemed paid by a domestic 
shareholder, first-tier corporation, or lower-tier corporation.
* * * * *
    (c) * * *
    (8) Effect of certain liquidations, reorganizations, or similar 
transactions on certain foreign taxes paid or accrued in taxable years 
beginning on or before August 5, 1997.
    (i) General rule.
    (ii) Example.
    (d) Dividends from controlled foreign corporations and 
noncontrolled section 902 corporations.
* * * * *


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

    (a) Carryback of deficits in post-1986 undistributed earnings of a 
first- or lower-tier corporation to pre-effective date taxable years.
* * * * *
    (b) Carryforward of deficit in pre-1987 accumulated profits of a 
first- or lower-tier corporation to post-1986 undistributed earnings 
for purposes of section 902.
* * * * *

0
Par. 5. Section 1.902-1 is amended as follows:
0
1. Revise paragraph (a)(4).
0
2. Revise paragraph (a)(6).
0
3. Revise paragraph (a)(7).
0
4. Revise paragraph (a)(8)(i).
0
5. In paragraph (a)(8)(iii), add the language ``in a taxable year 
beginning on or before December 31, 2002'' after the language ``(as 
defined in section 904(d)(2)(E)(i))'' and add the language ``(26 CFR 
revised as of April 1, 2006)'' after the language ``Sec.  1.904-
4(g)(2)(iii)''.
0
6. Revise the heading of paragraph (b).
0
7. Revise paragraph (c)(8).
0
8. Remove paragraph (c)(9).
0
9. Revise paragraphs (d)(1) and (d)(2)(i).
0
10. Remove paragraph (d)(3).
0
11. Revise paragraph (g).
    The revisions and additions read as follows:


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

    (a) * * *
    (4) Third- or lower-tier corporation. (i) In the case of dividends 
paid to a second-tier corporation by a foreign corporation in a taxable 
year beginning after December 31, 1986, a foreign corporation is a 
third-tier corporation if, at the time a second-tier corporation 
receives a dividend from that foreign corporation, the second-tier 
corporation owns at least 10 percent of the foreign corporation's 
voting stock and the product of the following equals at least 5 
percent--
    (A) The percentage of voting stock owned by the domestic 
shareholder in the first-tier corporation; multiplied by
    (B) The percentage of voting stock owned by the first-tier 
corporation in the second-tier corporation; multiplied by
    (C) The percentage of voting stock owned by the second-tier 
corporation in the third-tier corporation.

[[Page 24527]]

    (ii) Fourth-, fifth-, or sixth-tier corporation. [Reserved]. For 
further guidance, see Sec.  1.902-1T(a)(4)(ii).
* * * * *
    (6) Upper- and lower-tier corporations. [Reserved]. For further 
guidance, see Sec.  1.902-1T(a)(6).
    (7) Foreign income taxes. [Reserved]. For further guidance, see 
Sec.  1.902-1T(a)(7).
    (8) * * * (i) In general. [Reserved]. For further guidance, see 
Sec.  1.902-1T(a)(8)(i).
* * * * *
    (b) Computation of foreign income taxes deemed paid by a domestic 
shareholder, first-tier corporation, or lower-tier corporation.
* * * * *
    (c) * * *
    (8) Effect of certain liquidations, reorganizations, etc. on 
certain foreign taxes paid or accrued in taxable years beginning on or 
before August 5, 1997. [Reserved]. For further guidance, see Sec.  
1.902-1T(c)(8).
    (d) Dividends from controlled foreign corporations and 
noncontrolled section 902 corporations--(1) General rule. [Reserved]. 
For further guidance, see Sec.  1.902-1T(d)(1).
    (2) Look-through--(i) Dividends. [Reserved]. For further guidance, 
see Sec.  1.902-1T(d)(2)(i).
* * * * *
    (g) Effective date. [Reserved]. For further guidance, see Sec.  
1.902-1T(g).

0
Par. 6. Section 1.902-1T is added to read as follows:


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

    (a)(1) through (a)(3) [Reserved]. For further guidance, see Sec.  
1.902-1(a)(1) through (a)(3).
    (a)(4)(i) [Reserved]. For further guidance, see Sec.  1.902-
1(a)(4)(i).
    (ii) Fourth-, fifth-, or sixth-tier corporation. In the case of 
dividends paid to a third-, fourth-, or fifth-tier corporation by a 
foreign corporation in a taxable year beginning after August 5, 1997, 
the foreign corporation is a fourth-, fifth-, or sixth-tier 
corporation, respectively, if at the time the dividend is paid, the 
corporation receiving the dividend owns at least 10 percent of the 
foreign corporation's voting stock, the chain of foreign corporations 
that includes the foreign corporation is connected through stock 
ownership of at least 10 percent of their voting stock, the domestic 
shareholder in the first-tier corporation in such chain indirectly owns 
at least 5 percent of the voting stock of the foreign corporation 
through such chain, such corporation is a controlled foreign 
corporation (as defined in section 957) and the domestic shareholder is 
a United States shareholder (as defined in section 951(b)) in the 
foreign corporation. Taxes paid by a fourth-, fifth-, or sixth-tier 
corporation shall be taken into account in determining post-1986 
foreign income taxes only if such taxes are paid with respect to 
taxable years beginning after August 5, 1997, in which the corporation 
was a controlled foreign corporation.
    (a)(5) [Reserved]. For further guidance, see Sec.  1.902-1(a)(5).
    (6) Upper- and lower-tier corporations. In the case of a sixth-tier 
corporation, the term upper-tier corporation means a first-, second-, 
third-, fourth-, or fifth-tier corporation. In the case of a fifth-tier 
corporation, the term upper-tier corporation means a first-, second-, 
third-, or fourth-tier corporation. In the case of a fourth-tier 
corporation, the term upper-tier corporation means a first-, second-, 
or third-tier corporation. In the case of a third-tier corporation, the 
term upper-tier corporation means a first- or second-tier corporation. 
In the case of a second-tier corporation, the term upper-tier 
corporation means a first-tier corporation. In the case of a first-tier 
corporation, the term lower-tier corporation means a second-, third-, 
fourth-, fifth-, or sixth-tier corporation. In the case of a second-
tier corporation, the term lower-tier corporation means a third-, 
fourth-, fifth-, or sixth-tier corporation. In the case of a third-tier 
corporation, the term lower-tier corporation means a fourth-, fifth-, 
or sixth-tier corporation. In the case of a fourth-tier corporation, 
the term lower-tier corporation means a fifth- or sixth-tier 
corporation. In the case of a fifth-tier corporation, the term lower-
tier corporation means a sixth-tier corporation.
    (7) Foreign income taxes. The term foreign income taxes means 
income, war profits, and excess profits taxes as defined in Sec.  
1.902-1(a), and taxes included in the term income, war profits, and 
excess profits taxes by reason of section 903, that are imposed by a 
foreign country or a possession of the Untied States, including any 
such taxes deemed paid by a foreign corporation under this section. 
Foreign income, war profits, and excess profits taxes shall not include 
amounts excluded from the definition of those taxes pursuant to section 
901 and the regulations under that section. See sections 901(f) and (i) 
and paragraph (c)(5) of this section. Foreign income, war profits, and 
excess profits taxes also shall not include taxes for which a credit is 
disallowed under section 901 and the regulations thereunder. See 
sections 901(e), (h), (j), (k), and (l), and paragraphs (c)(4) and 
(c)(8) of this section.
    (8) Post-1986 foreign income taxes--(i) In general. Except as 
provided in paragraphs (a)(10) and (a)(13) of this section, the term 
post-1986 foreign income taxes of a foreign corporation means the sum 
of the foreign income taxes paid, accrued, or deemed paid in the 
taxable year of the foreign corporation in which it distributes a 
dividend plus the foreign income taxes paid, accrued, or deemed paid in 
the foreign corporation's prior taxable years beginning after December 
31, 1986, to the extent the foreign taxes were not attributable to 
dividends distributed to, or earnings otherwise included (e.g., under 
section 304, 367(b), 551, 951(a), 1248, or 1293) in the income of, a 
foreign or domestic shareholder in prior taxable years. Except as 
provided in paragraph (b)(4) of this section, foreign taxes paid or 
deemed paid by the foreign corporation on or with respect to earnings 
that were distributed or otherwise removed from post-1986 undistributed 
earnings in prior post-1986 taxable years shall be removed from post-
1986 foreign income taxes regardless of whether the shareholder is 
eligible to compute an amount of foreign taxes deemed paid under 
section 902, and regardless of whether the shareholder in fact chose to 
credit foreign income taxes under section 901 for the year of the 
distribution or inclusion. Thus, if an amount is distributed or deemed 
distributed by a foreign corporation to a United States person that is 
not a domestic shareholder within the meaning of paragraph (a)(1) of 
this section (e.g., an individual or a corporation that owns less than 
10% of the foreign corporation's voting stock), or to a foreign person 
that does not meet the definition of an upper-tier corporation under 
paragraph (a)(6) of this section, then although no foreign income taxes 
shall be deemed paid under section 902, foreign income taxes 
attributable to the distribution or deemed distribution that would have 
been deemed paid had the shareholder met the ownership requirements of 
paragraphs (a)(1) through (4) of this section shall be removed from 
post-1986 foreign income taxes. Further, if a domestic shareholder 
chooses to deduct foreign taxes paid or accrued for the taxable year of 
the distribution or inclusion, it shall nonetheless be deemed to have 
paid a proportionate share of the foreign

[[Page 24528]]

corporation's post-1986 foreign income taxes under section 902(a), and 
the foreign income taxes deemed paid must be removed from post-1986 
foreign income taxes. In the case of a foreign corporation the foreign 
income taxes of which are determined based on an accounting period of 
less than one year, the term year means that accounting period. See 
sections 441(b)(3) and 443.
    (a)(8)(ii) through (c)(7) [Reserved]. For guidance, see Sec.  
1.902-1(a)(8)(ii) through (c)(7).
    (8) Effect of certain liquidations, reorganizations, or similar 
transactions on certain foreign taxes paid or accrued in taxable years 
beginning on or before August 5, 1997--(i) General rule. 
Notwithstanding the effect of any liquidation, reorganization, or 
similar transaction, foreign taxes paid or accrued by a member of a 
qualified group (as defined in section 902(b)(2)) shall not be eligible 
to be deemed paid if they were paid or accrued in a taxable year 
beginning on or before August 5, 1997, by a corporation that was a 
fourth-, fifth- or sixth-tier corporation with respect to the taxpayer 
on the first day of the corporation's first taxable year beginning 
after August 5, 1997.
    (ii) Example. P, a domestic corporation, has owned 100 percent of 
the voting stock of foreign corporation S at all times since January 1, 
1987. Until June 30, 2002, S owned 100 percent of the voting stock of 
foreign corporation T, T owned 100 percent of the voting stock of 
foreign corporation U, and U owned 100 percent of the voting stock of 
foreign corporation V. P, S, T, U, and V each use the calendar year as 
their U.S. taxable year. Thus, beginning in 1998 V was a fourth-tier 
controlled foreign corporation, and its foreign taxes paid or accrued 
in 1998 and later taxable years were eligible to be deemed paid. On 
June 30, 2002, T was liquidated, causing S to acquire 100 percent of 
the stock of U. As a result, V became a third-tier controlled foreign 
corporation. In 2003, V paid a dividend to U. Under paragraph (c)(8) of 
this section, foreign taxes paid by V in taxable years beginning before 
1998 are not taken into account in computing the foreign taxes deemed 
paid with respect to the dividend paid by V to U.
    (d) Dividends from controlled foreign corporations and 
noncontrolled section 902 corporations--(1) General rule. If a dividend 
is described in paragraphs (d)(1) (A) through (D) of this section, the 
following rules apply. If a dividend is paid out of post-1986 
undistributed earnings or pre-1987 accumulated profits of a foreign 
corporation attributable to more than one separate category, the amount 
of foreign income taxes deemed paid by the domestic shareholder or the 
upper-tier corporation under section 902 and paragraph (b) of this 
section shall be computed separately with respect to the post-1986 
undistributed earnings or pre-1987 accumulated profits in each separate 
category out of which the dividend is paid. See Sec. Sec.  1.904-
5T(c)(4), 1.904-5(i), and paragraph (d)(2) of this section. The 
separately computed deemed-paid taxes shall be added to other taxes 
paid by the domestic shareholder or upper-tier corporation with respect 
to income in the appropriate separate category. The rules of this 
paragraph (d)(1) apply to dividends received by--
    (A) A domestic shareholder that is a United States shareholder (as 
defined in section 951(b) or section 953(c)) from a first-tier 
corporation that is a controlled foreign corporation;
    (B) A domestic shareholder from a first-tier corporation that is a 
noncontrolled section 902 corporation;
    (C) An upper-tier controlled foreign corporation from a lower-tier 
controlled foreign corporation if the corporations are related look-
through entities within the meaning of Sec.  1.904-5(i) (see Sec.  
1.904-5T(i)(3)); or
    (D) A foreign corporation that is eligible to compute an amount of 
foreign taxes deemed paid under section 902(b)(1), from a controlled 
foreign corporation or a noncontrolled section 902 corporation (i.e., 
both the payor and payee corporations are members of the same qualified 
group as defined in section 902(b)(2) (see Sec.  1.904-5T(i)(4)).
    (2) Look-through--(i) Dividends. Any dividend distribution by a 
controlled foreign corporation or noncontrolled section 902 corporation 
to a domestic shareholder or a foreign corporation that is eligible to 
compute an amount of foreign taxes deemed paid under section 902(b)(1) 
shall be deemed paid pro rata out of each separate category of income. 
Any dividend distribution by a controlled foreign corporation to a 
controlled foreign corporation that is a related look-through entity 
within the meaning of Sec.  1.904-5T(i)(3) shall also be deemed to be 
paid pro rata out of each separate category of income. See Sec. Sec.  
1.904-5T(c)(4), 1.904-5(i), and 1.904-7. The portion of the foreign 
income taxes attributable to a particular separate category that shall 
be deemed paid by the domestic shareholder or upper-tier corporation 
must be computed under the following formula:

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

    (e) through (f). [Reserved] For further guidance, see Sec.  1.902-
1(e) through (f).
    (g) Effective dates. This section and Sec.  1.902-1 apply to any 
distribution made in and after a foreign corporation's first taxable 
year beginning on or after January 1, 1987, except that the provisions 
of paragraphs (a)(4)(ii), (a)(6), (a)(7), (a)(8)(i), and (c)(8) of this 
section apply to distributions made in taxable years of foreign 
corporations beginning after April 25, 2006, and, except as provided in 
Sec.  1.904-7T(f)(9), the provisions of paragraph (d) of this section 
apply to distributions in taxable years of foreign corporations 
beginning after December 31, 2002.

0
Par. 7. Section 1.902-2 is amended as follows:
0
1. Revise the section heading and the headings for paragraphs (a) and 
(b).
0
2. In paragraph (a)(1), remove two instances of the language ``a first-
, second- or third-tier corporation'' and add the language ``a first- 
or lower-tier corporation'' in its place.
0
3. In paragraph (b)(1), remove the language ``a first-, second- or 
third-tier corporation'' and add the language ``a first- or lower-tier 
corporation'' in its place.
    The revisions read as follows:


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

    (a) Carryback of deficits in post-1986 undistributed earnings of a 
first- or lower-tier corporation to pre-effective date taxable years.
* * * * *
    (b) Carryforward of deficit in pre-1987 accumulated profits of a 
first- or lower-tier corporation to post-1986 undistributed earnings 
for purposes of section 902.

0
Par. 8. Section 1.904-0 is amended as follows:
0
1. Add the entries for Sec.  1.904-2(h), (h)(1), and (h)(2).
0
2. Revise the entry for Sec.  1.904-4(c)(4).

[[Page 24529]]

0
3. Remove the entry for Sec.  1.904-4(c)(5)(iv), and redesignate the 
entry for Sec.  1.904-4(c)(5)(v) as Sec.  1.904-4(c)(5)(iv).
0
4. Remove the entries for Sec.  1.904-4(g)(1) through (g)(3).
0
5. Redesignate the entries for Sec.  1.904-5(c)(2)(iii) and (iv) as 
Sec.  1.904-5(c)(2)(iv) and (v), respectively, and add the entry for 
Sec.  1.904-5(c)(2)(iii).
0
6. Revise the entry for Sec.  1.904-5(c)(4)(i), redesignate the entry 
for Sec.  1.904-5(c)(4)(iii) as Sec.  1.904-5(c)(4)(iv), and add the 
entry for Sec.  1.904-5(c)(4)(iii).
0
7. Remove the entry for Sec.  1.904-5(f)(2), and redesignate the 
entries for Sec.  1.904-5(f)(3) and (4) as Sec.  1.904-5(f)(2) and (3), 
respectively.
0
8. Revise the entry for Sec.  1.904-5(i)(3), redesignate the entry for 
Sec.  1.904-5(i)(4) as Sec.  1.904-5(i)(5), and add the entry for Sec.  
1.904-5(i)(4).
0
9. Add the entries for Sec.  1.904-5(m)(2)(i) and (ii).
0
10. Add the entries for Sec.  1.904-5(o)(1) and (2).
0
11. Revise the entry for Sec.  1.904-6(a)(2).
0
12. Add the entry for Sec.  1.904-7(f).
0
13. Add the entry for Sec.  1.904(f)-12(g).
    The revisions and additions read as follows:


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

* * * * *


Sec.  1.904-2  Carryback and carryover of unused foreign tax.

* * * * *
    (h) Transition rules for carryovers and carrybacks of pre-2003 and 
post-2002 unused foreign tax paid or accrued with respect to dividends 
from noncontrolled section 902 corporations.
    (1) Carryover of unused foreign tax.
    (2) Carryback of unused foreign tax.
* * * * *


Sec.  1.904-4  Separate application of section 904 with respect to 
certain categories of income.

* * * * *
    (c) * * *
    (4) Dividends and inclusions from controlled foreign corporations, 
dividends from noncontrolled section 902 corporations, and income of 
foreign QBUs.
* * * * *


Sec.  1.904-5  Look-through rules as applied to controlled foreign 
corporations and other entities.

* * * * *
    (c) * * *
    (2) * * *
    (iii) Allocating and apportioning expenses of a noncontrolled 
section 902 corporation.
* * * * *
    (4) * * *
    (i) Look-through rule for controlled foreign corporations. * * *
    (iii) Look-through rule for noncontrolled section 902 corporations. 
* * *
    (i) * * *
    (3) Special rule for dividends between controlled foreign 
corporations.
    (4) Payor and recipient of dividend are members of the same 
qualified group. * * *
    (m) * * *
    (2) * * *
    (i) Interest payments from controlled foreign corporations.
    (ii) Interest payments from noncontrolled section 902 corporations. 
* * *
    (o) * * *
    (i) Rules for controlled foreign corporations and other look-
through entities.
    (ii) Rules for noncontrolled section 902 corporations.


Sec.  1.904-6  Allocation and apportionment of taxes.

    (a) * * *
    (2) Reserved.
* * * * *


Sec.  1.904-7  Transition rules.

* * * * *
    (f) Treatment of non-look-through pools of a noncontrolled section 
902 corporation or a controlled foreign corporation in post-2002 
taxable years.
* * * * *


Sec.  1.904(f)-12  Transition rules.

* * * * *
    (g) Recapture in years beginning after December 31, 2002, of 
separate limitation losses and overall foreign losses incurred in years 
beginning before January 1, 2003, with respect to the separate category 
for dividends from a noncontrolled section 902 corporation.
* * * * *


0
Par. 9. Section 1.904-2 is amended as follows:
0
1. Revise paragraph (a).
0
2. Add new paragraph (h).
    The revisions and addition reads as follows:


Sec.  1.904-2  Carryback and carryover of unused foreign tax.

    (a) Credit for foreign tax carryback or carryover. [Reserved]. For 
further guidance, see Sec.  1.904-2T(a).
* * * * *
    (h) Transition rules for carryovers and carrybacks of pre-2003 and 
post-2002 unused foreign tax paid or accrued with respect to dividends 
from noncontrolled section 902 corporations. [Reserved]. For further 
guidance, see Sec.  1.904-2T(h).
* * * * *

0
Par. 10. Section 1.904-2T is added to read as follows:


Sec.  1.904-2T  Carryback and carryover of unused foreign tax 
(temporary).

    (a) Credit for foreign tax carryback or carryover (temporary). A 
taxpayer who chooses to claim a credit under section 901 for a taxable 
year is allowed a credit under that section not only for taxes 
otherwise allowable as a credit but also for taxes deemed paid or 
accrued in that year as a result of a carryback or carryover of an 
unused foreign tax under section 904(c). However, the taxes so deemed 
paid or accrued shall not be allowed as a deduction under section 
164(a). Paragraphs (b) through (g) of Sec.  1.904-2 and Sec.  1.904-3, 
providing rules for the computation of carryovers and carrybacks, do 
not reflect a number of intervening statutory amendments, including the 
redesignation of section 904(d) as section 904(c) for taxable years 
beginning after 1975, amendments to sections 904(d) and (f) regarding 
the application of separate limitations in taxable years beginning 
after 1986, the limitation of the carryback period to one year for 
unused foreign taxes arising in taxable years beginning after October 
22, 2004, and the extension of the carryover period to ten years for 
unused foreign taxes that may be carried to any taxable year ending 
after October 22, 2004. However, the principles of paragraphs (b) 
through (g) of Sec.  1.904-2 and Sec.  1.904-3 shall apply in 
determining carrybacks and carryovers of unused foreign taxes, modified 
so as to take into account the effect of statutory amendments. For 
transition rules relating to the carryover and carryback of unused 
foreign tax paid with respect to dividends from noncontrolled section 
902 corporations, see paragraph (h) of this section. For special rules 
regarding these computations in case of taxes paid, accrued, or deemed 
paid with respect to foreign oil and gas extraction income or foreign 
oil related income, see section 907(f) and the regulations under that 
section.
    (b) through (g) [Reserved]. For further guidance, see Sec.  1.904-
2(b) through (g).
    (h) Transition rules for carryovers and carrybacks of pre-2003 and 
post-2002 unused foreign tax paid or accrued with respect to dividends 
from noncontrolled section 902 corporations (temporary). (1) Carryover 
of unused foreign tax. Except as provided in Sec. Sec.  1.904-
7T(f)(9)(iv) and 1.904(f)-12T(g)(3), the rules of this paragraph (h)(1) 
apply to reallocate to the taxpayer's other separate categories any 
unused foreign

[[Page 24530]]

taxes (as defined in Sec.  1.904-2(b)(2)) that were paid or accrued or 
deemed paid under section 902 with respect to a dividend from a 
noncontrolled section 902 corporation paid in a taxable year of the 
noncontrolled section 902 corporation beginning before January 1, 2003, 
which taxes were subject to a separate limitation for dividends from 
that noncontrolled section 902 corporation. To the extent any such 
unused foreign taxes are carried forward to a taxable year of a 
domestic shareholder beginning on or after the first day of the 
noncontrolled section 902 corporation's first taxable year beginning 
after December 31, 2002, such taxes shall be allocated among the 
taxpayer's separate categories in the same proportions as the related 
dividend would have been assigned had such dividend been eligible for 
look-through treatment when paid. Accordingly, the taxes shall be 
allocated in the same percentages as the reconstructed earnings in the 
noncontrolled section 902 corporation's non-look-through pool and pre-
1987 accumulated profits that were accumulated in taxable years 
beginning before January 1, 2003, out of which the dividend was paid, 
in accordance with the rules of Sec.  1.904-7T(f), or, if the taxpayer 
elects the safe harbor of Sec.  1.904-7T(f)(4)(ii), in the same 
percentages as the taxpayer properly characterizes the stock of the 
noncontrolled section 902 corporation for purposes of apportioning its 
interest expense in its first taxable year ending after the first day 
of the noncontrolled section 902 corporation's first taxable year 
beginning after December 31, 2002. See Sec.  1.904-7T(f)(2) and (f)(4). 
In the case of unused foreign taxes allocable to dividends from a 
noncontrolled section 902 corporation with respect to which the 
taxpayer was no longer a domestic shareholder (as defined in Sec.  
1.902-1(a)) as of the first day of such taxable year, such taxes shall 
be allocated among the taxpayer's separate categories in the same 
percentages as the earnings in the noncontrolled section 902 
corporation's non-look-through pool or pre-1987 accumulated profits 
would have been assigned had they been distributed in the last taxable 
year in which the taxpayer was a domestic shareholder in such 
corporation. The unused foreign taxes that are carried forward shall be 
treated as allocable to general limitation income to the extent that 
such taxes would otherwise have been allocable to passive income, 
either on a look-through basis or as a result of inadequate 
substantiation under the rules of Sec.  1.904-7T(f)(4).
    (2) Carryback of unused foreign tax. The rules of this paragraph 
(h)(2) apply to any unused foreign taxes that were paid or accrued or 
deemed paid under section 902 with respect to a dividend from a 
noncontrolled section 902 corporation paid in a taxable year of a 
noncontrolled section 902 corporation beginning after December 31, 
2002, which dividends were eligible for look-through treatment. To the 
extent any such unused foreign taxes are carried back to a prior 
taxable year of a domestic shareholder, a credit for such taxes shall 
be allowed only to the extent of the excess limitation in the same 
separate category or categories to which the related look-through 
dividend was assigned and not in any separate category for dividends 
from noncontrolled section 902 corporations.

0
Par. 11. Section 1.904-4 is amended as follows:
0
1. Revise paragraphs (c)(2)(i), (c)(3), (c)(4), and (c)(6)(iv)(B).
0
2. Remove paragraph (c)(5)(iv), and redesignate paragraph (c)(5)(v) as 
paragraph (c)(5)(iv).
0
3. In paragraph (e)(5)(iii), remove the language ``and paragraph (9) of 
this section'' and add the language ``paid in taxable years beginning 
before January 1, 2003'' in its place.
0
4. In paragraph (f), remove the language ``received or accrued from a 
noncontrolled section 902 corporation,'' and add the language ``paid by 
a noncontrolled section 902 corporation in a taxable year beginning 
before January 1, 2003'' in its place.
0
5. Revise the text of paragraph (g).
    The revisions and additions read as follows:


Sec.  1.904-4  Separate application of section 904 with respect to 
certain categories of income.

* * * * *
    (c) * * * (2) * * *
    (i) Effective dates. [Reserved]. For further guidance, see Sec.  
1.904-4T(c)(2)(i). * * *
    (3) and (4) [Reserved]. For further guidance, see Sec.  1.904-
4T(c)(3) and (4).
* * * * *
    (c)(6) * * * (iv) * * * (A) * * *
    (B) Exception. For a special rule applicable to distributions prior 
to August 6, 1997, to U.S. shareholders not entitled to look-through 
treatment, see 26 CFR 1.904-4(c)(6)(iv)(B) (revised as of April 1, 
2006).
* * * * *
    (g) Noncontrolled section 902 corporation. See Sec.  1.904-5 for 
the treatment of dividends paid by a noncontrolled section 902 
corporation in taxable years beginning after December 31, 2002. For 
rules applicable to dividends paid by noncontrolled section 902 
corporations in taxable years beginning before January 1, 2003, see 26 
CFR 1.904-4 (revised as of April 1, 2006).
* * * * *

0
Par. 12. Section 1.904-4T is added to read as follows:


Sec.  1.904-4T  Separate application of section 904 with respect to 
certain categories of income (temporary).

    (a) through (b) [Reserved]. For further guidance, see Sec.  1.904-
4(a) through (b). (c)(1) [Reserved]. For further guidance, see Sec.  
1.904-4(c)(1).
    (2) Grouping of items of income in order to determine whether 
passive income is high-taxed income--(i) Effective dates. For purposes 
of determining whether passive income is high-taxed income, the 
grouping rules of paragraphs (c)(3) and (c)(4) of this section apply to 
taxable years beginning after December 31, 2002. For corresponding 
rules applicable to taxable years beginning before January 1, 2003, see 
26 CFR Sec.  1.904-4(c)(2)(i) (revised as of April 1, 2006).
    (c)(2)(ii) [Reserved]. For further guidance, see Sec.  1.904-
4(c)(2)(ii).
    (3) Amounts received or accrued by United States persons. Except as 
otherwise provided in Sec.  1.904-4(c)(5), all passive income received 
by a United States person shall be subject to the rules of this 
paragraph (c)(3). However, subpart F inclusions that are passive 
income, dividends from a controlled foreign corporation or 
noncontrolled section 902 corporation that are passive income, and 
income that is earned by a United States person through a foreign 
qualified business unit (foreign QBU) that is passive income shall be 
subject to the rules of this paragraph only to the extent provided in 
paragraph (c)(4) of this section. For purposes of this section, a 
foreign QBU is a QBU (as defined in section 989(a)), other than a 
controlled foreign corporation or noncontrolled section 902 
corporation, that has its principal place of business outside the 
United States. These rules shall apply whether the income is received 
from a controlled foreign corporation of which the United States person 
is a United States shareholder, from a noncontrolled section 902 
corporation of which the United States person is a domestic corporation 
meeting the stock ownership requirements of section 902(a), or from any 
other person. For purposes of determining whether passive income is 
high-taxed income, the following rules apply:

[[Page 24531]]

    (i) All passive income received during the taxable year that is 
subject to a withholding tax of fifteen percent or greater shall be 
treated as one item of income.
    (ii) All passive income received during the taxable year that is 
subject to a withholding tax of less than fifteen percent (but greater 
than zero) shall be treated as one item of income.
    (iii) All passive income received during the taxable year that is 
subject to no withholding tax or other foreign tax shall be treated as 
one item of income.
    (iv) All passive income received during the taxable year that is 
subject to no withholding tax but is subject to a foreign tax other 
than a withholding tax shall be treated as one item of income.
    (4) Dividends and inclusions from controlled foreign corporations, 
dividends from noncontrolled section 902 corporations, and income of 
foreign QBUs. Except as provided in paragraph (c)(5) of this section, 
all dividends and all amounts included in gross income of a United 
States shareholder under section 951(a)(1) with respect to the foreign 
corporation that (after application of the look-through rules of 
section 904(d)(3) and Sec.  1.904-5) are attributable to passive income 
received or accrued by a controlled foreign corporation, all dividends 
from a noncontrolled section 902 corporation that are received or 
accrued by a domestic corporate shareholder meeting the stock ownership 
requirements of section 902(a) that (after application of the look-
through rules of section 904(d)(4) and Sec.  1.904-5) are treated as 
passive income, and all amounts of passive income received or accrued 
by a United States person through a foreign QBU shall be subject to the 
rules of this paragraph (c)(4). This paragraph (c)(4) shall be applied 
separately to dividends and inclusions with respect to each controlled 
foreign corporation of which the taxpayer is a United States 
shareholder and to dividends with respect to each noncontrolled section 
902 corporation of which the taxpayer is a domestic corporate 
shareholder meeting the stock ownership requirements of section 902(a). 
This paragraph (c)(4) also shall be applied separately to income 
attributable to each QBU of a controlled foreign corporation, 
noncontrolled section 902 corporation, or any other look-through entity 
as defined in Sec.  1.904-5(i), except that if the entity subject to 
the look-through rules is a United States person, then this paragraph 
(c)(4) shall be applied separately only to each foreign QBU of that 
United States person.
    (c)(4)(i) through (m) [Reserved]. For further guidance, see Sec.  
1.904-4(c)(4)(i) through (m).

0
Par. 13. Section 1.904-5 is amended as follows:
0
1. Revise paragraph (a)(1).
0
2. Add paragraph (a)(4).
0
3. Revise paragraph (b).
0
4. Revise the heading of paragraph (c)(2)(ii), redesignate paragraphs 
(c)(2)(iii) and (2)(iv) as paragraphs (c)(2)(iv) and (2)(v) and add a 
new paragraph (c)(2)(iii).
0
5. Revise the heading of paragraph (c)(4)(i), redesignate paragraph 
(c)(4)(iii) as paragraph (c)(4)(iv), and add a new paragraph 
(c)(4)(iii).
0
6. Remove paragraph (f)(2).
0
7. Redesignate paragraphs (f)(3) and (f)(4) as paragraphs (f)(2) and 
(f)(3), respectively.
0
8. Revise paragraphs (i)(1) and (i)(3), redesignate paragraph (i)(4) as 
paragraph (i)(5), add a new paragraph (i)(4), and add two examples at 
the end of newly designated paragraph (i)(5).
0
9. Revise paragraph (m)(1), redesignate paragraph (m)(2) as paragraph 
(m)(2)(i) and add a heading for newly designated paragraph (m)(2)(i), 
add new paragraph (m)(2)(ii), and revise paragraph (m)(4)(i).
0
10. Revise paragraph (n).
0
11. Revise the heading for paragraph (o), redesignate paragraph (o) as 
paragraph (o)(1), add a heading for newly redesignated paragraph 
(o)(1), and add new paragraph (o)(2).
    The revisions read as follows:


Sec.  1.904-5  Look-through rules as applied to controlled foreign 
corporations and other entities.

    (a) and (a)(1) [Reserved]. For further guidance, see Sec.  1.904-
5T(a) and (a)(1).
* * * * *
    (4) [Reserved]. For further guidance, see Sec.  1.904-5T(a)(4).
    (b) [Reserved]. For further guidance, see Sec.  1.904-5T(b).
    (c) * * *
    (2) * * *
    (ii) Allocating and apportioning expenses of a controlled foreign 
corporation including interest paid to a related person. * * *
    (iii) [Reserved]. For further guidance, see Sec.  1.904-
5T(c)(2)(iii).
* * * * *
    (4) * * * (i) Look-through rule for controlled foreign 
corporations. * * *
* * * * *
    (iii) [Reserved]. For further guidance, see Sec.  1.904-
5T(c)(4)(iii).
* * * * *
    (i) * * *
    (1) [Reserved]. For further guidance, see Sec.  1.904-5T(i)(1).
* * * * *
    (3) and (4) [Reserved]. For further guidance, see Sec.  1.904-
5T(i)(3) and (4).
* * * * *
    (m) * * *
    (1) [Reserved]. For further guidance, see Sec.  1.904-5T(m)(1).
    (2) * * *
    (i) Interest payments from controlled foreign corporations. * * *
    (ii) [Reserved]. For further guidance, see Sec.  1.904-
5T(m)(2)(ii).
* * * * *
    (4) * * *
    (i) [Reserved]. For further guidance, see Sec.  1.904-5T(m)(4)(i).
* * * * *
    (n) [Reserved]. For further guidance, see Sec.  1.904-5T(n)
    (o) Effective dates--(1) Rules for controlled foreign corporations 
and other look-through entities. * * *
    (2) [Reserved]. For further guidance, see Sec.  1.904-5T(o)(2).

0
Par. 14. Section 1.904-5T is added as follows:


Sec.  1.904-5T  Look-through rules as applied to controlled foreign 
corporations and other entities (temporary).

    (a) Definitions. For purposes of sections 904(d)(3) and 904(d)(4) 
and the regulations under section 904, the following definitions apply:
    (1) The term separate category means, as the context requires, any 
category of income described in section 904(d)(1)(A), (B), (C), (D), 
(F), (G), (H), or (I) and in Sec.  1.904-4(b), (d), (e), and (f), any 
category of income described in Sec.  1.904-4(m), or any category of 
earnings and profits to which income described in such provisions is 
attributable.
    (2) and (3) [Reserved]. For further guidance, see Sec.  1.904-
5(a)(2) and (3).
    (4) The term noncontrolled section 902 corporation means any 
foreign corporation with respect to which the taxpayer meets the stock 
ownership requirements of section 902(a), or, with respect to a lower-
tier foreign corporation, the taxpayer meets the requirements of 
section 902(b). Except as provided in section 902 and the regulations 
under that section and paragraphs (i)(3) and (i)(4) of this section, a 
controlled foreign corporation shall not be treated as a noncontrolled 
section 902 corporation with respect to any distributions out of its 
earnings and profits for periods during which it was a controlled 
foreign corporation. In the case of a partnership owning a foreign 
corporation, the determination of whether a taxpayer meets the 
ownership requirements of section 902(a) or (b) will be made with 
respect to the taxpayer's indirect ownership, and not

[[Page 24532]]

the partnership's direct ownership, in the foreign corporation. See 
section 902(b)(7).
    (b) In general. Except as otherwise provided in section 904(d)(3) 
and (4) and this section, dividends, interest, rents, and royalties 
received or accrued by a taxpayer from a controlled foreign corporation 
in which the taxpayer is a United States shareholder shall be treated 
as general limitation income. See Sec.  1.904-5T(c)(4)(iii) for the 
treatment of dividends received by a domestic corporation from a 
noncontrolled section 902 corporation in which the domestic corporation 
meets the stock ownership requirements of section 902(a).
    (c)(1) through (c)(2)(ii) [Reserved]. For further guidance, see 
Sec.  1.904-5(c)(1) through (c)(2)(ii).
    (iii) Allocating and apportioning expenses of a noncontrolled 
section 902 corporation. Expenses of a noncontrolled section 902 
corporation shall be allocated and apportioned in the same manner as 
expenses of a controlled foreign corporation under Sec.  1.904-
5(c)(2)(ii), except that the related person interest rule of Sec.  
1.904-5(c)(2)(ii)(C) and (D) shall not apply.
    (c)(2)(iv) through (c)(4)(ii) [Reserved]. For further guidance, see 
Sec.  1.904-5(c)(2)(iv) through (c)(4)(ii).
    (iii) Look-through rule for dividends from noncontrolled section 
902 corporations. Except as otherwise provided in this subparagraph 
(iii), any dividend that is distributed by a noncontrolled section 902 
corporation and received or accrued by a domestic corporation that 
meets the stock ownership requirements of section 902(a) shall be 
treated as income in a separate category in proportion to the ratio of 
the portion of earnings and profits attributable to income in such 
category to the total amount of earnings and profits of the 
noncontrolled section 902 corporation. A dividend distributed by a 
noncontrolled section 902 corporation shall be treated as passive 
income if the look-through characterization of such dividend is not 
substantiated to the satisfaction of the Commissioner, or if such 
dividend is received or accrued by a shareholder that is neither a 
domestic corporation meeting the stock ownership requirements of 
section 902(a) nor a foreign corporation meeting the requirements of 
section 902(b). See Sec.  1.904-5T(i)(4). See Sec.  1.904-7T for 
transition rules concerning the treatment of undistributed earnings (or 
a deficit) of a noncontrolled section 902 corporation that were 
accumulated in taxable years beginning before January 1, 2003.
    (c)(4)(iv) through (h) [Reserved]. For further guidance, see Sec.  
1.904-5(c)(4)(iv) through (h).
    (i) Application of look-through rules to related entities--(1) In 
general. Except as provided in paragraphs (i)(2), (3), and (4) of this 
section, the principles of this section shall apply to distributions 
and payments that are subject to the look-through rules of section 
904(d)(3) and this section from a controlled foreign corporation or 
other entity otherwise entitled to look-through treatment (a ``look-
through entity'') under this section to a related look-through entity. 
A noncontrolled section 902 corporation shall be considered a look-
through entity only to the extent provided in paragraph (i)(4) of this 
section. Two look-through entities shall be considered to be related to 
each other if one owns, directly or indirectly, stock possessing more 
than 50 percent of the total voting power of all classes of voting 
stock of the other entity or more than 50 percent of the total value of 
such entity. In addition, two look-through entities are related if the 
same United States shareholders own, directly or indirectly, stock 
possessing more than 50 percent of the total voting power of all voting 
classes of stock (in the case of a corporation) or more than 50 percent 
of the total value of each look-through entity. In the case of a 
corporation, value shall be determined by taking into account all 
classes of stock. In the case of a partnership, value shall be 
determined under the rules in paragraph (h)(4) of this section. For 
purposes of this section, indirect ownership shall be determined under 
section 318 and the regulations thereunder.
    (2) [Reserved]. For further guidance, see Sec.  1.904-5(i)(2).
    (3) Special rule for dividends between controlled foreign 
corporations. Solely for purposes of dividend payments between 
controlled foreign corporations, two controlled foreign corporations 
shall be considered related look-through entities if the same United 
States shareholder owns, directly or indirectly, at least 10 percent of 
the total voting power of all classes of stock of each foreign 
corporation. If two controlled foreign corporations are not considered 
related look-through entities for purposes of this section because a 
United States shareholder does not satisfy the ownership requirement 
set forth in this paragraph (i)(3), the dividend payment will be 
characterized under the look-through rules of section 904(d)(4) and 
this section if the requirements set forth in paragraph (i)(4) of this 
section are satisfied.
    (4) Payor and recipient of dividend are members of same qualified 
group. Solely for purposes of dividend payments in taxable years 
beginning after December 31, 2002, between controlled foreign 
corporations, noncontrolled section 902 corporations, or a controlled 
foreign corporation and a noncontrolled section 902 corporation, the 
payor and recipient corporations shall be considered related look-
through entities if the corporations are members of the same qualified 
group as defined in section 902(b)(2) and the recipient corporation is 
eligible to compute foreign taxes deemed paid with respect to the 
dividend under section 902(b)(1).
    (5) Examples. The following examples illustrate the provisions of 
this paragraph (i):
    Examples 1 through 3 [Reserved]. For further guidance, see Sec.  
1.904-5(i)(5) Examples 1 through 3.

    Example 4. P, a domestic corporation, owns all of the voting 
stock of S, a controlled foreign corporation. S owns 5 percent of 
the voting stock of T, a controlled foreign corporation. The 
remaining 95 percent of the stock of T is owned by P. In 2006, T 
pays a $50 dividend to S and a $950 dividend to P. The dividend to S 
is not eligible for look-through treatment under paragraph (i)(4) of 
this section, and S is not eligible to compute an amount of foreign 
taxes deemed paid with respect to the dividend from T, because S and 
T are not members of the same qualified group (S owns less than 10 
percent of the voting stock of T). See section 902(b) and Sec.  
1.902-1(a)(3). However, the dividend is eligible for look-through 
treatment under paragraph (i)(3) of this section because P owns at 
least 10 percent of the voting power of all classes of stock of both 
S and T. The dividend is subpart F income of S that is taxable to P.
    Example 5.  P, a domestic corporation, owns 50 percent of the 
voting stock of S, a controlled foreign corporation. S owns 10 
percent of the voting stock of T, a controlled foreign corporation. 
The remaining 50 percent of the stock of S and the remaining 90 
percent of the stock of T are owned, respectively, by X and Y. X and 
Y are each United States shareholders of T but are not related to P, 
S, or each other. In 2006, T pays a $100 dividend to S. The dividend 
is not eligible for look-through treatment under paragraph (i)(3) of 
this section because no United States shareholder owns at least 10 
percent of the voting power of all classes of stock of both S and T 
(P and X each own only 5 percent of T). However, the dividend is 
eligible for look-through treatment under paragraph (i)(4) of this 
section, and S is eligible to compute an amount of foreign taxes 
deemed paid with respect to the dividend from T, because S and T are 
members of the same qualified group. See section 902(b) and Sec.  
1.902-1(a)(3). The dividend is subpart F income of S that is taxable 
to P and X.

    (j) through (l) [Reserved]. For further guidance, see Sec.  1.904-
5(j) through (l).

[[Page 24533]]

    (m) Application of section 904(g)--(1) In general. This paragraph 
(m) applies to certain amounts derived from controlled foreign 
corporations and noncontrolled section 902 corporations that are 
treated as United States-owned foreign corporations as defined in 
section 904(g)(6). For purposes of determining the portion of an 
interest payment that is allocable to income earned or accrued by a 
controlled foreign corporation or noncontrolled section 902 corporation 
from sources within the United States under section 904(g)(3), the 
rules in paragraph (m)(2) of this section apply. For purposes of 
determining the portion of a dividend (or amount treated as a dividend, 
including amounts described in section 951(a)(1)(B)) paid or accrued by 
a controlled foreign corporation or noncontrolled section 902 
corporation that is treated as from sources within the United States 
under section 904(g)(4), the rules in paragraph (m)(4) of this section 
apply. For purposes of determining the portion of an amount included in 
gross income under section 951(a)(1)(A) that is attributable to income 
of the controlled foreign corporation from sources within the United 
States under section 904(g)(2), the rules in paragraph (m)(5) of this 
section apply. In order to determine whether section 904(g) applies, 
section 904(g)(5) (exception if a United States-owned foreign 
corporation has a de minimis amount of United States source income) 
shall be applied to the total amount of earnings and profits of a 
controlled foreign corporation or noncontrolled section 902 corporation 
for a taxable year without regard to the characterization of those 
earnings under section 904(d).
    (2)(i) [Reserved]. For further guidance, see Sec.  1.904-
5(m)(2)(i).
    (ii) Interest payments from noncontrolled section 902 corporations. 
If interest is received or accrued by a shareholder from a 
noncontrolled section 902 corporation (where the shareholder is a 
domestic corporation that meets the stock ownership requirements of 
section 902(a)), the rules of subparagraph (m)(2)(i) apply in 
determining the portion of the interest payment that is from sources 
within the United States, except that the related party interest rules 
of subparagraph (c)(2)(ii)(C) shall not apply.
    (3) [Reserved]. For further guidance, see Sec.  1.904-5(m)(3).
    (4) Treatment of dividend payments--(i) Rule. Any dividend or 
distribution treated as a dividend under this section (including an 
amount included in gross income under section 951(a)(1)(B)) that is 
received or accrued by a United States shareholder from a controlled 
foreign corporation, or any dividend that is received or accrued by a 
domestic corporate shareholder meeting the stock ownership requirements 
of section 902(a) from a noncontrolled section 902 corporation, shall 
be treated as income in a separate category derived from sources within 
the United States in proportion to the ratio of the portion of the 
earnings and profits of the controlled foreign corporation or 
noncontrolled section 902 corporation in the corresponding separate 
category from United States sources to the total amount of earnings and 
profits of the controlled foreign corporation or noncontrolled section 
902 corporation in that separate category.
    (m)(4)(ii) through (7). [Reserved] For further guidance, see Sec.  
1.904-5(m)(4)(ii) through (7).
    (n) Order of application of sections 904(d) and (g). In order to 
apply the rules of this section, section 904(d)(1) shall first be 
applied to the controlled foreign corporation or noncontrolled section 
902 corporation to determine the amount of income and earnings and 
profits derived by the controlled foreign corporation or noncontrolled 
section 902 corporation in each separate category. The income and 
earnings and profits in each separate category that are from United 
States sources shall then be determined. Sections 904(d)(3), 904(d)(4), 
and 904(g), and this section shall then be applied for purposes of 
characterizing and sourcing income received, accrued, or included by a 
United States shareholder in the controlled foreign corporation or a 
domestic corporate shareholder that meets the stock ownership 
requirements of section 902(a) with respect to a noncontrolled section 
902 corporation that is attributable or allocable to income or earnings 
and profits of the foreign corporation.
    (o)(1) [Reserved]. For further guidance, see Sec.  1.904-5(o)(1).
    (2) Rules for noncontrolled section 902 corporations. Except as 
provided in Sec.  1.904-7T(f)(9), section 904(d)(4) and this section 
apply to distributions from a noncontrolled section 902 corporation 
that are paid during the first taxable year of the noncontrolled 
section 902 corporation beginning after December 31, 2002, and 
thereafter, without regard to whether the corresponding taxable year of 
the recipient of the distribution begins after December 31, 2002, 
except that the provisions of paragraphs (m)(1), (m)(2)(ii), (m)(4)(i), 
and (n) apply to distributions from a noncontrolled section 902 
corporation paid in taxable years of such corporation beginning after 
April 25, 2006. For corresponding rules applicable to taxable years 
beginning before January 1, 2003, see 26 CFR Sec.  1.904-5 (revised as 
of April 1, 2006).

0
Par. 15. Section 1.904-6 is amended as follows:
0
1. Revise paragraph (a)(2).
0
2. Revise paragraph (c) Example 6.
0
3. Remove paragraph (c) Example 7.
0
4. Redesignate paragraph (c) Example 8 as paragraph (c) Example 7.
    The revisions read as follows:


Sec.  1.904-6  Allocation and apportionment of taxes.

    (a) * * *
    (2) [Reserved].
* * * * *
    (c) Examples. * * *

    Example 6. P, a domestic corporation, owns all of the stock of 
S, a controlled foreign corporation that is incorporated in country 
X. In 2004, S has $100 of passive income, $200 of shipping income 
and $200 of general limitation income. S also has $100 of related 
person interest expense and $100 of other expenses that under 
foreign law are directly allocable to the general limitation income 
of S. S has no other expenses. Country X imposes a tax of 25 percent 
on all of the net income of S and S, therefore, pays $75 in foreign 
tax. Under paragraph (a)(1)(ii) of this section, the passive income 
of S is first reduced by the amount of related person interest for 
purposes of determining the net amount for purposes of allocating 
the $75 of tax. Under paragraph (a)(1)(ii) of this section, the 
general limitation income of S is reduced by the $100 of other 
expenses. Therefore, $50 of the foreign tax is allocated to the 
shipping income of S ($50 = $75 x $200/$300), $25 is allocated to 
the general limitation income of S ($25 = $75 x $100/$300), and no 
taxes are allocated to S's passive income.
* * * * *
0
Par. 16. Section 1.904-7 is amended by adding paragraph (f) to read as 
follows:


Sec.  1.904-7  Transition rules.

* * * * *
    (f) [Reserved]. For further guidance, see Sec.  1.904-7T(f).

0
Par. 17. Section 1.904-7T is added as follows:


Sec.  1.904-7T  Transition rules (temporary).

    (a) through (e) [Reserved]. For further guidance, see Sec.  1.904-
7(a) through (e).
    (f) Treatment of non-look-through pools of a noncontrolled section 
902 corporation or a controlled foreign corporation in post-2002 
taxable years--(1) Definition of non-look-through pools. The term non-
look-through pools means the pools of post-1986 undistributed earnings 
(as defined in Sec.  1.902-1(a)(9)) that were accumulated, and post-
1986 foreign income taxes (as defined in Sec.  1.902-1(a)(8)) paid, 
accrued, or deemed paid, in and after the first

[[Page 24534]]

taxable year in which the foreign corporation had a domestic 
shareholder (as defined in Sec.  1.902-1(a)(1)) but before any such 
shareholder was eligible for look-through treatment with respect to 
dividends from the foreign corporation.
    (2) Treatment of non-look-through pools of a noncontrolled section 
902 corporation. Any undistributed earnings in the non-look-through 
pool that were accumulated in taxable years beginning before January 1, 
2003, by a noncontrolled section 902 corporation as of the last day of 
the corporation's last taxable year beginning before January 1, 2003, 
shall be treated in taxable years beginning after December 31, 2002, as 
if they were accumulated during a period when a dividend paid by the 
noncontrolled section 902 corporation to a domestic shareholder would 
have been eligible for look-through treatment under section 904(d)(4) 
and Sec.  1.904-5. Post-1986 foreign income taxes paid, accrued or 
deemed paid with respect to such earnings shall be treated as if they 
were paid, accrued or deemed paid during a period when the related 
earnings were eligible for look-through treatment. Any such earnings 
and taxes in the non-look-through pools shall constitute the opening 
balance of the noncontrolled section 902 corporation's pools of post-
1986 undistributed earnings and post-1986 foreign income taxes on the 
first day of the foreign corporation's first taxable year beginning 
after December 31, 2002, in accordance with the rules of paragraph 
(f)(4) of this section.
    (3) Treatment of non-look-through pools of a controlled foreign 
corporation. A controlled foreign corporation may have non-look-through 
pools of post-1986 undistributed earnings and post-1986 foreign income 
taxes that were accumulated and paid in a taxable year beginning before 
January 1, 2003, in which it was a noncontrolled section 902 
corporation. Any such undistributed earnings in the non-look-through 
pool as of the last day of the controlled foreign corporation's last 
taxable year beginning before January 1, 2003, shall be treated in 
taxable years beginning on or after January 1, 2003, as if they were 
accumulated during a period when a dividend paid by the controlled 
foreign corporation out of such earnings, or an amount included in the 
gross income of a United States shareholder under section 951 that is 
attributable to such earnings, would have been eligible for look-
through treatment. Any post-1986 foreign income taxes paid, accrued, or 
deemed paid with respect to such earnings shall be treated in taxable 
years beginning on or after January 1, 2003, as if they were paid, 
accrued, or deemed paid during a period when a dividend or inclusion 
out of such earnings would have been eligible for look-through 
treatment. Any such undistributed earnings and taxes in the non-look-
through pools shall be added to the pools of post-1986 undistributed 
earnings and post-1986 foreign income taxes of the controlled foreign 
corporation in the appropriate separate categories on the first day of 
the controlled foreign corporation's first taxable year beginning after 
December 31, 2002, in accordance with the rules of paragraph (f)(4) of 
this section. Similar rules shall apply to characterize any previously-
taxed earnings and profits described in section 959(c)(1)(A) that are 
attributable to earnings in the non-look-through pool.
    (4) Substantiation of look-through character of undistributed 
earnings and taxes in a non-look-through pool--(i) Reconstruction of 
earnings and taxes pools. In order to substantiate the look-through 
characterization of undistributed earnings and taxes in a non-look-
through pool under section 904(d)(4) and Sec.  1.904-5, the taxpayer 
shall make a reasonable, good-faith effort to reconstruct the non-look-
through pools of post-1986 undistributed earnings and post-1986 foreign 
income taxes (and previously-taxed earnings and profits, if any) on a 
look-through basis for each year in the non-look-through period, 
beginning with the first taxable year in which post-1986 undistributed 
earnings were accumulated in the non-look-through pool. Reconstruction 
shall be based on reasonably available books and records and other 
relevant information, and it must account for earnings distributed and 
taxes deemed paid in these years as if they were distributed and deemed 
paid pro rata from the amounts that were added to the non-look-through 
pools during the non-look-through period.
    (ii) Safe harbor method. A taxpayer may allocate the undistributed 
earnings and taxes in the non-look-through pools to the foreign 
corporation's look-through pools of post-1986 undistributed earnings 
and post-1986 foreign income taxes in other separate categories on the 
first day of the foreign corporation's first taxable year beginning 
after December 31, 2002, in the same percentages as the taxpayer 
properly characterizes the stock of the foreign corporation in the 
separate categories for purposes of apportioning the taxpayer's 
interest expense in its first taxable year ending after the first day 
of the foreign corporation's first taxable year beginning after 
December 31, 2002, under Sec.  1.861-12T(c)(3) or (c)(4), as the case 
may be. If the modified gross income method described in Sec.  1.861-
9T(j) is used to apportion interest expense of the foreign corporation 
in its first taxable year beginning after December 31, 2002, the 
taxpayer must allocate the undistributed earnings and taxes in the non-
look-through pools to the foreign corporation's look-through pools of 
post-1986 undistributed earnings and post-1986 foreign income taxes 
based on an average of the foreign corporation's modified gross income 
ratios for the foreign corporation's taxable years beginning in 2003 
and 2004. A taxpayer may also use the safe harbor method described in 
this paragraph (f)(4)(ii) to allocate to separate categories any 
previously-taxed earnings and profits described in section 959(c)(1)(A) 
that are attributable to the non-look-through pool.
    (iii) Inadequate substantiation. If a taxpayer does not elect the 
safe harbor method described in paragraph (f)(4)(ii) of this section 
and the Commissioner determines that the look-through characterization 
of earnings and taxes in the non-look-through pools cannot reasonably 
be determined based on the available information, the Commissioner 
shall allocate the undistributed earnings and taxes in the non-look-
through pools to the foreign corporation's passive category.
    (iv) Examples. The following examples illustrate the application of 
this paragraph (f)(4):

    Example 1. P, a domestic corporation, has owned 50 percent of 
the voting stock of S, a foreign corporation, at all times since 
January 1, 1987, and S has been a noncontrolled section 902 
corporation with respect to P since that date. P and S each use the 
calendar year as their U.S. taxable year. 1987 was the first year in 
which post-1986 undistributed earnings were accumulated in the non-
look-through pool of S. As of December 31, 2002, S had 200u of post-
1986 undistributed earnings and $100 of post-1986 foreign income 
taxes in its non-look-through pools. P does not elect the safe 
harbor method under paragraph(f)(4)(ii) of this section to allocate 
the earnings and taxes in the non-look-through pools to S's other 
separate categories and does not attempt to substantiate the look-
through characterization of S's non-look-through pools. The 
Commissioner, however, reasonably determines, based on information 
used to characterize S's stock for purposes of apportioning P's 
interest expense in P's 2003 and 2004 taxable years, that 100u of 
the earnings and all $100 of the taxes in the non-look-through pools 
are properly assigned on a look-through basis to the general 
limitation category, and 100u of earnings and no taxes are properly 
assigned on a look-through basis to the passive category. Therefore, 
in accordance with the Commissioner's look-through characterization 
of the earnings and taxes in S's non-look-through pools, on

[[Page 24535]]

January 1, 2003, S has 100u of post-1986 undistributed earnings and 
$100 of post-1986 foreign income taxes in the general limitation 
category and 100u of post-1986 undistributed earnings and no post-
1986 foreign income taxes in the passive category.
    Example 2. The facts are the same as in Example 1, except that 
the Commissioner cannot reasonably determine, based on the available 
information, the proper look-through characterization of the 200u of 
undistributed earnings and $100 of taxes in S's non-look-through 
pools. Accordingly, the Commissioner will assign such earnings and 
taxes to the passive category, so that as of January 1, 2003, S has 
200u of post-1986 undistributed earnings and $100 of post-1986 
foreign income taxes in the passive category, and the Commissioner 
will treat S as a passive category asset for purposes of 
apportioning P's interest expense.

    (5) Treatment of a deficit accumulated in a non-look-through pool. 
Any deficit in the non-look-through pool of a noncontrolled section 902 
corporation or a controlled foreign corporation as of the end of its 
last taxable year beginning before January 1, 2003, shall be treated in 
taxable years beginning after December 31, 2002, as if the deficit had 
been accumulated during a period in which a dividend paid by the 
foreign corporation would have been eligible for look-through 
treatment. In the case of a noncontrolled section 902 corporation, the 
deficit and taxes, if any, in the non-look-through pools shall 
constitute the opening balance of the look-through pools of post-1986 
undistributed earnings and post-1986 foreign income taxes of the 
noncontrolled section 902 corporation in the appropriate separate 
categories on the first day of its first taxable year beginning after 
December 31, 2002. In the case of a controlled foreign corporation, the 
deficit and taxes, if any, in the non-look-through pools shall be added 
to the balance of the look-through pools of post-1986 undistributed 
earnings and post-1986 foreign income taxes of the controlled foreign 
corporation in the appropriate separate categories on the first day of 
its first taxable year beginning after December 31, 2002. The taxpayer 
must substantiate the look-through characterization of the deficit and 
taxes in accordance with the rules of paragraph (f)(4) of this section. 
If a taxpayer does not elect the safe harbor described in paragraph 
(f)(4)(ii) of this section and the Commissioner determines that the 
look-through characterization of the deficit and taxes cannot 
reasonably be determined based on the available information, the 
Commissioner shall allocate the deficit and taxes, if any, in the non-
look-through pools to the foreign corporation's passive category. If, 
as of the end of a taxable year beginning after December 31, 2002, in 
which it pays a dividend, the foreign corporation has zero or a deficit 
in post-1986 undistributed earnings (taking into account any earnings 
or a deficit accumulated in taxable years beginning before January 1, 
2003), the deficit in post-1986 undistributed earnings shall be carried 
back to reduce pre-1987 accumulated profits, if any, on a last-in 
first-out basis. See Sec.  1.902-2(a)(1). If, as of the end of a 
taxable year beginning after December 31, 2002, in which the foreign 
corporation pays a dividend out of current earnings and profits, it has 
zero or a deficit in post-1986 undistributed earnings (taking into 
account any earnings or a deficit accumulated in taxable years 
beginning before January 1, 2003), and the sum of current plus 
accumulated earnings and profits is zero or less than zero, no foreign 
taxes shall be deemed paid with respect to the dividend. See Sec.  
1.902-1(b)(4).
    (6) Treatment of pre-1987 accumulated profits. Any pre-1987 
accumulated profits (as defined in Sec.  1.902-1(a)(10)) of a 
controlled foreign corporation or noncontrolled section 902 corporation 
shall be treated in taxable years beginning after December 31, 2002, as 
if they were accumulated during a period in which a dividend paid by 
the foreign corporation would have been eligible for look-through 
treatment. Any pre-1987 foreign income taxes (as defined in Sec.  
1.902-1(a)(10)(iii)) shall be treated as if they were paid, accrued or 
deemed paid during a year when a dividend out of the related pre-1987 
accumulated profits would have been eligible for look-through 
treatment. The taxpayer must substantiate the look-through 
characterization of the pre-1987 accumulated profits and pre-1987 
foreign income taxes in accordance with the rules of paragraph (f)(4) 
of this section. If a taxpayer does not elect the safe harbor described 
in paragraph (f)(4)(ii) of this section and the Commissioner determines 
that the look-through characterization of the pre-1987 accumulated 
profits and pre-1987 foreign income taxes cannot reasonably be 
determined based on the available information, the pre-1987 accumulated 
profits and pre-1987 foreign income taxes shall be allocated to the 
foreign corporation's passive category.
    (7) Treatment of post-1986 undistributed earnings or a deficit of a 
controlled foreign corporation attributable to dividends from a 
noncontrolled section 902 corporation paid in taxable years beginning 
before January 1, 2003--(i) Look-through treatment of post-1986 
undistributed earnings at controlled foreign corporation level. 
Dividends paid by a noncontrolled section 902 corporation to a 
controlled foreign corporation in post-1986 taxable years of the 
noncontrolled section 902 corporation beginning before January 1, 2003, 
were assigned to a separate category for dividends from that 
noncontrolled section 902 corporation. Beginning on the first day of 
the controlled foreign corporation's first taxable year beginning on or 
after the first day of the lower-tier corporation's first taxable year 
beginning after December 31, 2002, any post-1986 undistributed 
earnings, or previously-taxed earnings and profits described in section 
959(c)(1) or (2), of the controlled foreign corporation in such a 
separate category shall be treated as if they were accumulated during a 
period when a dividend paid by the noncontrolled section 902 
corporation would have been eligible for look-through treatment. Any 
post-1986 foreign income taxes in such a separate category shall also 
be treated as if they were paid, accrued or deemed paid during a period 
when such a dividend would have been eligible for look-through 
treatment. Any such post-1986 undistributed earnings and post-1986 
foreign income taxes in a separate category for dividends from a 
noncontrolled section 902 corporation shall be added to the opening 
balance of the controlled foreign corporation's look-through pools of 
post-1986 undistributed earnings and post-1986 foreign income taxes in 
the appropriate separate categories on the first day of the controlled 
foreign corporation's first taxable year beginning on or after the 
first day of the lower-tier corporation's first taxable year beginning 
after December 31, 2002. The taxpayer must substantiate the look-
through characterization of such earnings and taxes in accordance with 
the rules of paragraph (f)(7)(iii) of this section.
    (ii) Look-through treatment of deficit in post-1986 undistributed 
earnings at controlled foreign corporation level. If a controlled 
foreign corporation has a deficit in a separate category for dividends 
from a lower-tier noncontrolled section 902 corporation that is a 
member of the controlled foreign corporation's qualified group as 
defined in section 902(b)(2), such deficit shall be treated in taxable 
years of the upper-tier corporation beginning on or after the first day 
of the lower-tier corporation's first taxable year beginning after 
December 31, 2002, as if the deficit had been accumulated during a 
period in which a dividend from the

[[Page 24536]]

lower-tier corporation would have been eligible for look-through 
treatment. Any post-1986 foreign income taxes in the separate category 
for dividends from the noncontrolled section 902 corporation shall also 
be treated as if they were paid, accrued or deemed paid during a period 
when the dividends were eligible for look-through treatment. The 
deficit and related post-1986 foreign income taxes, if any, shall be 
added to the opening balance of the controlled foreign corporation's 
look-through pools of post-1986 undistributed earnings and post-1986 
foreign income taxes in the appropriate separate categories on the 
first day of the controlled foreign corporation's first taxable year 
beginning on or after the first day of the lower-tier corporation's 
first taxable year beginning after December 31, 2002. The taxpayer must 
substantiate the look-through characterization of the deficit and taxes 
in accordance with the rules of paragraph (f)(7)(iii) of this section.
    (iii) Substantiation required for look-through treatment. The 
taxpayer must substantiate the look-through characterization of post-
1986 undistributed earnings, previously-taxed earnings and profits, or 
a deficit in post-1986 undistributed earnings in a separate category 
for dividends paid by a noncontrolled section 902 corporation in 
taxable years beginning before January 1, 2003, by making a reasonable, 
good-faith effort to reconstruct the earnings (or deficit) and taxes in 
the separate category at the level of the controlled foreign 
corporation on a look-through basis, in accordance with the principles 
of paragraph (f)(4)(i) of this section. Alternatively, the taxpayer may 
allocate the earnings (or deficit) and taxes to the controlled foreign 
corporation's look-through pools by electing to apply the safe harbor 
described in paragraph (f)(4)(ii) at the level of the controlled 
foreign corporation. If the taxpayer so elects, the earnings (or 
deficit) and taxes shall be allocated to the controlled foreign 
corporation's look-through pools in the appropriate separate categories 
on the first day of the controlled foreign corporation's first taxable 
year beginning on or after the first day of the lower-tier 
corporation's first taxable year beginning after December 31, 2002. The 
allocation shall be made in the same percentages as the controlled 
foreign corporation would properly characterize the stock of the lower-
tier noncontrolled section 902 corporation in the separate categories 
for purposes of apportioning the controlled foreign corporation's 
interest expense in its first taxable year ending after the first day 
of the noncontrolled section 902 corporation's first taxable year 
beginning after December 31, 2002. Under Sec.  1.861-12T(c)(3), the 
apportionment ratios properly used by the controlled foreign 
corporation are in turn based on the apportionment ratios properly used 
by the noncontrolled section 902 corporation to apportion its interest 
expense in its first taxable year beginning after December 31, 2002. In 
the case of a taxpayer that elects to use the safe harbor rule where 
the lower-tier noncontrolled section 902 corporation uses the modified 
gross income method described in Sec.  1.861-9T(j) to apportion 
interest expense for its first taxable year beginning after December 
31, 2002, earnings (or a deficit) and taxes in the separate category 
for dividends from the noncontrolled section 902 corporation shall be 
allocated to the look-through pools based on the average of the 
noncontrolled section 902 corporation's modified gross income ratios 
for its taxable years beginning in 2003 and 2004. In the case of a 
controlled foreign corporation that has in its qualified group a chain 
of lower-tier noncontrolled section 902 corporations, the safe harbor 
applies first to characterize the stock of the third-tier corporation 
and then to characterize the stock of the second-tier corporation. 
Where a taxpayer elects the safe harbor with respect to a lower-tier 
noncontrolled section 902 corporation with respect to which the 
taxpayer did not meet the requirements of section 902(a) as of the end 
of the upper-tier controlled foreign corporation's last taxable year 
beginning before January 1, 2003, the earnings (or deficit) and taxes 
in the separate category for dividends from the lower-tier corporation 
shall be allocated to the upper-tier corporation's look-through pools 
in the separate categories in the same percentages as the stock of the 
lower-tier corporation would have been characterized for purposes of 
apportioning the upper-tier corporation's interest expense in the last 
year the taxpayer met the ownership requirements of section 902(a) with 
respect to the lower-tier corporation if the look-through rules had 
applied in that year. If a taxpayer does not elect the safe harbor 
method described in this subparagraph (f)(7)(iii), and the Commissioner 
determines that the look-through characterization of the earnings (or 
deficit) and taxes cannot reasonably be determined based on the 
available information, the Commissioner shall allocate the earnings (or 
deficit) and associated foreign income taxes to the controlled foreign 
corporation's passive category.
    (8) Treatment of distributions received by an upper-tier 
corporation from a lower-tier noncontrolled section 902 corporation 
when the corporations do not have the same taxable years--(i) Rule. In 
the case of dividends paid by a lower-tier noncontrolled section 902 
corporation to an upper-tier corporation where both are members of the 
same qualified group as defined in section 902(b)(2), the following 
rules apply. Dividends paid by the lower-tier corporation in taxable 
years beginning before January 1, 2003, are assigned to a separate 
category for dividends from that corporation, regardless of whether the 
corresponding taxable year of the recipient corporation began after 
December 31, 2002. Post-1986 undistributed earnings, previously-taxed 
earnings and profits, and post-1986 foreign income taxes in such a 
separate category shall be treated, beginning on the first day of the 
upper-tier corporation's first taxable year beginning on or after the 
first day of the lower-tier corporation's first taxable year beginning 
after December 31, 2002, as if they were accumulated during a period 
when a dividend paid by the lower-tier corporation would have been 
eligible for look-through treatment under section 904(d)(4) and Sec.  
1.904-5. Dividends paid by a lower-tier corporation in taxable years 
beginning after December 31, 2002, are eligible for look-through 
treatment when paid, without regard to whether the corresponding 
taxable year of the recipient upper-tier corporation began after 
December 31, 2002.
    (ii) Example. The following example illustrates the application of 
paragraph (f) of this section:

    Example. M, a domestic corporation, has directly owned 50 
percent of the stock of X, and X has directly owned 50 percent of 
the stock of Y, at all times since X and Y were organized on January 
1, 1990. Accordingly, X and Y are noncontrolled section 902 
corporations with respect to M, and X and Y are members of the same 
qualified group. M and Y use the calendar year as their U.S. taxable 
year, and X uses a taxable year beginning on July 1. Under Sec.  
1.904-4(g) and paragraph (f)(10) of this section, a dividend paid to 
M by X on January 15, 2003 (during X's last pre-2003 taxable year) 
is not eligible for look-through treatment in 2003. However, under 
Sec.  1.861-12T(c)(4), M will characterize the stock of X on a look-
through basis for purposes of interest expense apportionment in its 
2003 taxable year. Under Sec.  1.904-4T(h)(1), any unused foreign 
taxes in M's separate category for dividends from X will be carried 
over to M's other separate categories on a look-through basis for 
M's taxable years beginning on and after January 1, 2004. Under 
paragraph (f)(2) of this section, any undistributed earnings and 
taxes in X's non-look-through pools will be

[[Page 24537]]

allocated to X's other separate categories on July 1, 2003. Under 
Sec.  1.904-5(i)(4) and paragraphs (f)(8)(i) and (f)(10) of this 
section, a dividend paid to X by Y on January 15, 2003 (during Y's 
first post-2002 taxable year) is eligible for look-through treatment 
when paid, notwithstanding that it is received in a pre-2003 taxable 
year of X.

    (9) Election to apply pre-AJCA rules to 2003 and 2004 taxable 
years--(i) Definition. The term single category for dividends from all 
noncontrolled section 902 corporations means the separate category 
described in section 904(d)(1)(E) as in effect for taxable years 
beginning after December 31, 2002, and prior to its repeal by the 
American Jobs Creation Act (AJCA), Public Law 108-357, 118 Stat. 1418 
(October 22, 2004).
    (ii) Time, manner, and form of election. A taxpayer may elect not 
to apply the provisions of section 403 of the AJCA and to apply the 
rules of this paragraph (f)(9) to taxable years of noncontrolled 
section 902 corporations beginning after December 31, 2002, and before 
January 1, 2005, without regard to whether the corresponding taxable 
years of the taxpayer or any upper-tier corporation begin before or 
after such dates. A taxpayer shall be eligible to make such an election 
provided that--
    (A) The taxpayer's tax liability as shown on an original or amended 
tax return for each of its affected taxable years is consistent with 
the rules of this paragraph (f)(9), the guidance set forth in Notice 
2003-5 (2003-1 C.B. 294) (see Sec.  601.601(d)(2) of this chapter), and 
the principles of Sec.  1.861-12T(c)(4) for each such year for which 
the statute of limitations does not preclude the filing of an amended 
return;
    (B) The taxpayer makes appropriate adjustments to eliminate any 
double benefit arising from the application of this paragraph (f)(9) to 
years that are not open for assessment; and
    (C) The taxpayer attaches a statement to its next tax return for 
which the due date (with extensions) is more than 90 days after April 
25, 2006, indicating that the taxpayer elects not to apply the 
provisions of section 403 of the AJCA to taxable years of its 
noncontrolled section 902 corporations beginning in 2003 and 2004, and 
that the taxpayer has filed original returns or will file amended 
returns reflecting tax liabilities for each affected year that satisfy 
the requirements described in this paragraph (f)(9)(ii).
    (iii) Treatment of non-look-through pools in taxable years 
beginning after December 31, 2004. Undistributed earnings (or a 
deficit) and taxes in the non-look-through pools of a controlled 
foreign corporation or a noncontrolled section 902 corporation as of 
the end of its last taxable year beginning before January 1, 2005, 
shall be treated in taxable years beginning after December 31, 2004, as 
if they were accumulated and paid during a period in which a 
distribution out of earnings in the non-look-through pool would have 
been eligible for look-through treatment. Such earnings (or deficit) 
and taxes shall be added to the foreign corporation's pools of post-
1986 undistributed earnings and post-1986 foreign income taxes in the 
appropriate separate categories on the first day of the foreign 
corporation's first taxable year beginning after December 31, 2004. In 
accordance with the principles of paragraph (f)(4) of this section, the 
taxpayer must reconstruct the non-look-through pools or, if the 
taxpayer elects the safe harbor, allocate the earnings and taxes in the 
non-look-through pools to the foreign corporation's look-through pools 
in the appropriate separate categories on the first day of the foreign 
corporation's first taxable year beginning after December 31, 2004. 
Under the safe harbor, this allocation is made in the same percentages 
as the taxpayer properly characterized the stock of the foreign 
corporation for purposes of apportioning the taxpayer's interest 
expense in the taxpayer's first taxable year ending after the first day 
of the foreign corporation's first taxable year beginning after 
December 31, 2002. See Sec.  1.861-12T(c)(3) and (4). If a taxpayer 
does not elect the safe harbor described in paragraph (f)(4)(ii) and 
the Commissioner determines that the look-through characterization of 
the earnings (or deficit) and taxes cannot reasonably be determined 
based on the available information, the earnings (or deficit) and taxes 
shall be allocated to the foreign corporation's passive category.
    (iv) Carryover of unused foreign tax. To the extent that a taxpayer 
has unused foreign taxes in the single category for dividends from all 
noncontrolled section 902 corporations, such taxes shall be carried 
forward to the appropriate separate categories in the taxpayer's 
taxable years beginning on or after the first day of the relevant 
noncontrolled section 902 corporation's first taxable year beginning 
after December 31, 2004. Such unused taxes shall be carried forward in 
the same manner as Sec.  1.904-2T(h)(1) provides that unused foreign 
taxes in the separate categories for dividends from each noncontrolled 
section 902 corporation are carried over to taxable years beginning on 
or after the first day of the noncontrolled section 902 corporation's 
first taxable year beginning after December 31, 2002, in the case of a 
taxpayer that does not make the election under paragraph (f)(9) of this 
section. The electing taxpayer shall determine which noncontrolled 
section 902 corporations paid the dividends to which the unused foreign 
taxes are attributable and assign the taxes to the appropriate separate 
categories as if such dividends had been eligible for look-through 
treatment when paid. Accordingly, the taxpayer must substantiate the 
look-through characterization of the unused foreign taxes in accordance 
with paragraph (f)(4) of this section by reconstructing the non-look-
through pools or, if the taxpayer elects the safe harbor, by allocating 
the unused foreign taxes to other separate categories in the same 
percentages as the taxpayer properly characterized the stock of the 
noncontrolled section 902 corporation for purposes of apportioning the 
taxpayer's interest expense for its first taxable year ending after the 
first day of the noncontrolled section 902 corporation's first taxable 
year beginning after December 31, 2002. The rule described in this 
paragraph (f)(9)(iv) shall apply only to unused foreign taxes 
attributable to dividends out of earnings that were accumulated by 
noncontrolled section 902 corporations in taxable years of such 
corporations beginning before January 1, 2003, because only unused 
foreign taxes attributable to distributions out of pre-2003 earnings 
are included in the single category for dividends from all 
noncontrolled section 902 corporations. To the extent that unused 
foreign taxes carried forward to the single category for dividends from 
all noncontrolled section 902 corporations under the rules of Notice 
2003-5 (see Sec.  601.601(d)(2) of this chapter) were either absorbed 
by low-taxed dividends paid by noncontrolled section 902 corporations 
out of the non-look-through pool in taxable years of such corporations 
beginning in 2003 or 2004, or expired unused, the amount of taxes 
carried forward to the separate categories on a look-through basis will 
be smaller than the aggregate amount of taxes initially carried forward 
to the single category for dividends from all noncontrolled section 902 
corporations. In this case, the unused foreign taxes arising in each 
taxable year shall be deemed attributable to each noncontrolled section 
902 corporation in the same ratio as the dividends included in the 
separate category that were paid by such corporation in such year bears 
to all such dividends paid by all noncontrolled section 902 
corporations in such year. Unused foreign taxes

[[Page 24538]]

carried forward from the separate categories for dividends from each 
noncontrolled section 902 corporation to the single category for 
dividends from all noncontrolled section 902 corporations will 
similarly be deemed to have been utilized on a pro rata basis. The 
remaining unused foreign taxes are then assigned to the appropriate 
separate categories under the rules of paragraph (f)(4) of this 
section. Unused foreign taxes shall be treated as allocable to general 
limitation income to the extent that such taxes would otherwise have 
been allocable to passive income (based on reconstructed pools or the 
safe harbor method), or to the extent that, under paragraph (f)(4)(iii) 
of this section, the Commissioner determines that the look-through 
characterization cannot reasonably be determined based on the available 
information.
    (v) Carryback of unused foreign tax. To the extent that a taxpayer 
has unused foreign taxes attributable to a dividend paid by a 
noncontrolled section 902 corporation that was eligible for look-
through treatment under section 904(d)(4) and Sec.  1.904-5, any such 
unused foreign taxes shall be carried back to prior taxable years 
within the same separate category and not to the single category for 
dividends from all noncontrolled section 902 corporations or any 
separate category for dividends from a noncontrolled section 902 
corporation. See Notice 2003-5 (see Sec.  601.601(d)(2) of this 
chapter) for rules relating to the carryback of unused foreign taxes in 
the single category for dividends from all noncontrolled section 902 
corporations.
    (vi) Recapture of overall foreign loss or separate limitation loss 
in the single category for dividends from all noncontrolled section 902 
corporations. To the extent that a taxpayer has a balance in a separate 
limitation loss or overall foreign loss account in the single category 
for dividends from all noncontrolled section 902 corporations under 
section 904(d)(1)(E) (prior to its repeal by the AJCA), at the end of 
the taxpayer's last taxable year beginning before January 1, 2005 (or a 
later taxable year in which the taxpayer received a dividend subject to 
the separate limitation for dividends from all noncontrolled section 
902 corporations), the amount of such balance shall be allocated on the 
first day of the taxpayer's next taxable year to the taxpayer's other 
separate categories. The amount of such balance that is attributable to 
each noncontrolled section 902 corporation shall be allocated in the 
same percentages as the taxpayer properly characterized the stock of 
such corporation for purposes of apportioning the taxpayer's interest 
expense for its first taxable year ending after the first day of such 
corporation's first taxable year beginning after December 31, 2002, 
under Sec.  1.861-12T(c)(3) or (c)(4), as the case may be. To the 
extent that a taxpayer has a balance in a separate limitation loss 
account for the single category for dividends from all noncontrolled 
section 902 corporations with respect to another separate category, and 
the separate limitation loss account would otherwise be assigned to 
that other category under this paragraph (f)(9)(vi), such balance shall 
be eliminated.
    (vii) Recapture of separate limitation losses in other separate 
categories. To the extent that a taxpayer has a balance in any separate 
limitation loss account in a separate category with respect to the 
single category for dividends from all noncontrolled section 902 
corporations at the end of the taxpayer's last taxable year with or 
within which ends the last taxable year of the relevant noncontrolled 
section 902 corporation beginning before January 1, 2005, such loss 
shall be recaptured in subsequent taxable years as income in the 
appropriate separate category. The separate limitation loss account 
shall be deemed attributable on a pro rata basis to those noncontrolled 
section 902 corporations that paid dividends out of earnings 
accumulated in taxable years beginning before January 1, 2003, in the 
years in which the separate limitation loss in the other separate 
category arose. The ratable portions of the separate limitation loss 
account shall be recaptured as income in the taxpayer's separate 
categories in the same percentages as the taxpayer properly 
characterized the stock of the relevant noncontrolled section 902 
corporation for purposes of apportioning the taxpayer's interest 
expense in its first taxable year ending after the first day of such 
corporation's first taxable year beginning after December 31, 2002, 
under Sec.  1.861-12T(c)(3) or (c)(4), as the case may be. To the 
extent that a taxpayer has a balance in any separate limitation loss 
account in any separate category that would have been recaptured as 
income in that same category under this paragraph (f)(9)(vii), such 
balance shall be eliminated.
    (viii) Treatment of undistributed earnings in an upper-tier 
corporation-level single category for dividends from lower-tier 
noncontrolled section 902 corporations. Where a controlled foreign 
corporation or noncontrolled section 902 corporation has a single 
category for dividends from all noncontrolled section 902 corporations 
containing earnings attributable to dividends paid by one or more 
lower-tier corporations, the following rules apply. The post-1986 
undistributed earnings, previously-taxed earnings and profits described 
in section 959(c)(1) or (2), if any, and associated post-1986 foreign 
income taxes shall be allocated to the upper-tier corporation's other 
separate categories in the same manner as earnings and taxes in a 
separate category for dividends from each noncontrolled section 902 
corporation maintained by the upper-tier corporation are allocated 
under paragraph (f)(7) of this section. Accordingly, post-1986 
undistributed earnings, previously-taxed earnings and profits, if any, 
and post-1986 foreign income taxes in the single category for dividends 
from all noncontrolled section 902 corporations shall be treated as if 
they were accumulated and paid, accrued or deemed paid during a period 
when a dividend paid by each lower-tier corporation that paid dividends 
included in the single category would have been eligible for look-
through treatment. If the taxpayer elects the safe harbor rule 
described in paragraph (f)(7)(iii) of this section, the earnings and 
taxes shall be allocated based on the apportionment ratios properly 
used by the lower-tier corporation to apportion its interest expense 
for its first taxable year beginning after December 31, 2002. The 
taxpayer must substantiate the look-through characterization of the 
earnings and taxes in accordance with the rules of paragraph 
(f)(7)(iii) of this section. If the taxpayer does not elect the safe 
harbor and the Commissioner determines that the look-through 
characterization of the earnings cannot reasonably be determined based 
on the available information, the earnings and taxes shall be assigned 
to the upper-tier corporation's passive category.
    (ix) Treatment of a deficit in the single category for dividends 
from lower-tier noncontrolled section 902 corporations. Where a 
controlled foreign corporation or noncontrolled section 902 corporation 
had an aggregate deficit in the single category for dividends from all 
noncontrolled section 902 corporations as of the end of the upper-tier 
corporation's last taxable year beginning before January 1, 2005, such 
deficit and the associated post-1986 foreign income taxes, if any, 
shall be allocated to the upper-tier corporation's other separate 
categories in the same percentages in which the non-look-through pools 
of each lower-tier corporation to which the deficit is attributable 
were assigned to such corporation's other separate categories in its 
first taxable year beginning after December 31, 2002. If the taxpayer

[[Page 24539]]

elects the safe harbor rule described in paragraph (f)(7)(iii) of this 
section, the deficit and taxes shall be allocated based on how the 
taxpayer properly characterized the stock of the lower-tier 
noncontrolled section 902 corporation for purposes of apportioning the 
upper-tier corporation's interest expense for the upper-tier 
corporation's first taxable year ending after the first day of the 
lower-tier corporation's first taxable year beginning after December 
31, 2002. The taxpayer must substantiate the look-through 
characterization of the deficit and taxes in accordance with the rules 
of paragraph (f)(7)(iii) of this section. If the taxpayer does not 
elect the safe harbor and the Commissioner determines that the look-
through characterization of the deficit cannot reasonably be determined 
based on the available information, the deficit and taxes shall be 
assigned to the upper-tier corporation's passive category.
    (10) Effective date. Except in the case of a taxpayer that makes 
the election under paragraph (f)(9) of this section, section 904(d)(4) 
and this paragraph (f) shall apply to dividends from a noncontrolled 
section 902 corporation that are paid during the first taxable year of 
the noncontrolled section 902 corporation beginning after December 31, 
2002, and thereafter, without regard to whether the corresponding 
taxable year of the recipient of the dividend begins after December 31, 
2002. In the case of a taxpayer that makes the election under paragraph 
(f)(9) of this section, the provisions of section 403 of the AJCA, 
including section 904(d)(4), and this paragraph (f) shall apply to 
dividends from a noncontrolled section 902 corporation that are paid in 
taxable years of the noncontrolled section 902 corporation beginning 
after December 31, 2004, without regard to whether the corresponding 
taxable year of the recipient of the dividend begins after December 31, 
2004.

0
Par. 18. Section 1.904(f)-12 is amended by adding paragraph (g) to read 
as follows:


Sec.  1.904(f)-12  Transition rules.

* * * * *
    (g) Recapture in years beginning after December 31, 2002, of 
separate limitation losses and overall foreign losses incurred in years 
beginning before January 1, 2003, with respect to the separate category 
for dividends from a noncontrolled section 902 corporation. [Reserved] 
For further guidance, see Sec.  1.904(f)-12T(g).

0
Par. 19. Section 1.904(f)-12T is added as follows:


Sec.  1.904(f)-12T  Transition rules (temporary).

    (a) through (f) [Reserved]. For further guidance, see Sec.  
1.904(f)-12(a) through (f).
    (g) Recapture in years beginning after December 31, 2002, of 
separate limitation losses and overall foreign losses incurred in years 
beginning before January 1, 2003, with respect to the separate category 
for dividends from a noncontrolled section 902 corporation--(1) 
Recapture of separate limitation loss or overall foreign loss incurred 
in a separate category for dividends from a noncontrolled section 902 
corporation. To the extent that a taxpayer has a balance in any 
separate limitation loss or overall foreign loss account in a separate 
category for dividends from a noncontrolled section 902 corporation 
under section 904(d)(1)(E) (prior to its repeal by Public Law 108-357, 
118 Stat. 1418 (October 22, 2004)) at the end of the taxpayer's last 
taxable year beginning before January 1, 2003 (or a later taxable year 
in which the taxpayer received a dividend subject to a separate 
limitation for dividends from that noncontrolled section 902 
corporation), the amount of such balance shall be allocated on the 
first day of the taxpayer's next taxable year to the taxpayer's other 
separate categories. The amount of such balance shall be allocated in 
the same percentages as the taxpayer properly characterized the stock 
of the noncontrolled section 902 corporation for purposes of 
apportioning the taxpayer's interest expense for its first taxable year 
ending after the first day of such corporation's first taxable year 
beginning after December 31, 2002, under Sec.  1.861-12T(c)(3) or 
(c)(4), as the case may be. To the extent a taxpayer has a balance in 
any separate limitation loss account in a separate category for 
dividends from a noncontrolled section 902 corporation with respect to 
another separate category, and the separate limitation loss would 
otherwise be assigned to that other category under this paragraph 
(g)(1), such balance shall be eliminated.
    (2) Recapture of separate limitation loss in another separate 
category. To the extent that a taxpayer has a balance in any separate 
limitation loss account in a separate category with respect to a 
separate category for dividends from a noncontrolled section 902 
corporation under section 904(d)(1)(E) (prior to its repeal by Public 
Law 108-357, 118 Stat. 1418 (October 22, 2004)) at the end of the 
taxpayer's last taxable year with or within which ends the last taxable 
year of the noncontrolled section 902 corporation beginning before 
January 1, 2003, such loss shall be recaptured in subsequent taxable 
years as income in the appropriate separate categories. The separate 
limitation loss shall be recaptured as income in other separate 
categories in the same percentages as the taxpayer properly 
characterizes the stock of the noncontrolled section 902 corporation 
for purposes of apportioning the taxpayer's interest expense in its 
first taxable year ending after the first day of the foreign 
corporation's first taxable year beginning after December 31, 2002, 
under Sec.  1.861-12T(c)(3) or (c)(4), as the case may be. To the 
extent a taxpayer has a balance in a separate limitation loss account 
in a separate category that would have been recaptured as income in 
that same category under this paragraph (g)(2), such balance shall be 
eliminated.
    (3) Exception. Where a taxpayer formerly met the stock ownership 
requirements of section 902(a) with respect to a foreign corporation, 
but did not meet the requirements of section 902(a) on December 20, 
2002 (or on the first day of the taxpayer's first taxable year 
beginning after December 31, 2002, in the case of a transaction that 
was the subject of a binding contract in effect on December 20, 2002), 
if the taxpayer has a balance in any separate limitation loss or 
overall foreign loss account for a separate category for dividends from 
that foreign corporation under section 904(d)(1)(E) (prior to its 
repeal by Public Law 108-357, 118 Stat. 1418 (October 22, 2004)) at the 
end of the taxpayer's last taxable year beginning before January 1, 
2003, then the amount of such balance shall not be subject to recapture 
under section 904(f) and this section. If a separate limitation loss or 
overall foreign loss account for such category is not subject to 
recapture under this paragraph (g)(3), the taxpayer cannot carry over 
any unused foreign taxes in such separate category to any other 
limitation category. However, a taxpayer may elect to recapture the 
balances of all separate limitation loss and overall foreign loss 
accounts for all separate categories for dividends from such formerly-
owned noncontrolled section 902 corporations under the rules of 
paragraphs (g)(1) and (2) of this section. If a taxpayer so elects, it 
may carry over any unused foreign taxes in these separate categories to 
the appropriate separate categories as provided in Sec.  1.904-2T(h).
    (4) Examples. The following examples illustrate the application of 
this paragraph (g):

    Example 1. X is a domestic corporation that meets the ownership 
requirements of

[[Page 24540]]

section 902(a) with respect to Y, a foreign corporation the stock of 
which X owns 50 percent. Therefore, Y is a noncontrolled section 902 
corporation with respect to X. Both X and Y use the calendar year as 
their taxable year. As of December 31, 2002, X had a $100 balance in 
its separate limitation loss account for the separate category for 
dividends from Y, of which $60 offset general limitation income and 
$40 offset passive income. For purposes of apportioning X's interest 
expense for its 2003 taxable year, X properly characterized the 
stock of Y as a multiple category asset (80% general and 20% 
passive). Under paragraph (g)(1) of this section, on January 1, 
2003, $80 ($100 x 80/100) of the $100 balance in the separate 
limitation loss account is assigned to the general limitation 
category. Of this $80 balance, $32 ($80 x 40/100) is with respect to 
the passive category, and $48 ($80 x 60/100) is with respect to the 
general limitation category and therefore is eliminated. The 
remaining $20 balance ($100 x 20/100) of the $100 balance is 
assigned to the passive category. Of this $20 balance, $12 ($20 x 
60/100) is with respect to the general limitation category, and $8 
($20 x 40/100) is with respect to the passive category and therefore 
is eliminated.
    Example 2. The facts are the same as in Example 1, except that 
as of December 31, 2002, X had a $30 balance in its separate 
limitation loss account in the general limitation category, and a 
$20 balance in its separate limitation loss account in the passive 
category, both of which offset income in the separate category for 
dividends from Y. Under paragraph (g)(2) of this section, the 
separate limitation loss accounts in the general limitation and 
passive categories with respect to the separate category for 
dividends from Y will be recaptured on and after January 1, 2003, 
from income in other separate categories, as follows. Of the $30 
balance in X's separate limitation loss account in the general 
category with respect to the separate category for dividends from Y, 
$6 ($30 x 20/100) is with respect to the passive category, and $24 
($30 x 80/100) is with respect to the general limitation category 
and therefore is eliminated. Of the $20 balance in X's separate 
limitation loss account in the passive category with respect to the 
separate category for dividends from Y, $16 ($20 x 80/100) will be 
recaptured out of general limitation income, and $4 ($20 x 20/100) 
would otherwise be recaptured out of passive income and therefore is 
eliminated.

    (5) Effective date. This paragraph (g) shall apply for taxable 
years beginning after December 31, 2002.

0
Par. 20. sSection 1.964-1 is amended as follows:
0
1. In the first sentence of paragraph (a) introductory text, remove the 
language ``For purposes of section 951 through 964'' and add ``For 
taxable years beginning after December 31, 1986,'' in its place, and 
remove the language ``, except as provided in paragraph (f) of this 
section,''.
0
2. Remove paragraphs (a)(4) and (a)(5), add the word ``and'' at the end 
of paragraph (a)(2), replace the semicolon with a period at the end of 
paragraph (a)(3), and remove the language ``may be made by following 
the procedures described in paragraphs (a)(1) through (5)'' in the 
first sentence of the undesignated paragraph following paragraph (a)(3) 
and add the language ``shall be made in the foreign corporation's 
functional currency (determined under section 985 and the regulations 
under that section) and may be made by following the procedures 
described in paragraphs (a)(1) through (a)(3)'' in its place.
0
3. Add a new sentence at the end of paragraph (a)(1).
0
4. Add a new paragraph (c)(1)(v).
0
5. Revise paragraphs (c)(2), (c)(3), (c)(4), (c)(5), and (c)(6).
0
6. Remove paragraphs (d), (e), and (f).
    The revisions read as follows:


Sec.  1.964-1  Determination of the earnings and profits of a foreign 
corporation.

    (a) * * *
    (1) * * * For rules for determining the earnings and profits (or 
deficit in earnings and profits) of a foreign corporation for taxable 
years beginning before January 1, 1987, for purposes of sections 951 
through 964, see 26 CFR 1.964-1(a) (revised as of April 1, 2006).
* * * * *
    (c) * * *
    (1) * * *
    (v) [Reserved]. For further guidance, see Sec.  1.964-1T(c)(1)(v).
    (c)(2) through (c)(6) [Reserved]. For further guidance, see Sec.  
1.964-1T(c)(2) through (c)(6).

0
Par. 21. Section 1.964-1T is amended as follows:
0
1. Revise the section heading.
0
2. Add new paragraph (c)(1)(v).
0
3. Add new paragraphs (c)(2) through (8).
0
4. Add new paragraphs (d), (e), and (f).
    The revisions and additions read as follows:


Sec.  1.964-1T  Determination of the earnings and profits of a foreign 
corporation (temporary).

    (a) Through (c)(1)(iv) [Reserved]. For further guidance, see Sec.  
1.964-1(a) through (c)(1)(iv).
    (v) Taxable years. The period for computation of taxable income and 
earnings and profits known as the taxable year shall reflect the 
provisions of section 441 and the regulations thereunder.
    (2) Adoption or change of method or taxable year. For the first 
taxable year of a foreign corporation beginning after April 25, 2006, 
in which a foreign corporation is a controlled foreign corporation (as 
defined in section 957 or 953) or a noncontrolled section 902 
corporation (as defined in section 904(d)(2)(E)), any method of 
accounting or taxable year allowable under this section may be adopted, 
and any election allowable under this section may be made, by such 
foreign corporation or on its behalf notwithstanding that, in previous 
years, its books or financial statements were prepared on a different 
basis, and notwithstanding that such election is required by the Code 
or regulations to be made in a prior taxable year. Any allowable 
methods adopted or elections made shall be reflected in the computation 
of the foreign corporation's earnings and profits for such taxable 
year, prior taxable years, and (unless the Commissioner consents to a 
change) subsequent taxable years. However, see section 898 for the 
rules regarding the taxable year of a specified foreign corporation as 
defined in section 898(b). Any allowable method of accounting or 
election that relates to events that first arise in a subsequent 
taxable year may be adopted or made by or on behalf of the foreign 
corporation for such year. See paragraph (a)(3) of this section for the 
manner in which a method of accounting or a taxable year may be adopted 
or changed on behalf of the foreign corporation. See paragraph (c)(4) 
and (g)(3) of this section for applicable rules if the amount of the 
foreign corporation's earnings and profits became significant for 
United States tax purposes before a method of accounting or taxable 
year was adopted by the foreign corporation or on its behalf in 
accordance with the rules of paragraph (c)(3) of this section. See 
paragraphs (c)(6) and (g)(2) of this section for special rules 
postponing the time for taking action by or on behalf of a foreign 
corporation until the amount of its earnings and profits becomes 
significant for U.S. tax purposes.
    (3) Action on behalf of corporation--(i) In general. An election 
shall be deemed made, or an adoption or change in method of accounting 
or taxable year deemed effectuated, on behalf of the foreign 
corporation only if its controlling domestic shareholders (as defined 
in paragraph (c)(5) of this section)--
    (A) Satisfy for such corporation any requirements imposed by the 
Internal Revenue Code or applicable regulations with respect to such 
election or such adoption or change in method or taxable year 
(including the provisions of sections 442 and 446 and the regulations 
thereunder, as well as any operative provisions), such as the filing of 
forms, the execution of consents, securing the permission of the

[[Page 24541]]

Commissioner, or maintaining books and records in a particular manner. 
For purposes of this paragraph (c)(3)(i)(A), the books of the foreign 
corporation shall be considered to be maintained in a particular manner 
if the controlling domestic shareholders or the foreign corporation 
regularly keep the records and accounts required by section 964(c) and 
the regulations thereunder in that manner;
    (B) File the statement described in paragraph (c)(3)(ii) of this 
section, at the time and in the manner prescribed therein; and
    (C) Provide the written notice required by paragraph (c)(3)(iii) of 
this section at the time and in the manner prescribed therein.
    (ii) Statement required to be filed with a tax return. The 
statement required by this paragraph (c)(3)(ii) shall set forth the 
name, country of organization, and U.S. employer identification number 
(if applicable) of the foreign corporation, the name, address, stock 
interests, and U.S. employer identification number of each controlling 
domestic shareholder (or, if applicable, the shareholder's common 
parent) approving the action, and the names, addresses, U.S. employer 
identification numbers, and stock interests of all other domestic 
shareholders notified of the action taken. Such statement shall 
describe the nature of the action taken on behalf of the foreign 
corporation and the taxable year for which made, and identify a 
designated shareholder who retains a jointly executed consent 
confirming that such action has been approved by all of the controlling 
domestic shareholders and containing the signature of a principal 
officer of each such shareholder (or its common parent). Each 
controlling domestic shareholder shall file the statement with its own 
tax return (or information return, if applicable) for its taxable year 
with or within which ends the taxable year of the foreign corporation 
for which the election is made or for which the method of accounting or 
taxable year is adopted or changed.
    (iii) Notice. On or before the filing date described in paragraph 
(c)(3)(ii) of this section, the controlling domestic shareholders shall 
provide written notice of the election made or the adoption or change 
of method or taxable year effected to all other persons known by them 
to be domestic shareholders who own (within the meaning of section 
958(a)) stock of the foreign corporation. Such notice shall set forth 
the name, country of organization and U.S. employer identification 
number (if applicable) of the foreign corporation, and the names, 
addresses, and stock interests of the controlling domestic 
shareholders. Such notice shall describe the nature of the action taken 
on behalf of the foreign corporation and the taxable year for which 
made, and identify a designated shareholder who retains a jointly 
executed consent confirming that such action has been approved by all 
of the controlling domestic shareholders and containing the signature 
of a principal officer of each such shareholder (or its common parent). 
However, the failure of the controlling domestic shareholders to 
provide such notice to a person required to be notified shall not 
invalidate the election made or the adoption or change of method or 
taxable year effected.
    (4) Effect of action or inaction by controlling domestic 
shareholders. Any action taken by the controlling domestic shareholders 
on behalf of the foreign corporation pursuant to paragraph (c)(3) of 
this section shall be reflected in the computation of the earnings and 
profits of such corporation under this section to the extent that it 
bears upon the tax liability of all domestic shareholders of the 
foreign corporation. See Sec.  1.964-1T(g)(5). In the event that action 
by or on behalf of the foreign corporation is not undertaken by the 
time specified in paragraph (c)(6) of this section and such failure is 
shown to the satisfaction of the Commissioner to be due to reasonable 
cause, such action may be undertaken during any period of at least 30 
days occurring after such showing is made which the Commissioner may 
specify as appropriate for this purpose. The principles of Sec.  1.964-
1T(g)(3) and (g)(4) shall apply in determining the effect of a failure 
of the controlling domestic shareholders to take action on behalf of 
the foreign corporation pursuant to paragraph (c)(3) of this section. 
Accordingly, if the earnings and profits of a noncontrolled section 902 
corporation became significant for United States income tax purposes in 
a taxable year beginning on or before April 25, 2006, the corporation's 
earnings and profits shall be computed as if no elections had been made 
and any permissible accounting methods not requiring an election and 
reflected in the books of account regularly maintained by the foreign 
corporation for purposes of accounting to its shareholders had been 
adopted. Any change in accounting method may be made by or on behalf of 
the foreign corporation only with the Commissioner's consent.
    (5) Controlling domestic shareholders--(i) Controlled foreign 
corporations. For purposes of this paragraph, the controlling domestic 
shareholders of a controlled foreign corporation shall be its 
controlling United States shareholders. The controlling United States 
shareholders of a controlled foreign corporation shall be those United 
States shareholders (as defined in section 951(b) or 953(c)) who, in 
the aggregate, own (within the meaning of section 958(a)) more than 50 
percent of the total combined voting power of all classes of the stock 
of such foreign corporation entitled to vote and who undertake to act 
on its behalf. In the event that the United States shareholders of the 
controlled foreign corporation do not, in the aggregate, own (within 
the meaning of section 958(a)) more than 50 percent of the total 
combined voting power of all classes of the stock of such foreign 
corporation entitled to vote, the controlling Untied States 
shareholders of the controlled foreign corporation shall be all those 
United States shareholders who own (within the meaning of section 
958(a)) stock of such corporation.
    (ii) Noncontrolled section 902 corporations. For purposes of this 
paragraph, the controlling domestic shareholders of a noncontrolled 
section 902 corporation that is not a controlled foreign corporation 
shall be its majority domestic corporate shareholders. The majority 
domestic corporate shareholders of a noncontrolled section 902 
corporation shall be those domestic corporations that meet the 
ownership requirements of section 902(a) with respect to the 
noncontrolled section 902 corporation (or to a first-tier foreign 
corporation that is a member of the same qualified group as defined in 
section 902(b)(2) as the noncontrolled section 902 corporation) that, 
in the aggregate, own directly or indirectly more than 50 percent of 
the combined voting power of all of the voting stock of the 
noncontrolled section 902 corporation that is owned directly or 
indirectly by all domestic corporations that meet the ownership 
requirements of section 902(a) with respect to the noncontrolled 
section 902 corporation (or a relevant first-tier foreign corporation).
    (6) Action not required until significant. Notwithstanding any 
other provision of this paragraph, action by or on behalf of a foreign 
corporation (other than a foreign corporation subject to tax under 
section 882) to make an election or to adopt a taxable year or method 
of accounting shall not be required until the due date (including 
extensions) of the return for a controlling domestic shareholder's 
first taxable year with or within which ends the foreign corporation's 
first taxable year in which the computation of its earnings and profits 
is significant for United States

[[Page 24542]]

tax purposes with respect to its controlling domestic shareholders (as 
defined in Sec.  1.964-1T(c)(5)). The filing of the information return 
required by section 6038 shall not itself constitute a significant 
event. For taxable years beginning on or after April 25, 2006, events 
that cause a foreign corporation's earnings and profits to have United 
States tax significance include, without limitation,
    (i) A distribution from the foreign corporation to its shareholders 
with respect to their stock;
    (ii) An amount is includible in gross income with respect to such 
corporation under section 951(a);
    (iii) An amount is excluded from subpart F income of the foreign 
corporation or another foreign corporation by reason of section 952(c);
    (iv) Any event making the foreign corporation subject to tax under 
section 882;
    (v) The use by the foreign corporation's controlling domestic 
shareholders of the tax book value (or alternative tax book value) 
method of allocating interest expense under section 864(e)(4); or
    (vi) A sale or exchange of the foreign corporation's stock of the 
controlling domestic shareholders that results in the 
recharacterization of gain under section 1248.
    (c)(7) and (8) [Reserved]. For further guidance, see Sec.  1.964-
1(c)(7) and (c)(8) and Sec.  1.964-1T(g)(6).
    (d) Through (f) [Reserved].
* * * * *

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

0
Par. 22. The authority citation for part 602 continues to read as 
follows:

    Authority: 26 U.S.C. 7805.
0
Par. 23. In Sec.  602.101, paragraph (b) is amended by adding the 
following entries in numerical order to the table to read, in part, as 
follows:


Sec.  602.101  OMB Control numbers

* * * * *

------------------------------------------------------------------------
                                                           Current OMB
   CFR part or section where identified and described      Control No.
------------------------------------------------------------------------
 
                                * * * * *
1.904-7T...............................................        1545-2104
 
                                * * * * *
1.964-1T...............................................        1545-2104
 
                                * * * * *
------------------------------------------------------------------------


Mark E. Matthews,
Deputy Commissioner for Services and Enforcement.
    Approved: April 14, 2006.
Eric Solomon,
Acting Deputy Assistant Secretary of the Treasury.
[FR Doc. 06-3882 Filed 4-20-06; 3:51 pm]
BILLING CODE 4830-01-P