[Federal Register Volume 85, Number 68 (Wednesday, April 8, 2020)]
[Rules and Regulations]
[Pages 19802-19857]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2020-05924]



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Vol. 85

Wednesday,

No. 68

April 8, 2020

Part II





 Department of the Treasury





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 Internal Revenue Service





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26 CFR Parts 1 and 301





Rules Regarding Certain Hybrid Arrangements; Final Rule

  Federal Register / Vol. 85, No. 68 / Wednesday, April 8, 2020 / Rules 
and Regulations  

[[Page 19802]]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Parts 1 and 301

[TD 9896]
RIN 1545-BO53


Rules Regarding Certain Hybrid Arrangements

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

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SUMMARY: This document contains final regulations providing guidance 
regarding hybrid dividends and certain amounts paid or accrued pursuant 
to hybrid arrangements, which generally involve arrangements whereby 
U.S. and foreign tax law classify a transaction or entity differently 
for tax purposes. This document also contains final regulations 
relating to dual consolidated losses and entity classifications to 
prevent the same deduction from being claimed under the tax laws of 
both the United States and a foreign jurisdiction. Finally, this 
document contains final regulations regarding information reporting to 
facilitate the administration of certain rules in the final 
regulations. The final regulations affect taxpayers that would 
otherwise claim a deduction related to such amounts and certain 
shareholders of foreign corporations that pay or receive hybrid 
dividends.

DATES: 
    Effective date: These regulations are effective on April 8, 2020.
    Applicability dates: For dates of applicability, see Sec. Sec.  
1.245A(e)-1(h), 1.267A-7, 1.1503(d)-8(b), 1.6038-2(m), 1.6038-3(l), 
1.6038A-2(g), and 301.7701-3(c).

FOR FURTHER INFORMATION CONTACT: Tracy Villecco at (202) 317-6933 or 
Tianlin (Laura) Shi at (202) 317-6936 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Background

    Sections 245A(e) and 267A were added to the Internal Revenue Code 
(``Code'') by the Tax Cuts and Jobs Act, Public Law 115-97 (2017) (the 
``Act''), which was enacted on December 22, 2017. On December 28, 2018, 
the Department of the Treasury (``Treasury Department'') and the IRS 
published proposed regulations (REG-104352-18) under sections 245A(e), 
267A, 1503(d), 6038, 6038A, 6038C, and 7701 in the Federal Register (83 
FR 67612) (the ``proposed regulations''). Terms used but not defined in 
this preamble have the meaning provided in the final regulations.
    A public hearing on the proposed regulations was scheduled for 
March 20, 2019, but it was not held because no speaker outlines were 
submitted to the IRS by the due date for submission, March 15, 2019. 
The Treasury Department and the IRS received written comments with 
respect to the proposed regulations. Comments received outside the 
scope of this rulemaking are generally not addressed but may be 
considered in connection with future regulations. All written comments 
received in response to the proposed regulations are available at 
www.regulations.gov or upon request.

Summary of Comments and Explanation of Revisions

I. Overview

    The final regulations retain the basic approach and structure of 
the proposed regulations, with certain revisions. This Summary of 
Comments and Explanation of Revisions section discusses the revisions 
as well as comments received in response to the solicitation of 
comments in the proposed regulations.

II. Comments and Revisions to Proposed Sec.  1.245A(e)-1--Special Rules 
for Hybrid Dividends

A. Background

    Section 245A(e) and the proposed regulations neutralize the double 
non-taxation effects of a hybrid dividend or tiered hybrid dividend 
through either denying the section 245A(a) dividends received deduction 
with respect to the dividend or requiring an inclusion under section 
951(a)(1)(A) (``subpart F inclusion'') with respect to the dividend, 
depending on whether the shareholder receiving the dividend is a 
domestic corporation or a controlled foreign corporation (``CFC''). The 
proposed regulations require that certain shareholders of a CFC 
maintain a hybrid deduction account with respect to each share of stock 
of the CFC that the shareholder owns, and provide that a dividend 
received by the shareholder from the CFC is a hybrid dividend or tiered 
hybrid dividend to the extent of the sum of those accounts.
    A hybrid deduction account with respect to a share of stock of a 
CFC reflects the amount of hybrid deductions of the CFC that have been 
allocated to the share. In general, a hybrid deduction is a deduction 
or other tax benefit allowed to a CFC (or a related person) under a 
relevant foreign tax law for an amount paid, accrued, or distributed 
with respect to an instrument of the CFC that is stock for U.S. tax 
purposes.

B. Hybrid Deductions

1. Current Use of Deduction or Other Tax Benefit
    One comment requested that for a deduction or other tax benefit 
allowed under a relevant foreign tax law to be a hybrid deduction, it 
must be used currently under the relevant foreign tax law and, thus, 
currently reduce foreign tax liability. The comment noted that a 
current use might not occur if, for example, the CFC has other 
deductions or losses under the relevant foreign tax law, or all of a 
CFC's income is exempt income (for example, if the CFC is a holding 
company and all of its income benefits from a 100 percent participation 
exemption). The comment asserted that absent a current use of a 
deduction, double non-taxation does not occur.
    The Treasury Department and the IRS have determined that it would 
not be appropriate for a deduction or other tax benefit to be a hybrid 
deduction only to the extent it is used currently. Even though a 
deduction or other tax benefit may not be used currently, it could be 
used in another taxable period--for example, as a result of a net 
operating loss carrying over to a subsequent taxable year--and thus 
could produce double non-taxation. In addition, it could be complex or 
burdensome to determine whether a deduction or other tax benefit is 
used currently (because it could, for example, require a factual 
analysis of how particular deductions offset items of gross income 
under the relevant foreign tax law) and then, to the extent not used 
currently, track the deduction or other tax benefit so that it is added 
to a hybrid deduction account only once it is in fact used. 
Accordingly, the final regulations do not adopt the comment, and the 
regulations clarify that a deduction or other tax benefit may be a 
hybrid deduction regardless of whether it is used currently under the 
relevant foreign tax law. See Sec.  1.245A(e)-1(d)(2).
2. Coordination With Foreign Disallowance Rules
i. Thin Capitalization and Other Rules
    A comment requested that a deduction or other tax benefit not be a 
hybrid deduction if under the relevant foreign tax law the deduction or 
other tax benefit is disallowed under a thin capitalization rule or a 
rule similar to section 163(j). Similar to the comment discussed in 
part II.B.1 of this Summary of Comments and Explanation of Revisions 
section, the comment asserted

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that such a disallowed deduction or other tax benefit does not produce 
double non-taxation.
    The final regulations do not adopt the comment for reasons similar 
to those discussed in part II.B.1 of this Summary of Comments and 
Explanation of Revisions section. For example, a thin capitalization 
rule or a rule similar to section 163(j) may suspend rather than 
disallow a deduction, and thus may not prevent eventual double non-
taxation. Moreover, because a thin capitalization rule or a rule 
similar to section 163(j) generally applies to all otherwise allowable 
deductions, it would be unduly complex and burdensome to determine the 
extent to which an amount disallowed under such a rule relates to a 
particular otherwise allowable deduction. Accordingly, the final 
regulations do not adopt the comment, and the regulations clarify that 
the determination of whether a deduction or other tax benefit is 
allowed is made without regard to a rule that disallows or suspends 
deductions if a certain ratio or percentage is exceeded. See Sec.  
1.245A(e)-1(d)(2)(ii)(A).
ii. Foreign Hybrid Mismatch Rules
    The proposed regulations do not provide rules to take into account 
the application of foreign hybrid mismatch rules--that is, hybrid 
mismatch rules under the relevant foreign tax law. Accordingly, if such 
hybrid mismatch rules deny a deduction to neutralize a deduction/no-
inclusion (``D/NI'') outcome, then, because the deduction is not 
allowed under the relevant foreign tax law, the deduction cannot be a 
hybrid deduction under the proposed regulations.
    The Treasury Department and the IRS have concluded that, in certain 
cases, whether a deduction or other tax benefit is a hybrid deduction 
should be determined without regard to foreign hybrid mismatch rules 
(and thus without regard to whether such rules disallow the deduction). 
The determination should be made in this manner in cases in which there 
is a close temporal connection between the amount giving rise to the 
deduction or other tax benefit and the payment of the amount as a 
dividend for U.S. tax purposes. In these cases, in order to prevent a 
D/NI outcome, the participation exemption under section 245A(a) should 
not apply to the dividend, as opposed to the participation exemption 
applying to the dividend to the extent that the foreign hybrid mismatch 
rules disallow a deduction for the amount in order to neutralize a D/NI 
outcome.
    This approach more closely aligns the rules of section 245A(e) with 
the approach set forth in the OECD/G20 report, Neutralising the Effects 
of Hybrid Mismatch Arrangements, Action 2: 2015 Final Report (the 
``Hybrid Mismatch Report''). Such an approach avoids potential 
circularity or other issues in cases in which the application of 
foreign hybrid mismatch rules depends on whether an amount will be 
included in income under U.S. tax law. See Hybrid Mismatch Report, 
para. 35 and Ex. 2.3. In addition, this approach is consistent with an 
approach suggested in a comment (which was received before the proposed 
regulations were issued but after the proposed regulations had been 
substantially developed) with respect to section 245A generally.
    Accordingly, the final regulations provide that the determination 
of whether a relevant foreign tax law allows a deduction or other tax 
benefit for an amount is made without regard to the application of 
foreign hybrid mismatch rules, provided that the amount gives rise to a 
dividend for U.S. tax purposes or is reasonably expected for U.S. tax 
purposes to give rise to a dividend that will be paid within 12 months 
after the taxable period in which the deduction or other tax benefit 
would otherwise be allowed. See Sec.  1.245A(e)-1(d)(2)(ii)(B).
    As an example, assume that but for foreign hybrid mismatch rules, a 
CFC would be allowed a deduction under the relevant foreign tax law for 
an amount paid or accrued pursuant to an instrument issued by the CFC 
and treated as stock for U.S. tax purposes. If the amount is an actual 
payment that gives rise to a dividend for U.S. tax purposes (or the 
amount is an accrual but is reasonably expected to give rise to a 
dividend for U.S. tax purposes that will be paid within 12 months after 
the taxable period for which the deduction would otherwise be allowed), 
then the amount generally gives rise to a hybrid deduction regardless 
of whether the foreign hybrid mismatch rules may disallow a deduction 
for the amount. If, on the other hand, the amount would give rise to a 
dividend in a later period, then the amount would not give rise to a 
hybrid deduction to the extent that the foreign hybrid mismatch rules 
disallow a deduction for the amount.
3. Effect of Withholding Taxes
    Under the proposed regulations, the determination of whether a 
deduction or other tax benefit is a hybrid deduction is generally made 
without regard to whether the amount is subject to withholding tax 
under the relevant foreign tax law. But see proposed Sec.  1.245A(e)-
1(g)(2), Example 2 (illustrating that withholding taxes imposed 
pursuant to an integration or imputation system may prevent a deduction 
or other tax benefit from being a hybrid deduction). A comment asserted 
that, to prevent double-taxation, a deduction or other tax benefit 
under a relevant foreign tax law should not be a hybrid deduction to 
the extent the amount giving rise to the deduction or other tax benefit 
is subject to withholding tax under such tax law.
    The purpose of withholding taxes generally is not to address 
mismatches in tax outcomes, but rather to allow the source jurisdiction 
to retain its right to tax the payment. For example, in many cases 
withholding taxes are imposed on payments not giving rise to D/NI 
concerns, such as nondeductible dividends. In addition, had Congress 
generally intended for withholding taxes to be taken into account for 
purposes of section 245A(e), it could have included in section 245A(e) 
a rule similar to the one in section 59A(c)(2)(B), which was enacted at 
the same time as section 245A(e). Thus, the Treasury Department and the 
IRS have concluded that withholding taxes generally should not be 
viewed as neutralizing a D/NI outcome. In addition, generally taking 
withholding taxes into account for purposes of determining whether a 
deductible amount gives rise to a hybrid deduction could raise 
administrability issues if the amount is subject to withholding taxes 
at the time of payment (with the result that the amount is not added to 
a hybrid deduction account at that time) but the taxes are refunded in 
a later period; in these cases it could be difficult or burdensome to 
retroactively add the amount to the hybrid deduction account and make 
corresponding adjustments. Accordingly, the final regulations do not 
adopt this comment. See also part II.B.5 of this Summary of Comments 
and Explanation of Revisions section (deductions or other tax benefits 
pursuant to imputation systems or other regimes intended to relieve 
double-taxation).
4. Deductions With Respect to Equity
    The proposed regulations provide that a hybrid deduction includes a 
deduction with respect to equity, such as a notional interest deduction 
(``NID''). See proposed Sec.  1.245A(e)-1(d)(2)(i)(B). The preamble to 
the proposed regulations explains that NIDs are hybrid deductions 
because they raise concerns similar to those raised by traditional 
hybrid instruments.
    Several comments asserted that NIDs should not be hybrid deductions

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because NIDs do not involve sufficient hybridity so as to be within the 
intended scope of section 245A(e). These comments noted that NIDs are 
generally available tax concessions that reflect tax policy decisions, 
and that NIDs are typically allowed without regard to dividend 
distributions, if any. Another comment asserted that because NIDs are 
the equivalent of a lower tax rate on profits, any policy concerns with 
NIDs are appropriately addressed by the global intangible low-taxed 
income regime (``GILTI'') under section 951A. Other comments raised 
concerns that treating NIDs as hybrid deductions departs from the 
Hybrid Mismatch Report (and thus the approaches taken by other 
countries to implement the Report) and, as a result, could impair the 
competiveness of U.S. multinational groups.
    As an alternative to not treating NIDs as hybrid deductions, some 
comments suggested other approaches. For example, a comment suggested 
that the final regulations reserve on whether NIDs are hybrid 
deductions so that, to the extent NIDs are viewed as providing 
inappropriate results, NIDs can be addressed on a multilateral basis. 
Other comments suggested that only NIDs resulting from an actual 
payment, accrual, or distribution should constitute hybrid deductions. 
Lastly, comments suggested that the final regulations treat NIDs as 
hybrid deductions on a delayed basis, or only if the NIDs are allowed 
with respect to an instrument issued after a certain date, to allow 
taxpayers to restructure certain instruments or undertake other 
restructurings.
    The Treasury Department and the IRS have concluded that NIDs should 
be hybrid deductions, without regard to whether NIDs result from an 
actual payment, accrual, or distribution. First, because NIDs offset 
income but generally do not give rise to a corresponding income 
inclusion, NIDs produce double non-taxation, and such double non-
taxation can occur regardless of whether NIDs result from an actual 
payment, accrual, or distribution. Second, the double non-taxation 
resulting from NIDs is in general a result of a mismatch in how 
different tax laws view an instrument of a CFC; that is, the relevant 
foreign tax law views the instrument as generating amounts similar to 
interest--to minimize the disparate treatment of debt and equity--and, 
were the tax law of the United States (the investor jurisdiction of the 
CFC) to similarly view the instrument as generating amounts treated as 
interest, there would generally be a corresponding income inclusion in 
the United States. Such double non-taxation resulting from the mismatch 
in the treatment of an instrument is the fundamental policy concern 
underlying section 245A(e). Moreover, including NIDs in the definition 
of a hybrid deduction is consistent with the broad language of section 
245A(e)(4)(B), which refers to any ``deduction (or other tax 
benefit).''
    Thus, the final regulations generally retain the approach of the 
proposed regulations and treat NIDs as hybrid deductions. However, in 
response to comments, the final regulations provide that only NIDs 
allowed to a CFC for taxable years beginning on or after December 20, 
2018, are hybrid deductions. See Sec.  1.245A(e)-1(d)(2)(iv). The 
Treasury Department and the IRS have determined that this delay 
(relative to the proposed regulations) is appropriate in order to 
account for restructurings intended to eliminate or minimize hybridity.
5. Deductions Pursuant to Imputation Systems or Other Regimes Intended 
To Relieve Double-Taxation
    In the case of a deduction or other tax benefit relating to or 
resulting from a distribution by a CFC with respect to an instrument 
treated as stock for purposes of a relevant foreign tax law, a special 
rule under the proposed regulations provides that the deduction or 
other tax benefit is a hybrid deduction only to the extent that it has 
the effect of causing the earnings that funded the distribution to not 
be included in income or otherwise subject to tax under such tax law. 
See proposed Sec.  1.245A(e)-1(d)(2)(i)(B). As noted in the preamble to 
the proposed regulations, this special rule ensures that deductions or 
other tax benefits allowed pursuant to certain integration or 
imputation systems, including through systems implemented in part 
through the imposition of withholding taxes, do not constitute hybrid 
deductions.
    The final regulations clarify the operation of this special rule. 
First, the final regulations clarify that the special rule only applies 
to deductions or other tax benefits relating to or resulting from a 
distribution by the CFC that is a dividend for purposes of the relevant 
foreign tax law. See Sec.  1.245A(e)-1(d)(2)(i)(B). Thus, for example, 
the special rule does not apply to NIDs as to which withholding tax is 
imposed under the relevant foreign tax law, because the imposition of 
withholding tax in these cases is not pursuant to an integration or 
imputation system (as such systems generally only apply to dividends) 
and, instead, may be imposed to provide parity between NIDs and an 
actual interest payment. Second, the final regulations clarify that the 
imposition of withholding tax pursuant to an integration or imputation 
system can reduce or eliminate the extent to which dividends paid 
deductions (as well as other similar tax benefits) give rise to a 
hybrid deduction. See id.; see also Sec.  1.245A(e)-1(g)(2), Example 2, 
alt. facts (imposition of withholding tax at a rate less than the tax 
rate at the which dividends paid deduction is allowed only prevents a 
portion of the deduction from being a hybrid deduction). Lastly, the 
final regulations clarify that, as a result of the special rule, 
dividends received deductions allowed pursuant to regimes intended to 
relieve double-taxation within a group do not constitute hybrid 
deductions. See Sec.  1.245A(e)-1(d)(2)(i)(B).
6. Deductions or Other Tax Benefits Allowed to a Person Related to the 
CFC
    Under the proposed regulations, a hybrid deduction of a CFC 
includes certain deductions or other tax benefits allowed under a 
relevant foreign tax law to a person related to the CFC (such as a 
shareholder of the CFC). See proposed Sec.  1.245A(e)-1(d)(2). The 
proposed regulations provide that relatedness is determined by 
reference to the rules of section 954(d)(3) (defining a related person 
based on ownership of more than 50 percent of interests in entities). 
See proposed Sec.  1.245A(e)-1(f)(4).
    A comment asserted that, although in certain cases it may be 
appropriate to treat a deduction or other tax benefit allowed to a 
related person as a hybrid deduction, the related person rule raises 
issues, including compliance issues, because it could be burdensome to 
determine whether any person related to a CFC receives certain 
deductions or other tax benefits. Accordingly, the comment recommended 
that the rule be narrowed in certain respects. For example, the comment 
suggested increasing the threshold for relatedness to 80 percent, 
including because such a threshold would be consistent with certain 
other areas of the Code such as the provisions involving consolidated 
groups. In addition, the comment suggested that a deduction or other 
tax benefit allowed to a related person be a hybrid deduction only if 
criteria in addition to those in the proposed regulations are 
satisfied, such as if (i) treating the deduction or other tax benefit 
as a hybrid deduction does not result in double-counting, and (ii) the 
IRS affirmatively demonstrates that, absent treating the deduction or 
other tax benefit as a hybrid deduction, double non-taxation would 
occur. Lastly, the comment asserted that the

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related person rule could inappropriately treat as a hybrid deduction a 
dividends received deduction, an impairment loss deduction, or a 
market-to-market deduction allowed to a shareholder.
    The Treasury Department and the IRS have determined that, because a 
deduction or other tax benefit allowed to a person related to a CFC may 
be economically equivalent to the CFC having been allowed a deduction 
or other tax benefit, or may otherwise produce a D/NI outcome, the 
related person rule is necessary to carry out the purpose of section 
245A(e). The final regulations therefore retain this rule, including 
defining relatedness by reference to section 954(d)(3), a well-
established standard applicable to controlled foreign corporations and 
consistent with section 267A, which similarly addresses hybrid 
mismatches. See section 267A(b)(2) (defining related person by 
reference to section 954(d)(3)). However, recently-issued final 
regulations under section 954(d)(3) narrow the definition of 
relatedness for section 954(d)(3) purposes by providing that 
relatedness is determined without regard to ``downward'' attribution. 
See TD 9883, 84 FR 63802. The Treasury Department and the IRS have 
determined that narrowing the definition of relatedness in this manner 
addresses the comment's concerns about potential burdens.
    In addition, the final regulations clarify that only deductions 
allowed under a relevant foreign tax law to a person related to a CFC 
may be hybrid deductions of the CFC; in general, a relevant foreign tax 
law is a foreign tax law under which the CFC is subject to tax. See 
Sec.  1.245A(e)-1(d)(2)(i) and (f)(5). Thus, for example, in the case 
of a CFC and a corporate shareholder of the CFC that are tax residents 
of different foreign countries, a dividends received deduction allowed 
to the corporate shareholder under its tax law for a dividend received 
from the CFC is not a hybrid deduction of the CFC.\1\
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    \1\ As an additional example, in the case of a CFC and a 
corporate shareholder of the CFC that are tax residents of different 
foreign countries, an exclusion (similar to the exclusion for 
previously taxed earnings and profits under section 959) allowed to 
the corporate shareholder under its tax law upon a distribution by 
the CFC of earnings and profits previously taxed under such tax law 
by reason of an anti-deferral regime is not a hybrid deduction of 
the CFC.
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    The final regulations do not adopt the comment's suggestion to 
include additional criteria to the related person rule. The Treasury 
Department and the IRS have concluded that other aspects of the final 
regulations generally address the comment's double-counting concerns. 
See part II.B.5 (deductions or other tax benefits pursuant to 
imputation systems or other regimes intended to relieve double-
taxation) and part II.C.3 (discussing an anti-duplication rule) of this 
Summary of Comments and Explanation of Revisions section. In addition, 
the Treasury Department and the IRS have concluded that requiring the 
IRS to affirmatively demonstrate double non-taxation would impose an 
excessive burden on the IRS and raise significant administrability 
concerns, particularly because the taxpayer may have better access to 
information (including information regarding the application of foreign 
tax law) than the IRS.
    Lastly, the final regulations clarify that a hybrid deduction of a 
CFC does not include an impairment loss deduction or a mark-to-market 
deduction allowed to a shareholder of the CFC with respect to its stock 
of the CFC. This is because such deductions do not relate to or result 
from an amount paid, accrued, or distributed with respect to an 
instrument issued by the CFC, and are not deductions allowed to the CFC 
with respect to equity. See Sec.  1.245A(e)-1(d)(2)(i)(B).
7. Relevant Foreign Tax Law
    The proposed regulations define a relevant foreign tax law as, with 
respect to a CFC, any regime of any foreign country or possession of 
the United States that imposes an income, war profits, or excess 
profits tax with respect to income of the CFC, other than a foreign 
anti-deferral regime under which an owner of the CFC is liable to tax. 
See proposed Sec.  1.245A(e)-1(f). In some countries, however, income 
taxes imposed by a subnational authority of the country (for example, a 
state, province, or canton of the country) may constitute a significant 
portion of a tax resident's overall income tax burden in the country. 
Accordingly, the Treasury Department and the IRS have determined that, 
in cases in which subnational income taxes of a country are covered 
taxes under an income tax treaty between the country and the United 
States (and therefore are likely to represent a significant portion of 
the overall income tax paid in the country), the tax law of the 
subnational authority should be treated as a tax law of a foreign 
country for purposes of section 245A(e). Thus, under the final 
regulations, a relevant foreign tax law may include a tax law of a 
political subdivision or other local authority of a foreign country. 
See Sec.  1.245A(e)-1(f)(5).

C. Hybrid Deduction Accounts

1. Nexus Between Hybrid Dividends and Hybrid Deductions
    Under the proposed regulations, a dividend received by a United 
States shareholder (``U.S. shareholder'') from a CFC is generally a 
hybrid dividend to the extent of the sum of the U.S. shareholder's 
hybrid deduction accounts with respect to each share of stock of the 
CFC, even if the dividend is paid on a share that has not had any 
hybrid deductions allocated to it. See proposed Sec.  1.245A(e)-
1(b)(2). As explained in the preamble to the proposed regulations, this 
approach is intended to prevent the avoidance of the purposes of 
section 245A(e).
    One comment noted that the hybrid deduction account approach in the 
proposed regulations appropriately safeguards against certain abuse. 
However, the comment and others asserted that, at least in certain 
cases, the approach is overbroad and could lead to inappropriate 
results, including causing a dividend to be a hybrid dividend even 
though a hybrid deduction was not allowed for the amount to which the 
dividend is attributable but instead was allowed for another amount. 
The comments recommended alternative approaches.
    Under some alternatives, an exception or similar rule would provide 
that a dividend is not a hybrid dividend to the extent that the 
distributed earnings and profits are attributable to earnings and 
profits that did not benefit from a hybrid deduction, or to the extent 
that the transactions giving rise to the dividend did not give rise to 
a hybrid deduction. For example, in the case of a dividend paid by a 
lower-tier CFC to an upper-tier CFC pursuant to a non-hybrid 
instrument, followed by a dividend paid by the upper-tier CFC to a 
domestic corporation pursuant to a hybrid instrument, the dividend paid 
by the upper-tier CFC would not be a hybrid dividend to the extent it 
is composed of earnings and profits (i) attributable to earnings and 
profits of the lower-tier CFC, and (ii) not offset under the upper-tier 
CFC's tax law by the upper-tier CFC's hybrid deductions (which might 
occur, for example, if, by reason of a participation exemption, the 
upper-tier CFC excludes from income the dividend paid by the lower-tier 
CFC). Or, deemed dividends such as a dividend under section 1248(a), or 
a dividend arising as a result of a compensatory payment for the 
surrender of a loss pursuant to a foreign group relief or similar 
regime, generally would not be a hybrid dividend, as the transactions 
giving rise to such deemed dividends typically do

[[Page 19806]]

not give rise to a deduction or other tax benefit under a relevant 
foreign tax law.
    Under another alternative, the hybrid deduction account approach in 
the proposed regulations would not apply to an amount if there is a 
legal obligation to pay it within 36 months (and the parties reasonably 
expect it to be so paid). In these cases, the comment recommended that 
the amount simply be subject to section 245A(e) once paid, such that it 
would not affect a hybrid deduction account--that is, the account would 
neither be increased at the time a deduction for the amount is allowed, 
nor decreased at the time of payment.
    The Treasury Department and the IRS have concluded that the hybrid 
deduction account approach under the proposed regulations appropriately 
carries out the purposes of section 245A(e), and prevents the avoidance 
of section 245A(e), in an administrable manner. Alternative approaches, 
such as those suggested by the comments, could be difficult to 
administer or could lead to inappropriate results. For example, the 
approach under the proposed regulations obviates the need (as would be 
the case under some of the alternatives) for complex analyses or rules 
tracking which particular earnings and profits benefited from a hybrid 
deduction, and how those earnings and profits are distributed to 
particular shareholders. In addition, excepting certain types of 
dividends from section 245A(e) could defer, potentially long-term, the 
application of section 245A(e), as those dividends would reduce (or in 
some cases eliminate) the CFC's earnings and profits and thereby might 
cause a subsequent distribution pursuant to a hybrid instrument to be 
described in section 301(c)(2) or (3) (rather than giving rise to a 
dividend subject to section 245A(e)). Further, if a 36-month approach 
like the one suggested in the comment were to apply, then additional 
rules would be necessary to ensure that, upon certain subsequent 
transfers of stock of the CFC, the transferee appropriately applies 
section 245A(e) when an amount to which the hybrid deduction account 
approach did not apply is paid. Accordingly, the final regulations do 
not adopt these comments.
2. Reduction for Certain Amounts Included in Income by U.S. 
Shareholders
    Under the proposed regulations, a hybrid deduction account is 
reduced only to the extent that an amount in the account gives rise to 
a hybrid dividend or a tiered hybrid dividend. See proposed Sec.  
1.245A(e)-1(d). The preamble to the proposed regulations requests 
comments on whether hybrid deductions attributable to a subpart F 
inclusion or an amount included in income under section 951A (``GILTI 
inclusion amount'') should not increase a hybrid deduction account, or, 
alternatively, on whether a hybrid deduction account should be reduced 
by distributions of previously taxed earnings and profits, and the 
effect of any deemed paid foreign tax credits associated with such 
inclusions.
    In response to the comment request, some comments suggested that 
subpart F inclusions or GILTI inclusion amounts (or a distribution of 
previously taxed earnings and profits) provide a dollar-for-dollar 
reduction of a hybrid deduction account. However, another comment noted 
that a dollar-for-dollar reduction could give rise to inappropriate 
results because the inclusions may not be fully taxed in the United 
States, given foreign tax credits associated with the amounts or, in 
the case of a GILTI inclusion amount, the deduction under section 250. 
The comment thus suggested that, as part of the end-of-year adjustments 
to a hybrid deduction account, the account be reduced by certain 
subpart F inclusions or GILTI inclusion amounts with respect to that 
year, but only to the extent that such amounts are fully taxed in the 
United States (determined by accounting for foreign tax credits and the 
section 250 deduction). Another comment suggested that a hybrid 
deduction not be added to the hybrid deduction account to the extent 
that the deduction relates to an amount directly included in U.S. 
income (for example, under section 882). Finally, comments suggested 
that, to avoid double-taxation, a hybrid deduction account should also 
be reduced when an amount is included in a U.S. shareholder's gross 
income under sections 951(a)(1)(B) and 956 by reason of the application 
of section 245A(e) to the hypothetical distribution described in Sec.  
1.956-1(a)(2).
    Section 245A(e) is generally intended to ensure that to the extent 
earnings and profits of a CFC have not been subject to foreign tax as a 
result of certain hybrid arrangements, earnings and profits of the CFC 
of an equal amount will, once distributed as a dividend, be ``included 
in income'' in the United States (that is, taken into account in income 
and not offset by, for example, a deduction or credit particular to the 
inclusion). To the extent the earnings and profits are so included by 
other means (for example, as a subpart F inclusion or GILTI inclusion 
amount), with the result that the double non-taxation effects of the 
hybrid arrangement are neutralized, section 245A(e) need not apply to a 
corresponding amount of earnings and profits. Accordingly, in these 
cases, the Treasury Department and the IRS have determined that hybrid 
deduction accounts with respect to stock of the CFC--which are 
generally intended to represent earnings and profits of the CFC that 
have neither been subject to foreign tax nor yet included in income in 
the United States--should be reduced. A separate notice of proposed 
rulemaking published in the Proposed Rules section of this issue of the 
Federal Register (REG-106013-19) provides rules to this effect, which 
taxpayers may rely on before the regulations described therein are 
effective. These rules are consistent with the comment recommending 
that a hybrid deduction account be reduced by amounts included in gross 
income under sections 951(a)(1)(B) and 956, as well as the comment 
recommending an account be reduced by certain subpart F inclusions or 
GILTI inclusion amounts, to the extent fully taxed in the United 
States. The Treasury Department and the IRS have determined that it 
would be too complex to adjust hybrid deduction accounts based on the 
extent to which under a relevant foreign tax law a hybrid deduction 
offsets certain types of income (such as effectively connected income 
subject to tax under section 882), and thus the final regulations do 
not adopt the comment suggesting such an approach.
3. Rules Regarding Transfers of Stock
    Because hybrid deduction accounts are maintained with respect to 
stock of a CFC, the proposed regulations provide rules that take into 
account transfers of stock of a CFC, including transfers pursuant to 
certain nonrecognition exchanges and liquidations. See proposed Sec.  
1.245A(e)-1(d)(4). In general, and depending on the type of transaction 
pursuant to which the transfer occurs, the transferee succeeds to the 
transferor's hybrid deduction accounts with respect to the transferred 
stock, or hybrid deduction accounts with respect to the transferred 
stock are tacked onto successor or similar interests. However, if the 
stock is transferred to a person that is not required to maintain a 
hybrid deduction account, such as an individual or a foreign 
corporation that is not a CFC, the hybrid deduction account generally 
terminates.
    Although a comment noted that these rules generally provide for 
appropriate results, the comment (and others) recommended that the 
rules be modified to address certain issues involving transfers of 
stock. First, a comment

[[Page 19807]]

recommended that the rules address certain distributions of stock under 
section 355. The comment suggested that the balance of a hybrid 
deduction account with respect to stock of the distributing CFC be 
allocated to a hybrid deduction account with respect to stock of the 
controlled CFC in a manner similar to how basis in stock of the 
distributing CFC is allocated to stock of the controlled CFC under 
section 358. The Treasury Department and the IRS agree that allocation 
rules should apply with respect to certain section 355 distributions, 
but have concluded that the allocation should be consistent with how 
earnings and profits of the distributing CFC are allocated between the 
distributing CFC and the controlled CFC. The final regulations thus 
provide a rule to this effect. See Sec.  1.245A(e)-1(d)(4)(iii)(B)(4). 
This rule, like the other rules in Sec.  1.245A(e)-1(d)(4)(iii)(B) that 
adjust hybrid deduction accounts upon certain nonrecognition 
transactions, is in addition to the general rule of Sec.  1.245A(e)-
1(d)(4)(iii)(A), pursuant to which an acquirer of stock of a CFC 
generally succeeds to the transferor's hybrid deduction accounts with 
respect to the stock. Accordingly, if the section 355 distribution 
involves a pre-existing controlled CFC, the shareholder's hybrid 
deductions accounts with respect to the controlled CFC immediately 
after the distribution are generally equal to the sum of (i) the hybrid 
deduction accounts with respect to the controlled CFC to which the 
shareholder succeeds under the rules of Sec.  1.245A(e)-
1(d)(4)(iii)(A), and (ii) the portions of the hybrid deduction accounts 
with respect to the distributing CFC that are allocated to hybrid 
deduction accounts with respect to stock of the controlled CFC under 
Sec.  1.245A(e)-1(d)(4)(iii)(B)(4).
    Second, a comment suggested that the final regulations adopt an 
anti-duplication rule to address cases in which a liquidation of a 
lower-tier CFC into an upper-tier CFC would in effect result in a 
duplication of hybrid deductions. For example, the comment noted that 
if the upper-tier CFC and lower-tier CFC have issued ``mirror'' hybrid 
instruments, then hybrid deduction accounts with respect to shares of 
stock of the upper-tier CFC would already reflect amounts attributable 
to hybrid deductions of the lower-tier CFC, with the result that, upon 
the liquidation of the lower-tier CFC, it would not be appropriate to 
increase hybrid deduction accounts with respect to shares of stock of 
the upper-tier CFC by the hybrid deductions of the lower-tier CFC. The 
Treasury Department and the IRS agree with this comment. However, 
rather than addressing this duplication issue only in the context of 
transfers of stock of a CFC, the final regulations provide a general 
anti-duplication rule. See Sec.  1.245A(e)-1(d)(2)(iii). This rule 
generally ensures that when deductions or other tax benefits under a 
relevant foreign tax law are in effect duplicated at different tiers, 
the deductions or other tax benefits only give rise to a hybrid 
deduction of the higher-tier CFC. Thus, in the mirror hybrid instrument 
example, the deduction allowed to the upper-tier CFC, but not the 
deduction allowed to the lower-tier CFC, would be a hybrid deduction, 
provided that the deductions arise under the same relevant foreign tax 
law.
    Lastly, a comment requested clarification that, when a section 
338(g) election is made with respect to a CFC target, the shareholder 
of the new target does not succeed to a hybrid deduction account with 
respect to a share of stock of the old target. The comment asserted 
that such a result is appropriate because the old target is generally 
treated as transferring all of its assets to an unrelated person, and 
the new target is generally treated as acquiring all of its assets from 
an unrelated person. The Treasury Department and the IRS agree with 
this comment because, in general, the new target does not inherit any 
of the earnings and profits of the old target and, as a result, no 
distributions by the new target could represent a distribution of 
earnings and profits of the old target sheltered from foreign tax by 
reason of hybrid deductions incurred by the old target. Accordingly, 
the final regulations clarify that, in connection with an election 
under section 338(g), a hybrid deduction account with respect to stock 
of the old target generally does not carry over to stock of the new 
target. See Sec.  1.245A(e)-1(d)(4)(iii)(B)(5).
4. Mid-Year Transfers of Stock
    Under the proposed regulations, if there is a transfer of stock of 
a CFC during the CFC's taxable year, then the determinations and 
adjustments that would otherwise be made at the close of the CFC's 
taxable year are generally made at the close of the date of the 
transfer. See proposed Sec.  1.245A(e)-1(d)(5). A comment requested 
clarification regarding how, in such cases, a hybrid deduction account 
with respect to a share of stock of the CFC is adjusted on the date of 
transfer, and whether hybrid dividends and tiered hybrid dividends that 
arise during the post-transfer period affect such adjustments.
    In response to this comment, the final regulations provide 
additional rules that, in general, adjust the hybrid deduction account 
based on the number of days in the taxable year within the pre-transfer 
period to the total number of days in the taxable year. See Sec.  
1.245A(e)-1(d)(5). The rules also coordinate the end-of-the year 
adjustments and the adjustments that must be made on the transfer date. 
See Id.
5. Applicability Date
    The proposed regulations provide that proposed Sec.  1.245A(e)-1, 
including the hybrid deduction account rules, applies to distributions 
made after December 31, 2017. However, the preamble to the proposed 
regulations explains that if proposed Sec.  1.245A(e)-1 is finalized 
after June 22, 2019, then Sec.  1.245A(e)-1 will apply only to 
distributions made during taxable years ending on or after the date the 
proposed regulations were issued (December 20, 2018).
    Some comments requested that, given that the statutory language of 
section 245A(e) does not include the concept of an account, the hybrid 
deduction account rules apply on a prospective basis to provide 
taxpayers time to comply with the rules and to prevent harsh results. 
One comment suggested that the rules apply only to distributions made 
after the proposed regulations were issued, and another suggested that 
the rules apply only to distributions made after December 31, 2018.
    The final regulations provide that the hybrid deduction account 
rules apply to distributions made after December 31, 2017, provided 
that such distributions occur during taxable years ending on or after 
the date the proposed regulations were issued. See Sec.  1.245A(e)-
1(h)(1). The Treasury Department and the IRS have determined that it 
would not be appropriate to delay the applicability date of the hybrid 
deduction account rules because the enactment of section 245A(e) 
provided notice that D/NI outcomes involving instruments that are stock 
for U.S. tax purposes--including D/NI outcomes involving a deduction or 
other tax benefit allowed for an amount on a particular date and a 
payment of a corresponding amount of earnings and profits as a dividend 
for U.S. tax purposes on a later date--would be neutralized under 
section 245A(e) (including in conjunction with the regulatory authority 
under section 245A(g)), and the hybrid deduction account rules are 
necessary to ensuring such D/NI outcomes are so neutralized.

[[Page 19808]]

D. Miscellaneous Issues

1. Treatment of Amounts Under Tax Law of Another Foreign Country
    Under the proposed regulations, a tiered hybrid dividend means an 
amount received by a CFC (``receiving CFC'') from another CFC to the 
extent that the amount would be a hybrid dividend under the proposed 
regulations if the receiving CFC were a domestic corporation. See 
proposed Sec.  1.245A(e)-1(c)(2). As noted in the preamble to the 
proposed regulations, whether a dividend is a tiered hybrid dividend is 
determined without regard to how the amount is treated under the tax 
law of which the receiving CFC is a tax resident (or under any other 
foreign tax law). Similarly, whether a deduction or other tax benefit 
allowed to a CFC (or a related person) under a relevant foreign tax law 
is a hybrid deduction is determined without regard to how the amount is 
treated under another foreign tax law.
    Comments suggested that the treatment of an amount under another 
foreign tax law be taken into account in two cases. First, a comment 
recommended an exception pursuant to which a dividend is not a tiered 
hybrid dividend to the extent that the receiving CFC includes the 
dividend in income under its tax law (or is subject to withholding tax 
under the payer CFC's tax law). The comment suggested that this 
approach only apply, however, to the extent that the inclusion (or 
withholding tax) is at a tax rate at least equal to the rate at which 
the hybrid deduction was allowed. The comment noted that such an 
approach could prevent double-taxation, though it might also result in 
additional complexity.
    The Treasury Department and the IRS have determined that not taking 
into account the treatment of an amount under the receiving CFC's tax 
law (or other foreign tax law), as provided in the proposed 
regulations, is consistent with the plain language of section 
245A(e)(2). In addition, the Treasury Department and the IRS have 
concluded that such an exception could give rise to inappropriate 
results in certain cases. For example, if the exception applied without 
regard to tax rates, then an inclusion by the receiving CFC at a low 
tax rate applicable to all income would discharge the application of 
section 245A(e) to a dividend even though the payer CFC deducted the 
amount at a high tax rate. See also part III.C.1 of this Summary of 
Comments and Explanation of Revisions section (discussing the effect of 
inclusions in another foreign country). Moreover, and as noted by the 
comment, a comparative tax rate test would create complexity and 
administrability issues--for example, it would require that hybrid 
deduction accounts track the tax rate at which the CFC (or a related 
person) was allowed a hybrid deduction. Accordingly, the final 
regulations do not adopt this comment.
    Second, a comment suggested that, in cases involving tiers of CFCs 
that are tax residents of different foreign countries, a deduction or 
other tax benefit allowed to the upper-tier CFC under a relevant 
foreign tax law not be a hybrid deduction to the extent that the 
deduction or other tax benefit offsets an amount that the upper-tier 
CFC includes in its income and that is attributable to a hybrid 
deduction of a lower-tier CFC.\2\ For example, the comment noted that, 
in the case of back-to-back hybrid instruments involving CFCs that are 
tax residents of different foreign countries (pursuant to which, for 
U.S. tax purposes, the lower-tier CFC pays a dividend to the upper-tier 
CFC and the upper-tier CFC pays a dividend to a domestic corporation), 
in effect only a single D/NI outcome occurs if under its tax law the 
upper-tier CFC includes in income the amount paid by the lower-tier 
CFC. The comment asserted that, in such a case, the deduction allowed 
to the upper-tier CFC should not be treated as a hybrid deduction 
because, by reason of treating the amount paid by the lower-tier CFC as 
a tiered hybrid dividend, the D/NI outcome associated with the 
arrangement is neutralized. The final regulations do not adopt this 
comment because it would be inconsistent with the statute, which does 
not take into account the overall effect of a deduction or other tax 
benefit under the relevant foreign tax law. In addition, the Treasury 
Department and the IRS have determined that such an exception would be 
complex and would give rise to administrability issues because it could 
require, for example, a factual analysis of how particular deductions 
offset items of gross income under a relevant foreign tax law. 
Moreover, pursuant to rules described in a separate notice of proposed 
rulemaking published in the Proposed Rules section of this issue of the 
Federal Register (REG-106013-19), the subpart F inclusion arising by 
reason of the upper-tier CFC receiving the tiered hybrid dividend will, 
to an extent, generally reduce the hybrid deduction accounts with 
respect to stock of the upper-tier CFC.
---------------------------------------------------------------------------

    \2\ In these cases, the anti-duplication rule described in part 
II.C.3 of this Summary of Comments and Explanation of Revisions 
section, which applies only to certain deductions or tax benefits 
under the same relevant foreign tax law, would not apply.
---------------------------------------------------------------------------

2. Application of Tiered Hybrid Dividend Rule to Non-Corporate U.S. 
Shareholders
    If an upper-tier CFC receives a tiered hybrid dividend from a 
lower-tier CFC, and a domestic corporation is a U.S. shareholder of 
both CFCs, then, notwithstanding any other provision of the Code (i) 
the tiered hybrid dividend is treated for purposes of section 
951(a)(1)(A) as subpart F income of the upper-tier CFC, (ii) the U.S. 
shareholder must include in gross income its pro rata share of the 
subpart F income, and (iii) the rules of section 245A(d) apply to the 
amount included in the U.S. shareholder's gross income. See proposed 
Sec.  1.245A(e)-1(c)(1). A comment requested that the final regulations 
address how the tiered hybrid dividend rule applies with respect to a 
non-corporate U.S. shareholder of the upper-tier CFC.
    The final regulations provide that the tiered hybrid dividend rule 
applies only as to a domestic corporation that is a U.S. shareholder of 
both the upper-tier CFC and the lower-tier CFC. See Sec.  1.245A(e)-
1(c)(1). Thus, for example, if a domestic corporation and a U.S. 
individual equally own all of the stock of an upper-tier CFC, and the 
upper-tier CFC receives a tiered hybrid dividend from a wholly-owned 
lower-tier CFC, the tiered hybrid dividend rule does not apply to cause 
a subpart F inclusion to the individual U.S. shareholder (though the 
dividend may otherwise result in a subpart F inclusion to the 
individual U.S. shareholder). If the dividend does not give rise to a 
subpart F inclusion to the individual U.S. shareholder, the earnings 
associated with the dividend would generally be subject to full U.S. 
tax when distributed to the individual as a dividend because 
individuals are not allowed a deduction under section 245A(a) and, as a 
result, it would be inappropriate for the tiered hybrid dividend rule 
to have applied to the individual.
3. Upper-Tier CFCs Required To Maintain Hybrid Deduction Accounts
    Under the proposed regulations, an upper-tier CFC is generally a 
specified owner of shares of stock of a lower-tier CFC, and thus the 
upper-tier CFC must maintain hybrid deduction accounts with respect to 
those shares. See proposed Sec.  1.245A(e)-1(d)(1) and (f)(5). However, 
in certain cases there may not be a domestic corporation that is a U.S. 
shareholder of the upper-tier CFC. For example, the only U.S. 
shareholders of the upper-tier CFC may be individuals,

[[Page 19809]]

with the result that section 245A(e)(2) would not apply to a dividend 
received by the upper-tier CFC from the lower-tier CFC. Or, the upper-
tier CFC may be a CFC solely by reason of the repeal of the limitation 
on the ``downward'' attribution rule under section 958(b)(4), with the 
result that even if a dividend received by the upper-tier CFC from the 
lower-tier CFC were a tiered hybrid dividend, there would be no 
meaningful U.S. tax consequence because no U.S. shareholder would have 
a subpart F inclusion with respect to the upper-tier CFC.
    To obviate the need for hybrid deduction accounts to be maintained 
in these cases, the final regulations provide that an upper-tier CFC is 
a specified owner of shares of stock of a lower-tier CFC only if, for 
purposes of sections 951 and 951A, a domestic corporation that is a 
U.S. shareholder of the upper-tier CFC owns (within the meaning of 
section 958(a), but for this purpose treating a domestic partnership as 
foreign) one or more shares of stock of the upper-tier CFC. See Sec.  
1.245A(e)-1(f)(6). The Treasury Department and the IRS expect that when 
proposed regulations under section 958 (REG-101828-19, 84 FR 29114) are 
finalized, the rule described in the preceding sentence treating a 
domestic partnership as foreign will be removed, as it will no longer 
be necessary. See proposed Sec.  1.958-1(d)(1).
4. Anti-Avoidance Rule
    The proposed regulations include an anti-avoidance rule that 
requires appropriate adjustments to be made, including adjustments that 
would disregard a transaction or arrangement, if a transaction or 
arrangement is engaged in with a principal purpose of avoiding the 
purposes of the proposed regulations. As an example, the anti-avoidance 
rule disregards a transaction or arrangement that is undertaken to 
affirmatively fail to satisfy the holding period requirement under 
section 246, such as the sale of lower-tier CFC stock before satisfying 
the holding period, if a principal purpose of the transaction or 
arrangement is to avoid the tiered hybrid dividend rules. A comment 
suggested that the anti-avoidance rule should not apply to a sale of 
lower-tier CFC stock before satisfying the holding period if the sale 
is to an unrelated party, even though the timing of the sale may be 
driven by tax considerations. Another comment requested clarification 
that the anti-avoidance rule does not apply to disregard a transaction 
pursuant to which the hybrid nature of an arrangement is eliminated 
(for example, a restructuring of a hybrid instrument into a non-hybrid 
instrument, so as to eliminate the accrual of a hybrid deduction under 
a relevant foreign tax law).
    The Treasury Department and the IRS have determined that the anti-
avoidance rule should not be limited to transactions or arrangements 
with related parties, as otherwise transactions or arrangements with 
unrelated parties could lead to the avoidance of section 245A(e) and 
the regulations thereunder. Accordingly, the final regulations retain 
the anti-avoidance rule in the proposed regulations, and thus whether 
the anti-avoidance rule applies to a transaction or arrangement depends 
solely on a principal purpose of the transaction or arrangement for the 
avoidance of section 245A(e) and the regulations thereunder and does 
not take into account the status of a counter party. See Sec.  
1.245A(e)-1(e). The Treasury Department and the IRS agree, however, 
with the comment asserting that the anti-avoidance rule should not 
apply to disregard a restructuring of a hybrid arrangement into a non-
hybrid arrangement and, accordingly, the rule is modified to this 
effect. See id.

III. Comments and Revisions to Proposed Sec. Sec.  1.267A-1 Through 
1.267A-7--Certain Payments Involving Hybrid and Branch Mismatches

A. Background

    The proposed regulations disallow a deduction for any interest or 
royalty paid or accrued (``specified payment'') to the extent the 
specified payment produces a D/NI outcome as a result of a hybrid or 
branch arrangement. The proposed regulations also disallow a deduction 
for a specified payment to the extent the specified payment produces an 
indirect D/NI outcome as a result of the effects of an offshore hybrid 
or branch arrangement being imported into the U.S. tax system. Finally, 
the proposed regulations disallow a deduction for a specified payment 
to the extent the specified payment produces a D/NI outcome and is made 
pursuant to a transaction a principal purpose of which is to avoid the 
purposes of the regulations under section 267A.

B. Hybrid and Branch Arrangements

1. Arrangements Giving Rise to Long-Term Deferral
i. In General
    Several provisions of the proposed regulations address long-term 
deferral, which results when there is deferral beyond a taxable period 
ending more than 36 months after the end of the specified party's 
taxable year. For example, to address long-term deferral arising as a 
result of different ordering or other rules under U.S. and foreign tax 
law, a hybrid transaction includes an instrument a payment with respect 
to which is interest for U.S. tax purposes but a return of principal 
for purposes of the tax law of a specified recipient of a payment. See 
proposed Sec.  1.267A-2(a)(2). In addition, the proposed regulations 
deem a specified payment as made pursuant to a hybrid transaction if 
differences between U.S. tax law and the taw law of a specified 
recipient of the payment (such as differences in tax accounting 
treatment) result in more than a 36-month deferral between the time the 
deduction would be allowed under U.S. tax law and the time the payment 
is taken into account in income under the specified recipient's tax 
law. See id. Further, a D/NI outcome is considered to occur with 
respect to a specified payment if under a relevant foreign tax law the 
payment is not included in income within the 36-month period. See 
proposed Sec.  1.267A-3(a)(1).
    One comment supported these provisions, on balance, noting that 
long-term deferral can create D/NI outcomes that should be neutralized 
by section 267A, but recommending certain of the modifications 
discussed in this part III.B.1 of the Summary of Comments and 
Explanation of Revisions section. Other comments suggested that the 
provisions be eliminated, because according to such comments they are 
potentially burdensome or are not appropriate since a D/NI outcome 
should not be viewed as occurring if the amount will eventually be 
included in income; in addition, one comment asserted that the 
provision dealing with mismatches in tax accounting treatment is 
neither supported by section 267A nor within the regulatory authority 
granted under section 267A(e). However, some comments also noted that 
the burden concerns could be addressed by adopting certain of the 
comments discussed in this part III.B.1 of the Summary of Comments and 
Explanation of Revisions section.
    The Treasury Department and the IRS have determined that the final 
regulations should retain the long-term deferral provisions because 
long-term deferral can in effect create D/NI outcomes and, absent such 
provisions, hybrid arrangements could be used to achieve results 
inconsistent with the purposes of section 267A. See S. Comm. on the 
Budget, Reconciliation Recommendations Pursuant to H. Con. Res. 71, S. 
Print No. 115-20, at 389 (2017) (expressing concern with hybrid 
arrangements that ``achieve double non-

[[Page 19810]]

taxation, including long-term deferral.''). In addition, the Treasury 
Department and the IRS have concluded that the provisions are 
consistent with section 267A and the broad regulatory authority 
thereunder. In particular, the Treasury Department and the IRS have 
concluded that deeming mismatches in tax accounting treatment to be 
hybrid transactions is consistent with section 267A(c) (defining a 
hybrid transaction), because in these cases a specified payment is 
deductible interest under U.S. tax law on a particular date whereas it 
is not includible interest under the foreign tax law until a later 
date.
    Therefore, the final regulations retain the long-term deferral 
provisions but, in response to comments, modify the provisions as 
discussed in this part III.B.1 of the Summary of Comments and 
Explanation of Revisions section.
ii. Recovery of Basis or Principal
    One comment requested that, in the case of a specified payment that 
is treated as a recovery of basis or principal under the tax law of a 
specified recipient, the final regulations clarify whether the 
specified recipient is considered to include the payment in income. The 
comment asserted that basis or principal should be viewed as a 
``generally applicable'' tax attribute such that recovery of basis or 
principal should not create a D/NI outcome and, therefore, the 
specified recipient should be considered to include the payment in 
income.
    The Treasury Department and the IRS have determined that basis or 
principal recovery can give rise to long-term deferral and thus can 
create a D/NI outcome. For example, consider a specified payment that 
is made pursuant to an instrument treated as indebtedness for U.S. tax 
purposes and equity for purposes of the tax law of a specified 
recipient, and that is treated as interest for U.S. tax purposes and a 
recovery of basis (under a rule similar to section 301(c)(2)) for 
purposes of the specified recipient's tax law. If section 267A were to 
not apply in such a case, then the specified party would generally be 
allowed a deduction at the time of the specified payment but the 
specified recipient would not have a taxable inclusion at that time 
and, indeed, might not have a taxable inclusion, if any, for an 
extended period.
    Accordingly, the final regulations clarify that a recovery of basis 
or principal can create a D/NI outcome. See Sec.  1.267A-3(a)(1)(ii). 
However, as discussed in parts III.B.1.iii (discussing a rule reducing 
a no-inclusion by certain amounts that are repayments of principal for 
U.S. tax purposes but included in income for foreign tax purposes) and 
III.B.1.iv (discussing hybrid sale/license transactions) of this 
Summary of Comments and Explanation of Revisions section, the final 
regulations modify the long-term deferral provisions. The Treasury 
Department and the IRS expect that these modifications will in many 
cases prevent a specified payment from being a disqualified hybrid 
amount when the payment is treated as a recovery of basis or principal 
under the tax law of a specified recipient.
iii. Defining Long-Term Deferral; Reduction of No-Inclusion by Certain 
Amounts
    Some comments noted that under the proposed regulations, to 
determine whether long-term deferral occurs with respect to a specified 
payment, the specified party must know at the time of the payment if, 
under the tax law of a specified recipient, the payment will be taken 
into account and included in income within the 36-month period. The 
comments stated that in certain cases this could be difficult or 
burdensome, including because, after the payment is made, the specified 
party might need to monitor the payment during the 36-month period to 
ensure that it is in fact taken into account and included in income 
(and, if it is not so taken into account and included, the specified 
party might need to amend its tax return to reflect a disallowance of 
the deduction). The comments suggested addressing these concerns by 
providing for a reasonable expectation standard, based on whether, at 
the time of the specified payment, it is reasonable to expect that the 
payment will be taken into account and included in income within the 
36-month period. The Treasury Department and the IRS agree with these 
comments and, thus, the final regulations provide rules to such effect. 
See Sec. Sec.  1.267A-2(a)(2)(ii)(A) and 1.267A-3(a)(1)(i).
    Comments also suggested that, to address certain cases in which 
there are different ordering or other rules under U.S. tax law and the 
tax law of a specified recipient, certain amounts related to a 
specified payment be aggregated for purposes of determining whether 
long-term deferral occurs. For example, under such an approach, if a 
year 1 $100x specified payment is interest for U.S. tax purposes and a 
return of principal for purposes of a specified recipient's tax law, 
but a year 2 $100x payment is a repayment of principal for U.S. tax 
purposes and interest for purposes of the specified recipient's tax law 
(and is included in income by the specified recipient), then there is 
no long-term deferral with respect to the year 1 payment and, as a 
result, the payment is not a disqualified hybrid amount. The Treasury 
Department and the IRS generally agree that the year 1 $100x specified 
payment should not be a disqualified hybrid amount. However, rather 
than addressing through an aggregation rule, which could give rise to 
uncertainty in certain cases, the final regulations provide a special 
rule pursuant to which a specified recipient's no-inclusion with 
respect to a specified payment is reduced by certain amounts that are 
repayments of principal for U.S. tax purposes but included in income by 
the specified recipient. See Sec.  1.267A-3(a)(4); see also Sec.  
1.267A-6(c)(1)(vi).
iv. Hybrid Sale/License Transactions
    Some comments suggested that hybrid sale/license transactions not 
be subject to the hybrid transaction rule. A hybrid sale/license 
transaction can occur, for example, when a specified payment is treated 
as a royalty for U.S. tax purposes, and a contingent payment of 
consideration for the purchase of intangible property under the tax law 
of a specified recipient. In such a case, if under the specified 
recipient's tax law the payment is treated as a recovery of basis, then 
a D/NI outcome would occur. Accordingly, if the specified payment is 
considered made pursuant to a hybrid transaction, then the payment 
would generally be a disqualified hybrid amount. Comments asserted that 
these transactions should be excluded because they are common, may be 
unavoidable, and are not abusive.
    The Treasury Department and the IRS have determined that in many 
cases there might not be a significant difference between the results 
occurring under a hybrid sale/license transaction and the results that 
would occur were the specified recipient's tax law to (like U.S. tax 
law) also view the transaction as a license and the specified payment 
as a royalty. For example, if the specified recipient's tax law were to 
view the transaction as a license and the specified payment as a 
royalty, then the payment could be offset by an amortization deduction 
attributable to the basis of the intangible property. In such a case, 
the amortization deduction--a generally available deduction or other 
tax attribute--would not prevent the specified recipient from being 
considered to include the payment in income. See Sec.  1.267A-3(a)(1). 
Thus, regardless of whether the transaction is a hybrid sale/license or 
an actual license, the specified payment

[[Page 19811]]

could under the specified recipient's tax law be offset by basis or a 
deduction that is a function of basis. These cases are generally 
distinguishable from ones in which a transaction is a hybrid debt 
instrument, because tax laws typically do not provide amortization or 
similar deductions with respect to indebtedness.
    Accordingly, the Treasury Department and the IRS have concluded 
that it is appropriate to exempt hybrid sale/license transactions from 
the hybrid transaction rule. The final regulations thus provide a rule 
to this effect. See Sec.  1.267A-2(a)(2)(ii)(B).
v. Other Modifications or Clarifications
    Comments suggested several other modifications to the long-term 
deferral provisions. First, although one comment generally supported a 
bright-line standard for measuring long-term deferral because it 
provides certainty, other comments suggested modifying the standard for 
measuring long-term deferral, either by lengthening the period to, for 
example, 120 months, or defining long-term deferral as an unreasonable 
period of time based on all the facts and circumstances. The final 
regulations do not adopt these comments because the Treasury Department 
and the IRS have concluded that, in general, a bright-line 36-month 
standard appropriately distinguishes between short-term and long-term 
deferral and avoids administrability issues that would likely arise if 
long-term deferral were based on a subjective standard (such as an 
``unreasonable'' period of time). See also Hybrid Mismatch Report para. 
56 (bright-line safe harbor pursuant to which inclusions within a 12-
month period are not considered to give rise to long-term deferral).
    Second, a comment suggested that, to balance the benefits of the 
bright-line standard with the resulting cliff effects, the final 
regulations provide a rule, similar to section 267(a)(3), that defers a 
deduction for a specified payment until taken into account under the 
foreign tax law. The final regulations do not adopt this approach 
because it would be inconsistent with the plain language of section 
267A, which provides for the disallowance of a deduction at the time of 
the payment, and not a deferral of a deduction. In addition, the 
Treasury Department and the IRS have determined that, if such an 
approach were adopted, tracking rules would be necessary and such rules 
would create additional complexity and administrative burden.
    Third, a comment requested that the final regulations clarify that 
if a specified payment will never be recognized under the tax law of a 
specified recipient (because, for example, such tax law does not impose 
an income tax), then the long-term deferral provision does not apply so 
as to deem the payment as made pursuant to a hybrid transaction. 
Finally, a comment requested clarification that a specified payment is 
treated as included in income if the payment is included in income in a 
prior taxable period. The Treasury Department and the IRS agree with 
these comments, and the final regulations thus include these 
clarifications. See Sec.  1.267A-2(a)(2)(ii)(A); Sec.  1.267A-
3(a)(1)(i).
2. Interest-Free Loans
    An interest-free loan includes, for example, an instrument that is 
treated as indebtedness under both U.S. tax law and the tax law of the 
holder of the instrument but provides no stated interest. If the issuer 
is allowed an imputed interest deduction, but the holder is not 
required to impute interest income, the instrument would give rise to a 
D/NI outcome. Because the imputed interest deduction is not regarded 
under the tax law of the holder of the instrument, the disregarded 
payment rule of the proposed regulations treats the imputed interest as 
a disregarded payment and, accordingly, a disqualified hybrid amount to 
the extent it exceeds dual inclusion income.
    A comment noted that the Hybrid Mismatch Report generally does not 
disallow deductions for imputed interest payments, such as interest 
imputed with respect to interest-free loans, and that imputed interest 
raises issues that should be further considered on a multilateral 
basis. The comment thus suggested that the final regulations generally 
reserve on whether imputed interest is subject to section 267A. The 
final regulations do not adopt this comment because imputed interest 
can give rise to D/NI outcomes that are no different than D/NI outcomes 
produced by other hybrid and branch arrangements. However, to more 
clearly address these transactions, and because interest-free loans are 
similar to hybrid transactions and are unlikely to involve dual 
inclusion income, the final regulations address imputed interest under 
the hybrid transaction rule, rather than the disregarded payment rule. 
See Sec.  1.267A-2(a)(4). The rules in the final regulations addressing 
interest-free loans and similar arrangements apply for taxable years 
beginning on or after December 20, 2018. See Sec.  1.267A-7(b)(1).
3. Disregarded Payments
i. Dual Inclusion Income
    In general, the proposed regulations provide that a disregarded 
payment is a disqualified hybrid amount to the extent it exceeds the 
specified party's dual inclusion income. For this purpose, an item of 
income of a specified party is dual inclusion income only if it is 
included in the income of both the specified party and the tax resident 
or taxable branch to which the disregarded payment is made (as 
determined under the rules of Sec.  1.267A-3(a)). See proposed Sec.  
1.267A-2(b)(3). A comment suggested that the final regulations address 
whether an item of income is dual inclusion income even though, as a 
result of a participation exemption, patent box, or other exemption 
regime, it is not included in the income of the tax resident or taxable 
branch to which the disregarded payment is made.
    The Treasury Department and the IRS have concluded that an item of 
income of a specified party should be dual inclusion income even 
though, by reason of a participation exemption or other relief 
particular to a dividend, it is not included in the income of the tax 
resident or taxable branch to which the disregarded payment is made, 
provided that the application of the participation exemption or other 
relief relieves double-taxation (rather than results in double non-
taxation). The final regulations are thus modified to this effect. See 
Sec.  1.267A-2(b)(3)(ii); see also Sec.  1.267A-6(c)(3)(iv). The final 
regulations provide a similar rule in cases in which an item of income 
of a specified party is included in the income of the tax resident or 
taxable branch to which the disregarded payment is made but not 
included in the income of the specified party by reason of a dividends 
received deduction (such as the section 245A(a) deduction). These rules 
do not apply to items that are excluded from income under a patent box 
or similar regime because, to the extent the payer of the item is 
allowed a deduction for the item under its tax law, the deduction and 
the exclusion, together, result in double non-taxation. See also Hybrid 
Mismatch Report para. 126.
ii. Exception for Payments Otherwise Taken Into Account Under Foreign 
Law
    Under the proposed regulations, a special rule ensures that a 
specified payment is not a deemed branch payment to the extent the 
payment is otherwise taken into account under the home office's tax law 
in such a manner that there is no mismatch. See proposed Sec.  1.267A-
2(c)(2). Absent such a rule, a

[[Page 19812]]

deduction for a deemed branch payment could be disallowed even though 
it does not give rise to a D/NI outcome. Thus, for example, if under an 
applicable treaty a U.S. taxable branch is deemed to pay an amount of 
interest or royalty to the home office that is not regarded under the 
home office's tax law, the payment is nevertheless not a deemed branch 
payment to the extent that under the home office's tax law a 
corresponding amount of interest or royalties is allocated and 
attributable to the U.S. taxable branch and therefore is not 
deductible. See id.
    However, the proposed regulations do not provide a similar special 
rule in analogous cases involving disregarded payments. For example, 
assume FX1, a tax resident of Country X, owns FX2, also a tax resident 
of Country X, and FX2 has a U.S. taxable branch (``USB''). Further, 
assume that FX1 borrows from a bank and on-lends the proceeds to FX2, 
and that pursuant to such transactions FX1 pays $100x of interest to 
the bank and FX2 pays $100x of interest to FX1 but, as a consequence of 
the Country X consolidation regime, FX2's payment to FX1 is treated as 
a disregarded transaction between group members. Lastly, assume that 
the entire $100x of FX2's payment of interest to FX1 is allocable to 
USB's effectively connected income under section 882 and thus is a 
specified payment under proposed Sec.  1.267A-5(b)(3). Under the 
proposed regulations, USB's specified payment of interest would be a 
disregarded payment, regardless of whether the payment is otherwise 
taken into account under Country X tax law. The specified payment would 
otherwise be taken into account under Country X tax law if, for 
example, FX1's payment of interest to the bank were allocated and 
attributed to USB and were therefore not deductible. Cf. Sec.  1.267A-
2(c)(2). To provide symmetry between the disregarded payment rule and 
the deemed branch payment rule, the final regulations add to the 
disregarded payment rule a special rule similar to the special rule in 
the deemed branch payment context. See Sec.  1.267A-2(b)(2)(ii)(B).
4. Payments by U.S. Taxable Branches
i. Allocation of Interest Expense to U.S. Taxable Branches
    The proposed regulations provide that a U.S. taxable branch of a 
foreign corporation is considered to pay or accrue interest allocable 
under section 882(c)(1) to effectively connected income of the U.S. 
taxable branch. See proposed Sec.  1.267A-5(b)(3). The proposed 
regulations include rules to identify the manner in which a specified 
payment of a U.S. taxable branch is considered made. See id. For 
directly allocable interest described in Sec.  1.882-5(a)(1)(ii)(A), or 
a U.S. booked liability described in Sec.  1.882-5(d)(2), a direct 
tracing approach applies; for any excess interest, the U.S. taxable 
branch is treated as paying or accruing interest to the same persons 
and pursuant to the same terms that the home office paid or accrued 
such interest on a pro-rata basis. See id. As explained in the preamble 
to the proposed regulations, these rules are necessary to determine 
whether a U.S. taxable branch's specified payment is made pursuant to a 
hybrid or branch arrangement (for example, made pursuant to a hybrid 
transaction or to a reverse hybrid).
    The proposed regulations do not, however, contain rules for tracing 
a foreign corporation's distributive share of interest expense when the 
foreign corporation is a partner in a partnership that has a U.S. 
asset, as described in Sec.  1.882-5(a)(1)(ii)(B), or rules for tracing 
interest that is determined under the separate currency pools method, 
as described in Sec.  1.882-5(e). The final regulations therefore 
provide that, like directly allocable interest and U.S. booked 
liabilities, a U.S. taxable branch must use a direct tracing approach 
to identify the person to whom interest described in Sec.  1.882-
5(a)(1)(ii)(B) or Sec.  1.882-5(e) is payable. See Sec.  1.267A-
5(b)(3)(ii)(A). In addition, the Treasury Department and the IRS have 
determined that a consistent approach should apply for purposes of 
identifying a U.S. branch interest payment in order to avoid treating 
similarly situated taxpayers differently under section 267A. 
Accordingly, similar to the tracing rules provided in the final 
regulations under section 59A, the final regulations provide that 
foreign corporations should use U.S. booked liabilities to identify the 
person to whom an interest expense is payable, without regard to which 
method the foreign corporation uses to determine its interest expense 
under section 882(c)(1). See id.; see also Sec.  1.59A-3(b)(4)(i)(B).
ii. Interaction With Income Tax Treaties
    Under the proposed regulations, the deemed branch payment rule 
addresses a D/NI outcome when, under an income tax treaty, a deductible 
payment is deemed to be made by a permanent establishment to its home 
office (or another branch of the home office) and offsets income not 
taxable to the home office, but the payment is not taken into account 
under the tax law of the home office or other branch. See proposed 
Sec.  1.267A-2(c)(2). A deemed branch payment is a notional payment 
that arises from applying Article 7 (Business Profits) of certain U.S. 
income tax treaties, which takes into account only the profits derived 
from the assets used, risks assumed and activities performed by the 
permanent establishment to determine the business profits that may be 
taxed where the permanent establishment is situated. See, for example, 
the U.S. Treasury Department Technical Explanation to the income tax 
convention between the United States and Belgium, signed November 27, 
2006 (``[T]he OECD Transfer Pricing Guidelines apply, by analogy, in 
determining the profits attributable to a permanent establishment.'').
    A comment questioned whether the deemed branch payment rule is a 
treaty override because it creates a new condition on the allowance of 
a deduction for purposes of computing the business profits of a U.S. 
permanent establishment based upon an intervening change in U.S. law. 
The comment noted that the deemed branch payment rule affects the 
allocation of taxing rights of business profits under the treaty. 
Another comment raised a similar concern and requested that the deemed 
branch payment rule be withdrawn because it is inconsistent with U.S. 
income tax treaty obligations.
    The Treasury Department and the IRS have determined that the deemed 
branch payment rule is not a treaty override and is consistent with 
U.S. income tax treaty obligations. The treaties that allow notional 
payments under Article 7 take into account interbranch transactions and 
value such interbranch transactions using the most appropriate arm's 
length methodology. Once expenses are either allocated or determined 
under arm's length principles to be taken into account in determining 
the business profits of the permanent establishment under Article 7, 
domestic limitations on deductibility of such expenses may apply in the 
same manner as they would if the amounts were paid by a domestic 
corporation. In other words, sections 163(j), 267(a)(3), and 267A 
generally apply to the same extent to the notional payments as they 
would to actual interest payments by a domestic subsidiary to a foreign 
parent. The commentary to paragraph 2 of Article 7 of the OECD Model 
Tax Convention adopts a comparable interpretation. See Para. 30 and 31 
of the commentary to para. 2 of Article 7 of the OECD Model Tax 
Convention. Accordingly, the final regulations retain the deemed branch 
payment rule.

[[Page 19813]]

5. Reverse Hybrids
i. Fiscally Transparent
    A reverse hybrid is an entity that is fiscally transparent for 
purposes of the tax law of the country in which it is established but 
not for purposes of the tax law of an investor of the entity. See Sec.  
1.267A-2(d)(2). Under the proposed regulations, whether an entity is 
fiscally transparent with respect to an item of income is determined 
under the principles of Sec.  1.894-1(d)(3)(ii) and (iii). See proposed 
Sec.  1.267A-5(a)(8).
    The final regulations provide special rules to address certain 
cases in which, given Sec.  1.894-1(d)(3)'s definition of fiscally 
transparent, an entity might not be considered a reverse hybrid under 
the proposed regulations with respect to a payment received by the 
entity, even though neither the entity nor an investor of the entity 
take the payment into account in income, with the result that the 
payment gives rise to a D/NI outcome. Pursuant to the special rules, an 
entity is considered fiscally transparent with respect to the payment 
under the tax law of the country where it is established if, under such 
tax law, the entity allocates the payment to an investor, with the 
result that under such tax law the investor is viewed as deriving the 
payment through the entity. See Sec.  1.267A-5(a)(8)(i); see also Sec.  
1.267A-6(c)(5)(vi). A similar rule applies for purposes of determining 
whether the entity is fiscally transparent with respect to the payment 
under an investor's tax law. See Sec.  1.267A-5(a)(8)(ii). Lastly, to 
address the fact that under Sec.  1.894-1(d)(3)(ii), certain collective 
investment vehicles and similar arrangements may not be considered 
fiscally transparent under the tax law of the country where 
established, a special rule provides that such arrangements are 
considered fiscally transparent under the tax law of the establishment 
country if neither the arrangement nor an investor is required to take 
the payment into account in income. See Sec.  1.267A-5(a)(8)(iii); see 
also Sec.  1.894-1(d)(5), Example 7.
ii. Current-Year Distributions From Reverse Hybrid
    Under the proposed regulations, when a specified payment is made to 
a reverse hybrid, it is generally a disqualified hybrid amount to the 
extent that an investor does not include the payment in income. See 
proposed Sec.  1.267A-2(d)(1). For this purpose, whether an investor 
includes the specified payment in income is determined without regard 
to a subsequent distribution by the reverse hybrid. See proposed Sec.  
1.267A-3(a)(3). As explained in the preamble to the proposed 
regulations, although a subsequent distribution may be included in the 
investor's income, the distribution may not occur for an extended 
period and, when it does occur, it may be difficult to determine 
whether the distribution is funded from an amount comprising the 
specified payment.
    A comment noted that if a reverse hybrid distributes all of its 
income during a taxable year, then current year distributions should be 
taken into account for purposes of determining whether an investor of 
the reverse hybrid includes in income a specified payment made to the 
reverse hybrid. The comment asserted that not doing so would be unduly 
harsh and could create unwarranted disparities between cases involving 
current year distributions and anti-deferral inclusions (which are 
taken into account for purposes of determining whether an investor 
includes in income a specified payment). The comment also suggested 
that the final regulations reserve on whether subsequent year 
distributions are taken into account.
    The Treasury Department and the IRS agree with the comment that 
current year distributions should be taken into account in cases in 
which the reverse hybrid distributes all of its income during the 
taxable year. The final regulations thus provide that in these cases a 
portion of a specified payment made to the reverse hybrid during the 
taxable year is considered to relate to each of the current year 
distributions from the reverse hybrid. As a result, to the extent that 
an investor includes in income a current year distribution, the 
investor is treated as including in income a corresponding portion of a 
specified payment made to the reverse hybrid during the year. See Sec.  
1.267A-3(a)(3). The Treasury Department and the IRS have determined 
that it would be too complex to take into account current year 
distributions in cases in which the reverse hybrid does not distribute 
all of its income during the taxable year, as in these cases stacking 
or similar rules would likely be needed to determine the extent that a 
specified payment is considered to relate to a distribution. For 
similar reasons, the Treasury Department and the IRS have determined 
that it would be too complex to take into account subsequent year 
distributions.
iii. Multiple Investors
    The final regulations clarify the application of the reverse hybrid 
rule in cases in which an investor of the reverse hybrid owns only a 
portion of the interests of the reverse hybrid and does not include in 
income a specified payment made to the reverse hybrid. In these cases, 
given the ``as a result of'' test, only the no-inclusion of the 
investor that occurs for its portion of the payment may give rise to a 
disqualified hybrid amount.
    For example, consider a case in which a $100x specified payment is 
made to a reverse hybrid 60% of the interests of which are owned by a 
Country X investor (the tax law of which treats the reverse hybrid as 
not fiscally transparent) and 40% of the interests of which are owned 
by a Country Y investor (the tax law of which treats the reverse hybrid 
as fiscally transparent). If the Country X investor does not include 
any portion of the payment in income, then $60x of the payment would 
generally be a disqualified hybrid amount under the reverse hybrid 
rule, calculated as $100x (the no-inclusion that actually occurs with 
respect to the Country X investor) less $40x (the no-inclusion that 
would occur with respect to the Country X investor absent hybridity). 
See Sec. Sec.  1.267A-2(d) and 1.267A-6(c)(5)(iv).
iv. Inclusion by Taxable Branch in Country in Which Reverse Hybrid is 
Established
    The final regulations provide an exception pursuant to which the 
reverse hybrid rule does not apply to a specified payment made to a 
reverse hybrid to the extent that, under the tax law of the country in 
which the reverse hybrid is established, a taxable branch the 
activities of which are carried on by an investor of the reverse hybrid 
includes the payment in income. See Sec.  1.267A-2(d)(4). The Treasury 
Department and the IRS have determined that, in these cases, the 
inclusion in the establishment country generally prevents a D/NI 
outcome and thus it is appropriate for an exception to apply.

C. Exceptions Relating to Disqualified Hybrid Amounts

1. Effect of Inclusion in Another Foreign Country
    Under the proposed regulations, a specified payment generally is a 
disqualified hybrid amount to the extent that a D/NI outcome occurs 
with respect to any foreign country as a result of a hybrid or branch 
arrangement, even if the payment is included in income in another 
foreign country (a ``third country''). See also part III.C.2 of this 
Summary of Comments and Explanation of Revisions section (exceptions 
for amounts included or includible in income in the United States). 
Absent such a rule, an inclusion of a specified

[[Page 19814]]

payment in income in a third country would discharge the application of 
section 267A even though a D/NI outcome occurs in a foreign country as 
a result of a hybrid or branch arrangement. The preamble to the 
proposed regulations expresses particular concern with cases in which 
the third country imposes a low tax rate.
    Comments requested that this rule be eliminated because requiring 
an income inclusion in multiple jurisdictions is not necessary or 
appropriate to prevent a D/NI outcome. One of these comments asserted 
that the rule is unfair and does not effectively prevent rate 
arbitrage. The comments further asserted that the rule is inconsistent 
with the policies of section 267A, other provisions of the Code (such 
as section 894(c) and Sec.  1.894-1(d)), and the Hybrid Mismatch 
Report. One comment stated that the rule is neither included in section 
267A nor permissible under the regulatory authority under section 
267A(e). Although the comments noted potential concerns associated with 
an income inclusion in a low-tax third country discharging the 
application of section 267A, the comments suggested addressing the 
concerns through the anti-avoidance rule included in the proposed 
regulations. Alternatively, a comment suggested retaining the general 
approach of the proposed regulations but permitting an inclusion in a 
third country to discharge the application of section 267A if the 
inclusion satisfies a rate test (for example, to the extent the 
inclusion is at a tax rate at least equal to the U.S. tax rate or the 
tax rate of the foreign country in which the no-inclusion occurs).
    The Treasury Department and the IRS have determined that the 
approach of the proposed regulations should be retained to prevent the 
avoidance of section 267A by routing a specified payment through a low-
tax third country, and to prevent the use of a hybrid or branch 
arrangement from placing a taxpayer in a better position than it would 
have been in absent the arrangement. In addition, the Treasury 
Department and the IRS have concluded that the rule is consistent with 
section 267A and the broad regulatory authority thereunder. Finally, 
the Treasury Department and the IRS have concluded that relying on the 
anti-avoidance rule would give rise to uncertainty and be an 
insufficient remedy, and that a rate test would also be an insufficient 
remedy because it would give rise to additional complexity and would 
require taking into account tax rates, which is beyond the scope of 
hybrid mismatch rules.
2. Amounts Included or Includible in Income in the United States
    The proposed regulations provide rules that, in general, ensure 
that a specified payment is not a disqualified hybrid amount to the 
extent it is included in the income of a tax resident of the United 
States or a U.S. taxable branch, or is taken into account by a U.S. 
shareholder under the subpart F or GILTI rules. See proposed Sec.  
1.267A-3(b). Several comments suggested retaining these rules, but 
revising them in certain respects.
    One comment suggested revising the rules relating to amounts taken 
into account under subpart F so that the determination is made without 
regard to the earnings and profits limitation under section 952. 
Another comment noted that the rules relating to amounts taken into 
account under GILTI could potentially give rise to rate arbitrage (for 
example, if the rate on the GILTI inclusion amount is in effect reduced 
by reason of the deduction under section 250(a)(1)(B), and the 
deduction for the specified payment offsets income that is not eligible 
for a reduced rate).\3\ Finally, a comment suggested an exception for 
specified payments received by a qualified electing fund (as described 
in section 1295) and taken into account by a tax resident of the United 
States under section 1293.
---------------------------------------------------------------------------

    \3\ For instance, in the case of a structured arrangement 
pursuant to which a domestic corporation (US1) makes a specified 
payment to a CFC of an unrelated domestic corporation (US2), a 
deduction allowed to US1 for the specified payment would offset 
income subject to tax at the full U.S. corporate tax rate, whereas 
US2's GILTI inclusion attributable to the payment would generally be 
subject to tax at a reduced rate by reason of the deduction under 
section 250(a)(1)(B).
---------------------------------------------------------------------------

    The Treasury Department and the IRS agree with these 
recommendations, and thus the final regulations provide rules to such 
effect. See Sec.  1.267A-3(b)(3) through (5).
3. Effect of Withholding Taxes on a Specified Payment
    Under the proposed regulations, the determination of whether a 
deduction for a specified payment is disallowed under section 267A is 
made without regard to whether the payment is subject to U.S. source-
based tax under section 871 or 881 and such tax has been deducted and 
withheld under section 1441 or 1442. The preamble to the proposed 
regulations explains that withholding tax policies are unrelated to the 
policies underlying hybrid arrangements and, because the approach of 
the proposed regulations is consistent with the Hybrid Mismatch Report, 
it may improve the coordination of section 267A with hybrid mismatch 
rules of other countries.
    In response to a request for comments in the proposed regulations, 
several comments recommended that withholding taxes be taken into 
account for purposes of section 267A. For example, comments suggested 
that to the extent the United States imposes withholding tax on a 
specified payment, section 267A generally should not apply to the 
payment because, otherwise, the payment may be effectively taxed twice 
by the United States (once as a result of the withholding tax, and 
second as a result of the denial of a deduction for the payment). The 
comments also asserted that such an approach would generally be 
consistent with the policies underlying the exceptions in Sec.  1.267A-
3(b) (certain amounts not treated as disqualified hybrid amounts to 
extent included or includible in income). Although one comment 
acknowledged that adopting an approach to withholding taxes that is 
inconsistent from the Hybrid Mismatch Report could raise potential 
coordination concerns, it recommended further work be undertaken on a 
multilateral level to avoid such issues and to ensure that economic 
double taxation does not occur.
    The Treasury Department and the IRS have determined that it would 
not be appropriate for withholding taxes to be taken into account for 
purposes of section 267A. The purpose of withholding taxes is generally 
not to address mismatches in tax outcomes but, rather, to allow the 
source jurisdiction to retain its right to tax a payment. In addition, 
and as explained in the preamble to the proposed regulations, taking 
withholding taxes into account could create issues regarding how 
section 267A interacts with foreign hybrid mismatch rules--for example, 
a foreign country with hybrid mismatch rules may not treat the 
imposition of U.S. withholding taxes on a specified payment as 
neutralizing a D/NI outcome and may therefore apply a secondary or 
defensive rule requiring the payee to include the payment in income. 
Moreover, had Congress intended for withholding taxes to be taken into 
account for purposes of section 267A, it could have added a rule 
similar to the one in section 59A(c)(2)(B), which was enacted at the 
same time as section 267A. Finally, providing an exception for 
withholding taxes could raise administrability issues in cases in which 
a specified payment is subject to U.S. withholding taxes at the time of 
payment (with the result that a deduction for the payment is not 
disallowed under section 267A at that

[[Page 19815]]

time) but the taxes are refunded in a later period; in these cases, it 
could be difficult or burdensome to retroactively deny the deduction 
and make corresponding adjustments. Thus, the Treasury Department and 
the IRS have determined that the exceptions in Sec.  1.267A-3(b) should 
generally be limited to inclusions similar to those described in the 
flush language of section 267A(b)(1) (inclusions under section 951(a)), 
which, unlike U.S. source income that is subject to withholding taxes, 
are included in the U.S. tax base on a net basis. Accordingly, the 
final regulations do not adopt the comment.

D. Disqualified Imported Mismatch Amounts

1. In General
    Under the proposed regulations, an ``imported mismatch rule'' 
prevents the effects of an offshore hybrid arrangement from being 
imported into the U.S. taxing jurisdiction through the use of a non-
hybrid arrangement. Pursuant to this rule, a specified payment is 
generally a disqualified imported mismatch amount, and therefore a 
deduction for the payment is disallowed, to the extent that the payment 
is (i) an imported mismatch payment, and (ii) income attributable to 
the payment is directly or indirectly offset by a hybrid deduction of a 
tax resident or taxable branch. See proposed Sec.  1.267A-4(a). The 
extent that a hybrid deduction directly or indirectly offsets income 
attributable to an imported mismatch payment is determined pursuant to 
a series of operating rules, including ordering rules, funding rules, 
and a pro rata allocation rule. See proposed Sec.  1.267A-4(c) and (e). 
Under these rules, a hybrid deduction is considered to offset income 
attributable to an imported mismatch payment only if the imported 
mismatch payment directly or indirectly funds the hybrid deduction. See 
proposed Sec.  1.267A-4(c).
    Some comments asserted that the imported mismatch rule is complex 
and could be difficult to administer. These comments suggested various 
ways to address these concerns. One comment suggested removing the 
imported mismatch rule because of the complexity and administrability 
concerns and also because, according to the comment, the rule exceeds 
the authority granted under section 267A. Another comment suggested 
modifying the rule such that an imported mismatch payment is a 
disqualified imported mismatch amount only if the income attributable 
to the payment is offset by a hybrid deduction that as a factual matter 
is connected to the payment; thus, under this approach, the operating 
rules under the proposed regulations would generally be replaced with a 
broader facts and circumstances inquiry, possibly supplemented by 
rebuttable presumptions. Other comments suggested modifications to 
specific aspects of the imported mismatch rule, such as the operating 
rules.
    The Treasury Department and the IRS have concluded that the general 
approach of the imported mismatch rule under the proposed regulations 
should be retained, and that the rule is consistent with the grant of 
regulatory authority under section 267A(e)(1) (regarding regulations to 
address conduit arrangements involving hybrid transactions or hybrid 
entities). The Treasury Department and the IRS have determined that the 
operating rules under the proposed regulations provide more certainty 
than under alternative approaches, such as determining disqualified 
imported mismatch amounts based on a factual tracing of hybrid 
deductions to imported mismatch payments. In addition, the Treasury 
Department and the IRS have determined that the general approach under 
the proposed regulations promotes parity between similarly situated 
taxpayers. For example, in the case of one taxpayer with an imported 
mismatch payment factually linked to a hybrid deduction and another 
taxpayer with an imported mismatch payment not factually linked to a 
hybrid deduction, only the first taxpayer's payment would be a 
disqualified imported mismatch amount under a factual tracing approach, 
even though as an economic matter (and taking into account the 
fungibility of money) the income attributable to each taxpayer's 
payment may be offset by a hybrid deduction. Further, the general 
approach under the proposed regulations is consistent with the approach 
recommended under the Hybrid Mismatch and Branch Mismatch reports, 
which would better align these rules with hybrids mismatch rules of 
other jurisdictions to ensure that imported mismatches are adequately 
addressed and do not result in a single hybrid deduction giving rise to 
a disallowance in more than one jurisdiction. See Hybrid Mismatch 
Report Recommendation 8; see also OECD/G20, Neutralising the Effects of 
Branch Mismatch Arrangements, Action 2: Inclusive Framework on BEPS 
(July 2017) Recommendation 5.
    However, in response to comments, the final regulations modify 
certain aspects of the imported mismatch rule in order to reduce 
complexity and facilitate compliance and administration of the rule. 
These modifications and others are discussed in parts III.D.2 through 5 
of this Summary of Comments and Explanation of Revisions section.
2. Imported Mismatch Payments
    Several comments suggested that the imported mismatch rule could 
result in double U.S. taxation in certain cases. For example, assume 
US1, a domestic corporation, owns all the interests of each of US2, a 
domestic corporation, and FX, a tax resident of Country X that is a CFC 
for U.S. tax purposes. Also assume that FX owns all the interests of 
FY, a tax resident of Country Y that is a disregarded entity for U.S. 
tax purposes. Lastly, assume that US2 makes a $100x non-hybrid 
specified payment to FY, and that FY incurs a $100x hybrid deduction. 
In such a case, according to the comments, treating US2's payment as a 
disqualified imported mismatch amount could result in double U.S. 
taxation, as the United States would be disallowing US2 a deduction for 
the payment even though the entire amount is indirectly included in 
US1's income as a subpart F inclusion. The comments thus requested 
modifying the imported mismatch rule such that it does not apply in 
cases like these.
    The Treasury Department and the IRS agree with these comments. As a 
result, the final regulations revise the definition of an imported 
mismatch payment, which under the proposed regulations is defined as 
any specified payment to the extent not a disqualified hybrid amount. 
Under the final regulations, a specified payment is an imported 
mismatch payment only to the extent that it is neither a disqualified 
hybrid amount nor included or includible in income in the United States 
(as determined under the rules of Sec.  1.267A-3(b)). See Sec.  1.267A-
4(a)(2)(v). Thus, in the example in the previous paragraph, none of 
US2's payment would be an imported mismatch payment, calculated as 
$100x (the amount of the payment) less $0 (the disqualified hybrid 
amount with respect to the payment), less $100x (the amount of the 
payment that is included or includible in income in the United States). 
Accordingly, none of the payment would be subject to disallowance under 
the imported mismatch rule.

[[Page 19816]]

3. Hybrid Deductions
i. Deductions Constituting Hybrid Deductions
    Under the proposed regulations, for a deduction allowed to a tax 
resident or taxable branch under its tax law to be a hybrid deduction, 
it generally must be one that would be disallowed if such tax law 
contained rules substantially similar to the rules under Sec. Sec.  
1.267A-1 through 1.267A-3 and 1.267A-5. See proposed Sec.  1.267A-4(b). 
A comment requested guidance on how this standard applies when the tax 
law of a tax resident or taxable branch contains hybrid mismatch rules. 
The comment posited several approaches, including (i) not treating 
deductions allowed to such a tax resident or taxable branch under its 
tax law as a hybrid deduction, or (ii) treating deductions allowed to a 
such a tax resident or taxable branch under its tax law as a hybrid 
deduction if the deduction would be disallowed if such tax law 
contained rules nearly identical to those under section 267A. The 
comment recommended the first approach.
    The Treasury Department and the IRS have determined that the first 
approach could give rise to inappropriate results. For example, in the 
case of a deduction allowed to a foreign tax resident under its tax law 
with respect to an interest-free loan, the deduction would not be a 
hybrid deduction under the first approach if the tax resident's tax law 
contains hybrid mismatch rules, even though the deduction would be 
disallowed under section 267A were section 267A to apply to the 
deduction. The Treasury Department and the IRS believe that these 
results could lead to avoidance of the purposes of section 267A. That 
is, the first approach could incentivize taxpayers to implement certain 
offshore hybrid arrangements and import the effects of the arrangement 
into the U.S. taxing jurisdiction, even though a deduction would be 
disallowed under section 267A were the arrangement to involve the U.S. 
taxing jurisdiction directly. Accordingly, the final regulations do not 
adopt this approach.
    However, in response to the comment, the final regulations provide 
an exclusive list of deductions that constitute hybrid deductions with 
respect to a tax resident or taxable branch the tax law of which 
contains hybrid mismatch rules. See Sec.  1.267A-4(b)(2)(i). This list, 
which represents deductions that would be disallowed under section 267A 
but may be allowed under the hybrid mismatch rules of the foreign 
country, includes deductions with respect to (i) equity, (ii) interest-
free loans (and similar arrangements), and (iii) amounts that are not 
included in income in a third foreign country. Thus, in the case of a 
tax resident or taxable branch the tax law of which contains hybrid 
mismatch rules, a taxpayer need only consider these three types of 
arrangements when determining whether the tax resident or taxable 
branch has hybrid deductions for purposes of the imported mismatch 
rule. The Treasury Department and the IRS have concluded that this 
approach increases certainty and improves the administration of the 
imported mismatch rule.
ii. NIDs
    Under the proposed regulations, a hybrid deduction includes NIDs 
allowed to a tax resident under its tax law. See proposed Sec.  1.267A-
4(b). The comments regarding NIDs in the context of section 267A were 
substantially similar to the comments regarding NIDs in the context of 
section 245A(e). See part II.B.4 of this Summary of Comments and 
Explanation of Revisions section. Thus, for reasons similar to the 
reasons discussed in that section, the final regulations generally 
retain the approach of the proposed regulations regarding NIDs, but 
provide that only NIDs allowed to a tax resident under its tax law for 
accounting periods beginning on or after December 20, 2018, are hybrid 
deductions. See Sec.  1.267A-4(b)(2)(iii).
    In addition, a comment suggested that including NIDs as a hybrid 
deduction conflicts with nondiscrimination provisions of income tax 
treaties that require interest and royalties paid by U.S. residents to 
residents of the other treaty country be deductible under the same 
conditions as if they had been paid to a resident of the United States. 
See, for example, paragraph (4) of Article 23 (Nondiscrimination) of 
the income tax convention between the United States and Belgium, signed 
November 27, 2006. However, the U.S. Treasury Department Technical 
Explanation of Article 23 of the U.S.-Belgium income tax treaty 
provides that ``. . . the common underlying premise [in each paragraph 
of the Article] is that if the difference in treatment is directly 
related to a tax-relevant difference in the situations of the domestic 
and foreign persons being compared, that difference is not to be 
treated as discriminatory. . . .'' In this case, the disallowance of a 
deduction is dependent solely on differences in U.S. tax law and the 
tax law of an imported mismatch payee (or certain other foreign 
parties), and the tax benefits allowed to the imported mismatch payee 
(or certain other foreign parties) under foreign tax law. Payments to 
related domestic persons would always be governed by the same Federal 
tax laws, and domestic law does not provide hybrid deductions, 
including NIDs, to domestic persons. Accordingly, the Treasury 
Department and the IRS have concluded that including NIDs as a hybrid 
deduction does not conflict with the nondiscrimination provision of 
applicable U.S. income tax treaties.
    The proposed regulations do not provide a rule pursuant to which 
NIDs are hybrid deductions only to the extent that the double non-
taxation produced by the NIDs is a result of hybridity. However, 
consistent with other aspects of the section 267A regulations, the 
Treasury Department and the IRS have concluded that such a rule is 
appropriate and the final regulations therefore provide a rule to this 
effect. See Sec.  1.267A-4(b)(1)(ii). Thus, for example, in the case of 
a tax resident all the interests of which are owned by an investor that 
is a tax resident of another country, NIDs allowed to the tax resident 
are not hybrid deductions if the tax law of the investor has a pure 
territorial regime (that is, only taxes income from domestic sources) 
or if such tax law does not impose an income tax.
iii. Deemed Branch Payments
    Under the proposed regulations, a hybrid deduction of a taxable 
branch includes a deduction that would be disallowed if the tax law of 
the taxable branch contained a provision substantially similar to 
proposed Sec.  1.267A-2(c) (regarding deemed branch payments). See 
proposed Sec.  1.267A-4(b). Proposed Sec.  1.267A-2(c) generally 
disallows a deduction for a deemed branch payment of a U.S. taxable 
branch only if the tax law of the home office provides an exclusion or 
exemption for income attributable to the branch. Proposed Sec.  1.267A-
2(c) thus provides a simpler standard than the dual inclusion income 
standard of proposed Sec.  1.267A-2(b) (regarding disregarded 
payments). The simpler standard applies for deemed branch payments 
because these payments may arise due to simply operating a U.S. trade 
or business (as opposed to disregarded payments that typically result 
from structured tax planning), as well as because, given that U.S. 
permanent establishments cannot consolidate or otherwise share losses 
with U.S. taxpayers, there is a more limited opportunity for a 
deduction for such payments to offset non-dual inclusion income.

[[Page 19817]]

    A comment noted that under a tax law of a foreign country a taxable 
branch could be permitted to consolidate or otherwise share losses with 
a tax resident of that country. The comment thus questioned whether, in 
the imported mismatch context, it is appropriate for the deemed branch 
payment rule to apply the branch exemption standard, rather than the 
dual inclusion income standard.
    The Treasury Department and the IRS have concluded that, in the 
imported mismatch context, the dual inclusion income standard should 
apply in cases in which the tax law of the taxable branch permits a 
loss of the taxable branch to be shared with a tax resident or another 
taxable branch, because in these cases the excess of the taxable 
branch's deemed branch payments over its dual inclusion income could 
offset non-dual inclusion income. The final regulations therefore 
provide a rule to this effect. See Sec.  1.267A-4(b)(2)(ii).
iv. Hybrid Deductions of CFCs
    Under the proposed regulations, only a tax resident or taxable 
branch that is not a specified party can incur a hybrid deduction. See 
proposed Sec.  1.267A-4(b). Similarly, under the proposed regulations, 
only a tax resident or a taxable branch that is not a specified party 
can make a funded taxable payment. See proposed Sec.  1.267A-4(c)(3). 
This approach was generally intended to ensure that section 267A does 
not result in double U.S. taxation in cases of specified payments 
involving CFCs, because payments to CFCs are generally includible in 
income in the United States and payments by CFCs are generally subject 
to disallowance as disqualified hybrid amounts.
    A comment noted that this approach could lead to inappropriate 
results in certain cases. For example, it could lead to the avoidance 
of the imported mismatch rule through the use CFCs that are not wholly-
owned by tax residents of the United States. The comment therefore 
recommended that the final regulations provide that CFCs can incur 
hybrid deductions and make funded taxable payments. However, to prevent 
double U.S. taxation, the comment suggested that a payment by a CFC not 
give rise to a hybrid deduction or a funded taxable payment to the 
extent that the payment gives rise to an increase in the U.S. tax base.
    The Treasury Department and the IRS agree with the comment and the 
final regulations therefore provide that CFCs can incur hybrid 
deductions and make funded taxable payments. See Sec.  1.267A-4(b)(1) 
and (c)(3)(v). The final regulations also provide rules to ensure that 
a hybrid deduction or funded taxable payment of a CFC does not include 
an amount that is a disqualified hybrid amount or included or 
includible in income in the United States (as determined under the 
rules of Sec.  1.267A-3(b)). See Sec.  1.267A-4(b)(2)(iv) and 
(c)(3)(v)(C). However, in the case of a disqualified hybrid amount of a 
CFC that is only partially owned by tax residents of the United States 
(or a disqualified hybrid amount a deduction for which would be 
allocated and apportioned to income not subject to U.S. tax), only a 
portion of the disqualified hybrid amount prevents a payment of the CFC 
from giving rise to a hybrid deduction or a funded taxable payment, as 
disallowing the CFC a deduction for the disqualified hybrid amount will 
only partially increase the U.S. tax base (or will not increase the 
U.S. tax base at all). See Sec.  1.267A-4(g). A new example illustrates 
these rules. See Sec.  1.267A-6(c)(11).
4. Setoff Rules
i. Funded Taxable Payments
    Under the proposed regulations, for an imported mismatch payment to 
indirectly fund a hybrid deduction, the imported mismatch payee must 
directly or indirectly make a funded taxable payment to the tax 
resident or taxable branch that incurs the hybrid deduction. See 
proposed Sec.  1.267A-4(c)(3). A comment requested that the final 
regulations clarify that, for a payment to be a funded taxable payment, 
it must be included in income of a tax resident or taxable branch. The 
Treasury Department and the IRS agree with the comment and the final 
regulations thus provide a clarification to this effect. See Sec.  
1.267A-4(c)(3)(v)(B).
ii. Hybrid Deduction First Offsets Imported Mismatch Payment With 
Closest Nexus to Deduction
    Under the proposed regulations, when there are multiple imported 
mismatch payments, a hybrid deduction is first considered to offset 
income attributable to the imported mismatch payment that has the 
closest nexus to the hybrid deduction. See proposed Sec. Sec.  1.267A-
4(c)(2) and 1.267A-6(c)(10). For example, in the case of two imported 
mismatch payments, one of which is made pursuant to a transaction 
entered into pursuant to the same plan pursuant to which the hybrid 
deduction is incurred (a ``factually-related imported mismatch 
payment'') and the other of which is not a factually-related imported 
mismatch payment, the hybrid deduction is first considered to offset 
income attributable to the factually-related imported mismatch payment. 
As an additional example, in the case of two imported mismatch 
payments, one of which is directly connected to a hybrid deduction 
(because the imported mismatch payee with respect to the payment is the 
tax resident or taxable branch that incurs the hybrid deduction) and 
the other of which is indirectly connected to the hybrid deduction 
(because the imported mismatch payee with respect to the payment makes 
a funded taxable payment to the tax resident or taxable branch that 
incurs the hybrid deduction), the hybrid deduction is first considered 
to offset income attributable to the imported mismatch payment that is 
directly connected to the hybrid deduction.
    The final regulations retain this approach and provide two 
clarifications. First, the final regulations clarify that an imported 
mismatch payment is a factually-related imported mismatch payment--and 
therefore is given priority in terms of funding the hybrid deduction 
over other imported mismatch payments--only if a design of the plan or 
series of related transactions pursuant to which the hybrid deduction 
is incurred was for the hybrid deduction to offset income attributable 
to the payment. See Sec.  1.267A-4(c)(2)(i).
    Second, the final regulations clarify that when there are multiple 
imported mismatch payments that are indirectly connected to the tax 
resident or taxable branch that incurs the hybrid deduction, the hybrid 
deduction is first considered to offset income attributable to an 
imported mismatch payment that is connected, through the fewest number 
of funded taxable payments, to the tax resident or taxable branch that 
incurs the hybrid deduction. See Sec.  1.267A-4(c)(3)(vii) and (viii). 
For example, in the case of back-to-back imported mismatch payments, 
the first such payment is given priority over more removed imported 
mismatch payments.
iii. Relatedness Requirement
    Under the proposed regulations, a hybrid deduction offsets income 
attributable to an imported mismatch payment only if the tax resident 
or taxable branch that incurs the hybrid deduction is related to the 
imported mismatch payer (or is a party to a structured arrangement 
pursuant to which the payment is made). See proposed Sec.  1.267A-4(a). 
A comment requested that, for an imported mismatch payment to 
indirectly fund a hybrid deduction and thus be offset by the deduction, 
the imported mismatch payee (and, if applicable, each intermediary tax 
resident or taxable

[[Page 19818]]

branch in the chain of funded taxable payments) must be related to the 
imported mismatch payer (or a party to a structured arrangement 
pursuant to which the payment is made). The Treasury Department and the 
IRS agree with the comment and the final regulations therefore provide 
rules to this effect. See Sec.  1.267A-4(c)(3)(ii) and (iv).
5. Coordination With Foreign Imported Mismatch Rules
i. Certain Payments Deemed To Be Imported Mismatch Payments
    The proposed regulations coordinate the U.S. imported mismatch rule 
with foreign imported mismatch rules, in order to prevent the same 
hybrid deduction from resulting in deductions for non-hybrid payments 
being disallowed under imported mismatch rules in more than one 
jurisdiction. In general, the proposed regulations do so through a 
special rule pursuant to which certain payments by non-specified 
parties are deemed to be imported mismatch payments (the ``Deemed IMP 
Rule''). See proposed Sec.  1.267A-4(f). In certain cases, the effect 
of the Deemed IMP Rule is that the rule reduces the extent to which a 
payment of a specified party is considered to fund a hybrid deduction 
(and therefore reduces the extent to which the hybrid deduction is 
considered to offset the income attributable to the imported mismatch 
payment). For example, a hybrid deduction may be considered directly 
funded by a payment of a non-specified party, rather than indirectly 
funded by a payment of a specified party; or, a hybrid deduction may be 
considered pro rata funded by a payment of a specified party and a 
payment of a non-specified party, rather than solely funded by the 
payment of the specified party. Under the proposed regulations, the 
Deemed IMP Rule applies only to payments by a tax resident or taxable 
branch the tax law of which contains hybrid mismatch rules, and only to 
the extent that pursuant to an imported mismatch rule under such tax 
law, the tax resident or taxable branch is denied a deduction for all 
or a portion of the payment.
    Comments recommended modifying the Deemed IMP Rule so that it takes 
into account payments subject to disallowance under a foreign imported 
mismatch rule, rather than payments a deduction for which is actually 
denied under the foreign imported mismatch rule. According to a 
comment, this would obviate the need for taxpayers to apply all foreign 
imported mismatch rules before the U.S. imported mismatch rule, 
determine which payments are ones for which a deduction is disallowed 
under the foreign rules, and then treat those payments as imported 
mismatch payments for purposes of the U.S. imported mismatch rule.
    The Treasury Department and the IRS generally agree with these 
comments and the final regulations therefore modify the Deemed IMP Rule 
to this effect. See Sec.  1.267A-4(f)(2). However, as discussed in part 
III.D.5.ii of this Summary of Comments and Explanation of Revisions 
section, the final regulations adjust the application of the imported 
mismatch rule in certain cases, in order to prevent the Deemed IMP Rule 
from giving rise to inappropriate results.
ii. Special Rules for Applying Imported Mismatch Rule
    In cases in which the U.S. imported mismatch rule treats a 
deduction as a hybrid deduction but a foreign imported mismatch rule 
does not, the Deemed IMP Rule could give rise to inappropriate results. 
For example, consider a case in which FW, a tax resident of Country W, 
owns all the interests of FX, a tax resident of Country X, which owns 
all the interests of FZ, a tax resident of Country Z (the tax law of 
which contains hybrid mismatch rules), and FZ owns all the interests of 
US1, a domestic corporation. Assume that US1 makes a non-hybrid 
interest payment to FZ (which FZ includes in income), FZ makes a non-
hybrid interest payment to FX (which FX includes in income), FX makes a 
payment to FW that is considered a hybrid deduction for purposes of the 
U.S. imported mismatch rule, and no other payments are made during the 
accounting period. Further, assume that FZ's payment is subject to 
disallowance under the Country Z imported mismatch rule, but that the 
Country Z imported mismatch rule does not treat FX's deduction as a 
hybrid deduction (for example, because it is with respect to an 
interest-free loan). If pursuant to the Deemed IMP Rule FZ's payment 
were deemed to be an imported mismatch payment, then, given that FZ's 
payment has a closer nexus to FX's hybrid deduction than US1's payment, 
the hybrid deduction would, for purposes of the U.S. imported mismatch 
rule, offset only the income attributable to FZ's payment. The Deemed 
IMP Rule would thus lead to neither the United States nor Country Z 
neutralizing the D/NI outcome produced by the hybrid arrangement, 
thereby creating a result contrary to the purpose of the rule.
    To address this concern, the final regulations provide that the 
U.S. imported mismatch rule is first applied by taking into account 
only certain hybrid deductions--that is, deductions that are unlikely 
to be treated as hybrid deductions for purposes of a foreign hybrid 
mismatch rule. See Sec.  1.267A-4(f)(1). The final regulations provide 
an exclusive list of such hybrid deductions, which covers the hybrid 
deductions similar to those on the list discussed in part III.D.3.i of 
this Summary of Comments and Explanation of Revisions section. See id. 
In addition, for purposes of applying the imported mismatch rule in 
this manner, the Deemed IMP Rule does not apply. Consequently, such 
hybrid deductions are considered to offset only income attributable to 
imported mismatch payments of specified parties. This approach 
generally ensures that a foreign imported mismatch rule does not turn 
off the U.S. imported mismatch rule in cases in which the foreign 
imported mismatch rule is unlikely to neutralize the D/NI outcome 
produced by the hybrid arrangement.
    For all other hybrid deductions, the imported mismatch rule is 
applied by taking into account the Deemed IMP Rule. See Sec.  1.267A-
4(f)(2). This generally ensures that, for deductions that are likely to 
be treated as hybrid deductions for both the U.S. and a foreign 
imported mismatch rule, there is a coordination mechanism to mitigate 
the likelihood of double-tax.
iii. Payments to a Country the Tax Law of Which Contains Hybrid 
Mismatch Rules
    Several comments suggested a special rule pursuant to which an 
imported mismatch payment is exempt from the U.S. imported mismatch 
rule if the tax law of the imported mismatch payee contains hybrid 
mismatch rules. According to the comments, such an approach would 
generally rely on an imported mismatch rule of the imported mismatch 
payee to neutralize the effects of offshore hybrid arrangements that 
have a closer nexus to the country of the imported mismatch payee than 
the United States.
    The final regulations do not incorporate a special rule to this 
effect because the Treasury Department and the IRS have determined that 
such a rule could give rise to inappropriate results similar to those 
discussed in part III.D.5.ii of this Summary of Comments and 
Explanation of Revisions section. In addition, the Treasury Department 
and the IRS have concluded that when the U.S. imported mismatch rule is 
applied by taking into account the Deemed IMP Rule, the Deemed IMP 
Rule--in conjunction with other portions of the

[[Page 19819]]

imported mismatch rule, such as the ordering and funding rules 
(including the waterfall approach)--generally obviates the need for the 
special rule. That is, when a hybrid deduction has a closer nexus to 
the country of the imported mismatch payee than the United States, the 
hybrid deduction is generally considered to offset income attributable 
to the imported mismatch payee's payment, rather than income 
attributable to the specified party's payment. As a result, the U.S. 
imported mismatch rule in effect relies on an imported mismatch rule of 
the imported mismatch payee to neutralize the effect of the offshore 
hybrid arrangement. See Sec.  1.267A-6(c)(10)(iv) and (c)(12).
iv. Priority for Certain Amounts Disallowed Under Foreign Imported 
Mismatch Rule
    One comment suggested a new coordination rule pursuant to which, to 
the extent that a foreign tax resident or taxable branch is disallowed 
a deduction for a payment under a foreign imported mismatch rule, the 
U.S. imported mismatch rule generally considers a hybrid deduction to 
offset income attributable to that payment before offsetting income 
attributable to other payments. Such an approach would in effect 
provide as a credit against the U.S. imported mismatch rule amounts 
disallowed under a foreign imported mismatch rule. According to the 
comment, such an approach would mitigate the chance of double tax and 
would be appropriate if the main purpose of the U.S. imported mismatch 
rule is to participate with the international community in neutralizing 
the effects of hybrid arrangements (as opposed to protecting the 
integrity of the U.S. tax base).
    The final regulations do not adopt this comment. The Treasury 
Department and the IRS have concluded that when a hybrid deduction has 
a closer nexus to the United States than a foreign country, the U.S. 
imported mismatch rule--rather than the foreign imported mismatch 
rule--should apply to neutralize the effects of the offshore hybrid 
arrangement. In addition, the Treasury Department and the IRS have 
determined that, for purposes of administrability, the U.S. imported 
mismatch rule should not require an analysis of amounts actually 
disallowed under a foreign imported mismatch rule. See also part 
III.D.5.i of this Summary of Comments and Explanation of Revisions 
section.

E. Other Issues

1. Definition of Interest
    As explained in the preamble to the proposed regulations, the 
definition of interest in proposed Sec.  1.267A-5(a)(12) is based on, 
and is similar in scope as, the definition of interest contained in the 
proposed regulations under section 163(j); no comments were received on 
this definition. However, the Treasury Department and IRS received 
numerous comments on the definition of interest in the proposed 
regulations under section 163(j). Taking into account those comments, 
the final regulations modify the definition of interest for section 
267A purposes in certain respects. For example, in view of comments 
recommending modification of the hedging rules, the final regulations 
under section 267A do not include rules requiring adjustments to the 
amount of interest expense to reflect the impact of derivatives that 
alter a taxpayer's effective cost of borrowing. See Sec.  1.267A-
5(a)(12). As another example, in view of comments regarding the 
treatment of swaps with nonperiodic payments, the final regulations 
provide exceptions for cleared swaps and for non-cleared swaps subject 
to margin or collateral requirements. See Sec.  1.267A-5(a)(12)(ii).
2. Structured Payments Treated as Interest
    In order to address certain structured transactions, the proposed 
regulations provide that structured payments are treated as specified 
payments and therefore are subject to section 267A. See proposed Sec.  
1.267A-5(b)(5)(i). Under the proposed regulations, structured payments 
include certain payments related to, or predominantly associated with, 
the time value of money, and adjustments for amounts affecting the 
effective cost of funds. See proposed Sec.  1.267A-5(b)(5)(ii). A 
comment noted that under the proposed regulations it is unclear in 
certain cases whether structured payments are treated as identical to 
interest for purposes of section 267A. The comment suggested that the 
final regulations address this ambiguity, including by providing that 
structured payments are treated as identical to interest or including 
structured payments within the definition of interest. The Treasury 
Department and the IRS agree with the comment, and thus the final 
regulations clarify that structured payments are treated as identical 
to interest for purposes of section 267A. See Sec.  1.267A-5(b)(5)(i).
    In addition, the final regulations modify the definition of a 
structured payment in light of comments that the Treasury Department 
and the IRS received regarding the definition of interest in the 
proposed regulations under section 163(j). Under proposed Sec.  1.267A-
5(b)(5)(ii), certain amounts that are closely related to interest and 
that affect the economic cost of funds, such as commitment fees, debt 
issuance costs, and guaranteed payments, are treated as structured 
payments. The final regulations do not specifically include these items 
as part of the definition of structured payments; instead, the final 
regulations provide an anti-avoidance rule under which any expense or 
loss that is economically equivalent to interest is treated as a 
structured payment for purposes of section 267A if a principal purpose 
of structuring the transaction is to reduce an amount incurred by the 
taxpayer that otherwise would have been treated as interest or as a 
structured payment under Sec.  1.267A-5(a)(12) or (b)(5)(ii). See Sec.  
1.267A-5(b)(5)(ii)(B).
3. Coordination With Capitalization and Recovery Provisions
    A comment noted that in certain cases a structured payment may not 
be deductible under the Code and, instead, the payment may be 
capitalized and give rise to amortization or depreciation deductions. 
The comment suggested that the final regulations clarify how section 
267A applies to such payments, including whether the payments are 
treated as ``paid or accrued'' for purposes of the regulations and 
whether amortization or depreciation deductions for the payments are 
subject to disallowance under section 267A. The comment asserted that 
the disallowance of deductions relating to capitalized costs should be 
limited to structured payments.
    The final regulations provide that section 267A applies to a 
structured payment, including a capitalized cost, in the same manner as 
if it were an amount of interest paid or accrued. See Sec.  1.267A-
5(b)(5)(i). In addition, the final regulations coordinate section 267A 
with the capitalization and recovery provisions of the Code. See Sec.  
1.267A-5(b)(1)(iii). Pursuant to this rule, to the extent a specified 
payment is described in Sec.  1.267A-1(b) (that is, a disqualified 
hybrid amount, a disqualified imported mismatch amount, or one to which 
the section 267A anti-avoidance rule applies), a deduction for the 
payment is considered permanently disallowed for all purposes of the 
Code and, therefore, the payment is not taken into account for purposes 
of any capitalization and recovery provision. See id. But see Sec.  
1.267A-5(b)(4) (a payment for which a

[[Page 19820]]

deduction is disallowed may still reduce the corporation's earnings and 
profits). This rule is not limited to structured payments because the 
Treasury Department and the IRS have determined that, if the rule were 
so limited, deductions for other specified payments could 
inappropriately give rise to D/NI outcomes through, for example, 
depreciation or amortization deductions.
4. Structured Arrangements
i. Definition
    Under the proposed regulations, an arrangement is a structured 
arrangement if either (i) a pricing test is satisfied, meaning that a 
hybrid mismatch is priced into the terms of the arrangement, or (ii) a 
principal purpose test is satisfied, meaning that, based on all the 
facts and circumstances, a hybrid mismatch is a principal purpose of 
the arrangement. See proposed Sec.  1.267A-5(a)(20).
    A comment suggested that the principal purpose test could be 
difficult to apply, as it requires a subjective analysis of actual 
motivation or intent. In addition, the comment noted that in certain 
cases it might not be clear whose actual motivation or intent controls 
for purposes of the test. Thus, the comment suggested replacing the 
principal purpose test with an objective test, such as a test that 
analyzes whether the arrangement was designed to produce the hybrid 
mismatch. Further, the comment suggested incorporating a ``reason to 
know'' standard into the structured arrangement rules, such that a tax 
resident or taxable branch would not be considered a party to a 
structured arrangement if the tax resident or taxable branch (or a 
related party) could not reasonably have been expected to be aware of 
the hybrid mismatch. Lastly, the comment noted that having a pricing 
test as an independent test could potentially lead to confusion if the 
other test (that is, the principal purpose test or the design test) 
also takes into account pricing considerations.
    The Treasury Department and the IRS agree with this comment. Thus, 
the final regulations provide for an objective design test, incorporate 
a reason to know standard, and incorporate the pricing test into the 
design test. See Sec.  1.267A-5(a)(20).
ii. Applicability Date
    A comment asserted that it may be difficult or costly to unwind a 
structured arrangement between unrelated parties. In order to 
facilitate restructuring of these arrangements, the comment suggested 
transitional relief for specified payments made pursuant to structured 
arrangements entered into on or before December 20, 2018 (or, 
alternatively, before December 22, 2017, the date of the Act). For 
example, the comment suggested that specified payments made pursuant to 
such arrangements be subject to section 267A beginning January 1, 2021.
    The Treasury Department and the IRS have determined that, to 
facilitate restructurings intended to eliminate or minimize hybridity 
for structured arrangements entered into before December 22, 2017, the 
final regulations should apply to specified payments made pursuant to 
such an arrangement only for taxable years beginning after December 31, 
2020. The final regulations therefore provide a rule to this effect. 
See Sec.  1.267A-7(b)(2).
5. De Minimis Exception
    The proposed regulations include a de minimis exception that 
exempts a specified party from the application of section 267A for any 
taxable year for which the sum of the specified party's interest and 
royalty deductions (plus interest and royalty deductions of any related 
specified parties) is below $50,000. See proposed Sec.  1.267A-1(c). 
This $50,000 threshold takes into account a specified party's interest 
or royalty deductions without regard to whether the deductions involve 
hybrid arrangements and therefore, absent the de minimis exception, 
would be disallowed under section 267A. See id.
    A comment suggested that the $50,000 threshold instead should apply 
to the total amount of interest or royalty deductions involving hybrid 
or branch arrangements. The comment suggested that such an approach 
would produce more equitable results between similarly situated 
taxpayers. The Treasury Department and the IRS agree with the comment, 
and the final regulations thus modify the de minimis exception to this 
effect. See Sec.  1.267A-1(c). In addition, for purposes of clarity, 
and because certain specified payments may not be deductible under the 
Code (but, instead, may be capitalized and give rise to other 
deductions, such as amortization or depreciation, or loss), the final 
regulations replace the reference in the de minimis exception to 
interest or royalty deductions with a reference to specified payments.
6. Tax Law of a Country
    The proposed regulations define a tax law of a country to include 
statutes, regulations, administrative or judicial rulings, and treaties 
of the country. See proposed Sec.  1.267A-5(a)(21). However, as 
discussed in part II.B.7 of this Summary of Comments and Explanation of 
Revisions section, the Treasury Department and the IRS have determined 
that it is appropriate to take into account a country's subnational tax 
laws when such laws impose income taxes that are covered taxes under an 
income tax treaty with the United States (and therefore are likely to 
comprise a significant amount of a taxpayer's overall tax burden in 
that country). The final regulations therefore provide that the tax law 
of a country includes the tax law of a political subdivision or other 
local authority of a country, provided that income taxes imposed under 
such a subnational tax law are covered by an income tax treaty between 
that country and the United States. See Sec.  1.267A-5(a)(21).
7. Specified Parties
    Under the proposed regulations, a specified party includes a CFC 
for which there are one or more U.S. shareholders that own (within the 
meaning of section 958(a)) at least ten percent of the stock of the 
CFC. See proposed Sec.  1.267A-5(a)(17). However, the Treasury 
Department and the IRS have determined that in certain cases involving 
CFCs the definition of specified party could be overbroad. For example, 
under the proposed regulations, a CFC wholly owned by a domestic 
partnership is a specified party, even if all the partners of the 
partnership are foreign persons.
    The final regulations thus provide that a CFC is a specified party 
only if there is a tax resident of the United States that, for purposes 
of sections 951 and 951A, owns (within the meaning of section 958(a), 
but for this purpose treating a domestic partnership as foreign) at 
least ten percent of the stock of the CFC. The Treasury Department and 
the IRS expect that when proposed regulations under section 958 (REG-
101828-19, 84 FR 29114) are finalized, the rule described in the 
preceding sentence treating a domestic partnership as foreign will be 
removed, as it will no longer be necessary. See proposed Sec.  1.958-
1(d)(1).
8. Coordination With Section 163(j)
    The proposed regulations provide a rule to coordinate section 267A 
with other provisions of the Code. See proposed Sec.  1.267A-5(b)(1). A 
comment requested that the final regulations clarify that section 267A 
applies to a specified payment before section 163(j) applies to the 
payment.
    The final regulations provide a clarification to this effect. See 
Sec.  1.267A-5(b)(1)(ii). In addition, the final regulations clarify 
that to the extent a

[[Page 19821]]

specified payment is not described in Sec.  1.267A-1(b) at the time it 
is subject to section 267A, the payment is not again subject to section 
267A at a subsequent time. See Sec.  1.267A-5(b)(1)(i). For example, if 
for the taxable year in which a specified payment is paid the payment 
is not described in Sec.  1.267A-1(b) but under section 163(j) a 
deduction for the payment is deferred, the payment is not again subject 
to section 267A in the taxable year for which section 163(j) no longer 
defers the deduction.
9. Anti-Avoidance Rule
    The proposed regulations include an anti-avoidance rule, which 
provides that a specified party's deduction for a specified payment is 
disallowed to the extent it gives rise to a D/NI outcome, and a 
principal purpose of the plan or arrangement is to avoid the purposes 
of the regulations under section 267A. See proposed Sec.  1.267A-
5(b)(6).
    One comment supported a purpose-based anti-avoidance rule, in 
general, but questioned whether the rule was appropriate in the context 
of the section 267A regulations--which sets forth detailed rules 
regarding the hybrid or branch arrangements addressed by section 267A--
and whether the rule appropriately balances fairness and 
administrability. The comment also raised concerns that the anti-
avoidance rule may be overly broad because it neither requires 
hybridity nor that the D/NI outcome be the cause of hybridity. Finally, 
the comment requested a clearer distinction between the structured 
arrangement rule and the anti-avoidance rule, and recommended that the 
anti-avoidance rule focus on the use of a specific structure or terms 
in order to accomplish a D/NI outcome while avoiding the application of 
the regulations.
    The Treasury Department and the IRS have determined that it is 
appropriate for the final regulations to retain a general anti-
avoidance rule because, even in the context of specific rules that 
target hybrid and branch arrangements, such rules might be circumvented 
in a manner that is contrary to the purposes of the section 267A 
regulations. However, the Treasury Department and the IRS agree with 
the comment that the anti-avoidance rule should focus on the terms or 
structure of an arrangement and require that the D/NI outcome produced 
is a result of a hybrid or branch arrangement. The final regulations 
thus provide rules to this effect. See Sec.  1.267A-5(b)(6).
10. Effect of Disallowance on Earnings and Profits
    The proposed regulations provide that the disallowance of a 
deduction under section 267A does not affect a corporation's earnings 
and profits. See proposed Sec.  1.267A-5(b)(4). Thus, a corporation's 
earnings and profits may be reduced as a result of a specified payment 
for which a deduction is disallowed under section 267A. One comment 
stated that this rule is generally appropriate. However, the comment 
questioned whether the rule is appropriate in the context of a CFC, as 
the reduction of the CFC's earnings and profits may, because of the 
limit in section 952(c)(1), limit or prevent a subpart F inclusion with 
respect to the CFC, thereby negating the effect of disallowing the 
CFC's deduction.
    The Treasury Department and the IRS agree with the comment and, 
accordingly, the final regulations adopt an anti-avoidance rule. See 
Sec.  1.267A-5(b)(4). Pursuant to this rule, for purposes of section 
952(c)(1) or Sec.  1.952-1(c), a CFC's earnings and profits are not 
reduced by a specified payment for which a deduction is disallowed if a 
principal purpose of the transaction giving rise to the specified 
payment is to reduce or limit the CFC's subpart F income. See id.

IV. Comments and Revisions to Dual Consolidated Loss Rules and Entity 
Classification Rules

A. Domestic Reverse Hybrids

    To address double-deduction outcomes that result from domestic 
reverse hybrid structures, the proposed regulations require, as a 
condition to a domestic entity electing to be treated as a corporation 
under Sec.  301.7701-3(c), that the domestic entity agree to be treated 
as a dual resident corporation for purposes of section 1503(d) for 
taxable years in which certain requirements are satisfied. See proposed 
Sec.  301.7701-3(c)(3).
    A comment agreed with the policy rationale for subjecting domestic 
reverse hybrids to the section 1503(d) regulations, and recommended 
that losses of domestic reverse hybrids be treated as dual consolidated 
losses. However, the comment expressed concern that the approach of the 
proposed regulations might establish a precedent allowing for a check-
the-box election to be conditioned on consenting to any rule, which the 
comment asserted would be contrary to sound tax policy. Nonetheless, 
the comment stated that the section 1503(d) regulations are closely 
connected to the check-the-box regime, and acknowledged that a consent 
approach had been noted in a comment on regulations under section 
1503(d) that were proposed in 2005. See TD 9315, 74 FR 12902. The 
comment recommended that, rather than the approach of the proposed 
regulations, the Treasury Department and the IRS directly subject 
domestic reverse hybrids to section 1503(d) or, if the Treasury 
Department and the IRS were to determine that there is not sufficient 
authority to do so, seek a legislative amendment.
    The Treasury Department and the IRS have determined that it is 
appropriate to condition a check-the-box election on consenting to be 
subject to the section 1503(d) regulations because the double-deduction 
concerns that result from domestic reverse hybrid structures are 
closely connected to the check-the-box regime. Moreover, as explained 
in the preamble to the proposed regulations, the approach of the 
proposed regulations is narrowly tailored such that the consent applies 
only for taxable years in which it is likely that losses of the 
domestic consenting corporation could result in a double-deduction 
outcome. The Treasury Department and the IRS have therefore determined 
that the approach of the proposed regulations is appropriate and 
consistent with ensuring that the check-the-box regime does not result 
in double-deduction outcomes. Accordingly, the final regulations retain 
the approach of the proposed regulations regarding domestic reverse 
hybrids.

B. Disregarded Payments Made to Domestic Corporations

    The preamble to the proposed regulations describes certain 
structures involving payments from foreign disregarded entities to 
their domestic corporate owners that are regarded for foreign tax 
purposes but disregarded for U.S. tax purposes. The preamble notes that 
these disregarded payment structures are not addressed under the 
current section 1503(d) regulations but give rise to significant policy 
concerns that are similar to those arising under sections 245A(e), 
267A, and 1503(d). In addition, the preamble states that the Treasury 
Department and the IRS are studying these structures and request 
comments. In response to this request, one comment was received.
    The Treasury Department and the IRS continue to study disregarded 
payment structures and the comment, and may in the future issue 
guidance addressing these structures. In addition, the Treasury 
Department and the IRS are studying other issues and comments received 
regarding the section 1503(d)

[[Page 19822]]

regulations, such as an issue involving the interaction of the section 
1503(d) regulations and the matching rule under Sec.  1.1502-13(c).

Special Analyses

I. Regulatory Planning and Review--Economic Analysis

    Executive Orders 13771, 13563, and 12866 direct agencies to assess 
costs and benefits of available regulatory alternatives and, if 
regulation is necessary, to select regulatory approaches that maximize 
net benefits (including potential economic, environmental, public 
health and safety effects, distributive impacts, and equity). Executive 
Order 13563 emphasizes the importance of quantifying both costs and 
benefits, of reducing costs, of harmonizing rules, and of promoting 
flexibility. For purposes of Executive Order 13771, this rule is 
regulatory.
    The Office of Information and Regulatory Affairs has designated the 
proposed regulations as significant under section 1(b) of the 
Memorandum of Agreement. between the Treasury Department and the Office 
of Management and Budget (OMB) regarding review of tax regulations 
(April 11, 2018). Accordingly, the OMB has reviewed the final 
regulations.

A. Background

    Multinational corporations (MNCs) that have operations in both the 
U.S. and foreign countries can engage in so-called ``hybrid 
arrangements.'' In some instances, the MNC structures its U.S. and 
foreign operations in a way that exploits differences between foreign 
tax rules and U.S. tax rules. By using particular organizational 
structures or financial instruments, the MNC can avoid paying taxes in 
one or both jurisdictions. Hybrid arrangements refer to particular 
strategies for achieving this type of tax outcome.
    Hybrid arrangements may be ``hybrid entities'' or ``hybrid 
instruments.'' A hybrid entity is a business that is treated as a flow-
through or so-called disregarded entity for U.S. tax purposes and as a 
corporation for foreign tax purposes. A ``reverse hybrid entity'' is a 
business that is treated as a corporation for U.S. tax purposes, but as 
a flow-through entity for foreign tax purposes. For example, a foreign 
parent could own a domestic limited liability partnership that elects 
to be treated as a corporation under U.S. tax law \4\ but is viewed as 
a partnership under foreign tax law. In this situation, the domestic 
subsidiary could be entitled to a deduction for U.S. tax purposes for 
interest payments it makes to the foreign parent, but the foreign 
country would not tax the interest income of the foreign parent because 
it treats it as payment between a partnership and a partner. In plain 
language, the result is that this portion of income would not be taxed 
in either country. This outcome is possible because of both the 
difference in the recognized business structure across countries (for 
the same business) and differences in the tax treatment applied to 
different business structures.
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    \4\ Treasury and IRS regulations contain a so-called ``check-
the-box'' provision under which certain taxpayers can choose whether 
they are treated as a corporation or as a partnership or disregarded 
entity. It is this election that facilitates the creation of hybrid 
entities.
---------------------------------------------------------------------------

    A similar result is possible under a hybrid instrument. A hybrid 
instrument is a financial instrument with characteristics of both debt 
and equity. Because the instrument has a mix of characteristics, one 
country may treat the instrument as debt while another country may 
treat it as equity. An example is ``perpetual debt,'' which the United 
States generally treats as equity and which many other countries treat 
as debt. If a foreign affiliate of a U.S.-based MNC issues perpetual 
debt to a U.S. holder, the interest payments made to the U.S. holder 
would be tax deductible in the foreign jurisdiction (if the foreign 
country treats perpetual debt as debt) and could potentially be 
eligible for a dividends received deduction (DRD) in the United States, 
which treats perpetual debt as equity. Again, the result is that this 
portion of income would not be taxed in either country. The double non-
taxation produced by hybrid instruments or deductible payments made by 
or to a hybrid entity is often referred to as a ``deduction/no-
inclusion outcome'' (D/NI outcome).
    The Act introduced two new provisions that affect the treatment of 
these hybrid arrangements. New section 245A(e) disallows the DRD for 
any dividend received by a U.S. shareholder from a controlled foreign 
corporation if the dividend is a hybrid dividend. In addition, section 
245A(e) treats hybrid dividends between controlled foreign corporations 
with a common U.S. shareholder as subpart F income. The statute defines 
a hybrid dividend as an amount received from a controlled foreign 
corporation for which a deduction would be allowed under section 
245A(a) and for which the controlled foreign corporation received a 
deduction or other tax benefit in a foreign country. The disallowance 
of the DRD for hybrid dividends and the treatment of hybrid dividends 
as subpart F income neutralize the D/NI outcome produced by hybrid 
dividends.
    The Act also added section 267A of the Code, which denies a 
deduction for any disqualified related party amount paid or accrued as 
a result of a hybrid transaction or by, or to, a hybrid entity. The 
statute defines a disqualified related party amount as any interest or 
royalty paid or accrued to a related party where there is no 
corresponding inclusion to the related party in the foreign tax 
jurisdiction or where the related party is allowed a deduction with 
respect to such amount in the foreign tax jurisdiction. The statute's 
definition of a hybrid transaction is any transaction where there is a 
mismatch in tax treatment between the U.S. and the other foreign 
jurisdiction. Similarly, a hybrid entity is any entity which is treated 
as fiscally transparent (that is, a flow-through or disregarded entity) 
for U.S. tax purposes but not for purposes of the foreign tax 
jurisdiction, or vice versa. The statute provides regulatory authority 
to address overly broad or under-inclusive applications of section 
267A.
    The Treasury Department and the IRS previously issued proposed 
regulations under sections 245A(e), 267A, 1503(d), 6038, 6038A, 6038C, 
and 7701 on December 20, 2018.

B. Overview of the Final Regulations

    These final regulations provide clarity to taxpayers regarding the 
determination and tracking of hybrid dividends. They also provide 
clarity and guidance on the disallowance of deductions for interest or 
royalties paid as a result of hybrid or branch arrangements.
1. Section 245A(e)
    Section 245A(e) applies in certain cases in which a CFC pays a 
hybrid dividend, which is a dividend paid by the CFC for which the CFC 
received a deduction or other tax benefit under foreign tax law (a 
hybrid deduction). The proposed regulations provide rules for 
identifying hybrid deductions and hybrid dividends. They further 
require taxpayers to maintain ``hybrid deduction accounts'' by which 
taxpayers would track those hybrid deductions. These accounts would 
allow for CFCs to track the amounts of hybrid deductions across sources 
and years and properly reduce the amounts when they are considered to 
give rise to inclusions under U.S. tax law. The final regulations 
largely retain the decisions made in the proposed regulations and 
provide additional clarity on what is a hybrid deduction and how the 
hybrid deduction account rules operate.

[[Page 19823]]

2. Section 267A
    Section 267A disallows a deduction for interest or royalties paid 
or accrued in certain transactions involving a hybrid arrangement. 
Congress intended this provision to address cases in which the taxpayer 
is provided a deduction under U.S. tax law, but the payee does not have 
a corresponding income inclusion under foreign tax law (the D/NI 
outcome). See S. Comm. on the Budget, Reconciliation Recommendations 
Pursuant to H. Con. Res. 71, S. Print No. 115-20, at 389 (2017).
    The proposed regulations disallow a deduction under section 267A 
only to the extent that the D/NI outcome is a result of a hybrid 
arrangement. Consistent with the grant of regulatory authority to 
address overly broad applications of section 267A, the proposed 
regulations provide several exceptions to section 267A in order to 
refine the scope of the provision and minimize burdens on taxpayers, 
and further provide de minimis rules that except small taxpayers from 
section 267A. Finally, the proposed regulations address the treatment 
of a comprehensive set of arrangements that give rise to D/NI outcomes 
to close off potential avenues for additional tax avoidance by applying 
the rules of section 267A to branch mismatches, reverse hybrids, 
certain transactions with unrelated parties that are structured to 
achieve D/NI outcomes, certain structured transactions involving 
amounts similar to interest, and imported mismatches. The final 
regulations largely retain these decisions while providing additional 
clarity for taxpayers.

C. Need for the Final Regulations

    Because the Act introduced new sections to the Code to address 
hybrid entities and hybrid instruments, a number of the relevant terms 
and necessary calculations that taxpayers are currently required to 
apply under the statute can benefit from greater specificity. The final 
regulations provide taxpayers with interpretive guidance and 
clarifications on which types of arrangements are subject to the 
statute and the effect of the application of the statute to such 
arrangements.

D. Economic Analysis

1. Baseline
    The Treasury Department and the IRS have assessed the benefits and 
costs of the final regulations relative to a no-action baseline 
reflecting anticipated Federal income tax-related behavior in the 
absence of these regulations.
2. Summary of Economic Effects
    These final regulations provide certainty and clarity to taxpayers 
regarding (i) the determination and tracking of hybrid dividends; and 
(ii) the deductibility of interest or royalties paid as a result of 
hybrid or branch arrangements. In the absence of this clarity, the 
likelihood that different taxpayers would interpret the rules regarding 
hybrid payments differently would be exacerbated. In general, overall 
economic performance is enhanced when businesses face more uniform 
signals about tax treatment. Certainty and clarity over tax treatment 
generally also reduce compliance costs for taxpayers.
    For those statutory provisions for which similar taxpayers would 
generally adopt similar interpretations of the statute even in the 
absence of guidance, the final regulations provide value by helping to 
ensure that those interpretations are consistent with the intent and 
purpose of the statute. For example, the final regulations may specify 
a tax treatment that few or no taxpayers would adopt in the absence of 
specific guidance.
    The Treasury Department and the IRS projected that the proposed 
regulations would have annual economic effects of less than $100 
million (2018$) if they were to be finalized. The final regulations 
differ from the proposed regulations primarily by incorporating certain 
changes that reduce administrative and compliance costs (relative to 
the proposed regulations) without substantially altering the final 
regulations' effectiveness (with regard to the intent and purpose of 
the statute). The assessment that the annual economic effects of the 
final regulations will be less than $100 million, relative to the no-
action baseline, is unchanged.
    The Treasury Department and the IRS undertook a rough estimate of 
the economic effects of the final regulations. As explained later, we 
estimate that roughly 9,000 unique taxpayers are potentially affected 
by the regulations. We assumed that the effect of the final regulations 
would be the denial of between 1 and 4 percent of the interest paid 
deductions by these potentially affected taxpayers; these are 
deductions that we assumed would be denied beyond those that would be 
disallowed under the no-action baseline.\5\ The Treasury Department and 
the IRS note that because the presence of a hybrid arrangement is not 
reported on a tax return, we do not have any specific data on the 
percent of interest paid deductions that are not allowed by the statute 
nor on the incremental portion of deductions that would not be allowed 
specifically by these final regulations. We further do not have readily 
available data or results from the academic literature to determine 
whether the assumed 1 to 4 percent range is accurate. We have selected 
these percentages to illustrate a plausible calculation of the final 
regulations' economic effects.\6\
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    \5\ While section 267A applies to both interest and royalty 
deductions, the Treasury Department and IRS do not have readily 
available data on royalty deductions.
    \6\ These percentages are comparable to estimates provided in 
OECD Measuring and Monitoring BEPS, Action 11--2015 Final Report. 
https://doi.org/10.1787/9789264241343-en.
---------------------------------------------------------------------------

    We assume that taxpayers will respond to the disallowance of 
hybrids by substituting towards other tax-reduction strategies. These 
strategies must necessarily be less beneficial to the taxpayer than the 
hybrid arrangements because otherwise the taxpayer would have adopted 
those strategies under the baseline. The Treasury Department and the 
IRS do not have readily available data or models to estimate the cost 
or availability of these tax strategies for particular taxpayers. In 
this exercise for the final regulations, we assume that taxpayers will 
effectively continue to be able to claim between 85 to 100 percent of 
the disallowed interest deductions through alternative tax-reduction 
strategies. This results in a net disallowance of interest deductions 
of between 0 and 0.6 percent.
    We next applied Treasury Department models to confidential tax data 
for tax year 2017 to calculate average effective tax rates for these 
potentially affected taxpayers.\7\ Because taxpayers are assumed to be 
unable to fully offset the disallowed interest deductions under the 
final regulations, their effective tax rates will rise. We modeled 
taxpayers' average effective tax rates with and without the assumed 
range of denied interest paid deductions that would result from the 
final regulations to estimate the changes in effective tax rates 
attributable to the final regulations.
---------------------------------------------------------------------------

    \7\ Because the most recently available complete tax data 
available for this exercise are from 2017, we multiplied average 
effective tax rates by 21/35 to reflect the 21 percent corporate tax 
rate that applies to these final regulations relative to the 35 
percent rate that applied in 2017. Because effective tax rates are 
not readily defined for taxpayers with zero or negative taxable 
income, our model assumes the effective rate to be the statutory 
rate for those taxpayers.
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    As a final step, we applied an estimate of the semi-elasticity of 
taxable income (0.2) to the range of estimated increases in the 
effective tax rates.\8\ The

[[Page 19824]]

result is an estimate of the reduction in taxable income for these 
taxpayers that results from their response to higher effective tax 
rates.
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    \8\ The semi-elasticity measures the percent change in taxable 
income that results from a one percentage point change in the 
effective tax rate. The parameter used for this exercise reflects 
the fact that this income is generally considered to be a 
supernormal return to investment. Supernormal income is highly 
inelastic.
---------------------------------------------------------------------------

    Based on these assumptions and modeling, the Treasury Department 
and the IRS estimate that the change in economic activity as a result 
of these final regulations, relative to the no-action baseline, is a 
decline of between $0 and $83 million (2019$) per year, with this 
number growing over time at the real rate of growth of taxable income.
    This approach does not capture many other important economic 
effects of the final regulations: (1) Under this approach, there is an 
increase in Federal tax revenue relative to the no-action baseline but 
the calculations do not include the effect of this increase on the rest 
of the United States economy. For example, an increase in Federal tax 
revenue resulting from these final regulations would either reduce the 
deficit or allow reductions in other taxes, and these changes would 
have their own set of economic effects. Incorporating these effects 
would reduce the net decline in economic activity that we estimate. 
Indeed, if the elasticity of taxable income were the same across all 
taxpayers and if Federal tax revenue were held constant, the particular 
economic effects estimated here would be zero except for any change in 
compliance costs, relative to the baseline.
    (2) This estimate does not account for the improved efficiency in 
the affected sectors that would result from the certainty and clarity 
provided by the final regulations, relative to the no-action baseline. 
Incorporating this factor would reduce the net decline in economic 
activity that we estimate and could lead the average estimate of 
economic effects to be positive rather than negative.
    (3) Finally, this estimate does not include any reduction in 
economically wasteful planning and monitoring (by taxpayers) of the 
amount of foregone hybrid arrangements. To the extent that taxpayers 
use hybrid arrangements solely for tax shifting and those arrangements 
are economically unproductive, our assumed range should include a 
negative end; that is, there may be an increase in real economic 
activity as a result of the final regulations. Incorporating this 
effect would reduce the net decline in economic activity that we 
estimate.
    The Treasury Department and the IRS have not undertaken more 
precise quantitative estimates of the economic effects the final 
regulations because we do not have readily available data or models to 
estimate with reasonable precision (i) the types or volume of hybrid 
arrangements that taxpayers would likely use under these regulations, 
under the no-action baseline, or under alternative regulatory 
approaches; nor (ii) the effects of those hybrid arrangements on 
businesses' overall economic performance, including possible 
differences in compliance costs.
    In the absence of such quantitative estimates, the Treasury 
Department and the IRS have undertaken a qualitative analysis of the 
economic effects of the final regulations relative to the no-action 
baseline and relative to alternative regulatory approaches. This 
analysis is presented in part I.D.4 of this Special Analyses section.
3. Number and Characteristics of Affected Taxpayers
    The Treasury Department and the IRS project that the upper bound of 
taxpayers likely to be affected by section 245A(e) is 2,000 and the 
upper bound likely to be affected by section 267A is 8,000.\9\ These 
estimates are based on the top 10 percent of taxpayers (by gross 
receipts) that filed a domestic corporate income tax return with a Form 
5471 attached (therefore potentially affected by section 245A(e)), or 
that filed a domestic corporate income tax return with a Form 5472, 
``Information Return of a 25% Foreign-Owned U.S. Corporation or a 
Foreign Corporation Engaged in a U.S. Trade or Business,'' or Form 
8865, ``Return of U.S. Persons With Respect to Certain Foreign 
Partnerships,'' attached or a foreign corporate income tax return with 
a Form 5472 attached (therefore potentially affected by section 267A) 
for tax year 2017.\10\ These estimates are upper bounds of the number 
of large corporations affected because they are based on all 
transactions, even though only a portion of such transactions involve 
hybrid arrangements. The tax data do not report whether these reported 
dividends or deductions were part of a hybrid arrangement because such 
information was not relevant for calculating tax prior to the Act.
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    \9\ Approximately 1,000 taxpayers are affected by both sections, 
so the number of taxpayers affected by at least one provision is 
approximately 9,000.
    \10\ Because of the complexities involved, primarily only large 
taxpayers engage in hybrid arrangements. The estimate that the top 
10 percent of otherwise-relevant taxpayers (by gross receipts) are 
likely to engage in hybrid arrangements is based on the judgment of 
the Treasury Department and IRS.
---------------------------------------------------------------------------

    The Treasury Department and the IRS also projected the types of 
taxpayers affected. We project that the population of taxpayers 
affected by section 267A and the final regulations under section 267A 
will seldom include U.S.-based companies as these companies are taxed 
under the new GILTI regime as well as subpart F. Instead, section 267A 
and the final regulations apply predominantly to U.S. affiliates of 
foreign-headquartered companies that employ hybrid arrangements to 
shift income out of the U.S. The Treasury Department and the IRS 
project that section 245A(e) applies primarily to U.S.-based companies. 
The amounts of dividends affected, however, are not likely to be large 
because a large portion of distributions will be treated as previously 
taxed earnings and profits due to the operation of both the GILTI 
regime and the transition tax under section 965, and such distributions 
are not subject to section 245A(e).
4. Economic Effects of Specific Provisions
i. Delayed Basis for Hybrid Deduction Characterizations
    In the proposed regulations under section 245A(e), taxpayers were 
instructed that notional interest deductions (NIDs) allowed to a CFC 
would be considered hybrid deductions. The final regulations retain 
this characterization, but on a delayed basis (relative to the proposed 
regulations). Thus, the final regulations provide that only NIDs 
allowed to a CFC for taxable years beginning on or after December 20, 
2018, are hybrid deductions for purposes of section 245A(e). Similarly, 
the final regulations provide that NIDs give rise to hybrid 
arrangements for section 267A purposes starting for accounting periods 
beginning on or after December 20, 2018. In addition, transition relief 
is provided for structured arrangements (that is, certain arrangements 
among unrelated parties) entered into before the enactment of the Act, 
such that section 267A does not apply to payments made pursuant to such 
arrangements until taxable years beginning after December 31, 2020. 
These delays provide affected taxpayers more time (relative to the 
proposed regulations) to restructure instruments, seek alternative 
investment arrangements, or otherwise take into account the application 
of the relevant rules to structured arrangements or arrangements 
involving NIDs. These delays may, in some circumstances, allow 
taxpayers to unwind current financial arrangements in a less costly

[[Page 19825]]

way than they would if no such delay were provided.
    Allowing a delay in the characterization of certain hybrid 
deductions will lower the compliance costs (relative to the proposed 
regulations) for some taxpayers. Taxpayers commented that accounting 
for those deductions back to the beginning of 2018 would be difficult, 
and the delay offered by the final regulations obviates the need to 
account for those deductions back to the beginning of 2018. In 
addition, the delay provided by the final regulations may facilitate 
restructurings (for example, the unwinding of certain structured 
arrangements) such that, following the delay, fewer taxpayers will 
incur hybrid deductions. However, the reduction in compliance costs 
(relative to the proposed regulations) as a result of that delay will 
only be temporary, as the regime for those instruments as specified 
under the proposed regulations and as retained for the final 
regulations will take effect after the delay period.
ii. De Minimis Exception
    The proposed regulations provided a de minimis rule that exempted a 
specified party from the application of 267A for any taxable year in 
the which the sum of the party's interest and royalty deductions (plus 
interest and royalty deductions of certain related persons) is below 
$50,000 (regardless of hybridity). The final regulations keep this 
threshold but specify that the deductible payments only count towards 
the de minimis threshold if they are from hybrid arrangements.
    Without this exception, two taxpayers with the same value of hybrid 
deductions (under $50,000) might be treated differently simply because 
one taxpayer operated in an industry with more royalties or interest 
payments than the other, with these royalties or interest payments 
arising as a normal course of business in that industry rather than as 
a tax-avoidance mechanism. Under the final regulations, the de minimis 
exception focuses only on payments the statute is looking to limit, the 
hybrid payments themselves, as opposed to all interest and royalties. 
This enhanced focus will potentially allow small firms to make 
decisions in their best economic interest as opposed to needing to 
structure contracts and payments (that did not even involve hybrid 
arrangements) in a way that would avoid exceeding the de minimis 
threshold.
    This provision expands the pool of taxpayers excepted from the 
hybrid provisions of the statute, relative to the proposed regulations. 
The Treasury Department and the IRS do not have readily available data 
to provide a reasonably precise projection of the number of taxpayers 
that would be affected by the de minimis provision under the final 
regulations.
iii. Timing Differences Under Section 245A(e)
    For some taxpayers and some transactions, there may be a timing 
difference between when a CFC pays an amount constituting a dividend 
for U.S. tax purposes and when the CFC receives a deduction or other 
tax benefit (a hybrid deduction) for the amount in a foreign 
jurisdiction. Tax regulations are necessary to make clear whether a 
deduction is considered a hybrid deduction and thus whether a dividend 
is considered a hybrid dividend in such situations. In the absence of 
such guidance, taxpayers could be uncertain about the tax treatment of 
certain dividends, an uncertainty that may result in an inefficient 
pattern of financing across taxpayers.
    The proposed regulations addressed the timing difference by 
requiring the establishment of ``hybrid deduction accounts'' and 
specifying rules to be used for these accounts. These accounts are to 
be maintained across years so that hybrid deductions that accrue in one 
year will be matched up with dividends arising in a different year, 
thus providing clear rules for when a dividend is a hybrid dividend and 
generally ensuring that income is neither doubly taxed nor doubly non-
taxed. The final regulations reaffirm this approach, and add additional 
guidance and clarifications as necessary, such as guidance regarding 
mid-year stock transfers and what types of deductions and other tax 
benefits are hybrid deductions.
    The final regulations also respond to a comment that suggested that 
a deduction could only be a hybrid deduction if it was currently used 
to reduce foreign tax. The final regulations determined that such an 
interpretation would not be appropriate, and provide additional clarity 
that a deduction can be a hybrid deduction regardless of whether it is 
currently used under relevant foreign tax law. Were the final 
regulations to adopt the approach of the commenter, taxpayers would be 
required to undertake potentially burdensome analyses regarding the 
extent that a deduction is used currently under foreign tax law and, to 
the extent not used currently, track the deduction across other tax 
years so as to ensure that, when the deduction is ultimately used, it 
becomes a hybrid deduction at that point.
iv. Determination of a Hybrid Dividend Under Section 245A(e)
    The proposed regulations required taxpayers to maintain hybrid 
deduction accounts. A hybrid deduction account generally reflects the 
amount of deductions or other tax benefits allowed to the CFC (or a 
person related to the CFC) under a foreign tax law with respect to 
instruments of the CFC that U.S. tax law views as stock, and thus 
generally reflects an amount of earnings of a CFC sheltered from 
foreign tax by reason of a hybrid arrangement. The proposed regulations 
provided that a dividend received by a domestic corporation that is a 
U.S. shareholder from a CFC is a hybrid dividend to the extent of the 
balance of the U.S. shareholder's hybrid deduction accounts with 
respect to its stock of the CFC. Some comments suggested modifications 
to this approach. The final regulations retain the approach in the 
proposed regulations, with small revisions made in part to respond to 
certain comments.
    One option for revising the approach in response to comments was to 
provide exceptions to the definition of a hybrid dividend such that 
certain dividends cannot be hybrid dividends, such as some dividends 
arising by reason of a transaction that under the foreign tax law does 
not give rise to a deduction (for example, a sale of stock that gives 
rise to a section 1248(a) dividend). However, the Department of 
Treasury and IRS decided not to adopt this approach because the 
dividend, to the extent of the balance of the hybrid deduction 
accounts, is likely composed of earnings that were sheltered from 
foreign tax by reason of a hybrid arrangement and is therefore one for 
which Congress did not intend that the section 245A(a) deduction be 
available.
    A second option was to provide an exception to when the hybrid 
deduction account rules apply, such that certain amounts (such as 
amounts that will be paid within 36-months from when the deduction is 
allowed under the foreign tax law) are not taken into account for 
purposes of determining a hybrid deduction account but instead are 
treated as hybrid dividends when paid. While such an approach might 
address D/NI outcomes resulting from hybrid arrangements in a tailored 
manner, it would also increase complexity and compliance burden, 
because it would in effect require two regimes under section 245A(e): 
The hybrid deduction account rules and separate tracking rules for 
cases in which an amount is excepted

[[Page 19826]]

from the hybrid deduction account rules.
    The third option, and the one adopted by the final regulations was 
to retain the approach of the proposed regulations, and thus continue 
to treat a dividend as a hybrid dividend to the extent of the balance 
of the U.S. shareholder's hybrid deduction accounts with respect to its 
shares of stock of the CFC. This option both avoids incentivizing 
double non-taxation and avoids the complexities of needing multiple 
accounts.
v. No Inclusion in a Third Country Under Section 267A
    The proposed regulations generally deny a deduction for an interest 
or royalty payment if the payment is not included in income in a 
foreign country by reason of a hybrid arrangement, regardless of 
whether the payment is included in income in a different foreign 
country (a ``third country''). Absent such an approach, payments 
involving hybrid arrangements could be funneled through low-tax 
countries, with an inclusion in the low-tax country turning off section 
267A even though a no-inclusion occurs in a high-tax country by reason 
of a hybrid arrangement. Some comments suggested modifications to this 
approach. The final regulations retain the approach of the proposed 
regulations.
    One option for responding to comments was to allow an inclusion in 
the third country to turn off section 267A. Although this would be a 
simple approach, it would permit inclusions in a low-taxed country to 
turn off section 267A even though a no-inclusion occurs in a high-tax 
country. Such an approach could thus incentivize certain hybrid 
arrangements, as it could allow parties to achieve a better tax result 
through a hybrid arrangement than they would have had the arrangement 
not existed with no corresponding productive economic activity.
    A second option was to only allow an inclusion in the third country 
to turn off section 267A if the third country's tax rate is at least 
equal to a certain rate (for example, the U.S. tax rate, or the tax 
rate of the foreign country where the no-inclusion occurs). This 
approach would result in additional complexity, and would key the 
application of the hybrid rules on minimum effective rates of tax, 
which is beyond the scope of anti-hybrid rules.
    A third option was to not allow an inclusion in a third country to 
turn off section 267A. The final regulations adopt this approach, as it 
prevents inclusions in low-tax countries from turning off section 267A 
and thus prevents hybrid arrangements from being used to reduce U.S. 
tax without any accompanying productive economic activity. The Treasury 
Department and the IRS have determined that the advantages of this 
approach outweigh the drawbacks, including potential instances of 
double-taxation, relative to other regulatory approaches. First, absent 
the approach, payments could be routed through low-tax countries in a 
manner that would turn off section 267A, thus giving rise to at least 
partial double non-taxation and tax planning opportunities. Second, the 
approach is less complex--and easier to administer--than a more precise 
one which would calibrate the disallowed deduction based on the amount 
of tax avoided by reason of the hybrid arrangement (which would have to 
in part take into account relevant tax rates). Third, these types of 
structures are generally planned in advance and thus the approach would 
deter behavior. In particular, it would be relatively easy for 
taxpayers to avoid these structures and it is unlikely that taxpayers 
would have these structures arise by accident.
vi. Conduit Arrangements/Imported Mismatches
    Section 267A(e)(1) provides regulatory authority to apply the rules 
of section 267A to conduit arrangements and thus to disallow a 
deduction in cases in which income attributable to a payment is 
directly or indirectly offset by an offshore hybrid deduction. Under 
the proposed regulations, the Treasury Department and the IRS 
implemented rules that applied to so-called imported mismatch payments. 
These rules are generally similar to the Organization of Economic 
Cooperation and Development's Base Erosion and Profit Shifting 
project's (BEPS) imported mismatch rules. See Hybrid Mismatch Report 
Recommendation 8; see also Branch Mismatch Report Recommendation 5.
    Some commenters suggested that the proposed regulations were too 
complex and would be difficult to comply with. However, the Treasury 
Department and IRS decided in the final regulations that the approach 
taken in the proposed regulations was appropriate. The first advantage 
of this approach is that it provides certainty to taxpayers over a 
greater range of arrangements about whether a deduction will or will 
not be disallowed under the rule relative to other possible regulatory 
approaches. A second advantage of this approach is that it helps ensure 
that income is not subject either to double non-taxation or double 
taxation. This approach minimizes the chances of double taxation 
because it is modeled off the BEPS approach, which is being implemented 
by other countries, and it also contains explicit rules to coordinate 
with foreign tax law. Coordinating with the global tax community 
reduces opportunities for tax avoidance that is not otherwise 
economically productive.
    As noted in the preamble to the proposed regulations, although such 
an approach involves greater complexity than alternative regulatory 
approaches, the Treasury Department and IRS expect the benefits of this 
approach's comprehensiveness, administrability, and conduciveness to 
taxpayer certainty, to be substantially greater than the complexity 
burden in comparison with available alternative approaches.
vii. Deemed Branch Payments and Branch Mismatch Payments
    The proposed regulations expand the application of section 267A to 
certain transactions involving branches. This treatment was necessary 
to ensure that taxpayers could not avoid section 267A by engaging in 
transactions that were economically similar to the hybrid arrangements 
that are covered by the statute. If these types of arrangements were 
not addressed, some firms would have likely used branch structures to 
avoid paying U.S. tax. In some cases, these structures would have been 
created solely to avoid section 267A, resulting in potential efficiency 
loss. The final regulations maintain the position of the proposed 
regulations.
viii. Exceptions for Income Included in U.S. Tax and GILTI Inclusions
    Section 267A(b)(1) provides that deductions for interest and 
royalties that are paid to a CFC and included under section 951(a) in 
income (as subpart F income) by a United States shareholder of such CFC 
are not subject to disallowance under section 267A. The statute does 
not state whether section 267A applies to a payment that is included 
directly in the U.S. tax base (for example, because the payment is made 
directly to a U.S. taxpayer or a U.S. taxable branch), or a payment 
made to a CFC that is taken into account under GILTI (as opposed to 
being included as subpart F income) by such CFC's United States 
shareholders. However, the grant of regulatory authority in section 
267A(e) includes a specific mention of exceptions in ``cases which the 
Secretary determines do not present a risk of eroding the Federal tax 
base.'' See section 267A(e)(7)(B). Payments that are included directly 
in the U.S. tax base or that are included in GILTI do not give rise to 
a D/NI outcome and, therefore, in the proposed

[[Page 19827]]

regulations, it was deemed consistent with the policy of section 267A 
and the grant of authority in section 267A(e) to exempt them from 
disallowance under section 267A.
    Several comments suggested small revisions to this provision to 
avoid potential arbitrage, and such small revisions were made in the 
final regulations while maintaining the overall approach to income 
included in U.S. tax and GILTI inclusions.
ix. Link Between Hybridity and D/NI
    The proposed regulations limited disallowance to cases in which the 
no-inclusion portion of the D/NI outcome is a result of hybridity as 
opposed to a different feature of foreign tax law, such as a general 
preference for royalty income. Disallowing hybrid arrangements in which 
the D/NI outcome was not the result of hybridity would have forced 
taxpayers to undertake potentially costly restructuring of arrangements 
with no change in outcome, since the hybridity was irrelevant to the D/
NI outcome. The final regulations maintain this position.
x. Timing Differences Under Section 267A
    A similar timing issue that was addressed for section 245A(e) 
arises under section 267A. Here, there may be a timing difference 
between when the deduction is otherwise permitted under U.S. tax law 
and when the payment is included in the payee's income under foreign 
tax law. The legislative history to section 267A indicates that in 
certain cases such timing differences can lead to ``long term 
deferral'' and that such long-term deferral should be treated as giving 
rise to a D/NI outcome. Examples of such long-term deferral include 
cases in which under the foreign tax law the payment is a recovery of 
principal or basis, or the payment is pursuant to a hybrid sale/license 
transaction.
    The Treasury Department and IRS decided to address only certain 
timing differences--namely, long-term timing differences, in the 
proposed regulations. The proposed regulations generally denied a 
deduction for an interest or royalty payment if, under foreign tax law, 
the payment is not included in the payee's income within 36-months. 
Some comments suggested modifications to this approach. The final 
regulations retain this overall approach but with small revisions, made 
in part to respond to certain comments.
    One option for responding to comments was to not address long-term 
deferral, because it will eventually reverse over time. Although this 
would be a simpler approach than the option adopted for the final 
regulations, the Treasury Department and IRS did not adopt this 
approach because, as indicated in the legislative history, long-term 
deferral can be equivalent to a permanent exclusion, and could lead to 
widespread avoidance.
    A second option was to continue to address long-term deferral but 
to not treat recovery of basis or principal as creating long-term 
deferral to the extent that the transaction giving rise to the basis, 
or the transaction pursuant to which the principal funds were 
generated, did not involve a hybrid arrangement. Although such an 
approach might be conceptually pure, it would raise significant 
practical and administrative difficulties. It would also be 
inconsistent with other areas of the Code, in that basis generally 
provides a dollar-for-dollar offset against income, as opposed to 
providing an offset against income only to the extent that the 
inclusion that generated the basis was at a tax rate at least equal to 
the tax rate at which the income is taken into account.
    The final option was to address long-term deferral but provide 
targeted modifications to excuse transactions unlikely to give rise to 
double non-taxation concerns--for example, hybrid sale/license cases, 
or cases in which different ordering or recovery rules under U.S. and 
foreign tax law reverse within 36-months.\11\ The final regulations 
adopt this approach, because it strikes an appropriate balance between 
administrability and ensuring that similar economic activities were 
taxed similarly.
---------------------------------------------------------------------------

    \11\ Other areas of the Code similarly adopt a 36-month period 
for administrability purposes. See, for example, Sec.  1.884-1(g) 
(36-month period for testing whether a foreign corporation is 
eligible to claim an exemption from, or a reduced rate of, branch 
profits tax); Sec.  1.7874-10 (36-month period for measuring whether 
prior distributions should be taken into account for purposes of the 
non-ordinary course distribution rule).
---------------------------------------------------------------------------

II. Paperwork Reduction Act

    The collections of information in the final regulations with 
respect to sections 245A(e) and 267A are in Sec. Sec.  1.6038-2(f)(13) 
and (14), 1.6038-3(g)(3), and 1.6038A-2(b)(5)(iii). These collections 
of information retain the collections of information in the proposed 
regulations, with a minor refinement to Sec.  1.6038-2(f)(14) to ensure 
that the IRS may require the reporting of certain information that will 
facilitate compliance with section 245A(e) and Sec.  1.245A(e)-1.
    The collection of information in Sec.  1.6038-2(f)(14) requires a 
U.S. person that controls a foreign corporation that pays or receives a 
hybrid dividend or tiered hybrid dividend under section 245A(e) during 
an annual accounting period to provide information about the hybrid 
dividend or tiered hybrid dividend on Form 5471, ``Information Return 
of U.S. Persons With Respect to Certain Foreign Corporations,'' (OMB 
control number 1545-0123), as the form and its instructions may 
prescribe. Section 1.6038-2(f)(14) was revised to ensure that the IRS 
may require the reporting of certain information that will facilitate 
compliance with section 245A(e) and Sec.  1.245A(e)-1 (such as 
information about hybrid deduction accounts). For purposes of the 
Paperwork Reduction Act of 1995 (44 U.S.C. 3507(d)) (``PRA''), the 
reporting burden associated with Sec.  1.6038-2(f)(14) will be 
reflected in the PRA submission associated with Form 5471 (see chart at 
the end of this part II of this Special Analyses section for the status 
of the PRA submission for Form 5471). The estimated number of 
respondents for the reporting burden associated with Sec.  1.6038-
2(f)(14) is based on a percentage of large taxpayers that file income 
tax returns with a Form 5471 attached and Schedule I, ``Summary of 
Shareholder's Income From Foreign Corporations,'' completed because 
only filers that are controlling U.S. shareholders of CFCs that pay or 
receive a dividend would be subject to the information collection 
requirements. As provided below, the IRS estimates the number of 
affected filers to be 2,000.
    As explained in the preamble to the proposed regulations, the 
remaining collections of information in Sec. Sec.  1.6038-2(f)(13), 
1.6038-3(g)(3), and 1.6038A-2(b)(5)(iii) will facilitate compliance 
with section 267A and the final regulations thereunder. For purposes of 
the PRA, the reporting burdens associated with Sec. Sec.  1.6038-
2(f)(13), 1.6038-3(g)(3), and 1.6038A-2(b)(5)(iii) will be reflected in 
the PRA submissions associated with Form 5471, Form 8865, ``Return of 
U.S. Persons With Respect to Certain Foreign Partnerships,'' (OMB 
control number 1545-1668), and Form 5472, ``Information Return of a 25% 
Foreign-Owned U.S. Corporation or a Foreign Corporation Engaged in a 
U.S. Trade or Business,'' (OMB control number 1545-0123), respectively 
(see chart at the end of this part II of this Special Analyses section 
for the status of the PRA submissions for Forms 5471, 8865, and 5472). 
The estimated number of respondents for the reporting burdens 
associated with Sec. Sec.  1.6038-2(f)(13), 1.6038-3(g)(3), and 
1.6038A-2(b)(5)(iii) is based on a percentage of large taxpayers that 
file income tax returns

[[Page 19828]]

with a Form 5471 (Schedule G, Other Information), Form 8865, or Form 
5472 attached. The IRS estimates the number of affected filers to be 
the following.

                           Tax Forms Impacted
------------------------------------------------------------------------
                                       Number of
                                      respondents       Forms in which
    Collection of information         (estimated,     information may be
                                  rounded to nearest       collected
                                        1,000)
------------------------------------------------------------------------
Sec.   1.6038-2(f)(13)..........               1,000  Form 5471
                                                       (Schedule G).
Sec.   1.6038-2(f)(14)..........               2,000  Form 5471
                                                       (Schedule I).
Sec.   1.6038A-2(b)(5)(iii).....               7,000  Form 5472.
Sec.   1.6038-3(g)(3)...........              <1,000  Form 8865.
------------------------------------------------------------------------
Source: IRS data (MeF, DCS, and Compliance Data Warehouse).

    The current status of the PRA submissions related to the tax forms 
that will be revised as a result of the information collections in the 
final regulations is provided in the accompanying table. As described 
above, the reporting burdens associated with the information 
collections in Sec. Sec.  1.6038-2(f)(13) and (14) and 1.6038A-
2(b)(5)(iii) are included in the aggregated burden estimates for OMB 
control number 1545-0123, which represents a total estimated burden 
time for all forms and schedules for corporations of 3.157 billion 
hours and total estimated monetized costs of $58.148 billion ($2017). 
The overall burden estimates provided for OMB control number 1545-0123 
are aggregate amounts that relate to the entire package of forms 
associated with the OMB control number and will in the future include 
but not isolate the estimated burden of the tax forms that will be 
revised as a result of the information collections in the proposed 
regulations. These burden estimates are therefore not accurate for 
future calculations needed to assess the burden imposed by the proposed 
regulations. These burden estimates have been reported for other 
regulations related to the taxation of cross-border income. The 
Treasury Department and IRS urge readers to recognize that many of the 
burden estimates reported for regulations related to taxation of cross-
border income are duplicates and to guard against overcounting the 
burden that international tax provisions impose. No burden estimates 
specific to the final regulations are currently available. The Treasury 
Department and IRS have not identified any burden estimates, including 
those for new information collections, related to the requirements 
under the final regulations. The Treasury Department and the IRS 
estimate PRA burdens on a taxpayer-type basis rather than a provision-
specific basis. Those estimates capture both changes made by the Act 
and those that arise out of discretionary authority exercised in the 
final regulations.
    The Treasury Department and the IRS request comments on all aspects 
of information collection burdens related to the final regulations, 
including estimates for how much time it would take to comply with the 
paperwork burdens described above for each relevant form and ways for 
the IRS to minimize the paperwork burden. Proposed revisions (if any) 
to these forms that reflect the information collections contained in 
these final regulations will be made available for public comment at 
https://apps.irs.gov/app/picklist/list/draftTaxForms.html and will not 
be finalized until after these forms have been approved by OMB under 
the PRA.

----------------------------------------------------------------------------------------------------------------
               Form                     Type of filer          OMB Nos.                     Status
----------------------------------------------------------------------------------------------------------------
Form 5471.........................  Business (NEW Model)          1545-0123  Published in the Federal Register
                                                                              on 9/30/19 (84 FR 51718). Public
                                                                              Comment period closed on 11/29/19.
                                                                              Approved by OMB through 1/31/2021.
                                       Link: https://www.federalregister.gov/documents/2019/09/30/2019-21068/proposed-collection-comment-request-for-forms-1065-1066-1120-1120-c-1120-f-1120-h-1120-nd-1120-s.
                                   -----------------------------------------------------------------------------
                                    Individual (NEW               1545-0074  Published in the Federal Register
                                     Model).                                  on 9/30/19 (84 FR 51712). Public
                                                                              Comment period closed on 11/29/19.
                                                                              Approved by OMB through 1/31/2021.
                                   -----------------------------------------------------------------------------
                                       Link: https://www.federalregister.gov/documents/2019/09/30/2019-21066/proposed-collection-comment-request-for-form-1040-form-1040nr-form-1040nr-ez-form-1040x-1040-sr-and-u.
                                   -----------------------------------------------------------------------------
Form 5472.........................  Business (NEW Model)          1545-0123  Published in the Federal Register
                                                                              on 9/30/19 (84 FR 51718). Public
                                                                              Comment period closed on 11/29/19.
                                                                              Approved by OMB through 1/31/2021.
                                   -----------------------------------------------------------------------------
                                       Link: https://www.federalregister.gov/documents/2019/09/30/2019-21068/proposed-collection-comment-request-for-forms-1065-1066-1120-1120-c-1120-f-1120-h-1120-nd-1120-s.
                                   -----------------------------------------------------------------------------
                                    Individual (NEW               1545-0074  Published in the Federal Register
                                     Model).                                  on 9/30/19 (84 FR 51712). Public
                                                                              Comment period closed on 11/29/19.
                                                                              Approved by OMB through 1/31/2021.
                                   -----------------------------------------------------------------------------
                                       Link: https://www.federalregister.gov/documents/2019/09/30/2019-21066/proposed-collection-comment-request-for-form-1040-form-1040nr-form-1040nr-ez-form-1040x-1040-sr-and-u.
                                   -----------------------------------------------------------------------------

[[Page 19829]]

 
Form 8865.........................  All other Filers              1545-1668  Published in the Federal Register
                                     (mainly trusts and                       on 10/1/18 (83 FR 49455). Public
                                     estates) (Legacy                         Comment period closed on 11/30/18.
                                     system).                                 Approved by OMB through 12/31/
                                                                              2021.
                                   -----------------------------------------------------------------------------
                                       Link: https://www.federalregister.gov/documents/2018/10/01/2018-21288/proposed-collection-comment-request-for-regulation-project.
                                   -----------------------------------------------------------------------------
                                    Business (NEW Model)          1545-0123  Published in the Federal Register
                                                                              on 9/30/19 (84 FR 51718). Public
                                                                              Comment period closed on 11/29/19.
                                                                              Approved by OMB through 1/31/2021.
                                   -----------------------------------------------------------------------------
                                       Link: https://www.federalregister.gov/documents/2019/09/30/2019-21068/proposed-collection-comment-request-for-forms-1065-1066-1120-1120-c-1120-f-1120-h-1120-nd-1120-s.
                                   -----------------------------------------------------------------------------
                                    Individual (NEW               1545-0074  Published in the Federal Register
                                     Model).                                  on 9/30/19 (84 FR 51712). Public
                                                                              Comment period closed on 11/29/19.
                                                                              Approved by OMB through 1/31/2021.
                                   -----------------------------------------------------------------------------
                                       Link: https://www.federalregister.gov/documents/2019/09/30/2019-21066/proposed-collection-comment-request-for-form-1040-form-1040nr-form-1040nr-ez-form-1040x-1040-sr-and-u.
                                   -----------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------

III. Regulatory Flexibility Act

    It is hereby certified that this final rule will not have a 
significant economic impact on a substantial number of small entities 
within the meaning of section 601(6) of the Regulatory Flexibility Act 
(5 U.S.C. chapter 6).
    The small entities that are subject to Sec. Sec.  1.6038-2(f)(13), 
1.6038-3(g)(3), and 1.6038A-2(b)(5)(iii) are small entities that are 
controlling U.S. shareholders of a CFC that is disallowed a deduction 
under section 267A, small entities that are controlling fifty-percent 
partners of a foreign partnership that makes a payment for which a 
deduction is disallowed under section 267A, and small entities that are 
25 percent foreign-owned domestic corporations and disallowed a 
deduction under section 267A, respectively. In addition, the small 
entities that are subject to Sec.  1.6038-2(f)(14) are controlling U.S. 
shareholders of a CFC that pays or receives a hybrid dividend or a 
tiered hybrid dividend.
    A controlling U.S. shareholder of a CFC is a U.S. person that owns 
more than 50 percent of the CFC's stock. A controlling fifty-percent 
partner is a U.S. person that owns more than a fifty-percent interest 
in the foreign partnership. A 25 percent foreign-owned domestic 
corporation is a domestic corporation at least 25 percent of the stock 
of which is owned by a foreign person.
    The Treasury Department and the IRS estimate that 15 taxpayers with 
gross receipts below $25 million (or $41.5 million for financial 
entities) would potentially be affected by these regulations.\12\ These 
are taxpayers who filed a domestic corporate income tax return in 2016 
with gross receipts below $25 million (or $41.5 million for financial 
entities) and that (i) attached either a Form 5471 (therefore 
potentially affected by section 245A(e)) or a Form 5472 (therefore 
potentially affected by section 267A) and (ii) reported on Form 5471 
dividends received by the domestic corporation from the foreign 
corporation, or on Form 5472 interest or royalty payments by the 
domestic corporation; and (iii) in the case of interest or royalties 
reported on Form 5472, the interest and royalty payments were above the 
$50,000 de minimis threshold for section 267A. The de minimis exception 
under section 267A excepts many small entities from the application of 
section 267A for any taxable year for which the sum of its interest and 
royalty deductions (plus interest and royalty deductions of certain 
related persons) involving hybrid arrangements is below $50,000. This 
estimate of 15 potentially affected taxpayers with gross receipts below 
the stated thresholds is less than 2 percent of potentially affected 
taxpayers of all sizes.
---------------------------------------------------------------------------

    \12\ This estimate is limited to those taxpayers who report 
gross receipts above $0.
---------------------------------------------------------------------------

    The Treasury Department and the IRS cannot readily identify from 
these data amounts that are paid pursuant to hybrid arrangements 
because those amounts are not separately reported on tax forms. Thus, 
dividends received as reported on Form 5471, and interest and royalty 
expenses as reported on Form 5472, are an upper bound on the amount of 
hybrid arrangements by these taxpayers.
    The Treasury Department and the IRS estimated the upper bound of 
the relative cost of the statutory and regulatory hybrids provisions, 
as a percentage of revenue, for these taxpayers as (i) the statutory 
tax rate of 21 percent multiplied by dividends received as reported on 
Form 5471 and or interest and royalty payments as reported on Form 
5472, divided by (ii) the taxpayer's gross receipts. Based on this 
calculation, the Treasury Department and the IRS estimate that the 
upper bound of the relative cost of these statutory and regulatory 
provisions is above 3 percent for more than half but fewer than all of 
the 15 entities identified in the preceding paragraph. Because this 
estimate is an upper bound, a smaller subset of these taxpayers 
(including potentially zero taxpayers) is likely to have a cost above 
three percent of gross receipts.
    Therefore, the Treasury Department and the IRS project that a 
substantial number of domestic small business entities will not be 
subject to Sec.  1.6038-2(f)(13) or (14), Sec.  1.6038-3(g)(3), or 
Sec.  1.6038A-2(b)(5)(iii). Accordingly, the Treasury Department and 
the IRS project that Sec.  1.6038-2(f)(13) or (14), Sec.  1.6038-
3(g)(3), or Sec.  1.6038A-2(b)(5)(iii) will not have a significant 
economic impact on a substantial number of small entities.

Drafting Information

    The principal authors of the final regulations are Shane M. 
McCarrick and Tracy M. Villecco of the Office of Associate Chief 
Counsel (International). However, other personnel from the Treasury 
Department and the IRS participated in the development of the final 
regulations.

[[Page 19830]]

List of Subjects

26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

26 CFR Part 301

    Employment taxes, Estate taxes, Excise taxes, Gift taxes, Income 
taxes, Penalties, Reporting and recordkeeping requirements.

Amendments to the Regulations

    Accordingly, 26 CFR parts 1 and 301 are amended as follows:

PART 1--INCOME TAXES

0
Paragraph 1. The authority citation for part 1 is amended by adding 
sectional authorities for Sec. Sec.  1.245A(e)-1 and 1.267A-1 through 
1.267A-7 in numerical order and revising the entry for Sec.  1.6038A-2 
to read in part as follows:

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

    Section 1.245A(e)-1 also issued under 26 U.S.C. 245A(g).
* * * * *
    Sections 1.267A-1 through 1.267A-7 also issued under 26 U.S.C. 
267A(e).
* * * * *
    Section 1.6038A-2 also issued under 26 U.S.C. 6038A and 6038C.
* * * * *

0
Par. 2. Section 1.245A(e)-1 is added to read as follows:


Sec.  1.245A(e)-1  Special rules for hybrid dividends.

    (a) Overview. This section provides rules for hybrid dividends. 
Paragraph (b) of this section disallows the deduction under section 
245A(a) for a hybrid dividend received by a United States shareholder 
from a CFC. Paragraph (c) of this section provides a rule for hybrid 
dividends of tiered corporations. Paragraph (d) of this section sets 
forth rules regarding a hybrid deduction account. Paragraph (e) of this 
section provides an anti-avoidance rule. Paragraph (f) of this section 
provides definitions. Paragraph (g) of this section illustrates the 
application of the rules of this section through examples. Paragraph 
(h) of this section provides the applicability date.
    (b) Hybrid dividends received by United States shareholders--(1) In 
general. If a United States shareholder receives a hybrid dividend, 
then--
    (i) The United States shareholder is not allowed a deduction under 
section 245A(a) for the hybrid dividend; and
    (ii) The rules of section 245A(d) (disallowance of foreign tax 
credits and deductions) apply to the hybrid dividend. See paragraph 
(g)(1) of this section for an example illustrating the application of 
paragraph (b) of this section.
    (2) Definition of hybrid dividend. The term hybrid dividend means 
an amount received by a United States shareholder from a CFC for which, 
without regard to section 245A(e) and this section as well as Sec.  
1.245A-5T, the United States shareholder would be allowed a deduction 
under section 245A(a), to the extent of the sum of the United States 
shareholder's hybrid deduction accounts (as described in paragraph (d) 
of this section) with respect to each share of stock of the CFC, 
determined at the close of the CFC's taxable year (or in accordance 
with paragraph (d)(5) of this section, as applicable). No other amount 
received by a United States shareholder from a CFC is a hybrid dividend 
for purposes of section 245A.
    (3) Special rule for certain dividends attributable to earnings of 
lower-tier foreign corporations. This paragraph (b)(3) applies if a 
domestic corporation directly or indirectly (as determined under the 
principles of Sec.  1.245A-5T(g)(3)(ii)) sells or exchanges stock of a 
foreign corporation and, pursuant to section 1248, the gain recognized 
on the sale or exchange is included in gross income as a dividend. In 
such a case, for purposes of this section--
    (i) To the extent that earnings and profits of a lower-tier CFC 
gave rise to the dividend under section 1248(c)(2), those earnings and 
profits are treated as distributed as a dividend by the lower-tier CFC 
directly to the domestic corporation under the principles of Sec.  
1.1248-1(d); and
    (ii) To the extent the domestic corporation indirectly owns (within 
the meaning of section 958(a)(2), and determined by treating a domestic 
partnership as foreign) shares of stock of the lower-tier CFC, the 
hybrid deduction accounts with respect to those shares are treated as 
the domestic corporation's hybrid deduction accounts with respect to 
stock of the lower-tier CFC. Thus, for example, if a domestic 
corporation sells or exchanges all the stock of an upper-tier CFC and 
under this paragraph (b)(3) there is considered to be a dividend paid 
directly by the lower-tier CFC to the domestic corporation, then the 
dividend is generally a hybrid dividend to the extent of the sum of the 
upper-tier CFC's hybrid deduction accounts with respect to stock of the 
lower-tier CFC.
    (4) Ordering rule. Amounts received by a United States shareholder 
from a CFC are subject to the rules of section 245A(e) and this section 
based on the order in which they are received. Thus, for example, if on 
different days during a CFC's taxable year a United States shareholder 
receives dividends from the CFC, then the rules of section 245A(e) and 
this section apply first to the dividend received on the earliest date 
(based on the sum of the United States shareholder's hybrid deduction 
accounts with respect to each share of stock of the CFC), and then to 
the dividend received on the next earliest date (based on the remaining 
sum).
    (c) Hybrid dividends of tiered corporations--(1) In general. If a 
CFC (the receiving CFC) receives a tiered hybrid dividend from another 
CFC, and a domestic corporation is a United States shareholder with 
respect to both CFCs, then, notwithstanding any other provision of the 
Code--
    (i) For purposes of section 951(a) as to the United States 
shareholder, the tiered hybrid dividend is treated for purposes of 
section 951(a)(1)(A) as subpart F income of the receiving CFC for the 
taxable year of the CFC in which the tiered hybrid dividend is 
received;
    (ii) The United States shareholder includes in gross income an 
amount equal to its pro rata share (determined in the same manner as 
under section 951(a)(2)) of the subpart F income described in paragraph 
(c)(1)(i) of this section; and
    (iii) The rules of section 245A(d) (disallowance of foreign tax 
credit, including for taxes that would have been deemed paid under 
section 960(a) or (b), and deductions) apply to the amount included 
under paragraph (c)(1)(ii) of this section in the United States 
shareholder's gross income. See paragraph (g)(2) of this section for an 
example illustrating the application of paragraph (c) of this section.
    (2) Definition of tiered hybrid dividend. The term tiered hybrid 
dividend means an amount received by a receiving CFC from another CFC 
to the extent that the amount would be a hybrid dividend under 
paragraph (b)(2) of this section if, for purposes of section 245A and 
the regulations in this part under section 245A (except for section 
245A(e)(2) and this paragraph (c)), the receiving CFC were a domestic 
corporation. A tiered hybrid dividend does not include an amount 
described in section 959(b). No other amount received by a receiving 
CFC from another CFC is a tiered hybrid dividend for purposes of 
section 245A.
    (3) Special rule for certain dividends attributable to earnings of 
lower-tier foreign corporations. This paragraph (c)(3) applies if a CFC 
directly or indirectly (as determined under the principles of Sec.  
1.245A-5T(g)(3)(ii)) sells or exchanges stock of a foreign corporation 
and pursuant to section

[[Page 19831]]

964(e)(1) the gain recognized on the sale or exchange is included in 
gross income as a dividend. In such a case, the rules of paragraph 
(b)(3) of this section apply, by treating the CFC as the domestic 
corporation described in paragraph (b)(3) of this section and 
substituting the phrase ``sections 964(e)(1) and 1248(c)(2)'' for the 
phrase ``section 1248(c)(2)'' in paragraph (b)(3)(i) of this section.
    (4) Interaction with rules under section 964(e). To the extent a 
dividend described in section 964(e)(1) (gain on certain stock sales by 
CFCs treated as dividends) is a tiered hybrid dividend, the rules of 
section 964(e)(4) do not apply as to a domestic corporation that is a 
United States shareholder of both of the CFCs described in paragraph 
(c)(1) of this section and, therefore, such United States shareholder 
is not allowed a deduction under section 245A(a) for the amount 
included in gross income under paragraph (c)(1)(ii) of this section.
    (d) Hybrid deduction accounts--(1) In general. A specified owner of 
a share of CFC stock must maintain a hybrid deduction account with 
respect to the share. The hybrid deduction account with respect to the 
share must reflect the amount of hybrid deductions of the CFC allocated 
to the share (as determined under paragraphs (d)(2) and (3) of this 
section), and must be maintained in accordance with the rules of 
paragraphs (d)(4) through (6) of this section.
    (2) Hybrid deductions--(i) In general. The term hybrid deduction of 
a CFC means a deduction or other tax benefit (such as an exemption, 
exclusion, or credit, to the extent equivalent to a deduction) for 
which the requirements of paragraphs (d)(2)(i)(A) and (B) of this 
section are both satisfied.
    (A) The deduction or other tax benefit is allowed to the CFC (or a 
person related to the CFC) under a relevant foreign tax law, regardless 
of whether the deduction or other tax benefit is used, or otherwise 
reduces tax, currently under the relevant foreign tax law.
    (B) The deduction or other tax benefit relates to or results from 
an amount paid, accrued, or distributed with respect to an instrument 
issued by the CFC and treated as stock for U.S. tax purposes, or is a 
deduction allowed to the CFC with respect to equity. Examples of such a 
deduction or other tax benefit include an interest deduction, a 
dividends paid deduction, and a notional interest deduction (or similar 
deduction determined with respect to the CFC's equity). However, a 
deduction or other tax benefit relating to or resulting from a 
distribution by the CFC that is a dividend for purposes of the relevant 
foreign tax law is considered a hybrid deduction only to the extent it 
has the effect of causing the earnings that funded the distribution to 
not be included in income (determined under the principles of Sec.  
1.267A-3(a)) or otherwise subject to tax under such tax law. Thus, for 
example, upon a distribution by a CFC that is treated as a dividend for 
purposes of the CFC's tax law to a shareholder of the CFC, a dividends 
paid deduction allowed to the CFC under its tax law (or a refund to the 
shareholder, including through a credit, of tax paid by the CFC on the 
earnings that funded the distribution) pursuant to an integration or 
imputation system is not a hybrid deduction of the CFC to the extent 
that the shareholder, if a tax resident of the CFC's country, includes 
the distribution in income under the CFC's tax law or, if not a tax 
resident of the CFC's country, is subject to withholding tax (as 
defined in section 901(k)(1)(B)) on the distribution under the CFC's 
tax law. As an additional example, upon a distribution by a CFC to a 
shareholder of the CFC that is a tax resident of the CFC's country, a 
dividends received deduction allowed to the shareholder under the tax 
law of such foreign country pursuant to a regime intended to relieve 
double-taxation within the group is not a hybrid deduction of the CFC 
(though if the CFC were also allowed a deduction or other tax benefit 
for the distribution under such tax, such deduction or other tax 
benefit would be a hybrid deduction of the CFC). See paragraphs (g)(1) 
and (2) of this section for examples illustrating the application of 
paragraph (d) of this section.
    (ii) Coordination with foreign disallowance rules. The following 
special rules apply for purposes of determining whether a deduction or 
other tax benefit is allowed to a CFC (or a person related to the CFC) 
under a relevant foreign tax law:
    (A) Whether the deduction or other tax benefit is allowed is 
determined without regard to a rule under the relevant foreign tax law 
that disallows or suspends deductions if a certain ratio or percentage 
is exceeded (for example, a thin capitalization rule that disallows 
interest deductions if debt to equity exceeds a certain ratio, or a 
rule similar to section 163(j) that disallows or suspends interest 
deductions if interest exceeds a certain percentage of income).
    (B) Except as provided in this paragraph (d)(2)(ii)(B), whether the 
deduction or other tax benefit is allowed is determined without regard 
to hybrid mismatch rules, if any, under the relevant foreign tax law 
that may disallow such deduction or other tax benefit. However, whether 
the deduction or other tax benefit is allowed is determined with regard 
to hybrid mismatch rules under the relevant foreign tax law if the 
amount giving rise to the deduction or other tax benefit neither gives 
rise to a dividend for U.S. tax purposes nor, based on all the facts 
and circumstances, is reasonably expected to give rise to a dividend 
for U.S. tax purposes that will be paid within 12 months from the end 
of the taxable period for which the deduction or other tax benefit 
would be allowed but for the hybrid mismatch rules. For purposes of 
this paragraph (d)(2)(ii)(B), the term hybrid mismatch rules has the 
meaning provided in Sec.  1.267A-5(b)(10).
    (iii) Anti-duplication rule. A deduction or other tax benefit 
allowed to a CFC (or a person related to the CFC) under a relevant 
foreign tax law for an amount paid, accrued, or distributed with 
respect to an instrument issued by the CFC is not a hybrid deduction to 
the extent that treating it as a hybrid deduction would have the effect 
of duplicating a hybrid deduction that is a deduction or other tax 
benefit allowed under such tax law for an amount paid, accrued, or 
distributed with respect to an instrument that is issued by a CFC at a 
higher tier and that has terms substantially similar to the terms of 
the first instrument. For example, if an upper tier CFC issues to a 
corporate United States shareholder a hybrid instrument (the ``upper 
tier instrument''), a lower tier CFC issues to the upper tier CFC a 
hybrid instrument that has terms substantially similar to the terms of 
the upper tier instrument (the ``mirror instrument''), the CFCs are tax 
residents of the same foreign country, and the upper tier CFC includes 
in income under its tax law (as determined under the principles of 
Sec.  1.267A-3(a)) amounts accrued with respect to the mirror 
instrument, then a deduction allowed to the lower tier CFC under such 
foreign tax law for an amount accrued pursuant to the mirror instrument 
is not a hybrid deduction (but a deduction allowed to the upper tier 
CFC under the foreign tax law for an amount accrued with respect to the 
upper tier instrument is a hybrid deduction).
    (iv) Application limited to items allowed in taxable years ending 
on or after December 20, 2018; special rule for deductions with respect 
to equity. A deduction or other tax benefit, other than a deduction 
with respect to equity, allowed to a CFC (or a person related to the 
CFC) under a relevant foreign tax law is taken into account for 
purposes of this section only if it was allowed

[[Page 19832]]

with respect to a taxable year under the relevant foreign tax law 
ending on or after December 20, 2018. A deduction with respect to 
equity allowed to a CFC under a relevant foreign tax law is taken into 
account for purposes of this section only if it was allowed with 
respect to a taxable year under the relevant foreign tax law beginning 
on or after December 20, 2018.
    (3) Allocating hybrid deductions to shares. A hybrid deduction is 
allocated to a share of stock of a CFC to the extent that the hybrid 
deduction (or amount equivalent to a deduction) relates to an amount 
paid, accrued, or distributed by the CFC with respect to the share. 
However, in the case of a hybrid deduction that is a deduction with 
respect to equity (such as a notional interest deduction), the 
deduction is allocated to a share of stock of a CFC based on the 
product of--
    (i) The amount of the deduction allowed for all of the equity of 
the CFC; and
    (ii) A fraction, the numerator of which is the value of the share 
and the denominator of which is the value of all of the stock of the 
CFC.
    (4) Maintenance of hybrid deduction accounts--(i) In general. A 
specified owner's hybrid deduction account with respect to a share of 
stock of a CFC is, as of the close of the taxable year of the CFC, 
adjusted pursuant to the following rules.
    (A) First, the account is increased by the amount of hybrid 
deductions of the CFC allocated to the share for the taxable year.
    (B) [Reserved]
    (C) Third, the account is decreased by the amount of hybrid 
deductions in the account that gave rise to a hybrid dividend or tiered 
hybrid dividend during the taxable year. If the specified owner has 
more than one hybrid deduction account with respect to its stock of the 
CFC, then a pro rata amount in each hybrid deduction account is 
considered to have given rise to the hybrid dividend or tiered hybrid 
dividend, based on the amounts in the accounts before applying this 
paragraph (d)(4)(i)(C).
    (ii) [Reserved]
    (iii) Acquisition of account and certain other adjustments--(A) In 
general. The following rules apply when a person (the acquirer) 
directly or indirectly through a partnership, trust, or estate acquires 
a share of stock of a CFC from another person (the transferor).
    (1) In the case of an acquirer that is a specified owner of the 
share immediately after the acquisition, the transferor's hybrid 
deduction account, if any, with respect to the share becomes the hybrid 
deduction account of the acquirer.
    (2) In the case of an acquirer that is not a specified owner of the 
share immediately after the acquisition, the transferor's hybrid 
deduction account, if any, is eliminated and accordingly is not 
thereafter taken into account by any person.
    (B) Additional rules. The following rules apply in addition to the 
rules of paragraph (d)(4)(iii)(A) of this section.
    (1) Certain section 354 or 356 exchanges. The following rules apply 
when a shareholder of a CFC (the CFC, the target CFC; the shareholder, 
the exchanging shareholder) exchanges stock of the target CFC for stock 
of another CFC (the acquiring CFC) pursuant to an exchange described in 
section 354 or 356 that occurs in connection with a transaction 
described in section 381(a)(2) in which the target CFC is the 
transferor corporation.
    (i) In the case of an exchanging shareholder that is a specified 
owner of one or more shares of stock of the acquiring CFC immediately 
after the exchange, the exchanging shareholder's hybrid deduction 
accounts with respect to the shares of stock of the target CFC that it 
exchanges are attributed to the shares of stock of the acquiring CFC 
that it receives in the exchange.
    (ii) In the case of an exchanging shareholder that is not a 
specified owner of one or more shares of stock of the acquiring CFC 
immediately after the exchange, the exchanging shareholder's hybrid 
deduction accounts with respect to its shares of stock of the target 
CFC are eliminated and accordingly are not thereafter taken into 
account by any person.
    (2) Section 332 liquidations. If a CFC is a distributor corporation 
in a transaction described in section 381(a)(1) (the distributor CFC) 
in which a controlled foreign corporation is the acquiring corporation 
(the distributee CFC), then each hybrid deduction account with respect 
to a share of stock of the distributee CFC is increased pro rata by the 
sum of the hybrid deduction accounts with respect to shares of stock of 
the distributor CFC.
    (3) Recapitalizations. If a shareholder of a CFC exchanges stock of 
the CFC pursuant to a reorganization described in section 368(a)(1)(E) 
or a transaction to which section 1036 applies, then the shareholder's 
hybrid deduction accounts with respect to the stock of the CFC that it 
exchanges are attributed to the shares of stock of the CFC that it 
receives in the exchange.
    (4) Certain distributions involving section 355 or 356. In the case 
of a transaction involving a distribution under section 355 (or so much 
of section 356 as it relates to section 355) by a CFC (the distributing 
CFC) of stock of another CFC (the controlled CFC), the balance of the 
hybrid deduction accounts with respect to stock of the distributing CFC 
is attributed to stock of the controlled CFC in a manner similar to how 
earnings and profits of the distributing CFC and controlled CFC are 
adjusted. To the extent the balance of the hybrid deduction accounts 
with respect to stock of the distributing CFC is not so attributed to 
stock of the controlled CFC, such balance remains as the balance of the 
hybrid deduction accounts with respect to stock of the distributing 
CFC.
    (5) Effect of section 338(g) election--(i) In general. If an 
election under section 338(g) is made with respect to a qualified stock 
purchase (as described in section 338(d)(3)) of stock of a CFC, then a 
hybrid deduction account with respect to a share of stock of the old 
target is not treated as (or attributed to) a hybrid deduction account 
with respect to a share of stock of the new target. Accordingly, 
immediately after the deemed asset sale described in Sec.  1.338-1, the 
balance of a hybrid deduction account with respect to a share of stock 
of the new target is zero; the account must then be maintained in 
accordance with the rules of paragraph (d) of this section.
    (ii) Special rule regarding carryover FT stock. Paragraph 
(d)(4)(iii)(B)(5)(i) of this section does not apply as to a hybrid 
deduction account with respect to a share of carryover FT stock (as 
described in Sec.  1.338-9(b)(3)(i)). A hybrid deduction account with 
respect to a share of carryover FT stock is attributed to the 
corresponding share of stock of the new target.
    (5) Determinations and adjustments made during year of transfer in 
certain cases. This paragraph (d)(5) applies if on a date other than 
the date that is the last day of the CFC's taxable year a United States 
shareholder of the CFC or an upper-tier CFC with respect to the CFC 
directly or indirectly (as determined under the principles of Sec.  
1.245A-5T(g)(3)(ii)) transfers a share of stock of the CFC, and, during 
the taxable year, but on or before the transfer date, the United States 
shareholder or upper-tier CFC receives an amount from the CFC that is 
subject to the rules of section 245A(e) and this section. In such a 
case, the following rules apply:
    (i) As to the United States shareholder or upper-tier CFC and the 
United States shareholder's or upper-tier CFC's hybrid deduction 
accounts with respect to each

[[Page 19833]]

share of stock of the CFC (regardless of whether such share is 
transferred), the determinations and adjustments under this section 
that would otherwise be made at the close of the CFC's taxable year are 
made at the close of the date of the transfer. When making these 
determinations and adjustments at the close of the date of the 
transfer, each hybrid deduction account described in the previous 
sentence is pursuant to paragraph (d)(4)(ii)(A) of this section 
increased by a ratable portion (based on the number of days in the 
taxable year within the pre-transfer period to the total number of days 
in the taxable year) of the hybrid deductions of the CFC allocated to 
the share for the taxable year, and pursuant to paragraph (d)(4)(ii)(C) 
of this section decreased by the amount of hybrid deductions in the 
account that gave rise to a hybrid dividend or tiered hybrid dividend 
during the portion of the taxable year up to and including the transfer 
date. Thus, for example, if a United States shareholder of a CFC 
exchanges stock of the CFC in an exchange described in Sec.  1.367(b)-
4(b)(1)(i) and is required to include in income as a deemed dividend 
the section 1248 amount attributable to the stock exchanged, then: As 
of the close of the date of the exchange, each of the United States 
shareholder's hybrid deductions accounts with respect to a share of 
stock of the CFC is increased by a ratable portion of the hybrid 
deductions of the CFC allocated to the share for the taxable year 
(based on the number of days in the taxable year within the pre-
transfer period to the total number of days in the taxable year); the 
deemed dividend is a hybrid dividend to the extent of the sum of the 
United States shareholder's hybrid deduction accounts with respect to 
each share of stock of the CFC; and, as the close of the date of the 
exchange, each of the accounts is decreased by the amount of hybrid 
deductions in the account that gave rise to a hybrid dividend during 
the portion of the taxable year up to and including the date of the 
exchange.
    (ii) As to a hybrid deduction account described in paragraph 
(d)(5)(i) of this section, the adjustments to the account as of the 
close of the taxable year of the CFC must take into account the 
adjustments, if any, occurring with respect to the account pursuant to 
paragraph (d)(5)(i) of this section. Thus, for example, if an 
acquisition of a share of stock of a CFC occurs on a date other than 
the date that is the last day of the CFC's taxable year and pursuant to 
paragraph (d)(4)(iii)(A)(1) of this section the acquirer succeeds to 
the transferor's hybrid deduction account with respect to the share, 
then, as of the close of the taxable year of the CFC, the account is 
increased by a ratable portion of the hybrid deductions of the CFC 
allocated to the share for the taxable year (based on the number of 
days in the taxable year within the post-transfer period to the total 
number of days in the taxable year), and, decreased by the amount of 
hybrid deductions in the account that gave rise to a hybrid dividend or 
tiered hybrid dividend during the portion of the taxable year following 
the transfer date.
    (6) Effects of CFC functional currency--(i) Maintenance of the 
hybrid deduction account. A hybrid deduction account with respect to a 
share of CFC stock must be maintained in the functional currency 
(within the meaning of section 985) of the CFC. Thus, for example, the 
amount of a hybrid deduction and the adjustments described in 
paragraphs (d)(4)(i)(A) and (B) of this section are determined based on 
the functional currency of the CFC. In addition, for purposes of this 
section, the amount of a deduction or other tax benefit allowed to a 
CFC (or a person related to the CFC) is determined taking into account 
foreign currency gain or loss recognized with respect to such deduction 
or other tax benefit under a provision of foreign tax law comparable to 
section 988 (treatment of certain foreign currency transactions).
    (ii) Determination of amount of hybrid dividend. This paragraph 
(d)(6)(ii) applies if a CFC's functional currency is other than the 
functional currency of a United States shareholder or upper-tier CFC 
that receives an amount from the CFC that is subject to the rules of 
section 245A(e) and this section. In such a case, the sum of the United 
States shareholder's or upper-tier CFC's hybrid deduction accounts with 
respect to each share of stock of the CFC is, for purposes of 
determining the extent that a dividend is a hybrid dividend or tiered 
hybrid dividend, translated into the functional currency of the United 
States shareholder or upper-tier CFC based on the spot rate (within the 
meaning of Sec.  1.988-1(d)) as of the date of the dividend.
    (e) Anti-avoidance rule. Appropriate adjustments are made pursuant 
to this section, including adjustments that would disregard the 
transaction or arrangement, if a transaction or arrangement is 
undertaken with a principal purpose of avoiding the purposes of section 
245A(e) and this section. For example, if a specified owner of a share 
of CFC stock transfers the share to another person, and a principal 
purpose of the transfer is to shift the hybrid deduction account with 
respect to the share to the other person or to cause the hybrid 
deduction account to be eliminated, then for purposes of this section 
the shifting or elimination of the hybrid deduction account is 
disregarded as to the transferor. As another example, if a transaction 
or arrangement is undertaken to affirmatively fail to satisfy the 
holding period requirement under section 246(c)(5) with a principal 
purpose of avoiding the tiered hybrid dividend rules described in 
paragraph (c) of this section, the transaction or arrangement is 
disregarded for purposes of this section. This paragraph (e) will not 
apply, however, to disregard (or make other adjustments with respect 
to) a transaction pursuant to which an instrument or arrangement that 
gives rise to hybrid deductions is eliminated or otherwise converted 
into another instrument or arrangement that does not give rise to 
hybrid deductions.
    (f) Definitions. The following definitions apply for purposes of 
this section.
    (1) The term controlled foreign corporation (or CFC) has the 
meaning provided in section 957.
    (2) The term domestic corporation means an entity classified as a 
domestic corporation under section 7701(a)(3) and (4) or otherwise 
treated as a domestic corporation by the Internal Revenue Code. 
However, for purposes of this section, a domestic corporation does not 
include a regulated investment company (as described in section 851), a 
real estate investment trust (as described in section 856), or an S 
corporation (as described in section 1361).
    (3) The term person has the meaning provided in section 7701(a)(1).
    (4) The term related has the meaning provided in this paragraph 
(f)(4). A person is related to a CFC if the person is a related person 
within the meaning of section 954(d)(3). See also Sec.  1.954-
1(f)(2)(iv)(B)(1) (neither section 318(a)(3), nor Sec.  1.958-2(d) or 
the principles thereof, applies to attribute stock or other interests).
    (5) The term relevant foreign tax law means, with respect to a CFC, 
any regime of any foreign country or possession of the United States 
that imposes an income, war profits, or excess profits tax with respect 
to income of the CFC, other than a foreign anti-deferral regime under 
which a person that owns an interest in the CFC is liable to tax. If a 
foreign country has an income tax treaty with the United States that 
applies to taxes imposed by a political subdivision or other local 
authority of that country, then the tax

[[Page 19834]]

law of the political subdivision or other local authority is deemed to 
be a tax law of a foreign country. Thus, the term includes any regime 
of a foreign country or possession of the United States that imposes 
income, war profits, or excess profits tax under which--
    (i) The CFC is liable to tax as a resident;
    (ii) The CFC has a branch that gives rise to a taxable presence in 
the foreign country or possession of the United States; or
    (iii) A person related to the CFC is liable to tax as a resident, 
provided that under such person's tax law the person is allowed a 
deduction for amounts paid or accrued by the CFC (because the CFC is 
fiscally transparent under the person's tax law).
    (6) The term specified owner means, with respect to a share of 
stock of a CFC, a person for which the requirements of paragraphs 
(f)(6)(i) and (ii) of this section are satisfied.
    (i) The person is a domestic corporation that is a United States 
shareholder of the CFC, or is an upper-tier CFC that would be a United 
States shareholder of the CFC were the upper-tier CFC a domestic 
corporation (provided that, for purposes of sections 951 and 951A, a 
domestic corporation that is a United States shareholder of the upper-
tier CFC owns (within the meaning of section 958(a), and determined by 
treating a domestic partnership as foreign) one or more shares of stock 
of the upper-tier CFC).
    (ii) The person owns the share directly or indirectly through a 
partnership, trust, or estate. Thus, for example, if a domestic 
corporation directly owns all the shares of stock of an upper-tier CFC 
and the upper-tier CFC directly owns all the shares of stock of another 
CFC, the domestic corporation is the specified owner with respect to 
each share of stock of the upper-tier CFC and the upper-tier CFC is the 
specified owner with respect to each share of stock of the other CFC.
    (7) The term United States shareholder has the meaning provided in 
section 951(b).
    (g) Examples. This paragraph (g) provides examples that illustrate 
the application of this section. For purposes of the examples in this 
paragraph (g), unless otherwise indicated, the following facts are 
presumed. US1 is a domestic corporation. FX and FZ are CFCs formed at 
the beginning of year 1, and the functional currency (within the 
meaning of section 985) of each of FX and FZ is the dollar. FX is a tax 
resident of Country X and FZ is a tax resident of Country Z. US1 is a 
United States shareholder with respect to FX and FZ. No distributed 
amounts are attributable to amounts which are, or have been, included 
in the gross income of a United States shareholder under section 
951(a). All instruments are treated as stock for U.S. tax purposes. 
Only the tax law of the United States contains hybrid mismatch rules.

    (1) Example 1. Hybrid dividend resulting from hybrid 
instrument--(i) Facts. US1 holds both shares of stock of FX, which 
have an equal value. One share is treated as indebtedness for 
Country X tax purposes (``Share A''), and the other is treated as 
equity for Country X tax purposes (``Share B''). During year 1, 
under Country X tax law, FX accrues $80x of interest to US1 with 
respect to Share A and is allowed a deduction for the amount (the 
``Hybrid Instrument Deduction''). During year 2, FX distributes $30x 
to US1 with respect to each of Share A and Share B. For U.S. tax 
purposes, each of the $30x distributions is treated as a dividend 
for which, without regard to section 245A(e) and this section as 
well as Sec.  1.245A-5T, US1 would be allowed a deduction under 
section 245A(a). For Country X tax purposes, the $30x distribution 
with respect to Share A represents a payment of interest for which a 
deduction was already allowed (and thus FX is not allowed an 
additional deduction for the amount), and the $30x distribution with 
respect to Share B is treated as a dividend (for which no deduction 
is allowed).
    (ii) Analysis. The entire $30x of each dividend received by US1 
from FX during year 2 is a hybrid dividend, because the sum of US1's 
hybrid deduction accounts with respect to each of its shares of FX 
stock at the end of year 2 ($80x) is at least equal to the amount of 
the dividends ($60x). See paragraph (b)(2) of this section. This is 
the case for the $30x dividend with respect to Share B even though 
there are no hybrid deductions allocated to Share B. See paragraph 
(b)(2) of this section. As a result, US1 is not allowed a deduction 
under section 245A(a) for the entire $60x of hybrid dividends and 
the rules of section 245A(d) (disallowance of foreign tax credits 
and deductions) apply. See paragraph (b)(1) of this section. 
Paragraphs (g)(1)(ii)(A) through (D) of this section describe the 
determinations under this section.
    (A) At the end of year 1, US1's hybrid deduction accounts with 
respect to Share A and Share B are $80x and $0, respectively, 
calculated as follows.
    (1) The $80x Hybrid Instrument Deduction allowed to FX under 
Country X tax law (a relevant foreign tax law) is a hybrid deduction 
of FX, because the deduction is allowed to FX and relates to or 
results from an amount accrued with respect to an instrument issued 
by FX and treated as stock for U.S. tax purposes. See paragraph 
(d)(2)(i) of this section. Thus, FX's hybrid deductions for year 1 
are $80x.
    (2) The entire $80x Hybrid Instrument Deduction is allocated to 
Share A, because the deduction was accrued with respect to Share A. 
See paragraph (d)(3) of this section. As there are no additional 
hybrid deductions of FX for year 1, there are no additional hybrid 
deductions to allocate to either Share A or Share B. Thus, there are 
no hybrid deductions allocated to Share B.
    (3) At the end of year 1, US1's hybrid deduction account with 
respect to Share A is increased by $80x (the amount of hybrid 
deductions allocated to Share A). See paragraph (d)(4)(i)(A) of this 
section. Because FX did not pay any dividends with respect to either 
Share A or Share B during year 1 (and therefore did not pay any 
hybrid dividends or tiered hybrid dividends), no further adjustments 
are made. See paragraph (d)(4)(i)(C) of this section. Therefore, at 
the end of year 1, US1's hybrid deduction accounts with respect to 
Share A and Share B are $80x and $0, respectively.
    (B) At the end of year 2, and before the adjustments described 
in paragraph (d)(4)(i)(C) of this section, US1's hybrid deduction 
accounts with respect to Share A and Share B remain $80x and $0, 
respectively. This is because there are no hybrid deductions of FX 
for year 2. See paragraph (d)(4)(i)(A) of this section.
    (C) Because at the end of year 2 (and before the adjustments 
described in paragraph (d)(4)(i)(C) of this section) the sum of 
US1's hybrid deduction accounts with respect to Share A and Share B 
($80x, calculated as $80x plus $0) is at least equal to the 
aggregate $60x of year 2 dividends, the entire $60x dividend is a 
hybrid dividend. See paragraph (b)(2) of this section.
    (D) At the end of year 2, US1's hybrid deduction account with 
respect to Share A is decreased by $60x, the amount of the hybrid 
deductions in the account that gave rise to a hybrid dividend or 
tiered hybrid dividend during year 2. See paragraph (d)(4)(i)(C) of 
this section. Because there are no hybrid deductions in the hybrid 
deduction account with respect to Share B, no adjustments with 
respect to that account are made under paragraph (d)(4)(i)(C) of 
this section. Therefore, at the end of year 2 and taking into 
account the adjustments under paragraph (d)(4)(i)(C) of this 
section, US1's hybrid deduction account with respect to Share A is 
$20x ($80x less $60x) and with respect to Share B is $0.
    (iii) Alternative facts--notional interest deductions. The facts 
are the same as in paragraph (g)(1)(i) of this section, except that 
for each of year 1 and year 2 FX is allowed $10x of notional 
interest deductions with respect to its equity, Share B, under 
Country X tax law (the ``NIDs''). In addition, during year 2, FX 
distributes $47.5x (rather than $30x) to US1 with respect to each of 
Share A and Share B. For U.S. tax purposes, each of the $47.5x 
distributions is treated as a dividend for which, without regard to 
section 245A(e) and this section as well as Sec.  1.245A-5T, US1 
would be allowed a deduction under section 245A(a). For Country X 
tax purposes, the $47.5x distribution with respect to Share A 
represents a payment of interest for which a deduction was already 
allowed (and thus FX is not allowed an additional deduction for the 
amount), and the $47.5x distribution with respect to Share B is 
treated as a dividend (for which no deduction is allowed). The 
entire $47.5x of each dividend received by US1 from FX during year 2 
is a hybrid dividend, because the sum of US1's hybrid deduction 
accounts with respect to each of

[[Page 19835]]

its shares of FX stock at the end of year 2 ($80x plus $20x, or 
$100x) is at least equal to the amount of the dividends ($95x). See 
paragraph (b)(2) of this section. As a result, US1 is not allowed a 
deduction under section 245A(a) for the $95x hybrid dividend and the 
rules of section 245A(d) (disallowance of foreign tax credits and 
deductions) apply. See paragraph (b)(1) of this section. Paragraphs 
(g)(1)(iii)(A) through (D) of this section describe the 
determinations under this section.
    (A) The $10x of NIDs allowed to FX under Country X tax law in 
year 1 are hybrid deductions of FX for year 1. See paragraph 
(d)(2)(i) of this section. The $10x of NIDs is allocated equally to 
each of Share A and Share B, because the hybrid deduction is with 
respect to equity and the shares have an equal value. See paragraph 
(d)(3) of this section. Thus, $5x of the NIDs is allocated to each 
of Share A and Share B for year 1. For the reasons described in 
paragraph (g)(1)(ii)(A)(2) of this section, the entire $80x Hybrid 
Instrument Deduction is allocated to Share A. Therefore, at the end 
of year 1, US1's hybrid deduction accounts with respect to Share A 
and Share B are $85x and $5x, respectively.
    (B) Similarly, the $10x of NIDs allowed to FX under Country X 
tax law in year 2 are hybrid deductions of FX for year 2, and $5x of 
the NIDs is allocated to each of Share A and Share B for year 2. See 
paragraphs (d)(2)(i) and (d)(3) of this section. Thus, at the end of 
year 2 (and before the adjustments described in paragraph 
(d)(4)(i)(C) of this section), US1's hybrid deduction account with 
respect to Share A is $90x ($85x plus $5x) and with respect to Share 
B is $10x ($5x plus $5x). See paragraph (d)(4)(i) of this section.
    (C) Because at the end of year 2 (and before the adjustments 
described in paragraph (d)(4)(i)(C) of this section) the sum of 
US1's hybrid deduction accounts with respect to Share A and Share B 
($100x, calculated as $90x plus $10x) is at least equal to the 
aggregate $95x of year 2 dividends, the entire $95x of dividends are 
hybrid dividends. See paragraph (b)(2) of this section.
    (D) At the end of year 2, US1's hybrid deduction accounts with 
respect to Share A and Share B are decreased by the amount of hybrid 
deductions in the accounts that gave rise to a hybrid dividend or 
tiered hybrid dividend during year 2. See paragraph (d)(4)(i)(C) of 
this section. A total of $95x of hybrid deductions in the accounts 
gave rise to a hybrid dividend during year 2. For the hybrid 
deduction account with respect to Share A, $85.5x in the account is 
considered to have given rise to a hybrid deduction (calculated as 
$95x multiplied by $90x/$100x). See paragraph (d)(4)(i)(C) of this 
section. For the hybrid deduction account with respect to Share B, 
$9.5x in the account is considered to have given rise to a hybrid 
deduction (calculated as $95x multiplied by $10x/$100x). See 
paragraph (d)(4)(i)(C) of this section. Thus, following these 
adjustments, at the end of year 2, US1's hybrid deduction account 
with respect to Share A is $4.5x ($90x less $85.5x) and with respect 
to Share B is $0.5x ($10x less $9.5x).
    (iv) Alternative facts--deduction in branch country--(A) Facts. 
The facts are the same as in paragraph (g)(1)(i) of this section, 
except that for Country X tax purposes Share A is treated as equity 
(and thus the Hybrid Instrument Deduction does not exist, and under 
Country X tax law FX is not allowed a deduction for the $30x 
distributed in year 2 with respect to Share A). However, FX has a 
branch in Country Z that gives rise to a taxable presence under 
Country Z tax law, and for Country Z tax purposes Share A is treated 
as indebtedness and Share B is treated as equity. Also, during year 
1, for Country Z tax purposes, FX accrues $80x of interest to US1 
with respect to Share A and is allowed an $80x interest deduction 
with respect to its Country Z branch income. Moreover, for Country Z 
tax purposes, the $30x distribution with respect to Share A in year 
2 represents a payment of interest for which a deduction was already 
allowed (and thus FX is not allowed an additional deduction for the 
amount), and the $30x distribution with respect to Share B in year 2 
is treated as a dividend (for which no deduction is allowed).
    (B) Analysis. The $80x interest deduction allowed to FX under 
Country Z tax law (a relevant foreign tax law) with respect to its 
Country Z branch income is a hybrid deduction of FX for year 1. See 
paragraphs (d)(2)(i) and (f)(5) of this section. For reasons similar 
to those discussed in paragraph (g)(1)(ii) of this section, at the 
end of year 2 (and before the adjustments described in paragraph 
(d)(4)(i)(C) of this section), US1's hybrid deduction accounts with 
respect to Share A and Share B are $80x and $0, respectively, and 
the sum of the accounts is $80x. Accordingly, the entire $60x of the 
year 2 dividend is a hybrid dividend. See paragraph (b)(2) of this 
section. Further, for the reasons described in paragraph 
(g)(1)(ii)(D) of this section, at the end of year 2 and taking into 
account the adjustments under paragraph (d)(4)(i)(C) of this 
section, US1's hybrid deduction account with respect to Share A is 
$20x ($80x less $60x) and with respect to Share B is $0.
    (2) Example 2. Tiered hybrid dividend rule; tax benefit 
equivalent to a deduction--(i) Facts. US1 holds all the stock of FX, 
and FX holds all 100 shares of stock of FZ (the ``FZ shares''), 
which have an equal value. The FZ shares are treated as equity for 
Country Z tax purposes. At the end of year 1, the sum of FX's hybrid 
deduction accounts with respect to each of its shares of FZ stock is 
$0. During year 2, FZ distributes $10x to FX with respect to each of 
the FZ shares, for a total of $1,000x. The $1,000x is treated as a 
dividend for U.S. and Country Z tax purposes, and is not deductible 
for Country Z tax purposes. If FX were a domestic corporation, then, 
without regard to section 245A(e) and this section as well as Sec.  
1.245A-5T, FX would be allowed a deduction under section 245A(a) for 
the $1,000x. Under Country Z tax law, 75% of the corporate income 
tax paid by a Country Z corporation with respect to a dividend 
distribution is refunded to the corporation's shareholders 
(regardless of where such shareholders are tax residents) upon a 
dividend distribution by the corporation. The corporate tax rate in 
Country Z is 20%. With respect to FZ's distributions, FX is allowed 
a refundable tax credit of $187.5x. The $187.5x refundable tax 
credit is calculated as $1,250x (the amount of pre-tax earnings that 
funded the distribution, determined as $1,000x (the amount of the 
distribution) divided by 0.8 (the percentage of pre-tax earnings 
that a Country Z corporation retains after paying Country Z 
corporate tax)) multiplied by 0.2 (the Country Z corporate tax rate) 
multiplied by 0.75 (the percentage of the Country Z tax credit). 
Under Country Z tax law, FX is not subject to Country Z withholding 
tax (or any other tax) with respect to the $1,000x dividend 
distribution.
    (ii) Analysis. As described in paragraphs (g)(2)(ii)(A) and (B) 
of this section, the sum of FX's hybrid deduction accounts with 
respect to each of its shares of FZ stock at the end of year 2 is 
$937.5x and, as a result, $937.5x of the $1,000x of dividends 
received by FX from FZ during year 2 is a tiered hybrid dividend. 
See paragraphs (b)(2) and (c)(2) of this section. The $937.5x tiered 
hybrid dividend is treated for purposes of section 951(a)(1)(A) as 
subpart F income of FX and US1 must include in gross income its pro 
rata share of such subpart F income, which is $937.5x. See paragraph 
(c)(1) of this section. This is the case notwithstanding any other 
provision of the Code, including section 952(c) or section 954(c)(3) 
or (6). In addition, the rules of section 245A(d) (disallowance of 
foreign tax credits and deductions) apply with respect to US1's 
inclusion. See paragraph (c)(1) of this section. Paragraphs 
(g)(2)(ii)(A) through (C) of this section describe the 
determinations under this section. The characterization of the FZ 
stock for Country X tax purposes (or for purposes of any other 
foreign tax law) does not affect this analysis.
    (A) The $187.5x refundable tax credit allowed to FX under 
Country Z tax law (a relevant foreign tax law) is equivalent to a 
$937.5x deduction, calculated as $187.5x (the amount of the credit) 
divided by 0.2 (the Country Z corporate tax rate). The $937.5x is a 
hybrid deduction of FZ because it is allowed to FX (a person related 
to FZ), it relates to or results from amounts distributed with 
respect to instruments issued by FZ and treated as stock for U.S. 
tax purposes, and it has the effect of causing the earnings that 
funded the distributions to not be included in income under Country 
Z tax law. See paragraph (d)(2)(i) of this section. $9.375x of the 
hybrid deduction is allocated to each of the FZ shares, calculated 
as $937.5x (the amount of the hybrid deduction) multiplied by 1/100 
(the value of each FZ share relative to the value of all the FZ 
shares). See paragraph (d)(3) of this section. The result would be 
the same if FX were instead a tax resident of Country Z (and not 
Country X), FX were allowed the $187.5x refundable tax credit under 
Country Z tax law, and under Country Z tax law FX were to not 
include the $1,000x in income (because, for example, Country Z tax 
law provides Country Z resident corporations a 100% exclusion or 
dividends received deduction with respect to dividends received from 
a resident corporation). See paragraph (d)(2)(i) of this section.
    (B) At the end of year 2, and before the adjustments described 
in paragraph

[[Page 19836]]

(d)(4)(i)(C) of this section, the sum of FX's hybrid deduction 
accounts with respect to each of its shares of FZ stock is $937.5x, 
calculated as $9.375x (the amount in each account) multiplied by 100 
(the number of accounts). See paragraph (d)(4)(i) of this section. 
Accordingly, $937.5x of the $1,000x dividend received by FX from FZ 
during year 2 is a tiered hybrid dividend. See paragraphs (b)(2) and 
(c)(2) of this section.
    (C) At the end of year 2, each of FX's hybrid deduction accounts 
with respect to its shares of FZ is decreased by the $9.375x in the 
account that gave rise to a hybrid dividend or tiered hybrid 
dividend during year 2. See paragraph (d)(4)(i)(C) of this section. 
Thus, following these adjustments, at the end of year 2, each of 
FX's hybrid deduction accounts with respect to its shares of FZ 
stock is $0, calculated as $9.375x (the amount in the account before 
the adjustments described in paragraph (d)(4)(i)(C) of this section) 
less $9.375x (the adjustment described in paragraph (d)(4)(i)(C) of 
this section with respect to the account).
    (iii) Alternative facts--imputation system that taxes 
shareholders. The facts are the same as in paragraph (g)(2)(i) of 
this section, except that under Country Z tax law the $1,000x 
dividend to FX is subject to a 30% gross basis withholding tax, or 
$300x, and the $187.5x refundable tax credit is applied against and 
reduces the withholding tax to $112.5x. The $187.5x refundable tax 
credit provided to FX is not a hybrid deduction because FX was 
subject to Country Z withholding tax of $300x on the $1,000x 
dividend (such withholding tax being greater than the $187.5x 
credit). See paragraph (d)(2)(i) of this section. If instead FZ were 
allowed a $1,000x dividends paid deduction for the $1,000x dividend 
(and FX were not allowed the refundable tax credit) and the dividend 
were subject to 5% gross basis withholding tax (or $50x), then $750x 
of the dividends paid deduction would be a hybrid deduction, 
calculated as the excess of $1,000x (the dividends paid deduction) 
over $250x (the amount of income that under Country Z tax law would 
produce an amount of tax equal to the $50x of withholding tax, 
calculated as $50x, the amount of withholding tax, divided by 0.2, 
the Country Z corporate tax rate). See paragraph (d)(2)(i) of this 
section.

    (h) Applicability dates--(1) In general. Except as provided in 
paragraph (h)(2) of this section, this section applies to distributions 
made after December 31, 2017, provided that such distributions occur 
during taxable years ending on or after December 20, 2018. However, 
taxpayers may apply this section in its entirety to distributions made 
after December 31, 2017 and occurring during taxable years ending 
before December 20, 2018. In lieu of applying the regulations in this 
section, taxpayers may apply the provisions matching this section from 
the Internal Revenue Bulletin (IRB) 2019-03 (https://www.irs.gov/pub/irs-irbs/irb19-03.pdf) in their entirety for all taxable years ending 
on or before April 8, 2020.
    (2) [Reserved]

0
Par. 3. Sections 1.267A-1 through 1.267A-7 are added to read as 
follows:

Sec.
* * * * *
1.267A-1 Disallowance of certain interest and royalty deductions.
1.267A-2 Hybrid and branch arrangements.
1.267A-3 Income inclusions and amounts not treated as disqualified 
hybrid amounts.
1.267A-4 Disqualified imported mismatch amounts.
1.267A-5 Definitions and special rules.
1.267A-6 Examples.
1.267A-7 Applicability dates.
* * * * *


Sec.  1.267A-1  Disallowance of certain interest and royalty 
deductions.

    (a) Scope. This section and Sec. Sec.  1.267A-2 through 1.267A-5 
provide rules regarding when a deduction for any interest or royalty 
paid or accrued is disallowed under section 267A. Section 1.267A-2 
describes hybrid and branch arrangements. Section 1.267A-3 provides 
rules for determining income inclusions and provides that certain 
amounts are not amounts for which a deduction is disallowed. Section 
1.267A-4 provides an imported mismatch rule. Section 1.267A-5 sets 
forth definitions and special rules that apply for purposes of section 
267A. Section 1.267A-6 illustrates the application of section 267A 
through examples. Section 1.267A-7 provides applicability dates.
    (b) Disallowance of deduction. This paragraph (b) sets forth the 
exclusive circumstances in which a deduction is disallowed under 
section 267A. Except as provided in paragraph (c) of this section, a 
specified party's deduction for any interest or royalty paid or accrued 
(the amount paid or accrued with respect to the specified party, a 
specified payment) is disallowed under section 267A to the extent that 
the specified payment is described in this paragraph (b). See also 
Sec.  1.267A-5(b)(5) (treating structured payments as interest paid or 
accrued for purposes of section 267A and the regulations in this part 
under section 267A). A specified payment is described in this paragraph 
(b) to the extent that it is--
    (1) A disqualified hybrid amount, as described in Sec.  1.267A-2 
(hybrid and branch arrangements);
    (2) A disqualified imported mismatch amount, as described in Sec.  
1.267A-4 (payments offset by a hybrid deduction); or
    (3) A specified payment for which the requirements of the anti-
avoidance rule of Sec.  1.267A-5(b)(6) are satisfied.
    (c) De minimis exception. Paragraph (b) of this section does not 
apply to a specified party for a taxable year in which the sum of the 
specified party's specified payments that but for this paragraph (c) 
would be described in paragraph (b) of this section is less than 
$50,000. For purposes of this paragraph (c), specified parties that are 
related (within the meaning of Sec.  1.267A-5(a)(14)) are treated as a 
single specified party.


Sec.  1.267A-2  Hybrid and branch arrangements.

    (a) Payments pursuant to hybrid transactions--(1) In general. If a 
specified payment is made pursuant to a hybrid transaction, then, 
subject to Sec.  1.267A-3(b) (amounts included or includible in 
income), the payment is a disqualified hybrid amount to the extent 
that--
    (i) A specified recipient of the payment does not include the 
payment in income, as determined under Sec.  1.267A-3(a) (to such 
extent, a no-inclusion); and
    (ii) The specified recipient's no-inclusion is a result of the 
payment being made pursuant to the hybrid transaction. For purposes of 
this paragraph (a)(1)(ii), the specified recipient's no-inclusion is a 
result of the specified payment being made pursuant to the hybrid 
transaction to the extent that the no-inclusion would not occur were 
the specified recipient's tax law to treat the payment as interest or a 
royalty, as applicable. See Sec.  1.267A-6(c)(1) and (2) for examples 
illustrating the application of paragraph (a) of this section.
    (2) Definition of hybrid transaction--(i) In general. The term 
hybrid transaction means any transaction, series of transactions, 
agreement, or instrument one or more payments with respect to which are 
treated as interest or royalties for U.S. tax purposes but are not so 
treated for purposes of the tax law of a specified recipient of the 
payment. Examples of a hybrid transaction include an instrument a 
payment with respect to which is treated as interest for U.S. tax 
purposes but, for purposes of a specified recipient's tax law, is 
treated as a distribution with respect to equity or a recovery of 
principal with respect to indebtedness.
    (ii) Special rules--(A) Long-term deferral. A specified payment is 
deemed to be made pursuant to a hybrid transaction if the taxable year 
in which a specified recipient of the payment takes the payment into 
account in income under its tax law (or, based on all the facts and 
circumstances, is reasonably expected to take the payment into account 
in income under its tax

[[Page 19837]]

law) ends more than 36 months after the end of the taxable year in 
which the specified party would be allowed a deduction for the payment 
under U.S. tax law. In addition, if the tax law of a specified 
recipient of the specified payment does not impose an income tax, then 
such tax law does not cause the payment to be deemed to be made 
pursuant to a hybrid transaction under this paragraph (a)(2)(ii)(A). 
See Sec.  1.267A-6(c)(8) for an example illustrating the application of 
this paragraph (a)(2)(ii)(A) in the context of the imported mismatch 
rule.
    (B) Royalties treated as payments in exchange for property under 
foreign law. In the case of a specified payment that is a royalty for 
U.S. tax purposes and for purposes of the tax law of a specified 
recipient of the payment is consideration received in exchange for 
property, the tax law of the specified recipient is not treated as 
causing the payment to be made pursuant to a hybrid transaction.
    (C) Coordination with disregarded payment rule. A specified payment 
is not considered made pursuant to a hybrid transaction if the payment 
is a disregarded payment, as described in paragraph (b)(2) of this 
section.
    (3) Payments pursuant to securities lending transactions, sale-
repurchase transactions, or similar transactions. This paragraph (a)(3) 
applies if a specified payment is made pursuant to a repo transaction 
and is not regarded under a foreign tax law, but another amount 
connected to the payment (the connected amount) is regarded under such 
foreign tax law. For purposes of this paragraph (a)(3), a repo 
transaction means a transaction one or more payments with respect to 
which are treated as interest (as defined in Sec.  1.267A-5(a)(12)) or 
a structured payment (as defined in Sec.  1.267A-5(b)(5)(ii)) for U.S. 
tax purposes and that is a securities lending transaction or sale-
repurchase transaction (including as described in Sec.  1.861-2(a)(7)), 
or other similar transaction or series of related transactions in which 
legal title to property is transferred and the property (or similar 
property, such as securities of the same class and issue) is reacquired 
or expected to be reacquired. For example, this paragraph (a)(3) 
applies if a specified payment arising from characterizing a repo 
transaction of stock in accordance with its substance (that is, 
characterizing the specified payment as interest) is not regarded as 
such under a foreign tax law but an amount consistent with the form of 
the transaction (such as a dividend) is regarded under such foreign tax 
law. When this paragraph (a)(3) applies, the determination of the 
identity of a specified recipient of the specified payment under the 
foreign tax law is made with respect to the connected amount. In 
addition, if the specified recipient includes the connected amount in 
income (as determined under Sec.  1.267A-3(a), by treating the 
connected amount as the specified payment), then the amount of the 
specified recipient's no-inclusion with respect to the specified 
payment is correspondingly reduced. Further, the principles of this 
paragraph (a)(3) apply to cases similar to repo transactions in which a 
foreign tax law does not characterize the transaction in accordance 
with its substance. See Sec.  1.267A-6(c)(2) for an example 
illustrating the application of this paragraph (a)(3).
    (4) Payments pursuant to interest-free loans and similar 
arrangements. In the case of a specified payment that is interest for 
U.S. tax purposes, the following special rules apply:
    (i) The payment is deemed to be made pursuant to a hybrid 
transaction to the extent that--
    (A) Under U.S. tax law, the payment is imputed (for example, under 
section 482 or 7872, including because the instrument pursuant to which 
it is made is indebtedness but the terms of the instrument provide for 
an interest rate equal to or less than the risk-free rate or the rate 
on sovereign debt with similar terms in the relevant foreign currency); 
and
    (B) A tax resident or taxable branch to which the payment is made 
does not take the payment into account in income under its tax law 
because such tax law does not impute any interest. The rules of 
paragraph (b)(4) of this section apply for purposes of determining 
whether the specified payment is made indirectly to a tax resident or 
taxable branch.
    (ii) A tax resident or taxable branch the tax law of which causes 
the payment to be deemed to be made pursuant to a hybrid transaction 
under paragraph (a)(4)(i) of this section is deemed to be a specified 
recipient of the payment for purposes of paragraph (a)(1) of this 
section.
    (b) Disregarded payments--(1) In general. Subject to Sec.  1.267A-
3(b) (amounts included or includible in income), the excess (if any) of 
the sum of a specified party's disregarded payments for a taxable year 
over its dual inclusion income for the taxable year is a disqualified 
hybrid amount. See Sec.  1.267A-6(c)(3) and (4) for examples 
illustrating the application of paragraph (b) of this section.
    (2) Definition of disregarded payment--(i) In general. The term 
disregarded payment means a specified payment to the extent that, under 
the tax law of a tax resident or taxable branch to which the payment is 
made, the payment is not regarded (for example, because under such tax 
law it is a payment involving a single taxpayer or members of a group) 
and, were the payment to be regarded (and treated as interest or a 
royalty, as applicable) under such tax law, the tax resident or taxable 
branch would include the payment in income, as determined under Sec.  
1.267A-3(a).
    (ii) Special rules--(A) Foreign consolidation and similar regimes. 
A disregarded payment includes a specified payment that, under the tax 
law of a tax resident or taxable branch to which the payment is made, 
is a payment that gives rise to a deduction or similar offset allowed 
to the tax resident or taxable branch (or group of entities that 
include the tax resident or taxable branch) under a foreign 
consolidation, fiscal unity, group relief, loss sharing, or any similar 
regime.
    (B) Certain payments of a U.S. taxable branch. In the case of a 
specified payment of a U.S. taxable branch, the payment is not a 
disregarded payment to the extent that under the tax law of the tax 
resident to which the payment is made the payment is otherwise taken 
into account. See paragraph (c)(2) of this section for an example of 
when an amount may be otherwise taken into account.
    (C) Coordination with other hybrid and branch arrangements. A 
disregarded payment does not include a deemed branch payment described 
in paragraph (c)(2) of this section, a specified payment pursuant to a 
repo transaction or similar transaction described in paragraph (a)(3) 
of this section, or a specified payment pursuant to an interest-free 
loan or similar transaction described in paragraph (a)(4) of this 
section.
    (3) Definition of dual inclusion income--(i) In general. With 
respect to a specified party, the term dual inclusion income means the 
excess, if any, of--
    (A) The sum of the specified party's items of income or gain for 
U.S. tax purposes that are included in the specified party's income, as 
determined under Sec.  1.267A-3(a) (by treating the items of income or 
gain as the specified payment; and, in the case of a specified party 
that is a CFC, by treating U.S. tax law as the CFC's tax law), to the 
extent the items of income or gain are included in the income of the 
tax resident or taxable branch to which the disregarded payments are 
made, as determined under Sec.  1.267A-3(a) (by treating the

[[Page 19838]]

items of income or gain as the specified payment); over
    (B) The sum of the specified party's items of deduction or loss for 
U.S. tax purposes (other than deductions for disregarded payments), to 
the extent the items of deduction or loss are allowable (or have been 
or will be allowable during a taxable year that ends no more than 36 
months after the end of the specified party's taxable year) under the 
tax law of the tax resident or taxable branch to which the disregarded 
payments are made.
    (ii) Special rule for certain dividends. An item of income or gain 
of a specified party that is included in the specified party's income 
but not included in the income of the tax resident or taxable branch to 
which the disregarded payments are made is considered described in 
paragraph (b)(3)(i)(A) of this section to the extent that, under the 
tax resident's or taxable branch's tax law, the item is a dividend that 
would have been included in the income of the tax resident or taxable 
branch but for an exemption, exclusion, deduction, credit, or other 
similar relief particular to the item, provided that the party paying 
the item is not allowed a deduction or other tax benefit for it under 
its tax law. Similarly, an item of income or gain of a specified party 
that is included in the income of the tax resident or taxable branch to 
which the disregarded payments are made but not included in the 
specified party's income is considered described in paragraph 
(b)(3)(ii)(A) of this section to the extent that, under U.S. tax law, 
the item is a dividend that would have been included in the income of 
the specified party but for a dividends received deduction with respect 
to the dividend (for example, a deduction under section 245A(a)), 
provided that the party paying the item is not allowed a deduction or 
other tax benefit for it under its tax law. See Sec.  1.267A-
6(c)(3)(iv) for an example illustrating the application of this 
paragraph (b)(3)(ii).
    (4) Payments made indirectly to a tax resident or taxable branch. A 
specified payment made to an entity an interest of which is directly or 
indirectly (determined under the rules of section 958(a) without regard 
to whether an intermediate entity is foreign or domestic, or under 
substantially similar rules under a tax resident's or taxable branch's 
tax law) owned by a tax resident or taxable branch is considered made 
to the tax resident or taxable branch to the extent that, under the tax 
law of the tax resident or taxable branch, the entity to which the 
payment is made is fiscally transparent (and all intermediate entities, 
if any, are also fiscally transparent).
    (c) Deemed branch payments--(1) In general. If a specified payment 
is a deemed branch payment, then the payment is a disqualified hybrid 
amount if the tax law of the home office provides an exclusion or 
exemption for income attributable to the branch. See Sec.  1.267A-
6(c)(4) for an example illustrating the application of this paragraph 
(c).
    (2) Definition of deemed branch payment. The term deemed branch 
payment means, with respect to a U.S. taxable branch that is a U.S. 
permanent establishment of a treaty resident eligible for benefits 
under an income tax treaty between the United States and the treaty 
country, any amount of interest or royalties allowable as a deduction 
in computing the business profits of the U.S. permanent establishment, 
to the extent the amount is deemed paid to the home office (or other 
branch of the home office), is not regarded (or otherwise taken into 
account) under the home office's tax law (or the other branch's tax 
law), and, were the payment to be regarded (and treated as interest or 
a royalty, as applicable) under the home office's tax law (or other 
branch's tax law), the home office (or other branch) would include the 
payment in income, as determined under Sec.  1.267A-3(a). An amount may 
be otherwise taken into account for purposes of this paragraph (c)(2) 
if, for example, under the home office's tax law a corresponding amount 
of interest or royalties is allocated and attributable to the U.S. 
permanent establishment and is therefore not deductible.
    (d) Payments to reverse hybrids--(1) In general. If a specified 
payment is made to a reverse hybrid, then, subject to Sec.  1.267A-3(b) 
(amounts included or includible in income), the payment is a 
disqualified hybrid amount to the extent that--
    (i) An investor, the tax law of which treats the reverse hybrid as 
not fiscally transparent, does not include the payment in income, as 
determined under Sec.  1.267A-3(a) (to such extent, a no-inclusion); 
and
    (ii) The investor's no-inclusion is a result of the payment being 
made to the reverse hybrid. For purposes of this paragraph (d)(1)(ii), 
the investor's no-inclusion is a result of the specified payment being 
made to the reverse hybrid to the extent that the no-inclusion would 
not occur were the investor's tax law to treat the reverse hybrid as 
fiscally transparent (and treat the payment as interest or a royalty, 
as applicable). See Sec.  1.267A-6(c)(5) for an example illustrating 
the application of paragraph (d) of this section.
    (2) Definition of reverse hybrid. The term reverse hybrid means an 
entity (regardless of whether domestic or foreign) that is fiscally 
transparent under the tax law of the country in which it is created, 
organized, or otherwise established but not fiscally transparent under 
the tax law of an investor of the entity.
    (3) Payments made indirectly to a reverse hybrid. A specified 
payment made to an entity an interest of which is directly or 
indirectly (determined under the rules of section 958(a) without regard 
to whether an intermediate entity is foreign or domestic, or under 
substantially similar rules under a tax resident's or taxable branch's 
tax law) owned by a reverse hybrid is considered made to the reverse 
hybrid to the extent that, under the tax law of an investor of the 
reverse hybrid, the entity to which the payment is made is fiscally 
transparent (and all intermediate entities, if any, are also fiscally 
transparent).
    (4) Exception for inclusion by taxable branch in establishment 
country. Paragraph (d)(1) of this section does not apply to a specified 
payment made to a reverse hybrid to the extent that a taxable branch 
located in the country in which the reverse hybrid is created, 
organized, or otherwise established (and the activities of which are 
carried on by one or more investors of the reverse hybrid) includes the 
payment in income, as determined under Sec.  1.267A-3(a).
    (e) Branch mismatch payments--(1) In general. If a specified 
payment is a branch mismatch payment, then, subject to Sec.  1.267A-
3(b) (amounts included or includible in income), the payment is a 
disqualified hybrid amount to the extent that--
    (i) A home office, the tax law of which treats the payment as 
income attributable to a branch of the home office, does not include 
the payment in income, as determined under Sec.  1.267A-3(a) (to such 
extent, a no-inclusion); and
    (ii) The home office's no-inclusion is a result of the payment 
being a branch mismatch payment. For purposes of this paragraph 
(e)(1)(ii), the home office's no-inclusion is a result of the specified 
payment being a branch mismatch payment to the extent that the no-
inclusion would not occur were the home office's tax law to treat the 
payment as income that is not attributable a branch of the home office 
(and treat the payment as interest or a royalty, as applicable). See 
Sec.  1.267A-6(c)(6) for an example illustrating the

[[Page 19839]]

application of paragraph (e) of this section.
    (2) Definition of branch mismatch payment. The term branch mismatch 
payment means a specified payment for which the following requirements 
are satisfied:
    (i) Under a home office's tax law, the payment is treated as income 
attributable to a branch of the home office; and
    (ii) Either--
    (A) The branch is not a taxable branch; or
    (B) Under the branch's tax law, the payment is not treated as 
income attributable to the branch.
    (f) Relatedness or structured arrangement limitation. A specified 
recipient, a tax resident or taxable branch to which a specified 
payment is made, an investor, or a home office is taken into account 
for purposes of paragraphs (a), (b), (d), and (e) of this section, 
respectively, only if the specified recipient, the tax resident or 
taxable branch, the investor, or the home office, as applicable, is 
related (as defined in Sec.  1.267A-5(a)(14)) to the specified party or 
is a party to a structured arrangement (as defined in Sec.  1.267A-
5(a)(20)) pursuant to which the specified payment is made.


Sec.  1.267A-3  Income inclusions and amounts not treated as 
disqualified hybrid amounts.

    (a) Income inclusions--(1) General rule. For purposes of section 
267A, a tax resident or taxable branch includes in income a specified 
payment to the extent that, under the tax law of the tax resident or 
taxable branch--
    (i) It takes the payment into account (or has taken the payment 
into account, or, based on all the facts and circumstances, is 
reasonably expected to take the payment into account during a taxable 
year that ends no more than 36 months after the end of the specified 
party's taxable year) in its income or tax base at the full marginal 
rate imposed on ordinary income (or, if different, the full marginal 
rate imposed on interest or a royalty, as applicable); and
    (ii) The payment is not reduced or offset by an exemption, 
exclusion, deduction, credit (other than for withholding tax imposed on 
the payment), or other similar relief particular to such type of 
payment. Examples of such reductions or offsets include a participation 
exemption, a dividends received deduction, a deduction or exclusion 
with respect to a particular category of income (such as income 
attributable to a branch, or royalties under a patent box regime), a 
credit for underlying taxes paid by a corporation from which a dividend 
is received, and a recovery of basis with respect to stock or a 
recovery of principal with respect to indebtedness. A specified payment 
is not considered reduced or offset by a deduction or other similar 
relief particular to the type of payment if it is offset by a generally 
applicable deduction or other tax attribute, such as a deduction for 
depreciation or a net operating loss. For purposes of this paragraph 
(a)(1)(ii), a deduction may be treated as being generally applicable 
even if it arises from a transaction related to the specified payment 
(for example, if the deduction and payment are in connection with a 
back-to-back financing arrangement).
    (2) Coordination with foreign hybrid mismatch rules. Whether a tax 
resident or taxable branch includes in income a specified payment is 
determined without regard to any defensive or secondary rule contained 
in hybrid mismatch rules, if any, under the tax law of the tax resident 
or taxable branch. For purposes of this paragraph (a)(2), a defensive 
or secondary rule means a provision of hybrid mismatch rules that 
requires a tax resident or taxable branch to include an amount in 
income if a deduction for the amount is not disallowed under the 
payer's tax law. However, a defensive or secondary rule does not 
include a rule pursuant to which a participation exemption or similar 
relief particular to a dividend is inapplicable as to a dividend for 
which the payer is allowed a deduction or other tax benefit under its 
tax law. Thus, a defensive or secondary rule does not include a rule 
consistent with recommendation 2.1 in Chapter 2 of OECD/G-20, 
Neutralising the Effects of Hybrid Mismatch Arrangements, Action 2: 
2015 Final Report (October 2015).
    (3) Inclusions with respect to reverse hybrids. With respect to a 
tax resident or taxable branch that is an investor of a reverse hybrid, 
whether the investor includes in income a specified payment made to the 
reverse hybrid is determined without regard to a distribution from the 
reverse hybrid (or the right to a distribution from the reverse hybrid 
triggered by the payment). However, if the reverse hybrid distributes 
all of its income during a taxable year, then, for that year, the 
determination of whether an investor includes in income a specified 
payment made to the reverse hybrid is made with regard to one or more 
distributions from the reverse hybrid during the year, by treating a 
portion of the specified payment as relating to each distribution 
during the year. For purposes of this paragraph (a)(3), the portion of 
the specified payment that is considered to relate to a distribution is 
the lesser of--
    (i) The specified payment multiplied by a fraction, the numerator 
of which is the amount of the distribution and the denominator of which 
is the aggregate amount of distributions from the reverse hybrid during 
the taxable year; and
    (ii) The amount of the distribution multiplied by a fraction, the 
numerator of which is the specified payment and the denominator of 
which is the sum of all specified payments made to the reverse hybrid 
during the taxable year.
    (4) Inclusions with respect to certain payments pursuant to hybrid 
transactions. This paragraph (a)(4) applies to a specified payment that 
is interest and that is made pursuant to a hybrid transaction, to the 
extent that, under the tax law of a specified recipient of the payment, 
the payment is a recovery of basis with respect to stock or a recovery 
of principal with respect to indebtedness such that, but for this 
paragraph (a)(4), a no-inclusion would occur with respect to the 
specified recipient. In such a case, an amount that is a repayment of 
principal for U.S. tax purposes and that is or has been paid (or, based 
on all the facts and circumstances, is reasonably expected to be paid) 
by the specified party pursuant to the hybrid transaction (such amount, 
the principal payment) is, to the extent included in the income of the 
specified recipient, treated as correspondingly reducing the specified 
recipient's no-inclusion with respect to the specified payment. For 
purposes of this paragraph (a)(4), whether the specified recipient 
includes the principal payment in income is determined under paragraph 
(a)(1) of this section, by treating the principal payment as the 
specified payment and the taxable year period described in paragraph 
(a)(1) as being composed of taxable years of the specified recipient 
ending no more than 36 months after the end of the specified party's 
taxable year during which the specified payment is made (as opposed to, 
for example, being composed of taxable years of the specified recipient 
ending no more than 36 months after the end of the specified party's 
taxable year during which the principal payment is reasonably expected 
to be made). Moreover, once a principal payment reduces a no-inclusion 
with respect to a specified payment, it is not again taken into account 
for purposes of applying this paragraph (a)(4) to another specified 
payment. See Sec.  1.267A-6(c)(1)(vi) for an example illustrating the 
application of this paragraph (a)(4).
    (5) Deemed full inclusions and de minimis inclusions. A 
preferential rate,

[[Page 19840]]

exemption, exclusion, deduction, credit, or similar relief particular 
to a type of payment that reduces or offsets 90 percent or more of the 
payment is considered to reduce or offset 100 percent of the payment. 
In addition, a preferential rate, exemption, exclusion, deduction, 
credit, or similar relief particular to a type of payment that reduces 
or offsets 10 percent or less of the payment is considered to reduce or 
offset none of the payment.
    (b) Certain amounts not treated as disqualified hybrid amounts to 
extent included or includible in income for U.S. tax purposes--(1) In 
general. A specified payment, to the extent that but for this paragraph 
(b) it would be a disqualified hybrid amount (such amount, a tentative 
disqualified hybrid amount), is reduced under the rules of paragraphs 
(b)(2) through (4) of this section, as applicable. The tentative 
disqualified hybrid amount, as reduced under such rules, is the 
disqualified hybrid amount. See Sec.  1.267A-6(c)(3) and (7) for 
examples illustrating the application of paragraph (b) of this section.
    (2) Included in income of United States tax resident or U.S. 
taxable branch. A tentative disqualified hybrid amount is reduced to 
the extent that a specified recipient that is a tax resident of the 
United States or a U.S. taxable branch takes the tentative disqualified 
hybrid amount into account in determining its gross income.
    (3) Includible in income under section 951(a)(1)(A). A tentative 
disqualified hybrid amount is reduced to the extent that the tentative 
disqualified hybrid amount is received by a CFC and includible under 
section 951(a)(1)(A) (determined without regard to properly allocable 
deductions of the CFC, qualified deficits under section 952(c)(1)(B), 
and the earnings and profits limitation under Sec.  1.952-1(c)) in the 
gross income of a United States shareholder of the CFC. However, if the 
United States shareholder is a domestic partnership, then the amount 
includible under section 951(a)(1)(A) in the gross income of the United 
States shareholder reduces the tentative disqualified hybrid amount 
only to the extent that a tax resident of the United States would take 
into account the amount.
    (4) Includible in income under section 951A(a). A tentative 
disqualified hybrid amount is reduced to the extent that the tentative 
disqualified hybrid amount increases a United States shareholder's pro 
rata share of tested income (as determined under Sec. Sec.  1.951A-
1(d)(2) and 1.951A-2(b)(1)) with respect to a CFC, reduces the 
shareholder's pro rata share of tested loss (as determined under 
Sec. Sec.  1.951A-1(d)(4) and 1.951A-2(b)(2)) of the CFC, or both. 
However, to the extent that a deduction for the tentative disqualified 
hybrid amount would be allowed to a tax resident of the United States 
or a U.S. taxable branch, or would be allowed to a CFC but would be 
allocated and apportioned to gross income of the CFC that is gross 
income taken into account in determining subpart F income (as described 
in section 952) or gross income that is effectively connected (or 
treated as effectively connected) with the conduct of a trade or 
business in the United States (as described in Sec.  1.882-4(a)(1)), 
the reduction provided under this paragraph (b)(4) is equal to the 
reduction that would be provided under this paragraph (b)(4) but for 
this sentence multiplied by the difference of 100 percent and the 
percentage described in section 250(a)(1)(B).
    (5) Includible in income under section 1293. A tentative 
disqualified hybrid amount is reduced to the extent that the tentative 
disqualified hybrid amount is received by a qualified electing fund (as 
described in section 1295) and is includible under section 1293 in the 
gross income of a United States person that owns stock of that fund. 
However, if the United States person is a domestic partnership, then 
the amount includible under section 1293 in the gross income of the 
United States person reduces the tentative disqualified hybrid amount 
only to the extent that a tax resident of the United States would take 
into account the amount.


Sec.  1.267A-4  Disqualified imported mismatch amounts.

    (a) Disqualified imported mismatch amounts--(1) Rule. An imported 
mismatch payment is a disqualified imported mismatch amount to the 
extent that, under the set-off rules of paragraph (c) of this section, 
the income attributable to the payment is directly or indirectly offset 
by a hybrid deduction incurred by a foreign tax resident or foreign 
taxable branch that is related to the imported mismatch payer (or that 
is a party to a structured arrangement pursuant to which the payment is 
made). See Sec.  1.267A-6(c)(8) through (12) for examples illustrating 
the application of this section.
    (2) Definitions of certain terms. The following definitions apply 
for purposes of this section:
    (i) A foreign tax resident means a tax resident that is not a tax 
resident of the United States.
    (ii) A foreign taxable branch means a taxable branch that is not a 
U.S. taxable branch.
    (iii) An imported mismatch payee means, with respect to an imported 
mismatch payment, a foreign tax resident or foreign taxable branch that 
includes the payment in income, as determined under Sec.  1.267A-3(a).
    (iv) An imported mismatch payer means, with respect to an imported 
mismatch payment, the specified party.
    (v) An imported mismatch payment means a specified payment to the 
extent that it is neither a disqualified hybrid amount nor included or 
includible in income in the United States. For purposes of this 
paragraph (a)(2)(v), a specified payment is included or includible in 
income in the United States to the extent that, if the payment were a 
tentative disqualified hybrid amount (as described in Sec.  1.267A-
3(b)(1)), it would be reduced under the rules of Sec.  1.267A-3(b)(2) 
through (5).
    (b) Hybrid deduction--(1) In general. A hybrid deduction means any 
of the following:
    (i) A deduction allowed to a foreign tax resident or foreign 
taxable branch under its tax law for an amount paid or accrued that is 
interest (including an amount that would be a structured payment under 
the principles of Sec.  1.267A-5(b)(5)(ii)) or royalty under such tax 
law, to the extent that a deduction for the amount would be disallowed 
if such tax law contained rules substantially similar to those under 
Sec. Sec.  1.267A-1 through 1.267A-3 and 1.267A-5. Such a deduction is 
a hybrid deduction regardless of whether or how the amount giving rise 
to the deduction would be recognized under U.S. tax law.
    (ii) A deduction allowed to a foreign tax resident or foreign 
taxable branch under its tax law with respect to equity (including 
deemed equity), such as a notional interest deduction (or similar 
deduction determined with respect to the foreign tax resident's or 
foreign taxable branch's equity). However, a deduction allowed to a 
foreign tax resident or foreign taxable branch with respect to equity 
is a hybrid deduction only to the extent that an investor of the 
foreign tax resident, or the home office of the foreign taxable branch, 
would include the amount in income if, for purposes of the investor's 
or home office's tax law, the amount were interest paid by the foreign 
tax resident ratably (by value) with respect to the interests of the 
foreign tax resident, or interest paid by the foreign taxable branch to 
the home office. For purposes of this paragraph (b)(1)(ii), the rules 
of Sec.  1.267A-3(a) apply to determine the extent that an investor or 
home office would include an amount in income, by

[[Page 19841]]

treating the amount as the specified payment.
    (2) Special rules--(i) Foreign tax law contains hybrid mismatch 
rules. In the case of a foreign tax resident or foreign taxable branch 
the tax law of which contains hybrid mismatch rules, only the following 
deductions allowed to the foreign tax resident or foreign taxable 
branch under its tax law are hybrid deductions:
    (A) A deduction described in paragraph (b)(1)(i) of this section, 
to the extent that the deduction would be disallowed if the foreign tax 
resident's or foreign taxable branch's tax law--
    (1) Contained a rule substantially similar to Sec.  1.267A-2(a)(4) 
(payments pursuant to interest-free loans and similar arrangements); or
    (2) Did not permit an inclusion in income in a third country to 
discharge the application of its hybrid mismatch rules as to the amount 
giving rise to the deduction when the amount is not included in income 
in another country as a result of a hybrid or branch arrangement.
    (B) A deduction described in paragraph (b)(1)(ii) of this section 
(deductions with respect to equity).
    (ii) Dual inclusion income used to determine hybrid deductions 
arising from deemed branch payments in certain cases. In the case of a 
foreign taxable branch the tax law of which permits a loss of the 
foreign taxable branch to be shared with a tax resident or taxable 
branch (without regard to whether it is in fact so shared or whether 
there is a tax resident or taxable branch with which the loss can be 
shared), a deduction allowed to the foreign taxable branch for an 
amount that would be a deemed branch payment were such tax law to 
contain a provision substantially similar to Sec.  1.267A-2(c) is a 
hybrid deduction to the extent of the excess (if any) of the sum of all 
such amounts over the foreign taxable branch's dual inclusion income 
(as determined under the principles of Sec.  1.267A-2(b)(3)). The rule 
in this paragraph (b)(2)(ii) applies without regard to whether the tax 
law of the home office provides an exclusion or exemption for income 
attributable to the branch.
    (iii) Certain deductions are hybrid deductions only if allowed for 
an accounting period beginning on or after December 20, 2018. A 
deduction described in paragraph (b)(1)(ii) of this section (deductions 
with respect to equity), or a deduction that would be disallowed if the 
foreign tax resident's or foreign taxable branch's tax law contained a 
rule substantially similar to Sec.  1.267A-2(a)(4) (payments pursuant 
to interest-free loans and similar arrangements), is a hybrid deduction 
only if allowed for an accounting period beginning on or after December 
20, 2018.
    (iv) Certain deductions of a CFC are not hybrid deductions. A 
deduction that but for this paragraph (b)(2)(iv) would be a hybrid 
deduction is not a hybrid deduction to the extent that the amount paid 
or accrued giving rise to the deduction is--
    (A) A disqualified hybrid amount (but subject to the special rule 
of paragraph (g) of this section); or
    (B) Included or includible in income in the United States. For 
purposes of this paragraph (b)(2)(iv)(B), an amount is included or 
includible in income in the United States to the extent that, if the 
amount were a tentative disqualified hybrid amount (as described in 
Sec.  1.267A-3(b)(1)), it would be reduced under the rules of Sec.  
1.267A-3(b)(2) through (5).
    (v) Loss carryovers. A hybrid deduction for a particular accounting 
period includes a loss carryover from another accounting period, but 
only to the extent that a hybrid deduction incurred in an accounting 
period ending on or after December 20, 2018, comprises the loss 
carryover.
    (c) Set-off rules--(1) In general. In the order described in 
paragraph (c)(2) of this section, a hybrid deduction directly or 
indirectly offsets the income attributable to an imported mismatch 
payment to the extent that, under paragraph (c)(3) of this section, the 
payment directly or indirectly funds the hybrid deduction. The rules of 
paragraphs (c)(2) and (3) of this section are applied by taking into 
account the application of paragraph (c)(4) of this section 
(adjustments to ensure that amounts not taken into account more than 
once).
    (2) Ordering rules. The following ordering rules apply for purposes 
of determining the extent that a hybrid deduction directly or 
indirectly offsets income attributable to imported mismatch payments.
    (i) First, the hybrid deduction offsets income attributable to a 
factually-related imported mismatch payment that directly or indirectly 
funds the hybrid deduction. For purposes of this paragraph (c)(2)(i), a 
factually-related imported mismatch payment means an imported mismatch 
payment that is made pursuant to a transaction, agreement, or 
instrument entered into pursuant to the same plan or series of related 
transactions that includes the transaction, agreement, or instrument 
pursuant to which the hybrid deduction is incurred, provided that a 
design of the plan or series of related transactions was for the hybrid 
deduction to offset income attributable to the payment (as determined 
under the principles of Sec.  1.267A-5(a)(20)(i), by treating the 
offset as the ``hybrid mismatch'' described in Sec.  1.267A-
5(a)(20)(i)).
    (ii) Second, to the extent remaining, the hybrid deduction offsets 
income attributable to an imported mismatch payment (other than a 
factually-related imported mismatch payment) that directly funds the 
hybrid deduction.
    (iii) Third, to the extent remaining, the hybrid deduction offsets 
income attributable to an imported mismatch payment (other than a 
factually-related imported mismatch payment) that indirectly funds the 
hybrid deduction.
    (3) Funding rules. The following funding rules apply for purposes 
of determining the extent that an imported mismatch payment directly or 
indirectly funds a hybrid deduction.
    (i) The imported mismatch payment directly funds a hybrid deduction 
to the extent that the imported mismatch payee incurs the hybrid 
deduction.
    (ii) The imported mismatch payment indirectly funds a hybrid 
deduction to the extent that the imported mismatch payee is allocated 
the hybrid deduction, and provided that the imported mismatch payee is 
related to the imported mismatch payer (or is a party to a structured 
arrangement pursuant to which the imported mismatch payment is made).
    (iii) The imported mismatch payee is allocated a hybrid deduction 
to the extent that the imported mismatch payee directly or indirectly 
makes a funded taxable payment to the foreign tax resident or foreign 
taxable branch that incurs the hybrid deduction.
    (iv) An imported mismatch payee indirectly makes a funded taxable 
payment to the foreign tax resident or foreign taxable branch that 
incurs a hybrid deduction to the extent that a chain of funded taxable 
payments connects the imported mismatch payee, each intermediary 
foreign tax resident or foreign taxable branch, and the foreign tax 
resident or foreign taxable branch that incurs the hybrid deduction, 
and provided that each intermediary foreign tax resident or foreign 
taxable branch is related to the imported mismatch payer (or is a party 
to a structured arrangement pursuant to which the imported mismatch 
payment is made).
    (v) The term funded taxable payment means an amount paid or accrued 
by a foreign tax resident or foreign taxable branch under its tax law 
(other than an amount that gives rise to a hybrid deduction), to the 
extent that--

[[Page 19842]]

    (A) The amount is deductible (but, if such tax law contains hybrid 
mismatch rules, determined without regard to a provision substantially 
similar to this section);
    (B) Another foreign tax resident or foreign taxable branch includes 
the amount in income, as determined under Sec.  1.267A-3(a) (by 
treating the amount as the specified payment); and
    (C) The amount is neither a disqualified hybrid amount (but subject 
to the special rule of paragraph (g) of this section) nor included or 
includible in income in the United States. For purposes of this 
paragraph (c)(3)(v)(C), an amount is included or includible in income 
in the United States to the extent that, if the amount were a tentative 
disqualified hybrid amount (as described in Sec.  1.267A-3(b)(1)), it 
would be reduced under the rules of Sec.  1.267A-3(b)(2) through (5).
    (vi) If a deduction or loss that is not incurred by a foreign tax 
resident or foreign taxable branch is directly or indirectly made 
available to offset income of the foreign tax resident or foreign 
taxable branch under its tax law, then, for purposes of this paragraph 
(c), the foreign tax resident or foreign taxable branch to which the 
deduction or loss is made available and the foreign tax resident or 
foreign taxable branch that incurs the deduction or loss are treated as 
a single foreign tax resident or foreign taxable branch. For example, 
if a deduction or loss of one foreign tax resident is made available to 
offset income of another foreign tax resident under a tax 
consolidation, fiscal unity, group relief, loss sharing, or any similar 
regime, then the foreign tax residents are treated as a single foreign 
tax resident for purposes of this paragraph (c).
    (vii) An imported mismatch payee that directly makes a funded 
taxable payment to the foreign tax resident or foreign taxable branch 
that incurs a hybrid deduction is allocated the hybrid deduction before 
the hybrid deduction (to the extent remaining) is allocated to an 
imported mismatch payee that indirectly makes a funded taxable payment 
to the foreign tax resident or foreign taxable branch that incurs the 
hybrid deduction.
    (viii) An imported mismatch payee that, through a chain of funded 
taxable payments consisting of a particular number of funded taxable 
payments, indirectly makes a funded taxable payment to the foreign tax 
resident or foreign taxable branch that incurs a hybrid deduction is 
allocated the hybrid deduction before the hybrid deduction (to the 
extent remaining) is allocated to an imported mismatch payee that, 
through a chain of funded taxable payments consisting of a greater 
number of funded taxable payments, indirectly makes a funded taxable 
payment to the foreign tax resident or foreign taxable branch that 
incurs the hybrid deduction.
    (4) Adjustments to ensure amounts not taken into account more than 
once. To the extent that the income attributable to an imported 
mismatch payment is directly or indirectly offset by a hybrid 
deduction, the imported mismatch payment, the hybrid deduction, and, if 
applicable, each funded taxable payment comprising the chain of funded 
taxable payments connecting the imported mismatch payee, each 
intermediary foreign tax resident or foreign taxable branch, and the 
foreign tax resident or foreign taxable branch that incurs the hybrid 
deduction is correspondingly reduced; as a result, such amounts are not 
again taken into account under this section.
    (d) Calculations based on aggregate amounts during accounting 
period. For purposes of this section, amounts are determined on an 
accounting period basis. Thus, for example, the amount of imported 
mismatch payments made by an imported mismatch payer to a particular 
imported mismatch payee is equal to the aggregate amount of all such 
payments made by the imported mismatch payer during the accounting 
period.
    (e) Pro rata adjustments. Amounts are allocated on a pro rata basis 
if there would otherwise be more than one permissible manner in which 
to allocate the amounts. Thus, for example, if multiple imported 
mismatch payers make an imported mismatch payment to a single imported 
mismatch payee, the sum of such payments exceeds the hybrid deduction 
incurred by the imported mismatch payee, and the payments are not 
factually-related imported mismatch payments, then a pro rata portion 
of each imported mismatch payer's payment is considered to directly 
fund the hybrid deduction. See Sec.  1.267A-6(c)(9) and (12) for 
examples illustrating the application of this paragraph (e).
    (f) Special rules regarding manner in which this section is 
applied--(1) Initial application of this section. This section is first 
applied without regard to paragraph (f)(2) of this section and by 
taking into account only the following hybrid deductions:
    (i) A hybrid deduction described in paragraph (b)(1)(i) of this 
section, to the extent that--
    (A) The deduction would be disallowed if the foreign tax resident's 
or foreign taxable branch's tax law contained a rule substantially 
similar to Sec.  1.267A-2(a)(4) (payments pursuant to interest-free 
loans and similar arrangements); or
    (B) The paid or accrued amount giving rise to the deduction is 
included in income in a third country but is not included in income in 
another country as a result of a hybrid or branch arrangement.
    (ii) A hybrid deduction described in paragraph (b)(1)(ii) of this 
section (deductions with respect to equity).
    (2) Subsequent application of this section takes into account 
certain amounts deemed to be imported mismatch payments. After this 
section is applied pursuant to the rules of paragraph (f)(1) of this 
section, the section is then applied by taking into account only hybrid 
deductions other than those described in paragraph (f)(1) of this 
section. In addition, when applying this section in the manner 
described in the previous sentence, for purposes of determining the 
extent to which the income attributable to an imported mismatch payment 
is directly or indirectly offset by a hybrid deduction, an amount paid 
or accrued by a foreign tax resident or foreign taxable branch that is 
not a specified party is deemed to be an imported mismatch payment (and 
such foreign tax resident or foreign taxable branch and a foreign tax 
resident or foreign taxable branch that includes the amount in income, 
as determined under Sec.  1.267A-3(a), by treating the amount as the 
specified payment, are deemed to be an imported mismatch payer and an 
imported mismatch payee, respectively) to the extent that--
    (i) The tax law of such foreign tax resident or foreign taxable 
branch contains hybrid mismatch rules; and
    (ii) The amount is subject to disallowance under a provision of the 
hybrid mismatch rules substantially similar to this section. See Sec.  
1.267A-6(c)(10) and (12) for examples illustrating the application of 
paragraph (f)(2) of this section.
    (g) Special rule regarding extent to which a disqualified hybrid 
amount of a CFC prevents a hybrid deduction or a funded taxable 
payment. A disqualified hybrid amount of a CFC is taken into account 
for purposes of paragraph (b)(2)(iv)(A) or (c)(3)(v)(C) of this section 
(certain deductions not hybrid deductions or funded taxable payments to 
the extent the amount giving rise to the deduction is a disqualified 
hybrid amount) only to the extent of the excess (if any) of the 
disqualified hybrid amount over the sum of the amounts described in 
paragraphs (g)(1) through (3) of this section. See Sec.  1.267A-
6(c)(11)

[[Page 19843]]

for an example illustrating the application of this paragraph (g).
    (1) The disqualified hybrid amount to the extent that, if allowed 
as a deduction, it would be allocated and apportioned to residual CFC 
gross income (as described in Sec.  1.951A-2(c)(5)(iii)(B)) of the CFC.
    (2) The disqualified hybrid amount to the extent that, if allowed 
as a deduction, it would be allocated and apportioned (under the rules 
of section 954(b)(5)) to gross income that is taken into account in 
determining the CFC's subpart F income (as described in section 952 and 
Sec.  1.952-1), multiplied by the difference of 100 percent and the 
percentage of stock (by value) of the CFC that, for purposes of 
sections 951 and 951A, is owned (within the meaning of section 958(a), 
and determined by treating a domestic partnership as foreign) by one or 
more tax residents of the United States that are United States 
shareholders of the CFC.
    (3) The disqualified hybrid amount to the extent that, if allowed 
as a deduction, it would be allocated and apportioned (under the rules 
of Sec.  1.951A-2(c)(3)) to gross tested income of the CFC (as 
described in section 951A(c)(2)(A) and Sec.  1.951A-2(c)(1)), 
multiplied by the difference of 100 percent and the percentage of stock 
(by value) of the CFC that, for purposes of sections 951 and 951A, is 
owned (within the meaning of section 958(a), and determined by treating 
a domestic partnership as foreign) by one or more tax residents of the 
United States that are United States shareholders of the CFC.


Sec.  1.267A-5  Definitions and special rules.

    (a) Definitions. For purposes of Sec. Sec.  1.267A-1 through 
1.267A-7 the following definitions apply.
    (1) The term accounting period means a taxable year, or a period of 
similar length over which, under a provision of hybrid mismatch rules 
substantially similar to Sec.  1.267A-4, computations similar to those 
under Sec.  1.267A-4 are made under a foreign tax law.
    (2) The term branch means a taxable presence of a tax resident in a 
country other than its country of residence as determined under either 
the tax resident's tax law or such other country's tax law.
    (3) The term branch mismatch payment has the meaning provided in 
Sec.  1.267A-2(e)(2).
    (4) The term controlled foreign corporation (or CFC) has the 
meaning provided in section 957.
    (5) The term deemed branch payment has the meaning provided in 
Sec.  1.267A-2(c)(2).
    (6) The term disregarded payment has the meaning provided in Sec.  
1.267A-2(b)(2).
    (7) The term entity means any person as described in section 
7701(a)(1), including an entity that under Sec. Sec.  301.7701-1 
through 301.7701-3 of this chapter is disregarded as an entity separate 
from its owner, other than an individual.
    (8) The term fiscally transparent means, with respect to an entity, 
fiscally transparent with respect to an item of income as determined 
under the principles of Sec.  1.894-1(d)(3)(ii) and (iii), without 
regard to whether a tax resident (either the entity or interest holder 
in the entity) that derives the item of income is a resident of a 
country that has an income tax treaty with the United States. In 
addition, the following special rules apply with respect to an item of 
income received by an entity:
    (i) The entity is fiscally transparent with respect to the item 
under the tax law of the country in which the entity is created, 
organized, or otherwise established if, under that tax law, the entity 
does not take the item into account in its income (without regard to 
whether such tax law requires an investor of the entity, wherever 
resident, to separately take into account on a current basis the 
investor's respective share of the item), and the effect under that tax 
law is that an investor of the entity is required to take the item into 
account in its income as if the item were realized directly from the 
source from which realized by the entity, whether or not distributed.
    (ii) The entity is fiscally transparent with respect to the item 
under the tax law of an investor of the entity if, under that tax law, 
an investor of the entity takes the item into account in its income 
(without regard to whether such tax law requires the investor to 
separately take into account on a current basis the investor's 
respective share of the item) as if the item were realized directly 
from the source from which realized by the entity, whether or not 
distributed.
    (iii) The entity is fiscally transparent with respect to the item 
under the tax law of the country in which the entity is created, 
organized, or otherwise established if--
    (A) That tax law imposes a corporate income tax; and
    (B) Under that tax law, neither the entity is required to take the 
item into account in its income nor an investor of the entity is 
required to take the item into account in its income as if the item 
were realized directly from the source from which realized by the 
entity, whether or not distributed.
    (9) The term home office means a tax resident that has a branch.
    (10) The term hybrid mismatch rules means rules, regulations, or 
other tax guidance substantially similar to section 267A, and includes 
rules the purpose of which is to neutralize the deduction/no-inclusion 
outcome of hybrid and branch mismatch arrangements. Examples of such 
rules would include rules based on, or substantially similar to, the 
recommendations contained in OECD/G-20, Neutralising the Effects of 
Hybrid Mismatch Arrangements, Action 2: 2015 Final Report (October 
2015), and OECD/G-20, Neutralising the Effects of Branch Mismatch 
Arrangements, Action 2: Inclusive Framework on BEPS (July 2017).
    (11) The term hybrid transaction has the meaning provided in Sec.  
1.267A-2(a)(2).
    (12) The term interest means any amount described in paragraph 
(a)(12)(i) or (ii) of this section that is paid or accrued, or treated 
as paid or accrued, for the taxable year or that is otherwise 
designated as interest expense in paragraph (a)(12)(i) or (ii) of this 
section.
    (i) In general. Interest is an amount paid, received, or accrued as 
compensation for the use or forbearance of money under the terms of an 
instrument or contractual arrangement, including a series of 
transactions, that is treated as a debt instrument for purposes of 
section 1275(a) and Sec.  1.1275-1(d), and not treated as stock under 
Sec.  1.385-3, or an amount that is treated as interest under other 
provisions of the Internal Revenue Code (Code) or the regulations in 
this part. Thus, interest includes, but is not limited to, the 
following--
    (A) Original issue discount (OID);
    (B) Qualified stated interest, as adjusted by the issuer for any 
bond issuance premium;
    (C) OID on a synthetic debt instrument arising from an integrated 
transaction under Sec.  1.1275-6;
    (D) Repurchase premium to the extent deductible by the issuer under 
Sec.  1.163-7(c);
    (E) Deferred payments treated as interest under section 483;
    (F) Amounts treated as interest under a section 467 rental 
agreement;
    (G) Forgone interest under section 7872;
    (H) De minimis OID taken into account by the issuer;
    (I) Amounts paid in connection with a sale-repurchase agreement 
treated as indebtedness under Federal tax principles;

[[Page 19844]]

    (J) Redeemable ground rent treated as interest under section 
163(c); and
    (K) Amounts treated as interest under section 636.
    (ii) Swaps with significant nonperiodic payments--(A) In general. 
Except as provided in paragraphs (a)(12)(ii)(B) and (C) of this 
section, a swap with significant nonperiodic payments is treated as two 
separate transactions consisting of an on-market, level payment swap 
and a loan. The loan must be accounted for by the parties to the 
contract independently of the swap. The time value component associated 
with the loan, determined in accordance with Sec.  1.446-
3(f)(2)(iii)(A), is recognized as interest expense to the payor.
    (B) Exception for cleared swaps. Paragraph (a)(12)(ii)(A) of this 
section does not apply to a cleared swap. The term cleared swap means a 
swap that is cleared by a derivatives clearing organization, as such 
term is defined in section 1a of the Commodity Exchange Act (7 U.S.C. 
1a), or by a clearing agency, as such term is defined in section 3 of 
the Securities Exchange Act of 1934 (15 U.S.C. 78c), that is registered 
as a derivatives clearing organization under the Commodity Exchange Act 
or as a clearing agency under the Securities Exchange Act of 1934, 
respectively, if the derivatives clearing organization or clearing 
agency requires the parties to the swap to post and collect margin or 
collateral.
    (C) Exception for non-cleared swaps subject to margin or collateral 
requirements. Paragraph (a)(12)(ii)(A) of this section does not apply 
to a non-cleared swap that requires the parties to meet the margin or 
collateral requirements of a Federal regulator or that provides for 
margin or collateral requirements that are substantially similar to a 
cleared swap or a non-cleared swap subject to the margin or collateral 
requirements of a Federal regulator. For purposes of this paragraph 
(a)(12)(ii)(C), the term Federal regulator means the Securities and 
Exchange Commission (SEC), the Commodity Futures Trading Commission 
(CFTC), or a prudential regulator, as defined in section 1a(39) of the 
Commodity Exchange Act (7 U.S.C. 1a), as amended by section 721 of the 
Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, 
Public Law 111-203, 124 Stat. 1376, Title VII.
    (13) The term investor means, with respect to an entity, any tax 
resident or taxable branch that directly or indirectly (determined 
under the rules of section 958(a) without regard to whether an 
intermediate entity is foreign or domestic, or under substantially 
similar rules under a tax resident's or taxable branch's tax law) owns 
an interest in the entity.
    (14) The term related has the meaning provided in this paragraph 
(a)(14). A tax resident or taxable branch is related to a specified 
party if the tax resident or taxable branch is a related person within 
the meaning of section 954(d)(3), determined by treating the specified 
party as the ``controlled foreign corporation'' referred to in section 
954(d)(3) and the tax resident or taxable branch as the ``person'' 
referred to in section 954(d)(3). In addition, for the purposes of this 
paragraph (a)(14), a tax resident that under Sec. Sec.  301.7701-1 
through 301.7701-3 of this chapter is disregarded as an entity separate 
from its owner for U.S. tax purposes, as well as a taxable branch, is 
treated as a corporation. See also Sec.  1.954-1(f)(2)(iv)(B)(1) 
(neither section 318(a)(3), nor Sec.  1.958-2(d) or the principles 
thereof, applies to attribute stock or other interests).
    (15) The term reverse hybrid has the meaning provided in Sec.  
1.267A-2(d)(2).
    (16) The term royalty includes amounts paid or accrued as 
consideration for the use of, or the right to use--
    (i) Any copyright, including any copyright of any literary, 
artistic, scientific or other work (including cinematographic films and 
software);
    (ii) Any patent, trademark, design or model, plan, secret formula 
or process, or other similar property (including goodwill); or
    (iii) Any information concerning industrial, commercial or 
scientific experience, but does not include--
    (A) Amounts paid or accrued for after-sales services;
    (B) Amounts paid or accrued for services rendered by a seller to 
the purchaser under a warranty;
    (C) Amounts paid or accrued for pure technical assistance; or
    (D) Amounts paid or accrued for an opinion given by an engineer, 
lawyer or accountant.
    (17) The term specified party means a tax resident of the United 
States, a CFC (other than a CFC with respect to which there is not a 
tax resident of the United States that, for purposes of sections 951 
and 951A, owns (within the meaning of section 958(a), and determined by 
treating a domestic partnership as foreign) at least ten percent (by 
vote or value) of the stock of the CFC), and a U.S. taxable branch. 
Thus, an entity that is fiscally transparent for U.S. tax purposes is 
not a specified party, though an owner of the entity may be a specified 
party. For example, in the case of a payment by a partnership, a 
domestic corporation that is a partner of the partnership is a 
specified party and a deduction for its allocable share of the payment 
is subject to disallowance under section 267A.
    (18) The term specified payment has the meaning provided in Sec.  
1.267A-1(b).
    (19) The term specified recipient means, with respect to a 
specified payment, any tax resident that derives the payment under its 
tax law or any taxable branch to which the payment is attributable 
under its tax law (or any tax resident that, based on all the facts and 
circumstances, is reasonably expected to derive the payment under its 
tax law, or any taxable branch to which, based on all the facts and 
circumstances, the payment is reasonably expected to be attributable 
under its tax law). The principles of Sec.  1.894-1(d)(1) apply for 
purposes of determining whether a tax resident derives (or is 
reasonably expected to derive) a specified payment under its tax law, 
without regard to whether the tax resident is a resident of a country 
that has an income tax treaty with the United States. There may be more 
than one specified recipient with respect to a specified payment.
    (20) The terms structured arrangement and party to a structured 
arrangement have the meaning set forth in this paragraph (a)(20).
    (i) Structured arrangement. A structured arrangement means an 
arrangement with respect to which one or more specified payments would 
be a disqualified hybrid amount (or a disqualified imported mismatch 
amount) without regard to the relatedness limitation in Sec.  1.267A-
2(f) (or without regard to the phrase ``that is related to the 
specified party'' in Sec.  1.267A-4(a)) (either such outcome, a hybrid 
mismatch), provided that, based on all the facts and circumstances 
(including the terms of the arrangement), the arrangement is designed 
to produce the hybrid mismatch. Facts and circumstances that indicate 
the arrangement is designed to produce the hybrid mismatch include the 
following:
    (A) The hybrid mismatch is priced into the terms of the 
arrangement, including--
    (1) The pricing of the arrangement is different from what the 
pricing would have been absent the hybrid mismatch;
    (2) Features that alter the terms of the arrangement, including its 
return if the hybrid mismatch is no longer available; or
    (3) A below-market return absent the tax effects or benefits 
resulting from the hybrid mismatch.

[[Page 19845]]

    (B) The arrangement is marketed as tax-advantaged where some or all 
of the tax advantage derives from the hybrid mismatch.
    (C) The arrangement is marketed to tax residents of a country the 
tax law of which enables the hybrid mismatch.
    (ii) Party to a structured arrangement. A party to a structured 
arrangement means a tax resident or taxable branch that participates in 
the structured arrangement. For purposes of this paragraph (a)(20)(ii), 
in the case of a tax resident or a taxable branch that is an entity, 
the tax resident's or taxable branch's participation in a structured 
arrangement is imputed to its investors. However, a tax resident or 
taxable branch is considered to participate in the structured 
arrangement only if--
    (A) The tax resident or taxable branch (or a related tax resident 
or taxable branch) could, based on all the facts and circumstances, 
reasonably be expected to be aware of the hybrid mismatch; and
    (B) The tax resident or taxable branch (or a related tax resident 
or taxable branch) shares in the value of the tax benefit resulting 
from the hybrid mismatch.
    (21) The term tax law of a country includes statutes, regulations, 
administrative or judicial rulings, and income tax treaties of the 
country. If a country has an income tax treaty with the United States 
that applies to taxes imposed by a political subdivision or other local 
authority of that country, then the tax law of the political 
subdivision or other local authority is deemed to be a tax law of a 
country. When used with respect to a tax resident or branch, tax law 
refers to--
    (i) In the case of a tax resident, the tax law of the country or 
countries where the tax resident is resident; and
    (ii) In the case of a branch, the tax law of the country where the 
branch is located.
    (22) The term taxable branch means a branch that has a taxable 
presence under its tax law.
    (23) The term tax resident means either of the following:
    (i) A body corporate or other entity or body of persons liable to 
tax under the tax law of a country as a resident. For purposes of this 
paragraph (a)(23)(i), an entity that is created, organized, or 
otherwise established under the tax law of a country that does not 
impose a corporate income tax is treated as liable to tax under the tax 
law of such country as a resident if under the corporate or commercial 
laws of such country the entity is treated as a body corporate or a 
company. A body corporate or other entity or body of persons may be a 
tax resident of more than one country.
    (ii) An individual liable to tax under the tax law of a country as 
a resident. An individual may be a tax resident of more than one 
country.
    (24) The term United States shareholder has the meaning provided in 
section 951(b).
    (25) The term U.S. taxable branch means a trade or business carried 
on in the United States by a tax resident of another country, except 
that if an income tax treaty applies, the term means a permanent 
establishment of a tax treaty resident eligible for benefits under an 
income tax treaty between the United States and the treaty country. 
Thus, for example, a U.S. taxable branch includes a U.S. trade or 
business of a foreign corporation taxable under section 882(a) or a 
U.S. permanent establishment of a tax treaty resident.
    (b) Special rules. For purposes of Sec. Sec.  1.267A-1 through 
1.267A-7, the following special rules apply.
    (1) Coordination with other provisions--(i) In general. Except as 
provided in paragraph (b)(1)(ii) of this section, a specified payment 
is subject to section 267A after the application of any other 
applicable provisions of the Code and regulations in this part. Thus, 
the determination of whether a deduction for a specified payment is 
disallowed under section 267A is made with respect to the taxable year 
for which a deduction for the payment would otherwise be allowed for 
U.S. tax purposes. See, for example, sections 163(e)(3) and 267(a)(3) 
for rules that may defer the taxable year for which a deduction is 
allowed. See also Sec.  1.882-5(a)(5) (providing that provisions that 
disallow interest expense apply after the application of Sec.  1.882-
5). In addition, provisions that characterize amounts paid or accrued 
as something other than interest or royalties, such as Sec.  1.894-
1(d)(2), govern the treatment of such amounts and therefore such 
amounts would not be treated as specified payments. Moreover, to the 
extent that a specified payment is not described in Sec.  1.267A-1(b) 
when it is subject to section 267A, the payment is not again subject to 
section 267A at a later time. For example, if for the taxable year in 
which a specified payment is paid the payment is not described in Sec.  
1.267A-1(b) but under section 163(j) a deduction for the payment is 
deferred, the payment is not again subject to section 267A in the 
taxable year for which section 163(j) no longer defers the deduction.
    (ii) Section 267A applied before certain provisions. In addition to 
the extent provided in any other applicable provision of the Code or 
regulations in this part, section 267A applies before the application 
of sections 163(j), 461(l), 465, and 469.
    (iii) Coordination with capitalization and recovery provisions. To 
the extent a specified payment is described in Sec.  1.267A-1(b), a 
deduction for the payment is considered permanently disallowed for all 
purposes of the Code and regulations in this part and, therefore, the 
payment is not taken into account for purposes of computing costs that 
are required to be capitalized and recovered through depreciation, 
amortization, cost of goods sold, adjustment to basis, or similar forms 
of recovery under any applicable provision of the Code or in 
regulations in this part. Thus, for example, to the extent an interest 
or royalty payment is a specified payment described in Sec.  1.267A-
1(b), the payment is not capitalized and included in inventory cost or 
added to basis under section 263A. As an additional example, to the 
extent that a debt issuance cost is a specified payment described in 
Sec.  1.267A-1(b), it is neither capitalized under section 263 or the 
regulations in this part under section 263 nor recoverable under Sec.  
1.446-5.
    (iv) Specified payments arising in taxable years beginning before 
January 1, 2018. Section 267A does not apply to a specified payment 
that is paid or accrued in a taxable year beginning before January 1, 
2018, regardless of whether under a provision of the Code or 
regulations in this part (for example, section 267(a)(3)) a deduction 
for the payment is deferred to a taxable year beginning after December 
31, 2017, or whether the payment is carried over to another taxable 
year and under another provision of the Code (for example, section 
163(j)) is considered paid or accrued in such taxable year.
    (2) Foreign currency gain or loss. Except as set forth in this 
paragraph (b)(2), section 988 gain or loss is not taken into account 
under section 267A. Foreign currency gain or loss recognized with 
respect to a specified payment is taken into account under section 267A 
to the extent that a deduction for the specified payment is disallowed 
under section 267A, provided that the foreign currency gain or loss is 
described in Sec.  1.988-2(b)(4) (relating to exchange gain or loss 
recognized by the issuer of a debt instrument with respect to accrued 
interest) or Sec.  1.988-2(c) (relating to items of expense or gross 
income or receipts which are to be paid after the date accrued). If a 
deduction for a specified payment is disallowed under section 267A, 
then a proportionate amount of foreign currency loss under section 988 
with respect to the specified payment is also

[[Page 19846]]

disallowed, and a proportionate amount of foreign currency gain under 
section 988 with respect to the specified payment reduces the amount of 
the disallowance. For purposes of this paragraph (b)(2), the 
proportionate amount is the amount of the foreign currency gain or loss 
under section 988 with respect to the specified payment multiplied by a 
fraction, the numerator of which is the amount of the specified payment 
for which a deduction is disallowed under section 267A and the 
denominator of which is the total amount of the specified payment.
    (3) U.S. taxable branch payments--(i) Amounts considered paid or 
accrued by a U.S. taxable branch. For purposes of section 267A, a U.S. 
taxable branch is considered to pay or accrue an amount of interest or 
royalty equal to either--
    (A) The amount of interest or royalty allocable to effectively 
connected income of the U.S. taxable branch under section 873(a) or 
882(c)(1), as applicable; or
    (B) In the case of a U.S. taxable branch that is a U.S. permanent 
establishment of a treaty resident eligible for benefits under an 
income tax treaty between the United States and the treaty country, the 
amount of interest or royalty allowable in computing the business 
profits attributable to the U.S. permanent establishment.
    (ii) Treatment of U.S. taxable branch payments--(A) Interest. 
Interest considered paid or accrued by a U.S. taxable branch of a 
foreign corporation under paragraph (b)(3)(i) of this section (the 
``U.S. taxable branch interest payment'') is treated as a payment 
directly to the person to which the interest is payable, to the extent 
it is paid or accrued with respect to a liability described in Sec.  
1.882-5(a)(1)(ii)(A) or (B) (resulting in directly allocable interest) 
or with respect to a U.S. booked liability, as described in Sec.  
1.882-5(d)(2). If the U.S. taxable branch interest payment exceeds in 
the aggregate the interest paid or accrued on the U.S. taxable branch's 
directly allocable interest and interest paid or accrued on U.S. booked 
liabilities, the excess amount is treated as paid or accrued by the 
U.S. taxable branch on a pro-rata basis to the same persons and 
pursuant to the same terms that the home office paid or accrued 
interest, excluding any directly allocable interest or interest paid or 
accrued on a U.S. booked liability. The rules of this paragraph 
(b)(3)(ii) for determining to whom interest is paid or accrued apply 
without regard to whether the U.S. taxable branch interest payment is 
determined under the method described in Sec.  1.882-5(b) through (d) 
or the method described in Sec.  1.882-5(e).
    (B) Royalties. Royalties considered paid or accrued by a U.S. 
taxable branch under paragraph (b)(3)(i) of this section are treated 
solely for purposes of section 267A as paid or accrued on a pro-rata 
basis by the U.S. taxable branch to the same persons and pursuant to 
the same terms that the home office paid or accrued such royalties.
    (C) Permanent establishments and interbranch payments. If a U.S. 
taxable branch is a permanent establishment in the United States, the 
principles of the rules in paragraphs (b)(3)(ii)(A) and (B) of this 
section apply with respect to interest and royalties allowed in 
computing the business profits of a treaty resident eligible for treaty 
benefits. This paragraph (b)(3)(ii)(C) does not apply to interbranch 
interest or royalty payments allowed as deduction under certain U.S. 
income tax treaties (as described in Sec.  1.267A-2(c)(2)).
    (4) Effect on earnings and profits. The disallowance of a deduction 
under section 267A does not affect whether the amount paid or accrued 
that gave rise to the deduction reduces earnings and profits of a 
corporation. However, for purposes of section 952(c)(1) and Sec.  
1.952-1(c), a CFC's earnings and profits are not reduced by a specified 
payment a deduction for which is disallowed under section 267A, if a 
principal purpose of the transaction pursuant to which the payment is 
made is to reduce or limit the CFC's subpart F income.
    (5) Application to structured payments--(i) In general. For 
purposes of section 267A and the regulations in this part under section 
267A, a structured payment (as defined in paragraph (b)(5)(ii) of this 
section) is treated as interest. Thus, a structured payment is treated 
as subject to section 267A and the regulations in this part under 
section 267A to the same extent as if the payment were an amount of 
interest paid or accrued.
    (ii) Structured payment. A structured payment means any amount 
described in paragraph (b)(5)(ii)(A) or (B) of this section.
    (A) Substitute interest payments. A substitute interest payment 
described in Sec.  1.861-2(a)(7) is treated as a structured payment for 
purposes of section 267A, unless the payment relates to a sale-
repurchase agreement or a securities lending transaction that is 
entered into by the payor in the ordinary course of the payor's 
business. This paragraph (b)(5)(ii)(A) does not apply to an amount 
described in paragraph (a)(12)(i)(I) of this section.
    (B) Amounts economically equivalent to interest--(1) Principal 
purpose to reduce interest expense. Any expense or loss economically 
equivalent to interest is treated as a structured payment for purposes 
of section 267A if a principal purpose of structuring the 
transaction(s) is to reduce an amount incurred by the taxpayer that 
otherwise would have been described in paragraph (a)(12) or 
(b)(5)(ii)(A) of this section. For purposes of this paragraph 
(b)(5)(ii)(B)(1), the fact that the taxpayer has a business purpose for 
obtaining the use of funds does not affect the determination of whether 
the manner in which the taxpayer structures the transaction(s) is with 
a principal purpose of reducing the taxpayer's interest expense. In 
addition, the fact that the taxpayer has obtained funds at a lower pre-
tax cost based on the structure of the transaction(s) does not affect 
the determination of whether the manner in which the taxpayer 
structures the transaction(s) is with a principal purpose of reducing 
the taxpayer's interest expense. For purposes of this paragraph 
(b)(5)(ii)(B), any expense or loss is economically equivalent to 
interest to the extent that the expense or loss is--
    (i) Deductible by the taxpayer;
    (ii) Incurred by the taxpayer in a transaction or series of 
integrated or related transactions in which the taxpayer secures the 
use of funds for a period of time;
    (iii) Substantially incurred in consideration of the time value of 
money; and
    (iv) Not described in paragraph (a)(12) or (b)(5)(ii)(A) of this 
section.
    (2) Principal purpose. Whether a transaction or a series of 
integrated or related transactions is entered into with a principal 
purpose described in paragraph (b)(5)(ii)(B)(1) of this section depends 
on all the facts and circumstances related to the transaction(s). A 
purpose may be a principal purpose even though it is outweighed by 
other purposes (taken together or separately). Factors to be taken into 
account in determining whether one of the taxpayer's principal purposes 
for entering into the transaction(s) include the taxpayer's normal 
borrowing rate in the taxpayer's functional currency, whether the 
taxpayer would enter into the transaction(s) in the ordinary course of 
the taxpayer's trade or business, whether the parties to the 
transaction(s) are related persons (within the meaning of section 
267(b) or 707(b)), whether there is a significant and bona fide 
business purpose for the structure of the transaction(s), whether the 
transactions are transitory, for example, due to a

[[Page 19847]]

circular flow of cash or other property, and the substance of the 
transaction(s).
    (6) Anti-avoidance rule. A specified party's deduction for a 
specified payment is disallowed to the extent that both of the 
following requirements are satisfied:
    (i) The payment (or income attributable to the payment) is not 
included in the income of a tax resident or taxable branch, as 
determined under Sec.  1.267A-3(a) (but without regard to the deemed 
full inclusion rule in Sec.  1.267A-3(a)(5)).
    (ii) A principal purpose of the terms or structure of the 
arrangement (including the form and the tax laws of the parties to the 
arrangement) is to avoid the application of the regulations in this 
part under section 267A in a manner that is contrary to the purposes of 
section 267A and the regulations in this part under section 267A.


Sec.  1.267A-6  Examples.

    (a) Scope. This section provides examples that illustrate the 
application of Sec. Sec.  1.267A-1 through 1.267A-5.
    (b) Presumed facts. For purposes of the examples in this section, 
unless otherwise indicated, the following facts are presumed:
    (1) US1, US2, and US3 are domestic corporations that are tax 
residents solely of the United States.
    (2) FW, FX, and FZ are bodies corporate established in, and tax 
residents of, Country W, Country X, and Country Z, respectively. They 
are not fiscally transparent under the tax law of any country. They are 
not specified parties.
    (3) Under the tax law of each country, interest and royalty 
payments are deductible.
    (4) The tax law of each country provides a 100 percent 
participation exemption for dividends received from non-resident 
corporations.
    (5) The tax law of each country, other than the United States, 
provides an exemption for income attributable to a branch.
    (6) Except as provided in paragraphs (b)(4) and (5) of this 
section, all amounts derived (determined under the principles of Sec.  
1.894-1(d)(1)) by a tax resident, or attributable to a taxable branch, 
are included in income, as determined under Sec.  1.267A-3(a).
    (7) Only the tax law of the United States contains hybrid mismatch 
rules.

    (c) Examples--(1) Example 1. Payment pursuant to a hybrid 
financial instrument--(i) Facts. FX holds all the interests of US1. 
FX also holds an instrument issued by US1 that is treated as equity 
for Country X tax purposes and indebtedness for U.S. tax purposes 
(the FX-US1 instrument). On date 1, US1 pays $50x to FX pursuant to 
the instrument. The amount is treated as an excludible dividend for 
Country X tax purposes (by reason of the Country X participation 
exemption) and as interest for U.S. tax purposes.
    (ii) Analysis. US1 is a specified party and thus a deduction for 
its $50x specified payment is subject to disallowance under section 
267A. As described in paragraphs (c)(1)(ii)(A) through (C) of this 
section, the entire $50x payment is a disqualified hybrid amount 
under the hybrid transaction rule of Sec.  1.267A-2(a) and, as a 
result, a deduction for the payment is disallowed under Sec.  
1.267A-1(b)(1).
    (A) US1's payment is made pursuant to a hybrid transaction 
because a payment with respect to the FX-US1 instrument is treated 
as interest for U.S. tax purposes but not for purposes of Country X 
tax law (the tax law of FX, a specified recipient that is related to 
US1). See Sec.  1.267A-2(a)(2) and (f). Therefore, Sec.  1.267A-2(a) 
applies to the payment.
    (B) For US1's payment to be a disqualified hybrid amount under 
Sec.  1.267A-2(a), a no-inclusion must occur with respect to FX. See 
Sec.  1.267A-2(a)(1)(i). As a consequence of the Country X 
participation exemption, FX includes $0 of the payment in income and 
therefore a $50x no-inclusion occurs with respect to FX. See Sec.  
1.267A-3(a)(1). The result is the same regardless of whether, under 
the Country X participation exemption, the $50x payment is simply 
excluded from FX's taxable income or, instead, is reduced or offset 
by other means, such as a $50x dividends received deduction. See 
Sec.  1.267A-3(a)(1).
    (C) Pursuant to Sec.  1.267A-2(a)(1)(ii), FX's $50x no-inclusion 
gives rise to a disqualified hybrid amount to the extent that it is 
a result of US1's payment being made pursuant to the hybrid 
transaction. FX's $50x no-inclusion is a result of the payment being 
made pursuant to the hybrid transaction because, were the payment to 
be treated as interest for Country X tax purposes, FX would include 
$50x in income and, consequently, the no-inclusion would not occur.
    (iii) Alternative facts--multiple specified recipients. The 
facts are the same as in paragraph (c)(1)(i) of this section, except 
that FX holds all the interests of FZ, which is fiscally transparent 
for Country X tax purposes, and FZ holds all of the interests of 
US1. Moreover, the FX-US1 instrument is held by FZ (rather than by 
FX) and US1 makes its $50x payment to FZ (rather than to FX); the 
payment is derived by FZ under its tax law and by FX under its tax 
law and, accordingly, both FZ and FX are specified recipients of the 
payment. Further, the payment is treated as interest for Country Z 
tax purposes and FZ includes it in income. For the reasons described 
in paragraph (c)(1)(ii) of this section, FX's no-inclusion causes 
the payment to be a disqualified hybrid amount. FZ's inclusion in 
income (regardless of whether Country Z has a low or high tax rate) 
does not affect the result, because the hybrid transaction rule of 
Sec.  1.267A-2(a) applies if any no-inclusion occurs with respect to 
a specified recipient of the payment as a result of the payment 
being made pursuant to the hybrid transaction.
    (iv) Alternative facts--preferential rate. The facts are the 
same as in paragraph (c)(1)(i) of this section, except that for 
Country X tax purposes US1's payment is treated as a dividend 
subject to a 4% tax rate, whereas the marginal rate imposed on 
ordinary income is 20%. FX includes $10x of the payment in income, 
calculated as $50x multiplied by 0.2 (.04, the rate at which the 
particular type of payment (a dividend for Country X tax purposes) 
is subject to tax in Country X, divided by 0.2, the marginal tax 
rate imposed on ordinary income). See Sec.  1.267A-3(a)(1). Thus, a 
$40x no-inclusion occurs with respect to FX ($50x less $10x). The 
$40x no-inclusion is a result of the payment being made pursuant to 
the hybrid transaction because, were the payment to be treated as 
interest for Country X tax purposes, FX would include the entire 
$50x in income at the full marginal rate imposed on ordinary income 
(20%) and, consequently, the no-inclusion would not occur. 
Accordingly, $40x of US1's payment is a disqualified hybrid amount.
    (v) Alternative facts--no-inclusion not the result of hybridity. 
The facts are the same as in paragraph (c)(1)(i) of this section, 
except that Country X has a pure territorial regime (that is, 
Country X only taxes income with a domestic source). Although US1's 
payment is pursuant to a hybrid transaction and a $50x no-inclusion 
occurs with respect to FX, FX's no-inclusion is not a result of the 
payment being made pursuant to the hybrid transaction. This is 
because if Country X tax law were to treat the payment as interest, 
FX would include $0 in income and, consequently, the $50x no-
inclusion would still occur. Accordingly, US1's payment is not a 
disqualified hybrid amount. See Sec.  1.267A-2(a)(1)(ii). The result 
would be the same if Country X instead did not impose a corporate 
income tax.
    (vi) Alternative facts--indebtedness under both tax laws but 
different ordering rules give rise to hybrid transaction; reduction 
of no-inclusion by reason of inclusion of a principal payment. The 
facts are the same as in paragraph (c)(1)(i) of this section, except 
that the FX-US1 instrument is indebtedness for both U.S. and Country 
X tax purposes. In addition, the $50x date 1 payment is treated as 
interest for U.S. tax purposes and a repayment of principal for 
Country X tax purposes. On date 1, based on all the facts and 
circumstances (including the terms of the FX-US1 instrument, the tax 
laws of the United States and Country X, and an absence of a plan 
pursuant to which FX would dispose of the FX-US1 instrument), it is 
reasonably expected that on date 2 (a date that is within 36 months 
after the end of the taxable year of US1 that includes date 1), US1 
will pay a total of $200x to FX and that, for U.S. tax purposes, 
$25x will be treated as interest and $175x as a repayment of 
principal, and, for Country X tax purposes, $75x will be treated as 
interest (and included in FX's income) and $125x as a repayment of 
principal. US1's $50x specified payment is made pursuant to a hybrid 
transaction and, but for Sec.  1.267A-3(a)(4), a $50x no-inclusion 
would occur with respect to FX. See Sec. Sec.  1.267A-2(a)(2) and 
1.267A-3(a)(1). However, pursuant to Sec.  1.267A-3(a)(4), FX's

[[Page 19848]]

inclusion in income with respect to $50x of the date 2 amount that 
is a repayment of principal for U.S. tax purposes is treated as 
correspondingly reducing FX's no-inclusion with respect to the 
specified payment. As a result, as to US1's $50x specified payment, 
a no-inclusion does not occur with respect to FX. See Sec.  1.267A-
3(a)(4). Therefore, US1's $50x specified payment is not a 
disqualified hybrid amount. See Sec.  1.267A-2(a)(1)(i).
    (2) Example 2. Payment pursuant to a repo transaction--(i) 
Facts. FX holds all the interests of US1, and US1 holds all the 
interests of US2. On date 1, US1 and FX enter into a sale and 
repurchase transaction. Pursuant to the transaction, US1 transfers 
shares of preferred stock of US2 to FX in exchange for $1,000x, 
subject to a binding commitment of US1 to reacquire those shares on 
date 3 for an agreed price, which represents a repayment of the 
$1,000x plus a financing or time value of money return reduced by 
the amount of any distributions paid with respect to the preferred 
stock between dates 1 and 3 that are retained by FX. On date 2, US2 
pays a $100x dividend on its preferred stock to FX. For Country X 
tax purposes, FX is treated as owning the US2 preferred stock and 
therefore is the beneficial owner of the dividend. For U.S. tax 
purposes, the transaction is treated as a loan from FX to US1 that 
is secured by the US2 preferred stock. Thus, for U.S. tax purposes, 
US1 is treated as owning the US2 preferred stock and is the 
beneficial owner of the dividend. In addition, for U.S. tax 
purposes, US1 is treated as paying $100x of interest to FX (an 
amount corresponding to the $100x dividend paid by US2 to FX). 
Further, the marginal tax rate imposed on ordinary income under 
Country X tax law is 25%. Moreover, instead of a participation 
exemption, Country X tax law provides its tax residents a credit for 
underlying foreign taxes paid by a non-resident corporation from 
which a dividend is received; with respect to the $100x dividend 
received by FX from US2, the credit is $10x.
    (ii) Analysis. US1 is a specified party and thus a deduction for 
its $100x specified payment is subject to disallowance under section 
267A. As described in paragraphs (c)(2)(ii)(A) through (D) of this 
section, $40x of the payment is a disqualified hybrid amount under 
the hybrid transaction rule of Sec.  1.267A-2(a) and, as a result, 
$40x of the deduction is disallowed under Sec.  1.267A-1(b)(1).
    (A) Although US1's $100x interest payment is not regarded under 
Country X tax law, a connected amount (US2's dividend payment) is 
regarded and derived by FX under such tax law. Thus, FX is 
considered a specified recipient with respect to US1's interest 
payment. See Sec.  1.267A-2(a)(3).
    (B) US1's payment is made pursuant to a hybrid transaction 
because a payment with respect to the sale and repurchase 
transaction is treated as interest for U.S. tax purposes but not for 
purposes of Country X tax law (the tax law of FX, a specified 
recipient that is related to US1), which does not regard the 
payment. See Sec.  1.267A-2(a)(2) and (f). Therefore, Sec.  1.267A-
2(a) applies to the payment.
    (C) For US1's payment to be a disqualified hybrid amount under 
Sec.  1.267A-2(a), a no-inclusion must occur with respect to FX. See 
Sec.  1.267A-2(a)(1)(i). As a consequence of Country X tax law not 
regarding US1's payment, FX includes $0 of the payment in income and 
therefore a $100x no-inclusion occurs with respect to FX. See Sec.  
1.267A-3(a). However, FX includes $60x of a connected amount (US2's 
dividend payment) in income, calculated as $100x (the amount of the 
dividend) less $40x (the portion of the connected amount that is not 
included in income in Country X due to the foreign tax credit, 
determined by dividing the amount of the credit, $10x, by 0.25, the 
tax rate in Country X). See Sec.  1.267A-3(a). Pursuant to Sec.  
1.267A-2(a)(3), FX's inclusion in income with respect to the 
connected amount correspondingly reduces the amount of its no-
inclusion with respect to US1's payment. Therefore, for purposes of 
Sec.  1.267A-2(a), FX's no-inclusion with respect to US1's payment 
is $40x ($100x less $60x). See Sec.  1.267A-2(a)(3).
    (D) Pursuant to Sec.  1.267A-2(a)(1)(ii), FX's $40x no-inclusion 
gives rise to a disqualified hybrid amount to the extent that FX's 
no-inclusion is a result of US1's payment being made pursuant to the 
hybrid transaction. FX's $40x no-inclusion is a result of US1's 
payment being made pursuant to the hybrid transaction because, were 
the sale and repurchase transaction to be treated as a loan from FX 
to US1 for Country X tax purposes, FX would include US1's $100x 
interest payment in income (because it would not be entitled to a 
foreign tax credit) and, consequently, the no-inclusion would not 
occur.
    (iii) Alternative facts--structured arrangement. The facts are 
the same as in paragraph (c)(2)(i) of this section, except that FX 
is a bank that is unrelated to US1. In addition, the sale and 
repurchase transaction is a structured arrangement and FX is a party 
to the structured arrangement. The result is the same as in 
paragraph (c)(2)(ii) of this section. That is, even though FX is not 
related to US1, it is taken into account with respect to the 
determinations under Sec.  1.267A-2(a) because it is a party to a 
structured arrangement pursuant to which the payment is made. See 
Sec.  1.267A-2(f).
    (3) Example 3. Disregarded payment--(i) Facts. FX holds all the 
interests of US1. For Country X tax purposes, US1 is a disregarded 
entity of FX. During taxable year 1, US1 pays $100x to FX pursuant 
to a debt instrument. The amount is treated as interest for U.S. tax 
purposes but is disregarded for Country X tax purposes as a 
transaction involving a single taxpayer. During taxable year 1, 
US1's only other items of income, gain, deduction, or loss are $125x 
of gross income (the entire amount of which is included in US1's 
income) and a $60x item of deductible expense. The $125x item of 
gross income is included in FX's income, and the $60x item of 
deductible expense is allowable for Country X tax purposes.
    (ii) Analysis. US1 is a specified party and thus a deduction for 
its $100x specified payment is subject to disallowance under section 
267A. As described in paragraphs (c)(3)(ii)(A) and (B) of this 
section, $35x of the payment is a disqualified hybrid amount under 
the disregarded payment rule of Sec.  1.267A-2(b) and, as a result, 
$35x of the deduction is disallowed under Sec.  1.267A-1(b)(1).
    (A) US1's $100x payment is not regarded under the tax law of 
Country X (the tax law of FX, a related tax resident to which the 
payment is made) because under such tax law the payment involves a 
single taxpayer. See Sec.  1.267A-2(b)(2) and (f). In addition, were 
the tax law of Country X to regard the payment (and treat it as 
interest), FX would include it in income. Therefore, the payment is 
a disregarded payment to which Sec.  1.267A-2(b) applies. See Sec.  
1.267A-2(b)(2).
    (B) Under Sec.  1.267A-2(b)(1), the excess (if any) of US1's 
disregarded payments for taxable year 1 ($100x) over its dual 
inclusion income for the taxable year is a disqualified hybrid 
amount. US1's dual inclusion income for taxable year 1 is $65x, 
calculated as $125x (the amount of US1's gross income that is 
included in FX's income) less $60x (the amount of US1's deductible 
expenses, other than deductions for disregarded payments, that are 
allowable for Country X tax purposes). See Sec.  1.267A-2(b)(3). 
Therefore, $35x is a disqualified hybrid amount ($100x less $65x). 
See Sec.  1.267A-2(b)(1).
    (iii) Alternative facts--non-dual inclusion income arising from 
hybrid transaction. The facts are the same as in paragraph (c)(3)(i) 
of this section, except that US1 holds all the interests of FZ (a 
specified party that is a CFC) and US1's only item of income, gain, 
deduction, or loss during taxable year 1 (other than the $100x 
payment to FX) is $80x paid to US1 by FZ pursuant to an instrument 
treated as indebtedness for U.S. and Country Z tax purposes and 
equity for Country X tax purposes (the US1-FZ instrument). The $80x 
is treated as interest for Country Z and U.S. tax purposes (the 
entire amount of which is included in US1's income) and is treated 
as an excludible dividend for Country X tax purposes (by reason of 
the Country X participation exemption). Paragraphs (c)(3)(iii)(A) 
and (B) of this section describe the extent to which the specified 
payments by FZ and US1, each of which is a specified party, are 
disqualified hybrid amounts.
    (A) The hybrid transaction rule of Sec.  1.267A-2(a) applies to 
FZ's payment because the payment is made pursuant to a hybrid 
transaction, as a payment with respect to the US1-FZ instrument is 
treated as interest for U.S. tax purposes but not for purposes of 
Country X's tax law (the tax law of FX, a specified recipient that 
is related to FZ). As a consequence of the Country X participation 
exemption, an $80x no-inclusion occurs with respect to FX, and such 
no-inclusion is a result of the payment being made pursuant to the 
hybrid transaction. Thus, but for Sec.  1.267A-3(b), the entire $80x 
of FZ's payment would be a disqualified hybrid amount. However, 
because US1 (a tax resident of the United States that is also a 
specified recipient of the payment) takes the entire $80x payment 
into account in its gross income, no portion of the payment is a 
disqualified hybrid amount. See Sec.  1.267A-3(b)(2).
    (B) The disregarded payment rule of Sec.  1.267A-2(b) applies to 
US1's $100x payment to FX, for the reasons described in paragraph 
(c)(3)(ii)(A) of this section. In

[[Page 19849]]

addition, US1 has no dual inclusion income for taxable year 1 
because, as a result of the Country X participation exemption, no 
portion of FZ's $80x payment to US1 (which is derived by FX under 
its tax law) is included in FX's income. See Sec. Sec.  1.267A-
2(b)(3) and 1.267A-3(a). Therefore, the entire $100x payment from 
US1 to FX is a disqualified hybrid amount, calculated as $100x (the 
amount of the payment) less $0 (the amount of dual inclusion 
income). See Sec.  1.267A-2(b)(1).
    (iv) Alternative facts--dual inclusion income despite 
participation exemption. The facts are the same as in paragraph 
(c)(3)(iii) of this section, except that the US1-FZ instrument is 
treated as indebtedness for U.S. tax purposes and equity for Country 
Z and Country X tax purposes. In addition, the $80x paid to US1 by 
FZ is treated as interest for U.S. tax purposes (the entire amount 
of which is included in US1's income), a dividend for Country Z tax 
purposes (for which FZ is not allowed a deduction or other tax 
benefit), and an excludible dividend for Country X tax purposes (by 
reason of the Country X participation exemption). For the reasons 
described in paragraph (c)(3)(iii)(A) of this section, the hybrid 
transaction rule of Sec.  1.267A-2(a) applies to FZ's payment but no 
portion of the payment is a disqualified hybrid amount. In addition, 
the disregarded payment rule of Sec.  1.267A-2(b) applies to US1's 
$100x payment to FX, for the reasons described in paragraph 
(c)(3)(ii)(B) of this section. US1's dual inclusion income for 
taxable year 1 is $80x. This is because the $80x paid to US1 by FZ 
is included in US1's income and, although not included in FX's 
income, it is a dividend for Country X tax purposes that would have 
been included in FX's income but for the Country X participation 
exemption, and FZ is not allowed a deduction or other tax benefit 
for it under Country Z tax law. See Sec.  1.267A-2(b)(3)(ii). 
Therefore, $20x of US1's $100x payment is a disqualified hybrid 
amount ($100x less $80x). See Sec.  1.267A-2(b)(1).
    (4) Example 4. Payment allocable to a U.S. taxable branch--(i) 
Facts. FX1 and FX2 are foreign corporations that are bodies 
corporate established in and tax residents of Country X. FX1 holds 
all the interests of FX2, and FX1 and FX2 file a consolidated return 
under Country X tax law. FX2 has a U.S. taxable branch (``USB''). 
During taxable year 1, FX2 pays $50x to FX1 pursuant to an 
instrument (the ``FX1-FX2 instrument''). The amount paid pursuant to 
the instrument is treated as interest for U.S. tax purposes but, as 
a consequence of the Country X consolidation regime, is treated as a 
disregarded transaction between group members for Country X tax 
purposes. Also during taxable year 1, FX2 pays $100x of interest to 
an unrelated bank that is not a party to a structured arrangement 
(the instrument pursuant to which the payment is made, the ``bank-
FX2 instrument''). FX2's only other item of income, gain, deduction, 
or loss for taxable year 1 is $200x of gross income. Under Country X 
tax law, the $200x of gross income is attributable to USB, but is 
not included in FX2's income because Country X tax law exempts 
income attributable to a branch. Under U.S. tax law, the $200x of 
gross income is effectively connected income of USB. Further, under 
section 882(c)(1), $75x of interest is, for taxable year 1, 
allocable to USB's effectively connected income. USB has neither 
liabilities that are directly allocable to it, as described in Sec.  
1.882-5(a)(1)(ii)(A), nor U.S. booked liabilities, as defined in 
Sec.  1.882-5(d)(2).
    (ii) Analysis. USB is a specified party and thus any interest or 
royalty allowable as a deduction in determining its effectively 
connected income is subject to disallowance under section 267A. 
Pursuant to Sec.  1.267A-5(b)(3)(i)(A), USB is treated as paying 
$75x of interest, and such interest is thus a specified payment. Of 
that $75x, $25x is treated as paid to FX1, calculated as $75x (the 
interest allocable to USB under section 882(c)(1)) multiplied by \1/
3\ ($50x, FX2's payment to FX1, divided by $150x, the total interest 
paid by FX2). See Sec.  1.267A-5(b)(3)(ii)(A). As described in 
paragraphs (c)(4)(ii)(A) and (B) of this section, the $25x of the 
specified payment treated as paid by USB to FX1 is a disqualified 
hybrid amount under the disregarded payment rule of Sec.  1.267A-
2(b) and, as a result, a deduction for that amount is disallowed 
under Sec.  1.267A-1(b)(1).
    (A) USB's $25x payment to FX1 is not regarded under the tax law 
of Country X (the tax law of FX1, a related tax resident to which 
the payment is made) because under such tax law it is a disregarded 
transaction between group members. See Sec.  1.267A-2(b)(2) and (f). 
In addition, were the tax law of Country X to regard the payment 
(and treat it as interest), FX1 would include it in income. 
Therefore, the payment is a disregarded payment to which Sec.  
1.267A-2(b) applies. See Sec.  1.267A-2(b)(2).
    (B) Under Sec.  1.267A-2(b)(1), the excess (if any) of USB's 
disregarded payments for taxable year 1 ($25x) over its dual 
inclusion income for the taxable year is a disqualified hybrid 
amount. USB's dual inclusion income for taxable year 1 is $0. This 
is because, as a result of the Country X exemption for income 
attributable to a branch, no portion of USB's $200x item of gross 
income is included in FX2's income. See Sec.  1.267A-2(b)(3). 
Therefore, the entire $25x of the specified payment treated as paid 
by USB to FX1 is a disqualified hybrid amount, calculated as $25x 
(the amount of the payment) less $0 (the amount of dual inclusion 
income). See Sec.  1.267A-2(b)(1).
    (iii) Alternative facts--deemed branch payment. The facts are 
the same as in paragraph (c)(4)(i) of this section, except that FX2 
does not pay any amounts during taxable year 1 (thus, it does not 
pay the $50x to FX1 or the $100x to the bank). However, under an 
income tax treaty between the United States and Country X, USB is a 
U.S. permanent establishment and, for taxable year 1, $25x of 
royalties is allowable as a deduction in computing the business 
profits of USB and is deemed paid to FX2. Under Country X tax law, 
the $25x is not regarded. Accordingly, the $25x is a specified 
payment that is a deemed branch payment. See Sec. Sec.  1.267A-
2(c)(2) and 1.267A-5(b)(3)(i)(B). In addition, the entire $25x is a 
disqualified hybrid amount for which a deduction is disallowed 
because the tax law of Country X provides an exclusion or exemption 
for income attributable to a branch. See Sec.  1.267A-2(c)(1).
    (5) Example 5. Payment to a reverse hybrid--(i) Facts. FX holds 
all the interests of US1 and FY, and FY holds all the interests of 
FV. FY is an entity established in Country Y, and FV is an entity 
established in Country V. FY is fiscally transparent for Country Y 
tax purposes but is not fiscally transparent for Country X tax 
purposes. FV is fiscally transparent for Country X tax purposes. On 
date 1, US1 pays $100x to FY. The payment is treated as interest for 
U.S. tax purposes and Country X tax purposes.
    (ii) Analysis. US1 is a specified party and thus a deduction for 
its $100x specified payment is subject to disallowance under section 
267A. As described in paragraphs (c)(5)(ii)(A) through (C) of this 
section, the entire $100x payment is a disqualified hybrid amount 
under the reverse hybrid rule of Sec.  1.267A-2(d) and, as a result, 
a deduction for the payment is disallowed under Sec.  1.267A-
1(b)(1).
    (A) US1's payment is made to a reverse hybrid because FY is 
fiscally transparent under the tax law of Country Y (the tax law of 
the country in which it is established) but is not fiscally 
transparent under the tax law of Country X (the tax law of FX, an 
investor that is related to US1). See Sec.  1.267A-2(d)(2) and (f). 
Therefore, Sec.  1.267A-2(d) applies to the payment. The result 
would be the same if the payment were instead made to FV. See Sec.  
1.267A-2(d)(3).
    (B) For US1's payment to be a disqualified hybrid amount under 
Sec.  1.267A-2(d), a no-inclusion must occur with respect to FX, an 
investor the tax law of which treats FY as not fiscally transparent. 
See Sec.  1.267A-2(d)(1)(i). Because FX does not derive the $100x 
payment under Country X tax law (as FY is not fiscally transparent 
under such tax law), FX includes $0 of the payment in income and 
therefore a $100x no-inclusion occurs with respect to FX. See Sec.  
1.267A-3(a).
    (C) Pursuant to Sec.  1.267A-2(d)(1)(ii), FX's $100x no-
inclusion gives rise to a disqualified hybrid amount to the extent 
that it is a result of US1's payment being made to the reverse 
hybrid. FX's $100x no-inclusion is a result of the payment being 
made to the reverse hybrid because, were FY to be treated as 
fiscally transparent for Country X tax purposes, FX would include 
$100x in income and, consequently, the no-inclusion would not occur. 
The result would be the same if Country X tax law instead viewed 
US1's payment as a dividend, rather than interest. See Sec.  1.267A-
2(d)(1)(ii).
    (iii) Alternative facts--inclusion under anti-deferral regime. 
The facts are the same as in paragraph (c)(5)(i) of this section, 
except that, under a Country X anti-deferral regime, FX takes into 
account $100x attributable to the $100x payment received by FY. If 
under the rules of Sec.  1.267A-3(a) FX includes the entire 
attributed amount in income (that is, if FX takes the amount into 
account in its income at the full marginal rate imposed on ordinary 
income and the amount is not reduced or offset by certain relief 
particular to the amount), then a no-inclusion does not occur with 
respect to FX. As a result, in such a case, no portion of US1's 
payment would be a disqualified hybrid amount under Sec.  1.267A-
2(d).

[[Page 19850]]

    (iv) Alternative facts--multiple investors. The facts are the 
same as in paragraph (c)(5)(i) of this section, except that FX holds 
all the interests of FZ, which is fiscally transparent for Country X 
tax purposes; FZ holds all the interests of FY, which is fiscally 
transparent for Country Z tax purposes; and FZ includes the $100x 
payment in income. Thus, each of FZ and FX is an investor of FY, as 
each directly or indirectly holds an interest of FY. See Sec.  
1.267A-5(a)(13). A $100x no-inclusion occurs with respect to FX, an 
investor the tax law of which treats FY as not fiscally transparent. 
FX's no-inclusion is a result of the payment being made to the 
reverse hybrid because, were FY to be treated as fiscally 
transparent for Country X tax purposes, then FX would include $100x 
in income (as FZ is fiscally transparent for Country X tax 
purposes). Accordingly, FX's no-inclusion is a result of US1's 
payment being made to the reverse hybrid and, consequently, the 
entire $100x payment is a disqualified hybrid amount. However, if 
instead FZ were not fiscally transparent for Country X tax purposes, 
then FX's no-inclusion would not be a result of US1's payment being 
made to the reverse hybrid and, therefore, the payment would not be 
a disqualified hybrid amount under Sec.  1.267A-2(d).
    (v) Alternative facts--portion of no-inclusion not the result of 
hybridity. The facts are the same as in paragraph (c)(5)(i) of this 
section, except that the $100x is viewed as a royalty for U.S. tax 
purposes and Country X tax purposes, and Country X tax law contains 
a patent box regime that provides an 80% deduction with respect to 
certain royalty income. If the royalty payment would qualify for the 
Country X patent box deduction were FY to be treated as fiscally 
transparent for Country X tax purposes, then only $20x of FX's $100x 
no-inclusion would be the result of the payment being paid to a 
reverse hybrid, calculated as $100x (the no-inclusion with respect 
to FX that actually occurs) less $80x (the no-inclusion with respect 
to FX that would occur if FY were to be treated as fiscally 
transparent for Country X tax purposes). See Sec.  1.267A-
2(d)(1)(ii) and 1.267A-3(a)(1)(ii). Accordingly, in such a case, 
only $20x of US1's payment would be a disqualified hybrid amount 
under Sec.  1.267A-2(d).
    (vi) Alternative facts--payment to a discretionary trust--(A) 
Facts. The facts are the same as in paragraph (c)(5)(i) of this 
section, except that FY is a discretionary trust established in, and 
a tax resident of, Country Y (and as a result, FY is generally not 
fiscally transparent for Country Y tax purposes under the principles 
of Sec.  1.894-1(d)(3)(ii)). In general, under Country Y tax law, 
FX, an investor of FY, is not required to separately take into 
account in its income US1's $100x payment received by FY; instead, 
FY is required to take the payment into account in its income. 
However, under the trust agreement, the trustee of FY may, with 
respect to certain items of income received by FY, allocate such an 
item to FY's beneficiary, FX. When this occurs, then, for Country Y 
tax purposes, FY does not take the item into account in its income, 
and FX is required to take the item into account in its income as if 
it received the item directly from the source from which realized by 
FY. For Country X tax purposes, FX in all cases does not take into 
account in its income any item of income received by FY. With 
respect to the $100x paid from US1 to FY, the trustee allocates the 
$100x to FX.
    (B) Analysis. FY is fiscally transparent with respect to US1's 
$100x payment under the tax law of Country Y (the tax law of the 
country in which FY is established). See Sec.  1.267A-5(a)(8)(i). In 
addition, FY is not fiscally transparent with respect to US1's $100x 
payment under the tax law of Country X (the tax law of FX, the 
investor of FY). See Sec.  1.267A-5(a)(8)(ii). Thus, FY is a reverse 
hybrid with respect to the payment. See Sec.  1.267A-2(d)(2) and 
(f). Therefore, for reasons similar to those discussed in paragraphs 
(c)(5)(ii)(B) and (C) of this section, the entire $100x payment is a 
disqualified hybrid amount.
    (6) Example 6. Branch mismatch payment--(i) Facts. FX holds all 
the interests of US1 and FZ. FZ owns BB, a Country B branch that 
gives rise to a taxable presence in Country B under Country Z tax 
law but not under Country B tax law. On date 1, US1 pays $50x to FZ. 
The amount is treated as a royalty for U.S. tax purposes and Country 
Z tax purposes. Under Country Z tax law, the amount is treated as 
income attributable to BB and, as a consequence of County Z tax law 
exempting income attributable to a branch, is excluded from FZ's 
income.
    (ii) Analysis. US1 is a specified party and thus a deduction for 
its $50x specified payment is subject to disallowance under section 
267A. As described in paragraphs (c)(6)(ii)(A) through (C) of this 
section, the entire $50x payment is a disqualified hybrid amount 
under the branch mismatch rule of Sec.  1.267A-2(e) and, as a 
result, a deduction for the payment is disallowed under Sec.  
1.267A-1(b)(1).
    (A) US1's payment is a branch mismatch payment because under 
Country Z tax law (the tax law of FZ, a home office that is related 
to US1) the payment is treated as income attributable to BB, and BB 
is not a taxable branch (that is, under Country B tax law, BB does 
not give rise to a taxable presence). See Sec.  1.267A-2(e)(2) and 
(f). Therefore, Sec.  1.267A-2(e) applies to the payment. The result 
would be the same if instead BB were a taxable branch and, under 
Country B tax law, US1's payment were treated as income attributable 
to FZ, the home office, and not BB. See Sec.  1.267A-2(e)(2).
    (B) For US1's payment to be a disqualified hybrid amount under 
Sec.  1.267A-2(e), a no-inclusion must occur with respect to FZ. See 
Sec.  1.267A-2(e)(1)(i). As a consequence of the Country Z branch 
exemption, FZ includes $0 of the payment in income and therefore a 
$50x no-inclusion occurs with respect to FZ. See Sec.  1.267A-3(a).
    (C) Pursuant to Sec.  1.267A-2(e)(1)(ii), FZ's $50x no-inclusion 
gives rise to a disqualified hybrid amount to the extent that it is 
a result of US1's payment being a branch mismatch payment. FZ's $50x 
no-inclusion is a result of the payment being a branch mismatch 
payment because, were the payment to not be treated as income 
attributable to BB for Country Z tax purposes, FZ would include $50x 
in income and, consequently, the no-inclusion would not occur.
    (7) Example 7. Reduction of disqualified hybrid amount for 
certain amounts includible in income--(i) Facts. US1 and FW hold 60% 
and 40%, respectively, of the interests of FX, and FX holds all the 
interests of FZ. Each of FX and FZ is a specified party that is a 
CFC. FX holds an instrument issued by FZ that it is treated as 
equity for Country X tax purposes and as indebtedness for U.S. tax 
purposes (the FX-FZ instrument). On date 1, FZ pays $100x to FX 
pursuant to the FX-FZ instrument. The amount is treated as a 
dividend for Country X tax purposes and as interest for U.S. tax 
purposes. In addition, pursuant to section 954(c)(6), the amount is 
not foreign personal holding company income of FX and, under section 
951A, the amount is gross tested income (as described in Sec.  
1.951A-2(c)(1)) of FX. Further, were FZ allowed a deduction for the 
amount, it would be allocated and apportioned to gross tested income 
(as described in Sec.  1.951A-2(c)(1)) of FZ. Lastly, Country X tax 
law provides an 80% participation exemption for dividends received 
from nonresident corporations and, as a result of such participation 
exemption, FX includes $20x of FZ's payment in income.
    (ii) Analysis. FZ, a CFC, is a specified party and thus a 
deduction for its $100x specified payment is subject to disallowance 
under section 267A. But for Sec.  1.267A-3(b), $80x of FZ's payment 
would be a disqualified hybrid amount (such amount, a ``tentative 
disqualified hybrid amount''). See Sec. Sec.  1.267A-2(a) and 
1.267A-3(b)(1). Pursuant to Sec.  1.267A-3(b), the tentative 
disqualified hybrid amount is reduced by $48x. See Sec.  1.267A-
3(b)(4). The $48x is the tentative disqualified hybrid amount to the 
extent that it increases US1's pro rata share of tested income with 
respect to FX under section 951A (calculated as $80x multiplied by 
60%). See Sec.  1.267A-3(b)(4). Accordingly, $32x of FZ's payment 
($80x less $48x) is a disqualified hybrid amount under Sec.  1.267A-
2(a) and, as a result, $32x of the deduction is disallowed under 
Sec.  1.267A-1(b)(1).
    (iii) Alternative facts--United States shareholder is a domestic 
partnership. The facts are the same as in paragraph (c)(7)(i) of 
this section, except that US1 is a domestic partnership, 90% of the 
interests of which are held by US2 and the remaining 10% of which 
are held by an individual that is a nonresident alien (as defined in 
section 7701(b)(1)(B)). Thus, although each of US1 and US2 is a 
United States shareholder of FX, only US2 has a pro rata share of 
any tested item of FX. See Sec.  1.951A-1(e). In addition, $43.2x of 
the $80x tentative disqualified hybrid amount increases US2's pro 
rata share of the tested income of FX (calculated as $80x multiplied 
by 60% multiplied by 90%). Thus, $36.8x of FZ's payment ($80x less 
$43.2x) is a disqualified hybrid amount under Sec.  1.267A-2(a). See 
Sec.  1.267A-3(b)(4).
    (8) Example 8. Imported mismatch rule--direct offset--(i) Facts. 
FX holds all the interests of FW, and FW holds all the interests of 
US1. FX holds an instrument issued by FW that is treated as equity 
for Country X tax purposes and indebtedness for Country W tax 
purposes (the FX-FW

[[Page 19851]]

instrument). FW holds an instrument issued by US1 that is treated as 
indebtedness for Country W and U.S. tax purposes (the FW-US1 
instrument). In accounting period 1, FW pays $100x to FX pursuant to 
the FX-FW instrument. The amount is treated as an excludible 
dividend for Country X tax purposes (by reason of the Country X 
participation exemption) and as interest for Country W tax purposes. 
Also in accounting period 1, US1 pays $100x to FW pursuant to the 
FW-US1 instrument. The amount is treated as interest for Country W 
and U.S. tax purposes and is included in FW's income. The FX-FW 
instrument was not entered into pursuant to the same plan or series 
of related transactions pursuant to which the FW-US1 instrument was 
entered into.
    (ii) Analysis. US1 is a specified party and thus a deduction for 
its $100x specified payment is subject to disallowance under section 
267A. US1's $100x payment is neither a disqualified hybrid amount 
nor included or includible in income in the United States. See Sec.  
1.267A-4(a)(2)(v). In addition, FW's $100x deduction is a hybrid 
deduction because it is a deduction allowed to FW that results from 
an amount paid that is interest under Country W tax law, and were 
Country W law to have rules substantially similar to those under 
Sec. Sec.  1.267A-1 through 1.267A-3 and 1.267A-5, a deduction for 
the payment would be disallowed (because under such rules the 
payment would be pursuant to a hybrid transaction and FX's no-
inclusion would be a result of the hybrid transaction). See 
Sec. Sec.  1.267A-2(a) and 1.267A-4(b). Under Sec.  1.267A-4(a)(2), 
US1's payment is an imported mismatch payment, US1 is an imported 
mismatch payer, and FW (the foreign tax resident that includes the 
imported mismatch payment in income) is an imported mismatch payee. 
The imported mismatch payment is a disqualified imported mismatch 
amount to the extent that the income attributable to the payment is 
directly or indirectly offset by the hybrid deduction incurred by FW 
(a foreign tax resident that is related to US1). See Sec.  1.267A-
4(a)(1). Under Sec.  1.267A-4(c)(1), the $100x hybrid deduction 
directly or indirectly offsets the income attributable to US1's 
imported mismatch payment to the extent that the payment directly or 
indirectly funds the hybrid deduction. The entire $100x of US1's 
payment directly funds the hybrid deduction because FW (the imported 
mismatch payee) incurs at least that amount of the hybrid deduction. 
See Sec.  1.267A-4(c)(3)(i). Accordingly, the entire $100x payment 
is a disqualified imported mismatch amount under Sec.  1.267A-
4(a)(1) and, as a result, a deduction for the payment is disallowed 
under Sec.  1.267A-1(b)(2).
    (iii) Alternative facts--long-term deferral. The facts are the 
same as in paragraph (c)(8)(i) of this section, except that the FX-
FW instrument is treated as indebtedness for Country X and Country W 
tax purposes, and FW does not pay any amounts pursuant to the 
instrument during accounting period 1. In addition, under Country W 
tax law, FW is allowed to deduct interest under the FX-FW instrument 
as it accrues, whereas under Country X tax law FX does not take into 
account in its income interest under the FX-FW instrument until the 
interest is paid. Further, FW accrues $100x of interest during 
accounting period 1, and FW will not pay such amount to FX for more 
than 36 months after the end of accounting period 1. The results are 
the same as in paragraph (c)(8)(ii) of this section. That is, FW's 
$100x deduction for the accrued interest is a hybrid deduction, see 
Sec. Sec.  1.267A-2(a), 1.267A-3(a), and 1.267A-4(b), and the income 
attributable to US1's $100x imported mismatch payment is offset by 
the hybrid deduction for the reasons described in paragraph 
(c)(8)(ii) of this section. As a result, a deduction for the payment 
is disallowed under Sec.  1.267A-1(b)(2). The result would be the 
same even if the FX-FW instrument is expected to be redeemed or 
capitalized before the $100x of interest is paid such that FX will 
never take into account in its income (and therefore will not 
include in income) the $100x of interest.
    (iv) Alternative facts--notional interest deduction. The facts 
are the same as in paragraph (c)(8)(i) of this section, except that 
there is no FX-FW instrument and thus FW does not pay any amounts to 
FX during accounting period 1. However, during accounting period 1, 
FW is allowed a $100x notional interest deduction with respect to 
its equity under Country W tax law. Pursuant to Sec.  1.267A-
4(b)(1)(ii), FW's notional interest deduction is a hybrid deduction. 
The results are the same as in paragraph (c)(8)(ii) of this section. 
That is, the income attributable to US1's $100x imported mismatch 
payment is offset by FW's hybrid deduction for the reasons described 
in paragraph (c)(8)(ii) of this section. As a result, a deduction 
for the payment is disallowed under Sec.  1.267A-1(b)(2). The result 
would be the same if the tax law of Country W contains hybrid 
mismatch rules because FW's deduction is a deduction with respect to 
equity. See Sec.  1.267A-4(b)(2)(i).
    (v) Alternative facts--foreign hybrid mismatch rules prevent 
hybrid deduction. The facts are the same as in paragraph (c)(8)(i) 
of this section, except that the tax law of Country W contains 
hybrid mismatch rules, and under such rules FW is not allowed a 
deduction for the $100x that it pays to FX pursuant to the FX-FW 
instrument. The $100x paid by FW therefore does not give rise to a 
hybrid deduction. See Sec.  1.267A-4(b). Accordingly, because the 
income attributable to US1's payment to FW is not directly or 
indirectly offset by a hybrid deduction, the payment is not a 
disqualified imported mismatch amount. Therefore, a deduction for 
the payment is not disallowed under Sec.  1.267A-1(b)(2).
    (9) Example 9. Imported mismatch rule--indirect offsets and pro 
rata allocations--(i) Facts. FX holds all the interests of FZ, and 
FZ holds all the interests of US1 and US2. FX has a Country B branch 
that, for Country X and Country B tax purposes, gives rise to a 
taxable presence in Country B and is therefore a taxable branch 
(``BB''). Under the Country B-Country X income tax treaty, BB is a 
permanent establishment entitled to deduct expenses properly 
attributable to BB for purposes of computing its business profits 
under the treaty. In addition, BB is deemed to pay a royalty to FX 
for the right to use intangibles developed by FX equal to cost plus 
y%. The deemed royalty is a deductible expense properly attributable 
to BB under the Country B-Country X income tax treaty. For Country X 
tax purposes, any transactions between BB and X are disregarded. The 
deemed royalty is $80x for accounting period 1. Country B tax law 
does not permit a loss of a taxable branch to be shared with a tax 
resident or another taxable branch. In addition, an instrument 
issued by FZ to FX is properly reflected as an asset on the books 
and records of BB (the FX-FZ instrument). The FX-FZ instrument is 
treated as indebtedness for Country X, Country Z, and Country B tax 
purposes. In accounting period 1, FZ pays $80x to FX pursuant to the 
FX-FZ instrument; the amount is treated as interest for Country X, 
Country Z, and Country B tax purposes, and is treated as income 
attributable to BB for Country X and Country B tax purposes (but, 
for Country X tax purposes, is excluded from FX's income as a 
consequence of the Country X exemption for income attributable to a 
branch). Further, in accounting period 1, US1 and US2 pay $60x and 
$40x, respectively, to FZ pursuant to instruments that are treated 
as indebtedness for Country Z and U.S. tax purposes; the amounts are 
treated as interest for Country Z and U.S. tax purposes and are 
included in FZ's income. Lastly, neither the instrument pursuant to 
which US1 pays the $60x nor the instrument pursuant to which US2 
pays the $40x was entered into pursuant to a plan or series of 
related transactions that includes the transaction or agreement 
giving rise to BB's deduction for the deemed royalty.
    (ii) Analysis. US1 and US2 are specified parties and thus 
deductions for their specified payments are subject to disallowance 
under section 267A. Neither of the payments is a disqualified hybrid 
amount, nor is either of the payments included or includible in 
income in the United States. See Sec.  1.267A-4(a)(2)(v). In 
addition, BB's $80x deduction for the deemed royalty is a hybrid 
deduction because it is a deduction allowed to BB that results from 
an amount paid that is treated as a royalty under Country B tax law 
(regardless of whether a royalty deduction would be allowed under 
U.S. law), and were Country B tax law to have rules substantially 
similar to those under Sec. Sec.  1.267A-1 through 1.267A-3 and 
1.267A-5, a deduction for the payment would be disallowed because 
under such rules the payment would be a deemed branch payment and 
Country X has an exclusion for income attributable to a branch. See 
Sec. Sec.  1.267A-2(c) and 1.267A-4(b). Under Sec.  1.267A-4(a)(2), 
each of US1's and US2's payments is an imported mismatch payment, 
US1 and US2 are imported mismatch payers, and FZ (the foreign tax 
resident that includes the imported mismatch payments in income) is 
an imported mismatch payee. The imported mismatch payments are 
disqualified imported mismatch amounts to the extent that the income 
attributable to the payments is directly or indirectly offset by the 
hybrid deduction incurred by BB (a foreign taxable branch that is 
related to US1 and US2). See Sec.  1.267A-4(a). Under Sec.  1.267A-
4(c)(1), the $80x hybrid deduction

[[Page 19852]]

directly or indirectly offsets the income attributable to the 
imported mismatch payments to the extent that the payments directly 
or indirectly fund the hybrid deduction. Paragraphs (c)(9)(ii)(A) 
and (B) of this section describe the extent to which the imported 
mismatch payments directly or indirectly fund the hybrid deduction.
    (A) Neither US1's nor US2's payment directly funds the hybrid 
deduction because FZ (the imported mismatch payee) does not incur 
the hybrid deduction. See Sec.  1.267A-4(c)(3)(i). To determine the 
extent to which the payments indirectly fund the hybrid deduction, 
the amount of the hybrid deduction that is allocated to FZ must be 
determined. See Sec.  1.267A-4(c)(3)(ii). FZ is allocated the hybrid 
deduction to the extent that it directly or indirectly makes a 
funded taxable payment to BB (the foreign taxable branch that incurs 
the hybrid deduction). See Sec.  1.267A-4(c)(3)(iii). The $80x that 
FZ pays pursuant to the FX-FZ instrument is a funded taxable payment 
of FZ to BB. See Sec.  1.267A-4(c)(3)(v). Therefore, because FZ 
makes a funded taxable payment to BB that is at least equal to the 
amount of the hybrid deduction, FZ is allocated the entire amount of 
the hybrid deduction. See Sec.  1.267A-4(c)(3)(iii).
    (B) But for US2's imported mismatch payment, the entire $60x of 
US1's imported mismatch payment would indirectly fund the hybrid 
deduction because FZ is allocated at least that amount of the hybrid 
deduction. See Sec.  1.267A-4(c)(3)(ii). Similarly, but for US1's 
imported mismatch payment, the entire $40x of US2's imported 
mismatch payment would indirectly fund the hybrid deduction because 
FZ is allocated at least that amount of the hybrid deduction. See 
Sec.  1.267A-4(c)(3)(ii). However, because the sum of US1's and 
US2's imported mismatch payments to FZ ($100x) exceeds the hybrid 
deduction allocated to FZ ($80x), pro rata adjustments must be made. 
See Sec.  1.267A-4(e). Thus, $48x of US1's imported mismatch payment 
is considered to indirectly fund the hybrid deduction, calculated as 
$80x (the amount of the hybrid deduction) multiplied by 60% ($60x, 
the amount of US1's imported mismatch payment to FZ, divided by 
$100x, the sum of the imported mismatch payments that US1 and US2 
make to FZ). Similarly, $32x of US2's imported mismatch payment is 
considered to indirectly fund the hybrid deduction, calculated as 
$80x (the amount of the hybrid deduction) multiplied by 40% ($40x, 
the amount of US2's imported mismatch payment to FZ, divided by 
$100x, the sum of the imported mismatch payments that US1 and US2 
make to FZ). Accordingly, $48x of US1's imported mismatch payment, 
and $32x of US2's imported mismatch payment, are disqualified 
imported mismatch amounts under Sec.  1.267A-4(a)(1) and, as a 
result, deductions for such amounts are disallowed under Sec.  
1.267A-1(b)(2).
    (iii) Alternative facts--loss made available through foreign 
group relief regime. The facts are the same as in paragraph 
(c)(9)(i) of this section, except that FZ holds all the interests in 
FZ2, a body corporate that is a tax resident of Country Z, FZ2 
(rather than FZ) holds all the interests of US1 and US2, and US1 and 
US2 make their respective $60x and $40x payments to FZ2 (rather than 
to FZ). Further, in accounting period 1, a $10x loss of FZ is made 
available to offset income of FZ2 through a Country Z foreign group 
relief regime. Pursuant to Sec.  1.267A-4(c)(3)(vi), FZ and FZ2 are 
treated as a single foreign tax resident for purposes of Sec.  
1.267A-4(c) because a loss that is not incurred by FZ2 (FZ's $10x 
loss) is made available to offset income of FZ2 under the Country Z 
group relief regime. Accordingly, the results are the same as in 
paragraph (c)(9)(ii) of this section. That is, by treating FZ and 
FZ2 as a single foreign tax resident for purposes of Sec.  1.267A-
4(c), BB's hybrid deduction offsets the income attributable to US1's 
and US2's imported mismatch payments to the same extent as described 
in paragraph (c)(9)(ii) of this section.
    (10) Example 10. Imported mismatch rule--ordering rules and rule 
deeming certain payments to be imported mismatch payments--(i) 
Facts. FX holds all the interests of FW, and FW holds all the 
interests of US1, US2, and FZ. FZ holds all the interests of US3. FX 
transfers cash to FW in exchange for an instrument that is treated 
as equity for Country X tax purposes and indebtedness for Country W 
tax purposes (the FX-FW instrument). FW transfers cash to US1 in 
exchange for an instrument that is treated as indebtedness for 
Country W and U.S. tax purposes (the FW-US1 instrument). The FX-FW 
instrument and the FW-US1 instrument were entered into pursuant to a 
plan a design of which was for deductions incurred by FW pursuant to 
the FX-FW instrument to offset income attributable to payments by 
US1 pursuant to the FW-US1 instrument. In accounting period 1, FW 
pays $125x to FX pursuant to the FX-FW instrument; the amount is 
treated as an excludible dividend for Country X tax purposes (by 
reason of the Country X participation exemption regime) and as 
interest for Country W tax purposes. Also in accounting period 1, 
US1 pays $50x to FW pursuant to the FW-US1 instrument; US2 pays $50x 
to FW pursuant to an instrument treated as indebtedness for Country 
W and U.S. tax purposes (the FW-US2 instrument); US3 pays $50x to FZ 
pursuant to an instrument treated as indebtedness for Country Z and 
U.S. tax purposes (the FZ-US3 instrument); and FZ pays $50x to FW 
pursuant to an instrument treated as indebtedness for Country W and 
Country Z tax purposes (FW-FZ instrument). The amounts paid by US1, 
US2, US3, and FZ are treated as interest for purposes of the 
relevant tax laws and are included in the income of FW (in the case 
of US1's, US2's and FZ's payment) or FZ (in the case of US3's 
payment). Lastly, neither the FW-US2 instrument, the FW-FZ 
instrument, nor the FZ-US3 instrument was entered into pursuant to a 
plan or series of related transactions that includes the transaction 
pursuant to which the FX-FW instrument was entered into.
    (ii) Analysis. US1, US2, and US3 are specified parties (but FZ 
is not a specified party, see Sec.  1.267A-5(a)(17)) and thus 
deductions for US1's, US2's, and US3's specified payments are 
subject to disallowance under section 267A. None of the specified 
payments is a disqualified hybrid amount, nor is any of the payments 
included or includible in income in the United States. See Sec.  
1.267A-4(a)(2)(v). Under Sec.  1.267A-4(a)(2), each of the payments 
is an imported mismatch payment, US1, US2, and US3 are imported 
mismatch payers, and FW and FZ (the foreign tax residents that 
include the imported mismatch payments in income) are imported 
mismatch payees. The imported mismatch payments are disqualified 
imported mismatch amounts to the extent that the income attributable 
to the payments is directly or indirectly offset by FW's $125x 
hybrid deduction. See Sec.  1.267A-4(a)(1) and (b). Under Sec.  
1.267A-4(c)(1), the $125x hybrid deduction directly or indirectly 
offsets the income attributable to the imported mismatch payments to 
the extent that the payments directly or indirectly fund the hybrid 
deduction. Paragraphs (c)(10)(ii)(A) through (C) of this section 
describe the extent to which the imported mismatch payments directly 
or indirectly fund the hybrid deduction and are therefore 
disqualified hybrid amounts for which a deduction is disallowed 
under Sec.  1.267A-1(b)(2).
    (A) First, the $125x hybrid deduction offsets the income 
attributable to US1's imported mismatch payment, a factually-related 
imported mismatch payment that directly funds the hybrid deduction. 
See Sec.  1.267A-4(c)(2)(i). The entire $50x of US1's payment 
directly funds the hybrid deduction because FW (the imported 
mismatch payee) incurs at least that amount of the hybrid deduction. 
See Sec.  1.267A-4(c)(3)(i). Accordingly, the entire $50x of the 
payment is a disqualified imported mismatch amount under Sec.  
1.267A-4(a)(1).
    (B) Second, the remaining $75x hybrid deduction offsets the 
income attributable to US2's imported mismatch payment, a factually-
unrelated imported mismatch payment that directly funds the 
remaining hybrid deduction. See Sec.  1.267A-4(c)(2)(ii). The entire 
$50x of US2's payment directly funds the remaining hybrid deduction 
because FW (the imported mismatch payee) incurs at least that amount 
of the remaining hybrid deduction. See Sec.  1.267A-4(c)(3)(i). 
Accordingly, the entire $50x of the payment is a disqualified 
imported mismatch amount under Sec.  1.267A-4(a)(1).
    (C) Third, the remaining $25x hybrid deduction offsets the 
income attributable to US3's imported mismatch payment, a factually-
unrelated imported mismatch payment that indirectly funds the 
remaining hybrid deduction. See Sec.  1.267A-4(c)(2)(iii). The 
imported mismatch payment indirectly funds the remaining hybrid 
deduction to the extent that FZ (the imported mismatch payee) is 
allocated the remaining hybrid deduction. See Sec.  1.267A-
4(c)(3)(ii). FZ is allocated the remaining hybrid deduction to the 
extent that it directly or indirectly makes a funded taxable payment 
to FW (the tax resident that incurs the hybrid deduction). See Sec.  
1.267A-4(c)(3)(iii). The $50x that FZ pays to FW pursuant to the FW-
FZ instrument is a funded taxable payment of FZ to FW. See Sec.  
1.267A-4(c)(3)(v). Therefore, because FZ makes a funded taxable 
payment to FW that is at least equal to the amount of the remaining 
hybrid deduction, FZ is

[[Page 19853]]

allocated the remaining hybrid deduction. See Sec.  1.267A-
4(c)(3)(iii). Accordingly, $25x of US3's payment indirectly funds 
the $25x remaining hybrid deduction and, consequently, $25x of US3's 
payment is a disqualified imported mismatch amount under Sec.  
1.267A-4(a)(2).
    (iii) Alternative facts--amount deemed to be an imported 
mismatch payment. The facts are the same as in paragraph (c)(10)(i) 
of this section, except that US1 is not a domestic corporation but 
instead is a body corporate that is only a tax resident of Country E 
(hereinafter, ``FE'') (thus, for purposes of this paragraph 
(c)(10)(iii), the FW-US1 instrument is instead issued by FE and is 
the ``FW-FE instrument''). In addition, the tax law of Country E 
contains hybrid mismatch rules and the $50x FE pays to FW pursuant 
to the FW-FE instrument is subject to disallowance under a provision 
of the hybrid mismatch rules substantially similar to Sec.  1.267A-
4. Pursuant to Sec.  1.267A-4(f)(2), the $50x that FE pays to FW 
pursuant to the FW-FE instrument is deemed to be an imported 
mismatch payment for purposes of determining the extent to which the 
income attributable to an imported mismatch payment is offset by 
FW's hybrid deduction (a hybrid deduction other than one described 
in Sec.  1.267A-4(f)(1)). The results are the same as in paragraphs 
(c)(10)(ii)(B) and (C) of this section. That is, by treating the 
$50x that FE pays to FW as an imported mismatch payment, and for 
reasons similar to those described in paragraphs (c)(10)(ii)(A) 
through (C) of this section, $50x of FW's $125x hybrid deduction 
offsets income attributable to FE's imported mismatch payment, $50x 
of the remaining $75x hybrid deduction offsets income attributable 
to US2's imported mismatch payment, and the remaining $25x hybrid 
deduction offsets income attributable to US3's imported mismatch 
payment. Accordingly, the entire $50x of US2's payment is a 
disqualified imported mismatch amount, and $25x of US3's payment is 
a disqualified imported mismatch amount.
    (iv) Alternative facts--amount deemed to be an imported mismatch 
payment and ``waterfall'' approach. The facts are the same as in 
paragraph (c)(10)(i) of this section, except that FZ holds all of 
the interests of US3 indirectly through FE, a body corporate that is 
only a tax resident of Country E (hereinafter, ``FE''), and US3 
makes its $50x payment to FE (rather than to FZ); such amount is 
treated as interest for Country E tax purposes and is included in 
FE's income. In addition, during accounting period 1, FE pays $50x 
to FZ pursuant to an instrument; such amount is treated as interest 
for Country E and Country Z tax purposes, and is included in FZ's 
income. Further, the tax law of Country E contains hybrid mismatch 
rules and the $50x FE pays to FZ pursuant to the instrument is 
subject to disallowance under a provision of the hybrid mismatch 
rules substantially similar to Sec.  1.267A-4. For purposes of 
determining the extent to which the income attributable to an 
imported mismatch payment is directly or indirectly offset by a 
hybrid deduction, the $50x that FE pays to FZ is deemed to be an 
imported mismatch payment (and FE and FZ are deemed to be an 
imported mismatch payer and imported mismatch payee, respectively). 
See Sec.  1.267A-4(f)(2). With respect to US1 and US2, the results 
are the same as described in paragraphs (c)(10)(ii)(A) and (B) of 
this section. No portion of US3's payment is a disqualified imported 
mismatch amount because, by treating the $50x that FE pays to FZ as 
an imported mismatch payment, the remaining $25x of FW's hybrid 
deduction offsets income attributable to FE's imported mismatch 
payment. This is because the remaining $25x of FW's hybrid deduction 
is indirectly funded solely by FE's imported mismatch payment (as 
opposed to also being funded by US3's imported mismatch payment), as 
FZ (the imported mismatch payee with respect to FE's payment) 
directly makes a funded taxable payment to FW, whereas FE (the 
imported mismatch payee with respect to US3's payment) indirectly 
makes a funded taxable payment to FW. See Sec.  1.267A-4(c)(3)(ii) 
through (v) and (vii).
    (11) Example 11. Imported mismatch rule--hybrid deduction of a 
CFC--(i) Facts. FX holds all the interests of US1, and FX and US1 
hold 80% and 20%, respectively, of the interests of FZ, a specified 
party that is a CFC. US1 also holds all the interests of US2, and FX 
also holds all the interests of FY. FY is an entity established in 
Country Y, and is fiscally transparent for Country Y tax purposes 
but is not fiscally transparent for Country X tax purposes. In 
accounting period 1, US2 pays $100x to FZ pursuant to an instrument 
(the FZ-US2 instrument). The amount is treated as interest for U.S. 
tax purposes and Country Z tax purposes, and is included in FZ's 
income; in addition, for U.S. tax purposes, the amount is foreign 
personal holding company income of FZ. Also in accounting period 1, 
FZ pays $100x to FY pursuant to an instrument (the FY-FZ 
instrument). The amount is treated as interest for U.S. tax purposes 
and Country Z tax purposes, and none of the amount is included in 
FX's income. Under Country Z tax law, FZ is allowed a deduction for 
its entire $100x payment. Under Sec.  1.267A-2(d), the entire $100x 
of FZ's payment is a disqualified hybrid amount (by reason of being 
made to a reverse hybrid) and, as a result, a deduction for the 
payment is disallowed under Sec.  1.267A-1(b)(1); in addition, if a 
deduction were allowed for the $100x, it would be allocated and 
apportioned (under the rules of section 954(b)(5)) to gross subpart 
F income of FZ. Lastly, the FZ-US2 instrument was not entered into 
pursuant to a plan or series of related transactions that includes 
the transaction pursuant to which the FY-FZ instrument was entered 
into.
    (ii) Analysis. US2 is a specified party and thus a deduction for 
its $100x specified payment is subject to disallowance under section 
267A. As described in paragraphs (c)(11)(ii)(A) through (C) of this 
section, $80x of US2's payment is a disqualified imported mismatch 
amount for which a deduction is disallowed under Sec.  1.267A-
1(b)(2).
    (A) $80x of US2's specified payment is an imported mismatch 
payment, calculated as $100x (the amount of the payment) less $0 
(the disqualified hybrid amount with respect to the payment) less 
$20 (the amount of the payment that is included or includible in 
income in the United States). See Sec.  1.267A-4(a)(2)(v). US2 is an 
imported mismatch payer and FZ (a foreign tax resident that includes 
the imported mismatch in income) is an imported mismatch payee. See 
Sec.  1.267A-4(a)(2).
    (B) But for Sec.  1.267A-4(b)(2)(iv), the entire $100x deduction 
allowed to FZ under its tax law would be a hybrid deduction. See 
Sec. Sec.  1.267A-2(d) and 1.267A-4(b)(1). However, pursuant to 
Sec.  1.267A-4(b)(2)(iv), only $80x of the deduction is a hybrid 
deduction, calculated as $100x (the deduction to the extent that it 
would be a hybrid deduction but for Sec.  1.267A-4(b)(2)(iv)) less 
$20x (the extent that FZ's payment giving rise to the deduction is a 
disqualified hybrid amount that is taken into account for purposes 
of Sec.  1.267A-4(b)(2)(iv)(A)), less $0 (the extent that FZ's 
payment giving rise to the deduction is included or includible in 
income in the United States). See Sec.  1.267A-4(b)(2)(iv). The $20x 
disqualified hybrid amount that is taken into account for purposes 
of Sec.  1.267A-4(b)(2)(iv)(A) is calculated as $100x (the extent 
that FZ's payment is a disqualified hybrid amount) less $80x ($100x, 
the disqualified hybrid amount to the extent that, if allowed as a 
deduction, it would be allocated and apportioned to gross subpart F 
income, multiplied by 80%, the difference of 100% and the percentage 
of the stock (by value) of FZ that is owned by US1)). See Sec.  
1.267A-4(g).
    (C) The $80x hybrid deduction offsets the income attributable to 
US2's imported mismatch payment, an imported mismatch payment that 
directly funds the hybrid deduction. See Sec.  1.267A-4(c)(2)(ii). 
The entire $80x of US2's imported mismatch payment directly funds 
the hybrid deduction because FZ (the imported mismatch payee) incurs 
at least that amount of the hybrid deduction. See Sec.  1.267A-
4(c)(3)(i). Accordingly, the entire $80x of US2's imported mismatch 
payment is a disqualified imported mismatch amount under Sec.  
1.267A-4(a)(1).
    (12) Example 12. Imported mismatch rule--application first with 
respect to certain hybrid deductions, then with respect to other 
hybrid deductions--(i) Facts. FX holds all the interests of FZ, and 
FZ holds all the interests of each of US1 and FE. The tax law of 
Country E contains hybrid mismatch rules. FX holds an instrument 
issued by FZ that is treated as equity for Country X tax purposes 
and indebtedness for Country Z tax purposes (the FX-FZ instrument). 
In accounting period 1, FZ pays $10x to FX pursuant to the FX-FZ 
instrument. The amount is treated as an excludible dividend for 
Country X tax purposes (by reason of the Country X participation 
exemption) and as interest for Country Z tax purposes. Also in 
accounting period 1, FZ is allowed a $90x notional interest 
deduction with respect to its equity under Country Z tax law. In 
addition, in accounting period 1, US1 pays $100x to FZ pursuant to 
an instrument (the FZ-US1 instrument); the amount is treated as 
interest for U.S. tax purposes and Country Z tax purposes, and is 
included in FZ's income. Further, in accounting period 1, FE pays 
$40x to FZ pursuant to an instrument (the FZ-FE instrument); the 
amount is treated as

[[Page 19854]]

interest for Country E and Country Z tax purposes, is included in 
FZ's income, and is subject to disallowance under a provision of 
Country E hybrid mismatch rules substantially similar to Sec.  
1.267A-4. Lastly, neither the FZ-US1 instrument nor the FZ-FE 
instrument was entered into pursuant to a plan or series of related 
transactions that includes the transaction pursuant to which the FX-
FZ instrument was entered into.
    (ii) Analysis. US1 is a specified party and thus a deduction for 
its $100x specified payment is subject to disallowance under section 
267A. As described in paragraphs (c)(12)(ii)(A) through (D) of this 
section, $92x of US1's payment is a disqualified imported mismatch 
amount for which a deduction is disallowed under Sec.  1.267A-
1(b)(2).
    (A) The entire $100x of US1's specified payment is an imported 
mismatch payment. See Sec.  1.267A-4(a)(2)(v). US1 is an imported 
mismatch payer and FZ (a foreign tax resident that includes the 
imported mismatch payment in income) is an imported mismatch payee. 
See Sec.  1.267A-4(a)(2).
    (B) FZ has $100x of hybrid deductions (the $10x deduction for 
the payment pursuant to the FX-FZ instrument plus the $90x notional 
interest deduction). See Sec.  1.267A-4(b). Pursuant to Sec.  
1.267A-4(f)(1), Sec.  1.267A-4 is first applied by taking into 
account only the $90x hybrid deduction consisting of the notional 
interest deduction; in addition, for purposes of applying Sec.  
1.267A-4 in this manner, FE's $40x payment is not treated as an 
imported mismatch payment. Thus, the $90x hybrid deduction offsets 
the income attributable to US1's imported mismatch payment, an 
imported mismatch payment that directly funds the hybrid deduction. 
See Sec.  1.267A-4(c)(2)(ii). Moreover, $90x of US1's imported 
mismatch payment directly funds the hybrid deduction because FZ (the 
imported mismatch payee) incurs at least that amount of the hybrid 
deduction. See Sec.  1.267A-4(c)(3)(i).
    (C) Section Sec.  1.267A-4 is next applied by taking into 
account only the $10x hybrid deduction consisting of the deduction 
for the payment pursuant to the FX-FZ instrument. See Sec.  1.267A-
4(f)(2). When applying Sec.  1.267A-4 in this manner, and for 
purposes of determining the extent to which the income attributable 
to an imported mismatch payment is directly or indirectly offset by 
a hybrid deduction, FE's $40x payment is treated as an imported 
mismatch payment. See Sec.  1.267A-4(f)(2). In addition, US1's 
imported mismatch payment is reduced from $100x to $10x. See Sec.  
1.267A-4(c)(4). But for FE's imported mismatch payment, the entire 
$10x of US1's imported mismatch payment would directly fund the $10x 
hybrid deduction because FZ incurred at least that amount of the 
hybrid deduction. See Sec.  1.267A-4(c)(3)(i). Similarly, but for 
US1's imported mismatch payment, the entire $40x of FE's imported 
mismatch payment would directly fund the $10x hybrid deduction 
because FZ incurred at least that amount of the hybrid deduction. 
See Sec.  1.267A-4(c)(3)(i). However, because the sum of US1's and 
FE's imported mismatch payments to FZ ($50x) exceeds the hybrid 
deduction incurred by FZ ($10x), pro rata adjustments must be made. 
See Sec.  1.267A-4(e). Thus, $2x of US1's imported mismatch payment 
is considered to directly fund the hybrid deduction, calculated as 
$10x (the amount of the hybrid deduction) multiplied by 20% ($10x, 
the amount of US1's imported mismatch payment to FZ, divided by 
$50x, the sum of the imported mismatch payments that US1 and FE make 
to FZ). Similarly, $8x of FE's imported mismatch payment is 
considered to directly fund the hybrid deduction, calculated as $10x 
(the amount of the hybrid deduction) multiplied by 80% ($40x, the 
amount of FE's imported mismatch payment to FZ, divided by $50x, the 
sum of the imported mismatch payments that US1 and FE make to FZ). 
Accordingly, $2x of FZ's $10x hybrid deduction offsets income 
attributable to US1's $10x imported mismatch payment, and $8x of the 
hybrid deduction offsets income attributable to FE's $40x imported 
mismatch payment.
    (D) Therefore, $92x of US1's imported mismatch payment is a 
disqualified imported mismatch amount, calculated as $90x (the 
amount that is a disqualified imported mismatch amount determined by 
applying Sec.  1.267A-4 in the manner set forth in Sec.  1.267A-
4(f)(1)) plus $2x (the amount that is a disqualified imported 
mismatch amount determined by applying Sec.  1.267A-4 in the manner 
set forth in Sec.  1.267A-4(f)(2)). See Sec.  1.267A-4(a)(1) and 
(f).
    (iii) Alternative facts--amount deemed to be an imported 
mismatch payment solely funds hybrid instrument deduction. The facts 
are the same as in paragraph (c)(12)(i) of this section, except that 
FZ holds all of the interests of US1 indirectly through FE, and US1 
makes its $100x payment to FE (rather than to FZ); such amount is 
treated as interest for U.S. and Country E tax purposes, and is 
included in FE's income. Moreover, FE pays $100x to FZ (rather than 
$40x); such amount is included in FZ's income, and is subject to 
disallowance under a provision of Country E hybrid mismatch rules 
substantially similar to Sec.  1.267A-4. As described in paragraphs 
(c)(12)(iii)(A) through (D) of this section, $90x of US1's payment 
is a disqualified imported mismatch amount for which a deduction is 
disallowed under Sec.  1.267A-1(b)(2).
    (A) The entire $100x of US1's specified payment is an imported 
mismatch payment. See Sec.  1.267A-4(a)(2)(v). US1 is an imported 
mismatch payer and FE (a foreign tax resident that includes the 
imported mismatch payment in income) is an imported mismatch payee. 
See Sec.  1.267A-4(a)(2).
    (B) FZ has $100x of hybrid deductions. See Sec.  1.267A-4(b). 
Pursuant to Sec.  1.267A-4(f)(1), Sec.  1.267A-4 is first applied by 
taking into account only the $90x hybrid deduction consisting of the 
notional interest deduction; in addition, for purposes of applying 
Sec.  1.267A-4 in this manner, FE's $100x payment is not treated as 
an imported mismatch payment. Thus, the $90x hybrid deduction 
offsets the income attributable to US1's imported mismatch payment, 
an imported mismatch payment that indirectly funds the hybrid 
deduction. See Sec.  1.267A-4(c)(2)(iii). The imported mismatch 
payment indirectly funds the hybrid deduction because FE (the 
imported mismatch payee) is allocated the deduction, as FE makes a 
funded taxable payment (the $100x payment to FZ) that is at least 
equal to the amount of the deduction. See Sec.  1.267A-4(c)(3)(ii), 
(iii), and (v).
    (C) Section Sec.  1.267A-4 is next applied by taking into 
account only the $10x hybrid deduction consisting of the deduction 
for the payment pursuant to the FX-FZ instrument. See Sec.  1.267A-
4(f)(2). For purposes of applying Sec.  1.267A-4 in this manner, 
FE's $100x payment is reduced from $100x to $10x, and similarly 
US1's imported mismatch payment is reduced from $100x to $10x. See 
Sec.  1.267A-4(c)(4). Further, FE's $10x payment is treated as an 
imported mismatch payment. See Sec.  1.267A-4(f)(2). The entire $10x 
of FE's imported mismatch payment directly funds the hybrid 
deduction because FZ (the imported mismatch payee with respect to 
FE's imported mismatch payment) incurs at least that amount of the 
hybrid deduction. See Sec.  1.267A-4(c)(3)(i). Accordingly, the $10x 
hybrid deduction offsets the income attributable to FE's imported 
mismatch payment, and none of the income attributable to US1's 
imported mismatch payment.
    (D) Therefore, $90x of US1's imported mismatch payment is a 
disqualified imported mismatch amount, calculated as $90x (the 
amount that is a disqualified imported mismatch amount determined by 
applying Sec.  1.267A-4 in the manner set forth in Sec.  1.267A-
4(f)(1)) plus $0 (the amount that is a disqualified imported 
mismatch amount determined by applying Sec.  1.267A-4 in the manner 
set forth in Sec.  1.267A-4(f)(2)). See Sec.  1.267A-4(a)(1) and 
(f).


Sec.  1.267A-7  Applicability dates.

    (a) General rule. Except as provided in paragraph (b) of this 
section, Sec. Sec.  1.267A-1 through 1.267A-6 apply to taxable years 
ending on or after December 20, 2018, provided that such taxable years 
begin after December 31, 2017. However, taxpayers may apply the 
regulations in Sec. Sec.  1.267A-1 through 1.267A-6 in their entirety 
for taxable years beginning after December 31, 2017, and ending before 
December 20, 2018. In lieu of applying the regulations in Sec. Sec.  
1.267A-1 through 1.267A-6, taxpayers may apply the provisions matching 
Sec. Sec.  1.267A-1 through 1.267A-6 from the Internal Revenue Bulletin 
(IRB) 2019-03 (https://www.irs.gov/pub/irs-irbs/irb19-03.pdf) in their 
entirety for all taxable years ending on or before April 8, 2020.
    (b) Special rules. The following special rules apply regarding 
applicability dates:
    (1) Sections 1.267A-2(a)(4) (payments pursuant to interest-free 
loans and similar arrangements), (b) (disregarded payments), (c) 
(deemed branch payments), and (e) (branch mismatch transactions), 
1.267A-4 (imported mismatch rule), and 1.267A-5(b)(5) (structured 
payments), except as provided in paragraph (b)(5) of this

[[Page 19855]]

section, apply to taxable years beginning on or after December 20, 
2018.
    (2) Section 1.267A-5(a)(20) (defining structured arrangement), as 
well as the portions of Sec. Sec.  1.267A-1 through 1.267A-3 that 
relate to structured arrangements and that are not otherwise described 
in paragraph (b) of this section, apply to taxable years beginning on 
or after December 20, 2018. However, in the case of a specified payment 
made pursuant to an arrangement entered into before December 22, 2017, 
Sec.  1.267A-5(a)(20), and the portions of Sec. Sec.  1.267A-1 through 
1.267A-3 that relate to structured arrangements and that are not 
otherwise described in paragraph (b) of this section, apply to taxable 
years beginning after December 31, 2020.
    (3) Except as provided in paragraph (b)(4) of this section, the 
rules provided in Sec.  1.267A-5(a)(12)(ii) (swaps with significant 
nonperiodic payments) apply to notional principal contracts entered 
into on or after April 8, 2021. However, taxpayers may apply the rules 
provided in Sec.  1.267A-5(a)(12)(ii) to notional principal contracts 
entered into before April 8, 2021.
    (4) For a notional principal contract entered into before April 8, 
2021, the interest equivalent rules provided in Sec.  1.267A-
5(b)(5)(ii)(B) (applied without regard to the references to Sec.  
1.267A-5(a)(12)(ii)) apply to a notional principal contract entered 
into on or after April 8, 2020.
    (5) Section 1.267A-5(b)(5)(ii)(B) (interest equivalent rules) 
applies to transactions entered into on or after April 8, 2020.

0
Par. 4 Section 1.1503(d)-1 is amended by:
0
1. In paragraph (b)(2)(i), removing the word ``and''.
0
2. In paragraph (b)(2)(ii), removing the second period and adding in 
its place ``; and''.
0
3. Adding paragraph (b)(2)(iii).
0
4. Redesignating paragraph (c) as paragraph (d).
0
5. Adding new paragraph (c).
0
6. In newly redesignated paragraph (d)(1), removing the language 
``(c)'' and ``(c)(2)'' and adding the language ``(d)'' and ``(d)(2)'' 
in their places, respectively.
0
7. In the first sentence of newly redesignated paragraph (d)(2)(ii) 
introductory text, removing the language ``(c)(2)(i)'' and adding the 
language ``(d)(2)(i)'' in its place.
    The additions read as follows:


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

* * * * *
    (b) * * *
    (2) * * *
    (iii) A domestic consenting corporation (as defined in Sec.  
301.7701-3(c)(3)(i) of this chapter), as provided in paragraph (c)(1) 
of this section. See Sec.  1.1503(d)-7(c)(41) for an example 
illustrating the application of section 1503(d) to a domestic 
consenting corporation.
* * * * *
    (c) Treatment of domestic consenting corporation as a dual resident 
corporation--(1) Rule. A domestic consenting corporation is treated as 
a dual resident corporation under paragraph (b)(2)(iii) of this section 
for a taxable year if, on any day during the taxable year, the 
following requirements are satisfied:
    (i) Under the tax law of a foreign country where a specified 
foreign tax resident is tax resident, the specified foreign tax 
resident derives or incurs (or would derive or incur) items of income, 
gain, deduction, or loss of the domestic consenting corporation 
(because, for example, the domestic consenting corporation is fiscally 
transparent under such tax law).
    (ii) The specified foreign tax resident bears a relationship to the 
domestic consenting corporation that is described in section 267(b) or 
707(b). See Sec.  1.1503(d)-7(c)(41) for an example illustrating the 
application of paragraph (c) of this section.
    (2) Definitions. The following definitions apply for purposes of 
this paragraph (c).
    (i) The term fiscally transparent means, with respect to a domestic 
consenting corporation or an intermediate entity, fiscally transparent 
as determined under the principles of Sec.  1.894-1(d)(3)(ii) and 
(iii), without regard to whether a specified foreign tax resident is a 
resident of a country that has an income tax treaty with the United 
States.
    (ii) The term specified foreign tax resident means a body corporate 
or other entity or body of persons liable to tax under the tax law of a 
foreign country as a resident.
* * * * *

0
Par. 5. Section 1.1503(d)-3 is amended by adding the language ``or 
(3)'' after the language ``paragraph (e)(2)'' in paragraph (e)(1) 
introductory text and adding paragraph (e)(3) to read as follows:


Sec.  1.1503(d)-3  Foreign use.

* * * * *
    (e) * * *
    (3) Exception for domestic consenting corporations. Paragraph 
(e)(1) of this section will not apply so as to deem a foreign use of a 
dual consolidated loss incurred by a domestic consenting corporation 
that is a dual resident corporation under Sec.  1.1503(d)-1(b)(2)(iii).


Sec.  1.1503(d)-6  [Amended]

0
Par. 6. Section 1.1503(d)-6 is amended by:
0
1. Removing the language ``a foreign government'' and ``a foreign 
country'' in paragraph (f)(5)(i) and adding the language ``a government 
of a country'' and ``the country'' in their places, respectively.
0
2. Removing the language ``a foreign government'' in paragraph 
(f)(5)(ii) and adding the language ``a government of a country'' in its 
place.
0
3. Removing the language ``the foreign government'' in paragraph 
(f)(5)(iii) and adding the language ``a government of a country'' in 
its place.

0
Par. 7. Section 1.1503(d)-7 is amended by:
0
1. Designating Examples 1 through 40 of paragraph (c) as paragraphs 
(c)(1) through (40), respectively.
0
2. In newly designated paragraphs (c)(1) through (40), removing 
``Alternative Facts'' and adding ``Alternative facts'' in its place 
wherever it appears.
0
3. For each newly designated paragraph listed in the table, remove the 
language in the ``Remove'' column and add in its place the language in 
the ``Add'' column:

------------------------------------------------------------------------
          Paragraph                  Remove                  Add
------------------------------------------------------------------------
(c)(2)(iii).................  paragraph (i) of      paragraph (c)(2)(i)
                               this Example 2.       of this section.
(c)(5)(iii).................  paragraph (i) of      paragraph (c)(5)(i)
                               this Example 5.       of this section.
(c)(5)(iv)..................  paragraph (iii), of   paragraph
                               this Example 5.       (c)(5)(iii) of this
                                                     section.
(c)(6)(iii).................  paragraph (i) of      paragraphs (c)(6)(i)
                               this Example 6.       of this section.
(c)(10)(iii)................  paragraph (i) of      paragraph (c)(10)(i)
                               this Example 10.      of this section.
(c)(10)(iii)................  paragraph (ii) of     paragraph
                               this Example 10.      (c)(10)(ii) of this
                                                     section.
(c)(11)(iii)................  paragraph (i) of      paragraph (c)(11)(i)
                               this Example 11.      of this section.
(c)(13)(iii) and (iv).......  paragraph (i) of      paragraph (c)(13)(i)
                               this Example 13.      of this section.

[[Page 19856]]

 
(c)(17)(iii)................  paragraph (i) of      paragraph (c)(17)(i)
                               this Example 17.      of this section.
(c)(18)(iii)................  paragraph (i) of      paragraph (c)(18)(i)
                               this Example 18.      of this section.
(c)(19)(iii)................  paragraph (i) of      paragraph (c)(19)(i)
                               this Example 19.      of this section.
(c)(21)(iii)................  paragraph (i) of      paragraph (c)(21)(i)
                               this Example 21.      of this section.
(c)(21)(iv).................  paragraph (iii) of    paragraph
                               this Example 21.      (c)(21)(iii) of
                                                     this section.
(c)(21)(v)..................  paragraph (iv) of     paragraph
                               this Example 21.      (c)(21)(iv) of this
                                                     section.
(c)(31)(iii)................  paragraph (i) of      paragraph (c)(31)(i)
                               this Example 31.      of this section.
(c)(33)(iii)................  paragraph (i) of      paragraph (c)(33)(i)
                               this Example 33.      of this section.
(c)(35)(iii)................  paragraph (i) of      paragraph (c)(35)(i)
                               this Example 35.      of this section.
(c)(40)(iii)................  paragraph (i) of      paragraph (c)(40)(i)
                               this Example 40.      of this section.
(c)(40)(iii)................  paragraph (ii) of     paragraph
                               this Example 40.      (c)(40)(ii) of this
                                                     section.
------------------------------------------------------------------------

0
4. In newly designated paragraphs (c)(29)(i)(A) and (c)(38)(i)(A), 
adding headings to the tables.
0
5. Adding paragraph (c)(41).
    The additions read as follows:


Sec.  1.1503(d)-7  Examples.

* * * * *
    (c) * * *
    (29) * * *
    (i) * * *
    (A) * * *
    Table 1 to paragraph (c)(29)(i)(A)
* * * * *
    (38) * * *
    (i) * * *
    (A)
    Table 2 to paragraph (c)(38)(i)(A)
* * * * *
    (41) Example 41. Domestic consenting corporation--treated as 
dual resident corporation--(i) Facts. FSZ1, a Country Z entity that 
is subject to Country Z tax on its worldwide income or on a 
residence basis and is classified as a foreign corporation for U.S. 
tax purposes, owns all the interests in DCC, a domestic eligible 
entity that has filed an election to be classified as an 
association. Under Country Z tax law, DCC is fiscally transparent. 
For taxable year 1, DCC's only item of income, gain, deduction, or 
loss is a $100x deduction and such deduction comprises a $100x net 
operating loss of DCC. For Country Z tax purposes, FSZ1's only item 
of income, gain, deduction, or loss, other than the $100x loss 
attributable to DCC, is $60x of operating income.
    (ii) Result. DCC is a domestic consenting corporation because by 
electing to be classified as an association, it consents to be 
treated as a dual resident corporation for purposes of section 
1503(d). See Sec.  301.7701-3(c)(3) of this chapter. For taxable 
year 1, DCC is treated as a dual resident corporation under Sec.  
1.1503(d)-1(b)(2)(iii) because FSZ1 (a specified foreign tax 
resident that bears a relationship to DCC that is described in 
section 267(b) or 707(b)) derives or incurs items of income, gain, 
deduction, or loss of DCC. See Sec.  1.1503(d)-1(c). FSZ1 derives or 
incurs items of income, gain, deduction, or loss of DCC because, 
under Country Z tax law, DCC is fiscally transparent. Thus, DCC has 
a $100x dual consolidated loss for taxable year 1. See Sec.  
1.1503(d)-1(b)(5). Because the loss is available to, and in fact 
does, offset income of FSZ1 under Country Z tax law, there is a 
foreign use of the dual consolidated loss in year 1. Accordingly, 
the dual consolidated loss is subject to the domestic use limitation 
rule of Sec.  1.1503(d)-4(b). The result would be the same if FSZ1 
were to indirectly own its DCC stock through an intermediate entity 
that is fiscally transparent under Country Z tax law, or if an 
individual were to wholly own FSZ1 and FSZ1 were a disregarded 
entity. In addition, the result would be the same if FSZ1 had no 
items of income, gain, deduction, or loss, other than the $100x loss 
attributable to DCC.
    (iii) Alternative facts--DCC not treated as a dual resident 
corporation. The facts are the same as in paragraph (c)(41)(i) of 
this section, except that DCC is not fiscally transparent under 
Country Z tax law and thus under Country Z tax law FSZ1 does not 
derive or incur items of income, gain, deduction, or loss of DCC. 
Accordingly, DCC is not treated as a dual resident corporation under 
Sec.  1.1503(d)-1(b)(2)(iii) for year 1 and, consequently, its $100x 
net operating loss in that year is not a dual consolidated loss.
    (iv) Alternative facts--mirror legislation. The facts are the 
same as in paragraph (c)(41)(i) of this section, except that, under 
provisions of Country Z tax law that constitute mirror legislation 
under Sec.  1.1503(d)-3(e)(1) and that are substantially similar to 
the recommendations in Chapter 6 of OECD/G-20, Neutralising the 
Effects of Hybrid Mismatch Arrangements, Action 2: 2015 Final Report 
(October 2015), Country Z tax law prohibits the $100x loss 
attributable to DCC from offsetting FSZ1's income that is not also 
subject to U.S. tax. As is the case in paragraph (c)(41)(ii) of this 
section, DCC is treated as a dual resident corporation under Sec.  
1.1503(d)-1(b)(2)(iii) for year 1 and its $100x net operating loss 
is a dual consolidated loss. Pursuant to Sec.  1.1503(d)-3(e)(3), 
however, the dual consolidated loss is not deemed to be put to a 
foreign use by virtue of the Country Z mirror legislation. 
Therefore, DCC is eligible to make a domestic use election for the 
dual consolidated loss.

0
Par. 8. Section 1.1503(d)-8 is amended by removing the language ``Sec.  
1.1503(d)-1(c)'' and adding in its place the language ``Sec.  
1.1503(d)-1(d)'' wherever it appears in paragraphs (b)(3)(i) and (iii) 
and adding paragraphs (b)(6) and (7) to read as follows:


Sec.  1.1503(d)-8  Effective dates.

* * * * *
    (b) * * *
    (6) Rules regarding domestic consenting corporations. Section 
1.1503(d)-1(b)(2)(iii) and (c), as well Sec.  1.1503(d)-3(e)(1) and 
(3), apply to determinations under Sec. Sec.  1.1503(d)-1 through 
1.1503(d)-7 relating to taxable years ending on or after December 20, 
2018. For taxable years ending before December 20, 2018, see Sec.  
1.1503(d)-3(e)(1) as contained in 26 CFR part 1 revised as of April 1, 
2018.
    (7) Compulsory transfer triggering event exception. Section 
1.1503(d)-6(f)(5)(i) through (iii) applies to transfers that occur on 
or after December 20, 2018. For transfers occurring before December 20, 
2018, see Sec.  1.1503(d)-6(f)(5)(i) through (iii) as contained in 26 
CFR part 1 revised as of April 1, 2018. However, taxpayers may 
consistently apply Sec.  1.1503(d)-6(f)(5)(i) through (iii) to 
transfers occurring before December 20, 2018.

0
Par. 9. Section 1.6038-2 is amended by adding paragraphs (f)(13) and 
(14) and (m)(3) to read as follows:


Sec.  1.6038-2  Information returns required of United States persons 
with respect to annual accounting periods of certain foreign 
corporations.

* * * * *
    (f) * * *
    (13) Amounts involving hybrid transactions or hybrid entities under 
section 267A. If for the annual accounting period, the corporation pays 
or accrues interest or royalties for which a deduction is disallowed 
under section 267A and the regulations in this part under section 267A 
of the Internal Revenue Code, then Form 5471 (or successor form) must 
contain such information about the disallowance in the form and manner 
and to the extent prescribed by the form, instruction, publication, or 
other guidance.
    (14) Hybrid dividends under section 245A(e). If for the annual 
accounting period, the corporation pays or receives a hybrid dividend 
or a tiered hybrid dividend under section 245A(e) and the regulations 
in this part under section 245A(e) of the Internal Revenue Code, then 
Form 5471 (or successor form)

[[Page 19857]]

must contain such information about the hybrid dividend or tiered 
hybrid dividend in the form and manner and to the extent prescribed by 
the form, instruction, publication, or other guidance. Form 5471 (or 
successor form) must also contain any other information relating to the 
rules of section 245A(e) and the regulations in this part under section 
245A(e) of the Internal Revenue Code (including information related to 
a specified owner's hybrid deduction account), as prescribed by the 
form, instruction, publication, or other guidance.
* * * * *
    (m) * * *
    (3) Rules relating to certain hybrid arrangements. Paragraphs 
(f)(13) and (14) of this section apply with respect to information for 
annual accounting periods beginning on or after December 20, 2018.

0
Par. 10. Section 1.6038-3 is amended by:
0
1. Adding paragraph (g)(3).
0
2. Redesignating paragraph (1) at the end of the section as paragraph 
(l).
0
3. In newly redesignated paragraph (l), revising the heading and adding 
a sentence at the end.
    The additions and revision read as follows:


Sec.  1.6038-3  Information returns required of certain United States 
persons with respect to controlled foreign partnerships (CFPs).

* * * * *
    (g) * * *
    (3) Amounts involving hybrid transactions or hybrid entities under 
section 267A. In addition to the information required pursuant to 
paragraphs (g)(1) and (2) of this section, if, during the partnership's 
taxable year for which the Form 8865 is being filed, the partnership 
paid or accrued interest or royalties for which a deduction is 
disallowed under section 267A and the regulations in this part under 
section 267A, the controlling fifty-percent partners must provide 
information about the disallowance in the form and manner and to the 
extent prescribed by Form 8865 (or successor form), instruction, 
publication, or other guidance.
* * * * *
    (l) Applicability dates. * * * Paragraph (g)(3) of this section 
applies for taxable years of a foreign partnership beginning on or 
after December 20, 2018.

0
Par. 11. Section 1.6038A-2 is amended by adding paragraph (b)(5)(iii) 
and adding a sentence at the end of paragraph (g) to read as follows:


Sec.  1.6038A-2  Requirement of return.

* * * * *
    (b) * * *
    (5) * * *
    (iii) If, for the taxable year, a reporting corporation pays or 
accrues interest or royalties for which a deduction is disallowed under 
section 267A and the regulations in this part under section 267A, then 
the reporting corporation must provide such information about the 
disallowance in the form and manner and to the extent prescribed by 
Form 5472 (or successor form), instruction, publication, or other 
guidance.
* * * * *
    (g) * * * Paragraph (b)(5)(iii) of this section applies with 
respect to information for annual accounting periods beginning on or 
after December 20, 2018.

PART 301--PROCEDURE AND ADMINISTRATION

0
Paragraph 12. The authority citation for part 301 continues to read in 
part as follows:

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

0
Par. 13. Section 301.7701-3 is amended by revising the sixth sentence 
of paragraph (a) and adding paragraph (c)(3) to read as follows:


Sec.  301.7701-3  Classification of certain business entities.

    (a) In general. * * * Paragraph (c) of this section provides rules 
for making express elections, including a rule under which a domestic 
eligible entity that elects to be classified as an association consents 
to be subject to the dual consolidated loss rules of section 1503(d). * 
* *
* * * * *
    (c) * * *
    (3) Consent to be subject to section 1503(d)--(i) Rule. A domestic 
eligible entity that elects to be classified as an association consents 
to be treated as a dual resident corporation for purposes of section 
1503(d) (such an entity, a domestic consenting corporation), for any 
taxable year for which it is classified as an association and the 
condition set forth in Sec.  1.1503(d)-1(c)(1) of this chapter is 
satisfied.
    (ii) Transition rule--deemed consent. If, as a result of the 
applicability date (see paragraph (c)(3)(iii) of this section) relating 
to paragraph (c)(3)(i) of this section, a domestic eligible entity that 
is classified as an association has not consented to be treated as a 
domestic consenting corporation pursuant to paragraph (c)(3)(i) of this 
section, then the domestic eligible entity is deemed to consent to be 
so treated as of its first taxable year beginning on or after December 
20, 2019. The first sentence of this paragraph (c)(3)(ii) does not 
apply if the domestic eligible entity elects, on or after December 20, 
2018 and effective before its first taxable year beginning on or after 
December 20, 2019, to be classified as a partnership or disregarded 
entity such that it ceases to be a domestic eligible entity that is 
classified as an association. For purposes of the election described in 
the second sentence of this paragraph (c)(3)(ii), the sixty month 
limitation under paragraph (c)(1)(iv) of this section is waived.
    (iii) Applicability date. The sixth sentence of paragraph (a) of 
this section and paragraph (c)(3)(i) of this section apply to a 
domestic eligible entity that on or after December 20, 2018 files an 
election to be classified as an association (regardless of whether the 
election is effective before December 20, 2018). Paragraph (c)(3)(ii) 
of this section applies as of December 20, 2018.
* * * * *

Sunita Lough,
Deputy Commissioner for Services and Enforcement.
    Approved: February 26, 2020.
David J. Kautter,
Assistant Secretary of the Treasury (Tax Policy).
[FR Doc. 2020-05924 Filed 4-7-20; 8:45 am]
BILLING CODE 4830-01-P