[Federal Register Volume 72, Number 52 (Monday, March 19, 2007)]
[Rules and Regulations]
[Pages 12902-12946]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E7-4618]



[[Page 12901]]

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Part III





Department of the Treasury





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Internal Revenue Service



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26 CFR Parts 1 and 602



Dual Consolidated Loss Regulations; Final Rule

Federal Register / Vol. 72, No. 52 / Monday, March 19, 2007 / Rules 
and Regulations

[[Page 12902]]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Parts 1 and 602

[TD 9315]
RIN 1545-BD10


Dual Consolidated Loss Regulations

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

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SUMMARY: This document contains final regulations under section 1503(d) 
of the Internal Revenue Code (Code) regarding dual consolidated losses. 
Section 1503(d) generally provides that a dual consolidated loss of a 
dual resident corporation cannot reduce the taxable income of any other 
member of the affiliated group unless, to the extent provided in 
regulations, the loss does not offset the income of any foreign 
corporation. Similar rules apply to losses of separate units of 
domestic corporations. These final regulations address various dual 
consolidated loss issues, including exceptions to the general 
prohibition against using a dual consolidated loss to reduce the 
taxable income of any other member of the affiliated group.

DATES: Effective Date: These regulations are effective on March 19, 
2007.
    Applicability Dates: For dates of applicability see Sec.  
1.1503(d)-8.

FOR FURTHER INFORMATION CONTACT: Jeffrey P. Cowan, (202) 622-3860 (not 
a toll-free number).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

    The collection of information contained in these final regulations 
has been reviewed and approved by the Office of Management and Budget 
in accordance with the Paperwork Reduction Act of 1995 (44 U.S.C. 
3507(d)) under control number 1545-1946.
    The collections of information in these final regulations are in 
Sec. Sec.  1.1503(d)-1(c), 1.1503(d)-3(e), 1.1503(d)-4(e), 1.1503(d)-
6(c), 1.1503(d)-6(d), 1.1503(d)-6(e), 1.1503(d)-6(f), 1.1503(d)-6(g), 
1.1503(d)-6(h), and 1.1503(d)-6(j). This information is required for 
various reasons. The information under Sec.  1.1503(d)-1(c) notifies 
the IRS when a taxpayer asserts that it had reasonable cause for 
failing to comply with certain filing requirements under the 
regulations. The information under Sec.  1.1503(d)-4(e) indicates when 
the taxpayer attempts to rebut the amount of presumed tainted income. 
The information under the other provisions provides the IRS with 
various information regarding domestic use elections, exceptions to the 
domestic use limitation, triggering events, new domestic use 
agreements, original elector statements, annual certifications, and 
terminations of existing domestic use elections.
    An agency may not conduct or sponsor, and a person is not required 
to respond to, a collection of information unless it displays a valid 
control number.
    Books or records relating to a collection of information must be 
retained as long as their contents might become material in the 
administration of any internal revenue law. Generally, tax returns and 
tax return information are confidential, as required by 26 U.S.C. 6103.

Background

    Congress enacted section 1503(d), as part of the Tax Reform Act of 
1986, to prevent a dual resident corporation from using a single 
economic loss once to offset income that was subject to U.S. tax, but 
not foreign tax, and a second time to offset income subject to foreign 
tax, but not U.S. tax (double dip). In 1988, Congress extended the 
application of section 1503(d), by adding section 1503(d)(3) and (4), 
to apply the provisions to separate units of domestic corporations and 
to grant the Secretary authority to promulgate regulations to prevent 
the avoidance of section 1503(d) through the contribution of assets to 
a corporation with a dual consolidated loss after the loss was 
sustained. The IRS and Treasury Department issued temporary regulations 
under section 1503(d) in 1989 (TD 8261, 1989-2 CB 220) and final 
regulations in 1992 (TD 8434, 1992-2 CB 240), see Sec.  
601.601(d)(2)(ii)(b). These final regulations were updated and amended 
over the next 11 years (current regulations).
    On May 24, 2005, the IRS and Treasury Department published in the 
Federal Register a notice of proposed rulemaking (REG-102144-04; 70 FR 
29868). The proposed regulations addressed the following fundamental 
concerns arising under the current regulations: (1) The potential over- 
and under-application of the current regulations; (2) various issues 
arising in the application of the current regulations, particularly in 
light of the adoption of the entity classification regulations under 
Sec. Sec.  301.7701-1 through 301.7701-3 (check-the-box regulations); 
and (3) the administrative burden of the current regulations. The 
public hearing with respect to the 2005 proposed regulations was 
cancelled because no request to speak was received. However, the IRS 
and Treasury Department received a number of written comments which are 
discussed in this preamble.

Summary of Comments and Explanation of Provisions

A. Application of Section 1503(d) to Regulated Investment Companies and 
Real Estate Investment Trusts

    Under the current regulations, a dual resident corporation is a 
domestic corporation that is subject to an income tax of a foreign 
country on its worldwide income or on a residence basis. As a result, 
unless specifically exempted, certain entities that are domestic 
corporations, but not generally taxed at the entity level, may be 
subject to the current regulations. The current regulations provide 
that an S corporation, which is a domestic corporation, is not treated 
as a dual resident corporation. The proposed regulations, and these 
final regulations, provide that an S corporation is not treated as a 
domestic corporation and thus cannot be a dual resident corporation or 
own a separate unit.
    Under the current regulations, as a domestic corporation, a 
regulated investment company (as defined in section 851) or a real 
estate investment trust (as defined in section 856) could be a dual 
resident corporation or own a separate unit. In the preamble to the 
proposed regulations, however, the IRS and Treasury Department 
requested comments as to whether regulated investment companies or real 
estate investment trusts should, like S corporations, be excluded from 
the application of the dual consolidated loss rules. One commentator 
suggested that regulated investment companies and real estate 
investment trusts should be subject to the dual consolidated loss 
rules, but would limit recapture pursuant to a domestic use agreement 
to situations where there was a foreign use and a section 381 
transaction occurred.
    The IRS and Treasury Department believe that subjecting regulated 
investment companies and real estate investment trusts to the dual 
consolidated loss rules is inappropriate. Section 1503(d) was intended 
to apply to domestic corporations that are subject to entity-level tax. 
Although regulated investment companies and real estate investment 
trusts are domestic corporations under the Code, unlike most domestic 
corporations these entities often do not pay tax at the entity level 
because they may deduct the

[[Page 12903]]

amount of dividends paid to their shareholders from their own taxable 
income. Thus, under the final regulations regulated investment 
companies and real estate investment trusts are excluded from the 
definition of a domestic corporation and, as a result, are not subject 
to the dual consolidated loss rules.

B. Separate Units

(1) Separate Unit Combination Rule
    Section 1.1503-2(c)(3)(ii) of the current regulations provides that 
if two or more foreign branches located in the same foreign country are 
owned by a single domestic corporation and the losses of each branch 
are available to offset the income of the other branches under the tax 
laws of the foreign country, then the branches are treated as a single 
separate unit.
    In response to comments that the current combination rule was 
unnecessarily limited and did not appropriately address the check-the-
box regulations, the proposed regulations adopt a broader combination 
rule that, subject to certain requirements, combines all separate units 
of a single domestic corporation. One requirement for combining 
separate units, both under the current regulations and the proposed 
regulations, is that the losses of each separate unit are made 
available to offset the income of the other separate units under the 
tax laws of a single foreign country.
    The combination rule in the proposed regulations does not combine 
dual resident corporations that are members of the same consolidated 
group, or separate units of multiple domestic corporations that are 
members of the same consolidated group. However, in the preamble to the 
proposed regulations, the IRS and Treasury Department requested 
comments as to whether combination was appropriate in these cases.
    Numerous comments were received on the scope and application of the 
combination rule. Commentators uniformly recommended that the 
combination rule be expanded to include separate units that are located 
in or subject to tax in the same foreign country (same-country separate 
units) and that are owned by multiple domestic corporations that are 
members of the same consolidated group. The IRS and Treasury Department 
believe that combining same-country separate units of domestic 
corporations that are members of the same consolidated group is 
consistent with the policies underlying section 1503(d) because, in 
general, all of the items of income, gain, deduction, and loss of such 
combined separate units are taken into account in both the United 
States and the foreign country. Therefore, these final regulations 
expand the combination rule to apply to same-country separate units of 
multiple domestic corporations that are members of the same 
consolidated group.
    Two commentators recommended that the combination rule be expanded 
to combine dual resident corporations that are members of the same 
consolidated group. The IRS and Treasury Department do not believe that 
Congress intended that multiple dual resident corporations be treated 
as a single domestic corporation for purposes of section 1503(d). 
Combining dual resident corporations and separate units would also add 
complexity because certain rules apply differently to dual resident 
corporations and separate units. As a result, the combination rule in 
these final regulations does not apply to dual resident corporations.
    Nevertheless, it is important to note that a dual resident 
corporation will often carry on its activities through a foreign branch 
(as defined in Sec.  1.367(a)-6T(g)(1)) and, as a result, will be a 
domestic owner of a foreign branch separate unit. In these cases, the 
foreign branch separate unit through which it carries on its activities 
in the foreign country will be eligible for combination. In addition, 
in many cases, a significant number of the items of income, gain, 
deduction, and loss of a dual resident corporation that owns a foreign 
branch separate unit will be attributable to the foreign branch 
separate unit (and therefore will not be items of the dual resident 
corporation itself). As a result, not extending the combination rule to 
dual resident corporations should, as a practical matter, have limited 
effect.
    One commentator recommended eliminating the proposed regulations' 
requirement that losses of each separate unit must be available to 
offset the income of other separate units under the tax laws of a 
single foreign country in order for them to combine. The IRS and 
Treasury Department believe that it is appropriate to remove this 
requirement, provided that the individual separate units are located, 
or subject to income tax on a worldwide or residence basis, in the same 
foreign country. This is the case because it is likely that all of the 
items of the combined separate unit will be recognized in both the 
United States and the foreign jurisdiction, without regard to whether 
such items are available for offset under the income tax laws of the 
foreign country. In addition, the IRS and Treasury Department believe 
that eliminating this requirement will reduce complexity, and will 
further refine the application of the rules. As a result, these final 
regulations eliminate this requirement from the combination rule.
    Commentators also recommended making combination elective in 
certain situations. The IRS and Treasury Department believe that 
elective combination would add complexity and create administrative 
burdens. Therefore, this comment is not adopted.
    The IRS and Treasury Department recognize that the expanded 
combination rule may necessitate that the basis of the stock of 
multiple domestic corporations, which are members of the same 
consolidated group, be adjusted to reflect the items of income, gain, 
deduction, and loss entering into the computation of the dual 
consolidated loss of a combined separate unit. These regulations 
provide guidance on the manner of such basis adjustments.
    These final regulations also clarify that the separate unit 
combination rule generally applies for all purposes of section 1503(d). 
As a result, except as specifically provided in these regulations, any 
individual separate unit composing a combined separate unit loses its 
character as an individual separate unit. For example, in determining 
whether there is a triggering event as a result of the transfer of the 
assets of a combined separate unit, all of the assets of the combined 
separate unit are taken into account (rather than only the assets of 
any individual separate unit within the combined separate unit).
(2) Definition of a Foreign Branch by Reference to Sec.  1.367(a)-6T(g)
    One commentator stated that the reference in the current and 
proposed regulations to Sec.  1.367(a)-6T(g) for the definition of a 
foreign branch, which implicitly includes references to Sec.  1.367(a)-
6T(g)(1) through (3), creates needless complexity. The IRS and Treasury 
Department generally agree with this comment. Accordingly, these final 
regulations clarify that a foreign branch is defined, in part, by 
reference to Sec.  1.367(a)-6T(g)(1), rather than by reference to Sec.  
1.367(a)-6T(g).
(3) Treaty Exception to the Definition of a Foreign Branch Separate 
Unit
    One commentator suggested that the definition of a foreign branch 
separate unit should not include a branch that would not be subject to 
income tax in a foreign jurisdiction either as a result of an income 
tax convention or because of the passive nature of the activities.

[[Page 12904]]

This commentator explained that such an exclusion is appropriate 
because in these cases there would be no potential use of a branch loss 
for foreign tax purposes.
    The IRS and Treasury Department agree that it is appropriate to 
exclude from the definition of a foreign branch separate unit certain 
business operations that, under an applicable income tax convention, 
would not be considered a permanent establishment. As a result, these 
final regulations include an exception to the definition of a foreign 
branch separate unit. The IRS and Treasury Department do not, however, 
believe an exception is appropriate where the business operations are 
not subject to tax in the foreign jurisdiction because of the passive 
nature of the activities. Such an exception would require the analysis 
of foreign law which, to the extent possible, should not be required 
under these rules.
(4) Activities Owned by a Dual Resident Corporation or a Hybrid Entity
    One commentator requested clarification that home-country 
activities of a dual resident corporation or hybrid entity separate 
unit can qualify as a foreign branch separate unit. The IRS and 
Treasury Department agree that this clarification is warranted and 
these final regulations are modified accordingly.

C. Elimination of the Consistency Rule

    As a result of the expansion of the separate unit combination rule 
in these final regulations, the IRS and Treasury Department believe 
that the consistency rule would have only limited application. 
Therefore, the consistency rule has been eliminated from these final 
regulations. The IRS and Treasury Department believe that eliminating 
the consistency rule will simplify the application of the dual 
consolidated rules and will eliminate various issues that arise under 
the rule.

D. Domestic Reverse Hybrid Entities

    One commentator noted that the application of the current and 
proposed regulations to certain structures involving domestic reverse 
hybrid entities appears inconsistent with the underlying policies of 
section 1503(d). In a typical structure, a foreign corporation owns the 
majority of the interests in a partnership or limited liability company 
that elects to be treated as a corporation for U.S. tax purposes and, 
therefore, is subject to tax on its worldwide income in the United 
States, but is treated as a pass-through entity under foreign law 
(domestic reverse hybrid). The domestic reverse hybrid is the parent of 
a consolidated group, is the obligor on group indebtedness, and holds 
stock of other group members. This structure allows the interest 
expense of the domestic reverse hybrid to offset income of the foreign 
corporation, which is not subject to U.S. tax, and to offset income of 
the other members of the consolidated group, which is not subject to 
foreign tax.
    The commentator noted that because the domestic reverse hybrid is 
neither a dual resident corporation (because it is not subject to tax 
on a residence basis or on its worldwide income in the foreign country, 
but is instead treated as a pass-through entity) nor a separate unit of 
a domestic corporation, the current and proposed regulations do not 
apply to the losses of the domestic reverse hybrid. The commentator 
asserted that this result is inconsistent with the policies underlying 
section 1503(d), which was adopted, in part, to ensure that domestic 
corporations were not put at a competitive disadvantage as compared to 
foreign corporations through the use of certain inbound acquisition 
structures. See S. Rep. No. 99-313, 1986-3 CB Vol. 3 at 420, see Sec.  
601.601(d)(2)(ii)(b). The commentator suggested that the scope of the 
final regulations be broadened to treat such entities as separate 
units, the losses of which are subject to the restrictions of section 
1503(d). This change would, in effect, apply the provisions of section 
1503(d) to a separate unit of a foreign corporation.
    The IRS and Treasury Department recognize that this type of 
structure results in a double dip similar to that which Congress 
intended to prevent through the adoption of section 1503(d). However, 
the IRS and Treasury Department believe that a domestic reverse hybrid 
is neither a dual resident corporation nor a separate unit and, 
therefore, is not subject to section 1503(d). As a result, this comment 
is not adopted. However, the IRS and Treasury Department continue to 
study these and similar structures.

E. Transparent Entities

    Section 1.1503-2(c)(3) and 1.1503-2(c)(4) of the current 
regulations define a separate unit of a domestic corporation as a 
foreign branch (within the meaning of Sec.  1.367(a)-6T(g)), and an 
interest in a partnership, trust, or hybrid entity. As a result, the 
current regulations potentially apply not only to entities that are 
subject to tax in a foreign country (for example, hybrid entities), but 
also to entities that are not subject to tax in a foreign country, and 
otherwise have no connection to a foreign jurisdiction (for example, a 
domestic partnership engaged in a U.S. trade or business).
    The proposed regulations modify the definition of a separate unit 
to exclude interests in non-hybrid entity partnerships and non-hybrid 
entity grantor trusts. These interests were excluded because the IRS 
and Treasury Department believe that it is unlikely that losses and 
deductions attributable to these interests could be put to a foreign 
use (as that term is defined in the proposed regulations). However, the 
proposed regulations retain the rule that a domestic corporation can 
own a separate unit through a non-hybrid entity partnership or non-
hybrid entity grantor trust.
    Commentators noted that, as a result of this change, the proposed 
regulations may not sufficiently and consistently address the treatment 
of certain entities. Such an entity is a pass-through entity for U.S. 
tax purposes (for example, a disregarded entity, a partnership or a 
grantor trust), but is not a hybrid entity because it is not subject to 
tax on its worldwide income or on a residence basis in a foreign 
country. In addition, the entity would not be treated as a pass-through 
entity under the laws of the applicable foreign country. One example of 
such an entity (transparent entity) is a limited liability company 
organized in the United States that for U.S. tax purposes is a 
partnership or disregarded entity, but, for purposes of the applicable 
foreign country, is not viewed as a pass-through entity. Another 
example is a foreign entity that is a pass-through entity for U.S. tax 
purposes, is not subject to income tax in a foreign country as a 
corporation (or otherwise at the entity level) either on its worldwide 
income or on a residence basis (because, for example, it is organized 
in a foreign country that does not impose an income tax), and is not 
treated as a pass-through entity under the laws of the applicable 
foreign country.
    The commentators noted that under the proposed regulations items of 
income, gain, deduction, and loss of a transparent entity that is a 
partnership for U.S. tax purposes would be taken into account in 
computing the dual consolidated loss of a dual resident corporation or 
hybrid entity separate unit that owns an interest in such entity, even 
though it is unlikely that the items are taken into account by the 
jurisdiction in which the dual resident corporation or hybrid entity is 
subject to tax. As a result, items of deduction or loss which are 
unlikely to be available for a double dip (because they are not

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taken into account by the foreign country in which the dual resident 
corporation or hybrid entity is subject to tax) could inappropriately 
result in a dual consolidated loss. The commentators further noted that 
items of income or gain which are unlikely to be taken into account by 
the foreign country could inappropriately reduce (or eliminate) a dual 
consolidated loss of the dual resident corporation or hybrid entity 
separate unit that owns an interest in such entity.
    The IRS and Treasury Department believe that losses attributable to 
interests in transparent entities should not be subject to section 
1503(d), but also believe that items attributable to these interests 
should not influence the calculation or use of a dual consolidated loss 
of a dual resident corporation or separate unit in a manner that is 
inconsistent with the purposes of section 1503(d). Accordingly, these 
final regulations provide four new rules that address transparent 
entities (and interests therein).
    First, these final regulations provide a definition of a 
transparent entity that is consistent with the description and examples 
in the preceding discussion.
    Second, rules are provided for attributing items of income, gain, 
deduction, and loss to interests in transparent entities. The rules 
applicable for attributing items to these interests are consistent with 
the rules for attributing items to hybrid entity separate units.
    Third, these final regulations provide that items of income, gain, 
deduction, and loss attributable to interests in transparent entities 
are not considered when calculating whether a dual resident corporation 
that holds an interest in such entity has income or a dual consolidated 
loss. This modification ensures that in cases where the foreign country 
in which the dual resident corporation is subject to tax is unlikely to 
take into account items of the transparent entity, such items do not 
inappropriately affect the computation of income or a dual consolidated 
loss of the dual resident corporation. Similar rules apply for purposes 
of calculating the income or dual consolidated loss of a separate unit 
through which an interest in a transparent entity is owned (directly or 
indirectly).
    Finally, an interest in a transparent entity will be treated as a 
domestic affiliate for purposes of determining whether there is a 
domestic use of a dual consolidated loss. This change prevents a dual 
consolidated loss from being used to offset the income of a transparent 
entity such that there is no inappropriate domestic use of the loss.
    These final regulations do not treat transparent entities, or 
interests therein, as dual resident corporations or separate units and, 
as a result, do not cause such entities (or interests therein) to be 
subject to the limitations of section 1503(d). Instead, the rules aim 
to appropriately take into account such entities when applying the dual 
consolidated loss rules to dual resident corporations and separate 
units.

F. Reasonable Cause Exception

    The current regulations require various filings to be included on a 
timely filed income tax return. In addition, taxpayers that fail to 
include these filings must request an extension of time to file under 
Sec. Sec.  301.9100-1 through 301.9100-3. The proposed regulations 
eliminate the requirement that a taxpayer obtain an extension of time 
under Sec. Sec.  301.9100-1 through 301.9100-3 and instead adopt a 
reasonable cause standard.
    On January 31, 2006, the IRS and Treasury Department published 
Notice 2006-13 (2006-8 IRB 496), see Sec.  601.601(d)(2)(ii)(b), 
announcing that taxpayers that must file agreements, statements, and 
other information under section 1503(d) may cure any late filings by 
applying a reasonable cause exception similar to the standard contained 
in the proposed regulations, until such time as the proposed 
regulations become final. In addition to allowing the use of the 
reasonable cause exception prior to the proposed regulations being 
published as final regulations in the Federal Register, the notice 
modifies the procedures for obtaining reasonable cause relief to ensure 
that requests for reasonable cause relief are handled in a timely and 
efficient manner.
    These final regulations adopt the reasonable cause standard 
contained in the proposed regulations and Notice 2006-13, with certain 
modifications. See paragraph S(3) of this preamble for the application 
of the reasonable cause exception to losses that are subject to the 
current regulations.

G. Foreign Use

(1) In General
    Section 1.1503-2(g)(2)(i) of the current regulations provides that, 
in order to elect relief from the general limitation on the use of a 
dual consolidated loss to offset income of a domestic affiliate 
((g)(2)(i) election), the taxpayer must, among other things, certify 
that no portion of the losses, expenses, or deductions taken into 
account in computing the dual consolidated loss has been, or will be, 
used to offset the income of any other person under the income tax laws 
of a foreign country. If, contrary to this certification, there is such 
a use, the dual consolidated loss subject to the (g)(2)(i) election 
generally must be recaptured and reported as gross income.
    The proposed regulations modify the definition of ``use'' and 
provide a rule based on ``foreign use'' in order to minimize the 
potential over- and under-application of the current regulations. The 
proposed regulations provide that a foreign use is deemed to occur only 
if two conditions are satisfied. The first condition is satisfied if 
any portion of a deduction or loss taken into account in computing the 
dual consolidated loss is made available under the income tax laws of a 
foreign country to offset or reduce, directly or indirectly, any item 
that is recognized as income or gain under such laws (including items 
of income or gain generated by the dual resident corporation or 
separate unit itself), regardless of whether income or gain is actually 
offset, and regardless of whether these items are recognized under U.S. 
tax principles. The second condition is satisfied if items that are (or 
could be) offset pursuant to the first condition are considered, under 
U.S. tax principles, to be items of: (1) A foreign corporation; or (2) 
a direct or indirect (for example, through a partnership) owner of an 
interest in a hybrid entity, provided such interest is not a separate 
unit.
(2) Indirect Foreign Use
    As noted, the proposed regulations provide that a foreign use of a 
dual consolidated loss will occur when any item of deduction or loss, 
entering into the computation of the dual consolidated loss, is made 
available, directly or indirectly, to offset under foreign law, income 
of a foreign corporation or an owner of an interest in a hybrid entity 
that is not a separate unit. The proposed regulations do not provide 
comprehensive examples illustrating when an indirect use of a dual 
consolidated loss occurs. However, the provision was included in the 
proposed regulations to address transactions that are structured to 
avoid the application of section 1503(d) through, for example, the use 
of a back-to-back lending or conduit financing-type arrangements, or 
through the use of one or more hybrid instruments.
    Commentators requested additional guidance regarding an indirect 
foreign use. In response to these comments, these final regulations 
clarify when an

[[Page 12906]]

indirect foreign use is deemed to occur, include an exception to the 
general indirect foreign use rule for certain ordinary course 
transactions, and provide related examples.
    The indirect foreign use rules are designed to limit an indirect 
use to situations in which taxpayers have engaged in transactions which 
have the effect of transferring an item of deduction or loss composing 
a dual consolidated loss to another entity for foreign tax purposes, so 
that it is made available to offset the income of a foreign corporation 
or the owner of an interest in an entity which is not a separate unit. 
In general, these rules are intended to target structured transactions 
that are designed to achieve a double dip that is contrary to the 
policies of section 1503(d), and are not intended to apply to ordinary 
business transactions.
(3) Exceptions to Foreign Use
    The proposed regulations contain three exceptions to the definition 
of a foreign use, including an exception where there is no dilution of 
an interest in a separate unit. In the preamble to the proposed 
regulations, the IRS and Treasury Department request comments as to 
whether a de minimis exception should be provided to the dilution 
limitation. The preamble also states that a revenue procedure would be 
issued, in conjunction with the proposed regulations being published as 
final regulations in the Federal Register, that would provide 
additional exceptions (safe harbors) under which a triggering event 
would be deemed rebutted if various conditions were satisfied, 
including, in certain cases, a demonstration that there can be no 
foreign use of a significant portion of the dual consolidated loss.
    The IRS and Treasury Department received a number of comments on 
transactions and situations that could be included in the list of safe 
harbors. One commentator suggested an exception whereby recapture would 
not be required following transactions outside the taxpayer's control. 
For example, this commentator suggested that a recapture of a dual 
consolidated loss should not occur following the conveyance or 
relinquishment of assets of a separate unit, or interests in a separate 
unit, to a foreign government.
    Commentators also suggested that relief should be provided 
following certain transactions, similar to those mentioned in the 
preamble to the proposed regulations, where there is a de minimis 
potential for foreign use, a de minimis carryover of asset basis, and 
for which rebuttal would otherwise be difficult or impossible. 
According to these commentators, this safe harbor would apply to many 
common business transactions in which the policies underlying section 
1503(d) would not be violated because of only a de minimis potential 
for foreign use.
    Another commentator stated that an exception to foreign use would 
be appropriate where the taxpayer enters into a binding and irrevocable 
agreement with the tax authorities of a foreign country which ensures 
that no portion of the dual consolidated loss can be put to a foreign 
use in the foreign country. The commentator explained that, pursuant to 
such an arrangement, the taxpayer and the foreign tax authorities would 
agree that the foreign tax attributes of a dual resident corporation or 
separate unit (for example, loss carryforwards and asset basis) would 
be eliminated such that there would be no opportunity for a foreign 
use.
    After considering these comments, the IRS and Treasury Department 
believe that it is appropriate to include certain safe harbors where a 
foreign use will be deemed not to occur. As a result, these final 
regulations (rather than a revenue procedure) set forth additional 
exceptions to the definition of a foreign use. These exceptions 
generally apply in cases where the potential for foreign use is de 
minimis, or where the transaction giving rise to a foreign use occurs 
as a result of events largely outside of the taxpayer's control.
    These new exceptions to foreign use include a de minimis rule and 
rules that apply to certain transactions involving the carry over of 
asset basis and the assumption of liabilities. Another new exception 
applies to a transaction that qualifies for the multiple-party event 
exception to a triggering event (referred to as successor elector 
events under the proposed regulations) where the acquiring unaffiliated 
domestic owner or consolidated group owns, immediately after the 
transaction, less than 100 percent of the acquired assets or interests. 
Without this exception to foreign use, many transactions that would 
qualify for the multiple-party event exception would immediately result 
in a foreign use triggering event when the unaffiliated domestic 
corporation or consolidated group acquires between 90 and 100 percent 
of the assets or interests. Finally, these regulations modify the ``no 
dilution'' exception contained in the proposed regulations to, among 
other things, incorporate a de minimis exception.
    These final regulations provide that the exceptions may be 
supplemented through subsequent guidance published in the Internal 
Revenue Bulletin, as appropriate. As a result, the IRS and Treasury 
Department request comments on additional transactions or situations 
that should be added as safe harbors. For example, additional comments 
are requested on arrangements with foreign tax authorities whereby 
foreign tax attributes could be eliminated to ensure that no portion of 
the dual consolidated loss can be put to a foreign use.
(4) Ordering Rules for Determining a Foreign Use
    The current and proposed regulations provide rules for determining 
the order in which dual consolidated losses are used in cases where the 
laws of a foreign country provide for the foreign use of such loss, but 
do not provide applicable rules for determining the order in which 
these losses are used in a taxable year.
    A commentator noted that in certain cases involving dual 
consolidated losses incurred in different taxable years, the ordering 
rules may result in losses being deemed to be made available for a 
foreign use resulting in recapture, even though there are other losses 
which, if deemed to be used, would not result in recapture. This 
commentator recommended that in these situations the losses be deemed 
to first be used in a manner that will not result in the recapture of a 
dual consolidated loss. The commentator also noted that this approach 
is consistent with the exception to foreign use contained in Sec.  
1.1503(d)-1(b)(14)(iii)(B) of the proposed regulations where there is 
no foreign country rule for determining use. Finally, the commentator 
stated that losses that do give rise to a foreign use should be deemed 
to be used on a ``last-in/first-out'' basis. The IRS and Treasury 
Department believe these rules are appropriate and, as a result, these 
comments are adopted.
(5) Mirror Legislation
    The current regulations contain a mirror legislation rule that 
denies a taxpayer the ability to make an election to use a dual 
consolidated loss to offset the income of a domestic affiliate where 
the foreign country has enacted legislation that operates in a manner 
similar to section 1503(d), and, as a result, prohibits the taxpayer 
from claiming the dual consolidated loss in the foreign country. The 
mirror legislation rule was designed to prevent the revenue gain 
resulting from the disallowance of a double dip from inuring solely to 
the foreign country. Staff of the Joint Committee on Taxation, General 
Explanation of the Tax Reform Act of 1986, at 1065-66 (J.

[[Page 12907]]

Comm. Print 1987), see Sec.  601.601(d)(2)(ii)(b); see also British Car 
Auctions, Inc. v. United States, 35 Fed. Cl. 123 (1996), aff'd without 
op., 116 F.3d 1497 (Fed. Cir. 1997) (upholding the validity of the 
mirror legislation rule). The effect of the mirror legislation rule is 
that a dual consolidated loss may be disallowed in the United States 
and in the foreign country. In such cases, Congress intended for the 
Treasury Department to pursue a bilateral agreement with the foreign 
jurisdiction so that the loss could offset income of an affiliate in 
only one country.
    The proposed regulations retain the mirror legislation rule and 
modify it to better take into account the policies underlying its 
adoption.
    A number of comments were received on the scope and utility of the 
mirror legislation rule. Several commentators encouraged the IRS and 
the Treasury Department to pursue bilateral agreements where the dual 
consolidated loss is disallowed in both the United States and the 
foreign country.
    The IRS and Treasury Department agree that such agreements are 
necessary and recently concluded a competent authority agreement on 
such matters with the United Kingdom on October 6, 2006 (the 
Agreement). For the text of the Agreement, see Announcement 2006-86, 
2006-45 IRB 842; see Sec.  601.601(d)(2)(ii)(b). The Agreement applies 
to dual consolidated losses attributable to certain UK permanent 
establishments that are otherwise subject to both section 1503(d) and 
mirror legislation enacted by the United Kingdom. In general, the 
Agreement provides that taxpayers can elect to use or relieve the loss 
in either the United Kingdom or the United States, but not both.
    The IRS and Treasury Department believe that these final 
regulations and the Agreement appropriately refine and limit the scope 
of the mirror rule. In addition, the IRS and Treasury Department 
believe that the provisions of the Agreement can serve as a model for 
future competent authority agreements, if necessary, between the United 
States and its treaty partners which would further the Congressional 
intent with respect to the application of the mirror legislation rule. 
Accordingly, comments are requested on the provisions of the Agreement 
and on specific jurisdictions and considerations that should be taken 
into account in future agreements.
    Commentators also suggested that a ``stand-alone'' exception to the 
mirror legislation rule be adopted. This exception would apply where 
filing a domestic use election with respect to a dual consolidated loss 
otherwise subject to the mirror legislation rule would not violate the 
policies of section 1503(d). According to the commentators, this is the 
case because the mirror legislation in the foreign country would not 
have the effect of forcing taxpayers to use the losses in the United 
States. The commentators suggested that the mirror legislation rule 
would not apply provided there is not a foreign affiliate to which the 
separate unit or dual resident corporation could put the dual 
consolidated loss to a foreign use. The commentators noted that in 
these situations, the mirror legislation does not result in the revenue 
loss inuring solely to the United States, because it is factually 
impossible for the loss to offset taxable income in the foreign country 
that is not also taken into account in the United States.
    The IRS and Treasury Department generally agree with this comment. 
As a result, these final regulations contain a stand-alone exception to 
the mirror legislation rule.

H. Elimination of a Dual Consolidated Loss After Certain Transactions

    Both the current and proposed regulations contain rules that 
eliminate a dual consolidated loss that is subject to the general 
restrictions under section 1503(d)(1) following certain transactions. 
In the case of a dual resident corporation, the dual consolidated loss 
is generally eliminated in transactions described in section 381(a) 
because the dual resident corporation ceases to exist. In the case of a 
separate unit, the dual consolidated loss is generally eliminated in 
transactions where the separate unit ceases to be a separate unit of 
its domestic owner (either through a transaction described in section 
381(a) or otherwise). In these cases, and subject to the exceptions 
discussed in this preamble, after the transaction it is no longer 
possible for the dual resident corporation or separate unit to generate 
income that can be offset by the dual consolidated loss. As a result, 
any unused dual consolidated loss is eliminated.
    Both the current and the proposed regulations provide exceptions to 
the general elimination rule in the case of certain transactions to 
which section 381(a) applies. These exceptions generally apply in cases 
where it is possible that income that is generated by the transferee 
corporation after the transaction is subject to tax in both the United 
States and the foreign country such that it is appropriate for the 
income to be offset by the dual consolidated loss that carries over to 
the transferee.
    These final regulations make certain modifications to the 
elimination rules. For example, the rules are modified to reflect the 
expansion of the separate unit combination rule. Thus, these final 
regulations take into account transactions involving combined separate 
units that have more than one domestic owner. For example, a dual 
consolidated loss of a domestic owner that is attributable to a 
separate unit will not be eliminated under these final regulations if 
the separate unit continues to be a separate unit of any member of its 
domestic owner's consolidated group.

I. Application of SRLY Limitation to a Former Dual Resident Corporation

    Section 1.1503(d)-3(c)(3) of the proposed regulations provides that 
a dual consolidated loss is treated as a loss incurred by a dual 
resident corporation or separate unit in a separate return limitation 
year (SRLY) and is generally subject to all the limitations of Sec.  
1.1502-21(c). The proposed regulations provide that when determining 
the general SRLY limitation with respect to a dual resident 
corporation, the calculation of aggregate consolidated taxable income 
only includes income, gain, deduction, and loss generated in years in 
which the dual resident corporation is a resident (or is taxed on its 
worldwide income) in the same foreign country in which it was a 
resident (or was taxed on its worldwide income) during the year in 
which the dual consolidated loss was generated. See proposed Sec.  
1.1503(d)-3(c)(3)(iii).
    One commentator noted that this rule prevents the dual consolidated 
loss of a dual resident corporation from being taken into account by 
its consolidated group after the dual resident corporation ceases to be 
subject to tax on a residence basis (or on its worldwide income), 
regardless of whether the former dual resident corporation contributes 
taxable income to the consolidated taxable income of the group. The 
commentator stated that this result is inappropriate because it does 
not merely limit the use of a dual consolidated loss from offsetting 
the income of a domestic affiliate, but has the effect of limiting the 
use of a dual consolidated loss from offsetting the domestic 
corporation's own taxable income.
    The IRS and Treasury Department agree with this comment. Section 
1503(d)(1) provides that a dual consolidated loss of a corporation 
shall not reduce the taxable income of any other member of the 
affiliated group for

[[Page 12908]]

the taxable year or for any other taxable year. However, the 
limitations of section 1503(d)(1) do not prevent the use of a dual 
consolidated loss to offset the income of the dual resident corporation 
that incurred the loss, even where the dual resident corporation ceases 
to be subject to tax in the foreign country. As a result, this rule is 
not contained in these final regulations. But see section 1503(d)(4) 
(relating to tainted assets contributed to a dual resident 
corporation).

J. Effect of Section 1503(d) on Foreign Tax Credits

    Section 1503(d)(2) generally defines a dual consolidated loss to 
mean any net operating loss of a dual resident corporation or a 
separate unit. Section 172(c) generally defines a net operating loss as 
the excess of deductions over gross income. Section 164(a)(3) generally 
provides that foreign taxes are allowed as a deduction for the taxable 
year in which paid or accrued. However, section 275(a)(4) provides that 
no deduction is allowed for any such taxes, to the extent the taxpayer 
chooses to take to any extent the benefits of section 901 (which 
permits taxpayers to claim a credit for certain taxes paid or accrued 
during the taxable year to any foreign country or any possession of the 
United States).
    Commentators asked whether a creditable foreign tax expenditure 
incurred by a dual resident corporation or separate unit, for which an 
election is made to claim a credit pursuant to section 901, may be 
subject to the limitations of section 1503(d)(1).
    The IRS and Treasury Department recognize that policy concerns 
arise in certain transactions in which two or more parties claim a 
credit for the same foreign taxes. Although these policy concerns are 
similar to those arising under section 1503(d), the IRS and Treasury 
Department do not believe that Congress intended the limitations of 
section 1503(d) to apply to foreign taxes, so long as the foreign taxes 
do not enter into the computation of a net operating loss (that is, so 
long as an election is made to claim a credit for such taxes, in lieu 
of deducting them). As a result, under the terms of the statute, the 
limitations of section 1503(d) do not apply to creditable foreign tax 
expenditures incurred by a dual resident corporation or a separate 
unit, provided an election is made to claim a credit with respect to 
such expenditures in accordance with section 901 and the related 
regulations.
    Even though section 1503(d) does not apply to foreign tax credits 
that are claimed by more than one person, the IRS and Treasury 
Department continue to study these transactions and, as appropriate, 
intend to address them in future published guidance under other 
provisions.

K. Tainted Income Rule

    Section 1503(d)(4) grants the Secretary authority to prescribe such 
regulations as may be necessary or appropriate to prevent the avoidance 
of the purposes of section 1503(d) by contributing assets to the 
corporation with the dual consolidated loss after such loss is 
incurred. Section 1.1503-2(e) of the current regulations prevents the 
dual consolidated loss of a dual resident corporation that ceases being 
a dual resident corporation from offsetting the income from assets that 
are acquired by the dual resident corporation in a nonrecognition 
transaction, or as a contribution to capital, at any time during the 
three taxable years immediately preceding the taxable year in which the 
corporation ceases to be a dual resident corporation, or any time 
thereafter. The proposed regulations retained the tainted income rule, 
with certain modifications.
    One commentator noted that the tainted income rule of the current 
and proposed regulations applies with respect to assets acquired by a 
dual resident corporation, regardless of whether such tainted assets 
were received from a member of the dual resident corporation's 
affiliated group. According to this commentator, because section 
1503(d) was intended to prevent the use of a dual consolidated loss 
from offsetting the taxable income of any other member of the 
affiliated group, applying the tainted income rule where the tainted 
assets were not received from a member of the dual resident 
corporation's affiliated group is inconsistent with the policies 
underlying section 1503(d).
    Section 1503(d)(4) grants the Secretary broad regulatory authority 
to implement the tainted income rule. In addition, the IRS and Treasury 
Department believe that adopting the rule suggested by the commentator 
would require the IRS to trace the source of tainted assets received 
(for example, to ensure that the rule cannot be avoided through the 
imposition of an intermediary entity, such as a partnership, or through 
indirect transfers of assets). Moreover, such a rule would be difficult 
for both taxpayers and the IRS to apply, and would increase complexity. 
Accordingly, the IRS and Treasury Department believe that the tainted 
income rule should continue to apply without regard to the source of 
the tainted assets. As a result, this comment is not adopted.

L. Items Taken Into Account in Computing Income or a Dual Consolidated 
Loss

(1) In General
    Section 1503(d)(2)(A) generally defines a dual consolidated loss to 
mean any net operating loss of a domestic corporation which is subject 
to an income tax of a foreign country on its income without regard to 
whether such income is from sources inside or outside such foreign 
country, or is subject to such a tax on a residence basis. Section 
1503(d)(3) grants the Secretary broad authority to subject any loss of 
a separate unit of a domestic corporation to the limitations of section 
1503(d). Because separate units are not themselves taxpayers, it is 
necessary to determine which items of income, gain, deduction, and loss 
of the domestic owner of the separate unit should be taken into account 
for purposes of calculating a dual consolidated loss.
    Section 1.1503-2(d)(1)(ii) of the current regulations provides a 
limited rule for attributing items of a domestic owner to a separate 
unit. Under this rule, a separate unit must compute its income as if it 
were a separate domestic corporation that is a dual resident 
corporation, using only those items of income, expense, deduction, and 
loss that are otherwise attributable to such separate unit. For this 
purpose, only items of the domestic owner that are recognized for U.S. 
tax purposes are taken into account.
    In response to requests for additional guidance in this area, the 
proposed regulations provide more detailed rules for determining the 
amount of income or dual consolidated loss of a separate unit. This 
determination depends on various factors, including the type of 
separate unit, the ownership structure, and the nature of the item. The 
determination generally turns on whether it is likely that the relevant 
foreign country would take into account the item (assuming the item is 
recognized) for tax purposes. This determination is solely for purposes 
of section 1503(d) and does not apply for any other purpose, such as 
attributing items under an applicable income tax treaty or under other 
Code sections such as section 884 or 987.
    These final regulations adopt the attribution rules contained in 
the proposed regulations, with modifications.

[[Page 12909]]

(2) Books and Records
    The proposed regulations provide that, in general, the items of 
income, gain, deduction, and loss that are attributable to a hybrid 
entity (and, therefore, attributable to interests in the hybrid entity) 
are those that are properly reflected on its books and records, as 
adjusted to conform to U.S. tax principles. The proposed regulations 
further provide that the principles of Sec.  1.988-4(b)(2) apply for 
purposes of making this determination.
    One commentator asked whether Sec.  1.988-4(b)(2) is a strict 
booking rule, or whether it would instead permit taxpayers to take 
positions contrary to how items are reflected on the books and records 
if, under the facts and circumstances, the items were not appropriately 
reflected on the books and records. Another commentator stated that the 
clause ``to the extent consistent with U.S. tax principles'' in the 
proposed regulations created uncertainty.
    In response to these comments, the final regulations clarify that 
only the Commissioner, and not the taxpayer, may make adjustments to 
the books and records where the booking practices are employed with a 
principle purpose of avoiding the principles of section 1503(d), 
including inconsistently treating the same or similar items of income, 
gain, deduction, and loss. In addition, these final regulations clarify 
that, in general, a domestic owner's items of income, gain, deduction, 
and loss are attributable to the domestic owner's hybrid entity 
separate unit, or interest in a transparent entity, to the extent such 
items are reflected on the hybrid entity or transparent entity's books 
and records (as defined in Sec.  1.989(a)-1(d)), as adjusted to conform 
to U.S. tax principles.
    The books and records standard set forth in these final regulations 
is intended to be consistent with the more detailed approach for 
attributing items that was adopted in proposed Sec.  1.987-2(b) that 
was published on September 7, 2006 (REG-208270-86, 71 FR 52875). It is 
anticipated that when those regulations are published as final 
regulations in the Federal Register, that approach will, as 
appropriate, be incorporated into these regulations. The IRS and 
Treasury Department believe that applying consistent standards under 
these two provisions, where appropriate, would make the rules more 
administrable. Comments are requested as to whether the standard 
contained in the section 987 proposed regulations is appropriate for 
purposes of section 1503(d).
(3) Attributing Interest Expense Under the Principles of Sec.  1.882-5
    The proposed regulations provide that the principles of Sec.  
1.882-5, as modified, apply for purposes of determining the interest 
expense that is attributable to a foreign branch separate unit. In 
making this determination, and solely for this purpose, the domestic 
owner is treated as a foreign corporation, the foreign branch separate 
unit is treated as a trade or business within the United States, and 
assets other than those of the foreign branch separate unit are treated 
as assets that are not U.S. assets.
    Two comments were received on the application of this rule. First, 
commentators stated that adopting the principles of Sec.  1.882-5 
results in unnecessary complexity. These commentators suggested that, 
in lieu of using the principles of Sec.  1.882-5, the interest expense 
of a foreign branch separate unit be determined by reference to its 
books and records. Another commentator noted the rationale of using the 
principles of Sec.  1.882-5 as a general matter, but suggested that 
where the foreign country looks to the books and records of the foreign 
branch separate unit for purposes of computing the interest expense of 
the separate unit, it would be appropriate to use the books and records 
for purposes of section 1503(d).
    The IRS and Treasury Department continue to believe that the 
principles of Sec.  1.882-5, as modified, serve as a reasonable proxy 
for determining the items of interest expense recognized for U.S. tax 
purposes that, if recognized by the foreign country, would be taken 
into account by the foreign country. Therefore, the principles of Sec.  
1.882-5, as modified, are retained as the general rule for purposes of 
determining the interest expense that is attributable to a foreign 
branch separate unit.
    However, to minimize complexity, the IRS and Treasury Department 
believe it is appropriate to use a books and records approach, where 
possible. Therefore, these final regulations provide an exception to 
the general rule such that interest expense is attributable to a 
foreign branch separate unit to the extent it is reflected on its books 
and records. This exception only applies if the foreign country in 
which the foreign branch is located determines, for purposes of 
computing the taxable income (or loss) under the laws of the foreign 
country, the interest expense of the foreign branch separate unit by 
taking into account only the items of interest expense reflected on the 
foreign branch separate unit's books and records. This rule will not 
apply, however, in cases where the foreign country does not use a 
strict booking approach for interest expense.
    Finally, it is important to note that in all cases only items of 
interest expense, as determined for U.S. tax purposes, are taken into 
account. The treatment of interest expense in the foreign country is 
only relevant for purposes of determining the method under which items 
of interest expense (determined for U.S. tax purposes) is attributed to 
the foreign branch separate unit.
(4) Treaty-Based Methods
    The proposed regulations provide that for purposes of determining 
the items of income, gain, deduction (other than interest), and loss 
that are taken into account in determining the taxable income or loss 
of a foreign branch separate unit, the principles of sections 864(c)(2) 
and (c)(4) as set forth in Sec. Sec.  1.864-4(c) and 1.864-6 shall 
apply.
    One commentator stated that domestic corporations operating foreign 
branch separate units should be allowed to attribute items to the 
foreign branch separate unit based on the method provided under an 
income tax treaty between the United States and the foreign country (or 
between two foreign countries if foreign branch operations are 
conducted by a hybrid entity outside its home country). The IRS and 
Treasury Department believe that this approach is inappropriate for two 
reasons. First, it would have the effect of attributing items 
recognized by the foreign jurisdiction, which may not be recognized as 
items for U.S. tax purposes. This would be inconsistent with section 
1503(d), which defines a dual consolidated loss solely based on U.S. 
tax rules. Second, this approach would require the interpretation of 
foreign law, which the IRS and Treasury Department believe should be 
avoided, to the extent possible. Accordingly, this comment is not 
adopted.
(5) Gain or Loss Recognized Under Section 987
    The proposed regulations do not provide whether gain or loss of a 
domestic owner recognized under section 987 as a result of a remittance 
or transfer is attributable to a separate unit for purposes of 
calculating income or dual consolidated loss, but instead request 
comments.
    Commentators stated that gain or loss recognized under section 987 
should not be attributable to a separate unit because in most cases the 
foreign country would not recognize such items since the income of the 
separate unit will be computed in the local currency. The IRS and 
Treasury Department agree

[[Page 12910]]

with this comment. As a result, these final regulations provide that 
gain or loss recognized under section 987, as a result of a remittance 
or transfer, will not be taken into account for purposes of computing 
the income or dual consolidated loss of a separate unit.
(6) Attributable To or Taken Into Account
    The proposed regulations generally provide that items are 
attributable to a hybrid entity separate unit, but are taken into 
account by a foreign branch separate unit. The IRS and Treasury 
Department believe that the use of these different terms is unnecessary 
and may lead to confusion. As a result, these final regulations provide 
that items are attributable to a separate unit, regardless of whether 
the separate unit is a foreign branch separate unit or a hybrid entity 
separate unit.

M. Basis Adjustments

    Section 1.1503-2(d)(3) of the current regulations contains special 
basis adjustment rules that override the normal investment adjustment 
rules under Sec.  1.1502-32 for stock of affiliated dual resident 
corporations and affiliated domestic owners owned by other members of 
the consolidated group. Similar rules apply to separate units arising 
from the ownership of an interest in a partnership. These special basis 
adjustment rules were included in the current regulations to prevent 
the indirect deduction of a dual consolidated loss. Although the 
proposed regulations retain these rules, the IRS and Treasury 
Department requested comments on whether the special basis adjustment 
rules should be retained.
    A number of commentators recommended that the special basis 
adjustment rules be removed for several reasons. For example, the 
commentators noted that an indirect use, which the special basis rules 
were intended to prevent, may not occur for many years after the dual 
consolidated loss was incurred. In response to these comments, the 
special basis rules are not contained in these final regulations. Thus, 
the basis adjustment rules under Sec.  1.1502-32 shall apply without 
modification for purposes of determining the adjusted basis in the 
stock of a dual resident corporation or the stock of an affiliated 
domestic owner owned by other members of the consolidated group. These 
final regulations also contain rules to ensure consistent treatment for 
a partner's basis in a partnership interest that is a separate unit, or 
through which a separate unit is owned indirectly.

N. Losses of a Foreign Insurance Company Treated as a Domestic 
Corporation

(1) In General
    Section 953(d) generally provides that a foreign corporation that 
would qualify to be taxed as an insurance company if it were a domestic 
corporation may, under certain circumstances, elect to be treated as a 
domestic corporation (section 953(d) company). Section 953(d)(3) 
provides that if a section 953(d) company is treated as a member of an 
affiliated group, any loss of such corporation is treated as a dual 
consolidated loss for purposes of section 1503(d), without regard to 
section 1503(d)(2)(B) (grant of regulatory authority to exclude losses 
which do not offset the income of foreign corporations from the 
definition of a dual consolidated loss).
    The current regulations do not address the application of section 
953(d)(3). In the proposed regulations, however, the definition of a 
dual resident corporation includes a section 953(d) company that is a 
member of an affiliated group. In addition, the proposed regulations 
clarify that a section 953(d) company may not make a domestic use 
election. These rules are consistent with section 953(d)(3).
    In response to comments, these final regulations provide additional 
guidance on the application of the dual consolidated loss rules to 
section 953(d)(3) companies, including the treatment of separate units 
owned by such companies.
(2) Transactions Intended To Avoid the Limitations of Sections 
953(d)(3) and 1503(d)
    The IRS and Treasury Department understand that taxpayers may be 
implementing structures that result in the same overall tax 
consequences as structures that Congress intended to be subject to the 
loss limitation rules provided under sections 953(d)(3) and 1503(d). 
However, taxpayers may be taking the position that the structures are 
not subject to these loss limitation rules. For example, a foreign 
insurance company may, in lieu of making an election under section 
953(d) and thus being subject to the limitations of sections 953(d)(3) 
and 1503(d), file a certificate of domestication in a state as a 
limited liability company. As a business entity with multiple charters, 
this entity would be treated as a domestic corporation for U.S. tax 
purposes under Sec.  301.7701-2(b)(9). Taxpayers may take the position 
that this entity would be entitled to the same benefits of a company 
that makes an election under section 953(d), without being subject to 
the limitations on the use of its losses that are imposed under 
sections 953(d)(3) and 1503(d).
    The IRS and Treasury Department disagree with the taxpayer's 
characterization of these structures under current law. In addition, 
the IRS and Treasury Department believe the taxpayers' characterization 
of the structures is contrary to the policies underlying section 
953(d). Accordingly, the IRS and Treasury Department are considering 
issuing regulations, which may be retroactive, that would clarify the 
application of section 953(d)(3) to these structures. These regulations 
would provide that if a foreign insurance company is eligible to make 
an election to be treated as a domestic corporation pursuant to section 
953(d), but in lieu of making such election becomes a domestic 
corporation through other means (for example, by filing a certificate 
of domestication in a state as a limited liability company), then such 
company shall be subject to the limitations under sections 953(d)(3) 
and 1503(d) (without regard to paragraph (2)(B) thereof). The IRS and 
Treasury Department request comments regarding appropriate rules to 
address these structures and other structures that are intended to 
avoid the purposes of section 953(d)(3).

O. All or Nothing Rule

    Under the current regulations a triggering event (other than a 
foreign use) generally can be rebutted only if no portion of the dual 
consolidated loss can be used by (or carries over to) another person 
under foreign law. See Sec.  1.1503-2(g)(2)(iii)(A)(2) through (7). 
Thus, even a de minimis foreign use will cause the entire amount of the 
dual consolidated loss to be recaptured and reported as income.
    The proposed regulations retain this so-called all or nothing 
principle because the IRS and Treasury Department recognize that 
departing from it would lead to significant administrative burdens for 
the Commissioner and taxpayers. Although the all or nothing principle 
was retained, the IRS and Treasury Department requested comments 
regarding administrable alternatives that would not involve substantial 
analysis of foreign law.
    Several comments were received with respect to this issue. A number 
of commentators stated that the final regulations should remove the all 
or nothing principle and allow for a pro-rata recapture such that, for 
example, the disposition of an individual separate unit, which is part 
of a combined

[[Page 12911]]

separate unit, would not result in the entire recapture of the combined 
separate unit's dual consolidated loss, but only the portion of the 
loss attributable to the individual separate unit. Another commentator 
suggested removing the all or nothing rule and allowing a taxpayer to 
establish that the losses otherwise subject to recapture were not, in 
fact, used under foreign law. The commentator suggested that any 
concerns regarding an analysis of foreign law could be mitigated by 
requiring the taxpayer to provide certified copies of foreign tax 
returns and, in addition, where the foreign tax base differs 
substantially from the U.S. tax base, by adopting an apportionment 
methodology.
    The IRS and Treasury Department continue to believe that, even 
under the approaches suggested by these commentators, departing from 
the all or nothing principle would lead to substantial administrative 
complexity. As a result, these comments are not adopted.
    Another commentator suggested that the final regulations include a 
general de minimis rule for purposes of applying the triggering and 
recapture provisions. Under this approach, if a taxpayer could 
establish that less than a specific percentage of the dual consolidated 
loss is available for a foreign use, the taxpayer could avoid recapture 
altogether. However, in situations where the potential loss available 
for a foreign use exceeds the de minimis amount, the dual consolidated 
loss would be recaptured to the extent it was actually put to a foreign 
use.
    The IRS and Treasury Department do not believe that a de minimis 
rule as described would be meaningful given that the Commissioner and 
taxpayers would be required to determine the actual amount of the dual 
consolidated loss available for foreign use, which poses the same 
administrative concerns as generally departing from the all or nothing 
principle (that is, a complex analysis of foreign law or complicated 
ordering, stacking, or tracing rules). As a result, this suggestion is 
not adopted.
    Finally, commentators suggested that following certain events 
otherwise requiring recapture, a taxpayer should be allowed to reduce 
the amount of recapture by establishing that a portion of the dual 
consolidated loss is attributable to items of deduction or loss that, 
due to permanent differences between the U.S. and foreign tax law, do 
not give rise to a corresponding item of deduction or loss in the 
foreign country. The commentators cited items of deduction or loss 
composing the dual consolidated loss attributable to a basis step-up 
following a section 338 election, or attributable to a deduction 
arising from the amortization of goodwill or certain intangibles under 
section 197, as examples of such items.
    The IRS and Treasury Department recognize that items of deduction 
or loss that are never taken into account in the foreign country cannot 
be put to a foreign use. However, the IRS and Treasury Department 
believe that the suggested approach would, in most situations, involve 
many items of deduction and loss and, as a result, would present the 
same concerns as are present in the other approaches discussed above. 
For example, if the deductions giving rise to a dual consolidated loss 
were the result of a step-up in basis following a section 338 election, 
but the various assets to which such basis attached had, prior to the 
election, a basis for foreign tax purposes, complex ordering and 
stacking rules would be required to determine that, in fact, no portion 
of the dual consolidated loss is attributable to the pre-existing 
foreign tax basis. In addition, this approach would require rules to 
distinguish a permanent (or base) difference from a timing difference, 
in order to ensure that the portion of the dual consolidated loss that 
is not being recaptured would not be available for a foreign use at 
some point in the future. As a result, such rules would add complexity 
and would be administratively burdensome. Accordingly, this comment is 
not adopted.
    Although these comments are not adopted in the final regulations, 
the IRS and Treasury Department believe that the application of the all 
or nothing rule will be significantly reduced under these regulations 
as a result of the new exceptions to foreign use and the further 
reduction of the term of the certification period.

P. Triggering Events and Related Rules

(1) Modification of Exceptions to Triggering Events
    The proposed regulations contain exceptions to triggering events 
that generally apply where assets or interests sold or disposed of are 
acquired, directly or through certain wholly-owned pass-through 
entities, by members of the consolidated group that includes the dual 
resident corporation or separate unit, or by the unaffiliated domestic 
owner.
    The final regulations generally retain these exceptions, but modify 
them to take into account the new exceptions to foreign use. For 
example, the exceptions are modified to include certain acquisitions by 
pass-through entities that are more than 90-percent owned (rather than 
wholly owned) by the consolidated group or unaffiliated domestic owner. 
These rules also address certain deemed transactions (for example, 
pursuant to Rev. Rul. 99-5 (1999-1 CB 434)) to minimize the likelihood 
that they result in triggering events, where appropriate, see Sec.  
601.601(d)(2)(ii)(b).
    Finally, in response to comments discussed in section G(3) of this 
preamble, these regulations contain a new exception to triggering 
events that occur as a result of certain compulsory transfers.
(2) Rebuttal
    Under the current regulations, taxpayers may rebut all but two of 
the triggering events such that there is no recapture of a certified 
dual consolidated loss (or related interest charge) as a result of a 
putative triggering event. In general, under the current regulations, a 
triggering event is rebutted if the taxpayer demonstrates to the 
satisfaction of the Commissioner that, depending on the triggering 
event, either: (1) The losses, expenses, or deductions of the dual 
resident corporation (or separate unit) cannot be used to offset income 
of another person under the laws of a foreign country; or (2) the 
transfer of assets did not result in a carryover under foreign law of 
the losses, expenses, or deductions of the dual resident corporation 
(or separate unit). See Sec.  1.1503-2(g)(2)(iii)(A)(2) through 1.1503-
2(g)(2)(iii)(A)(7). The dual consolidated loss rules do not require 
recapture or an interest charge in such cases because there is no 
opportunity for any portion of the dual consolidated loss to be used to 
offset income of any other person under the income tax laws of a 
foreign country.
    The proposed regulations generally retain the rebuttal standard 
contained in the current regulations, with modifications. Taxpayers may 
rebut a triggering event under the proposed regulations if it can be 
demonstrated, to the satisfaction of the Commissioner, that there can 
be no foreign use of the dual consolidated loss. However, unlike the 
current regulations that have different standards for different 
triggering events, the proposed regulations apply the same standard to 
all triggering events (other than a foreign use triggering event, which 
cannot be rebutted).
    One commentator noted that the rebuttal standard of the proposed 
regulations is unnecessarily broad with respect to certain asset 
transfers. For

[[Page 12912]]

example, according to this commentator, a triggering event cannot be 
rebutted under this standard where a separate unit transfers over 50 
percent of its assets in a transaction that does not result in a loss 
carryover to the transferee under foreign law. This is the case because 
the separate unit would not be able to establish that the dual 
consolidated loss, which did not carry over to the transferee, could 
never be put to a foreign use. Accordingly, this commentator requested 
that the rebuttal standard for asset transfers contained in the current 
regulations be adopted in the final regulations.
    The IRS and Treasury Department agree with this comment and these 
final regulations are modified accordingly.
    Another commentator noted that neither the proposed nor current 
regulations specify how taxpayers must demonstrate that there can be no 
foreign use during the remaining certification period by any means. The 
commentator stated that this lack of specificity creates uncertainty 
and, as a result, requested additional guidance as to how the 
determination is to be made.
    The IRS and Treasury Department believe that this demonstration can 
be made in a number of ways, including based on the taxpayer's 
interpretation of foreign law, on an opinion from local advisors, or on 
assurance from the local country tax authorities. In all cases, 
however, the determination must be made to the satisfaction of the 
Commissioner. These final regulations are modified accordingly.
(3) Reduction of Recapture Amount
    The proposed regulations permit the elector to reduce the amount of 
the dual consolidated loss that must be recaptured upon a triggering 
event. The recapture amount can be reduced to the extent the elector 
demonstrates that the dual consolidated loss would have offset other 
income of the dual resident corporation or separate unit reported on a 
timely filed U.S. income tax return for any taxable year up to and 
including the taxable year of the triggering event if such loss had 
been subject to the limitation under Sec.  1.1503(d)-2(b) of the 
proposed regulations.
    Commentators questioned the requirements for the reduction of the 
recapture amount. One commentator suggested that recapture should be 
reduced by the amount of subsequent income attributable to the dual 
resident corporation or separate unit, irrespective of the income or 
loss of other group members.
    The IRS and Treasury Department recognize that the policies 
underlying the SRLY rules differ from those underlying section 1503(d). 
Although the SRLY rules do not provide for a reduction in recapture in 
all cases consistent with the views of this commentator, the IRS and 
Treasury Department continue to believe that the SRLY rules are a 
reasonable and appropriate mechanism for implementing the restrictions 
of section 1503(d)(1) in the vast majority of cases. Further, the IRS 
and Treasury Department believe that deviating from the SRLY mechanism 
would add considerable complexity to the rules and could lead to 
unintended consequences. As a result, this comment is not adopted. The 
IRS and Treasury Department will consider addressing the interaction of 
the SRLY rules with the recapture provisions in future guidance. 
Comments are requested as to alternative mechanisms that are more 
consistent with dual consolidated loss policy and that are not unduly 
complicated.
(4) Interest Due on Recapture
    Under both the current regulations and these final regulations, 
taxpayers must pay an interest charge in connection with recapture that 
is computed under the rules of section 6601. In response to comments, 
these final regulations clarify that this interest charge is deductible 
to the same extent as interest under section 6601.
(5) Treatment of Recapture Income Under Section 384
    One commentator requested clarification regarding a subsequent 
elector's agreement to treat potential recapture amounts as unrealized 
built-in gain for purposes of section 384(a). The commentator stated 
that it may be unclear as to whether section 384 must otherwise apply 
to the transaction, whether the thresholds of section 384 apply, and 
whether potential recapture income treated as unrealized built-in gain 
is subject to reduction for income earned by a separate unit or dual 
resident corporation.
    The IRS and Treasury Department believe that potential recapture 
amounts should be treated as unrealized built-in gains for purposes of 
determining whether section 384 applies, but that the requirements and 
exceptions of section 384 otherwise apply. In addition, the potential 
recapture amount treated as unrealized built-in gain may be reduced by 
potential offset, as permitted under the regulations. These final 
regulations have been modified accordingly.
(6) Reconstituted Dual Consolidated Loss
    Both the current and proposed regulations contain a reconstituted 
loss provision. This rule generally provides that if a dual 
consolidated loss is recaptured as a result of a triggering event, the 
dual resident corporation or separate unit that incurred the loss is 
treated as having a net operating loss in an amount equal to the amount 
recaptured. The loss is reconstituted in the taxable year immediately 
following the year of the recapture and is subject to the general 
restrictions of section 1503(d). This rule is intended to put the 
taxpayer in the same approximate position it would have been in had it 
never made an election to use the dual consolidated loss.
    These final regulations modify the proposed regulations' 
reconstituted loss rule to reflect the expansion of the separate unit 
combination rule and the rules that eliminate dual consolidated losses 
following certain transactions. In addition, the rule was modified to 
better take into account the interaction of the dual consolidated loss 
rules with the general loss carryover rules. For example, these final 
regulations provide that, other than with respect to the multiple-party 
event exception, a transfer of an interest in a separate unit by its 
domestic owner to another corporation cannot cause all or a portion of 
the dual consolidated loss of such separate unit to carry over to the 
acquiring corporation, absent the application of section 381.

Q. Certification Period

    Section 1.1503-2(g)(2)(vi)(B) of the current regulations provides 
that if a (g)(2)(i) election is made with respect to a dual 
consolidated loss of a dual resident corporation or a hybrid entity 
separate unit, the consolidated group, unaffiliated dual resident 
corporation, or unaffiliated domestic owner, as the case may be, must 
file with its tax return an annual certification during the 15 year 
certification period. This filing permits the dual consolidated loss to 
be used in the United States to offset the income of a domestic 
affiliate but certifies that the losses or deductions that make up the 
dual consolidated loss have not been used to offset the income of 
another person under the tax laws of a foreign country. The current 
regulations do not require annual certifications for (g)(2)(i) 
agreements entered into with respect to dual consolidated losses of 
foreign branch separate units. The current regulations also provide 
that if there is a triggering event during the 15 year period

[[Page 12913]]

following the year in which the dual consolidated loss was incurred 
(certification period), the taxpayer must recapture and report as 
income the amount of the dual consolidated loss, and pay an interest 
charge. Sec.  1.1503-2(g)(2)(iii)(A).
    The proposed regulations reduce the certification period from 15 
years to seven years, and expand the annual certification requirement 
to include dual consolidated losses of foreign branch separate units.
    Commentators recommended that the certification period in the 
proposed regulations be further reduced to five years, because such 
five-year period would be sufficient to deter the types of double dips 
with which section 1503(d) is concerned, and would be consistent with 
time periods used under similar provisions (for example, the term of 
gain recognition agreements entered into under section 367(a)). The IRS 
and Treasury Department agree with this comment, and, as a result, the 
certification period in these final regulations is five years.
    Another commentator asserted that extending the annual 
certification requirement to foreign branch separate units is both 
unnecessary and administratively burdensome and, as a result, such 
certification should not be included in these final regulations.
    The IRS and Treasury Department continue to believe that the annual 
certification requirement improves taxpayer compliance and is 
beneficial in monitoring and deterring inappropriate double dips. In 
addition, the IRS and Treasury Department believe that, where 
appropriate, treating foreign branch separate units, hybrid entity 
separate units, and dual resident corporations consistently for 
purposes of section 1503(d) will reduce the administrative complexity 
of these regulations. As a result, this comment is not adopted.

R. Other Comments and Modifications

(1) Information Provided With Domestic Use Election
    One commentator recommended that certain information provided with 
the domestic use election should not bind a taxpayer if the information 
is provided in good faith, but subsequently is determined to be 
erroneous. The IRS and Treasury Department believe that adopting this 
recommendation would be administratively burdensome. Accordingly, this 
comment is not adopted.
(2) No possibility of Foreign Use
    One commentator noted that taxpayers may be eligible to demonstrate 
no possibility of foreign use, but still choose to enter into a 
domestic use agreement. The commentator explained that taxpayers may do 
so to avoid the cost and effort required to satisfy the no possibility 
of foreign use standard, recognizing that this demonstration would only 
be beneficial if there is a triggering event during the certification 
period. The commentator further stated that the taxpayer should 
nonetheless retain the ability to argue at a later time, when a foreign 
use may occur after a change in foreign law, that no dual consolidated 
loss existed in the year in which the loss was actually incurred. Thus, 
if there was a change in foreign law, taxpayers would not be penalized 
for being unable to rebut the triggering event in the current year (due 
to a change in foreign law) but could instead rely on the foreign law 
in effect for the year in which the loss was incurred.
    The IRS and Treasury Department recognize that taxpayers may simply 
choose to file a domestic use election, rather than engage in 
additional efforts to demonstrate no possibility of foreign use. The 
IRS and Treasury Department believe that these final regulations 
provide ample opportunities for taxpayers willing to demonstrate no 
possibility of foreign use. Taxpayers have three opportunities to 
demonstrate no possibility of foreign use under the final regulations: 
first under Sec.  1.1503(d)-6(c) to be excepted from the domestic use 
limitation, second under Sec.  1.1503(d)-6(e)(2) to rebut a triggering 
event, and third under Sec.  1.1503(d)-6(j)(2) to terminate a domestic 
use agreement. Because of these opportunities and the administrative 
burdens that would ensue from taking into account changes in foreign 
law, this comment is not adopted.

S. Effective Dates

(1) General Rule
    Except as provided in this preamble, these final regulations apply 
to dual consolidated losses incurred in taxable years beginning on or 
after April 18, 2007. However, a taxpayer may apply these regulations, 
in their entirety, to dual consolidated losses incurred in taxable 
years beginning on or after January 1, 2007.
(2) Certification Period
    A number of commentators requested that the reduced certification 
period of these final regulations apply with respect to dual 
consolidated losses that are subject to the current regulations. The 
commentators asserted that the policies underlying the reduced 
certification period should apply equally to dual consolidated losses 
that are subject to the current regulations. Commentators also 
recommended that the reduced certification period contained in these 
final regulations apply to closing agreements entered into between 
taxpayers and the IRS pursuant to Sec.  1.1503-2(g)(2)(iv)(B)(3)(i) and 
Rev. Proc. 2000-42 (2000-2 CB 394), see Sec.  601.601(d)(2)(ii)(b).
    The IRS and Treasury Department generally agree with these comments 
and these final regulations are modified accordingly.
(3) Reasonable Cause Exception
    These final regulations adopt the reasonable cause procedure for 
purposes of curing all late filings as introduced in the proposed 
regulations, and subsequently modified by Notice 2006-13 (2006-8 IRB 
496) see Sec.  601.601(d)(2)(ii)(b). Moreover, these final regulations 
provide that the reasonable cause procedures supplant the current 
procedures for all untimely filings with respect to dual consolidated 
losses incurred under the current regulations as well, except with 
respect to requests for closing agreements. Taxpayers requiring relief 
to cure a late request for a closing agreement must continue to seek 
extensions of time under Sec. Sec.  301.9100-1 through 301.9100-3 and 
Rev. Proc. 2000-42 (2000-2 CB 394), see Sec.  601.601(d)(2)(ii)(b). 
Taxpayers seeking relief for other late filings required in connection 
with such closing agreements must, however, use the reasonable cause 
procedure of these final regulations. Therefore, as a result of these 
changes, untimely filings under section 1503(d) and these regulations 
will no longer be eligible for the relief provided by Sec. Sec.  
301.9100-1 through 301.9100-3, regardless of whether such filings were 
required under the current regulations (except for certain closing 
agreements) or these final regulations.
(4) Multiple-Party Event Exception to Triggering Events
    These final regulations provide an exception to certain triggering 
events involving multiple parties. In general, the exceptions provided 
under these final regulations with respect to multiple-party events are 
similar to those provided under Sec.  1.1503-2(g)(2)(iv)(B)(1). The 
procedures required to satisfy these multiple-party event exceptions 
are also similar to those found in Sec.  1.1503-2(g)(2)(iv)(B)(3). One 
important difference is that these final regulations do not require (or 
permit) taxpayers to obtain closing agreements. These final regulations 
also provide a special effective date

[[Page 12914]]

provision with respect to events described in Sec.  1.1503-
2(g)(2)(iv)(B)(1) that occur after April 18, 2007, that are with 
respect to dual consolidated losses subject to the current regulations. 
Such events are not eligible for the exception described in Sec.  
1.1503-2(g)(2)(iv)(B)(1) and thus are not eligible for a closing 
agreement as described in Sec.  1.1503-2(g)(2)(iv)(B)(3)(i). Instead, 
such events are eligible for the multiple-party event exception 
described in these final regulations and as modified by the special 
effective date provision of Sec.  1.1503(d)-8(b)(4). Taxpayers may, 
however, choose to apply the multiple-party exception to events 
described in Sec.  1.1503-2(g)(2)(iv)(B)(1)(i) through (iii) that occur 
after March 19, 2007 and on or before April 18, 2007.
(5) Basis Adjustments
    One commentator requested that the elimination of the special basis 
adjustments described in paragraph M of this preamble be applied 
retroactively. The commentator further requested that such retroactive 
application apply to adjustments that occurred in closed taxable years 
if the basis of the stock is relevant in an open taxable year.
    The IRS and Treasury Department agree with this comment. As a 
result, these regulations provide that taxpayers may apply the basis 
adjustment rules of these final regulations for all taxable years if 
such adjustments affected tax basis that is relevant in an open taxable 
year.
(6) Other Provisions
    A number of commentators requested that the IRS and Treasury 
Department provide that taxpayers be allowed to electively apply other 
provisions of these regulations to dual consolidated losses that are 
subject to the current regulations.
    The IRS and Treasury Department do not believe that it would be 
appropriate to allow taxpayers to selectively apply provisions of these 
regulations (other than those that the IRS and Treasury Department view 
as clarifications) retroactively, because it would lead to 
administrative complexity for the IRS and could lead to unintended 
results.

Effect on Other Documents

    These final regulations obsolete Notice 2006-13 (2006-8 IRB 496), 
see Sec.  601.601(d)(2)(ii)(b). These final regulations also obsolete 
Rev. Proc. 2000-42 (2000-2 CB 394), see Sec.  601.601(d)(2)(ii)(b), 
with respect to triggering events occurring after April 18, 2007.

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 is hereby 
certified that these regulations will not have a significant economic 
impact on a substantial number of small entities. This certification is 
based on the fact that these regulations will primarily affect 
affiliated groups of corporations that also have a foreign affiliate, 
which tend to be larger businesses. Moreover, the number of taxpayers 
affected and the average burden are minimal. Therefore, a Regulatory 
Flexibility Analysis is not required. Pursuant to section 7805(f) of 
the Internal Revenue Code, the notice of proposed rulemaking preceding 
this regulation was submitted to the Chief Counsel for Advocacy of the 
Small Business for comment on its impact on small business.

Drafting Information

    The principal authors of these regulations are Jeffrey P. Cowan, of 
the Office of the Associate Chief Counsel (International), and 
Christopher L. Trump, formerly of the Office of the Associate Chief 
Counsel (International). However, other personnel from the IRS and 
Treasury Department participated in their development.

List of Subjects

26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

26 CFR Part 602

    Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

0
Accordingly, 26 CFR parts 1 and 602 are amended as follows:

PART 1--INCOME TAXES

0
Paragraph 1. The authority citation for part 1 is amended by adding an 
entry in numerical order to read in part as follows:

    Authority: 26 U.S.C. 7805 * * *
    Section 1.1503(d) also issued under 26 U.S.C. 953(d) and 26 
U.S.C. 1502.


Sec.  1.1502-21  [Amended]

0
Par. 2. In Sec.  1.1502-21, paragraph (c)(2)(v) is amended by removing 
the language ``Sec.  1.1503-2'' and adding ``Sec. Sec.  1.1503(d)-1 
through 1.1503(d)-8'' in its place.


Sec.  1.1503-2A  [Removed]

0
Par. 3. Section 1.1503-2A is removed.
0
Par. 4. New Sec. Sec.  1.1503(d)-0 through 1.1503(d)-8 are added to 
read as follows:


Sec.  1.1503(d)-0  Table of contents.

    This section lists the captions contained in Sec. Sec.  1.1503(d)-1 
through 1.1503(d)-8.

Sec.  1.1503(d)-1 Definitions and special rules for filings under 
section 1503(d).

(a) In general.
(b) Definitions.
(1) Domestic corporation.
(2) Dual resident corporation.
(3) Hybrid entity.
(4) Separate unit.
(i) In general.
(ii) Separate unit combination rule.
(iii) Business operations that do not constitute a permanent 
establishment.
(iv) Foreign branch separate units held by dual resident 
corporations or hybrid entities in the same foreign country.
(5) Dual consolidated loss.
(6) Subject to tax.
(7) Foreign country.
(8) Consolidated group.
(9) Domestic owner.
(10) Affiliated dual resident corporation and affiliated domestic 
owner.
(11) Unaffiliated dual resident corporation, unaffiliated domestic 
corporation, and unaffiliated domestic owner.
(12) Domestic affiliate.
(13) Domestic use.
(14) Foreign use.
(15) Grantor trust.
(16) Transparent entity.
    (i) In general.
(ii) Example.
    (17) Disregarded entity.
(18) Partnership.
(19) Indirectly.
(20) Certification period.
(c) Special rules for filings under section 1503(d).
(1) Reasonable cause exception.
(2) Requirements for reasonable cause relief.
    (i) Time of submission.
(ii) Notice requirement.
(3) Signature requirement.

Sec.  1.1503(d)-2 Domestic use.

Sec.  1.1503(d)-3 Foreign use.

(a) Foreign use.
    (1) In general.
    (2) Indirect use.
    (i) General rule.
    (ii) Exception.
    (iii) Examples.
    (3) Deemed use.
(b) Available for use.
(c) Exceptions.
    (1) In general.
    (2) Election or merger required to enable foreign use.
    (3) Presumed use where no foreign country rule for determining 
use.
    (4) Certain interests in partnerships or grantor trusts.
    (i) General rule.
    (ii) Combined separate unit.

[[Page 12915]]

    (iii) Reduction in interest.
    (5) De minimis reduction of an interest in a separate unit.
    (i) General rule.
    (ii) Limitations.
    (iii) Reduction in interest.
    (iv) Examples and coordination with exceptions to other 
triggering events.
    (6) Certain asset basis carryovers.
    (7) Assumption of certain liabilities.
    (i) In general.
    (ii) Ordinary course limitation.
    (8) Multiple-party events.
    (9) Additional guidance.
(d) Ordering rules for determining the foreign use of losses.
(e) Mirror legislation rule.
    (1) In general.
    (2) Stand-alone exception.
    (i) In general.
    (ii) Stand-alone domestic use agreement.
    (iii) Termination of stand-alone domestic use agreement.

Sec.  1.1503(d)-4 Domestic use limitation and related operating rules.

(a) Scope.
(b) Limitation on domestic use of a dual consolidated loss.
(c) Effect of a dual consolidated loss on a consolidated group, 
unaffiliated dual resident corporation, or unaffiliated domestic 
owner.
    (1) Dual resident corporation.
    (2) Separate unit.
    (3) SRLY limitation.
    (4) Items of a dual consolidated loss used in other taxable 
years.
    (5) Reconstituted net operating losses.
(d) Elimination of a dual consolidated loss after certain 
transactions.
    (1) General rule.
    (i) Transactions described in section 381(a).
    (ii) Cessation of separate unit status.
    (2) Exceptions.
    (i) Certain section 368(a)(1)(F) reorganizations.
    (ii) Acquisition of a dual resident corporation by another dual 
resident corporation.
    (iii) Acquisition of a separate unit by a domestic corporation.
    (A) Acquisition by a corporation that is not a member of the 
same consolidated group.
    (B) Acquisition by a member of the same consolidated group.
    (iv) Special rules for foreign insurance companies.
(e) Special rule denying the use of a dual consolidated loss to 
offset tainted income.
    (1) In general.
    (2) Tainted income.
    (i) Definition.
    (ii) Income presumed to be derived from holding tainted assets.
    (3) Tainted assets defined.
    (4) Exceptions.
(f) Computation of foreign tax credit limitation.

Sec.  1.1503(d)-5 Attribution of items and basis adjustments.

(a) In general.
(b) Determination of amount of income or dual consolidated loss of a 
dual resident corporation.
    (1) In general.
    (2) Exceptions.
(c) Determination of amount of income or dual consolidated loss 
attributable to a separate unit, and income or loss attributable to 
an interest in a transparent entity.
    (1) In general.
    (i) Scope and purpose.
    (ii) Only items of domestic owner taken into account.
    (iii) Separate application.
    (2) Foreign branch separate unit.
    (i) In general.
    (ii) Principles of Sec.  1.882-5.
    (iii) Exception where foreign country attributes interest 
expense solely by reference to books and records.
    (3) Hybrid entity separate unit and an interest in a transparent 
entity.
    (i) General rule.
    (ii) Interests in certain disregarded entities, partnerships, 
and grantor trusts owned by a hybrid entity or transparent entity.
    (4) Special rules.
    (i) Allocation of items between certain tiered separate units 
and interests in transparent entities.
    (A) Foreign branch separate unit.
    (B) Hybrid entity separate unit or interest in a transparent 
entity.
    (ii) Combined separate unit.
    (iii) Gain or loss on the direct or indirect disposition of a 
separate unit or an interest in a transparent entity.
    (A) In general.
    (B) Multiple separate units or interests in transparent 
entities.
    (iv) Inclusions on stock.
    (v) Foreign currency gain or loss recognized under section 987.
    (vi) Recapture of dual consolidated loss.
(d) Foreign tax treatment disregarded.
(e) Items generated or incurred while a dual resident corporation, a 
separate unit, or a transparent entity.
(f) Assets and liabilities of a separate unit or an interest in a 
transparent entity.
(g) Basis adjustments.
    (1) Affiliated dual resident corporation or affiliated domestic 
owner.
    (2) Interests in hybrid entities that are partnerships or 
interests in partnerships through which a separate unit is owned 
indirectly.
    (i) Scope.
    (ii) Determination of basis of partner's interest.
    (3) Combined separate units.

Sec.  1.1503(d)-6 Exceptions to the domestic use limitation rule.

    (a) In general.
    (1) Scope and purpose.
    (2) Absence of foreign affiliate or foreign consolidation 
regime.
    (3) Foreign insurance companies treated as domestic 
corporations.
(b) Elective agreement in place between the United States and a 
foreign country.
    (1) In general.
    (2) Application to combined separate units.
(c) No possibility of foreign use.
    (1) In general.
    (2) Statement.
(d) Domestic use election.
    (1) In general.
    (2) No domestic use election available if there is a triggering 
event in the year the dual consolidated loss is incurred.
(e) Triggering events requiring the recapture of a dual consolidated 
loss.
    (1) Events.
    (i) Foreign use.
    (ii) Disaffiliation.
    (iii) Affiliation.
    (iv) Transfer of assets.
    (v) Transfer of an interest in a separate unit.
    (vi) Conversion to a foreign corporation.
    (vii) Conversion to a regulated investment company, a real 
estate investment trust, or an S corporation.
    (viii) Failure to certify.
    (ix) Cessation of stand-alone status.
    (2) Rebuttal.
    (i) General rule.
    (ii) Certain asset transfers.
    (iii) Reporting.
    (iv) Examples.
(f) Triggering event exceptions.
    (1) Continuing ownership of assets or interests.
    (i) Disaffiliation as a result of a transaction described in 
section 381.
    (ii) Continuing ownership by consolidated group.
    (iii) Continuing ownership by unaffiliated dual resident 
corporation or unaffiliated domestic owner.
    (2) Transactions requiring a new domestic use agreement.
    (i) Multiple-party events.
    (ii) Events resulting in a single consolidated group.
    (iii) Requirements.
    (A) New domestic use agreement.
    (B) Statement filed by original elector.
    (3) Certain transfers qualifying for the de minimis exception to 
foreign use.
    (4) Deemed transactions as a result of certain transfers that do 
not result in a foreign use.
    (5) Compulsory transfers.
    (6) Subsequent triggering events.
(g) Annual certification reporting requirement.
(h) Recapture of dual consolidated loss and interest charge.
    (1) Presumptive rules.
    (i) Amount of recapture.
    (ii) Interest charge.
    (2) Reduction of presumptive recapture amount and presumptive 
interest charge.
    (i) Amount of recapture.
    (ii) Interest charge.
    (3) Rules regarding multiple-party event exceptions to 
triggering events.
    (i) Scope.
    (ii) Original elector and prior subsequent electors not subject 
to recapture or interest charge.
    (iii) Recapture tax amount and required statement.
    (A) In general.
    (B) Recapture tax amount.
    (iv) Tax assessment and collection procedures.
    (A) In general.

[[Page 12916]]

    (B) Collection from original elector and prior subsequent 
electors; joint and several liability.
    (C) Allocation of partial payments of tax.
    (D) Refund.
    (v) Definition of income tax liability.
    (vi) Example.
    (4) Computation of taxable income in year of recapture.
    (i) Presumptive rule.
    (ii) Exception to presumptive rule.
    (5) Character and source of recapture income.
    (6) Reconstituted net operating loss.
    (i) General rule.
    (ii) Exception.
    (iii) Special rule for recapture following multiple-party event 
exception to a triggering event.
(i) [Reserved]
(j) Termination of domestic use agreement and annual certifications.
    (1) Rebuttals, exceptions to triggering events, and recapture.
    (2) Termination of ability for foreign use.
    (i) In general.
    (ii) Statement.
    (3) Agreements filed in connection with stand-alone exception.

Sec.  1.1503(d)-7 Examples.

    (a) In general.
    (b) Presumed facts for examples.
    (c) Examples.

Sec.  1.1503(d)-8 Effective dates.

    (a) General rule.
    (b) Special rules.
    (1) Reduction of term of agreements filed under Sec. Sec.  
1.1503-2(g)(2)(i) or 1.1503-2T(g)(2)(i).
    (2) Reduction of term of closing agreements entered into 
pursuant to Sec.  1.1503-2(g)(2)(iv)(B)(3)(i).
    (3) Relief for untimely filings.
    (i) General rule.
    (ii) Closing agreements.
    (iii) Pending requests for relief.
    (4) Multiple-party event exception to triggering events.
    (5) Basis adjustment rules.

Sec.  1.1503(d)-1  Definitions and special rules for filings under 
section 1503(d).

    (a) In general. This section and Sec. Sec.  1.1503(d)-2 through 
1.1503(d)-8 provide rules concerning the determination and use of dual 
consolidated losses pursuant to section 1503(d). Paragraph (b) of this 
section provides definitions that apply for purposes of this section 
and Sec. Sec.  1.1503(d)-2 through 1.1503(d)-8. Paragraph (c) of this 
section provides a reasonable cause exception and a signature 
requirement for filings.
    (b) Definitions. The following definitions apply for purposes of 
this section and Sec. Sec.  1.1503(d)-2 through 1.1503(d)-8:
    (1) Domestic corporation means an entity classified as a domestic 
corporation under section 7701(a)(3) and (4) or otherwise treated as a 
domestic corporation by the Internal Revenue Code, including, but not 
limited to, sections 269B, 953(d), 1504(d), and 7874. However, solely 
for purposes of section 1503(d), the term domestic corporation shall 
not include a regulated investment company as defined in section 851, a 
real estate investment trust as defined in section 856, or an S 
corporation as defined in section 1361.
    (2) Dual resident corporation means--
    (i) A domestic corporation that is subject to an income tax of a 
foreign country on its worldwide income or on a residence basis. A 
corporation is taxed on a residence basis if it is taxed as a resident 
under the laws of the foreign country; and
    (ii) A foreign insurance company that makes an election to be 
treated as a domestic corporation pursuant to section 953(d) and is 
treated as a member of an affiliated group for purposes of chapter 6, 
even if such company is not subject to an income tax of a foreign 
country on its worldwide income or on a residence basis. See section 
953(d)(3).
    (3) Hybrid entity means an entity that is not taxable as an 
association for Federal tax purposes, but is subject to an income tax 
of a foreign country as a corporation (or otherwise at the entity 
level) either on its worldwide income or on a residence basis.
    (4) Separate unit--(i) In general. The term separate unit means 
either of the following that is carried on or owned, as applicable, 
directly or indirectly, by a domestic corporation (including a dual 
resident corporation):
    (A) Except to the extent provided in paragraph (b)(4)(iii) of this 
section, a business operation outside the United States that, if 
carried on by a U.S. person, would constitute a foreign branch as 
defined in Sec.  1.367(a)-6T(g)(1) (foreign branch separate unit).
    (B) An interest in a hybrid entity (hybrid entity separate unit).
    (ii) Separate unit combination rule. Except as otherwise provided 
in this paragraph, if a domestic owner, or two or more domestic owners 
that are members of the same consolidated group, have two or more 
separate units (individual separate units), then all such individual 
separate units that are located (in the case of a foreign branch 
separate unit) or subject to an income tax either on their worldwide 
income or on a residence basis (in the case of a hybrid entity an 
interest in which is a hybrid entity separate unit) in the same foreign 
country shall be treated as one separate unit (combined separate unit). 
See Sec.  1.1503(d)-7(c) Example 1. Separate units of a foreign 
insurance company that is a dual resident corporation under paragraph 
(b)(2)(ii) of this section, however, shall not be combined with 
separate units of any other domestic corporation. Except as 
specifically provided in this section or Sec. Sec.  1.1503(d)-2 through 
1.1503(d)-8, any individual separate unit composing a combined separate 
unit loses its character as an individual separate unit.
    (iii) Business operations that do not constitute a permanent 
establishment. A business operation carried on by a domestic 
corporation that is not a dual resident corporation shall not 
constitute a foreign branch separate unit, provided the business 
operation:
    (A) Is not carried on indirectly through a hybrid entity or a 
transparent entity; and
    (B) Is conducted in a country with which the United States has 
entered into an income tax convention and is not treated as a permanent 
establishment pursuant to that convention, or is not otherwise subject 
to tax on a net basis under that convention. See Sec.  1.1503(d)-7(c) 
Example 2.
    (iv) Foreign branch separate units held by dual resident 
corporations or hybrid entities in the same foreign country. A foreign 
branch separate unit may be owned by a dual resident corporation, or 
through a hybrid entity (an interest in which is a separate unit), even 
where the foreign branch is located in the same foreign country that 
subjects such dual resident corporation or hybrid entity to tax on its 
worldwide income or on a residence basis. But see the rule under 
paragraph (b)(4)(ii) of this section that combines certain same-country 
hybrid entity separate units and foreign branch separate units. See 
also Sec.  1.1503(d)-7(c) Example 1.
    (5) Dual consolidated loss means--
    (i) In the case of a dual resident corporation, and except to the 
extent provided in Sec.  1.1503(d)-5(b), the net operating loss (as 
defined in section 172(c) and the related regulations) incurred in a 
year in which the corporation is a dual resident corporation; and
    (ii) In the case of a separate unit, the net loss attributable to 
the separate unit under Sec.  1.1503(d)-5(c) through (e).
    (6) Subject to tax. For purposes of determining whether a domestic 
corporation or another entity is subject to an income tax of a foreign 
country on its income, the fact that it has no actual income tax 
liability to the foreign country for a particular taxable year shall 
not be taken into account.
    (7) Foreign country includes any possession of the United States.

[[Page 12917]]

    (8) Consolidated group has the meaning provided in Sec.  1.1502-
1(h).
    (9) Domestic owner means--
    (i) A domestic corporation (including a dual resident corporation) 
that has one or more separate units or interests in a transparent 
entity; and
    (ii) In the case of a combined separate unit, a domestic 
corporation (including a dual resident corporation) that has one or 
more individual separate units that are treated as part of the combined 
separate unit under paragraph (b)(4)(ii) of this section.
    (10) Affiliated dual resident corporation and affiliated domestic 
owner mean a dual resident corporation and a domestic owner, 
respectively, that is a member of a consolidated group.
    (11) Unaffiliated dual resident corporation, unaffiliated domestic 
corporation, and unaffiliated domestic owner mean a dual resident 
corporation, domestic corporation, and domestic owner, respectively, 
that is not a member of a consolidated group.
    (12) Domestic affiliate means--
    (i) A member of an affiliated group, without regard to the 
exceptions contained in section 1504(b) (other than section 1504(b)(3)) 
relating to includible corporations;
    (ii) A domestic owner;
    (iii) A separate unit; or
    (iv) An interest in a transparent entity, as defined in paragraph 
(b)(16) of this section.
    (13) Domestic use. See Sec.  1.1503(d)-2.
    (14) Foreign use. See Sec.  1.1503(d)-3.
    (15) Grantor trust means a trust, any portion of which is treated 
as being owned by the grantor or another person under subpart E of 
subchapter J of this chapter.
    (16) Transparent entity--(i) In general. The term transparent 
entity means an entity described in this paragraph (b)(16) where all or 
a portion of its interests are owned, directly or indirectly, by a 
domestic corporation. An entity is described in this paragraph (b)(16) 
if the entity--
    (A) Is not taxable as an association for Federal tax purposes;
    (B) Is not subject to income tax in a foreign country as a 
corporation (or otherwise at the entity level) either on its worldwide 
income or on a residence basis; and
    (C) Is not a pass-through entity under the laws of the applicable 
foreign country. For purposes of applying the preceding sentence, the 
applicable foreign country is the foreign country in which the relevant 
foreign branch separate unit is located, or the foreign country that 
subjects the relevant hybrid entity (an interest in which is a separate 
unit) or dual resident corporation to an income tax either on its 
worldwide income or on a residence basis.
    (ii) Example. A U.S. limited liability company (LLC) does not elect 
to be taxed as an association for Federal tax purposes and is not 
subject to income tax in a foreign country as a corporation (or 
otherwise at the entity level) either on its worldwide income or on a 
residence basis. The LLC is owned by a hybrid entity (an interest in 
which is a separate unit) that is the relevant hybrid entity. Provided 
the LLC is not treated as a pass-through entity by the applicable 
foreign country that subjects the relevant hybrid entity to an income 
tax either on its worldwide income or on a residence basis, the LLC 
would qualify as a transparent entity. See also Sec.  1.1503(d)-7(c) 
Example 26.
    (17) Disregarded entity means an entity that is disregarded as an 
entity separate from its owner, under Sec. Sec.  301.7701-1 through 
301.7701-3 of this chapter, for Federal tax purposes.
    (18) Partnership means an entity that is classified as a 
partnership, under Sec. Sec.  301.7701-1 through 301.7701-3 of this 
chapter, for Federal tax purposes.
    (19) Indirectly, when used in reference to ownership, means 
ownership through a partnership, a disregarded entity, or a grantor 
trust, regardless of whether the partnership, disregarded entity, or 
grantor trust is a U.S. person.
    (20) Certification period means the period of time up to and 
including the fifth taxable year following the year in which the dual 
consolidated loss that is the subject of a domestic use agreement (as 
described in Sec.  1.1503(d)-6(d)(1)) was incurred.
    (c) Special rules for filings under section 1503(d)--(1) Reasonable 
cause exception. A person that is permitted or required to file an 
election, agreement, statement, rebuttal, computation, or other 
information pursuant to section 1503(d) and these regulations, that 
fails to make such filing in a timely manner, shall be considered to 
have satisfied the timeliness requirement with respect to such filing 
if the person is able to demonstrate, to the Area Director, Field 
Examination, Small Business/Self Employed or the Director of Field 
Operations, Large and Mid-Size Business (Director) having jurisdiction 
of the taxpayer's tax return for the taxable year, that such failure 
was due to reasonable cause and not willful neglect. In determining 
whether the taxpayer has reasonable cause, the Director shall consider 
whether the taxpayer acted reasonably and in good faith. In general, 
the taxpayer must demonstrate that it exercised ordinary care and 
prudence in meeting its tax obligations but nonetheless did not comply 
with the prescribed duty within the prescribed time. Whether the 
taxpayer acted reasonably and in good faith will be determined after 
considering all the facts and circumstances. The Director shall notify 
the person in writing within 120 days of the filing if it is determined 
that the failure to comply was not due to reasonable cause, or if 
additional time will be needed to make such determination. For this 
purpose, the 120-day period shall begin on the date the taxpayer is 
notified in writing that the request has been received and assigned for 
review. If, once such period commences, the taxpayer is not again 
notified within 120 days, then the taxpayer shall be deemed to have 
established reasonable cause. The reasonable cause exception of this 
paragraph (c) shall only apply if, once the person becomes aware of its 
failure to file the election, agreement, statement, rebuttal, 
computation or other information in a timely manner, the person 
complies with the requirements of paragraph (c)(2) of this section.
    (2) Requirements for reasonable cause relief--(i) Time of 
submission. Requests for reasonable cause relief will only be 
considered if once the person becomes aware of the failure to file the 
election, agreement, statement, rebuttal, computation or other 
information, the person attaches all the documents that should have 
been filed, as well as a written statement setting forth the reasons 
for the failure to timely comply, to an amended return that amends the 
return to which the documents should have been attached pursuant to the 
rules of section 1503(d) and these regulations.
    (ii) Notice requirement. In addition to the requirements of 
paragraph (c)(2)(i) of this section, the taxpayer must provide a copy 
of the amended return and all required attachments to the Director as 
follows:
    (A) If the taxpayer is under examination for any taxable year when 
the taxpayer requests relief, the taxpayer must provide a copy of the 
amended return and attachments to the personnel conducting the 
examination.
    (B) If the taxpayer is not under examination for any taxable year 
when the taxpayer requests relief, the taxpayer must provide a copy of 
the amended return and attachments to the Director having jurisdiction 
of the taxpayer's return.
    (3) Signature requirement. When an election, agreement, statement, 
rebuttal, computation, or other information is required pursuant to 
section 1503(d) and these regulations to be attached to

[[Page 12918]]

and filed by the due date (including extensions) of a U.S. tax return 
and signed under penalties of perjury by the person who signs the 
return, the attachment and filing of an unsigned copy is considered to 
satisfy such requirement, provided the taxpayer retains the original in 
its records in the manner specified by Sec.  1.6001-1(e).


Sec.  1.1503(d)-2  Domestic use.

    A domestic use of a dual consolidated loss shall be deemed to occur 
when the dual consolidated loss is made available to offset, directly 
or indirectly, the income of a domestic affiliate (other than the dual 
resident corporation or separate unit that, in each case, incurred the 
dual consolidated loss) in the taxable year in which the dual 
consolidated loss is recognized, or in any other taxable year, 
regardless of whether the dual consolidated loss offsets income under 
the income tax laws of a foreign country and regardless of whether any 
income that the dual consolidated loss may offset in the foreign 
country is, has been, or will be subject to tax in the United States. A 
domestic use shall be deemed to occur in the year the dual consolidated 
loss is included in the computation of the taxable income of a 
consolidated group, unaffiliated dual resident corporation, or an 
unaffiliated domestic owner, as applicable, even if no tax benefit 
results from such inclusion in that year. See Sec.  1.1503(d)-7(c) 
Examples 2 through 4.


Sec.  1.1503(d)-3  Foreign use.

    (a) Foreign use--(1) In general. Except as provided in paragraph 
(c) of this section, a foreign use of a dual consolidated loss shall be 
deemed to occur when any portion of a deduction or loss taken into 
account in computing the dual consolidated loss is made available under 
the income tax laws of a foreign country to offset or reduce, directly 
or indirectly, any item that is recognized as income or gain under such 
laws and that is, or would be, considered under U.S. tax principles to 
be an item of--
    (i) A foreign corporation as defined in section 7701(a)(3) and 
(a)(5); or
    (ii) A direct or indirect owner of an interest in a hybrid entity, 
provided such interest is not a separate unit. See Sec.  1.1503(d)-7(c) 
Examples 5 through 10 and 37.
    (2) Indirect use--(i) General rule. Except to the extent provided 
in paragraph (a)(2)(ii) of this section, an item of deduction or loss 
shall be deemed to be made available indirectly if--
    (A) One or more items are taken into account as deductions or 
losses for foreign tax purposes, but do not give rise to corresponding 
items of income or gain for U.S. tax purposes; and
    (B) The item or items described in paragraph (a)(2)(i)(A) of this 
section have the effect of making an item of deduction or loss 
composing the dual consolidated loss available for a foreign use as 
described in paragraph (a)(1) of this section.
    (ii) Exception. The general rule provided in paragraph (a)(2)(i) of 
this section shall not apply if the consolidated group, unaffiliated 
domestic owner, or unaffiliated dual resident corporation demonstrates, 
to the satisfaction of the Commissioner, that the item or items 
described in paragraph (a)(2)(i)(A) of this section that gave rise to 
the indirect foreign use--
    (A) Were not incurred, or taken into account, with a principal 
purpose of avoiding the provisions of section 1503(d). For purposes of 
this paragraph (a)(2)(ii), an item incurred or taken into account as 
interest for foreign tax purposes, but disregarded for U.S. tax 
purposes, shall be deemed to have been incurred, or taken into account, 
with a principal purpose of avoiding the provisions of section 1503(d). 
Similarly, for purposes of this paragraph (a)(2)(ii), an item incurred 
or taken into account as the result of an instrument that is treated as 
debt for foreign tax purposes and equity for U.S. tax purposes, shall 
be deemed to have been incurred, or taken into account, with a 
principal purpose of avoiding the provisions of section 1503(d); and
    (B) Were incurred, or taken into account, in the ordinary course of 
the dual resident corporation's or separate unit's trade or business.
    (iii) Examples. See Sec.  1.1503(d)-7(c) Examples 6 through 8.
    (3) Deemed use. See paragraph (e) of this section for a deemed 
foreign use pursuant to the mirror legislation rule.
    (b) Available for use. A foreign use shall be deemed to occur in 
the year in which any portion of a deduction or loss taken into account 
in computing the dual consolidated loss is made available for an offset 
described in paragraph (a) of this section, regardless of whether it 
actually offsets or reduces any items of income or gain under the 
income tax laws of the foreign country in such year, and regardless of 
whether any of the items that may be so offset or reduced are regarded 
as income under U.S. tax principles.
    (c) Exceptions--(1) In general. Paragraphs (c)(2) through (9) of 
this section provide exceptions to the general definition of foreign 
use set forth in paragraphs (a) and (b) of this section. These 
exceptions only apply to a foreign use that occurs solely as a result 
of the conditions or circumstances described therein, and do not apply 
if a foreign use occurs in any other case or by any other means. For 
example, the exception under paragraph (c)(4) of this section 
(regarding certain interests in partnerships or grantor trusts) shall 
not apply where the item of deduction or loss is made available through 
a foreign consolidation regime (or similar method). In addition, these 
exceptions do not apply when attempting to demonstrate that no foreign 
use of a dual consolidated loss can occur in any other year by any 
means under Sec.  1.1503(d)-6(c), (e)(2)(i), or (j)(2). But see Sec.  
1.1503(d)-6(e)(2)(ii), which takes into account the exception under 
paragraph (c)(7) of this section for purposes of rebutting certain 
asset transfers.
    (2) Election or merger required to enable foreign use. Where the 
laws of a foreign country provide an election that would enable a 
foreign use, a foreign use shall be considered to occur only if the 
election is made. Similarly, where the laws of a foreign country would 
enable a foreign use through a sale, merger, or similar transaction, a 
foreign use shall be considered to occur only if the sale, merger, or 
similar transaction occurs.
    (3) Presumed use where no foreign country rule for determining use. 
This paragraph (c)(3) applies if the losses or deductions composing the 
dual consolidated loss are made available under the laws of a foreign 
country both to offset income that would constitute a foreign use and 
to offset income that would not constitute a foreign use, and the laws 
of the foreign country do not provide applicable rules for determining 
which income is offset by the losses or deductions. In such a case, the 
losses or deductions shall be deemed to be made available to offset the 
income that does not constitute a foreign use, to the extent of such 
income, before being considered to be made available to offset the 
income that does constitute a foreign use. See Sec.  1.1503(d)-7(c) 
Example 11.
    (4) Certain interests in partnerships or grantor trusts--(i) 
General rule. Except to the extent provided in paragraph (c)(4)(iii) of 
this section, this paragraph (c)(4)(i) applies to a dual consolidated 
loss attributable to an interest in a hybrid entity partnership or a 
hybrid entity grantor trust, or to a separate unit owned indirectly 
through a partnership or grantor trust. In such a case, a foreign use 
will not be considered to occur if the foreign use is solely the result 
of another person's ownership of an interest in the partnership or 
grantor trust, as applicable, and the allocation

[[Page 12919]]

or carry forward of an item of deduction or loss composing such dual 
consolidated loss as a result of such ownership. See Sec.  1.1503(d)-
7(c) Example 13.
    (ii) Combined separate unit. This paragraph applies to a dual 
consolidated loss attributable to a combined separate unit that 
includes an individual separate unit to which paragraph (c)(4)(i) of 
this section would apply, but for the application of the separate unit 
combination rule provided under Sec.  1.1503(d)-1(b)(4)(ii). In such a 
case, paragraph (c)(4)(i) of this section shall apply to the portion of 
the dual consolidated loss of such combined separate unit that is 
attributable, as provided under Sec.  1.1503(d)-5(c) through (e), to 
the individual separate unit (otherwise described in paragraph 
(c)(4)(i) of this section) that is a component of the combined separate 
unit. See Sec.  1.1503(d)-7(c) Example 14.
    (iii) Reduction in interest. The exception under paragraph 
(c)(4)(i) of this section shall not apply if, at any time following the 
year in which the dual consolidated loss is incurred, there is more 
than a de minimis reduction in the domestic owner's percentage interest 
in the partnership or grantor trust, as applicable, as described in 
paragraph (c)(5) of this section. In such a case, a foreign use shall 
be deemed to occur at the time the reduction in interest exceeds the de 
minimis amount. See Sec.  1.1503(d)-7(c) Example 13.
    (5) De minimis reduction of an interest in a separate unit--(i) 
General rule. This paragraph applies to a de minimis reduction of a 
domestic owner's interest in a separate unit (including an interest 
described in paragraph (c)(4)(i) of this section). Except to the extent 
provided in paragraph (c)(5)(ii) of this section, no foreign use shall 
be considered to occur with respect to a dual consolidated loss as a 
result of an item of deduction or loss composing such dual consolidated 
loss being made available solely as a result of a reduction in the 
domestic owner's interest in the separate unit, as provided under 
paragraph (c)(5)(iii) of this section. See Sec.  1.1503(d)-7(c) Example 
5.
    (ii) Limitations. The exception provided in paragraph (c)(5)(i) of 
this section shall not apply if--
    (A) During any 12-month period the domestic owner's percentage 
interest in the separate unit is reduced by 10 percent or more, as 
determined by reference to the domestic owner's interest at the 
beginning of the 12-month period; or
    (B) At any time the domestic owner's percentage interest in the 
separate unit is reduced by 30 percent or more, as determined by 
reference to the domestic owner's interest at the end of the taxable 
year in which the dual consolidated loss was incurred.
    (iii) Reduction in interest. The following rules apply for purposes 
of paragraphs (c)(4) and (5) of this section. A reduction of a domestic 
owner's interest in a separate unit shall include a reduction resulting 
from another person acquiring through sale, exchange, contribution, or 
other means, an interest in the foreign branch or hybrid entity, as 
applicable. A reduction may occur either directly or indirectly, 
including through an interest in a partnership, a disregarded entity, 
or a grantor trust through which a separate unit is carried on or 
owned. In the case of an interest in a hybrid entity partnership or a 
separate unit all or a portion of which is carried on or owned through 
a partnership, an interest in such separate unit (or portion of such 
separate unit) is determined by reference to the owner's interest in 
the profits or the capital in the separate unit. In the case of an 
interest in a hybrid entity grantor trust or a separate unit all or a 
portion of which is carried on or owned through a grantor trust, an 
interest in such separate unit (or portion of such separate unit) is 
determined by reference to the domestic owner's share of the assets and 
liabilities of the separate unit.
    (iv) Examples and coordination with exceptions to other triggering 
events. See Sec.  1.1503(d)-7(c) Examples 5, 13, and 14. See also Sec.  
1.1503(d)-6(f)(3) and (f)(5) for rules that coordinate the de minimis 
exception to foreign use with exceptions to other triggering events 
described in Sec.  1.1503(d)-6(e)(1), and provide an exception to 
foreign use following certain compulsory transfers.
    (6) Certain asset basis carryovers. No foreign use shall be 
considered to occur with respect to a dual consolidated loss solely as 
a result of items of deduction or loss composing such dual consolidated 
loss being made available as a result of the transfer of assets of a 
dual resident corporation or separate unit, provided--
    (i) Such items of loss and deduction are made available solely as a 
result of the basis of the transferred assets being determined, under 
foreign law, in whole or in part by reference to the basis of the 
assets in the hands of the dual resident corporation or separate unit;
    (ii) The aggregate adjusted basis, as determined under U.S. tax 
principles, of all the assets so transferred during any 12-month period 
is less than 10 percent of the aggregate adjusted basis, as determined 
under U.S. tax principles, of all the dual resident corporation's or 
separate unit's assets, determined by reference to the assets held at 
the beginning of such 12-month period; and
    (iii) The aggregate adjusted basis, as determined under U.S. tax 
principles, of all the assets so transferred at any time is less than 
30 percent of the aggregate adjusted basis, as determined under U.S. 
tax principles, of all the dual resident corporation's or separate 
unit's assets, determined by reference to the assets held at the end of 
the taxable year in which the dual consolidated loss was generated. See 
Sec.  1.1503(d)-7(c) Example 15.
    (7) Assumption of certain liabilities--(i) In general. Except to 
the extent provided in paragraph (c)(7)(ii) of this section, no foreign 
use shall be considered to occur with respect to any dual consolidated 
loss solely as a result of an item of deduction or loss composing such 
dual consolidated loss being made available following the assumption of 
liabilities of a dual resident corporation or separate unit, provided 
such availability arises solely as the result of an item of deduction 
or loss incurred with respect to, or as a result of, such liabilities. 
See Sec.  1.1503(d)-7(c) Example 16.
    (ii) Ordinary course limitation. Paragraph (c)(7)(i) of this 
section shall apply only to the extent the liabilities assumed were 
incurred in the ordinary course of the dual resident corporation's, or 
separate unit's, trade or business. For purposes of this paragraph, 
liabilities incurred in the ordinary course of a trade or business 
shall include debt incurred to finance the trade or business of the 
dual resident corporation or separate unit.
    (8) Multiple-party events. This paragraph applies to a transaction 
that qualifies for the triggering event exception described in Sec.  
1.1503(d)-6(f)(2)(i)(B) where the acquiring unaffiliated domestic 
corporation or consolidated group owns, directly or indirectly, more 
than 90 percent, but less than 100 percent, of the transferred assets 
or interests immediately after the transaction. In such a case, no 
foreign use shall be considered to occur with respect to a dual 
consolidated loss of the dual resident corporation or separate unit 
whose assets or interests were acquired, solely as a result of the less 
than 10 percent direct or indirect ownership of the acquired assets or 
interests by persons other than the acquiring unaffiliated domestic 
corporation or consolidated group, as applicable, immediately after the 
transaction. See Sec.  1.1503(d)-7(c) Example 37.

[[Page 12920]]

    (9) Additional guidance. The Commissioner may provide, by guidance 
published in the Internal Revenue Bulletin, that certain events or 
transactions do or do not result in a foreign use. Such guidance may 
also modify the triggering events and rebuttals described in Sec.  
1.1503(d)-6(e), and the exceptions thereto under Sec.  1.1503(d)-6(f), 
as appropriate.
    (d) Ordering rules for determining the foreign use of losses. If 
the laws of a foreign country provide for the foreign use of losses of 
a dual resident corporation or a separate unit, but do not provide 
applicable rules for determining the order in which such losses are 
used in a taxable year, the following rules shall apply:
    (1) Any net loss, or net income, that the dual resident corporation 
or separate unit has in a taxable year shall first be used to offset 
net income, or loss, recognized by its affiliates in the same taxable 
year before any carry over of its losses is considered to be used to 
offset any income from the taxable year.
    (2) If under the laws of the foreign country the dual resident 
corporation or separate unit has losses from different taxable years, 
it shall be deemed to use first the losses which would not constitute a 
triggering event that would result in the recapture of a dual 
consolidated loss pursuant to Sec.  1.1503(d)-6(h). Thereafter, it 
shall be deemed to use first the losses from the most recent taxable 
year from which a loss may be carried forward or back for foreign law 
purposes.
    (3) Where different losses or deductions (for example, capital 
losses and ordinary losses) of a dual resident corporation or separate 
unit incurred in the same taxable year are available for foreign use, 
the different losses shall be deemed to be used on a pro rata basis. 
See Sec.  1.1503(d)-7(c) Example 12.
    (e) Mirror legislation rule--(1) In general. Except as provided in 
paragraph (e)(2) of this section and Sec.  1.1503(d)-6(b) (relating to 
agreements entered into between the United States and a foreign 
country), a foreign use shall be deemed to occur if the income tax laws 
of a foreign country would deny any opportunity for the foreign use of 
the dual consolidated loss in the year in which the dual consolidated 
loss is incurred (mirror legislation), determined by assuming that such 
foreign country had recognized the dual consolidated loss in such year, 
for any of the following reasons:
    (i) The dual resident corporation or separate unit that incurred 
the loss is subject to income taxation by another country (for example, 
the United States) on its worldwide income or on a residence basis.
    (ii) The loss may be available to offset income (other than income 
of the dual resident corporation or separate unit) under the laws of 
another country (for example, the United States).
    (iii) The deductibility of any portion of a deduction or loss taken 
into account in computing the dual consolidated loss depends on whether 
such amount is deductible under the laws of another country (for 
example, the United States). See Sec.  1.1503(d)-7(c) Examples 17 
through 19.
    (2) Stand-alone exception--(i) In general. This paragraph (e)(2) 
applies if, in the absence of the mirror legislation described in 
paragraph (e)(1) of this section, no item of deduction or loss 
composing the dual consolidated loss of such dual resident corporation 
or separate unit would otherwise be available for a foreign use in the 
taxable year in which such dual consolidated loss is incurred. This 
determination is made without regard to whether such availability is 
limited by election (or other similar procedure). However, for purposes 
of this paragraph (e)(2)(i), no item of deduction or loss composing the 
dual consolidated loss of a dual resident corporation or separate unit 
is considered to be made available for foreign use solely because the 
laws of a foreign country would enable a foreign use through a sale, 
merger, or similar transaction (provided no such sale, merger, or 
similar transaction actually occurs). In such a case, no foreign use 
shall be considered to occur pursuant to paragraph (e)(1) of this 
section with respect to the dual consolidated loss, provided the 
requirements of paragraph (e)(2)(ii) of this section are satisfied. See 
Sec.  1.1503(d)-7(c) Examples 17 through 19.
    (ii) Stand-alone domestic use agreement. In order to qualify for 
the exception under paragraph (e)(2)(i) of this section, the 
consolidated group, unaffiliated dual resident corporation, or 
unaffiliated domestic owner, as the case may be, must enter into a 
domestic use agreement in accordance with the provisions of Sec.  
1.1503(d)-6(d) and, in addition, must include the following items in 
such domestic use agreement:
    (A) A statement that the document is also being submitted under the 
provisions of paragraph (e)(2) of this section.
    (B) A certification that the conditions of paragraph (e)(2)(i) of 
this section are satisfied during the taxable year in which the dual 
consolidated loss is incurred.
    (C) An agreement to include with each annual certification required 
under Sec.  1.1503(d)-6(g), a certification that the conditions 
described in paragraph (e)(2)(i) of this section are satisfied during 
the taxable year of each such certification.
    (iii) Termination of stand-alone domestic use agreement. This 
paragraph (e)(2)(iii) applies to a consolidated group, unaffiliated 
dual resident corporation, or unaffiliated domestic owner, as the case 
may be, that entered into a domestic use agreement pursuant to 
paragraph (e)(2)(ii) of this section, with respect to a dual 
consolidated loss, and which subsequently makes an election pursuant to 
Sec.  1.1503(d)-6(b) (relating to agreements entered into between the 
United States and a foreign country) with respect to such dual 
consolidated loss. In such a case, the dual consolidated loss shall be 
subject to the election under Sec.  1.1503(d)-6(b) (and any related 
agreements, representations and conditions), and the domestic use 
agreement entered into pursuant to paragraph (e)(2)(ii) of this section 
shall terminate and have no further effect.


Sec.  1.1503(d)-4  Domestic use limitation and related operating rules.

    (a) Scope. This section prescribes rules that apply when the 
general limitation on the domestic use of a dual consolidated loss 
under paragraph (b) of this section applies. Thus, the rules of this 
section do not apply when an exception to the domestic use limitation 
applies (for example, as a result of a domestic use election under 
Sec.  1.1503(d)-6(d)). In general, when the domestic use limitation 
applies, the dual consolidated loss of a dual resident corporation or 
separate unit is subject to the separate return limitation year (SRLY) 
provisions of Sec.  1.1502-21(c), as modified under this section. 
Paragraph (c) of this section provides rules that determine the effect 
of a dual consolidated loss on a consolidated group, an unaffiliated 
dual resident corporation, or an unaffiliated domestic owner. Paragraph 
(d) of this section provides rules that eliminate dual consolidated 
losses following certain transactions or events. Paragraph (e) of this 
section contains provisions that prevent dual consolidated losses from 
offsetting tainted income. Finally, paragraph (f) of this section 
provides rules for computing foreign tax credits.
    (b) Limitation on domestic use of a dual consolidated loss. Except 
as provided in Sec.  1.1503(d)-6, the domestic use of a dual 
consolidated loss is not permitted. See Sec.  1.1503(d)-2 for the 
definition of a domestic use. See also Sec.  1.1503(d)-7(c) Examples 2 
through 4.

[[Page 12921]]

    (c) Effect of a dual consolidated loss on a consolidated group, 
unaffiliated dual resident corporation, or unaffiliated domestic owner. 
For any taxable year in which a dual resident corporation or separate 
unit has a dual consolidated loss that is subject to the domestic use 
limitation of paragraph (b) of this section, the following rules shall 
apply:
    (1) Dual resident corporation. This paragraph (c)(1) applies to a 
dual consolidated loss of a dual resident corporation. The unaffiliated 
dual resident corporation, or consolidated group that includes the dual 
resident corporation, shall compute its taxable income (or loss), or 
consolidated taxable income (or loss), respectively, without taking 
into account those items of deduction and loss that compose the dual 
resident corporation's dual consolidated loss. For this purpose, the 
dual consolidated loss shall be treated as composed of a pro rata 
portion of each item of deduction and loss of the dual resident 
corporation taken into account in calculating the dual consolidated 
loss. The dual consolidated loss is subject to the limitations on its 
use contained in paragraph (c)(3) of this section and, subject to such 
limitations, may be carried over or back for use in other taxable years 
as a separate net operating loss carryover or carryback of the dual 
resident corporation arising in the year incurred. If the dual resident 
corporation owns a separate unit or an interest in a transparent 
entity, the limitations contained in paragraph (c)(3) of this section 
shall apply to the dual resident corporation as if the separate unit or 
interest in a transparent entity were a separate domestic corporation 
that filed a consolidated return with the unaffiliated dual resident 
corporation, or with the consolidated group of the affiliated dual 
resident corporation, as applicable.
    (2) Separate unit. This paragraph (c)(2) applies to a dual 
consolidated loss that is attributable to a separate unit. The 
unaffiliated domestic owner of a separate unit, or the consolidated 
group of an affiliated domestic owner of a separate unit, shall compute 
its taxable income (or loss) or consolidated taxable income (or loss), 
respectively, without taking into account those items of deduction and 
loss that compose the separate unit's dual consolidated loss. For this 
purpose, the dual consolidated loss shall be treated as composed of a 
pro rata portion of each item of deduction and loss of the separate 
unit taken into account in calculating the dual consolidated loss. The 
dual consolidated loss is subject to the limitations contained in 
paragraph (c)(3) of this section as if the separate unit to which the 
dual consolidated loss is attributable were a separate domestic 
corporation that filed a consolidated return with its unaffiliated 
domestic owner or with the consolidated group of its affiliated 
domestic owner, as applicable. Subject to such limitations, the dual 
consolidated loss may be carried over or back for use in other taxable 
years as a separate net operating loss carryover or carryback of the 
separate unit arising in the year incurred. See Sec.  1.1503(d)-7(c) 
Examples 29 and 38.
    (3) SRLY limitation. The dual consolidated loss shall be treated as 
a loss incurred by the dual resident corporation or separate unit in a 
separate return limitation year and shall be subject to all of the 
limitations of Sec.  1.1502-21(c) (SRLY limitation), subject to the 
following modifications--
    (i) Notwithstanding Sec.  1.1502-1(f)(2)(i), the SRLY limitation is 
applied to any dual consolidated loss of a common parent that is a dual 
resident corporation, or any dual consolidated loss attributable to a 
separate unit of a common parent;
    (ii) The SRLY limitation is applied without regard to Sec.  1.1502-
21(c)(2) (SRLY subgroup limitation) and 1.1502-21(g) (overlap with 
section 382);
    (iii) For purposes of calculating the general SRLY limitation under 
Sec.  1.1502-21(c)(1)(i), the calculation of aggregate consolidated 
taxable income shall only include items of income, gain, deduction, and 
loss generated--
    (A) In the case of a hybrid entity separate unit, in years in which 
the hybrid entity (an interest in which is a separate unit) is taxed as 
a corporation (or otherwise at the entity level) either on its 
worldwide income or as a resident in the same foreign country in which 
it was so taxed during the year in which the dual consolidated loss was 
generated; and
    (B) In the case of a foreign branch separate unit, in years in 
which the foreign branch qualified as a separate unit in the same 
foreign country in which it so qualified during the year in which the 
dual consolidated loss was generated.
    (iv) For purposes of calculating the general SRLY limitation under 
Sec.  1.1502-21(c)(1)(i), the calculation of aggregate consolidated 
taxable income shall not include any amount included in income pursuant 
to Sec.  1.1503(d)-6(h) (relating to the recapture of a dual 
consolidated loss).
    (4) Items of a dual consolidated loss used in other taxable years. 
A pro rata portion of each item of deduction or loss that composes the 
dual consolidated loss shall be considered to be used when the dual 
consolidated loss is used in other taxable years. See Sec.  1.1503(d)-
7(c) Examples 29 and 38.
    (5) Reconstituted net operating losses. For additional rules and 
limitations that apply to reconstituted net operating losses, see Sec.  
1.1503(d)-6(h)(6).
    (d) Elimination of a dual consolidated loss after certain 
transactions--(1) General rule. In general, a dual resident corporation 
has a net operating loss (and, therefore, a dual consolidated loss) 
only if it sustains such loss, or succeeds to such loss as a result of 
acquiring the assets of a corporation that sustained the loss in a 
transaction described in section 381(a). Similarly, a net loss 
generally is attributable to a separate unit of a domestic owner (and 
therefore is a dual consolidated loss) only if the domestic owner 
incurs the deductions or losses, or succeeds to such deductions or 
losses in a transaction described in section 381(a). Except as provided 
in Sec.  1.1503(d)-6(h)(6)(iii), section 1503(d) and these regulations 
do not alter these general rules. Thus, the provisions of Sec. Sec.  
1.1503(d)-1 through 1.1503(d)-8 generally do not cause a corporation to 
have a dual consolidated loss if it did not sustain (or inherit) the 
loss. Instead, these regulations either eliminate a dual consolidated 
loss that a corporation sustained (or inherited), or prevent the 
carryover of a dual consolidated loss under section 381 that would 
ordinarily occur, as a result of certain transactions.
    (i) Transactions described in section 381(a). This paragraph 
(d)(1)(i) applies to a dual consolidated loss of a dual resident 
corporation, or of a domestic owner attributable to a separate unit, 
that is subject to the domestic use limitation rule of paragraph (b) of 
this section. In such a case, and except as provided in paragraph 
(d)(2) of this section, the dual consolidated loss shall not carry over 
to another corporation in a transaction described in section 381(a) 
and, as a result, shall be eliminated. See Sec.  1.1503(d)-7(c) Example 
20.
    (ii) Cessation of separate unit status. This paragraph (d)(1)(ii) 
applies when a separate unit of an unaffiliated domestic owner ceases 
to be a separate unit of its domestic owner, or when a separate unit of 
an affiliated domestic owner ceases to be a separate unit with respect 
to its domestic owner and all other members of the affiliated domestic 
owner's consolidated group. In such a case, and except as provided in 
paragraph (d)(2)(iii) of this section, a dual consolidated loss of the 
domestic owner attributable to such separate unit, that is subject to 
the domestic use limitation of paragraph (b) of this section, shall be

[[Page 12922]]

eliminated. For purposes of this paragraph (d)(1)(ii), a separate unit 
may cease to be a separate unit if, for example, such separate unit is 
terminated, dissolved, liquidated, sold, or otherwise disposed of. See 
Sec.  1.1503(d)-7(c) Example 21.
    (2) Exceptions--(i) Certain section 368(a)(1)(F) reorganizations. 
Paragraph (d)(1)(i) of this section (relating to transactions described 
in section 381(a)) shall not apply to a dual consolidated loss of a 
dual resident corporation that undergoes a reorganization described in 
section 368(a)(1)(F) in which the resulting corporation is a domestic 
corporation. In such a case, the dual consolidated loss of the 
resulting corporation continues to be subject to the limitations of 
paragraphs (b) and (c) of this section, applied as if the resulting 
corporation incurred the dual consolidated loss.
    (ii) Acquisition of a dual resident corporation by another dual 
resident corporation. If a dual resident corporation transfers its 
assets to another dual resident corporation in a transaction described 
in section 381(a), and the transferee corporation is a resident of (or 
is taxed on its worldwide income by) the same foreign country of which 
the transferor was a resident (or was taxed on its worldwide income), 
then paragraph (d)(1)(i) of this section shall not apply with respect 
to dual consolidated losses of the dual resident corporation, and 
income generated by the transferee may be offset by the carryover dual 
consolidated losses of the transferor, subject to the limitations of 
paragraphs (b) and (c) of this section applied as if the transferee 
incurred the dual consolidated loss. Dual consolidated losses of the 
transferor dual resident corporation may not, however, be used to 
offset income attributable to separate units or interests in 
transparent entities owned by the transferee because they constitute 
domestic affiliates under Sec.  1.1503(d)-1(b)(12)(iii) and (iv), 
respectively.
    (iii) Acquisition of a separate unit by a domestic corporation. 
This paragraph (d)(2)(iii) provides exceptions to the general rules in 
paragraphs (d)(1)(i) and (ii) of this section that eliminate the dual 
consolidated loss of a domestic owner that is attributable to a 
separate unit following certain transactions or events. The exceptions 
set forth in this paragraph (d)(2)(iii) shall only apply where a 
domestic owner transfers its assets to a domestic corporation 
(transferee corporation) in a transaction described in section 381(a).
    (A) Acquisition by a corporation that is not a member of the same 
consolidated group--(1) General rule. If a domestic owner transfers 
either an individual separate unit or a combined separate unit to a 
transferee corporation that is not a member of its consolidated group 
in a transaction described in section 381(a), and the transferee 
corporation, or a member of the transferee's consolidated group, is a 
domestic owner of the transferred separate unit immediately after the 
transaction, then paragraphs (d)(1)(i) and (ii) of this section shall 
not apply to such transfer. In addition, income of the transferee, or a 
member of the transferee's consolidated group, that is attributable to 
the transferred separate unit may be offset by the carryover dual 
consolidated losses of the transferor domestic owner that were 
attributable to the transferred separate unit, subject to the 
limitations of paragraphs (b) and (c) of this section applied as if the 
transferee incurred the dual consolidated losses and such losses were 
attributable to the separate unit. See Sec.  1.1503(d)-7(c) Example 21.
    (2) Combination with separate units of the transferee. This 
paragraph (d)(2)(iii)(A)(2) applies to a transaction described in 
paragraph (d)(2)(iii)(A)(1) of this section where the transferred 
separate unit is combined with another separate unit of the transferee, 
or another member of the transferee's consolidated group, immediately 
after the transfer as provided under Sec.  1.1503(d)-1(b)(4)(ii). In 
such a case, income generated by the transferee, or another member of 
the transferee's consolidated group, that is attributable to the 
combined separate unit may be offset by the carryover dual consolidated 
losses that were attributable to the transferred separate unit, subject 
to the limitations of paragraphs (b) and (c) of this section, applied 
as if the transferee incurred the dual consolidated losses and such 
losses were attributable to the combined separate unit.
    (B) Acquisition by a member of the same consolidated group. If an 
affiliated domestic owner transfers its assets to another member of its 
consolidated group in a transaction described in section 381(a), and 
the transferee corporation or another member of such consolidated group 
is a domestic owner of the separate unit to which the dual consolidated 
loss was attributable, then paragraphs (d)(1)(i) and (ii) of this 
section shall not apply. In addition, income generated by the 
transferee that is attributable to the transferred separate unit may be 
offset by the carryover dual consolidated losses that were attributable 
to the transferred separate unit, subject to the limitations of 
paragraphs (b) and (c) of this section, applied as if the transferee 
incurred the dual consolidated losses and such losses were attributable 
to the separate unit. See Sec.  1.1503(d)-7(c) Example 21.
    (iv) Special rules for foreign insurance companies. See Sec.  
1.1503(d)-6(a) for additional limitations that apply where the 
transferor is a foreign insurance company that is a dual resident 
corporation under Sec.  1.1503(d)-1(b)(2)(ii).
    (e) Special rule denying the use of a dual consolidated loss to 
offset tainted income--(1) In general. Dual consolidated losses 
incurred by a dual resident corporation that are subject to the 
domestic use limitation rule under paragraph (b) of this section shall 
not be used to offset income it earns after it ceases to be a dual 
resident corporation to the extent that such income is tainted income.
    (2) Tainted income--(i) Definition. For purposes of paragraph 
(e)(1) of this section, the term tainted income means--
    (A) Income or gain recognized on the sale or other disposition of 
tainted assets; and
    (B) Income derived as a result of holding tainted assets.
    (ii) Income presumed to be derived from holding tainted assets. In 
the absence of evidence establishing the actual amount of income that 
is attributable to holding tainted assets, the portion of a 
corporation's income in a particular taxable year that is treated as 
tainted income derived as a result of holding tainted assets shall be 
an amount equal to the corporation's taxable income for the year (other 
than income described in paragraph (e)(2)(i)(A) of this section) 
multiplied by a fraction, the numerator of which is the fair market 
value of all tainted assets acquired by the corporation (determined at 
the time such assets were so acquired) and the denominator of which is 
the fair market value of the total assets owned by the corporation at 
the end of such taxable year. To establish the actual amount of income 
that is attributable to holding tainted assets, documentation must be 
attached to, and filed by the due date (including extensions) of, the 
domestic corporation's tax return or the consolidated tax return of an 
affiliated group of which it is a member, as the case may be, for the 
taxable year in which the income is generated. See Sec.  1.1503(d)-7(c) 
Example 22.
    (3) Tainted assets defined. For purposes of paragraph (e)(2) of 
this section, tainted assets are any assets acquired by a domestic 
corporation in a nonrecognition transaction, as defined in section 
7701(a)(45), any assets otherwise transferred to the corporation

[[Page 12923]]

as a contribution to capital, or any assets otherwise received from a 
separate unit or a transparent entity owned by such domestic 
corporation, at any time during the three taxable years immediately 
preceding the taxable year in which the corporation ceases to be a dual 
resident corporation or at any time thereafter.
    (4) Exceptions. Income derived from assets acquired by a domestic 
corporation shall not be subject to the limitation described in 
paragraph (e)(1) of this section, and in addition shall not be treated 
as tainted assets as defined in paragraph (e)(3) of this section, if--
    (i) For the taxable year in which the assets were acquired, the 
corporation did not have a dual consolidated loss (or a carryforward of 
a dual consolidated loss to such year); or
    (ii) The assets were acquired as replacement property in the 
ordinary course of business.
    (f) Computation of foreign tax credit limitation. If a dual 
consolidated loss is subject to the domestic use limitation rule under 
paragraph (b) of this section, the consolidated group, unaffiliated 
dual resident corporation, or unaffiliated domestic owner shall compute 
its foreign tax credit limitation by applying the limitations of 
paragraph (c) of this section. Thus, the items constituting the dual 
consolidated loss are not taken into account until the year in which 
such items are absorbed.


Sec.  1.1503(d)-5  Attribution of items and basis adjustments.

    (a) In general. This section provides rules for determining the 
amount of income or dual consolidated loss of a dual resident 
corporation. This section also provides rules for determining the 
income or dual consolidated loss attributable to a separate unit, as 
well as the income or loss attributable to an interest in a transparent 
entity. Paragraph (b) of this section provides rules with respect to 
dual resident corporations. Paragraph (c) of this section provides 
rules with respect to separate units and interests in transparent 
entities. These determinations are required for various purposes under 
section 1503(d). For example, it is necessary for purposes of applying 
the domestic use limitation rule under Sec.  1.1503(d)-4(b) to a dual 
consolidated loss, and for determining the extent to which a dual 
consolidated loss is available to offset income as provided under Sec.  
1.1503(d)-4(c). These determinations are also necessary for purposes of 
determining whether the amount subject to recapture may be reduced 
pursuant to Sec.  1.1503(d)-6(h)(2). Paragraph (d) of this section 
provides rules with respect to the foreign tax treatment of items. 
Paragraph (e) of this section provides rules regarding the treatment of 
items where a dual resident corporation, separate unit, or transparent 
entity only qualified as such during a portion of a taxable year. 
Paragraph (f) of this section provides rules for determining the assets 
and liabilities of a separate unit. Finally, paragraph (g) of this 
section provides rules for making basis adjustments to stock of certain 
members of a consolidated group and to certain interests in 
partnerships. The rules in this section apply for purposes of 
Sec. Sec.  1.1503(d)-1 through Sec.  1.1503(d)-7.
    (b) Determination of amount of income or dual consolidated loss of 
a dual resident corporation--(1) In general. For purposes of 
determining whether a dual resident corporation has income or a dual 
consolidated loss for the taxable year, and except as provided in 
paragraph (b)(2) of this section, the dual resident corporation shall 
compute its income or dual consolidated loss taking into account only 
those items of income, gain, deduction, and loss from such year 
(including any items recognized by such corporation as a result of an 
election under section 338). In the case of an affiliated dual resident 
corporation, such calculation shall be made in accordance with the 
rules set forth in the regulations under section 1502 governing the 
computation of consolidated taxable income. See also paragraphs (d) and 
(e) of this section.
    (2) Exceptions. For purposes of determining the income or dual 
consolidated loss of a dual resident corporation, the following shall 
not be taken into account--
    (i) Any net capital loss of the dual resident corporation;
    (ii) Any carryover or carryback losses; or
    (iii) Any items of income, gain, deduction, and loss that are 
attributable to a separate unit or an interest in a transparent entity 
of the dual resident corporation.
    (c) Determination of amount of income or dual consolidated loss 
attributable to a separate unit, and income or loss attributable to an 
interest in a transparent entity--(1) In general--(i) Scope and 
purpose. Paragraphs (c) through (e) of this section apply for purposes 
of determining the income or dual consolidated loss attributable to a 
separate unit, and the income or loss attributable to an interest in a 
transparent entity, for the taxable year. In the case of an affiliated 
domestic owner, this determination shall be made in accordance with the 
rules set forth in the regulations under section 1502 governing the 
computation of consolidated taxable income. These rules apply solely 
for purposes of section 1503(d).
    (ii) Only items of domestic owner taken into account. The 
computation made under paragraphs (c) through (e) of this section shall 
be made using only those existing items of income, gain, deduction, and 
loss of the separate unit's or transparent entity's domestic owner (or 
owners, in the case of certain combined separate units), as determined 
for U.S. tax purposes. These items must be translated into U.S. dollars 
(if necessary) at the appropriate exchange rate provided under section 
989(b), as modified by regulations. The computation shall be made as if 
the separate unit or interest in a transparent entity were a domestic 
corporation, using items that are attributable to the separate unit or 
interest in a transparent entity. However, for purposes of making this 
computation, net capital losses, and carryover or carryback losses, of 
the domestic owner shall not be taken into account. Items of income, 
gain, deduction, and loss that are otherwise disregarded for U.S. tax 
purposes shall not be regarded or taken into account for purposes of 
this section. See Sec.  1.1503(d)-7(c) Examples 6 and 23 through 25.
    (iii) Separate application. The attribution rules of this section 
shall apply separately to each separate unit or interest in a 
transparent entity. Thus, an item of income, gain, deduction, or loss 
shall not be considered attributable to more than one separate unit or 
interest in a transparent entity. In addition, for purposes of this 
section items of income, gain, deduction, and loss attributable to a 
separate unit or an interest in a transparent entity shall not offset 
items of income, gain, deduction, and loss of another separate unit or 
interest in a transparent entity. See Sec.  1.1503(d)-7(c) Example 24. 
See also the separate unit combination rule in Sec.  1.1503(d)-
1(b)(4)(ii).
    (2) Foreign branch separate unit--(i) In general. Except to the 
extent provided in paragraph (c)(4) of this section, for purposes of 
determining the items of income, gain, deduction (other than interest), 
and loss of a domestic owner that are attributable to the domestic 
owner's foreign branch separate unit, the principles of section 
864(c)(2), (c)(4), and (c)(5), as set forth in Sec.  1.864-4(c), and 
Sec. Sec.  1.864-5 through 1.864-7, shall apply. The principles apply 
without regard to limitations imposed on the effectively connected 
treatment of income, gain, or loss under the trade or business safe 
harbors in section 864(b) and the limitations for

[[Page 12924]]

treating foreign source income as effectively connected under section 
864(c)(4)(D). Except as provided in paragraph (c)(2)(iii) of this 
section, for purposes of determining the domestic owner's interest 
expense that is attributable to a foreign branch separate unit, the 
principles of Sec.  1.882-5, as modified in paragraph (c)(2)(ii) of 
this section, shall apply. When applying the principles of section 
864(c) (as modified by this paragraph) and Sec.  1.882-5 (as modified 
in paragraph (c)(2)(ii) of this section), the foreign branch separate 
unit's domestic owner shall be treated as a foreign corporation, the 
foreign branch separate unit shall be treated as a trade or business 
within the United States, and the other assets of the domestic owner 
shall be treated as assets that are not U.S. assets.
    (ii) Principles of Sec.  1.882-5. For purposes of paragraph 
(c)(2)(i) of this section, the principles of Sec.  1.882-5 shall be 
applied, subject to the following modifications--
    (A) Except as otherwise provided in this section, only the assets, 
liabilities, and interest expense of the domestic owner shall be taken 
into account in the Sec.  1.882-5 formula;
    (B) Except as provided under paragraph (c)(2)(ii)(C) of this 
section, a taxpayer may use the alternative tax book value method under 
Sec.  1.861-9(i) for purposes of determining the value of its U.S. 
assets pursuant to Sec.  1.882-5(b)(2) and its worldwide assets 
pursuant to Sec.  1.882-5(c)(2);
    (C) For purposes of determining the value of a U.S. asset pursuant 
to Sec.  1.882-5(b)(2), and worldwide assets pursuant to Sec.  1.882-
5(c)(2), the taxpayer must use the same methodology under Sec.  1.861-
9T(g) (that is, tax book value, alternative tax book value, or fair 
market value) that the taxpayer uses for purposes of allocating and 
apportioning interest expense for the taxable year under section 
864(e);
    (D) Asset values shall be determined pursuant to Sec.  1.861-
9T(g)(2); and
    (E) For purposes of determining the step-two U.S. connected 
liabilities, the amounts of worldwide assets and liabilities under 
Sec.  1.882-5(c)(2)(iii) and (iv) must be determined in accordance with 
U.S. tax principles, rather than substantially in accordance with U.S. 
tax principles.
    (iii) Exception where foreign country attributes interest expense 
solely by reference to books and records. The principles of Sec.  
1.882-5 shall not apply if the foreign country in which the foreign 
branch separate unit is located determines, for purposes of computing 
taxable income (or loss) of a permanent establishment or branch of a 
nonresident corporation under the laws of the foreign country, the 
interest expense of the foreign branch separate unit by taking into 
account only the items of interest expense reflected on the foreign 
branch separate unit's books and records. In such a case, only those 
items of the domestic owner's interest expense reflected on the foreign 
branch separate unit's books and records (as provided in paragraph 
(c)(3)(i) of this section), adjusted to conform to U.S. tax principles, 
shall be attributable to the foreign branch separate unit. This 
paragraph shall not apply where the foreign country does not use a 
method of attributing interest based solely on the interest that is 
reflected on the books and records. For example, this paragraph does 
not apply if the foreign country uses a method for attributing interest 
expense similar to Sec.  1.882-5 or that set forth in the Organization 
for Economic Co-operation and Development Report on the Attribution of 
Profits to Permanent Establishments, Part II (Banks), December 2006. 
See http://www.oecd.org.
    (3) Hybrid entity separate unit and an interest in a transparent 
entity--(i) General rule. This paragraph (c)(3) applies to determine 
the items of income, gain, deduction, and loss of a domestic owner that 
are attributable to a hybrid entity separate unit, or an interest in a 
transparent entity, of such domestic owner. Except to the extent 
provided in paragraph (c)(4) of this section, the domestic owner's 
items of income, gain, deduction, and loss are attributable to the 
extent they are reflected on the books and records of the hybrid entity 
or transparent entity, as applicable, as adjusted to conform to U.S. 
tax principles. See Sec.  1.1503(d)-7(c) Examples 23 through 26. For 
purposes of this paragraph (c)(3), the term ``books and records'' has 
the meaning provided under Sec.  1.989(a)-1(d). The treatment of items 
for foreign tax purposes, including under any type of foreign anti-
deferral regime, is not relevant for purposes of determining whether 
items are reflected on the books and records of the entity, or for 
purposes of making adjustments to such items to conform to U.S. tax 
principles. The method described in the second sentence of this 
paragraph shall not apply to the extent that the Commissioner 
determines that booking practices are employed with a principal purpose 
of avoiding the principles of section 1503(d), including inconsistently 
treating the same or similar items of income, gain, deduction, and 
loss. In such a case, the Commissioner may reallocate the items of 
income, gain, deduction, and loss between or among a domestic owner, 
its hybrid entities, its transparent entities (and interests therein), 
its separate units, or any other entity, as applicable, in a manner 
consistent with the principles of section 1503(d) and which properly 
reflects income (or loss).
    (ii) Interests in certain disregarded entities, partnerships, and 
grantor trusts owned by a hybrid entity or transparent entity. This 
paragraph (c)(3)(ii) applies if a hybrid entity or transparent entity 
to which paragraph (c)(3)(i) of this section applies owns, directly or 
indirectly (other than through a hybrid entity or transparent entity), 
an interest in an entity that is treated as a disregarded entity, 
partnership, or grantor trust for U.S. tax purposes, but is not a 
hybrid entity or a transparent entity. For example, the rules of this 
paragraph would apply when a hybrid entity holds an interest in a 
limited partnership created in the United States and, for both U.S. and 
foreign tax purposes the entity is considered a partnership. In such a 
case, and except to the extent provided in paragraph (c)(4) of this 
section, items of income, gain, deduction, and loss that are reflected 
on the books and records of such disregarded entity, partnership or 
grantor trust, as determined under paragraph (c)(3)(i) of this section, 
shall be treated as being reflected on the books and records of the 
hybrid entity or transparent entity for purposes of applying paragraph 
(c)(3)(i) of this section. See Sec.  1.1503(d)-7(c) Example 26.
    (4) Special rules. The following special rules shall apply for 
purposes of attributing items to separate units or interests in 
transparent entities under this section:
    (i) Allocation of items between certain tiered separate units and 
interests in transparent entities--(A) Foreign branch separate unit. 
This paragraph (c)(4)(i) applies where a hybrid entity or transparent 
entity owns directly or indirectly (other than through a hybrid entity 
or a transparent entity), a foreign branch separate unit. For purposes 
of determining items of income, gain, deduction, and loss of the 
domestic owner that are attributable to the domestic owner's foreign 
branch separate unit described in the preceding sentence, only items of 
income, gain, deduction, and loss that are attributable to the domestic 
owner's interest in the hybrid entity, or transparent entity, as 
provided in paragraph (c)(2) of this section, shall be taken into 
account. Further, only assets, liabilities, and activities of the 
domestic owner's interest in the hybrid entity or the transparent 
entity shall be taken into

[[Page 12925]]

account under paragraph (c)(2) of this section when applying the 
principles of 864(c)(2), (c)(4), (c)(5) (as set forth in Sec.  1.864-
4(c), and Sec. Sec.  1.864-5 through 1.864-7), and Sec.  1.882-5 (as 
modified in paragraph (c)(2)(ii) of this section). See Sec.  1.1503(d)-
7(c) Examples 25 and 26.
    (B) Hybrid entity separate unit or interest in a transparent 
entity. For purposes of determining items of income, gain, deduction, 
and loss that are attributable to a hybrid entity separate unit or an 
interest in a transparent entity described in paragraph (c)(3) of this 
section, such items shall not be taken into account to the extent they 
are attributable to a foreign branch separate unit pursuant to 
paragraph (c)(4)(i)(A) of this section. See Sec.  1.1503(d)-7(c) 
Examples 25 and 26.
    (ii) Combined separate unit. If two or more individual separate 
units defined in Sec.  1.1503(d)-1(b)(4)(i) are treated as one combined 
separate unit pursuant to Sec.  1.1503(d)-1(b)(4)(ii), the items of 
income, gain, deduction, and loss that are attributable to the combined 
separate unit shall be determined as follows:
    (A) Items of income, gain, deduction, and loss are first attributed 
to each individual separate unit without regard to Sec.  1.1503(d)-
1(b)(4)(ii), pursuant to the rules of paragraphs (c) through (e) of 
this section.
    (B) The combined separate unit then takes into account all of the 
items of income, gain, deduction, and loss attributable to its 
individual separate units pursuant to paragraph (c)(4)(ii)(A) of this 
section. See Sec.  1.1503(d)-7(c) Examples 25 and 26.
    (iii) Gain or loss on the direct or indirect disposition of a 
separate unit or an interest in a transparent entity--(A) In general. 
This paragraph (c)(4)(iii) applies for purposes of attributing items of 
income, gain, deduction, and loss that are recognized on the sale, 
exchange, or other disposition of a separate unit or an interest in a 
transparent entity (or an interest in a disregarded entity, 
partnership, or grantor trust that owns, directly or indirectly, a 
separate unit or an interest in a transparent entity). For purposes of 
this paragraph (c)(4)(iii), items taken into account on the sale, 
exchange, or other disposition include loss recapture income or gain 
under section 367(a)(3)(C) or 904(f)(3), and gain or loss recognized by 
the domestic owner as the result of an election under section 338. In 
cases where this paragraph (c)(4)(iii)(A) applies, items taken into 
account on the sale, exchange, or other disposition shall be 
attributable to the separate unit or the interest in the transparent 
entity to the extent of gain or loss that would have been recognized 
had the separate unit or transparent entity sold all its assets (as 
determined in paragraph (f) of this section) in a taxable exchange, 
immediately before the sale, exchange, or other disposition (deemed 
sale). For purposes of a deemed sale described in this paragraph 
(c)(4)(iii), the assets are treated as being sold for an amount equal 
to their fair market value, plus the assumption of the liabilities of 
the separate unit or interest in a transparent entity (as determined in 
paragraph (f) of this section). See Sec.  1.1503(d)-7(c) Example 27.
    (B) Multiple separate units or interests in transparent entities. 
This paragraph (c)(4)(iii)(B) applies to a sale, exchange, or other 
disposition described in paragraph (c)(4)(iii)(A) of this section that 
results in more than one separate unit or interest in a transparent 
entity being, directly or indirectly, disposed of. In such a case, 
items of income, gain, deduction, and loss recognized on such sale, 
exchange, or other disposition are allocated and attributed to each 
separate unit or interest in a transparent entity, based on the 
relative gain or loss that would have been recognized by each separate 
unit or interest in a transparent entity pursuant to a deemed sale of 
their assets. See Sec.  1.1503(d)-7(c) Example 28.
    (iv) Inclusions on stock. Any amount included in income of a 
domestic owner arising from ownership of stock in a foreign corporation 
(for example, under sections 78, 951, or 986(c)) through a separate 
unit, or interest in a transparent entity, shall be attributable to the 
separate unit or interest in a transparent entity, if an actual 
dividend from such foreign corporation would have been so attributed. 
See Sec.  1.1503(d)-7(c) Example 24.
    (v) Foreign currency gain or loss recognized under section 987. 
Foreign currency gain or loss of a domestic owner recognized under 
section 987 as a result of a transfer or remittance shall not be 
attributable to a separate unit or an interest in a transparent entity.
    (vi) Recapture of dual consolidated loss. If all or a portion of a 
dual consolidated loss that was attributable to a separate unit is 
included in the gross income of a domestic owner under the recapture 
provisions of Sec.  1.1503(d)-6(h), such amount shall be attributable 
to the separate unit that incurred the dual consolidated loss being 
recaptured. See Sec.  1.1503(d)-7(c) Examples 38 and 40.
    (d) Foreign tax treatment disregarded. The fact that a particular 
item taken into account in computing the income or dual consolidated 
loss of a dual resident corporation or a separate unit, or the income 
or loss of an interest in a transparent entity, is not taken into 
account in computing income (or loss) subject to a foreign country's 
income tax shall not cause such item to be excluded from being taken 
into account under paragraph (b), (c) or (e) of this section.
    (e) Items generated or incurred while a dual resident corporation, 
a separate unit, or a transparent entity. For purposes of determining 
the amount of the dual consolidated loss of a dual resident corporation 
for the taxable year, only the items of income, gain, deduction, and 
loss generated or incurred during the period the dual resident 
corporation qualified as such shall be taken into account. For purposes 
of determining the amount of income of a dual resident corporation for 
the taxable year, all the items of income, gain, deduction, and loss 
generated or incurred during the year shall be taken into account. For 
purposes of determining the amount of the income or dual consolidated 
loss attributable to a separate unit, or the income or loss 
attributable to an interest in a transparent entity, for the taxable 
year, only the items of income, gain, deduction, and loss generated or 
incurred during the period the separate unit or the interest in the 
transparent entity qualified as such shall be taken into account. For 
purposes of this paragraph (e), the allocation of items to periods 
shall be made under the principles of Sec.  1.1502-76(b).
    (f) Assets and liabilities of a separate unit or an interest in a 
transparent entity. A separate unit or an interest in a transparent 
entity shall be treated as owning assets to the extent items of income, 
gain, deduction, and loss from such assets would be attributable to the 
separate unit or interest in the transparent entity under paragraphs 
(c) through (e) of this section. Similarly, liabilities shall be 
treated as liabilities of a separate unit, or an interest in a 
transparent entity, to the extent interest expense incurred on such 
liabilities would be attributable to the separate unit, or the interest 
in a transparent entity, under paragraphs (c) through (e) of this 
section.
    (g) Basis adjustments--(1) Affiliated dual resident corporation or 
affiliated domestic owner. If a member of a consolidated group owns 
stock in an affiliated dual resident corporation or an affiliated 
domestic owner that is a member of the same consolidated group, the 
member shall adjust the basis of the stock in accordance with the 
provisions of Sec.  1.1502-32. Corresponding adjustments shall be made 
to the stock of other members in accordance with the provisions of 
Sec.  1.1502-32. In the case where two or more individual

[[Page 12926]]

separate units are treated as a combined separate unit pursuant to 
Sec.  1.1503(d)-1(b)(4)(ii), see paragraph (g)(3) of this section.
    (2) Interests in hybrid entities that are partnerships or interests 
in partnerships through which a separate unit is owned indirectly--(i) 
Scope. This paragraph (g)(2) applies for purposes of determining the 
adjusted basis of an interest in--
    (A) A hybrid entity that is a partnership; and
    (B) A partnership through which a domestic owner indirectly owns a 
separate unit.
    (ii) Determination of basis of partner's interest. The adjusted 
basis of an interest described in paragraph (g)(2)(i) of this section 
shall be adjusted in accordance with section 705 and this paragraph 
(g)(2). The adjusted basis shall not be decreased for any amount of a 
dual consolidated loss that is attributable to the partnership 
interest, or separate unit owned indirectly through the partnership 
interest, as applicable, that is not absorbed as a result of the 
application of Sec.  1.1503(d)-4(b) and (c). The adjusted basis shall, 
however, be decreased for the amount of such dual consolidated loss 
that is absorbed in a carryover or carryback taxable year. The adjusted 
basis shall be increased for any amount included in income pursuant to 
Sec.  1.1503(d)-6(h) as a result of the recapture of a dual 
consolidated loss that was attributable to the interest in the hybrid 
partnership, or separate unit owned indirectly through the partnership 
interest, as applicable.
    (3) Combined separate units. This paragraph (g)(3) applies where 
two or more individual separate units of one or more affiliated 
domestic owners are treated as one combined separate unit pursuant to 
Sec.  1.1503(d)-1(b)(4)(ii). In such a case, a member owning stock in 
an affiliated domestic owner of the combined separate unit shall adjust 
the basis in the stock of such domestic owner as provided in paragraph 
(g)(1) of this section, and an affiliated domestic owner shall adjust 
its basis in a partnership, as provided in paragraph (g)(2) of this 
section, taking into account only those items of income, gain, 
deduction, or loss attributable to each individual separate unit, prior 
to combination. For purposes of this rule, if the dual consolidated 
loss attributable to a combined separate unit is subject to the 
domestic use limitation of Sec.  1.1503(d)-4(b), then for purposes of 
this paragraph (g) and Sec.  1.1502-32, the dual consolidated loss 
shall be allocated to an individual separate unit to the extent such 
individual separate unit contributed items of deduction or loss giving 
rise to the dual consolidated loss. In addition, if one or more 
affiliated domestic owners are required to recapture all or a portion 
of a dual consolidated loss pursuant to paragraph (h) of this section, 
such recapture amount shall be allocated to the affiliated domestic 
owner of the individual separate units composing the combined separate 
unit, to the extent such individual separate units contributed items of 
deduction or loss giving rise to the recaptured dual consolidated loss.


Sec.  1.1503(d)-6  Exceptions to the domestic use limitation rule.

    (a) In general--(1) Scope and purpose. This section provides 
certain exceptions to the domestic use limitation rule of Sec.  
1.1503(d)-4(b). Paragraph (b) of this section provides an exception for 
bilateral elective agreements. Paragraph (c) of this section provides 
rules regarding an exception that applies when there is no possibility 
of a foreign use. Paragraphs (d) through (h) of this section provide 
rules for an exception where a domestic use election is made. Paragraph 
(e) of this section provides rules with respect to triggering events, 
and paragraph (f) of this section provides rules regarding exceptions 
to triggering events. Paragraph (g) of this section provides rules with 
respect to the annual certification reporting requirement. Paragraph 
(h) of this section provides rules regarding the recapture of dual 
consolidated losses. Finally, paragraph (j) of this section provides 
rules regarding the termination of domestic use agreements and the 
annual certification requirement.
    (2) Absence of foreign affiliate or foreign consolidation regime. 
The absence of a foreign affiliate or a foreign consolidation regime 
alone does not constitute an exception to the domestic use limitation 
rule. This is the case because it is still possible that all or a 
portion of the dual consolidated loss may be put to a foreign use. For 
example, there may be a foreign use with respect to an affiliate 
acquired in a year subsequent to the year in which the dual 
consolidated loss was incurred. In addition, a foreign use may occur in 
the absence of a foreign consolidation regime through a sale, merger, 
or similar transaction. See Sec.  1.1503(d)-7(c) Example 2.
    (3) Foreign insurance companies treated as domestic corporations. 
The exceptions contained in this section shall not apply to losses of a 
foreign insurance company that is a dual resident corporation under 
Sec.  1.1503(d)-1(b)(2)(ii), or to losses attributable to any separate 
unit of such foreign insurance company. In addition, these exceptions 
shall not apply to losses described in the preceding sentence that, 
subject to the rules of Sec.  1.1503(d)-4(d), carry over to a domestic 
corporation pursuant to a transaction described in section 381(a).
    (b) Elective agreement in place between the United States and a 
foreign country--(1) In general. The domestic use limitation rule of 
Sec.  1.1503(d)-4(b) shall not apply to a dual consolidated loss to the 
extent the consolidated group, unaffiliated dual resident corporation, 
or unaffiliated domestic owner, as the case may be, elects to deduct 
the loss in the United States pursuant to an agreement entered into 
between the United States and a foreign country that puts into place an 
elective procedure through which losses in a particular year may be 
used to offset income in only one country. This exception shall apply 
only if all the terms and conditions required under such agreement are 
satisfied, including any reporting or filing requirements. See Sec.  
1.1503(d)-3(e)(2)(iii) for the effect of an agreement described in this 
paragraph on a stand-alone domestic use agreement.
    (2) Application to combined separate units. This paragraph (b)(2) 
applies where two or more individual separate units are treated as one 
combined separate unit pursuant to Sec.  1.1503(d)-1(b)(4)(ii), and an 
agreement described in paragraph (b)(1) of this section would apply to 
at least one of the individual separate units. In such a case, and 
except to the extent provided in the agreement, the consolidated group, 
unaffiliated dual resident corporation, or unaffiliated domestic owner, 
as the case may be, may apply the agreement to the individual separate 
units, as applicable, provided the terms and conditions of the 
agreement are otherwise satisfied. See Sec.  1.1503(d)-7(c) Example 19.
    (c) No possibility of foreign use--(1) In general. The domestic use 
limitation rule of Sec.  1.1503(d)-4(b) shall not apply to a dual 
consolidated loss if the consolidated group, unaffiliated dual resident 
corporation, or unaffiliated domestic owner, as the case may be--
    (i) Demonstrates, to the satisfaction of the Commissioner, that no 
foreign use (as defined in Sec.  1.1503(d)-3) of the dual consolidated 
loss occurred in the year in which it was incurred, and that no foreign 
use can occur in any other year by any means; and
    (ii) Prepares a statement described in paragraph (c)(2) of this 
section that is attached to, and filed by the due date (including 
extensions) of, its U.S. income tax return for the taxable year in

[[Page 12927]]

which the dual consolidated loss is incurred. See Sec.  1.1503(d)-7(c) 
Examples 2, 30, and 31.
    (2) Statement. The statement described in this paragraph (c)(2) 
must be signed under penalties of perjury by the person who signs the 
tax return. The statement must be labeled ``No Possibility of Foreign 
Use of Dual Consolidated Loss Statement'' at the top of the page and 
must include the following items, in paragraphs labeled to correspond 
with the items set forth in paragraphs (c)(2)(i) through (iv) of this 
section:
    (i) A statement that the document is submitted under the provisions 
of paragraph (c) of this section.
    (ii) The name, address, taxpayer identification number, and place 
and date of incorporation of the dual resident corporation, and the 
country or countries that tax the dual resident corporation on its 
worldwide income or on a residence basis, or, in the case of a separate 
unit, identification of the separate unit, including the name under 
which it conducts business, its principal activity, and the country in 
which its principal place of business is located. In the case of a 
combined separate unit, such information must be provided for each 
individual separate unit that is treated as part of the combined 
separate unit under Sec.  1.1503(d)-1(b)(4)(ii).
    (iii) A statement of the amount of the dual consolidated loss at 
issue.
    (iv) An analysis, in reasonable detail and specificity, of the 
treatment of the losses and deductions composing the dual consolidated 
loss under the relevant facts. The analysis must include the reasons 
supporting the conclusion that no foreign use of the dual consolidated 
loss can occur as described in paragraph (c)(1)(i) of this section. The 
analysis must be supported with official or certified English 
translations of the relevant provisions of foreign law. The analysis 
may, for example, be based on the taxpayer's interpretation of foreign 
law, on advice received from local tax advisers in an opinion, or on a 
ruling from local country tax authorities. In all cases, however, the 
determination must be made to the satisfaction of the Commissioner.
    (d) Domestic use election--(1) In general. The domestic use 
limitation rule of Sec.  1.1503(d)-4(b) shall not apply to a dual 
consolidated loss if an election to be bound by the provisions of 
paragraphs (d) through (j) of this section is made by the consolidated 
group, unaffiliated dual resident corporation, or unaffiliated domestic 
owner, as the case may be (elector). In order to elect such relief, an 
agreement described in this paragraph (d)(1) (domestic use agreement) 
must be attached to, and filed by the due date (including extensions) 
of, the U.S. income tax return of the elector for the taxable year in 
which the dual consolidated loss is incurred. The domestic use 
agreement must be signed under penalties of perjury by the person who 
signs the return. If dual consolidated losses of more than one dual 
resident corporation or separate unit requires the filing of domestic 
use agreements by the same elector, the agreements may be combined in a 
single document, but the information required by paragraphs (d)(1)(ii) 
and (iv) of this section must be provided separately with respect to 
each dual consolidated loss. The domestic use agreement must be labeled 
``Domestic Use Election and Agreement'' at the top of the page and must 
include the following items, in paragraphs labeled to correspond with 
the following:
    (i) A statement that the document submitted is an election and an 
agreement under the provisions of paragraph (d) of this section.
    (ii) The information required by paragraph (c)(2)(ii) of this 
section.
    (iii) An agreement by the elector to comply with all of the 
provisions of paragraphs (d) through (j) of this section, as 
applicable.
    (iv) A statement of the amount of the dual consolidated loss at 
issue.
    (v) A certification that there has not been, and will not be, a 
foreign use (as defined in Sec.  1.1503(d)-3) during the certification 
period (as defined in Sec.  1.1503(d)-1(b)(20)).
    (vi) A certification that arrangements have been made to ensure 
that there will be no foreign use of the dual consolidated loss during 
the certification period, and that the elector will be informed of any 
such foreign use of the dual consolidated loss during such period.
    (vii) If applicable, a notification that an excepted triggering 
event under paragraph (f)(2) of this section has occurred with respect 
to the dual consolidated loss within the taxable year in which the loss 
is incurred. See paragraph (g) of this section for notification of 
excepted triggering events occurring during the certification period.
    (2) No domestic use election available if there is a triggering 
event in the year the dual consolidated loss is incurred. Except as 
otherwise provided in this section, if a dual resident corporation or 
separate unit incurs a dual consolidated loss in a taxable year and a 
triggering event, as described in paragraph (e)(1) of this section, 
occurs (and no exception applies) with respect to the dual consolidated 
loss in such taxable year, then the consolidated group, unaffiliated 
dual resident corporation, or unaffiliated domestic owner, as the case 
may be, may not make a domestic use election with respect to such dual 
consolidated loss and the loss will be subject to the domestic use 
limitation rule of Sec.  1.1503(d)-4(b). See Sec.  1.1503(d)-7(c) 
Examples 5 through 7. See also Sec.  1.1503(d)-4(d) for rules that 
eliminate a dual consolidated loss after certain transactions.
    (e) Triggering events requiring the recapture of a dual 
consolidated loss--(1) Events. Except as provided under paragraphs 
(e)(2) (rebuttal of triggering events) and (f) (exceptions to 
triggering events) of this section, if there is a triggering event 
described in this paragraph (e)(1) with respect to a dual consolidated 
loss of a dual resident corporation or a separate unit during the 
certification period (as defined in Sec.  1.1503(d)-1(b)(20)), the 
elector will recapture and report as ordinary income the amount of such 
dual consolidated loss as provided in paragraph (h) of this section on 
its tax return for the taxable year in which the triggering event 
occurs (or, when the triggering event is a foreign use of the dual 
consolidated loss, the taxable year that includes the last day of the 
foreign taxable year during which such use occurs). In addition, the 
elector must pay any applicable interest charge required by paragraph 
(h) of this section. For purposes of this section, any of the following 
events shall constitute a triggering event:
    (i) Foreign use. A foreign use (as defined in Sec.  1.1503(d)-3) of 
the dual consolidated loss. See Sec.  1.1503(d)-3(c) for exceptions to 
foreign use.
    (ii) Disaffiliation. An affiliated dual resident corporation or 
affiliated domestic owner that incurred directly or through a separate 
unit, respectively, a dual consolidated loss that is subject to a 
domestic use election, ceases to be a member of the consolidated group 
that made the domestic use election. For purposes of this paragraph 
(e)(1)(ii), an affiliated dual resident corporation or affiliated 
domestic owner shall be considered to cease to be a member of the 
consolidated group if it is no longer a member of the group within the 
meaning of Sec.  1.1502-1(b), or if the group ceases to exist (for 
example, when the group no longer files a consolidated return). See 
Sec.  1.1503(d)-7(c) Example 34. Any consequences resulting from this 
triggering event (for example, recapture of a dual consolidated loss) 
shall be taken into account on the tax return of the consolidated group 
for the

[[Page 12928]]

taxable year that includes the date on which the affiliated dual 
resident corporation or affiliated domestic owner ceases to be a member 
of the consolidated group. This paragraph (e)(1)(ii) shall not apply to 
an acquisition described in Sec.  1.1502-75(d)(3) where the 
consolidated group that includes the affiliated dual resident 
corporation or affiliated domestic owner, as applicable, is treated as 
remaining in existence.
    (iii) Affiliation. An unaffiliated dual resident corporation or 
unaffiliated domestic owner becomes a member of a consolidated group. 
Any consequences resulting from this triggering event (for example, 
recapture of a dual consolidated loss) shall be taken into account on 
the tax return of the unaffiliated dual resident corporation or 
unaffiliated domestic owner for the taxable year that ends at the end 
of the day on which such corporation becomes a member of the 
consolidated group.
    (iv) Transfer of assets. Fifty percent or more of the dual resident 
corporation's or separate unit's gross assets (measured by the fair 
market value of the assets at the time of such transaction or, for 
multiple transactions, at the time of the first transaction) is sold or 
otherwise disposed of in either a single transaction or a series of 
transactions within a twelve-month period. See Sec.  1.1503(d)-7(c) 
Examples 5 and 35 through 37. In determining whether fifty percent or 
more of such assets is sold or otherwise disposed of, any dispositions 
occurring in the ordinary course of the dual resident corporation's or 
separate unit's trade or business shall be disregarded. In addition, 
for purposes of this paragraph (e)(1)(iv), an interest in another 
separate unit and the shares of a dual resident corporation shall not 
be treated as assets of a separate unit or a dual resident corporation.
    (v) Transfer of an interest in a separate unit. Fifty percent or 
more of the interest in a separate unit (measured by voting power or 
value at the time of such transaction, or for multiple transactions, at 
the time of the first transaction) of the domestic owner, as determined 
by reference to such domestic owner's percentage interest on the last 
day of the taxable year in which the dual consolidated loss was 
incurred, is sold or otherwise disposed of either in a single 
transaction or a series of transactions within a twelve-month period. 
See Sec.  1.1503(d)-7(c) Examples 5 and 35 through 37.
    (vi) Conversion to a foreign corporation. An unaffiliated dual 
resident corporation, unaffiliated domestic owner, or hybrid entity an 
interest in which is a separate unit, that incurred the dual 
consolidated loss, becomes a foreign corporation (for example, as a 
result of a reorganization or an election to be classified as a 
corporation under Sec.  301.7701-3(c) of this chapter).
    (vii) Conversion to a regulated investment company, a real estate 
investment trust, or an S corporation. An unaffiliated dual resident 
corporation or unaffiliated domestic owner elects to be a regulated 
investment company pursuant to section 851(b)(1), a real estate 
investment trust pursuant to section 856(c)(1), or an S corporation 
pursuant to section 1362(a).
    (viii) Failure to certify. The elector fails to file a 
certification with respect to a dual consolidated loss as required 
under paragraph (g) of this section.
    (ix) Cessation of stand-alone status. In the case of a dual 
consolidated loss that is subject to the stand-alone exception 
described in Sec.  1.1503(d)-3(e)(2), the conditions described in Sec.  
1.1503(d)-3(e)(2)(i) are no longer satisfied. See Sec.  1.1503(d)-7(c) 
Example 18.
    (2) Rebuttal--(i) General rule. An event described in paragraph 
(e)(1) of this section shall not constitute a triggering event if the 
elector demonstrates, to the satisfaction of the Commissioner, that 
there can be no foreign use (as defined in Sec.  1.1503(d)-3) of the 
dual consolidated loss during the remaining certification period by any 
means. See paragraph (j)(1) of this section for rules regarding the 
termination of domestic use agreements and annual certifications 
following rebuttals under this general rule.
    (ii) Certain asset transfers. An event described in paragraph 
(e)(1)(iv) of this section shall not constitute a triggering event if 
the elector demonstrates, to the satisfaction of the Commissioner, that 
the transfer of assets did not result in a carryover under foreign law 
of the dual resident corporation's, or separate unit's, losses, 
expenses, or deductions to the transferee of the assets. For purposes 
of this determination, the exception to foreign use in Sec.  1.1503(d)-
3(c)(7) shall be taken into account. Following rebuttal under this 
paragraph (e)(2)(ii), the domestic use agreement continues in effect.
    (iii) Reporting. In order to satisfy the requirements of paragraph 
(e)(2)(i) or (ii) of this section, the elector must prepare a 
statement, labeled ``Rebuttal of Triggering Event'' at the top of the 
page, that indicates that it is submitted under the provisions of this 
paragraph (e)(2). The statement must include the information described 
in paragraphs (c)(2)(ii) and (iii) of this section. The statement must 
also include the information described in paragraph (c)(2)(iv) of this 
section that supports the conclusions under paragraph (e)(2)(i) or (ii) 
of this section, as applicable. The statement must be attached to, and 
filed by the due date (including extensions) of, the elector's income 
tax return for the taxable year in which the presumed triggering event 
occurs.
    (iv) Examples. See Sec.  1.1503(d)-7(c) Examples 32 and 33.
    (f) Triggering event exceptions--(1) Continuing ownership of assets 
or interests. The following events shall not constitute triggering 
events, requiring the recapture of the dual consolidated loss under 
paragraph (h) of this section:
    (i) Disaffiliation as a result of a transaction described in 
section 381. An affiliated dual resident corporation or affiliated 
domestic owner ceases to be a member of a consolidated group solely by 
reason of a transaction in which a member of the same consolidated 
group succeeds to the tax attributes of the dual resident corporation 
or domestic owner under the provisions of section 381.
    (ii) Continuing ownership by consolidated group. This paragraph 
(f)(1)(ii) applies when assets of an affiliated dual resident 
corporation, or assets of, or interests in, a separate unit of an 
affiliated domestic owner are sold or otherwise disposed of. In such a 
case, the sale or disposition shall not be treated as a triggering 
event to the extent the assets or interests are acquired by one or more 
members of the consolidated group that includes the affiliated dual 
resident corporation or affiliated domestic owner, or by a partnership 
or a grantor trust, but only if immediately after the acquisition more 
than 90 percent of the partnership's or grantor trust's interests is 
owned, directly or indirectly, by members of such consolidated group.
    (iii) Continuing ownership by unaffiliated dual resident 
corporation or unaffiliated domestic owner. This paragraph (f)(1)(iii) 
applies when assets of an unaffiliated dual resident corporation, or 
assets of, or interests in, a separate unit of an unaffiliated domestic 
owner, are sold or otherwise disposed of. In such a case, the sale or 
disposition shall not be a triggering event to the extent such assets 
or interests are acquired by the unaffiliated dual resident 
corporation, or unaffiliated domestic owner, as applicable, or by a 
partnership or grantor trust, but only if immediately after the 
acquisition more than 90 percent of the partnership's or grantor 
trust's interests is owned, directly or indirectly, by the unaffiliated 
dual resident corporation or unaffiliated

[[Page 12929]]

domestic owner. For example, this paragraph (f)(1)(iii) applies when an 
unaffiliated domestic owner acquires direct ownership of the assets of 
a separate unit that it had immediately before owned indirectly through 
a partnership.
    (2) Transactions requiring a new domestic use agreement--(i) 
Multiple-party events. If all the requirements of paragraph (f)(2)(iii) 
of this section are satisfied, the following events shall not 
constitute triggering events requiring the recapture of the dual 
consolidated loss under paragraph (h) of this section:
    (A) An affiliated dual resident corporation or affiliated domestic 
owner becomes an unaffiliated domestic corporation or a member of a new 
consolidated group (other than in a transaction described in paragraph 
(f)(2)(ii)(B) of this section).
    (B) Assets of a dual resident corporation or assets of, or 
interests in, a separate unit, are sold or otherwise disposed of in a 
transaction in which such assets or interests are acquired by an 
unaffiliated domestic corporation, one or more members of a new 
consolidated group, or by a partnership or grantor trust, but only if 
immediately after the sale or disposition more than 90 percent of the 
partnership's or grantor trust's interests is owned, directly or 
indirectly, by the unaffiliated domestic owner or by members of a new 
consolidated group, as applicable. See the related exception to foreign 
use provided under Sec.  1.1503(d)-3(c)(8). See also Sec.  1.1503(d)-
7(c) Examples 36 and 37.
    (ii) Events resulting in a single consolidated group. If the 
requirements of paragraph (f)(2)(iii)(A) of this section are satisfied, 
the following events shall not constitute triggering events requiring 
the recapture of the dual consolidated loss under paragraph (h) of this 
section:
    (A) An unaffiliated dual resident corporation or unaffiliated 
domestic owner becomes a member of a consolidated group.
    (B) A consolidated group ceases to exist as a result of a 
transaction described in Sec.  1.1502-13(j)(5)(i) (relating to 
acquisitions of the common parent of the consolidated group), other 
than a transaction in which any member of the terminating group, or the 
successor-in-interest of such member, is not a member of the surviving 
group immediately after the terminating group ceases to exist. See 
Sec.  1.1503(d)-7(c) Example 34.
    (iii) Requirements--(A) New domestic use agreement. The 
unaffiliated domestic corporation or new consolidated group (subsequent 
elector) must file an agreement described in paragraph (d)(1) of this 
section (new domestic use agreement). The new domestic use agreement 
must be labeled ``New Domestic Use Agreement'' at the top of the page, 
and must be attached to and filed by the due date (including 
extensions) of, the subsequent elector's income tax return for the 
taxable year in which the event described in paragraph (f)(2)(i) or 
(f)(2)(ii) of this section occurs. The new domestic use agreement must 
be signed under penalties of perjury by the person who signs the return 
and must include the following items:
    (1) A statement that the document submitted is an election and 
agreement under the provisions of paragraph (f)(2) of this section.
    (2) An agreement to assume the same obligations with respect to the 
dual consolidated loss as the unaffiliated dual resident corporation, 
unaffiliated domestic owner, or consolidated group, as applicable, that 
filed the original domestic use agreement (original elector) with 
respect to that loss. In such a case, obligations of an elector 
provided under this section shall also be considered to be obligations 
of a subsequent elector.
    (3) In the event of a transaction described in section 384(a) 
involving the subsequent elector, an agreement to treat any potential 
recapture amount under paragraph (h) of this section with respect to 
the dual consolidated loss as unrealized built-in gain for purposes of 
section 384(a), subject to any applicable exceptions (for example, the 
threshold requirements under section 382(h)(3)(B)). The potential 
recapture amount treated as unrealized built-in gain under this 
paragraph (f)(2)(iii)(A)(3) may be reduced to the extent permitted by 
paragraph (h)(2)(i) of this section.
    (4) In the case of a multiple-party event described in paragraph 
(f)(2)(i) of this section, an agreement to be subject to the rules 
provided in paragraph (h)(3) of this section.
    (5) The name, U.S. taxpayer identification number, and address of 
the original elector and prior subsequent electors, if any, with 
respect to the dual consolidated loss.
    (B) Statement filed by original elector. In the case of a multiple-
party event described in paragraph (f)(2)(i) of this section, the 
original elector must file a statement that is attached to and filed by 
the due date (including extensions) of its income tax return for the 
taxable year in which the event occurs. The statement must be labeled 
``Original Elector Statement'' at the top of the page, must be signed 
under penalties of perjury by the person who signs the tax return, and 
must include the following items:
    (1) A statement that the document submitted is an election and 
agreement under the provisions of paragraph (f)(2) of this section.
    (2) An agreement to be subject to the rules provided in paragraph 
(h)(3) of this section.
    (3) The name, U.S. taxpayer identification number, and address of 
the subsequent elector.
    (3) Certain transfers qualifying for the de minimis exception to 
foreign use. If a transaction or event qualifies for the de minimis 
exception to foreign use described in Sec.  1.1503(d)-3(c)(5), the 
transaction or event shall not constitute a triggering event under 
paragraph (e)(1)(iv) (transfers of assets) or (v) (transfers of an 
interest in a separate unit) of this section. For purposes of the 
preceding sentence, the transaction or event shall include deemed 
transfers that occur as a result of the transaction or event. See, for 
example, deemed transfers occurring pursuant to Rev. Rul. 99-5 (1999-1 
CB 434), see Sec.  601.601(d)(2)(ii)(b), and section 708 and the 
related regulations. See also Sec.  1.1503(d)-7 Example 5. This 
paragraph (f)(3) only applies if the entire transaction or event 
qualifies for the de minimis exception to foreign use. For example, if 
a domestic owner sells five percent of a separate unit to a foreign 
corporation, which would qualify for the de minimis exception to 
foreign use if it were the only transfer, but pursuant to the same 
transaction also sells 70 percent of the same separate unit to another 
corporation in a manner that results in a triggering event under 
paragraph (e)(1)(v) of this section, this paragraph shall not apply to 
prevent the transaction from resulting in a triggering event.
    (4) Deemed transactions as a result of certain transfers that do 
not result in a foreign use. The rules in this paragraph (f)(4) apply 
where the assets of, or the interests in, a separate unit are 
transferred in a transaction that would not result in a foreign use 
and, but for resulting deemed transactions or events, would not result 
in a triggering event described in paragraph (e)(1) of this section. 
For purposes of this paragraph (f)(4), deemed transactions or events 
shall include transactions or events that are deemed to occur pursuant 
to Rev. Rul. 99-5 and section 708 and the related regulations. In such 
a case, the deemed transactions shall not result in a triggering event 
under paragraph (e)(1)(iv) (transfers of assets) or (v) (transfers of 
an interest in a separate unit) of this section. See also Sec.  
1.1503(d)-7 Example 35.

[[Page 12930]]

    (5) Compulsory transfers. Transfers of the assets or stock of a 
dual resident corporation, or of the assets or interests in a separate 
unit, shall not constitute a triggering event (including a foreign use 
that occurs as a result of, or following, the transfer) if such 
transfers are--
    (i) Legally required by a foreign government as a necessary 
condition of doing business in a foreign country;
    (ii) Compelled by a genuine threat of immediate expropriation by a 
foreign government; or
    (iii) The result of the expropriation of assets by the foreign 
government.
    (6) Subsequent triggering events. Any triggering event described in 
paragraph (e) of this section that occurs subsequent to one of the 
transactions described in this paragraph (f), and that itself does not 
meet any of the exceptions provided in this paragraph (f), shall 
require recapture under paragraph (h) of this section by the elector or 
subsequent elector, as applicable.
    (g) Annual certification reporting requirement. Unless and until 
the domestic use agreement is terminated pursuant to paragraph (j) of 
this section, the elector must file a certification, labeled 
``Certification of Dual Consolidated Loss'' at the top of the page, 
that is attached to, and filed by the due date (including extensions) 
of, its income tax return for each taxable year during the 
certification period. The certification must provide that there has 
been no foreign use of the dual consolidated loss. The certification 
must identify the dual consolidated loss to which it pertains by 
setting forth the elector's year in which the loss was incurred and the 
amount of such loss. In addition, the certification must warrant that 
arrangements have been made to ensure that there will be no foreign use 
of the dual consolidated loss and that the elector will be informed of 
any such foreign use. If applicable, the certification must include a 
notification that an excepted triggering event under paragraph (f)(2) 
of this section has occurred with respect to the dual consolidated loss 
within the taxable year being certified. If dual consolidated losses of 
more than one taxable year are subject to the rules of this paragraph 
(g), the certification for those years may be combined in a single 
document, but each dual consolidated loss must be separately 
identified. See Sec.  1.1503(d)-3(e)(2)(ii) for additional 
certifications required where taxpayers elect the stand-alone exception 
of Sec.  1.1503(d)-3(e)(2).
    (h) Recapture of dual consolidated loss and interest charge--(1) 
Presumptive rules--(i) Amount of recapture. Except as otherwise 
provided in this section, upon the occurrence of a triggering event 
described in paragraph (e) of this section that does not meet any of 
the exceptions provided in paragraph (f) of this section, the dual 
resident corporation or domestic owner of the separate unit shall 
recapture as gross income the total amount of the dual consolidated 
loss to which the triggering event applies on its income tax return for 
the taxable year in which the triggering event occurs (or, when the 
triggering event is a foreign use of the dual consolidated loss, the 
taxable year that includes the last day of the foreign taxable year 
during which such foreign use occurs). See Sec.  1.1503(d)-5(c)(4)(vi) 
for rules with respect to the attribution of recapture income to a 
separate unit. See also Sec.  1.1503(d)-7 Examples 38 through 40.
    (ii) Interest charge. In connection with the recapture, the elector 
shall pay an interest charge. An interest charge may be due even if the 
amount of recapture income is reduced to zero pursuant to paragraph 
(h)(2)(i) of this section. See Sec.  1.1503(d)-7(c) Example 39. Except 
as otherwise provided in this section, the amount of the interest shall 
be computed under the rules of section 6601(a) by treating the 
additional tax resulting from the recapture as though it had been due 
and unpaid as of the date for payment of the tax for the taxable year 
in which the taxpayer received a tax benefit from the dual consolidated 
loss. For purposes of this paragraph (h)(1)(ii), a tax benefit shall be 
considered to have arisen in a taxable year in which the losses or 
deductions taken into account in computing the dual consolidated loss 
reduced U.S. taxable income. For the purpose of computing the interest 
charge, the additional tax resulting from the recapture is determined 
by treating the recapture income as the last income earned in the year 
of recapture. The interest shall be computed to the date for payment of 
the tax for the year of recapture and the interest thus computed 
becomes a part of the tax liability for that taxable year. See section 
6601 for the computation of interest on a tax liability that it is not 
paid timely. The recapture interest charge shall be deductible to the 
same extent as interest under section 6601.
    (2) Reduction of presumptive recapture amount and presumptive 
interest charge--(i) Amount of recapture. The dual resident corporation 
or domestic owner may recapture an amount less than the total dual 
consolidated loss if the elector demonstrates, to the satisfaction of 
the Commissioner, the lesser amount described in this paragraph 
(h)(2)(i). The reduction in the amount of recapture is the amount by 
which the dual consolidated loss would have offset other taxable income 
reported on a timely filed U.S. income tax return for any taxable year 
up to and including the taxable year of the triggering event (or, when 
the triggering event is a foreign use of the dual consolidated loss, 
the taxable year that includes the last day of the foreign taxable year 
during which such foreign use occurs) if no domestic use election had 
been made for the loss such that it was subject to the domestic use 
limitation of Sec.  1.1503(d)-4(b) (and therefore subject to the 
limitation under Sec.  1.1503(d)-4(c)). For this purpose, the rules for 
attributing items of income, gain, deduction, and loss under Sec.  
1.1503(d)-5 shall apply. An elector using this rebuttal rule must 
prepare a separate accounting showing the income for each year that 
would have offset the dual resident corporation's or separate unit's 
recapture amount if no domestic use election had been made for the dual 
consolidated loss. The separate accounting must be signed under 
penalties of perjury by the person who signs the elector's tax return, 
must be labeled ``Reduction of Recapture Amount'' at the top of the 
page, and must indicate that it is submitted under the provisions of 
this paragraph (h)(2)(i). The accounting must be attached to, and filed 
by the due date (including extensions) of, the elector's income tax 
return for the taxable year in which the triggering event occurs. See 
Sec.  1.1503(d)-7(c) Examples 38 through 40.
    (ii) Interest charge. The interest charge imposed under this 
section may be reduced if the elector demonstrates, to the satisfaction 
of the Commissioner, that the net interest owed would have been less 
than that provided in paragraph (h)(1)(ii) of this section if the 
elector had filed an amended return for the taxable year in which the 
recaptured dual consolidated loss was incurred, and for any other 
affected taxable years up to and including the taxable year of 
recapture, if no domestic use election had been made for the dual 
consolidated loss such that it had been subject to the restrictions of 
Sec.  1.1503(d)-4(b) (and therefore subject to the limitations under 
Sec.  1.1503(d)-4(c)). An elector using this rebuttal rule must prepare 
a computation demonstrating the reduction in the net interest owed as a 
result of treating the dual consolidated loss as a loss subject to the 
restrictions of Sec.  1.1503(d)-4(b) (and therefore subject to the 
limitations under Sec.  1.1503(d)-4(c)). The computation must be 
labeled ``Reduction of Interest Charge'' at the top of the page and 
must

[[Page 12931]]

indicate that it is submitted under the provisions of this paragraph 
(h)(2)(ii). The computation must be signed under penalties of perjury 
by the person who signs the elector's tax return, and must be attached 
to, and filed by the due date (including extensions) of, the elector's 
income tax return for the taxable year in which the triggering event 
occurs. See Sec.  1.1503(d)-7(c) Examples 39 and 40.
    (3) Rules regarding multiple-party event exceptions to triggering 
events--(i) Scope. The rules of this paragraph (h)(3) apply when, after 
a triggering event described in paragraph (e) of this section with 
respect to which the requirements of paragraph (f)(2)(i) of this 
section were met (excepted event), a triggering event under paragraph 
(e) of this section occurs, and no exception applies to such triggering 
event under paragraph (f) of this section (subsequent triggering 
event). See Sec.  1.1503(d)-7(c) Examples 36 and 37.
    (ii) Original elector and prior subsequent electors not subject to 
recapture or interest charge--(A) Except to the extent otherwise 
provided in this paragraph (h)(3), neither the original elector nor any 
prior subsequent elector shall be subject to the rules of this 
paragraph (h) with respect to dual consolidated losses subject to the 
original domestic use agreement.
    (B) In the case of a dual consolidated loss with respect to which 
multiple excepted events have occurred, only the subsequent elector 
that owns the dual resident corporation or separate unit at the time of 
the subsequent triggering event shall be subject to the recapture rules 
of this paragraph (h). For purposes of this paragraph (h), the term 
prior subsequent elector refers to all other subsequent electors.
    (iii) Recapture tax amount and required statement--(A) In general. 
If a subsequent triggering event occurs, the subsequent elector shall 
take into account the recapture tax amount as determined under 
paragraph (h)(3)(iii)(B) of this section. The subsequent elector must 
prepare a statement that computes the recapture tax amount, as provided 
under paragraph (h)(3)(iii)(B) of this section, with respect to the 
dual consolidated loss subject to the new domestic use agreement. This 
statement must be attached to, and filed by the due date (including 
extensions) of, the subsequent elector's income tax return for the 
taxable year in which the subsequent triggering event occurs (or, when 
the subsequent triggering event is a foreign use of the dual 
consolidated loss, the taxable year that includes the last day of the 
foreign taxable year during which such foreign use occurs). The 
statement must be signed under penalties of perjury by the person who 
signs the return. The statement must be labeled ``Statement Identifying 
Liability'' at the top and, in addition to the calculation of the 
recapture tax amount, must include the following items, in paragraphs 
labeled to correspond with the items set forth in paragraphs 
(h)(3)(iii)(A)(1) through (3) of this section:
    (1) A statement that the document is submitted under the provisions 
of Sec.  1.1503(d)-6(h)(3)(iii).
    (2) A statement identifying the amount of the dual consolidated 
losses at issue and the taxable years in which they were used.
    (3) The name, address, and taxpayer identification number of the 
original elector and all prior subsequent electors.
    (B) Recapture tax amount. The recapture tax amount equals the 
excess (if any) of--
    (1) The income tax liability of the subsequent elector for the 
taxable year that includes the amount of recapture and related interest 
charge with respect to the dual consolidated losses that are recaptured 
as a result of the subsequent triggering event, as provided under 
paragraphs (h)(1) and (h)(2) of this section; over
    (2) The income tax liability of the subsequent elector for such 
taxable year, computed by excluding the amount of recapture and related 
interest charge described in paragraph (h)(3)(iii)(B)(1) of this 
section.
    (iv) Tax assessment and collection procedures--(A) In general--(1) 
Subsequent elector. An assessment identifying an income tax liability 
of the subsequent elector is considered an assessment of the recapture 
tax amount where the recapture tax amount is part of the income tax 
liability being assessed and the recapture tax amount is reflected in a 
statement attached to the subsequent elector's income tax return as 
provided under paragraph (h)(3)(iii) of this section.
    (2) Original elector and prior subsequent electors. The assessment 
of the recapture tax amount as set forth in paragraph (h)(3)(iv)(A)(1) 
of this section shall be considered as having been properly assessed as 
an income tax liability of the original elector and of each prior 
subsequent elector, if any. The date of such assessment shall be the 
date the income tax liability of the subsequent elector was properly 
assessed. The Commissioner may collect all or a portion of such 
recapture tax amount from the original elector and/or the prior 
subsequent electors under the circumstances set forth in paragraph 
(h)(3)(iv)(B) of this section.
    (B) Collection from original elector and prior subsequent electors; 
joint and several liability--(1) In general. If the subsequent elector 
does not pay in full the income tax liability that includes a recapture 
tax amount, the Commissioner may collect that portion of the unpaid 
balance of such income tax liability attributable to the recapture tax 
amount in full or in part from the original elector and/or from any 
prior subsequent elector, provided that the following conditions are 
satisfied with respect to such elector:
    (i) The Commissioner properly has assessed the recapture tax amount 
pursuant to paragraph (h)(3)(iv)(A)(1) of this section.
    (ii) The Commissioner has issued a notice and demand for payment of 
the recapture tax amount to the subsequent elector in accordance with 
Sec.  301.6303-1 of this chapter.
    (iii) The subsequent elector has failed to pay all of the recapture 
tax amount by the date specified in such notice and demand.
    (iv) The Commissioner has issued a notice and demand for payment of 
the unpaid portion of the recapture tax amount to the original elector, 
or prior subsequent elector (as the case may be), in accordance with 
Sec.  301.6303-1 of this chapter.
    (2) Joint and several liability. The liability imposed under this 
paragraph (h)(3)(iv)(B) on the original elector and each prior 
subsequent elector shall be joint and several.
    (C) Allocation of partial payments of tax. If the subsequent 
elector's income tax liability for a taxable period includes a 
recapture tax amount, and if such income tax liability is satisfied in 
part by payment, credit, or offset, such payment, credit or offset 
shall be allocated first to that portion of the income tax liability 
that is not attributable to the recapture tax amount, and then to that 
portion of the income tax liability that is attributable to the 
recapture tax amount.
    (D) Refund. If the Commissioner makes a refund of any income tax 
liability that includes a recapture tax amount, the Commissioner shall 
allocate and pay the refund to each elector who paid a portion of such 
income tax liability as follows:
    (1) The Commissioner shall first determine the total amount of 
recapture tax paid by and/or collected from the original elector and 
from any prior subsequent electors. The Commissioner shall then 
allocate and pay such refund to the original elector and prior 
subsequent electors, with each such elector receiving an amount of such 
refund on a pro rata basis, not to exceed

[[Page 12932]]

the amount of recapture tax paid by and/or collected from such elector.
    (2) The Commissioner shall pay the balance of such refund, if any, 
to the subsequent elector.
    (v) Definition of income tax liability. Solely for purposes of 
paragraph (h)(3) of this section, the term income tax liability means 
the income tax liability imposed on a domestic corporation under Title 
26 of the United States Code for a taxable year, including additions to 
tax, additional amounts, penalties, and any interest charge related to 
such income tax liability.
    (vi) Example. See Sec.  1.1503(d)-7(c) Example 36.
    (4) Computation of taxable income in year of recapture--(i) 
Presumptive rule. Except to the extent provided in paragraph (h)(4)(ii) 
of this section, for purposes of computing the taxable income for the 
year of recapture, no current, carryover or carryback losses may offset 
and absorb the recapture amount.
    (ii) Exception to presumptive rule. The recapture amount included 
in gross income may be offset and absorbed by that portion of the 
elector's net operating loss carryover that is attributable to the dual 
resident corporation or separate unit that incurred the dual 
consolidated loss being recaptured, if the elector demonstrates, to the 
satisfaction of the Commissioner, the amount of such portion of the 
carryover. The principles of Sec.  1.1502-21(b)(2)(iv) shall apply for 
purposes of determining whether any portion of a net operating loss 
carryover is attributable to the dual resident corporation or separate 
unit. In the case of a separate unit, such determination shall be made 
by treating the separate unit as a domestic corporation and a member of 
the consolidated group composing its unaffiliated domestic owner, or 
members of the consolidated group of which its affiliated domestic 
owner is a member, as appropriate. An elector utilizing this rebuttal 
rule must prepare a computation demonstrating the amount of net 
operating loss carryover that, under this paragraph (h)(4)(ii), may 
absorb the recapture amount included in gross income. Such computation 
must be signed under penalties of perjury and attached to and filed by 
the due date (including extensions) of, the income tax return for the 
taxable year in which the triggering event occurs (or, when the 
triggering event is a foreign use of the dual consolidated loss, the 
taxable year that includes the last day of the foreign taxable year 
during which such foreign use occurs).
    (5) Character and source of recapture income. The amount recaptured 
under this paragraph (h) shall be treated as ordinary income. Except as 
provided in the prior sentence, such income shall be treated, as 
applicable, as income from the same source, having the same character, 
and falling within the same separate category, for all purposes, 
including sections 904(d) and 907, to which the items of deduction or 
loss composing the dual consolidated loss were allocated and 
apportioned, as provided under sections 861(b), 862(b), 863(a), 864(e), 
865, and the related regulations. For this determination, the pro rata 
computation of the items of deduction or loss composing the dual 
consolidated loss as described in Sec.  1.1503(d)-4(c)(4) shall apply. 
See Sec.  1.1503(d)-7(c) Example 38.
    (6) Reconstituted net operating loss--(i) General rule. Except as 
provided in paragraphs (h)(6)(ii) and (iii) of this section, commencing 
in the taxable year immediately following the year in which the dual 
consolidated loss is recaptured, the dual resident corporation, or the 
domestic owner of the separate unit, that incurred the dual 
consolidated loss that is recaptured shall be treated as having a net 
operating loss (reconstituted net operating loss) in an amount equal to 
the amount actually recaptured under this paragraph (h). If a domestic 
corporation (transferee) acquires the assets of the dual resident 
corporation or domestic owner in a transaction described in section 
381(a), the preceding sentence shall be applied by treating the 
transferee as the dual resident corporation or domestic owner, as 
applicable. In a case to which this paragraph (h)(6) applies, the 
transferee corporation shall be treated as having a reconstituted net 
operating loss in an amount equal to the amount actually recaptured 
under this paragraph (h). In no event, however, shall more than one 
corporation be treated as having a reconstituted net operating loss as 
a result of a single dual consolidated loss being recaptured. A 
reconstituted net operating loss of a domestic owner shall be 
attributable under Sec.  1.1503(d)-5 to the separate unit that incurred 
the dual consolidated loss that was recaptured. Moreover, a 
reconstituted net operating loss shall be subject to the domestic use 
limitation of Sec.  1.1503(d)-4(b) (and therefore subject to the 
limitation under Sec.  1.1503(d)-4(c)), without regard to the 
exceptions contained in paragraphs (b) through (d) of this section 
(relating to elective agreements in place between the United States and 
a foreign country, the ability to demonstrate no possibility of a 
foreign use, and a domestic use election, respectively). The 
reconstituted net operating loss shall be available only for carryover, 
under section 172(b), to taxable years following the taxable year of 
recapture. For purposes of determining the remaining carryover period, 
the reconstituted net operating loss shall be treated as if it had been 
recognized in the taxable year in which the dual consolidated loss that 
is the basis of the recapture amount was incurred. See Sec.  1.1503(d)-
7(c) Examples 36, 38, and 40.
    (ii) Exception. Paragraph (h)(6)(i) of this section shall not apply 
to the extent the dual consolidated loss that is the basis of the 
recapture amount would have been eliminated pursuant to Sec.  
1.1503(d)-4(d) if no domestic use election had been made for such loss. 
See Sec.  1.1503(d)-7(c) Example 40.
    (iii) Special rule for recapture following multiple-party event 
exception to a triggering event. This paragraph applies to an excepted 
event described in paragraph (f)(2)(i)(B) of this section that is 
followed by a subsequent triggering event requiring recapture as 
described in paragraph (f)(6) of this section. In such a case, the 
domestic corporation that owns, directly or indirectly, the assets of 
the dual resident corporation, or the assets of or the interests in a 
separate unit, immediately following the excepted event shall be 
treated as if it incurred the dual consolidated loss that is recaptured 
for purposes of applying paragraph (h)(6)(i) of this section. See Sec.  
1.1503(d)-7(c) Example 36.
    (i) [Reserved].
    (j) Termination of domestic use agreement and annual 
certifications--(1) Rebuttals, exceptions to triggering events, and 
recapture. The domestic use agreement filed with respect to a dual 
consolidated loss shall terminate prior to the end of the certification 
period and have no further effect if--
    (i) An elector is able to rebut the presumption of a triggering 
event pursuant to the general rule in paragraph (e)(2)(i) of this 
section;
    (ii) An event described in paragraph (e)(1) of this section is not 
a triggering event as a result of the application of paragraphs 
(f)(2)(i) or (ii) (relating to events requiring a new domestic use 
agreement) of this section; this paragraph (j)(1)(ii) does not, 
however, apply to terminate the new domestic use agreement filed in 
connection with the event pursuant to paragraph (f)(2)(iii)(A) of this 
section. See also paragraph (h)(3)(iv) of this section regarding 
collection from the original elector and

[[Page 12933]]

prior subsequent electors in certain cases; or
    (iii) A dual consolidated loss is recaptured pursuant to paragraph 
(h) of this section. See Sec.  1.1503(d)-7(c) Examples 32 through 34.
    (2) Termination of ability for foreign use--(i) In general. A 
domestic use agreement filed with respect to a dual consolidated loss 
shall terminate and have no further effect as of the end of a taxable 
year if the elector--
    (A) Demonstrates, to the satisfaction of the Commissioner, that as 
of the end of such taxable year no foreign use (as defined in Sec.  
1.1503(d)-3) of the dual consolidated loss can occur in any other year 
by any means; and
    (B) Prepares a statement described in paragraph (j)(2)(ii) of this 
section that is attached to, and filed by the due date (including 
extensions) of, its U.S. income tax return for such taxable year.
    (ii) Statement. The statement described in this paragraph 
(j)(2)(ii) must be signed under penalties of perjury by the person who 
signs the return. The statement must be labeled ``Termination of 
Ability for Foreign Use'' at the top of the page and must include the 
following information, in paragraphs labeled to correspond with the 
following:
    (A) A statement that the document is submitted under the provisions 
of paragraph (j)(2) of this section.
    (B) The information required by paragraph (c)(2)(ii) of this 
section.
    (C) A statement of the amount of the dual consolidated loss at 
issue and the year in which such dual consolidated loss was incurred.
    (D) The information described in paragraph (c)(2)(iv) of this 
section that supports the conclusion that no foreign use can occur as 
provided in paragraph (j)(2)(i)(A) of this section.
    (3) Agreements filed in connection with stand-alone exception. See 
Sec.  1.1503(d)-3(e)(2)(iii) for the termination of domestic use 
agreements filed in connection with the stand-alone exception to the 
mirror legislation rule when a subsequent election is made under 
paragraph (b) of this section (relating to agreements entered into 
between the United States and a foreign country).


Sec.  1.1503(d)-7  Examples.

    (a) In general. This section provides examples that illustrate the 
application of Sec. Sec.  1.1503(d)-1 through 1.1503(d)-6. This section 
also provides facts that are presumed for such examples.
    (b) Presumed facts for examples. For purposes of the examples in 
this section, unless otherwise indicated, the following facts are 
presumed:
    (1) Each entity has only a single class of equity outstanding, all 
of which is held by a single owner.
    (2) P, a domestic corporation and the common parent of the P 
consolidated group, owns S, a domestic corporation and a member of the 
P consolidated group.
    (3) DRC<INF>X</INF>, a domestic corporation, is subject to Country 
X tax on its worldwide income or on a residence basis, and is a dual 
resident corporation.
    (4) DE1<INF>X</INF> and DE2<INF>X</INF> are both Country X 
entities, subject to Country X tax on their worldwide income or on a 
residence basis, and disregarded as entities separate from their owners 
for U.S. tax purposes. DE3<INF>Y</INF> is a Country Y entity, subject 
to Country Y tax on its worldwide income or on a residence basis, and 
disregarded as an entity separate from its owner for U.S. tax purposes. 
All the interests in DE1<INF>X</INF>, DE2<INF>X</INF>, and 
DE3<INF>Y</INF> constitute hybrid entity separate units.
    (5) FB<INF>X</INF> is a Country X business operation that, if 
carried on by a U.S. person, would constitute a foreign branch, as 
defined in Sec.  1.367(a)-6T(g)(1), and is a Country X foreign branch 
separate unit.
    (6) Neither the assets nor the activities of an entity constitute a 
foreign branch separate unit.
    (7) FS<INF>X</INF> is a Country X entity that is subject to Country 
X tax on its worldwide income or on a residence basis and is classified 
as a foreign corporation for U.S. tax purposes.
    (8) The applicable foreign country has a consolidation regime 
that--
    (i) Includes as members of a consolidated group any commonly 
controlled branches and permanent establishments in such jurisdiction, 
and entities that are subject to tax in such jurisdiction on their 
worldwide income or on a residence basis; and
    (ii) Allows the losses of members of consolidated groups to offset 
income of other members.
    (9) There is no mirror legislation, within the meaning of Sec.  
1.1503(d)-3(e)(1), in the applicable foreign country.
    (10) There is no elective agreement described in Sec.  1.1503(d)-
6(b) between the United States and the applicable foreign country.
    (11) There is no income tax convention between the United States 
and the applicable foreign country.
    (12) If a domestic use election, within the meaning of Sec.  
1.1503(d)-6(d), is made, all the necessary filings related to such 
election are properly completed on a timely basis.
    (13) If there is a triggering event requiring recapture of a dual 
consolidated loss, the amount of recapture is not reduced pursuant to 
Sec.  1.1503(d)-6(h)(2).
    (14) There are no other items of income, gain, deduction, and loss. 
In addition, the United States and the applicable foreign country 
recognize the same items of income, gain, deduction, and loss in each 
taxable year.
    (15) All taxpayers use the calendar year as their taxable year.
    (c) Examples. The following examples illustrate the application of 
Sec. Sec.  1.1503(d)-1 through 1.1503(d)-6:

    Example 1. Separate unit combination rule. (i) Facts. P owns 
DE3<INF>Y</INF> which, in turn, owns DE1<INF>X</INF>. 
DE1<INF>X</INF> owns FB<INF>X</INF>. PRS, an entity treated as a 
partnership for both U.S. and Country X tax purposes, is owned 50 
percent by P and 50 percent by an unrelated foreign person. PRS 
carries on a business operation in Country X that, if carried on by 
a U.S. person, would constitute a foreign branch within the meaning 
of Sec.  1.367(a)-6T(g)(1). In addition, P owns DRC<INF>X</INF>, a 
member of the consolidated group of which P is the parent, which 
carries on business operations in Country X that constitute a 
foreign branch within the meaning of Sec.  1.367(a)-6T(g)(1). S owns 
DE2<INF>X</INF>.
    (ii) Result. Pursuant to Sec.  1.1503(d)-1(b)(4)(ii), the 
interest in DE1<INF>X</INF>, the interest in DE2<INF>X</INF>, 
FB<INF>X</INF>, P's share of the Country X business operations 
carried on by PRS (which is owned by P indirectly through its 
interest in PRS), and DRC<INF>X</INF>'s Country X business 
operations are combined and treated as a single separate unit of the 
consolidated group of which P is the parent. This is the case 
regardless of whether the losses of each individual separate unit 
are made available to offset the income of the other individual 
separate units under Country X tax laws. Because DRC<INF>X</INF> is 
a dual resident corporation, it is not combined and treated as part 
of this combined separate unit and, as a result, DRC<INF>x</INF>'s 
income or dual consolidated loss is not taken into account in 
determining the income or dual consolidated loss of the combined 
separate unit. In addition, P's interest in DE3<INF>Y</INF> is not 
combined and is another separate unit because it is subject to tax 
in Country Y, rather than Country X.
    Example 2. Definition of a separate unit and application of 
domestic use limitation--foreign branch separate unit. (i) Facts. P 
carries on business operations in Country X that constitute a 
permanent establishment under the U.S.-Country X income tax 
convention. In year 1, a loss is attributable to P's Country X 
permanent establishment, as determined under Sec.  1.1503(d)-5.
    (ii) Result. Under Sec. Sec.  1.1503(d)-1(b)(4)(i)(A) and 
1.367(a)-6T(g)(1), P's Country X permanent establishment constitutes 
a foreign branch separate unit. Therefore, the year 1 loss 
attributable to the foreign branch separate unit constitutes a dual 
consolidated loss pursuant to Sec.  1.1503(d)-1(b)(5)(ii). The dual 
consolidated loss rules apply to the dual consolidated loss even 
though there is no affiliate of the foreign branch separate unit in 
Country X, because it is still possible that all or a portion of the 
dual consolidated loss can

[[Page 12934]]

be put to a foreign use. For example, there may be a foreign use 
with respect to a Country X affiliate acquired in a year subsequent 
to the year in which the dual consolidated loss was incurred. See 
Sec.  1.1503(d)-6(a)(2). Accordingly, unless an exception under 
Sec.  1.1503(d)-6 applies (such as a domestic use election), the 
year 1 dual consolidated loss attributable to P's Country X 
permanent establishment is subject to the domestic use limitation 
rule of Sec.  1.1503(d)-4(b). As a result, pursuant to Sec.  
1.1503(d)-4(c), the year 1 dual consolidated loss cannot offset 
income of P that is not attributable to its Country X foreign branch 
separate unit, nor can it offset income of any other domestic 
affiliate. The loss can, however, offset income of the Country X 
foreign branch separate unit, subject to the application of Sec.  
1.1503(d)-4(c). The result would be the same even if Country X did 
not have a consolidation regime that includes as members of 
consolidated groups Country X branches or permanent establishments 
of nonresident corporations. The dual consolidated loss rules apply 
even in the absence of a consolidation regime in the foreign country 
because it is possible that all or a portion of a dual consolidated 
loss can be put to a foreign use by other means, such as through a 
sale, merger, or similar transaction. See Sec.  1.1503(d)-6(a)(2).
    (iii) Alternative facts. The facts are the same as in paragraph 
(i) of this Example 2, except that P's Country X business operations 
constitute a foreign branch as defined in Sec.  1.367(a)-6T(g)(1), 
but do not constitute a permanent establishment under the U.S.-
Country X income tax convention. Although the activities carried on 
by P in Country X would otherwise constitute a foreign branch 
separate unit as described in Sec.  1.1503(d)-1(b)(4)(i)(A), the 
exception under Sec.  1.1503(d)-1(b)(4)(iii) applies because the 
activities do not constitute a permanent establishment under the 
U.S.-Country X income tax convention. Thus, the Country X business 
operations do not constitute a foreign branch separate unit, and the 
year 1 loss is not subject to the dual consolidated loss rules. If P 
instead carried on its Country X business operations through 
DE1<INF>X</INF>, then the exception under Sec.  1.1503(d)-
1(b)(4)(iii) would not apply because P carries on the business 
operations through a hybrid entity and, as a result, the business 
operations would constitute a foreign branch separate unit. Thus, in 
such a case the year 1 loss would be subject to the dual 
consolidated loss rules.
    Example 3. Domestic use limitation--foreign branch separate unit 
owned through a partnership. (i) Facts. P and S organize a 
partnership, PRS<INF>X</INF>, under the laws of Country X. 
PRS<INF>X</INF> is treated as a partnership for both U.S. and 
Country X tax purposes. PRS<INF>X</INF> owns FB<INF>X</INF>. 
PRS<INF>X</INF> earns U.S. source income that is unconnected with 
its FB<INF>X</INF> branch operations, and such income is not subject 
to tax by Country X. In addition, such U.S. source income is not 
attributable to FB<INF>X</INF> under Sec.  1.1503(d)-5.
    (ii) Result. Under Sec.  1.1503(d)-1(b)(4)(i)(A), P's and S's 
shares of FB<INF>X</INF> owned indirectly through their interests in 
PRS<INF>X</INF> are individual foreign branch separate units. 
Pursuant to Sec.  1.1503(b)-1(b)(4)(ii), these individual separate 
units are combined and treated as a single separate unit of the 
consolidated group of which P is the parent. Unless an exception 
under Sec.  1.1503(d)-6 applies, any dual consolidated loss 
attributable to FB<INF>X</INF> cannot offset income of P or S (other 
than income attributable to FB<INF>X</INF>, subject to the 
application of Sec.  1.1503(d)-4(c)), including their distributive 
share of the U.S. source income earned through their interests in 
PRS<INF>X</INF>, nor can it offset income of any other domestic 
affiliates.
    Example 4. Definition of a separate unit and domestic use 
limitation--interest in hybrid entity partnership and indirectly 
owned foreign branch separate unit. (i) Facts. HPS<INF>X</INF> is a 
Country X entity that is subject to Country X tax on its worldwide 
income. HPS<INF>X</INF> is classified as a partnership for Federal 
tax purposes. P, S, and FS<INF>X</INF>, are the sole partners of 
HPS<INF>X</INF>. For U.S. tax purposes, P, S, and FS<INF>X</INF> 
each has an equal interest in each item of HPS<INF>X</INF>'s profit 
or loss. HPS<INF>X</INF> carries on operations in Country Y that, if 
carried on by a U.S. person, would constitute a foreign branch 
within the meaning of Sec.  1.367(a)-6T(g)(1).
    (ii) Result. Under Sec.  1.1503(d)-1(b)(4)(i)(B), the 
partnership interests in HPS<INF>X</INF> held by P and S are 
individual hybrid entity separate units. These individual separate 
units are combined into a single separate unit under Sec.  
1.1503(d)-1(b)(4)(ii). In addition, P's and S's share of the Country 
Y operations owned indirectly through their interests in 
HPS<INF>X</INF> are individual foreign branch separate units under 
Sec.  1.1503(d)-1(b)(4)(i)(B). These individual separate units are 
also combined into a single separate unit under Sec.  1.1503(d)-
1(b)(4)(ii). Unless an exception under Sec.  1.1503(d)-6 applies, 
dual consolidated losses attributable to P's and S's combined 
interests in HPS<INF>X</INF> can only be used to offset income 
attributable to their combined interests in HPS<INF>X</INF> (other 
than income attributable to P's and S's combined interests in the 
Country Y foreign branch separate unit), subject to the application 
of Sec.  1.1503(d)-4(c). Similarly, dual consolidated losses 
attributable to P's and S's combined interests in the Country Y 
operations of HPS<INF>X</INF> can only be used to offset income 
attributable to their combined interests in such Country Y 
operations, subject to the application of Sec.  1.1503(d)-4(c). 
Neither FS<INF>X</INF>'s interest in HPS<INF>X</INF>, nor its share 
of the Country Y operations owned by HPS<INF>X</INF>, is a separate 
unit because FS<INF>X</INF> is not a domestic corporation.
    Example 5. Foreign use--general rule and de minimis reduction 
exception. (i) Facts. P owns DE1<INF>X</INF>. DE1<INF>X</INF> owns 
FS<INF>X</INF>. In year 1, there is a $100x loss attributable to P's 
interest in DE1<INF>X</INF> that is a dual consolidated loss. Also 
in year 1, FS<INF>X</INF> earns $200x of income. DE1<INF>X</INF> and 
FS<INF>X</INF> file a Country X consolidated tax return. For Country 
X tax purposes, the year 1 $100x loss of DE1<INF>X</INF> is used to 
offset $100x of year 1 income generated by FS<INF>X</INF>. Under 
Country X tax law, unused losses are carried forward and available 
to offset income in subsequent taxable years.
    (ii) Result. The $100x loss attributable to P's interest in 
DE1<INF>X</INF> is available to, and in fact does, offset 
FS<INF>X</INF>'s income under the laws of Country X. In addition, 
under U.S. tax principles, such income is considered to be an item 
of FS<INF>X</INF>, a foreign corporation. As a result, under Sec.  
1.1503(d)-3(a), there has been a foreign use of the year 1 dual 
consolidated loss attributable to P's interest in DE1<INF>X</INF>. 
Therefore, P cannot make a domestic use election with respect to the 
loss as provided under Sec.  1.1503(d)-6(d)(2), and such loss will 
be subject to the domestic use limitation rule of Sec.  1.1503(d)-
4(b). The result would be the same even if FS<INF>X</INF>, under 
Country X tax law, had no income against which the dual consolidated 
loss of DE1<INF>X</INF> could be offset (unless FS<INF>X</INF>'s 
ability to use the loss under Country X tax law requires an 
election, and no such election is made).
    (iii) Alternative facts. The facts are the same as in paragraph 
(i) of this Example 5, except that FS<INF>X</INF> cannot use the 
loss of DE1<INF>X</INF> under Country X tax law without an election, 
and no such election is made. Pursuant to the exception in Sec.  
1.1503(d)-3(c)(2), there is no foreign use of the year 1 dual 
consolidated loss attributable to P's interest in DE1<INF>X</INF>. 
In addition, P files a domestic use election with respect to the 
year 1 dual consolidated loss attributable to its interest in 
DE1<INF>X</INF> and, at the beginning of year 3, P sells its 
interest in DE1<INF>X</INF> to F, a Country Y entity that is a 
foreign corporation. The sale of the interest in DE1<INF>X</INF> to 
F results in a foreign use triggering event pursuant to Sec.  
1.1503(d)-6(e)(1)(i) because, immediately after the sale, the loss 
attributable to the interest in DE1<INF>X</INF> carries over under 
Country X law and, therefore, is available under U.S. tax principles 
to offset income of the owner of the interest in DE1<INF>X</INF> 
which, in the hands of F, is not a separate unit. It is also a 
foreign use because the loss is available under U.S. tax principles 
to offset the income of F, a foreign corporation. See Sec.  
1.1503(d)-3(a)(1). Finally, the transfer is a triggering event 
pursuant to Sec.  1.1503(d)-6(e)(1)(iv) and (v).
    (iv) Alternative facts. The facts are the same as in paragraph 
(iii), of this Example 5, except that P only sells 5 percent of its 
interest in DE1<INF>X</INF> to F. Pursuant to Rev. Rul. 99-5 (1999-1 
CB 434), see Sec.  601.601(d)(2)(ii)(b) of this chapter, the 
transaction is treated as if P sold 5 percent of its interest in 
each of DE1<INF>X</INF>'s assets to F, and then immediately 
thereafter P and F transferred their interests in the assets of 
DE1<INF>X</INF> to a partnership in exchange for an ownership 
interest therein. The sale of the 5 percent interest in 
DE1<INF>X</INF> generally results in a foreign use triggering event 
because a portion of the dual consolidated loss carries over under 
Country X tax law and is available under U.S. tax principles to 
offset income of the owner of the interest in DE1<INF>X</INF>, a 
hybrid entity, which in the hands of F is not a separate unit. It is 
also a foreign use because the loss is available under U.S. tax 
principles to offset the income of F, a foreign corporation. See 
Sec.  1.1503(d)-3(a)(1). However, pursuant to the exception under 
Sec.  1.1503(d)-3(c)(5) (relating to a de minimis reduction of an 
interest in a separate unit), such availability does not result in a 
foreign use. In addition, pursuant to Sec.  1.1503(d)-6(f)(1) and 
(3), the deemed transfers pursuant to Rev. Rul. 1999-5 as a result 
of the sale are not treated as triggering events described in Sec.  
1.1503(d)-6(e)(1)(iv) or (v).

[[Page 12935]]

    Example 6. Foreign use and indirect foreign use--foreign reverse 
hybrid structure and disregarded payments. (i) Facts. P owns 
DE1<INF>X</INF>. DE1<INF>X</INF> owns 99 percent and S owns 1 
percent of FRH<INF>X</INF>, a Country X partnership that elected to 
be treated as a corporation for U.S. tax purposes. FRH<INF>X</INF> 
conducts a trade or business in Country X. In year 1, 
DE1<INF>X</INF> incurs interest expense on a third-party loan, which 
constitutes a dual consolidated loss attributable to P's interest in 
DE1<INF>X</INF>. In year 1, for Country X tax purposes, 
DE1<INF>X</INF> takes into account its distributive share of income 
generated by FRH<INF>X</INF> and offsets such income with its 
interest expense.
    (ii) Result. In year 1, the dual consolidated loss attributable 
to P's interest in DE1<INF>X</INF> is available to, and in fact 
does, offset income recognized in Country X and, under U.S. tax 
principles, the income is considered to be income of 
FRH<INF>X</INF>, a foreign corporation. Accordingly, pursuant to 
Sec.  1.1503(d)-3(a)(1), there is a foreign use of the dual 
consolidated loss. Therefore, P cannot make a domestic use election 
with respect to the year 1 dual consolidated loss attributable to 
its interest in DE1<INF>X</INF>, as provided under Sec.  1.1503(d)-
6(d)(2), and such loss will be subject to the domestic use 
limitation rule of Sec.  1.1503(d)-4(b).
    (iii) Alternative facts. (A) The facts are the same as in 
paragraph (i) of this Example 6, except as follows. Instead of 
owning DE1<INF>X</INF>, P owns DE3<INF>Y</INF> which, in turn, owns 
DE1<INF>X</INF>. In addition, DE3<INF>Y</INF>, rather than 
DE1<INF>X</INF>, is the obligor on the third-party loan and 
therefore incurs the interest expense on such loan. Finally, 
DE3<INF>Y</INF> on-lends the loan proceeds from the third-party loan 
to DE1<INF>X</INF>, and DE1<INF>X</INF> pays interest to 
DE3<INF>Y</INF> on such loan that is generally disregarded for U.S. 
tax purposes.
    (B) Pursuant to Sec.  1.1503(d)-5(c)(1)(ii), for purposes of 
calculating income or a dual consolidated loss, DE3<INF>Y</INF> and 
DE1<INF>X</INF> do not take into account interest income or interest 
expense, respectively, with respect to amounts paid on the 
disregarded loan from DE3<INF>Y</INF> to DE1<INF>X</INF>. As a 
result, such items neither create a dual consolidated loss with 
respect to the interest in DE1<INF>X</INF>, nor do they reduce (or 
eliminate) the dual consolidated loss attributable to the interest 
in DE3<INF>Y</INF>. Thus, in year 1, there is a dual consolidated 
loss attributable to P's interest in DE3<INF>Y</INF>, but not to P's 
indirect interest in DE1<INF>X</INF>.
    (C) In year 1, interest expense paid by DE1<INF>X</INF> to 
DE3<INF>Y</INF> on the disregarded loan is taken into account as a 
deduction in computing DE1<INF>X</INF>'s taxable income for Country 
X tax purposes, but does not give rise to a corresponding item of 
income or gain for U.S. tax purposes (because it is generally 
disregarded). In addition, such interest has the effect of making an 
item of deduction or loss composing the dual consolidated loss 
attributable to P's interest in DE3<INF>Y</INF> available for a 
foreign use. This is the case because it may reduce or offset items 
of deduction or loss composing the dual consolidated loss for 
foreign tax purposes, and creates another deduction or loss that may 
reduce or offset income of DE1<INF>X</INF> for foreign tax purposes 
that, under U.S. tax principles, is treated as income of 
FRH<INF>X</INF>, a foreign corporation. Moreover, because the 
disregarded item is incurred or taken into account as interest for 
foreign tax purposes, it is deemed to have been incurred or taken 
into account with a principal purpose of avoiding the provisions of 
section 1503(d). Accordingly, there is an indirect foreign use of 
the year 1 dual consolidated loss attributable to P's interest in 
DE3<INF>Y</INF>, and P cannot make a domestic use election with 
respect to such loss as provided under Sec.  1.1503(d)-6(d)(2). 
Thus, the loss will be subject to the domestic use limitation rule 
of Sec.  1.1503(d)-4(b).
    Example 7. Indirect foreign use--hybrid instrument. (i) Facts. P 
owns DE1<INF>X</INF> which, in turn, owns FS<INF>X</INF>. 
DE1<INF>X</INF> borrows cash from an unrelated lender and transfers 
the cash to FS<INF>X</INF> in exchange for an instrument (hybrid 
instrument). The hybrid instrument is treated as equity for U.S. tax 
purposes and debt for Country X tax purposes. Interest expense on 
the loan from the unrelated lender results in a dual consolidated 
loss being attributable to P's interest in DE1<INF>X</INF> in year 
1. DE1<INF>X</INF> does not elect under Country X law to consolidate 
with FS<INF>X</INF>. In year 1, FS<INF>X</INF> distributes its stock 
as a payment on the hybrid instrument to DE1<INF>X</INF>. For U.S. 
tax purposes, such payment is excluded from P's gross income under 
section 305. However, for Country X tax purposes, such payment is 
treated as interest and gives rise to a deduction taken into account 
in computing FS<INF>X</INF>'s Country X tax liability; the payment 
also gives rise to interest income to DE1<INF>X</INF> for Country X 
tax purposes.
    (ii) Result. The payment on the hybrid instrument does not give 
rise to an item of income or gain for U.S. tax purposes and 
therefore does not reduce (or eliminate) the dual consolidated loss 
attributable to P's interest in DE1<INF>X</INF>. In addition, such 
payment is taken into account as a deduction in computing 
FS<INF>X</INF>'s taxable income for Country X tax purposes. 
Moreover, such payment has the effect of making an item of deduction 
or loss composing the dual consolidated loss attributable to P's 
interest in DE1<INF>X</INF> available for a foreign use. This is the 
case because it may reduce or offset items of deduction or loss 
composing the dual consolidated loss for foreign tax purposes, and 
creates a deduction that reduces or offsets income of FS<INF>X</INF> 
for foreign tax purposes that, under U.S. tax principles, is income 
of a foreign corporation. Further, because the item is incurred, or 
taken into account, using an instrument that is treated as equity 
for U.S. tax purposes and debt for foreign tax purposes, it is 
deemed to have been engaged in with the principal purpose of 
avoiding the provisions of section 1503(d). As a result, there has 
been an indirect foreign use of the year 1 dual consolidated loss, 
and P cannot make a domestic use election with respect to such loss, 
as provided under Sec.  1.1503(d)-6(d)(2). Thus, the year 1 dual 
consolidated loss will be subject to the domestic use limitation 
rule of Sec.  1.1503(d)-4(b).
    Example 8. No indirect foreign use--transaction entered into in 
the ordinary course of business. (i) Facts. P owns DE1<INF>X</INF> 
and FB<INF>Y</INF>. FB<INF>Y</INF> is a foreign branch separate unit 
located in Country Y. DE1<INF>X</INF> owns FB<INF>X</INF> and 
FS<INF>X</INF>. P's interest in DE1<INF>X</INF> and FB<INF>X</INF> 
are combined and treated as a single separate unit (Country X 
separate unit) pursuant to Sec.  1.1503(d)-1(b)(4)(ii). Under 
Country X tax laws, DE1<INF>X</INF> elects to consolidate with 
FS<INF>X</INF>. FB<INF>Y</INF> engages in the business of providing 
services and, in connection with its ordinary course of business, 
provides services to unrelated third parties and to DE1<INF>X</INF>. 
As compensation for services, DE1<INF>X</INF> makes a payment to 
FB<INF>Y</INF>. Under Country X tax law, the payment is deductible. 
However, the payment is generally disregarded for U.S. tax purposes 
and, pursuant to Sec.  1.1503(d)-5(c)(1)(ii), is not taken into 
account in calculating the income or dual consolidated loss 
attributable to the Country X separate unit or FB<INF>Y</INF>. In 
year 1, the Country X separate unit and FB<INF>Y</INF> each has a 
dual consolidated loss. The dual consolidated loss attributable to 
the Country X separate unit is subject to the domestic use 
limitation under Sec.  1.1503(d)-4(b) because DE1<INF>X</INF> and 
FS<INF>X</INF> elect to consolidate and, as a result, the dual 
consolidated loss is put to a foreign use.
    (ii) Result. The payment made by DE1<INF>X</INF> to 
FB<INF>Y</INF> in connection with the performance of services is 
taken into account as a deduction in computing DE1<INF>X</INF>'s 
taxable income for Country X tax purposes, but does not give rise to 
an item of income or gain for U.S. tax purposes. In addition, such 
payment has the effect of making an item of deduction or loss 
composing the dual consolidated loss attributable to FB<INF>Y</INF> 
available for a foreign use. This is the case because it may reduce 
or offset items of deduction or loss composing the dual consolidated 
loss of FB<INF>Y</INF> for foreign tax purposes, and creates another 
deduction that reduces or offsets income of FS<INF>X</INF> for 
foreign tax purposes (because DE1<INF>X</INF> and FS<INF>X</INF> 
elect to file a consolidated return) that, under U.S. tax 
principles, is income of a foreign corporation. However, the 
transaction between DE1<INF>X</INF> and FB<INF>Y</INF> was entered 
into in the ordinary course of FB<INF>Y</INF>'s trade or business. 
As a result, if P can demonstrate to the satisfaction of the 
Commissioner that the transaction was not entered into with a 
principal purpose of avoiding the provisions of section 1503(d), 
FB<INF>Y</INF>'s year 1 dual consolidated loss will not be treated 
as having been made available for an indirect foreign use. In such a 
case, P would be entitled to make a domestic use election with 
respect to such loss.
    Example 9. Foreign use--dual resident corporation with hybrid 
entity joint venture. (i) Facts. P owns DRC<INF>X</INF>, a member of 
the P consolidated group. DRC<INF>X</INF> owns 80 percent of 
HPS<INF>X</INF>, a Country X entity that is subject to Country X tax 
on its worldwide income. HPS<INF>X</INF> is classified as a 
partnership for U.S. tax purposes. FS<INF>X</INF> owns the remaining 
20 percent of HPS<INF>X</INF>. In year 1, DRC<INF>X</INF> generates 
a $100x net operating loss (without regard to items attributable to 
DRC<INF>X</INF>'s interest in HPS<INF>X</INF>). Also in year 1, 
HPS<INF>X</INF> generates $100x of income, $80x of which is 
attributable to DRC<INF>X</INF>'s interest in HPS<INF>X</INF>. 
DRC<INF>X</INF> and HPS<INF>X</INF> file a consolidated tax return 
for Country X tax purposes, and HPS<INF>X</INF> offsets its $100x of 
income with the $100x loss generated by DRC<INF>X</INF>.
    (ii) Result. DRC<INF>X</INF> and its interest in HPS<INF>X</INF> 
are not combined because DRC<INF>X</INF> is a dual resident 
corporation and the combination rule under Sec.  1.1503(d)-
1(b)(4)(ii) only applies to separate units. The $100x year 1 net 
operating loss incurred by DRC<INF>X</INF> (without

[[Page 12936]]

regard to items attributable to DRC<INF>X</INF>'s interest in 
HPS<INF>X</INF>) is a dual consolidated loss. In addition, 
HPS<INF>X</INF> is a hybrid entity and DRC<INF>X</INF>'s interest in 
HPS<INF>X</INF> is a hybrid entity separate unit; however, there is 
no dual consolidated loss attributable to such separate unit in year 
1 (instead, there is $80x of income attributable to such separate 
unit). DRC<INF>X</INF>'s year 1 dual consolidated loss offsets $100x 
of income for Country X purposes, and $20x of such income is, under 
U.S. tax principles, income of FS<INF>X</INF>, which owns an 
interest in HPS<INF>X</INF> that is not a separate unit (in 
addition, FS<INF>X</INF> is a foreign corporation). As a result, 
pursuant to Sec.  1.1503(d)-3(a), there is a foreign use of the year 
1 dual consolidated loss of DRC<INF>X</INF>, and P cannot make a 
domestic use election with respect to such loss pursuant to Sec.  
1.1503(d)-6(d)(2). Therefore, such loss will be subject to the 
domestic use limitation rule of Sec.  1.1503(d)-4(b). The result 
would be the same even if HPS<INF>X</INF>, under Country X laws, had 
no income against which the dual consolidated loss could be offset 
(unless the ability to use the loss under Country X laws required an 
election, and no such election is made).
    Example 10. Foreign use--foreign parent corporation. (i) Facts. 
F1 and F2, nonresident alien individuals, each owns 50 percent of 
FP<INF>X</INF>, a Country X entity that is subject to Country X tax 
on its worldwide income. FP<INF>X</INF> is classified as a foreign 
corporation for U.S. tax purposes. FP<INF>X</INF> owns 
DRC<INF>X</INF>. DRC<INF>X</INF> is the parent of a consolidated 
group that includes as a member DS, a domestic corporation. In year 
1, DRC<INF>X</INF> incurs a dual consolidated loss of $100x and, for 
Country X tax purposes, FP<INF>X</INF> generates $100x of income. In 
year 1, FP<INF>X</INF> elects to consolidate with DRC<INF>X</INF> 
for Country X tax purposes, and the $100x year 1 loss of 
DRC<INF>X</INF> is used to offset the income of FP<INF>X</INF> under 
the laws of Country X. For U.S. tax purposes, the items of 
FP<INF>X</INF> do not constitute items of income in year 1.
    (ii) Result. The year 1 dual consolidated loss of 
DRC<INF>X</INF> offsets the income of FP<INF>X</INF> under the laws 
of Country X. Pursuant to Sec.  1.1503(d)-3(a), the offset 
constitutes a foreign use because the items constituting such income 
are considered under U.S. tax principles to be items of a foreign 
corporation. This is the case even though the United States does not 
recognize such items as income in year 1. Therefore, DRC<INF>X</INF> 
cannot make a domestic use election with respect to its year 1 dual 
consolidated loss pursuant to Sec.  1.1503(d)-6(d)(2). As a result, 
such loss will be subject to the domestic use limitation rule of 
Sec.  1.1503(d)-4(b).
    (iii) Alternative facts. The facts are the same as in paragraph 
(i) of this Example 10, except that FP<INF>X</INF> is classified as 
a partnership for U.S. tax purposes. The result would be the same as 
in paragraph (ii) of this Example 10, because the offset of the 
income generated by FP<INF>X</INF> is a foreign use pursuant to 
Sec.  1.1503(d)-3(a). This is the case because the items 
constituting such income are considered under U.S. tax principles to 
be items of F1 and F2, the owners of interests in FP<INF>X</INF> (a 
hybrid entity), that are not separate units. Moreover, the result 
would be the same if F1 and F2 owned their interests in 
FP<INF>X</INF> indirectly through another partnership.
    Example 11. No foreign use--absence of foreign loss allocation 
rules. (i) Facts. P owns DE1<INF>X</INF> and DRC<INF>X</INF>. 
DRC<INF>X</INF> is a member of the P consolidated group and owns 
FS<INF>X</INF>. DE1<INF>X</INF> owns FB<INF>X</INF>. P's interest in 
DE1<INF>X</INF> and P's indirect interest in FB<INF>X</INF> are 
individual separate units that are combined into a single separate 
unit (Country X separate unit) pursuant to Sec.  1.1503(d)-
1(b)(4)(ii). In year 1, DRC<INF>X</INF> incurs a $200x net operating 
loss and $200x of income is attributable to P's Country X separate 
unit. The $200x net operating loss incurred by DRC<INF>X</INF> is a 
dual consolidated loss. FS<INF>X</INF> also earns $200x of income in 
year 1. DRC<INF>X</INF>, DE1<INF>X</INF>, and FS<INF>X</INF> file a 
Country X consolidated tax return. However, Country X has no 
applicable rules for determining which income is offset by 
DRC<INF>X</INF>'s year 1 $200x loss.
    (ii) Result. Under Sec.  1.1503(d)-3(c)(3), DRC<INF>X</INF>'s 
$200x loss shall be treated as having been made available to offset 
the $200x of income attributable to P's Country X separate unit. P's 
Country X separate unit is not, under U.S. tax principles, a foreign 
corporation, and there is no interest in DE1<INF>X</INF> (which is a 
hybrid entity) that is not a separate unit. As a result, 
DRC<INF>X</INF>'s loss being made available to offset the income 
attributable to P's Country X separate unit is not considered a 
foreign use of such loss. Therefore, P can make a domestic use 
election with respect to DRC<INF>X</INF>'s year 1 dual consolidated 
loss.
    (iii) Alternative facts. The facts are the same as in paragraph 
(i) of this Example 11, except that in year 1 only $150x of income 
is attributable to P's Country X separate unit. Because only $150x 
of income is attributed to P's Country X separate unit, $50x of 
DRC<INF>X</INF>'s year 1 dual consolidated loss is treated as being 
made available to offset the income of FS<INF>X</INF>, a foreign 
corporation, and therefore constitutes a foreign use. As a result, 
DRC<INF>X</INF> cannot make a domestic use election with respect to 
its year 1 dual consolidated loss pursuant to Sec.  1.1503(d)-
6(d)(2), and such loss will be subject to the domestic use 
limitation rule of Sec.  1.1503(d)-4(b).
    Example 12. No foreign use--absence of foreign loss usage 
ordering rules. (i) Facts. (A) P owns DRC<INF>X</INF>, a member of 
the P consolidated group. DRC<INF>X</INF> owns FS<INF>X</INF>. Under 
the Country X consolidation regime, a consolidated group may elect 
in any given year to use all or a portion of the losses of one 
consolidated group member to offset income of other consolidated 
group members. If no such election is made in a year in which losses 
are generated by a consolidated member, such losses carry forward 
and are available, at the election of the consolidated group, to 
offset income of consolidated group members in subsequent taxable 
years. Country X law does not provide ordering rules for determining 
when a loss from a particular taxable year is used because, under 
Country X law, losses never expire. In addition, Country X law does 
not provide ordering rules for determining when a particular type of 
loss (for example, capital or ordinary) is used.
    (B) In year 1, DRC<INF>X</INF> incurs a capital loss of $80x 
which, under Sec.  1.1503(d)-5(b)(2), is not a dual consolidated 
loss. DRC<INF>X</INF> also incurs a net operating loss of $80x in 
year 1 which is a dual consolidated loss. FS<INF>X</INF> generates 
$60x of capital gain in year 1 which, for Country X purposes, can be 
offset by capital losses and net operating losses. Under the laws of 
Country X, DRC<INF>X</INF> elects to use $60x of its total year 1 
loss of $160x to offset the $60x of capital gain generated by 
FS<INF>X</INF> in year 1; the remaining $100x of year 1 loss carries 
forward. In both year 2 and year 3, DRC<INF>X</INF> incurs a net 
operating loss of $100x, while FS<INF>X</INF> incurs no income or 
loss in years 2 and 3. DRC<INF>X</INF>'s $100x losses incurred in 
year 2 and year 3 are dual consolidated losses. Because 
DRC<INF>X</INF> does not elect under the laws of Country X to use 
all or a portion of its year 2 or year 3 net operating losses of 
$100x to offset the income of other members of the Country X 
consolidated group, P is permitted to make (and in fact does make) a 
domestic use election with respect to both the year 2 and year 3 
dual consolidated losses of DRC<INF>X</INF>. In year 4, 
DRC<INF>X</INF> has a net operating loss of $10x and FS<INF>X</INF> 
generates $125x of income. Country X law permits, upon an election, 
FS<INF>X</INF>'s $125x of income generated in year 4 to be offset by 
losses (including carryover losses from prior years) of other group 
members. Accordingly, in year 4, DRC<INF>X</INF> elects to use $125x 
of its accumulated losses to offset the $125x of year 4 income 
generated by FS<INF>X</INF>.
    (ii) Result. (A) Under the ordering rules of Sec.  1.1503(d)-
3(d)(3), a pro rata amount of DRC<INF>X</INF>'s year 1 net operating 
loss ($30x) and capital loss ($30x) is considered to be used to 
offset FS<INF>X</INF>'s year 1 $60x capital gain. As a result, P 
cannot make a domestic use election with respect to 
DRC<INF>X</INF>'s year 1 $80x dual consolidated loss because a 
portion of such loss is put to a foreign use.
    (B) DRC<INF>X</INF>'s $10x year 4 net operating loss is also a 
dual consolidated loss. Under the ordering rules of Sec.  1.1503(d)-
3(d)(1), such loss is considered to be used to offset $10x of 
FS<INF>X</INF>'s year 4 $125x of income. Consequently, P cannot make 
a domestic use election with respect to such loss. Under the 
ordering rules of Sec.  1.1503(d)-3(d)(2), $50x of capital loss 
carryover and $50x of ordinary loss from year 1 will be considered 
to offset $100x of FS<INF>X</INF>'s year 4 income because the income 
is first deemed to have been offset by losses the use of which would 
not constitute a triggering event that would result in the recapture 
of a dual consolidated loss. The remaining $15x of FS<INF>X</INF>'s 
year 4 income is considered to be offset by losses from year 3 
because it is the most recent taxable year from which a loss may be 
carried forward. Thus, a portion of the year 3 dual consolidated 
loss has been put to a foreign use and the entire year 3 dual 
consolidated loss is recaptured. However, none of DRC<INF>X</INF>'s 
$100x year 2 net operating loss will be deemed to offset 
FS<INF>X</INF>'s year 4 income. As a result, DRC<INF>X</INF>'s year 
2 dual consolidated loss will not be recaptured.
    Example 13. Exception to foreign use through partnership 
interest. (i) Facts. (A) P owns 80 percent of HPS<INF>X</INF>, a 
Country X entity subject to Country X tax on its worldwide income. 
FS<INF>Z</INF>, an unrelated foreign corporation, owns the remaining 
20 percent of HPS<INF>X</INF>. HPS<INF>X</INF> is classified as a 
partnership for Federal tax purposes and carries on operations in 
Country X that, if carried on by a U.S. person, would constitute a 
foreign branch within the meaning of Sec.  1.367(a)-

[[Page 12937]]

6T(g)(1). P's interest in HPS<INF>X</INF> and P's indirect interest 
in the Country X branch are individual separate units that are 
combined into a single separate unit (Country X separate unit) 
pursuant to Sec.  1.1503(d)-1(b)(4)(ii).
    (B) In year 1, HPS<INF>X</INF> incurs a loss of $100x, $80x of 
which is attributable to P's Country X separate unit. The $80x of 
loss attributable to P's Country X separate unit constitutes a dual 
consolidated loss and P makes a domestic use election with respect 
to such loss. In year 2, HPS<INF>X</INF> generates $50x of income, 
$40x of which is attributable to P's interest in the Country X 
separate unit. Under Country X income tax laws, the $100x of year 1 
loss incurred by HPS<INF>X</INF> is carried forward and offsets the 
$50x of income generated by HPS<INF>X</INF> in year 2; the remaining 
$50x of loss is carried forward and is available to offset income 
generated by HPS<INF>X</INF> in subsequent years. P and 
FS<INF>Z</INF> maintain their ownership interests in HPS<INF>X</INF> 
throughout years 1 and 2.
    (ii) Result. In year 2, under the laws of Country X, the $100x 
of year 1 loss, which includes the $80x dual consolidated loss 
attributable to P's Country X separate unit, is made available to 
offset income of HPS<INF>X</INF>. Such income is attributable to P's 
interest in HPS<INF>X</INF>, which is a separate unit. Such income 
also is income of FS<INF>Z</INF>, a foreign corporation that is an 
owner of an interest in HPS<INF>X</INF>, which is not a separate 
unit. However, pursuant to Sec.  1.1503(d)-3(c)(4), there is no 
foreign use of the year 1 dual consolidated loss in year 2. This is 
the case because P's interest in HPS<INF>X</INF> as of the end of 
year 1 has not been reduced by more than a de minimis amount, and 
the portion of the $80x dual consolidated loss was made available 
for a foreign use in year 2 solely as a result of FS<INF>Z</INF>'s 
ownership in HPS<INF>X</INF> and the allocation or carry forward of 
the dual consolidated loss as a result of such ownership.
    (iii) Alternative facts. The facts are the same as in paragraph 
(i) of this Example 13, except that P also owns FS<INF>X</INF>. In 
addition, FS<INF>X</INF> and HPS<INF>X</INF> elect to file a 
consolidated return under Country X law. The exception to foreign 
use under Sec.  1.1503(d)-3(c)(4) does not apply because there is a 
foreign use other than by reason of the dual consolidated loss being 
made available as a result of FS<INF>Z</INF>'s ownership in 
HPS<INF>X</INF> and the allocation or carry forward of the dual 
consolidated loss as a result of such ownership. That is, the 
exception does not apply because there is also a foreign use of the 
dual consolidated loss as a result of FS<INF>X</INF> and 
HPS<INF>X</INF> filing a consolidated return under Country X law.
    (iv) Alternative facts. The facts are the same as in paragraph 
(i) of this Example 13, except that at the end of year 2, 
FS<INF>Z</INF> contributes cash to HPS<INF>X</INF> in exchange for 
additional equity of HPS<INF>X</INF>. As a result of the 
contribution, FS<INF>Z</INF>'s interest in HPS<INF>X</INF> increases 
from 20 percent to 30 percent, and P's interest in HPS<INF>X</INF> 
decreases from 80 percent to 70 percent. P's interest in 
HPS<INF>X</INF> is reduced within a single 12-month period by 12.5 
percent (10/80), as compared to P's interest in HPS<INF>X</INF> as 
of the beginning of such 12-month period. Accordingly, pursuant to 
Sec.  1.1503(d)-3(c)(4)(iii), the exception to foreign use provided 
under Sec.  1.1503(d)-3(c)(4)(i) does not apply. Therefore, in year 
2 there is a foreign use of the $80x year 1 dual consolidated loss 
attributable to P's Country X separate unit. Such foreign use 
constitutes a triggering event in year 2 and the $80x year 1 dual 
consolidated loss is recaptured. Alternatively, if FS<INF>Z</INF> 
were a domestic corporation, there would not be a foreign use of the 
$80x year 1 dual consolidated loss because the loss would not be 
available to offset income that, under U.S. tax principles, is 
income of a foreign corporation or a direct or indirect owner of an 
interest in a hybrid entity that is not a separate unit.
    Example 14. Exception to foreign use through partnership 
interest--combination rule. (i) Facts. (A) P and FS<INF>X</INF> form 
PRS<INF>X</INF>. P and FS<INF>X</INF> each own 50 percent of 
PRS<INF>X</INF> throughout years 1 and 2. PRS<INF>X</INF> is treated 
as a partnership for both U.S. and Country X tax purposes. 
PRS<INF>X</INF> owns DE<INF>Y</INF>. DE<INF>Y</INF> is a Country Y 
entity subject to Country Y tax on its worldwide income and 
disregarded as an entity separate from its owner for U.S. tax 
purposes. DE<INF>Y</INF> conducts business operations in Country Y 
that, if carried on by a U.S. person, would constitute a foreign 
branch as defined in Sec.  1.367(a)-6T(g)(1). P's interest in the 
Country Y operations conducted by DE<INF>Y</INF> is an individual 
foreign branch separate unit. P's interest in DE<INF>Y</INF>, owned 
indirectly through PRS<INF>X</INF>, is a hybrid entity individual 
separate unit. P also owns FB<INF>Y</INF>, a Country Y foreign 
branch individual separate unit. Under Sec.  1.1503(d)-1(b)(4)(ii), 
FB<INF>Y</INF> and P's indirect interests in DE<INF>Y</INF> and 
DE<INF>Y</INF>'s Country Y business operations are treated as a 
combined separate unit (Country Y separate unit).
    (B) In year 1, there is a $100x loss attributable to the Country 
Y business operations conducted by DE<INF>Y</INF>. Thus, there is a 
$50x loss attributable to P's interest in DE<INF>Y</INF>'s Country Y 
business operations in year 1. Also in year 1, there is a $200x loss 
attributable to FB<INF>Y</INF>. No income or loss is attributable to 
P's interest in DE<INF>Y</INF> in year 1. Under Sec.  1.1503(d)-
5(c)(4)(ii), the dual consolidated loss attributable to P's combined 
Country Y separate unit is $250x ($50x loss attributable to P's 
indirect interest in DE<INF>Y</INF>'s Country Y operations, plus 
$200x loss attributable to FB<INF>Y</INF>). In year 2, neither 
DE<INF>Y</INF> nor DE<INF>Y</INF>'s Country Y operations generates 
income or loss. Under Country Y law, the $100x of year 1 loss 
incurred by DE<INF>Y</INF> is carried forward and is available to 
offset income of DE<INF>Y</INF> in year 2.
    (ii) Result. As a result of the carryover of the year 1 $100x 
loss (which includes $50x of the year 1 dual consolidated loss) 
under Country Y law, a portion of such loss will be available to 
offset income of DE<INF>Y</INF> that is attributable to P's interest 
in DE<INF>Y</INF> owned indirectly through PRS<INF>X</INF>. A 
portion of such loss will also be available to offset income of 
DE<INF>Y</INF> that is attributable to FS<INF>X</INF>'s indirect 
ownership of DE<INF>Y</INF>. Accordingly, under Sec.  1.1503(d)-
3(a), there would be a foreign use of a portion of P's $250x year 1 
dual consolidated loss because it is available to offset an item of 
income of the owner of an interest in a hybrid entity, which is not 
a separate unit (there would also be a foreign use in this case 
because FS<INF>X</INF> is a foreign corporation). However, there has 
not been a reduction of P's interest in DE<INF>Y</INF>, 
DE<INF>Y</INF> has not consolidated under the laws of Country Y, and 
there has not been any other foreign use of the dual consolidated 
losses. As a result, no foreign use occurs as a result of the 
carryforward pursuant to Sec.  1.1503(d)-3(c)(4)(i) and (ii).
    Example 15. No foreign use--asset basis carryover exception. (i) 
Facts. P owns FB<INF>X</INF> and FS<INF>X</INF>. In year 1, there is 
a dual consolidated loss attributable to FB<INF>X</INF>. P's items 
of income, gain, deduction, and loss that are taken into account in 
calculating FB<INF>X</INF>'s dual consolidated loss include 
depreciation deductions attributable to FB<INF>X</INF>'s assets. P 
makes a domestic use election under Sec.  1.1503(d)-6(d) with 
respect to the year 1 dual consolidated loss of FB<INF>X</INF>. At 
the end of year 2, P contributes a portion of FB<INF>X</INF>'s 
assets to FS<INF>X</INF>, in exchange for stock in FS<INF>X</INF>. 
The aggregate adjusted basis of the assets transferred by P to 
FS<INF>X</INF> is less than 10 percent of the aggregate adjusted 
basis of all of FB<INF>X</INF>'s assets held at the beginning of 
year 2. In addition, no other assets of FB<INF>X</INF> are 
transferred during the certification period. Under Country X law, 
FS<INF>X</INF>'s basis in the transferred assets is determined by 
reference to P's basis in such assets. In addition, under Country X 
law, a portion of the depreciation deductions that were taken into 
account in year 1 for U.S. tax purposes, are taken into account in 
year 2 for Country X tax purposes.
    (ii) Result. As a result of the transfer of assets from P to 
FS<INF>X</INF>, a portion of the year 1 dual consolidated loss is 
available for a foreign use. This is the case because a portion of 
the basis in FB<INF>X</INF>'s assets, which gave rise to 
depreciation deductions that were taken into account in computing 
the year 1 dual consolidated loss, will give rise to a depreciation 
deduction under Country X laws that will be available, under U.S. 
tax principles, to offset the income of FS<INF>X</INF>, a foreign 
corporation, in year 2. However, the aggregate adjusted basis of all 
the assets transferred by P to FS<INF>X</INF>, within the 12-month 
period ending at the end of year 2, is less than 10 percent of the 
aggregate adjusted basis of all of FB<INF>X</INF>'s assets at the 
beginning of such 12-month period. Moreover, the aggregate adjusted 
basis of the assets transferred by P to FS<INF>X</INF> at any time 
during the certification period is less than 30 percent of the 
aggregate adjusted basis of FB<INF>X</INF>'s assets held at the end 
of year 1. In addition, the item of deduction giving rise to the 
foreign use is being made available solely as a result of the 
adjusted basis of the transferred assets being determined in whole, 
or in part, by reference to the adjusted basis of such transferred 
assets in the hands of FB<INF>X</INF>. As a result, this transfer 
will not result in a foreign use pursuant to Sec.  1.1503(d)-
3(c)(6).
    Example 16. No foreign use--liability assumption exception. (i) 
Facts. P owns FB<INF>X</INF>. In year 1, there is a dual 
consolidated loss attributable to FB<INF>X</INF> for which P makes a 
domestic use election under Sec.  1.1503(d)-6(d). The dual 
consolidated loss includes a deduction for salary expense that was 
deductible for U.S. tax purposes at the end of year 1, even though 
it was not paid until year 2. The deduction was incurred in the 
ordinary course of FB<INF>X</INF>'s trade or business. During year 
2, and before the accrued salary

[[Page 12938]]

expense liability was paid, P sells all the assets of FB<INF>X</INF> 
to FS<INF>X</INF> in exchange for cash and FS<INF>X</INF>'s 
assumption of the liabilities of the FB<INF>X</INF> trade or 
business, including the obligation to pay the accrued salary 
expense. Under Country X law, the accrued salary expense of 
FB<INF>X</INF> is deductible, and is taken into account for purposes 
of computing the taxable income of FB<INF>X</INF>, when paid. 
FB<INF>X</INF> pays the accrued salary expense after the sale of 
FB<INF>X</INF> to FS<INF>X</INF>.
    (ii) Result. (A) As a result of FS<INF>X</INF>'s assumption of 
the FB<INF>X</INF> liabilities, including the accrued salary 
expense, a portion of the dual consolidated loss is available for a 
foreign use in year 2. This is the case because the deduction that 
was taken into account in year 1 in computing the dual consolidated 
loss under U.S. tax principles will, under Country X tax law, be 
taken into account and will be available to offset the income of 
FS<INF>X</INF>, a foreign corporation, in year 2. However, because 
this item of expense is made available solely as a result of the 
assumption of a liability of FB<INF>X</INF>, and such liability was 
incurred in the ordinary course of FB<INF>X</INF>'s trade or 
business, there will not be a foreign use of the year 1 dual 
consolidated loss pursuant to Sec.  1.1503(d)-3(c)(7).
    (B) The transfer of all the assets of FB<INF>X</INF> to 
FS<INF>X</INF> is a triggering event under Sec.  1.1503(d)-
6(e)(1)(iv), unless P can rebut the triggering event under Sec.  
1.1503(d)-6(e)(2). For purposes of determining whether, under Sec.  
1.1503(d)-6(e)(2)(ii), the transfer of assets resulted in a 
carryover under foreign law of FB<INF>X</INF>'s losses, expenses, or 
deductions, the exception to foreign use for the assumption of 
liabilities is taken into account. However, the other exceptions to 
foreign use do not apply for this purpose (or for purposes of 
demonstrating that no foreign use of a dual consolidated loss can 
occur in any other year under Sec.  1.1503(d)-6(c), (e)(2)(i) or 
(j)(2)). See Sec.  1.1503(d)-3(c)(1). Provided the other 
requirements of Sec.  1.1503(d)-6(e)(2)(ii) and (iii) are satisfied, 
P may be able to rebut the occurrence of a triggering event upon the 
transfer of FB<INF>X</INF>'s assets to FS<INF>X</INF>.
    Example 17. Mirror legislation rule--dual resident corporation 
and hybrid entity separate unit. (i) Facts. P owns DRC<INF>X</INF>, 
a member of the P consolidated group. DRC<INF>X</INF> owns 
FS<INF>X</INF>. In year 1, DRC<INF>X</INF> incurs a $100x net 
operating loss that is a dual consolidated loss. To prevent 
corporations like DRC<INF>X</INF> from offsetting losses both 
against income of affiliates in Country X and against income of 
foreign affiliates under the tax laws of another country, Country X 
mirror legislation prevents a corporation that is subject to the 
income tax of another country on its worldwide income or on a 
residence basis from using the Country X form of consolidation. 
Accordingly, the Country X mirror legislation prevents the loss of 
DRC<INF>X</INF> from being made available to offset income of 
FS<INF>X</INF>.
    (ii) Result. Under Sec.  1.1503(d)-3(e), because the losses of 
DRC<INF>X</INF> are subject to Country X's mirror legislation, there 
is a deemed foreign use of DRC<INF>X</INF>'s year 1 dual 
consolidated loss. The stand-alone exception to the mirror rule in 
Sec.  1.1503(d)-3(e)(2) does not apply because, absent the mirror 
legislation, DRC<INF>X</INF>'s year 1 dual consolidated loss would 
be available for a foreign use (as defined in Sec.  1.1503(d)-3), 
without regard to whether such availability is limited by election 
or similar procedure. That is, absent the mirror legislation, all or 
a portion of the dual consolidated loss would be available to offset 
the income of FS<INF>X</INF> under the Country X consolidation 
regime. This is the case even if Country X did not recognize 
DRC<INF>X</INF> as having a loss in year 1. Therefore, P may not 
make a domestic use election with respect to DRC<INF>X</INF>'s year 
1 dual consolidated loss pursuant to Sec.  1.1503(d)-3(d)(2).
    (iii) Alternative facts. The facts are the same as in paragraph 
(i) of this Example 17, except that P owns DE1<INF>X</INF> (rather 
than DRC<INF>X</INF>) and, in year 1, there is a $100 dual 
consolidated loss attributable to P's interest in DE1<INF>X</INF> 
(rather than of DRC<INF>X</INF>). The Country X mirror legislation 
only applies to Country X dual resident corporations and, therefore, 
does not apply to losses attributable to P's interest in 
DE1<INF>X</INF>. As a result, the mirror legislation rule under 
Sec.  1.1503(d)-3(e) would not deny the opportunity of such loss 
from being put to a foreign use (for example, by offsetting the 
income of FS<INF>X</INF> through the Country X consolidation 
regime). Therefore, a domestic use election can be made with respect 
to the dual consolidated loss (provided the conditions for such an 
election are otherwise satisfied).
    Example 18. Mirror legislation rule--standalone foreign branch 
separate unit. (i) Facts. P owns FB<INF>X</INF>. In year 1, there is 
a $100x dual consolidated loss attributable to FB<INF>X</INF>. 
Country X enacted mirror legislation to prevent Country X branches 
and permanent establishments of nonresident corporations from 
offsetting losses both against income of Country X affiliates and 
against other income of its owner (or foreign affiliates thereof) 
under the tax laws of another country. The Country X mirror 
legislation prevents a Country X branch or permanent establishment 
of a nonresident corporation from offsetting its losses against the 
income of Country X affiliates if such losses may be deductible 
against income (other than income of the Country X branch or 
permanent establishment) under the laws of another country.
    (ii) Result. In general, under Sec.  1.1503(d)-3(e), because the 
losses of FB<INF>X</INF> are subject to Country X's mirror 
legislation, there is a deemed foreign use of FB<INF>X</INF>'s year 
1 dual consolidated loss. However, in the absence of the Country X 
mirror legislation, no item of deduction or loss composing 
FB<INF>X</INF>'s year 1 dual consolidated loss would be available in 
the year incurred for a foreign use (as defined in Sec.  1.1503(d)-
3), without regard to whether such availability is limited by 
election or otherwise. This is the case because there is no Country 
X entity through which the dual consolidated loss could be put to a 
foreign use (absent a sale, merger, or similar transaction involving 
FB<INF>X</INF>). As a result, the stand-alone exception in Sec.  
1.1503(d)-3(e)(2) may apply, provided P complies with the 
requirements of Sec.  1.1503(d)-3(e)(2)(ii). Accordingly, P may make 
a domestic use election with respect to the year 1 dual consolidated 
loss of FB<INF>X</INF> pursuant to Sec.  1.1503(d)-6(d). If, 
however, any item of the dual consolidated loss would otherwise be 
available for a foreign use during the certification period (for 
example, as a result of P acquiring a foreign corporation that is 
organized under the laws of Country X such that losses of 
FB<INF>X</INF> could be put to a foreign use through consolidation 
or similar means), then such loss would be recaptured pursuant to 
Sec.  1.1503(d)-6(e)(1)(ix).
    (iii) Alternative facts. The facts are the same as in paragraph 
(i) of this Example 18, except that the Country X mirror legislation 
operates in a manner similar to the rules under section 1503(d). 
That is, it allows the taxpayer to elect to use the loss to either 
offset income of an affiliate in Country X, or income of an 
affiliate (or other income of the owner of the Country X branch or 
permanent establishment) in the other country, but not both. Because 
the Country X mirror legislation permits the taxpayer to choose to 
put the dual consolidated loss to a foreign use, it does not deny 
the opportunity to put the loss to a foreign use. Therefore, there 
is no deemed foreign use of the dual consolidated loss pursuant to 
Sec.  1.1503(d)-4(e) and a domestic use election can be made for 
such loss.
    Example 19. Application of mirror legislation rule to combined 
separate unit. (i) Facts. P owns FB<INF>X</INF>, FS<INF>X</INF>, and 
DE1<INF>X</INF>. In year 1, there is a $50x dual consolidated loss 
attributable to FB<INF>X</INF> and $10x of income attributable to 
P's interest in DE1<INF>X</INF>. FS<INF>X</INF> has income of $100x. 
Pursuant to Sec.  1.1503(d)-1(b)(4)(ii), FB<INF>X</INF> and P's 
interest in DE1<INF>X</INF> are combined and treated as a single 
separate unit (Country X separate unit) which has a year 1 dual 
consolidated loss of $40x. Country X enacted mirror legislation to 
prevent Country X branches or permanent establishments of 
nonresident corporations from offsetting losses both against income 
of Country X affiliates and against other income of its owner (or 
foreign affiliates thereof) under the tax laws of another country. 
The Country X mirror legislation prevents a Country X branch or 
permanent establishment of a nonresident corporation from offsetting 
its losses against the income of Country X affiliates if such losses 
may be deductible against income (other than income of the Country X 
branch or permanent establishment) under the laws of another 
country. However, the United States and Country X have entered into 
an agreement described in Sec.  1.1503(d)-6(b) pursuant to the U.S.-
Country X income tax convention (mirror agreement). The mirror 
agreement applies to Country X foreign branch separate units of 
domestic corporations, but not to Country X hybrid entity separate 
units. The mirror agreement provides that neither the Country X 
mirror legislation nor the mirror legislation rule under Sec.  
1.1503(d)-3(e) will apply to losses attributable to Country X 
foreign branch separate units, provided certain conditions and 
reporting requirements are satisfied (including a domestic use 
election, if the loss is to be used to offset income of a domestic 
affiliate). Thus, losses attributable to Country X foreign branch 
separate units can, subject to the requirements of the mirror 
agreement, be used to offset income of a domestic affiliate or a 
Country X affiliate (but not both).
    (ii) Result. The Country X mirror legislation only applies to 
Country X foreign

[[Page 12939]]

branch separate units and does not apply to hybrid entity separate 
units. In addition, if P complies with the terms and conditions of 
the mirror agreement, the Country X mirror legislation would not 
apply to FB<INF>X</INF>. As a result, the income tax laws of Country 
X would not deny the opportunity of a loss of either individual 
separate unit that composes P's combined Country X separate unit 
from being put to a foreign use. Therefore, notwithstanding Sec.  
1.1503(d)-3(e), a domestic use election can be made with respect to 
the dual consolidated loss attributable to P's Country X separate 
unit, provided the terms and conditions of the mirror agreement are 
satisfied. See Sec.  1.1503(d)-6(b)(2).
    (iii) Alternative facts. The facts are the same as in paragraph 
(i) of this Example 19, except that the Country X mirror legislation 
also applies to losses attributable to DE1<INF>X</INF>, but the 
mirror agreement does not apply to such losses. The mirror 
legislation rule would apply with respect to P's interest in 
DE1<INF>X</INF> and, as a result, there is a deemed foreign use of 
the dual consolidated loss attributable to the Country X separate 
unit and a domestic use election cannot be made for such loss. This 
is the case even though, pursuant to Sec.  1.1503(d)-5(c)(4)(ii)(A), 
P's interest in DE1<INF>X</INF> (which is subject to the Country X 
mirror legislation) does not, as an individual separate unit, have a 
dual consolidated loss in year 1. Further, the stand-alone exception 
to the mirror legislation rule in Sec.  1.1503(d)-3(e)(2) does not 
apply because, absent the mirror legislation, the Country X combined 
separate unit's dual consolidated loss would be available in the 
year incurred for a foreign use (as defined in Sec.  1.1503(d)-3) 
because it could be used to offset income of FS<INF>X</INF> under 
the Country X consolidation regime. This is the case even if Country 
X requires an election to consolidate and no such election is made. 
The result would be the same even if Country X did not recognize 
DE1<INF>X</INF> as having a loss.
    Example 20. Dual consolidated loss limitation after section 381 
transaction--disposition of assets and subsequent liquidation of 
dual resident corporation. (i) Facts. P owns DRC<INF>X</INF>, a 
member of the P consolidated group. In year 1, DRC<INF>X</INF> 
incurs a dual consolidated loss and P does not make a domestic use 
election with respect to such loss. Under Sec.  1.1503(d)-4(b), 
DRC<INF>X</INF>'s year 1 dual consolidated loss is subject to the 
limitations under Sec.  1.1503(d)-4(c) and, therefore, may not be 
used to offset the income of P or S (or any other domestic 
affiliate) on the group's U.S. income tax return. At the beginning 
of year 2, DRC<INF>X</INF> sells all of its assets for cash and 
distributes the cash to P pursuant to a liquidation that qualifies 
under section 332.
    (ii) Result. In general, under section 381, P would succeed to, 
and be permitted to use, DRC<INF>X</INF>'s net operating loss 
carryover. However, Sec.  1.1503(d)-4(d)(1)(i) prohibits the dual 
consolidated loss of DRC<INF>X</INF> from carrying over to P. 
Therefore, DRC<INF>X</INF>'s year 1 net operating loss carryover is 
eliminated.
    Example 21. Dual consolidated loss limitation applied to a 
separate unit transferred in a section 381 transaction. (i) Facts. S 
owns DE1<INF>X</INF> which, in turn, owns FB<INF>X</INF>. S's 
interest in DE1<INF>X</INF> and its indirect interest in 
FB<INF>X</INF> are combined and treated as a single separate unit 
(Country X separate unit) pursuant to Sec.  1.1503(d)-1(b)(4)(ii). 
In year 1, a dual consolidated loss is attributable to the Country X 
separate unit, and P does not make a domestic use election with 
respect to such loss. Under Sec.  1.1503(d)-4(b), the year 1 dual 
consolidated loss attributable to the Country X separate unit may 
not be used to offset the income of P or S (other than income 
attributable to the Country X separate unit, subject to the 
application of Sec.  1.1503(d)-4(c)) on the group's consolidated 
U.S. income tax return (nor may it be used to offset the income of 
any other domestic affiliates). At the beginning of year 2, S 
transfers its entire interest in DE1<INF>X</INF>, and thus its 
entire indirect interest in FB<INF>X</INF>, to FS<INF>X</INF> in a 
transaction described in section 381.
    (ii) Result. Section 1.1503(d)-4(d)(1)(ii) provides that the 
dual consolidated loss attributable to a separate unit that is 
subject to the domestic use limitation under Sec.  1.1503(d)-4(b) is 
eliminated if the separate unit ceases to be a separate unit of its 
affiliated domestic owner and all other members of the affiliated 
domestic owner's separate group. As a result of the transfer of the 
Country X separate unit to FS<INF>X</INF>, the Country X separate 
unit ceases to be a separate unit of S, and is not a separate unit 
of any other member of the P consolidated group. In addition, the 
exceptions in Sec.  1.1503(d)-4(d)(2)(iii) do not apply because 
FS<INF>X</INF> is not a domestic corporation. Thus, the year 1 dual 
consolidated loss attributable to the Country X separate unit is 
eliminated.
    (iii) Alternative facts. Assume the same facts as in paragraph 
(i) of this Example 21, except S transfers its assets to DC, a 
domestic corporation that is not a member of the P consolidated 
group, in a transaction described in section 381(a). Immediately 
after the transaction, the Country X separate unit is a separate 
unit of DC. Under Sec.  1.1503(d)-4(d)(1)(ii), the year 1 dual 
consolidated loss of the Country X separate unit would be eliminated 
because it ceases to be a separate unit of S, and is not a separate 
unit of any other member of the P consolidated group. However, 
because the transferee is a domestic corporation and the Country X 
separate unit is a separate unit in the hands of DC immediately 
after the transaction, the exception under Sec.  1.1503(d)-
4(d)(2)(iii)(A) applies. As a result, the year 1 dual consolidated 
loss of the Country X separate unit is not eliminated and any income 
generated by DC that is attributable to the Country X separate unit 
following the transfer may be offset by the carryover dual 
consolidated losses attributable to the Country X separate unit, 
subject to the limitations of Sec.  1.1503(d)-4(b) and (c) applied 
as if DC generated the dual consolidated loss and such loss was 
attributable to the Country X separate unit.
    (iv) Alternative facts. Assume the same facts as in paragraph 
(iii) of this Example 21, except that P owns DE2<INF>X</INF> and the 
interest in DE2<INF>X</INF> is combined with and therefore included 
in the Country X separate unit. In addition, a portion of the dual 
consolidated loss of the Country X separate unit is attributable to 
P's interest in DE2<INF>X</INF>. Pursuant to Sec.  1.1503(d)-
4(d)(2)(iii)(A), the result would be the same as in paragraph (iii) 
of this Example 21, with respect to the portion of the dual 
consolidated loss attributable to the combined separate unit that is 
succeeded to and taken into account by DC pursuant to section 381. 
The portion of the dual consolidated loss attributable to P's 
interest in DE2<INF>X</INF>, however, does not carry over to DC but 
is retained by P and continues to be subject to the limitations of 
Sec.  1.1503(d)-4(b) and (c) with respect to P's interest in 
DE2<INF>X</INF>.
    (v) Alternative facts. Assume the same facts as in paragraph 
(iv) of this Example 21, except that DC is a member of the P 
consolidated group. Pursuant to Sec.  1.1503(d)-4(d)(2)(iii)(B), the 
dual consolidated loss of the Country X separate unit is not 
eliminated and income attributable to the Country X separate unit 
may continue to be offset by the dual consolidated loss that is 
succeeded to and taken into account by DC pursuant to section 381, 
subject to the limitations of Sec.  1.1503(d)-4(b) and (c). The 
result would be the same even if the interest in DE1<INF>X</INF> 
ceased to be a separate unit in the hands of DC (for example, 
because it dissolved under Country X law in connection with the 
transaction), provided P, or another member of the P consolidated 
group, continued to own a portion of the Country X separate unit.
    Example 22. Tainted income. (i) Facts. P owns 100 percent of 
DRC<INF>Z</INF>, a domestic corporation that is included as a member 
of the P consolidated group. DRC<INF>Z</INF> conducts a business in 
the United States. During year 1, DRC<INF>Z</INF> was managed and 
controlled in Country Z and therefore was subject to tax as a 
resident of Country Z and was a dual resident corporation. In year 
1, DRC<INF>Z</INF> incurred a dual consolidated loss of $200x, and P 
did not make a domestic use election with respect to such loss. As a 
result, such loss is subject to the domestic use limitation rule of 
Sec.  1.1503(d)-4(b). At the end of year 1, DRC<INF>Z</INF> moved 
its management and control to the United States and, as a result, 
ceased being a dual resident corporation. At the beginning of year 
2, P transferred asset A, a non-depreciable asset, to 
DRC<INF>Z</INF> in exchange for common stock in a transaction that 
qualified for nonrecognition under section 351. At the time of the 
transfer, P's tax basis in asset A equaled $50x and the fair market 
value of asset A equaled $100x. The tax basis of asset A in the 
hands of DRC<INF>Z</INF> immediately after the transfer equaled $50x 
pursuant to section 362. Asset A did not constitute replacement 
property acquired in the ordinary course of business. 
DRC<INF>Z</INF> did not generate income or gain during years 2, 3, 
or 4. On June 30, year 5, DRC<INF>Z</INF> sold asset A to a third 
party for $100x, its fair market value at the time of the sale, and 
recognized $50x of income on such sale. In addition to the $50x 
income generated on the sale of asset A, DRC<INF>Z</INF> generated 
$100x of operating income in year 5. At the end of year 5, the fair 
market value of all the assets of DRC<INF>Z</INF> was $400x.
    (ii) Result. DRC<INF>Z</INF> ceased being a dual resident 
corporation at the end of year 1. Therefore, its year 1 dual 
consolidated loss cannot be offset by tainted income. Asset A is a 
tainted asset because it was acquired in a nonrecognition 
transaction after DRC<INF>Z</INF>

[[Page 12940]]

ceased being a dual resident corporation (and was not replacement 
property acquired in the ordinary course of business). As a result, 
the $50x of income recognized by DRC<INF>Z</INF> on the disposition 
of asset A is tainted income and cannot be offset by the year 1 dual 
consolidated loss of DRC<INF>Z</INF>. In addition, absent evidence 
establishing the actual amount of tainted income, $25x of the $100x 
year 5 operating income of DRC<INF>Z</INF> (($100x/$400x) x $100x) 
also is treated as tainted income and cannot be offset by the year 1 
dual consolidated loss of DRC<INF>Z</INF> under Sec.  1.1503(d)-
4(e)(2)(ii). Therefore, $75x of the $150x year 5 income of 
DRC<INF>Z</INF> constitutes tainted income and may not be offset by 
the year 1 dual consolidated loss of DRC<INF>Z</INF>; however, the 
remaining $75x of year 5 income of DRC<INF>Z</INF> may be offset by 
such dual consolidated loss. The result would be the same if, 
instead of P transferring asset A to DRC<INF>Z</INF>, such asset was 
received from a separate unit or a transparent entity of 
DRC<INF>Z</INF>.
    Example 23. Treatment of disregarded item and books and records 
of a hybrid entity. (i) Facts. P owns DE1<INF>X</INF> which, in 
turn, owns FS<INF>X</INF>. In year 1, P borrows from a third party 
and on-lends the proceeds to DE1<INF>X</INF>. In year 1, P incurs 
interest expense attributable to the third-party loan. Also in year 
1, DE1<INF>X</INF> incurs interest expense attributable to its loan 
from P, but such expense is generally disregarded for U.S. tax 
purposes because DE1<INF>X</INF> is disregarded as an entity 
separate from P. The third-party loan and related interest expense 
are reflected on the books and records of P (and not on the books 
and records of DE1<INF>X</INF>). The loan from P to DE1<INF>X</INF> 
and related interest expense are reflected on the books and records 
of DE1<INF>X</INF>. There are no other items of income, gain, 
deduction, or loss reflected on the books and records of 
DE1<INF>X</INF> in year 1.
    (ii) Result. Because the interest expense on P's third-party 
loan is not reflected on the books and records of DE1<INF>X</INF>, 
no portion of such expense is attributable to P's interest in 
DE1<INF>X</INF> pursuant to Sec.  1.1503(d)-5(c)(3) for purposes of 
calculating the year 1 dual consolidated loss, if any, attributable 
to such interest. In addition, even though P's interest in 
DE1<INF>X</INF> is treated as a separate domestic corporation for 
purposes of determining the amount of income or dual consolidated 
loss attributable to it pursuant to Sec.  1.1503(d)-5(c)(1)(ii), 
such treatment does not cause the interest expense incurred on the 
loan from P to DE1<INF>X</INF> that is generally disregarded for 
U.S. tax purposes to be regarded for purposes of calculating the 
year 1 dual consolidated loss, if any, attributable to P's interest 
in DE1<INF>X</INF>. As a result, even though the disregarded 
interest expense is reflected on the books and records of 
DE1<INF>X</INF>, it is not taken into account for purposes of 
calculating income or a dual consolidated loss. Therefore, there is 
no dual consolidated loss attributable to P's interest in 
DE1<INF>X</INF> in year 1.
    Example 24. Dividend income attributable to a separate unit. (i) 
Facts. P owns DE1<INF>X</INF> which, in turn, owns FB<INF>X</INF>. 
P's interest in DE1<INF>X</INF> and its indirect interest in 
FB<INF>X</INF> are combined and treated as a single separate unit 
(Country X separate unit) pursuant to Sec.  1.1503(d)-1(b)(4)(ii). 
DE1<INF>X</INF> owns DE3<INF>Y</INF>. DE3<INF>Y</INF> owns the stock 
of FS<INF>X</INF>. P's Country X separate unit would, without regard 
to year 1 dividend income (or related section 78 gross-up) received 
from FS<INF>X</INF>, have a dual consolidated loss of $75x in year 
1. In year 1, FS<INF>X</INF> distributes $50x to DE3<INF>Y</INF> 
that is taxable as a dividend. DE3<INF>Y</INF> distributes the same 
amount to DE1<INF>X</INF>. P computes foreign taxes deemed paid on 
the dividend under section 902 of $25x and includes that amount in 
gross income under section 78.
    (ii) Result. The $50x dividend is reflected on the books and 
records of DE3<INF>Y</INF> and, therefore, is attributable to P's 
interest in DE3<INF>Y</INF> pursuant to Sec.  1.1503(d)-5(c)(3)(i). 
In addition, the $25x section 78 gross-up is attributable to P's 
interest in DE3<INF>Y</INF> pursuant to Sec.  1.1503(d)-5(c)(4)(iv). 
The distribution of $50x from DE3<INF>Y</INF> to DE1<INF>X</INF> is 
generally disregarded for U.S. tax purposes and, therefore, does not 
give rise to an item that is taken into account for purposes of 
calculating income or a dual consolidated loss. This is the case 
even though the item would be reflected on the books and records of 
DE1<INF>X</INF>. In addition, pursuant to Sec.  1.1503(d)-
5(c)(1)(iii), each separate unit must calculate its own income or 
dual consolidated loss, and each item of income, gain, deduction, 
and loss must be taken into account only once. As a result, the dual 
consolidated loss of $75x attributable to P's Country X separate 
unit in year 1 is not reduced by the amount of dividend income 
attributable to P's indirect interest in DE3<INF>Y</INF>.
    Example 25. Items reflected on books and records of a combined 
separate unit. (i) Facts. P owns DE1<INF>X</INF> which, in turn, 
owns FB<INF>X</INF>. P's interest in DE1<INF>X</INF> and its 
indirect interest in FB<INF>X</INF> are combined and treated as a 
single separate unit (Country X separate unit) pursuant to Sec.  
1.1503(d)-1(b)(4)(ii). The following items are reflected on the 
books and records of DE1<INF>X</INF> in year 1: Sales, depreciation 
expense, a political contribution, royalty expense paid to P, 
repairs and maintenance expense paid to a third party, and Country X 
income tax expense. The amount of sales under U.S. tax principles 
equals the amount of sales reported for accounting purposes. The 
depreciation expense is calculated on a straight-line basis over the 
useful life of the asset for accounting purposes, but is subject to 
accelerated depreciation for U.S. tax purposes. In addition, the 
repairs and maintenance expense, which is deducted when paid for 
accounting purposes, is properly capitalized and amortized over five 
years for U.S. tax purposes. Finally, P elects to claim as a credit 
under section 901 the Country X income tax expense that was paid in 
year 1.
    (ii) Result. (A) For purposes of determining the income or dual 
consolidated loss attributable to P's Country X separate unit, items 
of income, gain, deduction, and loss must first be attributed to the 
individual separate units (that is, P's interest in DE1<INF>X</INF> 
and its indirect interest in FB<INF>X</INF>). For purposes of 
attributing items to P's interest in DE1<INF>X</INF>, P's items that 
are reflected on DE1<INF>X</INF>'s books and records, as adjusted to 
conform to U.S. tax principles, are taken into account. See Sec.  
1.1503(d)-5(c)(3)(i). For purposes of attributing items (other than 
interest expense) to FB<INF>X</INF>, the principles of section 
864(c)(2), (c)(4), and (c)(5) (as set forth in Sec.  1.864-4(c) and 
Sec. Sec.  1.864-5 through 1.864-7) must be applied and, for 
interest expense, the principles of Sec.  1.882-5, as modified under 
Sec.  1.1503(d)-5(c)(2)(ii), must be applied; however, for these 
purposes, pursuant to Sec.  1.1503(d)-5(c)(4)(i)(A), FB<INF>X</INF> 
only takes into account items attributable to P's interest in 
DE1<INF>X</INF> and the assets, liabilities, and activities of such 
interest. In addition, to the extent such items are taken into 
account by FB<INF>X</INF>, they are not taken into account in 
determining the items attributable to P's interest in 
DE1<INF>X</INF>. Sec.  1.1503(d)-5(c)(4)(i)(B). Because P's interest 
in DE1<INF>X</INF> has no assets or liabilities, and conducts no 
activities, other than through its ownership of FB<INF>X</INF>, all 
of the items that are reflected on the books and records of 
DE1<INF>X</INF>, as adjusted to conform to U.S. tax principles, are 
attributable to FB<INF>X</INF>; no items are attributable to P's 
interest in DE1<INF>X</INF>.
    (B) The items reflected on the books and records of 
DE1<INF>X</INF> must be adjusted to conform to U.S. tax principles. 
No adjustment is required to sales because the amount of sales under 
U.S. tax principles equals the amount of sales for accounting 
purposes. The amount of straight-line depreciation expense reflected 
on DE1<INF>X</INF>'s books and records must be adjusted to reflect 
the amount of depreciation on the asset that is allowable for U.S. 
tax purposes. The political contribution is not taken into account 
because it is not deductible for U.S. tax purposes. Similarly, 
because the royalty expense is paid to P, and therefore is generally 
disregarded for U.S. tax purposes, it is not taken into account. The 
repair and maintenance expense that is deducted in year 1 for 
accounting purposes also must be adjusted to conform to U.S. tax 
principles. Thus, the repair and maintenance expense will be taken 
into account in computing the income or dual consolidated loss 
attributable to P's Country X separate unit over five years (even 
though no item related to such expense would be reflected on the 
books and records of DE1<INF>X</INF> for years 2 through 5). 
Finally, because P elected to claim as a credit the Country X 
foreign taxes paid during year 1, no deduction is allowed for such 
amount pursuant to section 275(a)(4) and, therefore, the Country X 
tax expense is not taken into account.
    (C) Pursuant to Sec.  1.1503(d)-5(c)(4)(ii)(B), the combined 
Country X separate unit of P calculates its income or dual 
consolidated loss by taking into account all the items of income, 
gain, deduction, and loss that were separately attributable to P's 
interest in DE1<INF>X</INF> and FB<INF>X</INF>. However, in this 
case, there are no items attributable to P's interest in 
DE1<INF>X</INF>. Therefore, the items attributable to the Country X 
separate unit are the items attributable to FB<INF>X</INF>.
    Example 26. Items attributable to a combined separate unit. (i) 
Facts. P owns DE1<INF>X</INF>. DE1<INF>X</INF> owns a 50 percent 
interest in PRS<INF>Z</INF>, a Country Z entity that is classified 
as a partnership both for Country Z tax purposes and for U.S. tax 
purposes. FS<INF>X</INF>, which is unrelated to P, owns the 
remaining 50 percent interest in PRS<INF>Z</INF>. PRS<INF>Z</INF> 
carries on operations in Country X that, if carried on by a U.S. 
person, would constitute a foreign branch as defined in Sec.  
1.367(a)-6T(g)(1).

[[Page 12941]]

Therefore, P's share of the Country X operations carried on by 
PRS<INF>Z</INF> constitutes a foreign branch separate unit. 
PRS<INF>Z</INF> also owns assets that do not constitute a part of 
its Country X branch, including all of the interests in 
TE<INF>T</INF>, a disregarded entity. TE<INF>T</INF> is an entity 
incorporated under the laws of Country T, a country that does not 
have an income tax. Under the laws of Country X, an interest holder 
of TE<INF>T</INF> does not take into account on a current basis the 
interest holder's share of items of income, gain, deduction, and 
loss of TE<INF>T</INF>.
    (ii) Result. (A) Pursuant to Sec.  1.1503(d)-1(b)(4)(ii), P's 
interest in DE1<INF>X</INF>, and P's indirect ownership of a portion 
of the Country X operations carried on by PRS<INF>Z</INF>, are 
combined and treated as a single separate unit (Country X separate 
unit). Pursuant to Sec.  1.1503(d)-5(c)(4)(ii)(A), for purposes of 
determining P's items of income, gain, deduction, and loss 
attributable to the Country X separate unit, the items of P are 
first attributed to each separate unit that composes the Country X 
separate unit.
    (B) Pursuant to Sec.  1.1503(d)-5(c)(2)(i), the principles of 
section 864(c)(2), (c)(4), and (c)(5) (as set forth in Sec.  1.864-
4(c) and Sec. Sec.  1.864-5 through 1.864-7), apply for purposes of 
determining P's items of income, gain, deduction (other than 
interest expense), and loss that are attributable to P's indirect 
interest in the Country X operations carried on by PRS<INF>Z</INF>. 
For purposes of determining P's interest expense that is 
attributable to P's indirect interest in the Country X operations 
carried on by PRS<INF>Z</INF>, the principles of Sec.  1.882-5, as 
modified under Sec.  1.1503(d)-5(c)(2)(ii), shall apply. For 
purposes of applying these rules, P is treated as a foreign 
corporation, the Country X operations carried on by PRS<INF>Z</INF> 
are treated as a trade or business within the United States, and the 
assets of P (including its share of the PRS<INF>Z</INF> assets, 
other than those of the Country X operations) are treated as assets 
that are not U.S. assets. In addition, because P carries on its 
share of the Country X operations through DE1<INF>X</INF>, a hybrid 
entity, Sec.  1.1503(d)-5(c)(4)(i)(A) provides that only the items 
attributable to P's interest in DE1<INF>X</INF>, and only the 
assets, liabilities, and activities of P's interest in 
DE1<INF>X</INF>, are taken into account for purposes of this 
determination.
    (C) TE<INF>T</INF> is a transparent entity as defined in Sec.  
1.1503(d)-1(b)(16) because it is not taxable as an association for 
Federal tax purposes, is not subject to income tax in a foreign 
country as a corporation (or otherwise at the entity level) either 
on its worldwide income or on a residence basis, and is not treated 
as a pass-through entity under the laws of Country X (the applicable 
foreign country). TE<INF>T</INF> is not a pass-through entity under 
the laws of Country X because a Country X holder of an interest in 
TE<INF>T</INF> does not take into account on a current basis the 
interest holder's share of items of income, gain, deduction, and 
loss of TE<INF>T</INF>. For purposes of determining P's items of 
income, gain, deduction, and loss that are attributable to P's 
interest in TE<INF>T</INF>, only those items of P that are reflected 
on the books and records of TE<INF>T</INF>, as adjusted to conform 
to U.S. tax principles, are taken into account. Sec.  1.1503(d)-
5(c)(3)(i). Because the interest in TE<INF>T</INF> is not a separate 
unit, a loss attributable to such interest is not a dual 
consolidated loss and is not subject to section 1503(d) and these 
regulations. Items must nevertheless be attributed to the interests 
in TE<INF>T</INF>. For example, such attribution is required for 
purposes of calculating the income or dual consolidated loss 
attributable to the Country X separate unit, and for purposes of 
applying the domestic use limitation under Sec.  1.1503(d)-4(b) to a 
dual consolidated loss attributable to the Country X separate unit.
    (D) For purposes of determining P's items of income, gain, 
deduction, and loss that are attributable to P's interest in 
DE1<INF>X</INF>, only those items of P that are reflected on the 
books and records of DE1<INF>X</INF>, as adjusted to conform to U.S. 
tax principles, are taken into account. Sec.  1.1503(d)-5(c)(3)(i). 
For this purpose, DE1<INF>X</INF>'s distributive share of the items 
of income, gain, deduction, and loss that are reflected on the books 
and records of PRS<INF>Z</INF>, as adjusted to conform to U.S. tax 
principles, are treated as being reflected on the books and records 
of DE1<INF>X</INF>, except to the extent such items are taken into 
account by the Country X operations of PRS<INF>Z</INF>. See Sec.  
1.1503(d)-5(c)(3)(ii) and (4)(i)(B). Because TE<INF>T</INF> is a 
transparent entity, the items reflected on its books and records are 
not treated as being reflected on the books and records of 
DE1<INF>X</INF>.
    (E) Pursuant to Sec.  1.1503(d)-5(c)(4)(ii)(B), the combined 
Country X separate unit of P calculates its income or dual 
consolidated loss by taking into account all the items of income, 
gain, deduction, and loss that were separately attributable to P's 
interest in DE1<INF>X</INF> and the Country X operations of 
PRS<INF>Z</INF> owned indirectly by P.
    Example 27. Sale of separate unit by another separate unit. (i) 
Facts. P owns DE3<INF>Y</INF> which, in turn, owns DE1<INF>X</INF>. 
DE3<INF>Y</INF> also owns other assets that do not constitute a 
foreign branch separate unit. DE1<INF>X</INF> owns FB<INF>X</INF>. 
Pursuant to Sec.  1.1503(d)-1(b)(4)(ii), P's indirect interests in 
DE1<INF>X</INF> and FB<INF>X</INF> are combined and treated as one 
Country X separate unit (Country X separate unit). DE3<INF>Y</INF> 
sells its interest in DE1<INF>X</INF> at the end of year 1 to an 
unrelated foreign person for cash. The sale results in an ordinary 
loss of $30x. Items of income, gain, deduction, and loss derived 
from the assets that gave rise to the $30x loss would be 
attributable to the Country X separate unit under Sec.  1.1503(d)-
5(c) through (e). Without regard to the sale of DE1<INF>X</INF>, no 
items of income, gain, deduction, and loss are attributable to P's 
Country X separate unit in year 1.
    (ii) Result. Pursuant to Sec.  1.1503(d)-5(c)(4)(iii)(A), the 
$30x ordinary loss recognized on the sale is attributable to the 
Country X separate unit, and not P's interest in DE3<INF>Y</INF>. 
This is the case because the Country X separate unit is treated as 
owning the assets that gave rise to the loss under Sec.  1.1503(d)-
5(f). Thus, the loss attributable to the sale creates a year 1 dual 
consolidated loss attributable to the Country X separate unit. In 
addition, pursuant to Sec.  1.1503(d)-6(d)(2), P cannot make a 
domestic use election with respect to the dual consolidated loss 
because the sale of the interest in DE1<INF>X</INF> is a triggering 
event described in Sec.  1.1503(d)-6(e)(1)(iv) and (v). Further, 
although the year 1 dual consolidated loss would otherwise be 
subject to the domestic use limitation rule of Sec.  1.1503(d)-4(b), 
it is eliminated pursuant to Sec.  1.1503(d)-4(d)(1)(ii). Finally, 
if there were a dual consolidated loss attributable to P's interest 
in DE3<INF>Y</INF>, the sale of the interest in DE1<INF>X</INF> 
would not be taken into account for purposes of determining whether 
there is an asset triggering event with respect to such dual 
consolidated loss under Sec.  1.1503(d)-6(e)(1)(iv).
    Example 28. Gain on sale of tiered separate units. (i) Facts. P 
owns 75 percent of HPS<INF>X</INF>, a Country X entity subject to 
Country X tax on its worldwide income. FS<INF>X</INF> owns the 
remaining 25 percent of HPS<INF>X</INF>. HPS<INF>X</INF> is 
classified as a partnership for Federal tax purposes. 
HPS<INF>X</INF> carries on operations in Country Y that, if carried 
on by a U.S. person, would constitute a foreign branch within the 
meaning of Sec.  1.367(a)-6T(g)(1). HPS<INF>X</INF> also owns assets 
that do not constitute a part of its Country Y operations and would 
not themselves constitute a foreign branch within the meaning of 
Sec.  1.367(a)-6T(g)(1) if owned by a U.S. person. Neither 
HPS<INF>X</INF> nor the Country Y operations has liabilities. P's 
indirect interest in the Country Y operations carried on by 
HPS<INF>X</INF>, and P's interest in HPS<INF>X</INF>, are each 
separate units. P sells its interest in HPS<INF>X</INF> and 
recognizes a gain of $150x on such sale. Immediately prior to P's 
sale of its interest in HPS<INF>X</INF>, P's portion of the assets 
of the Country Y operations (that is, assets the income, gain, 
deduction and loss from which would be attributable to P's Country Y 
foreign branch separate unit) had a built-in gain of $200x, and P's 
portion of HPS<INF>X</INF>'s other assets (that is, assets the 
income, gain, deduction and loss from which would be attributable to 
P's interest in HPS<INF>X</INF>) had a built-in gain of $100x.
    (ii) Result. Pursuant to Sec.  1.1503(d)-5(c)(4)(iii)(B), $100x 
of the total $150x of gain recognized ($200x/$300x x $150x) is 
attributable to P's indirect interest in its share of the Country Y 
operations carried on by HPS<INF>X</INF>. Similarly, $50x of such 
gain ($100x/$300x x $150x) is attributable to P's interest in 
HPS<INF>X</INF>.
    Example 29. Effect on domestic affiliate. (i) Facts. (A) P owns 
DE1<INF>X</INF> which, in turn, owns FB<INF>X</INF>. P's interest in 
DE1<INF>X</INF> and its indirect interest in FB<INF>X</INF> are 
combined and treated as a single separate unit (Country X separate 
unit) pursuant to Sec.  1.1503(d)-1(b)(4)(ii). In years 1 and 2, the 
items of income, gain, deduction, and loss that are attributable to 
P's Country X separate unit pursuant to Sec.  1.1503(d)-5 are as 
follows:

------------------------------------------------------------------------
                         Item                            Year 1   Year 2
------------------------------------------------------------------------
Sales income..........................................    $100x    $160x
Salary expense........................................   ($75x)   ($75x)
Research and experimental expense.....................   ($50x)   ($50x)
Interest expense......................................   ($25x)   ($25x)
                                                       -----------------
Income/(dual consolidated loss).......................   ($50x)     $10x
------------------------------------------------------------------------

    (B) P does not make a domestic use election with respect to the 
year 1 dual consolidated loss attributable to its Country X separate 
unit. Pursuant to Sec.  1.1503(d)-4(b) and (c)(2), the year 1 dual 
consolidated loss

[[Page 12942]]

of $50x is treated as a loss incurred by a separate domestic 
corporation and is subject to the limitations under Sec.  1.1503(d)-
4(c)(3). The P consolidated group has $100x of consolidated taxable 
income in year 2.
    (ii) Result. (A) P must compute its taxable income for year 1 
without taking into account the $50x dual consolidated loss, 
pursuant to Sec.  1.1503(d)-4(c)(2). Such amount consists of a pro 
rata portion of the expenses that were taken into account in 
calculating the year 1 dual consolidated loss. Thus, the items of 
the dual consolidated loss that are not taken into account by P in 
computing its taxable income are as follows: $25x of salary expense 
($75x/$150x x $50x); $16.67x of research and experimental expense 
($50x/$150x x $50x); and $8.33x of interest expense ($25x/$150x x 
$50x). The remaining amounts of each of these items, together with 
the $100x of sales income, are taken into account by P in computing 
its taxable income for year 1 as follows: $50x of salary expense 
($75x - $25x); $33.33x of research and experimental expense ($50x - 
$16.67x); and $16.67x of interest expense ($25x - $8.33x).
    (B) Subject to the limitations provided under Sec.  1.1503(d)-
4(c), the year 1 $50x dual consolidated loss is carried forward and 
is available to offset the $10x of income attributable to the 
Country X separate unit in year 2. Pursuant to Sec.  1.1503(d)-
4(c)(4), a pro rata portion of each item of deduction or loss 
included in such dual consolidated loss is considered to be used to 
offset the $10x of income, as follows: $5x of salary expense ($25x/
$50x x $10x); $3.33x of research and experimental expense ($16.67x/
$50x x $10x); and $1.67x of interest expense ($8.33x/$50x x $10x). 
The remaining amount of each item shall continue to be subject to 
the limitations under Sec.  1.1503(d)-4(c).
    Example 30. Exception to domestic use limitation--no possibility 
of foreign use because items are not deducted or capitalized under 
foreign law. (i) Facts. P owns DE1<INF>X</INF> which, in turn, owns 
FS<INF>X</INF>. In year 1, the sole item of income, gain, deduction, 
and loss attributable to P's interest in DE1<INF>X</INF>, as 
provided under Sec.  1.1503(d)-5, is $100x of interest expense paid 
on a loan to an unrelated lender. For Country X tax purposes, the 
$100x interest expense attributable to P's interest in 
DE1<INF>X</INF> in year 1 is treated as a repayment of principal and 
therefore cannot be deducted (at any time) or capitalized.
    (ii) Result. The $100x of interest expense attributable to P's 
interest in DE1<INF>X</INF> constitutes a dual consolidated loss. 
However, because the sole item constituting the dual consolidated 
loss cannot be deducted or capitalized (at any time) for Country X 
tax purposes, P can demonstrate that there can be no foreign use of 
the dual consolidated loss at any time. As a result, pursuant to 
Sec.  1.1503(d)-6(c)(1), if P prepares a statement described in 
Sec.  1.1503(d)-6(c)(2) and attaches it to its timely filed tax 
return, the year 1 dual consolidated loss attributable to P's 
interest in DE1<INF>X</INF> will not be subject to the domestic use 
limitation rule of Sec.  1.1503(d)-4(b).
    Example 31. No exception to domestic use limitation--inability 
to demonstrate no possibility of foreign use. (i) Facts. P owns 
DE1<INF>X</INF> which, in turn, owns FB<INF>X</INF>. P's interest in 
DE1<INF>X</INF> and its indirect interest in FB<INF>X</INF> are 
combined and treated as a single separate unit (Country X separate 
unit) pursuant to Sec.  1.1503(d)-1(b)(4)(ii). In year 1, the sole 
items of income, gain, deduction, and loss attributable to P's 
Country X separate unit, as provided under Sec.  1.1503(d)-5, are 
$75x of sales income and $100x of depreciation expense. For Country 
X tax purposes, DE1<INF>X</INF> also generates $75x of sales income 
in year 1, but the $100x of depreciation expense is not deductible 
until year 2.
    (ii) Result. The year 1 $25x net loss attributable to P's 
interest in the Country X separate unit constitutes a dual 
consolidated loss. In addition, even though DE1<INF>X</INF> has 
positive income in year 1 for Country X tax purposes, P cannot 
demonstrate that there is no possibility of foreign use with respect 
to the Country X separate unit's dual consolidated loss as provided 
under Sec.  1.1503(d)-6(c)(1)(i). P cannot make such a demonstration 
because the depreciation expense, an item composing the year 1 dual 
consolidated loss, is deductible (in a later year) for Country X tax 
purposes and, therefore, may be available to offset or reduce income 
for Country X purposes that would constitute a foreign use. For 
example, if DE1<INF>X</INF> elected to be classified as a 
corporation pursuant to Sec.  301.7701-3(c) of this chapter 
effective as of the end of year 1, and the deferred depreciation 
expense were available for Country X tax purposes to offset year 2 
income of DE1<INF>X</INF>, an entity treated as a foreign 
corporation in year 2 for U.S. tax purposes, there would be a 
foreign use.
    (iii) Alternative facts. (A) The facts are the same as in 
paragraph (i) of this Example 31, except as follows. In year 1, the 
sole items of income, gain, deduction, and loss attributable to P's 
Country X separate unit, as provided in Sec.  1.1503(d)-5, are $75x 
of sales income, $100x of interest expense, and $25x of depreciation 
expense. For Country X tax purposes, DE1<INF>X</INF> generates $75x 
of sales income in year 1; the $100x interest expense is treated as 
a repayment of principal and therefore cannot be deducted or 
capitalized (at any time); and the $25x of depreciation expense is 
not deductible in year 1, but is deductible in year 2.
    (B) In year 1, the $50x net loss attributable to P's Country X 
separate unit constitutes a dual consolidated loss. Even though the 
$100x interest expense, a nondeductible and noncapital item for 
Country X tax purposes, exceeds the $50x year 1 dual consolidated 
loss attributable to P's Country X separate unit, P cannot 
demonstrate that there is no possibility of foreign use of the dual 
consolidated loss as provided under Sec.  1.1503(d)-6(c)(1)(i). P 
cannot make such a demonstration because the $25x depreciation 
expense, an item of deduction or loss composing the year 1 dual 
consolidated loss, is deductible under Country X law (in year 2) 
and, therefore, may be available to offset or reduce income for 
Country X tax purposes that would constitute a foreign use.
    Example 32. Triggering event rebuttal--expiration of losses in 
foreign country. (i) Facts. P owns DRC<INF>X</INF>, a member of the 
P consolidated group. In year 1, DRC<INF>X</INF> incurs a dual 
consolidated loss of $100x. P makes a domestic use election with 
respect to DRC<INF>X</INF>'s year 1 dual consolidated loss and such 
loss therefore is included in the computation of the P group's 
consolidated taxable income. DRC<INF>X</INF> has no income or loss 
in year 2 through year 5. In year 5, P sells the stock of 
DRC<INF>X</INF> to FS<INF>X</INF>. At the time of the sale of the 
stock of DRC<INF>X</INF>, all of the losses and deductions that were 
included in the computation of the year 1 dual consolidated loss of 
DRC<INF>X</INF> had expired for Country X tax purposes because the 
laws of Country X only provide for a three-year carryover period for 
such items.
    (ii) Result. The sale of DRC<INF>X</INF> to FS<INF>X</INF> 
generally would be a triggering event under Sec.  1.1503(d)-
6(e)(1)(ii), which would require DRC<INF>X</INF> to recapture the 
year 1 dual consolidated loss (and pay an applicable interest 
charge) on the P consolidated group's tax return for the year that 
includes the date on which DRC<INF>X</INF> ceases to be a member of 
the P consolidated group. However, upon adequate documentation that 
the losses and deductions have expired for Country X tax purposes, P 
can rebut the presumption that a triggering event has occurred 
pursuant to Sec.  1.1503(d)-6(e)(2)(i). If the triggering event 
presumption is rebutted, the domestic use agreement filed by the P 
consolidated group with respect to the year 1 dual consolidated loss 
of DRC<INF>X</INF> is terminated and has no further effect pursuant 
to Sec.  1.1503(d)-6(j)(1)(i). If the presumptive triggering event 
is not rebutted, the domestic use agreement would terminate and have 
no further effect pursuant to Sec.  1.1503(d)-6(j)(1)(iii) because 
the dual consolidated loss would be recaptured.
    Example 33. Triggering events and rebuttals--tax basis carryover 
transaction. (i) Facts. (A) P owns DE1<INF>X</INF>. 
DE1<INF>X</INF>'s sole asset is A, which it acquired at the 
beginning of year 1 for $100x. DE1<INF>X</INF> does not have any 
liabilities. For U.S. tax purposes, DE1<INF>X</INF>'s tax basis in A 
at the beginning of year 1 is $100x and DE1<INF>X</INF>'s sole item 
of income, gain, deduction, and loss for year 1 is a $20x 
depreciation deduction attributable to A. As a result, the $20x 
depreciation deduction constitutes a dual consolidated loss 
attributable to P's interest in DE1<INF>X</INF>. P makes a domestic 
use election with respect to the year 1 dual consolidated loss.
    (B) For Country X tax purposes, DE1<INF>X</INF> has a $100x tax 
basis in A at the beginning of year 1, but A is not a depreciable 
asset. As a result, DE1<INF>X</INF> does not have any items of 
income, gain, deduction, and loss in year 1 for Country X tax 
purposes.
    (C) During year 2, P sells its interest in DE1<INF>X</INF> to 
FS<INF>X</INF> for $80x. P's disposition of its interest in 
DE1<INF>X</INF> constitutes a presumptive triggering event under 
Sec.  1.1503(d)-6(e)(1)(iv) and (v) requiring the recapture of the 
year 1 $20x dual consolidated loss (plus the applicable interest 
charge). For Country X tax purposes, DE1<INF>X</INF> retains its tax 
basis of $100x in A following the sale.
    (ii) Result. The year 1 dual consolidated loss is a result of 
the $20x depreciation deduction attributable to A. Although no item 
of deduction or loss was recognized by DE1<INF>X</INF> at the time 
of the sale for Country X tax purposes, the deduction composing the 
dual consolidated loss was retained by DE1<INF>X</INF> after the 
sale in the form of tax basis in A. As a result, a portion of the 
dual consolidated

[[Page 12943]]

loss may be available to offset income for Country X tax purposes in 
a manner that would constitute a foreign use. For example, if 
DE1<INF>X</INF> were to dispose of A, the amount of gain recognized 
by DE1<INF>X</INF> would be reduced (or an amount of loss recognized 
by DE1<INF>X</INF> would be increased) and, therefore, an item 
composing the dual consolidated loss would be available, under U.S. 
tax principles, to reduce income of a foreign corporation (and an 
owner of an interest in a hybrid entity that is not a separate 
unit). Thus, P cannot demonstrate pursuant to Sec.  1.1503(d)-
6(e)(2)(i) that there can be no foreign use of the year 1 dual 
consolidated loss following the triggering event, and must recapture 
the year 1 dual consolidated loss. Pursuant to Sec.  1.1503(d)-
6(j)(1)(iii), the domestic use agreement filed by the P consolidated 
group with respect to the year 1 dual consolidated loss is 
terminated and has no further effect.
    (iii) Alternative facts. The facts are the same as paragraph (i) 
of this Example 33, except that instead of P selling its interest in 
DE1<INF>X</INF> to FS<INF>X</INF>, DE1<INF>X</INF> sells asset A to 
FS<INF>X</INF> for $80x and, for Country X tax purposes, 
FS<INF>X</INF>'s tax basis in A immediately after the sale is $80x. 
P's disposition of Asset A constitutes a presumptive triggering 
event under Sec.  1.1503(d)-6(e)(1)(iv) requiring the recapture of 
the year 1 $20x dual consolidated loss (plus the applicable interest 
charge). For Country X tax purposes, FS<INF>X</INF>'s tax basis in A 
was not determined, in whole or in part, by reference to the basis 
of A in the hands of DE1<INF>X</INF>. As a result, the deduction 
composing the dual consolidated loss will not give rise to an item 
of deduction or loss in the form of tax basis for Country X tax 
purposes (for example, when FS<INF>X</INF> disposes of A). 
Therefore, P may be able to demonstrate (for example, by obtaining 
the opinion of a Country X tax advisor) pursuant to Sec.  1.1503(d)-
6(e)(2)(i) that there can be no foreign use of the year 1 dual 
consolidated loss and, thus, would not be required to recapture the 
year 1 dual consolidated loss.
    Example 34. Triggering event resulting in a single consolidated 
group where acquirer files a new domestic use agreement. (i) Facts. 
P owns DRC<INF>X</INF>, a member of the P consolidated group. In 
year 1, DRC<INF>X</INF> incurs a dual consolidated loss and P makes 
a domestic use election with respect to such loss. No member of the 
P consolidated group incurs a dual consolidated loss in year 2. At 
the end of year 2, T, the parent of the T consolidated group, 
acquires all the stock of P, and all the members of the P group, 
including DRC<INF>X</INF>, become members of a consolidated group of 
which T is the common parent.
    (ii) Result. (A) Under Sec.  1.1503(d)-6(f)(2)(ii)(B), the 
acquisition by T of the P consolidated group is not an event 
described in Sec.  1.1503(d)-6(e)(1)(ii) requiring the recapture of 
the year 1 dual consolidated loss of DRC<INF>X</INF> (and the 
payment of an interest charge), provided that the T consolidated 
group files a new domestic use agreement described in Sec.  
1.1503(d)-6(f)(2)(iii)(A). If a new domestic use agreement is filed, 
then pursuant to Sec.  1.1503(d)-6(j)(1)(ii), the domestic use 
agreement filed by the P consolidated group with respect to the year 
1 dual consolidated loss of DRC<INF>X</INF> is terminated and has no 
further effect.
    (B) Assume that T files a new domestic use agreement and a 
triggering event occurs at the end of year 3. As a result, the T 
consolidated group must recapture the dual consolidated loss that 
DRC<INF>X</INF> incurred in year 1 (and pay an interest charge), as 
provided in Sec.  1.1503(d)-6(h). Each member of the T consolidated 
group, including DRC<INF>X</INF> and any former members of the P 
consolidated group, is severally liable for the additional tax (and 
the interest charge) due upon the recapture of the dual consolidated 
loss of DRC<INF>X</INF>. In addition, pursuant to Sec.  1.1503(d)-
6(j)(1)(iii), the new domestic use agreement filed by the T group 
with respect to the year 1 dual consolidated loss of DRC<INF>X</INF> 
is terminated and has no further effect.
    Example 35. Triggering event exceptions for certain deemed 
transfers. (i) Facts. P owns DE1<INF>X</INF>. In year 1, there is a 
$100x dual consolidated loss attributable to P's interest in 
DE1<INF>X</INF>. P files a domestic use agreement under Sec.  
1.1503(d)-6(d) with respect to such loss. During year 2, P sells 33 
percent of its interest in DE1<INF>X</INF> to T, an unrelated 
domestic corporation.
    (ii) Result. Pursuant to Rev. Rul. 99-5, the transaction is 
treated as if P sold 33 percent of its interest in each of 
DE1<INF>X</INF>'s assets to T and then immediately thereafter P and 
T transferred their interests in the assets of DE1<INF>X</INF> to a 
partnership in exchange for an ownership interest therein. Upon the 
transfer of 33 percent of P's interest to T, a domestic corporation, 
no foreign use occurs and, therefore, there is no foreign use 
triggering event. However, P's deemed transfer of 67 percent of its 
interest in the assets of DE1<INF>X</INF> to a partnership is 
nominally a triggering event under Sec.  1.1503(d)-6(e)(1)(iv). 
Because the initial transfer of 33 percent of DE1<INF>X</INF>'s 
interest was to a domestic corporation and there is only a 
triggering event because of the deemed transfer under Rev. Rul. 99-
5, the deemed asset transfer is not treated as resulting in a 
triggering event pursuant to Sec.  1.1503(d)-6(f)(4).
    (iii) Alternative facts. The facts are the same as in paragraph 
(i) of this Example 35, except that P sells 60 percent (rather than 
33 percent) of its interest in DE1<INF>X</INF> to T. The sale is a 
triggering event under Sec.  1.1503(d)-6(e)(1)(iv) and (v) without 
regard to the occurrence of a deemed transaction. Therefore, Sec.  
1.1503(d)-6(f)(4) does not apply.
    Example 36. Triggering event exception involving multiple 
parties. (i) Facts. P owns DE1<INF>X</INF> which, in turn, owns 
FB<INF>X</INF>. P's interest in DE1<INF>X</INF> and its indirect 
interest in FB<INF>X</INF> are combined and treated as a single 
separate unit (Country X separate unit) pursuant to Sec.  1.1503(d)-
1(b)(4)(ii). In year 1, there is a $100x dual consolidated loss 
attributable to P's Country X separate unit and P makes a domestic 
use election with respect to such loss. No member of the P 
consolidated group incurs a dual consolidated loss in year 2. At the 
end of year 2, T, the parent of the T consolidated group, acquires 
all of P's interest in DE1<INF>X</INF> for cash.
    (ii) Result. (A) Under Sec.  1.1503(d)-6(f)(2)(i)(B), the 
acquisition by T of the interest in DE1<INF>X</INF> is not an event 
described in Sec.  1.1503(d)-6(e)(1)(iv) or (v) requiring the 
recapture of the year 1 dual consolidated loss attributable to the 
Country X separate unit (and the payment of an interest charge), 
provided: (1) the T consolidated group files a new domestic use 
agreement described in Sec.  1.1503(d)-6(f)(2)(iii)(A) with respect 
to the year 1 dual consolidated loss of the Country X separate unit; 
and (2) the P consolidated group files a statement described in 
Sec.  1.1503(d)-6(f)(2)(iii)(B) with respect to the year 1 dual 
consolidated loss. If these requirements are satisfied, then 
pursuant to Sec.  1.1503(d)-6(j)(1)(ii) the domestic use agreement 
filed by the P consolidated group with respect to the year 1 dual 
consolidated loss is terminated and has no further effect (if these 
requirements are not satisfied such that the P consolidated group 
recaptures the dual consolidated loss, the domestic use agreement 
would terminate pursuant to Sec.  1.1503(d)-6(j)(1)(iii)).
    (B) Assume a triggering event occurs at the end of year 3 that 
requires recapture by the T consolidated group of the year 1 dual 
consolidated loss, as well as the payment of an interest charge, as 
provided in Sec.  1.1503(d)-6(h). T continues to own the Country X 
separate unit after the triggering event. In that case, each member 
of the T consolidated group is severally liable for the additional 
tax (and the interest charge) due upon the recapture of the year 1 
dual consolidated loss. The T consolidated group must prepare a 
statement that computes the recapture tax amount as provided under 
Sec.  1.1503(d)-6(h)(3)(iii). Pursuant to Sec.  1.1503(d)-
6(h)(3)(iv)(A), the recapture tax amount is assessed as an income 
tax liability of the T consolidated group and is considered as 
having been properly assessed as an income tax liability of the P 
consolidated group. If the T consolidated group does not pay in full 
the income tax liability attributable to the recapture tax amount, 
the unpaid balance of such recapture tax amount may be collected 
from the P consolidated group in accordance with the provisions of 
Sec.  1.1503(d)-6(h)(3)(iv)(B). Pursuant to Sec.  1.1503(d)-
6(j)(1)(iii), the new domestic use agreement filed by the T 
consolidated group is terminated and has no further effect. Finally, 
pursuant to Sec.  1.1503(d)-6(h)(6)(iii), T is treated as if it 
incurred the dual consolidated loss that is recaptured for purposes 
of applying Sec.  1.1503(d)-6(h)(6)(i). Thus, T has a reconstituted 
net operating loss equal to the amount of the year 1 dual 
consolidated loss that was recaptured, and such loss is attributable 
to the Country X separate unit (and subject to the rules and 
limitations under Sec.  1.1503(d)-6(h)(6)(i)). Because T is treated 
as if it incurred the year 1 dual consolidated loss, P shall not be 
treated as having a net operating loss under Sec.  1.1503(d)-
6(h)(6)(i).
    Example 37. No foreign use following multiple-party event 
exception to triggering event. (i) Facts. P owns DE1<INF>X</INF> 
which, in turn, owns FB<INF>X</INF>. P's interest in DE1<INF>X</INF> 
and its indirect interest in FB<INF>X</INF> are combined and treated 
as a single separate unit (Country X separate unit) pursuant to 
Sec.  1.1503(d)-1(b)(4)(ii). In year 1, there is a $100x dual 
consolidated loss attributable to P's Country X separate unit and P 
makes a domestic use election with respect to such loss. T, a 
domestic corporation unrelated to P, owns 95

[[Page 12944]]

percent of PRS, a partnership. FS<INF>X</INF> owns the remaining 5 
percent of PRS. At the beginning of year 3, PRS purchases 100 
percent of the interest in DE1<INF>X</INF> from P for cash. For 
Country X tax purposes, the $100x loss incurred by DE1<INF>X</INF> 
in year 1 carries forward and is available to offset income of 
DE1<INF>X</INF> in subsequent years.
    (ii) Result. P's sale of its interest in DE1<INF>X</INF> is a 
triggering event under Sec.  1.1503(d)-6(e)(1)(iv) and (v). However, 
if P and T comply with the requirements under Sec.  1.1503(d)-
6(f)(2)(iii), the sale would qualify for the multiple-party event 
exception under Sec.  1.1503(d)-6(f)(2)(i). In addition, because the 
$100x loss of DE1<INF>X</INF> carries forward to subsequent years 
for Country X purposes and is available to offset income of 
DE1<INF>X</INF>, there would be a foreign use of the dual 
consolidated loss immediately after the sale pursuant to Sec.  
1.1503(d)-3(a)(1). This is the case because the dual consolidated 
loss would be available to offset or reduce income that is 
considered, under U.S. tax principles, to be an item of 
FS<INF>X</INF>, a foreign corporation (it would also be a foreign 
use because FS<INF>X</INF> is an indirect owner of an interest in a 
hybrid entity that is not a separate unit). However, there is no 
foreign use in this case as a result of FS<INF>X</INF>'s 5 percent 
interest in DE1<INF>X</INF> pursuant to Sec.  1.1503(d)-3(c)(8).
    Example 38. Character and source of recapture income. (i) Facts. 
(A) P owns FB<INF>X</INF>. In year 1, the items of income, gain, 
deduction, and loss that are attributable to FB<INF>X</INF> for 
purposes of determining whether it has a dual consolidated loss are 
as follows:

Sales income...................................................    $100x
Salary expense.................................................   ($75x)
Interest expense...............................................   ($50x)
                                                                --------
Dual consolidated loss.........................................   ($25x)
 

    (B) P makes a domestic use election with respect to the year 1 
dual consolidated loss attributable to FB<INF>X</INF> and, thus, the 
$25x dual consolidated loss is used to offset the P group's 
consolidated taxable income.
    (C) Pursuant to Sec.  1.861-8, the $75x of salary expense 
incurred by FB<INF>X</INF> is allocated and apportioned entirely to 
foreign source general limitation income. Pursuant to Sec.  1.861-
9T, $25x of the $50x interest expense attributable to FB<INF>X</INF> 
is allocated and apportioned to domestic source income, $15x of such 
interest expense is allocated and apportioned to foreign source 
general limitation income, and the remaining $10x of such interest 
expense is allocated and apportioned to foreign source passive 
income.
    (D) During year 2, $5x of income is attributable to 
FB<INF>X</INF> under the rules of Sec.  1.1503(d)-5, and the P 
consolidated group has $100x of consolidated taxable income. At the 
end of year 2, FB<INF>X</INF> undergoes a triggering event described 
in Sec.  1.1503(d)-6(e)(1), and P continues to own FB<INF>X</INF> 
following the triggering event. Pursuant to Sec.  1.1503(d)-
6(h)(2)(i), P is able to demonstrate to the satisfaction of the 
Commissioner that the $25x dual consolidated loss attributable to 
FB<INF>X</INF> in year 1 would have offset the $5x of income 
attributable to FB<INF>X</INF> in year 2, if no domestic use 
election were made with respect to the year 1 loss such that it was 
subject to the limitations of Sec.  1.1503(d)-4(b) and (c).
    (ii) Result. P must recapture and report as ordinary income $20x 
($25x - $5x) of FB<INF>X</INF>'s year 1 dual consolidated loss, plus 
applicable interest. The $20x recapture income is attributable to 
FB<INF>X</INF> pursuant to Sec.  1.1503(d)-5(c)(4)(vi). Pursuant to 
Sec.  1.1503(d)-6(h)(5), the recapture income is treated as ordinary 
income whose source and character (including section 904 separate 
limitation character) is determined by reference to the manner in 
which the recaptured items of expense or loss taken into account in 
calculating the dual consolidated loss were allocated and 
apportioned. Further, pursuant to Sec.  1.1503(d)-6(h)(5), the pro 
rata computation described in Sec.  1.1503(d)-4(c)(4) shall apply. 
Thus, the character and source of the recapture income is determined 
in the same proportion as each item of deduction or loss that 
contributed to the dual consolidated loss being recaptured. 
Accordingly, P's $20x of recapture income is characterized and 
sourced as follows: $4x of domestic source income (($25x/$125x) x 
$20x); $14.4x of foreign source general limitation income (($75x + 
$15x)/$125x) x $20x); and $1.6x of foreign source passive income 
(($10x/$125x) x $20x). Pursuant to Sec.  1.1503(d)-6(h)(6)(i), 
commencing in year 3, the $20x recapture amount is reconstituted and 
treated as a net operating loss incurred by FB<INF>X</INF> in a 
separate return limitation year, subject to the limitation under 
Sec.  1.1503(d)-4(b) (and therefore subject to the restrictions of 
Sec.  1.1503(d)-4(c)). Pursuant to Sec.  1.1503(d)-6(j)(1)(iii), the 
domestic use agreement filed by the P consolidated group with 
respect to the year 1 dual consolidated loss of FB<INF>X</INF> is 
terminated and has no further effect.
    Example 39. Interest charge without recapture. (i) Facts. P owns 
DE1<INF>X</INF> which, in turn, owns FB<INF>X</INF>. P's interest in 
DE1<INF>X</INF> and its indirect interest in FB<INF>X</INF> are 
combined and treated as a single separate unit (Country X separate 
unit) pursuant to Sec.  1.1503(d)-1(b)(4)(ii). In year 1, a dual 
consolidated loss of $100x is attributable to P's Country X separate 
unit. P makes a domestic use election with respect to such loss and 
uses the loss to offset the P group's consolidated taxable income. 
In year 2, there is $100x of income attributable to P's Country X 
separate unit and the P consolidated group has $200x of consolidated 
taxable income. At the end of year 2, the Country X separate unit 
undergoes a triggering event within the meaning of Sec.  1.1503(d)-
6(e)(1). P demonstrates, to the satisfaction of the Commissioner, 
that if no domestic use election were made with respect to the year 
1 dual consolidated loss such that it was subject to the limitations 
of Sec.  1.1503(d)-4(b) and (c), the year 1 $100x dual consolidated 
loss would have been offset by the $100x of year 2 income.
    (ii) Result. There is no recapture of the year 1 dual 
consolidated loss attributable to P's Country X separate unit 
because it is reduced to zero under Sec.  1.1503(d)-6(h)(2)(i). 
However, P is liable for one year of interest charge under Sec.  
1.1503(d)-6(h)(1)(ii), even though P's recapture amount is zero. 
This is the case because the P consolidated group had the benefit of 
the dual consolidated loss in year 1, and the income that offset the 
recapture income was not recognized until year 2. Pursuant to Sec.  
1.1503(d)-6(j)(1)(iii), the domestic use agreement filed by the P 
consolidated group with respect to the year 1 dual consolidated loss 
is terminated and has no further effect.
    Example 40. Reduced recapture and interest charge, and 
reconstituted dual consolidated loss. (i) Facts. S owns 
DE1<INF>X</INF> which, in turn, owns FB<INF>X</INF>. S's interest in 
DE1<INF>X</INF> and its indirect interest in FB<INF>X</INF> are 
combined and treated as a single separate unit (Country X separate 
unit) pursuant to Sec.  1.1503(d)-1(b)(4)(ii). In year 1, there is a 
$100x dual consolidated loss attributable to S's Country X separate 
unit, and P earns $100x. P makes a domestic use election with 
respect to the Country X separate unit's year 1 dual consolidated 
loss. Therefore, the consolidated group is permitted to offset P's 
$100x of income with the Country X separate unit's $100x dual 
consolidated loss. In year 2, $30x of income is attributable to the 
Country X separate unit under the rules of Sec.  1.1503(d)-5 and 
such income is offset by a $30x net operating loss incurred by P in 
such year. In year 3, $25x of income is attributable to the Country 
X separate unit under the rules of Sec.  1.1503(d)-5, and P earns 
$15x of income. In addition, at the end of year 3 there is a foreign 
use of the year 1 dual consolidated loss that constitutes a 
triggering event. S continues to own the Country X separate unit 
after the triggering event.
    (ii) Result. (A) Under the presumptive rule of Sec.  1.1503(d)-
6(h)(1)(i), S must recapture $100x (plus applicable interest). 
However, under Sec.  1.1503(d)-6(h)(2)(i), S may be able to 
demonstrate that a lesser amount is subject to recapture. The lesser 
amount is the amount of the $100x dual consolidated loss that would 
have remained subject to Sec.  1.1503(d)-4(c) at the time of the 
foreign use triggering event if a domestic use election had not been 
made for such loss.
    (B) Although the combined separate unit earned $30x of income in 
year 2, there was no consolidated taxable income in such year. As a 
result, as of the end of year 2 the $100x dual consolidated loss 
would continue to be subject to Sec.  1.1503(d)-4(c) if a domestic 
use election had not been made for such loss. However, the $30x 
earned in year 2 can be carried forward to subsequent taxable years 
and may reduce the recapture income to the extent of consolidated 
taxable income generated in subsequent years. In year 3, $25x of 
income was attributable to the Country X separate unit and P earns 
$15x of income. Thus, the P consolidated group has $40x of 
consolidated taxable income in year 3. As a result, the $100x of 
recapture income can be reduced by $40x. This is the case because if 
a domestic use election had not been made for the $100x year 1 dual 
consolidated loss such that it was subject to the limitations of 
Sec.  1.1503(d)-4(b) and (c), only $60x of the loss would have 
remained subject to such limitations at the time of the foreign use 
triggering event. Accordingly, if S can adequately document the 
lesser amount, the amount of recapture income is $60x ($100x - 
$40x). The $60x recapture income is attributable to the Country X 
separate unit pursuant to Sec.  1.1503(d)-5(c)(4)(vi).
    (C) Pursuant to Sec.  1.1503(d)-6(h)(6)(i), commencing in year 
4, the $60x recapture

[[Page 12945]]

amount is reconstituted and treated as a net operating loss incurred 
by the Country X separate unit of S in a separate return limitation 
year, subject to the limitation under Sec.  1.1503(d)-4(b) (and 
therefore subject to the restrictions of Sec.  1.1503(d)-4(c)). The 
loss is only available for carryover to taxable years after year 3 
(and is not available for carryback). The carryover period of the 
loss, for purposes of section 172(b), will start from year 1, when 
the dual consolidated loss that was subject to recapture was 
incurred. In addition, such reconstituted net operating loss is not 
eligible for the exceptions contained in Sec.  1.1503(d)-6(b) 
through (d). Pursuant to Sec.  1.1503(d)-6(j)(1)(iii), the domestic 
use agreement filed by the P consolidated group with respect to the 
year 1 dual consolidated of the Country X separate unit is 
terminated and has no further effect.
    (iii) Alternative facts. The facts are the same as in paragraph 
(i) of this Example 40, except that the triggering event that occurs 
at the end of year 3 is a sale by S of its entire interest in 
DE1<INF>X</INF> to B, an unrelated domestic corporation. The sale 
does not qualify as a transaction described in section 381. The 
results are the same as in paragraph (ii) of this Example 40, except 
that pursuant to Sec.  1.1503(d)-6(h)(6)(ii) the $60x net operating 
loss is not reconstituted (with respect to either S or B). The loss 
is not reconstituted with respect to S because the Country X 
separate unit ceases to be a separate unit of S (or any other member 
of the consolidated group that includes S) and therefore would have 
been eliminated pursuant to Sec.  1.1503(d)-4(d)(1)(ii) if no 
domestic use election had been made with respect to such loss. The 
loss is not reconstituted with respect to B because B was not the 
domestic owner of the combined separate unit when the dual 
consolidated loss that is recaptured was incurred, and B did not 
acquire the Country X separate unit in a section 381 transaction.


Sec.  1.1503(d)-8  Effective dates.

    (a) General rule. Except as provided in paragraph (b) of this 
section, this paragraph (a) provides the dates of applicability of 
Sec. Sec.  1.1503(d)-1 through 1.1503(d)-7. Sections 1.1503(d)-1 
through 1.1503(d)-7 shall apply to dual consolidated losses incurred in 
taxable years beginning on or after April 18, 2007. However, a taxpayer 
may apply Sec. Sec.  1.1503(d)-1 through 1.1503(d)-7, in their 
entirety, to dual consolidated losses incurred in taxable years 
beginning on or after January 1, 2007, by filing its return and 
attaching to such return the domestic use agreements, certifications, 
or other information in accordance with these regulations. For purposes 
of this section, the term application date means either April 18, 2007, 
or, if the taxpayer applies these regulations pursuant to the preceding 
sentence, January 1, 2007. Section 1.1503-2 applies for dual 
consolidated losses incurred in taxable years beginning on or after 
October 1, 1992, and before the application date.
    (b) Special rules--(1) Reduction of term of agreements filed under 
Sec. Sec.  1.1503-2(g)(2)(i) or 1.1503-2T(g)(2)(i). If an agreement was 
filed (or subsequently treated as filed) under Sec. Sec.  1.1503-
2(g)(2)(i) or 1.1503-2T(g)(2)(i) and remains in effect (that is, the 
dual consolidated loss subject to the agreement has not been recaptured 
pursuant to Sec.  1.1503-2(g)(2)(vii)) as of the application date, such 
agreement will be considered by the Internal Revenue Service to apply 
only for any taxable year up to and including the fifth taxable year 
following the year in which the dual consolidated loss that is the 
subject of the agreement was incurred and thereafter will have no 
effect.
    (2) Reduction of term of closing agreements entered into pursuant 
to Sec.  1.1503-2(g)(2)(iv)(B)(3)(i). Taxpayers subject to the terms of 
a closing agreement entered into with the Internal Revenue Service 
pursuant to Sec.  1.1503-2(g)(2)(iv)(B)(3)(i) and Rev. Proc. 2000-42 
(2000-2 CB 394), see Sec.  601.601(d)(2)(ii)(b) of this chapter, will 
be deemed to have satisfied the closing agreement's fifteen-year 
certification period requirement if the five-year certification period 
specified in Sec.  1.1503(d)-1(b)(20) has elapsed, provided such 
closing agreement is still in effect as of the application date, and 
provided the dual consolidated losses have not been recaptured. For 
example, if a calendar year taxpayer that has a January 1, 2007, 
application date entered into a closing agreement with respect to a 
dual consolidated loss incurred in 2003 and, as of January 1, 2007, the 
closing agreement is still in effect and the dual consolidated loss 
subject to the closing agreement has not been recaptured, then the 
closing agreement's fifteen-year certification period will be deemed 
satisfied when the five-year certification period described in Sec.  
1.1503(d)-1(b)(20) has elapsed. Thus, the dual consolidated loss will 
be subject to the recapture and certification provisions of the closing 
agreement in such a case only through December 31, 2008. Alternatively, 
if a calendar year taxpayer that has a January 1, 2007, application 
date entered into a closing agreement with respect to a dual 
consolidated loss incurred in 2000 and, as of January 1, 2007, the 
closing agreement is still in effect and the dual consolidated loss 
subject to the closing agreement has not been recaptured, then the 
certification period is deemed to be satisfied.
    (3) Relief for untimely filings. Paragraphs (b)(3)(i) through (iii) 
of this section set forth the effective dates for rules that provide 
relief for the failure to make timely filings of an election, 
agreement, statement, rebuttal, computation, closing agreement, or 
other information, pursuant to section 1503(d) and these regulations.
    (i) General rule. Except as provided in paragraphs (b)(3)(ii) and 
(iii) of this section, the reasonable cause relief standard of Sec.  
1.1503(d)-1(c) applies for all untimely filings with respect to dual 
consolidated losses, including with respect to dual consolidated losses 
incurred in taxable years beginning before the application date.
    (ii) Closing agreements. Solely with respect to closing agreements 
described in Sec.  1.1503-2(g)(2)(iv)(B)(3)(i) and Rev. Proc. 2000-42, 
taxpayers must request relief for untimely requests through the process 
provided under Sec. Sec.  301.9100-1 through 301.9100-3 of this 
chapter. See paragraph (b)(4) of this section for rules that permit the 
multiple-party event exception, rather than closing agreements, for 
certain triggering events.
    (iii) Pending requests for relief. Taxpayers that have letter 
ruling requests under Sec. Sec.  301.9100-1 through 301.9100-3 of this 
chapter pending as of March 19, 2007 (other than requests under 
paragraph (b)(3)(ii) of this section) are not required to use the 
reasonable cause procedure under Sec.  1.1503(d)-1(c); however, if such 
taxpayers have not yet received a determination of their request, they 
may withdraw their request consistent with the procedures contained in 
Rev. Proc. 2007-1 (2007-1 IRB 1), see Sec.  601.601(d)(2)(ii)(b) of 
this chapter, (or any succeeding document) and use the reasonable cause 
procedure set forth in Sec.  1.1503(d)-1(c). In that event, the 
Internal Revenue Service will refund the taxpayer's user fee.
    (4) Multiple-party event exception to triggering events. This 
paragraph (b)(4) applies to events described in Sec.  1.1503-
2(g)(2)(iv)(B)(1)(i) through (iii) that occur after April 18, 2007 and 
that are with respect to dual consolidated losses that were incurred in 
taxable years beginning on or after October 1, 1992, and before the 
application date. The events described in the previous sentence are not 
eligible for the exception described in Sec.  1.1503-2(g)(2)(iv)(B)(1), 
but instead are eligible for the multiple-party event exception 
described in Sec.  1.1503(d)-6(f)(2)(i), as modified by this paragraph 
(b)(4). Thus, such events are not eligible for a closing agreement 
described in Sec.  1.1503-2(g)(2)(iv)(B)(3)(i) and Rev. Proc. 2000-42. 
For purposes of applying Sec.  1.1503(d)-6(f)(2)(i) to transactions 
covered by this paragraph, agreements described in Sec.  1.1503-
2(g)(2)(i) (rather than domestic use agreements) shall be

[[Page 12946]]

filed, and subsequent triggering events and exceptions thereto have the 
meaning provided in Sec.  1.1503-2(g)(2)(iii)(A) and (iv) (other than 
the exception provided under Sec.  1.1503-2(g)(2)(iv)(B)(1)). For 
example, if a calendar year taxpayer that has a January 1, 2007, 
application date filed an election under Sec.  1.1503-2(g)(2)(i) with 
respect to a dual consolidated loss that was incurred in 2004, and a 
triggering event described in Sec.  1.1503-2(g)(2)(iv)(B)(1)(ii) occurs 
with respect to such dual consolidated loss after April 18, 2007, then 
the event is eligible for the multiple-party event exception under 
Sec.  1.1503(d)-6(f)(2)(i) (and not the exception under Sec.  1.1503-
2(g)(2)(iv)(B)(1)). However, in order to comply with Sec.  1.1503(d)-
6(f)(2)(iii)(A), the subsequent elector must file a new agreement 
described in Sec.  1.1503-2(g)(2)(i) (rather than a new domestic use 
agreement). In addition, for purposes of determining whether there is a 
subsequent triggering event, and exceptions thereto, pursuant to such 
new agreement, Sec.  1.1503-2(g)(2)(iii)(A) and (iv) (other than the 
exception provided under Sec.  1.1503-2(g)(2)(iv)(B)(1)) shall apply. 
Notwithstanding the general application of this paragraph (b)(4) to 
events described in described in Sec.  1.1503-2(g)(2)(iv)(B)(1)(i) 
through (iii) that occur after April 18, 2007, a taxpayer may choose to 
apply this paragraph (b)(4) to events described in Sec.  1.1503-
2(g)(2)(iv)(B)(1)(i) through (iii) that occur after March 19, 2007 and 
on or before April 18, 2007.
    (5) Basis adjustment rules. Taxpayers may apply the basis 
adjustment rules of Sec.  1.1503(d)-5(g) for all open years in which 
such basis is relevant, even if the basis adjustment is attributable to 
a dual consolidated loss incurred (or recaptured) in a closed taxable 
year. Taxpayers applying the provisions of Sec.  1.1503(d)-5(g), 
however, must do so consistently for all open years.

PART 602--OMB CONTROL NUMBERS UNDER PAPERWORK REDUCTION ACT

0
Par. 5. The authority citation for part 602 continues to read as 
follows:

    Authority: 26 U.S.C. 7805.


0
Par. 6. In Sec.  602.101, paragraph (b) is amended by adding entries in 
numerical order to the table to read as follows:


Sec.  602.101  OMB control numbers.

* * * * *
    (b) * * *

------------------------------------------------------------------------
                                                             Current OMB
     CFR part or section where identified and described      control No.
------------------------------------------------------------------------
 
                                * * * * *
1.1503(d)-1................................................    1545-1946
1.1503(d)-3................................................    1545-1946
1.1503(d)-4................................................    1545-1646
1.1503(d)-5................................................    1545-1946
1.1503(d)-6................................................    1545-1946
 
                                * * * * *
------------------------------------------------------------------------


    Approved: February 27, 2007.
Kevin M. Brown,
Deputy Commissioner for Services and Enforcement.
 Eric Solomon,
Assistant Secretary of the Treasury (Tax Policy).
 [FR Doc. E7-4618 Filed 3-16-07; 8:45 am]
BILLING CODE 4830-01-P