Application of Separate Limitations to Dividends From Noncontrolled Section 902 Corporations, 27868-27890 [E9-13521]

Agencies

• Internal Revenue Service
• DEPARTMENT OF THE TREASURY

[Federal Register Volume 74, Number 111 (Thursday, June 11, 2009)]
[Rules and Regulations]
[Pages 27868-27890]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: E9-13521]



[[Page 27867]]

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Part II





Department of the Treasury





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Internal Revenue Service



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26 CFR Parts 1 and 602



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

Federal Register / Vol. 74, No. 111 / Thursday, June 11, 2009 / Rules 
and Regulations

[[Page 27868]]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Parts 1 and 602

[TD 9452]
RIN 1545-BB28


Application of Separate Limitations to Dividends From 
Noncontrolled Section 902 Corporations

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations, temporary regulations, and removal of 
temporary regulations.

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SUMMARY: This document contains final regulations regarding the 
application of separate foreign tax credit limitations to dividends 
received from noncontrolled section 902 corporations. The American Jobs 
Creation Act of 2004 (AJCA) modified the treatment of such dividends 
effective for taxable years beginning after December 31, 2002. The Gulf 
Opportunity Zone Act of 2005 (GOZA) permits taxpayers to elect to defer 
the effective date of the AJCA amendments until taxable years beginning 
after December 31, 2004. The final regulations provide guidance needed 
to comply with these changes and affect corporations claiming foreign 
tax credits.

DATES: Effective Date: These regulations are effective on June 11, 
2009.
    Applicability Dates: For dates of applicability, see Sec. Sec.  
1.861-9(k), 1.861-12(c)(5), 1.902-1(g), 1.904-2(h)(1) and (2), 1.904-
4(n), 1.904-5(o)(2), 1.904-7(f)(10), 1.904(f)-12(g)(5), and 1.964-1(d).

FOR FURTHER INFORMATION CONTACT: Richard Chewning at (202) 622-3850 
(not a toll-free number).

SUPPLEMENTARY INFORMATION

Paperwork Reduction Act

    The collections of information contained in the final regulations 
have been reviewed and approved by the Office of Management and Budget 
in accordance with the Paperwork and Reduction Act (44 U.S.C. 3507(d)) 
under control number 1545-2014. The collections of information in the 
final regulations are in Sec. Sec.  1.904-7(f)(9)(ii)(C) and 1.964-
1(c)(3). This information is required, with respect to Sec.  1.904-
7(f)(9)(ii)(C), to notify the IRS that taxpayer has made the election 
to defer the applicability of the provisions of section 403 of the 
AJCA. With respect to Sec.  1.964-1(c)(3), this information is required 
to notify the IRS and domestic shareholders of a foreign corporation of 
elections made to adopt or change a method of accounting or taxable 
year of the foreign corporation.
    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 these collections of information must 
be retained as long as their contents may become material in the 
administration of any internal revenue law. Generally, tax returns and 
tax return information are confidential, as required by 26 U.S.C. 6103.

Background

    On April 20, 2006, a notice of proposed rulemaking by cross-
reference to temporary regulations (REG-144784-02) under sections 861, 
902, 904, and 964 of the Code and temporary regulations (TD 9260) (the 
2006 temporary regulations) were filed with the Office of the Federal 
Register. On April 25, 2006, the notice of proposed rulemaking by 
cross-reference to temporary regulations and the 2006 temporary 
regulations were published in the Federal Register (71 FR 24543 and 71 
FR 24516, respectively). Corrections to the 2006 temporary regulations 
were published on August 21, 2006, and December 26, 2006, in the 
Federal Register (71 FR 48474 and 71 FR 77264, respectively). Comments 
were received. A public hearing was not requested and none was held. 
After consideration of the comments, the proposed regulations are 
adopted as amended by this Treasury decision.

Explanation and Summary of Comments

    The IRS and the Treasury Department received written comments on 
the 2006 temporary regulations. Those comments are discussed in this 
preamble. These new regulations make several changes to the 2006 
temporary regulations to take into account comments received, while 
adopting without amendment most of the temporary regulations. The 
significant comments and revisions are described in this preamble.

I. Interest Expense Apportionment

A. Interest Expense of a 10/50 Corporation

    Section 904(d)(4)(A), as amended by the AJCA, provides that any 
dividend paid by a noncontrolled section 902 corporation (10/50 
corporation) shall be treated as income in a separate category based on 
the separate category of the underlying earnings and profits being 
distributed (look-through treatment), effective for taxable years 
beginning after December 31, 2002 (post-2002 taxable years), without 
regard to when the distributed earnings were accumulated. For purposes 
of apportioning interest expense of a 10/50 corporation in order to 
apply the dividend look-through rule, Sec.  1.861-9T(f)(4) of the 2006 
temporary regulations generally applies the same principles as Sec.  
1.861-9T(f)(3) (apportionment of interest expense of a controlled 
foreign corporation). Under these rules, interest expense of a 10/50 
corporation may be apportioned using either the asset method or the 
modified gross income method. Regardless of the interest expense 
apportionment methods used by its majority domestic corporate 
shareholders, the 10/50 corporation (or the majority domestic corporate 
shareholders on behalf of the 10/50 corporation) may elect to use any 
of the methods described in Sec.  1.861-9T or Sec.  1.861-9 (that is, 
the modified gross income, tax book value, alternative tax book value 
or fair market value method) to apportion the 10/50 corporation's 
interest expense.
    Section 1.861-9T(j)(1) provides a rule for ``tiering up'' the 
income of tiers of controlled foreign corporations (CFCs) that use the 
modified gross income method to apportion interest expense. Under that 
rule, the lowest-tier CFC's interest expense is allocated and 
apportioned based on its gross income, and its gross income reduced by 
such allocated and apportioned interest expense is then treated as 
gross income of the next-higher-tier CFC for purposes of apportioning 
the higher-tier CFC's interest expense. These steps are then 
essentially repeated, moving up the tiers. A commenter requested that 
the IRS and the Treasury Department clarify the mechanics of 
apportioning interest expense when tiered corporations elect different 
apportionment methods. This commenter raises issues that are beyond the 
scope of this regulation project and therefore are not addressed in 
this document.

B. Definition of ``10 Percent Owned Corporation''

    Prior to revision by the 2006 temporary regulations, Sec.  1.861-
12T(c)(2) required an affiliated group using the tax book value method 
in apportioning its interest expense to adjust the basis of stock in 
any ``10 percent owned corporation'' that is held directly by members 
of the group to reflect each member's pro rata share of such 10 percent 
owned corporation's earnings and profits (or deficit in earnings and 
profits). The rule, as revised by the 2006 temporary regulations, 
applies to stock

[[Page 27869]]

of a 10 percent owned corporation not only where its stock is held 
directly by members of the affiliated group, but also where its stock 
is held indirectly through a partnership or other pass-through entity. 
The revision was effective on April 25, 2006, and applied 
prospectively. The IRS and the Treasury Department stated in the 
preamble to the 2006 temporary regulations that the revision was a 
clarification.
    A commenter questioned why the regulations include a prospective, 
rather than a retroactive, effective date, if the revision clarified 
existing law. The IRS and the Treasury Department maintain that the 
revision is a clarification of existing law but continue to believe a 
prospective effective date is appropriate because the prior regulations 
were ambiguous.

II. Carryover of Unused Foreign Taxes Under Section 904(c)

    In the case of unused foreign taxes attributable to dividends from 
a 10/50 corporation with respect to which the taxpayer was no longer a 
qualifying shareholder as of the first day of the taxpayer's first 
taxable year ending after the first day of the 10/50 corporation's 
first post-2002 taxable year, Sec.  1.904-2T(h)(1) provides that the 
unused foreign taxes are allocated among the taxpayer's separate 
categories in the same percentages as the earnings in the 10/50 
corporation's non-look-through pool or pre-1987 accumulated profits 
``would have been assigned had they been distributed in the last 
taxable year in which the taxpayer was a domestic shareholder in such 
corporation.'' In response to a comment, Sec.  1.904-2(h)(1) of the 
final regulations clarifies that such taxes will be allocated as if 
look-through treatment applied in the year of the hypothetical 
distribution.

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

A. General Application of Look-Through

    With respect to applying the look-through rule to any dividend paid 
by a 10/50 corporation in a post-2002 taxable year, Sec.  1.904-
5T(c)(4)(iii) of the 2006 temporary regulations provides that any 
dividends paid in a post-2002 taxable year to a domestic corporation by 
a 10/50 corporation with respect to which the domestic corporation 
meets the stock ownership requirements of section 902(a) are treated as 
income in a separate category in proportion to the ratio of the portion 
of earnings and profits of the 10/50 corporation attributable to income 
in such category to the total amount of earnings and profits of the 10/
50 corporation.
    A commenter expressed concern that in some cases, where a domestic 
shareholder meets the stock ownership requirements of section 902(a) 
but has a relatively small ownership interest, the administrative 
burden on both the taxpayer and the IRS of applying look-through to 
earnings and foreign taxes in a 10/50 corporation's look-through pools 
could be significant. The commenter asserted that the process of 
obtaining and analyzing multiple years of historical financial data to 
ascertain the exact portion of distributions that relate to specific 
categories of income can be challenging, particularly where 
distributions relate to earnings from certain historical periods (for 
example, those during which the taxpayer did not own stock in the 10/50 
corporation). The commenter indicated that the reconstruction and safe 
harbor methods provided in Sec.  1.904-7T(f)(4)(i) and (ii) of the 2006 
temporary regulations, respectively, reduce difficulties in 
reconstructing historical accumulated earnings and taxes accounts of a 
10/50 corporation, but those rules apply only to undistributed earnings 
and taxes accumulated in non-look-through periods and do not apply to 
distributions of earnings accumulated in look-through pools. The 
commenter suggested that the IRS and the Treasury Department consider 
providing an elective safe harbor approach for domestic shareholders 
who own a relatively small interest, such as 15 percent or less, in the 
10/50 corporation, which would characterize a dividend paid by a 10/50 
corporation as income in a separate category by reference to the gross 
revenue of the 10/50 corporation for the last three years or a similar 
abbreviated period, with anti-abuse rules to address distortions.
    The IRS and the Treasury Department recognize that in some 
circumstances a domestic shareholder of a 10/50 corporation (as well as 
a noncontrolling shareholder of a controlled foreign corporation (CFC)) 
may face difficulties in substantiating accumulated earnings and taxes 
accounts of the 10/50 corporation (or CFC) on a look-through basis. 
However, the IRS and the Treasury Department believe use of a safe 
harbor is appropriate only as a limited rule for reconstructing 
earnings and taxes accumulated during prior year periods when the look-
through rules did not apply to dividends from 10/50 corporations. An 
ongoing safe harbor is not appropriate because the statutory look-
through rules, which apply to all domestic shareholders meeting the 
stock ownership requirements of section 902(a) (that is, 10 percent), 
generally require substantiation, and if the look-through treatment of 
a dividend from a 10/50 corporation has not been adequately 
substantiated, section 904(d)(4)(C)(ii) requires that such dividend be 
treated as passive income. See also Sec.  1.904-5T(c)(4)(iii) of the 
2006 temporary regulations.

B. Substantiation of Look-Through Treatment

    Section 1.904-5T(c)(4)(iii) of the 2006 temporary regulations 
provides that a dividend from a 10/50 corporation is treated as passive 
income if the look-through characterization of the dividend is not 
substantiated to the satisfaction of the Commissioner.
    A commenter expressed concern that if a 10/50 corporation has high-
taxed income outside the general and passive categories a taxpayer may 
intentionally fail to substantiate the look-through characterization of 
a dividend from the 10/50 corporation in order to achieve cross-
crediting. The commenter suggested that the final regulations include 
an anti-abuse rule for situations where the Commissioner determines 
that a taxpayer deliberately failed to substantiate the look-through 
characterization of the dividend. The commenter suggested that the 
anti-abuse rule could provide that in such a situation the earnings and 
associated taxes would be placed in a separate sub-basket to prevent 
cross-crediting. Alternatively, the commenter suggested that the final 
regulations could apply rules similar to the rules of section 907. 
Finally, the commenter suggested that the inadequate substantiation 
rule in Sec.  1.904-5T(c)(4)(iii) should be revised to conform to the 
rule in Sec.  1.904-7T(f)(4)(iii), which provides that the Commissioner 
will allocate the undistributed earnings and taxes in the non-look-
through pools to the foreign corporation's passive category only if the 
Commissioner determines that the look-through characterization of such 
earnings and taxes cannot reasonably be determined based on the 
available information. The IRS and the Treasury Department agree with 
this latter suggestion, and the rule in Sec.  1.904-5(c)(4)(iii) of the 
final regulations adopts this comment.

C. Application of Section 904(h) to 10/50 Corporations

    For purposes of the section 904 foreign tax credit limitation, 
section 904(h) (section 904(g) prior to redesignation in the AJCA) 
provides that certain income derived from a United States-owned foreign 
corporation which would be treated as foreign source income under other 
Code provisions is

[[Page 27870]]

treated as U.S. source income. This resourcing rule applies to certain 
payments of interest and dividends by a United States-owned foreign 
corporation as well as inclusions in gross income under sections 951(a) 
and 1293 to the extent the payments or inclusions are attributable to 
income of the United States-owned foreign corporation from sources 
within the United States. Section 904(h)(6) generally defines a United 
States-owned foreign corporation as any foreign corporation if United 
States persons (as defined in section 7701(a)(30)) hold 50 percent or 
more of either the total combined voting power of all classes of voting 
stock or the total value of the stock.
    Section 1.904-5(m) provides rules for the resourcing of certain 
amounts received or accrued (or treated as received or accrued) by a 
United States shareholder (as defined in section 951(b)) from a United 
States-owned foreign corporation. Section 1.904-5T(m)(1) of the 2006 
temporary regulations clarified that the resourcing rule applies not 
only to CFCs but also to 10/50 corporations that meet the definition of 
a United States-owned foreign corporation, and Sec.  1.904-5T(m)(2)(ii) 
and (4) provide rules for resourcing interest and dividend payments 
from 10/50 corporations.
    In the preamble to the 2006 temporary regulations, the IRS and the 
Treasury Department stated that this revision clarified that the rules 
for resourcing interest and dividends also apply to a 10/50 corporation 
that meets the definition of a United States-owned foreign corporation.
    A commenter suggested that the inclusion of 10/50 corporations 
within the resourcing rule of Sec.  1.904-5T(m) was not simply a 
clarification and that the combination of referring to this provision 
as only a clarification and the prospective application of the rule is 
confusing. In addition, the commenter requested guidance on the 
appropriate treatment of dividends from 10/50 corporations for 2003 
through 2006 under section 904(h) (section 904(g) as applicable for 
those years). The commenter suggested that Sec.  1.904-5T(m) be made 
retroactive to 2003 (or 2005 for taxpayers electing to apply the pre-
AJCA section 904(d) rules to assign dividends paid by 10/50 
corporations in their 2003 and 2004 taxable years to a single separate 
category for dividends from all 10/50 corporations) to match the 
retroactive effective date of the statutory changes to the look-through 
rules for 10/50 corporations and of the Sec.  1.904-7T rules for 
reconstructing non-look-through pools.
    This comment is not adopted. The IRS and the Treasury Department 
continue to believe that the revision is a clarification of existing 
law. A retroactive effective date is unnecessary, however, because the 
statute provides the applicable rule.
    A commenter suggested that, because section 904(h) applies exactly 
the same rule to both section 951(a) and section 1293 inclusions, Sec.  
1.904-5(m)(5) (other than the special rules for related person interest 
expense which are incorporated by cross-reference) should also 
reference section 1293 inclusions from United States-owned 10/50 
corporations. The IRS and the Treasury Department agree, and Sec.  
1.904-5(m)(5) of the final regulations adopts this comment.

D. Treatment of Earnings and Taxes Accumulated During a Non-Look-
Through Period

i. Reconstruction Method
    Section 1.904-7T(f)(2) of the 2006 temporary regulations provides 
that any undistributed earnings and foreign income taxes in the non-
look-through pools of a 10/50 corporation that were accumulated and 
paid as of the end of the 10/50 corporation's last pre-2003 taxable 
year are treated as if they were accumulated and paid during a period 
in which a distribution would have been eligible for look-through 
treatment. Section 1.904-7T(f)(4)(i) of the 2006 temporary regulations 
provides that in order to substantiate the look-through 
characterization of the earnings and taxes in the non-look-through 
pools, the taxpayer must make a reasonable, good-faith effort to 
reconstruct the non-look-through pools of earnings and taxes for each 
year in the non-look-through period, beginning with the first year in 
which earnings were accumulated in the non-look-through pool. Section 
1.904-7T(f)(4)(i) further provides that reconstruction will be based on 
reasonably available books and records and other relevant information, 
and must take into account earnings distributed and taxes deemed paid 
in the non-look-through period as if they were distributed and deemed 
paid pro rata from the amounts that were added to the non-look-through 
pools during the non-look-through period.
    In recognition of the difficulty in reconstructing the pools, the 
IRS and the Treasury Department stated in the preamble to the 2006 
temporary regulations that a reasonable approximation of the amounts 
properly included in the look-through pools, based on available records 
obtained through reasonable, good-faith efforts by the taxpayer, will 
adequately substantiate the reconstruction required by the statute.
    A commenter suggested that clarification of what constitutes other 
relevant information would be helpful. The IRS and the Treasury 
Department do not adopt this comment because the substantiation 
requirement requires evaluation of the facts and circumstances of each 
situation.
    With respect to earnings accumulated and foreign taxes paid in the 
2003 through 2006 taxable years, a commenter suggested that the rules 
in the 2006 temporary regulations concerning the look-through 
characterization and reconstruction of earnings and taxes in the non-
look-through pools need to be clarified to provide that taxpayers are 
required to determine the sub-characterization of earnings and taxes, 
if relevant. As an example, the commenter stated that if a 10/50 
corporation conducts a financing business but does not itself qualify 
as a financial services entity within the meaning of Sec.  1.904-
4(e)(3)(i), a qualifying shareholder of the 10/50 corporation must (if 
the shareholder does not elect the safe harbor method) determine what 
portion of the non-look-through earnings qualify as active financing 
income as defined in Sec.  1.904-4(e)(2)(i). Such a determination would 
be necessary in order to determine whether the income would be placed 
in the separate category for financial services income upon 
distribution to an upper-tier financial services entity. The IRS and 
the Treasury Department agree with this comment that sub-
characterization of earnings and taxes is required, if relevant, in 
determining the look-through characterization of earnings and taxes in 
the non-look-through pools and in reconstructing such pools. However, 
the IRS and the Treasury Department believe that the 2006 temporary 
regulations already require reconstruction as if look-through applied 
for all section 904 purposes, including any relevant sub-
characterization of the earnings and taxes pools. Accordingly, the 
final regulations adopt the rule in the 2006 temporary regulations 
without change.
ii. Safe Harbor
    Section 1.904-7T(f)(4)(ii) of the 2006 temporary regulations 
provides a safe harbor in reconstructing the non-look-through pools 
under which a taxpayer may allocate the earnings and taxes in the non-
look-through pools ratably to the look-through pools on the first day 
of the 10/50 corporation's first post-2002 taxable year in the same 
percentages as the taxpayer (or the qualified group member that owns 
the

[[Page 27871]]

10/50 corporation) properly characterizes the stock of the 10/50 
corporation in the separate categories for purposes of apportioning the 
taxpayer's (or qualified group member's) interest expense in its first 
taxable year ending after the first day of the 10/50 corporation's 
first post-2002 taxable year. If a taxpayer elects to use the safe 
harbor method with respect to a 10/50 corporation that uses the 
modified gross income method to apportion interest expense for the 10/
50 corporation's first post-2002 taxable year, earnings and taxes in 
the non-look-through pools are allocated to the look-through pools 
based on an average of the 10/50 corporation's modified gross income 
ratios for its taxable years beginning in 2003 and 2004. The IRS and 
the Treasury Department stated in the preamble to the 2006 temporary 
regulations that the two-year base period rule is necessary to avoid 
potential distortions associated with allocating earnings and taxes 
from the non-look-through pool to the look-through pools based on the 
10/50 corporation's modified gross income for just one taxable year.
    A commenter suggested that other potential distortions are not 
addressed in Sec.  1.904-7T(f)(4)(ii), such as instances in which a 
material change in the foreign corporation's operations (or asset 
composition) would distort the characterization of the non-look-through 
earnings and taxes under the safe harbor method. The commenter 
suggested that conditioning the use of the safe harbor method on the 
lack of any material change in the foreign corporation's operations, 
structure, assets or income from the non-look-through period would 
reduce the likelihood of a distortion.
    The IRS and the Treasury Department acknowledge that the safe 
harbor method does not address all potential distortions. However, the 
purpose of the safe harbor method is to provide certainty and to 
minimize administrative burdens. The IRS and the Treasury Department 
believe that revising the safe harbor method to reflect the commenter's 
suggestion would diminish these benefits of the safe harbor method.
    A commenter also suggested that the regulations should include 
guidance on how the safe harbor method election is to be made and the 
time frame for making the election. The commenter suggested that 
taxpayers should be allowed to elect the safe harbor method 
retroactively, on an amended return or during audit.
    The IRS and the Treasury Department agree with this comment. The 
final regulations provide that taxpayers may choose to use the safe 
harbor method on either timely filed or amended tax returns or during 
audit. However, if a taxpayer chooses to use the safe harbor method on 
an amended return or in the course of an audit, the taxpayer must make 
appropriate adjustments to eliminate any duplicate benefits arising 
from application of the safe harbor method to taxable years that are 
not open for assessment. A taxpayer's choice to use the safe harbor 
method is evidenced by simply employing the method. No separate 
statement need be filed.
    In addition, the final regulations clarify that the safe harbor 
method is only available as a transition rule for taxpayers who were 
required to characterize the stock of the foreign corporation for 
purposes of apportioning interest expense in the taxpayer's first 
taxable year ending after the first day of the foreign corporation's 
first post-2002 taxable year. The safe harbor is not available to 
determine the look-through treatment of earnings accumulated by a 
foreign corporation that did not have a shareholder that was entitled 
to look-through treatment in such a year.
iii. Treatment of a Deficit Accumulated in a Non-Look-Through Period
    Section 1.904-7T(f)(5) of the 2006 temporary regulations provides 
that if there is an accumulated deficit in the non-look-through pool of 
a 10/50 corporation or a CFC as of the end of the foreign corporation's 
last pre-2003 taxable year, the deficit and associated taxes, if any, 
are treated as if they had been accumulated and paid during a look-
through period. The earnings and deficits in earnings making up the 
accumulated deficit are assigned to the look-through pools based on 
where the foreign corporation's income and expenses or losses would 
have been assigned had they been incurred during a look-through period, 
or, if the taxpayer uses the safe harbor method, the deficit is 
allocated based on how the stock of the foreign corporation is properly 
characterized for interest expense apportionment purposes.
    A commenter suggested that the regulations should clarify that, for 
shareholders not using the safe harbor method, one or more separate 
income categories could have positive earnings, while one or more 
separate income categories could have a greater deficit. Thus, for 
example, if a 10/50 corporation had a $100 deficit accumulated in its 
non-look-through pool as of the end of its last pre-2003 taxable year, 
the deficit could consist of a $200 deficit in general limitation 
income and $100 earnings in the separate category for shipping income.
    The IRS and the Treasury Department believe that Sec.  1.904-
7T(f)(5) of the 2006 temporary regulations is clear that, as part of 
reconstruction of a non-look-through pool that contains an accumulated 
deficit, one or more separate income categories could have positive 
earnings, while one or more separate income categories could have a 
greater deficit, and that therefore, the rule does not need to be 
revised to reflect the comment.
iv. Section 952(c) Recapture Accounts
    In response to a comment, Sec.  1.904-7(f)(7) of the final 
regulations provides that section 952(c)(2) recapture accounts 
maintained by a CFC with respect to dividends received from a 10/50 
corporation that were subject to the earnings and profits limitation of 
section 952(c)(1) are allocated to separate categories in the same 
manner as the associated post-1986 undistributed earnings.
v. GOZA Election
    Conforming changes are made to the transition rules at Sec.  1.904-
7(f)(9) for taxpayers electing to defer the applicability of the look-
through rules for two years to reflect changes in response to comments 
made with respect to the general transition rules of Sec.  1.904-
7(f)(7).

E. Pre-Acquisition E&P

    Section 904(d)(4)(C)(i)(II), as amended by the AJCA, provides that 
the Secretary may prescribe regulations regarding the treatment of 
distributions out of earnings and profits of a 10/50 corporation for 
periods before the taxpayer's acquisition of the stock to which the 
distributions relate (pre-acquisition E&P). Such distributions may be 
out of post-1986 undistributed earnings accumulated by a 10/50 
corporation before the specific shareholder acquired its stock or out 
of pre-1987 accumulated profits accumulated before the 10/50 
corporation had any qualifying shareholder. The 2006 temporary 
regulations extend look-through treatment to dividends out of earnings 
and profits accumulated in non-look-through periods during which a 10/
50 corporation or a CFC had no qualifying shareholder and do not 
restrict look-through treatment of dividends paid to a new qualifying 
shareholder of an existing 10/50 corporation. The preamble to the 2006 
temporary regulations stated that the IRS and the Treasury Department 
believe that look-

[[Page 27872]]

through treatment of pre-acquisition earnings is the more appropriate 
policy result than passive category treatment, if look-through 
characterization can be adequately substantiated under Sec. Sec.  
1.904-5T(c)(4)(iii) and 1.904-7T(f)(4).
    A commenter suggested that the extension of look-through treatment 
to pre-acquisition E&P is inappropriate because the liberalized cross-
crediting of foreign taxes permitted by this treatment may encourage 
tax-motivated acquisitions in order to traffic in excess foreign taxes. 
The commenter suggested that the IRS and the Treasury Department 
exercise the regulatory authority under section 904(d)(4)(C)(i)(II) to 
create new separate categories for pre-acquisition earnings and 
profits.
    This comment is not adopted. The IRS and the Treasury Department 
continue to believe that look-through treatment of pre-acquisition 
earnings, where the earnings and taxes are substantiated, is the more 
appropriate policy result. Moreover, denying look-through treatment to 
dividends of earnings of a 10/50 corporation accumulated prior to a 
specific shareholder's acquisition of stock entails unacceptable 
administrative complexity associated with maintaining multiple sets of 
look-through pools starting on different dates for different 
shareholders. Accordingly, the final regulations adopt the rule in the 
2006 temporary regulations without change.

IV. Recapture of an Overall Foreign Loss or Separate Limitation Loss 
Incurred in a Separate Category for Dividends From a 10/50 Corporation

    Section 1.904(f)-12T(g)(1) of the 2006 temporary regulations 
provides that where a taxpayer had an overall foreign loss (OFL) or 
separate limitation loss (SLL) in a separate category for dividends 
from a 10/50 corporation, the OFL or SLL account is recaptured in 
subsequent taxable years out of income in the same separate categories 
in which the stock of the 10/50 corporation is properly characterized 
for purposes of apportioning the taxpayer's interest expense in its 
first taxable year in which dividends from the 10/50 corporation are 
eligible for look-through treatment (that is, its first taxable year 
ending after the first day of the 10/50 corporation's first post-2002 
taxable year).
    A commenter suggested that a rule providing for recapture of the 
OFL or SLL from the other separate categories in the same proportions 
that post-OFL or SLL dividends from the 10/50 corporation would have 
been assigned to such other separate categories had look-through 
applied would be more consistent with Sec.  1.904-2T(h)(1) and (2) 
(carryovers of excess foreign taxes from 10/50 baskets) and Sec.  
1.904-7T(f)(2) and (3) (characterization of non-look-through pools as 
if look-through had applied) that generally take the approach of 
following the consequences that would have applied if look-through had 
always been in effect. This comment is not adopted. The IRS and the 
Treasury Department stated in the preamble to the 2006 temporary 
regulations and continue to believe that recapturing losses from income 
earned in subsequent years is a forward-looking concept, and that 
reallocating OFL and SLL accounts based on the interest expense 
apportionment ratio (as opposed to, for example, reallocating losses 
based on reconstructed non-look-through pools) is consistent with that 
concept.

V. Regulations Under Section 964

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

    The 2006 temporary regulations at Sec.  1.964-1T(c)(2) and (3) 
provide rules allowing the majority domestic corporate shareholders of 
a 10/50 corporation to make an election, adopt a method of accounting 
or taxable year, or change a method of accounting or taxable year on 
behalf of the 10/50 corporation. The 2006 temporary regulations also 
allow the controlling United States shareholders of a CFC to make an 
election, adopt a method of accounting or taxable year, or change a 
method of accounting or taxable year on behalf of the CFC. Section 
1.964-1T(c)(2) provides that for the first taxable year of a foreign 
corporation beginning after April 25, 2006, in which such foreign 
corporation first qualifies as a CFC or 10/50 corporation, any method 
of accounting or taxable year allowable under this section may be 
adopted or elected by such foreign corporation or on its behalf 
notwithstanding that, in previous years, its books or financial 
statements were prepared on a different basis, and notwithstanding that 
such election is required by the Code or regulations to be made in a 
prior taxable year. Section 1.964-1T(c)(6) further provides that such 
actions may be deferred until the first year in which the computation 
of the foreign corporation's earnings and profits is significant for 
U.S. tax purposes, and includes a nonexclusive list of significant 
events for taxable years beginning after April 25, 2006.
    Section 1.964-1T(c)(4) of the 2006 temporary regulations 
acknowledges that a 10/50 corporation may have had a significant event 
in taxable years beginning on or before April 25, 2006, such as a 
distribution with respect to which the corporation's shareholder could 
claim a deemed-paid foreign tax credit under section 902. In order to 
determine the allowable foreign tax credit, at the time of the 
distribution the 10/50 corporation's domestic corporate shareholder 
would have had to compute the 10/50 corporation's earnings and profits, 
even though no procedure was then available for the controlling 
domestic shareholders to adopt or elect accounting methods on the 10/50 
corporation's behalf. Section 1.964-1T(c)(4) provides that in this 
situation the 10/50 corporation's earnings and profits shall be 
computed as if no accounting method elections were made and any 
permissible accounting method not requiring an election and reflected 
in the books of account regularly maintained by the 10/50 corporation 
for purposes of accounting to its shareholders had been adopted. 
Thereafter, in taxable years beginning after April 25, 2006, the 10/50 
corporation, or its controlling domestic shareholders, must obtain the 
consent of the Commissioner in order to change a particular accounting 
method or methods (or its taxable year) pursuant to the applicable 
revenue procedure. A commenter suggested that in post-2006 years the 
controlling domestic shareholders of a 10/50 corporation should be 
permitted to change accounting methods on its behalf without obtaining 
the consent of the Commissioner or making adjustments to the 10/50 
corporation's earnings and profits under the principles of section 481 
to prevent the duplication or omission of amounts attributable to 
previous years. This comment is not adopted. The IRS and the Treasury 
Department believe that it would be inappropriate to give the 
controlling domestic shareholders of a 10/50 corporation this type of 
``fresh start.''
    A commenter recommended simplifying the procedures in Sec.  1.964-
1T(c)(3) of the 2006 temporary regulations by which controlling 
domestic shareholders may make an election or adopt or change a method 
of accounting or taxable year on behalf of a foreign corporation. 
Specifically, the commenter suggested that Sec.  1.964-1T(c)(3)(i) and 
(ii) be revised to provide that where a United States shareholder 
changes a method of accounting on behalf of a CFC of which it is the 
sole shareholder, such shareholder need file

[[Page 27873]]

only the original Form 3115 with its tax return, and need not file the 
statement (described in Sec.  1.964-1T(c)(3)(ii)) that is required to 
be filed with each controlling domestic shareholder's tax return. The 
IRS and the Treasury Department agree with the comment and believe it 
is equally applicable to changes in the taxable year of the CFC. 
Accordingly, Sec.  1.964-1(c)(3)(ii) of the final regulations provides 
that in the case of a controlling domestic shareholder that is the sole 
shareholder of a CFC, no separate statement need be filed if the 
information described in Sec.  1.964-1(c)(3)(ii) is included on Form 
5471 (Information Return of U.S. Persons With Respect to Certain 
Foreign Corporations) and Form 3115 (Application for Change in 
Accounting Method) or Form 1128 (Application to Adopt, Change or Retain 
a Tax Year), as applicable, filed with respect to the CFC with the 
shareholder's return for such taxable year.

B. Section 481(a) Adjustments

    Prior to its expiration, Sec.  1.964-1T(g)(5) provided that 
adjustments to the appropriate separate category of earnings and 
profits and income of the controlled foreign corporation was required 
using the principles of section 481(a) to prevent any duplication or 
omission of amounts attributable to previous years that would otherwise 
result from any election or adoption of a method of accounting. This 
provision was cross-referenced in Sec.  1.964-1T(c)(4) of the 2006 
temporary regulations. Commenters requested clarification regarding the 
mechanics of making the adjustments according to the principles of 
section 481(a), such as the period over which the section 481(a) 
adjustment is spread and whether a correlative section 481(a) 
adjustment should be made at the domestic shareholder level in order to 
capture an increased subpart F inclusion that would have been generated 
had earnings and profits initially been determined using the method 
subsequently elected or adopted. One commenter suggested that the 
regulations state specifically that the applicable domestic principles 
should apply so that the section 481 adjustment would be taken into 
account in determining the current earnings and profits of the CFC or 
10/50 corporation beginning with the year of change and for the same 
period as the adjustment is taken into account for purposes of 
computing taxable income.
    In response to the comment, Sec.  1.964-1(c)(2) of the final 
regulations provides that adjustments to the appropriate separate 
category (as defined in Sec.  1.904-5(a)(1)) of earnings and profits 
and income of the foreign corporation shall be required under section 
481 to prevent any duplication or omission of amounts attributable to 
previous years that would otherwise result from any change in a method 
of accounting. The details concerning the section 481 adjustment are 
addressed in applicable revenue procedures. See, for example, Rev. 
Proc. 2008-52, 2008-36 IRB 587.

C. Miscellaneous Cross-References

    The 2006 temporary regulations included in Sec.  1.964-1T(c)(4) 
cross-references to expired Sec.  1.964-1T(g) that are updated in the 
final regulations. In addition, Sec.  1.964-1(c)(2) of the final 
regulations adds cross-references to Sec. Sec.  1.985-5, 1.985-6, and 
1.986-7, which provide that a qualified business unit must make 
adjustments to its earnings and profits when it changes its functional 
currency or begins to use the dollar approximate separate transactions 
method of accounting.
    Section 1.964-1(b)(1)(v) includes a cross-reference to ``paragraph 
(d) of this section.'' Because of revisions to Sec.  1.964-1, that 
cross-reference and a similar cross-reference in Sec.  1.989(b)-1 were 
no longer effective. The final regulations replace the cross-references 
to paragraph (d) with the appropriate cross-reference to section 988 
and the regulations under that section.

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 has also been 
determined that section 553(b) of 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 this regulation 
and temporary regulations were submitted to the Chief Counsel for 
Advocacy of the Small Business Administration for comment on their 
impact on small businesses.

Drafting Information

    The principal authors of the final regulations are Richard Chewning 
and Jeffrey Parry of the Office of Associate Chief Counsel 
(International). However, other personnel from the Treasury Department 
and the IRS participated in their development.

List of Subjects

26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

 26 CFR Part 602

    Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

0
Accordingly, 26 CFR parts 1 and 602 are amended as follows:

PART 1--INCOME TAXES

0
Paragraph 1. The authority for part 1 continues to read in part as 
follows:

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


0
Par. 2. Section 1.861-9 is amended by removing paragraphs (h)(5)(iii) 
and (i)(4), revising paragraphs (a), (b), (c), (d), (e), (f), and 
(g)(1)(i), and adding paragraph (k), to read as follows:


1.861-9  Allocation and apportionment of interest expense.

    (a) through (f)(3)(i) [Reserved]. For further guidance, see Sec.  
1.861-9T(a) through (f)(3)(i).
    (f)(3)(ii) Manner of election. The election shall be made by filing 
the statement and providing the written notice described in Sec.  
1.964-1(c)(3)(ii) and (iii), respectively, at the time and in the 
manner described therein. For further guidance, see Sec.  1.861-
9T(f)(3)(ii).
    (f)(3)(iii) and (iv) [Reserved]. For further guidance, see Sec.  
1.861-9T(f)(3)(iii) and (iv).
    (4) Noncontrolled section 902 corporations--(i) In general. For 
purposes of computing earnings and profits of a noncontrolled section 
902 corporation (as defined in section 904(d)(2)(E)) for Federal tax 
purposes, the interest expense of a noncontrolled section 902 
corporation may be apportioned using either the asset method described 
in Sec.  1.861-9T(g) or the modified gross income method described in 
Sec.  1.861-9T(j). A noncontrolled section 902 corporation that is not 
a controlled foreign corporation may elect to use a different method of 
apportionment than that elected by one or more of its shareholders. A 
noncontrolled section 902 corporation must use the same method of 
apportionment with respect to all its domestic corporate shareholders.
    (ii) Manner of election. The election to use the asset method 
described in Sec.  1.861-9T(g) or the modified gross income method 
described in Sec.  1.861-9T(j) may be made either by the

[[Page 27874]]

noncontrolled section 902 corporation or by the majority domestic 
corporate shareholders (as defined in Sec.  1.964-1(c)(5)(ii)) on 
behalf of the noncontrolled section 902 corporation. The election shall 
be made by filing the statement and providing the written notice 
described in Sec.  1.964-1(c)(3)(ii) and (iii), respectively, at the 
time and in the manner described therein. For further guidance, see 
Sec.  1.861-9T(f)(4)(ii).
    (iii) Stock characterization. In general, the stock of a 
noncontrolled section 902 corporation shall be characterized in the 
hands of any domestic corporation that meets the ownership requirements 
of section 902(a) with respect to the noncontrolled section 902 
corporation, or in the hands of any member of the same qualified group 
as defined in section 902(b)(2), using the same method that the 
noncontrolled section 902 corporation uses to apportion its interest 
expense. Stock in a noncontrolled section 902 corporation shall be 
characterized as a passive category asset in the hands of any such 
shareholder that fails to meet the substantiation requirements of Sec.  
1.904-5(c)(4)(iii), or in the hands of any shareholder that is not 
eligible to compute an amount of foreign taxes deemed paid with respect 
to a dividend from the noncontrolled section 902 corporation for the 
taxable year. See Sec.  1.861-12(c)(4).
    (f)(5) through (g)(1)(i) [Reserved]. For further guidance, see 
Sec.  1.861-9T(f)(5) through (g)(1)(i).
* * * * *
    (k) Effective/applicability date. Paragraph (h)(5) of this section 
applies to taxable years beginning after December 31, 1989. Paragraph 
(i) of this section applies to taxable years beginning on or after 
March 26, 2004. Paragraphs (f)(3)(ii) and (4) of this section apply to 
taxable years of shareholders ending on or after April 20, 2009. See 26 
CFR 1.861-9T(f)(3)(ii)(last sentence) and (4) (revised as of April 1, 
2009) for rules applicable to taxable years of shareholders ending 
after the first day of the first taxable year of the noncontrolled 
section 902 corporation beginning after December 31, 2002, and ending 
before April 20, 2009.

0
Par. 3. Section 1.861-9T is amended as follows:
0
1. Remove paragraph (b)(6)(viii).
0
2. Revise the last sentence of paragraph (f)(3)(ii) and paragraph 
(f)(4).
0
3. Add paragraph (k).
    The revisions and additions read as follows:


Sec.  1.861-9T  Allocation and apportionment of interest expense 
(temporary).

* * * * *
    (f) * * *
    (3) * * *
    (ii) * * * For guidance relating to the time and manner of this 
election, see Sec.  1.861-9(f)(3)(ii).
* * * * *
    (4) * * * For further guidance, see Sec.  1.861-9(f)(4).
* * * * *
    (k) Effective/applicability dates. Paragraph (b)(6) of this section 
applies to losses on any transaction described in paragraph (b)(6)(i) 
of this section that was entered into after September 14, 1988. 
Paragraph (b)(6) of this section also applies to any gain that was 
realized on any transaction described in paragraph (b)(6)(i) of this 
section that was entered into after August 11, 1989. Taxpayers may also 
apply paragraph (b)(6) of this section to any gain that was realized on 
any transaction described in paragraph (b)(6)(i) of this section that 
was entered into after September 14, 1988, and on or before August 11, 
1989, if the taxpayer can demonstrate to the satisfaction of the 
Commissioner that substantially all of the arrangements described in 
paragraph (b)(6)(i) of this section to which the taxpayer became a 
party during that interim period were identified on the taxpayer's 
books and records with the liabilities of the taxpayer in a 
substantially contemporaneous manner and that all losses and expenses 
that are subject to the rules of paragraph (b)(6) of this section were 
treated in the same manner as interest expense. For this purpose, 
arrangements that were identified in a substantially contemporaneous 
manner with the taxpayer's assets shall be ignored. For further 
guidance, see Sec.  1.861-9(k).

0
Par. 4. Section 1.861-12 is added as follows:


Sec.  1.861-12  Characterization rules and adjustments for certain 
assets.

    (a) through (c)(1) [Reserved]. For further guidance, see Sec.  
1.861-12T(a) through (c)(1).
    (2) Basis adjustment for stock in nonaffiliated 10 percent owned 
corporations-- (i) Taxpayers using the tax book value method--(A) 
General rule. For purposes of apportioning expenses on the basis of the 
tax book value of assets, the adjusted basis of any stock in a 10 
percent owned corporation owned by the taxpayer either directly or, for 
taxable years beginning after April 25, 2006, indirectly through a 
partnership or other pass-through entity shall be--
    (1) Increased by the amount of the earnings and profits of such 
corporation (and of lower-tier 10 percent owned corporations) 
attributable to such stock and accumulated during the period the 
taxpayer or other members of its affiliated group held 10 percent or 
more of such stock; or
    (2) Reduced (but not below zero) by any deficit in earnings and 
profits of such corporation (and of lower-tier 10 percent owned 
corporations) attributable to such stock for such period.
    (c)(2)(i)(B) through (c)(3) [Reserved] For further guidance, see 
Sec.  1.861-12T(c)(2)(i)(B) through (c)(3).
    (4) Characterization of stock of noncontrolled section 902 
corporations--(i) General rule. The principles of Sec.  1.861-12T(c)(3) 
shall apply to stock in a noncontrolled section 902 corporation (as 
defined in section 904(d)(2)(E)). Accordingly, stock in a noncontrolled 
section 902 corporation shall be characterized as an asset in the 
various separate limitation categories on the basis of either the asset 
method described in Sec.  1.861-12T(c)(3)(ii) or the modified gross 
income method described in Sec.  1.861-12T(c)(3)(iii). Stock in a 
noncontrolled section 902 corporation the interest expense of which is 
apportioned on the basis of assets shall be characterized in the hands 
of its domestic shareholders (as defined in Sec.  1.902-1(a)(1)) under 
the asset method described in Sec.  1.861-12T(c)(3)(ii). Stock in a 
noncontrolled section 902 corporation the interest expense of which is 
apportioned on the basis of gross income shall be characterized in the 
hands of its domestic shareholders under the gross income method 
described in Sec.  1.861-12T(c)(3)(iii).
    (ii) Nonqualifying shareholders. Stock in a noncontrolled section 
902 corporation shall be characterized as a passive category asset in 
the hands of a shareholder that is not eligible to compute an amount of 
foreign taxes deemed paid with respect to a dividend from the 
noncontrolled section 902 corporation for the taxable year, and in the 
hands of any shareholder with respect to whom look-through treatment is 
not substantiated. See Sec.  1.904-5(c)(4)(iii).
    (5) Effective/applicability date. Paragraphs (c)(2)(i)(A) and (4) 
of this section apply to taxable years of shareholders ending on or 
after April 20, 2009. See 26 CFR Sec.  1.861-12T(c)(2)(i) introductory 
text, (2)(i)(A), (2)(i)(B), and (4) (revised as of April 1, 2009) for 
rules applicable to taxable years of shareholders ending after the 
first day of the first taxable year of the

[[Page 27875]]

noncontrolled section 902 corporation beginning after December 31, 
2002, and ending before April 20, 2009.
    (d) through (j) [Reserved]. For further guidance, see Sec.  1.861-
12T(d) through (j).

0
Par. 5. Section 1.861-12T is amended as follows:
0
1. Paragraph (c)(2)(i) introductory text is removed.
0
2. Paragraph (c)(2)(i)(A) is revised.
0
3. Paragraph (c)(2)(i)(B) is removed.
0
4. A paragraph heading is added to the undesignated text following 
paragraph (c)(2), which is designated as new paragraph (c)(2)(i)(B).
0
5. Paragraph (c)(4) is revised.
0
6. A new paragraph (c)(5) is added.
    The revisions and additions read as follows:


Sec.  1.861-12T  Characterization rules and adjustments for certain 
assets (temporary).

* * * * *
    (c) * * *
    (2)(i)(A) [Reserved]. For further guidance, see Sec.  1.861-
12(c)(2)(i)(A).
    (B) Computational rules. * * *
    (4) [Reserved]. For further guidance, see Sec.  1.861-12(c)(4).
    (5) [Reserved]. For further guidance, see Sec.  1.861-12(c)(5).
* * * * *

0
Par. 6. Section 1.902-1 is amended by revising paragraphs (a)(4)(ii), 
(a)(6), (a)(7), (a)(8)(i), (c)(8), (d)(1), (d)(2)(i), and (g) to read 
as follows:


Sec.  1.902-1  Credit for domestic corporate shareholder of a foreign 
corporation for foreign income taxes paid by the foreign corporation.

    (a) * * *
    (4) * * *
    (ii) Fourth-, fifth-, or sixth-tier corporation. In the case of 
dividends paid to a third-, fourth-, or fifth-tier corporation by a 
foreign corporation in a taxable year beginning after August 5, 1997, 
the foreign corporation is a fourth-, fifth-, or sixth-tier 
corporation, respectively, if at the time the dividend is paid, the 
corporation receiving the dividend owns at least 10 percent of the 
foreign corporation's voting stock, the chain of foreign corporations 
that includes the foreign corporation is connected through stock 
ownership of at least 10 percent of their voting stock, the domestic 
shareholder in the first-tier corporation in such chain indirectly owns 
at least 5 percent of the voting stock of the foreign corporation 
through such chain, such corporation is a controlled foreign 
corporation (as defined in section 957) and the domestic shareholder is 
a United States shareholder (as defined in section 951(b)) in the 
foreign corporation. Taxes paid by a fourth-, fifth-, or sixth-tier 
corporation shall be taken into account in determining post-1986 
foreign income taxes only if such taxes are paid with respect to 
taxable years beginning after August 5, 1997, in which the corporation 
was a controlled foreign corporation.
* * * * *
    (6) Upper- and lower-tier corporations. In the case of a sixth-tier 
corporation, the term upper-tier corporation means a first-, second-, 
third-, fourth-, or fifth-tier corporation. In the case of a fifth-tier 
corporation, the term upper-tier corporation means a first-, second-, 
third-, or fourth-tier corporation. In the case of a fourth-tier 
corporation, the term upper-tier corporation means a first-, second-, 
or third-tier corporation. In the case of a third-tier corporation, the 
term upper-tier corporation means a first- or second-tier corporation. 
In the case of a second-tier corporation, the term upper-tier 
corporation means a first-tier corporation. In the case of a first-tier 
corporation, the term lower-tier corporation means a second-, third-, 
fourth-, fifth-, or sixth-tier corporation. In the case of a second-
tier corporation, the term lower-tier corporation means a third-, 
fourth-, fifth-, or sixth-tier corporation. In the case of a third-tier 
corporation, the term lower-tier corporation means a fourth-, fifth-, 
or sixth-tier corporation. In the case of a fourth-tier corporation, 
the term lower-tier corporation means a fifth- or sixth-tier 
corporation. In the case of a fifth-tier corporation, the term lower-
tier corporation means a sixth-tier corporation.
    (7) Foreign income taxes. The term foreign income taxes means 
income, war profits, and excess profits taxes as defined in Sec.  
1.901-2(a), and taxes included in the term income, war profits, and 
excess profits taxes by reason of section 903, that are imposed by a 
foreign country or a possession of the United States, including any 
such taxes deemed paid by a foreign corporation under this section. 
Foreign income, war profits, and excess profits taxes shall not include 
amounts excluded from the definition of those taxes pursuant to section 
901 and the regulations under that section. See section 901(f) and (i) 
and paragraph (c)(5) of this section. Foreign income, war profits, and 
excess profits taxes also shall not include taxes for which a credit is 
disallowed under section 901 and the regulations under section 901. See 
section 901(j), (k), and (l), and paragraphs (c)(4) and (8) of this 
section.
    (8) Post-1986 foreign income taxes--(i) In general. Except as 
provided in paragraphs (a)(10) and (13) of this section, the term post-
1986 foreign income taxes of a foreign corporation means the sum of the 
foreign income taxes paid, accrued, or deemed paid in the taxable year 
of the foreign corporation in which it distributes a dividend plus the 
foreign income taxes paid, accrued, or deemed paid in the foreign 
corporation's prior taxable years beginning after December 31, 1986, to 
the extent the foreign taxes were not attributable to dividends 
distributed to, or earnings otherwise included (for example, under 
section 304, 367(b), 551, 951(a), 1248, or 1293) in the income of, a 
foreign or domestic shareholder in prior taxable years. Except as 
provided in paragraph (b)(4) of this section, foreign taxes paid or 
deemed paid by the foreign corporation on or with respect to earnings 
that were distributed or otherwise removed from post-1986 undistributed 
earnings in prior post-1986 taxable years shall be removed from post-
1986 foreign income taxes regardless of whether the shareholder is 
eligible to compute an amount of foreign taxes deemed paid under 
section 902, and regardless of whether the shareholder in fact chose to 
credit foreign income taxes under section 901 for the year of the 
distribution or inclusion. Thus, if an amount is distributed or deemed 
distributed by a foreign corporation to a United States person that is 
not a domestic shareholder within the meaning of paragraph (a)(1) of 
this section (for example, an individual or a corporation that owns 
less than 10% of the foreign corporation's voting stock), or to a 
foreign person that does not meet the definition of an upper-tier 
corporation under paragraph (a)(6) of this section, then although no 
foreign income taxes shall be deemed paid under section 902, foreign 
income taxes attributable to the distribution or deemed distribution 
that would have been deemed paid had the shareholder met the ownership 
requirements of paragraphs (a)(1) through (4) of this section shall be 
removed from post-1986 foreign income taxes. Further, if a domestic 
shareholder chooses to deduct foreign taxes paid or accrued for the 
taxable year of the distribution or inclusion, it shall nonetheless be 
deemed to have paid a proportionate share of the foreign corporation's 
post-1986 foreign income taxes under section 902(a), and the foreign 
income taxes deemed paid must be removed from post-1986 foreign income 
taxes. In the case of a foreign corporation the foreign income taxes of 
which are determined based on an accounting period of less than one 
year,

[[Page 27876]]

the term year means that accounting period. See sections 441(b)(3) and 
443.
* * * * *
    (c) * * *
    (8) Effect of certain liquidations, reorganizations, or similar 
transactions on certain foreign taxes paid or accrued in taxable years 
beginning on or before August 5, 1997--(i) General rule. 
Notwithstanding the effect of any liquidation, reorganization, or 
similar transaction, foreign taxes paid or accrued by a member of a 
qualified group (as defined in section 902(b)(2)) shall not be eligible 
to be deemed paid if they were paid or accrued in a taxable year 
beginning on or before August 5, 1997, by a corporation that was a 
fourth-, fifth- or sixth-tier corporation with respect to the taxpayer 
on the first day of the corporation's first taxable year beginning 
after August 5, 1997.
    (ii) Example. The following examples illustrate the application of 
this paragraph (c)(8):

    Example. P, a domestic corporation, has owned 100 percent of the 
voting stock of foreign corporation S at all times since January 1, 
1987. Until June 30, 2002, S owned 100 percent of the voting stock 
of foreign corporation T, T owned 100 percent of the voting stock of 
foreign corporation U, and U owned 100 percent of the voting stock 
of foreign corporation V. P, S, T, U, and V each use the calendar 
year as their U.S. taxable year. Thus, beginning in 1998 V was a 
fourth-tier controlled foreign corporation, and its foreign taxes 
paid or accrued in 1998 and later taxable years were eligible to be 
deemed paid. On June 30, 2002, T was liquidated, causing S to 
acquire 100 percent of the stock of U. As a result, V became a 
third-tier controlled foreign corporation. In 2003, V paid a 
dividend to U. Under paragraph (c)(8) of this section, foreign taxes 
paid by V in taxable years beginning before 1998 are not taken into 
account in computing the foreign taxes deemed paid with respect to 
the dividend paid by V to U.

    (d) Dividends from controlled foreign corporations and 
noncontrolled section 902 corporations--(1) General rule. If a dividend 
is described in paragraphs (d)(1)(i) through (iv) of this section, the 
following rules apply. If a dividend is paid out of post-1986 
undistributed earnings or pre-1987 accumulated profits of a foreign 
corporation attributable to more than one separate category, the amount 
of foreign income taxes deemed paid by the domestic shareholder or the 
upper-tier corporation under section 902 and paragraph (b) of this 
section shall be computed separately with respect to the post-1986 
undistributed earnings or pre-1987 accumulated profits in each separate 
category out of which the dividend is paid. See Sec.  1.904-5(c)(4) and 
(i), and paragraph (d)(2) of this section. The separately computed 
deemed-paid taxes shall be added to other taxes paid by the domestic 
shareholder or upper-tier corporation with respect to income in the 
appropriate separate category. The rules of this paragraph (d)(1) apply 
to dividends received by --
    (i) A domestic shareholder that is a United States shareholder (as 
defined in section 951(b) or section 953(c)) from a first-tier 
corporation that is a controlled foreign corporation;
    (ii) A domestic shareholder from a first-tier corporation that is a 
noncontrolled section 902 corporation;
    (iii) An upper-tier controlled foreign corporation from a lower-
tier controlled foreign corporation if the corporations are related 
look-through entities within the meaning of Sec.  1.904-5(i) (see Sec.  
1.904-5(i)(3)); or
    (iv) A foreign corporation that is eligible to compute an amount of 
foreign taxes deemed paid under section 902(b)(1), from a controlled 
foreign corporation or a noncontrolled section 902 corporation (that 
is, both the payor and payee corporations are members of the same 
qualified group as defined in section 902(b)(2) (see Sec.  1.904-5 
(i)(4)).
    (2) Look-through--(i) Dividends. Any dividend distribution by a 
controlled foreign corporation or noncontrolled section 902 corporation 
to a domestic shareholder or a foreign corporation that is eligible to 
compute an amount of foreign taxes deemed paid under section 902(b)(1) 
shall be deemed paid pro rata out of each separate category of income. 
Any dividend distribution by a controlled foreign corporation to a 
controlled foreign corporation that is a related look-through entity 
within the meaning of Sec.  1.904-5(i)(3) shall also be deemed to be 
paid pro rata out of each separate category of income. See Sec. Sec.  
1.904-5(c)(4) and (i), and 1.904-7. The portion of the foreign income 
taxes attributable to a particular separate category that shall be 
deemed paid by the domestic shareholder or upper-tier corporation must 
be computed under the following formula:
[GRAPHIC] [TIFF OMITTED] TR11JN09.004

    (g) Effective/applicability dates. This section applies to any 
distribution made in and after a foreign corporation's first taxable 
year beginning on or after January 1, 1987, except that the provisions 
of paragraphs (a)(4)(ii), (a)(6), (a)(7), (a)(8)(i), and (c)(8) of this 
section and, except as provided in Sec.  1.904-7(f)(9), the provisions 
of paragraph (d) of this section apply to distributions made in taxable 
years of foreign corporations ending on or after April 20, 2009. See 26 
CFR 1.902-1T(a)(4)(ii), (a)(6), (a)(7), (a)(8)(i), and (c)(8) (revised 
as of April 1, 2