Rule2025-00318
Rules Regarding Certain Disregarded Payments and Dual Consolidated Losses
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
January 14, 2025
Effective
January 10, 2025
Issuing agencies
Treasury DepartmentInternal Revenue Service
Abstract
This document contains final regulations regarding certain disregarded payments that give rise to deductions for foreign tax purposes and avoid the application of the dual consolidated loss ("DCL") rules. The final regulations affect domestic corporate owners that make or receive such payments. This document also announces additional transition relief for the application of the DCL rules to certain foreign taxes that are intended to ensure that multinational enterprises pay a minimum level of tax.
Full Text
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<title>Federal Register, Volume 90 Issue 8 (Tuesday, January 14, 2025)</title>
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[Federal Register Volume 90, Number 8 (Tuesday, January 14, 2025)]
[Rules and Regulations]
[Pages 3003-3021]
From the Federal Register Online via the Government Publishing Office [<a href="http://www.gpo.gov">www.gpo.gov</a>]
[FR Doc No: 2025-00318]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Parts 1 and 301
[TD 10026]
RIN 1545-BQ72
Rules Regarding Certain Disregarded Payments and Dual
Consolidated Losses
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Final rule.
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SUMMARY: This document contains final regulations regarding certain
disregarded payments that give rise to deductions for foreign tax
purposes and
[[Page 3004]]
avoid the application of the dual consolidated loss (``DCL'') rules.
The final regulations affect domestic corporate owners that make or
receive such payments. This document also announces additional
transition relief for the application of the DCL rules to certain
foreign taxes that are intended to ensure that multinational
enterprises pay a minimum level of tax.
DATES:
Effective date: These regulations are effective on January 10,
2025.
Applicability dates: For dates of applicability, see Sec. Sec.
1.1503(d)-8(b)(11), (15), (17), and (18), and 301.7701-2(e)(10).
FOR FURTHER INFORMATION CONTACT: Andrew L. Wigmore at (202) 317-5443
(not a toll-free number).
SUPPLEMENTARY INFORMATION:
Authority
This document contains amendments to 26 CFR parts 1 and 301 (the
``final regulations'') under sections 1503(d) and 7701 of the Internal
Revenue Code (the ``Code''). The final regulations are issued pursuant
to the express delegations of authority under section 7805(a), which
authorizes the Secretary of the Treasury (the ``Secretary'') to
``prescribe all needful rules and regulations for the enforcement'' of
the Code, section 1503(d)(2)(B), which authorizes the Secretary to
provide exceptions to the term ``dual consolidated loss,'' and section
1503(d)(3), which authorizes the Secretary to address losses of
``separate units.''
Background
On December 11, 2023, the Department of Treasury (``Treasury
Department'') and the IRS released Notice 2023-80, 2023-52 IRB 1583,
which, among other things, described the interaction of the DCL rules
with model rules published by the OECD/G20 Inclusive Framework on BEPS
(the ``GloBE Model Rules'') \1\ and requested comments on such
interaction. The notice also announced limited transition relief from
the application of the DCL rules to the GloBE Model Rules for ``legacy
DCLs,'' which in general are DCLs incurred before the effective date of
the GloBE Model Rules.
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\1\ See OECD/G20, Tax Challenges Arising from the Digitalisation
of the Economy Global Anti-Base Erosion Model Rules (Pillar Two). As
the context requires, references to the GloBE Model Rules include
references to a foreign jurisdiction's legislation implementing the
GloBE Model Rules. Capitalized terms used in this preamble, but not
defined herein, have the meanings ascribed to such terms under the
GloBE Model Rules.
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On August 7, 2024, the Treasury Department and the IRS published
proposed regulations (REG-105128-23) in the Federal Register (89 FR
64750) under sections 1502, 1503(d), and 7701 of the Code, with a
correction published in the Federal Register on September 3, 2024 (89
FR 71214) (the ``2024 proposed regulations''), that would address
certain issues arising under the DCL rules. In general, the 2024
proposed regulations would clarify how the DCL rules interact with the
intercompany transaction rules in Sec. 1.1502-13, modify how items
arising from stock ownership are taken into account when computing the
amount of a DCL, and address the application of the DCL rules to
foreign taxes that are based on the GloBE Model Rules. The 2024
proposed regulations also included disregarded payment loss (``DPL'')
rules, under which domestic corporations would be required to include
amounts in income in certain cases involving disregarded payments.
Further, the 2024 proposed regulations included an anti-avoidance rule
applicable for both DCL and DPL purposes.
This document finalizes certain rules from the 2024 proposed
regulations. These rules and related comments received in response to
the 2024 proposed regulations are discussed in the Summary of Comments
and Explanation of Revisions section of this preamble. All comments are
available at <a href="https://www.regulations.gov">https://www.regulations.gov</a> or upon request. A public
hearing was held on the 2024 proposed regulations on November 22, 2024,
but the speaker requesting to testify did not attend the hearing. The
Treasury Department and the IRS intend to finalize, in future guidance,
the remaining rules from the 2024 proposed regulations.
This document also announces additional transition relief for the
application of the DCL rules to foreign taxes that are based on the
GloBE Model Rules. This relief is discussed in the Additional
Transition Relief with respect to the GloBE Model Rules section of this
preamble.
Summary of Comments and Explanation of Revisions
I. Scope
This document finalizes the rules from the 2024 proposed
regulations that relate to DPLs, including portions that are also
relevant for DCLs, such as the anti-avoidance rule and the deemed
ordering rule. The document retains the basic approach and structure of
these rules, with certain revisions.
Part II of the Summary of Comments and Explanation of Revisions
summarizes the DPL rules, including the purposes and general approach
of the rules under the 2024 proposed regulations, and discusses related
comments and revisions. Part III discusses comments and revisions
related to rules applicable to both DCLs and DPLs. Part IV discusses
applicability dates of the final regulations.
II. DPL Rules
A. Overview
The DPL rules are a component of the entity classification
regulations under Sec. Sec. 301.7701-1 through 301.7701-3 (the
``check-the-box regulations''). The check-the-box regulations were
intended to bring simplicity and administrability to entity
classifications under section 7701. They permit certain business
entities to be classified for U.S. tax purposes as entities disregarded
as separate from their owners. The classification may be determined
either pursuant to default rules or by election. However, the
application of these regulations to foreign entities, particularly
where a foreign entity is treated as a disregarded entity, has led to
unintended tax consequences, including avoidance of international
provisions of the Code. The purpose of the DPL rules is to prevent
certain arrangements involving disregarded entity classifications from
avoiding the DCL rules.
As an example, when a domestic corporation borrows from a bank and
on-lends the loan proceeds to its foreign disregarded entity, the
single economic borrowing could give rise to deductions under both U.S.
tax law (for interest payments to the bank) and foreign tax law (for
interest payments to the domestic corporation). As a result, if the
U.S. deduction is used to offset U.S. income that is not subject to
foreign tax, and the foreign tax deduction generates a foreign loss
that is used to offset foreign income that is not subject to U.S. tax
(for example under a consolidation regime), then the single economic
borrowing would give rise to a double deduction outcome. Such double
deduction outcome, however, would not be addressed by the existing DCL
rules because the loss of the disregarded entity would not be
recognized for U.S. tax purposes. Conversely, if the disregarded
entity's interest payments were regarded for U.S. tax purposes (for
example, if the arrangement involved direct financing of the
disregarded entity by the bank), the loss would be subject to the
existing DCL rules. This avoidance of the DCL rules is an unintended
consequence of the check-
[[Page 3005]]
the-box regulations which, as noted above, were issued for the
simplification and administrability of entity classification
determinations.
The DPL rules are intended to address these concerns by (i)
tracking whether certain payments involving a disregarded entity and
its owner give rise to potential double deduction outcomes, and (ii)
neutralizing any resulting double deduction outcome through an income
inclusion similar to the one that that the owner would have had with
respect to the payments had the payments been regarded for U.S. tax
purposes (that is, had the classification as a disregarded entity under
the check-the-box regulations not been taken into account). As revised
under the final regulations, the DPL rules also treat the income
inclusion as giving rise to a deduction, the use of which is suspended
until the entity takes into account certain disregarded income, with
the result that the rules are consistent with what would have occurred
if certain disregarded payments were regarded for U.S. tax purposes (as
discussed in part II.F of the Summary of Comments and Explanation of
Revisions). In this way, the check-the-box regulations continue to
permit certain entities to be disregarded for U.S. tax purposes
(including by election), but such classifications are subject to new
(targeted) rules that prevent the classifications from giving rise to
avoidance of the DCL rules. Alternative approaches to addressing these
concerns would include more broadly restricting disregarded entity
classifications (for example, by requiring a foreign entity to be
classified as an association for U.S. tax purposes if the entity is a
foreign tax resident, or classifying single-owner foreign entities as
associations in all cases).
Under the 2024 proposed regulations, the DPL rules would apply with
respect to a domestic corporation and a disregarded entity of the
domestic corporation (or a disregarded entity in which the domestic
corporation indirectly owns an interest) if transactions involving the
entity and domestic corporation are deductible under a foreign tax law,
such as where the entity is a tax resident of a foreign country. See
proposed Sec. 301.7701-3(c)(4). In these cases, the 2024 proposed
regulations described the domestic corporation as consenting to such
application of the DPL rules (generally by reason of the entity's
check-the-box election) and generally referred to the disregarded
entity and the domestic corporation as a disregarded payment entity
(``DPE'') and specified domestic owner, respectively. See proposed
Sec. Sec. 1.1503(d)-1(d)(1) and 301.7701-3(c)(4). This document
retains the nomenclature of the 2024 proposed regulations, with certain
simplifications or other modifications, such as referring to a
specified domestic owner as a DPE owner and eliminating references to
consent (discussed in part II.B.2 of the Summary of Comments and
Explanation of Revisions).\2\
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\2\ The final regulations also clarify that the DPL rules
address the avoidance of the DCL rules, which has been described
differently in prior guidance. See, for example, REG-104352-18, 83
FR 67612, 67624 (noting that the DCL regulations do not apply to DPL
structures, and that such structures give rise to outcomes similar
to ``D/NI outcomes . . . and double-deduction outcomes . . .'') and
REG-105128-23, 89 FR 64750, 64762 (noting that an income inclusion
under the proposed DPL rules ``generally neutralizes the D/NI
outcome'').
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Under the proposed DPL rules, the DPE owner would monitor whether
the DPE incurs a DPL or derives disregarded payment income (``DPI'').
See proposed Sec. 1.1503(d)-1(d)(1). A DPL or DPI would be determined
by taking into account only certain items under the relevant foreign
tax law (generally interest or royalties) that are not regarded for
U.S. tax purposes. See proposed Sec. 1.1503(d)-1(d)(6)(ii). The DPE
would have a DPL to the extent that, under the foreign tax law, its
deductions for such items exceed its income from such items, and it
would have DPI to the extent the reverse is true. See id. Under the
2024 proposed regulations, a DPE's cumulative amounts of DPL and DPI
would be tracked in the DPE's ``DPL cumulative register'' through
negative and positive adjustments, respectively, to the register. See
proposed Sec. 1.1503(d)-1(d)(5)(ii).
In the case of a DPL, the DPE owner generally would disclose the
DPL on an initial certification statement and file annual
certifications for a 60-month period affirming that the DPL has not
been put to a foreign use. See proposed Sec. 1.1503(d)-1(d)(1). A
failure to comply with this certification requirement, or a foreign use
of the DPL within the certification period (each, a ``triggering
event''), would require the DPE owner to include in gross income the
DPL inclusion amount. See proposed Sec. 1.1503(d)-1(d)(1) and (3). The
DPL inclusion amount would be equal to the amount of the DPL, reduced
by the positive balance (if any) in the DPL cumulative register. See
proposed Sec. 1.1503(d)-1(d)(2) through (5). Requiring the DPL
inclusion amount in the year of the triggering event (rather than the
year in which the DPL is incurred) would be consistent with the
approach under the current DCL rules and avoids any administrative or
compliance burdens that could result by instead requiring taxpayers to
extend the statute of limitations and amend tax returns upon a
triggering event of the DPL.
B. Rulemaking Authority
1. In General
Comments asserted that the DPL rules do not reflect a proper
exercise of the Treasury Department and the IRS's rulemaking authority
for a variety of reasons. Some comments claimed that Congress has not
expressed a concern with deduction/no inclusion outcomes arising from
disregarded payments because those types of outcomes are not explicitly
described in sections 245A(e), 267A, or 1503(d), the Code's anti-hybrid
provisions. These comments asserted that the DPL rules in effect
implement the recommendations from the OECD reports \3\ relating to
disregarded payments but noted that Congress has not adopted those
recommendations--whereas Congress did adopt other OECD recommendations
in enacting sections 245A(e) and 267A. The comments accordingly argued
that the 2024 proposed regulations inappropriately circumvent Congress
by implementing OECD policies that Congress has rejected.
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\3\ See OECD/G20, Neutralising the Effects of Hybrid Mismatch
Arrangements, Action 2: 2015 Final Report (October 2015) (``Hybrid
Mismatch Report'') and OECD/G20, Neutralising the Effects of Branch
Mismatch Arrangements, Action 2: Inclusive Framework on BEPS (July
2017) (``Branch Mismatch Report'').
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Other comments asserted that the DPL rules have no basis in section
1503(d), because section 1503(d) operates by disallowing a domestic
corporation's net operating loss. These comments contended that the DPL
rules go beyond what section 1503(d) permits because they impose an
income inclusion (rather than deny a loss) based on disregarded
transactions that cannot give rise to a net operating loss (which is
computed by reference to regarded items only). Comments similarly
argued that section 7701 provides no basis for the DPL rules because
section 7701 pertains to an entity's tax classification and does not
authorize income inclusions. One comment also contended that the
Treasury Department and the IRS cannot rely on section 7805(a)'s
general grant of rulemaking authority for the DPL rules because section
7805(a) authorizes the Secretary to issue regulations ``for the
enforcement'' of the Code, and, according to the comment, the DPL rules
do not relate to any Code provision.
Another set of comments argued that the DPL rules are arbitrary and
capricious. According to the comments,
[[Page 3006]]
the DPL rules address the erosion of foreign tax bases and thus are not
in furtherance of any recognized U.S. tax policy, which, one comment
stated, has historically permitted taxpayers to reduce their foreign
tax liability. One comment further argued that taxpayers have a
reliance interest on the certainty afforded by the check-the-box
regulations, which, according to the comment, Congress has impliedly
endorsed by leaving the regulations undisturbed since their issuance in
1996. The comment stated that the Treasury Department and the IRS
cannot upset those reliance interests by adding the DPL rules to the
check-the-box regime and asserted that changes to the regime to address
hybridity-related concerns should not be made absent direction from
Congress. The comment referred to Notice 98-11, 1998-1 C.B. 433, and
the temporary and proposed regulations issued under the notice that
treated a disregarded entity that engaged in certain transactions as a
foreign corporation for purposes of subpart F of the Code. The Senate
Finance Committee proposed a six-month moratorium on implementing the
regulations to provide Congress time to consider the issues. See S.
Rept. 105-174, at 107-110 (1998).
The Treasury Department and the IRS disagree with these comments.
The DPL rules prevent certain disregarded entity classifications from
giving rise to avoidance of the DCL rules (as discussed in part II.A of
the Summary of Comments and Explanation of Revisions). Because these
classifications arise under the check-the-box regulations, revising the
regulations to prevent abuse, other misuse, or unintended consequences
that only arise due to the classification rules under the check-the-box
regime is an appropriate exercise of the authority underlying the
regulations, including the express delegation of authority under
section 7805(a) of the Code. These revisions generally produce outcomes
consistent with what would have occurred if certain disregarded
payments were regarded for U.S. tax purposes (as discussed in part II.F
of the Summary of Comments and Explanation of Revisions).
As a limitation on disregarded entity classifications, the DPL
rules are consistent with other special rules in the check-the-box
regulations that regard an entity for certain limited purposes, while
generally retaining the entity's disregarded entity classification. For
example, disregarded entity status is not respected for purposes of
certain rules related to banking, federal tax liabilities, and
employment and excise taxes. See Sec. 301.7701-2(c)(2)(ii) through
(v). Similarly, Sec. 301.7701-2(c)(2)(vi) treats certain domestic
disregarded entities as corporations for purposes of section 6038A to
provide the IRS with access to information to satisfy its obligations
under international agreements and strengthen the enforcement of U.S.
tax laws.
When the check-the-box regulations were issued, the preamble made
clear that additional rules may be required to prevent inappropriate
outcomes. TD 8697 (61 FR 66584, 66585) (describing that, in light of
the increased flexibility under an elective regime for entity
classifications, the Treasury Department and the IRS will monitor for,
and take appropriate action to address, results that are inconsistent
with the policies and rules of particular Code provisions). Further,
the history of Notice 98-11 and the regulations issued thereunder do
not support the conclusion that the Treasury Department and the IRS
lack authority for the DPL rules. In fact, the Senate report
specifically stated that the proposed moratorium on the regulations
described in Notice 98-11 should not be interpreted as the Treasury
Department and the IRS lacking authority to impose limitations on
disregarded entity classifications. See S. Rept. 105-174, at 110
(1998).
Moreover, the DPL rules are a reasonable response to significant
policy concerns resulting from the check-the-box regulations.
Addressing these concerns by requiring an income inclusion (that
neutralizes the double deduction outcome by, in effect, offsetting the
related deduction that would otherwise be allowed for U.S. tax
purposes) prevents taxpayers from circumventing the DCL rules through
the artifice of causing payments to be disregarded. The approach in
this rulemaking maintains the simplicity and flexibility (including the
electivity component) of the check-the-box regulations while preventing
inappropriate outcomes through new rules with narrow application.
Further, taxpayers that prefer to avoid the application of the DPL
rules can do so by restructuring to avoid these inappropriate outcomes,
as illustrated in Sec. 1.1503(d)-7(c)(45) (Example 45). See also parts
II.D.1, II.D.2, II.F, and G.1 of the Summary of Comments and
Explanation of Revisions (discussing certain revisions in response to
comments, which have the effect of further narrowing and deferring the
application of the DPL rules). Thus, by preventing the check-the-box
regulations from enabling inappropriate outcomes, the DPL rules are a
reasonable modification of the regulations. Furthermore, the Treasury
Department and the IRS disagree that DPL rules inappropriately promote
the policy underlying the OECD recommendations to address double non-
taxation resulting from hybridity. Instead, the DPL rules promote the
U.S. tax policy underlying section 1503(d), which was enacted in 1986
(and modified in a technical correction in 1988), to prevent double
deduction outcomes; the OECD policy that was set forth in the Hybrids
Mismatch Report and Branch Mismatch Report, issued in 2015 and 2017,
respectively, is simply consistent with the existing, longstanding U.S.
policy.
Finally, the Treasury Department and the IRS have consistently
raised the concern that the check-the-box regulations could expand the
use of hybrid structures. This concern was identified in Notice 95-14,
1995-14 IRB 7, which first announced that an elective entity
classification regime was under consideration and solicited comments on
the propriety of extending an elective regime to foreign entities,
noting the increased potential for hybrid entities. Since then, the
check-the-box regime has increased the prevalence of hybrid structures
to an extent not initially foreseen, and many of these structures are
designed for tax avoidance. The Treasury Department and the IRS have
addressed this avoidance through targeted rules where feasible. See,
for example, Sec. 1.894-1(d)(2)(ii) and TD 8999 (67 FR 40157)
(relating to the use of domestic reverse hybrid entities to obtain
inappropriate treaty benefits); Sec. Sec. 1.1503(d)-1(c) and 301.7701-
3(c)(3) (relating to the use of domestic reverse hybrid entities to
obtain double-deduction outcomes). Taxpayers therefore should not have
an expectation that a disregarded entity classification can be used to
circumvent the DCL rules, and in any case, the Treasury Department and
the IRS are of the view that any such expectations would not constitute
a significant reliance interest that would caution against this
rulemaking, given the limited extent to which the DPL rules impose a
condition on certain payments involving disregarded entities. Reliance
interests, if any, are significantly outweighed by the need to prevent
inappropriate results.
2. Default Disregarded Entity Status and Non-Consolidated DPE Owners
Comments also asserted that the Treasury Department and the IRS do
not have authority to apply the DPL rules in specific fact patterns.
According to these comments, the DPL rules should not apply where no
entity classification
[[Page 3007]]
election is made under Sec. 301.7701-3, such as where a foreign entity
defaults to disregarded entity classification, because in these cases
there is no affirmative act by reason of which the taxpayer consents to
the application of the DPL rules. Another comment claimed that the DPL
rules should not apply where the DPE owner is not part of a group that
files a consolidated return, asserting that sections 1502 and 1503(d)
cannot apply to a corporation that is not a member of a consolidated
group.
The Treasury Department and the IRS disagree with these comments.
As discussed in part II.B.1 of the Summary of Comments and Explanation
of Revisions, the DPL rules are a component of the check-the-box
regime. Under the check-the-box regulations, promulgated in 1996, the
Treasury Department and the IRS permit certain entities with a single
owner to choose whether or not to be treated as disregarded as separate
from their owner for most federal income tax purposes. However, even
entities that choose to be disregarded as separate from their owner for
most federal income tax purposes are not disregarded for all purposes.
For example, these entities are regarded for purposes of federal income
tax liability, excise taxes, and employment taxes. See Sec. 301.7701-
2(c)(2). The treatment of an entity as disregarded for some purposes
and regarded for other purposes under Sec. 301.7701-2(c)(2) does not
depend on whether the entity is treated as disregarded pursuant to the
default rules or by election.
Like the other rules in Sec. 301.7701-2(c)(2) and as discussed in
part II.F of the Summary of Comments and Explanation of Revisions, the
DPL regulations effectively provide that a DPE is regarded for purposes
of recognizing certain interest and royalty payments between a DPE and
its owner or between a DPE and other disregarded entities. However, for
purposes of administrability, these rules do not regard the payment
more broadly or require the filing of amended returns to reflect the
revocation of a disregarded entity classification.
Further, the check-the-box regime is an elective regime that allows
eligible entities to choose their entity classification. The check-the-
box regulations provide default classification rules that aim to match
taxpayers' expectations and thus reduce the number of elections that
taxpayers must file to select their entity classification of choice.
See TD 8797 (61 FR 66584). Thus, through the check-the-box regulations,
an eligible entity chooses to be classified as a disregarded entity,
regardless of whether that choice occurs by accepting the default
classification (that is, by choosing not to elect an alternative
treatment) or by filing an election; it is merely the mechanics of
obtaining a disregarded entity classification that differ. On the other
hand, absent regulations under section 7701, no foreign business entity
would generally be treated as a disregarded entity.
Moreover, applying the DPL rules without regard to whether
disregarded entity classification is obtained by election or pursuant
to the default rules ensures consistency. Otherwise, similarly situated
taxpayers could have different outcomes based solely on whether the
entity they choose to use is an entity that satisfies the default rule
to be treated as a disregarded entity rather than requiring an election
to achieve that result.
Lastly, the DPL rules are not issued under section 1502 authority
(and section 1503(d) is not limited in application to consolidated
groups). The DPL rules are issued under the authority of sections
1503(d), 7701, and 7805(a) and are located under section 1503(d)
because the rules leverage concepts from, and prevent the avoidance of,
the DCL rules.
C. Integration of DPL and DCL Regimes
As discussed in part II.C of the Explanation of Provisions of the
2024 proposed regulations, the DPL rules operate independently of the
DCL rules. For example, only items that are regarded for U.S. tax
purposes are taken into account in computing a DCL (or the DCL
cumulative register), and only items that are disregarded for U.S. tax
purposes would be taken into account in computing a DPL (or the DPL
cumulative register). The view of the Treasury Department and the IRS
as expressed in the 2024 proposed regulations was that integrating the
two regimes would result in considerable complexity and administrative
burden. For example, fully integrating the regimes would likely require
a significantly broader scope of the DPL rules to take into account all
disregarded payments (consistent with the scope of the DCL rules, which
take into account all regarded payments) and to take into account all
of the triggering events that apply with respect to DCLs (rather than
only two triggering events that apply under the DPL rules).
Comments requested integration or coordination of the DPL rules and
DCL rules, suggesting that an integrated or coordinated set of rules
could ensure consistent treatment of similar transactions (regardless
of whether regarded or disregarded for U.S. tax purposes) and simplify
compliance. For example, one comment proposed withdrawing the DPL rules
and revising the DCL rules to ignore disregarded and intercompany
transactions (as defined in Sec. 1.1502-13(b)(1)) in calculating the
amount of a DCL, while at the same time taking such transactions into
account under a modified DCL register. Specifically, under this
approach, a separate unit would calculate its income or loss both with
and without disregarded and intercompany transaction items that offset
in amount, with the smaller amount of income being dual income and thus
increasing the DCL register, or with the smaller amount of loss being a
dual loss and thus a DCL. The difference between the with-and-without
calculation in a year would be tracked as an attribute--excess income
or excess loss--for purposes of applying the with-and-without
calculation in subsequent years. The comment stated that this approach
would provide parity between disregarded and intercompany transactions,
parity between calculation of a DCL register and the amount of a DCL,
and parity between different types of items.
The final regulations do not adopt these comments because the
Treasury Department and the IRS remain of the view that integration or
other coordination would result in considerable complexity and
administrative burden. Additionally, the with-and-without approach
proposed by a comment would not address the double deduction outcome
arising from a disregarded entity classification in a prototypical case
involving a DPL arising from back-to-back financing where the
disregarded entity does not also incur a DCL--that is, the excess loss
carried forward for purposes of the with-and-without calculation would
be relevant only to the extent that the disregarded entity's regarded
items of deduction or loss in a year exceed the regarded items of
income or gain in that year.
Another comment suggested that the DPL rules be replaced with an
approach that would treat a disregarded entity as a regarded pass-
through entity (for example, a one-partner partnership) solely for
purposes of the DCL rules, citing section 1503(d) as authority for such
an approach. The comment noted that the application of the DPL rules to
a disregarded entity can be avoided by introducing another owner
(thereby converting the entity to a partnership) and that the suggested
approach avoids the administrative complexity of this
[[Page 3008]]
type of restructuring. The final regulations do not adopt this approach
because it would require broader changes to check-the-box regulations
(for example, by creating a new type of regarded pass-through entity),
and it could increase complexity and compliance or administrative
burden as a result of regarding items that are outside the scope of the
DPL rules, such as payments for services and property transactions
giving rise to ordinary income or loss.
Lastly, a comment suggested that because the DPL rules were issued
as part of a notice of proposed rulemaking that also addresses the DCL
rules and those would operate independently of each other, the DPL
rules should be withdrawn and issued as a standalone notice of proposed
rulemaking. According to the comment, this approach would afford
taxpayers a more adequate notice-and-comment period and more clearly
signal to affected taxpayers the standalone nature of the DPL rules.
The Treasury Department and the IRS have determined that finalizing the
DPL rules is appropriate regardless of whether the proposed version of
the rules was included in a notice of proposed rulemaking that included
other concepts and that the proposed version of the rules provided
sufficient notice-and-comment, including about the standalone nature of
the DPL rules.
D. Scope of DPL Rules
1. In General
Under the 2024 proposed regulations, the DPL or DPI of a DPE would
be determined by taking into account only items that both (i) give rise
to deductions or income of the DPE under a foreign tax law (in the case
of deductions, determined with regard to any application of foreign
hybrid mismatch rules), and (ii) are disregarded for U.S. tax purposes
but would be interest, structured payments, or royalties if the items
were regarded.\4\ See proposed Sec. 1.1503(d)-1(d)(6)(ii) and
(d)(7)(v). This limited application of the DPL rules would address
transactions that are likely structured to avoid the DCL rules.
---------------------------------------------------------------------------
\4\ References to interest throughout this preamble include a
reference to a structured payment, as the context requires.
---------------------------------------------------------------------------
Comments suggested narrowing the scope of the DPL rules in several
respects (and not expanding the rules to cover other payments such as
for disregarded services), so that the rules better address
transactions likely to give rise to double non-taxation and minimize
compliance burden. Some comments suggested that the DPL rules not apply
to royalties, or at least royalties paid pursuant to a license executed
before the date of the 2024 proposed regulations. A comment asserted
that most foreign entities enter into intercompany licensing
arrangements for non-tax business reasons and that restructuring these
licenses is not always easy or feasible, including because of legal
restrictions or foreign tax costs. Other comments asserted that the
licenses generally create substantial dual inclusion income (either
through exploiting the intangible property or sub-licenses) and,
therefore, do not give rise to double non-taxation; one of these
comments, however, noted that absent at least partial integration of
the DCL and DPL regimes, the dual inclusion income attributable to a
license agreement could be double counted by both reducing a DPL and a
DCL.
Comments also suggested not applying the DPL rules to payments that
are subject to tax in another foreign country (for example, payments
between DPEs that are tax residents of different foreign countries), or
possibly only to the extent that the other foreign country has a
sufficiently high statutory or effective tax rate. A comment noted that
an effective tax rate analysis for purposes of such an exception could
rely on existing methods, like the GloBE Model Rules or the GILTI high-
tax exception in Sec. 1.951A-2(c)(7) but acknowledged resulting
compliance and administrative burdens. Comments also suggested not
applying the DPL rules if the disregarded entity has net income for
foreign tax purposes (for example where the DPE's net regarded income
or net disregarded services income exceeds its DPL), asserting that,
absent such an exception, the entity classification regime would be
more complex to administer and taxpayers would be incentivized to
restructure in a manner that is adverse to U.S. tax policy and results
in additional foreign tax and, in turn, additional foreign tax credits.
Further, comments recommended not applying the DPL rules to payments
subject to hybrid mismatch rules in the payor jurisdiction, contending
that such jurisdiction has taken the necessary steps to address erosion
of its tax base.
The final regulations generally do not adopt these specific
comments. The Treasury Department and the IRS have determined that
excluding all royalties from the DPL rules could incentivize new
licensing structures intended to give rise to avoidance of the DCL
rules given the ease with which licenses can be put in place.
The Treasury Department and the IRS have also determined that a
deduction in both the United States and a foreign country is not
adequately neutralized by an income inclusion in another foreign
country. Additionally, to the extent that taxpayers generally minimize
payments from entities in low-tax countries to related entities in
high-tax countries, an exception for payments taxed at a sufficiently
high tax rate would likely have limited effect while adding significant
complexity.
Further, the Treasury Department and the IRS have determined that
an exception under which the DPL rules do not apply if the disregarded
entity has net income for foreign tax purposes would be contrary to the
approach of maintaining separate DCL and DPL rules, and give rise to
inappropriate results, as discussed in parts II.C and III.B of the
Summary of Comments and Explanation of Revisions, respectively. Also,
taking into account the application of foreign hybrid mismatch rules in
determining a DPL or DPI will in many cases limit the application of
the DPL rules to DPEs subject to foreign hybrid mismatch rules.
Moreover, if there is no foreign use of a DPL and annual certification
requirements are satisfied, the DPL rules have no further effect. The
Treasury Department and the IRS remain of the view that the filing of
certification requirements is necessary, even in situations where there
may not be a net loss for foreign tax purposes in that particular year,
to ensure that any deduction or loss composing a DPL is not put to a
foreign use during the certification period. Moreover, this approach is
consistent with the requirement in the DCL rules that a domestic use
agreement be filed (to put a DCL to a domestic use) even in cases where
it may be unlikely that a DCL can be put to a foreign use in a
particular year, such as due to disregarded income that is not taken
into account for DCL purposes.
Finally, structures involving hybridity that produce double
deduction outcomes are contrary to the U.S. tax policies underlying
section 1503(d). Consistent with the current DCL rules, the DPL rules
apply even in circumstances where the absence of DPL rules could reduce
the amount of foreign income tax that would otherwise be creditable for
U.S. tax purposes or where the adoption of such rules may cause some
taxpayers to restructure in a manner that increases the amount of
creditable foreign income tax.
However, in response to these comments, the final regulations
provide a de minimis exception and (consistent with a comment) do not
apply the DPL
[[Page 3009]]
rules to royalties paid pursuant to a license agreement executed before
the date of the 2024 proposed regulations. See Sec. 1.1503(d)-
1(d)(5)(ii)(E) and (d)(6)(vii). Together, these modifications are
intended to further limit application of the DPL rules to cases that
are likely structured to produce double deduction outcomes. The
Treasury Department and the IRS have determined that this approach
strikes an appropriate balance between that goal and considerations
like those discussed in the preceding paragraphs, while also
eliminating compliance burden in certain cases.
Under the de minimis exception, a DPL with respect to a DPE and a
foreign taxable year is deemed to be zero if it is incurred in
connection with the conduct of an active trade or business (based on
rules set forth under Sec. 1.367(a)-2(d)), and the amount of the DPL
is less than the lesser of $3 million or 10 percent of the aggregate
amount of all items of the DPE that are deductible under a foreign tax
law. See Sec. 1.1503(d)-1(d)(6)(vii). This de minimis threshold is
determined based on the foreign tax law and, therefore, takes into
account items regardless of whether regarded or disregarded for U.S.
tax purposes.
2. Types of DPEs and Minority Interests
In addition to certain disregarded entities, the 2024 proposed
regulations would treat certain foreign branches and dual resident
corporations as DPEs. See proposed Sec. 1.1503(d)-1(d)(1). This is
because a payment treated as made by a foreign branch of a domestic
corporation, including a dual resident corporation, under foreign tax
law to a disregarded entity of the corporation could give rise to a
deduction for foreign tax purposes without an inclusion for U.S. tax
purposes, and any resulting double deduction generally would not occur
if the payee were regarded for U.S. tax purposes. Further, where a DPE
is owned through a partnership, the DPL rules would apply as to a DPE
owner on a proportionate basis, based on the percentage of interests
(by value) of the DPE that the DPE owner indirectly owns. See proposed
Sec. 1.1503(d)-1(d)(7)(ii).
Comments expressed concerns about applying the DPL rules to
minority interests in DPEs, contending that such interests do not
present the same related-party tax structuring concerns that the DPL
rules are intended to address, and noting that a foreign use triggering
event under the DPL rules requires a use by a person related to the DPE
owner. The comments further noted that the DPE combination rule would
exacerbate these concerns because, for example, a DPE owner's inability
to comply with certification requirements with respect to a minority
interest in a DPE could cause a triggering event with respect to a DPL
attributable to that DPE and other DPEs in the same foreign country.
Accordingly, the comments recommended applying the DPL rules with
respect to a DPE owner and DPE only if the entities are related
(determined under section 954(d)(3), for instance). A comment also
asserted that applying the DPL rules on a proportionate basis by
reference to the value of a partnership interest is burdensome because
it requires an annual valuation of the partnership, and the comment
suggested retaining this approach only to the extent that other
partnership rules require similar valuations.
The Treasury Department and the IRS agree that the DPL rules should
not apply to minority interests. Accordingly, the final regulations
revise the DPE definition to exclude entities that are not related,
within the meaning of section 954(d)(3), to a DPE owner. See Sec.
1.1503(d)-1(d)(5)(i). In addition, where a DPE owner indirectly owns
less than all the interests (but more than a minority interest) in a
DPE, the final regulations remove the requirement in the 2024 proposed
regulations that would apply the DPL rules on a proportionate basis
based on value, because the Treasury Department and the IRS have
determined that a DPE owner's proportionate interest can be determined
under other reasonable methods.
Further, the final regulations clarify that a foreign branch owned
by a domestic corporation through one or more partnerships may be a
DPE. See Sec. 1.1503(d)-1(d)(5)(i)(B). Thus, if a partnership makes a
payment to a disregarded entity of the partnership and the payment is
attributed to a foreign branch under foreign tax law, then (because the
foreign branch may be a DPE) a domestic corporate partner's
proportionate share of a resulting deduction under the foreign tax law
can give rise to a DPL. See Sec. 1.1503(d)-1(d)(6)(ii). Similarly, to
address deductions arising under foreign tax law by reason of the
partnership being a tax resident of a foreign country (rather than by
reason of the partnership having a foreign branch), the final
regulations provide that an entity that is treated as a partnership for
U.S. tax purposes, but is a foreign tax resident, may be a DPE. See
Sec. 1.1503(d)-1(d)(5)(i)(C).
3. ``True'' Foreign Branches
Because the DPL rules are a component of the check-the-box rules,
the rules do not apply with respect to deductions resulting under a
foreign tax law from payments treated as made between a ``true''
foreign branch (that is, a foreign taxable presence not conducted
through a disregarded entity) and its owner. One comment expressed
concerns with disparate treatment resulting from this limitation,
asserting that it would incentivize structures involving true foreign
branches.
The Treasury Department and the IRS have determined that this
concern does not detract from the utility of the DPL rules. To the
extent disregarded entity classifications facilitate structures
intended to give rise to avoidance of the DCL rules, addressing those
structures through new rules is appropriate regardless of whether the
new rules would also address structures that are less common or more
burdensome to implement.
E. Foreign Use Issues
1. ``All or Nothing'' Principle
Under the 2024 proposed regulations, a foreign use of a DPL would
be determined under the principles of the rules determining the foreign
use of a DCL, which are in Sec. 1.1503(d)-3. See proposed Sec.
1.1503(d)-1(d)(3)(i). Thus, for example, under the so-called ``made
available'' standard, a foreign use of a DPL would occur if any portion
of a deduction taken into account in computing the DPL is made
available under a relevant foreign tax law to offset an item of income
that, for U.S. tax purposes, is an item of income of a foreign
corporation that is related to the DPE owner. Generally, a foreign use
of a DPL (or DCL) would occur as a result of structures intended to
avoid the application of the DCL rules.
The concept of the entirety of a DPL (or DCL) being put to a
foreign use by reason of the availability under a relevant foreign tax
law of any portion of a deduction composing the DPL (or DCL) is, in
conjunction with the ``made available'' standard, referred to as the
``all or nothing'' principle. See TD 9315 (72 FR 12902, 12910-11). As
indicated in the preamble to the 2024 proposed regulations, the all or
nothing principle addresses a concern of the Treasury Department and
the IRS that alternative approaches, such as treating a foreign use as
occurring only to the extent that a deduction actually offsets income
of a foreign corporation, would lead to significant administrative
complexity and the need for detailed ordering rules.
A comment recommended against the all or nothing principle,
asserting that the administrability concerns underlying the principle
in the DCL
[[Page 3010]]
context are not applicable in the DPL context because a DPL is defined
only by reference to certain deductions existing for foreign tax
purposes and, thus, the DPL rules do not require an analysis of whether
an item that exists for U.S. tax purposes composes an item that exists
for, and has been made available for use under, a foreign tax law.
Additionally, the comment stated that the all or nothing principle is
inconsistent with OECD reports and can give rise to inappropriate
outcomes.
The Treasury Department and the IRS remain of the view that
departing from the all or nothing principle in the DPL context would
(like in the DCL context) give rise to significant administrability and
compliance concerns. See also TD 9315, 72 FR 12902, 12911 (``The IRS
and Treasury Department continue to believe that, even under the
approaches suggested by these commentators, departing from the all or
nothing principle would lead to substantial administrative
complexity.'') For example, specific rules would be needed to address a
situation where portions of each of a DPL and a non-DPL loss are shared
through foreign tax consolidation or a similar regime, as well as a
situation where a foreign corporation has a net operating loss that
forms part of a net operating loss carryforward that includes the DPL.
Additionally, the Treasury Department and the IRS have determined that
consistency is needed between the DCL rules and DPL rules because the
DPL rules are intended to prevent the avoidance of the DCL rules.
Accordingly, the final regulations do not adopt the comment.
2. Carrybacks and Carryforwards of Losses Under Foreign Tax Law
A comment stated that a foreign use of a DPL can occur only if,
under a foreign tax law, deductions composing a DPL are included in a
net operating loss that is carried forward or carried back to another
taxable year, and the comment suggested that the DPL certification
rules should be limited to monitoring whether such a carryover occurs.
According to the comment, the scenarios presenting the risk of a
foreign use of a DPL are more limited than the scenarios presenting the
risk of a foreign use of a DCL because, unlike DCLs, DPLs do not give
rise to timing differences between U.S. and foreign tax systems.
The Treasury Department and the IRS agree that a foreign use of a
DPL may occur through carryforwards or carrybacks of losses but have
determined that a foreign use would more commonly occur in the year in
which the DPL is incurred. A foreign use could also result from a
merger or similar transaction (such as the transfer of the interests in
the DPE that incurs the DPL to a related CFC). Accordingly, the final
regulations do not adopt this comment.
3. Mirror Legislation Rule
The final regulations narrow the definition of a foreign use for
DPL purposes by excluding the deemed foreign use that may occur under
the mirror legislation rule. See Sec. 1.1503(d)-3(e)(4). This
exception, which is consistent with the exception in Sec. 1.1503(d)-
3(e)(3) for domestic consenting corporations, clarifies that any denial
of a deduction for a disregarded payment under foreign hybrid mismatch
rules is not treated as giving rise to a DPL or a foreign use of a DPL.
See also Sec. 1.1503(d)-1(d)(6)(v) (coordination with foreign hybrid
mismatch rules).
F. DPL Cumulative Register and Deduction for a DPL Inclusion
The 2024 proposed regulations would provide that a DPL cumulative
register with respect to a DPE is, for each foreign taxable year of the
DPE, increased by the DPE's DPI or decreased by its DPL. See proposed
Sec. 1.1503(d)-1(d)(5)(ii). When a DPL of the DPE is triggered, any
positive balance in the cumulative register would be applied to the DPL
and, accordingly, would reduce the amount that the DPE owner must
include in income with respect to the DPE under the DPL rules. See
proposed Sec. 1.1503(d)-1(d)(2) and (5).
Comments recommended that the DPL cumulative register be adjusted
to include a DPL inclusion amount that has been included in the DPE
owner's gross income. The comments noted that, without such an
adjustment, a single DPL could be included in the DPE owner's income
more than once. Comments also recommended treating a DPL inclusion as
giving rise to a deduction (or similar offset) of the DPE owner in
subsequent taxable years to prevent the DPL rules from permanently
increasing U.S. taxable income. These comments suggested allowing such
a deduction (or similar offset) once the DPE has sufficient DPI or
``dual inclusion income'' (determined as the lesser of certain foreign
taxable income and certain U.S. taxable income) in subsequent years.
Further, a comment recommended treating the deduction as having the
same U.S. tax characteristics (for example, character and source) as
the DPL inclusion.
The Treasury Department and the IRS agree with these comments. The
final regulations thus modify the determination of a DPL cumulative
register so that a DPL does not decrease the register, thereby
preventing a negative balance in the register. See Sec. 1.1503(d)-
1(d)(2)(iii); see also Sec. 1.1503(d)-7(c)(42) (example illustrating
this rule). This approach generally achieves the same outcomes as those
recommended by comments, while also facilitating the application of any
positive register balance to a triggered DPL in cases where there are
multiple DPLs but not all the DPLs are triggered.
Additionally, to reflect a DPL inclusion (and consistent with
comments), the final regulations provide the DPE owner a deduction (not
to exceed the DPL inclusion) to the extent that the DPE derives DPI in
a year following the year of the DPL inclusion. See Sec. 1.1503(d)-
1(d)(1) and (d)(2)(ii). Regardless of the extent to which the DPI is
derived from interest or royalties, the deduction has the same
character and source as the DPL inclusion to which it relates. See
Sec. 1.1503(d)-1(d)(2)(iv)(B). In this way, the DPE owner's items of
income and deduction under the DPL rules are similar to the items that
the DPE owner would have had if the payments composing the DPL were
regarded for U.S. tax purposes. To illustrate, consider a case where a
disregarded entity makes a payment to its domestic corporate owner and
the payment gives rise to an interest deduction under foreign tax law
that is put to a foreign use in the current year. If the payment were
instead regarded for U.S. tax purposes (for example, if the payment
were instead a Sec. 1.1502-13 intercompany transaction), the payment
would give rise to an income inclusion in the current year and a
deduction, the use of which generally would be suspended under the DCL
rules until there is sufficient income in subsequent years. The DPL
rules produce a similar outcome.
Finally, to prevent a single DPL from giving rise to more than one
DPL inclusion, the final regulations terminate the certification period
with respect to a DPL as a result of a DPL inclusion. See Sec.
1.1503(d)-1(d)(6)(iii).
G. Computation of a DPL or DPI for Partial-Year DPE Status
Comments requested clarification on how to compute a DPL or DPI for
the first foreign taxable year in which an entity or branch is treated
as a DPE of a DPE owner. In such a case, some comments suggested a rule
pursuant to which the DPL or DPI would be computed without regard to
items incurred (or allocable to, including
[[Page 3011]]
under the principles of Sec. 1.1502-76(b)) during the portion of the
foreign taxable year that precedes the first day that the DPL rules
apply with respect to the DPE owner and DPE.
The Treasury Department and the IRS agree with these comments, and
the final regulations therefore clarify that items incurred or derived
in the portion of a foreign taxable year that an entity or foreign
branch is not a DPE are not taken into account for purposes of
calculating DPI or DPL. See Sec. 1.1503(d)-1(d)(5)(ii). On the other
hand, if an entity or foreign branch is a DPE at all times during the
foreign taxable year, this pro-ration rule does not apply even though
the DPE owner's U.S. taxable year may differ from the DPE's foreign
taxable year.
H. Additional Reporting and Documentation
One comment supported the DPL rules, noting that closing this
existing loophole and providing clarity is important to ensure tax
fairness, prevent abuse, and provide consistency. The comment also
suggested that the rules provide detailed guidance on the documentation
and reporting requirements for disregarded payments, such as specifying
that taxpayers must maintain detailed records and submit these records
as part of their tax filings.
The Treasury Department and the IRS have determined that the
documentation and reporting requirements in the proposed regulations,
as modified in these final regulations (such as to require additional
reporting in Sec. 1.1503(d)-1(d)(4)(iv) related to the suspended
deduction), are sufficient for the IRS to administer the rules
effectively. Further, the IRS may request additional information
regarding DPLs on audit, as necessary. Accordingly, this comment is not
adopted.
III. Rules That Apply to Both DCLs and DPLs
A. Anti-Avoidance Rule
The 2024 proposed regulations would include an anti-avoidance rule
that applies with respect to both DCLs and DPLs. This rule generally
would provide that appropriate adjustments may be made with respect to
a transaction, series of transactions, plan, or arrangement that is
engaged with a view to avoid the purposes of section 1503(d) and the
regulations thereunder. See proposed Sec. 1.1503(d)-1(f). The preamble
to the 2024 proposed regulations noted that the anti-avoidance rule
could address new avoidance structures or interpretations, rather than
continuing to address these transactions on a case-by-case basis
through the adoption of new rules. See part I.C. of the Explanation of
Provisions of the 2024 proposed regulations.
Some comments asserted that the application of the anti-avoidance
rule is unclear and should therefore be withdrawn. Other comments
requested that, rather than applying the anti-avoidance rule based on
whether there is ``a view'' to avoid the purposes of section 1503(d)
and the regulations thereunder, it should apply based on the more
common principal purpose-based standard, or if the taxpayer is
attempting to ``evade'' the purposes of section 1503(d). Comments also
requested additional examples illustrating the application or
nonapplication of the anti-avoidance rule, including examples that
would clarify that the anti-avoidance rule does not apply if taxpayers
restructure their operations to avoid the application of the DPL rules.
Finally, one comment requested that, consistent with the general
approach in the DCL rules to calculate the amount of a DCL based on
U.S. tax items, the anti-avoidance rule should be revised to ignore the
treatment of items under foreign law.
In response to the comments, the anti-avoidance rule is modified to
make clear that the purpose of section 1503(d) and the regulations
thereunder is to prevent double deduction and similar outcomes. Thus,
if taxpayers restructure their arrangements to avoid the application of
the DPL rules or the DCL rules, such as by converting disregarded
payments into regarded payments or terminating agreements that give
rise to disregarded payments, the anti-avoidance rule does not apply if
the restructured arrangement does not give rise to the potential for
two deductions--one for foreign tax purposes, and one for US. tax
purposes. See Sec. 1.1503(d)-1(f). The final regulations also provide
additional examples that illustrate the application, and
nonapplication, of the anti-avoidance rule. See Sec. 1.1503(d)-
7(c)(44) and (45). The Treasury Department and the IRS continue to
study how the intercompany transaction rules of Sec. 1.1502-13 would
apply to the facts such as those presented in the example in Sec.
1.1503(d)-7(c)(44).
The final regulations add certain exceptions to the application of
the anti-avoidance rule, as it applies to DCLs, for transactions or
interpretations that would be addressed by rules in the 2024 proposed
regulations. See Sec. 1.1503(d)-1(f)(2). For example, the anti-
avoidance rule does not apply to structures that may reduce or
eliminate a DCL by reason of items of income arising from the ownership
of stock and taken into account under Sec. 1.1503(d)-5(b)(1) or
(c)(4)(iv) (the ``stock ownership rule''). This exception is intended
to make clear that the anti-avoidance rule does not apply in such a
case even though the 2024 proposed regulations would eliminate the
stock ownership rule (other than with respect to certain portfolio
interests) and the preamble to the 2024 regulations states that
taxpayers may be affirmatively structuring into the rules to produce
inappropriate double-deduction outcomes. The Treasury Department and
the IRS have determined that the anti-avoidance rule should not apply
in such cases at this time, despite the policy concerns underlying the
transactions, because the substantive rules that would address the
transactions have not yet been finalized. These exceptions to the anti-
avoidance rule would be removed or modified if, after taking into
account comments, the corresponding rules in the 2024 proposed
regulations are finalized in a subsequent guidance project. The non-
application of the anti-avoidance rule in these cases does not affect
the potential application of other rules or judicial doctrines, such as
the substance-over-form or step-transaction doctrines. The Treasury
Department and the IRS request comments on the modification or removal
of these exceptions upon finalization of the corresponding proposed
rules.
In light of the additional certainty and clarity provided by the
modification to the rule and the additional examples, these final
regulations do not adopt the recommendations to withdraw the anti-
avoidance rule or employ a new standard based on a principal purpose or
evasion. Finally, because the anti-avoidance rule applies with respect
to the DPL rules, which are premised on the treatment of items under
foreign law, these final regulations do not adopt the recommendation to
ignore foreign law treatment in applying the anti-avoidance rule.
B. Deemed Ordering Rule
In determining the foreign use of a DPL, the 2024 proposed
regulations would provide that the principles of the exceptions in
Sec. 1.1503(d)-3(c) apply, which include the deemed ordering rule
under Sec. 1.1503(d)-3(c)(3). See proposed Sec. 1.1503(d)-1(d)(3)(i).
This rule generally would provide that if losses or deductions are
available under foreign law both to offset income that would constitute
a foreign use and income that would not constitute a foreign use, and
the foreign law does not provide applicable rules for determining which
[[Page 3012]]
income is offset by the losses or deductions, then the losses or
deductions are first deemed to be available to offset the income that
would not constitute a foreign use, to the extent thereof, before being
considered to be made available to offset the income that would
constitute a foreign use. See Sec. 1.1503(d)-3(c)(3).
In cases where a DPE has both a DPL and income that is not DPI,
such as items of income other than interest and royalties that are
disregarded for U.S. tax purposes or income that is regarded for U.S.
tax purposes, comments asserted that the application of the deemed
ordering rule is unclear, and that income that is not DPI should be
taken into account in determining whether the exception prevents a
foreign use of the DPL (or, alternatively, prevents the creation of a
DPL). Under this approach, a DPL would be treated as first offsetting
the DPE's income under the foreign tax law, regardless of whether that
income is regarded or disregarded. Accordingly, no foreign use of a DPL
would generally occur if the DPE has net positive income under the
foreign tax law.
The Treasury Department and the IRS disagree with these comments.
The deemed ordering rule is related to, and therefore must apply in a
manner consistent with, the rules that calculate a DCL or DPL and
related cumulative register. Thus, because the calculation of a DCL and
DCL cumulative register only takes into account regarded items, the
deemed ordering rule as applied to DCLs also must only take into
account such items. Similarly, because the calculation of a DPL and DPL
cumulative register only takes into account disregarded interest and
royalties, so too should the deemed ordering rule only take such items
into account. This consistent approach promotes coordinated outcomes,
ensures that all relevant items are appropriately taken into account,
and avoids double-counting concerns. A partial integration of the DCL
and DPL rules only in the deemed ordering rule would not be appropriate
without providing comprehensive rules to address, for example, the
opposite fact pattern where regarded items of deduction or loss could
be viewed as offsetting disregarded interest and royalty income and
thereby creating or increasing the amount of a DPL that is put to a
foreign use.
One comment requested clarification regarding the condition that
the deemed ordering rule applies only if the laws of the foreign
country do not provide applicable rules for determining which income is
offset by the losses or deductions. The comment noted, as an example,
that such uncertainty can arise in connection with the steps required
in applying the GloBE Model Rules. It has also been observed that the
method by which the foreign country takes into account items that
would, or would not, give rise to a foreign use likely would not change
the arithmetic result of determining taxable income under foreign law
or otherwise have economic significance. Further, there is no similar
condition in the rules that determine a DCL or DPL, or the related
cumulative registers, and as noted above these regimes should operate
in a consistent manner. As a result, the final regulations eliminate
this condition from the deemed ordering rule for purposes of both the
DPL and DCL rules. See Sec. 1.1503(d)-3(c)(3).
IV. Applicability Dates
A. DPL Rules
The 2024 proposed regulations would apply the DPL rules as of the
date those regulations were filed with the Federal Register (August 6,
2024), subject to a one-year delay for certain entities in existence on
that date. See proposed Sec. 301.7701-3(c)(4)(vi). Comments requested
a deferred application of the DPL rules, with some suggesting specific
dates (such as taxable years beginning after publication of final
regulations) and others generally suggesting additional time for
taxpayers to implement new processes and systems or undertake
restructurings to avoid the application of the DPL rules. Comments also
requested clarification on when the DPL rules would apply in cases like
one where a domestic corporation owns multiple disregarded entities
that are tax residents of foreign countries, with some (but not all)
formed or acquired after August 6, 2024, but before August 6, 2025.
The Treasury Department and the IRS agree with the suggestions to
defer application of the DPL rules. Accordingly, the final regulations
apply the DPL rules to taxable years of DPE owners beginning on or
after January 1, 2026. See Sec. Sec. 1.1503(d)-8(b)(11) and 301.7701-
2(e)(10). This use of a single applicability date obviates the need for
additional rules clarifying application of the DPL rules in cases like
ones where a domestic corporation owns multiple disregarded entities.
B. Other Rules
The final regulations apply the anti-avoidance rule to DCLs
incurred in taxable years ending on or after August 6, 2024, consistent
with the approach in the 2024 proposed regulations. See Sec.
1.1503(d)-8(b)(15). Further, consistent with the applicability date of
the DPL rules, the anti-avoidance rule applies to DPLs for taxable
years beginning on or after January 1, 2026. See id. Additionally, the
final regulations apply revisions to the deemed ordering rule in Sec.
1.1503(d)-3(c)(3) to DCLs incurred in taxable years beginning on or
after January 1, 2026, and to DPLs in taxable years beginning on or
after January 1, 2026 (each consistent with the applicability date of
the DPL rules). See Sec. 1.1503(d)-8(b)(17). Finally, the final
regulations apply the rule regarding the non-application of the sixty-
month limitation for an entity that, absent an election to change its
classification, would become a DPE as of August 6, 2024. See Sec.
301.7701-2(e)(10).
Additional Transition Relief With Respect to the GloBE Model Rules
As noted in the Background of this preamble, the 2024 proposed
regulations would address the application of the DCL rules to the GloBE
Model Rules. For example, the 2024 proposed regulations would provide
that an IIR or QDMTT may be an income tax for purposes of the DCL
rules.\5\ The 2024 proposed regulations also would address the effect
of an IIR or a QDMTT on certain entities and foreign business
operations, the application of the DCL rules to the Transitional CbCR
Safe Harbour, and the interaction of the duplicate loss arrangement
rules with the mirror legislation rule under Sec. 1.1503(d)-3(e). In
addition, the 2024 proposed regulations would extend and broaden, the
transition relief announced in Notice 2023-80 such that the DCL rules
(including the DPL rules) would generally apply without taking into
account QDMTTs or Top-up Taxes collected under an IIR or UTPR with
respect to losses incurred in taxable years beginning before August 6,
2024. See proposed Sec. 1.1503(d)-8(b)(12). This extension, and
broadening, would provide taxpayers more certainty, allow for further
consideration of the proposed regulations and related comments, and
allow for consideration of further developments at the OECD.
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\5\ The Qualified Domestic Minimum Top-up Tax (``QDMTT''), IIR
(also referred to as the income inclusion rule), and UTPR (also
referred to as the under-taxed profits rule) are defined in Article
10 of the GloBE Model Rules.
---------------------------------------------------------------------------
Several comments requested additional transition relief for the
application of the DCL rules and DPL rules to the GloBE Model Rules.
For example, comments suggested that the applicability date be delayed
until taxable years beginning on or after
[[Page 3013]]
January 1, 2025, or through 2026; another comment suggested that the
rules not apply until there are final DCL rules and final GloBE Model
Rules. Some comments requested additional transition relief because the
GloBE Model Rules are still evolving, and relief would allow for
additional time to take into account additional OECD guidance and
legislation enacted by jurisdictions to incorporate the GloBE Model
Rules. One comment stated that if the DCL rules and DPL rules apply
with respect to UTPRs that transition relief be provided for such
application for at least 2025. Finally, one comment requested
clarification that the transition relief is also available with respect
to DPLs.
The Treasury Department and the IRS agree that additional
transitional relief is warranted. As some comments noted, such relief
would allow additional time to consider future OECD guidance and
legislation enacted by foreign jurisdictions that would implement the
GloBE Model Rules. Accordingly, when the 2024 proposed regulations
addressing the application of the DCL rules to the GloBE Model Rules
are finalized, the applicability date set forth in the 2024 proposed
regulations will be modified. The final regulations will provide that
the DCL rules will apply without taking into account QDMTTs or Top-up
Taxes collected under an IIR or UTPR incurred in taxable years
beginning before August 31, 2025. The additional transition relief does
not affect the application of the DPL rules because the DPL rules do
not apply until taxable years beginning on or after January 1, 2026.
Taxpayers may rely on the guidance described in this paragraph until
final regulations are published in the Federal Register. The transition
relief is limited to an additional year to minimize the double
deduction outcomes that may result.
Special Analyses
I. Regulatory Planning and Review
Pursuant to the Memorandum of Agreement, Review of Treasury
Regulations under Executive Order 12866 (June 9, 2023), tax regulatory
actions issued by the IRS are not subject to the requirements of
section 6 of Executive Order 12866, as amended. Therefore, a regulatory
impact assessment is not required.
II. Paperwork Reduction Act
The Paperwork Reduction Act of 1995 (44 U.S.C. 3501-3520) (``PRA'')
requires that a Federal agency obtain the approval of the OMB before
collecting information from the public, whether such collection of
information is mandatory, voluntary, or required to obtain or retain a
benefit. Section 1.1503(d)-1(d)(4) of these regulations requires the
collection of information.
As discussed in part II.B.3 of the Explanation of Provisions of the
2024 proposed regulations, to avoid or reduce a DPL inclusion amount
certain taxpayers are required to make certifications, for example,
that no foreign use has occurred with respect to a disregarded payment
loss. The IRS will use this information to determine the extent to
which these taxpayers need to recognize income under these final
regulations.
The reporting burden associated with this collection of information
will be reflected in the PRA submissions associated with Form 1120 (OMB
control number 1545-0123). The Treasury Department and the IRS do not
have readily available data to determine the number of taxpayers
affected by this collection of information because no reporting module
currently identifies these types of disregarded payments.
III. Regulatory Flexibility Act
When an agency issues a rulemaking proposal, the Regulatory
Flexibility Act (5 U.S.C. chapter 6) (``RFA'') requires the agency to
prepare and make available for public comment an initial regulatory
flexibility analysis that will describe the impact of the proposed rule
on small entities. See 5 U.S.C. 603(a). Section 605 of the RFA provides
an exception to this requirement if the agency certifies that the
proposed rulemaking will not have a significant economic impact on a
substantial number of small entities. A small entity is defined as a
small business, small nonprofit organization, or small governmental
jurisdiction. See 5 U.S.C. 601(3) through (6).
The Treasury Department and the IRS do not expect that these final
regulations will have a significant economic impact on a substantial
number of small entities. However, because there is a possibility of
significant economic impact on a substantial number of small entities,
an initial regulatory flexibility analysis was provided in the 2024
proposed regulations. No comments were received in response to the
request for comments concerning the number of small entities that may
be impacted and whether that impact will be economically significant.
A. Reasons Why Action Is Being Considered
As explained in part II.A of the Explanation of Provisions of the
2024 proposed regulations, the disregarded payment loss rules in these
final regulations address certain hybrid payments that can give rise to
double deduction outcomes.
B. Objectives of, and Legal Basis for, the 2024 Proposed Regulations
The disregarded payment loss rules in these final regulations
require an income inclusion for U.S. tax purposes to prevent the
avoidance of the DCL rules that would otherwise arise from certain
disregarded payments. Sections 1503(d)(2)(B) and (d)(3), 7701, and 7805
of the Code are the legal basis for these regulations.
C. Small Entities to Which These Regulations Will Apply
Because an estimate of the number of small businesses affected is
not currently feasible, this regulatory flexibility analysis assumes
that a substantial number of small businesses will be affected. The
Treasury Department and the IRS do not expect that these final
regulations will affect a substantial number of small nonprofit
organizations or small governmental jurisdictions.
D. Projected Reporting, Recordkeeping, and Other Compliance
Requirements
The final regulations impose a certification requirement that is
filed with a domestic corporation's tax return, and to comply with that
requirement the domestic corporation may need to keep records such as
its DPL cumulative register as defined in Sec. 1.1503(d)-1(d)(2)(iii).
See Sec. 1.1503(d)-1(d)(4)(iii).
E. Duplicate, Overlapping, or Relevant Federal Rules
The Treasury Department and the IRS are not aware of any Federal
rules that duplicate, overlap, or conflict with these final
regulations.
F. Alternatives Considered
These final regulations address policy concerns that are similar to
the concerns underlying the enactment of section 1503(d), which applies
uniformly to large and small business entities. The Treasury Department
and the IRS have determined that these final regulations should
generally apply without regard to the size of the corporation--a small
business exception would undermine the anti-hybridity policies
underlying these regulations. Accordingly, there is no viable
alternative to these final regulations for small entities. The Treasury
Department and the IRS expect that the revisions in these final
regulations to apply a de minimis threshold, and exclude royalties from
[[Page 3014]]
pre-August 6, 2024, licenses and minority interests, will reduce any
economic impact that the regulations could have on small entities.
IV. Unfunded Mandates Reform Act
Section 202 of the Unfunded Mandates Reform Act of 1995 (``UMRA'')
requires that agencies assess anticipated costs and benefits and take
certain other actions before issuing a final rule that includes any
Federal mandate that may result in expenditures in any one year by a
State, local, or Tribal government, in the aggregate, or by the private
sector, of $100 million in 1995 dollars, updated annually for
inflation. The final rules do not include any Federal mandate that may
result in expenditures by State, local, or Tribal governments, or by
the private sector in excess of that threshold.
V. Executive Order 13132: Federalism
Executive Order 13132 (Federalism) prohibits an agency from
publishing any rule that has federalism implications if the rule either
imposes substantial, direct compliance costs on State and local
governments, and is not required by statute, or preempts State law,
unless the agency meets the consultation and funding requirements of
section 6 of Executive Order 13132. The final rules do not have
federalism implications and do not impose substantial direct compliance
costs on State and local governments or preempt State law within the
meaning of Executive Order 13132.
Effect on Other Documents
Section 3 of Notice 2023-80 (2023-52 IRB 1583) is obsolete as of
August 6, 2024.
Statement of Availability of IRS Documents
IRS Revenue Procedures, Revenue Rulings, Notices, and other
guidance cited in this document are published in the Internal Revenue
Bulletin or Cumulative Bulletin and are available from the
Superintendent of Documents, U.S. Government Publishing Office,
Washington, DC 20402, or by visiting the IRS website at <a href="https://www.irs.gov">https://www.irs.gov</a>.
Drafting Information
The principal author of these regulations is Andrew L. Wigmore of
the Office of the Associate Chief Counsel (International). However,
other personnel from the Treasury Department and the IRS participated
in their development.
List of Subjects
26 CFR Part 1
Income taxes, Reporting and recordkeeping requirements.
26 CFR Part 301
Employment taxes, Estate taxes, Excise taxes, Gift taxes, Income
taxes, Penalties, Reporting and recordkeeping requirements.
Adoption of Amendments to the Regulations
Accordingly, the Treasury Department and the IRS amend 26 CFR parts
1 and 301 as follows:
PART 1--INCOME TAXES
0
Paragraph 1. The authority citation for part 1 is amended by removing
the entry for Sec. 1.1503(d) and adding entries for Sec. Sec.
1.1503(d)-1 through 1.1503(d)-8 in numerical order to read as follows:
Authority: 26 U.S.C. 7805 * * *
* * * * *
Sections 1.1503(d)-1 through 8 also issued under 26 U.S.C.
953(d), 1502, 1503(d) and (d)(2)(B), (d)(3), and (d)(4), and 7701.
* * * * *
0
Par. 2. Section 1.1503(d)-1 is amended by:
0
1. Revising the section heading;
0
2. Revising and republishing paragraph (a);
0
3. Redesignating paragraph (d) as paragraph (e);
0
4. Adding a new paragraph (d);
0
5. Revising the paragraph heading for newly redesignated paragraph (e);
0
6. In newly redesignated paragraphs (e)(1) through (3), removing the
language ``section 1503(d) and these regulations'' in each place it
appears and adding the language ``this section and Sec. Sec.
1.1503(d)-2 through 1.1503(d)-8'' in its place; and
0
7. Adding paragraph (f).
The revisions and additions read as follows:
Sec. 1.1503(d)-1 Definitions, special rules, and filings.
(a) In general. This section and Sec. Sec. 1.1503(d)-2 through
1.1503(d)-8 provide rules concerning the determination and use of dual
consolidated losses pursuant to section 1503(d). Paragraph (b) of this
section provides definitions that apply for purposes of this section
and Sec. Sec. 1.1503(d)-2 through 1.1503(d)-8. Paragraph (c) of this
section provides rules for a domestic consenting corporation. Paragraph
(d) of this section provides rules for disregarded payment losses.
Paragraph (e) of this section provides relief for certain compliance
failures due to reasonable cause, and a signature requirement for
filings. Paragraph (f) of this section provides an anti-avoidance rule.
* * * * *
(d) Disregarded payment loss (DPL) rules--(1) In general. The
disregarded payment loss rules of this paragraph (d) only apply to a
domestic corporation (including a dual resident corporation) that
directly or indirectly owns an interest in a disregarded entity,
regardless of whether the disregarded entity is domestic or foreign
(such a domestic corporation, a disregarded payment entity owner, or
DPE owner). If these rules apply to a DPE owner, then the DPE owner
determines disregarded payment income or disregarded payment loss of
its disregarded payment entities (if any) described in paragraph
(d)(5)(i)(A), (B), (C), or (D) of this section in accordance with
paragraph (d)(5)(ii) of this section and, in the case of a disregarded
payment loss for which a triggering event occurs under paragraph (d)(3)
of this section, includes an amount equal to the DPL inclusion amount
in gross income and establishes a suspended deduction in accordance
with paragraph (d)(2) of this section. The inclusion required under
this paragraph (d)(1) and paragraph (d)(2)(i) of this section is
included in the taxable year of the DPE owner in which the triggering
event occurs, and the corresponding suspended deduction under this
paragraph (d)(1) and paragraph (d)(2)(ii) of this section is
established in the subsequent taxable year of the DPE owner. See Sec.
1.1503(d)-7(c)(42) for an example illustrating the application of the
disregarded payment loss rules.
(2) DPL amounts--(i) DPL inclusion amount. A DPL inclusion amount
means, with respect to a disregarded payment loss as to which a
triggering event occurs during the DPL certification period, an amount
equal to the disregarded payment loss. Such amount is reduced (but not
below zero) to the extent of the balance in the DPL cumulative register
of the disregarded payment entity if the certification requirement
under paragraph (d)(4)(iii) of this section is satisfied.
(ii) Suspended deduction. With respect to a DPL inclusion amount, a
DPE owner establishes a suspended deduction in an amount equal to the
DPL inclusion amount. The suspended deduction is allowed as a deduction
under the principles of Sec. 1.1503(d)-6(h)(6) by treating the
suspended deduction as if it were a reconstituted net operating loss
that becomes deductible only to the extent of
[[Page 3015]]
disregarded payment income derived in the taxable year in which the
suspended deduction is established or subsequent taxable years (as
measured by the disregarded payment entity's DPL cumulative register),
provided that the certification requirement under paragraph (d)(4)(iv)
of this section is satisfied.
(iii) DPL cumulative register. The term DPL cumulative register
means, with respect to the disregarded payment entity, an account the
balance of which is computed at the end of each foreign taxable year of
the entity, and which is--
(A) Increased by the amount of disregarded payment income of the
entity for the foreign taxable year, and then, after determining the
DPL inclusion amount for the year,
(B) Decreased by the amount of the cumulative register balance that
is used under paragraph (d)(2)(i) or (ii) of this section.
(iv) Character and source--(A) DPL inclusion amount. A DPE owner's
income inclusion for a DPL inclusion amount is, for all U.S. tax
purposes, treated as ordinary income, and characterized and sourced,
including for purposes of sections 904(d) and 907, in the same manner
as if the disregarded payment entity were a foreign corporation and the
amount were interest or royalty income paid by the foreign corporation
(taking into account, for example, section 904(d)(3) if such foreign
corporation would be a controlled foreign corporation). For these
purposes, the DPL inclusion amount is considered comprised of interest
or royalty income based on the proportion of interest or royalty
deductions taken into account, respectively, in computing the
disregarded payment loss relative to all the deductions taken into
account in computing the disregarded payment loss. Further, for these
purposes, a deduction attributable to a structured payment or a
deduction with respect to equity is treated as an interest deduction.
(B) Suspended deduction. A DPE owner's deduction with respect to a
suspended deduction is, for all U.S. tax purposes, characterized and
sourced in the same manner as the income for the DPL inclusion amount
to which it relates. If the income from the DPL inclusion amount is
assigned to multiple statutory and residual groupings, the deduction is
allocated and apportioned to each grouping in the same proportions as
the DPL inclusion amount.
(3) Triggering events. An event described in paragraph (d)(3)(i) or
(ii) of this section is a triggering event with respect to a
disregarded payment loss of a disregarded payment entity.
(i) Foreign use. A foreign use of the disregarded payment loss. For
this purpose, a foreign use is determined under the principles of Sec.
1.1503(d)-3 (including the exceptions in Sec. 1.1503(d)-3(c)), by
treating the disregarded payment loss as a dual consolidated loss,
treating the disregarded payment entity as a separate unit (or, in the
case of a disregarded payment entity that is a dual resident
corporation, by treating the disregarded payment entity as a dual
resident corporation), and, in Sec. 1.1503(d)-3(a)(1)(i) and (ii),
only taking into account a person that is related to the DPE owner of
the disregarded payment entity. Thus, for example, a foreign use of a
disregarded payment loss occurs if, under a relevant foreign tax law,
any portion of the foreign law deduction taken into account in
computing the disregarded payment loss is made available (including by
reason of a foreign consolidation regime or similar regime, or a sale,
merger, or similar transaction) to offset an item of income that, for
U.S. tax purposes, is an item of a foreign corporation, but only if
such foreign corporation is related to the DPE owner of the disregarded
payment entity. When applying the principles of the deemed ordering
rule in Sec. 1.1503(d)-3(c)(3), items of income or gain are taken into
account only to the extent such items are described in paragraph
(d)(5)(ii)(D) of this section; thus, for example, such items include
items of income that are or would be taken into account in determining
the amount of disregarded payment loss or disregarded payment income,
and exclude items that are regarded for U.S. tax purposes.
(ii) Failure to comply with certification requirements. A failure
by the DPE owner of the disregarded payment entity to comply with the
certification requirements of paragraphs (d)(4)(i) and (ii) of this
section.
(4) Certification requirements. Except as otherwise provided in
publications, forms, instructions, or other guidance, a DPE owner of a
disregarded payment entity is subject to the certification requirements
of this paragraph (d)(4) with respect to a disregarded payment loss of
the disregarded payment entity.
(i) For its taxable year that includes the date on which the
foreign taxable year in which a disregarded payment loss is incurred
ends, the DPE owner must attach with its timely filed tax return a
certification labeled ``Initial Disregarded Payment Loss Certification
Under Section 1503(d),'' which must contain--
(A) The information set forth in Sec. 1.1503(d)-6(c)(2)(ii)
(determined by substituting the phrase ``disregarded payment entity''
for the phrase ``separate unit'');
(B) A statement of the amount of the disregarded payment loss; and
(C) A statement that a foreign use of the disregarded payment loss
has not occurred during the DPL certification period.
(ii) During the DPL certification period, for each of its taxable
years after the taxable year described in paragraph (d)(4)(i) of this
section that includes a date on which a foreign taxable year ends, the
DPE owner must attach with its timely filed tax return a certification
labeled ``Annual Disregarded Payment Loss Certification Under Section
1503(d)'' and satisfying the requirements of this paragraph (d)(4)(ii).
Certifications with respect to multiple disregarded payment losses may
be combined in a single certification, but each disregarded payment
loss must be separately identified. To satisfy the requirements of this
paragraph (d)(4)(ii), the certification must--
(A) Identify the disregarded payment loss to which it pertains by
setting forth the foreign taxable year in which the disregarded payment
loss was incurred and the amount of such disregarded payment loss;
(B) State that there has been no foreign use of the disregarded
payment loss; and
(C) Warrant that arrangements have been made to ensure that there
will be no foreign use of the disregarded payment loss and that the DPE
owner will be informed of any such foreign use.
(iii) If a disregarded payment entity has a balance in its DPL
cumulative register upon a DPL triggering event and the DPE owner
includes in gross income a DPL inclusion amount that is less than the
amount of the disregarded payment loss, the DPE owner of the
disregarded payment entity must attach a statement labeled ``Reduction
of Disregarded Payment Loss Amount Under Section 1503(d)'' to its
income tax return for the taxable year in which the triggering event
occurs and provide any other information as requested by the
Commissioner. The statement must show the disregarded payment income or
disregarded payment loss of the disregarded payment entity for each
foreign taxable year (other than a foreign taxable year where the
entity or branch is not a disregarded payment entity) up to and
including the foreign taxable year
[[Page 3016]]
with respect to which the triggering event occurs.
(iv) If a DPE owner claims an allowed deduction with respect to a
suspended deduction, the DPE owner must attach a statement labeled
``Release of Suspended Deduction Under Section 1503(d)'' to the income
tax return for the taxable year in which the deduction is allowed and
provide any other information as requested by the Commissioner,
including in regulations, forms, instructions or other guidance. The
statement must describe the DPE owner's DPL inclusion amount to which
the suspended deduction relates and show the disregarded payment income
or disregarded payment loss of the disregarded payment entity for each
foreign taxable year up to and including the foreign taxable year
during which the deduction is allowed.
(5) Definitions. The following definitions apply for purposes of
this paragraph (d).
(i) The term disregarded payment entity means, with respect to a
DPE owner, any entity, foreign branch, or dual resident corporation
described in paragraph (d)(5)(i)(A), (B), (C) or (D) of this section.
(A) A disregarded entity that is a foreign tax resident and related
to the DPE owner, provided that the DPE owner directly or indirectly
owns interests in the disregarded entity.
(B) A foreign branch of the DPE owner and a foreign branch of an
entity that is related to the DPE owner and in which the DPE owner
directly or indirectly owns an interest.
(C) An entity that is treated as a partnership for U.S. tax
purposes that is a foreign tax resident and related to the DPE owner,
provided that the DPE owner directly or indirectly owns an interest in
the entity.
(D) The DPE owner itself if it is a dual resident corporation.
(ii) The terms disregarded payment income and disregarded payment
loss have the meanings set forth in this paragraph (d)(5)(ii). For
purposes of computing the disregarded payment income or disregarded
payment loss of a disregarded payment entity, a DPE owner takes into
account the disregarded payment income or disregarded payments loss of
each disregarded payment entity for each foreign taxable year that ends
with or within its U.S. taxable year and an item is taken into account
only if it gives rise to income or a deduction under the relevant
foreign tax law during the portion of the foreign taxable year in which
the entity or foreign branch is a disregarded payment entity; for
purposes of allocating an item to a period, the principles of Sec.
1.1502-76(b) apply. Thus, for example, if a DPE owner with a calendar
U.S. taxable year becomes subject to the disregarded payment loss rules
for the U.S. taxable year beginning on January 1, 2026, the disregarded
payment income or disregarded payment loss of a disregarded payment
entity of the DPE owner with a foreign taxable year ending on June 30,
2026, excludes items allocated (under the principles of Sec. 1.1502-
76(b)) to the pre-January 1, 2026, portion of that foreign taxable
year. Items taken into account in computing disregarded payment income
or disregarded payment loss are calculated in the currency used to
determine tax under the relevant foreign tax law. See Sec. 1.1503(d)-
7(c)(46) for an example illustrating items that are taken into account
in determining disregarded payment income or disregarded payment loss.
(A) Disregarded payment income. Disregarded payment income means,
with respect to a disregarded payment entity and a foreign taxable year
of the entity, the excess (if any) of the sum of the items described in
paragraph (d)(5)(ii)(D) of this section over the sum of the items
described in paragraph (d)(5)(ii)(C) of this section.
(B) Disregarded payment loss. Subject to the de minimis rule set
forth in paragraph (d)(6)(vii) of this section, a disregarded payment
loss means, with respect to a disregarded payment entity and a foreign
taxable year of the entity, the excess (if any) of the sum of the items
described in paragraph (d)(5)(ii)(C) of this section over the sum of
the items described in paragraph (d)(5)(ii)(D) of this section.
(C) Items of deduction. With respect to a disregarded payment
entity and a foreign taxable year of the entity, an item is described
in this paragraph (d)(5)(ii)(C) to the extent that it satisfies all of
the requirements set forth in paragraphs (d)(5)(ii)(C)(1) through (3)
of this section. In addition, an item of a disregarded payment entity
described in paragraph (d)(5)(i)(A) of this section is described in
this paragraph (d)(5)(ii)(C) if, under the relevant foreign tax law, it
is a deduction with respect to equity (including deemed equity) allowed
to the entity in such taxable year (for example, a notional interest
deduction) or a deduction for an imputed interest payment with respect
to a debt instrument (such as a deduction for an imputed interest
payment with respect to an interest-free loan).
(1) Under the relevant foreign tax law, the disregarded payment
entity is allowed a deduction in such taxable year for the item.
(2) The payment, accrual, or other transaction giving rise to the
item is disregarded for U.S. tax purposes as a transaction between a
disregarded entity and its tax owner or between disregarded entities
with the same tax owner (for example, a payment by a disregarded entity
to its tax owner or to another disregarded entity owned by its tax
owner, a payment from a dual resident corporation or partnership to a
disregarded entity it owns, or a payment from the home office of a
foreign branch to a disregarded entity the home office owns that is
attributable to the foreign branch).
(3) If the payment, accrual, or other transaction were regarded for
U.S. tax purposes, it would be interest, a structured payment, or a
royalty within the meaning of Sec. 1.267A-5(a)(12), (b)(5)(ii), or
(a)(16), respectively.
(D) Items of income. With respect to a disregarded payment entity
and a foreign taxable year of the entity, an item is described in this
paragraph (d)(5)(ii)(D) to the extent that it satisfies all of the
requirements set forth in paragraphs (d)(5)(ii)(D)(1) through (3) of
this section.
(1) Under the relevant foreign tax law, the disregarded payment
entity includes the item in income in such taxable year.
(2) The payment, accrual, or other transaction giving rise to the
item is disregarded for U.S. tax purposes as a transaction between a
disregarded entity and its tax owner or between disregarded entities
with the same tax owner (for example, because it is a payment to a
disregarded entity from the disregarded entity's tax owner or from
another disregarded entity of its tax owner, a payment to a dual
resident corporation or partnership from a disregarded entity it owns,
or a payment from a disregarded entity to the home office of a foreign
branch that is attributable to the foreign branch).
(3) If the payment, accrual, or other transaction were regarded for
U.S. tax purposes, it would be interest, a structured payment, or a
royalty with the meaning of Sec. 1.267A-5(a)(12), (b)(5)(ii), or
(a)(16), respectively.
(E) Translation into U.S. dollars. The amount of disregarded
payment income or disregarded payment loss with respect to a foreign
taxable year of a disregarded payment entity is translated into U.S.
dollars using the yearly average exchange rate (within the meaning of
Sec. 1.987-1(c)(2)) for that foreign taxable year.
(F) Royalties under pre-August 6, 2024 licenses excluded. Royalties
paid or accrued pursuant to a license agreement entered into before
August 6, 2024, are not taken into account when
[[Page 3017]]
determining the amount of disregarded payment income or disregarded
payment loss. The preceding sentence ceases to apply with respect to
any such agreement upon the significant modification of any terms of
the agreement, such as a change in the licensor or licensee or a
significant modification of the rights in consideration for which the
royalties are paid. In such case, any amounts paid or accrued on or
after the date of the significant modification are taken into account
when determining the amount of disregarded payment income or
disregarded payment loss. Termination of a license agreement and re-
entry into a license agreement between the same parties and with the
same terms (other than the term governing the period covered by the
agreement), an extension of the period covered by a license agreement
without modification of other terms, or an alteration of a legal right
or obligation that occurs by operation of the terms of the license
agreement (for example, where the license agreement provides for
updating the royalty based on updated transfer pricing studies), will
not be considered a significant modification of the first license
agreement. For purposes of this paragraph (d)(5)(ii)(F), a combined
disregarded payment entity is treated as a single licensor or licensee,
as the case may be.
(iii) The term DPL certification period includes, with respect to a
disregarded payment loss, the foreign taxable year in which the
disregarded payment loss is incurred, any prior foreign taxable years,
and, except as provided in paragraph (d)(6)(iii) of this section, the
60-month period following the foreign taxable year in which the
disregarded payment loss is incurred.
(iv) The term foreign branch means a branch (within the meaning of
Sec. 1.267A-5(a)(2)) that gives rise to a taxable presence under the
tax law of the foreign country where the branch is located.
(v) The term foreign taxable year means, with respect to a
disregarded payment entity, the entity's taxable year for purposes of a
relevant foreign tax law.
(vi) The term foreign tax resident means a tax resident (within the
meaning of Sec. 1.267A-5(a)(23)(i)) of a foreign country.
(vii) The term related has the meaning provided in this paragraph
(d)(5)(vii). A person is related to a DPE owner if the person is a
related person within the meaning of section 954(d)(3) and the
regulations thereunder, determined by treating the person as the
``controlled foreign corporation'' referred to in that section. In
addition, for purposes of determining relatedness, a disregarded entity
is treated as a corporation.
(viii) The term relevant foreign tax law means, with respect to a
disregarded payment entity, any tax law of a foreign country of which
the entity is a tax resident (within the meaning of Sec. 1.267A-
5(a)(23)(i)) or, in the case of a disregarded payment entity that is a
foreign branch, the tax law of the foreign country where the branch is
located.
(ix) The term DPE owner has the meaning provided in paragraph
(d)(1) of this section, and includes any successor to the corporation
described paragraph (d)(1) of this section.
(6) Special rules--(i) Disregarded payment entity combination rule.
For purposes of this paragraph (d), disregarded payment entities for
which the relevant foreign tax law is the same (for example, because
the entities are tax residents of the same foreign country) are
combined and treated as a combined disregarded payment entity under the
principles of paragraph (b)(4)(ii) of this section, provided that the
entities have the same foreign taxable year and are owned, or interests
in which are directly or indirectly owned, either by the same DPE owner
or by DPE owners that are members of the same consolidated group.
However, this paragraph (d)(6)(i) does not apply with respect to a dual
resident corporation treated as a disregarded payment entity pursuant
to paragraph (d)(5)(i)(D) of this section. In determining the
disregarded payment income or disregarded payment loss of a combined
disregarded payment entity, the principles of Sec. 1.1503(d)-
5(c)(4)(ii) apply. Thus, for example, if multiple individual
disregarded payment entities are treated as a combined disregarded
payment entity pursuant to this paragraph (d)(6)(i), then the combined
disregarded payment entity has either a single amount of disregarded
payment income or a single amount of disregarded payment loss.
(ii) Partial ownership of disregarded payment entity. If a DPE
owner of a disregarded payment entity indirectly owns through a
partnership less than all the interests in that disregarded payment
entity, then the rules of this paragraph (d) are applied based on the
DPE owner's proportionate interest in the disregarded payment entity.
In such a case, as to the DPE owner, only a proportionate share of the
disregarded payment entity's items of deduction or income are taken
into account in computing disregarded payment income or disregarded
payment loss of the entity. In addition, with respect to the
disregarded payment loss as so computed, the DPE owner must comply with
the certification requirements of paragraph (d)(4) of this section and,
upon a triggering event, directly include in gross income an amount
equal to the DPL inclusion amount.
(iii) Termination of DPL certification period. With respect to a
disregarded payment loss of a disregarded payment entity, the DPL
certification period does not include any date after the end of the DPE
owner's taxable year during which the DPE owner, or a person related to
the DPE owner, no longer owns directly or indirectly any of the
interests in the disregarded payment entity, or, in the case of a
disregarded payment entity that is a foreign branch, substantially all
of the assets of the foreign branch. In such a case, the DPE owner
ceases to be subject to the rules of paragraph (d) of this section with
respect to the disregarded payment loss; thus, for example, after the
end of such taxable year the DPE owner is not subject to the
certification requirements of paragraph (d)(4)(ii) of this section with
respect to the loss, and will not be required to include in gross
income the DPL inclusion amount with respect to such loss. The DPL
certification period will also terminate with respect to a disregarded
payment loss upon a DPE owner's inclusion of the DPL inclusion amount
attributable to the disregarded payment loss.
(iv) Agent for a consolidated group. If a DPE owner is a member of
a consolidated group, see Sec. 1.1502-77 for agent of the group rules
(generally treating the common parent as the agent of its consolidated
group).
(v) Coordination with foreign hybrid mismatch rules. Whether a
disregarded payment entity is allowed a deduction under a relevant
foreign tax law is determined with regard to hybrid mismatch rules, if
any, under the relevant foreign tax law. Thus, for example, if a
relevant foreign tax law denies a deduction for an item to prevent a
deduction/no-inclusion outcome (that is, a payment that is deductible
for the payer jurisdiction and is not included in the ordinary income
of the payee), the item is not taken into account for purposes of
computing the amount of disregarded payment income or disregarded
payment loss. For this purpose, the term hybrid mismatch rules has the
meaning provided in Sec. 1.267A-5(a)(10).
(vi) DPL inclusion amount and suspended deduction not taken into
account for dual consolidated loss purposes. A DPL inclusion amount
included in the gross income of a DPE owner, and any allowed amount of
a suspended deduction attributable to a DPL inclusion amount, are not
taken
[[Page 3018]]
into account for purposes of determining the income or dual
consolidated loss of the dual resident corporation, or the income or
dual consolidated loss attributable to the separate unit, under Sec.
1.1503(d)-5(b) or (c).
(vii) De minimis rule. A disregarded payment entity will be deemed
to have no disregarded payment loss with respect to a foreign taxable
year in which the conditions in paragraphs (d)(6)(vii)(A) and (B) of
this section are satisfied.
(A) The items that compose the disregarded payment loss are
incurred in connection with the conduct of an active trade or business
(within the meaning of Sec. 1.367(a)-2(d)(2) and (3), but for this
purpose treating the disregarded payment entity as the foreign
corporation referenced therein) carried on by the disregarded payment
entity. For purposes of the preceding sentence, the determination of
whether items are incurred in connection with an active trade or
business is made under Sec. 1.367(a)-2(d)(5), but for this purpose by
treating the property received by the disregarded payment entity
pursuant to the arrangement that gave rise to the item (such as cash or
the rights to use the intangible property) as the property described in
such section.
(B) The amount of the disregarded payment loss is less than the
lesser of $3 million or 10 percent of the aggregate amount of all the
items of the disregarded payment entity for the foreign taxable year
that satisfy the condition described in paragraph (d)(5)(ii)(C)(1) of
this section. For this purpose, the items of the disregarded payment
entity may include, for example, items that are regarded for both U.S.
and foreign tax purposes, or foreign law items that if regarded for
U.S. tax purposes would not be treated as interest, a structured
payment, or a royalty within the meaning of Sec. 1.267A-5(a)(12),
(b)(5)(ii), or (a)(16), respectively.
* * * * *
(e) Special rules for filings. * * *
* * * * *
(f) Anti-avoidance rule--(1) In general. Except to the extent
provided in paragraph (f)(2) of this section, if a transaction, series
of transactions, plan, or arrangement is engaged in with a view to
avoid the purposes of the rules in this section and Sec. Sec.
1.1503(d)-2 through 1.1503(d)-8, then appropriate adjustments will be
made. A transaction, series of transactions, plan, or arrangement
(including an arrangement to reflect, or not reflect, items on books
and records) is engaged in with a view to avoid the purposes of this
section and Sec. Sec. 1.1503(d)-2 through 1.1503(d)-8 only if it
results in a double deduction or similar outcome (for example, by
putting an item of deduction or loss that composes (or would compose) a
dual consolidated loss to both a domestic use and a foreign use
(determined under Sec. Sec. 1.1503(d)-2 and 1.1503(d)-3, respectively)
or putting a foreign law item of deduction or loss that is disregarded
for U.S. tax purposes to a foreign use). The appropriate adjustments
may include adjustments to disregard the transaction, series of
transactions, plan, or arrangement, or adjustments to modify the items
that are taken into account for purposes of determining the income or
dual consolidated loss of or attributable to a dual resident
corporation or a separate unit, or for purposes of determining income
or loss of an interest in a transparent entity under Sec. 1.1503(d)-5.
See Sec. 1.1503(d)-7(c)(43) through (45) for examples illustrating the
application of this paragraph (f).
(2) Exceptions. The anti-avoidance rule in paragraph (f)(1) of this
section does not apply to a reduction or elimination of a dual
consolidated loss solely by reason of intercompany transactions as
described in Sec. 1.1502-13, items of income arising from the
ownership of stock and taken into account under Sec. 1.1503(d)-5(b)(1)
or (c)(4)(iv), or the attribution to a hybrid entity separate unit or
an interest in a transparent entity of items that have not been and
will not be reflected on the entity's books and records. The anti-
avoidance rule in paragraph (f)(1) of this section also does not apply
with respect to the application of the dual consolidated loss rules to
the GloBE Model Rules, or to cause a foreign use of a dual consolidated
loss to occur solely in a period before the taxable year in which such
loss was incurred.
* * * * *
0
Par. 3. Section 1.1503(d)-3 is amended by:
0
1. Revising and republishing paragraph (c)(3).
0
2. Adding paragraph (e)(4).
The revision and addition read as follows:
Sec. 1.1503(d)-3 Foreign use.
* * * * *
(c) * * *
(3) Deemed ordering rule--(i) In general. This paragraph (c)(3)
applies if the losses or deductions composing the dual consolidated
loss are made available under the laws of a foreign country both in
part to offset income or gain that would constitute a foreign use and
in part to offset income or gain that would not constitute a foreign
use. In such a case, the losses or deductions shall be deemed to be
made available to offset the income or gain that does not constitute a
foreign use, to the extent of such income or gain, before being
considered to be made available to offset the income or gain that does
constitute a foreign use. See Sec. 1.1503(d)-7(c)(11) (Example 11).
(ii) Limitation. For purposes of applying this paragraph (c)(3),
items of income or gain are taken into account only to the extent such
items are or would be taken into account in determining the amount of
income or dual consolidated loss under Sec. 1.1503(d)-5(b) or (c).
Thus, for example, this paragraph does not apply with respect to items
of income or gain that are otherwise disregarded for U.S. tax purposes.
But see Sec. 1.1503(d)-1(d)(3)(i), which provides that when applying
the principles of this rule for purposes of the disregarded payment
loss rules, the only relevant items are those that are or would be
taken into account for purposes of determining a disregarded payment
loss or disregarded payment income.
* * * * *
(e) * * *
(4) Exception for disregarded payment losses. Paragraph (e)(1) of
this section will not apply so as to deem a foreign use of a
disregarded payment loss (within the meaning of Sec. 1.1503(d)-
1(d)(5)(ii)(B)).
0
Par. 4. Section 1.1503(d)-7 is amended by:
0
1. Adding a sentence after the first sentence in paragraph
(c)(6)(iii)(B);
0
2. Revising the (c)(11) paragraph heading;
0
3. Removing the last sentence in paragraph (c)(11)(i);
0
4. In the first sentence of paragraph (c)(11)(ii), removing the
language ``Sec. 1.1503(d)-3(c)(3)'' and adding in its place the
language ``Sec. 1.1503(d)-3(c)(3)(i)''.
0
5. Adding a sentence after the third sentence in paragraph (c)(23)(ii).
0
6. In paragraph (c)(25)(ii)(B), adding a sentence after the fifth
sentence.
0
7. Adding paragraphs (c)(42) through (c)(46).
The revisions and additions read as follows:
Sec. 1.1503(d)-7 Examples.
* * * * *
(c) * * *
(6) * * *
(iii) * * *
(B) * * * But see Sec. 1.1503(d)-1(d), which takes into account
certain
[[Page 3019]]
payments that are otherwise disregarded for purposes of section 1503(d)
and the regulations thereunder. * * *
* * * * *
(11) Example 11. No foreign use--deemed ordering rule. ***
* * * * *
(23) * * *
(ii) * * * But see Sec. 1.1503(d)-1(d), which takes into account
certain payments that are otherwise disregarded for purposes of section
1503(d) and the regulations thereunder. * * *
* * * * *
(25) * * *
(ii) * * *
(B) * * * But see Sec. 1.1503(d)-1(d), which takes into account
certain payments that are otherwise disregarded for purposes of section
1503(d) and the regulations thereunder. * * *
* * * * *
(42) Example 42. Disregarded payment loss rules--triggering event
resulting in DPL inclusion amount and suspended deduction--(i) Facts. P
owns DE1X, and DE1X owns FSX. In year 1, DE1X pays $100x to P pursuant
to a note. For U.S. tax purposes, the payment is disregarded as a
transaction between DE1X and P, but if the payment were regarded it
would be interest within the meaning of Sec. 1.267A-5(a)(12). Under
Country X tax law, the $100x is interest for which DE1X is allowed a
deduction in year 1. In year 1, pursuant to a Country X group relief
regime, DE1X's $100x deduction is made available to offset income of
FSX. At the end of year 1, DE1X extinguishes the note by repaying the
outstanding principal. In year 2, P enters into a licensing arrangement
with DE1X pursuant to which P makes a $60x payment to DE1X in each of
years 2 and 3. For U.S. tax purposes, the payment is disregarded as a
transaction between DE1X and P, but if the payment were regarded it
would be a royalty within the meaning of Sec. 1.267A-5(a)(16). Under
Country X tax law, the $60x is a royalty and included in the income of
DE1X in years 2 and 3.
(ii) Result.--(A) Year 1. Because P owns all of the interests in
DE1X, a disregarded entity, P is a DPE owner. See Sec. 1.1503(d)-
1(d)(1). In addition, DE1X, a disregarded payment entity with respect
to P, incurs a $100x disregarded payment loss with respect to its
Country X taxable year for year 1. See Sec. 1.1503(d)-1(d)(5)(i)(A)
and (d)(5)(ii)(B). DE1X's $100x deduction being made available to
offset income of FSX pursuant to the Country X group relief regime
constitutes a foreign use of, and thus a triggering event with respect
to, the disregarded payment loss during the DPL certification period.
See Sec. 1.1503(d)-1(d)(3)(i) and (d)(5)(iii). As a result, in year 1,
P must include in gross income $100x, the DPL inclusion amount with
respect to the disregarded payment loss. See Sec. 1.1503(d)-1(d)(1)
and (d)(2)(i). The $100x DPL inclusion amount is treated for U.S. tax
purposes as ordinary interest income, the source and character of which
is determined as if DE1X were a foreign corporation, and the amount
were interest income paid by the foreign corporation to P. See Sec.
1.1503(d)-1(d)(2)(iv)(A). The result would be the same if DE1X
recognized income in year 1 that was regarded for both U.S. and Country
X tax purposes, or if P made payments (other than interest, structured
payments, or royalties) to DE1X that were disregarded for U.S. tax
purposes but regarded for Country X tax purposes. See Sec. 1.1503(d)-
1(d)(3)(i) (describing the application of the principles of the deemed
ordering rule in Sec. 1.1503(d)-3(c)(3)).
(B) Years 2 and 3. In year 2, P establishes a suspended deduction
of $100x related to the year 1 DPL inclusion amount. See Sec.
1.1503(d)-1(d)(1) and (d)(2)(ii). In each of years 2 and 3, DE1X
derives $60x of disregarded payment income with respect to its Country
X taxable year. See Sec. 1.1503(d)-1(d)(5)(ii)(A). For year 2, P is
allowed a $60x deduction with respect to the suspended deduction, and
$40x remains suspended. See Sec. 1.1503(d)-1(d)(2)(ii). For year 3, P
is allowed a $40x deduction with respect to the suspended deduction.
See id. Thus, in years 2 and 3 P is allowed a $60x deduction and $40x
deduction, respectively, with respect to the suspended deduction
relating to the year 1 DPL inclusion amount. The deductions are treated
as interest deductions the source and character of which are determined
in the same manner as the income for the DPL inclusion amount to which
they relate. See Sec. 1.1503(d)-1(d)(2)(iv)(B). At the end of year 3,
the DPL cumulative register is $20x (that is, the $120x of disregarded
payment income for years 2 and 3, less the $100 of DPL cumulative
register that is used under Sec. 1.1503(d)-1(d)(2)(ii) in years 2 and
3). See Sec. 1.1503(d)-1(d)(2)(iii).
(43) Example 43. Income from U.S. business operations to avoid the
purposes of the dual consolidated loss rules--(i) Facts. P owns DE1X.
DE1X owns FSX. DE1X and FSX file a consolidated tax return for Country
X tax purposes such that deductions and losses of DE1X are available to
offset income of FSX. P conducts business operations in the United
States that are expected to generate items of income or gain (U.S.
business operations). With a view to avoid the purposes of the rules
under Sec. Sec. 1.1503(d)-1 through 1.1503(d)-8 by eliminating what
would otherwise be a dual consolidated loss and obtaining a double
deduction outcome, P transfers the U.S. business operations to DE1X.
But for P's items of income or gain from the U.S. business operations
(held indirectly through DE1X), there would be a dual consolidated loss
attributable to P's interest in DE1X and a foreign use of that dual
consolidated loss (as a result of the Country X consolidation regime).
For purposes of determining taxable income under the income tax laws of
Country X, items of income, gain, deduction, and loss attributable to a
permanent establishment (or similar taxable presence) in another
country, which would include the U.S. business operations, are not
taken into account.
(ii) Result. Because P transferred the U.S. business operations to
DE1X with a view to avoid the purposes of the rules under Sec. Sec.
1.1503(d)-1 through 1.1503(d)-8, and the transfer would otherwise
result in a double deduction outcome (that is, in effect putting DE1X's
items of deduction or loss that would compose a dual consolidated loss
to both a domestic use and a foreign use), the anti-avoidance rule in
Sec. 1.1503(d)-1(f)(1) applies. As a result, the income or gain that P
takes into account from the U.S. business operations (held indirectly
through DE1X) is not taken into account for purposes of determining the
amount of income or dual consolidated loss attributable to P's interest
in DE1X under Sec. 1.1503(d)-5(c). The result would be the same if,
instead of the income tax laws of Country X not taking into account the
items of income, gain, deduction, and loss attributable to a permanent
establishment (or similar taxable presence) in another country for
purposes of determining taxable income, the income tax laws of Country
X took such items into account for this purpose but provided a foreign
tax credit with respect to taxes paid on the taxable income determined
by taking such items into account.
(44) Example 44. Disallowed interest deductions--(i) Facts. P owns
S. S owns DE1X, a disregarded entity and, thus, is a DPE owner. See
Sec. 1.1503(d)-1(d)(1). DE1X owns FSX. DE1X and FSX file a
consolidated tax return for Country X tax purposes such that deductions
and losses of DE1X are available to offset income of FSX. With a view
to avoid the purposes of the rules under Sec. Sec. 1.1503(d)-1 through
1.1503(d)-8, and obtain a double deduction or similar
[[Page 3020]]
outcome, P transfers cash to DE1X in exchange for an interest-bearing
note. Under the terms of the note, payments of interest are made in
cash or, at the option of DE1X, in stock of S. In year 1, DE1X accrues
$100x of interest expense under the note. The taxpayer takes the
position that for U.S. tax purposes, the interest expense deductions
are disallowed under section 163(l) because DE1X has the option to pay
the interest with S stock. Further, because S's interest expense
deductions on the note held by P are disallowed, the taxpayer takes the
position that P's interest income on the loan is treated as tax-exempt
income under the intercompany transaction rules in Sec. 1.1502-13. In
year 1, DE1X is allowed a $100x interest expense deduction for Country
X tax purposes; the $100x deduction is available to offset FSX's income
for Country X tax purposes.
(ii) Result. DE1X issued the note to P in exchange for cash with a
view to avoid the purposes of Sec. Sec. 1.1503(d)-1 through 1.1503(d)-
8. Moreover, under the taxpayer's position, the issuance would
otherwise result in a double deduction or similar outcome (that is, a
foreign use of DE1X's $100x interest expense deduction where P does not
recognize a corresponding income inclusion for U.S. tax purposes).
Accordingly, the anti-avoidance rule in Sec. 1.1503(d)-1(f)(1)
applies. As a result, adjustments are made such that the $100x interest
expense deduction is treated as a disregarded payment loss of DE1X, a
disregarded payment entity. This is the case even though the $100x
interest payment is not disregarded for U.S. tax purposes as a
transaction between a disregarded entity and its tax owner or between
disregarded entities with the same tax owner under Sec. 1.1503(d)-
1(d)(5)(ii)(C)(2). Because the $100x disregarded payment loss is made
available under the Country X consolidation regime to offset income of
FSX, a foreign corporation, a foreign use triggering event (within the
meaning of Sec. 1.1503(d)-1(d)(3)(i)) occurs. As a result, S includes
in income a $100x DPL inclusion amount in year 1 and establishes a
suspended deduction of $100x in year 2. See Sec. 1.1503(d)-1(d)(1),
(d)(2)(i), and (d)(2)(ii).
(45) Example 45. Restructuring to avoid the application of the DPL
rules--(i) Facts. P owns DE1X and S. DE1X owns FSX. DE1X and FSX file a
consolidated tax return for Country X tax purposes such that deductions
and losses of DE1X are available to offset income of FSX. P holds an
interest-bearing note issued by DE1X. For U.S. tax purposes, interest
accrued and paid on the note is disregarded. For Country X tax
purposes, DE1X is allowed a $100x interest expense deduction each year
for interest accrued under the note. At the end of year 1, and with a
view to avoid the application of the disregarded payment loss rules
under Sec. 1.1503(d)-1(d) in year 2, P transfers the note to S. In
year 2, DE1X is allowed a $100x interest expense deduction for Country
X tax purposes. For U.S. tax purposes, the $100x interest expense
deduction in year 2 gives rise to a dual consolidated loss attributable
to P's interest in DE1X, a hybrid entity separate unit, and that loss
is subject to the domestic use limitation rule of Sec. 1.1503(d)-4(b).
(ii) Result. Although P transferred the note to S with a view to
avoid the application of the disregarded payment loss rules under Sec.
1.1503(d)-1(d), the anti-avoidance rule in Sec. 1.1503(d)-1(f)(1) does
not apply with respect to the transfer. This is because the resulting
year 2 $100x dual consolidated loss is subject to the domestic use
limitation rule of Sec. 1.1503(d)-4(b) (or the terms of a domestic use
agreement, if a domestic use election were to be made) and thus cannot
be put to both a domestic use and a foreign use (that is, it does not
result in a double deduction or similar outcome). The same result would
obtain if, instead of P transferring the note to S at the end of year
1, DE1X extinguished the note at the end of year 1 such that there are
no disregarded payments in year 2 and, thus, no double non-taxation
outcome.
(iii) Alternative facts. The facts are the same as in paragraph
(c)(45)(i) of this section, except that P does not transfer the note to
S in year 1. Instead, with a view to prevent a foreign use of a
disregarded payment loss attributable to DE1X, at the end of year 1 FSX
distributes all its property to DE1X in a complete liquidation
described in section 332. The anti-avoidance rule in Sec. 1.1503(d)-
1(f)(1) does not apply because the disregarded payment loss is not put
to a foreign use (that is, there is no double deduction or similar
outcome).
(46) Example 46. Disregarded payment loss rules--scope--(i) Facts.
P owns DE1X. DE1X owns FBZ. FBZ is a foreign branch, within the meaning
of Sec. 1.1503(d)-1(d)(5)(iv), located in Country Z. DE1X makes a $10x
payment to P, which, under the laws of Country Z, gives rise to a $10x
deduction allowable to FBZ. If such payment were regarded for U.S. tax
purposes, it would be interest within the meaning of Sec. 1.267A-
5(a)(12). In addition, under the laws of Country Z, FBZ is allowed a
$60x interest deduction for an accrual or other transaction between FBZ
and DE1X, and if such item were regarded for U.S. tax purposes, it
would be interest within the meaning of Sec. 1.267A-5(a)(12).
(ii) Result. P is a DPE owner because it owns DE1X, a disregarded
entity. See Sec. 1.1503(d)-1(d)(1). As such, P determines disregarded
payment income or disregarded payment loss of DE1X, a disregarded
payment entity described in Sec. 1.1503(d)-1(d)(5)(i)(A), and of FBZ,
a disregarded payment entity described in Sec. 1.1503(d)-
1(d)(5)(i)(B). See Sec. 1.1503(d)-1(d)(1). The payment from DE1X to P
is disregarded for U.S. tax purposes as a transaction between a
disregarded entity (DE1X) and its tax owner (P) and therefore satisfies
the condition in Sec. 1.1503(d)-1(d)(5)(ii)(C)(2). The payment also
satisfies the conditions described in Sec. 1.1503(d)-1(d)(5)(ii)(C)(1)
and (3) because FBZ is allowed a deduction under Country Z law for a
payment that, if regarded for U.S. tax purposes, would be interest
within the meaning of Sec. 1.267A-5(a)(12). As such, the $10x
deduction attributable to the payment from DE1X to P is taken into
account in determining whether FBZ has disregarded payment income or a
disregarded payment loss under Sec. 1.1503(d)-1(d)(5)(ii)(A) and (B),
respectively. The $60x item of deduction allowed to FBZ, however, does
not satisfy the condition described in Sec. 1.1503(d)-
1(d)(5)(ii)(C)(2), because the accrual or other transaction giving rise
to the deduction is not between a disregarded entity and its tax owner
(here, P), or between disregarded entities with the same tax owner.
Accordingly, the $60x item of deduction is not taken into account in
determining whether FBZ has disregarded payment income or a disregarded
payment loss. The result would be the same with respect to the $60x
deduction allowed to FBZ under the laws of Country Z if, instead of P
owning FBZ indirectly through DE1X, P owned FBZ directly and the
accrual or other transaction giving rise to the deduction is between
FBZ and P.
* * * * *
0
Par. 5. Section 1.1503(d)-8 is amended by:
0
1. Revising the section heading; and
0
2. Adding paragraphs (b)(9) through (17).
The revision and additions read as follows:
Sec. 1.1503(d)-8 Applicability dates.
* * * * *
(b) * * *
(9) [Reserved].
(10) [Reserved].
[[Page 3021]]
(11) Disregarded payment loss rules. Section 1.1503(d)-1(d) applies
to taxable years beginning on or after January 1, 2026. See also Sec.
301.7701-2(e)(10) of this chapter (applicability dates for the entity
classification provisions relevant to the disregarded payment loss
rules).
(12) [Reserved].
(13) [Reserved].
(14) [Reserved].
(15) Anti-avoidance rule. Section 1.1503(d)-1(f) applies to dual
consolidated losses incurred in taxable years ending on or after August
6, 2024, and to disregarded payment losses in taxable years beginning
on or after January 1, 2026.
(16) [Reserved].
(17) Deemed ordering rule. Section 1.1503(d)-3(c)(3) applies to
dual consolidated losses incurred in taxable years beginning on or
after January 1, 2026, and to disregarded payment losses in taxable
years beginning on or after January 1, 2026. For the application of the
deemed ordering rule to dual consolidated losses incurred in taxable
years beginning before January 1, 2026, but on or after April 18, 2007,
see Sec. 1.1503(d)-3(c)(3) as contained in 26 CFR part 1 revised as of
April 1, 2024.
(18) Exception to mirror legislation rule for disregarded payment
losses. Section 1.1503(d)-3(e)(4) applies to taxable years beginning on
or after January 1, 2026.
PART 301--PROCEDURE AND ADMINISTRATION
0
Par. 6. The authority citation for part 301 is amended by adding an
entry for Sec. 301.7701-2 to read as follows:
Authority: 26 U.S.C. 7805 * * *
* * * * *
Section 301.7701-2 also issued under 26 U.S.C. 7701.
* * * * *
0
Par. 7. Section 301.7701-2 is amended by:
0
1. In the last sentence of paragraph (a), removing the language
``(vi)'' and adding in its place the language ``(vii)'';
0
2. Adding paragraph (c)(2)(vii); and
0
3. Adding paragraph (e)(10).
The additions read as follows:
Sec. 301.7701-2 Business entities; definitions.
* * * * *
(c) * * *
(2) * * *
(vii) Special rules for certain disregarded payments--(A)
Disregarded payment loss rules. To the extent provided in Sec.
1.1503(d)-1(d) of this chapter, certain payments involving a business
entity that, under paragraph (c)(2)(i) of this section is otherwise
disregarded as an entity separate from its owner, are in effect taken
into account as if the entity were regarded and the deduction was
denied, and therefore give rise to an income inclusion, and
corresponding suspended deduction, to the entity's owner.
(B) Non-application of the sixty-month limitation. If an eligible
entity that is disregarded as an entity separate from its owner would
become a disregarded payment entity (within the meaning of Sec.
1.1503(d)-1(d)(5)(i)(A) of this chapter) when this paragraph
(c)(2)(vii) applies, the sixty-month limitation under Sec. 301.7701-
3(c)(1)(iv) does not apply with respect to an election by such eligible
entity to change its classification to an association effective before
January 1, 2026 (such that it would not become a disregarded payment
entity).
* * * * *
(e) * * *
(10) Paragraph (c)(2)(vii) of this section (special rules for
certain disregarded payments) applies to taxable years beginning on or
after January 1, 2026, except that paragraph (c)(2)(vii)(B) of this
section (non-application of sixty-month limitation) applies as of
August 6, 2024.
Douglas W. O'Donnell,
Deputy Commissioner.
Approved: January 2, 2025.
Aviva R. Aron-Dine,
Deputy Assistant Secretary of the Treasury (Tax Policy).
[FR Doc. 2025-00318 Filed 1-10-25; 11:15 am]
BILLING CODE 4830-01-P
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</html>Indexed from Federal Register on January 14, 2025.
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