Stock Transfer Rules: Carryover of Earnings and Taxes, 44887-44914 [06-6740]
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Federal Register / Vol. 71, No. 152 / Tuesday, August 8, 2006 / Rules and Regulations
of Food and Drugs and redelegated to
the Center for Veterinary Medicine, 21
CFR part 558 is amended as follows:
PART 558—NEW ANIMAL DRUGS FOR
USE IN ANIMAL FEEDS
1. The authority citation for 21 CFR
part 558 continues to read as follows:
I
Authority: 21 U.S.C. 360b, 371.
§ 558.450
[Amended]
2. In § 558.450, in the table in
paragraph (d)(2)(i) in the ‘‘Limitations’’
column, remove ‘‘in feed containing
oxytetracycline hydrochloride or monoalkyl (C8–C18) trimethyl ammonium
oxytetracycline’’; in the table in
paragraph (d)(2)(ii) in the ‘‘Limitations’’
column for both entries ‘‘1’’ and ‘‘2’’,
remove ‘‘as mono-alkyl (C8–C18)
trimethyl ammonium oxytetracycline’’;
and in the table in paragraph (d)(2)(iii)
in the ‘‘Limitations’’ column, remove
‘‘in feed containing monoalkyl (C8–C18)
trimethyl ammonium oxytetracycline’’.
I
Dated: July 25, 2006.
Bernadette A. Dunham,
Deputy Director, Office of New Animal Drug
Evaluation, Center for Veterinary Medicine.
[FR Doc. E6–12862 Filed 8–7–06; 8:45 am]
BILLING CODE 4160–01–S
DEPARTMENT OF THE TREASURY
SUPPLEMENTARY INFORMATION:
Background
The Treasury Department and the IRS
issued final regulations ’’1.367(b)–1
through 1.367(b)–6, dealing with tax
consequences of certain foreign-toforeign and inbound corporate
transactions, in June 1998 and January
2000 (the January 2000 final
regulations). The preamble to the
January 2000 final regulations referred
to proposed regulations that would be
issued to address the carryover of
certain corporate tax attributes in
transactions involving one or more
foreign corporations. Those proposed
regulations were issued on November
15, 2000, in the Federal Register ((65 FR
69138) (REG–116050–99)) (the 2000
proposed regulations). The public
hearing with respect to the 2000
proposed regulations was cancelled
because no request to speak was
received. However, the Treasury
Department and the IRS received and
considered several written comments,
which are discussed in this preamble.
After consideration of the 2000
proposed regulations and the comments
received, the Treasury Department and
the IRS adopt substantial portions of
those proposed regulations with
significant modifications as final
regulations under section 367(b).
Overview
Internal Revenue Service
A. General Policies of Section 367(b)
26 CFR Part 1
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 Subchapter C 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.
The Subchapter C carryover
provisions generally are drafted to apply
to domestic corporations and U.S.
shareholders. As a result, those
provisions often do not fully take into
account the relevant cross-border
aspects of U.S. taxation. For example,
section 381 does not specifically take
into account source and foreign tax
credit issues that arise when earnings
[TD 9273]
RIN 1545–AX65
Stock Transfer Rules: Carryover of
Earnings and Taxes
Internal Revenue Service (IRS),
Treasury.
ACTION: Final regulations.
sroberts on PROD1PC70 with RULES
AGENCY:
SUMMARY: This document contains final
regulations addressing the carryover of
certain tax attributes, such as earnings
and profits and foreign income tax
accounts, when two corporations
combine in a corporate reorganization or
liquidation that is described in both
section 367(b) and section 381 of the
Internal Revenue Code (Code).
DATES: Effective Date: These regulations
are effective August 8, 2006.
Applicability Date: These regulations
apply to certain section 367(b)
exchanges that occur on or after
November 6, 2006.
FOR FURTHER INFORMATION CONTACT:
Jeffrey L. Parry at (202) 622–3850 (not
a toll-free number).
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44887
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. A primary consideration in
this regard is 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 more
comprehensive statutory regime. H.R.
Rep. No. 658, 94th Cong., 1st 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.’’
These final regulations address the
carryover of foreign earnings and profits
and foreign income taxes in tax-free
corporate asset acquisitions by generally
applying the principles of Subchapter C
provisions such as section 381, which
governs the carryover of earnings and
profits (and other tax attributes) in
certain tax-free corporate
reorganizations described in section 368
and in corporate liquidations described
in section 332. However, these
regulations (like the 2000 proposed
regulations) modify certain of the
mechanics of the Subchapter C rules as
necessary or appropriate to ensure that
those rules are as consistent as possible
with key international tax policies of the
Code and to prevent material distortions
of income.
These final regulations address the
portions of the 2000 proposed
regulations (Prop. Reg.) dealing with
inbound nonrecognition transactions
(Prop. Reg. § 1.367(b)–3) and foreign
section 381 transactions (Prop. Reg.
§ 1.367(b)–7). They also address the
special rules of Prop. Reg. § 1.367–9.
The final regulations, however, do not
address the portions of the 2000
proposed regulations involving
corporate divisions of one or more
foreign corporations (Prop. Reg.
§ 1.367(b)-8). The Treasury Department
and the IRS believe that relevant crossborder tax consequences of section 355
transactions should be dealt with in a
separate guidance project.
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B. Specific Policies Related to Inbound
Nonrecognition Transactions
(§ 1.367(b)–3)
Section 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
an A, C, D, or F reorganization (inbound
nonrecognition transaction). Regulations
applying section 367 and section 368 to
cross-border A reorganizations were
recently issued. See TD 9242 (2006–7
I.R.B. 422).
As a general policy matter, the
importation of various tax attributes in
inbound transactions is carefully
scrutinized. In fact, inbound
importation issues have been the subject
of recent legislative reforms (see section
362(e)). The policy relating to
importation of tax attributes also has
been reflected in prior section 367
regulations. For example, the preamble
to the January 2000 final regulations
generally describes international policy
issues that can arise in inbound
nonrecognition transactions. 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
January 2000 final regulations clarify
that a domestic acquiring corporation
succeeds to those foreign taxes paid or
accrued by a foreign target corporation
only to the extent those taxes are
eligible for credit under section 906.
The preamble to the January 2000
final regulations also notes that it would
be consistent with the policy
considerations of section 367(b) for
future regulations to provide additional
rules with respect to the extent to which
attributes carry over from a foreign
corporation to a U.S. corporation.
Accordingly, the 2000 proposed
regulations provided 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 2000
proposed regulations generally provided
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 with a U.S. trade or business
(or attributable to a permanent
establishment, in the case of an
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applicable U.S. income tax treaty).
These final regulations adopt the rules
set forth in the 2000 proposed
regulations.
C. Specific Policies Related to Foreign
Section 381 Transactions (§ 1.367(b)–7)
Section 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 section 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). These
rules apply, for example, to A, C, D, or
F reorganizations or section 332
liquidations between two foreign
corporations.
The principal Code sections
implicated by the carryover of earnings
and profits and foreign income taxes in
a foreign section 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. Section 381(c)(2)(B). This is
commonly known as the ‘‘hovering
deficit rule’’. 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, for
example, Commissioner v. Phipps, 336
U.S. 410 (1949) final regulations
generally adopt the principles of section
381 in the cross-border context, but
adapt the operation of those rules in
consideration of the international
provisions, such as sections 902, 904,
and 959, that address foreign
corporations’ earnings and profits and
their related foreign income taxes. Thus,
for example, these final regulations
apply the section 381 earnings and
profits combination and deficit rules by
reference to the separate categories
income described in section 904(d) and
elsewhere (baskets) that are used to
compute foreign tax credit limitations.
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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. The Code
computes deemed-paid taxes with
regard to dividends from a relevant
foreign corporation by looking first to
the multi-year pools of earnings and
profits accumulated (and related foreign
income taxes paid or deemed paid) in
taxable years beginning after December
31, 1986, or beginning with the first year
in which a domestic corporation owns
10 percent or more of the voting stock
of the foreign corporation, whichever is
later. Section 902(c). (The Code and
regulations refer to pooled earnings and
profits and foreign income taxes as post1986 undistributed earnings and post1986 foreign income taxes even though
a particular corporation may not begin
to maintain multi-year pools until after
1986. Sections 902(c)(1) and (2),
§ 1.902–1(a)(8) and (9).)
Congress enacted the pooling rules
because it believed that blending foreign
income taxes and earnings and profits
into ‘‘pools’’ from which distributions
are made was fairer and more
appropriate than computing deemedpaid taxes with reference to annual
layers of earnings and profits (and
foreign income taxes). Joint Committee
on Taxation, 99th Cong., 2nd sess.,
General Explanation of the Tax Reform
Act of 1986 (JCS–10–87) (1986
Bluebook), at 870 (May 4, 1987).
Averaging foreign income taxes through
these blended pools prevents taxpayers
from inflating their foreign subsidiary’s
effective tax rate for a particular year in
order to obtain artificially enhanced
foreign tax credits. Id. Averaging also
prevents the loss of credits for foreign
income taxes that are trapped in years
in which a foreign subsidiary has no
earnings and profits for U.S. tax
purposes. Id.
However, Congress enacted pooling
on a limited basis. Earnings and profits
accumulated (and related foreign
income taxes paid or deemed paid) in
taxable years before the first year a
foreign corporation qualifies as a
pooling corporation and pre-1987
earnings and profits accumulated (and
related foreign income taxes paid or
deemed paid) by a pooling corporation
are not subject to the pooling rules.
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
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though a particular corporation may
have annual layers for years after 1986
(because of the absence of the requisite
domestic corporate shareholder).
Section 902(c)(6); § 1.902–1(a)(10).
A distribution of earnings and profits
is treated as 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 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 baskets of income derived from
different types of activities. (From 1987
through 2006, section 904 provides for
eight different baskets of income; for tax
years beginning after December 31,
2006, all but two section 904(d) baskets
of income are eliminated. Separate
baskets described in other Code sections
such as sections 56(g)(4)(C)(iii)(IV),
245(a)(10), 865(h), 901(j), and 904(g)(10)
will continue in effect after 2006. The
American Jobs Creation Act of 2004,
Public Law 108–357, 118 Stat. 1418
(AJCA), section 404(a).) The purpose of
the baskets is to limit taxpayers’ ability
to cross-credit taxes imposed with
respect to different categories of income.
Congress was concerned that, without
separate limitations, cross-crediting
opportunities would distort economic
incentives as to whether to invest in the
United States or abroad. 1986 Bluebook
at 862.
Another international provision
implicated by the movement of earnings
and profits in foreign section 381
transactions is section 959. Section 959
governs the distribution of earnings and
profits that represent income that has
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 Treasury
Department and the IRS 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
Treasury Department and the IRS have
opened a separate regulations project
under section 959 and expect to issue
regulations that address PTI issues
under section 959 in the future. Because
this project is still ongoing, these final
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regulations reserve on section 367(b)
issues related to PTI. Guidance in this
area will come in a separate project.
Summary of Comments Received and
Changes Made
A. Inbound Nonrecognition
Transactions
A comment was received regarding
the provision under the 2000 proposed
regulations that limits the carryover of
earnings and profits (or deficit in
earnings and profits) from a foreign
corporation to a domestic corporation in
an inbound nonrecognition transaction
to those earnings and profits that are
effectively connected with the conduct
of a trade or business within the United
States (or are attributable to a permanent
establishment in the United States, in
the context of an applicable U.S. income
tax treaty). The comment suggests that
there are better ways to avoid the two
most significant problems of importing
foreign earnings into domestic corporate
solution: Potential dividends-received
deductions on subsequent distribution
of the previously untaxed foreign
earnings, and taxing distributions of
previously taxed earnings and profits
described in section 959. The comment
goes on to state that, in particular,
eliminating deficits but taxing positive
earnings on an inbound nonrecognition
transaction by way of the all earnings
and profits inclusion under § 1.367(b)–
3 is inappropriate.
The Treasury Department and the IRS
have considered this comment. While
the comment identifies asymmetries in
the tax treatment of inbound
reorganizations, on balance the Treasury
Department and the IRS believe that the
2000 proposed regulations reached the
appropriate result. As indicated above,
the importation of favorable tax
attributes has been subject to greater
scrutiny in recent years. See, for
example, section 362(e). In that context,
it is not appropriate to provide for the
carryover of deficits or of earnings and
profits in excess of the all earnings and
profits inclusion. This conclusion also
has the benefit of administrative ease for
taxpayers and the IRS. Accordingly,
these final regulations do not modify the
rules regarding inbound nonrecognition
transactions as set forth in the 2000
proposed regulations, except to reserve
on the treatment of PTI for further
consideration.
B. Paradigm Based on Pooling Rather
Than Look-Through
The structure of the 2000 proposed
regulations was based in large part on
the categorization of foreign acquiring,
target, and surviving corporations as
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look-through corporations, non-lookthrough corporations, or less-than-10%U.S.-owned foreign corporations. Under
the international provisions of the Code
in effect at the time the 2000 proposed
regulations were published, a lookthrough-corporation included a
controlled foreign corporation as
defined in section 957 (CFC) or a
noncontrolled section 902 corporation
as defined in section 904(d)(2)(E) after
2003 (a look-through 10/50 corporation),
the effective date of section 1105(b) of
Public Law 105–34 (111 Stat. 788) (the
1997 Act). A non-look-through
corporation was a noncontrolled section
902 corporation before 2003 (non-lookthrough 10/50 corporation) and a lessthan-10%-U.S.-owned foreign
corporation was a foreign corporation
that was neither a CFC nor a 10/50
corporation.
The pools of earnings and profits and
foreign taxes associated with these three
categories of corporations were referred
to as the look-through pool, the nonlook-through pool, and the pre-pooling
annual layers, respectively. A number of
statutory and regulatory changes that
have occurred since the time the 2000
proposed regulations were published,
however, have necessitated appropriate
changes (and simplification) in the
organizational paradigm for these final
regulations.
At the time the 2000 proposed
regulations were issued (and continuing
prior to the AJCA), the treatment of
dividends from a 10/50 corporation paid
after 2002 varied according to the year
in which the earnings and profits from
which the dividend was paid were
accumulated. The look-through
approach applied to dividends paid out
of earnings and profits accumulated
after 2002, whereas dividends paid out
of earnings and profits accumulated
prior to 2003 were subject to a single
separate limitation for dividends from
all 10/50 corporations. Joint Committee
on Taxation, 105th Cong., 1st sess.,
General Explanation of Tax Legislation
enacted in 1997 (JCS–23–97), at 303
(December 17, 1997). The AJCA
conference report indicates that
Congress changed the treatment of
dividends from 10/50 corporations for
purposes of simplification. H.R. Rep.
No. 108–548, pt. 1 at 192 (2004).
In 2004, Congress amended the Code
(the 2004 amendment) to provide that
any dividend paid by a noncontrolled
section 902 corporation (10/50
corporation), as defined in section
904(d)(2)(E), to a 10 percent or greater
U.S. corporate shareholder is treated as
income in a basket based on the ratio of
the earnings and profits attributable to
income in such basket to the foreign
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corporation’s total earnings and profits
(the ‘‘look-through’’ approach). AJCA,
section 403. The 2004 amendment was
effective retroactively, 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), permitted taxpayers to
elect to defer the effective date of the
2004 amendment to taxable years
beginning after December 31, 2004.
Also, as part of the 2004 amendment,
dividends paid to 10% domestic
corporate shareholders of a CFC are
eligible for look-through treatment, even
if they are paid out of earnings that were
accumulated while the corporation was
not a CFC. Section 904(d)(4); see also
§ 1.904–7T(f)(3) and (6). Prior to the
effective date of the 2004 amendment,
dividends paid out of such earnings
were subject to a separate limitation.
See 26 CFR 1.904–4(g)(2)(ii) (revised as
of April 1, 2006).
As a result of the 2004 amendment,
the terms non-look-through 10/50
corporation and the related non-lookthrough pool as defined in the 2000
proposed regulations have become
obsolete and therefore have been
eliminated in these final regulations.
More generally, in light of the broader
availability of look-through treatment to
earnings paid out of pre-pooling annual
layers, the Treasury Department and the
IRS believe that a paradigm centered on
look-through or non-look-through status
is less relevant. Accordingly, the
organization of these final regulations is
based on the categorization of foreign
acquiring, target, and surviving
corporations as pooling or nonpooling
corporations. The relevant pools of
earnings and profits and associated
foreign taxes are referred to as post-1986
pools and pre-pooling annual layers.
Qualifying shareholders are eligible for
look-through treatment on dividends
out of post-1986 pools and pre-pooling
annual layers to the extent provided in
section 904(d)(3) and (4).
C. Hovering Deficits and Section 316
Comments were received regarding
the application under the 2000
proposed regulations of the hovering
deficit rules on a ‘‘basket-by-basket’’
basis. Under the 2000 proposed
regulations, a pre-transaction deficit in
a particular basket is generally subject to
the hovering deficit rule of section 381.
As a result, that deficit is not taken into
account in determining the current or
accumulated earnings and profits of the
surviving corporation for any purpose,
including for purposes of determining
dividends under section 316 and for
determining foreign tax credits under
section 902. However, any such pre-
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transaction deficits in earnings and
profits may be used to offset a foreign
surviving corporation’s accumulated
(but not current) post-transaction
earnings and profits in the same basket
as the deficit.
Several comments noted that, in
certain circumstances, this rule can give
rise to hovering deficits from one (or
both) of the merging corporations even
if it (or they) had aggregate positive
earnings and profits immediately prior
to the section 381 transaction. In
addition, if one (or both) of the merging
corporations’ pre-transaction earnings
consist both of positive earnings in one
basket and a deficit in another basket,
the earnings and profits of that
corporation available to support a
dividend under section 316 will
increase solely as a result of entering
into the section 381 transaction. This is
because the hovering deficit will no
longer offset the positive earnings in the
other basket for purposes of section 316.
As a result, even if a corporation has an
aggregate deficit in earnings and profits,
any positive baskets of earnings will be
able to support the distribution of a
dividend immediately after the
transaction.
The comments contend that the
prohibition described above against the
use of an earnings and profits deficit in
one basket from offsetting positive
earnings and profits in another basket
can produce results that are inconsistent
with the result of applying a pure
section 381(c)(2)(B) approach in
determining the amount of a
distribution that is a ‘‘dividend’’ under
section 316, and more generally are
inconsistent with the principles and
legislative history of the section
381(c)(2)(B) hovering deficit rule, which
was adopted to preserve, but not create,
the taxation of distributions by
corporations that engage in tax-free
reorganizations or liquidations.
To address these concerns, the
comments requested that (among other
things) the proposed regulations be
modified to conform to the principles
contained in Notice 88–71 (1988–2 C.B.
374), and § 1.960–1(i)(4), which pro-rate
an earnings and profits deficit in one
basket against positive earnings and
profits in other baskets for purposes of
computing post-1986 undistributed
earnings under section 902. It was also
requested that the rules under § 1.960–
1(i)(4) should be modified for purposes
of the hovering deficit rules to eliminate
the ‘‘springing’’ effect of an earnings and
profits deficit. Section 1.960–1(i)(4)
provides that a deficit in any basket
does not permanently reduce earnings
in other baskets, but after the deemedpaid taxes are computed, the deficit
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reverts to and is carried forward in the
same basket in which it was incurred.
It was asserted in the comments that
once a hovering deficit is used to reduce
earnings in another basket, it should not
revert to its original basket in a
subsequent taxable year because this
deficit reincarnation results in
unnecessary complexity in the
calculation of earnings and profits.
The Treasury Department and the IRS
have carefully considered these
comments. After this consideration,
they have concluded that the arguments
in these comments ultimately are not
persuasive. The purpose of the hovering
deficit rule in the domestic context is to
prevent trafficking in deficits in
earnings and profits. Absent this rule, a
corporation with positive earnings and
profits could acquire or be acquired by
another corporation with a deficit in
earnings and profits and immediately
reduce the amount of its positive
earnings and profits, thereby reducing
the amount of potentially taxable
distributions.
In transactions involving foreign
corporations, similar concerns exist
regarding the possibility of trafficking in
deficits in earnings and profits. In light
of the foreign tax credit rules, unique
tax benefits may arise from combining
positive and deficit earnings and profits
of different foreign corporations. 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
categorization of earnings and profits
according to the pooling and basket
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. The Treasury Department and
the IRS believe that these issues merit
targeted differences in the application of
the hovering deficit rule in this context.
Accordingly, these final regulations
retain the provisions of the 2000
proposed regulations that apply the
hovering deficit rule on a basket-bybasket basis.
The final regulations also include a
clarification that post-transaction
earnings and profits that may be offset
by hovering deficits do not include
earnings and profits that are distributed
or deemed distributed in the same
taxable year that they are earned. That
is, the hovering deficit rule does not
permit deficits to be offset against post-
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transaction earnings and profits until
those earnings and profits become
accumulated (as opposed to current) for
tax purposes. This rule is consistent
with a similar provision in the hovering
deficit regulations under section 381.
See § 1.381(c)(2)–1(a)(5).
D. Hovering Deficits and Section 902
Under section 902, the amount of
foreign taxes that are deemed paid by a
10% domestic corporate shareholder
receiving dividends from a foreign
corporation is equal to the foreign
corporation’s post-1986 foreign income
taxes multiplied by a fraction, the
numerator of which is the amount of the
dividend, and the denominator of which
is the foreign corporation’s post-1986
undistributed earnings. Post-1986
undistributed earnings include both
accumulated and current year earnings
and deficits, not taking into account
current year distributions. The section
902 calculation is done on a basket-bybasket basis. The 2000 proposed
regulations provide that a pretransaction deficit will only be taken
into account for purposes of
determining the accumulated earnings
and profits of the surviving corporation
in the section 902 denominator to the
extent of post-transaction earnings that
are accumulated in the same basket as
the deficit.
A comment was made requesting that
the hovering deficit rule not apply for
purposes of computing deemed-paid
credits under section 902, particularly
in the determination of accumulated
earnings and profits in the denominator
of the section 902 fraction. Under this
approach, the effect of the inclusion of
an otherwise hovering deficit on the
section 902 calculation could be
beneficial or detrimental to the
taxpayer, depending on the particular
taxpayer’s facts. For example, the
suggested approach would be
detrimental to taxpayers if the
unrestricted use of the otherwise
hovering deficit reduced the
denominator of the section 902 fraction
to or below zero. See § 1.902–1(b)(4)
(providing that no taxes are deemed
paid with respect to a ‘‘nimble
dividend’’ if post-1986 undistributed
earnings are zero or less than zero). The
rationale offered for this request is that
it would more properly follow the intent
of Congress when it amended section
902 in 1986 to average earnings and
profits and foreign taxes under a pooling
method.
After consideration of the comment,
the Treasury Department and the IRS
have concluded that it would not be
appropriate to allow a pre-transaction
hovering deficit from one corporation to
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offset pre-transaction earnings and
profits of another corporation for
purposes of determining the
denominator of the section 902 fraction.
Such an offset could increase the ratio
of foreign taxes to earnings and profits
in the pool and thereby in certain cases
could ‘‘supercharge’’ the amount of
foreign taxes that could be drawn out by
a given distribution. The Treasury
Department and the IRS believe this is
not an appropriate result and could
encourage taxpayers to enter into
section 381 transactions to take
advantage of the distortion that would
result from accelerating foreign tax
credits in certain cases. It is also
possible that such a rule could be
detrimental to taxpayers by otherwise
denying them access to creditable
foreign income taxes if their section 902
denominator were eliminated.
Moreover, the comment would further
complicate an already complex area by
mandating one set of hovering deficit
treatment and calculations of earnings
for section 316 and another for section
902.
An alternative request was made to
the effect that, if the hovering deficit
rule is retained, it should be modified
to allow a pre-transaction earnings and
profits deficit to offset the surviving
corporation’s post-transaction current
year earnings and profits for purposes of
determining the section 902
denominator, irrespective of whether
such earnings are distributed during the
taxable year.
After considering this comment, the
Treasury Department and the IRS
concluded that on balance it would not
be appropriate to modify the proposed
regulations in this manner. In many
cases, allowing the hovering deficit to
offset current year distributed earnings
and profits for purposes of the section
902 denominator would effectively
allow an offset of pre-transaction
earnings and profits. This is because the
opening balance of post-1986
undistributed earnings in the year
following the distribution would be
reduced a second time (the first
reduction having occurred as a result of
offsetting the current year distributed
earnings and profits by the hovering
deficit) as required by section 902 and
the regulations thereunder to account
for the distribution itself. This second
reduction would reduce pre-transaction
earnings and profits or, to the extent of
any excess over that amount, create a
deficit in accumulated earnings and
profits. As described, the Treasury
Department and the IRS believe that in
order to minimize credit trafficking
problems, pre-transaction deficits of one
corporation should not be allowed to
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44891
offset pre-transaction earnings of
another corporation.
Additionally, implementing the
modification requested in the comment
would create administrative burdens for
taxpayers and the IRS. If hovering
deficits offset current year distributed
earnings solely for purposes of section
902 but not for purposes of section 316,
dual accounts would be necessary to
track hovering deficits as they are
separately used under each section.
Moreover, certain taxpayers would be
disadvantaged under the requested
modification as compared to how those
taxpayers would be treated under the
rule adopted in these final regulations.
For example, if a foreign subsidiary has
a hovering deficit in a separate basket
that exceeds the sum of current plus
accumulated earnings in the basket and
the foreign subsidiary distributes
current year post-transaction earnings in
that same basket, under the requested
modification, the hovering deficit would
reduce the section 902 denominator to
zero, with the result that no deemedpaid taxes could be claimed on the
distribution. In fact, for this reason
certain taxpayers have specifically
requested that the hovering deficit rule
apply for purposes of the section 902
fraction. Under the rules adopted by the
final regulations, the hovering deficit
would not reduce the section 902
denominator and therefore taxpayers
would have access to deemed-paid taxes
on the distribution.
E. Hovering Taxes
Under the 2000 proposed regulations,
taxes associated with a hovering deficit
do not enter into the surviving
corporation’s post-1986 foreign income
taxes pool until the entire deficit has
been offset against post-transaction
accumulated earnings and profits.
Comments were made requesting that
the regulations be changed to provide
that foreign taxes related to a hovering
deficit enter the post-1986 foreign
income taxes pool on a pro rata basis as
the hovering deficit to which the foreign
taxes relate is used to offset posttransaction accumulated earnings and
profits. The Treasury Department and
IRS agree that a pro rata approach of this
nature more accurately ties the
availability of the foreign income taxes
with the use of the related hovering
deficit. Accordingly, this requested
change is reflected in the final
regulations.
F. Zipping Rule
The 2000 regulations provide that if
the foreign target corporation or foreign
acquiring corporation (or both) was a
look-through corporation and the
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foreign surviving corporation is a lessthan-10%-U.S.-owned foreign
corporation, the post-1986 pools of
earnings and profits of the look-through
corporation in the separate baskets are
recharacterized as a single, non-lookthrough pre-pooling annual layer which
accumulated immediately prior to the
381 transaction (the zipping rule). In
addition, the 2000 proposed regulations
provide that if the foreign surviving
corporation later changes to lookthrough status, any such recharacterized
earnings and profits do not regain either
their pooling or their look-through
character.
A comment was made that in a case
where the foreign surviving corporation
subsequently changes to look-through
status, if the recharacterized earnings
and profits do not revert to their lookthrough character, a dividend paid out
of those earnings would not be afforded
look-through treatment. The comment
argued that this would run counter to
section 904(d)(2)(E)(i) which provides
that look-through treatment applies to
distributions by a CFC out of any
earnings and profits accumulated during
periods in which it was a CFC.
The Treasury Department and IRS
note that this concern has been
addressed by intervening statutory and
regulatory changes. All distributions
from a look-through corporation now
receive look-through treatment,
regardless of whether they are paid out
of earnings and profits from post-1986
pools or pre-pooling annual layers. As a
result, the concern raised in the
comment is now effectively moot, and
look-through treatment generally
prevails. The final regulations otherwise
retain the zipping rule, however,
because with respect to the maintenance
of pools or annual layers, this rule
provides administrative advantages for
both taxpayers and the IRS by not
requiring subsequent U.S. shareholders
of a foreign surviving corporation that
continued to accumulate earnings on an
annual layer basis to recreate post-1986
pools of pre-transaction earnings and
profits carried over from a pooling
foreign target corporation. Accordingly,
the Treasury Department and the IRS
decided to retain the general zipping
rule provisions of the 2000 proposed
regulations in these final regulations for
pooling purposes, while allowing full
preservation of look-through treatment.
Moreover, it should be noted that
these final regulations define a pooling
corporation as one that has at any time
met the requirements of section
902(c)(3)(B). Accordingly, even if the
foreign surviving corporation does not
meet those requirements immediately
after the foreign section 381 transaction,
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it will still be a pooling corporation if
it had met those requirements at any
time prior to the transaction. See
§ 1.902–1(a)(13)(i).
G. Qualified and Chain Deficit Rules
Under Section 952(c)(1)(B) and (C)
The section 952(c)(1)(B) subpart F
qualified deficit rule and section
952(c)(1)(C) subpart F chain deficit rule
allow the use of a CFC’s deficit in
earnings and profits to limit subpart F
income inclusions for another year with
respect to the stock of the same CFC or
for the same year with respect to stock
of another CFC in certain cases. Under
the qualified deficit rule of section
952(c)(1)(B), a prior-year earnings and
profits deficit may be used to limit a
qualified shareholder’s current year
subpart F income in the same CFC if
such deficit is attributable to the same
qualified activity as the activity that
gives rise to the current year subpart F
income. Under the chain deficit rule of
section 952(c)(1)(C), a current year
earnings and profits deficit may be used
to limit a related corporation’s current
year subpart F income subject to the
same qualified activity restrictions.
The 2000 proposed regulations
provide that a pre-transaction deficit is
not taken into account for purposes of
calculating the earnings and profits
limitation under the chain deficit rule.
The 2000 proposed regulations are
silent, however, as to the qualified
deficit rule. A comment was made
requesting that pre-transaction deficits
be taken into account for purposes of
calculating the earnings and profits
limitations under both the qualified
deficit rules and the chain deficit rules.
The Treasury Department and the IRS
agree with this comment. The qualified
deficit rule does not limit the amount of
the subpart F income at the CFC level,
but rather limits the amount of a
particular shareholder’s subpart F
income inclusion under section 951(a).
Because qualified deficits in earnings
and profits are shareholder-level
attributes and anti-trafficking provisions
are already incorporated in the rules
regarding qualified deficits under
section 952(c)(1)(B), the Treasury
Department and the IRS believe that it
is appropriate to allow pre-transaction
deficits to be taken into account for
purposes of the calculation of qualified
deficits. Though the Treasury
Department and IRS believe this was
already a reasonable position that could
have been taken under the 2000
proposed regulations, the final
regulations include a more explicit
clarification of this position.
The final regulations also provide that
a current year pre-transaction deficit
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may be taken into account for purposes
of limiting subpart F income under the
chain deficit rule. The Treasury
Department and the IRS believe that the
narrow restrictions that apply to
application of the chain deficit rule are
not subject to manipulation through
entering into foreign section 381
transactions. Accordingly there is no
policy reason for denying a qualified
chain member access to a pretransaction deficit that otherwise
qualifies as a chain deficit solely
because the CFC with the chain deficit
engaged in a foreign section 381
transaction during the taxable year. Any
such pre-transaction deficit that
qualifies as a chain deficit will
nonetheless remain a hovering deficit of
the surviving corporation for purposes
of section 316 and section 902.
H. Allocation of Earnings and Profits,
Deficits, and Taxes During the
Transaction Year
The 2000 proposed regulations
include a rule that allocates the earnings
and profits for the taxable year of a
foreign surviving corporation in which
a foreign section 381 transaction occurs
as either pre-transaction earnings or
post-transaction earnings on the basis of
the number of days in the taxable year
before and after the date of the foreign
section 381 transaction. This rule
parallels a similar rule found under
§ 1.381(c)(2)–1(a)(6) and is necessary in
order to determine the amount of posttransaction earnings that may be offset
by hovering deficits. This rule is applied
on a basket-by-basket basis for any
basket in which there are positive
earnings and profits for the taxable year
in which the transaction occurred. No
comments were received on this point,
and the final regulations adopt this
provision, extending it to related foreign
income taxes as well.
These final regulations also contain a
rule for allocating deficits, and related
foreign income taxes, for the taxable
year in which a foreign section 381
transaction occurs as pre- and posttransaction deficits. If the surviving
corporation has a deficit in any basket
for the taxable year in which the
transaction occurred, unless the actual
accumulated earnings and profits, or
deficit, as of the date of the transaction
can be shown, the deficit shall be
allocated in the same pro rata manner
described above for positive earnings
and profits. This rule also parallels a
similar rule found under § 1.381(c)(2)–
1(a)(6) and is necessary in order to
determine the amount of pre-transaction
deficits that will hover. This rule is
applied on a basket-by-basket basis for
any basket in which there is a deficit in
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earnings and profits for the taxable year
in which the transaction occurred.
The Treasury Department and the IRS
believe that the addition of the
allocation rule for deficits provides
greater consistency with the principles
and rules of section 381. It is a neutral
provision and is consistent with
appropriate results that could be
reached under present law.
sroberts on PROD1PC70 with RULES
I. Special Rule for F Reorganizations
and Similar Transactions
The 2000 proposed regulations (Prop.
Reg. § 1.367(b)-9) provide that the
hovering deficit rules do not apply in
the case of a foreign section 381
transaction that is described in section
368(a)(1)(F) or in which either the
foreign target corporation or the foreign
acquiring corporation is newly created.
This rule was intended to prevent
inappropriate tax consequences that
could result from application of the
hovering deficit rules to the
combination of two corporations where
only one of those corporations has
meaningful tax attributes. 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.
The rule under the 2000 proposed
regulations addressing newly created
corporations was meant to capture any
transactions that are functionally
equivalent to F reorganizations.
However, the Treasury Department and
the IRS have determined that the newlycreated corporation standard under the
2000 proposed regulations is both
potentially underinclusive and
overinclusive in scope. It is
underinclusive in that it would not
apply to include foreign section 381
transactions that do not otherwise
qualify as an F reorganization but that
are between one foreign corporation
with meaningful tax attributes and a
shell corporation that is not newly
created, but nevertheless has no
meaningful tax attributes. In contrast,
this standard is overinclusive in that it
might be read to include a foreign
section 381 transaction involving
multiple foreign corporations with
meaningful tax attributes as long as at
least one party to the transaction is a
newly created corporation. These
transactions are neither F
reorganizations nor are they
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functionally equivalent to F
reorganizations.
Accordingly, these final regulations
clarify the 2000 proposed regulations by
providing that the hovering deficit rules
do not apply to a foreign section 381
transaction involving at least one
corporation that does not own more
than a nominal amount of property or
does not have more than a nominal
amount of tax attributes, but no more
than one corporation that does own
more than a nominal amount of
property or have more than a nominal
amount of tax attributes. In most cases
the transactions covered by this special
rule will be standard F reorganizations.
J. Anti-Abuse Rule
The 2000 proposed regulations
include an anti-abuse rule that gives the
Commissioner the discretion to turn off
the hovering deficit rules if a principal
purpose of a foreign section 381
transaction is to gain a tax benefit from
affirmative use of those rules.
Comments have criticized the anti-abuse
rule as overly broad and inconsistent
with establishing objective rules
regarding the taxation of earnings
distributed (or deemed distributed) by
foreign subsidiaries. Moreover, the point
was raised in some comments that the
proposed anti-abuse rule would prevent
taxpayers from relying on the existing
detailed set of rules for the calculation
of earnings and profits following a
corporate combination in any case in
which a taxpayer receives a U.S. tax
benefit related to the application of the
hovering deficit rule.
Upon consideration of these
comments, the Treasury Department
and the IRS have concluded that the
anti-abuse rule in the 2000 proposed
regulations should be eliminated. While
the anti-abuse rule has been eliminated,
the IRS will continue to examine the
application of the regulations to
transactions to which they apply, or
potentially apply, and will be prepared
to pursue issues where appropriate
under the regulations and other
established principles of existing law.
The Treasury Department and the IRS
may revisit the rules in light of
experience and propose prospective
changes as appropriate.
K. Miscellaneous
A number of conforming revisions
have been made to the 2000 proposed
regulations to account for relevant
statutory and regulatory changes
discussed above that have occurred in
the intervening time period since the
2000 proposed regulations were issued.
This includes the reduction of the
number of baskets under section
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44893
904(d)(1), applicable for tax years
beginning after December 31, 2006, as
well as the fact that distributions by
look-through corporations out of annual
layers accumulated during a non-lookthrough period are now accorded lookthrough treatment.
It is possible that special transition
rules might be needed relating to the
effect on hovering deficits in existence
on the effective date of the reduction in
the number of baskets under section
904(d)(1). If it is determined that such
rules are necessary, they would be
provided as part of a broader guidance
project currently under consideration to
address generally transition issues
relating to the reduction in baskets.
Special Analyses
It has been determined that this
Treasury decision is not a significant
regulatory action as defined in
Executive Order 12866. Therefore, a
regulatory assessment is not required. It
also has 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
regulations do not impose a collection
of information on small entities, the
Regulatory Flexibility Act (5 U.S.C.
chapter 6) does not apply. Pursuant to
section 7805(f) of the Code, the notice
of proposed rulemaking preceding these
regulations was submitted to the Chief
Counsel for Advocacy of the Small
Business Administration for comment
on their impact on small business.
Drafting Information
The principal author of these final
regulations is Jeffrey L. Parry of the
Office of Chief Counsel (International).
However, other personnel from the
Treasury Department and the IRS
participated in their development.
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and
recordkeeping requirements.
Amendments to the Regulations
Accordingly, 26 CFR part 1 is
amended as follows:
I
PART 1—INCOME TAXES
Paragraph 1. The authority citation
for part 1 is amended by revising the
entries for §§ 1.367(b)–7 and 1.367(b)–9
to read in part as follows:
I
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)–9 also issued under 26
U.S.C. 367(a) and (b), 26 U.S.C. 902, and 26
U.S.C. 904. * * *
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Federal Register / Vol. 71, No. 152 / Tuesday, August 8, 2006 / Rules and Regulations
I Par. 2. Section 1.367(b)–0 is amended
by:
I 1. Revising the introductory text.
I 2. Adding entries for § 1.367(b)–2(l).
I 3. Adding entries for § 1.367(b)–3(e)
and (f).
I 4. 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.
*
*
*
(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) Pooling corporation.
(10) Nonpooling corporation.
(11) Separate category.
(12) Passive category.
(13) General category.
§ 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) General rule.
(2) Previously taxed earnings and profits.
[Reserved]
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*
*
*
*
§ 1.367(b)–8 Allocation of earnings and
profits and foreign income taxes in certain
foreign corporate separations. [Reserved]
*
§ 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
pooling corporation.
(2) If foreign surviving corporation is a
nonpooling corporation.
(d) Post-1986 pool.
(1) In general.
(i) Qualifying earnings and taxes.
(ii) Carryover rule.
(2) Hovering deficit.
(i) In general.
(ii) Offset rule.
(iii) Related taxes.
(3) Examples.
(e) Pre-pooling annual layers.
(1) If foreign surviving corporation is a
pooling corporation.
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(i) Qualifying earnings and taxes.
(ii) Carryover rule.
(iii) Deficits.
(A) In general.
(B) Aggregate positive pre-1987 accumulated
profits.
(C) Aggregate deficit in pre-1987
accumulated profits.
(D) Deficit and positive separate categories
within annual layers
(iv) Pre-1987 section 960 earnings and profits
and foreign income taxes.
(v) Examples.
(2) If foreign surviving corporation is a
nonpooling corporation.
(i) Qualifying earnings and taxes.
(ii) Carryover rule.
(iii) Deficits.
(A) In general.
(B) Aggregate positive pre-1987 accumulated
profits.
(C) Aggregate deficit in pre-1987
accumulated profits.
(D) Deficit and positive separate categories
within annual layers.
(iv) Pre-1987 section 960 earnings and profits
and foreign income taxes.
(v) Examples.
(f) Special rules.
(1) Treatment of deficit.
(i) General rule.
(ii) Exceptions.
(iii) Examples.
(2) Reconciling taxable years.
(3) Post-transaction change of status.
(4) Ordering rule for multiple hovering
deficits.
(i) Rule.
(ii) Example.
(5) Pro rata rule for earnings and deficits
during transaction year.
(g) Effective date.
§ 1.367(b)–9 Special rule for F
reorganizations and similar transactions.
(a) Scope.
(b) Hovering deficit rules inapplicable.
(c) Foreign divisive transactions. [Reserved]
(d) Examples.
(e) Effective date.
*
*
*
*
*
Par. 3. Section 1.367(b)–1 is amended
by:
I 1. Removing the language ‘‘and’’ at the
end of paragraph (c)(2)(iii).
I 2. Removing the period at the end of
paragraph (c)(2)(iv)(B) and adding ‘‘;
and’’ in its place.
I 3. Adding paragraph (c)(2)(v).
I 4. Revising paragraphs (c)(3)(ii)(A),
(c)(4)(iv), and (c)(4)(v).
The additions and revisions read as
follows:
I
§ 1.367(b)–1
Other transfers.
*
*
*
*
*
(c) * * *
(2) * * *
(v) A foreign surviving corporation
described in § 1.367(b)–7(a).
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(3) * * *
(ii) * * *
(A) United States shareholders (as
defined in § 1.367(b)–3(b)(2)) of foreign
corporations described in paragraph
(c)(2)(i) or (v) 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 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;
*
*
*
*
*
I Par. 4. Section 1.367(b)–2 is amended
by:
I 1. Revising paragraph (j)(1)(i).
I 2. 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), 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.
*
*
*
*
*
(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
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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
first 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
described in 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
principles 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) Pooling corporation. The term
pooling corporation means a foreign
corporation with respect to which the
requirements of section 902(c)(3)(B)
have been met in the current taxable
year or any prior taxable year.
(10) Nonpooling corporation. The
term nonpooling corporation means a
foreign corporation that is not a pooling
corporation.
(11) 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(h)(10)
(or section 904(g)(10) for taxable years
beginning on or before December 31,
2006).
(12) Passive category. The term
passive category means the separate
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category that includes income described
in section 904(d)(1)(A).
(13) General category. The term
general category means the separate
category that includes income described
in section 904(d)(1)(B) (or section
904(d)(1)(I) for taxable years beginning
on or before December 31, 2006).
I Par. 5. 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—
(1) General rule. 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) 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 United States, 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.
(2) Previously taxed earnings and
profits. [Reserved]
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44895
I Par. 6. 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)–3,
and this section, apply to section 367(b)
exchanges that occur on or after
November 6, 2006. For guidance with
respect to section 367(b) exchanges that
occur prior to November 6, 2006, see
§§ 1.367(b)–1 through 1.367(b)–6 in
effect prior to November 6, 2006 (see 26
CFR part 1 revised as of April 1, 2006).
*
*
*
*
*
I Par. 7. 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 section 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) and the ordering
of distributions by the foreign surviving
corporation. See § 1.367(b)–9 for special
rules governing reorganizations
described in section 368(a)(1)(F) and
foreign section 381 transactions
involving foreign corporations that hold
no property and have no tax attributes
immediately before the transaction,
other than a nominal amount of assets
(and related tax attributes).
(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),
and (f) 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
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of a foreign surviving corporation’s
earnings and profits shall be ordered in
accordance with the rules of paragraph
(c)(1) or (2) of this section, depending
on whether the foreign surviving
corporation is a pooling corporation or
a nonpooling corporation.
(1) If foreign surviving corporation is
a pooling corporation. In the case of a
foreign surviving corporation that is a
pooling corporation, post-transaction
distributions shall be first out of the
post-1986 pool (as described in
paragraph (d) of this section) and
second out of the pre-pooling annual
layers (as described in paragraph (e)(1)
of this section) under an annual last-in,
first-out (LIFO) method.
(2) If foreign surviving corporation is
a nonpooling corporation. In the case of
a foreign surviving corporation that is a
nonpooling corporation, posttransaction distributions shall be out of
the pre-pooling annual layers (as
described in paragraph (e)(2) of this
section) under the LIFO method.
(d) Post-1986 pool. If the foreign
surviving corporation is a pooling
corporation, then the post-1986 pool
shall be determined under the rules of
this paragraph (d).
(1) In general—(i) Qualifying earnings
and taxes. The post-1986 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 (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-byseparate category basis.
(2) Hovering deficit—(i) In general. If
immediately prior to the foreign section
381 transaction either the foreign
acquiring corporation or the foreign
target corporation has a deficit in one or
more separate categories of post-1986
undistributed earnings or an aggregate
deficit in pre-1987 accumulated profits,
such deficit will be a hovering deficit of
the foreign surviving corporation. The
rules of this paragraph (d)(2) apply to
hovering deficits in separate categories
of post-1986 undistributed earnings. See
paragraphs (e)(1)(iii) and (e)(2)(iii) of
this section for rules that apply to
hovering deficits in pre-1987
accumulated profits. If the foreign
acquiring corporation and the foreign
target corporation each have a post-1986
hovering deficit in the same separate
category of post-1986 undistributed
earnings, such deficits and their related
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post-1986 foreign income taxes shall be
combined for purposes of applying this
paragraph (d)(2). See also paragraphs
(f)(1) and (4) of this section (describing
other rules applicable to a deficit
described in this paragraph (d)(2)).
(ii) Offset rule. A hovering deficit in
a separate category of post-1986
undistributed earnings shall offset only
earnings and profits accumulated by the
foreign surviving corporation after the
foreign section 381 transaction (posttransaction earnings) in the same
separate category of post-1986
undistributed earnings. For purposes of
this rule, however, post-transaction
earnings do not include post-1986
undistributed earnings in the same
category that are earned after the foreign
section 381 transaction, but are
distributed or deemed distributed in the
same year they are earned (that is, that
do not become accumulated). The offset
shall occur as of the first day of the
foreign surviving corporation’s first
taxable year following the year in which
the post-transaction earnings
accumulated.
(iii) Related taxes. Post-1986 foreign
income taxes that are related to a
hovering deficit in a separate category of
post-1986 undistributed earnings shall
only be added to the foreign surviving
corporation’s post-1986 foreign income
taxes in that separate category on a pro
rata basis as the hovering deficit is
absorbed. Pro rata means in the same
proportion as the portion of the
hovering deficit that offsets posttransaction earnings in the separate
category under paragraph (d)(2)(ii) of
this section bears to the total amount of
the hovering deficit.
(3) Examples. The following examples
illustrate the rules of this paragraph (d).
The examples assume the following
facts: Foreign corporations A and B are
controlled foreign corporations (CFCs)
that were incorporated after December
31, 1986, have always been pooling
corporations, and have always 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 section 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
post-1986 undistributed earnings in the
passive category resulted from a lookthrough dividend that was paid by a
lower-tier CFC out of earnings
accumulated when the CFC was a
noncontrolled section 902 corporation
and that qualified for the subpart F
same-country exception under section
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Sfmt 4700
954(c)(3)(A). The examples are as
follows:
Example 1. (i) Facts. (A) On December 31,
2006, foreign corporations A and B have the
following post-1986 undistributed earnings
and post-1986 foreign income taxes:
Separate category
E&P
Foreign
taxes
Foreign Corporation A
General .................
Passive .................
300u
100u
$60
40
400u
$100
Foreign Corporation B
General .................
300u
$70
(B) On January 1, 2007, foreign corporation
B acquires the assets of foreign corporation
A in a reorganization described in section
368(a)(1)(C). Immediately following the
foreign section 381 transaction, foreign
surviving corporation is a CFC.
(ii) Result. Under the rules described in
paragraph (d)(1) of this section, foreign
surviving corporation has the following post1986 undistributed earnings and post-1986
foreign income taxes:
Separate category
General .................
Passive .................
E&P
Foreign
taxes
600u
100u
$130
40
700u
$170
(iii) Post-transaction distribution. (A)
During 2007, foreign surviving corporation
does not accumulate any earnings and profits
or pay or accrue any foreign income taxes.
On December 31, 2007, foreign surviving
corporation distributes 350u 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, and
reduces, post–1986 undistributed earnings
and post-1986 foreign income taxes in the
separate categories on a pro rata basis, as
follows:
Separate category
General .................
Passive .................
E&P
Foreign
taxes
300u
50u
$65
20
350u
$85
(B) The foreign income taxes deemed paid
by qualifying shareholders of foreign
surviving corporation upon the distribution
are subject to generally applicable rules and
limitations, such as those of sections 78, 902,
and 904(d).
(C) Immediately after the distribution,
foreign surviving corporation has the
following post-1986 undistributed earnings
and post-1986 foreign income taxes:
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Separate category
General .................
Passive .................
Foreign
taxes
E&P
300u
50u
$65
20
350u
$85
Separate category
Example 2. (i) Facts. (A) On December 31,
2006, foreign corporations A and B have the
following post-1986 undistributed earnings
and post-1986 foreign income taxes:
Foreign
taxes
E&P
Separate category
E&P
200u
(100u)
$30
10
100u
$40
Foreign Corporation B
General .................
Passive .................
300u
100u
$60
30
Positive
E&P
General ............................................................................................................................
Passive ............................................................................................................................
$90
(B) On January 1, 2007, foreign corporation
B acquires the assets of foreign corporation
A in a reorganization described in section
368(a)(1)(C). Immediately following the
foreign section 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 post-1986 undistributed earnings
and post-1986 foreign income taxes:
Earnings & profits
Separate category
Foreign
taxes
400u
Foreign Corporation A
General .................
Passive .................
44897
Hovering
deficit
Foreign taxes
Foreign
taxes
available
Foreign
taxes associated with
hovering
deficit
....................
(100u)
$ 90
30
....................
$10
600u
(iii) Post-transaction distribution. (A)
During 2007, foreign surviving corporation
does not accumulate any earnings and profits
or pay or accrue any foreign income taxes.
On December 31, 2007, foreign surviving
corporation distributes 300u 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, and
reduces, post-1986 undistributed earnings
500u
100u
(100u)
$120
$10
and post-1986 foreign income taxes on a pro
rata basis as follows:
Separate category
General .................
Passive .................
Foreign
taxes
E&P
250u
50u
$45
15
300u
$60
(B) The foreign income taxes deemed paid
by qualifying shareholders of foreign
surviving corporation upon the distribution
are subject to generally applicable rules and
limitations, such as those of sections 78, 902,
and 904(d).
(C) Immediately after the distribution,
foreign surviving corporation has the
following post-1986 undistributed earnings
and post-1986 foreign income taxes:
Earnings & profits
Separate category
Positive
E&P
General ............................................................................................................................
Passive ............................................................................................................................
Hovering
deficit
Foreign taxes
Foreign
taxes
available
Foreign
taxes
associated
with hovering deficit
....................
(100u)
$45
15
....................
$10
300u
(iv) Post-transaction earnings—(A) In its
taxable year ending on December 31, 2008,
foreign surviving corporation accumulates
250u
50u
(100u)
$60
$10
earnings and profits and pays related foreign
income taxes as follows:
Separate category
E&P
(B) None of foreign surviving corporation’s
earnings and profits for its 2008 taxable year
qualifies as subpart F income as defined in
section 952(a). Under the rules described in
paragraphs (d)(2)(ii) and (iii) of this section,
the hovering deficit in the passive category
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will offset the post-transaction earnings in
that category and a proportionate amount of
the foreign taxes related to the hovering
deficit will be added to the post-1986 foreign
income taxes pool. Because the posttransaction earnings in the passive category
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50u
$20
$10
150u
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General ............................................................................................................................................................................
Passive ............................................................................................................................................................................
Foreign
taxes
$40
are half of the amount of the hovering deficit,
half of the related taxes are added to the post1986 foreign income taxes pool. Accordingly,
foreign surviving corporation has the
following post-1986 undistributed earnings
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and post-1986 foreign income taxes on
January 1, 2009:
Earnings & profits
Separate category
Positive
E&P
General ............................................................................................................................
Passive ............................................................................................................................
Hovering
deficit
Foreign taxes
Foreign
taxes
available
Foreign
taxes
associated
with hovering deficit
....................
(50u)
$65
30
....................
$5
400u
Example 3. (i) Facts. The facts are the same
as Example 2, except that the 50u of earnings
in the passive category accrued by foreign
surviving corporation during 2008 is subpart
F income, all of which is included in income
under section 951(a) by United States
shareholders (as defined in section 951(b)).
This example assumes that none of the
United States shareholders are able to reduce
their subpart F income inclusion with a
qualified deficit under section 952(c)(1)(B).
(ii) Result. (A) Under the rule described in
paragraph (f)(1) of this section, the (100u)
hovering deficit in the passive category does
350u
50u
(50u)
$95
$5
not reduce foreign surviving corporation’s
current passive earnings and profits for
purposes of determining subpart F income or
associated deemed paid credits. Thus, foreign
surviving corporation’s United States
shareholders include their pro rata shares of
50u 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 $12.50 (50u subpart
F inclusion / (50u + 50u post-1986
undistributed earnings in the passive
category = 100u) = 50%, × $25 post-1986
foreign income taxes in the passive category
= $12.50). The United States shareholders
will also include their pro rata shares of the
deemed-paid taxes of $12.50 in taxable
income for the year as a deemed dividend
pursuant to section 78.
(B) Immediately after the subpart F
inclusion and section 960 deemed paid taxes
(and taking into account the taxable year
2008 earnings and profits and related taxes
in the general category), foreign surviving
corporation has the following post-1986
undistributed earnings and post-1986 foreign
income taxes:
Earnings & profits
Separate category
Positive
E&P
General ............................................................................................................................
Passive ............................................................................................................................
Hovering
deficit
Foreign
taxes
Foreign
taxes
available
Foreign
taxes
associated
with hovering deficit
Separate category
....................
(100u)
$65.00
12.50
....................
$10
400u
(C) The 50u included as subpart F income
constitutes previously taxed earnings and
profits under section 959.
Example 4. (i) Facts. (A) On December 31,
2006, foreign corporations A and B have the
following post-1986 undistributed earnings
and post-1986 foreign income taxes:
350u
50u
(100u)
77.50
10
(B) On January 1, 2007, foreign corporation
B acquires the assets of foreign corporation
A in a reorganization described in section
368(a)(1)(C). Immediately following the
foreign section 381 transaction, foreign
surviving corporation is a CFC.
(ii) Result. (A) Under the rules described in
paragraphs (d)(1) and (2) of this section,
foreign surviving corporation has the
following post-1986 undistributed earnings
and post-1986 foreign income taxes:
Foreign
taxes
E&P
Foreign Corporation A
General .................
50u
$10
Foreign Corporation B
General .................
(100u)
$20
Earnings & profits
Separate category
Positive
E&P
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General ............................................................................................................................
(iii) Post-transaction earnings and
distribution. (A) In its taxable year ending on
December 31, 2007, foreign surviving
corporation earns 100u in the general
category and pays related foreign income
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taxes of $24. On December 31, 2007, foreign
surviving corporation distributes 75u to its
shareholders.
(B) Result. For purposes of determining the
dividend amount under section 316 and the
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Hovering
deficit
50u
(100u)
Foreign
taxes
Foreign
taxes
available
$10
Foreign
taxes
associated
with hovering deficit
$20
foreign income taxes deemed paid with
respect to that dividend under section 902,
under paragraph (d)(2)(ii) of this section the
hovering deficit does not offset the posttransaction current year earnings.
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Accordingly, the full 75u will be a dividend
under section 316. The deemed paid taxes on
that dividend are $17 (75u distribution /
(100u current earnings + 50u accumulated
earnings) = 50%, × ($10 accumulated foreign
taxes + $24 current year foreign taxes) = $17).
The 25u of undistributed earnings and profits
in 2007 will be offset by (25u) of the hovering
deficit for purposes of determining the
opening balance of the post-1986
undistributed earnings pool in 2008. Because
the amount of earnings offset by the hovering
deficit is 25% of the amount of the hovering
deficit, under paragraph (d)(2)(iii) of this
section $5 (25% of $20) of the related taxes
are added to the post-1986 foreign income
taxes pool at the beginning of the next
taxable year. Accordingly, foreign surviving
corporation has the following post-1986
undistributed earnings and post-1986 foreign
income taxes on January 1, 2008:
Earnings & profits
Separate category
Positive
E&P
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General ............................................................................................................................
(e) Pre-pooling annual layers—(1) If
foreign surviving corporation is a
pooling corporation. If the foreign
surviving corporation is a pooling
corporation, the pre-pooling annual
layers shall be determined under the
rules of this paragraph (e)(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 (e)(1)(iii) of this section, the
amounts described in paragraph (e)(1)(i)
of this section shall carry over to the
foreign surviving corporation but shall
not be combined. If 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 pre1987 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 (f)(2) of this section
(governing the reconciliation of taxable
years).
(iii) Deficit—(A) In general. The rules
of this paragraph (e)(1)(iii) apply when,
immediately prior to the foreign section
381 transaction, the foreign acquiring
corporation or the foreign target
corporation (or both) has a deficit in
earnings and profits for one or more of
the years that comprise its pre-1987
accumulated profits (see also paragraphs
(f)(1) and (4) of this section, describing
other rules applicable to a deficit
described in this paragraph (e)(1)(iii)).
(B) Aggregate positive pre-1987
accumulated profits. If the foreign
acquiring corporation or the foreign
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target corporation (or both) has an
aggregate positive (or zero) amount of
pre-1987 accumulated profits, but a
deficit in earnings and profits for one or
more years, then the rules otherwise
applicable to such deficits shall apply
separately to the pre-1987 accumulated
profits and related pre-1987 foreign
income taxes of such corporation. A
deficit in pre-1987 accumulated profits
for one or more years is applied to
reduce pre-1987 accumulated profits on
a LIFO basis. Any remaining deficit
shall be applied to reduce pre-1987
accumulated profits in succeeding
years. 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.
(C) Aggregate deficit in pre-1987
accumulated profits. If the foreign
acquiring corporation or the foreign
target corporation (or both) has an
aggregate deficit in pre-1987
accumulated profits, a hovering deficit
as defined under paragraph (d)(2)(i) of
this section, then the rules under
§ 1.902–2(b) shall apply to such
hovering deficit (and related pre-1987
foreign income taxes) immediately prior
to the transaction, except that the
aggregate hovering deficit that is carried
forward into the foreign surviving
corporation’s post-1986 pool shall offset
only post-transaction earnings
accumulated by the foreign surviving
corporation in the same separate
category of post-1986 undistributed
earnings to which the relevant portion
of the hovering deficit is attributable.
Post-transaction earnings do not include
earnings and profits that are earned after
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Fmt 4700
Sfmt 4700
44899
Hovering
deficit
50u
(75u)
Foreign taxes
Foreign
taxes
available
$22
Foreign
taxes
associated
with hovering deficit
$15
the foreign section 381 transaction but
distributed or deemed distributed in the
same year they are earned.
(D) Deficit and positive separate
categories within annual layers. For
purposes of applying the rules of
paragraphs (e)(1)(iii)(B) and (C) of this
section, if within a single pre-pooling
annual layer, the foreign acquiring
corporation or the foreign target
corporation (or both) has a deficit in
pre-1987 accumulated profits in a
separate category and positive pre-1987
accumulated profits in another separate
category, the deficit shall first be used
to offset the positive pre-1987
accumulated profits in the other
separate category in the same prepooling annual layer. Any remaining
deficit shall be carried forward or back
to other years according to the rules of
paragraph (e)(1)(iii)(B) or (C) of this
section as applicable.
(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 of 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
(e)(1). The examples assume the
following facts: Foreign corporation A
was incorporated in 2003 and was a
nonpooling corporation through
December 31, 2004. Foreign corporation
A became a CFC on January 1, 2005 and,
as a result, began to maintain a pool of
post-1986 undistributed earnings on
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44900
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that date. Foreign corporation B was
incorporated in 2003 and has always
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 have always 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, unless otherwise
stated, all earnings and profits of foreign
corporations A and B are in the general
category. The examples are as follows:
Example 1. (i) Facts. (A) On December 31,
2006, foreign corporations A and B have the
following earnings and profits and foreign
income taxes:
E&P
Foreign Corporation A:
Post-1986 pool .................................................................................................................................................................
2004 .................................................................................................................................................................................
2003 .................................................................................................................................................................................
1,000u
400u
100u
Foreign
taxes
$350
160u
5u
1,500u
Foreign Corporation B:
2006 ..............................................................................................................................................................................
2005 ..............................................................................................................................................................................
2004 ..............................................................................................................................................................................
2003 ..............................................................................................................................................................................
foreign section 381 transaction, foreign
surviving corporation is a CFC.
(ii) Result. Under the rules described in
paragraphs (e)(1)(i) and (ii) of this section,
20u
30u
50u
5u
300u
(B) On January 1, 2007, foreign corporation
B acquires the assets of foreign corporation
A in a reorganization described in section
368(a)(1)(C). Immediately following the
100u
150u
0u
50u
105u
foreign surviving corporation has the
following earnings and profits and foreign
income taxes:
E&P
Post-1986 Pool ....................................................................................................................................................................
2006 .....................................................................................................................................................................................
2005 .....................................................................................................................................................................................
Two Side-by-Side Layers of 2004 E&P:
2004 layer #1 (from Corp A) ........................................................................................................................................
2004 layer #2 (from Corp B) ........................................................................................................................................
Two Side-by-Side Layers of 2003 E&P:
2003 layer #1 (from Corp A) ........................................................................................................................................
2003 layer #2 (from Corp B) ........................................................................................................................................
Foreign
taxes
On December 31, 2007, foreign surviving
corporation distributes 1,725u to its
shareholders. Under the rules of paragraph
(c)(1) of this section, the distribution is first
$350
20u
30u
400u
0u
160u
50u
100u
50u
5u
5u
1,800u
(iii) Post-transaction distribution. (A)
During 2007, foreign surviving corporation
does not accumulate any earnings and profits
or pay or accrue any foreign income taxes.
1,000u
100u
150u
..................
out of the post-1986 pool, and then out of the
pre-pooling annual layers under the LIFO
method, as follows:
E&P
Post-1986 pool .................................................................................................................................................................
2006 .................................................................................................................................................................................
2005 .................................................................................................................................................................................
Two Side-by-Side Layers of 2004 E&P:
2004 layer #1 ............................................................................................................................................................
2004 layer #2 ............................................................................................................................................................
Two Side-by-Side Layers of 2003 E&P:
2003 layer #1 ............................................................................................................................................................
2003 layer #2 ............................................................................................................................................................
Foreign
taxes
1,000u
100u
150u
$350
20u
30u
400u
0u
160u
0u
* 50u
** 25u
2.5u
2.5u
1,725u
sroberts on PROD1PC70 with RULES
* 100u in layer/150u aggregate 2003 earnings = 66.67% × 75u distribution.
** 50u in layer/150u aggregate 2003 earnings = 33.33% × 75u distribution.
(B) The foreign income taxes deemed paid
by qualifying shareholders of foreign
surviving corporation upon the distribution
are subject to generally applicable rules and
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Jkt 208001
limitations, such as those of sections 78, 902,
and 904(d).
(C) Immediately after the distribution,
foreign surviving corporation has the
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Sfmt 4700
following earnings and profits and foreign
income taxes:
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Foreign
taxes
E&P
2004 layer #2 ...................................................................................................................................................................
Two Side-by-Side Layers of 2003 E&P:
2003 layer #1 ............................................................................................................................................................
2003 layer #2 ............................................................................................................................................................
44901
category, none of which qualify as subpart F
income under section 952(a), and pays $70 in
foreign income taxes. As of the close of the
2008 taxable year, foreign surviving
50u
50u
25u
2.5u
2.5u
75u
(iv) Post-transaction earnings. For the
taxable year ending on December 31, 2008,
foreign surviving corporation has 500u of
current earnings and profits in the general
0u
55u
corporation has the following earnings and
profits and foreign income taxes:
Foreign
taxes
E&P
Post-1986 pool .................................................................................................................................................................
2004 .................................................................................................................................................................................
Two Side-by-Side Layers of 2003 E&P:
2003 layer #1 ............................................................................................................................................................
2003 layer #2 ............................................................................................................................................................
500u
0u
$70
50u
50u
25u
2.5u
2.5u
575u
Example 2. (i) Facts. (A) On December 31,
2006, foreign corporations A and B have the
following earnings and profits and foreign
income taxes:
Foreign
taxes
E&P
Foreign Corporation A:
Post-1986 pool .............................................................................................................................................................
2004 ..........................................................................................................................................................................
2003 ..........................................................................................................................................................................
1,000u
100u
(50u)
$350
20u
5u
1,050u
Foreign Corporation B:
2006 ..........................................................................................................................................................................
2005 ..........................................................................................................................................................................
2004 ..........................................................................................................................................................................
2003 ..........................................................................................................................................................................
(ii) Result. Because foreign corporations A
and B have aggregate positive amounts of
pre-1987 accumulated profits with a deficit
in one or more years, the rules of paragraph
(e)(1)(iii)(B) of this section apply.
Accordingly, after the foreign section 381
20u
5u
50u
10u
150u
(B) On January 1, 2007, foreign corporation
B acquires the assets of foreign corporation
A in a reorganization described in section
368(a)(1)(C). Immediately following the
foreign section 381 transaction, foreign
surviving corporation is a CFC.
100u
(50u)
0u
100u
85u
transaction, foreign surviving corporation has
the following earnings and profits and
foreign income taxes:
Earnings & profits
Foreign taxes
sroberts on PROD1PC70 with RULES
Positive
E&P
Deficit E&P
Foreign
taxes
available
1,000u
100u
....................
....................
....................
(50u)
$350
20u
....................
100u
0u
....................
....................
20u
50u
....................
100u
(50u)
....................
....................
10u
E:\FR\FM\08AUR1.SGM
08AUR1
Post-1986 pool .................................................................................................................
2006 .................................................................................................................................
2005 .................................................................................................................................
Two Side-by-Side Layers of 2004 E&P:
2004 layer #1 (from Corp A) ....................................................................................
2004 layer #2 (from Corp B) ....................................................................................
Two Side-by-Side Layers of 2003 E&P:
2003 layer #1 (from Corp A) ....................................................................................
2003 layer #2 (from Corp B) ....................................................................................
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18:48 Aug 07, 2006
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Fmt 4700
Sfmt 4700
Foreign
taxes
assoicated
with deficit
E&P
5u
5u
44902
Federal Register / Vol. 71, No. 152 / Tuesday, August 8, 2006 / Rules and Regulations
Earnings & profits
Positive
E&P
Deficit E&P
1,300u
(iii) Post-transaction distribution. (A)
During 2007, foreign surviving corporation
does not accumulate any earnings and profits
or pay or accrue any foreign income taxes.
On December 31, 2007, foreign surviving
corporation distributes 1,175u to its
shareholders. Under the rules described in
paragraphs (c)(1) and (e)(1)(iii)(B) of this
(100u)
Foreign taxes
Foreign
taxes
available
Foreign
taxes
assoicated
with deficit
E&P
....................
10u
section, the distribution is first out of the
post-1986 pool, and then out of the prepooling annual layers, as follows:
Distribution
Foreign
taxes
E&P
Post-1986 pool .................................................................................................................................................................
2006 .................................................................................................................................................................................
2005 .................................................................................................................................................................................
Two Side-by-Side Layers of 2004 E&P:
2004 layer #1 ............................................................................................................................................................
2004 layer #2 ............................................................................................................................................................
Two Side-by-Side Layers of 2003 E&P:
2003 layer #1 ............................................................................................................................................................
2003 layer #2 ............................................................................................................................................................
1,000u
100u
0u
$350
20u
0u
50u
0u
20u
0u
0u
25u
0u
5u
1,175u
(B) Under paragraph (e)(1)(iii)(B) 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 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
50u can be distributed from foreign
corporation A’s pre-pooling annual layers
and is out of its 2004 layer #1 (after rolling
forward the (50u) deficit in 2003 layer #1 to
reduce earnings in 2004 layer #1 to 50u (100u
¥50u)). Under the principles of § 1.902–
1(b)(3), the full 20u of taxes related to 2004
layer #1 is reduced or deemed paid ($20 ×
(50/50)). 100u is distributed from foreign
corporation B’s 2006 annual layer. Foreign
corporation B’s (50u) deficit in 2005 is then
rolled back to offset its 2003 annual layer to
reduce earnings in that layer to 50u, 25u of
which is distributed. Thus, after the
distribution, 25u remains in 2003 layer # 2
along with 5u of foreign income taxes (10u
× (25u/50u)).
(C) The foreign income taxes deemed paid
by qualifying shareholders of foreign
surviving corporation upon the distribution
are subject to generally applicable rules and
limitations, such as those of sections 78, 902,
and 904(d).
(D) Immediately after the distribution,
foreign surviving corporation has the
following earnings and profits and foreign
income taxes:
Foreign
taxes
E&P
2005 .................................................................................................................................................................................
2004 layer #2 ...................................................................................................................................................................
Two Side-by-Side Layers of 2003 E&P:
2003 layer #1 ............................................................................................................................................................
2003 layer #2 ............................................................................................................................................................
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. See § 1.902–2(b)(2).
5u
50u
0u
25u
5u
5u
25u
(E) Under paragraph (e)(1)(iii)(B) of this
section, the 5u, 50u, and 5u of pre-1987
foreign income taxes related to foreign
surviving corporation’s 2005 layer, 2004
layer #2, and 2003 layer #1, respectively,
remain in those layers. These foreign income
0u
0u
65u
Example 3. (i) Facts. (A) On December 31,
2006, foreign corporations A and B have the
following earnings and profits and foreign
income taxes:
sroberts on PROD1PC70 with RULES
E&P
Foreign Corporation A:
Post-1986 pool .................................................................................................................................................................
2004 ..........................................................................................................................................................................
2003 ..........................................................................................................................................................................
1,000u
150u
100u
1,250u
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Jkt 208001
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Fmt 4700
Sfmt 4700
E:\FR\FM\08AUR1.SGM
08AUR1
Foreign
taxes
$350
20u
5u
Federal Register / Vol. 71, No. 152 / Tuesday, August 8, 2006 / Rules and Regulations
Foreign
taxes
E&P
Foreign Corporation B:
2006 ..........................................................................................................................................................................
2005 ..........................................................................................................................................................................
2004 ..........................................................................................................................................................................
2003 ..........................................................................................................................................................................
44903
1987 accumulated profits, the rules of
paragraph (e)(1)(iii)(C) of this section apply.
Accordingly, § 1.902–2(b) applies
immediately prior to the foreign section 381
transaction, except that the hovering deficit
is carried forward into the foreign surviving
corporation’s post-1986 undistributed
earnings pool and will offset only post-
85u
transaction earnings accumulated by foreign
surviving corporation in the general category.
Accordingly, after the foreign section 381
transaction, foreign surviving corporation has
the following earnings and profits and
foreign income taxes:
Earnings & profits
Positive
E&P
Post-1986 pool .................................................................................................................
2006 .................................................................................................................................
2005 .................................................................................................................................
Two Side-by-Side Layers of 2004 E&P:
2004 layer #1 (from Corp A) ....................................................................................
2004 layer #2 (from Corp B) ....................................................................................
Two Side-by-Side Layers of 2003 E&P:
2003 layer #1 (from Corp A) ....................................................................................
2003 layer #2 (from Corp B) ....................................................................................
20u
5u
50u
10u
(50u)
(B) On January 1, 2007, foreign corporation
B acquires the assets of foreign corporation
A in a reorganization described in section
368(a)(1)(C). Immediately following the
foreign section 381 transaction, foreign
surviving corporation is a CFC.
(ii) Result. (A) Because foreign corporation
B has an aggregate hovering deficit in pre-
100u
(250u)
0u
100u
Hovering
deficit
Foreign taxes
Foreign
taxes
available
sroberts on PROD1PC70 with RULES
(2) If foreign surviving corporation is
a nonpooling corporation. If the foreign
surviving corporation is a nonpooling
corporation, then the pre-pooling
annual layers shall be determined under
the rules of this paragraph (e)(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 post1986 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
VerDate Aug<31>2005
18:48 Aug 07, 2006
Jkt 208001
(50u)
....................
....................
$350
20u
5u
150u
0u
....................
....................
20u
50u
100u
0u
....................
....................
5u
10u
1,250u
(B) Under paragraph (e)(1)(iii)(C) of this
section, the 20u, 5u, 50u, and 10u of pre1987 foreign income taxes associated with
foreign corporation B’s pre-1987 accumulated
profits for 2006, 2005, 2004 layer #2, and
2003 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.
See § 1.902–2(b)(2).
1,000u
0u
0u
(50u)
....................
accumulated profits or deficits and pre1987 foreign income taxes of the foreign
acquiring corporation or the foreign
target corporation accumulated
immediately prior to the foreign section
381 transaction.
(ii) Carryover rule. Subject to
paragraph (e)(2)(iii) of this section, the
amounts described in paragraph (e)(2)(i)
of this section shall carry over to the
foreign surviving corporation but shall
not be combined. If 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 pre1987 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 (f)(2) of this section
(governing the reconciliation of taxable
years).
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Frm 00021
Fmt 4700
Sfmt 4700
Foreign
taxes
assoicated
with hovering deficit
$0
$0
(iii) Deficits—(A) In general. The rules
of this paragraph (e)(2)(iii) apply when,
immediately prior to the foreign section
381 transaction (and after application of
the last sentence of paragraph (e)(2)(i) of
this section), 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. See also
paragraphs (f)(1) and (4) of this section
(describing other rules applicable to a
deficit described in this paragraph
(e)(2)(iii)).
(B) Aggregate positive pre-1987
accumulated 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 pre-1987 accumulated profits
in one or more 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. A
deficit in pre-1987 accumulated profits
for one or more years is applied to
reduce pre-1987 accumulated profits on
a LIFO basis. Any remaining deficit
E:\FR\FM\08AUR1.SGM
08AUR1
44904
Federal Register / Vol. 71, No. 152 / Tuesday, August 8, 2006 / Rules and Regulations
shall be applied to reduce pre-1987
accumulated profits in succeeding
years. 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.
(C) Aggregate deficit in pre-1987
accumulated profits. If the foreign
acquiring corporation or the foreign
target corporation (or both) has an
aggregate deficit in pre-1987
accumulated profits, a hovering deficit
as defined under paragraph (d)(2)(i) of
this section, then the rules otherwise
applicable to such hovering deficits
shall apply separately to the pretransaction earnings and profits and
related taxes of the relevant corporation.
See, e.g., sections 316(a) and
381(c)(2)(B). Thus, any hovering deficit
shall offset only post-transaction
earnings accumulated by the foreign
surviving corporation in the same
separate category of earnings and profits
to which the relevant portion of the
hovering deficit is attributable. Posttransaction earnings do not include
earnings and profits that are earned after
the foreign section 381 transaction but
distributed or deemed distributed in the
same year they are earned. Following
the principles of § 1.902–2(b), if there is
an aggregate deficit in pre-1987
accumulated profits, any related pre1987 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 creates
a pre-transaction aggregate positive
balance for pre-1987 accumulated
profits.
(D) Deficit and positive separate
categories within annual layers. For
purposes of applying the rules of
paragraphs (e)(2)(iii)(B) and (C) of this
section, if within a single pre-pooling
annual layer, the foreign acquiring
corporation or the foreign target
corporation (or both) has a deficit in
pre-1987 accumulated profits in a
separate category and positive pre-1987
accumulated profits in another separate
category, the deficit shall first be used
to offset the positive pre-1987
accumulated profits in the other
separate category in the same prepooling annual layer. Any remaining
deficit shall be carried forward or back
to other years according to the rules of
paragraph (e)(2)(iii)(B) or (C) as
applicable.
(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 of 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
(e)(2). The examples assume the
following facts: Both foreign corporation
A and foreign corporation B have
always 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, and 1u = US$1
at all times. Finally, unless otherwise
stated, all earnings and profits of foreign
corporations A and B are in the general
category. The examples are as follows:
Example 1. (i) Facts. (A) Foreign
corporations A and B both were incorporated
in 2003. 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, 2006,
foreign corporations A and B have the
following earnings and profits and foreign
income taxes:
E&P
Foreign Corporation A:
2006 ..........................................................................................................................................................................
2005 ..........................................................................................................................................................................
2004 ..........................................................................................................................................................................
2003 ..........................................................................................................................................................................
Foreign
taxes
sroberts on PROD1PC70 with RULES
surviving corporation is a nonpooling
corporation that does not meet the
requirements of section 902(c)(3)(B).
(ii) Result. Under the rules described in
paragraphs (e)(2)(i) and (ii) of this section,
815u
100u
300u
0u
50u
20u
60u
50u
5u
450u
(B) On January 1, 2007, foreign corporation
B acquires the assets of foreign corporation
A in a reorganization described in section
368(a)(1)(C). Immediately following the
foreign section 381 transaction, foreign
350u
300u
160u
5u
1,400u
Foreign Corporation B:
2006 ..........................................................................................................................................................................
2005 ..........................................................................................................................................................................
2004 ..........................................................................................................................................................................
2003 ..........................................................................................................................................................................
500u
400u
400u
100u
135u
foreign surviving corporation has the
following earnings and profits and foreign
income taxes:
E&P
Two Side-by-Side Layers of 2006 E&P:
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20:43 Aug 07, 2006
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Sfmt 4700
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08AUR1
Foreign
taxes
Federal Register / Vol. 71, No. 152 / Tuesday, August 8, 2006 / Rules and Regulations
E&P
2006 layer #1 (from Corp A) ....................................................................................................................................
2006 layer #2 (from Corp B) ....................................................................................................................................
Two Side-by-Side Layers of 2005 E&P:
2005 layer #1 (from Corp A) ....................................................................................................................................
2005 layer #2 (from Corp B) ....................................................................................................................................
Two Side-by-Side Layers of 2004 E&P:
2004 layer #1 (from Corp A) ....................................................................................................................................
2004 layer #2 (from Corp B) ....................................................................................................................................
Two Side-by-Side Layers of 2003 E&P:
2003 layer #1 (from Corp A) ....................................................................................................................................
2003 layer #2 (from Corp B) ....................................................................................................................................
44905
Foreign
taxes
On December 31, 2007, foreign surviving
corporation distributes 600u to its
shareholders. Under the rules of paragraph
(c)(3) of this section, the distribution is out
350u
20u
400u
300u
300u
60u
400u
0u
160u
50u
100u
50u
5u
5u
1,850u
(iii) Post-transaction distribution. (A)
During 2007, foreign surviving corporation
does not accumulate any earnings and profits
or pay or accrue any foreign income taxes.
500u
100u
950u
of pre-pooling annual layers under the LIFO
method as follows:
E&P
Two Side-by-Side Layers of 2006 E&P:
2006 layer #1 (from Corp A) ....................................................................................................................................
2006 layer #2 (from Corp B) ....................................................................................................................................
Foreign
taxes
eligible to claim deemed paid foreign income
taxes under section 902. See § 1.902–
1(a)(10)(iii).
350u
20u
600u
(B) Foreign surviving corporation’s foreign
income tax accounts are reduced to reflect
the distribution of earnings and profits
notwithstanding that no shareholders are
500u
100u
370u
(C) Immediately after the distribution,
foreign surviving corporation has the
following earnings and profits and foreign
income taxes:
E&P
Two Side-by-Side Layers of 2005 E&P:
2005 layer #1 (from Corp A) ....................................................................................................................................
2005 layer #2 (from Corp B) ....................................................................................................................................
Two Side-by-Side Layers of 2004 E&P:
2004 layer #1 (from Corp A) ....................................................................................................................................
2004 layer #2 (from Corp B) ....................................................................................................................................
Two Side-by-Side Layers of 2003 E&P:
2003 layer #1 (from Corp A) ....................................................................................................................................
2003 layer #2 (from Corp B) ....................................................................................................................................
Foreign
taxes
of section 902(c)(3)(B) on January 1, 2005,
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 pooling
300u
60u
400u
0u
160u
50u
100u
50u
5u
5u
1,250u
Example 2. (i) Facts. (A) The facts are the
same as in Example 1 (i)(A), except that
foreign corporation A met the requirements
400u
300u
580u
corporation. On December 31, 2006, foreign
corporations A and B have the following
earnings and profits and foreign income
taxes:
E&P
sroberts on PROD1PC70 with RULES
Foreign Corporation A:
Post-1986 pool .........................................................................................................................................................
2004 ..........................................................................................................................................................................
2003 ..........................................................................................................................................................................
Foreign
taxes
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E:\FR\FM\08AUR1.SGM
08AUR1
$650
160u
5u
1,400u
Foreign Corporation B:
2006 ..........................................................................................................................................................................
2005 ..........................................................................................................................................................................
900u
400u
100u
....................
100u
300u
20u
60u
44906
Federal Register / Vol. 71, No. 152 / Tuesday, August 8, 2006 / Rules and Regulations
Foreign
taxes
E&P
2004 ..........................................................................................................................................................................
2003 ..........................................................................................................................................................................
surviving corporation is a nonpooling
corporation that does not meet the
requirements of section 902(c)(3)(B).
(ii) Result. Under the rules described in
paragraphs (e)(2)(i) and (ii) of this section,
50u
5u
450u
(B) On January 1, 2007, foreign corporation
B acquires the assets of foreign corporation
A in a reorganization described in section
368(a)(1)(C). Immediately following the
foreign section 381 transaction, foreign
0u
50u
135u
foreign surviving corporation has the
following earnings and profits and foreign
income taxes:
E&P
Two Side-by-Side Layers of 2006 E&P:
2006 layer #1 (from Corp A’s pool) ..........................................................................................................................
2006 layer #2 (from Corp B’s layer) .........................................................................................................................
2005 (from Corp B): .................................................................................................................................................
Two Side-by-Side Layers of 2004 E&P:
2004 layer #1 (from Corp A) ....................................................................................................................................
2004 layer #2 (from Corp B) ....................................................................................................................................
Two Side-by-Side Layers of 2003 E&P:
2003 layer #1 (from Corp A) ....................................................................................................................................
2003 layer #2 (from Corp B) ....................................................................................................................................
Foreign
taxes
900u
100u
300u
$650
20u
60u
400u
0u
160u
50u
100u
50u
5u
5u
1,850u
(iii) Subsequent ownership change. On July
1, 2010, USS (a domestic corporation)
acquires 100% of the stock of foreign
surviving corporation. Under the rules of
paragraph (f)(3) of this section, foreign
surviving corporation begins to pool its
earnings and profits under section 902(c)(3)
as of January 1, 2010. Foreign surviving
corporation’s earnings and profits and foreign
income taxes accrued before January 1, 2010
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, 2006, foreign corporations A
and B have the following earnings and profits
and foreign income taxes:
E&P
Foreign Corporation A:
Post-1986 pool .........................................................................................................................................................
2004 ..........................................................................................................................................................................
2003 ..........................................................................................................................................................................
Foreign
Taxes
1,000u
(200u)
400u
$500
10u
5u
1,200u
Foreign Corporation B
2006 ..........................................................................................................................................................................
2005 ..........................................................................................................................................................................
2004 ..........................................................................................................................................................................
2003 ..........................................................................................................................................................................
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 accumulated profits with a deficit
in one or more years, the rules of paragraph
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Positive
E&P
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135u
(e)(2)(iii)(B) of this section apply.
Accordingly, after the foreign section 381
transaction, foreign surviving corporation has
the following earnings and profits and
foreign income taxes:
Earnings & profits
Two Side-by-Side Layers of 2006 E&P:
2006 layer #1 (from Corp A’s pool) ..........................................................................
20u
60u
50u
5u
250u
(B) On January 1, 2007, foreign corporation
B acquires the assets of foreign corporation
A in a reorganization described in section
368(a)(1)(C). Immediately following the
foreign section 381 transaction, foreign
surviving corporation is a nonpooling
300u
(100u)
0u
50u
1,000u
Deficit E&P
....................
E:\FR\FM\08AUR1.SGM
08AUR1
Foreign taxes
Foreign
taxes
available
$500
Foreign
taxes associated with
deficit E&P
Federal Register / Vol. 71, No. 152 / Tuesday, August 8, 2006 / Rules and Regulations
Earnings & profits
44907
Foreign taxes
Foreign
taxes associated with
deficit E&P
Positive
E&P
(iii) Post-transaction distribution. (A)
During 2007, foreign surviving corporation
does not accumulate any earnings and profits
or pay or accrue any foreign income taxes.
Foreign
taxes
available
300u
....................
....................
(100u)
20u
....................
60u
....................
0u
(200u)
....................
....................
50u
10u
400u
50u
....................
....................
5u
5u
1,750u
2006 layer #2 (from Corp B’s layer) .........................................................................
2005 (from Corp B) ..................................................................................................
Two Side-by-Side Layers of 2004 E&P:
2004 layer #1 (from Corp A) ....................................................................................
2004 layer #2 (from Corp B) ....................................................................................
Two Side-by-Side Layers of 2003 E&P:
2003 layer #1 (from Corp A) ....................................................................................
2003 layer #2 (from Corp B) ....................................................................................
Deficit E&P
(300u)
....................
On December 31, 2007, foreign surviving
corporation distributes 1,300u to its
shareholders. Under the rules described in
paragraphs (c)(3) and (e)(2)(iii)(B) of this
70u
section, the distribution is out of the prepooling annual layers, as follows:
E&P
Foreign taxes
Two Side-by-Side Layers of 2006 E&P:
2006 layer #1 ............................................................................
2006 layer #2 ............................................................................
2003 E&P:
1,000u
250u
$500
20u
2003 layer #1 ............................................................................
50u
1,300u
1.25u (25% of 5u taxes)
(B) Under paragraph (e)(2)(iii)(B) 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 years, apply separately to the pre-1987
accumulated profits and related pre-1987
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, 1,000u of the distribution
is out of foreign corporation A’s 2006 layer
#1 and 250u is out of foreign corporation B’s
2006 layer #2 (after rolling forward (50u) of
the deficit in 2005 layer to reduce earnings
in 2006 layer #1 to 250u (300u¥50u)). Under
the principles of § 1.902–1(b)(3), all of the
taxes in each of those respective layers are
reduced. The remaining 50u is distributed
from foreign corporation A’s 2003 layer #1
(after rolling back the (200u) deficit in 2004
layer #1 to reduce earnings in 2003 layer #1
to 200u (400u¥200u)). Thus, after the
distribution, 150u remains in the 2003 layer
#1 along with 3.75u of foreign income taxes
(5u × (150u/200u)).
(C) Foreign surviving corporation’s foreign
income tax accounts are reduced to reflect
the distribution of earnings and profits
notwithstanding that no shareholders are
eligible to claim a credit for deemed paid
foreign income taxes under section 902. See
§ 1.902–1(a)(10)(iii).
(D) Immediately after the distribution,
foreign surviving corporation has the
following earnings and profits and foreign
income taxes:
Foreign
taxes
E&P
(E) Under paragraph (e)(2)(iii)(B) of
this section, the 60u, 10u, 50u, and 5u
of foreign income taxes related to
foreign surviving corporation’s 2005
layer, 2004 layer #1, 2004 layer #2, and
2003 layer #2, respectively, remain in
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18:48 Aug 07, 2006
Jkt 208001
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
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0u
60u
0u
0u
10u
50u
150u
0u
3.75u
5u
150u
sroberts on PROD1PC70 with RULES
2005 .................................................................................................................................................................................
Two Side-by-Side Layers of 2004 E&P:
2004 layer #1 ............................................................................................................................................................
2004 layer #2 ............................................................................................................................................................
Two Side-by-Side Layers of 2003 E&P:
2003 layer #1 ............................................................................................................................................................
2003 layer #2 ............................................................................................................................................................
128.75u
thus will be trapped. See § 1.902–
2(b)(2).
Example 4. (i) Facts. (A) The facts are the
same as in Example 2 (i)(A), except that on
December 31, 2006, foreign corporations A
and B have the following earnings and profits
and foreign income taxes:
E:\FR\FM\08AUR1.SGM
08AUR1
44908
Federal Register / Vol. 71, No. 152 / Tuesday, August 8, 2006 / Rules and Regulations
Foreign
Taxes
E&P
Foreign Corporation A:
Post-1986 pool .........................................................................................................................................................
2004 ..........................................................................................................................................................................
2003 ..........................................................................................................................................................................
(1,000u)
(200u)
400u
$20
10u
5u
(800u)
Foreign Corporation B:
2006
2005
2004
2003
..........................................................................................................................................................................
..........................................................................................................................................................................
..........................................................................................................................................................................
..........................................................................................................................................................................
of pre-1987 accumulated profits. Because
after the foreign section 381 transaction
foreign corporation A has an aggregate deficit
in pre-1987 accumulated profits, the rules of
paragraph (e)(2)(iii)(C) 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. The
(800u) aggregate deficit in foreign corporation
135u
A’s pre-1987 accumulated profits is a
hovering deficit that will offset only posttransaction earnings accumulated by foreign
surviving corporation in the general category.
Accordingly, after the foreign section 381
transaction, foreign surviving corporation has
the following earnings and profits and
foreign income taxes:
Earnings & profits
Positive
E&P
Hovering deficit from Corp A’s annual layers ..................................................................
Two Side-by-Side Layers of 2006 E&P:
2006 layer #1 (from Corp A’s pool) ..........................................................................
2006 layer #2 (from Corp B’s layer) .........................................................................
2005 (from Corp B) ..................................................................................................
Two Side-by-Side Layers of 2004 E&P:
2004 layer #1 (from Corp A) ....................................................................................
2004 layer #2 (from Corp B) ....................................................................................
Two Side-by-Side Layers of 2003 E&P:
2003 layer #1 (from Corp A) ....................................................................................
2003 layer #2 (from Corp B) ....................................................................................
20u
60u
50u
5u
450u
(B) On January 1, 2007, foreign corporation
A acquires the assets of foreign corporation
B in a reorganization described in section
368(a)(1)(C). Immediately following the
foreign section 381 transaction, foreign
surviving corporation is a nonpooling
corporation.
(ii) Result. (A) Under paragraph (e)(2)(i) of
this section, foreign corporation A’s post1986 pool is recharacterized as a 2006 layer
100u
300u
0u
50u
Deficit E&P
Foreign taxes
Foreign
taxes
available
Foreign
taxes
associated
deficit E&P
(800u)
....................
0
....................
100u
300u
0u
....................
....................
....................
20u
60u
$20
....................
....................
....................
0u
0u
....................
....................
50u
10u
....................
0u
50u
....................
....................
5u
5u
....................
....................
450u
(B) Under paragraph (e)(2)(iii)(C) of this
section, the $20, 10u, and 5u of pre-1987
foreign income taxes associated with foreign
corporation A’s pre-1987 accumulated profits
for 2006 layer #1, 2004 layer #1, and 2003
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
....................
(800u)
140u
....................
associated earnings pursuant to section
905(c), and thus will be trapped. See § 1.902–
2(b)(2).
(iii) Post-transaction distribution. (A)
During 2007, foreign surviving corporation
does not accumulate any earnings and profits
or pay or accrue any foreign income taxes.
On December 31, 2007, foreign surviving
corporation distributes 200u to its
shareholders. Under the rules described in
paragraph (e)(2)(iii)(C) of this section, no
distribution can be made out of the pre-1987
accumulated profits of foreign corporation A
(and the (800u) aggregate hovering deficit
will offset only post-transaction earnings
accumulated by foreign surviving
corporation). Thus, the distribution is out of
pre-pooling annual layers as follows:
E&P
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2006 layer #2 ...................................................................................................................................................................
2005 .................................................................................................................................................................................
Foreign
taxes paid
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08AUR1
20u
20u
200u
VerDate Aug<31>2005
100u
100u
40u
Federal Register / Vol. 71, No. 152 / Tuesday, August 8, 2006 / Rules and Regulations
(B) Foreign surviving corporation’s foreign
income tax accounts are reduced to reflect
the distribution of earnings and profits
notwithstanding that no shareholders are
eligible to claim deemed paid foreign income
taxes under section 902. See § 1.902–
1(a)(10)(iii).
(C) Immediately after the distribution,
foreign surviving corporation has the
following earnings and profits and foreign
income taxes:
Earnings & profits
Positive
E&P
Hovering deficit from Corp A’s annual layers ..................................................................
Two Side-by-Side Layers of 2006 E&P:
2006 layer #1 (from Corp A’s pool) ..........................................................................
2006 layer #2 (from Corp B’s layer) .........................................................................
2005 (from Corp B) ..................................................................................................
Two Side-by-Side Layers of 2004 E&P:
2004 layer #1 (from Corp A) ....................................................................................
2004 layer #2 (from Corp B) ....................................................................................
Two Side-by-Side Layers of 2003 E&P:
2003 layer #1 (from Corp A) ....................................................................................
2003 layer #2 (from Corp B) ....................................................................................
(f) Special rules—(1) Treatment of deficit—
(i) General rule. Any deficit described in
paragraph (d)(2), (e)(1)(iii), or (e)(2)(iii) of this
section shall not be taken into account in
determining current or accumulated earnings
and profits of a foreign surviving corporation
other than to offset post-transaction
accumulated earnings, as defined in
paragraph (d)(2)(ii) of this section, including
for purposes of calculating—
(A) The earnings and profits limitation of
section 952(c)(1)(A); and
(B) The amount of the foreign surviving
corporation’s subpart F income as defined in
section 952(a).
(ii) Exceptions. The rule in paragraph (i)
shall not apply for purposes of calculating an
earnings and profits limitation under section
952(c)(1)(B) or (C).
Deficit E&P
Foreign taxes
Taxes
avaialable
(800u)
....................
0
....................
0u
200u
0u
....................
....................
....................
0u
40u
$20
....................
....................
....................
0u
0u
....................
....................
50u
10u
....................
0u
50u
250u
....................
....................
(800u)
5u
5u
140u
....................
....................
....................
(iii) Examples. The following examples
illustrate the principles of this paragraph
(f)(1). The examples assume the following
facts: foreign corporation A, incorporated in
2002, is and always has been a wholly owned
subsidiary of USP, a domestic corporation.
Foreign corporation B, incorporated in 2004,
is and always has been a wholly owned
subsidiary of foreign corporation A. Both
foreign corporation A and foreign corporation
B are organized under the laws of foreign
country X and have always had a calendar
taxable year. Foreign corporations A and B
(and all of their respective qualified business
units as defined in section 989) maintain a
‘‘u’’ functional currency. Unless otherwise
stated, any earnings and profits or deficit in
earnings and profits of foreign corporation A
and B in the general category are attributable
to subpart F income derived from foreign
base company sales income. Foreign
corporation C is a wholly owned subsidiary
of USP2 and was organized in 2004 under the
laws of foreign country Y. Foreign
corporation C (and all of its qualified
business units as defined in section 989)
maintains a ‘‘u’’ functional currency.
Earnings and profits of foreign corporation C
in the general category are not attributable to
subpart F income. The examples are as
follows:
Example 1. (i) Facts. (A) On December 31,
2007, foreign corporations A and B have the
following post-1986 undistributed earnings
and post-1986 foreign income taxes:
Foreign Corporation A Separate Category:
General .....................................................................................................................................................................
Foreign Corporation B Separate Category:
General .....................................................................................................................................................................
all its property to foreign corporation A in a
liquidation described in section 332.
(ii) Result. Under the rules described in
paragraphs (d)(1) and (2) of this section,
foreign surviving corporation A has the
Foreign
taxes
Separate category
(100u)
$25
0u
$10
following post-1986 undistributed earnings
and post-1986 foreign income taxes:
Earnings & profits:
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Foreign
taxes
associated
with deficit
E&P
....................
E&P
(B) On January 1, 2008, foreign corporation
B elects under § 301.7701–3(c) of this chapter
to be disregarded as an entity separate from
foreign corporation A. Accordingly, foreign
corporation B is deemed to have distributed
44909
Positive
E&P
Hovering
deficit
Foreign
taxes
available
0u
(iii) Post-transaction earnings and subpart
F limitations. (A) In its taxable year ending
general category income with respect to
which it pays $50 in foreign income taxes.
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E:\FR\FM\08AUR1.SGM
08AUR1
$10
Foreign
taxes associated with
hovering
deficit
General ............................................................................................................................
on December 31, 2008, foreign surviving
corporation A earns 300u of subpart F
(100u)
Foreign taxes:
$25
44910
Federal Register / Vol. 71, No. 152 / Tuesday, August 8, 2006 / Rules and Regulations
The hovering deficit of (100u) meets the
requirements under section 952(c)(1)(B) and
therefore is taken into account as a qualified
deficit that may be used by USP to offset a
portion of its income inclusion related to
foreign surviving corporation A’s subpart F
income of 300u in the 2008 taxable year.
Accordingly, USP includes 200u in taxable
income for the year and is eligible for a
deemed paid foreign tax credit under section
960 of $40 (200u subpart F inclusion/300
post-1986 undistributed earnings in the
general category = 66.67%, × $60 foreign
income taxes in the general category = $40).
USP will also include the deemed paid
foreign taxes of $40 in taxable income for the
year as a deemed dividend pursuant to
section 78. Though the (100u) hovering
deficit of foreign surviving corporation A is
taken into account for purposes of limiting
USP’s subpart F income inclusion under
section 952(c)(1)(B), the amount of the
hovering deficit is not reduced for purposes
of sections 316 and 902 and none of the
associated foreign income taxes are included
in the post-1986 foreign income taxes pool.
(B) As of January 1, 2009, foreign surviving
corporation A has the following post-1986
undistributed earnings and post-1986 foreign
income taxes:
Earnings & profits
Separate category
Positive
E&P
General ............................................................................................................................
(C) The 200u included as subpart F income
constitutes previously taxed earnings under
section 959.
Example 2. (i) Facts. (A) On July 1, 2007,
foreign corporation B elects under
§ 301.7701–3(c) of this chapter to be
disregarded as an entity separate from foreign
Hovering
deficit
100u
corporation A. Accordingly, foreign
corporation B is deemed to have distributed
all of its property to foreign corporation A in
a liquidation described in section 332.
(B) Neither foreign corporation A nor B has
any post-1986 undistributed earnings or post1986 foreign income taxes as of the beginning
Foreign taxes
Foreign
taxes
available
(100u)
Foreign
taxes
associated
with
hovering
deficit
$20
$25
of the 2007 taxable year. For its short taxable
year ending on June 30, 2007, foreign
corporation B has the following post-1986
undistributed earnings and post-1986 foreign
income taxes:
FOREIGN CORPORATION B
Separate category
General ............................................................................................................................................................................
(C) For the 2007 taxable year, foreign
surviving corporation A earns a total of 200u
of subpart F foreign based company sales
income in the general category with respect
to which it pays $40 in foreign income taxes.
(ii) Result. (A) Under paragraph (d)(2) of
this section, foreign corporation B’s (200u)
deficit carries over to foreign surviving
corporation A as a hovering deficit.
Nevertheless, because it is a deficit of a
qualified chain member for a taxable year
ending within the 2007 taxable year of
foreign surviving corporation A, the (200u)
deficit meets the requirements under section
952(c)(1)(C) and therefore may still be taken
into account for purposes of limiting foreign
surviving corporation A’s subpart F income.
Accordingly, foreign surviving corporation
A’s 200u of subpart F income for the 2007
taxable year is fully offset by the (200u)
deficit of foreign corporation B, and USP will
have no subpart F income inclusion for the
2007 taxable year. The offset under section
952(c)(1)(C) does not result in a reduction of
the hovering deficit for purposes of section
316 or section 902. The hovering deficit may
not also be taken into account under section
952(c)(1)(B).
(B) Because USP has no subpart F income
inclusion, foreign surviving corporation A’s
subpart F earnings of 200u will accumulate
and be added to its post-1986 undistributed
earnings as of the beginning of 2008. Under
the rules of paragraph (f)(5) of this section,
a pro rata amount, in this case 50% or 100u,
will be deemed to have been accumulated
prior to the foreign section 381 transaction
and the other 50%, or 100u, will be deemed
Separate category
Positive
E&P
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General ............................................................................................................................
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18:48 Aug 07, 2006
Jkt 208001
100u
Hoverinig
deficit
(100u)
undistributed earnings and post-1986 foreign
income taxes:
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Fmt 4700
Sfmt 4700
(200u)
$30
to have been accumulated after the foreign
section 381 transaction. The 100u of posttransaction earnings will be offset by (100u)
of the hovering deficit for purposes of
determining the opening balance of the post1986 undistributed earnings pool in 2008.
Because the amount of earnings offset by the
hovering deficit is 50% of the total amount
of the hovering deficit, $15 (50% of $30) of
the related taxes are added to the post-1986
foreign income taxes pool as well. The 100u
of pre-transaction earnings remain in the
post-1986 undistributed earnings pool.
Accordingly, foreign surviving corporation A
has the following post-1986 undistributed
earnings and post-1986 foreign income taxes
on January 1, 2008:
Earnings & profits
Example 3. (i) Facts. (A) On January 1,
2007, foreign corporation B and foreign
corporation C have the following post-1986
Foreign
taxes
E&P
E:\FR\FM\08AUR1.SGM
08AUR1
Foreign taxes
Foreign
taxes
available
$55
Foreign
taxes
associated
with
hovering
deficit
$15
Federal Register / Vol. 71, No. 152 / Tuesday, August 8, 2006 / Rules and Regulations
Foreign
taxes
E&P
Foreign Corporation B Separate Category:
General .....................................................................................................................................................................
Foreign Corporation C Separate Category:
General .....................................................................................................................................................................
(B) On July 1, 2007, foreign corporation B
acquires the assets of foreign corporation C
in a reorganization described in section
368(a)(1)(C). Immediately following the
foreign section 381 transaction, foreign
surviving corporation B is a CFC.
(C) During the 2007 taxable year foreign
surviving corporation B has a current deficit
of (400u) and $60 of related foreign income
taxes. During its short taxable year ending on
June 30, 2007, foreign corporation C has no
additional earnings and pays or accrues no
foreign income taxes.
(ii) Result. (A) Under the rules of paragraph
(f)(5) of this section, a pro rata amount, in
this case 50% or (200u), of foreign surviving
corporation B’s (400u) current year deficit for
the 2007 taxable year will be deemed to have
been accumulated prior to the foreign section
381 transaction and be treated as a hovering
deficit. The other 50%, or (200u) of the
deficit will be deemed to have been
Separate category
Hovering
deficit
E&P
(iii) Subpart F income limitations. Even
though (200u) of the current year deficit is
treated as a hovering deficit, the full (400u)
current year deficit in 2007 of foreign
surviving corporation B meets the
requirements under section 952(c)(1)(C) and
therefore is available as a limitation on
subpart F income, to the extent foreign
corporation A, which wholly owns foreign
surviving corporation B, earns any subpart F
income in the 2007 taxable year. Any such
offset under section 952(c)(1)(C) will have no
effect on the earnings and profits and foreign
income tax accounts above of foreign
surviving corporation B for purposes of
sections 316 and 902. Moreover, to the extent
the hovering deficit reduces subpart F
income under section 952(c)(1)(C), it may not
also be taken into account under section
952(c)(1)(B).
(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
(e)(1)(ii) and (e)(2)(ii) of this section
shall apply with respect to the taxable
years that end within the same calendar
year.
(200u)
(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
pooling 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
were recharacterized as pre-1987
accumulated profits and pre-1987
foreign income taxes, respectively,
under paragraph (e)(2)(i) of this section
retain their characterization as a prepooling annual layer.
(4) Ordering rule for multiple hovering
deficits—(i) Rule. A foreign surviving
corporation shall apply the deficit rules
of paragraphs (d)(2), (e)(1)(iii), and
(e)(2)(iii) of this section in that order if
more than one of such rules applies to
the foreign surviving corporation.
(ii) Example. The following example
illustrates the principles of this
paragraph (f)(4). The example assumes
the following facts: Foreign corporation
A has been a pooling corporation since
(100u)
$0
0u
$10
accumulated after the foreign section 381
transaction. The related foreign income taxes
of $60 will also be allocated on a similar 50/
50 basis.
(B) Under the rules described in
paragraphs (d)(1) and (2) of this section,
foreign surviving corporation B has the
following post-1986 undistributed earnings
and post-1986 foreign income taxes as of
January 1, 2008:
Earnings & profits
General ............................................................................................................................
Foreign taxes
Foreign
taxes
available
(300u)
$40
Foreign
taxes
assoicated
with
hovering
deficit
$30
its incorporation on January 1, 1998.
Foreign corporation B has been a
nonpooling corporation since its
incorporation on January 1, 2000.
Foreign corporations A and B have
always 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. All earnings
and profits of foreign corporation B are
in the general category. Finally, unless
otherwise stated, any earnings and
profits in the passive category resulted
from a look-through dividend that was
paid by a lower-tier CFC out of earnings
accumulated when the CFC was a
noncontrolled section 902 corporation
and that qualified for the subpart F
same-country exception under section
954(c)(3)(A). The example is as follows:
Example—(i) Facts. (A) On December 31,
2006, foreign corporations A and B have the
following earnings and profits and foreign
income taxes:
E&P
Foreign Corporation A Post-1986 Pool Separate Category:
Passive .....................................................................................................................................................................
General .....................................................................................................................................................................
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Foreign
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$160
25
100u
Foreign Corporation B:
2006 ..........................................................................................................................................................................
2005 ..........................................................................................................................................................................
400u
(300u)
185
(300u)
100u
50u
25u
44912
Federal Register / Vol. 71, No. 152 / Tuesday, August 8, 2006 / Rules and Regulations
E&P
Foreign
taxes
(200u)
(B) On January 1, 2007, foreign corporation
B acquires the assets of foreign corporation
A in a reorganization described in section
368(a)(1)(C). Immediately following the
foreign section 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),
75u
and (e)(1)(iii) of this section, foreign
surviving corporation has the following
earnings and profits and foreign income
taxes:
Earnings & profits
Foreign taxes
Positive
E&P
(iii) Post-transaction earnings. (A) In the
taxable year ending on December 31, 2007,
foreign surviving corporation accumulates
Foreign
taxes
availabe
Foreign
taxes associated with
hovering
deficit
400u
....................
....................
0u
0u
....................
(300u)
(200u)
....................
....................
$160
....................
....................
50u
25u
....................
$25
0
....................
....................
400u
Post-1986 pool separate category:
Passive .....................................................................................................................
General .....................................................................................................................
Carryforward pre-pooling deficit from Corp B ..........................................................
2006 (from Corp B) ..................................................................................................
2005 (from Corp B) ..................................................................................................
Hovering
deficit
(500u)
....................
$25
earnings and profits and pays related foreign
income taxes as follows:
E&P
Post-1986 pool separate category:
Passive .....................................................................................................................................................................
General .....................................................................................................................................................................
Foreign
taxes
are first offset by a hovering deficit in the
same separate category in the post-1986 pool.
Thus, foreign surviving corporation’s (300u)
deficit in the general category offsets 300u of
post-transaction earnings in the general
category. After application of paragraph
(d)(2) of this section, the (200u) deficit in the
$40
60
550u
(B) None of the earnings and profits qualify
as subpart F income as defined in section
952(a). Under paragraph (f)(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, posttransaction earnings in a separate category
150u
400u
100
general category carried forward from foreign
corporation B’s pre-pooling aggregate deficit
offsets the remaining 100u of post-transaction
earnings in the general category.
Accordingly, foreign surviving corporation
has the following earnings and profits and
foreign income taxes at the end of 2007:
Earnings & profits
Foreign taxes
Foreign
taxes
associated
with hovering deficit
Positive
E&P
sroberts on PROD1PC70 with RULES
(C) Under paragraph (d)(2)(iii) of this
section, all of the $25 of post-1986 foreign
income taxes related to the (300u) hovering
deficit in the general category is added to the
foreign surviving corporation’s post-1986
foreign income taxes of $60 in that category
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Foreign
taxes
available
550u
....................
....................
0u
0u
....................
....................
(100u)
....................
....................
$200
$85
....................
50u
25u
$0
550u
Post-1986 pool separate category:
Passive .....................................................................................................................
General .....................................................................................................................
Carryforward pre-pooling deficit from Corp B .................................................................
2006 (from Corp B) ..........................................................................................................
2005 (from Corp B) ..........................................................................................................
Hovering
deficit
(100u)
....................
$0
(because post-transaction earnings in the
general category have exceeded the deficit in
that category). Under paragraph (e)(1)(iii)(C)
of this section, the 50u and 25u of foreign
income taxes associated with foreign
corporation B’s pre-1987 accumulated profits
PO 00000
Frm 00030
Fmt 4700
Sfmt 4700
for 2006 and 2005 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
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Federal Register / Vol. 71, No. 152 / Tuesday, August 8, 2006 / Rules and Regulations
905(c), and thus will be trapped. See § 1.902–
2(b)(2).
(5) Pro rata rule for earnings and
deficits during transaction year. (i) For
purposes of offsetting post-transaction
earnings of a foreign surviving
corporation under the rules described in
paragraphs (d)(2), (e)(1)(iii), and
(e)(2)(iii) of this section, the earnings
and profits, and any related foreign
income taxes, in each separate category
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).
(ii) For purposes of determining the
amount of pre-transaction deficits
described in paragraphs (d)(2), (e)(1)(iii),
and (e)(2)(iii) of this section, of a foreign
surviving corporation that has a deficit
in earnings and profits in any separate
category for its taxable year in which the
transaction occurs, unless the actual
accumulated earnings and profits, or
deficit, as of such date can be shown,
such pre-transaction deficit, and any
related foreign income taxes, shall be
deemed to have accumulated in a
manner similar to that described in
paragraph (f)(5)(i) of this section. See,
e.g., § 1.381(c)(2)–1(a)(7) Example 4
(illustrating application of this rule with
respect to domestic corporations).
(g) Effective date. This section shall
apply to section 367(b) transactions that
occur on or after November 6, 2006.
I Par. 8. Section 1.367(b)–8 is added
and reserved to read as follows:
§ 1.367(b)–8 Allocation of earnings and
profits and foreign income taxes in certain
foreign corporate separations. [Reserved]
I Par. 9. 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 a
foreign section 381 transaction (as
defined in § 1.367(b)–7(a)) either—
(1) That is described in section
368(a)(1)(F); or
(2) That involves—
(i) At least one foreign corporation
that holds no property and has no tax
attributes immediately before the
transaction, other than a nominal
44913
amount of assets (and related tax
attributes) to facilitate its organization
or preserve its existence as a
corporation; and
(ii) No more than one foreign
corporation that holds more than a
nominal amount of property or has more
than a nominal amount of tax attributes
immediately before the transaction.
(b) Hovering deficit rules
inapplicable. If a transaction is
described in paragraph (a) of this
section, a foreign surviving 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), and (e)(2)(iii).
(c) Foreign divisive transactions.
[Reserved]
(d) Examples. The following examples
illustrate the principles of this section:
Example 1. (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 1995, and has always had 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. On December 31,
2006, foreign corporation A has the following
post-1986 undistributed earnings and post1986 foreign income taxes:
Separate Category
E&P
Passive ............................................................................................................................................................................
General ............................................................................................................................................................................
Foreign
taxes
(ii) Result. Under § 1.367(b)–7(d), as
modified by paragraph (b) of this section, the
pre-transaction deficit of foreign corporation
A will not hover. Accordingly, foreign
$5
200
(800u)
(B) On January 1, 2007, foreign corporation
A moves its place of incorporation from
Country 1 to Country 2 in a reorganization
described in section 368(a)(1)(F).
(1,000u)
200u
205
surviving corporation has the following post1986 undistributed earnings and post-1986
foreign income taxes immediately after the
foreign section 381 transaction:
Separate category
E&P
Passive ............................................................................................................................................................................
General ............................................................................................................................................................................
Foreign
taxes
sroberts on PROD1PC70 with RULES
2001. Foreign corporation B does not own
any significant property and has no earnings
and profits or foreign income taxes accounts.
Both foreign corporations C and D have
always had a calendar taxable year. Foreign
corporations C and D (and all of their
$5
200
(800u)
Example 2. (i) Facts. (A) Foreign
corporations B, C and D are and always have
been wholly owned subsidiaries of USP, a
domestic corporation. Foreign corporation B
was incorporated in 2000 and foreign
corporations C and D were incorporated in
(1,000u)
200u
205
respective qualified business units as defined
in section 989) maintain a ‘‘u’’ functional
currency. On December 31, 2006, foreign
corporations C and D have the following
post-1986 undistributed earnings and post1986 foreign income taxes:
E&P
Foreign corporation C Separate Category:
Passive .....................................................................................................................................................................
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(900u)
Foreign
taxes
$50
44914
Federal Register / Vol. 71, No. 152 / Tuesday, August 8, 2006 / Rules and Regulations
Foreign
taxes
E&P
General .....................................................................................................................................................................
corporation with no property or tax
attributes, paragraph (b) of this section does
not apply because more than one foreign
corporation with significant tax attributes is
involved in the foreign section 381
transaction. Accordingly, under § 1.367(b)-
Positive
E&P
General ............................................................................................................................
Passive ............................................................................................................................
1200u
400u
400
100
500
7(d), foreign surviving corporation B has the
following post-1986 undistributed earnings
and post-1986 foreign income taxes
immediately after the foreign section 381
transaction:
Earnings & profits
Separate Category
150
1600u
(B) On January 1, 2007, USP foreign
corporations C and D merge into foreign
corporation B in a reorganization described
in section 368(a)(1)(A).
(ii) Result. Although the merger is a foreign
section 381 transaction involving a foreign
100
(1100u)
Foreign corporation D Separate Category:
Passive .....................................................................................................................................................................
General .....................................................................................................................................................................
(200u)
Hovering
deficit
Foreign taxes
Foreign
taxes available
Foreign
taxes associated with
hovering
deficit
Par. 10. In § 1.381(a)–1, paragraph (c)
is revised to read as follows:
I
§ 1.381(a)–1 General rule relating to
carryovers in certain corporate
acquisitions.
*
BILLING CODE 4830–01–P
$50
100
(1100u)
500
150
DEPARTMENT OF HOMELAND
SECURITY
Coast Guard
33 CFR Part 117
Drawbridge Operation Regulations;
Gulf Intracoastal Waterway, Galveston,
TX
Coast Guard, DHS.
Notice of temporary deviation
from regulations.
AGENCY:
ACTION:
SUMMARY: The Commander, Eighth
Coast Guard District, has issued a
temporary deviation from the regulation
governing the operation of the Galveston
Causeway Railroad Bascule Bridge
across the Gulf Intracoastal Waterway,
mile 357.2 west of Harvey Locks, at
Galveston, Galveston County, Texas.
This deviation provides for two (2)
three-hour closures to conduct
scheduled maintenance to the
drawbridge.
This deviation is effective from
7 a.m. until 4 p.m. on Wednesday,
August 16, 2006.
ADDRESSES: Materials referred to in this
document are available for inspection or
copying at the office of the Eighth Coast
Guard District, Bridge Administration
Branch, Hale Boggs Federal Building,
DATES:
sroberts on PROD1PC70 with RULES
$400
100
[CGD08–06–024]
*
*
*
*
(c) Foreign corporations. For
additional rules involving foreign
corporations, see §§ 1.367(b)–7 through
1.367(b)–9.
*
*
*
*
*
Mark E. Matthews,
Deputy Commissioner for Services and
Enforcement.
Approved: July 20, 2006.
Eric Solomon,
Acting Deputy Assistant Secretary (Tax
Policy).
[FR Doc. 06–6740 Filed 8–7–06; 8:45 am]
(900u)
(200u)
1600u
(e) Effective date. This section shall
apply to section 367(b) transactions that
occur on or after November 6, 2006.
1200u
400u
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room 1313, 500 Poydras Street, New
Orleans, Louisiana 70130–3310 between
7 a.m. and 3 p.m., Monday through
Friday, except Federal holidays. The
telephone number is (504) 671–2128.
The Bridge Administration Branch of
the Eighth Coast Guard District
maintains the public docket for this
temporary deviation.
FOR FURTHER INFORMATION CONTACT:
David Frank, Bridge Administration
Branch, telephone (504) 671–2129.
SUPPLEMENTARY INFORMATION: The
Burlington Northern Railway Company
has requested a temporary deviation
from the bridge operating requirements
of 33 CFR 117.5 in order to perform
necessary maintenance on the rail joints
of the Galveston Causeway Railroad
Bascule Bridge across the Gulf
Intracoastal Waterway, mile 357.2 west
of Harvey Locks, at Galveston,
Galveston County, Texas. The
maintenance is essential for the
continued safe operation of the railroad
bridge. This temporary deviation will
allow the bridge to remain in the closedto-navigation position from 7 a.m. until
10 a.m. and from 1 p.m. until 4 p.m. on
Wednesday, August 16, 2004.
The bridge has a vertical clearance of
10 feet above mean high water in the
closed-to-navigation position.
Navigation at the site of the bridge
consists mainly of tows with barges and
some recreational pleasure craft. Due to
E:\FR\FM\08AUR1.SGM
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Agencies
[Federal Register Volume 71, Number 152 (Tuesday, August 8, 2006)]
[Rules and Regulations]
[Pages 44887-44914]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 06-6740]
=======================================================================
-----------------------------------------------------------------------
DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[TD 9273]
RIN 1545-AX65
Stock Transfer Rules: Carryover of Earnings and Taxes
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Final regulations.
-----------------------------------------------------------------------
SUMMARY: This document contains final regulations addressing the
carryover of certain tax attributes, such as earnings and profits and
foreign income tax accounts, when two corporations combine in a
corporate reorganization or liquidation that is described in both
section 367(b) and section 381 of the Internal Revenue Code (Code).
DATES: Effective Date: These regulations are effective August 8, 2006.
Applicability Date: These regulations apply to certain section
367(b) exchanges that occur on or after November 6, 2006.
FOR FURTHER INFORMATION CONTACT: Jeffrey L. Parry at (202) 622-3850
(not a toll-free number).
SUPPLEMENTARY INFORMATION:
Background
The Treasury Department and the IRS issued final regulations
''1.367(b)-1 through 1.367(b)-6, dealing with tax consequences of
certain foreign-to-foreign and inbound corporate transactions, in June
1998 and January 2000 (the January 2000 final regulations). The
preamble to the January 2000 final regulations referred to proposed
regulations that would be issued to address the carryover of certain
corporate tax attributes in transactions involving one or more foreign
corporations. Those proposed regulations were issued on November 15,
2000, in the Federal Register ((65 FR 69138) (REG-116050-99)) (the 2000
proposed regulations). The public hearing with respect to the 2000
proposed regulations was cancelled because no request to speak was
received. However, the Treasury Department and the IRS received and
considered several written comments, which are discussed in this
preamble.
After consideration of the 2000 proposed regulations and the
comments received, the Treasury Department and the IRS adopt
substantial portions of those proposed regulations with significant
modifications as final regulations under section 367(b).
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
Subchapter C 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.
The Subchapter C carryover provisions generally are drafted to
apply to domestic corporations and U.S. shareholders. As a result,
those provisions often do not fully take into account the relevant
cross-border aspects of U.S. taxation. For example, section 381 does
not specifically 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. A
primary consideration in this regard is 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 more comprehensive statutory regime. H.R. Rep. No. 658, 94th Cong.,
1st 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.''
These final regulations address the carryover of foreign earnings
and profits and foreign income taxes in tax-free corporate asset
acquisitions by generally applying the principles of Subchapter C
provisions such as section 381, which governs the carryover of earnings
and profits (and other tax attributes) in certain tax-free corporate
reorganizations described in section 368 and in corporate liquidations
described in section 332. However, these regulations (like the 2000
proposed regulations) modify certain of the mechanics of the Subchapter
C rules as necessary or appropriate to ensure that those rules are as
consistent as possible with key international tax policies of the Code
and to prevent material distortions of income.
These final regulations address the portions of the 2000 proposed
regulations (Prop. Reg.) dealing with inbound nonrecognition
transactions (Prop. Reg. Sec. 1.367(b)-3) and foreign section 381
transactions (Prop. Reg. Sec. 1.367(b)-7). They also address the
special rules of Prop. Reg. Sec. 1.367-9. The final regulations,
however, do not address the portions of the 2000 proposed regulations
involving corporate divisions of one or more foreign corporations
(Prop. Reg. Sec. 1.367(b)-8). The Treasury Department and the IRS
believe that relevant cross-border tax consequences of section 355
transactions should be dealt with in a separate guidance project.
[[Page 44888]]
B. Specific Policies Related to Inbound Nonrecognition Transactions
(Sec. 1.367(b)-3)
Section 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 an A, C, D, or F
reorganization (inbound nonrecognition transaction). Regulations
applying section 367 and section 368 to cross-border A reorganizations
were recently issued. See TD 9242 (2006-7 I.R.B. 422).
As a general policy matter, the importation of various tax
attributes in inbound transactions is carefully scrutinized. In fact,
inbound importation issues have been the subject of recent legislative
reforms (see section 362(e)). The policy relating to importation of tax
attributes also has been reflected in prior section 367 regulations.
For example, the preamble to the January 2000 final regulations
generally describes international policy issues that can arise in
inbound nonrecognition transactions. 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 January 2000 final regulations clarify that a domestic acquiring
corporation succeeds to those foreign taxes paid or accrued by a
foreign target corporation only to the extent those taxes are eligible
for credit under section 906.
The preamble to the January 2000 final regulations also notes that
it would be consistent with the policy considerations of section 367(b)
for future regulations to provide additional rules with respect to the
extent to which attributes carry over from a foreign corporation to a
U.S. corporation. Accordingly, the 2000 proposed regulations provided
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 2000 proposed regulations generally
provided 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 with a U.S. trade or business (or
attributable to a permanent establishment, in the case of an applicable
U.S. income tax treaty). These final regulations adopt the rules set
forth in the 2000 proposed regulations.
C. Specific Policies Related to Foreign Section 381 Transactions (Sec.
1.367(b)-7)
Section 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 section 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). These rules apply, for example, to A, C, D, or
F reorganizations or section 332 liquidations between two foreign
corporations.
The principal Code sections implicated by the carryover of earnings
and profits and foreign income taxes in a foreign section 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.
Section 381(c)(2)(B). This is commonly known as the ``hovering deficit
rule''. 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, for example, Commissioner v.
Phipps, 336 U.S. 410 (1949) final regulations generally adopt the
principles of section 381 in the cross-border context, but adapt the
operation of those rules in consideration of the international
provisions, such as sections 902, 904, and 959, that address foreign
corporations' earnings and profits and their related foreign income
taxes. Thus, for example, these final regulations apply the section 381
earnings and profits combination and deficit rules by reference to the
separate categories income described in section 904(d) and elsewhere
(baskets) that are used to compute foreign tax credit limitations.
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. The Code computes deemed-paid taxes with regard to
dividends from a relevant foreign corporation by looking first to the
multi-year pools of earnings and profits accumulated (and related
foreign income taxes paid or deemed paid) in taxable years beginning
after December 31, 1986, or beginning with the first year in which a
domestic corporation owns 10 percent or more of the voting stock of the
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 not begin to maintain
multi-year pools until after 1986. Sections 902(c)(1) and (2), Sec.
1.902-1(a)(8) and (9).)
Congress enacted the pooling rules because it believed that
blending foreign income taxes and earnings and profits into ``pools''
from which distributions are made was fairer and more appropriate than
computing deemed-paid taxes with reference to annual layers of earnings
and profits (and foreign income taxes). Joint Committee on Taxation,
99th Cong., 2nd sess., General Explanation of the Tax Reform Act of
1986 (JCS-10-87) (1986 Bluebook), at 870 (May 4, 1987). Averaging
foreign income taxes through these blended pools prevents taxpayers
from inflating their foreign subsidiary's effective tax rate for a
particular year in order to obtain artificially enhanced foreign tax
credits. Id. Averaging also prevents the loss of credits for foreign
income taxes that are trapped in years in which a foreign subsidiary
has no earnings and profits for U.S. tax purposes. Id.
However, Congress enacted pooling on a limited basis. Earnings and
profits accumulated (and related foreign income taxes paid or deemed
paid) in taxable years before the first year a foreign corporation
qualifies as a pooling corporation and pre-1987 earnings and profits
accumulated (and related foreign income taxes paid or deemed paid) by a
pooling corporation are not subject to the pooling rules. 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
[[Page 44889]]
though a particular corporation may have annual layers for years after
1986 (because of the absence of the requisite domestic corporate
shareholder). Section 902(c)(6); Sec. 1.902-1(a)(10).
A distribution of earnings and profits is treated as 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 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 baskets
of income derived from different types of activities. (From 1987
through 2006, section 904 provides for eight different baskets of
income; for tax years beginning after December 31, 2006, all but two
section 904(d) baskets of income are eliminated. Separate baskets
described in other Code sections such as sections 56(g)(4)(C)(iii)(IV),
245(a)(10), 865(h), 901(j), and 904(g)(10) will continue in effect
after 2006. The American Jobs Creation Act of 2004, Public Law 108-357,
118 Stat. 1418 (AJCA), section 404(a).) The purpose of the baskets is
to limit taxpayers' ability to cross-credit taxes imposed with respect
to different categories of income. Congress was concerned that, without
separate limitations, cross-crediting opportunities would distort
economic incentives as to whether to invest in the United States or
abroad. 1986 Bluebook at 862.
Another international provision implicated by the movement of
earnings and profits in foreign section 381 transactions is section
959. Section 959 governs the distribution of earnings and profits that
represent income that has 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 Treasury Department and the IRS
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 Treasury Department and the IRS have opened a
separate regulations project under section 959 and expect to issue
regulations that address PTI issues under section 959 in the future.
Because this project is still ongoing, these final regulations reserve
on section 367(b) issues related to PTI. Guidance in this area will
come in a separate project.
Summary of Comments Received and Changes Made
A. Inbound Nonrecognition Transactions
A comment was received regarding the provision under the 2000
proposed regulations that limits the carryover of earnings and profits
(or deficit in earnings and profits) from a foreign corporation to a
domestic corporation in an inbound nonrecognition transaction to those
earnings and profits that are effectively connected with the conduct of
a trade or business within the United States (or are attributable to a
permanent establishment in the United States, in the context of an
applicable U.S. income tax treaty). The comment suggests that there are
better ways to avoid the two most significant problems of importing
foreign earnings into domestic corporate solution: Potential dividends-
received deductions on subsequent distribution of the previously
untaxed foreign earnings, and taxing distributions of previously taxed
earnings and profits described in section 959. The comment goes on to
state that, in particular, eliminating deficits but taxing positive
earnings on an inbound nonrecognition transaction by way of the all
earnings and profits inclusion under Sec. 1.367(b)-3 is inappropriate.
The Treasury Department and the IRS have considered this comment.
While the comment identifies asymmetries in the tax treatment of
inbound reorganizations, on balance the Treasury Department and the IRS
believe that the 2000 proposed regulations reached the appropriate
result. As indicated above, the importation of favorable tax attributes
has been subject to greater scrutiny in recent years. See, for example,
section 362(e). In that context, it is not appropriate to provide for
the carryover of deficits or of earnings and profits in excess of the
all earnings and profits inclusion. This conclusion also has the
benefit of administrative ease for taxpayers and the IRS. Accordingly,
these final regulations do not modify the rules regarding inbound
nonrecognition transactions as set forth in the 2000 proposed
regulations, except to reserve on the treatment of PTI for further
consideration.
B. Paradigm Based on Pooling Rather Than Look-Through
The structure of the 2000 proposed regulations was based in large
part on the categorization of foreign acquiring, target, and surviving
corporations as look-through corporations, non-look-through
corporations, or less-than-10%-U.S.-owned foreign corporations. Under
the international provisions of the Code in effect at the time the 2000
proposed regulations were published, a look-through-corporation
included a controlled foreign corporation as defined in section 957
(CFC) or a noncontrolled section 902 corporation as defined in section
904(d)(2)(E) after 2003 (a look-through 10/50 corporation), the
effective date of section 1105(b) of Public Law 105-34 (111 Stat. 788)
(the 1997 Act). A non-look-through corporation was a noncontrolled
section 902 corporation before 2003 (non-look-through 10/50
corporation) and a less-than-10%-U.S.-owned foreign corporation was a
foreign corporation that was neither a CFC nor a 10/50 corporation.
The pools of earnings and profits and foreign taxes associated with
these three categories of corporations were referred to as the look-
through pool, the non-look-through pool, and the pre-pooling annual
layers, respectively. A number of statutory and regulatory changes that
have occurred since the time the 2000 proposed regulations were
published, however, have necessitated appropriate changes (and
simplification) in the organizational paradigm for these final
regulations.
At the time the 2000 proposed regulations were issued (and
continuing prior to the AJCA), the treatment of dividends from a 10/50
corporation paid after 2002 varied according to the year in which the
earnings and profits from which the dividend was paid were accumulated.
The look-through approach applied to dividends paid out of earnings and
profits accumulated after 2002, whereas dividends paid out of earnings
and profits accumulated prior to 2003 were subject to a single separate
limitation for dividends from all 10/50 corporations. Joint Committee
on Taxation, 105th Cong., 1st sess., General Explanation of Tax
Legislation enacted in 1997 (JCS-23-97), at 303 (December 17, 1997).
The AJCA conference report indicates that Congress changed the
treatment of dividends from 10/50 corporations for purposes of
simplification. H.R. Rep. No. 108-548, pt. 1 at 192 (2004).
In 2004, Congress amended the Code (the 2004 amendment) to provide
that any dividend paid by a noncontrolled section 902 corporation (10/
50 corporation), as defined in section 904(d)(2)(E), to a 10 percent or
greater U.S. corporate shareholder is treated as income in a basket
based on the ratio of the earnings and profits attributable to income
in such basket to the foreign
[[Page 44890]]
corporation's total earnings and profits (the ``look-through''
approach). AJCA, section 403. The 2004 amendment was effective
retroactively, 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), permitted taxpayers to elect to defer the
effective date of the 2004 amendment to taxable years beginning after
December 31, 2004.
Also, as part of the 2004 amendment, dividends paid to 10% domestic
corporate shareholders of a CFC are eligible for look-through
treatment, even if they are paid out of earnings that were accumulated
while the corporation was not a CFC. Section 904(d)(4); see also Sec.
1.904-7T(f)(3) and (6). Prior to the effective date of the 2004
amendment, dividends paid out of such earnings were subject to a
separate limitation. See 26 CFR 1.904-4(g)(2)(ii) (revised as of April
1, 2006).
As a result of the 2004 amendment, the terms non-look-through 10/50
corporation and the related non-look-through pool as defined in the
2000 proposed regulations have become obsolete and therefore have been
eliminated in these final regulations. More generally, in light of the
broader availability of look-through treatment to earnings paid out of
pre-pooling annual layers, the Treasury Department and the IRS believe
that a paradigm centered on look-through or non-look-through status is
less relevant. Accordingly, the organization of these final regulations
is based on the categorization of foreign acquiring, target, and
surviving corporations as pooling or nonpooling corporations. The
relevant pools of earnings and profits and associated foreign taxes are
referred to as post-1986 pools and pre-pooling annual layers.
Qualifying shareholders are eligible for look-through treatment on
dividends out of post-1986 pools and pre-pooling annual layers to the
extent provided in section 904(d)(3) and (4).
C. Hovering Deficits and Section 316
Comments were received regarding the application under the 2000
proposed regulations of the hovering deficit rules on a ``basket-by-
basket'' basis. Under the 2000 proposed regulations, a pre-transaction
deficit in a particular basket is generally subject to the hovering
deficit rule of section 381. As a result, that deficit is not taken
into account in determining the current or accumulated earnings and
profits of the surviving corporation for any purpose, including for
purposes of determining dividends under section 316 and for determining
foreign tax credits under section 902. However, any such pre-
transaction deficits in earnings and profits may be used to offset a
foreign surviving corporation's accumulated (but not current) post-
transaction earnings and profits in the same basket as the deficit.
Several comments noted that, in certain circumstances, this rule
can give rise to hovering deficits from one (or both) of the merging
corporations even if it (or they) had aggregate positive earnings and
profits immediately prior to the section 381 transaction. In addition,
if one (or both) of the merging corporations' pre-transaction earnings
consist both of positive earnings in one basket and a deficit in
another basket, the earnings and profits of that corporation available
to support a dividend under section 316 will increase solely as a
result of entering into the section 381 transaction. This is because
the hovering deficit will no longer offset the positive earnings in the
other basket for purposes of section 316. As a result, even if a
corporation has an aggregate deficit in earnings and profits, any
positive baskets of earnings will be able to support the distribution
of a dividend immediately after the transaction.
The comments contend that the prohibition described above against
the use of an earnings and profits deficit in one basket from
offsetting positive earnings and profits in another basket can produce
results that are inconsistent with the result of applying a pure
section 381(c)(2)(B) approach in determining the amount of a
distribution that is a ``dividend'' under section 316, and more
generally are inconsistent with the principles and legislative history
of the section 381(c)(2)(B) hovering deficit rule, which was adopted to
preserve, but not create, the taxation of distributions by corporations
that engage in tax-free reorganizations or liquidations.
To address these concerns, the comments requested that (among other
things) the proposed regulations be modified to conform to the
principles contained in Notice 88-71 (1988-2 C.B. 374), and Sec.
1.960-1(i)(4), which pro-rate an earnings and profits deficit in one
basket against positive earnings and profits in other baskets for
purposes of computing post-1986 undistributed earnings under section
902. It was also requested that the rules under Sec. 1.960-1(i)(4)
should be modified for purposes of the hovering deficit rules to
eliminate the ``springing'' effect of an earnings and profits deficit.
Section 1.960-1(i)(4) provides that a deficit in any basket does not
permanently reduce earnings in other baskets, but after the deemed-paid
taxes are computed, the deficit reverts to and is carried forward in
the same basket in which it was incurred. It was asserted in the
comments that once a hovering deficit is used to reduce earnings in
another basket, it should not revert to its original basket in a
subsequent taxable year because this deficit reincarnation results in
unnecessary complexity in the calculation of earnings and profits.
The Treasury Department and the IRS have carefully considered these
comments. After this consideration, they have concluded that the
arguments in these comments ultimately are not persuasive. The purpose
of the hovering deficit rule in the domestic context is to prevent
trafficking in deficits in earnings and profits. Absent this rule, a
corporation with positive earnings and profits could acquire or be
acquired by another corporation with a deficit in earnings and profits
and immediately reduce the amount of its positive earnings and profits,
thereby reducing the amount of potentially taxable distributions.
In transactions involving foreign corporations, similar concerns
exist regarding the possibility of trafficking in deficits in earnings
and profits. In light of the foreign tax credit rules, unique tax
benefits may arise from combining positive and deficit earnings and
profits of different foreign corporations. 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 categorization of earnings and profits according to the pooling
and basket 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. The Treasury
Department and the IRS believe that these issues merit targeted
differences in the application of the hovering deficit rule in this
context. Accordingly, these final regulations retain the provisions of
the 2000 proposed regulations that apply the hovering deficit rule on a
basket-by-basket basis.
The final regulations also include a clarification that post-
transaction earnings and profits that may be offset by hovering
deficits do not include earnings and profits that are distributed or
deemed distributed in the same taxable year that they are earned. That
is, the hovering deficit rule does not permit deficits to be offset
against post-
[[Page 44891]]
transaction earnings and profits until those earnings and profits
become accumulated (as opposed to current) for tax purposes. This rule
is consistent with a similar provision in the hovering deficit
regulations under section 381. See Sec. 1.381(c)(2)-1(a)(5).
D. Hovering Deficits and Section 902
Under section 902, the amount of foreign taxes that are deemed paid
by a 10% domestic corporate shareholder receiving dividends from a
foreign corporation is equal to the foreign corporation's post-1986
foreign income taxes multiplied by a fraction, the numerator of which
is the amount of the dividend, and the denominator of which is the
foreign corporation's post-1986 undistributed earnings. Post-1986
undistributed earnings include both accumulated and current year
earnings and deficits, not taking into account current year
distributions. The section 902 calculation is done on a basket-by-
basket basis. The 2000 proposed regulations provide that a pre-
transaction deficit will only be taken into account for purposes of
determining the accumulated earnings and profits of the surviving
corporation in the section 902 denominator to the extent of post-
transaction earnings that are accumulated in the same basket as the
deficit.
A comment was made requesting that the hovering deficit rule not
apply for purposes of computing deemed-paid credits under section 902,
particularly in the determination of accumulated earnings and profits
in the denominator of the section 902 fraction. Under this approach,
the effect of the inclusion of an otherwise hovering deficit on the
section 902 calculation could be beneficial or detrimental to the
taxpayer, depending on the particular taxpayer's facts. For example,
the suggested approach would be detrimental to taxpayers if the
unrestricted use of the otherwise hovering deficit reduced the
denominator of the section 902 fraction to or below zero. See Sec.
1.902-1(b)(4) (providing that no taxes are deemed paid with respect to
a ``nimble dividend'' if post-1986 undistributed earnings are zero or
less than zero). The rationale offered for this request is that it
would more properly follow the intent of Congress when it amended
section 902 in 1986 to average earnings and profits and foreign taxes
under a pooling method.
After consideration of the comment, the Treasury Department and the
IRS have concluded that it would not be appropriate to allow a pre-
transaction hovering deficit from one corporation to offset pre-
transaction earnings and profits of another corporation for purposes of
determining the denominator of the section 902 fraction. Such an offset
could increase the ratio of foreign taxes to earnings and profits in
the pool and thereby in certain cases could ``supercharge'' the amount
of foreign taxes that could be drawn out by a given distribution. The
Treasury Department and the IRS believe this is not an appropriate
result and could encourage taxpayers to enter into section 381
transactions to take advantage of the distortion that would result from
accelerating foreign tax credits in certain cases. It is also possible
that such a rule could be detrimental to taxpayers by otherwise denying
them access to creditable foreign income taxes if their section 902
denominator were eliminated. Moreover, the comment would further
complicate an already complex area by mandating one set of hovering
deficit treatment and calculations of earnings for section 316 and
another for section 902.
An alternative request was made to the effect that, if the hovering
deficit rule is retained, it should be modified to allow a pre-
transaction earnings and profits deficit to offset the surviving
corporation's post-transaction current year earnings and profits for
purposes of determining the section 902 denominator, irrespective of
whether such earnings are distributed during the taxable year.
After considering this comment, the Treasury Department and the IRS
concluded that on balance it would not be appropriate to modify the
proposed regulations in this manner. In many cases, allowing the
hovering deficit to offset current year distributed earnings and
profits for purposes of the section 902 denominator would effectively
allow an offset of pre-transaction earnings and profits. This is
because the opening balance of post-1986 undistributed earnings in the
year following the distribution would be reduced a second time (the
first reduction having occurred as a result of offsetting the current
year distributed earnings and profits by the hovering deficit) as
required by section 902 and the regulations thereunder to account for
the distribution itself. This second reduction would reduce pre-
transaction earnings and profits or, to the extent of any excess over
that amount, create a deficit in accumulated earnings and profits. As
described, the Treasury Department and the IRS believe that in order to
minimize credit trafficking problems, pre-transaction deficits of one
corporation should not be allowed to offset pre-transaction earnings of
another corporation.
Additionally, implementing the modification requested in the
comment would create administrative burdens for taxpayers and the IRS.
If hovering deficits offset current year distributed earnings solely
for purposes of section 902 but not for purposes of section 316, dual
accounts would be necessary to track hovering deficits as they are
separately used under each section.
Moreover, certain taxpayers would be disadvantaged under the
requested modification as compared to how those taxpayers would be
treated under the rule adopted in these final regulations. For example,
if a foreign subsidiary has a hovering deficit in a separate basket
that exceeds the sum of current plus accumulated earnings in the basket
and the foreign subsidiary distributes current year post-transaction
earnings in that same basket, under the requested modification, the
hovering deficit would reduce the section 902 denominator to zero, with
the result that no deemed-paid taxes could be claimed on the
distribution. In fact, for this reason certain taxpayers have
specifically requested that the hovering deficit rule apply for
purposes of the section 902 fraction. Under the rules adopted by the
final regulations, the hovering deficit would not reduce the section
902 denominator and therefore taxpayers would have access to deemed-
paid taxes on the distribution.
E. Hovering Taxes
Under the 2000 proposed regulations, taxes associated with a
hovering deficit do not enter into the surviving corporation's post-
1986 foreign income taxes pool until the entire deficit has been offset
against post-transaction accumulated earnings and profits. Comments
were made requesting that the regulations be changed to provide that
foreign taxes related to a hovering deficit enter the post-1986 foreign
income taxes pool on a pro rata basis as the hovering deficit to which
the foreign taxes relate is used to offset post-transaction accumulated
earnings and profits. The Treasury Department and IRS agree that a pro
rata approach of this nature more accurately ties the availability of
the foreign income taxes with the use of the related hovering deficit.
Accordingly, this requested change is reflected in the final
regulations.
F. Zipping Rule
The 2000 regulations provide that if the foreign target corporation
or foreign acquiring corporation (or both) was a look-through
corporation and the
[[Page 44892]]
foreign surviving corporation is a less-than-10%-U.S.-owned foreign
corporation, the post-1986 pools of earnings and profits of the look-
through corporation in the separate baskets are recharacterized as a
single, non-look-through pre-pooling annual layer which accumulated
immediately prior to the 381 transaction (the zipping rule). In
addition, the 2000 proposed regulations provide that if the foreign
surviving corporation later changes to look-through status, any such
recharacterized earnings and profits do not regain either their pooling
or their look-through character.
A comment was made that in a case where the foreign surviving
corporation subsequently changes to look-through status, if the
recharacterized earnings and profits do not revert to their look-
through character, a dividend paid out of those earnings would not be
afforded look-through treatment. The comment argued that this would run
counter to section 904(d)(2)(E)(i) which provides that look-through
treatment applies to distributions by a CFC out of any earnings and
profits accumulated during periods in which it was a CFC.
The Treasury Department and IRS note that this concern has been
addressed by intervening statutory and regulatory changes. All
distributions from a look-through corporation now receive look-through
treatment, regardless of whether they are paid out of earnings and
profits from post-1986 pools or pre-pooling annual layers. As a result,
the concern raised in the comment is now effectively moot, and look-
through treatment generally prevails. The final regulations otherwise
retain the zipping rule, however, because with respect to the
maintenance of pools or annual layers, this rule provides
administrative advantages for both taxpayers and the IRS by not
requiring subsequent U.S. shareholders of a foreign surviving
corporation that continued to accumulate earnings on an annual layer
basis to recreate post-1986 pools of pre-transaction earnings and
profits carried over from a pooling foreign target corporation.
Accordingly, the Treasury Department and the IRS decided to retain the
general zipping rule provisions of the 2000 proposed regulations in
these final regulations for pooling purposes, while allowing full
preservation of look-through treatment.
Moreover, it should be noted that these final regulations define a
pooling corporation as one that has at any time met the requirements of
section 902(c)(3)(B). Accordingly, even if the foreign surviving
corporation does not meet those requirements immediately after the
foreign section 381 transaction, it will still be a pooling corporation
if it had met those requirements at any time prior to the transaction.
See Sec. 1.902-1(a)(13)(i).
G. Qualified and Chain Deficit Rules Under Section 952(c)(1)(B) and (C)
The section 952(c)(1)(B) subpart F qualified deficit rule and
section 952(c)(1)(C) subpart F chain deficit rule allow the use of a
CFC's deficit in earnings and profits to limit subpart F income
inclusions for another year with respect to the stock of the same CFC
or for the same year with respect to stock of another CFC in certain
cases. Under the qualified deficit rule of section 952(c)(1)(B), a
prior-year earnings and profits deficit may be used to limit a
qualified shareholder's current year subpart F income in the same CFC
if such deficit is attributable to the same qualified activity as the
activity that gives rise to the current year subpart F income. Under
the chain deficit rule of section 952(c)(1)(C), a current year earnings
and profits deficit may be used to limit a related corporation's
current year subpart F income subject to the same qualified activity
restrictions.
The 2000 proposed regulations provide that a pre-transaction
deficit is not taken into account for purposes of calculating the
earnings and profits limitation under the chain deficit rule. The 2000
proposed regulations are silent, however, as to the qualified deficit
rule. A comment was made requesting that pre-transaction deficits be
taken into account for purposes of calculating the earnings and profits
limitations under both the qualified deficit rules and the chain
deficit rules.
The Treasury Department and the IRS agree with this comment. The
qualified deficit rule does not limit the amount of the subpart F
income at the CFC level, but rather limits the amount of a particular
shareholder's subpart F income inclusion under section 951(a). Because
qualified deficits in earnings and profits are shareholder-level
attributes and anti-trafficking provisions are already incorporated in
the rules regarding qualified deficits under section 952(c)(1)(B), the
Treasury Department and the IRS believe that it is appropriate to allow
pre-transaction deficits to be taken into account for purposes of the
calculation of qualified deficits. Though the Treasury Department and
IRS believe this was already a reasonable position that could have been
taken under the 2000 proposed regulations, the final regulations
include a more explicit clarification of this position.
The final regulations also provide that a current year pre-
transaction deficit may be taken into account for purposes of limiting
subpart F income under the chain deficit rule. The Treasury Department
and the IRS believe that the narrow restrictions that apply to
application of the chain deficit rule are not subject to manipulation
through entering into foreign section 381 transactions. Accordingly
there is no policy reason for denying a qualified chain member access
to a pre-transaction deficit that otherwise qualifies as a chain
deficit solely because the CFC with the chain deficit engaged in a
foreign section 381 transaction during the taxable year. Any such pre-
transaction deficit that qualifies as a chain deficit will nonetheless
remain a hovering deficit of the surviving corporation for purposes of
section 316 and section 902.
H. Allocation of Earnings and Profits, Deficits, and Taxes During the
Transaction Year
The 2000 proposed regulations include a rule that allocates the
earnings and profits for the taxable year of a foreign surviving
corporation in which a foreign section 381 transaction occurs as either
pre-transaction earnings or post-transaction earnings on the basis of
the number of days in the taxable year before and after the date of the
foreign section 381 transaction. This rule parallels a similar rule
found under Sec. 1.381(c)(2)-1(a)(6) and is necessary in order to
determine the amount of post-transaction earnings that may be offset by
hovering deficits. This rule is applied on a basket-by-basket basis for
any basket in which there are positive earnings and profits for the
taxable year in which the transaction occurred. No comments were
received on this point, and the final regulations adopt this provision,
extending it to related foreign income taxes as well.
These final regulations also contain a rule for allocating
deficits, and related foreign income taxes, for the taxable year in
which a foreign section 381 transaction occurs as pre- and post-
transaction deficits. If the surviving corporation has a deficit in any
basket for the taxable year in which the transaction occurred, unless
the actual accumulated earnings and profits, or deficit, as of the date
of the transaction can be shown, the deficit shall be allocated in the
same pro rata manner described above for positive earnings and profits.
This rule also parallels a similar rule found under Sec. 1.381(c)(2)-
1(a)(6) and is necessary in order to determine the amount of pre-
transaction deficits that will hover. This rule is applied on a basket-
by-basket basis for any basket in which there is a deficit in
[[Page 44893]]
earnings and profits for the taxable year in which the transaction
occurred.
The Treasury Department and the IRS believe that the addition of
the allocation rule for deficits provides greater consistency with the
principles and rules of section 381. It is a neutral provision and is
consistent with appropriate results that could be reached under present
law.
I. Special Rule for F Reorganizations and Similar Transactions
The 2000 proposed regulations (Prop. Reg. Sec. 1.367(b)-9) provide
that the hovering deficit rules do not apply in the case of a foreign
section 381 transaction that is described in section 368(a)(1)(F) or in
which either the foreign target corporation or the foreign acquiring
corporation is newly created. This rule was intended to prevent
inappropriate tax consequences that could result from application of
the hovering deficit rules to the combination of two corporations where
only one of those corporations has meaningful tax attributes. 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.
The rule under the 2000 proposed regulations addressing newly
created corporations was meant to capture any transactions that are
functionally equivalent to F reorganizations. However, the Treasury
Department and the IRS have determined that the newly-created
corporation standard under the 2000 proposed regulations is both
potentially underinclusive and overinclusive in scope. It is
underinclusive in that it would not apply to include foreign section
381 transactions that do not otherwise qualify as an F reorganization
but that are between one foreign corporation with meaningful tax
attributes and a shell corporation that is not newly created, but
nevertheless has no meaningful tax attributes. In contrast, this
standard is overinclusive in that it might be read to include a foreign
section 381 transaction involving multiple foreign corporations with
meaningful tax attributes as long as at least one party to the
transaction is a newly created corporation. These transactions are
neither F reorganizations nor are they functionally equivalent to F
reorganizations.
Accordingly, these final regulations clarify the 2000 proposed
regulations by providing that the hovering deficit rules do not apply
to a foreign section 381 transaction involving at least one corporation
that does not own more than a nominal amount of property or does not
have more than a nominal amount of tax attributes, but no more than one
corporation that does own more than a nominal amount of property or
have more than a nominal amount of tax attributes. In most cases the
transactions covered by this special rule will be standard F
reorganizations.
J. Anti-Abuse Rule
The 2000 proposed regulations include an anti-abuse rule that gives
the Commissioner the discretion to turn off the hovering deficit rules
if a principal purpose of a foreign section 381 transaction is to gain
a tax benefit from affirmative use of those rules. Comments have
criticized the anti-abuse rule as overly broad and inconsistent with
establishing objective rules regarding the taxation of earnings
distributed (or deemed distributed) by foreign subsidiaries. Moreover,
the point was raised in some comments that the proposed anti-abuse rule
would prevent taxpayers from relying on the existing detailed set of
rules for the calculation of earnings and profits following a corporate
combination in any case in which a taxpayer receives a U.S. tax benefit
related to the application of the hovering deficit rule.
Upon consideration of these comments, the Treasury Department and
the IRS have concluded that the anti-abuse rule in the 2000 proposed
regulations should be eliminated. While the anti-abuse rule has been
eliminated, the IRS will continue to examine the application of the
regulations to transactions to which they apply, or potentially apply,
and will be prepared to pursue issues where appropriate under the
regulations and other established principles of existing law. The
Treasury Department and the IRS may revisit the rules in light of
experience and propose prospective changes as appropriate.
K. Miscellaneous
A number of conforming revisions have been made to the 2000
proposed regulations to account for relevant statutory and regulatory
changes discussed above that have occurred in the intervening time
period since the 2000 proposed regulations were issued. This includes
the reduction of the number of baskets under section 904(d)(1),
applicable for tax years beginning after December 31, 2006, as well as
the fact that distributions by look-through corporations out of annual
layers accumulated during a non-look-through period are now accorded
look-through treatment.
It is possible that special transition rules might be needed
relating to the effect on hovering deficits in existence on the
effective date of the reduction in the number of baskets under section
904(d)(1). If it is determined that such rules are necessary, they
would be provided as part of a broader guidance project currently under
consideration to address generally transition issues relating to the
reduction in baskets.
Special Analyses
It has been determined that this Treasury decision is not a
significant regulatory action as defined in Executive Order 12866.
Therefore, a regulatory assessment is not required. It also has 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
regulations do not impose a collection of information on small
entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not
apply. Pursuant to section 7805(f) of the Code, the notice of proposed
rulemaking preceding these regulations was submitted to the Chief
Counsel for Advocacy of the Small Business Administration for comment
on their impact on small business.
Drafting Information
The principal author of these final regulations is Jeffrey L. Parry
of the Office of Chief Counsel (International). However, other
personnel from the Treasury Department and the IRS participated in
their development.
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and recordkeeping requirements.
Amendments to the Regulations
0
Accordingly, 26 CFR part 1 is amended as follows:
PART 1--INCOME TAXES
0
Paragraph 1. The authority citation for part 1 is amended by revising
the entries for Sec. Sec. 1.367(b)-7 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)-9 also issued under 26 U.S.C. 367(a) and (b),
26 U.S.C. 902, and 26 U.S.C. 904. * * *
[[Page 44894]]
0
Par. 2. Section 1.367(b)-0 is amended by:
0
1. Revising the introductory text.
0
2. Adding entries for Sec. 1.367(b)-2(l).
0
3. Adding entries for Sec. 1.367(b)-3(e) and (f).
0
4. Adding entries for Sec. Sec. 1.367(b)-7 through 1.367(b)-9.
The revisions and additions read as follows:
Sec. 1.367(b)-0 Table of contents.
This section lists the paragraphs contained in Sec. Sec. 1.367(b)-
1 through 1.367(b)-9.
* * * * *
Sec. 1.367(b)-2 Definitions and special 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) Pooling corporation.
(10) Nonpooling corporation.
(11) Separate category.
(12) Passive category.
(13) General category.
Sec. 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) General rule.
(2) Previously taxed earnings and profits. [Reserved]
* * * * *
Sec. 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 pooling corporation.
(2) If foreign surviving corporation is a nonpooling corporation.
(d) Post-1986 pool.
(1) In general.
(i) Qualifying earnings and taxes.
(ii) Carryover rule.
(2) Hovering deficit.
(i) In general.
(ii) Offset rule.
(iii) Related taxes.
(3) Examples.
(e) Pre-pooling annual layers.
(1) If foreign surviving corporation is a pooling corporation.
(i) Qualifying earnings and taxes.
(ii) Carryover rule.
(iii) Deficits.
(A) In general.
(B) Aggregate positive pre-1987 accumulated profits.
(C) Aggregate deficit in pre-1987 accumulated profits.
(D) Deficit and positive separate categories within annual layers
(iv) Pre-1987 section 960 earnings and profits and foreign income
taxes.
(v) Examples.
(2) If foreign surviving corporation is a nonpooling corporation.
(i) Qualifying earnings and taxes.
(ii) Carryover rule.
(iii) Deficits.
(A) In general.
(B) Aggregate positive pre-1987 accumulated profits.
(C) Aggregate deficit in pre-1987 accumulated profits.
(D) Deficit and positive separate categories within annual layers.
(iv) Pre-1987 section 960 earnings and profits and foreign income
taxes.
(v) Examples.
(f) Special rules.
(1) Treatment of deficit.
(i) General rule.
(ii) Exceptions.
(iii) Examples.
(2) Reconciling taxable years.
(3) Post-transaction change of status.
(4) Ordering rule for multiple hovering deficits.
(i) Rule.
(ii) Example.
(5) Pro rata rule for earnings and deficits during transaction year.
(g) Effective date.
Sec. 1.367(b)-8 Allocation of earnings and profits and foreign income
taxes in certain foreign corporate separations. [Reserved]
Sec. 1.367(b)-9 Special rule for F reorganizations and similar
transactions.
(a) Scope.
(b) Hovering deficit rules inapplicable.
(c) Foreign divisive transactions. [Reserved]
(d) Examples.
(e) Effective date.
* * * * *
0
Par. 3. Section 1.367(b)-1 is amended by:
0
1. Removing the language ``and'' at the end of paragraph (c)(2)(iii).
0
2. Removing the period at the end of paragraph (c)(2)(iv)(B) and adding
``; and'' in its place.
0
3. Adding paragraph (c)(2)(v).
0
4. Revising paragraphs (c)(3)(ii)(A), (c)(4)(iv), and (c)(4)(v).
The additions and revisions read as follows:
Sec. 1.367(b)-1 Other transfers.
* * * * *
(c) * * *
(2) * * *
(v) A foreign surviving corporation described in Sec. 1.367(b)-
7(a).
(3) * * *
(ii) * * *
(A) United States shareholders (as defined in Sec. 1.367(b)-
3(b)(2)) of foreign corporations described in paragraph (c)(2)(i) or
(v) 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 Sec.
1.367(b)-7 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;
* * * * *
0
Par. 4. Section 1.367(b)-2 is amended by:
0
1. Revising paragraph (j)(1)(i).
0
2. Adding paragraph (l).
The revision and addition read as follows:
Sec. 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), 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
Sec. 1.985-5.
* * * * *
(l) Additional definitions--(1) Foreign income taxes. The term
foreign income taxes has the meaning set forth in Sec. 1.902-1(a)(7).
(2) Post-1986 undistributed earnings. The term post-1986
undistributed earnings has the meaning set forth in Sec. 1.902-
1(a)(9).
(3) Post-1986 foreign income taxes. The term post-1986 foreign
income taxes has the meaning set forth in Sec. 1.902-1(a)(8).
(4) Pre-1987 accumulated profits. The term pre-1987 accumulated
profits
[[Page 44895]]
means the earnings and profits described in Sec. 1.902-1(a)(10)(i),
computed in accordance with the rules of Sec. 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 Sec. 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 Sec. 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 first taxable year beginning after December
31, 1986. For further guidance, see Notice 88-70 (1988-2 C.B. 369, 370)
(see also Sec. 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 described in
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 principles of Sec. 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) Pooling corporation. The term pooling corporation means a
foreign corporation with respect to which the requirements of section
902(c)(3)(B) have been met in the current taxable year or any prior
taxable year.
(10) Nonpooling corporation. The term nonpooling corporation means
a foreign corporation that is not a pooling corporation.
(11) 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(h)(10) (or section 904(g)(10) for taxable years beginning on or
before December 31, 2006).
(12) Passive category. The term passive category means the separate
category that includes income described in section 904(d)(1)(A).
(13) General category. The term general category means the separate
category that includes income described in section 904(d)(1)(B) (or
section 904(d)(1)(I) for taxable years beginning on or before December
31, 2006).
0
Par. 5. Section 1.367(b)-3 is amended by adding paragraphs (e) and (f)
to read as follows:
Sec. 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 Sec.
601.601(d)(2) of this chapter).
(f) Carryover of earnings and profits--(1) General rule. Except to
the extent otherwise specifically provided (see, e.g., Notice 89-79
(1989-2 C.B. 392) (see also Sec. 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) 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 United
States, 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.
(2) Previously taxed earnings and profits. [Reserved]
0
Par. 6. In Sec. 1.367(b)-6, paragraph (a)(1) is revised to read as
follows:
Sec. 1.367(b)-6 Effective dates and coordination rules.
(a) Effective date--(1) In general. Sections 1.367(b)-1 through
1.367(b)-3, and this section, apply to section 367(b) exchanges that
occur on or after November 6, 2006. For guidance with respect to
section 367(b) exchanges that occur prior to November 6, 2006, see
Sec. Sec. 1.367(b)-1 through 1.367(b)-6 in effect prior to November 6,
2006 (see 26 CFR part 1 revised as of April 1, 2006).
* * * * *
0
Par. 7. Section 1.367(b)-7 is added to read as follows:
Sec. 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 section 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) and the ordering of
distributions by the foreign surviving corporation. See Sec. 1.367(b)-
9 for special rules governing reorganizations described in section
368(a)(1)(F) and foreign section 381 transactions involving foreign
corporations that hold no property and have no tax attributes
immediately before the transaction, other than a nominal amount of
assets (and related tax attributes).
(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), and (f) of this section.
Dividend distributions by the foreign surviving corporation (post-
transaction distributions) shall be out of earnin