67612 Federal Register / Vol. 83, No. 248 / Friday, December 28, 2018 / Proposed Rules 

DEPARTMENT OF THE TREASURY 

Internal Revenue Service 

26 CFR Parts 1 and 301 

[REG–104352–18] 

RIN 1545–BO53 

Rules Regarding Certain Hybrid 

Arrangements 

AGENCY: Internal Revenue Service (IRS), 

Treasury. 

ACTION: Notice of proposed rulemaking. 

SUMMARY: This document contains 

proposed regulations implementing 

sections 245A(e) and 267A of the 

Internal Revenue Code (‘‘Code’’) 

regarding hybrid dividends and certain 

amounts paid or accrued in hybrid 

transactions or with hybrid entities. 

Sections 245A(e) and 267A were added 

to the Code by the Tax Cuts and Jobs 

Act, Public Law 115–97 (2017) (the 

‘‘Act’’), which was enacted on December 

22, 2017. This document also contains 

proposed regulations under sections 

1503(d) and 7701 to prevent the same 

deduction from being claimed under the 

tax laws of both the United States and 

a foreign country. Further, this 

document contains proposed 

regulations under sections 6038, 6038A, 

and 6038C to facilitate administration of 

certain rules in the proposed 

regulations. The proposed regulations 

affect taxpayers that would otherwise 

claim a deduction related to such 

amounts and certain shareholders of 

foreign corporations that pay or receive 

hybrid dividends. 

DATES: Written or electronic comments 

and requests for a public hearing must 

be received by February 26, 2019. 

ADDRESSES: Send submissions to: 

Internal Revenue Service, 

CC:PA:LPD:PR (REG–104352–18), Room 

5203, Post Office Box 7604, Ben 

Franklin Station, Washington, DC 

20044. Submissions may be handdelivered Monday through Friday 

between the hours of 8 a.m. and 4 p.m. 

to CC:PA:LPD:PR (indicate REG– 

104352–18), Courier’s Desk, Internal 

Revenue Service, 1111 Constitution 

Avenue NW, Washington, DC 20224, or 

sent electronically, via the Federal 

eRulemaking Portal at 

www.regulations.gov (IRS REG–104352– 

18). 

FOR FURTHER INFORMATION CONTACT: 

Concerning the proposed regulations, 

contact Tracy Villecco at (202) 317– 

3800; concerning submissions of 

comments or requests for a public 

hearing, Regina L. Johnson at (202) 317– 

6901 (not toll free numbers). 

SUPPLEMENTARY INFORMATION: 

Background 

I. In General 

This document contains proposed 

amendments to 26 CFR parts 1 and 301 

under sections 245A(e), 267A, 1503(d), 

6038, 6038A, 6038C, and 7701 (the 

‘‘proposed regulations’’). Added to the 

Code by sections 14101(a) and 14222(a) 

of the Act, section 245A(e) denies the 

dividends received deduction under 

section 245A with respect to hybrid 

dividends, and section 267A denies 

certain interest or royalty deductions 

involving hybrid transactions or hybrid 

entities. The proposed regulations only 

include rules under section 245A(e); 

rules addressing other aspects of section 

245A, including the general eligibility 

requirements for the dividends received 

deduction under section 245A(a), will 

be addressed in a separate notice of 

proposed rulemaking. Section 14101(f) 

of the Act provides that section 245A, 

including section 245A(e), applies to 

distributions made after December 31, 

2017. Section 14222(c) of the Act 

provides that section 267A applies to 

taxable years beginning after December 

31, 2017. Other provisions of the Code, 

such as sections 894(c) and 1503(d), also 

address certain hybrid arrangements. 

II. Purpose of Anti-Hybrid Rules 

A cross-border transaction may be 

treated differently for U.S. and foreign 

tax purposes because of differences in 

the tax law of each country. In general, 

the U.S. tax treatment of a transaction 

does not take into account foreign tax 

law. However, in specific cases, foreign 

tax law is taken into account—for 

example, in the context of withholdable 

payments to hybrid entities for which 

treaty benefits are claimed under section 

894(c) and for dual consolidated losses 

subject to section 1503(d)—in order to 

address policy concerns resulting from 

the different treatment of the same 

transaction or arrangement under U.S. 

and foreign tax law. 

In response to international concerns 

regarding hybrid arrangements used to 

achieve double non-taxation, Action 2 

of the OECD’s Base Erosion and Profit 

Shifting (‘‘BEPS’’) project, and two final 

reports thereunder, address hybrid and 

branch mismatch arrangements. See 

OECD/G20, Neutralising the Effects of 

Hybrid Mismatch Arrangements, Action 

2: 2015 Final Report (October 2015) (the 

‘‘Hybrid Mismatch Report’’); OECD/G20, 

Neutralising the Effects of Branch 

Mismatch Arrangements, Action 2: 

Inclusive Framework on BEPS (July 

2017) (the ‘‘Branch Mismatch Report’’). 

The Hybrid Mismatch Report sets forth 

recommendations to neutralize the tax 

effects of hybrid arrangements that 

exploit differences in the tax treatment 

of an entity or instrument under the 

laws of two or more countries (such 

arrangements, ‘‘hybrid mismatches’’). 

The Branch Mismatch Report sets forth 

recommendations to neutralize the tax 

effects of certain arrangements involving 

branches that result in mismatches 

similar to hybrid mismatches (such 

arrangements, ‘‘branch mismatches’’). 

Given the similarity between hybrid 

mismatches and branch mismatches, the 

Branch Mismatch Report recommends 

that a jurisdiction adopting rules to 

address hybrid mismatches adopt, at the 

same time, rules to address branch 

mismatches. See Branch Mismatch 

Report, at p. 11, Executive Summary. 

Otherwise, taxpayers might ‘‘shift[] from 

hybrid mismatch to branch mismatch 

arrangements in order to secure the 

same tax advantages.’’ Id. 

The Act’s legislative history explains 

that section 267A is intended to be 

‘‘consistent with many of the 

approaches to the same or similar 

problems [regarding hybrid 

arrangements] taken in the Code, the 

OECD base erosion and profit shifting 

project (‘‘BEPS’’), bilateral income tax 

treaties, and provisions or rules of other 

countries.’’ See Senate Committee on 

Finance, Explanation of the Bill, at 384 

(November 22, 2017). The types of 

hybrid arrangements of concern are 

arrangements that ‘‘exploit differences 

in the tax treatment of a transaction or 

entity under the laws of two or more tax 

jurisdictions to achieve double nontaxation, including long-term deferral.’’ 

Id. Hybrid arrangements targeted by 

these provisions are those that rely on 

a hybrid element to produce such 

outcomes. 

These concerns also arise in the 

context of section 245A as a result of the 

enactment of a participation exemption 

system for taxing foreign income. Under 

this system, section 245A(e) generally 

prevents double non-taxation by 

disallowing the 100 percent dividends 

received deduction for dividends 

received from a controlled foreign 

corporation (‘‘CFC’’), or by mandating 

subpart F inclusions for dividends 

received from a CFC by another CFC, if 

there is a corresponding deduction or 

other tax benefit in the foreign country. 

Explanation of Provisions 

I. Section 245A(e)—Hybrid Dividends 

A. Overview 

The proposed regulations under 

section 245A(e) address certain 

dividends involving hybrid 

arrangements. The proposed regulations 


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neutralize the double non-taxation 

effects of these dividends by either 

denying the section 245A(a) dividends 

received deduction with respect to the 

dividend or requiring an inclusion 

under section 951(a) with respect to the 

dividend, depending on whether the 

dividend is received by a domestic 

corporation or a CFC. 

The proposed regulations provide that 

if a domestic corporation that is a 

United States shareholder within the 

meaning of section 951(b) (‘‘U.S. 

shareholder’’) of a CFC receives a 

‘‘hybrid dividend’’ from the CFC, then 

the U.S. shareholder is not allowed the 

section 245A(a) deduction for the 

hybrid dividend, and the rules of 

section 245A(d) (denial of foreign tax 

credits and deductions) apply. See 

proposed § 1.245A(e)–1(b). In general, a 

dividend is a hybrid dividend if it 

satisfies two conditions: (i) But for 

section 245A(e), the section 245A(a) 

deduction would be allowed, and (ii) 

the dividend is one for which the CFC 

(or a related person) is or was allowed 

a deduction or other tax benefit under 

a ‘‘relevant foreign tax law’’ (such a 

deduction or other tax benefit, a ‘‘hybrid 

deduction’’). See proposed § 1.245A(e)– 

1(b) and (d). The proposed regulations 

take into account certain deductions or 

other tax benefits allowed to a person 

related to a CFC (such as a shareholder) 

because, for example, certain tax 

benefits allowed to a shareholder of a 

CFC are economically equivalent to the 

CFC having been allowed a deduction. 

B. Relevant Foreign Tax Law 

The proposed regulations define a 

relevant foreign tax law as, with respect 

to a CFC, any regime of any foreign 

country or possession of the United 

States that imposes an income, war 

profits, or excess profits tax with respect 

to income of the CFC, other than a 

foreign anti-deferral regime under 

which an owner of the CFC is liable to 

tax. See proposed § 1.245A(e)–1(f). 

Thus, for example, a relevant foreign tax 

law includes the tax law of a foreign 

country of which the CFC is a tax 

resident, as well as the tax law 

applicable to a foreign branch of the 

CFC. 

C. Deduction or Other Tax Benefit 

1. In General 

Under the proposed regulations, only 

deductions or other tax benefits that are 

‘‘allowed’’ under the relevant foreign tax 

law may constitute a hybrid deduction. 

See proposed § 1.245A(e)–1(d). Thus, 

for example, if the relevant foreign tax 

law contains hybrid mismatch rules 

under which a CFC is denied a 

deduction for an amount of interest paid 

with respect to a hybrid instrument to 

prevent a deduction/no-inclusion (‘‘D/ 

NI’’) outcome, then the payment of the 

interest does not give rise to a hybrid 

deduction, because the deduction is not 

‘‘allowed.’’ This prevents doubletaxation that could arise if a hybrid 

dividend were subject to both section 

245A(e) and a hybrid mismatch rule 

under a relevant foreign tax law. 

For a deduction or other tax benefit to 

be a hybrid deduction, it must relate to 

or result from an amount paid, accrued, 

or distributed with respect to an 

instrument of the CFC that is treated as 

stock for U.S. tax purposes. That is, 

there must be a connection between the 

deduction or other tax benefit under the 

relevant foreign tax law and the 

instrument that is stock for U.S. tax 

purposes. Thus, a hybrid deduction 

includes an interest deduction under a 

relevant foreign tax law with respect to 

a hybrid instrument (stock for U.S. tax 

purposes, indebtedness for foreign tax 

purposes). It also includes dividends 

paid deductions and other deductions 

allowed on equity under a relevant 

foreign tax law, such as notional interest 

deductions (‘‘NIDs’’), which raise 

similar concerns as traditional hybrid 

instruments. However, it does not, for 

example, include an exemption 

provided to a CFC under its tax law for 

certain types of income (such as income 

attributable to a foreign branch), because 

there is not a connection between the 

tax benefit and the instrument that is 

stock for U.S. tax purposes. 

The proposed regulations provide that 

deductions or other tax benefits allowed 

pursuant to certain integration or 

imputation systems do not constitute 

hybrid deductions. See proposed 

§ 1.245A(e)–1(d)(2)(i)(B). However, a 

system that has the effect of exempting 

earnings that fund a distribution from 

foreign tax at both the CFC and 

shareholder level gives rise to a hybrid 

deduction. See id.; see also proposed 

§ 1.245A(e)–1(g)(2), Example 2. 

2. Effect of Foreign Currency Gain or 

Loss 

The payment of an amount by a CFC 

may, under a provision of foreign tax 

law comparable to section 988, give rise 

to gain or loss to the CFC that is 

attributable to foreign currency. The 

proposed regulations provide that such 

foreign currency gain or loss recognized 

with respect to such deduction or other 

tax benefit is taken into account for 

purposes of determining hybrid 

deductions. See proposed § 1.245A(e)– 

1(d)(6); see also section II.K.1 of this 

Explanation of Provisions (requesting 

comments on foreign currency rules). 

D. Tiered Hybrid Dividends 

Proposed § 1.245A(e)–1(c) sets forth 

rules related to hybrid dividends of 

tiered corporations (‘‘tiered hybrid 

dividends’’), as provided under section 

245A(e)(2). A tiered hybrid dividend 

means an amount received by a CFC 

from another CFC to the extent that the 

amount would be a hybrid dividend 

under proposed § 1.245A(e)–1(b) if the 

receiving CFC were a domestic 

corporation. Accordingly, the amount 

must be treated as a dividend under 

U.S. tax law to be treated as a tiered 

hybrid dividend; the treatment of the 

amount under the tax law in which the 

receiving CFC is a tax resident (or under 

any other foreign tax law) is irrelevant 

for this purpose. 

If a CFC receives a tiered hybrid 

dividend from another CFC, and a 

domestic corporation is a U.S. 

shareholder of both CFCs, then (i) the 

tiered hybrid dividend is treated as 

subpart F income of the receiving CFC, 

(ii) the U.S. shareholder must include in 

gross income its pro rata share of the 

subpart F income, and (iii) the rules of 

section 245A(d) apply to the amount 

included in the U.S. shareholder’s gross 

income. See proposed § 1.245A(e)– 

1(c)(1). This treatment applies 

notwithstanding any other provision of 

the Code. Thus, for example, exceptions 

to subpart F income such as those 

provided under section 954(c)(3) (‘‘same 

country’’ exception for income received 

from related persons) and section 

954(c)(6) (look-through rule for related 

CFCs) do not apply. As additional 

examples, the gross amount of subpart 

F income cannot be reduced by 

deductions taken into account under 

section 954(b)(5) and § 1.954–1(c), and 

is not subject to the current earnings 

and profits limitation under section 

952(c). 

E. Interaction With Section 959 

Distributions of previously taxed 

earnings and profits (‘‘PTEP’’) 

attributable to amounts that have been 

taken into account by a U.S. shareholder 

under section 951(a) are, in general, 

excluded from the gross income of the 

U.S. shareholder when distributed 

under section 959(a), and under section 

959(d) are not treated as a dividend 

(other than to reduce earnings and 

profits). As a result, distributions from 

a CFC to its U.S. shareholder out of 

PTEP are not eligible for the dividends 

received deduction under section 

245A(a), and section 245A(e) does not 

apply. Similarly, distributions of PTEP 

from a CFC to an upper-tier CFC are 

excluded from the gross income of the 

upper-tier CFC under section 959(b), but 


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only for the limited purpose of applying 

section 951(a). In addition, such 

amounts continue to be treated as 

dividends because section 959(d) does 

not apply to such amounts. 

Accordingly, distributions out of PTEP 

could qualify as tiered hybrid dividends 

that would result in an income 

inclusion to a U.S. shareholder. To 

prevent this result, the proposed 

regulations provide that a tiered hybrid 

dividend does not include amounts 

described in section 959(b). See 

proposed § 1.245A(e)–1(c)(2). 

F. Interaction With Section 964(e) 

Under section 964(e)(1), gain 

recognized by a CFC on the sale or 

exchange of stock in another foreign 

corporation may be treated as a 

dividend. In certain cases, section 

964(e)(4): (i) Treats the dividend as 

subpart F income of the selling CFC; (ii) 

requires a U.S. shareholder of the CFC 

to include in its gross income its pro 

rata share of the subpart F income; and 

(iii) allows the U.S. shareholder the 

section 245A(a) deduction for its 

inclusion in gross income. As is the case 

with the treatment of tiered hybrid 

dividends, the treatment of dividends 

under section 964(e)(4) applies 

notwithstanding any other provision of 

the Code. 

The proposed regulations coordinate 

the tiered hybrid dividend rules and the 

rules of section 964(e) by providing that, 

to the extent a dividend arising under 

section 964(e)(1) is a tiered hybrid 

dividend, the tiered hybrid dividend 

rules, rather than the rules of section 

964(e)(4), apply. Thus, in such a case, a 

U.S. shareholder that includes an 

amount in its gross income under the 

tiered hybrid dividend rule is not 

allowed the section 245A(a) deduction, 

or foreign tax credits or deductions, for 

the amount. See proposed § 1.245A(e)– 

1(c)(1) and (4). 

G. Hybrid Deduction Accounts 

1. In General 

In some cases, the actual payment by 

a CFC of an amount that is treated as a 

dividend for U.S. tax purposes will 

result in a corresponding hybrid 

deduction. In many cases, however, the 

dividend and the hybrid deduction may 

not arise pursuant to the same payment 

and may be recognized in different 

taxable years. This may occur in the 

case of a hybrid instrument for which 

under a relevant foreign tax law the CFC 

is allowed deductions for accrued (but 

not yet paid) interest. In such a case, to 

the extent that an actual payment has 

not yet been made on the instrument, 

there generally would not be a dividend 

for U.S. tax purposes for which the 

section 245A(a) deduction could be 

disallowed under section 245A(e). 

Nevertheless, because the earnings and 

profits of the CFC would not be reduced 

by the accrued interest deduction, the 

earnings and profits may give rise to a 

dividend when subsequently distributed 

to the U.S. shareholder. This same result 

could occur in other cases, such as 

when a relevant foreign tax law allows 

deductions on equity, such as NIDs. 

The disallowance of the section 

245A(a) deduction under section 

245A(e) should not be limited to cases 

in which the dividend and the hybrid 

deduction arise pursuant to the same 

payment (or in the same taxable year for 

U.S. tax purposes and for purposes of 

the relevant foreign tax law). 

Interpreting the provision in such a 

manner would result in disparate 

treatment for hybrid arrangements that 

produce the same D/NI outcome. 

Accordingly, the proposed regulations 

define a hybrid dividend (or tiered 

hybrid dividend) based, in part, on the 

extent of the balance of the ‘‘hybrid 

deduction accounts’’ of the domestic 

corporation (or CFC) receiving the 

dividend. See proposed § 1.245A(e)–1(b) 

and (d). This ensures that dividends are 

subject to section 245A(e) regardless of 

whether the same payment gives rise to 

the dividend and the hybrid deduction. 

A hybrid deduction account must be 

maintained with respect to each share of 

stock of a CFC held by a person that, 

given its ownership of the CFC and the 

share, could be subject to section 245A 

upon a dividend paid by the CFC on the 

share. See proposed § 1.245A(e)–1(d) 

and (f). The account, which is 

maintained in the functional currency of 

the CFC, reflects the amount of hybrid 

deductions of the CFC (allowed in 

taxable years beginning after December 

31, 2017) that have been allocated to the 

share. A dividend paid by a CFC to a 

shareholder that has a hybrid deduction 

account with respect to the CFC is 

generally treated as a hybrid dividend or 

tiered hybrid dividend to the extent of 

the shareholder’s balance in all of its 

hybrid deduction accounts with respect 

to the CFC, even if the dividend is paid 

on a share that has not had any hybrid 

deductions allocated to it. Absent such 

an approach, the purposes of section 

245A(e) might be avoided by, for 

example, structuring dividend payments 

such that they are generally made on 

shares of stock to which a hybrid 

deduction has not been allocated (rather 

than on shares of stock to which a 

hybrid deduction has been allocated, 

such as a share that is a hybrid 

instrument). 

Once an amount in a hybrid 

deduction account gives rise to a hybrid 

dividend or a tiered hybrid dividend, 

the account is correspondingly reduced. 

See proposed § 1.245A(e)–1(d). The 

Treasury Department and the IRS 

request comments on whether hybrid 

deductions attributable to amounts 

included in income under section 951(a) 

or section 951A should not increase the 

hybrid deduction account, or, 

alternatively, the hybrid deduction 

account should be reduced by 

distributions of PTEP, and on whether 

the effect of any deemed paid foreign 

tax credits associated with such 

inclusions or distributions should be 

considered. 

2. Transfers of Stock 

Because hybrid deduction accounts 

are with respect to stock of a CFC, the 

proposed regulations include rules that 

take into account transfers of the stock. 

See proposed § 1.245A(e)–1(d)(4)(ii)(A). 

These rules, which are similar to the 

‘‘successor’’ PTEP rules under section 

959 (see § 1.959–1(d)), ensure that 

section 245A(e) properly applies to 

dividends that give rise to a D/NI 

outcome in cases where the shareholder 

that receives the dividend is not the 

same shareholder that held the stock 

when the hybrid deduction was 

incurred. These rules only apply when 

the stock is transferred among persons 

that are required to keep hybrid 

deduction accounts. Thus, if the stock is 

transferred to a person that is not 

required to keep a hybrid deduction 

account—such as an individual or a 

foreign corporation that is not a CFC— 

the account terminates (subject to the 

anti-avoidance rule, discussed in 

section I.H of this Explanation of 

Provisions). Finally, the proposed 

regulations include rules that take into 

account certain non-recognition 

exchanges of the stock, such as 

exchanges in connection with asset 

reorganizations, recapitalizations, and 

liquidations, as well as transfers and 

exchanges that occur mid-way through 

a CFC’s taxable year. See proposed 

§ 1.245A(e)–1(d)(4)(ii)(B) and (d)(5). The 

Treasury Department and the IRS 

request comments on these rules. 

3. Dividends From Lower-Tier CFCs 

The proposed regulations provide a 

special rule to address earnings and 

profits of a lower-tier CFC that are 

included in a domestic corporation’s 

income as a dividend by virtue of 

section 1248(c)(2). In these cases, the 

proposed regulations treat the domestic 

corporation as having certain hybrid 

deduction accounts with respect to the 

lower-tier CFC that are held and 


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maintained by other CFCs. See proposed 

§ 1.245A(e)–1(b)(3). This ensures that, to 

the extent the earnings and profits of the 

lower-tier CFC give rise to the dividend, 

hybrid deduction accounts with respect 

to the lower-tier CFC are taken into 

account for purposes of the 

determinations under section 245A(e), 

even though the accounts are held 

indirectly by the domestic corporation. 

A similar rule applies with respect to 

gains on stock sales treated as dividends 

under section 964(e)(1). See proposed 

§ 1.245A(e)–1(c)(3). 

H. Anti-Avoidance Rule 

The proposed regulations include an 

anti-avoidance rule. This rule provides 

that appropriate adjustments are made, 

including adjustments that would 

disregard a transaction or arrangement, 

if a transaction or arrangement is 

engaged in with a principal purpose of 

avoiding the purposes of proposed 

§ 1.245A(e)–1. 

II. Section 267A—Related Party 

Amounts Involving Hybrid 

Transactions and Hybrid Entities 

A. Overview 

As indicated in the Senate Finance 

Committee’s Explanation of the Bill, 

hybrid arrangements may exploit 

differences under U.S. and foreign tax 

law between the tax characterization of 

an entity as transparent or opaque or 

differences in the treatment of financial 

instruments or other transactions. The 

proposed regulations under section 

267A address certain payments or 

accruals of interest or royalties for U.S. 

tax purposes (the amount of such 

interest or royalty, a ‘‘specified 

payment’’) that involve hybrid 

arrangements, or similar arrangements 

involving branches, that produce D/NI 

(deduction/no inclusion) outcomes or 

indirect D/NI outcomes. See also section 

II.J.1 of this Explanation of Provisions 

(discussing certain amounts that are 

treated as specified payments). The 

proposed regulations neutralize the 

double non-taxation effects of the 

arrangements by denying a deduction 

for the specified payment to the extent 

of the D/NI outcome. 

B. Scope 

1. Disallowed Deductions 

The proposed regulations generally 

disallow a deduction for a specified 

payment if and only if the payment is 

(i) a ‘‘disqualified hybrid amount,’’ 

meaning that it produces a D/NI 

outcome as a result of a hybrid or 

branch arrangement; (ii) a ‘‘disqualified 

imported mismatch amount,’’ meaning 

that it produces an indirect D/NI 

outcome as a result of the effects of an 

offshore hybrid or branch arrangement 

being imported into the U.S. tax system; 

or (iii) made pursuant to a transaction 

a principal purpose of which is to avoid 

the purposes of the regulations under 

section 267A and it produces a D/NI 

outcome. See proposed § 1.267A–1(b). 

Thus, the proposed regulations do not 

address D/NI outcomes that are not the 

result of hybridity. See also section II.E 

of this Explanation of Provisions 

(discussing the link between hybridity 

and a D/NI outcome). In addition, the 

proposed regulations do not address 

double-deduction outcomes. Section 

267A is intended to address D/NI 

outcomes; transactions that produce 

double-deduction outcomes are 

addressed through other provisions (or 

doctrines), such as the dual 

consolidated loss rules under section 

1503(d). See also section IV.A.1 of this 

Explanation of Provisions (discussing 

the dual consolidated loss rules). 

2. Parties Subject to Section 267A 

The application of section 267A by its 

terms is not limited to any particular 

category of persons. The proposed 

regulations, however, narrow the scope 

of section 267A so that it applies only 

to deductions of ‘‘specified parties.’’ 

Deductions of persons other than 

specified parties are not subject to 

disallowance under section 267A 

because the deductions of such other 

persons generally do not have 

significant U.S. tax consequences. 

A specified party means any of (i) a 

tax resident of the United States, (ii) a 

CFC for which there is one or more 

United States shareholders that own 

(within the meaning of section 958(a)) at 

least ten percent of the stock of the CFC, 

and (iii) a U.S. taxable branch (which 

includes a U.S. permanent 

establishment of a tax treaty resident). 

See proposed § 1.267A–5(a). The term 

generally includes a CFC because, for 

example, a specified payment made by 

a CFC to the foreign parent of the CFC’s 

U.S. shareholder, or a specified payment 

by the CFC to an unrelated party 

pursuant to a structured arrangement, 

may indirectly reduce income subject to 

U.S. tax. Specified payments made by a 

CFC to other related CFCs or to U.S. 

shareholders of the CFC, however, 

typically will not be subject to section 

267A because of the rules in proposed 

§ 1.267A–3(b) that exempt certain 

payments included in income of a U.S. 

tax resident or taken into account under 

the subpart F or global intangible lowtax income (‘‘GILTI’’) rules. See also 

section II.F of this Explanation of 

Provisions (discussing the relatedness or 

structured arrangement limitation); 

section II.H of this Explanation of 

Provisions (discussing exceptions for 

amounts included or includible in 

income). Similarly, the term includes a 

U.S. taxable branch because a payment 

made by the home office may be 

allocable to and thus reduce income 

subject to U.S. tax under sections 871(b) 

or 882. See also section II.K.2 of this 

Explanation of Provisions (discussing 

amounts considered paid or accrued by 

a U.S. taxable branch for section 267A 

purposes). 

The term specified party does not 

include a partnership because a 

partnership generally is not liable to tax 

and therefore is not the person allowed 

a deduction. However, a partner of a 

partnership may be a specified party. 

For example, in the case of a payment 

made by a partnership a partner of 

which is a domestic corporation, the 

domestic corporation is a specified 

party and its allocable share of the 

deduction for the payment is subject to 

disallowance under section 267A. 

C. Amount of a D/NI Outcome 

1. In General 

Proposed § 1.267A–3(a) provides rules 

for determining the ‘‘no-inclusion’’ 

aspect of a D/NI outcome—that is, the 

amount of a specified payment that is or 

is not included in income under foreign 

tax law. The proposed regulations 

provide that only ‘‘tax residents’’ or 

‘‘taxable branches’’ are considered to 

include an amount in income. Parties 

other than tax residents or taxable 

branches, for example, an entity that is 

fiscally transparent for purposes of the 

relevant tax laws, do not include an 

amount in income because such parties 

are not liable to tax. 

In general, a tax resident or taxable 

branch includes a specified payment in 

income for this purpose to the extent 

that, under its tax law, it includes the 

payment in its income or tax base at the 

full marginal rate imposed on ordinary 

income, and the payment is not reduced 

or offset by certain items (such as an 

exemption or credit) particular to that 

type of payment. See proposed 

§ 1.267A–3(a)(1). 

Whether a tax resident or taxable 

branch includes a specified payment in 

income is determined without regard to 

any defensive or secondary rule in 

hybrid mismatch rules (which generally 

requires the payee to include certain 

amounts in income, if the payer is not 

denied a deduction for the amount), if 

any, under the tax resident’s or taxable 

branch’s tax law. Otherwise, in cases in 

which such tax law contains a 

secondary response, the analysis of 

whether the specified payment is 


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included in income could become 

circular: For example, whether the 

United States denies a deduction under 

section 267A may depend on whether 

the payee includes the specified 

payment in income, and whether the 

payee includes it in income (under a 

secondary response) may depend on 

whether the United States denies the 

deduction. 

A specified payment may be 

considered included in income even 

though offset by a generally applicable 

deduction or other tax attribute, such as 

a deduction for depreciation or a net 

operating loss. For this purpose, a 

deduction may be treated as being 

generally applicable even if closely 

related to the specified payment (for 

example, if the deduction and payment 

are in connection with a back-to-back 

financing arrangement). 

If a specified payment is taxed at a 

preferential rate, or if there is a partial 

reduction or offset particular to the type 

of payment, a portion of the payment is 

considered included in income. The 

portion included in income is the 

amount that, taking into account the 

preferential rate or reduction or offset, is 

subject to tax at the full marginal rate 

applicable to ordinary income. See 

proposed § 1.267A–3(a)(1); see also 

proposed § 1.267A–6(c), Example 2 and 

Example 7. 

2. Timing Differences 

Some specified payments may never 

be included in income. For example, a 

specified payment treated as a dividend 

under a tax resident’s tax laws may be 

permanently excluded from its income 

under a participation exemption. 

Permanent exclusions are always treated 

as giving rise to a no-inclusion. See 

proposed § 1.267A–3(a)(1). 

Other specified payments, however, 

may be included in income but on a 

deferred basis. Some of these timing 

differences result from different 

methods of accounting between U.S. tax 

law and foreign tax law. For example, 

and subject to certain limitations such 

as those under sections 163(e)(3) and 

267(a) (generally applicable to payments 

involving related parties, but not to 

payments involving structured 

arrangements), a specified payment may 

be deductible for U.S. tax purposes 

when accrued and later included in a 

foreign tax resident’s income when 

actually paid. See also section II.K.3 of 

this Explanation of Provisions 

(discussing the coordination of section 

267A with rules such as sections 

163(e)(3) and 267(a)). Timing 

differences may also occur in cases in 

which all or a portion of a specified 

payment that is treated as interest for 

U.S. tax purposes is treated as a return 

of principal for purposes of the foreign 

tax law. 

In some cases, timing differences 

reverse after a short period of time and 

therefore do not provide a meaningful 

deferral benefit. The Treasury 

Department and the IRS have 

determined that routine, short-term 

deferral does not give rise to the policy 

concerns that section 267A is intended 

to address. In addition, subjecting such 

short-term deferral to section 267A 

could give rise to administrability issues 

for both taxpayers and the IRS, because 

it may be challenging to determine 

whether the taxable period in which a 

specified payment is included in 

income matches the taxable period in 

which the payment is deductible. 

Other timing differences, though, may 

provide a significant and long-term 

deferral benefit. Moreover, taxpayers 

may structure transactions that exploit 

these differences to achieve long-term 

deferral benefits. Timing differences 

that result in long-term deferral have an 

economic effect similar to a permanent 

exclusion and therefore give rise to 

policy concerns that section 267A is 

intended to address. See Senate 

Explanation, at 384 (expressing concern 

with hybrid arrangements that ‘‘achieve 

double non-taxation, including longterm deferral.’’). Accordingly, proposed 

§ 1.267A–3(a)(1) provides that shortterm deferral, meaning inclusion during 

a taxable year that ends no more than 

36 months after the end of the specified 

party’s taxable year, does not give rise 

to a D/NI outcome; inclusions outside of 

the 36-month timeframe, however, are 

treated as giving rise to a D/NI outcome. 

D. Hybrid and Branch Arrangements 

Giving Rise to Disqualified Hybrid 

Amounts 

1. Hybrid Transactions 

Proposed § 1.267A–2(a) addresses 

hybrid financial instruments and similar 

arrangements (collectively, ‘‘hybrid 

transactions’’) that result in a D/NI 

outcome. For example, in the case of an 

instrument that is treated as 

indebtedness for purposes of the payer’s 

tax law and stock for purposes of the 

payee’s tax law, a payment on the 

instrument may constitute deductible 

interest expense of the payer and 

excludible dividend income of the 

payee (for instance, under a 

participation exemption). 

In general, the proposed regulations 

provide that a specified payment is 

made pursuant to a hybrid transaction if 

there is a mismatch in the character of 

the instrument or arrangement such that 

the payment is not treated as interest or 

a royalty, as applicable, under the tax 

law of a ‘‘specified recipient.’’ Examples 

of such a specified payment include a 

payment that is treated as interest for 

U.S. tax purposes but, for purposes of a 

specified recipient’s tax law, is treated 

as a distribution on equity or a return 

of principal. When a specified payment 

is made pursuant to a hybrid 

transaction, it generally is a disqualified 

hybrid amount to the extent that the 

specified recipient does not include the 

payment in income. 

The proposed regulations broadly 

define specified recipient as (i) any tax 

resident that under its tax law derives 

the specified payment, and (ii) any 

taxable branch to which under its tax 

law the specified payment is 

attributable. See proposed § 1.267A– 

5(a)(19). In other words, a specified 

recipient is any party that may be 

subject to tax on the specified payment 

under its tax law. There may be more 

than one specified recipient of a 

specified payment. For example, in the 

case of a specified payment to an entity 

that is fiscally transparent for purposes 

of the tax law of its tax resident owners, 

each of the owners is a specified 

recipient of a share of the payment. In 

addition, if the entity is a tax resident 

of the country in which it is established 

or managed and controlled, then the 

entity is also a specified recipient. 

Moreover, in the case of a specified 

payment attributable to a taxable 

branch, both the taxable branch and the 

home office are specified recipients. 

The proposed regulations deem a 

specified payment as made pursuant to 

a hybrid transaction if there is a longterm mismatch between when the 

specified party is allowed a deduction 

for the payment under U.S. tax law and 

when a specified recipient includes the 

payment in income under its tax law. 

This rule applies, for example, when a 

specified payment is made pursuant to 

an instrument viewed as indebtedness 

under both U.S. and foreign tax law and, 

due to a mismatch in tax accounting 

treatment between the U.S. and foreign 

tax law, results in long-term deferral. In 

these cases, this rule treats the long-term 

deferral as giving rise to a hybrid 

transaction; the rules in proposed 

§ 1.267A–3(a)(1) (discussed in section 

II.C.2 of this Explanation of Provisions) 

treat the long-term deferral as creating a 

D/NI outcome. 

Lastly, proposed § 1.267A–2(a)(3) 

provides special rules to address 

securities lending transactions, salerepurchase transactions, and similar 

transactions. In these cases, a specified 

payment (that is, interest consistent 

with the substance of the transaction) 

might not be regarded under a foreign 


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tax law. As a result, there might not be 

a specified recipient of the specified 

payment under such foreign tax law, 

absent a special rule. To address this 

scenario, the proposed regulations 

provide that the determination of the 

identity of a specified recipient under 

the foreign tax law is made with respect 

to an amount connected to the specified 

payment and regarded under the foreign 

tax law—for example, a dividend 

consistent with the form of the 

transaction. The Treasury Department 

and the IRS request comments on 

whether similar rules should be 

extended to other specific transactions. 

2. Disregarded Payments 

Proposed § 1.267A–2(b) addresses 

disregarded payments. Disregarded 

payments generally give rise to a D/NI 

outcome because they are regarded 

under the payer’s tax law and are 

therefore available to offset income not 

taxable to the payee, but are disregarded 

under the payee’s tax law and therefore 

are not included in income. 

In general, the proposed regulations 

define a disregarded payment as a 

specified payment that, under a foreign 

tax law, is not regarded because, for 

example, it is a disregarded transaction 

involving a single taxpayer or between 

consolidated group members. For 

example, a disregarded payment 

includes a specified payment made by 

a domestic corporation to its foreign 

owner if, under the foreign tax law, the 

domestic corporation is a disregarded 

entity and therefore the payment is not 

regarded. It also includes a specified 

payment between related foreign 

corporations that are members of the 

same foreign consolidated group (or can 

otherwise share income or loss) if, 

under the foreign tax law, payments 

between group members are not 

regarded, or give rise to a deduction or 

similar offset to the payer member that 

is available to offset the corresponding 

income of the recipient member. 

In general, a disregarded payment is 

a disqualified hybrid amount only to the 

extent it exceeds dual inclusion income. 

For example, if a domestic corporation 

that for foreign tax purposes is a 

disregarded entity of its foreign owner 

makes a disregarded payment to its 

foreign owner, the payment is a 

disqualified hybrid amount only to the 

extent it exceeds the net of the items of 

gross income and deductible expense 

taken into account in determining the 

domestic corporation’s income for U.S. 

tax purposes and the foreign owner’s 

income for foreign tax purposes. This 

prevents the excess of the disregarded 

payment over dual inclusion income 

from offsetting non-dual inclusion 

income. Such an offset could otherwise 

occur, for example, through the U.S. 

consolidation regime, or a sale, merger, 

or similar transaction. 

A disregarded payment could also be 

viewed as being made pursuant to a 

hybrid transaction because the payment 

of interest or royalty would not be 

viewed as interest or royalty under the 

foreign tax law (since the payment is 

disregarded). The proposed regulations 

address disregarded payments 

separately from hybrid transactions, 

however, because disregarded payments 

are more likely to offset dual inclusion 

income and therefore are treated as 

disqualified hybrid amounts only to the 

extent they offset non-dual inclusion 

income. 

3. Deemed Branch Payments 

Proposed § 1.267A–2(c) addresses 

deemed branch payments. These 

payments result in a D/NI outcome 

when, under an income tax treaty, a 

deductible payment is deemed to be 

made by a permanent establishment to 

its home office and offsets income not 

taxable to the home office, but the 

payment is not taken into account under 

the home office’s tax law. 

In general, the proposed regulations 

define a deemed branch payment as 

interest or royalty considered paid by a 

U.S. permanent establishment to its 

home office under an income tax treaty 

between the United States and the home 

office country. See proposed § 1.267A– 

2(c)(2). Thus, for example, a deemed 

branch payment includes an amount 

allowed as a deduction in computing 

the business profits of a U.S. permanent 

establishment with respect to the use of 

intellectual property developed by the 

home office. See, for example, the U.S. 

Treasury Department Technical 

Explanation to the income tax 

convention between the United States 

and Belgium, signed November 27, 2006 

(‘‘[T]he OECD Transfer Pricing 

Guidelines apply, by analogy, in 

determining the profits attributable to a 

permanent establishment.’’). 

When a specified payment is a 

deemed branch payment, it is a 

disqualified hybrid amount if the home 

office’s tax law provides an exclusion or 

exemption for income attributable to the 

branch. In these cases, a deduction for 

the deemed branch payment would 

offset non-dual inclusion income and 

therefore give rise to a D/NI outcome. If 

the home office’s tax law does not have 

an exclusion or exemption for income 

attributable to the branch, then, because 

U.S. permanent establishments cannot 

consolidate or otherwise share losses 

with U.S. taxpayers, there would 

generally not be an opportunity for a 

deduction for the deemed branch 

payment to offset non-dual inclusion 

income. 

4. Reverse Hybrids 

Proposed § 1.267A–2(d) addresses 

payments to reverse hybrids. In general, 

and as discussed below, a reverse 

hybrid is an entity that is fiscally 

transparent for purposes of the tax law 

of the country in which it is established 

but not for purposes of the tax law of its 

owner. Thus, payments to a reverse 

hybrid may result in a D/NI outcome 

because the reverse hybrid is not a tax 

resident of the country in which it is 

established, and the owner does not 

derive the payment under its tax law. 

Because this D/NI outcome may occur 

regardless of whether the establishment 

country is a foreign country or the 

United States, the proposed regulations 

provide that both foreign and domestic 

entities may be reverse hybrids. A 

domestic entity that is a reverse hybrid 

for this purpose therefore differs from a 

‘‘domestic reverse hybrid entity’’ under 

§ 1.894–1(d)(2)(i), which is defined as ‘‘a 

domestic entity that is treated as not 

fiscally transparent for U.S. tax 

purposes and as fiscally transparent 

under the laws of an interest holder’s 

jurisdiction[.]’’ 

For an entity to be a reverse hybrid 

under the proposed regulations, two 

requirements must be satisfied. These 

requirements generally implement the 

definition of hybrid entity in section 

267A(d)(2), with certain modifications. 

First, the entity must be fiscally 

transparent under the tax law of the 

country in which it is established, 

whether or not it is a tax resident of 

another country. For this purpose, the 

determination of whether an entity is 

fiscally transparent with respect to an 

item of income is made using the 

principles of § 1.894–1(d)(3)(ii) (but 

without regard to whether there is an 

income tax treaty in effect between the 

entity’s jurisdiction and the United 

States). 

Second, the entity must not be fiscally 

transparent under the tax law of an 

‘‘investor.’’ An investor means a tax 

resident or taxable branch that directly 

or indirectly owns an interest in the 

entity. For this purpose, the 

determination of whether an investor’s 

tax law treats the entity as fiscally 

transparent with respect to an item of 

income is made under the principles of 

§ 1.894–1(d)(3)(iii) (but without regard 

to whether there is an income tax treaty 

in effect between the investor’s 

jurisdiction and the United States). If an 

investor views the entity as not fiscally 

transparent, the investor generally will 

not be currently taxed under its tax law 


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on payments to the entity. Thus, the 

non-fiscally-transparent status of the 

entity is determined on an investor-byinvestor basis, based on the tax law of 

each investor. In addition, a tax resident 

or a taxable branch may be an investor 

of a reverse hybrid even if the tax 

resident or taxable branch indirectly 

owns the reverse hybrid through one or 

more intermediary entities that, under 

the tax law of the tax resident or taxable 

branch, are not fiscally transparent. In 

such a case, however, the investor’s noinclusion would not be a result of the 

payment being made to the reverse 

hybrid and therefore would not be a 

disqualified hybrid amount. See also 

section II.E of this Explanation of 

Provisions (explaining that the D/NI 

outcome must be a result of hybridity); 

proposed § 1.267A–6(c), Example 5 

(analyzing whether a D/NI outcome 

with respect to an upper-tier investor is 

a result of the specified payment being 

made to the reverse hybrid). 

When a specified payment is made to 

a reverse hybrid, it is generally a 

disqualified hybrid amount to the extent 

that an investor does not include the 

payment in income. For this purpose, 

whether an investor includes the 

specified payment in income is 

determined without regard to a 

subsequent distribution by the reverse 

hybrid. Although a subsequent 

distribution may be included in the 

investor’s income, the distribution may 

not occur for an extended period and, 

when it does occur, it may be difficult 

to determine whether the distribution is 

funded from an amount comprising the 

specified payment. 

In addition, if an investor takes a 

specified payment into account under 

an anti-deferral regime, then the 

investor is considered to include the 

payment in income to the extent 

provided under the general rules of 

proposed § 1.267A–3(a). See proposed 

§ 1.267A–6(c), Example 5. Thus, for 

example, if the investor’s inclusion 

under the anti-deferral regime is subject 

to tax at a preferential rate, the investor 

is considered to include only a portion 

of the specified payment in income. 

5. Branch Mismatch Payments 

Proposed § 1.267A–2(e) addresses 

branch mismatch payments. These 

payments give rise to a D/NI outcome 

due to differences between the home 

office’s tax law and the branch’s tax law 

regarding the allocation of items of 

income or the treatment of the branch. 

This could occur, for example, if the 

home office’s tax law views a payment 

as attributable to the branch and 

exempts the branch’s income, but the 

branch’s tax law does not tax the 

payment. 

Under the proposed regulations, a 

specified payment is a branch mismatch 

payment when two requirements are 

satisfied. First, under a home office’s tax 

law, the specified payment is treated as 

attributable to a branch of the home 

office. Second, under the tax law of the 

branch country, either (i) the home 

office does not have a taxable presence 

in the country, or (ii) the specified 

payment is treated as attributable to the 

home office and not the branch. When 

a specified payment is a branch 

mismatch payment, it is generally a 

disqualified hybrid amount to the extent 

that the home office does not include 

the payment in income. 

E. Link Between Hybridity and D/NI 

Outcome 

Under section 267A(a), a deduction 

for a payment is generally disallowed if 

(i) the payment involves a hybrid 

arrangement, and (ii) a D/NI outcome 

occurs. In certain cases, although both 

of these conditions are satisfied, the D/ 

NI outcome is not a result of the 

hybridity. For example, in the hybrid 

transaction context, the D/NI outcome 

may be a result of the specified 

recipient’s tax law containing a pure 

territorial system (and thus exempting 

from taxation all foreign source income) 

or not having a corporate income tax, or 

a result of the specified recipient’s 

status as a tax-exempt entity under its 

tax law. 

The proposed regulations provide that 

a D/NI outcome gives rise to a 

disqualified hybrid amount only to the 

extent that the D/NI outcome is a result 

of hybridity. See, for example, proposed 

§ 1.267A–2(a)(1)(ii); see also Senate 

Explanation, at 384 (‘‘[T]he Committee 

believes that hybrid arrangements 

exploit differences in the tax treatment 

of a transaction or entity under the laws 

of two or more jurisdictions to achieve 

double non-taxation . . .’’) (emphasis 

added). 

To determine whether a D/NI 

outcome is a result of hybridity, the 

proposed regulations generally apply a 

test based on facts that are counter to 

the hybridity at issue. For example, in 

the hybrid transaction context, a 

specified recipient’s no-inclusion is a 

result of the specified payment being 

made pursuant to the hybrid transaction 

to the extent that the no-inclusion 

would not occur were the payment to be 

treated as interest or a royalty for 

purposes of the specified recipient’s tax 

law. 

This test also addresses cases in 

which, for example, a specified payment 

is made to a fiscally transparent entity 

(such as a partnership) and owners of 

the entity that are specified recipients of 

the payment each derive only a portion 

of the payment under its tax law. The 

test ensures that, with respect to each 

specified recipient, only the noinclusion that occurs for the portion of 

the specified payment that it derives 

may give rise to a disqualified hybrid 

amount. In addition, as a result of the 

relatedness or structured arrangement 

limitation discussed in section II.F of 

this Explanation of Provisions, the noinclusion with respect to the specified 

recipient is taken into account under the 

proposed regulations only if the 

specified recipient is related to the 

specified party or is a party to a 

structured arrangement pursuant to 

which the specified payment is made. 

F. Relatedness or Structured 

Arrangement Limitation 

In determining whether a specified 

payment is made pursuant to a hybrid 

or branch mismatch arrangement, the 

proposed regulations generally only 

consider the tax laws of tax residents or 

taxable branches that are related to the 

specified party. See proposed § 1.267A– 

2(f). For example, in general, only the 

tax law of a specified recipient that is 

related to the specified party is taken 

into account for purposes of 

determining whether the specified 

payment is made pursuant to a hybrid 

transaction. Because a deemed branch 

payment by its terms involves a related 

home office, the relatedness limitation 

in proposed § 1.267A–2(f) does not 

apply to proposed § 1.267A–2(c). 

The proposed regulations provide that 

related status is determined under the 

rules of section 954(d)(3) (involving 

ownership of more than 50 percent of 

interests) but without regard to 

downward attribution. See proposed 

§ 1.267A–5(a)(14). In addition, to ensure 

that a tax resident may be considered 

related to a specified party even though 

the tax resident is a disregarded entity 

for U.S. tax purposes, the proposed 

regulations provide that such a tax 

resident is treated as a corporation for 

purposes of the relatedness test. A 

similar rule applies with respect to a 

taxable branch. 

However, the Treasury Department 

and the IRS are aware that some hybrid 

arrangements involving unrelated 

parties are designed to give rise to a D/ 

NI outcome and therefore present the 

policy concerns underlying section 

267A. Furthermore, it is likely that in 

such cases the specified party will have, 

or can reasonably obtain, the 

information necessary to comply with 

section 267A. Accordingly, the 

proposed regulations generally provide 


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that the tax law of an unrelated tax 

resident or taxable branch is taken into 

account for purposes of section 267A if 

the tax resident or taxable branch is a 

party to a structured arrangement. See 

proposed § 1.267A–2(f). The proposed 

regulations set forth a test for when a 

transaction is a structured arrangement. 

See proposed § 1.267A–5(a)(20). In 

addition, the proposed regulations 

impute an entity’s participation in a 

structured arrangement to its investors. 

See id. Thus, for example, in the case of 

a specified payment to a partnership 

that is a party to a structured 

arrangement pursuant to which the 

payment is made, a tax resident that is 

a partner of the partnership is also a 

party to the structured arrangement, 

even though the tax resident may not 

have actual knowledge of the structured 

arrangement. 

G. Effect of Inclusion in Another 

Jurisdiction 

The proposed regulations provide that 

a specified payment is a disqualified 

hybrid amount if a D/NI outcome occurs 

as a result of hybridity in any foreign 

jurisdiction, even if the payment is 

included in income in another foreign 

jurisdiction. See proposed § 1.267A– 

6(c), Example 1. Absent such a rule, an 

inclusion of a specified payment in 

income in a jurisdiction with a 

(generally applicable) low rate might 

discharge the application of section 

267A even though a D/NI outcome 

occurs in another jurisdiction as a result 

of hybridity. 

For example, assume FX, a tax 

resident of Country X, owns US1, a 

domestic corporation, and FZ, a tax 

resident of Country Z that is fiscally 

transparent for Country X tax purposes. 

Also, assume that Country Z has a 

single, low-tax rate applicable to all 

income. Further, assume that FX holds 

an instrument issued by US1, a $100x 

payment with respect to which is 

treated as interest for U.S. tax purposes 

and an excludible dividend for Country 

X tax purposes. In an attempt to avoid 

US1’s deduction for the $100x payment 

being denied under the hybrid 

transaction rule, FX contributes the 

instrument to FZ, and, upon US1’s 

$100x payment, US1 asserts that, 

although a $100x no-inclusion occurs 

with respect to FX as a result of the 

payment being made pursuant to the 

hybrid transaction, the payment is not a 

disqualified hybrid amount because FZ 

fully includes the payment in income 

(albeit at a low-tax rate). The proposed 

regulations treat the payment as a 

disqualified hybrid amount. 

This rule only applies for inclusions 

under the laws of foreign jurisdictions. 

See proposed § 1.267A–3(b), and section 

II.H of this Explanation of Provisions, 

for exceptions that apply when the 

payment is included or includible in a 

U.S. tax resident’s or U.S. taxable 

branch’s income. 

The Treasury Department and IRS 

request comments on whether an 

exception should apply if the specified 

payment is included in income in any 

foreign jurisdiction, taking into account 

accommodation transactions involving 

low-tax entities. 

H. Exceptions for Certain Amounts 

Included or Includible in a U.S. Tax 

Resident’s or U.S. Taxable Branch’s 

Income 

Proposed § 1.267A–3(b) provides 

rules that reduce disqualified hybrid 

amounts to the extent the amounts are 

included or includible in a U.S. tax 

resident’s or U.S. taxable branch’s 

income. In general, these rules ensure 

that a specified payment is not a 

disqualified hybrid amount to the extent 

included in the income of a tax resident 

of the United States or a U.S. taxable 

branch, or taken into account by a U.S. 

shareholder under the subpart F or 

GILTI rules. 

Source-based withholding tax 

imposed by the United States (or any 

other country) on disqualified hybrid 

amounts does not neutralize the D/NI 

outcome and therefore does not reduce 

or otherwise affect disqualified hybrid 

amounts. Withholding tax policies are 

unrelated to the policies underlying 

hybrid arrangements—for example, 

withholding tax can be imposed on nonhybrid payments—and, accordingly, 

withholding tax is not a substitute for a 

specified payment being included in 

income by a tax resident or taxable 

branch. See also section II.L of this 

Explanation of Provisions (interaction 

with withholding taxes and income tax 

treaties). Furthermore, other 

jurisdictions applying the defensive or 

secondary rule to a payment (which 

generally requires the payee to include 

the payment in income, if the payer is 

not denied a deduction for the payment 

under the primary rule) may not treat 

withholding taxes as satisfying the 

primary rule and may therefore require 

the payee to include the payment in 

income if a deduction for the payment 

is not disallowed (regardless of whether 

withholding tax has been imposed). 

Thus, the proposed regulations do not 

treat amounts subject to U.S. 

withholding taxes as reducing 

disqualified hybrid amounts. 

Nevertheless, the Treasury Department 

and the IRS request comments on the 

interaction of the proposed regulations 

with withholding taxes and whether, 

and the extent to which, there should be 

special rules under section 267A when 

withholding taxes are imposed in 

connection with a specified payment, 

taking into account how such a rule 

could be coordinated with the hybrid 

mismatch rules of other jurisdictions. 

I. Disqualified Imported Mismatch 

Amounts 

Proposed § 1.267A–4 sets forth a rule 

to address ‘‘imported’’ hybrid and 

branch arrangements. This rule is 

generally intended to prevent the effects 

of an ‘‘offshore’’ hybrid arrangement (for 

example, a hybrid arrangement between 

two foreign corporations completely 

outside the U.S. taxing jurisdiction) 

from being shifted, or ‘‘imported,’’ into 

the U.S. taxing jurisdiction through the 

use of a non-hybrid arrangement. 

Accordingly, the proposed regulations 

disallow deductions for specified 

payments that are ‘‘disqualified 

imported mismatch amounts.’’ In 

general, a disqualified imported 

mismatch amount is a specified 

payment: (i) That is non-hybrid in 

nature, such as interest paid on an 

instrument that is treated as 

indebtedness for both U.S. and foreign 

tax purposes, and (ii) for which the 

income attributable to the payment is 

directly or indirectly offset by a hybrid 

deduction of a foreign tax resident or 

taxable branch. The rule addresses 

‘‘indirect’’ offsets in order to take into 

account, for example, structures 

involving intermediaries where the 

foreign tax resident that receives the 

specified payment is different from the 

foreign tax resident that incurs the 

hybrid deduction. See proposed 

§ 1.267A–6(c), Example 8, Example 9, 

and Example 10. 

In general, a hybrid deduction for 

purposes of the imported mismatch rule 

is an amount for which a foreign tax 

resident or taxable branch is allowed an 

interest or royalty deduction under its 

tax law, to the extent the deduction 

would be disallowed if such tax law 

were to contain rules substantially 

similar to the section 267A proposed 

regulations. For this purpose, it is not 

relevant whether the amount is 

recognized as interest or a royalty under 

U.S. law, or whether the amount would 

be allowed as a deduction under U.S. 

law. Thus, for example, a deduction 

with respect to equity (such as a 

notional interest deduction) constitutes 

a hybrid deduction even though such a 

deduction would not be recognized (or 

allowed) under U.S. tax law. As another 

example, a royalty deduction under 

foreign tax law may constitute a hybrid 

deduction even though for U.S. tax 

purposes the royalty is viewed as made 


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from a disregarded entity to its owner 

and therefore is not regarded. 

The requirement that the deduction 

would be disallowed if the foreign tax 

law were to contain rules substantially 

similar to those under section 267A is 

intended to limit the application of the 

imported mismatch rule to cases in 

which, had the foreign-to-foreign hybrid 

arrangement instead involved a 

specified party, section 267A would 

have applied to disallow the deduction. 

In other words, this requirement 

prevents the imported mismatch rule 

from applying to arrangements outside 

the general scope of section 267A, even 

if the arrangements are hybrid in nature 

and result in a D/NI (or similar) 

outcome. For example, in the case of a 

deductible payment of a foreign tax 

resident to a tax resident of a foreign 

country that does not impose an income 

tax, the deduction would generally not 

be a hybrid deduction—even though it 

may be made pursuant to a hybrid 

instrument—because the D/NI outcome 

would not be a result of hybridity. See 

section II.E of this Explanation of 

Provisions (requiring a link between 

hybridity and the D/NI outcome, for a 

specified payment to be a disqualified 

hybrid amount). 

Further, the proposed regulations 

include ‘‘ordering’’ and ‘‘funding’’ rules 

to determine the extent that a hybrid 

deduction directly or indirectly offsets 

income attributable to a specified 

payment. In addition, the proposed 

regulations provide that certain 

payments made by non-specified parties 

the tax laws of which contain hybrid 

mismatch rules are taken into account 

when applying the ordering and funding 

rules. Together, these provisions are 

intended to coordinate proposed 

§ 1.267A–4 with foreign imported 

mismatch rules, in order to prevent the 

same hybrid deduction from resulting in 

deductions for non-hybrid payments 

being disallowed under imported 

mismatch rules in more than one 

jurisdiction. 

J. Definitions of Interest and Royalty 

1. Interest 

There are no generally applicable 

regulations or statutory provisions 

addressing when financial instruments 

are treated as debt for U.S. tax purposes 

or when a payment is interest. As a 

general matter, however, the factors that 

distinguish debt from equity are 

described in Notice 94–47, 1994–1 C.B. 

357, and interest is defined as 

compensation for the use or forbearance 

of money. Deputy v. Dupont, 308 U.S. 

488 (1940). 

Using these principles, the proposed 

regulations define interest broadly to 

include interest associated with 

conventional debt instruments, other 

amounts treated as interest under the 

Code, as well as transactions that are 

indebtedness in substance although not 

in form. See proposed § 1.267A– 

5(a)(12). 

In addition, in order to address 

certain structured transactions, the 

proposed regulations apply equally to 

‘‘structured payments.’’ Proposed 

§ 1.267A–5(b)(5) defines structured 

payments to include a number of items 

such as an expense or loss 

predominately incurred in 

consideration of the time value of 

money in a transaction or series of 

integrated or related transactions in 

which a taxpayer secures the use of 

funds for a period of time. This 

approach is consistent with the rules 

treating such payments similarly to 

interest under §§ 1.861–9T and 1.954–2. 

The definitions of interest and 

structured payments also provide for 

adjustments to the amount of interest 

expense or structured payments, as 

applicable, to reflect the impact of 

derivatives that affect the economic 

yield or cost of funds of a transaction 

involving interest or structured 

payments. The definitions of interest 

and structured payments contained in 

the proposed regulations apply only for 

purposes of section 267A. However, 

solely for purposes of certain other 

provisions, similar definitions apply. 

For example, the definition of interest 

and structured payments under the 

proposed regulations is similar in scope 

to the definition of items treated 

similarly to interest under § 1.861–9T 

for purposes of allocating and 

apportioning deductions under section 

861 and similar to the items treated as 

interest expense for purposes of section 

163(j) in proposed regulations under 

section 163(j). 

The Treasury Department and the IRS 

considered three options with respect to 

the definition of interest for purposes of 

section 267A. The first option 

considered was to not provide a 

definition of interest, and thus rely on 

general tax principles and case law to 

define interest for purposes of section 

267A. While adopting this option might 

reduce complexity for some taxpayers, 

not providing an explicit definition of 

interest would create its own 

uncertainty as neither taxpayers nor the 

IRS might have a clear sense of what 

types of payments are treated as interest 

expense subject to disallowance under 

section 267A. Such uncertainty could 

increase burdens to the IRS and 

taxpayers by increasing the number of 

disputes about whether particular 

payments are interest for section 267A 

purposes. Moreover, this option could 

be distortive as it would provide an 

incentive to taxpayers to engage in 

transactions generating deductions 

economically similar to interest while 

asserting that such deductions are not 

described by existing principles 

defining interest expense. If successful, 

such strategies could allow taxpayers to 

avoid the application of section 267A 

through transactions that are similar to 

transactions involving interest. 

The second option considered would 

have been to adopt a definition of 

interest but limit the scope of the 

definition to cover only amounts 

associated with conventional debt 

instruments and amounts that are 

generally treated as interest for all 

purposes under the Code or regulations 

prior to the passage of the Act. This 

would be equivalent to only adopting 

the rule that is proposed in § 1.267A– 

5(a)(12)(i) without also addressing 

structured payments, which are 

described in proposed § 1.267A–5(b)(5). 

While this would clarify what would be 

deemed interest for purposes of section 

267A, the Treasury Department and the 

IRS have determined that this approach 

would potentially distort future 

financing transactions. Some taxpayers 

would choose to use financial 

instruments and transactions that 

provide a similar economic result of 

using a conventional debt instrument, 

but would avoid the label of interest 

expense under such a definition, 

potentially enabling these taxpayers to 

avoid the application of section 267A. 

As a result, under this second approach, 

there would still be an incentive for 

taxpayers to engage in the type of 

avoidance transactions discussed in the 

first alternative. 

The final option considered and the 

one ultimately adopted in the proposed 

regulations is to provide a complete 

definition of interest that addresses all 

transactions that are commonly 

understood to produce interest expense, 

as well as structured payments that may 

have been entered into to avoid the 

application of section 267A. The 

proposed regulations also reduce 

taxpayer burden by adopting definitions 

of interest that have already been 

developed and administered in 

§§ 1.861–9T and 1.954–2 and that have 

been proposed for purposes of section 

163(j). The definition of interest 

provided in the proposed regulations 

applies only for purposes of section 

267A and not for other purposes of the 

Code, such as section 904(d)(3). 

The Treasury Department and the IRS 

welcome comments on the definition of 


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interest for purposes of section 267A 

contained in the proposed regulations. 

2. Royalty 

Section 267A does not define the term 

royalty and there is no universal 

definition of royalty under the Code. 

The Treasury Department and the IRS 

considered providing no definition for 

royalties. However, similar to the 

discussion in Section II.J.1 of this 

Explanation of Provisions with respect 

to the definition of interest, not 

providing a definition for royalties and 

relying instead on general tax principles 

could create uncertainty as neither 

taxpayers nor the IRS might have a clear 

sense of what types of payments are 

treated as royalties subject to 

disallowance under section 267A. Such 

uncertainty could increase burdens to 

the IRS and taxpayers with respect to 

disputes about whether particular 

payments are royalties for section 267A 

purposes. 

Instead, the Treasury Department and 

the IRS have determined that providing 

a definition of royalties would increase 

certainty, and therefore the proposed 

regulations define the term royalty for 

purposes of section 267A to include 

amounts paid or accrued as 

consideration for the use of, or the right 

to use, certain intellectual property and 

certain information concerning 

industrial, commercial or scientific 

experience. See proposed § 1.267A– 

5(a)(16). The term does not include 

amounts paid or accrued for after-sales 

services, for services rendered by a 

seller to the purchaser under a warranty, 

for pure technical assistance, or for an 

opinion given by an engineer, lawyer or 

accountant. The definition of royalty 

provided in the proposed regulations 

applies only for purposes of section 

267A and not for other purposes of the 

Code, such as section 904(d)(3). 

The definition of royalty is generally 

based on the definition used in tax 

treaties and, in particular, the definition 

incorporated into Article 12 of the 2006 

U.S. Model Income Tax Treaty. This 

definition is also generally consistent 

with the language of section 861(a)(4). 

In addition, similar to the approach in 

the technical explanation to Article 12 

of the 2006 U.S. Model Income Tax 

Treaty, the proposed regulations 

provide certain circumstances where 

payments are not treated as paid or 

accrued in consideration for the use of 

information concerning industrial, 

commercial or scientific experience. By 

using definitions that have already been 

developed and administered in other 

contexts, the proposed regulations 

provide an approach that reduces 

taxpayer burdens and uncertainty. The 

Treasury Department and the IRS 

welcome comments on the definition of 

royalty for purposes of section 267A 

contained in the proposed regulations. 

K. Miscellaneous Issues 

1. Effect of Foreign Currency Gain or 

Loss 

The proposed regulations provide that 

foreign currency gain or loss recognized 

under section 988 is not separately 

taken into account under section 267A. 

See proposed § 1.267A–5(b)(2). Rather, 

foreign currency gain or loss recognized 

with respect to a specified payment is 

taken into account under section 267A 

only to the extent that the specified 

payment is in respect of accrued interest 

or an accrued royalty for which a 

deduction is disallowed under section 

267A. Thus, for example, a section 988 

loss recognized with respect to a 

specified payment of interest is not 

separately taken into account under 

section 267A (even though under the tax 

law of the tax resident to which the 

specified payment is made the tax 

resident does not include in income an 

amount corresponding to the section 

988 loss, as the specified payment is 

made in the tax resident’s functional 

currency). 

The Treasury Department and the IRS 

recognize that additional rules 

addressing the effect of different foreign 

currencies may be necessary. For 

example, a hybrid deduction for 

purposes of the imported mismatch rule 

may be denominated in a different 

currency than a specified payment, in 

which case a translation rule may be 

necessary to determine the amount of 

the specified payment that is subject to 

the imported mismatch rule. The 

Treasury Department and the IRS 

request comments on foreign currency 

rules, including any rules regarding the 

translation of amounts between 

currencies, for purposes of the proposed 

regulations under sections 245A and 

267A. 

2. Payments by U.S. Taxable Branches 

Certain expenses incurred by a 

nonresident alien or foreign corporation 

are allowed as deductions under 

sections 873(a) and 882(c) in 

determining that person’s effectively 

connected income. To the extent the 

deductions arise from transactions 

involving certain hybrid or branch 

arrangements, the deductions should be 

disallowed under section 267A, as 

discussed in section II.B of this 

Explanation of Provisions. The 

proposed regulations do so by (i) 

treating a U.S. taxable branch (which 

includes a permanent establishment of a 

foreign person) as a specified party, and 

(ii) providing rules regarding interest or 

royalties considered paid or accrued by 

a U.S. taxable branch, solely for 

purposes of section 267A (and thus not 

for other purposes, such as chapter 3 of 

the Code). See proposed § 1.267A– 

5(b)(3). The effect of this approach is 

that interest or royalties considered paid 

or accrued by a U.S. taxable branch are 

specified payments that are subject to 

the rules of proposed §§ 1.267A–1 

through 1.267A–4. See also proposed 

§ 1.267A–6(c), Example 4. 

In general, a U.S. taxable branch is 

considered to pay or accrue any interest 

or royalties allocated or apportioned to 

effectively connected income of the U.S. 

taxable branch. See proposed § 1.267A– 

5(b)(3)(i). However, if a U.S. taxable 

branch constitutes a U.S. permanent 

establishment of a treaty resident, then 

the U.S. permanent establishment is 

considered to pay or accrue the interest 

or royalties deductible in computing its 

business profits. Although interest paid 

by a U.S. taxable branch may be subject 

to withholding tax as determined under 

section 884(f)(1)(A) and § 1.884–4, those 

rules are not relevant for purposes of 

section 267A. 

The proposed regulations also provide 

rules to identify the manner in which a 

specified payment of a U.S. taxable 

branch is considered made. See 

proposed § 1.267A–5(b)(3)(ii). Absent 

such rules, it might be difficult to 

determine whether the specified 

payment is made pursuant to a hybrid 

or branch arrangement (for example, 

made pursuant to a hybrid transaction 

or to a reverse hybrid). However, these 

rules regarding the manner in which a 

specified payment is made do not apply 

to interest or royalties deemed paid by 

a U.S. permanent establishment in 

connection with inter-branch 

transactions that are permitted to be 

taken into account under certain U.S. 

tax treaties—such payments, by 

definition, constitute deemed branch 

payments (subject to disallowance 

under proposed § 1.267A–2(c)) and are 

therefore made pursuant to a branch 

arrangement. 

3. Coordination With Other Provisions 

Proposed § 1.267A–5(b)(1) 

coordinates the application of section 

267A with other provisions of the Code 

and regulations that affect the 

deductibility of interest and royalties. 

This rule provides that, in general, 

section 267A applies after the 

application of other provisions of the 

Code and regulations. For example, a 

specified payment is subject to section 

267A for the taxable year for which a 

deduction for the payment would 


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otherwise be allowed. Thus, if a 

deduction for an accrued amount is 

deferred under section 267(a) (in certain 

cases, deferring a deduction for an 

amount accrued to a related foreign 

person until paid), then the deduction is 

tested for disallowance under section 

267A for the taxable year in which the 

amount is paid. Absent such a rule, an 

accrued amount for which a deduction 

is deferred under section 267(a) could 

constitute a disqualified hybrid amount 

even though the amount will be 

included in the specified recipient’s 

income when actually paid. This 

coordination rule also provides that 

section 267A applies to interest or 

royalties after taking into account 

provisions that could otherwise 

recharacterize such amounts, such as 

§ 1.894–1(d)(2). 

4. E&P Reduction 

Proposed § 1.267A–5(b)(4) provides 

that the disallowance of a deduction 

under section 267A does not affect 

whether or when the amount paid or 

accrued that gave rise to the deduction 

reduces earnings and profits of a 

corporation. Thus, a corporation’s 

earnings and profits may be reduced as 

a result of a specified payment for 

which a deduction is disallowed under 

section 267A. This is consistent with 

the approach in the context of other 

disallowance rules. See § 1.312–7(b)(1) 

(‘‘A loss . . . may be recognized though 

not allowed as a deduction (by reason, 

for example, of the operation of sections 

267 and 1211 . . .) but the mere fact that 

it is not allowed does not prevent a 

decrease in earnings and profits by the 

amount of such disallowed loss.’’); 

Luckman v. Comm’r, 418 F.2d 381, 383– 

84 (7th Cir. 1969) (‘‘[T]rue expenses 

incurred by the corporation reduce 

earnings and profits despite their 

nondeductibility from current income 

for tax purposes.’’). 

5. De Minimis Exception 

The proposed regulations provide a 

de minimis exception to make the rules 

more administrable. See proposed 

§ 1.267A–1(c). As a result of this 

exception, a specified party is excepted 

from the application of section 267A for 

any taxable year for which the sum of 

its interest and royalty deductions (plus 

interest and royalty deductions of any 

related specified parties) is below 

$50,000. This rule applies based on any 

interest or royalty deductions, 

regardless of whether the deductions 

would be disallowed under section 

267A. In addition, for purposes of this 

rule, specified parties that are related 

are treated as a single specified party. 

The Treasury Department and the IRS 

welcome comments on the de minimis 

exception and whether another 

threshold would be more appropriate to 

implement the purposes of section 

267A. 

L. Interaction With Withholding Taxes 

and Income Tax Treaties 

The determination of whether a 

deduction for a specified payment is 

disallowed under section 267A is made 

without regard to whether the payment 

is subject to withholding under section 

1441 or 1442 or is eligible for a reduced 

rate of tax under an income tax treaty. 

Since the U.S. tax characterization of 

the payment prevails in determining the 

treaty rate for interest or royalties, 

regardless of whether the payment is 

made pursuant to a hybrid transaction, 

the proposed regulations will generally 

result in the disallowance of a 

deduction but treaty benefits may still 

be claimed, as long as the recipient is 

the beneficial owner of the payment and 

otherwise eligible for treaty benefits. On 

the other hand, if interest or royalties 

are paid to a fiscally transparent entity 

that is a reverse hybrid, as defined in 

proposed § 1.267A–2(d), the payment 

generally will not be deductible under 

the proposed regulations if the investor 

does not derive the payment, and will 

not be eligible for treaty benefits if the 

interest holder under § 1.894–1(d) does 

not derive the payment. The proposed 

regulations will only apply, however, if 

the investor is related to the specified 

party, whereas the reduced rate under 

the treaty may be denied without regard 

to whether the interest holder is related 

to the payer of the interest or royalties. 

Certain U.S. income tax treaties also 

address indirectly the branch mismatch 

rules under proposed § 1.267A–2(e). 

Special rules, generally in the limitation 

on benefits articles of income tax 

treaties, increase the tax treaty rate for 

interest and royalties to 15 percent 

(even if otherwise not taxable under the 

relevant treaty article) if the amount 

paid to a permanent establishment of 

the treaty resident is subject to minimal 

tax, and the foreign corporation that 

derives and beneficially owns the 

payment is a resident of a treaty country 

that excludes or otherwise exempts from 

gross income the profits attributable to 

the permanent establishment to which 

the payment was made. 

III. Information Reporting Under 

Sections 6038, 6038A, and 6038C 

Under section 6038(a)(1), U.S. persons 

that control foreign business entities 

must file certain information returns 

with respect to those entities, which 

includes information listed in section 

6038(a)(1)(A) through (a)(1)(E), as well 

as information that ‘‘the Secretary 

determines to be appropriate to carry 

out the provisions of this title.’’ Section 

6038A similarly requires 25-percent 

foreign-owned domestic corporations 

(reporting corporations) to file certain 

information returns with respect to 

those corporations, including 

information related to transactions 

between the reporting corporation and 

each foreign person which is a related 

party to the reporting corporation. 

Section 6038C imposes the same 

reporting requirements on certain 

foreign corporations engaged in a U.S. 

trade or business (also, a reporting 

corporation). 

The proposed regulations provide that 

a specified payment for which a 

deduction is disallowed under section 

267A, as well as hybrid dividends and 

tiered hybrid dividends under section 

245A, must be reported on the 

appropriate information reporting form 

in accordance with sections 6038 and 

6038A. See proposed §§ 1.6038–2(f)(13) 

and (14), 1.6038–3(g)(3), and 1.6038A– 

2(b)(5)(iii). 

IV. Sections 1503(d) and 7701— 

Application to Domestic Reverse 

Hybrids 

A. Overview 

1. Dual Consolidated Loss Rules 

Congress enacted section 1503(d) to 

prevent the ‘‘double dipping’’ of losses. 

See S. Rep. 313, 99th Cong., 2d Sess., at 

419–20 (1986). The Senate Report 

explains that ‘‘losses that a corporation 

uses to offset foreign tax on income that 

the United States does not subject to tax 

should not also be used to reduce any 

other corporation’s U.S. tax.’’ Id. Section 

1503(d) and the regulations thereunder 

generally provide that, subject to certain 

exceptions, a dual consolidated loss of 

a corporation cannot reduce the taxable 

income of a domestic affiliate (a 

‘‘domestic use’’). See §§ 1.1503(d)–2 and 

1.1503–4(b). Section 1.1503(d)–1(b)(5) 

defines a dual consolidated loss as a net 

operating loss of a dual resident 

corporation or the net loss attributable 

to a separate unit (generally defined as 

either a foreign branch or an interest in 

a hybrid entity). See § 1.1503(d)–1(b)(4). 

The general prohibition against the 

domestic use of a dual consolidated loss 

does not apply if, pursuant to a 

‘‘domestic use election,’’ the taxpayer 

certifies that there has not been and will 

not be a ‘‘foreign use’’ of the dual 

consolidated loss during a certification 

period. See § 1.1503(d)–6(d). If a foreign 

use or other triggering event occurs 

during the certification period, the dual 

consolidated loss is recaptured. A 


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foreign use occurs when any portion of 

the dual consolidated loss is made 

available to offset the income of a 

foreign corporation or the direct or 

indirect owner of a hybrid entity 

(generally non-dual inclusion income). 

See § 1.1503(d)–3(a)(1). Other triggering 

events include certain transfers of the 

stock or assets of a dual resident 

corporation, or the interests in or assets 

of a separate unit. See § 1.1503(d)–6(e). 

The regulations include a ‘‘mirror 

legislation’’ rule that, in general, 

prevents a domestic use election when 

a foreign jurisdiction has enacted 

legislation similar to section 1503(d) 

that denies any opportunity for a foreign 

use of the dual consolidated loss. See 

§ 1.1503(d)–3(e). As a result, the 

existence of mirror legislation may 

prevent the dual consolidated loss from 

being put to a domestic use (due to the 

domestic use limitation) or to a foreign 

use (due to the foreign ‘‘mirror 

legislation’’) such that the loss becomes 

‘‘stranded.’’ In such a case, the 

regulations contemplate that the 

taxpayer may enter into an agreement 

with the United States and the foreign 

country (for example, through the 

competent authorities) pursuant to 

which the losses are used in only one 

country. See § 1.1503(d)–6(b). 

2. Entity Classification Rules 

Sections 301.7701–1 through 

301.7701–3 classify a business entity 

with two or more members as either a 

corporation or a partnership, and a 

business entity with a single owner as 

either a corporation or a disregarded 

entity. Certain domestic business 

entities, such as limited liability 

companies, are classified by default as 

partnerships (if they have more than one 

member) or as disregarded entities (if 

they have only one owner) but are 

eligible to elect for federal tax purposes 

to be classified as corporations. See 

§ 301.7701–3(b)(1). 

B. Domestic Reverse Hybrids 

The Treasury Department and the IRS 

are aware that structures involving 

domestic reverse hybrids have been 

used to obtain double-deduction 

outcomes because they were not subject 

to limitation under current section 

1503(d) regulations. A domestic reverse 

hybrid generally refers to a domestic 

business entity that elects under 

§ 301.7701–3(c) to be treated as a 

corporation for U.S. tax purposes, but is 

treated as fiscally transparent under the 

tax law of its investors. In these 

structures, a foreign parent corporation 

typically owns the majority of the 

interests in the domestic reverse hybrid. 

Domestic reverse hybrid structures can 

lead to double-deduction outcomes 

because, for example, deductions 

incurred by the domestic reverse hybrid 

can be used (i) under U.S. tax law to 

offset income that is not subject to tax 

in the foreign parent’s country, such as 

income of domestic corporations with 

which the domestic reverse hybrid files 

a U.S. consolidated return, and (ii) 

under the foreign parent’s tax law to 

offset income not subject to U.S. tax, 

such as income of the foreign parent 

other than the income (if any) of the 

domestic reverse hybrid. Taxpayers take 

the position that these structures are not 

subject to the current section 1503(d) 

regulations because the domestic 

reverse hybrid is neither a dual resident 

corporation (because it is not subject to 

tax on a residence basis or on its 

worldwide income in the foreign parent 

country) nor a separate unit of a 

domestic corporation. 

A comment on regulations under 

section 1503(d) that were proposed in 

2005 asserted that this result is 

inconsistent with the policies 

underlying section 1503(d), which was 

adopted, in part, to ensure that domestic 

corporations were not put at a 

competitive disadvantage as compared 

to foreign corporations through the use 

of certain inbound acquisition 

structures. See TD 9315. The comment 

suggested that the scope of the final 

regulations be broadened to treat such 

entities as separate units, the losses of 

which are subject to the restrictions of 

section 1503(d). Id. 

In response to this comment, the 

preamble to the 2007 final dual 

consolidated loss regulations stated that 

the Treasury Department and the IRS 

acknowledged that this type of structure 

results in a double dip similar to that 

which Congress intended to prevent 

through the adoption of section 1503(d). 

The final regulations did not address 

these structures, however, because the 

Treasury Department and the IRS 

determined at that time that a domestic 

reverse hybrid was neither a dual 

resident corporation nor a separate unit 

and, therefore, was not subject to 

section 1503(d). See TD 9315. The 

preamble noted, however, that the 

Treasury Department and the IRS would 

continue to study these and similar 

structures. 

The Treasury Department and the IRS 

have determined that these structures 

are inconsistent with the principles of 

section 1503(d) and, as a result, raise 

significant policy concerns. 

Accordingly, the proposed regulations 

include rules under sections 1503(d) 

and 7701 to prevent the use of these 

structures to obtain a double-deduction 

outcome. The proposed regulations 

require, as a condition to a domestic 

entity electing to be treated as a 

corporation under § 301.7701–3(c), that 

the domestic entity consent to be treated 

as a dual resident corporation for 

purposes of section 1503(d) (such an 

entity, a ‘‘domestic consenting 

corporation’’) for taxable years in which 

two requirements are satisfied. See 

proposed § 301.7701–3(c)(3). The 

requirements are intended to restrict the 

application of section 1503(d) to cases 

in which it is likely that losses of the 

domestic consenting corporation could 

result in a double-deduction outcome. 

The requirements are satisfied if (i) a 

‘‘specified foreign tax resident’’ 

(generally, a body corporate that is a tax 

resident of a foreign country) under its 

tax law derives or incurs items of 

income, gain, deduction, or loss of the 

domestic consenting corporation, and 

(ii) the specified foreign tax resident is 

related to the domestic consenting 

corporation (as determined under 

section 267(b) or 707(b)). See proposed 

§ 1.1503(d)–1(c). For example, the 

requirements are satisfied if a specified 

foreign tax resident directly owns all the 

interests in the domestic consenting 

corporation and the domestic 

consenting corporation is fiscally 

transparent under the specified foreign 

tax resident’s tax law. In addition, an 

item of the domestic consenting 

corporation for a particular taxable year 

is considered derived or incurred by the 

specified tax resident during that year 

even if, under the specified foreign tax 

resident’s tax law, the item is 

recognized in, and derived or incurred 

by the specified foreign tax resident in, 

a different taxable year. 

Further, if a domestic entity filed an 

election to be treated as a corporation 

before December 20, 2018 such that the 

entity was not required to consent to be 

treated as a dual resident corporation, 

then the entity is deemed to consent to 

being treated as a dual resident 

corporation as of its first taxable year 

beginning on or after the end of a 12- 

month transition period. This deemed 

consent can be avoided if the entity 

elects, effective before its first taxable 

year beginning on or after the end of the 

transition period, to be treated as a 

partnership or disregarded entity such 

that it ceases to be a corporation for U.S. 

tax purposes. For purposes of such an 

election, the 60 month limitation under 

§ 301.7701–3(c)(1)(iv) is waived. 

Finally, the proposed regulations 

provide that the mirror legislation rule 

does not apply to dual consolidated 

losses of a domestic consenting 

corporation. See proposed § 1.1503(d)– 

3(e)(3). This exception is intended to 

minimize cases in which dual 


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consolidated losses could be ‘‘stranded’’ 

when, for example, the foreign parent 

jurisdiction has adopted rules similar to 

the recommendations in Chapter 6 of 

the Hybrid Mismatch Report. The 

exception does not apply to dual 

consolidated losses attributable to 

separate units because, in such cases, 

the United States is the parent 

jurisdiction and the dual consolidated 

loss rules should neutralize the doublededuction outcome. 

V. Triggering Event Exception for 

Compulsory Transfers 

As noted in section IV.A.1 of this 

Explanation of Provisions, certain 

triggering events require a dual 

consolidated loss that is subject to a 

domestic use election to be recaptured 

and included in income. The dual 

consolidated loss regulations also 

include various exceptions to these 

triggering events, including an 

exception for compulsory transfers 

involving foreign governments. See 

§ 1.1503(d)–6(f)(5). 

A comment on the 2007 final dual 

consolidated loss regulations stated that 

the policies underlying the triggering 

event exception for compulsory 

transfers involving foreign governments 

apply equally to compulsory transfers 

involving the United States government. 

Accordingly, the comment requested 

guidance under § 1.1503(d)–3(c)(9) to 

provide that the exception is not limited 

to foreign governments. The comment 

suggested, as an example, that the 

exception should apply to a divestiture 

of a hybrid entity engaged in proprietary 

trading pursuant to the ‘‘Volcker Rule’’ 

contained in the Dodd-Frank Wall Street 

Reform and Consumer Protection Act, 

Public Law 111–203 (2010). 

The Treasury Department and the IRS 

agree with this comment and, 

accordingly, the proposed regulations 

modify the compulsory transfer 

triggering event exception such that it 

will also apply with respect to the 

United States government. 

VI. Disregarded Payments Made to 

Domestic Corporations 

As discussed in sections II.D.2 and 3 

of this Explanation of Provisions, the 

proposed regulations under section 

267A address D/NI outcomes resulting 

from actual and deemed payments of 

interest and royalties that are regarded 

for U.S. tax purposes but disregarded for 

foreign tax purposes. The proposed 

regulations under section 267A do not, 

however, address similar structures 

involving payments to domestic 

corporations that are regarded for 

foreign tax purposes but disregarded for 

U.S. tax purposes. 

For example, USP, a domestic 

corporation that is the parent of a 

consolidated group, borrows from a 

bank to fund the acquisition of the stock 

of FT, a foreign corporation that is tax 

resident of Country X. USP contributes 

the loan proceeds to USS, a newly 

formed domestic corporation that is a 

member of the USP consolidated group, 

in exchange for all the stock of USS. 

USS then forms FDE, a disregarded 

entity that is tax resident of Country X, 

USS lends the loan proceeds to FDE, 

and FDE uses the proceeds to acquire 

the stock of FT. For U.S. tax purposes, 

USP claims a deduction for interest paid 

on the bank loan, and USS does not 

recognize interest income on interest 

payments made to it from FDE because 

the payments are disregarded. For 

Country X tax purposes, the interest 

paid from FDE to USS is regarded and 

gives rise to a loss that can be 

surrendered (or otherwise used, such as 

through a consolidation regime) to offset 

the operating income of FT. 

Under the current section 1503(d) 

regulations, the loan from USS to FDE 

does not result in a dual consolidated 

loss attributable to USS’s interest in FDE 

because interest paid on the loan is not 

regarded for U.S. tax purposes; only 

items that are regarded for U.S. tax 

purposes are taken into account for 

purposes of determining a dual 

consolidated loss. See § 1.1503(d)– 

5(c)(1)(ii). In addition, the regarded 

interest expense of USP is not attributed 

to USS’s interest in FDE because only 

regarded items of USS, the domestic 

owner of FDE, are taken into account for 

purposes of determining a dual 

consolidated loss. Id. The result would 

generally be the same, however, even if 

USS, rather than USP, were the 

borrower on the bank loan. See 

§ 1.1503(d)–7(c), Example 23. 

The Treasury Department and the IRS 

have determined that these transactions 

raise significant policy concerns that are 

similar to those relating to the D/NI 

outcomes addressed by sections 245A(e) 

and 267A, and the double-deduction 

outcomes addressed by section 1503(d). 

The Treasury Department and the IRS 

are studying these transactions and 

request comments. 

VII. Applicability Dates 

Under section 7805(b)(2), and 

consistent with the applicability date of 

section 245A, proposed § 1.245A(e)–1 

applies to distributions made after 

December 31, 2017. Under section 

7805(b)(2), proposed §§ 1.267A–1 

through 1.267A–6 generally apply to 

specified payments made in taxable 

years beginning after December 31, 

2017. This applicability date is 

consistent with the applicability date of 

section 267A. The Treasury Department 

and the IRS therefore expect to finalize 

such provisions by June 22, 2019. See 

section 7805(b)(2). However if such 

provisions are finalized after June 22, 

2019, then the Treasury Department and 

the IRS expect that such provisions will 

apply only to taxable years ending on or 

after December 20, 2018. See section 

7805(b)(1)(B). 

As provided in proposed § 1.267A– 

7(b), certain rules, such as the 

disregarded payment and deemed 

branch payment rules as well as the 

imported mismatch rule, apply to 

specified payments made in taxable 

years beginning on or after December 

20, 2018. See section 7805(b)(1)(B). 

Proposed §§ 1.6038–2, 1.6038–3, and 

1.6038A–2, which require certain 

reporting regarding deductions 

disallowed under section 267A, as well 

as hybrid dividends and tiered hybrid 

dividends under section 245A, apply 

with respect to information for annual 

accounting periods or tax years, as 

applicable, beginning on or after 

December 20, 2018. See section 

7805(b)(1)(B). 

Proposed §§ 1.1503(d)–1 and –3, 

treating domestic consenting 

corporations as dual resident 

corporations, apply to taxable years 

ending on or after December 20, 2018. 

See section 7805(b)(1)(B). 

Proposed § 1.1503(d)–6, amending the 

compulsory transfer triggering event 

exception, applies to transfers that occur 

on or after December 20, 2018, but 

taxpayers may apply the rules to earlier 

transfers. See section 7805(b)(1)(B). 

Proposed § 301.7701–3(a) and (c)(3) 

apply to a domestic eligible entity that 

on or after December 20, 2018 files an 

election to be classified as an 

association (regardless of whether the 

election is effective before December 20, 

2018). These provisions also apply to 

certain domestic eligible entities the 

interests in which are transferred or 

issued on or after December 20, 2018. 

See section 7805(b)(1)(B). 

Special Analyses 

I. Regulatory Planning and Review 

Executive Orders 13771, 13563, and 

12866 direct agencies to assess costs and 

benefits of available regulatory 

alternatives and, if regulation is 

necessary, to select regulatory 

approaches that maximize net benefits, 

including potential economic, 

environmental, public health and safety 

effects, distributive impacts, and equity. 

Executive Order 13563 emphasizes the 

importance of quantifying both costs 

and benefits, reducing costs, 


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harmonizing rules, and promoting 

flexibility. The preliminary E.O. 13771 

designation for this proposed 

rulemaking is regulatory. 

The proposed regulations have been 

designated by the Office of Management 

and Budget’s Office of Information and 

Regulatory Affairs (OIRA) as subject to 

review under Executive Order 12866 

pursuant to the Memorandum of 

Agreement (April 11, 2018) between the 

Treasury Department and the Office of 

Management and Budget regarding 

review of tax regulations (‘‘MOA’’). 

OIRA has determined that the proposed 

rulemaking is economically significant 

and subject to review under E.O. 12866 

and section 1(c) of the Memorandum of 

Agreement. Accordingly, the proposed 

regulations have been reviewed by the 

Office of Management and Budget. 

A. Background 

Hybrid arrangements include both 

‘‘hybrid entities’’ and ‘‘hybrid 

instruments.’’ A hybrid entity is 

generally an entity which is treated as 

a flow-through or disregarded entity for 

U.S. tax purposes but as a corporation 

for foreign tax purposes or vice versa. 

Hybrid instruments are financial 

instruments that share characteristics of 

both debt and equity and are treated as 

debt for U.S. tax purposes and equity in 

the foreign jurisdiction or vice versa. 

Before the Act, U.S. subsidiaries of 

foreign-based multinational enterprises 

could employ cross-border hybrid 

arrangements as legal tax-avoidance 

techniques by exploiting differences in 

tax treatment across jurisdictions. These 

arrangements allowed taxpayers to 

claim tax deductions in the United 

States without a corresponding 

inclusion in another jurisdiction. 

The United States has a check-the-box 

regulatory provision, under which some 

taxpayers can choose whether they are 

treated as corporations, where they may 

face a separate entity level tax, or as 

partnerships, where there is no such 

separate entity tax (but rather only 

owner-level tax), under the U.S. tax 

code. This choice allows taxpayers the 

ability to become hybrid entities that are 

viewed as corporations in one 

jurisdiction, but not in another. For 

example, a foreign parent could own a 

domestic subsidiary limited liability 

partnership (LLP) that, under the checkthe-box rules, elects to be treated as a 

corporation under U.S. tax law. 

However, this subsidiary could be 

viewed as a partnership under foreign 

tax law. The result is that the domestic 

subsidiary could be entitled to a 

deduction for U.S. tax purposes for 

making interest payments to the foreign 

parent, but the foreign country would 

see a payment between a partnership 

and a partner, and therefore would not 

tax the interest income. That is, the 

corporate structure would enable the 

business entity to avoid paying U.S. tax 

on the interest by allowing a deduction 

attributable to an intra-group loan, 

despite the interest income never being 

included under foreign tax law. 

In addition, there are hybrid 

instruments, which share characteristics 

of both debt and equity. Because of 

these shared characteristics, countries 

may be inconsistent in their treatment of 

such instruments. One example is 

perpetual debt, which many countries 

treat as debt, but the United States treats 

as equity. If a foreign affiliate of a U.S.- 

based multinational issued perpetual 

debt to a U.S. holder, the interest 

payments would be tax deductible in a 

foreign jurisdiction that treats the 

instrument as debt, while the payments 

are treated as dividends in the United 

States and potentially eligible for a 

dividends received deduction (DRD). 

The Act adds section 245A(e) to the 

Code to address issues of hybridity by 

introducing a hybrid dividends 

provision, which disallows the DRD for 

any dividend received by a U.S. 

shareholder from a controlled foreign 

corporation if the dividend is a hybrid 

dividend. The statute defines a hybrid 

dividend as an amount received from a 

controlled foreign corporation for which 

a deduction would be allowed under 

section 245A(a) and for which the 

controlled foreign corporation received 

a deduction or other tax benefit in a 

foreign country. Hybrid dividends 

between controlled foreign corporations 

with a common U.S. shareholder are 

treated as subpart F income. 

The Act also adds section 267A of the 

Code to deny a deduction for any 

disqualified related party amount paid 

or accrued as a result of a hybrid 

transaction or by, or to, a hybrid entity. 

The statute defines a disqualified 

related party amount as any interest or 

royalty paid or accrued to a related 

party where there is no corresponding 

inclusion to the related party in the 

other tax jurisdiction or the related 

party is allowed a deduction with 

respect to such amount in the other tax 

jurisdiction. The statute’s definition of a 

hybrid transaction is any transaction 

where there is a mismatch in tax 

treatment between the U.S. and the 

other foreign jurisdiction. Similarly, a 

hybrid entity is any entity which is 

treated as fiscally transparent for U.S. 

tax purposes but not for purposes of the 

foreign tax jurisdiction, or vice versa. 

B. Overview 

The hybrids provisions in the Act and 

the proposed regulations are anti-abuse 

measures. Taxpayers have been taking 

aggressive tax positions to take 

advantage of tax treatment mismatches 

between jurisdictions in order to 

achieve favorable tax outcomes at the 

detriment of tax revenues (see OECD/ 

G20 Hybrid Mismatch Report, October 

2015 and OECD/G20 Branch Mismatch 

Report, July 2017). The statute and the 

proposed regulations serve to conform 

the U.S. tax system to recently agreedupon international tax principles (see 

OECD/G20 Hybrids Mismatch Report, 

October 2015 and OECD/G20 Branch 

Mismatch Report, July 2017), consistent 

with statutory intent, while protecting 

U.S. interests and the U.S. tax base. 

International tax coordination is 

particularly advantageous in the context 

of hybrids as it has the potential to 

greatly curb opportunities for hybrid 

arrangements, while avoiding double 

taxation. The anticipated effect of the 

statute and proposed regulations is a 

reduction in tax revenue loss due to 

hybrid arrangements, at the cost of an 

increase in compliance burden for a 

limited number of sophisticated 

taxpayers, as explained below. 

C. Need for the Proposed Regulations 

Because the Act introduced new 

sections to the Code to address hybrid 

entities and hybrid instruments, a large 

number of the relevant terms and 

necessary calculations that taxpayers are 

currently required to apply under the 

statute can benefit from greater 

specificity. Taxpayers will lack clarity 

on which types of arrangements are 

subject to the statute without the 

additional interpretive guidance and 

clarifications contained in the proposed 

regulations. This lack of clarity could 

lead to a shifting of corporate income 

overseas through hybrid arrangements, 

further eroding U.S. tax revenues. 

Without accompanying rules to cover 

branches, structured arrangements, 

imported mismatches, and similar 

structures, the statute would be 

extremely easy to avoid, a pathway that 

is contrary to Congressional intent. It 

could also lead to otherwise similar 

taxpayers interpreting the statute 

differently, distorting the equity of tax 

treatment for otherwise similarly 

situated taxpayers. Finally, the lack of 

clarity could cause some taxpayers 

unnecessary compliance burden if they 

misinterpret the statute. 


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D. Economic Analysis 

1. Baseline 

The Treasury Department and the IRS 

have assessed the benefits and costs of 

the proposed regulations relative to a 

no-action baseline reflecting anticipated 

tax-related behavior and other economic 

behavior in the absence of the proposed 

regulations. 

The baseline includes the Act, which 

effectively cut the top statutory 

corporate income tax rate from 35 to 21 

percent. This change lowered the value 

of using hybrid arrangements for 

multinational corporations, because the 

value of such arrangements is 

proportional to the tax they allow the 

corporation to avoid. As such, some 

firms with an incentive to set up hybrid 

arrangements prior to the Act would no 

longer find it profitable to maintain 

these arrangements. The Act also 

modified section 163(j), and regulations 

interpreting this provision are expected 

to be finalized soon, which together 

further limit the deductibility of interest 

payments. These statutory and 

regulatory changes further curb the 

incentive to set up and maintain hybrid 

arrangements for multinational 

corporations, since interest payments 

are a primary vehicle through which 

hybrid arrangements generated 

deductions prior to the Act. Further, 

prior to the Act, the Treasury 

Department and the IRS issued a series 

of regulations that reduced or 

eliminated the incentive for 

multinational corporations to invert, or 

change their tax residence to avoid U.S. 

taxes (including setting up some hybrid 

arrangements). As a result, under the 

baseline, the value of hybrid 

arrangements reflects the existing 

regulatory framework and the Act and 

its associated soon-to-be-finalized 

regulations, all of which strongly affect 

the value of hybrid arrangements as a 

tax avoidance technique. 

2. Anticipated Costs and Benefits 

i. Economic Effects 

The Treasury Department has 

determined that the discretionary nonrevenue impacts of the proposed hybrid 

regulations will reduce U.S. Gross 

Domestic Product (GDP) by less than 

$100 million per year ($2018). 

To evaluate this effect, the Treasury 

Department considered the share of 

interest deductions that would be 

disallowed by the proposed regulations. 

Using Treasury Department models 

applied to confidential 2016 tax data, 

the Treasury Department calculated the 

average effective tax rate for potentially 

affected taxpayers under a range of 

levels of interest payment deductibility, 

including the level of deductibility 

under the Act without the proposed 

regulations. The difference between the 

estimated effective tax rate under the 

Act and without the discretionary 

elements of the proposed regulations 

and the range of estimated effective tax 

rates that include the proposed 

regulations provides a range of estimates 

of the net increase in the effective tax 

rate due to the discretion exercised in 

the proposed regulations. The Treasury 

Department next applied an elasticity of 

taxable income to the range of estimated 

increases in the effective tax rate to 

estimate the reduction in taxable 

income for each of the affected 

taxpayers in the sample. The Treasury 

Department then examined a range of 

estimates of the relationship between 

the change in taxable income and the 

real change in economic activity. 

Finally, the Treasury Department 

extrapolated the results through 2027. 

The Treasury Department concludes 

from this evaluation that the 

discretionary aspects of the proposed 

rules will reduce GDP annually by less 

than $100 million ($2018). The 

projected effects reflect the proposed 

regulations alone and do not include 

non-revenue economic effects stemming 

from the Act in the absence of the 

proposed regulations. More specifically, 

the analysis did not estimate the 

impacts of the statutory requirement 

that hybrid dividends shall be treated as 

subpart F income of the receiving 

controlled foreign corporations for 

purposes of section 951(a)(1)(A) for the 

taxable year and shall not be permitted 

a foreign tax credit. See section 245A(e). 

The Treasury Department solicits 

comments on the methodology used to 

evaluate the non-revenue economic 

effects of the proposed regulations and 

anticipates that further analysis will be 

provided at the final rule stage. 

ii. Anticipated Costs and Benefits of 

Specific Provisions 

a. Section 245A(e) 

Section 245A(e) applies in certain 

cases in which a CFC pays a hybrid 

dividend, which is a dividend paid by 

the CFC for which the CFC received a 

deduction or other tax benefit under 

foreign tax law (a hybrid deduction). 

The proposed regulations provide rules 

for identifying and tracking such hybrid 

deductions. These rules set forth 

common standards for identifying 

hybrid deductions and therefore clarify 

what is deemed a hybrid dividend by 

the statute and ensure equitable tax 

treatment of otherwise similar 

taxpayers. 

The proposed regulations also address 

timing differences to ensure that there is 

parity between economically similar 

transactions. Absent such rules, similar 

transactions may be treated differently 

due to timing differences. For example, 

if a CFC paid out a dividend in a given 

taxable year for which it received a 

deduction or other tax benefit in a prior 

taxable year, the taxpayer might claim 

the dividend is not a hybrid dividend, 

since the taxable year in which the 

dividend is paid for U.S. tax purposes 

and the year in which the tax benefit is 

received do not overlap. Absent rules, 

such as the proposed regulations, the 

purpose of section 245A(e) might be 

avoided and economically similar 

transactions might be treated differently. 

Finally, these rules excuse certain 

taxpayers from having to track hybrid 

deductions (namely taxpayers without a 

sufficient connection to a section 

245A(a) dividends received deduction). 

The utility of requiring these taxpayers 

to track hybrid deductions would be 

outweighed by the burdens of doing so. 

The proposed regulations reduce the 

compliance burden on taxpayers that 

are not directly dealing with hybrid 

dividends. 

b. Section 267A 

Section 267A disallows a deduction 

for interest or royalties paid or accrued 

in certain transactions involving a 

hybrid arrangement. Congress intended 

this provision to address cases in which 

the taxpayer is provided a deduction 

under U.S. tax law, but the payee does 

not have a corresponding income 

inclusion under foreign tax law, dubbed 

a ‘‘deduction/no-inclusion outcome’’ 

(D/NI outcome). See Senate 

Explanation, at 384. This affects 

taxpayers that attempt to use hybrid 

arrangements to strip income out of the 

United States taxing jurisdiction. 

The proposed regulations disallow a 

deduction under section 267A only to 

the extent that the D/NI outcome is a 

result of a hybrid arrangement. Note that 

under the statute but without the 

proposed regulations, a deduction 

would be disallowed simply if a D/NI 

outcome occurs and a hybrid 

arrangement exists (see section II.E of 

the Explanation of Provisions). For 

example, a royalty payment made to a 

hybrid entity in the U.K. qualifying for 

a low tax rate under the U.K. patent box 

regime could be denied a deduction in 

the U.S. under the statute. However, the 

low U.K. rate is a result of the lower tax 

rate on patent box income and not a 

result of any hybrid arrangement. In this 

example, there is no link between 

hybridity and the D/NI outcome, since 

it is the U.K. patent box regime that 


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yields the D/NI outcome and the low 

U.K. patent box rate is available to 

taxpayers regardless of whether they are 

organized as hybrid entities or not. The 

proposed regulations limit the 

application of section 267A to cases 

where the D/NI outcome occurs as a 

result of hybrid arrangements and not 

due to a generally applicable feature of 

the jurisdiction’s tax system. 

The proposed regulations also provide 

several exceptions to section 267A in 

order to refine the scope of the 

provision and minimize burdens on 

taxpayers. First, the proposed 

regulations generally exclude from 

section 267A payments that are 

included in a U.S. tax resident’s or U.S. 

taxable branch’s income or are taken 

into account for purposes of the subpart 

F or global intangible low-taxed income 

(GILTI) provisions. While the exception 

for income taken into account for 

purposes of subpart F is in the statute, 

the proposed regulations expand the 

exception to cover GILTI. This avoids 

potential double taxation on that 

income. In addition, as a refinement 

compared with the statute, the extent to 

which a payment is taken into account 

under subpart F is determined without 

regard to allocable deductions or 

qualified deficits. The proposed 

regulations also provide a de minimis 

rule that excepts small taxpayers from 

section 267A, minimizing the burden on 

small taxpayers. 

Finally, the proposed regulations 

address a comprehensive set of 

transactions that give rise to D/NI 

outcomes. The statute, as written, does 

not apply to certain hybrid 

arrangements, including branch 

arrangements and certain reverse 

hybrids, as described above (see section 

II.D of the Explanation of Provisions). 

The exclusion of these arrangements 

could have large economic and fiscal 

consequences due to taxpayers shifting 

tax planning towards these 

arrangements to avoid the new antiabuse statute. The proposed regulations 

close off this potential avenue for 

additional tax avoidance by applying 

the rules of section 267A to branch 

mismatches, reverse hybrids, certain 

transactions with unrelated parties that 

are structured to achieve D/NI 

outcomes, certain structured 

transactions involving amounts similar 

to interest, and imported mismatches. 

3. Alternatives Considered 

i. Addressing conduit arrangements/ 

imported mismatches 

Section 267A(e)(1) provides 

regulatory authority to apply the rules of 

section 267A to conduit arrangements 

and thus to disallow a deduction in 

cases in which income attributable to a 

payment is directly or indirectly offset 

by an offshore hybrid deduction. The 

Treasury Department and the IRS 

considered four options with regards to 

conduit arrangement rules. 

The first option was to not implement 

any conduit rules, and thus rely on 

existing and established judicial 

doctrines (such as conduit principles 

and substance-over-form principles) to 

police these transactions. A second 

option considered was to address 

conduit arrangement concerns through a 

broad anti-abuse rule. On the one hand, 

both of these approaches might reduce 

complexity by eliminating the need for 

detailed regulatory rules addressing 

conduit arrangements. On the other 

hand, such approaches could create 

uncertainty (as neither taxpayers nor the 

IRS might have a clear sense of what 

types of transactions might be 

challenged under the judicial doctrines 

or anti-abuse rule) and could increase 

burdens to the IRS (as challenging under 

judicial doctrines or anti-abuse rules are 

generally difficult and resource 

intensive). Significantly, such 

approaches could result in double nontaxation (if judicial doctrines or antiabuse rules were to not be successfully 

asserted) or double-taxation (if judicial 

doctrines or anti-abuse rules were to not 

take into account the application of 

foreign tax law, such as a foreign 

imported mismatch rule). 

A third option considered was to 

implement rules modeled off existing 

U.S. anti-conduit rules under § 1.881–3. 

On the positive side, such an approach 

would rely on an established and 

existing framework that taxpayers are 

already familiar with and thus there 

would be a lesser need to create and 

apply a new framework or set of rules. 

On the negative side, existing anticonduit rules are limited in certain 

respects as they apply only to certain 

financing arrangements, which exclude 

certain stock, and they address only 

withholding tax policies, which pose 

separate concerns from section 267A 

policies (D/NI policies). Furthermore, 

taxpayers have implemented structures 

that attempt to avoid the application of 

the existing anti-conduit rules. 

Detrimental to tax equity, such an 

approach could also lead to doubletaxation, as the existing anti-conduit 

rules do not take into account the 

application of foreign tax law, such as 

a foreign imported mismatch rule. 

The final option considered was to 

implement rules that are generally 

consistent with the BEPS imported 

mismatch rule. The first advantage of 

such an approach is that it provides 

certainty about when a deduction will 

or will not be disallowed under the rule. 

The second advantage of this approach 

is that it neutralizes the risk of double 

non-taxation, while also neutralizing the 

risk of double taxation. This is because 

this option is modeled off the BEPS 

approach, which is being implemented 

by other countries, and also contains 

explicit rules to coordinate with foreign 

tax law. Coordinating with the global 

tax community reduces opportunities 

for economic distortions. Although such 

an approach involves greater complexity 

than the alternatives, the Treasury 

Department and IRS expect the benefits 

of this approach’s comprehensiveness, 

administrability, and conduciveness to 

taxpayer certainty, to be substantially 

greater than the complexity burden in 

comparison with the available 

alternative approaches. Thus, this is the 

approach adopted in the proposed 

regulations. 

ii. De Minimis Rules 

The proposed regulations provide a 

de minimis exception that exempts 

taxpayers from the application of 

section 267A for any taxable year for 

which the sum of the taxpayer’s interest 

and royalty deductions (plus interest 

and royalty deductions of any related 

specified parties) is below $50,000. The 

exception’s $50,000 threshold looks to a 

taxpayer’s amount of interest or royalty 

deductions without regard to whether 

the deductions involve hybrid 

arrangements and therefore, absent the 

de minimis exception, would be 

disallowed under section 267A. 

The Treasury Department and the IRS 

considered not providing a de minimis 

exception because hybrid arrangements 

are highly likely to be tax-motivated 

structures undertaken only by mostly 

sophisticated investors. However, it is 

possible that, in limited cases, small 

taxpayers could be subject to these 

rules, for example, as a result of timing 

differences or a lack of familiarity with 

foreign law. Furthermore, section 267A 

is intended to stop base erosion and tax 

avoidance, and in the case of small 

taxpayers, it is expected that the 

revenue gains from applying these rules 

would be minimal since few small 

taxpayers are expected to engage in 

hybrid arrangements. 

The Treasury Department and IRS 

also considered a de minimis exception 

based on a dollar threshold with respect 

to the amount of interest or royalties 

involving hybrid arrangements. 

However, such an approach would 

require a taxpayer to first apply the 

rules of section 267A to identify its 

interest or royalty deductions involving 

hybrid arrangements in order to 


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determine whether the de minimis 

threshold is satisfied and thus whether 

it is subject to section 267A for the 

taxable year. This would therefore not 

significantly reduce burdens on 

taxpayers with respect to applying the 

rules of section 267A. 

Therefore, the proposed regulations 

adopt a rule that looks to the overall 

amount of interest and royalty 

payments, whether or not such 

payments involve hybrid arrangements. 

This has the effect of exempting, in an 

efficient manner, small taxpayers that 

are unlikely to engage in hybrid 

arrangements, and therefore such 

taxpayers do not need to consider the 

application of these rules. 

iii. Deemed Branch Payments and 

Branch Mismatch Payments 

The proposed regulations expand the 

application of section 267A to certain 

transactions involving branches. This 

was necessary in order to ensure that 

taxpayers could not avoid section 267A 

by engaging in transactions that were 

economically similar to the hybrid 

arrangements that are covered by the 

statute. For example, assume that a 

related party payment is made to a 

foreign entity in Country X that is 

owned by a parent company in Country 

Y. Further assume that there is a 

mismatch between how Country X 

views the entity (fiscally transparent) 

versus how Country Y views it (not 

fiscally transparent). In general, section 

267A’s hybrid entity rules prevent a D/ 

NI outcome in this case. However, 

assume instead that the parent company 

forms a branch in Country X instead of 

a foreign entity, and Country Y (the 

parent company’s jurisdiction) exempts 

all branch income under its territorial 

system. On the other hand, due to a 

mismatch in laws governing whether a 

branch exists, Country X does not view 

the branch as existing and therefore 

does not tax payments made to the 

branch. Absent regulations, taxpayers 

could easily avoid section 267A through 

use of branch structures, which are 

economically similar to the foreign 

entity structure in the first example. 

In the absence of the proposed 

regulations, taxpayers may have found it 

valuable to engage in transactions that 

are economically similar to hybrid 

arrangements but that avoided the 

application of 267A. Such transactions 

would have resulted in a loss in U.S. tax 

revenue without any accompanying 

efficiency gain. Furthermore, to the 

extent that these transactions were 

structured specifically to avoid the 

application of section 267A and were 

not available to all taxpayers, they 

would generally have led to an 

efficiency loss in addition to the loss in 

U.S. tax revenue. 

iv. Exceptions for Income Included in 

U.S. Tax and GILTI Inclusions 

Section 267A(b)(1) provides that 

deductions for interest and royalties that 

are paid to a CFC and included under 

section 951(a) in income (as subpart F 

income) by a United States shareholder 

of such CFC are not subject to 

disallowance under section 267A. The 

statute does not state whether section 

267A applies to a payment that is 

included directly in the U.S. tax base 

(for example, because the payment is 

made directly to a U.S. taxpayer or a 

U.S. taxable branch), or a payment made 

to a CFC that is taken into account 

under GILTI (as opposed to being 

included as subpart F income) by such 

CFC’s United States shareholders. 

However, the grant of regulatory 

authority in section 267A(e) includes a 

specific mention of exceptions in ‘‘cases 

which the Secretary determines do not 

present a risk of eroding the Federal tax 

base.’’ See section 267A(e)(7)(B). 

The Treasury Department and the IRS 

considered providing no additional 

exception for payments included in the 

U.S. tax base (either directly or under 

GILTI), therefore the only exception 

available would be the exception 

provided in the statute for payments 

included in the U.S tax base by subpart 

F inclusions. This approach was 

rejected in the case of a payment to a 

U.S. taxpayer since it would result in 

double taxation by the United States, as 

the United States would both deny a 

deduction for a payment as well as fully 

include such payment in income for 

U.S. tax purposes. Similarly, in the case 

of hybrid payments made by one CFC to 

another CFC with the same United 

States shareholders, a payment would 

be included in tested income of the 

recipient CFC and therefore taken into 

account under GILTI. If section 267A 

were to apply to also disallow the 

deduction by the payor CFC, this could 

also lead to the same amount being 

subject to section 951A twice because 

the payor CFC’s tested income would 

increase as a result of the denial of 

deduction, and the payee would have 

additional tested income for the same 

payment. 

Payments that are included directly in 

the U.S. tax base or that are included in 

GILTI do not give rise to a D/NI outcome 

and, therefore, it is consistent with the 

policy of section 267A and the grant of 

authority in section 267A(e) to exempt 

them from disallowance under section 

267A. Therefore, the proposed 

regulations provide that such payments 

are not subject to disallowance under 

section 267A. 

v. Link Between Hybridity and D/NI 

As discussed in section II.E of the 

Explanation of Provisions and section 

I.D.2.ii of this Special Analyses, the 

proposed regulations limit disallowance 

to cases in which the no-inclusion 

portion of the D/NI outcome is a result 

of hybridity as opposed to a different 

feature of foreign tax law, such as a 

general preference for royalty income. 

Under the language of the statute, no 

link between hybridity and the noinclusion outcome appears to be 

required. The Treasury Department and 

the IRS considered following this 

approach, which would have resulted in 

a deduction being disallowed even 

though if the transaction had been a 

non-hybrid transaction, the same noinclusion outcome would have resulted. 

However, the Treasury Department and 

the IRS rejected this option because it 

would lead to inconsistent and arbitrary 

results. In particular, such an approach 

would incentivize taxpayers to 

restructure to eliminate hybridity in 

order to avoid the application of section 

267A in cases where hybridity does not 

cause a D/NI outcome. Such 

restructuring would eliminate the 

hybridity without actually eliminating 

the D/NI outcome since the hybridity 

did not cause the D/NI outcome. 

Interpreting section 267A in a manner 

that incentivizes taxpayers to engage in 

restructurings of this type would 

generally impose costs on taxpayers to 

retain deductions where hybridity is 

irrelevant to a D/NI outcome, without 

furthering the statutory purpose of 

section 267A to neutralize hybrid 

arrangements. 

Furthermore, the policy of section 

267A is not to address all situations that 

give rise to no-inclusion outcomes, but 

to only address a subset of such 

situations where they arise due to 

hybrid arrangements. When base 

erosion or double non-taxation arises 

due to other features of the international 

tax system (such as the existence of lowtax jurisdictions or preferential regimes 

for certain types of income), there are 

other types of rules that are better suited 

to address these concerns (for example, 

through statutory impositions of 

withholding taxes, revisions to tax 

treaties, or new statutory provisions 

such as the base erosion and anti-abuse 

tax under section 59A). Moreover, the 

legislative history to section 267A 

makes clear that the policy of the 

provision is to eliminate the taxmotivated hybrid structures that lead to 

D/NI outcomes, and was not a general 

provision for eliminating all cases of D/ 


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NI outcomes. See Senate Explanation, at 

384 (‘‘[T]he Committee believes that 

hybrid arrangements exploit differences 

in the tax treatment of a transaction or 

entity under the laws of two or more 

jurisdictions to achieve double nontaxation . . .’’) (emphasis added). In 

addition, to the extent that regulations 

limit disallowance to those cases in 

which the no-inclusion portion of the D/ 

NI outcome is a result of hybridity, the 

scope of section 267A is limited and the 

burden on taxpayers is reduced without 

impacting the core policy underlying 

section 267A. Therefore, the proposed 

regulations provide that a deduction is 

disallowed under section 267A only to 

the extent that the no-inclusion portion 

of the D/NI outcome is a result of 

hybridity. 

vi. Timing Differences Under Section 

245A 

In some cases, there may be a timing 

difference between when a CFC pays an 

amount constituting a dividend for U.S. 

tax purposes and when the CFC receives 

a deduction for the amount in a foreign 

jurisdiction. Timing differences may 

raise issues about whether a deduction 

is a hybrid deduction and thus whether 

a dividend is considered a hybrid 

dividend. The Treasury Department and 

the IRS considered three options with 

respect to this timing issue. 

The first option considered was to not 

address timing differences, and thus not 

treat such transactions as giving rise to 

hybrid dividends. Not addressing the 

timing differences would raise policy 

concerns, since failure to treat the 

deduction as giving rise to a hybrid 

dividend would result in the section 

245A(a) DRD applying to the dividend, 

allowing the amount to permanently 

escape both foreign tax (through the 

deduction) and U.S. tax (through the 

DRD). 

The second option considered was to 

not address the timing difference 

directly under section 245A(e), but 

instead address it under another Code 

section or regime. For example, one 

method that would be consistent with 

the BEPS Report would be to mandate 

an income inclusion to the U.S. parent 

corporation at the time the deduction is 

permitted under foreign law. This 

would rely on a novel approach that 

deems an inclusion at a particular point 

in time despite the fact that the income 

has otherwise not been recognized for 

U.S. tax purposes. 

The final option was to address the 

timing difference by providing rules 

requiring the establishment of hybrid 

deduction accounts. These hybrid 

deduction accounts will be maintained 

across years so that deductions that 

accrue in one year will be matched up 

with income arising in a different year, 

thus addressing the timing differences 

issue. This approach appropriately 

addresses the timing differences under 

section 245A of the Code. The Treasury 

Department and IRS expect the benefits 

of this option’s comprehensiveness and 

clarity to be substantially greater than 

the tax administration and compliance 

costs it imposes, relative to the 

alternative options. This is the approach 

adopted by the proposed regulations. 

vii. Timing Differences Under Section 

267A 

A similar timing issue arises under 

section 267A. Here, there is a timing 

difference between when the deduction 

is otherwise permitted under U.S. tax 

law and when the payment is included 

in the payee’s income under foreign tax 

law. The legislative history to section 

267A indicates that in certain cases 

such timing differences can lead to 

‘‘long term deferral’’ and that such longterm deferral should be treated as giving 

rise to a D/NI outcome. In the context 

of section 267A, the Treasury 

Department and the IRS considered 

three options with respect to this timing 

issue. 

The first option considered was to not 

address timing differences, because they 

will eventually reverse over time. 

Although such an approach would 

result in a relatively simple rule, it 

would raise significant policy concerns 

because, as indicated in the legislative 

history, long-term deferral can be 

equivalent to a permanent exclusion. 

The second option considered was to 

address all timing differences, because 

even a timing difference that reverses 

within a short period of time provides 

a tax benefit during the short term. 

Although such an approach might be 

conceptually pure, it would raise 

significant practical and administrative 

difficulties. It could also lead to some 

double-tax, absent complicated rules to 

calibrate the disallowed amount to the 

amount of tax benefit arising from the 

timing mismatch. 

The final option considered was to 

address only certain timing 

differences—namely, long-term timing 

differences, such as timing differences 

that do not reverse within a 3 taxable 

year period. The Treasury Department 

and IRS expect that the net benefits of 

this option’s comprehensiveness, 

clarity, and tax administrability and 

compliance burden are substantially 

higher than those of the available 

alternatives. Thus, this option is 

adopted in the proposed regulations. 

4. Anticipated Impacts on 

Administrative and Compliance Costs 

The Treasury Department and the IRS 

estimate that there are approximately 

10,000 taxpayers in the current 

population of taxpayers affected by the 

proposed regulations or about 0.5% of 

all corporate filers. This is the best 

estimate of the number of sophisticated 

taxpayers with capabilities to structure 

a hybrid arrangement. However, the 

Treasury Department and the IRS 

anticipate that fewer taxpayers would 

engage in hybrid arrangements going 

forward as the statute and the proposed 

regulations would make such 

arrangements less beneficial to 

taxpayers. As such, the taxpayer counts 

provided in section II of this Special 

Analyses are an upper bound of the 

number of affected taxpayers by the 

proposed regulations. 

It is important to note that the 

population of taxpayers affected by 

section 267A and the proposed 

regulations under section 267A will 

seldom include U.S.-based companies 

as these companies are taxed under the 

new GILTI regime as well as subpart F. 

Instead, section 267A and the proposed 

regulations apply predominantly to 

foreign-headquartered companies that 

employ hybrid arrangements to strip 

income out of the U.S., undermining the 

collection of U.S. tax revenue. In 

addition, although section 245A(e) 

applies primarily to U.S.-based 

companies, the amounts of dividends 

affected are limited because a large 

portion of distributions will be treated 

as previously taxed earnings and profits 

due to the operation of both the GILTI 

regime and the transition tax under 

section 965, and such distributions are 

not subject to section 245A(e). 

II. Paperwork Reduction Act 

The collections of information in the 

proposed regulations are in proposed 

§§ 1.6038–2(f)(13) and (14), 1.6038– 

3(g)(3), and 1.6038A–2(b)(5)(iii). 

The collection of information in 

proposed § 1.6038–2(f)(13) and (14) is 

mandatory for every U.S. person that 

controls a foreign corporation that has a 

deduction disallowed under section 

267A, or that pays or receives a hybrid 

dividend or tiered hybrid dividend 

under section 245A, respectively, 

during an annual accounting period and 

files Form 5471 for that period (OMB 

control number 1545–0123, formerly, 

OMB control number 1545–0704). The 

collection of information in proposed 

§ 1.6038–2(f)(13) is satisfied by 

providing information about the 

disallowance of the deduction for any 

interest or royalty under section 267A 


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67630 Federal Register / Vol. 83, No. 248 / Friday, December 28, 2018 / Proposed Rules 

for the corporation’s accounting period 

as Form 5471 and its instructions may 

prescribe, and the collection of 

information in proposed § 1.6038– 

2(f)(14) is satisfied by providing 

information about hybrid dividends or 

tiered hybrid dividends under section 

245A(e) for the corporation’s accounting 

period as Form 5471 and its instructions 

may prescribe. For purposes of the PRA, 

the reporting burden associated with 

proposed § 1.6038–2(f)(13) and (14) will 

be reflected in the IRS Form 14029, 

Paperwork Reduction Act Submission, 

associated with Form 5471. As provided 

below, the estimated number of 

respondents for the reporting burden 

associated with proposed § 1.6038– 

2(f)(13) and (14) is 1,000 and 2,000, 

respectively. 

The collection of information in 

proposed § 1.6038–3(g)(3) is mandatory 

for every U.S. person that controls a 

foreign partnership that paid or accrued 

any interest or royalty for which a 

deduction is disallowed under section 

267A during the partnership tax year 

and files Form 8865 for that period 

(OMB control number 1545–1668). The 

collection of information in proposed 

§ 1.6038–3(g)(3) is satisfied by providing 

information about the disallowance of 

the deduction for any interest or royalty 

under section 267A for the partnership’s 

tax year as Form 8865 and its 

instructions may prescribe. For 

purposes of the PRA, the reporting 

burden associated with proposed 

§ 1.6038–3(g)(3) will be reflected in the 

IRS Form 14029, Paperwork Reduction 

Act submission, associated with Form 

8865. As provided below, the estimated 

number of respondents for the reporting 

burden associated with proposed 

§ 1.6038–3(g)(3) is less than 1,000. 

The collection of information in 

proposed § 1.6038A–2(b)(5)(iii) is 

mandatory for every reporting 

corporation that has a deduction 

disallowed under section 267A and files 

Form 5472 (OMB control number 1545– 

0123, formerly, OMB control number 

1545–0805) for the tax year. The 

collection of information in proposed 

§ 1.6038A–2(b)(5)(iii) is satisfied by 

providing information about the 

disallowance of the reporting 

corporation’s deduction for any interest 

or royalty under section 267A for the tax 

year as Form 5472 and its instructions 

may prescribe. For purposes of the PRA, 

the reporting burden associated with 

proposed § 1.6038A–2(b)(5)(iii) will be 

reflected in the IRS Form 14029, 

Paperwork Reduction Act submission, 

associated with Form 5472. As provided 

below, the estimated number of 

respondents for the reporting burden 

associated with proposed § 1.6038A– 

2(b)(5)(iii) is 7,000. 

The revised tax forms are as follows: 

New Revision of 

existing form 

Number of 

respondents 

(estimated, 

rounded to 

nearest 1,000) 

Schedule G (Form 5471) ................................................................................................. ........................ ✓ 1,000 

Schedule I (Form 5471) ................................................................................................... ........................ ✓ 2,000 

Form 5472 ....................................................................................................................... ........................ ✓ 7,000 

Form 8865 ....................................................................................................................... ........................ ✓ <1,000 

The current status of the Paperwork 

Reduction Act submissions related to 

the tax forms that will be revised as a 

result of the information collections in 

the proposed regulations is provided in 

the accompanying table. As described 

above, the reporting burdens associated 

with the information collections in 

proposed §§ 1.6038–2(f)(13) and (14) 

and 1.6038A–2(b)(5)(iii) are included in 

the aggregated burden estimates for 

OMB control number 1545–0123, which 

represents a total estimated burden time 

for all forms and schedules for 

corporations of 3.157 billion hours and 

total estimated monetized costs of 

$58.148 billion ($2017). The overall 

burden estimates provided in 1545– 

0123 are aggregate amounts that relate to 

the entire package of forms associated 

with the OMB control number and will 

in the future include but not isolate the 

estimated burden of the tax forms that 

will be revised as a result of the 

information collections in the proposed 

regulations. These numbers are 

therefore unrelated to the future 

calculations needed to assess the burden 

imposed by the proposed regulations. 

They are further identical to numbers 

provided for the proposed regulations 

relating to foreign tax credits (83 FR 

63200). The Treasury Department and 

IRS urge readers to recognize that these 

numbers are duplicates and to guard 

against overcounting the burden that 

international tax provisions imposed 

prior to the Act. No burden estimates 

specific to the proposed regulations are 

currently available. The Treasury 

Department has not identified any 

burden estimates, including those for 

new information collections, related to 

the requirements under the proposed 

regulations. Those estimates would 

capture both changes made by the Act 

and those that arise out of discretionary 

authority exercised in the proposed 

regulations. The Treasury Department 

and the IRS request comments on all 

aspects of information collection 

burdens related to the proposed 

regulations. In addition, when available, 

drafts of IRS forms are posted for 

comment at https://apps.irs.gov/app/ 

picklist/list/draftTaxForms.htm. 

Form Type of filer OMB No. Status 

Form 5471 ......................................... All other Filers (mainly trusts and estates) (Legacy system).1545–0121 ...... Approved by OMB through 10/30/2020. 

Link: https://www.reginfo.gov/public/do/PRAViewICR?ref_nbr=201704-1545-023. 

Business (NEW Model) ...................... 1545–0123 ...... Published in the Federal Register Notice 

(FRN) on 10/8/18. Public Comment period 

closed on 12/10/18. 

Link: https://www.federalregister.gov/documents/2018/10/09/2018-21846/proposed-collection-comment-request-for-forms-1065-1065-b-1066-1120-1120-c-1120-f-1120-h-1120-nd. 


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Federal Register / Vol. 83, No. 248 / Friday, December 28, 2018 / Proposed Rules 67631 

Form Type of filer OMB No. Status 

Individual (NEW Model) ..................... 1545–0074 ...... Limited Scope submission (1040 only) on 10/ 

11/18 at OIRA for review. Full ICR submission (all forms) scheduled in 3/2019. 

60 Day FRN not published yet for full collection. 

Link: https://www.reginfo.gov/public/do/PRAViewICR?ref_nbr=201808-1545-031. 

Form 5472 ......................................... Business (NEW Model) ...................... 1545–0123 ...... Published in the FRN on 10/8/18. Public Comment period closed on 12/10/18. 

Link: https://www.federalregister.gov/documents/2018/10/09/2018-21846/proposed-collection-comment-request-for-forms-1065-1065-b-1066-1120-1120-c-1120-f-1120-h-1120-nd. 

Individual (NEW Model) ..................... 1545–0074 ...... Limited Scope submission (1040 only) on 10/ 

11/18 at OIRA for review. Full ICR submission for all forms in 3/2019. 60 Day FRN not 

published yet for full collection. 

Link: https://www.reginfo.gov/public/do/PRAViewICR?ref_nbr=201808-1545-031. 

Form 8865 ......................................... All other Filers (mainly trusts and estates) (Legacy system).1545–1668 ...... Published in the FRN on 10/1/18. Public Comment period closed on 11/30/18. ICR in 

process by Treasury as of 10/17/18. 

Link: https://www.federalregister.gov/documents/2018/10/01/2018-21288/proposed-collection-comment-request-for-regulation-project. 

Business (NEW Model) ...................... 1545–0123 ...... Published in the FRN on 10/8/18. Public Comment period closed on 12/10/18. 

Link: https://www.federalregister.gov/documents/2018/10/09/2018-21846/proposed-collection-comment-request-for-forms-1065-1065-b-1066-1120-1120-c-1120-f-1120-h-1120-nd. 

Individual (NEW Model) ..................... 1545–0074 ...... Limited Scope submission (1040 only) on 10/ 

11/18 at OIRA for review. Full ICR submission for all forms in 3/2019. 60 Day FRN not 

published yet for full collection. 

Link: https://www.reginfo.gov/public/do/PRAViewICR?ref_nbr=201808-1545-031. 

III. Regulatory Flexibility Act 

It is hereby certified that this notice 

of proposed rulemaking will not have a 

significant economic impact on a 

substantial number of small entities 

within the meaning of section 601(6) of 

the Regulatory Flexibility Act (5 U.S.C. 

chapter 6). 

The small entities that are subject to 

proposed §§ 1.6038–2(f)(13), 1.6038– 

3(g)(3), and 1.6038A–2(b)(5)(iii) are 

small entities that are controlling U.S. 

shareholders of a CFC that is disallowed 

a deduction under section 267A, small 

entities that are controlling fifty-percent 

partners of a foreign partnership that 

makes a payment for which a deduction 

is disallowed under section 267A, and 

small entities that are 25 percent 

foreign-owned domestic corporations 

and disallowed a deduction under 

section 267A, respectively. In addition, 

the small entities that are subject to 

proposed § 1.6038–2(f)(14) are 

controlling U.S. shareholders of a CFC 

that pays or received a hybrid dividend 

or a tiered hybrid dividend. 

A controlling U.S. shareholder of a 

CFC is a U.S. person that owns more 

than 50 percent of the CFC’s stock. A 

controlling fifty-percent partner is a U.S. 

person that owns more than a fiftypercent interest in the foreign 

partnership. A 25 percent foreignowned domestic corporation is a 

domestic corporation at least 25 percent 

of the stock of which is owned by a 

foreign person. 

The Treasury Department and the IRS 

do not have data readily available to 

assess the number of small entities 

potentially affected by proposed 

§§ 1.6038–2(f)(13) or (14), 1.6038– 

3(g)(3), or 1.6038A–2(b)(5)(iii). 

However, entities potentially affected by 

these sections are generally not small 

businesses, because the resources and 

investment necessary for an entity to be 

a controlling U.S. shareholder, a 

controlling fifty-percent partner, or a 25 

percent foreign-owned domestic 

corporation are generally significant. 

Moreover, the de minimis exception 

under section 267A excepts many small 

entities from the application of section 

267A for any taxable year for which the 

sum of its interest and royalty 

deductions (plus interest and royalty 

deductions of certain related persons) is 

below $50,000. Therefore, the Treasury 

Department and the IRS do not believe 

that a substantial number of domestic 

small business entities will be subject to 

proposed §§ 1.6038–2(f)(13) or (14), 

1.6038–3(g)(3), or 1.6038A–2(b)(5)(iii). 

Accordingly, the Treasury Department 

and the IRS do not believe that 

proposed §§ 1.6038–2(f)(13) or (14), 

1.6038–3(g)(3), or 1.6038A–2(b)(5)(iii) 

will have a significant economic impact 

on a substantial number of small 

entities. Therefore, a Regulatory 

Flexibility Analysis under the 

Regulatory Flexibility Act is not 

required. 

The Treasury Department and the IRS 

do not believe that the proposed 

regulations have a significant economic 

impact on domestic small business 

entities. Based on published 

information from 2012 from form 5472, 

interest and royalty amounts paid to 

related foreign entities by foreign-owned 


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67632 Federal Register / Vol. 83, No. 248 / Friday, December 28, 2018 / Proposed Rules 

U.S. corporations over total receipts is 

1.6 percent (https://www.irs.gov/ 

statistics/soi-tax-stats-transactions-offoreign-owned-domestic-corporations#_

2, Classified by Industry 2012). This is 

substantially less than the 3 to 5 percent 

threshold for significant economic 

impact. The calculated percentage is 

likely to be an upper bound of the 

related party payments affected by the 

proposed hybrid regulations. In 

particular, this is the ratio of the 

potential income affected and not the 

tax revenues, which would be less than 

half this amount. While 1.6 percent is 

only for foreign-owned domestic 

corporations with total receipts of $500 

million or more, these are entities that 

are more likely to have related party 

payments and so the percentage would 

be higher. Moreover, hybrid 

arrangements are only a subset of these 

related party payments; therefore this 

percentage is higher than what it would 

be if only considering hybrid 

arrangements. 

Notwithstanding this certification, 

Treasury and IRS invite comments 

about the impact this proposal may have 

on small entities. 

Pursuant to section 7805(f) of the 

Code, this notice of proposed 

rulemaking has been submitted to the 

Chief Counsel for Advocacy of the Small 

Business Administration for comment 

on its impact on small business. 

Comments and Requests for a Public 

Hearing 

Before the proposed regulations are 

adopted as final regulations, 

consideration will be given to any 

comments that are submitted timely to 

the IRS as prescribed in this preamble 

under the ADDRESSES heading. The 

Treasury Department and the IRS 

request comments on all aspects of the 

proposed rules. All comments will be 

available at www.regulations.gov or 

upon request. A public hearing will be 

scheduled if requested in writing by any 

person that timely submits written 

comments. If a public hearing is 

scheduled, notice of the date, time, and 

place for the public hearing will be 

published in the Federal Register. 

Drafting Information 

The principal authors of the proposed 

regulations are Shane M. McCarrick and 

Tracy M. Villecco of the Office of 

Associate Chief Counsel (International). 

However, other personnel from the 

Treasury Department and the IRS 

participated in the development of the 

proposed regulations. 

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. 

Proposed Amendments to the 

Regulations 

Accordingly, 26 CFR parts 1 and 301 

are proposed to be amended as follows: 

PART 1—INCOME TAXES 

■ Paragraph 1. The authority citation 

for part 1 is amended by adding 

sectional authorities for §§ 1.245A(e)–1 

and 1.267A–1 through 1.267A–7 in 

numerical order and revising the entry 

for § 1.6038A–2 to read in part as 

follows: 

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

Section 1.245A(e)–1 also issued under 26 

U.S.C. 245A(g). 

* * * * * 

Sections 1.267A–1 through 1.267A–7 also 

issued under 26 U.S.C. 267A(e). 

* * * * * 

Section 1.6038A–2 also issued under 26 

U.S.C. 6038A and 6038C. 

* * * * * 

■ Par. 2. Section 1.245A(e)–1 is added 

to read as follows: 

§ 1.245A(e)–1 Special rules for hybrid 

dividends. 

(a) Overview. This section provides 

rules for hybrid dividends. Paragraph 

(b) of this section disallows the 

deduction under section 245A(a) for a 

hybrid dividend received by a United 

States shareholder from a CFC. 

Paragraph (c) of this section provides a 

rule for hybrid dividends of tiered 

corporations. Paragraph (d) of this 

section sets forth rules regarding a 

hybrid deduction account. Paragraph (e) 

of this section provides an antiavoidance rule. Paragraph (f) of this 

section provides definitions. Paragraph 

(g) of this section illustrates the 

application of the rules of this section 

through examples. Paragraph (h) of this 

section provides the applicability date. 

(b) Hybrid dividends received by 

United States shareholders—(1) In 

general. If a United States shareholder 

receives a hybrid dividend, then— 

(i) The United States shareholder is 

not allowed a deduction under section 

245A(a) for the hybrid dividend; and 

(ii) The rules of section 245A(d) 

(disallowance of foreign tax credits and 

deductions) apply to the hybrid 

dividend. 

(2) Definition of hybrid dividend. The 

term hybrid dividend means an amount 

received by a United States shareholder 

from a CFC for which but for section 

245A(e) and this section the United 

States shareholder would be allowed a 

deduction under section 245A(a), to the 

extent of the sum of the United States 

shareholder’s hybrid deduction 

accounts (as described in paragraph (d) 

of this section) with respect to each 

share of stock of the CFC, determined at 

the close of the CFC’s taxable year (or 

in accordance with paragraph (d)(5) of 

this section, as applicable). No other 

amount received by a United States 

shareholder from a CFC is a hybrid 

dividend for purposes of section 245A. 

(3) Special rule for certain dividends 

attributable to earnings of lower-tier 

foreign corporations. This paragraph 

(b)(3) applies if a domestic corporation 

sells or exchanges stock of a foreign 

corporation and, pursuant to section 

1248, the gain recognized on the sale or 

exchange is included in gross income as 

a dividend. In such a case, for purposes 

of this section— 

(i) To the extent that earnings and 

profits of a lower-tier CFC gave rise to 

the dividend under section 1248(c)(2), 

those earnings and profits are treated as 

distributed as a dividend by the lowertier CFC directly to the domestic 

corporation under the principles of 

§ 1.1248–1(d); and 

(ii) To the extent the domestic 

corporation indirectly owns (within the 

meaning of section 958(a)(2)) shares of 

stock of the lower-tier CFC, the hybrid 

deduction accounts with respect to 

those shares are treated as hybrid 

deduction accounts of the domestic 

corporation. Thus, for example, if a 

domestic corporation sells or exchanges 

all the stock of an upper-tier CFC and 

under this paragraph (b)(3) there is 

considered to be a dividend paid 

directly by the lower-tier CFC to the 

domestic corporation, then the dividend 

is generally a hybrid dividend to the 

extent of the sum of the upper-tier CFC’s 

hybrid deduction accounts with respect 

to stock of the lower-tier CFC. 

(4) Ordering rule. Amounts received 

by a United States shareholder from a 

CFC are subject to the rules of section 

245A(e) and this section based on the 

order in which they are received. Thus, 

for example, if on different days during 

a CFC’s taxable year a United States 

shareholder receives dividends from the 

CFC, then the rules of section 245A(e) 

and this section apply first to the 

dividend received on the earliest date 

(based on the sum of the United States 

shareholder’s hybrid deduction 

accounts with respect to each share of 

stock of the CFC), and then to the 


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dividend received on the next earliest 

date (based on the remaining sum). 

(c) Hybrid dividends of tiered 

corporations—(1) In general. If a CFC 

(the receiving CFC) receives a tiered 

hybrid dividend from another CFC, and 

a domestic corporation is a United 

States shareholder with respect to both 

CFCs, then, notwithstanding any other 

provision of the Code— 

(i) The tiered hybrid dividend is 

treated for purposes of section 

951(a)(1)(A) as subpart F income of the 

receiving CFC for the taxable year of the 

CFC in which the tiered hybrid 

dividend is received; 

(ii) The United States shareholder 

must include in gross income an 

amount equal to its pro rata share 

(determined in the same manner as 

under section 951(a)(2)) of the subpart F 

income described in paragraph (c)(1)(i) 

of this section; and 

(iii) The rules of section 245A(d) 

(disallowance of foreign tax credit, 

including for taxes that would have 

been deemed paid under section 960(a) 

or (b), and deductions) apply to the 

amount included under paragraph 

(c)(1)(ii) of this section in the United 

States shareholder’s gross income. 

(2) Definition of tiered hybrid 

dividend. The term tiered hybrid 

dividend means an amount received by 

a receiving CFC from another CFC to the 

extent that the amount would be a 

hybrid dividend under paragraph (b)(2) 

of this section if, for purposes of section 

245A and the regulations under section 

245A as contained in 26 CFR part 1 

(except for section 245A(e)(2) and this 

paragraph (c)), the receiving CFC were 

a domestic corporation. A tiered hybrid 

dividend does not include an amount 

described in section 959(b). No other 

amount received by a receiving CFC 

from another CFC is a tiered hybrid 

dividend for purposes of section 245A. 

(3) Special rule for certain dividends 

attributable to earnings of lower-tier 

foreign corporations. This paragraph 

(c)(3) applies if a CFC sells or exchanges 

stock of a foreign corporation and 

pursuant to section 964(e)(1) the gain 

recognized on the sale or exchange is 

included in gross income as a dividend. 

In such a case, rules similar to the rules 

of paragraph (b)(3) of this section apply. 

(4) Interaction with rules under 

section 964(e). To the extent a dividend 

described in section 964(e)(1) (gain on 

certain stock sales by CFCs treated as 

dividends) is a tiered hybrid dividend, 

the rules of section 964(e)(4) do not 

apply and, therefore, the United States 

shareholder is not allowed a deduction 

under section 245A(a) for the amount 

included in gross income under 

paragraph (c)(1)(ii) of this section. 

(d) Hybrid deduction accounts—(1) In 

general. A specified owner of a share of 

CFC stock must maintain a hybrid 

deduction account with respect to the 

share. The hybrid deduction account 

with respect to the share must reflect 

the amount of hybrid deductions of the 

CFC allocated to the share (as 

determined under paragraphs (d)(2) and 

(3) of this section), and must be 

maintained in accordance with the rules 

of paragraphs (d)(4) through (6) of this 

section. 

(2) Hybrid deductions—(i) In general. 

The term hybrid deduction of a CFC 

means a deduction or other tax benefit 

(such as an exemption, exclusion, or 

credit, to the extent equivalent to a 

deduction) for which the requirements 

of paragraphs (d)(2)(i)(A) and (B) of this 

section are both satisfied. 

(A) The deduction or other tax benefit 

is allowed to the CFC (or a person 

related to the CFC) under a relevant 

foreign tax law. 

(B) The deduction or other tax benefit 

relates to or results from an amount 

paid, accrued, or distributed with 

respect to an instrument issued by the 

CFC and treated as stock for U.S. tax 

purposes. Examples of such a deduction 

or other tax benefit include an interest 

deduction, a dividends paid deduction, 

and a deduction with respect to equity 

(such as a notional interest deduction). 

See paragraph (g)(1) of this section. 

However, a deduction or other tax 

benefit relating to or resulting from a 

distribution by the CFC with respect to 

an instrument treated as stock for 

purposes of the relevant foreign tax law 

is considered a hybrid deduction only to 

the extent it has the effect of causing the 

earnings that funded the distribution to 

not be included in income (determined 

under the principles of § 1.267A–3(a)) or 

otherwise subject to tax under the CFC’s 

tax law. Thus, for example, a refund to 

a shareholder of a CFC (including 

through a credit), upon a distribution by 

the CFC to the shareholder, of taxes paid 

by the CFC on the earnings that funded 

the distribution results in a hybrid 

deduction of the CFC, but only to the 

extent that the shareholder, if a tax 

resident of the CFC’s country, does not 

include the distribution in income 

under the CFC’s tax law or, if not a tax 

resident of the CFC’s country, is not 

subject to withholding tax (as defined in 

section 901(k)(1)(B)) on the distribution 

under the CFC’s tax law. See paragraph 

(g)(2) of this section. 

(ii) Application limited to items 

allowed in taxable years beginning after 

December 31, 2017. A deduction or 

other tax benefit allowed to a CFC (or 

a person related to the CFC) under a 

relevant foreign tax law is taken into 

account for purposes of this section only 

if it was allowed with respect to a 

taxable year under the relevant foreign 

tax law beginning after December 31, 

2017. 

(3) Allocating hybrid deductions to 

shares. A hybrid deduction is allocated 

to a share of stock of a CFC to the extent 

that the hybrid deduction (or amount 

equivalent to a deduction) relates to an 

amount paid, accrued, or distributed by 

the CFC with respect to the share. 

However, in the case of a hybrid 

deduction that is a deduction with 

respect to equity (such as a notional 

interest deduction), the deduction is 

allocated to a share of stock of a CFC 

based on the product of— 

(i) The amount of the deduction 

allowed for all of the equity of the CFC; 

and 

(ii) A fraction, the numerator of which 

is the value of the share and the 

denominator of which is the value of all 

of the stock of the CFC. 

(4) Maintenance of hybrid deduction 

accounts—(i) In general. A specified 

owner’s hybrid deduction account with 

respect to a share of stock of a CFC is, 

as of the close of the taxable year of the 

CFC, adjusted pursuant to the following 

rules. 

(A) First, the account is increased by 

the amount of hybrid deductions of the 

CFC allocable to the share for the 

taxable year. 

(B) Second, the account is decreased 

by the amount of hybrid deductions in 

the account that gave rise to a hybrid 

dividend or tiered hybrid dividend 

during the taxable year. If a specified 

owner has more than one hybrid 

deduction account with respect to its 

stock of the CFC, then a pro rata amount 

in each hybrid deduction account is 

considered to have given rise to the 

hybrid dividend or tiered hybrid 

dividend, based on the amounts in the 

accounts before applying this paragraph 

(d)(4)(i)(B). 

(ii) Acquisition of account—(A) In 

general. The following rules apply when 

a person (the acquirer) acquires a share 

of stock of a CFC from another person 

(the transferor). 

(1) In the case of an acquirer that is 

a specified owner of the share 

immediately after the acquisition, the 

transferor’s hybrid deduction account, if 

any, with respect to the share becomes 

the hybrid deduction account of the 

acquirer. 

(2) In the case of an acquirer that is 

not a specified owner of the share 

immediately after the acquisition, the 

transferor’s hybrid deduction account, if 

any, is eliminated and accordingly is 

not thereafter taken into account by any 

person. 


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(B) Additional rules. The following 

rules apply in addition to the rules of 

paragraph (d)(4)(ii)(A) of this section. 

(1) Certain section 354 or 356 

exchanges. The following rules apply 

when a shareholder of a CFC (the CFC, 

the target CFC; the shareholder, the 

exchanging shareholder) exchanges 

stock of the target CFC for stock of 

another CFC (the acquiring CFC) 

pursuant to an exchange described in 

section 354 or 356 that occurs in 

connection with a transaction described 

in section 381(a)(2) in which the target 

CFC is the transferor corporation. 

(i) In the case of an exchanging 

shareholder that is a specified owner of 

one or more shares of stock of the 

acquiring CFC immediately after the 

exchange, the exchanging shareholder’s 

hybrid deduction accounts with respect 

to the shares of stock of the target CFC 

that it exchanges are attributed to the 

shares of stock of the acquiring CFC that 

it receives in the exchange. 

(ii) In the case of an exchanging 

shareholder that is not a specified 

owner of one or more shares of stock of 

the acquiring CFC immediately after the 

exchange, the exchanging shareholder’s 

hybrid deduction accounts with respect 

to its shares of stock of the target CFC 

are eliminated and accordingly are not 

thereafter taken into account by any 

person. 

(2) Section 332 liquidations. If a CFC 

is a distributor corporation in a 

transaction described in section 

381(a)(1) (the distributing CFC) in which 

a controlled foreign corporation is the 

acquiring corporation (the distributee 

CFC), then each hybrid account with 

respect to a share of stock of the 

distributee CFC is increased pro rata by 

the sum of the hybrid accounts with 

respect to shares of stock of the 

distributing CFC. 

(3) Recapitalizations. If a shareholder 

of a CFC exchanges stock of the CFC 

pursuant to a reorganization described 

in section 368(a)(1)(E) or a transaction to 

which section 1036 applies, then the 

shareholder’s hybrid deduction 

accounts with respect to the stock of the 

CFC that it exchanges are attributed to 

the shares of stock of the CFC that it 

receives in the exchange. 

(5) Determinations and adjustments 

made on transfer date in certain cases. 

This paragraph (d)(5) applies if on a 

date other than the date that is the last 

day of the CFC’s taxable year a United 

States shareholder of the CFC or an 

upper-tier CFC with respect to the CFC 

directly or indirectly transfers a share of 

stock of the CFC, and, during the taxable 

year, but on or before the transfer date, 

the United States shareholder or uppertier CFC receives an amount from the 

CFC that is subject to the rules of 

section 245A(e) and this section. In such 

a case, as to the United States 

shareholder or upper-tier CFC and the 

United States shareholder’s or uppertier CFC’s hybrid deduction accounts 

with respect to each share of stock of the 

CFC (regardless of whether such share is 

transferred), the determinations and 

adjustments under this section that 

would otherwise be made at the close of 

the CFC’s taxable year are made at the 

close of the date of the transfer. Thus, 

for example, if a United States 

shareholder of a CFC exchanges stock of 

the CFC in an exchange described in 

§ 1.367(b)–4(b)(1)(i) and is required to 

include in income as a deemed 

dividend the section 1248 amount 

attributable to the stock exchanged, the 

sum of the United States shareholder’s 

hybrid deduction accounts with respect 

to each share of stock of the CFC is 

determined, and the accounts are 

adjusted, as of the close of the date of 

the exchange. For this purpose, the 

principles of § 1.1502–76(b)(2)(ii) apply 

to determine amounts in hybrid 

deduction accounts at the close of the 

date of the transfer. 

(6) Effects of CFC functional 

currency—(i) Maintenance of the hybrid 

deduction account. A hybrid deduction 

account with respect to a share of CFC 

stock must be maintained in the 

functional currency (within the meaning 

of section 985) of the CFC. Thus, for 

example, the amount of a hybrid 

deduction and the adjustments 

described in paragraphs (d)(4)(i)(A) and 

(B) of this section are determined based 

on the functional currency of the CFC. 

In addition, for purposes of this section, 

the amount of a deduction or other tax 

benefit allowed to a CFC (or a person 

related to the CFC) is determined taking 

into account foreign currency gain or 

loss recognized with respect to such 

deduction or other tax benefit under a 

provision of foreign tax law comparable 

to section 988 (treatment of certain 

foreign currency transactions). 

(ii) Determination of amount of hybrid 

dividend. This paragraph (d)(6)(ii) 

applies if a CFC’s functional currency is 

other than the functional currency of a 

United States shareholder or upper-tier 

CFC that receives an amount from the 

CFC that is subject to the rules of 

section 245A(e) and this section. In such 

a case, the sum of the United States 

shareholder’s or upper-tier CFC’s hybrid 

deduction accounts with respect to each 

share of stock of the CFC is, for 

purposes of determining the extent that 

a dividend is a hybrid dividend or 

tiered hybrid dividend, translated into 

the functional currency of the United 

States shareholder or upper-tier CFC 

based on the spot rate (within the 

meaning of § 1.988–1(d)) as of the date 

of the dividend. 

(e) Anti-avoidance rule. Appropriate 

adjustments are made pursuant to this 

section, including adjustments that 

would disregard the transaction or 

arrangement, if a transaction or 

arrangement is undertaken with a 

principal purpose of avoiding the 

purposes of this section. For example, if 

a specified owner of a share of CFC 

stock transfers the share to another 

person, and a principal purpose of the 

transfer is to shift the hybrid deduction 

account with respect to the share to the 

other person or to cause the hybrid 

deduction account to be eliminated, 

then for purposes of this section the 

shifting or elimination of the hybrid 

deduction account is disregarded as to 

the transferor. As another example, if a 

transaction or arrangement is 

undertaken to affirmatively fail to 

satisfy the holding period requirement 

under section 246(c)(5) with a principal 

purpose of avoiding the tiered hybrid 

dividend rules described in paragraph 

(c) of this section, the transaction or 

arrangement is disregarded for purposes 

of this section. 

(f) Definitions. The following 

definitions apply for purposes of this 

section. 

(1) The term controlled foreign 

corporation (or CFC) has the meaning 

provided in section 957. 

(2) The term person has the meaning 

provided in section 7701(a)(1). 

(3) The term related has the meaning 

provided in this paragraph (f)(3). A 

person is related to a CFC if the person 

is a related person within the meaning 

of section 954(d)(3). 

(4) The term relevant foreign tax law 

means, with respect to a CFC, any 

regime of any foreign country or 

possession of the United States that 

imposes an income, war profits, or 

excess profits tax with respect to income 

of the CFC, other than a foreign antideferral regime under which a person 

that owns an interest in the CFC is liable 

to tax. Thus, the term includes any 

regime of a foreign country or 

possession of the United States that 

imposes income, war profits, or excess 

profits tax under which— 

(i) The CFC is liable to tax as a 

resident; 

(ii) The CFC has a branch that gives 

rise to a taxable presence in the foreign 

country or possession of the United 

States; or 

(iii) A person related to the CFC is 

liable to tax as a resident, provided that 

under such person’s tax law the person 

is allowed a deduction for amounts paid 

or accrued by the CFC (because, for 


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example, the CFC is fiscally transparent 

under the person’s tax law). 

(5) The term specified owner means, 

with respect to a share of stock of a CFC, 

a person for which the requirements of 

paragraphs (f)(5)(i) and (ii) of this 

section are satisfied. 

(i) The person is a domestic 

corporation that is a United States 

shareholder of the CFC, or is an uppertier CFC that would be a United States 

shareholder of the CFC were the uppertier CFC a domestic corporation. 

(ii) The person owns the share 

directly or indirectly through a 

partnership, trust, or estate. Thus, for 

example, if a domestic corporation 

directly owns all the shares of stock of 

an upper-tier CFC and the upper-tier 

CFC directly owns all the shares of stock 

of another CFC, the domestic 

corporation is the specified owner with 

respect to each share of stock of the 

upper-tier CFC and the upper-tier CFC 

is the specified owner with respect to 

each share of stock of the other CFC. 

(6) The term United States 

shareholder has the meaning provided 

in section 951(b). 

(g) Examples. This paragraph (g) 

provides examples that illustrate the 

application of this section. For purposes 

of the examples in this paragraph (g), 

unless otherwise indicated, the 

following facts are presumed. US1 is a 

domestic corporation. FX and FZ are 

CFCs formed at the beginning of year 1. 

FX is a tax resident of Country X and 

FZ is a tax resident of Country Z. US1 

is a United States shareholder with 

respect to FX and FZ. No distributed 

amounts are attributable to amounts 

which are, or have been, included in the 

gross income of a United States 

shareholder under section 951(a). All 

instruments are treated as stock for U.S. 

tax purposes. 

(1) Example 1. Hybrid dividend resulting 

from hybrid instrument—(i) Facts. US1 holds 

both shares of stock of FX, which have an 

equal value. One share is treated as 

indebtedness for Country X tax purposes 

(‘‘Share A’’), and the other is treated as equity 

for Country X tax purposes (‘‘Share B’’). 

During year 1, under Country X tax law, FX 

accrues $80x of interest to US1 with respect 

to Share A and is allowed a deduction for the 

amount (the ‘‘Hybrid Instrument 

Deduction’’). During year 2, FX distributes 

$30x to US1 with respect to each of Share A 

and Share B. For U.S. tax purposes, each of 

the $30x distributions is treated as a 

dividend for which, but for section 245A(e) 

and this section, US1 would be allowed a 

deduction under section 245A(a). For 

Country X tax purposes, the $30x 

distribution with respect to Share A 

represents a payment of interest for which a 

deduction was already allowed (and thus FX 

is not allowed an additional deduction for 

the amount), and the $30x distribution with 

respect to Share B is treated as a dividend 

(for which no deduction is allowed). 

(ii) Analysis. The entire $30x of each 

dividend received by US1 from FX during 

year 2 is a hybrid dividend, because the sum 

of US1’s hybrid deduction accounts with 

respect to each of its shares of FX stock at 

the end of year 2 ($80x) is at least equal to 

the amount of the dividends ($60x). See 

paragraph (b)(2) of this section. This is the 

case for the $30x dividend with respect to 

Share B even though there are no hybrid 

deductions allocated to Share B. See id. As 

a result, US1 is not allowed a deduction 

under section 245A(a) for the entire $60x of 

hybrid dividends and the rules of section 

245A(d) (disallowance of foreign tax credits 

and deductions) apply. See paragraph (b)(1) 

of this section. Paragraphs (g)(1)(ii)(A) 

through (D) of this section describe the 

determinations under this section. 

(A) At the end of year 1, US1’s hybrid 

deduction accounts with respect to Share A 

and Share B are $80x and $0, respectively, 

calculated as follows. 

(1) The $80x Hybrid Instrument Deduction 

allowed to FX under Country X tax law (a 

relevant foreign tax law) is a hybrid 

deduction of FX, because the deduction is 

allowed to FX and relates to or results from 

an amount accrued with respect to an 

instrument issued by FX and treated as stock 

for U.S. tax purposes. See paragraph (d)(2)(i) 

of this section. Thus, FX’s hybrid deductions 

for year 1 are $80x. 

(2) The entire $80x Hybrid Instrument 

Deduction is allocated to Share A, because 

the deduction was accrued with respect to 

Share A. See paragraph (d)(3) of this section. 

As there are no additional hybrid deductions 

of FX for year 1, there are no additional 

hybrid deductions to allocate to either Share 

A or Share B. Thus, there are no hybrid 

deductions allocated to Share B. 

(3) At the end of year 1, US1’s hybrid 

deduction account with respect to Share A is 

increased by $80x (the amount of hybrid 

deductions allocated to Share A). See 

paragraph (d)(4)(i)(A) of this section. Because 

FX did not pay any dividends with respect 

to either Share A or Share B during year 1 

(and therefore did not pay any hybrid 

dividends or tiered hybrid dividends), no 

further adjustments are made. See paragraph 

(d)(4)(i)(B) of this section. Therefore, at the 

end of year 1, US1’s hybrid deduction 

accounts with respect to Share A and Share 

B are $80x and $0, respectively. 

(B) At the end of year 2, and before the 

adjustments described in paragraph 

(d)(4)(i)(B) of this section, US1’s hybrid 

deduction accounts with respect to Share A 

and Share B remain $80x and $0, 

respectively. This is because there are no 

hybrid deductions of FX for year 2. See 

paragraph (d)(4)(i)(A) of this section. 

(C) Because at the end of year 2 (and before 

the adjustments described in paragraph 

(d)(4)(i)(B) of this section) the sum of US1’s 

hybrid deduction accounts with respect to 

Share A and Share B ($80x, calculated as 

$80x plus $0) is at least equal to the aggregate 

$60x of year 2 dividends, the entire $60x 

dividend is a hybrid dividend. See paragraph 

(b)(2) of this section. 

(D) At the end of year 2, US1’s hybrid 

deduction account with respect to Share A is 

decreased by $60x, the amount of the hybrid 

deductions in the account that gave rise to a 

hybrid dividend or tiered hybrid dividend 

during year 2. See paragraph (d)(4)(i)(B) of 

this section. Because there are no hybrid 

deductions in the hybrid deduction account 

with respect to Share B, no adjustments with 

respect to that account are made under 

paragraph (d)(4)(i)(B) of this section. 

Therefore, at the end of year 2 and taking into 

account the adjustments under paragraph 

(d)(4)(i)(B) of this section, US1’s hybrid 

deduction account with respect to Share A is 

$20x ($80x less $60x) and with respect to 

Share B is $0. 

(iii) Alternative facts—notional interest 

deductions. The facts are the same as in 

paragraph (g)(1)(i) of this section, except that 

for each of year 1 and year 2 FX is allowed 

$10x of notional interest deductions with 

respect to its equity, Share B, under Country 

X tax law (the ‘‘NIDs’’). In addition, during 

year 2, FX distributes $47.5x (rather than 

$30x) to US1 with respect to each of Share 

A and Share B. For U.S. tax purposes, each 

of the $47.5x distributions is treated as a 

dividend for which, but for section 245A(e) 

and this section, US1 would be allowed a 

deduction under section 245A(a). For 

Country X tax purposes, the $47.5x 

distribution with respect to Share A 

represents a payment of interest for which a 

deduction was already allowed (and thus FX 

is not allowed an additional deduction for 

the amount), and the $47.5x distribution with 

respect to Share B is treated as a dividend 

(for which no deduction is allowed). The 

entire $47.5x of each dividend received by 

US1 from FX during year 2 is a hybrid 

dividend, because the sum of US1’s hybrid 

deduction accounts with respect to each of 

its shares of FX stock at the end of year 2 

($80x plus $20x, or $100x) is at least equal 

to the amount of the dividends ($95x). See 

paragraph (b)(2) of this section. As a result, 

US1 is not allowed a deduction under section 

245A(a) for the $95x hybrid dividend and the 

rules of section 245A(d) (disallowance of 

foreign tax credits and deductions) apply. 

See paragraph (b)(1) of this section. 

Paragraphs (g)(1)(iii)(A) through (D) of this 

section describe the determinations under 

this section. 

(A) The $10x of NIDs allowed to FX under 

Country X tax law in year 1 are hybrid 

deductions of FX for year 1. See paragraph 

(d)(2)(i) of this section. The $10x of NIDs is 

allocated equally to each of Share A and 

Share B, because the hybrid deduction is 

with respect to equity and the shares have an 

equal value. See paragraph (d)(3) of this 

section. Thus, $5x of the NIDs is allocated to 

each of Share A and Share B for year 1. For 

the reasons described in paragraph 

(g)(1)(ii)(A) of this section, the entire $80x 

Hybrid Instrument Deduction is allocated to 

Share A. Therefore, at the end of year 1, 

US1’s hybrid deduction accounts with 

respect to Share A and Share B are $85x and 

$5x, respectively. 

(B) Similarly, the $10x of NIDs allowed to 

FX under Country X tax law in year 2 are 

hybrid deductions of FX for year 2, and $5x 

of the NIDs is allocated to each of Share A 

and Share B for year 2. See paragraphs 

(d)(2)(i) and (d)(3) of this section. Thus, at the 


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end of year 2 (and before the adjustments 

described in paragraph (d)(4)(i)(B) of this 

section), US1’s hybrid deduction account 

with respect to Share A is $90x ($85x plus 

$5x) and with respect to Share B is $10x ($5x 

plus $5x). See paragraph (d)(4)(i) of this 

section. 

(C) Because at the end of year 2 (and before 

the adjustments described in paragraph 

(d)(4)(i)(B) of this section) the sum of US1’s 

hybrid deduction accounts with respect to 

Share A and Share B ($100x, calculated as 

$90x plus $10x) is at least equal to the 

aggregate $95x of year 2 dividends, the entire 

$95x of dividends are hybrid dividends. See 

paragraph (b)(2) of this section. 

(D) At the end of year 2, US1’s hybrid 

deduction accounts with respect to Share A 

and Share B are decreased by the amount of 

hybrid deductions in the accounts that gave 

rise to a hybrid dividend or tiered hybrid 

dividend during year 2. See paragraph 

(d)(4)(i)(B) of this section. A total of $95x of 

hybrid deductions in the accounts gave rise 

to a hybrid dividend during year 2. For the 

hybrid deduction account with respect to 

Share A, $85.5x in the account is considered 

to have given rise to a hybrid deduction 

(calculated as $95x multiplied by $90x/ 

$100x). See id. For the hybrid deduction 

account with respect to Share B, $9.5x in the 

account is considered to have given rise to 

a hybrid deduction (calculated as $95x 

multiplied by $10x/$100x). See id. Thus, 

following these adjustments, at the end of 

year 2, US1’s hybrid deduction account with 

respect to Share A is $4.5x ($90x less $85.5x) 

and with respect to Share B is $0.5x ($10x 

less $9.5x). 

(iv) Alternative facts—deduction in branch 

country—(A) Facts. The facts are the same as 

in paragraph (g)(1)(i) of this section, except 

that for Country X tax purposes Share A is 

treated as equity (and thus the Hybrid 

Instrument Deduction does not exist and 

under Country X tax law FX is not allowed 

a deduction for the $30x distributed in year 

2 with respect to Share A). However, FX has 

a branch in Country Z that gives rise to a 

taxable presence under Country Z tax law, 

and for Country Z tax purposes Share A is 

treated as indebtedness and Share B is 

treated as equity. Also, during year 1, for 

Country Z tax purposes, FX accrues $80x of 

interest to US1 with respect to Share A and 

is allowed an $80x interest deduction with 

respect to its Country Z branch income. 

Moreover, for Country Z tax purposes, the 

$30x distribution with respect to Share A in 

year 2 represents a payment of interest for 

which a deduction was already allowed (and 

thus FX is not allowed an additional 

deduction for the amount), and the $30x 

distribution with respect to Share B in year 

2 is treated as a dividend (for which no 

deduction is allowed). 

(B) Analysis. The $80x interest deduction 

allowed to FX under Country Z tax law (a 

relevant foreign tax law) with respect to its 

Country Z branch income is a hybrid 

deduction of FX for year 1. See paragraphs 

(d)(2)(i) and (f)(4) of this section. For reasons 

similar to those discussed in paragraph 

(g)(1)(ii) of this section, at the end of year 2 

(and before the adjustments described in 

paragraph (d)(4)(i)(B) of this section), US1’s 

hybrid deduction accounts with respect to 

Share A and Share B are $80x and $0, 

respectively, and the sum of the accounts is 

$80x. Accordingly, the entire $60x of the year 

2 dividend is a hybrid dividend. See 

paragraph (b)(2) of this section. Further, for 

the reasons described in paragraph 

(g)(1)(ii)(D) of this section, at the end of year 

2 and taking into account the adjustments 

under paragraph (d)(4)(i)(B) of this section, 

US1’s hybrid deduction account with respect 

to Share A is $20x ($80x less $60x) and with 

respect to Share B is $0. 

(2) Example 2. Tiered hybrid dividend rule; 

tax benefit equivalent to a deduction—(i) 

Facts. US1 holds all the stock of FX, and FX 

holds all 100 shares of stock of FZ (the ‘‘FZ 

shares’’), which have an equal value. The FZ 

shares are treated as equity for Country Z tax 

purposes. During year 2, FZ distributes $10x 

to FX with respect to each of the FZ shares, 

for a total of $1,000x. The $1,000x is treated 

as a dividend for U.S. and Country Z tax 

purposes, and is not deductible for Country 

Z tax purposes. If FX were a domestic 

corporation, then, but for section 245A(e) and 

this section, FX would be allowed a 

deduction under section 245A(a) for the 

$1,000x. Under Country Z tax law, 75% of 

the corporate income tax paid by a Country 

Z corporation with respect to a dividend 

distribution is refunded to the corporation’s 

shareholders (regardless of where such 

shareholders are tax residents) upon a 

dividend distribution by the corporation. The 

corporate tax rate in Country Z is 20%. With 

respect to FZ’s distributions, FX is allowed 

a refundable tax credit of $187.5x. The 

$187.5x refundable tax credit is calculated as 

$1,250x (the amount of pre-tax earnings that 

funded the distribution, determined as 

$1,000x (the amount of the distribution) 

divided by 0.8 (the percentage of pre-tax 

earnings that a Country Z corporation retains 

after paying Country Z corporate tax)) 

multiplied by 0.2 (the Country Z corporate 

tax rate) multiplied by 0.75 (the percentage 

of the Country Z tax credit). Under Country 

Z tax law, FX is not subject to Country Z 

withholding tax (or any other tax) with 

respect to the $1,000x dividend distribution. 

(ii) Analysis. $937.5x of the $1,000x of 

dividends received by FX from FZ during 

year 2 is a tiered hybrid dividend, because 

the sum of FX’s hybrid deduction accounts 

with respect to each of its shares of FZ stock 

at the end of year 2 is $937.5x. See 

paragraphs (b)(2) and (c)(2) of this section. As 

a result, the $937.5x tiered hybrid dividend 

is treated for purposes of section 951(a)(1)(A) 

as subpart F income of FX and US1 must 

include in gross income its pro rata share of 

such subpart F income, which is $937.5x. See 

paragraph (c)(1) of this section. In addition, 

the rules of section 245A(d) (disallowance of 

foreign tax credits and deductions) apply 

with respect to US1’s inclusion. Id. 

Paragraphs (g)(2)(ii)(A) through (C) of this 

section describe the determinations under 

this section. The characterization of the FZ 

stock for Country X tax purposes (or for 

purposes of any other foreign tax law) does 

not affect this analysis. 

(A) The $187.5x refundable tax credit 

allowed to FX under Country Z tax law (a 

relevant foreign tax law) is equivalent to a 

$937.5x deduction, calculated as $187.5x (the 

amount of the credit) divided by 0.2 (the 

Country Z corporate tax rate). The $937.5x is 

a hybrid deduction of FZ because it is 

allowed to FX (a person related to FZ), it 

relates to or results from amounts distributed 

with respect to instruments issued by FZ and 

treated as stock for U.S. tax purposes, and it 

has the effect of causing the earnings that 

funded the distributions to not be included 

in income under Country Z tax law. See 

paragraph (d)(2)(i) of this section. $9.375x of 

the hybrid deduction is allocated to each of 

the FZ shares, calculated as $937.5x (the 

amount of the hybrid deduction) multiplied 

by 1/100 (the value of each FZ share relative 

to the value of all the FZ shares). See 

paragraph (d)(3) of this section. The result 

would be the same if FX were instead a tax 

resident of Country Z (and not Country X) 

and under Country Z tax law FX were to not 

include the $1,000x in income (because, for 

example, Country Z tax law provides Country 

Z resident corporations a 100% exclusion or 

dividends received deduction with respect to 

dividends received from a resident 

corporation). See paragraph (d)(2)(i) of this 

section. 

(B) Thus, at the end of year 2, and before 

the adjustments described in paragraph 

(d)(4)(i)(B) of this section, the sum of FX’s 

hybrid deduction accounts with respect to 

each of its shares of FZ stock is $937.5x, 

calculated as $9.375x (the amount in each 

account) multiplied by 100 (the number of 

accounts). See paragraph (d)(4)(i) of this 

section. Accordingly, $937.5x of the $1,000x 

dividend received by FX from FZ during year 

2 is a tiered hybrid dividend. See paragraphs 

(b)(2) and (c)(2) of this section. 

(C) Lastly, at the end of year 2, each of FX’s 

hybrid deduction accounts with respect to its 

shares of FZ is decreased by the $9.375x in 

the account that gave rise to a hybrid 

dividend or tiered hybrid dividend during 

year 2. See paragraph (d)(4)(i)(B) of this 

section. Thus, following these adjustments, at 

the end of year 2, each of FX’s hybrid 

deduction accounts with respect to its shares 

of FZ stock is $0, calculated as $9.375x (the 

amount in the account before the adjustments 

described in paragraph (d)(4)(i)(B) of this 

section) less $9.375x (the adjustment 

described in paragraph (d)(4)(i)(B) of this 

section with respect to the account). 

(iii) Alternative facts—imputation system 

that taxes shareholders. The facts are the 

same as in paragraph (g)(2)(i) of this section, 

except that under Country Z tax law the 

$1,000 dividend to FX is subject to a 30% 

gross basis withholding tax, or $300x, and 

the $187.5x refundable tax credit is applied 

against and reduces the withholding tax to 

$112.5x. The $187.5x refundable tax credit 

provided to FX is not a hybrid deduction 

because FX was subject to Country Z 

withholding tax of $300x on the $1,000x 

dividend (such withholding tax being greater 

than the $187.5x credit). See paragraph 

(d)(2)(i) of this section. 

(h) Applicability date. This section 

applies to distributions made after 

December 31, 2017. 

■ Par. 3. Sections 1.267A–1 through 

1.267A–7 are added to read as follows: 


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§ 1.267A–1 Disallowance of certain 

interest and royalty deductions. 

(a) Scope. This section and 

§§ 1.267A–2 through 1.267A–5 provide 

rules regarding when a deduction for 

any interest or royalty paid or accrued 

is disallowed under section 267A. 

Section 1.267A–2 describes hybrid and 

branch arrangements. Section 1.267A–3 

provides rules for determining income 

inclusions and provides that certain 

amounts are not amounts for which a 

deduction is disallowed. Section 

1.267A–4 provides an imported 

mismatch rule. Section 1.267A–5 sets 

forth definitions and special rules that 

apply for purposes of section 267A. 

Section 1.267A–6 illustrates the 

application of section 267A through 

examples. Section 1.267A–7 provides 

applicability dates. 

(b) Disallowance of deduction. This 

paragraph (b) sets forth the exclusive 

circumstances in which a deduction is 

disallowed under section 267A. Except 

as provided in paragraph (c) of this 

section, a specified party’s deduction for 

any interest or royalty paid or accrued 

(the amount paid or accrued with 

respect to the specified party, a 

specified payment) is disallowed under 

section 267A to the extent that the 

specified payment is described in this 

paragraph (b). See also § 1.267A–5(b)(5) 

(treating structured payments as 

specified payments). A specified 

payment is described in this paragraph 

(b) to the extent that it is— 

(1) A disqualified hybrid amount, as 

described in § 1.267A–2 (hybrid and 

branch arrangements); 

(2) A disqualified imported mismatch 

amount, as described in § 1.267A–4 

(payments offset by a hybrid deduction); 

or 

(3) A specified payment for which the 

requirements of the anti-avoidance rule 

of § 1.267A–5(b)(6) are satisfied. 

(c) De minimis exception. Paragraph 

(b) of this section does not apply to a 

specified party for a taxable year in 

which the sum of the specified party’s 

interest and royalty deductions 

(determined without regard to this 

section) is less than $50,000. For 

purposes of this paragraph (c), specified 

parties that are related (within the 

meaning of § 1.267A–5(a)(14)) are 

treated as a single specified party. 

§ 1.267A–2 Hybrid and branch 

arrangements. 

(a) Payments pursuant to hybrid 

transactions—(1) In general. If a 

specified payment is made pursuant to 

a hybrid transaction, then, subject to 

§ 1.267A–3(b) (amounts included or 

includible in income), the payment is a 

disqualified hybrid amount to the extent 

that— 

(i) A specified recipient of the 

payment does not include the payment 

in income, as determined under 

§ 1.267A–3(a) (to such extent, a noinclusion); and 

(ii) The specified recipient’s noinclusion is a result of the payment 

being made pursuant to the hybrid 

transaction. For this purpose, the 

specified recipient’s no-inclusion is a 

result of the specified payment being 

made pursuant to the hybrid transaction 

to the extent that the no-inclusion 

would not occur were the specified 

recipient’s tax law to treat the payment 

as interest or a royalty, as applicable. 

See § 1.267A–6(c)(1) and (2). 

(2) Definition of hybrid transaction. 

The term hybrid transaction means any 

transaction, series of transactions, 

agreement, or instrument one or more 

payments with respect to which are 

treated as interest or royalties for U.S. 

tax purposes but are not so treated for 

purposes of the tax law of a specified 

recipient of the payment. Examples of a 

hybrid transaction include an 

instrument a payment with respect to 

which is treated as interest for U.S. tax 

purposes but, for purposes of a specified 

recipient’s tax law, is treated as a 

distribution with respect to equity or a 

return of principal. In addition, a 

specified payment is deemed to be made 

pursuant to a hybrid transaction if the 

taxable year in which a specified 

recipient recognizes the payment under 

its tax law ends more than 36 months 

after the end of the taxable year in 

which the specified party would be 

allowed a deduction for the payment 

under U.S. tax law. See also § 1.267A– 

6(c)(8). Further, a specified payment is 

not considered made pursuant to a 

hybrid transaction if the payment is a 

disregarded payment, as described in 

paragraph (b)(2) of this section. 

(3) Payments pursuant to securities 

lending transactions, sale-repurchase 

transactions, or similar transactions. 

This paragraph (a)(3) applies if a 

specified payment is made pursuant to 

a repo transaction and is not regarded 

under a foreign tax law but another 

amount connected to the payment (the 

connected amount) is regarded under 

such foreign tax law. For this purpose, 

a repo transaction means a transaction 

one or more payments with respect to 

which are treated as interest (as defined 

in § 1.267A–5(a)(12)) or a structured 

payment (as defined in § 1.267A– 

5(b)(5)(ii)) for U.S. tax purposes and that 

is a securities lending transaction or 

sale-repurchase transaction (including 

as described in § 1.861–2(a)(7)), or other 

similar transaction or series of related 

transactions in which legal title to 

property is transferred and the property 

(or similar property, such as securities 

of the same class and issue) is 

reacquired or expected to be reacquired. 

For example, this paragraph (a)(3) 

applies if a specified payment arising 

from characterizing a repo transaction of 

stock in accordance with its substance 

(that is, characterizing the specified 

payment as interest) is not regarded as 

such under a foreign tax law but an 

amount consistent with the form of the 

transaction (such as a dividend) is 

regarded under such foreign tax law. 

When this paragraph (a)(3) applies, the 

determination of the identity of a 

specified recipient of the specified 

payment under the foreign tax law is 

made with respect to the connected 

amount. In addition, if the specified 

recipient includes the connected 

amount in income (as determined under 

§ 1.267A–3(a), by treating the connected 

amount as the specified payment), then 

the amount of the specified recipient’s 

no-inclusion with respect to the 

specified payment is correspondingly 

reduced. See § 1.267A–6(c)(2). Further, 

the principles of this paragraph (a)(3) 

apply to cases similar to repo 

transactions in which a foreign tax law 

does not characterize the transaction in 

accordance with its substance. 

(b) Disregarded payments—(1) In 

general. Subject to § 1.267A–3(b) 

(amounts included or includible in 

income), the excess (if any) of the sum 

of a specified party’s disregarded 

payments for a taxable year over its dual 

inclusion income for the taxable year is 

a disqualified hybrid amount. See 

§ 1.267A–6(c)(3) and (4). 

(2) Definition of disregarded payment. 

The term disregarded payment means a 

specified payment to the extent that, 

under the tax law of a tax resident or 

taxable branch to which the payment is 

made, the payment is not regarded (for 

example, because under such tax law it 

is a disregarded transaction involving a 

single taxpayer or between group 

members) and, were the payment to be 

regarded (and treated as interest or a 

royalty, as applicable) under such tax 

law, the tax resident or taxable branch 

would include the payment in income, 

as determined under § 1.267A–3(a). In 

addition, a disregarded payment 

includes a specified payment that, 

under the tax law of a tax resident or 

taxable branch to which the payment is 

made, is a payment that gives rise to a 

deduction or similar offset allowed to 

the tax resident or taxable branch (or 

group of entities that include the tax 

resident or taxable branch) under a 

foreign consolidation, fiscal unity, 

group relief, loss sharing, or any similar 


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regime. Moreover, a disregarded 

payment does not include a deemed 

branch payment, or a specified payment 

pursuant to a repo transaction or similar 

transaction described in paragraph (a)(3) 

of this section. 

(3) Definition of dual inclusion 

income. With respect to a specified 

party, the term dual inclusion income 

means the excess, if any, of— 

(i) The sum of the specified party’s 

items of income or gain for U.S. tax 

purposes, to the extent the items of 

income or gain are included in the 

income of the tax resident or taxable 

branch to which the disregarded 

payments are made, as determined 

under § 1.267A–3(a) (by treating the 

items of income or gain as the specified 

payment); over 

(ii) The sum of the specified party’s 

items of deduction or loss for U.S. tax 

purposes (other than deductions for 

disregarded payments), to the extent the 

items of deduction or loss are allowable 

(or have been or will be allowable 

during a taxable year that ends no more 

than 36 months after the end of the 

specified party’s taxable year) under the 

tax law of the tax resident or taxable 

branch to which the disregarded 

payments are made. 

(4) Payments made indirectly to a tax 

resident or taxable branch. A specified 

payment made to an entity an interest 

of which is directly or indirectly 

(determined under the rules of section 

958(a) without regard to whether an 

intermediate entity is foreign or 

domestic) owned by a tax resident or 

taxable branch is considered made to 

the tax resident or taxable branch to the 

extent that, under the tax law of the tax 

resident or taxable branch, the entity to 

which the payment is made is fiscally 

transparent (and all intermediate 

entities, if any, are also fiscally 

transparent). 

(c) Deemed branch payments—(1) In 

general. If a specified payment is a 

deemed branch payment, then the 

payment is a disqualified hybrid 

amount if the tax law of the home office 

provides an exclusion or exemption for 

income attributable to the branch. See 

§ 1.267A–6(c)(4). 

(2) Definition of deemed branch 

payment. The term deemed branch 

payment means, with respect to a U.S. 

taxable branch that is a U.S. permanent 

establishment of a treaty resident 

eligible for benefits under an income tax 

treaty between the United States and the 

treaty country, any amount of interest or 

royalties allowable as a deduction in 

computing the business profits of the 

U.S. permanent establishment, to the 

extent the amount is deemed paid to the 

home office (or other branch of the 

home office) and is not regarded (or 

otherwise taken into account) under the 

home office’s tax law (or the other 

branch’s tax law). A deemed branch 

payment may be otherwise taken into 

account for this purpose if, for example, 

under the home office’s tax law a 

corresponding amount of interest or 

royalties is allocated and attributable to 

the U.S. permanent establishment and is 

therefore not deductible. 

(d) Payments to reverse hybrids—(1) 

In general. If a specified payment is 

made to a reverse hybrid, then, subject 

to § 1.267A–3(b) (amounts included or 

includible in income), the payment is a 

disqualified hybrid amount to the extent 

that— 

(i) An investor of the reverse hybrid 

does not include the payment in 

income, as determined under § 1.267A– 

3(a) (to such extent, a no-inclusion); and 

(ii) The investor’s no-inclusion is a 

result of the payment being made to the 

reverse hybrid. For this purpose, the 

investor’s no-inclusion is a result of the 

specified payment being made to the 

reverse hybrid to the extent that the noinclusion would not occur were the 

investor’s tax law to treat the reverse 

hybrid as fiscally transparent (and treat 

the payment as interest or a royalty, as 

applicable). See § 1.267A–6(c)(5). 

(2) Definition of reverse hybrid. The 

term reverse hybrid means an entity 

(regardless of whether domestic or 

foreign) that is fiscally transparent 

under the tax law of the country in 

which it is created, organized, or 

otherwise established but not fiscally 

transparent under the tax law of an 

investor of the entity. 

(3) Payments made indirectly to a 

reverse hybrid. A specified payment 

made to an entity an interest of which 

is directly or indirectly (determined 

under the rules of section 958(a) 

without regard to whether an 

intermediate entity is foreign or 

domestic) owned by a reverse hybrid is 

considered made to the reverse hybrid 

to the extent that, under the tax law of 

an investor of the reverse hybrid, the 

entity to which the payment is made is 

fiscally transparent (and all 

intermediate entities, if any, are also 

fiscally transparent). 

(e) Branch mismatch payments—(1) 

In general. If a specified payment is a 

branch mismatch payment, then, subject 

to § 1.267A–3(b) (amounts included or 

includible in income), the payment is a 

disqualified hybrid amount to the extent 

that— 

(i) A home office, the tax law of which 

treats the payment as income 

attributable to a branch of the home 

office, does not include the payment in 

income, as determined under § 1.267A– 

3(a) (to such extent, a no-inclusion); and 

(ii) The home office’s no-inclusion is 

a result of the payment being a branch 

mismatch payment. For this purpose, 

the home office’s no-inclusion is a result 

of the specified payment being a branch 

mismatch payment to the extent that the 

no-inclusion would not occur were the 

home office’s tax law to treat the 

payment as income that is not 

attributable a branch of the home office 

(and treat the payment as interest or a 

royalty, as applicable). See § 1.267A– 

6(c)(6). 

(2) Definition of branch mismatch 

payment. The term branch mismatch 

payment means a specified payment for 

which the following requirements are 

satisfied: 

(i) Under a home office’s tax law, the 

payment is treated as income 

attributable to a branch of the home 

office; and 

(ii) Either— 

(A) The branch is not a taxable 

branch; or 

(B) Under the branch’s tax law, the 

payment is not treated as income 

attributable to the branch. 

(f) Relatedness or structured 

arrangement limitation. A specified 

recipient, a tax resident or taxable 

branch to which a specified payment is 

made, an investor, or a home office is 

taken into account for purposes of 

paragraphs (a), (b), (d), and (e) of this 

section, respectively, only if the 

specified recipient, the tax resident or 

taxable branch, the investor, or the 

home office, as applicable, is related (as 

defined in § 1.267A–5(a)(14)) to the 

specified party or is a party to a 

structured arrangement (as defined in 

§ 1.267A–5(a)(20)) pursuant to which 

the specified payment is made. 

§ 1.267A–3 Income inclusions and 

amounts not treated as disqualified hybrid 

amounts. 

(a) Income inclusions—(1) General 

rule. For purposes of section 267A, a tax 

resident or taxable branch includes in 

income a specified payment to the 

extent that, under the tax law of the tax 

resident or taxable branch— 

(i) It includes (or it will include 

during a taxable year that ends no more 

than 36 months after the end of the 

specified party’s taxable year) the 

payment in its income or tax base at the 

full marginal rate imposed on ordinary 

income; and 

(ii) The payment is not reduced or 

offset by an exemption, exclusion, 

deduction, credit (other than for 

withholding tax imposed on the 

payment), or other similar relief 

particular to such type of payment. 


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Examples of such reductions or offsets 

include a participation exemption, a 

dividends received deduction, a 

deduction or exclusion with respect to 

a particular category of income (such as 

income attributable to a branch, or 

royalties under a patent box regime), 

and a credit for underlying taxes paid by 

a corporation from which a dividend is 

received. A specified payment is not 

considered reduced or offset by a 

deduction or other similar relief 

particular to the type of payment if it is 

offset by a generally applicable 

deduction or other tax attribute, such as 

a deduction for depreciation or a net 

operating loss. For this purpose, a 

deduction may be treated as being 

generally applicable even if it is arises 

from a transaction related to the 

specified payment (for example, if the 

deduction and payment are in 

connection with a back-to-back 

financing arrangement). 

(2) Coordination with foreign hybrid 

mismatch rules. Whether a tax resident 

or taxable branch includes in income a 

specified payment is determined 

without regard to any defensive or 

secondary rule contained in hybrid 

mismatch rules, if any, under the tax 

law of the tax resident or taxable 

branch. For this purpose, a defensive or 

secondary rule means a provision of 

hybrid mismatch rules that requires a 

tax resident or taxable branch to include 

an amount in income if a deduction for 

the amount is not disallowed under 

applicable tax law. 

(3) Inclusions with respect to reverse 

hybrids. With respect to a tax resident 

or taxable branch that is an investor of 

a reverse hybrid, whether the investor 

includes in income a specified payment 

made to the reverse hybrid is 

determined without regard to a 

distribution from the reverse hybrid (or 

right to a distribution from the reverse 

hybrid triggered by the payment). 

(4) De minimis inclusions and 

deemed full inclusions. A preferential 

rate, exemption, exclusion, deduction, 

credit, or similar relief particular to a 

type of payment that reduces or offsets 

90 percent or more of the payment is 

considered to reduce or offset 100 

percent of the payment. In addition, a 

preferential rate, exemption, exclusion, 

deduction, credit, or similar relief 

particular to a type of payment that 

reduces or offsets 10 percent or less of 

the payment is considered to reduce or 

offset none of the payment. 

(b) Certain amounts not treated as 

disqualified hybrid amounts to extent 

included or includible in income—(1) In 

general. A specified payment, to the 

extent that but for this paragraph (b) it 

would be a disqualified hybrid amount 

(such amount, a tentative disqualified 

hybrid amount), is reduced under the 

rules of paragraphs (b)(2) through (4) of 

this section, as applicable. The tentative 

disqualified hybrid amount, as reduced 

under such rules, is the disqualified 

hybrid amount. See § 1.267A–6(c)(3) 

and (7). 

(2) Included in income of United 

States tax resident or U.S. taxable 

branch. A tentative disqualified hybrid 

amount is reduced to the extent that a 

specified recipient that is a tax resident 

of the United States or a U.S. taxable 

branch takes the tentative disqualified 

hybrid amount into account in its gross 

income. 

(3) Includible in income under section 

951(a)(1). A tentative disqualified 

hybrid amount is reduced to the extent 

that the tentative disqualified hybrid 

amount is received by a CFC and 

includible under section 951(a)(1) 

(determined without regard to properly 

allocable deductions of the CFC and 

qualified deficits under section 

952(c)(1)(B)) in the gross income of a 

United States shareholder of the CFC. 

However, the tentative disqualified 

hybrid amount is reduced only if the 

United States shareholder is a tax 

resident of the United States or, if the 

United States shareholder is not a tax 

resident of the United States, then only 

to the extent that a tax resident of the 

United States would take into account 

the amount includible under section 

951(a)(1) in the gross income of the 

United States shareholder. 

(4) Includible in income under section 

951A(a). A tentative disqualified hybrid 

amount is reduced to the extent that the 

tentative disqualified hybrid amount 

increases a United States shareholder’s 

pro rata share of tested income (within 

the meaning of section 951A(c)(2)(A)) 

with respect to a CFC, reduces the 

shareholder’s pro rata share of tested 

loss (within the meaning of section 

951A(c)(2)(B)) of the CFC, or both. 

However, the tentative disqualified 

hybrid amount is reduced only if the 

United States shareholder is a tax 

resident of the United States or, if the 

United States shareholder is not a tax 

resident of the United States, then only 

to the extent that a tax resident of the 

United States would take into account 

the amount that increases the United 

States shareholder’s pro rata share of 

tested income with respect to the CFC, 

reduces the shareholder’s pro rata share 

of tested loss of the CFC, or both. 

§ 1.267A–4 Disqualified imported 

mismatch amounts. 

(a) Disqualified imported mismatch 

amounts. A specified payment (to the 

extent not a disqualified hybrid amount, 

as described in § 1.267A–2) is a 

disqualified imported mismatch amount 

to the extent that, under the set-off rules 

of paragraph (c) of this section, the 

income attributable to the payment is 

directly or indirectly offset by a hybrid 

deduction incurred by a tax resident or 

taxable branch that is related to the 

specified party (or that is a party to a 

structured arrangement pursuant to 

which the payment is made). For 

purposes of this section, any specified 

payment (to the extent not a disqualified 

hybrid amount) is referred to as an 

imported mismatch payment; the 

specified party is referred to as an 

imported mismatch payer; and a tax 

resident or taxable branch that includes 

the imported mismatch payment in 

income (or a tax resident or taxable 

branch the tax law of which otherwise 

prevents the imported mismatch 

payment from being a disqualified 

hybrid amount, for example, because 

under such tax law the tax resident’s noinclusion is not a result of hybridity) is 

referred to as the imported mismatch 

payee. See § 1.267A–6(c)(8), (9), and 

(10). 

(b) Hybrid deduction. A hybrid 

deduction means, with respect to a tax 

resident or taxable branch that is not a 

specified party, a deduction allowed to 

the tax resident or taxable branch under 

its tax law for an amount paid or 

accrued that is interest (including an 

amount that would be a structured 

payment under the principles of 

§ 1.267A–5(b)(5)(ii)) or royalty under 

such tax law (regardless of whether or 

how such amounts would be recognized 

under U.S. law), to the extent that a 

deduction for the amount would be 

disallowed if such tax law contained 

rules substantially similar to those 

under §§ 1.267A–1 through 1.267A–3 

and 1.267A–5. In addition, with respect 

to a tax resident that is not a specified 

party, a hybrid deduction includes a 

deduction allowed to the tax resident 

with respect to equity, such as a 

notional interest deduction. Further, a 

hybrid deduction for a particular 

accounting period includes a loss 

carryover from another accounting 

period, to the extent that a hybrid 

deduction incurred in an accounting 

period beginning on or after December 

20, 2018 comprises the loss carryover. 

(c) Set-off rules—(1) In general. In the 

order described in paragraph (c)(2) of 

this section, a hybrid deduction directly 

or indirectly offsets the income 

attributable to an imported mismatch 

payment to the extent that, under 

paragraph (c)(3) of this section, the 

payment directly or indirectly funds the 

hybrid deduction. 


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(2) Ordering rules. The following 

ordering rules apply for purposes of 

determining the extent that a hybrid 

deduction directly or indirectly offsets 

income attributable to imported 

mismatch payments. 

(i) First, the hybrid deduction offsets 

income attributable to a factually-related 

imported mismatch payment that 

directly or indirectly funds the hybrid 

deduction. For this purpose, a factuallyrelated imported mismatch payment 

means an imported mismatch payment 

that is made pursuant to a transaction, 

agreement, or instrument entered into 

pursuant to the same plan or series of 

related transactions that includes the 

transaction, agreement, or instrument 

pursuant to which the hybrid deduction 

is incurred. 

(ii) Second, to the extent remaining, 

the hybrid deduction offsets income 

attributable to an imported mismatch 

payment (other than a factually-related 

imported mismatch payment) that 

directly funds the hybrid deduction. 

(iii) Third, to the extent remaining, 

the hybrid deduction offsets income 

attributable to an imported mismatch 

payment (other than a factually-related 

imported mismatch payment) that 

indirectly funds the hybrid deduction. 

(3) Funding rules. The following 

funding rules apply for purposes of 

determining the extent that an imported 

mismatch payment directly or indirectly 

funds a hybrid deduction. 

(i) The imported mismatch payment 

directly funds a hybrid deduction to the 

extent that the imported mismatch 

payee incurs the deduction. 

(ii) The imported mismatch payment 

indirectly funds a hybrid deduction to 

the extent that the imported mismatch 

payee is allocated the deduction. 

(iii) The imported mismatch payee is 

allocated a hybrid deduction to the 

extent that the imported mismatch 

payee directly or indirectly makes a 

funded taxable payment to the tax 

resident or taxable branch that incurs 

the hybrid deduction. 

(iv) An imported mismatch payee 

indirectly makes a funded taxable 

payment to the tax resident or taxable 

branch that incurs a hybrid deduction to 

the extent that a chain of funded taxable 

payments exists connecting the 

imported mismatch payee, each 

intermediary tax resident or taxable 

branch, and the tax resident or taxable 

branch that incurs the hybrid deduction. 

(v) The term funded taxable payment 

means, with respect to a tax resident or 

taxable branch that is not a specified 

party, a deductible amount paid or 

accrued by the tax resident or taxable 

branch under its tax law, other than an 

amount that gives rise to a hybrid 

deduction. However, a funded taxable 

payment does not include an amount 

deemed to be an imported mismatch 

payment pursuant to paragraph (f) of 

this section. 

(vi) If, with respect to a tax resident 

or taxable branch that is not a specified 

party, a deduction or loss that is not 

incurred by the tax resident or taxable 

branch is directly or indirectly made 

available to offset income of the tax 

resident or taxable branch under its tax 

law, then, for purposes of this paragraph 

(c), the tax resident or taxable branch to 

which the deduction or loss is made 

available and the tax resident or branch 

that incurs the deduction or loss are 

treated as a single tax resident or taxable 

branch. For example, if a deduction or 

loss of one tax resident is made 

available to offset income of another tax 

resident under a tax consolidation, 

fiscal unity, group relief, loss sharing, or 

any similar regime, then the tax 

residents are treated as a single tax 

resident for purposes of paragraph (c) of 

this section. 

(d) Calculations based on aggregate 

amounts during accounting period. For 

purposes of this section, amounts are 

determined on an accounting period 

basis. Thus, for example, the amount of 

imported mismatch payments made by 

an imported mismatch payer to a 

particular imported mismatch payee is 

equal to the aggregate amount of all 

such payments made by the payer 

during the accounting period. 

(e) Pro rata adjustments. Amounts are 

allocated on a pro rata basis if there 

would otherwise be more than one 

permissible manner in which to allocate 

the amounts. Thus, for example, if 

multiple imported mismatch payers 

make an imported mismatch payment to 

a particular imported mismatch payee, 

the amount of such payments exceeds 

the hybrid deduction incurred by the 

payee, and the payments are not 

factually-related imported mismatch 

payments, then a pro rata portion of 

each payer’s payment is considered to 

directly fund the hybrid deduction. See 

§ 1.267A–6(c)(9). 

(f) Certain amounts deemed to be 

imported mismatch payments for 

certain purposes. For purposes of 

determining the extent that income 

attributable to an imported mismatch 

payment is directly or indirectly offset 

by a hybrid deduction, an amount paid 

or accrued by a tax resident or taxable 

branch that is not a specified party is 

deemed to be an imported mismatch 

payment (and such tax resident or 

taxable branch and a specified recipient 

of the amount, determined under 

§ 1.267A–5(a)(19), by treating the 

amount as the specified payment, are 

deemed to be an imported mismatch 

payer and an imported mismatch payee, 

respectively) to the extent that— 

(1) The tax law of such tax resident 

or taxable branch contains hybrid 

mismatch rules; and 

(2) Under a provision of the hybrid 

mismatch rules substantially similar to 

this section, the tax resident or taxable 

branch is denied a deduction for all or 

a portion of the amount. See § 1.267A– 

6(c)(10). 

§ 1.267A–5 Definitions and special rules. 

(a) Definitions. For purposes of 

§§ 1.267A–1 through 1.267A–7 the 

following definitions apply. 

(1) The term accounting period means 

a taxable year, or a period of similar 

length over which, under a provision of 

hybrid mismatch rules substantially 

similar to § 1.267A–4, computations 

similar to those under that section are 

made under a foreign tax law. 

(2) The term branch means a taxable 

presence of a tax resident in a country 

other than its country of residence 

under either the tax resident’s tax law 

or such other country’s tax law. 

(3) The term branch mismatch 

payment has the meaning provided in 

§ 1.267A–2(e)(2). 

(4) The term controlled foreign 

corporation (or CFC) has the meaning 

provided in section 957. 

(5) The term deemed branch payment 

has the meaning provided in § 1.267A– 

2(c)(2). 

(6) The term disregarded payment has 

the meaning provided in § 1.267A– 

2(b)(2). 

(7) The term entity means any person 

(as described in section 7701(a)(1), 

including an entity that under 

§§ 301.7701–1 through 301.7701–3 of 

this chapter is disregarded as an entity 

separate from its owner) other than an 

individual. 

(8) The term fiscally transparent 

means, with respect to an entity, fiscally 

transparent with respect to an item of 

income as determined under the 

principles of § 1.894–1(d)(3)(ii) and (iii), 

without regard to whether a tax resident 

(either the entity or interest holder in 

the entity) that derives the item of 

income is a resident of a country that 

has an income tax treaty with the 

United States. 

(9) The term home office means a tax 

resident that has a branch. 

(10) The term hybrid mismatch rules 

means rules, regulations, or other tax 

guidance substantially similar to section 

267A, and includes rules the purpose of 

which is to neutralize the deduction/noinclusion outcome of hybrid and branch 

mismatch arrangements. Examples of 

such rules would include rules based 


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on, or substantially similar to, the 

recommendations contained in OECD/ 

G–20, Neutralising the Effects of Hybrid 

Mismatch Arrangements, Action 2: 2015 

Final Report (October 2015), and OECD/ 

G–20, Neutralising the Effects of Branch 

Mismatch Arrangements, Action 2: 

Inclusive Framework on BEPS (July 

2017). 

(11) The term hybrid transaction has 

the meaning provided in § 1.267A– 

2(a)(2). 

(12) The term interest means any 

amount described in paragraph (a)(12)(i) 

or (ii) of this section (as adjusted by 

amounts described in paragraph 

(a)(12)(iii) of this section) that is paid or 

accrued, or treated as paid or accrued, 

for the taxable year or that is otherwise 

designated as interest expense in 

paragraph (a)(12)(i) or (ii) of this section 

(as adjusted by amounts described in 

paragraph (a)(12)(iii) of this section). 

(i) In general. Interest is an amount 

paid, received, or accrued as 

compensation for the use or forbearance 

of money under the terms of an 

instrument or contractual arrangement, 

including a series of transactions, that is 

treated as a debt instrument for 

purposes of section 1275(a) and 

§ 1.1275–1(d), and not treated as stock 

under § 1.385–3, or an amount that is 

treated as interest under other 

provisions of the Internal Revenue Code 

(Code) or the regulations under 26 CFR 

part 1. Thus, for example, interest 

includes— 

(A) Original issue discount (OID); 

(B) Qualified stated interest, as 

adjusted by the issuer for any bond 

issuance premium; 

(C) OID on a synthetic debt 

instrument arising from an integrated 

transaction under § 1.1275–6; 

(D) Repurchase premium to the extent 

deductible by the issuer under § 1.163– 

7(c); 

(E) Deferred payments treated as 

interest under section 483; 

(F) Amounts treated as interest under 

a section 467 rental agreement; 

(G) Forgone interest under section 

7872; 

(H) De minimis OID taken into 

account by the issuer; 

(I) Amounts paid or received in 

connection with a sale-repurchase 

agreement treated as indebtedness 

under Federal tax principles; in the case 

of a sale-repurchase agreement relating 

to tax-exempt bonds, however, the 

amount is not tax-exempt interest; 

(J) Redeemable ground rent treated as 

interest under section 163(c); and 

(K) Amounts treated as interest under 

section 636. 

(ii) Swaps with significant 

nonperiodic payments—(A) Noncleared swaps. A swap that is not a 

cleared swap and that has significant 

nonperiodic payments is treated as two 

separate transactions consisting of an 

on-market, level payment swap and a 

loan. The loan must be accounted for by 

the parties to the contract 

independently of the swap. The time 

value component associated with the 

loan, determined in accordance with 

§ 1.446–3(f)(2)(iii)(A), is recognized as 

interest expense to the payor. 

(B) [Reserved] 

(C) Definition of cleared swap. The 

term cleared swap means a swap that is 

cleared by a derivatives clearing 

organization, as such term is defined in 

section 1a of the Commodity Exchange 

Act (7 U.S.C. 1a), or by a clearing 

agency, as such term is defined in 

section 3 of the Securities Exchange Act 

of 1934 (15 U.S.C. 78c), that is registered 

as a derivatives clearing organization 

under the Commodity Exchange Act or 

as a clearing agency under the Securities 

Exchange Act of 1934, respectively, if 

the derivatives clearing organization or 

clearing agency requires the parties to 

the swap to post and collect margin or 

collateral. 

(iii) Amounts affecting the effective 

cost of borrowing that adjust the amount 

of interest expense. Income, deduction, 

gain, or loss from a derivative, as 

defined in section 59A(h)(4)(A), that 

alters a person’s effective cost of 

borrowing with respect to a liability of 

the person is treated as an adjustment to 

interest expense of the person. For 

example, a person that is obligated to 

pay interest at a floating rate on a note 

and enters into an interest rate swap 

that entitles the person to receive an 

amount that is equal to or that closely 

approximates the interest rate on the 

note in exchange for a fixed amount is, 

in effect, paying interest expense at a 

fixed rate by entering into the interest 

rate swap. Income, deduction, gain, or 

loss from the swap is treated as an 

adjustment to interest expense. 

Similarly, any gain or loss resulting 

from a termination or other disposition 

of the swap is an adjustment to interest 

expense, with the timing of gain or loss 

subject to the rules of § 1.446–4. 

(13) The term investor means, with 

respect to an entity, any tax resident or 

taxable branch that directly or indirectly 

(determined under the rules of section 

958(a) without regard to whether an 

intermediate entity is foreign or 

domestic) owns an interest in the entity. 

(14) The term related has the meaning 

provided in this paragraph (a)(14). A tax 

resident or taxable branch is related to 

a specified party if the tax resident or 

taxable branch is a related person 

within the meaning of section 954(d)(3), 

determined by treating the specified 

party as the ‘‘controlled foreign 

corporation’’ referred to in that section 

and the tax resident or taxable branch as 

the ‘‘person’’ referred to in that section. 

In addition, for these purposes, a tax 

resident that under §§ 301.7701–1 

through 301.7701–3 of this chapter is 

disregarded as an entity separate from 

its owner for U.S. tax purposes, as well 

as a taxable branch, is treated as a 

corporation. Further, for these purposes 

neither section 318(a)(3), nor § 1.958– 

2(d) or the principles thereof, applies to 

attribute stock or other interests to a tax 

resident, taxable branch, or specified 

party. 

(15) The term reverse hybrid has the 

meaning provided in § 1.267A–2(d)(2). 

(16) The term royalty includes 

amounts paid or accrued as 

consideration for the use of, or the right 

to use— 

(i) Any copyright, including any 

copyright of any literary, artistic, 

scientific or other work (including 

cinematographic films and software); 

(ii) Any patent, trademark, design or 

model, plan, secret formula or process, 

or other similar property (including 

goodwill); or 

(iii) Any information concerning 

industrial, commercial or scientific 

experience, but does not include— 

(A) Amounts paid or accrued for aftersales services; 

(B) Amounts paid or accrued for 

services rendered by a seller to the 

purchaser under a warranty; 

(C) Amounts paid or accrued for pure 

technical assistance; or 

(D) Amounts paid or accrued for an 

opinion given by an engineer, lawyer or 

accountant. 

(17) The term specified party means a 

tax resident of the United States, a CFC 

(other than a CFC with respect to which 

there is not a United States shareholder 

that owns (within the meaning of 

section 958(a)) at least ten percent (by 

vote or value) of the stock of the CFC), 

and a U.S. taxable branch. Thus, an 

entity that is fiscally transparent for U.S. 

tax purposes is not a specified party, 

though an owner of the entity may be 

a specified party. For example, in the 

case of a payment by a partnership, a 

domestic corporation or a CFC that is a 

partner of the partnership is a specified 

party whose deduction for its allocable 

share of the payment is subject to 

disallowance under section 267A. 

(18) The term specified payment has 

the meaning provided in § 1.267A–1(b). 

(19) The term specified recipient 

means, with respect to a specified 

payment, any tax resident that derives 

the payment under its tax law or any 

taxable branch to which the payment is 


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attributable under its tax law. The 

principles of § 1.894–1(d)(1) apply for 

purposes of determining whether a tax 

resident derives a specified payment 

under its tax law, without regard to 

whether the tax resident is a resident of 

a country that has an income tax treaty 

with the United States. There may be 

more than one specified recipient with 

respect to a specified payment. 

(20) The term structured arrangement 

means an arrangement with respect to 

which one or more specified payments 

would be a disqualified hybrid amount 

(or a disqualified imported mismatch 

amount) if the specified payment were 

analyzed without regard to the 

relatedness limitation in § 1.267A–2(f) 

(or without regard to the language ‘‘that 

is related to the specified party’’ in 

§ 1.267A–4(a)) (either such outcome, a 

hybrid mismatch), provided that either 

paragraph (a)(20)(i) or (ii) of this section 

is satisfied. A party to a structured 

arrangement means a tax resident or 

taxable branch that participates in the 

structured arrangement. For this 

purpose, an entity’s participation in a 

structured arrangement is imputed to its 

investors. 

(i) The hybrid mismatch is priced into 

the terms of the arrangement. 

(ii) Based on all the facts and 

circumstances, the hybrid mismatch is a 

principal purpose of the arrangement. 

Facts and circumstances that indicate 

the hybrid mismatch is a principal 

purpose of the arrangement include— 

(A) Marketing the arrangement as taxadvantaged where some or all of the tax 

advantage derives from the hybrid 

mismatch; 

(B) Primarily marketing the 

arrangement to tax residents of a 

country the tax law of which enables the 

hybrid mismatch; 

(C) Features that alter the terms of the 

arrangement, including the return, in 

the event the hybrid mismatch is no 

longer available; or 

(D) A below-market return absent the 

tax effects or benefits resulting from the 

hybrid mismatch. 

(21) The term tax law of a country 

includes statutes, regulations, 

administrative or judicial rulings, and 

treaties of the country. When used with 

respect to a tax resident or branch, tax 

law refers to— 

(i) In the case of a tax resident, the tax 

law of the country or countries where 

the tax resident is resident; and 

(ii) In the case of a branch, the tax law 

of the country where the branch is 

located. 

(22) The term taxable branch means 

a branch that has a taxable presence 

under its tax law. 

(23) The term tax resident means 

either of the following: 

(i) A body corporate or other entity or 

body of persons liable to tax under the 

tax law of a country as a resident. For 

this purpose, a body corporate or other 

entity or body of persons may be 

considered liable to tax under the tax 

law of a country as a resident even 

though such tax law does not impose a 

corporate income tax. A body corporate 

or other entity or body of persons may 

be a tax resident of more than one 

country. 

(ii) An individual liable to tax under 

the tax law of a country as a resident. 

An individual may be a tax resident of 

more than one country. 

(24) The term United States 

shareholder has the meaning provided 

in section 951(b). 

(25) The term U.S. taxable branch 

means a trade or business carried on in 

the United States by a tax resident of 

another country, except that if an 

income tax treaty applies, the term 

means a permanent establishment of a 

tax treaty resident eligible for benefits 

under an income tax treaty between the 

United States and the treaty country. 

Thus, for example, a U.S. taxable branch 

includes a U.S. trade or business of a 

foreign corporation taxable under 

section 882(a) or a U.S. permanent 

establishment of a tax treaty resident. 

(b) Special rules. For purposes of 

§§ 1.267A–1 through 1.267A–7, the 

following special rules apply. 

(1) Coordination with other 

provisions. Except as otherwise 

provided in the Code or in regulations 

under 26 CFR part 1, section 267A 

applies to a specified payment after the 

application of any other applicable 

provisions of the Code and regulations 

under 26 CFR part 1. Thus, the 

determination of whether a deduction 

for a specified payment is disallowed 

under section 267A is made with 

respect to the taxable year for which a 

deduction for the payment would 

otherwise be allowed for U.S. tax 

purposes. See, for example, sections 

163(e)(3) and 267(a)(3) for rules that 

may defer the taxable year for which a 

deduction is allowed. See also § 1.882– 

5(a)(5) (providing that provisions that 

disallow interest expense apply after the 

application of § 1.882–5). In addition, 

provisions that characterize amounts 

paid or accrued as something other than 

interest or royalty, such as § 1.894– 

1(d)(2), govern the treatment of such 

amounts and therefore such amounts 

would not be treated as specified 

payments. 

(2) Foreign currency gain or loss. 

Except as set forth in this paragraph 

(b)(2), section 988 gain or loss is not 

taken into account under section 267A. 

Foreign currency gain or loss recognized 

with respect to a specified payment is 

taken into account under section 267A 

to the extent that a deduction for the 

specified payment is disallowed under 

section 267A, provided that the foreign 

currency gain or loss is described in 

§ 1.988–2(b)(4) (relating to exchange 

gain or loss recognized by the issuer of 

a debt instrument with respect to 

accrued interest) or § 1.988–2(c) 

(relating to items of expense or gross 

income or receipts which are to be paid 

after the date accrued). If a deduction 

for a specified payment is disallowed 

under section 267A, then a 

proportionate amount of foreign 

currency loss under section 988 with 

respect to the specified payment is also 

disallowed, and a proportionate amount 

of foreign currency gain under section 

988 with respect to the specified 

payment reduces the amount of the 

disallowance. For this purpose, the 

proportionate amount is the amount of 

the foreign currency gain or loss under 

section 988 with respect to the specified 

payment multiplied by the amount of 

the specified payment for which a 

deduction is disallowed under section 

267A. 

(3) U.S. taxable branch payments—(i) 

Amounts considered paid or accrued by 

a U.S. taxable branch. For purposes of 

section 267A, a U.S. taxable branch is 

considered to pay or accrue an amount 

of interest or royalty equal to— 

(A) The amount of interest or royalty 

allocable to effectively connected 

income of the U.S. taxable branch under 

section 873(a) or 882(c)(1), as 

applicable; or 

(B) In the case of a U.S. taxable branch 

that is a U.S. permanent establishment 

of a treaty resident eligible for benefits 

under an income tax treaty between the 

United States and the treaty country, the 

amount of interest or royalty deductible 

in computing the business profits 

attributable to the U.S. permanent 

establishment, if such amounts differ 

from the amounts allocable under 

paragraph (b)(3)(i)(A) of this section. 

(ii) Treatment of U.S. taxable branch 

payments—(A) Interest. Interest 

considered paid or accrued by a U.S. 

taxable branch of a foreign corporation 

under paragraph (b)(3)(i) of this section 

is treated as a payment directly to the 

person to which the interest is payable, 

to the extent it is paid or accrued with 

respect to a liability described in 

§ 1.882–5(a)(1)(ii)(A) (resulting in 

directly allocable interest) or with 

respect to a U.S. booked liability, as 

defined in § 1.882–5(d)(2). If the amount 

of interest allocable to the U.S. taxable 

branch exceeds the interest paid or 


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accrued on its U.S. booked liabilities, 

the excess amount is treated as paid or 

accrued by the U.S. taxable branch on 

a pro-rata basis to the same persons and 

pursuant to the same terms that the 

home office paid or accrued interest for 

purposes of the calculations described 

in paragraph (b)(3)(i) of this section, 

excluding any interest treated as already 

paid directly by the branch. 

(B) Royalties. Royalties considered 

paid or accrued by a U.S. taxable branch 

under paragraph (b)(3)(i) of this section 

are treated solely for purposes of section 

267A as paid or accrued on a pro-rata 

basis by the U.S. taxable branch to the 

same persons and pursuant to the same 

terms that the home office paid or 

accrued such royalties. 

(C) Permanent establishments and 

interbranch payments. If a U.S. taxable 

branch is a permanent establishment in 

the United States, rules analogous to the 

rules in paragraphs (b)(3)(ii)(A) and (B) 

of this section apply with respect to 

interest and royalties allowed in 

computing the business profits of a 

treaty resident eligible for treaty 

benefits. This paragraph (b)(3)(ii)(C) 

does not apply to interbranch interest or 

royalty payments allowed as deduction 

under certain U.S. income tax treaties 

(as described in § 1.267A–2(c)(2)). 

(4) Effect on earnings and profits. The 

disallowance of a deduction under 

section 267A does not affect whether or 

when the amount paid or accrued that 

gave rise to the deduction reduces 

earnings and profits of a corporation. 

(5) Application to structured 

payments—(i) In general. For purposes 

of section 267A and the regulations 

under section 267A as contained in 26 

CFR part 1, a structured payment (as 

defined in paragraph (b)(5)(ii) of this 

section) is treated as a specified 

payment. 

(ii) Structured payment. A structured 

payment means any amount described 

in paragraphs (b)(5)(ii)(A) or (B) of this 

section (as adjusted by amounts 

described in paragraph (b)(5)(ii)(C) of 

this section). 

(A) Certain payments related to the 

time value of money (structured interest 

amounts)—(1) Substitute interest 

payments. A substitute interest payment 

described in § 1.861–2(a)(7). 

(2) Certain amounts labeled as fees— 

(i) Commitment fees. Any fees in respect 

of a lender commitment to provide 

financing if any portion of such 

financing is actually provided. 

(ii) [Reserved] 

(3) Debt issuance costs. Any debt 

issuance costs subject to § 1.446–5. 

(4) Guaranteed payments. Any 

guaranteed payments for the use of 

capital under section 707(c). 

(B) Amounts predominately 

associated with the time value of 

money. Any expense or loss, to the 

extent deductible, incurred by a person 

in a transaction or series of integrated or 

related transactions in which the person 

secures the use of funds for a period of 

time, if such expense or loss is 

predominately incurred in 

consideration of the time value of 

money. 

(C) Adjustment for amounts affecting 

the effective cost of funds. Income, 

deduction, gain, or loss from a 

derivative, as defined in section 

59A(h)(4)(A), that alters a person’s 

effective cost of funds with respect to a 

structured payment described in 

paragraph (b)(5)(ii)(A) or (B) of this 

section is treated as an adjustment to the 

structured payment of the person. 

(6) Anti-avoidance rule. A specified 

party’s deduction for a specified 

payment is disallowed to the extent that 

both of the following requirements are 

satisfied: 

(i) The payment (or income 

attributable to the payment) is not 

included in the income of a tax resident 

or taxable branch, as determined under 

§ 1.267A–3(a) (but without regard to the 

de minimis and full inclusion rules in 

§ 1.267A–3(a)(3)). 

(ii) A principal purpose of the plan or 

arrangement is to avoid the purposes of 

the regulations under section 267A. 

§ 1.267A–6 Examples. 

(a) Scope. This section provides 

examples that illustrate the application 

of §§ 1.267A–1 through 1.267A–5. 

(b) Presumed facts. For purposes of 

the examples in this section, unless 

otherwise indicated, the following facts 

are presumed: 

(1) US1, US2, and US3 are domestic 

corporations that are tax residents solely 

of the United States. 

(2) FW, FX, and FZ are bodies 

corporate established in, and tax 

residents of, Country W, Country X, and 

Country Z, respectively. They are not 

fiscally transparent under the tax law of 

any country. 

(3) Under the tax law of each country, 

interest and royalty payments are 

deductible. 

(4) The tax law of each country 

provides a 100 percent participation 

exemption for dividends received from 

non-resident corporations. 

(5) The tax law of each country, other 

than the United States, provides an 

exemption for income attributable to a 

branch. 

(6) Except as provided in paragraphs 

(b)(4) and (5) of this section, all amounts 

derived (determined under the 

principles of § 1.894–1(d)(1)) by a tax 

resident, or attributable to a taxable 

branch, are included in income, as 

determined under § 1.267A–3(a). 

(7) Only the tax law of the United 

States contains hybrid mismatch rules. 

(c) Examples—(1) Example 1. Payment 

pursuant to a hybrid financial instrument— 

(i) Facts. FX holds all the interests of US1. 

FX holds an instrument issued by US1 that 

is treated as equity for Country X tax 

purposes and indebtedness for U.S. tax 

purposes (the FX–US1 instrument). On date 

1, US1 pays $50x to FX pursuant to the 

instrument. The amount is treated as an 

excludible dividend for Country X tax 

purposes (by reason of the Country X 

participation exemption) and as interest for 

U.S. tax purposes. 

(ii) Analysis. US1 is a specified party and 

thus a deduction for its $50x specified 

payment is subject to disallowance under 

section 267A. As described in paragraphs 

(c)(1)(ii)(A) through (C) of this section, the 

entire $50x payment is a disqualified hybrid 

amount under the hybrid transaction rule of 

§ 1.267A–2(a) and, as a result, a deduction for 

the payment is disallowed under § 1.267A– 

1(b)(1). 

(A) US1’s payment is made pursuant to a 

hybrid transaction because a payment with 

respect to the FX–US1 instrument is treated 

as interest for U.S. tax purposes but not for 

purposes of Country X tax law (the tax law 

of FX, a specified recipient that is related to 

US1). See § 1.267A–2(a)(2) and (f). Therefore, 

§ 1.267A–2(a) applies to the payment. 

(B) For US1’s payment to be a disqualified 

hybrid amount under § 1.267A–2(a), a noinclusion must occur with respect to FX. See 

§ 1.267A–2(a)(1)(i). As a consequence of the 

Country X participation exemption, FX 

includes $0 of the payment in income and 

therefore a $50x no-inclusion occurs with 

respect to FX. See § 1.267A–3(a)(1). The 

result is the same regardless of whether, 

under the Country X participation 

exemption, the $50x payment is simply 

excluded from FX’s taxable income or, 

instead, is reduced or offset by other means, 

such as a $50x dividends received deduction. 

See id. 

(C) Pursuant to § 1.267A–2(a)(1)(ii), FX’s 

$50x no-inclusion gives rise to a disqualified 

hybrid amount to the extent that it is a result 

of US1’s payment being made pursuant to the 

hybrid transaction. FX’s $50x no-inclusion is 

a result of the payment being made pursuant 

to the hybrid transaction because, were the 

payment to be treated as interest for Country 

X tax purposes, FX would include $50x in 

income and, consequently, the no-inclusion 

would not occur. 

(iii) Alternative facts—multiple specified 

recipients. The facts are the same as in 

paragraph (c)(1)(i) of this section, except that 

FX holds all the interests of FZ, which is 

fiscally transparent for Country X tax 

purposes, and FZ holds all of the interests of 

US1. Moreover, the FX–US1 instrument is 

held by FZ (rather than by FX) and US1 

makes its $50x payment to FZ (rather than to 

FX); the payment is derived by FZ under its 

tax law and by FX under its tax law and, 

accordingly, both FZ and FX are specified 

recipients of the payment. Further, the 


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payment is treated as interest for Country Z 

tax purposes and FZ includes it in income. 

For the reasons described in paragraph 

(c)(1)(ii) of this section, FX’s no-inclusion 

causes the payment to be a disqualified 

hybrid amount. FZ’s inclusion in income 

(regardless of whether Country Z has a low 

or high tax rate) does not affect the result, 

because the hybrid transaction rule of 

§ 1.267A–2(a) applies if any no-inclusion 

occurs with respect to a specified recipient 

of the payment as a result of the payment 

being made pursuant to the hybrid 

transaction. 

(iv) Alternative facts—preferential rate. 

The facts are the same as in paragraph 

(c)(1)(i) of this section, except that for 

Country X tax purposes US1’s payment is 

treated as a dividend subject to a 4% tax rate, 

whereas the marginal rate imposed on 

ordinary income is 20%. FX includes $10x of 

the payment in income, calculated as $50x 

multiplied by 0.2 (.04, the rate at which the 

particular type of payment (a dividend for 

Country X tax purposes) is subject to tax in 

Country X, divided by 0.2, the marginal tax 

rate imposed on ordinary income). See 

§ 1.267A–3(a)(1). Thus, a $40x no-inclusion 

occurs with respect to FX ($50x less $10x). 

The $40x no-inclusion is a result of the 

payment being made pursuant to the hybrid 

transaction because, were the payment to be 

treated as interest for Country X tax 

purposes, FX would include the entire $50x 

in income at the full marginal rate imposed 

on ordinary income (20%) and, 

consequently, the no-inclusion would not 

occur. Accordingly, $40x of US1’s payment 

is a disqualified hybrid amount. 

(v) Alternative facts—no-inclusion not the 

result of hybridity. The facts are the same as 

in paragraph (c)(1)(i) of this section, except 

that Country X has a pure territorial regime 

(that is, Country X only taxes income with a 

domestic source). Although US1’s payment is 

pursuant to a hybrid transaction and a $50x 

no-inclusion occurs with respect to FX, FX’s 

no-inclusion is not a result of the payment 

being made pursuant to the hybrid 

transaction. This is because if Country X tax 

law were to treat the payment as interest, FX 

would include $0 in income and, 

consequently, the $50x no-inclusion would 

still occur. Accordingly, US1’s payment is 

not a disqualified hybrid amount. See 

§ 1.267A–2(a)(1)(ii). The result would be the 

same if Country X instead did not impose a 

corporate income tax. 

(2) Example 2. Payment pursuant to a repo 

transaction—(i) Facts. FX holds all the 

interests of US1, and US1 holds all the 

interests of US2. On date 1, US1 and FX enter 

into a sale and repurchase transaction. 

Pursuant to the transaction, US1 transfers 

shares of preferred stock of US2 to FX in 

return for $1,000x paid from FX to US1, 

subject to a binding commitment of US1 to 

reacquire those shares on date 3 for an agreed 

price, which represents a repayment of the 

$1,000x plus a financing or time value of 

money return reduced by the amount of any 

distributions paid with respect to the 

preferred stock between dates 1 and 3 that 

are retained by FX. On date 2, US2 pays a 

$100x dividend on its preferred stock to FX. 

For Country X tax purposes, FX is treated as 

owning the US2 preferred stock and therefore 

is the beneficial owner of the dividend. For 

U.S. tax purposes, the transaction is treated 

as a loan from FX to US1 that is secured by 

the US2 preferred stock. Thus, for U.S. tax 

purposes, US1 is treated as owning the US2 

preferred stock and is the beneficial owner of 

the dividend. In addition, for U.S. tax 

purposes, US1 is treated as paying $100x of 

interest to FX (an amount corresponding to 

the $100x dividend paid by US2 to FX). 

Further, the marginal tax rate imposed on 

ordinary income under Country X tax law is 

25%. Moreover, instead of a participation 

exemption, Country X tax law provides its 

tax residents a credit for underlying foreign 

taxes paid by a non-resident corporation from 

which a dividend is received; with respect to 

the $100x dividend received by FX from 

US2, the credit is $10x. 

(ii) Analysis. US1 is a specified party and 

thus a deduction for its $100x specified 

payment is subject to disallowance under 

section 267A. As described in paragraphs 

(c)(2)(ii)(A) through (D) of this section, $40x 

of the payment is a disqualified hybrid 

amount under the hybrid transaction rule of 

§ 1.267A–2(a) and, as a result, $40x of the 

deduction is disallowed under § 1.267A– 

1(b)(1). 

(A) Although US1’s $100x interest 

payment is not regarded under Country X tax 

law, a connected amount (US2’s dividend 

payment) is regarded and derived by FX 

under such tax law. Thus, FX is considered 

a specified recipient with respect to US1’s 

interest payment. See § 1.267A–2(a)(3). 

(B) US1’s payment is made pursuant to a 

hybrid transaction because a payment with 

respect to the sale and repurchase transaction 

is treated as interest for U.S. tax purposes but 

not for purposes of Country X tax law (the 

tax law of FX, a specified recipient that is 

related to US1), which does not regard the 

payment. See § 1.267A–2(a)(2) and (f). 

Therefore, § 1.267A–2(a) applies to the 

payment. 

(C) For US1’s payment to be a disqualified 

hybrid amount under § 1.267A–2(a), a noinclusion must occur with respect to FX. See 

§ 1.267A–2(a)(1)(i). As a consequence of 

Country X tax law not regarding US1’s 

payment, FX includes $0 of the payment in 

income and therefore a $100x no-inclusion 

occurs with respect to FX. See § 1.267A–3(a). 

However, FX includes $60x of a connected 

amount (US2’s dividend payment) in income, 

calculated as $100x (the amount of the 

dividend) less $40x (the portion of the 

connected amount that is not included in 

Country X due to the foreign tax credit, 

determined by dividing the amount of the 

credit, $10x, by 0.25, the tax rate in Country 

X). See id. Pursuant to § 1.267A–2(a)(3), FX’s 

inclusion in income with respect to the 

connected amount correspondingly reduces 

the amount of its no-inclusion with respect 

to US1’s payment. Therefore, for purposes of 

§ 1.267A–2(a), FX’s no-inclusion with respect 

to US1’s payment is considered to be $40x 

($100x less $60x). See § 1.267A–2(a)(3). 

(D) Pursuant to § 1.267A–2(a)(1)(ii), FX’s 

$40x no-inclusion gives rise to a disqualified 

hybrid amount to the extent that FX’s noinclusion is a result of US1’s payment being 

made pursuant to the hybrid transaction. 

FX’s $40x no-inclusion is a result of US1’s 

payment being made pursuant to the hybrid 

transaction because, were the sale and 

repurchase transaction to be treated as a loan 

from FX to US1 for Country X tax purposes, 

FX would include US1’s $100x interest 

payment in income (because it would not be 

entitled to a foreign tax credit) and, 

consequently, the no-inclusion would not 

occur. 

(iii) Alternative facts—structured 

arrangement. The facts are the same as in 

paragraph (c)(2)(i) of this section, except that 

FX is a bank that is unrelated to US1. In 

addition, the sale and repurchase transaction 

is a structured arrangement and FX is a party 

to the structured arrangement. The result is 

the same as in paragraph (c)(2)(ii) of this 

section. That is, even though FX is not 

related to US1, it is taken into account with 

respect to the determinations under 

§ 1.267A–2(a) because it is a party to a 

structured arrangement pursuant to which 

the payment is made. See § 1.267A–2(f). 

(3) Example 3. Disregarded payment—(i) 

Facts. FX holds all the interests of US1. For 

Country X tax purposes, US1 is a disregarded 

entity of FX. During taxable year 1, US1 pays 

$100x to FX pursuant to a debt instrument. 

The amount is treated as interest for U.S. tax 

purposes but is disregarded for Country X tax 

purposes as a transaction involving a single 

taxpayer. During taxable year 1, US1’s only 

other items of income, gain, deduction, or 

loss are $125x of gross income and a $60x 

item of deductible expense. The $125x item 

of gross income is included in FX’s income, 

and the $60x item of deductible expense is 

allowable for Country X tax purposes. 

(ii) Analysis. US1 is a specified party and 

thus a deduction for its $100x specified 

payment is subject to disallowance under 

section 267A. As described in paragraphs 

(c)(3)(ii)(A) and (B) of this section, $35x of 

the payment is a disqualified hybrid amount 

under the disregarded payment rule of 

§ 1.267A–2(b) and, as a result, $35x of the 

deduction is disallowed under § 1.267A– 

1(b)(1). 

(A) US1’s $100x payment is not regarded 

under the tax law of Country X (the tax law 

of FX, a related tax resident to which the 

payment is made) because under such tax 

law the payment is a disregarded transaction 

involving a single taxpayer. See § 1.267A– 

2(b)(2) and (f). In addition, were the tax law 

of Country X to regard the payment (and treat 

it as interest), FX would include it in income. 

Therefore, the payment is a disregarded 

payment to which § 1.267A–2(b) applies. See 

§ 1.267A–2(b)(2). 

(B) Under § 1.267A–2(b)(1), the excess (if 

any) of US1’s disregarded payments for 

taxable year 1 ($100x) over its dual inclusion 

income for the taxable year is a disqualified 

hybrid amount. US1’s dual inclusion income 

for taxable year 1 is $65x, calculated as $125x 

(the amount of US1’s gross income that is 

included in FX’s income) less $60x (the 

amount of US1’s deductible expenses, other 

than deductions for disregarded payments, 

that are allowable for Country X tax 

purposes). See § 1.267A–2(b)(3). Therefore, 

$35x is a disqualified hybrid amount ($100x 

less $65x). See § 1.267A–2(b)(1). 

(iii) Alternative facts—non-dual inclusion 

income arising from hybrid transaction. The 


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facts are the same as in paragraph (c)(3)(i) of 

this section, except that US1 holds all the 

interests of FZ (a CFC) and US1’s only item 

of income, gain, deduction, or loss during 

taxable year 1 (other than the $100x payment 

to FX) is $80x paid to US1 by FZ pursuant 

to an instrument treated as indebtedness for 

U.S. tax purposes and equity for Country X 

tax purposes (the US1–FZ instrument). In 

addition, the $80x is treated as interest for 

U.S. tax purposes and an excludible dividend 

for Country X tax purposes (by reason of the 

Country X participation exemption). 

Paragraphs (c)(3)(iii)(A) and (B) of this 

section describe the extent to which the 

specified payments by FZ and US1, each of 

which is a specified party, are disqualified 

hybrid amounts. 

(A) The hybrid transaction rule of 

§ 1.267A–2(a) applies to FZ’s payment 

because such payment is made pursuant to 

a hybrid transaction, as a payment with 

respect to the US1–FZ instrument is treated 

as interest for U.S. tax purposes but not for 

purposes of Country X’s tax law (the tax law 

of FX, a specified recipient that is related to 

FZ). As a consequence of the Country X 

participation exemption, an $80x noinclusion occurs with respect to FX, and 

such no-inclusion is a result of the payment 

being made pursuant to the hybrid 

transaction. Thus, but for § 1.267A–3(b), the 

entire $80x of FZ’s payment would be a 

disqualified hybrid amount. However, 

because US1 (a tax resident of the United 

States that is also a specified recipient of the 

payment) takes the entire $80x payment into 

account in its gross income, no portion of the 

payment is a disqualified hybrid amount. See 

§ 1.267A–3(b)(2). 

(B) The disregarded payment rule of 

§ 1.267A–2(b) applies to US1’s $100x 

payment to FX, for the reasons described in 

paragraph (c)(3)(ii)(A) of this section. In 

addition, US1’s dual inclusion income for 

taxable year 1 is $0 because, as a result of the 

Country X participation exemption, no 

portion of FZ’s $80x payment to US1 (which 

is derived by FX under its tax law) is 

included in FX’s income. See §§ 1.267A– 

2(b)(3) and 1.267A–3(a). Therefore, the entire 

$100x payment from US1 to FX is a 

disqualified hybrid amount, calculated as 

$100x (the amount of the payment) less $0 

(the amount of dual inclusion income). See 

§ 1.267A–2(b)(1). 

(4) Example 4. Payment allocable to a U.S. 

taxable branch—(i) Facts. FX1 and FX2 are 

foreign corporations that are bodies corporate 

established in and tax residents of Country X. 

FX1 holds all the interests of FX2, and FX1 

and FX2 file a consolidated return under 

Country X tax law. FX2 has a U.S. taxable 

branch (‘‘USB’’). During taxable year 1, FX2 

pays $50x to FX1 pursuant to an instrument 

(the ‘‘FX1–FX2 instrument’’). The amount 

paid pursuant to the instrument is treated as 

interest for U.S. tax purposes but, as a 

consequence of the Country X consolidation 

regime, is treated as a disregarded transaction 

between group members for Country X tax 

purposes. Also during taxable year 1, FX2 

pays $100x of interest to an unrelated bank 

that is not a party to a structured arrangement 

(the instrument pursuant to which the 

payment is made, the ‘‘bank-FX2 

instrument’’). FX2’s only other item of 

income, gain, deduction, or loss for taxable 

year 1 is $200x of gross income. Under 

Country X tax law, the $200x of gross income 

is attributable to USB, but is not included in 

FX’s income because Country X tax law 

exempts income attributable to a branch. 

Under U.S. tax law, the $200x of gross 

income is effectively connected income of 

USB. Further, under section 882, $75x of 

interest is, for taxable year 1, allocable to 

USB’s effectively connected income. USB has 

neither liabilities that are directly allocable to 

it, as described in § 1.882–5(a)(1)(ii)(A), nor 

booked liabilities, as defined in § 1.882– 

5(d)(2). 

(ii) Analysis. USB is a specified party and 

thus any interest or royalty allowable as a 

deduction in determining its effectively 

connected income is subject to disallowance 

under section 267A. Pursuant to § 1.267A– 

5(b)(3)(i)(A), USB is treated as paying $75x of 

interest, and such interest is thus a specified 

payment. Of that $75x, $25x is treated as 

paid to FX1, calculated as $75x (the interest 

allocable to USB under section 882) 

multiplied by 1⁄3 ($50x, FX2’s payment to 

FX1, divided by $150x, the total interest paid 

by FX2). See § 1.267A–5(b)(3)(ii)(A). As 

described in paragraphs (c)(4)(ii)(A) and (B) 

of this section, the $25x of the specified 

payment treated as paid by USB to FX1 is a 

disqualified hybrid amount under the 

disregarded payment rule of § 1.267A–2(b) 

and, as a result, a deduction for that amount 

is disallowed under § 1.267A–1(b)(1). 

(A) USB’s $25x payment to FX1 is not 

regarded under the tax law of Country X (the 

tax law of FX1, a related tax resident to 

which the payment is made) because under 

such tax law the payment is a disregarded 

transaction between group members. See 

§ 1.267A–2(b)(2) and (f). In addition, were the 

tax law of Country X to regard the payment 

(and treat it as interest), FX1 would include 

it in income. Therefore, the payment is a 

disregarded payment to which § 1.267A–2(b) 

applies. See § 1.267A–2(b)(2). 

(B) Under § 1.267A–2(b)(1), the excess (if 

any) of USB’s disregarded payments for 

taxable year 1 ($25x) over its dual inclusion 

income for the taxable year is a disqualified 

hybrid amount. USB’s dual inclusion income 

for taxable year 1 is $0. This is because, as 

a result of the Country X exemption for 

income attributable to a branch, no portion 

of USB’s $200x item of gross income is 

included in FX2’s income. See § 1.267A– 

2(b)(3). Therefore, the entire $25x of the 

specified payment treated as paid by USB to 

FX1 is a disqualified hybrid amount, 

calculated as $25x (the amount of the 

payment) less $0 (the amount of dual 

inclusion income). See § 1.267A–2(b)(1). 

(iii) Alternative facts—deemed branch 

payment. The facts are the same as in 

paragraph (c)(4)(i) of this section, except that 

FX2 does not pay any amounts during 

taxable year 1 (thus, it does not pay the $50x 

to FX1 or the $100x to the bank). However, 

under an income tax treaty between the 

United States and Country X, USB is a U.S. 

permanent establishment and, for taxable 

year 1, $25x of royalties is allowable as a 

deduction in computing the business profits 

of USB and is deemed paid to FX2. Under 

Country X tax law, the $25x is not regarded. 

Accordingly, the $25x is a specified payment 

that is a deemed branch payment. See 

§§ 1.267A–2(c)(2) and 1.267A–5(b)(3)(i)(B). 

The entire $25x is a disqualified hybrid 

amount for which a deduction is disallowed 

because the tax law of Country X provides an 

exclusion or exemption for income 

attributable to a branch. See § 1.267A–2(c)(1). 

(5) Example 5. Payment to a reverse 

hybrid—(i) Facts. FX holds all the interests 

of US1 and FY, and FY holds all the interests 

of FV. FY is an entity established in Country 

Y, and FV is an entity established in Country 

V. FY is fiscally transparent for Country Y tax 

purposes but is not fiscally transparent for 

Country X tax purposes. FV is fiscally 

transparent for Country X tax purposes. On 

date 1, US1 pays $100x to FY. The amount 

is treated as interest for U.S. tax purposes 

and Country X tax purposes. 

(ii) Analysis. US1 is a specified party and 

thus a deduction for its $100x specified 

payment is subject to disallowance under 

section 267A. As described in paragraphs 

(c)(5)(ii)(A) through (C) of this section, the 

entire $100x payment is a disqualified hybrid 

amount under the reverse hybrid rule of 

§ 1.267A–2(d) and, as a result, a deduction 

for the payment is disallowed under 

§ 1.267A–1(b)(1). 

(A) US1’s payment is made to a reverse 

hybrid because FY is fiscally transparent 

under the tax law of Country Y (the tax law 

of the country in which it is established) but 

is not fiscally transparent under the tax law 

of Country X (the tax law of FX, an investor 

that is related to US1). See § 1.267A–2(d)(2) 

and (f). Therefore, § 1.267A–2(d) applies to 

the payment. The result would be the same 

if the payment were instead made to FV. See 

§ 1.267A–2(d)(3). 

(B) For US1’s payment to be a disqualified 

hybrid amount under § 1.267A–2(d), a noinclusion must occur with respect to FX. See 

§ 1.267A–2(d)(1)(i). Because FX does not 

derive the $100x payment under Country X 

tax law (as FY is not fiscally transparent 

under such tax law), FX includes $0 of the 

payment in income and therefore a $100x noinclusion occurs with respect to FX. See 

§ 1.267A–3(a). 

(C) Pursuant to § 1.267A–2(d)(1)(ii), FX’s 

$100x no-inclusion gives rise to a 

disqualified hybrid amount to the extent that 

it is a result of US1’s payment being made 

to the reverse hybrid. FX’s $100x noinclusion is a result of the payment being 

made to the reverse hybrid because, were FY 

to be treated as fiscally transparent for 

Country X tax purposes, FX would include 

$100x in income and, consequently, the noinclusion would not occur. The result would 

be the same if Country X tax law instead 

viewed US1’s payment as a dividend, rather 

than interest. See § 1.267A–2(d)(1)(ii). 

(iii) Alternative facts—inclusion under 

anti-deferral regime. The facts are the same 

as in paragraph (c)(5)(i) of this section, except 

that, under a Country X anti-deferral regime, 

FX includes in its income $100x attributable 

to the $100x payment received by FY. If 

under the rules of § 1.267A–3(a) FX includes 

the entire attributed amount in income (that 

is, if FX includes the amount in its income 

at the full marginal rate imposed on ordinary 


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income and the amount is not reduced or 

offset by certain relief particular to the 

amount), then a no-inclusion does not occur 

with respect to FX. As a result, in such a 

case, no portion of US1’s payment would be 

a disqualified hybrid amount under 

§ 1.267A–2(d). 

(iv) Alternative facts—multiple investors. 

The facts are the same as in paragraph 

(c)(5)(i) of this section, except that FX holds 

all the interests of FZ, which is fiscally 

transparent for Country X tax purposes; FZ 

holds all the interests of FY, which is fiscally 

transparent for Country Z tax purposes; and 

FZ includes the $100x payment in income. 

Thus, each of FZ and FX is an investor of FY, 

as each directly or indirectly holds an 

interest of FY. See § 1.267A–5(a)(13). A noinclusion does not occur with respect to FZ, 

but a $100x no-inclusion occurs with respect 

to FX. FX’s no-inclusion is a result of the 

payment being made to the reverse hybrid 

because, were FY to be treated as fiscally 

transparent for Country X tax purposes, then 

FX would include $100x in income (as FZ is 

fiscally transparent for Country X tax 

purposes). Accordingly, FX’s no-inclusion is 

a result of US1’s payment being made to the 

reverse hybrid and, consequently, the entire 

$100x payment is a disqualified hybrid 

amount. 

(v) Alternative facts—portion of noinclusion not the result of hybridity. The facts 

are the same as in paragraph (c)(5)(i) of this 

section, except that the $100x is viewed as 

a royalty for U.S. tax purposes and Country 

X tax purposes, and Country X tax law 

contains a patent box regime that provides an 

80% deduction with respect to certain 

royalty income. If the payment would qualify 

for the Country X patent box deduction were 

FY to be treated as fiscally transparent for 

Country X tax purposes, then only $20x of 

FX’s $100x no-inclusion would be the result 

of the payment being paid to a reverse 

hybrid, calculated as $100x (the no-inclusion 

with respect to FX that actually occurs) less 

$80x (the no-inclusion with respect to FX 

that would occur if FY were to be treated as 

fiscally transparent for Country X tax 

purposes). See § 1.267A–3(a). Accordingly, in 

such a case, only $20x of US1’s payment 

would be a disqualified hybrid amount. 

(6) Example 6. Branch mismatch 

payment—(i) Facts. FX holds all the interests 

of US1 and FZ. FZ owns BB, a Country B 

branch that gives rise to a taxable presence 

in Country B under Country Z tax law but not 

under Country B tax law. On date 1, US1 

pays $50x to FZ. The amount is treated as a 

royalty for U.S. tax purposes and Country Z 

tax purposes. Under Country Z tax law, the 

amount is treated as income attributable to 

BB and, as a consequence of County Z tax 

law exempting income attributable to a 

branch, is excluded from FZ’s income. 

(ii) Analysis. US1 is a specified party and 

thus a deduction for its $50x specified 

payment is subject to disallowance under 

section 267A. As described in paragraphs 

(c)(6)(ii)(A) through (C) of this section, the 

entire $50x payment is a disqualified hybrid 

amount under the branch mismatch rule of 

§ 1.267A–2(e) and, as a result, a deduction for 

the payment is disallowed under § 1.267A– 

1(b)(1). 

(A) US1’s payment is a branch mismatch 

payment because under Country Z tax law 

(the tax law of FZ, a home office that is 

related to US1) the payment is treated as 

income attributable to BB, and BB is not a 

taxable branch (that is, under Country B tax 

law, BB does not give rise to a taxable 

presence). See § 1.267A–2(e)(2) and (f). 

Therefore, § 1.267A–2(e) applies to the 

payment. The result would be the same if 

instead BB were a taxable branch and, under 

Country B tax law, US1’s payment were 

treated as income attributable to FZ and not 

BB. See § 1.267A–2(e)(2). 

(B) For US1’s payment to be a disqualified 

hybrid amount under § 1.267A–2(e), a noinclusion must occur with respect to FZ. See 

§ 1.267A–2(e)(1)(i). As a consequence of the 

Country Z branch exemption, FZ includes $0 

of the payment in income and therefore a 

$50x no-inclusion occurs with respect to FZ. 

See § 1.267A–3(a). 

(C) Pursuant to § 1.267A–2(e)(1)(ii), FZ’s 

$50x no-inclusion gives rise to a disqualified 

hybrid amount to the extent that it is a result 

of US1’s payment being a branch mismatch 

payment. FZ’s $50x no-inclusion is a result 

of the payment being a branch mismatch 

payment because, were the payment to not be 

treated as income attributable to BB for 

Country Z tax purposes, FZ would include 

$50x in income and, consequently, the noinclusion would not occur. 

(7) Example 7. Reduction of disqualified 

hybrid amount for certain amounts 

includible in income—(i) Facts. US1 and FW 

hold 60% and 40%, respectively, of the 

interests of FX, and FX holds all the interests 

of FZ. Each of FX and FZ is a CFC. FX holds 

an instrument issued by FZ that it is treated 

as equity for Country X tax purposes and as 

indebtedness for U.S. tax purposes (the FX– 

FZ instrument). On date 1, FZ pays $100x to 

FX pursuant to the FX–FZ instrument. The 

amount is treated as a dividend for Country 

X tax purposes and as interest for U.S. tax 

purposes. In addition, pursuant to section 

954(c)(6), the amount is not foreign personal 

holding company income of FX. Further, 

under section 951A, the payment is included 

in FX’s tested income. Lastly, Country X tax 

law provides an 80% participation 

exemption for dividends received from 

nonresident corporations and, as a result of 

such participation exemption, FX includes 

$20x of FZ’s payment in income. 

(ii) Analysis. FZ, a CFC, is a specified party 

and thus a deduction for its $100x specified 

payment is subject to disallowance under 

section 267A. But for § 1.267A–3(b), $80x of 

FZ’s payment would be a disqualified hybrid 

amount (such amount, a ‘‘tentative 

disqualified hybrid amount’’). See 

§§ 1.267A–2(a) and 1.267A–3(b)(1). Pursuant 

to § 1.267A–3(b), the tentative disqualified 

hybrid amount is reduced by $48x. See 

§ 1.267A–3(b)(4). The $48x is the tentative 

disqualified hybrid amount to the extent that 

it increases US1’s pro rata share of tested 

income with respect to FX under section 

951A (calculated as $80x multiplied by 

60%). See id. Accordingly, $32x of FZ’s 

payment ($80x less $48x) is a disqualified 

hybrid amount under § 1.267A–2(a) and, as a 

result, $32x of the deduction is disallowed 

under § 1.267A–1(b)(1). 

(iii) Alternative facts—United States 

shareholder not a tax resident of the United 

States. The facts are the same as in paragraph 

(c)(7)(i) of this section, except that US1 is a 

domestic partnership, 90% of the interests of 

which are held by US2 and the remaining 

10% of which are held by a foreign 

individual that is a nonresident alien (as 

defined in section 7701(b)(1)(B)). As is the 

case in paragraph (c)(7)(ii) of this section, 

$48x of the $80x tentative disqualified hybrid 

amount increases US1’s pro rata share of the 

tested income of FX. However, US1 is not a 

tax resident of the United States. Thus, the 

$48x reduces the tentative disqualified 

hybrid amount only to the extent that the 

$48x would be taken into account by a tax 

resident of the United States. See § 1.267A– 

3(b)(4). US2 (a tax resident of the United 

States) would take into account $43.2x of 

such amount (calculated as $48x multiplied 

by 90%). Thus, $36.8x of FZ’s payment ($80x 

less $43.2x) is a disqualified hybrid amount 

under § 1.267A–2(a). See id. 

(8) Example 8. Imported mismatch rule— 

direct offset—(i) Facts. FX holds all the 

interests of FW, and FW holds all the 

interests of US1. FX holds an instrument 

issued by FW that is treated as equity for 

Country X tax purposes and indebtedness for 

Country W tax purposes (the FX–FW 

instrument). FW holds an instrument issued 

by US1 that is treated as indebtedness for 

Country W and U.S. tax purposes (the FW– 

US1 instrument). In accounting period 1, FW 

pays $100x to FX pursuant to the FX–FW 

instrument. The amount is treated as an 

excludible dividend for Country X tax 

purposes (by reason of the Country X 

participation exemption) and as interest for 

Country W tax purposes. Also in accounting 

period 1, US1 pays $100x to FW pursuant to 

the FW–US1 instrument. The amount is 

treated as interest for Country W and U.S. tax 

purposes and is included in FW’s income. 

The FX–FW instrument was not entered into 

pursuant to the same plan or series of related 

transactions pursuant to which the FW–US1 

instrument was entered into. 

(ii) Analysis. US1 is a specified party and 

thus a deduction for its $100x specified 

payment is subject to disallowance under 

section 267A. The $100x payment is not a 

disqualified hybrid amount. In addition, 

FW’s $100x deduction is a hybrid deduction 

because it is a deduction allowed to FW that 

results from an amount paid that is interest 

under Country W tax law, and were Country 

X law to have rules substantially similar to 

those under §§ 1.267A–1 through 1.267A–3 

and 1.267A–5, a deduction for the payment 

would be disallowed (because under such 

rules the payment would be pursuant to a 

hybrid transaction and FX’s no-inclusion 

would be a result of the hybrid transaction). 

See §§ 1.267A–2(a) and 1.267A–4(b). Under 

§ 1.267A–4(a), US1’s payment is an imported 

mismatch payment, US1 is an imported 

mismatch payer, and FW (the tax resident 

that includes the imported mismatch 

payment in income) is an imported mismatch 

payee. The imported mismatch payment is a 

disqualified imported mismatch amount to 

the extent that the income attributable to the 

payment is directly or indirectly offset by the 

hybrid deduction incurred by FX (a tax 


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resident that is related to US1). See § 1.267A– 

4(a). Under § 1.267A–4(c)(1), the $100x 

hybrid deduction directly or indirectly 

offsets the income attributable to US1’s 

imported mismatch payment to the extent 

that the payment directly or indirectly funds 

the hybrid deduction. The entire $100x of 

US1’s payment directly funds the hybrid 

deduction because FW (the imported 

mismatch payee) incurs at least that amount 

of the hybrid deduction. See § 1.267A– 

4(c)(3)(i). Accordingly, the entire $100x 

payment is a disqualified imported mismatch 

amount under § 1.267A–4(a) and, as a result, 

a deduction for the payment is disallowed 

under § 1.267A–1(b)(2). 

(iii) Alternative facts—long-term deferral. 

The facts are the same as in paragraph 

(c)(8)(i) of this section, except that the FX– 

FW instrument is treated as indebtedness for 

Country X and Country W tax purposes, and 

FW does not pay any amounts pursuant to 

the instrument during accounting period 1. 

In addition, under Country W tax law, FW is 

allowed to deduct interest under the FX–FW 

instrument as it accrues, whereas under 

Country X tax law FX does not recognize 

income under the FX–FW instrument until 

interest is paid. Further, FW accrues $100x 

of interest during accounting period 1, and 

FW will not pay such amount to FX for more 

than 36 months after the end of the 

accounting period. The results are the same 

as in paragraph (c)(8)(ii) of this section. That 

is, FW’s $100x deduction is a hybrid 

deduction, see §§ 1.267A–2(a), 1.267A–3(a), 

and 1.267A–4(b), and the income attributable 

to US1’s $100x imported mismatch payment 

is offset by the hybrid deduction for the 

reasons described in paragraph (c)(8)(ii) of 

this section. As a result, a deduction for the 

payment is disallowed under § 1.267A– 

1(b)(2). 

(iv) Alternative facts—notional interest 

deduction. The facts are the same as in 

paragraph (c)(8)(i) of this section, except that 

the FX–FW instrument does not exist and 

thus FW does not pay any amounts to FX 

during accounting period 1. However, during 

accounting period 1, FW is allowed a $100x 

notional interest deduction with respect to its 

equity under Country W tax law. Pursuant to 

§ 1.267A–4(b), FW’s notional interest 

deduction is a hybrid deduction. The results 

are the same as in paragraph (c)(8)(ii) of this 

section. That is, the income attributable to 

US1’s $100x imported mismatch payment is 

offset by FW’s hybrid deduction for the 

reasons described in paragraph (c)(8)(ii) of 

this section. As a result, a deduction for the 

payment is disallowed under § 1.267A– 

1(b)(2). 

(v) Alternative facts—foreign hybrid 

mismatch rules prevent hybrid deduction. 

The facts are the same as in paragraph 

(c)(8)(i) of this section, except that the tax 

law of Country W contains hybrid mismatch 

rules and under such rules FW is not allowed 

a deduction for the $100x that it pays to FX 

on the FX–FW instrument. The $100x paid 

by FW therefore does not give rise to a hybrid 

deduction. See § 1.267A–4(b). Accordingly, 

because the income attributable to US1’s 

payment is not directly or indirectly offset by 

a hybrid deduction, the payment is not a 

disqualified imported mismatch amount. 

Therefore, a deduction for the payment is not 

disallowed under § 1.267A–2(b)(2). 

(9) Example 9. Imported mismatch rule— 

indirect offsets and pro rata allocations—(i) 

Facts. FX holds all the interests of FZ, and 

FZ holds all the interests of US1 and US2. 

FX has a Country B branch that, for Country 

X and Country B tax purposes, gives rise to 

a taxable presence in Country B and is 

therefore a taxable branch (‘‘BB’’). Under the 

Country B-Country X income tax treaty, BB 

is a permanent establishment entitled to 

deduct expenses properly attributable to BB 

for purposes of computing its business profits 

under the treaty. BB is deemed to pay a 

royalty to FX for the right to use intangibles 

developed by FX equal to cost plus y%. The 

deemed royalty is a deductible expense 

properly attributable to BB under the Country 

B-Country X income tax treaty. For Country 

X tax purposes, any transactions between BB 

and X are disregarded. The deemed royalty 

amount is equal to $80x during accounting 

period 1. In addition, an instrument issued 

by FZ to FX is properly reflected as an asset 

on the books and records of BB (the FX–FZ 

instrument). The FX–FZ instrument is treated 

as indebtedness for Country X, Country Z, 

and Country B tax purposes. In accounting 

period 1, FZ pays $80x pursuant to the FX– 

FZ instrument; the amount is treated as 

interest for Country X, Country Z, and 

Country B tax purposes, and is treated as 

income attributable to BB for Country X and 

Country B tax purposes (but, for Country X 

tax purposes, is excluded from FX’s income 

as a consequence of the Country X exemption 

for income attributable to a branch). Further, 

in accounting period 1, US1 and US2 pay 

$60x and $40x, respectively, to FZ pursuant 

to instruments that are treated as 

indebtedness for Country Z and U.S. tax 

purposes; the amounts are treated as interest 

for Country Z and U.S. tax purposes and are 

included in FZ’s income for Country Z tax 

purposes. Lastly, neither the instrument 

pursuant to which US1 pays the $60x nor the 

instrument pursuant to which US2 pays the 

$40x was entered into pursuant to a plan or 

series of related transactions that includes 

the transaction or agreement giving rise to 

BB’s deduction for the deemed royalty. 

(ii) Analysis. US1 and US2 are specified 

parties and thus deductions for their 

specified payments are subject to 

disallowance under section 267A. Neither of 

the payments is a disqualified hybrid 

amount. In addition, BB’s $80x deduction for 

the deemed royalty is a hybrid deduction 

because it is a deduction allowed to BB that 

results from an amount paid that is treated 

as a royalty under Country B tax law 

(regardless of whether a royalty deduction 

would be allowed under U.S. law), and were 

Country B tax law to have rules substantially 

similar to those under §§ 1.267A–1 through 

1.267A–3 and 1.267A–5, a deduction for the 

payment would be disallowed because under 

such rules the payment would be a deemed 

branch payment and Country X has an 

exclusion for income attributable to a branch. 

See §§ 1.267A–2(c) and 1.267A–4(b). Under 

§ 1.267A–4(a), each of US1’s and US2’s 

payments is an imported mismatch payment, 

US1 and US2 are imported mismatch payers, 

and FZ (the tax resident that includes the 

imported mismatch payments in income) is 

an imported mismatch payee. The imported 

mismatch payments are disqualified 

imported mismatch amounts to the extent 

that the income attributable to the payments 

is directly or indirectly offset by the hybrid 

deduction incurred by BB (a taxable branch 

that is related to US1 and US2). See 

§ 1.267A–4(a). Under § 1.267A–4(c)(1), the 

$80x hybrid deduction directly or indirectly 

offsets the income attributable to the 

imported mismatch payments to the extent 

that the payments directly or indirectly fund 

the hybrid deduction. Paragraphs (c)(9)(ii)(A) 

and (B) of this section describe the extent to 

which the imported mismatch payments 

directly or indirectly fund the hybrid 

deduction. 

(A) Neither US1’s nor US2’s payment 

directly funds the hybrid deduction because 

FZ (the imported mismatch payee) did not 

incur the hybrid deduction. See § 1.267A– 

4(c)(3)(i). To determine the extent to which 

the payments indirectly fund the hybrid 

deduction, the amount of the hybrid 

deduction that is allocated to FZ must be 

determined. See § 1.267A–4(c)(3)(ii). FZ is 

allocated the hybrid deduction to the extent 

that it directly or indirectly makes a funded 

taxable payment to BB (the taxable branch 

that incurs the hybrid deduction). See 

§ 1.267A–4(c)(3)(iii). The $80x that FZ pays 

pursuant to the FX–FZ instrument is a 

funded taxable payment of FZ to BB. See 

§ 1.267A–4(c)(3)(v). Therefore, because FZ 

makes a funded taxable payment to BB that 

is at least equal to the amount of the hybrid 

deduction, FZ is allocated the entire amount 

of the hybrid deduction. See § 1.267A– 

4(c)(3)(iii). 

(B) But for US2’s imported mismatch 

payment, the entire $60x of US1’s imported 

mismatch payment would indirectly fund the 

hybrid deduction because FZ is allocated at 

least that amount of the hybrid deduction. 

See § 1.267A–4(c)(3)(ii). Similarly, but for 

US1’s imported mismatch payment, the 

entire $40x of US2’s imported mismatch 

payment would indirectly fund the hybrid 

deduction because FZ is allocated at least 

that amount of the hybrid deduction. See id. 

However, because the sum of US1’s and 

US2’s imported mismatch payments to FZ 

($100x) exceeds the hybrid deduction 

allocated to FZ ($80x), pro rata adjustments 

must be made. See § 1.267A–4(e). Thus, $48x 

of US1’s imported mismatch payment is 

considered to indirectly fund the hybrid 

deduction, calculated as $80x (the amount of 

the hybrid deduction) multiplied by 60% 

($60x, the amount of US1’s imported 

mismatch payment to FZ, divided by $100x, 

the sum of the imported mismatch payments 

that US1 and US2 make to FZ). Similarly, 

$32x of US2’s imported mismatch payment is 

considered to indirectly fund the hybrid 

deduction, calculated as $80x (the amount of 

the hybrid deduction) multiplied by 40% 

($40x, the amount of US2’s imported 

mismatch payment to FZ, divided by $100x, 

the sum of the imported mismatch payments 

that US1 and US2 make to FZ). Accordingly, 

$48x of US1’s imported mismatch payment, 

and $32x of US2’s imported mismatch 

payment, is a disqualified imported 

mismatch amount under § 1.267A–4(a) and, 


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as a result, a deduction for such amounts is 

disallowed under § 1.267A–1(b)(2). 

(iii) Alternative facts—loss made available 

through foreign group relief regime. The facts 

are the same as in paragraph (c)(9)(i) of this 

section, except that FZ holds all the interests 

in FZ2, a body corporate that is a tax resident 

of Country Z, FZ2 (rather than FZ) holds all 

the interests of US1 and US2, and US1 and 

US2 make their respective $60x and $40x 

payments to FZ2 (rather than to FZ). Further, 

in accounting period 1, a $10x loss of FZ is 

made available to offset income of FZ2 

through a Country Z foreign group relief 

regime. Pursuant to § 1.267A–4(c)(3)(vi), FZ 

and FZ2 are treated as a single tax resident 

for purposes of § 1.267A–4(c) because a loss 

that is not incurred by FZ2 (FZ’s $10x loss) 

is made available to offset income of FZ2 

under the Country Z group relief regime. 

Accordingly, the results are the same as in 

paragraph (c)(9)(ii) of this section. That is, by 

treating FZ and FZ2 as a single tax resident 

for purposes of § 1.267A–4(c), BB’s hybrid 

deduction offsets the income attributable to 

US1’s and US2’s imported mismatch 

payments to the same extent as described in 

paragraph (c)(9)(ii) of this section. 

(10) Example 10. Imported mismatch 

rule—ordering rules and rule deeming 

certain payments to be imported mismatch 

payments—(i) Facts. FX holds all the 

interests of FW, and FW holds all the 

interests of US1, US2, and FZ. FZ holds all 

the interests of US3. FX advances money to 

FW pursuant to an instrument that is treated 

as equity for Country X tax purposes and 

indebtedness for Country W tax purposes 

(the FX–FW instrument). In a transaction that 

is pursuant to the same plan pursuant to 

which the FX–FW instrument is entered into, 

FW advances money to US1 pursuant to an 

instrument that is treated as indebtedness for 

Country W and U.S. tax purposes (the FW– 

US1 instrument). In accounting period 1, FW 

pays $125x to FX pursuant to the FX–FW 

instrument; the amount is treated as an 

excludible dividend for Country X tax 

purposes (by reason of the Country X 

participation exemption regime) and as 

deductible interest for Country W tax 

purposes. Also in accounting period 1, US1 

pays $50x to FW pursuant to the FW–US1 

instrument; US2 pays $50x to FW pursuant 

to an instrument treated as indebtedness for 

Country W and U.S. tax purposes (the FW– 

US2 instrument); US3 pays $50x to FZ 

pursuant to an instrument treated as 

indebtedness for Country Z and U.S. tax 

purposes (the FZ–US3 instrument); and FZ 

pays $50x to FW pursuant to an instrument 

treated as indebtedness for Country W and 

Country Z tax purposes (FW–FZ instrument). 

The amounts paid by US1, US2, US3, and FZ 

are treated as interest for purposes of the 

relevant tax laws and are included in the 

respective specified recipient’s income. 

Lastly, neither the FW–US2 instrument, the 

FW–FZ instrument, nor the FZ–US3 

instrument was entered into pursuant to a 

plan or series of related transactions that 

includes the transaction pursuant to which 

the FX–FW instrument was entered into. 

(ii) Analysis. US1, US2, and US3 are 

specified parties (but FZ is not a specified 

party, see § 1.267A–5(a)(17)) and thus 

deductions for US1’s, US2’s, and US3’s 

specified payments are subject to 

disallowance under section 267A. None of 

the specified payments is a disqualified 

hybrid amount. Under § 1.267A–4(a), each of 

the payments is thus an imported mismatch 

payment, US1, US2, and US3 are imported 

mismatch payers, and FW and FZ (the tax 

residents that include the imported mismatch 

payments in income) are imported mismatch 

payees. The imported mismatch payments 

are disqualified imported mismatch amounts 

to the extent that the income attributable to 

the payments is directly or indirectly offset 

by FW’s $125x hybrid deduction. See 

§ 1.267A–4(a) and (b). Under § 1.267A– 

4(c)(1), the $125x hybrid deduction directly 

or indirectly offsets the income attributable 

to the imported mismatch payments to the 

extent that the payments directly or 

indirectly fund the hybrid deduction. 

Paragraphs (c)(10)(ii)(A) through (C) of this 

section describe the extent to which the 

imported mismatch payments directly or 

indirectly fund the hybrid deduction and are 

therefore disqualified hybrid amounts for 

which a deduction is disallowed under 

§ 1.267A–1(b)(2). 

(A) First, the $125x hybrid deduction 

offsets the income attributable to US1’s 

imported mismatch payment, a factuallyrelated imported mismatch payment that 

directly funds the hybrid deduction. See 

§ 1.267A–4(c)(2)(i). The entire $50x of US1’s 

payment directly funds the hybrid deduction 

because FW (the imported mismatch payee) 

incurs at least that amount of the hybrid 

deduction. See § 1.267A–4(c)(3)(i). 

Accordingly, the entire $50x of the payment 

is a disqualified imported mismatch amount 

under § 1.267A–4(a). 

(B) Second, the remaining $75x hybrid 

deduction offsets the income attributable to 

US2’s imported mismatch payment, a 

factually-unrelated imported mismatch 

payment that directly funds the remaining 

hybrid deduction. § 1.267A–4(c)(2)(ii). The 

entire $50x of US2’s payment directly funds 

the remaining hybrid deduction because FW 

(the imported mismatch payee) incurs at least 

that amount of the remaining hybrid 

deduction. See § 1.267A–4(c)(3)(i). 

Accordingly, the entire $50x of the payment 

is a disqualified imported mismatch amount 

under § 1.267A–4(a). 

(C) Third, the $25x remaining hybrid 

deduction offsets the income attributable to 

US3’s imported mismatch payment, a 

factually-unrelated imported mismatch 

payment that indirectly funds the remaining 

hybrid deduction. See § 1.267A–4(c)(2)(iii). 

The imported mismatch payment indirectly 

funds the remaining hybrid deduction to the 

extent that FZ (the imported mismatch 

payee) is allocated the remaining hybrid 

deduction. § 1.267A–4(c)(3)(ii). FZ is 

allocated the remaining hybrid deduction to 

the extent that it directly or indirectly makes 

a funded taxable payment to FW (the tax 

resident that incurs the hybrid deduction). 

§ 1.267A–4(c)(3)(iii). The $50x that FZ pays 

to FW pursuant to the FW–FZ instrument is 

a funded taxable payment of FZ to FW. 

§ 1.267A–4(c)(3)(v). Therefore, because FZ 

makes a funded taxable payment to FW that 

is at least equal to the amount of the 

remaining hybrid deduction, FZ is allocated 

the remaining hybrid deduction. § 1.267A– 

4(c)(3)(iii). Accordingly, $25x of US3’s 

payment indirectly funds the $25x remaining 

hybrid deduction and, consequently, $25x of 

US3’s payment is a disqualified imported 

mismatch amount under § 1.267A–4(a). 

(iii) Alternative facts—amount deemed to 

be an imported mismatch payment. The facts 

are the same as in paragraph (c)(10)(i) of this 

section, except that US1 is not a domestic 

corporation but instead is a body corporate 

that is only a tax resident of Country E 

(hereinafter, ‘‘FE’’) (thus, for purposes of this 

paragraph (c)(10)(iii), the FW–US1 

instrument is instead issued by FE and is the 

‘‘FW–FE instrument’’). In addition, the tax 

law of Country E contains hybrid mismatch 

rules and, under a provision of such rules 

substantially similar to § 1.267A–4, FE is 

denied a deduction for the $50x it pays to 

FW under the FW–FE instrument. Pursuant 

to § 1.267A–4(f), the $50x that FE pays to FW 

pursuant to the FW–FE instrument is deemed 

to be an imported mismatch payment for 

purposes of determining the extent to which 

the income attributable to US2’s and US3’s 

imported mismatch payments is offset by 

FW’s hybrid deduction. The results are the 

same as in paragraphs (c)(10)(ii)(B) and (C) of 

this section. That is, by treating the $50x that 

FE pays to FW as an imported mismatch 

payment, FW’s hybrid deduction offsets the 

income attributable to US2’s and US3’s 

imported mismatch payments to the same 

extent as described in paragraphs 

(c)(10)(ii)(B) and (C) of this section. 

(iv) Alternative facts—amount deemed to 

be an imported mismatch payment not 

treated as a funded taxable payment. The 

facts are the same as in paragraph (c)(10)(i) 

of this section, except that FZ holds its 

interests of US3 indirectly through FE, a 

body corporate that is only a tax resident of 

Country E (hereinafter, ‘‘FE’’), and US3 

makes its $50x payment to FE (rather than to 

FZ); US3’s $50x payment is treated as 

interest for Country E tax purposes and FE 

includes the payment in income. In addition, 

during accounting period 1, FE pays $50x of 

interest to FZ pursuant to an instrument and 

such amount is included in FZ’s income. 

Further, the tax law of Country E contains 

hybrid mismatch rules and, under a 

provision of such rules substantially similar 

to § 1.267A–4, FE is denied a deduction for 

$25x of the $50x it pays to FZ, because under 

such provision $25x of the income 

attributable to FE’s payment is considered 

offset against $25x of FW’s hybrid deduction. 

With respect to US1 and US2, the results are 

the same as described in paragraphs 

(c)(10)(ii)(A) and (B) of this section. However, 

no portion of US3’s payment is a disqualified 

imported mismatch amount. This is because 

the $50x that FE pays to FZ is not considered 

to be a funded taxable payment, because 

under a provision of Country E’s hybrid 

mismatch rules that is substantially similar to 

§ 1.267A–4, FE is denied a deduction for a 

portion of the $50x. See § 1.267A–4(c)(3)(v) 

and (f). Therefore, there is no chain of funded 

taxable payments connecting US3 (the 

imported mismatch payer) and FW (the tax 

resident that incurs the hybrid deduction); as 

a result, US3’s payment does not indirectly 


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Federal Register / Vol. 83, No. 248 / Friday, December 28, 2018 / Proposed Rules 67649 

fund the hybrid deduction. See § 1.267A– 

4(c)(3)(ii) through (iv). 

§ 1.267A–7 Applicability dates. 

(a) General rule. Except as provided in 

paragraph (b) of this section, §§ 1.267A– 

1 through 1.267A–6 apply to taxable 

years beginning after December 31, 

2017. 

(b) Special rules. Sections 1.267A– 

2(b), (c), (e), 1.267A–4, and 1.267A– 

5(b)(5) apply to taxable years beginning 

on or after December 20, 2018. In 

addition, § 1.267A–5(a)(20) (defining 

structured arrangement), as well as the 

portions of §§ 1.267A–1 through 

1.267A–3 that relate to structured 

arrangements and that are not otherwise 

described in this paragraph (b), apply to 

taxable years beginning on or after 

December 20, 2018. 

■ Par. 4. Section 1.1503(d)–1 is 

amended by: 

■ 1. In paragraph (b)(2)(i), removing the 

word ‘‘and’’. 

■ 2. In paragraph (b)(2)(ii), removing the 

second period and adding in its place ‘‘; 

and’’. 

■ 3. Adding paragraph (b)(2)(iii). 

■ 4. Redesignating paragraph (c) as 

paragraph (d). 

■ 5. Adding new paragraph (c). 

■ 6. In the first sentence of newlyredesignated paragraph (d)(2)(ii), 

removing the language ‘‘(c)(2)(i)’’ and 

adding the language ‘‘(d)(2)(i)’’ in its 

place. 

The additions read as follows: 

§ 1.1503(d)–1 Definitions and special rules 

for filings under section 1503(d). 

* * * * * 

(b) * * * 

(2) * * * 

(iii) A domestic consenting 

corporation (as defined in § 301.7701– 

3(c)(3)(i) of this chapter), as provided in 

paragraph (c)(1) of this section. See 

§ 1.1503(d)–7(c)(41). 

* * * * * 

(c) Treatment of domestic consenting 

corporation as a dual resident 

corporation—(1) Rule. A domestic 

consenting corporation is treated as a 

dual resident corporation under 

paragraph (b)(2)(iii) of this section for a 

taxable year if, on any day during the 

taxable year, the following requirements 

are satisfied: 

(i) Under the tax law of a foreign 

country where a specified foreign tax 

resident is tax resident, the specified 

foreign tax resident derives or incurs (or 

would derive or incur) items of income, 

gain, deduction, or loss of the domestic 

consenting corporation (because, for 

example, the domestic consenting 

corporation is fiscally transparent under 

such tax law). 

(ii) The specified foreign tax resident 

bears a relationship to the domestic 

consenting corporation that is described 

in section 267(b) or 707(b). See 

§ 1.1503(d)–7(c)(41). 

(2) Definitions. The following 

definitions apply for purposes of this 

paragraph (c). 

(i) The term fiscally transparent 

means, with respect to a domestic 

consenting corporation or an 

intermediate entity, fiscally transparent 

as determined under the principles of 

§ 1.894–1(d)(3)(ii) and (iii), without 

regard to whether a specified foreign tax 

resident is a resident of a country that 

has an income tax treaty with the 

United States. 

(ii) The term specified foreign tax 

resident means a body corporate or 

other entity or body of persons liable to 

tax under the tax law of a foreign 

country as a resident. 

* * * * * 

■ Par. 5. Section 1.1503(d)–3 is 

amended by adding the language ‘‘or 

(e)(3)’’ after the language ‘‘paragraph 

(e)(2)’’ in paragraph (e)(1), and adding 

paragraph (e)(3) to read as follows: 

§ 1.1503(d)–3 Foreign use. 

* * * * * 

(e) * * * 

(3) Exception for domestic consenting 

corporations. Paragraph (e)(1) of this 

section will not apply so as to deem a 

foreign use of a dual consolidated loss 

incurred by a domestic consenting 

corporation that is a dual resident 

corporation under § 1.1503(d)– 

1(b)(2)(iii). 

§ 1.1503(d)–6 [Amended] 

■ Par. 6. Section 1.1503(d)–6 is 

amended by: 

■ 1. Removing the language ‘‘a foreign 

government’’ and ‘‘a foreign country’’ in 

paragraph (f)(5)(i), and adding the 

language ‘‘a government of a country’’ 

and ‘‘the country’’ in their places, 

respectively. 

■ 2. Removing the language ‘‘a foreign 

government’’ in paragraph (f)(5)(ii), and 

adding the language ‘‘a government of a 

country’’ in its place. 

■ 3. Removing the language ‘‘the foreign 

government’’ in paragraph (f)(5)(iii), and 

adding the language ‘‘a government of a 

country’’ in its place. 

■ Par. 7. Section 1.1503(d)–7 is 

amended by redesignating Examples 1 

through 40 as paragraphs (c)(1) through 

(40), respectively, and adding paragraph 

(c)(41) to read as follows: 

§ 1.1503(d)–7 Examples. 

* * * * * 

(c) * * * 

(41) Example 41. Domestic consenting 

corporation—treated as dual resident 

corporation—(i) Facts. FSZ1, a Country Z 

entity that is subject to Country Z tax on its 

worldwide income or on a residence basis 

and is classified as a foreign corporation for 

U.S. tax purposes, owns all the interests in 

DCC, a domestic eligible entity that has filed 

an election to be classified as an association. 

Under Country Z tax law, DCC is fiscally 

transparent. For taxable year 1, DCC’s only 

item of income, gain, deduction, or loss is a 

$100x deduction and such deduction 

comprises a $100x net operating loss of DCC. 

For Country Z tax purposes, FSZ1’s only item 

of income, gain, deduction, or loss, other 

than the $100x loss attributable to DCC, is 

$60x of operating income. 

(ii) Result. DCC is a domestic consenting 

corporation because by electing to be 

classified as an association, it consents to be 

treated as a dual resident corporation for 

purposes of section 1503(d). See § 301.7701– 

3(c)(3) of this chapter. For taxable year 1, 

DCC is treated as a dual resident corporation 

under § 1.1503(d)–1(b)(2)(iii) because FSZ1 (a 

specified foreign tax resident that bears a 

relationship to DCC that is described in 

section 267(b) or 707(b)) derives or incurs 

items of income, gain, deduction, or loss of 

DCC. See § 1.1503(d)–1(c). FSZ1 derives or 

incurs items of income, gain, deduction, or 

loss of DCC because, under Country Z tax 

law, DCC is fiscally transparent. Thus, DCC 

has a $100x dual consolidated loss for 

taxable year 1. See § 1.1503(d)–1(b)(5). 

Because the loss is available to, and in fact 

does, offset income of FSZ1 under Country 

Z tax law, there is a foreign use of the dual 

consolidated loss in year 1. Accordingly, the 

dual consolidated loss is subject to the 

domestic use limitation rule of § 1.1503(d)– 

4(b). The result would be the same if FSZ1 

were to indirectly own its DCC stock through 

an intermediate entity that is fiscally 

transparent under Country Z tax law, or if an 

individual were to wholly own FSZ1 and 

FSZ1 were a disregarded entity. In addition, 

the result would be the same if FSZ1 had no 

items of income, gain, deduction, or loss, 

other than the $100x loss attributable to DCC. 

(iii) Alternative facts—DCC not treated as 

a dual resident corporation. The facts are the 

same as in paragraph (c)(41)(i) of this section, 

except that DCC is not fiscally transparent 

under Country Z tax law and thus under 

Country Z tax law FSZ1 does not derive or 

incur items of income, gain, deduction, or 

loss of DCC. Accordingly, DCC is not treated 

as a dual resident corporation under 

§ 1.1503(d)–1(b)(2)(iii) for year 1 and, 

consequently, its $100x net operating loss in 

that year is not a dual consolidated loss. 

(iv) Alternative facts—mirror legislation. 

The facts are the same as in paragraph 

(c)(41)(i) of this section, except that, under 

provisions of Country Z tax law that 

constitute mirror legislation under 

§ 1.1503(d)–3(e)(1) and that are substantially 

similar to the recommendations in Chapter 6 

of OECD/G–20, Neutralising the Effects of 

Hybrid Mismatch Arrangements, Action 2: 

2015 Final Report (October 2015), Country Z 

tax law prohibits the $100x loss attributable 

to DCC from offsetting FSZ1’s income that is 

not also subject to U.S. tax. As is the case in 


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67650 Federal Register / Vol. 83, No. 248 / Friday, December 28, 2018 / Proposed Rules 

paragraph (c)(41)(ii) of this section, DCC is 

treated as a dual resident corporation under 

§ 1.1503(d)–1(b)(2)(iii) for year 1 and its 

$100x net operating loss is a dual 

consolidated loss. Pursuant to § 1.1503(d)– 

3(e)(3), however, the dual consolidated loss 

is not deemed to be put to a foreign use by 

virtue of the Country Z mirror legislation. 

Therefore, DCC is eligible to make a domestic 

use election for the dual consolidated loss. 

■ Par. 8. Section 1.1503(d)–8 is 

amended by removing the language 

‘‘§ 1.1503(d)–1(c)’’ and adding in its 

place the language ‘‘§ 1.1503(d)–1(d)’’ 

wherever it appears in paragraphs 

(b)(3)(i) and (iii), and adding paragraphs 

(b)(6) and (7) to read as follows: 

§ 1.1503(d)–8 Effective dates. 

* * * * * 

(b) * * * 

(6) Rules regarding domestic 

consenting corporations. Section 

1.1503(d)–1(b)(2)(iii), (c), and (d), as 

well § 1.1503(d)–3(e)(1) and (e)(3), apply 

to determinations under §§ 1.1503(d)–1 

through 1.1503(d)–7 relating to taxable 

years ending on or after December 20, 

2018. For taxable years ending before 

December 20, 2018, see §§ 1.1503(d)– 

1(c) (previous version of § 1.1503(d)– 

1(d)) and 1.1503(d)–3(e)(1) (previous 

version of § 1.1503(d)–3(e)(1)) as 

contained in 26 CFR part 1 revised as of 

April 1, 2018. 

(7) Compulsory transfer triggering 

event exception. Sections 1.1503(d)– 

6(f)(5)(i) through (iii) apply to transfers 

that occur on or after December 20, 

2018. For transfers occurring before 

December 20, 2018, see § 1.1503(d)– 

6(f)(5)(i) through (iii) as contained in 26 

CFR part 1 revised as of April 1, 2018. 

However, taxpayers may consistently 

apply § 1.1503(d)–6(f)(5)(i) through (iii) 

to transfers occurring before December 

20, 2018. 

■ Par. 9. Section 1.6038–2 is amended 

by adding paragraphs (f)(13) and (14) 

and adding a sentence at the end of 

paragraph (m) to read as follows: 

§ 1.6038–2 Information returns required of 

United States persons with respect to 

annual accounting periods of certain 

foreign corporations beginning after 

December 31, 1962. 

* * * * * 

(f) * * * 

(13) Amounts involving hybrid 

transactions or hybrid entities under 

section 267A. If for the annual 

accounting period, the corporation pays 

or accrues interest or royalties for which 

a deduction is disallowed under section 

267A and the regulations under section 

267A as contained in 26 CFR part 1, 

then Form 5471 (or successor form) 

must contain such information about 

the disallowance in the form and 

manner and to the extent prescribed by 

the form, instruction, publication, or 

other guidance published in the Internal 

Revenue Bulletin. 

(14) Hybrid dividends under section 

245A. If for the annual accounting 

period, the corporation pays or receives 

a hybrid dividend or a tiered hybrid 

dividend under section 245A and the 

regulations under section 245A as 

contained in 26 CFR part 1, then Form 

5471 (or successor form) must contain 

such information about the hybrid 

dividend or tiered hybrid dividend in 

the form and manner and to the extent 

prescribed by the form, instruction, 

publication, or other guidance 

published in the Internal Revenue 

Bulletin. 

* * * * * 

(m) Applicability dates. * * * 

Paragraphs (f)(13) and (14) of this 

section apply with respect to 

information for annual accounting 

periods beginning on or after December 

20, 2018. 

■ Par. 10. Section 1.6038–3 is amended 

by: 

■ 1. Adding paragraph (g)(3). 

■ 2. Redesignating the final paragraph 

(1) of the section as paragraph (l), 

revising the paragraph heading for 

newly-designated paragraph (l), and 

adding a sentence to the end of newlydesignated paragraph (l). 

The additions and revision read as 

follows: 

§ 1.6038–3 Information returns required of 

certain United States persons with respect 

to controlled foreign partnerships (CFPs). 

* * * * * 

(g) * * * 

(3) Amounts involving hybrid 

transactions or hybrid entities under 

section 267A. In addition to the 

information required pursuant to 

paragraphs (g)(1) and (2) of this section, 

if, during the partnership’s taxable year 

for which the Form 8865 is being filed, 

the partnership paid or accrued interest 

or royalties for which a deduction is 

disallowed under section 267A and the 

regulations under section 267A as 

contained in 26 CFR part 1, the 

controlling fifty-percent partners must 

provide information about the 

disallowance in the form and manner 

and to the extent prescribed by Form 

8865 (or successor form), instruction, 

publication, or other guidance 

published in the Internal Revenue 

Bulletin. 

* * * * * 

(l) Applicability dates. * * * 

Paragraph (g)(3) of this section applies 

for taxable years of a foreign partnership 

beginning on or after December 20, 

2018. 

■ Par. 11. Section 1.6038A–2 is 

amended by adding paragraph (b)(5)(iii) 

and adding a sentence at the end of 

paragraph (g) to read as follows: 

§ 1.6038A–2 Requirement of return. 

* * * * * 

(b) * * * 

(5) * * * 

(iii) If, for the taxable year, a reporting 

corporation pays or accrues interest or 

royalties for which a deduction is 

disallowed under section 267A and the 

regulations under section 267A as 

contained in 26 CFR part 1, then the 

reporting corporation must provide such 

information about the disallowance in 

the form and manner and to the extent 

prescribed by Form 5472 (or successor 

form), instruction, publication, or other 

guidance published in the Internal 

Revenue Bulletin. 

* * * * * 

(g) * * * Paragraph (b)(5)(iii) of this 

section applies with respect to 

information for annual accounting 

periods beginning on or after December 

20, 2018. 

PART 301—PROCEDURE AND 

ADMINISTRATION 

■ Paragraph 12. The authority citation 

for part 301 continues to read in part as 

follows: 

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

■ Par. 13. Section 301.7701–3 is 

amended by revising the sixth sentence 

of paragraph (a) and adding paragraph 

(c)(3) to read as follows: 

§ 301.7701–3 Classification of certain 

business entities. 

(a) In general. * * * Paragraph (c) of 

this section provides rules for making 

express elections, including a rule 

under which a domestic eligible entity 

that elects to be classified as an 

association consents to be subject to the 

dual consolidated loss rules of section 

1503(d). 

* * * * * 

(c) * * * 

(3) Consent to be subject to section 

1503(d)—(i) Rule. A domestic eligible 

entity that elects to be classified as an 

association consents to be treated as a 

dual resident corporation for purposes 

of section 1503(d) (such an entity, a 

domestic consenting corporation), for 

any taxable year for which it is 

classified as an association and the 

condition set forth in § 1.1503(d)–1(c)(1) 

of this chapter is satisfied. 

(ii) Transition rule—deemed consent. 

If, as a result of the applicability date 

relating to paragraph (c)(3)(i) of this 

section, a domestic eligible entity that is 

classified as an association has not 


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Federal Register / Vol. 83, No. 248 / Friday, December 28, 2018 / Proposed Rules 67651 

consented to be treated as a domestic 

consenting corporation pursuant to 

paragraph (c)(3)(i) of this section, then 

the domestic eligible entity is deemed to 

consent to be so treated as of its first 

taxable year beginning on or after 

December 20, 2019. The first sentence of 

this paragraph (c)(3)(ii) does not apply 

if the domestic eligible entity elects, on 

or after December 20, 2018 and effective 

before its first taxable year beginning on 

or after December 20, 2019, to be 

classified as a partnership or 

disregarded entity such that it ceases to 

be a domestic eligible entity that is 

classified as an association. For 

purposes of the election described in the 

second sentence of this paragraph 

(c)(3)(ii), the sixty month limitation 

under paragraph (c)(1)(iv) of this section 

is waived. 

(iii) Applicability date. The sixth 

sentence of paragraph (a) of this section 

and paragraph (c)(3)(i) of this section 

apply to a domestic eligible entity that 

on or after December 20, 2018 files an 

election to be classified as an 

association (regardless of whether the 

election is effective before December 20, 

2018). Paragraph (c)(3)(ii) of this section 

applies as of December 20, 2018. 

* * * * * 

Kirsten Wielobob, 

Deputy Commissioner for Services and 

Enforcement. 

[FR Doc. 2018–27714 Filed 12–20–18; 4:15 pm] 

BILLING CODE 4830–01–P 


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