69138 Federal Register / Vol. 65, No. 221 / Wednesday, November 15, 2000 / Proposed Rules

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG–116050–99]

RIN 1545–AX65

Stock Transfer Rules: Carryover of

Earnings and Taxes

AGENCY: Internal Revenue Service (IRS),

Treasury.

ACTION: Notice of proposed rulemaking

and notice of public hearing.

SUMMARY: This document contains

proposed regulations addressing

transactions described in section 367(b)

of the Internal Revenue Code (section

367(b) transactions). A section 367(b)

transaction includes a corporate

reorganization, liquidation, or division

involving one or more foreign

corporations. The proposed regulations

address the carryover of certain tax

attributes, such as earnings and profits

and foreign income tax accounts, when

two corporations combine in a section

367(b) transaction. The proposed

regulations also address the allocation

of certain tax attributes when a

corporation distributes stock of another

corporation in a section 367(b)

transaction. This document also

provides notice of a public hearing on

the proposed regulations.

DATES: Written or electronic comments

and requests to speak (with outlines of

oral comments) at a public hearing

scheduled for March 13, 2001 must be

received by February 20, 2001.

ADDRESSES: Send submissions to:

CC:M&SP:RU (REG–116050–99), room

5226, Internal Revenue Service, POB

7604, Ben Franklin Station, Washington,

DC 20044. Submissions may be hand

delivered Monday through Friday

between the hours of 8 a.m. and 5 p.m.

to: CC:M&SP:RU (REG–116050–99),

Courier’s Desk, Internal Revenue

Service, 1111 Constitution Avenue,

NW., Washington, DC. Alternatively,

taxpayers may submit comments

electronically via the Internet by

selecting the ‘‘Tax Regs’’ option on the

IRS Home Page, or by submitting

comments directly to the IRS Internet

site at http://www.irs.gov/tax_regs/

regslist.html. The public hearing will be

held in room 7218, Internal Revenue

Building, 1111 Constitution Avenue,

NW., Washington DC.

FOR FURTHER INFORMATION CONTACT:

Concerning the proposed regulations,

Anne O’Connell Devereaux, at (202)

622–3850; concerning submissions of

comments, the hearing, and/or to be

placed on the building access list to

attend the hearing, Guy Traynor, at

(202) 622–7180 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

The collection of information

contained in this notice of proposed

rulemaking has been submitted to the

Office of Management and Budget for

review in accordance with the

Paperwork Reduction Act of 1995 (44

U.S.C. 3507(d)). Comments on the

collection of information should be sent

to the Office of Management and

Budget, Attn: Desk Officer for the

Department of the Treasury, Office of

Information and Regulatory Affairs,

Washington, DC 20503, with copies to

the Internal Revenue Service, Attn: IRS

Reports Clearance Officer,

W:CAR:MP:FP:S:O, Washington, DC

20224. Comments on the collection of

information should be received by

January 16, 2001. Comments are

specifically requested concerning:

• Whether the proposed collection of

information is necessary for the proper

performance of the functions of the IRS,

including whether the information will

have practical utility;

• The accuracy of the estimated

burden associated with the proposed

collection of information (see below);

• How the quality, utility, and clarity

of the information to be collected may

be enhanced;

• How the burden of complying with

the proposed collection of information

may be minimized, including through

the application of automated collection

techniques or other forms of information

technology; and

• Estimates of capital or start-up costs

and costs of operation, maintenance,

and purchase of services to provide

information.

The collection of information in this

proposed regulation is in § 1.367(b)–1.

This collection of information is

required by the IRS to verify compliance

with the regulations under section

367(b) relating to exchanges described

therein. The likely respondents are

corporations that are affected by such

exchanges.

Estimated total annual reporting

burden: 1,800 hours.

The estimated annual burden per

respondent: 3 hours.

Estimated number of respondents:

600.

Estimated annual frequency of

responses: One.

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 assigned by the Office of

Management and Budget.

Books or records relating to a

collection of information must be

retained as long as their contents may

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

On December 27, 1977, the IRS and

Treasury issued proposed and

temporary regulations under section

367(b) of the Code. Subsequent

guidance updated and amended the

1977 temporary regulations several

times over the next 14 years. On August

26, 1991, the IRS and Treasury issued

proposed regulations §§ 1.367(b)–1

through 1.367(b)–6 (the 1991 proposed

regulations). Final regulations under

section 367(b) of the Internal Revenue

Code (Code) were issued in June 1998

and January 2000 and the 1977

temporary regulations and the 1991

proposed regulations were generally

removed. The preamble to the January

2000 final regulations refers to proposed

regulations that would be issued at a

later date to address the carryover of

certain corporate tax attributes in

transactions involving one or more

foreign corporations. Those proposed

regulations are set forth in this

document.

Overview

A. General Policies of Section 367(b)

In general, section 367 governs

corporate restructurings under sections

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

(Subchapter C nonrecognition

transactions) in which the status of a

foreign corporation as a ‘‘corporation’’ is

necessary for the application of the

relevant nonrecognition provisions.

Other provisions in Subchapter C

(Subchapter C carryover provisions)

apply to such transactions in

conjunction with the enumerated

provisions and detail additional

consequences that occur in connection

with the transactions. For example,

sections 362 and 381 govern the

carryover of basis and earnings and

profits from the transferor corporation to

the transferee corporation in applicable

transactions and section 312 governs the

allocation of earnings and profits from

a distributing corporation in a

transaction described in section 355.

The Subchapter C carryover

provisions generally have been drafted

to apply to domestic corporations and

U.S. shareholders, and thus do not fully

take into account the cross-border

Federal Register / Vol. 65, No. 221 / Wednesday, November 15, 2000 / Proposed Rules 69139

aspects of U.S. taxation. For example,

sections 381 and 312 do not take into

account source and foreign tax credit

issues that arise when earnings and

profits move from one corporation to

another.

Congress enacted section 367(b) to

ensure that international tax

considerations in the Code are

adequately addressed when the

Subchapter C provisions apply to an

exchange involving a foreign

corporation in order to prevent the

avoidance of U.S. taxation. Because

determining the proper interaction of

the Code’s international and Subchapter

C provisions is ‘‘necessarily highly

technical,’’ Congress granted the

Secretary broad regulatory authority to

provide the ‘‘necessary or appropriate’’

rules rather than enacting a complex

statutory regime. H.R. Rep. No. 658,

94th Cong., 1st Sess. 241 (1975). Thus,

section 367(b)(2) provides in part that

the regulations ‘‘shall include (but shall

not be limited to) regulations * * *

providing * * * the extent to which

adjustments shall be made to earnings

and profits, basis of stock or securities,

and basis of assets.’’

The proposed regulations provide

rules regarding the movement of certain

corporate tax attributes between

corporations in a Subchapter C

nonrecognition transaction involving

one or more foreign corporations.

Generally, the regulations continue to

apply the principles of the Subchapter

C carryover provisions with

modifications as necessary or

appropriate to preserve international tax

policies of the Code and to prevent

material distortions of income.

The remainder of this Overview

section is divided by specific categories

of section 367(b) transactions and

describes the relevant Subchapter C and

international policies and provisions.

The ‘‘Details of Provisions’’ portion of

this preamble describes the proposed

regulations’ principal operative rules

that implement the policies and

reconcile the provisions described in

the Overview portion of this preamble.

The IRS and Treasury welcome

comments regarding both the general

approach and the specific provisions of

the proposed regulations.

B. Specific Policies Related to Inbound

Nonrecognition Transactions (Prop. Reg.

§ 1.367(b)–3)

Proposed § 1.367(b)–3 addresses

acquisitions by a domestic corporation

(domestic acquiring corporation) of the

assets of a foreign corporation (foreign

acquired corporation) in a section 332

liquidation or an asset acquisition

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

C, D, or F reorganization (inbound

nonrecognition transaction).

The preamble to the January 2000

final regulations generally describes

international policy issues that can arise

in an inbound nonrecognition

transaction. The preamble states that the

‘‘principal policy consideration of

section 367(b) with respect to inbound

nonrecognition transactions is the

appropriate carryover of attributes from

foreign to domestic corporations. This

consideration has interrelated

shareholder-level and corporate-level

components.’’ The final regulations

address the carryover of certain

attributes, such as the carryover of

foreign taxes, earnings and profits, and

basis. However, the carryover of

earnings and profits and basis are

addressed only to the extent attributable

to earnings and profits accumulated

during a U.S. shareholder’s holding

period, i.e., ‘‘the all earnings and profits

amount,’’ as defined in § 1.367(b)–2(d).

The preamble to the final regulations

also notes that it would be consistent

with the policy considerations of

section 367(b) for future regulations to

provide further rules with respect to the

extent to which attributes carry over

from a foreign corporation to a U.S.

corporation. The proposed regulations

do not comprehensively address this

issue. Compare Modify Treatment of

Built-In Losses and Other Attribute

Trafficking, General Explanations of the

Administration’s Fiscal Year 2001

Revenue Proposals at 205. However, the

proposed regulations do provide

additional rules concerning several

attributes, specifically net operating loss

and capital loss carryovers, and earnings

and profits that are not included in

income as an all earnings and profits

amount (or a deficit in earnings and

profits). The proposed regulations

generally provide that these tax

attributes carry over from a foreign

acquired corporation to a domestic

acquiring corporation only to the extent

that they are effectively connected to a

U.S. trade or business (or attributable to

a permanent establishment, in the case

of an applicable U.S. income tax treaty).

C. Specific Policies Related to Foreign

381 Transactions (Prop. Reg. § 1.367(b)–

7)

Proposed regulation § 1.367(b)–7

applies to an acquisition by a foreign

corporation (foreign acquiring

corporation) of the assets of another

foreign corporation (foreign target

corporation) in a transaction described

in section 381 (foreign 381 transaction)

and addresses the manner in which

earnings and profits and foreign income

taxes of the foreign acquiring

corporation and foreign target

corporation carry over to the surviving

foreign corporation (foreign surviving

corporation). This would include, for

example, a C, D, or F reorganization or

a section 332 liquidation between two

foreign corporations.

The international provisions of the

Code distinguish between categories of

foreign corporations. A foreign

acquiring, target, or surviving

corporation can be a controlled foreign

corporation as defined in section 957

(CFC), a noncontrolled section 902

corporation as defined in section

904(d)(2)(E) after 2003, the effective date

of section 1105(b) of Public Law 105–34

(111 Stat. 788) (the 1997 Act) (lookthrough 10/50 corporation and, together

with CFCs, look-through corporations),

a noncontrolled section 902 corporation

before 2003 (non-look-through 10/50

corporation and, together with lookthrough 10/50 corporations, 10/50

corporations), or a foreign corporation

that is neither a CFC nor a 10/50

corporation (less-than-10%-U.S.-owned

foreign corporation).

The principal Code sections

implicated by the carryover of earnings

and profits and foreign income taxes in

a foreign 381 transaction are sections

381, 902, 904, and 959. Section 381

generally permits earnings and profits

(or deficit in earnings and profits) to

carry over to a surviving corporation,

thus enabling ‘‘the successor

corporation to step into the ’tax shoes’

of its predecessor. * * * [and]

represents the economic integration of

two or more separate businesses into a

unified business enterprise.’’ H. Rep.

No. 1337, 83rd Cong., 2nd Sess. 41

(1954). However, a deficit in earnings

and profits of either the transferee or

transferor corporation can only be used

to offset earnings and profits

accumulated after the date of transfer

(hovering deficit rule). Section

381(c)(2)(B). The hovering deficit rule is

a legislative mechanism designed to

deter the trafficking in favorable tax

attributes that the IRS and courts had

repeatedly encountered. See, e.g.,

Commissioner v. Phipps, 336 U.S. 410

(1949). The proposed regulations adopt

the principles of section 381 but adapt

its operation in consideration of the

international provisions that address

foreign corporations’ earnings and

profits and their related foreign income

taxes, such as sections 902, 904, and

959.

Section 902 generally provides that a

deemed paid foreign tax credit is

available to a domestic corporation that

receives a dividend from a foreign

corporation in which it owns 10 percent

or more of the voting stock (i.e., a lookVerDate 11<MAY>2000 23:12 Nov 14, 2000 Jkt 194001 PO 00000 Frm 00003 Fmt 4701 Sfmt 4702 E:\FR\FM\15NOP2.SGM pfrm08 PsN: 15NOP2
69140 Federal Register / Vol. 65, No. 221 / Wednesday, November 15, 2000 / Proposed Rules

through corporation or non-lookthrough 10/50 corporation). The Code

modifies the general last-in, first-out

(LIFO) rule of section 316 and provides

that look-through corporations and nonlook-through 10/50 corporations pay

dividends out of multi-year pools of

earnings and profits and foreign income

taxes for earnings and profits

accumulated (and related foreign

income taxes paid or deemed paid) in

taxable years beginning after December

31, 1986, or the first day after which a

domestic corporation owns 10 percent

or more of the voting stock of a foreign

corporation, whichever is later. Section

902(c). (The Code and regulations refer

to pooled earnings and profits and

foreign income taxes as post-1986

undistributed earnings and post-1986

foreign income taxes even though a

particular corporation may begin to pool

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

§ 1.902–1(a)(8) and (9).)

Congress enacted the pooling rules

because it believed that averaging of

foreign income taxes was fairer than

distributions out of annual layers. Joint

Committee on Taxation, General

Explanation of the Tax Reform Act of

1986 (Public Law 99–514) (1986

Bluebook) at 870. Averaging prevents

taxpayers from inflating their foreign

income tax rate for a particular year in

order to obtain artificially enhanced

foreign tax credits. Id. Averaging also

prevents the trapping of foreign income

taxes in years in which a taxpayer may

have no earnings and profits. Id. 

However, Congress enacted pooling

on a limited basis. Earnings and profits

accumulated (and related foreign

income taxes paid or deemed paid)

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

corporation and pre-1987 earnings and

profits accumulated (and related foreign

income taxes paid or deemed paid) by

a look-through corporation or non-lookthrough 10/50 corporation are not

pooled. Rather, such earnings and

profits (and related foreign income

taxes) are maintained in separate annual

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

regulations refer to earnings and profits

and foreign income taxes in annual

layers as pre-1987 accumulated profits

and pre-1987 foreign income taxes even

though a particular corporation may

have annual layers for years after 1986.

Section 902(c)(6); § 1.902–1(a)(10).)

A distribution of earnings and profits

is first out of pooled earnings and

profits and then, only after all pooled

earnings and profits have been

distributed, out of annual layers of

earnings and profits on a LIFO basis.

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

annual layers beneath pooled earnings

and profits limits the need to recreate

tax histories, an administrative burden

that is more significant for periods

during which a corporation had limited

nexus to the U.S. taxing jurisdiction and

for pre-1987 earnings and profits when

pooling was not required.

The section 904 foreign tax credit

limitation ensures that taxpayers can

use foreign tax credits only to offset U.S.

tax on foreign source income. The

limitation is computed separately with

respect to different categories of income

(baskets). The purpose of the baskets is

to limit taxpayers’ ability to cross-credit

taxes from different categories of foreign

source income. Congress was concerned

that, without separate limitations, crosscrediting opportunities would distort

economic incentives to invest in the

United States versus abroad. 1986

Bluebook at 862.

A dividend received by a U.S.

shareholder that owns less than 10

percent of the stock of a foreign

corporation is categorized as passive

income because such a dividend is in

the nature of a portfolio investment.

1986 Bluebook at 866.

A dividend received by a U.S.

shareholder that owns 10 percent or

more of a foreign corporation is subject

to other limitations. Dividends paid by

a non-look-through 10/50 corporation to

a 10 percent or greater U.S. corporate

shareholder are currently subject to a

separate basket limitation on a

corporation-by-corporation basis.

Congress initially separately basketed

dividends from each 10/50 corporation

because it believed a minority

investment in a foreign corporation did

not create sufficient identity of interest

to justify look-through treatment and

that cross-crediting of taxes among

investments in 10/50 corporations was

inappropriate because the foreign

companies were not parts of a single

economic unit. 1986 Bluebook at 868. In

addition, Congress was concerned about

the administrability of applying the

look-through rules to 10/50

corporations. 1986 Bluebook at 868.

In 1997, Congress amended the Code’s

treatment of dividends from 10/50

corporations to provide that dividends

paid after taxable years beginning after

December 31, 2002 by a look-through

10/50 corporation out of earnings and

profits accumulated before 2003 are

subject to a single separate basket

limitation for all 10/50 corporations,

while dividends paid out of earnings

and profits accumulated after 2003 are

treated as income in a basket based on

the ratio of the earnings and profits

attributable to income in such basket to

the foreign corporation’s total earnings

and profits (the so-called ‘‘lookthrough’’ approach). Earnings and

profits accumulated after 2003 by a

look-through 10/50 corporation are

distributed before earnings and profits

accumulated by that same foreign

corporation before 2003. Joint

Committee on Taxation, General

Explanation of Tax Legislation Enacted

in 1997 (1997 Bluebook) at 303.

The legislative history indicates that

Congress changed its view with respect

to 10/50 corporations because the

separate basket limitation for dividends

from each 10/50 corporation imposed a

substantial recordkeeping burden and

discouraged minority investments in

foreign joint ventures. 1997 Bluebook at

302. However, as described above, the

1997 Act enacted look-through

treatment for 10/50 corporation

dividends only on a limited basis.

Furthermore, Congress provided

regulatory authority regarding the

treatment of distributions out of

earnings and profits for periods prior to

a taxpayer’s acquisition of stock in a

look-through 10/50 corporation because

of concerns that look-through treatment

could provide inappropriate

opportunities to traffic in foreign tax

credits.

Dividends paid by a CFC out of

earnings and profits accumulated while

the corporation was not a CFC are

treated as a distribution from a 10/50

corporation while dividends paid out of

earnings and profits accumulated while

the corporation was a CFC are eligible

for look-through treatment. Section

904(d)(2)(E)(i) and (d)(3). As in the case

of a look-through 10/50 corporation,

pooled earnings and profits of a CFC

that are eligible for look-through

treatment are distributed before other

pooled earnings and profits. Prop. Reg.

§ 1.904–4(g)(3)(iii). Congress provided

look-through treatment for dividends

paid by CFCs in order to provide greater

parity between the treatment of income

earned through a branch and a

subsidiary. 1986 Bluebook at 866.

Before 1997, except as otherwise

provided in regulations, dividend

distributions to a 10 percent U.S.

shareholder of a CFC did not obtain

look-through treatment unless the

distributed earnings and profits accrued

while the shareholder was a 10 percent

U.S. shareholder and the corporation

was a CFC. Section 904(d)(2)(E)(i), as in

effect before the 1997 Act. This rule was

intended to prevent trafficking in

foreign income taxes related to

preacquisition earnings and profits.

However, because of the administrative

issues presented by maintaining

shareholder-level earnings and profits

accounts, Congress modified the rule in

1997 to provide that look-through

Federal Register / Vol. 65, No. 221 / Wednesday, November 15, 2000 / Proposed Rules 69141

treatment applies with respect to CFC

earnings and profits without regard to

whether a 10 percent U.S. shareholder

was a shareholder at the time

accumulated. However, pre-CFC

earnings and profits continue to be

treated as earnings and profits of a 10/

50 corporation because of foreign tax

credit trafficking concerns.

The section 904 basketing rules reflect

Congress’ concern with respect to crosscrediting opportunities and its intent to

limit the benefit of look-through

treatment to appropriate circumstances.

Where Congress determined that lookthrough is inappropriate, a dividend is

treated as passive income or is subject

to a separate limitation for 10/50

corporations (whether separately or

collectively). Regulations have not yet

been issued with respect to

preacquisition earnings and profits of a

look-through 10/50 corporation and the

effect, if any, on the treatment of preCFC earnings and profits described in

section 904(d)(2)(E)(i). The IRS and

Treasury solicit comments as to the

appropriate treatment of such earnings

and profits after 2003 in light of

Congress’ anti-trafficking concerns, as

well as the impact that such rules

should have on the section 367(b)

regulations.

Another international provision

implicated by the movement of earnings

and profits in foreign 381 transactions is

section 959. Section 959 governs the

distribution of earnings and profits that

have been previously taxed to U.S.

shareholders under section 951(a) (PTI).

After studying the interaction of section

367(b) and the PTI rules, the IRS and

Treasury determined that more

guidance under section 959 would be

useful before issuing regulations to

address PTI issues that arise under

section 367(b). Accordingly, the IRS and

Treasury have opened a separate

regulations project under section 959

and expect to issue regulations that

address PTI issues under section 959 as

well as section 367(b) in the future. The

fundamental issue under consideration

in that project is whether earnings and

profits that are treated as PTI should be

distributable to another shareholder, as

well as the various implications that

result from that determination. The IRS

and Treasury invite comments with

respect to these issues. Accordingly, the

proposed regulations reserve on section

367(b) issues related to PTI.

Other sections may have also applied

to characterize pre-transaction earnings

of a foreign acquiring corporation or a

foreign target corporation for certain

purposes of the Code. For example,

certain earnings may have been subject

to characterization as U.S. source

earnings under section 904(g),

effectively connected earnings and

profits under section 884, or post-1986

undistributed U.S. earnings under

section 245. The characterization of

such earnings carry over to the foreign

surviving corporation for purposes of

applying the relevant Code sections. See

Georday Enterprises v. Commissioner,

126 F.2d 384 (4th Cir. 1942).

D. Specific Policies Related to Foreign

Divisive Transactions (Prop. Reg.

§ 1.367(b)–8)

Proposed regulation § 1.367(b)–8

addresses the allocation of earnings and

profits and foreign income taxes in a

transaction described in section 312(h)

(that is, a section 355 distribution

whether or not in connection with a

section 368(a)(1)(D) reorganization) in

which either or both the distributing or

the controlled corporation is a foreign

corporation (foreign divisive

transaction). The scope of proposed

§ 1.367(b)–8 thus encompasses three

situations: a domestic distributing

corporation that distributes stock of a

foreign controlled corporation, a foreign

distributing corporation that distributes

stock of a domestic controlled

corporation, and a foreign distributing

corporation that distributes stock of a

foreign controlled corporation. The

proposed regulations generally adopt

the principles embodied in the

regulations under section 312(h) but

modify their application in

consideration of the international

provisions such as the source and

foreign tax credit rules.

Regulations under section 312(h)

reflect the principle that a pro rata

portion of a distributing corporation’s

earnings and profits should be reduced

to account for the distribution of a

portion of its assets. § 1.312–10.

Furthermore, the earnings and profits of

a controlled corporation should include

the portion of the distributing

corporation’s earnings and profits

allocable to any assets transferred to the

controlled corporation in connection

with a section 368(a)(1)(D)

reorganization (D reorganization) that

immediately precedes the section 355

distribution (together with a D

reorganization, a D/355 distribution).

§ 1.312–10(a). If a section 355

distribution is not preceded by a D

reorganization, the earnings and profits

of the controlled corporation are at least

equal to the amount of the reduction in

the distributing corporation’s earnings

and profits. § 1.312–10(b). It is likely

that this rule was included to prevent

taxpayers from using a section 355

distribution as a device to facilitate a

bailout of earnings and profits through

the controlled corporation. (The

§ 1.312–10 rules are derived from the

Senate’s directions to the IRS and

Treasury in implementing the regulatory

authority in section 312(h); the Senate

Report does not, however, explain its

reasons for these rules. Senate Finance

Committee, Report on H.R. 8300 (1954),

at 249.)

The application of the § 1.312–10

rules to foreign divisive transactions

implicates the Code’s international

provisions because earnings and profits

are moving in the cross-border context

and because the earnings and profits of

controlled foreign corporations are

being adjusted. In transactions involving

a domestic distributing corporation and

a foreign controlled corporation, the

foreign controlled corporation may

succeed to earnings and profits of the

domestic distributing corporation. A

post-transaction distribution by the

foreign controlled corporation out of

earnings and profits it receives from the

domestic distributing corporation is

generally eligible for the dividends

received deduction and treated as U.S.

source income under sections 243(e)

and 861(a)(2)(C). This treatment is

appropriate because the earnings and

profits have already been subject to U.S.

corporate taxation and should not be

subject to a second level of U.S.

corporate tax upon repatriation if the

earnings and profits would have

qualified for the dividends received

deduction if distributed before the

section 355 distribution. H.R. Rep. No.

2101, at 3 (1960). In addition, such

earnings and profits should not increase

a domestic distributee’s foreign tax

credit limitation under section 904.

In circumstances where the foreign

controlled corporation makes a posttransaction distribution to foreign

shareholders, the foreign divisive

transaction should not alter the

character of earnings and profits

allocated from the domestic distributing

corporation. Otherwise, the section 355

distribution may serve as a vehicle to

avoid U.S. tax, including U.S.

withholding tax. Accordingly, the

proposed regulations provide that a

post-transaction distribution out of

earnings and profits of a distributing

corporation that carry over to a foreign

controlled corporation is generally

treated as a U.S. source dividend for

purposes of Chapter 3 of subtitle A of

the Code. See Georday Enterprises v.

Commissioner, 126 F.2d 384 (4th Cir.

1942).

Foreign divisive transactions

involving a foreign distributing

corporation and a domestic controlled

corporation are similar to inbound

nonrecognition transactions to the

69142 Federal Register / Vol. 65, No. 221 / Wednesday, November 15, 2000 / Proposed Rules

extent the domestic controlled

corporation receives assets of a foreign

corporation. Current regulations under

§ 1.367(b)–3 require direct and indirect

U.S. shareholders in an inbound asset

reorganization to include an all earnings

and profits amount in income in order

to ensure, in part, that the bases of

assets repatriated to the United States

reflect an after-tax amount. Section

1.367(b)–3(d) and proposed § 1.367(b)–

3(f) provide further rules regarding the

carryover of earnings and profits and

foreign income taxes from a foreign

corporation to a domestic corporation.

Those rules should also apply to a

section 355 distribution involving a

foreign distributing corporation and a

domestic controlled corporation. These

transactions also implicate the current

rules under § 1.367(b)–5, because a

reduction in a foreign distributing

corporation’s earnings and profits can

directly affect the post-transaction

application of section 1248 with respect

to U.S. shareholders of the distributing

corporation.

Foreign divisive transactions

involving a foreign distributing

corporation and a foreign controlled

corporation raise issues similar to those

raised in the context of a foreign 381

transaction described in § 1.367(b)–7, to

the extent the controlled corporation

succeeds to earnings and profits (and

related foreign income taxes) of the

distributing corporation. Accordingly,

the proposed regulations adopt the

principles of § 1.367(b)–7 to determine

the manner in which the foreign

controlled corporation succeeds to the

earnings and profits (and related foreign

income taxes) of a foreign distributing

corporation. These transactions also

implicate the § 1.367(b)–5 rules

concerning diminutions in U.S.

shareholders’ section 1248 amounts.

The proposed regulations under

§ 1.367(b)–8 balance the § 1.312–10

rules and policies with the interests and

concerns of the relevant international

provisions of the Code. However, the

IRS and Treasury recognize that the

mechanics of § 1.312–10 as applied in

the international context can be

cumbersome and complex. The IRS and

Treasury solicit comments as to whether

the mechanical difficulties of applying

the section 312 rules in the cross-border

context outweigh the benefits and, if so,

whether there are simpler alternative

regimes that would address the

international policy concerns without

compromising the Subchapter C policies

embodied in § 1.312–10.

Details of Provisions

A. Prop. Reg. § 1.367(b)–1

The proposed regulations supplement

the current § 1.367(b)–1 notice

requirements in consideration of the

transactions addressed by proposed

§§ 1.367(b)–7 and 1.367(b)–8.

Accordingly, foreign surviving

corporations described in proposed

§ 1.367(b)–7 and distributing and

controlled corporations involved in

transactions described in proposed

§ 1.367(b)–8 are included within the

scope of the § 1.367(b)–1 notice

requirement.

B. Prop. Reg. § 1.367(b)–3

The proposed regulations address the

carryover of net operating loss and

capital loss carryovers, and earnings and

profits that are not included in income

as an all earnings and profits amount (or

a deficit in earnings and profits). The

proposed regulations generally provide

that these tax attributes do not carry

over from a foreign acquired corporation

to a domestic acquiring corporation

unless they are effectively connected to

a U.S. trade or business (or attributable

to a permanent establishment, in the

context of a relevant U.S. income tax

treaty).

The limitations on the carryover of

these attributes prevent inappropriate or

anomalous results. For example, net

operating loss and capital loss

carryovers are eligible to carry over from

a foreign acquired corporation to a

domestic acquiring corporation only to

the extent the underlying deductions or

losses were allowable under Chapter 1

of subtitle A of the Code. Thus, only a

net operating loss or capital loss

carryover that is effectively connected to

a U.S. trade or business (or attributable

to a permanent establishment) may

carry over. Inappropriate or anomalous

results are thus avoided because losses

incurred by a foreign acquired

corporation outside the U.S. taxing

jurisdiction should not be available to

offset the future U.S. tax liability of a

domestic acquiring corporation.

Otherwise, a taxpayer would have an

incentive to import losses into the

United States in order to shelter future

income from U.S. tax.

The carryover of earnings and profits

(or a deficit in earnings and profits) of

the foreign acquired corporation can

create similarly inappropriate results.

For example, the policies underlying the

section 243(a) dividends received

deduction are not present with respect

to a subsequent distribution by the

domestic acquiring corporation out of

earnings and profits accumulated by the

foreign acquired corporation because

those earnings and profits are not

generally subject to a U.S. corporate

level of tax. On the other hand, if the

foreign acquired corporation has PTI,

those earnings should not be taxed again

when distributed to U.S. shareholders to

whom the PTI is attributable regardless

of whether or not the U.S. shareholder

is eligible for the dividends received

deduction. A deficit in earnings and

profits can also be used to avoid tax,

such as in the case of a foreign

shareholder of a domestic acquiring

corporation that imports a deficit and

therefore is not subject to U.S.

withholding tax on subsequent

corporate distributions.

As a result of the issues raised by a

carryover of earnings and profits and

given that § 1.367(b)–3 already requires

U.S. shareholders to include in income

as a deemed dividend the all earnings

and profits amount, the proposed

regulations provide that earnings and

profits (or deficit in earnings and

profits) of the foreign acquired

corporation do not carry over to the

domestic acquiring corporation except

to the extent effectively connected to a

U.S. trade or business (or attributable to

a permanent establishment, in the

context of a relevant U.S. income tax

treaty).

C. Prop. Reg. § 1.367(b)–7

Proposed § 1.367(b)–7 provides the

manner in which a foreign surviving

corporation succeeds to and takes into

account the earnings and profits and

foreign income taxes of a foreign

acquiring corporation and a foreign

target corporation. The proposed

regulation attempts to preserve the

character of earnings and profits and

foreign income taxes to the extent

possible in light of the applicable

statutory limitations, as well as the

relevant policy and administrative

concerns. Compare § 1.381(c)(2)–1(a)(3)

(ensuring that earnings and profits

accumulated before March 1, 1913

retain their character as pre-1913

earnings and profits after a section 381

transaction). Accordingly, the proposed

rules provide that, to the extent

possible, pooled earnings and profits

(and foreign income taxes) remain

pooled, earnings and profits (and

foreign income taxes) in annual layers

remain in annual layers, foreign income

taxes trapped before the transaction

remain trapped after the transaction,

and earnings and profits (and foreign

income taxes) remain in the same basket

before and after the transaction.

The proposed regulation also respects

the section 902 preference for

distributing pooled earnings and profits

before earnings and profits in annual

Federal Register / Vol. 65, No. 221 / Wednesday, November 15, 2000 / Proposed Rules 69143

layers. Accordingly, proposed

§ 1.367(b)–7 provides that a foreign

surviving corporation’s pooled earnings

and profits are distributed first (even

though earnings and profits in the

annual layers may have been

accumulated after earnings and profits

in the pool) and annual layers are

distributed on a LIFO basis. Similarly,

the proposed regulation also

incorporates the section 904 preference

for distributing pooled earnings and

profits eligible for look-through before

other pooled earnings and profits.

However, in certain cases, an

overriding statutory policy requires that

the proposed regulation modify the

character of earnings and profits (and

related foreign income taxes). For

example, if a CFC combines with a nonlook-through 10/50 corporation in a

foreign 381 transaction and the foreign

surviving corporation is a non-lookthrough 10/50 corporation, dividends

paid by the surviving non-look-through

10/50 corporation are required to be

separately basketed and do not obtain

the benefit of look-through. Thus,

earnings and profits of a CFC that would

have obtained the benefit of lookthrough if distributed before the foreign

381 transaction are not eligible for lookthrough after the transaction. (The loss

of look-through in connection with this

type of foreign 381 transaction is

somewhat ameliorated by a U.S.

shareholder’s section 1248 amount

inclusion under § 1.367(b)–4 with

respect to earnings and profits that

accrued during its holding period.)

Proposed regulation § 1.367(b)–7 also

provides rules regarding the carryover of

deficits in earnings and profits from one

foreign corporation to another. The

purpose of the hovering deficit rule in

the domestic context is to prevent the

trafficking of deficits in earnings and

profits. Otherwise, a corporation with

positive earnings and profits may

acquire or be acquired by another

corporation with a deficit in earnings

and profits and make distributions out

of capital rather than earnings and

profits.

In transactions involving foreign

corporations, similar concerns exist

regarding the trafficking of deficits in

earnings and profits. The ability to

benefit from combining positive and

deficit earnings and profits among

foreign corporations is different than in

the domestic context, however, because

of the nature of the foreign tax credit

rules. In a reorganization involving two

domestic corporations, the hovering

deficit rule applies to a corporation with

a net accumulated deficit in earnings

and profits because the relevant

statutory rules do not distinguish among

classes of earnings and profits. In

contrast, the foreign tax credit rules

require further subcategorization of

earnings and profits according to the

pooling and basketing rules. Because of

these distinctions, taxpayers may

inappropriately benefit by trafficking in

an earnings and profits deficit in a

basket, pool, or particular annual layer,

even though a corporation may have net

positive earnings and profits.

Accordingly, the proposed regulations

apply the hovering deficit principle to

the relevant subcategories of earnings

and profits and provide that foreign

income taxes related to the deficit are

not added to the foreign surviving

corporation’s foreign income tax

accounts until all of the deficit has been

offset with post-transaction earnings.

(Under proposed § 1.367(b)–9 (which is

described below), these hovering deficit

rules do not apply to F reorganizations

and foreign 381 transactions in which

either the foreign target corporation or

the foreign acquiring corporation is

newly created.)

Because the treatment of distributions

by a foreign surviving corporation

depends on whether it is a look-through

corporation, a non-look-through 10/50

corporation, or a less-than-10%-U.S.-

owned foreign corporation, proposed

§ 1.367(b)–7 is divided according to

these categories. The proposed

regulation uses the term surviving

corporation in order to prevent

confusion between the acquiring

corporation and the foreign surviving

entity. In addition, the term highlights

the proposed regulation’s general

approach that provides the same results

regardless of whether a corporation is

the ostensible acquiring or target

corporation.

1. Look-Through Surviving Corporation

Where the foreign surviving

corporation is a look-through

corporation, the proposed regulation

generally preserves the character of

earnings and profits and foreign income

taxes. For example, if a CFC (CFC1)

acquires the assets of another CFC

(CFC2) in a foreign 381 transaction and

the surviving corporation is a CFC, then

the corporations’ positive amounts of

earnings and profits and foreign income

taxes would carry over in a manner that

combines the look-through earnings and

profits pools (and related foreign

income taxes) of each corporation on a

basket-by-basket basis. Thus, for

example, CFC1’s passive basket would

be combined with CFC2’s passive

basket, CFC1’s general basket would be

combined with CFC2’s general basket,

and so forth.

If CFC1 or CFC2 has pooled earnings

and profits or foreign income taxes that

do not qualify for look-through

treatment (non-look-through pool) (for

example, earnings and profits

accumulated during a period when the

corporation was not a CFC and that are

subject to a separate 10/50 limitation),

such earnings and profits and foreign

income taxes would be distributed only

after all of the look-through earnings

and profits pool has been distributed.

This rule is consistent with the ordering

rule in Prop. Reg. § 1.904–4(g)(3)(iii),

which provides that when a 10/50

corporation becomes a CFC, pooled

earnings and profits accumulated and

foreign income taxes paid or accrued

while the corporation is a CFC are

distributed before pooled earnings and

profits accumulated and foreign income

taxes paid or accrued while the

corporation was a 10/50 corporation. (If

the foreign surviving corporation is

instead a look-through 10/50

corporation, this rule is also consistent

with the earnings and profits in the

look-through pool being distributed

before earnings and profits in the nonlook-through pool.)

When earnings and profits from the

non-look-through pool are distributed,

the earnings and profits will be

distributed pro rata out of the non-lookthrough pools of CFC1 and CFC2 (if any)

and placed in two separate baskets

under section 904(d)(1)(E). This

preserves the character of the earnings

and profits and related foreign income

taxes and is consistent with the policy

of section 904(d)(1)(E) to maintain

separate baskets for each 10/50

corporation. After 2003, these earnings

and profits will continue to be

distributed pro rata from separate nonlook-through pools but will be

combined into a single 10/50 basket in

the hands of the distributee.

Maintaining separate pools prevents the

refreshing of foreign income taxes that

would have been trapped had the

foreign 381 transaction not occurred.

(The same rules apply in the case of a

foreign surviving corporation that is a

look-through 10/50 corporation.)

If CFC1 or CFC2 has pre-1987

accumulated profits (i.e., annual layers

of earnings and profits) or foreign

income taxes, then those earnings and

profits are distributed only after the

distribution of all pooled earnings and

profits and taxes, regardless of whether

those earnings and profits may have

been accumulated after the pooled

earnings and profits of the other

corporation. Such earnings and profits

are distributed on a LIFO basis and pro

rata out of the respective corporation’s

annual layers if both companies have

69144 Federal Register / Vol. 65, No. 221 / Wednesday, November 15, 2000 / Proposed Rules

earnings and profits in the same year

that are treated as pre-1987 accumulated

profits and foreign income taxes. This

rule respects two international policies.

First, pooled earnings and profits are

distributed before earnings and profits

in annual layers. Second, earnings and

profits in annual layers should not be

pooled unless they are distributed to an

upper-tier entity. Compare § 1.902–

1(a)(8)(ii) (providing that distributions

out of pre-1987 earnings and profits by

a lower-tier corporation are included in

the post-1986 earnings and profits of an

upper-tier corporation). This rule is also

consistent with the section 902 rule that

traps foreign income taxes in annual

layers in which there are no earnings

and profits.

These results preserve the character of

earnings and profits and taxes because

pooled earnings and profits and taxes

remain pooled, earnings and profits and

taxes retain the same character under

the look-through provisions, and foreign

income taxes that were trapped before

the foreign 381 transaction remain

trapped. The rules are also consistent

with concerns about limiting the

administrative burden of requiring

taxpayers to recreate tax histories.

Because of the foreign tax credit

considerations presented by foreign 381

transactions, § 1.367(b)–7 applies the

hovering deficit rule to subcategories of

earnings and profits. Thus, deficits in

the look-through pool, non-look-through

pool, and net deficits in annual layers

can offset only future earnings and

profits of the foreign surviving

corporation. In addition, a hovering

deficit cannot be used to reduce current

earnings and profits of the foreign

surviving corporation and, as a result,

does not reduce subpart F income.

Foreign income taxes related to a

hovering deficit do not enter the foreign

income tax accounts of the surviving

corporation until the entire hovering

deficit offsets post-transaction earnings

and profits. However, foreign income

taxes related to the post-transaction

earnings that are offset by the hovering

deficit immediately enter the foreign

income tax accounts of the foreign

surviving corporation.

2. Non-Look-Through 10/50 Surviving

Corporation

The proposed regulation’s rules with

respect to a non-look-through 10/50

corporation apply if the foreign

surviving corporation is a 10/50

corporation before 2003. The principal

statutory limitation of a non-lookthrough 10/50 corporation is that a

dividend distribution is not eligible for

look-through treatment and is instead

separately basketed for each 10/50

corporation. As a result, earnings and

profits of an acquiring or target

corporation that would have been

eligible for look-through (assuming the

corporation qualified under the lookthrough rule) if distributed before the

foreign 381 transaction lose their lookthrough character after the transaction.

For example, suppose a CFC

combines with a non-look-through 10/

50 corporation in a foreign 381

transaction in 2001 and the surviving

entity is a non-look-through 10/50

corporation. Prior to the transaction, the

CFC maintained earnings and profits

and foreign income tax accounts

expecting that the look-through rules

would apply on a distribution of

earnings and profits to U.S.

shareholders. However, after the foreign

381 transaction, section 904(d)(1)(E)

requires that a distribution from the

surviving 10/50 corporation will be

deemed to be paid out of a single pool

of earnings and profits that will be

separately basketed. In order to address

the carryover of attributes to a non-lookthrough 10/50 corporation in a manner

consistent with section 904(d)(1)(E), the

proposed regulations combine the net

positive earnings and profits and foreign

income taxes in the respective pools of

the acquiring and target corporations.

(Thus, the separate baskets of pooled

earnings and profits and foreign income

taxes of the CFC would be netted into

a single pool along with the non-lookthrough 10/50 corporation’s pooled

earnings and profits and foreign income

taxes.)

Annual layers of the acquiring and

target corporations are carried over to

the foreign surviving corporation under

the same rules as described above with

respect to look-through corporations.

Hovering deficit rules similar to those

described with respect to a look-through

corporation’s non-look-through pool

and annual layers also apply to

surviving non-look-through 10/50

corporations.

Look-through treatment of earnings

and profits and foreign income taxes

does not re-emerge if the corporation

later becomes a look-through

corporation. For example, if the

surviving non-look-through 10/50

corporation becomes a CFC, all of the

earnings and profits and foreign income

taxes of the surviving non-look-through

10/50 corporation remain as earnings

and profits to which the look-through

rules do not apply. Look-through only

applies to earnings and profits

accumulated after the corporation

becomes a CFC. The IRS and Treasury

believe that this rule is appropriate

because of the administrative

difficulties posed by recreating tax

histories. In addition, earnings and

profits and foreign income taxes of a

CFC accumulated during a U.S.

shareholder’s holding period are

generally deemed distributed (and the

look-through rules apply) if a U.S.

shareholder includes a section 1248

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

connection with the foreign 381

transaction.

3. Less-than-10%-U.S.-owned Foreign

Surviving Corporation

Proposed § 1.367(b)–7 also determines

the manner in which earnings and

profits and foreign income taxes of the

acquiring and target corporation are

combined if the foreign surviving

corporation is a less-than-10%-U.S.-

owned foreign corporation. Generally,

rules similar to the rules provided for

annual layers of look-through

corporations and non-look-through 10/

50 corporations apply with respect to

the annual layers of the acquiring and

target corporation, but the rules take

into account the possibility that one of

the corporations may have been a CFC

or 10/50 corporation immediately prior

to the foreign 381 transaction.

If either the acquiring or target

corporation is a CFC or a 10/50

corporation, its pooled earnings and

profits and foreign income taxes are

treated as earnings and profits and

foreign income taxes accumulated in the

annual layer of the applicable

corporation immediately before the

foreign 381 transaction. For example,

suppose a less-than-10%-U.S.-owned

foreign corporation combines with a 10/

50 corporation and the foreign surviving

corporation is a less-than-10%-U.S.-

owned foreign corporation. The foreign

surviving corporation is an entity that

has never been required to pool earnings

and profits and foreign income taxes

under section 902(c)(3). Accordingly,

distributions from the foreign surviving

corporation are out of annual layers on

a LIFO basis. Rather than recreating the

tax history of the acquired 10/50

corporation for each year, the proposed

regulation places all pooled earnings

and profits and foreign income taxes of

the 10/50 corporation into a single

annual layer that closes immediately

before the foreign 381 transaction. This

rule is intended to ameliorate

administrative burdens while respecting

the policy that earnings and profits and

foreign income taxes are distributed

from annual layers for a less-than-10%-

U.S.-owned foreign corporation.

Because of concerns about neutrality,

the same result applies regardless of

whether the 10/50 corporation is the

ostensible acquiring or target

corporation.

Federal Register / Vol. 65, No. 221 / Wednesday, November 15, 2000 / Proposed Rules 69145

If the surviving less-than-10%-U.S.-

owned foreign corporation later

becomes a non-look-through 10/50

corporation or a look-through

corporation, earnings and profits and

foreign income taxes that were pooled

or obtained the benefit of look-through

prior to the foreign 381 transaction are

not recreated. Instead, those earnings

and profits and foreign income taxes

remain as earnings and profits

accumulated and foreign income taxes

paid or deemed paid while the

corporation was a less-than-10%-U.S.-

owned foreign corporation. As in the

case of a surviving non-look-through 10/

50 corporation that later becomes a

look-through corporation, this rule is

provided because of administrative

issues associated with recreating tax

histories. In addition, earnings and

profits and foreign income taxes of a

CFC accumulated during a shareholder’s

holding period generally would have

been deemed distributed (and the lookthrough rules would have applied) if the

shareholder was required to include a

section 1248 amount in income under

§ 1.367(b)–4 in connection with the

foreign 381 transaction.

D. Prop. Reg. § 1.367(b)–8

Section 1.367(b)–8 provides rules

applicable to foreign divisive

transactions. The regulation is divided

into four sections. Section 1.367(b)–8(b)

provides rules that are generally

applicable to foreign divisive

transactions. The other three sections

describe the application of the general

rules to specific situations. Section

1.367(b)–8(c) applies to a distribution by

a domestic distributing corporation of

the stock of a foreign controlled

corporation, § 1.367(b)–8(d) applies to a

distribution by a foreign distributing

corporation of the stock of a domestic

controlled corporation, and § 1.367(b)–

8(e) applies to a distribution by a foreign

distributing corporation of the stock of

a foreign controlled corporation.

1. General Rules Applicable to Foreign

Divisive Transactions

Section 1.367(b)–8(b) provides that

the rules of § 1.312–10 generally apply

to determine the allocation of earnings

and profits between a distributing and a

controlled corporation, as well as to

determine the reduction in the earnings

and profits of a distributing corporation.

The rules of § 1.312–10 are, however,

subject to certain modifications.

In a D/355 distribution involving a

controlled corporation that is newly

created as part of the transaction,

§ 1.312–10(a) allocates the pretransaction earnings and profits of the

distributing corporation between the

distributing and controlled corporations

based upon a comparison of the fair

market values of the assets received by

the controlled corporation and the

assets retained by the distributing

corporation after the D reorganization.

Section 1.312–10(a) provides that, ‘‘in a

proper case,’’ this allocation should be

based on the relative net bases of the

assets transferred and retained by the

distributing corporation, or based on

another ‘‘appropriate’’ method.

The proposed regulations generally

adopt the rule of § 1.312–10(a), except

that the allocation is based upon relative

net adjusted bases of assets transferred

and retained in all cases. This rule

reflects the view that net basis is the

most accurate measure of the

appropriate amount of earnings and

profits that should be allocated to the

assets transferred by a distributing

corporation in the D reorganization. For

example, in cases where the controlled

corporation recognizes gain on a later

sale or distribution of appreciated

property that it receives from the

distributing corporation an allocation

based upon relative bases prevents a

misallocation of earnings and profits to

the controlled corporation.

In a section 355 distribution that is

not preceded by a D reorganization,

§ 1.312–10(b) provides that the earnings

and profits of the distributing

corporation are decreased by an amount

equal to the lesser of (i) the amount by

which the earnings and profits of the

distributing corporation would have

been decreased if it had transferred the

stock of the controlled corporation to a

new corporation in a D/355 distribution,

and (ii) the net worth of the controlled

corporation. For this purpose, net worth

is defined as ‘‘the sum of the bases of

all of the properties plus cash minus all

liabilities.’’ If ‘‘the earnings and profits

of the controlled corporation

immediately before the transaction are

less than the amount of the decrease in

earnings and profits of the distributing

corporation . . . the earnings and

profits of the controlled corporation,

immediately after the transaction, shall

be equal to the amount of such decrease.

If the earnings and profits of the

controlled corporation immediately

before the transaction are more than the

amount of the decrease in the earnings

and profits of the distributing

corporation, they shall remain the

same.’’

Section 1.312–10(b) reflects the

principle that a pro rata portion of a

distributing corporation’s earnings and

profits should be reduced to account for

the distribution of the controlled

corporation. In addition, the

requirement that the earnings and

profits of the controlled corporation at

least equal the reduction in the

distributing corporation’s earnings and

profits appears intended to prevent a

bailout of earnings and profits through

the controlled corporation, while

preventing the potential double

counting of earnings and profits in

situations where the distributing

corporation did not organize the

controlled corporation.

In consideration of the complexities

raised by the cross-border application of

the § 1.312–10(b) adjustment to the

controlled corporation’s earnings and

profits, taken together with the current

rules that prevent the potential bailout

of earnings and profits in the

international context (such as the

§ 1.367(b)–5 requirement that a

shareholder include in income a

reduction in its section 1248 amount),

the IRS and Treasury have concluded

that the § 1.312–10(b) rules should be

modified when applied to section 367(b)

transactions. Accordingly, the proposed

regulations provide that the earnings

and profits of the distributing

corporation are decreased in an amount

equal to the amount by which the

earnings and profits of the distributing

corporation would have been decreased

if it had transferred the stock of the

controlled corporation to a new

corporation in a D/355 distribution.

However, the earnings and profits of the

controlled corporation are not increased

or replaced. The reduction in earnings

and profits (and related foreign income

taxes) of the distributing corporation

disappears unless otherwise included in

income, such as under § 1.367(b)–5.

Section 1.312–10 does not specifically

address the allocation and reduction of

earnings and profits in connection with

a D/355 distribution that involves a

preexisting controlled corporation. The

proposed regulations provide that, in

such a case, the distributing

corporation’s earnings and profits are

reduced in a manner that incorporates

both the rules applicable to a D/355

distribution with a newly created

controlled corporation and a section 355

distribution that is not preceded by a D

reorganization. The rule thus accounts

for a decrease in earnings and profits

attributable to assets transferred to the

controlled corporation as part of the D

reorganization as well as a decrease in

earnings and profits attributable to the

distribution of stock of a preexisting

controlled corporation (without regard

to the D reorganization). The controlled

corporation succeeds only to those

earnings and profits allocable to the

property it receives in the D

reorganization.

69146 Federal Register / Vol. 65, No. 221 / Wednesday, November 15, 2000 / Proposed Rules

In consideration of the international

provisions’ distinctions among classes

and categories of earnings and profits,

proposed § 1.367(b)–8(b) specifically

addresses the determination of which

earnings and profits of the distributing

corporation are affected by a foreign

divisive transaction. The proposed

regulation provides that an allocation or

reduction in earnings and profits shall

generally be pro rata out of a crosssection of the distributing corporation’s

tax history (except to the extent it is

included in income as a deemed

dividend such as under § 1.367(b)–3 or

§ 1.367(b)–5). This rule determines the

earnings and profits (and related foreign

income taxes, where applicable) that

remain in the distributing corporation

after the transaction as well as any

earnings and profits (and related foreign

income taxes, where applicable) to

which the controlled corporation

succeeds in a D reorganization.

The proposed § 1.367(b)–8(b) crosssection rule decreases the earnings and

profits of a distributing corporation

without regard to the type of income

generated by the assets of the controlled

corporation. This is consistent with the

general assumption in § 1.312–10 and

the proposed regulations that the

earnings and profits of the distributing

corporation should be decreased

proportionately to reflect the transfer or

distribution of assets, rather than by

some other measure, such as by

determining the earnings and profits

attributable to the income generated by

assets transferred or distributed (a

tracing model) or by decreasing most

recently accumulated earnings and

profits to the extent of assets transferred

or distributed (a dividend model).

2. Branch Profits Tax Considerations

Notwithstanding the above-described

rules, the proposed regulations provide

that an allocation or reduction in a

distributing corporation’s earnings and

profits shall not reduce the distributing

corporation’s effectively connected

earnings and profits or non-previously

taxed accumulated effectively

connected earnings and profits, as

defined in the branch profits rule in

section 884 (branch earnings). Both a

domestic or foreign distributing

corporation can potentially have branch

earnings that are subject to the branch

profits tax.

In the case of a foreign divisive

transaction that does not include a D

reorganization, a U.S. branch of a

foreign distributing corporation would

be retained by the foreign distributing

corporation. Accordingly, § 1.367(b)–8

should not reduce the foreign

distributing corporation’s branch

earnings because such a reduction

would improperly decrease the earnings

subject to the branch profits tax upon

the section 355 distribution (which

would trigger the branch profits tax

under section 884). The same issues

arise in the case of a D/355 distribution

in which a foreign distributing

corporation transfers the assets that are

not part of a U.S. branch to a controlled

corporation. The IRS and Treasury do

not believe that it is appropriate to

reduce the earnings that could give rise

to a subsequent branch profits tax under

these circumstances.

Different issues arise in a foreign

divisive transaction in which a foreign

distributing corporation transfers the

assets of a U.S. branch to a controlled

corporation as part of a D/355

distribution. While the branch profits

rules permit a deferral of the branch

profits tax in certain instances (by

allowing branch earnings to be allocated

to the domestic transferee in proportion

to the assets transferred when a branch

is incorporated in a section 351

exchange in a domestic corporation (see

§ 1.884–2T(d)(1)), the branch profits tax

is triggered in any event if stock of the

incorporated branch is later distributed

to its shareholders. See § 1.884–2T(d)(5).

Accordingly, because foreign divisive

transactions include a section 355

distribution immediately following the

D reorganization, it would be

unnecessary and inappropriate to

attribute branch earnings to a domestic

controlled corporation under proposed

§ 1.367(b)–8.

Similar branch profits issues can arise

with respect to a domestic distributing

corporation. While branch earnings are

accumulated by a foreign corporation,

such earnings may have been carried

over to a domestic corporation in a prior

section 351 or 381 transaction. See

§ 1.884–2T(c)(4). Accordingly, the

proposed regulations treat domestic

distributing corporations in the same

manner as foreign distributing

corporations with respect to branch

earnings.

3. Domestic Corporation Distributes

Stock of a Foreign Corporation

In foreign divisive transactions

involving a domestic distributing

corporation and a foreign controlled

corporation, the foreign controlled

corporation may succeed to earnings

and profits of the domestic distributing

corporation. The regulations provide

that sections 243(e) and 861(a)(2)(C)

apply to earnings and profits allocated

to the foreign controlled corporation

that were accumulated by a domestic

corporation. In addition, a posttransaction distribution out of earnings

and profits allocated to the foreign

controlled corporation is generally

treated as a U.S. source dividend under

section 904(g) and for purposes of

Chapter 3 of subtitle A of the Code. See

Georday Enterprises v. Commissioner,

126 F.2d 384 (4th Cir. 1942).

4. Foreign Corporation Distributes Stock

of a Domestic Corporation

In foreign divisive transactions

involving a foreign distributing

corporation and a domestic controlled

corporation, two issues arise in

determining the appropriate reduction

in the foreign distributing corporation’s

earnings and profits and its effects on

the earnings and profits of the domestic

controlled corporation. First, it should

be determined whether it is appropriate

to reduce PTI of the foreign distributing

corporation and, if so, in what manner

(e.g., if the foreign distributing

corporation has earnings and profits that

are PTI and not PTI, should the

reduction in earnings and profits be out

of PTI first, last, pro rata, or depending

on the identity of the controlled

corporation’s shareholders). As in the

case of § 1.367(b)–7, § 1.367(b)–8

reserves on PTI issues, and the IRS and

Treasury solicit comments with respect

to the appropriate treatment of these

amounts.

Second, a domestic corporation

succeeds to the earnings and profits of

a foreign corporation if the section 355

distribution is preceded by a D

reorganization. Because earnings and

profits are allocable from foreign

corporate solution to U.S. corporate

solution, U.S. shareholders are required

to include in income the all earnings

and profits amount attributable to

earnings and profits that carry over to

the controlled corporation. The

proposed regulations provide rules that

coordinate the proposed § 1.367(b)–8

and the current § 1.367(b)–3 regimes.

The regulations, however, reserve with

respect to the treatment of U.S. persons

that own foreign distributing

corporation stock after a non pro rata

distribution. The IRS and Treasury

invite comments as to whether U.S.

shareholders should have an all

earnings and profits amount inclusion

in connection with a non pro rata

foreign divisive transaction in which

they do not receive stock of the

domestic controlled corporation.

5. Foreign Corporation Distributes Stock

of a Foreign Corporation

In foreign divisive transactions

involving a foreign distributing

corporation and a foreign controlled

corporation, the foreign controlled

corporation may succeed to earnings

Federal Register / Vol. 65, No. 221 / Wednesday, November 15, 2000 / Proposed Rules 69147

and profits of the foreign distributing

corporation. Because such earnings and

profits are allocated from one foreign

corporation to another foreign

corporation, the transaction raises issues

similar to those in a foreign 381

transaction. Accordingly, the proposed

regulations adopt and apply the

principles in proposed regulation

§ 1.367(b)–7 to these transactions.

E. Prop. Reg. § 1.367(b)–9

Proposed § 1.367(b)–9 provides

special rules applicable to foreign-toforeign F reorganizations and foreign

381 transactions in which either the

foreign target corporation or the foreign

acquiring corporation is newly created.

Proposed § 1.367(b)–9 also applies to

foreign divisive transactions that

involve a foreign distributing and a

foreign controlled corporation, either of

which is newly created.

Under proposed § 1.367(b)–9, a

foreign surviving corporation succeeds

to earnings and profits, deficits in

earnings and profits, and foreign income

taxes without regard to the proposed

§ 1.367(b)–7 hovering deficit rules. See

section 1.381(b)–1(a)(2) (providing an

analogous rule with respect to domestic

F reorganizations).

This rule prevents inappropriate tax

consequences. For example, under the

generally applicable hovering deficit

rules, a foreign corporation with

significant deficits in earnings and

profits could combine with a newly

created foreign corporation and

thereafter distribute dividends (along

with deemed paid foreign income taxes

under section 902), despite the presence

of a significant deficit that would have

precluded a dividend distribution

before the transaction. Proposed

§ 1.367(b)–7 provides the Commissioner

discretion to apply the principles of

proposed § 1.367(b)–9 to circumstances

where a principal purpose of the foreign

381 transaction is to affirmatively use

the hovering deficit rule in order to gain

a tax benefit.

Proposed Effective Dates

These regulations are proposed to

apply to section 367(b) exchanges that

occur on or after 30 days after these

regulations are published as final

regulations in the Federal Register.

Special Analyses

It has been determined that this notice

of proposed rulemaking is not a

significant regulatory action as defined

in Executive Order 12866. Therefore, a

regulatory assessment is not required. It

has also been determined that section

553(b) of the Administrative Procedure

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

to these regulations, and because the

regulation does not impose a collection

of information on small entities, the

Regulatory Flexibility Act (5 U.S.C.

chapter 6) does not apply.

Comments and Public Hearing

Before these proposed regulations are

adopted as final regulations,

consideration will be given to any

electronic or written comments (a

signed original and eight (8) copies) that

are submitted timely to the IRS. The IRS

and Treasury Department request

comments on the clarity of the proposed

rules and how they can be made easier

to understand. All comments will be

available for public inspection and

copying.

A public hearing has been scheduled

for March 13, 2001, beginning at 10

a.m., in room 7218 of the Internal

Revenue Building, 1111 Constitution

Avenue, NW., Washington, DC. Due to

building security procedures, visitors

must enter at the 10th Street entrance,

located between Constitution and

Pennsylvania Avenues, NW. In

addition, all visitors must present photo

identification to enter the building.

Because of access restrictions, visitors

will not be admitted beyond the

immediate entrance area more than 15

minutes before the hearing starts. For

information about having your name

placed on the building access list to

attend the hearing, see the FOR FURTHER

INFORMATION CONTACT section of this

preamble.

The rules of 26 CFR 601.601(a)(3)

apply to the hearing. Persons who wish

to present oral comments at the hearing

must submit electronic or written

comments and an outline of the topics

to be discussed and the time to be

devoted to each topic (signed original

and eight (8) copies) by February 20,

2001. A period of 10 minutes will be

allotted to each person for making

comments. An agenda showing the

scheduling of the speakers will be

prepared after the deadline for receiving

outlines has passed. Copies of the

agenda will be available free of charge

at the hearing.

Drafting Information

The principal author of these

regulations is Anne O’Connell

Devereaux, Office of Associate Chief

Counsel (International). However, other

personnel from the IRS and Treasury

Department participated in their

development.

List of Subjects in 26 CFR Part 1

Income taxes, Reporting and

recordkeeping requirements.

Proposed Amendments to the

Regulations

Accordingly, 26 CFR part 1 is

proposed to be amended as follows:

PART 1—INCOME TAXES

Paragraph 1. The authority citation

for part 1 is amended by revising the

entries for sections 1.367(b)–7, 1.367(b)–

8, and 1.367(b)–9 to read in part as

follows:

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

Section 1.367(b)–7 also issued under 26

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

U.S.C. 904.

Section 1.367(b)–8 also issued under 26

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

U.S.C. 904.

Section 1.367(b)–9 also issued under 26

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

U.S.C. 904. * * *

Par. 2. Section 1.312–10 is amended

by adding paragraph (d) to read as

follows:

§ 1.312–10 Allocation of earnings in

certain corporate separations.

* * * * *

(d) For additional rules involving

foreign corporations, see § 1.367(b)–8.

Par. 3. Section 1.367(b)–0 is amended

by:

1. Revising the introductory text.

2. Revising the entry for § 1.367(b)–

2(j)(3) and adding entries for § 1.367(b)–

2(j)(4), (j)(5), and (l).

3. Adding entries for § 1.367(b)–3(e)

and (f).

4. Adding entries for § 1.367(b)–

5(c)(2)(i), (c)(2)(ii), and (e)(3).

5. Adding entries for §§ 1.367(b)-7

through 1.367(b)-9.

The revisions and additions read as

follows:

§ 1.367(b)–0 Table of contents.

This section lists the paragraphs

contained in §§ 1.367(b)–1 through

1.367(b)–9.

* * * * *

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

* * * * *

(j) * * *

(3) Dividend described in section 243(e).

(4) Coordination with § 1.367(b)–8(c)(2).

(5) Other rules.

* * * * *

(l) Additional definitions.

(1) Foreign income taxes.

(2) Post-1986 undistributed earnings.

(3) Post-1986 foreign income taxes.

(4) Pre-1987 accumulated profits.

(5) Pre-1987 foreign income taxes.

(6) Pre-1987 section 960 earnings and

profits.

(7) Pre-1987 section 960 foreign income

taxes.

(8) Earnings and profits.

(9) Look-through corporation.

69148 Federal Register / Vol. 65, No. 221 / Wednesday, November 15, 2000 / Proposed Rules

(10) Non-look-through 10/50 corporation.

(11) Less-than-10%-U.S.-owned foreign

corporation.

(12) Separate category.

(13) Statutory grouping of earnings and

profits.

§ 1.367(b)– Repatriation of foreign

corporate assets in certain nonrecognition

transactions.

* * * * *

(e) Net operating loss and capital loss

carryovers.

(f) Carryover of earnings and profits.

* * * * *

§ 1.367(b)–5 Distributions of stock

described in section 355.

* * * * *

(c) * * *

(2) * * *

(i) In general.

(ii) Exception.

* * * * *

(e) * * *

(3) Divisive D reorganization with a

preexisting controlled corporation.

* * * * *

§ 1.367(b)–7 Carryover of earnings and

profits and foreign income taxes in certain

foreign-to-foreign nonrecognition

transactions.

(a) Scope.

(b) General rules.

(1) Non-previously taxed earnings and

profits and related taxes.

(2) Previously taxed earnings and profits.

[Reserved]

(c) Ordering rule for post-transaction

distributions.

(1) If foreign surviving corporation is a

look-through corporation.

(2) If foreign surviving corporation is a

non-look-through 10/50 corporation.

(3) If foreign surviving corporation is a

less-than-10%-U.S.-owned foreign

corporation.

(d) Look-through pool.

(1) In general.

(i) Qualifying earnings and taxes.

(ii) Carryover rule.

(2) Hovering deficit.

(i) Offset Rule.

(ii) Related taxes.

(3) Examples.

(e) Non-look-through pool.

(1) If foreign surviving corporation is a

look-through corporation.

(i) Qualifying earnings and taxes.

(iii) Hovering deficit.

(A) Offset rule.

(B) Related taxes.

(iv) Examples.

(2) If foreign surviving corporation is a

non-look-through 10/50 corporation.

(i) Qualifying earnings and taxes.

(ii) Carryover rule.

(iii) Hovering deficit.

(A) Offset rule.

(B) Related taxes.

(iv Examples.

(f) Pre-pooling annual layers.

(1) If foreign surviving corporation is a

look-through corporation or a non-lookthrough 10/50 corporation.

(i) Qualifying earnings and taxes.

(ii) Carryover rule.

(iii) Deficits.

(A) Aggregate positive earnings and profits.

(B) Aggregate deficit in earnings and

profits.

(iv) Pre-1987 section 960 earnings and

profits and foreign income taxes.

(v) Examples.

(2) If foreign surviving corporation is a

less-than-10%-U.S.-owned foreign

corporation.

(i) Qualifying earnings and taxes.

(ii) Carryover rule.

(iii) Deficits.

(A) Aggregate positive earnings and profits.

(B) Aggregate deficit in earnings and

profits.

(iv) Pre-1987 section 960 earnings and

profits and foreign income taxes.

(v) Examples.

(g) Special rules.

(1) Treatment of deficit.

(2) Reconciling taxable years.

(3) Post-transaction change of status.

(4) Ordering rule for offsetting multiple

hovering deficits.

(i) Rule.

(ii) Example.

(5) Pro rata rule for earnings during

transaction year.

(6) Nonapplicability of hovering deficit

rules to certain transactions.

(i) Rule.

(ii) Example.

(h) Effective date.

§ 1.367(b)–8 Allocation of earnings and

profits and foreign income taxes in certain

foreign corporate separations.

(a) Scope.

(b) General rules.

(1) Application of § 1.312–10.

(i) In general.

(ii) Special rules for application of § 1.312–

10(b).

(A) Distributing corporation.

(B) Controlled corporation.

(iii) Net deficit in pre-transaction earnings.

(iv) Use of net bases.

(v) Gain recognized by distributing

corporation.

(vi) Coordination with branch profits tax.

(2) Cross-section of earnings and profits.

(3) Foreign income taxes.

(4) Divisive D reorganization with a

preexisting controlled corporation.

(i) Calculation of earnings and profits of

distributing corporation.

(ii) Calculation of earnings and profits of

controlled corporation.

(c) Foreign divisive transactions involving

a domestic distributing corporation and a

foreign controlled corporation.

(1) Scope.

(2) Earnings and profits allocated to a

foreign controlled corporation.

(3) Examples.

(d) Foreign divisive transactions involving

a foreign distributing corporation and a

domestic controlled corporation.

(1) Scope.

(2) Coordination with § 1.367(b)–3.

(i) In general.

(ii) Determination of all earnings and

profits amount.

(iii) Interaction with section 358 and

§ 1.367(b)–2(e)(3)(ii).

(iv) Coordination with § 1.367(b)–3(c).

(v) Special rule for U.S. persons that own

foreign distributing corporation stock after a

non pro rata distribution. [Reserved]

(3) Foreign income taxes.

(4) Previously taxed earnings and profits.

[Reserved]

(5) Coordination with § 1.367(b)–5.

(6) Examples.

(e) Foreign divisive transactions involving

a foreign distributing corporation and a

foreign controlled corporation.

(1) Scope.

(2) Earnings and profits of foreign

controlled corporation.

(i) In general.

(ii) Special rule for pre-transaction

earnings allocated to a newly created

controlled corporation.

(3) Foreign income taxes.

(4) Previously taxed earnings and profits.

[Reserved]

(5) Coordination with § 1.367(b)–5.

(6) Examples.

(f) Effective date.

§ 1.367(b)–9 Special rule for F

reorganizations and similar transactions.

(a) Scope.

(b) Hovering deficit rules inapplicable.

(c) Example.

(d) Effective date.

Par. 4. Section 1.367(b)–1 is amended

by:

1. Removing the language ‘‘and’’ at

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

2. Removing the period at the end of

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

its place.

3. Adding paragraphs (c)(2)(v),

(c)(2)(vi), and (c)(2)(vii).

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

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

The additions and revisions read as

follows:

§ 1.367(b)–1 Other transfers.

* * * * *

(c) * * *

(2) * * *

(v) A foreign surviving corporation

described in § 1.367(b)–7(a);

(vi) A distributing corporation that is

subject to the rules of § 1.367(b)–8; and

(vii) A controlled corporation that is

subject to the rules of § 1.367(b)–8.

(3) * * *

(ii) * * *

(A) United States shareholders (as

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

corporations described in paragraph

(c)(2)(i), (v), (vi), or (vii) of this section;

and

* * * * *

(4) * * *

(iv) A statement that describes any

amount (or amounts) required, under

the section 367(b) regulations, to be

taken into account as income or loss or

Federal Register / Vol. 65, No. 221 / Wednesday, November 15, 2000 / Proposed Rules 69149

as an adjustment (including an

adjustment under § 1.367(b)–7,

1.367(b)–8, or 1.367(b)–9) to basis,

earnings and profits, or other tax

attributes as a result of the exchange;

(v) Any information that is or would

be required to be furnished with a

Federal income tax return pursuant to

regulations under section 332, 351, 354,

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

not a Federal income tax return is

required to be filed), if such information

has not otherwise been provided by the

person filing the section 367(b) notice;

* * * * *

Par. 5. Section 1.367(b)–2 is amended

by:

1. Revising paragraph (j)(1)(i).

2. Redesignating paragraph (j)(3) as

paragraph (j)(5).

3. Adding new paragraphs (j)(3) and

(j)(4).

4. Adding paragraph (l).

The revision and addition read as

follows:

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

* * * * *

(j) Sections 985 through 989—(1)

Change in functional currency of a

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

result of a section 367(b) exchange

described in section 381(a) or 312(h), a

qualified business unit (as defined in

section 989(a)) (QBU) has a different

functional currency determined under

the rules of section 985(b) than it used

prior to the transaction, then the QBU

shall be deemed to have automatically

changed its functional currency

immediately prior to the transaction. A

QBU that is deemed to change its

functional currency pursuant to this

paragraph (j) must make the adjustments

described in § 1.985–5.

* * * * *

(3) Dividend described in section 243(e).

Dividend distributions by a foreign

corporation out of earnings and profits

accumulated by a domestic corporation

that are eligible for the dividends

received deduction under section 243(e)

shall not exceed an amount equal to the

U.S. dollar value of the earnings and

profits at the time the earnings and

profits were accumulated by such

domestic corporation. See § 1.367(b)–

8(c)(3), Example 1 and Example 3. 

(4) Coordination with § 1.367(b)–

8(c)(2). Solely for purposes of Chapter 3

of subtitle A of the Internal Revenue

Code, dividend distributions by a

foreign corporation that are treated

under § 1.367(b)—8(c)(2) as U.S. source

shall not exceed an amount equal to the

U.S. dollar value of the earnings and

profits at the time allocated to the

foreign corporation. See § 1.367(b)–

8(c)(3), Example 1.

* * * * *

(1) Additional definitions—(1) Foreign

income taxes. The term foreign income

taxes has the meaning set forth in

§ 1.902–1(a)(7).

(2) Post-1986 undistributed earnings.

The term post-1986 undistributed

earnings has the meaning set forth in

§ 1.902–1(a)(9).

(3) Post-1986 foreign income taxes.

The term post-1986 foreign income

taxes has the meaning set forth in

§ 1.902–1(a)(8).

(4) Pre-1987 accumulated profits. The

term pre-1987 accumulated profits

means the earnings and profits

described in § 1.902–1(a)(10)(i),

computed in accordance with the rules

of § 1.902–1(a)(10)(ii).

(5) Pre-1987 foreign income taxes. The

term pre-1987 foreign income taxes has

the meaning set forth in § 1.902-

1(a)(10)(iii).

(6) Pre-1987 section 960 earnings and

profits. The term pre-1987 section 960

earnings and profits means the earnings

and profits of a foreign corporation

accumulated in taxable years beginning

before January 1, 1987, computed under

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

into the functional currency (as

determined under section 985) of the

foreign corporation at the spot rate on

the first day of the foreign corporation’s

taxable year beginning after December

31, 1986. For further guidance, see

Notice 88–70 (1988–2 C.B. 369, 370)

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

The term pre-1987 section 960 earnings

and profits does not include earnings

and profits that represent previously

taxed earnings and profits for purposes

of section 959.

(7) Pre-1987 section 960 foreign

income taxes. The term pre-1987 section

960 foreign income taxes means the

foreign income taxes related to pre-1987

section 960 earnings and profits,

determined in accordance with the rules

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

U.S. dollar amounts of pre-1987 section

960 foreign income taxes are determined

by reference to the exchange rates in

effect when the taxes were paid or

accrued.

(8) Earnings and profits. The term

earnings and profits means post-1986

undistributed earnings, pre-1987

accumulated profits, and pre-1987

section 960 earnings and profits.

(9) Look-through corporation. The

term look-through corporation means a

foreign corporation that is subject to the

look-through rules of section 904(d)(3)

or section 904(d)(4) (as in effect for

taxable years beginning after December

31, 2002 (the day before the effective

date of section 1105(b) of Public Law

105–34 (111 Stat. 788)) and regulations

thereunder.

(10) Non-look-through 10/50

corporation. The term non-look-through

10/50 corporation means a

noncontrolled section 902 corporation

as defined in section 904(d)(2)(E) that is

not a look-through corporation.

(11) Less-than-10%-U.S.-owned

foreign corporation. The term less-than10%-U.S.-owned foreign corporation

means a foreign corporation that is

neither a look-through corporation nor a

non-look-through 10/50 corporation.

(12) Separate category. The term

separate category has the meaning set

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

include any other category of income to

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

applied separately under any other

provision of the Internal Revenue Code

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

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

904(g)(10)).

(13) Statutory grouping of earnings

and profits. The term statutory grouping

of earnings and profits means the

earnings and profits from a specific

source or activity that must be

determined for purposes of applying a

provision of the Internal Revenue Code.

Compare § 1.861–8(a)(4) (providing an

analogous definition for statutory

grouping of gross income).

Par. 6. Section 1.367(b)–3 is amended

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

as follows:

§ 1.367(b)–3 Repatriation of foreign

corporate assets in certain nonrecognition

transactions.

* * * * *

(e) Net operating loss and capital loss

carryovers. A net operating loss or

capital loss carryover of the foreign

acquired corporation is described in

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

eligible to carry over from the foreign

acquired corporation to the domestic

acquiring corporation only to the extent

the underlying deductions or losses

were allowable under chapter 1 of

subtitle A of the Internal Revenue Code.

Thus, only a net operating loss or

capital loss carryover that is effectively

connected with the conduct of a trade

or business within the United States (or

that is attributable to a permanent

establishment, in the context of an

applicable United States income tax

treaty) is eligible to be carried over

under section 381. For further guidance,

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

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

(f) Carryover of earnings and profits.

Except to the extent otherwise

specifically provided (see, e.g., 89–79

69150 Federal Register / Vol. 65, No. 221 / Wednesday, November 15, 2000 / Proposed Rules

(1989–2 C.B. 392) (see also

§ 601.601(d)(2) of this chapter)),

earnings and profits of the foreign

acquired corporation that are not

included in income as a deemed

dividend under the section 367(b)

regulations (or deficit in earnings and

profits) are eligible to carry over from

the foreign acquired corporation to the

domestic acquiring corporation under

section 381(c)(2) or § 1.367(b)–8(b)(1)(i)

only to the extent such earnings and

profits (or deficit in earnings and

profits) are effectively connected with

the conduct of a trade or business

within the United States (or are

attributable to a permanent

establishment, in the context of an

applicable United States income tax

treaty). All other earnings and profits (or

deficit in earnings and profits) of the

foreign acquired corporation shall not

carry over to the domestic acquiring

corporation and, as a result, shall be

eliminated.

Par. 7. Section 1.367(b)–5 is amended

by:

1. Revising paragraphs (b)(1)(ii) and

(c)(2).

2. Adding paragraph (e)(3).

The revisions and addition read as

follows:

§ 1.367(b)–5 Distributions of stock

described in section 355.

* * * * *

(b) * * *

(1) * * *

(ii) If the distributee is an individual

or a tax-exempt entity as described in

§ 1.337(d)–4(c)(2) then, solely for

purposes of determining the gain

recognized by the distributing

corporation, the controlled corporation

shall not be considered to be a

corporation, and the distributing

corporation shall recognize any gain

(but not loss) realized on the

distribution.

* * * * *

(c) * * *

(2) Adjustment to basis in stock and

income inclusion—(i) In general. If the

distributee’s postdistribution amount (as

defined in paragraph (e)(2) of this

section) with respect to the distributing

or controlled corporation is less than the

distributee’s predistribution amount (as

defined in paragraph (e)(1) of this

section) with respect to such

corporation, then the distributee’s basis

in such stock immediately after the

distribution (determined under the

normal principles of section 358) shall

be reduced by the amount of the

difference. However, the distributee’s

basis in such stock shall not be reduced

below zero, and to the extent the

foregoing reduction would have reduced

basis below zero, the distributee shall

instead include such amount in income

as a deemed dividend from such

corporation. See, e.g., paragraph (g)

Example 1 of this section.

(ii) Exception. The basis reduction

rule of paragraph (c)(2)(i) of this section

shall apply only to the extent such

reduction increases the distributee’s

section 1248 amount (as defined in

§ 1.367(b)–2(c)(1)) with respect to the

distributing or controlled corporation;

otherwise such basis reduction shall be

replaced by the income inclusion rule of

paragraph (c)(2)(i) of this section. See,

e.g., § 1.367(b)–8(d)(6) Example 2.

* * * * *

(e) * * *

(3) Divisive D reorganization with a

preexisting controlled corporation. In

the case of a transaction described in

§ 1.367(b)–8(b)(4), the predistribution

amount with respect to a distributing or

controlled corporation shall be

computed after the allocation of the

distributing corporation’s earnings and

profits described in § 1.367(b)–

8(b)(4)(i)(A) and (b)(4)(ii)(A) (without

regard to the parenthetical phrase in

§ 1.367(b)–8(b)(4)(ii)(A)), but before the

reduction in the distributing

corporation’s earnings and profits

described in § 1.367(b)–8(b)(4)(i)(B).

See, e.g., § 1.367(b)–8(d)(6) Example 3

and § 1.367(b)–8(e)(7) Example 3.

* * * * *

Par. 8. In § 1.367(b)–6, paragraph

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

§ 1.367(b)–6 Effective dates and

coordination rules.

(a) Effective date—(1) In general.

Sections 1.367(b)–1 through 1.367(b)–5,

and this section, apply to section 367(b)

exchanges that occur on or after the date

that is 30 days after the date these

regulations are published as final

regulations in the Federal Register. For

guidance with respect to section 367(b)

exchanges that occur prior to the date 30

days after these regulations are

published as final regulations in the

Federal Register, see §§ 1.367(b)–1

through 1.367(b)–6 in effect prior to the

date 30 days after these regulations are

published in the Federal Register (see

26 CFR part 1 revised as of April 1,

2000).

Par. 9. Section 1.367(b)–7 is added to

read as follows:

§ 1.367(b)–7 Carryover of earnings and

profits and foreign income taxes in certain

foreign-to-foreign nonrecognition

transactions.

(a) Scope. This section applies to an

acquisition by a foreign corporation

(foreign acquiring corporation) of the

assets of another foreign corporation

(foreign target corporation) in a

transaction described in section 381

(foreign 381 transaction). This section

describes the manner and extent to

which earnings and profits and foreign

income taxes of the foreign acquiring

corporation and the foreign target

corporation carry over to the surviving

foreign corporation (foreign surviving

corporation). See § 1.367(b)–9 for

special rules governing reorganizations

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

foreign 381 transactions in which either

the foreign target corporation or the

foreign acquiring corporation is newly

created.

(b) General rules—(1) Non-previously

taxed earnings and profits and related

taxes. Earnings and profits and related

foreign income taxes of the foreign

acquiring corporation and the foreign

target corporation (pre-transaction

earnings and pre-transaction taxes,

respectively) shall carry over to the

foreign surviving corporation in the

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

(f), and (g) of this section. Dividend

distributions by the foreign surviving

corporation (post-transaction

distributions) shall be out of earnings

and profits and shall reduce related

foreign income taxes in the manner

described in paragraph (c) of this

section.

(2) Previously taxed earnings and

profits. [Reserved]

(c) Ordering rule for post-transaction

distributions. Dividend distributions out

of a foreign surviving corporation’s

earnings and profits shall be ordered in

accordance with the rules of paragraph

(c)(1), (2), or (3) of this section,

depending on whether the foreign

surviving corporation is a look-through

corporation, a non-look-through 10/50

corporation, or a less-than-10%-U.S.-

owned foreign corporation.

(1) If foreign surviving corporation is

a look-through corporation. In the case

of a foreign surviving corporation that is

a look-through corporation, posttransaction distributions shall be first

out of the look-through pool (as

described in paragraph (d) of this

section), second out of the non-lookthrough pool (as described in paragraph

(e)(1) of this section), and third out of

the pre-pooling annual layers (as

described in paragraph (f)(1) of this

section) under an annual last-in, firstout (LIFO) method.

(2) If foreign surviving corporation is

a non-look-through 10/50 corporation.

In the case of a foreign surviving

corporation that is a non-look-through

10/50 corporation, post-transaction

distributions shall be first out of the

non-look-through pool (as described in

paragraph (e)(2) of this section), and

Federal Register / Vol. 65, No. 221 / Wednesday, November 15, 2000 / Proposed Rules 69151

second out of the pre-pooling annual

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

of this section) under the LIFO method.

(3) If foreign surviving corporation is

a less-than-10%-U.S.-owned foreign

corporation. In the case of a foreign

surviving corporation that is a less-than10%-U.S.-owned corporation, posttransaction distributions shall be out of

the pre-pooling annual layers (as

described in paragraph (f)(2) of this

section) under the LIFO method.

(d) Look-through pool. If the foreign

surviving corporation is a look-through

corporation, then the look-through pool

shall be determined under the rules of

this paragraph (d).

(1) In general—(i) Qualifying earnings

and taxes. The look-through pool shall

consist of the post-1986 undistributed

earnings and related post-1986 foreign

income taxes of the foreign acquiring

corporation and the foreign target

corporation that were subject to the

look-through provisions of section

904(d)(3) or section 904(d)(4) (as in

effect for taxable years beginning after

December 31, 2002 (the day before the

effective date of section 1105(b) of

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

regulations thereunder.

(ii) Carryover rule. Subject to

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

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

of this section attributable to the foreign

acquiring corporation and the foreign

target corporation shall carry over to the

foreign surviving corporation and shall

be combined on a separate category-byseparate category basis.

(2) Hovering deficit. The rules of this

paragraph (d)(2) apply when the foreign

acquiring corporation or the foreign

target corporation has a deficit in one or

more separate categories of post-1986

undistributed earnings described in

paragraph (d)(1)(i) of this section

immediately prior to the foreign 381

transaction. In the event both the foreign

acquiring corporation and the foreign

target corporation have a deficit in the

same separate category of earnings and

profits, such deficits and their related

foreign income taxes shall be combined

for purposes of applying this paragraph

(d)(2). See also paragraphs (g)(1) and (4)

of this section (describing other rules

applicable to a deficit described in this

paragraph (d)(2)).

(i) Offset rule. A deficit in a separate

category of earnings and profits

described in this paragraph (d)(2) shall

offset only earnings and profits

accumulated by the foreign surviving

corporation after the foreign 381

transaction (post-transaction earnings)

in the same separate category of

earnings and profits.

(ii) Related taxes. Foreign income

taxes that are related to a deficit in a

separate category of earnings and profits

described in this paragraph (d)(2) shall

be added to the foreign surviving

corporation’s post-1986 foreign income

taxes related to that separate category of

earnings and profits only after posttransaction earnings in the same

separate category have been offset by

and exceed the entire amount of the

deficit.

(3) Examples. The following examples

illustrate the rules of this paragraph (d).

The examples presume the following

facts: Foreign corporations A and B

were both incorporated after December

31, 1986, always have been controlled

foreign corporations, and always have

had calendar taxable years. None of the

shareholders of foreign corporations A

and B are required to include any

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

a result of the foreign 381 transaction.

Foreign corporations A and B (and all of

their respective qualified business units

as defined in section 989) maintain a

‘‘u’’ functional currency. Finally, unless

otherwise stated, any earnings and

profits described in section 904(d)(1)(D)

and 904(d)(1)(E) (shipping income and

10/50 dividends, respectively) qualified

for the high tax exception from subpart

F income under section 954(b)(4), and

all United States shareholders elected to

exclude such earnings and profits from

subpart F income under section

954(b)(4) and § 1.954–1(d)(5). The

examples are as follows:

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

2001, foreign corporations A and B have the

following earnings and profits and foreign

income taxes accounts:

E & P Foreign taxes

Foreign Corporation A:

Separate Category:

10/50 dividends from FC1, a noncontrolled section 902 corporation ....................................................... 100u $40

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

400u 100

Foreign Corporation B:

Separate Category:

Shipping ..................................................................................................................................................... 200u 40

10/50 dividends from FC2, a noncontrolled section 902 corporation ....................................................... 50u 20

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

550u 130

(B) On January 1, 2002, foreign corporation

B acquires the assets of foreign corporation

A in a reorganization described in section

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

foreign 381 transaction, foreign surviving

corporation is a controlled foreign

corporation (CFC).

(ii) Result. Under the rules described in

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

surviving corporation has the following

earnings and profits and foreign income taxes

accounts:

Separate category E&P Foreign taxes

Shipping ................................................................................................................................................................... 200u $40

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

10/50 dividends from FC1 ....................................................................................................................................... 100u 40

10/50 dividends from FC2 ....................................................................................................................................... 50u 20

950u 230

69152 Federal Register / Vol. 65, No. 221 / Wednesday, November 15, 2000 / Proposed Rules

(iii) Post-transaction distribution. (A)

During 2002, foreign surviving corporation

does not accumulate any earnings and profits

or pay or accrue any foreign income taxes.

On December 31, 2002, foreign surviving

corporation distributes 475u to its

shareholders. Under the rules described in

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

section, the distribution is out of separate

categories and reduces foreign income taxes

as follows:

Separate category E&P Foreign taxes

Shipping ................................................................................................................................................................... 100u $20

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

10/50 dividends from FC1 ....................................................................................................................................... 50u 20

10/50 dividends from FC2 ....................................................................................................................................... 25u 10

475u 115

(B) The foreign income taxes available to

foreign surviving corporation shareholders

upon the distribution are subject to the

generally applicable rules and limitations,

such as those of sections 902 and 904(d).

(C) Immediately after the distribution,

foreign surviving corporation has the

following earnings and profits and foreign

income taxes accounts:

Separate category E&P Foreign taxes

Shipping ................................................................................................................................................................... 100u $20

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

10/50 dividends from FC1 ....................................................................................................................................... 50u 20

10/50 dividends from FC2 ....................................................................................................................................... 25u 10

475u 115

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

2001, foreign corporations A and B have the

following earnings and profits and foreign

income taxes accounts:

E&P Foreign taxes

Foreign Corporation A:

Separate Category:

Shipping ................................................................................................................................................... (100u) $5

10/50 dividends ....................................................................................................................................... 400u 160

General .................................................................................................................................................... (200u) 25

100u 190

Foreign Corporation B:

Separate Category:

Shipping ................................................................................................................................................... 100u 20

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

400u 80

(B) On January 1, 2002, foreign corporation

B acquires the assets of foreign corporation

A in a reorganization described in section

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

foreign 381 transaction, foreign surviving

corporation is a CFC.

(ii) Result. Under the rules described in

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

foreign surviving corporation has the

following earnings and profits and foreign

income taxes accounts:

Separate category

Earnings and profits Foreign taxes

Positive

E&P

Hovering

deficit

Foreign

taxes

available

Foreign

taxes associated with

hovering

deficit

Shipping ......................................................................................................................... 100u (100u) $20 $5

10/50 dividends .............................................................................................................. 400u 0u 160 0

General .......................................................................................................................... 300u (200u) 60 25

800u (300u) 240 30

(iii) Post-transaction distribution. (A)

During 2002, foreign surviving corporation

does not accumulate any earnings and profits

or pay or accrue any foreign income taxes.

On December 31, 2002, foreign surviving

corporation distributes 400u to its

shareholders. Under the rules described in

section 904(d)(3) and paragraph (c)(1) of this

section, the distribution is out of separate

categories and reduces foreign income taxes

as follows:

Federal Register / Vol. 65, No. 221 / Wednesday, November 15, 2000 / Proposed Rules 69153

Separate category E&P Foreign taxes

Shipping ................................................................................................................................................................... 50u $10

10/50 dividends ........................................................................................................................................................ 200u 80

General .................................................................................................................................................................... 150u 30

400u 120

(B) The foreign income taxes available to

foreign surviving corporation shareholders

upon the distribution are subject to the

generally applicable rules and limitations,

such as those of sections 902 and 904(d).

(C) Immediately after the distribution,

foreign surviving corporation has the

following earnings and profits and foreign

income taxes accounts:

Separate category

Earnings and profits Foreign taxes

Positive

E&P

Hovering

deficit

Foreign

taxes

available

Foreign

taxes associated with

hovering

deficit

Shipping ......................................................................................................................... 50u (100u) $10 $5

10/50 dividends .............................................................................................................. 200u 0u 80 0

General .......................................................................................................................... 150u (200u) 30 25

400u (300u) 120 30

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

taxable year ending on December 31, 2003,

foreign surviving corporation accumulates

earnings and profits and pays related foreign

income taxes as follows:

Separate category E&P Foreign taxes

Shipping ................................................................................................................................................................... 105u $20

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

205u 40

(B) None of foreign surviving corporation’s

earnings and profits for its 2003 taxable year

qualify as subpart F income as defined in

section 952(a). Under the rules described in

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

foreign surviving corporation has the

following earnings and profits and foreign

income taxes accounts on December 31,

2003:

Separate category

Earnings and profits Foreign taxes

Positive

E&P

Hovering

deficit

Foreign

taxes

available

Foreign

taxes associated with

hovering

deficit

Shipping ......................................................................................................................... 55u 0u $35 $0

10/50 dividends .............................................................................................................. 200u 0u 80 0

General .......................................................................................................................... 150u (100u) 50 25

405u (100u) 165 25

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

same as Example 2 (i), (ii), (iii), and (iv)(A),

except that the 105u in the section

904(d)(1)(D) shipping separate category

accumulated by foreign surviving corporation

during 2003 qualify as subpart F income, all

of which is included in income under section

951(a) by United States shareholders (as

defined in section 951(b)).

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

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

hovering deficit in the shipping separate

category does not reduce foreign surviving

corporation’s current earnings and profits for

purposes of determining subpart F income.

Thus, foreign surviving corporation’s United

States shareholders include their pro rata

shares of the 105u in taxable income for the

year and are eligible for a deemed paid

foreign tax credit under section 960,

computed by reference to their pro rata

shares of $20.32 (105u subpart F inclusion ÷

(105u + 50u accumulated earnings and

profits in the shipping category = 155u) =

0.68%, × $30 foreign income taxes in the

shipping category = $20.32).

(B) Immediately after the subpart F

inclusion and section 960 deemed paid taxes

(and taking into account the taxable year

2003 earnings and profits and related taxes

in the general category), foreign surviving

corporation has the following earnings and

profits and foreign income taxes accounts:

69154 Federal Register / Vol. 65, No. 221 / Wednesday, November 15, 2000 / Proposed Rules

Separate category

Earnings and profits Foreign taxes

Positive

E&P

Hovering

deficit

Foreign

taxes

available

Foreign

taxes associated with

hovering

deficit

Shipping ......................................................................................................................... 50u (100u) $9.68 $5

10/50 dividends .............................................................................................................. 200u 0u 80.00 0

General .......................................................................................................................... 150u (100u) 50.00 25

400u (200u) 139.68 30

(C) The 105u included as subpart F income

constitutes previously taxed earnings and

profits under section 959.

(e) Non-look-through pool—(1) If

foreign surviving corporation is a lookthrough corporation. If the foreign

surviving corporation is a look-through

corporation, then the non-look-through

pool shall be determined under the

rules of this paragraph (e)(1).

(i) Qualifying earnings and taxes. The

non-look-through pool shall consist of

the post-1986 undistributed earnings

and related post-1986 foreign income

taxes that were accumulated (or treated

as accumulated) by the foreign target

corporation or the foreign acquiring

corporation while it was a non-lookthrough 10/50 corporation.

(ii) Carryover rule. Subject to

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

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

of this section attributable to the foreign

acquiring corporation and the foreign

target corporation shall carry over to the

foreign surviving corporation but shall

not be combined. Thus, post-transaction

distributions by the foreign surviving

corporation out of the non-look-through

pool shall be made from the separate

amounts attributable to the foreign

acquiring corporation and the foreign

target corporation on a pro rata basis,

and shall reduce a pro rata portion of

any related foreign income taxes.

(iii) Hovering deficit. The rules of this

paragraph (e)(1)(iii) apply when the

foreign acquiring corporation or the

foreign target corporation (or both) has

a deficit in the post-1986 undistributed

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

of this section immediately prior to the

foreign 381 transaction. In the event that

this paragraph (e)(1)(iii) applies to a

deficit of both the foreign acquiring

corporation and the foreign target

corporation, the deficits shall not be

combined and the rules of this

paragraph (e)(1)(iii) shall be applied

separately to each of such deficits on a

pro rata basis. See also paragraphs (g)(1)

and (g)(4) of this section (describing

other rules applicable to a deficit

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

(A) Offset rule. A deficit described in

this paragraph (e)(i)(iii) shall offset only

post-transaction earnings. The deficit

shall offset a pro rata portion of posttransaction earnings accumulated in

each separate category of earnings and

profits by the foreign surviving

corporation.

(B) Related taxes. Foreign income

taxes that are related to a deficit

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

shall be added to the foreign surviving

corporation’s post-1986 foreign income

taxes (in the applicable segregated

portion of the non-look-through pool)

only after post-transaction earnings have

been offset by and exceed the entire

amount of the deficit.

(iv) Examples. The following

examples illustrate the rules of this

paragraph (e)(1). The examples presume

the following facts: Foreign corporation

A was a non-look-through 10/50

corporation from its incorporation on

January 1, 1995 until December 31,

1997; foreign corporation A became a

CFC on January 1, 1998 and has been a

CFC since that time. Foreign corporation

B has been a non-look-through 10/50

corporation since its incorporation on

January 1, 1993. Both foreign

corporation A and foreign corporation B

always have had calendar taxable years.

None of the shareholders of foreign

corporation A are required to include

any amount in income under § 1.367(b)–

4 as a result of the foreign 381

transaction. Foreign corporations A and

B (and all of their respective qualified

business units as defined in section 989)

maintain a ‘‘u’’ functional currency.

Finally, any earnings and profits

described in section 904(d)(1)(E) (10/50

dividends) qualified for the high tax

exception from subpart F income under

section 954(b)(4), and all United States

shareholders elected to exclude such

earnings and profits from subpart F

income under section 954(b)(4) and

§ 1.954–1(d)(5). The examples are as

follows:

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

2001, foreign corporations A and B have the

following earnings and profits and foreign

income taxes accounts:

E&P Foreign taxes

Foreign Corporation A:

Separate Category:

10/50 dividends ......................................................................................................................................... 100u $40

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

E&P Accumulated as Non-Look-Through 10/50 Corporation ................................................................................. 400u 100

800u 200

Foreign Corporation B:

E&P Accumulated as Non-Look-Through 10/50 Corporation .......................................................................... 200u $40

(B) On January 1, 2002, foreign corporation

B acquires the assets of foreign corporation

A in a reorganization described in section

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

foreign 381 transaction, foreign surviving

corporation is a CFC.

(ii) Result. Under the rules described in

paragraphs (d)(1), (e)(1)(i), and (e)(1)(ii) of

this section, foreign surviving corporation

has the following earnings and profits and

foreign income taxes accounts:

Federal Register / Vol. 65, No. 221 / Wednesday, November 15, 2000 / Proposed Rules 69155

E&P Foreign taxes

Look-Through Pool Separate Category:

10/50 dividends ................................................................................................................................................ 100u $40

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

Two Side-by-Side Non-Look-Through Pool Amounts:

Non-look-through pool amount #1 (from Corp A) ............................................................................................ 400u 100

Non-look-through pool amount #2 (from Corp B) ............................................................................................ 200u 40

1,000u 240

(iii) Post-transaction distribution.—(A)

During 2002, foreign surviving corporation

does not accumulate any earnings and profits

or pay or accrue any foreign income taxes.

On December 31, 2002, foreign surviving

corporation distributes 700u to its

shareholders. Under the rules described in

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

the distribution is first out of the lookthrough pool, then out of the non-lookthrough pool, as follows:

E&P Foreign taxes

Look-Through Pool Separate Category:

10/50 dividends ................................................................................................................................................ 100u $40

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

Non-Look-Through Pool Amounts:

Non-look-through pool amount #1 .................................................................................................................... 200u 50

Non-look-through pool amount #2 .................................................................................................................... 100u 20

700u 170

(B) The foreign income taxes available to

foreign surviving corporation shareholders

upon the distribution are subject to the

generally applicable rules and limitations,

such as those of sections 902 and 904(d).

(C) Immediately after the distribution,

foreign surviving corporation has the

following earnings and profits and foreign

income taxes accounts:

E&P Foreign taxes

Two Side-by-Side Non-Look-Through Pool Amounts:

Non-look-through pool amount #1 .................................................................................................................... 200u $50

Non-look-through pool amount #2 .................................................................................................................... 100u 20

300u 70

Example 2—(i) Facts.—(A) On December 31, 2001, foreign corporations A and B have the following earnings and profits and

foreign income taxes accounts:

E&P Foreign taxes

Foreign Corporation A:

Look-through Pool Separate Category:

10/50 dividends ....................................................................................................................................... 100u $40

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

E&P Accumulated as Non-Look-Through 10/50 Corporation ............................................................................... 400u 100

800u 200

Foreign Corporation B:

E&P Accumulated as Non-Look-Through 10/50 Corporation ........................................................................ (200u) 5

(B) On January 1, 2002, foreign corporation

B acquires the assets of foreign corporation

A in a reorganization described in section

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

foreign 381 transaction, foreign surviving

corporation is a CFC.

(ii) Result. Under the rules described in

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

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

corporation has the following earnings and

profits and foreign income taxes accounts:

Earnings & profits Foreign taxes

Positive

E&P

Hovering

deficit

Foreign

taxes

available

Foreign

taxes associated with

hovering

deficit

Look-through Pool Separate Category:

10/50 dividends ........................................................................................................ 100u .................... $40 ....................

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

69156 Federal Register / Vol. 65, No. 221 / Wednesday, November 15, 2000 / Proposed Rules

Earnings & profits Foreign taxes

Positive

E&P

Hovering

deficit

Foreign

taxes

available

Foreign

taxes associated with

hovering

deficit

Two Side-by-Side Non-Look-Through Pool Amounts:

Non-look-through pool amount #1 ............................................................................ 400u .................... 100 ....................

Non-look-through pool amount #2 ............................................................................ .................... (200u) .................... $5

800u (200u) 200 5

(iii) Post-transaction distribution.—(A)

During 2002, foreign surviving corporation

does not accumulate any earnings and profits

or pay or accrue any foreign income taxes.

On December 31, 2002, foreign surviving

corporation distributes 600u to its

shareholders. Under the rules described in

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

the distribution is first out of the lookthrough pool, then out of the non-lookthrough pool, as follows:

E&P Foreign taxes

Look-Through Pool Separate Category:

10/50 dividends ................................................................................................................................................ 100u $40

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

Non-Look-Through Pool Amount:

Non-look-through pool amount #1 .................................................................................................................... 200u 50

600u 150

(B) The foreign income taxes available to

foreign surviving corporation shareholders

upon the distribution are subject to the

generally applicable rules and limitations,

such as those of sections 902 and 904(d).

(C) Immediately after the distribution,

foreign surviving corporation has the

following earnings and profits and foreign

income taxes accounts:

Earnings & profits Foreign taxes

Positive

E&P

Hovering

deficit

Foreign

taxes

available

Foreign

taxes associated with

hovering

deficit

Two Side-by-Side Non-Look-Through Pool Amounts:

Non-look-through pool amount #1 ............................................................................ 200u $50

Non-look-through pool amount #2 ............................................................................ (200u) $5

200u (200u) 50 5

(iv) Post-transaction earnings.—(A) In the taxable year ending on December 31, 2003, foreign surviving corporation accumulates

earnings and profits and pays related foreign income taxes as follows:

E&P Foreign taxes

Separate Category:

10/50 dividends ................................................................................................................................................ 150u $60

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

450u 120

(B) None of the earnings and profits qualify

as subpart F income as defined in section

952(a). Under the rules described in

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

200u deficit in non-look-through pool

amount #2 offsets a pro rata portion of the

foreign surviving corporation’s posttransaction earnings in each separate

category. Thus, the 200u deficit offsets

66.66u of section 904(d)(1)(E) 10/50

dividends separate category earnings

(33.33% of 200u) and offsets 133.34u of

section 904(d)(1)(I) general separate category

earnings (66.67% of 200u). Accordingly,

foreign surviving corporation has the

following earnings and profits and foreign

income taxes accounts as of December 31,

2002:

E&P Foreign taxes

Look-Through Pool Separate Category:

10/50 dividends ................................................................................................................................................ 83.34u $60

General ............................................................................................................................................................. 166.66u 60

Federal Register / Vol. 65, No. 221 / Wednesday, November 15, 2000 / Proposed Rules 69157

E&P Foreign taxes

Two Side-by-Side Non-Look-Through Pool Amounts:

Non-look-through pool amount #1 .................................................................................................................... 200u 50

Non-look-through pool amount #2 .................................................................................................................... 5

450u 175

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

section, the $5 of foreign income taxes

associated with the non-look-through pool

amount #2 hovering deficit are added to

foreign surviving corporation’s available

foreign income taxes because posttransaction earnings have been offset by and

exceed the deficit in the non-look-through

pool. However, the $5 of foreign income

taxes generally will not be reduced or

deemed paid unless a foreign tax refund

restores a positive balance to the associated

earnings pursuant to section 905(c), and thus

will be trapped.

(2) If foreign surviving corporation is

a non-look-through 10/50 corporation. If

the foreign surviving corporation is a

non-look-through 10/50 corporation,

then the non-look-through pool shall be

determined under the rules of this

paragraph (e)(2).

(i) Qualifying earnings and taxes. The

non-look-through pool shall consist of

the post-1986 undistributed earnings

and related post-1986 foreign income

taxes of the foreign acquiring

corporation and the foreign target

corporation.

(ii) Carryover rule. Subject to

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

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

of this section attributable to the foreign

acquiring corporation and the foreign

target corporation shall carry over to the

foreign surviving corporation and shall

be combined as a single separate

category of earnings and profits under

section 904(d)(1)(E).

(iii) Hovering deficit. The rules of this

paragraph (e)(2)(iii) apply when the

foreign acquiring corporation or the

foreign target corporation (or both) has

an aggregate deficit in its post-1986

undistributed earnings described in

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

immediately prior to the foreign 381

transaction. In the event that both the

foreign acquiring corporation and the

foreign target corporation have an

aggregate deficit in post-1986

undistributed earnings, such deficits

and their related foreign income taxes

shall be combined for purposes of

applying this paragraph (e)(2)(iii). See

also paragraphs (g)(1) and (4) of this

section (describing other rules

applicable to a deficit described in this

paragraph (e)(2)(iii)).

(A) Offset rule. A deficit described in

this paragraph (e)(2)(iii) shall offset only

post-transaction earnings accumulated

by the foreign surviving corporation.

(B) Related taxes. Foreign income

taxes that are related to a deficit

described in this paragraph (e)(2)(iii)

shall be added to the foreign surviving

corporation’s post-1986 foreign income

taxes only after post-transaction

earnings have been offset by and exceed

the entire amount of the deficit.

(iv) Examples. The following

examples illustrate the rules of this

paragraph (e)(2). The examples presume

the following facts: Both foreign

corporation A and foreign corporation B

always have had calendar taxable years.

Foreign corporations A and B (and all of

their respective qualified business units

as defined in section 989) maintain a

‘‘u’’ functional currency. Finally, any

earnings and profits described in section

904(d)(1)(E) (10/50 dividends) qualified

for the high tax exception from subpart

F income under section 954(b)(4), and

all United States shareholders elected to

exclude such earnings and profits from

subpart F income under section

954(b)(4) and § 1.954–1(d)(5). The

examples are as follows:

Example 1— (i) Facts. (A) Foreign

corporations A and B are and always have

been non-look-through 10/50 corporations

since they were incorporated in 1995. On

December 31, 2001, foreign corporations A

and B have the following earnings and profits

and foreign income taxes accounts:

E&P Foreign taxes

Foreign Corporation A: E&P accumulated as non-look-through 10/50 corporation ............................................... 400u $100

Foreign Corporation B: E&P accumulated as non-look-through 10/50 corporation ............................................... 200u 40

(B) On January 1, 2002, foreign corporation

B acquires the assets of foreign corporation

A in a reorganization described in section

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

foreign 381 transaction, foreign surviving

corporation is a non-look-through 10/50

corporation.

(ii) Result. Under the rules described in

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

foreign surviving corporation has the

following earnings and profits and foreign

income taxes accounts:

E&P Foreign taxes

Non-Look-Through Pool .......................................................................................................................................... 600u $140

Example 2—(i) Facts. (A) Foreign

corporation A is and always has been a CFC

since it was incorporated in 1995. Foreign

corporation B is and always has been a nonlook-through 10/50 corporation since it was

incorporated in 1995. Immediately before the

foreign 381 transaction (but after application

of the rules of § 1.367(b)–4 to foreign

corporation A and its shareholders), foreign

corporations A and B have the following

earnings and profits and foreign income taxes

accounts:

E&P Foreign taxes

Foreign Corporation A:

Separate Category:

Passive .................................................................................................................................................... (200u) $10

10/50 dividends ....................................................................................................................................... 100u 40

69158 Federal Register / Vol. 65, No. 221 / Wednesday, November 15, 2000 / Proposed Rules

E&P Foreign taxes

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

(200u) $110

Foreign Corporation B:

E&P accumulated as non-look-through 10/50 corporation ............................................................................ 200u $30

(B) On January 1, 2002, foreign corporation

B acquires the assets of foreign corporation

A in a reorganization described in section

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

foreign 381 transaction, foreign surviving

corporation is a non-look-through 10/50

corporation.

(ii) Result. Because neither foreign

corporation A nor foreign corporation B has

an aggregate deficit in post-1986

undistributed earnings, the rules described in

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

apply, but the rules described in paragraph

(e)(2)(iii) do not. Accordingly, foreign

corporation A’s net positive earnings and

profits of 200u (300u + 100u + (200u)) and

its aggregate foreign income taxes of $110

($10 + $40 + $60) are combined with the

earnings and profits and foreign income taxes

of foreign corporation B, so that foreign

surviving corporation has the following

earnings and profits and foreign income taxes

accounts:

E&P Foreign taxes

Non-Look-Through Pool .......................................................................................................................................... 400u $140

Example 3—(i) Facts. (A) Foreign

corporation A is and always has been a CFC

since it was incorporated in 1995. Foreign

corporation B is and always has been a nonlook-through 10/50 corporation since it was

incorporated in 1995. On December 31, 2001,

foreign corporations A and B have the

following earnings and profits and foreign

income taxes accounts:

E&P Foreign taxes

Foreign Corporation A:

Separate Category:

Passive .................................................................................................................................................... (200u) $10

10/50 dividends ....................................................................................................................................... 100u 40

General .................................................................................................................................................... (300u) 60

(400u) $110

Foreign Corporation B:

E&P accumulated as non-look-through 10/50 corporation ............................................................................ 200u $30

(B) On January 1, 2002, foreign corporation

B acquires the assets of foreign corporation

A in a reorganization described in section

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

foreign 381 transaction, foreign surviving

corporation is a non-look-through 10/50

corporation. (Assume that none of the

shareholders of foreign corporation A are

required to include an amount in income

under § 1.367(b)–4 with regard to this

transaction.)

(ii) Result. Because foreign corporation A

has an aggregate deficit in post-1986

undistributed earnings, the rules of

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

Accordingly, foreign corporation A’s 400u

aggregate deficit in earnings and profits

((200u) + 100u + (300u)) carries over as a

hovering deficit to foreign surviving

corporation, so that foreign surviving

corporation has the following earnings and

profits and foreign income taxes accounts:

Earnings and profits Foreign taxes

Positive

E&P

Hovering

deficit

Foreign

taxes

available

Foreign

taxes associated with

hovering

deficit

Non-Look-Through Pool .................................................................................................. 200u (400u) $30 $110

(iii) Post-transaction earnings. (A) In the taxable year ending on December 31, 2002, foreign surviving corporation accumulates

earnings and profits and pays related foreign income taxes as follows:

E&P Foreign taxes

E&P accumulated as non-look-through 10/50 corporation ..................................................................................... 500u $100

(B) Under the rule described in paragraph

(e)(2)(iii)(A) of this section, the hovering

deficit of 400u in the non-look-through pool

offsets 400u of post-transaction earnings.

Under the rules of paragraph (e)(2)(iii)(B) of

this section, the foreign income taxes related

to the hovering deficit are added to foreign

surviving corporation’s available foreign

income taxes because post-transaction

earnings have been offset by and exceed the

deficit in the non-look-through pool.

Accordingly, foreign surviving corporation

has the following earnings and profits and

foreign income taxes accounts as of

December 31, 2002:

Federal Register / Vol. 65, No. 221 / Wednesday, November 15, 2000 / Proposed Rules 69159

E&P Foreign taxes

Non-Look-Through Pool .......................................................................................................................................... 300u $240

(f) Pre-pooling annual layers—(1) If

foreign surviving corporation is a lookthrough corporation or a non-lookthrough 10/50 corporation. If the foreign

surviving corporation is a look-through

corporation or a non-look-through 10/50

corporation, the pre-pooling annual

layers shall be determined under the

rules of this paragraph (f)(1).

(i) Qualifying earnings and taxes. The

pre-pooling annual layers shall consist

of the pre-1987 accumulated profits and

the pre-1987 foreign income taxes of the

foreign acquiring corporation and the

foreign target corporation.

(ii) Carryover rule. Subject to

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

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

of this section attributable to the foreign

acquiring corporation and the foreign

target corporation shall carry over to the

foreign surviving corporation but shall

not be combined. Thus, when the

foreign acquiring corporation and the

foreign target corporation have pre-1987

accumulated profits in the same year

and a distribution is made therefrom,

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

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

foreign income taxes of the foreign

acquiring corporation and the foreign

target corporation on a pro rata basis.

For further guidance, see Rev. Rul. 68–

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

(1970–2 C.B. 152) (see also

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

paragraph (g)(2) of this section

(governing the reconciliation of taxable

years).

(iii) Deficits. The rules of this

paragraph (f)(1)(iii) apply when the

foreign acquiring corporation or the

foreign target corporation (or both) has

a deficit in one or more years that

comprise its pre-1987 accumulated

profits immediately prior to the foreign

381 transaction (see also paragraphs

(g)(1) and (g)(4) of this section,

describing other rules applicable to a

deficit described in this paragraph

(f)(1)(iii)).

(A) Aggregate positive earnings and

profits. If the foreign acquiring

corporation or the foreign target

corporation (or both) has an aggregate

positive (or zero) amount of pre-1987

accumulated profits, but a deficit in one

or more individual years, then the rules

otherwise applicable to such deficits

shall apply separately to the pre-1987

accumulated profits and related foreign

income taxes of such corporation. For

further guidance, see Rev. Rul. 74–550

(1974–2 C.B. 209) (see also

§ 601.601(d)(2) of this chapter);

Champion Int’l Corp. v. Commissioner,

81 T.C. 424 (1983), acq. in result, 1987–

2 C.B. 1; Rev. Rul. 87–72 (1987–2 C.B.

170) (see also § 601.601(d)(2) of this

chapter). As a result, no amount in

excess of the aggregate positive amount

of pre-1987 accumulated profits shall be

distributed from the pre-transaction

earnings of the foreign acquiring

corporation or the foreign target

corporation.

(B) Aggregate deficit in earnings and

profits. If the foreign acquiring

corporation or the foreign target

corporation (or both) has an aggregate

deficit in pre-1987 accumulated profits,

then the rules under § 1.902–2(b) shall

apply to such deficit (and related

foreign income taxes) immediately prior

to the transaction, except that the

aggregate deficit that is carried forward

into the look-through pool (in the case

of a foreign surviving corporation that is

a look-through corporation) or non-lookthrough pool (in the case of a foreign

surviving corporation that is a non-lookthrough 10/50 corporation) shall be

available to offset only post-transaction

earnings accumulated by the foreign

surviving corporation.

(iv) Pre-1987 section 960 earnings and

profits and foreign income taxes. The

pre-1987 section 960 earnings and

profits and pre-1987 section 960 foreign

income taxes attributable to the foreign

acquiring corporation and the foreign

target corporation shall carry over to the

foreign surviving corporation but shall

not be combined. The rules otherwise

applicable to such amounts shall apply

separately to the pre-1987 section 960

earnings and profits and pre-1987

section 960 foreign income taxes of the

foreign acquiring corporation and the

foreign target corporation on a pro rata

basis. For further guidance, see Notice

88–70 (1988–2 C.B. 369) (see also

§ 601.601(d)(2) of this chapter).

(v) Examples. The following examples

illustrate the rules of this paragraph

(f)(1). The examples presume the

following facts: foreign corporation A

was incorporated in 1998 and was a

less-than-10%-U.S.-owned foreign

corporation through December 31, 1999.

Foreign corporation A became a nonlook-through 10/50 corporation on

January 1, 2000 and, as a result, began

to maintain a pool of post-1986

undistributed earnings on that date.

Foreign corporation B was

incorporated in 1998 and always has

been owned by foreign shareholders

(and thus never has met the

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

Both foreign corporation A and foreign

corporation B always have had calendar

taxable years. Foreign corporations A

and B (and all of their respective

qualified business units as defined in

section 989) maintain a ‘‘u’’ functional

currency. The examples are as follows:

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

2001, foreign corporations A and B have the

following earnings and profits and foreign

income taxes accounts:

E&P Foreign taxes

Foreign Corporation A:

E&P accumulated as non-look-through 10/50 corporation ..................................................................................... 1,000u $350

1999 .................................................................................................................................................................. 400u 160u

1998 .................................................................................................................................................................. 100u 5u

1,500u

Foreign Corporation B:

2001 .................................................................................................................................................................. 100u 20u

2000 .................................................................................................................................................................. 150u 30u

1999 .................................................................................................................................................................. 0u 50u

1998 .................................................................................................................................................................. 50u 5u

300u 105u

69160 Federal Register / Vol. 65, No. 221 / Wednesday, November 15, 2000 / Proposed Rules

(B) On January 1, 2002, foreign corporation

B acquires the assets of foreign corporation

A in a reorganization described in section

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

foreign 381 transaction, foreign surviving

corporation is a non-look-through 10/50

corporation.

(ii) Result. Under the rules described in

paragraphs (e)(2)(i), (e)(2)(ii), (f)(1)(i), and

(f)(1)(ii) of this section, foreign surviving

corporation has the following earnings and

profits and foreign income taxes accounts:

E&P Foreign taxes

Non-look-through pool ............................................................................................................................................. 1,000u $350

2001 ......................................................................................................................................................................... 100u 20u

2000 ......................................................................................................................................................................... 150u 30u

Two Side-by-Side Layers of 1999 E&P:

1999 layer #1 (from Corp A) ............................................................................................................................ 400u 160u

1999 layer #2 (from Corp B) ............................................................................................................................ 0u 50u

Two Side-by-Side Layers of 1998 E&P:

1998 layer #1 (from Corp A) ............................................................................................................................ 100u 5u

1998 layer #2 (from Corp B) ............................................................................................................................ 50u 5u

1,800u

(iii) Post-transaction distribution. (A)

During 2002, foreign surviving corporation

does not accumulate any earnings and profits

or pay or accrue any foreign income taxes.

On December 31, 2002, foreign surviving

corporation distributes 1,700u to its

shareholders. Under the rules of paragraph

(c)(2) of this section, the distribution is first

out of the non-look-through pool, and then

out of the pre-pooling annual layers under

the LIFO method, as follows:

Distribution E&P Foreign taxes

Non-look-through pool ............................................................................................................................................. 1,000u $350

2001 ......................................................................................................................................................................... 100u 20u

2000 ......................................................................................................................................................................... 150u 30u

Two Side-by-Side Layers of 1999 E&P:

1999 layer #1 .................................................................................................................................................... 400u 160u

1999 layer #2 .................................................................................................................................................... 0u 0u

Two Side-by-Side Layers of 1998 E&P:

1998 layer #1 (100u in layer ÷ 150u aggregate 1997 earnings = 66.67% × 50u distribution) ....................... 33.33u 1.67u

1998 layer #2 (50u in layer ÷ 150u aggregate 1997 earnings = 33.33% × 50u distribution) ......................... 16.67u 1.67u

1,700u

(B) The foreign income taxes available to

foreign surviving corporation shareholders

upon the distribution are subject to the

generally applicable rules and limitations,

such as those of sections 902 and 904(d).

(C) Immediately after the distribution,

foreign surviving corporation has the

following earnings and profits and foreign

income taxes accounts:

E&P Foreign taxes

1999 layer #2 ........................................................................................................................................................... 0.00u 50.00u

Two Side-by-Side Layers of 1998 E&P:

1998 layer #1 .................................................................................................................................................... 66.67u 3.33u

1998 layer #2 .................................................................................................................................................... 33.33u 3.33u

100.00u 56.66u

(iv) Post-transaction earnings. For the

taxable year ending on December 31, 2003,

foreign surviving corporation accumulates

500u of current earnings and profits and pays

$70 in foreign income taxes. As of the close

of the 2003 taxable year, foreign surviving

corporation has the following earnings and

profits and foreign income taxes accounts:

E&P Foreign taxes

E&P accumulated as non-look-through 10/50 corporation ..................................................................................... 500.00u $70.00

1999 ......................................................................................................................................................................... 0.00u 50.00u

Two Side-by-Side Layers of 1998 E&P:.

1998 layer #1 .................................................................................................................................................... 66.67u 3.33u

1998 layer #2 .................................................................................................................................................... 33.33u 3.33u

600u

Example 2—(i) Facts. (A) On December 31, 2001, foreign corporations A and B have the following earnings and profits and

foreign income taxes accounts:

Federal Register / Vol. 65, No. 221 / Wednesday, November 15, 2000 / Proposed Rules 69161

E&P Foreign

taxes

Foreign Corporation A:

E&P accumulated as non-look-though 10/50 corporation ....................................................................................... 1,000u $350

1999 .......................................................................................................................................................................... 100u 20u

1998 .......................................................................................................................................................................... (50u) 5u

1,050u

Foreign Corporation B:

E&P Foreign Taxes.

2001 .......................................................................................................................................................................... 100u 20u

2000 .......................................................................................................................................................................... (50u) 5u

1999 .......................................................................................................................................................................... 0u 50u

1998 .......................................................................................................................................................................... 100u 10u

150u 85u

(B) On January 1, 2002, foreign corporation

B acquires the assets of foreign corporation

A in a reorganization described in section

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

foreign 381 transaction, foreign surviving

corporation is a non-look-through 10/50

corporation.

(ii) Result. Because foreign corporations A

and B have aggregate positive amounts of

pre-1987 accumulated profits with a deficit

in one or more individual years, the rules of

paragraph (f)(1)(iii)(A) of this section apply.

Accordingly, after the foreign 381

transaction, foreign surviving corporation has

the following earnings and profits and

foreign income taxes accounts:

Earnings and profits Foreign taxes

Positive

E&P Deficit E&P

Foreign

taxes available

Foreign

taxes associated with

deficit E&P

Non-Look-Through 10/50 Pool ........................................................................................ 1,000u .................... $350 ....................

2001 ................................................................................................................................. 100u .................... 20u ....................

2000 ................................................................................................................................. .................... (50u) .................... 5u

Two Side-by-Side Layers of 1999 E&P:

1999 layer #1 (from foreign corporation A) .............................................................. 100u .................... 20u ....................

1999 layer #2 (from foreign corporation B) .............................................................. 0u .................... 50u ....................

Two Side-by-Side Layers of 1998 E&P:

1998 layer #1 (from foreign corporation A) .............................................................. .................... (50u) .................... 5u

1998 layer #2 (from foreign corporation B) .............................................................. 100u .................... 10u ....................

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

(iii) Post-transaction distribution. (A)

During 2002, foreign surviving corporation

does not accumulate any earnings and profits

or pay or accrue any foreign income taxes.

On December 31, 2002, foreign surviving

corporation distributes 1,175u to its

shareholders. Under the rules described in

paragraphs (c)(2) and (f)(1)(iii)(A) of this

section, the distribution is first out of the

non-look-through pool, and then out of the

pre-pooling annual layers, as follows:

Distribution E&P Foreign taxes

Non-Look-Through 10/50 Amount ........................................................................................................................... 1,000u $350

2001 ......................................................................................................................................................................... 100u 20u

2000 ......................................................................................................................................................................... 0u 0u

Two Side-by-Side Layers of 1999 E&P:

1999 layer #1 .................................................................................................................................................... 50u 20u

1999 layer #2 .................................................................................................................................................... 0u 0u

Two Side-by-Side Layers of 1998 E&P:

1998 layer #1 .................................................................................................................................................... 0u 0u

1998 layer #2 .................................................................................................................................................... 25u 5u

1,175u

(B) Under the rules described in paragraph

(f)(1)(iii)(A) of this section, the rules

otherwise applicable when a foreign

corporation has an aggregate positive (or

zero) amount of pre-1987 accumulated

profits, but a deficit in one or more

individual years, apply separately to the pre1987 accumulated profits and related foreign

income taxes of foreign corporation A and

foreign corporation B. As a result,

distributions out of the pre-pooling annual

layers of foreign corporation A and foreign

corporation B can not exceed the aggregate

positive amount of pre-1987 accumulated

profits of each corporation. Accordingly, only

50u can be distributed from foreign

corporation A’s pre-pooling annual layers

and is out of its 1999 layer #1. Under

Champion Int’l Corp. v. Commissioner, 81

T.C. 424 (1983), the full 20u of taxes related

to 1999 layer #1 is reduced or deemed paid

($20 × (50 ÷ 50)). Under Rev. Rul. 74–550

(1974–2 C.B. 209) (see also § 601.601(d)(2) of

this chapter), 100u is distributed from foreign

corporation B’s 2001 annual layer. Foreign

corporation B’s deficit in 2000 is then rolled

back to offset its 1998 annual layer to reduce

69162 Federal Register / Vol. 65, No. 221 / Wednesday, November 15, 2000 / Proposed Rules

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

is distributed (and reduces one-half of that

year’s foreign income taxes).

(C) The foreign income taxes available to

foreign surviving corporation shareholders

upon the distribution are subject to the

generally applicable rules and limitations,

such as those of sections 902 and 904(d).

(D) Immediately after the distribution

foreign surviving corporation has the

following earnings and profits and foreign

income taxes accounts:

E&P Foreign

taxes

2000 ................................................................................................................................................................................. 0u 5u

1999 layer #2 ................................................................................................................................................................... 0u 50u

Two Side-by-Side Layers of 1998 E&P:

1998 layer #1 ............................................................................................................................................................ 0u 5u

1998 layer #2 ............................................................................................................................................................ 25u 5u

25u 65u

(E) Under the rules described in paragraph

(f)(1)(iii)(A) of this section, the 5u, 50u, and

5u of foreign income taxes related to foreign

surviving corporation’s 2000 layer, 1999

layer #2, and 1998 layer #1, respectively,

remain in those layers. These foreign income

taxes generally will not be reduced or

deemed paid unless a foreign tax refund

restores a positive balance to the associated

earnings pursuant to section 905(c), and thus

will be trapped.

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

2001, foreign corporations A and B have the

following earnings and profits and foreign

income taxes accounts:

E&P Foreign taxes

Foreign Corporation A:

E&P accumulated as non-look-through 10/50 corporation ............................................................................ 1,000u $350

1999 ................................................................................................................................................................ 150u 20u

1998 ................................................................................................................................................................ 100u 5u

1,250u

Foreign Corporation B:

2001 ................................................................................................................................................................ 100u 20u

2000 ................................................................................................................................................................ (250u) 5u

1999 ................................................................................................................................................................ 0u 50u

1998 ................................................................................................................................................................ 100u 10u

(50u) 85u

(B) On January 1, 2002, foreign corporation

B acquires the assets of foreign corporation

A in a reorganization described in section

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

foreign 381 transaction, foreign surviving

corporation is a non-look-through 10/50

corporation.

(ii) Result. (A) Because foreign corporation

B has an aggregate deficit in pre-1987

accumulated profits, the rules of paragraph

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

Accordingly, § 1.902–2(b) applies

immediately prior to the foreign 381

transaction, except that foreign corporation

B’s aggregate deficit in pre-1987 accumulated

profits is carried forward into the post-1986

undistributed earnings pool and is available

to offset only post-transaction earnings

accumulated by foreign surviving

corporation. Accordingly, after the foreign

381 transaction, foreign surviving

corporation has the following earnings and

profits and foreign income taxes accounts:

Earnings and profits Foreign taxes

Positive E&P Hovering

deficit

Foreign taxes

available

Foreign taxes

associated

with hovering

deficit

Non-Look-Through 10/50 Pool ........................................................................ 1,000u (50u) $350 $0

2001 ................................................................................................................. 0u ........................ 20u ........................

2000 ................................................................................................................. 0u ........................ 5u ;

Two Side-by-Side Layers of 1999 E&P:

1999 layer #1 (from Corp A) .................................................................... 150u ........................ 20u ........................

1999 layer #2 (from Corp B) .................................................................... 0u ........................ 50u ........................

Two Side-by-Side Layers of 1998 E&P:

1998 layer #1 (from Corp A) .................................................................... 100u ........................ 5u ........................

1998 layer #2 (from Corp B) .................................................................... 0u ........................ 10u ........................

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

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

section, the 20u, 5u, 50u, and 10u of foreign

income taxes associated with foreign

corporation B’s earnings and profits for 2001,

2000, 1999 layer #2, and 1998 layer #2,

respectively, remain in those layers. These

foreign income taxes generally will not be

reduced or deemed paid unless a foreign tax

refund restores a positive balance to the

associated earnings pursuant to section

905(c), and thus will be trapped.

Federal Register / Vol. 65, No. 221 / Wednesday, November 15, 2000 / Proposed Rules 69163

(2) If foreign surviving corporation is

a less-than-10%-U.S.-owned foreign

corporation. If the foreign surviving

corporation is a less-than-10%-U.S.-

owned foreign corporation, then the prepooling annual layers shall be

determined under the rules of this

paragraph (f)(2).

(i) Qualifying earnings and taxes. The

pre-pooling annual layers shall consist

of the pre-1987 accumulated profits and

the pre-1987 foreign income taxes of the

foreign acquiring corporation and the

foreign target corporation. If the foreign

acquiring corporation or the foreign

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

in post-1986 undistributed earnings,

then those earnings or deficits and any

related post-1986 foreign income taxes

shall be recharacterized as pre-1987

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

acquiring corporation or the foreign

target corporation accumulated

immediately prior to the foreign 381

transaction.

(ii) Carryover rule. Subject to

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

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

of this section attributable to the foreign

acquiring corporation and the foreign

target corporation shall carry over to the

foreign surviving corporation but shall

not be combined. Thus, when the

foreign acquiring corporation and the

foreign target corporation have pre-1987

accumulated profits in the same year

and a distribution is made therefrom,

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

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

foreign income taxes of the foreign

acquiring corporation and the foreign

target corporation on a pro rata basis.

For further guidance, see Rev. Rul. 68–

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

(1970–2 C.B. 152) (see also

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

paragraph (g)(2) of this section

(governing the reconciliation of taxable

years).

(iii) Deficits. The rules of this

paragraph (f)(2)(iii) apply when the

foreign acquiring corporation or the

foreign target corporation (or both) has

a deficit in one or more years that

comprise its pre-1987 accumulated

profits immediately prior to the foreign

381 transaction (and after application of

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

this section). See also paragraphs (g)(1)

and (4) of this section (describing other

rules applicable to a deficit described in

this paragraph (f)(2)(iii)).

(A) Aggregate positive earnings and

profits. If the foreign acquiring

corporation or the foreign target

corporation (or both) has an aggregate

positive (or zero) amount of pre-1987

accumulated profits, but a deficit in one

or more individual years, then the rules

otherwise applicable to such deficits

shall apply separately to the pre-1987

accumulated profits and related foreign

income taxes of such corporation. For

further guidance, see Rev. Rul. 74–550

(1974–2 C.B. 209) (see also

§ 601.601(d)(2) of this chapter);

Champion Int’l Corp. v. Commissioner,

81 T.C. 424 (1983), acq. in result, 1987–

2 C.B. 1; Rev. Rul. 87–72 (1987–2 C.B.

170) (see also § 601.601(d)(2) of this

chapter). As a result, no amount in

excess of the aggregate positive amount

of pre-1987 accumulated profits shall be

distributed from the pre-transaction

earnings of the foreign acquiring

corporation or the foreign target

corporation.

(B) Aggregate deficit in earnings and

profits. If the foreign acquiring

corporation or the foreign target

corporation (or both) has an aggregate

deficit in pre-1987 accumulated profits,

then the rules otherwise applicable to

such deficits shall apply separately to

the pre-transaction earnings and profits

and related taxes of the applicable

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

and 381(c)(2)(B). Thus, any aggregate

net deficit shall be available to offset

only post-transaction earnings

accumulated by the foreign surviving

corporation.

(iv) Pre-1987 section 960 earnings and

profits and foreign income taxes. The

pre-1987 section 960 earnings and

profits and pre-1987 section 960 foreign

income taxes attributable to the foreign

acquiring corporation and the foreign

target corporation shall carry over to the

foreign surviving corporation but shall

not be combined. The rules otherwise

applicable to such amounts shall apply

separately to the pre-1987 section 960

earnings and profits and pre-1987

section 960 foreign income taxes of the

foreign acquiring corporation and the

foreign target corporation on a pro rata

basis. For further guidance, see Notice

88–70 (1988–2 C.B. 369) (see also

§ 601.601(d)(2) of this chapter).

(v) Examples. The following examples

illustrate the rules of this paragraph

(f)(2). The examples presume the

following facts: Both foreign corporation

A and foreign corporation B always

have had calendar taxable years. Foreign

corporations A and B (and all of their

respective qualified business units as

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

functional currency. The examples are

as follows:

Example 1—(i) Facts. (A) Foreign

corporations A and B both were incorporated

in 1998. Nine percent of the voting stock of

foreign corporation A is owned by domestic

corporate shareholder C. Nine percent of the

voting stock of foreign corporation B is

owned by domestic corporate shareholder D.

Shareholders C and D are unrelated. The

remaining 91% of the voting stock of each

foreign corporation is owned by unrelated

foreign shareholders. Thus, neither

corporation meets the requirements of

section 902(c)(3)(B). On December 31, 2001,

foreign corporations A and B have the

following earnings and profits and foreign

income taxes accounts:

E&P Foreign taxes

Foreign Corporation A:

2001 .................................................................................................................................................................. 500u 350u

2000 .................................................................................................................................................................. 400u 300u

1999 .................................................................................................................................................................. 400u 160u

1998 .................................................................................................................................................................. 100u 5u

1,400u 815u

Foreign Corporation B:

2001 .................................................................................................................................................................. 100u 20u

2000 .................................................................................................................................................................. 300u 60u

1999 .................................................................................................................................................................. 0u 50u

1998 .................................................................................................................................................................. 50u 5u

450u 135u

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(B) On January 1, 2002, foreign corporation

B acquires the assets of foreign corporation

A in a reorganization described in section

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

foreign 381 transaction, foreign surviving

corporation is a less-than-10%-U.S.-owned

foreign corporation that does not meet the

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

(ii) Result. Under the rules described in

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

foreign surviving corporation has the

following earnings and profits and foreign

income taxes accounts:

E&P Foreign taxes

Two Side-by-Side Layers of 2001 E&P:

2001 layer #1 (from Corp A) ............................................................................................................................ 500u 350u

2001 layer #2 (from Corp B) ............................................................................................................................ 100u 20u

Two Side-by-Side Layers of 2000 E&P:

2000 layer #1 (from Corp A) ............................................................................................................................ 400u 300u

2000 layer #2 (from Corp B) ............................................................................................................................ 300u 60u

Two Side-by-Side Layers of 1999 E&P:

1999 layer #1 (from Corp A) ............................................................................................................................ 400u 160u

1999 layer #2 (from Corp B) ............................................................................................................................ 0u 50u

Two Side-by-Side Layers of 1998 E&P:

1998 layer #1 (from Corp A) ............................................................................................................................ 100u 5u

1998 layer #2 (from Corp B) ............................................................................................................................ 50u 5u

1,850u 950u

(iii) Post-transaction distribution. (A)

During 2002, foreign surviving corporation

does not accumulate any earnings and profits

or pay or accrue any foreign income taxes.

On December 31, 2002, foreign surviving

corporation distributes 600u to its

shareholders. Under the rules of paragraph

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

of pre-pooling annual layers under the LIFO

method as follows:

E&P Foreign taxes

Two Side-by-Side Layers of 2001 E&P:

2001 layer #1 (from Corp A) ............................................................................................................................ 500u 350u

2001 layer #2 (from Corp B) ............................................................................................................................ 100u 20u

600u 370u

(B) Foreign surviving corporation’s foreign

income tax accounts are reduced to reflect

the distribution of earnings and profits, see

§ 1.902–1(a)(10)(iii), notwithstanding that no

shareholders are eligible to claim deemed

paid foreign income taxes under section 902.

(C) Immediately after the distribution,

foreign surviving corporation has the

following earnings and profits and foreign

income taxes accounts:

E&P Foreign taxes

Two Side-by-Side Layers of 2000 E&P:

2000 layer #1 (from Corp A) ............................................................................................................................ 400u 300u

2000 layer #2 (from Corp B) ............................................................................................................................ 300u 60u

Two Side-by-Side Layers of 1999 E&P:

1999 layer #1 (from Corp A) ............................................................................................................................ 400u 160u

1999 layer #2 (from Corp B) ............................................................................................................................ 0u 50u

Two Side-by-Side Layers of 1998 E&P:

1998 layer #1 (from Corp A) ............................................................................................................................ 100u 5u

1998 layer #2 (from Corp B) ............................................................................................................................ 50u 5u

1,250u 580u

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

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

foreign corporation A met the requirements

of section 902(c)(3)(B) on January 1, 2000,

when U.S. corporate shareholder C acquired

an additional 1% of voting stock for a total

ownership interest of 10%; foreign

corporation A thereby became a non-lookthrough 10/50 corporation. On December 31,

2001, foreign corporations A and B have the

following earnings and profits and foreign

income taxes accounts:

E&P Foreign taxes

Foreign Corporation A:

E&P Accumulated as Non-Look-Through 10/50 Corporation .......................................................................... 900u $650

1999 .................................................................................................................................................................. 400u 160u

1998 .................................................................................................................................................................. 100u 5u

1,400u

Foreign Corporation B:

2001 .................................................................................................................................................................. 100u 20u

2000 .................................................................................................................................................................. 300u 60u

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E&P Foreign taxes

1999 .................................................................................................................................................................. 0u 50u

1998 .................................................................................................................................................................. 50u 5u

450u 135u

(B) On January 1, 2002, foreign corporation

B acquires the assets of foreign corporation

A in a reorganization described in section

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

foreign 381 transaction, foreign surviving

corporation is a less-than-10%-U.S.-owned

foreign corporation that does not meet the

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

(ii) Result. Under the rules described in

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

foreign surviving corporation has the

following earnings and profits and foreign

income taxes accounts:

E&P Foreign taxes

Two Side-by-Side Layers of 2001 E&P:

2001 layer #1 (from Corp A’s pool) .................................................................................................................. 900u $650

2001 layer #2 (from Corp B’s layer) ................................................................................................................. 100u 20u

2000 (from Corp B): ......................................................................................................................................... 300u 60u

Two Side-by-Side Layers of 1999 E&P:

1999 layer #1 (from Corp A) ............................................................................................................................ 400u 160u

1999 layer #2 (from Corp B) ............................................................................................................................ 0u 50u

Two Side-by-Side Layers of 1998 E&P:

1998 layer #1 (from Corp A) ............................................................................................................................ 100u 5u

1998 layer #2 (from Corp B) ............................................................................................................................ 50u 5u

1,850u

(iii) Subsequent ownership change. On

January 1, 2007, USS (a domestic

corporation) acquires 100% of the stock of

foreign surviving corporation. Under the

rules of paragraph (g)(3) of this section,

foreign surviving corporation begins to pool

its earnings and profits under section

902(c)(3) as of January 1, 2007. Foreign

surviving corporation’s earnings and profits

and foreign income taxes accrued before

January 1, 2007 retain their character as pre1987 accumulated profits and pre-1987

foreign income taxes.

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

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

December 31, 2001, foreign corporations A

and B have the following earnings and profits

and foreign income taxes accounts:

E&P Foreign taxes

Foreign Corporation A:

E&P Accumulated as Non-Look-Through 10/50 Corporation: ......................................................................... 1,000u $500

1999 .................................................................................................................................................................. (200u) 10u

1998 .................................................................................................................................................................. 400u 5u

1,200u

Foreign Corporation B:

2001 .................................................................................................................................................................. 300u 20u

2000 .................................................................................................................................................................. (100u) 60u

1999 .................................................................................................................................................................. 0u 50u

1998 .................................................................................................................................................................. 50u 5u

250u 135u

(B) On January 1, 2002, foreign corporation

B acquires the assets of foreign corporation

A in a reorganization described in section

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

foreign 381 transaction, foreign surviving

corporation is a less-than-10%-U.S.-owned

foreign corporation that does not meet the

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

(ii) Result. Because foreign corporations A

and B have aggregate positive amounts of

pre-1987 earnings and profits with a deficit

in one or more individuals years, the rules

of paragraphs (f)(2)(iii)(A) of this section

apply. Accordingly, after the foreign 381

transaction, foreign surviving corporation has

the following earnings and profits and

foreign income taxes accounts:

Earnings and profits Foreign taxes

Positive

E&P Deficit E&P

Foreign

taxes available

Foreign

taxes associated with

deficit E&P

Two Side-by-Side Layers of 2001 E&P:

2001 layer #1 (from Corp A’s non-look-through 10/50 pool) ................................... 1,000u $500

2001 layer #2 (from Corp B’s layer) ......................................................................... 300u .................... 20u ....................

2000 (from Corp B) .................................................................................................. .................... (100u) .................... 60u

69166 Federal Register / Vol. 65, No. 221 / Wednesday, November 15, 2000 / Proposed Rules

Earnings and profits Foreign taxes

Positive

E&P Deficit E&P

Foreign

taxes available

Foreign

taxes associated with

deficit E&P

Two Side-by-Side Layers of 1999 E&P:

1999 layer #1 (from Corp A) .................................................................................... .................... (200u) .................... 10u

1999 layer #2 (from Corp B) .................................................................................... 0u .................... 50u ....................

Two Side-by-Side Layers of 1998 E&P:

1998 layer #1 (from Corp A) .................................................................................... 400u .................... 5u ....................

1998 layer #2 (from Corp B) .................................................................................... 50u .................... 5u ....................

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

(iii) Post-transaction distribution.—(A)

During 2002, foreign surviving corporation

does not accumulate any earnings and profits

or pay or accrue any foreign income taxes.

On December 31, 2002, foreign surviving

corporation distributes 1,300u to its

shareholders. Under the rules described in

paragraphs (c)(3) and (f)(2)(iii)(A) of this

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

E&P Foreign taxes

paid

Two Side-by-Side Layers of 2001 E&P:

2001 layer #1 .................................................................................................................................................... 1,000u $500

2001 layer #2 .................................................................................................................................................... 250u 20u

1998 E&P:

1998 layer #1 .................................................................................................................................................... 50u *1.25u

1,300u

* 25% of 5u taxes.

(B) Under the rules described in paragraph

(f)(2)(iii)(A) of this section, the rules

otherwise applicable when a foreign

corporation has an aggregate positive (or

zero) amount of pre-1987 accumulated

profits, but a deficit in one or more

individual years, apply separately to the pre1987 accumulated profits and related foreign

income taxes of foreign corporation A and

foreign corporation B. As a result,

distributions out of the pre-pooling annual

layers of foreign corporation A and foreign

corporation B cannot exceed the aggregate

positive amount of pre-1987 accumulated

profits of each corporation. Accordingly, only

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

foreign corporation A’s and foreign

corporation B’s pre-pooling annual layers,

respectively. Thus, 1,250u of the distribution

is out of 1,000u of foreign corporation A’s

2001 layer #1 and 250u of foreign corporation

B’s 2001 layer #2. Under the principles of

§ 1.902–1(b)(3) and Champion Int’l Corp. v.

Commissioner, 81 T.C. 424 (1983), all of the

taxes in each of those respective layers are

reduced. Applying Rev. Rul. 74–550 (1974–

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

chapter), the remaining 50u is distributed

from foreign corporation A’s 1998 layer #1

(after rolling back the 200u deficit in 1999

layer #1 to reduce earnings in 1998 layer #1

to 200u (400u–200u)). Thus, after the

distribution, 150u remains in the 1998 layer

#1 along with 3.75u of foreign income taxes

(5u × (150u ÷ 200u)).

(C) Foreign surviving corporation’s foreign

income tax accounts are reduced to reflect

the distribution of earnings and profits, see

§ 1.902–1(a)(10)(iii), notwithstanding that no

shareholders are eligible to claim a credit for

deemed paid foreign income taxes under

section 902.

(D) Immediately after the distribution

foreign surviving corporation has the

following earnings and profits and foreign

income taxes accounts:

E&P Foreign taxes

2000 ......................................................................................................................................................................... 0u 60u

Two Side-by-Side Layers of 1999 E&P:

1999 layer #1 .................................................................................................................................................... 0u 10u

1999 layer #2 .................................................................................................................................................... 0u 50u

Two Side-by-Side Layers of 1998 E&P:

1998 layer #1 .................................................................................................................................................... 150u 3.75u

1998 layer #2 .................................................................................................................................................... 0u 5u

150u 128.75u

(E) Under the rules described in paragraph

(f)(2)(iii)(A) of this section, the 60u, 10u, 50u,

and 5u of foreign income taxes related to

foreign surviving corporation’s 2000 layer,

1999 layer #1, 1999 layer #2, and 1998 layer

#2, respectively, remain in those layers.

These foreign income taxes generally will not

be reduced or deemed paid unless a foreign

tax refund restores a positive balance to the

associated earnings pursuant to section

905(c), and thus will be trapped.

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

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

December 31, 2001, foreign corporations A

and B have the following earnings and profits

and foreign income taxes accounts:

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E&P Foreign taxes

Foreign Corporation A:

E&P Accumulated as Non-Look-Through 10/50 Corporation: ....................................................................... (1,000u) $20

1999 ................................................................................................................................................................ (200u) 10u

1998 ................................................................................................................................................................ 400u 5u

(800u)

Foreign Corporation B:

2001 ................................................................................................................................................................ 100u 20u

2000 ................................................................................................................................................................ 300u 60u

1999 ................................................................................................................................................................ 0u 50u

1998 ................................................................................................................................................................ 50u 5u

450u 135u

(B) On January 1, 2002, foreign corporation

A acquires the assets of foreign corporation

B in a reorganization described in section

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

foreign 381 transaction, foreign surviving

corporation is a less-than-10%-U.S.-owned

foreign corporation.

(ii) Result. Because foreign corporation A

has an aggregate deficit in pre-1987 earnings

and profits, the rules of paragraph

(f)(2)(iii)(B) of this section apply and the

rules otherwise applicable apply separately

to the pre-1987 accumulated profits that

carry over to foreign surviving corporation

from foreign corporation A. Accordingly,

after the foreign 381 transaction, foreign

surviving corporation has the following

earnings and profits and foreign income taxes

accounts:

Earnings & profits Foreign taxes

Positive

E&P Deficit E&P

Foreign

taxes

available

Foreign

taxes associated with

deficit E&P

Two Side-by-Side Layers of 2001 E&P:

2001 layer #1 (from Corp A) .................................................................................... (1,000u) $20

2001 layer #2 (from Corp B) .................................................................................... 100u 20u

2000 .......................................................................................................................... 300u 60u

Two Side-by-Side Layers of 1999 E&P:

1999 layer #1 (from Corp A) .................................................................................... (200u) 10u

1999 layer #2 (from Corp B) .................................................................................... 0u 50u

Two Side-by-Side Layers of 1998 E&P:

1998 layer #1 (from Corp A) .................................................................................... 400u 5u

1998 layer #2 (from Corp B) .................................................................................... 50u 5u

850u (1,200u) 140u

(iii) Post-transaction distribution. (A)

During 2002, foreign surviving corporation

does not accumulate any earnings and profits

or pay or accrue any foreign income taxes.

On December 31, 2002, foreign surviving

corporation distributes 200u to its

shareholders. Under the rules described in

paragraph (f)(2)(iii)(B) of this section, no

distribution can be made out of the pre-1987

accumulated profits of foreign corporation A

(and the 800u aggregate deficit is available to

offset only post-transaction earnings

accumulated by foreign surviving

corporation). Thus, the distribution is out of

pre-pooling annual layers as follows:

E&P Foreign taxes

paid

2001 layer #2 ........................................................................................................................................................... 100u 20u

2000 ......................................................................................................................................................................... 100u 20u

200u 40u

(B) Foreign surviving corporation’s foreign

income tax accounts are reduced to reflect

the distribution of earnings and profits, see

§ 1.902–1(a)(10)(iii), notwithstanding that no

shareholders are eligible to claim deemed

paid foreign income taxes under section 902.

(g) Special rules—(1) Treatment of

deficit. Any deficit described in

paragraph (d)(2), (e)(1)(iii), (e)(2)(iii),

(f)(1)(iii), or (f)(2)(iii) of this section

shall not be taken into account in

determining current or accumulated

earnings and profits of a foreign

surviving corporation, including for

purposes of calculating—

(A) The earnings and profits

limitation of section 952(c)(1)(A) and

(c)(1)(C); and

(B) the amount of the foreign

surviving corporation’s subpart F

income as defined in section 952(a).

(2) Reconciling taxable years. If a

foreign acquiring corporation and a

foreign target corporation had taxable

years ending on different dates, then the

pro rata distribution rules of paragraphs

(f)(1)(ii) and (f)(2)(ii) of this section shall

apply with respect to the taxable years

that end within the same calendar year.

(3) Post-transaction change of status.

If a foreign surviving corporation that is

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

of this section subsequently becomes a

look-through corporation, or if a foreign

surviving corporation that is subject to

the rules of paragraph (c)(3) of this

69168 Federal Register / Vol. 65, No. 221 / Wednesday, November 15, 2000 / Proposed Rules

section subsequently becomes a nonlook-through 10/50 corporation or a

look-through corporation, by reason, for

example, of a reorganization,

liquidation, or change of ownership,

then post-1986 undistributed earnings

and post-1986 foreign income taxes that

have lost their look-through or pooling

character by reason of this section shall

not have such look-through or pooling

character restored. See, e.g., paragraph

(f)(2)(v) Example 2 of this section.

(4) Ordering rule for offsetting

multiple hovering deficits—(i) Rule. A

foreign surviving corporation shall

apply the deficit rules of paragraphs

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

(f)(2)(iii) of this section in that order (in

the event that more than one of such

rules applies to the foreign surviving

corporation).

(ii) Example. The following example

illustrates the rules of this paragraph

(g)(4). The examples presume the

following facts: Foreign corporation A

was a non-look-through 10/50

corporation from its incorporation on

January 1, 1995 until December 31,

1997; foreign corporation A became a

CFC on January 1, 1998 and has been a

CFC since that time. Foreign corporation

B has been a non-look-through 10/50

corporation since its incorporation on

January 1, 1993. Foreign corporations A

and B always have had calendar taxable

years. Foreign corporations A and B

(and all of their respective qualified

business units as defined in section 989)

maintain a ‘‘u’’ functional currency.

Finally, any earnings and profits

described in section 904(d)(1)(E) (10/50

dividends) qualified for the high tax

exception from subpart F income under

section 954(b)(4), and all shareholders

elected to exclude such earnings and

profits from subpart F income under

section 954(b)(4) and § 1.954–1(d)(5).

The example is as follows:

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

2001, foreign corporations A and B have the

following earnings and profits and foreign

income taxes accounts:

E&P Foreign taxes

Foreign Corporation A:

Separate Category:

10/50 dividends from FC1, a noncontrolled section 902 corporation ..................................................... 100u $60

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

E&P Accumulated as Non-Look-Through 10/50 Corporation ............................................................................... 300u 100

100u 185

Foreign Corporation B:

E&P Accumulated as Non-Look-Through 10/50 Corporation ........................................................................ (200u) 50

(B) On January 1, 2002, foreign corporation

B acquires the assets of foreign corporation

A in a reorganization described in section

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

foreign 381 transaction, foreign surviving

corporation is a CFC.

(ii) Result. Under the rules described in

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

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

surviving corporation has the following

earnings and profits and foreign income taxes

accounts:

Earnings and profits Foreign taxes

Positive

E&P

Hovering

deficit

Foreign

taxes available

Foreign

taxes associated with

hovering

deficit

Look-Through Pool:

10/50 dividends ........................................................................................................ 100u .................... $60 ....................

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

Two Side-by-Side Non-Look-Through Pool Amounts:

Non-look-through pool amount #1 (from Corp A) .................................................... 300u .................... 100 ....................

Non-look-through pool amount #2 (from Corp B) .................................................... .................... (200u) .................... 50

400u (500u) 160 75

(iii) Post-transaction earnings. (A) In the taxable year ending on December 31, 2002, foreign surviving corporation accumulates

earnings and profits and pays related foreign income taxes as follows:

Separate category E&P Foreign taxes

10/50 dividends from FC1 ....................................................................................................................................... 150u $40

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

550u 100

(B) None of the earnings and profits qualify

as subpart F income as defined in section

952(a). Under the rules of paragraph (g)(4)(i)

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

of this section apply before the rules of

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

Accordingly, post-transaction earnings in a

separate category are first offset by a hovering

deficit in the same separate category in the

look-through pool. Thus, foreign surviving

corporation’s 300u deficit in the section

904(d)(1)(I) general separate category offsets

300u of post-transaction general separate

category earnings. After application of

paragraph (d)(2) ofthis section, foreign

surviving corporation has the following posttransaction earnings available for further

offset by a hovering deficit: 150u in the

section 904(d)(1)(E) 10/50 dividends separate

category and 100u in the general separate

category. Under paragraph (e)(1)(iii) of this

section, a deficit in the non-look-through

pool offsets a pro rata portion of posttransaction earnings in each separate

Federal Register / Vol. 65, No. 221 / Wednesday, November 15, 2000 / Proposed Rules 69169

category. Thus, foreign surviving

corporation’s 200u deficit in non-lookthrough pool amount #2 offsets the remaining

post-transaction earnings on a pro rata basis

(200u × (150u ÷ 250u) = 120u against 10/50

dividends separate category earnings and

200u × (100u ÷ 250u) = 80u against general

separate category earnings). Accordingly,

foreign surviving corporation has the

following earnings and profits and foreign

income taxes accounts at the end of 2002:

E&P Foreign taxes

Look-Through Pool Separate Category:

10/50 dividends ................................................................................................................................................ 130u $100

General ............................................................................................................................................................. 20u 85

Two Side-by-Side Non-Look-Through Pool Amounts:

Non-look-through pool amount #1 .................................................................................................................... 300u 100

Non-look-through pool amount #2 .................................................................................................................... 0u 50

450u 335

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

section, the $25 of foreign income taxes

related to the 300u hovering deficit in the

section 904(d)(1)(I) general separate category

is added to foreign surviving corporation’s

post-1986 foreign income taxes in that

separate category (because post-transaction

earnings in the general separate category

have been offset by and exceed the deficit in

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

of this section, the $50 of foreign income

taxes related to the 200u hovering deficit in

non-look-through pool amount #2 is added to

foreign surviving corporation’s post-1986

foreign income taxes for non-look-through

pool amount #2 (because post-transaction

earnings have been offset by and exceed the

deficit in the non-look-through pool).

However, the $50 of foreign income taxes

generally will not be reduced or deemed paid

unless a foreign tax refund restores a positive

balance to the associated earnings pursuant

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

(5) Pro rata rule for earnings during

transaction year. For purposes of

offsetting post-transaction earnings of a

foreign surviving corporation under the

rules described in paragraphs (d)(2),

(e)(1)(iii), (e)(2)(iii), (f)(1)(iii), and

(f)(2)(iii), the earnings and profits for the

taxable year of the foreign surviving

corporation in which the transaction

occurs shall be deemed to have been

accumulated after such transaction in an

amount which bears the same ratio to

the undistributed earnings and profits of

the foreign surviving corporation for

such taxable year (computed without

regard to any earnings and profits

carried over) as the number of days in

the taxable year after the date of

transaction bears to the total number of

days in the taxable year. See, e.g.,

§ 1.381(c)(2)–1(a)(7) Example 2

(illustrating application of this rule with

respect to domestic corporations).

(6) Nonapplicability of hovering

deficit rules to certain transactions—(i)

Rule. If a principal purpose of a foreign

381 transaction is to gain a tax benefit

from affirmative use of the hovering

deficit rule described in paragraph

(d)(2), (e)(1)(iii), (e)(2)(iii), (f)(1)(iii), or

(f)(2)(iii) of this section, then the

Commissioner may exercise discretion

to apply the principles of § 1.367(b)–9 to

such transaction.

(ii) Example. The following example

illustrates the rules of this paragraph

(h)(6). The example is as follows:

Example—(i) Facts.—(A) Foreign

corporations A and B are and always have

been wholly owned subsidiaries of USP, a

domestic corporation. Both foreign

corporations A and B were incorporated in

1990, and both always have been CFCs using

a calendar taxable year. Both foreign

corporations A and B (and all of their

respective qualified business units as defined

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

currency and 1u = US$1 at all times. Any

earnings and profits described in section

904(d)(1)(E) (10/50 dividends) qualified for

the high tax exception from subpart F income

under section 954(b)(4), and USP elected to

exclude such earnings and profits from

subpart F income under section 954(b)(4) and

§ 1.954–1(d)(5). On December 31, 2001,

foreign corporation A and foreign corporation

B have the following earnings and profits and

foreign income taxes accounts:

E&P Foreign taxes

Foreign Corporation A:

Separate Category:

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

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

(800u) 205

Foreign Corporation B:

Separate Category:

10/50 dividends ....................................................................................................................................... 5u 3

(B) On January 1, 2002, foreign corporation

B acquires the assets of foreign corporation

A in a reorganization described in section

368(a)(1)(C). A principal purpose of the

foreign 381 transaction is to gain a tax benefit

from affirmative use of the hovering deficit

rule described in paragraph (d)(2) of this

section. Immediately following the foreign

381 transaction, foreign surviving

corporation is a CFC.

(ii) Result under general rules. (A) If the

rules of paragraphs (d) (1) and (2) of this

section were to apply, foreign surviving

corporation would have the following

earnings and profits and foreign income taxes

accounts immediately after the foreign 381

transaction:

69170 Federal Register / Vol. 65, No. 221 / Wednesday, November 15, 2000 / Proposed Rules

Earnings and profits Foreign taxes

Positive

E&P

Hovering

deficit

Foreign

taxes available

Foreign

taxes associated with

hovering

deficit

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

10/50 dividends .............................................................................................................. 5u ...................... $3

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

205u (1,000u) 203 5

(B) Accordingly, if the hovering deficit

rules of paragraph (d)(2) of this section were

to apply, foreign surviving corporation would

be able to pay to USP a dividend of $205 that

would carry deemed paid foreign income

taxes of $203 under section 902.

(iii) Result under this paragraph (g)(6).

Because a principal purpose of the foreign

381 transaction was to gain a tax benefit from

affirmative use of the hovering deficit rule

described in paragraph (d)(2) of this section,

the Commissioner may exercise discretion to

apply the principles of § 1.367(b)–9 to the

transaction. Under the principles of

§ 1.367(b)–9, the earnings and profits and

foreign income taxes accounts of foreign

corporation A and foreign corporation B are

combined under paragraph (d)(1) of this

section without reference to the hovering

deficit rule of paragraph (d)(2) of this section.

Accordingly, foreign surviving corporation

would have the following earnings and

profits and foreign income taxes accounts

immediately after the transaction:

Separate category E&P Foreign taxes

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

10/50 dividends ........................................................................................................................................................ 5u 3

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

(795u) 208

(h) Effective date. This section shall

apply to section 367(b) exchanges that

occur on or after the date 30 days after

these regulations are published as final

regulations in the Federal Register.

Par. 10. Section 1.367(b)–8 is added

to read as follows:

§ 1.367(b)–8 Allocation of earnings and

profits and foreign income taxes in certain

foreign corporate separations.

(a) Scope. This section applies to

distributions to which section 355 (or so

much of section 356 as relates to section

355) applies, whether or not in

connection with a section 368(a)(1)(D)

reorganization (D reorganization), in

which the distributing corporation or

the controlled corporation (or both) is a

foreign corporation (foreign divisive

transaction). For purposes of this

section, the terms distributing

corporation and controlled corporation

have the same meaning as used in

section 355 and the regulations

thereunder. Paragraph (b) of this section

provides general rules governing the

allocation and reduction of a

distributing corporation’s earnings and

profits and foreign income taxes (pretransaction earnings and pre-transaction

taxes, respectively) in foreign divisive

transactions. Paragraphs (c), (d), and (e)

of this section describe special rules for

the application of paragraph (b) of this

section to specific situations, depending

upon whether the distributing

corporation or the controlled

corporation (or both the distributing and

the controlled corporation) is a foreign

corporation.

(b) General rules—(1) Application of

§ 1.312–10—(i) In general. Pretransaction earnings of a distributing

corporation shall be allocated between

the distributing corporation and the

controlled corporation in accordance

with the rules of § 1.312–10(a) and shall

be reduced in accordance with the rules

of § 1.312–10(b), except to the extent

otherwise provided in this section.

(ii) Special rules for application of

§ 1.312–10(b)—(A) Distributing

corporation. The pre-transaction

earnings of a distributing corporation

shall be reduced without taking into

account § 1.312–10(b)(2).

(B) Controlled corporation. Section

1.312–10(b) shall not apply to increase

or replace the earnings and profits of a

controlled corporation by the amount of

any decrease in the pre-transaction

earnings of a distributing corporation.

(iii) Net deficit in pre-transaction

earnings. Nothing in this section shall

permit any portion of the pretransaction earnings of a distributing

corporation that has a net deficit in pretransaction earnings to be allocated or

reduced under paragraph (b)(1)(i) of this

section. See § 1.312–10(c). Compare

paragraph (b)(2) of this section

(requiring an allocation or reduction of

a pro rata portion of deficits in statutory

groupings of earnings and profits when

a distributing corporation has a net

positive amount of pre-transaction

earnings).

(iv) Use of net bases. All allocations

and reductions described in paragraph

(b)(1)(i) of this section shall be

determined in accordance with the net

bases in assets. Net basis shall have the

same meaning as under § 1.312–10(a).

(v) Gain recognized by distributing

corporation. The pre-transaction

earnings that are subject to allocation or

reduction under paragraph (b)(1)(i) of

this section shall include any increase

in earnings and profits from gain

recognized or income included by the

distributing corporation as a result of

the foreign divisive transaction. See, for

example, section 367 (a) and (e), section

1248(f), and § 1.367(b)–5(b).

(vi) Coordination with branch profits

tax. An allocation or reduction in a

distributing corporation’s pretransaction earnings under paragraph

(b)(1)(i) of this section shall not be out

of or reduce effectively connected

earnings and profits or non-previously

taxed accumulated effectively

connected earnings and profits, as

defined in section 884. See also § 1.884–

2T(d)(5)(iii) (providing that such

earnings and profits are not subject to

reduction under § 1.312–10(b)).

(2) Cross-section of earnings and

profits. Except to the extent provided in

paragraphs (b)(1)(iii), (b)(1)(vi), (d)(2)(ii),

(d)(4), and (e)(4) of this section and

other than any portion attributable to an

inclusion under § 1.367(b)–5 or

Federal Register / Vol. 65, No. 221 / Wednesday, November 15, 2000 / Proposed Rules 69171

paragraph (d)(2)(i) of this section, an

allocation or reduction of pretransaction earnings described in

paragraph (b)(1)(i) of this section shall

decrease, on a pro rata basis, the

statutory groupings of earnings and

profits (or deficits in statutory groupings

of earnings and profits) of the

distributing corporation. Thus, for

example, a pro rata portion of a foreign

distributing corporation’s separate

categories, post-1986 undistributed

earnings, and annual layers of pre-1987

accumulated profits and pre-1987

section 960 earnings and profits shall be

allocated or reduced.

(3) Foreign income taxes. Pretransaction taxes of a distributing

corporation shall be ratably allocated or

reduced only to the extent described in

paragraphs (d)(3) and (e)(3) of this

section. Thus, a distributing

corporation’s excess foreign taxes

described in section 904(c) shall not be

allocated or reduced under this section.

(4) Divisive D reorganization with a

preexisting controlled corporation. In

the case of a foreign divisive transaction

that includes a D reorganization with a

controlled corporation that is not newly

created (a preexisting controlled

corporation), paragraph (b)(1)(i) of this

section shall apply in the following

manner:

(i) Calculation of earnings and profits

of distributing corporation. The pretransaction earnings of a distributing

corporation shall be reduced by the sum

of—

(A) The amount of the reduction in

the pre-transaction earnings of the

distributing corporation as described in

§ 1.312–10(a) (as determined under this

section); and

(B) The amount of the reduction in

the pre-transaction earnings of the

distributing corporation as described in

§ 1.312–10(b) (as determined under this

section).

(ii) Calculation of earnings and profits

of controlled corporation. The amount

of earnings and profits of the controlled

corporation immediately after the

foreign divisive transaction shall equal

the sum of—

(A) The amount described in

paragraph (b)(4)(i)(A) of this section

(except to the extent such amounts are

included in income as a deemed

dividend pursuant to the foreign

divisive transaction or are subject to the

rule of § 1.367(b)–3(f)); and

(B) The amount of earnings and

profits of the controlled corporation

immediately before the foreign divisive

transaction.

(c) Foreign divisive transactions

involving a domestic distributing

corporation and a foreign controlled

corporation—(1) Scope. The rules of

this paragraph (c) apply to a foreign

divisive transaction involving a

domestic distributing corporation and a

foreign controlled corporation.

(2) Earnings and profits allocated to a

foreign controlled corporation. Pretransaction earnings of a domestic

distributing corporation that are

allocated to a foreign controlled

corporation under the rules described in

paragraph (b)(1)(i) of this section shall

not be included in the foreign controlled

corporation’s post-1986 undistributed

earnings, pre-1987 accumulated profits,

or pre-1987 section 960 earnings and

profits. In addition, if a distribution by

the domestic distributing corporation

out of pre-transaction earnings

immediately before the foreign divisive

transaction would have been treated as

a U.S. source dividend under section

861(a)(2)(A) that would not be exempt

from tax under section 871(i)(2)(B) or

881(d), a distribution out of such

earnings and profits by the foreign

controlled corporation shall be treated

as a U.S. source dividend under section

904(g) and for purposes of Chapter 3 of

subtitle A of the Internal Revenue Code.

See Georday Enterprises v.

Commissioner, 126 F.2d 384 (4th Cir.

1942). See also sections 243(e) and

861(a)(2)(C) and § 1.367(b)–2(j) for other

rules that may apply.

(3) Examples. The following examples

illustrate the application of the rules of

this section to transactions described in

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

examples presume the following facts:

USD is a domestic corporation engaged

in manufacturing and shipping

activities through Business A and

Business B, respectively. FC is a foreign

corporation that is wholly owned by

USD. USD and FC use calendar taxable

years. FC (and all of its qualified

business units as defined in section 989)

maintains a ‘‘u’’ functional currency

and, except as otherwise specified, 1u =

US$1 at all times. The examples are as

follows:

Example 1—(i) Facts. The stock of USD is

owned in equal parts by three shareholders,

USP (a domestic corporation), USI (a United

States citizen), and FP (a foreign

corporation). USD owns assets with total net

bases of $260 (including $100 attributable to

the Business B shipping assets, which have

a $160 fair market value). USD has $500 of

earnings and profits (that it accumulated).

The entire $500 would have been treated as

a U.S. source dividend under section

861(a)(2)(A) that would not be exempt from

tax under sections 871(i)(2)(B) or 881(d) if

distributed by USD immediately before the

foreign divisive transaction. On January 1,

2002, USD incorporates FC and transfers to

FC the Business B shipping assets. USD then

distributes the FC stock pro rata to USP, USI,

and FP. The transaction meets the

requirements of sections 368(a)(1)(D) and

355.

(ii) Result—(A) Gain Recognition. Under

section 367(a)(5), USD recognizes gain equal

to the difference between the fair market

value and USD’s adjusted basis in the

Business B shipping assets ($160 ¥ $100 =

$60).

(B) Calculation of USD’s earnings and

profits. Under paragraph (b)(1)(v) of this

section, USD’s pre-transaction earnings

include any gain recognized or income

included as a result of the foreign divisive

transaction. As described in this Example 1

(ii)(A), USD recognizes $60 of gain as a result

of the foreign divisive transaction.

Accordingly, USD has $560 of pretransaction earnings ($500 + $60). Under

paragraph (b)(1)(i) of this section, USD’s pretransaction earnings are reduced by an

amount equal to its pre-transaction earnings

times the net bases of the assets transferred

to FC divided by the net bases of the assets

held by USD immediately before the foreign

divisive transaction ($560 × ($160 ÷ $320) =

$280). Following this reduction, USD has

$280 of earnings and profits ($560 ¥ $280).

(C) Calculation of FC’s earnings and

profits. Under paragraph (b)(1)(i) of this

section, the $280 reduction in USD’s pretransaction earnings is allocated to FC. Under

§ 1.367(b)–2(j)(1), the $280 is translated into

‘‘u’’ at the spot rate on January 1, 2002, to

280u. Under paragraph (c)(2) of this section,

the 280u is not included as part of FC’s post1986 undistributed earnings, pre-1987

accumulated profits, or section 960 earnings

and profits.

(iii) Post-transaction distribution. During

2002, FC does not accumulate any earnings

and profits or pay or accrue any foreign

income taxes. On December 31, 2002, at a

time when US$1 = 0.5u, FC distributes 180u

(or $360) to its shareholders. Thus, FP, USP,

and USI each receive a $120 dividend. See

section 989(b)(1). Under paragraph (c)(2) of

this section and § 1.367(b)–2(j)(4), $93.33 of

the distribution to FP is subject to

withholding under Chapter 3 of subtitle A of

the Internal Revenue Code ($280 ÷ 3 =

$93.33). Under section 243(e) and § 1.367(b)–

2(j)(3), $93.33 of the distribution to USP is

eligible for the dividends received deduction.

See also section 861(a)(2)(C). Under

paragraph (c)(2) of this section, the remaining

$26.67 distribution to USP is treated as U.S.

source under section 904(g) (and is not

eligible for the dividends received deduction

under section 243(e)). Under paragraph (c)(2)

of this section, the $120 dividend

distribution to USI is treated as U.S. source

under section 904(g).

Example 2—(i) Facts. The stock of USD is

owned by the following unrelated persons:

20 percent by USP (a domestic corporation),

20 percent by USI (a United States citizen),

and 60 percent by FP (a foreign corporation).

FC is a preexisting controlled corporation

that was incorporated in 1995 and USD

always has owned all of the FC stock. USD

owns assets with total net bases of $320

(including $160 attributable to the FC stock),

and USD has $500 of earnings and profits. FC

has 150u of earnings and profits in the

section 904(d)(1)(D) shipping separate

69172 Federal Register / Vol. 65, No. 221 / Wednesday, November 15, 2000 / Proposed Rules

category and has $60 of related foreign

income taxes. FC’s earnings and profits

qualified for the high tax exception from

subpart F income under section 954(b)(4),

and USD elected to exclude the earnings and

profits from subpart F income under section

954(b)(4) and § 1.954–1(d)(5). On January 1,

2002, USD distributes the stock of FC to its

shareholders in a transaction that meets the

requirements of section 355. FC is not a

controlled foreign corporation after the

foreign divisive transaction. On the date of

the foreign divisive transaction, the FC stock

has a $460 fair market value.

(ii) Result—(A) Gain Recognition. Under

§ 1.367(b)–5(b)(1)(ii), USD recognizes gain

equal to the difference between the fair

market value and USD’s adjusted basis in the

FC stock distributed to USI. Under

§ 1.367(e)–1(b)(1), USD recognizes gain equal

to the difference between the fair market

value and USD’s adjusted basis in the FC

stock distributed to FP. As a result of the

transfers to USI and FP, USD recognizes gain

of $240 (4⁄5 × ($460 ¥ $160)), $120 of which

is included in USD’s income as a dividend

under section 1248(a) and (f)(1) (4⁄5 × 150u,

translated at the spot rate under section

989(b)(2)). Under section 1248(a) and (f)(1),

USD includes as a dividend the difference

between the fair market value and its

adjusted basis in the FC stock distributed to

USP to the extent of FC’s earnings and profits

attributable to the distributed stock. For

further guidance, see also Notice 87–64

(1987–2 C.B. 375) (see also § 601.601(d)(2) of

this chapter). As a result of this transfer, USD

includes a $30 dividend under section

1248(a) and (f)(1) (1⁄5 × 150u). USD qualifies

for a section 902 deemed paid foreign tax

credit with respect to its $150 of section 1248

dividends.

(B) Calculation of USD’s earnings and

profits. Under paragraph (b)(1)(v) of this

section, USD’s pre-transaction earnings

include any gain recognized or income

included as a result of the foreign divisive

transaction. As described in this Example 2

(ii)(A), USD recognizes and includes a total

of $270 of gain and dividend income as a

result of the foreign divisive transaction.

Accordingly, USD has $770 of pretransaction earnings ($500 + $270). Under

paragraphs (b)(1)(i) and (b)(1)(ii)(A) of this

section, USD’s pre-transaction earnings are

reduced by the amount of the reduction that

would have been required if USD had

transferred the stock of FC to a new

corporation in a D reorganization. Thus,

USD’s pre-transaction earnings are reduced

by an amount equal to its pre-transaction

earnings times its net basis in the FC stock

divided by the net bases of the assets held

by USD immediately before the foreign

divisive transaction ($770 × ($430 ÷ $590) =

$561.19). Following this reduction, USD has

$208.81 of earnings and profits ($770 ¥

$561.19).

(C) Calculation of FC’s earnings and

profits. Under paragraph (b)(1)(ii)(B) of this

section, FC’s earnings and profits are not

increased (or replaced) as a result of the

foreign divisive transaction.

Example 3—(i) Facts. USP, a domestic

corporation, owns all of the stock of USD. FC

is a preexisting controlled corporation and

USD has owned all of the FC stock since FC

was incorporated in 1995. USD owns assets

with total net bases of $320 (including $100

attributable to the FC stock and $160

attributable to the Business B shipping

assets). USD has $500 of pre-transaction

earnings. FC has 150u of earnings and profits

in the section 904(d)(1)(D) shipping separate

category and has $60 of related foreign

income taxes. FC’s earnings and profits

qualified for the high tax exception from

subpart F income under section 954(b)(4),

and USD elected to exclude the earnings and

profits from subpart F income under section

954(b)(4) and § 1.954–1(d)(5). On January 1,

2002, USD transfers to FC the Business B

shipping assets. USD then distributes the FC

stock to USP. The transaction meets the

requirements of sections 368(a)(1)(D) and

355. USD’s transfer of the Business B

shipping assets to FC falls within the active

trade or business exception to section

367(a)(1) described in § 1.367(a)–2T.

Immediately after the foreign divisive

transaction, the FC stock has a $460 fair

market value. USP and USD meet and

comply with the requirements of section

367(a)(5) and 1248(f)(2) (and any regulations

thereunder). (Sections 1.367(b)–5(b)(1)(ii)

and 1.367(e)–1(b)(1) do not apply with

respect to the foreign divisive transaction

because the distributee, USP, is a domestic

corporation.)

(ii) Result—(A) Calculation of USD’s

earnings and profits. Under paragraph

(b)(4)(i) of this section, USD’s pre-transaction

earnings are reduced by the sum of the

amounts described in paragraphs (b)(4)(i)(A)

and (b)(4)(i)(B) of this section. Under

paragraph (b)(4)(i)(A) of this section, USD’s

pre-transaction earnings are reduced by an

amount equal to USD’s pre-transaction

earnings times the net bases of the assets

transferred to FC divided by the total net

bases of the assets held by USD immediately

before the foreign divisive transaction ($500

× ($160 ÷ $320) = $250). Under paragraph

(b)(4)(i)(B) of this section, USD’s pretransaction earnings are reduced by an

amount equal to USD’s pre-transaction

earnings times USD’s net basis in the stock

of FC (immediately before USD’s transfer of

the shipping assets) divided by the total net

bases of the assets held by USD immediately

before the foreign divisive transaction ($500

× ($100 ÷ $320) = $156.25). The sum of the

amounts described in paragraphs (b)(4)(i) (A)

and (B) of this section is $406.25 ($250 +

$156.25). Following the reduction described

in paragraph (b)(4)(i) of this section, USD has

$93.75 of earnings and profits ($500 ¥

$406.25).

(B) Calculation of FC’s earnings and

profits. Under paragraphs (b)(4)(ii) of this

section, the earnings and profits of FC

immediately after the foreign divisive

transaction are increased by the amount of

the reduction in USD’s pre-transaction

earnings described in paragraph (b)(4)(i)(A)

of this section ($250). Under § 1.367(b)–

2(j)(1), this $250 is translated into ‘‘u’’ at the

spot rate on January 1, 2002, to 250u. Under

paragraph (c)(2) of this section, the 250u is

not included as part of FC’s post-1986

undistributed earnings. FC has 400u in

earnings and profits (250u + 150u)

immediately after the foreign divisive

transaction.

(iii) Post-transaction distribution. FC does

not accumulate any earnings and profits or

pay or accrue any foreign income taxes

during 2002. On December 31, 2002, FC

distributes 100u as a dividend to USP, which

has remained its sole shareholder. Under

section 989(b)(1), the 100u distribution is

translated into US$ at the spot rate on

December 31, 2002, to $100. Proportionate

parts of the $100 dividend are attributable to

the pre-transaction earnings of FC ($37.50 =

$100 × (150 ÷ 400)) and USD ($62.50 = $100

× (250 ÷ 400)). See sections 243(e) and 245.

Thus, under sections 243(e) and § 1.367(b)–

2(j)(3), $62.50 of the distribution is eligible

for the dividends received deduction. See

also section 861(a)(2)(C). The remaining

$37.50 of the distribution (and $15 of related

foreign income taxes) is subject to the

generally applicable rules concerning

dividends paid by foreign corporations.

(d) Foreign divisive transactions

involving a foreign distributing

corporation and a domestic controlled

corporation—(1) Scope. The rules of this

paragraph (d) apply to a foreign divisive

transaction involving a foreign

distributing corporation and a domestic

controlled corporation.

(2) Coordination with § 1.367(b)–3—(i)

In general. In the case of a foreign

divisive transaction that includes a D

reorganization, the rules of § 1.367(b)–3

are applicable with respect to the pretransaction earnings of a foreign

distributing corporation that are

allocable to a domestic controlled

corporation under paragraph (b)(1)(i) of

this section.

(ii) Determination of all earnings and

profits amount. An all earnings and

profits amount inclusion under

paragraph (d)(2)(i) of this section shall

be computed with respect to the pretransaction earnings that are allocable to

the domestic controlled corporation,

without regard to the parenthetical

phrase in paragraph (b)(4)(ii)(A) of this

section.

(iii) Interaction with section 358 and

§ 1.367(b)–2(e)(3)(ii). The basis increase

provided in § 1.367(b)–2(e)(3)(ii) shall

apply to an all earnings and profits

amount inclusion under paragraph

(d)(2)(i) of this section, subject to the

following rules—

(A) Section 358 shall apply to

determine the distributee’s basis in the

foreign distributing and domestic

controlled corporation without regard to

the all earnings and profits amount

inclusion;

(B) After application of the rule in

paragraph (d)(2)(iii)(A) of this section,

the basis increase provided in

§ 1.367(b)–2(e)(3)(ii) shall be applied in

a manner that attributes such basis

increase solely to the exchanging

Federal Register / Vol. 65, No. 221 / Wednesday, November 15, 2000 / Proposed Rules 69173

shareholder’s stock in the domestic

controlled corporation; and

(C) the rule of paragraph (d)(2)(iii)(B)

of this section shall apply prior to

§ 1.367(b)–5(c)(4) and (d)(4).

(iv) Coordination with § 1.367(b)–3(c).

In applying the rule of § 1.367(b)–

3(c)(2), an exchanging shareholder

described in § 1.367(b)–3(c)(1) shall

recognize gain with respect to the stock

of the domestic controlled corporation

after the foreign divisive transaction.

(v) Special rule for U.S. persons that

own foreign distributing corporation

stock after a non pro rata distribution.

[Reserved]

(3) Foreign income taxes. Pretransaction taxes related to a foreign

distributing corporation’s pretransaction earnings that are allocable or

are reduced under the rules described in

paragraph (b)(1)(i) of this section shall

be ratably reduced. Pre-transaction taxes

related to a foreign distributing

corporation’s pre-transaction earnings

that are allocable to a domestic

controlled corporation under the rules

described in paragraph (b)(1)(i) of this

section shall not carry over to the

domestic controlled corporation.

Nothing in this paragraph (d)(3) shall

affect the deemed paid taxes that

otherwise would accompany an

inclusion under § 1.367(b)–5 or

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

(4) Previously taxed earnings and

profits. [Reserved]

(5) Coordination with § 1.367(b)–5.

See also § 1.367(b)–5(c) and (d) for other

rules that may apply to a foreign

divisive transaction described in

paragraph (d)(1) of this section.

(6) Examples. The following examples

illustrate the application of the rules of

this section to transactions described in

paragraph (d)(1) of this section. The

examples presume the following facts:

FD is a foreign corporation engaged in

manufacturing and shipping activities

through Business A and Business B,

respectively. Any earnings and profits of

FD described in section 904(d)(1)(D)

(shipping income) qualified for the high

tax exception from subpart F income

under section 954(b)(4), and FD’s

United States shareholders elected to

exclude the earnings and profits from

subpart F income under section

954(b)(4) and § 1.954–1(d)(5). USC is a

domestic corporation that is wholly

owned by FD. FD and USC use calendar

taxable years. FD (and all of its qualified

business units as defined in section 989)

maintains a ‘‘u’’ functional currency,

and 1u = US$1 at all times. The

examples are as follows:

Example 1—(i) Facts. (A) USP, a domestic

corporation, has owned all of the stock of FD

since FD’s incorporation in 1995. USP’s

adjusted basis in the FD stock is $100, and

the FD stock has a fair market value of $800.

FD owns assets with total net bases of 320u

(including 160u attributable to the Business

B shipping assets), and has the following pretransaction earnings and pre-transaction

taxes accounts:

Separate category E&P Foreign taxes

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

Shipping ................................................................................................................................................................... 200u 80

500u 140

(B) On January 1, 2002, FD incorporates

USC and transfers to USC the Business B

shipping assets. FD then distributes the USC

stock to USP. The transaction meets the

requirements of sections 368(a)(1)(D) and

355. Immediately after the foreign divisive

transaction, the FD stock and the USC stock

each have a fair market value of $400.

(ii) Results—(A) Calculation of FD’s

earnings and profits. Under paragraph

(b)(1)(i) of this section, FD’s pre-transaction

earnings are reduced by an amount equal to

its pre-transaction earnings times the net

bases of the assets transferred to USC divided

by the net bases of the assets held by FD

immediately before the foreign divisive

transaction (500u × (160u ÷ 320u) = 250u).

Following this reduction, FD has 250u of

earnings and profits (500u—250u).

(B) All earnings and profits amount

inclusion. Under § 1.367(b)–3 and paragraph

(d)(2)(i) of this section, USP includes in

income as an all earnings and profits amount

the pre-transaction earnings of FD that are

allocable to USC under paragraph (b)(1)(i) of

this section. Thus, USP’s all earnings and

profits amount inclusion is $250. See also

section 989(b)(1) and paragraph (d)(2)(ii) of

this section. Under § 1.367(b)–3(b)(3)(i) and

§ 1.367(b)–2(e), USP includes the all earnings

and profits amount as a deemed dividend

received from FD immediately before the

foreign divisive transaction. Because the

requirements of section 902 are met, USP

qualifies for a deemed paid foreign tax credit

with respect to the deemed dividend that it

receives from FD. Under § 1.902–1(d)(1), the

$250 deemed dividend is out of FD’s separate

categories and reduces foreign income taxes

as follows:

Separate category E&P Foreign taxes

General .................................................................................................................................................................... 150u $30

Shipping ................................................................................................................................................................... 100u 40

250u 70

(C) Calculation of USP’s basis in USC and

USC’s earnings and profits. Under paragraph

(d)(2)(iii) of this section, the § 1.367(b)–

2(e)(3)(ii) basis increase applies with respect

to USP’s all earnings and profits amount

inclusion from FD and is attributed solely to

USP’s basis in USC (after application of

section 358). Accordingly, USP has a $300

basis in the USC stock ($50 section 358 basis,

determined by reference to the relative values

of USP’s FD and USC stock: $100 pretransaction basis × ($400 ÷ $800) + $250

§ 1.367(b)–2(e)(3)(ii) basis increase = $300).

Because USP included in income as a

deemed dividend under § 1.367(b)–3 and

paragraph (d)(2) of this section the pretransaction earnings of FD that are allocable

to USC under paragraph (b)(1)(i) of this

section, such earnings and profits are not

available to increase USC’s earnings and

profits. As a result, USC has zero earnings

and profits immediately after the foreign

divisive transaction.

(D) Application of § 1.367(b)–5(c). The

basis adjustment and income inclusion rules

of § 1.367(b)–5(c)(2) apply if USP’s

postdistribution amount with respect to FD

stock is less than its predistribution amount

with respect to FD stock. Under § 1.367(b)–

5(e)(1), USP’s predistribution amount with

respect to FD stock is USP’s section 1248

amount attributable to such stock computed

immediately before the distribution but after

taking into account the allocation of earnings

and profits as a result of the D reorganization.

Thus, USP’s predistribution amount with

respect to FD stock is $250 (500u–250u). See

also section 989(b)(2). Under section 358,

USP allocates its $100 basis in FD stock

between FD stock and USC stock according

to the stock blocks’ relative values, yielding

a $50 ($100 x ($400 ÷ $800)) basis in FD

stock. See also paragraph (d)(2)(iii) of this

section. Under § 1.367(b)–5(e)(2), USP’s

postdistribution amount with respect to FD

69174 Federal Register / Vol. 65, No. 221 / Wednesday, November 15, 2000 / Proposed Rules

stock is USP’s section 1248 amount with

respect to such stock, computed immediately

after the distribution. Accordingly, USP’s

postdistribution amount with respect to FD

stock is $250. Because USP’s postdistribution

amount with respect to FD stock is not less

than its predistribution amount, USP is not

required to make any basis adjustment or

include any income under § 1.367(b)–5(c).

(E) FD’s earnings and profits after the

foreign divisive transaction. Following the

reduction described in this Example 1 (ii)(A)

and (B), FD has the following earnings and

profits and foreign income taxes accounts:

Separate category E&P Foreign taxes

General .................................................................................................................................................................... 150u $30

Shipping ................................................................................................................................................................... 100u 40

250u 70

Example 2—(i) Facts. (A) USP, a domestic

corporation, has owned all of the stock of FD

since FD’s incorporation in 1995. USP’s

adjusted basis in the FD stock is $400 and the

FD stock has a fair market value of $800. USC

is a preexisting controlled corporation. FD

owns assets with net total bases of 320u

(including 160u attributable to the USC

stock), and has the following pre-transaction

earnings and pre-transaction taxes accounts:

Separate category E&P Foreign taxes

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

Shipping ................................................................................................................................................................... 200u 80

500u 140

(B) On January 1, 2002, FD distributes the

USC stock to USP in a transaction that meets

the requirements of section 355. Immediately

after the foreign divisive transaction, the FD

stock and the USC stock each have a $400

fair market value.

(ii) Results—(A) Calculation of FD’s

earnings and profits. Under paragraphs

(b)(1)(i) and (b)(1)(ii)(A) of this section, FD’s

pre-transaction earnings are reduced by the

amount of the reduction that would have

been required if FD had transferred the stock

of USC to a new corporation in a D

reorganization. Thus, FD’s pre-transaction

earnings are reduced by an amount equal to

its pre-transaction earnings times its net basis

in the USC stock divided by the net bases of

the assets held by FD immediately before the

foreign divisive transaction

(500u×(160u÷320u)=250u). Following this

reduction, FD has 250u of earnings and

profits (500u¥250u).

(B) Calculation of USC’s earnings and

profits. Under paragraph (b)(1)(ii)(B) of this

section, USC’s earnings and profits are not

increased (or replaced) as a result of the

foreign divisive transaction. As a result, USP

is not required to include an amount in

income under paragraph (d)(2)(i) of this

section.

(C) Application of § 1.367(b)–5(c). The

basis adjustment and income inclusion rules

of § 1.367(b)–5(c)(2) apply if USP’s

postdistribution amount with respect to FD

stock is less than its predistribution amount

with respect to FD stock. Under § 1.367(b)–

5(e)(1), USP’s predistribution amount with

respect to FD stock is USP’s section 1248

amount attributable to such stock computed

immediately before the distribution. Thus,

USP’s predistribution amount with respect to

FD stock is $400 (the predistribution amount

is limited to USP’s built-in gain in FD stock

immediately before the distribution

($800¥$400)). See also section 989(b)(2).

Under section 358, USP allocates its $400

basis in FD stock between FD stock and USC

stock according to the stock blocks’ relative

values, yielding a $200 ($400×($400÷$800))

basis in each block. Under § 1.367(b)–5(e)(2),

USP’s postdistribution amount with respect

to FD stock is USP’s section 1248 amount

with respect to such stock, computed

immediately after the distribution.

Accordingly, USP’s postdistribution amount

with respect to FD stock is $200 (the

postdistribution amount is limited to USP’s

built-in gain in FD stock immediately after

the distribution ($400¥$200)). Because

USP’s postdistribution amount with respect

to FD stock is $200 less than its

predistribution amount with respect to such

stock ($400¥$200), § 1.367(b)–5(c)(2)(i) and

(ii) require USP to reduce its basis in FD

stock by the $200 difference, but only to the

extent such reduction increases USP’s

section 1248 amount with respect to the FD

stock. As a result, USP reduces its basis in

the FD stock from $200 to $150 and includes

$150 in income as a deemed dividend from

FD. Because the requirements of section 902

are met, USP qualifies for a deemed paid

foreign tax credit with respect to the deemed

dividend that it receives from FD. Under

§ 1.902–1(d)(1), the $150 deemed dividend is

out of FD’s separate categories and reduces

foreign income taxes as follows:

Separate category E&P Foreign taxes

General .................................................................................................................................................................... 90u $18

Shipping ................................................................................................................................................................... 60u 24

150u 42

(D) Basis adjustment. Under § 1.367(b)–

5(c)(3), USP does not increase its basis in FD

stock as a result of USP’s $150 deemed

dividend from FD. Under § 1.367(b)–5(c)(4),

USP increases its basis in the USC stock by

the amount by which it decreased its basis

in the FD stock, as well as by the amount of

its deemed dividend inclusion. The

§ 1.367(b)–5(c)(4) basis increase applies in

full because USP’s basis in the USC stock is

not increased above the fair market value of

such stock. Thus, USP increases its basis in

USC stock to $400 ($200+$50+$150).

(E) Reduction in FD’s statutory groupings

of earnings and profits. Under paragraph

(b)(2) of this section, the reduction in FD’s

pre-transaction earnings that is not

attributable to USP’s inclusion under

§ 1.367(b)–5 decreases FD’s statutory

groupings of earnings and profits on a pro

rata basis. Under paragraph (d)(3) of this

section, FD’s pre-transaction taxes also are

ratably reduced. As described in this

Example 2 (ii)(A), the reduction in FD’s pretransaction earnings is 250u. As described in

this Example 2 (ii)(C), 150u of the 250u

reduction is attributable to an inclusion

under § 1.367(b)–5. As a result, under

paragraphs (b)(2) and (d)(3) of this section the

remaining 100u reduction in FD’s pretransaction earnings is out of the following

separate categories of earnings and profits

and foreign income taxes:

Federal Register / Vol. 65, No. 221 / Wednesday, November 15, 2000 / Proposed Rules 69175

Separate category E&P Foreign taxes

General .................................................................................................................................................................... 60u $12

Shipping ................................................................................................................................................................... 40u 16

100u 28

(F) FD’s earnings and profits after the foreign divisive transaction. After the reductions described in this Example 2 (ii)(C) and

(E), FD has the following earnings and profits and foreign income taxes accounts:

Separate category E&P Foreign taxes

General .................................................................................................................................................................... 150u $30

Shipping ................................................................................................................................................................... 100u 40

250u 70

Example 3—(i) Facts. (A) USP, a domestic

corporation, has owned all of the stock of FD

since FD’s incorporation in 1995. USP’s

adjusted basis in the FD stock is $400 and the

FD stock has a fair market value of $800. USC

is a preexisting controlled corporation. FD

owns assets with total net bases of 320u

(including 160u attributable to the USC stock

and 80u attributable to the Business B

shipping assets), and has the following pretransaction earnings and pre-transaction

taxes accounts:

Separate category E&P Foreign taxes

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

Shipping ................................................................................................................................................................... 200u 80

500u 140

(B) On January 1, 2002, FD transfers to USC

the Business B shipping assets. FD then

distributes the USC stock to USP. The

transaction meets the requirements of

sections 368(a)(1)(D) and 355. Immediately

after the foreign divisive transaction, the FD

stock has a $200 fair market value and the

USC stock has a $600 fair market value.

(ii) Results—(A) Calculation of FD’s

earnings and profits. Under paragraph

(b)(4)(i) of this section, FD’s pre-transaction

earnings are reduced by the sum of the

amounts described in paragraphs (b)(4)(i)(A)

and (B) of this section. Under paragraph

(b)(4)(i)(A) of this section, FD’s pretransaction earnings are reduced by an

amount equal to FD’s pre-transaction

earnings times the net bases of the Business

B shipping assets transferred to USC divided

by the total net bases of the assets held by

FD immediately before the foreign divisive

transaction (500u × (80u ÷ 320u) = 125u).

Under paragraph (b)(4)(i)(B) of this section,

FD’s pre-transaction earnings are reduced by

an amount equal to FD’s pre-transaction

earnings times FD’s net basis in the stock of

USC divided by the total net bases of the

assets held by FD immediately before the

foreign divisive transaction (500u × (160u ÷

320u) = 250u). The sum of the amounts

described in paragraphs (b)(4)(i)(A) and (B) of

this section is 375u (125u + 250u).

(B) All earnings and profits amount

inclusion. Under § 1.367(b)–3 and paragraph

(d)(2)(i) of this section, USP is required to

include in income as an all earnings and

profits amount the pre-transaction earnings

of FD that are allocable to USC under

paragraph (b)(1)(i) of this section. Under

paragraph (b)(4)(ii)(A) of this section, the

125u of pre-transaction earnings described in

paragraph (b)(4)(i)(A) are allocable to USC.

Thus, the all earnings and profits amount is

$125. See also section 989(b)(1) and

paragraph (d)(2)(ii) of this section. Under

§§ 1.367(b)–3(b)(3)(i) and 1.367(b)–2(e), USP

includes the all earnings and profits amount

as a deemed dividend received from FD

immediately before the foreign divisive

transaction. Because the requirements of

section 902 are met, USP qualifies for a

deemed paid foreign tax credit with respect

to the deemed dividend that it receives from

FD. Under § 1.902–1(d)(1), the $125 deemed

dividend is out of FD’s separate categories

and reduces foreign income taxes as follows:

Separate category E&P Foreign taxes

General .................................................................................................................................................................... 75u $15

Shipping ................................................................................................................................................................... 50u 20

125u 35

(C) Calculation of USP’s basis in USC and

USC’s earnings and profits. Under paragraph

(d)(2)(iii) of this section, the § 1.367(b)–

2(e)(3)(ii) basis increase applies with respect

to USP’s all earnings and profits amount

inclusion and is attributed solely to USP’s

basis in USC (after application of section

358). Accordingly, USP has a $425 basis in

the USC stock ($300 section 358 basis,

determined by reference to the relative values

of USP’s FD and USC stock: $400 pretransaction basis × ($600 ÷ $800) + $125

§ 1.367(b)–2(e)(3)(ii) basis increase = $425).

Because USP included in income as a

deemed dividend under § 1.367(b)–3 and

paragraph (d)(2) of this section the pretransaction earnings of FD that are allocable

to USC under paragraph (b)(1)(i) of this

section, such earnings and profits are not

available to increase USC’s earnings and

profits. As a result, USC’s earnings and

profits are not increased as a result of the

foreign divisive transaction.

(D) Application of § 1.367(b)–5(c). The

basis adjustment and income inclusion rules

of § 1.367(b)–5(c)(2) apply if USP’s

postdistribution amount with respect to FD

stock is less than its predistribution amount

with respect to FD stock. Under § 1.367(b)–

5(e)(1) and (3), USP’s predistribution amount

with respect to FD stock is USP’s section

1248 amount attributable to such stock

computed immediately before the

distribution, after the allocation of FD’s pretransaction earnings described in paragraphs

(b)(4)(i)(A) and (ii)(A) of this section, but

without regard to the reduction in FD’s pretransaction earnings described in paragraph

(b)(4)(i)(B) of this section. Thus, USP’s

predistribution amount with respect to FD

stock is $375 ($500—$125). See also section

989(b)(2). Under section 358, USP allocates

its $400 basis in FD stock between FD stock

and USC stock according to the stock blocks’

relative values, yielding a $100 ($400 × ($200

69176 Federal Register / Vol. 65, No. 221 / Wednesday, November 15, 2000 / Proposed Rules

÷ $800)) basis in FD stock. See also paragraph

(d)(2)(iii) of this section. Under § 1.367(b)–

5(e)(2), USP’s postdistribution amount with

respect to FD stock is USP’s section 1248

amount with respect to such stock, computed

immediately after the distribution.

Accordingly, USP’s postdistribution amount

with respect to FD stock is $100. (While FD

has earnings and profits of 125u immediately

after the foreign divisive transaction, USP’s

postdistribution amount is limited to its

built-in gain in FD stock immediately after

the distribution ($200—$100).) Because

USP’s postdistribution amount with respect

to FD stock is $275 less than its

predistribution amount with respect to such

stock ($375—$100), § 1.367(b)–5(c)(2)(i) and

(ii) require USP to reduce its basis in FD

stock, but only to the extent such reduction

increases USP’s section 1248 amount with

respect to the FD stock. As a result, USP

reduces its basis in the FD stock from $100

to $75 and includes $250 in income as a

deemed dividend from FD. Because the

requirements of section 902 are met, USP

qualifies for a deemed paid foreign tax credit

with respect to the deemed dividend that it

receives from FD. Under § 1.902–1(d)(1), the

$250 deemed dividend is out of FD’s separate

categories and reduces foreign income taxes

as follows:

Separate category E&P Foreign taxes

General .................................................................................................................................................................... 150u $30

Shipping ................................................................................................................................................................... 100u 20

250u 50

(E) Basis adjustment. Under § 1.367(b)–

5(c)(3), USP does not increase its basis in FD

stock as a result of USP’s $250 deemed

dividend from FD. Under § 1.367(b)–5(c)(4),

USP increases its basis in the USC stock by

the amount by which it decreased its basis

in the FD stock, as well as by the amount of

its deemed dividend inclusion, but only up

to the fair market value of USP’s USC stock.

As described in this Example 3 (ii)(C), USP

has already increased its basis in the USC

stock to $525. Because the fair market value

of FD’s USC stock is $600, USP’s basis

increase under § 1.367(b)–5(c)(4) is limited to

$75. See also paragraph (d)(2)(iii)(C) of this

section. Thus, USP has a $600 basis in the

USC stock immediately after the foreign

divisive transaction.

(F) Reduction in FD’s statutory groupings

of earnings and profits. Under paragraph

(b)(2) of this section, the reduction in FD’s

pre-transaction earnings that is not

attributable to USP’s inclusion under

paragraph (d)(2)(i) of this section or

§ 1.367(b)–5 decrease FD’s statutory

groupings of earnings and profits on a pro

rata basis. Under paragraph (d)(3) of this

section, FD’s pre-transaction taxes are also

ratably reduced. As described in this

Example 3 (ii)(A), the reduction in FD’s pretransaction earnings is 375u. As described in

this Example 3 (ii)(B) and (D), the entire 375u

reduction was subject to inclusion as a

deemed dividend by USP under paragraph

(d)(2)(i) of this section or § 1.367(b)–5. Thus,

none of FD’s pre-transaction earnings remain

to be reduced under paragraph (b)(2) of this

section.

(G) FD’s earnings and profits after the

foreign divisive transaction. After the

reductions described in this Example 3 (ii)(B)

and (D), FD has the following earnings and

profits and foreign income taxes accounts:

Separate category E&P Foreign taxes

General .................................................................................................................................................................... 75u $15

Shipping ................................................................................................................................................................... 50u 20

125u 35

(e) Foreign divisive transactions

involving a foreign distributing

corporation and a foreign controlled

corporation—

(1) Scope. The rules of this paragraph

(e) apply to a foreign divisive

transaction involving a foreign

distributing corporation and a foreign

controlled corporation.

(2) Earnings and profits of foreign

controlled corporation—(i) In general.

Except to the extent specified in

paragraph (e)(2)(ii) of this section, pretransaction earnings of a foreign

distributing corporation that are

allocated to a foreign controlled

corporation under the rules described in

paragraphs (b)(1)(i) and (4) of this

section shall carry over to the foreign

controlled corporation in accordance

with the rules described in § 1.367(b)–

7.

(ii) Special rule for pre-transaction

earnings allocated to a newly created

controlled corporation. Section

1.367(b)–9 shall apply to pre-transaction

earnings that are allocated from a

foreign distributing corporation to a

newly created foreign controlled

corporation under the rules described in

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

(3) Foreign income taxes. Pretransaction taxes related to a foreign

distributing corporation’s pretransaction earnings that are allocated or

reduced under the rules described in

paragraph (b)(1)(i) of this section shall

be ratably reduced. Pre-transaction taxes

related to a foreign distributing

corporation’s pre-transaction earnings

that are allocated to a foreign controlled

corporation under the rules described in

paragraph (b)(1)(i) of this section shall

carry over to the foreign controlled

corporation in accordance with the rules

of § 1.367(b)–7. Section 1.367(b)–9 shall

apply to pre-transaction taxes that are

allocated from a foreign distributing

corporation to a newly created foreign

controlled corporation under the rules

described in paragraph (b)(1)(i) of this

section.

(4) Previously taxed earnings and

profits. [Reserved]

(5) Coordination with § 1.367(b)–5.

See also § 1.367(b)–5(c) and (d) for other

rules that may apply to a foreign

divisive transaction described in

paragraph (e)(1) of this section.

(6) Examples. The following examples

illustrate the application of the rules of

this section to transactions described in

paragraph (e)(1) of this section. The

examples presume the following facts:

FD is a foreign corporation engaged in

manufacturing and shipping activities

through Business A and Business B,

respectively. FC is a foreign corporation

that is wholly owned by FD. Any

earnings and profits of FD or FC

described in section 904(d)(1)(D)

(shipping income) qualified for the high

tax exception from subpart F income

under section 954(b)(4), and FD’s and

FC’s United States shareholders elected

to exclude the earnings and profits from

subpart F income under section

954(b)(4) and § 1.954–1(d)(1). FD and FC

have calendar taxable years. FD and FC

(and all of their respective qualified

business units as defined in section 989)

maintain a ‘‘u’’ functional currency, and

1u = US$1 at all times. The examples

are as follows:

Federal Register / Vol. 65, No. 221 / Wednesday, November 15, 2000 / Proposed Rules 69177

Example 1—(i) Facts. (A) USP, a domestic

corporation, has owned all of the stock of FD

since FD’s incorporation in 1995. USP’s

adjusted basis in the FD stock is $400 and the

FD stock has a fair market value of $800. FD

owns assets with total net bases of 320u

(including 160u attributable to the Business

B shipping assets), and has the following pretransaction earnings and pre-transaction

taxes accounts:

Separate category E&P Foreign taxes

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

Shipping ................................................................................................................................................................... 200u 80

500u 140

(B) On January 1, 2002, FD incorporates FC

and transfers to FC the Business B shipping

assets. FD then distributes the FC stock to

USP. The transaction meets the requirements

of sections 368(a)(1)(D) and 355. Immediately

after the foreign divisive transaction, the FD

stock and the FC stock each have a $400 fair

market value.

(ii) Result—(A) Calculation of FD’s

earnings and profits. Under paragraph

(b)(1)(i) of this section, FD’s pre-transaction

earnings are reduced by an amount equal to

its pre-transaction earnings times the net

bases of the assets transferred to FC divided

by the net bases of the assets held by FD

immediately before the foreign divisive

transaction (500u × (160u ÷ 320u) = 250u).

Following this reduction, FD has 250u of

earnings and profits (500u–250u).

(B) Application of § 1.367(b)–5(c). The

basis adjustment and income inclusion rules

of § 1.367(b)–5(c)(2) apply if USP’s

postdistribution amount with respect to FD

or FC stock is less than its predistribution

amount with respect to such stock. Under

§ 1.367(b)–5(e)(1), USP’s predistribution

amount with respect to FD or FC stock is

USP’s section 1248 amount attributable to

such stock computed immediately before the

distribution but after taking into account the

allocation of earnings and profits as a result

of the D reorganization. Thus, USP’s

predistribution amounts with respect to FD

and FC stock are both $200. See also section

989(b)(2) and § 1.1248–1(d)(3). Under section

358, USP allocates its $400 basis in FD stock

between FD stock and FC stock according to

the stock blocks’ relative values, yielding a

$200 ($400 × ($400 ÷ $800)) basis in each

block. Under § 1.367(b)–5(e)(2), USP’s

postdistribution amount with respect to FD

or FC stock is USP’s section 1248 amount

with respect to such stock, computed

immediately after the distribution.

Accordingly, USP’s postdistribution amounts

with respect to FD and FC stock are both

$200. Because USP’s postdistribution

amounts with respect to FD and FC stock are

not less than USP’s respective predistribution

amounts, USP is not required to make any

basis adjustment or include any income

under § 1.367(b)–5(c).

(C) Reduction in FD’s statutory groupings

of earnings and profits. Under paragraph

(b)(2) of this section, the 250u reduction in

FD’s pre-transaction earnings decreases FD’s

statutory groupings of earnings and profits on

a pro rata basis. Under paragraph (e)(3) of

this section, FD’s pre-transaction taxes also

are ratably reduced. Accordingly, FD’s pretransaction earnings and pre-transaction

taxes are reduced by the following amounts:

Separate category E&P Foreign taxes

General .................................................................................................................................................................... 150u $30

Shipping ................................................................................................................................................................... 100u 40

250u 70

(D) Calculation of FC’s earnings and

profits. Under paragraph (e)(2) of this section,

the pre-transaction earnings of FD that are

allocated to FC under paragraph (b)(1)(i) of

this section carry over to FC in accordance

with the rules of § 1.367(b)–7, subject to the

rule of § 1.367(b)–9. Under paragraph (e)(3) of

this section, FD’s pre-transaction taxes

related to the pre-transaction earnings that

are allocated to FC similarly carry over to FC

in accordance with the rules of § 1.367(b)–7,

subject to the rule of § 1.367(b)–9. As a result,

under § 1.367(b)–7(d), FC has the following

earnings and profits and foreign income taxes

accounts immediately after the foreign

divisive transaction:

Separate category E&P Foreign taxes

General .................................................................................................................................................................... 150u $30

Shipping ................................................................................................................................................................... 100u 40

250u 70

Example 2—(i) Facts. (A) USP, a domestic

corporation, has owned all of the stock of FD

since FD’s incorporation in 1995. USP’s

adjusted basis in the FD stock is $300 and the

FD stock has a fair market value of $1,500.

FC is a preexisting controlled corporation

and FD has always owned all of the FC stock.

FD owns assets with total net bases of 320u

(including 160u attributable to the FC stock).

FD and FC have the following earnings and

profits and foreign income taxes accounts:

FD E&P Foreign taxes

Separate Category:

General ........................................................................................................................................................... 400u $ 50

Passive ........................................................................................................................................................... (100u) 6

Shipping .......................................................................................................................................................... 200u 80

500u 136

69178 Federal Register / Vol. 65, No. 221 / Wednesday, November 15, 2000 / Proposed Rules

FC E&P Foreign taxes

Separate Category:

General ........................................................................................................................................................... 600u $100

Passive ........................................................................................................................................................... (50u) 6

Shipping .......................................................................................................................................................... 100u 40

650u 146

(B) On January 1, 2002, FD distributes the

FC stock to USP in a transaction that meets

the requirements of section 355. Immediately

after the foreign divisive transaction, the FD

stock and the FC stock each have a $750 fair

market value.

(ii) Result—(A) Calculation of FD’s

earnings and profits. Under paragraph

(b)(1)(i) and (ii)(A) of this section, FD’s pretransaction earnings are reduced by the

amount of the reduction that would have

been required if FD had transferred the stock

of FC to a new corporation in a D

reorganization. Thus, FD’s pre-transaction

earnings are reduced by an amount equal to

its pre-transaction earnings times its net basis

in the FC stock divided by the net bases of

the assets held by FD immediately before the

foreign divisive transaction (500u × (160u ÷

320u) = 250u). Following this reduction, FD

has 250u of earnings and profits (500u–

250u).

(B) Application of § 1.367(b)–5(c). The

basis adjustment and income inclusion rules

of § 1.367(b)–5(c) apply if USP’s

postdistribution amount with respect to FD

or FC stock is less than its predistribution

amount with respect to such stock. Under

§ 1.367(b)–5(e)(1), USP’s predistribution

amount with respect to FD or FC stock is

USP’s section 1248 amount attributable to

such stock computed immediately before the

distribution. Thus, USP’s predistribution

amounts with respect to FD and FC stock are

$500 and $650, respectively. See also section

989(b)(2). Under section 358, USP allocates

its $300 basis in FD stock between FD stock

and FC stock according to the stock blocks’

relative values, yielding a $150 ($300 × ($750

÷ $1,500)) basis in each block. Under

§ 1.367(b)–5(e)(2), USP’s postdistribution

amount with respect to FD or FC stock is

USP’s section 1248 amount with respect to

such stock, computed immediately after the

distribution. Accordingly, USP’s

postdistribution amount with respect to FD

stock is $250 (500u –250u), and its

postdistribution amount with respect to FC

stock is $600 (while FC has 650u of earnings

and profits immediately after the foreign

divisive transaction, USP’s postdistribution

amount is limited to its built-in gain in FC

stock immediately after the distribution

($750–$150)). USP’s postdistribution amount

with respect to both the FD and FC stock is

less than its predistribution amount with

respect to such stock. This difference is $50

with respect to FC ($650–$600), and $250

with respect to FD ($500–$250). Under

§ 1.367(b)–5(c)(2)(i) and (ii), USP is required

to reduce its basis in the FD and FC stock,

but only to the extent such reductions

increase USP’s section 1248 amount with

respect to the stock. Accordingly, USP

reduces its basis in the FC stock by $50, and

thereafter USP has a $100 basis in such stock

($150–$100). Because a reduction in USP’s

basis in FD stock would not increase any of

USP’s section 1248 amount with respect to

such stock, USP includes the entire $250

difference between its predistribution and

postdistribution amounts with respect to the

FD stock as a deemed dividend from FD.

Because the requirements of section 902 are

met, USP qualifies for a deemed paid foreign

tax credit with respect to the deemed

dividend that it receives from FD. Under

§ 1.960–1(i)(4), the 100u deficit in the section

904(d)(1)(A) passive separate category is

allocated proportionately against the other

separate categories for purposes of computing

the deemed paid credit on the distribution.

Thus, there are 333.33u (400u–(100u × (400u

÷ 600u))) of available earnings in the section

904(d)(1)(I) general separate category (along

with $50 of foreign income taxes) and

166.67u (200u–(100u × (200u ÷ 600u))) of

available earnings in the section 904(d)(1)(D)

shipping separate category (along with $50 of

foreign income taxes) and 166.67u (200u—

(100u × (200u ÷ 600u))) of available earnings

in the section 904(d)(1)(D) shipping separate

category (along with $80 of foreign income

taxes). Under § 1.902–1(d)(1), the $250

deemed dividend is out of FD’s separate

categories and reduces foreign income taxes

as follows:

Separate category E&P Foreign taxes

General .................................................................................................................................................................... 166.67u $25

Passive .................................................................................................................................................................... 0u 0

Shipping ................................................................................................................................................................... 83.33u 40

250u 65

(C) Basis adjustments. Under § 1.367(b)–

5(c)(3), USP does not increase its basis in FD

stock as a result of USP’s $250 deemed

dividend from FD. Under § 1.367(b)–5(c)(4),

USP increases its basis in the FD and FC

stock by the amount of its basis decrease or

deemed dividend inclusion with respect to

the other corporation, but only to the extent

such basis increase does not diminish USP’s

postdistribution amount with respect to that

other corporation and only to the extent of

the other corporation’s fair market value.

Under these rules, USP increases its basis in

the FD stock by the full amount by which it

decreased its basis in FC ($150 + $50 = $200).

USP does not increase its basis in the FC

stock as a result of its deemed dividend from

FD because any increase in the FC stock basis

would diminish USP’s postdistribution

amount with respect to such stock.

(D) FD’s earnings and profits after the

foreign divisive transaction. Because the

entire $250 reduction in FD’s pre-transaction

earnings was subject to inclusion under

§ 1.367(b)–5 (as described in this Example 2

(ii)(B)), paragraph (b)(2) of this section does

not apply. FD has the following earnings and

profits and foreign income taxes accounts

immediately after the foreign divisive

transaction (see § 1.960–1(i)(4)):

Federal Register / Vol. 65, No. 221 / Wednesday, November 15, 2000 / Proposed Rules 69179

Separate category E&P Foreign taxes

General .................................................................................................................................................................. 233.33u $25

Passive .................................................................................................................................................................. (100u) 6

Shipping ................................................................................................................................................................. 116.67u 40

250u 71

(E) Calculation of FC’s earnings and

profits. Under paragraph (b)(1)(ii)(B) of this

section, FC’s earnings and profits are not

increased (or replaced) as a result of the

foreign divisive transaction. FC’s earnings

and profits also are not reduced because USP

was not required to include a deemed

dividend out of FC under § 1.367(b)–5.

Example 3—(i) Facts.—(A) USP, a

domestic corporation, has owned all of the

stock of FD since FD’s incorporation in 1995.

USP’s adjusted basis in the FD stock is $100

and the FD stock has a fair market value of

$2,000. FC is a preexisting controlled

corporation and FD has always owned all of

the FC stock. FD owns assets with total net

bases of 320u (including 100u attributable to

the FC stock and 160u attributable to the

Business B shipping assets). FD and FC have

the following earnings and profits and

foreign income taxes accounts:

FD E&P Foreign taxes

Separate Category:

General ............................................................................................................................................................. 300u $50

10/50 dividends from FC1, a noncontrolled section 902 corporation .............................................................. 100u 6

Shipping ............................................................................................................................................................ 200u 80

600u 136

FC E&P Foreign taxes

Separate Category:

General ........................................................................................................................................................... 100u $10

Passive ........................................................................................................................................................... (50u) 6

Shipping ................................................................................................................................................................. 100u 40

.................................................................................................................................................................... 150u 56

(B) On January 1, 2002, FD transfers to FC

the Business B shipping assets. FD then

distributes the FC stock to USP. The

transaction meets the requirements of

sections 368(a)(1)(D) and 355. Immediately

after the foreign divisive transaction, the FD

stock and the FC stock each have a $1,000

fair market value.

(ii) Result—(A) Calculation of FD’s

earnings and profits. Under paragraph

(b)(4)(i) of this section, FD’s pre-transaction

earnings are reduced by the sum of the

amounts described in paragraphs (b)(4)(i)(A)

and (B) of this section. Under paragraph

(b)(4)(i)(A) of this section, FD’s pretransaction earnings are reduced by an

amount equal to FD’s pre-transaction

earnings times the net bases of the Business

B shipping assets transferred to FC divided

by the total net bases in the assets held by

FD immediately before the foreign divisive

transaction (600u × (160u ÷ 320u) = 300u).

Under paragraph (b)(4)(i)(B) of this section,

FD’s pre-transaction earnings are reduced by

an amount equal to FD’s pre-transaction

earnings times FD’s net bases in the stock of

FC divided by the total net bases of the assets

held by FD immediately before the foreign

divisive transaction (600u × (100u ÷ 320u) =

187.50u). The sum of the amounts described

in paragraphs (b)(4)(i)(A) and (B) of this

section is 487.50u.

(B) Application of § 1.367(b)–5(c). The

basis adjustment and income inclusion rules

of § 1.367(b)–5(c)(2) apply if USP’s

postdistribution amount with respect to FD

or FC stock is less than its predistribution

amount with respect to such stock. Under

§ 1.367(b) –5(e)(1) and (3), USP’s

predistribution amount with respect to FD or

FC stock is USP’s section 1248 amount

attributable to such stock computed

immediately before the distribution, after the

allocation of FD’s pre-transaction earnings

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

(ii)(A) of this section, but before the

reduction in FD’s pre-transaction earnings

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

section. Thus, USP’s predistribution amounts

with respect to FD and FC stock are $300

(600u–300u) and $450 (150u + 300u),

respectively. See also section 989(b)(2).

Under section 358, USP allocates its $100

basis in FD stock between FD stock and FC

stock according to the stock blocks’ relative

values, yielding a $50 ($100 × ($1,000 ÷

$2,000)) basis in each block. Under

§ 1.367(b)–5(e)(2), USP’s postdistribution

amount with respect to FD or FC stock is

USP’s section 1248 amount with respect to

such stock, computed immediately after the

distribution. Accordingly, USP’s

postdistribution amount with respect to FD

stock is $112.50 (600u–300u—187.50u), and

its postdistribution amount with respect to

FC stock is $450 (150u + 300u). Because

USP’s postdistribution amount with respect

to FC stock is not less than its predistribution

amount with respect to such stock, the

§ 1.367(b)–5(c)(2) basis adjustment and

income inclusion rules do not apply with

respect to the FC stock. Because USP’s

postdistribution amount with respect to FD

stock is $187.50 less than its predistribution

amount with respect to such stock

($300¥$112.50), § 1.367(b)–5(c)(2)(i) and (ii)

require USP to reduce its basis in FD stock,

but only to the extent such reduction

increases USP’s section 1248 amount with

respect to the FD stock. Because a reduction

in USP’s basis in the FD stock would not

increase any of USP’s section 1248 amount

with respect to such stock, USP includes the

entire $187.50 difference between its

predistribution and postdistribution amounts

with respect to the FD stock as a deemed

dividend from FD. Because the requirements

of section 902 are met, USP qualifies for a

deemed paid foreign tax credit with respect

to the deemed dividend that it receives from

FD. Under § 1.902–1(d)(1), the $187.50

deemed dividend is out of FD’s separate

categories and reduces foreign income taxes

as follows:

69180 Federal Register / Vol. 65, No. 221 / Wednesday, November 15, 2000 / Proposed Rules

Separate category E&P Foreign taxes

General .................................................................................................................................................................... 93.75u 15.63

10/50 dividends from FC1 ....................................................................................................................................... 31.25u 1.88

Shipping ................................................................................................................................................................... 62.50u 25

187.50u 42.51

(C) Basis adjustment. Under § 1.367(b)–

5(c)(3), the basis increase provided in

§ 1.367(b)–2(e)(3)(ii) does not apply with

respect to USP’s $187.50 deemed dividend

from FD. Under § 1.367(b)–5(c)(4), USP

increases its basis in the FC stock by the

amount of its deemed dividend inclusion

from FD, but only to the extent such basis

increase does not diminish USP’s

postdistribution amount with respect to FC

stock and only up to the fair market value of

the FC stock. Under these rules, USP

increases its basis in the FC stock by the full

amount of its deemed dividend from FD ($50

+ $187.50 = $237.50).

(D) Reduction in FD’s statutory groupings

of earnings and profits. Under paragraph

(b)(2) of this section, the reduction in FD’s

pre-transaction earnings that is not

attributable to USP’s inclusion under

§ 1.367(b)–5 decreases FD’s statutory

groupings of earnings and profits on a pro

rata basis. Under paragraph (e)(3) of this

section, FD’s pre-transaction taxes are also

ratably reduced. As described in this

Example 3 (ii)(A), the reduction in FD’s pretransaction earnings is 487.50u. As described

in this Example 3 (ii)(B), 187.50u of the

487.50u reduction is attributable to a deemed

dividend inclusion by USP under § 1.367(b)–

5. Thus, under paragraphs (b)(2) and (e)(3) of

this section, the remaining 300u reduction in

FD’s pre-transaction earnings and related pretransaction taxes is out of FD’s separate

categories and reduces foreign income taxes

as follows:

Separate category E&P Foreign taxes

General .................................................................................................................................................................... 150u $25

10/50 dividends from FC1 ....................................................................................................................................... 50u 3

Shipping ................................................................................................................................................................... 100u 40

300u 68

(E) Calculation of FC’s earnings and

profits. Under paragraph (b)(4)(ii) of this

section, FC’s earnings and profits

immediately after the foreign divisive

transaction equal the sum of FC’s earnings

and profits immediately before the foreign

divisive transaction, plus the amount of the

reduction in FD’s earnings and profits

described in paragraph (b)(4)(i)(A) of this

section, except to the extent such amount

was included in income as a deemed

dividend pursuant to the foreign divisive

transaction. The reduction in FD’s earnings

and profits described in paragraph (b)(4)(i)(A)

of this section is 300u, none of which was

included in income by USP as a deemed

dividend pursuant to the foreign divisive

transaction. Under paragraphs (e)(2) and (3)

of this section, the 300u of pre-transaction

earnings and related pre-transaction taxes

carry over to FC and combine with FC’s

earnings and profits and foreign income taxes

accounts in accordance with the rules

described in § 1.367(b)–7. Under § 1.367(b)–

7(d), FC has the following earnings and

profits and foreign income taxes accounts

immediately after the foreign divisive

transactions

Federal Register / Vol. 65, No. 221 / Wednesday, November 15, 2000 / Proposed Rules 69181

Separate category E&P Hovering deficit Taxes

Taxes associated w/hovering deficit

General ............................................................................................................ 250u ........................ $35 ........................

10/50 dividends from FC1 ............................................................................... 50u ........................ 3 ........................

Passive ............................................................................................................ ........................ (50u) ........................ $6

Shipping ........................................................................................................... 200u ........................ $80 ........................

500u (50u) 118 6

(F) FD’s earnings and profits after the foreign divisive transaction. Following the reductions described in this Example 3 (ii)(B)

and (D), FD has the following earnings and profits and foreign income taxes accounts:

Separate category E&P Foreign taxes

General .................................................................................................................................................................... 56.25u $9.37

10/50 dividends from FC1 ....................................................................................................................................... 18.75u 1.12

Shipping ................................................................................................................................................................... 37.50u 15

112.50u 25.49

(f) Effective date. This section shall

apply to section 367(b) exchanges that

occur on or after the date 30 days after

these regulations are published as final

regulations in the Federal Register.

Par. 11. Section 1.367(b)–9 is added

to read as follows:

§ 1.367(b)–9 Special rule for F

reorganizations and similar transactions.

(a) Scope. This section applies to any

foreign 381 transaction (as described in

§ 1.367(b)–7(a)) described in section

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

foreign target corporation or the foreign

acquiring corporation is newly created.

This section also applies to any foreign

divisive transaction (as described in

§ 1.367(b)–8(a)) that is described in

§ 1.367(b)–8(e)(1) and that involves a

newly created foreign distributing or

foreign controlled corporation.

(b) Hovering deficit rules

inapplicable. If a transaction is

described in paragraph (a) of this

section, a foreign surviving corporation

or a newly created controlled

corporation shall succeed to earnings

and profits, deficits in earnings and

profits, and foreign income taxes

without regard to the hovering deficit

rules of § 1.367(b)–7(d)(2), (e)(1)(iii),

(e)(2)(iii), (f)(1)(iii), and (f)(2)(iii). In the

case of a foreign divisive transaction,

nothing in this section shall affect the

application of § 1.367(b)–8(b)(iii).

(c) Example. The following example

illustrates the rules of this section:

Example—(i) Facts. (A) Foreign

corporation A is and always has been a

wholly owned subsidiary of USP, a domestic

corporation. Foreign corporation A was

incorporated in 1990, and always has been a

controlled foreign corporation using a

calendar taxable year. Foreign corporation A

(and all of its respective qualified business

units as defined in section 989) maintains a

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

all times. On December 31, 2001, foreign

corporation A has the following earnings and

profits and foreign income taxes accounts:

69182 Federal Register / Vol. 65, No. 221 / Wednesday, November 15, 2000 / Proposed Rules

Separate category E&P Foreign taxes

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

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

(800u) 205

(B) On January 1, 2002, foreign corporation

A moves its place of incorporation from

Country 1 to Country 2 in a reorganization

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

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

modified by paragraph (b) of this section,

foreign surviving corporation has the

following earnings and profits and foreign

income taxes accounts immediately after the

foreign 381 transaction:

Separate category E&P Foreign taxes

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

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

(800u) 205

(d) Effective date. This section shall

apply to section 367(b) exchanges that

occur on or after the date 30 days after

these regulations are published as final

regulations in the Federal Register.

Par. 12. In § 1.367(e)–1, paragraph (a)

is amended by adding a sentence at the

end of the paragraph to read as follows:

§ 1.367(e)–1 Distributions described in

section 367(e)(1).

(a) * * * See § 1.367(b)–8(c)(3) for an

example illustrating the interaction of

§ 1.367(e)–1 with other sections of the

Internal Revenue Code (such as sections

367(b) and 1248).

* * * * *

Par. 13. In § 1.381(a)–1, paragraph (c)

is revised to read as follows:

§ 1.381(a)–1 General rule relating to

carryovers in certain corporate

acquisitions.

* * * * *

(c) Foreign corporations. For

additional rules involving foreign

corporations see §§ 1.367(b)–7 and

1.367(b)–9.

* * * * *

Robert E. Wenzel,

Deputy Commissioner of Internal Revenue.

[FR Doc. 00–28950 Filed 11–8–00; 8:45 am]

BILLING CODE 4830–01–U