Application of Separate Limitations to Dividends From Noncontrolled Section 902 Corporations, 24516-24542 [06-3882]

Agencies

• Internal Revenue Service
• DEPARTMENT OF THE TREASURY

[Federal Register Volume 71, Number 79 (Tuesday, April 25, 2006)]
[Rules and Regulations]
[Pages 24516-24542]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 06-3882]



[[Page 24515]]

-----------------------------------------------------------------------

Part V





Department of the Treasury





-----------------------------------------------------------------------



Internal Revenue Service



-----------------------------------------------------------------------



26 CFR Parts 1 and 602



Application of Separate Limitations to Dividends From Noncontrolled 
Section 902 Corporations; Final Rule and Proposed Rule

Federal Register / Vol. 71, No. 79 / Tuesday, April 25, 2006 / Rules 
and Regulations

[[Page 24516]]


-----------------------------------------------------------------------

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Parts 1 and 602

[TD 9260]
RIN 1545-BF46


Application of Separate Limitations to Dividends From 
Noncontrolled Section 902 Corporations

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Temporary regulations.

-----------------------------------------------------------------------

SUMMARY: This document contains temporary regulations regarding the 
application of separate foreign tax credit limitations to dividends 
received from noncontrolled section 902 corporations under section 
904(d)(4). Section 403 of the American Jobs Creation Act of 2004, 
Public Law 108-357, 118 Stat. 1418 (October 22, 2004) (AJCA), modified 
the treatment of such dividends effective for taxable years beginning 
after December 31, 2002. Section 403(l) of the Gulf Opportunity Zone 
Act of 2005, Public Law 109-135, 119 Stat. 2577 (December 22, 2005) 
(GOZA), permits taxpayers to elect to defer the effective date of the 
AJCA amendments until taxable years beginning after December 31, 2004. 
The temporary regulations provide guidance needed to comply with these 
changes and affect corporations claiming foreign tax credits. The text 
of these temporary regulations also serves as the text of the proposed 
regulations (REG-144784-02) set forth in the notice of proposed 
rulemaking on this subject published elsewhere in this issue of the 
Federal Register.

DATES: Effective Date: These regulations are effective April 25, 2006. 
For dates of applicability, see Sec. Sec.  1.861-9T(f)(4)(iv), 1.861-
12T(c)(4)(iii), 1.902-1T(g), 1.904-2T(h)(1) and (2), 1.904-4T(c)(2)(i), 
1.904-5T(o)(2), 1.904-7T(f)(10), 1.904(f)-12T(g)(5), and 1.964-1T(c)(2) 
and (c)(6).
    Applicability Dates: These regulations generally apply to dividends 
paid in taxable years of noncontrolled section 902 corporations 
beginning after December 31, 2002.

FOR FURTHER INFORMATION CONTACT: Ginny Chung (202) 622-3850 (not a toll 
free call).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

    These temporary regulations are being issued without prior notice 
and public procedure pursuant to the Administrative Procedure Act (5 
U.S.C. 553). For this reason, the collections of information contained 
in these regulations have been reviewed and, pending receipt and 
evaluation of public comments, approved by the Office of Management and 
Budget under control number 1545-2014. Responses to these collections 
of information are required to obtain a tax benefit.
    An agency may not conduct or sponsor, and a person is not required 
to respond to, a collection of information unless the collection of 
information displays a valid OMB control number.
    For further information concerning these collections of 
information, and where to submit comments on the collections of 
information and the accuracy of the estimated burden, and suggestions 
for reducing this burden, please refer to the preamble of the cross-
referencing notice of proposed rulemaking published in this issue of 
the Federal Register.
    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

    This document contains amendments to the regulations under sections 
861, 902, 904, and 964 relating to the application of separate 
limitations to dividends from noncontrolled section 902 corporations 
(10/50 corporations) under section 904(d)(4), as amended by the AJCA 
and GOZA. Prior to the Taxpayer Relief Act of 1997, Public Law No. 105-
34, 111 Stat. 788, 971 (1997) (1997 Act), dividends from each 10/50 
corporation were subject to a separate foreign tax credit limitation (a 
separate category for dividends from each 10/50 corporation). The 1997 
Act modified these rules, effective for taxable years beginning after 
December 31, 2002. In lieu of the separate category treatment, the 1997 
Act provided that dividends paid by 10/50 corporations that are not 
passive foreign investment companies out of earnings and profits 
accumulated in taxable years beginning on or before December 31, 2002, 
(10/50 dividends out of pre-2003 earnings) would be included in a 
single separate category (the single category for dividends from all 
10/50 corporations), and dividends from 10/50 corporations out of 
earnings and profits accumulated in taxable years beginning after 
December 31, 2002, (10/50 dividends out of post-2002 earnings) would be 
treated as income in a separate category based on the separate category 
of the underlying earnings and profits being distributed (look-through 
treatment). On December 23, 2002, the IRS and the Treasury Department 
issued Notice 2003-5 (2003-1 C.B. 294), which provided guidance 
addressing the application of section 904 to dividends paid by 10/50 
corporations under the 1997 Act.
    The AJCA modified the 10/50 dividend rules in the 1997 Act and 
provided that dividends from 10/50 corporations would be eligible for 
look-through treatment effective for taxable years beginning after 
December 31, 2002, without regard to when the distributed earnings were 
accumulated. Section 403(l) of the GOZA provided a rule allowing a 
taxpayer to elect, for taxable years beginning after December 31, 2002, 
and before January 1, 2005, not to apply the expanded look-through 
rules enacted in the AJCA to 10/50 dividends out of pre-2003 earnings. 
Section 403(l) of the GOZA also provided, with respect to carrybacks 
and carryforwards under section 904(c) of excess foreign taxes 
allocable to a dividend from a 10/50 corporation, that a taxpayer that 
elects not to apply the expanded look-through rules enacted in the AJCA 
to taxable years beginning in 2003 and 2004 must defer the application 
of the look-through rules for carryovers of excess foreign taxes 
contained in section 904(d)(4)(C)(iv).
    The temporary regulations modify the section 902 and 904 
regulations to reflect the look-through treatment of dividends from 10/
50 corporations and provide transition rules for the treatment of 
overall foreign losses and separate limitation losses under section 
904(f) and the carryover of excess foreign taxes under section 904(c). 
The temporary regulations also modify the grouping rules of Sec.  
1.904-4(c) that apply for purposes of determining whether an item of 
income is considered high-taxed income, the rules under Sec.  1.861-9T 
governing the apportionment of interest expense of a 10/50 corporation, 
and the rules under Sec.  1.861-12T governing the characterization of 
stock of a 10/50 corporation for purposes of apportioning the 
shareholder's interest expense.
    In addition, the temporary regulations modify the regulations under 
section 964 to add rules permitting majority domestic corporate 
shareholders of a 10/50 corporation to make tax accounting elections on 
behalf of the 10/50 corporation. The temporary regulations also expand 
the section 964 regulations to allow controlling United States 
shareholders and majority domestic corporate shareholders to adopt or 
change the taxable year of a controlled foreign corporation or 10/50 
corporation (as the case may be) on behalf of the

[[Page 24517]]

foreign corporation. The temporary regulations also revise the 
regulations' procedural rules to permit statements evidencing the 
shareholders' action to be filed with the shareholders' tax returns 
instead of 183 days after the close of the foreign corporation's 
taxable year. Finally, the temporary regulations modify the section 964 
regulations to eliminate obsolete provisions and reorganize some of the 
rules contained in Sec.  1.964-1T(g).
    The IRS and the Treasury Department request comments on additional 
guidance that may be needed to implement section 403 of the AJCA and 
section 403(l) of the GOZA.

Explanation of Provisions

I. Interest Expense Apportionment

A. Interest Expense of a 10/50 Corporation
    For purposes of apportioning interest expense of a 10/50 
corporation in order to apply the dividend look-through rule, new Sec.  
1.861-9T(f)(4) generally applies the principles of Sec.  1.861-9T(f)(3) 
(apportionment of interest expense of a controlled foreign 
corporation). Under this rule, interest expense of a 10/50 corporation 
may be apportioned using either the asset method or the modified gross 
income method. Section 1.861-9T(f)(4) also provides that the election 
to use the asset method or modified gross income method may be made by 
either the 10/50 corporation itself or by the ``majority domestic 
corporate shareholders'' of the 10/50 corporation. The term majority 
domestic corporate shareholders means those domestic corporations that 
meet the ownership requirements of section 902(a) with respect to the 
10/50 corporation (or to a first-tier foreign corporation that is a 
member of the same qualified group as the 10/50 corporation) that, in 
the aggregate, own directly or indirectly more than 50 percent of the 
combined voting power of all of the voting stock of the 10/50 
corporation that is owned directly or indirectly by all domestic 
corporations that meet the ownership requirements of section 902(a) 
with respect to the 10/50 corporation (or a relevant first-tier 10/50 
corporation). Unlike a controlled foreign corporation (CFC), however, a 
10/50 corporation will not be required to use the asset method even 
though the majority domestic corporate shareholders elect the fair 
market value method of apportionment. Compare Sec.  1.861-9T(f)(3)(i) 
and Sec.  1.861-8T(c)(2) (requiring CFC to use fair market value method 
if controlling United States shareholders as defined in Sec.  1.861-
9T(f)(3)(ii) elect fair market value method). The IRS and the Treasury 
Department believe that the conformity rule of Sec.  1.861-8T(c)(2) 
should not apply to foreign corporations that are not controlled by 
domestic shareholders. Therefore, regardless of the methods used by the 
majority domestic corporate shareholders of a 10/50 corporation, the 
10/50 corporation (or the majority domestic corporate shareholders on 
behalf of the 10/50 corporation) may elect to use any of the methods 
described in Sec.  1.861-9T or Sec.  1.861-9 (e.g., the modified gross 
income, tax book value, alternative tax book value, or fair market 
value method) to apportion the 10/50 corporation's interest expense.
B. Characterization of Stock of a 10/50 Corporation
    For purposes of apportioning interest expense to income of a 
taxpayer in the various separate categories under section 904(d), Sec.  
1.861-12T(c)(4) currently treats stock of each 10/50 corporation owned 
by the taxpayer as an asset giving rise to income in a separate 
category. The temporary regulations are amended to reflect the repeal 
of separate categories for dividends from 10/50 corporations. Because 
dividends from 10/50 corporations are eligible for look-through 
treatment in the same manner as dividends from CFCs, the IRS and the 
Treasury Department believe that stock of a 10/50 corporation should be 
treated for interest expense apportionment purposes in the same manner 
as stock of a CFC, which is characterized based on the income produced 
in the current year, or expected to be produced in future years, by the 
assets of the CFC. See Sec.  1.861-12T(c)(3). Accordingly, Sec.  1.861-
12T(c)(4) is amended to provide that stock in a 10/50 corporation is 
characterized as an asset in the various separate categories on the 
basis of either the asset method (described in Sec.  1.861-
12T(c)(3)(ii)) or the modified gross income method (described in Sec.  
1.861-12T(c)(3)(iii)), depending on the method used by the 10/50 
corporation to apportion its interest expense. In addition, the 
temporary regulations eliminate the special rule in Sec.  1.861-
12T(c)(4)(ii) for separate limitation losses, which provided that a 
taxpayer could elect to reallocate interest expense that resulted in a 
loss in a separate category for dividends from a 10/50 corporation. 
This rule is no longer necessary due to the elimination of separate 
categories for dividends from 10/50 corporations.
C. Definition of ``10 Percent Owned Corporation''
    The current temporary regulations require an affiliated group using 
the tax book value method in apportioning its interest expense to 
adjust the basis of stock in any ``10 percent owned corporation'' that 
is held directly by members of the group to reflect the member's pro 
rata share of such corporation's earnings and profits (or deficit in 
earnings and profits). Sec.  1.861-12T(c)(1), (c)(2). The adjustment 
must take into account such corporation's pro rata share of the 
earnings and profits (or deficit) of any lower-tier 10 percent owned 
corporation. Sec.  1.861-12T(c)(2)(iii). In general, a corporation is a 
``10 percent owned corporation'' if members of the affiliated group own 
directly or indirectly 10 percent or more of the voting power of the 
corporation. Sec.  1.861-12T(c)(2)(ii). As amended by this Treasury 
Decision, the basis adjustment rule of Sec.  1.861-12T(c)(2)(i) is 
revised to clarify that it applies to stock of a 10 percent owned 
corporation not only where stock in a 10 percent owned corporation is 
held directly by members of the affiliated group, but also where the 
stock is held indirectly through a partnership or other pass-through 
entity. Thus, the basis adjustment is required whenever the stock 
(rather than the interest in the pass-through entity) is the relevant 
asset for purposes of interest expense apportionment.

II. Deemed Paid Credit Under Section 902

A. Extension of Look-Through Rules and Tier Limitation
    The 1997 Act and AJCA amendments expanded the look-through 
treatment of dividends from 10/50 corporations. The temporary 
regulations amend Sec.  1.902-1(d) to reflect these changes. The 
temporary regulations also reflect provisions of the 1997 Act amending 
section 902 to provide for the calculation of deemed-paid taxes with 
respect to distributions through up to six tiers of foreign 
corporations in a chain of corporations in a ``qualified group'' 
described in section 902(b)(2). Under section 902(b)(2), the term 
``qualified group'' does not include any foreign corporation below the 
third tier in the chain unless such corporation is a controlled foreign 
corporation of which the domestic corporation is a United States 
shareholder. For a member of the qualified group below the third tier, 
only foreign income taxes paid with respect to periods during which it 
was a controlled foreign corporation are eligible to be deemed paid. 
The temporary regulations modify

[[Page 24518]]

Sec.  1.902-1 to reflect these statutory amendments, effective for 
taxes paid by fourth-, fifth-, and sixth-tier qualified group members 
with respect to taxable years beginning after August 5, 1997.
B. Amounts Included in Post-1986 Foreign Income Taxes
    Under Sec.  1.902-1(a)(7), foreign income taxes do not include 
amounts not treated as a tax or certain taxes for which credit is 
disallowed under various provisions of section 901. The temporary 
regulations update the definition of foreign income taxes in Sec.  
1.902-1(a)(7) to exclude taxes for which a credit is disallowed under 
sections 901(j) (relating to the disallowance of a credit for foreign 
taxes paid or accrued to certain countries), sections 901(k) and (l) 
(disallowing credit for certain withholding taxes paid with respect to 
dividends or other income if the recipient does not meet certain 
holding period requirements or is under an obligation to make related 
payments with respect to substantially similar or related property), or 
any similar provision. In addition, the temporary regulations modify 
Sec.  1.902-1(a)(8) to reflect the amendment of section 902(c)(2)(B) in 
1997, which clarified the definition of post-1986 foreign income taxes 
by substituting the phrase ``attributable to'' for the phrase ``deemed 
paid with respect to.''
    Section 1113(c)(2) of the 1997 Act provided that in the case of any 
chain of foreign corporations described in clauses (i) and (ii) of 
section 902(b)(2)(B), no liquidation, reorganization, or similar 
transaction in a taxable year beginning after August 5, 1997, can have 
the effect of permitting taxes to be taken into account under section 
902 which could not have been taken into account under section 902 but 
for the transaction. This rule was enacted as part of the effective 
date of the 1997 Act's extension of the deemed-paid credit rules from 
three to six tiers as discussed above. Accordingly, Sec.  1.902-
1T(c)(8) is added to clarify that foreign taxes paid or accrued by a 
qualified group member are not eligible to be deemed paid if they were 
paid or accrued in a taxable year beginning on or before August 5, 
1997, if such member was a fourth-, fifth- or sixth-tier corporation 
with respect to the taxpayer on the first day of its first taxable year 
beginning after August 5, 1997.

III. Carryovers and Carrybacks of Excess Foreign Taxes Under Section 
904(c)

    Section 904(d)(4)(C)(iv), as amended by the AJCA, provides that 
look-through treatment applies to the carryover of excess foreign taxes 
from pre-2003 taxable years to post-2002 taxable years to the extent 
that they are allocable to dividends from 10/50 corporations. 
Consistent with this statutory amendment, Sec.  1.904-2T(h)(1) provides 
that to the extent that a taxpayer has paid, accrued, or deemed paid 
excess taxes in a separate category for dividends from a 10/50 
corporation paid in a pre-2003 taxable year and these excess taxes are 
carried over to taxable years beginning on or after the first day of 
the 10/50 corporation's first post-2002 taxable year, the excess taxes 
are assigned to the appropriate separate category as if the associated 
dividends had been eligible for look-through treatment when paid, based 
on the reconstruction of the 10/50 corporation's pre-2003 earnings in 
accordance with Sec.  1.904-7T(f) (discussed below in section V.E., 
``Treatment of earnings and taxes accumulated during a non-look-through 
period''). In the case of excess taxes attributable to dividends from a 
10/50 corporation with respect to which the taxpayer is no longer a 
qualifying shareholder as of the first day of its first post-2002 
taxable year, Sec.  1.904-2T(h)(1) provides that the excess taxes are 
assigned pro rata to the separate categories to which the foreign 
corporation's pre-2003 earnings would have been assigned had they been 
distributed in the last year that the taxpayer was a qualifying 
shareholder.
    If the Commissioner determines that the look-through 
characterization of the excess taxes cannot be reasonably determined 
under one of the methods described in Sec.  1.904-7T(f)(4), the 
Commissioner will assign such taxes to the general limitation category. 
Section 1.904-2T(h)(1) also provides that any excess taxes carried over 
from pre-2003 taxable years to post-2002 taxable years that would 
otherwise be assigned to the passive category are assigned to the 
general limitation category. The IRS and the Treasury Department 
believe that these rules are appropriate because to the extent the pre-
2003 dividend paid by the 10/50 corporation that generated the excess 
credits would have been treated as passive income, such income and 
associated taxes would have been considered high-taxed income under 
section 904(d)(2)(A)(iii)(III) and generally would have been 
recharacterized as general limitation income and taxes.
    Section 904(d)(4)(C)(iv), as amended by the AJCA, authorizes the 
Secretary to issue regulations for allocating carrybacks of excess 
taxes allocable to a dividend paid by a 10/50 corporation in a post-
2002 taxable year to a pre-2003 taxable year for purposes of allocating 
such dividend among the separate categories in effect for the taxable 
year to which carried. The IRS and the Treasury Department determined 
that the regulations should not provide for the carryback of post-2002 
excess taxes attributable to look-through dividends paid by a 10/50 
corporation to a separate limitation category for dividends from each 
10/50 corporation in pre-2003 years. Such a rule would be 
administratively burdensome because it would require taxpayers to 
maintain multiple sets of section 904(c) accounts for separate 
categories for the 2003 and 2004 taxable years and because it would 
necessitate complex stacking rules to determine the amount of excess 
taxes in a separate category that were attributable to dividends paid 
by specific 10/50 corporations. Accordingly, Sec.  1.904-2T(h)(2) 
provides that excess taxes that are allocable to dividends from 10/50 
corporations paid in post-2002 taxable years that are attributable to 
one or more separate categories are carried back to prior taxable years 
in the same separate categories to which the dividends were assigned.

IV. High-Taxed Income of a 10/50 Corporation

    In general, income received or accrued by a United States person 
that would otherwise be passive income is treated as general limitation 
income if the income is determined to be high-taxed income within the 
meaning of section 904(d)(2)(F). In determining whether passive income 
is high-taxed income, the grouping rules of Sec.  1.904-4(c) apply 
separately to dividends and subpart F inclusions from each controlled 
foreign corporation, income of a qualified business unit (QBU), and 
income of a QBU of a controlled foreign corporation and any other look-
through entity as defined in Sec.  1.904-5(i). Sec. Sec.  1.904-4(c)(4) 
and (c)(5)(iv). The temporary regulations at Sec.  1.904-4T(c)(3) and 
(c)(4) provide that the grouping rules similarly apply separately to 
dividends from each 10/50 corporation, which includes dividends that 
are treated as passive income either on a look-through basis or due to 
inadequate substantiation. The IRS and the Treasury Department believe 
that this rule is consistent with the intent of the existing separate 
grouping rules as well as legislative intent that ``the high-tax income 
rules apply appropriately to dividends treated as passive category 
income because of inadequate substantiation.'' H.R. Conf. Rep. No. 755, 
108th Cong. 2d Sess. 386 n.222 (2004). Consistent with the changes to 
the look-through rules enacted in the

[[Page 24519]]

AJCA, this rule is effective for dividends paid in post-2002 taxable 
years of 10/50 corporations.

V. Look-Through Rules as Applied to 10/50 Corporations

A. Treatment of Dividends Paid by a 10/50 Corporation in General
    Section 904(d)(4)(A), as amended by the AJCA, provides that look-
through treatment applies to any dividend paid by a 10/50 corporation 
in a post-2002 taxable year, regardless of the year in which the 
earnings were accumulated. Accordingly, Sec.  1.904-5T(c)(4)(iii) 
provides that any dividends paid in a post-2002 taxable year to a 
domestic corporation by a 10/50 corporation with respect to which the 
domestic corporation meets the stock ownership requirements of section 
902(a) are treated as income in a separate category in proportion to 
the ratio of the portion of earnings and profits attributable to income 
in such category to the total amount of earnings and profits of the 10/
50 corporation. Interest, rents, and royalties paid by a 10/50 
corporation to a domestic corporation are not eligible for look-through 
treatment and are treated as passive income except as otherwise 
provided in section 904(d)(2)(A) and the regulations thereunder. Any 
dividend distribution by a 10/50 corporation to a shareholder that is 
not a corporation meeting the stock ownership requirements of section 
902(a) or (b) is also treated as passive income. Finally, as provided 
in section 904(d)(4)(C)(ii), Sec.  1.904-5T(c)(4)(iii) provides that a 
dividend from a 10/50 corporation is treated as passive income if the 
look-through characterization of the dividend is not substantiated to 
the satisfaction of the Commissioner. These rules are generally 
applicable to dividends paid by a 10/50 corporation during its first 
post-2002 taxable year and thereafter, without regard to whether the 
corresponding taxable year of the dividend recipient is a post-2002 
taxable year.
B. Allocation and Apportionment of Expenses of a 10/50 Corporation
    In applying look-through to dividends from 10/50 corporations, 
expenses of the 10/50 corporation (such as payments of interest, rents, 
and royalties) must be allocated and apportioned to the 10/50 
corporation's pools of post-1986 undistributed earnings. Sec.  1.904-
5T(c)(2)(iii) provides that expenses of a 10/50 corporation are 
allocated and apportioned to the income of the 10/50 corporation in the 
same manner as expenses of a CFC. See, e.g., section 954(b)(5); Sec.  
1.904-5(c)(2)(ii)).
    The temporary regulations, however, do not extend the special 
allocation rule for related person interest expense under section 
954(b)(5) and Sec.  1.904-5(c)(2)(ii) (providing that interest paid by 
a CFC to a U.S. shareholder or any related look-through entity is first 
allocated to reduce foreign personal holding company income which is 
passive income) to interest paid by 10/50 corporations. The AJCA did 
not extend look-through treatment to interest paid by a 10/50 
corporation to a domestic shareholder or to a related entity, and 10/50 
corporations are not subject to subpart F. Accordingly, interest paid 
by a 10/50 corporation to a domestic shareholder, CFC, or another 10/50 
corporation is treated as passive income (or high withholding tax 
interest, financial services income, or high-taxed general limitation 
income, as appropriate) and is apportioned to reduce the payor's pools 
of post-1986 undistributed earnings under the rules applicable to 
unrelated person interest expense, even though the generally applicable 
expense allocation rules of Sec.  1.904-5 apply to determine which 
earnings are reduced at the payor 10/50 corporation level.
C. Treatment of Dividends Paid Between Lower-Tier Look-Through Entities
    To reflect the extension of look-through treatment to dividends 
paid by 10/50 corporations and the repeal of separate categories for 
dividends from each 10/50 corporation, the temporary regulations remove 
the rules of Sec.  1.904-4(g) and amend the relevant provisions of 
Sec. Sec.  1.902-1 and 1.904-5. In order for a dividend from a 10/50 
corporation to qualify for look-through treatment, the shareholder must 
be a domestic corporation meeting the stock ownership requirements of 
section 902(a) with respect to the 10/50 corporation. Sections 
904(d)(2)(E) and 904(d)(4).
    In determining whether dividends paid by lower-tier corporations 
are eligible for look-through treatment, the eligibility requirements 
for dividends from 10/50 corporations and CFCs cannot be precisely 
conformed, because a taxpayer's eligibility for look-through treatment 
of a dividend from a 10/50 corporation is based on whether the taxpayer 
meets the stock ownership requirements of section 902, whereas a 
taxpayer's eligibility for look-through treatment of a dividend from a 
CFC is based on whether the taxpayer is a United States shareholder 
with respect to the CFC under section 951(b). See sections 
904(d)(2)(E)(i), 904(d)(3)(A), 904(d)(3)(D), and 904(d)(4)(A). However, 
the IRS and the Treasury Department believe that the eligibility 
requirements for look-through treatment of dividends from 10/50 
corporations and CFCs should be conformed to the greatest extent 
possible.
    Accordingly, Sec.  1.902-1T(d)(1) provides that the amount of 
foreign taxes deemed paid is computed separately with respect to post-
1986 undistributed earnings or pre-1987 accumulated profits in each 
separate category out of which a look-through dividend is paid in the 
following situations: (1) A dividend from a CFC to a domestic 
corporation meeting the stock ownership requirements of section 902(a) 
that is a United States shareholder (as defined in section 951(b) or 
section 953(c)) of the CFC; (2) a dividend from a 10/50 corporation to 
a domestic corporation meeting the stock ownership requirements of 
section 902(a); (3) a dividend received by an upper-tier CFC from a 
lower-tier CFC where the CFCs are related look-through entities under 
Sec.  1.904-5(i)(3); and (4) a dividend from a CFC or 10/50 corporation 
to a foreign corporation that is eligible to compute an amount of 
foreign taxes deemed paid under section 902(b)(1) (i.e., both the payor 
and payee corporations are members of the same qualified group as 
defined in section 902(b)(2)). Similarly, the temporary regulations at 
Sec.  1.904-5T(i)(4) apply look-through treatment to any dividend paid 
by a CFC or 10/50 corporation to another member of the same qualified 
group (as defined in section 902(b)(2)) that is eligible to compute an 
amount of foreign taxes deemed paid under section 902(b)(1), and retain 
the current rule of Sec.  1.904-5(i)(3) to the extent that it applies 
look-through treatment to dividends between CFCs that have a common 10 
percent U.S. shareholder but do not meet the requirements of section 
902(b).
D. Application of Section 904(g) to 10/50 Corporations
    Section 904(g) (redesignated under the AJCA as section 904(h) for 
taxable years beginning after 2006) provides that certain inclusions, 
including dividends and interest paid or accrued by a United States-
owned foreign corporation to a United States shareholder or a related 
person and which would be treated as foreign source income, are treated 
as U.S. source income. Section 904(g)(6) defines a United States-owned 
foreign corporation as any foreign corporation if United States persons 
(as defined in section 7701(a)(30) hold 50 percent or more of either 
the total combined voting power of all classes of voting stock or the 
total value of the stock. Section

[[Page 24520]]

1.904-5(m) provides rules concerning the resourcing of certain amounts 
received or accrued (or treated as received or accrued) by a United 
States shareholder from a CFC. The temporary regulations at Sec.  
1.904-5T(m) clarify that the rules for resourcing interest and 
dividends also apply to a 10/50 corporation that meets the definition 
of a United States-owned foreign corporation. These temporary 
regulations apply to amounts paid by a 10/50 corporation in taxable 
years of such corporation beginning after April 25, 2006.
E. Treatment of Earnings and Taxes Accumulated During a Non-Look-
Through Period
    Section 1.904-7T(f)(2) provides that earnings accumulated and 
foreign income taxes paid after a 10/50 corporation had a domestic 
corporate shareholder that met the stock ownership requirements of 
section 902(a) but before any such shareholder was eligible for look-
through treatment of dividends (non-look-through pool) that exist as of 
the end of the 10/50 corporation's last pre-2003 taxable year are 
treated as if they were accumulated and paid during a period in which 
the distribution would have been eligible for look-through treatment 
(look-through period). These earnings and taxes are treated as the 
opening balance of the post-1986 undistributed earnings and taxes pools 
in the 10/50 corporation's other separate categories on the first day 
of the 10/50 corporation's first post-2002 taxable year. Dividends that 
were paid in pre-2003 taxable years out of earnings accumulated in a 
non-look-through pool are not eligible for look-through treatment.
    Section 1.904-7T(f)(4)(i) provides that in order to substantiate 
the look-through characterization of the earnings and taxes in the non-
look-through pools, the taxpayer must reconstruct the non-look-through 
pools of earnings and taxes for each year in the non-look-through 
period, beginning with the first year in which earnings were 
accumulated in the non-look-through pool. Earnings and taxes are 
treated as if they were accumulated during a look-through period, 
taking into account earnings distributed and taxes deemed paid in the 
non-look-through period as if they were distributed and deemed paid pro 
rata from the amounts that were added to the non-look-through pools 
during the non-look-through period. As reconstructed, earnings and 
taxes in the non-look-through pools as of the last day of the 10/50 
corporation's last pre-2003 taxable year are assigned to the look-
through pools on the first day of the 10/50 corporation's first post-
2002 taxable year.
    The IRS and the Treasury Department recognize that shareholders may 
face difficulties in reconstructing historical accumulated earnings and 
taxes accounts of a 10/50 corporation on a look-through basis, because 
noncontrolling shareholders may have difficulty obtaining detailed 
records for prior periods from the 10/50 corporation. Therefore, the 
IRS and the Treasury Department anticipate that a reasonable 
approximation of the amounts properly included in the look-through 
pools, based on available records obtained through reasonable, good-
faith efforts by the taxpayer, will adequately substantiate the 
reconstruction required by the statute.
    Alternatively, Sec.  1.904-7T(f)(4)(ii) provides a safe harbor in 
reconstructing the non-look-through pools. Under the safe harbor, a 
taxpayer may allocate the earnings and taxes in the non-look-through 
pools ratably to the look-through pools on the first day of the 10/50 
corporation's first post-2002 taxable year in the same percentages as 
the taxpayer (or the qualified group member that owns the 10/50 
corporation) properly characterizes the stock of the 10/50 corporation 
in the separate categories for purposes of apportioning the taxpayer's 
(or qualified group member's) interest expense in its first taxable 
year ending after the first day of the 10/50 corporation's first post-
2002 taxable year. Under Sec.  1.861-12T(c)(3) and (4), this 
characterization generally is based on how the assets or income of the 
10/50 corporation are characterized in the separate categories for 
purposes of apportioning interest expense of the 10/50 corporation in 
the 10/50 corporation's first post-2002 taxable year. However, Sec.  
1.904-7T(f)(4)(ii) provides that if a taxpayer elects to use the safe 
harbor rule with respect to a 10/50 corporation that uses the modified 
gross income method to apportion interest expense for the 10/50 
corporation's first post-2002 taxable year, earnings and taxes in the 
non-look-through pools are allocated to the look-through pools based on 
an average of the 10/50 corporation's modified gross income ratios for 
its taxable years beginning in 2003 and 2004. The IRS and the Treasury 
Department believe that the two-year base period rule is necessary to 
avoid potential distortions associated with allocating earnings and 
taxes from the non-look-through pool to the look-through pools based on 
the 10/50 corporation's modified gross income for just one taxable 
year.
    Section 904(d)(4)(C)(ii), as amended by the AJCA, provides that if 
the Secretary determines that look-through treatment of a dividend out 
of earnings formerly accumulated in the non-look-through pool has not 
been adequately substantiated, the dividend is treated as passive 
income for purposes of section 904(d). Section 1.904-7T(f)(4)(iii) 
provides that in the case where a taxpayer does not elect the safe 
harbor rule of Sec.  1.904-7T(f)(4)(ii) and the Commissioner determines 
that the look-through characterization of earnings and taxes in the 
non-look-through pools cannot reasonably be determined based on the 
available information, the Commissioner will assign the earnings and 
associated taxes to the passive category for purposes of section 
904(d).
    As provided in Sec.  1.904-7T(f)(3), rules similar to Sec.  1.904-
7T(f)(2) will apply in assigning to separate categories earnings and 
taxes of a CFC that were accumulated during a non-look-through period. 
As reconstructed, earnings and taxes in a CFC's non-look-through pools 
as of the last day of the CFC's last pre-2003 taxable year will be 
added to the opening balance of the CFC's look-through pools of 
earnings and taxes on the first day of the CFC's first post-2002 
taxable year. The taxpayer must substantiate the look-through 
characterization of such earnings and taxes in accordance with Sec.  
1.904-7T(f)(4) by either reconstructing the non-look-through pools or 
electing the safe harbor.
    In addition, as provided in Sec.  1.904-7T(f)(6), the rules of 
Sec.  1.904-7T(f)(2) will apply to assign to separate categories pre-
1987 accumulated profits and pre-1987 foreign income taxes of a foreign 
corporation that were accumulated during a non-look-through period and, 
prior to the AJCA amendments, would have been assigned to a separate 
category for dividends from a 10/50 corporation. Accordingly, pre-1987 
accumulated profits and pre-1987 foreign income taxes accumulated 
during a non-look-through period will be treated as if they were 
accumulated during a look-through period. The taxpayer must 
substantiate the look-through characterization of such earnings and 
taxes in accordance with Sec.  1.904-7T(f)(4) by either reconstructing 
the annual layers of pre-1987 accumulated profits or electing the safe 
harbor.
F. Treatment of a Deficit Accumulated in a Non-Look-Through Period
    Section 1.904-7T(f)(5) provides that if there is an accumulated 
deficit in the non-look-through pool as of the end of a 10/50 
corporation's last pre-2003

[[Page 24521]]

taxable year, the deficit and associated taxes are treated in the same 
manner as earnings and taxes in a positive non-look-through pool, i.e., 
the deficit and taxes are treated as if they had been accumulated and 
paid during a look-through period. The earnings and deficits in 
earnings making up the accumulated deficit are assigned to the look-
through pools based on where the 10/50 corporation's income and 
expenses or losses would have been assigned had they been incurred 
during a look-through period, or, if the taxpayer elects the safe 
harbor, the deficit is allocated based on how the stock of the 10/50 
corporation is properly characterized for interest expense 
apportionment purposes. If the taxpayer does not elect the safe harbor 
and the Commissioner determines that the look-through characterization 
of the deficit in the non-look-through pool cannot be reasonably 
determined based on the available information, the Commissioner will 
assign the deficit and any associated taxes to the 10/50 corporation's 
passive category.
    The temporary regulations treat the deficit in the non-look-through 
pool as the opening balance of the post-1986 undistributed earnings 
pools in the 10/50 corporation's other separate categories on the first 
day of the 10/50 corporation's first post-2002 taxable year. If the 10/
50 corporation makes a distribution in a post-2002 taxable year in 
which there is a deficit balance in the aggregate of the look-through 
pools (as increased or reduced by earnings or a deficit in the non-
look-through pool), the deficit balance is carried back, on a look-
through basis, to reduce pre-1987 accumulated profits on a last in-
first out basis, and the deficit is removed from post-1986 
undistributed earnings. See Sec.  1.902-2(a)(1). If the deficit reduces 
to zero all of the pre-1987 accumulated profits, no foreign taxes in 
any of the pre-1987 annual layers are deemed paid with respect to the 
dividend. See Sec.  1.902-1(b)(4).
    In the case of a CFC that was formerly a 10/50 corporation and has 
a deficit in the non-look-through pool that was accumulated while it 
was a 10/50 corporation, any deficit that was not absorbed by earnings 
in the look-through pools and that remains at the end of the CFC's last 
pre-2003 taxable year is assigned to the look-through pools on the 
first day of the CFC's first post-2002 taxable year based on the 
reconstruction or safe harbor rules of Sec.  1.904-7T(f)(4). Foreign 
income taxes associated with this deficit pool that were previously not 
creditable are also assigned to the look-through pools on the first day 
of the CFC's first post-2002 taxable year based on the same method. To 
the extent that the portion of the deficit in the non-look-through pool 
that is assigned to a separate category exceeds post-1986 undistributed 
earnings in that category as of the end of the CFC's last pre-2003 
taxable year, the deficit will carry forward into the CFC's post-1986 
undistributed earnings pools for 2003. Under Sec.  1.904-7T(f)(6), 
similar rules apply to recharacterize a deficit in pre-1987 accumulated 
profits and any associated pre-1987 foreign income taxes that were 
accumulated during a non-look-through period.
G. Pre-Acquisition E&P of a 10/50 Corporation
    Section 904(d)(4)(C)(i)(II), as amended by the AJCA, provides that 
the Secretary may prescribe regulations regarding the treatment of 
distributions out of earnings and profits of a 10/50 corporation for 
periods before the taxpayer's acquisition of the stock to which the 
distributions relate (pre-acquisition E&P). Such distributions may be 
out of post-1986 undistributed earnings accumulated by a 10/50 
corporation before the specific shareholder acquired its stock or out 
of pre-1987 accumulated profits accumulated before the 10/50 
corporation had any qualifying shareholder. Prior to the AJCA 
amendments, such distributions, as well as distributions by a CFC out 
of earnings and profits for periods during which it was not a CFC, were 
subject to a separate foreign tax credit limitation for dividends from 
a 10/50 corporation. See section 904(d)(1)(E), section 904(d)(2)(E), 
and Sec.  1.904-4(g)(3).
    The temporary regulations do not limit look-through treatment for 
dividends out of earnings and profits accumulated in non-look-through 
periods during which a 10/50 corporation or CFC had no qualifying 
shareholder. The IRS and the Treasury Department believe that look-
through treatment of pre-acquisition earnings is the more appropriate 
policy result than passive category treatment, if look-through 
characterization can be adequately substantiated under the rules of 
Sec. Sec.  1.904-5T(c)(4)(iii) and 1.904-7T(f)(4). In addition, the 
temporary regulations do not limit look-through treatment for dividends 
out of pre-acquisition E&P accumulated in periods during which the 
distributing corporation was a 10/50 corporation, because any such 
restriction would create administrative complexities associated with 
maintaining multiple sets of look-through pools starting on different 
dates for different U.S. shareholders. Accordingly, distributions of 
earnings and profits from 10/50 corporations and CFCs in post-2002 
taxable years are generally eligible for look-through treatment, 
regardless of whether the distributing corporation was a look-through 
entity when the earnings were accumulated, and regardless of when the 
taxpayer acquired its stock.
H. Post-1986 Undistributed Earnings of a CFC Attributable to Dividends 
From Lower-Tier 10/50 Corporations
    Where a CFC has a separate category for dividends from each 10/50 
corporation containing earnings attributable to pre-2003 distributions 
from the lower-tier 10/50 corporation, Sec.  1.904-7T(f)(7) provides 
that the CFC's look-through pools of earnings and taxes will be 
adjusted to account for accumulated earnings and taxes attributable to 
dividends from the lower-tier 10/50 corporation as if the earnings and 
taxes were accumulated and deemed paid during a look-through period. 
Therefore, the earnings and taxes are recharacterized on the same basis 
used by the taxpayer to reconstruct the non-look-through pools of the 
lower-tier 10/50 corporation under Sec.  1.904-7T(f)(4). Taxes in each 
separate category for dividends from a lower-tier 10/50 corporation are 
assigned to the upper-tier CFC's look-through pools based on where the 
associated earnings distributed by the lower-tier foreign corporation 
(prior to being reduced by, for example, expense apportionment or 
payment of foreign income taxes at the CFC level) would have been 
assigned had such earnings been eligible for look-through treatment 
when received by the CFC.
    If a CFC has a deficit in a separate category for dividends from a 
lower-tier 10/50 corporation (due to, for example, expense 
apportionment or the payment of foreign income taxes by the CFC with 
respect to the lower-tier 10/50 corporation), the deficit and any 
associated taxes are treated as if they had been accumulated and deemed 
paid during a look-through period. Accordingly, the deficit is assigned 
to the upper-tier CFC's look-through pools based on where the upper-
tier CFC's income and expenses or losses would have been assigned had 
dividends from the lower-tier 10/50 corporation been eligible for look-
through treatment in the year such dividends were paid or such expenses 
and losses were incurred by the CFC.
    Similar to Sec.  1.904-7T(f)(4)(ii) (which provides a safe harbor 
in reconstructing the non-look-through pools to account for 
undistributed earnings (or a deficit) and taxes in the non-look-through 
pool

[[Page 24522]]

of a 10/50 corporation or CFC), Sec.  1.904-7T(f)(7)(iii) provides a 
safe harbor in reconstructing the look-through pools at the CFC level 
to account for undistributed earnings (or a deficit) and taxes in a 
CFC-level separate category for dividends from a lower-tier 10/50 
corporation. The taxpayer may allocate the earnings (or deficit) and 
taxes to the look-through pools at the CFC level by applying the safe 
harbor at the level of the CFC. Thus, if the taxpayer elects the safe 
harbor, the earnings (or deficit) and taxes are allocated based on how 
the CFC would properly characterize the stock of the lower-tier 10/50 
corporation for purposes of apportioning the CFC's interest expense, 
which in turn is based on the apportionment ratios properly used by the 
10/50 corporation to apportion its interest expense in its first post-
2002 taxable year. In the case of a taxpayer that elects to use the 
safe harbor rule where the 10/50 corporation uses the modified gross 
income method to apportion interest expense for its first post-2002 
taxable year, undistributed earnings (or a deficit) and taxes in a CFC-
level separate category for dividends from a 10/50 corporation are 
allocated to the look-through pools based on the average of the 10/50 
corporation's modified gross income ratios for its taxable years 
beginning in 2003 and 2004.
    In the case of a CFC that has in its qualified group a chain of 10/
50 corporations, the safe harbor applies first to the stock of the 
third-tier 10/50 corporation and then to the stock of the second-tier 
10/50 corporation. In the case of a taxpayer that elects the safe 
harbor with respect to a lower-tier 10/50 corporation of which the 
taxpayer was no longer a qualifying shareholder as of the end of the 
upper-tier CFC's last pre-2003 taxable year (e.g., because the 10/50 
corporation was no longer a member of the CFC's qualified group), the 
earnings (or deficit) and taxes in the separate category for dividends 
from the lower-tier 10/50 corporation are assigned to the CFC's look-
through pools in the same percentages as the stock of the 10/50 
corporation would have been characterized had the look-through rules 
applied in the last year the taxpayer was a qualifying shareholder of 
the 10/50 corporation.
    If the taxpayer does not elect the safe harbor and the Commissioner 
determines that the look-through characterization of the undistributed 
earnings (or deficit) and taxes in a CFC's separate category for 
dividends from a lower-tier 10/50 corporation cannot reasonably be 
determined based on the available information, the Commissioner will 
assign the earnings (or deficit) and taxes to the CFC's passive 
category.
I. Treatment of Distributions Received by a 10/50 Corporation From a 
Lower-Tier 10/50 Corporation When the Corporations Do Not Have The Same 
Taxable Years
    Section 1.904-7T(f)(8) provides guidance concerning when a dividend 
paid by a lower-tier corporation to an upper-tier corporation that is a 
member of the same qualified group is eligible for look-through 
treatment when the corporations' first post-2002 taxable years begin on 
different dates. In the case of a dividend paid during the upper-tier 
corporation's post-2002 taxable year but during the lower-tier 
corporation's pre-2003 taxable year, the dividend will be included in a 
separate category in the year received. However, any earnings of the 
upper-tier corporation attributable to such dividends are treated, 
beginning on the first day of the upper-tier corporation's next taxable 
year, as if they were accumulated during a look-through period. 
Dividends paid during the upper-tier corporation's pre-2003 taxable 
year but during the lower-tier corporation's post-2002 taxable year are 
eligible for look-through treatment in the year received.

VI. Separate Limitation Losses and Overall Foreign Losses

    Because the 1997 Act and the AJCA eliminated separate categories 
for dividends from 10/50 corporations for post-2002 taxable years, the 
temporary regulations provide transition rules for recapture in a post-
2002 taxable year of (1) an overall foreign loss (OFL) or separate 
limitation loss (SLL) in a separate category for dividends from each 
10/50 corporation that offset U.S. source income or income in other 
separate categories, respectively, in a pre-2003 taxable year; and (2) 
an SLL in another separate category (e.g., the general limitation or 
passive category) that offset income in a separate category for 
dividends from each 10/50 corporation in a pre-2003 taxable year.
A. Recapture of an OFL or SLL Incurred in a Separate Category for 
Dividends From a 10/50 Corporation
    Section 1.904(f)-12T(g)(1) provides that where a taxpayer had an 
OFL or SLL in a separate category for dividends from a 10/50 
corporation (i.e., an OFL, or SLL, in the separate category that offset 
U.S. source income, or income in other separate categories, in a pre-
2003 taxable year, or a later year in which the taxpayer received a 
dividend in the separate category, and the OFL or SLL would have been 
recaptured out of income in the separate category for dividends from 
that 10/50 corporation), the OFL or SLL account is recaptured out of 
income in the taxpayer's other separate categories in the same 
percentages as the income generated by the assets of the 10/50 
corporation. Specifically, the loss account will be recaptured in 
subsequent taxable years out of income in the same separate categories 
in which the stock of the 10/50 corporation is properly characterized 
for purposes of apportioning the taxpayer's interest expense in its 
first taxable year in which dividends from the 10/50 corporation are 
eligible for look-through treatment (i.e., its first taxable year 
ending after the first day of the 10/50 corporation's first post-2002 
taxable year). Any SLL account in a separate category for dividends 
from a 10/50 corporation with respect to another category that would be 
assigned to that other category under this rule will be eliminated, 
since ``recapture'' to and from the same category would be meaningless. 
See Sec.  1.904(f)-12T(g)(4) Example 1.
    The IRS and the Treasury Department determined that it is 
appropriate to reallocate OFL and SLL accounts based on how the 
taxpayer characterizes the stock of the 10/50 corporation for interest 
expense apportionment purposes in its first taxable year ending after 
the first day of the 10/50 corporation's first post-2002 taxable year. 
The IRS and the Treasury Department believe that recapturing losses 
from income earned in subsequent years is a forward-looking concept. 
Reallocating losses that were incurred in a separate category for 
dividends from each 10/50 corporation to the appropriate separate 
category based on the interest expense apportionment ratio (as opposed 
to, for example, reallocating losses based on reconstructed non-look-
through pools) is consistent with that concept.
    In the case of a taxpayer that has an OFL or SLL account in a 
separate category for dividends from a 10/50 corporation but no longer 
is a qualifying shareholder with respect to the foreign corporation, 
the IRS and the Treasury Department determined that reallocating OFLs 
and SLLs incurred in separate categories for dividends from 10/50 
corporations to the other separate categories may be inappropriate. In 
pre-2003 taxable years, recapture of the OFL or SLL would not have 
occurred because the taxpayer would not have received any additional 
dividends from the corporation that would be treated as income in the 
separate 10/50 loss category (unless the former shareholder

[[Page 24523]]

reacquired a sufficient interest in the corporation to become a 
qualifying shareholder). Accordingly, Sec.  1.904(f)-12T(g)(3) provides 
that where a taxpayer was not a qualifying shareholder with respect to 
a foreign corporation on December 20, 2002 (or was not a qualifying 
shareholder on the first day of the taxpayer's first post-2002 taxable 
year, pursuant to a transaction that was the subject of a binding 
contract which was in effect on December 20, 2002), any OFL or SLL 
accounts in the taxpayer's separate category for dividends from that 
corporation will not be reallocated. See Notice 2003-5 (announcing 
regulations would provide that OFL and SLL accounts in a separate 
category for dividends from each 10/50 corporation where the taxpayer 
was no longer a qualifying shareholder of as of December 20, 2002, will 
not be consolidated into the OFL and SLL accounts of the single 
category for dividends from 10/50 corporations).
    Section 1.904(f)-12T(g)(3) also provides that where an OFL or SLL 
account in a separate category for dividends from each 10/50 
corporation is not reallocated because the taxpayer is no longer a 
qualifying shareholder of that foreign corporation, the taxpayer may 
not carry over any excess foreign taxes in that separate category to 
another separate category on a look-through basis. However, the 
temporary regulations allow the taxpayer to elect to carry over all 
excess taxes in its separate categories for dividends from 10/50 
corporations to the other separate categories, provided that the 
taxpayer also reallocates the OFL and SLL accounts of such separate 
categories for dividends from 10/50 corporations into the OFL and SLL 
accounts of the appropriate separate categories.
B. Recapture of an SLL Incurred in Other Categories
    To the extent that an SLL in another separate category (e.g., the 
general limitation or passive category) offset income in a separate 
category for dividends from each 10/50 corporation in a pre-2003 
taxable year (or later year with or within which the 10/50 
corporation's last pre-2003 taxable year ends), income subsequently 
earned in the loss category will be recaptured as income in the same 
separate categories in which the taxpayer properly characterizes the 
stock of the 10/50 corporation on a look-through basis for purposes of 
apportioning the taxpayer's interest expense. See Sec. Sec.  1.904(f)-
12T(g)(2). Section 1.904(f)-12T(g)(4), Example 2, illustrates how the 
apportionment rule applies to SLLs in the general limitation and 
passive categories that previously offset income in a separate category 
for dividends from a 10/50 corporation, where the taxpayer 
characterizes the stock of the 10/50 corporation as a multiple category 
asset.

VII. Tax Elections, Adoptions of Method of Accounting or Taxable Year, 
and Changes in Method of Accounting or Taxable Year Made on Behalf of a 
CFC or 10/50 Corporation

    Section 1.964-1T(c)(2) and (3) add rules allowing the majority 
domestic corporate shareholders of a 10/50 corporation to make an 
election, adopt a method of accounting or taxable year, or change a 
method of accounting or taxable year on behalf of the 10/50 
corporation. Under Sec.  1.964-1T(c)(5), the term majority domestic 
corporate shareholders is defined as those domestic corporations that 
meet the ownership requirements of section 902(a) with respect to the 
10/50 corporation (or to a first-tier foreign corporation that is a 
member of the same qualified group as the 10/50 corporation), that, in 
the aggregate, own directly or indirectly more than 50 percent of the 
combined voting power of all the voting stock of the 10/50 corporation 
that is owned directly or indirectly by all domestic corporations that 
meet the ownership requirements of section 902(a) with respect to the 
10/50 corporation (or a relevant first-tier foreign corporation).
    Section 1.964-1(c)(3) of the current final regulations permits 
controlling United States shareholders of a CFC to make an election, or 
to adopt or change a method of accounting, on behalf of the CFC. 
Subject to the rules of section 898, the temporary regulations at Sec.  
1.964-1T(c)(3) extend this rule to permit controlling United States 
shareholders of a CFC to adopt or change the taxable year of a CFC. 
Finally, the temporary regulations revise the requirement that the 
controlling shareholders file a written statement executed by each of 
the controlling shareholders with the IRS within 180 days of the close 
of the foreign corporation's taxable year for which the adoption or 
change in method of accounting is to be effective. In lieu of the 
written statement, Sec.  1.964-1T(c)(3)(i)(B) requires that the jointly 
executed statement evidencing the controlling shareholders' consent to 
the adoption or change be retained by one or more of the shareholders, 
and that each shareholder file a separate statement with its tax return 
for the taxable year with or within which the foreign corporation's 
taxable year ends. This change will facilitate e-filing by eliminating 
the signature requirement and will facilitate compliance by conforming 
the dates on which the election statement and the shareholder's tax 
return must be filed.

VIII. Election To Defer Effective Date of 10/50 Look-Through Rules

A. Time, Form, and Manner of Election
    As discussed in the Background section of this document, section 
403(l) of the GOZA provides a rule under which a taxpayer may elect not 
to apply the extended look-through rules enacted in the AJCA for 
taxable years of 10/50 corporations beginning after December 31, 2002, 
and before January 1, 2005 (2003 and 2004 taxable years). In order to 
make the election, a taxpayer must attach a statement notifying the IRS 
of such election to its next tax return for which the due date (with 
extensions) is more than 90 days after April 25, 2006. The electing 
taxpayer's tax liability as shown on its original or amended tax 
returns for its affected taxable years generally must be consistent 
with the guidance set forth in Notice 2003-5, 2003-1 C.B. 294, and the 
rules of Sec.  1.861-12T(c)(4) (characterizing the stock of a 10/50 
corporation as an asset in the various separate categories). The 
electing taxpayer must also make appropriate adjustments to eliminate 
any double benefit arising from the election in years that are not open 
for assessment. Sec.  1.904-7T(f)(9).
B. Transition Rules
    Taxpayers that elect to apply the pre-AJCA look-through rules for 
the 2003 and 2004 taxable years must assign dividends paid by 10/50 
corporations in their 2003 and 2004 taxable years out of pre-2003 
earnings to a single separate category for dividends from all 10/50 
corporations (see Notice 2003-5). The temporary regulations provide 
transition rules for applying the AJCA look-through rules in taxable 
years of 10/50 corporations beginning after December 31, 2004.
    Under Sec.  1.904-7T(f)(9)(iii), pre-2003 earnings (or a deficit) 
and taxes in the non-look-through pool that existed as of the end of 
the foreign corporation's last pre-2005 taxable year are treated as if 
they were accumulated and paid during a period in which a distribution 
from that corporation would have been eligible for look-through 
treatment. These earnings (or deficits) and taxes are added to the 
foreign corporation's post-1986 undistributed earnings and taxes pools 
in the appropriate separate categories on the first day of the foreign 
corporation's first post-2004 taxable year. In accordance with the 
principles of Sec.  1.904-7T(f)(4), the taxpayer must

[[Page 24524]]

reconstruct the non-look-through pools or, if the taxpayer elects the 
safe harbor, allocate the earnings and taxes in the foreign 
corporation's non-look-through pools to the foreign corporation's look-
through pools on the first day of the foreign corporation's first post-
2004 taxable year. Under the safe harbor, this allocation is made in 
the same percentages as the taxpayer properly characterized the stock 
of the foreign corporation for purposes of interest expense 
apportionment in the taxpayer's first taxable year ending after the 
first day of the foreign corporation's first post-2002 taxable year. If 
the taxpayer does not elect the safe harbor and the Commissioner 
determines that the look-through characterization of the earnings (or 
deficit) and taxes cannot reasonably be determined, the Commissioner 
will allocate the earnings (or deficit) and taxes to the passive 
category.
    To the extent that a taxpayer had excess foreign taxes in the 
single category for dividends from all 10/50 corporations (regardless 
of whether they were carried forward from separate categories for 
dividends from each 10/50 corporation in pre-2003 taxable years under 
Notice 2003-5 or resulted from dividends paid in 2003 and 2004 taxable 
years), they will be carried forward to the appropriate separate 
categories in the same manner as excess taxes in the separate 
categories for dividends from each 10/50 corporation are carried over 
in the case of a non-electing taxpayer. See Sec.  1.904-2T(h)(1). The 
taxpayer must determine which 10/50 corporations paid the dividends to 
which the excess taxes are attributable and then assign the taxes to 
the appropriate separate categories as if such dividends had been 
eligible for look-through treatment when paid. Accordingly, Sec.  
1.904-7T(f)(9)(iv) provides that excess taxes in the single category 
for dividends from 10/50 corporations are assigned to the appropriate 
separate categories by reconstructing the non-look-through pools or, if 
the taxpayer elects the safe harbor, by allocating the taxes in the 
same percentages as the taxpayer properly characterized the stock of 
the foreign corporation for purposes of apportioning the taxpayer's 
interest expense for its first taxable year with or within which the 
10/50 corporation's first post-2002 taxable year began. This transition 
rule applies only to excess taxes attributable to dividends out of pre-
2003 earnings, because only these taxes are included in the single 
category for dividends from all 10/50 corporations.
    To the extent that excess taxes carried forward to the single 
category for dividends from 10/50 corporations under the rules of 
Notice 2003-5 were absorbed by low-taxed dividends paid by 10/50 
corporations in 2003 or 2004 taxable years out of pre-2003 earnings, or 
expired unused, the amount of excess taxes carried forward to a 
separate category on a look-through basis will be smaller than the 
aggregate amount of excess taxes initially carried forward to the 
single category for dividends from 10/50 corporations. To simplify the 
process of determining which 10/50 corporations paid the dividends to 
which the remaining excess taxes are attributable, Sec.  1.904-
7T(f)(9)(iv) treats the remaining excess taxes as attributable pro rata 
to the dividends paid by all 10/50 corporations out of non-look-through 
pools in a particular taxable year that resulted in excess taxes that 
were eligible to be carried forward. Such excess taxes are then carried 
forward to the separate categories based on how the non-look-through 
pools are recharacterized under the rules of Sec.  1.904-7T(f)(4).
    Excess taxes that would other