[Federal Register Volume 85, Number 219 (Thursday, November 12, 2020)]
[Rules and Regulations]
[Pages 71998-72075]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2020-21819]



[[Page 71997]]

Vol. 85

Thursday,

No. 219

November 12, 2020

Part II





Department of the Treasury





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Internal Revenue Service





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26 CFR Parts 1 and 301





Guidance Related to the Allocation and Apportionment of Deductions and 
Foreign Taxes, Foreign Tax Redeterminations, Foreign Tax Credit 
Disallowance Under Section 965(g), Consolidated Groups, Hybrid 
Arrangements and Certain Payments Under Section 951A; Final Rule

  Federal Register / Vol. 85 , No. 219 / Thursday, November 12, 2020 / 
Rules and Regulations  

[[Page 71998]]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Parts 1 and 301

[TD 9922]
RIN 1545-BP21; 1545-BP22


Guidance Related to the Allocation and Apportionment of 
Deductions and Foreign Taxes, Foreign Tax Redeterminations, Foreign Tax 
Credit Disallowance Under Section 965(g), Consolidated Groups, Hybrid 
Arrangements and Certain Payments Under Section 951A

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final and temporary regulations and removal of temporary 
regulations.

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SUMMARY: This document contains final regulations that provide guidance 
relating to the allocation and apportionment of deductions and 
creditable foreign taxes, the definition of financial services income, 
foreign tax redeterminations, availability of foreign tax credits under 
the transition tax, the application of the foreign tax credit 
limitation to consolidated groups, adjustments to hybrid deduction 
accounts to take into account certain inclusions in income by a United 
States shareholder, conduit financing arrangements involving hybrid 
instruments, and the treatment of certain payments under the global 
intangible low-taxed income provisions.

DATES: Effective Date: These regulations are effective on January 11, 
2021.
    Applicability Dates: For dates of applicability, see Sec. Sec.  
1.245A(e)-1(h)(2), 1.704-1(b)(1)(ii)(b)(1), 1.861-8(h), 1.861-9(k), 
1.861-12(k), 1.861-14(k), 1.861-17(h), 1.861-20(i), 1.881-3(f), 1.904-
4(q), 1.904-6(g), 1.904(b)-3(f), 1.904(g)-3(l), 1.905-3(d), 1.905-4(f), 
1.905-5(f), 1.951A-7(d), 1.954-1(h), 1.954-2(i), 1.960-7, 1.965-9, 
1.1502-4(f), and 301.6689-1(e).

FOR FURTHER INFORMATION CONTACT: Concerning Sec.  1.245A(e)-1, Andrew 
L. Wigmore, (202) 317-5443; concerning Sec. Sec.  1.861-8, 1.861-9(b), 
1.861-12, 1.861-14, 1.861-17, and 1.954-2(h), Jeffrey P. Cowan, (202) 
317-4924; concerning Sec. Sec.  1.704-1, 1.861-9(e), 1.904-4(e), 
1.904(b)-3, 1.904(g)-3, 1.1502-4, and 1.1502-21, Jeffrey L. Parry, 
(202) 317-4916; concerning Sec. Sec.  1.861-20, 1.904-4(c), 1.904-6, 
1.960-1, and 1.960-7, Suzanne M. Walsh, (202) 317-4908; concerning 
Sec.  1.881-3, Richard F. Owens, (202) 317-6501; concerning Sec. Sec.  
1.965-5 and 1.965-9, Karen J. Cate, (202) 317-4667; concerning 
Sec. Sec.  1.905-3, 1.905-4, 1.905-5, 1.954-1, 301.6227-1, and 
301.6689-1, Corina Braun, (202) 317-5004; concerning Sec.  1.951A-2, 
Jorge M. Oben, at (202) 317-6934 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Background

I. Rules Relating to Foreign Tax Credits

    On December 7, 2018, the Department of the Treasury (the ``Treasury 
Department'') and the IRS published proposed regulations (REG-105600-
18) relating to foreign tax credits in the Federal Register (83 FR 
63200) (the ``2018 FTC proposed regulations''). The 2018 FTC proposed 
regulations addressed several significant changes that the Tax Cuts and 
Jobs Act (Pub. L. 115-97, 131 Stat. 2054, 2208 (2017)) (the ``TCJA'') 
made with respect to the foreign tax credit rules and related rules for 
allocating and apportioning deductions in determining the foreign tax 
credit limitation. Certain provisions of the 2018 FTC proposed 
regulations relating to Sec. Sec.  1.78-1, 1.861-12(c)(2), and 1.965-7 
were finalized as part of TD 9866, published in the Federal Register 
(84 FR 29288) on June 21, 2019.
    The remainder of the 2018 FTC proposed regulations were finalized 
on December 17, 2019 in TD 9882, published in the Federal Register (84 
FR 69022) (the ``2019 FTC final regulations''). On the same date, the 
Treasury Department and the IRS published proposed regulations (REG-
105495-19) relating to foreign tax credits in the Federal Register (84 
FR 69124) (the ``2019 FTC proposed regulations''). The 2019 FTC 
proposed regulations related to changes made by the TCJA and other 
foreign tax credit issues. Correcting amendments to the 2019 FTC final 
regulations and the 2019 FTC proposed regulations were published in the 
Federal Register on May 15, 2020, see 85 FR 29323 (2019 FTC final 
regulations) and 85 FR 29368 (2019 FTC proposed regulations). A public 
hearing on the proposed regulations was held on May 20, 2020.
    On November 7, 2007, the Federal Register published temporary 
regulations (TD 9362) at 72 FR 62771 and a notice of proposed 
rulemaking by cross-reference to the temporary regulations at 72 FR 
62805 relating to sections 905(c), 986(a), and 6689 of the Internal 
Revenue Code (``Code''). Portions of these temporary regulations were 
finalized in the 2019 FTC final regulations, while certain portions 
were reproposed in the 2019 FTC proposed regulations.
    This document contains final regulations (the ``final 
regulations'') addressing the following issues: (1) The allocation and 
apportionment of deductions under sections 861 through 865, including 
rules on the allocation and apportionment of expenditures for research 
and experimentation (``R&E''), stewardship, legal damages, and certain 
deductions of life insurance companies; (2) the allocation and 
apportionment of foreign income taxes; (3) the interaction of the 
branch loss and dual consolidated loss recapture rules with section 
904(f) and (g); (4) the effect of foreign tax redeterminations of 
foreign corporations, including for purposes of the application of the 
high-tax exception described in section 954(b)(4) (and for purposes of 
determining tested income under section 951A(c)(2)(A)(i)(III)), and 
required notifications under section 905(c) to the IRS of foreign tax 
redeterminations and related penalty provisions; (5) the definition of 
foreign personal holding company income under section 954; (6) the 
application of the foreign tax credit disallowance under section 
965(g); and (7) the application of the foreign tax credit limitation to 
consolidated groups.

II. Rules Relating to Hybrid Deduction Accounts, Hybrid Instruments 
Used in Conduit Financing Arrangements, and Certain Payments Under 
Section 951A

    On December 28, 2018, the Treasury Department and the IRS published 
proposed regulations (REG-104352-18) relating to hybrid arrangements, 
including hybrid arrangements to which section 245A(e) applies, in the 
Federal Register (83 FR 67612) (the ``2018 hybrids proposed 
regulations''). Those regulations were finalized as part of TD 9896, 
published in the Federal Register (85 FR 19802) on April 8, 2020 (the 
``2020 hybrids final regulations''). On the same date, the Treasury 
Department and the IRS published proposed regulations (REG-106013-19) 
in the Federal Register (85 FR 19858) (the ``2020 hybrids proposed 
regulations''). Correcting amendments to the 2020 hybrids final 
regulations and the 2020 hybrids proposed regulations were published in 
the Federal Register on August 4, 2020, August 11, 2020, and August 12, 
2020. See 85 FR 47027 (2020 hybrids final regulations), 85 FR 48485 
(2020 hybrids proposed regulations), and 85 FR 48651 (2020 hybrids 
final regulations).
    The 2020 hybrids proposed regulations address hybrid deduction 
accounts under section 245A(e), hybrid instruments used in conduit 
financing arrangements under section 881, and certain payments under 
section 951A (relating to global intangible low-taxed income). The 
Treasury Department and

[[Page 71999]]

the IRS received written comments with respect to the 2020 hybrids 
proposed regulations. All written comments received in response to the 
2020 hybrids proposed regulations are available at www.regulations.gov 
or upon request. A public hearing on the 2020 hybrids proposed 
regulations was not held because there were no requests to speak.
    This document contains final regulations addressing the following 
issues: (1) The reduction to a hybrid deduction account under section 
245A(e) by reason of an amount included in the gross income of a 
domestic corporation under section 951(a) or 951A(a) with respect to a 
controlled foreign corporation (``CFC''); (2) the treatment of a hybrid 
instrument as a financing transaction for purposes of the conduit 
financing rules under section 881; and (3) the treatment under section 
951A of certain prepayments made to a related CFC after December 31, 
2017, and before the CFC's first taxable year beginning after December 
31, 2017.

III. Scope of Provisions and Comments Discussed in This Preamble

    This rulemaking finalizes, without substantive change, certain 
provisions in the 2019 FTC proposed regulations and the 2020 hybrids 
proposed regulations with respect to which the Treasury Department and 
IRS did not receive any comments. See, for example, Sec.  1.904(b)-3, 
Sec.  1.904(g)-3, Sec.  1.951A-2(c)(6), Sec.  1.951A-7(d), Sec.  
1.1502-4, or Sec.  301.6689-1. These provisions are generally not 
discussed in this preamble.
    Comments received that do not pertain to the 2019 FTC proposed 
regulations or the 2020 hybrids proposed regulations, or that are 
otherwise outside the scope of this rulemaking, are generally not 
addressed in this preamble but may be considered in connection with 
future guidance projects.

Summary of Comments and Explanation of Revisions

I. Rules Under Section 245A(e) To Reduce Hybrid Deduction Accounts

A. Overview

    Section 245A(e) was added to the Code by the TCJA. Section 245A(e) 
and the 2020 hybrids final regulations neutralize the double non-
taxation effects of a hybrid dividend or tiered hybrid dividend by 
either denying the section 245A(a) dividends received deduction with 
respect to the dividend or requiring an inclusion under section 
951(a)(1)(A) with respect to the dividend, depending on whether the 
dividend is received by a domestic corporation or a CFC. The 2020 
hybrids final 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, reduced by the amount of hybrid deductions that gave rise to 
a hybrid dividend or tiered hybrid dividend.
    The 2020 hybrids proposed regulations generally reduced a hybrid 
deduction account with respect to a share of stock of a CFC by three 
categories of amounts included in the gross income of a domestic 
corporation with respect to the share, including an ``adjusted subpart 
F inclusion'' or an ``adjusted GILTI inclusion'' with respect to the 
share. See proposed Sec.  1.245A(e)-1(d)(4)(i)(B)(1) and (2). An 
adjusted subpart F inclusion or an adjusted GILTI inclusion with 
respect to a share is intended to measure, in an administrable manner, 
the extent to which a domestic corporation's inclusion under section 
951(a)(1)(A) (``subpart F inclusion'') or inclusion under section 951A 
(``GILTI inclusion amount'') attributable to the share is likely 
``included in income'' in the United States--that is, taken into 
account in income and not offset by, for example, foreign tax credits 
associated with the inclusion and, in the case of a GILTI inclusion 
amount, the deduction under section 250(a)(1)(B).
    The final regulations retain the basic approach and structure of 
the 2020 hybrids proposed regulations that reduced hybrid deduction 
accounts, with certain revisions. Part I.B of this Summary of Comments 
and Explanation of Revisions discusses the revisions as well as 
comments received that relate to these rules.

B. Computation of Adjusted Subpart F Income Inclusion and Adjusted 
GILTI Inclusion

1. In General
    Comments suggested several refinements or clarifications to the 
computation of an adjusted subpart F inclusion or adjusted GILTI 
inclusion with respect to a share of stock of a CFC, generally so that 
the adjusted subpart F inclusion or adjusted GILTI inclusion more 
closely reflects the extent that the subpart F inclusion or GILTI 
inclusion amount is in fact included in income in the United States.
2. Section 904 Limitation
    Under the 2020 hybrids proposed regulations, an adjusted subpart F 
inclusion or adjusted GILTI inclusion with respect to a share of stock 
is computed by taking into account foreign income taxes that, as a 
result of the application of section 960(a) or (d), are likely to give 
rise to deemed paid credits eligible to be claimed by the domestic 
corporation with respect to the subpart F inclusion or adjusted GILTI 
inclusion. See proposed Sec.  1.245A(e)-1(d)(4)(ii)(A) and (B). To 
minimize complexity, the 2020 hybrids proposed regulations did not take 
into account any limitations on foreign tax credits when computing 
foreign income taxes that are likely to give rise to deemed paid 
credits. See proposed Sec.  1.245A(e)-1(d)(4)(ii)(D). A comment 
suggested that the final regulations take into account the limitation 
under section 904.
    The Treasury Department and the IRS agree with the comment for 
computing an adjusted GILTI inclusion. Foreign income taxes that by 
reason of section 904 do not currently give rise to deemed paid credits 
eligible to be claimed with respect to the GILTI inclusion amount are 
not creditable in another year through a carryback or carryover. See 
section 904(c). Thus, there is generally no ability for such excess 
foreign income taxes to reduce the extent that an amount taken into 
account in income by the domestic corporation is included in income in 
the United States. The final regulations therefore provide that such 
foreign income taxes are not taken into account when computing an 
adjusted GILTI inclusion. See Sec.  1.245A(e)-1(d)(4)(ii)(D)(2)(iii) 
and (G). If the application of this rule results in circularity or 
ordering rule issues, a taxpayer may, solely for purposes of computing 
the adjusted GILTI inclusion, apply any reasonable method to compute 
the amount of foreign income taxes the creditability of which is 
limited by section 904.\1\
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    \1\ For example, in certain cases the section 904 limitation may 
be affected by the extent to which section 245A(e) applies to a 
dividend paid by the CFC (in particular, in connection with 
allocating and apportioning deductions under Sec. Sec.  1.861-8 
through 1.861-20); the application of section 245A(e) to the 
dividend may depend on the extent to which a hybrid deduction 
account is reduced by reason of an adjusted GILTI inclusion; and the 
adjusted GILTI inclusion may in turn depend on the section 904 
limitation. In such a case, to avoid circularity issues, a taxpayer 
may compute the section 904 limitation for purposes of determining 
the adjusted GILTI inclusion by, for instance, using simultaneous 
equations, or applying an ordering rule pursuant to which, solely 
for purposes of determining the adjusted GILTI inclusion, the 
section 904 limitation is determined without regard to the 
application of section 245A(e) (as well as any other provision the 
application of which depends on the extent to which section 245A(e) 
applies).

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[[Page 72000]]

    The final regulations do not adopt a similar rule for computing an 
adjusted subpart F inclusion. This is because foreign income taxes that 
by reason of section 904 do not currently give rise to deemed paid 
credits eligible to be claimed with respect to the subpart F inclusion 
may become creditable in another year under section 904(c). 
Consequently, for example, the foreign income taxes could in a later 
year reduce the extent that an amount is included in income in the 
United States, and could thus inappropriately result in an outcome 
similar to the one that would have occurred had the foreign income 
taxes given rise to deemed paid credits in the year of the subpart F 
inclusion and thereby reduced the extent that the subpart F inclusion 
was subject to tax in the United States at the full statutory rate. The 
Treasury Department and the IRS have determined that special rules to 
prevent such results would be complex or burdensome as they would 
require, for instance, tracking the creditability of the foreign income 
taxes over prior or later years (potentially through a 10-year period), 
and then adjusting the hybrid deduction account as the foreign income 
taxes become creditable.
3. Section 250 Deduction
    Under the 2020 hybrids proposed regulations, an adjusted GILTI 
inclusion is computed by taking into account the portion of the 
deduction allowed under section 250 by reason of section 250(a)(1)(B) 
that the domestic corporation is likely to claim with respect to the 
GILTI inclusion amount. See proposed Sec.  1.245A(e)-1(d)(4)(ii)(B). 
The 2020 hybrids proposed regulations did not take into account any 
limitations on the deduction under section 250(a)(2)(B). See id. A 
comment suggested that the final regulations take into account the 
taxable income limitation under section 250(a)(2).
    The Treasury Department and the IRS agree with the comment, because 
taking into account the taxable income limitation results in an 
adjusted GILTI inclusion that more closely reflects the extent to which 
the GILTI inclusion amount is included in income in the United States. 
The final regulations thus provide a rule to this effect. See Sec.  
1.245A(e)-1(d)(4)(ii)(B) and (H). Similar to the rule discussed in Part 
I.B.2 of this Summary of Comments and Explanation of Revisions (related 
to the section 904 limitation), a taxpayer may, solely for purposes of 
computing an adjusted GILTI inclusion, apply any reasonable method to 
compute the extent to which the portion of a deduction allowed under 
section 250 by reason of section 250(a)(1)(B) is limited under section 
250(a)(2)(B).
4. Limit on Reduction of a Hybrid Deduction Account
    The 2020 hybrids proposed regulations provided a limit to ensure 
that an adjusted subpart F inclusion or adjusted GILTI inclusion with 
respect to a share of stock of a CFC does not reduce the hybrid 
deduction account by an amount greater than the hybrid deductions 
allocated to the share for the taxable year multiplied by a fraction, 
the numerator of which is the subpart F income or tested income, as 
applicable, of the CFC for the taxable year and the denominator of 
which is the CFC's taxable income. See proposed Sec.  1.245A(e)-
1(d)(4)(i)(B)(1)(ii) and (d)(4)(i)(B)(2)(ii). In cases in which the 
CFC's taxable income is zero or negative, the 2020 hybrids proposed 
regulations prevented distortions to the fraction--which would 
otherwise occur because the fraction would involve dividing by zero or 
a negative number--by providing that the fraction is considered to be 
zero. See proposed Sec.  1.245A(e)-1(d)(4)(i)(B)(1)(ii) and 
(d)(4)(i)(B)(2)(ii).
    Distortions to the fraction could also occur if the CFC's taxable 
income is greater than zero but less than its subpart F income or 
tested income (due to losses in one category of income) because, absent 
a rule to address, the fraction would be greater than one. The final 
regulations eliminate these distortions by modifying the fraction so 
that the numerator and denominator only reflect items of gross income. 
See Sec.  1.245A(e)-1(d)(4)(i)(B)(1)(ii) and (d)(4)(i)(B)(2)(ii).
5. Clarifications
    Comments recommended that the final regulations clarify whether an 
adjusted subpart F inclusion or adjusted GILTI inclusion can be 
negative and result in an increase to the hybrid deduction account 
(that is, whether the hybrid deduction account can be reduced by a 
negative amount). The final regulations clarify that an adjusted 
subpart F inclusion or adjusted GILTI inclusion cannot be negative and 
thus cannot result in an increase to the hybrid deduction account. See 
Sec.  1.245A(e)-1(d)(4)(ii)(A) and (B).
    A comment also recommended that the final regulations clarify 
whether the computation of an adjusted subpart F inclusion takes into 
account an amount that the domestic corporation includes in gross 
income by reason of section 964(e)(4). As noted in the comment, an 
amount that the domestic corporation includes in gross income by reason 
of section 964(e)(4) is in many cases offset by a 100 percent dividends 
received deduction under section 245A(a), and thus no portion of the 
amount is included in income in the United States (that is, taken into 
account in income and not offset by a deduction or credit particular to 
the inclusion). The final regulations clarify that the computation of 
an adjusted subpart F inclusion does not take into account an amount 
that a domestic corporation includes in gross income by reason of 
section 964(e)(4), to the extent that a deduction under section 245A(a) 
is allowed for the amount. See Sec.  1.245A(e)-1(d)(4)(ii)(A).
6. Comments Outside the Scope of the 2020 Hybrids Proposed Regulations
    In response to a comment, the 2020 hybrids final regulations 
clarified that a deduction or other tax benefit may be a hybrid 
deduction regardless of whether it is used currently under the foreign 
tax law. See Sec.  1.245A(e)-1(d)(2). The preamble to the 2020 hybrids 
final regulations explained that even though a deduction or other tax 
benefit may not be used currently, it could be used in another taxable 
period and thus could produce double non-taxation. The preamble also 
noted that it could be complex or burdensome to determine whether a 
deduction or other tax benefit is used currently and, to the extent not 
used currently, to track the deduction or other tax benefit and add it 
to the hybrid deduction account if it is in fact used.
    Comments submitted with respect to the 2020 hybrids proposed 
regulations raised additional issues involving the extent to which a 
hybrid deduction account should be adjusted based on the availability-
for-use of a deduction or other tax benefit under the foreign tax law. 
These issues include the extent to which (or the mechanism by which) a 
hybrid deduction account should be adjusted when a deduction or other 
tax benefit reflected in the account is subsequently disallowed under 
the foreign tax law (for example, by reason of a foreign audit) or an 
economically equivalent adjustment is made under the foreign tax law, 
or the deduction or other tax benefit expires or otherwise cannot be 
used under the foreign tax law. The Treasury Department and the IRS are 
studying these comments, which are outside the scope of the 2020 
hybrids proposed regulations, and may address these issues in a future 
guidance project.

[[Page 72001]]

II. Allocation and Apportionment of Deductions and the Calculation of 
Taxable Income for Purposes of Section 904(a)

A. Stewardship Expenses, Litigation Damages Awards and Settlement 
Payments, Net Operating Losses, Interest Expense, and Other Expenses

1. Stewardship Expenses
    The 2019 FTC proposed regulations made several changes to the rules 
for allocating and apportioning stewardship expenses, which are 
generally expenses incurred to oversee a related corporation. Although 
the 2019 FTC proposed regulations did not change the definition of 
stewardship expenses, the regulations did provide that expenses 
incurred with respect to partnerships are treated as stewardship 
expenses. The 2019 FTC proposed regulations also expanded the types of 
income to which stewardship expenses are allocated to include not only 
dividends but also other inclusions received with respect to stock. The 
2019 FTC proposed regulations further provided that stewardship 
expenses are to be apportioned based on the relative values of stock 
held by a taxpayer, as computed for purposes of allocating and 
apportioning the taxpayer's interest expense. Additionally, the 
preamble to the 2019 FTC proposed regulations requested comments 
regarding how to distinguish stewardship expenses from supportive 
expenses.
    Several comments addressed the definition of stewardship expenses. 
Some comments recommended that the current regulations' definition be 
retained without changes. One comment recommended that, because 
stewardship is among those activities that are not treated as providing 
a benefit to a related party under the section 482 regulations, such 
expenses should be treated as supportive expenses. Another recommended 
that the definition of stewardship expenses be narrowed to apply solely 
to expenses that result from oversight with respect to foreign 
subsidiaries or non-affiliated domestic entities. Comments also 
requested clarification on how to identify and distinguish between 
stewardship and supportive expenses and sought greater flexibility in 
identifying stewardship expenses. One comment recommended that further 
guidance be left to a separate project.
    The final regulations generally retain the existing definition of 
stewardship expenses as either duplicative or shareholder activities as 
described in Sec.  1.482-9(l)(3)(iii) or (iv). Therefore, stewardship 
expenses either duplicate an expense incurred by the related entity 
without providing an additional benefit to that entity or are incurred 
primarily to protect the taxpayer's investment in another entity or to 
facilitate the taxpayer's compliance with its own reporting, legal or 
regulatory requirements. In contrast, supportive expenses are typically 
incurred in order to enhance the income-producing capabilities of the 
taxpayer itself, and so are definitely related and allocable to all, or 
broad classes, of the taxpayer's gross income. See Sec.  1.861-8(b)(3). 
The fact that expenses attributable to stewardship activities do not 
provide a benefit to the related party does not mean that the expenses 
are supportive of all of the taxpayer's income-producing activity. 
Instead, expenses categorized under Sec. Sec.  1.861-8(e)(4)(ii) and 
1.482-9(l)(3)(iii) and (iv) as stewardship expenses are properly 
allocated to income generated by the related party (and included in 
income of the taxpayer as a dividend or other inclusion), rather than 
to income earned directly by the taxpayer.
    Comments recommended that the definition of stewardship expenses be 
expanded to include expenses incurred with respect to branches and 
disregarded entities, in addition to corporations and partnerships. The 
Treasury Department and the IRS agree that stewardship expenses can 
also be incurred with respect to all business entities (whether foreign 
or domestic) as described in Sec.  301.7701-2(a) and not only those 
business entities that are classified as corporations or partnerships 
for Federal income tax purposes. Therefore, the final regulations at 
Sec.  1.861-8(e)(4)(ii)(A) provide that stewardship expenses incurred 
with respect to oversight of disregarded entities are also subject to 
allocation and apportionment under the rules of Sec.  1.861-8(e)(4). 
However, the Treasury Department and the IRS have determined that it is 
inappropriate to extend the definition of stewardship expense to 
include oversight expenses incurred with respect to an unincorporated 
branch of the taxpayer, since the branch's income is income of the 
taxpayer itself, not income of a separate entity in which the taxpayer 
is protecting its investment, and any reporting, legal or regulatory 
requirements that apply to an unincorporated branch of the taxpayer 
apply to the taxpayer itself.
    Comments also requested that the final regulations make clear that 
stewardship expenses can be allocated and apportioned to income and 
assets of all affiliated and consolidated group members, noting that a 
portion of the dividends and stock with respect to domestic affiliates 
may be treated as exempt income or assets under section 864(e)(3) and 
Sec.  1.861-8(d)(2)(ii) and excluded from the apportionment formula, 
which could reduce apportionment of expenses to U.S. source income. In 
response to the comments, the final regulations at Sec.  1.861-
8(e)(4)(ii)(A) provide that the affiliated group rules in Sec.  1.861-
14 do not apply for purposes of allocating and apportioning stewardship 
expenses. As a result, stewardship expenses incurred by one member of 
an affiliated group in order to oversee the activities of another 
member of the group are allocated and apportioned by the investor 
taxpayer on a separate entity basis, with reference to the investor's 
stock in the affiliated member. See Sec.  1.861-8(e)(4)(ii)(A). 
Furthermore, in response to comments, the final regulations at Sec.  
1.861-8(e)(4)(ii)(C) provide that the exempt income and asset rules in 
section 864(e)(3) and Sec.  1.861-8(d)(2) do not apply for purposes of 
apportioning stewardship expenses.
    Comments were also received regarding the rules for allocating 
stewardship expenses solely to income arising from the entity for which 
the stewardship expenses are being incurred in order to protect that 
investment. One comment argued that the rule in the prior final 
regulations for allocating stewardship expenses solely to dividend 
income should be retained and should not be expanded to include 
inclusions such as those under the GILTI rules. In contrast, another 
comment agreed with the approach to expand allocation to include 
shareholder-level inclusions such as GILTI inclusions in light of the 
changes made by the TCJA.
    The Treasury Department and the IRS have determined that allocating 
stewardship expenses to all types of income derived from ownership of 
the entity, rather than solely dividend income, is appropriate because 
dividends do not fully capture all of the statutory and residual 
groupings to which income from stock is assigned. Limiting the 
allocation of stewardship expenses only to dividends would preclude 
allocation to stock in a CFC or passive foreign investment company 
(``PFIC'') whose income gave rise only to subpart F, GILTI, or PFIC 
inclusions, even if the expense clearly relates to overseeing 
activities that generate income in the CFC or PFIC that give rise to 
such inclusions. Therefore, the Treasury Department and IRS agree with 
the comment supporting the expansion of stewardship expense allocation 
in

[[Page 72002]]

proposed Sec.  1.861-8(e)(4)(ii)(B) to include shareholder-level 
inclusions.
    One comment recommended adding dividends eligible for a section 
245A deduction to the list of income inclusions to which stewardship 
expenses are allocable. The existing regulations are already clear, 
however, that stewardship expenses are allocable to dividends. This 
allocation is not affected by the fact that dividends may qualify for 
the deduction under section 245A, which does not convert the dividends 
into exempt or excluded income for purposes of allocating and 
apportioning deductions. See Sec.  1.861-8(d)(2)(iii)(C). To the extent 
that stewardship expense is allocated and apportioned to dividend 
income in the section 245A subgroup, section 904(b)(4) requires certain 
adjustments to the taxpayer's foreign source taxable income and entire 
taxable income for purposes of computing the applicable foreign tax 
credit limitation. Accordingly, the final regulations are not modified 
in response to the comment.
    In response to a request for comments in the 2019 FTC proposed 
regulations on possible exceptions to the general rule for the 
allocation and apportionment of stewardship expenses, several comments 
recommended allowing taxpayers to show that stewardship expense 
factually relates only to the relevant income of a specific income-
producing entity or entities. The Treasury Department and the IRS agree 
that stewardship expenses may be factually related to the taxpayer's 
ownership of a specific entity (or entities) and should not be 
allocated and apportioned to the income derived from all entities in a 
group without taking into account the factual connection between the 
stewardship expense and the entity being overseen. Accordingly, the 
final regulations at Sec.  1.861-8(e)(4)(ii)(B) clarify that at the 
allocation step (but before applying the apportionment rules), only the 
gross income derived from entities to which the taxpayer's stewardship 
expense has a factual connection are included and, in such cases, the 
apportionment rule applies based on the tax book value of the 
taxpayer's investment in those particular entities. This approach 
recognizes that stewardship activities are not fungible in the same 
manner as interest expense.
    With respect to the apportionment of stewardship expenses, several 
comments recommended retaining the flexibility of the prior final 
regulations, which provide for several permissible methods of 
apportionment, or alternatively apportioning stewardship expenses on 
the basis of gross income, rather than assets. One comment questioned 
the appropriateness of applying the apportionment rule used for 
interest expense in the context of stewardship expenses.
    The Treasury Department and the IRS have determined that it is 
appropriate to provide a single, clear rule for the apportionment of 
stewardship expenses and that the asset-based rule for interest expense 
apportionment is the most appropriate method. The Treasury Department 
and the IRS have also determined that an explicit rule provides 
certainty for both taxpayers and the IRS and will minimize disputes. By 
definition, stewardship expenses typically relate to protecting the 
value of the taxpayer's ownership interest in another entity. 
Therefore, such expenses should be apportioned on the basis of the tax 
book value (or alternative tax book value) of the taxpayer's interest 
in the entity (or entities) in question, since that value more closely 
approximates the income generated by the entity over time, while income 
distributed from an entity (or entities) and taxed to the owner can 
vary from year to year and may not properly reflect all the income-
generating activity of the entity. Although stewardship activities may 
be definitely related to indirectly-owned entities, the Treasury 
Department and the IRS have determined that apportioning stewardship 
expenses based on the value of an indirectly-owned entity would lead to 
unnecessary complexity for taxpayers and administrative burdens for the 
IRS; instead, such expenses are apportioned based on the values of the 
entities that are owned directly by the taxpayer. See Sec.  1.861-
8(e)(4)(ii)(C).
    For purposes of determining the value of an entity, the final 
regulations at Sec.  1.861-8(e)(4)(ii)(C) provide that the value of the 
stock in an affiliated corporation is characterized as if the 
corporation were not affiliated and the stock is characterized by the 
taxpayer in the same ratios in which the affiliate's assets are 
characterized for purposes of allocating and apportioning the group's 
interest expense. The final regulations also provide that the tax book 
value of a taxpayer's investment in a disregarded entity is determined 
and characterized under the rules that would apply if the entity's 
stock basis were regarded for purposes of allocating and apportioning 
the investor taxpayer's interest expense.
2. Litigation Damages Awards, Prejudgment Interest, and Settlement 
Payments
    The 2019 FTC proposed regulations included special rules for the 
allocation and apportionment of damages awards, prejudgment interest, 
and settlement payments incurred in settlement of, or in anticipation 
of, claims for damages arising from product liability, events incident 
to the production or sale of goods or provision of services, and 
investor suits. Damages or settlement awards related to product 
liability, or events incident to the production or sale of goods or 
provision of services, are allocated to the class of gross income 
produced by the specific sales of products or services that gave rise 
to the claims for damages or injury, or to the class of gross income 
produced by the assets involved in the production or sales activity, 
respectively. Damages awards related to shareholder suits are allocated 
to all income of the corporation and apportioned based on the relative 
values of all of the corporation's assets that produce income in the 
statutory and residual groupings.
    One comment suggested that the proposed rules lacked clearly 
articulated rationales, in contrast to, for example, the rules for R&E 
expenditures. The Treasury Department and the IRS have determined that 
the rules included in the 2019 FTC proposed regulations for specific 
types of litigation-related expenses are consistent with the general 
principles of the allocation and apportionment rules, which are based 
on the factual connection between deductions and the class of gross 
income to which they relate. See Sec.  1.861-8(b)(1). Accordingly, no 
change is made in the final regulations in response to this comment. 
However, the final regulations at Sec.  1.861-8(e)(5)(ii) include a new 
paragraph heading and a sentence to clarify that the damages rule is 
not limited to product liability claims.
    One comment stated that the 2019 FTC proposed regulations could be 
interpreted to require a double allocation of deductions to royalty 
income, for example, if a taxpayer incurs damages from a patent 
infringement lawsuit and also indemnifies its CFC for damages paid in a 
separate lawsuit filed against the CFC. The Treasury Department and the 
IRS have determined that indemnification payments, to the extent 
deductible, are governed by the generally-applicable rules for 
allocating and apportioning expenses based on the factual relationship 
between the deduction and the class of gross income to which the 
deduction relates. The allocation of separate deductions that are both 
related to the same class of gross income does not constitute a double 
allocation. Accordingly, no changes are made in

[[Page 72003]]

the final regulations in response to this comment.
    The 2019 FTC proposed regulations contained an explicit 
apportionment rule for damages awards in response to industrial 
accidents and investor lawsuits, but not for product liability and 
similar claims. The final regulations add a sentence at Sec.  1.861-
8(e)(5)(ii) to clarify that deductions relating to product liability 
and similar claims are apportioned among the statutory and residual 
groupings based on the relative amounts of gross income in the relevant 
class in the groupings in the year the deductions are allowed.
    Finally, several comments disagreed with the approach in the 2019 
FTC proposed regulations regarding lawsuits filed by investors against 
a corporation. These comments argued that it is inappropriate to 
allocate deductions for such payments to income produced by all of the 
taxpayer's assets, because these expenses can have a closer factual 
connection to the jurisdiction where the litigation occurs or where the 
events (for example, any negligence, fraud, or malfeasance) at issue in 
the lawsuit occurred. Some comments advocated for a more flexible rule, 
noting that certain shareholder claims may have a very narrow 
geographic scope, whereas other claims may relate to a broader range of 
activities.
    The Treasury Department and the IRS have determined that it is 
inappropriate to allocate deductions for payments with respect to 
investor lawsuits on the basis of the situs of the underlying events or 
the location of the lawsuit. The purpose of direct investor lawsuits 
against a company is generally to compensate investors for damages to 
their investment in the entire company. Even where the underlying 
misconduct directly relates to only a portion of the taxpayer's 
business activities, the harm to the investor is generally attributable 
to the taxpayer's business more generally and, therefore, any damages 
payment is related to all of the taxpayer's income-producing 
activities. Moreover, any rule that attempted to quantify the portion 
of damages or settlements that relate to specific business activities 
and the portion that relates to more general reputational loss would by 
its nature be difficult for taxpayers to comply with and for the IRS to 
administer. Furthermore, the Treasury Department and the IRS disagree 
with the comments suggesting that award payments should be allocated 
based on the geographic location in which the lawsuit is filed, which 
could be governed by contractual terms or choice-of-law rules that have 
little to no factual relationship to the underlying activities to which 
the lawsuit relates. Accordingly, the comments are not adopted.
3. Net Operating Loss Deductions
    The 2019 FTC proposed regulations clarified the treatment of net 
operating losses (NOLs) by specifying how the statutory and residual 
grouping components of an NOL are determined in the taxable year of the 
loss and by clarifying the manner in which the net operating loss 
deduction allowed under section 172 is allocated and apportioned in the 
taxable year in which the deduction is allowed. Comments requested that 
for purposes of applying Sec.  1.861-8(e)(8) to section 250 as the 
operative section, NOLs arising in taxable years before the TCJA's 
enactment of section 250 should not be allocated and apportioned to 
gross FDDEI. On July 15, 2020, the Treasury Department and the IRS 
finalized regulations under section 250, which provide that the 
deduction under section 172(a) is not taken into account in computing 
FDDEI. See Sec.  1.250(b)-1(d)(2)(ii). Therefore, the comment is moot. 
However, a sentence is added to the final regulations at Sec.  1.861-
8(e)(8)(i) to clarify that in determining the component parts of an 
NOL, deductions that are considered absorbed in the year the loss arose 
for purposes of an operative section may differ from the deductions 
that are considered absorbed for purposes of another provision of the 
Code that requires determining the components of an NOL. Therefore, for 
example, a taxpayer's NOL may comprise excess deductions allocated to 
foreign source general category income for purposes of section 904, 
even though for purposes of section 172(b)(1)(B)(ii) the NOL is a 
farming loss comprising excess deductions allocated to U.S. source 
income from farming.
4. Application of the Exempt Income/Asset Rule to Insurance Companies 
in Connection With Certain Dividends and Tax-Exempt Interest
    The 2019 FTC proposed regulations clarified in proposed Sec.  
1.861-8(d)(2)(ii)(B), (d)(2)(v), and (e)(16) the effect of certain 
deduction limitations on the treatment of income and assets generating 
dividends-received deductions and tax-exempt interest held by insurance 
companies for purposes of allocating and apportioning deductions to 
such income and assets. Specifically, the 2019 FTC proposed regulations 
provided that in the case of insurance companies, exempt income 
includes dividends for which a deduction is provided by sections 
243(a)(1) and (2) and 245, without regard to the proration rules under 
section 805(a)(4)(A)(ii) disallowing a portion of the deduction 
attributable to the policyholder's share of the dividends or any 
similar disallowance under section 805(a)(4)(D). Similarly, the 
regulations provided that the term exempt income includes tax-exempt 
interest without regard to the proration rules.
    One comment requested that the final regulations modify Sec.  
1.861-8T(d)(2) to permit insurance companies to adjust the amount of 
income and assets that are exempted in apportioning deductions. The 
comment asserted that such adjustment is required in order to reflect 
the addition of section 864(e)(7)(E) and relied on legislative history 
to a provision in proposed technical corrections legislation (Technical 
Corrections Act of 1987, H.R. 2636, 100th Cong., section 112(g)(6)(A)) 
(June 10, 1987)) (the ``1987 bill'') to suggest that Congress intended 
to create a different result for insurance companies than for other 
companies.
    The 1987 bill, however, was not enacted, and the language in 
section 864(e)(7)(E) is not the same as the language proposed in the 
bill. Section 864(e)(7)(E) provides regulatory authority for the 
Secretary to issue regulations regarding any adjustments that may be 
appropriate in applying section 864(e)(3) to insurance companies. The 
legislative history to section 864(e)(7)(E) (which was enacted in 1988) 
does not contain the same language as did the committee reports from 
the 1987 bill, and the rule that was proposed in the 1987 bill is 
contrary to subsequent case law. See Travelers Insurance Company v. 
United States, 303 F.3d 1373 (2002). Therefore, the Treasury Department 
and the IRS have concluded that although section 864(e)(7)(E) provides 
regulatory authority for a rule applying section 864(e)(3) to insurance 
companies, there is no indication that Congress intended for Treasury 
to adopt a rule mirroring the rule in the 1987 bill (which Congress did 
not enact).
    Section 864(e)(3) is clear that exempt income includes income for 
which a deduction is allowed under sections 243 and 245, and no 
exception is provided in the statute for insurance companies. 
Furthermore, as explained in Part I.A.4 of the Explanation of 
Provisions in the 2019 FTC proposed regulations, a special rule for 
either tax-exempt interest of a life insurance company or dividends-
received deductions and tax-exempt interest of a nonlife insurance 
company is not appropriate because when a policyholder's share or 
applicable percentage is accounted for as either a reserve adjustment 
or a

[[Page 72004]]

reduction to losses incurred, no further modification to the generally 
applicable rules is required to ensure that the appropriate amount of 
expenses are apportioned to U.S. source income. Instead, the rule 
suggested by the comment would inappropriately distort the allocation 
and apportionment of deductions to U.S. source income. Therefore, the 
comment is not adopted.
5. Treatment of the Section 250 Deduction
    One comment requested clarification on the allocation and 
apportionment of the deduction allowed under section 250 (``section 250 
deduction'') with respect to members of a consolidated group. In 
general, under Sec.  1.1502-50(b), a consolidated group member's 
section 250 deduction is determined based on the member's share of the 
sum of all members' positive FDDEI or GILTI. Separate from this 
determination under Sec.  1.1502-50(b), a taxpayer must also allocate 
and apportion the section 250 deduction to gross income for purposes of 
determining its foreign tax credit limitation. For this purpose, in 
allocating and apportioning the section 250 deduction to statutory and 
residual groupings, under Sec.  1.861-8(e)(13) the portion of the 
section 250 deduction attributable to FDII is treated as definitely 
related and allocable to the specific class of gross income that is 
included in the taxpayer's FDDEI and then apportioned between the 
statutory and residual groupings based on the relative amounts of FDDEI 
in each grouping. In the context of an affiliated group, under Sec.  
1.861-14T(c)(1) expenses are generally allocated and apportioned by 
treating all members of an affiliated group as if they were a single 
corporation.
    In response to the comment requesting clarity on the allocation and 
apportionment of the section 250 deduction with respect to members of a 
consolidated group, the final regulations provide that the section 250 
deduction is allocated and apportioned as if all members of the 
consolidated group are treated as a single corporation. See Sec.  
1.861-14(e)(4). However, in the case of an affiliated group that is not 
a consolidated group, the section 250 deduction of a member of an 
affiliated group is allocated and apportioned on a separate entity 
basis under the rules of Sec.  1.861-8(e)(13) and (14).
6. Other Requests for Comments on Expense Allocation
    The preamble to the 2019 FTC proposed regulations requested 
comments on whether future regulations should allow taxpayers to 
capitalize and amortize certain expenses solely for purposes of the 
rules in Sec.  1.861-9 for allocating and apportioning interest expense 
in order to better reflect asset values under the tax book value 
method. One comment was received recommending that such a rule be 
included with respect to R&E and advertising expenditures. The Treasury 
Department and the IRS agree with this comment and, accordingly, this 
rule is included in a notice of proposed rulemaking in the Proposed 
Rules section of this issue of the Federal Register (the ``the 2020 FTC 
proposed regulations''). See Part V.A of the Explanation of Provisions 
in the 2020 FTC proposed regulations.
    One comment requested that a special rule be adopted in Sec.  
1.861-10T to directly allocate certain interest expense related to 
regulated utility companies. The Treasury Department and the IRS agree 
that a special rule is warranted, and have included a rule in the 2020 
FTC proposed regulations. See Part V.B. of the Explanation of 
Provisions in the 2020 FTC proposed regulations.
    Finally, the preamble to the 2019 FTC proposed regulations 
requested comments on whether the rules in Sec.  1.861-8(e)(6) for 
allocating and apportioning state income taxes should be revised in 
light of changes made by the TCJA and changes to state rules for taxing 
foreign income. One comment was received requesting that the existing 
rules, which rely on state law to determine the income to which state 
taxes relate, be retained. The Treasury Department and the IRS agree 
that no changes to the rules in Sec.  1.861-8(e)(6) are required at 
this time.
7. Examples Illustrating Allocation and Apportionment of Certain 
Expenses of an Affiliated Group of Corporations
    Examples 1 through 6 in Sec.  1.861-14T(j) apply the temporary 
regulations to fact patterns involving affiliated groups of 
corporations. However, Examples 1 and 4 of Sec.  1.861-14T(j) are no 
longer consistent with current law, and therefore the final regulations 
append an informational footnote to Sec.  1.861-14T(j) to reflect this 
fact. The Treasury Department and the IRS are also studying whether the 
remaining examples should be modified and whether new examples should 
be included in future guidance.

B. Partnership Transactions

    The 2019 FTC proposed regulations revised Sec. Sec.  1.861-9(b) and 
1.954-2(h)(2)(i) to provide that guaranteed payments for the use of 
capital described in section 707(c) are treated similarly to interest 
deductions for purposes of allocating and apportioning deductions under 
Sec. Sec.  1.861-8 through 1.861-14, and are treated as income 
equivalent to interest under section 954(c)(1)(E). These rules were 
intended to prevent the use of guaranteed payments to avoid the rules 
under Sec. Sec.  1.861-9(e)(8) and 1.954-2(h) that apply to partnership 
debt.
    One comment stated that while guaranteed payments for capital are 
economically similar to interest payments in some respects, guaranteed 
payments are, for Federal income tax purposes, payments with respect to 
equity, not debt, and regulations issued under section 707 narrowly 
circumscribe the situations in which a guaranteed payment is treated as 
something other than a distributive share of partnership income. The 
comment recommended that guaranteed payments for capital be treated as 
interest only in cases when the taxpayer harbors an abusive motive to 
circumvent the relevant rule.
    The Treasury Department and the IRS have determined that guaranteed 
payments for the use of capital share many of the characteristics of 
interest payments that a partnership would make to a lender and, 
therefore, should be treated as interest equivalents for purposes of 
allocating and apportioning deductions under Sec. Sec.  1.861-8 through 
1.861-14 and as income equivalent to interest under section 
954(c)(1)(E). This treatment is consistent with other sections of the 
Code in which guaranteed payments for the use of capital are treated 
similarly to interest. See, for example, Sec. Sec.  1.469-2(e)(2)(ii) 
and 1.263A-9(c)(2)(iii). In addition, the fact that a guaranteed 
payment for the use of capital may be treated as a payment attributable 
to equity under section 707(c), or that a guaranteed payment for the 
use of capital is not explicitly included in the definition of interest 
in Sec.  1.163(j)-1(b)(22), does not preclude applying the same 
allocation and apportionment rules that apply to interest expense 
attributable to debt, nor does it preclude treating such payments as 
``equivalent'' to interest under section 954(c)(1)(E). Instead, the 
relevant statutory provisions under sections 861 and 864, and section 
954(c)(1)(E), are clear that the rules can apply to amounts that are 
similar to interest.
    Finally, a rule that would require determining whether the 
transaction had an abusive motive would be difficult to administer. 
Therefore, the comment is not adopted.

[[Page 72005]]

C. Treatment of Section 818(f) Expenses for Consolidated Groups

    Section 818(f)(1) provides that a life insurance company's 
deduction for life insurance reserves and certain other deductions 
(``section 818(f) expenses'') are treated as items which cannot 
definitely be allocated to an item or class of gross income. When the 
life insurance company is a member of an affiliated group of 
corporations, proposed Sec.  1.861-14(h)(1) provided that section 
818(f) expenses are allocated and apportioned on a separate company 
basis.
    One comment argued that the separate company approach was 
inconsistent with the general rule in section 864(e)(6) that expenses 
other than interest that are not directly allocable or apportioned to 
any specific income-producing activity are allocated and apportioned as 
if all members of the affiliated group were a single corporation. The 
comment also argued that the separate company approach would encourage 
consolidated groups to use intercompany transactions, such as related 
party reinsurance arrangements, to shift their section 818(f) expenses 
and achieve a more desirable foreign tax credit result. The comment 
advocated that the regulations instead adopt a single entity approach 
for life insurance companies that operate businesses and manage assets 
and liabilities on a group basis (a ``life subgroup'' approach).
    In contrast, another comment argued that the separate company 
approach adopted in the proposed regulations was consistent with the 
fact that life insurance companies are regulated with respect to their 
reserves, investable assets, and capital. The comment, however, 
acknowledged that a life subgroup approach may be appropriate in 
certain cases, such as when an affiliated group of life insurance 
companies manages similar products on a cross-entity, product-line 
basis, rather than on an entity-by-entity basis. The comment 
recommended that final regulations provide a one-time election for 
taxpayers to choose either the separate company or life subgroup 
approach for allocating and apportioning section 818(f) expenses.
    The Treasury Department and the IRS agree that there are merits and 
drawbacks to both the separate company and the life subgroup approaches 
and that a one-time election, as suggested by the comments, should be 
considered. Therefore, the final regulations at Sec.  1.861-14(h) do 
not include the separate company rule for section 818(f) expenses. The 
2020 FTC proposed regulations instead propose a life subgroup approach 
as well as a one-time election for taxpayers to choose the separate 
company approach.

D. Allocation and Apportionment of R&E Expenditures

    The 2019 FTC proposed regulations proposed several changes to Sec.  
1.861-17, including eliminating the gross income method of 
apportionment, eliminating the legally-mandated R&E rule, and limiting 
the class of income to which R&E expenditures could be allocated to 
gross intangible income reasonably connected with a relevant Standard 
Industrial Code (SIC) category. In addition, the rule for exclusive 
apportionment of R&E expenditures was modified by eliminating the 
possibility of increased exclusive apportionment based on taxpayer-
specific facts and circumstances, and by providing that exclusive 
apportionment applies solely for purposes of section 904.
1. Scope of Gross Intangible Income
    Before being revised, Sec.  1.861-17(a) provided that R&E 
expenditures are related to all income reasonably connected to a broad 
line of business or SIC code category. The 2019 FTC proposed 
regulations narrowed and clarified the class of gross income to which 
R&E expenditures are considered to relate. The 2019 FTC proposed 
regulations defined the relevant class of gross income as gross 
intangible income (``GII''), which is defined as all income 
attributable, in whole or in part, to intangible property, including 
sales or leases of products or services derived, in whole or in part, 
from intangible property, income from sales of intangible property, 
income from platform contribution transactions, royalty income, and 
amounts taken into account under section 367(d) by reason of a transfer 
of intangible property. GII does not include dividends or any amounts 
included in income under section 951, 951A, or 1293.
    One comment disagreed with the exclusion from GII of section 951A 
inclusions. According to this comment, R&E expenditures ultimately 
benefit foreign subsidiaries such that allocation to income described 
in section 904(d)(1)(A) (the ``section 951A category'') is appropriate 
and should not be treated differently from other taxpayer expenses that 
reduce income in the section 951A category. Other comments generally 
supported the exclusion of GILTI and other income inclusions from GII 
on the grounds that a taxpayer incurring R&E expenditures to develop 
intangible property should be fully compensated for the value of that 
intellectual property and, conversely, the earnings of CFCs should not 
reflect returns on intellectual property owned by another person.
    The Treasury Department and the IRS have determined that GII should 
continue to exclude GILTI or other inclusions attributable to ownership 
of stock in a CFC. As described in Sec.  1.861-17(b), R&E expenditures, 
whether or not ultimately successful, are incurred to produce 
intangible property. Under the rules of sections 367(d) and 482, the 
person incurring the R&E expenditures must be compensated at arm's 
length when such intangible property is licensed, sold, or otherwise 
gives rise to income of controlled parties, and it is this income that 
gives rise to GII. In transactions not involving the direct transfer of 
intangible property to a related party, the section 482 regulations 
require compensation for the intangible property embedded in the 
underlying transaction. See generally Sec.  1.482-1(d)(3)(v). For 
example, Sec.  1.482-3(f) requires that intangible property embedded in 
tangible property be accounted for when determining the arm's length 
price for the transaction. Similarly, Sec.  1.482-9(m) requires that 
intangible property used in a controlled services transaction be 
accounted for in determining the arm's length price for the 
transaction.
    In contrast to R&E expenditures giving rise to income required by 
sections 367(d) and 482, subpart F or GILTI inclusions reflect income 
earned by a CFC and not the taxpayer incurring the R&E expenditures; 
the fact that such taxpayer is deemed under section 951 or 951A to have 
income through an inclusion from a CFC licensee does not mean that such 
income is a result of the R&E expenditures incurred by the taxpayer, 
assuming that the CFC pays the taxpayer an arm's length price for the 
transfer of the intangible property or, in the case of an exchange 
described in sections 351 or 361, the taxpayer reports the required 
annual income inclusion.\2\ Therefore, including income in the section 
951A category in GII would result in a mismatch between the R&E 
expenditures and the income

[[Page 72006]]

generated by such expenditures. Although (as noted in a comment) R&E 
expenditures that are ultimately unsuccessful could be viewed as 
intended to benefit a taxpayer's foreign subsidiaries more broadly, the 
Treasury Department and the IRS have determined that the GII earned by 
the taxpayer provides a reasonable proxy for how the taxpayer expects 
to recover its R&E costs, and providing separate rules for identifying 
and attributing unsuccessful R&E expenditures to a broader class of 
income would be unduly burdensome for taxpayers and difficult for the 
IRS to administer.
---------------------------------------------------------------------------

    \2\ To assist in determining an arm's length price in related 
party transactions, section 14221 of the TCJA and related technical 
corrections in the 2018 Consolidated Appropriations Act amended 
sections 482 and 367(d) to clarify the methods that may be applied 
to determine the value of intangible property and that the 
definition of intangible property includes workforce, goodwill and 
going concern value, or other items the value or potential value of 
which is not attributable to tangible property or the services of 
any individual. To the extent the comment reflects a concern that 
arm's length compensation for intangible property has not always 
been paid under sections 367(d) and 482, the comment raises issues 
beyond the scope of this rulemaking.
---------------------------------------------------------------------------

    Several comments noted that while income in the section 951A 
category is excluded from GII, income giving rise to foreign-derived 
intangible income (``FDII'') is included in GII. These comments 
generally argued that the exclusion from GII of income in the section 
951A category and inclusion of amounts included in FDII created a lack 
of parity between the two provisions even though the methodology and 
calculations of both are meant to be similar.
    The Treasury Department and the IRS disagree with these comments. 
The allocation and apportionment of R&E expenditures to separate 
categories for purposes of section 904 as the operative section and the 
allocation and apportionment of R&E expenditures to FDDEI for purposes 
of section 250 as the operative section both require identifying the 
class of income to which the R&E expenditures are attributable. R&E 
expenditures incurred by a United States shareholder (``U.S. 
shareholder'') are not allocated and apportioned to income in the 
section 951A category because such income, which relates to an 
inclusion of income earned by the CFC, is not a return on the U.S. 
shareholder's R&E expenditures and, thus, is not included in gross 
intangible income. In contrast, income giving rise to FDII is earned 
directly by the same taxpayer that incurs R&E expenditures and may 
include a return on those R&E expenditures. Income that gives rise to 
FDII is reduced by ``the deductions (including taxes) properly 
allocable to such gross income.'' See section 250(b)(3)(A)(ii) and 
Sec.  1.250(b)-1(d)(2). There is no indication that Congress intended 
to exclude R&E expenditures from that calculation. Furthermore, because 
expenses incurred by a CFC are allocated and apportioned to income of 
the CFC for purposes of computing tested income under section 
951A(c)(2)(A)(ii), contrary to the suggestion in the comments, R&E 
expenditures of the CFC are in fact allocated and apportioned to tested 
income under Sec.  1.861-17 and reduce the ultimate amount of the 
taxpayer's GILTI inclusion. Accordingly, the comment is not adopted.
    One comment requested modifications to the definition of GII to 
exclude both acquired intangible property and income from certain 
platform contribution transactions described in Sec.  1.482-
7(b)(1)(ii). According to the comment, income from these items should 
be excluded from GII because a taxpayer's R&E expenditures could not 
relate to gross income from intangible property acquired from a 
different taxpayer (as opposed to developed by the taxpayer), or to 
gross income from certain platform contributions.
    The Treasury Department and the IRS have determined that the 
comment does not accurately describe the premise on which the R&E 
allocation and apportionment rules are based. R&E expenditures are not 
reasonably expected to produce any current income in the taxable year 
in which the expenditures are incurred, and as the regulations 
explicitly recognize, the results of R&E expenditures are speculative. 
Accordingly, R&E expenditures are allocated to a class of currently 
recognized gross income only because it generally will be the best 
available proxy for the income that the current expense is reasonably 
expected to produce in the future. Specifically, although current R&E 
expense of a taxpayer likely does not directly contribute to gross 
intangible income currently recognized, it is reasonable to expect that 
R&E will contribute to GII earned by the taxpayer group in the future. 
The definition of GII is not intended to require a strict factual 
connection between the R&E expenditure and GII earned in the taxable 
year, but merely that the expenditures be ``reasonably connected'' with 
a class of income. The Treasury Department and the IRS have also 
determined that requiring the comment's suggested level of explicit 
factual connection between R&E expenditures and GII would outweigh the 
administrative benefit and ease of broadly defining GII. Moreover, in 
cases in which a taxpayer has a valid cost sharing agreement, even 
though R&E expenditures may be allocated to PCT payments, those 
expenses are generally apportioned based on sales by the taxpayer or 
other entities reasonably expected to benefit from current research and 
experimentation. This ensures that R&E expenditures offset the 
categories of income included in GII that are expected to benefit from 
those expenditures. Accordingly, the comment is not adopted.
    One comment requested clarification of the definition of GII and 
specifically that the final regulations provide that the services 
income included in GII does not include gross income allocated to or 
from a foreign branch under Sec.  1.904-4(f)(2)(vi) by reason of a 
disregarded payment for services performed by or for the foreign branch 
that contribute to earning GII of the taxpayer.
    Under Sec.  1.904-4(f)(2)(vi)(B), a disregarded payment from a 
foreign branch owner to its foreign branch to compensate the foreign 
branch for the provision of contract R&E services that, if regarded, 
would be allocable to general category gross intangible income 
attributable to the foreign branch owner under the principles of 
Sec. Sec.  1.861-8 through 1.861-17, would cause the general category 
GII attributable to the foreign branch owner to be adjusted downward 
and the GII attributable to the foreign branch and included in foreign 
branch category income to be adjusted upward. Although a disregarded 
payment for R&E services does not give rise to gross income for Federal 
income tax purposes and so does not in and of itself constitute GII, to 
the extent the disregarded payment results in the reattribution of 
regarded gross income that is GII from the general category to the 
foreign branch category (or vice versa), that income is treated as GII 
in the foreign branch category (or the general category). The final 
regulations at Sec.  1.861-17(b)(2) clarify that although GII does not 
include disregarded payments, certain disregarded payments that would 
be allocable to GII if regarded may result in the reassignment of GII 
from the general category to the foreign branch category or vice versa. 
Part II.D.6 of this Summary of Comments and Explanation of Revisions 
further describes comments regarding R&E expenditures and foreign 
branches.
    One comment sought clarification regarding the portion of product 
sales derived from intangible property that would be considered GII. 
The final regulations at Sec.  1.861-17(b)(2) clarify that GII includes 
the full amount of gross income from sales or leases of products or 
services, if the income is derived in whole or in part from intangible 
property. Under the definition of GII, there is no bifurcation or 
splitting of sales income between a portion attributable to intangible 
property and other amounts such as distribution or marketing functions. 
Additionally, the definition of GII has been modified to more clearly 
delineate between amounts from sales or leases of

[[Page 72007]]

products derived from intangible property versus sales or licenses of 
intangible property itself.
2. Allocation of R&E Expenditures
    One comment requested modifications to the general rule that 
allocates R&E expenditures to GII that is reasonably connected with one 
or more relevant SIC code categories. The comment noted that in some 
cases, taxpayers are restricted by law or contract from exploiting 
research, with the result that the research would only generate income 
in a particular statutory grouping after several years from the date of 
the contract. Accordingly, the comment requested that such R&E 
expenditures be allocated to the statutory or residual grouping of 
income within GII that corresponds to the market restrictions on the 
use of the R&E. Alternatively, the comment requested that taxpayers be 
provided with the option to allocate R&E expenditures in a manner 
consistent with the taxpayer's books and records to the extent there is 
a clear factual relationship between the expenditures and a particular 
category of income.
    The Treasury Department and the IRS have determined that it is 
inappropriate to provide exceptions to the general rule that R&E 
expenditures are allocated to GII reasonably connected with one or more 
relevant SIC code categories. The two approaches suggested by the 
comment are premised on a goal of seeking to ``trace'' R&E expenditures 
to the actual income that they are expected to produce in the future. 
However, as discussed in Part II.D.1 of this Summary of Comments and 
Explanation of Revisions, R&E expenditures are not reasonably expected 
to produce any current income in the taxable year in which the 
expenditures are incurred, and the regulations recognize that the 
results of R&E expenditures are speculative. Instead, Sec.  1.861-17 
relies on the use of current year sales as a proxy for the income that 
the expenses are reasonably expected to produce in the future, in 
recognition of the fact that it is difficult to ascertain the 
composition of future income that would be generated from R&E 
expenditures. This approach generally already takes into account the 
types of market or legal restrictions described by the comment--to the 
extent that a taxpayer's sales of products in the same SIC code 
category are generally restricted to a particular market, these 
restrictions will be reflected in its sales and therefore are already 
taken into account under the sales method provided in proposed Sec.  
1.861-17. Moreover, rules that specially allocate particular R&E 
expenditures based on the reasonableness of speculative expectations 
about sales that may or may not actually arise several years in the 
future would be very difficult for taxpayers to comply with and for the 
IRS to administer.
    Finally, allowing taxpayers to elect the use of a books-and-records 
method to allocate R&E expenditures to less than all of a taxpayer's 
GII would lead to inappropriate results, as taxpayers would only elect 
such option if the additional information reflected in the taxpayer's 
books and records improved the tax result; in contrast, the IRS would 
not have any such information available to it if the taxpayer chose not 
to make the election. Since this information would generally be in the 
form of predictions about future income streams, an elective books-and-
records rule would create administrability concerns for the IRS, which 
would have substantial difficulty verifying whether the predictions 
were reasonable. Accordingly, the comments are not adopted.
    One comment recommended that the Treasury Department and the IRS 
reconsider the elimination of the ``legally mandated R&E'' rule from 
the 2019 FTC proposed regulations, noting that the rule seemed to be 
required by section 864(g)(1)(A). As explained in the preamble to the 
2019 FTC proposed regulations, the legally mandated R&E rule was 
eliminated in light of changes to the international business 
environment and to simplify the regulations, and the comment does not 
argue the change is inappropriate. Additionally, the comment misstates 
the application of section 864(g)(1)(A), which is not applicable to the 
taxable years to which the final regulations apply. See section 
864(g)(6). Accordingly, the comment is not adopted.
    One comment sought clarification on the allocation of R&E 
expenditures where research is conducted with respect to more than one 
SIC code category. The comment noted that the current final regulations 
at Sec.  1.861-17(a)(2)(iii) mention two digit SIC code categories, or 
Major Groups in the terminology of the SIC Manual, yet the 2019 FTC 
proposed regulations omitted references to two digit SIC codes.
    The Treasury Department and the IRS have determined that it is 
appropriate to aggregate some or all three digit SIC categories within 
the same Major Group, but it is inappropriate to aggregate any three 
digit SIC categories within different Major Groups. While R&E 
expenditures are speculative, it is not reasonable to expect R&E 
conducted for one broad line of business to benefit an unrelated line 
of business and, therefore, the allocation and apportionment of 
expenses should not be determined by aggregating different Major 
Groups. For example, if a taxpayer engages in both the manufacturing 
and assembling of cars and trucks (SIC code 371) it may aggregate that 
category with another three digit category in Major Group 37, which 
includes six other three digit categories (for example, aircraft and 
parts (SIC code 372) or railroad equipment (SIC code 374)), but 
taxpayers may not aggregate a three digit SIC code from a Major Group 
with another three digit SIC code from a different Major Group, except 
as provided in Sec.  1.861-17(b)(3)(iv) (requiring aggregation of R&E 
expenditures related to sales-related activities with the most closely 
related three digit SIC code, other than those within the wholesale and 
retail trade divisions, if the taxpayer conducts material non-sales-
related activities with respect to a particular SIC code). The final 
regulations are modified accordingly.
3. Exclusive Apportionment of R&E Expenditures
i. Computation of FDII
    Several comments argued that if the Treasury Department and the IRS 
determine that GII should include amounts giving rise to FDII, then the 
rule in the 2019 FTC proposed regulations in Sec.  1.861-17(c), which 
limits exclusive apportionment of R&E expenditures solely for purposes 
of applying section 904 as the operative section, should be revised to 
also allow for exclusive apportionment for purposes of calculating a 
taxpayer's FDII deduction. The comments generally argued that the 
exclusive apportionment provision be applied such that 50 percent of a 
taxpayer's R&E expenditures should be apportioned to income that is not 
foreign derived deduction eligible income (``FDDEI'') provided that at 
least 50 percent of the taxpayer's research activities are conducted in 
the United States. Comments argued that such an exclusive apportionment 
rule would encourage R&E activity in the United States, consistent with 
the general intent of the TCJA to eliminate tax incentives for shifting 
activity and intellectual property overseas. Additionally, comments 
asserted that R&E expenditures provide greater value to the location 
where R&E is performed and that there is a technology ``lag''

[[Page 72008]]

before successful products are exported to foreign markets.
    The Treasury Department and the IRS have determined that it is not 
appropriate to apply an exclusive apportionment rule for purposes of 
computing FDII. As discussed in Part II.D.1 of this Summary of Comments 
and Explanation of Revisions, R&E expenditures are not reasonably 
expected to produce any current income in the taxable year in which the 
expenditures are incurred, and the regulations explicitly recognize 
that the results of R&E expenditures are speculative. Furthermore, to 
the extent there is consistently a ``lag'' before a taxpayer's 
successful products are exported to foreign markets, then such lag 
should generally be reflected in current year sales of newly successful 
products (which relate to R&E incurred in prior taxable years) being 
weighted towards domestic markets. Therefore, the rules' use of current 
year sales as a proxy for the income that the expense is reasonably 
expected to produce in the future already takes into account to some 
extent the potential for a ``lag'' between exploiting intangible 
property in the domestic market versus foreign markets.
    In addition, the Treasury Department and the IRS have determined 
that nothing in the text of the TCJA or its legislative history 
suggests that Congress intended that existing rules on allocation and 
apportionment of R&E expenditures be modified in a way to create 
particular incentives. Section 250(b)(3) requires determining the 
deductions that are ``properly allocable'' to deduction eligible 
income, and Sec.  1.250(b)-1(d)(2) confirms that the general rules 
under Sec.  1.861-17 apply for purposes of allocating and apportioning 
R&E expenditures to deduction eligible income and FDDEI. Nothing in the 
statute or legislative history suggests that any alternative allocation 
and apportionment rule should apply. Furthermore, adopting an R&E 
allocation and apportionment rule solely for purposes of increasing the 
amount of the FDII deduction to incentivize R&E activity (whether or 
not such expenditures were ``properly'' allocable to non-FDDEI income) 
would be inconsistent with the United States' position, including as 
stated in forums such as the OECD's Forum on Harmful Tax Practices, 
that the FDII regime is not intended to provide a tax inducement to 
shifting activities or income, but is intended to neutralize the effect 
of providing a lower U.S. effective tax rate with respect to the active 
earnings of a CFC of a domestic corporation (through a deduction for 
GILTI) by also providing a lower effective U.S. tax rate with respect 
to FDII earned directly by the domestic corporation. Such parity is 
generally furthered by ensuring that R&E expenditures incurred by a 
domestic corporation are allocated and apportioned to FDII in the same 
manner as R&E expenditures incurred by a CFC are allocated and 
apportioned to tested income that gives rise to GILTI.
    Therefore, the final regulations provide that the exclusive 
apportionment rule is limited to section 904 as the operative section.
ii. Increased Exclusive Apportionment
    Two comments recommended reinstating the rule allowing for an 
increased exclusive apportionment of R&E expenditures. Under the 
increased exclusive apportionment rule, a taxpayer may establish to the 
satisfaction of the Commissioner that an even greater amount of R&E 
expenditures should be exclusively apportioned. One comment indicated 
that there may be circumstances where an even greater amount of R&E 
expenditures should be apportioned, such as following the termination 
of a cost sharing arrangement (``CSA''). Another comment pointed out 
that the 2019 FTC proposed regulations reduce taxpayer options by 
eliminating both increased exclusive apportionment and the gross income 
method.
    The Treasury Department and the IRS have determined that a rule 
allowing for increased exclusive apportionment is not warranted. The 
facts and circumstances nature of the determination that would be 
required and the potential for disputes outweigh the benefits of 
affording taxpayers additional flexibility in rare or unusual cases. 
Additionally, to the extent that there is a tendency to exploit 
intellectual property in the same market where the taxpayer conducts 
R&E, this will already be reflected in current sales, as those in part 
reflect the results of recently-developed intellectual property. 
Accordingly, this comment is not adopted.
iii. Mandatory Application of Exclusive Apportionment
    Two comments generally objected to the required application of 
exclusive apportionment for purposes of section 904. According to the 
comments, in certain situations where a taxpayer has insufficient 
domestic source gross income to absorb the apportioned R&E 
expenditures, the resulting overall domestic loss (``ODL'') would 
reduce foreign source income in each separate category described in 
Sec.  1.904-5(a)(4)(v), including the section 951A and foreign branch 
categories, reducing the taxpayer's ability to claim foreign tax 
credits. The comments recommended that taxpayers either be allowed to 
elect out of exclusive apportionment or alternatively that it be 
applied in an amount less than 50 percent of the taxpayer's R&E 
expenditures. One comment alternatively recommended a modification to 
the ODL and R&E expenditure rules such that the majority of the amounts 
otherwise subjected to exclusive apportionment would instead be 
allocated to income in the general category rather than the section 
951A or foreign branch categories.
    The TCJA did not modify the operation of section 904(f) or (g) with 
respect to the section 951A or foreign branch categories, nor is there 
any indication in the TCJA or legislative history that Congress 
intended the rules under section 904(f) and (g), or the allocation and 
apportionment rules under section 861, to apply differently in 
connection with section 951A or foreign branch category income. To the 
extent an ODL account is created as the result of a domestic loss 
offsetting foreign source income in the section 951A or foreign branch 
category under section 904(f)(5)(D), this reduction is reversed in 
later years through the recapture provisions in section 904(g)(3), when 
U.S. source income is recharacterized as foreign source income in the 
separate categories that were offset by the ODL. Additionally, the 
Treasury Department and the IRS have determined that the consistent 
application of the exclusive apportionment rule for purposes of section 
904 promotes simplicity and certainty, whereas an optional rule would 
be more difficult to administer. Accordingly, these comments are not 
adopted.
4. Elimination of the Gross Income Method
    Several comments requested that the gross income method for 
apportioning R&E expenditures be retained. In general, these comments 
recommended allowing taxpayers to choose either the gross income method 
or the sales method rather than being required to utilize only the 
sales method, including by allowing taxpayers to choose one method for 
certain operative sections and another method for other operative 
sections. Some comments asserted that the mandatory use of the sales 
method would inappropriately allocate and apportion more R&E 
expenditures to FDDEI than under the gross income method in cases where 
U.S. taxpayers license their intellectual property for foreign use but 
sell products directly to

[[Page 72009]]

U.S. customers. One comment argued that the sales method could be 
distortive in certain situations where a taxpayer licenses its 
intellectual property to entities whose sales are at least partially 
attributable to self-developed intellectual property. Another comment 
argued that where a taxpayer's primary type of GII is royalty income, 
it will be difficult to apportion R&E based on sales numbers and that 
therefore the gross income method should be maintained.
    The Treasury Department and the IRS have determined that, on 
balance, the sales method results in substantially fewer distortions 
than the gross income method. Before being modified by these final 
regulations, taxpayers were permitted to apportion R&E expenditures 
under either a gross income or sales method. The Explanation of 
Provisions in the 2019 FTC proposed regulations explained that the 
gross income method could produce inappropriate, distortive results in 
certain cases. In particular, distortions could arise because the gross 
income method looks only to gross income earned directly by the 
taxpayer. Gross income that is earned by the taxpayer and that is 
attributable to one grouping (such as U.S. source income) may reflect 
value unrelated to intangible property, for example gross income from 
sales that reflect value from marketing or distribution activities of 
the taxpayer, whereas gross income of such taxpayer that is 
attributable to another grouping (such as foreign source income) may 
exclude such non-IP related value due, for example, to the fact that 
such gross income is earned solely from licensing intangible property 
to a related party without the performance of any marketing or 
distribution activities. The distortions arise both because gross 
income reflects a reduction of gross receipts for cost of goods sold 
but not for related deductible expenses, and also because the gross 
income method does not distinguish between gross income earned from 
customers (for which the gross income generally captures all of the 
value related to the product or service arising from the IP) versus 
from related parties (for which gross income generally only captures an 
intermediate portion of the value of the relevant product or service, 
which will generally be enhanced by the related party).
    In contrast, the sales method provides a consistent, reliable 
method with fewer distortions than the gross income method. In 
particular, the sales method focuses on the gross receipts from sales 
of a product to final customers. This approach is more likely to 
achieve consistent results in the case of the same or similar final 
products, and thereby allows for a consistent comparison of value 
derived from intangible property with respect to each grouping. That is 
the case regardless of whether the taxpayer chooses to license its 
intangible property to other persons (including related parties) for 
purposes of manufacturing final products, or the taxpayer manufactures 
products itself, and regardless of whether other persons enhance the 
product with additional value attributable to other intangible 
property. Therefore, the sales method ensures that differences in 
supply chain structures do not alter the nature of how R&E expenditures 
are allocated and apportioned.
    Alternatively, some comments recommended modifying the gross income 
method. One comment recommended modifying the gross income method to 
more accurately match income to related R&E expenditures by using only 
gross income that is attributable to the intangible property owned by 
the taxpayer. However, the Treasury Department and the IRS have 
determined that it would lead to complexity for taxpayers and 
administrative burdens for the IRS to seek to accurately determine the 
share of gross income that is attributable to intangible property when 
the intangible property is embedded in a final product. In addition, 
such a rule would be unlikely to result in significantly different 
results than under the sales method, because the ratio of gross income 
among groupings that is attributable solely to intangible property is 
likely to be broadly similar to the ratio of gross receipts from sales 
within those groupings, since the intangible component of gross income 
from sales is likely to be determined as a fraction of gross receipts, 
and such fraction would generally be the same for each grouping.
    One comment argued that the gross income method must be included in 
the final regulations because it is statutorily required under section 
864(g)(1). However, section 864(g) is not applicable to the taxable 
years covered by the final regulations. See section 864(g)(6). 
Therefore, the comment is not adopted.
    Finally, one comment recommended allowing taxpayers to use the 
gross income method if using the sales method would otherwise cause the 
taxpayer to have an ODL. The Treasury Department and the IRS have 
determined that it would be inappropriate to allow for the targeted 
application of a method solely for the purpose of avoiding the ODL 
rules, which are statutorily mandated. The regulations under section 
861, including Sec.  1.861-17, are premised on associating deductions 
in as accurate and reasonable a manner as possible with the income to 
which such deductions relate. It is inconsistent with this overall 
policy of relating deductions to the relevant income to revise the 
regulations under section 861 simply to achieve a specific result under 
an operative section. Accordingly, the final regulations eliminate the 
gross income method.
5. Application of Sales Method
    The 2019 FTC proposed regulations retained the rule in the prior 
final regulations which provides that for apportionment purposes, the 
sales method includes certain gross receipts of related and unrelated 
entities that are reasonably expected to benefit from the taxpayer's 
R&E expenditures, but does not include the receipts of entities that 
have entered into a valid CSA with the taxpayer. The 2019 FTC proposed 
regulations made limited changes to the sales method as it existed 
under the prior final regulations.
    One comment requested guidance on the application of the sales 
method in the context of foreign branch category income; this comment 
is discussed in Part II.D.6 of this Summary of Comments and Explanation 
of Revisions.
    Two comments asked for a modification to the treatment of 
controlled entities that terminate an existing CSA with a taxpayer. 
Under the sales method, gross receipts from sales of products or the 
provision of services within a relevant SIC code category by controlled 
parties of the taxpayer are taken into account when apportioning the 
taxpayer's R&E expenditures if the controlled party is reasonably 
expected to benefit from the taxpayer's research and experimentation. 
Under proposed Sec.  1.861-17(d)(4)(iv), the sales of controlled 
parties that enter into a valid CSA with a taxpayer are generally 
excluded from the apportionment formula because the controlled party is 
not expected to benefit from the taxpayer's R&E expenditures. The 
comments argued that when a CSA is terminated and a taxpayer licenses 
newly-developed intangibles to a controlled party, all gross receipts 
from the controlled party are included in the apportionment formula, 
even though for some post-termination period the controlled party may 
benefit more from intangibles created by its own R&E expenditures 
incurred under the previously-existing CSA rather than from the newly-
developed and licensed

[[Page 72010]]

intangibles. The comments recommended varying adjustments, including 
rules specific to CSA terminations or alternatively more generalized 
adjustments such as the retention of the increased exclusive 
apportionment rule or the gross income method.
    The Treasury Department and the IRS disagree with the comments' 
characterization of Sec.  1.861-17 as seeking directly to match R&E 
expenditures with the income that such expenditures generate. According 
to the comments, following a CSA termination with a controlled party, a 
taxpayer's current R&E expenditures should not offset the controlled 
party's royalty payment to the taxpayer because the controlled party's 
gross receipts would be attributable to the intangibles funded by the 
controlled party during the period the CSA existed. This assertion 
assumes that current sales are used to apportion R&E expenditures 
because they result from a taxpayer's current or recent research and, 
therefore, it is inappropriate to include gross receipts attributable 
to the research of a different taxpayer. The regulations, however, are 
based in part on the acknowledgement that R&E is a speculative, 
forward-looking activity that often does not result in income or sales 
in the current year, or even in future years. As discussed in Part 
II.D.2 of this Summary of Comments and Explanation of Revisions, 
current sales are nevertheless used because they generally will be the 
best available proxy for the income R&E expenditures are expected to 
produce in future years. Accordingly, once a CSA is terminated, it is 
appropriate to include the sales of a controlled party that previously 
participated in a CSA if that controlled party is reasonably expected 
to benefit from the taxpayer's current R&E expenditures to generate 
future sales. Additionally, the Treasury Department and the IRS have 
determined that attempting to distinguish between the sales 
attributable to the controlled party's intangible property and those 
attributable to intangible property licensed from the taxpayer is 
generally difficult and uncertain and may often lead to disputes, 
making such a rule difficult for taxpayers to comply with and 
burdensome for the IRS to administer. Because those concerns also exist 
when a taxpayer and a controlled party enter into a CSA, the final 
regulations also do not adopt comments requesting such a rule in that 
context. Furthermore, the Treasury Department and the IRS have 
determined that the tax consequences of terminating a CSA may vary 
depending on the facts and circumstances and are considering whether it 
would be appropriate to provide special rules for these transactions, 
and thus it would not be appropriate to provide special rules in 
connection with Sec.  1.861-17 until these transactions have undergone 
further study. Therefore, the comments are not adopted.
    Finally, several comments requested a modification to the rule in 
proposed Sec.  1.861-17(d)(3) and (4) providing that if a taxpayer has 
previously licensed, sold, or transferred intangible property related 
to a SIC code category to a controlled or uncontrolled party, then the 
taxpayer is presumed to expect to do so with respect to all future 
intangible property related to the same SIC code category. The comments 
argued that the 2019 FTC proposed regulations' use of the term 
``presumption'' suggested that taxpayers would be unable to rebut the 
presumption in appropriate cases. In response to the comments, the 
final regulations clarify that taxpayers may rebut the presumption by 
demonstrating that prior exploitation of the taxpayer's intangible 
property is inconsistent with reasonable future expectations.
    In addition, the final regulations make other revisions to the 
sales method. First, the final regulations specify under what 
circumstances the sales or services of uncontrolled or controlled 
parties are taken into account. In particular, the final regulations 
specify that the gross receipts are taken into account if the 
uncontrolled or controlled party is expected to acquire (through 
license, sale, or transfer) intangible property arising from the 
taxpayer's current R&E expenditures, products in which such intangible 
property is embedded or used in connection with the manufacture or sale 
of such products, or services that incorporate or benefit from such 
intangible property. Second, the final regulations revise Sec.  1.861-
17(d)(4) to refer to sales by controlled parties (which is defined as 
any person that is related to the taxpayer)), rather than controlled 
corporations, to clarify that, for example, sales made by a controlled 
partnership that is reasonably expected to license intangible property 
from the taxpayer are fully taken into account under the sales method. 
Finally, the final regulations revise Sec.  1.861-17(f)(3) to provide 
that if a partnership incurs R&E expenditures (and is not also an 
uncontrolled party or controlled party described in Sec.  1.861-
17(d)(3) or (4)) and makes related sales, then those sales are 
considered made by the partners in proportion to their distributive 
shares of gross income attributable to the sales.
6. Foreign Branch Category Income and R&E Expenditures
    Two comments addressed the interaction of Sec.  1.861-17 and 
foreign branch category income. One comment requested that a portion of 
sales earned by a foreign branch should be attributed to the general 
category for purposes of apportioning R&E expenditures in circumstances 
where a foreign branch utilizes intellectual property of the foreign 
branch owner to earn GII and pays a disregarded royalty to its U.S. 
owner. Under Sec.  1.904-4(f)(2)(vi)(A), the amount of foreign branch 
category income would be adjusted downward and the foreign branch 
owner's general category income would be adjusted upward by the amount 
of the disregarded royalty. According to the comment, after exclusive 
apportionment (as applicable), the 2019 FTC proposed regulations would 
apportion entirely to foreign branch category income the remaining R&E 
expense, which should instead be apportioned to the general category 
income originally attributable to the GII of the foreign branch that 
was reassigned by reason of the disregarded royalty.
    The Treasury Department and the IRS have determined that the 2019 
FTC proposed regulations, in combination with Sec.  1.904-4(f)(2)(vi), 
already operate in the manner requested by the comment. Under proposed 
Sec.  1.861-17(d)(1)(iii), gross receipts are assigned to the statutory 
grouping (or groupings) or residual grouping to which the GII related 
to the sale, lease, or service is assigned. Adjustments to the amounts 
of gross income attributable to a foreign branch by reason of 
disregarded payments change the separate category grouping to which the 
gross income is assigned, but do not change the total amount, 
character, or source of a United States person's gross income. See 
Sec.  1.904-4(f)(2)(vi)(A). After application of Sec.  1.904-
4(f)(2)(vi), GII related to the foreign branch's sales is assigned to 
the general category in the amount of the disregarded royalty payment, 
and only the balance of the GII is assigned to the foreign branch 
category. Accordingly, a proportionate amount of the gross receipts 
from sales made by the foreign branch to which a disregarded royalty 
payment would be allocable is assigned to the general and foreign 
branch categories in the same ratio as the disregarded royalty payment 
bears to the gross income attributable to the sales. The final 
regulations in Sec.  1.861-17(d)(1)(iii) clarify that the assignment of 
gross receipts occurs after gross income in the separate categories is 
adjusted under Sec.  1.904-4(f)(2)(vi) and

[[Page 72011]]

clarify through an example the formula used to reassign gross receipts 
as a result of a disregarded reallocation transaction. See Sec.  1.861-
17(g)(6) (Example 6).
    The second comment requested changes to the treatment of foreign 
branches that provide contract R&E services for the benefit of the 
foreign branch owner. According to the comment, when disregarded 
payments made by the foreign branch owner in respect of the provision 
of contract R&E services by a foreign branch cause GII to be 
reallocated to the foreign branch, R&E expenditures incurred by the 
foreign branch owner may be apportioned to foreign branch category 
income in a manner inconsistent with the economics of the branch's 
activities as a services provider, creating disparate tax results 
compared to those that would obtain if the services were performed by a 
CFC. The comment suggested that the foreign branch's regarded costs of 
providing the research services that give rise to the disregarded 
payment from the foreign branch owner should reduce the amount of GII 
that was assigned to the foreign branch category, or more generally 
that GII should not be assigned to the foreign branch category by 
reason of disregarded payments for research services.
    The Treasury Department and the IRS agree that R&E expenditures, 
including deductible expenses for the foreign branch's costs in 
providing research services to the foreign branch owner, may be 
apportioned to foreign branch category income that is GII, including 
GII that is treated as attributable to the foreign branch category 
under Sec.  1.904-4(f)(2)(vi) by reason of disregarded payments from 
the foreign branch owner compensating the foreign branch for its 
research services that will generate GII for the foreign branch owner, 
and that the apportionment is based upon gross receipts assigned to the 
statutory groupings. However, as noted in Sec.  1.904-4(f)(2)(vi)(A), 
the reattribution of gross income between the general and foreign 
branch categories by reason of disregarded payments cannot change the 
character of a taxpayer's realized gross income. The Treasury 
Department and the IRS have determined that the different 
characterization of services income earned by a CFC, which may not be 
GII, and sales income reflecting GII that is attributed to a foreign 
branch by reason of disregarded payments for services, results from the 
Federal income tax treatment of disregarded payments, which do not give 
rise to gross income, and that it is not appropriate effectively to 
override the characterization of gross income by modifying the rules 
for allocating and apportioning recognized R&E expenditures. 
Accordingly, the comment is not adopted.
7. Contract Research Arrangements
    In the Explanation of Provisions in the 2019 FTC proposed 
regulations, the Treasury Department and the IRS requested comments on 
whether contract research arrangements involving expenditures that are 
reimbursed by a foreign affiliate are generally paid or incurred by a 
U.S. taxpayer such that a deduction under section 174 would be 
allowable for such expenditures, and whether any special rules for such 
arrangements should be considered. Generally, the comments received 
stated that where contract research is performed in the United States 
and is connected with a U.S.-based multinational's trade or business, a 
deduction under section 174, rather than section 162, may be 
appropriate.
    The Treasury Department and the IRS have determined that it is 
beyond the scope of the final regulations to determine whether contract 
research expenses are, or are not, eligible to be deducted under either 
section 162 or 174.
8. Amended Returns and Applicability Dates
    One comment requested clarification of the applicability date 
provisions of the Sec.  1.861-17 portion of the 2019 FTC proposed 
regulations. The comment noted that it was unclear whether a taxpayer 
that originally elected to apply the gross income method on its 2018 
tax return would be eligible to amend its 2018 tax return to apply the 
sales method. The 2019 FTC final regulations included a provision 
addressing the binding election contained in former Sec.  1.861-
17(e)(1). Under this provision, as modified in the 2019 FTC final 
regulations at Sec.  1.861-17(e)(3), taxpayers otherwise subject to the 
binding election were permitted to change their election. On May 15, 
2020, correcting amendments to the 2019 FTC final regulations were 
issued in 85 FR 29323. These amendments make clear that the change in 
method can occur on an original or an amended return. See also Part VII 
of this Summary of Comments and Explanation of Revisions for a 
discussion of the ability for taxpayers to rely on the proposed or 
final versions of Sec.  1.861-17 for taxable years before the years in 
which the final regulations are applicable. Accordingly, changes to the 
applicability date provisions are not necessary in response to this 
comment.
    Finally, one comment requested that the applicability of the 
regulations under section 250 be deferred until after Sec.  1.861-17 is 
finalized. Because the applicability of the regulations under section 
250 has been deferred until taxable years beginning on or after January 
1, 2021, which is consistent with the applicability date of Sec.  
1.861-17, the comment is moot. See Sec.  1.250-1(b).

E. Application of Section 904(b) to Net Operating Losses

    Proposed Sec.  1.904(b)-3(d)(2) contained a coordination rule 
providing that for purposes of determining the source and separate 
category of a net operating loss, the separate limitation loss and 
overall foreign loss rules of section 904(f) and the overall domestic 
loss rules of section 904(g) are applied without taking into account 
the adjustments required under section 904(b). No comments were 
received on this provision, which is finalized without change.
    One comment requested that the final regulations include a rule 
switching off the application of section 904(b)(4) with respect to pre-
2018 U.S. source NOLs that offset foreign source income and created ODL 
accounts in pre-2018 taxable years, because in certain cases the 
increase in the denominator of the foreign tax credit limitation 
fraction required by section 904(b)(4) could limit the utilization of 
foreign tax credits that would otherwise be allowed by reason of the 
recapture of the ODL.
    Nothing in section 904(b)(4) allows for the rule to be applied 
differently in cases when a taxpayer recaptures a pre-2018 ODL versus a 
post-2017 ODL or has no ODL recapture at all. Instead, the adjustments 
required by section 904(b)(4) apply in all taxable years beginning 
after 2017. Therefore, the comment is not adopted.

III. Conduit Financing Rules Under Sec.  1.881-3 To Address Hybrid 
Instruments

A. Overview

    The conduit financing regulations in Sec.  1.881-3 allow the IRS to 
disregard the participation of one or more intermediate entities in a 
``financing arrangement'' where such entities are acting as conduit 
entities, and to recharacterize the financing arrangement as a 
transaction directly between the remaining parties for purposes of 
imposing tax under sections 871, 881, 1441 and 1442. In general, a 
financing arrangement exists when through a series of transactions one 
person advances money or other property (the financing entity), another

[[Page 72012]]

person receives money or other property (the financed entity), the 
advance and receipt are effected through one or more other persons 
(intermediate entities), and there are ``financing transactions'' 
linking each of those parties. See Sec.  1.881-3(a)(2)(i). An 
instrument that for U.S. tax purposes is stock (or a similar interest, 
such as an interest in a partnership) is not a financing transaction 
under the existing conduit financing regulations, unless it is 
``redeemable equity'' or is otherwise described in Sec.  1.881-
3(a)(2)(ii)(B)(1).
    The 2020 hybrids proposed regulations expanded the definition of a 
financing transaction, such that an instrument that for U.S. tax 
purposes is stock or a similar interest is a financing transaction if: 
(i) Under the tax law of a foreign country where the issuer is a tax 
resident or has a taxable presence, such as a permanent establishment, 
the issuer is allowed a deduction or another tax benefit, including a 
deduction with respect to equity, for an amount paid, accrued, or 
distributed with respect to the instrument; or (ii) under the issuer's 
tax laws, a person related to the issuer is entitled to a refund, 
including a credit, or similar tax benefit for taxes paid by the issuer 
upon a payment, accrual, or distribution with respect to the equity 
interest and without regard to the related person's tax liability in 
the issuer's jurisdiction. See proposed Sec.  1.881-
3(a)(2)(ii)(B)(1)(iv) and (v). The 2020 hybrids proposed regulations 
relating to conduit financing arrangements were proposed to apply to 
payments made on or after the date that final regulations are published 
in the Federal Register.

B. Scope of Instruments Treated as Financing Transactions

    A comment agreed that a financing transaction should include an 
instrument that is stock or a similar interest for U.S. tax purposes 
but debt under the tax law of the issuer's country because, according 
to the comment, cases of potential conduit abuse are likely to involve 
``classic'' hybrid instruments not covered by the types of equity 
described in Sec.  1.881-3(a)(2)(ii)(B)(1). However, the comment 
recommended that an instrument that is equity for purposes of both U.S. 
tax law and the issuer's tax law not be treated as a financing 
transaction, except in limited circumstances, such as if the instrument 
is issued by a special purpose company formed to facilitate the 
avoidance of tax under section 881 and the instrument gives rise to a 
notional deduction or a refund or credit to a related person. According 
to the comment, the proposed rule that treated an instrument that is 
equity for both U.S. and foreign tax purposes as a financing 
transaction was overbroad--as it could deem an operating company to 
have entered into a financing transaction simply because foreign tax 
law provides for notional interest deductions or a similar regime of 
general applicability--or was unclear or vague in certain cases.
    If the final regulations were to retain the proposed rules treating 
other types of equity instruments as financing transactions, the 
comment requested several clarifications, modifications, and 
limitations with respect to the rules. These included: (i) Treating an 
instrument that is equity in a partnership for U.S. tax purposes and 
under the issuer's tax law as a financing transaction only if the 
partnership is a hybrid entity that claims treaty benefits; (ii) either 
eliminating or clarifying the rule providing that an instrument can be 
a financing transaction by reason of generating tax benefits in a 
jurisdiction where the issuer has a permanent establishment; and (iii) 
modifying the applicability date for payments under existing financing 
arrangements.
    Consistent with the comment, the final regulations adopt without 
substantive change the rule that included as a financing transaction an 
instrument that is stock or a similar interest (including an interest 
in a partnership) for U.S. tax purposes but debt under the tax law of 
the country of which the issuer is a tax resident. See Sec.  1.881-
3(a)(2)(ii)(B)(1)(iv). In addition, the final regulations provide that 
if the issuer is not a tax resident of any country, such as an entity 
treated as a partnership under foreign tax law, the instrument is a 
financing transaction if the instrument is debt under the tax law of 
the country where the issuer is created, organized, or otherwise 
established. See id.
    The final regulations do not include the rules under the 2020 
hybrids proposed regulations that treated as a financing transaction an 
instrument that is stock or a similar interest for U.S. tax purposes 
but gives rise to notional interest deductions or other tax benefits 
(such as a deduction or credit allowed to a related person) under 
foreign tax law. The Treasury Department and the IRS plan to finalize 
those rules separately, in order to allow additional time to consider 
the comments received. In addition, the Treasury Department and the IRS 
are continuing to study instruments that generate tax benefits in the 
jurisdiction where the issuer has a permanent establishment and may 
address these instruments in future guidance.

IV. Foreign Tax Credit Limitation Under Section 904

A. Definition of Financial Services Entity

    In order to promote simplification and greater consistency with 
other Code provisions that have complementary policy objectives, Sec.  
1.904-4(e)(2) of the 2019 FTC proposed regulations proposed to define a 
financial services entity as an individual or a corporation 
``predominantly engaged in the active conduct of a banking, insurance, 
financing, or similar business,'' and proposed to define financial 
services income as ``income derived in the active conduct of a banking, 
insurance, financing, or similar business.'' These modified definitions 
are generally consistent with sections 954(h), 1297(b)(2)(B), and 
953(e); the 2019 FTC proposed regulations also included conforming 
changes to the rules for affiliated groups in proposed Sec.  1.904-
4(e)(2)(ii) and partnerships in proposed Sec.  1.904-4(e)(2)(i)(C).
    Comments stated that the 2019 FTC proposed regulations increased 
uncertainty and resulted in the disqualification of certain banks or 
insurance companies that would qualify as financial services entities 
under the existing final regulations. Comments also suggested that it 
was inappropriate to seek to align the relevant definitions in section 
904 with those in section 954 because of the differing policies and 
scope of the two rules. Comments suggested various modifications to 
more closely align the revisions with the existing approach under Sec.  
1.904-4(e), or in the alternative, withdrawing the proposed rules 
entirely.
    The Treasury Department and the IRS have determined that revisions 
to the financial services entity rules in Sec.  1.904-4(e) continue to 
be necessary in light of statutory changes made in 2004 (under the 
American Jobs Creation Act of 2004, Pub. L. 108-357) and the changes to 
the look-through rules in Sec.  1.904-5 in the 2019 FTC final 
regulations, which were precipitated by the revisions to section 904(d) 
under the TCJA. However, the Treasury Department and the IRS have 
determined the changes to Sec.  1.904-4(e) should be reproposed to 
allow further opportunity for comment. Therefore, the 2020 FTC proposed 
regulations contain new proposed regulations under Sec.  1.904-4(e), as 
well as a delayed applicability date. See Part IX.B. of the Explanation 
of Provisions in the 2020 FTC proposed regulations.

[[Page 72013]]

B. Allocation and Apportionment of Foreign Income Taxes

    Proposed Sec.  1.861-20 provided detailed guidance on how to match 
foreign income taxes with income, particularly in the case of 
differences in how U.S. and foreign law compute taxable income with 
respect to the same transactions. Proposed Sec.  1.861-20(c) provided 
that foreign tax expense is allocated and apportioned among the 
statutory and residual groupings by first assigning the items of gross 
income under foreign law (``foreign gross income'') on which a foreign 
tax is imposed to a grouping, then allocating and apportioning 
deductions under foreign law to that income, and finally allocating and 
apportioning the foreign tax among the groupings. See proposed Sec.  
1.861-20(c).
    Proposed Sec.  1.861-20(d)(2)(ii)(B) provided that if a taxpayer 
recognizes an item of foreign gross income that is attributable to a 
base difference, then the item of foreign gross income is assigned to 
the residual grouping, with the result that no credit is allowed if the 
tax on that item is paid by a CFC. The proposed regulations provided an 
exclusive list of items that are excluded from U.S. gross income and 
that, if taxable under foreign law, are treated as base differences.
    Several comments requested that distributions described in sections 
301(c)(2) and 733, representing nontaxable returns of capital, be 
removed from the list of base differences on the grounds that foreign 
tax on such distributions is more likely to result from timing 
differences. Some comments argued that the foreign law characterization 
of the distribution should govern the determination of the income group 
to which the foreign tax is allocated. Other comments suggested that 
foreign tax on return of capital distributions should be associated 
with passive category capital gains, because by reducing basis such 
distributions may increase the amount of capital gain recognized for 
U.S. tax purposes in the future.
    The purpose of the rules in Sec.  1.861-20, as well as Sec.  1.904-
6, is to allocate and apportion foreign income taxes to groupings of 
income determined under Federal income tax law, and the final 
regulations at Sec.  1.861-20(d)(1), consistent with the approach in 
former Sec.  1.904-6, provide that Federal income tax law applies to 
characterize foreign gross income and assign it to a grouping. 
Characterizing items solely based on foreign law, with no comparison to 
the U.S. tax base, would altogether eliminate base differences, which 
are expressly referenced in section 904(d)(2)(H)(i).
    However, the Treasury Department and the IRS have determined that 
in most cases, a foreign tax imposed on distributions described in 
sections 301(c)(2) and 733 is likely to represent tax on earnings and 
profits of the distributing entity that are accounted for at different 
times under U.S. and foreign tax law, such as earnings of a hybrid 
partnership, earnings that are accelerated and subsequently eliminated 
for U.S. tax purposes by reason of a section 338 election, or earnings 
and profits of lower-tier entities, rather than tax on amounts that are 
permanently excluded from the U.S. tax base. Although in some cases 
involving net basis foreign income taxes imposed at the shareholder 
level, distributions described in sections 301(c)(2) and 733 may 
reflect a timing difference in the recognition of unrealized gain with 
respect to the equity of the distributing entity, the Treasury 
Department and the IRS have determined that these situations are less 
likely to occur than timing differences in the recognition of earnings 
subject to withholding taxes because of the prevalence of foreign 
participation exemption regimes. Moreover, treating the foreign tax on 
distributions as representing a timing difference on earnings and 
profits of the distributing entity is more consistent with the general 
approach in the Code and regulations to the treatment of distributions 
as representing a tax on the earnings (see, for example, sections 
904(d)(3) and (4), and 960(b)) and with treating gain on stock sales as 
related in part to earnings and profits (see section 1248(a)).
    Therefore, these distributions are removed from the list of base 
differences, and the final regulations at Sec.  1.861-
20(d)(3)(ii)(B)(2) generally associate a foreign law dividend that 
gives rise to a return of capital distribution under section 301(c)(2) 
with hypothetical earnings of the distributing corporation, measured 
based on the groupings to which the tax book value of the corporation's 
stock is assigned under the asset method in Sec.  1.861-9. Similar 
rules are included in the 2020 FTC proposed regulations for partnership 
distributions described in section 733.
    The Treasury Department and the IRS have determined that similar 
rules should apply in appropriate cases to associate a portion of 
foreign tax imposed on an item of foreign gross income constituting 
gain recognized on the sale or other disposition of stock in a 
corporation or a partnership interest with amounts that constitute 
nontaxable basis recovery for U.S. tax purposes. Such similar treatment 
is appropriate to minimize differences in the foreign tax credit 
consequences of a sale or a distribution in redemption of the 
taxpayer's interest. Proposed rules on the allocation of foreign income 
tax on such dispositions are included in the 2020 FTC proposed 
regulations.
    Proposed Sec.  1.861-20 addressed the assignment to statutory and 
residual groupings of foreign gross income arising from disregarded 
payments between a foreign branch (as defined in Sec.  1.904-4(f)(3)) 
and its owner. If the foreign gross income item arises from a payment 
made by a foreign branch to its owner, proposed Sec.  1.861-
20(d)(3)(ii)(A) generally assigned the item by deeming the payment to 
be made ratably out of the foreign branch's accumulated after-tax 
income, calculated based on the tax book value of the branch's assets 
in each grouping. If the item of foreign gross income arises from a 
disregarded payment to a foreign branch from its owner, proposed Sec.  
1.861-20(d)(3)(ii)(B) generally assigned the item to the residual 
grouping, with the result that any taxes imposed on the disregarded 
payment would be allocated and apportioned to the residual grouping as 
well. In addition, proposed Sec.  1.904-6(b)(2) included special rules 
assigning foreign gross income items arising from certain disregarded 
payments for purposes of applying section 904 as the operative section.
    Several comments asserted that foreign tax on disregarded payments 
from a foreign branch owner to a foreign branch should not be allocated 
and apportioned to the residual grouping, which results in an effective 
denial of foreign tax credits in the case of a branch of a CFC, because 
items of foreign gross income that arise from disregarded payments of 
items such as interest or royalties should give rise to creditable 
foreign income taxes despite being nontaxable for Federal income tax 
purposes. Some comments recommended adopting a tracing regime similar 
to the rules in Sec.  1.904-4(f) to trace foreign gross income that a 
taxpayer includes by reason of a disregarded payment to current year 
income of the payor for purposes of determining the grouping to which 
tax on the disregarded payment is allocated and apportioned. Comments 
also requested that the final regulations clarify whether the rule for 
remittances or contributions applies in the case of payments between 
two foreign branches.
    The Treasury Department and the IRS generally agree with the 
comments that

[[Page 72014]]

rules similar to the rules in Sec.  1.904-4(f) should apply under Sec.  
1.861-20 to trace foreign gross income that a taxpayer includes by 
reason of a disregarded payment to the current year income of the payor 
to which the disregarded payment would be allocable if regarded for 
U.S. tax purposes. However, in order to provide taxpayers additional 
opportunity to comment, the final regulations reserve on the allocation 
and apportionment of foreign tax on disregarded payments, and new 
proposed rules are contained in the 2020 FTC proposed regulations. See 
Part V.F.4 of the Explanation of Provisions in the 2020 FTC proposed 
regulations. Similarly, the special rules in proposed Sec.  1.904-
6(b)(2) for assigning foreign gross income items arising from certain 
disregarded payments for purposes of applying section 904 as the 
operative section are reproposed in the 2020 FTC proposed regulations. 
The other special rules in proposed Sec.  1.861-20(d)(3) for allocating 
foreign tax in connection with a taxpayer's investment in a corporation 
or a disregarded entity are reorganized, and some of the definitions in 
proposed Sec.  1.861-20(b) are correspondingly revised, in the final 
regulations to group the rules on the basis of how the entity is 
classified, and whether the transaction giving rise to the item of 
foreign gross income results in the recognition of gross income or 
loss, for U.S. tax purposes. The rule in proposed Sec.  1.904-6(b)(3) 
relating to dispositions of property resulting in certain disregarded 
reallocation transactions is removed and reproposed as part of proposed 
Sec.  1.861-20 as contained in the 2020 FTC proposed regulations.
    Finally, one comment requested that Sec. Sec.  1.904-1 and 1.904-6 
clarify that the tax allocation rules apply to taxes paid to United 
States territories, which are generally treated as foreign countries 
for purposes of the foreign tax credit. The final regulations clarify 
this point by including a cross reference to Sec.  1.901-2(g), which 
defines a foreign country to include the territories. See Sec.  1.861-
20(b)(6).

V. Foreign Tax Redeterminations Under Section 905(c) and Penalty 
Provisions Under Section 6689

    Portions of the temporary regulations relating to sections 905(c), 
986(a), and 6689 (TD 9362) (the ``2007 temporary regulations'') were 
reproposed in order to provide taxpayers an additional opportunity to 
comment on those rules in light of the changes made by the TCJA. In 
particular, the rules in the 2007 temporary regulations that were 
reproposed in the 2019 FTC proposed regulations were: (1) Proposed 
Sec.  1.905-3(b)(2), which addressed foreign taxes deemed paid under 
section 960, (2) proposed Sec.  1.905-4, which in general provided the 
procedural rules for how to notify the IRS of a foreign tax 
redetermination, and (3) proposed Sec.  301.6689-1, which provided 
rules for the penalty for failure to notify the IRS of a foreign tax 
redetermination. In addition, the 2019 FTC proposed regulations 
contained a transition rule in proposed Sec. Sec.  1.905-3(b)(2)(iv) 
and 1.905-5 to address foreign tax redeterminations of foreign 
corporations that relate to taxable years that predated the amendments 
made by the TCJA.

A. Adjustments to Foreign Taxes Paid by Foreign Corporations

    One comment requested clarification on whether multiple payments to 
foreign tax authorities under a single assessment (for example, 
payments to stop the running of interest and penalties) each result in 
a foreign tax redetermination under section 905(c).
    Under Sec.  1.905-3(a) of the 2019 FTC final regulations, each 
payment of tax that has accrued in a later year in excess of the amount 
originally accrued results in a separate foreign tax redetermination. 
However, the 2019 FTC proposed regulations at Sec.  1.905-4(b)(1)(iv), 
which is finalized without change, only required one amended return for 
each affected prior year to reflect all foreign tax redeterminations 
that occur in the same taxable year. In the case of payments that are 
made across multiple taxable years, Sec.  1.905-4(b)(1)(iv) of the 
final regulations also provides that, if more than one foreign tax 
redetermination requires a redetermination of U.S. tax liability for 
the same affected year and those redeterminations occur within the same 
taxable year or within two consecutive taxable years, the taxpayer may 
file for the affected year one amended return and one statement under 
Sec.  1.905-4(c) with respect to all of the redeterminations. 
Otherwise, separate amended returns for each affected year are required 
to reflect each foreign tax redetermination. Accordingly, no changes 
are made in response to this comment.
    The comment also requested that the Treasury Department and the IRS 
clarify whether contested taxes that are paid before the contest is 
resolved are considered to accrue for foreign tax credit purposes when 
paid or whether they represent an advance payment against a future 
liability that does not accrue until the final liability is determined. 
Proposed rules addressing this issue are included in the 2020 FTC 
proposed regulations. See Part X.D.3 of the Explanation of Provisions 
in the 2020 FTC proposed regulations.

B. Deductions for Foreign Income Taxes

    One comment requested clarification on whether the general rules 
under section 905(c) apply to taxpayers who elect to take a deduction, 
rather than a credit, for creditable foreign taxes in the prior year to 
which the adjusted taxes relate. Additionally, the comment requested 
that the Treasury Department and the IRS clarify whether the ten-year 
statute of limitations under section 6511(d)(3)(A) applies to refund 
claims based on such deductions.
    In the case of a U.S. taxpayer that directly pays or accrues 
foreign income taxes, no U.S. tax redetermination is required in the 
case of a foreign tax redetermination of such taxes if the taxpayer did 
not claim a foreign tax credit in the taxable year to which such taxes 
relate. See Sec.  1.905-3(b)(1) (a redetermination of U.S. tax 
liability is required with respect to foreign income tax claimed as a 
credit under section 901). However, in the case of a U.S. shareholder 
of a CFC that pays or accrues foreign income tax, proposed Sec.  1.905-
3(b)(2)(i) and (ii), which are finalized without substantive change, 
provided that a redetermination of U.S. tax liability is required to 
account for the effect of a foreign tax redetermination even in 
situations in which the foreign tax credit is not changed, such as for 
purposes of computing earnings and profits or applying the high-tax 
exception described in section 954(b)(4), including in the case of a 
U.S. shareholder that chooses to deduct foreign income taxes rather 
than to claim a foreign tax credit. Additional guidance addressing the 
accrual rules for creditable foreign taxes that are deducted or claimed 
as a credit is included in Sec.  1.461-4(g)(6)(B)(iii) and in the 2020 
FTC proposed regulations.
    The question of whether section 6511(d)(3)(A) applies to refunds 
relating to foreign taxes that are deducted, instead of taken as a 
foreign tax credit, is beyond the scope of this rulemaking. See, 
however, Trusted Media Brands, Inc. v. United States, 899 F.3d 175 (2d. 
Cir. 2018) (holding that section 6511(d)(3)(A) only applies to refund 
claims based on foreign tax credits). In addition, the 2020 FTC 
proposed regulations include proposed amendments to the regulations 
under section 901(a), which provides that an election to claim foreign 
income taxes as a credit for a particular taxable year may be made or 
changed at any time before the expiration of the period prescribed for 
claiming a refund of U.S. tax for that year. See Part X.B.2 of the 
Explanation

[[Page 72015]]

of Provisions in the 2020 FTC proposed regulations.

C. Application to GILTI High-Tax Exclusion

    Proposed Sec.  1.905-3(b)(2)(ii) provided that the required 
adjustments to U.S. tax liability by reason of a foreign tax 
redetermination of a foreign corporation include not only adjustments 
to the amount of foreign taxes deemed paid and related section 78 
dividend, but also adjustments to the foreign corporation's income and 
earnings and profits and the amount of the U.S. shareholder's 
inclusions under sections 951 and 951A in the year to which the 
redetermined foreign tax relates.
    One comment requested that final regulations clarify whether a U.S. 
tax redetermination is required when the foreign tax redetermination 
affects whether the taxpayer is eligible for the GILTI high-tax 
exclusion. Specifically, the comment stated that because a 
redetermination of U.S. tax liability is required when the foreign tax 
redetermination affects whether a taxpayer is eligible for the subpart 
F high-tax election under section 954(b)(4), a similar result should 
apply for taxpayers that make (or seek to make) the GILTI high-tax 
exclusion election, and that taxpayers should be allowed to make the 
election on an annual basis. Further, the comment suggested that if 
taxpayers are allowed to make an annual election under the final GILTI 
high-tax exclusion regulations, then taxpayers should be permitted to 
make or revoke the election on an amended return following a foreign 
tax redetermination.
    Proposed Sec.  1.905-3(b)(2)(ii) provided that the required U.S. 
tax redetermination applies for purposes of determining amounts 
excluded from a CFC's gross tested income under section 
951A(c)(2)(A)(i)(III), and this provision is retained in the final 
regulations with minor modifications. Furthermore, under final 
regulations issued on July 23, 2020 (TD 9902, 85 FR 44620), taxpayers 
may make the GILTI high-tax exclusion election on an annual basis and 
may do so on an amended return filed within 24 months of the unextended 
due date of the original income tax return. See Sec.  1.951A-
2(c)(7)(viii)(A)(1)(i).

D. Foreign Tax Redeterminations of Successor Entities

    Proposed Sec.  1.905-3(b)(3) provided that if at the time of a 
foreign tax redetermination the person with legal liability for the tax 
(the ``successor'') is a different person than the person that had 
legal liability for the tax in the year to which the redetermined tax 
relates (the ``original taxpayer''), the required redetermination of 
U.S. tax liability is made as if the foreign tax redetermination 
occurred in the hands of the original taxpayer. The proposed 
regulations further provided that Federal income tax principles apply 
to determine the tax consequences if the successor remits, or receives 
a refund of, a tax that in the year to which the redetermined tax 
relates was the legal liability of, and thus considered paid by, the 
original taxpayer.
    One comment suggested that proposed Sec.  1.905-3(b)(3), as 
drafted, did not clearly address cases where the ownership of a 
disregarded entity changes. The comment recommended clarifying that in 
the case of a disregarded entity, the owner of the disregarded entity 
is treated as the person with legal liability for the tax or the person 
with the legal right to a refund, as applicable.
    The Treasury Department and the IRS have determined that no 
clarification is necessary. Existing regulations make clear that the 
owner of a disregarded entity is considered to be legally liable for 
the tax. See Sec.  1.901-2(f)(4)(ii) (legal liability for income taxes 
imposed on a disregarded entity).
    The same comment stated that the preamble to the proposed 
regulations incorrectly suggested that under U.S. tax principles the 
payment of tax by a successor entity owned by the original taxpayer 
(for example, by a CFC that was formerly a disregarded entity) is 
treated as a distribution. The comment further recommended addressing 
the issue of contingent liabilities in future guidance. The Treasury 
Department and the IRS agree that there may be multiple ways to 
characterize the tax consequences of tax paid by a successor in the 
example described in the preamble to the proposed regulations. 
Furthermore, the Treasury Department and the IRS have determined that 
the issue of contingent foreign tax liabilities in connection with 
foreign tax redeterminations under section 905(c) requires further 
study and may be considered as part of future guidance.

E. Notification to the IRS of Foreign Tax Redeterminations and Related 
Penalty Provisions

1. Notification Through Amended Returns
    In general, proposed Sec.  1.905-4(b)(1)(i) provided that any 
taxpayer for which a redetermination of U.S. tax liability is required 
must notify the IRS of the foreign tax redetermination by filing an 
amended return.
    Several comments suggested that taxpayers should be allowed to 
report adjustments to U.S. tax liability in prior years by reason of 
foreign tax redeterminations on an attachment to their Federal income 
tax return for the taxable year in which the redetermination occurs, 
instead of requiring taxpayers to file amended tax returns for the 
taxable year in which the adjusted foreign tax was claimed as a credit 
and any intervening years in which the foreign tax redetermination 
affected U.S. tax liability. Specifically, comments suggested that 
taxpayers could be allowed to file a statement with their return for 
the taxable year in which the foreign tax redetermination occurs 
notifying the IRS of overpayments or underpayments of U.S. tax and 
applicable interest due for prior taxable years that resulted from the 
foreign tax redetermination. One comment suggested that taxpayers could 
be required to maintain books and records reflecting all the 
adjustments that would normally accompany an amended return, without 
actually being required to prepare and file such a return. Another 
comment suggested that the IRS could amend Schedule E on Form 5471 to 
include this type of information about the changes to prior year U.S. 
tax liabilities that result from foreign tax redeterminations. Comments 
noted that providing an alternative to filing amended Federal income 
tax returns would relieve taxpayers from having to file amended state 
tax returns.
    The Treasury Department and the IRS have determined that, based on 
existing processes, the only manner in which taxpayers can properly 
notify the IRS of a change in U.S. tax liability for a prior taxable 
year that results from a foreign tax redetermination is by filing an 
amended return reflecting all the necessary U.S. tax adjustments. In 
addition, the Treasury Department and the IRS have determined that the 
type of statement suggested by the comments, reflecting a recomputation 
of Federal income tax liability for a prior year, could be viewed by 
state tax authorities as the functional equivalent of an amended 
Federal income tax return that may not necessarily operate to relieve 
taxpayers of their obligations to file amended state tax returns. In 
any event, taxpayer requests for relief from state tax filing 
obligations are properly directed to state tax authorities, rather than 
to the Treasury Department and the IRS. Therefore, the comments are not 
adopted. However, the Treasury Department and the IRS continue to study 
whether new processes or forms can be developed to streamline the

[[Page 72016]]

filing requirements while ensuring that the IRS receives the necessary 
information to verify that taxpayers have made the required adjustments 
to their U.S. tax liability. Under Sec.  1.905-4(b)(3) of the final 
regulations, the IRS may prescribe alternative notification 
requirements through forms, instructions, publications, or other 
guidance.
    Comments also suggested that the notification due date should be 
extended (for example, to up to three years from the due date of the 
original return for the taxable year in which the foreign tax 
redetermination occurred).
    The Treasury Department and the IRS have determined that deferring 
the due date of the required amended returns beyond the due date (with 
extensions) of the return for the year in which the foreign tax 
redetermination occurs would not substantially reduce compliance 
burdens and could be more difficult for the IRS to administer, because 
the same filing obligations would be required, though with respect to 
foreign tax redeterminations that occurred three years earlier rather 
than in the current taxable year. In addition, taxpayers have an 
economic incentive to promptly file amended returns claiming a refund 
of U.S. tax in cases where a foreign tax redetermination reduces, 
rather than increases, U.S. tax liability; the Treasury Department and 
the IRS have determined that it is appropriate to require comparable 
promptness when a foreign tax redetermination increases U.S. tax due in 
order to permit timely verification of the required U.S. tax 
adjustments when the relevant documentation and personnel are more 
readily available. Accordingly, the comments are not adopted. However, 
a transition rule is added at Sec.  1.905-4(b)(6) to give taxpayers an 
additional year to file required notifications with respect to foreign 
tax redeterminations occurring in taxable years ending on or after 
December 16, 2019, and before November 12, 2020.
    Comments also requested that the final regulations provide that for 
foreign tax redeterminations below a certain de minimis threshold (for 
example, 10 percent of foreign taxes as originally accrued, or $5 
million), taxpayers should be allowed to account for the foreign tax 
redeterminations by making adjustments to current year taxes and 
foreign tax credits claimed in the taxable year in which the foreign 
tax redetermination occurs, rather than by adjusting U.S. tax liability 
in the prior year or years in which the adjusted foreign taxes were 
claimed as a credit. Alternatively, some comments requested that for 
foreign tax redeterminations below a de minimis or materiality 
threshold, taxpayers should be completely relieved of adjusting U.S. 
tax liability and from all notification and amended return 
requirements.
    The Treasury Department and the IRS have determined that, as 
amended by the TCJA, section 905(c) mandates retroactive adjustments to 
U.S. tax liability when foreign taxes claimed as credits are 
redetermined. The TCJA repealed section 902 and the regulatory 
authority at the end of section 905(c)(1) to prescribe alternative 
adjustments to multi-year pools of earnings and taxes of foreign 
corporations in lieu of the required adjustments to U.S. tax liability 
for the affected years. Recharacterizing prior year taxes as current 
year taxes would have substantive effects on the amounts of a 
taxpayer's GILTI and subpart F inclusions, the applicable carryover 
periods for excess credits, the applicable currency translation 
conventions, the amounts of interest owed by or due to the taxpayer, 
and the applicable statutes of limitation for refund or assessment. 
Therefore, the comments are not adopted.
    Finally, a comment requested that Sec.  1.905-4(b)(1)(ii) be 
amended to allow a taxpayer that avails itself of special procedures 
under Revenue Procedure 94-69 to notify the IRS of a foreign tax 
redetermination when the taxpayer makes a Revenue Procedure 94-69 
disclosure during an audit for the taxable year for which U.S. tax 
liability is increased by reason of the foreign tax redetermination.
    In relevant part, Revenue Procedure 94-69 provides special 
procedures for a taxpayer in the Large Corporate Compliance program 
(formerly the Coordinated Examination Program or Coordinated Industry 
Case program) to avoid the potential application of the accuracy-
related penalty currently described in section 6662. Under Revenue 
Procedure 94-69, a taxpayer may file a written statement that is 
treated as a qualified amended return within 15 days after the IRS 
requests it. However, Revenue Procedure 94-69 does not provide any 
protection for penalties under section 6689 for failure to file a 
notice of a foreign tax redetermination, and it requires a statement 
that is less detailed than the notification statement required under 
Sec.  1.905-4(b)(1)(ii). Further, section 905(c) contemplates that the 
burden is on the taxpayer to notify the IRS of a foreign tax 
redetermination, whereas Revenue Procedure 94-69 places the burden on 
the IRS to request information. Finally, the notification requirement 
under Sec.  1.905-4(b)(1)(ii) affords a taxpayer more time to satisfy 
its reporting obligation as opposed to the 15-day notification 
requirement in Revenue Procedure 94-69. Therefore, the comment is not 
adopted.
2. Foreign Tax Redeterminations of Pass-Through Entities
    Proposed Sec.  1.905-4(b)(2) generally provided that a pass-through 
entity that reports creditable foreign income tax to its partners, 
shareholders, or beneficiaries is required to notify the IRS and its 
partners, shareholders, or beneficiaries if there is a foreign tax 
redetermination with respect to such foreign income tax. See proposed 
Sec.  1.905-4(c) for the information required to be provided with the 
notification. Additionally, proposed Sec.  1.905-4(b)(2)(ii) provided 
that if a redetermination of U.S. tax liability would require a 
partnership adjustment as defined in Sec.  301.6241-1(a)(6), the 
partnership must file an administrative adjustment request (``AAR'') 
under section 6227 without regard to the time restrictions on filing an 
AAR in section 6227(c). See also Sec.  1.6227-1(g).
    One comment suggested that S corporations should be allowed to 
follow similar notification procedures as partnerships that are subject 
to sections 6221 through 6241 (enacted in Sec.  1101 of the Bipartisan 
Budget Act of 2015, Pub. L. 114-74 (``BBA'') and as amended by the 
Protecting Americans from Tax Hikes Act of 2015, Pub. L. 114-113, div 
Q, and by sections 201 through 207 of the Tax Technical Corrections Act 
of 2018, contained in Title II of Division U of the Consolidated 
Appropriations Act of 2018, Pub. L. 115-141).
    By their terms, the BBA rules only apply to partnerships and not S 
corporations, except in the limited circumstance in which an S 
corporation is a partner in a partnership subject to the BBA rules. See 
sections 6226(b)(4) and 6227(b). But in cases where the S corporation 
is not a partner in a BBA partnership that made the election, there is 
no provision under BBA or any other provision of the Code to allow the 
S corporation to pay the imputed underpayment on behalf of its 
shareholders. Because the statute does not generally allow for S 
corporations to pay imputed underpayments on behalf of its 
shareholders, the approach suggested by the comment is not viable and 
therefore the comment is not adopted. However, as described in Part 
V.E.1 of this Summary of Comments and Explanation of Revisions, the 
Treasury Department and the IRS continue to study whether new processes 
or forms can be developed to streamline the amended return 
requirements, including in the case of S corporations that report

[[Page 72017]]

foreign tax redeterminations to their shareholders.
3. Foreign Tax Redeterminations of LB&I Taxpayers
    Proposed Sec.  1.905-4(b)(4) provided a limited alternative 
notification requirement for U.S. taxpayers that are under the 
jurisdiction of the IRS's Large Business & International (``LB&I'') 
Division. Under proposed Sec.  1.905-4(b)(4)(i)(B), the alternative 
notification requirement is available only if certain conditions are 
met, including that an amended return reflecting a foreign tax 
redetermination would otherwise be due while the return for the 
affected taxable year is under examination, and that the foreign tax 
redetermination results in a downward adjustment to the amount of 
foreign tax paid or accrued, or included in the computation of foreign 
taxes deemed paid.
    Several comments suggested broadening the scope of proposed Sec.  
1.905-4(b)(4) to include upward adjustments to foreign taxes paid or 
accrued. The comments also recommended that the special notification 
rules apply when multiple foreign tax redeterminations involving 
different foreign jurisdictions occur in the same taxable year and 
result in offsetting adjustments, for example, if there is an 
additional payment of foreign tax in one jurisdiction and a refund of a 
comparable amount in another jurisdiction.
    The proposed regulations limited the alternative notification 
requirement to cases where the foreign tax redetermination results in a 
downward adjustment to the amount of foreign taxes paid or accrued 
because failure to comply with the notification requirements exposes 
taxpayers to penalties under section 6689 only if the foreign tax 
redetermination results in an underpayment of U.S. tax. As provided in 
Sec.  1.905-4(b)(1)(iii), if a foreign tax redetermination results in 
an overpayment of U.S. tax, in order to claim a refund of U.S. tax the 
taxpayer must file an amended return within the period specified in 
section 6511. See section 6511(d)(3)(A), providing a special 10-year 
period of limitations for refund claims based on foreign tax credits. 
However, in unusual circumstances, an increase in foreign tax liability 
for a prior year may result in an underpayment (rather than an 
overpayment) of U.S. tax (for example, if an increase in foreign income 
tax liability causes a CFC to have a tested loss or to qualify for the 
high-tax exclusion of section 954(b)(4), reducing the amount of foreign 
taxes deemed paid).
    In addition, in some cases the complexity of the required 
computations may make it difficult for taxpayers to identify easily 
which particular foreign tax redeterminations will ultimately result in 
an underpayment of U.S. tax. Accordingly, the final regulations extend 
the alternative notification procedures to cover the case of any 
adjustment (whether upward or downward) of foreign taxes by reason of a 
foreign tax redetermination that increases U.S. tax liability, and so 
would otherwise require the filing of an amended return while the 
affected year of the LB&I taxpayer is under examination. In addition, 
the final regulations provide that an LB&I taxpayer that has a foreign 
tax redetermination that decreases U.S. tax liability for an affected 
year that is under examination may (but is not required to) notify the 
examiner of the adjustment in lieu of filing an amended return to claim 
a refund (within the time period provided in section 6511). However, 
because section 6511(d)(3) generally allows taxpayers 10 years to seek 
a U.S. tax refund attributable to foreign tax credits and the 
regulations do not preclude taxpayers from filing such an amended 
return before the audit of an affected year is completed, the IRS may 
either accept the alternative notification or require the taxpayer to 
file an amended return. The additional flexibility added to the final 
regulations will assure timely notification of, and penalty protection 
for taxpayers with respect to, all foreign tax redeterminations that 
may increase or decrease U.S. tax liability for an affected taxable 
year, including in the case of offsetting foreign tax redeterminations 
that occur in the same taxable year.
    Finally, comments recommended that examiners should be granted 
authority to accept notifications of foreign tax redeterminations 
outside the periods specified in Sec.  1.905-4(b)(4)(ii)(A) through (C) 
and for affected taxable years that are not currently under 
examination. For example, the comments suggested that the notification 
deadline for an LB&I taxpayer should be extended upon the taxpayer's 
request and at the examiner's discretion.
    The Treasury Department and the IRS have determined that amended 
returns reflecting additional U.S. tax due should be timely filed in 
order to ensure examiners have sufficient time to take into account any 
redetermination of U.S. tax liability without prolonging the audit. In 
addition, the special notification rules are not extended to taxpayers 
that are not currently under examination. The alternative notification 
rules in Sec.  1.905-4(b)(4) are predicated on the fact that the 
examiner is in the process of determining whether to propose 
adjustments to the items included on the taxpayer's return for the 
taxable year under examination, and it is appropriate to defer the 
requirement to file an amended return reflecting the effect of a 
foreign tax redetermination on the taxpayer's U.S. tax liability for 
that taxable year until the examination has concluded. These 
considerations do not apply to affected taxable years that are not 
currently under examination when an amended return would otherwise be 
due. Accordingly, these comments are not adopted.

F. Transition Rule Relating to the TCJA

    Proposed Sec. Sec.  1.905-3(b)(2)(iv) and 1.905-5 provided a 
transition rule providing that post-2017 redeterminations of pre-2018 
foreign income taxes of foreign corporations must be accounted for by 
adjusting the foreign corporation's taxable income and earnings and 
profits, post-1986 undistributed earnings, and post-1986 foreign income 
taxes (or pre-1987 accumulated profits and pre-1987 foreign income 
taxes, as applicable) in the pre-2018 year to which the redetermined 
foreign taxes relate.
    The preamble to the 2019 FTC proposed regulations requested 
comments on whether an alternative adjustment to account for post-2017 
foreign tax redeterminations with respect to pre-2018 taxable years of 
foreign corporations, such as an adjustment to the foreign 
corporation's taxable income and earnings and profits, post-1986 
undistributed earnings, and post-1986 foreign income taxes as of the 
foreign corporation's last taxable year beginning before January 1, 
2018, may provide for a simplified and reasonably accurate alternative.
    Several comments supported this suggestion. A comment further noted 
that certain taxpayers should be excluded from any alternative rule 
where it would be distortive. For example, the comment suggested 
excluding taxpayers that distributed material amounts of earnings and 
profits, as well as taxpayers who took advantage of the subpart F high-
tax exception in the foreign corporation's final pre-TCJA taxable year. 
Another comment noted that taxpayers should be allowed to adjust the 
foreign corporation's final pre-2018 year only if the adjustments would 
not cause a deficit in the foreign corporation's tax pool in that final 
year. A comment also suggested that the alternative rule should provide 
that in case of foreign corporations that ceased to be subject to

[[Page 72018]]

the pooling regime before 2018 (for example, due to a liquidation or 
sale to a foreign acquiror), the required adjustments should be made in 
the foreign corporation's last year in which the pooling rules are 
relevant). Additionally, several comments suggested that foreign tax 
redeterminations of foreign corporations below a certain threshold 
should not require a redetermination or adjustment of a taxpayer's 
section 965(a) inclusion or the amount of foreign taxes deemed paid 
with respect to such section 965(a) inclusion. Instead, some comments 
suggested that the redetermination be taken into account in the post-
2017 year of the redetermination.
    In response to comments, the final regulations under Sec.  1.905-
5(e) provide an irrevocable election for a foreign corporation's 
controlling domestic shareholders to account for all foreign tax 
redeterminations that occur in taxable years ending on or after 
November 2, 2020, with respect to pre-2018 taxable years of foreign 
corporations as if they occurred in the foreign corporation's last 
taxable year beginning before January 1, 2018 (the ``last pooling 
year''). The rules in Sec. Sec.  1.905-3T and 1.905-5T (as contained in 
26 CFR part 1 revised as of April 1, 2019) will apply for purposes of 
determining whether a particular foreign tax redetermination must 
instead be accounted for in the year to which the redetermined foreign 
tax relates, instead of in the last pooling year. The election is made 
by the foreign corporation's controlling domestic shareholders, and is 
binding on all persons who are, or were in a prior year to which the 
election applies, U.S. shareholders of the foreign corporation with 
respect to which the election is made for all of its subsequent foreign 
tax redeterminations, as well as foreign tax redeterminations of other 
members of the same CFC group as the foreign corporation for which the 
election is made. For this purpose, the definition of a CFC group in 
Sec.  1.905-5(e)(2)(iv)(B) is modeled off the definition contained in 
Sec.  1.951A-2(c)(7)(viii)(E)(2).
    No exception is provided that would allow taxpayers to avoid 
redetermination or adjustment of the amount of a taxpayer's section 
965(a) inclusion or foreign income taxes deemed paid with respect to 
such section 965(a) inclusion if under section 905(c) a foreign tax 
redetermination with respect to a foreign corporation's pre-2018 year 
requires such an adjustment to the taxpayer's U.S. tax liability. As 
discussed in Part V.E.1 of this Summary of Comments and Explanation of 
Revisions, section 905(c) mandates retroactive adjustments to U.S. tax 
liability when foreign taxes claimed as credits are redetermined, and 
there is no technical or policy basis on which to exclude such 
adjustments when the U.S. tax liability arises as a result of section 
965 as opposed to another section of the Code.

G. Protective Claims

    One comment requested guidance on how to file protective refund 
claims to account for contested foreign taxes that may result in 
foreign tax redeterminations after the expiration of the applicable 
statute of limitations. Providing guidance on the procedures for filing 
protective claims is beyond the scope of this rulemaking.

VI. Foreign Income Taxes Taken Into Account Under Section 954(b)(4)

    The 2019 FTC proposed regulations included a clarification relating 
to schemes involving jurisdictions that do not impose corporate income 
tax on a CFC until its earnings are distributed. The proposed 
regulations clarified that foreign income taxes that have not accrued 
because they are contingent on a future distribution are not taken into 
account for purposes of determining the amount of foreign income taxes 
paid or accrued with respect to an item of income.
    No comments were received with respect to this provision, and the 
rules are finalized without change. In addition, proposed Sec.  1.905-
1(d)(1) in the 2020 FTC proposed regulations further clarifies that 
taxes contingent on a future distribution are not treated as accrued.

VII. Applicability Dates

A. Regulations Relating to Foreign Tax Credits

    The 2019 FTC proposed regulations provided that the rules in 
proposed Sec. Sec.  1.861-8, 1.861-9, 1.861-12, 1.861-14, 1.904-4(c)(7) 
and (8), 1.904(b)-3, 1.905-3, 1.905-4, 1.905-5, 1.954-1, 1.954-2, 
1.965-5(b)(2), and 301.6689-1 are applicable to taxable years that end 
on or after December 16, 2019. Certain provisions, such as Sec. Sec.  
1.704-1(b)(4)(viii)(d)(1), 1.861-17, 1.861-20, 1.904-6, and 1.960-1, 
were proposed to be applicable to taxable years beginning after 
December 31, 2019, while proposed Sec. Sec.  1.904-4(e) and 1.904(g)-3 
were proposed to be applicable to taxable years ending on or after the 
date the final regulations are filed. Proposed Sec.  1.1502-4 was 
proposed to be applicable to taxable years for which the original 
consolidated Federal income tax return is due (without extensions) 
after December 17, 2019.
    Several comments requested that the applicability dates to the 2019 
FTC proposed regulations generally be delayed to taxable years 
beginning on or after the final regulations are published to allow more 
time for taxpayers to adapt to the new rules, and also requested that 
the regulations allow taxpayers the flexibility to rely on either the 
2019 FTC proposed regulations or the final regulations for any 
preceding taxable years.
    The Treasury Department and the IRS agree that the applicability 
date of the expense allocation rules in Sec. Sec.  1.861-8 and 1.861-
14, which particularly in the case of stewardship expenses contain 
significant changes relative to the 2019 FTC proposed regulations, 
should be delayed to allow taxpayers more time to comply with the 
revisions made in the final regulations. Therefore, the applicability 
dates of Sec. Sec.  1.861-8 and 1.861-14 are revised to apply to 
taxable years beginning after December 31, 2019 (consistent with the 
later applicability date provided for Sec. Sec.  1.861-17, 1.861-20, 
1.904-6, and 1.960-1). In addition, although the applicability date of 
the notification requirements for foreign tax redeterminations in Sec.  
1.905-4 is adopted as proposed to apply to foreign tax redeterminations 
occurring in taxable years ending on or after December 16, 2019, a 
transition rule is added to the final regulations to provide taxpayers 
an additional year to file required notifications with respect to 
foreign tax redeterminations occurring in taxable years ending before 
November 12, 2020. Also, because section 1503(a) provides that 
regulations under section 1502 only apply to consolidated tax returns 
if they are prescribed before the last day prescribed by law for the 
filing of such return, the applicability date of Sec.  1.1502-4 is 
revised to apply to taxable years for which the original consolidated 
Federal income tax return is due (without extensions) after November 
12, 2020. However, the other provisions in the 2019 FTC proposed 
regulations which were proposed to apply to taxable years ending on or 
after December 16, 2019 (Sec. Sec.  1.861-9, 1.861-12, 1.904-4(c)(7) 
and (8), 1.904(b)-3, 1.905-3, 1.905-5, 1.954-1, 1.954-2, 1.965-5(b)(2), 
and 301.6689-1), generally received minimal or no comments and have 
been adopted with no or minimal changes. Therefore, the Treasury 
Department and the IRS have determined that taxpayers with 2019 
calendar years have been sufficiently on notice of these rules and 
little benefit would be afforded by providing a delayed applicability 
date or an election

[[Page 72019]]

to apply either the proposed or final regulations to preceding years, 
given that these rules have not significantly changed between the 
proposed and final regulations.
    The 2019 FTC proposed regulations provided that, with respect to 
Sec.  1.861-17, taxpayers that use the sales method for taxable years 
beginning after December 31, 2017, and before January 1, 2020 (or 
taxpayers that use the sales method only for their last taxable year 
that begins before January 1, 2020), may rely on proposed Sec.  1.861-
17 if they apply it consistently with respect to such taxable year and 
any subsequent year. Therefore, a taxpayer using the sales method for 
its taxable year beginning in 2018 may rely on proposed Sec.  1.861-17 
but must also apply the sales method (relying on proposed Sec.  1.861-
17) for its taxable year beginning in 2019.
    These final regulations provide that a taxpayer may choose to apply 
Sec.  1.861-17 (as contained in these final regulations) to taxable 
years beginning before January 1, 2020, provided that it applies the 
final regulations in their entirety, and provided that if a taxpayer 
applies the final regulations to the taxable year beginning in 2018, 
the taxpayer must also apply the final regulations for the subsequent 
taxable year beginning in 2019. Alternatively, and consistent with the 
2019 FTC proposed regulations, a taxpayer may rely on proposed Sec.  
1.861-17 in its entirety for taxable years beginning after December 31, 
2017, and beginning before January 1, 2020. A taxpayer that applies 
either the proposed or final version of Sec.  1.861-17 to a taxable 
year beginning on or after January 1, 2018, and beginning before 
January 1, 2020, must apply it with respect to all operative sections 
(including both section 250 and 904). See Sec.  1.861-8(f).

B. Rules Relating to Hybrid Arrangements and Section 951A

    Under the 2020 hybrids proposed regulations, the rules under 
section 245A(e) relating to hybrid deduction accounts were proposed to 
be applicable to taxable years ending on or after the date that final 
regulations are published in the Federal Register, although a taxpayer 
could choose to consistently apply those final regulations to earlier 
taxable years. See proposed Sec.  1.245A(e)-1(h)(2). In addition, the 
2020 hybrids proposed regulations provided that a taxpayer could 
consistently rely on the proposed rules with respect to earlier taxable 
years.
    Further, under the 2020 hybrids proposed regulations, the rules 
under section 881 relating to conduit financing arrangements were 
proposed to be applicable to payments made on or after the date that 
final regulations are published in the Federal Register. See proposed 
Sec.  1.881-3(f). Finally, the rules under section 951A relating to 
disqualified payments were proposed to be applicable to taxable years 
of foreign corporations ending on or after April 7, 2020, and to 
taxable years of United States shareholders in which or with which such 
taxable years end. See proposed Sec.  1.951A-7(d).
    As discussed in Part III.B of this Summary of Comments and 
Explanation of Revisions, a comment recommended modifying the 
applicability date for the rules under section 881 if the final 
regulations were to include some of the proposed rules, such as the 
rule that treated as a financing transaction an instrument that is 
equity for both U.S. and foreign tax purposes and that gives rise to 
notional interest deductions. The final regulations do not include 
those rules. In addition, no comments suggested a modification to the 
applicability dates for the other rules under the 2020 hybrids proposed 
regulations. Therefore, the final regulations adopt applicability dates 
consistent with the proposed applicability dates under the 2020 hybrids 
proposed regulations. See Sec. Sec.  1.245A(e)-1(h)(2); 1.881-3(f); and 
1.951A-7(d). The final regulations also clarify that for a taxpayer to 
apply the final rules under section 245A(e) to a taxable year ending 
before November 12, 2020, the taxpayer must consistently apply those 
rules to that taxable year and any subsequent taxable year ending 
before November 12, 2020. See Sec.  1.245A(e)-1(h)(2).

Special Analyses

I. Regulatory Planning and Review

    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, reducing costs, harmonizing rules, and promoting flexibility. 
For purposes of Executive Order 13771, this final rule is regulatory.
    These final regulations have been designated as subject to review 
under Executive Order 12866 pursuant to the Memorandum of Agreement 
(MOA) (April 11, 2018) between the Treasury Department and the Office 
of Management and Budget (OMB) regarding review of tax regulations. The 
Office of Information and Regulatory Affairs has designated these 
regulations as economically significant under section 1(c) of the MOA. 
Accordingly, the OMB has reviewed these regulations.

A. Background and Need for the Final Regulations

1. Regulations Relating to Foreign Tax Credits
    Before the Tax Cuts and Jobs Act (TCJA), the United States taxed 
its citizens, residents, and domestic corporations on their worldwide 
income. However, to the extent that a foreign jurisdiction and the 
United States taxed the same income, this framework could have resulted 
in double taxation. The U.S. foreign tax credit (FTC) regime alleviated 
potential double taxation by allowing a non-refundable credit for 
foreign income taxes paid or accrued that could be applied to reduce 
the U.S. tax on foreign source income. Although TCJA eliminated the 
U.S. tax on some foreign source income, the United States continues to 
tax other foreign source income, and to provide foreign tax credits 
against this U.S. tax. The changes made by TCJA to international 
taxation necessitate certain changes in this FTC regime.
    The FTC calculation operates by defining different categories of 
foreign source income (a ``separate category'') based on the type of 
income.\3\ Foreign taxes paid or accrued as well as deductions for 
expenses borne by U.S. parents and domestic affiliates that support 
foreign operations are also allocated to the separate categories under 
similar principles. The taxpayer can then use foreign tax credits 
allocated to each category against the U.S. tax owed on income in that 
category. This approach means that taxpayers who pay foreign taxes on 
income in one category cannot claim a credit against U.S. taxes owed on 
income in a different category, an important feature of the FTC regime. 
For example, suppose a domestic corporate taxpayer has $100 of active 
foreign source income in the ``general category'' and $100 of passive 
foreign source income, such as interest income, in the ``passive 
category.'' It also has $50 of foreign taxes associated with the

[[Page 72020]]

``general category'' income and $0 of foreign taxes associated with the 
``passive category'' income. The allowable FTC is determined separately 
for the two categories. Therefore, none of the $50 of ``general 
category'' FTCs can be used to offset U.S. tax on the ``passive 
category'' income. This taxpayer has a pre-FTC U.S. tax liability of 
$42 (21 percent of $200) but can claim an FTC for only $21 (21 percent 
of $100) of this liability, which is the U.S. tax owed with respect to 
active foreign source income in the general category. The $21 
represents what is known as the taxpayer's foreign tax credit 
limitation. The taxpayer may carry the remaining $29 of foreign taxes 
($50 minus $21) back to the prior taxable year and then forward for up 
to 10 years (until used), and is allowed a credit against U.S. tax on 
general category foreign source income in the carryover year, subject 
to certain restrictions.
---------------------------------------------------------------------------

    \3\ Prior to the TCJA, these categories were primarily the 
passive income and general income categories. The TCJA added new 
separate categories for global intangible low-taxed income (the 
section 951A category) and foreign branch income.
---------------------------------------------------------------------------

    The final regulations are needed to address changes introduced by 
the TCJA and to respond to outstanding issues raised in comments to 
foreign tax credit regulations issued in 2018. In particular, the 
comments highlighted the following areas of concern: (a) Uncertainty 
concerning appropriate allocation of R&E expenditures across FTC 
categories, and (b) the need to treat loans from partnerships to 
partners the same as loans from partners to partnerships with respect 
to aligning interest income to interest expense. In addition, the final 
regulations are needed to expand the application of section 905(c) to 
cases where a foreign tax redetermination changes a taxpayer's 
eligibility for the high-taxed exception under subpart F and GILTI.
    In addition to the 2018 FTC final regulations, the Treasury 
Department and the IRS also issued final regulations in 2019 (84 FR 
69022) (2019 FTC final regulations) and proposed regulations (84 FR 
69124) (2019 FTC proposed regulations), which are being finalized in 
this document, and are issuing additional proposed regulations 
simultaneously with these final regulations.
2. Regulations Relating to Hybrid Arrangements and to Section 951A
    The TCJA introduced two new provisions, sections 245A(e) and 267A, 
that affect the treatment of hybrid arrangements, and a new section 
951A, which imposes tax on United States shareholders with respect to 
certain earnings of their CFCs.\4\ The Treasury Department and the IRS 
previously issued final regulations under sections 245A(e) and 267A 
(2020 hybrids final regulations) as well as proposed regulations under 
sections 245A(e), 881, and 951A (2020 hybrids proposed regulations). 
See TD 9896, 85 FR 19802; REG-106013-19, 85 FR 19858. The Treasury 
Department and the IRS are issuing additional final regulations 
relating to finalize the 2020 hybrids proposed regulations.
---------------------------------------------------------------------------

    \4\ Hybrid arrangements are tax-avoidance tools used by certain 
multinational corporations (MNCs) that have operations both in the 
U.S. and a foreign country. These hybrid arrangements use 
differences in tax treatment by the U.S. and a foreign country to 
reduce taxes in one or both jurisdictions. Hybrid arrangements can 
be ``hybrid entities,'' in which a taxpayer is treated as a flow-
through or disregarded entity in one country but as a corporation in 
another, or ``hybrid instruments,'' which are financial transactions 
that are treated as debt in one country and as equity in another.
---------------------------------------------------------------------------

    Section 245A(e) disallows the dividends received deduction (DRD) 
for any dividend received by a U.S. shareholder from a CFC if the 
dividend is a hybrid dividend. In addition, section 245A(e) treats 
hybrid dividends between CFCs with a common U.S. shareholder as subpart 
F income. The statute defines a hybrid dividend as an amount received 
from a CFC for which a deduction would be allowed under section 245A(a) 
and for which the CFC received a deduction or other tax benefit in a 
foreign country. This disallowance of the DRD for hybrid dividends and 
the treatment of hybrid dividends as subpart F income neutralizes the 
double non-taxation that might otherwise be produced by these 
dividends.\5\ The 2020 hybrids final regulations require that taxpayers 
maintain ``hybrid deduction accounts'' to track a CFC's (or a person 
related to a CFC's) hybrid deductions allowed in foreign jurisdictions 
across sources and years. The 2020 hybrids final regulations then 
provide that a dividend received by a U.S. shareholder from the CFC is 
a hybrid dividend to the extent of the sum of those accounts.
---------------------------------------------------------------------------

    \5\ The tax treatment under which certain payments are 
deductible in one jurisdiction and not included in income in a 
second jurisdiction is referred to as a deduction/no-inclusion 
outcome (``D/NI outcome'').
---------------------------------------------------------------------------

    These final regulations also include rules regarding conduit 
financing arrangements.\6\ Under the regulations in Sec.  1.881-3 (the 
``conduit financing regulations''), a ``financing arrangement'' means a 
series of transactions by which one entity (the financing entity) 
advances money or other property to another entity (the financed 
entity) through one or more intermediaries, and there are ``financing 
transactions'' linking each of those parties. If the IRS determines 
that a principal purpose of such an arrangement is to avoid U.S. tax, 
the IRS may disregard the participation of intermediate entities. As a 
result, U.S.-source payments from the financed entity are, for U.S. 
withholding tax purposes, treated as being made directly to the 
financing entity.
---------------------------------------------------------------------------

    \6\ On December 22, 2008, the Treasury Department and the IRS 
published a notice of proposed rulemaking (REG-113462-08) that 
proposed adding Sec.  1.881-3(a)(2)(i)(C) to the conduit financing 
regulations. The preamble to the proposed regulations provides that 
the Treasury Department and the IRS are also studying transactions 
where a financing entity advances cash or other property to an 
intermediate entity in exchange for a hybrid instrument (that is, an 
instrument treated as debt under the tax laws of the foreign country 
in which the intermediary is resident and equity for U.S. tax 
purposes), and states that they may issue separate guidance to 
address the treatment under Sec.  1.881-3 of certain hybrid 
instruments.
---------------------------------------------------------------------------

    For example, consider a foreign entity that is seeking to finance 
its U.S. subsidiary but is not entitled to U.S. tax treaty benefits; 
thus, U.S.-source payments made to this entity are not entitled to 
reduced withholding tax rates. Instead of lending money directly to the 
U.S. subsidiary, the foreign entity might loan money to an affiliate 
residing in a treaty jurisdiction and have the affiliate lend on to the 
U.S. subsidiary in order to access U.S. tax treaty benefits.
    Under the conduit financing regulations, if the IRS determines that 
a principal purpose of such an arrangement is to avoid U.S. tax, the 
IRS may disregard the participation of the affiliate. As a result, 
U.S.-source interest payments from the U.S. subsidiary are, for U.S. 
withholding tax purposes, treated as being made directly to the foreign 
entity.
    In general, the conduit financing regulations apply only if 
``financing transactions,'' as defined under the regulations, link the 
financing entity, the intermediate entities, and the financed entity. 
Under the prior conduit financing regulations, before the finalization 
of these regulations, an instrument that is equity for U.S. tax 
purposes generally will not be treated as a ``financing transaction'' 
unless it provides the holder significant redemption rights or the 
issuer has a right to redeem that likely will be exercised. This is the 
case even if the instrument is treated as debt under the laws of the 
foreign jurisdiction (for example, perpetual debt). As a result, the 
prior conduit financing regulations would not apply to an equity 
instrument in the absence of such attributes, and the U.S.-source 
payment might be entitled to a lower rate of U.S. withholding tax.
    These final regulations also implement items in section 951A of the 
TCJA. Section 951A provides for the taxation of global intangible low-
taxed

[[Page 72021]]

income (GILTI), effective beginning with the first taxable year of a 
CFC that begins after December 31, 2017. The existing final regulations 
under section 951A address the treatment of a deduction or loss 
attributable to basis created by certain transfers of property from one 
CFC to a related CFC after December 31, 2017, but before the date on 
which section 951A first applies to the transferring CFC's income. 
Those regulations state that such a deduction or loss is allocated to 
residual CFC gross income; that is, income that is not attributable to 
tested income, subpart F income, or income effectively connected with a 
trade or business in the United States.

B. Overview of the Final Regulations

1. Regulations Relating to Foreign Tax Credits
    These final regulations address the following issues: (1) The 
allocation and apportionment of deductions under sections 861 through 
865, including new rules on the allocation and apportionment of 
research and experimentation (R&E) expenditures; (2) the allocation of 
foreign income taxes to the foreign income to which such taxes relate; 
(3) the interaction of the branch loss and dual consolidated loss 
recapture rules with sections 904(f) and (g); (4) the effect of foreign 
tax redeterminations of foreign corporations on the application of the 
high-tax exception described in section 954(b)(4) (including for 
purposes of determining tested income under section 
951A(c)(2)(A)(i)(III)), and required notifications under section 905(c) 
to the IRS of foreign tax redeterminations and related penalty 
provisions; (5) the definition of foreign personal holding company 
income under section 954; (6) the application of the foreign tax credit 
disallowance under section 965(g); and (7) the application of the 
foreign tax credit limitation to consolidated groups.
2. Regulations Relating to Hybrid Arrangements and to Section 951A
    These final regulations address three main issues. First, these 
final regulations address adjustments to hybrid deduction accounts 
under section 245A(e) and the 2020 hybrids final regulations. The 2020 
hybrids final regulations stipulate that hybrid deduction accounts 
should generally be reduced to the extent that earnings and profits of 
the CFC that have not been subject to foreign tax as a result of 
certain hybrid arrangements are included in income in the United States 
by some provision other than section 245A(e). These final regulations 
provide new rules for reducing hybrid deduction accounts by reason of 
income inclusions attributable to subpart F, GILTI, and sections 
951(a)(1)(B) and 956. An inclusion due to subpart F or GILTI reduces a 
hybrid deduction account only to the extent that the inclusion is not 
offset by a deduction or credit, such as a foreign tax credit, that 
likely will be afforded to the inclusion. Because deductions and 
credits are not available to offset income inclusions under section 
951(a)(1)(B) and 956, these inclusions reduce a hybrid deduction 
account dollar-for-dollar.
    Second, these final regulations address conduit financing 
arrangements under Sec.  1.881-3 by expanding the types of transactions 
classified as financing transactions. These final regulations state 
that if a financial instrument is debt under the tax law of the foreign 
jurisdiction where the issuer is a resident, or, if the issuer is not a 
tax resident of any country, where it is created, organized, or 
otherwise established, then it may now be characterized as a financing 
transaction even though the instrument is equity for U.S. tax purposes. 
Accordingly, the conduit financing regulations would apply to multiple-
party financing arrangements using these types of instruments. This 
change is consistent with the policy of Sec.  1.881-3 and also helps to 
align the conduit regulations with the policy of section 267A by 
discouraging the exploitation of differences in treatment of financial 
instruments across jurisdictions. While section 267A and the 2020 
hybrids final regulations apply only if the D/NI outcome is a result of 
the use of a hybrid entity or instrument, the conduit financing 
regulations apply regardless of causation and instead look to whether 
there is a tax avoidance plan. Thus, this new rule, to a limited 
extent, will address economically similar transactions that section 
267A and the 2020 hybrids final regulations do not cover.
    Finally, these final regulations address certain payments made 
after December 31, 2017, but before the date of the start of the first 
fiscal year for the transferor CFC for which 951A applies (the 
``disqualified period'') in which payments, such as pre-payments of 
royalties, create income during the disqualified period and a 
corresponding deduction or loss claimed in taxable years after the 
disqualified period. Absent these final regulations, those deductions 
or losses could have been used to reduce tested income or increase 
tested losses, among other benefits. However, under these final 
regulations, these deductions will no longer provide such a tax 
benefit, and will instead be allocated to residual CFC income, similar 
to deductions or losses from certain property transfers in the 
disqualified period under the existing final regulations under section 
951A.

C. Economic Analysis

1. Baseline
    In this analysis, the Treasury Department and the IRS assess the 
benefits and costs of these 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
i. Regulations Relating to Foreign Tax Credits
    The final regulations provide certainty and clarity to taxpayers 
regarding the allocation of income, expenses, and foreign income taxes 
to the separate categories. In the absence of the enhanced specificity 
provided by these provisions of the regulations, similarly-situated 
taxpayers might interpret the foreign tax credit provisions of the Code 
differently, potentially resulting in inefficient patterns of economic 
activity. For example, in the absence of the final regulations, one 
taxpayer might have chosen not to undertake research (that is, incur 
R&E expenses) in a particular location, based on that taxpayer's 
interpretation of the tax consequences of such expenditures, that 
another taxpayer, making a different interpretation of the tax 
treatment of R&E, might have chosen to pursue. If this difference in 
interpretations confers a competitive advantage on the less productive 
enterprise, U.S. economic performance may suffer. Thus, the guidance 
provided in these regulations helps to ensure that taxpayers face more 
uniform incentives when making economic decisions. In general, economic 
performance is enhanced when businesses face more uniform signals about 
tax treatment.
    To the extent that taxpayers would generally, in the absence of 
this final guidance, have interpreted the foreign tax credit rules as 
being less favorable to the taxpayer than the final regulations 
provide, the final regulations may result in additional international 
activity by these taxpayers relative to the no-action baseline. This 
additional activity may include both activities that are beneficial to 
the U.S. economy (perhaps because they represent enhanced international 
opportunities for businesses with U.S. owners) and activities that are 
not beneficial

[[Page 72022]]

(perhaps because they are accompanied by reduced activity in the United 
States). The Treasury Department and the IRS recognize that additional 
foreign economic activity by U.S. taxpayers may be a complement or 
substitute to activity within the United States and that to the extent 
these regulations change this activity, relative to the no-action 
baseline or alternative regulatory approaches, a mix of results may 
occur.
    The Treasury Department and the IRS have not undertaken 
quantitative estimates of the economic effects of the foreign tax 
credit provisions of the regulations. The Treasury Department and the 
IRS do not have readily available data or models to estimate with 
reasonable precision (i) the tax stances that taxpayers would likely 
take in the absence of the final regulations or under alternative 
regulatory approaches; (ii) the difference in business decisions that 
taxpayers might make between the final regulations and the no-action 
baseline or alternative regulatory approaches as a result of these tax 
stances; or (iii) how this difference in those business decisions would 
affect measures of U.S. economic performance.
    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 Parts I.C.3.i through iii of this Special 
Analyses.
ii. Regulations Relating to Hybrid Arrangements and Section 951A
    These provisions of the final regulations provide certainty and 
clarity to taxpayers regarding (i) adjustments to hybrid deduction 
accounts under section 245A(e) and the 2020 hybrids final regulations; 
(ii) the determination of withholding taxes on payments made pursuant 
to conduit financing arrangements under Sec.  1.881-3; and (iii) the 
allocation of deductions for certain payments between related CFCs for 
purposes of section 951A and the final regulations under section 951A.
    In the absence of this clarity, the likelihood that different 
taxpayers would interpret the rules regarding hybrid arrangements and 
certain deductible payments under the final regulations under section 
951A 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. Because the tax treatment in these final 
regulations advances the intent and purpose of the statute, this 
guidance enhances U.S. economic performance, relative to the no-action 
baseline or alternative regulatory approaches, within the context of 
Congressional intent.
    These provisions of the final regulations will further enhance U.S. 
economic performance by helping to ensure that similar economic 
arrangements face similar tax treatments. Disparate tax treatment of 
similar economic transactions may create economic inefficiencies by 
leading taxpayers to undertake less productive economic activities.
    The Treasury Department and the IRS have not undertaken 
quantitative estimates of the economic effects of these provisions of 
the final regulations because they do not have readily available data 
or models to estimate with reasonable precision (i) the types or volume 
of hybrid arrangements or certain disqualified payments between related 
CFCs that would likely be covered under these regulations, under the 
no-action baseline, or under alternative regulatory approaches; or (ii) 
the effects of those hybrid arrangements or disqualified payments 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 Parts I.C.3.iv through vi of this Special 
Analyses.
iii. Summary of Economic Effects of All Provisions
    The Treasury Department and the IRS project that the final 
regulations will have economic effects greater than $100 million per 
year ($2020) relative to the no-action baseline. This determination is 
based on the substantial size of many of the businesses potentially 
affected by these regulations and the general responsiveness of 
business activity to effective tax rates,\7\ one component of which is 
the creditability of foreign taxes. Based on these two magnitudes, even 
modest changes in the treatment of foreign taxes or the allocation of 
deductions between related CFCs provided by the final regulations, 
relative to the no-action baseline, can be expected to have annual 
effects greater than $100 million ($2020).
---------------------------------------------------------------------------

    \7\ See E. Zwick and J. Mahon, ``Tax Policy and Heterogeneous 
Investment Behavior,'' at American Economic Review 2017, 107(1): 
217-48 and articles cited therein.
---------------------------------------------------------------------------

3. Economic Effects of Specific Provisions
i. Rules for Allocating R&E Expenditures Under the Sales Method
a. Background
    Under long-standing foreign tax credit rules, taxpayers must 
allocate expenditures to income categories. In the case of research and 
experimentation (R&E) expenditures, taxpayers can elect between a 
``sales method'' and a ``gross income method'' to allocate the R&E 
expenses.\8\
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    \8\ If the taxpayer chooses the gross income method, 25 percent 
of the R&E expenditures are exclusively apportioned to the source 
where more than 50 percent of the taxpayer's R&E activities occur 
(generally the United States), and the other 75 percent is 
apportioned ratably. If a taxpayer chooses the sales method then 50 
percent of the R&E expenditures are exclusively apportioned on the 
same basis, and the other 50 percent is apportioned ratably.
---------------------------------------------------------------------------

    The TCJA created some uncertainty regarding the application of the 
sales method because of the introduction of the section 951A category. 
In particular, comments raised issues regarding whether any R&E 
expenditures should be allocated to the section 951A category. The fact 
that sales by CFCs generate tested income and tested income is 
generally assigned to the section 951A category might imply that R&E 
expenditures should be allocated to the section 951A category. But the 
fact that royalty payments from the CFC to the U.S. taxpayer (e.g., in 
remuneration for IP held by the parent that is licensed to the CFC to 
create the products that are sold) are in the general category implies 
that R&E expenditures should be allocated to the general category.
    The gross income method is based on a different apportionment 
factor (gross income) as compared to the sales method (gross receipts). 
However, the gross income method is subject to certain conditions that 
require the result to be within a certain band around the result under 
the sales method, because historically the Treasury Department and the 
IRS have considered that the gross income method could lead to 
anomalous results and could be more easily manipulated than the sales

[[Page 72023]]

method.\9\ The uncertainty with respect to R&E expense allocation under 
the sales method needed resolution, and because the gross income method 
is tied to the sales method, any changes to the sales method required 
consideration of the gross income method.
---------------------------------------------------------------------------

    \9\ The gross income method is more susceptible to manipulation 
because taxpayers can manage the type and amount of their foreign 
gross income by, for example, not paying a dividend and because 
presuming a factual relationship between the R&E expenditure and the 
related class of income based on the relative amounts of a 
taxpayer's gross income was more attenuated than a factual 
relationship based on sales.
---------------------------------------------------------------------------

b. Options Considered for the Final Regulations
    The Treasury Department and the IRS considered three options with 
respect to the allocation of R&E expenditures to the section 951A 
category for purposes of calculating the FTC limitation. The first 
option was to confirm that R&E expenditures are allocated to the 
section 951A category under the sales method and to otherwise leave 
their treatment under the gross income method unchanged. The second 
option was to revise the sales method to provide that R&E expenditures 
are only allocated to the income that represents the taxpayer's return 
on intellectual property (thus, R&E expenditures could not be allocated 
to income from the taxpayer's CFC sales) and otherwise leave their 
treatment under the gross income method unchanged. The third option was 
to revise the sales method as considered in the second option and 
eliminate the gross income method for purposes of allocating R&E 
expenditures.
    The final regulations adopt the third option. This option allows 
for the provision of an allocation and apportionment method for R&E 
expenditures that generally matches the expense reasonably with the 
income it generates. The matching of income and expenses generally 
produces a more efficient tax system contingent on the overall Code 
relative to the alternative options. Additionally, because this option 
results in no R&E expense being allocated to section 951A category 
income, it does not incentivize taxpayers with excess credits (which 
cannot be carried over to prior or future taxable years and therefore 
become unusable) in the section 951A category to perform R&E through 
foreign subsidiaries; instead, the chosen option generally incentivizes 
choosing the location of R&E based on economic considerations rather 
than tax-related reasons, contingent on the overall Code. Finally, 
because the final regulations adopt the principle of allocating and 
apportioning R&E expenditures to IP-related income of the U.S. 
taxpayer, the gross income method is no longer relevant, because it 
allocates and apportions R&E expenditures to the section 951A category, 
and section 951A category gross income is not IP income to the U.S. 
taxpayer.
c. Number of Affected Taxpayers
    The Treasury Department and the IRS have determined that the 
population of affected taxpayers consists of any U.S. taxpayer with R&E 
expenditures and foreign operations. There are around 2,500 such 
taxpayers in currently available tax filings from tax year 2018. Based 
on Statistics of Income data, approximately $40 billion of R&E expenses 
of such taxpayers were allocated to foreign source income, out of a 
total of $190 billion in qualified research expenses reported by such 
taxpayers.\10\
---------------------------------------------------------------------------

    \10\ Note, however, that these taxpayers might have additional 
R&E expenses which are not qualified R&E expenses. The tax data do 
not separately identify such expenses.
---------------------------------------------------------------------------

ii. Application of Section 905(c) to Changes Affecting the High-Tax 
Exception
a. Background
    Section 905(c) provides special rules for a foreign tax 
redetermination (FTR), which is when the amount of foreign tax paid in 
an earlier year (origin year) is changed in a later year (FTR year). 
This redetermination may be necessary, for example, because the 
taxpayer gets a refund or because a foreign audit determines that the 
taxpayer owes additional foreign tax. Since these additional taxes (or 
refunds) relate to the origin year, an FTR affects a taxpayer's origin 
year tax position (as well as FTC carryovers from that year). Before 
the TCJA, FTRs of foreign corporations generally resulted in 
prospective ``pooling adjustments'' to foreign tax credits. Under this 
approach, taxpayers simply added to or reduced the amount of foreign 
taxes in their foreign subsidiary's FTC ``pool'' going forward rather 
than amend the deemed paid taxes claimed on their origin year return. 
TCJA eliminated the pooling mechanism for taxes (because the adoption 
of a participation exemption system along with the elimination of 
deferral made it unnecessary) and replaced it with a system where taxes 
are deemed paid each year with an inclusion or distribution of 
previously taxed earnings and profits (``PTEP'').
    The 2019 FTC final regulations make clear that an FTR of a United 
States taxpayer must always be accounted for in the origin year, and 
that the taxpayer must file an amended return reflecting any resulting 
change in the taxpayer's U.S. tax liability.
    Section 905(c) provides tools to enforce this amended return 
requirement. It suspends the statute of limitations with respect to the 
assessment of any additional U.S. tax liability that results from an 
FTR, and imposes a civil penalty on taxpayers who fail to notify the 
IRS (through an amended return) of an FTR. To reflect the repeal of the 
pooling mechanism, the final regulations generally require taxpayers to 
account for FTRs of foreign subsidiaries on an amended return that 
reflects revised foreign taxes deemed paid under section 960 and any 
resulting change in the taxpayer's U.S. tax liability. However, the 
2019 FTC final regulations require U.S. tax redeterminations only by 
reason of FTRs that affect the amount of foreign tax credit taxpayers 
claimed in the origin year. The rules do not apply to other tax 
effects, such as when the FTR changes the amount of earnings and 
profits the taxpayer's CFC had in the origin year, or affects whether 
or not the CFC's income qualifies for the high-tax exception under 
GILTI or subpart F.
    The interaction of FTRs and the high-tax exception under GILTI and 
subpart F increases the importance of filing an origin year amended 
return. In particular, FTRs can give rise to inaccurate origin year 
U.S. liability calculations in the absence of an amended return 
precisely because they can change taxpayers' eligibility for the high-
tax exception. Therefore, the final regulations provide that the 
section 905(c) rules cover situations in which the FTR affects not only 
the amount of FTCs taxpayers claimed in the origin year, but also 
whether or not their CFC's income qualified for the high-tax exception.
b. Options Considered for the Final Regulations
    The Treasury Department and the IRS considered two options in 
applying section 905(c) in connection with the high-tax exception. The 
first option was to limit section 905(c) to changes in the amount of 
FTCs. The second option was to provide that section 905(c) applies in 
connection with the high-tax exceptions under GILTI and subpart F.
    The final regulations adopt the second option. The first option 
would lead to frequent occurrences of inaccurate results with respect 
to the GILTI and subpart F high- tax exceptions because it is common 
for foreign audits to change the amount of tax paid in a prior

[[Page 72024]]

year. Furthermore, taxpayers would have an incentive to overpay their 
CFC's foreign tax in the origin year, claim the high-tax exception to 
avoid subpart F or GILTI inclusions, wait for the 3 year statute of 
limitations to pass, and then claim a foreign tax refund with the 
foreign authorities. Without section 905(c) applying, taxpayers would 
have no obligation or threat of penalty for not amending the origin 
year return. Although there are FTC regulations that deny a credit if 
taxpayers make a noncompulsory payment of tax (i.e., taxpayers paid 
more foreign tax than is necessary under foreign law), those rules are 
challenging to administer. While taxpayers have the burden to prove 
that they were legally required to pay the tax, the IRS may need to 
engage foreign tax law experts to establish that the taxpayer could 
have successfully fought paying it.
    The second option provides a more accurate tax calculation than the 
first option, and it is instrumental in avoiding abuse. The increased 
number of amended returns relative to the alternative regulatory 
approach will increase compliance costs for taxpayers, but the Treasury 
Department and the IRS consider that, in light of the high-tax 
exception, accurate origin year tax liability calculations necessitate 
these increased costs.
c. Number of Affected Taxpayers
    The Treasury Department and the IRS determined that the final 
regulations potentially affect those U.S. taxpayers that pay foreign 
taxes and have a redetermination of that tax. Although data reporting 
the number of taxpayers subject to an FTR in a given year are not 
readily available, some taxpayers currently subject to FTRs will file 
amended returns. The Treasury Department and the IRS estimate that 
there were between 8,900 and 13,500 taxpayers with foreign affiliates 
that filed amended returns in 2018. However, the elimination of the 
pooling mechanism and the expanded incidence of deemed paid taxes in 
connection with the GILTI regime may significantly increase the number 
of taxpayers filing amended returns, and the expansion of the section 
905(c) requirement to file an amended return to instances where a FTR 
changes eligibility for the high-tax exception under GILTI or subpart F 
(but does not affect the taxpayer's foreign tax credit) has the 
potential to modestly increase that number. The Treasury Department and 
the IRS have determined that a high upper bound for the number of 
taxpayers subject to a FTR that will be required to file amended 
returns (that is, taxpayers affected by this provision) can be derived 
by estimating the number of taxpayers with a potential GILTI or subpart 
F inclusion. Based on currently available tax filings for taxable year 
2018, there were about 16,500 C corporations with CFCs that filed at 
least one Form 5471 with their Form 1120 return. In addition, for the 
same year, there were about 41,000 individuals with CFCs that e-filed 
at least one Form 5471 with their Form 1040 return.
    In 2018, there were about 3,250 S corporations with CFCs that filed 
at least one Form 5471 with their 1120S return. The identified S 
corporations had an estimated 23,000 shareholders. Finally, the 
Treasury Department and the IRS estimate that there were approximately 
7,500 U.S. partnerships with CFCs that e-filed at least one Form 5471 
as Category 4 or 5 filers in 2018. The identified partnerships had 
approximately 1.7 million partners, as indicated by the number of 
Schedules K-1 filed by the partnerships. This number includes both 
domestic and foreign partners, so it substantially overstates the 
number of partners that would actually be affected by the final 
regulations because it includes foreign partners.
iii. Extension of the Partnership Loan Rule to Loans From the 
Partnership to a U.S. Partner
a. Background
    The 2019 FTC final regulations provide a rule that aligns interest 
income and expense when a U.S. partner makes a loan to the partnership. 
Under this matching rule, the partner's gross interest income is 
apportioned between U.S. and foreign sources in each separate category 
based on the partner's interest expense apportionment ratios. This rule 
minimizes the artificial increase in foreign source taxable income 
based solely on offsetting amounts of interest income and expense from 
a related party loan to a partnership. Comments in response to the 2018 
FTC proposed regulations requested an equivalent rule when the 
partnership makes a loan to a U.S. partner.
b. Options Considered for the Final Regulations
    The Treasury Department and the IRS considered two options with 
respect to this rule. The first option was to not provide a rule, 
because the abuse the Treasury Department and the IRS were concerned 
about was not relevant with respect to loans from the partnership to 
the partner. In the absence of a matching rule, the U.S. partner's U.S. 
source taxable income would be artificially increased but this income 
is not eligible to be sheltered by FTCs. The second option was to 
provide an identical rule for loans from the partnership to the partner 
as was provided in the 2019 FTC final regulations for loans from the 
partner to the partnership. The final regulations adopt the second 
option. This symmetry helps to ensure that similar economic 
transactions are treated similarly.
c. Number of Affected Taxpayers
    The Treasury Department and the IRS consider the population of 
affected taxpayers to consist of any U.S. partner in a partnership 
which has a loan from the partnership to the partner or certain other 
parties related to the partner. The Treasury Department and the IRS 
estimate that there are approximately 450 partnerships and 5,000 
partners that would be affected by this regulation.
iv. Section 245A(e)--Adjustment of Hybrid Deduction Account
a. Background
    Under the 2020 hybrids final regulations, taxpayers must maintain 
hybrid deduction accounts to track income of a CFC that was sheltered 
from foreign tax due to hybrid arrangements, so that it may be included 
in U.S. income under section 245A(e) when paid as a dividend. The final 
regulations address how hybrid deduction accounts should be adjusted to 
account for earnings and profits of a CFC included in U.S. income due 
to certain provisions other than section 245A(e). The final regulations 
provide rules reducing a hybrid deduction account for three categories 
of inclusions: subpart F inclusions, GILTI inclusions, and inclusions 
under sections 951(a)(1)(B) and 956.
b. Options Considered for the Final Regulations
    One option for addressing the treatment of earnings and profits 
included in U.S. income due to provisions other than section 245A(e) 
would be to not issue additional guidance beyond current tax rules and 
thus not to adjust hybrid deduction accounts to account for such 
inclusions. This would be the simplest approach among those considered, 
but under this approach, some income could be subject to double 
taxation in the United States. For example, if no adjustment is made, 
to the extent that a CFC's earnings and profits were sheltered from 
foreign tax as a result of certain hybrid arrangements, the section 
245A DRD would be disallowed for an amount of

[[Page 72025]]

dividends equal to the amount of the sheltered earnings and profits, 
even if some of the sheltered earnings and profits were included in the 
income of a U.S. shareholder under the subpart F rules. The U.S. 
shareholder would be subject to tax on both the dividends and on the 
subpart F inclusion. Owing to this double taxation, the final 
regulations do not adopt this approach.
    A second option would be to reduce hybrid deduction accounts by 
amounts included in gross income under the three categories; that is, 
without regard to deductions or credits that may offset the inclusion. 
While this option is also relatively simple, it could lead to double 
non-taxation and thus would give rise to results not intended by the 
statute. Subpart F and GILTI inclusions may be offset by--and thus may 
not be fully taxed in the United States as a result of--foreign tax 
credits and, in the case of GILTI, the section 250 deduction.\11\ 
Therefore, this option for reducing hybrid deduction accounts may 
result in some income that was sheltered from foreign tax due to hybrid 
arrangements also escaping full U.S. taxation. This double non-taxation 
is economically inefficient because otherwise similar activities are 
taxed differently, potentially leading to inefficient business 
decisions.
---------------------------------------------------------------------------

    \11\ Deductions or credits are not available to offset income 
inclusions under sections 951(a)(1)(B) and 956, the third category 
of income inclusions that reduce hybrid deduction accounts addressed 
by these final regulations.
---------------------------------------------------------------------------

    A third option, which is the option finalized by the Treasury 
Department and the IRS, is to reduce hybrid deduction accounts by the 
amount of the inclusions from the three categories, but only to the 
extent that the inclusions are likely not offset by foreign tax credits 
or, in the case of GILTI, the section 250 deduction. For subpart F and 
GILTI inclusions, the final regulations stipulate adjustments to be 
made to account for the foreign tax credits and the section 250 
deduction available for GILTI inclusions. These adjustments are 
intended to provide a precise, administrable manner for measuring the 
extent to which a subpart F or GILTI inclusion is included in U.S. 
income and not shielded by foreign tax credits or deductions. This 
option results in an outcome aligned with statutory intent, as it 
generally ensures that the section 245A DRD is disallowed (and thus a 
dividend is included in U.S. income without any regard for foreign tax 
credits) only for amounts that were sheltered from foreign tax by 
reason of a hybrid arrangement but that have not yet been subject to 
U.S. tax.
    Relative to a no-action baseline, these final regulations provide 
taxpayers with new instructions regarding how to adjust hybrid 
deduction accounts to account for earnings and profits that are 
included in U.S. income by reason of certain provisions other than 
section 245A(e). This new instruction avoids possible double taxation. 
Double taxation is inconsistent with the intent and purpose of the 
statute and is economically inefficient because it may result in 
otherwise similar income streams facing different tax treatment, 
incentivizing taxpayers to finance operations with specific income 
streams and activities that may not be the most economically 
productive.
    The Treasury Department and the IRS have not estimated the 
difference in compliance costs under each of the three options for the 
treatment of earnings and profits included in U.S. income due to 
provisions other than section 245A(e) because they do not have readily 
available data or models that can provide such estimates.
c. Number of Affected Taxpayers
    The Treasury Department and IRS estimate that this provision will 
impact an upper bound of approximately 2,000 taxpayers. This estimate 
is based on the top 10 percent of taxpayers (by gross receipts) that 
filed a domestic corporate income tax return for tax year 2017 with a 
Form 5471 attached, because only domestic corporations that are U.S. 
shareholders of CFCs are potentially affected by section 245A(e).\12\
---------------------------------------------------------------------------

    \12\ 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.
---------------------------------------------------------------------------

    This estimate is an upper bound on the number of large corporations 
affected because it is 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 were part of a hybrid 
arrangement because such information was not relevant for calculating 
tax before the TCJA. In addition, this estimate is an upper bound 
because the Treasury Department and the IRS anticipate that fewer 
taxpayers would engage in hybrid arrangements going forward as the 
statute and Sec.  1.245A(e)-1 would make such arrangements less 
beneficial to taxpayers. Further, it is anticipated that the final 
regulations will result in only a small increase in compliance costs 
for those taxpayers who do engage in hybrid arrangements (relative to 
the baseline) because a reduction to hybrid deduction accounts under 
these final regulations generally uses information required to be 
computed under other provisions of the Code.
v. Conduit Financing Regulations To Address Hybrid Instruments
a. Background
    The conduit financing regulations allow the IRS to disregard 
intermediate entities in a multiple-party financing arrangement for the 
purposes of determining withholding tax rates if the instruments used 
in the arrangement are considered ``financing transactions.'' Financing 
transactions generally exclude instruments that are treated as equity 
for U.S. tax purposes unless they have significant redemption-type 
features. Thus, in the absence of further guidance, the conduit 
financing regulations would not apply to an equity instrument in the 
absence of such features. This would allow payments made under these 
arrangements to continue to be eligible for reduced withholding tax 
rates through a conduit structure.
b. Options Considered for the Final Regulations
    One option for addressing the current disparate treatment would be 
to not change the conduit financing regulations, which currently treat 
equity as a financing transaction only if it has specific redemption-
type features; this is the no-action baseline. This option is not 
adopted by the Treasury Department and the IRS, since it is 
inconsistent with the Treasury Department's and the IRS's ongoing 
efforts to address financing transactions that use hybrid instruments, 
as discussed in the 2008 proposed regulations.
    A second option, which is adopted in the final regulations, is to 
treat as a financing transaction an instrument that is equity for U.S. 
tax purposes but debt under the tax law of the issuer's jurisdiction of 
residence or, if the issuer is not a tax resident of any country, the 
tax law of the country in which the issuer is created, organized or 
otherwise established. This approach will prevent taxpayers from using 
this type of hybrid instrument to engage in treaty shopping through a 
conduit jurisdiction. However, this approach does not cover certain 
cases, such as if a jurisdiction offers a tax benefit to non-debt 
instruments (for example, a notional interest deduction with respect to 
equity). The Treasury Department and the IRS adopt this second option 
in these final regulations because it will, in a manner that is clear 
and

[[Page 72026]]

administrable, prevent a basic form of inappropriate avoidance of the 
conduit financing regulations.
    A third option considered, which was proposed in the 2020 hybrids 
proposed regulations, would be to treat as a financing transaction any 
instrument that is equity for U.S. tax purposes and which entitles its 
issuer or its shareholder a deduction or similar tax benefit in the 
issuer's resident jurisdiction or in the jurisdiction where the 
resident has a permanent establishment. This rule would be broader than 
the second option. It would cover all instruments that give rise to 
deductions or similar tax benefits, such as credits, rather than only 
those instruments that are treated as debt under foreign law. This rule 
would also cover instruments where a financing payment is attributable 
to a permanent establishment of the issuer, and the tax law of the 
permanent establishment's jurisdiction allows a deduction or similar 
treatment for the instrument. This approach would prevent issuers from 
routing transactions through their permanent establishments to avoid 
the anti-conduit rules. The Treasury Department and the IRS did not 
adopt this third option in these final regulations. As discussed in 
Part III.B of the Summary of Comments and Explanation of Revisions, the 
Treasury Department and the IRS plan to finalize this rule separately 
to allow additional time to consider the comments received.
    Relative to a no-action baseline, the final regulations are likely 
to incentivize some taxpayers to shift away from conduit financing 
arrangements and hybrid arrangements, a shift that is likely to result 
in little to no overall economic loss, or even an economic gain, 
because conduit arrangements are generally not economically productive 
arrangements and are typically pursued only for tax-related reasons. 
The Treasury Department and the IRS recognize, however, that as a 
result of these provisions, some taxpayers may face a higher effective 
tax rate, which may lower their economic activity.
    The Treasury Department and the IRS have not undertaken more 
precise quantitative estimates of either of these economic effects 
because they do not have readily available data or models to estimate 
with reasonable precision: (i) The types or volume of conduit 
arrangements that taxpayers would likely use under the final 
regulations or under the no-action baseline; or (ii) the effects of 
those arrangements on businesses' overall economic performance, 
including possible differences in compliance costs.
c. Number of Affected Taxpayers
    The Treasury Department and the IRS estimate that the number of 
taxpayers potentially affected by the final conduit financing 
regulations will be an upper bound of approximately 7,000 taxpayers. 
This estimate is based on the top 10 percent of taxpayers (by gross 
receipts) 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,'' attached 
because primarily foreign entities that advance money or other property 
to a related U.S. entity through one or more foreign intermediaries are 
potentially affected by the conduit financing regulations.\13\
---------------------------------------------------------------------------

    \13\ Because of the complexities involved, primarily only large 
taxpayers engage in conduit financing arrangements. The estimate 
that the top 10 percent of otherwise-relevant taxpayers (by gross 
receipts) are likely to engage in conduit financing arrangements is 
based on the judgment of the Treasury Department and IRS.
---------------------------------------------------------------------------

    This estimate is an upper bound on the number of large corporations 
affected because it is based on all domestic corporate arrangements 
involving foreign related parties, even though only a portion of such 
arrangements are conduit financing arrangements that use hybrid 
instruments. The tax data do not report whether these arrangements were 
part of a conduit financing arrangement because such information is not 
provided on tax forms. In addition, this estimate is an upper bound 
because the Treasury Department and the IRS anticipate that fewer 
taxpayers would engage in conduit financing arrangements that use 
hybrid instruments going forward as the proposed conduit financing 
regulations would make such arrangements less beneficial to taxpayers.
vi. Rules Under Section 951A To Address Certain Disqualified Payments 
Made During the Disqualified Period
a. Background
    The final section 951A regulations include a rule that addresses 
certain transactions involving disqualified transfers of property 
between related CFCs during the disqualified period that may have the 
effect of reducing GILTI inclusions due to timing differences between 
when income is included and when resulting deductions, such as 
depreciation expenses, are claimed. The disqualified period of a CFC is 
the period between December 31, 2017, which is the last earnings and 
profits measurement date under section 965, and the beginning of the 
CFC's first taxable year that begins after December 31, 2017, which is 
the first taxable year with respect to which section 951A is effective. 
The final regulations refine this rule to extend its applicability to 
other transactions for which similar timing differences can arise.
b. Options Considered for the Final Regulations
    The Treasury Department and the IRS considered two options with 
respect to providing a rule that would apply to certain transactions 
during the disqualified period in addition to disqualified transfers. 
The first option was to not provide a rule that would apply to 
additional transactions. This option was not adopted in the final 
regulations, since it would result in certain transactions involving 
payments during the disqualified period giving rise to reduced GILTI 
inclusions simply due to timing differences. In addition, this option 
would not provide a similar tax treatment for transactions involving 
payments as for disqualified transfers of property occurring during the 
disqualified period.
    The second option, which is the option adopted in the final 
regulations, is to provide an identical rule for disqualified payments 
between related CFCs as was provided in the section 951A final 
regulations for disqualified transfers of property between related CFCs 
during the disqualified period. This symmetry helps to ensure that 
similar economic transactions are treated similarly.
    In the absence of such a rule, certain payments between related 
CFCs made during the disqualified period may give rise to lower income 
inclusions for their U.S. shareholders. For example, suppose that a CFC 
licensed property to a related CFC for ten years and received pre-
payments of royalties during the disqualified period from the related 
CFC. Since these prepayments were received by the licensor CFC during 
the disqualified period, they would not have affected amounts included 
under section 965 nor given rise to GILTI tested income. However, the 
licensee CFC that made the payments would not have claimed the total of 
the corresponding deductions during the disqualified period, since the 
timing of deductions are generally tied to economic performance over 
the period of use. The licensee CFC would claim deductions over the ten 
years of the contract, and since these deductions would be claimed 
during taxable years when section 951A is in effect, these deductions 
would reduce GILTI tested income or increase GILTI tested loss. Thus, 
this type of transaction could

[[Page 72027]]

lower overall income inclusions for the U.S. shareholder of these CFCs 
in a manner that does not accurately reflect the earnings of the CFCs 
over time.
    Under the final regulations, all deductions attributable to 
disqualified payments to a related CFC during the disqualified period 
are allocated and apportioned to residual CFC gross income. These 
deductions will not thereby reduce tested, subpart F or effectively 
connected income. This rule provides similar treatment to transactions 
involving payments as the rule in the section 951A final regulations 
provides to property transfers between related CFCs during the 
disqualified period.
    Relative to a no-action baseline, the final regulations harmonize 
the treatment of similar transactions. Since this rule applies to 
deductions resulting from transactions that occurred during the 
disqualified period and not to any new transactions, the Treasury 
Department and the IRS do not expect changes in taxpayer behavior under 
the final regulations, relative to the no-action baseline.
c. Number of Affected Taxpayers
    The Treasury Department and the IRS estimate that the number of 
taxpayers potentially affected by this rule will be an upper bound of 
approximately 25,000 to 35,000 taxpayers. This estimate is based on 
filers of income tax returns with a Form 5471 attached because only 
filers that are U.S. shareholders of CFCs or that have at least a 10 
percent ownership in a foreign corporation would be subject to section 
951A. This estimate is an upper bound because it is based on all filers 
subject to section 951A, even though only a portion of such taxpayers 
may have engaged in the pre-payment transactions during the 
disqualified period described in the proposed regulations. Therefore, 
the Treasury Department and the IRS estimate that the number of 
taxpayers potentially affected by this rule will be substantially less 
than 25,000 to 35,000 taxpayers.

II. Paperwork Reduction Act

A. Regulations Relating to Foreign Tax Credits

    For purposes of the Paperwork Reduction Act of 1995 (44 U.S.C. 
3507(d)) (``PRA''), there is a collection of information in Sec. Sec.  
1.905-4 and 1.905-5(b) and (e). When a redetermination of U.S. tax 
liability is required by reason of a foreign tax redetermination (FTR), 
the final regulations generally require the taxpayer to notify the IRS 
of the FTR and provide certain information necessary to redetermine the 
U.S. tax due for the year or years affected by the FTR. If there is no 
change in the U.S. tax liability as a result of the FTR or if the FTR 
is caused by certain de minimis fluctuations in foreign currency rates, 
the taxpayer may simply attach the notification to their next filed tax 
return and make any appropriate adjustments in that year. However, 
taxpayers are generally required to file an amended return (or an 
administrative adjustment request in the case of certain partnerships) 
for the year or years affected by the FTR along with an updated Form 
1116 Foreign Tax Credit (Individual, Estate, or Trust) (covered under 
OMB Control Number 1545-0074 individual, or 1545-0121 and 1545-0092 
estate and trust) or Form 1118 Foreign Tax Credit-Corporations (OMB 
Control Number 1545-0123), and a written statement providing specific 
information relating to the FTR (covered under OMB Control Number 1545-
1056). Since the burden for filing amended income tax returns and the 
Forms 1116 and 1118 is covered under the OMB Control Numbers listed in 
the prior sentence, the burden estimates for OMB Control Number 1545-
1056 only cover the burden for the written statements. Sections 1.905-
5(b) and 1.905-5(e) only apply to foreign tax redeterminations of 
foreign corporations that relate to a taxable year of the foreign 
corporation beginning before January 1, 2018. Section 1.905-4 applies 
to all other foreign tax redeterminations. Section 1.905-5(b) and (e) 
reference the same notification and information requirements as Sec.  
1.905-4, subject to certain modifications.
    For purposes of the PRA, the reporting burden associated with 
Sec. Sec.  1.905-4 and 1.905-5(b) and (e) will be reflected in the PRA 
submission associated with OMB control number 1545-1056, which is set 
to expire on December 31, 2020. The number of respondents to this 
collection was estimated to be in a range from 8,900 to 13,500 and the 
total estimated burden time was estimated to be 56,000 hours and total 
estimated monetized costs of $2,583,840 ($2017). The IRS will be 
requesting a revision of the paperwork burden under OMB control number 
1545-1056 prior to its expiration date.
    For taxpayers who are required to file an amended return (along 
with related Form 1116 or Form 1118) in order to report an FTR, and for 
purposes of the PRA, the reporting burden for filing the amended return 
will be reflected in OMB control numbers 1545-0123 (relating to 
business filers, which represents a total estimated burden time, 
including all related forms and schedules, of 3.344 billion hours and 
total estimated monetized costs of $61.558 billion ($2019)), 1545-0074 
(relating to individual filers, which represents a total estimated 
burden time, including all related forms and schedules, of 1.717 
billion hours and total estimated monetized costs of $33.267 billion 
($2019)), 1545-0092 (relating to estate and trust filers with respect 
to all related forms and schedules except Form 1116, which represents a 
total estimated burden time, including all related forms and schedules 
except Form 1116, of 307,844,800 hours and total estimated monetized 
costs of $14.077 billion ($2018)), and 1545-0121 (relating to estate 
and trust filers but solely with respect to Form 1116, which represents 
a total estimated burden time related solely to Form 1116 of 25,066,693 
hours and total estimated monetized costs of $1.744 billion ($2018)). 
In general, burden estimates for OMB control numbers 1545-0123 and 
1545-0074 include, and therefore do not isolate, the estimated burden 
of the foreign tax credit-related forms. These reported burdens are 
therefore insufficient for future calculations of the burden imposed by 
the final regulations. However, with respect to estate and trust filers 
(OMB control numbers 1545-0121 and 1545-0092) the burdens with respect 
to foreign tax credit-related forms are isolated in OMB control number 
1545-0121 which relates solely to Form 1116, and, therefore may be 
sufficient to determine future burdens imposed by the final 
regulations. These particular burden estimates, except OMB control 
number 1545-0121, have also been reported for other regulations related 
to the taxation of cross-border income and the Treasury Department and 
the IRS urge readers to recognize that these numbers are duplicates and 
to guard against overcounting the burden that international tax 
provisions imposed prior to the TCJA.
    As a result of the changes made in the TCJA to the foreign tax 
credit rules generally, and to section 905(c) specifically, the 
Treasury Department and the IRS anticipate that the number of 
respondents may increase among taxpayers who file Form 1120 series 
returns. The possible increase in the number of respondents is due to 
the increase in foreign tax credits claimed by taxpayers in connection 
with the new GILTI regime and the elimination of adjustments to pools 
of post-1986 earnings and profits and post-1986 foreign income taxes as 
an alternative to filing an amended return following the changes made 
in the TCJA. These

[[Page 72028]]

changes to the burden estimate will be reflected in the PRA submission 
for the renewal of OMB control number 1545-1056 as well as in the OMB 
control numbers 1545-0074 (for individuals) and 1545-0123 (for business 
taxpayers).
    The estimates for the number of impacted filers with respect to the 
collections of information described in this Part II of the Special 
Analyses are based on filers of income tax returns that file a Form 
1065, Form 1040, or Form 1120 series for years 2015 through 2017 
because only filers of these forms are generally subject to the 
collection of information requirement. The IRS estimates the number of 
impacted filers to be the following:

                           Tax Forms Impacted
------------------------------------------------------------------------
                                    Number of        Forms to which the
   Collection of information       respondents       information may be
                                   (estimated)            attached
------------------------------------------------------------------------
Sec.   1.905-4................      8,900--13,500  Form 1065 series,
                                                    Form 1040 series,
                                                    and Form 1120
                                                    series.
Sec.   1.905-5(b).............      8,900--13,500  Form 1065 series,
                                                    Form 1040 series,
                                                    and Form 1120
                                                    series.
Sec.   1.905-5(e).............      8,900--13,500  Form 1065 series,
                                                    Form 1040 series,
                                                    and Form 1120
                                                    series.
------------------------------------------------------------------------
Source: IRS data (MeF, DCS, and Compliance Data Warehouse).

    No burden estimates specific to the final regulations are currently 
available. The Treasury Department and the IRS have not estimated the 
burden, including that of any new information collections, related to 
the requirements under the final regulations. Those estimates would 
capture both changes made by the TCJA 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 the forms that reflect the information collection burdens related to 
the final regulations, including estimates for how much time it would 
take to comply with the paperwork burdens related to the forms 
described and ways for the IRS to minimize the paperwork burden. 
Proposed revisions (if any) to these forms that reflect the information 
collections related to the 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.

B. Regulations Relating to Hybrid Arrangements and Section 951A

    Pursuant to Sec.  1.6038-2(f)(14), certain U.S. shareholders of a 
CFC must provide information relating to the CFC and the rules of 
section 245A(e) on Form 5471, ``Information Return of U.S. Persons With 
Respect to Certain Foreign Corporations,'' (OMB control number 1545-
0123), as the form or other guidance may prescribe. The final 
regulations do not impose any additional information collection 
requirements relating to section 245A(e). However, the final 
regulations provide guidance regarding certain computations required 
under section 245A(e), and such could affect the information required 
to be reported on Form 5471. For purposes of the PRA, the reporting 
burden associated with Sec.  1.6038-2(f)(14) is reflected in the PRA 
submission for Form 5471. See the chart at the end of this Part II.B of 
this Special Analyses section for the status of the PRA submission for 
Form 5471. As described in the Special Analyses section in the 2020 
hybrids final regulations, and as set forth in the chart below, the 
Treasury Department and the IRS estimate the number of affected filers 
to be 2,000.
    Pursuant to Sec.  1.6038-5, certain U.S. shareholders of a CFC must 
provide information relating to the CFC and the U.S. shareholder's 
GILTI inclusion under section 951A on new Form 8992, ``U.S. Shareholder 
Calculation of Global Intangible Low-Taxed Income (GILTI),'' (OMB 
control number 1545-0123), as the form or other guidance may prescribe. 
The final regulations do not impose any additional information 
collection requirements relating to section 951A. However, the final 
regulations provide guidance regarding computations required under 
section 951A for taxpayers who engaged in certain transactions during 
the disqualified period, and such guidance could affect the information 
required to be reported by these taxpayers on Form 8992. For purposes 
of the PRA, the reporting burden associated with the collection of 
information under Sec.  1.6038-5 is reflected in the PRA submission for 
Form 8992. See the chart at the end of this Part II.B of the Special 
Analyses for the status of the PRA submission for Form 8992. As 
discussed in the Special Analyses of the preamble to the proposed 
regulations under section 951A (REG-104390-18, 83 FR 51072), and as set 
forth in the chart below, the Treasury Department and the IRS estimate 
the number of filers subject to Sec.  1.6038-5 to be 25,000 to 35,000. 
Since the final regulations only apply to taxpayers who engaged in 
certain transactions during the disqualified period, the Treasury 
Department and the IRS estimate that the number of filers affected by 
the final regulations and subject to the collection of information in 
Sec.  1.6038-5 will be significantly less than 25,000 to 35,000.
    There is no existing collection of information relating to conduit 
financing arrangements, and the final regulations do not impose any new 
information collection requirements relating to conduit financing 
arrangements. Therefore, a PRA analysis is not required with respect to 
the final regulations relating to conduit financing arrangements. As a 
result, the Treasury Department and the IRS estimate the number of 
filers affected by the final regulations for hybrid arrangements and 
section 951A to be the following.

                                               Tax Forms Impacted
----------------------------------------------------------------------------------------------------------------
                                                  Number of respondents
           Collection of information              (estimated, rounded to     Forms in which information may be
                                                      nearest 1,000)                     collected
----------------------------------------------------------------------------------------------------------------
Sec.   1.6038-2(f)(14).........................                    2,000  Form 5471 (Schedule I).
Sec.   1.6038-5................................           25,000--35,000  Form 8992.
----------------------------------------------------------------------------------------------------------------
Source: IRS data (MeF, DCS, and Compliance Data Warehouse).


[[Page 72029]]

    The current status of the PRA submissions related to the tax forms 
associated with the information collections in Sec. Sec.  1.6038-
2(f)(14) and 1.6038-5 is provided in the accompanying table. The 
reporting burdens associated with the information collections in 
Sec. Sec.  1.6038-2(f)(14) and 1.6038-5 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 in 
1545-0123 are aggregate amounts that relate to the entire package of 
forms associated with the OMB control number, and are therefore not 
suitable for future calculations needed to assess the burden specific 
to certain regulations, such as the information collections under Sec.  
1.6038-2(f)(14) or Sec.  1.6038-5.
    No burden estimates specific to the final regulations are currently 
available. The Treasury Department and the 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. Changes in those estimates from 
the estimates reported here will capture both changes made by the TCJA 
and those that arise out of discretionary authority exercised in the 
final regulations.
    The Treasury Department and the IRS request comments on the forms 
that reflect the information collection burdens related to the final 
regulations, including estimates for how much time it would take to 
comply with the paperwork burdens related to the forms described and 
ways for the IRS to minimize the paperwork burden. Proposed revisions 
(if any) to these forms that reflect the information collections 
related to the 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 No.(s)              Status
----------------------------------------------------------------------------------------------------------------
Form 5471...............................  Business (NEW Model)......       1545-0123  Approved by OIRA 1/30/2020
                                                                                       until 1/31/2021.
                                         -----------------------------------------------------------------------
                                          Link: https://www.reginfo.gov/public/do/PRAViewICR?ref_nbr=201907-1545-001 001
                                         -----------------------------------------------------------------------
                                          Individual (NEW Model)....       1545-0074  Approved by OIRA 1/30/2020
                                                                                       until 1/31/2021.
                                         -----------------------------------------------------------------------
                                          Link: https://www.reginfo.gov/public/do/PRAViewICR?ref_nbr=201909-1545-021 021
                                         -----------------------------------------------------------------------
Form 8992...............................  Business (NEW Model)......       1545-0123  Approved by OIRA 1/30/2020
                                                                                       until 1/31/2021.
                                         -----------------------------------------------------------------------
                                          Link: https://www.reginfo.gov/public/do/PRAViewICR?ref_nbr=201907-1545-001 001
----------------------------------------------------------------------------------------------------------------

III. Regulatory Flexibility Act

    Pursuant to the Regulatory Flexibility Act (5 U.S.C. chapter 6), it 
is hereby certified that these final regulations 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.

A. Regulations Relating to Foreign Tax Credits

    These final regulations provide guidance needed to comply with 
statutory changes and affect individuals and corporations claiming 
foreign tax credits. The domestic small business entities that are 
subject to the foreign tax credit rules in the Code and in these final 
regulations are generally those domestic small business entities that 
are at least 10 percent corporate shareholders of foreign corporations, 
and so are eligible to claim dividends-received deductions or compute 
foreign taxes deemed paid under section 960 with respect to inclusions 
under subpart F and section 951A from CFCs. Other aspects of these 
final regulations also affect domestic small business entities that 
operate in foreign jurisdictions or that have income from sources 
outside of the United States. Based on 2017 Statistics of Income data, 
the Treasury Department and the IRS computed the fraction of taxpayers 
owning a CFC by gross receipts size class. The smaller size classes 
have a relatively small fraction of taxpayers that own CFCs, which 
suggests that many domestic small business entities would be unaffected 
by these regulations.
    Many of the important aspects of these final regulations, including 
all of the rules in Sec. Sec.  1.861-8(d)(2)(ii)(B), 1.904-4(c)(7), 
1.904-6(f), 1.905-3(b)(2), 1.905-5, 1.954-1, 1.954-2, and 1.965-5(b)(2) 
apply only to U.S. persons that operate a foreign business in corporate 
form, and, in most cases, only if the foreign corporation is a CFC. 
Other provisions in these final regulations, including the rules in 
Sec. Sec.  1.861-8(d)(2)(v) and (e)(16), 1.861-14, 1.1502-4, and 
1.1502-21, generally apply only to members of a consolidated group and 
insurance companies or other members of the financial services industry 
earning income from sources outside of the United States. It is 
infrequent for domestic small entities to operate as part of an 
affiliated group, to be taxed as an insurance company, or to constitute 
a financial services entity, and also earn income from sources outside 
of the United States. Consequently, the Treasury Department and the IRS 
expect that these final regulations are unlikely to affect a 
substantial number of domestic small business entities; however, 
adequate data are not available at this time to certify that a 
substantial number of small entities would be unaffected.
    The Treasury Department and the IRS have determined that these 
final regulations will not have a significant economic impact on 
domestic small business entities. Based on published information from 
2017, foreign tax credits as a percentage of three different tax-
related measures of annual receipts (see Table for variables) by 
corporations are substantially less than the 3 to 5 percent threshold 
for significant economic impact for businesses in all categories of 
business receipts. The amount of foreign tax credits in 2017 is an 
upper bound on the change in foreign tax credits resulting from these 
final regulations.

[[Page 72030]]



--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                               $500,000   $1,000,000   $5,000,000  $10,000,000   $50,000,000  $100,000,000
          Size  (by business receipts)               Under       under       under       under        under         under         under     $250,000,000
                                                   $500,000   $1,000,000  $5,000,000  $10,000,000  $50,000,000  $100,000,000  $250,000,000     or more
--------------------------------------------------------------------------------------------------------------------------------------------------------
FTC/Total Receipts..............................       0.12%       0.00%       0.00%        0.01%        0.01%         0.01%         0.02%         0.28%
FTC/(Total Receipts-Total Deductions)...........       0.61%       0.03%       0.09%        0.05%        0.35%         0.71%         1.38%         9.89%
FTC/Business Receipts...........................       0.84%       0.00%       0.00%        0.00%        0.01%         0.01%         0.02%         0.05%
--------------------------------------------------------------------------------------------------------------------------------------------------------
Source: RAAS: KDA: (Tax Year 2017 SOI Data).

    Although Sec.  1.905-4 contains a collection of information 
requirement, the small businesses that are subject to the requirements 
of Sec.  1.905-4 are domestic small entities with significant foreign 
operations. The data to assess precise counts of small entities 
affected by Sec.  1.905-4 are not readily available. However, as 
demonstrated in the accompanying Table in this Part III, foreign tax 
credits do not have a significant economic impact for any gross-
receipts class of business entities. Accordingly, it is hereby 
certified that the requirements of Sec.  1.905-4 will not have a 
significant economic impact on a substantial number of small entities.
    Pursuant to section 7805(f), the proposed regulations preceding 
these final regulations (REG-105495-19) were submitted to the Chief 
Counsel for Advocacy of the Small Business Administration for comment 
on its impact on small businesses and no comments were received.

B. Regulations Relating to Hybrid Arrangements and Section 951A

    The final regulations amend certain computations required under 
section 245A(e) or section 951A. As discussed in the Special Analyses 
accompanying the preambles to the 2020 hybrids final regulations and 
the proposed regulations under section 951A (REG-104390-18, 83 FR 
51072), as well as in Part II.B of the Special Analyses, the Treasury 
Department and the IRS project that a substantial number of domestic 
small business entities will not be subject to sections 245A(e) and 
951A, and therefore, the existing requirements in Sec. Sec.  1.6038-
2(f)(14) and 1.6038-5 will not have a significant economic impact on a 
substantial number of small entities.
    The small entities that are subject to section 245A(e) and Sec.  
1.6038-2(f)(14) are controlling U.S. shareholders of a CFC that engage 
in a hybrid arrangement, and the small entities that are subject to 
section 951A and Sec.  1.6038-5 are U.S. shareholders of a CFC. A CFC 
is a foreign corporation in which more than 50 percent of its stock is 
owned by U.S. shareholders, measured either by value or voting power. A 
U.S. shareholder is any U.S. person that owns 10 percent or more of a 
foreign corporation's stock, measured either by value or voting power, 
and a controlling U.S. shareholder of a CFC is a U.S. person that owns 
more than 50 percent of the CFC's stock.
    The Treasury Department and the IRS estimate that there are only a 
small number of taxpayers having gross receipts below either $25 
million (or $41.5 million for financial entities) who would potentially 
be affected by these regulations.\14\ The Treasury Department and the 
IRS's estimate of those entities who could potentially be affected is 
based on their review of those taxpayers who filed a domestic corporate 
income tax return in 2016 with gross receipts below either $25 million 
(or $41.5 million for financial institutions) who also reported 
dividends on a Form 5471. The Treasury Department and the IRS estimate 
that this number is between 1 and 6 percent of all affected entities 
regardless of size.
---------------------------------------------------------------------------

    \14\ 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 received pursuant to hybrid arrangements 
because those amounts are not separately reported on tax forms. Thus, 
dividends received as reported on Form 5471 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, 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 of the small entities 
described 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.
    Pursuant to section 7805(f), the proposed regulations preceding 
these final regulations (REG-106013-19) were submitted to the Chief 
Counsel for Advocacy of the Small Business Administration for comment 
on its impact on small businesses and no comments were received.

IV. Unfunded Mandates Reform Act

    Section 202 of the Unfunded Mandates Reform Act of 1995 (UMRA) 
requires that agencies assess anticipated costs and benefits and take 
certain other actions before issuing a final rule that includes any 
Federal mandate that may result in expenditures in any one year by a 
state, local, or tribal government, in the aggregate, or by the private 
sector, of $100 million in 1995 dollars, updated annually for 
inflation. This rule does not include any Federal mandate that may 
result in expenditures by state, local, or tribal governments, or by 
the private sector in excess of that threshold.

V. Executive Order 13132: Federalism

    Executive Order 13132 (entitled ``Federalism'') prohibits an agency 
from publishing any rule that has federalism implications if the rule 
either imposes substantial, direct compliance costs on state and local 
governments, and is not required by statute, or preempts state law, 
unless the agency meets the consultation and funding requirements of 
section 6 of the Executive order. This rule does not have federalism 
implications and does not impose substantial direct compliance costs on 
state and local governments or preempt state law within the meaning of 
the Executive order.

VI. Congressional Review Act

    The Administrator of the Office of Information and Regulatory 
Affairs of the OMB has determined that this Treasury decision is a 
major rule for purposes of the Congressional Review Act (5 U.S.C. 801 
et seq.) (``CRA''). Under section 801(3) of the CRA, a major rule takes 
effect 60 days after the rule is published in the Federal Register. 
Accordingly, the Treasury Department and IRS are adopting these final 
regulations with the delayed

[[Page 72031]]

effective date generally prescribed under the Congressional Review Act.

Drafting Information

    The principal authors of the final regulations are Corina Braun, 
Karen J. Cate, Jeffrey P. Cowan, Jorge M. Oben, Richard F. Owens, 
Jeffrey L. Parry, Tracy M. Villecco, Suzanne M. Walsh, and Andrew L. 
Wigmore of the Office of Associate Chief Counsel (International). 
However, other personnel from the Treasury Department and the IRS 
participated in their development.

List of Subjects

26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

26 CFR Part 301

    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 revising 
the entry for Sec.  1.861-14 and adding an entry for Sec.  1.905-4 in 
numerical order to read in part as follows:

    Authority:  26 U.S.C. 7805.
* * * * *
    Section 1.861-14 also issued under 26 U.S.C. 864(e)(7).
* * * * *
    Section 1.905-4 also issued under 26 U.S.C. 989(c)(4), 26 U.S.C. 
6227(d), 26 U.S.C. 6241(11), and 26 U.S.C. 6689(a).
* * * * *
0
Par. 2. Section 1.245A(e)-1 is amended by:
0
1. Adding paragraphs (d)(4)(i)(B) and (d)(4)(ii).
0
2. Adding a sentence at the end of the introductory text of paragraph 
(g).
0
3. Adding paragraphs (g)(1)(v) and (h)(2).
    The additions read as follows:


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

* * * * *
    (d) * * *
    (4) * * *
    (i) * * *
    (B) Second, the account is decreased (but not below zero) pursuant 
to the rules of paragraphs (d)(4)(i)(B)(1) through (3) of this section, 
in the order set forth in this paragraph (d)(4)(i)(B).
    (1) Adjusted subpart F inclusions--(i) In general. Subject to the 
limitation in paragraph (d)(4)(i)(B)(1)(ii) of this section, the 
account is reduced by an adjusted subpart F inclusion with respect to 
the share for the taxable year, as determined pursuant to the rules of 
paragraph (d)(4)(ii) of this section.
    (ii) Limitation. The reduction pursuant to paragraph 
(d)(4)(i)(B)(1)(i) of this section cannot exceed the hybrid deductions 
of the CFC allocated to the share for the taxable year multiplied by a 
fraction, the numerator of which is the sum of the items of gross 
income of the CFC that give rise to subpart F income (determined 
without regard to an amount treated as subpart F income by reason of 
section 964(e)(4)(A)(i), to the extent that a deduction under section 
245A(a) is allowed for a portion of the amount included under section 
964(e)(4)(A)(ii) in the gross income of a domestic corporation) of the 
CFC for the taxable year and the denominator of which is the sum of all 
the items of gross income of the CFC for the taxable year.
    (iii) Special rule allocating otherwise unused adjusted subpart F 
inclusions across accounts in certain cases. This paragraph 
(d)(4)(i)(B)(1)(iii) applies after each of the specified owner's hybrid 
deduction accounts with respect to its shares of stock of the CFC are 
adjusted pursuant to paragraph (d)(4)(i)(B)(1)(i) of this section but 
before the accounts are adjusted pursuant to paragraph (d)(4)(i)(B)(2) 
of this section, to the extent that one or more of the hybrid deduction 
accounts would have been reduced by an amount pursuant to paragraph 
(d)(4)(i)(B)(1)(i) of this section but for the limitation in paragraph 
(d)(4)(i)(B)(1)(ii) of this section (the aggregate of the amounts that 
would have been reduced but for the limitation, the unused reduction 
amount, and the accounts that would have been reduced by the unused 
reduction amount, the unused reduction amount accounts). When this 
paragraph (d)(4)(i)(B)(1)(iii) applies, the specified owner's hybrid 
deduction accounts other than the unused reduction amount accounts (if 
any) are ratably reduced by the lesser of the unused reduction amount 
and the difference of the following two amounts: The hybrid deductions 
of the CFC allocated to the specified owner's shares of stock of the 
CFC for the taxable year multiplied by the fraction described in 
paragraph (d)(4)(i)(B)(1)(ii) of this section; and the reductions 
pursuant to paragraph (d)(4)(i)(B)(1)(i) of this section with respect 
to the specified owner's shares of stock of the CFC.
    (2) Adjusted GILTI inclusions--(i) In general. Subject to the 
limitation in paragraph (d)(4)(i)(B)(2)(ii) of this section, the 
account is reduced by an adjusted GILTI inclusion with respect to the 
share for the taxable year, as determined pursuant to the rules of 
paragraph (d)(4)(ii) of this section.
    (ii) Limitation. The reduction pursuant to paragraph 
(d)(4)(i)(B)(2)(i) of this section cannot exceed the hybrid deductions 
of the CFC allocated to the share for the taxable year multiplied by a 
fraction, the numerator of which is the sum of the items of gross 
tested income of the CFC for the taxable year and the denominator of 
which is the sum of all the items of gross income of the CFC for the 
taxable year.
    (iii) Special rule allocating otherwise unused adjusted GILTI 
inclusions across accounts in certain cases. This paragraph 
(d)(4)(i)(B)(2)(iii) applies after each of the specified owner's hybrid 
deduction accounts with respect to its shares of stock of the CFC are 
adjusted pursuant to paragraph (d)(4)(i)(B)(2)(i) of this section but 
before the accounts are adjusted pursuant to paragraph (d)(4)(i)(B)(3) 
of this section, to the extent that one or more of the hybrid deduction 
accounts would have been reduced by an amount pursuant to paragraph 
(d)(4)(i)(B)(2)(i) of this section but for the limitation in paragraph 
(d)(4)(i)(B)(2)(ii) of this section (the aggregate of the amounts that 
would have been reduced but for the limitation, the unused reduction 
amount, and the accounts that would have been reduced by the unused 
reduction amount, the unused reduction amount accounts). When this 
paragraph (d)(4)(i)(B)(2)(iii) applies, the specified owner's hybrid 
deduction accounts other than the unused reduction amount accounts (if 
any) are ratably reduced by the lesser of the unused reduction amount 
and the difference of the following two amounts: The hybrid deductions 
of the CFC allocated to the specified owner's shares of stock of the 
CFC for the taxable year multiplied by the fraction described in 
paragraph (d)(4)(i)(B)(2)(ii) of this section; and the reductions 
pursuant to paragraph (d)(4)(i)(B)(2)(i) of this section with respect 
to the specified owner's shares of stock of the CFC. See paragraph 
(g)(1)(v)(C) of this section for an illustration of the application of 
this paragraph (d)(4)(i)(B)(2)(iii).
    (3) Certain section 956 inclusions. The account is reduced by an 
amount included in the gross income of a domestic corporation under 
sections 951(a)(1)(B) and 956 with respect to the share for the taxable 
year of the domestic corporation in which or with which the CFC's 
taxable year ends, to the extent so included by reason of the 
application of section 245A(e) and this

[[Page 72032]]

section to the hypothetical distribution described in Sec.  1.956-
1(a)(2).
* * * * *
    (ii) Rules regarding adjusted subpart F and GILTI inclusions. (A) 
The term adjusted subpart F inclusion means, with respect to a share of 
stock of a CFC for a taxable year of the CFC, a domestic corporation's 
pro rata share of the CFC's subpart F income included in gross income 
under section 951(a)(1)(A) (determined without regard to an amount 
included in gross income by the domestic corporation by reason of 
section 964(e)(4)(A)(ii), to the extent a deduction under section 
245A(a) is allowed for the amount) for the taxable year of the domestic 
corporation in which or with which the CFC's taxable year ends, to the 
extent attributable to the share (as determined under the principles of 
section 951(a)(2) and Sec.  1.951-1(b) and (e)), adjusted (but not 
below zero) by--
    (1) Adding to the amount the associated foreign income taxes with 
respect to the amount; and
    (2) Subtracting from such sum the quotient of the associated 
foreign income taxes divided by the percentage described in section 
11(b).
    (B) The term adjusted GILTI inclusion means, with respect to a 
share of stock of a CFC for a taxable year of the CFC, a domestic 
corporation's GILTI inclusion amount (within the meaning of Sec.  
1.951A-1(c)(1)) for the U.S. shareholder inclusion year (within the 
meaning of Sec.  1.951A-1(f)(7)), to the extent attributable to the 
share (as determined under paragraph (d)(4)(ii)(C) of this section), 
adjusted (but not below zero) by--
    (1) Adding to the amount the associated foreign income taxes with 
respect to the amount;
    (2) Multiplying such sum by the difference of 100 percent and the 
section 250(a)(1)(B)(i) deduction percentage; and
    (3) Subtracting from such product the quotient of 80 percent of the 
associated foreign income taxes divided by the percentage described in 
section 11(b).
    (C) A domestic corporation's GILTI inclusion amount for a U.S. 
shareholder inclusion year is attributable to a share of stock of the 
CFC based on a fraction--
    (1) The numerator of which is the domestic corporation's pro rata 
share of the tested income of the CFC for the U.S. shareholder 
inclusion year, to the extent attributable to the share (as determined 
under the principles of Sec.  1.951A-1(d)(2)); and
    (2) The denominator of which is the aggregate of the domestic 
corporation's pro rata share of the tested income of each tested income 
CFC (as defined in Sec.  1.951A-2(b)(1)) for the U.S. shareholder 
inclusion year.
    (D) The term associated foreign income taxes means--
    (1) With respect to a domestic corporation's pro rata share of the 
subpart F income of the CFC included in gross income under section 
951(a)(1)(A) and attributable to a share of stock of a CFC for a 
taxable year of the CFC, current year tax (as described in Sec.  1.960-
1(b)(4)) allocated and apportioned under Sec.  1.960-1(d)(3)(ii) to the 
subpart F income groups (as described in Sec.  1.960-1(b)(30)) of the 
CFC for the taxable year, to the extent allocated to the share under 
paragraph (d)(4)(ii)(E) of this section; and
    (2) With respect to a domestic corporation's GILTI inclusion amount 
under section 951A attributable to a share of stock of a CFC for a 
taxable year of the CFC, the product of--
    (i) Current year tax (as described in Sec.  1.960-1(b)(4)) 
allocated and apportioned under Sec.  1.960-1(d)(3)(ii) to the tested 
income groups (as described in Sec.  1.960-1(b)(33)) of the CFC for the 
taxable year, to the extent allocated to the share under paragraph 
(d)(4)(ii)(F) of this section;
    (ii) The domestic corporation's inclusion percentage (as described 
in Sec.  1.960-2(c)(2)); and
    (iii) The section 904 limitation fraction with respect to the 
domestic corporation for the U.S. shareholder inclusion year.
    (E) Current year tax allocated and apportioned to a subpart F 
income group of a CFC for a taxable year is allocated to a share of 
stock of the CFC by multiplying the foreign income tax by a fraction--
    (1) The numerator of which is the domestic corporation's pro rata 
share of the subpart F income of the CFC for the taxable year, to the 
extent attributable to the share (as determined under the principles of 
section 951(a)(2) and Sec.  1.951-1(b) and (e)); and
    (2) The denominator of which is the subpart F income of the CFC for 
the taxable year.
    (F) Current year tax allocated and apportioned to a tested income 
group of a CFC for a taxable year is allocated to a share of stock of 
the CFC by multiplying the foreign income tax by a fraction--
    (1) The numerator of which is the domestic corporation's pro rata 
share of tested income of the CFC for the taxable year, to the extent 
attributable to the share (as determined under the principles Sec.  
1.951A-1(d)(2)); and
    (2) The denominator of which is the tested income of the CFC for 
the taxable year.
    (G) The term section 904 limitation fraction means, with respect to 
a domestic corporation for a U.S. shareholder inclusion year, a 
fraction--
    (1) The numerator of which is the amount of foreign tax credits for 
the U.S. shareholder inclusion year that, by reason of sections 901 and 
960(d) and taking into account section 904, the domestic corporation is 
allowed for the separate category set forth in section 904(d)(1)(A) 
(amounts includible in gross income under section 951A); and
    (2) The denominator of which is the amount of foreign tax credits 
for the U.S. shareholder inclusion year that, by reason of sections 901 
and 960(d) and without regard to section 904, the domestic corporation 
would be allowed for the separate category set forth in section 
904(d)(1)(A) (amounts includible in gross income under section 951A).
    (H) The term section 250(a)(1)(B)(i) deduction percentage means, 
with respect to a domestic corporation for a U.S. shareholder inclusion 
year, a fraction--
    (1) The numerator of which is the amount of the deduction under 
section 250 allowed to the domestic corporation for the U.S. 
shareholder inclusion year by reason of section 250(a)(1)(B)(i) (taking 
into account section 250(a)(2)(B)); and
    (2) The denominator of which is the domestic corporation's GILTI 
inclusion amount for the U.S. shareholder inclusion year.
* * * * *
    (g) * * * No amounts are included in the gross income of US1 under 
section 951(a)(1)(A), 951A(a), or 951(a)(1)(B) and section 956.
    (1) * * *

    (v) Alternative facts--account reduced by adjusted GILTI 
inclusion. The facts are the same as in paragraph (g)(1)(i) of this 
section, except that for taxable year 1 FX has $130x of gross tested 
income and $10.5x of current year tax (as described in Sec.  1.960-
1(b)(4)) that is allocated and apportioned under Sec.  1.960-
1(d)(3)(ii) to the tested income groups of FX. US1's ability to 
credit the $10.5x of current year tax is not limited under section 
904(a). In addition, FX has $119.5x of tested income ($130x of gross 
tested income, less the $10.5x of current year tax deductions 
properly allocable to the gross tested income). Further, of US1's 
pro rata share of the tested income ($119.5x), $80x is attributable 
to Share A and $39.5x is attributable to Share B (as determined 
under the principles of Sec.  1.951A-1(d)(2)). Moreover, US1's net 
deemed tangible income return (as defined in Sec.  1.951A-1(c)(3)) 
for taxable year 1 is $71.7x, and US1 does not own any stock of a 
CFC

[[Page 72033]]

other than its stock of FX. Thus, US1's GILTI inclusion amount 
(within the meaning of Sec.  1.951A-1(c)(1)) for taxable year 1, the 
U.S. shareholder inclusion year, is $47.8x (net CFC tested income of 
$119.5x, less net deemed tangible income return of $71.7x) and US1's 
inclusion percentage (as described in Sec.  1.960-2(c)(2)) is 40 
($47.8x/$119.5x). The deduction allowed to US1 under section 250 by 
reason of section 250(a)(1)(B)(i) is not limited as a result of 
section 250(a)(2)(B). At the end of year 1, US1's hybrid deduction 
account with respect to Share A is: First, increased by $80x (the 
amount of hybrid deductions allocated to Share A); and second, 
decreased by $10x (the sum of the adjusted GILTI inclusion with 
respect to Share A, and the adjusted GILTI inclusion with respect to 
Share B that is allocated to the hybrid deduction account with 
respect to Share A) to $70x. See paragraphs (d)(4)(i)(A) and (B) of 
this section. In year 2, 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 ($70x) is at least equal to 
the amount of the dividends ($60x). See paragraph (b)(2) of this 
section. 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 give rise to a hybrid dividend or 
tiered hybrid dividend during year 2) to $10x. See paragraph 
(d)(4)(i)(C) of this section. Paragraphs (g)(1)(v)(A) through (C) of 
this section describe the computations pursuant to paragraph 
(d)(4)(i)(B)(2) of this section.
    (A) To determine the adjusted GILTI inclusion with respect to 
Share A for taxable year 1, it must be determined to what extent 
US1's $47.8x GILTI inclusion amount is attributable to Share A. See 
paragraph (d)(4)(ii)(B) of this section. Here, $32x of the inclusion 
is attributable to Share A, calculated as $47.8x multiplied by a 
fraction, the numerator of which is $80x (US1's pro rata share of 
the tested income of FX attributable to Share A) and denominator of 
which is $119.5x (US1's pro rata share of the tested income of FX, 
its only CFC). See paragraph (d)(4)(ii)(C) of this section. Next, 
the associated foreign income taxes with respect to the $32x GILTI 
inclusion amount attributable to Share A must be determined. See 
paragraphs (d)(4)(ii)(B) and (D) of this section. Such associated 
foreign income taxes are $2.8x, calculated as $10.5x (the current 
year tax allocated and apportioned to the tested income groups of 
FX) multiplied by a fraction, the numerator of which is $80x (US1's 
pro rata share of the tested income of FX attributable to Share A) 
and the denominator of which is $119.5x (the tested income of FX), 
multiplied by 40% (US1's inclusion percentage), multiplied by 1 (the 
section 904 limitation fraction with respect to US1's GILTI 
inclusion amount). See paragraphs (d)(4)(ii)(D), (F), and (G) of 
this section. Thus, pursuant to paragraph (d)(4)(ii)(B) of this 
section, the adjusted GILTI inclusion with respect to Share A is 
$6.7x, computed by--
    (1) Adding $2.8x (the associated foreign income taxes with 
respect to the $32x GILTI inclusion attributable to Share A) to 
$32x, which is $34.8x;
    (2) Multiplying $34.8x (the sum of the amounts in paragraph 
(g)(1)(v)(A)(1) of this section) by 50% (the difference of 100 
percent and the section 250(a)(1)(B)(i) deduction percentage), which 
is $17.4x; and
    (3) Subtracting $10.7x (calculated as $2.24x (80% of the $2.8x 
of associated foreign income taxes) divided by .21 (the percentage 
described in section 11(b)) from $17.4x (the product of the amounts 
in paragraph (g)(1)(v)(A)(2) of this section), which is $6.7x.
    (B) Pursuant to computations similar to those discussed in 
paragraph (g)(1)(v)(A) of this section, the adjusted GILTI inclusion 
with respect to Share B is $3.3x. However, the hybrid deduction 
account with respect to Share B is not reduced by such $3.3x, 
because of the limitation in paragraph (d)(4)(i)(B)(2)(ii) of this 
section, which, with respect to Share B, limits the reduction 
pursuant to paragraph (d)(4)(i)(B)(2)(i) of this section to $0 
(calculated as $0, the hybrid deductions allocated to the share for 
the taxable year, multiplied by 1, the fraction described in 
paragraph (d)(4)(i)(B)(2)(ii) of this section (computed as $130x, 
the sole item of gross tested income, divided by $130x, the sole 
item of gross income)). See paragraphs (d)(4)(i)(B)(2)(i) and (ii) 
of this section.
    (C) US1's hybrid deduction account with respect to Share A is 
reduced by the entire $6.7x adjusted GILTI inclusion with respect to 
the share, as such $6.7x does not exceed the limit in paragraph 
(d)(4)(i)(B)(2)(ii) of this section ($80x, calculated as $80x, the 
hybrid deductions allocated to the share for the taxable year, 
multiplied by 1, the fraction described in paragraph 
(d)(4)(i)(B)(2)(ii) of this section). See paragraphs 
(d)(4)(i)(B)(2)(i) and (ii) of this section. In addition, the hybrid 
deduction account is reduced by another $3.3x, the amount of the 
adjusted GILTI inclusion with respect to Share B that is allocated 
to the hybrid deduction account with respect to Share A. See 
paragraph (d)(4)(i)(B)(2)(iii) of this section. As a result, 
pursuant to paragraph (d)(4)(i)(B)(2) of this section, US1's hybrid 
deduction account with respect to Share A is reduced by $10x ($6.7x 
plus $3.3x).
* * * * *
    (h) * * *
    (2) Special rules. Paragraphs (d)(4)(i)(B) and (d)(4)(ii) of this 
section (decrease of hybrid deduction accounts; rules regarding 
adjusted subpart F and GILTI inclusions) apply to taxable years ending 
on or after November 12, 2020. However, a taxpayer may choose to apply 
paragraphs (d)(4)(i)(B) and (d)(4)(ii) of this section to a taxable 
year ending before November 12, 2020, so long as the taxpayer 
consistently applies paragraphs (d)(4)(i)(B) and (d)(4)(ii) of this 
section to that taxable year and any subsequent taxable year ending 
before November 12, 2020.

0
Par. 3. Section 1.704-1 is amended by:
0
1. In paragraph (b)(1)(ii)(b)(1), revising the fourth sentence and 
adding a new fifth sentence.
0
2. Revising paragraph (b)(4)(viii)(d)(1).
    The revisions and addition read as follows:


Sec.  1.704-1  Partner's distributive share.

* * * * *
    (b) * * *
    (1) * * *
    (ii) * * *
    (b) * * *
    (1) * * * Except as provided in the next sentence, the provisions 
of paragraphs (b)(4)(viii)(a)(1), (b)(4)(viii)(c)(1), 
(b)(4)(viii)(c)(2)(ii) and (iii), (b)(4)(viii)(c)(3) and (4), and 
(b)(4)(viii)(d)(1) (as in effect on July 24, 2019) and in paragraphs 
(b)(6)(i), (ii), and (iii) of this section (Examples 1, 2, and 3) apply 
for partnership taxable years that both begin on or after January 1, 
2016, and end after February 4, 2016. For partnership taxable years 
beginning after December 31, 2019, paragraph (b)(4)(viii)(d)(1) of this 
section applies. * * *
* * * * *
    (4) * * *
    (viii) * * *
    (d) * * * (1) In general. CFTEs are allocated and apportioned to 
CFTE categories in accordance with Sec.  1.861-20 by treating each CFTE 
category as a statutory grouping (with no residual grouping). See 
paragraphs (b)(6)(ii) and (iii) of this section (Examples 2 and 3), 
which illustrate the application of this paragraph (b)(4)(viii)(d)(1) 
in the case of serial disregarded payments subject to withholding tax. 
In addition, if as described in Sec.  1.861-20(e), foreign law does not 
provide for the direct allocation or apportionment of expenses, losses 
or other deductions allowed under foreign law to a CFTE category of 
income, then such expenses, losses or other deductions must be 
allocated and apportioned to gross income as determined under foreign 
law in a manner that is consistent with the allocation and 
apportionment of such items for purposes of determining the net income 
in the CFTE categories for Federal income tax purposes pursuant to 
paragraph (b)(4)(viii)(c)(3) of this section.
* * * * *

0
Par. 4. Section 1.861-8 is amended by:
0
1. Adding a sentence to the end of paragraph (a)(1).
0
2. In paragraph (d)(1), removing the language ``Sec.  1.1502-4(d)(1) 
and the last sentence of'' in the fifth sentence and removing the last 
sentence.
0
3. Revising paragraph (d)(2)(ii)(B).

[[Page 72034]]

0
4. Adding paragraph (d)(2)(v).
0
5. Revising paragraph (e)(4)(ii).
0
6. Redesignating paragraph (e)(5) as paragraph (e)(5)(i).
0
7. Adding a heading for paragraph (e)(5) and paragraphs (e)(5)(ii) and 
(iii).
0
8. Revising the first sentence of paragraph (e)(6)(i) and paragraphs 
(e)(7) and (8).
0
9. Adding paragraphs (e)(16) and (g)(15) through (18).
0
10. Revising paragraph (h).
    The additions and revisions read as follows:


Sec.  1.861-8  Computation of taxable income from sources within the 
United States and from other sources and activities.

    (a) * * *
    (1) * * * The term section 861 regulations means this section and 
Sec. Sec.  1.861-8T, 1.861-9, 1.861-9T, 1.861-10, 1.861-10T, 1.861-11, 
1.861-11T, 1.861-12, 1.861-12T, 1.861-13, 1.861-14, 1.861-14T, 1.861-
17, and 1.861-20.
* * * * *
    (d) * * *
    (2) * * *
    (ii) * * *
    (B) Certain stock and dividends. The term exempt income includes 
the portion of the dividends that are deductible under section 
243(a)(1) or (2) (relating to the dividends received deduction) or 
section 245(a) (relating to the dividends received deduction for 
dividends from certain foreign corporations). Thus, for purposes of 
apportioning deductions using a gross income method, gross income does 
not include a dividend to the extent that it gives rise to a dividends-
received deduction under either section 243(a)(1), section 243(a)(2), 
or section 245(a). In addition, for purposes of apportioning deductions 
using an asset method, assets do not include that portion of the value 
of the stock (determined in accordance with Sec.  1.861-9(g), and, as 
relevant, Sec. Sec.  1.861-12 and 1.861-13) equal to the portion of 
dividends that would be offset by a deduction under either section 
243(a)(1), section 243(a)(2), or section 245(a), to the extent the 
stock generates, has generated, or can reasonably be expected to 
generate such dividends. For example, in the case of stock for which 
all dividends would be allowed a deduction of 50 percent under section 
243(a)(1), 50 percent of the value of the stock is treated as an exempt 
asset. In the case of stock which generates, has generated, or can 
reasonably be expected to generate qualifying dividends deductible 
under section 243(a)(3), such stock does not constitute an exempt 
asset. However, such stock and the qualifying dividends thereon are 
eliminated from consideration in the apportionment of interest expense 
under the affiliated group rule set forth in Sec.  1.861-11T(c), and in 
the apportionment of other expenses under the affiliated group rules 
set forth in Sec.  1.861-14T.
* * * * *
    (v) Dividends-received deduction and tax-exempt interest of 
insurance companies--(A) In general. For purposes of characterizing 
gross income or assets as exempt or not exempt under this section, the 
following rules apply on a company wide basis pursuant to the rules in 
paragraphs (d)(2)(v)(A)(1) and (2) of this section.
    (1) In the case of an insurance company taxable under section 801, 
the term exempt income includes the portion of dividends received that 
satisfy the requirements of deductibility under sections 243(a)(1) and 
(2) and 245(a) but without regard to any disallowance under section 
805(a)(4)(A)(ii) of the policyholder's share of the dividends or any 
similar disallowance under section 805(a)(4)(D), and also includes tax-
exempt interest but without reduction for the policyholder's share of 
tax-exempt interest that reduces the closing balance of items described 
in section 807(c), as provided under section 807(a)(2)(B) and 
807(b)(1)(B). The term exempt assets includes the corresponding portion 
of assets that generates, has generated, or can reasonably be expected 
to generate exempt income described in the preceding sentence. See 
Sec.  1.861-8(e)(16) for a special rule concerning the allocation of 
reserve expenses to dividends received by a life insurance company.
    (2) In the case of an insurance company taxable under section 831, 
the term exempt income includes the portion of interest and dividends 
deductible under sections 832(c)(7) and (12) or sections 834(c)(1) and 
(7). Exempt income also includes the amounts reducing the losses 
incurred under section 832(b)(5) to the extent such amounts are not 
already taken into account in the preceding sentence. The term exempt 
assets includes the corresponding portion of assets that give rise to 
exempt income described in the preceding two sentences.
    (B) Examples. The following examples illustrate the application of 
paragraph (d)(2)(v)(A) of this section.
    (1) Example 1--(i) Facts. U.S.C. is a domestic life insurance 
company that has $300x; of gross income, consisting of $100x of foreign 
source general category income and $200x of U.S. source passive 
category interest income, $100x; of the latter of which is tax-exempt 
interest income from municipal bonds under section 103. U.S.C.'s 
opening balance of its section 807(c) reserves is $50,000x; and USP's 
closing balance of its section 807(c) reserves is $50,130x. Under 
section 807(b)(1)(B), USP's closing balance of its section 807(c) 
reserves, $50,130x, is reduced by the amount of the policyholder's 
share of tax-exempt interest. The policyholder's share of tax-exempt 
interest under section 812(b) is equal to 30 percent of the $100x of 
tax-exempt interest ($30x). Therefore, under sections 803(a)(2) and 
807(b), USP's reserve deduction is $100x ($50,130x of reserve deduction 
minus $30x (30 percent of $100x of tax-exempt interest), minus 
$50,000x). U.S.C. has no other income or deductions.
    (ii) Analysis--allocation. Under section 818(f)(1), U.S.C.'s 
reserve deduction is treated as an item that cannot be definitely 
allocated to an item or class of gross income. Accordingly, under 
paragraph (b)(5) of this section, U.S.C.'s reserve deduction is 
allocable to all of U.S.C.'s gross income as a class.
    (iii) Analysis--apportionment. Under paragraph (c)(3) of this 
section, the reserve deduction is ratably apportioned between the 
statutory grouping (foreign source general category income) and the 
residual grouping (U.S. source income) on the basis of the relative 
amounts of gross income in each grouping. For purposes of apportioning 
deductions under Sec.  1.861-8T(d)(2)(i)(B), exempt income is not taken 
into account. Under paragraph (d)(2)(v)(A)(1) of this section, in the 
case of an insurance company taxable under section 801, exempt income 
includes tax-exempt interest without regard to any reduction for the 
policyholder's share. U.S.C. has U.S. source income of $200x of which 
$100x is tax-exempt without regard to the reduction for the 
policyholder's share of tax-exempt interest that reduces the closing 
balance of items described in section 807(c). Thus, the gross income 
taken into account in apportioning U.S.C.'s reserve deduction is $100x 
of foreign source general category gross income and $100x of U.S. 
source gross income. Of U.S.C.'s $100x reserve deduction, $50x ($100 x 
$100x;/$200x) is apportioned to foreign source general category gross 
income and $50x ($100x x $100x/$200x) is apportioned to U.S. source 
gross income.
    (2) Example 2--(i) Facts. U.S.C. is a domestic life insurance 
company that has $300x of gross income consisting of $10x of foreign 
source general category income and $200x of U.S. source general 
category dividend income eligible for the 50% dividends received

[[Page 72035]]

deduction (DRD) under section 243(a)(1). Under section 
805(a)(4)(A)(ii), U.S.C. is allowed a 50% DRD on the company's share of 
the dividend received. Under section 812(a), the company's share of the 
dividend is equal to 70% of the dividend income eligible for the DRD 
under section 243(a)(1), which results in a DRD of $70x (50% x 70% x 
$200), and under section 812(b), the policyholder's share of the 
dividend is equal to 30% of the dividend income eligible for the DRD 
under section 243(a)(1), which would result in a DRD of $30x (50% x 30% 
x $200x). U.S.C. is entitled to a $130x deduction for an increase in 
its life insurance reserves under sections 803(a)(2) and 807(b). Unlike 
for tax-exempt interest income, there is no adjustment under section 
807(b)(1)(B) to the reserve deduction for the policyholder's share of 
dividends that would be offset by the DRD under section 243(a)(1). 
U.S.C. has no other income or deductions.
    (ii) Analysis--allocation. Under section 818(f)(1), U.S.C.'s 
reserve deduction is treated as an item that cannot be definitely 
allocated to an item or class of gross income except that, under Sec.  
1.861-8(e)(16), an amount of reserve expenses of a life insurance 
company equal to the DRD that is disallowed because it is attributable 
to the policyholder's share of dividends is treated as definitely 
related to such dividends. Thus, U.S.C. has a life insurance reserve 
deduction of $130x, of which $30 (equal to the policyholder's share of 
the DRD that would have been allowed under section 243(a)(1)) is 
directly allocated and apportioned to U.S. source dividend income. 
Under paragraph (b)(5) of this section, the remaining portion of 
U.S.C.'s reserve deduction ($100x) is allocable to all of U.S.C.'s 
gross income as a class.
    (iii) Analysis--apportionment. Under paragraph (c)(3) of this 
section, the deduction is ratably apportioned between the statutory 
grouping (foreign source general category income) and the residual 
grouping (U.S. source income) on the basis of the relative amounts of 
gross income in each grouping. For purposes of apportioning deductions 
under Sec.  1.861-8T(d)(2)(i)(B), exempt income is not taken into 
account. Under paragraph (d)(2)(v)(A)(1) of this section, in the case 
of an insurance company taxable under section 801, exempt income 
includes dividends deductible under section 805(a)(4) without regard to 
any reduction to the DRD for the policyholder's share in section 
804(a)(4)(A)(ii). Thus, the gross income taken into account in 
apportioning $100x of U.S.C.'s remaining reserve deduction is $100x of 
foreign source general category gross income and $100x of U.S. source 
gross income. Of U.S.C.'s $100x remaining reserve deduction, $50x 
($100x x $100x /$200x) is apportioned to foreign source general 
category gross income and $50x ($100x x $100x/$200x) is apportioned to 
U.S. source gross income.
* * * * *
    (e) * * *
    (4) * * *
    (ii) Stewardship expenses--(A) In general. Stewardship expenses are 
those expenses resulting from ``duplicative activities'' (as defined in 
Sec.  1.482-9(l)(3)(iii)) or ``shareholder activities'' (as defined in 
Sec.  1.482-9(l)(3)(iv)) that are undertaken for a person's own benefit 
as an investor in a related entity, which for purposes of this 
paragraph (e)(4)(ii) includes a business entity as described in Sec.  
301.7701-2(a) of this chapter that is classified for Federal income tax 
purposes as either a corporation or a partnership, or is disregarded as 
an entity separate from its owner (``disregarded entity''). Thus, for 
example, stewardship expenses include expenses of an activity the sole 
effect of which is to protect the investor's capital investment in the 
entity or to facilitate compliance by the investor with reporting, 
legal, or regulatory requirements applicable specifically to the 
investor. If an investor has a foreign or international department 
which exercises oversight functions with respect to related entities 
and, in addition, the department performs other functions that generate 
other foreign-source income (such as fees for services rendered outside 
of the United States for the benefit of foreign related corporations or 
foreign-source royalties), some part of the deductions with respect to 
that department are considered definitely related to the other foreign-
source income. In some instances, the operations of a foreign or 
international department will also generate U.S. source income (such as 
fees for services performed in the United States). Stewardship expenses 
are allocated and apportioned on a separate entity basis without regard 
to the affiliated group rules in Sec.  1.861-14. See Sec.  1.861-
14(e)(1)(i).
    (B) Allocation. In the case of stewardship expenses incurred to 
oversee a corporation, the expenses are considered definitely related 
and allocable to dividends received or amounts included, or to be 
received or included, under sections 78, 301, 951, 951A, 1291, 1293, 
and 1296, from the corporation. In the case of stewardship expenses 
incurred to oversee a partnership, the expenses are considered 
definitely related and allocable to a partner's distributive share of 
partnership income. In the case of stewardship expenses incurred to 
oversee a disregarded entity, the expenses are considered definitely 
related and allocable to all gross income attributable to the 
disregarded entity. Stewardship expenses are allocated to income from a 
particular entity (or entities) related to the taxpayer if the expense 
is definitely related to the oversight of that entity or entities as 
provided in Sec.  1.861-8(b)(1) under all the facts and circumstances.
    (C) Apportionment. Stewardship expenses must be apportioned between 
the statutory and residual groupings based on the relative values of 
the entity or entities in each grouping that are owned by the investor 
taxpayer, and without regard to the relative amounts of gross income in 
the statutory and residual groupings to which the stewardship expense 
is allocated. In the case of stewardship expenses incurred to oversee a 
lower-tier entity owned indirectly by the taxpayer, the stewardship 
expenses must be apportioned based on the relative values of the owner 
or owners of the lower-tier entity that are owned directly by the 
taxpayer. In the case of stewardship expenses incurred to oversee a 
corporation, the corporation's value is the value of its stock as 
determined and characterized under the asset method in Sec.  1.861-9 
(and, as relevant, Sec. Sec.  1.861-12 and 1.861-13) for purposes of 
allocating and apportioning the taxpayer's interest expense. For 
purposes of the preceding sentence, if the corporation is a member of 
the same affiliated group as the investor, the value of the 
corporation's stock is determined under the asset method in Sec.  
1.861-9 and is characterized by the investor in proportion to how the 
corporation's assets are characterized for purposes of apportioning the 
group's interest expense. In the case of stewardship expenses incurred 
to oversee a partnership, the partnership's value is determined and 
characterized under the asset method in Sec.  1.861-9 (taking into 
account any adjustments under sections 734(b) and 743(b)). In the case 
of stewardship expenses incurred to oversee a disregarded entity, the 
disregarded entity's character and value is determined using the 
principles of the asset method in Sec.  1.861-9 as if the disregarded 
entity were treated as a corporation for Federal income tax purposes. 
For purposes of determining the tax book value of assets under this

[[Page 72036]]

paragraph (e)(4)(ii)(C), section 864(e)(3) and Sec.  1.861-8(d)(2) do 
not apply.
    (5) Legal and accounting fees and expenses; damages awards, 
prejudgment interest, and settlement payments-- * * *
    (ii) Product liability and other claims for damages. Except as 
otherwise provided in this paragraph (e)(5), awards for litigation or 
arbitral damages, prejudgment interest, and payments in settlement of 
or in anticipation of claims for damages, including punitive damages, 
arising from claims relating to sales, licenses, or leases of products 
or the provision of services, are definitely related and allocable to 
the class of gross income of the type produced by the specific sales or 
leases of the products or provision of services that gave rise to the 
claims for damage or injury. Such damages and payments may include, but 
are not limited to, product liability or patent infringement claims. 
The deductions are apportioned among the statutory and residual 
groupings on the basis of the relative amounts of gross income in the 
relevant class in each grouping in the year in which the deductions are 
allowed. If the claims arise from an event incident to the production 
or sale of products or provision of services (such as an industrial 
accident), the payments are definitely related and allocable to the 
class of gross income ordinarily produced by the assets that are 
involved in the event. The deductions are apportioned among the 
statutory and residual groupings on the basis of the relative values 
(as determined under the asset method in Sec.  1.861-9 for purposes of 
allocating and apportioning the taxpayer's interest expense) of the 
assets that were involved in the event or that were used to produce or 
sell products or services in the relevant class in each grouping; such 
values are determined in the year the deductions are allowed.
    (iii) Investor lawsuits. If the claims are made by investors in a 
corporation and arise from negligence, fraud, or other malfeasance of 
the corporation (or its representatives), then the damages, prejudgment 
interest, and settlement payments paid by the corporation are 
definitely related and allocable to all income of the corporation and 
are apportioned among the statutory and residual groupings based on the 
relative value of the corporation's assets in each grouping (as 
determined under the asset method in Sec.  1.861-9 for purposes of 
allocating and apportioning the taxpayer's interest expense) in the 
year the deductions are allowed.
    (6) * * *
    (i) * * * The deduction for foreign income, war profits, and excess 
profits taxes allowed by section 164 is allocated and apportioned among 
the applicable statutory and residual groupings under Sec.  1.861-20. * 
* *
* * * * *
    (7) Losses on the sale, exchange, or other disposition of property. 
See Sec. Sec.  1.865-1 and 1.865-2 for rules regarding the allocation 
and apportionment of certain losses.
    (8) Net operating loss deduction--(i) Components of net operating 
loss. A net operating loss is separated into components that are 
assigned to statutory or residual groupings by reference to the losses 
in each such statutory or residual grouping that are not allocated to 
reduce income in other groupings in the taxable year of the loss. For 
example, for purposes of applying this paragraph (e)(8)(i) with respect 
to section 904 as the operative section, the source and separate 
category components of a net operating loss are determined by reference 
to the amounts of separate limitation loss and U.S. source loss 
(determined without regard to adjustments required under section 
904(b)) that are not allocated to reduce U.S. source income or income 
in other separate categories under the rules of sections 904(f) and 
904(g) for the taxable year in which the net operating loss arose. See 
Sec.  1.904(g)-3(d)(2). See Sec.  1.1502-4 for rules applicable in 
computing the foreign tax credit limitation and determining the source 
and separate category of a net operating loss of a consolidated group. 
Similarly, for purposes of applying this paragraph (e)(8)(i) with 
respect to another operative section (as described in Sec.  1.861-
8(f)(1)), a net operating loss is divided into component parts based on 
the amounts of the deductions that are assigned to the relevant 
statutory and residual groupings and that are not absorbed in the 
taxable year in which the loss is incurred under the rules of that 
operative section. Deductions that are considered absorbed for purposes 
of an operative section may differ from the deductions that are 
considered absorbed for purposes of another provision of the Code that 
requires determining the components of a net operating loss.
    (ii) Allocation and apportionment of section 172 deduction. A net 
operating loss deduction allowed under section 172 is allocated and 
apportioned to statutory and residual groupings by reference to the 
statutory and residual groupings of the components of the net operating 
loss (as determined under paragraph (e)(8)(i) of this section) that is 
deducted in the taxable year. Except as provided under the rules for an 
operative section, a partial net operating loss deduction is treated as 
ratably comprising the components of a net operating loss. See, for 
example, Sec.  1.904(g)-3, which is an exception to the general rule 
described in the previous sentence and provides rules for determining 
the source and separate category of a partial net operating loss 
deduction for purposes of section 904 as the operative section.
* * * * *
    (16) Special rule for the allocation and apportionment of reserve 
expenses of a life insurance company. An amount of reserve expenses of 
a life insurance company equal to the dividends received deduction that 
is disallowed because it is attributable to the policyholders' share of 
dividends received is treated as definitely related to such dividends. 
See paragraph (d)(2)(v)(B)(2) of this section (Example 2).
* * * * *
    (g) * * *
    (15) Example 15: Payment in settlement of claim for damages 
allocated to specific class of gross income--(i) Facts. USP, a domestic 
corporation, sells Product A in the United States. USP also owns and 
operates a disregarded entity (FDE) in Country X. FDE, which 
constitutes a foreign branch of USP within the meaning of Sec.  1.904-
4(f)(3)(vii), sells Product A inventory in Country X. FDE's functional 
currency is the U.S. dollar. In each of its taxable years from 2018 
through 2020, USP earns $2,000x of U.S. source gross income from sales 
of Product A to customers in the United States. USP also sells Product 
A to FDE for an arm's length price and FDE sells Product A to customers 
in Country X. After the application of section 862(a)(6), Sec.  1.861-
7(c), and the disregarded payment rules of Sec.  1.904-4(f)(2)(vi), the 
sales of Product A in Country X result in $1,500x of general category 
foreign source gross income and $500x of foreign branch category 
foreign source gross income in each of 2018 and 2019 and $2,500x of 
general category foreign source gross income and $500x of foreign 
branch category foreign source gross income in 2020. FDE is sued for 
damages in 2019 after Product A harms a customer in Country X in 2018. 
In 2020, FDE makes a deductible payment of $60x to the Country X 
customer in settlement of the legal claims for damages.
    (ii) Analysis. Under paragraph (e)(5)(ii) of this section, the 
deductible settlement payment is definitely related and allocable to 
the class of gross income of the type produced by the specific sales of 
property that gave rise

[[Page 72037]]

to the damages claims, that is USP's gross income from sales of Product 
A in Country X. Claims that might arise from damages caused by Product 
A to customers in the United States are irrelevant in allocating the 
deduction for the settlement payments made to the customer in Country 
X. For purposes of determining USP's foreign tax credit limitation 
under section 904(d), because in 2020 that class of gross income 
consists of both foreign source foreign branch category income and 
foreign source general category income, the settlement payment of $60x 
is apportioned between gross income in the two categories in proportion 
to the relative amounts of gross income in each category in 2020, the 
year the deduction is allowed. Therefore, $10x ($60x x $500x/$3,000x) 
is apportioned to foreign source foreign branch category income, and 
the remaining $50x ($60x x $2,500x/$3,000x) is apportioned to foreign 
source general category income.
    (16) Example 16: Legal damages payment arising from event incident 
to production and sale--(i) Facts--The facts are the same as in 
paragraph (g)(15) of this section (the facts in Example 15) except that 
instead of a product liability lawsuit relating to a 2018 event, in 
2019 there is a disaster at a warehouse owned by USP in the United 
States arising from the negligence of an employee. The warehouse is 
used to store Product A inventory intended for sale both by USP in the 
United States and by FDE in Country X. In 2020, the warehouse asset is 
characterized under Sec.  1.861-9T(g)(3)(ii) as a multiple category 
asset that is assigned 10% to the foreign source foreign branch 
category, 50% to the foreign source general category, and 40% to the 
residual grouping of U.S. source income. The inventory of Product A in 
the warehouse is destroyed and USP employees as well as residents in 
the vicinity of the warehouse are injured. USP's reputation in the 
United States suffers such that USP expects to subsequently lose market 
share in the United States. In 2020, USP makes deductible damages 
payments totaling $50x to injured employees and the nearby residents, 
all of whom are in the United States.
    (ii) Analysis. USP's warehouse in the United States is used in 
connection with sales of Product A to customers in both the United 
States and Country X. Thus, under paragraph (e)(5)(ii) of this section, 
the $50x damages payment arises from an event incident to the sales of 
Product A and is therefore definitely related and allocable to the 
class of gross income ordinarily produced by the asset (the warehouse) 
that is involved in the event--that is, the gross income from sales of 
Product A by USP in the United States and by FDE in Country X. Under 
paragraph (e)(5)(ii) of this section, the $50x deduction for the 
damages payment is apportioned for purposes of applying section 904(d) 
on the basis of the relative value in each grouping (as determined 
under Sec.  1.861-9(g) for purposes of allocating and apportioning 
USP's interest expense) of USP's warehouse, the asset involved in the 
event, in 2020, the year the deduction is allowed. USP's warehouse is a 
multiple category asset as described in Sec.  1.861-9T(g)(3)(ii) and 
10% of the value of USP's warehouse is properly characterized as an 
asset generating foreign source foreign branch category in 2020. 
Accordingly, $5x (10% x $50x) of the deduction is apportioned to 
foreign source foreign branch category income. Additionally, 50% of the 
value of USP's warehouse is properly characterized as an asset 
generating foreign source general category income in 2020 and, 
accordingly, $25x (50% x $50x) is apportioned to such grouping. The 
remaining $20x (40% x $50x) is apportioned to U.S. source income.
    (17) Example 17: Payment following a change in law--(i) Facts. The 
facts are the same as in paragraph (g)(16) of this section (the facts 
in Example 16), except that the disaster at USP's warehouse occurred 
not in 2019 but in 2016 and thus before the enactment of the section 
904(d) separate category for foreign branch category income. The 
deductible damages payments are made in 2020.
    (ii) Analysis. USP's U.S. warehouse was used in connection with 
making sales of Product A in both the United States and Country X. 
Under paragraph (e)(5)(ii) of this section, the 2020 damages payment 
arises from an event incident to the sales of Product A and is 
therefore definitely related and allocable to the class of gross income 
ordinarily produced by the asset (the warehouse) that is involved in 
the event, that is the gross income from sales of Product A by USP in 
the United States and by FDE in Country X. Under the law in effect in 
2016, the income earned from the Product A sales in Country X was 
solely general category income. Under paragraph (e)(5)(ii) of this 
section, the damages payment is definitely related and allocable to the 
class of gross income consisting of sales of Product A by USP in the 
United States and by FDE in Country X, and apportioned to the statutory 
and residual groupings based on the relative value in each grouping (as 
determined under Sec.  1.861-9(g) for purposes of allocating and 
apportioning USP's interest expense) of USP's warehouse, the asset 
involved in the event, in 2020, the year in which the deduction is 
allowed. Accordingly, for purposes of determining USP's foreign tax 
credit limitation under section 904(d), the 2020 deductible damages 
payment of $50x is allocated and apportioned in the same manner as in 
paragraph (g)(16)(ii) of this section (the analysis in Example 16).
    (18) Example 18: Stewardship and supportive expenses--(i) Facts--
(A) Overview. USP, a domestic corporation, manufactures and sells 
Product A in the United States. USP directly owns 100% of the stock of 
USSub, a domestic corporation, and each of CFC1, CFC2, and CFC3, which 
are all controlled foreign corporations. USP and USSub file separate 
returns for U.S. Federal income tax purposes but are members of the 
same affiliated group as defined in section 243(b)(2). USSub, CFC1, 
CFC2, and CFC3 perform similar functions in the United States and in 
the foreign countries T, U, and V, respectively. USP's tax book value 
in the stock of USSub is $15,000x. USP's tax book value in the stock of 
each of CFC1, CFC2, and CFC3 is, respectively, $5,000x, $10,000x, and 
$15,000x.
    (B) USP Department expenses. USP's supervision department (the 
Department) incurs expenses of $1,500x. The Department is responsible 
for the supervision of its four subsidiaries and for rendering certain 
services to the subsidiaries, and the Department provides all the 
supportive functions necessary for USP's foreign activities. The 
Department performs three types of activities. First, the Department 
performs services that cost $900x outside the United States for the 
direct benefit of CFC2 for which a marked-up fee is paid by CFC2 to 
USP. Second, the Department provides services at a cost of $60x related 
to license agreements that USP maintains with subsidiaries CFC1 and 
CFC2 and which give rise to foreign source general category income to 
USP. Third, the Department performs activities described in Sec.  
1.482-9(l)(3)(iii) that are in the nature of shareholder oversight, 
that duplicate functions performed by all four of the subsidiaries' own 
employees, and that do not provide an additional benefit to the 
subsidiaries. For example, a team of auditors from USP's accounting 
department periodically audits the subsidiaries' books and prepares 
internal reports for use by USP's management. Similarly, USP's 
treasurer periodically reviews the subsidiaries' financial policies for 
the board of directors of USP. These activities do not provide an 
additional benefit to the related corporations. The Department's

[[Page 72038]]

oversight activities are related to all the subsidiaries. The cost of 
the duplicative activities is $540x.
    (C) USP's income. USP earns the following items of income: First, 
under section 951(a), USP has $2,000x of subpart F income that is 
passive category income. Second, USP has a GILTI inclusion amount of 
$2,000x. Third, USP earns $1,000x of royalties, paid by CFC1 and CFC2, 
that are foreign source general category income. Finally, USP receives 
a fee of $1,000x from CFC2 that is foreign source general category 
income.
    (ii) Analysis--(A) Character of USP Department services. The first 
and second activities (the services rendered for the benefit of CFC2, 
and the provision of services related to license agreements with CFC1 
and CFC2) are not properly characterized as stewardship expenses 
because they are not incurred solely to protect the corporation's 
capital investment in the related corporation or to facilitate 
compliance by the corporation with reporting, legal, or regulatory 
requirements applicable specifically to the corporation. The third 
activity described is in the nature of shareholder oversight and is 
characterized as stewardship as described in paragraph (e)(4)(ii)(A) of 
this section because the expense is related to duplicative activities.
    (B) Allocation. First, the deduction of $900x for expenses related 
to services rendered for the benefit of CFC2 is definitely related (and 
therefore allocable) to the fees for services that USP receives from 
CFC2. Second, the $60x of deductions attributable to USP's license 
agreements with CFC1 and CFC2 are definitely related (and therefore 
allocable) solely to royalties received from CFC1 and CFC2. Third, 
based on the relevant facts and circumstances and the Department's 
oversight activities, the stewardship deduction of $540x is related to 
the oversight of all of USP's subsidiaries and therefore is definitely 
related (and therefore allocable) to dividends and inclusions received 
or included from all the subsidiaries.
    (C) Apportionment. (1) No apportionment of USP's deduction of $900x 
for expenses related to the services performed for CFC2 is necessary 
because the class of gross income to which the deduction is allocated 
consists entirely of a single statutory grouping, foreign source 
general category income.
    (2) No apportionment of USP's deduction of $60x attributable to the 
services related to license agreements is necessary because the class 
of gross income to which the deduction is allocated consists entirely 
of a single statutory grouping, foreign source general category income.
    (3) For purposes of apportioning USP's $540x stewardship expenses 
in determining the foreign tax credit limitation, the statutory 
groupings are foreign source general category income, foreign source 
passive category income, and foreign source section 951A category 
income. The residual grouping is U.S. source income.
    (4) USP's deduction of $540x for the Department's stewardship 
expenses which are allocable to dividends and amounts included from the 
subsidiaries are apportioned using the same value of USP's stock in 
USSub, CFC1, CFC2, and CFC3 that is used for purposes of allocating and 
apportioning USP's interest expense. Pursuant to paragraph 
(e)(4)(ii)(A) of this section and Sec.  1.861-14(e)(1)(i), the value of 
USP's stock in USSub is included for purposes of apportioning USP's 
stewardship expense. The value of USSub's stock is $15,000x, and USSub 
only owns assets that generate income in the residual grouping of gross 
income from U.S. sources. Therefore, for purposes of apportioning USP's 
stewardship expense, all of the $15,000x value of the USSub stock is 
characterized as an asset generating U.S. source income. Although USSub 
stock would be eliminated from consideration as an asset under 
paragraph (d)(2)(ii)(B) of this section, for purposes of apportioning 
USP's stewardship expense section 864(e)(3) and paragraph (d)(2) of 
this section do not apply. USP uses the asset method described in Sec.  
1.861-12T(c)(3)(ii) to characterize the stock in its CFCs. After 
application of Sec.  1.861-13(a), USP determines that with respect to 
its three CFCs in the aggregate it has $15,000x of section 951A 
category stock in the non-section 245A subgroup, $6,000x of general 
category stock in the section 245A subgroup, and $9,000x of passive 
category stock in the non-section 245A subgroup. Although under 
paragraph (d)(2)(ii)(C)(2) of this section $7,500x of the stock that is 
section 951A category stock is an exempt asset, for purposes of 
apportioning USP's stewardship expense section 864(e)(3) and paragraph 
(d)(2) of this section do not apply. Finally, even though USP may be 
allowed a section 245A deduction with respect to dividends from the 
CFCs, no portion of the value of the stock of the CFCs is eliminated, 
because the section 245A deduction does not create exempt income or 
result in the stock being treated as an exempt asset. See section 
864(e)(3) and paragraph (d)(2)(iii)(C) of this section.
    (5) Taking into account the characterization of USP's stock in 
USSub, CFC1, CFC2, and CFC3 with a total value of $45,000x ($15,000x + 
$6,000x + $9,000x + $15,000x), the $540x of Department expenses is 
apportioned as follows: $180x ($540x x $15,000x/$45,000x) to section 
951A category income, $72x ($540x x $6,000x/$45,000x) to general 
category income, $108x ($540x x $9,000x/$45,000x) to passive category 
income, and $180x ($540x x $15,000x/$45,000x) to the residual grouping 
of U.S. source income. Section 904(b)(4)(B)(i) and Sec.  1.904(b)-3 
apply to $72x of the stewardship expense apportioned to the CFCs' stock 
that is characterized as being in the section 245A subgroup in the 
general category.
* * * * *
    (h) Applicability date. (1) Except as provided in this paragraph 
(h), this section applies to taxable years that both begin after 
December 31, 2017, and end on or after December 4, 2018.
    (2) Paragraphs (d)(2)(ii)(B), (d)(2)(v), (e)(4) and (5), (e)(6)(i), 
(e)(8) and (16), and (g)(15) through (18) of this section apply to 
taxable years that begin after December 31, 2019. For taxable years 
that both begin after December 31, 2017, and end on or after December 
4, 2018, and also begin on or before December 31, 2019, see Sec.  
1.861-8(d)(2)(ii)(B), (e)(4) and (5), (e)(6)(i), and (e)(8) as in 
effect on December 17, 2019.
    (3) The last sentence of paragraph (d)(2)(ii)(C)(1) of this section 
and paragraph (f)(1)(vi)(N) of this section apply to taxable years 
beginning on or after January 1, 2021.

0
Par. 5.Section 1.861-8T is amended by revising paragraph (d)(2)(ii)(B) 
to read as follows:


Sec.  1.861-8T  Computation of taxable income from sources within the 
United States and from other sources and activities (temporary).

* * * * *
    (d) * * *
    (2) * * *
    (ii) * * *
    (B) Certain stock and dividends. For further guidance, see Sec.  
1.861-8(d)(2)(ii)(B).
* * * * *

0
Par. 6. Section 1.861-9 is amended by:
0
1. Revising paragraph (a).
0
2. Adding paragraph (b).
0
3. Revising paragraphs (e)(8)(vi)(C) and (D).
0
4. Adding paragraph (e)(9).
0
5. Revising paragraph (k).
    The revisions and additions read as follows:

[[Page 72039]]

Sec.  1.861-9   Allocation and apportionment of interest expense and 
rules for asset-based apportionment.

    (a) In general. For further guidance, see Sec.  1.861-9T(a).
    (b) Interest equivalent--(1) Certain expenses and losses--(i) 
General rule. Any expense or loss (to the extent deductible) incurred 
in a transaction or series of integrated or related transactions in 
which the taxpayer secures the use of funds for a period of time is 
subject to allocation and apportionment under the rules of this section 
and Sec.  1.861-9T(b) if such expense or loss is substantially incurred 
in consideration of the time value of money. However, the allocation 
and apportionment of a loss under this paragraph (b) and Sec.  1.861-
9T(b) does not affect the characterization of such loss as capital or 
ordinary for any purpose other than for purposes of the section 861 
regulations (as defined in Sec.  1.861-8(a)(1)).
    (ii) Examples. For further guidance, see Sec.  1.861-9T(b)(1)(ii).
    (2) Certain foreign currency borrowings. For further guidance, see 
Sec.  1.861-9T(b)(2) through (7).
    (3) through (7) [Reserved]
    (8) Guaranteed payments. Any deductions for guaranteed payments for 
the use of capital under section 707(c) are allocated and apportioned 
in the same manner as interest expense.
* * * * *
    (e) * * *
    (8) * * *
    (vi) * * *
    (C) Downstream partnership loan. The term downstream partnership 
loan means a loan to a partnership for which the loan receivable is 
held, directly or indirectly through one or more other partnerships or 
other pass-through entities (as defined in Sec.  1.904-5(a)(4)), by a 
person (or any person in the same affiliated group as such person) that 
owns an interest, directly or indirectly through one or more other 
partnerships or other pass-through entities, in the partnership.
    (D) Downstream partnership loan interest expense (DPL interest 
expense). The term downstream partnership loan interest expense, or DPL 
interest expense, means an item of interest expense paid or accrued 
with respect to a downstream partnership loan, without regard to 
whether the expense was currently deductible (for example, by reason of 
section 163(j) or the election to waive deductions pursuant to Sec.  
1.59A-3(c)(6)).
* * * * *
    (9) Special rule for upstream partnership loans--(i) In general. 
For purposes of apportioning interest expense that is not directly 
allocable under paragraph (e)(4) of this section or Sec.  1.861-10T, an 
upstream partnership loan debtor's (UPL debtor) pro rata share of the 
value of the upstream partnership loan (as determined under paragraph 
(h)(4)(i) of this section) is not considered an asset of the UPL debtor 
taken into account as described in paragraphs (e)(2) and (3) of this 
section.
    (ii) Treatment of interest expense and interest income attributable 
to an upstream partnership loan. If a UPL debtor (or any other person 
in the same affiliated group as the UPL debtor) takes into account a 
distributive share of upstream partnership loan interest income (UPL 
interest income), the UPL debtor (or any other person in the same 
affiliated group as the UPL debtor) assigns an amount of its 
distributive share of the UPL interest income equal to the matching 
expense amount for the taxable year that is attributable to the same 
loan to the same statutory and residual groupings using the same ratios 
as the statutory and residual groupings of gross income from which the 
upstream partnership loan interest expense (UPL interest expense) is 
deducted by the UPL debtor (or any other person in the same affiliated 
group as the UPL debtor). Therefore, the amount of the distributive 
share of UPL interest income that is assigned to each statutory and 
residual grouping is the amount that bears the same proportion to the 
matching expense amount as the UPL interest expense in that statutory 
or residual grouping bears to the total UPL interest expense of the UPL 
debtor (or any other person in the same affiliated group as the UPL 
debtor).
    (iii) Anti-avoidance rule for third party back-to-back loans. If, 
with a principal purpose of avoiding the rules in this paragraph 
(e)(9), a partnership makes a loan to a person that is not related 
(within the meaning of section 267(b) or 707) to the lender, the 
unrelated person makes a loan to a direct or indirect partner in the 
partnership (or any person in the same affiliated group as a direct or 
indirect partner), and the first loan would constitute an upstream 
partnership loan if made directly to the direct or indirect partner (or 
person in the same affiliated group as a direct or indirect partner), 
then the rules of this paragraph (e)(9) apply as if the first loan was 
made directly by the partnership to the partner (or affiliate of the 
partner), and the interest expense paid by the partner is treated as 
made with respect to the first loan. Such a series of loans will be 
subject to the recharacterization rule in this paragraph (e)(9)(iii) 
without regard to whether there was a principal purpose of avoiding the 
rules in this paragraph (e)(9) if the loan to the unrelated person 
would not have been made or maintained on substantially the same terms 
but for the loan of funds by the unrelated person to the direct or 
indirect partner (or affiliate of the partner). The principles of this 
paragraph (e)(9)(iii) also apply to similar transactions that involve 
more than two loans and regardless of the order in which the loans are 
made.
    (iv) Interest equivalents. The principles of this paragraph (e)(9) 
apply in the case of a partner, or any person in the same affiliated 
group as the partner, that takes into account a distributive share of 
income and has a matching expense amount (treating any interest 
equivalent described in paragraph (b) of this section and Sec.  1.861-
9T(b) as interest income or expense for purposes of paragraph 
(e)(9)(v)(B) of this section) that is allocated and apportioned in the 
same manner as interest expense under paragraph (b) of this section and 
Sec.  1.861-9T(b).
    (v) Definitions. For purposes of this paragraph (e)(9), the 
following definitions apply.
    (A) Affiliated group. The term affiliated group has the meaning 
provided in Sec.  1.861-11(d)(1).
    (B) Matching expense amount. The term matching expense amount means 
the lesser of the total amount of the UPL interest expense taken into 
account directly or indirectly by the UPL debtor for the taxable year 
with respect to an upstream partnership loan or the total amount of the 
distributive shares of the UPL interest income of the UPL debtor (or 
any other person in the same affiliated group as the UPL debtor) with 
respect to the loan.
    (C) Upstream partnership loan. The term upstream partnership loan 
means a loan by a partnership to a person (or any person in the same 
affiliated group as such person) that owns an interest, directly or 
indirectly through one or more other partnerships or other pass-through 
entities (as defined in Sec.  1.904-5(a)(4)(iv)), in the partnership.
    (D) Upstream partnership loan debtor (UPL debtor). The term 
upstream partnership loan debtor, or UPL debtor, means the person that 
has the payable with respect to an upstream partnership loan. If a 
partnership has the payable, then any partner in the partnership (other 
than a partner described in paragraph (e)(4)(i) of this section) is 
also considered a UPL debtor.
    (E) Upstream partnership loan interest expense (UPL interest 
expense). The term upstream partnership loan

[[Page 72040]]

interest expense, or UPL interest expense, means an item of interest 
expense paid or accrued with respect to an upstream partnership loan, 
without regard to whether the expense was currently deductible (for 
example, by reason of section 163(j) or the election to waive 
deductions pursuant to Sec.  1.59A-3(c)(6)).
    (F) Upstream partnership loan interest income (UPL interest 
income). The term upstream partnership loan interest income, or UPL 
interest income, means an item of gross interest income received or 
accrued with respect to an upstream partnership loan.
    (vi) Examples. The following examples illustrate the application of 
this paragraph (e)(9).
    (A) Example 1--(1) Facts. US1, a domestic corporation, directly 
owns 60% of PRS, a foreign partnership that is not engaged in a U.S. 
trade or business. The remaining 40% of PRS is directly owned by US2, a 
domestic corporation that is unrelated to US1. US1, US2, and PRS all 
use the calendar year as their taxable year. In Year 1, PRS loans 
$1,000x to US1. For Year 1, US1 has $100x of interest expense with 
respect to the loan and PRS has $100x of interest income with respect 
to the loan. US1's distributive share of the interest income is $60x. 
Under paragraph (e)(2) of this section, $75x of US1's interest expense 
with respect to the loan is allocated and apportioned to U.S. source 
income and $25x is allocated and apportioned to foreign source foreign 
branch category income. Under paragraph (h)(4)(i) of this section, 
US1's share of the total value of the loan between US1 and PRS is 
$600x.
    (2) Analysis. The loan by PRS to US1 is an upstream partnership 
loan and US1 is an UPL debtor. Under paragraph (e)(9)(iv)(B) of this 
section, the matching expense amount is $60x, the lesser of the UPL 
interest expense taken into account by US1 with respect to the loan for 
the taxable year ($100x) and US1's distributive share of the UPL 
interest income ($60x). Under paragraph (e)(9)(ii) of this section, US1 
assigns $45x of the UPL interest income to U.S. source income ($60x x 
$75x/$100x) and $15x of the UPL interest income to foreign source 
foreign branch category income ($60x x $25x/$100x). Under paragraph 
(e)(9)(i) of this section, the disregarded portion of the upstream 
partnership loan is $600x, and is not taken into account as described 
in paragraphs (e)(2) and (3) of this section.
    (B) Example 2--(1) Facts. The facts are the same as in paragraph 
(e)(9)(vi)(A)(1) of this section (the facts in Example 1), except that 
US1 and US2 are part of the same affiliated group with the same ratio 
of U.S. and foreign assets that US1 had in paragraph (e)(9)(vi)(A)(1), 
US2's distributive share of the interest income is $40x, and under 
paragraph (h)(4)(i) of this section US2's share of the total value of 
the loan between US1 and PRS is $400x.
    (2) Analysis. The loan by PRS to US1 is an upstream partnership 
loan and US1 is an UPL debtor. Under paragraph (e)(9)(iv)(B) of this 
section, the matching expense amount is $100x, the lesser of the UPL 
interest expense taken into account by US1 with respect to the loan for 
the taxable year ($100x) and the total amount of US1 and US2's 
distributive shares of the UPL interest income ($100x). Under paragraph 
(e)(9)(ii) of this section, US1 and US2 assign $75x of their total UPL 
interest income to U.S. source income ($100x x $75x/$100x) and $25x of 
their total UPL interest income to foreign source foreign branch 
category income ($100x x $25x/$100x). Under paragraph (e)(9)(i) of this 
section, the disregarded portion of the upstream partnership loan is 
$1,000x, the total amount of US1 and US2's share of the loan between 
US1 and PRS, and is not taken into account as described in paragraphs 
(e)(2) and (3) of this section.
* * * * *
    (k) Applicability date. (1) Except as provided in paragraph (k)(2) 
of this section, this section applies to taxable years that both begin 
after December 31, 2017, and end on or after December 4, 2018.
    (2) Paragraphs (b)(1)(i), (b)(8), and (e)(9) of this section apply 
to taxable years that end on or after December 16, 2019. For taxable 
years that both begin after December 31, 2017, and end on or after 
December 4, 2018, and also end before December 16, 2019, see Sec.  
1.861-9T(b)(1)(i) as contained in 26 CFR part 1 revised as of April 1, 
2019.

0
Par. 7. Section 1.861-9T is amended by revising paragraph (b)(1)(i) and 
adding paragraph (b)(8) to read as follows:


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

* * * * *
    (b) * * *
    (1) * * *
    (i) General rule. For further guidance, see Sec.  1.861-9(b)(1)(i).
* * * * *
    (8) Guaranteed payments. For further guidance, see Sec.  1.861-
9(b)(8).
* * * * *

0
Par. 8. Section 1.861-12 is amended by revising paragraph (e), adding 
paragraphs (f) and (g), and revising paragraph (k) to read as follows:


Sec.  1.861-12  Characterization rules and adjustments for certain 
assets.

* * * * *
    (e) Portfolio securities that constitute inventory or generate 
primarily gains. For further guidance, see Sec.  1.861-12T(e).
    (f) Assets connected with capitalized, deferred, or disallowed 
interest--(1) In general. In the case of any asset in connection with 
which interest expense accruing during a taxable year is capitalized, 
deferred, or disallowed under any provision of the Code, the value of 
the asset for allocation and apportionment purposes is reduced by the 
principal amount of indebtedness the interest on which is so 
capitalized, deferred, or disallowed. Assets are connected with debt 
(the interest on which is capitalized, deferred, or disallowed) only if 
using the debt proceeds to acquire or produce the asset causes the 
interest to be capitalized, deferred, or disallowed.
    (2) Examples. The following examples illustrate the application of 
paragraph (f)(1) of this section.
    (i) Example 1: Capitalized interest under section 263A--(A) Facts. 
X is a domestic corporation that uses the tax book value method of 
apportionment. X has $1,000x of indebtedness and incurs $100x of 
interest expense. Using $800x of the $1,000x debt proceeds to produce 
tangible property, X capitalizes $80x of interest expense under the 
rules of section 263A. X deducts the remaining $20x of interest 
expense.
    (B) Analysis. Because interest on $800x of debt is capitalized 
under section 263A by reason of the use of debt proceeds to produce the 
tangible property, $800x of the principal amount of X's debt is 
connected to the tangible property under paragraph (f)(1) of this 
section. Therefore, for purposes of apportioning the remaining $20x of 
X's interest expense, the adjusted basis of the tangible property is 
reduced by $800x.
    (ii) Example 2: Disallowed interest under section 163(l)--(A) 
Facts. X, a domestic corporation, owns 100% of the stock of Y, a 
domestic corporation. X and Y file a consolidated return and use the 
tax book value method of apportionment. In Year 1, X makes a loan of 
$1,000x to Y (Loan A) and Y then uses the Loan A proceeds to acquire in 
a cash purchase all the stock of a foreign corporation, Z. Interest on 
Loan A is payable in U.S. dollars or, at the option of Y, in stock of 
Z.
    (B) Analysis. Under section 163(l), Loan A is a disqualified debt 
instrument because interest on Loan A is payable at the option of Y in 
stock of a related party to Y. Because Loan A is a

[[Page 72041]]

disqualified debt instrument, section 163(l)(1) disallows Y's interest 
deduction for interest payable on Loan A. However, the value of the Z 
stock is not reduced under paragraph (f)(1) of this section because the 
use of the Loan A proceeds to acquire the stock of Z is not the cause 
of Y's interest deduction being disallowed. Rather, the Loan A terms 
allowing interest to be paid in stock of Z is the cause of Y's interest 
deduction being disallowed under section 163(l). Therefore, no 
adjustment is made to Y's adjusted basis in the stock of Z for purposes 
of allocating the interest expense of X and Y.
    (g) Special rules for FSCs. For further guidance, see Sec.  1.861-
12T(g) through (j).
* * * * *
    (k) Applicability date. (1) Except as provided in paragraph (k)(2) 
of this section, this section applies to taxable years that both begin 
after December 31, 2017, and end on or after December 4, 2018.
    (2) Paragraph (f) of this section applies to taxable years that end 
on or after December 16, 2019. For taxable years that both begin after 
December 31, 2017, and end on or after December 4, 2018, and before 
December 16, 2019, see Sec.  1.861-12T(f) as contained in 26 CFR part 1 
revised as of April 1, 2019.

0
Par. 9. Section 1.861-12T is amended by revising paragraph (f) to read 
as follows:


Sec.  1.861-12T  Characterization rules and adjustments or certain 
assets (temporary).

* * * * *
    (f) Assets connected with capitalized, deferred, or disallowed 
interest. For further guidance, see Sec.  1.861-12(f).
* * * * *


Sec.  1.861-13T  [REMOVED]

0
Par. 10. Section 1.861-13T is removed.

0
Par. 11. Section 1.861-14 is amended by:
0
1. Removing the last sentence in paragraph (d)(1) and paragraphs (d)(3) 
through (e)(5).
0
2. Adding paragraph (d)(3), reserved paragraph (d)(4), paragraph (e) 
heading, and paragraphs (e)(1) through (5).
0
3. Removing the heading for paragraph (e)(6).
0
4. Redesignating paragraph (e)(6)(i) as paragraph (e)(6).
0
5. Revising the heading for newly redesignated paragraph (e)(6).
0
6. Removing paragraphs (e)(6)(ii) and (f) through (j).
0
7. Adding paragraph (f), reserved paragraph (g), paragraph (h), 
reserved paragraphs (i) and (j), and paragraph (k).
    The additions and revisions read as follows:


Sec.  1.861-14   Special rules for allocating and apportioning certain 
expenses (other than interest expense) of an affiliated group of 
corporations.

* * * * *
    (d) * * *
    (3) Inclusion of financial corporations. For further guidance, see 
Sec.  1.861-14T(d)(3) through (4).
    (4) [Reserved]
    (e) Expenses to be allocated and apportioned under this section--
(1) Expenses not directly allocable to specific income-producing 
activities or property. (i) The expenses that are required to be 
allocated and apportioned under the rules of this section are expenses 
that are not directly allocable to specific income-producing activities 
or property solely of the member of the affiliated group that incurred 
the expense, including (but not limited to) certain expenses related to 
research and experimental expenses, supportive functions, deductions 
under section 250, legal and accounting expenses, and litigation 
damages awards, prejudgment interest, and settlement payments. Interest 
expense of members of an affiliated group of corporations is allocated 
and apportioned under Sec.  1.861-11T and not under the rules of this 
section. Expenses that are included in inventory costs or that are 
capitalized are not subject to allocation and apportionment under the 
rules of this section. In addition, stewardship expenses are not 
subject to allocation and apportionment under the rules of this 
section; instead, stewardship expenses of a taxpayer are allocated and 
apportioned on a separate entity basis without treating members of the 
affiliated group as a single taxpayer. See Sec.  1.861-8(e)(4)(ii)(A).
    (ii) For further guidance, see Sec.  1.861-14T(e)(1)(ii).
    (2) Research and experimental expenditures. R&E expenditures (as 
defined in Sec.  1.861-17(a)) in the case of an affiliated group are 
allocated and apportioned under the rules of Sec.  1.861-17 as if all 
members of the affiliated group were a single taxpayer. Thus, R&E 
expenditures are allocated to all gross intangible income of all 
members of the affiliated group reasonably connected with the relevant 
broad SIC code category. If fewer than all members of the affiliated 
group derive gross intangible income reasonably connected with that 
relevant broad SIC code category, then such expenditures are 
apportioned under the rules of this paragraph (e)(2) only among those 
members, as if those members were a single taxpayer.
    (3) Expenses related to supportive functions. For further guidance, 
see Sec.  1.861-14T(e)(3).
    (4) Section 250 deduction. Except as provided in this paragraph 
(e)(4), the deduction allowed under section 250(a) (the section 250 
deduction) to a member of an affiliated group is allocated and 
apportioned on a separate entity basis under the rules of Sec.  1.861-
8(e)(13) and (14). However, the section 250 deduction of a member of a 
consolidated group is not directly allocable to specific income-
producing activities or property solely of the member of the affiliated 
group that is allowed the deduction. See Sec.  1.1502-50 for rules on 
applying section 250 and Sec. Sec.  1.250-1 through 1.250(b)-6 to a 
member of a consolidated group. In such case, the section 250 deduction 
is allocated and apportioned as if all members of the consolidated 
group are treated as a single corporation.
    (5) Legal and accounting fees and expenses; damages awards, 
prejudgment interest, and settlement payments. Legal and accounting 
fees and expenses, as well as litigation or arbitral damages awards, 
prejudgment interest, and settlement payments, are allocated and 
apportioned under the rules of Sec.  1.861-8(e)(5). To the extent that 
under Sec.  1.861-14T(c)(2) and (e)(1)(ii) such expenses are not 
directly allocable to specific income-producing activities or property 
of one or more members of the affiliated group, such expenses must be 
allocated and apportioned as if all members of the affiliated group 
were a single corporation. Specifically, such expenses must be 
allocated to a class of gross income that takes into account the gross 
income which is generated, has been generated, or is reasonably 
expected to be generated by the other members of the affiliated group. 
If the expenses relate to the gross income of fewer than all members of 
the affiliated group as determined under Sec.  1.861-14T(c)(2), then 
those expenses must be apportioned under the rules of Sec.  1.861-
14T(c)(2), as if those fewer members were a single corporation. Such 
expenses must be apportioned taking into account the apportionment 
factors contributed by the members of the group that are treated as a 
single corporation.
    (6) Charitable contribution expenses. * * *
    (f) Computation of FSC or DISC combined taxable income. For further 
guidance, see Sec.  1.861-14T(f) and (g).
    (g) [Reserved]
    (h) Special rule for the allocation and apportionment of reserve 
expenses of a life insurance company. Section 1.861-

[[Page 72042]]

8(e)(16) applies for purposes of allocating and apportioning reserve 
expenses with respect to dividends received by a life insurance 
company. The remaining reserve expenses of such company are allocated 
and apportioned under the rules of Sec.  1.861-8 and this section.
    (i) through (j) [Reserved]
    (k) Applicability date. This section applies to taxable years 
beginning after December 31, 2019.

0
Par. 12. Section 1.861-14T is amended by:
0
1. Revising paragraphs (e)(1)(i) and (e)(2)(i).
0
2. Removing and reserving paragraph (e)(2)(ii).
0
3. Revising paragraphs (e)(4) and (5) and (h).
0
4. Adding footnote 1 at the end of paragraph (j) introductory text.
    The revisions and additions read as follows:


Sec.  1.861-14T  Special rules for allocating and apportioning certain 
expenses (other than interest expense) of an affiliated group of 
corporations (temporary).

* * * * *
    (e) * * *
    (1) * * *
    (i) For further guidance, see Sec.  1.861-14(e)(1)(i).
* * * * *
    (2) * * *
    (i) For further guidance, see Sec.  1.861-14(e)(2)(i) and (ii).
* * * * *
    (4) Section 250 deduction. For further guidance, see Sec.  1.861-
14(e)(4).
    (5) Legal and accounting fees and expenses; damages awards, 
prejudgment interest, and settlement payments. For further guidance, 
see Sec.  1.861-14(e)(5).
* * * * *
    (h) Special rule for allocation of reserve expenses of life 
insurance companies. For further guidance, see Sec.  1.861-14(h).
* * * * *
    (j) * * *
    \1\ Examples 1 and 4 of this paragraph (j) apply to taxable years 
beginning before January 1, 2018.
* * * * *

0
Par. 13. Section 1.861-17 is revised to read as follows:


Sec.  1.861-17  Allocation and apportionment of research and 
experimental expenditures.

    (a) Scope. This section provides rules for the allocation and 
apportionment of research and experimental expenditures that a taxpayer 
deducts, or amortizes and deducts, in a taxable year under section 174 
or section 59(e) (applicable to expenditures that are allowable as a 
deduction under section 174(a)) (R&E expenditures). R&E expenditures do 
not include any expenditures that are not deductible expenses by reason 
of the second sentence under Sec.  1.482-7(j)(3)(i) (relating to CST 
Payments (as defined in Sec.  1.482-7(b)(1)) owed to a controlled 
participant in a cost sharing arrangement).
    (b) Allocation--(1) In general. The method of allocation and 
apportionment of R&E expenditures set forth in this section recognizes 
that research and experimentation is an inherently speculative 
activity, that findings may contribute unexpected benefits, and that 
the gross income derived from successful research and experimentation 
must bear the cost of unsuccessful research and experimentation. In 
addition, the method set forth in this section recognizes that 
successful R&E expenditures ultimately result in the creation of 
intangible property that will be used to generate income. Therefore, 
R&E expenditures ordinarily are considered deductions that are 
definitely related to gross intangible income (as defined in paragraph 
(b)(2) of this section) reasonably connected with the relevant SIC code 
category (or categories) of the taxpayer and therefore allocable to 
gross intangible income as a class related to the SIC code category (or 
categories) and apportioned under the rules in this section. For 
purposes of the allocation under this paragraph (b)(1), a taxpayer's 
SIC code category (or categories) are determined in accordance with the 
provisions of paragraph (b)(3) of this section. For purposes of this 
section, the term intangible property means intangible property (as 
defined in section 367(d)(4)), including intangible property either 
created or acquired by the taxpayer, that is derived from R&E 
expenditures.
    (2) Definition of gross intangible income. The term gross 
intangible income means all gross income earned by a taxpayer that is 
attributable to a sale or license of intangible property (including 
income from platform contribution transactions described in Sec.  
1.482-7(b)(1)(ii), royalty income from the licensing of intangible 
property, or amounts taken into account under section 367(d) by reason 
of a transfer of intangible property), and the full amount of gross 
income from sales or leases of products or services if the income is 
derived directly or indirectly (in whole or in part) from intangible 
property. Gross intangible income also includes a distributive share of 
any amounts described in the previous sentence, but does not include 
dividends or any amounts included in income under section 951, 951A, or 
1293. See Sec.  1.904-4(f)(2)(vi) for rules addressing the assignment 
of gross income, including gross intangible income, to a separate 
category by reason of certain disregarded payments to or from a 
taxpayer's foreign branch.
    (3) SIC code categories--(i) Allocation based on SIC code 
categories. Ordinarily, a taxpayer's R&E expenditures are incurred to 
produce gross intangible income that is reasonably connected with one 
or more relevant SIC code categories. Except as provided in paragraph 
(b)(3)(iv) of this section, where research and experimentation is 
conducted with respect to more than one SIC code category, the taxpayer 
may aggregate the categories for purposes of allocation and 
apportionment, provided the categories are in the same Major Group. 
However, the taxpayer may not subdivide any categories. Where research 
and experimentation is not clearly related to any SIC code category (or 
categories), it will be considered conducted with respect to all of the 
taxpayer's SIC code categories.
    (ii) Use of three digit standard industrial classification codes. A 
taxpayer determines the relevant Major Groups and SIC code categories 
by reference to the two digit and three digit classification, 
respectively, of the Standard Industrial Classification Manual (SIC 
code). The SIC Manual is available at https://www.osha.gov/pls/imis/sic_manual.html.
    (iii) Consistency. Once a taxpayer selects a SIC code category or 
Major Group for the first taxable year for which this section applies 
to the taxpayer, it must continue to use that category in following 
years unless the taxpayer establishes to the satisfaction of the 
Commissioner that, due to changes in the relevant facts, a change in 
the category is appropriate. Therefore, once a taxpayer elects a 
permissible aggregation of three digit SIC code categories into a two 
digit Major Group, it must continue to use that two digit category in 
following years unless the taxpayer establishes to the satisfaction of 
the Commissioner that, due to changes in the relevant facts, a change 
is appropriate.
    (iv) Wholesale trade and retail trade categories. A taxpayer must 
use a SIC code category within the divisions of ``wholesale trade'' or 
``retail trade'' if it is engaged solely in sales-related activities 
with respect to a particular category of products. In the case of a 
taxpayer that conducts material non-sales-related activities with 
respect to a particular category of products, all R&E

[[Page 72043]]

expenditures related to sales of the products must be allocated and 
apportioned as if the expenditures were reasonably connected to the 
most closely related three digit SIC code category other than those 
within the wholesale and retail trade divisions. For example, if a 
taxpayer engages in both the manufacturing and assembling of cars and 
trucks (SIC code 371) and in a wholesaling activity related to motor 
vehicles and motor vehicle parts and supplies (SIC code 501), the 
taxpayer must allocate and apportion all R&E expenditures related to 
both activities as if they relate solely to the manufacturing SIC code 
371. By contrast, if the taxpayer engages only in the wholesaling 
activity related to motor vehicles and motor vehicle parts and 
supplies, the taxpayer must allocate and apportion all R&E expenditures 
to the wholesaling SIC code 501.
    (c) Exclusive apportionment. Solely for purposes of applying this 
section to section 904 as the operative section, an amount equal to 
fifty percent of a taxpayer's R&E expenditures in a SIC code category 
(or categories) is apportioned exclusively to the residual grouping of 
U.S. source gross intangible income if research and experimentation 
that accounts for at least fifty percent of such R&E expenditures was 
performed in the United States. Similarly, an amount equal to fifty 
percent of a taxpayer's R&E expenditures in a SIC code category (or 
categories) is apportioned exclusively to the statutory grouping (or 
groupings) of foreign source gross intangible income in that SIC code 
category if research and experimentation that accounts for more than 
fifty percent of such R&E expenditures was performed outside the United 
States. If there are multiple separate categories with foreign source 
gross intangible income in the SIC code category, the fifty percent of 
R&E expenditures apportioned under the previous sentence is apportioned 
ratably to foreign source gross intangible income based on the relative 
amounts of gross receipts from gross intangible income in the SIC code 
category in each separate category, as determined under paragraph (d) 
of this section. Solely for purposes of determining whether fifty 
percent or more of R&E expenditures in a year are performed within or 
without the United States under this paragraph (c), a taxpayer's R&E 
expenditures with respect to a taxable year are determined by taking 
into account only the R&E expenditures incurred in such taxable year 
(without regard to whether such expenditures are capitalized under 
section 59(e) or any other provision in the Code), and do not include 
amounts that were capitalized in a prior taxable year and are deducted 
in such taxable year.
    (d) Apportionment based on gross receipts from sales of products or 
services--(1) In general. A taxpayer's R&E expenditures not apportioned 
under paragraph (c) of this section are apportioned between the 
statutory grouping (or among the statutory groupings) within the class 
of gross intangible income and the residual grouping within such class 
according to the rules in paragraphs (d)(1)(i) through (iv) of this 
section. See paragraph (b) of this section for defining the class of 
gross intangible income in relation to SIC code categories.
    (i) A taxpayer's R&E expenditures not apportioned under paragraph 
(c) of this section are apportioned in the same proportions that:
    (A) The amounts of the taxpayer's gross receipts from sales and 
leases of products (as measured by gross receipts without regard to 
cost of goods sold) or services that are related to gross intangible 
income within the statutory grouping (or statutory groupings) and in 
the residual grouping bear, respectively; to
    (B) The total amount of such gross receipts in the class.
    (ii) For purposes of this paragraph (d), gross receipts from sales 
and leases of products are related to gross intangible income if 
intangible property is embedded or used in connection with the 
manufacture or sale of such products, and gross income from services is 
related to gross intangible income if intangible property is 
incorporated in or directly or indirectly benefits such services. See 
paragraph (g)(7) of this section (Example 7). The amount of the gross 
receipts used to apportion R&E expenditures also includes gross 
receipts from sales and leases of products or services of any 
controlled or uncontrolled party to the extent described in paragraphs 
(d)(3) and (4) of this section. A royalty or other amount paid to the 
taxpayer for intangible property constitutes gross intangible income, 
but is not considered part of gross receipts arising from the sale or 
lease of a product or service, and so is not taken into account in 
apportioning the taxpayer's R&E expenditures to its gross intangible 
income.
    (iii) The statutory grouping (or groupings) or residual grouping to 
which the gross receipts are assigned is the grouping to which the 
gross intangible income related to the sale, lease, or service is 
assigned. In cases where the gross intangible income of the taxpayer is 
income not described in paragraph (d)(3) or (4) of this section, the 
grouping to which the taxpayer's gross receipts and the gross 
intangible income are assigned is the same. In cases where the 
taxpayer's gross intangible income is related to sales, leases, or 
services described in paragraph (d)(3) or (4) of this section, the 
gross receipts that will be used for purposes of this paragraph (d) are 
the gross receipts of the controlled and uncontrolled parties that are 
taken into account under paragraphs (d)(3) and (4) of this section. The 
grouping to which the controlled or uncontrolled parties' gross 
receipts are assigned is determined based on the grouping of the 
taxpayer's gross intangible income attributable to the license, sale, 
or other transfer of intangible property to such controlled or 
uncontrolled party as described in paragraph (d)(3)(i) or (d)(4)(i) of 
this section, and not the grouping to which the gross receipts would be 
assigned if the assignment were based on the income earned by the 
controlled or uncontrolled party. See paragraph (g)(1) of this section 
(Example 1). For purposes of applying this paragraph (d)(1)(iii) to 
section 250 or section 904 as the operative section, the assignment of 
gross receipts to the general and foreign branch categories is made 
after taking into account the assignment of gross intangible income to 
those categories as adjusted by reason of disregarded payments under 
the rules of Sec.  1.904-4(f)(2)(vi), and by making similar adjustments 
to gross receipts under the principles of Sec.  1.904-4(f)(2)(vi).
    (iv) For purposes of applying this section to section 904 as the 
operative section, because a United States person's gross intangible 
income cannot include income assigned to the section 951A category, no 
R&E expenditures of a United States person are apportioned to foreign 
source income in the section 951A category.
    (2) Apportionment in excess of gross income. Amounts apportioned 
under this section may exceed the amount of gross income related to the 
SIC code category within the statutory or residual grouping. In such 
case, the excess is applied against other gross income within the 
statutory or residual grouping. See Sec.  1.861-8(d)(1) for applicable 
rules where the apportionment results in an excess of deductions over 
gross income within the statutory or residual grouping.
    (3) Sales or services of uncontrolled parties--(i) In general. For 
purposes of the apportionment within a class under paragraph (d)(1) of 
this section, if a taxpayer reasonably expects an

[[Page 72044]]

uncontrolled party to (through a license, purchase, or transfer): 
Acquire intangible property that would arise from the taxpayer's 
current R&E expenditures; acquire products in which such intangible 
property is embedded or used in connection with the manufacture or sale 
of such products; or receive services that incorporate or directly or 
indirectly benefit from such intangible property, then the gross 
receipts of the uncontrolled party from sales, licenses, leases, or 
services of the particular products or services in which the taxpayer's 
intangible property is embedded or incorporated or which the taxpayer's 
intangible property directly or indirectly benefitted are taken into 
account. If the taxpayer has previously licensed, sold, or transferred 
intangible property related to a SIC code category to an uncontrolled 
party, the taxpayer is presumed to expect to license, sell, or transfer 
to that uncontrolled party all future intangible property related to 
the same SIC code category. The presumption described in the preceding 
sentence may be rebutted by the taxpayer with facts that demonstrate 
that the taxpayer reasonably expects not to license, sell, or transfer 
future intangible property to the uncontrolled party.
    (ii) Definition of uncontrolled party. For purposes of this 
paragraph (d)(3), the term uncontrolled party means a person that is 
not a controlled party as defined in paragraph (d)(4)(ii) of this 
section.
    (iii) Sales of components. In the case of a sale or lease of a 
product by an uncontrolled party that is derived from the taxpayer's 
intangible property but is incorporated as a component of a larger 
product (for example, where the product incorporating the intangible 
property is a component of a large machine), only the portion of the 
gross receipts from the larger product that are attributable to the 
component derived from the intangible property is included. For 
purposes of the preceding sentence, a reasonable estimate based on the 
principles of section 482 must be made. See paragraph (g)(4)(ii)(B)(3) 
of this section (Example 4).
    (iv) Reasonable estimates of gross receipts. If the amount of gross 
receipts of an uncontrolled party is unknown, a reasonable estimate of 
gross receipts must be made annually. Appropriate economic analyses, 
based on the principles of section 482, must be used to estimate gross 
receipts. See paragraph (g)(5)(ii)(B)(3)(ii) of this section (Example 
5).
    (4) Sales or services of controlled parties--(i) In general. For 
purposes of the apportionment within a class under paragraph (d)(1) of 
this section, if the controlled party is reasonably expected to 
(through a license, sale, or transfer): Acquire intangible property 
that would arise from the taxpayer's current R&E expenditures; acquire 
products in which such intangible property is embedded or used in 
connection with the manufacture or sale of such products; or receive 
services that incorporate or directly or indirectly benefit from such 
intangible property, then the gross receipts of the controlled party 
from all of its sales, licenses, leases, or services are taken into 
account. Except to the extent provided in paragraph (d)(4)(iv) of this 
section, if the taxpayer has previously licensed, sold, or transferred 
intangible property related to a SIC code category to a controlled 
party, the taxpayer is presumed to expect to license, sell, or transfer 
to that controlled party all future intangible property related to the 
same SIC code category. The presumption described in the preceding 
sentence may be rebutted by the taxpayer with facts that demonstrate 
that the taxpayer will not license, sell, or transfer future intangible 
property to the controlled party.
    (ii) Definition of a controlled party. For purposes of this 
paragraph (d)(4), the term controlled party means any person that has a 
relationship to the taxpayer specified in section 267(b) or 707(b), or 
is a member of a controlled group of corporations (within the meaning 
of section 267(f)) to which the taxpayer belongs. Because an affiliated 
group is treated as a single taxpayer, a member of an affiliated group 
is not a controlled party. See paragraph (e) of this section.
    (iii) Gross receipts not to be taken into account more than once. 
Sales, licenses, leases, or services among the taxpayer, controlled 
parties, and uncontrolled parties are not taken into account more than 
once; in such a situation, the amount of gross receipts of the selling 
person must be subtracted from the gross receipts of the buying person. 
Therefore, the gross receipts taken into account under paragraph 
(d)(4)(i) of this section generally reflect the gross receipts from 
sales made to end users.
    (iv) Effect of cost sharing arrangements. If the controlled party 
has entered into a cost sharing arrangement, in accordance with the 
provisions of Sec.  1.482-7, with the taxpayer for the purpose of 
developing intangible property, then the taxpayer is not reasonably 
expected to license, sell, or transfer to that controlled party, 
directly or indirectly, intangible property that would arise from the 
taxpayer's share of the R&E expenditures with respect to the cost 
shared intangibles as defined in Sec.  1.482-7(j)(1)(i). Therefore, 
solely for purposes of apportioning a taxpayer's R&E expenditures 
(which do not include the amount of CST Payments received by the 
taxpayer; see paragraph (a) of this section) that are intangible 
development costs (as defined in Sec.  1.482-7(d)) with respect to a 
cost sharing arrangement, the controlled party's gross receipts are not 
taken into account for purposes of paragraphs (d)(1) and (d)(4)(i) of 
this section.
    (5) Application of section 864(e)(3). Section 864(e)(3) and Sec.  
1.861-8(d)(2) do not apply for purposes of this section.
    (e) Affiliated groups. See Sec.  1.861-14(e)(2) for rules on 
allocating and apportioning R&E expenditures of an affiliated group (as 
defined in Sec.  1.861-14(d)).
    (f) Special rules for partnerships--(1) R&E expenditures. For 
purposes of applying this section, if R&E expenditures are incurred by 
a partnership in which the taxpayer is a partner, the taxpayer's R&E 
expenditures include the taxpayer's distributive share of the 
partnership's R&E expenditures.
    (2) Purpose and location of expenditures. In applying exclusive 
apportionment under paragraph (c) of this section, a partner's 
distributive share of R&E expenditures incurred by a partnership is 
treated as incurred by the partner for the same purpose and in the same 
location as incurred by the partnership.
    (3) Apportionment based on gross receipts. In applying the 
remaining apportionment under paragraph (d) of this section, if a 
taxpayer is a partner in a partnership that incurs R&E expenditures 
described in paragraph (f)(1) of this section and the taxpayer is not 
reasonably expected to license, sell, or transfer to the partnership 
(directly or indirectly) intangible property that would arise from the 
taxpayer's current R&E expenditures, in the manner described in 
paragraph (d)(3)(i) or (d)(4)(i) of this section, then the taxpayer's 
gross receipts in a SIC code category include only the taxpayer's share 
of any gross receipts in the SIC code category of the partnership. For 
purposes of the preceding sentence, the taxpayer's share of gross 
receipts is proportionate to the taxpayer's distributive share of the 
partnership's gross income in the product category. However, if the 
taxpayer is reasonably expected to license, sell, or transfer to the 
partnership (directly or indirectly) intangible property that would 
arise from the taxpayer current R&E expenditures, in the manner 
described in paragraph (d)(3)(i) or (d)(4)(i) of this

[[Page 72045]]

section, then the taxpayer's gross receipts in a SIC code category 
include the full amount of any gross receipts in the SIC code category 
of the partnership as provided in paragraph (d)(3)(i) or (d)(4)(i) of 
this section.
    (g) Examples. The following examples illustrate the application of 
the rules in this section.
    (1) Example 1: Controlled party and single product--(i) Facts. X, a 
domestic corporation, is a manufacturer and distributor of small 
gasoline engines for lawnmowers. Gasoline engines are a product within 
the category, Engines and Turbines (SIC Industry Group 351). Y, a 
wholly owned foreign subsidiary of X, also manufactures and sells these 
engines abroad. X owns no other foreign subsidiaries. During Year 1, X 
incurred R&E expenditures of $60,000x, which it deducts under section 
174 as a current expense, to invent and patent a new and improved 
gasoline engine. All of the research and experimentation was performed 
in the United States. Also in Year 1, the domestic gross receipts of X 
from sales of gasoline engines total $500,000x and foreign gross 
receipts of Y from sales of gasoline engines total $300,000x. X 
provides technology for the manufacture of engines to Y through a 
license that requires the payment of an arm's length royalty. Because X 
has licensed its intangible property to Y related to the SIC code, it 
is presumed to reasonably expect to license the intangible property 
that would be developed from the current research and experimentation. 
In Year 1, X's gross income is $210,000x, of which $140,000x is U.S. 
source income from domestic sales of gasoline engines, $40,000x is 
income included under section 951A, all of which relates to Y's foreign 
source income from sales of gasoline engines, $20,000x is foreign 
source royalties from Y, and $10,000x is U.S. source interest income. 
None of the foreign source royalties are allocable to passive category 
income of Y, and therefore, under Sec. Sec.  1.904-4(d) and 1.904-
5(c)(3), the foreign source royalties are general category income to X.
    (ii) Analysis--(A) Allocation. The R&E expenditures were incurred 
in connection with developing intangible property related to small 
gasoline engines and they are definitely related to X's items of gross 
intangible income related to the SIC code category 351, namely gross 
income from the sale of small gasoline engines in the United States and 
royalties received from subsidiary Y, a foreign manufacturer of 
gasoline engines. Accordingly, under paragraph (b) of this section, the 
R&E expenditures are allocable to the class of gross intangible income 
related to SIC code category 351, all of which is general category 
income of X. X's U.S. source interest income and income included under 
section 951A are not within this class of gross intangible income and, 
therefore, no portion of the R&E expenditures are allocated to the U.S. 
source interest income or foreign source income in the section 951A 
category.
    (B) Apportionment--(1) In general. For purposes of applying this 
section to section 904 as the operative section, the statutory grouping 
of gross intangible income is foreign source general category income 
and the residual grouping of gross intangible income is U.S. source 
income.
    (2) Exclusive apportionment. Under paragraph (c) of this section, 
because at least 50% of X's research and experimental activity was 
performed in the United States, 50% of the R&E expenditures, or 
$30,000x ($60,000x x 50%), is apportioned exclusively to the residual 
grouping of U.S. source gross intangible income. The remaining 50% of 
the R&E expenditures is then apportioned between the statutory and 
residual groupings on the basis of the relative amounts of gross 
receipts from sales of small gasoline engines by X and Y that are 
related to the U.S. source sales income and foreign source royalty 
income, respectively.
    (3) Apportionment based on gross receipts. After taking into 
account exclusive apportionment, X has $30,000x ($60,000x-$30,000x) of 
R&E expenditures that must be apportioned between the statutory and 
residual groupings. Under paragraph (d)(4) of this section, Y's gross 
receipts within the SIC code are taken into account in apportioning X's 
R&E expenditures. Although X has gross intangible income of $140,000x 
from domestic sales and $20,000x in royalties from Y, X's R&E 
expenditures are apportioned to that gross intangible income on the 
basis of the relative amounts of gross receipts arising from the sale 
of products by X and Y (and not the relative amounts of X's gross 
intangible income) in the statutory and residual groupings. Therefore, 
under paragraphs (d)(1) and (4) of this section $11,250x ($30,000x x 
$300,000x/($500,000x + $300,000x)) is apportioned to the statutory 
grouping of X's gross intangible income attributable to its license of 
intangible property to Y, or foreign source general category income. No 
portion of the gross receipts by X or Y are disregarded under section 
864(e)(3), regardless of whether the income related to those sales is 
eligible for a deduction under section 250(a)(1)(A). The remaining 
$18,750x ($30,000x x $500,000x/($500,000x + $300,000x)) is apportioned 
to the residual grouping of gross intangible income, or U.S. source 
income.
    (4) Summary. Accordingly, for purposes of the foreign tax credit 
limitation, $11,250x of X's R&E expenditures are apportioned to foreign 
source general category income, and $48,750x ($30,000x + $18,750x) of 
X's R&E expenditures are apportioned to U.S. source income.
    (2) Example 2: Controlled party and two products in same SIC code 
category--(i) Facts. The facts are the same as in paragraph (g)(1)(i) 
of this section (the facts in Example 1), except that X also spends 
$30,000x in Year 1 for research on steam turbines, all of which is 
performed in the United States, and X has steam turbine gross receipts 
in the United States of $400,000x. X's foreign subsidiary Y neither 
manufactures nor sells steam turbines. The steam turbine research is in 
addition to the $60,000x in R&E expenditures incurred by X on gasoline 
engines for lawnmowers. X thus has $90,000x of R&E expenditures. X's 
gross income is $260,000x, of which $140,000x is U.S. source income 
from domestic sales of gasoline engines, $50,000x is U.S. source income 
from domestic sales of steam turbines, $40,000x is income included 
under section 951A all of which relates to foreign source income 
derived from Y's sales of gasoline engines, $20,000x is foreign source 
royalties from Y, and $10,000x is U.S. source interest income.
    (ii) Analysis--(A) Allocation. X's R&E expenditures generate gross 
intangible income from sales of small gasoline engines and steam 
turbines. Both of these products are in the same three digit SIC code 
category, Engines and Turbines (SIC Industry Group 351). Therefore, 
under paragraph (a) of this section, X's R&E expenditures are 
definitely related to all items of gross intangible income attributable 
to SIC code category 351. These items of X's gross intangible income 
are gross income from the sale of small gasoline engines and steam 
turbines in the United States and royalties from foreign subsidiary Y, 
a foreign manufacturer and seller of small gasoline engines. X's U.S. 
source interest income and income included under section 951A is not 
within this class of gross intangible income and, therefore, no portion 
of X's R&E expenditures are allocated to the U.S. source interest 
income or income in the section 951A category.
    (B) Apportionment--(1) In general. For purposes of applying this 
section to section 904 as the operative section, the statutory grouping 
of gross intangible

[[Page 72046]]

income is foreign source general category income and the residual 
grouping of gross intangible income is U.S. source income.
    (2) Exclusive apportionment. Under paragraph (c) of this section, 
because at least 50% of X's research and experimental activity was 
performed in the United States, 50% of the R&E expenditures, or 
$45,000x ($90,000x x 50%), are apportioned exclusively to the residual 
grouping of U.S. source gross intangible income. The remaining 50% of 
the R&E expenditures is then apportioned between the statutory and 
residual groupings on the basis of the relative amounts of gross 
receipts of small gasoline engines and steam turbines by X and Y with 
respect to which gross intangible income is foreign source general 
category income and U.S. source income.
    (3) Apportionment based on gross receipts. After taking into 
account exclusive apportionment, X has $45,000x ($90,000x-$45,000x) of 
R&E expenditures that must be apportioned between the statutory and 
residual groupings. Although X has gross intangible income of $190,000x 
from domestic sales and $20,000x in royalties from Y, X's R&E 
expenditures are apportioned to that gross intangible income on the 
basis of the relative amounts of gross receipts arising from the sale 
of products by X and Y (and not the relative amounts of X's gross 
intangible income) in the statutory and residual groupings. Even though 
a portion of the R&E expenditures that must be apportioned are 
attributable to research performed with respect to steam turbines, and 
Y does not sell steam turbines, because Y is reasonably expected to 
license all intangible property related to SIC code category 351 from 
X, including intangible property related to steam turbines, under 
paragraphs (d)(1) and (4) of this section $11,250x ($45,000x x 
$300,000x/($500,000x + $400,000x + $300,000x)) is apportioned to the 
statutory grouping of gross intangible income, or foreign source 
general category income attributable to the royalty income to which the 
gross receipts of Y are related. The remaining $33,750x ($45,000x x 
($500,000x + $400,000x)/($500,000x + $400,000x + $300,000x)) is 
apportioned to the residual grouping of gross intangible income, or 
U.S. source gross income.
    (4) Summary. Accordingly, for purposes of the foreign tax credit 
limitation, $11,250x of X's R&E expenditures are apportioned to foreign 
source general category income and $78,750x ($45,000x + $33,750x) of 
X's R&E expenditures are apportioned to U.S. source income.
    (3) Example 3: Cost sharing arrangement--(i) Facts--(A) 
Acquisitions and transfers by X. The facts are the same as in paragraph 
(g)(1)(i) of this section (the facts in Example 1) except that, in Year 
2, X and Y terminate the license for the manufacture of engines that 
was in place in Year 1 and enter into a cost sharing arrangement, in 
accordance with the provisions of Sec.  1.482-7, to share the costs and 
risks of developing the intangible property related to the engines. 
Pursuant to the cost sharing arrangement, X has the exclusive rights to 
exploit the cost shared intangibles within the United States, and Y has 
the exclusive rights to exploit the cost shared intangibles outside the 
United States. X's and Y's shares of the reasonably anticipated 
benefits from the cost shared intangibles are 70% and 30%, 
respectively. In Year 2, Y makes a PCT Payment (as defined in Sec.  
1.482-7(b)(1)(ii)) of $50,000x that is characterized and sourced as a 
royalty for a license of small gasoline engine technology.
    (B) Gross receipts and R&E expenditures. In Year 2, X and Y 
continue to sell gasoline engines, with gross receipts of $600,000x in 
the United States by X and $400,000x abroad by Y. X incurs intangible 
development costs associated with the cost shared intangibles of 
$100,000x in Year 2, which consist exclusively of research activities 
conducted in the United States. Y also makes a $30,000x CST Payment (as 
defined in Sec.  1.482-7(b)(1)(i)) under the cost sharing arrangement. 
X is entitled to deduct $70,000x of its intangible development costs 
($100,000x less the $30,000x CST Payment by Y) by reason of the second 
sentence under Sec.  1.482-7(j)(3)(i) (relating to CST Payments).
    (C) Gross income of X. In Year 2, X's gross income is $360,000x, of 
which $200,000x is U.S. source income from domestic sales of small 
gasoline engines, $50,000x is foreign source general category income 
attributable to the PCT Payment, $100,000x is income included under 
section 951A (all of which relates to foreign source income derived 
from engine sales by Y), and $10,000x is U.S. source interest income.
    (ii) Analysis--(A) Allocation. The $70,000x of R&E expenditures 
incurred in Year 2 by X in connection with small gasoline engines are 
definitely related to the items of gross intangible income related to 
the SIC code category, namely gross income from the sale of small 
gasoline engines in the United States and PCT Payments from Y. 
Accordingly, under paragraph (a) of this section, the R&E expenditures 
are allocable to this class of gross intangible income. X's U.S. source 
interest income and income included under section 951A are not within 
this class of gross intangible income and, therefore, no portion of X's 
R&E expenditures is allocated to X's U.S. source interest income or 
section 951A category income.
    (B) Apportionment--(1) In general. For purposes of applying this 
section to section 904 as the operative section, the statutory grouping 
of gross intangible income is foreign source general category income, 
and the residual grouping of gross intangible income is U.S. source 
income.
    (2) Exclusive apportionment. Under paragraph (c) of this section, 
because at least 50% of X's research and experimentation in Year 2 was 
performed in the United States, 50% of the R&E expenditures, or 
$35,000x ($70,000x x 50%), is apportioned exclusively to the residual 
grouping of gross intangible income, U.S. source income.
    (3) Apportionment based on gross receipts. Although X has gross 
intangible income of $200,000x from domestic sales and $50,000x as a 
PCT Payment from Y, X's R&E expenditures are apportioned to its gross 
intangible income on the basis of the relative amounts of gross 
receipts arising from the sale of products by X (and not the relative 
amounts of X's gross intangible income) in the statutory and residual 
groupings. Under paragraph (d)(4)(iv) of this section, because of the 
cost sharing arrangement, Y's gross receipts from sales are not taken 
into account in apportioning X's R&E expenditures that are intangible 
development costs with respect to the cost sharing arrangement. Because 
all of the gross receipts from sales that are taken into account under 
paragraph (d)(1) of this section relate to gross intangible income that 
is included in the residual grouping, $35,000x is apportioned to the 
residual grouping of gross intangible income, or U.S. source income.
    (4) Summary. Accordingly, for purposes of the foreign tax credit 
limitation, $70,000x of X's R&E expenditures are apportioned to U.S. 
source income.
    (4) Example 4: Uncontrolled party--(i) Facts--(A) X's R&E 
expenditures. X, a domestic corporation, is engaged in continuous 
research and experimentation to improve the quality of the products 
that it manufactures and sells, which are floodlights, flashlights, 
fuse boxes, and solderless connectors. All of these products are in the 
same three digit SIC code category, Electric

[[Page 72047]]

Lighting and Wiring Equipment (SIC Industry Group 364). X incurs 
$100,000x of R&E expenditures in Year 1 that is performed exclusively 
in the United States. As a result of this research activity, X acquires 
patents that it uses in its own manufacturing activity.
    (B) License to Y and Z. In Year 1, X licenses its floodlight patent 
to Y and Z, uncontrolled parties, for use in their own territories, 
Countries Y and Z, respectively. Y pays X a royalty of $3,000x plus 
$0.20x for each unit sold. Gross receipts from sales of floodlights by 
Y for the taxable year are $135,000x (30,000 units at $4.50x per unit), 
and the royalty is $9,000x ($3,000x + $0.20x/unit x 30,000 units). Y 
has sales of other products of $500,000x. Z pays X a royalty of $3,000x 
plus $0.30x for each unit sold. Z manufactures 30,000 floodlights in 
the taxable year, and the royalty is $12,000x ($3,000x + $0.30x/unit x 
30,000 units). The dollar value of Z's gross receipts from floodlight 
sales is not known to X because, in this case, the floodlights are not 
sold separately by Z but are instead used as a component in Z's 
manufacture of lighting equipment for theaters. However, a reasonable 
estimate of Z's gross receipts attributable to the floodlights, based 
on the principles of section 482, is $120,000x. The gross receipts from 
sales of all Z's products, including the lighting equipment for 
theaters, are $1,000,000x. Because X has licensed its intangible 
property to Y and Z related to the SIC code, it is presumed to 
reasonably expect to license the intangible property that would be 
developed from the current research and experimentation.
    (C) X's gross receipts and gross income. X's gross receipts from 
sales of floodlights for the taxable year are $500,000x and its sales 
of its other products (flashlights, fuse boxes, and solderless 
connectors) are $400,000x. X has gross income of $500,000x, consisting 
of U.S. source gross income from domestic sales of floodlights, 
flashlights, fuse boxes, and solderless connectors of $479,000x, and 
foreign source gross income from royalties of $9,000x and $12,000x from 
foreign corporations Y and Z, respectively. The royalty income is 
general category income to X under Sec.  1.904-4(b)(2)(ii).
    (ii) Analysis--(A) Allocation. X's R&E expenditures are definitely 
related to all of the gross intangible income from the products that it 
produces, which are floodlights, flashlights, fuse boxes, and 
solderless connectors. All of these products are in SIC code category 
364. Therefore, under paragraph (b) of this section, X's R&E 
expenditures are definitely related to the class of gross intangible 
income related to SIC code category 364 and to all items of gross 
intangible income attributable to the class. These items of X's gross 
intangible income are gross income from the sale of floodlights, 
flashlights, fuse boxes, and solderless connectors in the United States 
and royalties from Corporations Y and Z.
    (B) Apportionment--(1) In general. For purposes of applying this 
section to section 904 as the operative section, the statutory grouping 
of gross intangible income is foreign source general category income, 
and the residual grouping of gross intangible income is U.S. source 
income.
    (2) Exclusive apportionment. Under paragraph (c) of this section, 
because at least 50% of X's research and experimentation was performed 
in the United States, 50% of the R&E expenditures, or $50,000x 
($100,000x x 50%), is apportioned exclusively to the residual grouping 
of U.S. source gross intangible income.
    (3) Apportionment based on gross receipts. After taking into 
account exclusive apportionment, X has $50,000x ($100,000x-$50,000x) of 
R&E expenditures that must be apportioned between the statutory and 
residual groupings. Under paragraph (d)(3)(i) of this section, gross 
receipts from sales of Y and Z are taken into account in apportioning 
X's R&E expenditures. Although X has gross intangible income of 
$479,000x from domestic sales and $21,000x in royalties from Y and Z, 
X's R&E expenditures are apportioned to its gross intangible income on 
the basis of the relative amounts of gross receipts arising from the 
sale of products by X, Y and Z (and not the relative amounts of X's 
gross intangible income) in the statutory and residual groupings. In 
addition, under paragraph (d)(3)(iii) of this section only the portion 
of Z's gross receipts that are attributable to the floodlights that 
incorporate the intangible property licensed from X, rather than Z's 
total gross receipts, are used for purposes of apportionment. All of 
X's gross receipts from sales in the entire SIC code category are 
included for purposes of apportionment on the basis of gross intangible 
income attributable to those sales. Under paragraph (d)(1) of this 
section, $11,039x ($50,000x x ($135,000x + $120,000x)/($900,000x + 
$135,000x + $120,000x)) is apportioned to the statutory grouping of 
gross intangible income, or foreign source general category income. The 
remaining $38,961x ($50,000x x $900,000x/($900,000x + $135,000x + 
$120,000x)) is apportioned to the residual grouping of gross intangible 
income, or U.S. source income.
    (4) Summary. Accordingly, for purposes of the foreign tax credit 
limitation, $11,039x of X's R&E expenditures are apportioned to foreign 
source general category income and $88,961x ($50,000x + $38,961x) of 
X's R&E expenditures are apportioned to U.S. source income.
    (5) Example 5: Uncontrolled party and sublicense--(i) Facts. X, a 
domestic corporation, is a cloud storage service provider. Cloud 
storage services are a service within the category, Computer 
Programming, Data Processing, and other Computer Related Services (SIC 
Industry Group 737). During Year 1, X incurs R&E expenditures of 
$50,000x to invent and copyright new storage monitoring and management 
software. All of the research and experimentation is performed in the 
United States. X uses this software in its own business to provide 
services to customers. X also licenses a version of the software that 
can be used by other businesses that provide cloud storage services. X 
licenses the software to uncontrolled party U, which sub-licenses the 
software to other businesses that provide cloud storage services to 
customers. U does not use the software except to sublicense it. As a 
part of the licensing agreement with U, U and its sub-licensees are 
only permitted to use the software in certain countries outside of the 
United States. Under the contract with U, U pays X a royalty of 50% on 
the amount it receives from its sub-licensees that use the software to 
provide services to customers. Because X has licensed its intangible 
property to U related to the SIC code and U has sublicensed it to other 
businesses, it is presumed that X is reasonably expected to license the 
intangible property that would be developed from its current research 
and experimentation to U and that U would sublicense it to other 
businesses. In Year 1, X earns $300,000x of gross receipts from 
providing cloud storage services within the United States. Further, in 
Year 1 U receives $10,000x of royalty income from its sub-licensees and 
pays a royalty of $5,000x to X. Thus, X earns $300,000x of U.S. source 
general category gross income and also earns $5,000x of foreign source 
general category royalty income from licensing its software to U for 
use outside of the United States.
    (ii) Analysis--(A) Allocation. The R&E expenditures were incurred 
in connection with the development of cloud computing software and they 
are definitely related to the items of gross intangible income related 
to the SIC Code category, namely gross income

[[Page 72048]]

from the storage monitoring and management software in the United 
States and royalties received from U. Accordingly, under paragraph (b) 
of this section, the R&E expenditures are allocable to this class of 
gross intangible income.
    (B) Apportionment--(1) In general. For purposes of applying this 
section to section 904 as the operative section, the statutory grouping 
of gross intangible income is foreign source general category income, 
and the residual grouping of gross intangible income is U.S. source 
income.
    (2) Exclusive apportionment. Under paragraph (c) of this section, 
because at least 50% of X's research and experimental activity was 
performed in the United States, 50% of the R&E expenditures, or 
$25,000x ($50,000x x 50%), is apportioned exclusively to the residual 
grouping of U.S. source gross intangible income.
    (3) Apportionment based on gross receipts--(i) In general. After 
taking into account exclusive apportionment, X has $25,000x ($50,000x-
$25,000x) of R&E expenditures that must be apportioned between the 
statutory and residual groupings. Because X has licensed its intangible 
property related to the SIC code to U and U has licensed it to the sub-
licensees, under paragraph (d)(3)(i) of this section, gross receipts 
from sales of U's sublicensees are taken into account in apportioning 
X's R&E expenditures. Although X has gross intangible income of 
$300,000x from domestic sales of services and $5,000x in royalties from 
U, X's R&E expenditures are apportioned to its gross intangible income 
on the basis of the relative amounts of gross receipts arising from the 
sale of services by X and U's sub-licensees (and not the relative 
amounts of X's gross intangible income) in the statutory and residual 
groupings.
    (ii) Determination of U's sub-licensee's gross receipts. Under 
paragraph (d)(3)(iv) of this section, X can make a reasonable estimate 
of the gross receipts of U's sub-licensees from services incorporating 
the intangible property licensed by X by estimating, after an 
appropriate economic analysis, that U would charge a royalty of 5% of 
the sub-licensee's sales. U received a royalty of $10,000x from the 
sub-licensees. X then determines U's sub-licensees' foreign sales by 
dividing the total royalty payments received by U by the royalty 
estimated rate ($10,000x/.05 = $200,000x).
    (iii) Results of apportionment based on gross receipts. Therefore, 
under paragraphs (d)(1) and (3) of this section, $10,000x ($25,000x x 
$200,000x/($300,000x + $200,000x)) is apportioned to the statutory 
grouping of gross intangible income, or foreign source general category 
income. The remaining $15,000x ($25,000x x $300,000x/($300,000x + 
$200,000x)) is apportioned to the residual grouping of gross intangible 
income, or U.S. source income.
    (4) Summary. Accordingly, for purposes of the foreign tax credit 
limitation, $10,000x of X's R&E expenditures are apportioned to foreign 
source general category income and $40,000x ($25,000x + $15,000x) of 
X's R&E expenditures are apportioned to U.S. source income.
    (6) Example 6: Foreign branch--(i) Facts--(A) Overview for X. X, a 
domestic corporation, owns FDE, a disregarded entity that is a foreign 
branch within the meaning of Sec.  1.904-4(f)(3)(vii). FDE conducts 
activities solely in Country Y. FDE's functional currency is the U.S. 
dollar. X is a manufacturer and distributor of small gasoline engines 
for lawnmowers in the United States. Gasoline engines are a product 
within the category, Engines and Turbines (SIC Industry Group 351). FDE 
also manufactures and distributes small gasoline engines but only in 
Country Y. During Year 1, X incurred R&E expenditures of $60,000x, 
which it deducts under section 174 as a current expense, to invent and 
patent a new and improved gasoline engine. All of the research and 
experimentation was performed in the United States. Also in Year 1, the 
domestic gross receipts of X from gasoline engines total $500,000x. X 
provides technology for the manufacture of engines to FDE through a 
license. FDE compensates X for the technology with an arm's length 
royalty payment of $10,000x, which is disregarded for Federal income 
tax purposes.
    (B) Overview for FDE. FDE accrues and records on its books and 
records $100,000x of gross income from sales of gasoline engines to 
unrelated persons. FDE's gross income is non-passive category income 
and is foreign source income. In Year 1, the foreign gross receipts of 
FDE from sales of gasoline engines total $300,000x. The disregarded 
royalty payment from FDE to X is not recorded on FDE's separate books 
and records (as adjusted to conform to Federal income tax principles) 
within the meaning of paragraph Sec.  1.904-4(f)(2)(i) because it is 
disregarded for Federal income tax purposes. However, the $10,000x 
disregarded royalty payment would be allocable to foreign source gross 
income attributable to FDE under Sec.  1.904-4(f)(2)(vi)(B)(1)(ii). 
Therefore, under Sec.  1.904-4(f)(2)(vi)(A) the amount of foreign 
source gross income attributable to FDE is adjusted downwards and the 
amount of foreign source gross income attributable to X is adjusted 
upward to take the $10,000x disregarded royalty payment into account.
    (C) Assignment of X's gross income to separate categories. In Year 
1, X has U.S. source general category gross income of $140,000x from 
domestic sales of gasoline engines. After application of Sec.  1.904-
4(f)(2)(vi)(A) to the disregarded payment made by FDE, X has $10,000x 
of foreign source general category gross income and X also has $90,000x 
of foreign source foreign branch category gross income.
    (ii) Analysis--(A) Allocation. The R&E expenditures were incurred 
in connection with developing intangible property related to small 
gasoline engines and are definitely related to the items of gross 
intangible income related to the SIC code category 351, namely gross 
income from the sale of small gasoline engines in both the United 
States and Country Y.
    (B) Apportionment--(1) In general. For purposes of applying this 
section to section 904 as the operative section, the statutory 
groupings of gross intangible income are foreign source general 
category income and foreign source foreign branch category income, and 
the residual grouping of gross intangible income is U.S. source income.
    (2) Exclusive apportionment. Under paragraph (c) of this section, 
because at least 50% of X's research and experimental activity was 
performed in the United States, 50% of the R&E expenditures, or $30,000 
($60,000x x 50%), is apportioned exclusively to the residual grouping 
of U.S. source gross intangible income. The remaining 50% of the R&E 
expenditures is then apportioned between the statutory and residual 
groupings on the basis of the relative amounts of gross receipts from 
sales of small gasoline engines that are related to U.S. source income, 
foreign source general category income, and foreign source foreign 
branch category income.
    (3) Apportionment based on gross receipts. After taking into 
account exclusive apportionment, X has $30,000x ($60,000x-$30,000x) of 
R&E expenditures that must be apportioned between the statutory and 
residual groupings. Because X's gross intangible income is not 
described in paragraph (d)(3) or (4) of this section (that is, there is 
no gross intangible income related to sales, leases or services from 
controlled or uncontrolled parties that are incorporating intangible 
property that was licensed, sold, or transferred to controlled or 
uncontrolled parties), the

[[Page 72049]]

groupings to which the taxpayer's gross receipts and gross intangible 
income are assigned is the same. However, because the assignment of X's 
gross income to the foreign branch and general categories is made by 
taking into account disregarded payments under Sec.  1.904-4(f)(2)(vi), 
the assignment of gross receipts between the general category and 
foreign branch category must be determined by making similar 
adjustments to X's gross receipts under the principles of Sec.  1.904-
4(f)(2)(vi). See paragraph (d)(1)(iii) of this section. Foreign gross 
receipts of FDE from gasoline engines total $300,000x. However, those 
gross receipts are adjusted under the principles of Sec.  1.904-
4(f)(2)(vi) for purposes of apportioning the remaining R&E expenditures 
by reducing the gross receipts initially assigned to the foreign branch 
category by an amount equal to the ratio of the royalty income to FDE's 
gross income that is initially assigned to the foreign branch category. 
Accordingly, since the disregarded royalty payment of $10,000x caused 
an adjustment equal to 10% of FDE's initial gross income of $100,000x, 
10% of the gross receipts or $30,000x (10% x $300,000x) are similarly 
assigned to the grouping of foreign source general category income, and 
the remaining $270,000x of gross receipts are assigned to the grouping 
of foreign source foreign branch category income. Therefore, under 
paragraph (d)(1) of this section, $1,125x ($30,000x x $30,000x/
($500,000x + $270,000x + $30,000x)) is apportioned to the statutory 
grouping of X's gross intangible income attributable to foreign source 
general category income. $10,125x ($30,000x x $270,000x/($500,000x + 
$270,000x + $30,000x)) is apportioned to the statutory grouping of X's 
foreign source foreign branch category income. The remaining $18,750x 
($30,000x x $500,000x/($500,000x + $270,000x + $30,000x)) is 
apportioned to the residual grouping of gross intangible income or U.S. 
source income.
    (7) Example 7: Indirectly derived gross intangible income-(i) 
Facts. P, a domestic corporation, develops and publishes an internet 
website that persons use (referred to as ``users'' and collectively 
referred to as ``user base'') without a fee. P incurs R&E expenditures 
to update software code and write new software code to maintain the 
website and develop new products that are incorporated into the 
website. P's activities consist of services that fall within SIC code 
category 737 (computer programming, data processing, and other computer 
related services). P sells space on its website for businesses to 
advertise to its user base in exchange for a fee. P's technology allows 
it to collect data on users and to use that data to effectively target 
advertisements. P does not grant rights to the technology or other 
intangible property to the businesses advertising on its website. In 
Year 1, P incurs R&E expenditures of $60,000x, which it deducts under 
section 174. All the research and experimentation is performed in the 
United States. Also in Year 1, P earns gross receipts of $200,000x from 
the sale of advertisements, all of which gives rise to U.S. source 
gross income.
    (ii) Analysis--(A) Allocation. The R&E expenditures were incurred 
in connection with developing intangible property used for P's website. 
Accordingly, they are definitely related and allocable to gross 
intangible income derived directly or indirectly (in whole or in part) 
from that intangible property. Because P's advertising sales are 
dependent on the users attracted to its website, P's gross income from 
advertising is indirectly derived from intangible property and is 
included in gross intangible income. Accordingly, under paragraph (b) 
of this section, the R&E expenditures are allocable to the class of 
gross intangible income related to SIC code category 737, which 
consists of U.S. source income.
    (B) Apportionment. Because all gross receipts from services that 
the intangible property directly or indirectly benefits result in U.S. 
source income, no apportionment is required.
    (h) Applicability date. This section applies to taxable years 
beginning after December 31, 2019. However, taxpayers may choose to 
apply this section to taxable years beginning on or after January 1, 
2018, and before January 1, 2020, provided they apply this section in 
its entirety and for any subsequent year beginning before January 1, 
2020.

0
Par. 14. Section 1.861-20 is added to read as follows:


Sec.  1.861-20  Allocation and apportionment of foreign income taxes.

    (a) Scope. This section provides rules for the allocation and 
apportionment of foreign income taxes, including allocating and 
apportioning foreign income taxes to separate categories for purposes 
of the foreign tax credit. The rules of this section apply except as 
modified under the rules for an operative section (as described in 
Sec.  1.861-8(f)(1)). See, for example, Sec. Sec.  1.704-
1(b)(4)(viii)(d)(1), 1.904-6, 1.960-1(d)(3)(ii), and 1.965-5(b)(2). 
Paragraph (b) of this section provides definitions for the purposes of 
this section. Paragraph (c) of this section provides the general rule 
for allocation and apportionment of foreign income taxes. Paragraph (d) 
of this section provides rules for assigning foreign gross income to 
statutory and residual groupings. Paragraph (e) of this section 
provides rules for allocating and apportioning foreign law deductions 
to foreign gross income in the statutory and residual groupings. 
Paragraph (f) of this section provides rules for apportioning foreign 
income taxes among statutory and residual groupings. Paragraph (g) of 
this section provides examples that illustrate the application of this 
section. Paragraph (h) of this section provides the applicability date 
for this section.
    (b) Definitions. The following definitions apply for purposes of 
this section.
    (1) Corporation. The term corporation has the same meaning as set 
forth in Sec.  301.7701-2(b) of this chapter, and so includes a reverse 
hybrid.
    (2) Corresponding U.S. item. The term corresponding U.S. item means 
the item of U.S. gross income or U.S. loss, if any, that arises from 
the same transaction or other realization event from which an item of 
foreign gross income also arises. An item of U.S. gross income or U.S. 
loss is a corresponding U.S. item even if the item of foreign gross 
income that arises from the same transaction or realization event 
differs in amount from the item of U.S. gross income or U.S. loss. A 
corresponding U.S. item does not include an item of gross income that 
is exempt, excluded, or eliminated from U.S. gross income, nor does it 
include an item of U.S. gross income or U.S. loss that is not realized, 
recognized or taken into account by the taxpayer in the U.S. taxable 
year in which the taxpayer paid or accrued the foreign income tax, 
except as provided in the next sentence. If a taxpayer pays or accrues 
a foreign income tax that is imposed on foreign taxable income that 
includes an item of foreign gross income by reason of a transaction or 
other realization event that also gave rise to an item of U.S. gross 
income or U.S. loss, but the U.S. and foreign taxable years end on 
different dates and the event occurred in the last U.S. taxable year 
that ends before the end of the foreign taxable year, then the item of 
U.S. gross income or U.S. loss is a corresponding U.S. item.
    (3) Disregarded entity. The term disregarded entity means an entity 
described in Sec.  301.7701-2(c)(2) of this chapter that is disregarded 
as an entity separate from its owner for Federal income tax purposes.

[[Page 72050]]

    (4) Foreign capital gain amount. The term foreign capital gain 
amount means the portion of a distribution that under foreign law gives 
rise to gross income of a type described in section 301(c)(3)(A).
    (5) Foreign dividend amount. The term foreign dividend amount means 
the portion of a distribution that is taxable as a dividend under 
foreign law.
    (6) Foreign gross income. The term foreign gross income means the 
items of gross income included in the base upon which a foreign income 
tax is imposed. This includes all items of foreign gross income 
included in the foreign tax base, even if the foreign taxable year 
begins in the U.S. taxable year that precedes the U.S. taxable year in 
which the taxpayer pays or accrues the foreign income tax.
    (7) Foreign income tax. The term foreign income tax means an 
income, war profits, or excess profits tax within the meaning of Sec.  
1.901-2(a) that is a separate levy within the meaning of Sec.  1.901-
2(d) and that is paid or accrued to any foreign country (as defined in 
Sec.  1.901-2(g)).
    (8) Foreign law CFC. The term foreign law CFC means an entity that 
is a body corporate under foreign law, certain of the earnings of which 
are taxable to its shareholder under a foreign law inclusion regime.
    (9) Foreign law disposition. The term foreign law disposition means 
an event that foreign law treats as a taxable disposition or deemed 
disposition of property but that Federal income tax law does not treat 
as a disposition causing the recognition of gain or loss (for example, 
marking property to market under foreign law).
    (10) Foreign law distribution. The term foreign law distribution 
means an event that foreign law treats as a taxable distribution (other 
than by reason of a foreign law inclusion regime) but that Federal 
income tax law does not treat as a distribution of property within the 
meaning of section 317(a) (for example, a stock dividend described in 
section 305 or a foreign law consent dividend).
    (11) Foreign law inclusion regime. A foreign law inclusion regime 
is a foreign law tax regime similar to the subpart F or GILTI regime 
described in sections 951 through 959, or the PFIC regime described in 
sections 1293 through 1295 (relating to qualified electing funds), that 
imposes a tax on a shareholder of an entity based on an inclusion in 
the shareholder's taxable income of certain of the entity's current 
earnings, whether or not the foreign law deems the entity's earnings to 
be distributed.
    (12) Foreign law inclusion regime income. The term foreign law 
inclusion regime income means the items of foreign gross income 
included by a taxpayer with respect to a foreign law CFC by reason of a 
foreign law inclusion regime.
    (13) Foreign law pass-through income. The term foreign law pass-
through income means the items of a reverse hybrid, computed under 
foreign law, that give rise to an inclusion in a taxpayer's foreign 
gross income under the laws of a foreign country imposing tax by reason 
of the taxpayer's ownership of the reverse hybrid.
    (14) Foreign taxable income. The term foreign taxable income means 
foreign gross income reduced by the deductions that are allowed under 
foreign law.
    (15) Foreign taxable year. The term foreign taxable year has the 
meaning set forth in section 7701(a)(23), applied by substituting 
``under foreign law'' for the phrase ``under subtitle A.''
    (16) Partnership. The term partnership has the same meaning as set 
forth in Sec.  301.7701-2(c)(1) of this chapter.
    (17) Reverse hybrid. The term reverse hybrid means a corporation 
that is a fiscally transparent entity (under the principles of Sec.  
1.894-1(d)(3)) or a branch under the laws of a foreign country imposing 
tax on the income of the entity.
    (18) Taxpayer. The term taxpayer has the meaning described in Sec.  
1.901-2(f)(1).
    (19) U.S. capital gain amount. The term U.S. capital gain amount 
means gain recognized by a taxpayer on the sale or exchange of stock 
or, in the case of a distribution with respect to stock, the portion of 
the distribution to which section 301(c)(3)(A) applies. However, a U.S. 
capital gain amount does not include any portion of the gain recognized 
by a taxpayer that is treated as a dividend under section 964(e) or 
1248.
    (20) U.S. dividend amount. The term U.S. dividend amount means the 
portion of a distribution that is made out of earnings and profits 
under Federal income tax law, including distributions out of previously 
taxed earnings and profits described in section 959(a) or (b). It also 
includes amounts included in gross income as a dividend by reason of 
section 1248 or section 964(e).
    (21) U.S. gross income. The term U.S. gross income means the items 
of gross income that a taxpayer recognizes and includes in taxable 
income under Federal income tax law for its U.S. taxable year.
    (22) U.S. loss. The term U.S. loss means the item of loss that a 
taxpayer recognizes and includes in taxable income under Federal income 
tax law for its U.S. taxable year.
    (23) U.S. return of capital amount. The term U.S. return of capital 
amount means, in the case of the sale or exchange of stock, the 
adjusted basis of the stock, and in the case of a distribution with 
respect to stock, the portion of a distribution to which section 
301(c)(2) applies.
    (24) U.S. taxable year. The term U.S. taxable year has the same 
meaning as that of the term taxable year set forth in section 
7701(a)(23).
    (c) General rule. A foreign income tax is allocated and apportioned 
to the statutory and residual groupings that include the items of 
foreign gross income included in the base on which the tax is imposed. 
Each foreign income tax (that is, each separate levy) is allocated and 
apportioned separately under the rules in this section. A foreign 
income tax is allocated and apportioned to or among the statutory and 
residual groupings under the following steps:
    (1) First, by assigning the items of foreign gross income to the 
groupings under the rules of paragraph (d) of this section;
    (2) Second, by allocating and apportioning the deductions that are 
allowed under foreign law to the foreign gross income in the groupings 
under the rules of paragraph (e) of this section; and
    (3) Third, by allocating and apportioning the foreign income tax by 
reference to the foreign taxable income in the groupings under the 
rules of paragraph (f) of this section.
    (d) Assigning items of foreign gross income to the statutory and 
residual groupings--(1) In general. Each item of foreign gross income 
is assigned to a statutory or residual grouping. The amount of the item 
is determined under foreign law. However, Federal income tax law 
applies to characterize the item and the transaction or other 
realization event from which the item arose, and to assign it to a 
grouping. Except as provided in paragraph (d)(3) of this section, if a 
taxpayer pays or accrues a foreign income tax that is imposed on 
foreign taxable income that includes an item of foreign gross income 
with respect to which the taxpayer also realizes, recognizes, or takes 
into account a corresponding U.S. item, then the item of foreign gross 
income is assigned to the grouping to which the corresponding U.S. item 
is assigned. See paragraph (g)(2) of this section (Example 1). If the 
corresponding U.S. item is a U.S. loss (or zero), the foreign gross 
income is assigned to the grouping to which a gain would be assigned 
had the transaction or other realization event given rise to a gain, 
rather than a U.S. loss (or zero), for Federal income tax

[[Page 72051]]

purposes, and not (if different) to the grouping to which the U.S. loss 
is allocated and apportioned in computing U.S. taxable income. 
Paragraph (d)(3) of this section provides special rules regarding the 
assignment of the item of foreign gross income in particular 
circumstances.
    (2) Items of foreign gross income with no corresponding U.S. item--
(i) In general. The rules in paragraphs (d)(2)(ii) and (iii) of this 
section apply for purposes of characterizing an item of foreign gross 
income and assigning it to a grouping if the taxpayer does not realize, 
recognize, or take into account a corresponding U.S. item. But see 
paragraphs (d)(3)(i)(C) and (d)(3)(iii) of this section for special 
rules with respect to items of foreign gross income attributable to 
foreign law pass-through income and foreign law inclusion regime 
income.
    (ii) Foreign gross income from U.S. nonrecognition event, or U.S. 
recognition event that falls in a different U.S. taxable year--(A) In 
general. If a taxpayer recognizes an item of foreign gross income 
arising from a transaction or other foreign realization event that does 
not result in the recognition of gross income or loss under Federal 
income tax law in the same U.S. taxable year in which the foreign 
income tax is paid or accrued or (in the circumstance described in the 
last sentence of paragraph (b)(2) of this section) in the immediately 
preceding U.S. taxable year, then the item of foreign gross income is 
characterized and assigned to the grouping to which the corresponding 
U.S. item (or the items described in paragraph (d)(3) of this section 
that are used to assign certain items of foreign gross income to the 
statutory and residual groupings) would be assigned if the event giving 
rise to the foreign gross income resulted in the recognition of gross 
income or loss under Federal income tax law in the U.S. taxable year in 
which the foreign income tax is paid or accrued.
    (B) Foreign law distributions. An item of foreign gross income that 
a taxpayer includes as a result of a foreign law distribution with 
respect to either stock or a partnership interest is assigned to the 
same statutory or residual groupings to which the foreign gross income 
would be assigned if a distribution of property in the amount of the 
taxable distribution under foreign law were made for Federal income tax 
purposes on the date on which the foreign law distribution occurred. 
See paragraph (g)(6) of this section (Example 5). See paragraph 
(d)(3)(i)(B) of this section for rules regarding the assignment of 
foreign gross income arising from a distribution with respect to stock. 
For purposes of applying paragraph (d)(3)(i)(B) of this section to a 
foreign law distribution, the U.S. dividend amount, U.S. capital gain 
amount, and U.S. return of capital amount are computed as if the 
distribution occurred on the date the distribution occurs for foreign 
law purposes. See Sec.  1.960-1(d)(3)(ii) for rules for assigning 
foreign gross income arising from a foreign law distribution to income 
groups or PTEP groups for purposes of section 960 as the operative 
section.
    (C) Foreign law dispositions. A foreign gross income item of gain 
that a taxpayer includes as a result of a foreign law disposition of 
property is assigned to the grouping to which a corresponding U.S. item 
of gain or loss would be assigned on a taxable disposition of the 
property under Federal income tax law in exchange for an amount equal 
to the gross receipts or other value used under foreign law to 
determine the amount of the items of foreign gross income arising from 
the foreign law disposition in the U.S. taxable year in which the 
taxpayer paid or accrued the foreign income tax. For example, an item 
of foreign gross income that results from a deemed disposition of stock 
under a foreign law mark-to-market regime is assigned under the rules 
of this paragraph (d)(2)(ii)(C) as though a taxable disposition of the 
stock occurred under Federal income tax law for an amount equal to the 
fair market value determined under foreign law for purposes of marking 
the stock to market. See paragraph (g)(3) of this section (Example 2).
    (iii) Foreign gross income of a type that is recognized but 
excluded from U.S. gross income--(A) In general. If a taxpayer 
recognizes an item of foreign gross income that is a type of recognized 
gross income that Federal income tax law excludes from U.S. gross 
income, then the item of foreign gross income is assigned to the 
grouping to which the item of gross income would be assigned if it were 
included in U.S. gross income. See paragraph (g)(4) of this section 
(Example 3). Notwithstanding the first sentence of this paragraph 
(d)(2)(iii)(A), foreign gross income that is attributable to a base 
difference is assigned under paragraph (d)(2)(iii)(B) of this section.
    (B) Base differences. If a taxpayer recognizes an item of foreign 
gross income that is attributable to a base difference, then the item 
of foreign gross income is assigned to the residual grouping. But see 
Sec.  1.904-6(b)(1) (assigning foreign gross income attributable to a 
base difference to foreign source income in the separate category 
described in section 904(d)(2)(H)(i)) for purposes of applying section 
904 as the operative section). An item of foreign gross income is 
attributable to a base difference under this paragraph (d)(2)(iii)(B) 
only if the item results from the receipt of one of the following 
items:
    (1) Death benefits described in section 101;
    (2) Gifts and inheritances described in section 102;
    (3) Contributions to capital described in section 118;
    (4) Money or other property in exchange for stock described in 
section 1032 (including by reason of a transfer described in section 
351(a)); or
    (5) Money or other property in exchange for a partnership interest 
described in section 721.
    (3) Special rules for assigning certain items of foreign gross 
income to a statutory or residual grouping--(i) Items of foreign gross 
income that a taxpayer includes by reason of its ownership of an 
interest in a corporation--(A) Scope. The rules of this paragraph 
(d)(3)(i) apply to characterize and assign to a statutory or residual 
grouping an item of foreign gross income that a taxpayer includes in 
foreign taxable income as a result of its ownership of an interest in a 
corporation with respect to which there is a distribution under both 
foreign and Federal income tax law or an inclusion of foreign law pass-
through income.
    (B) Foreign gross income items arising from a distribution with 
respect to a corporation--(1) In general. If there is a distribution by 
a corporation that is treated as a distribution of property for both 
foreign law and Federal income tax purposes, a taxpayer first applies 
the rules of paragraph (d)(3)(i)(B)(2) of this section, and then (if 
necessary) applies the rules of paragraph (d)(3)(i)(B)(3) of this 
section to characterize and assign to the statutory and residual 
groupings the items of foreign gross income that constitute the foreign 
dividend amount and the foreign capital gain amount, if any, that arise 
from the distribution. See paragraph (g)(5) of this section (Example 
4). For purposes of this paragraph (d)(3)(i)(B), the U.S. dividend 
amount, U.S. capital gain amount, and U.S. return of capital amount 
that result from a distribution (including a distribution that occurs 
on the same date, but in different taxable years, for foreign law 
purposes and Federal income tax purposes) are computed on the date the 
distribution occurred for Federal income tax purposes. See paragraph 
(d)(2)(ii)(B) of this section for rules for assigning foreign gross 
income arising from any portion of a distribution that

[[Page 72052]]

is a foreign law distribution. See Sec.  1.960-1(d)(3)(ii) for rules 
for assigning foreign gross income arising from a distribution 
described in this paragraph (d)(3)(i)(B) to income groups or PTEP 
groups for purposes of section 960 as the operative section.
    (2) Foreign dividend amounts. The foreign dividend amount is, to 
the extent of the U.S. dividend amount, assigned to the same statutory 
and residual grouping (or ratably to the groupings) from which a 
distribution of the U.S. dividend amount is made under Federal income 
tax law. If the foreign dividend amount exceeds the U.S. dividend 
amount, the excess foreign dividend amount is an item of foreign gross 
income that is, to the extent of the U.S. return of capital amount, 
assigned to the same statutory and residual grouping (or ratably to the 
groupings) to which earnings equal to the U.S. return of capital amount 
would be assigned if they were recognized for Federal income tax 
purposes in the U.S. taxable year in which the distribution is made. 
These earnings are deemed to arise in the statutory and residual 
groupings in the same proportions as the proportions in which the tax 
book value of the stock of the distributing corporation is (or would be 
if the taxpayer were a United States person) assigned to the groupings 
under the asset method in Sec.  1.861-9 in the U.S. taxable year in 
which the distribution is made. Any additional excess of the foreign 
dividend amount over the sum of the U.S. dividend amount and the U.S. 
return of capital amount is an item of foreign gross income that is 
assigned to the statutory or residual grouping (or ratably to the 
groupings) to which the U.S. capital gain amount is assigned.
    (3) Foreign capital gain amounts. The foreign capital gain amount 
is, to the extent of the U.S. capital gain amount, assigned to the 
statutory and residual groupings to which the U.S. capital gain amount 
is assigned under Federal income tax law. If the foreign capital gain 
amount exceeds the U.S. capital gain amount, the excess is, to the 
extent of the U.S. return of capital amount, assigned to the statutory 
and residual groupings to which earnings equal to the U.S. return of 
capital amount would be assigned if they were recognized in the U.S. 
taxable year in which the distribution is made. These earnings are 
deemed to arise in the statutory and residual groupings in the same 
proportions as the proportions in which the tax book value of the stock 
of the distributing corporation is (or would be if the taxpayer were a 
United States person) assigned under the asset method in Sec.  1.861-9 
in the U.S. taxable year in which the distribution is made. Any excess 
of the foreign capital gain amount over the sum of the U.S. capital 
gain amount and the U.S. return of capital amount is assigned ratably 
to the statutory and residual groupings to which the U.S. dividend 
amount is assigned.
    (C) Foreign law pass-through income from a reverse hybrid. An item 
of foreign law pass-through income that a taxpayer includes in its 
foreign taxable income as a result of its direct or indirect ownership 
of a reverse hybrid is assigned to a statutory or residual grouping by 
treating the taxpayer's items of foreign law pass-through income as the 
foreign gross income of the reverse hybrid, and applying the rules in 
this paragraph (d) by treating the reverse hybrid as the taxpayer in 
the reverse hybrid's U.S. taxable year with or within which its foreign 
taxable year (under the law of the foreign jurisdiction imposing the 
owner-level tax) ends. See Sec.  1.904-6(f) for special rules that 
apply for purposes of section 904 with respect to items of foreign 
gross income that under this paragraph (d)(3)(iii) would be assigned to 
a separate category that includes income that gives rise to inclusions 
under section 951A.
    (ii) [Reserved]
    (iii) Foreign law inclusion regime income. A gross item of foreign 
law inclusion regime income that a taxpayer includes in its capacity as 
a shareholder under foreign law of a foreign law CFC under a foreign 
law inclusion regime is assigned to the same statutory and residual 
groupings as the item of foreign gross income of the foreign law CFC 
that gives rise to the item of foreign law inclusion regime income of 
the taxpayer. The assignment is made by treating the gross items of 
foreign law inclusion regime income of the taxpayer as the items of 
foreign gross income of the foreign law CFC and applying the rules in 
this paragraph (d) by treating the foreign law CFC as the taxpayer in 
its U.S. taxable year with or within which its foreign taxable year 
(under the law of the foreign jurisdiction imposing the shareholder-
level tax) ends. See paragraphs (g)(7) and (8) of this section 
(Examples 6 and 7). See Sec.  1.904-6(f) for special rules with respect 
to items of foreign gross income relating to items of the foreign law 
CFC that give rise to inclusions under section 951A for purposes of 
applying section 904 as the operative section.
    (iv) Gain on sale of disregarded entity. An item of foreign gross 
income arising from gain recognized on the sale, exchange, or other 
disposition of a disregarded entity that is characterized as a 
disposition of assets for Federal income tax purposes is assigned to 
statutory and residual groupings in the same proportion as the gain 
that would be treated as foreign gross income in each grouping if the 
transaction were treated as a disposition of assets for foreign tax law 
purposes. See paragraph (g)(9) of this section (Example 8).
    (e) Allocating and apportioning deductions (allowed under foreign 
law) to foreign gross income in a grouping--(1) Application of foreign 
law expense allocation rules. In order to determine foreign taxable 
income in each statutory grouping, or the residual grouping, foreign 
gross income in each grouping is reduced by deducting any expenses, 
losses, or other amounts that are deductible under foreign law that are 
specifically allocable to the items of foreign gross income in the 
grouping under the laws of that foreign country. If expenses are not 
specifically allocated under foreign law, then the expenses are 
allocated and apportioned among the groupings under the principles of 
foreign law. Thus, for example, if foreign law provides that expenses 
will be apportioned on a gross income basis, the foreign law deductions 
are apportioned on the basis of the relative amounts of foreign gross 
income assigned to each grouping.
    (2) Application of U.S. expense allocation rules in the absence of 
foreign law rules. If foreign law does not provide rules for the 
allocation or apportionment of expenses, losses or other deductions to 
particular items of foreign gross income, then the principles of the 
section 861 regulations (as defined in Sec.  1.861-8(a)(1)) apply in 
allocating and apportioning such expenses, losses, or other deductions 
to foreign gross income. For example, in the absence of foreign law 
expense allocation rules, the principles of the section 861 regulations 
apply to allocate definitely related expenses to particular categories 
of foreign gross income and provide the methods for apportioning 
foreign law expenses that are definitely related to more than one 
statutory grouping or that are not definitely related to any statutory 
grouping. For purposes of this paragraph (e)(2), the apportionment of 
expenses required to be made under the principles of the section 861 
regulations need not be made on other than a separate company basis. If 
the taxpayer applies the principles of the section 861 regulations for 
purposes of allocating foreign law deductions under this paragraph (e), 
the taxpayer must apply the principles in the same manner as the 
taxpayer applies such principles in determining the income or earnings 
and profits for

[[Page 72053]]

Federal income tax purposes of the taxpayer (or of the foreign branch, 
controlled foreign corporation, or other entity that paid or accrued 
the foreign taxes, as the case may be). For example, a taxpayer must 
use the modified gross income method under Sec.  1.861-9T when applying 
the principles of that section for purposes of this paragraph (e) to 
determine the amount of foreign taxable income in each grouping if the 
taxpayer applies the modified gross income method in determining the 
income and earnings and profits of a controlled foreign corporation for 
Federal income tax purposes.
    (f) Allocation and apportionment of foreign income tax. Foreign 
income tax is allocated to the statutory or residual grouping or 
groupings to which the items of foreign gross income are assigned under 
the rules of paragraph (d) of this section. If foreign gross income is 
assigned to more than one grouping, then the foreign income tax is 
apportioned among the statutory and residual groupings by multiplying 
the foreign income tax by a fraction, the numerator of which is the 
foreign taxable income in a grouping and the denominator of which is 
all foreign taxable income on which the foreign income tax is imposed. 
If foreign law, including by reason of an income tax convention, 
exempts certain types of income from tax, or if foreign taxable income 
is reduced to or below zero by foreign law deductions, then no foreign 
income tax is allocated and apportioned to that income. A withholding 
tax (as defined in section 901(k)(1)(B)) is allocated and apportioned 
to the foreign gross income from which it is withheld. If foreign law, 
including by reason of an income tax convention, provides for a 
specific rate of tax with respect to certain types of income (for 
example, capital gains), or allows credits only against tax on 
particular items or types of income (for example, credit for foreign 
withholding taxes), then such provisions are taken into account in 
determining the amount of foreign tax imposed on such foreign taxable 
income.
    (g) Examples. The following examples illustrate the application of 
this section and Sec.  1.904-6.
    (1) Presumed facts. Except as otherwise provided in this paragraph 
(g), the following facts are assumed for purposes of the examples in 
paragraphs (g)(2) through (9) of this section:
    (i) USP and US2 are domestic corporations, which are unrelated;
    (ii) USP elects to claim a foreign tax credit under section 901;
    (iii) CFC, CFC1, and CFC2 are controlled foreign corporations 
organized in Country A, and are not reverse hybrids;
    (iv) All parties have a U.S. dollar functional currency and a U.S. 
taxable year and foreign taxable year that correspond to the calendar 
year;
    (v) No party has expenses for Country A tax purposes or expenses 
for U.S. tax purposes (other than foreign income tax expense); and
    (vi) Section 904 is the operative section, and terms have the 
meaning provided in this section or Sec. Sec.  1.904-4 and 1.904-5.
    (2) Example 1: Corresponding U.S. item--(i) Facts. USP conducts 
business in Country A that gives rise to a foreign branch (as defined 
in Sec.  1.904-4(f)(3)). In Year 1, in a transaction that is a sale for 
purposes of the laws of Country A and Federal income tax law, the 
foreign branch transfers Asset X to US2 for $1,000x. For Country A tax 
purposes, USP earns $600x of gross income from the sale of Asset X and 
incurs foreign income tax of $80x. For Federal income tax purposes, USP 
earns $800x of foreign branch category income from the sale of Asset X.
    (ii) Analysis. For purposes of allocating and apportioning the $80x 
of Country A foreign income tax, the $600x of Country A gross income 
from the sale of Asset X is first assigned to separate categories. The 
$800x of foreign branch category income from the sale of Asset X is the 
corresponding U.S. item to the Country A item of gross income. Under 
paragraph (d)(1) of this section, because USP recognizes a 
corresponding U.S. item with respect to the Country A item of gross 
income in the same U.S. taxable year, the $600x of Country A gross 
income is assigned to the same separate category as the corresponding 
U.S. item. This is the case even though the amount of gross income 
recognized for Federal income tax purposes differs from the amount 
recognized for Country A tax purposes. Accordingly, the $600x of 
Country A gross income is assigned to the foreign branch category. 
Additionally, because all of the Country A taxable income is assigned 
to a single separate category, the $80x of Country A tax is also 
allocated to the foreign branch category. No apportionment of the $80x 
is necessary because the class of gross income to which the tax is 
allocated consists entirely of a single statutory grouping, foreign 
branch category income.
    (3) Example 2: Foreign law disposition--(i) Facts. USP owns all of 
the outstanding stock of CFC, which conducts business in Country A. CFC 
sells Asset X for $1,000x. For Country A tax purposes, CFC's basis in 
Asset X is $600x, the sale of Asset X occurs in Year 1, and CFC 
recognizes $400x of foreign gross income and incurs $80x of foreign 
income tax. For Federal income tax purposes, CFC's basis in Asset X is 
$500x, the sale of Asset X occurs in Year 2, and CFC recognizes $500x 
of general category income.
    (ii) Analysis. For purposes of allocating and apportioning the $80x 
of Country A foreign income tax in Year 1, the $400x of Country A gross 
income from the sale of Asset X is first assigned to separate 
categories. There is no corresponding U.S. item because the sale occurs 
on a different date and in a different U.S. taxable year for U.S. and 
foreign tax purposes. Under paragraph (d)(2)(ii)(C) of this section, 
the item of foreign gross income (the $400x from the sale of Asset X) 
is characterized and assigned to the groupings to which the 
corresponding U.S. item would be assigned if for Federal income tax 
purposes Asset X were sold for $1,000x in Year 1, the same U.S. taxable 
year in which the foreign income tax accrued. This is the case even 
though the amount of gross income that would be recognized for Federal 
income tax purposes differs from the amount recognized for Country A 
tax purposes. Accordingly, the $400x of Country A gross income is 
assigned to the general category. Additionally, because all of the 
Country A taxable income is assigned to a single separate category, the 
$80x of Country A tax is also allocated to the general category. No 
apportionment of the $80x is necessary because the class of gross 
income to which the deduction is allocated consists entirely of a 
single statutory grouping, general category income.
    (4) Example 3: Foreign gross income excluded from U.S. gross 
income--(i) Facts. USP conducts business in Country A. In Year 1, USP 
earns $200x of interest income on a State or local bond. For Country A 
tax purposes, the $200x of income is included in gross income and 
incurs $10x of foreign income tax. For Federal income tax purposes, the 
$200x is excluded from gross income under section 103.
    (ii) Analysis. For purposes of allocating and apportioning the $10x 
of Country A foreign income tax, the $200x of Country A gross income is 
first assigned to separate categories. There is no corresponding U.S. 
item because the interest income is excluded from U.S. gross income. 
Thus, the rules of paragraph (d)(2) of this section apply to 
characterize and assign the foreign gross income to the groupings to 
which a corresponding U.S. item would be assigned if it were recognized 
under Federal income tax law in that U.S. taxable year. The interest 
income is

[[Page 72054]]

excluded from U.S. gross income but is otherwise described or 
identified by section 103. Accordingly, under paragraph (d)(2)(iii)(A) 
of this section, the $200x of Country A gross income is assigned to the 
separate category to which the interest income would be assigned under 
Federal income tax law if the income were included in gross income. 
Under section 904(d)(2)(B)(i), the interest income would be passive 
category income. Accordingly, the $200x of Country A gross income is 
assigned to the passive category. Additionally, because all of the 
Country A taxable income is assigned to a single separate category, the 
$10x of Country A tax is also allocated to the passive category 
(subject to the rules in Sec.  1.904-4(c)). No apportionment of the 
$10x is necessary because the class of gross income to which the 
deduction is allocated consists entirely of a single statutory 
grouping, passive category income.
    (5) Example 4: Actual distribution--(1) Facts. USP owns all of the 
outstanding stock of CFC1, which in turn owns all of the outstanding 
stock of CFC2. CFC1 and CFC2 conduct business in Country A. In Year 1, 
CFC2 distributes $300x to CFC1. For Country A tax purposes, $100x of 
the distribution is the foreign dividend amount, $160x is treated as a 
nontaxable return of capital, and the remaining $40x is the foreign 
capital gain amount. CFC1 incurs $20x of foreign income tax with 
respect to the foreign dividend amount and $4x of foreign income tax 
with respect to the foreign capital gain amount. The $20x and $4x of 
foreign income tax are each a separate levy within the meaning of Sec.  
1.901-2(d). For Federal income tax purposes, $150x of the distribution 
is the U.S. dividend amount, $100x is the U.S. return of capital 
amount, and the remaining $50x is the U.S. capital gain amount. Under 
section 904(d)(3)(D) and Sec. Sec.  1.904-4(d) and 1.904-5(c)(4), the 
$150x of U.S. dividend amount consists solely of general category 
income in the hands of CFC1. Under section 904(d)(2)(B)(i) and Sec.  
1.904-4(b)(2)(i)(A), the $50x of U.S. capital gain amount is passive 
category income to CFC1.
    (ii) Analysis--(A) In general. Because the $20x of Country A 
foreign income tax and the $4x of Country A foreign income tax are 
separate levies, the taxes are allocated and apportioned separately. 
For purposes of allocating and apportioning each foreign income tax, 
the relevant item of Country A gross income (the foreign dividend 
amount or foreign capital gain amount) is first assigned to separate 
categories. The U.S. dividend amount and U.S. capital gain amount are 
corresponding U.S. items. However, paragraph (d)(3)(i)(B) of this 
section (and not paragraph (d)(1) of this section) applies to assign 
the items of foreign gross income arising from the distribution.
    (B) Foreign dividend amount. Under paragraph (d)(3)(i)(B)(2) of 
this section, the foreign dividend amount ($100x) is, to the extent of 
the U.S. dividend amount ($150x), assigned to the same separate 
category from which the distribution of the U.S. dividend amount is 
made under Federal income tax law. Thus, $100x of foreign gross income 
that is the foreign dividend amount is assigned to the general 
category. Additionally, because all of the Country A taxable income 
included in the base on which the $20x of foreign income tax is imposed 
is assigned to a single separate category, the $20x of Country A tax on 
the foreign dividend amount is also allocated to the general category. 
No apportionment of the $20x is necessary because the class of gross 
income to which the deduction for foreign income tax is allocated 
consists entirely of a single statutory grouping, general category 
income. See also section 245A(d) for rules that may apply to disallow a 
credit or deduction for certain foreign taxes.
    (C) Foreign capital gain amount. Under paragraph (d)(3)(i)(B)(3) of 
this section, the foreign capital gain amount ($40x) is, to the extent 
of the U.S. capital gain amount ($50x), assigned to the same separate 
category to which the U.S. capital gain is assigned under Federal 
income tax law. Thus, the $40x of foreign gross income that is the 
foreign capital gain amount is assigned to the passive category. 
Additionally, because all of the Country A taxable income in the base 
on which the $4x of foreign income tax is imposed is assigned to a 
single separate category, the $4x of Country A tax on the foreign 
dividend amount is also allocated to the passive category. No 
apportionment of the $4x is necessary because the class of gross income 
to which the deduction is allocated consists entirely of a single 
statutory grouping, passive category income.
    (6) Example 5: Foreign law distribution--(i) Facts. USP owns all of 
the outstanding stock of CFC. In Year 1, for Country A tax purposes, 
CFC distributes $1,000x of its stock that is treated entirely as a 
dividend to USP, and Country A imposes a withholding tax on USP of 
$150x with respect to the $1,000x of foreign gross income. For Federal 
income tax purposes, the distribution is treated as a stock dividend 
described in section 305(a) and USP recognizes no U.S. gross income. At 
the time of the distribution, CFC has $800x of section 965(a) PTEP (as 
defined in Sec.  1.960-3(c)(2)(vi)) in a single annual PTEP account (as 
defined in Sec.  1.960-3(c)(1)), and $500x of earnings and profits 
described in section 959(c)(3). Section 965(g) is the operative section 
for purposes of this paragraph (g)(6). See Sec.  1.965-5(b)(2). Section 
904 is also a relevant operative section, but is not addressed in this 
paragraph (g)(6).
    (ii) Analysis. For purposes of allocating and apportioning the 
$150x of Country A foreign income tax, the $1,000x of Country A gross 
income is first assigned to the relevant statutory and residual 
groupings for purposes of applying section 965(g) as the operative 
section. Under Sec.  1.965-5(b)(2), the statutory grouping is the 
portion of the distribution that is attributable to section 965(a) 
previously taxed earnings and profits and the residual grouping is the 
portion of the distribution attributable to other earnings and profits. 
There is no corresponding U.S. item because under section 305(a) USP 
recognizes no U.S. gross income with respect to the distribution. Under 
paragraph (d)(2)(ii)(B) of this section, the item of foreign gross 
income (the $1,000x distribution) is assigned under the rules of 
paragraph (d)(3)(i)(B) of this section to the same statutory or 
residual groupings to which the foreign gross income would be assigned 
if a distribution of the same amount were made for Federal income tax 
purposes in Year 1 on the date the distribution occurs for foreign law 
purposes. If recognized for Federal income tax purposes, a $1,000x 
distribution in Year 1 would result in a U.S. dividend amount of 
$1,000x. Under paragraph (d)(3)(i)(B)(2) of this section, the foreign 
dividend amount ($1,000x) is, to the extent of the U.S. dividend amount 
($1,000x), assigned to the same statutory or residual groupings from 
which a distribution of the U.S. dividend amount would be made under 
Federal income tax law. Thus, $800x of foreign gross income related to 
the foreign dividend amount is assigned to the statutory grouping for 
the portion of the distribution attributable to section 965(a) 
previously taxed earnings and profits and $200x of foreign gross income 
is assigned to the residual grouping. Under paragraph (f) of this 
section, $120x ($150x x $800x/$1,000x) of the Country A foreign income 
tax is apportioned to the statutory grouping and $30x ($150x x $200x/
$1,000x) of the Country A foreign income tax is apportioned to the 
residual grouping. See section 965(g)(2) and Sec.  1.965-5(b) for 
application of the applicable

[[Page 72055]]

percentage (as defined in Sec.  1.965-5(d)) to the foreign income tax 
allocated and apportioned to the statutory grouping.
    (7) Example 6: Foreign law inclusion regime, CFC shareholder--(i) 
Facts. USP owns all of the outstanding stock of CFC1, which in turn 
owns all of the outstanding stock of CFC2. CFC2 is organized and 
conducts business in Country B. Country A has a foreign law inclusion 
regime that imposes a tax on CFC1 for certain earnings of CFC2, a 
foreign law CFC. In Year 1, CFC2 earns $400x of interest income and 
$200x of royalty income. CFC2 incurs no foreign income tax. For Country 
A tax purposes, the $400x of interest income and $200x of royalty 
income are each an item of foreign law inclusion regime income of CFC2 
that are included in the gross income of CFC1. CFC1 incurs $150x of 
Country A foreign income tax with respect to the foreign law inclusion 
regime income. For Federal income tax purposes, with respect to CFC2, 
the $400x of interest income is passive category income under section 
904(d)(2)(B)(i) and the $200x of royalty income is general category 
income under Sec.  1.904-4(b)(2)(iii).
    (ii) Analysis. For purposes of allocating and apportioning CFC1's 
$150x of Country A foreign income tax, the $600x of Country A gross 
income is first assigned to separate categories. The $600x of foreign 
gross income is not included in the U.S. gross income of CFC1, and 
thus, there is no corresponding U.S. item. Under paragraph (d)(3)(iii) 
of this section, each item of foreign law inclusion regime income that 
is included in CFC1's foreign gross income is assigned to the same 
separate category as the items of foreign gross income of CFC2 that 
give rise to the foreign law inclusion regime income of CFC1. With 
respect to CFC2, the $400x of interest income and the $200x of royalty 
income would be corresponding U.S. items if CFC2 were the taxpayer. 
Accordingly, $400x of CFC1's foreign gross income is assigned to the 
passive category and $200x of CFC1's foreign gross income is assigned 
to the general category. Under paragraph (f) of this section, $100x 
($150x x $400x/$600x) of the Country A foreign income tax is 
apportioned to the passive category and $50x ($150x x $200x/$600x) of 
the Country A foreign income tax is apportioned to the general 
category.
    (8) Example 7: Foreign law inclusion regime, U.S. shareholder--(i) 
Facts. The facts are the same as in paragraph (g)(7)(i) of this section 
(the facts in Example 6), except that both CFC1 and CFC2 are organized 
and conduct business in Country B, all of the outstanding stock of CFC1 
is owned by Individual X, a U.S. citizen resident in Country A, and 
Country A imposes tax of $150x on foreign gross income of $600x under 
its foreign law inclusion regime on Individual X, rather than on CFC1. 
For Federal income tax purposes, in the hands of CFC2, the $400x of 
interest income is passive category subpart F income and the $200x of 
royalty income is general category tested income (as defined in Sec.  
1.951A-2(b)(1)). CFC2's $400x of interest income gives rise to a 
passive category subpart F inclusion under section 951(a)(1)(A), and 
its $200x of tested income gives rise to a GILTI inclusion amount (as 
defined in Sec.  1.951A-1(c)(1)) of $200x, with respect to Individual 
X.
    (ii) Analysis. The analysis is the same as in paragraph (g)(7)(ii) 
of this section (the analysis in Example 6) except that under Sec.  
1.904-6(f), because $50x of the Country A foreign income tax is 
allocated and apportioned under paragraph (d)(3)(iii) of this section 
to CFC2's general category tested income group to which Individual X's 
inclusion under section 951A is attributable, the $50x of Country A 
foreign income tax is allocated and apportioned in the hands of 
Individual X to the section 951A category.
    (9) Example 8: Sale of disregarded entity--(i) Facts. USP sells 
FDE, a disregarded entity that is organized and operates a trade or 
business in Country A, for $500x. FDE owns Asset X and Asset Y in 
Country A, each having a fair market value of $250x. For Country A tax 
purposes, FDE has a basis in Asset X of $100x and a basis in Asset Y of 
$200x, USP's basis in FDE is $100x, and the sale is treated as a sale 
of stock. Country A imposes foreign income tax of $40x on USP on the 
Country A gross income of $400x resulting from the sale of FDE, based 
on its rules for taxing capital gains of nonresidents selling stock of 
companies operating a trade or business in Country A. For Federal 
income tax purposes, USP has a basis of $150x in each of Assets X and 
Y, and so the sale of FDE results in $100x of passive category income 
with respect to the sale of Asset X and $100x of general category 
income with respect to the sale of Asset Y.
    (ii) Analysis. For purposes of allocating and apportioning USP's 
$40x of Country A foreign income tax, the $400x of Country A gross 
income resulting from the sale of FDE is first assigned to separate 
categories. Under paragraph (d)(3)(iv) of this section, USP's $400x of 
Country A gross income is assigned among the statutory groupings in the 
same percentages as the foreign gross income in each grouping that 
would have resulted if the sale of FDE were treated as an asset sale 
for Country A tax purposes. Because for Country A tax purposes Asset X 
had a built-in gain of $150x and Asset Y had a built-in gain of $50x, 
$300x ($400x x $150x/$200x) of the Country A gross income is assigned 
to the passive category and $100x ($400x x $50x/$200x) is assigned to 
the general category. Under paragraph (f) of this section, $30x ($40x x 
$300x/$400x) of the Country A foreign income tax is apportioned to the 
passive category, and $10x ($40x x $100x/$400x) of the Country A 
foreign income tax is apportioned to the general category.
    (h) [Reserved]
    (i) Applicability date. This section applies to taxable years 
beginning after December 31, 2019.

0
Par. 15. Section 1.881-3 is amended by:
0
1. Adding two sentences at the end of paragraph (a)(1).
0
2. Revising paragraph (a)(2)(i)(C).
0
3. In paragraph (a)(2)(ii)(B)(1) introductory text, removing ``one of 
the following'' and adding ``one or more of the following'' in its 
place.
0
4. In paragraph (a)(2)(ii)(B)(1)(ii), removing the word ``or'' at the 
end of the paragraph.
0
5. In paragraph (a)(2)(ii)(B)(1)(iii), removing the period at the end 
and adding ``; or'' in its place.
0
6. Adding paragraph (a)(2)(ii)(B)(1)(iv) and reserved paragraph 
(a)(2)(ii)(B)(1)(v).
0
7. In paragraph (c)(2)(ii), adding ``(as in effect for taxable years 
beginning before January 1, 2018)'' at the end of the last sentence.
0
8. Adding reserved paragraph (d)(1)(iii).
0
9. Adding a sentence at the end of paragraph (e) introductory text.
0
10. In paragraph (e), designating Examples 1 through 26 as paragraphs 
(e)(1) through (26), respectively.
0
11. Redesignating newly designated paragraphs (e)(4) through (26) as 
paragraphs (e)(5) through (27), respectively.
0
12. Adding new paragraph (e)(4).
0
13. For each paragraph listed in the table, remove the language in the 
``Remove'' column and add in its place the language in the ``Add'' 
column:

[[Page 72056]]



----------------------------------------------------------------------------------------------------------------
             Paragraph                               Remove                                  Add
----------------------------------------------------------------------------------------------------------------
(a)(2)(i)(A).......................  Examples 1, 2, 3 and 4 of paragraph    paragraphs (e)(1) through (5) of
                                      (e) of this section.                   this section (Examples 1 through
                                                                             5).
(a)(2)(i)(B).......................  Examples 5 and 6 of paragraph (e) of   paragraphs (e)(6) and (7) of this
                                      this section.                          section (Examples 6 and 7).
(a)(3)(ii)(E)(2)(ii)...............  Example 7 of paragraph (e) of this     paragraph (e)(8) of this section
                                      section.                               (Example 8).
(a)(4)(ii)(B)......................  Examples 8 and 9 of paragraph (e) of   paragraphs (e)(9) and (10) of this
                                      this section.                          section (Examples 9 and 10).
(b)(1).............................  Examples 12 and 13 of paragraph (e)    paragraphs (e)(13) and (14) of this
                                      of this section.                       section (Examples 13 and 14).
(b)(2)(i)..........................  Examples 14, 15 and 16 of paragraph    paragraphs (e)(15) through (17) of
                                      (e) of this section.                   this section (Examples 15 through
                                                                             17).
(b)(2)(iii)........................  Example 17 of paragraph (e) of this    paragraph (e)(18) of this section
                                      section.                               (Example 18).
(b)(2)(iv).........................  Example 18 of paragraph (e) of this    paragraph (e)(19) of this section
                                      section.                               (Example 19).
(b)(3)(i)..........................  Examples 22, 23 and 24 of paragraph    paragraphs (e)(23) through (25) of
                                      (e) of this section.                   this section (Examples 23 through
                                                                             25).
(d)(1)(i)..........................  Example 25 of paragraph (e) of this    paragraph (e)(26) of this section
                                      section.                               (Example 26).
(d)(1)(ii)(A)......................  Example 26 of paragraph (e)..........  paragraph (e)(27) of this section
                                                                             (Example 27).
newly designated paragraph (e)(3)..  Example 2............................  paragraph (e)(2) of this section
                                                                             (the facts in Example 2).
newly designated paragraph (e)(3)..  Sec.   301.7701-3....................  Sec.   301.7701-3 of this chapter.
newly designated paragraph           (a)(4)(i)............................  (a)(4)(i) of this section.
 (e)(8)(ii).
newly designated paragraph           Example 20...........................  paragraph (e)(21) of this section
 (e)(22)(i).                                                                 (the facts in Example 21).
newly designated paragraph           Example 19...........................  paragraph (e)(20) of this section
 (e)(22)(ii).                                                                (Example 20).
newly designated paragraph           paragraph (i) of this Example 21.....  paragraph (e)(22)(i) of this section
 (e)(22)(ii).                                                                (this Example 22).
newly designated paragraph           Example 22...........................  paragraph (e)(23) of this section
 (e)(24)(i).                                                                 (the facts in Example 23).
newly designated paragraph           Example 22...........................  paragraph (e)(23) of this section
 (e)(25)(i).                                                                 (the facts in Example 23).
(f)................................  Paragraph (a)(2)(i)(C) and Example 3   Paragraphs (a)(2)(i)(C) and (e)(3)
                                      of paragraph (e) of this section.      (Example 3) of this section.
----------------------------------------------------------------------------------------------------------------

0
14. In paragraph (f), revising the heading and adding a sentence at the 
end of the paragraph.
    The additions and revisions read as follows:


Sec.  1.881-3  Conduit financing arrangements.

    (a) * * *
    (1) * * * See Sec.  1.1471-3(e)(5) for withholding rules applicable 
to conduit financing arrangements for purposes of sections 1471 and 
1472. See also Sec. Sec.  1.267A-1 and 1.267A-4 (disallowing a 
deduction for certain interest or royalty payments to the extent the 
income attributable to the payment is offset by a hybrid deduction).
    (2) * * *
    (i) * * *
    (C) Treatment of disregarded entities. For purposes of this 
section, the term person includes a business entity that is disregarded 
as an entity separate from its single member owner under Sec. Sec.  
301.7701-1 through 301.7701-3 of this chapter and, therefore, such 
entity may, for example, be treated as a party to a financing 
transaction with its owner. See paragraph (e)(3) of this section 
(Example 3).
    (ii) * * *
    (B) * * *
    (1) * * *
    (iv) The stock or similar interest is treated as debt under the tax 
law of the issuer's country of residence or, if the issuer is not a tax 
resident of any country, such as a partnership, the tax law of the 
country in which the issuer is created, organized, or otherwise 
established.
* * * * *
    (e) * * * For purposes of the examples in this paragraph (e), 
unless otherwise indicated, it is assumed that no stock is of the type 
described in paragraph (a)(2)(ii)(B)(1)(iv) of this section.
* * * * *
    (4) Example 4. Hybrid instrument as financing arrangement. The 
facts are the same as in paragraph (e)(2) of this section (the facts in 
Example 2), except that FP assigns the DS note to FS in exchange for 
stock issued by FS. The stock issued by FS is in form convertible debt 
with a 49-year term that is treated as debt under the tax law of 
Country T. The FS stock is not subject to any of the redemption, 
acquisition, or payment rights or requirements specified in paragraphs 
(a)(2)(ii)(B)(1)(i) through (iii) of this section. However, because the 
FS stock is treated as debt under the tax law of Country T, the FS 
stock is a financing transaction under paragraph (a)(2)(ii)(B)(1)(iv) 
of this section. Therefore, the DS note held by FS and the FS stock 
held by FP are financing transactions within the meaning of paragraphs 
(a)(2)(ii)(A)(1) and (2) of this section, respectively, and together 
constitute a financing arrangement within the meaning of paragraph 
(a)(2)(i) of this section. See also Sec.  1.267A-4 for rules applicable 
to disqualified imported mismatch amounts.
* * * * *
    (f) Applicability date. * * * Paragraph (a)(2)(ii)(B)(1)(iv) of 
this section applies to payments made on or after November 12, 2020.

[[Page 72057]]


0
Par. 16. Section 1.904-1 is amended by revising the section heading and 
paragraph (a) as follows:


Sec.  1.904-1  Limitation on credit for foreign income taxes.

    (a) In general. For each separate category described in Sec.  
1.904-5(a)(4)(v), the total credit for foreign income taxes (as defined 
in Sec.  1.901-2(a)) paid or accrued (including those deemed to have 
been paid or accrued other than by reason of section 904(c)) to any 
foreign country (as defined in Sec.  1.901-2(g)) does not exceed that 
proportion of the tax against which such credit is taken which the 
taxpayer's taxable income from foreign sources (but not in excess of 
the taxpayer's entire taxable income) in such separate category bears 
to the taxpayer's entire taxable income for the same taxable year.
* * * * *

0
Par. 17. Section 1.904-4 is amended by:
0
1. Revising paragraph (c)(7)(i), the third and fourth sentences of 
paragraph (c)(7)(ii), and paragraph (c)(7)(iii).
0
2. Adding paragraphs (c)(8)(v) through (viii).
0
3. In paragraph (o), removing the language ``Sec.  1.904-6(b)'' and 
adding the language ``1.904-6(e)'' in its place.
0
4. Revising paragraph (q).
    The revisions and additions read as follows:


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

* * * * *
    (c) * * *
    (7) * * *
    (i) In general. If the effective rate of tax imposed by a foreign 
country on income of a foreign corporation that is included in a 
taxpayer's gross income is reduced under foreign law on distribution of 
such income, the rules of this paragraph (c) apply at the time that the 
income is included in the taxpayer's gross income, without regard to 
the possibility of a subsequent reduction of foreign tax on the 
distribution. If the inclusion is considered to be high-taxed income, 
then the taxpayer must initially treat the inclusion as general 
category income, section 951A category income, or income in a specified 
separate category as provided in paragraph (c)(1) of this section. When 
the foreign corporation distributes the earnings and profits to which 
the inclusion was attributable and the foreign tax on the inclusion is 
reduced, then if a redetermination of U.S. tax liability is required 
under Sec.  1.905-3(b)(2), the taxpayer must redetermine whether the 
revised inclusion (if any) is considered to be high-taxed income. See 
Sec.  1.905-3(b)(2)(ii) (requiring a redetermination of the amount of 
the inclusion, the application of the high-tax exception under section 
954(b)(4), and the amount of foreign taxes deemed paid). If, taking 
into account the reduction in foreign tax, the inclusion is not 
considered high-taxed income, then the taxpayer, in redetermining its 
U.S. tax liability for the year or years affected, must treat the 
inclusion and the associated taxes (as reduced on the distribution) as 
passive category income and taxes. For purposes of this paragraph (c), 
the foreign tax on an inclusion under section 951(a)(1) or 951A(a) is 
considered reduced on distribution of the earnings and profits 
associated with the inclusion if the total taxes paid and deemed paid 
on the inclusion and the distribution (taking into account any 
reductions in tax and any withholding taxes) is less than the total 
taxes deemed paid in the year of inclusion. Therefore, any foreign 
currency gain associated with the earnings and profits that are 
distributed with respect to the inclusion is not taken into account in 
determining whether there is a reduction of tax requiring a 
redetermination of whether the inclusion is high-taxed income.
    (ii) * * * If, however, foreign law does not attribute a reduction 
in taxes to a particular year or years, then the reduction in taxes 
shall be attributable, on an annual last in-first out (LIFO) basis, to 
foreign taxes potentially subject to reduction that are associated with 
previously taxed income, then on a LIFO basis to foreign taxes 
associated with income that under paragraph (c)(7)(iii) of this section 
remains as passive income but that was excluded from subpart F income 
or tested income under section 954(b)(4) or section 
951A(c)(2)(A)(i)(III), and finally on a LIFO basis to foreign taxes 
associated with other earnings and profits. Furthermore, in applying 
the ordering rules of section 959(c), distributions shall be considered 
made on a LIFO basis first out of earnings described in section 
959(c)(1) and (2), then on a LIFO basis out of earnings and profits 
associated with income that remains passive income under paragraph 
(c)(7)(iii) of this section but that was excluded from subpart F income 
or tested income under section 954(b)(4) or section 
951A(c)(2)(A)(i)(III), and finally on a LIFO basis out of other 
earnings and profits. * * *
    (iii) Treatment of income excluded under section 954(b)(4) or 
section 951A(c)(2)(A)(i)(III). If the effective rate of tax imposed by 
a foreign country on income of a foreign corporation is reduced under 
foreign law on distribution of that income, the rules of section 
954(b)(4) (including for purposes of determining tested income under 
section 951A(c)(2)(A)(i)(III)) are applied in the year of inclusion 
without regard to the possibility of a subsequent reduction of foreign 
tax. See Sec. Sec.  1.954-1(d)(3)(iii) and 1.951A-2(c)(6)(iv). If a 
taxpayer excludes passive income from a controlled foreign 
corporation's foreign personal holding company income or tested income 
under section 954(b)(4) or section 951A(c)(2)(A)(i)(III), then, 
notwithstanding the general rule of Sec.  1.904-5(d)(2), the income is 
considered to be passive category income until distribution of that 
income. At that time, if after the redetermination of U.S. tax 
liability required under Sec.  1.905-3(b)(2) the taxpayer still elects 
to exclude the passive income under section 954(b)(4) or section 
951A(c)(2)(A)(i)(III), the rules of this paragraph (c)(7)(iii) apply to 
determine whether the income is high-taxed income upon distribution 
and, therefore, income in another separate category. For purposes of 
determining whether a reduction in tax is attributable to taxes on 
income excluded under section 954(b)(4) or section 
951A(c)(2)(A)(i)(III), the rules of paragraph (c)(7)(ii) of this 
section apply. The rules of paragraph (c)(7)(ii) of this section also 
apply for purposes of ordering distributions to determine whether such 
distributions are out of earnings and profits associated with such 
excluded income. For an example illustrating the operation of this 
paragraph (c)(7)(iii), see paragraph (c)(8)(vi) of this section 
(Example 6).
    (8) * * *
    (v) Example 5. CFC, a controlled foreign corporation, is a wholly-
owned subsidiary of USP, a domestic corporation. USP and CFC are 
calendar year taxpayers. In Year 1, CFC's only earnings consist of 
$200x of pre-tax passive income that is foreign personal holding 
company income that is earned in foreign Country X. Under Country X's 
tax system, the corporate tax on particular earnings is reduced on 
distribution of those earnings and no withholding tax is imposed. In 
Year 1, CFC pays $100x of foreign tax with respect to its passive 
income. USP does not elect to exclude this income from subpart F under 
section 954(b)(4) and includes $200x in gross income ($100x of net 
foreign personal holding company income and $100x of the amount under 
section 78 (the ``section 78 dividend'')). At the time of the 
inclusion, the income is considered to be high-taxed income under 
paragraphs (c)(1) and (c)(6)(i) of this section and is general category 
income to USP ($100x > $42x (21% x

[[Page 72058]]

$200x)). CFC does not distribute any of its earnings in Year 1. In Year 
2, CFC has no additional earnings. On December 31, Year 2, CFC 
distributes the $100x of earnings from Year 1. At that time, CFC 
receives a $60x refund from Country X attributable to the reduction of 
the Country X corporate tax imposed on the Year 1 earnings. The refund 
is a foreign tax redetermination under Sec.  1.905-3(a) that under 
Sec. Sec.  1.905-3(b)(2) and 1.954-1(d)(3)(iii) requires a 
redetermination of CFC's Year 1 subpart F income and the application of 
section 954(b)(4), as well as a redetermination of USP's Year 1 
inclusion under section 951(a)(1), its deemed paid taxes under section 
960(a), and its Year 1 U.S. tax liability. As recomputed taking into 
account the $60x refund, CFC's Year 1 passive category net foreign 
personal holding company income is increased by $60x to $160x, CFC's 
foreign income taxes attributable to that income are reduced from $100x 
to $40x, and the income still qualifies to be excluded from CFC's 
subpart F income under section 954(b)(4) ($40x > $37.80x (90% x 21% x 
$200x)). Assuming USP does not change its Year 1 election, USP's Year 1 
inclusion under section 951(a)(1) is increased by $60x to $160x, and 
the associated deemed paid tax and section 78 dividend are reduced by 
$60x to $40x. Under paragraph (c)(7)(i) of this section, in connection 
with the adjustments required under section 905(c), USP must 
redetermine whether the adjusted Year 1 inclusion is high-taxed income 
of USP. Taking into account the $60x refund, the inclusion is not 
considered high-taxed income of USP ($40x < $42x (21% x $200x)). 
Therefore, USP must treat the $200x of income ($160x inclusion plus 
$40x section 78 amount) and the $40x of taxes associated with the 
inclusion in Year 1 as passive category income and taxes. USP must also 
follow the appropriate procedures under Sec.  1.905-4.
    (vi) Example 6. The facts are the same as in paragraph (c)(8)(v) of 
this section (the facts in Example 5), except that in Year 1, USP 
elects to apply section 954(b)(4) to exclude CFC's passive income from 
its subpart F income, both before and after the recomputation of CFC's 
Year 1 subpart F income and USP's Year 1 U.S. tax liability that is 
required by reason of the Year 2 $60x foreign tax redetermination. 
Although the income is not considered to be subpart F income, under 
paragraph (c)(7)(iii) of this section it remains passive category 
income until distribution. In Year 2, the $100x distribution is a 
dividend to USP, because CFC has $160x of accumulated earnings and 
profits described in section 959(c)(3) (the $100x of earnings in Year 1 
increased by the $60x refund received in Year 2 that under Sec.  1.905-
3(b)(2) is taken into account in Year 1). Under paragraph (c)(7)(iii) 
of this section, USP must determine whether the dividend income is 
high-taxed income to USP in Year 2. The treatment of the dividend as 
passive category income may be relevant in determining deductions 
allocable or apportioned to such dividend income or related stock that 
are excluded in the computation of USP's foreign tax credit limitation 
under section 904(a) in Year 2. See section 904(b)(4). Under paragraph 
(c)(1) of this section, the dividend income is passive category income 
to USP because the foreign taxes paid and deemed paid by USP ($0x) with 
respect to the dividend income do not exceed the highest U.S. tax rate 
on that income.
    (vii) Example 7. The facts are the same as in paragraph (c)(8)(v) 
of this section (the facts in Example 5), except that the distribution 
in Year 2 is subject to a withholding tax of $25x. Under paragraph 
(c)(7)(i) of this section, USP must redetermine whether its Year 1 
inclusion should be considered high-taxed income of USP because there 
is a net $35x reduction ($60x refund of foreign corporate tax--$25x 
withholding tax) of foreign tax. By taking into account both the 
reduction in foreign corporate tax and the additional withholding tax, 
the inclusion continues to be considered high-taxed income of USP in 
Year 1 ($65x > $42x (21% x $200)). USP must follow the appropriate 
section 905(c) procedures. USP must redetermine its U.S. tax liability 
for Year 1, but the Year 1 inclusion and the $65x taxes ($40x of deemed 
paid tax in Year 1 and $25x withholding tax in Year 2) will continue to 
be treated as general category income and taxes.
    (viii) Example 8. (A) CFC, a controlled foreign corporation 
operating in Country G, is a wholly-owned subsidiary of USP, a domestic 
corporation. USP and CFC are calendar year taxpayers. Country G imposes 
a tax of 50% on CFC's earnings. Under Country G's system, the foreign 
corporate tax on particular earnings is reduced on distribution of 
those earnings to 30% and no withholding tax is imposed. Under Country 
G's law, distributions are treated as made out of a pool of 
undistributed earnings subject to the 50% tax rate. For Year 1, CFC's 
only earnings consist of passive income that is foreign personal 
holding company income that is earned in foreign Country G. CFC has 
taxable income of $110x for Federal income tax purposes and $100x for 
Country G purposes. Country G, therefore, imposes a tax of $50x on the 
Year 1 earnings of CFC. USP does not elect to exclude this income from 
subpart F under section 954(b)(4) and includes $110x in gross income 
($60x of net foreign personal holding company income under section 
951(a) and $50x of the section 78 dividend). The highest rate of tax 
under section 11 in Year 1 is 34%. Therefore, at the time of the 
section 951(a) inclusion, the income is considered to be high-taxed 
income under paragraph (c) of this section ($50x > $37.4x (34% x 
$110x)) and is general category income to USP. CFC does not distribute 
any of its earnings in Year 1.
    (B) In Year 2, CFC earns general category income that is not 
subpart F income or tested income. CFC again has $110x in taxable 
income for Federal income tax purposes and $100x in taxable income for 
Country G purposes, and CFC pays $50x of tax to foreign Country G. In 
Year 3, CFC has no taxable income or earnings. On December 31, Year 3, 
CFC distributes $60x of its total $120x of earnings and receives a 
refund of foreign tax of $24x. The $24x refund is a foreign tax 
redetermination under Sec.  1.905-3(a) that under Sec.  1.905-3(b)(2) 
requires a redetermination of CFC's Year 1 subpart F income and USP's 
deemed paid taxes and Year 1 U.S. tax liability. Country G treats the 
distribution of earnings as out of the 50% tax rate pool of $200x of 
earnings accumulated in Year 1 and Year 2, as calculated for Country G 
tax purposes. However, under paragraph (c)(7)(ii) of this section, the 
distribution, and, therefore, the reduction of tax is treated as first 
attributable to the $60x of passive category earnings attributable to 
income previously taxed in Year 1, and none of the distribution is 
treated as made out of the $60x of earnings accumulated in Year 2 
(which is not previously taxed). Because 40 percent (the reduction in 
tax rates from 50 percent to 30 percent is a 40 percent reduction in 
the tax) of the $50x of foreign taxes attributable to the $60x of Year 
1 passive income as calculated for Federal income tax purposes is 
refunded, $20x of the $24x foreign tax refund reduces foreign taxes on 
CFC's Year 1 passive income from $50x to $30x. The other $4x of the tax 
refund reduces the taxes imposed in Year 2 on CFC's general category 
income from $50x to $46x.
    (C) Under paragraph (c)(7) of this section, in connection with the 
section 905(c) adjustment USP must redetermine whether its Year 1 
subpart F inclusion is considered high-taxed income. By taking into 
account the reduction in foreign tax, the inclusion is

[[Page 72059]]

increased by $20x to $80x, the deemed paid taxes are reduced by $20x to 
$30x, and the inclusion is not considered high-taxed income ($30x < 34% 
x $110x). Therefore, USP must treat the revised section 951(a) 
inclusion and the taxes associated with the section 951(a) inclusion as 
passive category income and taxes in Year 1. USP must follow the 
appropriate procedures under Sec.  1.905-4.
* * * * *
    (q) Applicability date. (1) Except as provided in paragraph (q)(2) 
and (3) of this section, this section applies for taxable years that 
both begin after December 31, 2017, and end on or after December 4, 
2018.
    (2) Paragraphs (c)(7)(i) and (iii) and (c)(8)(v) through (viii) 
apply to taxable years ending on or after December 16, 2019. For 
taxable years that both begin after December 31, 2017, and end on or 
after December 4, 2018, and also end before December 16, 2019, see 
Sec.  1.904-4(c)(7)(i) and (iii) as in effect on December 17, 2019.

0
Par. 18. Section 1.904-6 is amended by:
0
1. Revising the section heading and paragraph (a).
0
2. Redesignating paragraph (b) as paragraph (e).
0
3. Adding a new paragraph (b) and paragraph (c).
0
4. Revising paragraph (d).
0
5. In newly redesignated paragraph (e)(4)(i), removing the language 
``paragraph (b)(4)(ii)'' and adding the language ``paragraph 
(e)(4)(ii)'' in its place.
0
6. In newly redesignated paragraph (e)(4)(ii)(C), removing the language 
``paragraph (b)(4)(ii)(B)'' and adding the language ``paragraph 
(e)(4)(ii)(B)'' in its place.
0
7. Adding paragraphs (f) and (g).
    The revisions and additions read as follows:


Sec.  1.904-6   Allocation and apportionment of foreign income taxes.

    (a) In general. The amount of foreign income taxes paid or accrued 
with respect to a separate category (as defined in Sec.  1.904-
5(a)(4)(v)) of income (including U.S. source income assigned to the 
separate category) includes only those foreign income taxes that are 
allocated and apportioned to the separate category under the rules of 
Sec.  1.861-20 (as modified by this section). In applying the foreign 
tax credit limitation under sections 904(a) and (d) to general category 
income described in section 904(d)(2)(A)(ii) and Sec.  1.904-4(d), 
foreign source income in the general category is a statutory grouping. 
However, general category income is the residual grouping of income for 
purposes of assigning foreign income taxes to separate categories. In 
addition, in determining the numerator of the foreign tax credit 
limitation under sections 904(a) and (d), where U.S. source income is 
the residual grouping, the amount of foreign income taxes paid or 
accrued for which a deduction is allowed, for example, under section 
901(k)(7), with respect to foreign source income in a separate category 
includes only those foreign income taxes that are allocated and 
apportioned to foreign source income in the separate category under the 
rules of Sec.  1.861-20 (as modified by this section). For purposes of 
this section, unless otherwise stated, terms have the same meaning as 
provided in Sec.  1.861-20(b). For examples illustrating the 
application of this section, see Sec.  1.861-20(g).
    (b) Assigning an item of foreign gross income to a separate 
category. For purposes of assigning an item of foreign gross income to 
a separate category or categories (or foreign source income in a 
separate category) under Sec.  1.861-20, the rules of this paragraph 
(b) apply.
    (1) Base differences. Any item of foreign gross income that is 
attributable to a base difference described in Sec.  1.861-
20(d)(2)(ii)(B) is assigned to the separate category described in 
section 904(d)(2)(H)(i), and to foreign source income in that category.
    (2) [Reserved]
    (c) Allocating and apportioning deductions. For purposes of 
applying Sec.  1.861-20(e) to allocate and apportion deductions allowed 
under foreign law to foreign gross income in the separate categories, 
before undertaking the steps outlined in Sec.  1.861-20(e), foreign 
gross income in the passive category is first reduced by any related 
person interest expense that is allocated to the income under the 
principles of section 954(b)(5) and Sec.  1.904-5(c)(2)(ii)(C). In 
allocating and apportioning expenses not specifically allocated under 
foreign law, the principles of foreign law are applied only after 
taking into account the reduction of passive income by the application 
of section 954(b)(5). In allocating and apportioning expenses when 
foreign law does not provide rules for the allocation or apportionment 
of expenses, losses or other deductions to particular items of foreign 
gross income, then the principles of section 954(b)(5), in addition to 
the principles of the section 861 regulations (as defined in Sec.  
1.861-8(a)(1)), apply to allocate and apportion expenses, losses or 
other foreign law deductions to foreign gross income after reduction of 
passive income by the amount of related person interest expense 
allocated to passive income under section 954(b)(5) and Sec.  1.904-
5(c)(2)(ii)(C).
    (d) Apportionment of taxes for purposes of applying the high-tax 
income tests. If taxes have been allocated and apportioned to passive 
income under the rules of paragraph (a) this section, the taxes must 
further be apportioned to the groups of income described in Sec.  
1.904-4(c)(3) through (5) for purposes of determining if the group is 
high-taxed income that is recharacterized as income in another separate 
category under the rules of Sec.  1.904-4(c). See also Sec.  1.954-
1(c)(1)(iii)(B) (defining a single item of passive category foreign 
personal holding company income by reference to the grouping rules 
under Sec.  1.904-4(c)(3) through (5)). Taxes are related to income in 
a particular group under the same rules as those in paragraph (a) of 
this section except that those rules are applied by apportioning 
foreign income taxes to the groups described in Sec.  1.904-4(c)(3) 
through (5) instead of separate categories.
* * * * *
    (f) Treatment of certain foreign income taxes paid or accrued by 
United States shareholders. Some or all of the foreign gross income of 
a United States shareholder of a controlled foreign corporation that is 
attributable to foreign law inclusion regime income with respect to a 
foreign law CFC described in Sec.  1.861-20(d)(3)(iii) or foreign law 
pass-through income from a reverse hybrid described in Sec.  1.861-
20(d)(3)(i)(C) is assigned to the section 951A category if, were the 
controlled foreign corporation the taxpayer that recognizes the foreign 
gross income, the foreign gross income would be assigned to the 
controlled foreign corporation's tested income group (as defined in 
Sec.  1.960-1(b)(33)) within the general category to which an inclusion 
under section 951A is attributable. The amount of the United States 
shareholder's foreign gross income that is assigned to the section 951A 
category (or a specified separate category associated with the section 
951A category) is based on the inclusion percentage (as defined in 
Sec.  1.960-2(c)(2)) of the United States shareholder. For example, if 
a United States shareholder has an inclusion percentage of 60 percent, 
then 60 percent of the foreign gross income of a United States 
shareholder that would be assigned (under Sec.  1.861-20(d)(3)(iii)) to 
the tested income group within the general category income of a reverse 
hybrid that is a controlled foreign corporation to which an inclusion 
under section 951A is attributable is assigned to the section

[[Page 72060]]

951A category or the specified separate category for income resourced 
under a tax treaty, and not to the general category.
    (g) Applicability date. This section applies to taxable years 
beginning after December 31, 2019. For taxable years that both begin 
after December 31, 2017, and end on or after December 4, 2018, and also 
begin before January 1, 2020, see Sec.  1.904-6 as in effect on 
December 17, 2019.

0
Par. 19. Section 1.904(b)-3 is amended by revising the first sentence 
in paragraph (c)(1), adding paragraph (d)(2), and revising paragraph 
(f) to read as follows:


Sec.  1.904(b)-3  Disregard of certain dividends and deductions under 
section 904(b)(4).

* * * * *
    (c) * * *
    (1) * * * For purposes of applying the section 861 regulations (as 
defined in Sec.  1.861-8(a)) to the deductions of a United States 
shareholder, the only gross income included in a section 245A subgroup 
is dividend income for which a deduction is allowed under section 245A. 
* * *
* * * * *
    (d) * * *
    (2) Net operating losses. If the taxpayer has a net operating loss 
in the current taxable year, then solely for purposes of determining 
the source and separate category of the net operating loss, the overall 
foreign loss rules in section 904(f) and the overall domestic loss 
rules in section 904(g) are applied without taking into account the 
adjustments required under section 904(b) and this section.
* * * * *
    (f) Applicability dates. (1) Except as provided in paragraph (f)(2) 
of this section, this section applies to taxable years beginning after 
December 31, 2017.
    (2) Paragraph (d)(2) of this section applies to taxable years 
ending on or after December 16, 2019.

0
Par. 20. Section 1.904(g)-3 is amended by:
0
1. Adding a sentence at the end of paragraph (b)(1) and adding 
paragraph (j).
0
2. Revising paragraph (l).
    The additions and revision read as follows:


Sec.  1.904(g)-3  Ordering rules for the allocation of net operating 
losses, net capital losses, U.S. source losses, and separate limitation 
losses, and for the recapture of separate limitation losses, overall 
foreign losses, and overall domestic losses.

* * * * *
    (b) * * *
    (1) * * * See Sec. Sec.  1.861-8(e)(8), 1.904(b)-3(d)(2), and 
1.1502-4(c)(1)(iii) for rules to determine the source and separate 
category components of a net operating loss.
* * * * *
    (j) Step Nine: Dispositions that result in additional income 
recognition under the branch loss recapture and dual consolidated loss 
recapture rules--(1) In general. If, after any gain is required to be 
recognized under section 904(f)(3) on a transaction that is otherwise a 
nonrecognition transaction, an additional amount of income is 
recognized under section 91(d), section 367(a)(3)(C) (as applicable to 
losses incurred before January 1, 2018), or Sec.  1.1503(d)-6, and that 
additional income amount is determined by taking into account an offset 
for the amount of gain recognized under section 904(f)(3) and so is not 
initially taken into account in applying paragraph (b) of this section, 
then paragraphs (b) through (h) of this section are applied to 
determine the allocation of any additional net operating loss deduction 
and other deductions or losses and the applicable increases in the 
taxpayer's overall foreign loss, separate limitation loss, and overall 
domestic loss accounts, as well as any additional recapture and 
reduction of the taxpayer's separate limitation loss, overall foreign 
loss, and overall domestic loss accounts.
    (2) Rules for additional recapture of loss accounts. For the 
purpose of recapturing and reducing loss accounts under paragraph 
(j)(1) of this section, the taxpayer also takes into account any 
creation of or addition to loss accounts that result from the 
application of paragraphs (b) through (i) of this section in the 
current tax year. If any of the additional income described in 
paragraph (j)(1) of this section is foreign source income in a separate 
category for which there is a remaining balance in an overall foreign 
loss account after applying paragraph (i) of this section, the section 
904(f)(1) recapture amount under Sec.  1.904(f)-2(c) for that 
additional income is determined by first computing a hypothetical 
recapture amount as it would have been determined prior to the 
application of paragraph (i) of this section but taking into account 
the additional foreign source income described in this paragraph (j)(2) 
and then subtracting the actual overall foreign loss recapture 
determined prior to the application of paragraph (i) of this section 
(that did not take into account the additional foreign source income). 
The remainder is the overall foreign loss recapture amount with respect 
to the additional foreign source income described in this paragraph 
(j)(2).
* * * * *
    (l) Applicability date. This section applies to taxable years 
ending on or after November 2, 2020.

0
Par. 21. Section 1.905-3 is amended by:
0
1. Revising the section heading and the first sentence of paragraph 
(a).
0
2. Adding paragraphs (b)(2) and (3).
0
3. Revising paragraph (d).
    The revisions and additions read as follows:


Sec.  1.905-3  Adjustments to U.S. tax liability and to current 
earnings and profits as a result of a foreign tax redetermination.

    (a) * * * For purposes of this section and Sec.  1.905-4, the term 
foreign tax redetermination means a change in the liability for foreign 
income tax, as defined in Sec.  1.960-1(b)(5), or certain other changes 
described in this paragraph (a) that may affect a taxpayer's U.S. tax 
liability, including by reason of a change in the amount of its foreign 
tax credit, the amount of its distributions or inclusions under section 
951, 951A, or 1293, the application of the high-tax exception described 
in section 954(b)(4) (including for purposes of determining amounts 
excluded from gross tested income under section 951A(c)(2)(A)(i)(III) 
and Sec.  1.951A-2(c)(1)(iii)), or the amount of tax determined under 
sections 1291(c)(2) and 1291(g)(1)(C)(ii). * * *
    (b) * * *
    (2) Foreign income taxes paid or accrued by foreign corporations--
(i) In general. A redetermination of U.S. tax liability is required to 
account for the effect of a redetermination of foreign income taxes 
taken into account by a foreign corporation in the year accrued, or a 
refund of foreign income taxes taken into account by the foreign 
corporation in the year paid.
    (ii) Required adjustments. If a redetermination of U.S. tax 
liability is required for any taxable year under paragraph (b)(2)(i) of 
this section, the foreign corporation's taxable income, earnings and 
profits, and current year taxes (as defined in Sec.  1.960-1(b)(4)) 
must be adjusted in the year to which the redetermined tax relates (or, 
in the case of a foreign corporation that receives a refund of foreign 
income tax and uses the cash basis of accounting, in the year the tax 
was paid). The redetermination of U.S. tax liability is made by 
treating the redetermined amount of foreign tax as the amount of tax 
paid or accrued by the foreign corporation in such year. For example, 
in the case of a refund of foreign income

[[Page 72061]]

taxes taken into account in the year accrued, the foreign corporation's 
subpart F income, tested income, and current earnings and profits are 
increased, as appropriate, in the year to which the foreign tax relates 
to reflect the functional currency amount of the foreign income tax 
refund. The required redetermination of U.S. tax liability must account 
for the effect of the foreign tax redetermination on the 
characterization and amount of distributions or inclusions under 
section 951, 951A, or 1293 taken into account by each of the foreign 
corporation's United States shareholders, on the application of the 
high-tax exception described in section 954(b)(4) (including for 
purposes of determining the exclusions from gross tested income under 
section 951A(c)(2)(A)(i)(III) and Sec.  1.951A-2(c)(1)(iii)), and the 
amount of tax determined under sections 1291(c)(2) and 
1291(g)(1)(C)(ii), as well as on the amount of foreign taxes deemed 
paid under section 960 in such year, regardless of whether any such 
shareholder chooses to deduct or credit its foreign income taxes in any 
taxable year. In addition, a redetermination of U.S. tax liability is 
required for any subsequent taxable year in which the characterization 
or amount of a United States shareholder's distribution or inclusion 
from the foreign corporation is affected by the foreign tax 
redetermination, up to and including the taxable year in which the 
foreign tax redetermination occurs, as well as any year to which unused 
foreign taxes from such year were carried under section 904(c).
    (iii) Reduction of corporate level tax on distribution of earnings 
and profits. If a United States shareholder of a controlled foreign 
corporation receives a distribution out of previously taxed earnings 
and profits described in section 959(c)(1) and (2) and a foreign 
country has imposed tax on the income of the controlled foreign 
corporation, which tax is reduced on distribution of the earnings and 
profits of the corporation (resulting in a foreign tax 
redetermination), then the United States shareholder must redetermine 
its U.S. tax liability for the year or years affected. See also Sec.  
1.904-4(c)(7)(i).
    (iv) Foreign tax redeterminations relating to taxable years 
beginning before January 1, 2018. In the case of a foreign tax 
redetermination of a foreign corporation that relates to a taxable year 
of the foreign corporation beginning before January 1, 2018, a 
redetermination of U.S. tax liability is required under the rules of 
Sec.  1.905-5.
    (v) Examples. The following examples illustrate the application of 
this paragraph (b)(2).
    (A) Presumed Facts. Except as otherwise provided in this paragraph 
(b)(2)(v), the following facts are assumed for purposes of the examples 
in paragraphs (b)(2)(v)(B) through (E) of this section:
    (1) All parties are accrual basis taxpayers that use the calendar 
year as their taxable year both for Federal income tax purposes and for 
foreign tax purposes and use the average exchange rate to translate 
accrued foreign income taxes;
    (2) CFC, CFC1, and CFC2 are controlled foreign corporations 
organized in Country X that use the ``u'' as their functional currency;
    (3) No income adjustment is required to reflect exchange gain or 
loss (within the meaning of Sec.  1.988-1(e)) with respect to the 
disposition of nonfunctional currency attributable to a refund of 
foreign income taxes received by any CFC, because all foreign income 
taxes are denominated and paid in the CFC's functional currency;
    (4) The highest rate of U.S. tax in section 11 and the rate 
applicable to USP in all years is 21 percent;
    (5) No election to exclude high-taxed income under section 
954(b)(4) or Sec.  1.951A-2(c)(7) is made with respect to CFC, CFC1, or 
CFC2; and
    (6) USP's foreign tax credit limitation under section 904(a) 
exceeds the amount of foreign income taxes it is deemed to pay.
    (B) Example 1: Refund of tested foreign income taxes--(1) Facts. 
CFC is a wholly-owned subsidiary of USP, a domestic corporation. In 
Year 1, CFC earns 3,660u of general category gross tested income and 
accrues and pays 300u of foreign income taxes with respect to that 
income. CFC has no allowable deductions other than the foreign income 
tax expense. Accordingly, CFC has tested income of 3,360u in Year 1. 
CFC has no qualified business asset investment (within the meaning of 
section 951A(d) and Sec.  1.951A-3(b)). In Year 1, no portion of USP's 
deduction under section 250 (``section 250 deduction'') is reduced by 
reason of section 250(a)(2)(B)(ii). USP's inclusion percentage (as 
defined in Sec.  1.960-2(c)(2)) is 100%. In Year 1, USP earns no other 
income and has no other expenses. The average exchange rate used to 
translate USP's inclusion under section 951A and CFC's foreign income 
taxes into dollars for Year 1 is $1x:1u. See section 989(b)(3) and 
Sec. Sec.  1.951A-1(d)(1) and 1.986(a)-1(a)(1). Accordingly, for Year 
1, USP's tested foreign income taxes (as defined in Sec.  1.960-
2(c)(3)) with respect to CFC are $300x. In Year 3, CFC carries back a 
loss for foreign tax purposes and receives a refund of foreign tax of 
100u that relates to Year 1.
    (2) Analysis--(i) Result in Year 1. In Year 1, CFC has tested 
income of 3,360u and tested foreign income taxes of $300x. Under 
section 951A(a) and Sec.  1.951A-1(c)(1), USP has a GILTI inclusion 
amount of $3,360x (3,360u translated at $1x:1u). Under section 960(d) 
and Sec.  1.960-2(c), USP is deemed to have paid $240x (80% x 100% x 
$300x) of foreign income taxes. Under section 78 and Sec.  1.78-1(a), 
USP is treated as receiving a dividend of $300x (a ``section 78 
dividend''). USP's section 250 deduction is $1,830x (50% x ($3,360x + 
$300x)). Accordingly, for Year 1, USP has taxable income of $1,830x 
($3,360x + $300x-$1,830x) and pre-credit U.S. tax liability of $384.30x 
(21% x $1,830x). Accordingly, USP pays U.S. tax of $144.30x ($384.30x-
$240x).
    (ii) Result in Year 3. The refund of 100u to CFC in Year 3 is a 
foreign tax redetermination under paragraph (a) of this section. Under 
paragraph (b)(2)(ii) of this section, USP must account for the effect 
of the foreign tax redetermination on its GILTI inclusion amount and 
foreign taxes deemed paid in Year 1. In redetermining USP's U.S. tax 
liability for Year 1, USP must increase CFC's tested income and its 
earnings and profits in Year 1 by the refunded tax amount of 100u, must 
determine the effect of that increase on its GILTI inclusion amount, 
and must adjust the amount of foreign taxes deemed paid and the section 
78 dividend to account for CFC's refund of foreign tax. Under Sec.  
1.986(a)-1(c), the refund is translated into dollars at the exchange 
rate that was used to translate such amount when initially accrued. As 
a result of the foreign tax redetermination, for Year 1, CFC has tested 
income of 3,460u (3,360u + 100u) and tested foreign income taxes of 
$200x ($300x-$100x). Under section 951A(a) and Sec.  1.951A-1(c)(1), 
USP has a redetermined GILTI inclusion amount of $3,460x (3,460u 
translated at $1x:1u). Under section 960(d) and Sec.  1.960-2(c), USP 
is deemed to have paid $160x (80% x 100% x $200x) of foreign income 
taxes. Under section 78 and Sec.  1.78-1(a), USP's section 78 dividend 
is $200x. USP's redetermined section 250 deduction is $1,830x (50% x 
($3,460x + $200x)). Accordingly, USP's redetermined taxable income is 
$1,830x ($3,460x + $200x-$1,830x) and its pre-credit U.S. tax liability 
is $384.30x (21% x $1,830x). Therefore, USP's redetermined U.S. tax 
liability is

[[Page 72062]]

$224.3x ($384.30x-$160x), an increase of $80x ($224.30x-$144.30x).
    (C) Example 2: Additional payment of foreign income taxes--(1) 
Facts. CFC is a wholly-owned subsidiary of USP, a domestic corporation. 
In Year 1, CFC earns 1,000u of general category gross foreign base 
company sales income and accrues and pays 100u of foreign income taxes 
with respect to that income. CFC has no allowable deductions other than 
the foreign income tax expense. The average exchange rate used to 
translate USP's subpart F inclusion and CFC's foreign income taxes into 
dollars for Year 1 is $1x:1u. See section 989(b)(3) and Sec.  1.986(a)-
1(a)(1). In Year 1, USP earns no other income and has no other 
expenses. In Year 5, pursuant to a Country X audit CFC accrues and pays 
additional foreign income tax of 80u with respect to its 1,000u of 
general category foreign base company sales income earned in Year 1. 
The spot rate (as defined in Sec.  1.988-1(d)) on the date of payment 
of the tax in Year 5 is $1x:0.8u. The foreign income taxes accrued and 
paid in Year 1 and Year 5 are properly attributable to CFC's foreign 
base company sales income that is included in income by USP under 
section 951(a)(1)(A) (``subpart F inclusion'') in Year 1 with respect 
to CFC.
    (2) Analysis--(i) Result in Year 1. In Year 1, CFC has subpart F 
income of 900u (1,000u-100u). Accordingly, USP has a $900x (900u 
translated at $1x:1u) subpart F inclusion. Under section 960(a) and 
Sec.  1.960-2(b), USP is deemed to have paid $100x (100u translated at 
$1x:1u) of foreign income taxes. Under section 78 and Sec.  1.78-1(a), 
USP's section 78 dividend is $100x. Accordingly, for Year 1, USP has 
taxable income of $1,000x ($900x + $100x) and pre-credit U.S. tax 
liability of $210x (21% x $1,000x). Accordingly, USP's U.S. tax 
liability is $110x ($210x-$100x).
    (ii) Result in Year 5. CFC's payment of 80u of additional foreign 
income tax in Year 5 with respect to Year 1 is a foreign tax 
redetermination as defined in paragraph (a) of this section. Under 
paragraph (b)(2)(ii) of this section, USP must reduce CFC's subpart F 
income and its earnings and profits in Year 1 by the additional tax 
amount of 80u. Further, USP must reduce its subpart F inclusion, adjust 
the amount of foreign taxes deemed paid, and adjust the amount of the 
section 78 dividend to account for CFC's additional payment of foreign 
tax. Under section 986(a)(1)(B)(i) and Sec.  1.986(a)-1(a)(2)(i), 
because CFC's payment of additional tax occurs more than 24 months 
after the close of the taxable year to which it relates, the additional 
tax is translated into dollars at the spot rate on the date of payment 
($1x:0.8u). Therefore, CFC has foreign income taxes of $200x (100u 
translated at $1x:1u plus 80u translated at $1x:0.8u) that are properly 
attributable to CFC's foreign base company sales income that gives rise 
to USP's subpart F inclusion in Year 1. As a result of the foreign tax 
redetermination, for Year 1, USP has a subpart F inclusion of $820x 
(1,000u-180u = 820u translated at $1x:1u). Under section 960(a) and 
Sec.  1.960-2(b), USP is deemed to have paid $200x of foreign income 
taxes. Under section 78 and Sec.  1.78-1(a), USP's section 78 dividend 
is $200x. USP's redetermined U.S. taxable income is $1,020x ($820x + 
$200x) and its pre-credit U.S. tax liability is $214.20x (21% x 
$1,020x). Therefore, USP's redetermined U.S. tax liability is $14.20x 
($214.20x-$200x), a decrease of $95.80x ($110x-$14.20x). If USP makes a 
timely refund claim within the period allowed by section 6511, USP will 
be entitled to a refund of any overpayment resulting from the 
redetermination of its U.S. tax liability.
    (D) Example 3: Two-year rule--(1) Facts. CFC is a wholly-owned 
subsidiary of USP, a domestic corporation. In Year 1, CFC earns 1,000u 
of general category gross foreign base company sales income and accrues 
210u of foreign income taxes with respect to that income. In Year 1, 
USP earns no other income and has no other expenses. The average 
exchange rate used to translate USP's subpart F inclusion and CFC's 
foreign income taxes into dollars for Year 1 is $1x:1u. See sections 
989(b)(3) and 986(a)(1)(A) and Sec.  1.986(a)-1(a)(1). CFC does not pay 
its foreign income taxes for Year 1 until September 1, Year 5, when the 
spot rate is $0.8x:1u. The foreign income taxes accrued and paid in 
Year 1 and Year 5, respectively, are properly attributable to CFC's 
foreign base company sales income that gives rise to USP's subpart F 
inclusion in Year 1 with respect to CFC.
    (2) Analysis--(i) Result in Year 1. In Year 1, CFC has subpart F 
income of 790u (1,000u-210u). Accordingly, USP has a $790x (790u 
translated at $1x:1u) subpart F inclusion. Under section 960(a) and 
Sec.  1.960-2(b), USP is deemed to have paid $210x (210u translated at 
$1x:1u) of foreign income taxes. Under section 78 and Sec.  1.78-1(a), 
USP's section 78 dividend is $210x. Accordingly, for Year 1, USP has 
taxable income of $1,000x ($790x + $210x) and pre-credit U.S. tax 
liability of $210x (21% x $1,000x). Accordingly, USP owes no U.S. tax 
($210x-$210x = 0).
    (ii) Result in Year 3. CFC's failure to pay the tax by the end of 
Year 3 results in a foreign tax redetermination under paragraph (a) of 
this section. Because the taxes are not paid on or before the date 24 
months after the close of the taxable year to which the tax relates, 
under paragraph (a) of this section CFC must account for the 
redetermination as if the unpaid 210u of taxes were refunded on the 
last day of Year 3. Under paragraph (b)(2)(ii) of this section, USP 
must increase CFC's subpart F income and its earnings and profits in 
Year 1 by the unpaid tax amount of 210u. Further, USP must increase its 
subpart F inclusion, and decrease the amount of foreign taxes deemed 
paid and the amount of the section 78 dividend to account for the 
unpaid taxes. As a result of the foreign tax redetermination, for Year 
1, USP has a subpart F inclusion of $1,000x (1,000u translated at 
$1x:1u). Under section 960(a) and Sec.  1.960-2(b), USP is deemed to 
have paid no foreign income taxes. Under section 78 and Sec.  1.78-
1(a), USP has no section 78 dividend. Accordingly, USP's redetermined 
taxable income is $1,000x and its pre-credit U.S. tax liability is 
unchanged at $210x (21% x $1,000x). However, USP has no foreign tax 
credits. Therefore, USP's redetermined U.S. tax liability for Year 1 is 
$210x, an increase of $210x.
    (iii) Result in Year 5. CFC's payment of the Year 1 tax liability 
of 210u on September 1, Year 5, results in a second foreign tax 
redetermination under paragraph (a) of this section. Under paragraph 
(b)(2)(ii) of this section, USP must decrease CFC's subpart F income 
and its earnings and profits in Year 1 by the tax paid amount of 210u. 
Further, USP must reduce its subpart F inclusion, and adjust the amount 
of foreign taxes deemed paid and the amount of the section 78 dividend 
to account for CFC's payment of foreign tax. Under section 
986(a)(1)(B)(i) and Sec.  1.986(a)-1(a)(2)(i), because the tax was paid 
more than 24 months after the close of the year to which the tax 
relates, CFC must translate the 210u of tax at the spot rate on the 
date of payment of the foreign taxes in Year 5. Therefore, CFC has 
foreign income taxes of $168x (210u translated at $0.8x:1u) that are 
properly attributable to CFC's foreign base company sales income that 
gives rise to USP's subpart F inclusion in Year 1. As a result of the 
foreign tax redetermination, for Year 1, USP has a subpart F inclusion 
of $790x (1,000u-210u = 790u translated at $1x:1u). Under section 
960(a) and Sec.  1.960-2(b), USP is deemed to have paid $168x of 
foreign income taxes.

[[Page 72063]]

Under section 78 and Sec.  1.78-1(a), USP's section 78 dividend is 
$168x. Accordingly, USP's redetermined taxable income is $958x ($790x + 
$168x), its pre-credit U.S. tax liability is $201.18x (21% x $958x), 
and its redetermined U.S. tax liability is $33.18 ($201.18x-$168x), a 
decrease of $176.82x ($210x-$33.18x). If USP makes a timely refund 
claim within the period allowed by section 6511, USP will be entitled 
to a refund of any overpayment resulting from the redetermination of 
its U.S. tax liability.
    (E) Example 4: Contested tax--(1) Facts. CFC is a wholly-owned 
subsidiary of USP, a domestic corporation. In Year 1, CFC earns 360u of 
general category gross tested income and accrues and pays 160u of 
current year taxes with respect to that income. CFC has no allowable 
deductions other than the foreign income tax expense. Accordingly, CFC 
has tested income of 200u in Year 1. CFC has no qualified business 
asset investment (within the meaning of section 951A(d) and Sec.  
1.951A-3(b)). In Year 1, no portion of USP's section 250 deduction is 
reduced by reason of section 250(a)(2)(B)(ii). USP's inclusion 
percentage (as defined in Sec.  1.960-2(c)(2)) is 100%. In Year 1, USP 
earns no other income and has no other expenses. The average exchange 
rate used to translate USP's section 951A inclusion and CFC's foreign 
income taxes into dollars for Year 1 is $1x:1u. See section 989(b)(3) 
and Sec. Sec.  1.951A-1(d)(1) and 1.986(a)-1(a)(1). Accordingly, for 
Year 1, CFC's tested foreign income taxes (as defined in Sec.  1.960-
2(c)(3)) with respect to USP are $160x. In Year 3, Country X assessed 
an additional 30u of tax with respect to CFC's Year 1 income. CFC did 
not pay the additional 30u of tax and contested the assessment. After 
exhausting all effective and practical remedies to reduce, over time, 
its liability for foreign income tax, CFC settled the contest with 
Country X in Year 4 for 20u, which CFC did not pay until January 15, 
Year 5, when the spot rate was $1.1x:1u. CFC did not earn any other 
income or accrue any other foreign income taxes in Years 2 through 6 
and made no distributions to USP. The additional taxes paid in Year 5 
are also tested foreign income taxes of CFC with respect to USP.
    (2) Analysis--(i) Result in Year 1. In Year 1, CFC has tested 
income of 200u and tested foreign income taxes of $160x. Under section 
951A(a) and Sec.  1.951A-1(c)(1), USP has a GILTI inclusion amount of 
$200x (200u translated at $1x:1u). Under section 960(d) and Sec.  
1.960-2(c), USP is deemed to have paid $128x (80% x 100% x $160x) of 
foreign income taxes. Under section 78 and Sec.  1.78-1(a), USP's 
section 78 dividend is $160x. USP's section 250 deduction is $180x (50% 
x ($200x + $160x)). Accordingly, for Year 1, USP has taxable income of 
$180x ($200x + $160x-$180x) and a pre-credit U.S. tax liability of 
$37.80x (21% x $180x). Under section 904(a), because all of USP's 
income is section 951A category income (see Sec.  1.904-4(g)), USP's 
foreign tax credit limitation is $37.80x ($37.80x x $180x/$180x), which 
is less than the $128x of foreign income tax that USP is deemed to have 
paid. Accordingly, USP owes no U.S. tax ($37.80x-$37.80x = 0).
    (ii) Result in Year 5. CFC's accrual and payment of the additional 
20u of foreign income tax with respect to Year 1 is a foreign tax 
redetermination under paragraph (a) of this section. Under Sec.  1.461-
4(g)(6)(iii)(B), the additional taxes accrue when the tax contest is 
resolved, that is, in Year 4. However, because the taxes, which relate 
to Year 1, were not paid on or before the date 24 months after close of 
CFC's taxable year to which the tax relates, that is, Year 1, under 
section 905(c)(2) and paragraph (a) of this section CFC cannot take 
these taxes into account when they accrue in Year 4. Instead, the taxes 
are taken into account when they are paid in Year 5. Under paragraph 
(b)(2)(ii) of this section, USP must decrease CFC's tested income and 
its earnings and profits in Year 1 by the additional tax amount of 20u. 
Further, USP must adjust its GILTI inclusion amount, the amount of 
foreign taxes deemed paid, and the amount of the section 78 dividend to 
account for CFC's additional payment of tax. Under section 
986(a)(1)(B)(i) and Sec.  1.986(a)-1(a)(2)(i), because CFC's payment of 
additional tax occurs more than 24 months after the close of the 
taxable year to which it relates, the additional tax is translated into 
dollars at the spot rate on the date of payment ($1.1x:1u). Therefore, 
CFC has tested foreign income taxes of $182x (160u translated at $1x:1u 
plus 20u translated at $1.1x:1u). As a result of the foreign tax 
redetermination, for Year 1, CFC has tested income of 180u (200u-20u). 
Under section 951A(a) and Sec.  1.951A-1(c)(1), USP has a redetermined 
GILTI inclusion amount of $180x (180u, translated at $1x:1u). Under 
section 960(d) and Sec.  1.960-2(c), USP is deemed to have paid 
$145.60x (80% x 100% x $182x) of foreign income taxes. Under section 78 
and Sec.  1.78-1(a), USP's section 78 dividend is $182x. USP's 
redetermined section 250 deduction is $181x (50% x ($180x + $182x)). 
Accordingly, USP's redetermined taxable income is $181x ($180x + $182x-
$181x), its pre-credit U.S. tax liability is $38.01x (21% x $181x), and 
its redetermined U.S. tax liability is zero ($38.01x-$38.01x).
    (3) Foreign tax redeterminations of successors or transferees. If 
at the time of a foreign tax redetermination the person with legal 
liability for the tax (or in the case of a refund, the legal right to 
such refund) (the ``successor'') is a different person than the person 
that had legal liability for the tax in the year to which the 
redetermined tax relates (the ``original taxpayer''), the required 
redetermination of U.S. tax liability is made as if the foreign tax 
redetermination occurred in the hands of the original taxpayer. Federal 
income tax principles apply to determine the tax consequences if the 
successor remits (or receives a refund of) a tax that in the year to 
which the redetermined tax relates was the legal liability of, and thus 
under Sec.  1.901-2(f) is considered paid by, the original taxpayer.
* * * * *
    (d) Applicability dates. This section applies to foreign tax 
redeterminations occurring in taxable years ending on or after December 
16, 2019, and to foreign tax redeterminations of foreign corporations 
occurring in taxable years that end with or within a taxable year of a 
United States shareholder ending on or after December 16, 2019 and that 
relate to taxable years of foreign corporations beginning after 
December 31, 2017.

0
Par. 22. Section 1.905-4 is added to read as follows:


Sec.  1.905-4  Notification of foreign tax redetermination.

    (a) Application of this section. The rules of this section apply 
if, as a result of a foreign tax redetermination (as defined in Sec.  
1.905-3(a)), a redetermination of U.S. tax liability is required under 
section 905(c) and Sec.  1.905-3(b).
    (b) Time and manner of notification--(1) Redetermination of U.S. 
tax liability--(i) In general. Except as provided in paragraphs 
(b)(1)(v) and (b)(2) through (4) of this section, any taxpayer for 
which a redetermination of U.S. tax liability is required must notify 
the Internal Revenue Service (IRS) of the foreign tax redetermination 
by filing an amended return, Form 1118 (Foreign Tax Credit--
Corporations) or Form 1116 (Foreign Tax Credit (Individual, Estate, or 
Trust)), and the statement described in paragraph (c) of this section 
for the taxable year with respect to which a redetermination of U.S. 
tax liability is required. Such notification must be filed within the 
time prescribed by this

[[Page 72064]]

paragraph (b) and contain the information described in paragraph (c) of 
this section. If a foreign tax redetermination requires an individual 
to redetermine the individual's U.S. tax liability, and if, after 
taking into account such foreign tax redetermination, the amount of 
creditable foreign taxes (as defined in section 904(j)(3)(B)) that are 
paid or accrued by such individual during the taxable year does not 
exceed the applicable dollar limitation in section 904(j), the 
individual is not required to file Form 1116 with the amended return 
for such taxable year if the individual satisfies the requirements of 
section 904(j).
    (ii) Increase in amount of U.S. tax liability. Except as provided 
in paragraphs (b)(1)(iv) and (v) and (b)(2) through (4) of this 
section, for each taxable year of the taxpayer with respect to which a 
redetermination of U.S. tax liability is required by reason of a 
foreign tax redetermination that increases the amount of U.S. tax 
liability, for example, by reason of a downward adjustment to the 
amount of foreign income taxes paid or accrued by the taxpayer or a 
foreign corporation with respect to which the taxpayer computes an 
amount of foreign taxes deemed paid, the taxpayer must file a separate 
notification by the due date (with extensions) of the original return 
for the taxpayer's taxable year in which the foreign tax 
redetermination occurs.
    (iii) Decrease in amount of U.S. tax liability. Except as provided 
in paragraphs (b)(1)(iv) and (v) and (b)(2) through (4) of this 
section, for each taxable year of the taxpayer with respect to which a 
redetermination of U.S. tax liability is required by reason of a 
foreign tax redetermination that decreases the amount of U.S. tax 
liability and results in an overpayment, for example, by reason of an 
increase in the amount of foreign income taxes paid or accrued by the 
taxpayer or a foreign corporation with respect to which the taxpayer 
computes an amount of foreign taxes deemed paid, the taxpayer must file 
a claim for refund with the IRS within the period provided in section 
6511. See section 6511(d)(3)(A) for the special refund period for 
refunds attributable to an increase in foreign tax credits.
    (iv) Multiple redeterminations of U.S. tax liability for same 
taxable year. The rules of this paragraph (b)(1)(iv) apply except as 
provided in paragraphs (b)(1)(v) and (b)(2) through (4) of this 
section. If more than one foreign tax redetermination requires a 
redetermination of U.S. tax liability for the same affected taxable 
year of the taxpayer and those foreign tax redeterminations occur 
within the same taxable year or within two consecutive taxable years of 
the taxpayer, the taxpayer may file for the affected taxable year one 
amended return, Form 1118 or Form 1116, and the statement described in 
paragraph (c) of this section that reflects all such foreign tax 
redeterminations. If the taxpayer chooses to file one notification for 
such redeterminations, one or more of such redeterminations would 
increase the U.S. tax liability, and the net effect of all such 
redeterminations is to increase the U.S. tax liability for the affected 
taxable year, the taxpayer must file such notification by the due date 
(with extensions) of the original return for the taxpayer's taxable 
year in which the first foreign tax redetermination that would result 
in an increased U.S. tax liability occurred. If the taxpayer chooses to 
file one notification for such redeterminations, one or more of such 
redeterminations would decrease the U.S. tax liability, and the net 
effect of all such redeterminations is to decrease the total amount of 
U.S. tax liability for the affected taxable year, the taxpayer must 
file such notification as provided in paragraph (b)(1)(iii) of this 
section, within the period provided by section 6511. If a foreign tax 
redetermination with respect to the taxable year for which a 
redetermination of U.S. tax liability is required occurs after the date 
for providing such notification, more than one amended return may be 
required with respect to that taxable year.
    (v) Amended return required only if there is a change in amount of 
U.S. tax due. If a redetermination of U.S. tax liability is required by 
reason of a foreign tax redetermination (or multiple foreign tax 
redeterminations, in the case of redeterminations described in 
paragraph (b)(1)(iv) of this section), but does not change the amount 
of U.S. tax due for any taxable year, the taxpayer may, in lieu of 
applying the applicable rules of paragraphs (b)(1)(i) through (iv) of 
this section, notify the IRS of such redetermination by attaching a 
statement to the original return for the taxpayer's taxable year in 
which the foreign tax redetermination occurs. The statement must be 
filed by the due date (with extensions) of the original return for the 
taxpayer's taxable year in which the foreign tax redetermination occurs 
and contain the information described in Sec.  1.904-2(f). If a 
redetermination of U.S. tax liability is required by reason of a 
foreign tax redetermination (either alone, or if the taxpayer chooses 
to apply paragraph (b)(1)(iv) of this section, in combination with 
other foreign tax redeterminations, as provided therein) and the 
redetermination of U.S. tax liability results in a change to the amount 
of U.S. tax due for a taxable year, but does not change the amount of 
U.S. tax due for other taxable years, for example, because of a 
carryback or carryover of an unused foreign tax under section 904(c), 
the notification requirements for such other taxable years are deemed 
to be satisfied if the taxpayer complies with the applicable rules of 
paragraphs (b)(1)(i) through (iv) of this section with respect to each 
taxable year for which the foreign tax redetermination changes the 
amount of U.S. tax due.
    (2) Notification with respect to a change in the amount of foreign 
tax reported to an owner by a pass-through entity--(i) In general. If a 
partnership, trust, or other pass-through entity that reports to its 
beneficial owners (or to any intermediary on behalf of its beneficial 
owners), including partners, shareholders, beneficiaries, or similar 
persons, an amount of creditable foreign tax expenditures, such pass-
through entity must notify both the IRS and its owners of any foreign 
tax redetermination described in Sec.  1.905-3(a) with respect to the 
foreign tax so reported. For purposes of this paragraph (b)(2), whether 
or not a redetermination has occurred within the meaning of Sec.  
1.905-3(a) is determined as if the pass-through entity were a domestic 
corporation which had elected to and claimed foreign tax credits in the 
amount reported for the year to which such foreign taxes relate. The 
notification required under this paragraph (b)(2) must include the 
statement described in paragraph (c) of this section along with any 
information necessary for the owners to redetermine their U.S. tax 
liability.
    (ii) Partnerships subject to subchapter C of chapter 63 of the 
Code. Except as provided in paragraph (b)(4) of this section, if a 
redetermination of U.S. tax liability that is required under Sec.  
1.905-3(b) by reason of a foreign tax redetermination described in 
Sec.  1.905-3(a) would require a partnership adjustment as defined in 
Sec.  301.6241-1(a)(6) of this chapter, the partnership must file an 
administrative adjustment request under section 6227 and make any 
adjustments required under section 6227. See Sec. Sec.  301.6227-2 and 
301.6227-3 of this chapter for procedures for making adjustments with 
respect to an administrative adjustment request. An administrative 
adjustment request required under this paragraph (b)(2)(ii) must be 
filed by the due date (with extensions) of the original return for the 
partnership's taxable year in which the

[[Page 72065]]

foreign tax redetermination occurs, and the restrictions in section 
6227(c) do not apply to such filing. However, unless the administrative 
adjustment request may otherwise be filed after applying the 
limitations contained in section 6227(c), such a request is limited to 
adjustments that are required to be made under section 905(c). The 
requirements of paragraph (b)(2)(i) of this section are deemed to be 
satisfied with respect to any item taken into account in an 
administrative adjustment request filed under this paragraph 
(b)(2)(ii).
    (3) Alternative notification requirements. An amended return and 
Form 1118 (Foreign Tax Credit--Corporations) or Form 1116 (Foreign Tax 
Credit (Individual, Estate, or Trust)), is not required to notify the 
IRS of the foreign tax redetermination and redetermination of U.S. tax 
liability if the taxpayer satisfies alternative notification 
requirements that may be prescribed by the IRS through forms, 
instructions, publications, or other guidance.
    (4) Taxpayers under examination within the jurisdiction of the 
Large Business and International Division--(i) In general. The 
alternative notification requirements of this paragraph (b)(4) apply if 
all of the conditions described in paragraphs (b)(4)(i)(A) through (E) 
of this section are satisfied.
    (A) A foreign tax redetermination occurs while the taxpayer is 
under examination within the jurisdiction of the Large Business and 
International Division.
    (B) The foreign tax redetermination results in an adjustment to the 
amount of foreign income taxes paid or accrued by the taxpayer or a 
foreign corporation with respect to which the taxpayer computes an 
amount of foreign income taxes deemed paid.
    (C) The foreign tax redetermination requires a redetermination of 
U.S. tax liability that increases the amount of U.S. tax liability, and 
accordingly, but for this paragraph (b)(4), the taxpayer would be 
required to notify the IRS of such foreign tax redetermination under 
paragraph (b)(1)(ii) of this section (determined without regard to 
paragraphs (b)(1)(iv) and (v) of this section) or paragraph (b)(2)(ii) 
of this section. See paragraph (b)(4)(v) of this section regarding 
foreign tax redeterminations that decrease the amount of U.S. tax 
liability.
    (D) The return for the taxable year for which a redetermination of 
U.S. tax liability is required is under examination.
    (E) The due date specified in paragraph (b)(1)(ii) or (b)(2)(ii) of 
this section for providing notice of such foreign tax redetermination 
is not before the later of the opening conference or the hand-delivery 
or postmark date of the opening letter concerning an examination of the 
return for the taxable year for which a redetermination of U.S. tax 
liability is required by reason of such foreign tax redetermination.
    (ii) Notification requirements--(A) Foreign tax redetermination 
occurring before commencement of the examination. If a foreign tax 
redetermination described in paragraphs (b)(4)(i)(B) and (C) of this 
section occurs before the later of the opening conference or the hand-
delivery or postmark date of the opening letter and if the condition 
provided in paragraph (b)(4)(i)(E) of this section with respect to such 
foreign tax redetermination is met, the taxpayer, in lieu of applying 
the rules of paragraphs (b)(1)(i) and (ii) of this section (requiring 
the filing of an amended return, Form 1116 or 1118, and the statement 
described in paragraph (c) of this section) or paragraph (b)(2)(ii) of 
this section (requiring the filing of an administrative adjustment 
request), must notify the IRS of such redetermination by providing the 
statement described in paragraph (b)(4)(iii) of this section to the 
examiner no later than 120 days after the later of the date of the 
opening conference of the examination, or the hand-delivery or postmark 
date of the opening letter concerning the examination.
    (B) Foreign tax redetermination occurring within 180 days after 
commencement of the examination. If a foreign tax redetermination 
described in paragraphs (b)(4)(i)(B) and (C) of this section occurs on 
or after the latest of the opening conference or the hand-delivery or 
postmark date of the opening letter and on or before the date that is 
180 days after the later of the opening conference or the hand-delivery 
or postmark date of the opening letter, the taxpayer, in lieu of 
applying the rules of paragraph (b)(1)(i) and (ii) of this section or 
paragraph (b)(2) of this section, must notify the IRS of such 
redetermination by providing the statement described in paragraph 
(b)(4)(iii) of this section to the examiner no later than 120 days 
after the date the foreign tax redetermination occurs.
    (C) Foreign tax redetermination occurring more than 180 days after 
commencement of the examination. If a foreign tax redetermination 
described in paragraphs (b)(4)(i)(B) and (C) of this section occurs 
after the date that is 180 days after the later of the opening 
conference or the hand-delivery or postmark date of the opening letter, 
the taxpayer must either apply the rules of paragraphs (b)(1)(i) and 
(ii) of this section or paragraph (b)(2) of this section, or, in lieu 
of applying paragraphs (b)(1)(i) and (ii) of this section or paragraph 
(b)(2) of this section, provide the statement described in paragraph 
(b)(4)(iii) of this section to the examiner within 120 days after the 
date the foreign tax redetermination occurs. However, the IRS, in its 
discretion, may either accept such statement or require the taxpayer to 
comply with the rules of paragraphs (b)(1)(i) and (ii) of this section 
or paragraph (b)(2) of this section, as applicable.
    (iii) Statement. The statement required by paragraphs (b)(4)(ii)(A) 
and (B) of this section must provide the original amount of foreign 
income taxes paid or accrued, the revised amount of foreign income 
taxes paid or accrued, and documentation with respect to the revisions, 
including exchange rates and dates of accrual or payment, and, if 
applicable, the information described in paragraph (c)(8) of this 
section. The statement must include the following declaration signed by 
a person authorized to sign the return of the taxpayer: ``Under 
penalties of perjury, I declare that I have examined this written 
statement, and to the best of my knowledge and belief, this written 
statement is true, correct, and complete.''
    (iv) Penalty for failure to file notice of a foreign tax 
redetermination. A taxpayer subject to the rules of this paragraph 
(b)(4) must satisfy the rules of paragraph (b)(4)(ii) of this section 
in order not to be subject to the penalty relating to the failure to 
file notice of a foreign tax redetermination under section 6689 and 
Sec.  301.6689-1 of this chapter.
    (v) Notification of foreign tax redetermination that decreases U.S. 
tax liability in an affected year under audit. A taxpayer may (but is 
not required to) notify the IRS as provided in this paragraph (b)(4)(v) 
if the taxpayer has a foreign tax redetermination that meets the 
conditions in paragraphs (b)(4)(i)(A), (B), and (D) of this section and 
results in a decrease in the amount of U.S. tax liability that, but for 
this paragraph (b)(4), would require the taxpayer to notify the IRS of 
such foreign tax redetermination under paragraph (b)(1)(iii) or 
(b)(2)(ii) of this section (determined without regard to paragraphs 
(b)(1)(iv) and (v) of this section). The notification should be made in 
the time and manner specified in paragraph (b)(4)(ii) of this section. 
The IRS, in its discretion, may either accept such alternate 
notification or require the taxpayer to comply with the

[[Page 72066]]

rules of paragraphs (b)(1)(i) and (iii) or paragraphs (b)(2) of this 
section, as applicable.
    (5) Examples. The following examples illustrate the application of 
paragraph (b) of this section.
    (i) Example 1. (A) X, a domestic corporation, is an accrual basis 
taxpayer and uses the calendar year as its U.S. taxable year. X 
conducts business through a branch in Country M, the currency of which 
is the m, and also conducts business through a branch in Country N, the 
currency of which is the n. X uses the average exchange rate to 
translate foreign income taxes. X is able to claim a credit under 
section 901 for all foreign income taxes paid or accrued.
    (B) In Year 1, X accrued and paid 100m of Country M income taxes 
with respect to 400m of foreign source foreign branch category income. 
The average exchange rate for Year 1 was $1:1m. Also in Year 1, X 
accrued and paid 50n of Country N income taxes with respect to 150n of 
foreign source foreign branch category income. The average exchange 
rate for Year 1 was $1:1n. On its Year 1 Federal income tax return, X 
claimed a foreign tax credit under section 901 of $150 ($100 (100m 
translated at $1:1m) + $50 (50n translated at $1:1n)) with respect to 
its foreign source foreign branch category income. See Sec.  1.986(a)-
1(a)(1).
    (C) In Year 2, X accrued and paid 100n of Country N income taxes 
with respect to 300n of foreign source foreign branch category income. 
The average exchange rate for Year 2 was $1.50:1n. On its Year 2 
Federal income tax return, X claimed a foreign tax credit under section 
901 of $150 (100n translated at $1.5:1n). See Sec.  1.986(a)-1(a)(1).
    (D) On June 15, Year 5, when the spot rate was $1.40:1n, X received 
a refund of 10n from Country N, and, on March 15, Year 6, when the spot 
rate was $1.20:1m, X was assessed by and paid Country M an additional 
20m of tax. Both payments were with respect to X's foreign source 
foreign branch category income in Year 1. On May 15, Year 6, when the 
spot rate was $1.45:1n, X received a refund of 5n from Country N with 
respect to its foreign source foreign branch category income in Year 2.
    (E) Both of the refunds and the assessment are foreign tax 
redeterminations under Sec.  1.905-3(a). Under Sec.  1.905-3(b)(1), X 
must redetermine its U.S. tax liability for both Year 1 and Year 2. 
With respect to Year 1, under paragraph (b)(1)(ii) of this section X 
must notify the IRS of the June 15, Year 5, refund of 10n from Country 
N that increased X's U.S. tax liability by filing an amended return, 
Form 1118, and the statement required by paragraph (c) of this section 
for Year 1 by the due date of the original return (with extensions) for 
Year 5. The amended return and Form 1118 would reflect the reduced 
amount of foreign income taxes claimed as a credit under section 901 
and the increase in X's U.S. tax liability of $10 (10n refund 
translated at the average exchange rate for Year 1, or $1:1n (see Sec.  
1.986(a)-1(c)). With respect to the March 15, Year 6, additional 
assessment of 20m by Country M, under paragraph (b)(1)(iii) of this 
section X must notify the IRS within the time period provided by 
section 6511, increasing the foreign income taxes available as a credit 
and reducing X's U.S. tax liability by $24 (20m translated at the spot 
rate on the date of payment, or $1.20:1m). See sections 986(a)(1)(B)(i) 
and 986(a)(2)(A) and Sec.  1.986(a)-1(a)(2)(i). X may so notify the IRS 
by filing a second amended return, Form 1118, and the statement 
described in paragraph (c) of this section for Year 1, within the time 
period provided by section 6511. Alternatively, under paragraph 
(b)(1)(iv) of this section, when X redetermines its U.S. tax liability 
for Year 1 to take into account the 10n refund from Country N that 
occurred in Year 5, X may also take into account the 20m additional 
assessment by Country M that occurred on March 15, Year 6. If X 
reflects both foreign tax redeterminations on the same amended return, 
Form 1118, and in the statement described in paragraph (c) of this 
section for Year 1, the amount of X's foreign income taxes available as 
a credit would be reduced by $10 (10n refund translated at $1:1n), and 
increased by $24 (20m additional assessment translated at the spot rate 
on the date of payment, March 15, Year 6, or $1.20:1m). The foreign 
income taxes available as a credit therefore would be increased by $14 
($24 (additional assessment)-$10 (refund)). Because the net effect of 
the foreign tax redeterminations is to increase the amount of foreign 
taxes paid or accrued and decrease X's U.S. tax liability for Year 1, 
under paragraph (b)(1)(iv) of this section the Year 1 amended return, 
Form 1118, and the statement required in paragraph (c) of this section 
reflecting foreign tax redeterminations in both years must be filed 
within the period provided by section 6511.
    (F) With respect to Year 2, under paragraph (b)(1)(ii) of this 
section X must notify the IRS by filing an amended return, Form 1118, 
and the statement required by paragraph (c) of this section for Year 2, 
in addition to the amended return, Form 1118, and statement that are 
required by reason of the separate foreign tax redeterminations that 
affect Year 1. The amended return, Form 1118, and the statement 
required by paragraph (c) of this section for Year 2 must be filed by 
the due date (with extensions) of X's original return for Year 6. The 
amended return and Form 1118 must reflect the reduced amount of foreign 
income taxes claimed as a credit under section 901 and the increase in 
X's U.S. tax liability of $7.50 (5n refund translated at the average 
exchange rate for Year 2, or $1.50:1n).
    (ii) Example 2. X, a taxpayer within the jurisdiction of the Large 
Business and International Division, uses the calendar year as its U.S. 
taxable year. On November 15, Year 2, X receives a refund of foreign 
income taxes that constitutes a foreign tax redetermination and 
necessitates a redetermination of U.S. tax liability for X's Year 1 
taxable year. Under paragraph (b)(1)(ii) of this section, X is required 
to notify the IRS of the foreign tax redetermination that increased its 
U.S. tax liability by filing an amended return, Form 1118, and the 
statement described in paragraph (c) of this section for its Year 1 
taxable year by October 15, Year 3 (the due date (with extensions) of 
the original return for X's Year 2 taxable year). On December 15, Year 
3, the IRS hand delivers an opening letter concerning the examination 
of the return for X's Year 1 taxable year, and the opening conference 
for such examination is scheduled for January 15, Year 4. Because the 
date for notifying the IRS of the foreign tax redetermination under 
paragraph (b)(1)(ii) of this section (October 15, Year 3) is before the 
date of the opening conference concerning the examination of the return 
for X's Year 1 taxable year (January 15, Year 4), the condition of 
paragraph (b)(4)(i)(E) of this section is not met, and so paragraph 
(b)(4)(i) of this section does not apply. Accordingly, X must notify 
the IRS of the foreign tax redetermination by filing an amended return, 
Form 1118, and the statement described in paragraph (c) of this section 
for the Year 1 taxable year by October 15, Year 3.
    (6) Transition rule for certain foreign tax redeterminations. In 
the case of foreign tax redeterminations occurring in taxable years 
ending on or after December 16, 2019, and before November 12, 2020, and 
foreign tax redeterminations of foreign corporations occurring in 
taxable years that end with or within a taxable year of a United States 
shareholder ending on or after December 16, 2019, and before November 
12, 2020, any amended return or other notification that under paragraph 
(b)(1)(ii), (iv), or (v) or

[[Page 72067]]

(b)(2)(ii) of this section must be filed by the due date (with 
extensions) of, or attached to, the original return for the taxpayer's 
taxable year in which the foreign tax redetermination occurs must 
instead be filed by the due date (with extensions) of, or attached to, 
the original return for the taxpayer's first taxable year ending on or 
after November 12, 2020. For purposes of paragraph (b)(4)(i)(E) of this 
section, the relevant due date is the due date specified in this 
paragraph (b)(6).
    (c) Notification contents. The statement required by paragraphs 
(b)(1)(i) through (iv) and (b)(2) of this section must contain 
information sufficient for the IRS to redetermine U.S. tax liability if 
such a redetermination is required under section 905(c). The 
information must be in a form that enables the IRS to verify and 
compare the original computation of U.S. tax liability, the revised 
computation resulting from the foreign tax redetermination, and the net 
changes resulting therefrom. The statement must include the following:
    (1) The taxpayer's name, address, identifying number, the taxable 
year or years of the taxpayer that are affected by the foreign tax 
redetermination, and, in the case of foreign taxes deemed paid, the 
name and identifying number, if any, of the foreign corporation;
    (2) The date or dates the foreign income taxes were accrued, if 
applicable; the date or dates the foreign income taxes were paid; the 
amount of foreign income taxes paid or accrued on each date (in foreign 
currency) and the exchange rate used to translate each such amount, as 
provided in Sec.  1.986(a)-1(a) or (b);
    (3) Information sufficient to determine any change to the 
characterization of a distribution, the amount of any inclusion under 
section 951(a), 951A, or 1293, or the deferred tax amount under section 
1291;
    (4) Information sufficient to determine any interest due from or 
owing to the taxpayer, including the amount of any interest paid by the 
foreign government to the taxpayer and the dates received;
    (5) In the case of any foreign income tax that is refunded in whole 
or in part, the taxpayer must provide the date of each such refund; the 
amount of such refund (in foreign currency); and the exchange rate that 
was used to translate such amount when originally claimed as a credit 
(as provided in Sec.  1.986(a)-1(c)) and the spot rate (as defined in 
Sec.  1.988-1(d)) for the date the refund was received (for purposes of 
computing foreign currency gain or loss under section 988);
    (6) In the case of any foreign income taxes that are not paid on or 
before the date that is 24 months after the close of the taxable year 
to which such taxes relate, the amount of such taxes in foreign 
currency, and the exchange rate that was used to translate such amount 
when originally claimed as a credit or added to PTEP group taxes (as 
defined in Sec.  1.960-3(d)(1));
    (7) If a redetermination of U.S. tax liability results in an amount 
of additional tax due, and the carryback or carryover of an unused 
foreign income tax under section 904(c) only partially eliminates such 
amount, the information required in Sec.  1.904-2(f); and
    (8) In the case of a pass-through entity, the name, address, and 
identifying number of each beneficial owner to which foreign taxes were 
reported for the taxable year or years to which the foreign tax 
redetermination relates, and the amount of foreign tax initially 
reported to each beneficial owner for each such year and the amount of 
foreign tax allocable to each beneficial owner for each such year after 
the foreign tax redetermination is taken into account.
    (d) Payment or refund of U.S. tax. The amount of tax, if any, due 
upon a redetermination of U.S. tax liability is paid by the taxpayer 
after notice and demand has been made by the IRS. Subchapter B of 
chapter 63 of the Internal Revenue Code (relating to deficiency 
procedures) does not apply with respect to the assessment of the amount 
due upon such redetermination. In accordance with sections 905(c) and 
6501(c)(5), the amount of additional tax due is assessed and collected 
without regard to the provisions of section 6501(a) (relating to 
limitations on assessment and collection). The amount of tax, if any, 
shown by a redetermination of U.S. tax liability to have been overpaid 
is credited or refunded to the taxpayer in accordance with subchapter B 
of chapter 66 (sections 6511 through 6515).
    (e) Interest and penalties--(1) In general. If a redetermination of 
U.S. tax liability is required by reason of a foreign tax 
redetermination, interest is computed on the underpayment or 
overpayment in accordance with sections 6601 and 6611. No interest is 
assessed or collected on any underpayment resulting from a refund of 
foreign income taxes for any period before the receipt of the refund, 
except to the extent interest was paid by the foreign country or 
possession of the United States on the refund for the period before the 
receipt of the refund. See section 905(c)(5). In no case, however, will 
interest assessed and collected pursuant to the preceding sentence for 
any period before receipt of the refund exceed the amount that 
otherwise would have been assessed and collected under section 6601 for 
that period. Interest is assessed from the time the taxpayer (or the 
foreign corporation, partnership, trust, or other pass-through entity 
of which the taxpayer is a shareholder, partner, or beneficiary) 
receives a refund until the taxpayer pays the additional tax due the 
United States.
    (2) Imposition of penalty. Failure to comply with the provisions of 
this section subjects the taxpayer to the penalty provisions of section 
6689 and Sec.  301.6689-1 of this chapter.
    (f) Applicability date. This section applies to foreign tax 
redeterminations (as defined in Sec.  1.905-3(a)) occurring in taxable 
years ending on or after December 16, 2019, and to foreign tax 
redeterminations of foreign corporations occurring in taxable years 
that end with or within a taxable year of a United States shareholder 
ending on or after December 16, 2019.


Sec.  1.905-4T  [REMOVED]

0
Par. 23. Section 1.904-4T is removed.

0
Par. 24. Section 1.905-5 is added to read as follows:


Sec.  1.905-5  Foreign tax redeterminations of foreign corporations 
that relate to taxable years of the foreign corporation beginning 
before January 1, 2018.

    (a) In general--(1) Effect of foreign tax redetermination of a 
foreign corporation. Except as provided in paragraph (e) of this 
section, a foreign tax redetermination (as defined in Sec.  1.905-3(a)) 
of a foreign corporation that relates to a taxable year of the foreign 
corporation beginning before January 1, 2018, and that may affect a 
taxpayer's foreign tax credit in any taxable year, must be accounted 
for by adjusting the foreign corporation's taxable income and earnings 
and profits, post-1986 undistributed earnings as defined in Sec.  
1.902-1(a)(9), and post-1986 foreign income taxes as defined in Sec.  
1.902-1(a)(8) (or its pre-1987 accumulated profits as defined in Sec.  
1.902-1(a)(10)(i) and pre-1987 foreign income taxes as defined in Sec.  
1.902-1(a)(10)(iii), as applicable) in the taxable year of the foreign 
corporation to which the foreign taxes relate.
    (2) Required redetermination of U.S. tax liability. Except as 
provided in paragraph (e) of this section, a redetermination of U.S. 
tax liability is required to account for the effect of the foreign tax 
redetermination on the earnings and profits and taxable income

[[Page 72068]]

of the foreign corporation, the taxable income of a United States 
shareholder, and the amount of foreign taxes deemed paid by the United 
States shareholder under section 902 or 960 (as in effect before 
December 22, 2017), in the year to which the redetermined foreign taxes 
relate. For example, in the case of a refund of foreign income taxes, 
the subpart F income, earnings and profits, and post-1986 undistributed 
earnings (or pre-1987 accumulated profits, as applicable) of the 
foreign corporation are increased in the year to which the foreign tax 
relates to reflect the functional currency amount of the foreign income 
tax refund. The required redetermination of U.S. tax liability must 
account for the effect of the foreign tax redetermination on the 
characterization and amount of distributions or inclusions under 
section 951 or 1293 taken into account by each of the foreign 
corporation's United States shareholders and on the application of the 
high-tax exception described in section 954(b)(4), as well as on the 
amount of foreign income taxes deemed paid in such year. In addition, a 
redetermination of U.S. tax liability is required for any subsequent 
taxable year in which the United States shareholder received or accrued 
a distribution or inclusion from the foreign corporation, up to and 
including the taxable year in which the foreign tax redetermination 
occurs, as well as any year to which unused foreign taxes from such 
year were carried under section 904(c).
    (b) Notification requirements--(1) In general. The notification 
requirements of Sec.  1.905-4, as modified by paragraphs (b)(2) and (3) 
of this section, apply if a redetermination of U.S. tax liability is 
required under paragraph (a) or (e) of this section.
    (2) Notification relating to post-1986 undistributed earnings and 
post-1986 foreign income taxes. In the case of foreign tax 
redeterminations with respect to taxes included in post-1986 foreign 
income taxes, in addition to the information required by Sec.  1.905-
4(c), the taxpayer must provide the balances of the pools of post-1986 
undistributed earnings and post-1986 foreign income taxes before and 
after adjusting the pools, the dates and amounts of any dividend 
distributions or other inclusions made out of earnings and profits for 
the affected year or years, and the amount of earnings and profits from 
which such dividends were paid or such inclusions were made for the 
affected year or years.
    (3) Notification relating to pre-1987 accumulated profits and pre-
1987 foreign income taxes. In the case of foreign tax redeterminations 
with respect to pre-1987 accumulated profits, in addition to the 
information required by Sec.  1.905-4(c), the taxpayer must provide the 
following: The dates and amounts of any dividend distributions made out 
of earnings and profits for the affected year or years; the rate of 
exchange on the date of any such distribution; and the amount of 
earnings and profits from which such dividends were paid for the 
affected year or years.
    (c) Currency translation rules for adjustments to pre-1987 foreign 
income taxes. Foreign income taxes paid with respect to pre-1987 
accumulated profits that are deemed paid under section 960 (or under 
section 902 in the case of an amount treated as a dividend under 
section 1248) are translated into dollars at the spot rate for the date 
of the payment of the foreign income taxes, and refunds of such taxes 
are translated into dollars at the spot rate for the date of the 
refund. Foreign income taxes deemed paid by a taxpayer under section 
902 with respect to an actual distribution of pre-1987 accumulated 
profits and refunds of such taxes are translated into dollars at the 
spot rate for the date of the distribution of the earnings to which the 
foreign income taxes relate. See section 902(c)(6) (as in effect before 
December 22, 2017) and Sec.  1.902-1(a)(10)(iii). For purposes of this 
section, the term spot rate has the meaning provided in Sec.  1.988-
1(d).
    (d) Timing and effect of pooling adjustments. The redetermination 
of U.S. tax liability required by paragraphs (a) and (e) of this 
section is made in accordance with section 905(c) as in effect for 
those taxable years, without regard (except as provided in paragraph 
(e) of this section) to rules that required adjustments to a foreign 
corporation's pools of post-1986 undistributed earnings and post-1986 
foreign income taxes in the year of the foreign tax redetermination 
rather than in the year to which the redetermined foreign tax relates. 
No underpayment or overpayment of U.S. tax liability results from a 
foreign tax redetermination unless the required adjustments change the 
U.S. tax liability. Consequently, no interest is paid by or to a 
taxpayer as a result of adjustments, required by reason of a foreign 
tax redetermination, to a foreign corporation's pools of post-1986 
undistributed earnings and post-1986 foreign income taxes in the year 
to which the redetermined foreign tax relates (or a subsequent year) 
that did not result in a change to U.S. tax liability, for example, 
because no foreign taxes were deemed paid in that year.
    (e) Election to account for certain foreign tax redeterminations 
with respect to pre-2018 taxable years in the foreign corporation's 
last pooling year--(1) In general. A taxpayer may elect under the rules 
in paragraph (e)(2) of this section to account for foreign tax 
redeterminations of a foreign corporation that occur in the foreign 
corporation's taxable years ending with or within a taxable year of a 
United States shareholder of the foreign corporation ending on or after 
November 2, 2020, and that relate to taxable years of the foreign 
corporation beginning before January 1, 2018, by treating such foreign 
tax redeterminations as if they occurred in the foreign corporation's 
last taxable year beginning before January 1, 2018 (the ``last pooling 
year''), and applying the rules in Sec. Sec.  1.905-3T(d) and 1.905-5T 
for purposes of determining whether the foreign tax redetermination is 
accounted for in the foreign corporation's last pooling year or must be 
accounted for in the year to which the redetermined foreign tax 
relates. Except with respect to determining under the preceding 
sentence whether the foreign tax redetermination is accounted for in 
the foreign corporation's last pooling year or in the year to which the 
redetermined foreign tax relates, the rules of this section apply to 
foreign tax redeterminations covered by an election under this 
paragraph (e). Therefore, unless an exception in Sec.  1.905-3T(d)(3) 
applies, a foreign tax redetermination to which an election under this 
paragraph (e) applies is accounted for under paragraph (a)(2) of this 
section by adjusting the foreign corporation's pools of post-1986 
undistributed earnings and post-1986 foreign income taxes in the last 
pooling year, rather than in the year to which the redetermined foreign 
tax relates. For purposes of this paragraph (e), references to 
Sec. Sec.  1.905-3T and 1.905-5T are to such provisions as contained in 
26 CFR part 1, revised as of April 1, 2019.
    (2) Rules regarding the election--(i) Time and manner of election. 
For a foreign corporation's first taxable year that ends with or within 
a taxable year of a United States shareholder of the foreign 
corporation ending on or after November 2, 2020 in which the foreign 
corporation has a foreign tax redetermination (the ``first 
redetermination year''), the controlling domestic shareholders (as 
defined in Sec.  1.964-1(c)(5)) of the foreign corporation make the 
election described in paragraph (e)(1) of this section by--
    (A) Filing the statement required under Sec.  1.964-1(c)(3)(ii) 
with a timely filed original income tax return for the taxable year of 
each controlling

[[Page 72069]]

domestic shareholder of the foreign corporation in which or with which 
the foreign corporation's first redetermination year ends;
    (B) Providing any notices required under Sec.  1.964-1(c)(3)(iii);
    (C) Filing amended returns as required under Sec.  1.905-4 and this 
section for each controlling domestic shareholder's taxable year with 
or within which ends the foreign corporation's last pooling year and 
each other affected year before the controlling domestic shareholder's 
taxable year with or within which ends the foreign corporation's first 
redetermination year reflecting a redetermination of the controlling 
domestic shareholder's U.S. tax liability for each such taxable year, 
in cases where a redetermination of the shareholder's U.S. tax 
liability for taxable years ending before the foreign corporation's 
last pooling year ends is not required under the rules in Sec. Sec.  
1.905-3T(d) and 1.905-5T;
    (D) Filing amended returns as required under Sec.  1.905-4 and this 
section with respect to each affected year before the controlling 
domestic shareholder's taxable year with or within which ends the 
foreign corporation's first redetermination year reflecting a 
redetermination of the controlling domestic shareholder's U.S. tax 
liability for each such taxable year, in cases where a redetermination 
of the shareholder's U.S. tax liability for taxable years ending before 
the foreign corporation's last pooling year ends is required under the 
rules in Sec. Sec.  1.905-3T(d) and 1.905-5T and this section; and
    (E) Providing any additional information required by applicable 
administrative pronouncements.
    (ii) Scope, duration, and effect of election. An election under 
paragraph (e)(1) of this section with respect to the first 
redetermination year of a foreign corporation is binding on all persons 
who are, or were in a prior year to which the election applies, United 
States shareholders of the foreign corporation. In addition, such 
election applies to all foreign tax redeterminations in the first 
redetermination year and all subsequent taxable years of such foreign 
corporation and cannot be revoked. For foreign tax redeterminations 
that occur in taxable years after the first redetermination year, all 
United States shareholders of such foreign corporation must account for 
the foreign tax redeterminations under the rules in paragraph (e)(1) of 
this section by filing amended returns and providing other information 
as required by Sec.  1.905-4 and paragraphs (e)(2)(i)(C) through (E) of 
this section.
    (iii) Requirements for valid election. An election under paragraph 
(e)(1) of this section is valid only if all of the requirements in 
paragraph (e)(2)(i) of this section, including the requirement to 
provide notice under paragraph (e)(2)(i)(B) of this section, are 
satisfied by each of the controlling domestic shareholders with respect 
to the first redetermination year.
    (iv) CFC group conformity requirement--(A) In general. An election 
made under paragraph (e)(1) of this section applies to all controlled 
foreign corporations that are members of the same CFC group, and the 
rules in paragraphs (e)(1) and (e)(2)(i) through (iii) of this section 
apply by reference to the CFC group. Therefore, an election by the 
controlling domestic shareholders of any controlled foreign corporation 
with respect to that controlled foreign corporation's first 
redetermination year also applies to foreign tax redeterminations of 
all members of the CFC group that includes that controlled foreign 
corporation, determined as of the close of that controlled foreign 
corporation's first redetermination year. The election is binding on 
all persons who are, or were in a prior year to which the election 
applies, United States shareholders of any member of the CFC group, 
applies with respect to foreign tax redeterminations of each member 
that occur in and after that member's first taxable year with or within 
which ends such controlled foreign corporation's first redetermination 
year, and cannot be revoked.
    (B) Determination of the CFC group--(1) Definition. Subject to the 
rules in paragraphs (b)(2)(iv)(B)(2) and (3) of this section, the term 
CFC group means an affiliated group as defined in section 1504(a) 
without regard to section 1504(b)(1) through (6), except that section 
1504(a) is applied by substituting ``more than 50 percent'' for ``at 
least 80 percent'' each place it appears, and section 1504(a)(2)(A) is 
applied by substituting ``or'' for ``and.'' For purposes of this 
paragraph (e)(2)(iv)(B)(1), stock ownership is determined by applying 
the constructive ownership rules of section 318(a), other than section 
318(a)(3)(A) and (B), by applying section 318(a)(4) only to options (as 
defined in Sec.  1.1504-4(d)) that are reasonably certain to be 
exercised as described in Sec.  1.1504-4(g), and by substituting in 
section 318(a)(2)(C) ``5 percent'' for ``50 percent.''
    (2) Member of a CFC group. The determination of whether a 
controlled foreign corporation is included in a CFC group is made as of 
the close of the first redetermination year of any controlled foreign 
corporation for which an election is made under paragraph (e)(1) of 
this section. One or more controlled foreign corporations are members 
of a CFC group if the requirements of paragraph (e)(2)(iv)(B)(2) of 
this section are satisfied as of the end of the first redetermination 
year of at least one of the controlled foreign corporations, even if 
the requirements are not satisfied as of the end of the first 
redetermination year of all controlled foreign corporations. If the 
controlling domestic shareholders do not have the same taxable year, 
the determination of whether a controlled foreign corporation is a 
member of a CFC group is made with respect to the first redetermination 
year that ends with or within the taxable year of the majority of the 
controlling domestic shareholders (determined based on voting power) 
or, if no such majority taxable year exists, the calendar year.
    (3) Controlled foreign corporations included in only one CFC group. 
A controlled foreign corporation cannot be a member of more than one 
CFC group. If a controlled foreign corporation would be a member of 
more than one CFC group under paragraph (e)(2)(iv)(B)(2) of this 
section, then ownership of stock of the controlled foreign corporation 
is determined by applying paragraph (e)(2)(iv)(B)(2) of this section 
without regard to section 1504(a)(2)(B) or, if applicable, by reference 
to the ownership existing as of the end of the first redetermination 
year of a controlled foreign corporation that would cause a CFC group 
to exist.
    (3) Rules for successor entities. All of the United States persons 
that own equity interests in a successor entity to a foreign 
corporation (``U.S. owners'') may elect under the principles of 
paragraph (e)(2) of this section to apply the rules in paragraph (e)(1) 
to foreign tax redeterminations of such foreign corporation that occur 
in taxable years of the successor entity that end with or within 
taxable years of its U.S. owners ending on or after November 2, 2020.
    (f) Applicability date. This section applies to foreign tax 
redeterminations (as defined in Sec.  1.905-3(a)) of foreign 
corporation and successor entities that occur in taxable years that end 
with or within taxable years of a United States shareholder or other 
United States persons ending on or after November 2, 2020, and that 
relate to taxable years of such foreign corporations beginning before 
January 1, 2018.


Sec.  1.905-5T   [REMOVED]

0
Par. 25. Section 1.905-5T is removed.

[[Page 72070]]


0
Par. 26. Section 1.951A-2 is amended by adding paragraph (c)(6) to read 
as follows:


Sec.  1.951A-2  Tested income and tested loss.

* * * * *
    (c) * * *
    (6) Allocation of deductions attributable to disqualified 
payments--(i) In general. A deduction related directly or indirectly to 
a disqualified payment is allocated and apportioned solely to residual 
CFC gross income, and any deduction related to a disqualified payment 
is not properly allocable to property produced or acquired for resale 
under section 263, 263A, or 471.
    (ii) Definitions. The following definitions apply for purposes of 
this paragraph (c)(6).
    (A) Disqualified payment. The term disqualified payment means a 
payment made by a person to a related recipient CFC during the 
disqualified period with respect to the related recipient CFC, to the 
extent the payment would constitute income described in section 
951A(c)(2)(A)(i) and paragraph (c)(1) of this section without regard to 
whether section 951A applies.
    (B) Disqualified period. The term disqualified period has the 
meaning provided in Sec.  1.951A-3(h)(2)(ii)(C)(1), substituting 
``related recipient CFC'' for ``transferor CFC.''
    (C) Related recipient CFC. The term related recipient CFC means, 
with respect to a payment by a person, a recipient of the payment that 
is a controlled foreign corporation that bears a relationship to the 
payor described in section 267(b) or 707(b) immediately before or after 
the payment.
    (iii) Treatment of partnerships. For purposes of determining 
whether a payment is made by a person to a related recipient CFC for 
purposes of paragraph (c)(6)(ii)(A) of this section, a payment by or to 
a partnership is treated as made proportionately by or to its partners, 
as applicable.
    (iv) Examples. The following examples illustrate the application of 
this paragraph (c)(6).
    (A) Example 1: Deduction related directly to disqualified payment 
to related recipient CFC--(1) Facts. USP, a domestic corporation, owns 
all of the stock in CFC1 and CFC2, each a controlled foreign 
corporation. Both USP and CFC2 use the calendar year as their taxable 
year. CFC1 uses a taxable year ending November 30. On October 15, 2018, 
before the start of its first CFC inclusion year, CFC1 receives and 
accrues a payment from CFC2 of $100x of prepaid royalties with respect 
to a license. The $100x payment is excluded from subpart F income 
pursuant to section 954(c)(6) and would constitute income described in 
section 951A(c)(2)(A)(i) and paragraph (c)(1) of this section without 
regard to whether section 951A applies.
    (2) Analysis. CFC1 is a related recipient CFC (within the meaning 
of paragraph (c)(6)(ii)(C) of this section) with respect to the royalty 
prepayment by CFC2 because it is related to CFC2 within the meaning of 
section 267(b). The royalty prepayment is received by CFC1 during its 
disqualified period (within the meaning of paragraph (c)(6)(ii)(B) of 
this section) because it is received during the period beginning 
January 1, 2018, and ending November 30, 2018. Because it would 
constitute income described in section 951A(c)(2)(A)(i) and paragraph 
(c)(1) of this section without regard to whether section 951A applies, 
the payment is a disqualified payment. Accordingly, CFC2's deductions 
related to such payment accrued during taxable years ending on or after 
April 7, 2020, are allocated and apportioned solely to residual CFC 
gross income under paragraph (c)(6)(i) of this section.
    (B) Example 2: Deduction related indirectly to disqualified payment 
to partnership in which related recipient CFC is a partner--(1) Facts. 
The facts are the same as in paragraph (c)(6)(iv)(A)(1) of this section 
(the facts in Example 1), except that CFC1 and USP own 99% and 1%, 
respectively of FPS, a foreign partnership, which has a taxable year 
ending November 30. USP receives a prepayment of $110x from CFC2 for 
the performance of future services. USP subcontracts the performance of 
these future services to FPS for which FPS receives and accrues a $100x 
prepayment from USP. The services will be performed in the same country 
under the laws of which CFC1 and FPS are created or organized, and the 
$100x prepayment is not foreign base company services income under 
section 954(e) and Sec.  1.954-4(a). The $100x prepayment would 
constitute income described in section 951A(c)(2)(A)(i) and paragraph 
(c)(1) of this section without regard to whether section 951A applies.
    (2) Analysis. CFC1 is a related recipient CFC (within the meaning 
of paragraph (c)(6)(ii)(C) of this section) with respect to the 
services prepayment by USP because, under paragraph (c)(6)(iii) of this 
section, it is treated as receiving $99x (99% of $100x) of the services 
prepayment from USP, and it is related to USP within the meaning of 
section 267(b). The services prepayment is received by CFC1 during its 
disqualified period (within the meaning of paragraph (c)(6)(ii)(B) of 
this section) because it is received during the period beginning 
January 1, 2018, and ending November 30, 2018. Because it would 
constitute income described in section 951A(c)(2)(A)(i) and paragraph 
(c)(1) of this section without regard to whether section 951A applies, 
the prepayment is a disqualified payment. In addition, CFC2's 
deductions related to its prepayment to USP are indirectly related to 
the disqualified payment by USP. Accordingly, CFC2's deductions related 
to such payment accrued during taxable years ending on or after April 
7, 2020 are allocated and apportioned solely to residual CFC gross 
income under paragraph (c)(6)(i) of this section.
* * * * *

0
Par. 27. Section 1.951A-7 is amended by adding reserved paragraph (c) 
and paragraph (d) to read as follows:


Sec.  1.951A-7  Applicability dates.

* * * * *
    (d) Deduction for disqualified payments. Section 1.951A-2(c)(6) 
applies to taxable years of foreign corporations ending on or after 
April 7, 2020, and to taxable years of United States shareholders in 
which or with which such taxable years end.

0
Par. 28. Section 1.954-1 is amended by:
0
1. In paragraph (c)(1)(i)(C), removing the language ``reduced by 
related person'' and adding the language ``reduced (but not below zero) 
by related person'' in its place.
0
2. Adding two sentences to the end of paragraph (d)(3)(iii).
0
3. Revising paragraph (h)(1).
    The revision and additions read as follows:


Sec.  1.954-1  Foreign base company income.

* * * * *
    (d) * * *
    (3) * * *
    (iii) * * * In addition, foreign income taxes that have not been 
paid or accrued because they are contingent on a future distribution of 
earnings are not taken into account for purposes of this paragraph 
(d)(3). If, pursuant to section 905(c) and Sec.  1.905-3(b)(2), a 
redetermination of U.S. tax liability is required to account for the 
effect of a foreign tax redetermination (as defined in Sec.  1.905-
3(a)), this paragraph (d) is applied in the adjusted year taking into 
account the adjusted amount of the redetermined foreign tax.
* * * * *
    (h) * * *
    (1) Paragraph (d)(3) of this section. Paragraph (d)(3) of this 
section applies to taxable years of a controlled foreign corporation 
ending on or after December

[[Page 72071]]

16, 2019. For taxable years of a controlled foreign corporation ending 
on or after December 4, 2018, but ending before December 16, 2019, see 
Sec.  1.954-1(d)(3) as contained in 26 CFR part 1 revised as of April 
1, 2019.
* * * * *

0
Par. 29. Section 1.954-2 is amended by:
0
1. Removing the text ``and'' from paragraph (h)(2)(i)(H).
0
2. Redesignating paragraph (h)(2)(i)(I) as paragraph (h)(2)(i)(J).
0
3. Adding a new paragraph (h)(2)(i)(I).
0
4. Adding a sentence to the end of paragraph (i)(3).
    The additions read as follows:


Sec.  1.954-2  Foreign personal holding company income.

* * * * *
    (h) * * *
    (2) * * *
    (i) * * *
    (I) Any guaranteed payments for the use of capital under section 
707(c); and
* * * * *
    (i) * * *
    (3) * * * Paragraph (h)(2)(i)(I) of this section applies to taxable 
years of controlled foreign corporations ending on or after December 
16, 2019, and to taxable years of United States shareholders in which 
or with which such taxable years end.

0
Par. 30. Section 1.960-1 is amended by:
0
1. Adding a sentence at the end of paragraph (c)(2).
0
2. Revising paragraphs (d)(3)(ii)(A) and (B).
0
3. Removing paragraph (d)(3)(ii)(C).
    The addition and revisions read as follows:


Sec.  1.960-1  Overview, definitions, and computational rules for 
determining foreign income taxes deemed paid under section 960(a), (b), 
and (d).

* * * * *
    (c) * * *
    (2) * * * An item of income with respect to a current taxable year 
does not include an amount included as subpart F income of a controlled 
foreign corporation by reason of the recharacterization of a recapture 
account established in a prior U.S. taxable year (and the corresponding 
earnings and profits) of the controlled foreign corporation under 
section 952(c)(2) and Sec.  1.952-1(f).
* * * * *
    (d) * * *
    (3) * * *
    (ii) * * *
    (A) In general. A current year tax is allocated and apportioned 
among the section 904 categories under the rules of Sec.  1.904-6. An 
amount of the current year tax that is allocated and apportioned to a 
section 904 category is then allocated and apportioned among the income 
groups within the section 904 category under Sec.  1.861-20 (as 
modified by Sec.  1.904-6(c)) by treating each income group as a 
statutory grouping and treating the residual income group as the 
residual grouping. Therefore, foreign gross income attributable to a 
base difference is assigned to the residual income grouping under Sec.  
1.861-20(d)(2)(ii)(B). See, however, paragraph (d)(3)(ii)(B) of this 
section for special rules for applying Sec.  1.861-20 in the case of 
PTEP groups. For purposes of determining foreign income taxes deemed 
paid under the rules in Sec. Sec.  1.960-2 and 1.960-3, the U.S. dollar 
amount of a current year tax is assigned to the section 904 categories, 
income groups, and PTEP groups (to the extent provided in paragraph 
(d)(3)(ii)(B) of this section) to which the current year tax is 
allocated and apportioned.
    (B) Foreign taxable income that includes previously taxed earnings 
and profits. For purposes of allocating and apportioning a current year 
tax under this paragraph (d)(3)(ii), a PTEP group that is increased 
under Sec.  1.960-3(c)(3) as a result of the receipt of a section 
959(b) distribution in the current taxable year of the controlled 
foreign corporation is treated as an income group within the section 
904 category. In such case, under Sec.  1.861-20, the portion of the 
foreign gross income (as defined in Sec.  1.861-20(b)(5)) that is 
characterized under Federal income tax principles as a distribution of 
previously taxed earnings and profits that results in the increase in 
the PTEP group in the current taxable year is assigned to that PTEP 
group. If a PTEP group is not treated as an income group under the 
first sentence of this paragraph (d)(3)(ii)(B), and the rules of Sec.  
1.861-20 would otherwise apply to assign foreign gross income to a PTEP 
group, that foreign gross income is instead assigned to the subpart F 
income group or tested income group to which the income that gave rise 
to the previously taxed earnings and profits would be assigned if the 
income were recognized by the recipient controlled foreign corporation 
under Federal income tax principles in the current taxable year. For 
example, a net basis or withholding tax imposed on a controlled foreign 
corporation's receipt of a section 959(b) distribution is allocated or 
apportioned to a PTEP group. In contrast, a withholding tax imposed on 
a disregarded payment from a disregarded entity to its controlled 
foreign corporation owner is never treated as related to a PTEP group, 
even if all of the controlled foreign corporation's earnings are 
previously taxed earnings and profits, because the payment that gives 
rise to the foreign gross income from which the tax was withheld does 
not constitute a section 959(b) distribution in the current taxable 
year. That foreign gross income, however, may be assigned to a subpart 
F income group or tested income group.
* * * * *

0
Par. 31. Section 1.960-2 is amended by adding a sentence at the end of 
paragraph (b)(3)(iii) to read as follows:


Sec.  1.960-2  Foreign income taxes deemed paid under sections 960(a) 
and (d).

* * * * *
    (b) * * *
    (3) * * *
    (iii) * * * See Sec.  1.960-1(c)(2) for a rule regarding the 
treatment of an increase in the subpart F income of a controlled 
foreign corporation by reason of the recharacterization of a recapture 
account and the corresponding accumulated earnings and profits under 
section 952(c) and Sec.  1.952-1(f).
* * * * *


Sec.  1.960-3  [Amended]

0
Par. 32. Section 1.960-3 is amended by removing the language ``Sec.  
1.951A-6(b)(2)'' from the twelfth sentence of paragraph (e)(2)(i) and 
adding the language ``Sec.  1.951A-5(b)(2)'' in its place.

0
Par. 33. Section 1.960-4 is amended in table 2 to paragraph (f)(1) by 
revising the entry ``Limitation for Year 2 before increase under 
section 960(c)(1) ($10.50x x $0/$50x)'' to read as follows:


Sec.  1.960-4   Additional foreign tax credit in year of receipt of 
previously taxed earnings and profits.

* * * * *
    (f) * * *
    (1) * * *

[[Page 72072]]



                       Table 2 to Paragraph (f)(1)
------------------------------------------------------------------------
 
------------------------------------------------------------------------
 
                              * * * * * * *
Limitation for Year 2 before increase     ..............               0
 under section 960(c)(1) ($10.50x x $0/
 $50x)..................................
 
                              * * * * * * *
------------------------------------------------------------------------

* * * * *

0
Par. 34. Section 1.960-7 is revised to read as follows:


Sec.  1.960-7  Applicability dates.

    (a) Except as provided in paragraph (b) of this section, Sec. Sec.  
1.960-1 through 1.960-6 apply to each taxable year of a foreign 
corporation ending on or after December 4, 2018, and to each taxable 
year of a domestic corporation that is a United States shareholder of 
the foreign corporation in which or with which such taxable year of 
such foreign corporation ends.
    (b) Section 1.960-1(c)(2) and (d)(3)(ii) applies to taxable years 
of a foreign corporation beginning after December 31, 2019, and to each 
taxable year of a domestic corporation that is a United States 
shareholder of the foreign corporation in which or with which such 
taxable year of such foreign corporation ends. For taxable years of a 
foreign corporation that end on or after December 4, 2018, and also 
begin before January 1, 2020, see Sec.  1.960-1(c)(2) and (d)(3)(ii) as 
in effect on December 17, 2019.

0
Par. 35. Section 1.965-5 is amended by:
0
1. Designating the text of paragraph (b) as paragraph (b)(1).
0
2. Adding a heading for newly designated paragraph (b)(1).
0
3. Adding paragraph (b)(2).
    The revision and additions read as follows:


Sec.  1.965-5   Allowance of a credit or deduction for foreign income 
taxes.

* * * * *
    (b) * * *
    (1) In general. * * *
    (2) Attributing taxes to section 959(a) distributions of section 
965 previously taxed earnings and profits. For purposes of paragraph 
(b)(1) of this section, foreign income taxes are attributable to a 
distribution of section 965(a) previously taxed earnings and profits or 
section 965(b) previously taxed earnings and profits if such taxes 
would be allocated and apportioned to a distribution of such previously 
taxed earnings and profits under the principles of Sec.  1.904-
6(a)(1)(iv), regardless of whether an actual distribution is made or 
recognized for Federal income tax purposes. Therefore, for example, a 
credit or deduction for the applicable percentage of foreign income 
taxes imposed on a United States shareholder that pays foreign tax on a 
distribution that is not recognized for Federal income tax purposes 
(for example, in the case of a consent dividend or stock dividend upon 
which a withholding tax is imposed) is not allowed under paragraph 
(b)(1) of this section to the extent it is attributable to a 
distribution of section 965(a) previously taxed earnings and profits or 
section 965(b) previously taxed earnings and profits under the 
principles of Sec.  1.904-6(a)(1)(iv). For taxable years of foreign 
corporations beginning after December 31, 2019, in lieu of applying the 
principles of Sec.  1.904-6 under this paragraph (b)(2), the rules in 
Sec.  1.861-20 apply by treating the portion of a distribution 
attributable to section 965(a) previously taxed earnings and profits 
and the portion of a distribution attributable to section 965(b) 
previously taxed earnings and profits each as a statutory grouping, and 
the portion of the distribution that is attributable to other earnings 
and profits as the residual grouping. See Sec.  1.861-20(g)(7) (Example 
6).
* * * * *

0
Par. 36. Section 1.965-9 is amended by adding a sentence to the end of 
paragraph (c) to read as follows:


Sec.  1.965-9  Applicability dates.

* * * * *
    (c) * * * Section 1.965-5(b)(2) applies to taxable years of foreign 
corporations that end on or after December 16, 2019, and with respect 
to a United States person, to the taxable years in which or with which 
such taxable years of the foreign corporations end.

0
Par. 37. Section 1.1502-4 is revised to read as follows:


Sec.  1.1502-4  Consolidated foreign tax credit.

    (a) In general. The foreign tax credit under section 901 is allowed 
to the group only if the agent for the group (as defined in Sec.  
1.1502-77(a)) chooses to use the credit in the computation of the 
consolidated tax liability of the group for the consolidated return 
year. If that choice is made, section 275(a)(4) provides that no 
deduction against taxable income may be taken on the consolidated 
return for foreign taxes paid or accrued by any member. However, if 
section 275(a)(4) does not apply, a deduction against consolidated 
taxable income may be allowed for certain taxes for which a credit is 
not allowed, even though the choice is made to claim a credit for other 
taxes. See, for example, sections 901(j)(3), 901(k)(7), 901(l)(4), 
901(m)(6), and 908(b).
    (b) Computation of foreign tax credit. The foreign tax credit for 
the consolidated return year is determined on a consolidated basis 
under the principles of sections 901 through 909 and 960. All foreign 
income taxes paid or accrued by members of the group for the year 
(including those deemed paid under section 960 and paragraph (d) of 
this section) must be aggregated.
    (c) Computation of limitation on credit. For purposes of computing 
the group's limiting fraction under section 904, the following rules 
apply:
    (1) Computation of taxable income from foreign sources--(i) 
Separate categories. The group must compute a separate foreign tax 
credit limitation for income in each separate category (as defined in 
Sec.  1.904-5(a)(4)(v)) for purposes of this section. The numerator of 
the limiting fraction in any separate category is the consolidated 
taxable income of the group determined in accordance with Sec.  1.1502-
11, taking into account adjustments required under section 904(b), if 
any, from sources without the United States in that category, 
determined in accordance with the rules of Sec. Sec.  1.904-4 and 
1.904-5 and the section 861 regulations (as defined in Sec.  1.861-
8(a)(1)).
    (ii) Adjustments under sections 904(f) and (g). The rules for 
allocation and recapture of separate limitation losses and overall 
foreign losses under section 904(f) and Sec.  1.1502-9 apply to 
determine the foreign source and U.S. source taxable income in each 
separate category of the consolidated group. Similarly, the rules for 
allocation and recapture of overall domestic losses under section 
904(g) and Sec.  1.1502-9 apply to determine the foreign source and 
U.S. source taxable income in each separate category of the 
consolidated group. See Sec.  1.904(g)-3 for allocation rules under 
sections 904(f) and 904(g).

[[Page 72073]]

The rules of sections 904(f) and 904(g) do not operate to 
recharacterize foreign income tax attributable to any separate 
category.
    (iii) Computation of consolidated net operating loss. The source 
and separate category of the group's consolidated net operating loss 
(``CNOL''), as that term is defined in Sec.  1.1502-21(e), for the 
taxable year, if any, is determined based on the amounts of any 
separate limitation losses and U.S. source loss that are not allocated 
to reduce U.S. source income or income in other separate categories 
under the rules of sections 904(f) and 904(g) in computing the group's 
consolidated foreign tax credit limitations for the taxable year under 
paragraphs (c)(1)(i) and (ii) of this section.
    (iv) Characterization of CNOL carried to a separate return year--
(A) In general. The total amount of CNOL attributable to a member that 
is carried to a separate return year is determined under the rules of 
Sec.  1.1502-21(b)(2). The source and separate category of the portion 
of the CNOL that is attributable to a member is determined under this 
paragraph (c)(1)(iv).
    (B) Tentative apportionment. For the portion of the CNOL that is 
attributable to the member described in paragraph (c)(1)(iv) of this 
section, the consolidated group determines a tentative allocation and 
apportionment to each statutory and residual grouping (as described in 
Sec.  1.861-8(a)(4) with respect to section 904 as the operative 
section) under the principles of Sec.  1.1502-9(c)(2)(i), (ii), (iv), 
and (v) by treating the portion of the group's CNOL in each statutory 
and residual grouping as if it were a CSLL account, as that term is 
described in Sec.  1.1502-9(b)(4). This determination is made as of the 
end of the taxable year of the consolidated group in which the CNOL 
arose or, if earlier and applicable, when the member leaves the 
consolidated group.
    (C) Adjustments. (1) If the total tentative apportionment for all 
statutory and residual groupings exceeds the portion of the CNOL 
attributable to the member described in paragraph (c)(1)(iv)(A) of this 
section (the ``excess amount''), then the tentative apportionment in 
each grouping is reduced by an amount equal to the excess amount 
multiplied by a fraction, the numerator of which is the tentative 
apportionment in that grouping, and the denominator of which is the 
total tentative apportionments in all groupings.
    (2) If the total tentative apportionment for all statutory and 
residual groupings is less than the total CNOL attributable to the 
member described in paragraph (c)(1)(iv)(A) (the ``deficiency''), then 
the tentative apportionment in each grouping is increased by an amount 
equal to the deficiency multiplied by a fraction, the numerator of 
which is the CNOL in that grouping that was not tentatively 
apportioned, and the denominator of which is the total CNOL in all 
groupings that was not tentatively apportioned.
    (v) Consolidated net capital losses. The principles of the rules in 
paragraphs (c)(1)(i) through (iv) of this section apply for purposes of 
determining the source and separate category of consolidated net 
capital losses described in Sec.  1.1502-22(e).
    (2) Computation of consolidated taxable income. The denominator of 
the limiting fraction in any separate category is the consolidated 
taxable income of the group determined in accordance with Sec.  1.1502-
11, taking into account adjustments required under section 904(b), if 
any.
    (3) Computation of tax against which credit is taken. The tax 
against which the limiting fraction under section 904(a) is applied 
will be the consolidated tax liability of the group determined under 
Sec.  1.1502-2, but without regard to Sec.  1.1502-2(a)(2) through (4) 
and (8) and (9), and without regard to any credit against such 
liability. See sections 26(b) and 901(a).
    (d) Carryover and carryback of unused foreign tax--(1) Allowance of 
unused foreign tax as consolidated carryover or carryback. The 
consolidated group's carryovers and carrybacks of unused foreign tax 
(as defined in Sec.  1.904-2(c)(1)) to the taxable year is determined 
on a consolidated basis under the principles of section 904(c) and 
Sec.  1.904-2 and is deemed to be paid or accrued to a foreign country 
or possession for that year. The consolidated group's unused foreign 
tax carryovers and carrybacks to the taxable year consist of any unused 
foreign tax of the consolidated group, plus any unused foreign tax of 
members for separate return years, which may be carried over or back to 
the taxable year under the principles of section 904(c) and Sec.  
1.904-2. The consolidated group's unused foreign tax carryovers and 
carrybacks do not include any unused foreign taxes apportioned to a 
corporation for a separate return year pursuant to Sec.  1.1502-79(d). 
A consolidated group's unused foreign tax in each separate category is 
the excess of the foreign taxes paid, accrued or deemed paid under 
section 960 by the consolidated group over the limitation in the 
applicable separate category for the consolidated return year. See 
paragraph (c) of this section.
    (2) Absorption rules. For purposes of determining the amount, if 
any, of an unused foreign tax which can be carried to a taxable year 
(whether a consolidated or separate return year), the amount of the 
unused foreign tax that is absorbed in a prior consolidated return year 
under section 904(c) shall be determined by--
    (i) Applying all unused foreign taxes which can be carried to a 
prior year in the order of the taxable years in which those unused 
foreign taxes arose, beginning with the taxable year that ends 
earliest; and
    (ii) Applying all unused foreign taxes which can be carried to such 
prior year from taxable years ending on the same date on a pro rata 
basis.
    (e) Example. The following example illustrates the application of 
this section:
    (1) Facts. (i) Domestic corporation P is incorporated on January 1, 
Year 1. On that same day, P incorporates domestic corporations S and T 
as wholly owned subsidiaries. P, S, and T file consolidated returns for 
Years 1 and 2 on the basis of a calendar year. T engages in business 
solely through a qualified business unit in Country A. S engages in 
business solely through qualified business units in Countries A and B. 
P does business solely in the United States. During Year 1, T sold an 
item of inventory to P at a gain of $2,000. Under Sec.  1.1502-13 the 
intercompany gain has not been taken into account as of the close of 
Year 1. The taxable income of each member for Year 1 from foreign and 
U.S. sources, and the foreign taxes paid on such foreign income, are as 
follows:

[[Page 72074]]



                                         Table 1 to Paragraph (e)(1)(i)
----------------------------------------------------------------------------------------------------------------
                                                           Foreign branch
                                         U.S. source      category foreign    Foreign branch     Total taxable
             Corporation                taxable income     source taxable    category foreign        income
                                                               income            tax paid
----------------------------------------------------------------------------------------------------------------
P...................................            $40,000  .................  .................            $40,000
T...................................  .................            $20,000            $12,000             20,000
S...................................  .................             20,000              9,000             20,000
Group...............................             40,000             40,000             21,000             80,000
----------------------------------------------------------------------------------------------------------------

    (ii) The separate taxable income of each member was computed by 
taking into account the rules under Sec.  1.1502-12. Accordingly, T's 
intercompany gain of $2,000 is not included in T's taxable income for 
Year 1. The group's consolidated taxable income (computed in accordance 
with Sec.  1.1502-11) is $80,000. The consolidated tax liability 
against which the credit may be taken (computed in accordance with 
paragraph (c)(3) of this section) is $16,800.
    (2) Analysis. Under section 904(d) and paragraph (c)(1)(i) of this 
section, the aggregate amount of foreign income taxes paid to all 
foreign countries with respect to the foreign branch category income of 
$21,000 ($12,000 + $9,000) that may be claimed as a credit in Year 1 is 
limited to $8,400 ($16,800 x $40,000/$80,000). Assuming P, as the agent 
for the group, chooses to use the foreign taxes paid as a credit, the 
group may claim a $8,400 foreign tax credit.
    (f) Applicability date. This section applies to taxable years for 
which the original consolidated Federal income tax return is due 
(without extensions) after January 11, 2021.

0
Par. 38. Section 1.1502-21 is amended by adding a sentence to the end 
of paragraph (b)(2)(iv)(B)(1) to read as follows:


Sec.  1.1502-21  Net operating losses.

* * * * *
    (b) * * *
    (2) * * *
    (iv) * * *
    (B) * * *
    (1) * * * The source and section 904(d) separate category of the 
CNOL attributable to a member is determined under Sec.  1.1502-
4(c)(1)(iii).
* * * * *

PART 301--PROCEDURE AND ADMINISTRATION

0
Par. 39. The authority citation for part 301 is amended by adding an 
entry for Sec.  301.6689-1 in numerical order to read in part as 
follows:

    Authority:  26 U.S.C. 7805.
* * * * *
    Section 301.6689-1 also issued under 26 U.S.C. 6689(a), 26 
U.S.C. 6227(d), and 26 U.S.C. 6241(11).
* * * * *

0
Par. 40. Section 301.6227-1 is amended by adding paragraph (g) to read 
as follows:


Sec.  301.6227-1  Administrative adjustment request by partnership.

* * * * *
    (g) Notice requirement and partnership adjustments required as a 
result of a foreign tax redetermination. For special rules applicable 
when an adjustment to a partnership related item (as defined in section 
6241(2)) is required as part of a redetermination of U.S. tax liability 
under section 905(c) and Sec.  1.905-3(b) of this chapter as a result 
of a foreign tax redetermination (as defined in Sec.  1.905-3(a) of 
this chapter), see Sec.  1.905-4(b)(2)(ii) of this chapter.
* * * * *

0
Par. 41. Section 301.6689-1 is added to read as follows:


Sec.  301.6689-1  Failure to file notice of redetermination of foreign 
income taxes.

    (a) Application of civil penalty. If a foreign tax redetermination 
occurs, and the taxpayer failed to notify the Internal Revenue Service 
(IRS) on or before the date and in the manner prescribed in Sec.  
1.905-4 of this chapter, or as required under section 404A(g)(2), for 
giving notice of a foreign tax redetermination, then, unless paragraph 
(d) of this section applies, there is added to the deficiency (or the 
imputed underpayment as determined under section 6225) attributable to 
such redetermination an amount determined under paragraph (b) of this 
section. Subchapter B of chapter 63 of the Internal Revenue Code 
(relating to deficiency proceedings) does not apply with respect to the 
assessment of the amount of the penalty.
    (b) Amount of the penalty. The amount of the penalty shall be equal 
to--
    (1) Five percent of the deficiency (or imputed underpayment) if the 
failure is for not more than one month; plus
    (2) An additional five percent of the deficiency (or imputed 
underpayment) for each month (or fraction thereof) during which the 
failure continues, but not to exceed in the aggregate twenty-five 
percent of the deficiency (or imputed underpayment).
    (c) Foreign tax redetermination defined. For purposes of this 
section, a foreign tax redetermination is any redetermination for which 
a notice is required under sections 905(c) or 404A(g)(2). See 
Sec. Sec.  1.905-3 through 1.905-5 of this chapter for rules relating 
to the notice requirement under section 905(c).
    (d) Reasonable cause. The penalty set forth in this section shall 
not apply if it is established to the satisfaction of the IRS that the 
failure to file the notification within the prescribed time was due to 
reasonable cause and not due to willful neglect. An affirmative showing 
of reasonable cause must be made in the form of a written statement 
that sets forth all the facts alleged as reasonable cause for the 
failure to file the notification on time and that contains a 
declaration by the taxpayer that the statement is made under the 
penalties of perjury. This statement must be filed with the Internal 
Revenue Service Center in which the notification was required to be 
filed. The taxpayer must file this statement with the notice required 
under section 905(c) or 404A(g)(2). If the taxpayer exercised ordinary 
business care and prudence and was nevertheless unable to file the 
notification within the prescribed time, then the delay will be 
considered to be due to reasonable cause and not willful neglect.
    (e) Applicability date. This section applies to foreign tax 
redeterminations occurring in taxable years ending on or after December 
16, 2019, and to foreign tax redeterminations of foreign corporations 
occurring in taxable years that end with or within a taxable year of a 
United States shareholder ending on or after December 16, 2019.

[[Page 72075]]

Sec.  301.6689-1T   [REMOVED]

0
Par. 42. Section 301.6689-1T is removed.

Sunita Lough,
Deputy Commissioner for Services and Enforcement.
    Approved: September 18, 2020.
David J. Kautter,
Assistant Secretary of the Treasury (Tax Policy).
[FR Doc. 2020-21819 Filed 11-2-20; 11:15 am]
BILLING CODE 4830-01-P