**OVERVIEW OF PRESENT-LAW RULESRELATING TO INTERNATIONAL TAXATIONAND DESCRIPTION OF H.R. 2018,THE INTERNATIONAL TAX SIMPLIFICATIONFOR AMERICAN COMPETITIVENESS ACT OF 1999
Scheduled for a Public Hearing 

Before the

SUBCOMMITTEE ON OVERSIGHT

of the

HOUSE COMMITTEE ON WAYS AND MEANS

on June 22, 1999

Prepared by the Staff

of the

June 18, 1999

JCX-30-99

**CONTENTS**

**INTRODUCTION**

**I.  PRESENT LAW**

A.  Summary

B.  U.S. Taxation of U.S. Persons with Foreign Income
     1.	Overview     2.	Foreign operations conducted directly     3.	Foreign operations conducted through a foreign corporation     4.	Transfer pricing rules     5.	Foreign tax credit rules     6.	Foreign sales corporations
C.  U.S. Taxation of Foreign Persons with U.S. Income
     1.	Overview     2.	Net-basis taxation     3.	Gross-basis taxation
D.  Income Tax Treaties

**II.  DESCRIPTION OF H.R. 2018**

A.  Treatment of Controlled Foreign Corporations
     1.	Permanent subpart F exemption for active financing income (sec. 101 of the bill)     2.	Study of proper treatment of European Union under same country exceptions (sec. 102 of the bill)     3.	Expansion of de minimis rule under subpart F (sec. 103 of the bill)     4.	Subpart F earnings and profits determined under generally accepted accounting principles (sec. 104 of the bill)     5.	Clarification of treatment of pipeline transportation income (sec. 105 of the bill)     6.	Subpart F treatment of income from transmission of high voltage electricity (sec. 106 of the bill)     7.	Look-through treatment for sales of partnership interests (sec. 107 of the bill)
B.  Provisions Relating to Foreign Tax Credit
     1. 	Extension of period to which excess foreign taxes may be carried (sec. 201 of the bill)     2.	Recharacterization of overall domestic loss (sec. 202 of the bill)     3.	Special rules relating to financial services income (sec. 203 of the bill)     4.	Look-through rules to apply to dividends from noncontrolled section 902 corporations (sec. 204 of the bill)     5.	Application of look-through rules to foreign tax credit (sec. 205 of the bill)     6.	Ordering rules for foreign tax credit carryovers (sec. 206 of the bill)     7.	Repeal of limitation of foreign tax credit under alternative minimum tax (sec. 207 of the bill)     8.	Repeal of special rules for applying foreign tax credit in case of foreign oil and gas income (sec. 208 of the bill)
C.  Other Provisions
     1.	Deduction for dividends received from certain foreign corporations (sec. 301 of the bill)     2.	Application of uniform capitalization rules to foreign persons (sec. 302 of the bill)     3.	Treatment of military property of foreign sales corporations (sec. 303 of the bill)     4.	United States property not to include certain assets acquired by dealers in ordinary course of trade or business (sec. 304 of the bill)     5.	Treatment of certain dividends of regulated investment companies (sec. 305 of the bill)     6.	Regulatory authority to exclude certain preliminary agreements from definition of intangible property (sec. 306 of the bill)     7.	Airline mileage awards to certain foreign persons (sec. 307 of the bill)     8.	Repeal of reduction of subpart F income of export trade corporations (sec. 308 of the bill)     9.	Study of interest allocation (sec. 309 of the bill)     10.	Interest payments deductible where disqualified guarantee has economic effect (sec. 310 of the bill)     11.	Modifications of reporting requirements for certain foreign owned corporations (sec. 311 of the bill)
**INTRODUCTION**

	The Subcommittee on Oversight of the House Committee on Ways and Means hasscheduled a public hearing on June 22, 1999, on issues relating to international tax simplificationand competitiveness. This document,(1) prepared by the staff of the Joint Committee on Taxation,provides an overview of certain aspects of present law and a description of H.R. 2018, theInternational Tax Simplification for American Competitiveness Act of 1999, introduced byMessrs. Houghton, Levin, Sam Johnson, Herger, Matsui, Crane, and English on June 7, 1999.(2)

	Part I of the document provides an overview of certain present-law income tax rules thatapply to U.S. persons doing business abroad and foreign persons doing business in the UnitedStates. Part II is a description of the provisions of H.R. 2018.

**I.  PRESENT LAW**

**A.  Summary**

	Under the present-law Federal income tax system, U.S. persons are subject to U.S.income tax on all income, whether derived in the United States or abroad. However, the UnitedStates generally allows a credit against the U.S. tax imposed on income derived from foreignsources for foreign income taxes imposed on such income. Foreign persons are subject to U.S.tax only on income that has a sufficient connection to the United States.

	Within this basic framework, there are a variety of rules that affect the U.S. taxation ofinternational transactions. Detailed rules govern the determination of the source of income andthe allocation and apportionment of expenses between foreign-source and U.S.-source income.Such rules are relevant not only for purposes of determining the U.S. taxation of foreign persons(because foreign persons are subject to U.S. tax only on income that is from U.S. sources orotherwise has sufficient U.S. nexus), but also for purposes of determining the U.S. taxation ofU.S. persons (because the U.S. tax on a U.S. person's foreign-source income may be reduced oreliminated by foreign tax credits). Authority is provided for the reallocation of items of incomeand deduction between related persons in order to ensure the clear reflection of the income ofeach person and to prevent the evasion of tax. Although U.S. tax generally is not imposed on aforeign corporation that operates abroad, several anti-deferral regimes apply to impose currentU.S. tax on certain income from foreign operations of a U.S.-owned foreign corporation.

	An international transaction potentially gives rise to tax consequences in two (or more)countries. The tax treatment in each country generally is determined under the tax laws of therespective country. However, an income tax treaty between the two countries may operate tocoordinate the two tax regimes and minimize the double taxation of the transaction. In thisregard, the United States' network of bilateral income tax treaties includes provisions affectingboth U.S. and foreign taxation of both U.S. persons with foreign income and foreign personswith U.S. income.

**B.  U.S. Taxation of U.S. Persons with Foreign Income**

**1.  Overview**

	The United States taxes U.S. citizens, residents, and corporations (collectively, U.S.persons) on all income, whether derived in the United States or elsewhere. By contrast, theUnited States taxes nonresident alien individuals and foreign corporations only on income with asufficient nexus to the United States.

	The United States generally cedes the primary right to tax income derived from sourcesoutside the United States to the foreign country where such income is derived. Thus, a creditagainst the U.S. income tax imposed on foreign-source taxable income is provided for foreigntaxes paid on that income. In order to implement the rules for computing the foreign tax credit,the Code and the regulations thereunder set forth an extensive set of rules governing thedetermination of the source, either U.S. or foreign, of items of income and the allocation andapportionment of items of expense against such categories of income.

	The tax rules of foreign countries that apply to foreign income of U.S. persons varywidely. For example, some foreign countries impose income tax at higher effective rates than theUnited States. In such cases, the foreign tax credit allowed by the United States is likely toeliminate any U.S. tax on income from a U.S. person's operations in the foreign country. On theother hand, operations in countries that have low statutory tax rates or generous deductionallowances or that offer tax incentives (e.g., tax holidays) to foreign investors are apt to be taxedat effective tax rates lower than the U.S. rates. In such cases, after application of the foreign taxcredit, a residual U.S. tax generally is imposed on income from a U.S. person's operations in theforeign country.

	Under income tax treaties, the tax that otherwise would be imposed under applicableforeign law on certain foreign-source income earned by U.S. persons may be reduced oreliminated. Moreover, U.S. tax on foreign-source income may be reduced or eliminated by treatyprovisions that treat certain foreign taxes as creditable for purposes of computing U.S. taxliability.

**2.  Foreign operations conducted directly**

	The tax rules applicable to U.S. persons that control business operations in foreigncountries depend on whether the business operations are conducted directly (through a foreignbranch, for example) or indirectly (through a separate foreign corporation). A U.S. person thatconducts foreign operations directly includes the income and losses from such operations on suchperson's U.S. tax return for the year the income is earned or the loss is incurred. Detailed rulesare provided for the translation into U.S. currency of amounts with respect to such foreignoperations. Thus, the income from the U.S. person's foreign operations is subject to current U.S.tax. However, a foreign tax credit may reduce or eliminate the U.S. tax on such income.

**3.  Foreign operations conducted through a foreign corporation**

In general.--Income earned by a foreign corporation from its foreign operations generallyis subject to U.S. tax only when such income is distributed to any U.S. persons that hold stock insuch corporation. Accordingly, a U.S. person that conducts foreign operations through a foreigncorporation generally is subject to U.S. tax on the income from those operations when theincome is repatriated to the United States through a dividend distribution to the U.S. person. Theincome is reported on the U.S. person's tax return for the year the distribution is received, and theUnited States imposes tax on such income at that time. A foreign tax credit may reduce the U.S.tax imposed on such income.

	A variety of complex anti-deferral regimes impose current U.S. tax on a U.S. shareholderof a foreign corporation with respect to income earned by the foreign corporation. The main anti-deferral regimes set forth in the Code (in order of enactment) are the foreign personal holdingcompany rules (secs. 551-558), the controlled foreign corporation rules of subpart F (secs.951-964), and the passive foreign investment company rules (secs. 1291-1298). Additional anti-deferral regimes set forth in the Code are the personal holding company rules (secs. 541-547), theaccumulated earnings tax (secs. 531-537), and the foreign investment company and electingforeign investment company rules (secs. 1246 and 1247).

Foreign personal holding companies.--The Revenue Act of 1937 established an anti-deferral regime for foreign personal holding companies ("FPHCs"). A FPHC generally is definedas any foreign corporation if five or fewer U.S. individual citizens or residents own (directly,indirectly, or constructively) more than 50 percent of the corporation's stock (measured by voteor value), and at least 60 percent of the corporation's gross income consists of certain types ofpassive income (such as dividends, interest, certain royalties and certain rents).(3) If a foreigncorporation is a FPHC, all the U.S. shareholders of the corporation are subject to U.S. taxcurrently on their pro rata share of the corporation's undistributed foreign personal holdingcompany income.

Controlled foreign corporations.--The Revenue Act of 1962 established an anti-deferralregime for controlled foreign corporations ("CFCs") under subpart F of the Code. A CFCgenerally is defined as any foreign corporation if U.S. persons own (directly, indirectly, orconstructively) more than 50 percent of the corporation's stock (measured by vote or value),taking into account only those U.S. persons that own at least 10 percent of the stock (measuredby vote only). Under the subpart F rules, the United States generally taxes the U.S. 10-percentshareholders of a CFC on their pro rata shares of certain income of the CFC (referred to as"subpart F income"), without regard to whether the income is distributed to the shareholders.Subpart F income typically is passive income or income that is relatively movable from onetaxing jurisdiction to another. Subpart F income consists of foreign base company income(defined in sec. 954), insurance income (defined in sec. 953), and certain income relating tointernational boycotts and other violations of public policy (defined in sec. 952(a)(3)-(5)).Foreign base company income, in turn, includes foreign personal holding company income,foreign base company sales income, foreign base company services income, foreign basecompany shipping income and foreign base company oil-related income. For example, foreignpersonal holding company income includes, among other items, dividends, interest, rents androyalties (subject to certain exceptions). In effect, the United States treats the U.S. 10-percentshareholders of a CFC as having received a current distribution out of the CFC's subpart Fincome. In addition, the U.S. 10-percent shareholders of a CFC are required to include currentlyin income for U.S. tax purposes their pro rata shares of the CFC's earnings invested in U.S.property. The U.S. tax on such amounts may be reduced through foreign tax credits.

Passive foreign investment companies.--The Tax Reform Act of 1986 established an anti-deferral regime for passive foreign investment companies ("PFICs"). A PFIC generally is definedas any foreign corporation if 75 percent or more of its gross income for the taxable year consistsof passive income, or 50 percent or more of its assets consists of assets that produce, or are heldfor the production of, passive income.(4) Alternative sets of income inclusion rules apply to U.S.persons that are shareholders in a PFIC, regardless of their percentage ownership in the PFIC.One set of rules applies to PFICs that are "qualified electing funds," under which electing U.S.shareholders currently include in gross income their respective shares of the PFIC's earnings,with a separate election to defer payment of tax, subject to an interest charge, on income notcurrently received. A second set of rules applies to PFICs that are not qualified electing funds,under which U.S. shareholders pay tax on certain income or gain realized through the PFIC, plusan interest charge that is attributable to the value of deferral. A third set of rules applies to PFICstock that is marketable, under which electing U.S. shareholders currently take into account asincome (or loss) the difference between the fair market value of their PFIC stock as of the closeof the taxable year and their adjusted basis in such stock (subject to certain limitations).

	Detailed rules for coordination among the anti-deferral regimes are provided to preventU.S. persons from being subject to U.S. tax on the same item of income under multiple regimes.For example, the PFIC rules generally do not apply to U.S. shareholders that are subject to thesubpart F rules.

**4.  Transfer pricing rules**

	In the case of a multinational enterprise that includes at least one U.S. corporation and atleast one foreign corporation, the United States taxes all of the income of the U.S. corporation,but only so much of the income of the foreign corporation as is determined to have sufficientnexus to the United States. The determination of the amount that properly is the income of theU.S. member of a multinational enterprise and the amount that properly is the income of aforeign member of the same multinational enterprise thus is critical to determining the amount ofincome the United States may tax (as well as the amount of income other countries may tax).

	Due to the variance in tax rates and tax systems among countries, a multinationalenterprise may have a strong incentive to shift income, deductions, or tax credits amongcommonly controlled entities in order to arrive at a reduced overall tax burden. Such a shifting ofitems between commonly controlled entities could be accomplished by establishing artificialtransfer prices for transactions between group members.

	Under section 482, the Secretary of the Treasury is authorized to redetermine the incomeof an entity subject to U.S. taxation when it appears that an improper shifting of income betweenthat entity and a commonly controlled entity has occurred. This authority is not limited toreallocations of income between different countries; it permits reallocations in any commoncontrol situation, including reallocations between two U.S. entities. However, it has significantapplication to multinational enterprises due to the incentives for taxpayers to shift income toobtain the benefits of significantly different effective tax rates.

	Section 482 grants the Secretary of the Treasury broad authority to allocate income,deductions, credits or allowances between any commonly controlled organizations, trades, orbusinesses in order to prevent evasion of taxes or to clearly reflect income. The statute generallydoes not prescribe any specific reallocation rules that must be followed, other than establishingthe general standards of preventing tax evasion and clearly reflecting income. Treasuryregulations adopt the concept of an arm's-length standard as the method for determining whetherreallocations are appropriate. Thus, the regulations attempt to identify the respective amounts oftaxable income of the related parties that would have resulted if the parties had been uncontrolledparties dealing at arm's length. The regulations contain complex rules governing thedetermination of an arm's-length charge for various types of transactions. The regulationsgenerally attempt to prescribe methods for identifying a relevant comparable unrelated partytransaction and for providing adjustments for differences between such transactions and therelated party transactions in question. In some instances, the regulations also provide safeharbors.

	Determinations under section 482 that result in the allocation of additional income to theUnited States theoretically might subject a taxpayer to double taxation if, for example, both theUnited States and another country imposed tax on the same income and the other country did notagree that the income should be reallocated to the United States. Tax treaties generally providemechanisms that attempt to resolve such disputes in a manner that may avoid double taxation ifboth countries agree. Such mechanisms include the designation of a "competent authority" byeach country to act as that country's representative in the negotiation attempting to resolve suchdisputes. Such competent authority procedures, however, do not guarantee that double tax willnot be imposed in a particular case.

	One method for addressing the issue of double taxation is through the advance pricingagreement ("APA") procedures. An APA is an advance agreement establishing an approvedtransfer pricing methodology entered into between the taxpayer, the Internal Revenue Service("IRS"), and a foreign tax authority. The taxpayer generally is required to use the approvedtransfer pricing methodology for the duration of the APA. The IRS and the foreign tax authoritygenerally agree to accept the results of such approved methodology. An APA also may benegotiated between only the taxpayer and the IRS; such an APA establishes an approved transferpricing methodology for U.S. tax purposes. The APA process may prove to be particularly usefulin cases involving industries such as financial products and services for which transfer pricingdeterminations are especially difficult.(5)

**5.  Foreign tax credit rules**

	Because the United States taxes U.S. persons on their worldwide income, Congressenacted the foreign tax credit in 1918 to prevent U.S. taxpayers from being taxed twice on theirforeign-source income: once by the foreign country where the income is earned and again by theUnited States. The foreign tax credit generally allows U.S. taxpayers to reduce the U.S. incometax on their foreign-source income by the foreign income taxes they pay on that income. Theforeign tax credit, however, does not operate to offset U.S. income tax on U.S.-source income.

	A credit against U.S. tax on foreign-source income is allowed for foreign taxes directlypaid or accrued by a U.S. person (the "direct" foreign tax credit). In addition, a credit is allowedto a U.S. corporation for foreign taxes paid by certain foreign subsidiary corporations anddeemed paid by the U.S. corporation upon a dividend received by, or certain other incomeinclusions of, the U.S. corporation with respect to earnings of the foreign subsidiary (the"deemed-paid" or "indirect" foreign tax credit).

	The foreign tax credit provisions are elective on a year-by-year basis. In lieu of electingthe foreign tax credit, U.S. persons generally are permitted to deduct foreign taxes. For purposesof the alternative minimum tax, foreign tax credits generally cannot be used to offset more than90 percent of the U.S. person's pre-foreign tax credit tentative minimum tax.

	A foreign tax credit limitation, which is calculated separately for various categories ofincome, is imposed to prevent the use of foreign tax credits to offset U.S. tax on U.S.-sourceincome. Under this limitation, the credit for foreign taxes on income in a particular category maynot exceed the same proportion of the taxpayer's U.S. tax liability which the taxpayer's foreign-source taxable income in that category bears to the taxpayer's worldwide taxable income for thetaxable year. Detailed rules are provided for the allocation of expenses against foreign-sourceincome. Special rules apply to require the recharacterization of foreign-source income for a yearsubsequent to a foreign loss year as U.S.-source income.

	The amount of creditable taxes paid or accrued (or deemed paid) in any taxable yearwhich exceeds the foreign tax credit limitation is permitted to be carried back to the twoimmediately preceding taxable years and carried forward to the first five succeeding taxableyears, and credited in such years to the extent that the taxpayer otherwise has excess foreign taxcredit limitation for those years. For purposes of determining excess foreign tax credit limitationamounts, the foreign tax credit separate limitation rules apply.

**6.  Foreign sales corporations**

	A foreign sales corporation ("FSC") typically is owned by a U.S. corporation thatproduces goods in the United States. The U.S. corporation either supplies goods to the FSC forresale abroad to unrelated persons or pays the FSC a commission in connection with its sales tounrelated persons. Under special tax provisions, a portion of the export income of an eligibleFSC is exempt from U.S. income tax (secs. 921-927). In addition, a U.S. corporation is notsubject to U.S. tax on dividends distributed from the FSC out of earnings attributable to certainexport income. Thus, there generally is no corporate level tax imposed on a portion of the incomefrom exports of a FSC.(6)

**C.  U.S. Taxation of Foreign Persons with U.S. Income**

**1.  Overview**

	The United States imposes tax on nonresident alien individuals and foreign corporations(collectively, foreign persons) only on income that has a sufficient nexus to the United States. Incontrast, the United States imposes tax on U.S. persons on all income, whether derived in theUnited States or in a foreign country.

	Foreign persons are subject to U.S. tax on income that is "effectively connected" with theconduct of a trade or business in the United States, without regard to whether such income isderived from U.S. sources or foreign sources. Such income generally is taxed in the same mannerand at the same rates as income of a U.S. person. An applicable tax treaty may limit theimposition of U.S. tax on business operations of a foreign person to cases where the business isconducted through a permanent establishment in the United States.

	In addition, foreign persons generally are subject to U.S. tax at a 30-percent rate oncertain gross income derived from U.S. sources. Pursuant to an applicable tax treaty, the30-percent gross-basis tax imposed on foreign persons may be reduced or eliminated.

	The source of income for U.S. tax purposes is determined based on various factors,including the location or nationality of the payor, the location or nationality of the recipient, thelocation of the activities that generate the income, and the location of the assets that generate theincome.  For example, income from the sale or exchange of inventory property that is produced(in whole or in part) within the United States and sold or exchanged outside the United States, orproduced (in whole or in part) outside the United States and sold or exchanged within the UnitedStates, is treated as partly from U.S. sources and partly from foreign sources. In general, 50percent of such income is treated as attributable to production activities and is sourced based onthe location of the production assets; the other 50 percent of such income is treated as attributableto sales activities and generally is sourced where the sale occurs.

**2.  Net-basis taxation**

	The United States taxes on a net basis and at the generally applicable U.S. tax rates theincome of foreign persons that is "effectively connected" with the conduct of a trade or businessin the United States. Any gross income earned by the foreign person that is not effectivelyconnected with the person's U.S. business is not taken into account in determining the rates ofU.S. tax applicable to the person's income from such business.

	The determination of whether a foreign person is engaged in a U.S. trade or business isbased on the facts and circumstances. Basic issues involved in the determination include whetherthe activity constitutes business rather than investing, whether sufficient activities in connectionwith the business are conducted in the United States, and whether the relationship between theforeign person and persons performing functions in the United States with respect to the businessis sufficient to attribute those functions to the foreign person.

	The factors taken into account in determining whether income, gain or loss is effectivelyconnected with a U.S. trade or business include, for example, in the case of U.S.-source capitalgains and certain U.S.-source passive income, whether the amount is derived from assets used orheld for use in the conduct of the U.S. trade or business and whether the activities of the trade orbusiness were a material factor in the realization of such amount. In the case of any otherU.S.-source income, gain, or loss, such amounts are all treated as effectively connected with theconduct of the trade or business in the United States. Only specific types of foreign-sourceincome are considered to be effectively connected with a U.S. trade or business (sec. 864(c)(4)).Foreign-source income of a type not specified generally is exempt from U.S. tax.

**3.  Gross-basis taxation**

	In the case of U.S.-source interest, dividends, rents, royalties, or other similar types ofincome (known as fixed or determinable, annual or periodical gains, profits and income), theUnited States generally imposes a flat 30-percent tax on the gross amount paid to a foreignperson if such income or gain is not effectively connected with the conduct of a U.S. trade orbusiness. This tax generally is collected by means of withholding by the person making thepayment to the foreign person receiving the income. Accordingly, the 30-percent gross-basis taxis generally referred to as a withholding tax. In most instances, the amount withheld by the U.S.payor is the final tax liability of the foreign recipient and, thus, the foreign recipient files no U.S.tax return with respect to this income.

	Certain exclusions or exceptions from the withholding tax apply. For example, the UnitedStates generally does not tax capital gains of a foreign corporation that are not connected with aU.S. trade or business. Capital gains of a nonresident alien individual that are not connected witha U.S. business generally are subject to the 30-percent gross-basis tax only if the individual waspresent in the United States for 183 days or more during the year (sec. 871(a)(2)). In addition,certain types of interest (for example, interest from certain bank deposits and from certainportfolio obligations) are not subject to the withholding tax.

**D.  Income Tax Treaties**

	In addition to the U.S. and foreign statutory rules for the taxation of foreign income ofU.S. persons and U.S. income of foreign persons, bilateral income tax treaties limit the amountof income tax that may be imposed by one treaty partner on residents of the other treaty partner.For example, treaties often reduce or exempt withholding taxes imposed by a treaty country oncertain types of income (e.g., dividends, interest and royalties) paid to residents of the othertreaty country. Treaties also contain provisions governing the creditability of taxes imposed bythe treaty country in which income was earned in computing the amount of tax owed to the othercountry by its residents with respect to such income. Treaties further provide procedures underwhich inconsistent positions taken by the treaty countries with respect to a single item of incomeor deduction may be mutually resolved by the two countries.

**II.  DESCRIPTION OF H.R. 2018**

**A.  Treatment of Controlled Foreign Corporations**

**1.  Permanent subpart F exemption for active financing income (sec. 101 of the bill)**

**Present Law**

	Under the subpart F rules, U.S. 10-percent shareholders of a controlled foreigncorporation ("CFC") are subject to U.S. tax currently on certain income earned by the CFC,whether or not such income is distributed to the shareholders (referred to as "subpart F income").Subpart F income includes, among other things, foreign personal holding company income andinsurance income. Foreign personal holding company income generally consists of thefollowing: (1) dividends, interest, royalties, rents and annuities; (2) net gains from the sale orexchange of (a) property that gives rise to the preceding types of income, (b) property that doesnot give rise to income, and (c) interests in trusts, partnerships, and REMICs; (3) net gains fromcommodities transactions; (4) net gains from foreign currency transactions; (5) income that isequivalent to interest; (6) income from notional principal contracts; and (7) payments in lieu ofdividends. The U.S. 10-percent shareholders of a CFC also are subject to current inclusion withrespect to their shares of the CFC's foreign base company services income (i.e., income derivedfrom services performed for a related person outside the country in which the CFC is organized).

	Temporary exceptions from foreign personal holding company income and foreign basecompany services income apply for subpart F purposes for certain income that is derived in theactive conduct of a banking, financing, or similar business, or in the conduct of an insurancebusiness (so-called "active financing income"). These exceptions are applicable only for taxableyears beginning in 1999.(7)

	With respect to income derived in the active conduct of a banking, financing, or similarbusiness, a CFC is required to be predominantly engaged in such business and to conductsubstantial activity with respect to such business in order to qualify for the exceptions. Inaddition, certain nexus requirements apply, which provide that income derived by a CFC or aqualified business unit ("QBU") of a CFC from transactions with customers is eligible for theexceptions if, among other things, substantially all of the activities in connection with suchtransactions are conducted directly by the CFC or QBU in its home country, and such income istreated as earned by the CFC or QBU in its home country for purposes of such country's taxlaws. Moreover, the exceptions apply to income derived from certain cross border transactions,provided that certain requirements are met. Additional exceptions from foreign personal holdingcompany income apply for certain income derived by a securities dealer within the meaning ofsection 475 and for gain from the sale of active financing assets.

	In the case of insurance, in addition to a temporary exception from foreign personalholding company income for certain income of a qualifying insurance company with respect torisks located within the CFC's country of creation or organization, certain temporary exceptionsfrom insurance income and from foreign personal holding company income apply for certainincome of a qualifying branch of a qualifying insurance company with respect to risks locatedwithin the home country of the branch, provided certain requirements are met under each of theexceptions. Further, additional temporary exceptions from insurance income and from foreignpersonal holding company income apply for certain income of certain CFCs or branches withrespect to risks located in a country other than the United States, provided that the requirementsfor these exceptions are met.

**Description of Proposal**

	The proposal would make permanent the exceptions from subpart F for active financingincome.

**Effective Date**

	The proposal would be effective for taxable years of a foreign corporation beginning afterDecember 31, 1999, and taxable years of U.S. shareholders with or within which such taxableyears of such foreign corporation end.

**2.  Study of proper treatment of European Union under same country exceptions (sec. 102of the bill)**

**Present Law**

	In general,  U.S. 10-percent shareholders of a controlled foreign corporation ("CFC") arerequired to include in income for U.S. tax purposes currently certain income of the CFC (referredto as "subpart F income"), without regard to whether the income is distributed to the shareholders(sec. 951(a)(1)(A)). In effect, the Code treats the U.S. 10-percent shareholders of a CFC ashaving received a current distribution of their pro rata shares of the CFC's subpart F income.  Forthis purpose, a U.S. 10-percent shareholder is a U.S. person that owns 10 percent or more of thecorporation's stock (measured by vote) (sec. 951(b)).  In general, a foreign corporation is a CFCif U.S. 10-percent shareholders own more than 50 percent of such corporation's stock (measuredby vote or by value) (sec. 957).

	Subpart F income typically is passive income or income that is relatively movable fromone taxing jurisdiction to another. Subpart F income consists of foreign base company income(defined in sec. 954), insurance income (defined in sec. 953), and certain income relating tointernational boycotts and other violations of public policy (defined in sec. 952(a)(3)-(5)).Subpart F income does not include income of the CFC that is effectively connected with theconduct of a trade or business within the United States (on which income the CFC is subject tocurrent U.S. tax) (sec. 952(b)).

	Income of a CFC may be excepted from the subpart F provisions under various samecountry exceptions.  For example, a major category of foreign base company income is foreignpersonal holding company income which generally includes, among other things, certaindividends, interest, rents and royalties (sec. 954(c)).  Same country exceptions from treatment asforeign personal holding company income generally are provided for dividends and interestreceived by the CFC from a related person which (1) is a corporation organized under the laws ofthe same foreign country in which the CFC is created or organized and (2) has a substantial partof its assets used in a trade or business located in such same foreign country.  Similarly, samecountry exceptions from foreign personal holding income generally are provided for rents androyalties received by the CFC from a related corporation for the use of property within thecountry in which the CFC is created or organized (sec. 954(c)(3)).  

**Description of Proposal**

	The proposal would direct the Secretary of Treasury to conduct a study of the feasibilityof treating all countries included in the European Union as one country for purposes of applying same country exceptions under subpart F.  The proposal would require that the study includeconsideration of methods to ensure that taxpayers would be subject to a substantial effective rateof foreign tax in such countries if the European Union were treated as one country for subpart Fpurposes.

	The proposal would require the results of the study to be reported to the HouseCommittee on Ways and Means and the Senate Committee on Finance, along with anylegislative recommendations, no later than 6 months after the date of enactment.

**3.  Expansion of de minimis rule under subpart F (sec. 103 of the bill)**

**Present Law**

	Under the rules of subpart F, U.S. 10-percent shareholders of a controlled foreigncorporation ("CFC") are required to include in income currently for U.S. tax purposes certaintypes of income of the CFC, whether or not such income is actually distributed currently to theshareholders (referred to as "subpart F income").  Subpart F income includes foreign basecompany income and certain insurance income.  Foreign base company income includes fivecategories of income: foreign personal holding company income, foreign base company salesincome, foreign base company services income, foreign base company shipping income, andforeign base company oil-related income (sec. 954(a)).  Under a de minimis rule, if the grossamount of a CFC's foreign base company income and insurance income for a taxable year is lessthan the lesser of 5 percent of the CFC's gross income or $1 million, then no part of the CFC'sgross income is treated as foreign base company income or insurance income (sec. 954(b)(3)(A)).

**Description of Proposal**

	The proposal would expand the subpart F de minimis exception to the lesser of 10 percentof gross income or $2 million. Accordingly, under the proposal, if the gross amount of a CFC'sforeign base company income and insurance income for the taxable year is less than the lesser of10 percent of the CFC's gross income or $2 million, then no part of the CFC's gross incomewould be treated as foreign base company income or insurance income subject to currentinclusion by the U.S. shareholders of the CFC.

**Effective Date**

	The proposal would be effective for taxable years of CFCs beginning after December 31,1999, and taxable years of U.S. shareholders with or within which such taxable years of CFCsend.

**4.  Subpart F earnings and profits determined under generally accepted accountingprinciples (sec. 104 of the bill)**

**Present Law**

	For purposes of subpart F, the earnings and profits of any foreign corporation, and thedeficit in earnings and profits of any foreign corporation, for any taxable year are to bedetermined, under regulations prescribed by the Secretary, through the application of rulessubstantially similar to those applicable to domestic corporations (sec. 964(a)).  Severaladjustments must be made to convert the foreign corporation's income for financial reportingpurposes into earnings and profits for tax purposes.(8)

	The determination of earnings and profits is relevant for foreign corporations for a varietyof  reasons. For example, subpart F income of a CFC for any taxable year may not exceed theearnings and profits of the CFC (sec. 952(c)(1)(A)).  Certain prior year deficits in earnings andprofits can be carried forward to reduce a shareholder's subpart F inclusion (sec. 952(c)(1)(B)). Additionally, distributions from a foreign corporation's earnings and profits may carry deemedpaid foreign tax credits to a U.S. shareholder of the foreign corporation (sec. 902).

**Description of Proposal**

	The proposal would require foreign corporations to determine their earnings and profitsfor purposes of subpart F using U.S. generally accepted accounting principles.

**Effective Date**

	The proposal would be effective for distributions during, and the determination ofinclusions under subpart F with respect to, taxable years of a foreign corporation beginning afterDecember 31, 1999.

**5.  Clarification of treatment of pipeline transportation income (sec. 105 of the bill)**

**Present Law**

	Under the subpart F rules, U.S. 10-percent shareholders of a controlled foreigncorporation ("CFC") are subject to U.S. tax currently on their shares of certain income earned bythe foreign corporation, whether or not such income is distributed to the shareholders (referred toas "subpart F income").  Subpart F income includes, among other things, foreign base companyoil related income (sec. 954(g)).  Foreign base company oil related income is income derivedoutside the United States from the processing of minerals extracted from oil or gas wells intotheir primary products; the transportation, distribution, or sale of such minerals or primaryproducts; the disposition of assets used by the taxpayer in a trade or business involving theforegoing; or the performance of any related services.  However, foreign base company oilrelated income does not include income derived from a source within a foreign country inconnection with: (1) oil or gas which was extracted from a well located in such foreign countryor, (2), oil, gas, or a primary product of oil or gas which is sold by the CFC or a related personfor use or consumption within such foreign country or is loaded in such country as fuel on avessel or aircraft.  An exclusion also is provided for income of a CFC that is a small producer(i.e., a corporation whose average daily oil and natural gas production, including production byrelated corporations, is less than 1,000 barrels).

**Description of Proposal**

	The proposal would provide an additional exception to the definition of foreign basecompany oil related income.  Under the proposal, foreign base company oil related incomewould not include income derived from a source within a foreign country in connection with thepipeline transportation of oil or gas within such foreign country.  Thus, the proposed exceptionwould apply whether or not the CFC which owns the pipeline also owns any interest in the oil orgas transported.  In addition, the proposed exception would apply to income earned from thetransportation of oil or gas by pipeline in a country in which the oil or gas was neither extractednor consumed within such foreign country.

**Effective Date**

	The proposal would be effective for taxable years of CFCs beginning after December 31,1999 and taxable years of U.S. shareholders with or within which such taxable years of CFCsend.

**6.  Subpart F treatment of income from transmission of high voltage electricity (sec. 106 ofthe bill)**

**Present Law**

	Under the rules of subpart F, U.S. 10-percent shareholders of a controlled foreigncorporation ("CFC") are required to include in income currently for U.S. tax purposes certaintypes of income of the CFC, whether or not such income is actually distributed currently to theshareholders (referred to as "subpart F income").  Subpart F income includes foreign basecompany income, which in turn includes five categories of income: foreign personal holdingcompany income, foreign base company sales income, foreign base company services income,foreign base company shipping income, and foreign base company oil-related income (sec.954(a)).

	Foreign base company services income includes income from services performed (1) foror on behalf of a related party and (2) outside the country of the CFC's incorporation (sec.954(e)).   Treasury regulations provide that the services of the foreign corporation will be treatedas performed for or on behalf of the related party if, for example, a party related to the foreigncorporation furnishes substantial assistance to the foreign corporation in connection with theprovision of services (Treas. Reg. sec. 1.954-4(b)(1)(iv)).

**Description of Proposal**

	The proposal would exempt income derived from the transmission of high voltageelectricity from the definition of foreign base company services income.  Thus, the income of aCFC that owns a high voltage transmission line for the purpose of providing electricity generatedby a related party to a third party outside the CFC's country of incorporation would not constituteforeign base company services income.  No inference would be intended as to the treatment ofsuch income under present law.

**Effective Date**

	The proposal would be effective for taxable years of CFCs beginning after December 31,1999, and taxable years of U.S. shareholders with or within which such taxable years of CFCsend.

**7.  Look-through treatment for sales of partnership interests (sec. 107 of the bill)**

**Present Law**

	Under the rules of subpart F, U.S. 10-percent shareholders of a controlled foreigncorporation ("CFC") are required to include in income currently for U.S. tax purposes certaintypes of income of the CFC, whether or not such income is actually distributed currently to theshareholders (referred to as "subpart F income").  Subpart F income includes foreign personalholding company income.  Foreign personal holding company income generally consists of thefollowing: (1) dividends, interest, royalties, rents, and annuities; (2) net gains from the sale orexchange of (a) property that gives rise to the preceding types of income, (b) property that doesnot give rise to income, and (c) interests in trusts, partnerships, and REMICs; (3) net gains fromcommodities transactions; (4) net gains from foreign currency transactions; (5) income that isequivalent to interest; (6) income from notional principal contracts; and (7) payments in lieu ofdividends.  Thus, if a CFC sells a partnership interest at a gain, the gain generally constitutesforeign personal holding company income and is included in the income of 10-percent U.S.shareholders of the CFC as subpart F income.

**Description of Proposal**

	The proposal would treat the sale by a CFC of a partnership interest as a sale of theproportionate share of partnership assets attributable to such interest for purposes of determiningsubpart F foreign personal holding company income.  This rule would apply only to partnersowning directly, indirectly, or constructively at least 10 percent of a capital or profits interest inthe partnership.  Thus, the sale of a 10-percent or greater partnership interest by a CFC wouldconstitute subpart F income only to the extent that a proportionate sale of the underlyingpartnership assets attributable to the partnership interest would constitute subpart F income.

**Effective Date**

	The proposal would be effective for taxable years of CFCs beginning after December 31,1999, and taxable years of U.S. shareholders with or within which such taxable years of CFCsend.

**B.  Provisions Relating to Foreign Tax Credit**

**1.  Extension of period to which excess foreign taxes may be carried (sec. 201 of the bill)**

**Present Law**

	The foreign tax credit is subject to an overall limitation. That is, the total amount of thecredit may not exceed the same proportion of the taxpayer's U.S. tax which the taxpayer'sforeign-source taxable income bears to the taxpayer's worldwide taxable income for the taxableyear. In addition, the foreign tax credit limitation is calculated separately for various categoriesof income, generally referred to as "separate limitation categories." The total amount of the creditfor foreign taxes on income in each separate limitation category may not exceed the sameproportion of the taxpayer's U.S. tax which the taxpayer's foreign-source taxable income in thatcategory bears to its worldwide taxable income.

	The amount of creditable taxes paid or accrued (or deemed paid) in any taxable yearwhich exceeds the foreign tax credit limitation is permitted to be carried back to the twoimmediately preceding taxable years and carried forward to the first five succeeding taxableyears and credited (not deducted) to the extent that the taxpayer otherwise has excess foreign taxcredit limitation for those years. For purposes of determining excess foreign tax credit amounts,the foreign tax credit separate limitation rules apply. Thus, if a taxpayer has excess foreign taxcredits in one separate limitation category for a taxable year, those excess credits are carried backand forward only as taxes allocable to that category notwithstanding the fact that the taxpayermay have excess foreign tax credit limitation in another category for that year.

**Description of Proposal**

	The proposal would extend the excess foreign tax credit carryforward period from 5 to 10years.

**Effective Date**

	The proposal would be effective for excess foreign tax credits arising in taxable yearsbeginning after December 31, 1999.

**2.  Recharacterization of overall domestic loss (sec. 202 of the bill)**

**Present Law**

	A premise of the foreign tax credit is that it should not reduce a taxpayer's U.S. tax on itsU.S. source income; rather, it should only reduce U.S. tax on foreign source income.  An overallforeign tax credit limitation prevents taxpayers from using foreign tax credits to offset U.S. taxon U.S. source income. The overall limitation is calculated by prorating a taxpayer's pre-creditU.S. tax on its worldwide income between its U.S. source and foreign source taxable income.The ratio (not exceeding 100 percent) of the taxpayer's foreign source taxable income toworldwide taxable income is multiplied by its pre-credit U.S. tax to establish the amount of U.S.tax allocable to the taxpayer's foreign source income and, thus, the upper limit on the foreign taxcredit for the year. If the taxpayer's foreign source taxable income exceeds worldwide taxableincome (because of a domestic source loss), then the full amount of pre-credit U.S. tax may beoffset by the foreign tax credit.

	If a taxpayer's losses from foreign sources exceed its foreign source income, the excess("overall foreign loss" or "OFL") may offset U.S. source income. Such an offset reduces theeffective rate of U.S. tax on U.S. source income. To eliminate a double benefit (that is, thereduction of U.S. tax previously noted and, later, full allowance of a foreign tax credit withrespect to foreign source income), an OFL recapture rule was enacted in 1976. Under this rule, aportion of foreign source taxable income earned after an OFL year is recharacterized as U.S.source taxable income for foreign tax credit purposes (and for purposes of the possessions taxcredit) (sec. 904(f)(1)). Foreign source taxable income up to the amount of the unrecaptured OFLmay be so treated. Unless a taxpayer elects a higher percentage, however, generally no more than50 percent of the foreign source taxable income earned in any particular taxable year isrecharacterized as U.S. source taxable income.(9) The effect of the recapture is to reduce theforeign tax credit limitation in one or more years following an OFL year and, therefore, theamount of U.S. tax that can be offset by foreign tax credits in the later year or years.

	An overall U.S. source loss reduces pre-credit U.S. tax on worldwide income to anamount less than the hypothetical tax that would apply to the taxpayer's foreign source income ifviewed in isolation. The existence of foreign source taxable income in the year of the U.S. lossreduces or eliminates any net operating loss carryover that the U.S. loss would otherwise havegenerated absent the foreign income. In addition, as the pre-credit U.S. tax on worldwide incomeis reduced, so is the foreign tax credit limitation. As a result, some foreign tax credits in the yearof the U.S. loss must be credited, if at all, in a carryover year. Tax on domestic source taxableincome in a subsequent year may be offset by a net operating loss carryforward, but not by aforeign tax credit carryforward. There is presently no mechanism for resourcing such subsequentU.S. source income as foreign.

**Description of Proposal**

	The proposal would apply a resourcing rule to U.S. source income where the taxpayer hassuffered a reduction in the amount of its foreign tax credit limitation due to a prior overalldomestic loss. Under the proposal, in the case of a taxpayer that has incurred an overall domesticloss, that portion of the taxpayer's U.S. source taxable income for each succeeding taxable year,which is equal to the lesser of (1) the amount of the unrecharacterized overall domestic loss, or(2) 50 percent of the taxpayer's U.S. source taxable income for such succeeding taxable year,would be recharacterized as foreign source taxable income.

	The proposal would define an overall domestic loss for this purpose as any domestic lossto the extent it offsets foreign source taxable income for the current taxable year or for anypreceding taxable year by reason of a loss carryback. For this purpose, a domestic loss means theamount by which the U.S. source gross income for the taxable year is exceeded by the sum of thedeductions properly apportioned or allocated thereto, determined without regard to any losscarried back from a subsequent taxable year. Under the proposal, an overall domestic loss wouldnot include any loss for any taxable year unless the taxpayer elected the use of the foreign taxcredit for such taxable year.

	Any U.S. source income resourced under the proposal would be allocated among andwould increase the various foreign tax credit separate limitation categories in the sameproportion that those categories were reduced by the prior overall domestic loss.

	It is anticipated that situations could arise where a taxpayer would generate an overalldomestic loss in a year following a year in which it had an overall foreign loss, or vice versa. Insuch a case, it would be necessary for ordering and other coordination rules to be developed forpurposes of computing the foreign tax credit limitation in subsequent taxable years. The proposalwould grant the Secretary of Treasury authority to prescribe such regulations as may benecessary to coordinate the operation of the OFL recapture rules with the operation of the overalldomestic loss recapture rules that would be added by the proposal.

**Effective Date**

	The proposal would apply to losses incurred in taxable years beginning after December31, 1999.

**3.  Special rules relating to financial services income (sec. 203 of the bill)**

**Present Law**

	U.S. persons generally are subject to U.S. income tax on their worldwide income.  Acredit against U.S. tax on foreign income is allowed for foreign taxes paid or accrued by a U.S.person (sec. 901). In addition, a credit is allowed to a U.S. corporation for foreign taxes paid bycertain foreign subsidiary corporations and deemed paid by the U.S. corporation upon a dividendreceived by, or certain other income inclusions of, the U.S. corporation with respect to earningsof the foreign subsidiary (the "deemed-paid" or "indirect" foreign tax credit) (secs. 902, 960).

	In order to prevent foreign taxes from reducing U.S. tax on U.S. source-income, theforeign tax credit is subject to an overall limitation and separate limitations. Under the overalllimitation, the total amount of the credit may not exceed the same proportion of the taxpayer'sU.S. tax which the taxpayer's foreign source taxable income bears to the taxpayer's worldwidetaxable income for the taxable year (sec. 904(a)). In addition, the foreign tax credit limitation iscalculated separately for various categories of income (sec. 904(d)). Under these separatelimitations, the total amount of the credit for foreign taxes on income in each category may notexceed the same proportion of the taxpayer's U.S. tax which the taxpayer's foreign-source taxableincome in that category bears to the taxpayer's worldwide taxable income for the taxable year.(10)

	The separate limitation categories include, among other things, limitation categories forhigh withholding tax interest and financial services income (sec. 904(d)).  "High withholding taxinterest" generally means any interest that is subject to a withholding tax of a foreign country orpossession of the United States (or other tax determined on a gross basis) at a rate of at least 5percent (sec. 904(d)(2)(B)).  "Financial services income" generally means certain passive andbusiness income received or accrued by a person predominantly engaged in the active conduct ofa banking, insurance, financing or similar business (sec. 904(d)(2)(C)).

	In order to prevent the conversion to foreign-source income of certain U.S.-sourceincome such as to increase a taxpayer's overall limitation, certain amounts that otherwise wouldbe foreign-source income that are derived from a U.S.-owned foreign corporation are treated forforeign tax credit limitation purposes as U.S.-source income (sec. 904(g)).  Income inclusionsunder subpart F and the foreign personal holding company provisions, and certain incomeinclusions for qualified electing funds under the passive foreign investment company rules, aretreated as U.S.-source income to the extent attributable to U.S.-source income of the foreigncorporation from which the inclusions are required.   In addition, interest paid or accrued by aU.S.-owned foreign corporation to a 10-percent U.S. shareholder (or a related person) that isproperly allocable to U.S.-source income of the foreign corporation generally is treated as U.S.-source income.  Moreover, a pro rata portion of dividends paid by a U.S.-owned foreigncorporation out of its U.S.-source earnings and profits generally is treated as U.S.-source income.Certain exceptions apply where the foreign corporation has earnings and profits and less than 10percent of such earnings and profits is attributable to U.S. sources.  

**Description of Proposal**

	The proposal would except from the separate limitation category for "high withholdingtax interest" any interest received or accrued on a security by a person that holds the security inconnection with its activities as a dealer in securities.

	The proposal also would modify the separate limitation category for  "financial servicesincome" to provide that if the financial services income of a person exceeds 80 percent of grossincome, the entire gross income for the taxable year will be treated as financial services incomefor foreign tax credit limitation purposes.

	Further, the proposal would provide that foreign-source income derived from a U.S.-owned foreign corporation that is derived from income which is received or accrued on a securityby a person that holds the security in connection with its activities as a dealer in securities isexcepted from the resourcing rule of section 904(g). 

**Effective Date**

	In general, the proposal would be effective for taxable years beginning after December31, 1999.  In the case of any "deemed-paid" credits, the proposal would apply to taxable years offoreign corporations beginning after December 31, 1999, and to taxable years of U.S.shareholders in such corporations with or within which such taxable year of the foreigncorporation ends.

**4.  Look-through rules to apply to dividends from noncontrolled section 902 corporations(sec. 204 of the bill)**

**Present Law**

	U.S. persons may credit foreign taxes against U.S. tax on foreign-source income. Theamount of foreign tax credits that may be claimed in a year is subject to a limitation that preventstaxpayers from using foreign tax credits to offset U.S. tax on U.S.-source income. Separatelimitations are applied to specific categories of income.

	Special foreign tax credit limitations apply in the case of dividends received from aforeign corporation in which the taxpayer owns at least 10 percent of the stock by vote and whichis not a controlled foreign corporation (a so-called "10/50 company").(11) Dividends paid by a10/50 company in taxable years beginning before January 1, 2003 are subject to a separateforeign tax credit limitation for each 10/50 company. Dividends paid by a 10/50 company that isnot a passive foreign investment company in taxable years beginning after December 31, 2002,out of earnings and profits accumulated in taxable years beginning before January 1, 2003, aresubject to a single foreign tax credit limitation for all 10/50 companies (other than passiveforeign investment companies). Dividends paid by a 10/50 company that is a passive foreigninvestment company out of earnings and profits accumulated in taxable years beginning beforeJanuary 1, 2003, continue to be subject to a separate foreign tax credit limitation for each such10/50 company. Dividends paid by a 10/50 company in taxable years beginning after December31, 2002, out of earnings and profits accumulated in taxable years after December 31, 2002, aretreated as income in a foreign tax credit limitation category in proportion to the ratio of theearnings and profits attributable to income in such foreign tax credit limitation category to thetotal earnings and profits (a so-called "look-through" approach). For these purposes, distributionsare treated as made from the most recently accumulated earnings and profits. Regulatoryauthority is granted to provide rules regarding the treatment of distributions out of earnings andprofits for periods prior to the taxpayer's acquisition of such stock.

**Description of Proposal**

	The proposal would simplify the application of the foreign tax credit limitation byapplying the look-through approach immediately to all dividends paid by a 10/50 company,regardless of the year in which the earnings and profits out of which the dividend is paid wereaccumulated.

**Effective Date**

	The proposal would be effective for taxable years beginning after December 31, 1999.

**5.  Application of look-through rules to foreign tax credit (sec. 205 of the bill)**

**Present Law**

	U.S. persons may credit foreign taxes against U.S. tax on foreign-source income. Theamount of foreign tax credits that may be claimed in a year is subject to a limitation that preventstaxpayers from using foreign tax credits to offset U.S. tax on U.S.-source income. Separatelimitations are applied to specific categories of income.

	Certain look-through rules apply for foreign tax credit limitation purposes. For example,dividends, interest, rents, royalties, and subpart F inclusions received (or deemed received) fromcontrolled foreign corporations ("CFCs") by their U.S. 10-percent shareholders generally aresubject to the general limitation or the various separate limitations (as the case may be) inaccordance with look-through rules that take into account the extent to which the income of thepayor itself is subject to one or more of these limitations (sec. 904(d)(3)). The Code providesregulatory authority to apply similar look-through rules for interest, rents, and royalties receivedor accrued from entities which would be CFCs if they were foreign corporations (sec.904(d)(6)(C)). Regulations generally provide look-through rules for distributive shares ofpartnership income received by partners with a 10-percent or greater interest in the partnership(Treas. Reg. sec. 1.904-5(h)).

	In addition, for foreign tax credit limitation purposes, look-through rules apply to certaindividends received from a foreign corporation in which the taxpayer owns at least 10 percent ofthe stock by vote and which is not a controlled foreign corporation (a so-called "10/50company").(12) In this regard, dividends paid by a 10/50 company in taxable years beginning afterDecember 31, 2002, out of earnings and profits accumulated in taxable years after December 31,2002, are treated as income in a foreign tax credit limitation category in proportion to the ratio ofthe earnings and profits attributable to income in such foreign tax credit limitation category to thetotal earnings and profits.(13)

**Description of Proposal**

	The proposal would apply look-through rules, for foreign tax credit limitation purposes,to interest, rents, or royalties received or accrued from a 10/50 company by a U.S. shareholder.Thus, such amounts would be treated as subject to the various separate limitations to the extentthe amounts are properly allocable (under regulations prescribed by the Secretary) to the incomeof the payor.

**Effective Date**

	The proposal would be effective for taxable years beginning after December 31, 1999.

**6.  Ordering rules for foreign tax credit carryovers (sec. 206 of the bill)**

**Present Law**

	The ability to claim the benefits of a foreign tax credit is subject to an overall limitation(sec. 904(a)).  The total amount of the credit may not exceed the same proportion of thetaxpayer's U.S. income tax that the taxpayer's foreign source taxable income bears to thetaxpayer's worldwide taxable income for the taxable year.  In addition, the foreign tax creditlimitation is calculated separately for various categories of income, generally referred to as"separate limitation categories" (sec. 904(d)).  The total amount of the credit for foreign taxes onincome in each separate limitation category may not exceed the same proportion of thetaxpayer's U.S. tax that the taxpayer's foreign source taxable income in that category bears to itsworldwide taxable income.

	The amount of creditable taxes paid or accrued (or deemed paid) in any taxable year thatexceeds the foreign tax credit limitation may be carried back to the two immediately precedingtaxable years and carried forward to the first five succeeding taxable years, and credited to theextent that the taxpayer otherwise has excess foreign tax credit limitation for those years (sec.904(c)).  For purposes of determining excess foreign tax credit amounts, the foreign tax creditseparate limitation rules apply.  Thus, if a taxpayer has excess foreign tax credits in one separatelimitation category for a taxable year, those excess credits are carried back and forward only astaxes allocable to that category notwithstanding the fact that the taxpayer may have excessforeign tax credit limitation in another category for that year.

	Foreign taxes that are paid or accrued (or deemed paid) during the taxable year in which aforeign tax credit is being claimed are considered to be used prior to any foreign tax creditcarryforwards or carrybacks.  Excess foreign tax credits for the year are carried back to thesecond preceding year followed by the first preceding year and then forward to the first, second,third, fourth, and fifth succeeding years, in that order. 

**Description of Proposal**

	The proposal would modify the ordering rules for foreign tax credits to provide thatforeign tax credits are considered utilized first from carryforwards, then from the current year,and finally from carrybacks.  The proposal also would extend the excess foreign tax creditcarryforward period from 5 to 10 years. 

**Effective Date**

	The proposal would apply to taxable years beginning after December 31, 1999.

**7.  Repeal of limitation of foreign tax credit under alternative minimum tax (sec. 207 of thebill)**

**Present Law**

	Under present law, taxpayers are subject to an alternative minimum tax ("AMT"), whichis payable, in addition to all other tax liabilities, to the extent that it exceeds the taxpayer'sregular income tax liability. The tax is imposed at a flat rate of 20 percent, in the case ofcorporate taxpayers, on alternative minimum taxable income ("AMTI") in excess of a phased-outexemption amount. The maximum rate for noncorporate taxpayers is 28 percent. AMTI is thetaxpayer's taxable income increased for certain tax preferences and adjusted by determining thetax treatment of certain items in a manner which negates the exclusion or deferral of incomeresulting from the regular tax treatment of those items.

	Taxpayers are permitted to reduce their AMT liability by an AMT foreign tax credit. TheAMT foreign tax credit for a taxable year is determined under principles similar to those used incomputing the regular tax foreign tax credit, except that (1) the numerator of the AMT foreigntax credit limitation fraction is foreign source AMTI and (2) the denominator of that fraction istotal AMTI.(14) Taxpayers may elect to use as their AMT foreign tax credit limitation fraction theratio of foreign source *regular* taxable income to total AMTI (sec. 59(a)(4)).

	The AMT foreign tax credit for any taxable year generally may not offset a taxpayer'sentire pre-credit AMT. Rather, the AMT foreign tax credit is limited to 90 percent of AMTcomputed without an AMT net operating loss deduction, an AMT energy preference deduction,or an AMT foreign tax credit. For example, assume that a corporation has $10 million of AMTI,has no AMT net operating loss or energy preference deductions, and is subject to the AMT. Inthe absence of the AMT foreign tax credit, the corporation's tax liability would be $2 million.Accordingly, the AMT foreign tax credit cannot be applied to reduce the taxpayer's tax liabilitybelow $200,000. Any unused AMT foreign tax credit may be carried back 2 years and carriedforward 5 years for use against AMT in those years under the principles of the foreign tax creditcarryback and carryforward set forth in section 904(c).

**Description of Proposal**

	The proposal would repeal the 90-percent limitation on the utilization of the AMT foreigntax credit.

**Effective Date**

	The proposal would be effective for taxable years beginning after December 31, 1999.

**8.  Repeal of special rules for applying foreign tax credit in case of foreign oil and gasincome (sec. 208 of the bill)**

**Present Law**

	U.S. persons are subject to U.S. income tax on their worldwide income. A credit againstU.S. tax on foreign-source income is allowed for foreign taxes paid or accrued (or deemed paid)(secs. 901, 902).

	The amount of foreign tax credits that a taxpayer may claim in a year is subject to alimitation that prevents taxpayers from using foreign tax credits to offset U.S. tax on U.S.-sourceincome (sec. 904).  The foreign tax credit limitation is calculated on an overall basis andseparately for specific categories of income. The amount of creditable taxes paid or accrued (ordeemed paid) in any taxable year which exceeds the foreign tax credit limitation is permitted tobe carried back two years and carried forward five years (sec. 904(c)).

	Special rules apply with respect to the foreign tax credit in the case of foreign oil and gasincome (sec. 907).  Under a special limitation, taxes on foreign oil and gas extraction income arecreditable only to the extent that they do not exceed a specified amount (e.g., 35 percent of suchincome in the case of a corporation) (sec. 907(a)).  For this purpose, foreign oil and gasextraction income is income derived from foreign sources from the extraction of minerals fromoil or gas wells or the sale or exchange of assets used by the taxpayer in such extraction.  A  taxpayer must have excess limitation under the special rules applicable to foreign extractiontaxes and excess limitation under the general foreign tax credit provisions in order to utilizeexcess foreign oil and gas extraction taxes in a carryback or carryforward year. A recapture ruleapplicable to foreign oil and gas extraction losses treats income that otherwise would be foreignoil and gas extraction income as foreign-source income that is not considered oil and gasextraction income; the taxes on such income retain their character as foreign oil and gasextraction taxes and continue to be subject to the special limitation imposed on such taxes.

	In the case of taxes paid or accrued to any foreign country with respect to foreign oilrelated income, discriminatory foreign taxes are not treated as creditable foreign taxes (sec.907(b)).  Foreign taxes are discriminatory for this purpose to the extent that the TreasurySecretary determines that the foreign law imposing the tax is structured, or in facts operates, sothat the amount of tax imposed with respect to foreign oil related income will be materiallygreater, over a reasonable period of time, than the amount imposed on non-oil related and non-extraction income.  Foreign oil related income is income derived from foreign sources from theprocessing of mineral extracted from oil or gas wells into their primary products, thetransportation, distribution or sale of such minerals or primary products, the disposition of assetsused by the taxpayer in one of the foregoing businesses, or the performance of any relatedservice.  To the extent that such taxes are treated as not creditable, the amount is treated as adeduction under foreign law (i.e., the amount is treated as a deductible business expense forpurposes of computing an appropriate level of foreign income tax and for U.S. tax purposes).

**Description of Proposal**

	The proposal would repeal the special rules of section 907 for applying the foreign taxcredit in the case of foreign oil and gas income.  Thus, taxes attributable to foreign oil and gasextraction income would no longer be subject to a special limitation, but rather would be subjectto the general limitation rules of section 904.  Additionally, the special rules of section 907 withrespect to discriminatory taxes on foreign oil related income would no longer apply.

**Effective Date**

	The proposal would be effective for taxable years beginning after December 31, 1999.

**C.  Other Provisions**

**1.  Deduction for dividends received from certain foreign corporations (sec. 301 of the bill)**

**Present Law**

	A dividends received deduction generally is available to U.S. corporations that receivedividends from another U.S. corporation.  The amount of the dividends received deduction iscalculated as a percentage of the dividend received.  The dividends received deductionpercentage is based on the amount of stock that the recipient corporation owns in the payingcorporation, as follows: (1) 70 percent if the ownership is less than 20 percent; (2) 80 percent ifthe ownership is at least 20 percent and less than 80 percent; and (3) 100 percent if the ownershipis at least 80 percent (sec. 243).

	In certain cases, a U.S. corporation that receives a dividend from a foreign corporationmay be eligible for a dividends received deduction (sec. 245).  For example, a U.S. corporationmay claim a dividends received deduction with respect to dividends received from a foreigncorporation (other than a foreign personal holding company or passive foreign investmentcompany) in which the U.S. corporation owns at least 10 percent of the stock of the foreigncorporation, measured by either vote or value (a "10-percent owned foreign corporation") (sec.245(a)).

	The amount of the dividend from a foreign corporation that is eligible for the dividendsreceived deduction is based on the U.S.-source portion of such dividend, which is defined as theratio of the 10-percent owned foreign corporation's post-1986 undistributed U.S.-source earningsand profits to its post-1986 total undistributed earnings and profits.(15)  For these purposes, post-1986 undistributed U.S.-source earnings and profits includes:  (1) income that is effectivelyconnected with a U.S. trade or business (and that is subject to U.S. taxation), or (2) dividendsreceived (directly or through a wholly-owned foreign corporation) from a U.S. corporation inwhich 80 percent or more of the stock of such corporation is owned by the 10-percent ownedforeign corporation, directly or through a wholly-owned foreign corporation (the "80-percentownership requirement").(16)

	Under the rules of subpart F, U.S. 10-percent shareholders of a controlled foreigncorporation ("CFC") are required to include in income currently for U.S. tax purposes certaintypes of income of the CFC, whether or not such income is actually distributed currently to theshareholders (referred to as a "subpart F income inclusion").  A CFC generally is defined as anyforeign corporation if U.S. persons own (directly, indirectly, or constructively) more than 50percent of the corporation's stock (measured by vote or value), taking into account only thoseU.S. persons that own at least 10 percent of the stock (measured by vote only).

**Description of Proposal**

	The proposal would treat a subpart F income inclusion as a "dividend" for purposes ofsection 245(a).  Thus, deemed dividends from a 10-percent owned foreign corporation that is aCFC may be eligible for the dividends received deduction.

	The proposal also would apply the attribution rules under section 318(a) in determiningwhether the 80-percent ownership requirement (i.e., 80-percent ownership in a U.S. corporationdirectly or through a wholly-owned foreign corporation) is satisfied for purposes of determiningthe undistributed U.S.-source earnings and profits of a 10-percent owned foreign corporation. Thus, the 80-percent ownership requirement could be satisfied not only through direct ownershipor through wholly-owned foreign corporations, but also by application of general indirect andconstructive ownership rules.

**Effective Date**

	The proposal would apply to taxable years beginning after December 31, 1999.

**2.  Application of uniform capitalization rules to foreign persons (sec. 302 of the bill)**

**Present Law**

**In general**

	For purposes of computing a taxpayer's taxable income and earnings and profits ("E&P"),certain costs reduce net income as they are incurred (e.g., ordinary and necessary businessexpenses); other costs reduce net income only to the extent that the income-producing assets withwhich those costs are associated generate income. Generally accepted accounting principles("GAAP") guide businesses in determining which costs to expense and which costs to capitalizeinto the basis of property (or include in inventory) in preparing financial statements. Pursuant tothe Code, Treasury Regulations prescribe a different set of rules for this purpose (the "uniformcapitalization rules"), which tend to allow less costs to be expensed, and require more costs--including both direct and indirect costs allocable to property--to be capitalized or included ininventories, than do GAAP (sec. 263A(a)). In general, the uniform capitalization rules apply toproperty produced by a taxpayer or acquired by a taxpayer for resale. Property produced for ataxpayer under contract with the taxpayer is treated as being produced by the taxpayer.

	In the case of interest expense, the uniform capitalization rules apply only to interest paidor incurred during the property's production period (17) and that is allocable to property producedby the taxpayer or acquired for resale which (1) is either real property or property with a class lifeof at least 20 years, (2) has an estimated production period exceeding 2 years, or (3) has anestimated production period exceeding 1 year and a cost exceeding $1,000,000 (sec. 263A(f)).

**Application to foreign persons**

     In general

	The uniform capitalization rules apply to foreign persons, whether or not engaged inbusiness in the United States. In the case of a foreign corporation carrying on a U.S. trade orbusiness, for example, the uniform capitalization rules apply for purposes of computing thecorporation's U.S. effectively connected taxable income, as well as computing its effectivelyconnected earnings and profits for purposes of the branch profits tax.

	When a foreign corporation is not engaged in business in the United States, its taxableincome and earnings and profits may nonetheless be relevant under the Code. For example, thesubpart F income of a controlled foreign corporation may be currently includible on the return ofa U.S. shareholder of the controlled foreign corporation.  Regardless of whether or not a foreigncorporation is U.S.-controlled, its accumulated E&P must be computed in order to determine theamount of taxable dividend and the indirect foreign tax credit carried by distributions from theforeign corporation to any domestic corporation that owns at least 10 percent of its voting stock.

	The E&P surplus or deficit of any foreign corporation, for any taxable year, is generallydetermined according to rules substantially similar to those applicable to domestic corporations. The temporary regulations under the uniform capitalization rules included the followingstatement:
	The provisions of section 263A (including the effective dates thereof) areapplicable to all persons engaging in the production of property, or the acquisitionof property for resale, including, for example, certain foreign persons which maybe organized and operated exclusively outside the United States.(18)

	Furthermore, Treas. Reg. sec. 1.263A-1(a)(3)(vii) provides that the uniform capitalizationrules generally apply to property produced or property acquired for resale by foreign persons.

	However, Prop. Treas. Reg. sec. 1.964-1(c)(1)(ii)(B) provides that, for purposes ofcomputing a foreign corporation's E&P, the amount of expenses that must be capitalized intoinventory may not exceed the amount required to be capitalized under generally acceptedaccounting principles (and reflected in the foreign corporation's financial statements). ThePreamble to this proposed regulation states that taxpayers have suggested that maintainingseparate inventory accounts for U.S. tax and financial accounting purposes is unduly burdensomeand that use of a single set of accounts would reduce compliance burdens.(19)  This proposedregulation would apply only for purposes of determining a foreign corporation's E&P and wouldnot apply for purposes of determining subpart F income or income effectively connected with aU.S. trade or business of a foreign corporation.

     U.S. ratio election

	In 1988, the IRS issued Notice 88-104(20) to inform taxpayers of forthcoming guidancedesigned to provide an elective, simplified method of accounting for the costs required to becapitalized in connection with foreign businesses of foreign or U.S. persons under the uniformcapitalization rules. The notice stated that the guidance will provide a simplified "U.S. ratio"method of accounting for costs other than interest that are required to be capitalized.

	To apply the U.S. ratio method, there must be a U.S. trade or business carried on by theperson carrying on the foreign business, or by a related party. The U.S. business so carried onthat is the same or most similar to the foreign business must distinguish between costscapitalized in the basis of its relevant property before application of the uniform capitalizationrules, and costs capitalized only as a result of those rules, and compute the ratio of the latter tothe former ("the U.S. ratio"). The foreign business multiplies this U.S. ratio by the amount of itscosts capitalized (without regard to the uniform capitalization rules) in the basis of its relevantproperty. The product of this multiplication yields the amount of additional costs (other thaninterest) required to be capitalized by a foreign person under the uniform capitalization rules.(21)

	All expenses that the foreign person otherwise treats as deductible are decreased ratably,to equal the amount of the increase in costs capitalized under the U.S. ratio method for thetaxable year. The appropriate ratio is applied to the costs of property produced or propertyacquired for resale incurred by the foreign person for each taxable year. A separate ratio isrequired to be computed for each taxable year for properties related to each separate trade orbusiness.

	An election to use the U.S. ratio method was originally limited by Notice 88-104 totaxable years beginning before January 1, 1988. However, the IRS subsequently extended theprovisions of that Notice to taxable years beginning after 1987 and acknowledged that thoseprovisions would remain in effect until further guidance under the uniform capitalization rules isissued.(22) The IRS further provided in Notice 89-67 that if a taxpayer failed to elect the use of theU.S. ratio method for its first taxable year for which the uniform capitalization rules applied, itcould so elect (1) on an amended tax return for such first taxable year, or (2) on its tax return forthe second taxable year for which the uniform capitalization rules were effective, if and only ifthe method used by the taxpayer for the prior taxable year was a correct method of accountingunder the uniform capitalization guidelines. In addition, the Notice provided that it is anticipatedthat forthcoming regulations will permit a taxpayer to elect the U.S. ratio method regardless ofwhether it had made the election for previous taxable years.

**Capitalization of interest expense**

	The IRS has also provided advance guidance on the application of the interestcapitalization rules of section 263A(f).(23) Under the interest capitalization rules, taxpayers mustfirst capitalize debt which is directly attributable to the production expenditures of a propertyspecified in section 263A(f)(1)(B) (i.e., "traced debt"). Debt generally is allocated to a particularexpenditure by tracing disbursements of the debt proceeds to that expenditure. Traced debtincludes only amounts of the taxpayer's eligible debt that do not exceed the property'saccumulated production expenditures.

	After determining the amount of traced debt directly attributable to the property'sproduction expenditures, taxpayers then must assign any other eligible debt to any remainingproduction expenditures and interest on such debt must be capitalized, to the extent that thetaxpayer's interest costs could have been reduced if such production expenditures had not beenincurred (i.e., "avoided cost debt").(24) The determination of whether the taxpayer's interest costscould have been reduced if such production expenditures had not been incurred is made byassuming that the amounts expended for production had instead been used to repay the taxpayer'sdebt, thus reducing the principal balance of such debt and the interest costs thereon. Theoperation of the avoided cost concept does not depend on whether, in fact, the taxpayer actuallywould have used the amounts otherwise expended for production to repay debt.

**Capitalization of the interest of parties related to producers of property**

	The interest costs of parties (including foreign corporations) related to the taxpayerproducing qualified property can also be subjected to capitalization requirements (and avoidedcost rules).(25) In the case of related parties to which the avoided cost rules apply, a deferred assetmethod generally is used to comply with the interest capitalization requirements. Under thismethod, the related party is required to capitalize interest equal to an amount that the producingtaxpayer would have capitalized, using the avoided cost principles, had the producing taxpayeritself incurred the interest on the eligible debt of the related party.(26)

	Under the deferred asset method, the related party accounts for capitalized interest as anasset in the same manner (and at the same time) as the producing taxpayer would have accountedfor such interest had the interest been capitalized into the basis of the qualified property on thetaxpayer's books and records. The interest capitalized by the related party is then recovered at thesame time and in the same manner as it would have been recovered had it been capitalized intothe basis of the property produced by the taxpayer.(27)

	A producing taxpayer may elect to use a substitute cost method instead of subjecting therelated party to the deferred asset method. Under the substitute cost method, the producingtaxpayer capitalizes, during each year of the production period, certain "substitute" costs in lieuof the taxpayer's related parties being required to capitalize interest on their related party avoidedcost debt.

	For taxable years of producing taxpayers beginning on or after January 1, 1988, if interestincurred by related parties becomes subject to the interest capitalization rules, the followingordering rules apply in determining which related party's interest is first capitalized, and indetermining the production expenditures of which producing taxpayer are first subject to thedeferred asset method: (1) with respect to producing taxpayers organized outside of the UnitedStates, interest incurred by every related party organized outside the United States must becapitalized before the interest of any other related party is capitalized; (2) with respect toproducing taxpayers organized within the United States, interest incurred by every related partyorganized within the United States must be capitalized before the interest of any other relatedparty is capitalized.

**Description of Proposal**

	The proposal would apply the uniform capitalization rules to foreign persons only forpurposes of determining U.S. effectively connected income.  Thus, foreign persons (includingU.S.-controlled foreign corporations) that conduct no U.S. trade or business would not be subjectto the uniform capitalization rules.  Section 481 would not apply to any change in method ofaccounting by reason of the proposal.

**Effective Date**

	The proposal would apply to taxable years beginning after December 31, 1999.

**3.  Treatment of military property of foreign sales corporations (sec. 303 of the bill)**

**Present Law**

	A portion of the foreign trade income of an eligible foreign sales corporation ("FSC") isexempt from federal income tax. Foreign trade income is defined as the gross income of a FSCthat is attributable to foreign trading gross receipts. In general, the term "foreign trading grossreceipts" means the gross receipts of a FSC from the sale or lease of export property, servicesrelated and subsidiary to the sale or lease of export property, engineering or architectural servicesfor construction projects located outside the United States, and certain managerial services for anunrelated FSC or DISC.

	Section 923(a)(5) contains a special limitation relating to the export of military property.Under regulations prescribed by the Treasury Secretary, the portion of a FSC's foreign tradinggross receipts from the disposition of, or services relating to, military property that may betreated as exempt foreign trade income is limited to 50 percent of the amount that wouldotherwise be so treated. For this purpose, the term "military property" means any property that isan arm, ammunition, or implement of war designated in the munitions list published pursuant tofederal law.(28) Under this provision, the export of military property through a FSC is accordedone-half the tax benefit that is accorded to exports of non-military property.

**Description of Proposal**

	The proposal would repeal the special FSC limitation relating to the export of militaryproperty, thus providing exports of military property through a FSC with the same treatmentcurrently provided exports of non-military property.

**Effective Date**

	The proposal would be effective for taxable years of FSCs beginning after December 31,1999.

**4. United States property not to include certain assets acquired by dealers in ordinarycourse of trade or business (sec. 304 of the bill)**

**Present Law**

	Under the rules of subpart F, the U.S. 10-percent shareholders of a controlled foreigncorporation ("CFC") generally are subject to U.S. tax currently on their pro rata shares of certainincome of the  CFC (referred to  as "subpart F income"), whether or not such earnings aredistributed currently to the shareholders.   In addition, the U.S. 10-percent shareholders of a CFCare subject to U.S. tax currently on their pro rata shares of the CFC's earnings to the extentinvested by the CFC in certain U.S. property (sec. 951(a)(1)(B)).

	A shareholder's current income inclusion with respect to a CFC's investment in U.S.property for a taxable year is based on the CFC's average investment in U.S. property for suchyear.  For this purpose, the U.S. property held (directly or indirectly) by the CFC must bemeasured as of the close of each quarter in the taxable year (sec. 956(a)).  The amount taken intoaccount with respect to any property is the property's adjusted basis as determined for purposesof reporting the CFC's earnings and profits, reduced by any liability to which the property issubject.  The amount determined for current inclusion is the shareholder's pro rata share of anamount equal to the lesser of (1) the CFC's average investment in U.S. property as of the end ofeach quarter of such taxable year, to the extent that such investment exceeds the foreigncorporation's earnings and profits that were previously taxed on that basis, or (2) the CFC'scurrent or accumulated earnings and profits (but not including a deficit), reduced by distributionsduring the year and by earnings that have been taxed previously as earnings invested in U.S.property (secs. 956 and 959). An income inclusion is required only to the extent that the amountso calculated exceeds the amount of the CFC's earnings that have been previously taxed assubpart F income (secs. 951(a)(1)(B) and 959).

	For purposes of section 956, U.S. property generally is defined to include tangibleproperty located in the United States, stock of a U.S. corporation, an obligation of a U.S. person,and certain intangible assets including a patent or copyright, an invention, model or design, asecret formula or process or similar property right which is acquired or developed by the CFC foruse in the United States. (sec. 956(c)(1)).

	Specified exceptions from the definition of U.S. property are provided for (1) obligationsof the United States and U.S. bank deposits, (2) certain export property, (3) certain trade orbusiness obligations, (4) aircraft, railroad rolling stock, vessels, motor vehicles or containers usedin transportation in foreign commerce and used predominantly outside of the United States, (5)certain insurance company reserves and unearned premiums related to insurance of foreign risks,(6) stock or debt of certain unrelated U.S. corporations (7) moveable property (other than a vesselor aircraft) used for the purpose of exploring, developing, or certain other activities in connectionwith the ocean waters of the U.S. Continental Shelf, (8) an amount of assets equal to the CFC'saccumulated earnings and profits attributable to income effectively connected with a U.S. tradeor business, (9) property (to the extent provided in regulations) held by a foreign salescorporation and related to its export activities, (10) certain deposits or receipts of collateral ormargin by a securities or commodities dealer, if such deposit is made or received on commercialterms in the ordinary course of the dealer's business as a securities or commodities dealer, and(11) certain repurchase and reverse repurchase agreement transactions entered into by or with adealer in securities or commodities in the ordinary course of its business as a securities orcommodities dealer (sec. 956(c)(2)).

**Description of Proposal**

	The proposal would add a new exception from the definition of "United States property"for section 956 purposes for securities acquired and held by a CFC in the ordinary course of itstrade or business as a dealer in securities.  The exception would apply only if the CFC dealer (1)accounts for the securities as securities held primarily for sale to customers in the ordinary courseof business and (2) disposes of such securities (or such securities mature while being held by thedealer) within a period consistent with the holding of securities for sale to customers in theordinary course of business.

**Effective Date**

	The proposal would be effective for taxable years of foreign corporations beginning afterDecember 31, 1999, and for taxable years of United States shareholders with or within whichsuch taxable year of the foreign corporation ends.

**5.  Treatment of certain dividends of regulated investment companies (sec. 305 of the bill)**

**Present Law**

**Regulated investment companies**

	A regulated investment company ("RIC") is a domestic corporation that, at all timesduring the taxable year, is registered under the Investment Company Act of 1940 as amanagement company or as a unit investment trust, or has elected to be treated as a businessdevelopment company under that Act (sec. 851(a)).

	In addition, to qualify as a RIC, a corporation must elect such status and must satisfycertain tests (sec. 851(b)).  These tests include a requirement that the corporation derive at least90 percent of its gross income from dividends, interest, payments with respect to certainsecurities loans, and gains on the sale or other disposition of stock or securities or foreigncurrencies, or other income derived with respect to its business of investment in such stock,securities, or currencies.

	Generally, a RIC pays no income tax because it is permitted to deduct dividends paid toits shareholders in computing its taxable income.  The amount of any distribution generally is notconsidered as a dividend for purposes of computing the dividends paid deduction unless thedistribution is pro rata, with no preference to any share of stock as compared with other shares ofthe same class (sec. 562(c)).  For distributions by RICs to shareholders who made initialinvestments of at least $10,000,000, however, the distribution is not treated as non-pro rata orpreferential solely by reason of an increase in the distribution due to reductions in administrativeexpenses of the company.

	A RIC generally may pass through to its shareholders the character of its long-termcapital gains.  It does this by designating a dividend it pays as a capital gain dividend to theextent that the RIC has net capital gain (i.e., net long-term capital gain over net short-term capitalloss).  These capital gain dividends are treated as long-term capital gain by the shareholders.  ARIC generally also can pass through to its shareholders the character of tax-exempt interest fromState and municipal bonds, but only if, at the close of each quarter of its taxable year, at least 50percent of the value of the total assets of the RIC consists of these obligations.  In this case, theRIC generally may designate a dividend it pays as an exempt-interest dividend to the extent thatthe RIC has tax-exempt interest income.  These exempt-interest dividends are treated as interestexcludable from gross income by the shareholders.

**U.S. source investment income of foreign persons**

     In general

	The United States generally imposes a flat 30-percent tax, collected by withholding, onthe gross amount of U.S.-source investment income payments, such as interest, dividends, rents,royalties or similar types of income, to nonresident alien individuals and foreign corporations("foreign persons") (secs. 871(a), 881, 1441, and 1442).  Under treaties, the United States mayreduce or eliminate such taxes.  Even taking into account U.S. treaties, however, the tax on adividend generally is not entirely eliminated.  Instead, U.S.-source portfolio investmentdividends received by foreign persons generally are subject to U.S. withholding tax at a rate of atleast 15 percent.

     Interest

	Although payments of U.S.-source interest that is not effectively connected with a U.S.trade or business generally are subject to the 30-percent withholding tax, there are significantexceptions to that rule.  For example, interest from certain deposits with banks and otherfinancial institutions is exempt from tax (secs. 871(i)(2)(A) and 881(d)).  Original issue discounton obligations maturing in 183 days or less from the date of original issue (without regard to theperiod held by the taxpayer) is also exempt from tax (sec. 871(g)).  An additional exception isprovided for certain interest paid on portfolio obligations (secs. 871(h) and 881(c)).  "Portfoliointerest" generally is defined as any U.S.-source interest (including original issue discount), noteffectively connected with the conduct of a U.S. trade or business, (i) on an obligation thatsatisfies certain registration requirements or specified exceptions thereto (i.e., the obligation is"foreign targeted"), and (ii) that is not received by a 10-percent shareholder (secs. 871(h)(3) and 881(c)(3)).  With respect to a registered obligation, a statement that the beneficial owner is not aU.S. person is required (secs. 871(h)(2), (5) and 881(c)(2)).  This exception is not available forany interest received either by a bank on a loan extended in the ordinary course of its business(except in the case of interest paid on an obligation of the United States), or by a controlledforeign corporation from a related person (sec. 881(c)(3)).  Moreover, this exception is notavailable for certain contingent interest payments (secs. 871(h)(4) and 881(c)(4)).  The paymentof interest must not be to any person within a foreign country (and must not be a paymentaddressed to, or for the account of, persons within a foreign country) with respect to which theTreasury Secretary has determined that exchange of information is inadequate to prevent evasionof U.S. income tax by U.S. persons (secs. 871(h)(6), and 881(c)(6)).

     Capital gains

	Foreign persons generally are not subject to U.S. tax on gain realized on the dispositionof stock or securities issued by a U.S. person (other than a "U.S. real property holdingcorporation," as described below), unless the gain is effectively connected with the conduct of atrade or business in the United States.  This exemption does not apply, however, to the extentthat the foreign person is a nonresident alien individual present in the United States for a periodor periods aggregating 183 days or more during the taxable year (sec. 871(a)(2)).  A RIC mayelect not to withhold on a distribution to a foreign person representing a capital gain dividend. (Treas. Reg. sec. 1.1441-3(c)(2)(D)).

	Under the Foreign Investment in Real Property Tax Act of 1980 ("FIRPTA"), asamended, gain or loss of a foreign person from the disposition of a U.S. real property interest issubject to net basis tax as if the taxpayer were engaged in a trade or business within the UnitedStates and the gain or loss were effectively connected with such trade or business (sec. 897).  Inaddition to an interest in real property located in the United States or the Virgin Islands, U.S. realproperty interests include (among other things) any interest in a domestic corporation unless thetaxpayer establishes that the corporation was not, during a 5-year period ending on the date of thedisposition of the interest, a U.S. real property holding corporation (which is defined generally tomean a corporation the fair market value of whose U.S. real property interests equals or exceeds50 percent of the sum of the fair market values of its real property interests and any other of itsassets used or held for use in a trade or business).

	Under the FIRPTA provisions, a distribution by a real estate investment trust ("REIT") toa foreign person is, to the extent attributable to gain from sales or exchanges by the REIT of U.S.real property interests, treated as gain recognized by the foreign person from the sale or exchangeof a U.S. real property interest (sec. 897(h)).   Under Treasury regulations, a REIT generally isrequired to withhold tax upon such a distribution to a foreign person, at a rate of 35 percent timesthe maximum amount of that distribution that could be designated by the REIT as a capital gaindividend (Treas. Reg. sec. 1.1445-8(a)(2), (b)(1), and (c)(2)).

	In view of the nature of a REIT, an interest in a REIT may in some cases be considered tobe a U.S. real property interest. An interest in a domestically-controlled REIT, however, is notconsidered a U.S. real property interest (sec. 897(h)(2)).  Nonetheless, the foreign ownershippercentage of taxable appreciation in the value of a U.S. real property interest distributed by adomestically-controlled REIT is subject to tax in the hands of the REIT (sec. 897(h)(3)).

**Estate taxation**

	Decedents who were citizens or residents of the United States are generally subject toFederal estate tax on all property, wherever situated.  Nonresidents who are not U.S. citizens,however, are subject to estate tax only on their  property which is within the United States.Property within the United States generally includes debt obligations of U.S. persons, includingthe Federal government and State and local governments (sec. 2104(c)), but does not includeeither bank deposits or portfolio obligations, the interest on which would be exempt from U.S.income tax under section 871 (sec. 2105(b)).  Stock owned and held by a nonresident who is nota U.S. citizen is treated as property within the United States only if the stock was issued by adomestic corporation (sec. 2104(a); Treas. Reg. sec. 20.2104-1(a)(5)).

	Treaties may reduce U.S. taxation on transfers by estates of nonresident decedents whoare not U.S. citizens. Under recent treaties, for example, U.S. tax may generally be eliminatedexcept insofar as the property transferred includes U.S. real property or business property of aU.S. permanent establishment.

**Description of Proposal**

**In general**

	Under the proposal, a RIC that earns certain interest income which would not be subjectto U.S. tax if earned by a foreign person directly may, to the extent of such income, designate adividend it pays as derived from such interest income. A foreign person who is a shareholder inthe RIC generally would treat such a dividend as exempt from gross-basis U.S. tax, just as if theforeign person had earned the interest directly.  Similarly, a RIC that earns an excess of netshort-term capital gains over net long-term capital losses, which excess would not be subject toU.S. tax if earned by a foreign person, generally may, to the extent of such excess, designate adividend it pays as derived from such excess.  A foreign person who is a shareholder in the RICgenerally would treat such a dividend as exempt from gross-basis U.S. tax, just as if the foreignperson had realized the excess directly.  The estate of a foreign decedent would be exempt fromU.S. estate tax on a transfer of stock in the RIC in the proportion that the assets held by the RICare debt obligations, deposits, or other property that would generally be treated as situatedoutside the United States if held directly by the estate.

**Interest-related dividends**

	Under the proposal, a RIC could, under certain circumstances, designate all or a portionof a dividend as an "interest-related dividend," by written notice mailed to its shareholders notlater than 60 days after the close of its taxable year. An interest-related dividend received by aforeign person generally would generally be exempt from U.S. gross-basis tax under sections871(a), 881, 1441 and 1442.

	This exemption would not apply, however, to a dividend on shares of RIC stock in a casewhere the withholding agent does not receive a statement, similar to that required under theportfolio interest rules, that the beneficial owner of the shares is not a U.S. person. Theexemption would not apply to a dividend paid to any person within a foreign country (ordividends addressed to, or for the account of, persons within such foreign country) with respectto which the Treasury Secretary has determined, under the portfolio interest rules, that exchangeof information is inadequate to prevent evasion of U.S. income tax by U.S. persons.

	In addition, the exemption generally would not apply to dividends paid to a controlledforeign corporation to the extent such dividends are attributable to income received by the RICon a debt obligation of a person with respect to which the recipient of the dividend (i.e., thecontrolled foreign corporation) is a related person.  Nor would the exemption generally apply todividends to the extent such dividends are attributable to income (other than short-term originaldiscount or bank deposit interest) received by the RIC on indebtedness issued by the RIC-dividend recipient or by any corporation or partnership with respect to which the recipient of theRIC dividend is a 10-percent shareholder.  In these two cases, however, the RIC remains exemptfrom its withholding obligation unless the RIC knows that the dividend recipient is such acontrolled foreign corporation or 10-percent shareholder.  To the extent that an interest-relateddividend received by a controlled foreign corporation is attributable to interest income of the RICthat would be portfolio interest if received by a foreign corporation, the dividend would betreated as portfolio interest for purposes of the de minimis rules, the high-tax exception, and thesame country exceptions of subpart F (see sec. 881(c)(5)(A)).

	The aggregate amount designated as interest-related dividends for the RIC's taxable year(including dividends so designated that are paid after the close of the taxable year but treated aspaid during that year as described in section 855) generally is limited to the qualified net interestincome of the RIC for the taxable year. The qualified net interest income of the RIC equals theexcess of (1) the amount of qualified interest income of the RIC over (2) the amount of expensesof the RIC properly allocable to such interest income.

	Qualified interest income of the RIC is the sum of its U.S.-source income with respect to(1) bank deposit interest, (2) short term original issue discount that is currently exempt from thegross-basis tax under section 871, (3) any interest (including amounts recognized as ordinaryincome in respect of original issue discount, market discount, or acquisition discount under theprovisions of sections 1271-1288, and such other amounts as regulations may provide) on anobligation which is in registered form, unless it is earned on an obligation issued by a corporationor partnership in which the RIC is a 10-percent shareholder or is contingent interest not treated asportfolio interest under section 871(h)(4), and (4) any interest-related dividend from another RIC.

	Where the amount designated as an interest-related dividend is greater than the qualifiednet interest income described above, then the portion of the distribution so designated whichconstitutes an interest-related dividend will be only that proportion of the amount so designatedas the amount of the qualified net interest income bears to the amount so designated.

**Short-term capital gain dividends**

	Under the proposal, a RIC could also, under certain circumstances, designate all or aportion of a dividend as a "short-term capital gain dividend," by written notice mailed to itsshareholders not later than 60 days after the close of its taxable year.  For purposes of the U.S.gross-basis tax, a short-term capital gain dividend received by a foreign person generally wouldbe exempt from U.S. gross-basis tax under sections 871(a), 881, 1441 and 1442.  This exemptionwould not apply to the extent that the foreign person is a nonresident alien individual present inthe United States for a period or periods aggregating 183 days or more during the taxable year. In this case, however, the RIC remains exempt from its withholding obligation unless the RICknows that the dividend recipient has been present in the United States for such period.

	The aggregate amount qualified to be designated as short-term capital gain dividends forthe RIC's taxable year (including dividends so designated that are paid after the close of thetaxable year but treated as paid during that year as described in sec. 855) is the excess of theRIC's net short-term capital gains over net long-term capital losses. The short-term capital gainwould include short-term capital gain dividends from another RIC.  As is provided under presentlaw for purposes of computing the amount of a capital gain dividend, the amount is determined(except in the case where an election under sec. 4982(e)(4) applies) without regard to any netcapital loss or net short-term capital loss attributable to transactions after October 31 of the year.Instead, that loss would be treated as arising on the first day of the next taxable year.  To theextent provided in regulations, this rule would apply also for purposes of computing the taxableincome of the RIC.

	In computing the amount of short-term capital gain dividends for the year, no reduction ismade for the amount of expenses of the RIC allocable to such net gains.  In addition, where theamount designated as short-term capital gain dividends is greater than the amount of qualifiedshort-term capital gain, then the portion of the distribution so designated which constitutes ashort-term capital gain dividend will be only that proportion of the amount so designated as theamount of the excess bears to the amount so designated.

	As is true under current law for distributions from REITs, the proposal would providethat any distribution by a RIC to a foreign person shall, to the extent attributable to gains fromsales or exchanges by the RIC of an asset that is considered a U.S. real property interest, betreated as gain recognized by the foreign person from the sale or exchange of a U.S. real propertyinterest. The proposal also would extend the special rules for domestically-controlled REITs todomestically-controlled RICs.

**Estate tax treatment**

	Under the proposal, a portion of the stock in a RIC held by the estate of a nonresidentdecedent who is not a U.S. citizen would be treated as property without the United States.  Theportion so treated would be based on the proportion of the assets held by the RIC at the end ofthe quarter immediately preceding the decedent's death (or such other time as the Secretary maydesignate in regulations) that are "qualifying assets."  Qualifying assets for this purpose are bankdeposits of the type that are exempt from gross-basis income tax, portfolio debt obligations,certain original issue discount obligations, debt obligations of a domestic corporation that aretreated as giving rise to foreign source income, and other property not within the United States.

**Effective Date**

	The proposal generally would apply to dividends with respect to taxable years of RICsbeginning after the date of enactment.  With respect to the treatment of a RIC for estate taxpurposes, the proposal would apply to estates of decedents dying after the date of enactment. With respect to the treatment of RICs under section 897 (dealing with U.S. real propertyinterests), the proposal would be effective on the date of enactment.

**6.  Regulatory authority to exclude certain preliminary agreements from definition ofintangible property (sec. 306 of the bill)**

**Present Law**

	Section 367 applies to require gain recognition upon certain transfers by U.S. persons toforeign corporations. Under section 367(d), a U.S. person that contributes intangible property toa foreign corporation is treated as having sold the property to the corporation and is treated asreceiving deemed royalty payments from the corporation. The deemed royalty payments aretreated as foreign-source income to the same extent that an actual royalty payment would beconsidered to be foreign-source income. Regulatory authority is granted to provide similartreatment in the case of a transfer of intangible property to a partnership. For these purposes,intangible property is defined (by reference to sec. 936(h)(3)(B)) to include such items as patents,copyrights, trademarks, franchises, licenses, and contracts (sec. 367(d)).

	Section 482 authorizes the Treasury Secretary to distribute, apportion or allocate grossincome, deductions, credits or allowances between or among commonly controlled parties toprevent tax evasion or to clearly reflect income. Section 482 provides that in the case of anytransfer or license of intangible property (as defined in sec. 936(h)(3)(B)), the income withrespect to such transfer or license is required to be commensurate with the income attributable tothe intangible.

**Description of Proposal**

	The proposal would direct the Secretary of the Treasury to provide by regulation that theterm "intangible property," as defined in section 936(h)(3)(B), does not include preliminaryagreements which are not legally enforceable. Thus, such agreements would be excluded fromthe definition of intangible property for purposes of sections 367 and 482.

**Effective Date**

	The proposal would apply to agreements entered into after date of enactment.

**7.  Airline mileage awards to certain foreign persons (sec. 307 of the bill)**

**Present Law**

	Excise taxes are imposed on domestic and international air passenger transportation andon domestic air cargo transportation to fund Airport and Airway Trust Fund programs.  Table 1,below, summarizes the current aviation excise taxes.  With the exception of 4.3 cents per gallonof the aviation fuels taxes, all of these taxes are scheduled to expire after September 30, 2007.

**Table 1.-Airport and Airway Trust Fund Excise Tax Rates**

**Tax****Tax rate**
Domestic air passenger transportation
International air passenger transportation

Rights to free and reduced-rate air passenger transportation

Air cargo transportation          Domestic transportation          International transportation8 percent of fare *plus* $2 per     domestic flight segment (through     September 30, 1999).1
$12.20 per arrival and $12.20 per     departure.2

7.5 percent of amount paid to     air carrier.

6.25 percent of the amount charged.3No tax.
____________________

1  The *ad valorem* portion of the rate is scheduled to decline to 7.5 percent, effective fortransportation beginning after September 30, 1999.

	The flight segment portion of the rate is scheduled to increase to $2.25 per flight segment  forOctober 1, 1999-December 31, 1999, to $2.50 for January 1, 2000-December 31, 2000, to $2.75 forJanuary 1, 2001-December 31, 2001, and to $3 for January 1, 2002-December 31, 2002.  Beginning onJanuary 1, 2003, the $3 flight segment rate will be indexed annually for inflation.

	Flight segments to or from qualified rural airports are subject to a 7.5-percent *ad valorem* rate(i.e., the rate is not phased in), and no flight segment rate is imposed.

2  As enacted in 1997, the rate was $12 per arrival or departure.  This amount is indexed annuallyfor inflation, beginning on January 1, 1999.

3  Tax does not apply to amounts attributable to "accessorial ground services."

**Table 1.-Airport and Airway Trust Fund Excise Tax Rates (Continued)**

**Tax****Tax rate**
Aviation fuels    Commercial aviation fuels4
    Noncommercial aviation:5      Aviation gasoline      Aviation jet fuel

        4.3 cents per gallon
      19.3 cents per gallon      21.8 cents per gallon

4  Commercial aviation fuels are subject to an additional 0.1-cent-per-gallon rate through March31, 2005, to fund the Leaking Underground Storage Tank Trust Fund.

5  Noncommercial aviation fuels are subject to an additional 0.1-cent-per-gallon rate throughMarch 31, 2005, to fund the Leaking Underground Storage Tank Trust Fund.

As described in Table 1, amounts paid to air carriers (in cash or in kind) for the right toaward or otherwise distribute free or reduced-rate air transportation are treated as amounts paidfor taxable air transportation, subject to the 7.5 percent *ad valorem* tax rate.  Like the general airpassenger transportation tax, the tax on the purchase of these rights to air transportation (e.g.,frequent flyer mileage awards) applies to payments, whether made within the United States orelsewhere, if the rights to transportation for which payments are made can be used in whole or inpart for transportation that, if purchased directly, would be subject to either the domestic orinternational air passenger taxes.  Also, subject to an exception for miles actually used for certainnon-air transportation uses, the tax applies without regard to whether transportation ultimately isprovided pursuant to the transferred rights.  Examples of amounts taxable under this provisioninclude (1) payments for frequent flyer miles (including other rights to air transportation)purchased by credit card companies, telephone companies, rental car companies, televisionnetworks, restaurants and hotels, air carriers (or related parties), mutual funds, and otherbusinesses, and (2) amounts received by airlines (whether paid in cash or in kind) pursuant tojoint venture credit card or other air transportation marketing arrangements as compensation forthe right to air travel.

**Description of Proposal**

	The proposal would direct the Treasury Department to adopt regulations exemptingawards to persons having a mailing address outside the United States from the tax on amountspaid for the right to award free or reduced-rate air transportation under frequent flyer and similarprograms.

**Effective Date**

	The proposal would apply to amounts paid after December 31, 1997.

**8.  Repeal of reduction of subpart F income of export trade corporations (sec. 308 of thebill)**

**Present Law**

	Under the rules of subpart F, the U.S. 10-percent shareholders of a controlled foreigncorporation ("CFC") generally are subject to U.S. tax currently on their pro rata shares of certainincome of the CFC (referred to as "subpart F income"), without regard to whether the income isdistributed to the shareholders (sec. 951(a)(1)(A)).  To the extent that such undistributed incomewas previously taxed under subpart F, such amounts will not be subject to U.S. tax again upondistribution (sec. 959).

	Subpart F income includes, among other things, foreign base company income (sec. 954). The export trade corporation ("ETC") provisions, however,  reduce the subpart F income of anETC by certain export trade income that constitutes foreign base company income (sec. 970).   Ineffect, an ETC is permitted deferral of U.S. tax on such export-related earnings until thoseearnings are repatriated.

	An ETC is a CFC (as defined in sec. 957) in which (1) 90 percent or more of the grossincome for the immediately preceding 3-year period was derived from sources without theUnited States and (2) 75 percent or more (50 percent in the case of certain agricultural products)of its gross income for such period was export trade income (sec. 971).

	In 1971, the ETC provisions were replaced by rules applicable to domestic internationalsales corporations ("DISCs") (secs. 991-997).  Only those ETCs in existence at that time (i.e.,ETCs that qualified for taxable years beginning before October 31, 1971) were permitted tocontinue operating as ETCs (sec. 971(a)(3)).  In 1984, the DISC provisions were largely replacedby the rules applicable to foreign sales corporations ("FSCs") (secs. 921-927).  Certain foreigntrade income of a FSC is exempt from U.S. income tax.  In connection with the enactment of theFSC provisions, ETCs were given the opportunity to elect to convert to FSC status (or todissolve as ETCs) and repatriate their then accumulated export trade earnings (i.e., earningsderived before January 1, 1985) without U.S. tax.  ETCs that did not make this election werepermitted to continue operating as ETCs.

	The Tax Reform Act of 1986 established an anti-deferral regime for passive foreigninvestment companies ("PFICs") (secs. 1291-1298).  The Small Business Job Protection Act of1996 clarified that foreign trade income of a FSC and export trade income of an ETC do notconstitute passive income for purposes of the PFIC provisions (sec. 1297(b)(2)(D)).  

**Description of Proposal**

	The proposal would repeal the ETC provisions.  The proposal also would treat post-enactment distributions by former ETCs as previously taxed income (thereby exempting suchdistributions from U.S. taxation) to the extent of any actual distributions of export trade incomethat were made after December 31, 1986 by an ETC (or a former ETC that was an ETC onDecember 31, 1986).(29)

**Effective Date**

	The proposal would be effective for taxable years beginning after December 31, 1999.

**9.  Study of interest allocation (sec. 309 of the bill)**

**Present Law**

**In general**

	In order to compute the foreign tax credit limitation, a taxpayer must determine theamount of taxable income from foreign sources. Thus the taxpayer must allocate and apportiondeductions between items of U.S. source gross income, on the one hand, and items of foreignsource gross income, on the other. Generally it is left to the Treasury to provide detailed rules forthe allocation and apportionment of expenses.

	In the case of interest expense, regulations generally are based on the approach thatmoney is fungible and that interest expense is properly attributable to all business activities andproperty of a taxpayer, regardless of any specific purpose for incurring an obligation on whichinterest is paid. (Exceptions to the fungibility concept are recognized or required, however, inparticular cases, some of which are described below.) The Code provides that for interestallocation purposes all members of an affiliated group of corporations generally are to be treatedas a single corporation (the so-called "one-taxpayer rule"), and that allocation must be made onthe basis of assets rather than gross income.

**Affiliated group**

	The term "affiliated group" in this context generally is defined by reference to the rulesfor determining whether corporations are eligible to file consolidated returns. However, somegroups of corporations are eligible to file consolidated returns yet are not treated as affiliated forinterest allocation purposes, and other groups of corporations are treated as affiliated for interestallocation purposes even though they are not eligible to file consolidated returns. Thus, under theone-taxpayer rule, the factors affecting the allocation of interest expense of one corporation mayaffect the sourcing of taxable income of another, related corporation even if the two corporationsdo not elect to file, or are ineligible to file, consolidated returns. (See, e.g., Treas. Reg. sec.1.861-11T(g).)

     Definition of affiliated group--consolidated return rules

	For consolidation purposes, the term "affiliated group" means one or more chains ofincludible corporations connected through stock ownership with a common parent corporationwhich is an includible corporation, but only if the common parent owns directly at least 80percent of the total voting power of all classes of stock and at least 80 percent of the total valueof all outstanding stock of at least one other includible corporation. In addition, for each suchother includible corporation (except the common parent), stock possessing at least 80 percent ofthe total voting power of all classes of its stock and at least 80 percent of the total value of all ofits outstanding stock must be directly owned by one or more other includible corporations.

	Generally the term "includible corporation" means any domestic corporation exceptcertain corporations exempt from tax under section 501 (for example, corporations organized andoperated exclusively for charitable or educational purposes), certain life insurance companies,corporations electing application of the possession tax credit, regulated investment companies,real estate investment trusts, and domestic international sales corporations. A foreign corporationis not an includible corporation.

     Definition of affiliated group--special interest allocation rules

	Subject to exceptions, the consolidated return and interest allocation definitions ofaffiliation generally are consistent with each other. For example, both definitions exclude allforeign corporations from the affiliated group. Thus, while debt generally is considered fungibleamong the assets of a group of domestic affiliated corporations, the same rule does not apply asbetween the domestic and foreign members of a group with the same degree of common controlas the domestic affiliated group. Moreover, Congress in 1986 expressly considered and rejected arule that would have accomplished a result more consistent with worldwide fungibility by takingforeign members' borrowings into account when allocating the interest expense of the domesticmembers (H. Rept. 99-841, II-605 (1986)). In practice, the limit in the degree of fungibilityrecognized by present law can reduce the foreign tax credit limitations that otherwise wouldapply if the principle of fungibility were extended to foreign and domestic members of acommonly controlled group.

	The statutory definition of affiliation for purposes of group-wide allocation of interestexpenses expressly provides for two exceptions from the definition of affiliation forconsolidation purposes, one of which contracts the affiliated group and the other of whichexpands it.

     Banks, savings institutions and other financial affiliates

	Under the first-mentioned exception, the affiliated group for interest allocation purposesgenerally excludes what are known in the regulations as "financial corporations" (Treas. Reg.sec. 1.861-11T(d)(4)). These include any corporation, otherwise a member of the affiliated groupfor consolidation purposes, that is a financial institution (described in section 581 or 591), thebusiness of which is predominantly with persons other than related persons or their customers,and which is required by State or Federal law to be operated separately from any other entitywhich is not a financial institution (sec. 864(e)(5)(C)). The category of financial corporationsalso includes, to the extent provided in regulations, bank holding companies and subsidiaries ofbanks, bank holding companies, and savings institutions predominantly engaged in the activeconduct of a banking, financing, or similar business (sec. 864(e)(5)(D)).

	A financial corporation is not treated as a member of the regular affiliated group forpurposes of applying the one-taxpayer rule to other nonfinancial members of that group. Instead,all such financial corporations which would be so affiliated are treated as a separate singlecorporation for interest allocation purposes.

     Section 936 corporations

	Under the second exception referred to above, the affiliated group for interest allocationpurposes includes any corporation which has elected the application of the possession tax creditfor the taxable year, if the corporation would be excluded solely for this reason from theaffiliated group as defined for consolidation purposes (sec. 864(e)(5)(A)).

**Description of Proposal**

	The proposal would direct the Secretary of the Treasury to conduct a study of the interestexpense allocation rules, including an analysis of the effects of such rules such as effects therules have on different industries. The proposal would require the results of the study to bereported to the House Committee on Ways and Means and the Senate Committee on Finance,along with any legislative recommendations, no later than six months after date of enactment.

**10.  Interest payments deductible where disqualified guarantee has economic effect (sec.310 of the bill)**

**Present Law**

	Interest expenses of a U.S. corporate taxpayer are generally deductible, whether or not theinterest is paid to a related party and whether or not the interest income is subject to U.S. taxationin the hands of the recipient. In certain cases where interest is paid by a corporation to a relatedperson, and no U.S. tax is imposed on the recipient's interest income, the so-called "earningsstripping rules" in the Code provide for denial of interest deductions by the corporate payor tothe extent that the corporation's net interest expenses exceed 50 percent of its adjusted taxableincome (sec. 163(j)). The disallowance is limited by, among other things, the amount of tax-exempt interest paid to related persons.

	Under the earnings stripping rules, interest paid on a loan from an unrelated partygenerally is treated as interest paid to a related person with respect to which no U.S. tax isimposed if: (1) no gross-basis U.S. income tax is imposed on the interest (whether or not theinterest recipient is subject to net-basis U.S. income tax with respect to that interest), and (2)there is a disqualified guarantee of the loan. A "disqualified guarantee" generally is defined forthese purposes as any guaranty of a loan by a related person which is either exempt from U.S.Federal income tax or is a foreign person. Disqualified guarantees do not include cases in whichthe taxpayer controls the guarantor, and in cases, identified by regulation, where the interest onthe indebtedness would have been subject to net basis tax if the interest had been paid to theguarantor. Except as provided in regulations, a guarantee is defined to include any arrangementunder which a person directly or indirectly assures, on a conditional or unconditional basis, thepayment of another's obligation.  

**Description of Proposal**

	The proposal would provide an additional exception from the term "disqualifiedguarantee," for purposes of the earnings stripping rules, for guarantees by a foreign person incases in which the taxpayer establishes to the satisfaction of the Treasury Secretary that the loangiving rise to the indebtedness would have been made by the unrelated person without regard tothe guarantee and that the guarantee resulted in a reduction in interest payable on the loan.

**Effective Date**

	The proposal would be effective with respect to guarantees issued on or after the date ofenactment.

**11.  Modifications of reporting requirements for certain foreign owned corporations (sec.311 of the bill)**

**Present Law**

	U.S. corporations with a 25-percent or greater foreign shareholder are subject to specialreporting rules (sec. 6038A).(30)  For example, a U.S. corporation that engages in specifiedtransactions with its 25-percent foreign shareholder (or a foreign related party) is required toreport the transactions annually on Form 5472 (sec.  6038A(b)).  Information reporting relatingto such transactions is required regardless of the respective amounts of the individualtransactions, the aggregate amount of all transactions, or the size of the taxpayer.

	In addition, U.S. corporations with a 25-percent foreign shareholder are required tomaintain permanent books of account or records that are sufficient to establish the correcttreatment of transactions with related parties (sec. 6038A(a)).  If the IRS requests that certainrecords be translated into English, the U.S. corporation is required to produce the translateddocuments within 30 days of the request (Treas. Reg. sec. 1.6038A-3(f)(2)).

	The IRS may request that a 25-percent foreign shareholder (or a foreign related party)authorize the U.S. corporation to be its agent for purposes of responding to an IRS request toexamine records (or to produce testimony) or an IRS summons (sec. 6038A(e)(1)).

	A U.S. corporation is not subject to the requirements under section 6038A to maintainrecords or authorize an agent in any tax year in which either (1) the U.S. corporation has lessthan $10 million in U.S. gross receipts, or (2) the aggregate value of all gross reportablepayments is not more than $5 million and is less than 10 percent of its U.S. gross income (Treas.Reg. sec. 1.6038A-1(h) and (i)).  These exceptions do not apply to the information reportingrequirements with respect to transactions with foreign related parties.

**Description of Proposal**

	The proposal would exempt the U.S. corporation from the reporting requirements withrespect to transactions with foreign related parties under section 6038A if the aggregate value ofthe transactions between the U.S. corporation and its 25-percent foreign shareholder (or a foreignrelated party) during a tax year does not exceed $5 million.  Thus, in such cases, the U.S.corporation would not be required to file Form 5472.

	The proposal also would extend the period of time in which the U.S. corporation isrequired to produce translated documents, after requested by the IRS, from 30 days to 60 days.

**Effective Date**

	The proposal relating to the exception from the section 6038A reporting requirementswould apply to taxable years beginning after December 31, 1999.  The proposal relating totranslations of specific documents would apply to requests made by the IRS after December 31,1999.
**FOOTNOTES**
1.   This document may be cited as follows: Joint Committee on Taxation,*Overview ofPresent-Law Rules Relating to International Taxation and Description of H.R. 2018, theInternational Tax Simplification for American Competitiveness Act of 1999* (JCX-30-99), June18, 1999.
2.  An identical bill, S. 1164, was introduced by Senators Hatch, Baucus and Mack on May27, 1999.
3.   Once the corporation qualifies as a FPHC, the gross income threshold for eachsubsequent year generally is 50 percent.
4.   For purposes of applying the PFIC asset test, a foreign corporation that is publiclytraded measures its assets using fair market value, a CFC that is not publicly traded measures itsassets using adjusted tax basis, and any other foreign corporation that is not publicly tradedmeasures its assets using fair market value unless the corporation elects to use adjusted tax basis.
5.   There is ongoing litigation in the U.S. District Court between the Bureau of NationalAffairs, Inc. ("BNA"), a tax publisher, and the IRS involving the public release of APAs. TheIRS announced on January 11, 1999, that it was conceding that APAs are subject to disclosureunder section 6110. (See IR-1999-05). The continuing issues are, among other things, the processof redacting confidential information from the APAs and the schedule under which such APAswill be released.
6.   Two export-related provisions preceded the enactment of the FSC provisions. Underprovisions enacted in 1962, CFCs that qualified as export trade corporations were permitted toreduce their subpart F income by the amount of certain export trade income (secs. 970 and 971).No CFC may qualify as an export trade corporation unless it so qualified as of 1971. Underprovisions enacted in 1971, domestic international sales corporations ("DISCs") were permittedto defer U.S. tax on certain export receipts (secs. 991-997). The FSC rules generally wereenacted to replace the DISC rules to address concerns with General Agreement on Tarriffs andTrade subsidy rules. Upon enactment of the FSC provisions in 1984, a special rule permitted anyDISC to transfer its deferred earnings to a FSC. An interest charge is now imposed on thedeferral of tax on the earnings of any remaining DISC. In July 1998, the European Unionrequested that a World Trade Organization ("WTO") dispute panel investigate the FSC regimeand its compliance with WTO rules including the Agreement on Subsidies and CountervailingMeasures. A WTO dispute panel was established in September 1998 to address these issues.
7.   Temporary exceptions from the subpart F provisions for certain active financingincome applied only for taxable years beginning in 1998. Those exceptions were extended andmodified as part of the present-law provision.
8.   See Treas. Reg. sec. 1.964-1.
9.   If a taxpayer with an OFL disposes of property that was used predominantly outside theUnited States in a trade or business, the taxpayer generally is deemed to have received andrecognized foreign source taxable income as the result of a disposition in an amount at leastequal to the lesser of the gain actually realized on the disposition or the remaining amount of theunrecaptured OFL. Furthermore, the annual 50-percent limit on the resourcing of foreign sourceincome does not apply to that amount of foreign source income realized by reason of thedisposition. 
10.   The amount of creditable taxes paid or accrued (or deemed paid) in any taxable yearwhich exceeds the foreign tax credit limitation is permitted to be carried back two years andcarried forward five years (sec. 904(c)).
11.   A controlled foreign corporation in which the taxpayer owns at least 10 percent of thestock by vote is treated as a 10/50 company with respect to any distribution out of earnings andprofits for periods when it was not a controlled foreign corporation. 
12.   A CFC in which the taxpayer owns at least 10 percent of the stock by vote is treated asa 10/50 company with respect to any distribution out of earnings and profits for periods when itwas not a controlled foreign corporation. 
13.   Dividends paid by a 10/50 company in taxable years beginning after December 31,2002, out of earnings and profits accumulated in taxable years beginning before January 1, 2003,are subject to a single foreign tax credit limitation for all 10/50 companies (other than passiveforeign investment companies). Dividends paid by a 10/50 company in taxable years beginningbefore January 1, 2003, are subject to a separate foreign tax credit limitation for each 10/50company.
14.   Similar to the regular tax foreign tax credit, the AMT foreign tax credit is subject tothe separate limitation categories set forth in section 904(d). Under the AMT foreign tax credit,however, the determination of whether any income is high taxed for purposes of thehigh-tax-kick-out rules (sec. 904(d)(2)) is made on the basis of the applicable AMT rate ratherthan the highest applicable rate of regular tax.
15.   U.S. corporations that receive dividends from foreign corporations generally may beeligible for foreign tax credits with respect to such dividends.  However, foreign tax creditsgenerally may not be claimed with respect to the U.S.-source portion of any dividend from a 10-percent owned foreign corporation (sec. 245(a)(8) and (9)).
16.   The dividends received deduction on the eligible portion of the dividend is based onthe percentage of stock ownership of the foreign corporation, as described in section 243.
17.   The production period with respect to a property is the period beginning on the date onwhich production of the property begins and ending on the date on which the property is ready tobe placed in service or to be held for sale.
18.   52 Fed. Reg. 10059 (March 30, 1987). 
19.   57 Fed. Reg. 29246 (July 1, 1992).
20.   1988-2 C.B. 443. 
21.   "Additional section 263A costs" as defined in Temp. Treas. Reg. sec. 1.263A-1T(b)(5)(iii). 
22.   Notice 89-67, 1989-1 C.B. 723. 
23.   Notice 88-99, 1988-2 C.B. 422. 
24.   Notice 88-99 allows taxpayers to elect to forego the debt tracing step by treating all ofits debt that would be traced debt as avoided cost debt. 
25.   For taxable years of the producing taxpayer beginning on or after January 1, 1988, aperson is considered related to the producing taxpayer if such person and the taxpayer aremembers of the same parent-subsidiary controlled group of corporations as defined in section1563(a)(1) regardless of whether such persons would be treated as component members of suchgroup under section 1563(b). For this purpose, the constructive ownership rules of section1563(e) apply. See Notice 88-99. Thus, a foreign corporation may be treated as a member of acontrolled group, even though it is not a member of the consolidated group, and thus may besubject to the interest capitalization and avoided cost rules. 
26.   The interest incurred by related parties is subject to these rules only if the producingtaxpayer's accumulated production expenditures exceed the total amount of its traced andavoided cost debt, and only if interest on the eligible debt of related parties has not already beenallocated by the related party with respect to its own production expenditures of qualifiedproperty for the taxable year. 
27.   In the event that the related party leaves the controlled group, the producing taxpayerincreases its basis in the qualified property by the amount remaining in the deferred asset accountof the related party that corresponds to the particular qualified property. The former related partyis not permitted to continue to amortize, deduct, or take into account the capitalized interest. 
28.   Section 923(a)(5) defines "military property" by reference to section 995(b)(3)(B),which contains a technical error.  Section 995(b)(3)(B)  references the Military Security Act of1954.  The proper reference should have been to the Mutual Security Act of 1954 whichsubsequently was superceded by the International Security Assistance and Arms Export ControlAct of 1976.  Current Treasury regulations provide the correct reference for purposes of defining"military property." 
29.   The post-enactment distributions that are treated as previously taxed income under thisprovision would be treated as an amount described in section 951(a)(2)(B) that reduces the prorata share of subpart F income described in section 951(a)(2)(A).
30.   Failure on behalf of the U.S. corporation to comply with such rules may subject theU.S. corporation to penalties.**