Consolidated Returns -- Consolidated Overall
Foreign Losses & Separate Limitation Losses

DEPARTMENT OF THE TREASURY
Internal Revenue Service 26 CFR Part 1 [REG-106902-98] RIN 1545-AW08

TITLE: Consolidated returns -- Consolidated overall foreign losses
and separate limitation losses

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking; notice of proposed rulemaking
by cross-reference to temporary regulations; and notice of public
hearing

SUMMARY: This document contains proposed consolidated return
regulations relating to the treatment of overall foreign losses and
separate limitation losses in the computation of the foreign tax
credit limitation. The proposed rules are necessary to modify
existing guidance with respect to overall foreign losses and to
provide guidance with respect to separate limitation losses. These
proposed regulations affect consolidated groups that compute the
foreign tax credit limitation or that dispose of property used in a
foreign trade or business. This document also provides notice of a
public hearing on these proposed regulations.

DATES: Written comments must be received by February 10, 1999.

Outlines of oral comments to be discussed at the public hearing
scheduled for 10 a.m. on February 17, 1999, must be received by
January 27, 1999.

ADDRESSES: Send submissions to CC:DOM:CORP:R (REG-106902-98), room
5226, Internal Revenue Service, POB 7604, Ben Franklin Station,
Washington, DC 20044. Submissions may be hand delivered Monday
through Friday between the hours of 8 a.m. and 5 p.m. to:
CC:DOM:CORP:R (REG-106902-98), Courier's Desk, Internal Revenue
Service, 1111 Constitution Avenue, NW., Washington, DC.
Alternatively, taxpayers may submit comments electronically via the
Internet by selecting the A Tax Regs @ option on the IRS Home Page,
or by submitting comments directly to the IRS Internet site at
http://www.irs.ustreas.gov/prod/tax_regs/comments. html. The public
hearing will be held in room 2615, Internal Revenue Building, 1111
Constitution Avenue, NW., Washington, DC.

FOR FURTHER INFORMATION CONTACT: Concerning the regulations in
general, Trina Dang of the Office of Associate Chief Counsel
(International), (202) 622-3850; concerning submissions of comments,
the hearing, and/or to be placed on the building access list to
attend the hearing, LaNita Van Dyke, (202) 622-7180 (not toll-free
numbers).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

The collection of information contained in this notice of proposed
rulemaking has been submitted to the Office of Management and Budget
for review in accordance with the Paperwork Reduction Act of 1995
(44 U.S.C. 3507(d)). Comments on the collection of information
should be sent to the Office of.3 Management and Budget, Attn: Desk
Officer for the Department of the Treasury, Office of Information
and Regulatory Affairs, Washington, DC 20503, with copies to the
Internal Revenue Service, Attn: IRS Reports Clearance Officer,
OP:FS:FP, Washington, DC 20224. Comments on the collection of
information should be received by March 1, 1999. Comments are
specifically requested concerning:

Whether the proposed collection of information is necessary for the
proper performance of the Internal Revenue Service, including
whether the information will have practical utility; The accuracy of
the estimated burden associated with the proposed collection of
information (see below);

How the quality, utility, and clarity of the information to be
collected may be enhanced;

How the burden of complying with the proposed collection of
information may be minimized, including through the application of
automated collection techniques or other forms of information
technology; and Estimates of capital or start-up costs and costs of
operation, maintenance, and purchase of service to provide
information.

The collection of information in this proposed regulation is in
�1.1502-9(c)(2)(iv). This information is required to help the
Internal Revenue Service monitor compliance with the provisions of
the proposed regulations and to ensure that taxpayers use consistent
asset valuations in applying the proposed regulations.

This information will be used for tax administration purposes.

The collection of information is mandatory. The likely respondents
are business or other for-profit institutions.

Estimated total annual reporting burden: 3,000 hoU.S.

Estimated average annual burden per respondent: 1.5 hoU.S.

Estimated number of respondents: 2,000.

Estimated annual frequency of responses: on occasion.

An agency may not conduct or sponsor, and a person is not required
to respond to, a collection of information unless it displays a
valid control number assigned by the Office of Management and
Budget.

Books or records relating to a collection of information must be
retained so long as their contents may become material in the
administration of any internal revenue law. Generally, tax returns
and tax return information are confidential, as required by 26
U.S.C. 6103.

Background

This document contains proposed consolidated return regulations
under section 1502 of the Internal Revenue Code. The regulations
provide guidance concerning the application of the overall foreign
loss (OFL) and separate limitation loss (SLL) rules of section
904(f) in the context of a consolidated group.

On January 12, 1998, the IRS and Treasury published in the Federal
Register (TD 8751, 63 FR 1740) temporary regulations modifying the
rules governing the absorption of certain tax attributes, including
OFL accounts and foreign tax credit carryovers and carrybacks. The
temporary regulations eliminated.5 the limitation on OFL recapture
and foreign tax credit utilization with respect to separate return
limitation years (SRLYs). As explained in the preamble to those
temporary regulations, one reason for the repeal of the SRLY
limitation for the foreign tax credit attributes was the conceptual
and practical difficulty of measuring a member's contribution to a
group's ability to absorb these attributes in light of foreign tax
credit provisions that allocate interest expense and certain other
expenses (and intercompany interest income) of a member based upon
the entire group's assets or activities. The preamble to those
regulations noted that these expense allocation provisions also
create similar problems with respect to the notional account method
of apportioning OFL accounts to a member ceasing to be a member of a
group and stated that the IRS and Treasury expected to modify these
rules in the near future.

Overview The proposed regulations modify the existing regulations
under �1.1502-9, which were promulgated in 1987 (the 1987
regulations). The 1987 regulations are proposed to be amended in
three major respects: the notional account method for apportioning
OFL accounts to a departing member is replaced by an asset-based
allocation method, the interaction between the intercompany
transaction rules and the disposition rules of section 904(f)(3) and
(5)(F) is simplified and refined, and guidance is provided
concerning the computation of a group's SLLs (whereas the 1987
regulations addressed only OFLs).

The 1987 regulations allocated an OFL account to a departing member
based upon the member's "notional" OFL account. A separate notional
account was established for each member of a group that contributed
to a consolidated OFL account. The accounts were adjusted annually.
A member was considered to have contributed to a group's OFL account
if the member had an overall foreign loss (deductions allocated
against foreign-source income exceeded foreign-source gross income)
in a year in which the group added to its consolidated OFL account.

At the time the 1987 regulations were being drafted, however,
Congress substantially changed the rules for allocating interest
expense in the Tax Reform Act of 1986. Congress believed that
corporations were borrowing in ways designed to inappropriately
minimize the amount of interest expense allocated against foreign-
source income, thus inflating the amount of foreign-source income
that could be sheltered from U.S. tax by foreign tax credits. In the
case of an affiliated group, Congress was concerned that interest
expense allocation could be manipulated by placing the borrowing
function in group members with no foreign assets, while diverting
available equity in the group to members with substantial foreign
assets. Congress therefore enacted section 864(e), which requires an
affiliated group to allocate interest expense of each member as if
all such members were a single corporation. Under this rule,
although the borrowing corporation incurs the interest expense, that
expense is allocated among U.S. and foreign income based upon the
assets of the group as a whole. (Group-based expense allocation is
also required for research and experimental expenditures under
section 864(f) and expenses not directly allocable to specific
income under section 864(e)(6).)

Due in large measure to these group-based expense allocation
provisions, the notional account method can result in a member
taking from a group an OFL or SLL account that is unrelated to
either the member's activities or future income. For example, assume
that P holds all the stock of S and S holds all the stock of R. P,
S, and R file a consolidated return. P has no assets other than the
stock of S. S's operations are foreign and R's operations are
entirely domestic. S's assets have a tax book value of $600 and R's
assets have a tax book value of $400. S is entirely equity financed,
but R borrows funds from an unrelated lender. S earns $100 foreign-
source income and incurs $100 of foreign-allocated expense. R earns
$200 U.S.-source income and incurs $100 of interest expense. Under
section 864(e)(1) and �1.861-11T, the $100 of interest expense is
allocated to R's U.S. and foreign-source gross income based upon the
assets of the group as a whole. Thus R, with no foreign operations,
is treated as having a $60 foreign loss (no foreign income and $60
foreign expense), but S, the only member with foreign operations,
does not have a foreign loss. R's notional OFL account would thus be
$60 (100 percent of the consolidated OFL account) and, if R left the
group, R would take the entire consolidated OFL account with it. The
group, however, would retain the foreign assets and the.8 OFL
account might never be recaptured.

As described in more detail below, the proposed regulations do not
apply the notional account approach, but instead apportion accounts
to a departing member based upon the member's share of the group's
foreign assets that produce foreign-source income that would be
subject to recapture. The new approach does not attempt to measure a
member's "contribution" to the group's consolidated account; rather,
the asset approach associates an OFL or SLL account with a member's
foreign assets that produce income subject to recapture and measures
each member's share of the group OFL or SLL account based upon the
member's share of these assets. This approach is more in keeping
with the interest allocation provisions for affiliated groups
enacted in 1986.

The proposed regulations also modify the interaction between section
904(f) and the intercompany transaction rules of �1.1502- 13. Under
the 1987 regulations, a consolidated OFL account could trigger gain
recognition with respect to an otherwise tax-free intercompany
transaction (such as a member's contribution under section 351 to
another member of the group) that is a disposition subject to
section 904(f)(3) or (5)(F). This gain recognition could occur even
though the gain would not be taken into account currently under
�1.1502-13. Because the gain is not taken into account, however, the
consolidated OFL account is not reduced.

Since the consolidated OFL account is not reduced, it can continue
to recharacterize foreign-source income or trigger gain recognition
with respect to subsequent dispositions subject to.9 section 904(f)
(3) or (5)(F). This regime thus has the potential to multiply the
effects of a consolidated OFL account. This rule was necessary under
the notional account system of apportioning OFL accounts to a
departing member because otherwise a member with a notional OFL
account could contribute appreciated foreign assets to a new
subsidiary, and the new subsidiary could then leave the group
unencumbered by the OFL account, contrary to the purpose of section
904(f)(3). As described in more detail below, the proposed
regulations ease the section 904(f)(3) and (5)(F) disposition rules
in the case of intercompany transactions.

Finally, the proposed regulations provide computational rules and
nomenclature for SLLs as well as OFLs. Because the regulations
issued in 1987 were actually drafted prior to the enactment of the
SLL rules in 1986, the 1987 regulations provide rules only for OFLs,
although rules for SLLs could be derived by analogy.

Explanation of Provisions

The proposed regulations do not provide comprehensive guidance under
section 904(f) and address only particular section 904(f) issues
that arise in the context of a consolidated group.

The proposed regulations must be read in conjunction with general
guidance under section 904(f), such as Notice 89-3 (1989-1 C.B.
623).

Proposed �1.1502-9(b)(1) through (4) provides computational rules
for consolidated OFL and SLL accounts. Generally, a group applies
section 904(f) on a group-wide basis. Thus, it nets.10 together all
members' income and losses from the same separate limitation income
category (or basket) to determine its consolidated separate
limitation income or loss for the basket.

Pursuant to section 904(f)(5), the group then nets any consolidated
separate limitation loss for a basket (a loss basket) against
consolidated separate limitation income for all other baskets (the
income baskets) on a proportionate basis.

Such netting creates a consolidated SLL account (a CSLL account) for
the loss basket with respect to one or more income baskets.

The group then nets any remaining consolidated separate limitation
loss for a loss basket against its U.S.-source income.

Such netting creates a consolidated OFL account (a COFL account) for
the loss basket. The group recaptures a COFL or CSLL account as
required by section 904(f).

Proposed �1.1502-9(b)(5) addresses the interaction between section
904(f) and the intercompany transaction rules. In the case of an
intercompany transaction in which gain is recognized but not
currently taken into account, the gain is treated as subject to
section 904(f)(3) or (5)(F) only when taken into account under
�1.1502-13, to the extent of the COFL or CSLL account existing at
that time. In the case of an intercompany transaction in which gain
is not recognized (such as a section 351 contribution), section
904(f) will not trigger gain recognition.

Proposed �1.1502-9(c) provides rules for members becoming or ceasing
to be members of a group. Consistent with the temporary regulations
issued in January 1998, and modified in March 1998 and in temporary
regulations published elsewhere in this issue of the Federal
Register, a member that enters a group with an OFL or SLL account
adds this account to the consolidated account, without any SRLY
limitation. A departing member takes a portion of the group's COFL
and CSLL accounts based upon the member's share of the group's
assets that generate income subject to recapture (i.e., assets that
generate income in the same basket as the loss basket). The proposed
regulations rely on the characterization principles of ��1.861-9T(g)
(3) and 1.861-12T to identify the member's share of assets that
generate foreign-source income subject to recapture in each basket.
The value of the foreign assets is determined under the asset
valuation rules of �1.861-9T(g)(1) and (2) using either tax book
value or fair market value under the method chosen by the group for
purposes of interest apportionment as provided in �1.861-9T(g)(1)
(ii).

Although actual market values generally provide a better means of
apportioning accounts than tax book values (since market values more
accurately represent the projected future earnings of an asset),
apportionment based upon tax book value is permitted in the interest
of administrative convenience. For groups using tax book value,
however, an upper limitation is placed upon a member's share of the
consolidated accounts to prevent extreme situations in which
disparities between tax book value and fair market value could
result in the removal of excessive OFL or SLL accounts from the
group. The proposed regulations provide an anti-abuse rule that is
designed to prevent taxpayers from manipulating the COFL and CSLL
account apportionment rules to achieve results inconsistent with the
purpose of the OFL and SLL rules.

Proposed �1.1502-9(c)(2)(i) provides that a group apportions COFL
and CSLL accounts to a departing member only after the group makes
the annual additions or reductions to the accounts to reflect
current-year foreign-source income or loss. To the extent this rule
conflicts with the ordering rules of �1.904(f)-1( e)(1), the
proposed rule, when finalized, is intended to supersede the existing
regulations.

Proposed Effective Dates

These regulations are proposed to apply to consolidated return years
for which a return is due after the date final regulations are
published in the Federal Register. However, �1.1502-9(b)(5)
(intercompany transactions) is not applicable for intercompany
transactions that occur before January 28, 1999.

Also, �1.1502-9(c)(2) (apportionment of consolidated account to
departing member) is not applicable for members ceasing to be
members of a group before January 28, 1999.

Election to Defer Repeal of SRLY Limitation Temporary regulations
published elsewhere in this issue of the Federal Register permit
consolidated groups to elect to continue to apply the SRLY
limitation for overall foreign loss accounts for consolidated years
beginning before January 1, 1998, as announced in Notice 98-40
(1998-35 I.R.B. 7). The text of those temporary regulations also
serves as the text of these proposed regulations. The preamble to
the temporary regulations explains the temporary regulations.

Special Analyses

It has been determined that this notice of proposed rulemaking is
not a significant regulatory action as defined in Executive Order
12866. Therefore, a regulatory impact analysis is not required. It
is hereby certified that these regulations will not have a
significant economic impact on a substantial number of small
entities. This certification is based on the fact that these
regulations principally affect corporations filing consolidated
federal income tax returns that have overall foreign losses or
separate limitation losses. Available data indicates that many
consolidated return filers are large companies (not small
businesses). In addition, the data indicates that an insubstantial
number of consolidated return filers that are smaller companies have
overall foreign losses or separate limitation losses. Therefore, a
Regulatory Flexibility Analysis under the Regulatory Flexibility Act
(5 U.S.C. chapter 6) is not required. Pursuant to section 7805(f) of
the Internal Revenue Code, this notice of proposed rulemaking will
be submitted to the Chief Counsel for Advocacy of the Small Business
Administration for comment on its impact on small businesses.

Comments and Public Hearing

Before these proposed regulations are adopted as final regulations,
consideration will be given to any written comments that are
submitted timely to the IRS (a signed original and eight (8)
copies). In particular, the IRS and Treasury request comments on the
clarity of the proposed rules and how they may be made easier to
understand. All comments will be available for public inspection and
copying.

A public hearing has been scheduled for February 17, 1999, beginning
at 10 a.m. in room 2615 of the Internal Revenue Building, 1111
Constitution Avenue, NW., Washington, DC. Due to building security
procedures, visitors must enter at the 10 Street entrance, located
between Constitution and th Pennsylvania Avenues, NW. In addition,
all visitors must present photo identification to enter the
building. Because of access restrictions, visitors will not be
admitted beyond the immediate entrance area more than 15 minutes
before the hearing starts.

For information about having your name placed on the building access
list to attend the hearing, see the A FOR FURTHER INFORMATION
CONTACT @ section of this preamble.

The rules of 26 CFR 601.601(a)(3) apply to the hearing.

Persons who wish to present oral comments at the hearing must submit
written comments and an outline of the topics to be discussed and
the time to be devoted to each topic (signed original and eight (8)
copies) by January 27, 1999. A period of 10 minutes will be allotted
to each person for making comments.

An agenda showing the scheduling of the speakers will be prepared
after the deadline for receiving outlines has passed. Copies of the
agenda will be available free of charge at the hearing.

Drafting Information

The principal authors of these regulations are Seth B.

Goldstein and Trina Dang, of the Office of the Associate Chief
Counsel (International), IRS. However, other personnel from the IRS
and Treasury Department participated in their development.

List of Subjects in 26 CFR Part 1

Income taxes, Reporting and recordkeeping requirements.

Proposed Amendments to the Regulations

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

PART 1--INCOME TAXES

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

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

Section 1.1502-9 also issued under 26 U.S.C. 1502. * * *

Section 1.1502-9A also issued under 26 U.S.C. 1502. * * *

Par. 2. Section 1.1502-3, as proposed to be amended at 63 FR 12717,
March 16, 1998, is further amended by removing the last sentence of
paragraph (c)(4) and adding two sentences in its place to read as
follows:

�1.1502-3 Consolidated investment credit.

* * * * *

(c) * * *

(4) * * * [The last two sentences of proposed paragraph (c)(4) is
the same as the last two sentences of �1.1502-3T(c)(4) published
elsewhere in this issue of the Federal Register.]

* * * * *

Par. 3. Immediately following �1.1504-4 an undesignated center
heading is added to read as follows:

REGULATIONS APPLICABLE FOR TAX YEARS FOR WHICH A RETURN IS DUE ON OR
BEFORE THE DATE FINAL REGULATIONS ARE PUBLISHED IN THE FEDERAL
REGISTER

Par. 4. Section 1.1502-9 is redesignated as �1.1502-9A and added
under the new undesignated center heading.

Par. 5. Newly designated �1.1502-9A is amended by:

1. Revising the section heading.

2. Redesignating the heading and text of paragraph (a) as the
heading and text of paragraph (a)(2).

3. Adding a new heading to paragraph (a), and new paragraphs (a)(1),
(b)(1)(v) and (b)(1)(vi).

The revisions and additions read as follows:

�1.1502-9A Application of overall foreign loss recapture rules to
corporations filing consolidated returns due on or before the date
final regulations are published in the Federal Register.

(a) Scope--(1) Effective date. This section applies only to
consolidated return years for which the due date of the income tax
return (without extensions) is on or before the date final
regulations are published in the Federal Register.

(2) In general. * * *

(b) * * *

(1) * * *

(v) [The text of this proposed paragraph (b)(1)(v) is the same as
the text of �1.1502-9T(b)(1)(v) published elsewhere in this issue of
the Federal Register.]

(vi) [The text of this proposed paragraph (b)(1)(vi) is the same as
the text of �1.1502-9T(b)(1)(vi) published elsewhere in this issue
of the Federal Register.]

* * * * *

Par. 6. New �1.1502-9 is added to read as follows:

�1.1502-9 Consolidated overall foreign losses and separate
limitation losses.

(a) In general. This section provides rules for applying section
904(f) (including its definitions and nomenclature) to a group and
its members. Generally, section 904(f) concerns rules relating to
overall foreign losses (OFLs) and separate limitation losses (SLLs)
and the consequences of such losses. As provided in section 904(f)
(5), losses are computed separately in each category of income
described in section 904(d)(1) (basket).

Paragraph (b) of this section defines terms and provides
computational and accounting rules, including rules regarding
recapture. Paragraph (c) of this section provides rules that apply
to OFLs and SLLs when a member becomes or ceases to be a member of a
group. Paragraph (d) of this section provides a predecessor and
successor rule. Paragraph (e) of this section provides effective
dates.

(b) Consolidated application of section 904(f). A group applies
section 904(f) for a consolidated return year in accordance with
that section, subject to the following rules:

(1) Computation of CSLI or CSLL and consolidated U.S. source.18
income or loss. The group computes its consolidated separate
limitation income (CSLI) or consolidated separate limitation loss
(CSLL) for each basket under the principles of �1.1502-11 by
aggregating each member's foreign-source taxable income or loss in
such basket computed under the principles of �1.1502-12, and taking
into account the foreign portion of the consolidated items described
in �1.1502-11(a)(2) through (8) for such basket. The group computes
its consolidated U.S.-source taxable income or loss under similar
principles.

(2) Netting CSLLs, CSLIs, and consolidated U.S. source taxable
income or loss. The group applies section 904(f)(5) to determine the
extent to which a CSLL for a basket reduces CSLI for another basket
or consolidated U.S.-source taxable income.

(3) CSLL and COFL accounts. To the extent provided in section
904(f), the amount by which a CSLL for a basket (the loss basket)
reduces CSLI for another basket (the income basket) shall result in
the creation of (or addition to) a CSLL account for the loss basket
with respect to the income basket. Likewise, the amount by which a
CSLL for a loss basket reduces consolidated U.S.-source income will
create (or add to) a consolidated overall foreign loss account (a
COFL account).

(4) Recapture of COFL and CSLL accounts. In the case of a COFL
account for a loss basket, section 904(f)(1) and (3) recharacterizes
some or all of the foreign-source income in the loss basket as U.S.-
source income. In the case of a CSLL account for a loss basket with
respect to an income basket, section 904(f)(5)(C) and (F)
recharacterizes some or all of the foreign- source income in the
loss basket as foreign-source income in the income basket. The COFL
account or CSLL account is reduced to the extent amounts are
recharacterized with respect to such account.

(5) Intercompany transactions--(i) Nonapplication of section 904(f)
disposition rules. Neither section 904(f)(3) (in the case of a COFL
account) nor (5)(F) (in the case of a CSLL account) applies at the
time of a disposition that is an intercompany transaction to which
�1.1502-13 applies. Instead, section 904(f)(3) and (5)(F) applies
only at such time and only to the extent that the group is required
under �1.1502-13 (without regard to section 904(f)(3) and (5)(F)) to
take into account any intercompany items resulting from the
disposition, based on the COFL or CSLL account existing at the end
of the consolidated return year during which the group takes the
intercompany items into account.

(ii) Example. Paragraph (b)(5)(i) of this section is illustrated by
the following examples. The identity of the parties and the basic
assumptions set forth in �1.1502- 13(c)(7)(i) apply to the examples.
Except as otherwise stated, assume further that the consolidated
group recognizes no foreign-source income other than as a result of
the transactions described. The examples are as follows:

Example 1. (i) On June 10, Year 1, S transfers nondepreciable
property with a basis of $100 and a fair market value of $250 to B
in a transaction to which section 351 applies.

The property was predominantly used without the United States in a
trade or business, within the meaning of section 904(f)(3). B
continues to use the property without the United States. The group
has a COFL account in the relevant loss basket of $120 as.20 of
December 31, Year 1.

(ii) Because the contribution from S to B is an intercompany
transaction, section 904(f)(3) does not apply to result in any gain
recognition in Year 1. See paragraph (b)(5)(i) of this section.

(iii) On January 10, Year 4, B ceases to be a member of the group.
Because S did not recognize gain in Year 1 under section 351, no
gain is taken into account in Year 4 under �1.1502-13(d).

Thus, no portion of the group's COFL account is recaptured in Year
4. For rules requiring apportionment of a portion of the COFL
account to B, see paragraph (c)(2) of this section.

Example 2. (i) The facts are the same as in paragraph (i) of Example
1. On January 10, Year 4, B sells the property to X for $300. As of
December 31, Year 4, the group's COFL account is $40. (The COFL
account was reduced between Year 1 and Year 4 due to unrelated
foreign-source income taken into account by the group.) (ii) B takes
into account gain of $200 in Year 4. The $40 COFL account in Year 4
recharacterizes $40 of the gain as U.S. source. See section 904(f)
(3).

Example 3. (i) On June 10, Year 1, S sells nondepreciable property
with a basis of $100 and a fair market value of $250 to B for $250
cash. The property was predominantly used without the United States
in a trade or business, within the meaning of section 904(f)(3). The
group has a COFL account in the relevant loss basket of $120 as of
December 31, Year 1. B predominately uses the property in a trade or
business without the United States.

(ii) Because the sale is an intercompany transaction, section 904(f)
(3) does not require the group to take into account any gain in Year
1. Thus, under paragraph (b)(5)(i) of this section, the COFL account
is not reduced in Year 1.

(iii) On January 10, Year 4, B sells the property to X for $300. As
of December 31, Year 4, the group's COFL account is $60. (The COFL
account was reduced between Year 1 and Year 4 due to unrelated
foreign-source income taken into account by the group.)

(iv) In Year 4, S's $150 intercompany gain and B's $50 corresponding
gain are taken into account to produce the same effect on
consolidated taxable income as if S and B were divisions of a single
corporation. See �1.1502-13(c). All of B's $50 corresponding gain is
recharacterized under section 904(f)(3). If S and B were divisions
of a single corporation and the intercompany sale were a transfer
between the divisions, B would succeed to S's $100 basis in the
property and would have.21 $200 of gain ($60 of which would be
recharacterized under section 904(f)(3)), instead of a $50 gain.
Consequently, S's $150 intercompany gain and B's $50 corresponding
gain are taken into account, and $10 of S's gain is recharacterized
under section 904(f)(3) as U.S. source to reflect the $10 difference
between B's $50 recharacterized gain and the $60 recomputed gain
that would have been recharacterized.

(c) Becoming or ceasing to be a member of a group--(1) Adding
separate accounts on becoming a member. At the time that a
corporation becomes a member of a group (a new member), the group
adds to the balance of its COFL or CSLL account the balance of the
new member's corresponding OFL account or SLL account. A new
member's OFL account corresponds to a COFL account if the account is
for the same loss basket. A new member's SLL account corresponds to
a CSLL account if the account is for the same loss basket and with
respect to the same income basket. If the group does not have a COFL
or CSLL account corresponding to the new member's account, it
creates a COFL or CSLL account with a balance equal to the balance
of the member's account.

(2) Apportionment of consolidated account to departing member--(i)
In general. A group apportions to a member that ceases to be a
member (a departing member) a portion of each COFL and CSLL account
as of the end of the year during which the member ceases to be a
member and after the group makes the additions or reductions to such
account required under paragraphs (b)(3), (b)(4) and (c)(1) of this
section (other than an addition under paragraph (c)(1) of this
section attributable to a member becoming a member after the
departing member ceases to be a member). The group computes such
portion under paragraph (c)(2)(ii) of this section, as limited by
paragraph (c)(2)(iii) of this section. The departing member carries
such portion to its first separate return year after it ceases to be
a member.

Also, the group reduces each account by such portion and carries
such reduced amount to its first consolidated return year beginning
after the year in which the member ceases to be a member. If two or
more members cease to be members in the same year, the group
computes the portion allocable to each such member (and reduces its
accounts by such portion) in the order that the members cease to be
members.

(ii) Departing member's portion of group's account. A departing
member's portion of a group's COFL or CSLL account for a loss basket
is computed based upon the member's share of the group's assets that
generate income subject to recapture at the time that the member
ceases to be a member. Under the characterization principles of
��1.861-9T(g)(3) and 1.861-12T, the group identifies the assets of
the departing member and the remaining members that generate
foreign-source income (foreign assets) in each basket. The assets
are characterized based upon the income that the assets are
reasonably expected to generate after the member ceases to be a
member. The member's portion of a group's COFL or CSLL account for a
loss basket is the group's COFL or CSLL account, respectively,
multiplied by a fraction, the numerator of which is the value of the
member's foreign assets for the loss basket and the denominator of
which is the value of the foreign assets of the group (including the
departing member) for the loss basket. The value of the foreign
assets is determined under the asset valuation rules of �1.861-9T(g)
(1) and

(2) using either tax book value or fair market value under the
method chosen by the group for purposes of interest apportionment as
provided in �1.861-9T(g)(1)(ii). For purposes of this paragraph (c)
(2)(ii), �1.861-9T(g)(2)(iv) (assets in intercompany transactions)
shall apply, but �1.861-9T(g)(2)(iii) (adjustments for directly
allocated interest) shall not apply. If the group uses the tax book
value method, the member's portions of COFL and CSLL accounts are
limited by paragraph (c)(2)(iii) of this section. The assets should
be valued at the time the member ceases to be a member, but values
on other dates may be used unless this creates substantial
distortions. For example, if a member ceases to be a member in the
middle of the group's consolidated return year, an average of the
values of assets at the beginning and end of the year (as provided
in �1.861- 9T(g)(2)) may be used or, if a member ceases to be a
member in the early part of the group's consolidated return year,
values at the beginning of the year may be used, unless this creates
substantial distortions.

(iii) Limitation on member's portion for groups using tax book value
method. If a group uses the tax book value method of valuing assets
for purposes of paragraph (c)(2)(ii) of this section and the
aggregate of a member's portions of COFL and CSLL accounts for a
loss basket (with respect to one or more income baskets) determined
under paragraph (c)(2)(ii) of this section exceeds 150 percent of
the actual fair market value of the member's foreign assets in the
loss basket, the member's portion of the COFL or CSLL accounts for
the loss basket shall be reduced (proportionately, in the case of
multiple accounts) by such excess. This rule does not apply if the
departing member and all other members that cease to be members as
part of the same transaction own all (or substantially all) the
foreign assets in the loss basket.

(iv) Determination of values of foreign assets binding on departing
member. The group's determination of the value of the member's and
the group's foreign assets for a loss basket is binding on the
member, unless the District Director concludes that the
determination is not appropriate. The common parent of the group
must attach a statement to the return for the taxable year that the
departing member ceases to be a member of the group that sets forth
the name and taxpayer identification number of the departing member,
the amount of each COFL or CSLL for each loss basket that is
apportioned to the departing member under this paragraph (c)(2), the
method used to determine the value of the member's and the group's
foreign assets in each such loss basket, and the value of the
member's and the group's foreign assets in each such loss basket.
The common parent must also furnish a copy of the statement to the
departing member.

(v) Anti-abuse rule. If a corporation becomes a member and ceases to
be a member, and a principal purpose of the corporation becoming and
ceasing to be a member is to transfer the corporation's OFL account
or SLL account to the group or to transfer the group's COFL or CSLL
account to the corporation, appropriate adjustments will be made to
eliminate the benefit of such a transfer of accounts. Similarly, if
any member acquires assets or disposes of assets (including a
transfer of assets between members of the group and the departing
member) with a principal purpose of affecting the apportionment of
accounts under paragraph (c)(2)(i) of this section, appropriate
adjustments will be made to eliminate the benefit of such
acquisition or disposition.

(vi) Examples. The following examples illustrate this paragraph (c):

Example 1. (i) On November 6, Year 1, S, a member of the P group, a
consolidated group with a calendar consolidated return year, ceases
to be a member of the group. On December 31, Year 1, the P group has
a $40 COFL account for the general limitation basket, a $20 CSLL
account for the general limitation basket (i.e., the loss basket)
with respect to the passive basket (i.e., the income basket), and a
$10 CSLL account for the shipping income basket (i.e., the loss
basket) with respect to the passive basket, (i.e., the income
basket). No member of the group has foreign-source income or loss in
Year 1. The group apportions its interest expense according to the
tax book value method.

(ii) On November 6, Year 1, the group identifies S's assets and its
own assets (including S's assets) expected to produce foreign
general limitation income. Use of end-of-the-year values will not
create substantial distortions in determining the relative values of
S's and the group's relevant assets on November 6, Year 1. The group
determines that S's relevant assets have a tax book value of $2,000
and a fair market value of $2,200. Also, the group's relevant assets
(including S's assets) have a tax book value of $8,000. On November
6, Year 1, S has no assets expected to produce foreign shipping
income.

(iii) Under paragraph (c)(2)(ii) of this section, S takes a $10 COFL
account for the general limitation basket ($40 x $2000/$8000) and a
$5 CSLL account for the general limitation basket with respect to
the passive basket ($20 x $2000/$8000). S does not take any portion
of the shipping income basket CSLL account. The limitation described
in paragraph (c)(2)(iii) of this section does not apply because the
aggregate of the COFL and CSLL accounts for the general limitation
basket that are apportioned to S ($15) is less than 150 percent of
the actual fair market value of S's general limitation foreign
assets ($2,200 x 150%).

Example 2. (i) Assume the same facts as in Example 1, except that
the fair market value of S's general limitation foreign assets is $4
as of November 6, Year 1.

(ii) Under paragraph (c)(2)(iii) of this section, S's COFL and CSLL
accounts for the general limitation basket must be reduced by $9,
which is the excess of $15 (the aggregate amount of the accounts
apportioned under paragraph (c)(2)(ii) of this section) over $6 (150
percent of the $4 actual fair market value of S's general limitation
foreign assets). S thus takes a $4 COFL account for the general
limitation basket ($10 - ($9 x $10/$15)) and a $2 CSLL account for
the general limitation basket with respect to the passive basket ($5
- ($9 x $5/$15)).

(d) Predecessor and successor. A reference to a member includes, as
the context may require, a reference to a predecessor or successor
of the member. See �1.1502-1(f).

(e) Effective dates. This section applies to consolidated return
years for which the due date of the income tax return (without
extensions) is after the date final regulations are published in the
Federal Register. However, paragraph (b)(5) of this section
(intercompany transactions) is not applicable for intercompany
transactions that occur before January 28, 1999. A group applies the
principles of �1.1502-9A(e) to a disposition which is an
intercompany transaction to which �1.1502-13 applies and that occurs
before January 28, 1999. Also, paragraph (c)(2) of this section
(apportionment of consolidated account to departing member) is not
applicable for members ceasing to be members of a group before
January 28, 1999. A group applies the principles of �1.1502-9A
(rather than paragraph (c)(2) of this section) to determine the
amount of a consolidated account that is apportioned to a member
that ceases to be a member of the group before January 28, 1999 (and
reduces its consolidated account by such apportioned amount) before
applying paragraph (c)(2) of this section to members that cease to
be members on or after January 28, 1999.

Robert E. Wenzel
Deputy Commissioner of Internal Revenue

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