Proposed Rule2024-27227
Previously Taxed Earnings and Profits and Related Basis Adjustments
Primary source
Metadata and text below are from the Federal Register, a public-domain U.S. government work. Always verify the official published version before relying on it for any legal matter.
Published
December 2, 2024
Issuing agencies
Treasury DepartmentInternal Revenue Service
Abstract
This document contains proposed regulations regarding previously taxed earnings and profits of foreign corporations and related basis adjustments. The proposed regulations affect foreign corporations with previously taxed earnings and profits and their shareholders.
Full Text
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<title>Federal Register, Volume 89 Issue 231 (Monday, December 2, 2024)</title>
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[Federal Register Volume 89, Number 231 (Monday, December 2, 2024)]
[Proposed Rules]
[Pages 95362-95464]
From the Federal Register Online via the Government Publishing Office [<a href="http://www.gpo.gov">www.gpo.gov</a>]
[FR Doc No: 2024-27227]
[[Page 95361]]
Vol. 89
Monday,
No. 231
December 2, 2024
Part II
Department of the Treasury
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Internal Revenue Service
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26 CFR Part 1
Previously Taxed Earnings and Profits and Related Basis Adjustments;
Proposed Rule
Federal Register / Vol. 89 , No. 231 / Monday, December 2, 2024 /
Proposed Rules
[[Page 95362]]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[REG-105479-18]
RIN 1545-BO61
Previously Taxed Earnings and Profits and Related Basis
Adjustments
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Notice of proposed rulemaking.
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SUMMARY: This document contains proposed regulations regarding
previously taxed earnings and profits of foreign corporations and
related basis adjustments. The proposed regulations affect foreign
corporations with previously taxed earnings and profits and their
shareholders.
DATES: Written or electronic comments and requests for a public hearing
must be received by March 3, 2025.
ADDRESSES: Commenters are strongly encouraged to submit public comments
electronically. Submit electronic submissions via the Federal
eRulemaking Portal at <a href="http://www.regulations.gov">www.regulations.gov</a> (indicate IRS and REG-105479-
18) by following the online instructions for submitting comments.
Requests for a public hearing must be submitted as prescribed in the
``Comments and Requests for a Public Hearing'' section. Once submitted
to the Federal eRulemaking Portal, comments cannot be edited or
withdrawn. The Department of the Treasury (Treasury Department) and the
IRS will publish for public availability any comment submitted
electronically or on paper to its public docket. Send paper submissions
to: CC:PA:01:PR (REG-105479-18), Room 5203, Internal Revenue Service,
P.O. Box 7604, Ben Franklin Station, Washington, DC 20044.
FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations
generally, Elena M. Madaj at (202) 317-3576; concerning the portions of
the proposed regulations relating to section 1502, Jeremy Aron-Dine at
(202) 317-6847; concerning the portions of the proposed regulations
relating to partnerships, Jennifer N. Keeney at (202) 317-6850; and
concerning submissions of comments and requests for a public hearing,
contact the Publications and Regulations Section of the Office of
Associate Chief Counsel (Procedure and Administration) by email at
<a href="/cdn-cgi/l/email-protection#d7a7a2b5bbbeb4bfb2b6a5beb9b0a497bea5a4f9b0b8a1"><span class="__cf_email__" data-cfemail="176762757b7e747f7276657e797064577e656439707861">[email protected]</span></a> (preferred) or by telephone at (202) 317-6901
(not toll-free numbers).
SUPPLEMENTARY INFORMATION:
Authority
This document contains proposed additions and amendments to 26 CFR
part 1 (proposed regulations) under sections 959 and 961 and certain
other provisions of the Internal Revenue Code (Code) regarding
previously taxed earnings and profits (PTEP). As discussed in the
Explanation of Provisions, the primary provisions of the proposed
regulations are issued pursuant to the express delegations of authority
under sections 245A(g), 743(b), 904(d)(7), 951A(f)(1)(B), 960(f),
961(a) through (c), 965(o), 986(c)(2), 989(c), and 1502. The proposed
regulations are also issued pursuant to the express delegation of
authority under section 7805(a).
Background
I. Scope
The Background describes PTEP, including provisions giving rise to
PTEP and provisions regarding the treatment of PTEP, and related
guidance and issues under existing law. Any term used but not defined
in this preamble has the meaning given to it in the proposed
regulations.
II. PTEP
A. Overview
Sections 959 and 961 are intended to operate in tandem to prevent
double taxation of PTEP, which is earnings and profits (E&P) of a
foreign corporation described in section 959(c)(1) or (c)(2). Section
959 designates amounts of E&P as PTEP based on amounts included, or
treated as included, in gross income with respect to the foreign
corporation under section 951(a).
The remainder of this part II of the Background summarizes
provisions giving rise to PTEP, provisions regarding the treatment of
PTEP, and existing regulations under sections 959 and 961.
B. Provisions Giving Rise to PTEP
1. Section 951(a)
Section 951(a)(1)(A) requires a United States shareholder (as
defined in section 951(b) or, if applicable, section 953(c)(1)(A)) of a
foreign corporation to include in gross income its pro rata share of
the corporation's subpart F income (as defined in section 952) for a
taxable year of the corporation (subpart F income inclusion), if the
corporation is a controlled foreign corporation (CFC) (as defined in
section 957(a) or, if applicable, section 957(b) or 953(c)(1)(B)) at
any time during the taxable year and the shareholder owns (within the
meaning of section 958(a)) stock of the corporation on the last day of
the taxable year on which the corporation is a CFC (last relevant day).
Pursuant to section 951(a)(1)(B), the United States shareholder is
generally required to also include in gross income its amount
determined under section 956 (section 956 amount) for the taxable year
of the foreign corporation (section 956 inclusion). This amount
represents an effective repatriation of E&P and is computed based on
certain United States property held by the corporation. Ownership of
stock within the meaning of section 958(a) means stock owned directly
and stock owned indirectly through foreign entities, including domestic
partnerships to the extent treated as foreign partnerships under Sec.
1.958-1(d)(1) (discussed in part III.B of the Background). For purposes
of the remainder of this preamble, a reference to stock ownership means
stock owned within the meaning of section 958(a).
Section 951(a)(2) determines a United States shareholder's pro rata
share of a foreign corporation's subpart F income by first allocating a
portion of such subpart F income to the United States shareholder, and
then reducing such allocation in accordance with section 951(a)(2)(B)
to take into account certain distributions where ownership of the stock
of the foreign corporation is acquired by the United States shareholder
during the corporation's taxable year. See Sec. 1.951-1(b). Subpart F
income allocated to a United States shareholder before the application
of section 951(a)(2)(B) is computed by multiplying the subpart F income
by a fraction, the numerator of which is the portion of the foreign
corporation's hypothetical distribution described in Sec. 1.951-1(e)
that would be distributed with respect to the shareholder's stock of
the corporation, and the denominator of which is the amount of such
hypothetical distribution. See Sec. 1.951-1(e). The amount of the
hypothetical distribution is equal to the foreign corporation's
allocable E&P, which is generally the corporation's E&P for the taxable
year (not reduced by distributions during the year). See Sec. 1.951-
1(e)(1)(ii).
A special rule under section 245A(e) treats certain hybrid
dividends received by a CFC as subpart F income of the receiving CFC
for purposes of section 951(a)(1)(A). Similarly, section 964(e)(4)
treats certain gain from a sale of stock of a foreign corporation by a
CFC as subpart F income of the selling CFC for purposes of section
951(a)(1)(A). Consequently, a United States shareholder of such a
receiving CFC or selling CFC includes in gross income
[[Page 95363]]
under section 951(a)(1)(A) its pro rata share of such subpart F income.
2. Section 951A(a)
Pursuant to section 951A(a), a United States shareholder of a CFC
is required to include in gross income its global intangible low-taxed
income (GILTI inclusion). See Sec. 1.951A-1(b). A United States
shareholder's GILTI inclusion is determined by taking into account the
shareholder's pro rata share of tested items (as defined in Sec.
1.951A-1(f)(5)) of CFCs in which the shareholder owns stock, such as
tested income, tested loss, and qualified business asset investment.
See Sec. 1.951A-1(c). A United States shareholder's pro rata share of
a CFC's tested items is determined in the same manner as a pro rata
share of subpart F income under section 951(a)(2), subject to certain
modifications. See Sec. 1.951A-1(d).
Section 951A(f)(1)(A) provides that a GILTI inclusion is treated in
the same manner as a subpart F income inclusion for purposes of
applying certain provisions of the Code, including sections 959 and
961. Section 951A(f)(1)(B) grants the Secretary authority to provide
rules for applying section 951A(f)(1)(A) to other provisions of the
Code in any case in which the determination of subpart F income is
required to be made at the level of the CFC.
3. Section 1248(a) or (f)
Section 1248(a) requires a United States person that satisfies
certain ownership requirements with respect to stock in a foreign
corporation to include gain recognized on a sale or exchange of stock
in such foreign corporation in gross income as a dividend, to the
extent of the E&P of the foreign corporation attributable to the stock
(including E&P of certain lower-tier foreign corporations pursuant to
section 1248(c)(2), but not including PTEP pursuant to section
1248(d)(1)). Section 1248(f) provides similar rules for certain
distributions in nonrecognition transactions.
Section 959(e) treats an amount included in gross income of any
person as a dividend under section 1248(a) or (f) as an amount included
in gross income under section 951(a)(1)(A), for purposes of section
959.
4. Section 965
The transition tax imposed under section 965 as part of the Tax
Cuts and Jobs Act, Public Law 115-97, 131 Stat. 2054 (2017) (the Act)
increased the subpart F income of certain foreign corporations and
treated such foreign corporations as CFCs for purposes of section 951
(if not already the case). Section 965(a) and (e). Consequently, a
United States shareholder of such a foreign corporation generally
included in gross income under section 951(a)(1)(A) its pro rata share
of such additional subpart F income, subject to reduction under section
965(b) for certain E&P deficits attributable to stock of other foreign
corporations owned by the shareholder.
For purposes of section 959, the transition tax also treated the
amount of a reduction to a United States shareholder's inclusion with
respect to a foreign corporation under section 965(b) as an amount
included in the shareholder's gross income with respect to the foreign
corporation under section 951(a). Section 965(b)(4)(A).
C. Provisions Regarding the Treatment of PTEP
1. Gross Income Exclusions Under Section 959
Section 959 prevents double taxation by excluding PTEP from gross
income of United States persons and CFCs. See H.R. Rep. No. 87-1447, at
A101-102 (1962).
Section 959(a) provides that, when PTEP of a foreign corporation is
distributed to, or would otherwise be included under section
951(a)(1)(B) in gross income of, a United States shareholder whose
inclusion under section 951(a) gave rise to the PTEP, the PTEP is
excluded from the United States shareholder's gross income. Under
successor rules within section 959(a), the exclusion extends to any
other United States person who acquires from any person any portion of
the United States shareholder's interest in the foreign corporation
(subject to any proof of identity rules that may be prescribed by the
Secretary).
Section 959(b) applies for purposes of section 951(a) and provides
that, when PTEP of a CFC is distributed through a chain of ownership
described under section 958(a), the PTEP is excluded from the gross
income of another CFC in the chain for purposes of applying section
951(a) to such CFC with respect to the United States shareholder whose
inclusion under section 951(a) gave rise to the PTEP. Under successor
rules within section 959(b), the exclusion extends to any CFC of any
other United States shareholder who acquires from any person any
portion of the United States shareholder's interest in the CFC (subject
to any proof of identity rules that may be prescribed by the
Secretary).
Section 959(c) treats PTEP as distributed before E&P that is not
PTEP. It does so by allocating distributions first to PTEP described in
section 959(c)(1) (PTEP resulting from a section 956 inclusion or PTEP
that have been excluded under section 959(a)(2)), then to PTEP
described in section 959(c)(2) (all other PTEP), and finally to non-
PTEP (section 959(c)(3) E&P).
For purposes of section 959, section 951A(f)(1) treats the portion
of a United States shareholder's GILTI inclusion that is allocated to a
CFC in the same manner as a subpart F income inclusion.
Section 959(f) allocates a section 956 amount first to PTEP
described in section 959(c)(2) and then to section 959(c)(3) E&P,
taking into account distributions made by the foreign corporation. A
section 956 amount is not allocated to PTEP described in section
959(c)(1) because, under section 956(a) and (b)(1), that PTEP is taken
into account in determining the section 956 amount.
Thus, under section 959, a CFC's E&P for a taxable year of the CFC
is first classified as PTEP to reflect any subpart F income inclusions
or GILTI inclusions with respect to the CFC. Next, any distributions
made by the CFC during the taxable year are allocated to PTEP (and such
PTEP is reduced). Then, any section 956 amount with respect to the CFC
is determined for the taxable year, which is allocated to remaining
section 959(c)(2) PTEP (and such PTEP is reclassified as section
959(c)(1) PTEP). Finally, the CFC's E&P for the taxable year is
classified as PTEP to reflect any inclusion under section 951(a)(1)(B).
2. Basis Adjustments Under Section 961
Section 961 describes rules that provide for basis increases to
reflect amounts included in gross income under section 951(a) and basis
reductions and gain recognition to reflect distributions of PTEP. Basis
increases prevent undistributed PTEP of a foreign corporation from
giving rise to gain or a subpart F income inclusion of a covered
shareholder, and thus additional tax, in a sale or exchange of stock of
the foreign corporation or property through which such stock is owned.
See H.R. Rep. No. 87-1447, at A106 (1962); H.R. Rep. No. 105-148, at
529-30 (1997). Basis reductions and gain recognition prevent double
benefits that would otherwise arise (for example, by ensuring a
distribution of PTEP does not create a loss in the stock or other
property on which the distribution is made because of basis provided
under section 961 for the inclusion that gave rise to the PTEP).
Section 961(a) provides that, under regulations prescribed by the
Secretary, a United States shareholder's basis in its
[[Page 95364]]
stock in a CFC, and basis in property through which it owns such stock,
is increased by the amount included in the shareholder's gross income
under section 951(a) with respect to such stock or property.
Section 961(b)(1) provides that, under regulations prescribed by
the Secretary, when a United States shareholder or a United States
person receives an amount that is excluded from gross income under
section 959(a), the basis of the stock or other property with respect
to which the amount is received is reduced by the amount so excluded.
To the extent that an amount excluded from gross income under section
959(a) exceeds the basis of the stock or other property with respect to
which it is received, section 961(b)(2) treats the amount as gain from
the sale or exchange of property.
Section 961(c) provides that, under regulations prescribed by the
Secretary, if a United States shareholder owns stock in a CFC that is
owned by another CFC, then adjustments similar to the adjustments
provided by section 961(a) and (b) are made to the basis of such stock,
and the basis of stock in any other CFC through which the United States
shareholder owns the stock of the first mentioned CFC, but only for the
purposes of determining the amount included under section 951 in the
gross income of such United States shareholder. Under successor rules
within section 961(c), basis adjustments carry over to any other United
States shareholder who acquires from any person any portion of the
interest of the United States shareholder by reason of which the
shareholder was treated as owning the relevant CFC stock (subject to
any proof of identity rules that may be prescribed by the Secretary).
Section 961(c) further provides that the adjustments described in
section 961(c) do not apply to any stock owned by the United States
shareholder to which a basis adjustment applies under section 961(a) or
(b).
For purposes of section 961, section 951A(f)(1) treats the portion
of a United States shareholder's GILTI inclusion that is allocated to a
CFC in the same manner as a subpart F income inclusion.
Section 1.965-2(f)(1) generally provides that basis is not
increased under section 961 to reflect PTEP resulting from section
965(b), but Sec. 1.965-2(f)(2) permits taxpayers to elect to make
certain basis adjustments.
3. Foreign Currency Gain or Loss Under Section 986(c)
Section 986(c)(1) requires the recognition of foreign currency gain
or loss with respect to distributions of PTEP attributable to movements
in exchange rates between the date of the income inclusion that gave
rise to the PTEP and the distribution of the PTEP. Section 986(c)(1)
further provides that such foreign currency gain or loss is treated as
ordinary income or loss from the same source as the associated income
inclusion. Section 986(c)(2) provides that the Secretary shall
prescribe regulations with respect to distributions of PTEP through
tiers of foreign corporations. Section 989(c) provides that the
Secretary shall prescribe such regulations as may be necessary or
appropriate to carry out the purposes of the subpart that includes
section 986 (subpart J of part III, subchapter N, chapter 1, subtitle A
of the Code).
Notice 88-71, 1988-2 C.B. 374 (1988 notice), provides guidance
regarding foreign currency gain or loss with respect to PTEP and
announced an intent to issue regulations consistent with the guidance.
Under the 1988 notice, such foreign currency gain or loss is determined
with respect to each separate category of income listed in section
904(d)(1) pursuant to a formula and is recognized immediately before
certain sales or exchanges of stock of a foreign corporation with
respect to undistributed PTEP of the foreign corporation. See also
Sec. 1.985-5(e)(2) (requiring a United States shareholder to recognize
foreign currency gain or loss when a CFC changes its functional
currency to the U.S. dollar); Sec. 1.367(b)-2(j)(2)(i) (application of
section 986(c) to certain nonrecognitions).
Section 1.986(c)-1 addresses foreign currency gain or loss with
respect to distributions of PTEP resulting from section 965. The rules
provide that foreign currency gain or loss with respect to PTEP
resulting from section 965(a) is determined based on movements in the
exchange rate between December 31, 2017, and the time such PTEP is
distributed, and that any such gain or loss recognized is reduced in
the same proportion as the reduction by a section 965(c) deduction
amount (as defined in Sec. 1.965-1(f)(42)) of the section 965(a)
inclusion amount (as defined in Sec. 1.965-1(f)(38)) that gave rise to
the PTEP. The rules also provide that section 986(c) does not apply
with respect to distributions of PTEP resulting from section 965(b).
4. Foreign Income Taxes Under Sections 164(a), 901(a), and 960(b)
Section 164(a) generally provides that a taxpayer is allowed a
deduction for certain foreign income taxes paid or accrued by the
taxpayer.
Section 901(a) generally provides that a taxpayer choosing to
credit foreign income taxes is allowed a credit for certain foreign
income taxes paid or accrued by the taxpayer plus, in the case of a
domestic corporation, the taxes deemed to have been paid by the
domestic corporation under section 960.
Section 960(b) applies for purposes of sections 901 through 909
(relating to the foreign tax credit). Section 960(b)(1) provides that,
if PTEP distributed by a CFC to a corporate United States shareholder
of the CFC is excluded from gross income under section 959(a), the
United States shareholder is deemed to have paid the foreign income
taxes that are properly attributable to the PTEP and that have not
already been deemed paid by a domestic corporation. Similarly, section
960(b)(2) provides that, if PTEP distributed by a CFC to another CFC is
excluded from gross income under section 959(b), the recipient CFC is
deemed to have paid the foreign income taxes that are properly
attributable to the PTEP and that have not already been deemed paid by
a domestic corporation. Section 960(f) provides that the Secretary
shall prescribe such regulations or other guidance as may be necessary
or appropriate to carry out the provisions of section 960. Section
904(d)(1) provides that certain provisions including section 960 apply
separately with respect to certain categories of income, and section
904(d)(7) provides that the Secretary shall prescribe such regulations
as may be necessary or appropriate for the purposes of section 904(d).
For purposes of determining the amount of foreign income taxes
deemed paid, Sec. 1.960-3 requires the establishment and maintenance
of foreign corporation-level accounts that track a foreign
corporation's PTEP and foreign income taxes associated with the PTEP.
Those regulations adopt a system of accounting for PTEP in annual
accounts for each separate section 904 category (as defined in Sec.
1.960-1(b)(23)) and further segregate each annual account among ten
PTEP groups.
Section 965(g) and Sec. 1.965-5 disallow a percentage (referred to
as the applicable percentage, as defined in Sec. 1.965-5(d)) of any
credit or deduction for foreign income taxes associated with PTEP
resulting from section 965(a) or (b). Section 245A(d) and Sec.
1.245A(d)-1 disallow the entirety of any credit or deduction for
foreign income taxes associated with PTEP resulting from income
inclusions by reason of section 245A(e)(2) (regarding hybrid dividends)
or certain income inclusions by reason of section 964(e)(4) (regarding
sales of
[[Page 95365]]
stock of a foreign corporation by a CFC). Sections 245A(g) and 965(o)
provide that the Secretary shall prescribe such regulations or other
guidance as may be necessary or appropriate to carry out the provisions
of sections 245A and 965, respectively.
5. Election Under Section 962
Section 962(a) provides that, under regulations prescribed by the
Secretary, an individual United States shareholder may elect to be
taxed at domestic corporate rates on amounts included in the
individual's gross income under section 951(a) and that those amounts
are treated as taken into account by a domestic corporation for
purposes of applying the relevant provisions of section 960. The
election also applies to amounts included in the individual's gross
income under section 951A(a) because, for purposes of section 962, such
amounts are treated in the same manner as a subpart F income inclusion.
See section 951A(f)(1). The purpose of section 962 generally is to
equate an individual's tax burden with respect to certain earnings of a
CFC with the tax burden the individual would have had if the individual
were to own the CFC through a domestic corporation. See S. Rep. No. 87-
1881, at 92-93 (1962).
To carry out this purpose, section 962(d) generally subjects PTEP
to an additional level of taxation when distributed. It does so by,
notwithstanding section 959(a)(1), requiring that the distributed PTEP
be included in gross income to the extent it exceeds the amount of tax
paid on the amounts to which the election under section 962 applied.
Section 961(a) also carries out this purpose by, in the case of an
election under section 962, limiting a basis increase for an income
inclusion to which the election applied to the amount of tax paid by
the individual with respect to the income inclusion. Additionally, in a
distribution of PTEP, section 961(b)(1) limits a basis decrease to the
amount that is excluded from gross income under section 959(a) after
the application of section 962(d).
6. Section 1411
Section 1411 generally imposes a 3.8 percent tax on the net
investment income of certain individuals, trusts, and estates. Under
section 1411(c)(1) and Sec. 1411-4(a), net investment income includes
certain income from dividends and net gain from the disposition of
property. Section 1.1411-10 provides, in relevant part, rules regarding
the application of section 1411 to individuals, trusts, and estates
that own stock of a CFC, and Sec. 1.1411-10(g) allows an election with
respect to a CFC to treat amounts included in income under section
951(a) with respect to the CFC as net investment income for purposes of
Sec. 1.1411-4(a)(1)(i). See also Sec. 1.951A-5(b)(1) (treating a
GILTI inclusion in the same manner as a subpart F income inclusion for
purposes of applying section 1411). If the election provided under
Sec. 1.1411-10(g) is made, a distribution of E&P that is not treated
as a dividend pursuant to section 959(d) is generally not treated as a
dividend for purposes of section 1411(c)(1)(A)(i) and Sec. 1.1411-
4(a)(1)(i). See Sec. 1.1411-10(c)(1)(i)(B). If the election provided
under Sec. 1.1411-10(g) is not made, however, net investment income
could reflect value attributable to PTEP, either when the PTEP is
distributed or when a United States shareholder directly or indirectly
disposes of stock of the CFC. Thus, if no election is made, a
distribution of E&P that is not treated as a dividend pursuant to
section 959(d) is nevertheless a dividend for purposes of determining
net investment income under section 1411(c)(1)(A)(i) and Sec. 1.1411-
4(a)(1)(i), provided the distribution is attributable to amounts that
are or have been included in gross income under section 951(a) in a
taxable year beginning after December 31, 2012. See Sec. 1.1411-
10(c)(1)(i)(A)(1). For purposes of calculating gain on the disposition
of stock of a CFC, basis adjustments under section 961(a) and (b) are
similarly not taken into account for section 1411 purposes in the
absence of the election. See Sec. 1.1411-10(d)(1).
D. Regulations Under Sections 959 and 961
The current regulations under sections 959 and 961 were issued in
1965 and have not been updated to reflect certain statutory changes
(for example, the enactment of section 961(c)). The regulations also do
not address a number of issues relating to the operation of sections
959 and 961.
In 2006, the Treasury Department and the IRS issued a notice of
proposed rulemaking (71 FR 51155) (2006 proposed regulations) to
provide more complete rules and address various open issues under
sections 959 and 961 and related provisions.
In 2018, the Treasury Department and the IRS issued Notice 2019-01,
2019-02 I.R.B. 275 (2019 notice), which announced an intent to withdraw
the 2006 proposed regulations and issue a new notice of proposed
rulemaking under sections 959 and 961 to address certain issues arising
from the Act. The 2019 notice described rules for the maintenance of
PTEP accounts and other aspects relating to the operation of section
959 and requested comments on certain topics. The Treasury Department
and the IRS received several written comments in response to the 2019
notice. In 2022, the Treasury Department and the IRS formally withdrew
the 2006 proposed regulations (87 FR 63981).
As indicated in the 2019 notice, changes made by the Act had a
significant impact on the role of PTEP and how it functions within the
U.S. tax system and, in certain cases, exacerbated the need to address
longstanding issues. Thus, in addition to the need for updated and more
complete rules as contemplated in the 2006 proposed regulations, the
issuance of new regulations requires consideration of multiple issues
raised by the Act. Certain significant considerations about the role of
PTEP in the current U.S. tax system are summarized below.
First, the Act significantly increased the types of income that
give rise to PTEP, several of which involve specific rules and
limitations to determine foreign currency gain or loss and the
availability of foreign tax credits. Giving effect to the various rules
and limitations introduced by the Act requires a detailed accounting
system to track PTEP in new groups, and to ensure those rules and
limitations are appropriately applied by taxpayers and can be
administered by the IRS.
The Act also substantially increased the amount of PTEP in the U.S.
tax system. In many cases, a considerable portion of a CFC's income has
been (or will be) subject to tax under section 951(a)(1)(A) or 951A(a),
including by reason of the transition tax imposed under section 965,
and thus only the residual amount of the CFC's income constitutes
section 959(c)(3) E&P.
At the same time, the Act introduced section 245A, which in certain
cases allows a domestic corporation to claim a dividends received
deduction for section 959(c)(3) E&P. As a result, unlike before the Act
where section 959(c)(3) E&P generally was subject to U.S. tax (with a
possible foreign tax credit in some cases) when repatriated to the
domestic corporation, such E&P may now generally be repatriated without
U.S. tax to a recipient domestic corporation. Nonetheless, there are
important distinctions between section 959(c)(3) E&P and PTEP--in
particular, the section 245A deduction generally allows E&P to be
distributed without a corresponding basis reduction (but see sections
961(d) and 1059), whereas a distribution of PTEP reduces basis (or
gives rise to gain) in accordance with section 961(b). Therefore, PTEP
may not
[[Page 95366]]
be preferable to section 959(c)(3) E&P and taxpayers might take
inappropriate positions to maximize the existence of section 959(c)(3)
E&P. For example, a taxpayer may wish to claim a section 961 basis
increase for an amount included in gross income but apply the section
245A deduction on a distribution of the corresponding E&P so that such
E&P is repatriated tax-free without any basis reduction under section
961(b). To prevent this type of planning, it is critical for the system
to properly maintain the PTEP character of that E&P so that section
961(b) applies when the E&P is distributed.
Existing rules governing PTEP also do not adequately address
structures where a United States shareholder owns only a portion of the
stock in an upper-tier CFC that owns stock in a lower-tier CFC. In
particular, there are no rules prescribing the manner in which basis
under section 961(c) functions in these non-wholly owned structures.
Further, after the enactment of section 951A in the Act, it is much
more likely for United States shareholders to have disparate amounts of
PTEP with respect to the same CFC because a United States shareholder's
GILTI inclusion is determined based on items attributable to all the
stock of CFCs owned by the United States shareholder, and this can
raise issues about how section 959(b) applies in distributions of the
PTEP (such as the issues discussed in part II.D.1.ii of the Explanation
of Provisions). Thus, changes in the Act have compounded already
existing complexities with respect to the treatment of PTEP and basis
in stock in non-wholly owned structures.
Finally, existing rules do not sufficiently address the operation
of the PTEP provisions with respect to domestic partnerships (or
certain S corporations) in light of the enactment of section 951A and
the extension of aggregate treatment to such entities in determining
inclusions under both sections 951(a) and 951A(a) (as discussed in part
III.A of the Background). Moreover, certain unresolved issues, such as
whether a partnership obtains basis in stock of a CFC to account for
PTEP, which had previously been limited to foreign partnerships, now
apply equally to domestic partnerships (and certain S corporations).
III. Other Guidance and Issues
A. Regulations Under Section 958
Before the Act, domestic partnerships (and S corporations by
operation of section 1373(a)) were treated as owning stock of a foreign
corporation for purposes of determining inclusions in gross income
under section 951(a), and, thus, PTEP accounts under section 959 were
maintained, and related basis adjustments under section 961 were made,
at the partnership level.
Following the enactment of section 951A in the Act, in 2019 the
Treasury Department and the IRS published final regulations treating a
domestic partnership (and certain S corporations) as an aggregate of
its partners for purposes of applying section 951A and related
provisions. TD 9866, 84 FR 29288. That is, partners do not take into
account a distributive share of a section 951A inclusion with respect
to the domestic partnership and its CFCs, but instead are treated as
proportionately owning the stock of those CFCs, with the result that
(as with foreign partnerships) income inclusions under section 951A are
determined directly (and solely) by partners that are United States
shareholders with respect to a CFC. Subsequently, in 2022, the Treasury
Department and the IRS published Sec. 1.958-1(d) which, consistent
with the approach adopted under section 951A, extends the aggregate
treatment of domestic partnerships to section 951. TD 9960, 87 FR 3648.
Under Sec. 1.958-1(d), for purposes of sections 951, 951A, and
956(a), as well as any provision that specifically applies by reference
to those sections (or regulations issued under those sections), a
domestic partnership is generally not treated as owning stock of a
foreign corporation under section 958(a), and stock of a foreign
corporation owned by the domestic partnership is instead treated in the
same manner as stock of a foreign corporation owned by a foreign
partnership under section 958(a)(2) and Sec. 1.958-1(b). Accordingly,
because sections 959 and 961 specifically apply by reference to
sections 951 and 951A (in the latter case, as a result of section
951A(f)(1)(A)), aggregate treatment of domestic partnerships applies
for purposes of sections 959 and 961 pursuant to Sec. 1.958-1(d).
Regulations do not, however, specifically address the application of
sections 959 and 961 with respect to domestic partnerships or their
partners under Sec. 1.958-1(d).
B. Regulations Under Section 1502
Section 1502 authorizes the Secretary to prescribe regulations for
an affiliated group of corporations that join in filing (or that are
required to join in filing) a consolidated return (consolidated group,
as defined in Sec. 1.1502-1(h)) to clearly reflect the U.S. tax
liability of the consolidated group and to prevent avoidance of such
tax liability. For purposes of carrying out those objectives, section
1502 also permits the Secretary to prescribe rules that may be
different from the provisions of chapter 1 of subtitle A of the Code
that would apply if the corporations composing the consolidated group
filed separate returns. Pursuant to these rules, members of a
consolidated group are treated as separate entities for some purposes
but as divisions of a single corporation for other purposes. See, for
example, Sec. 1.1502-13(a)(2).
Regulations issued under section 1502 address the application of
certain provisions of subpart F in the context of consolidated groups.
See, for example, Sec. 1.1502-51 (application of section 951A to
consolidated groups); Sec. 1.1502-80(j) (addressing determination of
section 951(a)(2)(B) reduction for distributions under section 959(b)
for purposes of sections 951(a)(1)(A) and 951A(a)). However,
regulations do not address the application of sections 959 and 961 with
respect to a consolidated group or its members.
Explanation of Provisions
I. Scope
The proposed regulations provide rules addressing core aspects of
the PTEP system, including rules that address longstanding issues under
sections 959 and 961, account for new provisions and amendments under
the Act, and implement the 1988 notice and 2019 notice. Future guidance
will address certain issues not addressed in the proposed regulations,
for example, issues involving nonrecognition transactions, redemptions,
transactions to which section 964(e) applies, and structures where CFCs
are partners in a partnership. See also Notice 2024-16, 2024-5 I.R.B.
622 (announcing intent to issue proposed regulations addressing the
treatment of section 961(c) basis in certain transactions in which a
domestic corporation acquires stock of a CFC in a liquidation described
in section 332 or an asset reorganization described in section
368(a)(1)). Future guidance may also address any issues regarding the
interaction of the proposed regulations with existing rules under other
provisions.
II. Section 959 Regulations
A. Overview
The proposed regulations under section 959 provide rules for PTEP
accounting (both at the shareholder-level and foreign corporation-
level), exclusions from gross income, and related determinations and
adjustments.
[[Page 95367]]
B. PTEP Accounting (Proposed Sec. 1.959-2)
1. Shareholder-Level Accounts
i. In General
Integral to the proposed regulations are annual PTEP accounts,
dollar basis pools, and PTEP tax pools, which are established and
maintained by a covered shareholder with respect to a foreign
corporation in which the shareholder owns stock. See proposed Sec.
1.959-2(b)(1). These are integral aspects of the PTEP system because
they ensure proper tracking of amounts described under provisions of
the Code such as sections 959(a), 986(c), and 960(b). These rules are
issued pursuant to the express delegations of authority under sections
245A(g), 904(d)(7), 960(f), 965(o), and 989(c).
A covered shareholder means any United States person, other than a
domestic partnership. See proposed Sec. 1.959-1(b); see also part
VIII.A of the Explanation of Provisions (providing that an S
corporation is generally treated in the same manner as a domestic
partnership). Domestic partnerships are excluded from this definition
because they are treated as aggregates of their partners in determining
stock ownership for purposes of section 959 (discussed in part III.A of
the Background). A covered shareholder is not limited to a United
States shareholder because the exclusion under section 959(a) is not
limited to United States shareholders. For example, section 959(a)
applies to any United States person who acquires from any person an
interest in a foreign corporation with PTEP.
ii. Annual PTEP Accounts
Annual PTEP accounts track a foreign corporation's PTEP with
respect to a covered shareholder. See proposed Sec. 1.959-2(b)(1).
These accounts represent PTEP distributable exclusively to the covered
shareholder (or a successor), directly or indirectly through tiers, on
any stock of the foreign corporation.
Each annual PTEP account relates to a single taxable year of the
foreign corporation and a single section 904 category, and PTEP within
an annual PTEP account is maintained in the foreign corporation's
functional currency and assigned among ten PTEP groups and two
subgroups. See proposed Sec. 1.959-2(b)(2). Tracking PTEP on an annual
basis is necessary to apply the ``last-in, first-out'' rule for
distributions of PTEP in section 959(c), and PTEP is maintained in the
foreign corporation's functional currency pursuant to section 986(b).
Tracking PTEP by section 904 category and by PTEP groups is necessary
to implement rules determining foreign currency gain or loss and
foreign tax credits with respect to PTEP.
The ten PTEP groups fall within two categories--section 959(c)(2)
PTEP groups and section 959(c)(1) PTEP groups. See proposed Sec.
1.959-2(b)(2)(i). The section 959(c)(2) groups separately track PTEP
resulting from subpart F income inclusions, GILTI inclusions,
application of section 965(a) or 965(b), or income inclusions to which
section 245A(d) applies (PTEP resulting from section 245A(e)(2) or
certain PTEP resulting from section 959(e) (concerning section 1248) or
section 964(e)(4) (concerning certain dispositions of foreign stock)).
The section 959(c)(1) PTEP groups correspond to the section 959(c)(2)
PTEP groups and account for the reclassification of PTEP pursuant to
section 959(a)(2). PTEP arising from section 956 inclusions is combined
with reclassified PTEP arising from subpart F income inclusions.
The two subgroups track PTEP arising from income inclusions of
certain covered shareholders. See proposed Sec. 1.959-2(b)(2)(ii). One
subgroup tracks PTEP arising from an income inclusion of an individual
and includible in gross income under section 962(d) when distributed in
a distribution to which section 959(a) would otherwise apply (taxable
section 962 PTEP). The second subgroup tracks PTEP arising from an
income inclusion of an individual, estate, or trust that would be
includible in net investment income under section 1411(c) when
distributed (that is, the election under Sec. 1.1411-10(g) is not made
and, thus, the income inclusion giving rise to the PTEP was not taken
into account in determining net investment income).
Additionally, for PTEP resulting from the application of section
965(a) or (b), an adjusted applicable percentage must be maintained,
which tracks the percentage of a credit or deduction for foreign income
taxes associated with PTEP that is disallowed under Sec. 1.965-5. See
proposed Sec. 1.959-2(b)(2)(iii)(A). Similarly, for PTEP resulting
from the application of section 965(a), a section 965(c) deduction
percentage must be maintained, which tracks the percentage of foreign
currency gain or loss with respect to PTEP that is not recognized under
Sec. 1.986(c)-1. See proposed Sec. 1.959-2(b)(2)(iii)(B). The
adjusted applicable percentage and the section 965(c) deduction
percentage are tracked by section 904 category. Each is determined
using a single weighted average across that section 904 category, which
is intended to reduce the compliance burden and facilitate
administrability in cases in which the applicable percentage or section
965(c) deduction amount differs with respect to PTEP in the section 904
category by not requiring the separate tracking of those percentages or
amounts. See also part IX.B.3. of the Explanation of Provisions
(describing transition rules for the initial determination of the
adjusted applicable percentage and section 965(c) deduction
percentage).
iii. Dollar Basis Pools and PTEP Tax Pools
Dollar basis pools track the basis in U.S. dollars of a foreign
corporation's PTEP with respect to a covered shareholder, and such
dollar basis is used to determine foreign currency gain or loss under
section 986(c). See proposed Sec. 1.959-2(b)(1). PTEP tax pools track
the U.S. dollar amount of foreign income taxes associated with a
foreign corporation's PTEP with respect to a covered shareholder, and
such taxes are assigned to a creditable PTEP tax group to the extent
eligible to be deemed paid under section 960(b). See proposed Sec.
1.959-2(b)(1) and (4)(ii). The creditable PTEP tax group tracks foreign
income taxes that are eligible to be deemed paid under section 960(b).
Furthermore, together, dollar basis and the U.S. dollar amount of
associated foreign income taxes determine basis reductions under
section 961 for distributions of PTEP. See also part III.C.2 of the
Explanation of Provisions.
Tracking foreign income taxes associated with PTEP in a
shareholder-specific manner (consistent with how PTEP is tracked)
differs from the approach under existing Sec. 1.960-3 (and the 1988
notice), which tracks such taxes only at the CFC-level (without regard
to the shareholder whose PTEP account was reduced by the taxes). This
new approach ensures that, in structures involving multiple covered
shareholders, foreign income taxes are associated with PTEP with
respect to a particular covered shareholder and do not include foreign
income taxes that were imposed on PTEP with respect to another covered
shareholder. Thus, in a distribution of PTEP to a covered shareholder,
the covered shareholder's basis is reduced under section 961(b) by the
foreign income taxes that are (i) associated with (and consequently
reduced) PTEP with respect to the covered shareholder, and (ii) deemed
paid by the covered shareholder. This method is intended to prevent
each covered shareholder from incurring double taxation on a single
item of income, by ensuring that a covered
[[Page 95368]]
shareholder is able to take into account the foreign income taxes
associated with the PTEP with respect to the covered shareholder.
Generally, dollar basis pools and PTEP tax pools are maintained on
a year-by-year basis, with one pool for each PTEP group within each
annual PTEP account. See proposed Sec. 1.959-2(b)(3) and (4).
Maintenance of separate dollar basis pools for each PTEP group prevents
the commingling of dollar basis of PTEP that is subject to different
rules with respect to the recognition of foreign currency gain or loss
under section 986(c). Maintenance of separate PTEP tax pools for each
PTEP group prevents the commingling of foreign income taxes for which
the related PTEP is subject to different rules regarding the
applicability of section 960(b).
Under an exception intended to simplify PTEP accounting, a covered
shareholder may elect to combine dollar basis pools and PTEP tax pools
across years. See proposed Sec. 1.959-2(c). In such a case, each
dollar basis pool and PTEP tax pool relates to PTEP assigned to a
single PTEP group and a single section 904 category (without regard to
the taxable years to which the PTEP relates). See proposed Sec. 1.959-
2(b)(3) and (4). This election is consistent with a comment in response
to the 2019 notice that recommended allowing taxpayers to pool dollar
basis across years within section 904 categories.
If a covered shareholder elects to combine dollar basis pools and
PTEP tax pools across years, the election applies to the covered
shareholder's dollar basis pools and PTEP tax pools with respect to
each foreign corporation in which the covered shareholder owns stock.
See proposed Sec. 1.959-2(c)(1). This ensures consistent treatment by
not permitting a covered shareholder to maintain combined pools with
respect to some foreign corporations but not others. A combined pool
election may be revoked only with the consent of the Commissioner. See
proposed Sec. 1.959-2(c)(2).
2. Foreign Corporation-Level Accounts
Foreign corporation-level accounts track a foreign corporation's
PTEP and associated foreign income taxes (corporate PTEP accounts and
corporate PTEP tax pools, respectively). See proposed Sec. 1.959-
2(d)(1) and (d)(2). A corporate PTEP account and corporate PTEP tax
pool each relate to a single covered shareholder, and PTEP or foreign
income taxes within such an account are assigned to section 904
categories and PTEP groups (as is the case in shareholder-level
accounts). These accounts reflect that PTEP and associated foreign
income taxes are foreign corporation-level attributes (which, as
discussed in part II.B.1 of the Explanation of Provisions, are tracked
in a shareholder-specific manner). These accounts also are necessary to
allocate and apportion current year taxes paid or accrued by a foreign
corporation among the relevant statutory and residual groupings of the
foreign corporation, as discussed in part II.F of the Explanation of
Provisions, as well as for computations under section 956, which take
into account E&P described in section 959(c)(1). Finally, as with
shareholder-level accounts, these rules are issued pursuant to the
express delegations of authority under sections 245A(g), 904(d)(7),
960(f), 965(o), and 989(c).
A corporate PTEP account relating to a covered shareholder
represents all PTEP within the covered shareholder's annual PTEP
accounts with respect to the foreign corporation (therefore, unlike
shareholder-level accounts, a corporate PTEP account does not relate to
a single taxable year of the foreign corporation). Similarly, a
corporate PTEP tax pool for a covered shareholder represents all
foreign income taxes within the covered shareholder's PTEP tax pools
with respect to the foreign corporation. Thus, as a covered
shareholder's annual PTEP accounts and PTEP tax pools with respect to a
foreign corporation are adjusted, the foreign corporation-level
accounts (including the PTEP groups within the accounts) are also
adjusted.
The proposed regulations do not provide rules for maintaining a
foreign corporation-level account for section 959(c)(3) E&P because the
Treasury Department and the IRS are studying whether such E&P should be
separately computed with respect to each covered shareholder in certain
instances and related issues (for example, coordination with section
1248). For example, assume a case in which US1 and US2, each a covered
shareholder, own 60% and 40%, respectively, of the stock of CFC1, a
foreign corporation. CFC1 has $75x and $0 of PTEP with respect to US1
and US2, respectively, but only $50x of total E&P as a result of
incurring a deficit in E&P after generating the PTEP. Under a
shareholder-specific approach to computing CFC1's section 959(c)(3)
E&P, such E&P would be negative $45x with respect to US1 ($50x x 60%-
$75x) and $20x with respect to US2 ($50x x 40%-$0). Under a non-
shareholder-specific approach to computing section 959(c)(3) E&P,
CFC1's section 959(c)(3) E&P would be negative $25x ($50x-$75x).
The proposed regulations clarify that a foreign corporation's E&P
is determined independently of the foreign corporation's PTEP. See
proposed Sec. 1.959-2(d)(3). For example, in a distribution by a
foreign corporation with respect to its stock, section 316 determines
the extent to which the distribution is made out of the foreign
corporation's E&P, and section 959 determines the extent to which the
portion that is made out of E&P is a distribution of PTEP. See also
proposed Sec. 1.959-10(c)(2)(iii) (Example 2, alternative facts,
regarding a distribution of built-in loss property). Additionally, as
in the example in the preceding paragraph, the proposed regulations
clarify that a foreign corporation's E&P may be less than the foreign
corporation's PTEP because a loss does not reduce PTEP.
C. Shareholder-Level Account Adjustments (Proposed Sec. 1.959-3)
1. In General
The proposed regulations describe the adjustments made to a covered
shareholder's annual PTEP accounts (including PTEP groups within those
accounts and, if applicable, relevant percentages for section 965 PTEP
and PTEP subgroups), dollar basis pools, and PTEP tax pools with
respect to a foreign corporation. See proposed Sec. 1.959-3. The rules
for making these adjustments are issued pursuant to the express
delegations of authority under sections 245A(g), 904(d)(7), 986(c)(2),
960(f), 965(o), and 989(c).
These adjustments reflect income inclusions and transactions
related to a taxable year of the foreign corporation, and the
adjustments preserve the character of the foreign corporation's PTEP
with respect to the covered shareholder (for example, the taxable year,
section 904 category, and PTEP group to which PTEP relates). In
applying these rules to tiers of foreign corporations, the adjustments
are applied successively from the lowest-tier foreign corporation to
the highest-tier foreign corporation. See proposed Sec. 1.959-3(g).
An adjustment to annual PTEP accounts is treated as made at one of
three points in time (each of which is discussed below in this part
II.C of the Explanation of Provisions), which determines when PTEP
becomes (or ceases to be) available for distribution to the covered
shareholder: (i) at the beginning of the first day of the foreign
corporation's taxable year, (ii) concurrently with the transaction
giving rise to the adjustment, or (iii) at the end of the last day of
the foreign
[[Page 95369]]
corporation's taxable year. See proposed Sec. 1.959-3(f). An
adjustment to dollar basis pools and PTEP tax pools is treated as made
concurrently with the related adjustment to annual PTEP accounts.
2. Beginning of Year Adjustments
Three types of PTEP are added to annual PTEP accounts at the
beginning of the foreign corporation's taxable year (even if, for
example, the determination of the amount giving rise to the PTEP occurs
at the end of such taxable year). This timing ensures that PTEP
generated or received during the taxable year is available for
distribution as of the start of the taxable year, consistent with
sections 316(a)(2) and 959(c) (which determine dividend treatment and
the application of section 959(a) or (b) based on E&P for the taxable
year).
The first type is PTEP arising from the covered shareholder's
subpart F income inclusion or GILTI inclusion with respect to the
foreign corporation for the taxable year. See proposed Sec. 1.959-
3(c)(1)(i) and (ii). To reflect the addition of this PTEP, basis equal
to the U.S. dollar amount of the income inclusion giving rise to the
PTEP is added to related dollar basis pools. See proposed Sec. 1.959-
3(d)(1)(i).
The second type is PTEP with respect to the covered shareholder
that is distributed to the foreign corporation during the taxable year
(discussed in part II.D of the Explanation of Provisions). See proposed
Sec. 1.959-3(c)(1)(iii). To reflect the addition of this PTEP, the
dollar basis and associated foreign income taxes of the PTEP are added
to related dollar basis pools and PTEP tax pools, and such taxes are
assigned to the creditable PTEP tax group to the extent the foreign
corporation is deemed to pay the taxes under section 960(b)(2) and
proposed Sec. 1.960-3(c). See proposed Sec. 1.959-3(d)(1)(ii),
(e)(1)(i). Further, the PTEP is reduced by current year taxes allocated
and apportioned to the PTEP (that is, by foreign income taxes imposed
on the PTEP and paid or accrued by the foreign corporation in the
taxable year, as distinguished from foreign income taxes described in
the preceding sentence, which were paid or accrued by another foreign
corporation in a prior distribution of the PTEP). See proposed Sec.
1.959-3(c)(1)(v); see also part II.F of the Explanation of Provisions
(rules for allocating and apportioning current year taxes to PTEP).
Such current year taxes reduce related dollar basis pools and are added
to related PTEP tax pools, where the taxes are assigned to the
creditable PTEP tax group to the extent the foreign corporation is a
CFC and a credit for the taxes is not disallowed or suspended at the
level of the CFC. See proposed Sec. 1.959-3(d)(1)(iii), (e)(1)(ii).
The third type is PTEP with respect to the covered shareholder that
results from the application of the foreign corporation's section
961(c) basis to gain recognized by the foreign corporation during the
taxable year (discussed in part III.E of the Explanation of
Provisions). See proposed Sec. 1.959-3(c)(1)(iv). To reflect the
addition of this PTEP, the dollar basis of the PTEP is added to related
dollar basis pools. See proposed Sec. 1.959-3(d)(1)(ii). Further,
current year taxes allocated and apportioned to the PTEP reduce the
PTEP, reduce related dollar basis pools, and are added to related PTEP
tax pools, where (like in a distribution) the taxes are assigned to the
creditable PTEP tax group to the extent the foreign corporation is a
CFC and a credit for the taxes is not disallowed or suspended at the
level of the CFC. See proposed Sec. 1.959-3(d)(1)(iii), (e)(1)(ii).
3. Time of Transaction Adjustments
Three types of PTEP are added to, or removed from, annual PTEP
accounts concurrently with the relevant transaction occurring during
the foreign corporation's taxable year.
The first type is PTEP distributed by the foreign corporation
during the taxable year. See proposed Sec. 1.959-3(c)(1)(vi). To
reflect the removal of this PTEP, the dollar basis and associated
foreign income taxes of the PTEP are removed from related dollar basis
pools and PTEP tax pools. See proposed Sec. 1.959-3(d)(1)(iv),
(e)(1)(iii).
The second type is PTEP arising from gain recognized by the covered
shareholder on the sale or exchange of stock during the taxable year
that is recharacterized and included in gross income as a dividend
under section 1248 by reason of E&P attributed to stock of the foreign
corporation under section 1248. See proposed Sec. 1.959-3(c)(1)(vii);
see also section 959(e). This timing prevents iterative computations
that could result if the PTEP were available for distribution earlier
in the taxable year. To reflect the addition of this PTEP, basis equal
to the U.S. dollar amount of the income inclusion giving rise to the
PTEP is added to related dollar basis pools. See proposed Sec. 1.959-
3(d)(1)(i). The Treasury Department and the IRS are studying whether a
foreign corporation's PTEP should similarly be increased to reflect
gain treated as a dividend under section 964(e)(1) by reason of E&P of
the foreign corporation, which amount generally increases the selling
CFC's PTEP, and welcome comments on whether increasing the foreign
corporation's PTEP would be appropriate notwithstanding the duplicative
result (that is, PTEP would be in the selling CFC and the foreign
corporation whose E&P gave rise to the dividend).
The third type is PTEP that transfers from (or to) the covered
shareholder under section 959's successor rules (discussed in part II.G
of the Explanation of Provisions). See proposed Sec. 1.959-
3(c)(1)(viii), (ix). To reflect the removal (or addition) of this PTEP,
the dollar basis and associated foreign income taxes of the PTEP are
removed from (or added to) related dollar basis pools and PTEP tax
pools. See proposed Sec. 1.959-3(d)(1)(iv) and (v), (e)(1)(iii) and
(iv).
4. End of Year Adjustments
Two types of adjustments are made at the end of the foreign
corporation's taxable year. These adjustments relate to the covered
shareholder's section 956 amount with respect to the foreign
corporation for the taxable year.
First, PTEP to which the section 956 amount is allocated (which, as
discussed in part II.E of the Explanation of Provisions, is excluded
from the covered shareholder's gross income under section 959(a)(2)) is
reassigned within annual PTEP accounts from section 959(c)(2) PTEP
groups to section 959(c)(1) PTEP groups. See proposed Sec. 1.959-
3(c)(1)(x). To reflect the reclassification, the dollar basis and
associated foreign income taxes of the PTEP are moved from dollar basis
pools and PTEP tax pools relating to section 959(c)(2) PTEP groups to
dollar basis pools and PTEP tax pools relating to section 959(c)(1)
PTEP groups. See proposed Sec. 1.959-3(d)(1)(vi), (e)(1)(v).
Next, PTEP arising from the portion of the section 956 amount
included in the covered shareholder's gross income under section
951(a)(1)(B) is added to annual PTEP accounts. See proposed Sec.
1.959-3(c)(1)(xi). In addition, an amount of basis equal to the U.S.
dollar amount of the section 956 inclusion giving rise to the PTEP is
added to related dollar basis pools. See proposed Sec. 1.959-
3(d)(1)(i).
Further, additional rules address cases where the covered
shareholder acquires ownership of stock of the foreign corporation on
or after the last relevant day of the foreign corporation's taxable
year (that is, the last day of such taxable year on which the foreign
corporation is a CFC) and a portion of a section 956 amount of a United
States shareholder is attributable to such stock. See proposed Sec.
1.959-3(c)(4). Under these rules, PTEP of the foreign corporation that
has transferred to the
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covered shareholder but to which such portion of the section 956 amount
is ultimately allocated (discussed in part II.E of the Explanation of
Provisions) is reclassified from section 959(c)(2) PTEP groups to
section 959(c)(1) PTEP groups. Moreover, the foreign corporation's PTEP
with respect to the covered shareholder is increased to reflect the
inclusion in income by the United States shareholder of such portion of
the section 956 amount.
D. Distributions of PTEP (Proposed Sec. 1.959-4)
1. Application of Exclusions
i. In General
The proposed regulations provide rules regarding the exclusions
from gross income under section 959(a)(1) and (b) for PTEP that is
distributed to a covered shareholder or a CFC. See proposed Sec.
1.959-4; see also part II.D.2 of the Explanation of Provisions
(determining distributed PTEP).
Under the section 959(a)(1) exclusion, PTEP distributed to a
covered shareholder, other than taxable section 962 PTEP, is excluded
from the covered shareholder's gross income. See proposed Sec. 1.959-
4(b)(1); see also section 962(d) and proposed Sec. 1.312-8(c)
(domestic corporation's receipt of PTEP does not increase E&P,
discussed in part VIII.I of the Explanation of Provisions).
Under the section 959(b) exclusion, PTEP distributed by a CFC to
another CFC is excluded from the recipient CFC's gross income for
purposes of determining the recipient CFC's subpart F income and tested
income or tested loss, provided that the PTEP relates to a covered
shareholder that is a United States shareholder in both CFCs. See
proposed Sec. 1.959-4(b)(2); see also Sec. 1.312-6(b) (the
distribution generally increases the recipient CFC's E&P) and proposed
Sec. 1.952-1(c)(4) (the distribution does not increase the recipient
CFC's current year E&P for purposes of the limitation in section
952(c)(1)(A), discussed in part VIII.I of the Explanation of
Provisions).
Applying the section 959(b) exclusion for purposes of determining
the recipient CFC's tested income or tested loss prevents double
taxation (and thus is consistent with the policy of section 959) in
cases where the distribution is not a related party dividend described
in section 951A(c)(2)(A)(i)(IV) and therefore could otherwise result in
tested income. The Treasury Department and the IRS are of the view that
this approach, which is issued under the express delegation of
authority in section 951A(f)(1)(B), is consistent with section
951A(f)(1)(A) (treating an inclusion under section 951A(a) in the same
manner as an inclusion under section 951(a)(1)(A) for purposes of
section 959), which should be interpreted as allowing references to
section 951(a) in section 959 to be treated as including a reference to
section 951A(a).
Applying the section 959(b) exclusion only to PTEP distributed by a
CFC to another CFC is consistent with the statute. However, under the
express delegation of authority in section 965(o), the proposed
regulations provide a special rule pursuant to which a specified
foreign corporation (as defined in Sec. 1.965-1(f)(45)(i)(B)) that is
not a CFC is treated as a CFC for purposes of applying the section
959(b) exclusion to section 965 PTEP distributed by the specified
foreign corporation, which ensures that the section 959(b) exclusion
applies to such PTEP when received by a CFC. See proposed Sec. 1.959-
4(b)(2)(ii). The Treasury Department and the IRS are studying the
application of section 959(b) to other PTEP distributed by a foreign
corporation that is not a CFC (for example, in a case where the foreign
corporation was a CFC when the PTEP was generated but is no longer a
CFC when the PTEP is distributed). Irrespective of whether the section
959(b) exclusion applies to PTEP distributed to a foreign corporation,
the PTEP remains PTEP and, in a subsequent distribution, may be
excluded from gross income under section 959(a)(1) or (b). See proposed
Sec. Sec. 1.959-2 and 1.959-3 (describing shareholder-level annual
PTEP accounts and related adjustments with respect to a foreign
corporation without regard to CFC status). This treatment is required
to give effect to section 959(a), which does not depend on the CFC
status of any intermediary entities through which a covered shareholder
ultimately receives PTEP.
ii. Split-Ownership Structures
Under the proposed regulations, the section 959(b) exclusion
applies at the CFC-level by excluding a distribution of PTEP from the
recipient CFC's gross income for certain purposes. In structures where
stock of a CFC is not all owned by a single United States shareholder,
the application of the section 959(b) exclusion at the CFC-level could,
absent special rules, result in all United States shareholders of the
CFC sharing any benefits of the exclusion (rather than just the United
States shareholder to which the excluded PTEP relates) and partial
double taxation to the United States shareholder to which the excluded
PTEP relates (to the extent the exclusion benefits other United States
shareholders).
Guidance issued before the Act generally used a ``gross-up''
mechanism to address this issue. Rev. Rul. 82-16, 1982-1 C.B. 106,
considered a scenario where a United States shareholder owned 70% of
the stock of an upper-tier CFC, with the remaining 30% owned by non-
United States shareholders, and the upper-tier CFC owned all the stock
of a lower-tier CFC. The lower-tier CFC earned $100x of subpart F
income, which gave rise to a $70x subpart F income inclusion and, thus,
$70x of PTEP with respect to the United States shareholder. In a later
year, the lower-tier CFC distributed $200x to the upper-tier CFC. The
ruling concluded that section 959(b) looks to the total amount of E&P
of the lower-tier CFC that caused the United States shareholder's
subpart F income inclusion, with the result that section 959(b)
excluded $100x (rather than $70x) from the upper-tier CFC's subpart F
income in applying section 951(a) to the United States shareholder.
Conversely, a $70x exclusion under section 959(b) would have caused the
upper-tier CFC to have an additional $30x of subpart F income from the
distribution, which would have led to a $21x ($30x x 70%) subpart F
income inclusion for the United States shareholder even though its
share of the distribution was all attributable to PTEP.
However, a gross-up mechanism raises certain issues. For example,
computing a gross-up may be complex or burdensome in light of the
increased prevalence of PTEP that is not pro rata with respect to
United States shareholders following the Act (for instance, PTEP
resulting from a GILTI inclusion, which is not determined solely by
reference to a particular CFC). Additionally, a gross-up mechanism
could result in the need for different determinations of a CFC's
subpart F income (and tested income or tested loss) for different
United States shareholders of the CFC, which is inconsistent with the
way that these types of income are treated under existing regulations
for other purposes of the Code such as the expense allocation rules or
foreign tax credit rules.
Accordingly, instead of a gross-up mechanism, the proposed
regulations coordinate the section 959(b) exclusion with revisions to
the pro rata share rules of section 951(a) (discussed in part IV.C of
the Explanation of Provisions). Under this approach, a CFC's subpart F
income is determined with respect to all
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shareholders by excluding the same amount of PTEP received by the CFC,
and United States shareholders' pro rata shares of the CFC's subpart F
income are computed in a manner so that any benefits of the application
of the section 959(b) exclusion to PTEP with respect to a United States
shareholder generally inure only to that United States shareholder. For
instance, if two United States shareholders own equal interests in a
CFC, and the CFC receives a distribution half of which is PTEP with
respect to one United States shareholder (because there is PTEP with
respect to the United States shareholder at least equal to its share of
distribution) and the other half of which gives rise to subpart F
income (because there is no PTEP with respect to the other United
States shareholder and no exception from subpart F income applies),
then only the United States shareholder with respect to which there is
no PTEP has a pro rata share of the subpart F income resulting from the
distribution.
The Treasury Department and the IRS are of the view that the
approach in the proposed regulations appropriately carries out the
shareholder-specific nature of section 959(b) (that is, excluding PTEP
with respect to a United States shareholder from a CFC's gross income
for purposes of the application of section 951(a) to the CFC with
respect to the United States shareholder). Additionally, this approach
conforms with the approach for applying section 961(c) which, under the
proposed regulations (as discussed in part III.E of the Explanation of
Provisions), also provides for a gross income exclusion at the CFC-
level that is coordinated with the section 951(a) pro rata share rules
to ensure its benefits generally inure only to the appropriate United
States shareholder.
iii. Issues Involving Allocation Rules Under Section 861
The approach in the proposed regulations discussed in part
II.D.1.ii of the Explanation of Provisions (applying the section 959(b)
exclusion, as well as section 961(c), at the CFC-level) can lead to
issues involving the rules of section 861 for allocating and
apportioning deductions because a CFC's deductions that are not current
year taxes are not allocated and apportioned under section 861 to PTEP.
See Sec. 1.960-1(c)(1)(ii) and proposed Sec. 1.959-6(d)(1).
For example, in a case where some, but not all, of a distribution
received by a CFC is PTEP, an amount of the CFC's deductible interest
expense could reduce the non-PTEP portion of the distribution. See also
proposed Sec. 1.951-1(h)(2)(ii)(C) (Example 1, alternative facts).
This may result in a benefit if the non-PTEP portion would give rise to
subpart F income or tested income, but otherwise may not be beneficial
if the interest deductions reduce section 959(c)(3) E&P and thus the
potential for a dividends received deduction under section 245A.
Comments are requested on how to appropriately allocate and apportion
deductions of a CFC when some, but not all, of a distribution (or gain
recognized) is PTEP.
For example, comments are requested on whether deductions that are
not current year taxes, such as deductible interest expense, should be
allocated and apportioned to, and therefore reduce, the CFC's PTEP.
Under this approach, to the extent PTEP with respect to a United States
shareholder is reduced by deductions that are not current year taxes,
the shareholder could be allowed to retain an equivalent amount of
adjusted basis in property directly owned by the shareholder and on
which the remaining PTEP is ultimately distributed, with the result
that the shareholder would receive a benefit equivalent to a deduction
(similar to the result discussed in Part III.C.2.ii of the Explanation
of Provisions in the case of foreign income taxes that are associated
with PTEP but not credited under section 901).
Comments are also requested on whether, as an alternative to the
approach in the proposed regulations, sections 959(b) and 961(c) should
apply at the shareholder-level. Under this type of approach, instead of
section 959(b) preventing a distribution to a CFC from giving rise to
subpart F income (as it has historically been interpreted, but with
respect to a particular shareholder), section 959(b) would generally
reduce a United States shareholder's pro rata share of the CFC's
subpart F income, to the extent attributable to distributed PTEP.
Furthermore, section 961(c) would apply in a similar manner in the case
of a CFC's gain from a sale or other disposition of stock of a foreign
corporation. Comments should address whether a CFC's deductions that
are not current year taxes, such as deductible interest expense, should
be allocated and apportioned to gross income of the CFC that does not
give rise to an inclusion at the shareholder-level under section 959(b)
or 961(c) or whether CFC-level provisions (such as section 954(c)(3) or
(c)(6) or 964(e)(1)) apply to such income and, if so applied, whether
the E&P from the income should be treated as section 959(c)(3) E&P or
PTEP to ensure that the CFC-level and shareholder-level provisions
interact appropriately.
2. Determining Distributed PTEP
i. Covered Distributions
For a distribution to be considered a distribution of PTEP under
section 959, the proposed regulations first require that the
distribution be a covered distribution, which is generally defined as
any distribution made by a foreign corporation with respect to its
stock to the extent that the distribution is a dividend (as defined in
section 316), determined without regard to section 959(d). See proposed
Sec. 1.959-4(c)(1). While a covered distribution may include deemed
distributions treated as dividends (for example, distributions under
section 304), a covered distribution does not include an amount treated
as a dividend by reason of section 78, 367(b), 964(e)(1), or 1248. A
deemed dividend under section 78 is determined without regard to E&P
(and does not represent a distribution of E&P to any shareholder), and
deemed dividends under the other provisions, regardless of whether they
constitute deemed distributions of E&P, are determined by excluding
PTEP (apart from Sec. 1.367(b)-2(j)(2)(ii), which separately provides
for a deemed distribution of PTEP in certain nonrecognition
transactions, and Sec. 1.367(b)-3(g)(1), which separately provides for
a deemed distribution of E&P, including PTEP, in certain inbound
nonrecognition transactions described in Sec. 1.367(b)-3). The
proposed regulations do not address the treatment of dividends arising
under section 356(a)(2) as covered distributions, which will be
addressed in future guidance regarding reorganizations (although no
inference is intended as to the treatment of such dividends under
current law). See proposed Sec. 1.959-4(c)(2).
Comments on the 2019 notice asserted that a distribution of PTEP
should not depend on the existence of E&P that would result in a
dividend under section 316, stating that section 959(c) requires
applying section 316 separately to sections 959(c)(1), (c)(2), and
(c)(3) in determining whether there is sufficient E&P under section 316
to support a distribution of E&P under that paragraph. Comments noted
that the approach described in the 2019 notice was contrary to section
959(a) and inconsistent with the policy of section 959 to facilitate
the repatriation of PTEP. The Treasury Department and the IRS remain of
the view described in the 2019 notice under which the reference to
section 316(a) in section 959(c) indicates that, under the statute, a
distribution of PTEP cannot occur unless there is sufficient current or
[[Page 95372]]
accumulated E&P to support what would otherwise be a dividend under
section 316. This reading of the statute is consistent with the
principle underlying section 959 that PTEP represents a type of E&P.
Thus, the proposed regulations do not adopt the comments.
ii. Analyzing Covered Distributions
The proposed regulations provide rules for determining the extent
to which PTEP is distributed in a covered distribution. See proposed
Sec. 1.959-4(d). Under these rules, each covered shareholder first
determines its share of the covered distribution, which is the portion
of the covered distribution that is made to the covered shareholder or
any portion of the covered distribution that is made to an upper-tier
foreign corporation and assigned to the covered shareholder under
proposed Sec. 1.951-2 (discussed in part IV.B of the Explanation of
Provisions). See proposed Sec. 1.959-4(d)(1). For this purpose, the
portion of a covered distribution that is made to a partnership, or
that is treated as made to the partnership in the case of tiered
partnerships, is treated as made to the partnership's partners in
accordance with their respective distributive shares of such portion.
See proposed Sec. 1.959-4(c)(3). Thus, if a covered shareholder is a
partner in an upper-tier partnership, the covered shareholder's share
of a covered distribution would include a portion of the covered
distribution that is made to a lower-tier partnership because an amount
of the covered distribution made to the lower-tier partnership would be
treated as made to the upper-tier partnership by reason of the upper-
tier partnership being a partner in the lower-tier partnership and, in
turn, an amount of the covered distribution treated as made to the
upper-tier partnership would be treated as made to the covered
shareholder by reason of the covered shareholder being a partner in the
upper-tier partnership.
Next, each covered shareholder allocates its share of the covered
distribution to the distributing foreign corporation's PTEP with
respect to the covered shareholder, to the extent thereof and in
accordance with the composition rules described in part II.D.2.iii of
the Explanation of Provisions, and then allocates any remaining portion
of such share to the distributing foreign corporation's section
959(c)(3) E&P. See proposed Sec. 1.959-4(d)(2) and (e)(1). For this
purpose, the distributing foreign corporation's PTEP is determined
immediately before the covered distribution (and thus includes PTEP
resulting from a subpart F income inclusion or GILTI inclusion for the
distributing foreign corporation's taxable year in which the covered
distribution is made because such PTEP is added to the covered
shareholder's annual PTEP accounts at the beginning of the taxable
year).
Further, because the amount of a covered shareholder's share of a
covered distribution is determined on an aggregate basis rather than on
a share-specific basis, the proposed regulations treat a pro rata
portion of all PTEP distributed in each covered shareholder's share of
the covered distribution as distributed with respect to each share of
stock of the distributing foreign corporation on which the covered
shareholder's share of the covered distribution is made. See proposed
Sec. 1.959-4(d)(4); see also proposed Sec. 1.959-10(c)(1) (Example
1). In this way, basis adjustments resulting from distributed PTEP can
be made on each share of stock of the foreign corporation in accordance
with section 961 and, if applicable, PTEP of a recipient foreign
corporation can be increased.
iii. Composition Rules
As discussed in part II.C of the Background, different types of
PTEP can have different tax effects, including with respect to foreign
currency gain or loss under section 986(c) or deemed paid taxes under
section 960(b). Thus, once a covered shareholder has identified the
portion of its share of a covered distribution that is allocated to
PTEP, it is necessary to determine the specific PTEP that is
distributed. The proposed regulations include composition rules for
this purpose. See proposed Sec. 1.959-4(d)(3) and (e)(2) through (5);
see also proposed Sec. 1.959-10(c)(2) (Example 2).
Under these composition rules, PTEP is sourced from section
959(c)(1) PTEP groups before section 959(c)(2) PTEP groups and then
from each group within the section 959(c)(1) PTEP groups or section
959(c)(2) PTEP groups, respectively, on a ``last-in, first-out'' basis,
subject to a priority rule for PTEP resulting from section 965 (section
965 priority rule). See proposed Sec. 1.959-4(e)(2), (3).
Additionally, PTEP that otherwise has the same priority is sourced
first from PTEP that is not taxable section 962 PTEP and then from
taxable section 962 PTEP, consistent with the rules currently in Sec.
1.962-3. See proposed Sec. 1.959-4(e)(4). Lastly, PTEP that has the
same priority is sourced on a pro rata basis. See proposed Sec. 1.959-
4(e)(5).
The section 965 priority rule sources PTEP in section 959(c)(1)
PTEP groups first from the reclassified section 965(a) PTEP group, then
from the reclassified section 965(b) PTEP group, and finally from the
remaining section 959(c)(1) PTEP groups. See proposed Sec. 1.959-
4(e)(2)(ii). Similarly, for PTEP in section 959(c)(2) PTEP groups, the
section 965 priority rule sources such PTEP first from the section
965(a) PTEP group, then from the section 965(b) PTEP group, and finally
from the remaining section 959(c)(2) PTEP groups. See proposed Sec.
1.959-4(e)(2)(iii). The section 965 priority rule, which is issued
under the express delegation of authority in section 965(o), is
consistent with the 2019 notice and is intended to simplify PTEP
recordkeeping and IRS administration.
Comments on the 2019 notice stated that the section 965 priority
rule (as described in the notice) would be a departure from the last-
in, first-out approach for sourcing distributions from E&P, and also
argued that there is no suggestion in section 965 or its legislative
history that such a departure was intended or is necessary or
appropriate. Other comments asserted that the policy for the section
965 priority rule was unclear, stating that a pure last-in, first-out
approach does not impose additional burdens on taxpayers because once a
taxpayer has determined its section 965 PTEP the additional burden of
maintaining that information is minimal. Further, even if the section
965 priority rule simplifies PTEP recordkeeping, comments noted that
this may be outweighed by the reduction in foreign tax credits under
section 960(b) that accompanies distributions of section 965 PTEP.
Another comment noted that the section 965 priority rule would
adversely affect certain individuals who made section 962 elections and
are economically compelled to distribute their PTEP every year to pay
taxes arising under section 951(a) because it would accelerate the
distribution of PTEP that is not excluded from gross income under
section 962(d). Given these concerns, and because the section 965
priority rule departs from the longstanding approach in existing Sec.
1.959-3(b), comments requested that taxpayers be able to elect to apply
a last-in, first-out approach with no prioritization of section 965
PTEP.
The Treasury Department and the IRS continue to be of the view that
the section 965 priority rule will simplify PTEP recordkeeping and IRS
administration in the future by eventually eliminating section 965 PTEP
(which, as noted in part II.C of the Background requires specific and
detailed rules to apply sections 960(b)
[[Page 95373]]
and 986(c)) and reducing the overall number of PTEP groups that need to
be tracked. The Treasury Department and the IRS are of the view that,
on balance, this benefit outweighs the concerns raised in comments.
Additionally, the section 965 priority rule is within the scope of the
authority delegated to the Treasury Department and the IRS to
administer section 965, including through sections 965(o) and 7805(a).
Further, the proposed regulations do not adopt comments suggesting that
taxpayers be allowed to not apply the section 965 priority rule because
this would undermine the simplification and burden reduction policy of
the rule.
iv. Dollar Basis and Associated Foreign Income Taxes Rules
The proposed regulations provide a pro rata approach for
determining the dollar basis and associated foreign income taxes of
PTEP distributed in a covered shareholder's share of a covered
distribution. See proposed Sec. 1.959-4(e)(3), (f) and (g). Under this
approach, the portion of a dollar basis pool or PTEP tax pool, as
applicable, attributed to distributed PTEP is determined based on the
percentage that such PTEP represents of all PTEP relating to the dollar
basis pool or PTEP tax pool. As discussed in part II.B.1.iii of the
Explanation of Provisions, dollar basis pools and PTEP tax pools are
maintained separately within each annual PTEP account for each PTEP
group unless a combined pool election is in effect, in which case each
dollar basis pool and PTEP tax pool relates to PTEP assigned to a
single PTEP group and a single section 904 category (without regard to
the taxable years to which the PTEP relates).
E. PTEP to Which a Section 956 Amount Is Allocated (Proposed Sec.
1.959-5)
The proposed regulations provide rules regarding the exclusion from
gross income under section 959(a)(2) for PTEP that would otherwise be
included under section 951(a)(1)(B). See proposed Sec. 1.959-5; see
also proposed Sec. 1.959-10(c)(4) (Example 4). Under these rules, a
covered shareholder allocates its section 956 amount (that is, the
amount determined under section 956 and Sec. 1.956-1 with respect to
the covered shareholder and a CFC) first to the CFC's PTEP that is with
respect to the covered shareholder and assigned to section 959(c)(2)
PTEP groups, to the extent thereof and in accordance with the
principles of the composition rules for distributions of PTEP, and then
allocates any remaining portion of such section 956 amount to the CFC's
section 959(c)(3) E&P. See proposed Sec. 1.959-5(c)(1) and (d)(1).
For purposes of these rules, the CFC's PTEP is determined on the
last relevant day of the CFC's taxable year to which the section 956
amount relates (that is, the last day of such taxable year on which the
foreign corporation is a CFC). See proposed Sec. 1.959-5(d)(2).
However, the CFC's PTEP is reduced to the extent it is distributed on
or after the last relevant day to ensure that the section 956 amount is
allocated only to section 959(c)(2) PTEP that remains after accounting
for all covered distributions during the CFC's taxable year, in
accordance with section 959(f)(2). Moreover, the PTEP is determined
without regard to any transfer of PTEP from the covered shareholder to
a successor covered shareholder on (or after) the last relevant day,
thereby ensuring that section 959(c)(2) PTEP that exists with respect
to the covered shareholder when the covered shareholder's ownership of
stock of the CFC is determined for purposes of sections 951(a)(1)(B)
and 956 may be taken into account for purposes of section 959(a)(2).
As with distributions of PTEP, the proposed regulations use a pro
rata approach to determine the dollar basis and associated foreign
income taxes of PTEP to which a section 956 amount is allocated. See
proposed Sec. 1.959-5(e) and (f).
F. Allocating and Apportioning Current Year Taxes to PTEP (Proposed
Sec. 1.959-6)
The proposed regulations provide rules for the application of Sec.
1.861-20 to allocate and apportion current year taxes to the statutory
groupings (as generally described in Sec. 1.861-8(a)(4)) of PTEP of a
foreign corporation. See proposed Sec. 1.959-6(b) (describing the
statutory groupings for purposes of proposed Sec. 1.959-6 as the
corporate PTEP accounts of the foreign corporation described in
proposed Sec. 1.959-2(d)(1)). These rules are issued pursuant to the
express delegations of authority under sections 245A(g), 904(d)(7),
960(f), and 965(o).
Under the proposed regulations, current year taxes are generally
associated with PTEP to the extent the foreign corporation pays or
accrues such taxes with respect to PTEP arising by reason of a PTEP
realization event that occurs in the same taxable year. See proposed
Sec. 1.959-6(b); see also proposed Sec. 1.959-10(c)(3) (Example 3). A
PTEP realization event occurs if there is a distribution of PTEP or
gain recognized on a sale, exchange, or other disposition of foreign
stock that is treated as PTEP as a result of the application of section
961(c) basis. Current year taxes that are paid or accrued with respect
to a PTEP realization event that occurs in a different taxable year may
not be associated with PTEP of a foreign corporation (consistent with
the rule in current Sec. 1.960-1(d)(3)(ii)(B)). See proposed Sec.
1.959-6(b) and 1.960-1(d)(3)(ii)(B).
Proposed Sec. 1.959-6(c) provides rules relating to the
application of the allocation and apportionment rules in Sec. 1.861-
20. Current year taxes (in the foreign corporation's functional
currency) are allocated and apportioned to each corporate PTEP account
of the foreign corporation that is increased during the taxable year as
the result of a PTEP realization event by applying the rules in Sec.
1.861-20 and treating PTEP with respect to each covered shareholder
arising by reason of a PTEP realization event as an amount of dividend
income (in the case of a distribution of PTEP) or gain from the sale,
exchange, or other disposition of foreign stock (in the case of PTEP
resulting from the application of section 961(c) basis). See proposed
Sec. 1.959-6(c) for purposes of identifying the corresponding U.S.
item under Sec. 1.861-20(b) through (c). While certain United States
shareholders (taking into account the application of Sec. 1.958-1(d))
must take into account a pro rata share of a CFC's subpart F income and
tested income (or loss), the CFC's deductions are not divided into pro
rata shares allocable to particular shareholders, and instead, must be
allocated and apportioned to gross income of the CFC before the
determination of each United States shareholder's pro rata share of
subpart F income and tested income (or loss). As a result, because
deductions must be allocated and apportioned to a CFC's income (rather
than being allocated directly to United States shareholders), it is
necessary to allocate and apportion current year taxes with respect to
the statutory groupings of PTEP of the foreign corporation, which the
proposed regulations provide are the corporate PTEP accounts described
in proposed Sec. 1.959-2(d)(1).
The proposed regulations also clarify other aspects of allocations
of deductions involving PTEP. In particular, the proposed regulations
provide that no deductions, other than current year taxes, may be
allocated and apportioned to the statutory groupings of PTEP of a
foreign corporation (consistent with the rule in current Sec. 1.960-
1(c)(1)(ii)). See proposed Sec. 1.959-6(d)(1). See also the request
for comments in Part II.D.1.iii of the
[[Page 95374]]
Explanation of Provisions on an approach that would also allocate and
apportion deductions, other than current year taxes, to PTEP.
Finally, the proposed regulations provide that current year taxes
paid or accrued by a foreign corporation that are denominated in a
currency other than the functional currency of the foreign corporation
are translated into the functional currency of the foreign corporation
at the spot rate on the day on which the current year taxes are paid or
accrued. See proposed Sec. 1.959-6(d)(2). This currency translation
rule applies for purposes of (i) making certain adjustments to accounts
maintained under section 959 and the proposed regulations in the
foreign corporation's functional currency and (ii) allocating and
apportioning functional currency amounts at the level of the foreign
corporation.
G. General Successor Transactions (Proposed Sec. 1.959-7)
1. In General
If there is an acquisition of stock of a foreign corporation that
results in a change of ownership of stock of the foreign corporation,
successor rules in section 959 generally transfer the foreign
corporation's PTEP with respect to the covered shareholder that
relinquishes ownership of stock of the foreign corporation to the
covered shareholder that acquires ownership of the stock. See section
959(a) (applying the rules of section 959(a) to any other United States
person who acquires any portion of a United States shareholder's
interest in a foreign corporation from any person); section 959(b)
(similarly applying to any other United States shareholder who acquires
any portion of a United States shareholder's interest in a CFC from any
person). These successor rules generally ensure that PTEP is not
subject to U.S. tax again in the hands of the acquiring covered
shareholder when received in a distribution, even though that
shareholder did not own the stock of the foreign corporation when the
PTEP was generated and therefore did not have the inclusion that gave
rise to the PTEP. Additionally, the rules ensure that E&P retains its
PTEP status and thus remains subject to the rules under sections 959
and 961, rather than reverting to section 959(c)(3) E&P and potentially
becoming eligible for a deduction under section 245A without a
reduction in basis.
The proposed regulations address certain transactions subject to
the successor rules in section 959, which the proposed regulations
refer to as general successor transactions. See proposed Sec. 1.959-
7(b)(1); see also part III.C.4 of the Explanation of Provisions
(discussing rules for section 961(c) basis in general successor
transactions). A general successor transaction occurs when a covered
shareholder (successor covered shareholder) acquires ownership of stock
of one or more foreign corporations (each, an acquired foreign
corporation) that, immediately before the transaction, is owned by
another covered shareholder (transferor covered shareholder). The
acquisition may be direct or indirect. For example, a sale of stock of
a foreign corporation by a covered shareholder (or by an upper-tier
foreign corporation owned by the covered shareholder) to another
covered shareholder (or to an upper-tier foreign corporation owned by
such other covered shareholder) is a general successor transaction.
However, a general successor transaction is determined without
regard to any portion of an acquisition of ownership of stock of a
foreign corporation that results from any of the following: (i) an
issuance of stock or a partnership interest, (ii) a redemption of stock
(within the meaning of section 317(b)) or a liquidating distribution in
redemption of a partnership interest, or (iii) a transfer of stock of a
foreign corporation, or any property through which stock of a foreign
corporation is owned, if such stock or property is substituted basis
property. See proposed Sec. 1.959-7(b)(2). For example, an exchange of
stock of a foreign corporation solely for stock of another foreign
corporation in an exchange under section 351(a) or 354(a), or as part
of an exchange described in section 361, is not a general successor
transaction because such stock is substituted basis property, even if
covered shareholders' ownership of stock of the foreign corporation
changes in the exchange. Alternatively, to the extent stock of a
foreign corporation is not substituted basis property in such
transactions (for example, if basis in the stock is determined under
section 301(d) or 358(a)(2)), then the acquisition of ownership of
stock of the foreign corporation is a general successor transaction.
The Treasury Department and the IRS intend to issue additional rules
regarding the transfer of PTEP in acquisitions that are not general
successor transactions and proposed Sec. Sec. 1.959-8 and 1.959-9 are
reserved for this purpose. In these acquisitions, the Treasury
Department and the IRS are considering adding a rule as part of
finalization of the proposed regulations providing that, for any period
before those additional rules apply and after existing Sec. 1.959-1(d)
(successor in interest rules) is removed upon finalization of the
proposed regulations, PTEP will transfer automatically (that is,
without any requirement to submit proof of identity to the IRS) in
accordance with the statute and consistent with the manner in which
PTEP transfers in general successor transactions (as discussed in part
II.G.2 of the Explanation of Provisions). The Treasury Department and
the IRS request comments on this potential rule.
2. Categories of Transferred PTEP
The proposed regulations provide that two categories of an acquired
foreign corporation's PTEP transfer from the transferor covered
shareholder to the successor covered shareholder (and thus become PTEP
with respect to the successor covered shareholder) in a general
successor transaction. See proposed Sec. 1.959-7(c); see also Sec.
1.959-10(c)(5) (Example 5). For both categories of PTEP, the transfer
is not subject to any requirement to submit proof of identity to the
IRS (in contrast to current Sec. 1.959-1(d)) and, thus, the transfer
occurs automatically, although taxpayers should maintain sufficient
records to substantiate the transfer on examination. See also Sec.
1.245A-5(c)(4) (automatically transferring certain shareholder-level
accounts in certain acquisitions of stock); Sec. 1.245A(e)-
1(d)(4)(iii) (similar). The automatic transfer ensures that E&P retains
PTEP status and, therefore, will be excluded from income under section
959 and give rise to basis reductions under section 961 in subsequent
distributions.
The first category of PTEP that transfers is PTEP of the acquired
foreign corporation with respect to the transferor covered shareholder,
as determined immediately before the general successor transaction.
However, if the general successor transaction occurs before the last
relevant day of the acquired foreign corporation's taxable year,
certain current year PTEP does not transfer because such current year
PTEP relates to shares of stock either retained by the transferor
covered shareholder or acquired by the transferor covered shareholder
concurrently with or after the general successor transaction. See
proposed Sec. 1.959-7(c)(1). Only a pro rata portion of this PTEP
(called general successor PTEP) transfers, and the amount is determined
based on the percentage of a hypothetical distribution by the acquired
foreign corporation that would be made with respect to the stock of the
corporation acquired by the successor covered shareholder. See proposed
Sec. 1.959-7(d). In this way, distributions made by the acquired
[[Page 95375]]
foreign corporation after the general successor transaction will
generally be allocated to PTEP to the same extent the distributions
would be so allocated if the general successor transaction did not
occur.
The second category of PTEP that transfers is PTEP resulting from
the application of section 1248 to gain recognized by the transferor
covered shareholder in the general successor transaction. See proposed
Sec. 1.959-7(c)(2). Because section 1248 only applies to the extent of
E&P of the acquired foreign corporation that is attributable to the
stock being sold or exchanged in the general successor transaction, the
Treasury Department and the IRS determined that it is appropriate for
PTEP described in this category (called section 959(e) successor PTEP)
to transfer in the general successor transaction. The transfer of all
PTEP arising under section 1248 in a sale or exchange of a foreign
corporation is consistent with existing guidance. See Rev. Rul. 90-31,
1990-1 C.B. 147.
Like for distributions, the proposed regulations use a pro rata
approach to determine the dollar basis and associated foreign income
taxes of general successor PTEP. See proposed Sec. 1.959-7(e)(1) and
(f)(1). The dollar basis of section 959(e) successor PTEP is the U.S.
dollar amount of the income inclusion giving rise to the PTEP. See
proposed Sec. 1.959-7(e)(2). There are no associated foreign income
taxes with respect to section 959(e) successor PTEP because the PTEP is
newly created PTEP to which foreign income taxes will not yet have been
allocated and apportioned. See proposed Sec. 1.959-7(f)(2).
3. Deemed Covered Shareholder
Section 959(a) applies to any other United States person ``who
acquires from any person'' any portion of a United States shareholder's
interest in a foreign corporation. See also section 959(b) (similarly
applying to an acquisition from ``any person''). Accordingly, if there
is an acquisition of stock of a foreign corporation, section 959 does
not condition a transfer of the foreign corporation's PTEP on whether
the transfer is by or from a covered shareholder (or United States
shareholder).
For example, if a nonresident alien individual acquires ownership
of all the stock of a foreign corporation that has PTEP from a covered
shareholder and another covered shareholder subsequently acquires
ownership of all the stock from the individual, then, absent an
election under section 338(g), the foreign corporation's PTEP transfers
to the second covered shareholder. This prevents double taxation of the
PTEP and ensures that PTEP does not become section 959(c)(3) E&P
(potentially eligible for a dividends received deduction under section
245A(a)). However, existing guidance does not clearly address whether
the amount of PTEP that transfers is reduced for transactions during
the individual's ownership period (for example, for E&P distributed by
the foreign corporation to the individual).
To address the transfer of a foreign corporation's PTEP among
covered shareholders where there is intervening foreign ownership, the
proposed regulations treat any stock of a foreign corporation not owned
by a covered shareholder as owned by a single hypothetical person that
is deemed to be a covered shareholder (the deemed covered shareholder).
See proposed Sec. 1.959-7(g). Under these rules, the deemed covered
shareholder is treated in the same manner as a covered shareholder for
purposes of transferring PTEP under section 959, and a reference to a
covered shareholder includes the deemed covered shareholder. See
proposed Sec. 1.959-7(g)(1). Thus, in the example described in the
preceding paragraph, the foreign corporation's PTEP transfers in the
first acquisition from the first covered shareholder to the deemed
covered shareholder (who is a hypothetical person treated as owning all
the stock of the foreign corporation owned by the nonresident alien
individual). Then, in the second acquisition, the foreign corporation's
PTEP, adjusted using a reasonable method to reflect transactions during
the deemed covered shareholder's ownership period (for example,
reductions for distributions), transfers from the deemed covered
shareholder to the second covered shareholder. See Sec. 1.959-7(g)(2).
In cases where there are no previous covered shareholders or PTEP, the
deemed covered shareholder rules have no effect.
The Treasury Department and the IRS are of the view that
alternative approaches such as ``freezing'' a foreign corporation's
PTEP during periods in which its stock is not owned by a covered
shareholder could inappropriately separate a foreign corporation's PTEP
from its E&P and give rise to double taxation or other distortions. For
example, under such an alternative, a covered shareholder could
transfer the stock of an upper-tier foreign corporation that owns stock
of a lower-tier foreign corporation with PTEP to a nonresident alien
individual, the lower-tier foreign corporation could distribute all its
E&P to the upper-tier foreign corporation without affecting its PTEP,
and then the stock of the upper-tier foreign corporation could be
transferred to another individual covered shareholder that would
succeed to the PTEP that remains with the lower-tier foreign
corporation even though it has no E&P. If the form of the transaction
were respected for Federal income tax purposes, the result would be
that a distribution by the upper-tier foreign corporation would not be
sourced from PTEP and the transferred PTEP of the lower-tier foreign
corporation could be distributed only to the extent that the lower-tier
foreign corporation earns section 959(c)(3) E&P.
The Treasury Department and the IRS recognize that shareholders of
a foreign corporation may not track PTEP of the foreign corporation
that transfers to the deemed covered shareholder. In these cases, a
covered shareholder that eventually succeeds to the PTEP must determine
the amount and character of the PTEP, including by reconstructing
transactions that affected the PTEP while the foreign corporation was
under foreign ownership. This reconstruction is similar to other
determinations that shareholders must make in certain acquisitions of
stock of a foreign corporation for which an election under section
338(g) is not made, for example determinations regarding the foreign
corporation's basis in assets or its E&P. The use of a single deemed
covered shareholder to represent all foreign ownership of a foreign
corporation is intended to ease the burden of this reconstruction by
focusing only on whether and how PTEP moves under foreign ownership
rather than, for example, by attributing portions of PTEP to each
shareholder that is a nonresident alien individual and separately
analyzing such portions. The Treasury Department and the IRS welcome
comments about how to decrease the compliance burden and improve the
administrability of this regime while still ensuring that the correct
amount and character of PTEP is transferred from one covered
shareholder to another even when there is intervening foreign
ownership. For instance, the Treasury Department and the IRS welcome
comments on whether a majority United States shareholder of a CFC
should be permitted or required to track PTEP that transfers from a
minority United States shareholder of that CFC to the deemed covered
shareholder.
[[Page 95376]]
III. Section 961 Regulations
A. Overview
As discussed in part II.C.2 of the Background, section 961
authorizes regulations that provide for basis increases to reflect
income inclusions under section 951 and basis reductions and gain
recognition to reflect distributions of PTEP. Generally, the purpose of
basis increases is to prevent PTEP of a foreign corporation from giving
rise to additional U.S. tax in a sale or exchange of stock of the
foreign corporation or property through which such stock is owned (for
example, an interest in a partnership) when the stock or other property
is sold before the PTEP is distributed. The purpose of basis reductions
and gain recognition is to prevent double benefits from the basis
increases provided under section 961.
Thus, the proposed regulations under section 961 adjust the basis
in shares of stock of a foreign corporation owned by a covered
shareholder, and the basis in any items of property through which the
covered shareholder owns stock of the foreign corporation, to reflect
the foreign corporation's PTEP with respect to the covered shareholder
(for example, to reflect income inclusions giving rise to the PTEP or
distributions of the PTEP). Unlike annual PTEP accounts, basis
adjustments under the proposed regulations are specific to a share of
stock or other item of property, consistent with each item of property
having separate basis under the Code. Timing of basis adjustments
generally matches the timing of related adjustments to annual PTEP
accounts. Further, the proposed regulations under section 961 provide
rules for different types of basis under section 961, including the tax
consequences of the basis, and are issued pursuant to the express
delegations of authority in section 961(a), (b), and (c).
As discussed in part III.A of the Background, a covered shareholder
does not include a domestic partnership because a domestic partnership
is treated as an aggregate of its partners in determining stock
ownership for purposes of section 961. See proposed Sec. 1.961-1(b);
see also part VIII.A of the Explanation of Provisions (providing that
an S corporation is generally treated in the same manner as a domestic
partnership). As also discussed in part III.A of the Background, under
section 958(a) stock ownership means stock owned directly and stock
owned indirectly through foreign entities, including domestic
partnerships to the extent treated as foreign partnerships under Sec.
1.958-1(d)(1). Thus, the adjustments provided for by the proposed
section 961 regulations also apply at the partner level to covered
shareholders that own stock of a foreign corporation through one or
more domestic (or foreign) partnerships. See part III.B.3 of this
Explanation of Provisions for a discussion of basis provided in stock
of a foreign corporation directly owned by a partnership.
B. Types of Property Units and Basis (Proposed Sec. 1.961-2)
1. In General
Under the proposed regulations, the type of basis provided in an
item of property depends on whether the direct owner of the item is a
covered shareholder, partnership, or CFC. This is because when the
direct owner of an item of property is a partnership or CFC, covered
shareholder-specific basis is necessary so that the benefits of basis
provided in the item to reflect income inclusions of a covered
shareholder inure only to that shareholder. Additionally, section
961(c) provides that the basis in the case of an item of property
directly owned by a CFC only applies for the purposes of determining
the amount included under section 951 in the gross income of a United
States shareholder. Specific rules are therefore needed with respect to
basis adjustments for property owned by a CFC to reflect the limited
purposes of basis under section 961(c).
Thus, the proposed regulations set forth rules for three types of
property (each referred to as a property unit) and basis: (i) section
961(a) ownership units and adjusted basis, which is provided to a
covered shareholder, (ii) derivative ownership units and derived basis,
which is provided to a partnership and is covered shareholder-specific,
and (iii) section 961(c) ownership units and section 961(c) basis,
which is provided to a CFC and is covered shareholder-specific. See
proposed Sec. 1.961-2; see also proposed Sec. 1.961-12(c) (Example
1). Each type of basis is maintained in U.S. dollars to ensure that
basis reductions for a distribution of PTEP are commensurate with prior
basis increases reflecting the income inclusion giving rise to the
PTEP, regardless of movements in exchange rates (with any such
movements taken into account under the rules for recognizing foreign
currency gain or loss pursuant to section 986(c)).
2. Section 961(a) Ownership Units and Adjusted Basis
A section 961(a) ownership unit is a share of stock of a foreign
corporation directly owned by a covered shareholder, or a partnership
interest directly owned by a covered shareholder and through which the
covered shareholder owns stock of a foreign corporation. See proposed
Sec. 1.961-2(c). For example, if a covered shareholder directly owns
an interest in a partnership and the partnership owns (directly or
indirectly) stock of a foreign corporation, the partnership interest is
a section 961(a) ownership unit. A covered shareholder is provided
adjusted basis in a section 961(a) ownership unit.
3. Derivative Ownership Units and Derived Basis
A derivative ownership unit is a share of stock of a foreign
corporation directly owned by a partnership and owned (indirectly) by
one or more covered shareholders through only one or more partnerships
(for example, not through a foreign corporation), or a partnership
interest directly owned by another partnership and through which one or
more covered shareholders own stock of a foreign corporation through
only partnerships. See proposed Sec. 1.961-2(d)(1). For example, if a
covered shareholder directly owns an interest in a partnership and the
partnership directly owns shares of stock of a foreign corporation,
each share of stock of the foreign corporation is a derivative
ownership unit (and the interest in the partnership is a section 961(a)
ownership unit). If, instead, the partnership is a lower-tier
partnership an interest in which is directly owned by an upper-tier
partnership and the covered shareholder directly owns an interest in
the upper-tier partnership, the upper-tier partnership's interest in
the lower-tier partnership is also a derivative ownership unit along
with each share of stock of the foreign corporation directly owned by
the lower-tier partnership (and the interest in the upper-tier
partnership directly owned by the covered shareholder is a section
961(a) ownership unit).
A partnership is provided derived basis in a derivative ownership
unit, which is maintained separately with respect to each covered
shareholder that owns the derivative ownership unit through only one or
more partnerships. See proposed Sec. 1.961-2(d)(2). Derived basis may
be positive or negative and is treated as an attribute of the
partnership but has no effect on the partnership's common basis in the
derivative ownership unit (that is, the partnership's basis that is
shared among all partners) or any other asset of the partnership. See
part III.C of the Explanation of Provisions for a
[[Page 95377]]
discussion of adjustments to derived basis, including the allowance of
negative derived basis. Derived basis is intended to operate in a
manner similar to a basis adjustment under section 743(b). See parts
III.D and F of the Explanation of Provisions for the tax consequences
of derived basis.
4. Section 961(c) Ownership Units and Section 961(c) Basis
A section 961(c) ownership unit is a share of stock of a foreign
corporation directly owned by a CFC and owned (indirectly) by one or
more covered shareholders. See proposed Sec. 1.961-2(e)(1). For
example, if a covered shareholder directly owns stock of an upper-tier
CFC and the upper-tier CFC directly owns shares of stock of a lower-
tier foreign corporation, each share of stock of the lower-tier foreign
corporation owned by the upper-tier CFC is a section 961(c) ownership
unit.
A CFC is provided section 961(c) basis in a section 961(c)
ownership unit, which is maintained separately with respect to each
covered shareholder that owns the section 961(c) ownership unit. See
proposed Sec. 1.961-2(e)(2). Section 961(c) basis may be positive or
negative and is treated as an attribute of the CFC that generally is
taken into account on the sale, exchange, or other disposition of the
section 961(c) ownership unit, but has no effect on the CFC's adjusted
basis in the section 961(c) ownership unit or any other asset of the
CFC. See part III.C of the Explanation of Provisions for a discussion
of adjustments to section 961(c) basis, including the allowance of
negative section 961(c) basis. Section 961(c) basis applies only for
the purposes prescribed in the section 961 regulations and, therefore,
does not affect the amount of the CFC's gross income or E&P. See parts
III.E through G of the Explanation of Provisions for the tax
consequences of section 961(c) basis.
5. Certain Basis Not Addressed
i. Section 961(c) Basis and Non-CFCs
Consistent with the statutory language of section 961(c), the
proposed regulations provide for basis under section 961(c) only with
respect to stock of a CFC that is directly owned by another CFC.
Although a section 961(c) ownership unit is defined as a share of stock
of a foreign corporation directly owned by a CFC, section 961(c) basis
adjustments are generally made only with respect to section 961(c)
ownership units that are shares of stock in a CFC, as discussed in part
III.C of the Explanation of Provisions. See proposed Sec. 1.961-3
(basis increases for income inclusions); proposed Sec. 1.961-4(d)
(basis reductions for distributions); proposed Sec. 1.961-5(b)
(adjustments for foreign currency gain or loss). The Treasury
Department and the IRS are studying whether, and to what extent, basis
adjustments may or should also be made under section 961(c) in cases
where stock of a CFC is owned by a covered shareholder through a
foreign corporation that is not a CFC or where a CFC owns stock of a
foreign corporation that used to be a CFC.
A CFC's section 961(c) basis with respect to a covered shareholder
in stock of a lower-tier foreign corporation that is provided under the
proposed regulations when that lower-tier foreign corporation was a CFC
continues to exist, however, if that lower-tier foreign corporation
ceases to be a CFC (a share of stock of the lower-tier foreign
corporation is a section 961(c) ownership unit regardless of CFC
status). Thus, for example, section 961(c) basis in stock of a foreign
corporation that was a CFC but ceases to be a CFC may transfer to
another covered shareholder in a general successor transaction and
become section 961(c) basis with respect to that covered shareholder.
See proposed Sec. 1.961-5(c) (discussed in part III.C.4 of the
Explanation of Provisions). Similarly, a CFC's positive section 961(c)
basis in stock of a foreign corporation that was a CFC but ceases to be
a CFC may be applied to certain gain recognized by the CFC with respect
to stock of that foreign corporation. See proposed Sec. 1.961-9
(discussed in part III.E of the Explanation of Provisions).
ii. Partnership Interests Owned by Foreign Corporations
Under the proposed regulations, a property unit does not include a
share of stock of a foreign corporation or a partnership interest to
the extent the share of stock or partnership interest is directly owned
by a partnership and the interests of such partnership are owned by
foreign corporations (including CFCs). Nor does a property unit include
a partnership interest directly owned by a foreign corporation. For
example, assume a covered shareholder directly owns all the stock of
two upper-tier CFCs, the upper-tier CFCs are the only direct partners
in a partnership, and the partnership directly owns all the stock of a
lower-tier CFC. In such a case, neither the shares of stock of the
lower-tier CFC directly owned by the partnership, nor the upper-tier
CFCs' interests in the partnership, are property units. The Treasury
Department and the IRS are studying whether the basis that should be
provided in these items of property should be similar to derived basis
or section 961(c) basis or have characteristics of both. Thus, the
proposed regulations do not address the extent to which section 961
provides basis in such items.
C. Basis Adjustments (Proposed Sec. Sec. 1.961-3, 1.961-4, and 1.961-
5)
1. Basis Increases for Certain Income Inclusions
i. In General
To reflect a covered shareholder's income inclusions under sections
951(a) and 951A(a) for a taxable year of a CFC, the proposed
regulations provide rules to increase the basis of property units that
are shares of stock of the CFC owned by the covered shareholder and the
basis of any property units through which the covered shareholder owns
such stock. See proposed Sec. 1.961-3(b); see also proposed Sec.
1.961-12(c) (Example 2). For this purpose, a reference to basis means
adjusted basis of the covered shareholder in the case of a section
961(a) ownership unit, derived basis with respect to the covered
shareholder in the case of a derivative ownership unit, and section
961(c) basis with respect to the covered shareholder in the case of a
section 961(c) ownership unit.
Generally, the basis of each property unit is increased by the
amount that would be distributed with respect to the property unit in a
hypothetical distribution by the CFC equal to the U.S. dollar amount of
the covered shareholder's income inclusions (hypothetical distribution
rule). See proposed Sec. 1.961-3(c)(1) and (4); see also part
III.C.1.ii of the Explanation of Provisions (discussing additional
rules that apply in the case of a midyear transaction). The
hypothetical distribution is treated as made through all tiers to the
covered shareholder on the last relevant day of the CFC's taxable year
(taking into account only stock or other property owned by the covered
shareholder). See proposed Sec. 1.961-3(e). In this way, under the
grant of regulatory authority in section 961, a property unit is
generally provided an amount of basis matching the amount by which
basis of the property unit is reasonably expected to be reduced under
section 961 when PTEP resulting from the income inclusions is
subsequently distributed to the covered shareholder. The amount of
basis provided to a particular property unit will generally equal the
covered shareholder's income inclusion attributable to that property
unit, but the amount may differ in certain cases.
[[Page 95378]]
For example, consider a case where the covered shareholder owns all
the stock of the CFC, with such stock consisting of a single preferred
share with a $10x preference and common stock. The CFC has $100x of E&P
for its taxable year, consisting of $90x of subpart F income, $0 of
tested income or tested loss, and $10x of other income. The covered
shareholder includes $90x in gross income under section 951(a)(1)(A)
(under Sec. 1.951-1, $9x of the inclusion is attributable to the
preferred share and the remaining $81x is attributable to the common
stock), and, consequently, the CFC's PTEP with respect to the covered
shareholder increases by $90x. While only $9x of the covered
shareholder's $90x income inclusion is attributable to the preferred
share, the proposed regulations increase the basis of the preferred
share by $10x and the basis of the common stock by the remaining $80x.
This approach takes into account that, of the first $10x of PTEP
distributed by the CFC to the covered shareholder, that amount is
likely to be distributed on the preferred share. And, if the basis
adjustments to the preferred share were to instead match the income
inclusion attributable to that share ($9x), the covered shareholder
would receive a $10x distribution on the preferred share, thus
potentially giving rise to gain under section 961(b)(2) in an amount
equal to that difference. The proposed regulations prevent that result
by adjusting the basis in the preferred share by $10x. The Treasury
Department and the IRS request comments on this approach, including
whether there are ways to improve the accuracy of allocating basis to a
property unit without undue complexity and additional compliance and
administrative burden, and without creating the possibility of
inappropriate results.
However, if the CFC distributes PTEP with respect to the covered
shareholder before the last relevant day of the CFC's taxable year, the
policies underlying the hypothetical distribution rule (matching basis
with distributed PTEP) are better carried out by using such actual
distributions (rather than a hypothetical distribution on the last
relevant day) to allocate basis increases among property units,
particularly when there are midyear transactions (though where there is
no midyear transaction the two approaches generally produce the same
results). Thus, an actual distribution rule applies in these cases and
consequently reduces the amount that can give rise to a basis increase
pursuant to the hypothetical distribution rule. See proposed Sec.
1.961-3(c)(3).
The actual distribution rule applies in chronological order to
distributions of the CFC's PTEP with respect to the covered
shareholder, and in each case generally increases basis of a share of
stock of the CFC on which the distribution is made by the amount of the
reduction required under section 961 to such basis by reason of the
distribution. See proposed Sec. 1.961-3(d)(2). However, basis
increases to stock of the CFC under the actual distribution rule cannot
exceed the U.S. dollar amount of the covered shareholder's income
inclusions, excluding for this purpose an income inclusion under
section 951(a)(1)(B) because such inclusion does not give rise to PTEP
that could be distributed before the last relevant day of the CFC's
taxable year. Additionally, the actual distribution rule applies only
to distributions on stock of the CFC that the covered shareholder owns
on the last relevant day because the covered shareholder's income
inclusions with respect to the CFC are attributable only to that stock.
Basis increases to stock of the CFC under the actual distribution
rule ``tier up'' through property units through which the covered
shareholder owns such stock, based on how the PTEP that is actually
distributed would be further distributed in a hypothetical distribution
made at the time of the actual distribution. See proposed Sec. 1.961-
3(d)(3). The Treasury Department and the IRS considered alternative
approaches to tiering such as analyzing the extent to which PTEP is
further distributed before the last relevant day, but those approaches
could give rise to additional complexity and burden. For instance, the
approaches could require rules tracing distributed PTEP through tiers
of foreign corporation and coordinating applications of the actual
distribution rule at each tier. The Treasury Department and the IRS
welcome comments on the actual distribution rule, including whether
there are ways to improve the accuracy of tiering without undue
complexity and additional compliance and administrative burden.
Generally, each basis increase under the hypothetical distribution
rule or actual distribution rule is treated as made at the beginning of
the first day of the CFC's taxable year or, if later, at the beginning
of the first day in the taxable year on which the covered shareholder
owns the property unit. See proposed Sec. 1.961-3(d)(1), (e)(1). In
this way, the timing of a basis increase generally matches when PTEP to
which the basis is attributable could first be distributed on the
property unit. Additionally, the portion of a basis increase for a
section 951(a)(1)(B) inclusion is treated as made at the end of the
last day of the taxable year, subject to a special rule. See proposed
Sec. 1.961-3(e)(1). The special rule applies where a property unit
that will receive a basis increase for the section 951(a)(1)(B)
inclusion is transferred before the end of the taxable year (but on or
after the last relevant day of the taxable year), and in such a case
accelerates the basis increase to the property unit so that it is
treated as made immediately before the transfer, thereby ensuring that
the basis is available in determining the tax consequences of the
transfer. See proposed Sec. 1.961-3(e)(4).
ii. Midyear Transactions
Additional rules address unique timing considerations for basis
increases when a midyear transaction occurs during the taxable year of
a CFC. See proposed Sec. 1.961-3(c)(2). A midyear transaction
represents any transaction occurring before the last relevant day of
the taxable year that changes the covered shareholder's ownership
structure of the CFC (for example, an exchange of the covered
shareholder's stock of the CFC or an issuance of stock of the CFC to
the covered shareholder).
In the case of a midyear transaction, a basis increase under the
hypothetical distribution rule or actual distribution rule is treated
as made at the earliest time during the CFC's taxable year at which the
same ownership structure is in place as the ownership structure when
the relevant hypothetical or actual distribution is made. See proposed
Sec. 1.961-3(d)(1), (e)(1). Thus, for a basis increase under the
actual distribution rule, if the distribution is made before all
midyear transactions, the basis increase is treated as made at the
beginning of the first day of the CFC's taxable year; on the other
hand, if the distribution is made after a midyear transaction, the
basis increase is treated as made immediately after the most recent
midyear transaction preceding the distribution. This approach is
intended to prevent distortions, including possible duplication of
basis in certain cases.
For example, assume a covered shareholder (US1) directly owns all
the stock of two CFCs (CFC1 and CFC2) on January 1 of year 1. On June
30 of year 1, US1 exchanges all the stock of CFC1 solely for stock of
CFC2 in an exchange described in section 351(a) (which is a midyear
transaction with respect to CFC1 and CFC2). CFC1 makes no
[[Page 95379]]
distributions during its taxable year ending on December 31 of year 1,
and US1 has a $100x subpart F income inclusion with respect to CFC1 for
that taxable year. Thus, under the hypothetical distribution rule, US1
increases its adjusted basis in its stock of CFC2 by $100x and CFC2
increases its section 961(c) basis with respect to US1 in its stock of
CFC1 by $100x. However, basis could be inappropriately duplicated if
the $100x basis increase in the stock of CFC1 were treated as made on
January 1 of year 1, which would be the case absent the section 351
exchange. This could occur if US1's basis in its stock of CFC2 were to
both be increased under the hypothetical distribution rule and take a
basis under section 358(a) reflecting the basis increase in the stock
of CFC1 under the hypothetical distribution rule. To address this,
special timing rules treat the $100x basis increase in each of the
stock of CFC1 and stock of CFC2 as made immediately after the section
351 exchange, which is the first time during CFC1's taxable year at
which the same ownership structure is in place as the ownership
structure on the last relevant day of the taxable year (when the
hypothetical distribution determining the basis increase is made).
2. Basis Reductions and Gain Recognition for Distributions
i. In General
As discussed in part II.C.2 of the Background, section 961(b)(1)
provides for reductions to the basis of stock or other property with
respect to which a covered shareholder receives PTEP excluded from its
gross income under section 959(a), with amounts in excess of such basis
resulting in gain under section 961(b)(2). Section 961(c) indicates
that the Secretary should issue regulations providing for adjustments
similar to those in section 961(b) with respect to PTEP received by a
CFC and amounts in excess of section 961(c) basis.
In order to implement the statutory language of section 961, the
proposed regulations provide rules for reducing basis and recognizing
gain with respect to property units to reflect distributions of PTEP.
See proposed Sec. 1.961-4; see also proposed Sec. 1.961-12(c)(3)
(Example 3). These rules describe the amounts of adjustments,
limitations on basis reductions, and treatment of gain under section
961, which can differ depending on the type of property unit for which
the basis is being adjusted. The adjustments are treated as made
concurrently with the distribution if the property unit is stock of a
foreign corporation or, if the property unit is an interest in a
partnership, concurrently with an adjustment to the partnership
interest under section 705 resulting from the distribution. See
proposed Sec. 1.961-4(e) and (f)(1).
ii. Adjustments to Section 961(a) Ownership Units
If a covered shareholder receives a distribution of PTEP that is
excluded from its gross income under section 959(a) (that is, PTEP
other than taxable section 962 PTEP), then the covered shareholder's
adjusted basis of each section 961(a) ownership unit is generally
reduced by the dollar basis and associated foreign income taxes of the
PTEP received with respect to the section 961(a) ownership unit. See
proposed Sec. 1.961-4(b)(2)(i) and (ii). Associated foreign income
taxes are taken into account for this purpose because when foreign
income taxes are allocated and apportioned to PTEP, the foreign income
taxes reduce the PTEP and the dollar basis of the PTEP, as discussed in
part II.C.2 of the Explanation of Provisions. As a result, the sum of
the dollar basis and associated foreign income taxes of PTEP represent
the amount by which basis was increased under section 961 when the PTEP
was generated.
However, the associated foreign income taxes (which represent PTEP
that was eliminated by foreign income taxes) reduce adjusted basis only
to the extent the covered shareholder is allowed a credit under section
901 for those taxes. See proposed Sec. 1.961-4(b)(2)(i). Consequently,
associated foreign income taxes ultimately give rise to either a credit
or an amount equivalent to a deduction (in the form of retained
adjusted basis, which, in turn, will produce a lesser amount of gain or
an additional amount of loss on a subsequent sale of the section 961(a)
ownership unit relative to the gain or loss that would result if
adjusted basis were reduced by associated foreign income taxes). The
Treasury Department and the IRS are of the view that this prevents
double taxation of PTEP but are studying whether the policies of
section 245A(d) or 965(g) (denying a credit or deduction for foreign
income taxes) should require reducing adjusted basis for associated
foreign income taxes of PTEP resulting from section 245A(e) or 965.
Further, to the extent the required reduction to adjusted basis of
a section 961(a) ownership unit exceeds such adjusted basis, the
covered shareholder is treated as recognizing gain from a sale or
exchange of the section 961(a) ownership unit, in accordance with
section 961(b)(2). See proposed Sec. 1.961-4(b)(2)(iii) and (f)(1).
Basis of another section 961(a) ownership unit (for example, another
share of stock of the foreign corporation) cannot be used to reduce
gain under section 961(b)(2), which is consistent with the approach in
section 301(c)(3), pursuant to which basis is not shared among shares
of stock on distributions. See also Johnson v. United States, 435 F.2d
1257 (4th Cir. 1971).
Moreover, unlike the approach described in the 2006 proposed
regulations, basis attributable to section 961 does not shift from one
share to another share when PTEP is distributed with respect to the
other share. The Treasury Department and the IRS are of the view that a
shifting approach could give rise to inappropriate results, is not
required by section 961 (which increases basis for income inclusions
without any indication that such basis must or should remain tied to
the PTEP resulting from the income inclusion), and would depart from
analogous provisions like section 358 (which, for example, increases
basis for contributions to capital without subsequently shifting such
basis to follow distributions of capital). Further, the approach in the
proposed regulations is consistent with the share-by-share approach in
the current regulations under section 961. See Sec. 1.961-2(b) and
(c).
As an example of inappropriate results that could arise from basis
shifting, assume a covered shareholder owns all the stock of a foreign
corporation with PTEP and contributes money to the corporation in
exchange for a newly-issued share of stock, and the corporation
subsequently distributes the PTEP, including on the newly-issued share.
If a portion of the basis that had been provided under section 961(a)
for the PTEP were to shift from the original shares to the newly-issued
share as a result of the distribution, then that basis would be added
on top of the existing fair market value basis in the newly-issued
share (by an amount equal to the amount of PTEP distributed on that
share), which could produce a noneconomic loss in the newly-issued
share. Additionally, as indicated in the document withdrawing the 2006
proposed regulations (87 FR 63981), the Treasury Department and the IRS
are aware of transactions in which taxpayers have taken positions that
basis shifting produces large uneconomic losses, and the IRS may
challenge such positions and other positions giving rise to abuse or
inappropriate results.
[[Page 95380]]
iii. Adjustments to Derivative Ownership Units
If, through a partnership or tiered partnerships, one or more
covered shareholder partners are treated as receiving PTEP that is
excluded from gross income under section 959(a) and the proposed
section 959 regulations, then each such partnership's derived basis
with respect to such covered shareholders of derivative ownership units
is reduced to reflect the PTEP received with respect to the derivative
ownership units. See proposed Sec. 1.961-4(c)(1); see also part
II.D.2.ii of the Explanation of Provisions (portion of a covered
distribution that is made to a partnership, or that is treated as made
to the partnership in the case of tiered partnerships, is treated as
made to the partnership's partners in accordance with their respective
distributive shares of such portion). Specifically, starting with the
partnership at the lowest tier, the partnership's derived basis with
respect to each covered shareholder partner of each derivative
ownership unit is generally reduced by the dollar basis and associated
foreign income taxes of the PTEP with respect to the covered
shareholder that is treated as received by the covered shareholder
through the partnership with respect to the derivative ownership unit.
See proposed Sec. 1.961-4(c)(2)(i) and (ii). A basis increase under
section 705 for the distribution occurs at the same time as the
reduction to derived basis, with the result that, in tiered partnership
structures, derived basis of an upper-tier partnership in a lower-tier
partnership interest is reduced and common basis in the lower-tier
partnership interest is increased (the common basis, in turn, may be
decreased in a distribution to the upper-tier partnership by the lower-
tier partnership of the amounts that constituted the PTEP, for
example).
However, to the extent the required reduction to derived basis with
respect to a covered shareholder of a derivative ownership unit exceeds
the derived basis (for example, because a partnership purchased stock
of a CFC and thus has no derived basis with respect to the derivative
ownership unit), the excess first reduces the covered shareholder's
positive section 743(b) basis adjustment of the derivative ownership
unit (if any), but not below zero. See proposed Sec. 1.961-
4(c)(2)(iii). Thus, this rule, by treating the positive section 743(b)
basis adjustment in the same manner as adjusted basis specific to the
covered shareholder, is consistent with Sec. 1.743-1(j) (regarding the
effect of a basis adjustment under section 743(b)). Then, any remaining
portion of the excess reduces the derived basis below zero, subject to
a limitation. See id. As discussed in part III.C.2.v of the Explanation
Provisions, this limitation is intended to prevent reductions to
derived basis of the derivative ownership unit from having the effect
of reducing the partnership's total basis (measured for this purpose by
netting common basis and all negative derived basis) of the derivative
ownership unit below zero.
Finally, to the extent the required reduction to derived basis with
respect to a covered shareholder of a derivative ownership unit exceeds
the amount of positive derived basis, positive section 743(b) basis,
and negative derived basis created, the partnership is treated as
recognizing gain from a sale or exchange of the derivative ownership
unit. See proposed Sec. 1.961-4(c)(2)(iv). The gain is allocated by
the partnership solely to the covered shareholder and is taken into
account in adjusting basis under section 705, but it has no effect on
any partnership's computations or allocations of any other items under
section 703 or 704 or on the covered shareholder's capital account. See
proposed Sec. 1.961-4(f)(2).
iv. Adjustments to Section 961(c) Ownership Units
If a CFC receives a distribution of PTEP, then the CFC's section
961(c) basis with respect to each covered shareholder of each section
961(c) ownership unit is generally reduced by the dollar basis and
associated foreign income taxes of the PTEP with respect to the covered
shareholder that is received with respect to the section 961(c)
ownership unit. See proposed Sec. 1.961-4(d)(2)(i) and (ii).
To the extent the required reduction to section 961(c) basis with
respect to a covered shareholder of a section 961(c) ownership unit
exceeds such section 961(c) basis (for example, because a CFC purchased
stock of another CFC and thus has no section 961(c) basis with respect
to the section 961(c) ownership unit or a portion of the distributed
PTEP is section 965(b) PTEP), the excess reduces the section 961(c)
basis below zero, subject to a limitation. See proposed Sec. 1.961-
4(d)(2)(ii). As discussed in part III.C.2.v of the Explanation of
Provisions, this limitation is intended to prevent reductions to
section 961(c) basis of the section 961(c) ownership unit from having
the effect of reducing the CFC's total basis (measured for this purpose
by netting adjusted basis and all negative section 961(c) basis) of the
section 961(c) ownership unit below zero. Then, any remaining portion
of the excess is treated as gain recognized by the CFC from a sale or
exchange of the section 961(c) ownership unit, and such gain is
assigned from the CFC solely to the covered shareholder. See proposed
Sec. 1.961-4(d)(2)(iii). Gain recognized by a CFC under this rule
applies only for purposes of determining amounts included in gross
income of United States shareholders under proposed Sec. 1.961-11
(discussed in part III.G. of the Explanation of Provisions) because
section 961(c) applies only for limited purposes. See proposed Sec.
1.961-4(f)(3). Therefore, the gain does not affect the CFC's items of
gross income for purposes of section 952 or 951A or its E&P.
The Treasury Department and the IRS are of the view that the gain
recognition rules described in this part III.C.2 of the Explanation of
Provisions appropriately prevent use of the same basis more than once,
provide similar outcomes for similar transactions at different tiers,
and ensure the tax consequences of the gain are covered shareholder-
specific. Any alternative approach that did not require gain
recognition under section 961(b)(2) and (c) for amounts in excess of
basis would necessarily have to narrow the application of section
961(c) basis (discussed in part III.E of the Explanation of
Provisions), with the result that section 961(c) basis would not be
available for use in a section 301(c)(3) transaction and, in a sale,
might be available for use only to the extent of undistributed PTEP.
Consider the following examples illustrating that the proposed
regulations provide a consistent approach ensuring that distributions
appropriately reduce basis or result in the recognition of gain. First,
assume US1, a covered shareholder, directly owns the single share of
outstanding stock of CFC1, a newly formed foreign corporation. For
simplicity, assume US1 has $0 basis in its stock in CFC1. In year 1,
CFC1 generates $100x of PTEP with respect to US1, which increases US1's
adjusted basis of the share of stock of CFC1 from $0 to $100x. In year
2, CFC1 makes a $100x distribution out of E&P and, in year 3, CFC1
makes a $100x distribution that is not out of E&P. In this case, the
year 2 distribution is tax-free (that is, the distribution is excluded
from US1's gross income under section 959(a) but reduces US1's adjusted
basis in its stock of CFC1 under section 961(b)(1)), and the year 3
distribution requires US1 to recognize $100x of gain under section
301(c)(3). Alternatively, assume CFC1 generates a deficit in E&P in
year 2 and generates E&P in year 3, with the result that the year 3
distribution, but not the year 2
[[Page 95381]]
distribution, is out of E&P. In such a case, the year 2 $100x
distribution is tax-free under section 301(c)(2) by reason of US1's
adjusted basis pursuant to section 961(a), and the year 3 $100x
distribution requires US1 to recognize $100x of gain under section
961(b)(2), which appropriately prevents a double use of basis.
Now assume instead that CFC2, a foreign corporation directly owned
by US1, directly owns the single share of stock of CFC1 (rather than
US1), CFC2's adjusted basis of the share of stock of CFC1 is $0, and
CFC2's section 961(c) basis with respect to US1 of the share of stock
of CFC1 is increased from $0 to $100x to reflect the $100x of PTEP
generated by CFC1 with respect to US1. In that case, if CFC1's year 2
distribution is out of E&P, the year 2 distribution is tax-free under
sections 959 and 961 and the year 3 distribution requires CFC2 to
recognize $100x of gain under section 301(c)(3), which US1 will
generally include in gross income under section 951(a). Alternatively,
if the year 3 distribution is out of E&P instead of the year 2
distribution, the year 2 distribution is tax-free by reason of CFC2's
section 961(c) basis and the year 3 distribution requires CFC2 to
recognize $100x of gain pursuant to section 961(c), which US1 will
generally include in gross income under the rules described in part
III.G of the Explanation of Provisions.
v. Limitations on Negative Derived Basis and Negative Section 961(c)
Basis
As discussed in parts III.C.2.iii and iv of the Explanation of
Provisions, a partnership's derived basis or a CFC's section 961(c)
basis with respect to a covered shareholder of a property unit can be
reduced below zero (and therefore result in negative basis instead of
triggering immediate gain recognition) as a result of a distribution of
PTEP with respect to the property unit, subject to a limitation. The
concept of negative section 961(c) basis stems from the language of
section 961(c) (providing ``adjustments similar to the adjustments'' of
section 961(a) and (b), ``but only for the purposes of determining the
amount included under section 951''), which contemplates section 961(c)
basis replicating the outcomes that would occur for section 951
purposes if the CFC's adjusted basis could be increased or reduced
under section 961(a) or (b). In this way, negative section 961(c) basis
can be conceptualized as a reduction to adjusted basis that has no tax
effect until a transaction relevant for purposes of section 951 occurs
with respect to the property unit. Negative derived basis follows the
same concept.
Under the limitation, a distribution can reduce (or further reduce)
derived basis or section 961(c) basis below zero only to the extent of
the amount of the partnership's common basis or the CFC's adjusted
basis of the property unit that is available with respect to the
covered shareholder (determined as described in the next paragraph).
See proposed Sec. 1.961-4(c)(3)(i) and (d)(3)(i). In the case of a
partnership, the amount of common basis available with respect to the
covered shareholder is reduced by the covered shareholder's negative
section 743(b) basis adjustment of the derivative ownership unit (if
applicable). See proposed Sec. 1.961-4(c)(3)(i).
The common basis or adjusted basis available with respect to the
covered shareholder is determined by first computing the partnership's
common basis or the CFC's adjusted basis of the property unit, reduced,
as applicable, by all negative derived basis or all negative section
961(c) basis of the property unit (regardless of the covered
shareholders to which the negative basis relates). See proposed Sec.
1.961-4(c)(3)(ii) and (d)(3)(ii). This amount represents the
partnership's common basis or the CFC's adjusted basis that is
potentially available to reduce derived basis or section 961(c) basis
of the property unit below zero. To address concurrent adjustments with
respect to multiple covered shareholders, the partnership's available
common basis or the CFC's available adjusted basis is then multiplied
by a fraction. The fraction determines the basis available with respect
to a covered shareholder based on relative amounts by which derived
basis or section 961(c) basis with respect to the covered shareholders
would be reduced below zero without limitation.
The Treasury Department and the IRS are of the view that allowing,
but limiting the amount of, negative basis in this way has the effect
of permitting the partnership's common basis or CFC's adjusted basis of
the property unit to be reduced to, but not below, zero. These rules do
not affect the treatment or availability of a partnership's common
basis or a CFC's adjusted basis under any other provision of the Code
(and, thus, for example, do not impact the application of section
704(c)).
The Treasury Department and the IRS considered other approaches to
the limitation such as looking to a covered shareholder's share of
common basis or adjusted basis, based on the percentage of the
interests in the partnership (using Sec. 1.743-1(d) principles, for
example) or the stock of the CFC that is owned by the covered
shareholder. However, those approaches would give rise to additional
complexity and burden because, for example, they could require rules
adjusting negative basis with respect to a covered shareholder to the
extent that an issuance reduces the covered shareholder's share of
common basis or adjusted basis. Further, as discussed in part III.F of
the Explanation of Provisions, rules requiring gain recognition in
transactions involving negative basis adequately prevent a covered
shareholder from disproportionality benefiting from common basis or
adjusted basis because gain recognized by a partnership or a CFC under
those rules is allocated or assigned to covered shareholders based on
relative amounts of negative basis with respect to the covered
shareholders. Thus, although a partnership's common basis or a CFC's
adjusted basis is available with respect to all covered shareholders in
determining the amount by which derived basis or section 961(c) basis
can be negative, a covered shareholder will generally be required to
include in gross income any gain attributable to negative basis with
respect to the covered shareholder.
The Treasury Department and the IRS request comments on the
approach to limiting negative basis in the proposed regulations,
including alternative methods for determining the amount of a
partnership's common basis or a CFC's adjusted basis available with
respect to a covered shareholder for this purpose.
3. Basis Adjustments for Foreign Currency Gain or Loss
To reflect foreign currency gain or loss recognized under section
986(c) by a covered shareholder with respect to a foreign corporation's
PTEP in a general successor transaction or other transaction not
including a distribution of PTEP (see proposed Sec. 1.986(c)-1,
discussed in part V of the Explanation of Provisions), the proposed
regulations provide rules to adjust the basis of property units that
are shares of stock of the foreign corporation owned by the covered
shareholder. These adjustments ``tier up'' through any property units
through which the covered shareholder owns such stock, with the result
that the basis of such property units is also adjusted. See proposed
Sec. 1.961-5(b)(1). For purposes of these rules, a reference to basis
means adjusted basis of the covered shareholder in the case of a
section 961(a) ownership unit, derived basis with respect to the
covered shareholder in the case of a derivative ownership unit, and
section 961(c) basis with respect to the covered shareholder
[[Page 95382]]
in the case of a section 961(c) ownership unit. These rules are issued
pursuant to the express delegations of authority under sections 965(o)
and 989(c) (as well as those under sections 961(a), (b), and (c), as
described in part III.A. of the Explanation of Provisions).
The amount of the basis adjustments is equal to the amount of net
foreign currency gain or loss. See proposed Sec. 1.961-5(b)(2). This
is determined by comparing the sum of all foreign currency gain and the
sum of all foreign currency loss that the covered shareholder
recognizes with respect to the foreign corporation's PTEP in the
transaction under section 986(c), without regard to limitations on the
recognition of such foreign currency gain or loss for PTEP resulting
from section 965.
Generally, the basis of each property unit is increased by the
property unit's share of net foreign currency gain or is reduced by the
property unit's share of net foreign currency loss, as applicable,
determined in each case based on a hypothetical distribution by the
foreign corporation equal to all PTEP of the foreign corporation with
respect to which the covered shareholder recognizes (or, but for
limitations for PTEP resulting from section 965, would recognize)
foreign currency gain or loss in the transaction. See proposed Sec.
1.961-5(b)(3) and (4). The basis adjustments are treated as made
immediately before the transaction (and therefore are taken into
account in the transaction). See proposed Sec. 1.959-5(b)(4).
Additionally, like in the case of distributions of PTEP, a reduction to
basis can reduce derived basis or section 961(c) basis below zero and
can result in gain recognition with respect to a property unit. See id.
These basis adjustments are consistent with the 1988 notice and
prevent foreign currency gain or loss with respect to PTEP, which is
recognized at the covered shareholder-level under section 986(c), from
also being taken into account with respect to property units sold or
exchanged in the transaction (which might otherwise occur if basis of
the property units were not adjusted to reflect movements in exchange
rates between the time of the income inclusion that gave rise to the
PTEP (and basis) and the time of the transaction). The adjustments to
basis are determined without regard to the limitations on the
recognition of foreign currency gain or loss with respect to PTEP
resulting from section 965, which ensures that such unrecognized
foreign currency gain or loss does not result in a commensurate amount
of gain or loss with respect to property units sold or exchanged in the
transaction. See also part V.B of the Explanation of Provisions
(discussing rules under which foreign currency gain or loss with
respect to PTEP resulting from section 965(a) is reduced based on the
section 965(c) deduction percentage, and no foreign currency gain or
loss is recognized for PTEP arising under section 965(b)).
4. Successor Basis
i. In General
If there is an acquisition of stock of a foreign corporation that
results in a change of ownership of stock of the foreign corporation,
successor rules in section 961(c) generally transfer the foreign
corporation's section 961(c) basis with respect to the covered
shareholder that relinquishes ownership of stock of the foreign
corporation to the covered shareholder who acquires ownership of the
stock. See section 961(c) (prescribed adjustments to basis in CFC stock
also apply to any United States shareholder that acquires from any
person any portion of the interest of a United States shareholder by
reason of which such shareholder was treated as owning CFC stock).
These rules generally ensure that undistributed PTEP of a lower-tier
foreign corporation does not give rise to additional U.S. tax in the
hands of the acquiring covered shareholder when stock of the
corporation is later sold by an upper-tier CFC, even though the covered
shareholder did not own such stock when the PTEP was generated and
section 961(c) basis was increased. These successor basis rules are
issued pursuant to the express delegation of authority under section
743(b) (as well as the express delegation of authority under section
961(c), as described in part III.A. of the Explanation of Provisions).
The proposed regulations set forth rules for transferring section
961(c) basis in a general successor transaction, as well as for
transferring a partnership's derived basis if the general successor
transaction involves an acquisition of an interest in a partnership
(acquired partnership). See proposed Sec. 1.961-5(c). These rules
generally provide parity between derived basis and section 961(c) basis
in a general successor transaction and, in the case of an acquired
partnership, ensure that the successor covered shareholder succeeds to
derived basis (as compared to an approach that attempted to replace all
or a portion of derived basis with a section 743(b) basis adjustment,
which would require an election under section 754 to be in effect or a
substantial built-in loss). The Treasury Department and the IRS intend
to issue additional rules regarding the transfer of section 961(c)
basis and derived basis (as well as the transfer of PTEP) in
acquisitions that are not general successor transactions. In these
acquisitions, the Treasury Department and the IRS are considering
adding a rule as part of finalization of the proposed regulations that,
similar to the potential rule discussed in part II.G.1 of the
Explanation of Provisions, provides that section 961(c) basis and
derived basis transfer automatically in periods before those additional
rules apply.
In a general successor transaction, a portion of an acquired
partnership's derived basis or acquired foreign corporation's section
961(c) basis with respect to the transferor covered shareholder of a
property unit transfers to the successor covered shareholder and
therefore becomes with respect to the successor covered shareholder.
Thus, to reflect the general successor transaction, derived basis or
section 961(c) basis is increased (or reduced) by the basis that
transfers to (or from) the covered shareholder, and those adjustments
are treated as made concurrently with the general successor
transaction. See proposed Sec. 1.961-5(c)(1) and (2)(iii). The amount
of basis that transfers may be a positive or negative amount and is
equal to a pro rata portion of the derived basis or section 961(c)
basis of the property unit immediately before the general successor
transaction, plus any increase, or minus any decrease, to the basis for
foreign currency gain or loss recognized under section 986(c) in the
general successor transaction (discussed in part V of the Explanation
of Provisions). See proposed Sec. 1.961-5(c)(2)(i) and (ii).
The pro rata portion is determined based on the percentage, by
value, of the transferor covered shareholder's interests in the
acquired partnership or acquired foreign corporation that the successor
covered shareholder acquires in the general successor transaction. See
proposed Sec. 1.961-5(c)(2)(i). This approach is intended to transfer
derived basis or section 961(c) basis commensurate with the percentage
change of the transferor covered shareholder's indirect interests in
the partnership's common basis or foreign corporation's adjusted basis
by reason of the general successor transaction. The Treasury Department
and the IRS are of the view that alternative approaches--such as
transferring an amount of derived basis or section 961(c) basis equal
to the amount of PTEP that transfers in the general successor
transaction--could give rise to
[[Page 95383]]
inappropriate outcomes or undue complexity where derived basis or
section 961(c) basis is not equal to the PTEP that transfers in the
general successor transaction.
ii. Deemed Covered Shareholder
Consistent with the deemed covered shareholder rules discussed in
part II.G.3 of the Explanation of Provisions, the proposed regulations
provide that the deemed covered shareholder is treated in the same
manner as a covered shareholder in determining the transfer of derived
basis or section 961(c) basis. See proposed Sec. 1.961-5(c)(3)(i).
Thus, for example, if a covered shareholder owns all the stock of an
upper-tier CFC, the upper-tier CFC directly owns all the stock of a
lower-tier CFC, and the covered shareholder sells a portion of its
stock of the upper-tier CFC to a nonresident alien individual, then a
portion of the upper-tier CFC's section 961(c) basis in the stock of
the lower-tier CFC transfers from the seller covered shareholder to the
deemed covered shareholder. The proposed regulations further provide
that, to the extent the deemed covered shareholder is treated as owning
stock of any foreign corporation that is not otherwise a CFC, the
foreign corporation is treated as a CFC for purposes of determining
section 961(c) basis that transfers to or from the deemed covered
shareholder. See proposed Sec. 1.961-5(c)(3)(ii). This is intended to
allow for section 961(c) basis to transfer from the deemed covered
shareholder to a subsequent covered shareholder (as properly adjusted
under the proposed section 961 regulations) even if both an upper-tier
foreign corporation and the lower-tier foreign corporation in which the
upper-tier foreign corporation directly owns stock cease to be CFCs
during the period in which the stock of the foreign corporations is
considered owned by the deemed covered shareholder.
In cases where basis of a derivative ownership unit or section
961(c) ownership unit transfers from the deemed covered shareholder to
a covered shareholder, the covered shareholder must use a reasonable
method to determine the amount of transferred basis. See proposed Sec.
1.961-5(c)(3)(iii). The proposed regulations provide that such method
must take into account adjustments to basis with respect to the deemed
covered shareholder that would have been made under the proposed
regulations if the basis were with respect to a covered shareholder
during the time that it was with respect to the deemed covered
shareholder.
Like in the context of the deemed covered shareholder rules for
purposes of transferring PTEP, the Treasury Department and the IRS
welcome comments on this regime.
iii. Coordination With Section 743(b)
In certain general successor transactions in which an acquired
partnership has a section 754 election in effect or a substantial
built-in loss as defined under section 743(d), property of the acquired
partnership will receive a section 743(b) basis adjustment with respect
to the successor covered shareholder. Accordingly, the proposed
regulations take into account derived basis that transfers to the
successor covered shareholder in calculating the overall section 743(b)
basis adjustment and its allocation among the acquired partnership's
assets with respect to the successor covered shareholder. See proposed
Sec. 1.961-5(d). In transactions involving multiple tiers of acquired
partnerships, this coordination rule applies to each acquired
partnership.
5. Basis Adjustments for Deemed Dividends Under Section 1248(c)(2) or
964(e)(1)
The Treasury Department and the IRS are studying whether basis
under section 961 should be increased to reflect gain treated as a
dividend under section 1248(c)(2) or 964(e)(1). For example, to the
extent gain recognized by a covered shareholder on a sale of stock of a
first-tier CFC is treated as a dividend under section 1248(c)(2) by
reason of E&P of a third-tier CFC (and therefore gives rise to PTEP
under section 959(e)), the Treasury Department and the IRS are
considering whether (and to what extent) the first-tier CFC's and
second-tier CFC's section 961(c) basis can and should be increased to
reflect the resulting PTEP. The Treasury Department and the IRS request
comments on this topic.
D. Tax Consequences of Positive Derived Basis (Proposed Sec. 1.961-8)
1. In General
The rules for a partnership's positive derived basis with respect
to a covered shareholder are generally intended to replicate the
outcome that would occur on a sale, exchange, or other disposition of
the derivative ownership unit if such basis were an additional amount
of common basis taken into account in determining gain or loss
allocable to the covered shareholder. These rules are generally modeled
after the rules in Sec. 1.743-1.
Under the proposed regulations, in a sale, exchange, or other
disposition by a partnership (transferring partnership) of one or more
derivative ownership units (transferred units), each partner's
distributive share of gain or loss recognized by the transferring
partnership is first determined under section 704 without regard to
positive derived basis (but with regard to any section 743(b) basis
adjustment with respect to the partner). See proposed Sec. 1.961-
8(b)(1). Then, positive derived basis is applied to each covered
shareholder's distributive share of such gain or loss, in an amount
equal to the transferring partnership's positive derived basis with
respect to the covered shareholder of the transferred units, subject to
two limitations (discussed in part III.D.2 of the Explanation of
Provisions). See proposed Sec. 1.961-8(b)(2)(i); see also proposed
Sec. 1.961-12(c)(4) (Example 4). This application of positive derived
basis can decrease a distributive share of gain, increase a
distributive share of loss, or convert a distributive share of gain to
a distributive share of loss.
The application of positive derived basis to a covered
shareholder's distributive share is generally treated as an application
of positive derived basis by the transferring partnership. See proposed
Sec. 1.961-8(b)(1). However, if the covered shareholder owns the
transferred units through tiered partnerships, only the partnership in
which the covered shareholder directly owns an interest is treated as
applying the positive derived basis).
To coordinate with section 705, the proposed regulations provide
that adjusted basis of a partnership interest directly owned by the
covered shareholder is adjusted under section 705 after taking into
account the partnership's application of positive derived basis to the
covered shareholder's distributive share of gain or loss with respect
to the transferred units. See proposed Sec. 1.961-8(c). On the other
hand, in tiered partnership structures, an upper-tier partnership's
common basis in a lower-tier partnership interest is adjusted under
section 705 without regard to the application of positive derived basis
to the covered shareholder's distributive share. See proposed Sec.
1.961-8(d). Additionally, an upper-tier partnership's derived basis
with respect to the covered shareholder in a lower-tier partnership
interest (starting at the lowest-tier if there is more than one lower-
tier partnership) is concurrently reduced (or gain is recognized, as
applicable) by the amount of positive derived basis applied to the
covered shareholder's distributive share. In this way, an upper-tier
partnership's derived basis in a lower-tier partnership interest
[[Page 95384]]
is replaced with common basis under section 705 (which may be decreased
under section 705(a)(2) when the lower-tier partnership makes a
distribution).
2. Limitations
As discussed in part III.D.1 of the Explanation of Provisions, the
amount of positive derived basis applied to a covered shareholder's
distributive share of gain or loss with respect to transferred units is
equal to the transferring partnership's positive derived basis with
respect to the covered shareholder of the transferred units, subject to
two limitations. See proposed Sec. 1.961-8(b)(2)(i).
The first limitation applies in nonrecognition transactions to
replicate the effect of additional basis under the ``boot-within-gain''
rule of section 351(b) or 356(a)(1), where additional basis might
reduce the amount of gain realized but not the amount of gain
recognized. See proposed Sec. 1.961-8(b)(2)(ii). Under this
limitation, the amount of positive derived basis applied to the covered
shareholder's distributive share is equal to the excess of the amount
of positive derived basis with respect to the covered shareholder of
the transferred units over the covered shareholder's share of the gain
realized but not recognized by the transferring partnership with
respect to the transferred units (determined without regard to derived
basis). In this way, positive derived basis is available for use only
to the extent that, if the positive derived basis were additional
common basis taken into account in determining gain allocable to the
covered shareholder, such derived basis would reduce gain recognized
with respect to the transferred units.
To illustrate this limitation, assume US1, a covered shareholder,
directly owns a 50 percent interest in PRS1, a partnership, and PRS1
directly owns the single share of outstanding stock of F1, a foreign
corporation. The fair market value of the share is $150x. PRS1's common
basis of the share is $100x, and PRS1's derived basis with respect to
US1 of the share is $15x. PRS1 exchanges the share for $120x of stock
and $30x of money in a reorganization described in section
368(a)(1)(D), recognizing $30x of gain on the exchange under section
356(a)(1) (the lesser of the $30x of money received and the $50x of
gain in the stock of F1) and therefore $20x of the $50x of realized
gain is not recognized due to the boot limitation in section 356(a)(1).
US1's distributive share of the recognized gain is $15x ($30x x 50%),
determined without regard to derived basis. Under the limitation in the
proposed regulations, only $5x of positive derived basis is applied to
such distributive share (thus, $10x of the $15x of derived basis is not
available for use). The $5x is computed as the excess of $15x (the
amount of positive derived basis with respect to US1 without regard to
the limitation), over $10x ($20x x 50%, which represents US1's share of
the realized-but-not-recognized gain). Accordingly, US1's distributive
share of gain taking into account derived basis is $10x (US1's $15x
distributive share of gain without regard to derived basis over $5x of
positive derived basis available under the limitation). This $10x
represents the amount of gain that would be recognized under section
356(a)(1) and allocated to US1 if such were determined based on $75x of
value (50% of each of the $120x of stock consideration and $30x of
money) and $65x of basis (50% of the $100x of common basis, increased
by the $15x of derived basis).
Under the second limitation, positive derived basis can increase or
create a distributive share of loss only if the transferring
partnership recognizes, or would recognize, loss on the sale, exchange,
or other disposition of the transferred units and a current deduction
in respect of the loss is, or would be, allowable. See proposed Sec.
1.961-8(b)(2)(iii). Thus, for example, positive derived basis cannot
create a distributive share of loss if the gain recognized with respect
to the transferred units is pursuant to section 301(c)(3).
3. Certain Scenarios Not Addressed
The proposed regulations do not address the interaction of derived
basis with the rules regarding distributions by a partnership (for
example, sections 732 and 734). The Treasury Department and the IRS
request comments on this interaction, including whether derived basis
with respect to a covered shareholder should be taken into account in
the case of a distribution by a partnership of a derivative ownership
unit to the covered shareholder or to another partner and whether
derived basis should be taken into account in the case of distributions
of other types of assets by a partnership.
The proposed regulations also do not address the effect of derived
basis under the dividend recharacterization rules of section 1248. The
Treasury Department and the IRS are studying this and other issues with
respect to the application of section 1248 when stock of a foreign
corporation is owned through a partnership (for example, the manner in
which section 1248(d)(1) applies to exclude PTEP in determining deemed
dividend treatment), and welcome comments on these issues.
E. Tax Consequences of Positive Section 961(c) Basis (Proposed Sec.
1.961-9)
1. In General
As discussed in part III.B.4 of the Explanation of Provisions, a
CFC's section 961(c) basis applies only for the purposes prescribed in
the section 961 regulations and thus does not affect the amount of the
CFC's gross income or E&P. Under the rules in the proposed regulations
for the tax consequences of positive section 961(c) basis, gain to
which positive section 961(c) basis is applied is treated as PTEP that
is generally excluded from the CFC's gross income under section 961(c)
(section 961(c) exclusion). See proposed Sec. 1.961-9. The proposed
regulations describe the section 961(c) exclusion, the application of
section 961(c) basis to gain, and the PTEP that results from such
application (including the character of the PTEP).
2. Section 961(c) Exclusion
i. In General
The section 961(c) exclusion operates in a similar manner to the
section 959(b) exclusion. It provides that PTEP resulting from the
application of a CFC's section 961(c) basis to gain recognized by the
CFC is excluded from the CFC's gross income for purposes of determining
the CFC's subpart F income and tested income or tested loss, provided
that the PTEP relates to a covered shareholder that is a United States
shareholder in the CFC. See proposed Sec. 1.961-9(b); see also part
III.E.3 of the Explanation of Provisions (determining PTEP resulting
from section 961(c) basis).
The Treasury Department and the IRS are of the view that E&P
attributable to gain to which section 961(c) basis is applied gives
rise to PTEP. Section 959(a) refers to E&P of a foreign corporation
that is ``attributable to amounts which are, or have been, included in
gross income under section 951(a) [or 951A(a)].'' Gain recognized by an
upper-tier foreign corporation on the disposition of stock of a lower-
tier foreign corporation may likewise reflect amounts included in gross
income under section 951(a) or 951A(a) with respect to the lower-tier
foreign corporation and, thus, give rise to E&P that is attributable to
such amounts. Because section 961(c) basis reflects amounts included in
gross income under section 951(a) or 951A(a), the application of
section 961(c) basis to such gain means that the resulting E&P is
attributable to an amount included in gross income under section 951(a)
or
[[Page 95385]]
951A(a) in accordance with the language of section 959(a).
Additionally, treating the resulting E&P as PTEP (rather than section
959(c)(3) E&P) prevents double non-taxation and double taxation and
provides symmetry between distributions and dispositions involving
foreign stock, as discussed in part III.E.2.ii of the Explanation of
Provisions.
The proposed regulations apply the section 961(c) exclusion for
purposes of determining a CFC's tested income or tested loss pursuant
to the express delegation of authority in section 951A(f)(1)(B), which
prevents double taxation and is therefore consistent with the policy of
section 961. Additionally, this approach is consistent with section
951A(f)(1)(A) (treating an inclusion under section 951A(a) in the same
manner as an inclusion under section 951(a)(1)(A) for purposes of
section 961), which should be interpreted as allowing references to
section 951 in section 961(c) to be treated as including a reference to
section 951A(a). This approach is also consistent with a comment
received in response to the 2019 notice, which requested clarification
that section 961(c) basis applies for purposes of determining tested
income, noting that some comments asserted that section 961(c) basis
only applies in determining a CFC's subpart F income. See also TD 9866,
84 FR 29288, 29298 (describing similar comments received in response to
proposed regulations under section 951A).
Further, the application of the section 961(c) exclusion at the
CFC-level is coordinated with the pro rata share rules of section
951(a) (discussed in part IV.C of the Explanation of Provisions). Under
this approach, a CFC's subpart F income is determined with respect to
all shareholders by excluding the same amount of PTEP resulting from
section 961(c) basis of the CFC, and United States shareholders' pro
rata shares of the CFC's subpart F income are computed in a manner so
that any benefits of the application of the section 961(c) exclusion to
PTEP with respect to a United States shareholder generally inure only
to that United States shareholder. For instance, if two United States
shareholders own equal interests in a CFC and, on a sale of foreign
stock by the CFC, the CFC recognizes gain half of which is treated as
PTEP with respect to one United States shareholder (because there is
positive section 961(c) basis with respect to the United States
shareholder at least equal to its share of the gain) and the other half
of which gives rise to subpart F income (because there is no section
961(c) basis with respect to the other United States shareholder and no
exception from subpart F income applies), then only the United States
shareholder with respect to which there is no section 961(c) basis has
a pro rata share of the subpart F income resulting from the sale.
Lastly, by applying section 961(c) at the CFC-level, the proposed
regulations provide symmetry between sections 959(b) and 961(c), which
are companion provisions with a common purpose. Thus, PTEP is generally
treated the same under the proposed regulations regardless of whether
it arises from a distribution or disposition involving stock of a
foreign corporation. As indicated in part II.D.1.iii of the Explanation
of Provisions, the Treasury Department and the IRS request comments on
the CFC-level approach in the proposed regulations, including
alternative approaches providing symmetry between sections 959(b) and
961(c) (such as a shareholder-level approach), or whether symmetry is
necessary under the statute.
ii. Considerations in Treating Sheltered E&P as PTEP
The Treasury Department and the IRS considered treating a CFC's E&P
that is sheltered from tax by positive section 961(c) basis with
respect to a covered shareholder as section 959(c)(3) E&P. However,
such an approach could give rise to double non-taxation or double
taxation. Moreover, treating sheltered E&P as PTEP provides symmetry
between distributions and dispositions involving foreign stock because
both E&P to which annual PTEP accounts are applied and E&P to which
section 961(c) basis is applied are treated as PTEP.
For example, double non-taxation could occur if the sheltered E&P
were to subsequently give rise to a dividend for which the covered
shareholder is allowed a dividends received deduction under section
245A (including as a result of a disposition pursuant to section
1248(j)). In that case, the taxable portion of any unrealized
appreciation in stock of the CFC, to the extent attributable to
unrealized appreciation in the CFC's assets, could be reduced by the
amount of the dividend (because the dividend reduces the value of the
CFC stock without a corresponding basis reduction or, in a disposition
of stock, because gain attributable to the appreciation is
recharacterized as a dividend). See also TD 9866, 84 FR 29288, 29298
(discussing this concern and requesting comments). This would result in
double non-taxation when combined with the covered shareholder's
adjusted basis (increased under section 961(a)) in its top-tier CFC
stock, which generally would not be reduced when section 959(c)(3) E&P
is distributed with respect to the stock. Treating the sheltered E&P as
PTEP prevents this outcome because section 961 reduces basis for
distributions of PTEP (thereby preventing double benefits) and, in a
disposition, PTEP is not taken into account under section 1248.
In a case where the covered shareholder is not eligible for a
section 245A deduction (for example, because the covered shareholder is
an individual), the covered shareholder would generally include the
sheltered E&P in gross income when distributed by the CFC if the
sheltered E&P were treated as section 959(c)(3) E&P. This would
represent double taxation with respect to the E&P that gave rise to the
section 961(c) basis because such E&P was taxed under section 951(a) or
951A(a) when earned and would in effect be taxed again when the
sheltered E&P is distributed to the covered shareholder. Although the
covered shareholder's adjusted basis under section 961(a) in its top-
tier CFC stock would generally not be reduced for the distribution of
the sheltered E&P, there would nevertheless be double taxation until or
unless that basis can be utilized, and even in that case there may be a
character mismatch. See also TD 9866, 84 FR 29288, 29298 (requesting
comments on the extent to which adjustments should be made to the
operation of section 961(c) to minimize the potential for the same item
of income being subject to tax more than once); 2006 proposed
regulations, 71 FR 51155, 51162 (noting similar concerns). Treating the
sheltered E&P as PTEP prevents this outcome because a distribution of
PTEP to a covered shareholder is generally excluded from gross income
under section 959(a).
The Treasury Department and the IRS also considered treating
sheltered E&P as section 959(c)(3) E&P but reducing basis (including
the covered shareholder's adjusted basis in its top-tier CFC stock) to
the extent the sheltered E&P is eligible for a section 245A deduction.
However, this approach is not being proposed because it would raise
other issues, including the timing of the basis reduction (either
immediately upon creation of sheltered E&P, which may later cause
excess taxation, or only upon distribution of sheltered E&P, which
would require additional tracking), and would not address the double
taxation issue for covered shareholders that do not qualify for a
section 245A deduction.
[[Page 95386]]
3. Application of Section 961(c) Basis to Gain and Resulting PTEP
i. In General
The rules for applying a CFC's positive section 961(c) basis with
respect to a covered shareholder are generally intended to replicate
the outcome that would occur on a sale, exchange, or other disposition
of the section 961(c) ownership unit if such basis were an additional
amount of adjusted basis taken into account in determining gain
allocable to the covered shareholder under section 951.
Under the proposed regulations, in a sale, exchange, or other
disposition by a CFC of one or more section 961(c) ownership units that
are shares of stock of a single foreign corporation (transferred
units), the CFC first determines gain recognized with respect to the
transferred units (covered gain). See proposed Sec. 1.961-9(c)(1).
Covered gain is determined on an aggregate basis with respect to all
transferred units, without regard to section 961(c) basis or loss
recognized on any transferred unit (and before any application of
section 964(e) or other dividend recharacterization provisions). Then,
portions of the covered gain are assigned to covered shareholders under
proposed Sec. 1.951-2 (the same rules that assign covered
distributions, discussed in part IV.B of the Explanation of
Provisions), and this determines a covered shareholder's share of the
covered gain. See proposed Sec. 1.961-9(d)(1).
Next, positive section 961(c) basis is applied (on an aggregate
basis) to each covered shareholder's share of the covered gain, in an
amount equal to the CFC's positive section 961(c) basis with respect to
the covered shareholder of the transferred units (but not in excess of
such share), and subject to a limitation in nonrecognition transactions
(similar to the limitation rule that applies to derived basis discussed
in part III.D.1 of the Explanation of Provisions). See proposed Sec.
1.961-9(d)(2), (e). This application of positive section 961(c) basis
characterizes the covered shareholder's share of the covered gain as
PTEP with respect to the covered shareholder, and that PTEP is
generally excluded from the CFC's gross income for purposes of
determining its subpart F income and tested income or tested loss. See
proposed Sec. 1.961-9(b), (d)(3); see also proposed Sec. 1.961-
12(c)(5) (Example 5).
An aggregate approach to applying positive section 961(c) basis
allows positive section 961(c) basis of a transferred unit to be
applied to a portion of the covered shareholder's share of the covered
gain that is recognized with respect to another transferred unit. For
example, in a case where there are two transferred units, one of which
is sold at a loss but has positive section 961(c) basis with respect to
the covered shareholder and the other of which is sold at a gain but
has no section 961(c) basis with respect to the covered shareholder,
positive section 961(c) basis in the first transferred unit will be
applied to gain recognized with respect to the second transferred unit
(and, to the extent so applied, the gain will be treated as PTEP and
will be reduced only by any foreign income taxes allocated and
apportioned to the PTEP). Aggregating positive section 961(c) basis in
this manner is intended to replicate the effect of netting gains and
losses on similar types of property in determining a CFC's subpart F
income. See section 954(c)(1)(B) (foreign personal holding company
income includes the portion of gross income that consists of the excess
of gains over losses from the sale or exchange of certain property).
Although aggregation differs from the share-by-share approach under
section 961 to adjusting basis (including for purposes of determining
the consequences of distributions of PTEP), it provides a simpler and
more direct way of achieving the same effect as a share-by-share
approach to the use of positive section 961(c) basis that allows excess
section 961(c) basis on a particular share to be applied to gain
recognized on another share of stock in the same foreign corporation
for which there is not sufficient section 961(c) basis to fully offset
the gain. See also part III.E.4 of the Explanation of Provisions
(discussing a rule allocating PTEP to shares of stock in order to
facilitate the application of dividend recharacterization provisions
like section 964(e)).
The proposed regulations, however, do not allow positive section
961(c) basis of transferred units in excess of the covered
shareholder's share of the covered gain to be applied to other covered
gain or to create a loss that reduces subpart F income or tested
income. Allowing section 961(c) basis in stock of a foreign corporation
to only reduce a section 951 inclusion attributable to sales,
exchanges, or other dispositions of stock of that foreign corporation
is consistent with the language of section 961(c), with the result that
only shares of stock of the same foreign corporation should be viewed
as similar types of property for purposes of replicating the effect of
netting under section 961(c). Unused positive section 961(c) basis,
however, may be applied to gain recognized pursuant to section 961(c),
provided the gain is recognized with respect to stock of the foreign
corporation to which the section 961(c) basis relates, as discussed in
part III.G of the Explanation of Provisions.
ii. Character and Dollar Basis of Resulting PTEP
As discussed in part II.C of the Background, the character of PTEP
(for example, the taxable year, section 904 category, and PTEP group to
which the PTEP relates) must be tracked to ensure the proper
application of provisions regarding the treatment of PTEP. Accordingly,
the proposed regulations provide rules for determining the character of
a CFC's PTEP with respect to a covered shareholder that results from
the application of positive section 961(c) basis to the covered
shareholder's share of covered gain (section 961(c) PTEP). See proposed
Sec. 1.961-9(d)(3) and (f)(1). Generally, the effect of these rules is
to duplicate undistributed PTEP of lower-tier foreign corporations by
having the PTEP ``tier up'' into the CFC, but without reducing PTEP of
the lower-tier foreign corporations, and this effect is analogous to
the effect of section 964(e)(1) (``tiering-up'' certain section
959(c)(3) E&P of lower-tier foreign corporation in certain sales or
exchanges of stock by a CFC).
The proposed regulations generally adopt a mirroring approach,
which provides that section 961(c) PTEP takes the same character as
PTEP that transfers from the covered shareholder under section 959 or
is eliminated (for example, by reason of an election under section
338(g)) in the sale, exchange, or other disposition of the transferred
units (referred to as mirrored PTEP). See proposed Sec. 1.961-9(f)(2);
see also proposed Sec. 1.961-12(c)(5) (Example 5). Mirrored PTEP is
increased for foreign income taxes associated with such transferred or
eliminated PTEP because those taxes relate to PTEP to which section
961(c) basis used in the transaction is attributable. The mirroring
rule is intended to identify (and duplicate) PTEP to which section
961(c) basis used in the transaction is attributable in an
administrable manner that does not impose undue burden on taxpayers.
Alternative approaches that were considered include requiring section
961(c) basis to be established and maintained with the same
characterizations with which annual PTEP accounts are established and
maintained (so that section 961(c) PTEP could be characterized based on
section 961(c) basis, portions of would relate to
[[Page 95387]]
each PTEP group). However, the view of the Treasury Department and the
IRS is that those approaches would be unduly burdensome because they
would substantially increase the information required to be tracked
under section 961(c).
In some cases, section 961(c) PTEP may be less than mirrored PTEP.
This could occur, for example, if a foreign corporation's assets
depreciate in value before the transaction or if mirrored PTEP consists
of PTEP attributable to section 965(b) (which does not increase section
961(c) basis). In that case, section 961(c) PTEP takes the same
character as a pro rata portion of mirrored PTEP. In other words, the
mirroring rule applies but mirrored PTEP is pro rata reduced to equal
section 961(c) PTEP.
In other cases, section 961(c) PTEP may exceed mirrored PTEP. This
could occur if section 961(c) basis used in the transaction is
attributable to PTEP that was distributed before the transaction in a
manner different than how the PTEP was expected to be distributed when
the section 961(c) basis was provided. In that case, the mirroring rule
applies to the extent of mirrored PTEP, with a ``lookback'' rule
applying to the portion of section 961(c) PTEP that is not
characterized under the mirroring rule (excess section 961(c) PTEP).
See proposed Sec. 1.961-9(f)(3). Under the lookback rule, excess
section 961(c) PTEP takes the same character as lookback PTEP, which is
PTEP that resulted from income inclusions under sections 951(a) and
951A(a) of the covered shareholder attributable to the transferred
units (including stock of a lower-tier foreign corporation owned
through the transferred units) during a 36-month lookback period
(without any reduction for foreign income taxes imposed on that PTEP).
The lookback rule is intended to provide an administrable method to
approximate PTEP that should be viewed as duplicated in the
transaction, while minimizing taxpayer burden in the limited cases
where section 961(c) PTEP exceeds mirrored PTEP. Like under the
mirroring rule, lookback PTEP is pro rata reduced to equal excess
section 961(c) PTEP if excess section 961(c) PTEP is less than lookback
PTEP.
If excess section 961(c) PTEP is greater than lookback PTEP, the
portion of excess section 961(c) PTEP that is not characterized under
the lookback rule is characterized as PTEP relating to the section
245A(d) PTEP group, the taxable year in which the transaction occurs,
and the general category under section 904(d)(1)(D). See proposed Sec.
1.961-9(f)(4). The Treasury Department and the IRS are of the view that
this rule is a necessary consequence of balancing compliance and
administrative burden with precision under the mirroring rule and
lookback rule, and that alternative characterizations could
inappropriately incentivize transactions intended to distribute PTEP to
which section 961(c) basis used in the transaction is attributable in a
manner different than the manner in which the PTEP was expected to be
distributed when the section 961(c) basis was provided.
Finally, the proposed regulations provide that the dollar basis of
section 961(c) PTEP is equal to the U.S. dollar amount of section
961(c) basis giving rise to the PTEP. See proposed Sec. 1.961-9(g).
Because section 961(c) basis is adjusted to take into account foreign
currency gain or loss recognized in the transaction (as discussed in
part III.C.3 of the Explanation of Provisions), any foreign currency
gain or loss subsequently recognized with respect to the section 961(c)
PTEP is determined by reference to the time the section 961(c) PTEP
comes into existence.
4. Coordination With Dividend Recharacterization Provisions
The proposed regulations provide two rules to coordinate with
provisions of the Code or regulations that would treat covered gain, in
whole or in part, as a dividend. The first rule provides that such
dividend recharacterization provisions do not apply to the portion of
covered gain that is PTEP. See proposed Sec. 1.961-9(c)(2). Thus, for
example, section 961(c) basis applies and characterizes covered gain as
PTEP before the application of section 964(e) (treating gain recognized
by a CFC on the sale or exchange of stock in a foreign corporation as a
dividend in certain cases), similar to how adjusted basis must be taken
into account to determine gain recognized before applying section
964(e).
The second rule allocates PTEP resulting from section 961(c) basis
to transferred units. See proposed Sec. 1.961-9(d)(5) and (h). This
rule is intended to facilitate the application of dividend
recharacterization provisions by providing certainty about the amount
of gain with respect to a particular transferred unit that is treated
as PTEP, which otherwise might be unclear in light of the aggregation
component in applying positive section 961(c) basis (discussed in part
III.E.3.i of the Explanation of Provisions).
Further, the Treasury Department and the IRS are studying other
issues involving dividend recharacterization provisions (for example,
the application of section 1248(d)(1) in section 964(e) transactions)
and may address these issues in future guidance.
F. Gain Recognition in Transactions Involving Property Units With
Negative Basis (Proposed Sec. 1.961-10)
To account for negative derived basis and negative section 961(c)
basis, the proposed regulations provide rules that treat a partnership
or CFC as recognizing gain with respect to a property unit. See
proposed Sec. 1.961-10. These rules are consistent with the theory of
negative basis described in part III.C.2.v the Explanation of
Provisions, which provides that negative basis is akin to a reduction
to common basis or adjusted basis that only has a tax effect when the
common basis or adjusted basis becomes relevant to determining taxable
income in a transaction.
One set of rules applies in any transaction in which a
partnership's common basis or CFC's adjusted basis of a property unit
is relevant in determining gain or loss recognized with respect to the
property unit--for example, a sale or exchange of the property unit or
a distribution under section 301(c)(2) on the property unit. See
proposed Sec. 1.961-10(b)(1) and (c)(1); see also proposed Sec.
1.961-12(c)(6) and (7) (Examples 6 and 7). In these cases, the
partnership or CFC is treated as recognizing gain with respect to the
property unit to the extent of the additional amount of gain, plus the
lesser amount of loss, that it would have recognized in the transaction
if its common basis or adjusted basis of the property unit were reduced
by all negative derived basis or negative section 961(c) basis of the
property unit. In this way, negative basis gives rise to gain that
reflects income that would exist or counteracts loss that would not
exist if common basis or adjusted basis were reduced by the negative
basis, thereby replicating the outcome that would occur in the
transaction if common basis or adjusted basis were so reduced.
So, for example, in a sale of a property unit, negative basis of
the property unit generally gives rise to an equal amount of gain. In
contrast, in a distribution under section 301(c)(2) with respect to a
property unit or an exchange of a property unit under section 351,
negative basis of the property unit gives rise to an amount of gain
equal to the gain that would have been recognized under section
301(c)(3) or 351(b), as applicable, if common basis (in the case of a
partnership) or adjusted basis (in the case of a CFC) were reduced by
all negative basis of the property unit.
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Another set of rules applies in any transaction in which a property
unit loses its status as a derivative ownership unit or section 961(c)
ownership unit. This could occur, for example, as a result of a
transfer by a partnership of a derivative ownership unit to a foreign
corporation in an exchange to which section 351 applies, or a
distribution by a CFC of a section 961(c) ownership unit to a domestic
corporation in a transaction to which sections 332 and 337 apply. See
proposed Sec. 1.961-10(b)(2)(ii) and (c)(2)(ii). This could also occur
if an upper-tier foreign corporation ceases to be a CFC, in which case
shares of stock of a
[…truncated; see source link]Indexed from Federal Register on December 2, 2024.
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