Centralized Partnership Audit Regime: International Tax Rules, 56765-56779 [2017-25740]

Agencies

• Internal Revenue Service
• DEPARTMENT OF THE TREASURY

[Federal Register Volume 82, Number 229 (Thursday, November 30, 2017)]
[Proposed Rules]
[Pages 56765-56779]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2017-25740]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 301

[REG-119337-17]
RIN 1545-BN95


Centralized Partnership Audit Regime: International Tax Rules

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking.

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SUMMARY: This document contains proposed regulations implementing 
section 1101 of the Bipartisan Budget Act of 2015 (BBA), which was 
enacted into law on November 2, 2015. Section 1101 of the BBA repeals 
the current rules governing partnership audits and replaces them with a 
new centralized partnership audit regime that, in general, assesses and 
collects tax at the partnership level. These proposed regulations 
provide rules addressing how certain international rules operate in the 
context of the centralized partnership audit regime, including rules 
relating to the withholding of tax on foreign persons, withholding of 
tax to enforce reporting on certain foreign accounts, and the treatment 
of creditable foreign tax expenditures of a partnership.

DATES: Written or electronic comments and requests for a public hearing 
must be received by January 29, 2018.

ADDRESSES: Send submissions to: CC:PA:LPD:PR (REG-119337-17), Room 
5207, Internal Revenue Service, P.O. Box 7604, Ben Franklin Station, 
Washington, DC 20044. Submissions may be hand delivered Monday through 
Friday between the hours of 8:00 a.m. and 4:00 p.m. to CC:PA:LPD:PR 
(REG-119337-17), Courier's Desk, Internal Revenue Service, 1111 
Constitution Avenue NW., Washington, DC 20224, or sent electronically 
via the Federal eRulemaking Portal at www.regulations.gov (IRS REG-
119337-17).

FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations 
relating to creditable foreign tax expenditures, Larry R. Pounders, 
Jr., of the Office of Associate Chief Counsel (International), (202) 
317-5465; concerning the proposed regulations relating to chapters 3 
and 4 of subtitle A of the Internal Revenue Code (other than section 
1446), Subin Seth of the Office of Associate Chief Counsel 
(International), (202) 317-5003; concerning the proposed regulations 
relating to section 1446, Ronald M.

[[Page 56766]]

Gootzeit of the Office of Associate Chief Counsel (International), 
(202) 317-4953; concerning the submission of comments or a request for 
a public hearing, Regina Johnson, (202) 317-6901 (not toll-free 
numbers).

SUPPLEMENTARY INFORMATION: 

Background

    This document contains proposed amendments to 26 CFR part 301. 
These proposed regulations supplement the regulations proposed in the 
notice of proposed rulemaking (REG-136118-15) published in the Federal 
Register on June 14, 2017 (82 FR 27334) (the ``June 14 NPRM'') and 
amend the Procedure and Administration Regulations (26 CFR part 301) 
under Subpart--Tax Treatment of Partnership Items to implement the 
centralized partnership audit regime.

1. The New Centralized Partnership Audit Regime

    For information relating to (1) the new centralized partnership 
audit regime enacted by the BBA, Public Law 114-74 (129 Stat. 58 
(2015)) (as amended by the Protecting Americans from Tax Hikes Act of 
2015, Public Law 114-113 (129 Stat. 2242 (2015))); (2) Notice 2016-23 
(2016-13 I.R.B. 490 (March 28, 2016)), which requested comments on the 
new partnership audit regime enacted by the BBA; and (3) the temporary 
regulations (TD 9780, 81 FR 51795) and a notice of proposed rulemaking 
(REG-105005-16, 81 FR 51835), which provided the time, form, and manner 
for a partnership to make an election into the centralized partnership 
audit regime for a partnership taxable year beginning before the 
general effective date of the regime, see the Background section of the 
June 14 NPRM.

2. Proposed Regulations Implementing the Centralized Partnership Audit 
Regime

    The June 14 NPRM addresses various issues concerning the scope and 
process of the new centralized partnership audit regime. Unless 
otherwise noted, all references to proposed regulations in this 
Background refer to regulations proposed by the June 14 NPRM.
    With respect to the scope of the centralized partnership audit 
regime, proposed Sec.  301.6221(a)-1(a) provides that any adjustment to 
items of income, gain, loss, deduction, or credit of a partnership and 
any partner's distributive share is determined at the partnership 
level. Proposed Sec.  301.6221(a)-1(b)(1) broadly defines the phrase 
``items of income, gain, loss, deduction, or credit'' to include all 
items and information required to be shown, or reflected, on a 
partnership return or maintained in the partnership's books and 
records. For example, proposed Sec.  301.6221(a)-1(b)(1)(i)(A) provides 
that the character, timing, source, and amount of the partnership's 
income, gain, loss, deductions, and credits, including whether an item 
is deductible, tax-exempt, or a tax-preference item, must be determined 
under the centralized partnership audit regime. Similarly, proposed 
Sec.  301.6221(a)-1(b)(1)(i)(F) provides that an adjustment to the 
separate category, timing, and amount of the partnership's creditable 
foreign tax expenditures described in Sec.  1.704-1(b)(4)(viii)(b), is 
included within the centralized partnership audit regime. Finally, 
proposed Sec.  301.6221(a)-1(d) provides that the IRS is not precluded 
from making an adjustment to an item that must be determined under the 
centralized partnership audit regime for purposes of determining taxes 
imposed by provisions of the Internal Revenue Code (the Code) outside 
of chapter 1 of subtitle A (chapter 1).
    Proposed Sec.  301.6222-1 generally requires a partner to treat 
items consistently with the partnership's return; however, a partner 
may take an inconsistent position on an original income tax return if 
the partner provides notice of the inconsistent position in accordance 
with proposed Sec.  301.6222-1(c). If a partner treats an item 
inconsistently with the partnership return position without providing 
notice, the item may be adjusted to conform to the partnership return, 
and any underpayment resulting from that adjustment may be assessed and 
collected as if it were on account of a mathematical or clerical error 
appearing on the partner's return.
    Proposed Sec.  301.6223-1 provides rules relating to the 
designation of the partnership representative. Proposed Sec.  301.6223-
2 provides rules relating to the authority of the partnership 
representative and the effect of actions taken by the partnership 
through the partnership representative. Partners are bound by the 
actions of the partnership representative and may not take a position 
that is inconsistent with the actions of the partnership (except with 
notice on the partner's return, as provided under section 6222 and 
proposed Sec.  301.6222-1).
    Proposed Sec. Sec.  301.6225-1, 301.6225-2, and 301.6225-3 provide 
rules relating to partnership adjustments, including the computation of 
the imputed underpayment, modification of the imputed underpayment, and 
the treatment of adjustments that do not result in an imputed 
underpayment. Under proposed Sec.  301.6225-1(d), adjustments are 
separated into four groupings: the reallocation grouping, the credit 
grouping, the creditable expenditure grouping, and the residual 
grouping. The June 14 NPRM reserved Sec.  301.6225-1(d)(2)(iv) for 
rules addressing the treatment of items in the creditable expenditure 
grouping. Each grouping is further divided into subgroupings of 
adjustments to account for preferences, restrictions, limitations, and 
conventions. For example, an adjustment in the residual grouping could 
be further divided into subgroupings by character, source, category, 
and other restrictions under the Code.
    Under proposed Sec.  301.6225-1, the net positive adjustments in 
all subgroupings of the residual and reallocation groupings are summed. 
The sum is the total netted partnership adjustment, which is multiplied 
by the highest applicable tax rate in effect for the reviewed year (as 
defined in proposed Sec.  301.6241-1(a)(8)). The resulting figure is 
then increased, or decreased, by the net adjustments in the credit 
grouping to produce the imputed underpayment amount. A net non-positive 
adjustment in the reallocation grouping or the residual grouping (or 
any subgrouping thereof) is treated as an adjustment that does not 
result in an imputed underpayment and is taken into account in the 
adjustment year (as defined under proposed Sec.  301.6241-1(a)(1)) 
under proposed Sec.  301.6225-3.
    The partnership may request a modification, under proposed Sec.  
301.6225-2, to adjust the imputed underpayment calculated under 
proposed Sec.  301.6225-1. The modification rules set out in proposed 
Sec.  301.6225-2 generally allow: (1) Modifications that result in the 
exclusion of certain adjustments, or portions thereof, from the 
calculation of the imputed underpayment (such as a modification under 
proposed Sec.  301.6225-2(d)(2) (amended returns by partners), (d)(3) 
(tax-exempt partners), (d)(5) (certain passive losses of publicly 
traded partnerships), (d)(7) (partnerships with partners that are 
qualified investment entities described in section 860), (d)(8) 
(partner closing agreements), and, if applicable, (d)(9) (other 
modifications)); (2) rate modifications, which affect only the taxable 
rate applied to the total netted partnership adjustment (described in 
proposed Sec.  301.6225-2(d)(4)); and (3) modifications to the number 
and composition of imputed underpayments (described in proposed Sec.  
301.6225-2(d)(6)).

[[Page 56767]]

    Proposed Sec.  301.6225-3 sets forth rules for the treatment of 
adjustments that do not result in an imputed underpayment. In general, 
pursuant to proposed Sec.  301.6225-3(b)(1) the partnership takes the 
adjustment into account in the adjustment year as a reduction in non-
separately stated income or as an increase in non-separately stated 
loss depending on whether the adjustment is to an item of income or 
loss. Proposed Sec.  301.6225-3(b)(2) provides that if an adjustment is 
to an item that is required to be separately stated under section 702, 
the adjustment shall be taken into account by the partnership on its 
adjustment year return as an adjustment to such separately stated item. 
Proposed Sec.  301.6225-3(b)(3) provides that an adjustment to a credit 
is taken into account as a separately stated item.
    Proposed Sec. Sec.  301.6226-1, 301.6226-2, and 301.6226-3 provide 
rules relating to the election under section 6226 by a partnership to 
have its partners take into account the partnership adjustments in lieu 
of paying the imputed underpayment determined under section 6225, the 
statements the partnership must send to its partners (including the 
computation of the partners' safe harbor amounts), and the computation 
and payment of the partners' liability. If a partnership makes the 
election under section 6226 to ``push out'' adjustments to its reviewed 
year partners, the partnership is not liable for the imputed 
underpayment. Instead, under proposed Sec.  301.6226-3, reviewed year 
partners must either pay any additional chapter 1 tax that results from 
taking the adjustments reflected on the statements into account in the 
reviewed year and from changes to the tax attributes in the intervening 
years, or pay a safe harbor amount, which is calculated based on rules 
similar to those used to calculate the imputed underpayment. In 
addition to being liable for the additional tax or safe harbor amount, 
the partner must also pay its allocable share of any penalties, 
additions to tax, or additional amounts reflected on the statement from 
the partnership, and any interest determined in accordance with 
proposed Sec.  301.6226-3(d).
    Proposed Sec.  301.6227-1 provides rules for a partnership to file 
an administrative adjustment request (AAR). A partnership subject to 
the centralized partnership audit regime may file a request for an 
administrative adjustment to one or more items of income, gain, loss, 
deduction, or credit of the partnership for any partnership taxable 
year. Filing an AAR is the only mechanism provided by the centralized 
partnership audit regime to request a change to an item reported on a 
partnership return that has already been filed with the IRS. Proposed 
Sec.  301.6227-1(a) provides that only a partnership representative 
acting on behalf of the partnership may file an AAR; a partner may not 
make a request for an item to be adjusted administratively, such as by 
filing an amended return to take a position that is inconsistent with 
the partnership return. However, this rule does not preclude a partner 
from taking an inconsistent position on an original income tax return 
if the partner provides notice of the inconsistent position in 
accordance with proposed Sec.  301.6222-1(c).
    Proposed Sec. Sec.  301.6227-2 and 301.6227-3 provide rules for how 
the partnership accounts for adjustments in an AAR and for how partners 
must account for adjustments in an AAR, respectively. Subject to 
certain special rules, adjustments in an AAR are generally taken into 
account in a manner similar to IRS-initiated adjustments. For example, 
an adjustment requested in an AAR may result in an imputed underpayment 
calculated in a manner similar to the computation of the imputed 
underpayment under section 6225, although modification is more 
restricted in the context of an AAR (see proposed Sec.  301.6227-
2(a)(2)). The partnership must pay the imputed underpayment or elect to 
have it and its partners take the adjustments into account under rules 
similar to those under section 6226. One significant difference between 
an IRS-initiated adjustment and an adjustment requested in an AAR is 
that requested adjustments that do not result in an imputed 
underpayment are accounted for under rules similar to those under 
section 6226.
    Finally, proposed Sec.  301.6241-1 provides definitions for 
purposes of the centralized partnership audit regime.

Explanation of Provisions

1. In General

    These proposed regulations provide guidance on certain 
international issues related to the centralized partnership audit 
regime. This Explanation of Provisions proceeds as follows: Part 2 
discusses provisions related to chapters 3 and 4 of subtitle A of the 
Code. Part 3 discusses provisions related to creditable foreign tax 
expenditures and foreign tax credits. Part 4 discusses issues related 
to treaties and reductions to the rate of tax on foreign persons under 
the Code. Part 5 discusses issues related to certain foreign 
corporations.
    Unless otherwise stated, all references to proposed regulations in 
this Explanation of Provisions are to the new proposed regulations in 
this Notice of Proposed Rulemaking. Because these regulations are 
supplementing the regulations published in the June 14 NPRM, the 
numbering and ordering of some of the provisions do not follow typical 
conventions. The Department of the Treasury (Treasury Department) and 
the IRS intend to appropriately integrate these provisions when both 
these regulations and the proposed regulations in the June 14 NPRM are 
finalized.

2. Provisions Related to Chapters 3 and 4 of Subtitle A of the Code

A. Background
    Chapter 3 (Withholding of Tax on Nonresident Aliens and Foreign 
Corporations) of subtitle A of the Code imposes withholding 
requirements on payments or allocations of income to foreign persons 
(under sections 1441 through 1446) and provides rules regarding the 
application of those withholding provisions (under sections 1461 
through 1464). Sections 1441 and 1442 require all persons having the 
control, receipt, custody, disposal, or payment of certain specified 
items of income of any nonresident alien, foreign partnership, or 
foreign corporation to withhold tax at a 30-percent rate from such 
items unless a reduced rate of withholding applies. Amounts subject to 
withholding under sections 1441 and 1442 include amounts from sources 
within the United States that constitute fixed or determinable annual 
or periodical income, which in turn is defined under Sec.  1.1441-
2(b)(1)(i) to include all income included in gross income under section 
61, subject to certain exceptions. In addition to being required to 
withhold on a payment made to a foreign person, a domestic (U.S.) 
partnership is required to withhold under sections 1441 and 1442 on an 
amount subject to withholding that is includible in the gross income of 
a partner that is a foreign person. See Sec.  1.1441-5(b)(2)(i). A 
foreign partnership may also be required to withhold with respect to 
its foreign partners under sections 1441 and 1442 if it is either a 
foreign withholding partnership as described in Sec.  1.1441-5(c)(2), 
or fails to meet the requirements described in Sec.  1.1441-5(c)(3)(v). 
A partnership satisfies its withholding requirements with respect to 
its foreign partners by withholding on distributions made to the 
partner that include amounts subject to withholding, or, to the extent 
the partnership's withholding liability is not satisfied by withholding 
on distributions, by

[[Page 56768]]

withholding on the partner's distributive share. See Sec.  1.1441-
5(b)(2)(i).
    Section 1446 requires a partnership to pay withholding tax to the 
extent that the partnership has effectively connected taxable income 
(ECTI) that is allocable to a foreign partner, at the highest rate 
applicable to that partner. See Sec.  1.1446-3(a)(2). ECTI generally 
refers to the partnership's taxable income as computed under section 
703, with adjustments as provided in section 1446(c) and Sec.  1.1446-
2, and computed with consideration of only those partnership items that 
are effectively connected (or treated as effectively connected) with 
the conduct of a trade or business in the United States. See Sec.  
1.1446-2.
    Section 1443 imposes withholding requirements on certain payments 
or allocations of income made to foreign tax-exempt organizations, 
including income includible under section 512 for computing unrelated 
business taxable income (subject to section 1443(a)) and income subject 
to tax under section 4948 (subject to section 1443(b)). Because the tax 
under section 4948 is not a chapter 1 tax, and therefore is not 
implicated by the centralized partnership audit regime, references to 
chapter 3 in this preamble and these proposed regulations refer to the 
provisions in chapter 3 of subtitle A of the Code, excluding section 
1443(b). See proposed Sec.  301.6225-1(a)(4).
    Section 1445 imposes withholding requirements upon the disposition 
of a U.S. real property interest (as defined in section 897(c)) by a 
foreign person and certain related distributions. To the extent that a 
partnership's income from the disposition of a U.S. real property 
interest is allocable to a foreign partner, the partnership is subject 
to the requirements under section 1446. See Sec. Sec.  1.1446-2; 
1.1446-3(c)(2).
    Chapter 4 (Taxes to Enforce Reporting on Certain Foreign Accounts) 
of subtitle A of the Code (chapter 4) requires a withholding agent (as 
defined in Sec.  1.1473-1(d)) to withhold tax at a 30-percent rate on a 
withholdable payment (as defined in Sec.  1.1473-1(a)) made to a 
foreign financial institution (FFI) unless the FFI has entered into an 
agreement described in section 1471(b) to obtain status as a 
participating FFI, or the FFI is deemed to have satisfied the 
requirements of section 1471(b). A participating FFI is required to 
withhold tax with respect to payments made to recalcitrant account 
holders (as defined in Sec.  1.1471-5(g)(2)) and nonparticipating FFIs 
(as defined in Sec.  1.1471-1(b)(82)) to the extent required under 
Sec.  1.1471-4(b). Chapter 4 also generally requires a withholding 
agent to withhold tax at a 30-percent rate on a withholdable payment 
made to a nonfinancial foreign entity (NFFE) unless the NFFE has 
provided information to the withholding agent with respect to the 
NFFE's substantial U.S. owners or has certified that it has no such 
owners. See section 1472.
    Under sections 1461 and 1474, any person required to withhold tax 
under chapters 3 and 4 is made liable for such tax, and may also be 
liable for any penalties, additions to tax, additional amounts, and 
interest that may apply for failure to timely pay the tax required to 
be withheld. To the extent that the tax required to be withheld is paid 
by the beneficial owner of the income (as defined in Sec. Sec.  1.1441-
1(c)(6) and 1.1471-1(b)(8)) or by the withholding agent (as defined in 
Sec. Sec.  1.1441-7(a)(1) and 1.1473-1(d)), the tax will not be 
collected a second time from the other; however, the person that did 
not pay the tax is not relieved from liability for any penalties, 
additions to tax, or interest that may apply. See Sec. Sec.  1.1446-
3(e); 1.1463-1; 1.1474-4.
    Under Sec. Sec.  1.1462-1 and 1.1474-3, a beneficial owner is 
required to include in gross income the entire amount of income from 
which tax is required to be withheld, but the amount of any tax 
actually withheld (including any amount withheld on a partner's 
distributive share) is allowed as a credit under section 33 against the 
beneficial owner's income tax liability. Similarly, under Sec.  1.1446-
3(d)(2)(i), the amount of section 1446 tax paid by the partnership that 
is allocable to a foreign partner is allowed as a credit under section 
33 against the partner's income tax liability. In general, because the 
beneficial owner will have gross income during the taxable year when 
the withholding occurs, the beneficial owner will be required to file a 
U.S. income tax return for that year. See section 6012. However, a 
beneficial owner's requirement to file a return is waived when it is 
not engaged in a U.S. trade or business and its tax liability has been 
fully satisfied through withholding at source. See Sec. Sec.  1.6012-
1(b)(2)(i); 1.6012-2(g)(2)(i).
B. Coordination of the Centralized Partnership Audit Regime With 
Chapters 3 and 4
    Proposed Sec.  301.6221(a)-1(a) (June 14 NPRM) provides that all 
adjustments to items of income, gain, loss, deduction, or credit of a 
partnership, and any partner's distributive share of those adjusted 
items are determined, and any tax attributable thereto is assessed and 
collected, at the partnership level under the centralized partnership 
audit regime. Proposed Sec.  301.6221(a)-1(b)(1)(i) (June 14 NPRM) 
broadly defines the phrase ``items of income, gain, loss, deduction, or 
credit'' to include all items and information required to be shown, or 
reflected, on a partnership return or maintained in the partnership's 
books and records. Proposed Sec.  301.6221(a)-1(b)(3) (June 14 NPRM) 
defines tax for purposes of the centralized partnership audit regime to 
be the tax imposed by chapter 1. Proposed Sec.  301.6221(a)-1(d) (June 
14 NPRM), however, provides that nothing in subchapter C of chapter 63 
and the regulations thereunder (the centralized partnership audit 
regime) precludes the IRS from making any adjustment to any of these 
items for purposes of determining taxes imposed by other chapters of 
the Code. The preamble to the June 14 NPRM explains that those taxes 
that are not covered by the centralized partnership audit regime 
include taxes imposed by chapters 3 and 4. Accordingly, the IRS will 
continue to examine a partnership's compliance with its obligations 
under chapters 3 and 4 in a proceeding outside of the centralized 
partnership audit regime.
    As discussed in Part 2.A of this Explanation of Provisions, a 
partnership that receives a payment or has income allocable to a 
partner that is a foreign person, an FFI, or an NFFE may have 
withholding requirements under chapters 3 and 4. These requirements are 
imposed on the partnership to ensure that any chapter 1 tax owed by its 
partners with respect to the item of income is collected, or in the 
case of chapter 4, to ensure compliance with certain information 
reporting obligations regarding U.S. persons that hold foreign 
financial accounts or interests in passive foreign entities. The 
provisions of chapters 3 and 4, therefore, create a collection 
mechanism for tax that would otherwise be due from the beneficial owner 
of the income under chapter 1. This could potentially result in taxes 
being collected twice and, for this reason, and as discussed in Part 
2.A of this Explanation of Provisions, chapters 3 and 4 provide that 
the tax is collected only once--either from the withholding agent or 
from the beneficial owner of the income. Similarly, because an imputed 
underpayment may now be assessed and collected at the partnership level 
under the centralized partnership audit regime, and is designed to 
closely reflect the chapter 1 tax that the partners would have reported 
and paid had the partnership and partners reported

[[Page 56769]]

correctly, coordination rules are necessary to clarify how the 
centralized partnership audit regime interacts with a partnership's 
obligations under chapters 3 and 4, and to ensure that tax is collected 
only once with respect to the same item of income.
    To demonstrate the rules regarding the scope of the centralized 
partnership audit regime and the examination of the partnership's 
obligations under chapters 3 and 4 outside of the centralized 
partnership audit regime, these proposed regulations provide examples 
that illustrate what occurs when (1) a partnership fails to withhold at 
the correct rate on an item of income allocable to a foreign partner, 
and (2) a partnership fails to report an item of income and, therefore, 
also fails to withhold on the additional income allocable to a foreign 
partner. Example 1 under proposed Sec.  301.6221(a)-1(f) clarifies that 
a partnership's withholding tax liability for failure to withhold at 
the correct rate on an item of income that the partnership received and 
properly reported on its partnership return may be adjusted by the IRS 
under the procedures applicable to an examination under chapter 3 or 
chapter 4, and that the procedures under the centralized partnership 
audit regime do not apply to the adjustment. The same result would 
occur on a partnership's failure to withhold at the correct rate under 
section 1441 on a payment made to an unrelated foreign person, or upon 
a partnership's failure to withhold as a transferee of a U.S. real 
property interest at the correct rate under section 1445. Example 2 
under proposed Sec.  301.6221(a)-1(f) presents a case in which the 
partnership has failed to report on its partnership return an item of 
income that it received for which it would have had a withholding 
obligation under chapters 3 and 4, and the failure to report the item 
is discovered in an examination of the partnership's compliance with 
its obligations under chapters 3 and 4. Because an adjustment to 
increase the partnership's income would be an adjustment to an item of 
income of the partnership, it would be subject to the centralized 
partnership audit regime. See proposed Sec.  301.6221(a)-1(a) (June 14 
NPRM). However, under proposed Sec.  301.6221(a)-1(d) (June 14 NPRM), 
the IRS is not precluded from determining an adjustment to the same 
item under chapters 3 and 4 outside of the centralized partnership 
audit regime.
    To address situations in which an item subject to the centralized 
partnership audit regime is also subject to the rules under chapters 3 
and 4, these proposed regulations provide rules that coordinate the 
interaction between the separate regimes, and ensure that tax is 
collected only once with respect to the same adjustment. When an 
examination of the partnership's obligations under chapters 3 and 4 is 
conducted before the initiation of an administrative proceeding under 
the centralized partnership audit regime, proposed Sec.  301.6225-
1(c)(5) provides that to the extent that the IRS has collected tax 
under chapter 3 or chapter 4 attributable to an adjustment to an amount 
subject to withholding (as defined in Sec.  301.6226-2(h)(3)(i)), that 
adjustment (or portion thereof) will be disregarded for purposes of 
calculating the total netted partnership adjustment (upon which the 
imputed underpayment amount is determined) under the centralized 
partnership audit regime. When the IRS has not collected tax under 
chapter 3 or chapter 4 on an amount subject to withholding, and the 
partnership is subject to examination under the centralized audit 
partnership regime, proposed Sec.  301.6225-1(a)(4) provides that if 
the partnership pays the imputed underpayment pursuant to section 6225, 
and the total netted partnership adjustment (upon which the imputed 
underpayment amount is determined) includes an adjustment to an amount 
subject to withholding under chapter 3 or chapter 4, the partnership is 
treated as having paid the amount required to be withheld with respect 
to that adjustment under chapter 3 or chapter 4 for purposes of 
applying Sec.  1.1463-1 or Sec.  1.1474-4. Therefore, the partnership 
is considered to have satisfied its withholding tax liability 
associated with the adjustment. The partnership, however, is not 
relieved from any interest, penalties, or additions to tax that may 
otherwise apply under current rules for failure to withhold under 
chapters 3 and 4. See Sec. Sec.  1.1461-1(a)(2); 1.1461-3; 1.1474-1(h). 
Under proposed Sec.  301.6227-2(b)(3), this same rule applies when the 
partnership pays the imputed underpayment in an AAR pursuant to section 
6227.
C. Requirement To Withhold and Report Under Chapters 3 and 4 Upon a 
Section 6226 Election
    Under section 6226, a partnership may elect to ``push out'' 
adjustments to its reviewed year partners rather than paying an imputed 
underpayment determined under section 6225. If a partnership makes a 
valid election under section 6226 (a section 6226 election), proposed 
Sec.  301.6226-2 (June 14 NPRM) requires it to furnish a statement to 
each reviewed year partner that includes information regarding the 
partner's allocable share of partnership adjustments with respect to 
the imputed underpayment for which the election is made and the 
partner's share of any penalties, additions to tax, or additional 
amounts (a section 6226 statement). The partnership must also calculate 
and include on each section 6226 statement a safe harbor amount and, 
for each reviewed year partner that is an individual, an interest safe 
harbor amount. Under proposed Sec.  301.6226-3 (June 14 NPRM), each 
reviewed year partner must increase its tax imposed under chapter 1 by 
its additional reporting year tax for the taxable year that includes 
the date on which the section 6226 statement is furnished (the 
reporting year). The additional reporting year tax is either the 
aggregate of the adjustment amounts (as computed under proposed Sec.  
301.6226-3(b) (June 14 NPRM)) or the safe harbor amount. In addition, 
each reviewed year partner must also pay its share of any penalties, 
additions to tax, additional amounts, and interest (either as computed 
at the partner level under proposed Sec.  301.6226-3(d)(1) (June 14 
NPRM) or, if applicable, the interest safe harbor amount).
    As discussed in the preamble to the June 14 NPRM, it is the view of 
the Treasury Department and the IRS that, consistent with the purposes 
of chapters 3 and 4, if adjustments reflected on a section 6226 
statement represent additional income allocable to a foreign or 
domestic partner that was not properly accounted for in the reviewed 
year, and the partnership makes a section 6226 election to have the 
partners take the adjustments into account, these allocations of income 
should be subject to the rules in chapters 3 and 4 to the same extent 
that these amounts would have been if they had been properly accounted 
for by the partnership in the reviewed year. Accordingly, these 
proposed regulations provide rules that apply withholding and reporting 
requirements under chapters 3 and 4 to a partnership that makes a 
section 6226 election with respect to a reviewed year partner that 
would have been subject to withholding in the reviewed year, and rules 
that apply to the reviewed year partner when taking these adjustments 
into account. Under proposed Sec.  301.6227-2(b)(4), these same rules 
apply when a partnership elects to have its reviewed year partners take 
into account adjustments requested in an AAR.
    Proposed Sec.  301.6226-2(h)(3)(i) requires a partnership that 
makes a section 6226 election to pay the amount of tax required to be 
withheld under chapters 3 and 4 on any adjustment

[[Page 56770]]

allocable to a reviewed year partner that would have been subject to 
withholding in the reviewed year. The partnership must pay the 
withholding tax (in the manner prescribed by the IRS in forms, 
instructions, and other guidance) on or before the due date for 
furnishing the section 6226 statement that reports the adjusted item. 
Proposed Sec.  301.6226-2(h)(3)(iii) clarifies the reporting 
requirements of chapters 3 and 4, including a requirement to file an 
applicable return (Form 1042, Annual Withholding Tax Return for U.S. 
Source Income of Foreign Persons, or Form 8804, Annual Return for 
Partnership Withholding Tax (Section 1446)) and any associated 
information returns (Forms 1042-S, Foreign Person's U.S. Source Income 
Subject to Withholding, or Forms 8805, Foreign Partner's Information 
Statement of Section 1446 Withholding Tax). The partnership must file 
the return and issue information returns for the partnership's taxable 
year (for withholding reported on Forms 8804 and 8805) or the calendar 
year (for withholding reported on Forms 1042 and 1042-S) that includes 
the date on which the partnership furnishes the section 6226 statement.
    Proposed Sec.  301.6226-2(h)(3)(ii) allows a partnership that is 
required to pay withholding tax under proposed Sec.  301.6226-
2(h)(3)(i) to reduce the amount of that tax to the extent that the 
reviewed year partner provides valid documentation to establish that it 
is entitled to a reduced rate of tax under chapters 3 and 4. For this 
purpose, these proposed regulations allow the partnership to rely on 
documentation that the partnership possesses that is valid with respect 
to the reviewed year (determined without regard to the expiration after 
the reviewed year of any validity period prescribed in chapters 3 and 
4), or new documentation that the partnership obtains from the reviewed 
year partner if the partner includes a signed affidavit stating that 
the associated information and representations are accurate with 
respect to the reviewed year. However, proposed Sec.  301.6226-
2(h)(3)(ii) does not allow the partnership to reduce the amount of 
withholding tax due based on partner-level items as provided in Sec.  
1.1446-6. Consideration of these partner-level items raises 
administrability issues given the partner's activities in the 
intervening taxable years between the reviewed year and the reporting 
year. For example, partner-level deductions and losses certified to the 
partnership for the reviewed year may have been used in a subsequent 
year to offset the partner's allocable share of partnership ECTI or 
income effectively connected (or treated as effectively connected) with 
the conduct of a trade or business in the United States from other 
sources. Accordingly, reductions to the amount of withholding tax a 
partnership is required to pay under proposed Sec.  301.6226-2(h)(3)(i) 
are limited to those based on a reduced rate of tax. The procedures 
under proposed Sec.  301.6226-2(h)(3)(ii) do not constitute a 
modification as described in section 6225.
    Proposed Sec.  301.6226-3(f) requires a reviewed year partner that 
is subject to withholding under proposed Sec.  301.6226-2(h)(3)(i) to 
file a return for the reporting year to report its additional reporting 
year tax and its share of penalties, additions to tax, additional 
amounts, and interest, notwithstanding any filing exception in Sec.  
1.6012-1(b)(2)(i) or Sec.  1.6012-2(g)(2)(i). Therefore, a reviewed 
year partner whose allocable share of adjustments is subject to 
withholding under chapters 3 and 4 must file a federal income tax 
return for the reporting year and pay its allocable share of penalties, 
additions to tax, additional amounts, and interest, even if the 
partner's additional reporting year tax has been satisfied by the 
partnership through withholding at source and the partner would not 
otherwise be required to file a federal income tax return under an 
exception in the section 6012 regulations.
    In certain circumstances, the reviewed year partner is allowed a 
credit under section 33 for tax paid by the partnership under proposed 
Sec.  301.6226-2(h)(3)(i) that the partner may apply against its income 
tax liability for its reporting year. For purposes of sections 1441 
through 1443 and 1471 through 1474, a reviewed year partner is allowed 
a credit for the amount of tax actually withheld from that partner 
(including any amounts withheld on the partner's distributive share). 
To the extent the tax is not withheld, but is instead paid by the 
partnership (because, for example, the reviewed year partner is no 
longer a partner in the partnership), the partnership (rather than the 
partner) is allowed a credit against its withholding tax liability for 
the amount of tax paid. In that case, the tax will not be collected a 
second time from the partner, but the partner would remain liable for 
any applicable penalties, additions to tax, or interest. See Sec. Sec.  
1.1463-1; 1.1464-1; 1.1474-4. For purposes of section 1446, a reviewed 
year partner is allowed a credit for the tax paid by the partnership 
with respect to ECTI allocable to the partner. See Sec.  1.1446-
3(d)(2). A partner claiming a credit under section 33 must properly 
report the additional reporting year tax on its return and substantiate 
the credit with the appropriate information return (Form 1042-S or Form 
8805), as well as any other requirements prescribed by the IRS in 
forms, instructions, and other guidance.
    Because Sec.  301.6226-1(c)(1) (June 14 NPRM) requires a 
partnership to satisfy the provisions of proposed Sec. Sec.  301.6226-1 
and 301.6226-2 (June 14 NPRM) to make a valid section 6226 election, a 
partnership must pay the tax due under proposed Sec.  301.6226-
2(h)(3)(i) and meet the reporting obligations under proposed Sec.  
301.6226-2(h)(3)(iii) to satisfy this requirement. However, a 
partnership that anticipates making a section 6226 election may instead 
request during the modification process that the IRS determine a 
specific imputed underpayment (as defined in Sec.  301.6225-
1(e)(2)(iii) (June 14 NPRM)) with respect to adjustments allocated to 
reviewed year partners that would have been subject to withholding in 
the reviewed year, and a general imputed underpayment (as defined in 
Sec.  301.6225-1(e)(2)(ii) (June 14 NPRM)) with respect to all other 
adjustments. If the IRS agrees with the modification request, upon 
receipt of the notice of final partnership adjustment the partnership 
could then (1) pay under section 6225 the specific imputed underpayment 
that includes adjustments subject to withholding, and (2) make a timely 
section 6226 election with respect to the adjustments that result in 
the general imputed underpayment. A partnership might make such a 
request so that its partners subject to withholding under chapters 3 
and 4 would not need to file a return as they would under proposed 
Sec.  301.6226-3(f) when the partnership makes a section 6226 election 
with respect to those adjustments.
    The Treasury Department and the IRS are considering additional ways 
to alleviate the filing obligation in proposed Sec.  301.6226-3(f) for 
foreign persons when a partnership pushes out its adjustments and does 
not make a specific imputed underpayment for adjustments subject to 
withholding. Specifically, the Treasury Department and the IRS are 
considering whether to allow a partnership that pays the withholding 
tax required under proposed Sec.  301.6226-2(h)(3)(i) to elect to pay 
the share of penalties, additions to tax, additional amounts, and 
interest attributable to a partner that would have been subject to 
withholding in the reviewed year. Under this approach, if the partner's 
additional reporting year tax and the partner's share of penalties,

[[Page 56771]]

additions to tax, additional amounts, and interest have been satisfied 
by the partnership, the partner's tax liability would be treated as 
having been fully satisfied through withholding at source with respect 
to the adjustments on its section 6226 statement. In that case, the 
partner may be relieved of any filing obligation that would otherwise 
arise upon receiving a section 6226 statement if the foreign partner 
otherwise qualifies for a filing exception under Sec.  1.6012-
1(b)(2)(i) or Sec.  1.6012-2(g)(2)(i). Comments are requested regarding 
this approach and how it should operate.
    In the June 14 NPRM, the Treasury Department and the IRS requested 
comments on how the rules under chapters 3 and 4 should apply when a 
section 6226 statement includes income allocable to a foreign partner 
that is an intermediary or flow through entity. The Treasury Department 
and the IRS continue to study this issue in conjunction with the 
broader issue of how to treat pass-through partners generally under the 
section 6226 regime. Specifically, comments are still requested 
regarding the application of chapters 3 and 4 to section 6226 in the 
case of partners that are foreign flow through entities, including 
partners that assume primary withholding responsibility as withholding 
foreign partnerships or withholding foreign trusts.

3. Provisions Related to U.S. Foreign Tax Credits

A. Background
    Subject to limitations, a taxpayer may elect to claim a credit 
under section 901 for income, war profits, and excess profits taxes 
paid or accrued during the taxable year to any foreign country or 
possession of the United States. This credit is generally referred to 
as the foreign tax credit (FTC). Under section 902, certain 
corporations are deemed, for FTC purposes, to have paid the foreign 
taxes that are paid or accrued by foreign subsidiaries from which they 
receive a dividend. Under section 960, inclusions under subpart F of 
part III of subchapter N of chapter 1 of the Code (subpart F) are 
treated as dividends for purposes of computing the foreign taxes deemed 
paid under section 902.
    A partnership is not eligible to claim an FTC under section 901 (or 
a deduction for foreign taxes under section 164). See section 
703(b)(3). Instead, under sections 702(a)(6), 706(a), and 901(b)(5) 
each partner takes into account its distributive share of the 
creditable foreign taxes paid or accrued by the partnership in the 
partner's tax year with or within which the partnership's tax year 
ends. See Sec.  1.702-1(a)(6). Under section 702(a)(6), this amount, 
known as a creditable foreign tax expenditure (CFTE), is accounted for 
as a separately stated item. Similarly, under section 902(c)(7), a 
partner is treated as owning a proportional share of stock owned by or 
for the partnership for purposes of computing a deemed paid credit 
under section 902. Therefore, while a partnership is not deemed to pay 
foreign taxes paid by a foreign corporation in which it holds stock, 
each of its domestic corporate partners, if eligible, independently 
calculates foreign taxes deemed paid with respect to dividends or 
subpart F inclusions relating to stock owned by or for the partnership.
    The amount of FTC allowed against a taxpayer's U.S. tax in a given 
year is limited to the amount of pre-credit U.S. tax on the taxpayer's 
foreign source income. See section 904. This FTC limitation is applied 
separately to foreign source income in each of the separate categories 
described in section 904(d)(1) (i.e., the passive category and general 
category) and additional separate categories described in Sec.  1.904-
4(m). The components of the FTC limitation computation are maintained 
and adjusted at the partner level; several of these attributes must be 
tracked from year to year and can affect the computation of the 
partner's FTC and FTC limitation (e.g., FTC carrybacks or carryovers 
under section 904(c) and overall foreign loss accounts or overall 
domestic loss accounts under section 904(f) and (g)). Other specific 
rules may further limit a taxpayer's utilization of FTCs (e.g., 
sections 901, 907, 908, and 909). If a taxpayer pays or accrues 
creditable foreign tax in excess of the limitation, the taxpayer may 
not use the excess credits in that year. However, section 904(c) 
provides that excess FTCs are first carried back one year and then 
forward for up to 10 years and are utilized in the first year in which 
the taxpayer has sufficient excess limitation to use the FTCs.
    Given the nature and purpose of the FTC to mitigate the effects of 
double taxation and the importance of preventing the inappropriate use 
of the credit, special procedural rules often apply. For example, 
because the amount of foreign tax may change as the result of a foreign 
audit, refund claim, or other dispute resolution process involving a 
foreign tax authority, taxpayers are required to notify the IRS if a 
foreign tax for which credit is claimed is refunded (in whole or in 
part), if an accrued tax remains unpaid after two years, or if the 
amount of taxes paid differs from the amount accrued. See section 
905(c). Any underpayment resulting from a change to the amount of 
creditable foreign tax paid or accrued is collectable upon notice and 
demand, without regard to the generally applicable statute of 
limitations. See section 6501(c)(5). Moreover, taxpayers have a special 
ten-year period of limitations under section 6511(d)(3) for claiming 
refunds of overpayments attributable to the application of an FTC. The 
IRS also permits a taxpayer to accrue a contested foreign tax if the 
amount of the tax has actually been paid to the foreign tax authority. 
Rev. Rul. 70-290 (1970-1 C.B. 160). These special rules allow increased 
flexibility with regard to the timing of adjustments in order to better 
match foreign income and the foreign tax on that income and thereby 
mitigate double taxation of income.
    Neither the statutory text of the centralized partnership audit 
regime nor the explanation of that text prepared by the staff of the 
Joint Committee on Taxation explicitly addresses coordination with the 
FTC rules. Joint Comm. on Taxation, JCS-1-16, General Explanations of 
Tax Legislation Enacted in 2015, 57 (2016) (JCS-1-16). Nothing in the 
BBA indicates that the new procedures should increase the incidence of 
double taxation or alter the pre-existing restrictions, limitations, or 
obligations affecting a taxpayer's right to claim (or retain) an FTC. 
It is also unlikely that the enactment of the new centralized 
partnership audit regime was meant to change significant and well-
established FTC rules without any explicit reference to those rules in 
the statutory text.
    The view of the Treasury Department and the IRS is that, to the 
maximum extent possible, the long-standing FTC rules should be 
preserved while implementing the broader purpose of the centralized 
partnership audit regime. In order to coordinate these provisions in a 
manner that is administrable and fair, rules should be promulgated to 
clarify the appropriate interaction of these two regimes. Some of these 
issues are discussed in this preamble and addressed in the regulations 
proposed herein, such as the treatment of CFTEs under the imputed 
underpayment provisions of the centralized partnership audit regime. 
Additionally, this preamble discusses the application of the FTC 
limitation of partners in a partnership subject to the centralized 
partnership audit regime, certain special procedural FTC rules 
(including those under sections 905(c) and 6511(d)(3)), and the 
treatment of credits under sections 902 and 960 (which are not 
themselves items of the partnership, but the calculation of

[[Page 56772]]

which turns on certain items of the partnership, such as the amount and 
separate category of dividend or subpart F inclusion). The Treasury 
Department and the IRS request comments both with respect to the items 
specifically identified and also with respect to any additional issues 
regarding the coordination of the FTC regime and the new centralized 
partnership audit regime that warrant clarification or additional 
guidance.
B. Adjustments Affecting the Category or Amount of CFTEs of a BBA 
Partnership
    A partnership reports CFTEs to its partners as separately stated 
items, allowing each partner to elect either a credit under section 901 
or a deduction under section 164(a)(3). See Sections 702(a)(6) and 
901(b)(5). Under current rules, the partnership is not required to 
maintain records or report to the IRS whether its partners claimed 
credits or deductions with respect to their CFTEs or the extent to 
which any such credits are subject to a partner's FTC limitation. 
Accordingly, the tax effects of an adjustment to the CFTEs reported by 
a partnership cannot be determined solely by examining the return and 
other records of the partnership. Similarly, the partnership lacks the 
necessary information to determine those tax effects in connection with 
an AAR.
    Proposed Sec.  301.6225-1(a)(2) (June 14 NPRM) provides that for 
purposes of determining the imputed underpayment, all applicable 
preferences, restrictions, limitations, and conventions will be taken 
into account to disallow netting of adjustments as if the adjusted item 
was originally taken into account in the manner most beneficial to the 
partners. Similarly, proposed Sec.  301.6225-1(d)(1) (June 14 NPRM) 
provides that items within each grouping are divided into subgroups, 
for netting purposes, based on preferences, limitations, restrictions, 
and conventions, such as source, character, holding period, or 
restrictions under the Code applicable to such items.
    Consistent with this general approach, proposed rules are added in 
the paragraph reserved in the June 14 NPRM for the creditable 
expenditure grouping, proposed Sec.  301.6225-1(d)(2)(iv)(A), relating 
to the treatment of adjustments to CFTEs made in an administrative 
proceeding under the centralized partnership audit regime. Proposed 
Sec.  301.6225-1(d)(2)(iv)(A)(1) provides that the creditable 
expenditure grouping includes all adjustments to CFTEs, as defined in 
Sec.  1.704-1(b)(4)(viii)(b). Proposed Sec.  301.6225-1(d)(2)(iv)(A)(2) 
further provides that adjustments to CFTEs are included in subgroupings 
based on the category of income to which the CFTEs relate in accordance 
with section 904(d) and the regulations thereunder and in order to 
account for different allocations of CFTEs between partners. Proposed 
Sec.  301.6225-1(d)(2)(iv)(A)(3) provides rules used in computing the 
imputed underpayment when there are one or more adjustments to CFTEs. 
Specifically, proposed Sec.  301.6225-1(d)(2)(iv)(A)(3) provides that a 
net reduction to CFTEs in any subgrouping is treated as a decrease to 
credits in the credits grouping and therefore increases the imputed 
underpayment (and safe harbor amount) on a dollar-for-dollar basis. A 
net increase to CFTEs in any subgrouping is an adjustment that does not 
result in an imputed underpayment and is therefore taken into account 
in the adjustment year in accordance with proposed Sec.  301.6225-3 
(June 14 NPRM). Examples 6, 7, 8, and 9 are added to proposed Sec.  
301.6225-1(f) to illustrate the application of the rules in proposed 
Sec.  301.6225-1(d)(2)(iv).
    These CFTE subgrouping rules serve several goals. First, 
subgrouping prevents netting of CFTEs between partners, or between 
separate categories with respect to the same partner, a restriction 
which is necessary to preserve the application of the category-by-
category limitation required under section 904 and the regulations 
thereunder. Second, by subgrouping based on the sharing ratio of the 
partners in the reviewed year, adjustments that would be allocable to 
one partner cannot be netted against adjustments to CFTEs that would be 
allocable to another partner. This is intended to provide greater 
consistency with the requirement that CFTEs be allocated in accordance 
with the partners' interests in the partnership under section 704 and 
the regulations thereunder. Subgrouping based on the category and 
allocation of the adjustment between the partners is necessary to avoid 
a net reduction in the U.S. tax collected as the result of adjustments 
to CFTEs for which no credit would have been allowed to the partner if 
the CFTEs had been correctly reported in the reviewed year.
    One comment received in response to Notice 2016-23 addressed the 
treatment of adjustments to CFTEs in calculating the imputed 
underpayment. Specifically, the comment noted the complex FTC 
limitation computation which must be made at the partner level, based 
on components maintained and adjusted each year by the partner. After 
discussing several possible approaches, the comment recommended that 
CFTEs be treated as a credit for purposes of computing the imputed 
underpayment, increasing the imputed underpayment to account for any 
decrease to CFTEs, but suggested that the regulations disallow any 
reduction to the imputed underpayment based on an increase to CFTEs, 
since they may be subject to limitation at the partner level. The 
comment explained that while this treatment may cause the imputed 
underpayment to overstate the correct tax amount, this overstatement 
can be remedied if the partnership provides additional information 
through the modification process.
    Proposed Sec.  301.6225-1(d)(2)(iv) generally adopts the 
recommended approach. If the amount of CFTEs is decreased on audit, the 
proposed regulations treat the item as if the partners had reduced 
their U.S. tax by that amount and, therefore, increase the imputed 
underpayment by the amount of the CFTE reduction. Conversely, if the 
amount of CFTEs is increased on audit, the proposed regulations treat 
the item as if the FTC limitation would prevent use of the increased 
credit and, therefore, do not reduce the imputed underpayment.
    The Treasury Department and the IRS recognize that the rules 
proposed in Sec.  301.6225-1(d)(2)(iv) may cause the amount of the 
imputed underpayment to exceed the amount of tax that would have been 
due if the partnership had accurately reported in the reviewed year, 
either because CFTEs reported in the reviewed year were not claimed by 
all partners as FTCs or because any additional CFTEs agreed to on audit 
could be claimed as FTCs. However, because the partners' FTC posture is 
neither reflected on the partnership returns nor required to be 
maintained in the partnership's books and records, the only practical 
way to maintain the efficacy of the FTC rules is to assume both that 
the partners claimed FTCs for all CFTEs originally reported and that 
the FTC limitation would prevent any additional CFTEs from being 
claimed as credits. This approach preserves the long-standing 
principles underlying the FTC regime, especially the FTC limitation 
rules in section 904 and the regulations thereunder, and is consistent 
with the general rule in Sec.  301.6225-1(a)(2) (June 14 NPRM) which 
explicitly provides that the adjusted items are treated as if they were 
originally taken into account by the partnership or the partners, as 
applicable, in the manner most beneficial to the partnership and the 
partners. The modification process under section 6225 (including

[[Page 56773]]

modification resulting from a partner filing an amended return or 
entering into a closing agreement) will generally provide an 
opportunity for the partnership to take the partners particular facts 
and circumstances into account when determining the imputed 
underpayment, while at the same time adhering to those long-standing 
principles.
    In addition to the amended return modification or section 6226 
election available under the current rules, additional types of 
modification may be appropriate with respect to some CFTEs under 
section 6225(c)(6) and proposed Sec.  301.6225-2(d)(9) (June 14 NPRM). 
For example, not all partners are eligible to look through the 
partnership for purposes of determining the separate category of their 
CFTEs. See Sec.  1.904-5(h). Such partners have only passive category 
CFTEs, regardless of the category of those items at the partnership 
level. Under these circumstances, a partnership may request 
modification under section 6225(c)(6) by providing sufficient evidence 
that a particular portion of CFTEs would be allocable to a partner or 
group of partners who cannot look through the partnership to 
characterize such CFTEs, so that all adjustments to CFTEs allocable to 
that partner or group of partners may be netted without regard to 
separate category. Similarly, if different sharing ratios apply to the 
allocation of adjusted CFTEs, some portion of the adjustments subject 
to different sharing ratios may still ultimately be allocable to the 
same partner or group of partners. Under these circumstances, the 
partnership may request modification by providing sufficient evidence 
of the portion of each adjustment that is allocable to the same partner 
or group of partners in order to allow netting of those CFTEs by 
modification, where appropriate.
    The Treasury Department and the IRS request comments on the 
application of the netting rules to CFTEs and the related computation 
of the imputed underpayment, including any special modification rules 
that may be appropriate with respect to CFTEs. The Treasury Department 
and the IRS also request comments regarding circumstances in which the 
grouping and subgrouping of CFTE adjustments could be improved while 
preserving the FTC limitation rules.
    These proposed regulations continue to reserve the rules on 
creditable expenditures other than CFTEs. The Treasury Department and 
the IRS request comments as to whether special rules are needed to 
address any other creditable expenditures and if so, whether those 
rules should follow or differ from the grouping and netting rules for 
CFTEs set forth in these proposed regulations.
C. Preserving FTC Limitation Rules Under Section 904
    Under the principles of proposed section 301.6225-1 (June NPRM), an 
adjustment decreasing the amount of foreign source income would not 
offset an adjustment increasing the amount of U.S. source income under 
the netting process described in proposed Sec.  301.6225-1(c) (June 14 
NPRM). Instead, these items, the foreign source income adjustment 
(which is negative) and the U.S. source income adjustment (which is 
positive), would be in separate subgroups. Assuming no other 
adjustments, the decrease in foreign source income would be treated as 
an adjustment which does not result in an imputed underpayment, and the 
increase in U.S. source income would be a net positive adjustment 
included in computing the imputed underpayment. This is an appropriate 
result.
    Without a subgrouping requirement, the netting of U.S. and foreign 
source items would circumvent FTC limitation calculations under section 
904 by effectively ignoring the potential impact of changes to foreign 
source income on FTCs. Specifically, netting U.S. and foreign source 
items at the partnership level would, in many cases, understate the 
true underpayment of tax caused by the partnership treating these items 
incorrectly in the reviewed year and, in other cases, would cause a 
permanent reduction in the partners' FTC limitation over time. 
Similarly, in the case of adjustments to items allocable to foreign 
partners, because foreign partners typically owe tax only with respect 
to U.S. source income, netting adjustments to U.S. source items against 
adjustments to foreign source items may understate the tax owed. 
Grouping adjustments by source may also facilitate modification 
requests with respect to amounts allocable to foreign partners.
    One obstacle to subgrouping foreign source and U.S. source items is 
that the source (or allocation and apportionment) of certain 
partnership items is determinable only by the partners. In this regard, 
section 861 and the regulations thereunder provide that deductible 
expenses, including interest expense and research and experimentation 
(R&E) expense, are allocated and apportioned between foreign source 
gross income and other income on the basis of partner-level attributes. 
For example, Sec.  1.861-9(e) provides that, subject to certain 
exceptions, a partner's distributive share of the interest expense of a 
partnership is considered to be related to all income-producing 
activities and assets of the partner and is apportioned between a 
partner's U.S. and foreign source income based on the relative values 
of the partner's assets. See also, for example, Sec.  1.871-17 
(providing rules for the allocation and apportionment of R&E expense).
    Therefore, these expense items, when allocated and apportioned, 
affect the partners' net foreign and U.S. source income (and therefore 
the partner's FTC limitation), in amounts that cannot be determined at 
the partnership level. Similarly, items of gain or loss attributable to 
sales of non-inventory property are sourced at the partner level. See 
section 865(i)(5). Because the source of certain items cannot be 
accurately established at the partnership level (and because certain 
expenses must be allocated and apportioned at the partner level), those 
items cannot definitively be included in either foreign or U.S. source 
income subgroupings for purposes of computing the imputed underpayment. 
Moreover, if an adjustment to items sourced (or allocated and 
apportioned) at the partner level can offset other adjustments not 
sourced (or allocated and apportioned) in that manner, the purposes of 
the FTC limitation rules could effectively be circumvented.
    Under the proposed regulations in the June 14 NPRM, adjustments to 
items that may be sourced (or allocated and apportioned) at the partner 
level will generally be divided into subgroups in accordance with the 
specific method applicable for the sourcing (or allocation and 
apportionment) of those items in order to avoid netting that would 
undermine the application of the FTC limitation under section 904 
unless the IRS determines otherwise. See proposed Sec.  301.6225-
1(a)(2) (June 14 NPRM). This would prevent, for example, an increase to 
interest expense from being netted against an increase to U.S. source 
income. However, netting of an increase to interest expense from one 
activity against a decrease to interest expense from another activity 
would generally be permissible because netting these adjustments would 
not typically affect the partners' section 904 limitation.
    The Treasury Department and the IRS recognize that subgrouping 
significant items of expense, such as R&E or interest, may cause 
imputed underpayments to exceed the tax that would have been owed had 
all items been treated correctly in the reviewed year. While the 
partnership can attempt to reduce this distortion during the

[[Page 56774]]

modification process or by making a section 6226 election, the Treasury 
Department and the IRS request comments regarding whether such 
distortions can be reduced when computing the imputed underpayment 
before the modification process, while remaining consistent with the 
purpose of the source and allocation and apportionment rules under 
sections 861 and 865, as well as the application of the FTC limitation 
under section 904.
    The Treasury Department and the IRS request comments with respect 
to the grouping and subgrouping of items of income, gain, loss, or 
deduction based on source and separate category. Specifically, the 
Treasury Department and the IRS request comments on any rule or 
modification method that would allow the calculation of the imputed 
underpayment to more accurately reflect the amount of tax that would 
have been due if the partnership had reported correctly in the reviewed 
year. The Treasury Department and the IRS also specifically request 
comments relating to any rules that would preserve the potential 
effects of adjustments to partnership items that are sourced (or 
allocated and apportioned) at the partner level in determining the 
imputed underpayment without requiring that all of these items be 
assigned to separate subgroupings.
D. Application of Section 905(c) to Creditable Foreign Tax Expenditures
    Section 905(c) generally requires a taxpayer to notify the IRS in 
the event of certain changes to creditable foreign taxes. A taxpayer 
must notify the IRS if any foreign tax claimed as a credit is refunded 
in whole or in part. Similarly, a taxpayer must notify the IRS if an 
accrued foreign tax claimed as a credit remains unpaid after two years 
or if the amount when paid differs from the amount accrued. The notice 
requirement under section 905(c) is generally satisfied by the taxpayer 
filing an amended return for the year or years to which the foreign tax 
relates and paying any underpayment that results from the adjustment to 
the amount of creditable foreign tax. If such an adjustment results in 
an overpayment of tax, a taxpayer may generally claim a refund or 
credit within the 10-year period described in section 6511(d)(3). See 
section 905(c)(3). In the context of a partnership, the partner who 
claimed the FTC has historically borne the primary obligation to notify 
the IRS if there was a change in the foreign tax liability described in 
section 905(c) (and to pay any underpayment, upon notice and demand, or 
timely file a claim for refund of any overpayment). However, several 
aspects of the centralized partnership audit regime make it difficult 
to determine the most appropriate application of section 905(c) with 
respect to CFTEs reported by a partnership subject to the centralized 
partnership audit regime.
    Neither the statutory text of the centralized partnership audit 
regime, nor the explanation of that text prepared by the staff of the 
Joint Committee on Taxation, explicitly addresses section 905(c). See 
JCS-1-16. There is no indication that the new procedures were intended 
to restrict either the taxpayer's or the government's right to recoup 
any overpayment or underpayment of U.S. tax resulting from a 
redetermination required under section 905(c). It is also unlikely that 
Congress would effectuate a change to long-standing principles through 
generic procedural provisions without any specific discussion of 
section 905(c) in the statutory text.
    Generally, if a partnership reports CFTEs and has an adjustment 
described in section 905(c), there are two ways of viewing the 
adjustment required under section 905(c): It is either an adjustment at 
the partnership level, which is subject to the centralized partnership 
audit regime, or it is an adjustment at the partner level, which is 
subject to the historic application of this provision in the 
partnership context. Either of these two approaches presents 
administrative challenges. Therefore, the Treasury Department and the 
IRS request comments addressing coordination and administration of 
section 905(c) and the centralized partnership audit regime. 
Specifically, the Treasury Department and the IRS request comments on 
using the AAR process for purposes of satisfying the requirements of 
section 905(c) with respect to changes to the foreign tax liability 
reported by a partnership as a CFTE.
E. Foreign Taxes Deemed Paid Under Sections 902 and 960
    Under sections 902 and 960, certain domestic corporations are 
permitted to claim credits for foreign taxes ``deemed paid'' 
corresponding to foreign taxes paid by a foreign subsidiary from which 
the domestic corporation receives a dividend or with respect to which 
the domestic corporation has a subpart F inclusion. As discussed in 
Part 3.A. of this Explanation of Provisions, section 902(c)(7) provides 
that stock of a foreign corporation held by or on behalf of a 
partnership will be treated as if it was actually owned 
(proportionally) by the partners for purposes of computing the foreign 
taxes deemed paid under sections 902 and 960. Thus, qualifying partners 
are generally entitled to claim FTCs for deemed paid taxes attributable 
to their allocable share of partnership dividend income and subpart F 
inclusions.
    Section 6221(a) provides that any adjustment to an item of income, 
gain, loss, deduction, or credit of a partnership for a partnership 
taxable year must be determined, and any tax attributable thereto must 
be assessed and collected, at the partnership level pursuant to the 
centralized partnership audit regime. Further, proposed Sec.  
301.6221(a)-1 (June 14 NPRM) provides that all items required to be 
shown or reflected on the partnership's return and information in the 
partnership's books and records related to a determination of these 
items, as well as factors that affect the determination of items of 
income, gain, loss, deduction, or credit, are subject to determination 
and adjustment at the partnership level under the centralized 
partnership audit regime.
    Under existing filing requirements, a partnership reports dividends 
from its subsidiaries, foreign and domestic, and domestic (U.S.) 
partnerships also report subpart F inclusions, but neither foreign nor 
domestic partnerships are required to report the amount of foreign 
taxes deemed paid by a partner with respect to stock held by or for the 
partnership. Further, a partnership is generally not required to 
maintain or report all information upon which the computations of those 
amounts are based (for example, the foreign subsidiary's pools of post-
1986 undistributed earnings and post-1986 foreign income taxes). 
Accordingly, the amount of any deemed paid foreign tax computed with 
respect to stock owned by or for a partnership cannot be determined 
based on existing partnership reporting requirements.
    The centralized partnership audit regime did not explicitly address 
the treatment of FTCs allowed with respect to deemed paid foreign taxes 
under the centralized partnership audit regime. However, the dividends 
and subpart F inclusions that trigger the availability of the deemed 
paid FTC are subject to that regime. Therefore, in order to preserve 
the IRS's ability to audit FTCs for deemed paid taxes claimed with 
respect to stock owned through partnerships subject to the centralized 
partnership audit regime, coordinating rules are necessary. These rules 
should ensure that all restrictions and limitations on the FTC allowed 
under sections 902 and 960 are given effect with respect to both the 
items giving rise to FTCs and the FTCs themselves.
    The broad scope of the centralized partnership audit regime 
contemplates

[[Page 56775]]

that all tax effects, including FTCs for deemed paid taxes, are 
considered during a centralized partnership audit. However, in the case 
of sections 902 and 960, the current rules require the partners, and 
not the partnership, to maintain and report the relevant information. 
Therefore, the Treasury Department and the IRS request comments on 
whether it would be appropriate to require a partnership, as opposed to 
the individual partners, to maintain and report the information 
necessary to compute deemed paid foreign taxes with respect to foreign 
corporations in which the partnership owns shares, so that the IRS can 
audit foreign tax credits under section 902 and 960 entirely at the 
partnership level. The Treasury Department and IRS request comments on 
how this information-reporting requirement could be crafted to minimize 
compliance costs and burdens, especially for partnerships whose 
partners are not eligible to compute deemed paid taxes. Alternatively, 
the Treasury Department and the IRS request comments on any approach, 
consistent with the statutory principles of the centralized partnership 
audit regime and the FTC regime, whereby the IRS could effectively 
adjust credits for deemed paid foreign taxes at either the partnership 
level or at the partner level, without creating unreasonable 
distortions or undue burdens on taxpayers or tax administration.
4. Modification of an Imputed Underpayment Based on the Status of a 
Foreign Partner and Other Treaty Issues
    Proposed Sec.  301.6225-2(d)(2) through (8) (June 14 NPRM) provides 
seven enumerated types of modifications the IRS will consider if 
requested by the partnership. The preamble to the June 14 NPRM 
requested comments on modifications that could be considered 
appropriate where a partner is a foreign person and thus may be subject 
to gross basis taxation under section 871(a) or 881(a), or where a 
partnership, partner, or indirect partner is entitled to a reduced rate 
of tax under the Code or as a resident of a country that has in effect 
an income tax treaty with the United States.
    Under U.S. tax treaties, a foreign partner or partnership may be 
entitled to benefits with respect to an item of income, profit, or gain 
paid to an entity that is fiscally transparent under the laws of the 
United States to the extent it is treated as an item of income, profit, 
or gain of a resident of the applicable treaty jurisdiction. See also 
section 894. Thus, for example, the Treasury Department and the IRS are 
considering providing a modification in proposed Sec.  301.6225-2(d) 
(June 14 NPRM) that would apply as illustrated in the following 
example: The IRS initiates an administrative proceeding with respect to 
a domestic partnership, and determines a single partnership adjustment 
increasing the U.S. source dividend income received by the partnership. 
The partnership had two equal partners during the reviewed year: A, a 
U.S. citizen, and B, a nonresident alien individual resident in Country 
X. The United States has in effect an income tax treaty with Country X, 
and Country X treats the partnership as fiscally transparent. Assuming 
that the other requirements set forth in the regulations for 
modifications are satisfied, if the partnership provides documentation 
demonstrating to the IRS's satisfaction the amount of the adjustment 
that is allocable to B under the partnership agreement and B's 
entitlement to a reduced rate of tax on dividends in the reviewed year 
pursuant to the income tax treaty between Country X and the United 
States, the IRS could agree to a modification to the imputed 
underpayment with respect to the amount of the adjustment allocable to 
B that is subject to a reduced rate of tax under the income tax treaty. 
Additionally, other methods for modifications could be provided in 
future guidance with respect to other Code-based exemptions from tax 
applicable to foreign persons, including sections 871(h) and 881(c), 
which provide an exemption from tax for foreign persons with respect to 
interest on certain portfolio debt investments. See also sections 
871(a)(2) and 881(a) (limiting taxation of foreign persons on U.S. 
source capital gains).
    The Treasury Department and the IRS are still considering 
additional modifications to address circumstances where a partnership, 
partner, or indirect partner is a foreign person, and which potential 
modifications, such as modifications for portfolio interest and U.S. 
source capital gains, may already be addressed by one of the seven 
types of modifications included in the June 14 NPRM. See proposed Sec.  
301.6225-2(d)(3) (June 14 NPRM) (providing rules for modifications for 
tax-exempt partners which, as defined, includes certain foreign persons 
or entities). Accordingly, the Treasury Department and the IRS continue 
to request comments on what specific types of modifications available 
to partners or partnerships that are foreign persons (including 
partners that are foreign persons described under section 501(c)) 
should be included in proposed Sec.  301.6225-2(d) (June 14 NPRM).
    The June 14 NPRM also requested comments on the coordination of the 
proposed rules with the mutual agreement procedures (MAP) available 
under income tax treaties that a partnership, partner, or indirect 
partner may invoke in order to determine eligibility for treaty 
benefits that may affect the calculation of the imputed underpayment. 
Pursuant to income tax treaties in effect between the United States and 
other jurisdictions, the Treasury Department and the IRS intend to 
allow access to MAP, when and where appropriate, for a partnership, 
partner, or indirect partner that is subject to the centralized 
partnership audit regime. However, the Treasury Department and the IRS 
are continuing to study this issue and request comments on how to 
coordinate MAP with the centralized partnership audit regime.
5. Foreign Corporations
    The preamble to the June 14 NPRM stated that the Treasury 
Department and the IRS intend to issue regulations to address 
situations where a partnership pushes out an adjustment under section 
6226 to a direct partner in the partnership that is a foreign entity, 
such as a trust or corporation, that may not be liable for U.S. federal 
income tax with respect to one or more adjustments, but an owner of the 
direct partner is or could be liable for tax with respect to that 
amount. For example, if a direct partner in the audited partnership is 
a controlled foreign corporation, the foreign corporation as a direct 
partner may not have a U.S. tax liability with respect to a given 
adjustment; however, the adjustment may impact the tax liability of its 
U.S. shareholder(s) by increasing the subpart F income of the CFC that 
is included in the income of the U.S. shareholder(s) under section 
951(a). The Treasury Department and the IRS continue to study this 
issue and continue to request comments both on how the reporting 
obligations concerning foreign entities should be modified to ensure 
that statements issued under section 6226 are reflected on the returns 
of the U.S. owners of these entities, and more generally, on how to 
incorporate rules governing foreign corporations into the centralized 
partnership audit regime.

Special Analyses

    Certain IRS regulations, including these, are exempt from the 
requirements of Executive Order 12866, as supplemented and reaffirmed 
by Executive Order 13563. Therefore, a

[[Page 56776]]

regulatory impact assessment is not required. Because the regulations 
would 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, these regulations have 
been submitted to the Chief Counsel for Advocacy of the Small Business 
Administration for comment on its impact on small business.

Statement of Availability of IRS Documents

    IRS Revenue Procedures, Revenue Rulings, Notices and other guidance 
cited in this preamble are published in the Internal Revenue Bulletin 
(or Cumulative Bulletin) and are available from the Superintendent of 
Documents, U.S. Government Publishing Office, Washington, DC 20402, or 
by visiting the IRS Web site at www.irs.gov.

Comments and Requests for Public Hearing

    Before these proposed regulations are adopted as final regulations, 
consideration will be given to any electronic and written comments that 
are submitted timely to the IRS as prescribed in this preamble under 
the ADDRESSES heading. The Treasury Department and the IRS request 
comments on all aspects of the proposed rules. All comments will be 
available at www.regulations.gov or upon request. A public hearing will 
be scheduled if requested in writing by any person that timely submits 
written comments. If a public hearing is scheduled, then notice of the 
date, time, and place for the public hearing will be published in the 
Federal Register.

Drafting Information

    The principal authors of these proposed regulations are Larry R. 
Pounders, Jr., Ronald M. Gootzeit, and Subin Seth of the Office of the 
Associate Chief Counsel (International). However, other personnel from 
the Treasury Department and the IRS participated in their development.

List of Subjects in 26 CFR Part 301

    Employment taxes, Estate taxes, Excise taxes, Gift taxes, Income 
taxes, Penalties, Reporting and recordkeeping requirements.

Proposed Amendments to the Regulations

    Accordingly, 26 CFR part 301, as proposed to be amended June 14, 
2017 (82 FR 27334), is proposed to be further amended as follows:

PART 301--PROCEDURE AND ADMINISTRATION

0
Paragraph 1. The authority citation for part 301 continues to read in 
part as follows:

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

0
Par. 2. Section 301.6221(a)-1 is amended by adding paragraph (f) to 
read as follows:


Sec.  301.6221(a)-1  Scope of the partnership procedures under 
subchapter C of chapter 63 of the Internal Revenue Code.

* * * * *
    (f) Examples. The following examples illustrate the rules of 
paragraphs (a) and (d) of this section as applied to cases in which a 
partnership has a withholding obligation under chapter 3 or chapter 4 
of subtitle A of the Internal Revenue Code (Code) with respect to 
income that the partnership earns. For purposes of these examples, each 
partnership is subject to the provisions of subchapter C of chapter 63 
of the Code, and the partnership and its partners are calendar year 
taxpayers.

    Example 1.  Partnership, a partnership created or organized in 
the United States, has two equal partners, A and B. A is a 
nonresident alien who is a resident of Country A, and B is a U.S. 
citizen. In 2018, Partnership earned $200 of U.S. source royalty 
income. Partnership was required to withhold 30 percent of the gross 
amount of the royalty income allocable to A unless Partnership had 
documentation that it could rely on to establish that A was entitled 
to a reduced rate of withholding. See Sec. Sec.  1.1441-1(b)(1) and 
1.1441-5(b)(2)(i)(A) of this chapter. Partnership withheld $15 from 
the $100 of royalty income allocable to A based on its incorrect 
belief that A is entitled to a reduced rate of withholding under the 
U.S.-Country A Income Tax Treaty. In 2020, the IRS determines in an 
examination of Partnership's Form 1042, Annual Withholding Tax 
Return for U.S. Source Income of Foreign Persons, that Partnership 
should have withheld $30 instead of $15 on the $100 of royalty 
income allocable to A because Partnership failed to obtain 
documentation from A establishing a valid treaty claim for a reduced 
rate of withholding. The rate of withholding on the income allocable 
to A is not an item of income, gain, loss, deduction, or credit 
under paragraph (b)(1) of this section. Therefore, in accordance 
with paragraph (a) of this section, the adjustment to increase 
Partnership's withholding tax liability by $15 is not determined 
under subchapter C of chapter 63, and instead must be determined as 
part of the Form 1042 examination.
    Example 2.  Partnership, a partnership created or organized in 
the United States, has two equal partners, A and B. A is a 
nonresident alien who is a resident of Country A, and B is a U.S. 
citizen. In 2018, Partnership earned $100 of U.S. source dividend 
income. Partnership was required to report the dividend income on 
its 2018 Form 1065, ``U.S. Return of Partnership Income,'' and 
withhold 30 percent of the gross amount of the dividend income 
allocable to A unless Partnership had documentation that it could 
rely on to establish that A was entitled to a reduced rate of 
withholding. See Sec. Sec.  1.1441-1(b)(1) and 1.1441-5(b)(2)(i)(A) 
of this chapter. In 2020, in an examination of Partnership's Form 
1042, the IRS determines that Partnership earned but failed to 
report the $100 of U.S. source dividend income in 2018. The 
adjustment to increase Partnership's dividend income by $100 would 
be an adjustment to an item of income, gain, loss, deduction, or 
credit under paragraph (b)(1) of this section if made in an 
administrative proceeding under subchapter C of chapter 63. The tax 
imposed on Partnership for its failure to withhold on that income, 
however, is not a tax as defined in paragraph (b)(3) of this section 
because it is a tax imposed by chapter 3 of subtitle A of the Code 
(chapter 3 tax). Pursuant to paragraph (d) of this section, the IRS 
may determine, assess, and collect that chapter 3 tax without 
conducting a proceeding under subchapter C of chapter 63. Therefore, 
the IRS may determine the chapter 3 tax in the examination of 
Partnership's Form 1042 by adjusting Partnership's withholding tax 
liability by an additional $15 for failing to withhold on the $50 of 
dividend income allocable to A. If the IRS subsequently initiates an 
administrative proceeding under subchapter C of chapter 63 and makes 
an adjustment to the same item of income, the portion of the 
dividend income allocable to A will be disregarded in the 
calculation of the imputed underpayment to the extent that the 
chapter 3 tax has been collected with respect to such income. See 
Sec.  301.6225-1(c)(5).

0
Par. 3. Section 301.6225-1 is amended by adding paragraphs (a)(4) and 
(c)(5), revising paragraph (d)(2)(iv), and adding Examples 6 through 9 
to paragraph (f) to read as follows:


Sec.  301.6225-1  Partnership Adjustment by the Internal Revenue 
Service.

* * * * *
    (a) * * *
    (4) Coordination with chapters 3 and 4 when partnership pays an 
imputed underpayment. If a partnership pays an imputed underpayment (as 
determined under paragraph (c) of this section) and the total netted 
partnership adjustment (as determined under paragraph (c)(3) of this 
section) includes a partnership adjustment to an amount subject to 
withholding (as defined in Sec.  301.6226-2(h)(3)(i)), the partnership 
is treated as having paid (at the time that the imputed underpayment is 
paid) the amount required to be withheld with respect to that 
adjustment under chapter 3 or chapter 4 for purposes of applying 
Sec. Sec.  1.1463-1 and 1.1474-4 of this chapter. For purposes of the 
regulations under subchapter C of chapter 63 of the Internal Revenue 
Code (Code), the term

[[Page 56777]]

chapter 3 means sections 1441 through 1464 of subtitle A of the Code, 
but does not include section 1443(b), and the term chapter 4 means 
sections 1471 through 1474 of subtitle A of the Code. See paragraph 
(c)(5) of this section for the coordination rule that applies when an 
adjustment is made to an amount subject to withholding for which tax 
has been collected under chapter 3 or chapter 4.
* * * * *
    (c) * * *
    (5) Adjustments to items for which tax has been collected under 
chapters 3 and 4. To the extent that the IRS has collected tax under 
chapter 3 or chapter 4 (as defined in paragraph (a)(4) of this section) 
attributable to an adjustment to an amount subject to withholding (as 
defined in Sec.  301.6226-2(h)(3)(i)), that adjustment (or portion 
thereof) will be disregarded for purposes of calculating the total 
netted partnership adjustment under paragraph (c)(3) of this section. 
See paragraph (a)(4) of this section for the coordination rule that 
applies when a partnership pays an imputed underpayment that includes 
an adjustment to an amount subject to withholding under chapter 3 or 
chapter 4.
    (d) * * *
    (2) * * *
    (iv) Creditable expenditure grouping--(A) Creditable foreign tax 
expenditures--(1) In general. The creditable expenditure grouping 
includes all partnership adjustments (including reallocation 
adjustments as described in paragraph (d)(2)(ii) of this section) to 
creditable foreign tax expenditures (CFTEs) as defined in Sec.  1.704-
1(b)(4)(viii)(b) of this chapter.
    (2) Subgroupings. Adjustments to CFTEs are grouped into 
subgroupings based on the separate category of income to which the 
CFTEs relate in accordance with section 904(d) and the regulations 
thereunder, and to account for different allocations of CFTEs between 
partners. Two or more adjustments are included within the same 
subgrouping only if each adjustment relates to CFTEs in the same 
separate category and each adjusted item would be allocated to the 
partners in the same ratio had those items been properly reflected on 
the partnership return for the reviewed year. An adjustment that 
changes the separate category of a CFTE for section 904 purposes or 
that reallocates the distributive share of a CFTE between partners is 
treated as two separate adjustments: An increase to the amount of CFTEs 
in one subgrouping and a decrease in another subgrouping.
    (3) Effect on Imputed Underpayment. For purposes of computing the 
imputed underpayment in paragraph (c)(1) of this section, a net 
decrease to CFTEs in any CFTE subgrouping is treated as a decrease to 
credits in the credit grouping described in paragraph (d)(2)(iii) of 
this section. A net increase to CFTEs in any CFTE subgrouping is 
treated as a net non-positive adjustment, as defined in paragraph 
(d)(3)(ii)(C) of this section. See paragraphs (b) and (c)(2) of this 
section and Sec.  301.6225-3 for the treatment of adjustments that do 
not result in an imputed underpayment.
    (B) Other creditable expenditures. [Reserved]
* * * * *
    (f) * * *

    Example 6.  Partnership reports on its 2019 partnership return 
$400 of CFTEs in the general category under section 904(d). The IRS 
initiates an administrative proceeding with respect to Partnership's 
2019 taxable year and determines that the amount of CFTEs was $300 
instead of $400 ($100 adjustment to CFTEs). No other adjustments are 
made for the 2019 taxable year. The $100 adjustment to CFTEs falls 
within the creditable expenditure grouping described in paragraph 
(d)(2)(iv) of this section and is within the general category 
subgrouping. Because there are no other adjustments for the 2019 
taxable year in this subgrouping, the net adjustment in the 
subgrouping is $100. Pursuant to paragraph (d)(2)(iv)(A)(3) of this 
section, a net decrease to CFTEs in a subgrouping in the creditable 
expenditure grouping is treated as a decrease to credits under 
paragraph (d)(2)(iii) of this section. Because no other adjustments 
have been made, the $100 adjustment to credits under paragraph 
(d)(2)(iii) of this section produces an imputed underpayment of $100 
under paragraph (c)(1) of this section.
    Example 7.  Partnership reports on its 2019 partnership return 
$400 of CFTEs in the passive category under section 904(d). The IRS 
initiates an administrative proceeding with respect to Partnership's 
2019 taxable year and determines that the CFTEs reported by 
Partnership were general category instead of passive category CFTEs. 
No other adjustments are made. Under the rules in paragraph 
(d)(2)(iv)(A)(2) of this section, an adjustment to the category of a 
CFTE is treated as two separate adjustments: An increase to general 
category CFTEs of $400 and a decrease to passive category CFTEs of 
$400. Both adjustments are included in the creditable expenditure 
grouping under paragraph (d)(2)(iv) of this section, but they are 
included in separate subgroupings. Therefore, the two amounts do not 
net. Instead, the $400 increase to CFTEs in the general category 
subgrouping is treated as a net non-positive adjustment within the 
meaning of paragraph (d)(3)(ii)(C) of this section and is an 
adjustment that does not result in an imputed underpayment within 
the meaning of paragraphs (b) and (c)(2) of this section. Therefore, 
the $400 increase to CFTEs in the general category subgrouping of 
the creditable expenditure grouping is taken into account in 
accordance with Sec.  301.6225-3. The decrease to CFTEs in the 
passive category subgrouping of the creditable expenditure grouping 
results in a net decrease to CFTEs. Therefore, pursuant to paragraph 
(d)(2)(iv)(A)(3) of this section, it is treated as a decrease to 
credits under paragraph (d)(2)(iii) of this section, which results 
in an imputed underpayment of $400 under paragraph (c)(1) of this 
section.
    Example 8.  Partnership has two partners, A and B. Under the 
partnership agreement, $100 of the CFTE is specially allocated to A 
for the 2019 taxable year. The IRS initiates an administrative 
proceeding with respect to Partnership's 2019 taxable year and 
determines that $100 of CFTE should be reallocated from A to B. The 
partnership adjustment is a <$100> adjustment to general category 
CFTE allocable to A and an increase of $100 to general category CFTE 
allocable to B. Pursuant to paragraph (d)(2)(iv)(A)(2) of this 
section, the <$100> adjustment to general category CFTE and the 
increase of $100 to general category CFTE are included in separate 
subgroupings, and the increase is disregarded for purposes of 
computing the imputed underpayment under paragraph (c)(1) of this 
section. The increase and decrease of $100 of general category CFTE 
do not net. Instead, the net increase to CFTEs in the general-
category, B-allocation subgrouping is treated as a net non-positive 
adjustment, which does not result in an imputed underpayment and is 
therefore taken into account by the partnership in the adjustment 
year in accordance with Sec.  301.6225-3. The net decrease to CFTEs 
in the general-category, A-allocation subgrouping is treated as a 
decrease to credits in the credit grouping under paragraph 
(d)(2)(iii) of this section, resulting in an imputed underpayment of 
$100 under paragraph (c)(1) of this section.
    Example 9.  Partnership has two partners, A and B. Partnership 
owns two entities, DE1 and DE2, that are disregarded as separate 
from their owner within the meaning of Sec.  301.7701-3 and are 
operating in and paying taxes to foreign jurisdictions. The 
partnership agreement provides that all items (income, gain, loss, 
deduction, credit, etc.) from DE1 and DE2 are allocable to A and B 
in the following manner. Items related to DE1: To A 75% and to B 
25%. Items related to DE2: To A 25% and to B 75%. Partnership 
reports CFTEs in the general category of $300, $100 with respect to 
DE1 and $200 with respect to DE2. Partnership allocates the $300 of 
CFTEs $125 and $175 to A and B respectively. On examination, the IRS 
determines that Partnership understated the amount of creditable 
foreign tax paid by DE2 by $40 and overstated the amount of 
creditable foreign tax paid by DE1 by $80. No other adjustments are 
made. Because the two adjustments each relate to CFTEs that are 
subject to different allocations, the two adjustments are in 
different subgroupings under paragraph (d)(2)(iv)(A)(2) of this 
section. The adjustment reducing the CFTEs related to DE1 produces a 
net decrease to CFTEs within that subgrouping and is treated as a 
reduction to credits under paragraph (d)(2)(iii) of this section and 
results in an imputed

[[Page 56778]]

underpayment of $80 under paragraph (c)(1) of this section. The 
increase of $40 of general category CFTE related to the DE2 
subgrouping results in a net increase to CFTEs within that 
subgrouping and is treated as a net non-positive adjustment, which 
does not result in an imputed underpayment and is taken into account 
in the adjustment year in accordance with Sec.  301.6225-3.

* * * * *
0
 Par. 4. Section 301.6226-2 is amended by revising paragraph (h)(3) to 
read as follows:


Sec.  301.6226-2  Statements furnished to partners and filed with the 
IRS.

* * * * *
    (h) * * *
    (3) Adjustments subject to chapters 3 and 4--(i) In general. A 
partnership that makes an election under Sec.  301.6226-1 with respect 
to an imputed underpayment must pay the amount of tax required to be 
withheld under chapter 3 or chapter 4 (as defined in Sec.  301.6225-
1(a)(4)) on the amount of any adjustment set forth in the statement 
described in paragraph (a) of this section to the extent that it is an 
adjustment to an amount subject to withholding and the IRS has not 
already collected tax attributable to the adjustment under chapter 3 or 
chapter 4. The partnership must pay the amount due under this paragraph 
(h)(3)(i) on or before the due date (as determined under paragraph (b) 
of this section) for furnishing the statement required under paragraph 
(a) of this section that reflects the adjustment, and must make the 
payment in the manner prescribed by the IRS in forms, instructions, and 
other guidance. For purposes of the regulations under subchapter C of 
chapter 63 of the Internal Revenue Code, the term amount subject to 
withholding means an amount subject to withholding (as defined in Sec.  
1.1441-2(a) of this chapter), a withholdable payment (as defined in 
Sec.  1.1473-1(a) of this chapter), or the allocable share of 
effectively connected taxable income (as computed under Sec.  1.1446-
2(b) of this chapter).
    (ii) Reduced rate of tax. A partnership may reduce the amount of 
tax it is required to pay under paragraph (h)(3)(i) of this section to 
the extent that it can associate valid documentation from a reviewed 
year partner pursuant to the regulations under chapter 3 or chapter 4 
(other than pursuant to Sec.  1.1446-6 of this chapter) with the 
portion of the adjustment that would have been subject to a reduced 
rate of tax in the reviewed year. For this purpose, the partnership may 
rely on documentation that the partnership possesses that is valid with 
respect to the reviewed year (determined without regard to the 
expiration after the reviewed year of any validity period prescribed in 
Sec.  1.1441-1(e)(4)(ii), Sec.  1.1446-1(c)(2)(iv)(A), or Sec.  1.1471-
3(c)(6)(ii) of this chapter), or new documentation that the partnership 
obtains from the reviewed year partner that includes a signed affidavit 
stating that the information and representations associated with the 
documentation are accurate with respect to the reviewed year.
    (iii) Reporting requirements. A partnership required to pay tax 
under paragraph (h)(3)(i) of this section must file the appropriate 
return and issue information returns as required by regulations under 
chapter 3 or chapter 4. For return and information return requirements, 
see Sec.  1.1446-3(d)(1)(iii); Sec.  1.1461-1(b), (c); Sec.  1.1474-
1(c), (d) of this chapter. The partnership must file the return and 
issue information returns for the year that includes the date on which 
the partnership furnishes the statement required under paragraph (a) of 
this section. The partnership must report the information on the return 
and information returns in the manner prescribed by the IRS in forms, 
instructions, and other guidance.
* * * * *
0
Par. 5. Section 301.6226-3 is amended by revising paragraph (f), and 
adding Example 6 to paragraph (g) to read as follows:


Sec.  301.6226-3  Adjustments Taken Into Account by Partners.

* * * * *
    (f) Partners subject to withholding under chapters 3 and 4. A 
reviewed year partner that is subject to withholding under Sec.  
301.6226-2(h)(3)(i) must file an income tax return for the reporting 
year to report its additional reporting year tax and its share of any 
penalties, additions to tax, additional amounts, and interest 
(notwithstanding any filing exception in Sec.  1.6012-1(b)(2)(i) or 
Sec.  1.6012-2(g)(2)(i) of this chapter). The amount of tax paid by a 
partnership under Sec.  301.6226-2(h)(3)(i) is allowed as a credit 
under section 33 to the reviewed year partner to the extent that the 
tax is allocable to the reviewed year partner (within the meaning of 
Sec.  1.1446-3(d)(2) of this chapter) or is actually withheld from the 
reviewed year partner (within the meaning of Sec.  1.1464-1(a) or Sec.  
1.1474-3 of this chapter). The credit is allowed against the reviewed 
year partner's income tax liability for its reporting year. The 
reviewed year partner must substantiate the credit by attaching the 
applicable Form 1042-S, ``Foreign Person's U.S. Source Income Subject 
to Withholding,'' or Form 8805, ``Foreign Partner's Information 
Statement of Section 1446 Withholding Tax,'' to its income tax return 
for the reporting year, as well as meeting any other requirements 
prescribed by the IRS in forms and instructions.
    (g) * * *

    Example 6.  On its partnership return for the 2020 tax year, 
Partnership, a domestic partnership, reported U.S. source dividend 
income of $2,000. On June 1, 2023, the IRS mails an FPA to 
Partnership for Partnership's 2020 year increasing the amount of 
U.S. source dividend income to $4,000 and asserting an imputed 
underpayment plus an accuracy-related penalty under section 6662(b). 
Partnership makes a timely election under section 6226 in accordance 
with Sec.  301.6226-1 with respect to the imputed underpayment in 
the FPA for Partnership's 2020 year and does not file a petition for 
readjustment. The time to file a petition expires on August 30, 
2023. Pursuant to Sec.  301.6226-2(b), the partnership adjustments 
become finally determined on August 30, 2023. On September 30, 2023, 
Partnership files the statements described under Sec.  301.6226-2 
with the IRS and furnishes to partner A, a nonresident alien 
individual who was a partner in Partnership during 2020 (and remains 
a partner in Partnership in 2023), a statement described in Sec.  
301.6226-2. A had a 50 percent interest in Partnership during all of 
2020 and was allocated 50 percent of all items from Partnership for 
that year. The statement shows A's share of U.S. source dividend 
income reported on Partnership's return for the reviewed year of 
$1,000 and an adjustment to U.S. source dividend income of $1,000. 
In addition, the statement reports A's share of the accuracy-related 
penalty related to the imputed underpayment, and A's safe harbor 
amount and interest safe harbor amount (as determined under Sec.  
301.6226-2(g)). Under Sec.  301.6226-2(h)(3)(i), because the 
additional $1,000 in U.S. source dividend income allocated to A is 
an amount subject to withholding (as defined in Sec.  301.6226-
2(h)(3)(i)), Partnership must pay the amount of tax required to be 
withheld on the adjustment. See Sec. Sec.  1.1441-1(b)(1) and 
1.1441-5(b)(2)(i)(A) of this chapter. Under Sec.  301.6226-
2(h)(3)(ii), Partnership may reduce the amount of withholding tax it 
must pay because it has valid documentation from 2020 that 
establishes that A was entitled to a reduced rate of withholding in 
2020 on U.S. source dividend income of 10 percent pursuant to a 
treaty. Partnership withholds $100 of tax from A's distributive 
share, remits the tax to the IRS, and files the necessary return and 
information returns required by Sec.  1.1461-1 of this chapter. A 
does not elect to pay the safe harbor amount and therefore must pay 
the additional reporting year tax as determined in accordance with 
paragraph (b) of this section, in addition to A's share of the 
penalty and interest. On his 2023 return, A must report the 
additional reporting year tax determined in accordance with 
paragraph (b) of this section, plus A's share of the accuracy 
related penalty determined at the partnership level, and interest 
determined in accordance with

[[Page 56779]]

paragraph (d) of this section. Under paragraph (f) of this section, 
A may claim the $100 withholding tax paid by Partnership pursuant to 
Sec.  301.6226-2(h)(3)(i) as a credit under section 33 against A's 
income tax liability on his 2023 return.
* * * * *
0
Par. 6. Section 301.6227-2 is amended by adding paragraphs (b)(3) and 
(4) to read as follows.


Sec.  301.6227-2  Determining and accounting for adjustments requested 
in an administrative adjustment request by the partnership.

* * * * *
    (b) * * *
    (3) Coordination with chapters 3 and 4 when partnership pays an 
imputed underpayment. If a partnership pays an imputed underpayment 
resulting from adjustments requested in an AAR under paragraph (b)(1) 
of this section, the rules in Sec.  301.6225-1(a)(4) apply to treat the 
partnership as having paid the amount required to be withheld under 
chapter 3 or chapter 4 (as defined in Sec.  301.6225-1(a)(4)).
    (4) Coordination with chapters 3 and 4 when partnership elects to 
have adjustments taken into account by reviewed year partners. If a 
partnership elects under paragraph (c) of this section to have its 
reviewed year partners take into account adjustments requested in an 
AAR, the rules in Sec.  301.6226-2(h)(3) apply to the partnership, and 
the rules in Sec.  301.6226-3(f) apply to the reviewed year partners 
that take into account the adjustments pursuant to Sec.  301.6227-3.
* * * * *

Kirsten Wielobob,
Deputy Commissioner for Services and Enforcement.
[FR Doc. 2017-25740 Filed 11-29-17; 8:45 am]
BILLING CODE 4830-01-P