| REG-116050-99 |
March 20, 2001 |
Stock Transfer Rules:
Carryover of Earnings & Taxes
DEPARTMENT OF THE TREASURY
Internal Revenue Service 26 CFR Part 1 [REG-116050-99] RIN 1545-AX65
TITLE: Stock Transfer Rules: Carryover of Earnings and Taxes
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Notice of proposed rulemaking and notice of public hearing.
SUMMARY: This document contains proposed regulations addressing
transactions described in section 367(b) of the Internal Revenue
Code (section 367(b) transactions). A section 367(b) transaction
includes a corporate reorganization, liquidation, or division
involving one or more foreign corporations. The proposed regulations
address the carryover of certain tax attributes, such as earnings
and profits and foreign income tax accounts, when two corporations
combine in a section 367(b) transaction. The proposed regulations
also address the allocation of certain tax attributes when a
corporation distributes stock of another corporation in a section
367(b) transaction. This document also provides notice of a public
hearing on the proposed regulations.
DATES: Written or electronic comments and requests to speak (with
outlines of oral comments) at a public hearing scheduled for March
13, 2001 must be received by February 20, 2001.
ADDRESSES: Send submissions to: CC:M&SP:RU (REG-116050-99), 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:M&SP:RU
(REG-116050-99), Courier's Desk, Internal Revenue Service, 1111
Constitution Avenue, NW., Washington, DC. Alternatively, taxpayers
may submit comments electronically via the Internet by selecting the
"Tax Regs" option on the IRS Home Page, or by submitting comments
directly to the IRS Internet site at
http://www.irs.gov/tax_regs/regslist.html. The public hearing will
be held in room 7218, Internal Revenue Building, 1111 Constitution
Avenue, NW., Washington DC.
FOR FURTHER INFORMATION CONTACT: Concerning the proposed
regulations, Anne O'Connell Devereaux, at (202) 622-3850; concerning
submissions of comments, the hearing, and/or to be placed on the
building access list to attend the hearing, Guy Traynor, at (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 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,
W:CAR:MP:FP:S:O, Washington, DC 20224. Comments on the collection of
information should be received by January 16, 2001. Comments are
specifically requested concerning:
Whether the proposed collection of information is necessary for the
proper performance of the functions of the IRS, 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 services to provide information.
The collection of information in this proposed regulation is in
§1.367(b)-1. This collection of information is required by the
IRS to verify compliance with the regulations under section 367(b)
relating to exchanges described therein. The likely respondents are
corporations that are affected by such exchanges.
Estimated total annual reporting burden: 1,800 hours.
The estimated annual burden per respondent is 3 hours.
Estimated number of respondents: 600.
Estimated annual frequency of responses: One.
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 as long as their contents may become material in the
administration of any internal revenue law. Generally, tax returns
and tax return information are confidential, as required by 26
U.S.C. 6103.
Background
On December 27, 1977, the IRS and Treasury issued proposed and
temporary regulations under section 367(b) of the Code.
Subsequent guidance updated and amended the 1977 temporary
regulations several times over the next 14 years. On August 26,
1991, the IRS and Treasury issued proposed regulations
§§1.367(b)-1 through 1.367(b)-6 (the 1991 proposed
regulations). Final regulations under section 367(b) of the Internal
Revenue Code (Code) were issued in June 1998 and January 2000 and
the 1977 temporary regulations and the 1991 proposed regulations
were generally removed. The preamble to the January 2000 final
regulations refers to proposed regulations that would be issued at a
later date to address the carryover of certain corporate tax
attributes in transactions involving one or more foreign
corporations. Those proposed regulations are set forth in this
document.
Overview
A. General Policies of Section 367(b)
In general, section 367 governs corporate restructurings under
sections 332, 351, 354, 355, 356, and 361 (Subchapter C
nonrecognition transactions) in which the status of a foreign
corporation as a "corporation" is necessary for the application of
the relevant nonrecognition provisions. Other provisions in
Subchapter C (Subchapter C carryover provisions) apply to such
transactions in conjunction with the enumerated provisions and
detail additional consequences that occur in connection with the
transactions. For example, sections 362 and 381 govern the carryover
of basis and earnings and profits from the transferor corporation to
the transferee corporation in applicable transactions and section
312 governs the allocation of earnings and profits from a
distributing corporation in a transaction described in section 355.
The Subchapter C carryover provisions generally have been drafted to
apply to domestic corporations and U.S. shareholders, and thus do
not fully take into account the cross-border aspects of U.S.
taxation. For example, sections 381 and 312 do not take into account
source and foreign tax credit issues that arise when earnings and
profits move from one corporation to another. Congress enacted
section 367(b) to ensure that international tax considerations in
the Code are adequately addressed when the Subchapter C provisions
apply to an exchange involving a foreign corporation in order to
prevent the avoidance of U.S. taxation. Because determining the
proper interaction of the Code's international and Subchapter C
provisions is "necessarily highly technical," Congress granted the
Secretary broad regulatory authority to provide the "necessary or
appropriate" rules rather than enacting a complex statutory regime.
H.R. Rep. No. 658, 94th Cong., 1sp Sess. 241
(1975). Thus, section 367(b)(2) provides in part that the
regulations "shall include (but shall not be limited to) regulations
. . . providing . . . the extent to which adjustments shall be made
to earnings and profits, basis of stock or securities, and basis of
assets."
The proposed regulations provide rules regarding the movement of
certain corporate tax attributes between corporations in a
Subchapter C nonrecognition transaction involving one or more
foreign corporations. Generally, the regulations continue to apply
the principles of the Subchapter C carryover provisions with
modifications as necessary or appropriate to preserve international
tax policies of the Code and to prevent material distortions of
income.
The remainder of this Overview section is divided by specific
categories of section 367(b) transactions and describes the relevant
Subchapter C and international policies and provisions. The "Details
of Provisions" portion of this preamble describes the proposed
regulations' principal operative rules that implement the policies
and reconcile the provisions described in the Overview portion of
this preamble. The IRS and Treasury welcome comments regarding both
the general approach and the specific provisions of the proposed
regulations.
B. Specific Policies Related to Inbound Nonrecognition Transactions
(Prop. Reg. §1.367(b)-3) Proposed §1.367(b)-3 addresses
acquisitions by a domestic corporation (domestic acquiring
corporation) of the assets of a foreign corporation (foreign
acquired corporation) in a section 332 liquidation or an asset
acquisition described in section 368(a)(1), such as a C, D, or F
reorganization (inbound nonrecognition transaction).
The preamble to the January 2000 final regulations generally
describes international policy issues that can arise in an inbound
nonrecognition transaction. The preamble states that the "principal
policy consideration of section 367(b) with respect to inbound
nonrecognition transactions is the appropriate carryover of
attributes from foreign to domestic corporations. This consideration
has interrelated shareholder-level and corporate-level components."
The final regulations address the carryover of certain attributes,
such as the carryover of foreign taxes, earnings and profits, and
basis. However, the carryover of earnings and profits and basis are
addressed only to the extent attributable to earnings and profits
accumulated during a U.S. shareholder's holding period, i.e., "the
all earnings and profits amount," as defined in §1.367(b)-2(d).
The preamble to the final regulations also notes that it would be
consistent with the policy considerations of section 367(b) for
future regulations to provide further rules with respect to the
extent to which attributes carry over from a foreign corporation to
a U.S. corporation. The proposed regulations do not comprehensively
address this issue. Compare Modify Treatment of Built-In Losses and
Other Attribute Trafficking, General Explanations of the
Administration's Fiscal Year 2001 Revenue Proposals at 205. However,
the proposed regulations do provide additional rules concerning
several attributes, specifically net operating loss and capital loss
carryovers, and earnings and profits that are not included in income
as an all earnings and profits amount (or a deficit in earnings and
profits). The proposed regulations generally provide that these tax
attributes carry over from a foreign acquired corporation to a
domestic acquiring corporation only to the extent that they are
effectively connected to a U.S. trade or business (or attributable
to a permanent establishment, in the case of an applicable U.S.
income tax treaty).
C. Specific Policies Related to Foreign 381 Transactions (Prop. Reg.
§1.367(b)-7)
Proposed regulation §1.367(b)-7 applies to an acquisition by a
foreign corporation (foreign acquiring corporation) of the assets of
another foreign corporation (foreign target corporation) in a
transaction described in section 381 (foreign 381 transaction) and
addresses the manner in which earnings and profits and foreign
income taxes of the foreign acquiring corporation and foreign target
corporation carry over to the surviving foreign corporation (foreign
surviving corporation). This would include, for example, a C, D, or
F reorganization or a section 332 liquidation between two foreign
corporations.
The international provisions of the Code distinguish between
categories of foreign corporations. A foreign acquiring, target, or
surviving corporation can be a controlled foreign corporation as
defined in section 953 or 957 (CFC), a noncontrolled section 902
corporation as defined in section 904(d)(2)(E) after 2003, the
effective date of section 1105(b) of Public Law 105-34 (111 Stat.
788) (the 1997 Act) (look-through 10/50 corporation and, together
with CFCs, look-through corporations), a noncontrolled section 902
corporation before 2003 (non-look-through 10/50 corporation and,
together with look-through 10/50 corporations, 10/50 corporations),
or a foreign corporation that is neither a CFC nor a 10/50
corporation (less-than-10%-U.S.-owned foreign corporation).
The principal Code sections implicated by the carryover of earnings
and profits and foreign income taxes in a foreign 381 transaction
are sections 381, 902, 904, and 959. Section 381 generally permits
earnings and profits (or deficit in earnings and profits) to carry
over to a surviving corporation, thus enabling "the successor
corporation to step into the 'tax shoes' of its predecessor. . . .
[and] represents the economic integration of two or more separate
businesses into a unified business enterprise." H. Rep. No. 1337,
83rd Cong., 2nd Sess. 41 (1954). However, a deficit in earnings and
profits of either the transferee or transferor corporation can only
be used to offset earnings and profits accumulated after the date of
transfer (hovering deficit rule). Section 381(c)(2)(B). The hovering
deficit rule is a legislative mechanism designed to deter the
trafficking in favorable tax attributes that the IRS and courts had
repeatedly encountered. See, e.g., Commissioner v. Phipps, 336 U.S.
410 (1949). The proposed regulations adopt the principles of section
381 but adapt its operation in consideration of the international
provisions that address foreign corporations' earnings and profits
and their related foreign income taxes, such as sections 902, 904,
and 959.
Section 902 generally provides that a deemed paid foreign tax credit
is available to a domestic corporation that receives a dividend from
a foreign corporation in which it owns 10 percent or more of the
voting stock (i.e., a look-through corporation or non-look-through
10/50 corporation). The Code modifies the general last-in, first-out
(LIFO) rule of section 316 and provides that look-through
corporations and non-look-through 10/50 corporations pay dividends
out of multi-year pools of earnings and profits and foreign income
taxes for earnings and profits accumulated (and related foreign
income taxes paid or deemed paid) in taxable years beginning after
December 31, 1986, or the first day after which a domestic
corporation owns 10 percent or more of the voting stock of a foreign
corporation, whichever is later. Section 902(c). (The Code and
regulations refer to pooled earnings and profits and foreign income
taxes as post-1986 undistributed earnings and post-1986 foreign
income taxes even though a particular corporation may begin to pool
after 1986. Sections 902(c)(1) and (2), §1.902-1(a)(8) and
(9).)
Congress enacted the pooling rules because it believed that
averaging of foreign income taxes was fairer than distributions out
of annual layers. Joint Committee on Taxation, General Explanation
of the Tax Reform Act of 1986 (Public Law 99-514) (1986 Bluebook) at
870. Averaging prevents taxpayers from inflating their foreign
income tax rate for a particular year in order to obtain
artificially enhanced foreign tax credits. Id. Averaging also
prevents the trapping of foreign income taxes in years in which a
taxpayer may have no earnings and profits. Id. However, Congress
enacted pooling on a limited basis. Earnings and profits accumulated
(and related foreign income taxes paid or deemed paid) while a
foreign corporation is a less-than- 10%-U.S.-owned foreign
corporation and pre-1987 earnings and profits accumulated (and
related foreign income taxes paid or deemed paid) by a look-through
corporation or non-look-through 10/50 corporation are not pooled.
Rather, such earnings and profits (and related foreign income taxes)
are maintained in separate annual layers. Section 902(c)(6). (The
Code and regulations refer to earnings and profits and foreign
income taxes in annual layers as pre-1987 accumulated profits and
pre-1987 foreign income taxes even though a particular corporation
may have annual layers for years after 1986. Section 902(c)(6);
§1.902-1(a)(10).)
A distribution of earnings and profits is first out of pooled
earnings and profits and then, only after all pooled earnings and
profits have been distributed, out of annual layers of earnings and
profits on a LIFO basis. Section 902(a) and (c). The retention of
annual layers beneath pooled earnings and profits limits the need to
recreate tax histories, an administrative burden that is more
significant for periods during which a corporation had limited nexus
to the U.S. taxing jurisdiction and for pre-1987 earnings and
profits when pooling was not required.
The section 904 foreign tax credit limitation ensures that taxpayers
can use foreign tax credits only to offset U.S. tax on foreign
source income. The limitation is computed separately with respect to
different categories of income (baskets). The purpose of the baskets
is to limit taxpayers' ability to cross-credit taxes from different
categories of foreign source income. Congress was concerned that,
without separate limitations, cross- crediting opportunities would
distort economic incentives to invest in the United States versus
abroad. 1986 Bluebook at 862.
A dividend received by a U.S. shareholder that owns less than 10
percent of the stock of a foreign corporation is categorized as
passive income because such a dividend is in the nature of a
portfolio investment. 1986 Bluebook at 866.
A dividend received by a U.S. shareholder that owns 10 percent or
more of a foreign corporation is subject to other limitations.
Dividends paid by a non-look-through 10/50 corporation to a 10
percent or greater U.S. corporate shareholder are currently subject
to a separate basket limitation on a corporation-by-corporation
basis. Congress initially separately basketed dividends from each
10/50 corporation because it believed a minority investment in a
foreign corporation did not create sufficient identity of interest
to justify look-through treatment and that cross-crediting of taxes
among investments in 10/50 corporations was inappropriate because
the foreign companies were not parts of a single economic unit. 1986
Bluebook at 868. In addition, Congress was concerned about the
administrability of applying the look-through rules to 10/50
corporations. 1986 Bluebook at 868.
In 1997, Congress amended the Code's treatment of dividends from
10/50 corporations to provide that dividends paid after taxable
years beginning after December 31, 2002 by a look-through 10/50
corporation out of earnings and profits accumulated before 2003 are
subject to a single separate basket limitation for all 10/50
corporations, while dividends paid out of earnings and profits
accumulated after 2003 are treated as income in a basket based on
the ratio of the earnings and profits attributable to income in such
basket to the foreign corporation's total earnings and profits (the
so-called "look-through" approach). Earnings and profits accumulated
after 2003 by a look-through 10/50 corporation are distributed
before earnings and profits accumulated by that same foreign
corporation before 2003. Joint Committee on Taxation, General
Explanation of Tax Legislation Enacted in 1997 (1997 Bluebook) at
303.
The legislative history indicates that Congress changed its view
with respect to 10/50 corporations because the separate basket
limitation for dividends from each 10/50 corporation imposed a
substantial recordkeeping burden and discouraged minority
investments in foreign joint ventures. 1997 Bluebook at 302.
However, as described above, the 1997 Act enacted look-through
treatment for 10/50 corporation dividends only on a limited basis.
Furthermore, Congress provided regulatory authority regarding the
treatment of distributions out of earnings and profits for periods
prior to a taxpayer's acquisition of stock in a look-through 10/50
corporation because of concerns that look-through treatment could
provide inappropriate opportunities to traffic in foreign taxes.
Dividends paid by a CFC out of earnings and profits accumulated
while the corporation was not a CFC are treated as a distribution
from a 10/50 corporation while dividends paid out of earnings and
profits accumulated while the corporation was a CFC are eligible for
look-through treatment. Section 904(d)(2)(E)(i) and (d)(3). As in
the case of a look-through 10/50 corporation, pooled earnings and
profits of a CFC that are eligible for look-through treatment are
distributed before other pooled earnings and profits. Prop. Reg.
§1.904-4(g)(3)(iii). Congress provided look-through treatment
for dividends paid by CFCs in order to provide greater parity
between the treatment of income earned through a branch and a
subsidiary. 1986 Bluebook at 866.
Before 1997, except as otherwise provided in regulations, dividend
distributions to a 10 percent U.S. shareholder of a CFC did not
obtain look-through treatment unless the distributed earnings and
profits accrued while the shareholder was a 10 percent U.S.
shareholder and the corporation was a CFC. Section 904(d)(2)(E)(i),
as in effect before the 1997 Act. This rule was intended to prevent
trafficking in foreign income taxes related to preacquisition
earnings and profits. However, because of the administrative issues
presented by maintaining shareholder-level earnings and profits
accounts, Congress modified the rule in 1997 to provide that look-
through treatment applies with respect to CFC earnings and profits
without regard to whether a 10 percent U.S. shareholder was a
shareholder at the time accumulated. However, pre-CFC earnings and
profits continue to be treated as earnings and profits of a 10/50
corporation because of foreign tax credit trafficking concerns.
The section 904 basketing rules reflect Congress' concern with
respect to cross-crediting opportunities and its intent to limit the
benefit of look-through treatment to appropriate circumstances.
Where Congress determined that look-through is inappropriate, a
dividend is treated as passive income or is subject to a separate
limitation for 10/50 corporations (whether separately or
collectively). Regulations have not yet been issued with respect to
preacquisition earnings and profits of a look-through 10/50
corporation and the effect, if any, on the treatment of pre-CFC
earnings and profits described in section 904(d)(2)(E)(i). The IRS
and Treasury solicit comments as to the appropriate treatment of
such earnings and profits after 2003 in light of Congress' anti-
trafficking concerns, as well as the impact that such rules should
have on the section 367(b) regulations.
Another international provision implicated by the movement of
earnings and profits in foreign 381 transactions is section 959.
Section 959 governs the distribution of earnings and profits that
have been previously taxed to U.S. shareholders under section 951(a)
(PTI). After studying the interaction of section 367(b) and the PTI
rules, the IRS and Treasury determined that more guidance under
section 959 would be useful before issuing regulations to address
PTI issues that arise under section 367(b). Accordingly, the IRS and
Treasury have opened a separate regulations project under section
959 and expect to issue regulations that address PTI issues under
section 959 as well as section 367(b) in the future. The fundamental
issue under consideration in that project is whether earnings and
profits that are treated as PTI should be distributable to another
shareholder, as well as the various implications that result from
that determination. The IRS and Treasury invite comments with
respect to these issues. Accordingly, the proposed regulations
reserve on section 367(b) issues related to PTI.
Other sections may have also applied to characterize pre-transaction
earnings of a foreign acquiring corporation or a foreign target
corporation for certain purposes of the Code. For example, certain
earnings may have been subject to characterization as U.S. source
earnings under section 904(g), effectively connected earnings and
profits under section 884, or post-1986 undistributed U.S. earnings
under section 245. The characterization of such earnings carry over
to the foreign surviving corporation for purposes of applying the
relevant Code sections. See Georday Enterprises v. Commissioner, 126
F.2d 384 (4th Cir. 1942).
D. Specific Policies Related to Foreign Divisive Transactions (Prop.
Reg. §1.367(b)-8)
Proposed regulation §1.367(b)-8 addresses the allocation of
earnings and profits and foreign income taxes in a transaction
described in section 312(h) (that is, a section 355 distribution
whether or not in connection with a section 368(a)(1)(D)
reorganization) in which either or both the distributing or the
controlled corporation is a foreign corporation (foreign divisive
transaction). The scope of proposed §1.367(b)-8 thus
encompasses three situations: a domestic distributing corporation
that distributes stock of a foreign controlled corporation, a
foreign distributing corporation that distributes stock of a
domestic controlled corporation, and a foreign distributing
corporation that distributes stock of a foreign controlled
corporation. The proposed regulations generally adopt the principles
embodied in the regulations under section 312(h) but modify their
application in consideration of the international provisions such as
the source and foreign tax credit rules.
Regulations under section 312(h) reflect the principle that a pro
rata portion of a distributing corporation's earnings and profits
should be reduced to account for the distribution of a portion of
its assets. §1.312-10. Furthermore, the earnings and profits of
a controlled corporation should include the portion of the
distributing corporation's earnings and profits allocable to any
assets transferred to the controlled corporation in connection with
a section 368(a)(1)(D) reorganization (D reorganization) that
immediately precedes the section 355 distribution (together with a D
reorganization, a D/355 distribution). §1.312-10(a). If a
section 355 distribution is not preceded by a D reorganization, the
earnings and profits of the controlled corporation are at least
equal to the amount of the reduction in the distributing
corporation's earnings and profits. §1.312-10(b). It is likely
that this rule was included to prevent taxpayers from using a
section 355 distribution as a device to facilitate a bailout of
earnings and profits through the controlled corporation. (The
§1.312-10 rules are derived from the Senate's directions to the
IRS and Treasury in implementing the regulatory authority in section
312(h); the Senate Report does not, however, explain its reasons for
these rules. Senate Finance Committee, Report on H.R. 8300 (1954),
at 249.)
The application of the §1.312-10 rules to foreign divisive
transactions implicates the Code's international provisions because
earnings and profits are moving in the cross-border context and
because the earnings and profits of controlled foreign corporations
are being adjusted. In transactions involving a domestic
distributing corporation and a foreign controlled corporation, the
foreign controlled corporation may succeed to earnings and profits
of the domestic distributing corporation. A post-transaction
distribution by the foreign controlled corporation out of earnings
and profits it receives from the domestic distributing corporation
is generally eligible for the dividends received deduction and
treated as U.S. source income under sections 243(e) and 861(a)(2)
(C). This treatment is appropriate because the earnings and profits
have already been subject to U.S. corporate taxation and should not
be subject to a second level of U.S. corporate tax upon repatriation
if the earnings and profits would have qualified for the dividends
received deduction if distributed before the section 355
distribution. H.R. Rep. No. 2101, at 3 (1960). In addition, such
earnings and profits should not increase a domestic distributee's
foreign tax credit limitation under section 904.
In circumstances where the foreign controlled corporation makes a
post-transaction distribution to foreign shareholders, the foreign
divisive transaction should not alter the character of earnings and
profits allocated from the domestic distributing corporation.
Otherwise, the section 355 distribution may serve as a vehicle to
avoid U.S. tax, including U.S. withholding tax. Accordingly, the
proposed regulations provide that a post-transaction distribution
out of earnings and profits of a distributing corporation that carry
over to a foreign controlled corporation is generally treated as a
U.S. source dividend for purposes of Chapter 3 of subtitle A of the
Code. See Georday Enterprises v. Commissioner, 126 F.2d 384 (4th
Cir. 1942).
Foreign divisive transactions involving a foreign distributing
corporation and a domestic controlled corporation are similar to
inbound nonrecognition transactions to the extent the domestic
controlled corporation receives assets of a foreign corporation.
Current regulations under §1.367(b)-3 require direct and
indirect U.S. shareholders in an inbound asset reorganization to
include an all earnings and profits amount in income in order to
ensure, in part, that the bases of assets repatriated to the United
States reflect an after-tax amount. Section 1.367(b)-3(d) and
proposed §1.367(b)-3(f) provide further rules regarding the
carryover of earnings and profits and foreign income taxes from a
foreign corporation to a domestic corporation. Those rules should
also apply to a section 355 distribution involving a foreign
distributing corporation and a domestic controlled corporation.
These transactions also implicate the current rules under
§1.367(b)-5, because a reduction in a foreign distributing
corporation's earnings and profits can directly affect the post-
transaction application of section 1248 with respect to U.S.
shareholders of the distributing corporation.
Foreign divisive transactions involving a foreign distributing
corporation and a foreign controlled corporation raise issues
similar to those raised in the context of a foreign 381 transaction
described in §1.367(b)-7, to the extent the controlled
corporation succeeds to earnings and profits (and related foreign
income taxes) of the distributing corporation. Accordingly, the
proposed regulations adopt the principles of §1.367(b)-7 to
determine the manner in which the foreign controlled corporation
succeeds to the earnings and profits (and related foreign income
taxes) of a foreign distributing corporation. These transactions
also implicate the §1.367(b)-5 rules concerning diminutions in
U.S. shareholders' section 1248 amounts.
The proposed regulations under §1.367(b)-8 balance the
§1.312-10 rules and policies with the interests and concerns of
the relevant international provisions of the Code. However, the IRS
and Treasury recognize that the mechanics of §1.312-10 as
applied in the international context can be cumbersome and complex.
The IRS and Treasury solicit comments as to whether the mechanical
difficulties of applying the section 312 rules in the cross-border
context outweigh the benefits and, if so, whether there are simpler
alternative regimes that would address the international policy
concerns without compromising the Subchapter C policies embodied in
§1.312-10.
Details of Provisions
A. Prop. Reg. §1.367(b)-1
The proposed regulations supplement the current §1.367(b)-1
notice requirements in consideration of the transactions addressed
by proposed §§1.367(b)-7 and 1.367(b)-8. Accordingly,
foreign surviving corporations described in proposed
§1.367(b)-7 and distributing and controlled corporations
involved in transactions described in proposed §1.367(b)-8 are
included within the scope of the §1.367(b)-1 notice
requirement.
B. Prop. Reg. §1.367(b)-3
The proposed regulations address the carryover of net operating loss
and capital loss carryovers, and earnings and profits that are not
included in income as an all earnings and profits amount (or a
deficit in earnings and profits). The proposed regulations generally
provide that these tax attributes do not carry over from a foreign
acquired corporation to a domestic acquiring corporation unless they
are effectively connected to a U.S. trade or business (or
attributable to a permanent establishment, in the context of a
relevant U.S. income tax treaty).
The limitations on the carryover of these attributes prevent
inappropriate or anomalous results. For example, net operating loss
and capital loss carryovers are eligible to carry over from a
foreign acquired corporation to a domestic acquiring corporation
only to the extent the underlying deductions or losses were
allowable under Chapter 1 of subtitle A of the Code. Thus, only a
net operating loss or capital loss carryover that is effectively
connected to a U.S. trade or business (or attributable to a
permanent establishment) may carry over. Inappropriate or anomalous
results are thus avoided because losses incurred by a foreign
acquired corporation outside the U.S. taxing jurisdiction should not
be available to offset the future U.S. tax liability of a domestic
acquiring corporation. Otherwise, a taxpayer would have an incentive
to import losses into the United States in order to shelter future
income from U.S. tax.
The carryover of earnings and profits (or a deficit in earnings and
profits) of the foreign acquired corporation can create similarly
inappropriate results. For example, the policies underlying the
section 243(a) dividends received deduction are not present with
respect to a subsequent distribution by the domestic acquiring
corporation out of earnings and profits accumulated by the foreign
acquired corporation because those earnings and profits are not
generally subject to a U.S. corporate level of tax. On the other
hand, if the foreign acquired corporation has PTI, those earnings
should not be taxed again when distributed to U.S. shareholders to
whom the PTI is attributable regardless of whether or not the U.S.
shareholder is eligible for the dividends received deduction. A
deficit in earnings and profits can also be used to avoid tax, such
as in the case of a foreign shareholder of a domestic acquiring
corporation that imports a deficit and therefore is not subject to
U.S. withholding tax on subsequent corporate distributions.
As a result of the issues raised by a carryover of earnings and
profits and given that §1.367(b)-3 already requires U.S.
shareholders to include in income as a deemed dividend the all
earnings and profits amount, the proposed regulations provide that
earnings and profits (or deficit in earnings and profits) of the
foreign acquired corporation do not carry over to the domestic
acquiring corporation except to the extent effectively connected to
a U.S. trade or business (or attributable to a permanent
establishment, in the context of a relevant U.S. income tax treaty).
C. Prop. Reg. §1.367(b)-7
Proposed §1.367(b)-7 provides the manner in which a foreign
surviving corporation succeeds to and takes into account the
earnings and profits and foreign income taxes of a foreign acquiring
corporation and a foreign target corporation. The proposed
regulation attempts to preserve the character of earnings and
profits and foreign income taxes to the extent possible in light of
the applicable statutory limitations, as well as the relevant policy
and administrative concerns. Compare §1.381(c)(2)-1(a)(3)
(ensuring that earnings and profits accumulated before March 1, 1913
retain their character as pre-1913 earnings and profits after a
section 381 transaction). Accordingly, the proposed rules provide
that, to the extent possible, pooled earnings and profits (and
foreign income taxes) remain pooled, earnings and profits (and
foreign income taxes) in annual layers remain in annual layers,
foreign income taxes trapped before the transaction remain trapped
after the transaction, and earnings and profits (and foreign income
taxes) remain in the same basket before and after the transaction.
The proposed regulation also respects the section 902 preference for
distributing pooled earnings and profits before earnings and profits
in annual layers. Accordingly, proposed §1.367(b)-7 provides
that a foreign surviving corporation's pooled earnings and profits
are distributed first (even though earnings and profits in the
annual layers may have been accumulated after earnings and profits
in the pool) and annual layers are distributed on a LIFO basis.
Similarly, the proposed regulation also incorporates the section 904
preference for distributing pooled earnings and profits eligible for
look-through before other pooled earnings and profits.
However, in certain cases, an overriding statutory policy requires
that the proposed regulation modify the character of earnings and
profits (and related foreign income taxes). For example, if a CFC
combines with a non-look-through 10/50 corporation in a foreign 381
transaction and the foreign surviving corporation is a non-look-
through 10/50 corporation, dividends paid by the surviving non-look-
through 10/50 corporation are required to be separately basketed and
do not obtain the benefit of look-through. Thus, earnings and
profits of a CFC that would have obtained the benefit of look-
through if distributed before the foreign 381 transaction are not
eligible for look-through after the transaction. (The loss of look-
through in connection with this type of foreign 381 transaction is
somewhat ameliorated by a U.S. shareholder's section 1248 amount
inclusion under §1.367(b)-4 with respect to earnings and
profits that accrued during its holding period.)
Proposed regulation §1.367(b)-7 also provides rules regarding
the carryover of deficits in earnings and profits from one foreign
corporation to another. The purpose of the hovering deficit rule in
the domestic context is to prevent the trafficking of deficits in
earnings and profits. Otherwise, a corporation with positive
earnings and profits may acquire or be acquired by another
corporation with a deficit in earnings and profits and make
distributions out of capital rather than earnings and profits.
In transactions involving foreign corporations, similar concerns
exist regarding the trafficking of deficits in earnings and profits.
The ability to benefit from combining positive and deficit earnings
and profits among foreign corporations is different than in the
domestic context, however, because of the nature of the foreign tax
credit rules. In a reorganization involving two domestic
corporations, the hovering deficit rule applies to a corporation
with a net accumulated deficit in earnings and profits because the
relevant statutory rules do not distinguish among classes of
earnings and profits. In contrast, the foreign tax credit rules
require further subcategorization of earnings and profits according
to the pooling and basketing rules. Because of these distinctions,
taxpayers may inappropriately benefit by trafficking in an earnings
and profits deficit in a basket, pool, or particular annual layer,
even though a corporation may have net positive earnings and
profits. Accordingly, the proposed regulations apply the hovering
deficit principle to the relevant subcategories of earnings and
profits and provide that foreign income taxes related to the deficit
are not added to the foreign surviving corporation's foreign income
tax accounts until all of the deficit has been offset with post-
transaction earnings. (Under proposed §1.367(b)-9 (which is
described below), these hovering deficit rules do not apply to F
reorganizations and foreign 381 transactions in which either the
foreign target corporation or the foreign acquiring corporation is
newly created.)
Because the treatment of distributions by a foreign surviving
corporation depends on whether it is a look-through corporation, a
non-look-through 10/50 corporation, or a less-than- 10%-U.S.-owned
foreign corporation, proposed §1.367(b)-7 is divided according
to these categories. The proposed regulation uses the term surviving
corporation in order to prevent confusion between the acquiring
corporation and the foreign surviving entity. In addition, the term
highlights the proposed regulation's general approach that provides
the same results regardless of whether a corporation is the
ostensible acquiring or target corporation.
1. Look-through surviving corporation
Where the foreign surviving corporation is a look-through
corporation, the proposed regulation generally preserves the
character of earnings and profits and foreign income taxes. For
example, if a CFC (CFC1) acquires the assets of another CFC (CFC2)
in a foreign 381 transaction and the surviving corporation is a CFC,
then the corporations' positive amounts of earnings and profits and
foreign income taxes would carry over in a manner that combines the
look-through earnings and profits pools (and related foreign income
taxes) of each corporation on a basket-by-basket basis. Thus, for
example, CFC1's passive basket would be combined with CFC2's passive
basket, CFC1's general basket would be combined with CFC2's general
basket, and so forth.
If CFC1 or CFC2 has pooled earnings and profits or foreign income
taxes that do not qualify for look-through treatment (non-look-
through pool) (for example, earnings and profits accumulated during
a period when the corporation was not a CFC and that are subject to
a separate 10/50 limitation), such earnings and profits and foreign
income taxes would be distributed only after all of the look-through
earnings and profits pool has been distributed. This rule is
consistent with the ordering rule in Prop. Reg. §1.904-4(g)(3)
(iii), which provides that when a 10/50 corporation becomes a CFC,
pooled earnings and profits accumulated and foreign income taxes
paid or accrued while the corporation is a CFC are distributed
before pooled earnings and profits accumulated and foreign income
taxes paid or accrued while the corporation was a 10/50 corporation.
(If the foreign surviving corporation is instead a look-through
10/50 corporation, this rule is also consistent with the earnings
and profits in the look-through pool being distributed before
earnings and profits in the non-look-through pool.)
When earnings and profits from the non-look-through pool are
distributed, the earnings and profits will be distributed pro rata
out of the non-look-through pools of CFC1 and CFC2 (if any) and
placed in two separate baskets under section 904(d)(1)(E). This
preserves the character of the earnings and profits and related
foreign income taxes and is consistent with the policy of section
904(d)(1)(E) to maintain separate baskets for each 10/50
corporation. After 2003, these earnings and profits will continue to
be distributed pro rata from separate non-look-through pools but
will be combined into a single 10/50 basket in the hands of the
distributee. Maintaining separate pools prevents the refreshing of
foreign income taxes that would have been trapped had the foreign
381 transaction not occurred. (The same rules apply in the case of a
foreign surviving corporation that is a look-through 10/50
corporation.)
If CFC1 or CFC2 has pre-1987 accumulated profits (i.e., annual
layers of earnings and profits) or foreign income taxes, then those
earnings and profits are distributed only after the distribution of
all pooled earnings and profits and taxes, regardless of whether
those earnings and profits may have been accumulated after the
pooled earnings and profits of the other corporation. Such earnings
and profits are distributed on a LIFO basis and pro rata out of the
respective corporation's annual layers if both companies have
earnings and profits in the same year that are treated as pre-1987
accumulated profits and foreign income taxes. This rule respects two
international policies. First, pooled earnings and profits are
distributed before earnings and profits in annual layers. Second,
earnings and profits in annual layers should not be pooled unless
they are distributed to an upper-tier entity. Compare
§1.902-1(a)(8)(ii) (providing that distributions out of
pre-1987 earnings and profits by a lower-tier corporation are
included in the post-1986 earnings and profits of an upper-tier
corporation). This rule is also consistent with the section 902 rule
that traps foreign income taxes in annual layers in which there are
no earnings and profits.
These results preserve the character of earnings and profits and
taxes because pooled earnings and profits and taxes remain pooled,
earnings and profits and taxes retain the same character under the
look-through provisions, and foreign income taxes that were trapped
before the foreign 381 transaction remain trapped. The rules are
also consistent with concerns about limiting the administrative
burden of requiring taxpayers to recreate tax histories.
Because of the foreign tax credit considerations presented by
foreign 381 transactions, §1.367(b)-7 applies the hovering
deficit rule to subcategories of earnings and profits. Thus,
deficits in the look-through pool, non-look-through pool, and net
deficits in annual layers can offset only future earnings and
profits of the foreign surviving corporation. In addition, a
hovering deficit cannot be used to reduce current earnings and
profits of the foreign surviving corporation and, as a result, does
not reduce subpart F income. Foreign income taxes related to a
hovering deficit do not enter the foreign income tax accounts of the
surviving corporation until the entire hovering deficit offsets
post-transaction earnings and profits. However, foreign income taxes
related to the post-transaction earnings that are offset by the
hovering deficit immediately enter the foreign income tax accounts
of the foreign surviving corporation.
2. Non-look-through 10/50 surviving corporation
The proposed regulation's rules with respect to a non-look-through
10/50 corporation apply if the foreign surviving corporation is a
10/50 corporation before 2003. The principal statutory limitation of
a non-look-through 10/50 corporation is that a dividend distribution
is not eligible for look-through treatment and is instead separately
basketed for each 10/50 corporation. As a result, earnings and
profits of an acquiring or target corporation that would have been
eligible for look-through (assuming the corporation qualified under
the look-through rule) if distributed before the foreign 381
transaction lose their look-through character after the transaction.
For example, suppose a CFC combines with a non-look-through 10/50
corporation in a foreign 381 transaction in 2001 and the surviving
entity is a non-look-through 10/50 corporation. Prior to the
transaction, the CFC maintained earnings and profits and foreign
income tax accounts expecting that the look-through rules would
apply on a distribution of earnings and profits to U.S.
shareholders. However, after the foreign 381 transaction, section
904(d)(1)(E) requires that a distribution from the surviving 10/50
corporation will be deemed to be paid out of a single pool of
earnings and profits that will be separately basketed. In order to
address the carryover of attributes to a non-look-through 10/50
corporation in a manner consistent with section 904(d)(1)(E), the
proposed regulations combine the net positive earnings and profits
and foreign income taxes in the respective pools of the acquiring
and target corporations. (Thus, the separate baskets of pooled
earnings and profits and foreign income taxes of the CFC would be
netted into a single pool along with the non-look-through 10/50
corporation's pooled earnings and profits and foreign income taxes.)
Annual layers of the acquiring and target corporations are carried
over to the foreign surviving corporation under the same rules as
described above with respect to look-through corporations. Hovering
deficit rules similar to those described with respect to a look-
through corporation's non-look-through pool and annual layers also
apply to surviving non-look-through 10/50 corporations.
Look-through treatment of earnings and profits and foreign income
taxes does not re-emerge if the corporation later becomes a look-
through corporation. For example, if the surviving non-look- through
10/50 corporation becomes a CFC, all of the earnings and profits and
foreign income taxes of the surviving non-look-through 10/50
corporation remain as earnings and profits to which the look-through
rules do not apply. Look-through only applies to earnings and
profits accumulated after the corporation becomes a CFC. The IRS and
Treasury believe that this rule is appropriate because of the
administrative difficulties posed by recreating tax histories. In
addition, earnings and profits and foreign income taxes of a CFC
accumulated during a U.S. shareholder's holding period are generally
deemed distributed (and the look-through rules apply) if a U.S.
shareholder includes a section 1248 amount in income under
§1.367(b)-4 in connection with the foreign 381 transaction.
3. Less-than-10%-U.S.-owned foreign surviving corporation
Proposed §1.367(b)-7 also determines the manner in which
earnings and profits and foreign income taxes of the acquiring and
target corporation are combined if the foreign surviving corporation
is a less-than-10%-U.S.-owned foreign corporation. Generally, rules
similar to the rules provided for annual layers of look-through
corporations and non-look-through 10/50 corporations apply with
respect to the annual layers of the acquiring and target
corporations, but the rules take into account the possibility that
one of the corporations may have been a CFC or 10/50 corporation
immediately prior to the foreign 381 transaction.
If either the acquiring or target corporation is a CFC or a 10/50
corporation, its pooled earnings and profits and foreign income
taxes are treated as earnings and profits and foreign income taxes
accumulated in the annual layer of the applicable corporation
immediately before the foreign 381 transaction. For example, suppose
a less-than-10%-U.S.-owned foreign corporation combines with a 10/50
corporation and the foreign surviving corporation is a less-
than-10%-U.S.-owned foreign corporation. The foreign surviving
corporation is an entity that has never been required to pool
earnings and profits and foreign income taxes under section 902(c)
(3). Accordingly, distributions from the foreign surviving
corporation are out of annual layers on a LIFO basis. Rather than
recreating the tax history of the acquired 10/50 corporation for
each year, the proposed regulation places all pooled earnings and
profits and foreign income taxes of the 10/50 corporation into a
single annual layer that closes immediately before the foreign 381
transaction. This rule is intended to ameliorate administrative
burdens while respecting the policy that earnings and profits and
foreign income taxes are distributed from annual layers for a less-
than-10%-U.S.-owned foreign corporation. Because of concerns about
neutrality, the same result applies regardless of whether the 10/50
corporation is the ostensible acquiring or target corporation.
If the surviving less-than-10%-U.S.-owned foreign corporation later
becomes a non-look-through 10/50 corporation or a look-through
corporation, earnings and profits and foreign income taxes that were
pooled or obtained the benefit of look-through prior to the foreign
381 transaction are not recreated. Instead, those earnings and
profits and foreign income taxes remain as earnings and profits
accumulated and foreign income taxes paid or deemed paid while the
corporation was a less-than-10%- U.S.-owned foreign corporation. As
in the case of a surviving non-look-through 10/50 corporation that
later becomes a look-through corporation, this rule is provided
because of administrative issues associated with recreating tax
histories. In addition, earnings and profits and foreign income
taxes of a CFC accumulated during a shareholder's holding period
generally would have been deemed distributed (and the look-through
rules would have applied) if the shareholder was required to include
a section 1248 amount in income under §1.367(b)-4 in connection
with the foreign 381 transaction.
D. Prop. Reg. §1.367(b)-8
Section 1.367(b)-8 provides rules applicable to foreign divisive
transactions. The regulation is divided into four sections. Section
1.367(b)-8(b) provides rules that are generally applicable to
foreign divisive transactions. The other three sections describe the
application of the general rules to specific situations. Section
1.367(b)-8(c) applies to a distribution by a domestic distributing
corporation of the stock of a foreign controlled corporation,
§1.367(b)-8(d) applies to a distribution by a foreign
distributing corporation of the stock of a domestic controlled
corporation, and §1.367(b)-8(e) applies to a distribution by a
foreign distributing corporation of the stock of a foreign
controlled corporation.
1. General rules applicable to foreign divisive transactions
Section 1.367(b)-8(b) provides that the rules of §1.312-10
generally apply to determine the allocation of earnings and profits
between a distributing and a controlled corporation, as well as to
determine the reduction in the earnings and profits of a
distributing corporation. The rules of §1.312-10 are, however,
subject to certain modifications.
In a D/355 distribution involving a controlled corporation that is
newly created as part of the transaction, §1.312-10(a)
allocates the pre-transaction earnings and profits of the
distributing corporation between the distributing and controlled
corporations based upon a comparison of the fair market values of
the assets received by the controlled corporation and the assets
retained by the distributing corporation after the D reorganization.
Section 1.312-10(a) provides that, "in a proper case," this
allocation should be based on the relative net bases of the assets
transferred and retained by the distributing corporation, or based
on another "appropriate" method.
The proposed regulations generally adopt the rule of §1.312-
10(a), except that the allocation is based upon relative net
adjusted bases of assets transferred and retained in all cases. This
rule reflects the view that net basis is the most accurate measure
of the appropriate amount of earnings and profits that should be
allocated to the assets transferred by a distributing corporation in
the D reorganization. For example, in cases where the controlled
corporation recognizes gain on a later sale or distribution of
appreciated property that it receives from the distributing
corporation an allocation based upon relative bases prevents a
misallocation of earnings and profits to the controlled corporation.
In a section 355 distribution that is not preceded by a D
reorganization, §1.312-10(b) provides that the earnings and
profits of the distributing corporation are decreased by an amount
equal to the lesser of (i) the amount by which the earnings and
profits of the distributing corporation would have been decreased if
it had transferred the stock of the controlled corporation to a new
corporation in a D/355 distribution, and (ii) the net worth of the
controlled corporation. For this purpose, net worth is defined as
"the sum of the bases of all of the properties plus cash minus all
liabilities." If "the earnings and profits of the controlled
corporation immediately before the transaction are less than the
amount of the decrease in earnings and profits of the distributing
corporation . . . the earnings and profits of the controlled
corporation, immediately after the transaction, shall be equal to
the amount of such decrease. If the earnings and profits of the
controlled corporation immediately before the transaction are more
than the amount of the decrease in the earnings and profits of the
distributing corporation, they shall remain the same."
Section 1.312-10(b) reflects the principle that a pro rata portion
of a distributing corporation's earnings and profits should be
reduced to account for the distribution of the controlled
corporation. In addition, the requirement that the earnings and
profits of the controlled corporation at least equal the reduction
in the distributing corporation's earnings and profits appears
intended to prevent a bailout of earnings and profits through the
controlled corporation, while preventing the potential double
counting of earnings and profits in situations where the
distributing corporation did not organize the controlled
corporation.
In consideration of the complexities raised by the cross-border
application of the §1.312-10(b) adjustment to the controlled
corporation's earnings and profits, taken together with the current
rules that prevent the potential bailout of earnings and profits in
the international context (such as the §1.367(b)-5 requirement
that a shareholder include in income a reduction in its section 1248
amount), the IRS and Treasury have concluded that the
§1.312-10(b) rules should be modified when applied to section
367(b) transactions. Accordingly, the proposed regulations provide
that the earnings and profits of the distributing corporation are
decreased in an amount equal to the amount by which the earnings and
profits of the distributing corporation would have been decreased if
it had transferred the stock of the controlled corporation to a new
corporation in a D/355 distribution. However, the earnings and
profits of the controlled corporation are not increased or replaced.
The reduction in earnings and profits (and related foreign income
taxes) of the distributing corporation disappears unless otherwise
included in income, such as under §1.367(b)-5.
Section 1.312-10 does not specifically address the allocation and
reduction of earnings and profits in connection with a D/355
distribution that involves a preexisting controlled corporation. The
proposed regulations provide that, in such a case, the distributing
corporation's earnings and profits are reduced in a manner that
incorporates both the rules applicable to a D/355 distribution with
a newly created controlled corporation and a section 355
distribution that is not preceded by a D reorganization. The rule
thus accounts for a decrease in earnings and profits attributable to
assets transferred to the controlled corporation as part of the D
reorganization as well as a decrease in earnings and profits
attributable to the distribution of stock of a preexisting
controlled corporation (without regard to the D reorganization). The
controlled corporation succeeds only to those earnings and profits
allocable to the property it receives in the D reorganization.
In consideration of the international provisions' distinctions among
classes and categories of earnings and profits, proposed
§1.367(b)-8(b) specifically addresses the determination of
which earnings and profits of the distributing corporation are
affected by a foreign divisive transaction. The proposed regulation
provides that an allocation or reduction in earnings and profits
shall generally be pro rata out of a cross-section of the
distributing corporation's tax history (except to the extent it is
included in income as a deemed dividend such as under
§1.367(b)-3 or §1.367(b)-5). This rule determines the
earnings and profits (and related foreign income taxes, where
applicable) that remain in the distributing corporation after the
transaction as well as any earnings and profits (and related foreign
income taxes, where applicable) to which the controlled corporation
succeeds in a D reorganization.
The proposed §1.367(b)-8(b) cross-section rule decreases the
earnings and profits of a distributing corporation without regard to
the type of income generated by the assets of the controlled
corporation. This is consistent with the general assumption in
§1.312-10 and the proposed regulations that the earnings and
profits of the distributing corporation should be decreased
proportionately to reflect the transfer or distribution of assets,
rather than by some other measure, such as by determining the
earnings and profits attributable to the income generated by assets
transferred or distributed (a tracing model) or by decreasing most
recently accumulated earnings and profits to the extent of assets
transferred or distributed (a dividend model).
2. Branch profits tax considerations
Notwithstanding the above-described rules, the proposed regulations
provide that an allocation or reduction in a distributing
corporation's earnings and profits shall not reduce the distributing
corporation's effectively connected earnings and profits or non-
previously taxed accumulated effectively connected earnings and
profits, as defined in the branch profits rule in section 884
(branch earnings). Both a domestic or foreign distributing
corporation can potentially have branch earnings that are subject to
the branch profits tax.
In the case of a foreign divisive transaction that does not include
a D reorganization, a U.S. branch of a foreign distributing
corporation would be retained by the foreign distributing
corporation. Accordingly, §1.367(b)-8 should not reduce the
foreign distributing corporation's branch earnings because such a
reduction would improperly decrease the earnings subject to the
branch profits tax upon the section 355 distribution (which would
trigger the branch profits tax under section 884). The same issues
arise in the case of a D/355 distribution in which a foreign
distributing corporation transfers the assets that are not part of a
U.S. branch to a controlled corporation. The IRS and Treasury do not
believe that it is appropriate to reduce the earnings that could
give rise to a subsequent branch profits tax under these
circumstances.
Different issues arise in a foreign divisive transaction in which a
foreign distributing corporation transfers the assets of a U.S.
branch to a controlled corporation as part of a D/355 distribution.
While the branch profits rules permit a deferral of the branch
profits tax in certain instances (by allowing branch earnings to be
allocated to the domestic transferee in proportion to the assets
transferred when a branch is incorporated in a section 351 exchange
in a domestic corporation (see §1.884-2T(d)(1)), the branch
profits tax is triggered in any event if stock of the incorporated
branch is later distributed to its shareholders. See
§1.884-2T(d)(5). Accordingly, because foreign divisive
transactions include a section 355 distribution immediately
following the D reorganization, it would be unnecessary and
inappropriate to attribute branch earnings to a domestic controlled
corporation under proposed §1.367(b)-8. Similar branch profits
issues can arise with respect to a domestic distributing
corporation. While branch earnings are accumulated by a foreign
corporation, such earnings may have been carried over to a domestic
corporation in a prior section 351 or 381 transaction. See
§1.884-2T(c)(4). Accordingly, the proposed regulations treat
domestic distributing corporations in the same manner as foreign
distributing corporations with respect to branch earnings.
3. Domestic corporation distributes stock of a foreign corporation
In foreign divisive transactions involving a domestic distributing
corporation and a foreign controlled corporation, the foreign
controlled corporation may succeed to earnings and profits of the
domestic distributing corporation. The regulations provide that
sections 243(e) and 861(a)(2)(C) apply to earnings and profits
allocated to the foreign controlled corporation that were
accumulated by a domestic corporation. In addition, a post-
transaction distribution out of earnings and profits allocated to
the foreign controlled corporation is generally treated as a U.S.
source dividend under section 904(g) and for purposes of Chapter 3
of subtitle A of the Code. See Georday Enterprises v. Commissioner,
126 F.2d 384 (4th Cir. 1942).
4. Foreign corporation distributes stock of a domestic corporation
In foreign divisive transactions involving a foreign distributing
corporation and a domestic controlled corporation, two issues arise
in determining the appropriate reduction in the foreign distributing
corporation's earnings and profits and its effects on the earnings
and profits of the domestic controlled corporation. First, it should
be determined whether it is appropriate to reduce PTI of the foreign
distributing corporation and, if so, in what manner (e.g., if the
foreign distributing corporation has earnings and profits that are
PTI and not PTI, should the reduction in earnings and profits be out
of PTI first, last, pro rata, or depending on the identity of the
controlled corporation's shareholders). As in the case of
§1.367(b)-7, §1.367(b)-8 reserves on PTI issues, and the
IRS and Treasury solicit comments with respect to the appropriate
treatment of these amounts.
Second, a domestic corporation succeeds to the earnings and profits
of a foreign corporation if the section 355 distribution is preceded
by a D reorganization. Because earnings and profits are allocable
from foreign corporate solution to U.S. corporate solution, U.S.
shareholders are required to include in income the all earnings and
profits amount attributable to earnings and profits that carry over
to the controlled corporation. The proposed regulations provide
rules that coordinate the proposed §1.367(b)-8 and the current
§1.367(b)-3 regimes. The regulations, however, reserve with
respect to the treatment of U.S. persons that own foreign
distributing corporation stock after a non pro rata distribution.
The IRS and Treasury invite comments as to whether U.S. shareholders
should have an all earnings and profits amount inclusion in
connection with a non pro rata foreign divisive transaction in which
they do not receive stock of the domestic controlled corporation.
5. Foreign corporation distributes stock of a foreign corporation
In foreign divisive transactions involving a foreign distributing
corporation and a foreign controlled corporation, the foreign
controlled corporation may succeed to earnings and profits of the
foreign distributing corporation. Because such earnings and profits
are allocated from one foreign corporation to another foreign
corporation, the transaction raises issues similar to those in a
foreign 381 transaction. Accordingly, the proposed regulations adopt
and apply the principles in proposed regulation §1.367(b)-7 to
these transactions.
E. Prop. Reg. §1.367(b)-9
Proposed §1.367(b)-9 provides special rules applicable to
foreign-to-foreign F reorganizations and foreign 381 transactions in
which either the foreign target corporation or the foreign acquiring
corporation is newly created. Proposed §1.367(b)-9 also applies
to foreign divisive transactions that involve a foreign distributing
and a foreign controlled corporation, either of which is newly
created.
Under proposed §1.367(b)-9, a foreign surviving corporation
succeeds to earnings and profits, deficits in earnings and profits,
and foreign income taxes without regard to the proposed
§1.367(b)-7 hovering deficit rules. See section 1.381(b)-1(a)
(2) (providing an analogous rule with respect to domestic F
reorganizations).
This rule prevents inappropriate tax consequences. For example,
under the generally applicable hovering deficit rules, a foreign
corporation with significant deficits in earnings and profits could
combine with a newly created foreign corporation and thereafter
distribute dividends (along with deemed paid foreign income taxes
under section 902), despite the presence of a significant deficit
that would have precluded a dividend distribution before the
transaction. Proposed §1.367(b)-7 provides the Commissioner
discretion to apply the principles of proposed §1.367(b)-9 to
circumstances where a principal purpose of the foreign 381
transaction is to affirmatively use the hovering deficit rule in
order to gain a tax benefit.
Proposed Effective Dates
These regulations are proposed to apply to section 367(b) exchanges
that occur on or after 30 days after these regulations are published
as final regulations in the Federal Register.
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 assessment is not required. It has
also been determined that section 553(b) of the Administrative
Procedure Act (5 U.S.C. chapter 5) does not apply to these
regulations, and because the regulation does not impose a collection
of information on small entities, the Regulatory Flexibility Act (5
U.S.C. chapter 6) does not apply.
Comments and Public Hearing
Before these proposed regulations are adopted as final regulations,
consideration will be given to any electronic or written comments (a
signed original and eight (8) copies) that are submitted timely to
the IRS. The IRS and Treasury Department request comments on the
clarity of the proposed rules and how they can be made easier to
understand. All comments will be available for public inspection and
copying.
A public hearing has been scheduled for March 13, 2001, beginning at
10 a.m., in room 7218 of the Internal Revenue Building, 1111
Constitution Avenue, NW., Washington, DC. Due to building security
procedures, visitors must enter at the 10th Street entrance, located
between Constitution and 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 "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 electronic
or 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 February 20, 2001. 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 author of these regulations is Anne O'Connell
Devereaux, Office of Associate Chief Counsel (International).
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
revising the entries for sections 1.367(b)-7, 1.367(b)-8, and
1.367(b)-9 to read in part as follows:
Authority: 26 U.S.C. 7805 * * *
Section 1.367(b)-7 also issued under 26 U.S.C. 367(a) and (b), 26
U.S.C. 902, and 26 U.S.C. 904.
Section 1.367(b)-8 also issued under 26 U.S.C. 367(a) and (b), 26
U.S.C. 902, and 26 U.S.C. 904.
Section 1.367(b)-9 also issued under 26 U.S.C. 367(a) and (b), 26
U.S.C. 902, and 26 U.S.C. 904. * * *
Par. 2. Section 1.312-10 is amended by adding paragraph (d) to read
as follows:
§1.312-10 Allocation of earnings in certain corporate
separations.
* * * * *
(d) For additional rules involving foreign corporations, see
§1.367(b)-8.
Par. 3. Section 1.367(b)-0 is amended by:
1. Revising the introductory text.
2. Revising the entry for §1.367(b)-2(j)(3) and adding entries
for §1.367(b)-2(j)(4), (j)(5), and (l).
3. Adding entries for §1.367(b)-3(e) and (f).
4. Adding entries for §1.367(b)-5(c)(2)(i), (c)(2)(ii), and (e)
(3).
5. Adding entries for §§1.367(b)-7 through 1.367(b)-9.
The revisions and additions read as follows:
§1.367(b)-0 Table of contents.
This section lists the paragraphs contained in
§§1.367(b)-1 through 1.367(b)-9.
* * * * *
§1.367(b)-2 Definitions and special rules.
* * * * *
(j) * * *
(3) Dividend described in section 243(e).
(4) Coordination with §1.367(b)-8(c)(2).
(5) Other rules.
* * * * *
(l) Additional definitions.
(1) Foreign income taxes.
(2) Post-1986 undistributed earnings.
(3) Post-1986 foreign income taxes.
(4) Pre-1987 accumulated profits.
(5) Pre-1987 foreign income taxes.
(6) Pre-1987 section 960 earnings and profits.
(7) Pre-1987 section 960 foreign income taxes.
(8) Earnings and profits.
(9) Look-through corporation.
(10) Non-look-through 10/50 corporation.
(11) Less-than-10%-U.S.-owned foreign corporation.
(12) Separate category.
(13) Statutory grouping of earnings and profits. §1.367(b)-3
Repatriation of foreign corporate assets in certain nonrecognition
transactions.
* * * * *
(e) Net operating loss and capital loss carryovers.
(f) Carryover of earnings and profits.
* * * * *
§1.367(b)-5 Distributions of stock described in section 355.
* * * * *
(c) * * *
(2) * * *
(i) In general.
(ii) Exception.
* * * * *
(e) * * *
(3) Divisive D reorganization with a preexisting controlled
corporation.
* * * * *
§1.367(b)-7 Carryover of earnings and profits and foreign
income taxes in certain foreign-to-foreign nonrecognition
transactions.
(a) Scope.
(b) General rules.
(1) Non-previously taxed earnings and profits and related taxes.
(2) Previously taxed earnings and profits. [Reserved]
(c) Ordering rule for post-transaction distributions.
(1) If foreign surviving corporation is a look-through corporation.
(2) If foreign surviving corporation is a non-look-through 10/50
corporation.
(3) If foreign surviving corporation is a less-than-10%-U.S.-owned
foreign corporation.
(d) Look-through pool.
(1) In general.
(i) Qualifying earnings and taxes.
(ii) Carryover rule.
(2) Hovering deficit.
(i) Offset rule.
(ii) Related taxes.
(3) Examples.
(e) Non-look-through pool.
(1) If foreign surviving corporation is a look-through corporation.
(i) Qualifying earnings and taxes.
(ii) Carryover rule.
(iii) Hovering deficit.
(A) Offset rule.
(B) Related taxes.
(iv) Examples.
(2) If foreign surviving corporation is a non-look-through 10/50
corporation.
(i) Qualifying earnings and taxes.
(ii) Carryover rule.
(iii) Hovering deficit.
(A) Offset rule.
(B) Related taxes.
(iv) Examples.
(f) Pre-pooling annual layers.
(1) If foreign surviving corporation is a look-through corporation
or a non-look-through 10/50 corporation.
(i) Qualifying earnings and taxes.
(ii) Carryover rule.
(iii) Deficits.
(a) Aggregate positive earnings and profits.
(b) Aggregate deficit in earnings and profits.
(iv) Pre-1987 section 960 earnings and profits and foreign income
taxes.
(v) Examples.
(2) If foreign surviving corporation is a less-than-10%-U.S.-owned
foreign corporation.
(i) Qualifying earnings and taxes.
(ii) Carryover rule.
(iii) Deficits.
(a) Aggregate positive earnings and profits.
(b) Aggregate deficit in earnings and profits.
(iv) Pre-1987 section 960 earnings and profits and foreign income
taxes.
(v) Examples.
(g) Special rules.
(1) Treatment of deficit.
(2) Reconciling taxable years.
(3) Post-transaction change of status.
(4) Ordering rule for offsetting multiple hovering deficits.
(i) Rule.
(ii) Example.
(5) Pro rata rule for earnings during transaction year.
(6) Nonapplicability of hovering deficit rules to certain
transactions.
(i) Rule.
(ii) Example.
(h) Effective date.
§1.367(b)-8 Allocation of earnings and profits and foreign
income taxes in certain foreign corporate separations.
(a) Scope.
(b) General rules.
(1) Application of §1.312-10.
(i) In general.
(ii) Special rules for application of §1.312-10(b).
(a) Distributing corporation.
(b) Controlled corporation.
(iii) Net deficit in pre-transaction earnings.
(iv) Use of net bases.
(v) Gain recognized by distributing corporation.
(vi) Coordination with branch profits tax.
(2) Cross-section of earnings and profits.
(3) Foreign income taxes.
(4) Divisive D reorganization with a preexisting controlled
corporation.
(i) Calculation of earnings and profits of distributing corporation.
(ii) Calculation of earnings and profits of controlled corporation.
(c) Foreign divisive transactions involving a domestic distributing
corporation and a foreign controlled corporation.
(1) Scope.
(2) Earnings and profits allocated to a foreign controlled
corporation.
(3) Examples.
(d) Foreign divisive transactions involving a foreign distributing
corporation and a domestic controlled corporation.
(1) Scope.
(2) Coordination with §1.367(b)-3.
(i) In general.
(ii) Determination of all earnings and profits amount.
(iii) Interaction with section 358 and §1.367(b)-2(e)(3)(ii).
(iv) Coordination with §1.367(b)-3(c).
(v) Special rule for U.S. persons that own foreign distributing
corporation stock after a non pro rata distribution. [Reserved]
(3) Foreign income taxes.
(4) Previously taxed earnings and profits. [Reserved]
(5) Coordination with §1.367(b)-5.
(6) Examples.
(e) Foreign divisive transactions involving a foreign distributing
corporation and a foreign controlled corporation.
(1) Scope.
(2) Earnings and profits of foreign controlled corporation.
(i) In general.
(ii) Special rule for pre-transaction earnings allocated to a newly
created controlled corporation.
(3) Foreign income taxes.
(4) Previously taxed earnings and profits. [Reserved] (5)
Coordination with §1.367(b)-5.
(6) Examples.
(f) Effective date.
§1.367(b)-9 Special rule for F reorganizations and similar
transactions.
(a) Scope.
(b) Hovering deficit rules inapplicable.
(c) Example.
(d) Effective date.
Par. 4. Section 1.367(b)-1 is amended by:
1. Removing the language "and" at the end of paragraph (c)(2)(iii).
2. Removing the period at the end of paragraph (c)(2)(iv)(B) and
adding ";" in its place.
3. Adding paragraphs (c)(2)(v), (c)(2)(vi), and (c)(2)(vii).
4. Revising paragraphs (c)(3)(ii)(A), (c)(4)(iv), and (c)(4)(v).
The additions and revisions read as follows:
§1.367(b)-1 Other transfers.
* * * * *
(c) * * *
(2) * * *
(v) A foreign surviving corporation described in
§1.367(b)-7(a);
(vi) A distributing corporation that is subject to the rules of
§1.367(b)-8; and
(vii) A controlled corporation that is subject to the rules of
§1.367(b)-8.
(3) * * *
(ii) * * *
(A) United States shareholders (as defined in §1.367(b)-3(b)
(2)) of foreign corporations described in paragraph (c)(2)(i), (v),
(vi), or (vii) of this section; and
* * * * *
(4) * * *
(iv) A statement that describes any amount (or amounts) required,
under the section 367(b) regulations, to be taken into account as
income or loss or as an adjustment (including an adjustment under
§1.367(b)-7, 1.367(b)-8, or 1.367(b)-9) to basis, earnings and
profits, or other tax attributes as a result of the exchange;
(v) Any information that is or would be required to be furnished
with a Federal income tax return pursuant to regulations under
section 332, 351, 354, 355, 356, 361, 368, or 381 (whether or not a
Federal income tax return is required to be filed), if such
information has not otherwise been provided by the person filing the
section 367(b) notice;
* * * * *
Par. 5. Section 1.367(b)-2 is amended by:
1. Revising paragraph (j)(1)(i).
2. Redesignating paragraph (j)(3) as paragraph (j)(5).
3. Adding new paragraphs (j)(3) and (j)(4).
4. Adding paragraph (l).
The revision and addition read as follows:
§1.367(b)-2 Definitions and special rules.
* * * * *
(j) Sections 985 through 989--(1) Change in functional currency of a
qualified business unit--
(i) Rule. If, as a result of a section 367(b) exchange described in
section 381(a) or 312(h), a qualified business unit (as defined in
section 989(a)) (QBU) has a different functional currency determined
under the rules of section 985(b) than it used prior to the
transaction, then the QBU shall be deemed to have automatically
changed its functional currency immediately prior to the
transaction. A QBU that is deemed to change its functional currency
pursuant to this paragraph (j) must make the adjustments described
in §1.985-5.
* * * * *
(3) Dividend described in section 243(e). Dividend distributions by
a foreign corporation out of earnings and profits accumulated by a
domestic corporation that are eligible for the dividends received
deduction under section 243(e) shall not exceed an amount equal to
the U.S. dollar value of the earnings and profits at the time the
earnings and profits were accumulated by such domestic corporation.
See §1.367(b)-8(c)(3), Example 1 and Example 3.
(4) Coordination with §1.367(b)-8(c)(2). Solely for purposes of
Chapter 3 of subtitle A of the Internal Revenue Code, dividend
distributions by a foreign corporation that are treated under
§1.367(b)-8(c)(2) as U.S. source shall not exceed an amount
equal to the U.S. dollar value of the earnings and profits at the
time allocated to the foreign corporation. See §1.367(b)-8(c)
(3), Example 1.
* * * * *
(l) Additional definitions--(1) Foreign income taxes. The term
foreign income taxes has the meaning set forth in §1.902- 1(a)
(7).
(2) Post-1986 undistributed earnings. The term post-1986
undistributed earnings has the meaning set forth in §1.902-
1(a)(9).
(3) Post-1986 foreign income taxes. The term post-1986 foreign
income taxes has the meaning set forth in §1.902-1(a)(8).
(4) Pre-1987 accumulated profits. The term pre-1987 accumulated
profits means the earnings and profits described in §1.902-1(a)
(10)(i), computed in accordance with the rules of §1.902-1(a)
(10)(ii).
(5) Pre-1987 foreign income taxes. The term pre-1987 foreign income
taxes has the meaning set forth in §1.902- 1(a)(10)(iii).
(6) Pre-1987 section 960 earnings and profits. The term pre-1987
section 960 earnings and profits means the earnings and profits of a
foreign corporation accumulated in taxable years beginning before
January 1, 1987, computed under §1.964-1(a) through (e), and
translated into the functional currency (as determined under section
985) of the foreign corporation at the spot rate on the first day of
the foreign corporation's taxable year beginning after December 31,
1986. For further guidance, see Notice 88-70 (1988-2 C.B. 369, 370)
(see also §601.601(d)(2) of this chapter). The term pre-1987
section 960 earnings and profits does not include earnings and
profits that represent previously taxed earnings and profits for
purposes of section 959.
(7) Pre-1987 section 960 foreign income taxes. The term pre-1987
section 960 foreign income taxes means the foreign income taxes
related to pre-1987 section 960 earnings and profits, determined in
accordance with the rules of §1.902- 1(a)(10)(iii), except that
the U.S. dollar amounts of pre-1987 section 960 foreign income taxes
are determined by reference to the exchange rates in effect when the
taxes were paid or accrued.
(8) Earnings and profits. The term earnings and profits means
post-1986 undistributed earnings, pre-1987 accumulated profits, and
pre-1987 section 960 earnings and profits.
(9) Look-through corporation. The term look-through corporation
means a foreign corporation that is subject to the look-through
rules of section 904(d)(3) or section 904(d)(4) (as in effect for
taxable years beginning after December 31, 2002 (the day before the
effective date of section 1105(b) of Public Law 105-34 (111 Stat.
788))) and regulations thereunder.
(10) Non-look-through 10/50 corporation. The term non-look-through
10/50 corporation means a noncontrolled section 902 corporation as
defined in section 904(d)(2)(E) that is not a look-through
corporation.
(11) Less-than-10%-U.S.-owned foreign corporation. The term less-
than-10%-U.S.-owned foreign corporation means a foreign corporation
that is neither a look-through corporation nor a non-look- through
10/50 corporation.
(12) Separate category. The term separate category has the meaning
set forth in section 904(d)(1), and shall also include any other
category of income to which section 904(a), (b), and (c) are applied
separately under any other provision of the Internal Revenue Code
(e.g., sections 56(g)(4)(C)(iii)(IV), 245(a)(10), 865(h), 901(j),
and 904(g)(10)).
(13) Statutory grouping of earnings and profits. The term statutory
grouping of earnings and profits means the earnings and profits from
a specific source or activity that must be determined for purposes
of applying a provision of the Internal Revenue Code. Compare
§1.861-8(a)(4) (providing an analogous definition for statutory
grouping of gross income). Par. 6. Section 1.367(b)-3 is amended by
adding paragraphs (e) and (f) to read as follows:
§1.367(b)-3 Repatriation of foreign corporate assets in certain
nonrecognition transactions.
* * * * *
(e) Net operating loss and capital loss carryovers. A net operating
loss or capital loss carryover of the foreign acquired corporation
is described in section 381(c)(1) and (c)(3) and thus is eligible to
carry over from the foreign acquired corporation to the domestic
acquiring corporation only to the extent the underlying deductions
or losses were allowable under chapter 1 of subtitle A of the
Internal Revenue Code. Thus, only a net operating loss or capital
loss carryover that is effectively connected with the conduct of a
trade or business within the United States (or that is attributable
to a permanent establishment, in the context of an applicable United
States income tax treaty) is eligible to be carried over under
section 381. For further guidance, see Rev. Rul. 72-421 (1972-2 C.B.
166) (see also §601.601(d)(2) of this chapter).
(f) Carryover of earnings and profits. Except to the extent
otherwise specifically provided (see, e.g., Notice 89-79 (1989-2
C.B. 392) (see also §601.601(d)(2) of this chapter)), earnings
and profits of the foreign acquired corporation that are not
included in income as a deemed dividend under the section 367(b)
regulations (or deficit in earnings and profits) are eligible to
carry over from the foreign acquired corporation to the domestic
acquiring corporation under section 381(c)(2) or §1.367(b)-8(b)
(1)(i) only to the extent such earnings and profits (or deficit in
earnings and profits) are effectively connected with the conduct of
a trade or business within the United States (or are attributable to
a permanent establishment, in the context of an applicable United
States income tax treaty). All other earnings and profits (or
deficit in earnings and profits) of the foreign acquired corporation
shall not carry over to the domestic acquiring corporation and, as a
result, shall be eliminated. Par. 7. Section 1.367(b)-5 is amended
by:
1. Revising paragraphs (b)(1)(ii) and (c)(2).
2. Adding paragraph (e)(3).
The revisions and addition read as follows:
§1.367(b)-5 Distributions of stock described in section 355.
* * * * *
(b) * * *
(1) * * *
(ii) If the distributee is an individual or a tax-exempt entity as
described in §1.337(d)-4(c)(2) then, solely for purposes of
determining the gain recognized by the distributing corporation, the
controlled corporation shall not be considered to be a corporation,
and the distributing corporation shall recognize any gain (but not
loss) realized on the distribution.
* * * * *
(c) * * *
(2) Adjustment to basis in stock and income inclusion--
(i)In general. If the distributee's postdistribution amount (as
defined in paragraph (e)(2) of this section) with respect to the
distributing or controlled corporation is less than the
distributee's predistribution amount (as defined in paragraph (e)(1)
of this section) with respect to such corporation, then the
distributee's basis in such stock immediately after the distribution
(determined under the normal principles of section 358) shall be
reduced by the amount of the difference. However, the distributee's
basis in such stock shall not be reduced below zero, and to the
extent the foregoing reduction would have reduced basis below zero,
the distributee shall instead include such amount in income as a
deemed dividend from such corporation. See, e.g., paragraph (g)
Example 1 of this section.
(ii) Exception. The basis reduction rule of paragraph (c)(2)(i) of
this section shall apply only to the extent such reduction increases
the distributee's section 1248 amount (as defined in
§1.367(b)-2(c)(1)) with respect to the distributing or
controlled corporation; otherwise such basis reduction shall be
replaced by the income inclusion rule of paragraph (c)(2)(i) of this
section. See, e.g., §1.367(b)-8(d)(6) Example 2.
* * * * *
(e) * * *
(3) Divisive D reorganization with a preexisting controlled
corporation. In the case of a transaction described in
§1.367(b)-8(b)(4), the predistribution amount with respect to a
distributing or controlled corporation shall be computed after the
allocation of the distributing corporation's earnings and profits
described in §1.367(b)-8(b)(4)(i)(A) and (b)(4)(ii)(A) (without
regard to the parenthetical phrase in §1.367(b)-8( b)(4)(ii)
(A)), but before the reduction in the distributing corporation's
earnings and profits described in §1.367(b)-8( b)(4)(i)(B).
See, e.g., §1.367(b)-8(d)(6) Example 3 and §1.367(b)-8(e)
(7) Example 3.
* * * * *
Par. 8. In §1.367(b)-6, paragraph (a)(1) is revised to read as
follows:
§1.367(b)-6 Effective dates and coordination rules.
(a) Effective date--
(1) In general. Sections 1.367(b)-1 through 1.367(b)-5, and this
section, apply to section 367(b) exchanges that occur on or after
the date that is 30 days after the date these regulations are
published as final regulations in the Federal Register. For guidance
with respect to section 367(b) exchanges that occur prior to the
date 30 days after these regulations are published as final
regulations in the Federal Register, see §§1.367(b)-1
through 1.367(b)-6 in effect prior to the date 30 days after these
regulations are published in the Federal Register (see 26 CFR part 1
revised as of April 1, 2000). Par. 9. Section 1.367(b)-7 is added to
read as follows: §1.367(b)-7 Carryover of earnings and profits
and foreign income taxes in certain foreign-to-foreign
nonrecognition transactions.
(a) Scope. This section applies to an acquisition by a foreign
corporation (foreign acquiring corporation) of the assets of another
foreign corporation (foreign target corporation) in a transaction
described in section 381 (foreign 381 transaction). This section
describes the manner and extent to which earnings and profits and
foreign income taxes of the foreign acquiring corporation and the
foreign target corporation carry over to the surviving foreign
corporation (foreign surviving corporation). See §1.367(b)-9
for special rules governing reorganizations described in section
368(a)(1)(F) and foreign 381 transactions in which either the
foreign target corporation or the foreign acquiring corporation is
newly created.
(b) General rules--
(1) Non-previously taxed earnings and profits and related taxes.
Earnings and profits and related foreign income taxes of the foreign
acquiring corporation and the foreign target corporation (pre-
transaction earnings and pre- transaction taxes, respectively) shall
carry over to the foreign surviving corporation in the manner
described in paragraphs (d), (e), (f), and (g) of this section.
Dividend distributions by the foreign surviving corporation (post-
transaction distributions) shall be out of earnings and profits and
shall reduce related foreign income taxes in the manner described in
paragraph (c) of this section.
(2) Previously taxed earnings and profits. [Reserved]
(c) Ordering rule for post-transaction distributions. Dividend
distributions out of a foreign surviving corporation's earnings and
profits shall be ordered in accordance with the rules of paragraph
(c)(1), (2), or (3) of this section, depending on whether the
foreign surviving corporation is a look-through corporation, a non-
look-through 10/50 corporation, or a less-than- 10%-U.S.-owned
foreign corporation.
(1) If foreign surviving corporation is a look-through corporation.
In the case of a foreign surviving corporation that is a look-
through corporation, post-transaction distributions shall be first
out of the look-through pool (as described in paragraph (d) of this
section), second out of the non-look-through pool (as described in
paragraph (e)(1) of this section), and third out of the pre-pooling
annual layers (as described in paragraph (f)(1) of this section)
under an annual last-in, first-out (LIFO) method.
(2) If foreign surviving corporation is a non-look-through 10/50
corporation. In the case of a foreign surviving corporation that is
a non-look-through 10/50 corporation, post- transaction
distributions shall be first out of the non-look-through pool (as
described in paragraph (e)(2) of this section), and second out of
the pre-pooling annual layers (as described in paragraph (f)(1) of
this section) under the LIFO method.
(3) If foreign surviving corporation is a less-than-10%-U. S.-owned
foreign corporation. In the case of a foreign surviving corporation
that is a less-than-10%-U.S.-owned corporation, post-transaction
distributions shall be out of the pre-pooling annual layers (as
described in paragraph (f)(2) of this section) under the LIFO
method.
(d) Look-through pool. If the foreign surviving corporation is a
look-through corporation, then the look-through pool shall be
determined under the rules of this paragraph (d).
(1) In general--
(i) Qualifying earnings and taxes. The look-through pool shall
consist of the post-1986 undistributed earnings and related
post-1986 foreign income taxes of the foreign acquiring corporation
and the foreign target corporation that were subject to the look-
through provisions of section 904(d)(3) or section 904(d)(4) (as in
effect for taxable years beginning after December 31, 2002 (the day
before the effective date of section 1105(b) of Public Law 105-34
(111 Stat. 788))) and regulations thereunder.
(ii) Carryover rule. Subject to paragraph (d)(2) of this section,
the amounts described in paragraph (d)(1)(i) of this section
attributable to the foreign acquiring corporation and the foreign
target corporation shall carry over to the foreign surviving
corporation and shall be combined on a separate category-by-separate
category basis.
(2) Hovering deficit. The rules of this paragraph (d)(2) apply when
the foreign acquiring corporation or the foreign target corporation
has a deficit in one or more separate categories of post-1986
undistributed earnings described in paragraph (d)(1)(i) of this
section immediately prior to the foreign 381 transaction. In the
event both the foreign acquiring corporation and the foreign target
corporation have a deficit in the same separate category of earnings
and profits, such deficits and their related foreign income taxes
shall be combined for purposes of applying this paragraph (d)(2).
See also paragraphs (g)(1) and (4) of this section (describing other
rules applicable to a deficit described in this paragraph (d)(2)).
(i) Offset rule. A deficit in a separate category of earnings and
profits described in this paragraph (d)(2) shall offset only
earnings and profits accumulated by the foreign surviving
corporation after the foreign 381 transaction (post- transaction
earnings) in the same separate category of earnings and profits.
(ii) Related taxes. Foreign income taxes that are related to a
deficit in a separate category of earnings and profits described in
this paragraph (d)(2) shall be added to the foreign surviving
corporation's post-1986 foreign income taxes related to that
separate category of earnings and profits only after post-
transaction earnings in the same separate category have been offset
by and exceed the entire amount of the deficit.
(3) Examples. The following examples illustrate the rules of this
paragraph (d). The examples presume the following facts: Foreign
corporations A and B were both incorporated after December 31, 1986,
always have been controlled foreign corporations, and always have
had calendar taxable years. None of the shareholders of foreign
corporations A and B are required to include any amount in income
under §1.367(b)-4 as a result of the foreign 381 transaction.
Foreign corporations A and B (and all of their respective qualified
business units as defined in section 989) maintain a "u" functional
currency. Finally, unless otherwise stated, any earnings and profits
described in section 904(d)(1)(D) and 904(d)(1)(E) (shipping income
and 10/50 dividends, respectively) qualified for the high tax
exception from subpart F income under section 954(b)(4), and all
United States shareholders elected to exclude such earnings and
profits from subpart F income under section 954(b)(4) and
§1.954-1(d)(5).
The examples are as follows:
Example 1--
(i) Facts.
(A) On December 31, 2001, foreign corporations A and B have the
following earnings and profits and foreign income taxes accounts:
Foreign Corporation A
Separate Category | E&P | Foreign Taxes
----------------------------+--------+----------------
10/50 dividends from FC1, | |
| |
a noncontrolled section | 100u | $40
902 corporation | 300u | $60
----------------------------+--------+----------------
General | 400u | $100
Foreign Corporation B
Separate Category | E&P | Foreign Taxes
----------------------------+--------+----------------
Shipping | 200u | $40
| |
10/50 dividends from FC2, | |
| |
a noncontrolled section | 50u | $20
902 corporation | 300u | $70
----------------------------+--------+----------------
General | 550u | $130
(B) On January 1, 2002, foreign corporation B acquires the assets of
foreign corporation A in a reorganization described in section
368(a)(1)(C). Immediately following the foreign 381 transaction,
foreign surviving corporation is a controlled foreign corporation
(CFC).
(ii) Result. Under the rules described in paragraph (d)(1) of this
section, foreign surviving corporation has the following earnings
and profits and foreign income taxes accounts:
Separate Category | E&P | Foreign Taxes
----------------------------+--------+----------------
Shipping | 200u | $40
General | 600u | $130
10/50 dividends from FC1 | 100u | $40
10/50 dividends from FC2 | 50u | $20
----------------------------+--------+----------------
| 950u | $230
(iii) Post-transaction distribution. (A) During 2002, foreign
surviving corporation does not accumulate any earnings and profits
or pay or accrue any foreign income taxes. On December 31, 2002,
foreign surviving corporation distributes 475u to its shareholders.
Under the rules described in §1.902-1(d)(1) and paragraph (c)
(1) of this section, the distribution is out of separate categories
and reduces foreign income taxes as follows:
Separate Category | E&P | Foreign Taxes
----------------------------+--------+----------------
Shipping | 100u | $20
General | 300u | $65
10/50 dividends from FC1 | 50u | $20
10/50 dividends from FC2 | 25u | $10
----------------------------+--------+----------------
| 475u | $115
(B) The foreign income taxes available to foreign surviving
corporation shareholders upon the distribution are subject to the
generally applicable rules and limitations, such as those of
sections 902 and 904(d).
(c) Immediately after the distribution, foreign surviving
corporation has the following earnings and profits and foreign
income taxes accounts:
Separate Category | E&P | Foreign Taxes
----------------------------+--------+----------------
Shipping | 100u | $20
General | 300u | $65
10/50 dividends from FC1 | 50u | $20
10/50 dividends from FC2 | 25u | $10
----------------------------+--------+----------------
| 475u | $115
Example 2--
(i) Facts.
(A) On December 31, 2001, foreign corporations A and B have the
following earnings and profits and foreign income taxes accounts:
Separate Category | E&P | Foreign Taxes
----------------------------+--------+----------------
Shipping | (100u) | $ 5
10/50 dividends | 400u | $160
General | 200u | $ 25
----------------------------+--------+----------------
| 100u | $190
Separate Category | E&P | Foreign Taxes
----------------------------+--------+----------------
Shipping | 100u | $20
General | 300u | $60
----------------------------+--------+----------------
| 400u | $80
(B) On January 1, 2002, foreign corporation B acquires the assets of
foreign corporation A in a reorganization described in section
368(a)(1)(C). Immediately following the foreign 381 transaction,
foreign surviving corporation is a CFC.
(ii) Result. Under the rules described in paragraphs (d)(1) and (2)
of this section, foreign surviving corporation has the following
earnings and profits and foreign income taxes accounts:
| Earnings & Profits: | Foreign Taxes:
-------------------+----------------------------+--------------------
| | | |Foreign
| | | |Taxes
| | | |Associated
| | |Foreign |with
| Positive | |Taxes |Hovering
Separate Category | E&P |Hovering Deficit|Available|Deficit
-------------------+-----------+----------------+---------+----------
Shipping | 100u | (100u) | $ 20 | $ 5
-------------------+-----------+----------------+---------+----------
10/50 dividends | 400u | 0u | $160 | $ 0
-------------------+-----------+----------------+---------+----------
General | 300u | (200u) | $ 60 | $25
-------------------+-----------+----------------+---------+----------
| 800u | (300u) | $240 | $30
(iii) Post-transaction distribution--
(A) During 2002, foreign surviving corporation does not accumulate
any earnings and profits or pay or accrue any foreign income taxes.
On December 31, 2002, foreign surviving corporation distributes 400u
to its shareholders. Under the rules described in section 904(d)(3)
and paragraph (c)(1) of this section, the distribution is out of
separate categories and reduces foreign income taxes as follows:
Separate Category | E&P | Foreign Taxes
----------------------------+--------+----------------
Shipping | 50u | $ 10
----------------------------+--------+----------------
10/50 dividends | 200u | $ 80
----------------------------+--------+----------------
General | 150u | $ 30
----------------------------+--------+----------------
| 400u | $120
(B) The foreign income taxes available to foreign surviving
corporation shareholders upon the distribution are subject to the
generally applicable rules and limitations, such as those of
sections 902 and 904(d).
(c) Immediately after the distribution, foreign surviving
corporation has the following earnings and profits and foreign
income taxes accounts:
| Earnings & Profits: | Foreign Taxes:
-------------------+----------------------------+--------------------
| | | |Foreign
| | | |Taxes
| | | |Associated
| | |Foreign |with
| Positive | |Taxes |Hovering
Separate Category | E&P |Hovering Deficit|Available|Deficit
-------------------+-----------+----------------+---------+----------
Shipping | 50u | (100u) | $ 10 | $ 5
-------------------+-----------+----------------+---------+----------
10/50 dividends | 200u | 0u | $ 80 | $ 0
-------------------+-----------+----------------+---------+----------
General | 150u | (200u) | $ 30 | $25
-------------------+-----------+----------------+---------+----------
| 400u | (300u) | $120 | $30
(iv) Post-transaction earnings.
(A) In its taxable year ending on December 31, 2003, foreign
surviving corporation accumulates earnings and profits and pays
related foreign income taxes as follows:
Separate Category | E&P | Foreign Taxes
----------------------------+--------+----------------
Shipping | 105u | $20
----------------------------+--------+----------------
General | 100u | $20
----------------------------+--------+----------------
| 205u | $40
(B) None of foreign surviving corporation's earnings and
profits for its 2003 taxable year qualify as subpart F income as
defined in section 952(a). Under the rules described in
paragraphs (d)(2)(i) and (ii) of this section, foreign surviving
corporation has the following earnings and profits and foreign
income taxes accounts on December 31, 2003:
| Earnings & Profits: | Foreign Taxes:
-------------------+----------------------------+--------------------
| | | |Foreign
| | | |Taxes
| | | |Associated
| | |Foreign |with
| Positive | |Taxes |Hovering
Separate Category | E&P |Hovering Deficit|Available|Deficit
-------------------+-----------+----------------+---------+----------
Shipping | 55u | 0u | $ 35 | $ 0
-------------------+-----------+----------------+---------+----------
10/50 dividends | 200u | 0u | $ 80 | $ 0
-------------------+-----------+----------------+---------+----------
General | 150u | (100u) | $ 50 | $25
-------------------+-----------+----------------+---------+----------
| 405u | (100u) | $165 | $25
Example 3--
(i) Facts. The facts are the same as Example 2 (i), (ii), (iii), and
(iv)(A), except that the 105u in the section 904(d)(1)(D) shipping
separate category accumulated by foreign surviving corporation
during 2003 qualify as subpart F income, all of which is included in
income under section 951(a) by United States shareholders (as
defined in section 951(b)).
(ii) Result.
(A) Under the rule described in paragraph (g)(1) of this section,
the 100u hovering deficit in the shipping separate category does not
reduce foreign surviving corporation's current earnings and profits
for purposes of determining subpart F income. Thus, foreign
surviving corporation's United States shareholders include their pro
rata shares of the 105u in taxable income for the year and are
eligible for a deemed paid foreign tax credit under section 960,
computed by reference to their pro rata shares of $20.32 (105u
subpart F inclusion ÷ (105u + 50u accumulated earnings and
profits in the shipping category = 155u) = 0.68%, x $30 foreign
income taxes in the shipping category = $20.32).
(B) Immediately after the subpart F inclusion and section 960 deemed
paid taxes (and taking into account the taxable year 2003 earnings
and profits and related taxes in the general category), foreign
surviving corporation has the following earnings and profits and
foreign income taxes accounts:
| Earnings & Profits: | Foreign Taxes:
-------------------+----------------------------+--------------------
| | | |Foreign
| | | |Taxes
| | | |Associated
| | |Foreign |with
| Positive | |Taxes |Hovering
Separate Category | E&P |Hovering Deficit|Available|Deficit
-------------------+-----------+----------------+---------+----------
Shipping | 50u | (100u) | $ 9.68 | $ 5
-------------------+-----------+----------------+---------+----------
10/50 dividends | 200u | 0u | $ 80.00 | $ 0
-------------------+-----------+----------------+---------+----------
General | 150u | (100u) | $ 50.00 | $25
-------------------+-----------+----------------+---------+----------
| 400u | (200u) | $139.68 | $30
(C) The 105u included as subpart F income constitutes previously
taxed earnings and profits under section 959.
(e) Non-look-through pool--
(1) If foreign surviving corporation is a look-through corporation.
If the foreign surviving corporation is a look-through corporation,
then the non-look-through pool shall be determined under the rules
of this paragraph (e)(1).
(i) Qualifying earnings and taxes. The non-look-through pool shall
consist of the post-1986 undistributed earnings and related
post-1986 foreign income taxes that were accumulated (or treated as
accumulated) by the foreign target corporation or the foreign
acquiring corporation while it was a non-look-through 10/50
corporation.
(ii) Carryover rule. Subject to paragraph (e)(1)(iii) of this
section, the amounts described in pararaph (e)(1)(i) of this section
attributable to the foreign acquiring corporation and the foreign
target corporation shall carry over to the foreign surviving
corporation but shall not be combined. Thus, post-transaction
distributions by the foreign surviving corporation out of the non-
look-through pool shall be made from the separate amounts
attributable to the foreign acquiring corporation and the foreign
target corporation on a pro rata basis, and shall reduce a pro rata
portion of any related foreign income taxes.
(iii) Hovering deficit. The rules of this paragraph (e)(1)(iii)
apply when the foreign acquiring corporation or the foreign target
corporation (or both) has a deficit in the post-1986 undistributed
earnings described in paragraph (e)(1)(i) of this section
immediately prior to the foreign 381 transaction. In the event that
this paragraph (e)(1)(iii) applies to a deficit of both the foreign
acquiring corporation and the foreign target corporation, the
deficits shall not be combined and the rules of this paragraph (e)
(1)(iii) shall be applied separately to each of such deficits on a
pro rata basis. See also paragraphs (g)(1) and (g)(4) of this
section (describing other rules applicable to a deficit described in
this paragraph (e)(1)(iii)).
(A) Offset rule. A deficit described in this paragraph (e)(i)(iii)
shall offset only post-transaction earnings. The deficit shall
offset a pro rata portion of post-transaction earnings accumulated
in each separate category of earnings and profits by the foreign
surviving corporation.
(B) Related taxes. Foreign income taxes that are related to a
deficit described in this paragraph (e)(1)(iii) shall be added to
the foreign surviving corporation's post-1986 foreign income taxes
(in the applicable segregated portion of the non-look-through pool)
only after post-transaction earnings have been offset by and exceed
the entire amount of the deficit.
(iv) Examples. The following examples illustrate the rules of this
paragraph (e)(1). The examples presume the following facts: Foreign
corporation A was a non-look-through 10/50 corporation from its
incorporation on January 1, 1995 until December 31, 1997; foreign
corporation A became a CFC on January 1, 1998 and has been a CFC
since that time. Foreign corporation B has been a non-look-through
10/50 corporation since its incorporation on January 1, 1993. Both
foreign corporation A and foreign corporation B always have had
calendar taxable years. None of the shareholders of foreign
corporation A are required to include any amount in income under
§1.367(b)-4 as a result of the foreign 381 transaction. Foreign
corporations A and B (and all of their respective qualified business
units as defined in section 989) maintain a "u" functional currency.
Finally, any earnings and profits described in section 904(d)(1)(E)
(10/50 dividends) qualified for the high tax exception from subpart
F income under section 954(b)(4), and all United States shareholders
elected to exclude such earnings and profits from subpart F income
under section 954(b)(4) and §1.954-1(d)(5). The examples are as
follows:
Example 1--
(i) Facts.
(A) On December 31, 2001, foreign corporations A and B have the
following earnings and profits and foreign income taxes accounts:
Foreign Corporation A | E&P Foreign | Taxes
Separate Category: | |
-----------------------------+------------------+--------------
10/50 dividends | 100u | $ 40
-----------------------------+------------------+--------------
General | 300u | $ 60
-----------------------------+------------------+--------------
E&P Accumulated as Non-Look- | |
Through 10/50 Corporation: | 400u | $100
-----------------------------+------------------+--------------
| 800u | $200
Foreign Corporation B | E&P Foreign | Taxes
-----------------------------+------------------+--------------
E&P Accumulated as Non-Look- | |
Through 10/50 Corporation: | 200u | $ 40
-----------------------------+------------------+--------------
(B) On January 1, 2002, foreign corporation B acquires the assets of
foreign corporation A in a reorganization described in section
368(a)(1)(C). Immediately following the foreign 381 transaction,
foreign surviving corporation is a CFC.
(ii) Result. Under the rules described in paragraphs (d)(1), (e)(1)
(i), and (e)(1)(ii) of this section, foreign surviving corporation
has the following earnings and profits and foreign income taxes
accounts:
| E&P | Foreign Taxes
-------------------------------------+------------+------------------
Look-Through Pool Separate Category: | |
| |
10/50 dividends | 100u | $ 40
-------------------------------------+------------+------------------
General | 300u | $ 60
-------------------------------------+------------+------------------
Two Side-by-Side Non-Look- | |
Through Pool Amounts: | |
| |
Non-look-through pool amount #1 | |
(from Corp A) | 400u | $100
-------------------------------------+------------+------------------
Non-look-through pool amount #2 | |
(from Corp B) | 200u | $ 40
-------------------------------------+------------+------------------
| 1,000u | $240
(iii) Post-transaction distribution.
(A) During 2002, foreign surviving corporation does not accumulate
any earnings and profits or pay or accrue any foreign income taxes.
On December 31, 2002, foreign surviving corporation distributes 700u
to its shareholders. Under the rules described in paragraphs (c)(1)
and (e)(1)(ii) of this section, the distribution is first out of the
look-through pool, then out of the non-look-through pool, as
follows:
Look-Through Pool Separate Category: | E&P | Foreign Taxes
-------------------------------------+------------+------------------
10/50 dividends | 100u | $ 40
-------------------------------------+------------+------------------
General | 300u | $ 60
-------------------------------------+------------+------------------
Non-Look-Through Pool Amounts: | |
| |
Non-look-through pool amount #1 | 200u | $ 50
Non-look-through pool amount #2 | 100u | $ 20
-------------------------------------+------------+------------------
| 700u | $170
(B) The foreign income taxes available to foreign surviving
corporation shareholders upon the distribution are subject to the
generally applicable rules and limitations, such as those of
sections 902 and 904(d).
(c) Immediately after the distribution, foreign surviving
corporation has the following earnings and profits and foreign
income taxes accounts:
| E&P | Foreign Taxes
-------------------------------------+------------+------------------
Two Side-by-Side Non-Look- | |
Through Pool Amounts: | |
| |
Non-look-through pool amount #1 | 200u | $50
-------------------------------------+------------+------------------
Non-look-through pool amount #2 | 100u | $20
-------------------------------------+------------+------------------
| 300u | $70
Example 2--
(i) Facts--
(A) On December 31, 2001, foreign corporations A and B have the
following earnings and profits and foreign income taxes accounts:
Foreign Corporation A | E&P | Foreign Taxes
-------------------------------------+-----------+-----------------
Look-through Pool Separate Category: | |
| |
10/50 dividends | 100u | $ 40
-------------------------------------+-----------+-----------------
General | 300u | $ 60
-------------------------------------+-----------+-----------------
| |
E&P Accumulated as Non-Look- | |
Through 10/50 Corporation: | 400u | $100
-------------------------------------+-----------+-----------------
| 800u | $200
-------------------------------------+-----------+-----------------
Foreign Corporation B | E&P | Foreign Taxes
-------------------------------------+-----------+-----------------
E&P Accumulated as Non-Look- | |
Through 10/50 Corporation: | (200u) | $ 5
(B) On January 1, 2002, foreign corporation B acquires the assets of
foreign corporation A in a reorganization described in section
368(a)(1)(C). Immediately following the foreign 381 transaction,
foreign surviving corporation is a CFC.
(ii) Result. Under the rules described in paragraphs (d)(1), (e)(1)
(i), (e)(1)(ii), and (e)(1)(iii) of this section, foreign surviving
corporation has the following earnings and profits and foreign
income taxes accounts:
| Earnings & Profits: | Foreign Taxes:
-------------------+----------------------------+--------------------
| | | |Foreign
| | | |Taxes
| | | |Associated
| | |Foreign |with
| Positive | |Taxes |Hovering
Separate Category | E&P |Hovering Deficit|Available|Deficit
-------------------+-----------+----------------+---------+----------
Look-through Pool | | | |
Separate Category: | | | |
| | | |
10/50 dividends | 100u | | $ 40 |
-------------------+-----------+----------------+---------+----------
General | 300u | | $ 60 |
-------------------+-----------+----------------+---------+----------
Two Side-by-Side | | | |
Non-Look-Through | | | |
Pool Amounts: | | | |
| | | |
Non-look-through | | | |
pool amount #1 | 400u | | $100 |
-------------------+-----------+----------------+---------+----------
Non-look-through | | | |
pool amount #2 | _____ | (200u) | ____ | $5
-------------------+-----------+----------------+---------+----------
| 800u | (200u) | $200 | $5
(iii) Post-transaction distribution.
(A) During 2002, foreign surviving corporation does not accumulate
any earnings and profits or pay or accrue any foreign income taxes.
On December 31, 2002, foreign surviving corporation distributes 600u
to its shareholders. Under the rules described in paragraphs (c)(1)
and (e)(1)(ii) of this section, the distribution is first out of the
look-through pool, then out of the non-look-through pool, as
follows:
Look-Through Pool Separate Category: | E&P | Foreign Taxes
-------------------------------------+------------+------------------
10/50 dividends | 100u | $ 40
-------------------------------------+------------+------------------
General | 300u | $ 60
-------------------------------------+------------+------------------
Non-Look-Through Pool Amount: | |
| |
Non-look-through pool amount #1 | 200u | $ 50
-------------------------------------+------------+------------------
| 600u | $150
(B) The foreign income taxes available to foreign surviving
corporation shareholders upon the distribution are subject to the
generally applicable rules and limitations, such as those of
sections 902 and 904(d).
(C) Immediately after the distribution, foreign surviving
corporation has the following earnings and profits and foreign
income taxes accounts:
| Earnings & Profits: | Foreign Taxes:
-------------------+----------------------------+--------------------
| | | |Foreign
| | | |Taxes
| | | |Associated
| | |Foreign |with
| Positive | |Taxes |Hovering
Separate Category | E&P |Hovering Deficit|Available|Deficit
-------------------+-----------+----------------+---------+----------
Two Side-by- | | | |
Side Non-Look- | | | |
Through Pool | | | |
Amounts: | | | |
| | | |
Non-look-through | | | |
pool amount #1 | 200u | | $50 |
-------------------+-----------+----------------+---------+----------
Non-look-through | | | |
pool amount #2 | ____ | (200u) | ___ | $5
-------------------+-----------+----------------+---------+----------
| 200u | (200u) | $50 | $5
(iv) Post-transaction earnings.
(A) In the taxable year ending on December 31, 2003, foreign
surviving corporation accumulates earnings and profits and pays
related foreign income taxes as follows:
Separate Category | E&P | Foreign Taxes
----------------------------+--------+----------------
10/50 dividends | 150u | $ 60
----------------------------+--------+----------------
General | 300u | $ 60
----------------------------+--------+----------------
| 450u | $120
(B) None of the earnings and profits qualify as subpart F income as
defined in section 952(a). Under the rules described in paragraph
(e)(1)(iii)(A) of this section, the 200u deficit in non-look-through
pool amount #2 offsets a pro rata portion of the foreign surviving
corporation's post-transaction earnings in each separate category.
Thus, the 200u deficit offsets 66.66u of section 904(d)(1)(E) 10/50
dividends separate category earnings (33.33% of 200u) and offsets
133.34u of section 904(d)(1)(I) general separate category earnings
(66.67% of 200u).
Accordingly, foreign surviving corporation has the following
earnings and profits and foreign income taxes accounts as of
December 31, 2002:
| E&P Foreign | Taxes
Look-Through Pool Separate Category:| |
------------------------------------+---------------+------------
10/50 dividends | 83.34u | $ 60
------------------------------------+---------------+------------
General | 166.66u | $ 60
------------------------------------+---------------+------------
Two Side-by-Side Non-Look-Through | |
Pool Amounts: | |
| |
Non-look-through pool amount #1 | 200u | $ 50
------------------------------------+---------------+------------
Non-look-through pool amount #2 | ____ | $ 5
------------------------------------+---------------+------------
| 450u | $175
(C) Under paragraph (e)(1)(iii)(B) of this section, the $5 of
foreign income taxes associated with the non-look-through pool
amount #2 hovering deficit are added to foreign surviving
corporation's available foreign income taxes because post-
transaction earnings have been offset by and exceed the deficit in
the non-look-through pool. However, the $5 of foreign income taxes
generally will not be reduced or deemed paid unless a foreign tax
refund restores a positive balance to the associated earnings
pursuant to section 905(c), and thus will be trapped.
(2) If foreign surviving corporation is a non-look-through 10/50
corporation. If the foreign surviving corporation is a non-look-
through 10/50 corporation, then the non-look-through pool shall be
determined under the rules of this paragraph (e)(2).
(i) Qualifying earnings and taxes. The non-look-through pool shall
consist of the post-1986 undistributed earnings and related
post-1986 foreign income taxes of the foreign acquiring corporation
and the foreign target corporation.
(ii) Carryover rule. Subject to paragraph (e)(2)(iii) of this
section, the amounts described in paragraph (e)(2)(i) of this
section attributable to the foreign acquiring corporation and the
foreign target corporation shall carry over to the foreign surviving
corporation and shall be combined as a single separate category of
earnings and profits under section 904(d)(1)(E).
(iii) Hovering deficit. The rules of this paragraph (e)(2)(iii)
apply when the foreign acquiring corporation or the foreign target
corporation (or both) has an aggregate deficit in its post-1986
undistributed earnings described in paragraph (e)(2)(i) of this
section immediately prior to the foreign 381 transaction. In the
event that both the foreign acquiring corporation and the foreign
target corporation have an aggregate deficit in post-1986
undistributed earnings, such deficits and their related foreign
income taxes shall be combined for purposes of applying this
paragraph (e)(2)(iii). See also paragraphs (g)(1) and (4) of this
section (describing other rules applicable to a deficit described in
this paragraph (e)(2)(iii)).
(A) Offset rule. A deficit described in this paragraph (e)(2)(iii)
shall offset only post-transaction earnings accumulated by the
foreign surviving corporation.
(B) Related taxes. Foreign income taxes that are related to a
deficit described in this paragraph (e)(2)(iii) shall be added to
the foreign surviving corporation's post-1986 foreign income taxes
only after post-transaction earnings have been offset by and exceed
the entire amount of the deficit.
(iv) Examples. The following examples illustrate the rules of this
paragraph (e)(2). The examples presume the following facts: Both
foreign corporation A and foreign corporation B always have had
calendar taxable years. Foreign corporations A and B (and all of
their respective qualified business units as defined in section 989)
maintain a "u" functional currency. Finally, any earnings and
profits described in section 904(d)(1)(E) (10/50 dividends)
qualified for the high tax exception from subpart F income under
section 954(b)(4), and all United States shareholders elected to
exclude such earnings and profits from subpart F income under
section 954(b)(4) and §1.954- 1(d)(5). The examples are as
follows:
Example 1--
(i) Facts.
(A) Foreign corporations A and B are
and always have been non-look-through 10/50 corporations since
they were incorporated in 1995. On December 31, 2001, foreign
corporations A and B have the following earnings and profits and
foreign income taxes accounts:
Foreign Corporation A | E&P | Foreign Taxes
-------------------------------+------------+------------------
E&P accumulated as non- | |
look-through 10/50 corporation | 400u | $100
-------------------------------+------------+------------------
Foreign Corporation B | E&P | Foreign Taxes
-------------------------------+------------+------------------
E&P accumulated as non- | |
look-through 10/50 corporation | 200u | $ 40
(B) On January 1, 2002, foreign corporation B acquires the assets of
foreign corporation A in a reorganization described in section
368(a)(1)(C). Immediately following the foreign 381 transaction,
foreign surviving corporation is a non-look-through 10/50
corporation.
(ii) Result. Under the rules described in paragraphs (e)(2)(i) and
(ii) of this section, foreign surviving corporation has the
following earnings and profits and foreign income taxes accounts:
| E&P | Foreign Taxes
-----------------------+-------+-------------------
Non-Look-Through Pool: | 600u | $140
Example 2--
(i) Facts--
(A) Foreign corporation A is and always has been a CFC since it was
incorporated in 1995. Foreign corporation B is and always has been a
non-look-through 10/50 corporation since it was incorporated in
1995. Immediately before the foreign 381 transaction (but after
application of the rules of §1.367(b)-4 to foreign corporation
A and its shareholders), foreign corporations A and B have the
following earnings and profits and foreign income taxes accounts:
Foreign Corporation A | E&P | Foreign Taxes
-------------------------------+------------+------------------
Separate Category: | |
Passive | (200u) | $ 10
-------------------------------+------------+------------------
10/50 dividends | 100u | $ 40
-------------------------------+------------+------------------
General | 300u | $ 60
-------------------------------+------------+------------------
| 200u | $110
Foreign Corporation B | E&P | Foreign Taxes
-------------------------------+------------+------------------
E&P accumulated as non- | |
look-through 10/50 corporation:| 200u | $ 30
(B) On January 1, 2002, foreign corporation B acquires the assets of
foreign corporation A in a reorganization described in section
368(a)(1)(C). Immediately following the foreign 381 transaction,
foreign surviving corporation is a non-look-through 10/50
corporation.
(ii) Result. Because neither foreign corporation A nor foreign
corporation B has an aggregate deficit in post-1986 undistributed
earnings, the rules described in paragraphs (e)(2)(i) and (ii) of
this section apply, but the rules described in paragraph (e)(2)(iii)
do not. Accordingly, foreign corporation A's net positive earnings
and profits of 200u (300u + 100u + (200u)) and its aggregate foreign
income taxes of $110 ($10 + $40 + $60) are combined with the
earnings and profits and foreign income taxes of foreign corporation
B, so that foreign surviving corporation has the following earnings
and profits and foreign income taxes accounts:
| E&P | Foreign Taxes
-----------------------+-------+-------------------
Non-Look-Through Pool: | 400u | $140
Example 3--
(i) Facts.
(A) Foreign corporation A is and always has been a CFC since it was
incorporated in 1995. Foreign corporation B is and always has been a
non-look-through 10/50 corporation since it was incorporated in
1995. On December 31, 2001, foreign corporations A and B have the
following earnings and profits and foreign income taxes accounts:
Foreign Corporation A | E&P | Foreign Taxes
-------------------------------+------------+------------------
Separate Category: | |
Passive | (200u) | $ 10
-------------------------------+------------+------------------
10/50 dividends | 100u | $ 40
-------------------------------+------------+------------------
General | (300u) | $ 60
-------------------------------+------------+------------------
| (400u) | $110
Foreign Corporation B | E&P | Foreign Taxes
-------------------------------+------------+------------------
E&P accumulated as non- | |
look-through 10/50 corporation:| 200u | $ 30
(B) On January 1, 2002, foreign corporation B acquires the
assets of foreign corporation A in a reorganization described in
section 368(a)(1)(C). Immediately following the foreign 381
transaction, foreign surviving corporation is a non-look-through
10/50 corporation. (Assume that none of the shareholders of
foreign corporation A are required to include an amount in income
under §1.367(b)-4 with regard to this transaction.)
(ii) Result. Because foreign corporation A has an aggregate
deficit in post-1986 undistributed earnings, the rules of
paragraph (e)(2)(iii) of this section apply. Accordingly,
foreign corporation A's 400u aggregate deficit in earnings and
profits ((200u) + 100u + (300u)) carries over as a hovering
deficit to foreign surviving corporation, so that foreign
surviving corporation has the following earnings and profits and
foreign income taxes accounts:
| Earnings & Profits: | Foreign Taxes:
-------------------+----------------------------+--------------------
| | | |Foreign
| | | |Taxes
| | | |Associated
| | |Foreign |with
| Positive | |Taxes |Hovering
Separate Category | E&P |Hovering Deficit|Available|Deficit
-------------------+-----------+----------------+---------+----------
Non-Look- | | | |
Through Pool: | 200u | (400u) | $30 | $110
(iii) Post-transaction earnings.
(A) In the taxable year ending on December 31, 2002, foreign
surviving corporation accumulates earnings and profits and pays
related foreign income taxes as follows:
| E&P | Foreign Taxes
------------------------------+-------+-------------------
E&P accumulated as non-look- | |
through 10/50 corporation: | 500u | $100
(B) Under the rule described in paragraph (e)(2)(iii)(A) of this
section, the hovering deficit of 400u in the non-look-through pool
offsets 400u of post-transaction earnings. Under the rules of
paragraph (e)(2)(iii)(B) of this section, the foreign income taxes
related to the hovering deficit are added to foreign surviving
corporation's available foreign income taxes because post-
transaction earnings have been offset by and exceed the deficit in
the non-look-through pool. Accordingly, foreign surviving
corporation has the following earnings and profits and foreign
income taxes accounts as of December 31, 2002:
| E&P | Foreign Taxes
-----------------------+-------+-------------------
Non-Look-Through Pool: | 300u | $240
(f) Pre-pooling annual layers--
(1) If foreign surviving corporation is a look-through corporation
or a non-look-through 10/50 corporation. If the foreign surviving
corporation is a look-through corporation or a non-look-through
10/50 corporation, the pre-pooling annual layers shall be determined
under the rules of this paragraph (f)(1).
(i) Qualifying earnings and taxes. The pre-pooling annual layers
shall consist of the pre-1987 accumulated profits and the pre-1987
foreign income taxes of the foreign acquiring corporation and the
foreign target corporation.
(ii) Carryover rule. Subject to paragraph (f)(1)(iii) of this
section, the amounts described in paragraph (f)(1)(i) of this
section attributable to the foreign acquiring corporation and the
foreign target corporation shall carry over to the foreign surviving
corporation but shall not be combined. Thus, when the foreign
acquiring corporation and the foreign target corporation have
pre-1987 accumulated profits in the same year and a distribution is
made therefrom, the rules of §1.902- 1(b)(2)(ii) and (b)(3)
shall apply separately to reduce pre-1987 accumulated profits and
pre-1987 foreign income taxes of the foreign acquiring corporation
and the foreign target corporation on a pro rata basis. For further
guidance, see Rev. Rul. 68-351 (1968-2 C.B. 307); Rev. Rul. 70-373
(1970-2 C.B. 152) (see also §601.601(d)(2) of this chapter);
see also paragraph (g)(2) of this section (governing the
reconciliation of taxable years).
(iii) Deficits. The rules of this paragraph (f)(1)(iii)
apply when the foreign acquiring corporation or the foreign
target corporation (or both) has a deficit in one or more years
that comprise its pre-1987 accumulated profits immediately prior
to the foreign 381 transaction (see also paragraphs (g)(1) and
(g)(4) of this section, describing other rules applicable to a
deficit described in this paragraph (f)(1)(iii)).
(A) Aggregate positive earnings and profits. If the foreign
acquiring corporation or the foreign target corporation (or both)
has an aggregate positive (or zero) amount of pre-1987 accumulated
profits, but a deficit in one or more individual years, then the
rules otherwise applicable to such deficits shall apply separately
to the pre-1987 accumulated profits and related foreign income taxes
of such corporation. For further guidance, see Rev. Rul. 74-550
(1974-2 C.B. 209) (see also §601.601(d)(2) of this chapter);
Champion Int'l Corp. v. Commissioner, 81 T.C. 424 (1983), acq. in
result, 1987-2 C.B. 1; Rev. Rul. 87-72 (1987- 2 C.B. 170) (see also
§601.601(d)(2) of this chapter). As a result, no amount in
excess of the aggregate positive amount of pre-1987 accumulated
profits shall be distributed from the pre- transaction earnings of
the foreign acquiring corporation or the foreign target corporation.
(B) Aggregate deficit in earnings and profits. If the foreign
acquiring corporation or the foreign target corporation (or both)
has an aggregate deficit in pre-1987 accumulated profits, then the
rules under §1.902-2(b) shall apply to such deficit (and
related foreign income taxes) immediately prior to the transaction,
except that the aggregate deficit that is carried forward into the
look-through pool (in the case of a foreign surviving corporation
that is a look-through corporation) or non-look-through pool (in the
case of a foreign surviving corporation that is a non-look-through
10/50 corporation) shall be available to offset only post-
transaction earnings accumulated by the foreign surviving
corporation.
(iv) Pre-1987 section 960 earnings and profits and foreign income
taxes. The pre-1987 section 960 earnings and profits and pre-1987
section 960 foreign income taxes attributable to the foreign
acquiring corporation and the foreign target corporation shall carry
over to the foreign surviving corporation but shall not be combined.
The rules otherwise applicable to such amounts shall apply
separately to the pre-1987 section 960 earnings and profits and
pre-1987 section 960 foreign income taxes of the foreign acquiring
corporation and the foreign target corporation on a pro rata basis.
For further guidance, see Notice 88-70 (1988-2 C.B. 369) (see also
§601.601(d)(2) of this chapter).
(v) Examples. The following examples illustrate the rules of this
paragraph (f)(1). The examples presume the following facts: foreign
corporation A was incorporated in 1998 and was a less-than-10%-U.S.-
owned foreign corporation through December 31, 1999. Foreign
corporation A became a non-look-through 10/50 corporation on January
1, 2000 and, as a result, began to maintain a pool of post-1986
undistributed earnings on that date. Foreign corporation B was
incorporated in 1998 and always has been owned by foreign
shareholders (and thus never has met the requirements of section
902(c)(3)(B)). Both foreign corporation A and foreign corporation B
always have had calendar taxable years. Foreign corporations A and B
(and all of their respective qualified business units as defined in
section 989) maintain a "u" functional currency. The examples are as
follows:
Example 1--
(i) Facts.
(A) On December 31, 2001, foreign corporations A and B have the
following earnings and profits and foreign income taxes accounts:
Foreign Corporation A | E&P | Foreign Taxes
-------------------------------+------------+------------------
E&P accumulated as non- | |
look-through 10/50 corporation:| 1,000u | $350
-------------------------------+------------+------------------
1999 | 400u | 160u
-------------------------------+------------+------------------
1998 | 100u | 5u
-------------------------------+------------+------------------
| 1,500u |
Foreign Corporation B | E&P | Foreign Taxes
-------------------------------+------------+------------------
2001 | 100u | 20u
-------------------------------+------------+------------------
2000 | 150u | 30u
-------------------------------+------------+------------------
1999 | 0u | 50u
-------------------------------+------------+------------------
1998 | 50u | 5u
-------------------------------+------------+------------------
| 300u | 105u
(B) On January 1, 2002, foreign corporation B acquires the assets of
foreign corporation A in a reorganization described in section
368(a)(1)(C). Immediately following the foreign 381 transaction,
foreign surviving corporation is a non-look-through 10/50
corporation.
(ii) Result. Under the rules described in paragraphs (e)(2)(i), (e)
(2)(ii), (f)(1)(i), and (f)(1)(ii) of this section, foreign
surviving corporation has the following earnings and profits and
foreign income taxes accounts:
| E&P | Foreign Taxes
------------------------------------+-------+-------------------
Non-look-through pool | 1,000u| $350
------------------------------------+-------+-------------------
2001 | 100u| 20u
------------------------------------+-------+-------------------
2000 | 150u| 30u
------------------------------------+-------+-------------------
Two Side-by-Side Layers of 1999 E&P:| |
1999 layer #1 (from Corp A) | 400u| 160u
------------------------------------+-------+-------------------
1999 layer #2 (from Corp B) | 0u| 50u
------------------------------------+-------+-------------------
Two Side-by-Side Layers of 1998 E&P:| |
1998 layer #1 (from Corp A) | 100u| 5u
------------------------------------+-------+-------------------
1998 layer #2 (from Corp B) | 50u| 5u
------------------------------------+-------+-------------------
| 1,800u|
(iii) Post-transaction distribution.
(A) During 2002, foreign surviving corporation does not accumulate
any earnings and profits or pay or accrue any foreign income taxes.
On December 31, 2002, foreign surviving corporation distributes
1,700u to its shareholders. Under the rules of paragraph (c)(2) of
this section, the distribution is first out of the non-look-through
pool, and then out of the pre-pooling annual layers under the LIFO
method, as follows:
Distribution | E&P | Foreign Taxes
--------------------------+---------------------+------------------
Non-look-through pool | 1,000u | $350
--------------------------+---------------------+------------------
2001 | 100u | 20u
--------------------------+---------------------+------------------
2000 | 150u | 30u
--------------------------+---------------------+------------------
Two Side-by-Side | |
Layers of 1999 E&P: | |
1999 layer #1 | 400u | 160u
--------------------------+---------------------+------------------
1999 layer #2 | 0u | 0u
--------------------------+---------------------+------------------
Two Side-by-Side | |
Layers of 1998 E&P: | |
1998 layer #1 | 33.33u | 1.67u
|(100u in layer / |
| 150u aggregate 1997 |
| earnings = 66.67% x |
| 50u distribution) |
--------------------------+---------------------+------------------
1998 layer #2 | 16.67u | 1.67u
|(50u in layer / |
| 150u aggregate 1997 |
| earnings = 33.33% x |
| 50u distribution) |
--------------------------+---------------------+------------------
| 1,700u |
(B) The foreign income taxes available to foreign surviving
corporation shareholders upon the distribution are subject to the
generally applicable rules and limitations, such as those of
sections 902 and 904(d).
(C) Immediately after the distribution, foreign surviving
corporation has the following earnings and profits and foreign
income taxes accounts:
| E&P | Foreign Taxes
------------------------------------+--------+-------------------
1999 layer #2 | 0.00u | 50.00u
------------------------------------+--------+-------------------
Two Side-by-Side Layers of 1998 E&P:| |
1998 layer #1 | 66.67u | 3.33u
------------------------------------+--------+-------------------
1998 layer #2 | 33.33u | 3.33u
------------------------------------+--------+-------------------
|100.00u | 56.66u
(iv) Post-transaction earnings. For the taxable year ending
on December 31, 2003, foreign surviving corporation accumulates
500u of current earnings and profits and pays $70 in foreign
income taxes. As of the close of the 2003 taxable year, foreign
surviving corporation has the following earnings and profits and
foreign income taxes accounts:
| E&P | Foreign Taxes
------------------------------------+--------+-------------------
E&P accumulated as non- | |
look-through 10/50 corporation | 500.00u| $70.00
------------------------------------+--------+-------------------
1999 | 0.00u| 50.00u
------------------------------------+--------+-------------------
Two Side-by-Side Layers of 1998 E&P:| |
1998 layer #1 | 66.67u| 3.33u
------------------------------------+--------+-------------------
1998 layer #2 | 33.33u| 3.33u
------------------------------------+--------+-------------------
| 600u|
Example 2--
(i) Facts.
(A) On December 31, 2001, foreign
corporations A and B have the following earnings and profits and
foreign income taxes accounts:
Foreign Corporation A | E&P | Foreign Taxes
-------------------------------+------------+------------------
E&P accumulated as non- | |
look-though 10/50 corporation | 1,000u | $350
-------------------------------+------------+------------------
1999 | 100u | 20u
-------------------------------+------------+------------------
1998 | (50u) | 5u
-------------------------------+------------+------------------
| 1,050u |
Foreign Corporation B | E&P | Foreign Taxes
-------------------------------+------------+------------------
2001 | 100u | 20u
-------------------------------+------------+------------------
2000 | (50u) | 5u
-------------------------------+------------+------------------
1999 | 0u | 50u
-------------------------------+------------+------------------
1998 | 100u | 10u
-------------------------------+------------+------------------
| 150u | 85u
(B) On January 1, 2002, foreign corporation B acquires the assets of
foreign corporation A in a reorganization described in section
368(a)(1)(C). Immediately following the foreign 381 transaction,
foreign surviving corporation is a non-look-through 10/50
corporation.
(ii) Result. Because foreign corporations A and B have aggregate
positive amounts of pre-1987 accumulated profits with a deficit in
one or more individual years, the rules of paragraph (f)(1)(iii)(A)
of this section apply. Accordingly, after the foreign 381
transaction, foreign surviving corporation has the following
earnings and profits and foreign income taxes accounts:
| Earnings & Profits: | Foreign Taxes:
-------------------+---------------------------+--------------------
| | | |Foreign
| | | |Taxes
| | | |Associated
| | |Foreign |with
| Positive | |Taxes |Hovering
Separate Category | E&P | Deficit E&P |Available|Deficit E&P
-------------------+----------+----------------+---------+-----------
Non-Look-Through | | | |
10/50 Pool | 1,000u | | $350 |
-------------------+----------+----------------+---------+-----------
2001 | 100u | | 20u |
-------------------+----------+----------------+---------+-----------
2000 | | (50u) | | 5u
-------------------+----------+----------------+---------+-----------
Two Side-by- | | | |
Side Layers of | | | |
1999 E&P: | | | |
1999 layer #1 | | | |
(from foreign | | | |
corporation A) | 100u | | 20u |
-------------------+----------+----------------+---------+-----------
1999 layer #2 | | | |
(from foreign | | | |
corporation B) | 0u | | 50u |
-------------------+----------+----------------+---------+-----------
Two Side-by- | | | |
Side Layers of | | | |
1998 E&P: | | | |
1998 layer #1 | | | |
(from foreign | | | |
corporation A) | | (50u) | | 5u
-------------------+----------+----------------+---------+-----------
1998 layer #2 | | | |
(from foreign | | | |
corporation B) | 100u | | 10u |
-------------------+----------+----------------+---------+-----------
| 1,300u | (100u) | | 10u
(iii) Post-transaction distribution--
(A) During 2002, foreign surviving corporation does not accumulate
any earnings and profits or pay or accrue any foreign income taxes.
On December 31, 2002, foreign surviving corporation distributes
1,175u to its shareholders. Under the rules described in paragraphs
(c)(2) and (f)(1)(iii)(A) of this section, the distribution is first
out of the non-look-through pool, and then out of the pre-pooling
annual layers, as follows:
Distribution | E&P | Foreign Taxes
-----------------------------+---------------------+------------------
Non-Look-Through 10/50 Amount| 1,000u | $350
-----------------------------+---------------------+------------------
2001 | 100u | 20u
-----------------------------+---------------------+------------------
2000 | 0u | 0u
-----------------------------+---------------------+------------------
Two Side-by-Side Layers | |
of 1999 E&P: | |
1999 layer #1 | 50u | 20u
-----------------------------+---------------------+------------------
1999 layer #2 | 0u | 0u
-----------------------------+---------------------+------------------
Two Side-by-Side Layers | |
of 1998 E&P: | |
1998 layer #1 | 0u | 0u
-----------------------------+---------------------+------------------
1998 layer #2 | 25u | 5u
-----------------------------+---------------------+------------------
| 1,175u |
(B) Under the rules described in paragraph (f)(1)(iii)(A) of this
section, the rules otherwise applicable when a foreign corporation
has an aggregate positive (or zero) amount of pre-1987 accumulated
profits, but a deficit in one or more individual years, apply
separately to the pre-1987 accumulated profits and related foreign
income taxes of foreign corporation A and foreign corporation B. As
a result, distributions out of the pre-pooling annual layers of
foreign corporation A and foreign corporation B can not exceed the
aggregate positive amount of pre-1987 accumulated profits of each
corporation. Accordingly, only 50u can be distributed from foreign
corporation A's pre-pooling annual layers and is out of its 1999
layer #1. Under Champion Int'l Corp. v. Commissioner, 81 T.C. 424
(1983), the full 20u of taxes related to 1999 layer #1 is reduced or
deemed paid ($20 x (50 ÷ 50)). Under Rev. Rul. 74-550 (1974-2
C.B. 209) (see also §601.601(d)(2) of this chapter), 100u is
distributed from foreign corporation B's 2001 annual layer. Foreign
corporation B's deficit in 2000 is then rolled back to offset its
1998 annual layer to reduce earnings in that layer to 50u, 25u of
which is distributed (and reduces one-half of that year's foreign
income taxes).
(C) The foreign income taxes available to foreign surviving
corporation shareholders upon the distribution are subject to the
generally applicable rules and limitations, such as those of
sections 902 and 904(d).
(D) Immediately after the distribution foreign surviving corporation
has the following earnings and profits and foreign income taxes
accounts:
| E&P | Foreign Taxes
------------------------------+--------+-------------------
2000 | 0u | 5u
------------------------------+--------+-------------------
1999 layer #2 | 0u | 50u
------------------------------+--------+-------------------
Two Side-by-Side Layers | |
of 1998 E&P: | |
1998 layer #1 | 0u | 5u
------------------------------+--------+-------------------
1998 layer #2 | 25u | 5u
------------------------------+--------+-------------------
| 25u | 65u
(E) Under the rules described in paragraph (f)(1)(iii)(A) of
this section, the 5u, 50u, and 5u of foreign income taxes related
to foreign surviving corporation's 2000 layer, 1999 layer #2, and
1998 layer #1, respectively, remain in those layers. These
foreign income taxes generally will not be reduced or deemed paid
unless a foreign tax refund restores a positive balance to the
associated earnings pursuant to section 905(c), and thus will be
trapped.
Example 3--
(i) Facts.
(A) On December 31, 2001, foreign corporations A and B have the
following earnings and profits and foreign income taxes accounts:
Foreign Corporation A | E&P | Foreign Taxes
-------------------------------+------------+------------------
E&P accumulated as non- | |
look-through 10/50 corporation:| 1,000u | $350
-------------------------------+------------+------------------
1999 | 150u | 20u
-------------------------------+------------+------------------
1998 | 100u | 5u
-------------------------------+------------+------------------
| 1,250u |
Foreign Corporation B | E&P | Foreign Taxes
-------------------------------+------------+------------------
2001 | 100u | 20u
-------------------------------+------------+------------------
2000 | (250u) | 5u
-------------------------------+------------+------------------
1999 | 0u | 50u
-------------------------------+------------+------------------
1998 | 100u | 10u
-------------------------------+------------+------------------
| (50u) | 85u
(B) On January 1, 2002, foreign corporation B acquires the assets of
foreign corporation A in a reorganization described in section
368(a)(1)(C). Immediately following the foreign 381 transaction,
foreign surviving corporation is a non-look-through 10/50
corporation.
(ii) Result.
(A) Because foreign corporation B has an aggregate deficit in
pre-1987 accumulated profits, the rules of paragraph (f)(1)(iii)(B)
of this section apply. Accordingly, §1.902-2(b) applies
immediately prior to the foreign 381 transaction, except that
foreign corporation B's aggregate deficit in pre-1987 accumulated
profits is carried forward into the post-1986 undistributed earnings
pool and is available to offset only post-transaction earnings
accumulated by foreign surviving corporation. Accordingly, after the
foreign 381 transaction, foreign surviving corporation has the
following earnings and profits and foreign income taxes accounts:
| Earnings & Profits: | Foreign Taxes:
-------------------+----------------------------+--------------------
| | | |Foreign
| | | |Taxes
| | | |Associated
| | |Foreign |with
| Positive | |Taxes |Hovering
Separate Category | E&P |Hovering Deficit|Available|Deficit
-------------------+-----------+----------------+---------+----------
Non-Look- | | | |
Through 10/50 | | | |
Pool | 1,000u | (50u) | $350 | $0
-------------------+-----------+----------------+---------+----------
2001 | 0u | | 20u |
-------------------+-----------+----------------+---------+----------
2000 | 0u | | 5u |
-------------------+-----------+----------------+---------+----------
Two Side-by-Side Layers of 1999 E&P:
1999 layer #1 | | | |
(from Corp A) | 150u | | 20u |
-------------------+-----------+----------------+---------+----------
1999 layer #2 | | | |
(from Corp B) | 0u | | 50u |
-------------------+-----------+----------------+---------+----------
Two Side-by-Side Layers of 1998 E&P:
1998 layer #1 | | | |
(from Corp A) | 100u | | 5u |
-------------------+-----------+----------------+---------+----------
1998 layer #2 | | | |
(from Corp B) | 0u | | 10u |
-------------------+-----------+----------------+---------+----------
| 1,250u | (50u) | | $0
(B) Under paragraph (f)(1)(iii)(B) of this section, the 20u, 5u,
50u, and 10u of foreign income taxes associated with foreign
corporation B's earnings and profits for 2001, 2000, 1999 layer #2,
and 1998 layer #2, respectively, remain in those layers. These
foreign income taxes generally will not be reduced or deemed paid
unless a foreign tax refund restores a positive balance to the
associated earnings pursuant to section 905(c), and thus will be
trapped.
(2) If foreign surviving corporation is a less-than-10%-U. S.-owned
foreign corporation. If the foreign surviving corporation is a less-
than-10%-U.S.-owned foreign corporation, then the pre-pooling annual
layers shall be determined under the rules of this paragraph (f)(2).
(i) Qualifying earnings and taxes. The pre-pooling annual layers
shall consist of the pre-1987 accumulated profits and the pre-1987
foreign income taxes of the foreign acquiring corporation and the
foreign target corporation. If the foreign acquiring corporation or
the foreign target corporation (or both) has post-1986 undistributed
earnings or a deficit in post-1986 undistributed earnings, then
those earnings or deficits and any related post-1986 foreign income
taxes shall be recharacterized as pre-1987 accumulated profits or
deficits and pre-1987 foreign income taxes of the foreign acquiring
corporation or the foreign target corporation accumulated
immediately prior to the foreign 381 transaction.
(ii) Carryover rule. Subject to paragraph (f)(2)(iii) of this
section, the amounts described in paragraph (f)(2)(i) of this
section attributable to the foreign acquiring corporation and the
foreign target corporation shall carry over to the foreign surviving
corporation but shall not be combined. Thus, when the foreign
acquiring corporation and the foreign target corporation have
pre-1987 accumulated profits in the same year and a distribution is
made therefrom, the principles of §1.902- 1(b)(2)(ii) and (3)
shall apply separately to reduce pre-1987 accumulated profits and
pre-1987 foreign income taxes of the foreign acquiring corporation
and the foreign target corporation on a pro rata basis. For further
guidance, see Rev. Rul. 68-351 (1968-2 C.B. 307); Rev. Rul. 70-373
(1970-2 C.B. 152) (see also §601.601(d)(2) of this chapter);
see also paragraph (g)(2) of this section (governing the
reconciliation of taxable years).
(iii) Deficits. The rules of this paragraph (f)(2)(iii) apply when
the foreign acquiring corporation or the foreign target corporation
(or both) has a deficit in one or more years that comprise its
pre-1987 accumulated profits immediately prior to the foreign 381
transaction (and after application of the last sentence of paragraph
(f)(2)(i) of this section). See also paragraphs (g)(1) and (4) of
this section (describing other rules applicable to a deficit
described in this paragraph (f)(2)(iii)).
(A) Aggregate positive earnings and profits. If the foreign
acquiring corporation or the foreign target corporation (or both)
has an aggregate positive (or zero) amount of pre-1987 accumulated
profits, but a deficit in one or more individual years, then the
rules otherwise applicable to such deficits shall apply separately
to the pre-1987 accumulated profits and related foreign income taxes
of such corporation. For further guidance, see Rev. Rul. 74-550
(1974-2 C.B. 209) (see also §601.601(d)(2) of this chapter);
Champion Int'l Corp. v. Commissioner, 81 T.C. 424 (1983), acq. in
result, 1987-2 C.B. 1; Rev. Rul. 87-72 (1987- 2 C.B. 170) (see also
§601.601(d)(2) of this chapter). As a result, no amount in
excess of the aggregate positive amount of pre-1987 accumulated
profits shall be distributed from the pre- transaction earnings of
the foreign acquiring corporation or the foreign target corporation.
(B) Aggregate deficit in earnings and profits. If the foreign
acquiring corporation or the foreign target corporation (or both)
has an aggregate deficit in pre-1987 accumulated profits, then the
rules otherwise applicable to such deficits shall apply separately
to the pre-transaction earnings and profits and related taxes of the
applicable corporation. See, e.g., sections 316(a) and 381(c)(2)(B).
Thus, any aggregate net deficit shall be available to offset only
post-transaction earnings accumulated by the foreign surviving
corporation.
(iv) Pre-1987 section 960 earnings and profits and foreign income
taxes. The pre-1987 section 960 earnings and profits and pre-1987
section 960 foreign income taxes attributable to the foreign
acquiring corporation and the foreign target corporation shall carry
over to the foreign surviving corporation but shall not be combined.
The rules otherwise applicable to such amounts shall apply
separately to the pre-1987 section 960 earnings and profits and
pre-1987 section 960 foreign income taxes of the foreign acquiring
corporation and the foreign target corporation on a pro rata basis.
For further guidance, see Notice 88-70 (1988-2 C.B. 369) (see also
§601.601(d)(2) of this chapter).
(v) Examples. The following examples illustrate the rules of this
paragraph (f)(2). The examples presume the following facts: Both
foreign corporation A and foreign corporation B always have had
calendar taxable years. Foreign corporations A and B (and all of
their respective qualified business units as defined in section 989)
maintain a "u" functional currency. The examples are as follows:
Example 1--
(i) Facts.
(A) Foreign corporations A and B both were incorporated in 1998.
Nine percent of the voting stock of foreign corporation A is owned
by domestic corporate shareholder C. Nine percent of the voting
stock of foreign corporation B is owned by domestic corporate
shareholder D. Shareholders C and D are unrelated. The remaining 91%
of the voting stock of each foreign corporation is owned by
unrelated foreign shareholders. Thus, neither corporation meets the
requirements of section 902(c)(3)(B). On December 31, 2001, foreign
corporations A and B have the following earnings and profits and
foreign income taxes accounts:
Foreign Corporation A | E&P | Foreign Taxes
-------------------------------+------------+------------------
2001 | 500u | 350u
-------------------------------+------------+------------------
2000 | 400u | 300u
-------------------------------+------------+------------------
1999 | 400u | 160u
-------------------------------+------------+------------------
1998 | 100u | 5u
-------------------------------+------------+------------------
| 1,400u | 815u
Foreign Corporation B | E&P | Foreign Taxes
-------------------------------+------------+------------------
2001 | 100u | 20u
-------------------------------+------------+------------------
2000 | 300u | 60u
-------------------------------+------------+------------------
1999 | 0u | 50u
-------------------------------+------------+------------------
1998 | 50u | 5u
-------------------------------+------------+------------------
| 450u | 135u
(B) On January 1, 2002, foreign corporation B acquires the
assets of foreign corporation A in a reorganization described in
section 368(a)(1)(C). Immediately following the foreign 381
transaction, foreign surviving corporation is a less-than-10%-U.
S.-owned foreign corporation that does not meet the
requirements of section 902(c)(3)(B).
(ii) Result. Under the rules described in paragraphs
(f)(2)(i) and (ii) of this section, foreign surviving corporation
has the following earnings and profits and foreign income taxes
accounts:
| E&P | Foreign Taxes
------------------------------------+---------+------------------
Two Side-by-Side Layers of 2001 E&P:| |
2001 layer #1 (from Corp A) | 500u | 350u
------------------------------------+---------+------------------
2001 layer #2 (from Corp B) | 100u | 20u
------------------------------------+---------+------------------
Two Side-by-Side Layers of 2000 E&P:| |
2000 layer #1 (from Corp A) | 400u | 300u
------------------------------------+---------+------------------
2000 layer #2 (from Corp B) | 300u | 60u
------------------------------------+---------+------------------
Two Side-by-Side Layers of 1999 E&P:| |
1999 layer #1 (from Corp A) | 400u | 160u
------------------------------------+---------+------------------
1999 layer #2 (from Corp B) | 0u | 50u
------------------------------------+---------+------------------
Two Side-by-Side Layers of 1998 E&P:| |
1998 layer #1 (from Corp A) | 100u | 5u
------------------------------------+---------+------------------
1998 layer #2 (from Corp B) | 50u | 5u
------------------------------------+---------+------------------
| 1,850u | 950u
(iii) Post-transaction distribution.
(A) During 2002, foreign surviving corporation does not accumulate
any earnings and profits or pay or accrue any foreign income taxes.
On December 31, 2002, foreign surviving corporation distributes 600u
to its shareholders. Under the rules of paragraph (c)(3) of this
section, the distribution is out of pre-pooling annual layers under
the LIFO method as follows:
| E&P | Foreign Taxes
------------------------------------+---------+------------------
Two Side-by-Side Layers of 2001 E&P:| |
2001 layer #1 (from Corp A) | 500u | 350u
------------------------------------+---------+------------------
2001 layer #2 (from Corp B) | 100u | 20u
------------------------------------+---------+------------------
| 600u | 370u
(B) Foreign surviving corporation's foreign income tax
accounts are reduced to reflect the distribution of earnings and
profits, see §1.902-1(a)(10)(iii), notwithstanding that no
shareholders are eligible to claim deemed paid foreign income
taxes under section 902.
(c) Immediately after the distribution, foreign surviving
corporation has the following earnings and profits and foreign
income taxes accounts:
| E&P | Foreign Taxes
------------------------------------+---------+------------------
Two Side-by-Side Layers of 2000 E&P:| |
2000 layer #1 (from Corp A) | 400u | 300u
------------------------------------+---------+------------------
2000 layer #2 (from Corp B) | 300u | 60u
------------------------------------+---------+------------------
Two Side-by-Side Layers of 1999 E&P:| |
1999 layer #1 (from Corp A) | 400u | 160u
------------------------------------+---------+------------------
1999 layer #2 (from Corp B) | 0u | 50u
------------------------------------+---------+------------------
Two Side-by-Side Layers of 1998 E&P:| |
1998 layer #1 (from Corp A) | 100u | 5u
------------------------------------+---------+------------------
1998 layer #2 (from Corp B) | 50u | 5u
------------------------------------+---------+------------------
| 1,250u | 580u
Example 2--
(i) Facts.
(A) The facts are the same as in Example 1 (i)(A), except that
foreign corporation A met the requirements of section 902(c)(3)(B)
on January 1, 2000, when U.S. corporate shareholder C acquired an
additional 1% of voting stock for a total ownership interest of 10%;
foreign corporation A thereby became a non-look-through 10/50
corporation. On December 31, 2001, foreign corporations A and B have
the following earnings and profits and foreign income taxes
accounts:
Foreign Corporation A | E&P | Foreign Taxes
-------------------------------+------------+------------------
E&P Accumulated as Non-Look- | |
Through 10/50 Corporation: | 900u | $650
-------------------------------+------------+------------------
1999 | 400u | 160u
-------------------------------+------------+------------------
1998 | 100u | 5u
-------------------------------+------------+------------------
| 1,400u |
Foreign Corporation B | E&P | Foreign Taxes
-------------------------------+------------+------------------
2001 | 100u | 20u
-------------------------------+------------+------------------
2000 | 300u | 60u
-------------------------------+------------+------------------
1999 | 0u | 50u
-------------------------------+------------+------------------
1998 | 50u | 5u
-------------------------------+------------+------------------
| 450u | 135u
(B) On January 1, 2002, foreign corporation B acquires the
assets of foreign corporation A in a reorganization described in
section 368(a)(1)(C). Immediately following the foreign 381
transaction, foreign surviving corporation is a less-than-10%-U.
S.-owned foreign corporation that does not meet the
requirements of section 902(c)(3)(B).
(ii) Result. Under the rules described in paragraphs
(f)(2)(i) and (ii) of this section, foreign surviving corporation
has the following earnings and profits and foreign income taxes
accounts:
| E&P | Foreign Taxes
------------------------------------+---------+------------------
Two Side-by-Side Layers of 2000 E&P:| |
2001 layer #1 (from Corp A's pool) | 900u | $650
------------------------------------+---------+------------------
2001 layer #2 (from Corp B's layer) | 100u | 20u
------------------------------------+---------+------------------
2000 (from Corp B): | 300u | 60u
------------------------------------+---------+------------------
Two Side-by-Side Layers of 1999 E&P:| |
1999 layer #1 (from Corp A) | 400u | 160u
------------------------------------+---------+------------------
1999 layer #2 (from Corp B) | 0u | 50u
------------------------------------+---------+------------------
Two Side-by-Side Layers of 1998 E&P:| |
1998 layer #1 (from Corp A) | 100u | 5u
------------------------------------+---------+------------------
1998 layer #2 (from Corp B) | 50u | 5u
------------------------------------+---------+------------------
| 1,850u |
(iii) Subsequent ownership change. On January 1, 2007, USS (a
domestic corporation) acquires 100% of the stock of foreign
surviving corporation. Under the rules of paragraph (g)(3) of this
section, foreign surviving corporation begins to pool its earnings
and profits under section 902(c)(3) as of January 1, 2007. Foreign
surviving corporation's earnings and profits and foreign income
taxes accrued before January 1, 2007 retain their character as
pre-1987 accumulated profits and pre-1987 foreign income taxes.
Example 3--
(i) Facts.
(A) The facts are the same as in Example 2 (i)(A), except that on
December 31, 2001, foreign corporations A and B have the following
earnings and profits and foreign income taxes accounts:
Foreign Corporation A | E&P | Foreign Taxes
-------------------------------+------------+------------------
E&P Accumulated as Non-Look- | |
Through 10/50 Corporation: | 1,000u | $500
-------------------------------+------------+------------------
1999 | (200u) | 10u
-------------------------------+------------+------------------
1998 | 400u | 5u
-------------------------------+------------+------------------
| 1,200u |
Foreign Corporation B | E&P | Foreign Taxes
-------------------------------+------------+------------------
2001 | 300u | 20u
-------------------------------+------------+------------------
2000 | (100u) | 60u
-------------------------------+------------+------------------
1999 | 0u | 50u
-------------------------------+------------+------------------
1998 | 50u | 5u
-------------------------------+------------+------------------
| 250u | 135u
(B) On January 1, 2002, foreign corporation B acquires the assets of
foreign corporation A in a reorganization described in section
368(a)(1)(C). Immediately following the foreign 381 transaction,
foreign surviving corporation is a less-than-10%-U. S.-owned foreign
corporation that does not meet the requirements of section 902(c)(3)
(B).
(ii) Result. Because foreign corporations A and B have aggregate
positive amounts of pre-1987 earnings and profits with a deficit in
one or more individual years, the rules of paragraph (f)(2)(iii)(A)
of this section apply. Accordingly, after the foreign 381
transaction, foreign surviving corporation has the following
earnings and profits and foreign income taxes accounts:
| Earnings & Profits: | Foreign Taxes:
-------------------+---------------------------+--------------------
| | | |Foreign
| | | |Taxes
| | | |Associated
| | |Foreign |with
| Positive | |Taxes |Hovering
Separate Category | E&P | Deficit E&P |Available|Deficit E&P
-------------------+----------+----------------+---------+-----------
Two Side-by- | | | |
Side Layers of | | | |
2001 E&P: | | | |
2001 layer #1 | | | |
(from Corp | | | |
A's non-look- | | | |
through 10/50 | | | |
pool) | 1,000u | | $500 |
-------------------+----------+----------------+---------+-----------
2001 layer #2 | | | |
(from Corp | | | |
B's layer) | 300u | | 20u |
-------------------+----------+----------------+---------+-----------
2000 (from | | | |
Corp B) | | (100u) | | 60u
-------------------+----------+----------------+---------+-----------
Two Side-by- | | | |
Side Layers of | | | |
1999 E&P: | | | |
1999 layer #1 | | | |
(from Corp A) | | (200u) | | 10u
-------------------+----------+----------------+---------+-----------
1999 layer #2 | | | |
(from Corp B) | 0u | | 50u |
-------------------+----------+----------------+---------+-----------
Two Side-by- | | | |
Side Layers of | | | |
1998 E&P: | | | |
1998 layer #1 | | | |
(from Corp A) | 400u | | 5u |
-------------------+----------+----------------+---------+-----------
1998 layer #2 | | | |
(from Corp B) | 50u | | 5u |
-------------------+----------+----------------+---------+-----------
| 1,750u | (300u) | 70u |
(iii) Post-transaction distribution.
(A) During 2002, foreign surviving corporation does not accumulate
any earnings and profits or pay or accrue any foreign income taxes.
On December 31, 2002, foreign surviving corporation distributes
1,300u to its shareholders. Under the rules described in paragraphs
(c)(3) and (f)(2)(iii)(A) of this section, the distribution is out
of the pre-pooling annual layers, as follows:
| E&P | Foreign Taxes
| | Paid
------------------------------------+---------+------------------
Two Side-by-Side Layers of 2001 E&P:| |
2001 layer #1 | 1,000u | $500
------------------------------------+---------+------------------
2001 layer #2 | 250u | 20u
------------------------------------+---------+------------------
1998 E&P: | |
1998 layer #1 | 50u | 1.25u (25% of
| | 5u taxes)
------------------------------------+---------+------------------
| 1,300u |
(B) Under the rules described in paragraph (f)(2)(iii)(A) of this
section, the rules otherwise applicable when a foreign corporation
has an aggregate positive (or zero) amount of pre-1987 accumulated
profits, but a deficit in one or more individual years, apply
separately to the pre-1987 accumulated profits and related foreign
income taxes of foreign corporation A and foreign corporation B. As
a result, distributions out of the pre-pooling annual layers of
foreign corporation A and foreign corporation B cannot exceed the
aggregate positive amount of pre-1987 accumulated profits of each
corporation. Accordingly, only 1,200u and 250u can be distributed
out of foreign corporation A's and foreign corporation B's pre-
pooling annual layers, respectively. Thus, 1,250u of the
distribution is out of 1,000u of foreign corporation A's 2001 layer
#1 and 250u of foreign corporation B's 2001 layer #2. Under the
principles of §1.902- 1(b)(3) and Champion Int'l Corp. v.
Commissioner, 81 T.C. 424 (1983), all of the taxes in each of those
respective layers are reduced. Applying Rev. Rul. 74-550 (1974-2
C.B. 209) (see also §601.601(d)(2) of this chapter), the
remaining 50u is distributed from foreign corporation A's 1998 layer
#1 (after rolling back the 200u deficit in 1999 layer #1 to reduce
earnings in 1998 layer #1 to 200u (400u - 200u)). Thus, after the
distribution, 150u remains in the 1998 layer #1 along with 3.75u of
foreign income taxes (5u x (150u ÷ 200u)).
(C) Foreign surviving corporation's foreign income tax accounts are
reduced to reflect the distribution of earnings and profits, see
§1.902-1(a)(10)(iii), notwithstanding that no shareholders are
eligible to claim a credit for deemed paid foreign income taxes
under section 902.
(D) Immediately after the distribution foreign surviving corporation
has the following earnings and profits and foreign income taxes
accounts:
| E&P | Foreign Taxes
------------------------------------+---------+------------------
2000 | 0u | 60u
------------------------------------+---------+------------------
Two Side-by-Side Layers | |
of 1999 E&P: | |
1999 layer #1 | 0u | 10u
------------------------------------+---------+------------------
1999 layer #2 | 0u | 50u
------------------------------------+---------+------------------
Two Side-by-Side Layers | |
of 1998 E&P: | |
1998 layer #1 | 150u | 3.75u
------------------------------------+---------+------------------
1998 layer #2 | 0u | 5u
------------------------------------+---------+------------------
| 150u | 128.75u
(E) Under the rules described in paragraph (f)(2)(iii)(A) of this
section, the 60u, 10u, 50u, and 5u of foreign income taxes related
to foreign surviving corporation's 2000 layer, 1999 layer #1, 1999
layer #2, and 1998 layer #2, respectively, remain in those layers.
These foreign income taxes generally will not be reduced or deemed
paid unless a foreign tax refund restores a positive balance to the
associated earnings pursuant to section 905(c), and thus will be
trapped.
Example 4--
(i) Facts.
(A) The facts are the same as in Example 2 (i)(A), except that on
December 31, 2001, foreign corporations A and B have the following
earnings and profits and foreign income taxes accounts:
Foreign Corporation A | E&P | Foreign Taxes
-------------------------------+------------+------------------
E&P Accumulated as Non-Look- | |
Through 10/50 Corporation: | (1,000u) | $20
-------------------------------+------------+------------------
1999 | (200u) | 10u
-------------------------------+------------+------------------
1998 | 400u | 5u
-------------------------------+------------+------------------
| (800u) |
Foreign Corporation B | E&P | Foreign Taxes
-------------------------------+------------+------------------
2001 | 100u | 20u
-------------------------------+------------+------------------
2000 | 300u | 60u
-------------------------------+------------+------------------
1999 | 0u | 50u
-------------------------------+------------+------------------
1998 | 50u | 5u
-------------------------------+------------+------------------
| 450u | 135u
(B) On January 1, 2002, foreign corporation A acquires the assets of
foreign corporation B in a reorganization described in section
368(a)(1)(C). Immediately following the foreign 381 transaction,
foreign surviving corporation is a less-than-10%-U. S.-owned foreign
corporation.
(ii) Result. Because foreign corporation A has an aggregate deficit
in pre-1987 earnings and profits, the rules of paragraph (f)(2)(iii)
(B) of this section apply and the rules otherwise applicable apply
separately to the pre-1987 accumulated profits that carry over to
foreign surviving corporation from foreign corporation A.
Accordingly, after the foreign 381 transaction, foreign surviving
corporation has the following earnings and profits and foreign
income taxes accounts:
| Earnings & Profits: | Foreign Taxes:
-------------------+---------------------------+--------------------
| | | |Foreign
| | | |Taxes
| | | |Associated
| | |Foreign |with
| Positive | |Taxes |Hovering
Separate Category | E&P | Deficit E&P |Available|Deficit E&P
-------------------+----------+----------------+---------+-----------
Two Side-by- | | | |
Side Layers of | | | |
2001 E&P: | | | |
layer #1 | | | |
(from Corp A) | | (1,000u) | | $20
-------------------+----------+----------------+---------+-----------
2001 layer #2 | | | |
(from Corp B) | 100u | | 20u |
-------------------+----------+----------------+---------+-----------
2000 | 300u | | 60u |
-------------------+----------+----------------+---------+-----------
Two Side-by- | | | |
Side Layers | | | |
of 1999 E&P: | | | |
1999 layer #1 | | | |
(from Corp A) | | (200u) | | 10u
-------------------+----------+----------------+---------+-----------
1999 layer #2 | | | |
(from Corp B) | 0u | | 50u |
-------------------+----------+----------------+---------+-----------
Two Side-by-Side | | | |
Layers of 1998 E&P:| | | |
1998 layer #1 | | | |
(from Corp A) | 400u | | 5u |
-------------------+----------+----------------+---------+-----------
1998 layer #2 | | | |
(from Corp B) | 50u | | 5u |
-------------------+----------+----------------+---------+-----------
| 850u | (1,200u) | 140u |
(iii) Post-transaction distribution.
(A) During 2002, foreign surviving corporation does not accumulate
any earnings and profits or pay or accrue any foreign income taxes.
On December 31, 2002, foreign surviving corporation distributes 200u
to its shareholders. Under the rules described in paragraph (f)(2)
(iii)(B) of this section, no distribution can be made out of the
pre-1987 accumulated profits of foreign corporation A (and the 800u
aggregate deficit is available to offset only post-transaction
earnings accumulated by foreign surviving corporation). Thus, the
distribution is out of pre-pooling annual layers as follows:
| E&P | Foreign Taxes
| | Paid
------------------------------------+---------+------------------
2001 layer #2 | 100u | 20u
------------------------------------+---------+------------------
2000 | 100u | 20u
------------------------------------+---------+------------------
| 200u | 40u
(B) Foreign surviving corporation's foreign income tax accounts are
reduced to reflect the distribution of earnings and profits, see
§1.902-1(a)(10)(iii), notwithstanding that no shareholders are
eligible to claim deemed paid foreign income taxes under section
902.
(g) Special rules--
(1) Treatment of deficit. Any deficit described in paragraph (d)(2),
(e)(1)(iii), (e)(2)(iii), (f)(1)(iii), or (f)(2)(iii) of this
section shall not be taken into account in determining current or
accumulated earnings and profits of a foreign surviving corporation,
including for purposes of calculating--
(A) The earnings and profits limitation of section 952(c)(1)(A) and
(c)(1)(C); and
(B) the amount of the foreign surviving corporation's subpart F
income as defined in section 952(a).
(2) Reconciling taxable years. If a foreign acquiring corporation
and a foreign target corporation had taxable years ending on
different dates, then the pro rata distribution rules of paragraphs
(f)(1)(ii) and (f)(2)(ii) of this section shall apply with respect
to the taxable years that end within the same calendar year.
(3) Post-transaction change of status. If a foreign surviving
corporation that is subject to the rules of paragraph (c)(2) of this
section subsequently becomes a look-through corporation, or if a
foreign surviving corporation that is subject to the rules of
paragraph (c)(3) of this section subsequently becomes a non-look-
through 10/50 corporation or a look-through corporation, by reason,
for example, of a reorganization, liquidation, or change of
ownership, then post-1986 undistributed earnings and post-1986
foreign income taxes that have lost their look-through or pooling
character by reason of this section shall not have such look-through
or pooling character restored. See, e.g., paragraph (f)(2)(v)
Example 2 of this section.
(4) Ordering rule for offsetting multiple hovering deficits --
(i) Rule. A foreign surviving corporation shall apply the deficit
rules of paragraphs (d)(2), (e)(1)(iii), (e)(2)(iii), (f)(1)(iii),
and (f)(2)(iii) of this section in that order (in the event that
more than one of such rules applies to the foreign surviving
corporation).
(ii) Example. The following example illustrates the rules of this
paragraph (g)(4). The examples presume the following facts: Foreign
corporation A was a non-look-through 10/50 corporation from its
incorporation on January 1, 1995 until December 31, 1997; foreign
corporation A became a CFC on January 1, 1998 and has been a CFC
since that time. Foreign corporation B has been a non-look-through
10/50 corporation since its incorporation on January 1, 1993.
Foreign corporations A and B always have had calendar taxable years.
Foreign corporations A and B (and all of their respective qualified
business units as defined in section 989) maintain a "u" functional
currency. Finally, any earnings and profits described in section
904(d)(1)(E) (10/50 dividends) qualified for the high tax exception
from subpart F income under section 954(b)(4), and all shareholders
elected to exclude such earnings and profits from subpart F income
under section 954(b)(4) and §1.954-1(d)(5). The example is as
follows:
Example--
(i) Facts.
(A) On December 31, 2001, foreign corporations A and B have the
following earnings and profits and foreign income taxes accounts:
Foreign Corporation A | E&P | Foreign Taxes
----------------------------+-----------------+----------------
Separate Category: | |
10/50 dividends from FC1, | |
a noncontrolled section | |
902 corporation | 100u | $60
----------------------------+-----------------+----------------
General | (300u) | $25
----------------------------+-----------------+----------------
E&P Accumulated as Non-Look-| |
Through 10/50 Corporation: | 300u | $100
----------------------------+-----------------+----------------
| 100u | $185
Foreign Corporation B | E&P | Foreign Taxes
E&P Accumulated as Non-Look-| |
----------------------------+-----------------+----------------
Through 10/50 Corporation: | (200u) | $50
(B) On January 1, 2002, foreign corporation B acquires the
assets of foreign corporation A in a reorganization described in
section 368(a)(1)(C). Immediately following the foreign 381
transaction, foreign surviving corporation is a CFC.
(ii) Result. Under the rules described in paragraphs
(d)(1), (d)(2), (e)(1)(i), (e)(1)(ii), and (e)(1)(iii) of this
section, foreign surviving corporation has the following earnings
and profits and foreign income taxes accounts:
| Earnings & Profits: | Foreign Taxes:
-------------------+----------------------------+--------------------
| | | |Foreign
| | | |Taxes
| | | |Associated
| | |Foreign |with
| Positive | |Taxes |Hovering
Separate Category | E&P |Hovering Deficit|Available|Deficit
-------------------+-----------+----------------+---------+----------
Look-Through Pool: | | | |
10/50 dividends | 100u | | $60 |
-------------------+-----------+----------------+---------+----------
General | | (300u) | | $25
-------------------+-----------+----------------+---------+----------
Two Side-by- | | | |
Side Non-Look- | | | |
Through Pool | | | |
Amounts: | | | |
Non-look- | | | |
through pool | | | |
amount #1 (from | | | |
Corp A) | 300u | | $100 |
-------------------+-----------+----------------+---------+----------
Non-look- | | | |
through pool | | | |
amount #2 (from | | | |
Corp B) | | (200u) | | $50
-------------------+-----------+----------------+---------+----------
| 400u | (500u) | $160 | $75
(iii) Post-transaction earnings.
(A) In the taxable year ending on December 31, 2002, foreign
surviving corporation accumulates earnings and profits and pays
related foreign income taxes as follows:
Separate Category | E&P | Foreign Taxes
-------------------------+-------+------------------
10/50 dividends from FC1 | 150u | $ 40
-------------------------+-------+------------------
General | 400u | $ 60
-------------------------+-------+------------------
| 550u | $100
(B) None of the earnings and profits qualify as subpart F income as
defined in section 952(a). Under the rules of paragraph (g)(4)(i) of
this section, the rules of paragraph (d)(2) of this section apply
before the rules of paragraph (e)(1)(iii) of this section.
Accordingly, post-transaction earnings in a separate category are
first offset by a hovering deficit in the same separate category in
the look-through pool. Thus, foreign surviving corporation's 300u
deficit in the section 904(d)(1)(I) general separate category
offsets 300u of post-transaction general separate category earnings.
After application of paragraph (d)(2) of this section, foreign
surviving corporation has the following post-transaction earnings
available for further offset by a hovering deficit: 150u in the
section 904(d)(1)(E) 10/50 dividends separate category and 100u in
the general separate category. Under paragraph (e)(1)(iii) of this
section, a deficit in the non-look-through pool offsets a pro rata
portion of post-transaction earnings in each separate category.
Thus, foreign surviving corporation's 200u deficit in non-look-
through pool amount #2 offsets the remaining post-transaction
earnings on a pro rata basis (200u x (150u ÷ 250u) = 120u
against 10/50 dividends separate category earnings and 200u x (100u
÷ 250u) = 80u against general separate category earnings).
Accordingly, foreign surviving corporation has the following
earnings and profits and foreign income taxes accounts at the end of
2002:
| E&P | Foreign Taxes
------------------------------------+-----------+-----------------
Look-Through Pool Separate Category:| |
10/50 dividends | 130u | $100
------------------------------------+-----------+-----------------
General | 20u | $85
------------------------------------+-----------+-----------------
Two Side-by-Side Non-Look-Through | |
Pool Amounts: | |
Non-look-through pool amount #1 | 300u | $100
------------------------------------+-----------+-----------------
Non-look-through pool amount #2 | 0u | $ 50
------------------------------------+-----------+-----------------
| 450u | $335
(C) Under paragraph (d)(2)(ii) of this section, the $25 of foreign
income taxes related to the 300u hovering deficit in the section
904(d)(1)(I) general separate category is added to foreign surviving
corporation's post-1986 foreign income taxes in that separate
category (because post-transaction earnings in the general separate
category have been offset by and exceed the deficit in that
category). Under paragraph (e)(1)(iii)(B) of this section, the $50
of foreign income taxes related to the 200u hovering deficit in non-
look-through pool amount #2 is added to foreign surviving
corporation's post-1986 foreign income taxes for non-look-through
pool amount #2 (because post-transaction earnings have been offset
by and exceed the deficit in the non-look- through pool). However,
the $50 of foreign income taxes generally will not be reduced or
deemed paid unless a foreign tax refund restores a positive balance
to the associated earnings pursuant to section 905(c), and thus will
be trapped.
(5) Pro rata rule for earnings during transaction year. For purposes
of offsetting post-transaction earnings of a foreign surviving
corporation under the rules described in paragraphs (d)(2), (e)(1)
(iii), (e)(2)(iii), (f)(1)(iii), and (f)(2)(iii), the earnings and
profits for the taxable year of the foreign surviving corporation in
which the transaction occurs shall be deemed to have been
accumulated after such transaction in an amount which bears the same
ratio to the undistributed earnings and profits of the foreign
surviving corporation for such taxable year (computed without regard
to any earnings and profits carried over) as the number of days in
the taxable year after the date of transaction bears to the total
number of days in the taxable year. See, e.g., §1.381(c)
(2)-1(a)(7) Example 2 (illustrating application of this rule with
respect to domestic corporations).
(6) Nonapplicability of hovering deficit rules to certain
transactions--
(i) Rule. If a principal purpose of a foreign 381 transaction is to
gain a tax benefit from affirmative use of the hovering deficit rule
described in paragraph (d)(2), (e)(1)(iii), (e)(2)(iii), (f)(1)
(iii), or (f)(2)(iii) of this section, then the Commissioner may
exercise discretion to apply the principles of §1.367(b)-9 to
such transaction.
(ii) Example. The following example illustrates the rules of this
paragraph (h)(6). The example is as follows:
Example--
(i) Facts.
(A) Foreign corporations A and B are and always have been wholly
owned subsidiaries of USP, a domestic corporation. Both foreign
corporations A and B were incorporated in 1990, and both always have
been CFCs using a calendar taxable year. Both foreign corporations A
and B (and all of their respective qualified business units as
defined in section 989) maintain a "u" functional currency and 1u =
US$1 at all times. Any earnings and profits described in section
904(d)(1)(E) (10/50 dividends) qualified for the high tax exception
from subpart F income under section 954(b)(4), and USP elected to
exclude such earnings and profits from subpart F income under
section 954(b)(4) and §1.954-1(d)(5). On December 31, 2001,
foreign corporation A and foreign corporation B have the following
earnings and profits and foreign income taxes accounts:
Foreign Corporation A | E&P | Foreign Taxes
----------------------------+-----------------+----------------
Separate Category: | |
Passive | (1,000u) | $ 5
General | 200u | $200
| (800u) | $205
Foreign Corporation A | E&P | Foreign Taxes
----------------------------+-----------------+----------------
Separate Category: | |
10/50 dividends | 5u | $ 3
(B) On January 1, 2002, foreign corporation B acquires the assets of
foreign corporation A in a reorganization described in section
368(a)(1)(C). A principal purpose of the foreign 381 transaction is
to gain a tax benefit from affirmative use of the hovering deficit
rule described in paragraph (d)(2) of this section. Immediately
following the foreign 381 transaction, foreign surviving corporation
is a CFC.
(ii) Result under general rules.
(A) If the rules of paragraphs (d)(1) and (2) of this section were
to apply, foreign surviving corporation would have the following
earnings and profits and foreign income taxes accounts immediately
after the foreign 381 transaction:
| Earnings & Profits: | Foreign Taxes:
-------------------+----------------------------+--------------------
| | | |Foreign
| | | |Taxes
| | | |Associated
| | |Foreign |with
| Positive | |Taxes |Hovering
Separate Category | E&P |Hovering Deficit|Available|Deficit
-------------------+-----------+----------------+---------+----------
Passive | | (1,000u) | | $5
-------------------+-----------+----------------+---------+----------
10/50 dividends | 5u | | $ 3 |
-------------------+-----------+----------------+---------+----------
General | 200u | | $200 |
-------------------+-----------+----------------+---------+----------
| 205u | (1,000u) | $203 | $5
(B) Accordingly, if the hovering deficit rules of paragraph (d)(2)
of this section were to apply, foreign surviving corporation would
be able to pay to USP a dividend of $205 that would carry deemed
paid foreign income taxes of $203 under section 902.
(iii) Result under this paragraph (g)(6). Because a principal
purpose of the foreign 381 transaction was to gain a tax benefit
from affirmative use of the hovering deficit rule described in
paragraph (d)(2) of this section, the Commissioner may exercise
discretion to apply the principles of §1.367(b)-9 to the
transaction. Under the principles of §1.367(b)-9, the earnings and
profits and foreign income taxes accounts of foreign corporation A
and foreign corporation B are combined under paragraph (d)(1) of
this section without reference to the hovering deficit rule of
paragraph (d)(2) of this section. Accordingly, foreign surviving
corporation would have the following earnings and profits and
foreign income taxes accounts immediately after the transaction:
Separate Category | E&P | Foreign Taxes
--------------------+---------+------------------
Passive |(1,000u) | $ 5
--------------------+---------+------------------
10/50 dividends | 5u | $ 3
--------------------+---------+------------------
General | 200u | $200
--------------------+---------+------------------
| (795u) | $208
(h) Effective date. This section shall apply to section 367(b)
exchanges that occur on or after the date 30 days after these
regulations are published as final regulations in the Federal
Register.
Par. 10. Section 1.367(b)-8 is added to read as follows:
§1.367(b)-8 Allocation of earnings and profits and foreign
income taxes in certain foreign corporate separations.
(a) Scope. This section applies to distributions to which section
355 (or so much of section 356 as relates to section 355) applies,
whether or not in connection with a section 368(a)(1)(D)
reorganization (D reorganization), in which the distributing
corporation or the controlled corporation (or both) is a foreign
corporation (foreign divisive transaction). For purposes of this
section, the terms distributing corporation and controlled
corporation have the same meaning as used in section 355 and the
regulations thereunder. Paragraph (b) of this section provides
general rules governing the allocation and reduction of a
distributing corporation's earnings and profits and foreign income
taxes (pre-transaction earnings and pre-transaction taxes,
respectively) in foreign divisive transactions. Paragraphs (c), (d),
and (e) of this section describe special rules for the application
of paragraph (b) of this section to specific situations, depending
upon whether the distributing corporation or the controlled
corporation (or both the distributing and the controlled
corporation) is a foreign corporation.
(b) General rules--
(1) Application of §1.312-10--
(i) In general. Pre-transaction earnings of a distributing
corporation shall be allocated between the distributing corporation
and the controlled corporation in accordance with the rules of
§1.312- 10(a) and shall be reduced in accordance with the rules
of §1.312-10(b), except to the extent otherwise provided in
this section.
(ii) Special rules for application of §1.312-10(b)--
(A) Distributing corporation. The pre-transaction earnings of a
distributing corporation shall be reduced without taking into
account §1.312-10(b)(2).
(B) Controlled corporation. Section 1.312-10(b) shall not apply to
increase or replace the earnings and profits of a controlled
corporation by the amount of any decrease in the pre- transaction
earnings of a distributing corporation.
(iii) Net deficit in pre-transaction earnings. Nothing in
this section shall permit any portion of the pre-transaction
earnings of a distributing corporation that has a net deficit in
pre-transaction earnings to be allocated or reduced under
paragraph (b)(1)(i) of this section. See §1.312-10(c). Compare
paragraph (b)(2) of this section (requiring an allocation or
reduction of a pro rata portion of deficits in statutory
groupings of earnings and profits when a distributing corporation
has a net positive amount of pre-transaction earnings).
(iv) Use of net bases. All allocations and reductions described in
paragraph (b)(1)(i) of this section shall be determined in
accordance with the net bases in assets. Net basis shall have the
same meaning as under §1.312-10(a).
(v) Gain recognized by distributing corporation. The pre-transaction
earnings that are subject to allocation or reduction
under paragraph (b)(1)(i) of this section shall include any
increase in earnings and profits from gain recognized or income
included by the distributing corporation as a result of the
foreign divisive transaction. See, for example, section 367(a)
and (e), section 1248(f), and §1.367(b)-5(b).
(vi) Coordination with branch profits tax. An allocation or
reduction in a distributing corporation's pre-transaction
earnings under paragraph (b)(1)(i) of this section shall not be
out of or reduce effectively connected earnings and profits or
non-previously taxed accumulated effectively connected earnings
and profits, as defined in section 884. See also §1.884-
2T(d)(5)(iii) (providing that such earnings and profits are not
subject to reduction under §1.312-10(b)).
(2) Cross-section of earnings and profits. Except to the
extent provided in paragraphs (b)(1)(iii), (b)(1)(vi),
(d)(2)(ii), (d)(4), and (e)(4) of this section and other than any
portion attributable to an inclusion under §1.367(b)-5 or
paragraph (d)(2)(i) of this section, an allocation or reduction
of pre-transaction earnings described in paragraph (b)(1)(i) of
this section shall decrease, on a pro rata basis, the statutory
groupings of earnings and profits (or deficits in statutory
groupings of earnings and profits) of the distributing
corporation. Thus, for example, a pro rata portion of a foreign
distributing corporation's separate categories, post-1986
undistributed earnings, and annual layers of pre-1987 accumulated
profits and pre-1987 section 960 earnings and profits shall be
allocated or reduced.
(3) Foreign income taxes. Pre-transaction taxes of a
distributing corporation shall be ratably allocated or reduced
only to the extent described in paragraphs (d)(3) and (e)(3) of
this section. Thus, a distributing corporation's excess foreign
taxes described in section 904(c) shall not be allocated or
reduced under this section.
(4) Divisive D reorganization with a preexisting controlled
corporation. In the case of a foreign divisive transaction that
includes a D reorganization with a controlled corporation that is
not newly created (a preexisting controlled corporation),
paragraph (b)(1)(i) of this section shall apply in the following
manner:
(i) Calculation of earnings and profits of distributing
corporation. The pre-transaction earnings of a distributing
corporation shall be reduced by the sum of--
(A) The amount of the reduction in the pre-transaction earnings of
the distributing corporation as described in §1.312- 10(a) (as
determined under this section); and
(B) The amount of the reduction in the pre-transaction earnings of
the distributing corporation as described in §1.312- 10(b) (as
determined under this section).
(ii) Calculation of earnings and profits of controlled
corporation. The amount of earnings and profits of the
controlled corporation immediately after the foreign divisive
transaction shall equal the sum of--
(A) The amount described in paragraph (b)(4)(i)(A) of this section
(except to the extent such amounts are included in income as a
deemed dividend pursuant to the foreign divisive transaction or are
subject to the rule of §1.367(b)-3(f)); and
(B) The amount of earnings and profits of the controlled corporation
immediately before the foreign divisive transaction.
(C) Foreign divisive transactions involving a domestic distributing
corporation and a foreign controlled corporation--
(1) Scope. The rules of this paragraph (c) apply to a foreign
divisive transaction involving a domestic distributing
corporation and a foreign controlled corporation.
(2) Earnings and profits allocated to a foreign controlled
corporation. Pre-transaction earnings of a domestic distributing
corporation that are allocated to a foreign controlled corporation
under the rules described in paragraph (b)(1)(i) of this section
shall not be included in the foreign controlled corporation's
post-1986 undistributed earnings, pre-1987 accumulated profits, or
pre-1987 section 960 earnings and profits. In addition, if a
distribution by the domestic distributing corporation out of pre-
transaction earnings immediately before the foreign divisive
transaction would have been treated as a U.S. source dividend under
section 861(a)(2)(A) that would not be exempt from tax under section
871(i)(2)(B) or 881(d), a distribution out of such earnings and
profits by the foreign controlled corporation shall be treated as a
U.S. source dividend under section 904(g) and for purposes of
Chapter 3 of subtitle A of the Internal Revenue Code. See Georday
Enterprises v. Commissioner, 126 F.2d 384 (4th Cir. 1942). See also
sections 243(e) and 861(a)(2)(C) and §1.367(b)-2(j) for other
rules that may apply.
(3) Examples. The following examples illustrate the application of
the rules of this section to transactions described in paragraph (c)
(1) of this section. The examples presume the following facts: USD
is a domestic corporation engaged in manufacturing and shipping
activities through Business A and Business B, respectively. FC is a
foreign corporation that is wholly owned by USD. USD and FC use
calendar taxable years. FC (and all of its qualified business units
as defined in section 989) maintains a "u" functional currency and,
except as otherwise specified, 1u = US$1 at all times. The examples
are as follows:
Example 1--
(i) Facts. The stock of USD is owned in equal parts by three
shareholders, USP (a domestic corporation), USI (a United States
citizen), and FP (a foreign corporation). USD owns assets with total
net bases of $260 (including $100 attributable to the Business B
shipping assets, which have a $160 fair market value). USD has $500
of earnings and profits (that it accumulated). The entire $500 would
have been treated as a U.S. source dividend under section 861(a)(2)
(A) that would not be exempt from tax under sections 871(i)(2)(B) or
881(d) if distributed by USD immediately before the foreign divisive
transaction. On January 1, 2002, USD incorporates FC and transfers
to FC the Business B shipping assets. USD then distributes the FC
stock pro rata to USP, USI, and FP. The transaction meets the
requirements of sections 368(a)(1)(D) and 355.
(ii) Result--
(A) Gain Recognition. Under section
367(a)(5), USD recognizes gain equal to the difference between
the fair market value and USD's adjusted basis in the Business B
shipping assets ($160 - $100 = $60).
(B) Calculation of USD's earnings and profits. Under paragraph (b)
(1)(v) of this section, USD's pre-transaction earnings include any
gain recognized or income included as a result of the foreign
divisive transaction. As described in this Example 1 (ii)(A), USD
recognizes $60 of gain as a result of the foreign divisive
transaction. Accordingly, USD has $560 of pre- transaction earnings
($500 + $60). Under paragraph (b)(1)(i) of this section, USD's pre-
transaction earnings are reduced by an amount equal to its pre-
transaction earnings times the net bases of the assets transferred
to FC divided by the net bases of the assets held by USD immediately
before the foreign divisive transaction ($560 x ($160 ÷ $320)
= $280). Following this reduction, USD has $280 of earnings and
profits ($560 - $280).
(C) Calculation of FC's earnings and profits. Under paragraph (b)(1)
(i) of this section, the $280 reduction in USD's pre-transaction
earnings is allocated to FC. Under §1.367(b)-2( j)(1), the $280
is translated into "u" at the spot rate on January 1, 2002, to 280u.
Under paragraph (c)(2) of this section, the 280u is not included as
part of FC's post-1986 undistributed earnings, pre-1987 accumulated
profits, or section 960 earnings and profits.
(iii) Post-transaction distribution. During 2002, FC does not
accumulate any earnings and profits or pay or accrue any foreign
income taxes. On December 31, 2002, at a time when US$1 = 0.5u, FC
distributes 180u (or $360) to its shareholders. Thus, FP, USP, and
USI each receive a $120 dividend. See section 989(b)(1). Under
paragraph (c)(2) of this section and §1.367(b)-2(j)(4), $93.33
of the distribution to FP is subject to withholding under Chapter 3
of subtitle A of the Internal Revenue Code ($280 ÷ 3 =
$93.33). Under section 243(e) and §1.367(b)-2(j)(3), $93.33 of
the distribution to USP is eligible for the dividends received
deduction. See also section 861(a)(2)(C). Under paragraph (c)(2) of
this section, the remaining $26.67 distribution to USP is treated as
U.S. source under section 904(g) (and is not eligible for the
dividends received deduction under section 243(e)). Under paragraph
(c)(2) of this section, the $120 dividend distribution to USI is
treated as U.S. source under section 904(g).
Example 2--
(i) Facts. The stock of USD is owned by the following unrelated
persons: 20 percent by USP (a domestic corporation), 20 percent by
USI (a United States citizen), and 60 percent by FP (a foreign
corporation). FC is a preexisting controlled corporation that was
incorporated in 1995 and USD always has owned all of the FC stock.
USD owns assets with total net bases of $320 (including $160
attributable to the FC stock), and USD has $500 of earnings and
profits. FC has 150u of earnings and profits in the section 904(d)
(1)(D) shipping separate category and has $60 of related foreign
income taxes. FC's earnings and profits qualified for the high tax
exception from subpart F income under section 954(b)(4), and USD
elected to exclude the earnings and profits from subpart F income
under section 954(b)(4) and §1.954-1(d)(5). On January 1, 2002,
USD distributes the stock of FC to its shareholders in a transaction
that meets the requirements of section 355. FC is not a controlled
foreign corporation after the foreign divisive transaction. On the
date of the foreign divisive transaction, the FC stock has a $460
fair market value.
(ii) Result--
(A) Gain Recognition. Under §1.367(b)-5(b)(1)(ii), USD
recognizes gain equal to the difference between the fair market
value and USD's adjusted basis in the FC stock distributed to USI.
Under §1.367(e)-1(b)(1), USD recognizes gain equal to the
difference between the fair market value and USD's adjusted basis in
the FC stock distributed to FP. As a result of the transfers to USI
and FP, USD recognizes gain of $240 (4/5 x ($460 - $160)), $120 of
which is included in USD's income as a dividend under section
1248(a) and (f)(1) (4/5 x 150u, translated at the spot rate under
section 989(b)(2)). Under section 1248(a) and (f)(1), USD includes
as a dividend the difference between the fair market value and its
adjusted basis in the FC stock distributed to USP to the extent of
FC's earnings and profits attributable to the distributed stock. For
further guidance, see also Notice 87-64 (1987-2 C.B. 375) (see also
§601.601(d)(2) of this chapter). As a result of this transfer,
USD includes a $30 dividend under section 1248(a) and (f)(1) (1/5 x
150u). USD qualifies for a section 902 deemed paid foreign tax
credit with respect to its $150 of section 1248 dividends.
(B) Calculation of USD's earnings and profits. Under paragraph (b)
(1)(v) of this section, USD's pre-transaction earnings include any
gain recognized or income included as a result of the foreign
divisive transaction. As described in this Example 2 (ii)(A), USD
recognizes and includes a total of $270 of gain and dividend income
as a result of the foreign divisive transaction. Accordingly, USD
has $770 of pre-transaction earnings ($500 + $270). Under paragraphs
(b)(1)(i) and (b)(1)(ii)(A) of this section, USD's pre-transaction
earnings are reduced by the amount of the reduction that would have
been required if USD had transferred the stock of FC to a new
corporation in a D reorganization. Thus, USD's pre-transaction
earnings are reduced by an amount equal to its pre-transaction
earnings times its net basis in the FC stock divided by the net
bases of the assets held by USD immediately before the foreign
divisive transaction ($770 x ($430 ÷ $590) = $561.19).
Following this reduction, USD has $208.81 of earnings and profits
($770 -$ 561.19).
(C) Calculation of FC's earnings and profits. Under paragraph (b)(1)
(ii)(B) of this section, FC's earnings and profits are not increased
(or replaced) as a result of the foreign divisive transaction.
Example 3--
(i) Facts. USP, a domestic corporation, owns all of the stock of
USD. FC is a preexisting controlled corporation and USD has owned
all of the FC stock since FC was incorporated in 1995. USD owns
assets with total net bases of $320 (including $100 attributable to
the FC stock and $160 attributable to the Business B shipping
assets). USD has $500 of pre-transaction earnings. FC has 150u of
earnings and profits in the section 904(d)(1)(D) shipping separate
category and has $60 of related foreign income taxes. FC's earnings
and profits qualified for the high tax exception from subpart F
income under section 954(b)(4), and USD elected to exclude the
earnings and profits from subpart F income under section 954(b)(4)
and §1.954-1(d)(5). On January 1, 2002, USD transfers to FC the
Business B shipping assets. USD then distributes the FC stock to
USP. The transaction meets the requirements of sections 368(a)(1)(D)
and 355. USD's transfer of the Business B shipping assets to FC
falls within the active trade or business exception to section
367(a)(1) described in §1.367(a)-2T. Immediately after the
foreign divisive transaction, the FC stock has a $460 fair market
value. USP and USD meet and comply with the requirements of section
367(a)(5) and 1248(f)(2) (and any regulations thereunder). (Sections
1.367(b)-5(b)(1)(ii) and 1.367(e)-1(b)(1) do not apply with respect
to the foreign divisive transaction because the distributee, USP, is
a domestic corporation.)
(ii) Result--
(A) Calculation of USD's earnings and profits. Under paragraph (b)
(4)(i) of this section, USD's pre- transaction earnings are reduced
by the sum of the amounts described in paragraphs (b)(4)(i)(A) and
(b)(4)(i)(B) of this section. Under paragraph (b)(4)(i)(A) of this
section, USD's pre-transaction earnings are reduced by an amount
equal to USD's pre-transaction earnings times the net bases of the
assets transferred to FC divided by the total net bases of the
assets held by USD immediately before the foreign divisive
transaction ($500 x ($160 ÷ $320) = $250). Under paragraph
(b)(4)(i)(B) of this section, USD's pre-transaction earnings are
reduced by an amount equal to USD's pre-transaction earnings times
USD's net basis in the stock of FC (immediately before USD's
transfer of the shipping assets) divided by the total net bases of
the assets held by USD immediately before the foreign divisive
transaction ($500 x ($100 ÷ $320) = $156.25). The sum of the
amounts described in paragraphs (b)(4)(i)(A) and (B) of this section
is $406.25 ($250 + $156.25). Following the reduction described in
paragraph (b)(4)(i) of this section, USD has $93.75 of earnings and
profits ($500 - $406.25).
(B) Calculation of FC's earnings and profits. Under paragraphs (b)
(4)(ii) of this section, the earnings and profits of FC immediately
after the foreign divisive transaction are increased by the amount
of the reduction in USD's pre-transaction earnings described in
paragraph (b)(4)(i)(A) of this section ($250). Under
§1.367(b)-2(j)(1), this $250 is translated into "u" at the spot
rate on January 1, 2002, to 250u. Under paragraph (c)(2) of this
section, the 250u is not included as part of FC's post-1986
undistributed earnings. FC has 400u in earnings and profits (250u +
150u) immediately after the foreign divisive transaction.
(iii) Post-transaction distribution. FC does not accumulate any
earnings and profits or pay or accrue any foreign income taxes
during 2002. On December 31, 2002, FC distributes 100u as a dividend
to USP, which has remained its sole shareholder. Under section
989(b)(1), the 100u distribution is translated into US$ at the spot
rate on December 31, 2002, to $100. Proportionate parts of the $100
dividend are attributable to the pre-transaction earnings of FC
($37.50 = $100 x (150 ÷ 400)) and USD ($62.50 = $100 x (250
÷ 400)). See sections 243(e) and 245. Thus, under sections
243(e) and §1.367(b)-2(j)(3), $62.50 of the distribution is
eligible for the dividends received deduction. See also section
861(a)(2)(C). The remaining $37.50 of the distribution (and $15 of
related foreign income taxes) is subject to the generally applicable
rules concerning dividends paid by foreign corporations.
(d) Foreign divisive transactions involving a foreign distributing
corporation and a domestic controlled corporation--
(1) Scope. The rules of this paragraph (d) apply to a foreign
divisive transaction involving a foreign distributing corporation
and a domestic controlled corporation.
(2) Coordination with §1.367(b)-3--
(i) In general. In the case of a foreign divisive transaction that
includes a D reorganization, the rules of §1.367(b)-3 are
applicable with respect to the pre-transaction earnings of a foreign
distributing corporation that are allocable to a domestic controlled
corporation under paragraph (b)(1)(i) of this section.
(ii) Determination of all earnings and profits amount. An all
earnings and profits amount inclusion under paragraph (d)(2)(i) of
this section shall be computed with respect to the pre-transaction
earnings that are allocable to the domestic controlled corporation,
without regard to the parenthetical phrase in paragraph (b)(4)(ii)
(A) of this section.
(iii) Interaction with section 358 and §1.367(b)-2(e)(3)(ii).
The basis increase provided in §1.367(b)-2(e)(3)(ii) shall
apply to an all earnings and profits amount inclusion under
paragraph (d)(2)(i) of this section, subject to the following
rules--
(A) Section 358 shall apply to determine the distributee's basis in
the foreign distributing and domestic controlled corporation without
regard to the all earnings and profits amount inclusion;
(B) After application of the rule in paragraph (d)(2)(iii)(A) of
this section, the basis increase provided in §1.367(b)-2(e)(3)
(ii) shall be applied in a manner that attributes such basis
increase solely to the exchanging shareholder's stock in the
domestic controlled corporation; and (C) the rule of paragraph (d)
(2)(iii)(B) of this section shall apply prior to §1.367(b)-5(c)
(4) and (d)(4).
(iv) Coordination with §1.367(b)-3(c). In applying the rule of
§1.367(b)-3(c)(2), an exchanging shareholder described in
§1.367(b)-3(c)(1) shall recognize gain with respect to the
stock of the domestic controlled corporation after the foreign
divisive transaction.
(v) Special rule for U.S. persons that own foreign distributing
corporation stock after a non pro rata distribution.
[Reserved]
(3) Foreign income taxes. Pre-transaction taxes related to a foreign
distributing corporation's pre-transaction earnings that are
allocable or are reduced under the rules described in paragraph (b)
(1)(i) of this section shall be ratably reduced. Pre-transaction
taxes related to a foreign distributing corporation's pre-
transaction earnings that are allocable to a domestic controlled
corporation under the rules described in paragraph (b)(1)(i) of this
section shall not carry over to the domestic controlled corporation.
Nothing in this paragraph (d)(3) shall affect the deemed paid taxes
that otherwise would accompany an inclusion under §1.367(b)-5
or paragraph (d)(2)(i) of this section.
(4) Previously taxed earnings and profits.
[Reserved]
(5) Coordination with §1.367(b)-5. See also §1.367(b)-5(c)
and (d) for other rules that may apply to a foreign divisive
transaction described in paragraph (d)(1) of this section.
(6) Examples. The following examples illustrate the application of
the rules of this section to transactions described in paragraph (d)
(1) of this section. The examples presume the following facts: FD is
a foreign corporation engaged in manufacturing and shipping
activities through Business A and Business B, respectively. Any
earnings and profits of FD described in section 904(d)(1)(D)
(shipping income) qualified for the high tax exception from subpart
F income under section 954(b)(4), and FD's United States
shareholders elected to exclude the earnings and profits from
subpart F income under section 954(b)(4) and §1.954-1(d)(5).
USC is a domestic corporation that is wholly owned by FD. FD and USC
use calendar taxable years. FD (and all of its qualified business
units as defined in section 989) maintains a "u" functional
currency, and 1u = US$1 at all times. The examples are as follows:
Example 1--
(i) Facts. (A) USP, a domestic corporation, has owned all of the
stock of FD since FD's incorporation in 1995. USP's adjusted basis
in the FD stock is $100, and the FD stock has a fair market value of
$800. FD owns assets with total net bases of 320u (including 160u
attributable to the Business B shipping assets), and has the
following pre-transaction earnings and pre-transaction taxes
accounts:
Separate Category | E&P | Foreign Taxes
--------------------+---------+------------------
General | 300u | $60
--------------------+---------+------------------
Shipping | 200u | $80
--------------------+---------+------------------
| 500u | $140
(B) On January 1, 2002, FD incorporates USC and transfers to USC the
Business B shipping assets. FD then distributes the USC stock to
USP. The transaction meets the requirements of sections 368(a)(1)(D)
and 355. Immediately after the foreign divisive transaction, the FD
stock and the USC stock each have a fair market value of $400.
(ii) Results--
(A) Calculation of FD's earnings and profits. Under paragraph (b)(1)
(i) of this section, FD's pre- transaction earnings are reduced by
an amount equal to its pre-transaction earnings times the net bases
of the assets transferred to USC divided by the net bases of the
assets held by FD immediately before the foreign divisive
transaction (500u x (160u ÷ 320u) = 250u). Following this
reduction, FD has 250u of earnings and profits (500u - 250u).
(B) All earnings and profits amount inclusion. Under
§1.367(b)-3 and paragraph (d)(2)(i) of this section, USP
includes in income as an all earnings and profits amount the pre-
transaction earnings of FD that are allocable to USC under paragraph
(b)(1)(i) of this section. Thus, USP's all earnings and profits
amount inclusion is $250. See also section 989(b)(1) and paragraph
(d)(2)(ii) of this section. Under §1.367(b)-3(b)(3)(i) and
§1.367(b)-2(e), USP includes the all earnings and profits
amount as a deemed dividend received from FD immediately before the
foreign divisive transaction. Because the requirements of section
902 are met, USP qualifies for a deemed paid foreign tax credit with
respect to the deemed dividend that it receives from FD. Under
§1.902-1(d)(1), the $250 deemed dividend is out of FD's
separate categories and reduces foreign income taxes as follows:
Separate Category | E&P | Foreign Taxes
--------------------+---------+------------------
General | 150u | $30
--------------------+---------+------------------
Shipping | 100u | $40
--------------------+---------+------------------
| 250u | $70
(C) Calculation of USP's basis in USC and USC's earnings and
profits. Under paragraph (d)(2)(iii) of this section, the
§1.367(b)-2(e)(3)(ii) basis increase applies with respect to
USP's all earnings and profits amount inclusion from FD and is
attributed solely to USP's basis in USC (after application of
section 358). Accordingly, USP has a $300 basis in the USC stock
($50 section 358 basis, determined by reference to the relative
values of USP's FD and USC stock: $100 pre-transaction basis x ($400
÷ $800) + $250 §1.367(b)-2(e)(3)(ii) basis increase =
$300). Because USP included in income as a deemed dividend under
§1.367(b)-3 and paragraph (d)(2) of this section the pre-
transaction earnings of FD that are allocable to USC under paragraph
(b)(1)(i) of this section, such earnings and profits are not
available to increase USC's earnings and profits. As a result, USC
has zero earnings and profits immediately after the foreign divisive
transaction.
(D) Application of §1.367(b)-5(c). The basis adjustment and
income inclusion rules of §1.367(b)-5(c)(2) apply if USP's
postdistribution amount with respect to FD stock is less than its
predistribution amount with respect to FD stock. Under
§1.367(b)-5(e)(1), USP's predistribution amount with respect to
FD stock is USP's section 1248 amount attributable to such stock
computed immediately before the distribution but after taking into
account the allocation of earnings and profits as a result of the D
reorganization. Thus, USP's predistribution amount with respect to
FD stock is $250 (500u - 250u). See also section 989(b)(2). Under
section 358, USP allocates its $100 basis in FD stock between FD
stock and USC stock according to the stock blocks' relative values,
yielding a $50 ($100 x ($400 ÷ $800)) basis in FD stock. See
also paragraph (d)(2)(iii) of this section. Under
§1.367(b)-5(e)(2), USP's postdistribution amount with respect
to FD stock is USP's section 1248 amount with respect to such stock,
computed immediately after the distribution. Accordingly, USP's
postdistribution amount with respect to FD stock is $250. Because
USP's postdistribution amount with respect to FD stock is not less
than its predistribution amount, USP is not required to make any
basis adjustment or include any income under §1.367(b)-5(c).
(E) FD's earnings and profits after the foreign divisive
transaction. Following the reduction described in this Example 1
(ii)(A) and (B), FD has the following earnings and profits and
foreign income taxes accounts:
Separate Category | E&P | Foreign Taxes
--------------------+---------+------------------
General | 150u | $30
--------------------+---------+------------------
Shipping | 100u | $40
--------------------+---------+------------------
| 250u | $70
Example 2--
(i) Facts.
(A) USP, a domestic corporation, has owned all of the stock of FD
since FD's incorporation in 1995. USP's adjusted basis in the FD
stock is $400 and the FD stock has a fair market value of $800. USC
is a preexisting controlled corporation. FD owns assets with net
total bases of 320u (including 160u attributable to the USC stock),
and has the following pre-transaction earnings and pre-transaction
taxes accounts:
Separate Category | E&P | Foreign Taxes
--------------------+---------+------------------
General | 300u | $60
--------------------+---------+------------------
Shipping | 200u | $80
--------------------+---------+------------------
| 500u | $140
(B) On January 1, 2002, FD distributes the USC stock to USP
in a transaction that meets the requirements of section 355.
Immediately after the foreign divisive transaction, the FD stock
and the USC stock each have a $400 fair market value.
(ii) Results--
(A) Calculation of FD's earnings and profits. Under paragraphs (b)
(1)(i) and (b)(1)(ii)(A) of this section, FD's pre-transaction
earnings are reduced by the amount of the reduction that would have
been required if FD had transferred the stock of USC to a new
corporation in a D reorganization. Thus, FD's pre-transaction
earnings are reduced by an amount equal to its pre-transaction
earnings times its net basis in the USC stock divided by the net
bases of the assets held by FD immediately before the foreign
divisive transaction (500u x (160u ÷ 320u) = 250u). Following
this reduction, FD has 250u of earnings and profits (500u - 250u).
(B) Calculation of USC's earnings and profits. Under paragraph (b)
(1)(ii)(B) of this section, USC's earnings and profits are not
increased (or replaced) as a result of the foreign divisive
transaction. As a result, USP is not required to include an amount
in income under paragraph (d)(2)(i) of this section.
(C) Application of §1.367(b)-5(c). The basis adjustment and
income inclusion rules of §1.367(b)-5(c)(2) apply if USP's
postdistribution amount with respect to FD stock is less than its
predistribution amount with respect to FD stock. Under
§1.367(b)-5(e)(1), USP's predistribution amount with respect to
FD stock is USP's section 1248 amount attributable to such stock
computed immediately before the distribution. Thus, USP's
predistribution amount with respect to FD stock is $400 (the
predistribution amount is limited to USP's built-in gain in FD stock
immediately before the distribution ($800 - $400)). See also section
989(b)(2). Under section 358, USP allocates its $400 basis in FD
stock between FD stock and USC stock according to the stock blocks'
relative values, yielding a $200 ($400 x ($400 ÷ $800)) basis
in each block. Under §1.367(b)-5(e)(2), USP's postdistribution
amount with respect to FD stock is USP's section 1248 amount with
respect to such stock, computed immediately after the distribution.
Accordingly, USP's postdistribution amount with respect to FD stock
is $200 (the postdistribution amount is limited to USP's built-in
gain in FD stock immediately after the distribution ($400 - $200)).
Because USP's postdistribution amount with respect to FD stock is
$200 less than its predistribution amount with respect to such stock
($400 - $200), §1.367(b)-5(c)(2)(i) and (ii) require USP to
reduce its basis in FD stock by the $200 difference, but only to the
extent such reduction increases USP's section 1248 amount with
respect to the FD stock. As a result, USP reduces its basis in the
FD stock from $200 to $150 and includes $150 in income as a deemed
dividend from FD. Because the requirements of section 902 are met,
USP qualifies for a deemed paid foreign tax credit with respect to
the deemed dividend that it receives from FD. Under §1.902-1(d)
(1), the $150 deemed dividend is out of FD's separate categories and
reduces foreign income taxes as follows:
Separate Category | E&P | Foreign Taxes
--------------------+---------+------------------
General | 90u | $18
--------------------+---------+------------------
Shipping | 60u | $24
--------------------+---------+------------------
| 150u | $42
(D) Basis adjustment. Under §1.367(b)-5(c)(3), USP does not
increase its basis in FD stock as a result of USP's $150 deemed
dividend from FD. Under §1.367(b)-5(c)(4), USP increases its
basis in the USC stock by the amount by which it decreased its basis
in the FD stock, as well as by the amount of its deemed dividend
inclusion. The §1.367(b)-5(c)(4) basis increase applies in full
because USP's basis in the USC stock is not increased above the fair
market value of such stock. Thus, USP increases its basis in USC
stock to $400 ($200 + $50 + $150).
(E) Reduction in FD's statutory groupings of earnings and profits.
Under paragraph (b)(2) of this section, the reduction in FD's pre-
transaction earnings that is not attributable to USP's inclusion
under §1.367(b)-5 decreases FD's statutory groupings of
earnings and profits on a pro rata basis. Under paragraph (d)(3) of
this section, FD's pre-transaction taxes also are ratably reduced.
As described in this Example 2 (ii)(A), the reduction in FD's pre-
transaction earnings is 250u. As described in this Example 2 (ii)
(C), 150u of the 250u reduction is attributable to an inclusion
under §1.367(b)-5. As a result, under paragraphs (b)(2) and (d)
(3) of this section the remaining 100u reduction in FD's pre-
transaction earnings is out of the following separate categories of
earnings and profits and foreign income taxes:
Separate Category | E&P | Foreign Taxes
--------------------+---------+------------------
General | 60u | $12
--------------------+---------+------------------
Shipping | 40u | $16
--------------------+---------+------------------
| 100u | $28
(F) FD's earnings and profits after the foreign divisive
transaction. After the reductions described in this Example 2 (ii)
(C) and (E), FD has the following earnings and profits and foreign
income taxes accounts:
Separate Category | E&P | Foreign Taxes
--------------------+---------+------------------
General | 150u | $30
--------------------+---------+------------------
Shipping | 100u | $40
--------------------+---------+------------------
| 250u | $70
Example 3--
(i) Facts.
(A) USP, a domestic corporation, has owned all of the stock of FD
since FD's incorporation in 1995. USP's adjusted basis in the FD
stock is $400 and the FD stock has a fair market value of $800. USC
is a preexisting controlled corporation. FD owns assets with total
net bases of 320u (including 160u attributable to the USC stock and
80u attributable to the Business B shipping assets), and has the
following pre-transaction earnings and pre-transaction taxes
accounts:
Separate Category | E&P | Foreign Taxes
--------------------+---------+------------------
General | 300u | $60
--------------------+---------+------------------
Shipping | 200u | $80
--------------------+---------+------------------
| 500u | $140
(B) On January 1, 2002, FD transfers to USC the Business B
shipping assets. FD then distributes the USC stock to USP. The
transaction meets the requirements of sections 368(a)(1)(D) and
355. Immediately after the foreign divisive transaction, the FD
stock has a $200 fair market value and the USC stock has a $600
fair market value.
(ii) Results--
(A) Calculation of FD's earnings and profits. Under paragraph (b)(4)
(i) of this section, FD's pre-transaction earnings are reduced by
the sum of the amounts described in paragraphs (b)(4)(i)(A) and (B)
of this section. Under paragraph (b)(4)(i)(A) of this section, FD's
pre-transaction earnings are reduced by an amount equal to FD's pre-
transaction earnings times the net bases of the Business B shipping
assets transferred to USC divided by the total net bases of the
assets held by FD immediately before the foreign divisive
transaction (500u x (80u ÷ 320u) = 125u). Under paragraph (b)
(4)(i)(B) of this section, FD's pre-transaction earnings are reduced
by an amount equal to FD's pre-transaction earnings times FD's net
basis in the stock of USC divided by the total net bases of the
assets held by FD immediately before the foreign divisive
transaction (500u x (160u ÷ 320u) = 250u). The sum of the
amounts described in paragraphs (b)(4)(i)(A) and (B) of this section
is 375u (125u + 250u).
(B) All earnings and profits amount inclusion. Under
§1.367(b)-3 and paragraph (d)(2)(i) of this section, USP is
required to include in income as an all earnings and profits amount
the pre-transaction earnings of FD that are allocable to USC under
paragraph (b)(1)(i) of this section. Under paragraph (b)(4)(ii)(A)
of this section, the 125u of pre-transaction earnings described in
paragraph (b)(4)(i)(A) are allocable to USC. Thus, the all earnings
and profits amount is $125. See also section 989(b)(1) and paragraph
(d)(2)(ii) of this section. Under §§1.367(b)-3(b)(3)(i)
and 1.367(b)-2(e), USP includes the all earnings and profits amount
as a deemed dividend received from FD immediately before the foreign
divisive transaction. Because the requirements of section 902 are
met, USP qualifies for a deemed paid foreign tax credit with respect
to the deemed dividend that it receives from FD. Under
§1.902-1(d)(1), the $125 deemed dividend is out of FD's
separate categories and reduces foreign income taxes as follows:
Separate Category | E&P | Foreign Taxes
--------------------+---------+------------------
General | 75u | $15
--------------------+---------+------------------
Shipping | 50u | $20
--------------------+---------+------------------
| 125u | $35
(C) Calculation of USP's basis in USC and USC's earnings and
profits. Under paragraph (d)(2)(iii) of this section, the
§1.367(b)-2(e)(3)(ii) basis increase applies with respect to
USP's all earnings and profits amount inclusion and is attributed
solely to USP's basis in USC (after application of section 358).
Accordingly, USP has a $425 basis in the USC stock ($300 section 358
basis, determined by reference to the relative values of USP's FD
and USC stock: $400 pre-transaction basis x ($600 ÷ $800) +
$125 §1.367(b)-2(e)(3)(ii) basis increase = $425). Because USP
included in income as a deemed dividend under §1.367(b)-3 and
paragraph (d)(2) of this section the pre-transaction earnings of FD
that are allocable to USC under paragraph (b)(1)(i) of this section,
such earnings and profits are not available to increase USC's
earnings and profits. As a result, USC's earnings and profits are
not increased as a result of the foreign divisive transaction.
(D) Application of §1.367(b)-5(c). The basis adjustment and
income inclusion rules of §1.367(b)-5(c)(2) apply if USP's
postdistribution amount with respect to FD stock is less than its
predistribution amount with respect to FD stock. Under
§1.367(b)-5(e)(1) and (3), USP's predistribution amount with
respect to FD stock is USP's section 1248 amount attributable to
such stock computed immediately before the distribution, after the
allocation of FD's pre-transaction earnings described in paragraphs
(b)(4)(i)(A) and (ii)(A) of this section, but without regard to the
reduction in FD's pre-transaction earnings described in paragraph
(b)(4)(i)(B) of this section. Thus, USP's predistribution amount
with respect to FD stock is $375 ($500 -$ 125). See also section
989(b)(2). Under section 358, USP allocates its $400 basis in FD
stock between FD stock and USC stock according to the stock blocks'
relative values, yielding a $100 ($400 x ($200 ÷ $800)) basis
in FD stock. See also paragraph (d)(2)(iii) of this section. Under
§1.367(b)-5(e)(2), USP's postdistribution amount with respect
to FD stock is USP's section 1248 amount with respect to such stock,
computed immediately after the distribution. Accordingly, USP's
postdistribution amount with respect to FD stock is $100. (While FD
has earnings and profits of 125u immediately after the foreign
divisive transaction, USP's postdistribution amount is limited to
its built-in gain in FD stock immediately after the distribution
($200 - $100).) Because USP's postdistribution amount with respect
to FD stock is $275 less than its predistribution amount with
respect to such stock ($375 - $100), §1.367(b)-5(c)(2)(i) and
(ii) require USP to reduce its basis in FD stock, but only to the
extent such reduction increases USP's section 1248 amount with
respect to the FD stock. As a result, USP reduces its basis in the
FD stock from $100 to $75 and includes $250 in income as a deemed
dividend from FD. Because the requirements of section 902 are met,
USP qualifies for a deemed paid foreign tax credit with respect to
the deemed dividend that it receives from FD. Under §1.902-1(d)
(1), the $250 deemed dividend is out of FD's separate categories and
reduces foreign income taxes as follows:
Separate Category | E&P | Foreign Taxes
--------------------+---------+------------------
General | 150u | $30
--------------------+---------+------------------
Shipping | 100u | $40
--------------------+---------+------------------
| 250u | $70
(E) Basis adjustment. Under §1.367(b)-5(c)(3), USP does not
increase its basis in FD stock as a result of USP's $250 deemed
dividend from FD. Under §1.367(b)-5(c)(4), USP increases its
basis in the USC stock by the amount by which it decreased its basis
in the FD stock, as well as by the amount of its deemed dividend
inclusion, but only up to the fair market value of USP's USC stock.
As described in this Example 3 (ii)(C), USP has already increased
its basis in the USC stock to $425. Because the fair market value of
FD's USC stock is $600, USP's basis increase under
§1.367(b)-5(c)(4) is limited to $175. See also paragraph (d)(2)
(iii)(C) of this section. Thus, USP has a $600 basis in the USC
stock immediately after the foreign divisive transaction.
(F) Reduction in FD's statutory groupings of earnings and profits.
Under paragraph (b)(2) of this section, the reduction in FD's pre-
transaction earnings that is not attributable to USP's inclusion
under paragraph (d)(2)(i) of this section or §1.367(b)-5
decrease FD's statutory groupings of earnings and profits on a pro
rata basis. Under paragraph (d)(3) of this section, FD's pre-
transaction taxes are also ratably reduced. As described in this
Example 3 (ii)(A), the reduction in FD's pre- transaction earnings
is 375u. As described in this Example 3 (ii)(B) and (D), the entire
375u reduction was subject to inclusion as a deemed dividend by USP
under paragraph (d)(2)(i) of this section or §1.367(b)-5. Thus,
none of FD's pre-transaction earnings remain to be reduced under
paragraph (b)(2) of this section.
(G) FD's earnings and profits after the foreign divisive
transaction. After the reductions described in this Example 3 (ii)
(B) and (D), FD has the following earnings and profits and foreign
income taxes accounts:
Separate Category | E&P | Foreign Taxes
--------------------+---------+------------------
General | 75u | $15
--------------------+---------+------------------
Shipping | 50u | $20
--------------------+---------+------------------
| 125u | $35
(e) Foreign divisive transactions involving a foreign distributing
corporation and a foreign controlled corporation--
(1) Scope. The rules of this paragraph (e) apply to a foreign
divisive transaction involving a foreign distributing corporation
and a foreign controlled corporation.
(2) Earnings and profits of foreign controlled corporation --
(i) In general. Except to the extent specified in paragraph
(e)(2)(ii) of this section, pre-transaction earnings of a foreign
distributing corporation that are allocated to a foreign
controlled corporation under the rules described in paragraphs
(b)(1)(i) and (4) of this section shall carry over to the foreign
controlled corporation in accordance with the rules described in
§1.367(b)-7.
(ii) Special rule for pre-transaction earnings allocated to a newly
created controlled corporation. Section 1.367(b)-9 shall apply to
pre-transaction earnings that are allocated from a foreign
distributing corporation to a newly created foreign controlled
corporation under the rules described in paragraph (b)(1)(i) of this
section.
(3) Foreign income taxes. Pre-transaction taxes related to a foreign
distributing corporation's pre-transaction earnings that are
allocated or reduced under the rules described in paragraph (b)(1)
(i) of this section shall be ratably reduced. Pre-transaction taxes
related to a foreign distributing corporation's pre-transaction
earnings that are allocated to a foreign controlled corporation
under the rules described in paragraph (b)(1)(i) of this section
shall carry over to the foreign controlled corporation in accordance
with the rules of §1.367(b)-7. Section 1.367(b)-9 shall apply
to pre-transaction taxes that are allocated from a foreign
distributing corporation to a newly created foreign controlled
corporation under the rules described in paragraph (b)(1)(i) of this
section.
(4) Previously taxed earnings and profits.
[Reserved]
(5) Coordination with §1.367(b)-5. See also §1.367(b)-5(c)
and (d) for other rules that may apply to a foreign divisive
transaction described in paragraph (e)(1) of this section.
(6) Examples. The following examples illustrate the application of
the rules of this section to transactions described in paragraph (e)
(1) of this section. The examples presume the following facts: FD is
a foreign corporation engaged in manufacturing and shipping
activities through Business A and Business B, respectively. FC is a
foreign corporation that is wholly owned by FD. Any earnings and
profits of FD or FC described in section 904(d)(1)(D) (shipping
income) qualified for the high tax exception from subpart F income
under section 954(b)(4), and FD's and FC's United States
shareholders elected to exclude the earnings and profits from
subpart F income under section 954(b)(4) and §1.954-1(d)(1). FD
and FC have calendar taxable years. FD and FC (and all of their
respective qualified business units as defined in section 989)
maintain a "u" functional currency, and 1u = US$1 at all times. The
examples are as follows:
Example 1--
(i) Facts.
(A) USP, a domestic corporation, has owned all of the stock of FD
since FD's incorporation in 1995. USP's adjusted basis in the FD
stock is $400 and the FD stock has a fair market value of $800. FD
owns assets with total net bases of 320u (including 160u
attributable to the Business B shipping assets), and has the
following pre-transaction earnings and pre- transaction taxes
accounts:
Separate Category | E&P | Foreign Taxes
--------------------+---------+------------------
General | 300u | $60
--------------------+---------+------------------
Shipping | 200u | $80
--------------------+---------+------------------
| 500u | $140
(B) On January 1, 2002, FD incorporates FC and transfers to FC the
Business B shipping assets. FD then distributes the FC stock to USP.
The transaction meets the requirements of sections 368(a)(1)(D) and
355. Immediately after the foreign divisive transaction, the FD
stock and the FC stock each have a $400 fair market value.
(ii) Result.
(A) Calculation of FD's earnings and profits. Under paragraph (b)(1)
(i) of this section, FD's pre-transaction earnings are reduced by an
amount equal to its pre-transaction earnings times the net bases of
the assets transferred to FC divided by the net bases of the assets
held by FD immediately before the foreign divisive transaction (500u
x (160u ÷ 320u) = 250u). Following this reduction, FD has
250u of earnings and profits (500u - 250u).
(B) Application of §1.367(b)-5(c). The basis adjustment and
income inclusion rules of §1.367(b)-5(c)(2) apply if USP's
postdistribution amount with respect to FD or FC stock is less than
its predistribution amount with respect to such stock. Under
§1.367(b)-5(e)(1), USP's predistribution amount with respect to
FD or FC stock is USP's section 1248 amount attributable to such
stock computed immediately before the distribution but after taking
into account the allocation of earnings and profits as a result of
the D reorganization. Thus, USP's predistribution amounts with
respect to FD and FC stock are both $200. See also section 989(b)(2)
and §1.1248-1(d)(3). Under section 358, USP allocates its $400
basis in FD stock between FD stock and FC stock according to the
stock blocks' relative values, yielding a $200 ($400 x ($400
÷ $800)) basis in each block. Under §1.367(b)-5(e)(2),
USP's postdistribution amount with respect to FD or FC stock is
USP's section 1248 amount with respect to such stock, computed
immediately after the distribution. Accordingly, USP's
postdistribution amounts with respect to FD and FC stock are both
$200. Because USP's postdistribution amounts with respect to FD and
FC stock are not less than USP's respective predistribution amounts,
USP is not required to make any basis adjustment or include any
income under §1.367(b)-5(c).
(C) Reduction in FD's statutory groupings of earnings and profits.
Under paragraph (b)(2) of this section, the 250u reduction in FD's
pre-transaction earnings decreases FD's statutory groupings of
earnings and profits on a pro rata basis. Under paragraph (e)(3) of
this section, FD's pre-transaction taxes also are ratably reduced.
Accordingly, FD's pre-transaction earnings and pre-transaction taxes
are reduced by the following amounts:
Separate Category | E&P | Foreign Taxes
--------------------+---------+------------------
General | 150u | $30
--------------------+---------+------------------
Shipping | 100u | $40
--------------------+---------+------------------
| 250u | $70
(D) Calculation of FC's earnings and profits. Under paragraph (e)(2)
of this section, the pre-transaction earnings of FD that are
allocated to FC under paragraph (b)(1)(i) of this section carry over
to FC in accordance with the rules of §1.367(b)-7, subject to
the rule of §1.367(b)-9. Under paragraph (e)(3) of this
section, FD's pre-transaction taxes related to the pre-transaction
earnings that are allocated to FC similarly carry over to FC in
accordance with the rules of §1.367(b)-7, subject to the rule
of §1.367(b)-9. As a result, under §1.367(b)-7(d), FC has
the following earnings and profits and foreign income taxes accounts
immediately after the foreign divisive transaction:
Separate Category | E&P | Foreign Taxes
--------------------+---------+------------------
General | 150u | $30
--------------------+---------+------------------
Shipping | 100u | $40
--------------------+---------+------------------
| 250u | $70
Example 2--
(i) Facts.
(A) USP, a domestic corporation, has
owned all of the stock of FD since FD's incorporation in 1995.
USP's adjusted basis in the FD stock is $300 and the FD stock has
a fair market value of $1,500. FC is a preexisting controlled
corporation and FD has always owned all of the FC stock. FD owns
assets with total net bases of 320u (including 160u attributable
to the FC stock). FD and FC have the following earnings and
profits and foreign income taxes accounts:
FD:
Separate Category | E&P | Foreign Taxes
--------------------+---------+------------------
General | 400u | $ 50
--------------------+---------+------------------
Passive | (100u) | $ 6
--------------------+---------+------------------
Shipping | 200u | $ 80
--------------------+---------+------------------
| 500u | $136
FC:
Separate Category | E&P | Foreign Taxes
--------------------+---------+------------------
General | 600u | $100
--------------------+---------+------------------
Passive | (50u) | $ 6
--------------------+---------+------------------
Shipping | 100u | $ 40
--------------------+---------+------------------
| 650u | $146
(B) On January 1, 2002, FD distributes the FC stock to USP in a
transaction that meets the requirements of section 355. Immediately
after the foreign divisive transaction, the FD stock and the FC
stock each have a $750 fair market value.
(ii) Result--
(A) Calculation of FD's earnings and profits. Under paragraph (b)(1)
(i) and (ii)(A) of this section, FD's pre- transaction earnings are
reduced by the amount of the reduction that would have been required
if FD had transferred the stock of FC to a new corporation in a D
reorganization. Thus, FD's pre- transaction earnings are reduced by
an amount equal to its pre-transaction earnings times its net basis
in the FC stock divided by the net bases of the assets held by FD
immediately before the foreign divisive transaction (500u x (160u
÷ 320u) = 250u). Following this reduction, FD has 250u of
earnings and profits (500u - 250u).
(B) Application of §1.367(b)-5(c). The basis adjustment and
income inclusion rules of §1.367(b)-5(c) apply if USP's
postdistribution amount with respect to FD or FC stock is less than
its predistribution amount with respect to such stock. Under
§1.367(b)-5(e)(1), USP's predistribution amount with respect to
FD or FC stock is USP's section 1248 amount attributable to such
stock computed immediately before the distribution. Thus, USP's
predistribution amounts with respect to FD and FC stock are $500 and
$650, respectively. See also section 989(b)(2). Under section 358,
USP allocates its $300 basis in FD stock between FD stock and FC
stock according to the stock blocks' relative values, yielding a
$150 ($300 x ($750 ÷ $1,500)) basis in each block. Under
§1.367(b)-5(e)(2), USP's postdistribution amount with respect
to FD or FC stock is USP's section 1248 amount with respect to such
stock, computed immediately after the distribution. Accordingly,
USP's postdistribution amount with respect to FD stock is $250 (500u
-250u), and its postdistribution amount with respect to FC stock is
$600 (while FC has 650u of earnings and profits immediately after
the foreign divisive transaction, USP's postdistribution amount is
limited to its built-in gain in FC stock immediately after the
distribution ($750 - $150)). USP's postdistribution amount with
respect to both the FD and FC stock is less than its predistribution
amount with respect to such stock. This difference is $50 with
respect to FC ($650 - $600), and $250 with respect to FD ($500 -
$250). Under §1.367(b)-5(c)(2)(i) and (ii), USP is required to
reduce its basis in the FD and FC stock, but only to the extent such
reductions increase USP's section 1248 amount with respect to the
stock. Accordingly, USP reduces its basis in the FC stock by $50,
and thereafter USP has a $100 basis in such stock ($150 - $100).
Because a reduction in USP's basis in FD stock would not increase
any of USP's section 1248 amount with respect to such stock, USP
includes the entire $250 difference between its predistribution and
postdistribution amounts with respect to the FD stock as a deemed
dividend from FD. Because the requirements of section 902 are met,
USP qualifies for a deemed paid foreign tax credit with respect to
the deemed dividend that it receives from FD. Under §1.960-
1(i)(4), the 100u deficit in the section 904(d)(1)(A) passive
separate category is allocated proportionately against the other
separate categories for purposes of computing the deemed paid credit
on the distribution. Thus, there are 333.33u (400u -(100u x (400u
÷ 600u))) of available earnings in the section 904(d)(1)(I)
general separate category (along with $50 of foreign income taxes)
and 166.67u (200u - (100u x (200u ÷ 600u))) of available
earnings in the section 904(d)(1)(D) shipping separate category
(along with $80 of foreign income taxes). Under §1.902- 1(d)
(1), the $250 deemed dividend is out of FD's separate categories and
reduces foreign income taxes as follows:
Separate Category | E&P | Foreign Taxes
--------------------+---------+------------------
General | 166.67u | $25
--------------------+---------+------------------
Passive | 0u | $ 0
--------------------+---------+------------------
Shipping | 83.33u | $40
--------------------+---------+------------------
| 250u | $65
(C) Basis adjustments. Under §1.367(b)-5(c)(3), USP does
not increase its basis in FD stock as a result of USP's $250
deemed dividend from FD. Under §1.367(b)-5(c)(4), USP increases
its basis in the FD and FC stock by the amount of its basis
decrease or deemed dividend inclusion with respect to the other
corporation, but only to the extent such basis increase does not
diminish USP's postdistribution amount with respect to that other
corporation and only to the extent of the other corporation's
fair market value. Under these rules, USP increases its basis in
the FD stock by the full amount by which it decreased its basis
in FC ($150 + $50 = $200). USP does not increase its basis in
the FC stock as a result of its deemed dividend from FD because
any increase in the FC stock basis would diminish USP's
postdistribution amount with respect to such stock.
(D) FD's earnings and profits after the foreign divisive
transaction. Because the entire $250 reduction in FD's pre-transaction
earnings was subject to inclusion under §1.367(b)-5
(as described in this Example 2 (ii)(B)), paragraph (b)(2) of
this section does not apply. FD has the following earnings and
profits and foreign income taxes accounts immediately after the
foreign divisive transaction (see §1.960-1(i)(4)):
Separate Category | E&P | Foreign Taxes
--------------------+---------+------------------
General | 233.33u | $25
--------------------+---------+------------------
Passive | (100u)| $ 6
--------------------+---------+------------------
Shipping | 116.67u | $40
--------------------+---------+------------------
| 250u | $71
(E) Calculation of FC's earnings and profits. Under paragraph (b)(1)
(ii)(B) of this section, FC's earnings and profits are not increased
(or replaced) as a result of the foreign divisive transaction. FC's
earnings and profits also are not reduced because USP was not
required to include a deemed dividend out of FC under
§1.367(b)-5.
Example 3--
(i) Facts. (A) USP, a domestic corporation, has owned all of the
stock of FD since FD's incorporation in 1995. USP's adjusted basis
in the FD stock is $100 and the FD stock has a fair market value of
$2,000. FC is a preexisting controlled corporation and FD has always
owned all of the FC stock. FD owns assets with total net bases of
320u (including 100u attributable to the FC stock and 160u
attributable to the Business B shipping assets). FD and FC have the
following earnings and profits and foreign income taxes accounts:
FD:
Separate Category | E&P | Foreign Taxes
---------------------------+---------+------------------
General | 300u | $ 50
---------------------------+---------+------------------
10/50 dividends from FC1, | |
a noncontrolled section | |
902 corporation | 100u | $ 6
---------------------------+---------+------------------
Shipping | 200u | $ 80
---------------------------+---------+------------------
| 600u | $136
FC:
Separate Category | E&P | Foreign Taxes
---------------------------+---------+------------------
General | 100u | $10
---------------------------+---------+------------------
Passive | (50u) | $ 6
---------------------------+---------+------------------
Shipping | 100u | $40
---------------------------+---------+------------------
| 150u | $56
(B) On January 1, 2002, FD transfers to FC the Business B shipping
assets. FD then distributes the FC stock to USP. The transaction
meets the requirements of sections 368(a)(1)(D) and 355. Immediately
after the foreign divisive transaction, the FD stock and the FC
stock each have a $1,000 fair market value.
(ii) Result--
(A) Calculation of FD's earnings and profits. Under paragraph (b)(4)
(i) of this section, FD's pre-transaction earnings are reduced by
the sum of the amounts described in paragraphs (b)(4)(i)(A) and (B)
of this section. Under paragraph (b)(4)(i)(A) of this section, FD's
pre-transaction earnings are reduced by an amount equal to FD's pre-
transaction earnings times the net bases of the Business B shipping
assets transferred to FC divided by the total net bases in the
assets held by FD immediately before the foreign divisive
transaction (600u x (160u ÷ 320u) = 300u). Under paragraph
(b)(4)(i)(B) of this section, FD's pre-transaction earnings are
reduced by an amount equal to FD's pre-transaction earnings times
FD's net bases in the stock of FC divided by the total net bases of
the assets held by FD immediately before the foreign divisive
transaction (600u x (100u ÷ 320u) = 187.50u). The sum of the
amounts described in paragraphs (b)(4)(i)(A) and (B) of this section
is 487.50u.
(B) Application of §1.367(b)-5(c). The basis adjustment and
income inclusion rules of §1.367(b)-5(c)(2) apply if USP's
postdistribution amount with respect to FD or FC stock is less than
its predistribution amount with respect to such stock. Under
§1.367(b)-5(e)(1) and (3), USP's predistribution amount with
respect to FD or FC stock is USP's section 1248 amount attributable
to such stock computed immediately before the distribution, after
the allocation of FD's pre-transaction earnings described in
paragraphs (b)(4)(i)(A) and (ii)(A) of this section, but before the
reduction in FD's pre-transaction earnings described in paragraph
(b)(4)(i)(B) of this section. Thus, USP's predistribution amounts
with respect to FD and FC stock are $300 (600u - 300u) and $450
(150u + 300u), respectively. See also section 989(b)(2). Under
section 358, USP allocates its $100 basis in FD stock between FD
stock and FC stock according to the stock blocks' relative values,
yielding a $50 ($100 x ($1,000 ÷ $2,000)) basis in each
block. Under §1.367(b)-5(e)(2), USP's postdistribution amount
with respect to FD or FC stock is USP's section 1248 amount with
respect to such stock, computed immediately after the distribution.
Accordingly, USP's postdistribution amount with respect to FD stock
is $112.50 (600u - 300u - 187.50u), and its postdistribution amount
with respect to FC stock is $450 (150u + 300u). Because USP's
postdistribution amount with respect to FC stock is not less than
its predistribution amount with respect to such stock, the
§1.367(b)-5(c)(2) basis adjustment and income inclusion rules
do not apply with respect to the FC stock. Because USP's
postdistribution amount with respect to FD stock is $187.50 less
than its predistribution amount with respect to such stock ($300 -
$112.50), §1.367(b)-5(c)(2)(i) and (ii) require USP to reduce
its basis in FD stock, but only to the extent such reduction
increases USP's section 1248 amount with respect to the FD stock.
Because a reduction in USP's basis in the FD stock would not
increase any of USP's section 1248 amount with respect to such
stock, USP includes the entire $187.50 difference between its
predistribution and postdistribution amounts with respect to the FD
stock as a deemed dividend from FD. Because the requirements of
section 902 are met, USP qualifies for a deemed paid foreign tax
credit with respect to the deemed dividend that it receives from FD.
Under §1.902-1(d)(1), the $187.50 deemed dividend is out of
FD's separate categories and reduces foreign income taxes as
follows:
Separate Category | E&P | Foreign Taxes
---------------------------+---------+------------------
General | 93.75u | $15.63
---------------------------+---------+------------------
10/50 dividends from FC1 | 31.25u | $ 1.88
---------------------------+---------+------------------
Shipping | 62.50u | $25
---------------------------+---------+------------------
| 187.50u | $42.51
(C) Basis adjustment. Under §1.367(b)-5(c)(3), the basis
increase provided in §1.367(b)-2(e)(3)(ii) does not apply with
respect to USP's $187.50 deemed dividend from FD. Under
§1.367(b)-5(c)(4), USP increases its basis in the FC stock by
the amount of its deemed dividend inclusion from FD, but only to the
extent such basis increase does not diminish USP's postdistribution
amount with respect to FC stock and only up to the fair market value
of the FC stock. Under these rules, USP increases its basis in the
FC stock by the full amount of its deemed dividend from FD ($50 +
$187.50 = $237.50).
(D) Reduction in FD's statutory groupings of earnings and profits.
Under paragraph (b)(2) of this section, the reduction in FD's pre-
transaction earnings that is not attributable to USP's inclusion
under §1.367(b)-5 decreases FD's statutory groupings of
earnings and profits on a pro rata basis. Under paragraph (e)(3) of
this section, FD's pre-transaction taxes are also ratably reduced.
As described in this Example 3 (ii)(A), the reduction in FD's pre-
transaction earnings is 487.50u. As described in this Example 3 (ii)
(B), 187.50u of the 487.50u reduction is attributable to a deemed
dividend inclusion by USP under §1.367(b)-5. Thus, under
paragraphs (b)(2) and (e)(3) of this section, the remaining 300u
reduction in FD's pre-transaction earnings and related pre-
transaction taxes is out of FD's separate categories and reduces
foreign income taxes as follows:
Separate Category | E&P | Foreign Taxes
---------------------------+---------+------------------
General | 150u | $25
10/50 dividends from FC1 | 50u | $ 3
Shipping | 100u | $40
| 300u | $68
(E) Calculation of FC's earnings and profits. Under paragraph (b)(4)
(ii) of this section, FC's earnings and profits immediately after
the foreign divisive transaction equal the sum of FC's earnings and
profits immediately before the foreign divisive transaction, plus
the amount of the reduction in FD's earnings and profits described
in paragraph (b)(4)(i)(A) of this section, except to the extent such
amount was included in income as a deemed dividend pursuant to the
foreign divisive transaction. The reduction in FD's earnings and
profits described in paragraph (b)(4)(i)(A) of this section is 300u,
none of which was included in income by USP as a deemed dividend
pursuant to the foreign divisive transaction. Under paragraphs (e)
(2) and (3) of this section, the 300u of pre-transaction earnings
and related pre-transaction taxes carry over to FC and combine with
FC's earnings and profits and foreign income taxes accounts in
accordance with the rules described in §1.367(b)-7. Under
§1.367(b)-7(d), FC has the following earnings and profits and
foreign income taxes accounts immediately after the foreign divisive
transaction:
| | | | Taxes
| | | | Associated w/
| | Hovering | | Hovering
Separate Category | E&P | Deficit | Taxes | Deficit
---------------------+--------+-----------+--------+----------------
General | 250u | | $35 |
---------------------+--------+-----------+--------+----------------
10/50 dividends | 50u | | $ 3 |
---------------------+--------+-----------+--------+----------------
from FC1 | | | |
Passive | | (50u) | | $6
---------------------+--------+-----------+--------+----------------
Shipping | 200u | | $80 | __
---------------------+--------+-----------+--------+----------------
| 500u | (50u) | $118 | $6
(F) FD's earnings and profits after the foreign divisive
transaction. Following the reductions described in this Example 3
(ii)(B) and (D), FD has the following earnings and profits and
foreign income taxes accounts:
Separate Category | E&P | Foreign Taxes
---------------------------+---------+------------------
General | 56.25u | $ 9.37
---------------------------+---------+------------------
10/50 dividends from FC1 | 18.75u | $ 1.12
---------------------------+---------+------------------
Shipping | 37.50u | $15
---------------------------+---------+------------------
| 112.50u | $25.49
(f) Effective date. This section shall apply to section 367(b)
exchanges that occur on or after the date 30 days after these
regulations are published as final regulations in the Federal
Register.
Par. 11. Section 1.367(b)-9 is added to read as follows:
§1.367(b)-9 Special rule for F reorganizations and similar
transactions.
(a) Scope. This section applies to any foreign 381 transaction (as
described in §1.367(b)-7(a)) described in section 368(a)(1)(F)
or in which either the foreign target corporation or the foreign
acquiring corporation is newly created. This section also applies to
any foreign divisive transaction (as described in
§1.367(b)-8(a)) that is described in §1.367(b)-8(e)(1) and
that involves a newly created foreign distributing or foreign
controlled corporation.
(b) Hovering deficit rules inapplicable. If a transaction is
described in paragraph (a) of this section, a foreign surviving
corporation or a newly created controlled corporation shall succeed
to earnings and profits, deficits in earnings and profits, and
foreign income taxes without regard to the hovering deficit rules of
§1.367(b)-7(d)(2), (e)(1)(iii), (e)(2)(iii), (f)(1)(iii), and
(f)(2)(iii). In the case of a foreign divisive transaction, nothing
in this section shall affect the application of §1.367(b)-8(b)
(iii).
(c) Example. The following example illustrates the rules of this
section:
Example--
(i) Facts.
(A) Foreign corporation A is and always has been a wholly owned
subsidiary of USP, a domestic corporation. Foreign corporation A was
incorporated in 1990, and always has been a controlled foreign
corporation using a calendar taxable year. Foreign corporation A
(and all of its respective qualified business units as defined in
section 989) maintains a "u" functional currency, and 1u = US$1 at
all times. On December 31, 2001, foreign corporation A has the
following earnings and profits and foreign income taxes accounts:
Separate Category | E&P | Foreign Taxes
---------------------------+---------+------------------
Passive | (1,000u)| $ 5
---------------------------+---------+------------------
General | 200u | $200
---------------------------+---------+------------------
| (800u)| $205
(B) On January 1, 2002, foreign corporation A moves its place of
incorporation from Country 1 to Country 2 in a reorganization
described in section 368(a)(1)(F).
(ii) Result. Under §1.367(b)-7(d), as modified by paragraph (b)
of this section, foreign surviving corporation has the following
earnings and profits and foreign income taxes accounts immediately
after the foreign 381 transaction:
Separate Category | E&P | Foreign Taxes
---------------------------+---------+------------------
Passive | (1,000u)| $ 5
---------------------------+---------+------------------
General | 200u | $200
---------------------------+---------+------------------
| (800u)| $205
(d) Effective date. This section shall apply to section
367(b) exchanges that occur on or after the date 30 days after
these regulations are published as final regulations in the
Federal Register.
Par. 12. In §1.367(e)-1, paragraph (a) is amended by adding
a sentence at the end of the paragraph to read as follows:
§1.367(e)-1 Distributions described in section 367(e)(1).
(a) * * * See §1.367(b)-8(c)(3) for an example illustrating
the interaction of §1.367(e)-1 with other sections of the
Internal Revenue Code (such as sections 367(b) and 1248).
* * * * *
Par. 13. In §1.381(a)-1, paragraph (c) is revised to read
as follows:
§1.381(a)-1 General rule relating to carryovers in certain
corporate acquisitions.
* * * * *
(c) Foreign corporations. For additional rules involving
foreign corporations see §§1.367(b)-7 and 1.367(b)-9.
* * * * *
Robert E. Wenzel
Deputy Commissioner of Internal Revenue
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