Federal Register / Vol. 71, No. 152 / Tuesday, August 8, 2006 / Rules and Regulations 44887 

of Food and Drugs and redelegated to 

the Center for Veterinary Medicine, 21 

CFR part 558 is amended as follows: 

PART 558—NEW ANIMAL DRUGS FOR 

USE IN ANIMAL FEEDS 

■ 1. The authority citation for 21 CFR 

part 558 continues to read as follows: 

Authority: 21 U.S.C. 360b, 371. 

§ 558.450 [Amended] 

■ 2. In § 558.450, in the table in 

paragraph (d)(2)(i) in the ‘‘Limitations’’

column, remove ‘‘in feed containing 

oxytetracycline hydrochloride or monoalkyl (C8–C18) trimethyl ammonium 

oxytetracycline’’; in the table in 

paragraph (d)(2)(ii) in the ‘‘Limitations’’

column for both entries ‘‘1’’ and ‘‘2’’, 

remove ‘‘as mono-alkyl (C8–C18) 

trimethyl ammonium oxytetracycline’’; 

and in the table in paragraph (d)(2)(iii) 

in the ‘‘Limitations’’ column, remove 

‘‘in feed containing monoalkyl (C8–C18) 

trimethyl ammonium oxytetracycline’’. 

Dated: July 25, 2006. 

Bernadette A. Dunham, 

Deputy Director, Office of New Animal Drug 

Evaluation, Center for Veterinary Medicine. 

[FR Doc. E6–12862 Filed 8–7–06; 8:45 am] 

BILLING CODE 4160–01–S 

DEPARTMENT OF THE TREASURY 

Internal Revenue Service 

26 CFR Part 1 

[TD 9273] 

RIN 1545–AX65 

Stock Transfer Rules: Carryover of 

Earnings and Taxes 

AGENCY: Internal Revenue Service (IRS), 

Treasury. 

ACTION: Final regulations. 

SUMMARY: This document contains final 

regulations addressing the carryover of 

certain tax attributes, such as earnings 

and profits and foreign income tax 

accounts, when two corporations 

combine in a corporate reorganization or 

liquidation that is described in both 

section 367(b) and section 381 of the 

Internal Revenue Code (Code). 

DATES: Effective Date: These regulations 

are effective August 8, 2006. 

Applicability Date: These regulations 

apply to certain section 367(b) 

exchanges that occur on or after 

November 6, 2006. 

FOR FURTHER INFORMATION CONTACT: 

Jeffrey L. Parry at (202) 622–3850 (not 

a toll-free number). 

SUPPLEMENTARY INFORMATION:

Background 

The Treasury Department and the IRS 

issued final regulations ’’1.367(b)–1 

through 1.367(b)–6, dealing with tax 

consequences of certain foreign-toforeign and inbound corporate 

transactions, in June 1998 and January 

2000 (the January 2000 final 

regulations). The preamble to the 

January 2000 final regulations referred 

to proposed regulations that would be 

issued to address the carryover of 

certain corporate tax attributes in 

transactions involving one or more 

foreign corporations. Those proposed 

regulations were issued on November 

15, 2000, in the Federal Register ((65 FR 

69138) (REG–116050–99)) (the 2000 

proposed regulations). The public 

hearing with respect to the 2000 

proposed regulations was cancelled 

because no request to speak was 

received. However, the Treasury 

Department and the IRS received and 

considered several written comments, 

which are discussed in this preamble. 

After consideration of the 2000 

proposed regulations and the comments 

received, the Treasury Department and 

the IRS adopt substantial portions of 

those proposed regulations with 

significant modifications as final 

regulations under section 367(b). 

Overview 

A. General Policies of Section 367(b) 

In general, section 367 governs 

corporate restructurings under sections 

332, 351, 354, 355, 356, and 361 

(Subchapter C nonrecognition 

transactions) in which the status of a 

foreign corporation as a ‘‘corporation’’ is 

necessary for the application of the 

relevant Subchapter C nonrecognition 

provisions. Other provisions in 

Subchapter C (Subchapter C carryover 

provisions) apply to such transactions 

in conjunction with the enumerated 

provisions and detail additional 

consequences that occur in connection 

with the transactions. For example, 

sections 362 and 381 govern the 

carryover of basis and earnings and 

profits from the transferor corporation to 

the transferee corporation in applicable 

transactions. 

The Subchapter C carryover 

provisions generally are drafted to apply 

to domestic corporations and U.S. 

shareholders. As a result, those 

provisions often do not fully take into 

account the relevant cross-border 

aspects of U.S. taxation. For example, 

section 381 does not specifically take 

into account source and foreign tax 

credit issues that arise when earnings 

and profits move from one corporation 

to another. 

Congress enacted section 367(b) to 

ensure that international tax 

considerations in the Code are 

adequately addressed when the 

Subchapter C provisions apply to an 

exchange involving a foreign 

corporation. A primary consideration in 

this regard is to prevent the avoidance 

of U.S. taxation. Because determining 

the proper interaction of the Code’s 

international and Subchapter C 

provisions is ‘‘necessarily highly 

technical,’’ Congress granted the 

Secretary broad regulatory authority to 

provide the ‘‘necessary or appropriate’’

rules rather than enacting a more 

comprehensive statutory regime. H.R. 

Rep. No. 658, 94th Cong., 1st Sess. 241 

(1975). Thus, section 367(b)(2) provides 

in part that the regulations ‘‘shall 

include (but shall not be limited to) 

regulations * * * providing * * * the 

extent to which adjustments shall be 

made to earnings and profits, basis of 

stock or securities, and basis of assets.’’

These final regulations address the 

carryover of foreign earnings and profits 

and foreign income taxes in tax-free 

corporate asset acquisitions by generally 

applying the principles of Subchapter C 

provisions such as section 381, which 

governs the carryover of earnings and 

profits (and other tax attributes) in 

certain tax-free corporate 

reorganizations described in section 368 

and in corporate liquidations described 

in section 332. However, these 

regulations (like the 2000 proposed 

regulations) modify certain of the 

mechanics of the Subchapter C rules as 

necessary or appropriate to ensure that 

those rules are as consistent as possible 

with key international tax policies of the 

Code and to prevent material distortions 

of income. 

These final regulations address the 

portions of the 2000 proposed 

regulations (Prop. Reg.) dealing with 

inbound nonrecognition transactions 

(Prop. Reg. § 1.367(b)–3) and foreign 

section 381 transactions (Prop. Reg. 

§ 1.367(b)–7). They also address the 

special rules of Prop. Reg. § 1.367–9. 

The final regulations, however, do not 

address the portions of the 2000 

proposed regulations involving 

corporate divisions of one or more 

foreign corporations (Prop. Reg. 

§ 1.367(b)-8). The Treasury Department 

and the IRS believe that relevant crossborder tax consequences of section 355 

transactions should be dealt with in a 

separate guidance project. 


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44888 Federal Register / Vol. 71, No. 152 / Tuesday, August 8, 2006 / Rules and Regulations 

B. Specific Policies Related to Inbound 

Nonrecognition Transactions 

(§ 1.367(b)–3) 

Section 1.367(b)–3 addresses 

acquisitions by a domestic corporation 

(domestic acquiring corporation) of the 

assets of a foreign corporation (foreign 

acquired corporation) in a section 332 

liquidation or an asset acquisition 

described in section 368(a)(1), such as 

an A, C, D, or F reorganization (inbound 

nonrecognition transaction). Regulations 

applying section 367 and section 368 to 

cross-border A reorganizations were 

recently issued. See TD 9242 (2006–7 

I.R.B. 422). 

As a general policy matter, the 

importation of various tax attributes in 

inbound transactions is carefully 

scrutinized. In fact, inbound 

importation issues have been the subject 

of recent legislative reforms (see section 

362(e)). The policy relating to 

importation of tax attributes also has 

been reflected in prior section 367 

regulations. For example, the preamble 

to the January 2000 final regulations 

generally describes international policy 

issues that can arise in inbound 

nonrecognition transactions. The 

preamble states that the ‘‘principal 

policy consideration of section 367(b) 

with respect to inbound nonrecognition 

transactions is the appropriate carryover 

of attributes from foreign to domestic 

corporations. This consideration has 

interrelated shareholder-level and 

corporate-level components.’’ The 

January 2000 final regulations clarify 

that a domestic acquiring corporation 

succeeds to those foreign taxes paid or 

accrued by a foreign target corporation 

only to the extent those taxes are 

eligible for credit under section 906. 

The preamble to the January 2000 

final regulations also notes that it would 

be consistent with the policy 

considerations of section 367(b) for 

future regulations to provide additional 

rules with respect to the extent to which 

attributes carry over from a foreign 

corporation to a U.S. corporation. 

Accordingly, the 2000 proposed 

regulations provided rules concerning 

several attributes, specifically net 

operating loss and capital loss 

carryovers, and earnings and profits that 

are not included in income as an all 

earnings and profits amount (or a deficit 

in earnings and profits). The 2000 

proposed regulations generally provided 

that these tax attributes carry over from 

a foreign acquired corporation to a 

domestic acquiring corporation only to 

the extent that they are effectively 

connected with a U.S. trade or business 

(or attributable to a permanent 

establishment, in the case of an 

applicable U.S. income tax treaty). 

These final regulations adopt the rules 

set forth in the 2000 proposed 

regulations. 

C. Specific Policies Related to Foreign 

Section 381 Transactions (§ 1.367(b)–7) 

Section 1.367(b)–7 applies to an 

acquisition by a foreign corporation 

(foreign acquiring corporation) of the 

assets of another foreign corporation 

(foreign target corporation) in a 

transaction described in section 381 

(foreign section 381 transaction) and 

addresses the manner in which earnings 

and profits and foreign income taxes of 

the foreign acquiring corporation and 

foreign target corporation carry over to 

the surviving foreign corporation 

(foreign surviving corporation). These 

rules apply, for example, to A, C, D, or 

F reorganizations or section 332 

liquidations between two foreign 

corporations. 

The principal Code sections 

implicated by the carryover of earnings 

and profits and foreign income taxes in 

a foreign section 381 transaction are 

sections 381, 902, 904, and 959. Section 

381 generally permits earnings and 

profits (or deficit in earnings and 

profits) to carry over to a surviving 

corporation, thus enabling ‘‘the 

successor corporation to step into the 

‘tax shoes’ of its predecessor. * * * 

[and] represents the economic 

integration of two or more separate 

businesses into a unified business 

enterprise.’’ H. Rep. No. 1337, 83rd 

Cong. 2nd Sess. 41 (1954). However, a 

deficit in earnings and profits of either 

the transferee or transferor corporation 

can only be used to offset earnings and 

profits accumulated after the date of 

transfer. Section 381(c)(2)(B). This is 

commonly known as the ‘‘hovering 

deficit rule’’. The hovering deficit rule 

is a legislative mechanism designed to 

deter the trafficking in favorable tax 

attributes that the IRS and courts had 

repeatedly encountered. See, for 

example, Commissioner v. Phipps, 336 

U.S. 410 (1949) final regulations 

generally adopt the principles of section 

381 in the cross-border context, but 

adapt the operation of those rules in 

consideration of the international 

provisions, such as sections 902, 904, 

and 959, that address foreign 

corporations’ earnings and profits and 

their related foreign income taxes. Thus, 

for example, these final regulations 

apply the section 381 earnings and 

profits combination and deficit rules by 

reference to the separate categories 

income described in section 904(d) and 

elsewhere (baskets) that are used to 

compute foreign tax credit limitations. 

Section 902 generally provides that a 

deemed paid foreign tax credit is 

available to a domestic corporation that 

receives a dividend from a foreign 

corporation in which it owns 10 percent 

or more of the voting stock. The Code 

computes deemed-paid taxes with 

regard to dividends from a relevant 

foreign corporation by looking first to 

the multi-year pools of earnings and 

profits accumulated (and related foreign 

income taxes paid or deemed paid) in 

taxable years beginning after December 

31, 1986, or beginning with the first year 

in which a domestic corporation owns 

10 percent or more of the voting stock 

of the foreign corporation, whichever is 

later. Section 902(c). (The Code and 

regulations refer to pooled earnings and 

profits and foreign income taxes as post1986 undistributed earnings and post1986 foreign income taxes even though 

a particular corporation may not begin 

to maintain multi-year pools until after 

1986. Sections 902(c)(1) and (2), 

§ 1.902–1(a)(8) and (9).) 

Congress enacted the pooling rules 

because it believed that blending foreign 

income taxes and earnings and profits 

into ‘‘pools’’ from which distributions 

are made was fairer and more 

appropriate than computing deemedpaid taxes with reference to annual 

layers of earnings and profits (and 

foreign income taxes). Joint Committee 

on Taxation, 99th Cong., 2nd sess., 

General Explanation of the Tax Reform 

Act of 1986 (JCS–10–87) (1986 

Bluebook), at 870 (May 4, 1987). 

Averaging foreign income taxes through 

these blended pools prevents taxpayers 

from inflating their foreign subsidiary’s 

effective tax rate for a particular year in 

order to obtain artificially enhanced 

foreign tax credits. Id. Averaging also 

prevents the loss of credits for foreign 

income taxes that are trapped in years 

in which a foreign subsidiary has no 

earnings and profits for U.S. tax 

purposes. Id. 

However, Congress enacted pooling 

on a limited basis. Earnings and profits 

accumulated (and related foreign 

income taxes paid or deemed paid) in 

taxable years before the first year a 

foreign corporation qualifies as a 

pooling corporation and pre-1987 

earnings and profits accumulated (and 

related foreign income taxes paid or 

deemed paid) by a pooling corporation 

are not subject to the pooling rules. 

Rather, such earnings and profits (and 

related foreign income taxes) are 

maintained in separate annual layers. 

Section 902(c)(6). The Code and 

regulations refer to earnings and profits 

and foreign income taxes in annual 

layers as pre-1987 accumulated profits 

and pre-1987 foreign income taxes even 


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Federal Register / Vol. 71, No. 152 / Tuesday, August 8, 2006 / Rules and Regulations 44889 

though a particular corporation may 

have annual layers for years after 1986 

(because of the absence of the requisite 

domestic corporate shareholder). 

Section 902(c)(6); § 1.902–1(a)(10). 

A distribution of earnings and profits 

is treated as first out of pooled earnings 

and profits and then, only after all 

pooled earnings and profits have been 

distributed, out of annual layers of 

earnings and profits on a LIFO basis. 

Section 902(a) and (c). The retention of 

annual layers beneath pooled earnings 

and profits limits the need to recreate 

tax histories, an administrative burden 

that is more significant for periods 

during which a corporation had limited 

nexus to the U.S. taxing jurisdiction and 

for pre-1987 earnings and profits when 

pooling was not required. 

The foreign tax credit limitation 

ensures that taxpayers can use foreign 

tax credits only to offset U.S. tax on 

foreign source income. The limitation is 

computed separately with respect to 

different baskets of income derived from 

different types of activities. (From 1987 

through 2006, section 904 provides for 

eight different baskets of income; for tax 

years beginning after December 31, 

2006, all but two section 904(d) baskets 

of income are eliminated. Separate 

baskets described in other Code sections 

such as sections 56(g)(4)(C)(iii)(IV), 

245(a)(10), 865(h), 901(j), and 904(g)(10) 

will continue in effect after 2006. The 

American Jobs Creation Act of 2004, 

Public Law 108–357, 118 Stat. 1418 

(AJCA), section 404(a).) The purpose of 

the baskets is to limit taxpayers’ ability 

to cross-credit taxes imposed with 

respect to different categories of income. 

Congress was concerned that, without 

separate limitations, cross-crediting 

opportunities would distort economic 

incentives as to whether to invest in the 

United States or abroad. 1986 Bluebook 

at 862. 

Another international provision 

implicated by the movement of earnings 

and profits in foreign section 381 

transactions is section 959. Section 959 

governs the distribution of earnings and 

profits that represent income that has 

been previously taxed to U.S. 

shareholders under section 951(a) (PTI). 

After studying the interaction of section 

367(b) and the PTI rules, the Treasury 

Department and the IRS determined that 

more guidance under section 959 would 

be useful before issuing regulations to 

address PTI issues that arise under 

section 367(b). Accordingly, the 

Treasury Department and the IRS have 

opened a separate regulations project 

under section 959 and expect to issue 

regulations that address PTI issues 

under section 959 in the future. Because 

this project is still ongoing, these final 

regulations reserve on section 367(b) 

issues related to PTI. Guidance in this 

area will come in a separate project. 

Summary of Comments Received and 

Changes Made 

A. Inbound Nonrecognition 

Transactions 

A comment was received regarding 

the provision under the 2000 proposed 

regulations that limits the carryover of 

earnings and profits (or deficit in 

earnings and profits) from a foreign 

corporation to a domestic corporation in 

an inbound nonrecognition transaction 

to those earnings and profits that are 

effectively connected with the conduct 

of a trade or business within the United 

States (or are attributable to a permanent 

establishment in the United States, in 

the context of an applicable U.S. income 

tax treaty). The comment suggests that 

there are better ways to avoid the two 

most significant problems of importing 

foreign earnings into domestic corporate 

solution: Potential dividends-received 

deductions on subsequent distribution 

of the previously untaxed foreign 

earnings, and taxing distributions of 

previously taxed earnings and profits 

described in section 959. The comment 

goes on to state that, in particular, 

eliminating deficits but taxing positive 

earnings on an inbound nonrecognition 

transaction by way of the all earnings 

and profits inclusion under § 1.367(b)–

3 is inappropriate. 

The Treasury Department and the IRS 

have considered this comment. While 

the comment identifies asymmetries in 

the tax treatment of inbound 

reorganizations, on balance the Treasury 

Department and the IRS believe that the 

2000 proposed regulations reached the 

appropriate result. As indicated above, 

the importation of favorable tax 

attributes has been subject to greater 

scrutiny in recent years. See, for 

example, section 362(e). In that context, 

it is not appropriate to provide for the 

carryover of deficits or of earnings and 

profits in excess of the all earnings and 

profits inclusion. This conclusion also 

has the benefit of administrative ease for 

taxpayers and the IRS. Accordingly, 

these final regulations do not modify the 

rules regarding inbound nonrecognition 

transactions as set forth in the 2000 

proposed regulations, except to reserve 

on the treatment of PTI for further 

consideration. 

B. Paradigm Based on Pooling Rather 

Than Look-Through 

The structure of the 2000 proposed 

regulations was based in large part on 

the categorization of foreign acquiring, 

target, and surviving corporations as 

look-through corporations, non-lookthrough corporations, or less-than-10%- 

U.S.-owned foreign corporations. Under 

the international provisions of the Code 

in effect at the time the 2000 proposed 

regulations were published, a lookthrough-corporation included a 

controlled foreign corporation as 

defined in section 957 (CFC) or a 

noncontrolled section 902 corporation 

as defined in section 904(d)(2)(E) after 

2003 (a look-through 10/50 corporation), 

the effective date of section 1105(b) of 

Public Law 105–34 (111 Stat. 788) (the 

1997 Act). A non-look-through 

corporation was a noncontrolled section 

902 corporation before 2003 (non-lookthrough 10/50 corporation) and a lessthan-10%-U.S.-owned foreign 

corporation was a foreign corporation 

that was neither a CFC nor a 10/50 

corporation. 

The pools of earnings and profits and 

foreign taxes associated with these three 

categories of corporations were referred 

to as the look-through pool, the nonlook-through pool, and the pre-pooling 

annual layers, respectively. A number of 

statutory and regulatory changes that 

have occurred since the time the 2000 

proposed regulations were published, 

however, have necessitated appropriate 

changes (and simplification) in the 

organizational paradigm for these final 

regulations. 

At the time the 2000 proposed 

regulations were issued (and continuing 

prior to the AJCA), the treatment of 

dividends from a 10/50 corporation paid 

after 2002 varied according to the year 

in which the earnings and profits from 

which the dividend was paid were 

accumulated. The look-through 

approach applied to dividends paid out 

of earnings and profits accumulated 

after 2002, whereas dividends paid out 

of earnings and profits accumulated 

prior to 2003 were subject to a single 

separate limitation for dividends from 

all 10/50 corporations. Joint Committee 

on Taxation, 105th Cong., 1st sess., 

General Explanation of Tax Legislation 

enacted in 1997 (JCS–23–97), at 303 

(December 17, 1997). The AJCA 

conference report indicates that 

Congress changed the treatment of 

dividends from 10/50 corporations for 

purposes of simplification. H.R. Rep. 

No. 108–548, pt. 1 at 192 (2004). 

In 2004, Congress amended the Code 

(the 2004 amendment) to provide that 

any dividend paid by a noncontrolled 

section 902 corporation (10/50 

corporation), as defined in section 

904(d)(2)(E), to a 10 percent or greater 

U.S. corporate shareholder is treated as 

income in a basket based on the ratio of 

the earnings and profits attributable to 

income in such basket to the foreign 


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44890 Federal Register / Vol. 71, No. 152 / Tuesday, August 8, 2006 / Rules and Regulations 

corporation’s total earnings and profits 

(the ‘‘look-through’’ approach). AJCA, 

section 403. The 2004 amendment was 

effective retroactively, for taxable years 

beginning after December 31, 2002. 

Section 403(l) of the Gulf Opportunity 

Zone Act of 2005, Public Law 109–135 

(119 Stat. 2577), permitted taxpayers to 

elect to defer the effective date of the 

2004 amendment to taxable years 

beginning after December 31, 2004. 

Also, as part of the 2004 amendment, 

dividends paid to 10% domestic 

corporate shareholders of a CFC are 

eligible for look-through treatment, even 

if they are paid out of earnings that were 

accumulated while the corporation was 

not a CFC. Section 904(d)(4); see also 

§ 1.904–7T(f)(3) and (6). Prior to the 

effective date of the 2004 amendment, 

dividends paid out of such earnings 

were subject to a separate limitation. 

See 26 CFR 1.904–4(g)(2)(ii) (revised as 

of April 1, 2006). 

As a result of the 2004 amendment, 

the terms non-look-through 10/50 

corporation and the related non-lookthrough pool as defined in the 2000 

proposed regulations have become 

obsolete and therefore have been 

eliminated in these final regulations. 

More generally, in light of the broader 

availability of look-through treatment to 

earnings paid out of pre-pooling annual 

layers, the Treasury Department and the 

IRS believe that a paradigm centered on 

look-through or non-look-through status 

is less relevant. Accordingly, the 

organization of these final regulations is 

based on the categorization of foreign 

acquiring, target, and surviving 

corporations as pooling or nonpooling 

corporations. The relevant pools of 

earnings and profits and associated 

foreign taxes are referred to as post-1986 

pools and pre-pooling annual layers. 

Qualifying shareholders are eligible for 

look-through treatment on dividends 

out of post-1986 pools and pre-pooling 

annual layers to the extent provided in 

section 904(d)(3) and (4). 

C. Hovering Deficits and Section 316 

Comments were received regarding 

the application under the 2000 

proposed regulations of the hovering 

deficit rules on a ‘‘basket-by-basket’’

basis. Under the 2000 proposed 

regulations, a pre-transaction deficit in 

a particular basket is generally subject to 

the hovering deficit rule of section 381. 

As a result, that deficit is not taken into 

account in determining the current or 

accumulated earnings and profits of the 

surviving corporation for any purpose, 

including for purposes of determining 

dividends under section 316 and for 

determining foreign tax credits under 

section 902. However, any such pretransaction deficits in earnings and 

profits may be used to offset a foreign 

surviving corporation’s accumulated 

(but not current) post-transaction 

earnings and profits in the same basket 

as the deficit. 

Several comments noted that, in 

certain circumstances, this rule can give 

rise to hovering deficits from one (or 

both) of the merging corporations even 

if it (or they) had aggregate positive 

earnings and profits immediately prior 

to the section 381 transaction. In 

addition, if one (or both) of the merging 

corporations’ pre-transaction earnings 

consist both of positive earnings in one 

basket and a deficit in another basket, 

the earnings and profits of that 

corporation available to support a 

dividend under section 316 will 

increase solely as a result of entering 

into the section 381 transaction. This is 

because the hovering deficit will no 

longer offset the positive earnings in the 

other basket for purposes of section 316. 

As a result, even if a corporation has an 

aggregate deficit in earnings and profits, 

any positive baskets of earnings will be 

able to support the distribution of a 

dividend immediately after the 

transaction. 

The comments contend that the 

prohibition described above against the 

use of an earnings and profits deficit in 

one basket from offsetting positive 

earnings and profits in another basket 

can produce results that are inconsistent 

with the result of applying a pure 

section 381(c)(2)(B) approach in 

determining the amount of a 

distribution that is a ‘‘dividend’’ under 

section 316, and more generally are 

inconsistent with the principles and 

legislative history of the section 

381(c)(2)(B) hovering deficit rule, which 

was adopted to preserve, but not create, 

the taxation of distributions by 

corporations that engage in tax-free 

reorganizations or liquidations. 

To address these concerns, the 

comments requested that (among other 

things) the proposed regulations be 

modified to conform to the principles 

contained in Notice 88–71 (1988–2 C.B. 

374), and § 1.960–1(i)(4), which pro-rate 

an earnings and profits deficit in one 

basket against positive earnings and 

profits in other baskets for purposes of 

computing post-1986 undistributed 

earnings under section 902. It was also 

requested that the rules under § 1.960–

1(i)(4) should be modified for purposes 

of the hovering deficit rules to eliminate 

the ‘‘springing’’ effect of an earnings and 

profits deficit. Section 1.960–1(i)(4) 

provides that a deficit in any basket 

does not permanently reduce earnings 

in other baskets, but after the deemedpaid taxes are computed, the deficit 

reverts to and is carried forward in the 

same basket in which it was incurred. 

It was asserted in the comments that 

once a hovering deficit is used to reduce 

earnings in another basket, it should not 

revert to its original basket in a 

subsequent taxable year because this 

deficit reincarnation results in 

unnecessary complexity in the 

calculation of earnings and profits. 

The Treasury Department and the IRS 

have carefully considered these 

comments. After this consideration, 

they have concluded that the arguments 

in these comments ultimately are not 

persuasive. The purpose of the hovering 

deficit rule in the domestic context is to 

prevent trafficking in deficits in 

earnings and profits. Absent this rule, a 

corporation with positive earnings and 

profits could acquire or be acquired by 

another corporation with a deficit in 

earnings and profits and immediately 

reduce the amount of its positive 

earnings and profits, thereby reducing 

the amount of potentially taxable 

distributions. 

In transactions involving foreign 

corporations, similar concerns exist 

regarding the possibility of trafficking in 

deficits in earnings and profits. In light 

of the foreign tax credit rules, unique 

tax benefits may arise from combining 

positive and deficit earnings and profits 

of different foreign corporations. In a 

reorganization involving two domestic 

corporations, the hovering deficit rule 

applies to a corporation with a net 

accumulated deficit in earnings and 

profits because the relevant statutory 

rules do not distinguish among classes 

of earnings and profits. In contrast, the 

foreign tax credit rules require 

categorization of earnings and profits 

according to the pooling and basket 

rules. Because of these distinctions, 

taxpayers may inappropriately benefit 

by trafficking in an earnings and profits 

deficit in a basket, pool, or particular 

annual layer, even though a corporation 

may have net positive earnings and 

profits. The Treasury Department and 

the IRS believe that these issues merit 

targeted differences in the application of 

the hovering deficit rule in this context. 

Accordingly, these final regulations 

retain the provisions of the 2000 

proposed regulations that apply the 

hovering deficit rule on a basket-bybasket basis. 

The final regulations also include a 

clarification that post-transaction 

earnings and profits that may be offset 

by hovering deficits do not include 

earnings and profits that are distributed 

or deemed distributed in the same 

taxable year that they are earned. That 

is, the hovering deficit rule does not 

permit deficits to be offset against postVerDate Aug<31>2005 18:48 Aug 07, 2006 Jkt 208001 PO 00000 Frm 00008 Fmt 4700 Sfmt 4700 E:\FR\FM\08AUR1.SGM 08AUR1

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Federal Register / Vol. 71, No. 152 / Tuesday, August 8, 2006 / Rules and Regulations 44891 

transaction earnings and profits until 

those earnings and profits become 

accumulated (as opposed to current) for 

tax purposes. This rule is consistent 

with a similar provision in the hovering 

deficit regulations under section 381. 

See § 1.381(c)(2)–1(a)(5). 

D. Hovering Deficits and Section 902 

Under section 902, the amount of 

foreign taxes that are deemed paid by a 

10% domestic corporate shareholder 

receiving dividends from a foreign 

corporation is equal to the foreign 

corporation’s post-1986 foreign income 

taxes multiplied by a fraction, the 

numerator of which is the amount of the 

dividend, and the denominator of which 

is the foreign corporation’s post-1986 

undistributed earnings. Post-1986 

undistributed earnings include both 

accumulated and current year earnings 

and deficits, not taking into account 

current year distributions. The section 

902 calculation is done on a basket-bybasket basis. The 2000 proposed 

regulations provide that a pretransaction deficit will only be taken 

into account for purposes of 

determining the accumulated earnings 

and profits of the surviving corporation 

in the section 902 denominator to the 

extent of post-transaction earnings that 

are accumulated in the same basket as 

the deficit. 

A comment was made requesting that 

the hovering deficit rule not apply for 

purposes of computing deemed-paid 

credits under section 902, particularly 

in the determination of accumulated 

earnings and profits in the denominator 

of the section 902 fraction. Under this 

approach, the effect of the inclusion of 

an otherwise hovering deficit on the 

section 902 calculation could be 

beneficial or detrimental to the 

taxpayer, depending on the particular 

taxpayer’s facts. For example, the 

suggested approach would be 

detrimental to taxpayers if the 

unrestricted use of the otherwise 

hovering deficit reduced the 

denominator of the section 902 fraction 

to or below zero. See § 1.902–1(b)(4) 

(providing that no taxes are deemed 

paid with respect to a ‘‘nimble 

dividend’’ if post-1986 undistributed 

earnings are zero or less than zero). The 

rationale offered for this request is that 

it would more properly follow the intent 

of Congress when it amended section 

902 in 1986 to average earnings and 

profits and foreign taxes under a pooling 

method. 

After consideration of the comment, 

the Treasury Department and the IRS 

have concluded that it would not be 

appropriate to allow a pre-transaction 

hovering deficit from one corporation to 

offset pre-transaction earnings and 

profits of another corporation for 

purposes of determining the 

denominator of the section 902 fraction. 

Such an offset could increase the ratio 

of foreign taxes to earnings and profits 

in the pool and thereby in certain cases 

could ‘‘supercharge’’ the amount of 

foreign taxes that could be drawn out by 

a given distribution. The Treasury 

Department and the IRS believe this is 

not an appropriate result and could 

encourage taxpayers to enter into 

section 381 transactions to take 

advantage of the distortion that would 

result from accelerating foreign tax 

credits in certain cases. It is also 

possible that such a rule could be 

detrimental to taxpayers by otherwise 

denying them access to creditable 

foreign income taxes if their section 902 

denominator were eliminated. 

Moreover, the comment would further 

complicate an already complex area by 

mandating one set of hovering deficit 

treatment and calculations of earnings 

for section 316 and another for section 

902. 

An alternative request was made to 

the effect that, if the hovering deficit 

rule is retained, it should be modified 

to allow a pre-transaction earnings and 

profits deficit to offset the surviving 

corporation’s post-transaction current 

year earnings and profits for purposes of 

determining the section 902 

denominator, irrespective of whether 

such earnings are distributed during the 

taxable year. 

After considering this comment, the 

Treasury Department and the IRS 

concluded that on balance it would not 

be appropriate to modify the proposed 

regulations in this manner. In many 

cases, allowing the hovering deficit to 

offset current year distributed earnings 

and profits for purposes of the section 

902 denominator would effectively 

allow an offset of pre-transaction 

earnings and profits. This is because the 

opening balance of post-1986 

undistributed earnings in the year 

following the distribution would be 

reduced a second time (the first 

reduction having occurred as a result of 

offsetting the current year distributed 

earnings and profits by the hovering 

deficit) as required by section 902 and 

the regulations thereunder to account 

for the distribution itself. This second 

reduction would reduce pre-transaction 

earnings and profits or, to the extent of 

any excess over that amount, create a 

deficit in accumulated earnings and 

profits. As described, the Treasury 

Department and the IRS believe that in 

order to minimize credit trafficking 

problems, pre-transaction deficits of one 

corporation should not be allowed to 

offset pre-transaction earnings of 

another corporation. 

Additionally, implementing the 

modification requested in the comment 

would create administrative burdens for 

taxpayers and the IRS. If hovering 

deficits offset current year distributed 

earnings solely for purposes of section 

902 but not for purposes of section 316, 

dual accounts would be necessary to 

track hovering deficits as they are 

separately used under each section. 

Moreover, certain taxpayers would be 

disadvantaged under the requested 

modification as compared to how those 

taxpayers would be treated under the 

rule adopted in these final regulations. 

For example, if a foreign subsidiary has 

a hovering deficit in a separate basket 

that exceeds the sum of current plus 

accumulated earnings in the basket and 

the foreign subsidiary distributes 

current year post-transaction earnings in 

that same basket, under the requested 

modification, the hovering deficit would 

reduce the section 902 denominator to 

zero, with the result that no deemedpaid taxes could be claimed on the 

distribution. In fact, for this reason 

certain taxpayers have specifically 

requested that the hovering deficit rule 

apply for purposes of the section 902 

fraction. Under the rules adopted by the 

final regulations, the hovering deficit 

would not reduce the section 902 

denominator and therefore taxpayers 

would have access to deemed-paid taxes 

on the distribution. 

E. Hovering Taxes 

Under the 2000 proposed regulations, 

taxes associated with a hovering deficit 

do not enter into the surviving 

corporation’s post-1986 foreign income 

taxes pool until the entire deficit has 

been offset against post-transaction 

accumulated earnings and profits. 

Comments were made requesting that 

the regulations be changed to provide 

that foreign taxes related to a hovering 

deficit enter the post-1986 foreign 

income taxes pool on a pro rata basis as 

the hovering deficit to which the foreign 

taxes relate is used to offset posttransaction accumulated earnings and 

profits. The Treasury Department and 

IRS agree that a pro rata approach of this 

nature more accurately ties the 

availability of the foreign income taxes 

with the use of the related hovering 

deficit. Accordingly, this requested 

change is reflected in the final 

regulations. 

F. Zipping Rule 

The 2000 regulations provide that if 

the foreign target corporation or foreign 

acquiring corporation (or both) was a 

look-through corporation and the 


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foreign surviving corporation is a lessthan-10%-U.S.-owned foreign 

corporation, the post-1986 pools of 

earnings and profits of the look-through 

corporation in the separate baskets are 

recharacterized as a single, non-lookthrough pre-pooling annual layer which 

accumulated immediately prior to the 

381 transaction (the zipping rule). In 

addition, the 2000 proposed regulations 

provide that if the foreign surviving 

corporation later changes to lookthrough status, any such recharacterized 

earnings and profits do not regain either 

their pooling or their look-through 

character. 

A comment was made that in a case 

where the foreign surviving corporation 

subsequently changes to look-through 

status, if the recharacterized earnings 

and profits do not revert to their lookthrough character, a dividend paid out 

of those earnings would not be afforded 

look-through treatment. The comment 

argued that this would run counter to 

section 904(d)(2)(E)(i) which provides 

that look-through treatment applies to 

distributions by a CFC out of any 

earnings and profits accumulated during 

periods in which it was a CFC. 

The Treasury Department and IRS 

note that this concern has been 

addressed by intervening statutory and 

regulatory changes. All distributions 

from a look-through corporation now 

receive look-through treatment, 

regardless of whether they are paid out 

of earnings and profits from post-1986 

pools or pre-pooling annual layers. As a 

result, the concern raised in the 

comment is now effectively moot, and 

look-through treatment generally 

prevails. The final regulations otherwise 

retain the zipping rule, however, 

because with respect to the maintenance 

of pools or annual layers, this rule 

provides administrative advantages for 

both taxpayers and the IRS by not 

requiring subsequent U.S. shareholders 

of a foreign surviving corporation that 

continued to accumulate earnings on an 

annual layer basis to recreate post-1986 

pools of pre-transaction earnings and 

profits carried over from a pooling 

foreign target corporation. Accordingly, 

the Treasury Department and the IRS 

decided to retain the general zipping 

rule provisions of the 2000 proposed 

regulations in these final regulations for 

pooling purposes, while allowing full 

preservation of look-through treatment. 

Moreover, it should be noted that 

these final regulations define a pooling 

corporation as one that has at any time 

met the requirements of section 

902(c)(3)(B). Accordingly, even if the 

foreign surviving corporation does not 

meet those requirements immediately 

after the foreign section 381 transaction, 

it will still be a pooling corporation if 

it had met those requirements at any 

time prior to the transaction. See 

§ 1.902–1(a)(13)(i). 

G. Qualified and Chain Deficit Rules 

Under Section 952(c)(1)(B) and (C) 

The section 952(c)(1)(B) subpart F 

qualified deficit rule and section 

952(c)(1)(C) subpart F chain deficit rule 

allow the use of a CFC’s deficit in 

earnings and profits to limit subpart F 

income inclusions for another year with 

respect to the stock of the same CFC or 

for the same year with respect to stock 

of another CFC in certain cases. Under 

the qualified deficit rule of section 

952(c)(1)(B), a prior-year earnings and 

profits deficit may be used to limit a 

qualified shareholder’s current year 

subpart F income in the same CFC if 

such deficit is attributable to the same 

qualified activity as the activity that 

gives rise to the current year subpart F 

income. Under the chain deficit rule of 

section 952(c)(1)(C), a current year 

earnings and profits deficit may be used 

to limit a related corporation’s current 

year subpart F income subject to the 

same qualified activity restrictions. 

The 2000 proposed regulations 

provide that a pre-transaction deficit is 

not taken into account for purposes of 

calculating the earnings and profits 

limitation under the chain deficit rule. 

The 2000 proposed regulations are 

silent, however, as to the qualified 

deficit rule. A comment was made 

requesting that pre-transaction deficits 

be taken into account for purposes of 

calculating the earnings and profits 

limitations under both the qualified 

deficit rules and the chain deficit rules. 

The Treasury Department and the IRS 

agree with this comment. The qualified 

deficit rule does not limit the amount of 

the subpart F income at the CFC level, 

but rather limits the amount of a 

particular shareholder’s subpart F 

income inclusion under section 951(a). 

Because qualified deficits in earnings 

and profits are shareholder-level 

attributes and anti-trafficking provisions 

are already incorporated in the rules 

regarding qualified deficits under 

section 952(c)(1)(B), the Treasury 

Department and the IRS believe that it 

is appropriate to allow pre-transaction 

deficits to be taken into account for 

purposes of the calculation of qualified 

deficits. Though the Treasury 

Department and IRS believe this was 

already a reasonable position that could 

have been taken under the 2000 

proposed regulations, the final 

regulations include a more explicit 

clarification of this position. 

The final regulations also provide that 

a current year pre-transaction deficit 

may be taken into account for purposes 

of limiting subpart F income under the 

chain deficit rule. The Treasury 

Department and the IRS believe that the 

narrow restrictions that apply to 

application of the chain deficit rule are 

not subject to manipulation through 

entering into foreign section 381 

transactions. Accordingly there is no 

policy reason for denying a qualified 

chain member access to a pretransaction deficit that otherwise 

qualifies as a chain deficit solely 

because the CFC with the chain deficit 

engaged in a foreign section 381 

transaction during the taxable year. Any 

such pre-transaction deficit that 

qualifies as a chain deficit will 

nonetheless remain a hovering deficit of 

the surviving corporation for purposes 

of section 316 and section 902. 

H. Allocation of Earnings and Profits, 

Deficits, and Taxes During the 

Transaction Year 

The 2000 proposed regulations 

include a rule that allocates the earnings 

and profits for the taxable year of a 

foreign surviving corporation in which 

a foreign section 381 transaction occurs 

as either pre-transaction earnings or 

post-transaction earnings on the basis of 

the number of days in the taxable year 

before and after the date of the foreign 

section 381 transaction. This rule 

parallels a similar rule found under 

§ 1.381(c)(2)–1(a)(6) and is necessary in 

order to determine the amount of posttransaction earnings that may be offset 

by hovering deficits. This rule is applied 

on a basket-by-basket basis for any 

basket in which there are positive 

earnings and profits for the taxable year 

in which the transaction occurred. No 

comments were received on this point, 

and the final regulations adopt this 

provision, extending it to related foreign 

income taxes as well. 

These final regulations also contain a 

rule for allocating deficits, and related 

foreign income taxes, for the taxable 

year in which a foreign section 381 

transaction occurs as pre- and posttransaction deficits. If the surviving 

corporation has a deficit in any basket 

for the taxable year in which the 

transaction occurred, unless the actual 

accumulated earnings and profits, or 

deficit, as of the date of the transaction 

can be shown, the deficit shall be 

allocated in the same pro rata manner 

described above for positive earnings 

and profits. This rule also parallels a 

similar rule found under § 1.381(c)(2)–

1(a)(6) and is necessary in order to 

determine the amount of pre-transaction 

deficits that will hover. This rule is 

applied on a basket-by-basket basis for 

any basket in which there is a deficit in 


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earnings and profits for the taxable year 

in which the transaction occurred. 

The Treasury Department and the IRS 

believe that the addition of the 

allocation rule for deficits provides 

greater consistency with the principles 

and rules of section 381. It is a neutral 

provision and is consistent with 

appropriate results that could be 

reached under present law. 

I. Special Rule for F Reorganizations 

and Similar Transactions 

The 2000 proposed regulations (Prop. 

Reg. § 1.367(b)-9) provide that the 

hovering deficit rules do not apply in 

the case of a foreign section 381 

transaction that is described in section 

368(a)(1)(F) or in which either the 

foreign target corporation or the foreign 

acquiring corporation is newly created. 

This rule was intended to prevent 

inappropriate tax consequences that 

could result from application of the 

hovering deficit rules to the 

combination of two corporations where 

only one of those corporations has 

meaningful tax attributes. For example, 

under the generally applicable hovering 

deficit rules, a foreign corporation with 

significant deficits in earnings and 

profits could combine with a newly 

created foreign corporation and 

thereafter distribute dividends (along 

with deemed paid foreign income taxes 

under section 902), despite the presence 

of a significant deficit that would have 

precluded a dividend distribution 

before the transaction. 

The rule under the 2000 proposed 

regulations addressing newly created 

corporations was meant to capture any 

transactions that are functionally 

equivalent to F reorganizations. 

However, the Treasury Department and 

the IRS have determined that the newlycreated corporation standard under the 

2000 proposed regulations is both 

potentially underinclusive and 

overinclusive in scope. It is 

underinclusive in that it would not 

apply to include foreign section 381 

transactions that do not otherwise 

qualify as an F reorganization but that 

are between one foreign corporation 

with meaningful tax attributes and a 

shell corporation that is not newly 

created, but nevertheless has no 

meaningful tax attributes. In contrast, 

this standard is overinclusive in that it 

might be read to include a foreign 

section 381 transaction involving 

multiple foreign corporations with 

meaningful tax attributes as long as at 

least one party to the transaction is a 

newly created corporation. These 

transactions are neither F 

reorganizations nor are they 

functionally equivalent to F 

reorganizations. 

Accordingly, these final regulations 

clarify the 2000 proposed regulations by 

providing that the hovering deficit rules 

do not apply to a foreign section 381 

transaction involving at least one 

corporation that does not own more 

than a nominal amount of property or 

does not have more than a nominal 

amount of tax attributes, but no more 

than one corporation that does own 

more than a nominal amount of 

property or have more than a nominal 

amount of tax attributes. In most cases 

the transactions covered by this special 

rule will be standard F reorganizations. 

J. Anti-Abuse Rule 

The 2000 proposed regulations 

include an anti-abuse rule that gives the 

Commissioner the discretion to turn off 

the hovering deficit rules if a principal 

purpose of a foreign section 381 

transaction is to gain a tax benefit from 

affirmative use of those rules. 

Comments have criticized the anti-abuse 

rule as overly broad and inconsistent 

with establishing objective rules 

regarding the taxation of earnings 

distributed (or deemed distributed) by 

foreign subsidiaries. Moreover, the point 

was raised in some comments that the 

proposed anti-abuse rule would prevent 

taxpayers from relying on the existing 

detailed set of rules for the calculation 

of earnings and profits following a 

corporate combination in any case in 

which a taxpayer receives a U.S. tax 

benefit related to the application of the 

hovering deficit rule. 

Upon consideration of these 

comments, the Treasury Department 

and the IRS have concluded that the 

anti-abuse rule in the 2000 proposed 

regulations should be eliminated. While 

the anti-abuse rule has been eliminated, 

the IRS will continue to examine the 

application of the regulations to 

transactions to which they apply, or 

potentially apply, and will be prepared 

to pursue issues where appropriate 

under the regulations and other 

established principles of existing law. 

The Treasury Department and the IRS 

may revisit the rules in light of 

experience and propose prospective 

changes as appropriate. 

K. Miscellaneous 

A number of conforming revisions 

have been made to the 2000 proposed 

regulations to account for relevant 

statutory and regulatory changes 

discussed above that have occurred in 

the intervening time period since the 

2000 proposed regulations were issued. 

This includes the reduction of the 

number of baskets under section 

904(d)(1), applicable for tax years 

beginning after December 31, 2006, as 

well as the fact that distributions by 

look-through corporations out of annual 

layers accumulated during a non-lookthrough period are now accorded lookthrough treatment. 

It is possible that special transition 

rules might be needed relating to the 

effect on hovering deficits in existence 

on the effective date of the reduction in 

the number of baskets under section 

904(d)(1). If it is determined that such 

rules are necessary, they would be 

provided as part of a broader guidance 

project currently under consideration to 

address generally transition issues 

relating to the reduction in baskets. 

Special Analyses 

It has been determined that this 

Treasury decision is not a significant 

regulatory action as defined in 

Executive Order 12866. Therefore, a 

regulatory assessment is not required. It 

also has been determined that section 

553(b) of the Administrative Procedure 

Act (5 U.S.C. chapter 5) does not apply 

to these regulations, and because the 

regulations do not impose a collection 

of information on small entities, the 

Regulatory Flexibility Act (5 U.S.C. 

chapter 6) does not apply. Pursuant to 

section 7805(f) of the Code, the notice 

of proposed rulemaking preceding these 

regulations was submitted to the Chief 

Counsel for Advocacy of the Small 

Business Administration for comment 

on their impact on small business. 

Drafting Information 

The principal author of these final 

regulations is Jeffrey L. Parry of the 

Office of Chief Counsel (International). 

However, other personnel from the 

Treasury Department and the IRS 

participated in their development. 

List of Subjects in 26 CFR Part 1 

Income taxes, Reporting and 

recordkeeping requirements. 

Amendments to the Regulations 

■ Accordingly, 26 CFR part 1 is 

amended as follows: 

PART 1—INCOME TAXES 

■ Paragraph 1. The authority citation 

for part 1 is amended by revising the 

entries for §§ 1.367(b)–7 and 1.367(b)–9 

to read in part as follows: 

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

Section 1.367(b)–7 also issued under 26 

U.S.C. 367(a) and (b), 26 U.S.C. 902, and 26 

U.S.C. 904. 

Section 1.367(b)–9 also issued under 26 

U.S.C. 367(a) and (b), 26 U.S.C. 902, and 26 

U.S.C. 904. * * * 


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■ Par. 2. Section 1.367(b)–0 is amended 

by: 

■ 1. Revising the introductory text. 

■ 2. Adding entries for § 1.367(b)–2(l). 

■ 3. Adding entries for § 1.367(b)–3(e) 

and (f). 

■ 4. Adding entries for §§ 1.367(b)–7 

through 1.367(b)–9. 

The revisions and additions read as 

follows: 

§ 1.367(b)–0 Table of contents. 

This section lists the paragraphs 

contained in §§ 1.367(b)–1 through 

1.367(b)–9. 

* * * * * 

§ 1.367(b)–2 Definitions and special rules. 

* * * * * 

(l) Additional definitions. 

(1) Foreign income taxes. 

(2) Post-1986 undistributed earnings. 

(3) Post-1986 foreign income taxes. 

(4) Pre-1987 accumulated profits. 

(5) Pre-1987 foreign income taxes. 

(6) Pre-1987 section 960 earnings and profits. 

(7) Pre-1987 section 960 foreign income 

taxes. 

(8) Earnings and profits. 

(9) Pooling corporation. 

(10) Nonpooling corporation. 

(11) Separate category. 

(12) Passive category. 

(13) General category. 

§ 1.367(b)–3 Repatriation of foreign 

corporate assets in certain nonrecognition 

transactions. 

* * * * * 

(e) Net operating loss and capital loss 

carryovers. 

(f) Carryover of earnings and profits. 

(1) General rule. 

(2) Previously taxed earnings and profits. 

[Reserved] 

* * * * * 

§ 1.367(b)–7 Carryover of earnings and 

profits and foreign income taxes in certain 

foreign-to-foreign nonrecognition 

transactions. 

(a) Scope. 

(b) General rules. 

(1) Non-previously taxed earnings and profits 

and related taxes. 

(2) Previously taxed earnings and profits. 

[Reserved] 

(c) Ordering rule for post-transaction 

distributions. 

(1) If foreign surviving corporation is a 

pooling corporation. 

(2) If foreign surviving corporation is a 

nonpooling corporation. 

(d) Post-1986 pool. 

(1) In general. 

(i) Qualifying earnings and taxes. 

(ii) Carryover rule. 

(2) Hovering deficit. 

(i) In general. 

(ii) Offset rule. 

(iii) Related taxes. 

(3) Examples. 

(e) Pre-pooling annual layers. 

(1) If foreign surviving corporation is a 

pooling corporation. 

(i) Qualifying earnings and taxes. 

(ii) Carryover rule. 

(iii) Deficits. 

(A) In general. 

(B) Aggregate positive pre-1987 accumulated 

profits. 

(C) Aggregate deficit in pre-1987 

accumulated profits. 

(D) Deficit and positive separate categories 

within annual layers 

(iv) Pre-1987 section 960 earnings and profits 

and foreign income taxes. 

(v) Examples. 

(2) If foreign surviving corporation is a 

nonpooling corporation. 

(i) Qualifying earnings and taxes. 

(ii) Carryover rule. 

(iii) Deficits. 

(A) In general. 

(B) Aggregate positive pre-1987 accumulated 

profits. 

(C) Aggregate deficit in pre-1987 

accumulated profits. 

(D) Deficit and positive separate categories 

within annual layers. 

(iv) Pre-1987 section 960 earnings and profits 

and foreign income taxes. 

(v) Examples. 

(f) Special rules. 

(1) Treatment of deficit. 

(i) General rule. 

(ii) Exceptions. 

(iii) Examples. 

(2) Reconciling taxable years. 

(3) Post-transaction change of status. 

(4) Ordering rule for multiple hovering 

deficits. 

(i) Rule. 

(ii) Example. 

(5) Pro rata rule for earnings and deficits 

during transaction year. 

(g) Effective date. 

§ 1.367(b)–8 Allocation of earnings and 

profits and foreign income taxes in certain 

foreign corporate separations. [Reserved] 

§ 1.367(b)–9 Special rule for F 

reorganizations and similar transactions. 

(a) Scope. 

(b) Hovering deficit rules inapplicable. 

(c) Foreign divisive transactions. [Reserved] 

(d) Examples. 

(e) Effective date. 

* * * * * 

■ Par. 3. Section 1.367(b)–1 is amended 

by: 

■ 1. Removing the language ‘‘and’’ at the 

end of paragraph (c)(2)(iii). 

■ 2. Removing the period at the end of 

paragraph (c)(2)(iv)(B) and adding ‘‘; 

and’’ in its place. 

■ 3. Adding paragraph (c)(2)(v). 

■ 4. Revising paragraphs (c)(3)(ii)(A), 

(c)(4)(iv), and (c)(4)(v). 

The additions and revisions read as 

follows: 

§ 1.367(b)–1 Other transfers. 

* * * * * 

(c) * * * 

(2) * * * 

(v) A foreign surviving corporation 

described in § 1.367(b)–7(a). 

(3) * * * 

(ii) * * * 

(A) United States shareholders (as 

defined in § 1.367(b)–3(b)(2)) of foreign 

corporations described in paragraph 

(c)(2)(i) or (v) of this section; and 

* * * * * 

(4) * * * 

(iv) A statement that describes any 

amount (or amounts) required, under 

the section 367(b) regulations, to be 

taken into account as income or loss or 

as an adjustment (including an 

adjustment under § 1.367(b)–7 or 

1.367(b)–9) to basis, earnings and 

profits, or other tax attributes as a result 

of the exchange; 

(v) Any information that is or would 

be required to be furnished with a 

Federal income tax return pursuant to 

regulations under section 332, 351, 354, 

355, 356, 361, 368, or 381 (whether or 

not a Federal income tax return is 

required to be filed), if such information 

has not otherwise been provided by the 

person filing the section 367(b) notice; 

* * * * * 

■ Par. 4. Section 1.367(b)–2 is amended 

by: 

■ 1. Revising paragraph (j)(1)(i). 

■ 2. Adding paragraph (l). 

The revision and addition read as 

follows: 

§ 1.367(b)–2 Definitions and special rules. 

* * * * * 

(j) Sections 985 through 989—(1) 

Change in functional currency of a 

qualified business unit—(i) Rule. If, as a 

result of a section 367(b) exchange 

described in section 381(a), a qualified 

business unit (as defined in section 

989(a)) (QBU) has a different functional 

currency determined under the rules of 

section 985(b) than it used prior to the 

transaction, then the QBU shall be 

deemed to have automatically changed 

its functional currency immediately 

prior to the transaction. A QBU that is 

deemed to change its functional 

currency pursuant to this paragraph (j) 

must make the adjustments described in 

§ 1.985–5. 

* * * * * 

(l) Additional definitions—(1) Foreign 

income taxes. The term foreign income 

taxes has the meaning set forth in 

§ 1.902–1(a)(7). 

(2) Post-1986 undistributed earnings. 

The term post-1986 undistributed 

earnings has the meaning set forth in 

§ 1.902–1(a)(9). 

(3) Post-1986 foreign income taxes. 

The term post-1986 foreign income 

taxes has the meaning set forth in 

§ 1.902–1(a)(8). 

(4) Pre-1987 accumulated profits. The 

term pre-1987 accumulated profits 


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means the earnings and profits 

described in § 1.902–1(a)(10)(i), 

computed in accordance with the rules 

of § 1.902–1(a)(10)(ii). 

(5) Pre-1987 foreign income taxes. The 

term pre-1987 foreign income taxes has 

the meaning set forth in § 1.902–

1(a)(10)(iii). 

(6) Pre-1987 section 960 earnings and 

profits. The term pre-1987 section 960 

earnings and profits means the earnings 

and profits of a foreign corporation 

accumulated in taxable years beginning 

before January 1, 1987, computed under 

§ 1.964–1(a) through (e), and translated 

into the functional currency (as 

determined under section 985) of the 

foreign corporation at the spot rate on 

the first day of the foreign corporation’s 

first taxable year beginning after 

December 31, 1986. For further 

guidance, see Notice 88–70 (1988–2 C.B. 

369, 370) (see also § 601.601(d)(2) of this 

chapter). The term pre-1987 section 960 

earnings and profits does not include 

earnings and profits that represent 

previously taxed earnings and profits 

described in section 959. 

(7) Pre-1987 section 960 foreign 

income taxes. The term pre-1987 section 

960 foreign income taxes means the 

foreign income taxes related to pre-1987 

section 960 earnings and profits, 

determined in accordance with the 

principles of § 1.902–1(a)(10)(iii), except 

that the U.S. dollar amounts of pre-1987 

section 960 foreign income taxes are 

determined by reference to the exchange 

rates in effect when the taxes were paid 

or accrued. 

(8) Earnings and profits. The term 

earnings and profits means post-1986 

undistributed earnings, pre-1987 

accumulated profits, and pre-1987 

section 960 earnings and profits. 

(9) Pooling corporation. The term 

pooling corporation means a foreign 

corporation with respect to which the 

requirements of section 902(c)(3)(B) 

have been met in the current taxable 

year or any prior taxable year. 

(10) Nonpooling corporation. The 

term nonpooling corporation means a 

foreign corporation that is not a pooling 

corporation. 

(11) Separate category. The term 

separate category has the meaning set 

forth in section 904(d)(1), and shall also 

include any other category of income to 

which section 904(a), (b), and (c) are 

applied separately under any other 

provision of the Internal Revenue Code 

(e.g., sections 56(g)(4)(C)(iii)(IV), 

245(a)(10), 865(h), 901(j), and 904(h)(10) 

(or section 904(g)(10) for taxable years 

beginning on or before December 31, 

2006). 

(12) Passive category. The term 

passive category means the separate 

category that includes income described 

in section 904(d)(1)(A). 

(13) General category. The term 

general category means the separate 

category that includes income described 

in section 904(d)(1)(B) (or section 

904(d)(1)(I) for taxable years beginning 

on or before December 31, 2006). 

■ Par. 5. Section 1.367(b)–3 is amended 

by adding paragraphs (e) and (f) to read 

as follows: 

§ 1.367(b)–3 Repatriation of foreign 

corporate assets in certain nonrecognition 

transactions. 

* * * * * 

(e) Net operating loss and capital loss 

carryovers. A net operating loss or 

capital loss carryover of the foreign 

acquired corporation is described in 

section 381(c)(1) and (c)(3) and thus is 

eligible to carry over from the foreign 

acquired corporation to the domestic 

acquiring corporation only to the extent 

the underlying deductions or losses 

were allowable under chapter 1 of 

subtitle A of the Internal Revenue Code. 

Thus, only a net operating loss or 

capital loss carryover that is effectively 

connected with the conduct of a trade 

or business within the United States (or 

that is attributable to a permanent 

establishment, in the context of an 

applicable United States income tax 

treaty) is eligible to be carried over 

under section 381. For further guidance, 

see Rev. Rul. 72–421 (1972–2 C.B. 166) 

(see also § 601.601(d)(2) of this chapter). 

(f) Carryover of earnings and profits—

(1) General rule. Except to the extent 

otherwise specifically provided (see, 

e.g., Notice 89–79 (1989–2 C.B. 392) (see 

also § 601.601(d)(2) of this chapter)), 

earnings and profits of the foreign 

acquired corporation that are not 

included in income as a deemed 

dividend under the section 367(b) 

regulations (or deficit in earnings and 

profits) are eligible to carry over from 

the foreign acquired corporation to the 

domestic acquiring corporation under 

section 381(c)(2) only to the extent such 

earnings and profits (or deficit in 

earnings and profits) are effectively 

connected with the conduct of a trade 

or business within the United States (or 

are attributable to a permanent 

establishment in the United States, in 

the context of an applicable United 

States income tax treaty). All other 

earnings and profits (or deficit in 

earnings and profits) of the foreign 

acquired corporation shall not carry 

over to the domestic acquiring 

corporation and, as a result, shall be 

eliminated. 

(2) Previously taxed earnings and 

profits. [Reserved] 

■ Par. 6. In § 1.367(b)–6, paragraph 

(a)(1) is revised to read as follows: 

§ 1.367(b)–6 Effective dates and 

coordination rules. 

(a) Effective date—(1) In general. 

Sections 1.367(b)–1 through 1.367(b)–3, 

and this section, apply to section 367(b) 

exchanges that occur on or after 

November 6, 2006. For guidance with 

respect to section 367(b) exchanges that 

occur prior to November 6, 2006, see 

§§ 1.367(b)–1 through 1.367(b)–6 in 

effect prior to November 6, 2006 (see 26 

CFR part 1 revised as of April 1, 2006). 

* * * * * 

■ Par. 7. Section 1.367(b)–7 is added to 

read as follows: 

§ 1.367(b)–7 Carryover of earnings and 

profits and foreign income taxes in certain 

foreign-to-foreign nonrecognition 

transactions. 

(a) Scope. This section applies to an 

acquisition by a foreign corporation 

(foreign acquiring corporation) of the 

assets of another foreign corporation 

(foreign target corporation) in a 

transaction described in section 381 

(foreign section 381 transaction). This 

section describes the manner and extent 

to which earnings and profits and 

foreign income taxes of the foreign 

acquiring corporation and the foreign 

target corporation carry over to the 

surviving foreign corporation (foreign 

surviving corporation) and the ordering 

of distributions by the foreign surviving 

corporation. See § 1.367(b)–9 for special 

rules governing reorganizations 

described in section 368(a)(1)(F) and 

foreign section 381 transactions 

involving foreign corporations that hold 

no property and have no tax attributes 

immediately before the transaction, 

other than a nominal amount of assets 

(and related tax attributes). 

(b) General rules—(1) Non-previously 

taxed earnings and profits and related 

taxes. Earnings and profits and related 

foreign income taxes of the foreign 

acquiring corporation and the foreign 

target corporation (pre-transaction 

earnings and pre-transaction taxes, 

respectively) shall carry over to the 

foreign surviving corporation in the 

manner described in paragraphs (d), (e), 

and (f) of this section. Dividend 

distributions by the foreign surviving 

corporation (post-transaction 

distributions) shall be out of earnings 

and profits and shall reduce related 

foreign income taxes in the manner 

described in paragraph (c) of this 

section. 

(2) Previously taxed earnings and 

profits. [Reserved] 

(c) Ordering rule for post-transaction 

distributions. Dividend distributions out 


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of a foreign surviving corporation’s 

earnings and profits shall be ordered in 

accordance with the rules of paragraph 

(c)(1) or (2) of this section, depending 

on whether the foreign surviving 

corporation is a pooling corporation or 

a nonpooling corporation. 

(1) If foreign surviving corporation is 

a pooling corporation. In the case of a 

foreign surviving corporation that is a 

pooling corporation, post-transaction 

distributions shall be first out of the 

post-1986 pool (as described in 

paragraph (d) of this section) and 

second out of the pre-pooling annual 

layers (as described in paragraph (e)(1) 

of this section) under an annual last-in, 

first-out (LIFO) method. 

(2) If foreign surviving corporation is 

a nonpooling corporation. In the case of 

a foreign surviving corporation that is a 

nonpooling corporation, posttransaction distributions shall be out of 

the pre-pooling annual layers (as 

described in paragraph (e)(2) of this 

section) under the LIFO method. 

(d) Post-1986 pool. If the foreign 

surviving corporation is a pooling 

corporation, then the post-1986 pool 

shall be determined under the rules of 

this paragraph (d). 

(1) In general—(i) Qualifying earnings 

and taxes. The post-1986 pool shall 

consist of the post-1986 undistributed 

earnings and related post-1986 foreign 

income taxes of the foreign acquiring 

corporation and the foreign target 

corporation. 

(ii) Carryover rule. Subject to 

paragraph (d)(2) of this section, the 

amounts described in paragraph (d)(1)(i) 

of this section attributable to the foreign 

acquiring corporation and the foreign 

target corporation shall carry over to the 

foreign surviving corporation and shall 

be combined on a separate category-byseparate category basis. 

(2) Hovering deficit—(i) In general. If 

immediately prior to the foreign section 

381 transaction either the foreign 

acquiring corporation or the foreign 

target corporation has a deficit in one or 

more separate categories of post-1986 

undistributed earnings or an aggregate 

deficit in pre-1987 accumulated profits, 

such deficit will be a hovering deficit of 

the foreign surviving corporation. The 

rules of this paragraph (d)(2) apply to 

hovering deficits in separate categories 

of post-1986 undistributed earnings. See 

paragraphs (e)(1)(iii) and (e)(2)(iii) of 

this section for rules that apply to 

hovering deficits in pre-1987 

accumulated profits. If the foreign 

acquiring corporation and the foreign 

target corporation each have a post-1986 

hovering deficit in the same separate 

category of post-1986 undistributed 

earnings, such deficits and their related 

post-1986 foreign income taxes shall be 

combined for purposes of applying this 

paragraph (d)(2). See also paragraphs 

(f)(1) and (4) of this section (describing 

other rules applicable to a deficit 

described in this paragraph (d)(2)). 

(ii) Offset rule. A hovering deficit in 

a separate category of post-1986 

undistributed earnings shall offset only 

earnings and profits accumulated by the 

foreign surviving corporation after the 

foreign section 381 transaction (posttransaction earnings) in the same 

separate category of post-1986 

undistributed earnings. For purposes of 

this rule, however, post-transaction 

earnings do not include post-1986 

undistributed earnings in the same 

category that are earned after the foreign 

section 381 transaction, but are 

distributed or deemed distributed in the 

same year they are earned (that is, that 

do not become accumulated). The offset 

shall occur as of the first day of the 

foreign surviving corporation’s first 

taxable year following the year in which 

the post-transaction earnings 

accumulated. 

(iii) Related taxes. Post-1986 foreign 

income taxes that are related to a 

hovering deficit in a separate category of 

post-1986 undistributed earnings shall 

only be added to the foreign surviving 

corporation’s post-1986 foreign income 

taxes in that separate category on a pro 

rata basis as the hovering deficit is 

absorbed. Pro rata means in the same 

proportion as the portion of the 

hovering deficit that offsets posttransaction earnings in the separate 

category under paragraph (d)(2)(ii) of 

this section bears to the total amount of 

the hovering deficit. 

(3) Examples. The following examples 

illustrate the rules of this paragraph (d). 

The examples assume the following 

facts: Foreign corporations A and B are 

controlled foreign corporations (CFCs) 

that were incorporated after December 

31, 1986, have always been pooling 

corporations, and have always had 

calendar taxable years. None of the 

shareholders of foreign corporations A 

and B are required to include any 

amount in income under § 1.367(b)–4 as 

a result of the foreign section 381 

transaction. Foreign corporations A and 

B (and all of their respective qualified 

business units as defined in section 989) 

maintain a ‘‘u’’ functional currency. 

Finally, unless otherwise stated, any 

post-1986 undistributed earnings in the 

passive category resulted from a lookthrough dividend that was paid by a 

lower-tier CFC out of earnings 

accumulated when the CFC was a 

noncontrolled section 902 corporation 

and that qualified for the subpart F 

same-country exception under section 

954(c)(3)(A). The examples are as 

follows: 

Example 1. (i) Facts. (A) On December 31, 

2006, foreign corporations A and B have the 

following post-1986 undistributed earnings 

and post-1986 foreign income taxes: 

Separate category E&P Foreign 

taxes 

Foreign Corporation A 

General ................. 300u $60 

Passive ................. 100u 40 

400u $100 

Foreign Corporation B 

General ................. 300u $70 

(B) On January 1, 2007, foreign corporation 

B acquires the assets of foreign corporation 

A in a reorganization described in section 

368(a)(1)(C). Immediately following the 

foreign section 381 transaction, foreign 

surviving corporation is a CFC. 

(ii) Result. Under the rules described in 

paragraph (d)(1) of this section, foreign 

surviving corporation has the following post1986 undistributed earnings and post-1986 

foreign income taxes: 

Separate category E&P Foreign 

taxes 

General ................. 600u $130 

Passive ................. 100u 40 

700u $170 

(iii) Post-transaction distribution. (A) 

During 2007, foreign surviving corporation 

does not accumulate any earnings and profits 

or pay or accrue any foreign income taxes. 

On December 31, 2007, foreign surviving 

corporation distributes 350u to its 

shareholders. Under the rules described in 

§ 1.902–1(d)(1) and paragraph (c)(1) of this 

section, the distribution is out of, and 

reduces, post–1986 undistributed earnings 

and post-1986 foreign income taxes in the 

separate categories on a pro rata basis, as 

follows: 

Separate category E&P Foreign 

taxes 

General ................. 300u $65 

Passive ................. 50u 20 

350u $85 

(B) The foreign income taxes deemed paid 

by qualifying shareholders of foreign 

surviving corporation upon the distribution 

are subject to generally applicable rules and 

limitations, such as those of sections 78, 902, 

and 904(d). 

(C) Immediately after the distribution, 

foreign surviving corporation has the 

following post-1986 undistributed earnings 

and post-1986 foreign income taxes: 


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Separate category E&P Foreign 

taxes 

General ................. 300u $65 

Passive ................. 50u 20 

350u $85 

Example 2. (i) Facts. (A) On December 31, 

2006, foreign corporations A and B have the 

following post-1986 undistributed earnings 

and post-1986 foreign income taxes: 

Separate category E&P Foreign 

taxes 

Foreign Corporation A 

General ................. 200u $30 

Passive ................. (100u) 10 

100u $40 

Foreign Corporation B 

General ................. 300u $60 

Passive ................. 100u 30 

Separate category E&P Foreign 

taxes 

400u $90 

(B) On January 1, 2007, foreign corporation 

B acquires the assets of foreign corporation 

A in a reorganization described in section 

368(a)(1)(C). Immediately following the 

foreign section 381 transaction, foreign 

surviving corporation is a CFC. 

(ii) Result. Under the rules described in 

paragraphs (d)(1) and (2) of this section, 

foreign surviving corporation has the 

following post-1986 undistributed earnings 

and post-1986 foreign income taxes: 

Separate category 

Earnings & profits Foreign taxes 

Positive 

E&P 

Hovering 

deficit 

Foreign 

taxes 

available 

Foreign 

taxes associated with 

hovering 

deficit 

General ............................................................................................................................ 500u .................... $ 90 ....................

Passive ............................................................................................................................ 100u (100u) 30 $10 

600u (100u) $120 $10 

(iii) Post-transaction distribution. (A) 

During 2007, foreign surviving corporation 

does not accumulate any earnings and profits 

or pay or accrue any foreign income taxes. 

On December 31, 2007, foreign surviving 

corporation distributes 300u to its 

shareholders. Under the rules described in 

§ 1.902–1(d)(1) and paragraph (c)(1) of this 

section, the distribution is out of, and 

reduces, post-1986 undistributed earnings 

and post-1986 foreign income taxes on a pro 

rata basis as follows: 

Separate category E&P Foreign 

taxes 

General ................. 250u $45 

Passive ................. 50u 15 

300u $60 

(B) The foreign income taxes deemed paid 

by qualifying shareholders of foreign 

surviving corporation upon the distribution 

are subject to generally applicable rules and 

limitations, such as those of sections 78, 902, 

and 904(d). 

(C) Immediately after the distribution, 

foreign surviving corporation has the 

following post-1986 undistributed earnings 

and post-1986 foreign income taxes: 

Separate category 

Earnings & profits Foreign taxes 

Positive 

E&P 

Hovering 

deficit 

Foreign 

taxes 

available 

Foreign 

taxes 

associated 

with hovering deficit 

General ............................................................................................................................ 250u .................... $45 ....................

Passive ............................................................................................................................ 50u (100u) 15 $10 

300u (100u) $60 $10 

(iv) Post-transaction earnings—(A) In its 

taxable year ending on December 31, 2008, 

foreign surviving corporation accumulates 

earnings and profits and pays related foreign 

income taxes as follows: 

Separate category E&P Foreign 

taxes 

General ............................................................................................................................................................................ 100u $20 

Passive ............................................................................................................................................................................ 50u $10 

150u $40 

(B) None of foreign surviving corporation’s 

earnings and profits for its 2008 taxable year 

qualifies as subpart F income as defined in 

section 952(a). Under the rules described in 

paragraphs (d)(2)(ii) and (iii) of this section, 

the hovering deficit in the passive category 

will offset the post-transaction earnings in 

that category and a proportionate amount of 

the foreign taxes related to the hovering 

deficit will be added to the post-1986 foreign 

income taxes pool. Because the posttransaction earnings in the passive category 

are half of the amount of the hovering deficit, 

half of the related taxes are added to the post1986 foreign income taxes pool. Accordingly, 

foreign surviving corporation has the 

following post-1986 undistributed earnings 


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and post-1986 foreign income taxes on 

January 1, 2009: 

Separate category 

Earnings & profits Foreign taxes 

Positive 

E&P 

Hovering 

deficit 

Foreign 

taxes 

available 

Foreign 

taxes 

associated 

with hovering deficit 

General ............................................................................................................................ 350u .................... $65 ....................

Passive ............................................................................................................................ 50u (50u) 30 $5 

400u (50u) $95 $5 

Example 3. (i) Facts. The facts are the same 

as Example 2, except that the 50u of earnings 

in the passive category accrued by foreign 

surviving corporation during 2008 is subpart 

F income, all of which is included in income 

under section 951(a) by United States 

shareholders (as defined in section 951(b)). 

This example assumes that none of the 

United States shareholders are able to reduce 

their subpart F income inclusion with a 

qualified deficit under section 952(c)(1)(B). 

(ii) Result. (A) Under the rule described in 

paragraph (f)(1) of this section, the (100u) 

hovering deficit in the passive category does 

not reduce foreign surviving corporation’s 

current passive earnings and profits for 

purposes of determining subpart F income or 

associated deemed paid credits. Thus, foreign 

surviving corporation’s United States 

shareholders include their pro rata shares of 

50u in taxable income for the year and are 

eligible for a deemed paid foreign tax credit 

under section 960, computed by reference to 

their pro rata shares of $12.50 (50u subpart 

F inclusion / (50u + 50u post-1986 

undistributed earnings in the passive 

category = 100u) = 50%, × $25 post-1986 

foreign income taxes in the passive category 

= $12.50). The United States shareholders 

will also include their pro rata shares of the 

deemed-paid taxes of $12.50 in taxable 

income for the year as a deemed dividend 

pursuant to section 78. 

(B) Immediately after the subpart F 

inclusion and section 960 deemed paid taxes 

(and taking into account the taxable year 

2008 earnings and profits and related taxes 

in the general category), foreign surviving 

corporation has the following post-1986 

undistributed earnings and post-1986 foreign 

income taxes: 

Separate category 

Earnings & profits 

Foreign 

taxes 

available 

Foreign 

taxes 

Positive 

E&P 

Hovering 

deficit 

Foreign 

taxes 

associated 

with hovering deficit 

General ............................................................................................................................ 350u .................... $65.00 ....................

Passive ............................................................................................................................ 50u (100u) 12.50 $10 

400u (100u) 77.50 10 

(C) The 50u included as subpart F income 

constitutes previously taxed earnings and 

profits under section 959. 

Example 4. (i) Facts. (A) On December 31, 

2006, foreign corporations A and B have the 

following post-1986 undistributed earnings 

and post-1986 foreign income taxes: 

Separate category E&P Foreign 

taxes 

Foreign Corporation A 

General ................. 50u $10 

Foreign Corporation B 

General ................. (100u) $20 

(B) On January 1, 2007, foreign corporation 

B acquires the assets of foreign corporation 

A in a reorganization described in section 

368(a)(1)(C). Immediately following the 

foreign section 381 transaction, foreign 

surviving corporation is a CFC. 

(ii) Result. (A) Under the rules described in 

paragraphs (d)(1) and (2) of this section, 

foreign surviving corporation has the 

following post-1986 undistributed earnings 

and post-1986 foreign income taxes: 

Separate category 

Earnings & profits 

Foreign 

taxes 

available 

Foreign 

taxes 

Positive 

E&P 

Hovering 

deficit 

Foreign 

taxes 

associated 

with hovering deficit 

General ............................................................................................................................ 50u (100u) $10 $20 

(iii) Post-transaction earnings and 

distribution. (A) In its taxable year ending on 

December 31, 2007, foreign surviving 

corporation earns 100u in the general 

category and pays related foreign income 

taxes of $24. On December 31, 2007, foreign 

surviving corporation distributes 75u to its 

shareholders. 

(B) Result. For purposes of determining the 

dividend amount under section 316 and the 

foreign income taxes deemed paid with 

respect to that dividend under section 902, 

under paragraph (d)(2)(ii) of this section the 

hovering deficit does not offset the posttransaction current year earnings. 


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Accordingly, the full 75u will be a dividend 

under section 316. The deemed paid taxes on 

that dividend are $17 (75u distribution / 

(100u current earnings + 50u accumulated 

earnings) = 50%, × ($10 accumulated foreign 

taxes + $24 current year foreign taxes) = $17). 

The 25u of undistributed earnings and profits 

in 2007 will be offset by (25u) of the hovering 

deficit for purposes of determining the 

opening balance of the post-1986 

undistributed earnings pool in 2008. Because 

the amount of earnings offset by the hovering 

deficit is 25% of the amount of the hovering 

deficit, under paragraph (d)(2)(iii) of this 

section $5 (25% of $20) of the related taxes 

are added to the post-1986 foreign income 

taxes pool at the beginning of the next 

taxable year. Accordingly, foreign surviving 

corporation has the following post-1986 

undistributed earnings and post-1986 foreign 

income taxes on January 1, 2008: 

Separate category 

Earnings & profits Foreign taxes 

Positive 

E&P 

Hovering 

deficit 

Foreign 

taxes 

available 

Foreign 

taxes 

associated 

with hovering deficit 

General ............................................................................................................................ 50u (75u) $22 $15 

(e) Pre-pooling annual layers—(1) If 

foreign surviving corporation is a 

pooling corporation. If the foreign 

surviving corporation is a pooling 

corporation, the pre-pooling annual 

layers shall be determined under the 

rules of this paragraph (e)(1). 

(i) Qualifying earnings and taxes. The 

pre-pooling annual layers shall consist 

of the pre-1987 accumulated profits and 

the pre-1987 foreign income taxes of the 

foreign acquiring corporation and the 

foreign target corporation. 

(ii) Carryover rule. Subject to 

paragraph (e)(1)(iii) of this section, the 

amounts described in paragraph (e)(1)(i) 

of this section shall carry over to the 

foreign surviving corporation but shall 

not be combined. If the foreign 

acquiring corporation and the foreign 

target corporation have pre-1987 

accumulated profits in the same year 

and a distribution is made therefrom, 

the rules of § 1.902–1(b)(2)(ii) and (b)(3) 

shall apply separately to reduce pre1987 accumulated profits and pre-1987 

foreign income taxes of the foreign 

acquiring corporation and the foreign 

target corporation on a pro rata basis. 

For further guidance, see Rev. Rul. 68–

351 (1968–2 C.B. 307); Rev. Rul. 70–373 

(1970–2 C.B. 152) (see also 

§ 601.601(d)(2) of this chapter); see also 

paragraph (f)(2) of this section 

(governing the reconciliation of taxable 

years). 

(iii) Deficit—(A) In general. The rules 

of this paragraph (e)(1)(iii) apply when, 

immediately prior to the foreign section 

381 transaction, the foreign acquiring 

corporation or the foreign target 

corporation (or both) has a deficit in 

earnings and profits for one or more of 

the years that comprise its pre-1987 

accumulated profits (see also paragraphs 

(f)(1) and (4) of this section, describing 

other rules applicable to a deficit 

described in this paragraph (e)(1)(iii)). 

(B) Aggregate positive pre-1987 

accumulated profits. If the foreign 

acquiring corporation or the foreign 

target corporation (or both) has an 

aggregate positive (or zero) amount of 

pre-1987 accumulated profits, but a 

deficit in earnings and profits for one or 

more years, then the rules otherwise 

applicable to such deficits shall apply 

separately to the pre-1987 accumulated 

profits and related pre-1987 foreign 

income taxes of such corporation. A 

deficit in pre-1987 accumulated profits 

for one or more years is applied to 

reduce pre-1987 accumulated profits on 

a LIFO basis. Any remaining deficit 

shall be applied to reduce pre-1987 

accumulated profits in succeeding 

years. See Rev. Rul. 74–550 (1974–2 

C.B. 209) (see also § 601.601(d)(2) of this 

chapter); Champion Int’l Corp. v. 

Commissioner, 81 T.C. 424 (1983), acq. 

in result, 1987–2 C.B. 1; Rev. Rul. 87–

72 (1987–2 C.B. 170) (see also 

§ 601.601(d)(2) of this chapter). As a 

result, no amount in excess of the 

aggregate positive amount of pre-1987 

accumulated profits shall be distributed 

from the pre-transaction earnings of the 

foreign acquiring corporation or the 

foreign target corporation. 

(C) Aggregate deficit in pre-1987 

accumulated profits. If the foreign 

acquiring corporation or the foreign 

target corporation (or both) has an 

aggregate deficit in pre-1987 

accumulated profits, a hovering deficit 

as defined under paragraph (d)(2)(i) of 

this section, then the rules under 

§ 1.902–2(b) shall apply to such 

hovering deficit (and related pre-1987 

foreign income taxes) immediately prior 

to the transaction, except that the 

aggregate hovering deficit that is carried 

forward into the foreign surviving 

corporation’s post-1986 pool shall offset 

only post-transaction earnings 

accumulated by the foreign surviving 

corporation in the same separate 

category of post-1986 undistributed 

earnings to which the relevant portion 

of the hovering deficit is attributable. 

Post-transaction earnings do not include 

earnings and profits that are earned after 

the foreign section 381 transaction but 

distributed or deemed distributed in the 

same year they are earned. 

(D) Deficit and positive separate 

categories within annual layers. For 

purposes of applying the rules of 

paragraphs (e)(1)(iii)(B) and (C) of this 

section, if within a single pre-pooling 

annual layer, the foreign acquiring 

corporation or the foreign target 

corporation (or both) has a deficit in 

pre-1987 accumulated profits in a 

separate category and positive pre-1987 

accumulated profits in another separate 

category, the deficit shall first be used 

to offset the positive pre-1987 

accumulated profits in the other 

separate category in the same prepooling annual layer. Any remaining 

deficit shall be carried forward or back 

to other years according to the rules of 

paragraph (e)(1)(iii)(B) or (C) of this 

section as applicable. 

(iv) Pre-1987 section 960 earnings and 

profits and foreign income taxes. The 

pre-1987 section 960 earnings and 

profits and pre-1987 section 960 foreign 

income taxes of the foreign acquiring 

corporation and the foreign target 

corporation shall carry over to the 

foreign surviving corporation but shall 

not be combined. The rules otherwise 

applicable to such amounts shall apply 

separately to the pre-1987 section 960 

earnings and profits and pre-1987 

section 960 foreign income taxes of the 

foreign acquiring corporation and the 

foreign target corporation on a pro rata 

basis. For further guidance, see Notice 

88–70 (1988–2 C.B. 369) (see also 

§ 601.601(d)(2) of this chapter). 

(v) Examples. The following examples 

illustrate the rules of this paragraph 

(e)(1). The examples assume the 

following facts: Foreign corporation A 

was incorporated in 2003 and was a 

nonpooling corporation through 

December 31, 2004. Foreign corporation 

A became a CFC on January 1, 2005 and, 

as a result, began to maintain a pool of 

post-1986 undistributed earnings on 


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that date. Foreign corporation B was 

incorporated in 2003 and has always 

been owned by foreign shareholders 

(and thus never has met the 

requirements of section 902(c)(3)(B)). 

Both foreign corporation A and foreign 

corporation B have always had calendar 

taxable years. Foreign corporations A 

and B (and all of their respective 

qualified business units as defined in 

section 989) maintain a ‘‘u’’ functional 

currency. Finally, unless otherwise 

stated, all earnings and profits of foreign 

corporations A and B are in the general 

category. The examples are as follows: 

Example 1. (i) Facts. (A) On December 31, 

2006, foreign corporations A and B have the 

following earnings and profits and foreign 

income taxes: 

E&P Foreign 

taxes 

Foreign Corporation A: 

Post-1986 pool ................................................................................................................................................................. 1,000u $350 

2004 ................................................................................................................................................................................. 400u 160u 

2003 ................................................................................................................................................................................. 100u 5u 

1,500u 

Foreign Corporation B: 

2006 .............................................................................................................................................................................. 100u 20u 

2005 .............................................................................................................................................................................. 150u 30u 

2004 .............................................................................................................................................................................. 0u 50u 

2003 .............................................................................................................................................................................. 50u 5u 

300u 105u 

(B) On January 1, 2007, foreign corporation 

B acquires the assets of foreign corporation 

A in a reorganization described in section 

368(a)(1)(C). Immediately following the 

foreign section 381 transaction, foreign 

surviving corporation is a CFC. 

(ii) Result. Under the rules described in 

paragraphs (e)(1)(i) and (ii) of this section, 

foreign surviving corporation has the 

following earnings and profits and foreign 

income taxes: 

E&P Foreign 

taxes 

Post-1986 Pool .................................................................................................................................................................... 1,000u $350 

2006 ..................................................................................................................................................................................... 100u 20u 

2005 ..................................................................................................................................................................................... 150u 30u 

Two Side-by-Side Layers of 2004 E&P: 

2004 layer #1 (from Corp A) ........................................................................................................................................ 400u 160u 

2004 layer #2 (from Corp B) ........................................................................................................................................ 0u 50u 

Two Side-by-Side Layers of 2003 E&P: 

2003 layer #1 (from Corp A) ........................................................................................................................................ 100u 5u 

2003 layer #2 (from Corp B) ........................................................................................................................................ 50u 5u 

1,800u ..................

(iii) Post-transaction distribution. (A) 

During 2007, foreign surviving corporation 

does not accumulate any earnings and profits 

or pay or accrue any foreign income taxes. 

On December 31, 2007, foreign surviving 

corporation distributes 1,725u to its 

shareholders. Under the rules of paragraph 

(c)(1) of this section, the distribution is first 

out of the post-1986 pool, and then out of the 

pre-pooling annual layers under the LIFO 

method, as follows: 

E&P Foreign 

taxes 

Post-1986 pool ................................................................................................................................................................. 1,000u $350 

2006 ................................................................................................................................................................................. 100u 20u 

2005 ................................................................................................................................................................................. 150u 30u 

Two Side-by-Side Layers of 2004 E&P: 

2004 layer #1 ............................................................................................................................................................ 400u 160u 

2004 layer #2 ............................................................................................................................................................ 0u 0u 

Two Side-by-Side Layers of 2003 E&P: 

2003 layer #1 ............................................................................................................................................................ * 50u 2.5u 

2003 layer #2 ............................................................................................................................................................ ** 25u 2.5u 

1,725u 

* 100u in layer/150u aggregate 2003 earnings = 66.67% × 75u distribution. 

** 50u in layer/150u aggregate 2003 earnings = 33.33% × 75u distribution. 

(B) The foreign income taxes deemed paid 

by qualifying shareholders of foreign 

surviving corporation upon the distribution 

are subject to generally applicable rules and 

limitations, such as those of sections 78, 902, 

and 904(d). 

(C) Immediately after the distribution, 

foreign surviving corporation has the 

following earnings and profits and foreign 

income taxes: 


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E&P Foreign 

taxes 

2004 layer #2 ................................................................................................................................................................... 0u 50u 

Two Side-by-Side Layers of 2003 E&P: 

2003 layer #1 ............................................................................................................................................................ 50u 2.5u 

2003 layer #2 ............................................................................................................................................................ 25u 2.5u 

75u 55u 

(iv) Post-transaction earnings. For the 

taxable year ending on December 31, 2008, 

foreign surviving corporation has 500u of 

current earnings and profits in the general 

category, none of which qualify as subpart F 

income under section 952(a), and pays $70 in 

foreign income taxes. As of the close of the 

2008 taxable year, foreign surviving 

corporation has the following earnings and 

profits and foreign income taxes: 

E&P Foreign 

taxes 

Post-1986 pool ................................................................................................................................................................. 500u $70 

2004 ................................................................................................................................................................................. 0u 50u 

Two Side-by-Side Layers of 2003 E&P: 

2003 layer #1 ............................................................................................................................................................ 50u 2.5u 

2003 layer #2 ............................................................................................................................................................ 25u 2.5u 

575u 

Example 2. (i) Facts. (A) On December 31, 

2006, foreign corporations A and B have the 

following earnings and profits and foreign 

income taxes: 

E&P Foreign 

taxes 

Foreign Corporation A: 

Post-1986 pool ............................................................................................................................................................. 1,000u $350 

2004 .......................................................................................................................................................................... 100u 20u 

2003 .......................................................................................................................................................................... (50u) 5u 

1,050u 

Foreign Corporation B: 

2006 .......................................................................................................................................................................... 100u 20u 

2005 .......................................................................................................................................................................... (50u) 5u 

2004 .......................................................................................................................................................................... 0u 50u 

2003 .......................................................................................................................................................................... 100u 10u 

150u 85u 

(B) On January 1, 2007, foreign corporation 

B acquires the assets of foreign corporation 

A in a reorganization described in section 

368(a)(1)(C). Immediately following the 

foreign section 381 transaction, foreign 

surviving corporation is a CFC. 

(ii) Result. Because foreign corporations A 

and B have aggregate positive amounts of 

pre-1987 accumulated profits with a deficit 

in one or more years, the rules of paragraph 

(e)(1)(iii)(B) of this section apply. 

Accordingly, after the foreign section 381 

transaction, foreign surviving corporation has 

the following earnings and profits and 

foreign income taxes: 

Earnings & profits Foreign taxes 

Positive 

E&P Deficit E&P 

Foreign 

taxes 

available 

Foreign 

taxes 

assoicated 

with deficit 

E&P 

Post-1986 pool ................................................................................................................. 1,000u .................... $350 

2006 ................................................................................................................................. 100u .................... 20u 

2005 ................................................................................................................................. .................... (50u) .................... 5u 

Two Side-by-Side Layers of 2004 E&P: 

2004 layer #1 (from Corp A) .................................................................................... 100u .................... 20u 

2004 layer #2 (from Corp B) .................................................................................... 0u .................... 50u 

Two Side-by-Side Layers of 2003 E&P: 

2003 layer #1 (from Corp A) .................................................................................... .................... (50u) .................... 5u 

2003 layer #2 (from Corp B) .................................................................................... 100u .................... 10u 


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Earnings & profits Foreign taxes 

Positive 

E&P Deficit E&P 

Foreign 

taxes 

available 

Foreign 

taxes 

assoicated 

with deficit 

E&P 

1,300u (100u) .................... 10u 

(iii) Post-transaction distribution. (A) 

During 2007, foreign surviving corporation 

does not accumulate any earnings and profits 

or pay or accrue any foreign income taxes. 

On December 31, 2007, foreign surviving 

corporation distributes 1,175u to its 

shareholders. Under the rules described in 

paragraphs (c)(1) and (e)(1)(iii)(B) of this 

section, the distribution is first out of the 

post-1986 pool, and then out of the prepooling annual layers, as follows: 

Distribution E&P Foreign 

taxes 

Post-1986 pool ................................................................................................................................................................. 1,000u $350 

2006 ................................................................................................................................................................................. 100u 20u 

2005 ................................................................................................................................................................................. 0u 0u 

Two Side-by-Side Layers of 2004 E&P: 

2004 layer #1 ............................................................................................................................................................ 50u 20u 

2004 layer #2 ............................................................................................................................................................ 0u 0u 

Two Side-by-Side Layers of 2003 E&P: 

2003 layer #1 ............................................................................................................................................................ 0u 0u 

2003 layer #2 ............................................................................................................................................................ 25u 5u 

1,175u 

(B) Under paragraph (e)(1)(iii)(B) of this 

section, the rules otherwise applicable when 

a foreign corporation has an aggregate 

positive (or zero) amount of pre-1987 

accumulated profits, but a deficit in one or 

more years, apply separately to the pre-1987 

accumulated profits and related foreign 

income taxes of foreign corporation A and 

foreign corporation B. As a result, 

distributions out of the pre-pooling annual 

layers of foreign corporation A and foreign 

corporation B cannot exceed the aggregate 

positive amount of pre-1987 accumulated 

profits of each corporation. Accordingly, only 

50u can be distributed from foreign 

corporation A’s pre-pooling annual layers 

and is out of its 2004 layer #1 (after rolling 

forward the (50u) deficit in 2003 layer #1 to 

reduce earnings in 2004 layer #1 to 50u (100u 

¥50u)). Under the principles of § 1.902–

1(b)(3), the full 20u of taxes related to 2004 

layer #1 is reduced or deemed paid ($20 × 

(50/50)). 100u is distributed from foreign 

corporation B’s 2006 annual layer. Foreign 

corporation B’s (50u) deficit in 2005 is then 

rolled back to offset its 2003 annual layer to 

reduce earnings in that layer to 50u, 25u of 

which is distributed. Thus, after the 

distribution, 25u remains in 2003 layer # 2 

along with 5u of foreign income taxes (10u 

× (25u/50u)). 

(C) The foreign income taxes deemed paid 

by qualifying shareholders of foreign 

surviving corporation upon the distribution 

are subject to generally applicable rules and 

limitations, such as those of sections 78, 902, 

and 904(d). 

(D) Immediately after the distribution, 

foreign surviving corporation has the 

following earnings and profits and foreign 

income taxes: 

E&P Foreign 

taxes 

2005 ................................................................................................................................................................................. 0u 5u 

2004 layer #2 ................................................................................................................................................................... 0u 50u 

Two Side-by-Side Layers of 2003 E&P: 

2003 layer #1 ............................................................................................................................................................ 0u 5u 

2003 layer #2 ............................................................................................................................................................ 25u 5u 

25u 65u 

(E) Under paragraph (e)(1)(iii)(B) of this 

section, the 5u, 50u, and 5u of pre-1987 

foreign income taxes related to foreign 

surviving corporation’s 2005 layer, 2004 

layer #2, and 2003 layer #1, respectively, 

remain in those layers. These foreign income 

taxes generally will not be reduced or 

deemed paid unless a foreign tax refund 

restores a positive balance to the associated 

earnings pursuant to section 905(c), and thus 

will be trapped. See § 1.902–2(b)(2). 

Example 3. (i) Facts. (A) On December 31, 

2006, foreign corporations A and B have the 

following earnings and profits and foreign 

income taxes: 

E&P Foreign 

taxes 

Foreign Corporation A: 

Post-1986 pool ................................................................................................................................................................. 1,000u $350 

2004 .......................................................................................................................................................................... 150u 20u 

2003 .......................................................................................................................................................................... 100u 5u 

1,250u 


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E&P Foreign 

taxes 

Foreign Corporation B: 

2006 .......................................................................................................................................................................... 100u 20u 

2005 .......................................................................................................................................................................... (250u) 5u 

2004 .......................................................................................................................................................................... 0u 50u 

2003 .......................................................................................................................................................................... 100u 10u 

(50u) 85u 

(B) On January 1, 2007, foreign corporation 

B acquires the assets of foreign corporation 

A in a reorganization described in section 

368(a)(1)(C). Immediately following the 

foreign section 381 transaction, foreign 

surviving corporation is a CFC. 

(ii) Result. (A) Because foreign corporation 

B has an aggregate hovering deficit in pre1987 accumulated profits, the rules of 

paragraph (e)(1)(iii)(C) of this section apply. 

Accordingly, § 1.902–2(b) applies 

immediately prior to the foreign section 381 

transaction, except that the hovering deficit 

is carried forward into the foreign surviving 

corporation’s post-1986 undistributed 

earnings pool and will offset only posttransaction earnings accumulated by foreign 

surviving corporation in the general category. 

Accordingly, after the foreign section 381 

transaction, foreign surviving corporation has 

the following earnings and profits and 

foreign income taxes: 

Earnings & profits Foreign taxes 

Positive 

E&P 

Hovering 

deficit 

Foreign 

taxes 

available 

Foreign 

taxes 

assoicated 

with hovering deficit 

Post-1986 pool ................................................................................................................. 1,000u (50u) $350 $0 

2006 ................................................................................................................................. 0u .................... 20u 

2005 ................................................................................................................................. 0u .................... 5u 

Two Side-by-Side Layers of 2004 E&P: 

2004 layer #1 (from Corp A) .................................................................................... 150u .................... 20u 

2004 layer #2 (from Corp B) .................................................................................... 0u .................... 50u 

Two Side-by-Side Layers of 2003 E&P: 

2003 layer #1 (from Corp A) .................................................................................... 100u .................... 5u 

2003 layer #2 (from Corp B) .................................................................................... 0u .................... 10u 

1,250u (50u) .................... $0 

(B) Under paragraph (e)(1)(iii)(C) of this 

section, the 20u, 5u, 50u, and 10u of pre1987 foreign income taxes associated with 

foreign corporation B’s pre-1987 accumulated 

profits for 2006, 2005, 2004 layer #2, and 

2003 layer #2, respectively, remain in those 

layers. These foreign income taxes generally 

will not be reduced or deemed paid unless 

a foreign tax refund restores a positive 

balance to the associated earnings pursuant 

to section 905(c), and thus will be trapped. 

See § 1.902–2(b)(2). 

(2) If foreign surviving corporation is 

a nonpooling corporation. If the foreign 

surviving corporation is a nonpooling 

corporation, then the pre-pooling 

annual layers shall be determined under 

the rules of this paragraph (e)(2). 

(i) Qualifying earnings and taxes. The 

pre-pooling annual layers shall consist 

of the pre-1987 accumulated profits and 

the pre-1987 foreign income taxes of the 

foreign acquiring corporation and the 

foreign target corporation. If the foreign 

acquiring corporation or the foreign 

target corporation (or both) has post1986 undistributed earnings or a deficit 

in post-1986 undistributed earnings, 

then those earnings or deficits and any 

related post-1986 foreign income taxes 

shall be recharacterized as pre-1987 

accumulated profits or deficits and pre1987 foreign income taxes of the foreign 

acquiring corporation or the foreign 

target corporation accumulated 

immediately prior to the foreign section 

381 transaction. 

(ii) Carryover rule. Subject to 

paragraph (e)(2)(iii) of this section, the 

amounts described in paragraph (e)(2)(i) 

of this section shall carry over to the 

foreign surviving corporation but shall 

not be combined. If the foreign 

acquiring corporation and the foreign 

target corporation have pre-1987 

accumulated profits in the same year 

and a distribution is made therefrom, 

the principles of § 1.902–1(b)(2)(ii) and 

(3) shall apply separately to reduce pre1987 accumulated profits and pre-1987 

foreign income taxes of the foreign 

acquiring corporation and the foreign 

target corporation on a pro rata basis. 

For further guidance, see Rev. Rul. 68–

351 (1968–2 C.B. 307); Rev. Rul. 70–373 

(1970–2 C.B. 152) (see also 

§ 601.601(d)(2) of this chapter); see also 

paragraph (f)(2) of this section 

(governing the reconciliation of taxable 

years). 

(iii) Deficits—(A) In general. The rules 

of this paragraph (e)(2)(iii) apply when, 

immediately prior to the foreign section 

381 transaction (and after application of 

the last sentence of paragraph (e)(2)(i) of 

this section), the foreign acquiring 

corporation or the foreign target 

corporation (or both) has a deficit in one 

or more years that comprise its pre-1987 

accumulated profits. See also 

paragraphs (f)(1) and (4) of this section 

(describing other rules applicable to a 

deficit described in this paragraph 

(e)(2)(iii)). 

(B) Aggregate positive pre-1987 

accumulated profits. If the foreign 

acquiring corporation or the foreign 

target corporation (or both) has an 

aggregate positive (or zero) amount of 

pre-1987 accumulated profits, but a 

deficit in pre-1987 accumulated profits 

in one or more years, then the rules 

otherwise applicable to such deficits 

shall apply separately to the pre-1987 

accumulated profits and related foreign 

income taxes of such corporation. A 

deficit in pre-1987 accumulated profits 

for one or more years is applied to 

reduce pre-1987 accumulated profits on 

a LIFO basis. Any remaining deficit 


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shall be applied to reduce pre-1987 

accumulated profits in succeeding 

years. See Rev. Rul. 74–550 (1974–2 

C.B. 209) (see also § 601.601(d)(2) of this 

chapter); Champion Int’l Corp. v. 

Commissioner, 81 T.C. 424 (1983), acq. 

in result, 1987–2 C.B. 1; Rev. Rul. 87–

72 (1987–2 C.B. 170) (see also 

§ 601.601(d)(2) of this chapter). As a 

result, no amount in excess of the 

aggregate positive amount of pre-1987 

accumulated profits shall be distributed 

from the pre-transaction earnings of the 

foreign acquiring corporation or the 

foreign target corporation. 

(C) Aggregate deficit in pre-1987 

accumulated profits. If the foreign 

acquiring corporation or the foreign 

target corporation (or both) has an 

aggregate deficit in pre-1987 

accumulated profits, a hovering deficit 

as defined under paragraph (d)(2)(i) of 

this section, then the rules otherwise 

applicable to such hovering deficits 

shall apply separately to the pretransaction earnings and profits and 

related taxes of the relevant corporation. 

See, e.g., sections 316(a) and 

381(c)(2)(B). Thus, any hovering deficit 

shall offset only post-transaction 

earnings accumulated by the foreign 

surviving corporation in the same 

separate category of earnings and profits 

to which the relevant portion of the 

hovering deficit is attributable. Posttransaction earnings do not include 

earnings and profits that are earned after 

the foreign section 381 transaction but 

distributed or deemed distributed in the 

same year they are earned. Following 

the principles of § 1.902–2(b), if there is 

an aggregate deficit in pre-1987 

accumulated profits, any related pre1987 foreign income taxes generally will 

not be reduced or deemed paid unless 

a foreign tax refund restores a positive 

balance to the associated earnings 

pursuant to section 905(c), and creates 

a pre-transaction aggregate positive 

balance for pre-1987 accumulated 

profits. 

(D) Deficit and positive separate 

categories within annual layers. For 

purposes of applying the rules of 

paragraphs (e)(2)(iii)(B) and (C) of this 

section, if within a single pre-pooling 

annual layer, the foreign acquiring 

corporation or the foreign target 

corporation (or both) has a deficit in 

pre-1987 accumulated profits in a 

separate category and positive pre-1987 

accumulated profits in another separate 

category, the deficit shall first be used 

to offset the positive pre-1987 

accumulated profits in the other 

separate category in the same prepooling annual layer. Any remaining 

deficit shall be carried forward or back 

to other years according to the rules of 

paragraph (e)(2)(iii)(B) or (C) as 

applicable. 

(iv) Pre-1987 section 960 earnings and 

profits and foreign income taxes. The 

pre-1987 section 960 earnings and 

profits and pre-1987 section 960 foreign 

income taxes of the foreign acquiring 

corporation and the foreign target 

corporation shall carry over to the 

foreign surviving corporation but shall 

not be combined. The rules otherwise 

applicable to such amounts shall apply 

separately to the pre-1987 section 960 

earnings and profits and pre-1987 

section 960 foreign income taxes of the 

foreign acquiring corporation and the 

foreign target corporation on a pro rata 

basis. For further guidance, see Notice 

88–70 (1988–2 C.B. 369) (see also 

§ 601.601(d)(2) of this chapter). 

(v) Examples. The following examples 

illustrate the rules of this paragraph 

(e)(2). The examples assume the 

following facts: Both foreign corporation 

A and foreign corporation B have 

always had calendar taxable years. 

Foreign corporations A and B (and all of 

their respective qualified business units 

as defined in section 989) maintain a 

‘‘u’’ functional currency, and 1u = US$1 

at all times. Finally, unless otherwise 

stated, all earnings and profits of foreign 

corporations A and B are in the general 

category. The examples are as follows: 

Example 1. (i) Facts. (A) Foreign 

corporations A and B both were incorporated 

in 2003. Nine percent of the voting stock of 

foreign corporation A is owned by domestic 

corporate shareholder C. Nine percent of the 

voting stock of foreign corporation B is 

owned by domestic corporate shareholder D. 

Shareholders C and D are unrelated. The 

remaining 91% of the voting stock of each 

foreign corporation is owned by unrelated 

foreign shareholders. Thus, neither 

corporation meets the requirements of 

section 902(c)(3)(B). On December 31, 2006, 

foreign corporations A and B have the 

following earnings and profits and foreign 

income taxes: 

E&P Foreign 

taxes 

Foreign Corporation A: 

2006 .......................................................................................................................................................................... 500u 350u 

2005 .......................................................................................................................................................................... 400u 300u 

2004 .......................................................................................................................................................................... 400u 160u 

2003 .......................................................................................................................................................................... 100u 5u 

1,400u 815u 

Foreign Corporation B: 

2006 .......................................................................................................................................................................... 100u 20u 

2005 .......................................................................................................................................................................... 300u 60u 

2004 .......................................................................................................................................................................... 0u 50u 

2003 .......................................................................................................................................................................... 50u 5u 

450u 135u 

(B) On January 1, 2007, foreign corporation 

B acquires the assets of foreign corporation 

A in a reorganization described in section 

368(a)(1)(C). Immediately following the 

foreign section 381 transaction, foreign 

surviving corporation is a nonpooling 

corporation that does not meet the 

requirements of section 902(c)(3)(B). 

(ii) Result. Under the rules described in 

paragraphs (e)(2)(i) and (ii) of this section, 

foreign surviving corporation has the 

following earnings and profits and foreign 

income taxes: 

E&P Foreign 

taxes 

Two Side-by-Side Layers of 2006 E&P: 


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E&P Foreign 

taxes 

2006 layer #1 (from Corp A) .................................................................................................................................... 500u 350u 

2006 layer #2 (from Corp B) .................................................................................................................................... 100u 20u 

Two Side-by-Side Layers of 2005 E&P: 

2005 layer #1 (from Corp A) .................................................................................................................................... 400u 300u 

2005 layer #2 (from Corp B) .................................................................................................................................... 300u 60u 

Two Side-by-Side Layers of 2004 E&P: 

2004 layer #1 (from Corp A) .................................................................................................................................... 400u 160u 

2004 layer #2 (from Corp B) .................................................................................................................................... 0u 50u 

Two Side-by-Side Layers of 2003 E&P: 

2003 layer #1 (from Corp A) .................................................................................................................................... 100u 5u 

2003 layer #2 (from Corp B) .................................................................................................................................... 50u 5u 

1,850u 950u 

(iii) Post-transaction distribution. (A) 

During 2007, foreign surviving corporation 

does not accumulate any earnings and profits 

or pay or accrue any foreign income taxes. 

On December 31, 2007, foreign surviving 

corporation distributes 600u to its 

shareholders. Under the rules of paragraph 

(c)(3) of this section, the distribution is out 

of pre-pooling annual layers under the LIFO 

method as follows: 

E&P Foreign 

taxes 

Two Side-by-Side Layers of 2006 E&P: 

2006 layer #1 (from Corp A) .................................................................................................................................... 500u 350u 

2006 layer #2 (from Corp B) .................................................................................................................................... 100u 20u 

600u 370u 

(B) Foreign surviving corporation’s foreign 

income tax accounts are reduced to reflect 

the distribution of earnings and profits 

notwithstanding that no shareholders are 

eligible to claim deemed paid foreign income 

taxes under section 902. See § 1.902–

1(a)(10)(iii). 

(C) Immediately after the distribution, 

foreign surviving corporation has the 

following earnings and profits and foreign 

income taxes: 

E&P Foreign 

taxes 

Two Side-by-Side Layers of 2005 E&P: 

2005 layer #1 (from Corp A) .................................................................................................................................... 400u 300u 

2005 layer #2 (from Corp B) .................................................................................................................................... 300u 60u 

Two Side-by-Side Layers of 2004 E&P: 

2004 layer #1 (from Corp A) .................................................................................................................................... 400u 160u 

2004 layer #2 (from Corp B) .................................................................................................................................... 0u 50u 

Two Side-by-Side Layers of 2003 E&P: 

2003 layer #1 (from Corp A) .................................................................................................................................... 100u 5u 

2003 layer #2 (from Corp B) .................................................................................................................................... 50u 5u 

1,250u 580u 

Example 2. (i) Facts. (A) The facts are the 

same as in Example 1 (i)(A), except that 

foreign corporation A met the requirements 

of section 902(c)(3)(B) on January 1, 2005, 

when U.S. corporate shareholder C acquired 

an additional 1% of voting stock for a total 

ownership interest of 10%; foreign 

corporation A thereby became a pooling 

corporation. On December 31, 2006, foreign 

corporations A and B have the following 

earnings and profits and foreign income 

taxes: 

E&P Foreign 

taxes 

Foreign Corporation A: 

Post-1986 pool ......................................................................................................................................................... 900u $650 

2004 .......................................................................................................................................................................... 400u 160u 

2003 .......................................................................................................................................................................... 100u 5u 

1,400u ....................

Foreign Corporation B: 

2006 .......................................................................................................................................................................... 100u 20u 

2005 .......................................................................................................................................................................... 300u 60u 


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E&P Foreign 

taxes 

2004 .......................................................................................................................................................................... 0u 50u 

2003 .......................................................................................................................................................................... 50u 5u 

450u 135u 

(B) On January 1, 2007, foreign corporation 

B acquires the assets of foreign corporation 

A in a reorganization described in section 

368(a)(1)(C). Immediately following the 

foreign section 381 transaction, foreign 

surviving corporation is a nonpooling 

corporation that does not meet the 

requirements of section 902(c)(3)(B). 

(ii) Result. Under the rules described in 

paragraphs (e)(2)(i) and (ii) of this section, 

foreign surviving corporation has the 

following earnings and profits and foreign 

income taxes: 

E&P Foreign 

taxes 

Two Side-by-Side Layers of 2006 E&P: 

2006 layer #1 (from Corp A’s pool) .......................................................................................................................... 900u $650 

2006 layer #2 (from Corp B’s layer) ......................................................................................................................... 100u 20u 

2005 (from Corp B): ................................................................................................................................................. 300u 60u 

Two Side-by-Side Layers of 2004 E&P: 

2004 layer #1 (from Corp A) .................................................................................................................................... 400u 160u 

2004 layer #2 (from Corp B) .................................................................................................................................... 0u 50u 

Two Side-by-Side Layers of 2003 E&P: 

2003 layer #1 (from Corp A) .................................................................................................................................... 100u 5u 

2003 layer #2 (from Corp B) .................................................................................................................................... 50u 5u 

1,850u 

(iii) Subsequent ownership change. On July 

1, 2010, USS (a domestic corporation) 

acquires 100% of the stock of foreign 

surviving corporation. Under the rules of 

paragraph (f)(3) of this section, foreign 

surviving corporation begins to pool its 

earnings and profits under section 902(c)(3) 

as of January 1, 2010. Foreign surviving 

corporation’s earnings and profits and foreign 

income taxes accrued before January 1, 2010 

retain their character as pre-1987 

accumulated profits and pre-1987 foreign 

income taxes. 

Example 3. (i) Facts. (A) The facts are the 

same as in Example 2(i)(A), except that on 

December 31, 2006, foreign corporations A 

and B have the following earnings and profits 

and foreign income taxes: 

E&P Foreign 

Taxes 

Foreign Corporation A: 

Post-1986 pool ......................................................................................................................................................... 1,000u $500 

2004 .......................................................................................................................................................................... (200u) 10u 

2003 .......................................................................................................................................................................... 400u 5u 

1,200u 

Foreign Corporation B 

2006 .......................................................................................................................................................................... 300u 20u 

2005 .......................................................................................................................................................................... (100u) 60u 

2004 .......................................................................................................................................................................... 0u 50u 

2003 .......................................................................................................................................................................... 50u 5u 

250u 135u 

(B) On January 1, 2007, foreign corporation 

B acquires the assets of foreign corporation 

A in a reorganization described in section 

368(a)(1)(C). Immediately following the 

foreign section 381 transaction, foreign 

surviving corporation is a nonpooling 

corporation that does not meet the 

requirements of section 902(c)(3)(B). 

(ii) Result. Because foreign corporations A 

and B have aggregate positive amounts of 

pre-1987 accumulated profits with a deficit 

in one or more years, the rules of paragraph 

(e)(2)(iii)(B) of this section apply. 

Accordingly, after the foreign section 381 

transaction, foreign surviving corporation has 

the following earnings and profits and 

foreign income taxes: 

Earnings & profits Foreign taxes 

Positive 

E&P Deficit E&P 

Foreign 

taxes 

available 

Foreign 

taxes associated with 

deficit E&P 

Two Side-by-Side Layers of 2006 E&P: 

2006 layer #1 (from Corp A’s pool) .......................................................................... 1,000u .................... $500 


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Earnings & profits Foreign taxes 

Positive 

E&P Deficit E&P 

Foreign 

taxes 

available 

Foreign 

taxes associated with 

deficit E&P 

2006 layer #2 (from Corp B’s layer) ......................................................................... 300u .................... 20u 

2005 (from Corp B) .................................................................................................. .................... (100u) .................... 60u 

Two Side-by-Side Layers of 2004 E&P: 

2004 layer #1 (from Corp A) .................................................................................... .................... (200u) .................... 10u 

2004 layer #2 (from Corp B) .................................................................................... 0u .................... 50u 

Two Side-by-Side Layers of 2003 E&P: 

2003 layer #1 (from Corp A) .................................................................................... 400u .................... 5u 

2003 layer #2 (from Corp B) .................................................................................... 50u .................... 5u 

1,750u (300u) .................... 70u 

(iii) Post-transaction distribution. (A) 

During 2007, foreign surviving corporation 

does not accumulate any earnings and profits 

or pay or accrue any foreign income taxes. 

On December 31, 2007, foreign surviving 

corporation distributes 1,300u to its 

shareholders. Under the rules described in 

paragraphs (c)(3) and (e)(2)(iii)(B) of this 

section, the distribution is out of the prepooling annual layers, as follows: 

E&P Foreign taxes 

Two Side-by-Side Layers of 2006 E&P: 

2006 layer #1 ............................................................................ 1,000u $500 

2006 layer #2 ............................................................................ 250u 20u 

2003 E&P: 

2003 layer #1 ............................................................................ 50u 1.25u (25% of 5u taxes) 

1,300u 

(B) Under paragraph (e)(2)(iii)(B) of this 

section, the rules otherwise applicable when 

a foreign corporation has an aggregate 

positive (or zero) amount of pre-1987 

accumulated profits, but a deficit in one or 

more years, apply separately to the pre-1987 

accumulated profits and related pre-1987 

foreign income taxes of foreign corporation A 

and foreign corporation B. As a result, 

distributions out of the pre-pooling annual 

layers of foreign corporation A and foreign 

corporation B cannot exceed the aggregate 

positive amount of pre-1987 accumulated 

profits of each corporation. Accordingly, only 

1,200u and 250u can be distributed out of 

foreign corporation A’s and foreign 

corporation B’s pre-pooling annual layers, 

respectively. Thus, 1,000u of the distribution 

is out of foreign corporation A’s 2006 layer 

#1 and 250u is out of foreign corporation B’s 

2006 layer #2 (after rolling forward (50u) of 

the deficit in 2005 layer to reduce earnings 

in 2006 layer #1 to 250u (300u¥50u)). Under 

the principles of § 1.902–1(b)(3), all of the 

taxes in each of those respective layers are 

reduced. The remaining 50u is distributed 

from foreign corporation A’s 2003 layer #1 

(after rolling back the (200u) deficit in 2004 

layer #1 to reduce earnings in 2003 layer #1 

to 200u (400u¥200u)). Thus, after the 

distribution, 150u remains in the 2003 layer 

#1 along with 3.75u of foreign income taxes 

(5u × (150u/200u)). 

(C) Foreign surviving corporation’s foreign 

income tax accounts are reduced to reflect 

the distribution of earnings and profits 

notwithstanding that no shareholders are 

eligible to claim a credit for deemed paid 

foreign income taxes under section 902. See 

§ 1.902–1(a)(10)(iii). 

(D) Immediately after the distribution, 

foreign surviving corporation has the 

following earnings and profits and foreign 

income taxes: 

E&P Foreign 

taxes 

2005 ................................................................................................................................................................................. 0u 60u 

Two Side-by-Side Layers of 2004 E&P: 

2004 layer #1 ............................................................................................................................................................ 0u 10u 

2004 layer #2 ............................................................................................................................................................ 0u 50u 

Two Side-by-Side Layers of 2003 E&P: 

2003 layer #1 ............................................................................................................................................................ 150u 3.75u 

2003 layer #2 ............................................................................................................................................................ 0u 5u 

150u 128.75u 

(E) Under paragraph (e)(2)(iii)(B) of 

this section, the 60u, 10u, 50u, and 5u 

of foreign income taxes related to 

foreign surviving corporation’s 2005 

layer, 2004 layer #1, 2004 layer #2, and 

2003 layer #2, respectively, remain in 

those layers. These foreign income taxes 

generally will not be reduced or deemed 

paid unless a foreign tax refund restores 

a positive balance to the associated 

earnings pursuant to section 905(c), and 

thus will be trapped. See § 1.902–

2(b)(2). 

Example 4. (i) Facts. (A) The facts are the 

same as in Example 2 (i)(A), except that on 

December 31, 2006, foreign corporations A 

and B have the following earnings and profits 

and foreign income taxes: 


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E&P Foreign 

Taxes 

Foreign Corporation A: 

Post-1986 pool ......................................................................................................................................................... (1,000u) $20 

2004 .......................................................................................................................................................................... (200u) 10u 

2003 .......................................................................................................................................................................... 400u 5u 

(800u) 

Foreign Corporation B: 

2006 .......................................................................................................................................................................... 100u 20u 

2005 .......................................................................................................................................................................... 300u 60u 

2004 .......................................................................................................................................................................... 0u 50u 

2003 .......................................................................................................................................................................... 50u 5u 

450u 135u 

(B) On January 1, 2007, foreign corporation 

A acquires the assets of foreign corporation 

B in a reorganization described in section 

368(a)(1)(C). Immediately following the 

foreign section 381 transaction, foreign 

surviving corporation is a nonpooling 

corporation. 

(ii) Result. (A) Under paragraph (e)(2)(i) of 

this section, foreign corporation A’s post1986 pool is recharacterized as a 2006 layer 

of pre-1987 accumulated profits. Because 

after the foreign section 381 transaction 

foreign corporation A has an aggregate deficit 

in pre-1987 accumulated profits, the rules of 

paragraph (e)(2)(iii)(C) of this section apply 

and the rules otherwise applicable apply 

separately to the pre-1987 accumulated 

profits that carry over to foreign surviving 

corporation from foreign corporation A. The 

(800u) aggregate deficit in foreign corporation 

A’s pre-1987 accumulated profits is a 

hovering deficit that will offset only posttransaction earnings accumulated by foreign 

surviving corporation in the general category. 

Accordingly, after the foreign section 381 

transaction, foreign surviving corporation has 

the following earnings and profits and 

foreign income taxes: 

Earnings & profits Foreign taxes 

Positive 

E&P Deficit E&P 

Foreign 

taxes 

available 

Foreign 

taxes 

associated 

deficit E&P 

Hovering deficit from Corp A’s annual layers .................................................................. .................... (800u) .................... 0 

Two Side-by-Side Layers of 2006 E&P: 

2006 layer #1 (from Corp A’s pool) .......................................................................... .................... 0u .................... $20

2006 layer #2 (from Corp B’s layer) ......................................................................... 100u .................... 20u ....................

2005 (from Corp B) .................................................................................................. 300u .................... 60u ....................

Two Side-by-Side Layers of 2004 E&P: 

2004 layer #1 (from Corp A) .................................................................................... .................... 0u .................... 10u 

2004 layer #2 (from Corp B) .................................................................................... 0u .................... 50u ....................

Two Side-by-Side Layers of 2003 E&P: 

2003 layer #1 (from Corp A) .................................................................................... 0u .................... 5u ....................

2003 layer #2 (from Corp B) .................................................................................... 50u .................... 5u ....................

450u (800u) 140u ....................

(B) Under paragraph (e)(2)(iii)(C) of this 

section, the $20, 10u, and 5u of pre-1987 

foreign income taxes associated with foreign 

corporation A’s pre-1987 accumulated profits 

for 2006 layer #1, 2004 layer #1, and 2003 

layer #1, respectively, remain in those layers. 

These foreign income taxes generally will not 

be reduced or deemed paid unless a foreign 

tax refund restores a positive balance to the 

associated earnings pursuant to section 

905(c), and thus will be trapped. See § 1.902–

2(b)(2). 

(iii) Post-transaction distribution. (A) 

During 2007, foreign surviving corporation 

does not accumulate any earnings and profits 

or pay or accrue any foreign income taxes. 

On December 31, 2007, foreign surviving 

corporation distributes 200u to its 

shareholders. Under the rules described in 

paragraph (e)(2)(iii)(C) of this section, no 

distribution can be made out of the pre-1987 

accumulated profits of foreign corporation A 

(and the (800u) aggregate hovering deficit 

will offset only post-transaction earnings 

accumulated by foreign surviving 

corporation). Thus, the distribution is out of 

pre-pooling annual layers as follows: 

E&P Foreign 

taxes paid 

2006 layer #2 ................................................................................................................................................................... 100u 20u 

2005 ................................................................................................................................................................................. 100u 20u 

200u 40u 


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(B) Foreign surviving corporation’s foreign 

income tax accounts are reduced to reflect 

the distribution of earnings and profits 

notwithstanding that no shareholders are 

eligible to claim deemed paid foreign income 

taxes under section 902. See § 1.902–

1(a)(10)(iii). 

(C) Immediately after the distribution, 

foreign surviving corporation has the 

following earnings and profits and foreign 

income taxes: 

Earnings & profits Foreign taxes 

Positive 

E&P Deficit E&P Taxes avaialable 

Foreign 

taxes 

associated 

with deficit 

E&P 

Hovering deficit from Corp A’s annual layers .................................................................. .................... (800u) .................... 0 

Two Side-by-Side Layers of 2006 E&P: 

2006 layer #1 (from Corp A’s pool) .......................................................................... .................... 0u .................... $20

2006 layer #2 (from Corp B’s layer) ......................................................................... 0u .................... 0u ....................

2005 (from Corp B) .................................................................................................. 200u .................... 40u ....................

Two Side-by-Side Layers of 2004 E&P: 

2004 layer #1 (from Corp A) .................................................................................... .................... 0u .................... 10u 

2004 layer #2 (from Corp B) .................................................................................... 0u .................... 50u ....................

Two Side-by-Side Layers of 2003 E&P: 

2003 layer #1 (from Corp A) .................................................................................... 0u .................... 5u ....................

2003 layer #2 (from Corp B) .................................................................................... 50u .................... 5u ....................

250u (800u) 140u ....................

(f) Special rules—(1) Treatment of deficit—

(i) General rule. Any deficit described in 

paragraph (d)(2), (e)(1)(iii), or (e)(2)(iii) of this 

section shall not be taken into account in 

determining current or accumulated earnings 

and profits of a foreign surviving corporation 

other than to offset post-transaction 

accumulated earnings, as defined in 

paragraph (d)(2)(ii) of this section, including 

for purposes of calculating—

(A) The earnings and profits limitation of 

section 952(c)(1)(A); and 

(B) The amount of the foreign surviving 

corporation’s subpart F income as defined in 

section 952(a). 

(ii) Exceptions. The rule in paragraph (i) 

shall not apply for purposes of calculating an 

earnings and profits limitation under section 

952(c)(1)(B) or (C). 

(iii) Examples. The following examples 

illustrate the principles of this paragraph 

(f)(1). The examples assume the following 

facts: foreign corporation A, incorporated in 

2002, is and always has been a wholly owned 

subsidiary of USP, a domestic corporation. 

Foreign corporation B, incorporated in 2004, 

is and always has been a wholly owned 

subsidiary of foreign corporation A. Both 

foreign corporation A and foreign corporation 

B are organized under the laws of foreign 

country X and have always had a calendar 

taxable year. Foreign corporations A and B 

(and all of their respective qualified business 

units as defined in section 989) maintain a 

‘‘u’’ functional currency. Unless otherwise 

stated, any earnings and profits or deficit in 

earnings and profits of foreign corporation A 

and B in the general category are attributable 

to subpart F income derived from foreign 

base company sales income. Foreign 

corporation C is a wholly owned subsidiary 

of USP2 and was organized in 2004 under the 

laws of foreign country Y. Foreign 

corporation C (and all of its qualified 

business units as defined in section 989) 

maintains a ‘‘u’’ functional currency. 

Earnings and profits of foreign corporation C 

in the general category are not attributable to 

subpart F income. The examples are as 

follows: 

Example 1. (i) Facts. (A) On December 31, 

2007, foreign corporations A and B have the 

following post-1986 undistributed earnings 

and post-1986 foreign income taxes: 

E&P Foreign 

taxes 

Foreign Corporation A Separate Category: 

General ..................................................................................................................................................................... (100u) $25 

Foreign Corporation B Separate Category: 

General ..................................................................................................................................................................... 0u $10 

(B) On January 1, 2008, foreign corporation 

B elects under § 301.7701–3(c) of this chapter 

to be disregarded as an entity separate from 

foreign corporation A. Accordingly, foreign 

corporation B is deemed to have distributed 

all its property to foreign corporation A in a 

liquidation described in section 332. 

(ii) Result. Under the rules described in 

paragraphs (d)(1) and (2) of this section, 

foreign surviving corporation A has the 

following post-1986 undistributed earnings 

and post-1986 foreign income taxes: 

Separate category 

Earnings & profits: Foreign taxes: 

Positive 

E&P 

Hovering 

deficit 

Foreign 

taxes 

available 

Foreign 

taxes associated with 

hovering 

deficit 

General ............................................................................................................................ 0u (100u) $10 $25 

(iii) Post-transaction earnings and subpart 

F limitations. (A) In its taxable year ending 

on December 31, 2008, foreign surviving 

corporation A earns 300u of subpart F 

general category income with respect to 

which it pays $50 in foreign income taxes. 


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The hovering deficit of (100u) meets the 

requirements under section 952(c)(1)(B) and 

therefore is taken into account as a qualified 

deficit that may be used by USP to offset a 

portion of its income inclusion related to 

foreign surviving corporation A’s subpart F 

income of 300u in the 2008 taxable year. 

Accordingly, USP includes 200u in taxable 

income for the year and is eligible for a 

deemed paid foreign tax credit under section 

960 of $40 (200u subpart F inclusion/300 

post-1986 undistributed earnings in the 

general category = 66.67%, × $60 foreign 

income taxes in the general category = $40). 

USP will also include the deemed paid 

foreign taxes of $40 in taxable income for the 

year as a deemed dividend pursuant to 

section 78. Though the (100u) hovering 

deficit of foreign surviving corporation A is 

taken into account for purposes of limiting 

USP’s subpart F income inclusion under 

section 952(c)(1)(B), the amount of the 

hovering deficit is not reduced for purposes 

of sections 316 and 902 and none of the 

associated foreign income taxes are included 

in the post-1986 foreign income taxes pool. 

(B) As of January 1, 2009, foreign surviving 

corporation A has the following post-1986 

undistributed earnings and post-1986 foreign 

income taxes: 

Separate category 

Earnings & profits Foreign taxes 

Positive 

E&P 

Hovering 

deficit 

Foreign 

taxes 

available 

Foreign 

taxes 

associated 

with 

hovering 

deficit 

General ............................................................................................................................ 100u (100u) $20 $25 

(C) The 200u included as subpart F income 

constitutes previously taxed earnings under 

section 959. 

Example 2. (i) Facts. (A) On July 1, 2007, 

foreign corporation B elects under 

§ 301.7701–3(c) of this chapter to be 

disregarded as an entity separate from foreign 

corporation A. Accordingly, foreign 

corporation B is deemed to have distributed 

all of its property to foreign corporation A in 

a liquidation described in section 332. 

(B) Neither foreign corporation A nor B has 

any post-1986 undistributed earnings or post1986 foreign income taxes as of the beginning 

of the 2007 taxable year. For its short taxable 

year ending on June 30, 2007, foreign 

corporation B has the following post-1986 

undistributed earnings and post-1986 foreign 

income taxes: 

FOREIGN CORPORATION B 

Separate category E&P Foreign 

taxes 

General ............................................................................................................................................................................ (200u) $30 

(C) For the 2007 taxable year, foreign 

surviving corporation A earns a total of 200u 

of subpart F foreign based company sales 

income in the general category with respect 

to which it pays $40 in foreign income taxes. 

(ii) Result. (A) Under paragraph (d)(2) of 

this section, foreign corporation B’s (200u) 

deficit carries over to foreign surviving 

corporation A as a hovering deficit. 

Nevertheless, because it is a deficit of a 

qualified chain member for a taxable year 

ending within the 2007 taxable year of 

foreign surviving corporation A, the (200u) 

deficit meets the requirements under section 

952(c)(1)(C) and therefore may still be taken 

into account for purposes of limiting foreign 

surviving corporation A’s subpart F income. 

Accordingly, foreign surviving corporation 

A’s 200u of subpart F income for the 2007 

taxable year is fully offset by the (200u) 

deficit of foreign corporation B, and USP will 

have no subpart F income inclusion for the 

2007 taxable year. The offset under section 

952(c)(1)(C) does not result in a reduction of 

the hovering deficit for purposes of section 

316 or section 902. The hovering deficit may 

not also be taken into account under section 

952(c)(1)(B). 

(B) Because USP has no subpart F income 

inclusion, foreign surviving corporation A’s 

subpart F earnings of 200u will accumulate 

and be added to its post-1986 undistributed 

earnings as of the beginning of 2008. Under 

the rules of paragraph (f)(5) of this section, 

a pro rata amount, in this case 50% or 100u, 

will be deemed to have been accumulated 

prior to the foreign section 381 transaction 

and the other 50%, or 100u, will be deemed 

to have been accumulated after the foreign 

section 381 transaction. The 100u of posttransaction earnings will be offset by (100u) 

of the hovering deficit for purposes of 

determining the opening balance of the post1986 undistributed earnings pool in 2008. 

Because the amount of earnings offset by the 

hovering deficit is 50% of the total amount 

of the hovering deficit, $15 (50% of $30) of 

the related taxes are added to the post-1986 

foreign income taxes pool as well. The 100u 

of pre-transaction earnings remain in the 

post-1986 undistributed earnings pool. 

Accordingly, foreign surviving corporation A 

has the following post-1986 undistributed 

earnings and post-1986 foreign income taxes 

on January 1, 2008: 

Separate category 

Earnings & profits Foreign taxes 

Positive 

E&P 

Hoverinig 

deficit 

Foreign 

taxes 

available 

Foreign 

taxes 

associated 

with 

hovering 

deficit 

General ............................................................................................................................ 100u (100u) $55 $15 

Example 3. (i) Facts. (A) On January 1, 

2007, foreign corporation B and foreign 

corporation C have the following post-1986 

undistributed earnings and post-1986 foreign 

income taxes: 


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E&P Foreign 

taxes 

Foreign Corporation B Separate Category: 

General ..................................................................................................................................................................... (100u) $0 

Foreign Corporation C Separate Category: 

General ..................................................................................................................................................................... 0u $10 

(B) On July 1, 2007, foreign corporation B 

acquires the assets of foreign corporation C 

in a reorganization described in section 

368(a)(1)(C). Immediately following the 

foreign section 381 transaction, foreign 

surviving corporation B is a CFC. 

(C) During the 2007 taxable year foreign 

surviving corporation B has a current deficit 

of (400u) and $60 of related foreign income 

taxes. During its short taxable year ending on 

June 30, 2007, foreign corporation C has no 

additional earnings and pays or accrues no 

foreign income taxes. 

(ii) Result. (A) Under the rules of paragraph 

(f)(5) of this section, a pro rata amount, in 

this case 50% or (200u), of foreign surviving 

corporation B’s (400u) current year deficit for 

the 2007 taxable year will be deemed to have 

been accumulated prior to the foreign section 

381 transaction and be treated as a hovering 

deficit. The other 50%, or (200u) of the 

deficit will be deemed to have been 

accumulated after the foreign section 381 

transaction. The related foreign income taxes 

of $60 will also be allocated on a similar 50/ 

50 basis. 

(B) Under the rules described in 

paragraphs (d)(1) and (2) of this section, 

foreign surviving corporation B has the 

following post-1986 undistributed earnings 

and post-1986 foreign income taxes as of 

January 1, 2008: 

Separate category 

Earnings & profits Foreign taxes 

E&P Hovering 

deficit 

Foreign 

taxes 

available 

Foreign 

taxes 

assoicated 

with 

hovering 

deficit 

General ............................................................................................................................ (200u) (300u) $40 $30 

(iii) Subpart F income limitations. Even 

though (200u) of the current year deficit is 

treated as a hovering deficit, the full (400u) 

current year deficit in 2007 of foreign 

surviving corporation B meets the 

requirements under section 952(c)(1)(C) and 

therefore is available as a limitation on 

subpart F income, to the extent foreign 

corporation A, which wholly owns foreign 

surviving corporation B, earns any subpart F 

income in the 2007 taxable year. Any such 

offset under section 952(c)(1)(C) will have no 

effect on the earnings and profits and foreign 

income tax accounts above of foreign 

surviving corporation B for purposes of 

sections 316 and 902. Moreover, to the extent 

the hovering deficit reduces subpart F 

income under section 952(c)(1)(C), it may not 

also be taken into account under section 

952(c)(1)(B). 

(2) Reconciling taxable years. If a 

foreign acquiring corporation and a 

foreign target corporation had taxable 

years ending on different dates, then the 

pro rata distribution rules of paragraphs 

(e)(1)(ii) and (e)(2)(ii) of this section 

shall apply with respect to the taxable 

years that end within the same calendar 

year. 

(3) Post-transaction change of status. 

If a foreign surviving corporation that is 

subject to the rules of paragraph (c)(2) 

of this section subsequently becomes a 

pooling corporation (by reason, for 

example, of a reorganization, 

liquidation, or change of ownership), 

then post-1986 undistributed earnings 

and post-1986 foreign income taxes that 

were recharacterized as pre-1987 

accumulated profits and pre-1987 

foreign income taxes, respectively, 

under paragraph (e)(2)(i) of this section 

retain their characterization as a prepooling annual layer. 

(4) Ordering rule for multiple hovering 

deficits—(i) Rule. A foreign surviving 

corporation shall apply the deficit rules 

of paragraphs (d)(2), (e)(1)(iii), and 

(e)(2)(iii) of this section in that order if 

more than one of such rules applies to 

the foreign surviving corporation. 

(ii) Example. The following example 

illustrates the principles of this 

paragraph (f)(4). The example assumes 

the following facts: Foreign corporation 

A has been a pooling corporation since 

its incorporation on January 1, 1998. 

Foreign corporation B has been a 

nonpooling corporation since its 

incorporation on January 1, 2000. 

Foreign corporations A and B have 

always had calendar taxable years. 

Foreign corporations A and B (and all of 

their respective qualified business units 

as defined in section 989) maintain a 

‘‘u’’ functional currency. All earnings 

and profits of foreign corporation B are 

in the general category. Finally, unless 

otherwise stated, any earnings and 

profits in the passive category resulted 

from a look-through dividend that was 

paid by a lower-tier CFC out of earnings 

accumulated when the CFC was a 

noncontrolled section 902 corporation 

and that qualified for the subpart F 

same-country exception under section 

954(c)(3)(A). The example is as follows: 

Example—(i) Facts. (A) On December 31, 

2006, foreign corporations A and B have the 

following earnings and profits and foreign 

income taxes: 

E&P Foreign 

taxes 

Foreign Corporation A Post-1986 Pool Separate Category: 

Passive ..................................................................................................................................................................... 400u $160 

General ..................................................................................................................................................................... (300u) 25 

100u 185 

Foreign Corporation B: 

2006 .......................................................................................................................................................................... (300u) 50u 

2005 .......................................................................................................................................................................... 100u 25u 


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E&P Foreign 

taxes 

(200u) 75u 

(B) On January 1, 2007, foreign corporation 

B acquires the assets of foreign corporation 

A in a reorganization described in section 

368(a)(1)(C). Immediately following the 

foreign section 381 transaction, foreign 

surviving corporation is a CFC. 

(ii) Result. Under the rules described in 

paragraphs (d)(1), (d)(2), (e)(1)(i), (e)(1)(ii), 

and (e)(1)(iii) of this section, foreign 

surviving corporation has the following 

earnings and profits and foreign income 

taxes: 

Earnings & profits Foreign taxes 

Positive 

E&P 

Hovering 

deficit 

Foreign 

taxes 

availabe 

Foreign 

taxes associated with 

hovering 

deficit 

Post-1986 pool separate category: 

Passive ..................................................................................................................... 400u .................... $160 ....................

General ..................................................................................................................... .................... (300u) .................... $25 

Carryforward pre-pooling deficit from Corp B .......................................................... .................... (200u) .................... 0 

2006 (from Corp B) .................................................................................................. 0u .................... 50u ....................

2005 (from Corp B) .................................................................................................. 0u .................... 25u ....................

400u (500u) .................... $25 

(iii) Post-transaction earnings. (A) In the 

taxable year ending on December 31, 2007, 

foreign surviving corporation accumulates 

earnings and profits and pays related foreign 

income taxes as follows: 

E&P Foreign 

taxes 

Post-1986 pool separate category: 

Passive ..................................................................................................................................................................... 150u $40 

General ..................................................................................................................................................................... 400u 60 

550u 100 

(B) None of the earnings and profits qualify 

as subpart F income as defined in section 

952(a). Under paragraph (f)(4)(i) of this 

section, the rules of paragraph (d)(2) of this 

section apply before the rules of paragraph 

(e)(1)(iii) of this section. Accordingly, posttransaction earnings in a separate category 

are first offset by a hovering deficit in the 

same separate category in the post-1986 pool. 

Thus, foreign surviving corporation’s (300u) 

deficit in the general category offsets 300u of 

post-transaction earnings in the general 

category. After application of paragraph 

(d)(2) of this section, the (200u) deficit in the 

general category carried forward from foreign 

corporation B’s pre-pooling aggregate deficit 

offsets the remaining 100u of post-transaction 

earnings in the general category. 

Accordingly, foreign surviving corporation 

has the following earnings and profits and 

foreign income taxes at the end of 2007: 

Earnings & profits Foreign taxes 

Positive 

E&P 

Hovering 

deficit 

Foreign 

taxes 

available 

Foreign 

taxes 

associated 

with hovering deficit 

Post-1986 pool separate category: 

Passive ..................................................................................................................... 550u .................... $200 

General ..................................................................................................................... .................... .................... $85 

Carryforward pre-pooling deficit from Corp B ................................................................. .................... (100u) .................... $0 

2006 (from Corp B) .......................................................................................................... 0u .................... 50u 

2005 (from Corp B) .......................................................................................................... 0u .................... 25u 

550u (100u) .................... $0 

(C) Under paragraph (d)(2)(iii) of this 

section, all of the $25 of post-1986 foreign 

income taxes related to the (300u) hovering 

deficit in the general category is added to the 

foreign surviving corporation’s post-1986 

foreign income taxes of $60 in that category 

(because post-transaction earnings in the 

general category have exceeded the deficit in 

that category). Under paragraph (e)(1)(iii)(C) 

of this section, the 50u and 25u of foreign 

income taxes associated with foreign 

corporation B’s pre-1987 accumulated profits 

for 2006 and 2005 remain in those layers. 

These foreign income taxes generally will not 

be reduced or deemed paid unless a foreign 

tax refund restores a positive balance to the 

associated earnings pursuant to section 


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905(c), and thus will be trapped. See § 1.902–

2(b)(2). 

(5) Pro rata rule for earnings and 

deficits during transaction year. (i) For 

purposes of offsetting post-transaction 

earnings of a foreign surviving 

corporation under the rules described in 

paragraphs (d)(2), (e)(1)(iii), and 

(e)(2)(iii) of this section, the earnings 

and profits, and any related foreign 

income taxes, in each separate category 

for the taxable year of the foreign 

surviving corporation in which the 

transaction occurs shall be deemed to 

have been accumulated after such 

transaction in an amount which bears 

the same ratio to the undistributed 

earnings and profits of the foreign 

surviving corporation for such taxable 

year (computed without regard to any 

earnings and profits carried over) as the 

number of days in the taxable year after 

the date of transaction bears to the total 

number of days in the taxable year. See, 

e.g., § 1.381(c)(2)–1(a)(7) Example 2 

(illustrating application of this rule with 

respect to domestic corporations). 

(ii) For purposes of determining the 

amount of pre-transaction deficits 

described in paragraphs (d)(2), (e)(1)(iii), 

and (e)(2)(iii) of this section, of a foreign 

surviving corporation that has a deficit 

in earnings and profits in any separate 

category for its taxable year in which the 

transaction occurs, unless the actual 

accumulated earnings and profits, or 

deficit, as of such date can be shown, 

such pre-transaction deficit, and any 

related foreign income taxes, shall be 

deemed to have accumulated in a 

manner similar to that described in 

paragraph (f)(5)(i) of this section. See, 

e.g., § 1.381(c)(2)–1(a)(7) Example 4 

(illustrating application of this rule with 

respect to domestic corporations). 

(g) Effective date. This section shall 

apply to section 367(b) transactions that 

occur on or after November 6, 2006. 

■ Par. 8. Section 1.367(b)–8 is added 

and reserved to read as follows: 

§ 1.367(b)–8 Allocation of earnings and 

profits and foreign income taxes in certain 

foreign corporate separations. [Reserved] 

■ Par. 9. Section 1.367(b)–9 is added to 

read as follows: 

§ 1.367(b)–9 Special rule for F 

reorganizations and similar transactions. 

(a) Scope. This section applies to a 

foreign section 381 transaction (as 

defined in § 1.367(b)–7(a)) either—

(1) That is described in section 

368(a)(1)(F); or 

(2) That involves—

(i) At least one foreign corporation 

that holds no property and has no tax 

attributes immediately before the 

transaction, other than a nominal 

amount of assets (and related tax 

attributes) to facilitate its organization 

or preserve its existence as a 

corporation; and 

(ii) No more than one foreign 

corporation that holds more than a 

nominal amount of property or has more 

than a nominal amount of tax attributes 

immediately before the transaction. 

(b) Hovering deficit rules 

inapplicable. If a transaction is 

described in paragraph (a) of this 

section, a foreign surviving corporation 

shall succeed to earnings and profits, 

deficits in earnings and profits, and 

foreign income taxes without regard to 

the hovering deficit rules of § 1.367(b)–

7(d)(2), (e)(1)(iii), and (e)(2)(iii). 

(c) Foreign divisive transactions. 

[Reserved] 

(d) Examples. The following examples 

illustrate the principles of this section: 

Example 1. (i) Facts. (A) Foreign 

corporation A is and always has been a 

wholly owned subsidiary of USP, a domestic 

corporation. Foreign corporation A was 

incorporated in 1995, and has always had a 

calendar taxable year. Foreign corporation A 

(and all of its respective qualified business 

units as defined in section 989) maintains a 

‘‘u’’ functional currency. On December 31, 

2006, foreign corporation A has the following 

post-1986 undistributed earnings and post1986 foreign income taxes: 

Separate Category E&P Foreign 

taxes 

Passive ............................................................................................................................................................................ (1,000u) $5 

General ............................................................................................................................................................................ 200u 200 

(800u) 205 

(B) On January 1, 2007, foreign corporation 

A moves its place of incorporation from 

Country 1 to Country 2 in a reorganization 

described in section 368(a)(1)(F). 

(ii) Result. Under § 1.367(b)–7(d), as 

modified by paragraph (b) of this section, the 

pre-transaction deficit of foreign corporation 

A will not hover. Accordingly, foreign 

surviving corporation has the following post1986 undistributed earnings and post-1986 

foreign income taxes immediately after the 

foreign section 381 transaction: 

Separate category E&P Foreign 

taxes 

Passive ............................................................................................................................................................................ (1,000u) $5 

General ............................................................................................................................................................................ 200u 200 

(800u) 205 

Example 2. (i) Facts. (A) Foreign 

corporations B, C and D are and always have 

been wholly owned subsidiaries of USP, a 

domestic corporation. Foreign corporation B 

was incorporated in 2000 and foreign 

corporations C and D were incorporated in 

2001. Foreign corporation B does not own 

any significant property and has no earnings 

and profits or foreign income taxes accounts. 

Both foreign corporations C and D have 

always had a calendar taxable year. Foreign 

corporations C and D (and all of their 

respective qualified business units as defined 

in section 989) maintain a ‘‘u’’ functional 

currency. On December 31, 2006, foreign 

corporations C and D have the following 

post-1986 undistributed earnings and post1986 foreign income taxes: 

E&P Foreign 

taxes 

Foreign corporation C Separate Category: 

Passive ..................................................................................................................................................................... (900u) $50 


sroberts on PROD1PC70 with RULES
44914 Federal Register / Vol. 71, No. 152 / Tuesday, August 8, 2006 / Rules and Regulations 

E&P Foreign 

taxes 

General ..................................................................................................................................................................... (200u) 100 

(1100u) 150 

Foreign corporation D Separate Category: 

Passive ..................................................................................................................................................................... 1200u 400 

General ..................................................................................................................................................................... 400u 100 

1600u 500 

(B) On January 1, 2007, USP foreign 

corporations C and D merge into foreign 

corporation B in a reorganization described 

in section 368(a)(1)(A). 

(ii) Result. Although the merger is a foreign 

section 381 transaction involving a foreign 

corporation with no property or tax 

attributes, paragraph (b) of this section does 

not apply because more than one foreign 

corporation with significant tax attributes is 

involved in the foreign section 381 

transaction. Accordingly, under § 1.367(b)- 

7(d), foreign surviving corporation B has the 

following post-1986 undistributed earnings 

and post-1986 foreign income taxes 

immediately after the foreign section 381 

transaction: 

Separate Category 

Earnings & profits Foreign taxes 

Positive 

E&P 

Hovering 

deficit 

Foreign 

taxes available 

Foreign 

taxes associated with 

hovering 

deficit 

General ............................................................................................................................ 1200u (900u) $400 $50 

Passive ............................................................................................................................ 400u (200u) 100 100 

1600u (1100u) 500 150 

(e) Effective date. This section shall 

apply to section 367(b) transactions that 

occur on or after November 6, 2006. 

■ Par. 10. In § 1.381(a)–1, paragraph (c) 

is revised to read as follows: 

§ 1.381(a)–1 General rule relating to 

carryovers in certain corporate 

acquisitions. 

* * * * * 

(c) Foreign corporations. For 

additional rules involving foreign 

corporations, see §§ 1.367(b)–7 through 

1.367(b)–9. 

* * * * * 

Mark E. Matthews, 

Deputy Commissioner for Services and 

Enforcement. 

Approved: July 20, 2006. 

Eric Solomon, 

Acting Deputy Assistant Secretary (Tax 

Policy). 

[FR Doc. 06–6740 Filed 8–7–06; 8:45 am] 

BILLING CODE 4830–01–P 

DEPARTMENT OF HOMELAND 

SECURITY 

Coast Guard 

33 CFR Part 117 

[CGD08–06–024] 

Drawbridge Operation Regulations; 

Gulf Intracoastal Waterway, Galveston, 

TX 

AGENCY: Coast Guard, DHS. 

ACTION: Notice of temporary deviation 

from regulations. 

SUMMARY: The Commander, Eighth 

Coast Guard District, has issued a 

temporary deviation from the regulation 

governing the operation of the Galveston 

Causeway Railroad Bascule Bridge 

across the Gulf Intracoastal Waterway, 

mile 357.2 west of Harvey Locks, at 

Galveston, Galveston County, Texas. 

This deviation provides for two (2) 

three-hour closures to conduct 

scheduled maintenance to the 

drawbridge. 

DATES: This deviation is effective from 

7 a.m. until 4 p.m. on Wednesday, 

August 16, 2006. 

ADDRESSES: Materials referred to in this 

document are available for inspection or 

copying at the office of the Eighth Coast 

Guard District, Bridge Administration 

Branch, Hale Boggs Federal Building, 

room 1313, 500 Poydras Street, New 

Orleans, Louisiana 70130–3310 between 

7 a.m. and 3 p.m., Monday through 

Friday, except Federal holidays. The 

telephone number is (504) 671–2128. 

The Bridge Administration Branch of 

the Eighth Coast Guard District 

maintains the public docket for this 

temporary deviation. 

FOR FURTHER INFORMATION CONTACT: 

David Frank, Bridge Administration 

Branch, telephone (504) 671–2129. 

SUPPLEMENTARY INFORMATION: The 

Burlington Northern Railway Company 

has requested a temporary deviation 

from the bridge operating requirements 

of 33 CFR 117.5 in order to perform 

necessary maintenance on the rail joints 

of the Galveston Causeway Railroad 

Bascule Bridge across the Gulf 

Intracoastal Waterway, mile 357.2 west 

of Harvey Locks, at Galveston, 

Galveston County, Texas. The 

maintenance is essential for the 

continued safe operation of the railroad 

bridge. This temporary deviation will 

allow the bridge to remain in the closedto-navigation position from 7 a.m. until 

10 a.m. and from 1 p.m. until 4 p.m. on 

Wednesday, August 16, 2004. 

The bridge has a vertical clearance of 

10 feet above mean high water in the 

closed-to-navigation position. 

Navigation at the site of the bridge 

consists mainly of tows with barges and 

some recreational pleasure craft. Due to 


sroberts on PROD1PC70 with RULES