[Federal Register Volume 76, Number 137 (Monday, July 18, 2011)]
[Rules and Regulations]
[Pages 42038-42048]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2011-17920]



[[Page 42038]]

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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 9535]
RIN 1545-BK25


Determining the Amount of Taxes Paid for Purposes of the Foreign 
Tax Credit

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations and removal of temporary regulations.

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SUMMARY: This document contains final regulations providing guidance 
relating to the determination of the amount of taxes paid for purposes 
of the foreign tax credit. These regulations address certain highly 
structured transactions that produce inappropriate foreign tax credit 
results. The regulations affect individuals and corporations that claim 
direct and indirect foreign tax credits.

DATES: Effective Date: These regulations are effective on July 18, 
2011.
    Applicability Date: For dates of applicability, see Sec.  1.901-
1(j) and Sec.  1.901-2(h)(2).

FOR FURTHER INFORMATION CONTACT: Jeffrey P. Cowan, at (202) 622-3850.

SUPPLEMENTARY INFORMATION:

Background

    On March 30, 2007, the Federal Register published proposed 
regulations (72 FR 15081) under section 901 of the Internal Revenue 
Code (``Code'') relating to the amount of taxes paid for purposes of 
the foreign tax credit (the ``2007 proposed regulations''). The IRS and 
the Treasury Department received written comments on the 2007 proposed 
regulations and a public hearing was held on July 30, 2007. In response 
to written comments, the IRS and the Treasury Department issued Notice 
2007-95 (2007-2 CB 1091 (December 3, 2007)) (see Sec.  
601.601(d)(2)(ii)(b)) providing that the proposed rule for U.S.-owned 
foreign groups would be severed from the portion of the 2007 proposed 
regulations addressing the treatment of foreign payments attributable 
to certain structured passive investment arrangements. On July 16, 
2008, a notice of proposed rulemaking by cross-reference to temporary 
regulations and temporary regulations (TD 9416) (the ``2008 temporary 
regulations'') were published in the Federal Register at 73 FR 40792 
and 73 FR 40727, respectively. Corrections to those temporary 
regulations were published on November 14, 2008, in the Federal 
Register (73 FR 67387). The 2008 temporary regulations address the 
treatment of foreign payments attributable to structured passive 
investment arrangements and do not address the treatment of U.S.-owned 
foreign groups.
    The IRS and the Treasury Department received written comments on 
the 2008 temporary regulations, which are discussed in this preamble. 
All comments are available at http://www.regulations.gov or upon 
request. A public hearing was not requested and none was held. This 
Treasury decision adopts the proposed regulation with the changes 
discussed in this preamble.

Summary of Comments and Explanation of Revisions

A. Treatment of Amounts Attributable to a Structured Passive Investment 
Arrangement
    These final regulations retain the basic approach and structure of 
the 2008 temporary regulations. Thus, the final regulations provide 
that amounts paid to a foreign taxing authority that are attributable 
to a structured passive investment arrangement are not treated as an 
amount of tax paid for purposes of the foreign tax credit. An 
arrangement that satisfies six conditions, as described in this 
preamble, is treated as a structured passive investment arrangement.
    A comment presented several proposals that collectively would have 
required further differentiation both among the various investors in 
structured passive investment arrangements based upon their business 
practices and relationships to other parties, as well as among the 
particular transactions undertaken by a special purpose vehicle 
involved in the arrangement. Because the IRS and the Treasury 
Department believe these proposals would introduce several subjective 
and factually-intensive elements into the regulations that would 
increase administrative burdens for taxpayers and the IRS, including a 
rule providing for only partial disallowance of foreign tax credits, 
the final regulations retain the approach of the 2008 temporary 
regulations, relying on objective, generally applicable standards to 
the extent possible. The IRS and the Treasury Department believe that 
this approach will appropriately disallow any foreign tax credits 
arising from artificial structures that are utilized to generate 
foreign tax credits and material duplicative foreign tax benefits.
B. Structured Passive Investment Arrangements
    A comment recommended adding a requirement that the 2008 temporary 
regulations' six conditions be fulfilled as part of a plan or series of 
related transactions. The IRS and the Treasury Department did not adopt 
this comment. The standard in the regulations is designed to depend 
upon key objective aspects of an arrangement that indicate an abusive 
arrangement. The IRS and the Treasury Department believe that the 
introduction of a plan requirement or similar rule would introduce a 
subjective inquiry that is difficult to apply and unnecessary to 
achieve the purpose of the regulations.
C. Section 1.901-2(e)(5)(iv)(B)(1): Special Purpose Vehicle
    The first condition provided in Sec.  1.901-2T(e)(5)(iv)(B)(1) of 
the 2008 temporary regulations is that the arrangement utilizes an 
entity that meets two requirements (the ``SPV condition''). The first 
requirement is that substantially all of the entity's gross income, as 
determined under U.S. tax principles, is attributable to passive 
investment income and substantially all of the entity's assets are held 
to produce such passive investment income. The term entity, as defined 
in Sec.  1.901-2T(e)(5)(iv)(C)(3) of the 2008 temporary regulations, 
includes a corporation, trust, partnership, or disregarded entity. For 
purposes of the first requirement, Sec.  1.901-2T(e)(5)(iv)(C)(5) of 
the 2008 temporary regulations defines passive investment income as 
income defined in section 954(c) with certain modifications. Passive 
investment income generally includes the income of an upper-tier entity 
attributable to its equity interest in a lower-tier entity, but such 
income may be excluded from passive investment income where it is 
attributable to a qualified equity interest in certain lower-tier 
entities that are engaged in an active trade or business and other 
conditions apply (the ``holding company exception''). See Sec.  1.901-
2T(e)(5)(iv)(c)(5)(ii).
    One comment recommended that the definition of passive investment 
income be modified to exclude personal service contract income as 
described in section 954(c)(1)(H) because such income is not derived 
from passive assets and would not ordinarily be used in a structured 
passive investment arrangement. The IRS and the Treasury Department 
agree with the comment, and accordingly these final regulations provide 
that passive investment income does not include personal service 
contract

[[Page 42039]]

income as described in section 954(c)(1)(H).
    The IRS and the Treasury Department also received several comments 
regarding the holding company exception. One comment recommended that 
the definition of passive investment income exclude income attributable 
to equity interests in pass-through entities except to the extent that 
the income of the lower-tier entity satisfies the definition of passive 
investment income. The IRS and the Treasury Department did not adopt 
this proposal because the IRS and the Treasury Department believe that 
the rule in the 2008 temporary regulations is necessary to prevent 
taxpayers from using pass-through entities to avoid the limitations on 
the holding company exception, such as the holding of qualified equity 
interests and the sharing of investment risk. The interests in a pass-
through entity can be substantially indistinguishable from interests in 
a corporate subsidiary, and, therefore, these final regulations treat 
such interests the same for purposes of the definition of passive 
investment income. The final regulations clarify that income 
attributable to equity interests in pass-through entities (including a 
partner's distributive share of partnership income and the income 
attributable to an entity disregarded for U.S. tax purposes) is treated 
as passive investment income unless the holding company exception 
applies.
    The IRS and the Treasury Department have deleted the last two 
sentences in the 2008 temporary regulations in Sec.  1.901-
2T(e)(5)(iv)(B)(1)(i). These sentences described rules set out in more 
detail in the definition of passive investment income. The IRS and the 
Treasury Department believe that these sentences did not provide 
additional clarity to the definition of passive investment income.
    One comment recommended expanding the holding company exception to 
treat income attributable to certain portfolio interests as active 
income if the income earned by the lower-tier entity was active income. 
As a condition to the application of the holding company exception, the 
potential holding company's equity interest in the lower-tier entity 
must be a qualified equity interest. The holding company exception 
focuses on whether a joint venture arrangement conducted through a 
holding company structure economically replicates the interests of the 
joint venturers in the active business of the lower-tier entity. It is 
not intended to insulate portfolio investments in lower-tier entities 
even if they operate active businesses. Therefore, the IRS and the 
Treasury Department do not believe that it is appropriate to broaden 
the holding company exception to apply to portfolio investments 
notwithstanding that in certain cases the lower-tier entity may have 
active operations.
    Another comment recommended that the holding company exception be 
replaced with a rule that generally attributes all activities of lower-
tier entities to their owners, subject to an anti-abuse exception. 
Under the suggested anti-abuse rule, the attribution rule would not 
apply if, with a view to avoiding the SPV condition, a holding company 
holds assets other than stock in subsidiaries, and, based on all the 
facts and circumstances, the ownership of those assets is expected to 
achieve substantially the same effect as holding those assets in a 
separate entity. A similar comment was considered and not adopted 
during the promulgation of the 2008 temporary regulations. The IRS and 
the Treasury Department believe that the commentator's recommendation 
would be difficult to administer because it would require factually 
intensive and subjective determinations. Therefore, this comment was 
not adopted.
    Additionally, comments recommended clarifying the requirement in 
the holding company exception that substantially all of a potential 
holding company's opportunity for gain and risk of loss with respect to 
its qualified equity interest in a lower-tier entity be shared by the 
U.S. party or parties (or persons that are related to a U.S. party) and 
a counterparty or counterparties (or persons that are related to a 
counterparty). According to the comments, there are common situations 
where it is not clear that gain and risk of loss are shared, including 
preferred stock and stock-based compensation. The IRS and the Treasury 
Department believe that existing legal principles should apply to 
determine if an interest holder possesses the opportunity for gain and 
risk of loss and that additional guidance is generally unnecessary. The 
IRS and the Treasury Department further believe that the sharing of 
gain and risk of loss is dependent on facts and circumstances and 
therefore the final regulations provide that the assessment of 
opportunity for gain and risk of loss is based on all facts and 
circumstances.
    Finally, comments requested clarification regarding the application 
of the holding company exception to fact patterns involving multiple 
counterparties or multiple U.S. parties. In response to the comments, 
these final regulations clarify that in cases involving more than one 
U.S. party or more than one counterparty or both, the requirement that 
the parties must share in substantially all of the upper-tier entity's 
opportunity for gain and risk of loss with respect to its interest in a 
lower-tier entity is applied by examining whether there is sufficient 
risk sharing by each of the groups comprising all U.S. parties (or 
person related to such U.S. parties) and all counterparties (or persons 
related to such counterparties). The IRS and the Treasury Department 
believe that the risk sharing requirement, as so modified, will 
continue to ensure that only bona fide joint ventures are eligible for 
the holding company exception. If there is more than one U.S. party or 
more than one counterparty, the final regulations do not require that 
each member of the U.S. party and counterparty groups share in the 
underlying investment risk. Finally, the holding company exception has 
been modified to provide that where a U.S. party owns an interest in an 
entity indirectly through a chain of entities, the exception is applied 
beginning with the lowest-tier entity in the chain before proceeding 
upward and the opportunity for gain and risk of loss borne by any 
upper-tier entity in the chain that is a counterparty is disregarded to 
the extent borne indirectly by a U.S. party.
    The second of the two requirements of the SPV condition in the 2008 
temporary regulations is that there is a foreign payment attributable 
to income of the entity. See Sec.  1.901-2T(e)(5)(iv)(B)(1)(ii). The 
foreign payment may be paid by the entity itself or by the owner(s) of 
the entity. The 2007 proposed regulations and the 2008 temporary 
regulations both provide an exception that a foreign payment does not 
include a withholding tax imposed on distributions or payments made by 
an entity to a U.S. party. However, the IRS and the Treasury Department 
have become aware that taxpayers can enter into arrangements that 
generate duplicative benefits involving foreign withholding taxes 
imposed on distributions made by an entity to a U.S. party. For 
example, if the parties undertake a transaction in which interests in 
an SPV are transferred by the U.S. party to a counterparty subject to a 
repurchase obligation, withholding taxes imposed on distributions from 
the SPV may be claimed as creditable in both jurisdictions.
    Accordingly, the exception for withholding taxes imposed on 
distributions or payments to U.S. parties is eliminated from Sec.  
1.901-2(e)(5)(iv)(B)(1)(ii) of the final regulations. The IRS and the 
Treasury

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Department will promulgate additional guidance to clarify that a 
foreign payment attributable to income of an entity includes a 
withholding tax imposed on a dividend or other distribution (including 
distributions made by a pass-through entity or an entity that is 
disregarded as an entity separate from its owner for U.S. tax purposes) 
with respect to the equity of the entity.
    The 2008 temporary regulations attribute to income of an entity 
foreign payments attributable to the entity's share of income of a 
lower-tier entity that is a branch or pass-through entity under either 
foreign or U.S. law. One comment recommended that the foreign payment 
rule be modified by eliminating the attribution of foreign payments 
made by a lower-tier entity that is a branch or pass-through entity 
under only U.S. law to the income of its owner because such attribution 
would not occur if the lower-tier entity were regarded as a corporation 
for U.S. tax purposes. The IRS and the Treasury Department agree with 
the comment that foreign payments by a lower-tier entity should not be 
attributed to the income of its owner. In cases where a lower-tier 
entity is liable for foreign payments under foreign law, the 
disallowance of foreign tax credits with respect to such taxes should 
turn on whether that entity, and not the owner of such entity, 
satisfies the SPV condition. Accordingly, the applicable sentence has 
been eliminated from Sec.  1.901-2(e)(5)(iv)(B)(1)(ii) of the final 
regulations.
D. Section 1.901-2(e)(5)(iv)(B)(2): U.S. Party
    Section 1.901-2(e)(5)(iv)(B)(2) of the final regulations adopts 
without change the second condition of the 2008 temporary regulations 
that a U.S. party is a person who is eligible to claim a credit under 
section 901(a), including a credit for taxes deemed paid under section 
902 or 960, for all or a portion of the foreign payment if the foreign 
payment were an amount of tax paid (the ``U.S. party condition''). 
Comments recommended that the U.S. party condition be supplemented with 
a de minimis exception, including an exclusion for U.S. citizens and 
residents. The IRS and the Treasury Department do not believe that such 
a modification is consistent with the purposes of these regulations. 
Therefore, the IRS and the Treasury Department have not adopted this 
comment.
    Another comment recommended that if a U.S. party is a member of an 
affiliated group of corporations that files a consolidated federal 
income tax return, then all members of the affiliated group should be 
treated as a single U.S. party for purposes of applying the final 
regulations. The IRS and the Treasury Department did not adopt this 
comment because the final regulations provide aggregation rules that 
address the comment.
E. Section 1.901-2(e)(5)(iv)(B)(3): Direct Investment
    Section 1.901-2(e)(5)(iv)(B)(3) of the final regulations adopts 
without change the third condition of the 2008 temporary regulations 
(the ``direct investment condition''). The direct investment condition 
requires that the U.S. party's share of the foreign payment or payments 
is (or is expected to be) substantially greater than the amount of 
credits, if any, that the U.S. party reasonably would expect to be 
eligible to claim under section 901(a) for foreign taxes attributable 
to income generated by the U.S. party's proportionate share of the 
assets owned by the SPV if the U.S. party directly owned such assets.
    Comments suggested that this condition in the 2008 temporary 
regulations will always be satisfied because it assumes the assets 
would not be held through a branch operation subject to net basis 
taxation and excludes assets that produce income subject to gross basis 
withholding tax. One comment recommended that the final regulations 
limit the condition to cases in which the arrangement increases the 
foreign payments attributable to the U.S. party relative to what would 
have been paid in the absence of a duplicative tax benefit. In 
contrast, the 2008 temporary regulations compare the amount of the U.S. 
party's foreign payment with the amount of taxes that would be expected 
to be paid if the U.S. party directly owned the assets in question.
    The IRS and the Treasury Department disagree with this 
recommendation. The introduction of a standard that compares the 
foreign payments arising from a structured passive investment 
arrangement to alternative transactions that might have been undertaken 
under different incentives would add administrative complexity and 
uncertainty in the application of these regulations. Accordingly, the 
IRS and the Treasury Department have retained the condition unchanged 
from the 2008 temporary regulations both because it describes one of 
the abusive aspects of these arrangements and because it ensures that 
the regulations cannot be avoided through the use of foreign securities 
that produce income subject to withholding taxes.
F. Section 1.901-2(e)(5)(iv)(B)(4): Foreign Tax Benefit
    Section 1.901-2(e)(5)(iv)(B)(4) of the final regulations adopts 
with minor changes the fourth condition of the 2008 temporary 
regulations (the ``foreign tax benefit condition''). The foreign tax 
benefit condition requires that the arrangement is reasonably expected 
to result in a tax benefit to a counterparty (or a related person) 
under the laws of a foreign country. If the foreign tax benefit 
available to the counterparty is a credit, then such credit must 
correspond to 10 percent or more of the U.S. party's share (for U.S. 
tax purposes) of the foreign payment. Other types of foreign tax 
benefits, such as exemptions, deductions, exclusions or losses, must 
correspond to 10 percent or more of the foreign base with respect to 
which the U.S. party's share (for U.S. tax purposes) of the foreign 
payment is imposed.
    The IRS and the Treasury Department received several comments with 
respect to the foreign tax benefit condition. The comments asserted 
that the rule in the 2008 temporary regulations requiring at least 10 
percent correspondence between the foreign tax benefit and the U.S. 
party's share of the foreign payment (``the 10 percent correspondence 
requirement'') is vague and more difficult to apply than a similar rule 
in the 2007 proposed regulations. Under the 2007 proposed regulations, 
any foreign tax benefit satisfied the condition, but the counterparty 
condition, described below, included minimum ownership requirements. 
One comment favored the clarity of the 2007 proposed rule. In addition, 
the comments questioned whether certain types of foreign tax benefits, 
such as exemptions or reduced tax rates on certain types of income, 
should be treated as foreign tax benefits for these purposes. Finally, 
comments sought clarification regarding how the percentage of 
correspondence is determined in cases involving more than two persons 
owning an interest in an SPV.
    The 10 percent correspondence requirement is intended to limit any 
potential disallowance of foreign tax credits to cases in which there 
is a material duplication of the tax benefits. Accordingly, the final 
regulations retain this requirement. In addition, the final regulations 
do not exclude any particular tax benefit from the foreign tax benefit 
condition because duplication of tax benefits can assume a wide variety 
of forms. The IRS and the Treasury Department also believe that whether 
foreign tax benefits duplicate or correspond to the U.S. party's share 
of

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the foreign tax benefits will generally be clear and no further 
elaboration of the rules is required.
    Another comment noted that the foreign tax benefit condition may be 
difficult to apply in cases where the foreign tax benefit is claimed by 
a party related to the counterparty. The IRS and the Treasury 
Department concluded that it was necessary to include related parties 
because of the variety of duplication techniques otherwise available to 
taxpayers, including the use of benefits arising to members of a 
related group of entities, and accordingly the comment was not adopted.
    Comments sought clarification that in arrangements involving two or 
more unrelated counterparties, the 10 percent correspondence 
requirement cannot be satisfied by aggregating the value of duplicative 
tax benefits received by the unrelated counterparties. The comments 
assert that the inclusion of benefits received by parties related to a 
counterparty in the foreign tax benefit condition in the 2008 temporary 
regulations suggested, by negative implication, that any benefits 
claimed by unrelated counterparties should not be aggregated. The IRS 
and the Treasury Department did not adopt this comment. The 10 percent 
correspondence requirement is intended to ensure that the disallowance 
of credits applies only where the duplication of tax benefits in the 
arrangement is material relative to the value of the otherwise 
creditable foreign payment, irrespective of whether the arrangement 
involves multiple U.S. parties, multiple counterparties, or both. Thus, 
in the final regulations the 10 percent correspondence requirement 
compares the aggregate amount of foreign tax benefits available to all 
counterparties and persons related to such counterparties to the 
aggregate amount of the U.S. parties' share of the foreign payment or 
the foreign base, as the case may be.
    Comments also objected to the language in the foreign tax benefit 
condition providing that the arrangement is ``reasonably expected'' to 
result in a foreign tax benefit. According to the comments, a U.S. 
party may be unable to assess whether a counterparty is reasonably 
expected to receive a foreign tax benefit and it would be inappropriate 
to disallow a foreign tax credit where a U.S. party cannot make such an 
assessment. The IRS and the Treasury Department believe the 
reasonableness standard in the 2008 temporary regulations affords 
sufficient protection against unknowable or unexpected outcomes in the 
majority of cases. Further, the IRS and the Treasury Department are 
concerned that an actual knowledge requirement would be difficult to 
administer. Accordingly, the IRS and the Treasury Department have not 
adopted this comment.
G. Section 1.901-2(e)(5)(iv)(B)(5): Counterparty
    The fifth condition provided in Sec.  1.901-2T(e)(5)(iv)(B)(5) of 
the 2008 temporary regulations is that the arrangement include a person 
that, under the tax laws of a foreign country in which the person is 
subject to tax on the basis of place of management, place of 
incorporation or similar criterion or otherwise subject to a net basis 
tax, directly or indirectly owns or acquires equity interests in, or 
assets of, the SPV (the ``counterparty condition''). The 2008 temporary 
regulations provide that a counterparty does not include the SPV or a 
person with respect to which the same domestic corporation, U.S. 
citizen or resident alien individual directly or indirectly owns more 
than 80 percent of the total value of the stock (or equity interests) 
of each of the U.S. party and such person. Also, a counterparty does 
not include a person with respect to which the U.S. party directly or 
indirectly owns more than 80 percent of the total value of the stock 
(or equity interests), but only if the U.S. party is a domestic 
corporation, a U.S. citizen or a resident alien individual.
    The IRS and the Treasury Department received several comments with 
respect to the counterparty condition. Comments noted that in certain 
tiered structures the rule could treat as a counterparty an upper-tier 
entity in which a U.S. investor and a foreign investor each hold 
interests, and that to the extent that the foreign tax benefits 
resulting from such structures are not duplicative, the counterparty 
condition is overly broad. For example, if a U.S. investor and foreign 
investor each own 50 percent of an upper-tier entity which in turn owns 
an SPV, the comments argue that the exempt treatment of distributions 
from the SPV to its upper-tier owner is not problematic so long as each 
of the investors in the upper-tier entity ultimately receives only 
those tax benefits associated with its 50 percent interest in the 
upper-tier entity. Comments suggested revising the counterparty 
condition to exclude such intermediary entities.
    The IRS and the Treasury Department agree that foreign tax benefits 
claimed by a jointly-held upper-tier entity are not problematic so long 
as none of the indirect U.S. or foreign owners of the SPV claims 
duplicative tax benefits attributable to the arrangement. However, the 
IRS and the Treasury Department are concerned that revising the 
counterparty condition to exclude jointly-held entities could create 
opportunities for avoidance of the regulations. Accordingly, in lieu of 
revising the counterparty condition, the final regulations revise the 
foreign tax benefit condition to provide that certain tax benefits 
claimed by upper-tier entities do not correspond to the U.S. party's 
share of the foreign payment. Specifically, where a U.S. party 
indirectly owns a non-hybrid equity interest in an SPV, a foreign tax 
benefit available to a foreign entity in the chain of ownership which 
begins with the SPV and ends with the first-tier entity in such chain 
does not correspond to the U.S. party's share of the foreign payment 
attributable to the SPV to the extent that such benefit relates to 
earnings of the SPV that are distributed with respect to non-hybrid 
equity interests in the SPV that are owned indirectly by the U.S. party 
for purposes of both U.S. and foreign tax law. See Sec.  1.901-
2(e)(5)(iv)(B)(4). This revision is intended to ensure that the foreign 
tax benefit condition is not satisfied in cases where the U.S. and 
foreign investors claim only those tax benefits that are consistent 
with their respective investments in the arrangement and their 
interests are treated as equity and owned by the same persons in both 
jurisdictions.
    One comment also recommended that dual citizens or U.S. residents, 
who are generally subject to U.S. tax on their worldwide income, should 
not be treated as counterparties because any reduction in foreign tax 
liability will result in a corresponding increase in U.S. tax. The IRS 
and the Treasury Department agree with this comment and have modified 
the final regulations to reflect this change.
    One comment also recommended that individuals who are family 
members of a U.S. party not be treated as counterparties. The IRS and 
the Treasury Department disagree with the comment. The exception from 
the counterparty condition for certain U.S.-controlled foreign 
counterparties is based on the premise that the foreign tax benefit 
available to such a counterparty confers only a timing benefit that 
will reverse when the counterparty repatriates its earnings to the 
United States. Because such timing benefits are not the focus of these 
regulations, the 2007 proposed regulations and 2008 temporary 
regulations excluded certain foreign persons owned by the U.S. party or 
by certain United States persons who also own the U.S. party. In 
contrast, where an individual is related to a U.S.

[[Page 42042]]

party but is not a United States person for U.S. tax purposes, the 
reduction in foreign tax liability obtained by such individual does not 
result in a corresponding increase in U.S. tax. Accordingly, the final 
regulations do not include an exclusion for such individuals.
    One comment recommended that individuals receiving stock in 
connection with the performance of services should not be treated as 
counterparties. The tax policy concerns of the IRS and the Treasury 
Department regarding structured transactions addressed by these 
regulations exist regardless of the means by which a person acquires 
its interest in an SPV. The presence of a duplicative tax benefit is no 
less problematic because its recipient acquired its interest in an SPV 
in return for services instead of capital. Accordingly, this 
recommendation was not adopted.
    One comment recommended that in cases where one U.S. party owns 
more than 80 percent of a counterparty but another U.S. party does not, 
the regulations should treat a foreign payment as noncompulsory only to 
the extent of the unrelated U.S. party's share of the foreign payment. 
This comment was not adopted. These regulations are intended to 
disallow foreign tax credits claimed in connection with structured 
passive investment arrangements. The tax policy concerns of the IRS and 
the Treasury Department regarding such abusive transactions remain the 
same regardless of whether the arrangement satisfies the six conditions 
of the regulations with respect to one U.S. party or multiple U.S. 
parties.
    One comment recommended that the final regulations adopt the de 
minimis rule set forth in the 2007 proposed regulations that requires a 
counterparty to own a certain percentage of the equity or assets of the 
SPV. In contrast, as explained in the preamble to the 2008 temporary 
regulations, the 2008 temporary regulations focus on whether there is a 
duplicative foreign tax benefit. The IRS and the Treasury Department 
continue to believe that focusing on a threshold amount of duplicative 
tax benefits is more consistent with the concerns underlying the 
regulations. Accordingly, this comment is not adopted.
    Another comment recommended that the percentage of U.S. ownership 
required to exclude a person from being treated as a counterparty be 
reduced from the 2008 temporary regulations' threshold of more than 80 
percent. The comment recommended that the threshold be reduced to 
either 80 percent or more, or 75 percent or more. The IRS and the 
Treasury Department do not believe that the proposal is consistent with 
the policy concerns addressed by these final regulations. Accordingly, 
this comment is not adopted.
H. Section 1.901-2(e)(5)(iv)(B)(6): Inconsistent Treatment
    The IRS and the Treasury Department also received several comments 
with respect to the sixth condition of the 2008 temporary regulations 
(the ``inconsistent treatment condition''). The inconsistent treatment 
condition requires that the United States and an applicable foreign 
country treat the arrangement inconsistently under their respective tax 
systems and that the U.S. treatment results in either materially less 
income or a materially greater amount of foreign tax credits than would 
be available if the foreign law controlled the U.S. tax treatment. This 
condition is intended to limit the disallowance of credits to those 
arrangements that exploit inconsistencies in U.S. and foreign law to 
secure a foreign tax credit benefit.
    A comment recommended that the final regulations adopt an 
additional requirement that the foreign tax benefit obtained by the 
counterparty be materially less if the U.S. tax treatment controlled 
for foreign tax purposes as well. The recommendation is intended to 
require that both the U.S. party's share of the foreign payments and 
the foreign tax benefit arise from the inconsistent treatment. The IRS 
and the Treasury Department believe that the foreign tax benefit 
condition of the 2008 temporary regulations is sufficient to ensure 
that the foreign tax benefit corresponds to or duplicates the U.S. 
party's share of the foreign payments or the foreign base and that such 
duplication is sufficiently indicative of inconsistency. Therefore, the 
IRS and the Treasury Department believe that any additional requirement 
under the inconsistent treatment condition is unnecessary, and the 
comment was not adopted.
    These final regulations clarify the application of the inconsistent 
treatment condition in cases where multiple U.S. parties exist. Where 
an arrangement involves multiple U.S. parties, the inconsistent 
treatment condition is satisfied only if the amount of income 
attributable to the SPV that is recognized for U.S. tax purposes by the 
SPV and all the U.S. parties (and persons related to the U.S. party or 
parties) is materially less than the amount of income that would be 
recognized if the foreign tax treatment controlled for U.S. tax 
purposes or if the amount of foreign tax credits claimed by all U.S. 
parties is materially greater than it would be if the foreign tax 
treatment controlled for U.S. tax purposes.
I. Examples
    These final regulations provide two new examples to illustrate 
changes that were adopted in the final regulations. Example 8 
illustrates the application of the holding company exception when there 
is more than one U.S. party or more than one counterparty. Example 12 
illustrates the application of the revised foreign tax benefit 
condition to a tiered holding company structure. Modifications to 
examples in the 2008 temporary regulations were also made to reflect 
comments received and other changes to the regulations.
J. Miscellaneous Amendments
    These final regulations adopt with minor changes amendments made by 
the 2008 temporary regulations to Sec.  1.901-1(a) and (b) to reflect 
statutory changes made by the Foreign Investors Tax Act of 1966 (Pub. 
L. 89-809 (80 Stat. 1539), section 106(b)), the Tax Reform Act of 1976 
(Pub. L. 94-455 (90 Stat. 1520), section 1901(a)(114)), and the 
American Jobs Creation Act of 2004 (Pub. L. 108-357 (118 Stat. 1418-
20), section 405(b)).
K. Effective Date
    These final regulations generally apply to payments that, if such 
payments were an amount of tax paid, would be considered paid or 
accrued on or after July 17, 2011.
    The IRS and the Treasury Department will continue to closely 
scrutinize other arrangements that are not covered by the regulations 
but produce inappropriate foreign tax credit results. Such arrangements 
may include arrangements that are similar to arrangements described in 
the final regulations, but that do not meet all of the conditions 
included in the final regulations. The IRS will continue to challenge 
the claimed U.S. tax results in appropriate cases, including under 
judicial doctrines. The IRS and the Treasury Department may also issue 
additional regulations in the future to address such other 
arrangements.

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 is hereby 
certified that these regulations will not have a significant economic 
impact on a substantial number of small

[[Page 42043]]

entities. This certification is based on the fact that these 
regulations will primarily affect affiliated groups of corporations 
that have foreign operations which tend to be larger businesses. 
Moreover the number of taxpayers affected and the average burden are 
minimal. Therefore, a Regulatory Flexibility Analysis is not required. 
Pursuant to section 7805(f) of the Code, the notice of proposed 
rulemaking preceding this regulation was submitted to the Chief Counsel 
for Advocacy of the Small Business Administration for comment on its 
impact on small business.

Drafting Information

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

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

    Accordingly, 26 CFR part 1 is amended as follows:

PART 1--INCOME TAXES

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

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


0
Par. 2. Section 1.901-1 is amended by revising paragraphs (a) and (b), 
and adding a second sentence in paragraph (j) to read as follows:


Sec.  1.901-1  Allowance of credit for taxes.

    (a) In general. Citizens of the United States, domestic 
corporations, and certain aliens resident in the United States or 
Puerto Rico may choose to claim a credit, as provided in section 901, 
against the tax imposed by chapter 1 of the Internal Revenue Code 
(Code) for taxes paid or accrued to foreign countries and possessions 
of the United States, subject to the conditions prescribed in 
paragraphs (a)(1) through (a)(3) and paragraph (b) of this section.
    (1) Citizen of the United States. A citizen of the United States, 
whether resident or nonresident, may claim a credit for--
    (i) The amount of any income, war profits, and excess profits taxes 
paid or accrued during the taxable year to any foreign country or to 
any possession of the United States; and
    (ii) His share of any such taxes of a partnership of which he is a 
member, or of an estate or trust of which he is a beneficiary.
    (2) Domestic corporation. A domestic corporation may claim a credit 
for--
    (i) The amount of any income, war profits, and excess profits taxes 
paid or accrued during the taxable year to any foreign country or to 
any possession of the United States;
    (ii) Its share of any such taxes of a partnership of which it is a 
member, or of an estate or trust of which it is a beneficiary; and
    (iii) The taxes deemed to have been paid under section 902 or 960.
    (3) Alien resident of the United States or Puerto Rico. Except as 
provided in a Presidential proclamation described in section 901(c), an 
alien resident of the United States, or an alien individual who is a 
bona fide resident of Puerto Rico during the entire taxable year, may 
claim a credit for--
    (i) The amount of any income, war profits, and excess profits taxes 
paid or accrued during the taxable year to any foreign country or to 
any possession of the United States; and
    (ii) His distributive share of any such taxes of a partnership of 
which he is a member, or of an estate or trust of which he is a 
beneficiary.
    (b) Limitations. Certain Code sections, including sections 814, 
901(e) through (m), 904, 906, 907, 908, 909, 911, 999, and 6038, limit 
the credit against the tax imposed by chapter 1 of the Code for certain 
foreign taxes.
* * * * *
    (j) Effective/applicability date. * * * Paragraphs (a) and (b) of 
this section apply to taxable years ending after July 13, 2011.


Sec.  1.901-1T  [Removed]

0
Par. 3. Section 1.901-1T is removed.

0
Par. 4. Section 1.901-2 is amended by removing and reserving paragraph 
(e)(5)(iii), revising paragraph (e)(5)(iv), and revising paragraph 
(h)(2) to read as follows:


Sec.  1.901-2  Income, war profits, or excess profits tax paid or 
accrued.

* * * * *
    (e) * * *
    (5) * * *
    (iii) [Reserved].
    (iv) Structured passive investment arrangements--(A) In general. 
Notwithstanding paragraph (e)(5)(i) of this section, an amount paid to 
a foreign country (a ``foreign payment'') is not a compulsory payment, 
and thus is not an amount of tax paid, if the foreign payment is 
attributable (within the meaning of paragraph (e)(5)(iv)(B)(1)(ii) of 
this section) to a structured passive investment arrangement (as 
described in paragraph (e)(5)(iv)(B) of this section).
    (B) Conditions. An arrangement is a structured passive investment 
arrangement if all of the following conditions are satisfied:
    (1) Special purpose vehicle (SPV). An entity that is part of the 
arrangement meets the following requirements:
    (i) Substantially all of the gross income (for U.S. tax purposes) 
of the entity, if any, is passive investment income, and substantially 
all of the assets of the entity are assets held to produce such passive 
investment income.
    (ii) There is a foreign payment attributable to income of the 
entity (as determined under the laws of the foreign country to which 
such foreign payment is made), including the entity's share of income 
of a lower-tier entity that is a branch or pass-through entity under 
the laws of such foreign country, that, if the foreign payment were an 
amount of tax paid, would be paid or accrued in a U.S. taxable year in 
which the entity meets the requirements of paragraph 
(e)(5)(iv)(B)(1)(i) of this section. A foreign payment attributable to 
income of an entity includes a foreign payment attributable to income 
that is required to be taken into account by an owner of the entity, if 
the entity is a branch or pass-through entity under the laws of such 
foreign country.
    (2) U.S. party. A person would be eligible to claim a credit under 
section 901(a) (including a credit for foreign taxes deemed paid under 
section 902 or 960) for all or a portion of the foreign payment 
described in paragraph (e)(5)(iv)(B)(1)(ii) of this section if the 
foreign payment were an amount of tax paid.
    (3) Direct investment. The U.S. party's proportionate share of the 
foreign payment or payments described in paragraph (e)(5)(iv)(B)(1)(ii) 
of this section is (or is expected to be) substantially greater than 
the amount of credits, if any, that the U.S. party reasonably would 
expect to be eligible to claim under section 901(a) for foreign taxes 
attributable to income generated by the U.S. party's proportionate 
share of the assets owned by the SPV if the U.S. party directly owned 
such assets. For this purpose, direct ownership shall not include 
ownership through a branch, a permanent establishment or any other 
arrangement (such as an agency arrangement or dual resident status) 
that would result in the income generated by the U.S. party's 
proportionate share of the assets being subject to tax on a net basis 
in the foreign country to which the payment is made. A U.S. party's 
proportionate

[[Page 42044]]

share of the assets of the SPV shall be determined by reference to such 
U.S. party's proportionate share of the total value of all of the 
outstanding interests in the SPV that are held by its equity owners and 
creditors. A U.S. party's proportionate share of the assets of the SPV, 
however, shall not include any assets that produce income subject to 
gross basis withholding tax.
    (4) Foreign tax benefit. The arrangement is reasonably expected to 
result in a credit, deduction, loss, exemption, exclusion or other tax 
benefit under the laws of a foreign country that is available to a 
counterparty or to a person that is related to the counterparty 
(determined under the principles of paragraph (e)(5)(iv)(C)(7) of this 
section by applying the tax laws of a foreign country in which the 
counterparty is subject to tax on a net basis). However, a foreign tax 
benefit in the form of a credit is described in this paragraph 
(e)(5)(iv)(B)(4) only if the amount of any such credit corresponds to 
10 percent or more of the amount of the U.S. party's share (for U.S. 
tax purposes) of the foreign payment referred to in paragraph 
(e)(5)(iv)(B)(1)(ii) of this section. In addition, a foreign tax 
benefit in the form of a deduction, loss, exemption, exclusion or other 
tax benefit is described in this paragraph (e)(5)(iv)(B)(4) only if 
such amount corresponds to 10 percent or more of the foreign base with 
respect to which the U.S. party's share (for U.S. tax purposes) of the 
foreign payment is imposed. For purposes of the preceding two 
sentences, if an arrangement involves more than one U.S. party or more 
than one counterparty or both, the aggregate amount of foreign tax 
benefits available to all of the counterparties and persons related to 
such counterparties is compared to the aggregate amount of all of the 
U.S. parties' shares of the foreign payment or foreign base, as the 
case may be. Where a U.S. party indirectly owns interests in an SPV 
that are treated as equity interests for both U.S. and foreign tax 
purposes, a foreign tax benefit available to a foreign entity in the 
chain of ownership that begins with the SPV and ends with the first-
tier entity in the chain does not correspond to the U.S. party's share 
of the foreign payment attributable to income of the SPV to the extent 
that such benefit relates to earnings of the SPV that are distributed 
with respect to equity interests in the SPV that are owned directly or 
indirectly by the U.S. party for purposes of both U.S. and foreign tax 
law.
    (5) Counterparty. The arrangement involves a counterparty. A 
counterparty is a person that, under the tax laws of a foreign country 
in which the person is subject to tax on the basis of place of 
management, place of incorporation or similar criterion or otherwise 
subject to a net basis tax, directly or indirectly owns or acquires 
equity interests in, or assets of, the SPV. However, a counterparty 
does not include the SPV or a person with respect to which for U.S. tax 
purposes the same domestic corporation, U.S. citizen or resident alien 
individual directly or indirectly owns more than 80 percent of the 
total value of the stock (or equity interests) of each of the U.S. 
party and such person. A counterparty also does not include a person 
with respect to which for U.S. tax purposes the U.S. party directly or 
indirectly owns more than 80 percent of the total value of the stock 
(or equity interests), but only if the U.S. party is a domestic 
corporation, a U.S. citizen or a resident alien individual. In 
addition, a counterparty does not include an individual who is a U.S. 
citizen or resident alien.
    (6) Inconsistent treatment. The United States and an applicable 
foreign country treat one or more of the aspects of the arrangement 
listed in paragraph (e)(5)(iv)(B)(6)(i) through (e)(5)(iv)(B)(6)(iv) of 
this section differently under their respective tax systems, and for 
one or more tax years when the arrangement is in effect one or both of 
the following two conditions applies; either the amount of income 
attributable to the SPV that is recognized for U.S. tax purposes by the 
SPV, the U.S. party or parties, and persons related to a U.S. party or 
parties is materially less than the amount of income that would be 
recognized if the foreign tax treatment controlled for U.S. tax 
purposes; or the amount of credits claimed by the U.S. party or parties 
(if the foreign payment described in paragraph (e)(5)(iv)(B)(1)(ii) of 
this section were an amount of tax paid) is materially greater than it 
would be if the foreign tax treatment controlled for U.S. tax purposes:
    (i) The classification of the SPV (or an entity that has a direct 
or indirect ownership interest in the SPV) as a corporation or other 
entity subject to an entity-level tax, a partnership or other flow-
through entity or an entity that is disregarded for tax purposes.
    (ii) The characterization as debt, equity or an instrument that is 
disregarded for tax purposes of an instrument issued by the SPV (or an 
entity that has a direct or indirect ownership interest in the SPV) to 
a U.S. party, a counterparty or a person related to a U.S. party or a 
counterparty.
    (iii) The proportion of the equity of the SPV (or an entity that 
directly or indirectly owns the SPV) that is considered to be owned 
directly or indirectly by a U.S. party and a counterparty.
    (iv) The amount of taxable income that is attributable to the SPV 
for one or more tax years during which the arrangement is in effect.
    (C) Definitions. The following definitions apply for purposes of 
paragraph (e)(5)(iv) of this section.
    (1) Applicable foreign country. An applicable foreign country means 
each foreign country to which a foreign payment described in paragraph 
(e)(5)(iv)(B)(1)(ii) of this section is made or which confers a foreign 
tax benefit described in paragraph (e)(5)(iv)(B)(4) of this section.
    (2) Counterparty. The term counterparty means a person described in 
paragraph (e)(5)(iv)(B)(5) of this section.
    (3) Entity. The term entity includes a corporation, trust, 
partnership or disregarded entity described in Sec.  301.7701-
2(c)(2)(i).
    (4) Indirect ownership. Indirect ownership of stock or another 
equity interest (such as an interest in a partnership) shall be 
determined in accordance with the principles of section 958(a)(2), 
regardless of whether the interest is owned by a U.S. or foreign 
entity.
    (5) Passive investment income--(i) In general. The term passive 
investment income means income described in section 954(c), as modified 
by this paragraph (e)(5)(iv)(C)(5)(i) and paragraph 
(e)(5)(iv)(C)(5)(ii) of this section. In determining whether income is 
described in section 954(c), paragraphs (c)(1)(H), (c)(3), and (c)(6) 
of that section shall be disregarded. Sections 954(c), 954(h), and 
954(i) shall be applied at the entity level as if the entity (as 
defined in paragraph (e)(5)(iv)(C)(3) of this section) were a 
controlled foreign corporation (as defined in section 957(a)). For 
purposes of determining if sections 954(h) and 954(i) apply for 
purposes of this paragraph (e)(5)(iv)(C)(5)(i) and paragraph 
(e)(5)(iv)(C)(5)(ii) of this section, any income of an entity 
attributable to transactions that, assuming the entity is an SPV, are 
with a person that is a counterparty, or with persons that are related 
to a counterparty within the meaning of paragraph (e)(5)(iv)(B)(4) of 
this section, shall not be treated as qualified banking or financing 
income or as qualified insurance income, and shall not be taken into 
account in applying sections 954(h) and 954(i) for purposes of 
determining whether other income of the entity is excluded from section

[[Page 42045]]

954(c)(1) under section 954(h) or 954(i), but only if any such person 
(or a person that is related to such person within the meaning of 
paragraph (e)(5)(iv)(B)(4) of this section) is eligible for a foreign 
tax benefit described in paragraph (e)(5)(iv)(B)(4) of this section. In 
addition, in applying section 954(h) for purposes of this paragraph 
(e)(5)(iv)(C)(5)(i) and paragraph (e)(5)(iv)(C)(5)(ii) of this section, 
section 954(h)(3)(E) shall not apply, section 954(h)(2)(A)(ii) shall be 
satisfied only if the entity conducts substantial activity with respect 
to its business through its own employees, and the term ``any foreign 
country'' shall be substituted for ``home country'' wherever it appears 
in section 954(h).
    (ii) Income attributable to lower-tier entities; holding company 
exception. Income of an upper-tier entity that is attributable to an 
equity interest in a lower-tier entity, including dividends, an 
allocable share of partnership income, and income attributable to the 
ownership of an interest in an entity that is disregarded as an entity 
separate from its owner is passive investment income unless 
substantially all of the upper-tier entity's assets consist of 
qualified equity interests in one or more lower-tier entities, each of 
which is engaged in the active conduct of a trade or business and 
derives more than 50 percent of its gross income from such trade or 
business, and substantially all of the upper-tier entity's opportunity 
for gain and risk of loss with respect to each such interest in a 
lower-tier entity is shared by the U.S. party (or persons that are 
related to a U.S. party) and, assuming the entity is an SPV, a 
counterparty (or persons that are related to a counterparty) (``holding 
company exception''). If an arrangement involves more than one U.S. 
party or more than one counterparty or both, then substantially all of 
the upper-tier entity's opportunity for gain and risk of loss with 
respect to its interest in any lower-tier entity must be shared 
(directly or indirectly) by one or more U.S. parties (or persons 
related to such U.S. parties) and, assuming the upper-tier entity is an 
SPV, one or more counterparties (or persons related to such 
counterparties). Substantially all of the upper-tier entity's 
opportunity for gain and risk of loss with respect to its interest in 
any lower-tier entity is not shared if the opportunity for gain and 
risk of loss is borne (directly or indirectly) by one or more U.S. 
parties (or persons related to such U.S. party or parties) or, assuming 
the upper-tier entity is an SPV, by one or more counterparties (or 
persons related to such counterparty or counterparties). Whether and 
the extent to which a person is considered to share in an upper-tier 
entity's opportunity for gain and risk of loss is determined based on 
all the facts and circumstances, provided, however, that a person does 
not share in an upper-tier entity's opportunity for gain and risk of 
loss if its equity interest in the upper-tier entity was acquired in a 
sale-repurchase transaction or if its interest is treated as debt for 
U.S. tax purposes. If a U.S. party owns an interest in an entity 
indirectly through a chain of entities, the application of the holding 
company exception begins with the lowest-tier entity in the chain that 
may satisfy the holding company exception and proceeds upward; 
provided, however, that the opportunity for gain and risk of loss borne 
by any upper-tier entity in the chain that is a counterparty shall be 
disregarded to the extent borne indirectly by a U.S. party. An upper-
tier entity that satisfies the holding company exception is itself 
considered to be engaged in the active conduct of a trade or business 
and to derive more than 50 percent of its gross income from such trade 
or business for purposes of applying the holding company exception to 
the owners of such entity. A lower-tier entity that is engaged in a 
banking, financing, or similar business shall not be considered to be 
engaged in the active conduct of a trade or business unless the income 
derived by such entity would be excluded from section 954(c)(1) under 
section 954(h) or 954(i) as modified by paragraph (e)(5)(iv)(C)(5)(i) 
of this section.
    (6) Qualified equity interest. With respect to an interest in a 
corporation, the term qualified equity interest means stock 
representing 10 percent or more of the total combined voting power of 
all classes of stock entitled to vote and 10 percent or more of the 
total value of the stock of the corporation or disregarded entity, but 
does not include any preferred stock (as defined in section 351(g)(3)). 
Similar rules shall apply to determine whether an interest in an entity 
other than a corporation is a qualified equity interest.
    (7) Related person. Two persons are related if--
    (i) One person directly or indirectly owns stock (or an equity 
interest) possessing more than 50 percent of the total value of the 
other person; or
    (ii) The same person directly or indirectly owns stock (or an 
equity interest) possessing more than 50 percent of the total value of 
both persons.
    (8) Special purpose vehicle (SPV). The term SPV means the entity 
described in paragraph (e)(5)(iv)(B)(1) of this section.
    (9) U.S. party. The term U.S. party means a person described in 
paragraph (e)(5)(iv)(B)(2) of this section.
    (D) Examples. The following examples illustrate the rules of 
paragraph (e)(5)(iv) of this section. No inference is intended as to 
whether a taxpayer would be eligible to claim a credit under section 
901(a) if a foreign payment were an amount of tax paid. The examples 
set forth below do not limit the application of other principles of 
existing law to determine the proper tax consequences of the structures 
or transactions addressed in the regulations.

    Example 1. U.S. borrower transaction. (i) Facts. A domestic 
corporation (USP) forms a country M corporation (Newco), 
contributing $1.5 billion in exchange for 100% of the stock of 
Newco. Newco, in turn, loans the $1.5 billion to a second country M 
corporation (FSub) wholly owned by USP. USP then sells its entire 
interest in Newco to a country M corporation (FP) for the original 
purchase price of $1.5 billion, subject to an obligation to 
repurchase the interest in five years for $1.5 billion. The sale has 
the effect of transferring ownership of the Newco stock to FP for 
country M tax purposes. Assume the sale-repurchase transaction is 
structured in a way that qualifies as a collateralized loan for U.S. 
tax purposes. Therefore, USP remains the owner of the Newco stock 
for U.S. tax purposes. In year 1, FSub pays Newco $120 million of 
interest. Newco pays $36 million to country M with respect to such 
interest income and distributes the remaining $84 million to FP. 
Under country M law, the $84 million distribution is excluded from 
FP's income. None of FP's stock is owned, directly or indirectly, by 
USP or any shareholders of USP that are domestic corporations, U.S. 
citizens, or resident alien individuals. Under an income tax treaty 
between country M and the United States, country M does not impose 
country M tax on interest received by U.S. residents from sources in 
country M.
    (ii) Result. The $36 million payment by Newco to country M is 
not a compulsory payment, and thus is not an amount of tax paid 
because the foreign payment is attributable to a structured passive 
investment arrangement. First, Newco is an SPV because all of 
Newco's income is passive investment income described in paragraph 
(e)(5)(iv)(C)(5) of this section; Newco's only asset, a note, is 
held to produce such income; the payment to country M is 
attributable to such income; and if the payment were an amount of 
tax paid it would be paid or accrued in a U.S. taxable year in which 
Newco meets the requirements of paragraph (e)(5)(iv)(B)(1)(i) of 
this section. Second, if the foreign payment were treated as an 
amount of tax paid, USP would be deemed to pay the foreign payment 
under section 902(a) and, therefore, would be eligible to claim a 
credit for such payment under section 901(a). Third, USP would not 
pay any

[[Page 42046]]

country M tax if it directly owned Newco's loan receivable. Fourth, 
the distribution from Newco to FP is exempt from tax under country M 
law, and the exempt amount corresponds to more than 10% of the 
foreign base with respect to which USP's share (which is 100% under 
U.S. tax law) of the foreign payment was imposed. Fifth, FP is a 
counterparty because FP owns stock of Newco under country M law and 
none of FP's stock is owned by USP or shareholders of USP that are 
domestic corporations, U.S. citizens, or resident alien individuals. 
Sixth, FP is the owner of 100% of Newco's stock for country M tax 
purposes, while USP is the owner of 100% of Newco's stock for U.S. 
tax purposes, and the amount of credits claimed by USP if the 
payment to country M were an amount of tax paid is materially 
greater than it would be if country M tax treatment controlled for 
U.S. tax purposes such that FP, rather than USP, owned 100% of 
Newco's stock. Because the payment to country M is not an amount of 
tax paid, USP is not deemed to pay any country M tax under section 
902(a). USP has dividend income of $84 million and also has interest 
expense of $84 million. FSub's post-1986 undistributed earnings are 
reduced by $120 million of interest expense.
    Example 2.  U.S. borrower transaction. (i) Facts. The facts are 
the same as in Example 1, except that FSub is a wholly-owned 
subsidiary of Newco. In addition, assume FSub is engaged in the 
active conduct of manufacturing and selling widgets and derives more 
than 50% of its gross income from such business.
    (ii) Result. The results are the same as in Example 1. Although 
Newco wholly owns FSub, which is engaged in the active conduct of 
manufacturing and selling widgets and derives more than 50% of its 
income from such business, Newco's income that is attributable to 
Newco's equity interest in FSub is passive investment income because 
the sale-repurchase transaction limits FP's interest in Newco and 
its assets to that of a creditor, so that substantially all of 
Newco's opportunity for gain and risk of loss with respect to its 
stock in FSub is borne by USP. See paragraph (e)(5)(iv)(C)(5)(ii) of 
this section. Accordingly, Newco's stock in FSub is held to produce 
passive investment income. Thus, Newco is an SPV because all of 
Newco's income is passive investment income described in paragraph 
(e)(5)(iv)(C)(5) of this section, Newco's assets are held to produce 
such income, the payment to country M is attributable to such 
income, and if the payment were an amount of tax paid it would be 
paid or accrued in a U.S. taxable year in which Newco meets the 
requirements of paragraph (e)(5)(iv)(B)(1)(i) of this section.
    Example 3. U.S. borrower transaction. (i) Facts. (A) A domestic 
corporation (USP) loans $750 million to its wholly-owned domestic 
subsidiary (Sub). USP and Sub form a country M partnership 
(Partnership) to which each contributes $750 million. Partnership 
loans all of its $1.5 billion of capital to Issuer, a wholly-owned 
country M affiliate of USP, in exchange for a note and coupons 
providing for the payment of interest at a fixed rate over a five-
year term. Partnership sells all of the coupons to Coupon Purchaser, 
a country N partnership owned by a country M corporation (Foreign 
Bank) and a wholly-owned country M subsidiary of Foreign Bank, for 
$300 million. At the time of the coupon sale, the fair market value 
of the coupons sold is $290 million and, pursuant to section 
1286(b)(3), Partnership's basis allocated to the coupons sold is 
$290 million. Several months later and prior to any interest 
payments on the note, Foreign Bank and its subsidiary sell all of 
their interests in Coupon Purchaser to an unrelated country O 
corporation for $280 million. None of Foreign Bank's stock or its 
subsidiary's stock is owned, directly or indirectly, by USP or Sub 
or by any shareholders of USP or Sub that are domestic corporations, 
U.S. citizens, or resident alien individuals.
    (B) Assume that both the United States and country M respect the 
sale of the coupons for tax law purposes. In the year of the coupon 
sale, for country M tax purposes USP's and Sub's shares of 
Partnership's profits total $300 million, a payment of $60 million 
to country M is made with respect to those profits, and Foreign Bank 
and its subsidiary, as partners of Coupon Purchaser, are entitled to 
deduct the $300 million purchase price of the coupons from their 
taxable income. For U.S. tax purposes, USP and Sub recognize their 
distributive shares of the $10 million premium income and claim a 
direct foreign tax credit for their shares of the $60 million 
payment to country M. Country M imposes no additional tax when 
Foreign Bank and its subsidiary sell their interests in Coupon 
Purchaser. Country M also does not impose country M tax on interest 
received by U.S. residents from sources in country M.
    (ii) Result. The payment to country M is not a compulsory 
payment, and thus is not an amount of tax paid, because the foreign 
payment is attributable to a structured passive investment 
arrangement. First, Partnership is an SPV because all of 
Partnership's income is passive investment income described in 
paragraph (e)(5)(iv)(C)(5) of this section; Partnership's only 
asset, Issuer's note, is held to produce such income; the payment to 
country M is attributable to such income; and if the payment were an 
amount of tax paid, it would be paid or accrued in a U.S. taxable 
year in which Partnership meets the requirements of paragraph 
(e)(5)(iv)(B)(1)(i) of this section. Second, if the foreign payment 
were an amount of tax paid, USP and Sub would be eligible to claim a 
credit for such payment under section 901(a). Third, USP and Sub 
would not pay any country M tax if they directly owned Issuer's 
note. Fourth, for country M tax purposes, Foreign Bank and its 
subsidiary deduct the $300 million purchase price of the coupons and 
are exempt from country M tax on the $280 million received upon the 
sale of Coupon Purchaser, and the deduction and exemption correspond 
to more than 10% of the $300 million base with respect to which 
USP's and Sub's 100% share of the foreign payments was imposed. 
Fifth, Foreign Bank and its subsidiary are counterparties because 
they indirectly acquired assets of Partnership, the interest coupons 
on Issuer's note, and are not directly or indirectly owned by USP or 
Sub or shareholders of USP or Sub that are domestic corporations, 
U.S. citizens, or resident alien individuals. Sixth, the amount of 
taxable income of Partnership for one or more years is different for 
U.S. and country M tax purposes, and the amount of income 
attributable to USP and Sub for U.S. tax purposes is materially less 
than the amount of income they would recognize if the country M tax 
treatment of the coupon sale controlled for U.S. tax purposes. 
Because the payment to country M is not an amount of tax paid, USP 
and Sub are not considered to pay tax under section 901. USP and Sub 
have income of $10 million in the year of the coupon sale.
    Example 4. Active business; no SPV. (i) Facts. A, a domestic 
corporation, wholly owns B, a country X corporation engaged in the 
manufacture and sale of widgets. On January 1, year 1, C, also a 
country X corporation, loans $400 million to B in exchange for an 
instrument that is debt for U.S. tax purposes and equity in B for 
country X tax purposes. As a result, C is considered to own stock of 
B for country X tax purposes. B loans $55 million to D, a country Y 
corporation wholly owned by A. In year 1, B has $166 million of net 
income attributable to its sales of widgets and $3.3 million of 
interest income attributable to the loan to D. Substantially all of 
B's assets are used in its widget business. Country Y does not 
impose tax on interest paid to nonresidents. B makes a payment of 
$50.8 million to country X with respect to B's net income. Country X 
does not impose tax on dividend payments between country X 
corporations. None of C's stock is owned, directly or indirectly, by 
A or by any shareholders of A that are domestic corporations, U.S. 
citizens, or resident alien individuals.
    (ii) Result. B is not an SPV within the meaning of paragraph 
(e)(5)(iv)(B)(1) of this section because the amount of interest 
income received from D does not constitute substantially all of B's 
income and the $55 million note from D does not constitute 
substantially all of B's assets. Accordingly, the $50.8 million 
payment to country X is not attributable to a structured passive 
investment arrangement.
    Example 5. U.S. lender transaction. (i) Facts. (A) A country X 
corporation (Foreign Bank) contributes $2 billion to a newly-formed 
country X company (Newco) in exchange for 90% of the common stock of 
Newco and securities that are treated as debt of Newco for U.S. tax 
purposes and preferred stock of Newco for country X tax purposes. A 
domestic corporation (USP) contributes $1 billion to Newco in 
exchange for 10% of Newco's common stock and securities that are 
treated as preferred stock of Newco for U.S. tax purposes and debt 
of Newco for country X tax purposes. Newco loans the $3 billion to a 
wholly-owned, country X subsidiary of Foreign Bank (FSub) in return 
for a $3 billion, seven-year note paying interest currently. The 
Newco securities held by USP entitle the holder to fixed 
distributions of $4 million per year, and the Newco securities held 
by Foreign Bank entitle the holder to receive $82 million per year, 
payable only on maturity of the $3 billion FSub note in year 7. At 
the end of

[[Page 42047]]

year 5, pursuant to a prearranged plan, Foreign Bank acquires USP's 
Newco stock and securities for a prearranged price of $1 billion. 
Country X does not impose tax on dividends received by one country X 
corporation from a second country X corporation. Under an income tax 
treaty between country X and the United States, country X does not 
impose country X tax on interest received by U.S. residents from 
sources in country X. None of Foreign Bank's stock is owned, 
directly or indirectly, by USP or any shareholders of USP that are 
domestic corporations, U.S. citizens, or resident alien individuals.
    (B) In each of years 1 through 7, FSub pays Newco $124 million 
of interest on the $3 billion note. Newco distributes $4 million to 
USP in each of years 1 through 5. The distributions are deductible 
for country X tax purposes, and Newco pays country X $36 million 
with respect to $120 million of taxable income from the FSub note in 
each year. For U.S. tax purposes, in each year Newco's post-1986 
undistributed earnings are increased by $124 million of interest 
income and reduced by accrued interest expense with respect to the 
Newco securities held by Foreign Bank.
    (ii) Result. The $36 million payment to country X is not a 
compulsory payment, and thus is not an amount of tax paid, because 
the foreign payment is attributable to a structured passive 
investment arrangement. First, Newco is an SPV because all of 
Newco's income is passive investment income described in paragraph 
(e)(5)(iv)(C)(5) of this section; Newco's only asset, a note of 
FSub, is held to produce such income; the payment to country X is 
attributable to such income; and if the payment were an amount of 
tax paid it would be paid or accrued in a U.S. taxable year in which 
Newco meets the requirements of paragraph (e)(5)(iv)(B)(1)(i) of 
this section. Second, if the foreign payment were an amount of tax 
paid, USP would be deemed to pay its pro rata share of the foreign 
payment under section 902(a) in each of years 1 through 5 and, 
therefore, would be eligible to claim a credit under section 901(a). 
Third, USP would not pay any country X tax if it directly owned its 
proportionate share of Newco's assets, a note of FSub. Fourth, for 
country X tax purposes, Foreign Bank is eligible to receive a tax-
free distribution of $82 million attributable to each of years 1 
through 5, and that amount corresponds to more than 10% of the 
foreign base with respect to which USP's share of the foreign 
payment was imposed. Fifth, Foreign Bank is a counterparty because 
it owns stock of Newco for country X tax purposes and none of 
Foreign Bank's stock is owned, directly or indirectly, by USP or 
shareholders of USP that are domestic corporations, U.S. citizens, 
or resident alien individuals. Sixth, the United States and country 
X treat various aspects of the arrangement differently, including 
whether the Newco securities held by Foreign Bank and USP are debt 
or equity. The amount of credits claimed by USP if the payment to 
country X were an amount of tax paid is materially greater than it 
would be if the country X tax treatment controlled for U.S. tax 
purposes such that the securities held by USP were treated as debt 
or the securities held by Foreign Bank were treated as equity, and 
the amount of income recognized by Newco for U.S. tax purposes is 
materially less than the amount of income recognized for country X 
tax purposes. Because the payment to country X is not an amount of 
tax paid, USP is not deemed to pay any country X tax under section 
902(a). USP has dividend income of $4 million in each of years 1 
through 5.
    Example 6. Holding company; no SPV. (i) Facts. A, a country X 
corporation, and B, a domestic corporation, each contribute $1 
billion to a newly-formed country X entity (C) in exchange for 50% 
of the common stock of C. C is treated as a corporation for country 
X purposes and a partnership for U.S. tax purposes. C contributes 
$1.95 billion to a newly-formed country X corporation (D) in 
exchange for 100% of D's common stock. C loans its remaining $50 
million to D. Accordingly, C's sole assets are stock and debt of D. 
D uses the entire $2 billion to engage in the business of 
manufacturing and selling widgets. In year 1, D derives $300 million 
of income from its widget business and derives $2 million of 
interest income. Also in year 1, C has dividend income of $200 
million and interest income of $3.2 million with respect to its 
investment in D. Country X does not impose tax on dividends received 
by one country X corporation from a second country X corporation. C 
makes a payment of $960,000 to country X with respect to C's net 
income.
    (ii) Result. C qualifies for the holding company exception 
described in paragraph (e)(5)(iv)(C)(5)(ii) of this section because 
C holds a qualified equity interest in D, D is engaged in an active 
trade or business and derives more than 50% of its gross income from 
such trade or business, C's interest in D constitutes substantially 
all of C's assets, and A and B share in substantially all of C's 
opportunity for gain and risk of loss with respect to D. As a 
result, C's dividend income from D is not passive investment income 
and C's stock in D is not held to produce such income. Accordingly, 
C is not an SPV within the meaning of paragraph (e)(5)(iv)(B)(1) of 
this section, and the $960,000 payment to country X is not 
attributable to a structured passive investment arrangement.
    Example 7. Holding company; no SPV. (i) Facts. The facts are the 
same as in Example 6, except that instead of loaning $50 million to 
D, C contributes the $50 million to E in exchange for 10% of the 
stock of E. E is a country Y corporation that is not engaged in the 
active conduct of a trade or business. Also in year 1, D pays no 
dividends to C, E pays $3.2 million in dividends to C, and C makes a 
payment of $960,000 to country X with respect to C's net income.
    (ii) Result. C qualifies for the holding company exception 
described in paragraph (e)(5)(iv)(C)(5)(ii) of this section because 
C holds a qualified equity interest in D, D is engaged in an active 
trade or business and derives more than 50% of its gross income from 
such trade or business, C's interest in D constitutes substantially 
all of C's assets, and A and B share in substantially all of C's 
opportunity for gain and risk of loss with respect to D. As a 
result, less than substantially all of C's assets are held to 
produce passive investment income. Accordingly, C is not an SPV 
because it does not meet the requirements of paragraph 
(e)(5)(iv)(B)(1) of this section, and the $960,000 payment to 
country X is not attributable to a structured passive investment 
arrangement.
    Example 8. Holding company; no SPV. (i) Facts. The facts are the 
same as in Example 6, except that B's $1 billion investment in C 
consists of 30% of C's common stock and 100% of C's preferred stock. 
A's $1 billion investment in C consists of 70% of C's common stock. 
B sells its preferred stock to F, a country X corporation, subject 
to a repurchase obligation. Assume that under country X tax law, but 
not U.S. tax law, F is treated as the owner of the preferred shares 
and receives a distribution in year 1 of $50 million. The remaining 
earnings are distributed 70% to A and 30% to B.
    (ii) Result. C qualifies for the holding company exception 
described in paragraph (e)(5)(iv)(C)(5)(ii) of this section because 
C holds a qualified equity interest in D, D is engaged in an active 
trade or business and derives more than 50% of its gross income from 
such trade or business, and C's interest in D constitutes 
substantially all of C's assets. Additionally, although F does not 
share in C's opportunity for gain and risk of loss with respect to 
C's interest in D because F acquired its interest in C in a sale-
repurchase transaction, B (the U.S. party) and in the aggregate A 
and F (who would be counterparties assuming C were an SPV) share in 
substantially all of C's opportunity for gain and risk of loss with 
respect to D and such opportunity for gain and risk of loss is not 
borne exclusively either by B or by A and F in the aggregate. 
Accordingly, C's shares in D are not held to produce passive 
investment income and the $200 million dividend from D is not 
passive investment income. C is not an SPV within the meaning of 
paragraph (e)(5)(iv)(B)(1) of this section, and the $960,000 payment 
to country X is not attributable to a structured passive investment 
arrangement.
    Example 9. Asset holding transaction. (i) Facts. (A) A domestic 
corporation (USP) contributes $6 billion of country Z debt 
obligations to a country Z entity (DE) in exchange for all of the 
class A and class B stock of DE. DE is a disregarded entity for U.S. 
tax purposes and a corporation for country Z tax purposes. A 
corporation unrelated to USP and organized in country Z (FC) 
contributes $1.5 billion to DE in exchange for all of the class C 
stock of DE. DE uses the $1.5 billion contributed by FC to redeem 
USP's class B stock. The terms of the class C stock entitle its 
holder to all income from DE, but FC is obligated immediately to 
contribute back to DE all distributions on the class C stock. USP 
and FC enter into--
    (1) A contract under which USP agrees to buy after five years 
the class C stock for $1.5 billion; and
    (2) An agreement under which USP agrees to pay FC periodic 
payments on $1.5 billion.
    (B) The transaction is structured in such a way that, for U.S. 
tax purposes, there is a loan of $1.5 billion from FC to USP, and 
USP is the owner of the class C stock and the class A stock. In year 
1, DE earns $400 million of

[[Page 42048]]

interest income on the country Z debt obligations. DE makes a 
payment to country Z of $100 million with respect to such income and 
distributes the remaining $300 million to FC. FC contributes the 
$300 million back to DE. None of FC's stock is owned, directly or 
indirectly, by USP or shareholders of USP that are domestic 
corporations, U.S. citizens, or resident alien individuals. Assume 
that country Z imposes a withholding tax on interest income derived 
by U.S. residents.
    (C) Country Z treats FC as the owner of the class C stock. 
Pursuant to country Z tax law, FC is required to report the $400 
million of income with respect to the $300 million distribution from 
DE, but is allowed to claim credits for DE's $100 million payment to 
country Z. For country Z tax purposes, FC is entitled to current 
deductions equal to the $300 million contributed back to DE.
    (ii) Result. The payment to country Z is not a compulsory 
payment, and thus is not an amount of tax paid because the payment 
is attributable to a structured passive investment arrangement. 
First, DE is an SPV because all of DE's income is passive investment 
income described in paragraph (e)(5)(iv)(C)(5) of this section; all 
of DE's assets are held to produce such income; the payment to 
country Z is attributable to such income; and if the payment were an 
amount of tax paid it would be paid or accrued in a U.S. taxable 
year in which DE meets the requirements of paragraph 
(e)(5)(iv)(B)(1)(i) of this section. Second, if the payment were an 
amount of tax paid, USP would be eligible to claim a credit for such 
amount under section 901(a). Third, USP's proportionate share of 
DE's foreign payment of $100 million is substantially greater than 
the amount of credits USP would be eligible to claim if it directly 
held its proportionate share of DE's assets, excluding any assets 
that would produce income subject to gross basis withholding tax if 
directly held by USP. Fourth, FC is entitled to claim a credit under 
country Z tax law for the payment and recognizes a deduction for the 
$300 million contributed to DE under country Z law. The credit 
claimed by FC corresponds to more than 10% of USP's share (for U.S. 
tax purposes) of the foreign payment and the deductions claimed by 
FC correspond to more than 10% of the base with respect to which 
USP's share of the foreign payment was imposed. Fifth, FC is a 
counterparty because FC is considered to own equity of DE under 
country Z law and none of FC's stock is owned, directly or 
indirectly, by USP or shareholders of USP that are domestic 
corporations, U.S. citizens, or resident alien individuals. Sixth, 
the United States and country X treat certain aspects of the 
transaction differently, including the proportion of equity owned in 
DE by USP and FC, and the amount of credits claimed by USP if the 
country Z payment were an amount of tax paid is materially greater 
than it would be if the country X tax treatment controlled for U.S. 
tax purposes such that FC, rather than USP, owned the class C stock. 
Because the payment to country Z is not an amount of tax paid, USP 
is not considered to pay tax under section 901. USP has $400 million 
of interest income.
    Example 10. Loss surrender. (i) Facts. The facts are the same as 
in Example 9, except that the deductions attributable to the 
arrangement contribute to a loss recognized by FC for country Z tax 
purposes, and pursuant to a group relief regime in country Z FC 
elects to surrender the loss to its country Z subsidiary.
    (ii) Result. The results are the same as in Example 9. The 
surrender of the loss to a related party is a foreign tax benefit 
that corresponds to the base with respect to which USP's share of 
the foreign payment was imposed.
    Example 11. Joint venture; no foreign tax benefit. (i) Facts. 
FC, a country X corporation, and USC, a domestic corporation, each 
contribute $1 billion to a newly-formed country X entity (C) in 
exchange for stock of C. FC and USC are entitled to equal 50% shares 
of all of C's income, gain, expense and loss. C is treated as a 
corporation for country X purposes and a partnership for U.S. tax 
purposes. In year 1, C earns $200 million of net passive investment 
income, makes a payment to country X of $60 million with respect to 
that income, and distributes $70 million to each of FC and USC. 
Country X does not impose tax on dividends received by one country X 
corporation from a second country X corporation.
    (ii) Result. FC's tax-exempt receipt of $70 million, or its 50% 
share of C's profits, is not a foreign tax benefit within the 
meaning of paragraph (e)(5)(iv)(B)(4) of this section because it 
does not correspond to any part of the foreign base with respect to 
which USC's share of the foreign payment was imposed. Accordingly, 
the $60 million payment to country X is not attributable to a 
structured passive investment arrangement.
    Example 12. Joint venture; no foreign tax benefit. (i) Facts. 
The facts are the same as in Example 11, except that C in turn 
contributes $2 billion to a wholly-owned and newly-formed country X 
entity (D) in exchange for stock of D. D is treated as a corporation 
for country X purposes and disregarded as an entity separate from 
its owner for U.S. tax purposes. C has no other assets and earns no 
other income. In year 1, D earns $200 million of passive investment 
income, makes a payment to country X of $60 million with respect to 
that income, and distributes $140 million to C.
    (ii) Result. C's tax-exempt receipt of $140 million is not a 
foreign tax benefit within the meaning of paragraph (e)(5)(iv)(B)(4) 
of this section because it does not correspond to any part of the 
foreign base with respect to which USC's share of the foreign 
payment was imposed. Fifty percent of C's foreign tax exemption is 
not a foreign tax benefit within the meaning of paragraph 
(e)(5)(iv)(B)(4) because it relates to earnings of D that are 
distributed with respect to an equity interest in D that is owned 
indirectly by USC under both U.S. and foreign tax law. The remaining 
50% of C's foreign tax exemption, as well as FC's tax-exempt receipt 
of $70 million from C, is also not a foreign tax benefit because it 
does not correspond to any part of the foreign base with respect to 
which USC's share of the foreign payment was imposed. Accordingly, 
the $60 million payment to country X is not attributable to a 
structured passive investment arrangement.
* * * * *
    (h) * * *
    (2) Paragraph (e)(5)(iv) of this section applies to foreign 
payments that, if such payments were an amount of tax paid, would be 
considered paid or accrued under Sec.  1.901-2(f) on or after July 13, 
2011. See 26 CFR 1.901-2T(e)(5)(iv) (revised as of April 1, 2011), for 
rules applicable to foreign payments that, if such payments were an 
amount of tax paid, would be considered paid or accrued before July 13, 
2011.


Sec.  1.901-2T  [Removed]

0
Par. 5. Section 1.901-2T is removed.


Steven T. Miller,
Deputy Commissioner for Services and Enforcement.
    Approved: July 11, 2011.
Emily S. McMahon,
Acting Assistant Secretary of the Treasury (Tax Policy).
[FR Doc. 2011-17920 Filed 7-13-11; 11:15 am]
BILLING CODE 4830-01-P