Dual Consolidated Loss Regulations, 12902-12946 [E7-4618]

Agencies

• Internal Revenue Service
• DEPARTMENT OF THE TREASURY

[Federal Register Volume 72, Number 52 (Monday, March 19, 2007)]
[Rules and Regulations]
[Pages 12902-12946]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: E7-4618]



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Part III





Department of the Treasury





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Internal Revenue Service



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26 CFR Parts 1 and 602



Dual Consolidated Loss Regulations; Final Rule

Federal Register / Vol. 72, No. 52 / Monday, March 19, 2007 / Rules 
and Regulations

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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Parts 1 and 602

[TD 9315]
RIN 1545-BD10


Dual Consolidated Loss Regulations

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

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SUMMARY: This document contains final regulations under section 1503(d) 
of the Internal Revenue Code (Code) regarding dual consolidated losses. 
Section 1503(d) generally provides that a dual consolidated loss of a 
dual resident corporation cannot reduce the taxable income of any other 
member of the affiliated group unless, to the extent provided in 
regulations, the loss does not offset the income of any foreign 
corporation. Similar rules apply to losses of separate units of 
domestic corporations. These final regulations address various dual 
consolidated loss issues, including exceptions to the general 
prohibition against using a dual consolidated loss to reduce the 
taxable income of any other member of the affiliated group.

DATES: Effective Date: These regulations are effective on March 19, 
2007.
    Applicability Dates: For dates of applicability see Sec.  
1.1503(d)-8.

FOR FURTHER INFORMATION CONTACT: Jeffrey P. Cowan, (202) 622-3860 (not 
a toll-free number).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

    The collection of information contained in these final regulations 
has been reviewed and approved by the Office of Management and Budget 
in accordance with the Paperwork Reduction Act of 1995 (44 U.S.C. 
3507(d)) under control number 1545-1946.
    The collections of information in these final regulations are in 
Sec. Sec.  1.1503(d)-1(c), 1.1503(d)-3(e), 1.1503(d)-4(e), 1.1503(d)-
6(c), 1.1503(d)-6(d), 1.1503(d)-6(e), 1.1503(d)-6(f), 1.1503(d)-6(g), 
1.1503(d)-6(h), and 1.1503(d)-6(j). This information is required for 
various reasons. The information under Sec.  1.1503(d)-1(c) notifies 
the IRS when a taxpayer asserts that it had reasonable cause for 
failing to comply with certain filing requirements under the 
regulations. The information under Sec.  1.1503(d)-4(e) indicates when 
the taxpayer attempts to rebut the amount of presumed tainted income. 
The information under the other provisions provides the IRS with 
various information regarding domestic use elections, exceptions to the 
domestic use limitation, triggering events, new domestic use 
agreements, original elector statements, annual certifications, and 
terminations of existing domestic use elections.
    An agency may not conduct or sponsor, and a person is not required 
to respond to, a collection of information unless it displays a valid 
control number.
    Books or records relating to a collection of information must be 
retained as long as their contents might become material in the 
administration of any internal revenue law. Generally, tax returns and 
tax return information are confidential, as required by 26 U.S.C. 6103.

Background

    Congress enacted section 1503(d), as part of the Tax Reform Act of 
1986, to prevent a dual resident corporation from using a single 
economic loss once to offset income that was subject to U.S. tax, but 
not foreign tax, and a second time to offset income subject to foreign 
tax, but not U.S. tax (double dip). In 1988, Congress extended the 
application of section 1503(d), by adding section 1503(d)(3) and (4), 
to apply the provisions to separate units of domestic corporations and 
to grant the Secretary authority to promulgate regulations to prevent 
the avoidance of section 1503(d) through the contribution of assets to 
a corporation with a dual consolidated loss after the loss was 
sustained. The IRS and Treasury Department issued temporary regulations 
under section 1503(d) in 1989 (TD 8261, 1989-2 CB 220) and final 
regulations in 1992 (TD 8434, 1992-2 CB 240), see Sec.  
601.601(d)(2)(ii)(b). These final regulations were updated and amended 
over the next 11 years (current regulations).
    On May 24, 2005, the IRS and Treasury Department published in the 
Federal Register a notice of proposed rulemaking (REG-102144-04; 70 FR 
29868). The proposed regulations addressed the following fundamental 
concerns arising under the current regulations: (1) The potential over- 
and under-application of the current regulations; (2) various issues 
arising in the application of the current regulations, particularly in 
light of the adoption of the entity classification regulations under 
Sec. Sec.  301.7701-1 through 301.7701-3 (check-the-box regulations); 
and (3) the administrative burden of the current regulations. The 
public hearing with respect to the 2005 proposed regulations was 
cancelled because no request to speak was received. However, the IRS 
and Treasury Department received a number of written comments which are 
discussed in this preamble.

Summary of Comments and Explanation of Provisions

A. Application of Section 1503(d) to Regulated Investment Companies and 
Real Estate Investment Trusts

    Under the current regulations, a dual resident corporation is a 
domestic corporation that is subject to an income tax of a foreign 
country on its worldwide income or on a residence basis. As a result, 
unless specifically exempted, certain entities that are domestic 
corporations, but not generally taxed at the entity level, may be 
subject to the current regulations. The current regulations provide 
that an S corporation, which is a domestic corporation, is not treated 
as a dual resident corporation. The proposed regulations, and these 
final regulations, provide that an S corporation is not treated as a 
domestic corporation and thus cannot be a dual resident corporation or 
own a separate unit.
    Under the current regulations, as a domestic corporation, a 
regulated investment company (as defined in section 851) or a real 
estate investment trust (as defined in section 856) could be a dual 
resident corporation or own a separate unit. In the preamble to the 
proposed regulations, however, the IRS and Treasury Department 
requested comments as to whether regulated investment companies or real 
estate investment trusts should, like S corporations, be excluded from 
the application of the dual consolidated loss rules. One commentator 
suggested that regulated investment companies and real estate 
investment trusts should be subject to the dual consolidated loss 
rules, but would limit recapture pursuant to a domestic use agreement 
to situations where there was a foreign use and a section 381 
transaction occurred.
    The IRS and Treasury Department believe that subjecting regulated 
investment companies and real estate investment trusts to the dual 
consolidated loss rules is inappropriate. Section 1503(d) was intended 
to apply to domestic corporations that are subject to entity-level tax. 
Although regulated investment companies and real estate investment 
trusts are domestic corporations under the Code, unlike most domestic 
corporations these entities often do not pay tax at the entity level 
because they may deduct the

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amount of dividends paid to their shareholders from their own taxable 
income. Thus, under the final regulations regulated investment 
companies and real estate investment trusts are excluded from the 
definition of a domestic corporation and, as a result, are not subject 
to the dual consolidated loss rules.

B. Separate Units

(1) Separate Unit Combination Rule
    Section 1.1503-2(c)(3)(ii) of the current regulations provides that 
if two or more foreign branches located in the same foreign country are 
owned by a single domestic corporation and the losses of each branch 
are available to offset the income of the other branches under the tax 
laws of the foreign country, then the branches are treated as a single 
separate unit.
    In response to comments that the current combination rule was 
unnecessarily limited and did not appropriately address the check-the-
box regulations, the proposed regulations adopt a broader combination 
rule that, subject to certain requirements, combines all separate units 
of a single domestic corporation. One requirement for combining 
separate units, both under the current regulations and the proposed 
regulations, is that the losses of each separate unit are made 
available to offset the income of the other separate units under the 
tax laws of a single foreign country.
    The combination rule in the proposed regulations does not combine 
dual resident corporations that are members of the same consolidated 
group, or separate units of multiple domestic corporations that are 
members of the same consolidated group. However, in the preamble to the 
proposed regulations, the IRS and Treasury Department requested 
comments as to whether combination was appropriate in these cases.
    Numerous comments were received on the scope and application of the 
combination rule. Commentators uniformly recommended that the 
combination rule be expanded to include separate units that are located 
in or subject to tax in the same foreign country (same-country separate 
units) and that are owned by multiple domestic corporations that are 
members of the same consolidated group. The IRS and Treasury Department 
believe that combining same-country separate units of domestic 
corporations that are members of the same consolidated group is 
consistent with the policies underlying section 1503(d) because, in 
general, all of the items of income, gain, deduction, and loss of such 
combined separate units are taken into account in both the United 
States and the foreign country. Therefore, these final regulations 
expand the combination rule to apply to same-country separate units of 
multiple domestic corporations that are members of the same 
consolidated group.
    Two commentators recommended that the combination rule be expanded 
to combine dual resident corporations that are members of the same 
consolidated group. The IRS and Treasury Department do not believe that 
Congress intended that multiple dual resident corporations be treated 
as a single domestic corporation for purposes of section 1503(d). 
Combining dual resident corporations and separate units would also add 
complexity because certain rules apply differently to dual resident 
corporations and separate units. As a result, the combination rule in 
these final regulations does not apply to dual resident corporations.
    Nevertheless, it is important to note that a dual resident 
corporation will often carry on its activities through a foreign branch 
(as defined in Sec.  1.367(a)-6T(g)(1)) and, as a result, will be a 
domestic owner of a foreign branch separate unit. In these cases, the 
foreign branch separate unit through which it carries on its activities 
in the foreign country will be eligible for combination. In addition, 
in many cases, a significant number of the items of income, gain, 
deduction, and loss of a dual resident corporation that owns a foreign 
branch separate unit will be attributable to the foreign branch 
separate unit (and therefore will not be items of the dual resident 
corporation itself). As a result, not extending the combination rule to 
dual resident corporations should, as a practical matter, have limited 
effect.
    One commentator recommended eliminating the proposed regulations' 
requirement that losses of each separate unit must be available to 
offset the income of other separate units under the tax laws of a 
single foreign country in order for them to combine. The IRS and 
Treasury Department believe that it is appropriate to remove this 
requirement, provided that the individual separate units are located, 
or subject to income tax on a worldwide or residence basis, in the same 
foreign country. This is the case because it is likely that all of the 
items of the combined separate unit will be recognized in both the 
United States and the foreign jurisdiction, without regard to whether 
such items are available for offset under the income tax laws of the 
foreign country. In addition, the IRS and Treasury Department believe 
that eliminating this requirement will reduce complexity, and will 
further refine the application of the rules. As a result, these final 
regulations eliminate this requirement from the combination rule.
    Commentators also recommended making combination elective in 
certain situations. The IRS and Treasury Department believe that 
elective combination would add complexity and create administrative 
burdens. Therefore, this comment is not adopted.
    The IRS and Treasury Department recognize that the expanded 
combination rule may necessitate that the basis of the stock of 
multiple domestic corporations, which are members of the same 
consolidated group, be adjusted to reflect the items of income, gain, 
deduction, and loss entering into the computation of the dual 
consolidated loss of a combined separate unit. These regulations 
provide guidance on the manner of such basis adjustments.
    These final regulations also clarify that the separate unit 
combination rule generally applies for all purposes of section 1503(d). 
As a result, except as specifically provided in these regulations, any 
individual separate unit composing a combined separate unit loses its 
character as an individual separate unit. For example, in determining 
whether there is a triggering event as a result of the transfer of the 
assets of a combined separate unit, all of the assets of the combined 
separate unit are taken into account (rather than only the assets of 
any individual separate unit within the combined separate unit).
(2) Definition of a Foreign Branch by Reference to Sec.  1.367(a)-6T(g)
    One commentator stated that the reference in the current and 
proposed regulations to Sec.  1.367(a)-6T(g) for the definition of a 
foreign branch, which implicitly includes references to Sec.  1.367(a)-
6T(g)(1) through (3), creates needless complexity. The IRS and Treasury 
Department generally agree with this comment. Accordingly, these final 
regulations clarify that a foreign branch is defined, in part, by 
reference to Sec.  1.367(a)-6T(g)(1), rather than by reference to Sec.  
1.367(a)-6T(g).
(3) Treaty Exception to the Definition of a Foreign Branch Separate 
Unit
    One commentator suggested that the definition of a foreign branch 
separate unit should not include a branch that would not be subject to 
income tax in a foreign jurisdiction either as a result of an income 
tax convention or because of the passive nature of the activities.

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This commentator explained that such an exclusion is appropriate 
because in these cases there would be no potential use of a branch loss 
for foreign tax purposes.
    The IRS and Treasury Department agree that it is appropriate to 
exclude from the definition of a foreign branch separate unit certain 
business operations that, under an applicable income tax convention, 
would not be considered a permanent establishment. As a result, these 
final regulations include an exception to the definition of a foreign 
branch separate unit. The IRS and Treasury Department do not, however, 
believe an exception is appropriate where the business operations are 
not subject to tax in the foreign jurisdiction because of the passive 
nature of the activities. Such an exception would require the analysis 
of foreign law which, to the extent possible, should not be required 
under these rules.
(4) Activities Owned by a Dual Resident Corporation or a Hybrid Entity
    One commentator requested clarification that home-country 
activities of a dual resident corporation or hybrid entity separate 
unit can qualify as a foreign branch separate unit. The IRS and 
Treasury Department agree that this clarification is warranted and 
these final regulations are modified accordingly.

C. Elimination of the Consistency Rule

    As a result of the expansion of the separate unit combination rule 
in these final regulations, the IRS and Treasury Department believe 
that the consistency rule would have only limited application. 
Therefore, the consistency rule has been eliminated from these final 
regulations. The IRS and Treasury Department believe that eliminating 
the consistency rule will simplify the application of the dual 
consolidated rules and will eliminate various issues that arise under 
the rule.

D. Domestic Reverse Hybrid Entities

    One commentator noted that the application of the current and 
proposed regulations to certain structures involving domestic reverse 
hybrid entities appears inconsistent with the underlying policies of 
section 1503(d). In a typical structure, a foreign corporation owns the 
majority of the interests in a partnership or limited liability company 
that elects to be treated as a corporation for U.S. tax purposes and, 
therefore, is subject to tax on its worldwide income in the United 
States, but is treated as a pass-through entity under foreign law 
(domestic reverse hybrid). The domestic reverse hybrid is the parent of 
a consolidated group, is the obligor on group indebtedness, and holds 
stock of other group members. This structure allows the interest 
expense of the domestic reverse hybrid to offset income of the foreign 
corporation, which is not subject to U.S. tax, and to offset income of 
the other members of the consolidated group, which is not subject to 
foreign tax.
    The commentator noted that because the domestic reverse hybrid is 
neither a dual resident corporation (because it is not subject to tax 
on a residence basis or on its worldwide income in the foreign country, 
but is instead treated as a pass-through entity) nor a separate unit of 
a domestic corporation, the current and proposed regulations do not 
apply to the losses of the domestic reverse hybrid. The commentator 
asserted that this result is inconsistent with the policies underlying 
section 1503(d), which was adopted, in part, to ensure that domestic 
corporations were not put at a competitive disadvantage as compared to 
foreign corporations through the use of certain inbound acquisition 
structures. See S. Rep. No. 99-313, 1986-3 CB Vol. 3 at 420, see Sec.  
601.601(d)(2)(ii)(b). The commentator suggested that the scope of the 
final regulations be broadened to treat such entities as separate 
units, the losses of which are subject to the restrictions of section 
1503(d). This change would, in effect, apply the provisions of section 
1503(d) to a separate unit of a foreign corporation.
    The IRS and Treasury Department recognize that this type of 
structure results in a double dip similar to that which Congress 
intended to prevent through the adoption of section 1503(d). However, 
the IRS and Treasury Department believe that a domestic reverse hybrid 
is neither a dual resident corporation nor a separate unit and, 
therefore, is not subject to section 1503(d). As a result, this comment 
is not adopted. However, the IRS and Treasury Department continue to 
study these and similar structures.

E. Transparent Entities

    Section 1.1503-2(c)(3) and 1.1503-2(c)(4) of the current 
regulations define a separate unit of a domestic corporation as a 
foreign branch (within the meaning of Sec.  1.367(a)-6T(g)), and an 
interest in a partnership, trust, or hybrid entity. As a result, the 
current regulations potentially apply not only to entities that are 
subject to tax in a foreign country (for example, hybrid entities), but 
also to entities that are not subject to tax in a foreign country, and 
otherwise have no connection to a foreign jurisdiction (for example, a 
domestic partnership engaged in a U.S. trade or business).
    The proposed regulations modify the definition of a separate unit 
to exclude interests in non-hybrid entity partnerships and non-hybrid 
entity grantor trusts. These interests were excluded because the IRS 
and Treasury Department believe that it is unlikely that losses and 
deductions attributable to these interests could be put to a foreign 
use (as that term is defined in the proposed regulations). However, the 
proposed regulations retain the rule that a domestic corporation can 
own a separate unit through a non-hybrid entity partnership or non-
hybrid entity grantor trust.
    Commentators noted that, as a result of this change, the proposed 
regulations may not sufficiently and consistently address the treatment 
of certain entities. Such an entity is a pass-through entity for U.S. 
tax purposes (for example, a disregarded entity, a partnership or a 
grantor trust), but is not a hybrid entity because it is not subject to 
tax on its worldwide income or on a residence basis in a foreign 
country. In addition, the entity would not be treated as a pass-through 
entity under the laws of the applicable foreign country. One example of 
such an entity (transparent entity) is a limited liability company 
organized in the United States that for U.S. tax purposes is a 
partnership or disregarded entity, but, for purposes of the applicable 
foreign country, is not viewed as a pass-through entity. Another 
example is a foreign entity that is a pass-through entity for U.S. tax 
purposes, is not subject to income tax in a foreign country as a 
corporation (or otherwise at the entity level) either on its worldwide 
income or on a residence basis (because, for example, it is organized 
in a foreign country that does not impose an income tax), and is not 
treated as a pass-through entity under the laws of the applicable 
foreign country.
    The commentators noted that under the proposed regulations items of 
income, gain, deduction, and loss of a transparent entity that is a 
partnership for U.S. tax purposes would be taken into account in 
computing the dual consolidated loss of a dual resident corporation or 
hybrid entity separate unit that owns an interest in such entity, even 
though it is unlikely that the items are taken into account by the 
jurisdiction in which the dual resident corporation or hybrid entity is 
subject to tax. As a result, items of deduction or loss which are 
unlikely to be available for a double dip (because they are not

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taken into account by the foreign country in which the dual resident 
corporation or hybrid entity is subject to tax) could inappropriately 
result in a dual consolidated loss. The commentators further noted that 
items of income or gain which are unlikely to be taken into account by 
the foreign country could inappropriately reduce (or eliminate) a dual 
consolidated loss of the dual resident corporation or hybrid entity 
separate unit that owns an interest in such entity.
    The IRS and Treasury Department believe that losses attributable to 
interests in transparent entities should not be subject to section 
1503(d), but also believe that items attributable to these interests 
should not influence the calculation or use of a dual consolidated loss 
of a dual resident corporation or separate unit in a manner that is 
inconsistent with the purposes of section 1503(d). Accordingly, these 
final regulations provide four new rules that address transparent 
entities (and interests therein).
    First, these final regulations provide a definition of a 
transparent entity that is consistent with the description and examples 
in the preceding discussion.
    Second, rules are provided for attributing items of income, gain, 
deduction, and loss to interests in transparent entities. The rules 
applicable for attributing items to these interests are consistent with 
the rules for attributing items to hybrid entity separate units.
    Third, these final regulations provide that items of income, gain, 
deduction, and loss attributable to interests in transparent entities 
are not considered when calculating whether a dual resident corporation 
that holds an interest in such entity has income or a dual consolidated 
loss. This modification ensures that in cases where the foreign country 
in which the dual resident corporation is subject to tax is unlikely to 
take into account items of the transparent entity, such items do not 
inappropriately affect the computation of income or a dual consolidated 
loss of the dual resident corporation. Similar rules apply for purposes 
of calculating the income or dual consolidated loss of a separate unit 
through which an interest in a transparent entity is owned (directly or 
indirectly).
    Finally, an interest in a transparent entity will be treated as a 
domestic affiliate for purposes of determining whether there is a 
domestic use of a dual consolidated loss. This change prevents a dual 
consolidated loss from being used to offset the income of a transparent 
entity such that there is no inappropriate domestic use of the loss.
    These final regulations do not treat transparent entities, or 
interests therein, as dual resident corporations or separate units and, 
as a result, do not cause such entities (or interests therein) to be 
subject to the limitations of section 1503(d). Instead, the rules aim 
to appropriately take into account such entities when applying the dual 
consolidated loss rules to dual resident corporations and separate 
units.

F. Reasonable Cause Exception

    The current regulations require various filings to be included on a 
timely filed income tax return. In addition, taxpayers that fail to 
include these filings must request an extension of time to file under 
Sec. Sec.  301.9100-1 through 301.9100-3. The proposed regulations 
eliminate the requirement that a taxpayer obtain an extension of time 
under Sec. Sec.  301.9100-1 through 301.9100-3 and instead adopt a 
reasonable cause standard.
    On January 31, 2006, the IRS and Treasury Department published 
Notice 2006-13 (2006-8 IRB 496), see Sec.  601.601(d)(2)(ii)(b), 
announcing that taxpayers that must file agreements, statements, and 
other information under section 1503(d) may cure any late filings by 
applying a reasonable cause exception similar to the standard contained 
in the proposed regulations, until such time as the proposed 
regulations become final. In addition to allowing the use of the 
reasonable cause exception prior to the proposed regulations being 
published as final regulations in the Federal Register, the notice 
modifies the procedures for obtaining reasonable cause relief to ensure 
that requests for reasonable cause relief are handled in a timely and 
efficient manner.
    These final regulations adopt the reasonable cause standard 
contained in the proposed regulations and Notice 2006-13, with certain 
modifications. See paragraph S(3) of this preamble for the application 
of the reasonable cause exception to losses that are subject to the 
current regulations.

G. Foreign Use

(1) In General
    Section 1.1503-2(g)(2)(i) of the current regulations provides that, 
in order to elect relief from the general limitation on the use of a 
dual consolidated loss to offset income of a domestic affiliate 
((g)(2)(i) election), the taxpayer must, among other things, certify 
that no portion of the losses, expenses, or deductions taken into 
account in computing the dual consolidated loss has been, or will be, 
used to offset the income of any other person under the income tax laws 
of a foreign country. If, contrary to this certification, there is such 
a use, the dual consolidated loss subject to the (g)(2)(i) election 
generally must be recaptured and reported as gross income.
    The proposed regulations modify the definition of ``use'' and 
provide a rule based on ``foreign use'' in order to minimize the 
potential over- and under-application of the current regulations. The 
proposed regulations provide that a foreign use is deemed to occur only 
if two conditions are satisfied. The first condition is satisfied if 
any portion of a deduction or loss taken into account in computing the 
dual consolidated loss is made available under the income tax laws of a 
foreign country to offset or reduce, directly or indirectly, any item 
that is recognized as income or gain under such laws (including items 
of income or gain generated by the dual resident corporation or 
separate unit itself), regardless of whether income or gain is actually 
offset, and regardless of whether these items are recognized under U.S. 
tax principles. The second condition is satisfied if items that are (or 
could be) offset pursuant to the first condition are considered, under 
U.S. tax principles, to be items of: (1) A foreign corporation; or (2) 
a direct or indirect (for example, through a partnership) owner of an 
interest in a hybrid entity, provided such interest is not a separate 
unit.
(2) Indirect Foreign Use
    As noted, the proposed regulations provide that a foreign use of a 
dual consolidated loss will occur when any item of deduction or loss, 
entering into the computation of the dual consolidated loss, is made 
available, directly or indirectly, to offset under foreign law, income 
of a foreign corporation or an owner of an interest in a hybrid entity 
that is not a separate unit. The proposed regulations do not provide 
comprehensive examples illustrating when an indirect use of a dual 
consolidated loss occurs. However, the provision was included in the 
proposed regulations to address transactions that are structured to 
avoid the application of section 1503(d) through, for example, the use 
of a back-to-back lending or conduit financing-type arrangements, or 
through the use of one or more hybrid instruments.
    Commentators requested additional guidance regarding an indirect 
foreign use. In response to these comments, these final regulations 
clarify when an

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indirect foreign use is deemed to occur, include an exception to the 
general indirect foreign use rule for certain ordinary course 
transactions, and provide related examples.
    The indirect foreign use rules are designed to limit an indirect 
use to situations in which taxpayers have engaged in transactions which 
have the effect of transferring an item of deduction or loss composing 
a dual consolidated loss to another entity for foreign tax purposes, so 
that it is made available to offset the income of a foreign corporation 
or the owner of an interest in an entity which is not a separate unit. 
In general, these rules are intended to target structured transactions 
that are designed to achieve a double dip that is contrary to the 
policies of section 1503(d), and are not intended to apply to ordinary 
business transactions.
(3) Exceptions to Foreign Use
    The proposed regulations contain three exceptions to the definition 
of a foreign use, including an exception where there is no dilution of 
an interest in a separate unit. In the preamble to the proposed 
regulations, the IRS and Treasury Department request comments as to 
whether a de minimis exception should be provided to the dilution 
limitation. The preamble also states that a revenue procedure would be 
issued, in conjunction with the proposed regulations being published as 
final regulations in the Federal Register, that would provide 
additional exceptions (safe harbors) under which a triggering event 
would be deemed rebutted if various conditions were satisfied, 
including, in certain cases, a demonstration that there can be no 
foreign use of a significant portion of the dual consolidated loss.
    The IRS and Treasury Department received a number of comments on 
transactions and situations that could be included in the list of safe 
harbors. One commentator suggested an exception whereby recapture would 
not be required following transactions outside the taxpayer's control. 
For example, this commentator suggested that a recapture of a dual 
consolidated loss should not occur following the conveyance or 
relinquishment of assets of a separate unit, or interests in a separate 
unit, to a foreign government.
    Commentators also suggested that relief should be provided 
following certain transactions, similar to those mentioned in the 
preamble to the proposed regulations, where there is a de minimis 
potential for foreign use, a de minimis carryover of asset basis, and 
for which rebuttal would otherwise be difficult or impossible. 
According to these commentators, this safe harbor would apply to many 
common business transactions in which the policies underlying section 
1503(d) would not be violated because of only a de minimis potential 
for foreign use.
    Another commentator stated that an exception to foreign use would 
be appropriate where the taxpayer enters into a binding and irrevocable 
agreement with the tax authorities of a foreign country which ensures 
that no portion of the dual consolidated loss can be put to a foreign 
use in the foreign country. The commentator explained that, pursuant to 
such an arrangement, the taxpayer and the foreign tax authorities would 
agree that the foreign tax attributes of a dual resident corporation or 
separate unit (for example, loss carryforwards and asset basis) would 
be eliminated such that there would be no opportunity for a foreign 
use.
    After considering these comments, the IRS and Treasury Department 
believe that it is appropriate to include certain safe harbors where a 
foreign use will be deemed not to occur. As a result, these final 
regulations (rather than a revenue procedure) set forth additional 
exceptions to the definition of a foreign use. These exceptions 
generally apply in cases where the potential for foreign use is de 
minimis, or where the transaction giving rise to a foreign use occurs 
as a result of events largely outside of the taxpayer's control.
    These new exceptions to foreign use include a de minimis rule and 
rules that apply to certain transactions involving the carry over of 
asset basis and the assumption of liabilities. Another new exception 
applies to a transaction that qualifies for the multiple-party event 
exception to a triggering event (referred to as successor elector 
events under the proposed regulations) where the acquiring unaffiliated 
domestic owner or consolidated group owns, immediately after the 
transaction, less than 100 percent of the acquired assets or interests. 
Without this exception to foreign use, many transactions that would 
qualify for the multiple-party event exception would immediately result 
in a foreign use triggering event when the unaffiliated domestic 
corporation or consolidated group acquires between 90 and 100 percent 
of the assets or interests. Finally, these regulations modify the ``no 
dilution'' exception contained in the proposed regulations to, among 
other things, incorporate a de minimis exception.
    These final regulations provide that the exceptions may be 
supplemented through subsequent guidance published in the Internal 
Revenue Bulletin, as appropriate. As a result, the IRS and Treasury 
Department request comments on additional transactions or situations 
that should be added as safe harbors. For example, additional comments 
are requested on arrangements with foreign tax authorities whereby 
foreign tax attributes could be eliminated to ensure that no portion of 
the dual consolidated loss can be put to a foreign use.
(4) Ordering Rules for Determining a Foreign Use
    The current and proposed regulations provide rules for determining 
the order in which dual consolidated losses are used in cases where the 
laws of a foreign country provide for the foreign use of such loss, but 
do not provide applicable rules for determining the order in which 
these losses are used in a taxable year.
    A commentator noted that in certain cases involving dual 
consolidated losses incurred in different taxable years, the ordering 
rules may result in losses being deemed to be made available for a 
foreign use resulting in recapture, even though there are other losses 
which, if deemed to be used, would not result in recapture. This 
commentator recommended that in these situations the losses be deemed 
to first be used in a manner that will not result in the recapture of a 
dual consolidated loss. The commentator also noted that this approach 
is consistent with the exception to foreign use contained in Sec.  
1.1503(d)-1(b)(14)(iii)(B) of the proposed regulations where there is 
no foreign country rule for determining use. Finally, the commentator 
stated that losses that do give rise to a foreign use should be deemed 
to be used on a ``last-in/first-out'' basis. The IRS and Treasury 
Department believe these rules are appropriate and, as a result, these 
comments are adopted.
(5) Mirror Legislation
    The current regulations contain a mirror legislation rule that 
denies a taxpayer the ability to make an election to use a dual 
consolidated loss to offset the income of a domestic affiliate where 
the foreign country has enacted legislation that operates in a manner 
similar to section 1503(d), and, as a result, prohibits the taxpayer 
from claiming the dual consolidated loss in the foreign country. The 
mirror legislation rule was designed to prevent the revenue gain 
resulting from the disallowance of a double dip from inuring solely to 
the foreign country. Staff of the Joint Committee on Taxation, General 
Explanation of the Tax Reform Act of 1986, at 1065-66 (J.

[[Page 12907]]

Comm. Print 1987), see Sec.  601.601(d)(2)(ii)(b); see also British Car 
Auctions, Inc. v. United States, 35 Fed. Cl. 123 (1996), aff'd without 
op., 116 F.3d 1497 (Fed. Cir. 1997) (upholding the validity of the 
mirror legislation rule). The effect of the mirror legislation rule is 
that a dual consolidated loss may be disallowed in the United States 
and in the foreign country. In such cases, Congress intended for the 
Treasury Department to pursue a bilateral agreement with the foreign 
jurisdiction so that the loss could offset income of an affiliate in 
only one country.
    The proposed regulations retain the mirror legislation rule and 
modify it to better take into account the policies underlying its 
adoption.
    A number of comments were received on the scope and utility of the 
mirror legislation rule. Several commentators encouraged the IRS and 
the Treasury Department to pursue bilateral agreements where the dual 
consolidated loss is disallowed in both the United States and the 
foreign country.
    The IRS and Treasury Department agree that such agreements are 
necessary and recently concluded a competent authority agreement on 
such matters with the United Kingdom on October 6, 2006 (the 
Agreement). For the text of the Agreement, see Announcement 2006-86, 
2006-45 IRB 842; see Sec.  601.601(d)(2)(ii)(b). The Agreement applies 
to dual consolidated losses attributable to certain UK permanent 
establishments that are otherwise subject to both section 1503(d) and 
mirror legislation enacted by the United Kingdom. In general, the 
Agreement provides that taxpayers can elect to use or relieve the loss 
in either the United Kingdom or the United States, but not both.
    The IRS and Treasury Department believe that these final 
regulations and the Agreement appropriately refine and limit the scope 
of the mirror rule. In addition, the IRS and Treasury Department 
believe that the provisions of the Agreement can serve as a model for 
future competent authority agreements, if necessary, between the United 
States and its treaty partners which would further the Congressional 
intent with respect to the application of the mirror legislation rule. 
Accordingly, comments are requested on the provisions of the Agreement 
and on specific jurisdictions and considerations that should be taken 
into account in future agreements.
    Commentators also suggested that a ``stand-alone'' exception to the 
mirror legislation rule be adopted. This exception would apply where 
filing a domestic use election with respect to a dual consolidated loss 
otherwise subject to the mirror legislation rule would not violate the 
policies of section 1503(d). According to the commentators, this is the 
case because the mirror legislation in the foreign country would not 
have the effect of forcing taxpayers to use the losses in the United 
States. The commentators suggested that the mirror legislation rule 
would not apply provided there is not a foreign affiliate to which the 
separate unit or dual resident corporation could put the dual 
consolidated loss to a foreign use. The commentators noted that in 
these situations, the mirror legislation does not result in the revenue 
loss inuring solely to the United States, because it is factually 
impossible for the loss to offset taxable income in the foreign country 
that is not also taken into account in the United States.
    The IRS and Treasury Department generally agree with this comment. 
As a result, these final regulations contain a stand-alone exception to 
the mirror legislation rule.

H. Elimination of a Dual Consolidated Loss After Certain Transactions

    Both the current and proposed regulations contain rules that 
eliminate a dual consolidated loss that is subject to the general 
restrictions under section 1503(d)(1) following certain transactions. 
In the case of a dual resident corporation, the dual consolidated loss 
is generally eliminated in transactions described in section 381(a) 
because the dual resident corporation ceases to exist. In the case of a 
separate unit, the dual consolidated loss is generally eliminated in 
transactions where the separate unit ceases to be a separate unit of 
its domestic owner (either through a transaction described in section 
381(a) or otherwise). In these cases, and subject to the exceptions 
discussed in this preamble, after the transaction it is no longer 
possible for the dual resident corporation or separate unit to generate 
income that can be offset by the dual consolidated loss. As a result, 
any unused dual consolidated loss is eliminated.
    Both the current and the proposed regulations provide exceptions to 
the general elimination rule in the case of certain transactions to 
which section 381(a) applies. These exceptions generally apply in cases 
where it is possible that income that is generated by the transferee 
corporation after the transaction is subject to tax in both the United 
States and the foreign country such that it is appropriate for the 
income to be offset by the dual consolidated loss that carries over to 
the transferee.
    These final regulations make certain modifications to the 
elimination rules. For example, the rules are modified to reflect the 
expansion of the separate unit combination rule. Thus, these final 
regulations take into account transactions involving combined separate 
units that have more than one domestic owner. For example, a dual 
consolidated loss of a domestic owner that is attributable to a 
separate unit will not be eliminated under these final regulations if 
the separate unit continues to be a separate unit of any member of its 
domestic owner's consolidated group.

I. Application of SRLY Limitation to a Former Dual Resident Corporation

    Section 1.1503(d)-3(c)(3) of the proposed regulations provides that 
a dual consolidated loss is treated as a loss incurred by a dual 
resident corporation or separate unit in a separate return limitation 
year (SRLY) and is generally subject to all the limitations of Sec.  
1.1502-21(c). The proposed regulations provide that when determining 
the general SRLY limitation with respect to a dual resident 
corporation, the calculation of aggregate consolidated taxable income 
only includes income, gain, deduction, and loss generated in years in 
which the dual resident corporation is a resident (or is taxed on its 
worldwide income) in the same foreign country in which it was a 
resident (or was taxed on its worldwide income) during the year in 
which the dual consolidated loss was generated. See proposed Sec.  
1.1503(d)-3(c)(3)(iii).
    One commentator noted that this rule prevents the dual consolidated 
loss of a dual resident corporation from being taken into account by 
its consolidated group after the dual resident corporation ceases to be 
subject to tax on a residence basis (or on its worldwide income), 
regardless of whether the former dual resident corporation contributes 
taxable income to the consolidated taxable income of the group. The 
commentator stated that this result is inappropriate because it does 
not merely limit the use of a dual consolidated loss from offsetting 
the income of a domestic affiliate, but has the effect of limiting the 
use of a dual consolidated loss from offsetting the domestic 
corporation's own taxable income.
    The IRS and Treasury Department agree with this comment. Section 
1503(d)(1) provides that a dual consolidated loss of a corporation 
shall not reduce the taxable income of any other member of the 
affiliated group for

[[Page 12908]]

the taxable year or for any other taxable year. However, the 
limitations of section 1503(d)(1) do not prevent the use of a dual 
consolidated loss to offset the income of the dual resident corporation 
that incurred the loss, even where the dual resident corporation ceases 
to be subject to tax in the foreign country. As a result, this rule is 
not contained in these final regulations. But see section 1503(d)(4) 
(relating to tainted assets contributed to a dual resident 
corporation).

J. Effect of Section 1503(d) on Foreign Tax Credits

    Section 1503(d)(2) generally defines a dual consolidated loss to 
mean any net operating loss of a dual resident corporation or a 
separate unit. Section 172(c) generally defines a net operating loss as 
the excess of deductions over gross income. Section 164(a)(3) generally 
provides that foreign taxes are allowed as a deduction for the taxable 
year in which paid or accrued. However, section 275(a)(4) provides that 
no deduction is allowed for any such taxes, to the extent the taxpayer 
chooses to take to any extent the benefits of section 901 (which 
permits taxpayers to claim a credit for certain taxes paid or accrued 
during the taxable year to any foreign country or any possession of the 
United States).
    Commentators asked whether a creditable foreign tax expenditure 
incurred by a dual resident corporation or separate unit, for which an 
election is made to claim a credit pursuant to section 901, may be 
subject to the limitations of section 1503(d)(1).
    The IRS and Treasury Department recognize that policy concerns 
arise in certain transactions in which two or more parties claim a 
credit for the same foreign taxes. Although these policy concerns are 
similar to those arising under section 1503(d), the IRS and Treasury 
Department do not believe that Congress intended the limitations of 
section 1503(d) to apply to foreign taxes, so long as the foreign taxes 
do not enter into the computation of a net operating loss (that is, so 
long as an election is made to claim a credit for such taxes, in lieu 
of deducting them). As a result, under the terms of the statute, the 
limitations of section 1503(d) do not apply to creditable foreign tax 
expenditures incurred by a dual resident corporation or a separate 
unit, provided an election is made to claim a credit with respect to 
such expenditures in accordance with section 901 and the related 
regulations.
    Even though section 1503(d) does not apply to foreign tax credits 
that are claimed by more than one person, the IRS and Treasury 
Department continue to study these transactions and, as appropriate, 
intend to address them in future published guidance under other 
provisions.

K. Tainted Income Rule

    Section 1503(d)(4) grants the Secretary authority to prescribe such 
regulations as may be necessary or appropriate to prevent the avoidance 
of the purposes of section 1503(d) by contributing assets to the 
corporation with the dual consolidated loss after such loss is 
incurred. Section 1.1503-2(e) of the current regulations prevents the 
dual consolidated loss of a dual resident corporation that ceases being 
a dual resident corporation from offsetting the income from assets that 
are acquired by the dual resident corporation in a nonrecognition 
transaction, or as a contribution to capital, at any time during the 
three taxable years immediately preceding the taxable year in which the 
corporation ceases to be a dual resident corporation, or any time 
thereafter. The proposed regulations retained the tainted income rule, 
with certain modifications.
    One commentator noted that the tainted income rule of the current 
and proposed regulations applies with respect to assets acquired by a 
dual resident corporation, regardless of whether such tainted assets 
were received from a member of the dual resident corporation's 
affiliated group. According to this commentator, because section 
1503(d) was intended to prevent the use of a dual consolidated loss 
from offsetting the taxable income of any other member of the 
affiliated group, applying the tainted income rule where the tainted 
assets were not received from a member of the dual resident 
corporation's affiliated group is inconsistent with the policies 
underlying section 1503(d).
    Section 1503(d)(4) grants the Secretary broad regulatory authority 
to implement the tainted income rule. In addition, the IRS and Treasury 
Department believe that adopting the rule suggested by the commentator 
would require the IRS to trace the source of tainted assets received 
(for example, to ensure that the rule cannot be avoided through the 
imposition of an intermediary entity, such as a partnership, or through 
indirect transfers of assets). Moreover, such a rule would be difficult 
for both taxpayers and the IRS to apply, and would increase complexity. 
Accordingly, the IRS and Treasury Department believe that the tainted 
income rule should continue to apply without regard to the source of 
the tainted assets. As a result, this comment is not adopted.

L. Items Taken Into Account in Computing Income or a Dual Consolidated 
Loss

(1) In General
    Section 1503(d)(2)(A) generally defines a dual consolidated loss to 
mean any net operating loss of a domestic corporation which is subject 
to an income tax of a foreign country on its income without regard to 
whether such income is from sources inside or outside such foreign 
country, or is subject to such a tax on a residence basis. Section 
1503(d)(3) grants the Secretary broad authority to subject any loss of 
a separate unit of a domestic corporation to the limitations of section 
1503(d). Because separate units are not themselves taxpayers, it is 
necessary to determine which items of income, gain, deduction, and loss 
of the domestic owner of the separate unit should be taken into account 
for purposes of calculating a dual consolidated loss.
    Section 1.1503-2(d)(1)(ii) of the current regulations provides a 
limited rule for attributing items of a domestic owner to a separate 
unit. Under this rule, a separate unit must compute its income as if it 
were a separate domestic corporation that is a dual resident 
corporation, using only those items of income, expense, deduction, and 
loss that are otherwise attributable to such separate unit. For this 
purpose, only items of the domestic owner that are recognized for U.S. 
tax purposes are taken into account.
    In response to requests for additional guidance in this area, the 
proposed regulations provide more detailed rules for determining the 
amount of income or dual consolidated loss of a separate unit. This 
determination depends on various factors, including the type of 
separate unit, the ownership structure, and the nature of the item. The 
determination generally turns on whether it is likely that the relevant 
foreign country would take into account the item (assuming the item is 
recognized) for tax purposes. This determination is solely for purposes 
of section 1503(d) and does not apply for any other purpose, such as 
attributing items under an applicable income tax treaty or under other 
Code sections such as section 884 or 987.
    These final regulations adopt the attribution rules contained in 
the proposed regulations, with modifications.

[[Page 12909]]

(2) Books and Records
    The proposed regulations provide that, in general, the items of 
income, gain, deduction, and loss that are attributable to a hybrid 
entity (and, therefore, attributable to interests in the hybrid entity) 
are those that are properly reflected on its books and records, as 
adjusted to conform to U.S. tax principles. The proposed regulations 
further provide that the principles of Sec.  1.988-4(b)(2) apply for 
purposes of making this determination.
    One commentator asked whether Sec.  1.988-4(b)(2) is a strict 
booking rule, or whether it would instead permit taxpayers to take 
positions contrary to how items are reflected on the books and records 
if, under the facts and circumstances, the items were not appropriately 
reflected on the books and records. Another commentator stated that the 
clause ``to the extent consistent with U.S. tax principles'' in the 
proposed regulations created uncertainty.
    In response to these comments, the final regulations clarify that 
only the Commissioner, and not the taxpayer, may make adjustments to 
the books and records where the booking practices are employed with a 
principle purpose of avoiding the principles of section 1503(d), 
including inconsistently treating the same or similar items of income, 
gain, deduction, and loss. In addition, these final regulations clarify 
that, in general, a domestic owner's items of income, gain, deduction, 
and loss are attributable to the domestic owner's hybrid entity 
separate unit, or interest in a transparent entity, to the extent such 
items are reflected on the hybrid entity or transparent entity's books 
and records (as defined in Sec.  1.989(a)-1(d)), as adjusted to conform 
to U.S. tax principles.
    The books and records standard set forth in these final regulations 
is intended to be consistent with the more detailed approach for 
attributing items that was adopted in proposed Sec.  1.987-2(b) that 
was published on September 7, 2006 (REG-208270-86, 71 FR 52875). It is 
anticipated that when those regulations are published as final 
regulations in the Federal Register, that approach will, as 
appropriate, be incorporated into these regulations. The IRS and 
Treasury Department believe that applying consistent standards under 
these two provisions, where appropriate, would make the rules more 
administrable. Comments are requested as to whether the standard 
contained in the section 987 proposed regulations is appropriate for 
purposes of section 1503(d).
(3) Attributing Interest Expense Under the Principles of Sec.  1.882-5
    The proposed regulations provide that the principles of Sec.  
1.882-5, as modified, apply for purposes of determining the interest 
expense that is attributable to a foreign branch separate unit. In 
making this determination, and solely for this purpose, the domestic 
owner is treated as a foreign corporation, the foreign branch separate 
unit is treated as a trade or business within the United States, and 
assets other than those of the foreign branch separate unit are treated 
as assets that are not U.S. assets.
    Two comments were received on the application of this rule. First, 
commentators stated that adopting the principles of Sec.  1.882-5 
results in unnecessary complexity. These commentators suggested that, 
in lieu of using the principles of Sec.  1.882-5, the interest expense 
of a foreign branch separate unit be determined by reference to its 
books and records. Another commentator noted the rationale of using the 
principles of Sec.  1.882-5 as a general matter, but suggested that 
where the foreign country looks to the books and records of the foreign 
branch separate unit for purposes of computing the interest expense of 
the separate unit, it would be appropriate to use the books and records 
for purposes of section 1503(d).
    The IRS and Treasury Department continue to believe that the 
principles of Sec.  1.882-5, as modified, serve as a reasonable proxy 
for determining the items of interest expense recognized for U.S. tax 
purposes that, if recognized by the foreign country, would be taken 
into account by the foreign country. Therefore, the principles of Sec.  
1.882-5, as modified, are retained as the general rule for purposes of 
determining the interest expense that is attributable to a foreign 
branch separate unit.
    However, to minimize complexity, the IRS and Treasury Department 
believe it is appropriate to use a books and records approach, where 
possible. Therefore, these final regulations provide an exception to 
the general rule such that interest expense is attributable to a 
foreign branch separate unit to the extent it is reflected on its books 
and records. This exception only applies if the foreign country in 
which the foreign branch is located determines, for purposes of 
computing the taxable income (or loss) under the laws of the foreign 
country, the interest expense of the foreign branch separate unit by 
taking into account only the items of interest expense reflected on the 
foreign branch separate unit's books and records. This rule will not 
apply, however, in cases where the foreign country does not use a 
strict booking approach for interest expense.
    Finally, it is important to note that in all cases only items of 
interest expense, as determined for U.S. tax purposes, are taken into 
account. The treatment of interest expense in the foreign country is 
only relevant for purposes of determining the method under which items 
of interest expense (determined for U.S. tax purposes) is attributed to 
the foreign branch separate unit.
(4) Treaty-Based Methods
    The proposed regulations provide that for purposes of determining 
the items of income, gain, deduction (other than interest), and loss 
that are taken into account in determining the taxable income or loss 
of a foreign branch separate unit, the principles of sections 864(c)(2) 
and (c)(4) as set forth in Sec. Sec.  1.864-4(c) and 1.864-6 shall 
apply.
    One commentator stated that domestic corporations operating foreign 
branch separate units should be allowed to attribute items to the 
foreign branch separate unit based on the method provided under an 
income tax treaty between the United States and the foreign country (or 
between two foreign countries if foreign branch operations are 
conducted by a hybrid entity outside its home country). The IRS and 
Treasury Department believe that this approach is inappropriate for two 
reasons. First, it would have the effect of attributing items 
recognized by the foreign jurisdiction, which may not be recognized as 
items for U.S. tax purposes. This would be inconsistent with section 
1503(d), which defines a dual consolidated loss solely based on U.S. 
tax rules. Second, this approach would require the interpretation of 
foreign law, which the IRS and Treasury Department believe should be 
avoided, to the extent possible. Accordingly, this comment is not 
adopted.
(5) Gain or Loss Recognized Under Section 987
    The proposed regulations do not provide whether gain or loss of a 
domestic owner recognized under section 987 as a result of a remittance 
or transfer is attributable to a separate unit for purposes of 
calculating income or dual consolidated loss, but instead request 
comments.
    Commentators stated that gain or loss recognized under section 987 
should not be attributable to a separate unit because in most cases the 
foreign country would not recognize such items since the income of the 
separate unit will be computed in the local currency. The IRS and 
Treasury Department agree

[[Page 12910]]

with this comment. As a result, these final regulations provide that 
gain or loss recognized under section 987, as a result of a remittance 
or transfer, will not be taken into account for purposes of computing 
the income or dual consolidated loss of a separate unit.
(6) Attributable To or Taken Into Account
    The proposed regulations generally provide that items are 
attributable to a hybrid entity separate unit, but are taken into 
account by a foreign branch separate unit. The IRS and Treasury 
Department believe that the use of these different terms is unnecessary 
and may lead to confusion. As a result, these final regulations provide 
that items are attributable to a separate unit, regardless of whether 
the separate unit is a foreign branch separate unit or a hybrid entity 
separate unit.

M. Basis Adjustments

    Section 1.1503-2(d)(3) of the current regulations contains special 
basis adjustment rules that override the normal investment adjustment 
rules under Sec.  1.1502-32 for stock of affiliated dual resident 
corporations and affiliated domestic owners owned by other members of 
the consolidated group. Similar rules apply to separate units arising 
from the ownership of an interest in a partnership. These special basis 
adjustment rules were included in the current regulations to prevent 
the indirect deduction of a dual consolidated loss. Although the 
proposed regulations retain these rules, the IRS and Treasury 
Department requested comments on whether the special basis adjustment 
rules should be retained.
    A number of commentators recommended that the special basis 
adjustment rules be removed for several reasons. For example, the 
commentators noted that an indirect use, which the special basis rules 
were intended to prevent, may not occur for many years after the dual 
consolidated loss was incurred. In response to these comments, the 
special basis rules are not contained in these final regulations. Thus, 
the basis adjustment rules under Sec.  1.1502-32 shall apply without 
modification for purposes of determining the adjusted basis in the 
stock of a dual resident corporation or the stock of an affiliated 
domestic owner owned by other members of the consolidated group. These 
final regulations also contain rules to ensure consistent treatment for 
a partner's basis in a partnership interest that is a separate unit, or 
through which a separate unit is owned indirectly.

N. Losses of a Foreign Insurance Company Treated as a Domestic 
Corporation

(1) In General
    Section 953(d) generally provides that a foreign corporation that 
would qualify to be taxed as an insurance company if it were a domestic 
corporation may, under certain circumstances, elect to be treated as a 
domestic corporation (section 953(d) company). Section 953(d)(3) 
provides that if a section 953(d) company is treated as a member of an 
affiliated group, any loss of such corporation is treated as a dual 
consolidated loss for purposes of section 1503(d), without regard to 
section 1503(d)(2)(B) (grant of regulatory authority to exclude losses 
which do not offset the income of foreign corporations from the 
definition of a dual consolidated loss).
    The current regulations do not address the application of section 
953(d)(3). In the proposed regulations, however, the definition of a 
dual resident corporation includes a section 953(d) company that is a 
member of an affiliated group. In addition, the proposed regulations 
clarify that a section 953(d) company may not make a domestic use 
election. These rules are consistent with section 953(d)(3).
    In response to comments, these final regulations provide additional 
guidance on the application of the dual consolidated loss rules to 
section 953(d)(3) companies, including the treatment of separate units 
owned by such companies.
(2) Transactions Intended To Avoid the Limitations of Sections 
953(d)(3) and 1503(d)
    The IRS and Treasury Department understand that taxpayers may be 
implementing structures that result in the same overall tax 
consequences as structures that Congress intended to be subject to the 
loss limitation rules provided under sections 953(d)(3) and 1503(d). 
However, taxpayers may be taking the position that the structures are 
not subject to these loss limitation rules. For example, a foreign 
insurance company may, in lieu of making an election under section 
953(d) and thus being subject to the limitations of sections 953(d)(3) 
and 1503(d), file