`[Federal Register Volume 89, Number 231 (Monday, December 2, 2024)]
[Proposed Rules]
[Pages 95362-95464]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2024-27227]



[[Page 95361]]

Vol. 89

Monday,

No. 231

December 2, 2024

Part II





 Department of the Treasury





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 Internal Revenue Service





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26 CFR Part 1





Previously Taxed Earnings and Profits and Related Basis Adjustments; 
Proposed Rule

  Federal Register / Vol. 89 , No. 231 / Monday, December 2, 2024 / 
Proposed Rules  

[[Page 95362]]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-105479-18]
RIN 1545-BO61


Previously Taxed Earnings and Profits and Related Basis 
Adjustments

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking.

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SUMMARY: This document contains proposed regulations regarding 
previously taxed earnings and profits of foreign corporations and 
related basis adjustments. The proposed regulations affect foreign 
corporations with previously taxed earnings and profits and their 
shareholders.

DATES: Written or electronic comments and requests for a public hearing 
must be received by March 3, 2025.

ADDRESSES: Commenters are strongly encouraged to submit public comments 
electronically. Submit electronic submissions via the Federal 
eRulemaking Portal at www.regulations.gov (indicate IRS and REG-105479-
18) by following the online instructions for submitting comments. 
Requests for a public hearing must be submitted as prescribed in the 
``Comments and Requests for a Public Hearing'' section. Once submitted 
to the Federal eRulemaking Portal, comments cannot be edited or 
withdrawn. The Department of the Treasury (Treasury Department) and the 
IRS will publish for public availability any comment submitted 
electronically or on paper to its public docket. Send paper submissions 
to: CC:PA:01:PR (REG-105479-18), Room 5203, Internal Revenue Service, 
P.O. Box 7604, Ben Franklin Station, Washington, DC 20044.

FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations 
generally, Elena M. Madaj at (202) 317-3576; concerning the portions of 
the proposed regulations relating to section 1502, Jeremy Aron-Dine at 
(202) 317-6847; concerning the portions of the proposed regulations 
relating to partnerships, Jennifer N. Keeney at (202) 317-6850; and 
concerning submissions of comments and requests for a public hearing, 
contact the Publications and Regulations Section of the Office of 
Associate Chief Counsel (Procedure and Administration) by email at 
[email protected] (preferred) or by telephone at (202) 317-6901 
(not toll-free numbers).

SUPPLEMENTARY INFORMATION: 

Authority

    This document contains proposed additions and amendments to 26 CFR 
part 1 (proposed regulations) under sections 959 and 961 and certain 
other provisions of the Internal Revenue Code (Code) regarding 
previously taxed earnings and profits (PTEP). As discussed in the 
Explanation of Provisions, the primary provisions of the proposed 
regulations are issued pursuant to the express delegations of authority 
under sections 245A(g), 743(b), 904(d)(7), 951A(f)(1)(B), 960(f), 
961(a) through (c), 965(o), 986(c)(2), 989(c), and 1502. The proposed 
regulations are also issued pursuant to the express delegation of 
authority under section 7805(a).

Background

I. Scope

    The Background describes PTEP, including provisions giving rise to 
PTEP and provisions regarding the treatment of PTEP, and related 
guidance and issues under existing law. Any term used but not defined 
in this preamble has the meaning given to it in the proposed 
regulations.

II. PTEP

A. Overview
    Sections 959 and 961 are intended to operate in tandem to prevent 
double taxation of PTEP, which is earnings and profits (E&P) of a 
foreign corporation described in section 959(c)(1) or (c)(2). Section 
959 designates amounts of E&P as PTEP based on amounts included, or 
treated as included, in gross income with respect to the foreign 
corporation under section 951(a).
    The remainder of this part II of the Background summarizes 
provisions giving rise to PTEP, provisions regarding the treatment of 
PTEP, and existing regulations under sections 959 and 961.
B. Provisions Giving Rise to PTEP
1. Section 951(a)
    Section 951(a)(1)(A) requires a United States shareholder (as 
defined in section 951(b) or, if applicable, section 953(c)(1)(A)) of a 
foreign corporation to include in gross income its pro rata share of 
the corporation's subpart F income (as defined in section 952) for a 
taxable year of the corporation (subpart F income inclusion), if the 
corporation is a controlled foreign corporation (CFC) (as defined in 
section 957(a) or, if applicable, section 957(b) or 953(c)(1)(B)) at 
any time during the taxable year and the shareholder owns (within the 
meaning of section 958(a)) stock of the corporation on the last day of 
the taxable year on which the corporation is a CFC (last relevant day). 
Pursuant to section 951(a)(1)(B), the United States shareholder is 
generally required to also include in gross income its amount 
determined under section 956 (section 956 amount) for the taxable year 
of the foreign corporation (section 956 inclusion). This amount 
represents an effective repatriation of E&P and is computed based on 
certain United States property held by the corporation. Ownership of 
stock within the meaning of section 958(a) means stock owned directly 
and stock owned indirectly through foreign entities, including domestic 
partnerships to the extent treated as foreign partnerships under Sec.  
1.958-1(d)(1) (discussed in part III.B of the Background). For purposes 
of the remainder of this preamble, a reference to stock ownership means 
stock owned within the meaning of section 958(a).
    Section 951(a)(2) determines a United States shareholder's pro rata 
share of a foreign corporation's subpart F income by first allocating a 
portion of such subpart F income to the United States shareholder, and 
then reducing such allocation in accordance with section 951(a)(2)(B) 
to take into account certain distributions where ownership of the stock 
of the foreign corporation is acquired by the United States shareholder 
during the corporation's taxable year. See Sec.  1.951-1(b). Subpart F 
income allocated to a United States shareholder before the application 
of section 951(a)(2)(B) is computed by multiplying the subpart F income 
by a fraction, the numerator of which is the portion of the foreign 
corporation's hypothetical distribution described in Sec.  1.951-1(e) 
that would be distributed with respect to the shareholder's stock of 
the corporation, and the denominator of which is the amount of such 
hypothetical distribution. See Sec.  1.951-1(e). The amount of the 
hypothetical distribution is equal to the foreign corporation's 
allocable E&P, which is generally the corporation's E&P for the taxable 
year (not reduced by distributions during the year). See Sec.  1.951-
1(e)(1)(ii).
    A special rule under section 245A(e) treats certain hybrid 
dividends received by a CFC as subpart F income of the receiving CFC 
for purposes of section 951(a)(1)(A). Similarly, section 964(e)(4) 
treats certain gain from a sale of stock of a foreign corporation by a 
CFC as subpart F income of the selling CFC for purposes of section 
951(a)(1)(A). Consequently, a United States shareholder of such a 
receiving CFC or selling CFC includes in gross income

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under section 951(a)(1)(A) its pro rata share of such subpart F income.
2. Section 951A(a)
    Pursuant to section 951A(a), a United States shareholder of a CFC 
is required to include in gross income its global intangible low-taxed 
income (GILTI inclusion). See Sec.  1.951A-1(b). A United States 
shareholder's GILTI inclusion is determined by taking into account the 
shareholder's pro rata share of tested items (as defined in Sec.  
1.951A-1(f)(5)) of CFCs in which the shareholder owns stock, such as 
tested income, tested loss, and qualified business asset investment. 
See Sec.  1.951A-1(c). A United States shareholder's pro rata share of 
a CFC's tested items is determined in the same manner as a pro rata 
share of subpart F income under section 951(a)(2), subject to certain 
modifications. See Sec.  1.951A-1(d).
    Section 951A(f)(1)(A) provides that a GILTI inclusion is treated in 
the same manner as a subpart F income inclusion for purposes of 
applying certain provisions of the Code, including sections 959 and 
961. Section 951A(f)(1)(B) grants the Secretary authority to provide 
rules for applying section 951A(f)(1)(A) to other provisions of the 
Code in any case in which the determination of subpart F income is 
required to be made at the level of the CFC.
3. Section 1248(a) or (f)
    Section 1248(a) requires a United States person that satisfies 
certain ownership requirements with respect to stock in a foreign 
corporation to include gain recognized on a sale or exchange of stock 
in such foreign corporation in gross income as a dividend, to the 
extent of the E&P of the foreign corporation attributable to the stock 
(including E&P of certain lower-tier foreign corporations pursuant to 
section 1248(c)(2), but not including PTEP pursuant to section 
1248(d)(1)). Section 1248(f) provides similar rules for certain 
distributions in nonrecognition transactions.
    Section 959(e) treats an amount included in gross income of any 
person as a dividend under section 1248(a) or (f) as an amount included 
in gross income under section 951(a)(1)(A), for purposes of section 
959.
4. Section 965
    The transition tax imposed under section 965 as part of the Tax 
Cuts and Jobs Act, Public Law 115-97, 131 Stat. 2054 (2017) (the Act) 
increased the subpart F income of certain foreign corporations and 
treated such foreign corporations as CFCs for purposes of section 951 
(if not already the case). Section 965(a) and (e). Consequently, a 
United States shareholder of such a foreign corporation generally 
included in gross income under section 951(a)(1)(A) its pro rata share 
of such additional subpart F income, subject to reduction under section 
965(b) for certain E&P deficits attributable to stock of other foreign 
corporations owned by the shareholder.
    For purposes of section 959, the transition tax also treated the 
amount of a reduction to a United States shareholder's inclusion with 
respect to a foreign corporation under section 965(b) as an amount 
included in the shareholder's gross income with respect to the foreign 
corporation under section 951(a). Section 965(b)(4)(A).
C. Provisions Regarding the Treatment of PTEP
1. Gross Income Exclusions Under Section 959
    Section 959 prevents double taxation by excluding PTEP from gross 
income of United States persons and CFCs. See H.R. Rep. No. 87-1447, at 
A101-102 (1962).
    Section 959(a) provides that, when PTEP of a foreign corporation is 
distributed to, or would otherwise be included under section 
951(a)(1)(B) in gross income of, a United States shareholder whose 
inclusion under section 951(a) gave rise to the PTEP, the PTEP is 
excluded from the United States shareholder's gross income. Under 
successor rules within section 959(a), the exclusion extends to any 
other United States person who acquires from any person any portion of 
the United States shareholder's interest in the foreign corporation 
(subject to any proof of identity rules that may be prescribed by the 
Secretary).
    Section 959(b) applies for purposes of section 951(a) and provides 
that, when PTEP of a CFC is distributed through a chain of ownership 
described under section 958(a), the PTEP is excluded from the gross 
income of another CFC in the chain for purposes of applying section 
951(a) to such CFC with respect to the United States shareholder whose 
inclusion under section 951(a) gave rise to the PTEP. Under successor 
rules within section 959(b), the exclusion extends to any CFC of any 
other United States shareholder who acquires from any person any 
portion of the United States shareholder's interest in the CFC (subject 
to any proof of identity rules that may be prescribed by the 
Secretary).
    Section 959(c) treats PTEP as distributed before E&P that is not 
PTEP. It does so by allocating distributions first to PTEP described in 
section 959(c)(1) (PTEP resulting from a section 956 inclusion or PTEP 
that have been excluded under section 959(a)(2)), then to PTEP 
described in section 959(c)(2) (all other PTEP), and finally to non-
PTEP (section 959(c)(3) E&P).
    For purposes of section 959, section 951A(f)(1) treats the portion 
of a United States shareholder's GILTI inclusion that is allocated to a 
CFC in the same manner as a subpart F income inclusion.
    Section 959(f) allocates a section 956 amount first to PTEP 
described in section 959(c)(2) and then to section 959(c)(3) E&P, 
taking into account distributions made by the foreign corporation. A 
section 956 amount is not allocated to PTEP described in section 
959(c)(1) because, under section 956(a) and (b)(1), that PTEP is taken 
into account in determining the section 956 amount.
    Thus, under section 959, a CFC's E&P for a taxable year of the CFC 
is first classified as PTEP to reflect any subpart F income inclusions 
or GILTI inclusions with respect to the CFC. Next, any distributions 
made by the CFC during the taxable year are allocated to PTEP (and such 
PTEP is reduced). Then, any section 956 amount with respect to the CFC 
is determined for the taxable year, which is allocated to remaining 
section 959(c)(2) PTEP (and such PTEP is reclassified as section 
959(c)(1) PTEP). Finally, the CFC's E&P for the taxable year is 
classified as PTEP to reflect any inclusion under section 951(a)(1)(B).
2. Basis Adjustments Under Section 961
    Section 961 describes rules that provide for basis increases to 
reflect amounts included in gross income under section 951(a) and basis 
reductions and gain recognition to reflect distributions of PTEP. Basis 
increases prevent undistributed PTEP of a foreign corporation from 
giving rise to gain or a subpart F income inclusion of a covered 
shareholder, and thus additional tax, in a sale or exchange of stock of 
the foreign corporation or property through which such stock is owned. 
See H.R. Rep. No. 87-1447, at A106 (1962); H.R. Rep. No. 105-148, at 
529-30 (1997). Basis reductions and gain recognition prevent double 
benefits that would otherwise arise (for example, by ensuring a 
distribution of PTEP does not create a loss in the stock or other 
property on which the distribution is made because of basis provided 
under section 961 for the inclusion that gave rise to the PTEP).
    Section 961(a) provides that, under regulations prescribed by the 
Secretary, a United States shareholder's basis in its

[[Page 95364]]

stock in a CFC, and basis in property through which it owns such stock, 
is increased by the amount included in the shareholder's gross income 
under section 951(a) with respect to such stock or property.
    Section 961(b)(1) provides that, under regulations prescribed by 
the Secretary, when a United States shareholder or a United States 
person receives an amount that is excluded from gross income under 
section 959(a), the basis of the stock or other property with respect 
to which the amount is received is reduced by the amount so excluded. 
To the extent that an amount excluded from gross income under section 
959(a) exceeds the basis of the stock or other property with respect to 
which it is received, section 961(b)(2) treats the amount as gain from 
the sale or exchange of property.
    Section 961(c) provides that, under regulations prescribed by the 
Secretary, if a United States shareholder owns stock in a CFC that is 
owned by another CFC, then adjustments similar to the adjustments 
provided by section 961(a) and (b) are made to the basis of such stock, 
and the basis of stock in any other CFC through which the United States 
shareholder owns the stock of the first mentioned CFC, but only for the 
purposes of determining the amount included under section 951 in the 
gross income of such United States shareholder. Under successor rules 
within section 961(c), basis adjustments carry over to any other United 
States shareholder who acquires from any person any portion of the 
interest of the United States shareholder by reason of which the 
shareholder was treated as owning the relevant CFC stock (subject to 
any proof of identity rules that may be prescribed by the Secretary). 
Section 961(c) further provides that the adjustments described in 
section 961(c) do not apply to any stock owned by the United States 
shareholder to which a basis adjustment applies under section 961(a) or 
(b).
    For purposes of section 961, section 951A(f)(1) treats the portion 
of a United States shareholder's GILTI inclusion that is allocated to a 
CFC in the same manner as a subpart F income inclusion.
    Section 1.965-2(f)(1) generally provides that basis is not 
increased under section 961 to reflect PTEP resulting from section 
965(b), but Sec.  1.965-2(f)(2) permits taxpayers to elect to make 
certain basis adjustments.
3. Foreign Currency Gain or Loss Under Section 986(c)
    Section 986(c)(1) requires the recognition of foreign currency gain 
or loss with respect to distributions of PTEP attributable to movements 
in exchange rates between the date of the income inclusion that gave 
rise to the PTEP and the distribution of the PTEP. Section 986(c)(1) 
further provides that such foreign currency gain or loss is treated as 
ordinary income or loss from the same source as the associated income 
inclusion. Section 986(c)(2) provides that the Secretary shall 
prescribe regulations with respect to distributions of PTEP through 
tiers of foreign corporations. Section 989(c) provides that the 
Secretary shall prescribe such regulations as may be necessary or 
appropriate to carry out the purposes of the subpart that includes 
section 986 (subpart J of part III, subchapter N, chapter 1, subtitle A 
of the Code).
    Notice 88-71, 1988-2 C.B. 374 (1988 notice), provides guidance 
regarding foreign currency gain or loss with respect to PTEP and 
announced an intent to issue regulations consistent with the guidance. 
Under the 1988 notice, such foreign currency gain or loss is determined 
with respect to each separate category of income listed in section 
904(d)(1) pursuant to a formula and is recognized immediately before 
certain sales or exchanges of stock of a foreign corporation with 
respect to undistributed PTEP of the foreign corporation. See also 
Sec.  1.985-5(e)(2) (requiring a United States shareholder to recognize 
foreign currency gain or loss when a CFC changes its functional 
currency to the U.S. dollar); Sec.  1.367(b)-2(j)(2)(i) (application of 
section 986(c) to certain nonrecognitions).
    Section 1.986(c)-1 addresses foreign currency gain or loss with 
respect to distributions of PTEP resulting from section 965. The rules 
provide that foreign currency gain or loss with respect to PTEP 
resulting from section 965(a) is determined based on movements in the 
exchange rate between December 31, 2017, and the time such PTEP is 
distributed, and that any such gain or loss recognized is reduced in 
the same proportion as the reduction by a section 965(c) deduction 
amount (as defined in Sec.  1.965-1(f)(42)) of the section 965(a) 
inclusion amount (as defined in Sec.  1.965-1(f)(38)) that gave rise to 
the PTEP. The rules also provide that section 986(c) does not apply 
with respect to distributions of PTEP resulting from section 965(b).
4. Foreign Income Taxes Under Sections 164(a), 901(a), and 960(b)
    Section 164(a) generally provides that a taxpayer is allowed a 
deduction for certain foreign income taxes paid or accrued by the 
taxpayer.
    Section 901(a) generally provides that a taxpayer choosing to 
credit foreign income taxes is allowed a credit for certain foreign 
income taxes paid or accrued by the taxpayer plus, in the case of a 
domestic corporation, the taxes deemed to have been paid by the 
domestic corporation under section 960.
    Section 960(b) applies for purposes of sections 901 through 909 
(relating to the foreign tax credit). Section 960(b)(1) provides that, 
if PTEP distributed by a CFC to a corporate United States shareholder 
of the CFC is excluded from gross income under section 959(a), the 
United States shareholder is deemed to have paid the foreign income 
taxes that are properly attributable to the PTEP and that have not 
already been deemed paid by a domestic corporation. Similarly, section 
960(b)(2) provides that, if PTEP distributed by a CFC to another CFC is 
excluded from gross income under section 959(b), the recipient CFC is 
deemed to have paid the foreign income taxes that are properly 
attributable to the PTEP and that have not already been deemed paid by 
a domestic corporation. Section 960(f) provides that the Secretary 
shall prescribe such regulations or other guidance as may be necessary 
or appropriate to carry out the provisions of section 960. Section 
904(d)(1) provides that certain provisions including section 960 apply 
separately with respect to certain categories of income, and section 
904(d)(7) provides that the Secretary shall prescribe such regulations 
as may be necessary or appropriate for the purposes of section 904(d).
    For purposes of determining the amount of foreign income taxes 
deemed paid, Sec.  1.960-3 requires the establishment and maintenance 
of foreign corporation-level accounts that track a foreign 
corporation's PTEP and foreign income taxes associated with the PTEP. 
Those regulations adopt a system of accounting for PTEP in annual 
accounts for each separate section 904 category (as defined in Sec.  
1.960-1(b)(23)) and further segregate each annual account among ten 
PTEP groups.
    Section 965(g) and Sec.  1.965-5 disallow a percentage (referred to 
as the applicable percentage, as defined in Sec.  1.965-5(d)) of any 
credit or deduction for foreign income taxes associated with PTEP 
resulting from section 965(a) or (b). Section 245A(d) and Sec.  
1.245A(d)-1 disallow the entirety of any credit or deduction for 
foreign income taxes associated with PTEP resulting from income 
inclusions by reason of section 245A(e)(2) (regarding hybrid dividends) 
or certain income inclusions by reason of section 964(e)(4) (regarding 
sales of

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stock of a foreign corporation by a CFC). Sections 245A(g) and 965(o) 
provide that the Secretary shall prescribe such regulations or other 
guidance as may be necessary or appropriate to carry out the provisions 
of sections 245A and 965, respectively.
5. Election Under Section 962
    Section 962(a) provides that, under regulations prescribed by the 
Secretary, an individual United States shareholder may elect to be 
taxed at domestic corporate rates on amounts included in the 
individual's gross income under section 951(a) and that those amounts 
are treated as taken into account by a domestic corporation for 
purposes of applying the relevant provisions of section 960. The 
election also applies to amounts included in the individual's gross 
income under section 951A(a) because, for purposes of section 962, such 
amounts are treated in the same manner as a subpart F income inclusion. 
See section 951A(f)(1). The purpose of section 962 generally is to 
equate an individual's tax burden with respect to certain earnings of a 
CFC with the tax burden the individual would have had if the individual 
were to own the CFC through a domestic corporation. See S. Rep. No. 87-
1881, at 92-93 (1962).
    To carry out this purpose, section 962(d) generally subjects PTEP 
to an additional level of taxation when distributed. It does so by, 
notwithstanding section 959(a)(1), requiring that the distributed PTEP 
be included in gross income to the extent it exceeds the amount of tax 
paid on the amounts to which the election under section 962 applied.
    Section 961(a) also carries out this purpose by, in the case of an 
election under section 962, limiting a basis increase for an income 
inclusion to which the election applied to the amount of tax paid by 
the individual with respect to the income inclusion. Additionally, in a 
distribution of PTEP, section 961(b)(1) limits a basis decrease to the 
amount that is excluded from gross income under section 959(a) after 
the application of section 962(d).
6. Section 1411
    Section 1411 generally imposes a 3.8 percent tax on the net 
investment income of certain individuals, trusts, and estates. Under 
section 1411(c)(1) and Sec.  1411-4(a), net investment income includes 
certain income from dividends and net gain from the disposition of 
property. Section 1.1411-10 provides, in relevant part, rules regarding 
the application of section 1411 to individuals, trusts, and estates 
that own stock of a CFC, and Sec.  1.1411-10(g) allows an election with 
respect to a CFC to treat amounts included in income under section 
951(a) with respect to the CFC as net investment income for purposes of 
Sec.  1.1411-4(a)(1)(i). See also Sec.  1.951A-5(b)(1) (treating a 
GILTI inclusion in the same manner as a subpart F income inclusion for 
purposes of applying section 1411). If the election provided under 
Sec.  1.1411-10(g) is made, a distribution of E&P that is not treated 
as a dividend pursuant to section 959(d) is generally not treated as a 
dividend for purposes of section 1411(c)(1)(A)(i) and Sec.  1.1411-
4(a)(1)(i). See Sec.  1.1411-10(c)(1)(i)(B). If the election provided 
under Sec.  1.1411-10(g) is not made, however, net investment income 
could reflect value attributable to PTEP, either when the PTEP is 
distributed or when a United States shareholder directly or indirectly 
disposes of stock of the CFC. Thus, if no election is made, a 
distribution of E&P that is not treated as a dividend pursuant to 
section 959(d) is nevertheless a dividend for purposes of determining 
net investment income under section 1411(c)(1)(A)(i) and Sec.  1.1411-
4(a)(1)(i), provided the distribution is attributable to amounts that 
are or have been included in gross income under section 951(a) in a 
taxable year beginning after December 31, 2012. See Sec.  1.1411-
10(c)(1)(i)(A)(1). For purposes of calculating gain on the disposition 
of stock of a CFC, basis adjustments under section 961(a) and (b) are 
similarly not taken into account for section 1411 purposes in the 
absence of the election. See Sec.  1.1411-10(d)(1).
D. Regulations Under Sections 959 and 961
    The current regulations under sections 959 and 961 were issued in 
1965 and have not been updated to reflect certain statutory changes 
(for example, the enactment of section 961(c)). The regulations also do 
not address a number of issues relating to the operation of sections 
959 and 961.
    In 2006, the Treasury Department and the IRS issued a notice of 
proposed rulemaking (71 FR 51155) (2006 proposed regulations) to 
provide more complete rules and address various open issues under 
sections 959 and 961 and related provisions.
    In 2018, the Treasury Department and the IRS issued Notice 2019-01, 
2019-02 I.R.B. 275 (2019 notice), which announced an intent to withdraw 
the 2006 proposed regulations and issue a new notice of proposed 
rulemaking under sections 959 and 961 to address certain issues arising 
from the Act. The 2019 notice described rules for the maintenance of 
PTEP accounts and other aspects relating to the operation of section 
959 and requested comments on certain topics. The Treasury Department 
and the IRS received several written comments in response to the 2019 
notice. In 2022, the Treasury Department and the IRS formally withdrew 
the 2006 proposed regulations (87 FR 63981).
    As indicated in the 2019 notice, changes made by the Act had a 
significant impact on the role of PTEP and how it functions within the 
U.S. tax system and, in certain cases, exacerbated the need to address 
longstanding issues. Thus, in addition to the need for updated and more 
complete rules as contemplated in the 2006 proposed regulations, the 
issuance of new regulations requires consideration of multiple issues 
raised by the Act. Certain significant considerations about the role of 
PTEP in the current U.S. tax system are summarized below.
    First, the Act significantly increased the types of income that 
give rise to PTEP, several of which involve specific rules and 
limitations to determine foreign currency gain or loss and the 
availability of foreign tax credits. Giving effect to the various rules 
and limitations introduced by the Act requires a detailed accounting 
system to track PTEP in new groups, and to ensure those rules and 
limitations are appropriately applied by taxpayers and can be 
administered by the IRS.
    The Act also substantially increased the amount of PTEP in the U.S. 
tax system. In many cases, a considerable portion of a CFC's income has 
been (or will be) subject to tax under section 951(a)(1)(A) or 951A(a), 
including by reason of the transition tax imposed under section 965, 
and thus only the residual amount of the CFC's income constitutes 
section 959(c)(3) E&P.
    At the same time, the Act introduced section 245A, which in certain 
cases allows a domestic corporation to claim a dividends received 
deduction for section 959(c)(3) E&P. As a result, unlike before the Act 
where section 959(c)(3) E&P generally was subject to U.S. tax (with a 
possible foreign tax credit in some cases) when repatriated to the 
domestic corporation, such E&P may now generally be repatriated without 
U.S. tax to a recipient domestic corporation. Nonetheless, there are 
important distinctions between section 959(c)(3) E&P and PTEP--in 
particular, the section 245A deduction generally allows E&P to be 
distributed without a corresponding basis reduction (but see sections 
961(d) and 1059), whereas a distribution of PTEP reduces basis (or 
gives rise to gain) in accordance with section 961(b). Therefore, PTEP 
may not

[[Page 95366]]

be preferable to section 959(c)(3) E&P and taxpayers might take 
inappropriate positions to maximize the existence of section 959(c)(3) 
E&P. For example, a taxpayer may wish to claim a section 961 basis 
increase for an amount included in gross income but apply the section 
245A deduction on a distribution of the corresponding E&P so that such 
E&P is repatriated tax-free without any basis reduction under section 
961(b). To prevent this type of planning, it is critical for the system 
to properly maintain the PTEP character of that E&P so that section 
961(b) applies when the E&P is distributed.
    Existing rules governing PTEP also do not adequately address 
structures where a United States shareholder owns only a portion of the 
stock in an upper-tier CFC that owns stock in a lower-tier CFC. In 
particular, there are no rules prescribing the manner in which basis 
under section 961(c) functions in these non-wholly owned structures. 
Further, after the enactment of section 951A in the Act, it is much 
more likely for United States shareholders to have disparate amounts of 
PTEP with respect to the same CFC because a United States shareholder's 
GILTI inclusion is determined based on items attributable to all the 
stock of CFCs owned by the United States shareholder, and this can 
raise issues about how section 959(b) applies in distributions of the 
PTEP (such as the issues discussed in part II.D.1.ii of the Explanation 
of Provisions). Thus, changes in the Act have compounded already 
existing complexities with respect to the treatment of PTEP and basis 
in stock in non-wholly owned structures.
    Finally, existing rules do not sufficiently address the operation 
of the PTEP provisions with respect to domestic partnerships (or 
certain S corporations) in light of the enactment of section 951A and 
the extension of aggregate treatment to such entities in determining 
inclusions under both sections 951(a) and 951A(a) (as discussed in part 
III.A of the Background). Moreover, certain unresolved issues, such as 
whether a partnership obtains basis in stock of a CFC to account for 
PTEP, which had previously been limited to foreign partnerships, now 
apply equally to domestic partnerships (and certain S corporations).

III. Other Guidance and Issues

A. Regulations Under Section 958
    Before the Act, domestic partnerships (and S corporations by 
operation of section 1373(a)) were treated as owning stock of a foreign 
corporation for purposes of determining inclusions in gross income 
under section 951(a), and, thus, PTEP accounts under section 959 were 
maintained, and related basis adjustments under section 961 were made, 
at the partnership level.
    Following the enactment of section 951A in the Act, in 2019 the 
Treasury Department and the IRS published final regulations treating a 
domestic partnership (and certain S corporations) as an aggregate of 
its partners for purposes of applying section 951A and related 
provisions. TD 9866, 84 FR 29288. That is, partners do not take into 
account a distributive share of a section 951A inclusion with respect 
to the domestic partnership and its CFCs, but instead are treated as 
proportionately owning the stock of those CFCs, with the result that 
(as with foreign partnerships) income inclusions under section 951A are 
determined directly (and solely) by partners that are United States 
shareholders with respect to a CFC. Subsequently, in 2022, the Treasury 
Department and the IRS published Sec.  1.958-1(d) which, consistent 
with the approach adopted under section 951A, extends the aggregate 
treatment of domestic partnerships to section 951. TD 9960, 87 FR 3648.
    Under Sec.  1.958-1(d), for purposes of sections 951, 951A, and 
956(a), as well as any provision that specifically applies by reference 
to those sections (or regulations issued under those sections), a 
domestic partnership is generally not treated as owning stock of a 
foreign corporation under section 958(a), and stock of a foreign 
corporation owned by the domestic partnership is instead treated in the 
same manner as stock of a foreign corporation owned by a foreign 
partnership under section 958(a)(2) and Sec.  1.958-1(b). Accordingly, 
because sections 959 and 961 specifically apply by reference to 
sections 951 and 951A (in the latter case, as a result of section 
951A(f)(1)(A)), aggregate treatment of domestic partnerships applies 
for purposes of sections 959 and 961 pursuant to Sec.  1.958-1(d). 
Regulations do not, however, specifically address the application of 
sections 959 and 961 with respect to domestic partnerships or their 
partners under Sec.  1.958-1(d).
B. Regulations Under Section 1502
    Section 1502 authorizes the Secretary to prescribe regulations for 
an affiliated group of corporations that join in filing (or that are 
required to join in filing) a consolidated return (consolidated group, 
as defined in Sec.  1.1502-1(h)) to clearly reflect the U.S. tax 
liability of the consolidated group and to prevent avoidance of such 
tax liability. For purposes of carrying out those objectives, section 
1502 also permits the Secretary to prescribe rules that may be 
different from the provisions of chapter 1 of subtitle A of the Code 
that would apply if the corporations composing the consolidated group 
filed separate returns. Pursuant to these rules, members of a 
consolidated group are treated as separate entities for some purposes 
but as divisions of a single corporation for other purposes. See, for 
example, Sec.  1.1502-13(a)(2).
    Regulations issued under section 1502 address the application of 
certain provisions of subpart F in the context of consolidated groups. 
See, for example, Sec.  1.1502-51 (application of section 951A to 
consolidated groups); Sec.  1.1502-80(j) (addressing determination of 
section 951(a)(2)(B) reduction for distributions under section 959(b) 
for purposes of sections 951(a)(1)(A) and 951A(a)). However, 
regulations do not address the application of sections 959 and 961 with 
respect to a consolidated group or its members.

Explanation of Provisions

I. Scope

    The proposed regulations provide rules addressing core aspects of 
the PTEP system, including rules that address longstanding issues under 
sections 959 and 961, account for new provisions and amendments under 
the Act, and implement the 1988 notice and 2019 notice. Future guidance 
will address certain issues not addressed in the proposed regulations, 
for example, issues involving nonrecognition transactions, redemptions, 
transactions to which section 964(e) applies, and structures where CFCs 
are partners in a partnership. See also Notice 2024-16, 2024-5 I.R.B. 
622 (announcing intent to issue proposed regulations addressing the 
treatment of section 961(c) basis in certain transactions in which a 
domestic corporation acquires stock of a CFC in a liquidation described 
in section 332 or an asset reorganization described in section 
368(a)(1)). Future guidance may also address any issues regarding the 
interaction of the proposed regulations with existing rules under other 
provisions.

II. Section 959 Regulations

A. Overview
    The proposed regulations under section 959 provide rules for PTEP 
accounting (both at the shareholder-level and foreign corporation-
level), exclusions from gross income, and related determinations and 
adjustments.

[[Page 95367]]

B. PTEP Accounting (Proposed Sec.  1.959-2)
1. Shareholder-Level Accounts
i. In General
    Integral to the proposed regulations are annual PTEP accounts, 
dollar basis pools, and PTEP tax pools, which are established and 
maintained by a covered shareholder with respect to a foreign 
corporation in which the shareholder owns stock. See proposed Sec.  
1.959-2(b)(1). These are integral aspects of the PTEP system because 
they ensure proper tracking of amounts described under provisions of 
the Code such as sections 959(a), 986(c), and 960(b). These rules are 
issued pursuant to the express delegations of authority under sections 
245A(g), 904(d)(7), 960(f), 965(o), and 989(c).
    A covered shareholder means any United States person, other than a 
domestic partnership. See proposed Sec.  1.959-1(b); see also part 
VIII.A of the Explanation of Provisions (providing that an S 
corporation is generally treated in the same manner as a domestic 
partnership). Domestic partnerships are excluded from this definition 
because they are treated as aggregates of their partners in determining 
stock ownership for purposes of section 959 (discussed in part III.A of 
the Background). A covered shareholder is not limited to a United 
States shareholder because the exclusion under section 959(a) is not 
limited to United States shareholders. For example, section 959(a) 
applies to any United States person who acquires from any person an 
interest in a foreign corporation with PTEP.
ii. Annual PTEP Accounts
    Annual PTEP accounts track a foreign corporation's PTEP with 
respect to a covered shareholder. See proposed Sec.  1.959-2(b)(1). 
These accounts represent PTEP distributable exclusively to the covered 
shareholder (or a successor), directly or indirectly through tiers, on 
any stock of the foreign corporation.
    Each annual PTEP account relates to a single taxable year of the 
foreign corporation and a single section 904 category, and PTEP within 
an annual PTEP account is maintained in the foreign corporation's 
functional currency and assigned among ten PTEP groups and two 
subgroups. See proposed Sec.  1.959-2(b)(2). Tracking PTEP on an annual 
basis is necessary to apply the ``last-in, first-out'' rule for 
distributions of PTEP in section 959(c), and PTEP is maintained in the 
foreign corporation's functional currency pursuant to section 986(b). 
Tracking PTEP by section 904 category and by PTEP groups is necessary 
to implement rules determining foreign currency gain or loss and 
foreign tax credits with respect to PTEP.
    The ten PTEP groups fall within two categories--section 959(c)(2) 
PTEP groups and section 959(c)(1) PTEP groups. See proposed Sec.  
1.959-2(b)(2)(i). The section 959(c)(2) groups separately track PTEP 
resulting from subpart F income inclusions, GILTI inclusions, 
application of section 965(a) or 965(b), or income inclusions to which 
section 245A(d) applies (PTEP resulting from section 245A(e)(2) or 
certain PTEP resulting from section 959(e) (concerning section 1248) or 
section 964(e)(4) (concerning certain dispositions of foreign stock)). 
The section 959(c)(1) PTEP groups correspond to the section 959(c)(2) 
PTEP groups and account for the reclassification of PTEP pursuant to 
section 959(a)(2). PTEP arising from section 956 inclusions is combined 
with reclassified PTEP arising from subpart F income inclusions.
    The two subgroups track PTEP arising from income inclusions of 
certain covered shareholders. See proposed Sec.  1.959-2(b)(2)(ii). One 
subgroup tracks PTEP arising from an income inclusion of an individual 
and includible in gross income under section 962(d) when distributed in 
a distribution to which section 959(a) would otherwise apply (taxable 
section 962 PTEP). The second subgroup tracks PTEP arising from an 
income inclusion of an individual, estate, or trust that would be 
includible in net investment income under section 1411(c) when 
distributed (that is, the election under Sec.  1.1411-10(g) is not made 
and, thus, the income inclusion giving rise to the PTEP was not taken 
into account in determining net investment income).
    Additionally, for PTEP resulting from the application of section 
965(a) or (b), an adjusted applicable percentage must be maintained, 
which tracks the percentage of a credit or deduction for foreign income 
taxes associated with PTEP that is disallowed under Sec.  1.965-5. See 
proposed Sec.  1.959-2(b)(2)(iii)(A). Similarly, for PTEP resulting 
from the application of section 965(a), a section 965(c) deduction 
percentage must be maintained, which tracks the percentage of foreign 
currency gain or loss with respect to PTEP that is not recognized under 
Sec.  1.986(c)-1. See proposed Sec.  1.959-2(b)(2)(iii)(B). The 
adjusted applicable percentage and the section 965(c) deduction 
percentage are tracked by section 904 category. Each is determined 
using a single weighted average across that section 904 category, which 
is intended to reduce the compliance burden and facilitate 
administrability in cases in which the applicable percentage or section 
965(c) deduction amount differs with respect to PTEP in the section 904 
category by not requiring the separate tracking of those percentages or 
amounts. See also part IX.B.3. of the Explanation of Provisions 
(describing transition rules for the initial determination of the 
adjusted applicable percentage and section 965(c) deduction 
percentage).
iii. Dollar Basis Pools and PTEP Tax Pools
    Dollar basis pools track the basis in U.S. dollars of a foreign 
corporation's PTEP with respect to a covered shareholder, and such 
dollar basis is used to determine foreign currency gain or loss under 
section 986(c). See proposed Sec.  1.959-2(b)(1). PTEP tax pools track 
the U.S. dollar amount of foreign income taxes associated with a 
foreign corporation's PTEP with respect to a covered shareholder, and 
such taxes are assigned to a creditable PTEP tax group to the extent 
eligible to be deemed paid under section 960(b). See proposed Sec.  
1.959-2(b)(1) and (4)(ii). The creditable PTEP tax group tracks foreign 
income taxes that are eligible to be deemed paid under section 960(b).
    Furthermore, together, dollar basis and the U.S. dollar amount of 
associated foreign income taxes determine basis reductions under 
section 961 for distributions of PTEP. See also part III.C.2 of the 
Explanation of Provisions.
    Tracking foreign income taxes associated with PTEP in a 
shareholder-specific manner (consistent with how PTEP is tracked) 
differs from the approach under existing Sec.  1.960-3 (and the 1988 
notice), which tracks such taxes only at the CFC-level (without regard 
to the shareholder whose PTEP account was reduced by the taxes). This 
new approach ensures that, in structures involving multiple covered 
shareholders, foreign income taxes are associated with PTEP with 
respect to a particular covered shareholder and do not include foreign 
income taxes that were imposed on PTEP with respect to another covered 
shareholder. Thus, in a distribution of PTEP to a covered shareholder, 
the covered shareholder's basis is reduced under section 961(b) by the 
foreign income taxes that are (i) associated with (and consequently 
reduced) PTEP with respect to the covered shareholder, and (ii) deemed 
paid by the covered shareholder. This method is intended to prevent 
each covered shareholder from incurring double taxation on a single 
item of income, by ensuring that a covered

[[Page 95368]]

shareholder is able to take into account the foreign income taxes 
associated with the PTEP with respect to the covered shareholder.
    Generally, dollar basis pools and PTEP tax pools are maintained on 
a year-by-year basis, with one pool for each PTEP group within each 
annual PTEP account. See proposed Sec.  1.959-2(b)(3) and (4). 
Maintenance of separate dollar basis pools for each PTEP group prevents 
the commingling of dollar basis of PTEP that is subject to different 
rules with respect to the recognition of foreign currency gain or loss 
under section 986(c). Maintenance of separate PTEP tax pools for each 
PTEP group prevents the commingling of foreign income taxes for which 
the related PTEP is subject to different rules regarding the 
applicability of section 960(b).
    Under an exception intended to simplify PTEP accounting, a covered 
shareholder may elect to combine dollar basis pools and PTEP tax pools 
across years. See proposed Sec.  1.959-2(c). In such a case, each 
dollar basis pool and PTEP tax pool relates to PTEP assigned to a 
single PTEP group and a single section 904 category (without regard to 
the taxable years to which the PTEP relates). See proposed Sec.  1.959-
2(b)(3) and (4). This election is consistent with a comment in response 
to the 2019 notice that recommended allowing taxpayers to pool dollar 
basis across years within section 904 categories.
    If a covered shareholder elects to combine dollar basis pools and 
PTEP tax pools across years, the election applies to the covered 
shareholder's dollar basis pools and PTEP tax pools with respect to 
each foreign corporation in which the covered shareholder owns stock. 
See proposed Sec.  1.959-2(c)(1). This ensures consistent treatment by 
not permitting a covered shareholder to maintain combined pools with 
respect to some foreign corporations but not others. A combined pool 
election may be revoked only with the consent of the Commissioner. See 
proposed Sec.  1.959-2(c)(2).
2. Foreign Corporation-Level Accounts
    Foreign corporation-level accounts track a foreign corporation's 
PTEP and associated foreign income taxes (corporate PTEP accounts and 
corporate PTEP tax pools, respectively). See proposed Sec.  1.959-
2(d)(1) and (d)(2). A corporate PTEP account and corporate PTEP tax 
pool each relate to a single covered shareholder, and PTEP or foreign 
income taxes within such an account are assigned to section 904 
categories and PTEP groups (as is the case in shareholder-level 
accounts). These accounts reflect that PTEP and associated foreign 
income taxes are foreign corporation-level attributes (which, as 
discussed in part II.B.1 of the Explanation of Provisions, are tracked 
in a shareholder-specific manner). These accounts also are necessary to 
allocate and apportion current year taxes paid or accrued by a foreign 
corporation among the relevant statutory and residual groupings of the 
foreign corporation, as discussed in part II.F of the Explanation of 
Provisions, as well as for computations under section 956, which take 
into account E&P described in section 959(c)(1). Finally, as with 
shareholder-level accounts, these rules are issued pursuant to the 
express delegations of authority under sections 245A(g), 904(d)(7), 
960(f), 965(o), and 989(c).
    A corporate PTEP account relating to a covered shareholder 
represents all PTEP within the covered shareholder's annual PTEP 
accounts with respect to the foreign corporation (therefore, unlike 
shareholder-level accounts, a corporate PTEP account does not relate to 
a single taxable year of the foreign corporation). Similarly, a 
corporate PTEP tax pool for a covered shareholder represents all 
foreign income taxes within the covered shareholder's PTEP tax pools 
with respect to the foreign corporation. Thus, as a covered 
shareholder's annual PTEP accounts and PTEP tax pools with respect to a 
foreign corporation are adjusted, the foreign corporation-level 
accounts (including the PTEP groups within the accounts) are also 
adjusted.
    The proposed regulations do not provide rules for maintaining a 
foreign corporation-level account for section 959(c)(3) E&P because the 
Treasury Department and the IRS are studying whether such E&P should be 
separately computed with respect to each covered shareholder in certain 
instances and related issues (for example, coordination with section 
1248). For example, assume a case in which US1 and US2, each a covered 
shareholder, own 60% and 40%, respectively, of the stock of CFC1, a 
foreign corporation. CFC1 has $75x and $0 of PTEP with respect to US1 
and US2, respectively, but only $50x of total E&P as a result of 
incurring a deficit in E&P after generating the PTEP. Under a 
shareholder-specific approach to computing CFC1's section 959(c)(3) 
E&P, such E&P would be negative $45x with respect to US1 ($50x x 60%-
$75x) and $20x with respect to US2 ($50x x 40%-$0). Under a non-
shareholder-specific approach to computing section 959(c)(3) E&P, 
CFC1's section 959(c)(3) E&P would be negative $25x ($50x-$75x).
    The proposed regulations clarify that a foreign corporation's E&P 
is determined independently of the foreign corporation's PTEP. See 
proposed Sec.  1.959-2(d)(3). For example, in a distribution by a 
foreign corporation with respect to its stock, section 316 determines 
the extent to which the distribution is made out of the foreign 
corporation's E&P, and section 959 determines the extent to which the 
portion that is made out of E&P is a distribution of PTEP. See also 
proposed Sec.  1.959-10(c)(2)(iii) (Example 2, alternative facts, 
regarding a distribution of built-in loss property). Additionally, as 
in the example in the preceding paragraph, the proposed regulations 
clarify that a foreign corporation's E&P may be less than the foreign 
corporation's PTEP because a loss does not reduce PTEP.
C. Shareholder-Level Account Adjustments (Proposed Sec.  1.959-3)
1. In General
    The proposed regulations describe the adjustments made to a covered 
shareholder's annual PTEP accounts (including PTEP groups within those 
accounts and, if applicable, relevant percentages for section 965 PTEP 
and PTEP subgroups), dollar basis pools, and PTEP tax pools with 
respect to a foreign corporation. See proposed Sec.  1.959-3. The rules 
for making these adjustments are issued pursuant to the express 
delegations of authority under sections 245A(g), 904(d)(7), 986(c)(2), 
960(f), 965(o), and 989(c).
    These adjustments reflect income inclusions and transactions 
related to a taxable year of the foreign corporation, and the 
adjustments preserve the character of the foreign corporation's PTEP 
with respect to the covered shareholder (for example, the taxable year, 
section 904 category, and PTEP group to which PTEP relates). In 
applying these rules to tiers of foreign corporations, the adjustments 
are applied successively from the lowest-tier foreign corporation to 
the highest-tier foreign corporation. See proposed Sec.  1.959-3(g).
    An adjustment to annual PTEP accounts is treated as made at one of 
three points in time (each of which is discussed below in this part 
II.C of the Explanation of Provisions), which determines when PTEP 
becomes (or ceases to be) available for distribution to the covered 
shareholder: (i) at the beginning of the first day of the foreign 
corporation's taxable year, (ii) concurrently with the transaction 
giving rise to the adjustment, or (iii) at the end of the last day of 
the foreign

[[Page 95369]]

corporation's taxable year. See proposed Sec.  1.959-3(f). An 
adjustment to dollar basis pools and PTEP tax pools is treated as made 
concurrently with the related adjustment to annual PTEP accounts.
2. Beginning of Year Adjustments
    Three types of PTEP are added to annual PTEP accounts at the 
beginning of the foreign corporation's taxable year (even if, for 
example, the determination of the amount giving rise to the PTEP occurs 
at the end of such taxable year). This timing ensures that PTEP 
generated or received during the taxable year is available for 
distribution as of the start of the taxable year, consistent with 
sections 316(a)(2) and 959(c) (which determine dividend treatment and 
the application of section 959(a) or (b) based on E&P for the taxable 
year).
    The first type is PTEP arising from the covered shareholder's 
subpart F income inclusion or GILTI inclusion with respect to the 
foreign corporation for the taxable year. See proposed Sec.  1.959-
3(c)(1)(i) and (ii). To reflect the addition of this PTEP, basis equal 
to the U.S. dollar amount of the income inclusion giving rise to the 
PTEP is added to related dollar basis pools. See proposed Sec.  1.959-
3(d)(1)(i).
    The second type is PTEP with respect to the covered shareholder 
that is distributed to the foreign corporation during the taxable year 
(discussed in part II.D of the Explanation of Provisions). See proposed 
Sec.  1.959-3(c)(1)(iii). To reflect the addition of this PTEP, the 
dollar basis and associated foreign income taxes of the PTEP are added 
to related dollar basis pools and PTEP tax pools, and such taxes are 
assigned to the creditable PTEP tax group to the extent the foreign 
corporation is deemed to pay the taxes under section 960(b)(2) and 
proposed Sec.  1.960-3(c). See proposed Sec.  1.959-3(d)(1)(ii), 
(e)(1)(i). Further, the PTEP is reduced by current year taxes allocated 
and apportioned to the PTEP (that is, by foreign income taxes imposed 
on the PTEP and paid or accrued by the foreign corporation in the 
taxable year, as distinguished from foreign income taxes described in 
the preceding sentence, which were paid or accrued by another foreign 
corporation in a prior distribution of the PTEP). See proposed Sec.  
1.959-3(c)(1)(v); see also part II.F of the Explanation of Provisions 
(rules for allocating and apportioning current year taxes to PTEP). 
Such current year taxes reduce related dollar basis pools and are added 
to related PTEP tax pools, where the taxes are assigned to the 
creditable PTEP tax group to the extent the foreign corporation is a 
CFC and a credit for the taxes is not disallowed or suspended at the 
level of the CFC. See proposed Sec.  1.959-3(d)(1)(iii), (e)(1)(ii).
    The third type is PTEP with respect to the covered shareholder that 
results from the application of the foreign corporation's section 
961(c) basis to gain recognized by the foreign corporation during the 
taxable year (discussed in part III.E of the Explanation of 
Provisions). See proposed Sec.  1.959-3(c)(1)(iv). To reflect the 
addition of this PTEP, the dollar basis of the PTEP is added to related 
dollar basis pools. See proposed Sec.  1.959-3(d)(1)(ii). Further, 
current year taxes allocated and apportioned to the PTEP reduce the 
PTEP, reduce related dollar basis pools, and are added to related PTEP 
tax pools, where (like in a distribution) the taxes are assigned to the 
creditable PTEP tax group to the extent the foreign corporation is a 
CFC and a credit for the taxes is not disallowed or suspended at the 
level of the CFC. See proposed Sec.  1.959-3(d)(1)(iii), (e)(1)(ii).
3. Time of Transaction Adjustments
    Three types of PTEP are added to, or removed from, annual PTEP 
accounts concurrently with the relevant transaction occurring during 
the foreign corporation's taxable year.
    The first type is PTEP distributed by the foreign corporation 
during the taxable year. See proposed Sec.  1.959-3(c)(1)(vi). To 
reflect the removal of this PTEP, the dollar basis and associated 
foreign income taxes of the PTEP are removed from related dollar basis 
pools and PTEP tax pools. See proposed Sec.  1.959-3(d)(1)(iv), 
(e)(1)(iii).
    The second type is PTEP arising from gain recognized by the covered 
shareholder on the sale or exchange of stock during the taxable year 
that is recharacterized and included in gross income as a dividend 
under section 1248 by reason of E&P attributed to stock of the foreign 
corporation under section 1248. See proposed Sec.  1.959-3(c)(1)(vii); 
see also section 959(e). This timing prevents iterative computations 
that could result if the PTEP were available for distribution earlier 
in the taxable year. To reflect the addition of this PTEP, basis equal 
to the U.S. dollar amount of the income inclusion giving rise to the 
PTEP is added to related dollar basis pools. See proposed Sec.  1.959-
3(d)(1)(i). The Treasury Department and the IRS are studying whether a 
foreign corporation's PTEP should similarly be increased to reflect 
gain treated as a dividend under section 964(e)(1) by reason of E&P of 
the foreign corporation, which amount generally increases the selling 
CFC's PTEP, and welcome comments on whether increasing the foreign 
corporation's PTEP would be appropriate notwithstanding the duplicative 
result (that is, PTEP would be in the selling CFC and the foreign 
corporation whose E&P gave rise to the dividend).
    The third type is PTEP that transfers from (or to) the covered 
shareholder under section 959's successor rules (discussed in part II.G 
of the Explanation of Provisions). See proposed Sec.  1.959-
3(c)(1)(viii), (ix). To reflect the removal (or addition) of this PTEP, 
the dollar basis and associated foreign income taxes of the PTEP are 
removed from (or added to) related dollar basis pools and PTEP tax 
pools. See proposed Sec.  1.959-3(d)(1)(iv) and (v), (e)(1)(iii) and 
(iv).
4. End of Year Adjustments
    Two types of adjustments are made at the end of the foreign 
corporation's taxable year. These adjustments relate to the covered 
shareholder's section 956 amount with respect to the foreign 
corporation for the taxable year.
    First, PTEP to which the section 956 amount is allocated (which, as 
discussed in part II.E of the Explanation of Provisions, is excluded 
from the covered shareholder's gross income under section 959(a)(2)) is 
reassigned within annual PTEP accounts from section 959(c)(2) PTEP 
groups to section 959(c)(1) PTEP groups. See proposed Sec.  1.959-
3(c)(1)(x). To reflect the reclassification, the dollar basis and 
associated foreign income taxes of the PTEP are moved from dollar basis 
pools and PTEP tax pools relating to section 959(c)(2) PTEP groups to 
dollar basis pools and PTEP tax pools relating to section 959(c)(1) 
PTEP groups. See proposed Sec.  1.959-3(d)(1)(vi), (e)(1)(v).
    Next, PTEP arising from the portion of the section 956 amount 
included in the covered shareholder's gross income under section 
951(a)(1)(B) is added to annual PTEP accounts. See proposed Sec.  
1.959-3(c)(1)(xi). In addition, an amount of basis equal to the U.S. 
dollar amount of the section 956 inclusion giving rise to the PTEP is 
added to related dollar basis pools. See proposed Sec.  1.959-
3(d)(1)(i).
    Further, additional rules address cases where the covered 
shareholder acquires ownership of stock of the foreign corporation on 
or after the last relevant day of the foreign corporation's taxable 
year (that is, the last day of such taxable year on which the foreign 
corporation is a CFC) and a portion of a section 956 amount of a United 
States shareholder is attributable to such stock. See proposed Sec.  
1.959-3(c)(4). Under these rules, PTEP of the foreign corporation that 
has transferred to the

[[Page 95370]]

covered shareholder but to which such portion of the section 956 amount 
is ultimately allocated (discussed in part II.E of the Explanation of 
Provisions) is reclassified from section 959(c)(2) PTEP groups to 
section 959(c)(1) PTEP groups. Moreover, the foreign corporation's PTEP 
with respect to the covered shareholder is increased to reflect the 
inclusion in income by the United States shareholder of such portion of 
the section 956 amount.
D. Distributions of PTEP (Proposed Sec.  1.959-4)
1. Application of Exclusions
i. In General
    The proposed regulations provide rules regarding the exclusions 
from gross income under section 959(a)(1) and (b) for PTEP that is 
distributed to a covered shareholder or a CFC. See proposed Sec.  
1.959-4; see also part II.D.2 of the Explanation of Provisions 
(determining distributed PTEP).
    Under the section 959(a)(1) exclusion, PTEP distributed to a 
covered shareholder, other than taxable section 962 PTEP, is excluded 
from the covered shareholder's gross income. See proposed Sec.  1.959-
4(b)(1); see also section 962(d) and proposed Sec.  1.312-8(c) 
(domestic corporation's receipt of PTEP does not increase E&P, 
discussed in part VIII.I of the Explanation of Provisions).
    Under the section 959(b) exclusion, PTEP distributed by a CFC to 
another CFC is excluded from the recipient CFC's gross income for 
purposes of determining the recipient CFC's subpart F income and tested 
income or tested loss, provided that the PTEP relates to a covered 
shareholder that is a United States shareholder in both CFCs. See 
proposed Sec.  1.959-4(b)(2); see also Sec.  1.312-6(b) (the 
distribution generally increases the recipient CFC's E&P) and proposed 
Sec.  1.952-1(c)(4) (the distribution does not increase the recipient 
CFC's current year E&P for purposes of the limitation in section 
952(c)(1)(A), discussed in part VIII.I of the Explanation of 
Provisions).
    Applying the section 959(b) exclusion for purposes of determining 
the recipient CFC's tested income or tested loss prevents double 
taxation (and thus is consistent with the policy of section 959) in 
cases where the distribution is not a related party dividend described 
in section 951A(c)(2)(A)(i)(IV) and therefore could otherwise result in 
tested income. The Treasury Department and the IRS are of the view that 
this approach, which is issued under the express delegation of 
authority in section 951A(f)(1)(B), is consistent with section 
951A(f)(1)(A) (treating an inclusion under section 951A(a) in the same 
manner as an inclusion under section 951(a)(1)(A) for purposes of 
section 959), which should be interpreted as allowing references to 
section 951(a) in section 959 to be treated as including a reference to 
section 951A(a).
    Applying the section 959(b) exclusion only to PTEP distributed by a 
CFC to another CFC is consistent with the statute. However, under the 
express delegation of authority in section 965(o), the proposed 
regulations provide a special rule pursuant to which a specified 
foreign corporation (as defined in Sec.  1.965-1(f)(45)(i)(B)) that is 
not a CFC is treated as a CFC for purposes of applying the section 
959(b) exclusion to section 965 PTEP distributed by the specified 
foreign corporation, which ensures that the section 959(b) exclusion 
applies to such PTEP when received by a CFC. See proposed Sec.  1.959-
4(b)(2)(ii). The Treasury Department and the IRS are studying the 
application of section 959(b) to other PTEP distributed by a foreign 
corporation that is not a CFC (for example, in a case where the foreign 
corporation was a CFC when the PTEP was generated but is no longer a 
CFC when the PTEP is distributed). Irrespective of whether the section 
959(b) exclusion applies to PTEP distributed to a foreign corporation, 
the PTEP remains PTEP and, in a subsequent distribution, may be 
excluded from gross income under section 959(a)(1) or (b). See proposed 
Sec. Sec.  1.959-2 and 1.959-3 (describing shareholder-level annual 
PTEP accounts and related adjustments with respect to a foreign 
corporation without regard to CFC status). This treatment is required 
to give effect to section 959(a), which does not depend on the CFC 
status of any intermediary entities through which a covered shareholder 
ultimately receives PTEP.
ii. Split-Ownership Structures
    Under the proposed regulations, the section 959(b) exclusion 
applies at the CFC-level by excluding a distribution of PTEP from the 
recipient CFC's gross income for certain purposes. In structures where 
stock of a CFC is not all owned by a single United States shareholder, 
the application of the section 959(b) exclusion at the CFC-level could, 
absent special rules, result in all United States shareholders of the 
CFC sharing any benefits of the exclusion (rather than just the United 
States shareholder to which the excluded PTEP relates) and partial 
double taxation to the United States shareholder to which the excluded 
PTEP relates (to the extent the exclusion benefits other United States 
shareholders).
    Guidance issued before the Act generally used a ``gross-up'' 
mechanism to address this issue. Rev. Rul. 82-16, 1982-1 C.B. 106, 
considered a scenario where a United States shareholder owned 70% of 
the stock of an upper-tier CFC, with the remaining 30% owned by non-
United States shareholders, and the upper-tier CFC owned all the stock 
of a lower-tier CFC. The lower-tier CFC earned $100x of subpart F 
income, which gave rise to a $70x subpart F income inclusion and, thus, 
$70x of PTEP with respect to the United States shareholder. In a later 
year, the lower-tier CFC distributed $200x to the upper-tier CFC. The 
ruling concluded that section 959(b) looks to the total amount of E&P 
of the lower-tier CFC that caused the United States shareholder's 
subpart F income inclusion, with the result that section 959(b) 
excluded $100x (rather than $70x) from the upper-tier CFC's subpart F 
income in applying section 951(a) to the United States shareholder. 
Conversely, a $70x exclusion under section 959(b) would have caused the 
upper-tier CFC to have an additional $30x of subpart F income from the 
distribution, which would have led to a $21x ($30x x 70%) subpart F 
income inclusion for the United States shareholder even though its 
share of the distribution was all attributable to PTEP.
    However, a gross-up mechanism raises certain issues. For example, 
computing a gross-up may be complex or burdensome in light of the 
increased prevalence of PTEP that is not pro rata with respect to 
United States shareholders following the Act (for instance, PTEP 
resulting from a GILTI inclusion, which is not determined solely by 
reference to a particular CFC). Additionally, a gross-up mechanism 
could result in the need for different determinations of a CFC's 
subpart F income (and tested income or tested loss) for different 
United States shareholders of the CFC, which is inconsistent with the 
way that these types of income are treated under existing regulations 
for other purposes of the Code such as the expense allocation rules or 
foreign tax credit rules.
    Accordingly, instead of a gross-up mechanism, the proposed 
regulations coordinate the section 959(b) exclusion with revisions to 
the pro rata share rules of section 951(a) (discussed in part IV.C of 
the Explanation of Provisions). Under this approach, a CFC's subpart F 
income is determined with respect to all

[[Page 95371]]

shareholders by excluding the same amount of PTEP received by the CFC, 
and United States shareholders' pro rata shares of the CFC's subpart F 
income are computed in a manner so that any benefits of the application 
of the section 959(b) exclusion to PTEP with respect to a United States 
shareholder generally inure only to that United States shareholder. For 
instance, if two United States shareholders own equal interests in a 
CFC, and the CFC receives a distribution half of which is PTEP with 
respect to one United States shareholder (because there is PTEP with 
respect to the United States shareholder at least equal to its share of 
distribution) and the other half of which gives rise to subpart F 
income (because there is no PTEP with respect to the other United 
States shareholder and no exception from subpart F income applies), 
then only the United States shareholder with respect to which there is 
no PTEP has a pro rata share of the subpart F income resulting from the 
distribution.
    The Treasury Department and the IRS are of the view that the 
approach in the proposed regulations appropriately carries out the 
shareholder-specific nature of section 959(b) (that is, excluding PTEP 
with respect to a United States shareholder from a CFC's gross income 
for purposes of the application of section 951(a) to the CFC with 
respect to the United States shareholder). Additionally, this approach 
conforms with the approach for applying section 961(c) which, under the 
proposed regulations (as discussed in part III.E of the Explanation of 
Provisions), also provides for a gross income exclusion at the CFC-
level that is coordinated with the section 951(a) pro rata share rules 
to ensure its benefits generally inure only to the appropriate United 
States shareholder.
iii. Issues Involving Allocation Rules Under Section 861
    The approach in the proposed regulations discussed in part 
II.D.1.ii of the Explanation of Provisions (applying the section 959(b) 
exclusion, as well as section 961(c), at the CFC-level) can lead to 
issues involving the rules of section 861 for allocating and 
apportioning deductions because a CFC's deductions that are not current 
year taxes are not allocated and apportioned under section 861 to PTEP. 
See Sec.  1.960-1(c)(1)(ii) and proposed Sec.  1.959-6(d)(1).
    For example, in a case where some, but not all, of a distribution 
received by a CFC is PTEP, an amount of the CFC's deductible interest 
expense could reduce the non-PTEP portion of the distribution. See also 
proposed Sec.  1.951-1(h)(2)(ii)(C) (Example 1, alternative facts). 
This may result in a benefit if the non-PTEP portion would give rise to 
subpart F income or tested income, but otherwise may not be beneficial 
if the interest deductions reduce section 959(c)(3) E&P and thus the 
potential for a dividends received deduction under section 245A. 
Comments are requested on how to appropriately allocate and apportion 
deductions of a CFC when some, but not all, of a distribution (or gain 
recognized) is PTEP.
    For example, comments are requested on whether deductions that are 
not current year taxes, such as deductible interest expense, should be 
allocated and apportioned to, and therefore reduce, the CFC's PTEP. 
Under this approach, to the extent PTEP with respect to a United States 
shareholder is reduced by deductions that are not current year taxes, 
the shareholder could be allowed to retain an equivalent amount of 
adjusted basis in property directly owned by the shareholder and on 
which the remaining PTEP is ultimately distributed, with the result 
that the shareholder would receive a benefit equivalent to a deduction 
(similar to the result discussed in Part III.C.2.ii of the Explanation 
of Provisions in the case of foreign income taxes that are associated 
with PTEP but not credited under section 901).
    Comments are also requested on whether, as an alternative to the 
approach in the proposed regulations, sections 959(b) and 961(c) should 
apply at the shareholder-level. Under this type of approach, instead of 
section 959(b) preventing a distribution to a CFC from giving rise to 
subpart F income (as it has historically been interpreted, but with 
respect to a particular shareholder), section 959(b) would generally 
reduce a United States shareholder's pro rata share of the CFC's 
subpart F income, to the extent attributable to distributed PTEP. 
Furthermore, section 961(c) would apply in a similar manner in the case 
of a CFC's gain from a sale or other disposition of stock of a foreign 
corporation. Comments should address whether a CFC's deductions that 
are not current year taxes, such as deductible interest expense, should 
be allocated and apportioned to gross income of the CFC that does not 
give rise to an inclusion at the shareholder-level under section 959(b) 
or 961(c) or whether CFC-level provisions (such as section 954(c)(3) or 
(c)(6) or 964(e)(1)) apply to such income and, if so applied, whether 
the E&P from the income should be treated as section 959(c)(3) E&P or 
PTEP to ensure that the CFC-level and shareholder-level provisions 
interact appropriately.
2. Determining Distributed PTEP
i. Covered Distributions
    For a distribution to be considered a distribution of PTEP under 
section 959, the proposed regulations first require that the 
distribution be a covered distribution, which is generally defined as 
any distribution made by a foreign corporation with respect to its 
stock to the extent that the distribution is a dividend (as defined in 
section 316), determined without regard to section 959(d). See proposed 
Sec.  1.959-4(c)(1). While a covered distribution may include deemed 
distributions treated as dividends (for example, distributions under 
section 304), a covered distribution does not include an amount treated 
as a dividend by reason of section 78, 367(b), 964(e)(1), or 1248. A 
deemed dividend under section 78 is determined without regard to E&P 
(and does not represent a distribution of E&P to any shareholder), and 
deemed dividends under the other provisions, regardless of whether they 
constitute deemed distributions of E&P, are determined by excluding 
PTEP (apart from Sec.  1.367(b)-2(j)(2)(ii), which separately provides 
for a deemed distribution of PTEP in certain nonrecognition 
transactions, and Sec.  1.367(b)-3(g)(1), which separately provides for 
a deemed distribution of E&P, including PTEP, in certain inbound 
nonrecognition transactions described in Sec.  1.367(b)-3). The 
proposed regulations do not address the treatment of dividends arising 
under section 356(a)(2) as covered distributions, which will be 
addressed in future guidance regarding reorganizations (although no 
inference is intended as to the treatment of such dividends under 
current law). See proposed Sec.  1.959-4(c)(2).
    Comments on the 2019 notice asserted that a distribution of PTEP 
should not depend on the existence of E&P that would result in a 
dividend under section 316, stating that section 959(c) requires 
applying section 316 separately to sections 959(c)(1), (c)(2), and 
(c)(3) in determining whether there is sufficient E&P under section 316 
to support a distribution of E&P under that paragraph. Comments noted 
that the approach described in the 2019 notice was contrary to section 
959(a) and inconsistent with the policy of section 959 to facilitate 
the repatriation of PTEP. The Treasury Department and the IRS remain of 
the view described in the 2019 notice under which the reference to 
section 316(a) in section 959(c) indicates that, under the statute, a 
distribution of PTEP cannot occur unless there is sufficient current or

[[Page 95372]]

accumulated E&P to support what would otherwise be a dividend under 
section 316. This reading of the statute is consistent with the 
principle underlying section 959 that PTEP represents a type of E&P. 
Thus, the proposed regulations do not adopt the comments.
ii. Analyzing Covered Distributions
    The proposed regulations provide rules for determining the extent 
to which PTEP is distributed in a covered distribution. See proposed 
Sec.  1.959-4(d). Under these rules, each covered shareholder first 
determines its share of the covered distribution, which is the portion 
of the covered distribution that is made to the covered shareholder or 
any portion of the covered distribution that is made to an upper-tier 
foreign corporation and assigned to the covered shareholder under 
proposed Sec.  1.951-2 (discussed in part IV.B of the Explanation of 
Provisions). See proposed Sec.  1.959-4(d)(1). For this purpose, the 
portion of a covered distribution that is made to a partnership, or 
that is treated as made to the partnership in the case of tiered 
partnerships, is treated as made to the partnership's partners in 
accordance with their respective distributive shares of such portion. 
See proposed Sec.  1.959-4(c)(3). Thus, if a covered shareholder is a 
partner in an upper-tier partnership, the covered shareholder's share 
of a covered distribution would include a portion of the covered 
distribution that is made to a lower-tier partnership because an amount 
of the covered distribution made to the lower-tier partnership would be 
treated as made to the upper-tier partnership by reason of the upper-
tier partnership being a partner in the lower-tier partnership and, in 
turn, an amount of the covered distribution treated as made to the 
upper-tier partnership would be treated as made to the covered 
shareholder by reason of the covered shareholder being a partner in the 
upper-tier partnership.
    Next, each covered shareholder allocates its share of the covered 
distribution to the distributing foreign corporation's PTEP with 
respect to the covered shareholder, to the extent thereof and in 
accordance with the composition rules described in part II.D.2.iii of 
the Explanation of Provisions, and then allocates any remaining portion 
of such share to the distributing foreign corporation's section 
959(c)(3) E&P. See proposed Sec.  1.959-4(d)(2) and (e)(1). For this 
purpose, the distributing foreign corporation's PTEP is determined 
immediately before the covered distribution (and thus includes PTEP 
resulting from a subpart F income inclusion or GILTI inclusion for the 
distributing foreign corporation's taxable year in which the covered 
distribution is made because such PTEP is added to the covered 
shareholder's annual PTEP accounts at the beginning of the taxable 
year).
    Further, because the amount of a covered shareholder's share of a 
covered distribution is determined on an aggregate basis rather than on 
a share-specific basis, the proposed regulations treat a pro rata 
portion of all PTEP distributed in each covered shareholder's share of 
the covered distribution as distributed with respect to each share of 
stock of the distributing foreign corporation on which the covered 
shareholder's share of the covered distribution is made. See proposed 
Sec.  1.959-4(d)(4); see also proposed Sec.  1.959-10(c)(1) (Example 
1). In this way, basis adjustments resulting from distributed PTEP can 
be made on each share of stock of the foreign corporation in accordance 
with section 961 and, if applicable, PTEP of a recipient foreign 
corporation can be increased.
iii. Composition Rules
    As discussed in part II.C of the Background, different types of 
PTEP can have different tax effects, including with respect to foreign 
currency gain or loss under section 986(c) or deemed paid taxes under 
section 960(b). Thus, once a covered shareholder has identified the 
portion of its share of a covered distribution that is allocated to 
PTEP, it is necessary to determine the specific PTEP that is 
distributed. The proposed regulations include composition rules for 
this purpose. See proposed Sec.  1.959-4(d)(3) and (e)(2) through (5); 
see also proposed Sec.  1.959-10(c)(2) (Example 2).
    Under these composition rules, PTEP is sourced from section 
959(c)(1) PTEP groups before section 959(c)(2) PTEP groups and then 
from each group within the section 959(c)(1) PTEP groups or section 
959(c)(2) PTEP groups, respectively, on a ``last-in, first-out'' basis, 
subject to a priority rule for PTEP resulting from section 965 (section 
965 priority rule). See proposed Sec.  1.959-4(e)(2), (3). 
Additionally, PTEP that otherwise has the same priority is sourced 
first from PTEP that is not taxable section 962 PTEP and then from 
taxable section 962 PTEP, consistent with the rules currently in Sec.  
1.962-3. See proposed Sec.  1.959-4(e)(4). Lastly, PTEP that has the 
same priority is sourced on a pro rata basis. See proposed Sec.  1.959-
4(e)(5).
    The section 965 priority rule sources PTEP in section 959(c)(1) 
PTEP groups first from the reclassified section 965(a) PTEP group, then 
from the reclassified section 965(b) PTEP group, and finally from the 
remaining section 959(c)(1) PTEP groups. See proposed Sec.  1.959-
4(e)(2)(ii). Similarly, for PTEP in section 959(c)(2) PTEP groups, the 
section 965 priority rule sources such PTEP first from the section 
965(a) PTEP group, then from the section 965(b) PTEP group, and finally 
from the remaining section 959(c)(2) PTEP groups. See proposed Sec.  
1.959-4(e)(2)(iii). The section 965 priority rule, which is issued 
under the express delegation of authority in section 965(o), is 
consistent with the 2019 notice and is intended to simplify PTEP 
recordkeeping and IRS administration.
    Comments on the 2019 notice stated that the section 965 priority 
rule (as described in the notice) would be a departure from the last-
in, first-out approach for sourcing distributions from E&P, and also 
argued that there is no suggestion in section 965 or its legislative 
history that such a departure was intended or is necessary or 
appropriate. Other comments asserted that the policy for the section 
965 priority rule was unclear, stating that a pure last-in, first-out 
approach does not impose additional burdens on taxpayers because once a 
taxpayer has determined its section 965 PTEP the additional burden of 
maintaining that information is minimal. Further, even if the section 
965 priority rule simplifies PTEP recordkeeping, comments noted that 
this may be outweighed by the reduction in foreign tax credits under 
section 960(b) that accompanies distributions of section 965 PTEP. 
Another comment noted that the section 965 priority rule would 
adversely affect certain individuals who made section 962 elections and 
are economically compelled to distribute their PTEP every year to pay 
taxes arising under section 951(a) because it would accelerate the 
distribution of PTEP that is not excluded from gross income under 
section 962(d). Given these concerns, and because the section 965 
priority rule departs from the longstanding approach in existing Sec.  
1.959-3(b), comments requested that taxpayers be able to elect to apply 
a last-in, first-out approach with no prioritization of section 965 
PTEP.
    The Treasury Department and the IRS continue to be of the view that 
the section 965 priority rule will simplify PTEP recordkeeping and IRS 
administration in the future by eventually eliminating section 965 PTEP 
(which, as noted in part II.C of the Background requires specific and 
detailed rules to apply sections 960(b)

[[Page 95373]]

and 986(c)) and reducing the overall number of PTEP groups that need to 
be tracked. The Treasury Department and the IRS are of the view that, 
on balance, this benefit outweighs the concerns raised in comments. 
Additionally, the section 965 priority rule is within the scope of the 
authority delegated to the Treasury Department and the IRS to 
administer section 965, including through sections 965(o) and 7805(a). 
Further, the proposed regulations do not adopt comments suggesting that 
taxpayers be allowed to not apply the section 965 priority rule because 
this would undermine the simplification and burden reduction policy of 
the rule.
iv. Dollar Basis and Associated Foreign Income Taxes Rules
    The proposed regulations provide a pro rata approach for 
determining the dollar basis and associated foreign income taxes of 
PTEP distributed in a covered shareholder's share of a covered 
distribution. See proposed Sec.  1.959-4(e)(3), (f) and (g). Under this 
approach, the portion of a dollar basis pool or PTEP tax pool, as 
applicable, attributed to distributed PTEP is determined based on the 
percentage that such PTEP represents of all PTEP relating to the dollar 
basis pool or PTEP tax pool. As discussed in part II.B.1.iii of the 
Explanation of Provisions, dollar basis pools and PTEP tax pools are 
maintained separately within each annual PTEP account for each PTEP 
group unless a combined pool election is in effect, in which case each 
dollar basis pool and PTEP tax pool relates to PTEP assigned to a 
single PTEP group and a single section 904 category (without regard to 
the taxable years to which the PTEP relates).
E. PTEP to Which a Section 956 Amount Is Allocated (Proposed Sec.  
1.959-5)
    The proposed regulations provide rules regarding the exclusion from 
gross income under section 959(a)(2) for PTEP that would otherwise be 
included under section 951(a)(1)(B). See proposed Sec.  1.959-5; see 
also proposed Sec.  1.959-10(c)(4) (Example 4). Under these rules, a 
covered shareholder allocates its section 956 amount (that is, the 
amount determined under section 956 and Sec.  1.956-1 with respect to 
the covered shareholder and a CFC) first to the CFC's PTEP that is with 
respect to the covered shareholder and assigned to section 959(c)(2) 
PTEP groups, to the extent thereof and in accordance with the 
principles of the composition rules for distributions of PTEP, and then 
allocates any remaining portion of such section 956 amount to the CFC's 
section 959(c)(3) E&P. See proposed Sec.  1.959-5(c)(1) and (d)(1).
    For purposes of these rules, the CFC's PTEP is determined on the 
last relevant day of the CFC's taxable year to which the section 956 
amount relates (that is, the last day of such taxable year on which the 
foreign corporation is a CFC). See proposed Sec.  1.959-5(d)(2). 
However, the CFC's PTEP is reduced to the extent it is distributed on 
or after the last relevant day to ensure that the section 956 amount is 
allocated only to section 959(c)(2) PTEP that remains after accounting 
for all covered distributions during the CFC's taxable year, in 
accordance with section 959(f)(2). Moreover, the PTEP is determined 
without regard to any transfer of PTEP from the covered shareholder to 
a successor covered shareholder on (or after) the last relevant day, 
thereby ensuring that section 959(c)(2) PTEP that exists with respect 
to the covered shareholder when the covered shareholder's ownership of 
stock of the CFC is determined for purposes of sections 951(a)(1)(B) 
and 956 may be taken into account for purposes of section 959(a)(2).
    As with distributions of PTEP, the proposed regulations use a pro 
rata approach to determine the dollar basis and associated foreign 
income taxes of PTEP to which a section 956 amount is allocated. See 
proposed Sec.  1.959-5(e) and (f).
F. Allocating and Apportioning Current Year Taxes to PTEP (Proposed 
Sec.  1.959-6)
    The proposed regulations provide rules for the application of Sec.  
1.861-20 to allocate and apportion current year taxes to the statutory 
groupings (as generally described in Sec.  1.861-8(a)(4)) of PTEP of a 
foreign corporation. See proposed Sec.  1.959-6(b) (describing the 
statutory groupings for purposes of proposed Sec.  1.959-6 as the 
corporate PTEP accounts of the foreign corporation described in 
proposed Sec.  1.959-2(d)(1)). These rules are issued pursuant to the 
express delegations of authority under sections 245A(g), 904(d)(7), 
960(f), and 965(o).
    Under the proposed regulations, current year taxes are generally 
associated with PTEP to the extent the foreign corporation pays or 
accrues such taxes with respect to PTEP arising by reason of a PTEP 
realization event that occurs in the same taxable year. See proposed 
Sec.  1.959-6(b); see also proposed Sec.  1.959-10(c)(3) (Example 3). A 
PTEP realization event occurs if there is a distribution of PTEP or 
gain recognized on a sale, exchange, or other disposition of foreign 
stock that is treated as PTEP as a result of the application of section 
961(c) basis. Current year taxes that are paid or accrued with respect 
to a PTEP realization event that occurs in a different taxable year may 
not be associated with PTEP of a foreign corporation (consistent with 
the rule in current Sec.  1.960-1(d)(3)(ii)(B)). See proposed Sec.  
1.959-6(b) and 1.960-1(d)(3)(ii)(B).
    Proposed Sec.  1.959-6(c) provides rules relating to the 
application of the allocation and apportionment rules in Sec.  1.861-
20. Current year taxes (in the foreign corporation's functional 
currency) are allocated and apportioned to each corporate PTEP account 
of the foreign corporation that is increased during the taxable year as 
the result of a PTEP realization event by applying the rules in Sec.  
1.861-20 and treating PTEP with respect to each covered shareholder 
arising by reason of a PTEP realization event as an amount of dividend 
income (in the case of a distribution of PTEP) or gain from the sale, 
exchange, or other disposition of foreign stock (in the case of PTEP 
resulting from the application of section 961(c) basis). See proposed 
Sec.  1.959-6(c) for purposes of identifying the corresponding U.S. 
item under Sec.  1.861-20(b) through (c). While certain United States 
shareholders (taking into account the application of Sec.  1.958-1(d)) 
must take into account a pro rata share of a CFC's subpart F income and 
tested income (or loss), the CFC's deductions are not divided into pro 
rata shares allocable to particular shareholders, and instead, must be 
allocated and apportioned to gross income of the CFC before the 
determination of each United States shareholder's pro rata share of 
subpart F income and tested income (or loss). As a result, because 
deductions must be allocated and apportioned to a CFC's income (rather 
than being allocated directly to United States shareholders), it is 
necessary to allocate and apportion current year taxes with respect to 
the statutory groupings of PTEP of the foreign corporation, which the 
proposed regulations provide are the corporate PTEP accounts described 
in proposed Sec.  1.959-2(d)(1).
    The proposed regulations also clarify other aspects of allocations 
of deductions involving PTEP. In particular, the proposed regulations 
provide that no deductions, other than current year taxes, may be 
allocated and apportioned to the statutory groupings of PTEP of a 
foreign corporation (consistent with the rule in current Sec.  1.960-
1(c)(1)(ii)). See proposed Sec.  1.959-6(d)(1). See also the request 
for comments in Part II.D.1.iii of the

[[Page 95374]]

Explanation of Provisions on an approach that would also allocate and 
apportion deductions, other than current year taxes, to PTEP.
    Finally, the proposed regulations provide that current year taxes 
paid or accrued by a foreign corporation that are denominated in a 
currency other than the functional currency of the foreign corporation 
are translated into the functional currency of the foreign corporation 
at the spot rate on the day on which the current year taxes are paid or 
accrued. See proposed Sec.  1.959-6(d)(2). This currency translation 
rule applies for purposes of (i) making certain adjustments to accounts 
maintained under section 959 and the proposed regulations in the 
foreign corporation's functional currency and (ii) allocating and 
apportioning functional currency amounts at the level of the foreign 
corporation.
G. General Successor Transactions (Proposed Sec.  1.959-7)
1. In General
    If there is an acquisition of stock of a foreign corporation that 
results in a change of ownership of stock of the foreign corporation, 
successor rules in section 959 generally transfer the foreign 
corporation's PTEP with respect to the covered shareholder that 
relinquishes ownership of stock of the foreign corporation to the 
covered shareholder that acquires ownership of the stock. See section 
959(a) (applying the rules of section 959(a) to any other United States 
person who acquires any portion of a United States shareholder's 
interest in a foreign corporation from any person); section 959(b) 
(similarly applying to any other United States shareholder who acquires 
any portion of a United States shareholder's interest in a CFC from any 
person). These successor rules generally ensure that PTEP is not 
subject to U.S. tax again in the hands of the acquiring covered 
shareholder when received in a distribution, even though that 
shareholder did not own the stock of the foreign corporation when the 
PTEP was generated and therefore did not have the inclusion that gave 
rise to the PTEP. Additionally, the rules ensure that E&P retains its 
PTEP status and thus remains subject to the rules under sections 959 
and 961, rather than reverting to section 959(c)(3) E&P and potentially 
becoming eligible for a deduction under section 245A without a 
reduction in basis.
    The proposed regulations address certain transactions subject to 
the successor rules in section 959, which the proposed regulations 
refer to as general successor transactions. See proposed Sec.  1.959-
7(b)(1); see also part III.C.4 of the Explanation of Provisions 
(discussing rules for section 961(c) basis in general successor 
transactions). A general successor transaction occurs when a covered 
shareholder (successor covered shareholder) acquires ownership of stock 
of one or more foreign corporations (each, an acquired foreign 
corporation) that, immediately before the transaction, is owned by 
another covered shareholder (transferor covered shareholder). The 
acquisition may be direct or indirect. For example, a sale of stock of 
a foreign corporation by a covered shareholder (or by an upper-tier 
foreign corporation owned by the covered shareholder) to another 
covered shareholder (or to an upper-tier foreign corporation owned by 
such other covered shareholder) is a general successor transaction.
    However, a general successor transaction is determined without 
regard to any portion of an acquisition of ownership of stock of a 
foreign corporation that results from any of the following: (i) an 
issuance of stock or a partnership interest, (ii) a redemption of stock 
(within the meaning of section 317(b)) or a liquidating distribution in 
redemption of a partnership interest, or (iii) a transfer of stock of a 
foreign corporation, or any property through which stock of a foreign 
corporation is owned, if such stock or property is substituted basis 
property. See proposed Sec.  1.959-7(b)(2). For example, an exchange of 
stock of a foreign corporation solely for stock of another foreign 
corporation in an exchange under section 351(a) or 354(a), or as part 
of an exchange described in section 361, is not a general successor 
transaction because such stock is substituted basis property, even if 
covered shareholders' ownership of stock of the foreign corporation 
changes in the exchange. Alternatively, to the extent stock of a 
foreign corporation is not substituted basis property in such 
transactions (for example, if basis in the stock is determined under 
section 301(d) or 358(a)(2)), then the acquisition of ownership of 
stock of the foreign corporation is a general successor transaction. 
The Treasury Department and the IRS intend to issue additional rules 
regarding the transfer of PTEP in acquisitions that are not general 
successor transactions and proposed Sec. Sec.  1.959-8 and 1.959-9 are 
reserved for this purpose. In these acquisitions, the Treasury 
Department and the IRS are considering adding a rule as part of 
finalization of the proposed regulations providing that, for any period 
before those additional rules apply and after existing Sec.  1.959-1(d) 
(successor in interest rules) is removed upon finalization of the 
proposed regulations, PTEP will transfer automatically (that is, 
without any requirement to submit proof of identity to the IRS) in 
accordance with the statute and consistent with the manner in which 
PTEP transfers in general successor transactions (as discussed in part 
II.G.2 of the Explanation of Provisions). The Treasury Department and 
the IRS request comments on this potential rule.
2. Categories of Transferred PTEP
    The proposed regulations provide that two categories of an acquired 
foreign corporation's PTEP transfer from the transferor covered 
shareholder to the successor covered shareholder (and thus become PTEP 
with respect to the successor covered shareholder) in a general 
successor transaction. See proposed Sec.  1.959-7(c); see also Sec.  
1.959-10(c)(5) (Example 5). For both categories of PTEP, the transfer 
is not subject to any requirement to submit proof of identity to the 
IRS (in contrast to current Sec.  1.959-1(d)) and, thus, the transfer 
occurs automatically, although taxpayers should maintain sufficient 
records to substantiate the transfer on examination. See also Sec.  
1.245A-5(c)(4) (automatically transferring certain shareholder-level 
accounts in certain acquisitions of stock); Sec.  1.245A(e)-
1(d)(4)(iii) (similar). The automatic transfer ensures that E&P retains 
PTEP status and, therefore, will be excluded from income under section 
959 and give rise to basis reductions under section 961 in subsequent 
distributions.
    The first category of PTEP that transfers is PTEP of the acquired 
foreign corporation with respect to the transferor covered shareholder, 
as determined immediately before the general successor transaction. 
However, if the general successor transaction occurs before the last 
relevant day of the acquired foreign corporation's taxable year, 
certain current year PTEP does not transfer because such current year 
PTEP relates to shares of stock either retained by the transferor 
covered shareholder or acquired by the transferor covered shareholder 
concurrently with or after the general successor transaction. See 
proposed Sec.  1.959-7(c)(1). Only a pro rata portion of this PTEP 
(called general successor PTEP) transfers, and the amount is determined 
based on the percentage of a hypothetical distribution by the acquired 
foreign corporation that would be made with respect to the stock of the 
corporation acquired by the successor covered shareholder. See proposed 
Sec.  1.959-7(d). In this way, distributions made by the acquired

[[Page 95375]]

foreign corporation after the general successor transaction will 
generally be allocated to PTEP to the same extent the distributions 
would be so allocated if the general successor transaction did not 
occur.
    The second category of PTEP that transfers is PTEP resulting from 
the application of section 1248 to gain recognized by the transferor 
covered shareholder in the general successor transaction. See proposed 
Sec.  1.959-7(c)(2). Because section 1248 only applies to the extent of 
E&P of the acquired foreign corporation that is attributable to the 
stock being sold or exchanged in the general successor transaction, the 
Treasury Department and the IRS determined that it is appropriate for 
PTEP described in this category (called section 959(e) successor PTEP) 
to transfer in the general successor transaction. The transfer of all 
PTEP arising under section 1248 in a sale or exchange of a foreign 
corporation is consistent with existing guidance. See Rev. Rul. 90-31, 
1990-1 C.B. 147.
    Like for distributions, the proposed regulations use a pro rata 
approach to determine the dollar basis and associated foreign income 
taxes of general successor PTEP. See proposed Sec.  1.959-7(e)(1) and 
(f)(1). The dollar basis of section 959(e) successor PTEP is the U.S. 
dollar amount of the income inclusion giving rise to the PTEP. See 
proposed Sec.  1.959-7(e)(2). There are no associated foreign income 
taxes with respect to section 959(e) successor PTEP because the PTEP is 
newly created PTEP to which foreign income taxes will not yet have been 
allocated and apportioned. See proposed Sec.  1.959-7(f)(2).
3. Deemed Covered Shareholder
    Section 959(a) applies to any other United States person ``who 
acquires from any person'' any portion of a United States shareholder's 
interest in a foreign corporation. See also section 959(b) (similarly 
applying to an acquisition from ``any person''). Accordingly, if there 
is an acquisition of stock of a foreign corporation, section 959 does 
not condition a transfer of the foreign corporation's PTEP on whether 
the transfer is by or from a covered shareholder (or United States 
shareholder).
    For example, if a nonresident alien individual acquires ownership 
of all the stock of a foreign corporation that has PTEP from a covered 
shareholder and another covered shareholder subsequently acquires 
ownership of all the stock from the individual, then, absent an 
election under section 338(g), the foreign corporation's PTEP transfers 
to the second covered shareholder. This prevents double taxation of the 
PTEP and ensures that PTEP does not become section 959(c)(3) E&P 
(potentially eligible for a dividends received deduction under section 
245A(a)). However, existing guidance does not clearly address whether 
the amount of PTEP that transfers is reduced for transactions during 
the individual's ownership period (for example, for E&P distributed by 
the foreign corporation to the individual).
    To address the transfer of a foreign corporation's PTEP among 
covered shareholders where there is intervening foreign ownership, the 
proposed regulations treat any stock of a foreign corporation not owned 
by a covered shareholder as owned by a single hypothetical person that 
is deemed to be a covered shareholder (the deemed covered shareholder). 
See proposed Sec.  1.959-7(g). Under these rules, the deemed covered 
shareholder is treated in the same manner as a covered shareholder for 
purposes of transferring PTEP under section 959, and a reference to a 
covered shareholder includes the deemed covered shareholder. See 
proposed Sec.  1.959-7(g)(1). Thus, in the example described in the 
preceding paragraph, the foreign corporation's PTEP transfers in the 
first acquisition from the first covered shareholder to the deemed 
covered shareholder (who is a hypothetical person treated as owning all 
the stock of the foreign corporation owned by the nonresident alien 
individual). Then, in the second acquisition, the foreign corporation's 
PTEP, adjusted using a reasonable method to reflect transactions during 
the deemed covered shareholder's ownership period (for example, 
reductions for distributions), transfers from the deemed covered 
shareholder to the second covered shareholder. See Sec.  1.959-7(g)(2). 
In cases where there are no previous covered shareholders or PTEP, the 
deemed covered shareholder rules have no effect.
    The Treasury Department and the IRS are of the view that 
alternative approaches such as ``freezing'' a foreign corporation's 
PTEP during periods in which its stock is not owned by a covered 
shareholder could inappropriately separate a foreign corporation's PTEP 
from its E&P and give rise to double taxation or other distortions. For 
example, under such an alternative, a covered shareholder could 
transfer the stock of an upper-tier foreign corporation that owns stock 
of a lower-tier foreign corporation with PTEP to a nonresident alien 
individual, the lower-tier foreign corporation could distribute all its 
E&P to the upper-tier foreign corporation without affecting its PTEP, 
and then the stock of the upper-tier foreign corporation could be 
transferred to another individual covered shareholder that would 
succeed to the PTEP that remains with the lower-tier foreign 
corporation even though it has no E&P. If the form of the transaction 
were respected for Federal income tax purposes, the result would be 
that a distribution by the upper-tier foreign corporation would not be 
sourced from PTEP and the transferred PTEP of the lower-tier foreign 
corporation could be distributed only to the extent that the lower-tier 
foreign corporation earns section 959(c)(3) E&P.
    The Treasury Department and the IRS recognize that shareholders of 
a foreign corporation may not track PTEP of the foreign corporation 
that transfers to the deemed covered shareholder. In these cases, a 
covered shareholder that eventually succeeds to the PTEP must determine 
the amount and character of the PTEP, including by reconstructing 
transactions that affected the PTEP while the foreign corporation was 
under foreign ownership. This reconstruction is similar to other 
determinations that shareholders must make in certain acquisitions of 
stock of a foreign corporation for which an election under section 
338(g) is not made, for example determinations regarding the foreign 
corporation's basis in assets or its E&P. The use of a single deemed 
covered shareholder to represent all foreign ownership of a foreign 
corporation is intended to ease the burden of this reconstruction by 
focusing only on whether and how PTEP moves under foreign ownership 
rather than, for example, by attributing portions of PTEP to each 
shareholder that is a nonresident alien individual and separately 
analyzing such portions. The Treasury Department and the IRS welcome 
comments about how to decrease the compliance burden and improve the 
administrability of this regime while still ensuring that the correct 
amount and character of PTEP is transferred from one covered 
shareholder to another even when there is intervening foreign 
ownership. For instance, the Treasury Department and the IRS welcome 
comments on whether a majority United States shareholder of a CFC 
should be permitted or required to track PTEP that transfers from a 
minority United States shareholder of that CFC to the deemed covered 
shareholder.

[[Page 95376]]

III. Section 961 Regulations

A. Overview
    As discussed in part II.C.2 of the Background, section 961 
authorizes regulations that provide for basis increases to reflect 
income inclusions under section 951 and basis reductions and gain 
recognition to reflect distributions of PTEP. Generally, the purpose of 
basis increases is to prevent PTEP of a foreign corporation from giving 
rise to additional U.S. tax in a sale or exchange of stock of the 
foreign corporation or property through which such stock is owned (for 
example, an interest in a partnership) when the stock or other property 
is sold before the PTEP is distributed. The purpose of basis reductions 
and gain recognition is to prevent double benefits from the basis 
increases provided under section 961.
    Thus, the proposed regulations under section 961 adjust the basis 
in shares of stock of a foreign corporation owned by a covered 
shareholder, and the basis in any items of property through which the 
covered shareholder owns stock of the foreign corporation, to reflect 
the foreign corporation's PTEP with respect to the covered shareholder 
(for example, to reflect income inclusions giving rise to the PTEP or 
distributions of the PTEP). Unlike annual PTEP accounts, basis 
adjustments under the proposed regulations are specific to a share of 
stock or other item of property, consistent with each item of property 
having separate basis under the Code. Timing of basis adjustments 
generally matches the timing of related adjustments to annual PTEP 
accounts. Further, the proposed regulations under section 961 provide 
rules for different types of basis under section 961, including the tax 
consequences of the basis, and are issued pursuant to the express 
delegations of authority in section 961(a), (b), and (c).
    As discussed in part III.A of the Background, a covered shareholder 
does not include a domestic partnership because a domestic partnership 
is treated as an aggregate of its partners in determining stock 
ownership for purposes of section 961. See proposed Sec.  1.961-1(b); 
see also part VIII.A of the Explanation of Provisions (providing that 
an S corporation is generally treated in the same manner as a domestic 
partnership). As also discussed in part III.A of the Background, under 
section 958(a) stock ownership means stock owned directly and stock 
owned indirectly through foreign entities, including domestic 
partnerships to the extent treated as foreign partnerships under Sec.  
1.958-1(d)(1). Thus, the adjustments provided for by the proposed 
section 961 regulations also apply at the partner level to covered 
shareholders that own stock of a foreign corporation through one or 
more domestic (or foreign) partnerships. See part III.B.3 of this 
Explanation of Provisions for a discussion of basis provided in stock 
of a foreign corporation directly owned by a partnership.
B. Types of Property Units and Basis (Proposed Sec.  1.961-2)
1. In General
    Under the proposed regulations, the type of basis provided in an 
item of property depends on whether the direct owner of the item is a 
covered shareholder, partnership, or CFC. This is because when the 
direct owner of an item of property is a partnership or CFC, covered 
shareholder-specific basis is necessary so that the benefits of basis 
provided in the item to reflect income inclusions of a covered 
shareholder inure only to that shareholder. Additionally, section 
961(c) provides that the basis in the case of an item of property 
directly owned by a CFC only applies for the purposes of determining 
the amount included under section 951 in the gross income of a United 
States shareholder. Specific rules are therefore needed with respect to 
basis adjustments for property owned by a CFC to reflect the limited 
purposes of basis under section 961(c).
    Thus, the proposed regulations set forth rules for three types of 
property (each referred to as a property unit) and basis: (i) section 
961(a) ownership units and adjusted basis, which is provided to a 
covered shareholder, (ii) derivative ownership units and derived basis, 
which is provided to a partnership and is covered shareholder-specific, 
and (iii) section 961(c) ownership units and section 961(c) basis, 
which is provided to a CFC and is covered shareholder-specific. See 
proposed Sec.  1.961-2; see also proposed Sec.  1.961-12(c) (Example 
1). Each type of basis is maintained in U.S. dollars to ensure that 
basis reductions for a distribution of PTEP are commensurate with prior 
basis increases reflecting the income inclusion giving rise to the 
PTEP, regardless of movements in exchange rates (with any such 
movements taken into account under the rules for recognizing foreign 
currency gain or loss pursuant to section 986(c)).
2. Section 961(a) Ownership Units and Adjusted Basis
    A section 961(a) ownership unit is a share of stock of a foreign 
corporation directly owned by a covered shareholder, or a partnership 
interest directly owned by a covered shareholder and through which the 
covered shareholder owns stock of a foreign corporation. See proposed 
Sec.  1.961-2(c). For example, if a covered shareholder directly owns 
an interest in a partnership and the partnership owns (directly or 
indirectly) stock of a foreign corporation, the partnership interest is 
a section 961(a) ownership unit. A covered shareholder is provided 
adjusted basis in a section 961(a) ownership unit.
3. Derivative Ownership Units and Derived Basis
    A derivative ownership unit is a share of stock of a foreign 
corporation directly owned by a partnership and owned (indirectly) by 
one or more covered shareholders through only one or more partnerships 
(for example, not through a foreign corporation), or a partnership 
interest directly owned by another partnership and through which one or 
more covered shareholders own stock of a foreign corporation through 
only partnerships. See proposed Sec.  1.961-2(d)(1). For example, if a 
covered shareholder directly owns an interest in a partnership and the 
partnership directly owns shares of stock of a foreign corporation, 
each share of stock of the foreign corporation is a derivative 
ownership unit (and the interest in the partnership is a section 961(a) 
ownership unit). If, instead, the partnership is a lower-tier 
partnership an interest in which is directly owned by an upper-tier 
partnership and the covered shareholder directly owns an interest in 
the upper-tier partnership, the upper-tier partnership's interest in 
the lower-tier partnership is also a derivative ownership unit along 
with each share of stock of the foreign corporation directly owned by 
the lower-tier partnership (and the interest in the upper-tier 
partnership directly owned by the covered shareholder is a section 
961(a) ownership unit).
    A partnership is provided derived basis in a derivative ownership 
unit, which is maintained separately with respect to each covered 
shareholder that owns the derivative ownership unit through only one or 
more partnerships. See proposed Sec.  1.961-2(d)(2). Derived basis may 
be positive or negative and is treated as an attribute of the 
partnership but has no effect on the partnership's common basis in the 
derivative ownership unit (that is, the partnership's basis that is 
shared among all partners) or any other asset of the partnership. See 
part III.C of the Explanation of Provisions for a

[[Page 95377]]

discussion of adjustments to derived basis, including the allowance of 
negative derived basis. Derived basis is intended to operate in a 
manner similar to a basis adjustment under section 743(b). See parts 
III.D and F of the Explanation of Provisions for the tax consequences 
of derived basis.
4. Section 961(c) Ownership Units and Section 961(c) Basis
    A section 961(c) ownership unit is a share of stock of a foreign 
corporation directly owned by a CFC and owned (indirectly) by one or 
more covered shareholders. See proposed Sec.  1.961-2(e)(1). For 
example, if a covered shareholder directly owns stock of an upper-tier 
CFC and the upper-tier CFC directly owns shares of stock of a lower-
tier foreign corporation, each share of stock of the lower-tier foreign 
corporation owned by the upper-tier CFC is a section 961(c) ownership 
unit.
    A CFC is provided section 961(c) basis in a section 961(c) 
ownership unit, which is maintained separately with respect to each 
covered shareholder that owns the section 961(c) ownership unit. See 
proposed Sec.  1.961-2(e)(2). Section 961(c) basis may be positive or 
negative and is treated as an attribute of the CFC that generally is 
taken into account on the sale, exchange, or other disposition of the 
section 961(c) ownership unit, but has no effect on the CFC's adjusted 
basis in the section 961(c) ownership unit or any other asset of the 
CFC. See part III.C of the Explanation of Provisions for a discussion 
of adjustments to section 961(c) basis, including the allowance of 
negative section 961(c) basis. Section 961(c) basis applies only for 
the purposes prescribed in the section 961 regulations and, therefore, 
does not affect the amount of the CFC's gross income or E&P. See parts 
III.E through G of the Explanation of Provisions for the tax 
consequences of section 961(c) basis.
5. Certain Basis Not Addressed
i. Section 961(c) Basis and Non-CFCs
    Consistent with the statutory language of section 961(c), the 
proposed regulations provide for basis under section 961(c) only with 
respect to stock of a CFC that is directly owned by another CFC. 
Although a section 961(c) ownership unit is defined as a share of stock 
of a foreign corporation directly owned by a CFC, section 961(c) basis 
adjustments are generally made only with respect to section 961(c) 
ownership units that are shares of stock in a CFC, as discussed in part 
III.C of the Explanation of Provisions. See proposed Sec.  1.961-3 
(basis increases for income inclusions); proposed Sec.  1.961-4(d) 
(basis reductions for distributions); proposed Sec.  1.961-5(b) 
(adjustments for foreign currency gain or loss). The Treasury 
Department and the IRS are studying whether, and to what extent, basis 
adjustments may or should also be made under section 961(c) in cases 
where stock of a CFC is owned by a covered shareholder through a 
foreign corporation that is not a CFC or where a CFC owns stock of a 
foreign corporation that used to be a CFC.
    A CFC's section 961(c) basis with respect to a covered shareholder 
in stock of a lower-tier foreign corporation that is provided under the 
proposed regulations when that lower-tier foreign corporation was a CFC 
continues to exist, however, if that lower-tier foreign corporation 
ceases to be a CFC (a share of stock of the lower-tier foreign 
corporation is a section 961(c) ownership unit regardless of CFC 
status). Thus, for example, section 961(c) basis in stock of a foreign 
corporation that was a CFC but ceases to be a CFC may transfer to 
another covered shareholder in a general successor transaction and 
become section 961(c) basis with respect to that covered shareholder. 
See proposed Sec.  1.961-5(c) (discussed in part III.C.4 of the 
Explanation of Provisions). Similarly, a CFC's positive section 961(c) 
basis in stock of a foreign corporation that was a CFC but ceases to be 
a CFC may be applied to certain gain recognized by the CFC with respect 
to stock of that foreign corporation. See proposed Sec.  1.961-9 
(discussed in part III.E of the Explanation of Provisions).
ii. Partnership Interests Owned by Foreign Corporations
    Under the proposed regulations, a property unit does not include a 
share of stock of a foreign corporation or a partnership interest to 
the extent the share of stock or partnership interest is directly owned 
by a partnership and the interests of such partnership are owned by 
foreign corporations (including CFCs). Nor does a property unit include 
a partnership interest directly owned by a foreign corporation. For 
example, assume a covered shareholder directly owns all the stock of 
two upper-tier CFCs, the upper-tier CFCs are the only direct partners 
in a partnership, and the partnership directly owns all the stock of a 
lower-tier CFC. In such a case, neither the shares of stock of the 
lower-tier CFC directly owned by the partnership, nor the upper-tier 
CFCs' interests in the partnership, are property units. The Treasury 
Department and the IRS are studying whether the basis that should be 
provided in these items of property should be similar to derived basis 
or section 961(c) basis or have characteristics of both. Thus, the 
proposed regulations do not address the extent to which section 961 
provides basis in such items.
C. Basis Adjustments (Proposed Sec. Sec.  1.961-3, 1.961-4, and 1.961-
5)
1. Basis Increases for Certain Income Inclusions
i. In General
    To reflect a covered shareholder's income inclusions under sections 
951(a) and 951A(a) for a taxable year of a CFC, the proposed 
regulations provide rules to increase the basis of property units that 
are shares of stock of the CFC owned by the covered shareholder and the 
basis of any property units through which the covered shareholder owns 
such stock. See proposed Sec.  1.961-3(b); see also proposed Sec.  
1.961-12(c) (Example 2). For this purpose, a reference to basis means 
adjusted basis of the covered shareholder in the case of a section 
961(a) ownership unit, derived basis with respect to the covered 
shareholder in the case of a derivative ownership unit, and section 
961(c) basis with respect to the covered shareholder in the case of a 
section 961(c) ownership unit.
    Generally, the basis of each property unit is increased by the 
amount that would be distributed with respect to the property unit in a 
hypothetical distribution by the CFC equal to the U.S. dollar amount of 
the covered shareholder's income inclusions (hypothetical distribution 
rule). See proposed Sec.  1.961-3(c)(1) and (4); see also part 
III.C.1.ii of the Explanation of Provisions (discussing additional 
rules that apply in the case of a midyear transaction). The 
hypothetical distribution is treated as made through all tiers to the 
covered shareholder on the last relevant day of the CFC's taxable year 
(taking into account only stock or other property owned by the covered 
shareholder). See proposed Sec.  1.961-3(e). In this way, under the 
grant of regulatory authority in section 961, a property unit is 
generally provided an amount of basis matching the amount by which 
basis of the property unit is reasonably expected to be reduced under 
section 961 when PTEP resulting from the income inclusions is 
subsequently distributed to the covered shareholder. The amount of 
basis provided to a particular property unit will generally equal the 
covered shareholder's income inclusion attributable to that property 
unit, but the amount may differ in certain cases.

[[Page 95378]]

    For example, consider a case where the covered shareholder owns all 
the stock of the CFC, with such stock consisting of a single preferred 
share with a $10x preference and common stock. The CFC has $100x of E&P 
for its taxable year, consisting of $90x of subpart F income, $0 of 
tested income or tested loss, and $10x of other income. The covered 
shareholder includes $90x in gross income under section 951(a)(1)(A) 
(under Sec.  1.951-1, $9x of the inclusion is attributable to the 
preferred share and the remaining $81x is attributable to the common 
stock), and, consequently, the CFC's PTEP with respect to the covered 
shareholder increases by $90x. While only $9x of the covered 
shareholder's $90x income inclusion is attributable to the preferred 
share, the proposed regulations increase the basis of the preferred 
share by $10x and the basis of the common stock by the remaining $80x. 
This approach takes into account that, of the first $10x of PTEP 
distributed by the CFC to the covered shareholder, that amount is 
likely to be distributed on the preferred share. And, if the basis 
adjustments to the preferred share were to instead match the income 
inclusion attributable to that share ($9x), the covered shareholder 
would receive a $10x distribution on the preferred share, thus 
potentially giving rise to gain under section 961(b)(2) in an amount 
equal to that difference. The proposed regulations prevent that result 
by adjusting the basis in the preferred share by $10x. The Treasury 
Department and the IRS request comments on this approach, including 
whether there are ways to improve the accuracy of allocating basis to a 
property unit without undue complexity and additional compliance and 
administrative burden, and without creating the possibility of 
inappropriate results.
    However, if the CFC distributes PTEP with respect to the covered 
shareholder before the last relevant day of the CFC's taxable year, the 
policies underlying the hypothetical distribution rule (matching basis 
with distributed PTEP) are better carried out by using such actual 
distributions (rather than a hypothetical distribution on the last 
relevant day) to allocate basis increases among property units, 
particularly when there are midyear transactions (though where there is 
no midyear transaction the two approaches generally produce the same 
results). Thus, an actual distribution rule applies in these cases and 
consequently reduces the amount that can give rise to a basis increase 
pursuant to the hypothetical distribution rule. See proposed Sec.  
1.961-3(c)(3).
    The actual distribution rule applies in chronological order to 
distributions of the CFC's PTEP with respect to the covered 
shareholder, and in each case generally increases basis of a share of 
stock of the CFC on which the distribution is made by the amount of the 
reduction required under section 961 to such basis by reason of the 
distribution. See proposed Sec.  1.961-3(d)(2). However, basis 
increases to stock of the CFC under the actual distribution rule cannot 
exceed the U.S. dollar amount of the covered shareholder's income 
inclusions, excluding for this purpose an income inclusion under 
section 951(a)(1)(B) because such inclusion does not give rise to PTEP 
that could be distributed before the last relevant day of the CFC's 
taxable year. Additionally, the actual distribution rule applies only 
to distributions on stock of the CFC that the covered shareholder owns 
on the last relevant day because the covered shareholder's income 
inclusions with respect to the CFC are attributable only to that stock.
    Basis increases to stock of the CFC under the actual distribution 
rule ``tier up'' through property units through which the covered 
shareholder owns such stock, based on how the PTEP that is actually 
distributed would be further distributed in a hypothetical distribution 
made at the time of the actual distribution. See proposed Sec.  1.961-
3(d)(3). The Treasury Department and the IRS considered alternative 
approaches to tiering such as analyzing the extent to which PTEP is 
further distributed before the last relevant day, but those approaches 
could give rise to additional complexity and burden. For instance, the 
approaches could require rules tracing distributed PTEP through tiers 
of foreign corporation and coordinating applications of the actual 
distribution rule at each tier. The Treasury Department and the IRS 
welcome comments on the actual distribution rule, including whether 
there are ways to improve the accuracy of tiering without undue 
complexity and additional compliance and administrative burden.
    Generally, each basis increase under the hypothetical distribution 
rule or actual distribution rule is treated as made at the beginning of 
the first day of the CFC's taxable year or, if later, at the beginning 
of the first day in the taxable year on which the covered shareholder 
owns the property unit. See proposed Sec.  1.961-3(d)(1), (e)(1). In 
this way, the timing of a basis increase generally matches when PTEP to 
which the basis is attributable could first be distributed on the 
property unit. Additionally, the portion of a basis increase for a 
section 951(a)(1)(B) inclusion is treated as made at the end of the 
last day of the taxable year, subject to a special rule. See proposed 
Sec.  1.961-3(e)(1). The special rule applies where a property unit 
that will receive a basis increase for the section 951(a)(1)(B) 
inclusion is transferred before the end of the taxable year (but on or 
after the last relevant day of the taxable year), and in such a case 
accelerates the basis increase to the property unit so that it is 
treated as made immediately before the transfer, thereby ensuring that 
the basis is available in determining the tax consequences of the 
transfer. See proposed Sec.  1.961-3(e)(4).
ii. Midyear Transactions
    Additional rules address unique timing considerations for basis 
increases when a midyear transaction occurs during the taxable year of 
a CFC. See proposed Sec.  1.961-3(c)(2). A midyear transaction 
represents any transaction occurring before the last relevant day of 
the taxable year that changes the covered shareholder's ownership 
structure of the CFC (for example, an exchange of the covered 
shareholder's stock of the CFC or an issuance of stock of the CFC to 
the covered shareholder).
    In the case of a midyear transaction, a basis increase under the 
hypothetical distribution rule or actual distribution rule is treated 
as made at the earliest time during the CFC's taxable year at which the 
same ownership structure is in place as the ownership structure when 
the relevant hypothetical or actual distribution is made. See proposed 
Sec.  1.961-3(d)(1), (e)(1). Thus, for a basis increase under the 
actual distribution rule, if the distribution is made before all 
midyear transactions, the basis increase is treated as made at the 
beginning of the first day of the CFC's taxable year; on the other 
hand, if the distribution is made after a midyear transaction, the 
basis increase is treated as made immediately after the most recent 
midyear transaction preceding the distribution. This approach is 
intended to prevent distortions, including possible duplication of 
basis in certain cases.
    For example, assume a covered shareholder (US1) directly owns all 
the stock of two CFCs (CFC1 and CFC2) on January 1 of year 1. On June 
30 of year 1, US1 exchanges all the stock of CFC1 solely for stock of 
CFC2 in an exchange described in section 351(a) (which is a midyear 
transaction with respect to CFC1 and CFC2). CFC1 makes no

[[Page 95379]]

distributions during its taxable year ending on December 31 of year 1, 
and US1 has a $100x subpart F income inclusion with respect to CFC1 for 
that taxable year. Thus, under the hypothetical distribution rule, US1 
increases its adjusted basis in its stock of CFC2 by $100x and CFC2 
increases its section 961(c) basis with respect to US1 in its stock of 
CFC1 by $100x. However, basis could be inappropriately duplicated if 
the $100x basis increase in the stock of CFC1 were treated as made on 
January 1 of year 1, which would be the case absent the section 351 
exchange. This could occur if US1's basis in its stock of CFC2 were to 
both be increased under the hypothetical distribution rule and take a 
basis under section 358(a) reflecting the basis increase in the stock 
of CFC1 under the hypothetical distribution rule. To address this, 
special timing rules treat the $100x basis increase in each of the 
stock of CFC1 and stock of CFC2 as made immediately after the section 
351 exchange, which is the first time during CFC1's taxable year at 
which the same ownership structure is in place as the ownership 
structure on the last relevant day of the taxable year (when the 
hypothetical distribution determining the basis increase is made).
2. Basis Reductions and Gain Recognition for Distributions
i. In General
    As discussed in part II.C.2 of the Background, section 961(b)(1) 
provides for reductions to the basis of stock or other property with 
respect to which a covered shareholder receives PTEP excluded from its 
gross income under section 959(a), with amounts in excess of such basis 
resulting in gain under section 961(b)(2). Section 961(c) indicates 
that the Secretary should issue regulations providing for adjustments 
similar to those in section 961(b) with respect to PTEP received by a 
CFC and amounts in excess of section 961(c) basis.
    In order to implement the statutory language of section 961, the 
proposed regulations provide rules for reducing basis and recognizing 
gain with respect to property units to reflect distributions of PTEP. 
See proposed Sec.  1.961-4; see also proposed Sec.  1.961-12(c)(3) 
(Example 3). These rules describe the amounts of adjustments, 
limitations on basis reductions, and treatment of gain under section 
961, which can differ depending on the type of property unit for which 
the basis is being adjusted. The adjustments are treated as made 
concurrently with the distribution if the property unit is stock of a 
foreign corporation or, if the property unit is an interest in a 
partnership, concurrently with an adjustment to the partnership 
interest under section 705 resulting from the distribution. See 
proposed Sec.  1.961-4(e) and (f)(1).
ii. Adjustments to Section 961(a) Ownership Units
    If a covered shareholder receives a distribution of PTEP that is 
excluded from its gross income under section 959(a) (that is, PTEP 
other than taxable section 962 PTEP), then the covered shareholder's 
adjusted basis of each section 961(a) ownership unit is generally 
reduced by the dollar basis and associated foreign income taxes of the 
PTEP received with respect to the section 961(a) ownership unit. See 
proposed Sec.  1.961-4(b)(2)(i) and (ii). Associated foreign income 
taxes are taken into account for this purpose because when foreign 
income taxes are allocated and apportioned to PTEP, the foreign income 
taxes reduce the PTEP and the dollar basis of the PTEP, as discussed in 
part II.C.2 of the Explanation of Provisions. As a result, the sum of 
the dollar basis and associated foreign income taxes of PTEP represent 
the amount by which basis was increased under section 961 when the PTEP 
was generated.
    However, the associated foreign income taxes (which represent PTEP 
that was eliminated by foreign income taxes) reduce adjusted basis only 
to the extent the covered shareholder is allowed a credit under section 
901 for those taxes. See proposed Sec.  1.961-4(b)(2)(i). Consequently, 
associated foreign income taxes ultimately give rise to either a credit 
or an amount equivalent to a deduction (in the form of retained 
adjusted basis, which, in turn, will produce a lesser amount of gain or 
an additional amount of loss on a subsequent sale of the section 961(a) 
ownership unit relative to the gain or loss that would result if 
adjusted basis were reduced by associated foreign income taxes). The 
Treasury Department and the IRS are of the view that this prevents 
double taxation of PTEP but are studying whether the policies of 
section 245A(d) or 965(g) (denying a credit or deduction for foreign 
income taxes) should require reducing adjusted basis for associated 
foreign income taxes of PTEP resulting from section 245A(e) or 965.
    Further, to the extent the required reduction to adjusted basis of 
a section 961(a) ownership unit exceeds such adjusted basis, the 
covered shareholder is treated as recognizing gain from a sale or 
exchange of the section 961(a) ownership unit, in accordance with 
section 961(b)(2). See proposed Sec.  1.961-4(b)(2)(iii) and (f)(1). 
Basis of another section 961(a) ownership unit (for example, another 
share of stock of the foreign corporation) cannot be used to reduce 
gain under section 961(b)(2), which is consistent with the approach in 
section 301(c)(3), pursuant to which basis is not shared among shares 
of stock on distributions. See also Johnson v. United States, 435 F.2d 
1257 (4th Cir. 1971).
    Moreover, unlike the approach described in the 2006 proposed 
regulations, basis attributable to section 961 does not shift from one 
share to another share when PTEP is distributed with respect to the 
other share. The Treasury Department and the IRS are of the view that a 
shifting approach could give rise to inappropriate results, is not 
required by section 961 (which increases basis for income inclusions 
without any indication that such basis must or should remain tied to 
the PTEP resulting from the income inclusion), and would depart from 
analogous provisions like section 358 (which, for example, increases 
basis for contributions to capital without subsequently shifting such 
basis to follow distributions of capital). Further, the approach in the 
proposed regulations is consistent with the share-by-share approach in 
the current regulations under section 961. See Sec.  1.961-2(b) and 
(c).
    As an example of inappropriate results that could arise from basis 
shifting, assume a covered shareholder owns all the stock of a foreign 
corporation with PTEP and contributes money to the corporation in 
exchange for a newly-issued share of stock, and the corporation 
subsequently distributes the PTEP, including on the newly-issued share. 
If a portion of the basis that had been provided under section 961(a) 
for the PTEP were to shift from the original shares to the newly-issued 
share as a result of the distribution, then that basis would be added 
on top of the existing fair market value basis in the newly-issued 
share (by an amount equal to the amount of PTEP distributed on that 
share), which could produce a noneconomic loss in the newly-issued 
share. Additionally, as indicated in the document withdrawing the 2006 
proposed regulations (87 FR 63981), the Treasury Department and the IRS 
are aware of transactions in which taxpayers have taken positions that 
basis shifting produces large uneconomic losses, and the IRS may 
challenge such positions and other positions giving rise to abuse or 
inappropriate results.

[[Page 95380]]

iii. Adjustments to Derivative Ownership Units
    If, through a partnership or tiered partnerships, one or more 
covered shareholder partners are treated as receiving PTEP that is 
excluded from gross income under section 959(a) and the proposed 
section 959 regulations, then each such partnership's derived basis 
with respect to such covered shareholders of derivative ownership units 
is reduced to reflect the PTEP received with respect to the derivative 
ownership units. See proposed Sec.  1.961-4(c)(1); see also part 
II.D.2.ii of the Explanation of Provisions (portion of a covered 
distribution that is made to a partnership, or that is treated as made 
to the partnership in the case of tiered partnerships, is treated as 
made to the partnership's partners in accordance with their respective 
distributive shares of such portion). Specifically, starting with the 
partnership at the lowest tier, the partnership's derived basis with 
respect to each covered shareholder partner of each derivative 
ownership unit is generally reduced by the dollar basis and associated 
foreign income taxes of the PTEP with respect to the covered 
shareholder that is treated as received by the covered shareholder 
through the partnership with respect to the derivative ownership unit. 
See proposed Sec.  1.961-4(c)(2)(i) and (ii). A basis increase under 
section 705 for the distribution occurs at the same time as the 
reduction to derived basis, with the result that, in tiered partnership 
structures, derived basis of an upper-tier partnership in a lower-tier 
partnership interest is reduced and common basis in the lower-tier 
partnership interest is increased (the common basis, in turn, may be 
decreased in a distribution to the upper-tier partnership by the lower-
tier partnership of the amounts that constituted the PTEP, for 
example).
    However, to the extent the required reduction to derived basis with 
respect to a covered shareholder of a derivative ownership unit exceeds 
the derived basis (for example, because a partnership purchased stock 
of a CFC and thus has no derived basis with respect to the derivative 
ownership unit), the excess first reduces the covered shareholder's 
positive section 743(b) basis adjustment of the derivative ownership 
unit (if any), but not below zero. See proposed Sec.  1.961-
4(c)(2)(iii). Thus, this rule, by treating the positive section 743(b) 
basis adjustment in the same manner as adjusted basis specific to the 
covered shareholder, is consistent with Sec.  1.743-1(j) (regarding the 
effect of a basis adjustment under section 743(b)). Then, any remaining 
portion of the excess reduces the derived basis below zero, subject to 
a limitation. See id. As discussed in part III.C.2.v of the Explanation 
Provisions, this limitation is intended to prevent reductions to 
derived basis of the derivative ownership unit from having the effect 
of reducing the partnership's total basis (measured for this purpose by 
netting common basis and all negative derived basis) of the derivative 
ownership unit below zero.
    Finally, to the extent the required reduction to derived basis with 
respect to a covered shareholder of a derivative ownership unit exceeds 
the amount of positive derived basis, positive section 743(b) basis, 
and negative derived basis created, the partnership is treated as 
recognizing gain from a sale or exchange of the derivative ownership 
unit. See proposed Sec.  1.961-4(c)(2)(iv). The gain is allocated by 
the partnership solely to the covered shareholder and is taken into 
account in adjusting basis under section 705, but it has no effect on 
any partnership's computations or allocations of any other items under 
section 703 or 704 or on the covered shareholder's capital account. See 
proposed Sec.  1.961-4(f)(2).
iv. Adjustments to Section 961(c) Ownership Units
    If a CFC receives a distribution of PTEP, then the CFC's section 
961(c) basis with respect to each covered shareholder of each section 
961(c) ownership unit is generally reduced by the dollar basis and 
associated foreign income taxes of the PTEP with respect to the covered 
shareholder that is received with respect to the section 961(c) 
ownership unit. See proposed Sec.  1.961-4(d)(2)(i) and (ii).
    To the extent the required reduction to section 961(c) basis with 
respect to a covered shareholder of a section 961(c) ownership unit 
exceeds such section 961(c) basis (for example, because a CFC purchased 
stock of another CFC and thus has no section 961(c) basis with respect 
to the section 961(c) ownership unit or a portion of the distributed 
PTEP is section 965(b) PTEP), the excess reduces the section 961(c) 
basis below zero, subject to a limitation. See proposed Sec.  1.961-
4(d)(2)(ii). As discussed in part III.C.2.v of the Explanation of 
Provisions, this limitation is intended to prevent reductions to 
section 961(c) basis of the section 961(c) ownership unit from having 
the effect of reducing the CFC's total basis (measured for this purpose 
by netting adjusted basis and all negative section 961(c) basis) of the 
section 961(c) ownership unit below zero. Then, any remaining portion 
of the excess is treated as gain recognized by the CFC from a sale or 
exchange of the section 961(c) ownership unit, and such gain is 
assigned from the CFC solely to the covered shareholder. See proposed 
Sec.  1.961-4(d)(2)(iii). Gain recognized by a CFC under this rule 
applies only for purposes of determining amounts included in gross 
income of United States shareholders under proposed Sec.  1.961-11 
(discussed in part III.G. of the Explanation of Provisions) because 
section 961(c) applies only for limited purposes. See proposed Sec.  
1.961-4(f)(3). Therefore, the gain does not affect the CFC's items of 
gross income for purposes of section 952 or 951A or its E&P.
    The Treasury Department and the IRS are of the view that the gain 
recognition rules described in this part III.C.2 of the Explanation of 
Provisions appropriately prevent use of the same basis more than once, 
provide similar outcomes for similar transactions at different tiers, 
and ensure the tax consequences of the gain are covered shareholder-
specific. Any alternative approach that did not require gain 
recognition under section 961(b)(2) and (c) for amounts in excess of 
basis would necessarily have to narrow the application of section 
961(c) basis (discussed in part III.E of the Explanation of 
Provisions), with the result that section 961(c) basis would not be 
available for use in a section 301(c)(3) transaction and, in a sale, 
might be available for use only to the extent of undistributed PTEP.
    Consider the following examples illustrating that the proposed 
regulations provide a consistent approach ensuring that distributions 
appropriately reduce basis or result in the recognition of gain. First, 
assume US1, a covered shareholder, directly owns the single share of 
outstanding stock of CFC1, a newly formed foreign corporation. For 
simplicity, assume US1 has $0 basis in its stock in CFC1. In year 1, 
CFC1 generates $100x of PTEP with respect to US1, which increases US1's 
adjusted basis of the share of stock of CFC1 from $0 to $100x. In year 
2, CFC1 makes a $100x distribution out of E&P and, in year 3, CFC1 
makes a $100x distribution that is not out of E&P. In this case, the 
year 2 distribution is tax-free (that is, the distribution is excluded 
from US1's gross income under section 959(a) but reduces US1's adjusted 
basis in its stock of CFC1 under section 961(b)(1)), and the year 3 
distribution requires US1 to recognize $100x of gain under section 
301(c)(3). Alternatively, assume CFC1 generates a deficit in E&P in 
year 2 and generates E&P in year 3, with the result that the year 3 
distribution, but not the year 2

[[Page 95381]]

distribution, is out of E&P. In such a case, the year 2 $100x 
distribution is tax-free under section 301(c)(2) by reason of US1's 
adjusted basis pursuant to section 961(a), and the year 3 $100x 
distribution requires US1 to recognize $100x of gain under section 
961(b)(2), which appropriately prevents a double use of basis.
    Now assume instead that CFC2, a foreign corporation directly owned 
by US1, directly owns the single share of stock of CFC1 (rather than 
US1), CFC2's adjusted basis of the share of stock of CFC1 is $0, and 
CFC2's section 961(c) basis with respect to US1 of the share of stock 
of CFC1 is increased from $0 to $100x to reflect the $100x of PTEP 
generated by CFC1 with respect to US1. In that case, if CFC1's year 2 
distribution is out of E&P, the year 2 distribution is tax-free under 
sections 959 and 961 and the year 3 distribution requires CFC2 to 
recognize $100x of gain under section 301(c)(3), which US1 will 
generally include in gross income under section 951(a). Alternatively, 
if the year 3 distribution is out of E&P instead of the year 2 
distribution, the year 2 distribution is tax-free by reason of CFC2's 
section 961(c) basis and the year 3 distribution requires CFC2 to 
recognize $100x of gain pursuant to section 961(c), which US1 will 
generally include in gross income under the rules described in part 
III.G of the Explanation of Provisions.
v. Limitations on Negative Derived Basis and Negative Section 961(c) 
Basis
    As discussed in parts III.C.2.iii and iv of the Explanation of 
Provisions, a partnership's derived basis or a CFC's section 961(c) 
basis with respect to a covered shareholder of a property unit can be 
reduced below zero (and therefore result in negative basis instead of 
triggering immediate gain recognition) as a result of a distribution of 
PTEP with respect to the property unit, subject to a limitation. The 
concept of negative section 961(c) basis stems from the language of 
section 961(c) (providing ``adjustments similar to the adjustments'' of 
section 961(a) and (b), ``but only for the purposes of determining the 
amount included under section 951''), which contemplates section 961(c) 
basis replicating the outcomes that would occur for section 951 
purposes if the CFC's adjusted basis could be increased or reduced 
under section 961(a) or (b). In this way, negative section 961(c) basis 
can be conceptualized as a reduction to adjusted basis that has no tax 
effect until a transaction relevant for purposes of section 951 occurs 
with respect to the property unit. Negative derived basis follows the 
same concept.
    Under the limitation, a distribution can reduce (or further reduce) 
derived basis or section 961(c) basis below zero only to the extent of 
the amount of the partnership's common basis or the CFC's adjusted 
basis of the property unit that is available with respect to the 
covered shareholder (determined as described in the next paragraph). 
See proposed Sec.  1.961-4(c)(3)(i) and (d)(3)(i). In the case of a 
partnership, the amount of common basis available with respect to the 
covered shareholder is reduced by the covered shareholder's negative 
section 743(b) basis adjustment of the derivative ownership unit (if 
applicable). See proposed Sec.  1.961-4(c)(3)(i).
    The common basis or adjusted basis available with respect to the 
covered shareholder is determined by first computing the partnership's 
common basis or the CFC's adjusted basis of the property unit, reduced, 
as applicable, by all negative derived basis or all negative section 
961(c) basis of the property unit (regardless of the covered 
shareholders to which the negative basis relates). See proposed Sec.  
1.961-4(c)(3)(ii) and (d)(3)(ii). This amount represents the 
partnership's common basis or the CFC's adjusted basis that is 
potentially available to reduce derived basis or section 961(c) basis 
of the property unit below zero. To address concurrent adjustments with 
respect to multiple covered shareholders, the partnership's available 
common basis or the CFC's available adjusted basis is then multiplied 
by a fraction. The fraction determines the basis available with respect 
to a covered shareholder based on relative amounts by which derived 
basis or section 961(c) basis with respect to the covered shareholders 
would be reduced below zero without limitation.
    The Treasury Department and the IRS are of the view that allowing, 
but limiting the amount of, negative basis in this way has the effect 
of permitting the partnership's common basis or CFC's adjusted basis of 
the property unit to be reduced to, but not below, zero. These rules do 
not affect the treatment or availability of a partnership's common 
basis or a CFC's adjusted basis under any other provision of the Code 
(and, thus, for example, do not impact the application of section 
704(c)).
    The Treasury Department and the IRS considered other approaches to 
the limitation such as looking to a covered shareholder's share of 
common basis or adjusted basis, based on the percentage of the 
interests in the partnership (using Sec.  1.743-1(d) principles, for 
example) or the stock of the CFC that is owned by the covered 
shareholder. However, those approaches would give rise to additional 
complexity and burden because, for example, they could require rules 
adjusting negative basis with respect to a covered shareholder to the 
extent that an issuance reduces the covered shareholder's share of 
common basis or adjusted basis. Further, as discussed in part III.F of 
the Explanation of Provisions, rules requiring gain recognition in 
transactions involving negative basis adequately prevent a covered 
shareholder from disproportionality benefiting from common basis or 
adjusted basis because gain recognized by a partnership or a CFC under 
those rules is allocated or assigned to covered shareholders based on 
relative amounts of negative basis with respect to the covered 
shareholders. Thus, although a partnership's common basis or a CFC's 
adjusted basis is available with respect to all covered shareholders in 
determining the amount by which derived basis or section 961(c) basis 
can be negative, a covered shareholder will generally be required to 
include in gross income any gain attributable to negative basis with 
respect to the covered shareholder.
    The Treasury Department and the IRS request comments on the 
approach to limiting negative basis in the proposed regulations, 
including alternative methods for determining the amount of a 
partnership's common basis or a CFC's adjusted basis available with 
respect to a covered shareholder for this purpose.
3. Basis Adjustments for Foreign Currency Gain or Loss
    To reflect foreign currency gain or loss recognized under section 
986(c) by a covered shareholder with respect to a foreign corporation's 
PTEP in a general successor transaction or other transaction not 
including a distribution of PTEP (see proposed Sec.  1.986(c)-1, 
discussed in part V of the Explanation of Provisions), the proposed 
regulations provide rules to adjust the basis of property units that 
are shares of stock of the foreign corporation owned by the covered 
shareholder. These adjustments ``tier up'' through any property units 
through which the covered shareholder owns such stock, with the result 
that the basis of such property units is also adjusted. See proposed 
Sec.  1.961-5(b)(1). For purposes of these rules, a reference to basis 
means adjusted basis of the covered shareholder in the case of a 
section 961(a) ownership unit, derived basis with respect to the 
covered shareholder in the case of a derivative ownership unit, and 
section 961(c) basis with respect to the covered shareholder

[[Page 95382]]

in the case of a section 961(c) ownership unit. These rules are issued 
pursuant to the express delegations of authority under sections 965(o) 
and 989(c) (as well as those under sections 961(a), (b), and (c), as 
described in part III.A. of the Explanation of Provisions).
    The amount of the basis adjustments is equal to the amount of net 
foreign currency gain or loss. See proposed Sec.  1.961-5(b)(2). This 
is determined by comparing the sum of all foreign currency gain and the 
sum of all foreign currency loss that the covered shareholder 
recognizes with respect to the foreign corporation's PTEP in the 
transaction under section 986(c), without regard to limitations on the 
recognition of such foreign currency gain or loss for PTEP resulting 
from section 965.
    Generally, the basis of each property unit is increased by the 
property unit's share of net foreign currency gain or is reduced by the 
property unit's share of net foreign currency loss, as applicable, 
determined in each case based on a hypothetical distribution by the 
foreign corporation equal to all PTEP of the foreign corporation with 
respect to which the covered shareholder recognizes (or, but for 
limitations for PTEP resulting from section 965, would recognize) 
foreign currency gain or loss in the transaction. See proposed Sec.  
1.961-5(b)(3) and (4). The basis adjustments are treated as made 
immediately before the transaction (and therefore are taken into 
account in the transaction). See proposed Sec.  1.959-5(b)(4). 
Additionally, like in the case of distributions of PTEP, a reduction to 
basis can reduce derived basis or section 961(c) basis below zero and 
can result in gain recognition with respect to a property unit. See id.
    These basis adjustments are consistent with the 1988 notice and 
prevent foreign currency gain or loss with respect to PTEP, which is 
recognized at the covered shareholder-level under section 986(c), from 
also being taken into account with respect to property units sold or 
exchanged in the transaction (which might otherwise occur if basis of 
the property units were not adjusted to reflect movements in exchange 
rates between the time of the income inclusion that gave rise to the 
PTEP (and basis) and the time of the transaction). The adjustments to 
basis are determined without regard to the limitations on the 
recognition of foreign currency gain or loss with respect to PTEP 
resulting from section 965, which ensures that such unrecognized 
foreign currency gain or loss does not result in a commensurate amount 
of gain or loss with respect to property units sold or exchanged in the 
transaction. See also part V.B of the Explanation of Provisions 
(discussing rules under which foreign currency gain or loss with 
respect to PTEP resulting from section 965(a) is reduced based on the 
section 965(c) deduction percentage, and no foreign currency gain or 
loss is recognized for PTEP arising under section 965(b)).
4. Successor Basis
i. In General
    If there is an acquisition of stock of a foreign corporation that 
results in a change of ownership of stock of the foreign corporation, 
successor rules in section 961(c) generally transfer the foreign 
corporation's section 961(c) basis with respect to the covered 
shareholder that relinquishes ownership of stock of the foreign 
corporation to the covered shareholder who acquires ownership of the 
stock. See section 961(c) (prescribed adjustments to basis in CFC stock 
also apply to any United States shareholder that acquires from any 
person any portion of the interest of a United States shareholder by 
reason of which such shareholder was treated as owning CFC stock). 
These rules generally ensure that undistributed PTEP of a lower-tier 
foreign corporation does not give rise to additional U.S. tax in the 
hands of the acquiring covered shareholder when stock of the 
corporation is later sold by an upper-tier CFC, even though the covered 
shareholder did not own such stock when the PTEP was generated and 
section 961(c) basis was increased. These successor basis rules are 
issued pursuant to the express delegation of authority under section 
743(b) (as well as the express delegation of authority under section 
961(c), as described in part III.A. of the Explanation of Provisions).
    The proposed regulations set forth rules for transferring section 
961(c) basis in a general successor transaction, as well as for 
transferring a partnership's derived basis if the general successor 
transaction involves an acquisition of an interest in a partnership 
(acquired partnership). See proposed Sec.  1.961-5(c). These rules 
generally provide parity between derived basis and section 961(c) basis 
in a general successor transaction and, in the case of an acquired 
partnership, ensure that the successor covered shareholder succeeds to 
derived basis (as compared to an approach that attempted to replace all 
or a portion of derived basis with a section 743(b) basis adjustment, 
which would require an election under section 754 to be in effect or a 
substantial built-in loss). The Treasury Department and the IRS intend 
to issue additional rules regarding the transfer of section 961(c) 
basis and derived basis (as well as the transfer of PTEP) in 
acquisitions that are not general successor transactions. In these 
acquisitions, the Treasury Department and the IRS are considering 
adding a rule as part of finalization of the proposed regulations that, 
similar to the potential rule discussed in part II.G.1 of the 
Explanation of Provisions, provides that section 961(c) basis and 
derived basis transfer automatically in periods before those additional 
rules apply.
    In a general successor transaction, a portion of an acquired 
partnership's derived basis or acquired foreign corporation's section 
961(c) basis with respect to the transferor covered shareholder of a 
property unit transfers to the successor covered shareholder and 
therefore becomes with respect to the successor covered shareholder. 
Thus, to reflect the general successor transaction, derived basis or 
section 961(c) basis is increased (or reduced) by the basis that 
transfers to (or from) the covered shareholder, and those adjustments 
are treated as made concurrently with the general successor 
transaction. See proposed Sec.  1.961-5(c)(1) and (2)(iii). The amount 
of basis that transfers may be a positive or negative amount and is 
equal to a pro rata portion of the derived basis or section 961(c) 
basis of the property unit immediately before the general successor 
transaction, plus any increase, or minus any decrease, to the basis for 
foreign currency gain or loss recognized under section 986(c) in the 
general successor transaction (discussed in part V of the Explanation 
of Provisions). See proposed Sec.  1.961-5(c)(2)(i) and (ii).
    The pro rata portion is determined based on the percentage, by 
value, of the transferor covered shareholder's interests in the 
acquired partnership or acquired foreign corporation that the successor 
covered shareholder acquires in the general successor transaction. See 
proposed Sec.  1.961-5(c)(2)(i). This approach is intended to transfer 
derived basis or section 961(c) basis commensurate with the percentage 
change of the transferor covered shareholder's indirect interests in 
the partnership's common basis or foreign corporation's adjusted basis 
by reason of the general successor transaction. The Treasury Department 
and the IRS are of the view that alternative approaches--such as 
transferring an amount of derived basis or section 961(c) basis equal 
to the amount of PTEP that transfers in the general successor 
transaction--could give rise to

[[Page 95383]]

inappropriate outcomes or undue complexity where derived basis or 
section 961(c) basis is not equal to the PTEP that transfers in the 
general successor transaction.
ii. Deemed Covered Shareholder
    Consistent with the deemed covered shareholder rules discussed in 
part II.G.3 of the Explanation of Provisions, the proposed regulations 
provide that the deemed covered shareholder is treated in the same 
manner as a covered shareholder in determining the transfer of derived 
basis or section 961(c) basis. See proposed Sec.  1.961-5(c)(3)(i). 
Thus, for example, if a covered shareholder owns all the stock of an 
upper-tier CFC, the upper-tier CFC directly owns all the stock of a 
lower-tier CFC, and the covered shareholder sells a portion of its 
stock of the upper-tier CFC to a nonresident alien individual, then a 
portion of the upper-tier CFC's section 961(c) basis in the stock of 
the lower-tier CFC transfers from the seller covered shareholder to the 
deemed covered shareholder. The proposed regulations further provide 
that, to the extent the deemed covered shareholder is treated as owning 
stock of any foreign corporation that is not otherwise a CFC, the 
foreign corporation is treated as a CFC for purposes of determining 
section 961(c) basis that transfers to or from the deemed covered 
shareholder. See proposed Sec.  1.961-5(c)(3)(ii). This is intended to 
allow for section 961(c) basis to transfer from the deemed covered 
shareholder to a subsequent covered shareholder (as properly adjusted 
under the proposed section 961 regulations) even if both an upper-tier 
foreign corporation and the lower-tier foreign corporation in which the 
upper-tier foreign corporation directly owns stock cease to be CFCs 
during the period in which the stock of the foreign corporations is 
considered owned by the deemed covered shareholder.
    In cases where basis of a derivative ownership unit or section 
961(c) ownership unit transfers from the deemed covered shareholder to 
a covered shareholder, the covered shareholder must use a reasonable 
method to determine the amount of transferred basis. See proposed Sec.  
1.961-5(c)(3)(iii). The proposed regulations provide that such method 
must take into account adjustments to basis with respect to the deemed 
covered shareholder that would have been made under the proposed 
regulations if the basis were with respect to a covered shareholder 
during the time that it was with respect to the deemed covered 
shareholder.
    Like in the context of the deemed covered shareholder rules for 
purposes of transferring PTEP, the Treasury Department and the IRS 
welcome comments on this regime.
iii. Coordination With Section 743(b)
    In certain general successor transactions in which an acquired 
partnership has a section 754 election in effect or a substantial 
built-in loss as defined under section 743(d), property of the acquired 
partnership will receive a section 743(b) basis adjustment with respect 
to the successor covered shareholder. Accordingly, the proposed 
regulations take into account derived basis that transfers to the 
successor covered shareholder in calculating the overall section 743(b) 
basis adjustment and its allocation among the acquired partnership's 
assets with respect to the successor covered shareholder. See proposed 
Sec.  1.961-5(d). In transactions involving multiple tiers of acquired 
partnerships, this coordination rule applies to each acquired 
partnership.
5. Basis Adjustments for Deemed Dividends Under Section 1248(c)(2) or 
964(e)(1)
    The Treasury Department and the IRS are studying whether basis 
under section 961 should be increased to reflect gain treated as a 
dividend under section 1248(c)(2) or 964(e)(1). For example, to the 
extent gain recognized by a covered shareholder on a sale of stock of a 
first-tier CFC is treated as a dividend under section 1248(c)(2) by 
reason of E&P of a third-tier CFC (and therefore gives rise to PTEP 
under section 959(e)), the Treasury Department and the IRS are 
considering whether (and to what extent) the first-tier CFC's and 
second-tier CFC's section 961(c) basis can and should be increased to 
reflect the resulting PTEP. The Treasury Department and the IRS request 
comments on this topic.
D. Tax Consequences of Positive Derived Basis (Proposed Sec.  1.961-8)
1. In General
    The rules for a partnership's positive derived basis with respect 
to a covered shareholder are generally intended to replicate the 
outcome that would occur on a sale, exchange, or other disposition of 
the derivative ownership unit if such basis were an additional amount 
of common basis taken into account in determining gain or loss 
allocable to the covered shareholder. These rules are generally modeled 
after the rules in Sec.  1.743-1.
    Under the proposed regulations, in a sale, exchange, or other 
disposition by a partnership (transferring partnership) of one or more 
derivative ownership units (transferred units), each partner's 
distributive share of gain or loss recognized by the transferring 
partnership is first determined under section 704 without regard to 
positive derived basis (but with regard to any section 743(b) basis 
adjustment with respect to the partner). See proposed Sec.  1.961-
8(b)(1). Then, positive derived basis is applied to each covered 
shareholder's distributive share of such gain or loss, in an amount 
equal to the transferring partnership's positive derived basis with 
respect to the covered shareholder of the transferred units, subject to 
two limitations (discussed in part III.D.2 of the Explanation of 
Provisions). See proposed Sec.  1.961-8(b)(2)(i); see also proposed 
Sec.  1.961-12(c)(4) (Example 4). This application of positive derived 
basis can decrease a distributive share of gain, increase a 
distributive share of loss, or convert a distributive share of gain to 
a distributive share of loss.
    The application of positive derived basis to a covered 
shareholder's distributive share is generally treated as an application 
of positive derived basis by the transferring partnership. See proposed 
Sec.  1.961-8(b)(1). However, if the covered shareholder owns the 
transferred units through tiered partnerships, only the partnership in 
which the covered shareholder directly owns an interest is treated as 
applying the positive derived basis).
    To coordinate with section 705, the proposed regulations provide 
that adjusted basis of a partnership interest directly owned by the 
covered shareholder is adjusted under section 705 after taking into 
account the partnership's application of positive derived basis to the 
covered shareholder's distributive share of gain or loss with respect 
to the transferred units. See proposed Sec.  1.961-8(c). On the other 
hand, in tiered partnership structures, an upper-tier partnership's 
common basis in a lower-tier partnership interest is adjusted under 
section 705 without regard to the application of positive derived basis 
to the covered shareholder's distributive share. See proposed Sec.  
1.961-8(d). Additionally, an upper-tier partnership's derived basis 
with respect to the covered shareholder in a lower-tier partnership 
interest (starting at the lowest-tier if there is more than one lower-
tier partnership) is concurrently reduced (or gain is recognized, as 
applicable) by the amount of positive derived basis applied to the 
covered shareholder's distributive share. In this way, an upper-tier 
partnership's derived basis in a lower-tier partnership interest

[[Page 95384]]

is replaced with common basis under section 705 (which may be decreased 
under section 705(a)(2) when the lower-tier partnership makes a 
distribution).
2. Limitations
    As discussed in part III.D.1 of the Explanation of Provisions, the 
amount of positive derived basis applied to a covered shareholder's 
distributive share of gain or loss with respect to transferred units is 
equal to the transferring partnership's positive derived basis with 
respect to the covered shareholder of the transferred units, subject to 
two limitations. See proposed Sec.  1.961-8(b)(2)(i).
    The first limitation applies in nonrecognition transactions to 
replicate the effect of additional basis under the ``boot-within-gain'' 
rule of section 351(b) or 356(a)(1), where additional basis might 
reduce the amount of gain realized but not the amount of gain 
recognized. See proposed Sec.  1.961-8(b)(2)(ii). Under this 
limitation, the amount of positive derived basis applied to the covered 
shareholder's distributive share is equal to the excess of the amount 
of positive derived basis with respect to the covered shareholder of 
the transferred units over the covered shareholder's share of the gain 
realized but not recognized by the transferring partnership with 
respect to the transferred units (determined without regard to derived 
basis). In this way, positive derived basis is available for use only 
to the extent that, if the positive derived basis were additional 
common basis taken into account in determining gain allocable to the 
covered shareholder, such derived basis would reduce gain recognized 
with respect to the transferred units.
    To illustrate this limitation, assume US1, a covered shareholder, 
directly owns a 50 percent interest in PRS1, a partnership, and PRS1 
directly owns the single share of outstanding stock of F1, a foreign 
corporation. The fair market value of the share is $150x. PRS1's common 
basis of the share is $100x, and PRS1's derived basis with respect to 
US1 of the share is $15x. PRS1 exchanges the share for $120x of stock 
and $30x of money in a reorganization described in section 
368(a)(1)(D), recognizing $30x of gain on the exchange under section 
356(a)(1) (the lesser of the $30x of money received and the $50x of 
gain in the stock of F1) and therefore $20x of the $50x of realized 
gain is not recognized due to the boot limitation in section 356(a)(1). 
US1's distributive share of the recognized gain is $15x ($30x x 50%), 
determined without regard to derived basis. Under the limitation in the 
proposed regulations, only $5x of positive derived basis is applied to 
such distributive share (thus, $10x of the $15x of derived basis is not 
available for use). The $5x is computed as the excess of $15x (the 
amount of positive derived basis with respect to US1 without regard to 
the limitation), over $10x ($20x x 50%, which represents US1's share of 
the realized-but-not-recognized gain). Accordingly, US1's distributive 
share of gain taking into account derived basis is $10x (US1's $15x 
distributive share of gain without regard to derived basis over $5x of 
positive derived basis available under the limitation). This $10x 
represents the amount of gain that would be recognized under section 
356(a)(1) and allocated to US1 if such were determined based on $75x of 
value (50% of each of the $120x of stock consideration and $30x of 
money) and $65x of basis (50% of the $100x of common basis, increased 
by the $15x of derived basis).
    Under the second limitation, positive derived basis can increase or 
create a distributive share of loss only if the transferring 
partnership recognizes, or would recognize, loss on the sale, exchange, 
or other disposition of the transferred units and a current deduction 
in respect of the loss is, or would be, allowable. See proposed Sec.  
1.961-8(b)(2)(iii). Thus, for example, positive derived basis cannot 
create a distributive share of loss if the gain recognized with respect 
to the transferred units is pursuant to section 301(c)(3).
3. Certain Scenarios Not Addressed
    The proposed regulations do not address the interaction of derived 
basis with the rules regarding distributions by a partnership (for 
example, sections 732 and 734). The Treasury Department and the IRS 
request comments on this interaction, including whether derived basis 
with respect to a covered shareholder should be taken into account in 
the case of a distribution by a partnership of a derivative ownership 
unit to the covered shareholder or to another partner and whether 
derived basis should be taken into account in the case of distributions 
of other types of assets by a partnership.
    The proposed regulations also do not address the effect of derived 
basis under the dividend recharacterization rules of section 1248. The 
Treasury Department and the IRS are studying this and other issues with 
respect to the application of section 1248 when stock of a foreign 
corporation is owned through a partnership (for example, the manner in 
which section 1248(d)(1) applies to exclude PTEP in determining deemed 
dividend treatment), and welcome comments on these issues.
E. Tax Consequences of Positive Section 961(c) Basis (Proposed Sec.  
1.961-9)
1. In General
    As discussed in part III.B.4 of the Explanation of Provisions, a 
CFC's section 961(c) basis applies only for the purposes prescribed in 
the section 961 regulations and thus does not affect the amount of the 
CFC's gross income or E&P. Under the rules in the proposed regulations 
for the tax consequences of positive section 961(c) basis, gain to 
which positive section 961(c) basis is applied is treated as PTEP that 
is generally excluded from the CFC's gross income under section 961(c) 
(section 961(c) exclusion). See proposed Sec.  1.961-9. The proposed 
regulations describe the section 961(c) exclusion, the application of 
section 961(c) basis to gain, and the PTEP that results from such 
application (including the character of the PTEP).
2. Section 961(c) Exclusion
i. In General
    The section 961(c) exclusion operates in a similar manner to the 
section 959(b) exclusion. It provides that PTEP resulting from the 
application of a CFC's section 961(c) basis to gain recognized by the 
CFC is excluded from the CFC's gross income for purposes of determining 
the CFC's subpart F income and tested income or tested loss, provided 
that the PTEP relates to a covered shareholder that is a United States 
shareholder in the CFC. See proposed Sec.  1.961-9(b); see also part 
III.E.3 of the Explanation of Provisions (determining PTEP resulting 
from section 961(c) basis).
    The Treasury Department and the IRS are of the view that E&P 
attributable to gain to which section 961(c) basis is applied gives 
rise to PTEP. Section 959(a) refers to E&P of a foreign corporation 
that is ``attributable to amounts which are, or have been, included in 
gross income under section 951(a) [or 951A(a)].'' Gain recognized by an 
upper-tier foreign corporation on the disposition of stock of a lower-
tier foreign corporation may likewise reflect amounts included in gross 
income under section 951(a) or 951A(a) with respect to the lower-tier 
foreign corporation and, thus, give rise to E&P that is attributable to 
such amounts. Because section 961(c) basis reflects amounts included in 
gross income under section 951(a) or 951A(a), the application of 
section 961(c) basis to such gain means that the resulting E&P is 
attributable to an amount included in gross income under section 951(a) 
or

[[Page 95385]]

951A(a) in accordance with the language of section 959(a). 
Additionally, treating the resulting E&P as PTEP (rather than section 
959(c)(3) E&P) prevents double non-taxation and double taxation and 
provides symmetry between distributions and dispositions involving 
foreign stock, as discussed in part III.E.2.ii of the Explanation of 
Provisions.
    The proposed regulations apply the section 961(c) exclusion for 
purposes of determining a CFC's tested income or tested loss pursuant 
to the express delegation of authority in section 951A(f)(1)(B), which 
prevents double taxation and is therefore consistent with the policy of 
section 961. Additionally, this approach is consistent with section 
951A(f)(1)(A) (treating an inclusion under section 951A(a) in the same 
manner as an inclusion under section 951(a)(1)(A) for purposes of 
section 961), which should be interpreted as allowing references to 
section 951 in section 961(c) to be treated as including a reference to 
section 951A(a). This approach is also consistent with a comment 
received in response to the 2019 notice, which requested clarification 
that section 961(c) basis applies for purposes of determining tested 
income, noting that some comments asserted that section 961(c) basis 
only applies in determining a CFC's subpart F income. See also TD 9866, 
84 FR 29288, 29298 (describing similar comments received in response to 
proposed regulations under section 951A).
    Further, the application of the section 961(c) exclusion at the 
CFC-level is coordinated with the pro rata share rules of section 
951(a) (discussed in part IV.C of the Explanation of Provisions). Under 
this approach, a CFC's subpart F income is determined with respect to 
all shareholders by excluding the same amount of PTEP resulting from 
section 961(c) basis of the CFC, and United States shareholders' pro 
rata shares of the CFC's subpart F income are computed in a manner so 
that any benefits of the application of the section 961(c) exclusion to 
PTEP with respect to a United States shareholder generally inure only 
to that United States shareholder. For instance, if two United States 
shareholders own equal interests in a CFC and, on a sale of foreign 
stock by the CFC, the CFC recognizes gain half of which is treated as 
PTEP with respect to one United States shareholder (because there is 
positive section 961(c) basis with respect to the United States 
shareholder at least equal to its share of the gain) and the other half 
of which gives rise to subpart F income (because there is no section 
961(c) basis with respect to the other United States shareholder and no 
exception from subpart F income applies), then only the United States 
shareholder with respect to which there is no section 961(c) basis has 
a pro rata share of the subpart F income resulting from the sale.
    Lastly, by applying section 961(c) at the CFC-level, the proposed 
regulations provide symmetry between sections 959(b) and 961(c), which 
are companion provisions with a common purpose. Thus, PTEP is generally 
treated the same under the proposed regulations regardless of whether 
it arises from a distribution or disposition involving stock of a 
foreign corporation. As indicated in part II.D.1.iii of the Explanation 
of Provisions, the Treasury Department and the IRS request comments on 
the CFC-level approach in the proposed regulations, including 
alternative approaches providing symmetry between sections 959(b) and 
961(c) (such as a shareholder-level approach), or whether symmetry is 
necessary under the statute.
ii. Considerations in Treating Sheltered E&P as PTEP
    The Treasury Department and the IRS considered treating a CFC's E&P 
that is sheltered from tax by positive section 961(c) basis with 
respect to a covered shareholder as section 959(c)(3) E&P. However, 
such an approach could give rise to double non-taxation or double 
taxation. Moreover, treating sheltered E&P as PTEP provides symmetry 
between distributions and dispositions involving foreign stock because 
both E&P to which annual PTEP accounts are applied and E&P to which 
section 961(c) basis is applied are treated as PTEP.
    For example, double non-taxation could occur if the sheltered E&P 
were to subsequently give rise to a dividend for which the covered 
shareholder is allowed a dividends received deduction under section 
245A (including as a result of a disposition pursuant to section 
1248(j)). In that case, the taxable portion of any unrealized 
appreciation in stock of the CFC, to the extent attributable to 
unrealized appreciation in the CFC's assets, could be reduced by the 
amount of the dividend (because the dividend reduces the value of the 
CFC stock without a corresponding basis reduction or, in a disposition 
of stock, because gain attributable to the appreciation is 
recharacterized as a dividend). See also TD 9866, 84 FR 29288, 29298 
(discussing this concern and requesting comments). This would result in 
double non-taxation when combined with the covered shareholder's 
adjusted basis (increased under section 961(a)) in its top-tier CFC 
stock, which generally would not be reduced when section 959(c)(3) E&P 
is distributed with respect to the stock. Treating the sheltered E&P as 
PTEP prevents this outcome because section 961 reduces basis for 
distributions of PTEP (thereby preventing double benefits) and, in a 
disposition, PTEP is not taken into account under section 1248.
    In a case where the covered shareholder is not eligible for a 
section 245A deduction (for example, because the covered shareholder is 
an individual), the covered shareholder would generally include the 
sheltered E&P in gross income when distributed by the CFC if the 
sheltered E&P were treated as section 959(c)(3) E&P. This would 
represent double taxation with respect to the E&P that gave rise to the 
section 961(c) basis because such E&P was taxed under section 951(a) or 
951A(a) when earned and would in effect be taxed again when the 
sheltered E&P is distributed to the covered shareholder. Although the 
covered shareholder's adjusted basis under section 961(a) in its top-
tier CFC stock would generally not be reduced for the distribution of 
the sheltered E&P, there would nevertheless be double taxation until or 
unless that basis can be utilized, and even in that case there may be a 
character mismatch. See also TD 9866, 84 FR 29288, 29298 (requesting 
comments on the extent to which adjustments should be made to the 
operation of section 961(c) to minimize the potential for the same item 
of income being subject to tax more than once); 2006 proposed 
regulations, 71 FR 51155, 51162 (noting similar concerns). Treating the 
sheltered E&P as PTEP prevents this outcome because a distribution of 
PTEP to a covered shareholder is generally excluded from gross income 
under section 959(a).
    The Treasury Department and the IRS also considered treating 
sheltered E&P as section 959(c)(3) E&P but reducing basis (including 
the covered shareholder's adjusted basis in its top-tier CFC stock) to 
the extent the sheltered E&P is eligible for a section 245A deduction. 
However, this approach is not being proposed because it would raise 
other issues, including the timing of the basis reduction (either 
immediately upon creation of sheltered E&P, which may later cause 
excess taxation, or only upon distribution of sheltered E&P, which 
would require additional tracking), and would not address the double 
taxation issue for covered shareholders that do not qualify for a 
section 245A deduction.

[[Page 95386]]

3. Application of Section 961(c) Basis to Gain and Resulting PTEP
i. In General
    The rules for applying a CFC's positive section 961(c) basis with 
respect to a covered shareholder are generally intended to replicate 
the outcome that would occur on a sale, exchange, or other disposition 
of the section 961(c) ownership unit if such basis were an additional 
amount of adjusted basis taken into account in determining gain 
allocable to the covered shareholder under section 951.
    Under the proposed regulations, in a sale, exchange, or other 
disposition by a CFC of one or more section 961(c) ownership units that 
are shares of stock of a single foreign corporation (transferred 
units), the CFC first determines gain recognized with respect to the 
transferred units (covered gain). See proposed Sec.  1.961-9(c)(1). 
Covered gain is determined on an aggregate basis with respect to all 
transferred units, without regard to section 961(c) basis or loss 
recognized on any transferred unit (and before any application of 
section 964(e) or other dividend recharacterization provisions). Then, 
portions of the covered gain are assigned to covered shareholders under 
proposed Sec.  1.951-2 (the same rules that assign covered 
distributions, discussed in part IV.B of the Explanation of 
Provisions), and this determines a covered shareholder's share of the 
covered gain. See proposed Sec.  1.961-9(d)(1).
    Next, positive section 961(c) basis is applied (on an aggregate 
basis) to each covered shareholder's share of the covered gain, in an 
amount equal to the CFC's positive section 961(c) basis with respect to 
the covered shareholder of the transferred units (but not in excess of 
such share), and subject to a limitation in nonrecognition transactions 
(similar to the limitation rule that applies to derived basis discussed 
in part III.D.1 of the Explanation of Provisions). See proposed Sec.  
1.961-9(d)(2), (e). This application of positive section 961(c) basis 
characterizes the covered shareholder's share of the covered gain as 
PTEP with respect to the covered shareholder, and that PTEP is 
generally excluded from the CFC's gross income for purposes of 
determining its subpart F income and tested income or tested loss. See 
proposed Sec.  1.961-9(b), (d)(3); see also proposed Sec.  1.961-
12(c)(5) (Example 5).
    An aggregate approach to applying positive section 961(c) basis 
allows positive section 961(c) basis of a transferred unit to be 
applied to a portion of the covered shareholder's share of the covered 
gain that is recognized with respect to another transferred unit. For 
example, in a case where there are two transferred units, one of which 
is sold at a loss but has positive section 961(c) basis with respect to 
the covered shareholder and the other of which is sold at a gain but 
has no section 961(c) basis with respect to the covered shareholder, 
positive section 961(c) basis in the first transferred unit will be 
applied to gain recognized with respect to the second transferred unit 
(and, to the extent so applied, the gain will be treated as PTEP and 
will be reduced only by any foreign income taxes allocated and 
apportioned to the PTEP). Aggregating positive section 961(c) basis in 
this manner is intended to replicate the effect of netting gains and 
losses on similar types of property in determining a CFC's subpart F 
income. See section 954(c)(1)(B) (foreign personal holding company 
income includes the portion of gross income that consists of the excess 
of gains over losses from the sale or exchange of certain property). 
Although aggregation differs from the share-by-share approach under 
section 961 to adjusting basis (including for purposes of determining 
the consequences of distributions of PTEP), it provides a simpler and 
more direct way of achieving the same effect as a share-by-share 
approach to the use of positive section 961(c) basis that allows excess 
section 961(c) basis on a particular share to be applied to gain 
recognized on another share of stock in the same foreign corporation 
for which there is not sufficient section 961(c) basis to fully offset 
the gain. See also part III.E.4 of the Explanation of Provisions 
(discussing a rule allocating PTEP to shares of stock in order to 
facilitate the application of dividend recharacterization provisions 
like section 964(e)).
    The proposed regulations, however, do not allow positive section 
961(c) basis of transferred units in excess of the covered 
shareholder's share of the covered gain to be applied to other covered 
gain or to create a loss that reduces subpart F income or tested 
income. Allowing section 961(c) basis in stock of a foreign corporation 
to only reduce a section 951 inclusion attributable to sales, 
exchanges, or other dispositions of stock of that foreign corporation 
is consistent with the language of section 961(c), with the result that 
only shares of stock of the same foreign corporation should be viewed 
as similar types of property for purposes of replicating the effect of 
netting under section 961(c). Unused positive section 961(c) basis, 
however, may be applied to gain recognized pursuant to section 961(c), 
provided the gain is recognized with respect to stock of the foreign 
corporation to which the section 961(c) basis relates, as discussed in 
part III.G of the Explanation of Provisions.
ii. Character and Dollar Basis of Resulting PTEP
    As discussed in part II.C of the Background, the character of PTEP 
(for example, the taxable year, section 904 category, and PTEP group to 
which the PTEP relates) must be tracked to ensure the proper 
application of provisions regarding the treatment of PTEP. Accordingly, 
the proposed regulations provide rules for determining the character of 
a CFC's PTEP with respect to a covered shareholder that results from 
the application of positive section 961(c) basis to the covered 
shareholder's share of covered gain (section 961(c) PTEP). See proposed 
Sec.  1.961-9(d)(3) and (f)(1). Generally, the effect of these rules is 
to duplicate undistributed PTEP of lower-tier foreign corporations by 
having the PTEP ``tier up'' into the CFC, but without reducing PTEP of 
the lower-tier foreign corporations, and this effect is analogous to 
the effect of section 964(e)(1) (``tiering-up'' certain section 
959(c)(3) E&P of lower-tier foreign corporation in certain sales or 
exchanges of stock by a CFC).
    The proposed regulations generally adopt a mirroring approach, 
which provides that section 961(c) PTEP takes the same character as 
PTEP that transfers from the covered shareholder under section 959 or 
is eliminated (for example, by reason of an election under section 
338(g)) in the sale, exchange, or other disposition of the transferred 
units (referred to as mirrored PTEP). See proposed Sec.  1.961-9(f)(2); 
see also proposed Sec.  1.961-12(c)(5) (Example 5). Mirrored PTEP is 
increased for foreign income taxes associated with such transferred or 
eliminated PTEP because those taxes relate to PTEP to which section 
961(c) basis used in the transaction is attributable. The mirroring 
rule is intended to identify (and duplicate) PTEP to which section 
961(c) basis used in the transaction is attributable in an 
administrable manner that does not impose undue burden on taxpayers. 
Alternative approaches that were considered include requiring section 
961(c) basis to be established and maintained with the same 
characterizations with which annual PTEP accounts are established and 
maintained (so that section 961(c) PTEP could be characterized based on 
section 961(c) basis, portions of would relate to

[[Page 95387]]

each PTEP group). However, the view of the Treasury Department and the 
IRS is that those approaches would be unduly burdensome because they 
would substantially increase the information required to be tracked 
under section 961(c).
    In some cases, section 961(c) PTEP may be less than mirrored PTEP. 
This could occur, for example, if a foreign corporation's assets 
depreciate in value before the transaction or if mirrored PTEP consists 
of PTEP attributable to section 965(b) (which does not increase section 
961(c) basis). In that case, section 961(c) PTEP takes the same 
character as a pro rata portion of mirrored PTEP. In other words, the 
mirroring rule applies but mirrored PTEP is pro rata reduced to equal 
section 961(c) PTEP.
    In other cases, section 961(c) PTEP may exceed mirrored PTEP. This 
could occur if section 961(c) basis used in the transaction is 
attributable to PTEP that was distributed before the transaction in a 
manner different than how the PTEP was expected to be distributed when 
the section 961(c) basis was provided. In that case, the mirroring rule 
applies to the extent of mirrored PTEP, with a ``lookback'' rule 
applying to the portion of section 961(c) PTEP that is not 
characterized under the mirroring rule (excess section 961(c) PTEP). 
See proposed Sec.  1.961-9(f)(3). Under the lookback rule, excess 
section 961(c) PTEP takes the same character as lookback PTEP, which is 
PTEP that resulted from income inclusions under sections 951(a) and 
951A(a) of the covered shareholder attributable to the transferred 
units (including stock of a lower-tier foreign corporation owned 
through the transferred units) during a 36-month lookback period 
(without any reduction for foreign income taxes imposed on that PTEP). 
The lookback rule is intended to provide an administrable method to 
approximate PTEP that should be viewed as duplicated in the 
transaction, while minimizing taxpayer burden in the limited cases 
where section 961(c) PTEP exceeds mirrored PTEP. Like under the 
mirroring rule, lookback PTEP is pro rata reduced to equal excess 
section 961(c) PTEP if excess section 961(c) PTEP is less than lookback 
PTEP.
    If excess section 961(c) PTEP is greater than lookback PTEP, the 
portion of excess section 961(c) PTEP that is not characterized under 
the lookback rule is characterized as PTEP relating to the section 
245A(d) PTEP group, the taxable year in which the transaction occurs, 
and the general category under section 904(d)(1)(D). See proposed Sec.  
1.961-9(f)(4). The Treasury Department and the IRS are of the view that 
this rule is a necessary consequence of balancing compliance and 
administrative burden with precision under the mirroring rule and 
lookback rule, and that alternative characterizations could 
inappropriately incentivize transactions intended to distribute PTEP to 
which section 961(c) basis used in the transaction is attributable in a 
manner different than the manner in which the PTEP was expected to be 
distributed when the section 961(c) basis was provided.
    Finally, the proposed regulations provide that the dollar basis of 
section 961(c) PTEP is equal to the U.S. dollar amount of section 
961(c) basis giving rise to the PTEP. See proposed Sec.  1.961-9(g). 
Because section 961(c) basis is adjusted to take into account foreign 
currency gain or loss recognized in the transaction (as discussed in 
part III.C.3 of the Explanation of Provisions), any foreign currency 
gain or loss subsequently recognized with respect to the section 961(c) 
PTEP is determined by reference to the time the section 961(c) PTEP 
comes into existence.
4. Coordination With Dividend Recharacterization Provisions
    The proposed regulations provide two rules to coordinate with 
provisions of the Code or regulations that would treat covered gain, in 
whole or in part, as a dividend. The first rule provides that such 
dividend recharacterization provisions do not apply to the portion of 
covered gain that is PTEP. See proposed Sec.  1.961-9(c)(2). Thus, for 
example, section 961(c) basis applies and characterizes covered gain as 
PTEP before the application of section 964(e) (treating gain recognized 
by a CFC on the sale or exchange of stock in a foreign corporation as a 
dividend in certain cases), similar to how adjusted basis must be taken 
into account to determine gain recognized before applying section 
964(e).
    The second rule allocates PTEP resulting from section 961(c) basis 
to transferred units. See proposed Sec.  1.961-9(d)(5) and (h). This 
rule is intended to facilitate the application of dividend 
recharacterization provisions by providing certainty about the amount 
of gain with respect to a particular transferred unit that is treated 
as PTEP, which otherwise might be unclear in light of the aggregation 
component in applying positive section 961(c) basis (discussed in part 
III.E.3.i of the Explanation of Provisions).
    Further, the Treasury Department and the IRS are studying other 
issues involving dividend recharacterization provisions (for example, 
the application of section 1248(d)(1) in section 964(e) transactions) 
and may address these issues in future guidance.
F. Gain Recognition in Transactions Involving Property Units With 
Negative Basis (Proposed Sec.  1.961-10)
    To account for negative derived basis and negative section 961(c) 
basis, the proposed regulations provide rules that treat a partnership 
or CFC as recognizing gain with respect to a property unit. See 
proposed Sec.  1.961-10. These rules are consistent with the theory of 
negative basis described in part III.C.2.v the Explanation of 
Provisions, which provides that negative basis is akin to a reduction 
to common basis or adjusted basis that only has a tax effect when the 
common basis or adjusted basis becomes relevant to determining taxable 
income in a transaction.
    One set of rules applies in any transaction in which a 
partnership's common basis or CFC's adjusted basis of a property unit 
is relevant in determining gain or loss recognized with respect to the 
property unit--for example, a sale or exchange of the property unit or 
a distribution under section 301(c)(2) on the property unit. See 
proposed Sec.  1.961-10(b)(1) and (c)(1); see also proposed Sec.  
1.961-12(c)(6) and (7) (Examples 6 and 7). In these cases, the 
partnership or CFC is treated as recognizing gain with respect to the 
property unit to the extent of the additional amount of gain, plus the 
lesser amount of loss, that it would have recognized in the transaction 
if its common basis or adjusted basis of the property unit were reduced 
by all negative derived basis or negative section 961(c) basis of the 
property unit. In this way, negative basis gives rise to gain that 
reflects income that would exist or counteracts loss that would not 
exist if common basis or adjusted basis were reduced by the negative 
basis, thereby replicating the outcome that would occur in the 
transaction if common basis or adjusted basis were so reduced.
    So, for example, in a sale of a property unit, negative basis of 
the property unit generally gives rise to an equal amount of gain. In 
contrast, in a distribution under section 301(c)(2) with respect to a 
property unit or an exchange of a property unit under section 351, 
negative basis of the property unit gives rise to an amount of gain 
equal to the gain that would have been recognized under section 
301(c)(3) or 351(b), as applicable, if common basis (in the case of a 
partnership) or adjusted basis (in the case of a CFC) were reduced by 
all negative basis of the property unit.

[[Page 95388]]

    Another set of rules applies in any transaction in which a property 
unit loses its status as a derivative ownership unit or section 961(c) 
ownership unit. This could occur, for example, as a result of a 
transfer by a partnership of a derivative ownership unit to a foreign 
corporation in an exchange to which section 351 applies, or a 
distribution by a CFC of a section 961(c) ownership unit to a domestic 
corporation in a transaction to which sections 332 and 337 apply. See 
proposed Sec.  1.961-10(b)(2)(ii) and (c)(2)(ii). This could also occur 
if an upper-tier foreign corporation ceases to be a CFC, in which case 
shares of stock of a lower-tier foreign corporation directly owned by 
the upper-tier foreign corporation would no longer be section 961(c) 
ownership units. In these cases, the partnership or CFC is treated as 
recognizing gain with respect to the property unit to the extent of all 
negative derived basis or negative section 961(c) basis of the property 
unit, and this addresses a concern that the negative basis might 
otherwise not be taken into account. The Treasury Department and the 
IRS are studying to what extent this set of rules should be narrowed or 
eliminated in future guidance if a rule is adopted that converts one 
type of basis into another type (for example, a rule that converts 
derived basis into section 961(c) basis or section 961(c) basis into 
adjusted basis in a nonrecognition transaction).
    A portion of gain recognized by a partnership or CFC under these 
rules is allocated by the partnership or assigned from the CFC, as 
applicable, to each covered shareholder by multiplying the gain by the 
percentage of the aggregate negative basis of the property unit that is 
negative basis with respect to the covered shareholder. See proposed 
Sec.  1.961-10(b)(3) and (c)(3). This approach treats the gain (which 
may be less than the aggregate negative basis of the property unit) as 
relating pro rata to the negative basis with respect to each covered 
shareholder, thereby preventing a covered shareholder from 
disproportionality benefiting from common basis or adjusted basis that 
enabled the creation of negative basis (as discussed in part III.C.2.v 
of the Explanation of Provisions) and ensuring the tax consequences of 
negative basis are specific to the covered shareholder to which the 
negative basis relates.
    Additionally, the gain is treated in the same manner as gain 
recognized in connection with distributions of PTEP in excess of basis 
(discussed in part III.C.2.iii and iv of the Explanation of 
Provisions), which reflects that the negative basis giving rise to the 
gain arose as a result of prior distributions of PTEP. See proposed 
Sec.  1.961-10(b)(4) and (c)(4). Thus, the gain applies for all 
purposes of the Code in the case of a partnership and, in the case of a 
CFC, is recognized pursuant to section 961(c) and applies only for 
purposes of determining amounts included in gross income of United 
States shareholders under the rules discussed in part III.G of the 
Explanation of Provisions. Further, the gain is treated as separate 
from the transaction and therefore, for example, does not give rise to 
basis adjustments under section 358 or 362 in a nonrecognition 
transaction.
    Lastly, after determining gain required to be recognized under 
these rules, negative derived basis or negative section 961(c) basis 
that causes the gain to be recognized is eliminated concurrently with 
the transaction. See proposed Sec.  1.961-10(b)(5) and (c)(5). Thus, if 
the covered shareholder continues to own the property unit (for 
example, if the transaction is a section 301(c)(2) distribution), then 
such negative basis will cease to be taken into account with respect to 
the covered shareholder and, if the transaction is a general successor 
transaction, then the negative basis will not be taken into account 
with respect to the successor covered shareholder.
G. United States Shareholder Inclusions for Gain Recognized Under 
Section 961(c) (Proposed Sec.  1.961-11)
1. In General
    The proposed regulations provide rules requiring United States 
shareholders of a CFC to include in gross income their allocated 
portions of the CFC's section 961(c) income. See proposed Sec.  1.961-
11; see also proposed Sec.  1.961-12(c)(8) (Example 8). A CFC's section 
961(c) income is, for a taxable year of the CFC, all gain recognized by 
the CFC pursuant to section 961(c) for amounts in excess of basis or by 
reason of a trigger of negative section 961(c) basis (as discussed in 
parts III.C.2.iv, C.3, and F of the Explanation of Provisions).
    These rules are intended to ensure section 961(c) income is taken 
into account (and thus has a tax consequence) at the covered 
shareholder-level such that section 961(c) basis is treated in the same 
manner as adjusted basis in directly held CFC stock or derived basis 
(where, for example, amounts in excess of basis under section 961 are 
always taken into account at the covered shareholder-level). 
Specifically, a United States shareholder owning stock of a CFC on the 
last relevant day of a taxable year of the CFC must include in gross 
income its allocated amount of the CFC's section 961(c) income for that 
taxable year. See proposed Sec.  1.961-11(b). The amount so allocated 
to a United States shareholder is the sum of any portions of such 
section 961(c) income assigned to the United States shareholder under 
the section 961 regulations (adjusted, if applicable, for transfers of 
stock of the CFC, as discussed in part III.G.2 of the Explanation of 
Provisions), reduced by any loss that the CFC is treated as recognizing 
under section 961(c) with respect to the United shareholder. See 
proposed Sec.  1.961-11(c).
    This loss under section 961(c) is equal to the CFC's positive 
section 961(c) basis with respect to the United States shareholder of 
section 961(c) ownership units sold, exchanged, or disposed of by the 
CFC in the taxable year, but only to the extent the positive section 
961(c) basis is not applied to covered gain, and subject to two 
limitations. See proposed Sec.  1.961-11(e). Under the first 
limitation, positive section 961(c) basis can create or increase a loss 
under section 961(c) only if the CFC recognizes, or would recognize, 
loss on the sale, exchange, or other disposition and a current 
deduction in respect of the loss is, or would be, allowable. Under the 
second limitation, positive section 961(c) basis can create or increase 
a loss under section 961(c) only to the extent of the amount of section 
961(c) income that both is otherwise allocable to the United States 
shareholder and relates to stock of the same foreign corporation to 
which the positive section 961(c) basis relates. This is consistent 
with the same foreign corporation limitation for applying positive 
section 961(c) basis to covered gain (discussed in part III.E.3.i of 
the Explanation of Provisions).
    The United States shareholder includes its allocated amount of 
section 961(c) income in gross income in its taxable year in which or 
with which the CFC's taxable year ends, and the allocated amount is 
treated in the same manner as an amount included in gross income under 
section 951(a)(1)(A) for purposes of applying sections 961 and 989(b). 
See proposed Sec.  1.961-11(b). Thus, under section 961, the inclusion 
increases basis in the United States shareholder's stock of the CFC and 
any property units through which the United States shareholder owns 
stock of the CFC, consistent with how a subpart F income inclusion 
increases basis. The inclusion does not increase the CFC's PTEP, 
however, because the section 961(c) income does not give rise to E&P at 
the level of the CFC, and thus there is no amount related to the 
inclusion satisfying section 959's description of PTEP (E&P 
attributable to amounts

[[Page 95389]]

which are, or have been, included in gross income under section 
951(a)). Moreover, increasing basis but not PTEP helps to ensure that 
gain is not recognized on subsequent distributions of PTEP the 
distribution of which gave rise to the section 961(c) income.
2. Adjustments for Transfers of CFC Stock
    The proposed regulations provide additional rules in allocating a 
CFC's section 961(c) income for a taxable year if stock of the CFC is 
transferred during the taxable year. See proposed Sec.  1.961-11(d). 
These rules are necessary because gain comprising section 961(c) income 
is assigned to covered shareholders at the time of the transaction 
giving rise to the gain (for example, a distribution in excess of 
basis) but, due to a transfer of stock of the CFC, a covered 
shareholder to which a portion of the gain is assigned may not own 
stock of the CFC stock on the last relevant day of the CFC's taxable 
year.
    One set of rules applies if the CFC is an acquired foreign 
corporation in a general successor transaction that occurs during the 
taxable year. See proposed Sec.  1.961-11(d)(1). In such a case, if the 
general successor transaction occurs before the last relevant day of 
the taxable year, then a pro rata portion of section 961(c) income that 
is recognized before the general successor transaction and assigned to 
the transferor covered shareholder is treated as instead assigned to 
the successor covered shareholder. Alternatively, if the general 
successor transaction occurs on or after the last relevant day of the 
taxable year, then a pro rata portion of section 961(c) income that is 
recognized after the general successor transaction and assigned to the 
successor covered shareholder is treated as instead assigned to the 
transferor covered shareholder. In both cases, the pro rata portion is 
determined based on the percentage of the CFC's section 961(c) basis 
that transfers in the general successor transaction.
    A second set of rules applies the principles of the first set of 
rules to transactions, other than general successor transactions, in 
which the CFC's section 961(c) basis is transferred to another covered 
shareholder. See proposed Sec.  1.961-11(d)(2).

IV. Section 951 Regulations

A. Overview
    The proposed regulations under section 951 provide two coordinated 
sets of rules regarding the assignment and allocation of covered items, 
which are gross income of a foreign corporation consisting of covered 
distributions or covered gains. One set applies at the foreign 
corporation-level to assign covered items to covered shareholders, with 
these rules identifying the portions of covered items to which 
attributes specific to a covered shareholder (PTEP or section 961(c) 
basis) may be applied to exclude such portions under section 959(b) or 
961(c). See proposed Sec.  1.951-2 (discussed in part IV.B of the 
Explanation of Provisions). The other set applies at the shareholder-
level to allocate a CFC's subpart F income to United States 
shareholders, with these rules ensuring that the CFC's subpart F income 
attributable to covered items is allocated consistently with how the 
covered items were assigned under the first set of rules. See proposed 
Sec.  1.951-1(c) (discussed in part IV.C of the Explanation of 
Provisions).
B. Foreign Corporation-Level Rules for Assigning Covered Items 
(Proposed Sec.  1.951-2)
1. In General
    The proposed regulations assign portions of a foreign corporation's 
covered items to covered shareholders that own stock of the foreign 
corporation during the foreign corporation's taxable year in which the 
covered items are received or recognized by the foreign corporation. 
See proposed Sec.  1.951-2(b). The assignments are done on a covered-
item-by-covered-item basis, in each case first by assigning the covered 
item under a general assignment rule, and then by adjusting assignments 
for any general successor transactions.
2. General Assignment Rule
    The general assignment rule assigns a pro rata portion of a covered 
item of a foreign corporation to each covered shareholder that owns 
stock of the foreign corporation on the last relevant day of the 
foreign corporation's taxable year in which the covered item is 
received or recognized by the foreign corporation (that is, the last 
day of such taxable year on which the foreign corporation is a CFC). 
See proposed Sec.  1.951-2(c)(1); see also proposed Sec.  1.951-
2(h)(3)(i) (Example 1). The pro rata portion is determined based on the 
percentage of the foreign corporation's allocable E&P for the taxable 
year that would be allocated to the covered shareholder in the 
hypothetical distribution described in Sec.  1.951-1(e), applied by 
treating allocable E&P as equal to the greater of the foreign 
corporation's E&P for the taxable year and all covered items of the 
foreign corporation. See proposed Sec.  1.951-2(d). By applying Sec.  
1.951-1(e) in this way, the general assignment rule is consistent with 
the principles of the pro rata share rules under section 951(a). See 
Sec.  1.951-1(e).
3. Adjustments for General Successor Transactions
    A foreign corporation that is an acquired foreign corporation in a 
general successor transaction that occurs before the last relevant day 
of a taxable year of the foreign corporation may receive or recognize a 
covered item before the general successor transaction (pre-transaction 
covered item). In that case, the general successor transaction could 
preclude PTEP or section 961(c) basis with respect to the transferor 
covered shareholder from being applied to the covered item (as a result 
of reducing the allocation of the foreign corporation's E&P to the 
covered shareholder in the hypothetical distribution described in Sec.  
1.951-1(e) and therefore reducing the covered shareholder's assignment 
under the general assignment rule). This could inappropriately separate 
PTEP and basis from the appropriate covered shareholder.
    To illustrate this issue, assume US1 is a covered shareholder and 
each of CFC1 and CFC2 is a CFC with a calendar taxable year. On January 
1 of year 1, US1 owns all the stock of CFC1, and CFC1 owns all the 
stock of CFC2. On June 30 of year 1, CFC2 makes a $100x covered 
distribution to CFC1, which immediately makes a $100x covered 
distribution to US1. On September 30 of year 1, US1 sells all its stock 
of CFC1 to US2, an unrelated covered shareholder in what constitutes a 
general successor transaction. Without regard to the covered 
distributions, CFC2 has $100x of PTEP with respect to US1 (relating to 
the prior year) and CFC1 has $0 of PTEP.
    Under the general assignment rule, the entire $100x of the covered 
distribution received by CFC1 would be assigned to US2 (the covered 
shareholder owning all the stock of CFC1 on December 31 of year 1, the 
last relevant day of CFC1's taxable year). As a result, no PTEP would 
be applied to either covered distribution (and each covered 
distribution would reduce the distributing CFC's section 959(c)(3) E&P 
by $100x).
    The proposed regulations include additional rules to address this 
issue. Specifically, the additional rules increase the portion of a 
pre-transaction covered item that otherwise (without the additional 
rules) would be assigned to the transferor covered shareholder

[[Page 95390]]

and correspondingly decrease the portions of the item that otherwise 
(without the additional rules) would be assigned to connected covered 
shareholders. See proposed Sec.  1.951-2(e); see also proposed Sec.  
1.951-2(h)(3)(ii) (Example 2). A connected covered shareholder means 
the successor covered shareholder (or any other covered shareholder 
owning the stock acquired in the general successor transaction, in the 
case of back-to-back general successor transactions, for example) and 
any covered shareholder related to such covered shareholder (determined 
under section 267(b) or 707(b)). See proposed Sec.  1.951-2(g).
    Thus, in the example above, the additional rules assign all the 
covered distribution received by CFC1 to US1 (rather than to US2, a 
connected covered shareholder), and $100x of CFC2's PTEP with respect 
to US1 is applied to the covered distribution (which, in turn, 
increases CFC1's PTEP with respect to US1 by $100x). As a result, that 
covered distribution is treated in the same manner as if the sale had 
not occurred, and $100x of CFC1's PTEP with respect to US1 is then 
available to be (and in fact is) distributed by CFC1 to US1. If, 
instead, CFC1 did not make a covered distribution before the sale, then 
$100x of PTEP of CFC1 with respect to US1 would transfer from US1 to 
US2 in the sale.
    Subject to two limitations, the increase to the transferor covered 
shareholder's assignment is equal to the additional amount of the pre-
transaction covered item that would have been assigned to the 
transferor covered shareholder if the date on which the covered item is 
received or recognized were the last relevant day and the hypothetical 
distribution for purposes of the general assignment rule were treated 
as made immediately before the covered item is received or recognized. 
See proposed Sec.  1.951-2(e)(2)(i). In this way, the transferor 
covered shareholder's assignment of a pre-transaction covered item is, 
as illustrated above, generally consistent with what would have been 
its assignment if the general successor transaction and any subsequent 
transactions that change the ownership of stock of the acquired foreign 
corporation (for example, issuances of stock by the acquired foreign 
corporation) had not occurred.
    With the limitations, the increase applies only to the extent it 
results in additional PTEP or section 961(c) basis with respect to the 
transferor covered shareholder being applied to the pre-transaction 
covered item, and the increase cannot exceed the portions of the 
covered item that otherwise (without the additional rules) would be 
assigned to connected covered shareholders. See proposed Sec.  1.951-
2(e)(2)(iii). Thus, the additional rules only shift an assignment of 
gross income identified under the principles of section 951(a) as 
allocable to covered shareholders that bear a defined relationship to 
the transferor covered shareholder (through the general successor 
transaction or relatedness). The Treasury Department and the IRS are of 
the view that this approach reasonably balances the policies of the 
general assignment rule (following the principles of section 951(a)) 
and the additional rules (assuring the tax consequences of PTEP and 
basis remain with the appropriate covered shareholder).
    The corresponding decrease applies, first, to assignments of 
connected covered shareholders owning, on the last relevant day, stock 
acquired in the general successor transaction and, next, to assignments 
of other connected covered shareholders, in each case on a pro rata 
basis. See proposed Sec.  1.951-2(e)(3) and (4). With this ordering, 
assignments of such other connected covered shareholders are decreased 
only if their ownership of stock of the acquired foreign corporation 
increases after the general successor transaction. The Treasury 
Department and the IRS are of the view that applying the additional 
rules to such other connected covered shareholders maintains the 
integrity of the additional rules (for example, by preventing issuances 
to covered shareholders related to the successor covered shareholder 
from reducing the application of the additional rules, as could 
otherwise occur because the issuances would have the effect of reducing 
the successor covered shareholder's assignment under the general 
assignment rule, which, in turn, would limit the increase to the 
transferor covered shareholder's assignment).
    Similar additional rules apply if a foreign corporation is an 
acquired foreign corporation in a general successor transaction that 
occurs on or after the last relevant day of a taxable year of the 
foreign corporation and the foreign corporation receives or recognizes 
a covered item after the general successor transaction. See proposed 
Sec.  1.951-2(e)(2)(ii). In these cases, the additional rules increase 
the portion of such an item that otherwise (without the additional 
rules) would be assigned to the successor covered shareholder, 
generally by correspondingly decreasing the portion of the item that 
otherwise (without the additional rules) would be assigned to the 
transferor covered shareholder. See also proposed Sec.  1.951-
2(h)(3)(iii) (Example 3).
C. Shareholder-Level Rules for Allocating Subpart F Income (Proposed 
Sec.  1.951-1)
    Under Sec.  1.951-1 (and as discussed in part II.B.1 of the 
Background), a CFC's subpart F income is allocated to each United 
States shareholder of the CFC based on a fraction, the numerator of 
which is the United States shareholder's share of the CFC's allocable 
E&P, and denominator of which is the CFC's allocable E&P. See Sec.  
1.951-1(e). The amount of subpart F income so allocated to a United 
States shareholder is the United States shareholder's pro rata share of 
the foreign corporation's subpart F income, subject to certain 
adjustments. See Sec.  1.951-1(b); see also Sec.  1.951A-1(d) 
(determining pro rata shares of tested income in the same manner).
    If a CFC's subpart F income attributable to covered items were 
allocated to United States shareholders in the same manner, the income 
might be allocated differently than how the covered items were assigned 
at the CFC-level as part of determining the extent to which the covered 
items are PTEP excluded from the CFC's gross income under section 
959(b) or 961(c). See also proposed Sec.  1.951-2 (assignment rules, 
discussed in part IV.B of the Explanation of Provisions). This could 
cause the tax consequences of PTEP or section 961(c) basis to not be 
specific to the United States shareholder to which such attribute 
relates, which would be inconsistent with the shareholder-specific 
nature of sections 959(b) and 961(c) and could result in partial double 
taxation to the United States shareholder.
    For instance, assume two unrelated United States shareholders are 
assigned equal portions of covered gain recognized by a CFC, with the 
half assigned to one United States shareholder characterized as PTEP 
excluded from the CFC's gross income under section 961(c) (because 
there is positive section 961(c) basis with respect to the United 
States shareholder at least equal to such shareholder's share of the 
covered gain) and the half assigned to the other United States 
shareholder characterized as subpart F income (because there is no 
section 961(c) basis with respect to the other United States 
shareholder and no exception from subpart F income applies). In such a 
case, the Treasury Department and the IRS are of the view that 
allocating half of the subpart F

[[Page 95391]]

income from the covered gain to each United States shareholder would be 
inconsistent with sections 951(a) and 961(c), as doing so would cause 
the United States shareholders to share both any benefits of the 
section 961(c) exclusion and any detriments of the inclusion in subpart 
F income.
    To address this, the proposed regulations modify Sec.  1.951-1 so 
that a CFC's subpart F income attributable to covered items is 
separately allocated to United States shareholders. See proposed Sec.  
1.951-1(c)(1); see also proposed Sec.  1.951-1(h)(2)(ii) (Example 1). 
Subpart F income attributable to covered items is determined on a 
covered-item-by-covered-item basis, and in each case is the portion of 
the covered item that is included in the CFC's foreign base company 
income (adjusted net foreign base company income as defined in Sec.  
1.954-1(a)(5)) or insurance income (adjusted net insurance income as 
defined in Sec.  1.954-1(a)(6)). See proposed Sec.  1.951-1(c)(2)(i). 
The proposed regulations facilitate these determinations by treating 
each portion of gross foreign base company income (as defined in Sec.  
1.954-1(a)(2)) that consists of a covered item as a single item of 
income. See proposed Sec.  1.954-1(c)(1)(iii)(C).
    Subpart F income attributable to a covered item is allocated to 
United States shareholders consistently with how the covered item was 
assigned at the CFC-level as part of determining the extent to which 
the covered item is PTEP excluded from the CFC's gross income under 
section 959(b) or 961(c). Specifically, subpart F income attributable 
to a covered item is allocated to each United States shareholder based 
on a fraction, the numerator of which is the portion of the covered 
item that is both assigned at the CFC-level to the United States 
shareholder and included in the CFC's adjusted gross foreign base 
company income or adjusted gross insurance company income (as defined 
in Sec.  1.954-1(a)(3) or (6)), and the denominator of which is the 
portion of the covered item that is included in adjusted gross foreign 
base company income or adjusted gross insurance company income. See 
proposed Sec.  1.951-1(c)(2)(ii). In this way, a United States 
shareholder's pro rata share of subpart F income attributable to a 
covered item is the subpart F income that results from the United 
States shareholder's assigned portion of the covered item.
    Then, remaining subpart F income (that is, subpart F income not 
attributable to covered items) is allocated pro rata to United States 
shareholders in accordance with existing Sec.  1.951-1. Specifically, 
such subpart F income is allocated to each United States shareholder 
based on a fraction, the numerator of which is the United States 
shareholder's share of the CFC's allocable E&P (determined under Sec.  
1.951-1(e)), and the denominator of which is the CFC's allocable E&P. 
See proposed Sec.  1.951-1(c)(2)(iii).
    Thus, under the proposed regulations, the effect of sections 959(b) 
and 961(c) on allocations under section 951(a) is limited to ensuring 
that any benefits of the application of the relevant exclusion to a 
portion of a covered item, or any detriments of an inclusion of such 
portion in subpart F income, generally inure only to the United States 
shareholder to which the portion was assigned in determining the extent 
to which the portion is excludable PTEP. Accordingly, under the 
proposed regulations, sections 959(b) and 961(c) do not affect the 
allocation of subpart F income attributable to gross income not 
eligible for exclusion under those sections. Similarly, the proposed 
regulations do not affect the allocation of tested items under section 
951A. See proposed Sec.  1.951A-1(d) (pro rata shares of tested income, 
tested loss, and qualified business asset investment are determined in 
the same manner as the determination of pro rata shares of subpart F 
income not attributable to covered items); see also Sec.  1.951A-
1(d)(5) and (6) (pro rata shares of tested interest expense and tested 
interest income determined by reference to pro rata shares of tested 
income and tested loss, as applicable).
    An alternative approach that treated the allocation of subpart F 
income attributable to covered items as altering the manner in which 
other income of the CFC is allocated would require broader revisions to 
Sec.  1.951-1. Under this type of approach, a CFC would be treated as 
having four types of allocable income, which together would equal 
allocable E&P: subpart F income, tested income, excludable PTEP income 
(that is, PTEP that is distributed to, or results from section 961(c) 
basis of, the CFC and is excluded from the CFC's gross income under 
section 959(b) or 961(c), reduced by current year taxes allocated and 
apportioned thereto), and residual income (equal to the excess of the 
CFC's E&P for the taxable year over the sum of the other types of 
income). A United States shareholder's share of the CFC's allocable E&P 
would be treated as first relating to income attributable to covered 
items, with any remaining portion of the share treated as relating on a 
pro rata basis to all other income. However, this approach would 
generally produce the same results as the approach in the proposed 
regulations, except in cases where a deductible item (other than 
current year taxes) disproportionately reduces a covered item (because 
some, but not all, of the covered item is excludable PTEP and thus the 
deduction reduces only the non-PTEP portion of the covered item). 
Moreover, the Treasury Department and the IRS are of the view that 
sections 959(b) and 961(c) do not require such an approach.
    Lastly, the Treasury Department and the IRS request comments on 
whether additional rules are warranted for allocating tested items in 
cases where a covered item is excluded from subpart F income by reason 
of section 954(b)(3)(A)'s de minimis rule and may consequently give 
rise to tested income (which, under the proposed regulations, would be 
allocated under the rules for subpart F income not attributable to 
covered items).

V. Section 986(c) Regulations (Proposed Sec.  1.986(c)-1)

A. Overview
    The proposed regulations under section 986(c) describe the 
circumstances in which a covered shareholder recognizes foreign 
currency gain or loss with respect to PTEP and provide rules for 
determining the amount of gain or loss that is recognized. These rules 
are issued pursuant to the express delegations of authority under 
sections 986(c)(2), 965(o), and 989(c). See also part VIII.F of the 
Explanation of Provisions (proposing to withdraw or studying whether to 
withdraw provisions regarding foreign currency gain or loss in 
Sec. Sec.  1.985-5 and 1.985-7).
B. Circumstances in Which Foreign Currency Gain or Loss Is Recognized
    Under the proposed regulations, a covered shareholder recognizes 
foreign currency gain or loss under section 986(c) with respect to PTEP 
in two circumstances. See proposed Sec.  1.986(c)-1(b)(1). The first 
circumstance is when PTEP is distributed to the covered shareholder 
(including PTEP treated as received through a partnership). The second 
circumstance is when PTEP ceases to be with respect to the covered 
shareholder (for example, as a result of being transferred to another 
covered shareholder in a general successor transaction or eliminated as 
a consequence of an election under section 338(g)). These rules, which 
are generally consistent with the 1988 notice, provide parity between 
distributions of PTEP and dispositions of foreign stock that in each 
case present

[[Page 95392]]

the last opportunity for the covered shareholder to recognize foreign 
currency gain or loss with respect to PTEP.
    The proposed regulations provide that no foreign currency gain or 
loss is recognized in a distribution of PTEP to a foreign corporation. 
See proposed Sec.  1.986(c)-1(c). In these cases, the Treasury 
Department and the IRS are of the view that preserving the dollar basis 
of the PTEP (through adjustments to shareholder-level dollar basis 
pools) is the appropriate application of section 986(c) at the time of 
the distribution, with such dollar basis then determining foreign 
currency gain or loss when the PTEP is subsequently distributed to the 
covered shareholder.
    Foreign currency gain or loss is also generally not recognized (and 
dollar basis is preserved) when PTEP transfers in a transaction other 
than a general successor transaction (for example, a transfer of stock 
of a CFC by a domestic corporation to a non-consolidated domestic 
corporation in a section 351 transaction). See proposed Sec.  1.986(c)-
1(b)(5); but see Sec.  1.367(b)-2(j)(2)(i). This rule limits the 
ability to recognize foreign currency gain or loss in nonrecognition 
transactions or other transactions where gain or loss is generally not 
recognized. Comments are requested on this rule and, more generally, 
whether foreign currency gain or loss should not be recognized and thus 
deferred in sales or other transactions involving related parties.
    Foreign currency gain or loss recognized with respect to PTEP is 
recognized concurrently with the transaction requiring recognition of 
such gain or loss. See proposed Sec.  1.986(c)-1(b)(4). Additionally, 
the foreign currency gain or loss is treated as ordinary income or loss 
from the same source and relating to the same section 904 category as 
the income inclusion that gave rise to the PTEP (consistent with the 
rule in Sec.  1.904-4(p) for distributions of PTEP). See also proposed 
Sec.  1.961-5(b) (adjusting basis for foreign currency gain or loss 
recognized in a transaction other than a distribution, as discussed in 
part III.C.3 of this Explanation of Provisions).
C. Determining Foreign Currency Gain or Loss
    Foreign currency gain or loss with respect to PTEP is determined by 
translating the PTEP (which is denominated in the foreign corporation's 
functional currency) into U.S. dollars at the spot rate on the day of 
the transaction requiring recognition of such gain or loss and 
subtracting from that U.S. dollar amount the dollar basis of the PTEP. 
See proposed Sec.  1.986(c)-1(b)(2); see also proposed Sec.  1.959-
10(c)(2) (Example 2). A positive difference is foreign currency gain 
and the absolute value of a negative difference is foreign currency 
loss.
    As a result, foreign currency gain or loss with respect to PTEP is 
based on movements in exchange rates between the time of the income 
inclusion giving rise to the PTEP (translated pursuant to the 
appropriate exchange rate) or, if applicable, the most recent prior 
transfer of the PTEP (treated as the deemed distribution described in 
section 986(c)(1)), and the date of the transaction requiring 
recognition of such gain or loss (treated as the actual distribution 
described in section 986(c)(1)).
D. Limitations
    Consistent with existing Sec.  1.986(c)-1 (discussed in part II.C.3 
of the Background of this preamble), only a portion of foreign currency 
gain or loss with respect to PTEP resulting from section 965(a) is 
recognized, based on the section 965(c) deduction percentage with 
respect to the PTEP, and no foreign currency gain or loss is recognized 
with respect to PTEP resulting from section 965(b). See proposed Sec.  
1.986(c)-1(b)(3)(i) and (ii). Further, no foreign currency gain or loss 
is recognized with respect to taxable section 962 PTEP because such 
PTEP is included in gross income pursuant to section 962(d) and, 
therefore, the foreign currency gain or loss is accounted for in gross 
income. See proposed Sec.  1.986(c)-1(b)(3)(iii).

VI. Section 960 Regulations (Proposed Sec. Sec.  1.960-1 and1.960-3)

    Current Sec. Sec.  1.960-1 and 1.960-2 provide rules for computing 
the amount of foreign income taxes deemed paid under section 960(a) and 
(d), and current Sec. Sec.  1.960-1 and 1.960-3 provide rules for 
computing the amount of foreign income taxes deemed paid under section 
960(b). The PTEP accounting rules under proposed Sec.  1.959-2 replace 
the rules in current Sec.  1.960-3 that describe a CFC's PTEP, and the 
rules allocating and apportioning current year taxes to PTEP in 
proposed Sec.  1.959-6 replace the rules in current Sec.  1.960-1 for 
purposes of applying section 960(b). Other rules relating to PTEP that 
are included in current Sec. Sec.  1.960-1 and 1.960-3 have also been 
replaced by rules in the proposed regulations under section 959 to 
ensure conformity and proper tracking of amounts described in sections 
959 and 960(b). Current Sec. Sec.  1.960-1 through 1.960-3, as modified 
by proposed Sec. Sec.  1.960-1 and 1.960-3, will generally continue to 
describe how deemed paid taxes are computed under section 960, and 
incorporate updates to coordinate those rules with the proposed 
regulations under sections 959 and 961.
    Proposed Sec.  1.960-1 limits the rules in Sec.  1.960-1 to the 
computation of deemed paid taxes under section 960(a) and (d). To this 
end, proposed Sec.  1.960-1 treats a CFC's PTEP arising by reason of a 
PTEP realization event during its taxable year as gross income in a 
residual income group, rather than as gross income in a PTEP group. See 
proposed Sec.  1.960-1(d)(2)(ii)(D). However, proposed Sec.  1.959-6 
provides specific rules for allocating and apportioning current year 
taxes arising by reason of a PTEP realization event that occurred 
during a taxable year to the statutory groupings of PTEP of a foreign 
corporation. Additionally, proposed Sec.  1.959-2 generally provides 
rules for tracking the foreign income taxes associated with PTEP. See 
parts II.F and II.B of the Explanation of Provisions for a discussion 
of proposed Sec. Sec.  1.959-6 and 1.959-2, respectively. Finally, 
proposed Sec.  1.960-1(d)(3)(ii)(B) (consistent with current Sec.  
1.960-1(d)(3)(ii)(B)) provides specific rules for assigning foreign 
gross income to the statutory and residual groupings of income of a CFC 
when the CFC pays or accrues current year taxes with respect to a PTEP 
realization event that occurs in a different U.S. taxable year. 
Proposed Sec.  1.960-1 also includes changes to current Sec.  1.960-1 
to conform with the approach and terminology used in the proposed 
regulations under sections 959 and 961 and in proposed Sec.  1.960-3.
    Proposed Sec.  1.960-3 provides rules for determining foreign 
income taxes that are deemed paid under section 960(b) with respect to 
the receipt of a distribution of PTEP, primarily by reference to PTEP 
tax pools. In particular, the foreign income taxes that are properly 
attributable to a distribution of PTEP are the foreign income taxes 
removed from the corporate PTEP tax pools of the distributing CFC under 
proposed Sec.  1.959-2(d)(2) and the PTEP tax pools of the covered 
shareholder under Sec.  1.959-3(e)(1)(iii) (that is, the foreign income 
taxes associated with the distributed PTEP under proposed Sec.  1.959-
4), but only to the extent the foreign income taxes are in the 
creditable PTEP tax group immediately before the distribution.
    These rules are issued pursuant to the express delegation of 
authority under section 960(f).

[[Page 95393]]

VII. Section 1502 Regulations (Proposed Sec.  1.1502-59)

    The proposed regulations provide rules specific to members of a 
consolidated group. See proposed Sec.  1.1502-59. These rules are 
issued pursuant to the express delegation of authority under section 
1502.
    The proposed regulations provide that members of a consolidated 
group are treated as a single covered shareholder for purposes of 
section 959 and the regulations thereunder. See proposed Sec.  1.1502-
59(c). This approach is consistent with guidance on the application of 
other international tax rules to consolidated groups (for example, 
Sec. Sec.  1.1502-50, 1.1502-51, and 1.1502-80(j)).
    Consequently, a consolidated group maintains only a single set of 
annual PTEP accounts, dollar basis pools, and PTEP tax pools with 
respect to a foreign corporation whose stock is owned by one or more 
members. These annual PTEP accounts track the foreign corporation's 
PTEP with respect to the group and thus, for example, determine whether 
a covered distribution received by any member of the group from the 
foreign corporation is a distribution of PTEP.
    This application of single-entity treatment is important to ensure 
the proper reflection of the consolidated group's income. Without the 
application of single-entity treatment for purposes of shareholder-
level PTEP accounting, a consolidated group effectively could elect in 
or out of PTEP distributions by changing the structure through which it 
owns stock of foreign corporations. For example, assume that a member 
of a consolidated group (M1) owns all the stock of CFC and has a 
subpart F income inclusion of $100x in year 1 with respect to CFC. 
Absent single-entity treatment, M1, and not the consolidated group, 
would have $100x of PTEP in its annual PTEP accounts with respect to 
CFC. In year 2, the first $100x of covered distributions from CFC would 
be characterized as distributions of PTEP. However, if another member 
(M2) made a contribution to CFC at the beginning of year 2 in exchange 
for 50% of the stock of CFC, only the first $100x of covered 
distributions to M1, and no covered distribution to M2, would be 
characterized as a distribution of PTEP. Therefore, if CFC made a pro 
rata covered distribution of $100x, only $50x would be characterized as 
PTEP. Applying single-entity treatment thus ensures that changes in the 
location of ownership of foreign stock within a consolidated group do 
not change the group's characterization of a distribution by the 
foreign corporation.
    In contrast, the proposed regulations incorporate a mix of single- 
and separate-entity treatment for purposes of section 961 in order to 
prevent basis shifting between members. See proposed Sec.  1.1502-
59(d); see also part III.C.2.ii of the Explanation of Provisions 
(describing how, outside of the consolidated group context, basis 
cannot be shared among section 961(a) ownership units even if owned by 
the same covered shareholder). The proposed regulations respect each 
member's separate basis in its directly held property units, and 
adjustments to the basis of section 961(a) ownership units are thus 
computed on a separate-entity basis. Consequently, a distribution of 
PTEP may result in the recognition of gain under section 961(b)(2) if 
the distributee member has insufficient basis in a section 961(a) 
ownership unit. The Treasury Department and the IRS are of the view 
that an approach like that in the 2006 proposed regulations, in which 
one member may access basis belonging to another member, would create 
opportunities for inappropriate tax planning by shifting basis among 
members in a way that does not reflect the economics of the members' 
investments.
    For indirectly held property units (for example, lower-tier CFC 
stock), a consolidated group is treated as a single covered 
shareholder. For example, a partnership has only a single derived basis 
in a derivative ownership unit with respect to a group, and, similarly, 
a CFC has only a single section 961(c) basis in a section 961(c) 
ownership unit with respect to a group and increases to derived basis 
and section 961(c) basis generally are computed on a single-entity 
basis. However, the proposed regulations also include rules to prevent 
basis shifting among members with respect to these property units, 
because member shareholders may have different bases in these property 
units under other rules (for example, under section 743(b)). When 
computing reductions in basis to derivative ownership units or section 
961(c) ownership units, the proposed rules provide that the group basis 
of the relevant property unit is allocated to the member shareholders, 
the basis reduction is computed separately for each member (and may 
trigger gain if there is insufficient basis), and then the basis is 
recombined.
    The proposed regulations also provide rules for corporations that 
become or cease to be members of a consolidated group. See proposed 
Sec.  1.1502-59(e). These rules generally implement single-entity 
treatment by mirroring the principles that would apply if members of 
the group were divisions of a single corporation. For example, if a 
shareholder of a foreign corporation joins a consolidated group, solely 
for purposes of applying sections 959 and 961, the transaction is 
treated as if the group directly acquired the stock in the foreign 
corporation. Similarly, if a shareholder of a foreign corporation 
ceases to be a member of a consolidated group, solely for purposes of 
applying sections 959 and 961, the transaction is treated as if the 
group directly disposed of the stock in the foreign corporation.
    When the proposed regulations are finalized, the Treasury 
Department and the IRS intend to conform the terminology in Sec.  
1.1502-80(j) (treating a consolidated group as a single United States 
shareholder for purposes of applying section 951(a)(2)(B) to 
distributions of PTEP from one CFC to another) to match these 
regulations, and may relocate that rule to Sec.  1.1502-59.

VIII. Miscellaneous Provisions

A. S Corporations
    Consistent with section 1373(a), the proposed regulations generally 
treat an S corporation in the same manner as a domestic partnership and 
thus as not a covered shareholder. See proposed Sec. Sec.  1.959-
1(c)(1) and 1.961-1(c)(1). When this treatment applies, each owner of 
the S corporation maintains annual PTEP accounts, dollar basis pools, 
and PTEP tax pools (as applicable) with respect to a foreign 
corporation in which the S corporation owns stock (rather than the S 
corporation itself). Also, like domestic partnerships, an S corporation 
is provided derived basis in a derivative ownership unit directly owned 
by the S corporation.
    Notwithstanding the general rule that an S corporation is not 
treated as a covered shareholder, an exception provides that an S 
corporation is a covered shareholder for any taxable year of the S 
corporation for which the S corporation is treated as an entity 
separate from its owners in determining stock ownership for purposes of 
section 951(a) or 951A(a). See proposed Sec. Sec.  1.959-11(d) and 
1.961-13(c); see also part IX.B.5 of the Explanation of Provisions 
(describing transition rules applicable to domestic partnerships, 
including S corporations). Thus, the exception applies if the S 
corporation has made an election described in Sec.  1.958-1(e), as 
proposed to be amended at 87 FR 3890 (Jan. 25, 2022), or section 3.02 
of Notice 2020-69, 2020-39 I.R.B.

[[Page 95394]]

604. Accordingly, an S corporation is a covered shareholder if such 
election is in effect and the S corporation thus includes amounts in 
gross income under sections 951(a) and 951A(a).
    Where the exception applies to an S corporation (and thus both the 
S corporation and its owners are covered shareholders), rules relating 
to distributions of PTEP, derived basis (of a partnership that is owned 
by the S corporation), and section 961(c) basis (of a CFC that is owned 
by the S corporation) apply to the S corporation in its capacity as a 
covered shareholder before those rules apply to an owner of the S 
corporation. See proposed Sec. Sec.  1.959-11(d) and 1.961-13(c). For 
example, a covered distribution made to the S corporation is first a 
distribution of the distributing foreign corporation's PTEP with 
respect to the S corporation, and then, to the extent remaining, a 
distribution of the distributing foreign corporation's PTEP with 
respect to owners of the S corporation.
B. Passive Foreign Investment Companies
    The proposed regulations do not address passive foreign investment 
companies (PFICs) (as defined in 1297(a)) or a PFIC's earnings and 
profits described in section 1293(c). The Treasury Department and the 
IRS are studying issues involving PFICs, including coordination of 
sections 959 and 1293(c), and may address these issues in future 
guidance.
C. Foreign Trusts and Foreign Estates
    For purposes of determining ownership under section 958(a)(2), 
stock owned by a foreign trust (within the meaning of section 
7701(a)(31)(B)) described in sections 671 through 679 (relating to 
grantors and others treated as substantial owners) is treated as being 
owned proportionately by its grantors or other persons treated as 
owners under sections 671 through 679 of any portion of the trust that 
includes the stock. See Sec.  1.958-1(b). Similarly, stock owned by any 
other foreign trust (not described in sections 671 through 679) or a 
foreign estate (within the meaning of section 7701(a)(31)(A)) is 
treated as being owned proportionately by its beneficiaries. See id. 
Consistent with section 961(a) and (b), which provide for adjustments 
to the basis of property of a United States shareholder by reason of 
which the shareholder is considered under section 958(a)(2) as owning 
stock of a CFC, the current regulations under section 961 provide for 
adjustments to a United States shareholder's basis in a beneficial 
interest in a foreign trust or foreign estate through which the United 
States shareholder owns stock of a CFC. See Sec. Sec.  1.961-1 and 
1.961-2.
    The proposed regulations, however, do not address the operation of 
sections 959 and 961 with respect to foreign trusts (thus, for example, 
if a covered shareholder owns stock of a CFC through a foreign trust, 
the proposed regulations do not address the treatment of a covered 
distribution received by the foreign trust from the CFC or basis in the 
covered shareholder's interest in the foreign trust or the trust's 
stock of the CFC). The Treasury Department and the IRS are studying the 
manner in which section 959 should be applied in these structures to 
ensure that PTEP distributed to a covered shareholder through a foreign 
trust is properly excluded from the covered shareholder's gross income. 
Comments are requested on the treatment of foreign trusts under section 
959, including whether treatment similar to a foreign corporation or 
partnership is appropriate or would impose significant burdens on such 
trusts, their owners, or beneficiaries. Comments are also requested on 
the appropriateness and effect of providing basis adjustments under 
section 961 in structures involving these entities as well as the 
interaction between these provisions and the rules in section 643(i) 
that treat certain loans from foreign trusts as distributions.
    Comments are likewise requested on how foreign estates, which are 
also not addressed in the proposed regulations, should be treated for 
purposes of sections 959 and 961.
D. Section 962
    Consistent with section 962(d), the proposed regulations do not 
exclude taxable section 962 PTEP that is distributed to a covered 
shareholder from the shareholder's gross income. See proposed Sec.  
1.959-4(b)(1). Similarly, consistent with section 961(a) and (b), the 
proposed regulations do not increase or reduce adjusted basis or 
derived basis for taxable section 962 PTEP. See proposed Sec. Sec.  
1.961-3(f)(2) and 1.961-4(b)(1), (c)(1). However, the proposed 
regulations apply the section 959(b) exclusion to, and provide section 
961(c) basis for, taxable section 962 PTEP to prevent further tax on 
such PTEP in distributions to, or dispositions of stock by, a CFC. See 
proposed Sec. Sec.  1.959-4(b)(2) and 1.961-3. Thus, taxable section 
962 PTEP is generally subject to an additional level of taxation only 
in distributions to a covered shareholder or dispositions of section 
961(a) ownership units or derivative ownership units.
    Under the proposed regulations, PTEP retains its character as 
taxable section 962 PTEP in a general successor transaction and thus 
may transfer from a transferor covered shareholder to a successor 
covered shareholder. Likewise, taxable section 962 PTEP may be 
reflected in PTEP resulting from section 961(c) basis. In this way, the 
proposed regulations are consistent with the requirement in section 
962(d) that taxable section 962 PTEP be included in gross income when 
distributed because it has not been sufficiently taxed.
    Further, the proposed regulations remove Sec.  1.962-3 because the 
proposed regulations generally incorporate the rules in Sec.  1.962-3. 
See, for example, proposed Sec.  1.959-4. The proposed regulations, 
however, do not incorporate Sec.  1.962-3(b)(3)(iv), which describes 
the application of a foreign corporation's E&P deficit to taxable 
section 962 PTEP, and Sec.  1.962-3(b)(4), which provides that Sec.  
1.962-3 does not apply to a distribution of section 962 PTEP treated as 
in exchange for stock. The Treasury Department and the IRS request 
comments on these rules, including whether they continue to be needed 
and, if so, their interaction with these regulations.
E. Currency Translation
    In applying the proposed regulations in certain cases, an amount 
must be translated into a currency different than the currency in which 
it is denominated. For example, in a distribution of PTEP to a foreign 
corporation, the PTEP must be translated into the functional currency 
of the recipient foreign corporation (if the recipient foreign 
corporation and distributing foreign corporation have different 
functional currencies) so that the PTEP can be added to annual PTEP 
accounts with respect to the recipient foreign corporation (which are 
maintained in the recipient foreign corporation's functional currency). 
As an additional example, in applying section 961(c) basis to a CFC's 
covered gain, the section 961(c) basis (which is maintained is U.S. 
dollars) must be translated into the CFC's functional currency if the 
CFC does not use the U.S. dollar as its functional currency. 
Accordingly, the proposed regulations provide currency translation 
rules where relevant. See, for example, proposed Sec. Sec.  1.951-2(f), 
1.959-3(c)(5), 1.959-6(d)(2), and 1.961-9(e)(3). The Treasury 
Department and the IRS welcome comments on these rules.
F. Section 985
    When a CFC changes its functional currency to the U.S. dollar, 
Sec.  1.985-5(e)(2) requires a United States shareholder of that CFC to 
recognize

[[Page 95395]]

foreign currency gain or loss with respect to PTEP under section 986(c) 
as if all of the PTEP were distributed to the United States shareholder 
immediately before the change. No rules currently require recognition 
of foreign currency gain or loss with respect to PTEP when a CFC with a 
functional currency other than the U.S. dollar distributes PTEP to a 
CFC with a functional currency that is the U.S. dollar, nor does Sec.  
1.985-5(e)(2) apply when a CFC changes its functional currency to a 
currency other than the U.S. dollar. As a result, current law requires 
recognizing foreign currency gain or loss on PTEP deemed distributed to 
a CFC immediately before it converts its functional currency to the 
U.S. dollar but not immediately after.
    As noted in part V.A of this Explanation of provisions, the rules 
in the proposed regulations for recognizing foreign currency gain or 
loss with respect to PTEP require recognizing such gain or loss in 
distributions of PTEP to a covered shareholder and dispositions of 
foreign stock because those circumstances present the last opportunity 
for the covered shareholder to recognize foreign currency gain or loss 
with respect to the PTEP. In the case of a distribution of PTEP to a 
foreign corporation, the dollar basis is preserved, which in turn 
preserves the appropriate application of section 986(c) until one of 
the circumstances noted in the previous sentence occurs. The Treasury 
Department and the IRS are of the view that the appropriate time to 
recognize foreign currency gain or loss should not depend on whether 
and when a CFC changes its functional currency, nor on the functional 
currencies involved. The proposed regulations provide a comprehensive 
system for determining and tracking the dollar basis of PTEP (through 
dollar basis pools, PTEP groups, and annual PTEP accounts), as well as 
for using these accounts to determine foreign currency gain or loss 
when appropriate. To the extent the rule in Sec.  1.985-5(e)(2) was 
supported by concerns that having a U.S. dollar basis in PTEP that are 
measured in the U.S. dollar might create administrative difficulties or 
lead to the undercounting of foreign currency gain or loss, the 
Treasury Department and the IRS are of the view that the comprehensive 
system promulgated in the proposed regulations alleviates that concern. 
See, for example, part V of this Explanation of Provisions for rules 
determining currency gain and loss. Finally, the Treasury Department 
and the IRS are also concerned that the rule in Sec.  1.985-5(e)(2) may 
permit taxpayers to inappropriately accelerate foreign currency loss by 
deeming a distribution of such PTEP to a CFC that then changes its 
functional currency to the U.S. dollar. Accordingly, the proposed 
regulations withdraw the rule in Sec.  1.985-5(e)(2).
    For similar reasons, the Treasury Department and the IRS are 
studying whether Sec.  1.985-7(c)(3), which requires certain 
adjustments by a United States shareholder related to foreign currency 
gain or loss with respect to PTEP in cases involving dollar approximate 
separate transactions method of accounting, should be modified.
G. Qualified Deficit Transition Rule for Domestic Partnerships 
(Including S Corporations)
    Under the qualified deficit rule of section 952(c)(1)(B), a United 
States shareholder's pro rata share of any prior-year E&P deficit of a 
CFC may generally be used to reduce the United States shareholder's 
subpart F income inclusion with respect to the CFC to the extent such 
deficit is attributable to the same qualified activity as the activity 
that gives rise to the current year subpart F income of the CFC (and 
has not already been taken into account under section 952(c)(1)(B)). 
For this purpose, the United States shareholder's pro rata share of any 
prior-year E&P deficit is the lesser of the amount determined (under 
rules similar to section 951(a)(2)) at the close of the current taxable 
year or at the close of the taxable year in which the deficit arose. 
Section 952(c)(1)(B)(iv).
    As described in part III.A of the Background, because a domestic 
partnership was previously treated as an entity for purposes of 
including amounts in income under section 951(a)(1)(A) with respect to 
CFCs it owned, the domestic partnership would have been entitled to 
utilize those CFCs' qualified deficits to reduce its subpart F income 
inclusions. However, under Sec.  1.958-1(d), a domestic partnership is 
now generally treated as an aggregate of its partners for purposes of 
determining which United States shareholder has a subpart F income 
inclusion with respect to a CFC. To accommodate this aggregate approach 
for domestic partnerships, and like the transition rule for 
partnership-level accounts described in proposed Sec.  1.959-11(e) and 
part IX.B.5 of the Explanation of Provisions, the proposed regulations 
provide a transition rule that ensures a prior-year E&P deficit of a 
CFC is taken into account by a domestic partnership's United States 
shareholder partners for taxable years of the CFC to which Sec.  1.958-
1(d) applies to the domestic partnership. See proposed Sec.  1.952-
1(c)(5).
    Under the transition rule, a United States shareholder that owns 
stock of a CFC through an interest in a domestic partnership on the 
transition date (which is the last day of the first taxable year of the 
CFC to which Sec.  1.958-1(d) applies to the domestic partnership) 
takes into account its assigned portion of any prior-year E&P deficit 
of the CFC that arose before the application of Sec.  1.958-1(d) in 
determining the shareholder's pro rata share of a prior-year E&P 
deficit under section 952(c)(1)(B)(iv)(II). See proposed Sec.  1.952-
1(c)(5)(i). The United States shareholder's assigned portion is 
determined based on liquidation rights as of the transition date. See 
proposed Sec.  1.952-1(c)(5)(ii); see also part IX.B.5 of the 
Explanation of Provisions (discussing a similar concept used in pushing 
out annual PTEP accounts, dollar basis pools, and PTEP tax pools to 
partners). The United States shareholder's pro rata share of the prior-
year E&P deficit as of the close of the taxable year in which section 
952(c)(1)(B) would apply to reduce its subpart F income inclusion is 
determined by reference to the United States shareholder's ownership of 
the stock of the CFC at such time.
    As with the proposed regulations generally, an S corporation is 
treated in the same manner as a domestic partnership for purposes of 
applying this transition rule. See section 1373(a) and part VIII.A of 
the Explanation of Provisions. However, unlike domestic partnerships, 
an S corporation may have elected to defer the application of Sec.  
1.958-1(d) and maintain entity treatment for purposes of section 
951(a)(1)(A), in which case the transition rule may not apply until 
such election ceases to have effect. See part VIII.A of the Explanation 
of Provisions.
    The transition rule generally applies with respect to taxable years 
of foreign corporations beginning on or after the date the proposed 
regulations are finalized in a Treasury Decision, although taxpayers 
are permitted to apply the transition rule to earlier taxable years if 
certain consistency requirements are satisfied and the period of 
limitations on assessment is open for those taxable years under section 
6501. See proposed Sec.  1.952-1(c)(5)(iii).
H. Anti-Avoidance Rules
    The proposed regulations include anti-avoidance rules. See proposed 
Sec. Sec.  1.959-1(d) and 1.961-1(d). Under these rules, appropriate 
adjustments are made if a transaction, series of

[[Page 95396]]

transactions, plan, or arrangement is engaged in with a principal 
purpose of avoiding the purposes of section 959 or 961 or the 
regulations thereunder. These rules are intended to address 
transactions that are designed to produce double-nontaxation by, for 
instance, converting distributions of E&P from PTEP (which generally 
may be received tax-free under section 959 but requires a basis 
reduction under section 961) to section 959(c)(3) E&P (which may be 
received tax-free under other provisions and may not require a basis 
reduction) or vice versa.
    For example, assume a corporate covered shareholder owns all the 
stock of a foreign corporation and the foreign corporation has PTEP 
with respect to the corporate covered shareholder. If an individual who 
would have purchased newly issued shares in the foreign corporation 
instead purchases shares from the corporate covered shareholder with a 
principal purpose of succeeding to a portion of the foreign 
corporation's PTEP with respect to the corporate covered shareholder's 
PTEP and with the expectation that at some point in the future the 
corporate covered shareholder will contribute the proceeds to the 
foreign corporation (thus achieving the individual's intended effect of 
acquiring newly issued shares, while also transferring the PTEP from 
the corporate covered shareholder to the individual), appropriate 
adjustments may be made to disregard the transfer of PTEP. The result 
would be the same if the transaction was entered into with a principal 
purpose of reducing the foreign corporation's PTEP with respect to the 
corporate covered shareholder.
I. Clarifications and Other Matters
    The proposed regulations clarify that a distribution of PTEP does 
not increase the E&P of a recipient domestic corporation (because the 
E&P of a domestic corporation is increased for, and at the time of, an 
inclusion giving rise to PTEP, and distributions to which sections 959 
and 961(b) apply are described in section 312(f)(2)). See proposed 
Sec. Sec.  1.312-6(f) and 1.312-8(c). No inference is intended as to 
the treatment under these provisions of other amounts a domestic 
corporation includes in its gross income as a result of ownership of 
stock in a foreign corporation, such as inclusions with respect to a 
PFIC, and the Treasury Department and IRS continue to consider these 
issues. Additionally, the proposed regulations clarify that, solely for 
purposes of the limitation in section 952(c)(1)(A), PTEP received by, 
or resulting from section 961(c) basis of, a CFC is not included in the 
CFC's current year E&P. See proposed Sec.  1.952-1(c)(4). This 
treatment is consistent with Sec.  1.952-1(c)(3) (Example 1) and 
coordinates sections 952(c), 959(b), and 961(c) so that PTEP does not 
have the effect of increasing subpart F income.
    The proposed regulations also provide that, for purposes of section 
163(j), PTEP received by, or resulting from section 961(c) basis of, a 
foreign corporation does not give rise to tentative taxable income 
(because the income that gave rise to the PTEP has already been taken 
into account), and this rule is issued under the express delegation of 
authority in section 163(j)(8)(B). See proposed Sec.  1.163(j)-7(g)(2). 
Moreover, the proposed regulations revise Sec.  1.951-1(a)(1) to 
reflect the repeal of provisions relating to foreign base company 
shipping income and foreign investments in less developed countries and 
move the examples in Sec.  1.951-1(e)(7) to a separate example 
paragraph.
    The proposed regulations modify Sec.  1.905-3(b)(2)(ii) to clarify 
that if a foreign tax redetermination impacts the characterization or 
amount of a distribution or inclusion in any other year, that year is 
an affected year for which a redetermination of U.S. tax is required. 
This is a conforming change relating to the timing and ordering rules 
in the proposed regulations, which could, in certain situations, result 
in a foreign tax redetermination impacting the characterization or 
amount of a distribution or inclusion not only in a subsequent year, 
but in a prior year.

IX. Applicability Dates and Transition Rules

A. Applicability Dates
1. General Applicability Date and Application to 2019 Notice Years
    The proposed regulations would generally apply to taxable years of 
foreign corporations beginning on or after the date the proposed 
regulations are finalized in a Treasury Decision and to taxable years 
of persons for which such taxable years of foreign corporations are 
relevant (general applicability date). See, for example, proposed 
Sec. Sec.  1.951-1(i), 1.951-2(i), 1.959-12(b), 1.960-7(c), 1.961-
14(b), 1.986(c)-1(e), and 1.1502-59(g).
    Notwithstanding the general applicability date, portions of the 
proposed section 959 regulations relating to rules described in the 
2019 notice would apply before the general applicability date to 
taxable years of United States shareholders (and successors in 
interest) ending after December 14, 2018, and taxable years of foreign 
corporations ending with or within those taxable years, as described in 
the 2019 notice (2019 notice years). See proposed Sec.  1.959-12(c). 
For this purpose, taxpayers are required to apply to 2019 notice years 
the rules in proposed Sec. Sec.  1.959-1(c) (treatment of S 
corporations), 1.959-2 (accounting of PTEP), 1.959-3 (adjustments to 
shareholder-level accounts and, consequently, foreign-corporation level 
accounts), 1.959-4(e) and 1.959-5(d) (allocation of distributions and 
section 956 amounts), and the relevant definitions in 1.959-1(b) 
(collectively, the 2019 notice provisions). Consistent with the 2019 
notice, PTEP is treated as distributed under section 959 to the extent 
the distribution constitutes a dividend under section 316 (determined 
without regard to section 959(d)). Additionally, because taxpayers may 
have maintained PTEP groups in accordance with the groups described in 
the 2019 notice, taxpayers may use those PTEP groups for 2019 notice 
years instead of the PTEP groups listed in proposed Sec.  1.959-2. 
Furthermore, neither the portions of proposed Sec. Sec.  1.959-2 and 
1.959-3 relating to PTEP tax pools, corporate PTEP tax pools, adjusted 
applicable percentages, and section 965(c) deduction percentages, nor 
the portions of proposed Sec. Sec.  1.959-3 through 1.959-5 and 1.959-7 
relating to the timing of adjustments and determinations, are 2019 
notice provisions, and, therefore, taxpayers are not required to apply 
these provisions to 2019 notice years.
    Apart from the 2019 notice provisions, the proposed regulations 
would apply before the general applicably date only if taxpayers choose 
to apply the proposed regulations early in accordance with the rules 
described in part IX.A.2 of the Explanation of Provisions.
2. Early Application Option
    Taxpayers would be permitted to choose to apply the proposed 
regulations in their entirety to taxable years of foreign corporations 
beginning before the general applicability date (such years to which 
the regulations are applied, the early application years) if certain 
conditions prescribed in proposed Sec.  1.959-12(d) are satisfied 
(early application option). See, for example, proposed Sec. Sec.  
1.951-1(i), 1.951-2(i), 1.960-7(c), 1.961-14(b), 1.986(c)-1(e), and 
1.1502-59(g). The early application option would satisfy, and therefore 
supersede, the required application of the 2019 notice provisions if 
the first early application year precedes, or is the same as, the first 
2019 notice year. See proposed Sec.  1.959-12(c).

[[Page 95397]]

    Under the early application option, taxpayers must apply the 
proposed regulations, as finalized, in their entirety to an early 
application year and all succeeding early application years, all 
taxable years of covered shareholders for which the early application 
years are relevant, and all taxable years of related foreign 
corporations (determined under section 267(b)) that end on or after the 
later of the last day of the first early application year and the first 
day on which the foreign corporations are related. See proposed Sec.  
1.959-12(d)(2). Further, all taxable years of covered shareholders for 
which the early application years are relevant must be open under 
section 6501, which each covered shareholder must confirm in a written 
statement to the foreign corporation that also provides the covered 
shareholder's consent to apply the proposed regulations before the 
general applicability date. See proposed Sec.  1.959-12(d)(3) and (4). 
These conditions are intended to promote consistency and 
administrability.
B. Transition Rules
1. In General
    To facilitate the initial application of the proposed regulations, 
the proposed regulations include transition rules under section 959 for 
establishing and conforming accounts under section 959, as well as 
rules under section 961 for establishing derived basis and section 
961(c) basis. These rules also address particular transition issues 
relating to the treatment of domestic partnerships (including S 
corporations).
2. Annual PTEP Accounts, Dollar Basis Pools, and Corporate PTEP 
Accounts
    As of the beginning of the first taxable year of a foreign 
corporation to which the proposed section 959 regulations apply 
pursuant to the 2019 notice or the early application option, a 
reasonable method must be used to establish annual PTEP accounts, 
dollar basis pools, and corporate PTEP accounts in accordance with 
proposed Sec.  1.959-2, including to reflect any prior adjustments that 
would have been made under the principles of proposed Sec. Sec.  1.959-
2 through 1.959-5 and 1.959-7. See proposed Sec.  1.959-11(b)(1) and 
(2)(i). Additionally, adjustments must be made to account for the 
transition tax under section 965. See proposed Sec.  1.959-11(b)(3).
    In establishing these accounts, any existing accounts of a covered 
shareholder must be conformed to the requirements of proposed Sec.  
1.959-2. See proposed Sec.  1.959-11(b)(2)(i). Further, in the case of 
existing accounts tracking PTEP or dollar basis in multi-year pools, a 
reasonable method to conforming the accounts includes an approach 
consistent with the rules in the 2019 notice. See proposed Sec.  1.959-
11(b)(2)(ii).
    Lastly, a reasonable method used to establish annual PTEP accounts, 
dollar basis pools, and corporate PTEP accounts must be consistently 
applied by the covered shareholder with respect to all foreign 
corporations in which the covered shareholder owns stock. The same 
method must also be applied by all covered shareholders that join in 
filing a federal income tax return (for example, domestic corporations 
that file a consolidated federal income tax return in cases where the 
early application option does not apply). See proposed Sec.  1.959-
11(b)(2)(i). In cases where there are multiple covered shareholders of 
a foreign corporation, corporate PTEP accounts of a foreign corporation 
are established based on the reasonable method applied by each covered 
shareholder. Thus, for example, assume US1, a covered shareholder, owns 
all the stock of CFC1 and 40% of the stock of CFC2, and that both CFC1 
and CFC2 are foreign corporations. The remaining 60% of the stock of 
CFC2 is owned by US2, a covered shareholder unrelated to US1. US1 must 
consistently use a reasonable method for establishing its annual PTEP 
accounts and dollar basis pools with respect to CFC1 and CFC2, and US2 
must use a reasonable method for its own determination of those 
accounts with respect to CFC2. CFC1's corporate PTEP accounts would 
then reflect the annual PTEP accounts of US1, and CFC2's corporate PTEP 
accounts would then reflect the annual PTEP accounts of US1 and US2.
3. PTEP Tax Pools, Corporate PTEP Tax Pools, and Section 965 Related 
Amounts
    As of the beginning of the first taxable year of a foreign 
corporation to which the proposed section 959 regulations apply 
pursuant to the general applicability date or the early application 
option, the proposed regulations require the establishment of PTEP tax 
pools, corporate PTEP tax pools, adjusted applicable percentages, and 
section 965(c) deduction percentages reflecting the foreign 
corporation's PTEP. See proposed Sec.  1.959-11(c)(1).
    PTEP tax pools and corporate PTEP tax pools are established by 
adding a pro rata portion of the foreign corporation's PTEP group taxes 
(prior-law PTEP group taxes) with respect to PTEP groups (prior-law 
PTEP group), as those terms are defined in current Sec.  1.960-3, to 
each PTEP tax pool with respect to the foreign corporation. See 
proposed Sec.  1.959-11(c)(2). This is determined by multiplying the 
prior-law PTEP group taxes by a fraction, the numerator of which is the 
balance of the prior-law PTEP group that is PTEP relating to the PTEP 
tax pool, and the denominator of which is the balance of the prior-law 
PTEP group.
    An adjusted applicable percentage is established with respect to 
all the foreign corporation's PTEP resulting from section 965 within a 
covered shareholder's annual PTEP accounts relating to the same section 
904 category by calculating a weighted average of the applicable 
percentages with respect to the PTEP (as defined in Sec.  1.965-5(d)). 
See proposed Sec.  1.959-11(c)(3). A section 965(c) deduction 
percentage is established with respect to all the foreign corporation's 
PTEP resulting from section 965(a) within a covered shareholder's 
annual PTEP accounts relating to the same section 904 category by 
calculating a weighted average of the percentages for which foreign 
currency gain or loss recognized under section 986(c) with respect to 
distributions of the PTEP would be reduced under current Sec.  
1.986(c)-1. See proposed Sec.  1.959-11(c)(4).
4. Derived Basis of Partnerships and Section 961(c) Basis
    As of the beginning of the first taxable year of a foreign 
corporation to which the proposed section 961 regulations apply 
pursuant to the general applicability date or the early application 
option, a partnership's derived basis or a CFC's section 961(c) basis 
of a property unit is established based on the amount of basis that 
would exist in the property unit if the principles of the applicable 
proposed section 961 regulations were to have applied for all prior 
periods, determined using a reasonable method. See proposed Sec.  
1.961-13(b)(1), (2), and (3). The reasonable method must be 
consistently applied to each foreign corporation owned by the 
partnership or CFC and with respect to each covered shareholder that 
owns an interest in the partnership or stock in the CFC. For this 
purpose, the establishment of section 961(c) basis includes replacing 
any existing basis under section 961(c) in the property unit, to the 
extent a foreign corporation took the position under current law that 
it was afforded such basis, with section 961(c) basis as prescribed in 
the proposed section 961 regulations.
    The rule for establishing derived basis applies to foreign 
partnerships and is also applicable to domestic partnerships (including 
S corporations) to the extent

[[Page 95398]]

that aggregate treatment applies with respect to the domestic 
partnership under Sec.  1.958-1(d) or former Sec.  1.951A-1(e)(1) (as 
in effect before TD 9960, 87 FR 3648) before the application of the 
proposed section 961 regulations. However, in the case of a domestic 
partnership, the amount of any derived basis does not take into account 
amounts included in income by the domestic partnership or any lower-
tier domestic partnership for periods in which aggregate treatment does 
not apply. For example, if a domestic partnership directly owns stock 
in a CFC, the domestic partnership's derived basis is determined 
without regard to any subpart F income inclusion of the domestic 
partnership attributable to the CFC in a period before Sec.  1.958-1(d) 
applies to the domestic partnership, which instead gives rise to 
adjusted basis of the domestic partnership under section 961(a). See 
part IX.B.5 of the Explanation of Provisions for a discussion of the 
treatment of such basis under the proposed regulations, which is not 
converted into derived basis as a result of Sec.  1.958-1(d) applying 
to the domestic partnership.
    The proposed regulations also provide that a specified foreign 
corporation that is not otherwise a CFC is treated as a CFC for 
purposes of applying the principles of proposed Sec.  1.961-3 to an 
income inclusion under section 951(a)(1)(A) that arises by reason of 
section 965(a). See proposed Sec.  1.961-13(b)(4). This rule is 
intended to clarify that basis increases are made to stock of a foreign 
corporation for inclusions arising under section 965(a) regardless of 
CFC status. However, no basis increases are afforded under section 961 
for PTEP attributable to section 965(b). See section 965(b)(4)(A) 
(providing that the amount of the reduction described in section 965(b) 
is treated as included in gross income under section 951(a) only for 
purposes of applying section 959).
    The transition rules for the establishment of derived basis and 
section 961(c) basis are intended to facilitate the application of the 
rules governing such basis under the proposed regulations and should 
not be interpreted in a manner that results in a double benefit. To 
ensure this result, the proposed regulations provide that derived basis 
or section 961(c) basis is increased to reflect an income inclusion 
under section 951(a)(1)(A) or 951A(a) only to the extent such an 
increase would not duplicate basis at the level of the partnership or 
CFC to reflect the income inclusion. See proposed Sec.  1.961-13(b)(5). 
Thus, for example, if a foreign partnership was provided basis with 
respect to stock in a foreign corporation under Sec.  1.965-2(h)(5)(ii) 
for an income inclusion, no derived basis is provided to the foreign 
partnership under the proposed regulations for the inclusion (and any 
existing basis under Sec.  1.965-2(h)(5)(ii) in the property unit 
remains and, thus, is not converted to derived basis). As an additional 
example, if a CFC previously claimed basis under section 961(c) for an 
income inclusion, section 961(c) basis is provided to the CFC under the 
proposed regulations for the inclusion only to the extent the 
previously-claimed-basis has not been used (and, therefore, can be 
replaced with section 961(c) basis pursuant to the proposed 
regulations).
5. Treatment of Domestic Partnerships (Including S Corporations)
    For taxable years of a domestic partnership (including an S 
corporation by operation of section 1373(a)) to which Sec.  1.958-
1(d)(1) does not apply, the domestic partnership is treated as an 
entity separate from its owners in determining stock ownership for 
purposes of section 951(a) and therefore is required to include amounts 
in gross income under section 951(a). In these cases, foreign 
corporations may have PTEP with respect to the domestic partnership and 
the domestic partnership may have been provided basis under section 
961(a). Moreover, in a case where former Sec.  1.951A-1(e)(1) (as in 
effect before TD 9960, 87 FR 3648) treated the domestic partnership as 
an aggregate of its partners for purposes of applying section 951A and 
related provisions, both the domestic partnership and its partners may 
be United States shareholders with income inclusions attributable to 
the same CFC.
    The proposed regulations address the treatment of domestic 
partnerships before the application of Sec.  1.958-1(d)(1) by, in these 
cases, treating the domestic partnership as a covered shareholder. See 
proposed Sec. Sec.  1.959-11(d) and 1.961-13(c). In addition, rules 
regarding distributions of PTEP, derived basis (of a partnership that 
is owned by the domestic partnership), and section 961(c) basis (of a 
CFC that is owned by the domestic partnership) apply to the domestic 
partnership in its capacity as a covered shareholder before those rules 
apply to covered shareholders that own interests in the domestic 
partnership. See proposed Sec. Sec.  1.959-11(d) and 1.961-13(c). In 
this way, the PTEP and basis afforded with respect to a domestic 
partnership as a covered shareholder are taken into account before 
looking to the PTEP and basis with respect to covered shareholders that 
own interests in the partnership. In addition to providing a rule for 
coordinating the operation of these provisions in the interim period 
before Sec.  1.958-1(d)(1) applies, this rule should reduce the amount 
of PTEP and basis of a domestic partnership that ultimately must be 
converted to be with respect to covered shareholders that own interests 
in the partnership when Sec.  1.958-1(d) applies.
    Once both Sec.  1.958-1(d)(1) and the proposed regulations apply to 
a domestic partnership (and, consequently, the domestic partnership is 
no longer a covered shareholder), the proposed regulations convert the 
domestic partnership's accounts described in proposed Sec.  1.959-2 
(annual PTEP accounts, dollar basis pools, and PTEP tax pools) to 
accounts with respect to covered shareholders owning interests in the 
domestic partnership, including the deemed covered shareholder to the 
extent any interest in the domestic partnership is not owned by a 
covered shareholder. See proposed Sec.  1.959-11(e). Similarly, the 
proposed regulations convert a CFC's section 961(c) basis with respect 
to the domestic partnership to section 961(c) basis with respect to 
covered shareholders owning interests in the domestic partnership 
(including the deemed covered shareholder). See proposed Sec.  1.961-
13(d). Additionally, because another partnership may have derived basis 
with respect to the domestic partnership (for example, if the domestic 
partnership owns an interest in a foreign partnership that owns stock 
of a CFC, with the foreign partnership having derived basis with 
respect to the domestic partnership), the proposed regulations likewise 
convert the other partnership's derived basis to derived basis with 
respect to covered shareholders owning interests in the domestic 
partnership. See id.
    The conversion of the domestic partnership's annual PTEP accounts, 
dollar basis pools, and PTEP tax pools is based on liquidation rights 
and occurs once the proposed regulations apply to the domestic 
partnership (either pursuant to the general applicability date or the 
early application option) or, if later, once Sec.  1.958-1(d) first 
applies to the domestic partnership (including, in the case of S 
corporations, because an election not to apply Sec.  1.958-1(d) ceases 
to have effect). See proposed Sec.  1.959-11(e)(2)(i)(B). Because the 
conversion of accounts under these rules depends on when Sec.  1.958-
1(d) first applies to a particular domestic partnership, the rules may 
apply at different times in cases where stock of a foreign corporation 
is owned through tiers of domestic partnerships.

[[Page 95399]]

    The conversion of derived basis or section 961(c) basis is 
determined consistently, and occurs concurrently, with the conversion 
of the accounts under section 959. See proposed Sec.  1.961-13(d)(2)(i) 
and (3)(i). The proposed regulations do not convert basis previously 
provided to the domestic partnership under section 961(a) into derived 
basis, nor do the proposed regulations affect prior basis adjustments 
made under section 705. Thus, for example, if a domestic corporation 
owns an interest in a foreign partnership, and that foreign partnership 
owns an interest in a domestic partnership that owns stock of a CFC, 
the proposed regulations do not alter the treatment of basis provided 
to the domestic partnership in its CFC stock under section 961(a) or 
the related basis afforded to the foreign partnership in its domestic 
partnership interest under section 705.

Special Analyses

I. Regulatory Planning and Review--Economic Analysis

    Pursuant to the Memorandum of Agreement, Review of Treasury 
Regulations under Executive Order 12866 (June 9, 2023), tax regulatory 
actions issued by the IRS are not subject to the requirements of 
section 6 of Executive Order 12866, as amended. Therefore, a regulatory 
impact assessment is not required.

II. Paperwork Reduction Act

    The Paperwork Reduction Act of 1995 (44 U.S.C. 3501-3520) generally 
requires that a Federal agency obtain the approval of the Office of 
Management and Budget before collecting information from the public, 
whether such collection of information is mandatory, voluntary, or 
required to obtain or retain a benefit. There are no additional 
information collection requirements associated with the proposed 
regulations.

III. Regulatory Flexibility Act

    When an agency issues a rulemaking proposal, the Regulatory 
Flexibility Act (5 U.S.C. chapter 6) (RFA) requires the agency to 
prepare and make available for public comment an initial regulatory 
flexibility analysis that will describe the impact of the proposed rule 
on small entities. See 5 U.S.C. 603(a). Section 605 of the RFA provides 
an exception to this requirement if the agency certifies that the 
proposed rulemaking will not have a substantial economic impact on a 
substantial number of small entities. A small entity is defined as a 
small business, small nonprofit organization, or small governmental 
jurisdiction. See U.S.C. 601(3) through (6).
    The Treasury Department and the IRS do not expect that the proposed 
regulations will have a significant economic impact on a substantial 
number of small entities within the meaning of sections 601(3) through 
(6) of the RFA. The proposed regulations provide guidance on issues 
regarding sections 959 and 961 and related provisions but do not change 
the economic impact of the existing regulations or impose any new costs 
on small entities. It is unlikely the proposed regulations will affect 
a substantial number of small businesses due to the significant 
resources and investment required to engage in the type of foreign 
operations to which the proposed regulations are relevant. However, 
because there is a possibility of significant economic impact on a 
substantial number of small entities, an initial regulatory flexibility 
analysis for the regulation is provided below. The Treasury Department 
and the IRS request comments from the public on the number of small 
entities that may be impacted and whether that impact will be 
economically significant.
    Pursuant to section 7805(f) of the Code, the proposed regulations 
have been submitted to the Chief Counsel for Advocacy of the Small 
Business Administration for comment on their impact on small 
businesses.
A. Reasons Why the Action Is Being Considered
    The proposed regulations update the core aspects of the PTEP system 
in a manner that addresses both longstanding issues and more recent 
issues (such as those arising under the Act), thereby reducing 
potential uncertainty under the existing regulations, ensuring 
consistent outcomes across taxpayers and economically similar 
transactions, and preventing double taxation and double non-taxation. 
These updates to the PTEP system involve PTEP accounting, the 
application of section 959(b), the application of section 961 as to 
certain property owned by a partnership, the application of section 
961(c), and rules coordinating sections 951(a), 959(b), and 961(c).
    The proposed regulations described in part II of the Explanation of 
Provisions establish covered shareholder-specific PTEP accounts, and 
this accounting prevents inappropriate outcomes that could arise under 
an alternative approach in light of the Act (such as share-specific 
accounting) while ensuring a covered shareholder the benefit of PTEP 
relating to it. This covered shareholder-specific accounting applies to 
the other aspects of the PTEP system--namely, sections 986(c) and 
960(b)--and ensures consistency across the PTEP system. The proposed 
regulations also provide rules under sections 959(b) and 951 that 
address longstanding issues that arise in certain split-ownership 
structures (that is, structures in which stock of a CFC is not all 
owned by a single United States shareholder), which issues were 
exacerbated by the Act.
    The proposed regulations described in part III of the Explanation 
of Provisions provide guidance addressing longstanding issues under 
section 961. That is, the proposed regulations provide rules to adjust 
the basis in shares of stock of a foreign corporation owned indirectly 
by a covered shareholder through only one or more partnerships, and the 
basis under section 961(c) in shares of stock of a foreign corporation 
owned by a CFC, to reflect the foreign corporation's PTEP with respect 
to the covered shareholder. Additionally, the proposed regulations, as 
discussed in part III.E of the Explanation of Provisions, provide rules 
treating E&P generated by gain to which section 961(c) is applied as 
PTEP. This approach ensures consistent outcomes across economically 
similar transactions regardless of how a foreign corporation's PTEP is 
monetized (whether through a distribution to which section 959(b) 
applies or a disposition to which section 961(c) applies), and, by 
treating the E&P as PTEP, reflects the policy of sections 959 and 961 
and prevents both double taxation and double non-taxation.
    The proposed regulations, as discussed in part IV of the 
Explanation of Provisions, provide rules under section 951 that work in 
tandem with sections 959(b) and 961(c) to perfect the approach 
discussed in the preceding paragraphs. These rules comprise two sets of 
rules, one applying at the foreign corporation-level and one applying 
at the shareholder-level, that together ensure that attributes like 
PTEP and section 961(c) basis are allocated to the appropriate 
shareholder, consistent with the shareholder-specific nature of 
sections 959(b) and 961(c).
B. Objectives of, and Legal Basis for, the Proposed Regulations
    The proposed regulations are intended to provide guidance 
addressing core aspects of the PTEP system and significant statutory 
changes since the current regulations were finalized. The legal basis 
for these regulations is contained in various sections of the Code, 
including sections 959, 960, 961, 965, 986, and 7805.

[[Page 95400]]

C. Small Business Entities to Which These Regulations Will Apply
    Because an estimate of the number of small businesses affected is 
not currently feasible, this initial regulatory flexibility analysis 
assumes that a substantial number of small businesses will be affected. 
However, as noted above, the Treasury Department and the IRS believe 
that it is unlikely the proposed regulations will affect a substantial 
number of small businesses due to the significant resources and 
investment required to engage in the type of foreign operations to 
which the proposed regulations are relevant. The Treasury Department 
and the IRS do not expect that these regulations will affect a 
substantial number of small nonprofit or small governmental 
jurisdictions.
D. Projected Reporting, Recordkeeping, and Other Compliance 
Requirements
    In certain cases, the proposed regulations require information that 
currently is tracked at the foreign corporation-level to also be 
tracked at the shareholder-level.
E. Duplicate, Overlapping, or Relevant Federal Rules
    The proposed regulations would replace portions of existing 
regulations. The Treasury Department and the IRS are not aware of any 
Federal rules that duplicate, overlap, or conflict with these 
regulations.
F. Alternatives Considered
    The Treasury Department and the IRS considered alternatives 
including alternatives to treating E&P generated by gain to which 
section 961(c) applies as PTEP. One alternative, as discussed in part 
III.E.2.ii of the Explanation of Provisions, involved treating such E&P 
as section 959(c)(3) E&P. However, this approach was not adopted 
because it could lead to double taxation or double non-taxation, while 
also creating dissymmetry between distributions (E&P to which annual 
PTEP accounts apply is PTEP) and dispositions involving foreign stock 
(E&P to which section 961(c) basis applies is not PTEP). The proposed 
regulations, by providing certainty regarding longstanding issues under 
section 961(c), reduce economic burden, and, by protecting the policies 
underlying sections 959 and 961, ensure a covered shareholder the 
benefit of PTEP relating to it; this represents the approach with the 
least economic impact.
    The Treasury Department and the IRS also considered alternatives to 
the proposed rules under section 951 that work in tandem with sections 
959(b) and 961(c). But the alternatives either could not provide the 
certainty or the consistency of the approach in the proposed 
regulations or could not properly protect against double taxation or 
double non-taxation.
    The proposed regulations, and the PTEP system generally, apply 
uniformly to large and small business entities. The Treasury Department 
and the IRS are of the view that such an approach is necessitated by 
the statutory scheme; in other words, a small business exception could 
undermine the provisions comprising the PTEP system. Accordingly, there 
is no viable alternative to the proposed regulations for small 
entities.

IV. Unfunded Mandates Reform Act

    Section 202 of the Unfunded Mandates Reform Act of 1995 requires 
that agencies assess anticipated costs and benefits and take certain 
other actions before issuing a final rule that includes any Federal 
mandate that may result in expenditures in any one year by a State, 
local, or Tribal government, in the aggregate, or by the private 
sector, of $100 million in 1995 dollars, updated annually for 
inflation. The proposed regulations do not include any Federal mandate 
that may result in expenditures by State, local, or Tribal governments, 
or by the private sector in excess of that threshold.

V. Executive Order 13132: Federalism

    Executive Order 13132 (Federalism) prohibits an agency from 
publishing any rule that has federalism implications if the rule either 
imposes substantial, direct compliance costs on State and local 
governments, and is not required by statute, or preempts State law, 
unless the agency meets the consultation and funding requirements of 
section 6 of the Executive order. The proposed regulations do not have 
federalism implications, do not impose substantial direct compliance 
costs on State and local governments, and do not preempt State law 
within the meaning of the Executive order.

Comments and Requests for a Public Hearing

    Before the proposed regulations are adopted as final regulations, 
consideration will be given to comments that are submitted timely to 
the IRS as prescribed in the preamble under the ADDRESSES section. In 
addition to the comments specifically requested in the Explanation of 
Provisions, the Treasury Department and the IRS request comments on all 
aspects of the proposed regulations. Any comments submitted will be 
made available at www.regulations.gov or upon request.
    A public hearing will be scheduled if requested in writing by any 
person who timely submits written comments. Requests for a public 
hearing are encouraged to be made electronically. If a public hearing 
is scheduled, notice of the date and time for the public hearing will 
be published in the Federal Register.

Statement of Availability of IRS Documents

    Any IRS Revenue Procedures, Revenue Rulings, Notices, or other 
guidance cited in this document are published in the Internal Revenue 
Bulletin (or Cumulative Bulletin) and are available from the 
Superintendent of Documents, U.S. Government Publishing Office, 
Washington, DC 20402, or by visiting the IRS website at www.irs.gov.

Drafting Information

    The principal authors of these regulations are Karen R. Li, Elena 
M. Madaj and Chadwick Rowland, Office of Associate Chief Counsel 
(International). However, other personnel from the IRS and the 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, the Treasury Department and the IRS propose to amend 
26 CFR part 1 as follows:

PART 1--INCOME TAXES

0
Paragraph 1. The authority citation for part 1 is amended by revising 
the entry for Sec.  1.951-1, adding entries in numerical order for 
Sec. Sec.  1.951-2, 1.959-1 through 1.959-12, and 1.961-1 through 
1.961-13, revising the entry for Sec.  1.986(c)-1, and adding an entry 
in numerical order for Sec.  1.1502-59 to read in part as follows:

    Authority: 26 U.S.C. 7805 * * *
* * * * *
    Sections 1.951-1 and 1.951-2 also issued under 26 U.S.C. 951, 
959, and 961.
* * * * *
    Sections 1.959-1 through 1.959-12 also issued under 26 U.S.C. 
245A(g), 904(d)(7), 951A(f)(1)(B), 959, 960(f), 962, 965(o), 986, 
986(c)(2), 989(c), and 1373.
* * * * *
    Sections 1.961-1 through 1.961-13 also issued under 26 U.S.C. 
743(b), 959, 961 and 961(a), (b), and (c), 965(o), and 1373.
* * * * *

[[Page 95401]]

    Section 1.986(c)-1 also issued under 26 U.S.C. 962, 965(o), 986 
and 986(c)(2), and 989(c).
* * * * *
    Section 1.1502-59 also issued under 26 U.S.C. 959, 960, 961, 
986, and 1502.
* * * * *
0
Par. 2. Section 1.163(j)-7 is amended by:
0
1. Revising paragraph (g)(2); and
0
2. Adding a sentence to the end of paragraph (m)(2).
    The revision and addition read as follows:


Sec.  1.163(j)-7  Application of the section 163(j) limitation to 
foreign corporations and United States shareholders.

* * * * *
    (g) * * *
    (2) Treatment of certain dividends and previously taxed earnings 
and profits. For purposes of computing the ATI of a relevant foreign 
corporation for a taxable year, the following amounts are (without 
duplication) subtracted from tentative taxable income--
    (i) Any dividend included in gross income that is received from a 
related person, within the meaning of section 954(d)(3), with respect 
to the distributee; and
    (ii) Any previously taxed earnings and profits that are distributed 
to the foreign corporation in a covered distribution (determined under 
Sec.  1.959-4) or that result from the application of section 961(c) 
basis to covered gain recognized by the foreign corporation (determined 
under Sec.  1.961-9).
* * * * *
    (m) * * *
    (2) * * * Paragraph (g)(2)(ii) of this section applies to a taxable 
year of a foreign corporation that begins on or after [date of 
publication of final regulations in the Federal Register] or is an 
early application year (as described in Sec.  1.959-12(d)) and to a 
taxable year of a person for which such taxable year of that foreign 
corporation is relevant.
* * * * *
0
Par. 3. Section 1.245A(d)-1 is amended by:
0
1. Revising the first sentence of paragraph (c)(22); and
0
2. For each paragraph listed in the table, removing the language in the 
``Remove'' column wherever it appears and adding in its place the 
language in the ``Add'' column:

------------------------------------------------------------------------
          Paragraph                  Remove                  Add
------------------------------------------------------------------------
(d)(2)(i)...................  section 951A PTEP     previously taxed
                               (as defined in Sec.   earnings and
                                 1.960-              profits assigned to
                               3(c)(2)(viii)) in a   the section 951A
                               single annual PTEP    PTEP group (as
                               account (as defined   defined in Sec.
                               in Sec.   1.960-      1.959-1(b)) within
                               3(c)(1)).             a single annual
                                                     PTEP account (as
                                                     defined in Sec.
                                                     1.959-1(b)).
(d)(2)(ii)(B)...............  section 951A PTEP...  previously taxed
                                                     earnings and
                                                     profits assigned to
                                                     the section 951A
                                                     PTEP group.
(d)(3)(i)...................  section 951A PTEP     previously taxed
                               (as defined in Sec.   earnings and
                                 1.960-              profits assigned to
                               3(c)(2)(viii)) in a   the section 951A
                               single annual PTEP    PTEP group (as
                               account (as defined   defined in Sec.
                               in Sec.   1.960-      1.959-1(b)) within
                               3(c)(1)).             a single annual
                                                     PTEP account (as
                                                     defined in Sec.
                                                     1.959-1(b)).
(d)(3)(ii)(B)...............  section 951A PTEP...  previously taxed
                                                     earnings and
                                                     profits assigned to
                                                     the section 951A
                                                     PTEP group.
(d)(4)(i)...................  section 951(a)(1)(A)  previously taxed
                               PTEP (as defined in   earnings and
                               Sec.   1.960-         profits assigned to
                               3(c)(2)(x)) in a      the section
                               single annual PTEP    951(a)(1)(A) PTEP
                               account (as defined   group (as defined
                               in Sec.   1.960-      in Sec.   1.959-
                               3(c)(1)).             1(b)) within a
                                                     single annual PTEP
                                                     account (as defined
                                                     in Sec.   1.959-
                                                     1(b)).
(d)(4)(i)...................  section 951(a)(1)(A)  previously taxed
                               PTEP.                 earnings and
                                                     profits assigned to
                                                     the section
                                                     951(a)(1)(A) PTEP
                                                     group.
(d)(4)(ii)(B)(1) through      section 951(a)(1)(A)  previously taxed
 (3), and (D).                 PTEP.                 earnings and
                                                     profits assigned to
                                                     the section
                                                     951(a)(1)(A) PTEP
                                                     group.
------------------------------------------------------------------------

    The revision reads as follows:


Sec.  1.245A(d)-1  Disallowance of foreign tax credit or deduction.

* * * * *
    (c) * * *
    (22) * * * The term section 245A(d) PTEP means previously taxed 
earnings and profits assigned to a section 245A(d) PTEP group or a 
reclassified section 245A(d) PTEP group (each as defined in Sec.  
1.959-1(b)). * * *
* * * * *
0
Par. 4. Section 1.312-6 is amended by adding paragraph (f) to read as 
follows:


Sec.  1.312-6  Earnings and profits.

* * * * *
    (f) An amount included in a corporation's gross income under 
section 951(a) or 951A(a) for a particular period is taken into account 
in computing the corporation's earnings and profits for that period. 
See also Sec.  1.312-8(c) (domestic corporation's receipt of previously 
taxed earnings and profits does not increase earnings and profits). 
This paragraph (f) applies to a taxable year of a corporation beginning 
on or after [date of publication of final regulations in the Federal 
Register]. This paragraph (f) also applies to a taxable year of a 
domestic corporation that is a shareholder in a foreign corporation, if 
a taxable year of the foreign corporation that is an early application 
year (as described in Sec.  1.959-12(d)) ends with or within the 
taxable year of the domestic corporation.
0
Par. 5. Section 1.312-8 is amended by adding paragraph (c) to read as 
follows:


Sec.  1.312-8  Effect on earnings and profits of receipt of tax-free 
distributions requiring adjustment or allocation of basis of stock.

* * * * *
    (c) Previously taxed earnings and profits that are distributed to a 
domestic corporation in a covered distribution (determined under Sec.  
1.959-4) do not increase the corporation's earnings and profits. See 
Sec. Sec.  1.959-4 and 1.961-4 for rules excluding distributed 
previously taxed earnings and profits from gross income and reducing 
basis. See also Sec.  1.312-6(f) (sections 951(a) and 951A(a) 
inclusions increase earnings and profits). This paragraph (c) applies 
to a taxable year of a domestic corporation beginning on or after [date 
of publication of final regulations in the Federal Register]. This 
paragraph (c) also applies to a taxable year of a domestic corporation 
that is a shareholder in a foreign corporation, if a taxable year of 
the foreign corporation that is an early application year (as described 
in Sec.  1.959-12(d)) ends with or within the taxable year of the 
domestic corporation.
0
Par. 6. Section 1.743-1 is amended by adding paragraphs (d)(4) and 
(j)(7) to read as follows:

[[Page 95402]]

Sec.  1.743-1  Optional adjustment to basis of partnership property.

* * * * *
    (d) * * *
    (4) Coordination with derived basis. See Sec.  1.961-5(d) for a 
rule coordinating the application of this paragraph (d) with derived 
basis that transfers to a transferee.
* * * * *
    (j) * * *
    (7) Covered distributions treated as previously taxed earnings and 
profits. See Sec.  1.961-4(c)(2)(iii) for rules regarding the use of a 
positive basis adjustment under section 743(b) upon the receipt of a 
covered distribution that is treated as previously taxed earnings and 
profits with respect to certain direct or indirect partners of the 
partnership.
* * * * *


Sec.  1.861-20  [Amended]

0
Par. 7. Section 1.861-20 is amended by:
0
1. In paragraph (a), adding the language ``1.959-6,'' after the 
language, ``1.904-6,'';
0
2. In paragraph (d)(2)(ii)(B), adding the language ``Sec.  1.959-6(c) 
and'' before the language ``Sec.  1.960-1(d)(3)(ii)'', and removing the 
language ``income groups or PTEP groups'' and adding the language 
``previously taxed earnings and profits and to income groups, 
respectively,'' in its place;
0
3. In paragraph (d)(3)(i)(B)(1), adding the language ``Sec.  1.959-6(c) 
and'' before the language ``Sec.  1.960-1(d)(3)(ii)'', and removing the 
language ``income groups or PTEP groups'' and adding the language 
``previously taxed earnings and profits and to income groups, 
respectively,'' in its place; and
0
4. In paragraph (g)(6)(i), removing the language ``section 965(a) PTEP 
(as defined in Sec.  1.960-3(c)(2)(vi)) in a single annual PTEP account 
(as defined in Sec.  1.960-3(c)(1))'' and adding the language 
``previously taxed earnings and profits assigned to the section 965(a) 
PTEP group (as defined in Sec.  1.959-1(b)) within a single annual PTEP 
account (as defined in Sec.  1.959-1(b))'' in its place.


Sec.  1.904-6  [Amended]

0
Par. 8. Section 1.904-6 is amended by:
0
1. In paragraph (e)(2), removing the language ``Sec.  1.959-1'' and 
adding the language ``Sec.  1.959-4'' in its place, adding the language 
``(as defined in Sec.  1.959-1(b))'' after ``annual PTEP account'', and 
removing the language ``Sec.  1.960-3(c)'' and adding the language 
``Sec.  1.959-1(b)'' in its place;
0
2. Removing paragraph (e)(3);
0
3. Redesignating paragraph (e)(4) as new paragraph (e)(3);
0
4. In newly redesignated paragraph (e)(3)(i), removing the language 
``(e)(4)(ii)'' and adding the language ``(e)(3)(ii)'' in its place; and
0
5. In newly redesignated paragraph (e)(3)(ii)(C), removing the language 
``(e)(4)(ii)(B)'' and adding the language ``(e)(3)(ii)(B)'' in its 
place.


Sec.  1.905-3  [Amended]

0
Par. 9. Section 1.905-3 is amended by:
0
1. In paragraph (a), removing the language ``PTEP group taxes (as 
defined in Sec.  1.960-3(d)(1))'' and adding the language ``a tax pool 
described in Sec.  1.959-2(b)(4) or (d)(2)'' in its place;
0
2. In the fifth sentence of paragraph (a), removing the language ``PTEP 
group taxes'' and adding the language ``a tax pool described in Sec.  
1.959-2(b)(4) or (d)(2)'' in its place;
0
3. In the last sentence of paragraph (a), removing the language ``PTEP 
group taxes'' and adding the language ``a tax pool described in Sec.  
1.959-2(b)(4) or (d)(2)'' in its place; and
0
4. In the last sentence of paragraph (b)(2)(ii), removing the language 
``subsequent''.


Sec.  1.905-4  [Amended]

0
Par. 10. Section 1.905-4 is amended by, in paragraph (c)(6), removing 
the language ``PTEP group taxes (as defined in Sec.  1.960-3(d)(1))'' 
and adding the language ``a tax pool described in Sec.  1.959-2(b)(4) 
or (d)(2)'' in its place.
0
Par. 11. Section 1.951-1 is amended by:
0
1. Removing the introductory text of paragraph (a), revising paragraphs 
(a)(1) and (2), and adding headings for paragraphs (a)(3) and (4);
0
2. In the introductory text of paragraph (b)(1), removing the language 
``(a)(2)(i)'' and ``(e)'' and adding the language ``(a)(1)(i)'' and 
``(c)'' in their places, respectively;
0
3. Adding paragraph (c);
0
4. Revising the heading for paragraph (e) and revising paragraph 
(e)(1)(i);
0
5. In paragraph (e)(1)(ii)(A), adding the language ``and not reduced by 
distributions during the year'' immediately before the semicolon;
0
6. In paragraph (g)(1), adding the language ``(or, if applicable 
pursuant to section 953(c)(1)(A), any stock of such foreign 
corporation)'' immediately before the period;
0
7. Revising paragraph (h);
0
8. Redesignating paragraph (e)(7) as paragraph (h)(1) and revising the 
heading and introductory text of newly redesignated paragraph (h)(1);
0
9. In newly redesignated paragraph (h)(1)(i)(I), adding the language 
``covered items (within the meaning of paragraph (c)(3) of this 
section),'' immediately after the language ``neither'';
0
10. In newly redesignated paragraphs (h)(1)(ii) through (viii), 
removing the language ``(e)(1) of this section'' wherever it may appear 
and adding the language ``(c)(1) of this section'' in its place;
0
11. In newly redesignated paragraph (h)(1)(viii)(A), removing the 
language ``(e)(7)(vii)(A) of this section'' and adding the language 
``(h)(1)(vii)(A) of this section'' in its place;
0
12. Adding paragraph (h)(2); and
0
13. Adding paragraph (i).
    The revisions and additions read as follows:


Sec.  1.951-1  Amounts included in gross income of United States 
shareholders.

    (a) * * *
    (1) Section 951(a) inclusions. If a foreign corporation is a 
controlled foreign corporation (within the meaning of section 957 or, 
if applicable, section 953(c)(1)(B)) at any time during a taxable year 
of the foreign corporation, every person who is a United States 
shareholder (as defined in section 951(b) and paragraph (g) of this 
section) of the foreign corporation at any time during such taxable 
year and owns (within the meaning of section 958(a)) stock in the 
foreign corporation on the last day in such taxable year on which the 
foreign corporation is a controlled foreign corporation shall, for the 
United States shareholder's taxable year in which or with which such 
taxable year of the foreign corporation ends, include in gross income 
the sum of--
    (i) The United States shareholder's pro rata share (determined 
under paragraph (b) of this section) of the foreign corporation's 
subpart F income (as defined in section 952) for the taxable year of 
the foreign corporation; and
    (ii) The amount determined under section 956 with respect to the 
United States shareholder for the taxable year of the foreign 
corporation, but only to the extent not excluded from gross income 
under section 959(a)(2) and Sec.  1.959-5.
    (2) Currency translation. See section 989(b) for translating an 
amount included in income under this section into U.S. dollars.
    (3) Characterization of inclusion in determining a personal holding 
company. * * *
    (4) Certain stock ownership rules. * * *
* * * * *
    (c) Pro rata share of subpart F income--(1) In general. For 
purposes of paragraph (b) of this section, a United

[[Page 95403]]

States shareholder's pro rata share of the foreign corporation's 
subpart F income for the taxable year of the foreign corporation is the 
sum of all subpart F income allocated to the United States shareholder 
in accordance with the rules described in paragraph (c)(2) of this 
section. Under those rules, subpart F income attributable to covered 
items (that is, subpart F income attributable to certain distributions 
and certain gain with respect to stock) is separately allocated, in 
each case consistently with how the covered item is assigned at the 
foreign corporation-level under Sec.  1.951-2 as part of determining 
the extent to which attributes specific to the United States 
shareholder (that is, previously taxed earnings and profits or section 
961(c) basis) are applied to exclude the covered item from the foreign 
corporation's subpart F income under section 959(b) or 961(c). Then, 
subpart F income not attributable to covered items is allocated based 
on the United States shareholder's share of the foreign corporation's 
allocable earnings and profits (as determined under paragraph (e) of 
this section). See paragraphs (c)(3) and (h) of this section for 
definitions and examples, respectively.
    (2) Rules for allocating subpart F income--(i) Determine subpart F 
income attributable to each covered item. First, determine the subpart 
F income of the foreign corporation attributable to each covered item, 
computed as the portion of the covered item that is included in foreign 
base company income (as defined in Sec.  1.954-1(a)(5)) or insurance 
income (as defined in Sec.  1.954-1(a)(6)). See Sec.  1.951-2(b) for 
the definition of a covered item.
    (ii) Allocate subpart F income attributable to each covered item. 
Second, allocate to the United States shareholder a pro rata portion of 
the subpart F income attributable to each covered item, determined by 
multiplying such subpart F income by a fraction. The numerator of the 
fraction is the portion of the covered item that is both assigned to 
the United States shareholder under Sec.  1.951-2 and included in 
adjusted gross foreign base company income (as defined in Sec.  1.954-
1(a)(3)) or adjusted gross insurance company income (as defined in 
Sec.  1.954-1(a)(6)), and the denominator of the fraction is the 
portion of the covered item that is included in adjusted gross foreign 
base company income or adjusted gross insurance company income. 
However, if the denominator of the fraction would be zero, then the 
fraction is considered to be zero.
    (iii) Allocate subpart F income not attributable to covered items. 
Third, allocate to the United States shareholder a pro rata portion of 
all subpart F income of the foreign corporation not attributable to 
covered items, determined by multiplying all such subpart F income by a 
fraction. The numerator of the fraction is the portion of the foreign 
corporation's hypothetical distribution described in paragraph (e) of 
this section that would be distributed with respect to the stock of the 
corporation that the United States shareholder owns (within the meaning 
of section 958(a)), and the denominator of the fraction is the amount 
of such hypothetical distribution.
    (3) Definitions. For purposes of this paragraph (c), the term 
covered item has the meaning provided in Sec.  1.951-2(b).
* * * * *
    (e) Hypothetical distribution--(1) * * *
    (i) Hypothetical distribution and hypothetical distribution date. 
For a taxable year of a controlled foreign corporation, the 
hypothetical distribution described in this paragraph (e) (hypothetical 
distribution) is a distribution treated as made by the corporation with 
respect to stock of the corporation owned by all shareholders of the 
corporation in an amount equal to the corporation's allocable earnings 
and profits for the taxable year, on the last day of the taxable year 
on which the corporation is a controlled foreign corporation 
(hypothetical distribution date).
* * * * *
    (h) Examples--(1) Examples not involving covered items. The 
following examples illustrate the application of paragraphs (c) and (e) 
of this section in cases not involving covered items.
* * * * *
    (2) Examples involving covered items. The following examples 
illustrate the application of paragraphs (c) and (e) of this section in 
cases involving covered items.
    (i) Assumed facts. For purposes of the examples in this paragraph 
(h)(2), unless otherwise indicated, the following facts are assumed:
    (A) US1 and US2 are unrelated domestic corporations that are 
covered shareholders. Neither US1 nor US2 is a member of a consolidated 
group (as defined in Sec.  1.1502-1(h)).
    (B) F1, F2, and F3 are foreign corporations, each of which is a 
controlled foreign corporation and uses the British pound ([pound]) as 
its functional currency.
    (C) Each entity uses the calendar year as its taxable year, and no 
entity has a short taxable year.
    (D) To the extent a covered item received or recognized by a 
foreign corporation is previously taxed earnings and profits, the 
covered item is excluded in determining the foreign corporation's 
subpart F income and tested income or tested loss under section 959(b) 
and Sec.  1.959-4 or section 961(c) and Sec.  1.961-9, as applicable.
    (E) To the extent a covered item received or recognized by a 
foreign corporation is not previously taxed earnings and profits, the 
covered item is--
    (1) In the case of a covered distribution, excluded in determining 
the foreign corporation's subpart F income and tested income or tested 
loss under sections 954(c)(6) and 951A(c)(2)(A)(i)(IV); and
    (2) In the case of covered gain, included in the foreign 
corporation's foreign personal holding company income (as defined in 
section 954(c)) and then its adjusted gross foreign base company income 
(as defined in Sec.  1.954-1(a)(3)) either because section 964(e)(1) 
does not apply or because section 964(e)(4) applies.
    (F) The only reductions to adjusted gross foreign base company 
income (as defined in Sec.  1.954-1(a)(3)) are for deductions under 
Sec.  1.954-1(a)(4). Thus, there are no reductions by reason of section 
952(c) (subpart F income limited to current earnings and profits) or 
section 954(b)(4) (exception for certain income subject to high foreign 
taxes).
    (G) To the extent a covered item received or recognized by a 
foreign corporation is excluded in determining the foreign 
corporation's subpart F income and tested income or tested loss as 
described in this paragraph (h)(2)(i), the listed exclusion is not 
necessarily the only applicable exclusion.
    (ii) Example 1: Subpart F income attributable to covered items--(A) 
Facts--(1) In general. US1 and US2 each directly own 50% of the single 
class of outstanding stock of F1. F1 directly owns all the outstanding 
stock of each of F2 and F3. For F1's taxable year ending on December 31 
of year 3, F1's gross income consists of two covered items, which are a 
[pound]60x covered distribution received from F2 and [pound]40x of 
covered gain recognized with respect to stock of F3. US1 and US2 are 
assigned equal portions of each covered item under Sec.  1.951-2. The 
entirety of US1's assigned portion of each covered item is previously 
taxed earnings and profits (because, in the case of the covered 
distribution, [pound]30x of F2's previously taxed earnings and profits 
with respect to US1 is applied to US1's assigned portion and, in the 
case of the covered gain, [pound]20x of F1's section 961(c) basis with 
respect to US1 is applied to US1's assigned portion). None of US2's

[[Page 95404]]

assigned portion of either covered item is previously taxed earnings 
and profits (because F2 has no previously taxed earnings and profits 
with respect to US2 and F1 has no section 961(c) basis with respect to 
US2). F1 has no deductions for the taxable year.
    (2) Subpart F income. For F1's taxable year ending on December 31 
of year 3, F1 has [pound]20x of subpart F income consisting of foreign 
base company income (adjusted net foreign base company income as 
defined in Sec.  1.954-1(a)(5)), which in turn consists of foreign 
personal holding company income (as defined in section 954(c)). Table 1 
in this paragraph (h)(2)(ii)(A)(2) provides the treatment of F1's gross 
income in computing its adjusted net foreign base company income.

           Table 1 to Paragraph (h)(2)(ii)(A)(2) of This Section--Foreign Base Company Income Analysis
----------------------------------------------------------------------------------------------------------------
                                                              Foreign base company income
             Gross income             --------------------------------------------------------------------------
                                          Adjusted gross FBCI          Reductions           Adjusted net FBCI
----------------------------------------------------------------------------------------------------------------
[pound]60x covered distribution from
 F2:
    US1's [pound]30x assigned portion  [pound]0 (Sec.   959(b))
    US2's [pound]30x assigned portion  [pound]0 (Sec.
                                        954(c)(6)).
[pound]40x covered gain on F3 stock:
    US1's [pound]20x assigned portion  [pound]0 (Sec.   961(c))  [pound]0..............  [pound]20x ([pound]20x
                                                                                           [pound]0).
    US2's [pound]20x assigned portion  [pound]20x..............
----------------------------------------------------------------------------------------------------------------

    (B) Analysis. Under paragraph (c) of this section, F1's subpart F 
income attributable to each covered item is separately allocated to US1 
and US2. F1 has [pound]0 of subpart F income attributable to the 
covered distribution and [pound]20x of subpart F income attributable to 
the covered gain because in each case that is the portion of the 
covered item that is included in F1's adjusted net foreign base company 
income. See paragraph (c)(2)(i) of this section. The [pound]20x of 
subpart F income attributable to the covered gain is allocated to each 
of US1 and US2 by multiplying the amount of such subpart F income by a 
fraction, the numerator of which is the portion of the covered gain 
that is both assigned to the United States shareholder under Sec.  
1.951-2 and included in F1's adjusted gross foreign base company income 
([pound]0 in the case of US1, and [pound]20x in the case of US2), and 
the denominator of which is the portion of the covered gain that is 
included in F1's adjusted gross foreign base company income 
([pound]20x). See paragraph (c)(2)(ii) of this section. Thus, US2 is 
allocated all [pound]20x of the subpart F income attributable to the 
covered gain. Accordingly, for purposes of paragraph (b) of this 
section, US1 has a [pound]0 pro rata share, and US2 has a [pound]20x 
pro rata share, of F1's [pound]20x of subpart F income. See paragraph 
(c)(1) of this section.
    (C) Alternative facts: expenses--(1) Facts. The facts are the same 
as in paragraph (h)(2)(ii)(A) of this section, except as follows. Only 
[pound]10x of US1's assigned portion of the covered gain is previously 
taxed earnings and profits (because there is only [pound]10x of section 
961(c) basis with respect to US1 available to be applied to US1's 
assigned portion). In addition, F1 has [pound]5x of deductions, which 
are not foreign income taxes, that are definitely related to the 
covered gain. The deductions reduce F1's adjusted gross foreign base 
company income by [pound]5x in computing net foreign base company 
income under Sec.  1.954-1(a)(4). Thus, F1 has [pound]25x of subpart F 
income, all of which is attributable to the covered gain.
    (2) Analysis. As summarized in Table 1 in this paragraph 
(h)(2)(ii)(C)(2), the [pound]25x of subpart F income attributable to 
the covered gain is allocated to each of US1 and US2 by multiplying the 
amount of such subpart F income by a fraction, the numerator of which 
is the portion of the covered gain that is both assigned to the United 
States shareholder under Sec.  1.951-2 and included in F1's adjusted 
gross foreign base company income ([pound]10x in the case of US1, and 
[pound]20x in the case of US2), and the denominator of which is the 
portion of the covered gain that is included in F1's adjusted gross 
foreign base company income ([pound]30x). See paragraph (c)(2)(ii) of 
this section. Accordingly, for purposes of paragraph (b) of this 
section, US1 has a [pound]8.3x pro rata share, and US2 has a 
[pound]16.7x pro rata share, of F1's [pound]25x of subpart F income.

           Table 1 to Paragraph (h)(2)(ii)(C)(2) of This Section--Foreign Base Company Income Analysis
----------------------------------------------------------------------------------------------------------------
                                         Foreign base company income             Allocation of subpart F income
                              ------------------------------------------------- attributable to the covered item
         Gross income                                                            under Sec.   1.951-1(c)(2)(ii)
                                Adjusted gross    Reductions     Adjusted net  ---------------------------------
                                     FBCI                            FBCI             US1              US2
----------------------------------------------------------------------------------------------------------------
[pound]60x covered
 distribution from F2:
    US1's [pound]30x assigned  [pound]0 (Sec.
     portion.                    959(b)).
    US2's [pound]30x assigned  [pound]0 (Sec.
     portion.                    954(c)(6)).
[pound]40x covered gain on F3
 stock:
    US1's [pound]20x assigned  [pound]10x       [pound]5x....  [pound]25x       [pound]8.3x      [pound]16.7x
     portion.                   (Sec.   961(c)                  ([pound]30x -    ([pound]25x x    ([pound]25x x
                                for remaining                   [pound]5x).      [pound]10x/      [pound]20x/
                                [pound]10x).                                     [pound]30x).     [pound]30x).
    US2's [pound]20x assigned  [pound]20x.....
     portion.
----------------------------------------------------------------------------------------------------------------

    (iii) Example 2: Subpart F income attributable and not attributable 
to covered items--(A) Facts--(1) In general. US1 and US2 each directly 
own 50% of the single class of outstanding stock of F1. F1 directly 
owns all the outstanding stock of each of F2 and F3. For F1's taxable 
year ending on December 31 of year 3, F1 has [pound]500x of allocable 
earnings and profits for purposes of the hypothetical distribution 
described in paragraph (e) of this section. F1's gross income for the 
taxable year consists of a [pound]60x covered distribution received 
from F2, [pound]40x of covered gain recognized with respect to stock of 
F3, [pound]295x of royalty income received from an unrelated person, 
and [pound]125x of foreign oil and gas extraction income (as defined in 
section 907(c)(1)). US1 and US2 are assigned equal portions of each 
covered item under Sec.  1.951-2, and the entirety of US1's assigned 
portion of each covered item,

[[Page 95405]]

but none of US2's assigned portion of either covered item, is 
previously taxed earnings and profits (because, in the case of the 
covered distribution, there are sufficient previously taxed earnings 
and profits with respect to US1 to be applied to US1's assigned portion 
and there are no previously taxed earnings and profits with respect to 
US2 to be applied to US2's assigned portion, and, in the case of the 
covered gain, there is sufficient section 961(c) basis with respect to 
US1 to be applied to US1's assigned portion and there is no section 
961(c) basis with respect to US2 to be applied to US2's assigned 
portion). F1 has [pound]20x of deductions for the taxable year, 
consisting of [pound]15x of foreign withholding taxes imposed on the 
covered distribution and [pound]5x of expenses, which are not foreign 
income taxes, that are definitely related to the covered gain. The 
[pound]5x of expenses reduce F1's adjusted gross foreign base company 
income by [pound]5x in computing net foreign base company income under 
Sec.  1.954-1(a)(4).
    (2) Subpart F income. For F1's taxable year ending on December 31 
of year 3, F1 has [pound]310x of subpart F income consisting of foreign 
base company income (adjusted net foreign base company income as 
defined in Sec.  1.954-1(a)(5)). Table 1 in this paragraph 
(h)(2)(iii)(A)(2) provides the treatment of F1's items of gross income 
in computing its adjusted net foreign base company income.

          Table 1 to Paragraph (h)(2)(iii)(A)(2) of This Section--Foreign Base Company Income Analysis
----------------------------------------------------------------------------------------------------------------
                                                              Foreign base company income
             Gross income             --------------------------------------------------------------------------
                                          Adjusted gross FBCI          Reductions           Adjusted net FBCI
----------------------------------------------------------------------------------------------------------------
[pound]60x covered distribution from
 F2:
    US1's [pound]30x assigned portion  [pound]0 (Sec.   959(b))
    US2's [pound]30x assigned portion  [pound]0 (Sec.
                                        954(c)(6)).
[pound]40x covered gain on F3 stock:
    US1's [pound]20x assigned portion  [pound]0 (Sec.   961(c))  [pound]5x.............  [pound]15x ([pound]20x-
                                                                                          [pound]5x).
    US2's [pound]20x assigned portion  [pound]20x..............
[pound]295x royalty income...........  [pound]295x.............  [pound]0..............  [pound]295x
                                                                                          ([pound]295x-
                                                                                          [pound]0).
[pound]125x foreign oil and gas        [pound]0................
 extraction income.
----------------------------------------------------------------------------------------------------------------

    (B) Analysis--(1) In general. Under paragraph (c) of this section, 
F1's subpart F income attributable to each covered item is separately 
allocated to US1 and US2, and then F1's remaining subpart F income is 
allocated to the United States shareholders. As described in paragraphs 
(h)(2)(iii)(B)(2) and (3) of this section and summarized in Table 1 in 
this paragraph (h)(2)(iii)(B)(1), US1 is allocated a total of 
[pound]147.5x, and US2 is allocated a total of [pound]162.5x, of 
subpart F income. Accordingly, for purposes of paragraph (b) of this 
section, US1 has a [pound]147.5x pro rata share, and US2 has a 
[pound]162.5x pro rata share, of F1's [pound]310x of subpart F income. 
See paragraph (c)(1) of this section.

          Table 1 to Paragraph (h)(2)(iii)(B)(1) of This Section--Foreign Base Company Income Analysis
----------------------------------------------------------------------------------------------------------------
                                         Foreign base company income             Allocation of subpart F income
                              -------------------------------------------------  under Sec.   1.951-1(c)(2)(ii)
         Gross income                                                                       and (iii)
                                Adjusted gross    Reductions     Adjusted net  ---------------------------------
                                     FBCI                            FBCI             US1              US2
----------------------------------------------------------------------------------------------------------------
[pound]60x covered
 distribution from F2:
    US1's [pound]30x assigned  [pound]0 (Sec.
     portion.                    959(b)).
    US2's [pound]30x assigned  [pound]0 (Sec.
     portion.                    954(c)(6)).
[pound]40x covered gain on F3
 stock:.
    US1's [pound]20x assigned  [pound]0 (Sec.   [pound]5x....  [pound]15x       [pound]0         [pound]15x
     portion.                    961(c)).                       ([pound]20x-     ([pound]15x x    ([pound]15x x
                                                                [pound]5x).      [pound]0/        [pound]20x/
                                                                                 [pound]20x).     [pound]20x).
    US2's [pound]20x assigned  [pound]20x.....
     portion.
[pound]295x royalty income...  [pound]295x....  [pound]0.....  [pound]295x      [pound]147.5x    [pound]147.5x
                                                                ([pound]295x-    ([pound]295x x   ([pound]295x x
                                                                [pound]0).       [pound]250x/     [pound]250x/
                                                                                 [pound]500x).    [pound]500x).
[pound]125x foreign oil and    [pound]0.......
 gas extraction income.
----------------------------------------------------------------------------------------------------------------

    (2) Allocation of subpart F income attributable to covered items. 
F1 has [pound]0 of subpart F income attributable to the covered 
distribution and [pound]15x of subpart F income attributable to the 
covered gain because in each case that is the portion of the covered 
item that is included in F1's adjusted net foreign base company income. 
See paragraph (c)(2)(i) of this section. The [pound]15x of subpart F 
income attributable to the covered gain is allocated to each of US1 and 
US2 by multiplying the amount of such subpart F income by a fraction, 
the numerator of which is the portion of the covered gain that is both 
assigned to the United States shareholder under Sec.  1.951-2 and 
included in F1's adjusted gross foreign base company income ([pound]0 
in the case of US1, and [pound]20x in the case of US2), and the 
denominator of which is the portion of the covered gain that is 
included in F1's adjusted gross foreign base company income 
([pound]20x). See paragraph (c)(2)(ii) of this section. Thus, US2 is 
allocated all [pound]15x of the subpart F income attributable to the 
covered gain.
    (3) Allocation of subpart F income not attributable to covered 
items. F1 has [pound]295x of subpart F income not attributable to 
covered items ([pound]310x-[pound]15x). This subpart F income is 
allocated to each of US1 and US2 by multiplying the amount of the 
subpart F income by a fraction, the numerator of which is portion of 
F1's [pound]500x hypothetical distribution described in paragraph (e) 
of this section that would be distributed with respect to stock of F1 
that the United States shareholder owns ([pound]250x in the case of 
each of US1 and US2), and the denominator of which is the amount of the 
hypothetical distribution ([pound]500x). See paragraph (c)(2)(iii) of 
this section. Thus, each of US1 and US2 is allocated [pound]147.5x of 
the subpart F income not attributable to covered items.
    (C) Alternative facts: tested income--(1) Facts. The facts are the 
same as in

[[Page 95406]]

paragraph (h)(2)(iii)(A) of this section, except that F1's [pound]125x 
item of foreign oil and gas extraction income is instead gross tested 
income. Because there are no allowable deductions properly allocable to 
the gross tested income, F1 thus has [pound]125x of tested income.
    (2) Analysis. The results are the same as in paragraph 
(h)(2)(iii)(B) of this section. In addition, each of US1 and US2 has a 
[pound]62.5x pro rata share of F1's [pound]125x of tested income, 
determined by multiplying the amount of the tested income by the 
fraction used in allocating F1's subpart F income not attributable to 
covered items to the United States shareholder ([pound]250x/
[pound]500x, as described in paragraph (h)(2)(iii)(B)(3) of this 
section). See Sec.  1.951A-1(d)(2).
    (i) Applicability date. This section applies to taxable years of 
foreign corporations that begin on or after [date of publication of 
final regulations in the Federal Register] or are early application 
years (as described in described in Sec.  1.959-12(d)) and to taxable 
years of persons for which such taxable years of those foreign 
corporations are relevant. See Sec.  1.951-1 as contained in 26 CFR 
part 1 revised as of April 1, 2024, for a version of this section 
applicable to prior taxable years.
0
Par. 12. Add section 1.951-2 to read as follows:


Sec.  1.951-2  Foreign corporation-level assignment rules for covered 
items.

    (a) Scope. This section sets forth the rules for assigning a 
foreign corporation's covered items to covered shareholders. Under 
Sec. Sec.  1.959-4 and 1.961-9, these assignments determine the extent 
to which shareholder-specific attributes (previously taxed earnings and 
profits or section 961(c) basis) are applied to the covered items. 
Paragraph (b) of this section defines a covered item. Paragraph (c) of 
this section describes the rules for assigning covered items. Paragraph 
(d) of this section describes a fraction determining assignments under 
the general assignment rule. Paragraph (e) of this section adjusts 
assignments to account for general successor transactions. Paragraph 
(f) of this section provides a currency translation rule. Paragraph (g) 
of this section provides definitions and rules of general applicability 
for purposes of this section. Paragraph (h) of this section provides 
examples illustrating the application of this section. Paragraph (i) of 
this section provides the applicability date of this section.
    (b) Covered items. A covered item is gross income of a foreign 
corporation that consists of either the portion of a covered 
distribution received by the foreign corporation (determined under 
Sec.  1.959-4) or a covered gain recognized by the foreign corporation 
(determined under Sec.  1.961-9). Covered shareholders that own stock 
of a foreign corporation during a taxable year of the foreign 
corporation in which the foreign corporation receives or recognizes a 
covered item are assigned portions of the covered item in accordance 
with the rules described in paragraph (c) of this section. See also 
paragraph (g) of this section, incorporating Sec.  1.959-1(b) for the 
definition of covered shareholder, Sec.  1.959-4(c) for the definition 
of covered distribution, and Sec.  1.961-9(c) for the definition of 
covered gain.
    (c) Rules for assigning a covered item--(1) Determine assignments 
based on stock ownership on the last relevant day. First, assign a pro 
rata portion of the covered item to each covered shareholder that owns 
stock of the foreign corporation on the last relevant day of the 
foreign corporation's taxable year (defined in Sec.  1.959-1(b) as the 
last day of the taxable year on which the foreign corporation is a 
controlled foreign corporation), determined by multiplying the amount 
of the covered item by the fraction computed in accordance with 
paragraph (d) of this section. If there is no day during the taxable 
year on which the foreign corporation is a controlled foreign 
corporation, then treat the last day of the taxable year as the last 
relevant day.
    (2) Adjust assignments for general successor transactions. Second, 
if the foreign corporation is an acquired foreign corporation in one or 
more general successor transactions that occur during the foreign 
corporation's taxable year, then, for each such general successor 
transaction (starting with the earliest transaction), adjust covered 
shareholders' assigned portions of the covered item in accordance with 
paragraph (e) of this section. See also paragraph (g) of this section, 
incorporating Sec.  1.959-7(b) for the definitions of acquired foreign 
corporation and general successor transaction.
    (d) Fraction in determining assignments--(1) In general. In 
determining a covered shareholder's assigned portion of a covered item 
of a foreign corporation under paragraph (c)(1) of this section, the 
fraction described in that paragraph is computed as follows. The 
numerator of the fraction is the amount that would be the covered 
shareholder's share of the hypothetical distribution described in Sec.  
1.951-1(e) for the foreign corporation's taxable year if, for purposes 
of this paragraph (d), Sec.  1.951-1(e) were applied with the 
modifications described in paragraph (d)(2) of this section. The 
denominator of the fraction is the amount that would be the 
hypothetical distribution described in Sec.  1.951-1(e) for the foreign 
corporation's taxable year if, for purposes of this paragraph (d), 
Sec.  1.951-1(e) were applied with the modifications described in 
paragraph (d)(2) of this section.
    (2) Modifications--(i) Allocable earnings and profits. For purposes 
of this paragraph (d), the foreign corporation's allocable earnings and 
profits (as defined in Sec.  1.951-1(e)(1)(ii)) are treated as the 
amount that is the greater of--
    (A) The earnings and profits of the foreign corporation for the 
taxable year, determined under section 964 and not reduced by 
distributions during the taxable year; and
    (B) The sum of all covered items of the foreign corporation for the 
taxable year.
    (ii) Controlled foreign corporation status. For purposes of this 
paragraph (d), Sec.  1.951-1(e) applies without regard to whether the 
foreign corporation is a controlled foreign corporation. In addition, 
if there is no day during the taxable year on which the foreign 
corporation is a controlled foreign corporation, then the hypothetical 
distribution date (as defined in Sec.  1.951-1(e)(1)(i)) is treated as 
the last day of the taxable year.
    (e) Rules for general successor transactions--(1) In general. In 
adjusting covered shareholders' assignments of a covered item for a 
general successor transaction under paragraph (c)(2) of this section, 
increase an assignment in accordance with paragraph (e)(2) of this 
section, and then decrease assignments in accordance with paragraphs 
(e)(3) and (4) of this section. Generally, under these rules (together 
with Sec. Sec.  1.959-4 and 1.961-9), previously taxed earnings and 
profits or section 961(c) basis with respect to the transferor covered 
shareholder (if the general successor transaction occurs before the 
last relevant day) or successor covered shareholder (if the general 
successor transaction occurs on or after the last relevant day) are 
applied to a covered item to the same extent such previously taxed 
earnings and profits or section 961(c) basis would have been applied if 
the general successor transaction had not occurred.
    (2) Increase--(i) General successor transaction occurring before 
the last relevant day. If the general successor transaction occurs 
before the last relevant day of the taxable year but after the covered 
item is received or recognized, then, subject to the

[[Page 95407]]

limitation in paragraph (e)(2)(iii) of this section, increase the 
transferor covered shareholder's assignment of the covered item as 
follows. Increase the assignment by the additional portion of the 
covered item that would have been assigned to the transferor covered 
shareholder under paragraph (c)(1) of this section if the day on which 
the covered item is received or recognized were the last relevant day 
and the hypothetical distribution described in paragraph (d)(1) of this 
section were treated as made immediately before the covered item is 
received or recognized.
    (ii) General successor transaction occurring on or after the last 
relevant day. If the general successor transaction occurs on or after 
the last relevant day of the taxable year but before the covered item 
is received or recognized, then, subject to the limitation in paragraph 
(e)(2)(iii) of this section, increase the successor covered 
shareholder's assignment of the covered item as follows. Increase the 
assignment by the additional portion of the covered item that would 
have been assigned to the successor covered shareholder under paragraph 
(c)(1) of this section if the day on which the covered item is received 
or recognized were the last relevant day and the hypothetical 
distribution described in paragraph (d)(1) of this section were treated 
as made immediately before the covered item is received or recognized.
    (iii) Limitations. The increase pursuant to paragraph (e)(2)(i) or 
(ii) of this section applies only to the extent it results in an 
additional portion of the covered item being previously taxed earnings 
and profits that are both with respect to the covered shareholder 
described in that paragraph and excluded from the foreign corporation's 
gross income under section 959(b) and Sec.  1.959-4 or section 961(c) 
and Sec.  1.961-9. Further, the increase cannot exceed the aggregate of 
each connected covered shareholder's assigned portion of the covered 
item under paragraph (c)(1) of this section.
    (3) Decreases for connected covered shareholders owning acquired 
stock. For each connected covered shareholder that owns acquired stock 
of the foreign corporation on the last relevant day of the taxable 
year, decrease the connected covered shareholder's assignment (but not 
below zero) by the product of the increase pursuant to paragraph (e)(2) 
of this section and a fraction. The numerator of the fraction is the 
connected covered shareholder's assigned portion of the covered item 
under paragraph (c)(1) of this section, and the denominator of the 
fraction is the aggregate of the assigned portion of the covered item 
under paragraph (c)(1) of this section of each connected covered 
shareholder described in the preceding sentence.
    (4) Decreases for connected covered shareholders not owning 
acquired stock. For each connected covered shareholder that does not 
own acquired stock of the foreign corporation on the last relevant day 
of the taxable year, decrease the connected covered shareholder's 
assignment by the product of the increase pursuant to paragraph (e)(2) 
of this section, reduced by the decreases pursuant to paragraph (e)(3) 
of this section, and a fraction. The numerator of the fraction is the 
connected covered shareholder's assigned portion of the covered item 
under paragraph (c)(1) of this section, and the denominator of the 
fraction is the aggregate of the assigned portion of the covered item 
under paragraph (c)(1) of this section of each connected covered 
shareholder described in the preceding sentence.
    (f) Currency rule. For purposes of this section, if a covered item 
of a foreign corporation is denominated in a currency other than the 
foreign corporation's functional currency, then the covered item is 
translated into the foreign corporation's functional currency at the 
spot rate on the day on which the covered item is received or 
recognized.
    (g) Definitions and rules of general applicability. The definitions 
in Sec. Sec.  1.959-1(b) and 1.961-(b), and the rules of general 
applicability in Sec. Sec.  1.959-1(c) and (d) and 1.961-1(c) and (d), 
apply for purposes of this section, with the following additions.
    Acquired stock. The term acquired stock means, in a general 
successor transaction, stock of an acquired foreign corporation the 
ownership of which is acquired by the successor covered shareholder.
    Connected covered shareholder. The term connected covered 
shareholder means, in a general successor transaction, a covered 
shareholder that owns acquired stock of an acquired foreign corporation 
on the last relevant day of the acquired foreign corporation's taxable 
year in which the general successor transaction occurs, or any covered 
shareholder bearing a relationship described in section 267(b) 
(determined without regard to section 267(c)(3)) or 707(b) to a covered 
shareholder first described in this sentence.
    Covered item. The term covered item has the meaning provided in 
paragraph (b) of this section.
    (h) Examples--(1) In general. This paragraph (h) provides examples 
illustrating the application of this section.
    (2) Assumed facts. For purposes of the examples in this paragraph 
(h), unless otherwise indicated, the following facts are assumed:
    (i) US1 and US2 are unrelated domestic corporations that are 
covered shareholders. Neither US1 nor US2 is a member of a consolidated 
group (as defined in Sec.  1.1502-1(h)).
    (ii) F1, F2, and F3 are foreign corporations, each of which is a 
controlled foreign corporation and uses the British pound ([pound]) as 
its functional currency.
    (iii) Each entity uses the calendar year as its taxable year, and 
no entity has a short taxable year.
    (3) Examples--(i) Example 1: General assignment rule and single 
class of stock--(A) Facts. US1 and US2 each directly own 50% of the 
single class of outstanding stock of F1. F1 directly owns all the 
outstanding stock of each of F2 and F3. For F1's taxable year ending on 
December 31 of year 3, the last relevant day is December 31, and F1 has 
[pound]500x of earnings and profits and two covered items. The covered 
items are a [pound]60x covered distribution received from F2 and 
[pound]40x of covered gain recognized with respect to stock of F3.
    (B) Analysis. The portion of each covered item assigned to each of 
US1 and US2 is determined by multiplying the amount of the covered item 
by a fraction, the numerator of which is the portion of a [pound]500x 
hypothetical distribution treated as made by F1 on the last relevant 
day that would be distributed with respect to stock of F1 that the 
covered shareholder owns ([pound]250x in the case of each US1 and US2), 
and the denominator of which is the amount of the hypothetical 
distribution ([pound]500x). See paragraphs (c)(1) and (d)(1) of this 
section; see also paragraph (d)(2) of this section (treating F1's 
hypothetical distribution as equal to the greater of [pound]500x, F1's 
earnings and profits for the taxable year, and [pound]100x, the sum of 
F1's covered items for the taxable year). Thus, US1 and US2 are each 
assigned [pound]30x of the covered distribution ([pound]60x x 
[pound]250x/[pound]500x) and [pound]20x of the covered gain ([pound]40x 
x [pound]250x/[pound]500x).
    (C) Alternative facts: common stock and preferred stock--(1) Facts. 
The facts are the same as in paragraph (h)(3)(i)(A) of this section 
(Example 1), except as follows. The stock of F1 owned by US1 is an 8% 
nonparticipating, voting preferred share of stock with a par value of 
[pound]1,000x, and the stock of F1 owned by US2 is common stock. There 
are no accrued but unpaid dividends with respect to the preferred 
stock.

[[Page 95408]]

    (2) Analysis. The portion of each covered item assigned to each of 
US1 and US2 is determined by multiplying the amount of the covered item 
by a fraction, the numerator of which is the portion of a [pound]500x 
hypothetical distribution treated as made by F1 on the last relevant 
day that would be distributed with respect to stock of F1 that the 
covered shareholder owns ([pound]80x in the case of US1, computed as 
0.08 x [pound]1,000x, and [pound]420x in the case of US2, computed as 
[pound]500x - [pound]80x), and the denominator of which is the amount 
of the hypothetical distribution ([pound]500x). See paragraphs (c)(1) 
and (d) of this section. Thus, US1 is assigned [pound]9.6x of the 
covered distribution ([pound]60x x [pound]80x/[pound]500x) and 
[pound]6.4x of the covered gain ([pound]40x x [pound]80x/[pound]500x), 
and US2 is assigned [pound]50.4x of the covered distribution 
([pound]60x x [pound]420x/[pound]500x) and [pound]33.6x of the covered 
gain ([pound]40x x [pound]420x/[pound]500x).
    (ii) Example 2: General successor transaction occurs before the 
last relevant day and after a covered distribution--(A) Facts. US1 
directly owns all the shares of the single class of outstanding stock 
of F1, and F1 directly owns all the outstanding stock of F2. On June 30 
of year 3, US1 sells all the stock of F1 to US2 for money equal to the 
fair market value of the stock in a general successor transaction. For 
F1's taxable year ending on December 31 of year 3, the last relevant 
day is December 31, and F1 has [pound]500x of earnings and profits and 
one covered item. The covered item is a [pound]100x covered 
distribution received by F1 from F2 on March 31. Immediately before the 
covered distribution, F2 has [pound]100x of previously taxed earnings 
and profits with respect to US1.
    (B) Analysis--(1) In general. Without regard to paragraphs (c)(2) 
and (e) of this section (adjustments for general successor 
transactions), US2 would be assigned all [pound]100x (and thus US1 
would be assigned none) of the covered item because US2 owns all the 
stock of F1 on the last relevant day and therefore US2 would have a 
100% share of a [pound]500x hypothetical distribution treated as made 
by F1 on that day. See paragraphs (c)(1) and (d) of this section. 
However, because the sale is a general successor transaction occurring 
before the last relevant day but after F1 receives the covered item, 
the assignments to US1 (the transferor covered shareholder) and US2 (a 
connected covered shareholder by reason of owning acquired stock of F1 
on the last relevant day) are adjusted. See paragraphs (c)(2) and 
(e)(1) of this section. The specific adjustments are described in 
paragraph (h)(3)(ii)(B)(2) of this section. As a result of these 
adjustments, the entirety of the covered item is a distribution to F1 
of F2's previously taxed earnings and profits with respect to US1 under 
Sec.  1.959-4. Moreover, the previously taxed earnings and profits 
could be distributed by F1 to US1 before the sale and, to the extent 
not so distributed, are previously taxed earnings and profits of F1 
that transfer from US1 to US2 in the sale under Sec.  1.959-7.
    (2) Adjustments. US1's assigned portion of the covered item is 
increased by [pound]100x, which is the additional portion of the 
covered item that would have been assigned to US1 under paragraph 
(c)(1) of this section if March 31 were the last relevant day (and, 
thus, F1's [pound]500x hypothetical distribution were treated as made 
when US1 owned all the stock of F1 and would therefore have a 100% 
share of the hypothetical distribution). See paragraph (e)(2)(i) of 
this section. In determining this increase, the first limitation in 
paragraph (e)(2)(iii) of this section does not apply because a 
[pound]100x increase does not exceed the amount of F2's previously 
taxed earnings and profits with respect to US1 that could be applied to 
exclude such additional portion of the covered item from F1's gross 
income under section 959(b). In addition, the second limitation in 
paragraph (e)(2)(iii) of this section does not apply because a 
[pound]100x increase does not exceed the amount of the covered item 
assigned to US2 under paragraph (c)(1) of this section. The [pound]100x 
increase to US1's assigned portion of the covered item decreases US2's 
assigned portion of the covered item from [pound]100x to [pound]0. See 
paragraph (e)(3) of this section.
    (C) Alternative facts: limitation on increase and multiple 
connected covered shareholders--(1) Facts. The facts are the same as in 
paragraph (h)(3)(ii)(A) of this section (Example 2), except as follows. 
Immediately before the [pound]100x covered distribution on March 31, F2 
has [pound]90x (rather than [pound]100x) of previously taxed earnings 
and profits with respect to US1. On September 30 of year 3, F1 issues 
shares of its single class of outstanding stock to US3, a corporate 
covered shareholder related to US2 within the meaning of section 
267(b), with the result that US2 and US3 each own half of the stock of 
F1 on the last relevant day.
    (2) Analysis--(i) In general. Without regard to paragraphs (c)(2) 
and (e) of this section (adjustments for general successor 
transactions), US2 and US3 would each be assigned [pound]50x (and thus 
US1 would be assigned none) of the covered item because US2 and US3 
each own half of the stock of F1 on the last relevant day and therefore 
would each have a 50% share of a [pound]500x hypothetical distribution 
treated as made by F1 on that day. See paragraphs (c)(1) and (d) of 
this section. However, because the sale is a general successor 
transaction occurring before the last relevant day but after F1 
receives the covered item, the assignments to US1 (the transferor 
covered shareholder), US2 (a connected covered shareholder by reason of 
owning acquired stock of F1 on the last relevant day), and US3 (a 
connected covered shareholder by reason of bearing a relationship 
described in section 267(b) to US2) are adjusted. See paragraphs (c)(2) 
and (e)(1) of this section. The specific adjustments are described in 
paragraph (h)(3)(ii)(C)(2)(ii) of this section. As a result of these 
adjustments, [pound]90x of the covered item is a distribution to F1 of 
F2's previously taxed earnings and profits with respect to US1 under 
Sec.  1.959-4. Moreover, the previously taxed earnings and profits 
could be distributed by F1 to US1 before the sale and, to the extent 
not so distributed, are previously taxed earnings and profits of F1 
that transfer from US1 to US2 in the sale under Sec.  1.959-7.
    (ii) Adjustments. US1's assigned portion of the covered item is 
increased by [pound]90x, which is the lesser of the additional portion 
of the covered item that would have been assigned to US1 if March 31 
were the last relevant day ([pound]100x) and the amount of F2's 
previously taxed earnings and profits with respect to US1 that could be 
applied to exclude such additional portion of the covered item from 
F1's gross income under section 959(b) ([pound]90x). See paragraphs 
(e)(2)(i) and (iii) of this section. Because US2 owns acquired stock of 
F1 on the last relevant day, the [pound]90x increase to US1's assigned 
portion of the covered item first decreases US2's assigned portion of 
the covered item, from [pound]50x to [pound]0. See paragraph (e)(3) of 
this section. Then, the remaining [pound]40x increase to US1's assigned 
portion of the covered item decreases US3's assigned portion of the 
covered item, from [pound]50x to [pound]10x. See paragraph (e)(4) of 
this section.
    (iii) Example 3: General successor transaction occurs after the 
last relevant day--(A) Facts. US1 directly owns all 100 shares of the 
single class of outstanding stock of F1. F1 directly owns all the 
outstanding stock of F2. On March 31 of year 3, F1 issues 100 shares of 
its single class of outstanding stock to a nonresident alien individual 
and, consequently, F1 ceases to be a controlled foreign corporation. On 
June 30 of year 3, US1 sells its 100 shares of stock of F1 to US2 for 
money equal to the stock's fair market value in a general

[[Page 95409]]

successor transaction. For F1's taxable year ending on December 31 of 
year 3, the last relevant day is March 31 and F1 has [pound]500x of 
earnings and profits and one covered item. The covered item is a 
[pound]100x covered distribution received by F1 from F2 on September 
30. Immediately before the covered distribution, F2 has [pound]50x of 
previously taxed earnings and profits with respect to US2 (all of which 
transferred from US1 to US2 in the Sale).
    (B) Analysis--(1) In general. Without regard to paragraphs (c)(2) 
and (e) of this section (adjustments for general successor 
transactions), US2 would be assigned none of the covered item because 
US2 owns none of the stock of F1 on the last relevant day and therefore 
US2 would have a 0% share of a [pound]500x hypothetical distribution 
treated as made by F1 on that day. See paragraphs (c)(1) and (d) of 
this section. However, because the sale is a general successor 
transaction occurring on or after the last relevant day but before F1 
receives the covered item, the assignments to US2 (the successor 
covered shareholder) and US1 (a connected covered shareholder by reason 
of owning acquired stock of F1 on the last relevant day) are adjusted. 
See paragraphs (c)(2) and (e)(1) of this section. The specific 
adjustments are described in paragraph (h)(3)(iii)(B)(2) of this 
section. As a result of these adjustments, [pound]50x of the covered 
item is a distribution to F1 of F2's previously taxed earnings and 
profits with respect to US2 under Sec.  1.959-4.
    (2) Adjustments. US2's assigned portion of the covered item is 
increased by [pound]50x, which is the additional portion of the covered 
item that would have been assigned to US2 under paragraph (c)(1) of 
this section if September 30 were the last relevant day (and, thus, 
F1's [pound]500x hypothetical distribution were treated as made when 
US2 owned half of the stock of F1 and would therefore have a 50% share 
of the hypothetical distribution). See paragraph (e)(2)(ii) of this 
section. In determining this increase, the first limitation in 
paragraph (e)(2)(iii) of this section does not apply because a 
[pound]50x increase does not exceed the amount of F2's previously taxed 
earnings and profits with respect to US2 that could be applied to 
exclude such additional portion of the covered item from F1's gross 
income under section 959(b). In addition, the second limitation in 
paragraph (e)(2)(iii) of this section does not apply because a 
[pound]50x increase does not exceed the amount of the covered item 
assigned to US1 under paragraph (c)(1) of this section. The [pound]50x 
increase to US2's assigned portion of the covered item decreases US1's 
assigned portion of the covered item by [pound]50x. See paragraph 
(e)(3) of this section.
    (i) Applicability date. This section applies to taxable years of 
foreign corporations that begin on or after [date of publication of 
final regulations in the Federal Register] or are early application 
years (as described in Sec.  1.959-12(d)) and to taxable years of 
persons for which such taxable years of those foreign corporations are 
relevant.


Sec.  1.951A-1  [Amended]

0
Par. 13. Section 1.951A-1 is amended by, for each paragraph listed in 
the following table, removing the language in the ``Remove'' column 
wherever it appears and adding in its place the language in the ``Add'' 
column:

------------------------------------------------------------------------
          Paragraph                  Remove                  Add
------------------------------------------------------------------------
(d)(1)......................  Sec.   1.951-1(b)     Sec.   1.951-1(b)
                               and (e).              and (c).
(d)(1)......................  subpart F income....  subpart F income not
                                                     attributable to
                                                     covered items.
(d)(2)(i)...................  Sec.   1.951-1(b)     Sec.   1.951-1(b)
                               and (e).              and (c).
(d)(2)(i)...................  substituting          substituting
                               ``tested income''     ``tested income''
                               for ``subpart F       for ``subpart F
                               income'' each place   income'' each place
                               it appears, other     it appears in Sec.
                               than in Sec.           1.951-1(b) other
                               1.951-1(e)(1)(ii)(B   than in the
                               ) and the             denominator of the
                               denominator of the    fraction described
                               fraction described    in Sec.   1.951-
                               in Sec.   1.951-      1(b)(1)(ii)(A),
                               1(b)(1)(ii)(A).       substituting
                                                     ``tested income of
                                                     the foreign
                                                     corporation'' for
                                                     ``all subpart F
                                                     income of the
                                                     foreign corporation
                                                     not attributable to
                                                     covered items'' in
                                                     Sec.   1.951-
                                                     1(c)(2)(iii), and
                                                     substituting ``such
                                                     tested income'' for
                                                     ``such subpart F
                                                     income'' in Sec.
                                                     1.951-1(c)(2)(iii).
(d)(3)(iii).................  Sec.   1.951-         Sec.   1.951-
                               1(e)(7)(vii).         1(h)(1)(vii).
(d)(3)(iii)(A)(2)(i)........  Sec.   1.951-1(e)(1)  Sec.   1.951-
                                                     1(c)(2)(iii).
(d)(4)(i)...................  Sec.   1.951-1(b)     Sec.   1.951-1(b)
                               and (e).              and (c).
(d)(4)(i)(A)................  substituted for       substituted for
                               ``subpart F           ``subpart F
                               income'' each place   income'' each place
                               it appears.           it appears in Sec.
                                                      1.951-1(b) and
                                                     (c), ``tested loss
                                                     of the foreign
                                                     corporation'' is
                                                     substituted for
                                                     ``all subpart F
                                                     income of the
                                                     foreign corporation
                                                     not attributable to
                                                     covered items'' in
                                                     Sec.   1.951-
                                                     1(c)(2)(iii), and
                                                     ``such tested
                                                     loss'' is
                                                     substituted for
                                                     ``such subpart F
                                                     income'' in Sec.
                                                     1.951-1(c)(2)(iii).
(d)(4)(iv)..................  Sec.   1.951-         Sec.   1.951-
                               1(e)(7)(viii).        1(h)(1)(viii).
------------------------------------------------------------------------

0
Par. 14. Section 1.951A-2 is amended by:
0
1. In paragraph (c)(1)(iv), removing the language ``and'';
0
2. In paragraph (c)(1)(v), removing the period and adding the language 
``, and'' in its place; and
0
3. Adding paragraph (c)(1)(vi).
    The addition reads as follows:


Sec.  1.951A-2  Tested income and tested loss.

* * * * *
    (c) * * *
    (1) * * *
    (vi) Previously taxed earnings and profits excluded from the 
corporation's gross income under section 959(b) and Sec.  1.959-4 or 
section 961(c) and Sec.  1.961-9.
* * * * *
0
Par. 15. Section 1.951A-7 is amended by adding paragraph (f) to read as 
follows:


Sec.  1.951A-7  Applicability dates.

* * * * *
    (f) Pro rata share determinations and exclusions under sections 
959(b) and 961(c). Sections 1.951A-1(d) and 1.951A-2(c)(1)(vi) apply to 
taxable years of foreign corporations that begin on or after [date of 
publication of final regulations in the Federal Register] or are early 
application years (as described in Sec.  1.959-12(d)) and to taxable 
years of persons for which such taxable years of those foreign 
corporations are relevant. See Sec.  1.951A-1(d) as contained in 26

[[Page 95410]]

CFR part 1 revised as of April 1, 2024, for a version of Sec.  1.951A-
1(d) applicable to prior taxable years.
0
Par. 16. Section 1.952-1 is amended by adding paragraphs (c)(4), 
(c)(5), and (h) to read as follows:


Sec.  1.952-1  Subpart F income defined.

* * * * *
    (c) * * *
    (4) Coordination of earnings and profits limitation with sections 
959(b) and 961(c)--(i) In general. Distributions of previously taxed 
earnings and profits received by a controlled foreign corporation, and 
previously taxed earnings and profits resulting from the application of 
a controlled foreign corporation's section 961(c) basis to gain 
recognized by the controlled foreign corporation, are not included in 
the controlled foreign corporation's earnings and profits for the 
taxable year for purposes of the limitation in section 952(c)(1)(A). 
See paragraph (h) of this section (regarding excluding previously taxed 
earnings and profits from a controlled foreign corporation's gross 
income for purposes of determining its subpart F income).
    (ii) Applicability date. Paragraph (c)(4)(i) of this section 
applies to taxable years of foreign corporations that begin on or after 
[date of publication of final regulations in the Federal Register] or 
are early application years (as described in Sec.  1.959-12(d)) and to 
taxable years of persons for which such taxable years of those foreign 
corporations are relevant.
    (5) Transition rule for deficits of a domestic partnership that was 
an inclusion shareholder with respect to a controlled foreign 
corporation--(i) In general. For purposes of applying section 
952(c)(1)(B) to any taxable year of a controlled foreign corporation, a 
United States shareholder that owns (within the meaning of section 
958(a)) stock of the controlled foreign corporation by reason of an 
interest in a domestic partnership on the last day of the first taxable 
year of the controlled foreign corporation during which Sec.  1.958-
1(d) applies to the domestic partnership (or, if earlier, the last day 
of such taxable year on which the foreign corporation is a controlled 
foreign corporation) (transition date) takes into account its assigned 
portion of any prior year deficit (determined under paragraph 
(c)(5)(ii) of this section) for any taxable year of the controlled 
foreign corporation ending before the application of Sec.  1.958-1(d) 
in determining the United States shareholder's pro rata share of a 
prior year deficit under section 952(c)(1)(B)(iv)(II), and the domestic 
partnership ceases to take into account such prior year deficit.
    (ii) Assigned portion of prior year deficit. A United States 
shareholder's assigned portion of a prior year deficit is determined on 
the transition date by multiplying a domestic partnership's pro rata 
share of the prior year deficit (determined under section 
952(c)(1)(B)(iv)(II) as of the close of the taxable year in which the 
deficit arose) by a fraction, the numerator of which is the liquidation 
value of the United States shareholder's interest in the partnership 
and the denominator of which is the aggregate liquidation value of all 
partners' interests in the partnership. For purposes of this fraction, 
the liquidation value of a partner's interest in the partnership is the 
amount of cash the partner would receive with respect to the interest 
if, on the transition date, the partnership (and any partnership 
through which the partner indirectly owns an interest in the 
partnership) sold all of its property for an amount of cash equal to 
the fair market value of the property (taking into account section 
7701(g)), satisfied all of its liabilities (other than those described 
in Sec.  1.752-7), paid an unrelated third party to assume all of its 
Sec.  1.752-7 liabilities in a fully taxable transaction, and then the 
partnership (and any partnership through which the partner indirectly 
owns an interest in the partnership) liquidated.
    (iii) Applicability date. This paragraph (c)(5) applies to taxable 
years of foreign corporations beginning on or after [date of 
publication of final regulations in the Federal Register], and to 
taxable years of United States shareholders in which or with which such 
taxable years of foreign corporation end. A United States shareholder 
may apply this paragraph (c)(5) to a taxable year of a foreign 
corporation that precedes the taxable years described in the preceding 
sentence if each of the following conditions is satisfied--
    (A) Consistent application condition. This paragraph (c)(5) is 
applied in its entirety to the taxable year and all succeeding taxable 
years of the foreign corporation, to all taxable years of United States 
shareholders to which such a taxable year of the foreign corporation is 
relevant, and to all taxable years of related foreign corporations that 
end on or after the later of the last day of the first taxable year of 
the foreign corporation to which this paragraph (c)(5) applies and the 
first day on which the foreign corporations are related. For purposes 
of the preceding sentence, foreign corporations are related if the 
foreign corporations bear a relationship to each other described in 
section 267(b).
    (B) Open period of limitations condition. The period of limitations 
on assessment for each taxable year described in paragraph 
(c)(5)(iii)(A) of this section is open under section 6501.
    (C) Written consent condition. Each United States shareholder 
described in paragraph (c)(5)(iii)(A) of this section provides to the 
foreign corporation a written statement in which the United States 
shareholder consents to apply the rules described in this paragraph 
(c)(5) to the taxable years of the United States shareholder described 
in paragraph (c)(5)(iii)(A) of this section and affirms that the period 
of limitations on assessment for each such taxable year is open under 
section 6501.
* * * * *
    (h) Exclusions from gross income under sections 959(b) and 961(c). 
See Sec. Sec.  1.959-4 and 1.961-9 for rules excluding previously taxed 
earnings and profits from a controlled foreign corporation's gross 
income for purposes of determining its subpart F income.
0
Par. 17. Section 1.954-1 is amended by:
0
1. In paragraph (c)(1)(iii)(A), adding the language ``or income from a 
covered item'' immediately after the language ``that is passive''; and
0
2. Adding paragraphs (c)(1)(iii)(C) and (h)(4).
    The additions read as follows:


Sec.  1.954-1  Foreign base company income.

* * * * *
    (c) * * *
    (1) * * *
    (iii) * * *
    (C) Covered items. A single item of income is the portion of a 
covered item (as defined in Sec.  1.951-2(b)) that--
    (1) Falls within a single category of foreign base company income 
described in paragraph (c)(1)(iii)(A)(1) or (2) of this section;
    (2) Falls within a separate category (as defined in Sec.  1.904-
5(a)(4)(v)); and
    (3) In the case of any amount which constitutes passive foreign 
personal holding company income, falls within a single group of passive 
income under the grouping rules of Sec.  1.904-4(c)(3), (4), or (5).
* * * * *
    (h) * * *
    (4) Paragraph (c)(1)(iii)(C) of this section. Paragraph 
(c)(1)(iii)(C) of this section applies to taxable years of a foreign 
corporation that begin on or after [date of publication of final 
regulations in the Federal Register] or are early application years (as 
described in Sec.  1.959-12(d)), and to taxable years of a

[[Page 95411]]

United States shareholder of the foreign corporation in which or with 
which such taxable year of such foreign corporation ends.
0
Par. 18. Section 1.959-1 is revised to read as follows:


Sec.  1.959-1  Overview, definitions, and rules of general 
applicability.

    (a) Overview--(1) In general. The section 959 regulations provide 
rules regarding previously taxed earnings and profits. This section 
sets forth definitions and rules of general applicability. Section 
1.959-2 sets forth rules for shareholder-level and foreign corporation-
level accounting of a foreign corporation's previously taxed earnings 
and profits. Section 1.959-3 provides the adjustments under section 959 
to shareholder-level accounts with respect to a foreign corporation. 
Section 1.959-4 provides rules for excluding previously taxed earnings 
and profits received in a distribution from gross income of a covered 
shareholder or controlled foreign corporation. Section 1.959-5 provides 
rules for excluding the portion of a section 956 amount that is 
allocated to previously taxed earnings and profits from gross income of 
a covered shareholder. Section 1.959-6 provides rules for allocating 
and apportioning current year taxes paid or accrued by a foreign 
corporation to its previously taxed earnings and profits. Section 
1.959-7 provides rules for transferring previously taxed earnings and 
profits in a general successor transaction. Sections 1.959-8 through 
1.959-9 are reserved. Section 1.959-10 provides examples illustrating 
the application of the section 959 regulations. Section 1.959-11 sets 
forth transition rules. Section 1.959-12 sets forth applicability 
dates. See Sec.  1.1502-59 for additional rules for a consolidated 
group.
    (2) Scope. This section sets forth definitions and rules of general 
applicability for purposes of the section 959 regulations. Paragraph 
(b) of this section provides definitions. Paragraph (c) of this section 
provides rules relating to S corporations. Paragraph (d) of this 
section provides an anti-avoidance rule.
    (b) Definitions. The following definitions apply for purposes of 
the section 959 regulations.
    2019 notice provisions. The term 2019 notice provisions has the 
meaning provided in Sec.  1.959-12(c)(2).
    Acquired foreign corporation. The term acquired foreign corporation 
has the meaning provided in Sec.  1.959-7(b).
    Adjusted applicable percentage. The term adjusted applicable 
percentage has the meaning provided in Sec.  1.959-2(b)(2)(iii)(A).
    Annual PTEP account. The term annual PTEP account means an account 
that is described in Sec.  1.959-2(b)(1) and tracks previously taxed 
earnings and profits.
    Character. The term character means, with respect to previously 
taxed earnings and profits, the taxable year, section 904 category, 
PTEP group and, if applicable, PTEP subgroup to which the previously 
taxed earnings and profits relate, as well as, if applicable, the 
adjusted applicable percentage and section 965(c) deduction percentage 
with respect to the previously taxed earnings and profits.
    Controlled foreign corporation. The term controlled foreign 
corporation has the meaning provided in section 957(a) (or, if 
applicable, section 957(b) or 953(c)(1)(B)).
    Corporate PTEP account. The term corporate PTEP account has the 
meaning provided in Sec.  1.959-2(d)(1).
    Corporate PTEP tax pool. The term corporate PTEP tax pool has the 
meaning provided in Sec.  1.959-2(d)(2).
    Covered distribution. The term covered distribution has the meaning 
provided in Sec.  1.959-4(c).
    Covered gain. The term covered gain has the meaning provided in 
Sec.  1.961-9(c).
    Covered shareholder. The term covered shareholder means a United 
States person (as described in section 7701(a)(30)), other than a 
domestic partnership.
    Creditable PTEP tax group. The term creditable PTEP tax group has 
the meaning provided in Sec.  1.959-2(b)(4)(ii).
    Current year taxes. The term current year taxes has the meaning 
provided in Sec.  1.960-1(b)(4) except that ``foreign corporation'' is 
substituted for ``controlled foreign corporation'' and ``the foreign 
corporation's taxable year'' is substituted for ``current taxable 
year''.
    Deemed covered shareholder. The term deemed covered shareholder has 
the meaning provided in Sec.  1.959-7(g).
    Dollar basis pool. The term dollar basis pool means an account that 
is described in Sec.  1.959-2(b)(1) and that tracks the basis in U.S. 
dollars of previously taxed earnings and profits.
    Domestic partnership. The term domestic partnership has the meaning 
provided in section 7701(a)(2) and (4). See paragraph (c) of this 
section, providing that an S corporation is treated in the same manner 
as a domestic partnership.
    Early application corporation. The term early application 
corporation has the meaning provided in Sec.  1.959-12(d)(1).
    Early application years. The term early application years has the 
meaning provided in Sec.  1.959-12(d)(1).
    Foreign income taxes. The term foreign income taxes has the meaning 
provided in Sec.  1.901-2(a).
    General successor PTEP. The term general successor PTEP has the 
meaning provided in Sec.  1.959-7(c)(1).
    General successor transaction. The term general successor 
transaction has the meaning provided in Sec.  1.959-7(b).
    GILTI inclusion amount. The term GILTI inclusion amount has the 
meaning provided in Sec.  1.951A-1(c)(1) (or Sec.  1.1502-51(b) in the 
case of a member of a consolidated group, as defined in Sec.  1.1502-
1(h)).
    Last relevant day. The term last relevant day means the last day of 
a taxable year of a foreign corporation on which the foreign 
corporation is a controlled foreign corporation.
    Multi-year dollar basis account. The term multi-year dollar basis 
account has the meaning provided in Sec.  1.959-11(b)(2)(ii)(B).
    Multi-year PTEP account. The term multi-year PTEP account has the 
meaning provided in Sec.  1.959-11(b)(2)(ii)(A).
    Own. The term own (or ownership or owned), when used with respect 
to stock of a foreign corporation, means to own the stock within the 
meaning of section 958(a) and Sec.  1.958-1(a) (thus determined by 
treating a domestic partnership in the same manner as a foreign 
partnership pursuant to Sec.  1.958-1(d)). When used with respect to 
interests in a partnership, own (or ownership or owned) means to own 
the interests within the meaning of the preceding sentence, determined 
by treating the interests as stock of a foreign corporation.
    Previously taxed earnings and profits. The term previously taxed 
earnings and profits means earnings and profits of a foreign 
corporation that are described in section 959(c)(1) or (2). See Sec.  
1.959-2(b) and (d) for covered shareholder-level and foreign 
corporation-level accounting of previously taxed earnings and profits.
    Prior-law PTEP groups. The term prior-law PTEP groups has the 
meaning provided in Sec.  1.959-11(c)(2)(iii).
    Prior-law PTEP group taxes. The term prior-law PTEP group taxes has 
the meaning provided in Sec.  1.959-11(c)(2)(iii).
    PTEP group. The term PTEP group means any of the groups listed in 
Sec.  1.959-2(b)(2)(i).
    PTEP realization event. The term PTEP realization event has the 
meaning provided in Sec.  1.959-6(b).

[[Page 95412]]

    PTEP subgroup. The term PTEP subgroup means any of the groups 
listed in Sec.  1.959-2(b)(2)(ii).
    PTEP tax pool. The term PTEP tax pool means an account that is 
described in Sec.  1.959-2(b)(1) and that tracks the U.S. dollar amount 
of foreign income taxes associated with previously taxed earnings and 
profits.
    Relevant taxable year. The term relevant taxable year has the 
meaning provided in Sec.  1.959-3(b).
    S corporation. The term S corporation has the meaning provided in 
section 1361(a)(1). See paragraph (c) of this section, providing that 
an S corporation is treated in the same manner as a domestic 
partnership.
    Same priority PTEP. The term same priority PTEP has the meaning 
provided in Sec.  1.959-4(e)(5).
    Section 904 category. The term section 904 category has the meaning 
provided in Sec.  1.960-1(b).
    Section 956 amount. The term section 956 amount has the meaning 
provided in Sec.  1.959-5(c).
    Section 959 regulations. The term section 959 regulations means the 
regulations in this part issued under section 959.
    Section 965(c) deduction percentage. The term section 965(c) 
deduction percentage has the meaning provided in Sec.  1.959-
2(b)(2)(iii)(B).
    Spot rate. The term spot rate has the meaning provided in Sec.  
1.988-1(d).
    Substituted basis property. The term substituted basis property has 
the meaning provided in section 7701(a)(42).
    Successor covered shareholder. The term successor covered 
shareholder has the meaning provided in Sec.  1.959-7(b).
    Subpart F income. The term subpart F income has the meaning 
provided in section 952 and Sec.  1.952-1.
    Taxable year. The term taxable year has the meaning provided in 
section 7701(a)(23), determined by treating a person (as described in 
section 7701(a)(1)) other than an individual that does not otherwise 
have a taxable year as computing taxable income on the basis of the 
calendar year.
    Tested income. The term tested income has the meaning provided in 
section 951A(c)(2) and Sec.  1.951A-2(b)(1).
    Tested loss. The term tested loss has the meaning provided in 
section 951A(c)(2) and Sec.  1.951A-2(b)(2).
    Transferor covered shareholder. The term transferor covered 
shareholder has the meaning provided in Sec.  1.959-7(b).
    United States shareholder. The term United States shareholder has 
the meaning provided in section 951(b) (or, if applicable, section 
953(c)(1)(A)).
    (c) Treatment of an S corporation--(1) In general. Except as 
provided in paragraph (c)(2) of this section, for purposes of the 
section 959 regulations, an S corporation is treated in the same manner 
as a domestic partnership, a reference to a domestic partnership 
includes an S corporation, and shareholders of an S corporation are 
treated as partners of such partnership. See section 1373(a). As 
applicable, the treatment of an S corporation and its shareholders 
under the preceding sentence is determined by replacing any 
partnership-specific provision with the equivalent provision for S 
corporations (for example, a reference to a partner's distributive 
share of a partnership's income refers to a shareholder's pro rata 
share of an S corporation's income).
    (2) Treatment as a covered shareholder for taxable years for which 
elective entity treatment applies for Sec.  1.958-1(d)(1) purposes. See 
Sec.  1.959-11(d) for a rule treating an S corporation as a covered 
shareholder for any taxable year of the S corporation for which Sec.  
1.958-1(d)(1) does not apply and Sec.  1.959-11(e) for a transition 
rule converting S corporation-level accounts (for example, annual PTEP 
accounts) to accounts of covered shareholders owning interests in the S 
corporation once the S corporation is no longer treated as a covered 
shareholder.
    (d) Anti-avoidance rule. If a transaction, series of transactions, 
plan, or arrangement is engaged in with a principal purpose of avoiding 
the purposes of section 959 and the section 959 regulations, then 
appropriate adjustments are made, which may include adjustments to 
disregard the transaction, series of transactions, plan, or 
arrangement.
0
Par. 19. Section 1.959-2 is revised to read as follows:


Sec.  1.959-2  Accounting of previously taxed earnings and profits.

    (a) Scope. This section sets forth rules for shareholder-level and 
foreign corporation-level accounting of a foreign corporation's 
previously taxed earnings and profits. Paragraph (b) of this section 
provides the shareholder-level accounting rules. Paragraph (c) of this 
section provides rules relating to combined pool elections for certain 
covered shareholder-level accounts. Paragraph (d) of this section 
provides the foreign corporation-level accounting rules.
    (b) Shareholder-level accounting--(1) In general. A covered 
shareholder that owns stock of a foreign corporation must establish and 
maintain annual PTEP accounts, dollar basis pools, and PTEP tax pools 
with respect to the foreign corporation in accordance with this 
paragraph (b) and the adjustments prescribed in Sec.  1.959-3. The 
annual PTEP accounts track the foreign corporation's previously taxed 
earnings and profits with respect to the covered shareholder, the 
dollar basis pools track the basis in U.S. dollars of the previously 
taxed earnings and profits, and the PTEP tax pools track the U.S. 
dollar amount of any foreign income taxes associated with the 
previously taxed earnings and profits. See also Sec.  1.1502-59(c)(2), 
treating members of a consolidated group as a single covered 
shareholder for purposes of section 959.
    (2) Annual PTEP accounts--(i) In general. Each annual PTEP account 
must relate to a single taxable year of the foreign corporation and a 
single section 904 category. In addition, previously taxed earnings and 
profits within each annual PTEP account must be maintained in the 
foreign corporation's functional currency and assigned to the PTEP 
groups identified in the following table.

                           Table 1 to Paragraph (b)(2)(i) of This Section--PTEP Groups
----------------------------------------------------------------------------------------------------------------
                 Section 959(c)(1) PTEP groups                            Section 959(c)(2) PTEP groups
----------------------------------------------------------------------------------------------------------------
               Group                        Description                 Group                 Description
----------------------------------------------------------------------------------------------------------------
General section 959(c)(1) PTEP      Earnings and profits        Section 951(a)(1)(A)   Earnings and profits
 group.                              described in section        PTEP group.            described in section
                                     959(c)(1) and not                                  959(c)(2) and not
                                     described in another PTEP                          described in another
                                     group.                                             PTEP group.
Reclassified section 951A PTEP      Earnings and profits        Section 951A PTEP      Earnings and profits
 group.                              described in section        group.                 described in section
                                     959(c)(1) and initially                            959(c)(2) by reason of
                                     assigned to the section                            section 951A.
                                     951A PTEP group.

[[Page 95413]]

 
Reclassified section 245A(d) PTEP   Earnings and profits        Section 245A(d) PTEP   Earnings and profits
 group.                              described in section        group.                 described in section
                                     959(c)(1) and initially                            959(c)(2) by reason of
                                     assigned to the section                            an income inclusion to
                                     245A(d) PTEP group.                                which section 245A(d)
                                                                                        applies.
Reclassified section 965(a) PTEP    Earnings and profits        Section 965(a) PTEP    Earnings and profits
 group.                              described in section        group.                 described in section
                                     959(c)(1) and initially                            959(c)(2) by reason of
                                     assigned to the section                            section 965(a).
                                     965(a) PTEP group.
Reclassified section 965(b) PTEP    Earnings and profits        Section 965(b) PTEP    Earnings and profits
 group.                              described in section        group.                 described in section
                                     959(c)(1) and initially                            959(c)(2) by reason of
                                     assigned to the section                            section 965(b).
                                     965(b) PTEP group.
----------------------------------------------------------------------------------------------------------------

    (ii) Subgroups--(A) In general. To the extent required under Sec.  
1.959-3(c), previously taxed earnings and profits assigned to a PTEP 
group within an annual PTEP account must be further assigned to the 
taxable section 962 PTEP subgroup or taxable section 1411 subgroup. 
These subgroups track previously taxed earnings and profits that will 
be includible in gross income under section 962(d) or includible in net 
investment income under section 1411(c) when distributed to the covered 
shareholder, as applicable.
    (B) Coordination rule. A subgroup described in paragraph 
(b)(2)(ii)(A) of this section is not treated as a separate PTEP group 
for purposes of establishing and maintaining dollar basis pools and 
PTEP tax pools.
    (iii) Percentages with respect to section 965 previously taxed 
earnings and profits--(A) Adjusted applicable percentage. An adjusted 
applicable percentage must be established and maintained with respect 
to all previously taxed earnings and profits assigned to the 
reclassified section 965(a) PTEP group, reclassified section 965(b) 
PTEP group, section 965(a) PTEP group, and section 965(b) PTEP group 
and relating to a single section 904 category (therefore without regard 
to the taxable years to which the previously taxed earnings and profits 
relate). The adjusted applicable percentage tracks the percentage of a 
credit or deduction for foreign income taxes associated with previously 
taxed earnings and profits that is disallowed under Sec.  1.965-5. See 
Sec.  1.959-11(c)(3) for the initial determination of the adjusted 
applicable percentage and Sec.  1.959-3(c)(3) for adjustments.
    (B) Section 965(c) deduction percentage. A section 965(c) deduction 
percentage must be established and maintained with respect to all 
previously taxed earnings and profits assigned to the reclassified 
section 965(a) PTEP group and section 965(a) PTEP group and relating to 
a single section 904 category (therefore without regard to the taxable 
years to which the previously taxed earnings and profits relate). The 
section 965(c) deduction percentage tracks the percentage of foreign 
currency gain or loss with respect to previously taxed earnings and 
profits that is not recognized under Sec.  1.986(c)-1. See Sec.  1.959-
11(c)(4) for the initial determination of the section 965(c) deduction 
percentage and Sec.  1.959-3(c)(3) for adjustments.
    (iv) Deemed taxable years. If previously taxed earnings and profits 
are distributed to an upper-tier foreign corporation or result from the 
application of section 961(c) basis to gain recognized by an upper-tier 
corporation, and the previously taxed earnings and profits relate to a 
taxable year of a lower-tier foreign corporation that includes one or 
more days on which the upper-tier foreign corporation did not exist, 
then, solely for purposes of the establishment and maintenance of 
annual PTEP accounts, the upper-tier corporation is treated as having 
the taxable year or taxable years it would have had if it were to have 
existed on those days, determined based on the manner in which it 
computes its taxable income for its initial taxable year.
    (3) Dollar basis pools. Each dollar basis pool must relate to 
previously taxed earnings and profits assigned to a single PTEP group 
within a single annual PTEP account or, if a combined pool election 
applies to the covered shareholder, previously taxed earnings and 
profits assigned to a single PTEP group and relating to a single 
section 904 category (therefore without regard to the taxable years to 
which the previously taxed earnings and profits relate). Basis within 
each dollar basis pool must be maintained in U.S. dollars.
    (4) PTEP tax pools--(i) In general. Each PTEP tax pool must relate 
to previously taxed earnings and profits assigned to a single PTEP 
group within a single annual PTEP account or, if a combined pool 
election applies to the covered shareholder, previously taxed earnings 
and profits assigned to a single PTEP group and relating to a single 
section 904 category (therefore without regard to the taxable years to 
which the previously taxed earnings and profits relate). Foreign income 
taxes within each PTEP tax pool must be maintained in U.S. dollars.
    (ii) Creditable PTEP tax group. To the extent required under Sec.  
1.959-3(e), foreign income taxes within each PTEP tax pool must be 
assigned to the creditable PTEP tax group. This group tracks foreign 
income taxes that are eligible to be deemed paid under section 960(b).
    (c) Combined pool elections--(1) In general. For purposes of 
paragraph (c) of this section, a combined pool election is made for a 
taxable year of a covered shareholder and, once made, remains in effect 
until revoked. The combined pool election applies with respect to each 
foreign corporation in which the covered shareholder owns stock, 
beginning as of the first day of the first taxable year of the foreign 
corporation that ends with or within the taxable year of the covered 
shareholder for which the combined pool election is made or, if later, 
the first day in which the covered shareholder owns stock of the 
foreign corporation.
    (2) Revocation. A combined pool election may only be revoked with 
the consent of the Commissioner (and in the time and manner specified 
by the Commissioner), and such consent will be granted only in rare and 
unusual circumstances.
    (3) Time and manner of making election--(i) In general. Except as 
otherwise provided by a form, instruction, publication, or other 
guidance, a covered shareholder makes a combined pool election by, for 
a transaction related to a timely filed (including extensions) original 
Federal income tax return of the covered shareholder, computing the 
dollar basis of, or foreign income taxes associated with, previously 
taxed earnings and profits consistent with a combined pool election.

[[Page 95414]]

    (ii) Sixty-month limitation on a subsequent election. A covered 
shareholder is not permitted to make a combined pool election for any 
taxable year beginning less than 60 months after the last day that a 
previous combined pool election applied to the covered shareholder (or 
a predecessor).
    (4) Converting to combined pools. As of the beginning of the first 
day that a covered shareholder's combined pool election applies with 
respect to a foreign corporation, each of the covered shareholder's 
dollar basis pools or PTEP tax pools with respect to the foreign 
corporation (a combined pool) is equal to the sum of all of the dollar 
basis pools or PTEP tax pools, as applicable, that, immediately before 
the combined pool election applies, related to the same PTEP group and 
section 904 category to which the combined pool relates.
    (d) Foreign corporation-level accounting--(1) Corporate PTEP 
accounts. Corporate PTEP accounts must be established and maintained 
with respect to a foreign corporation. Each corporate PTEP account must 
relate to a single covered shareholder, and previously taxed earnings 
and profits within a corporate PTEP account must be assigned to section 
904 categories and the PTEP groups identified in the table to paragraph 
(b)(2)(i) of this section. A corporate PTEP account for a covered 
shareholder is equal to the aggregate of all previously taxed earnings 
and profits that are within such covered shareholder's annual PTEP 
accounts with respect to the foreign corporation. Thus, as a covered 
shareholder's annual PTEP accounts with respect to the foreign 
corporation are adjusted under Sec.  1.959-3, the foreign corporation's 
corporate PTEP account for the covered shareholder and the foreign 
corporation's earnings and profits described in section 959(c)(1) or 
(c)(2) are also adjusted.
    (2) Corporate PTEP tax pools. Corporate PTEP tax pools must be 
established and maintained by a foreign corporation. Each corporate 
PTEP tax pool must relate to a single covered shareholder, and foreign 
income taxes within a corporate PTEP tax pool must be assigned to 
section 904 categories and the PTEP groups identified in the table to 
paragraph (b)(2)(i) of this section. A corporate PTEP tax pool relating 
to a covered shareholder is equal to the aggregate of all foreign 
income taxes that are within that covered shareholder's PTEP tax pools 
with respect to the foreign corporation. Thus, as a covered 
shareholder's PTEP tax pools with respect to the foreign corporation 
are adjusted under Sec.  1.959-3, the foreign corporation's corporate 
PTEP tax pool relating to the covered shareholder is also adjusted. 
Foreign income taxes within a corporate PTEP tax pool that are eligible 
to be deemed paid under section 960(b) are assigned to the creditable 
PTEP tax group within the covered shareholder's PTEP tax pools.
    (3) Earnings and profits determined independently of previously 
taxed earnings and profits. A foreign corporation's earnings and 
profits are determined independently of the foreign corporation's 
previously taxed earnings and profits. Thus, for example, the extent to 
which a distribution is made out of a foreign corporation's earnings 
and profits is determined independently of the foreign corporation's 
corporate PTEP accounts. See section 316. Similarly, a foreign 
corporation's earnings and profits may be less than the foreign 
corporation's previously taxed earning and profits (with the result 
that the foreign corporation has a deficit in earnings and profits 
described in section 959(c)(3)).
0
Par. 20. Section 1.959-3 is revised to read as follows:


Sec.  1.959-3  Adjustments to shareholder-level accounts.

    (a) Scope. This section provides the adjustments under section 959 
to shareholder-level accounts with respect to a foreign corporation. 
Paragraph (b) of this section provides the general rule, pursuant to 
which shareholder-level accounts (annual PTEP accounts, dollar basis 
pools, and PTEP tax pools) are adjusted with respect to a foreign 
corporation to reflect income inclusions relating to, and transactions 
occurring within, the foreign corporation's taxable year. Paragraph (c) 
of this section describes adjustments to annual PTEP accounts. 
Paragraph (d) of this section describes adjustments to dollar basis 
pools. Paragraph (e) of this section describes adjustments to PTEP tax 
pools. Paragraph (f) of this section provides timing rules for when 
adjustments are treated as made. Paragraph (g) of this section provides 
an ordering rule for the application of this section to tiered foreign 
corporations. See also Sec.  1.959-2(d)(1) and (2), providing that as 
shareholder-level accounts are adjusted with respect to a foreign 
corporation under this section, the foreign corporation-level accounts 
are consequently also adjusted.
    (b) In general. To reflect income inclusions and transactions 
related to a taxable year of a foreign corporation (such taxable year 
for which this section is being applied, the relevant taxable year), a 
covered shareholder's annual PTEP accounts, dollar basis pools, and 
PTEP tax pools with respect to the foreign corporation must be adjusted 
in accordance with the rules in this section.
    (c) Adjustments to annual PTEP accounts--(1) In general--(i) 
Increases for amounts included in gross income under section 
951(a)(1)(A). If the foreign corporation is a controlled foreign 
corporation and the covered shareholder includes in gross income its 
pro rata share of the corporation's subpart F income for the relevant 
taxable year under section 951(a)(1)(A) (including by reason of section 
245A(e)(2) or 964(e)(4), but not including an amount described in 
section 959(e)), then, for each annual PTEP account that relates to the 
relevant taxable year and a section 904 category to which a portion of 
the inclusion is assigned (determined at the level of the covered 
shareholder, thus after the application of Sec.  1.904-4(c)), add an 
amount of previously taxed earnings and profits equal to such portion 
to the annual PTEP account. Assign such previously taxed earnings and 
profits to the section 951(a)(1)(A) PTEP group, except assign 
previously taxed earnings and profits to the section 245A(d) PTEP group 
to the extent section 245A(d) applies to the inclusion giving rise to 
the previously taxed earnings and profits (see sections 245A(e)(3) and 
964(e)(4)). If applicable, further assign previously taxed earnings and 
profits to a PTEP subgroup in accordance with paragraph (c)(2) of this 
section.
    (ii) Increases for amounts included in gross income under section 
951A(a). If the foreign corporation is a controlled foreign corporation 
and the covered shareholder includes in gross income the portion of its 
GILTI inclusion amount that is treated as with respect to the 
corporation for the relevant taxable year under section 951A(a) and 
(f)(2), then, for each annual PTEP account that relates to the relevant 
taxable year and a section 904 category to which a portion of the 
inclusion is assigned (determined at the level of the covered 
shareholder, thus after the application of Sec.  1.904-4(c)), add an 
amount of previously taxed earnings and profits equal to such portion 
to the annual PTEP account. Assign such previously taxed earnings and 
profits to the section 951A PTEP group. If applicable, further assign 
previously taxed earnings and profits to a PTEP subgroup in accordance 
with paragraph (c)(2) of this section.
    (iii) Increases for receipt of distributed previously taxed 
earnings and profits. If, during the relevant taxable year, previously 
taxed earnings and profits with respect to the covered shareholder

[[Page 95415]]

are distributed to the foreign corporation in a covered distribution 
(determined under Sec.  1.959-4), then add such distributed previously 
taxed earnings and profits to the annual PTEP accounts in accordance 
with paragraph (c)(3) of this section.
    (iv) Increases for previously taxed earnings and profits resulting 
from section 961(c) basis. If, during the relevant taxable year, 
previously taxed earnings and profits with respect to the covered 
shareholder result from the application of positive section 961(c) 
basis to covered gain recognized by the foreign corporation (determined 
under Sec.  1.961-9), then add such resulting previously taxed earnings 
and profits to the annual PTEP accounts in accordance with paragraph 
(c)(3) of this section.
    (v) Decreases for current year taxes. If previously taxed earnings 
and profits are added to a PTEP group within an annual PTEP account 
pursuant to paragraph (c)(1)(iii) or (iv) of this section, then reduce 
the previously taxed earnings and profits in that PTEP group by the 
amount of the current year taxes allocated and apportioned under Sec.  
1.959-6 to the corresponding PTEP group of the foreign corporation. The 
corresponding PTEP group of the foreign corporation is the PTEP group 
of the foreign corporation that is of the same type as the increased 
PTEP group and that is within a corporate PTEP account of the foreign 
corporation that is with respect to the covered shareholder. If the 
PTEP group of that type in multiple annual PTEP accounts increases 
pursuant to paragraph (c)(1)(iii) or (iv) of this section, apportion 
the amount of the current year taxes allocated and apportioned under 
Sec.  1.959-6 to the corresponding PTEP group of the foreign 
corporation among those increased PTEP groups under the principles of 
Sec.  1.861-20.
    (vi) Decreases for distributed previously taxed earnings and 
profits. If, during the relevant taxable year, the foreign corporation 
distributes previously taxed earnings and profits with respect to the 
covered shareholder in a covered distribution (determined under Sec.  
1.959-4), then remove such distributed previously taxed earnings and 
profits from the annual PTEP accounts.
    (vii) Increases for amounts included in gross income as a dividend 
under section 1248(a) or (f). If, during the relevant taxable year, 
gain recognized by the covered shareholder is included in gross income 
as a dividend under section 1248(a) or (f) by reason of earnings and 
profits of the foreign corporation, then, for each annual PTEP account 
that relates to the relevant taxable year and a section 904 category to 
which a portion of the inclusion is assigned (determined at the level 
of the covered shareholder, thus after the application of Sec.  1.904-
4(c)), add an amount of previously taxed earnings and profits equal to 
such portion to the annual PTEP account (see section 959(e)). Assign 
such previously taxed earnings and profits to the section 951(a)(1)(A) 
PTEP group, except assign previously taxed earnings and profits to the 
section 245A(d) PTEP group to the extent section 245A(d) applies to the 
inclusion giving rise to the previously taxed earnings and profits 
(including by reason of section 245A(e)(3)). If applicable, further 
assign previously taxed earnings and profits to a PTEP subgroup in 
accordance with paragraph (c)(2) of this section.
    (viii) Decreases with respect to transferor covered shareholder for 
transferred previously taxed earnings and profits. If, during the 
relevant taxable year, previously taxed earnings and profits of the 
foreign corporation transfer from the covered shareholder in a general 
successor transaction (determined under Sec.  1.959-7), then remove 
such transferred previously taxed earnings and profits from the annual 
PTEP accounts.
    (ix) Increases with respect to successor covered shareholder for 
transferred previously taxed earnings and profits. If, during the 
relevant taxable year, previously taxed earnings and profits of the 
foreign corporation transfer to the covered shareholder in a general 
successor transaction (determined under Sec.  1.959-7), then add such 
transferred previously taxed earnings and profits to the annual PTEP 
accounts in accordance with paragraph (c)(3) of this section.
    (x) Reassignments for previously taxed earnings and profits to 
which a section 956 amount is allocated. If the foreign corporation is 
a controlled foreign corporation and a portion of the covered 
shareholder's section 956 amount with respect to the corporation for 
the relevant taxable year is allocated to previously taxed earnings and 
profits (determined under Sec.  1.959-5), then reassign such previously 
taxed earnings and profits from a section 959(c)(2) PTEP group to the 
section 959(c)(1) PTEP group in the same row in the table in Sec.  
1.959-2(b)(2)(i). If applicable, further assign previously taxed 
earnings and profits to the PTEP subgroup to which they relate. See 
paragraph (c)(4) of this section in the case of certain acquisitions of 
stock to which a section 956 amount of another shareholder is 
attributable.
    (xi) Increases for amounts included in gross income under section 
951(a)(1)(B). If the foreign corporation is a controlled foreign 
corporation and the covered shareholder includes in gross income a 
portion of its section 956 amount with respect to the corporation for 
the relevant taxable year under section 951(a)(1)(B), then, for each 
annual PTEP account that relates to the relevant taxable year and a 
section 904 category to which a portion of the inclusion is assigned 
(determined at the level of the covered shareholder, thus after the 
application of Sec.  1.904-4(c)), add an amount of previously taxed 
earnings and profits equal to such portion to the annual PTEP account. 
Assign such previously taxed earnings and profits to the general 
section 959(c)(1) PTEP group. If applicable, further assign previously 
taxed earnings and profits to a PTEP subgroup in accordance with 
paragraph (c)(2) of this section. See paragraph (c)(4) of this section 
in the case of certain acquisitions of stock to which a section 956 
amount of another shareholder is attributable.
    (2) Assignment to PTEP subgroups--(i) Taxable section 962 PTEP 
subgroup. If the covered shareholder is an individual and an election 
under Sec.  1.962-2 applies to the covered shareholder's income 
inclusions under section 951(a) or 951A(a) for the relevant taxable 
year, then further assign a portion of previously taxed earnings and 
profits added pursuant to paragraph (c)(1)(i), (ii), or (xi) of this 
section (section 951(a) or 951A(a) inclusions) to the taxable section 
962 PTEP subgroup. The portion of previously taxed earnings and profits 
assigned to the taxable section 962 PTEP subgroup is equal to the 
excess of the previously taxed earnings and profits over the income tax 
paid under this chapter on the income inclusions giving rise to the 
previously taxed earnings and profits (determined by translating such 
tax into the foreign corporation's functional currency at the exchange 
rate at which the income inclusion is translated into U.S. dollars 
under section 989(b)).
    (ii) Taxable section 1411 PTEP subgroup. If the covered shareholder 
is an individual, estate, or trust, then further assign previously 
taxed earnings and profits added pursuant to paragraph (c)(1)(i), (ii), 
(vii), and (xi) of this section (section 951(a), 951A(a), or 1248(a) or 
(f) inclusions) to the taxable section 1411 PTEP subgroup to the extent 
the income inclusion giving rise to the previously taxed earnings and 
profits is not taken into account in determining net investment income 
under Sec.  1.1411-4(a)(1)(i).

[[Page 95416]]

    (3) Preserving the character of previously taxed earnings and 
profits--(i) In general. Add previously taxed earnings and profits that 
are described in paragraph (c)(1)(iii), (iv), or (ix) of this section 
(previously taxed earnings and profits received in a distribution, 
resulting from section 961(c) basis, or transferred to the covered 
shareholder) and that relate to a single section 904 category and 
single taxable year to the annual PTEP account that relates to such 
section 904 category and such taxable year or a taxable year (including 
a deemed taxable year) that ends with, or closest to, the last day of 
such taxable year, as applicable. Assign the previously taxed earnings 
and profits to the PTEP group, and if applicable PTEP subgroup, to 
which they relate. See Sec.  1.959-4, 1.959-7, or 1.961-9 for rules 
determining the character of previously taxed earnings and profits 
received, transferred, or resulting from section 961(c) basis, 
respectively.
    (ii) Recalculate percentages with respect to section 965 previously 
taxed earnings and profits--(A) In general. If applicable in adding 
previously taxed earnings and profits described in paragraph 
(c)(1)(iii), (iv), or (ix) of this section (previously taxed earnings 
and profits received in a distribution, resulting from section 961(c) 
basis, or transferred to the covered shareholder) to annual PTEP 
accounts relating to the same section 904 category, recalculate an 
adjusted applicable percentage or section 965(c) deduction percentage 
with respect to relevant previously taxed earnings and profits within 
such annual PTEP accounts so that the percentage is a weighted average 
of--
    (1) The adjusted applicable percentage or section 965(c) deduction 
percentage with respect to relevant previously taxed earnings and 
profits within the annual PTEP accounts immediately before the 
addition; and
    (2) The adjusted applicable percentage or section 965(c) deduction 
percentage with respect to relevant previously taxed earnings and 
profits added to the annual PTEP accounts.
    (B) Determining the weighted average. The weighted average is 
determined as the sum of the product of each percentage described in 
paragraph (c)(3)(ii)(A)(1) or (2) of this section and the amount of 
previously taxed earnings and profits described in that paragraph, 
divided by the sum of the amounts of previously taxed earnings and 
profits described in those paragraphs.
    (4) Certain acquisitions of stock to which a section 956 amount is 
attributable. If the covered shareholder acquires ownership of stock of 
the foreign corporation during the relevant taxable year but on or 
after the last relevant day of the relevant taxable year (for example, 
in a general successor transaction), and a portion of a section 956 
amount of a United States shareholder is attributable to such stock, 
then treat such portion of the section 956 amount and any inclusion 
thereof in gross income of the United States shareholder as being of 
the covered shareholder for purposes of paragraphs (c)(1)(x) and (xi) 
of this section.
    (5) Currency rule. All adjustments to annual PTEP accounts are made 
in the functional currency of the foreign corporation, determined, as 
applicable, by translating an inclusion described in paragraph 
(c)(1)(ii) of this section into functional currency at the average 
exchange rate for the relevant taxable year (see Sec.  1.951A-5(b)(3)) 
and by translating previously taxed earnings and profits described in 
paragraph (c)(1)(iii) of this section into functional currency at the 
spot rate on the day of the distribution (see section 989(b)). See also 
Sec.  1.961-9 (determining previously taxed earnings and profits 
described in paragraph (c)(1)(iv) of this section in functional 
currency), and Sec.  1.959-6 (determining current year taxes described 
in paragraph (c)(1)(v) of this section in functional currency).
    (d) Adjustments to dollar basis pools--(1) In general--(i) 
Increases for U.S. dollar amount of income inclusions under sections 
951(a), 951A(a), and 1248(a) or (f). For each addition pursuant to 
paragraph (c)(1)(i), (ii), (vii), or (xi) of this section of previously 
taxed earnings and profits relating to a single dollar basis pool, add 
an amount of basis equal to the income inclusion under section 951(a), 
951A(a), or 1248(a) or (f) giving rise to such previously taxed 
earnings and profits to the dollar basis pool.
    (ii) Increases for dollar basis of received or resulting previously 
taxed earnings and profits. For each addition pursuant to paragraph 
(c)(1)(iii) or (iv) of this section of previously taxed earnings and 
profits relating to a single dollar basis pool, add the dollar basis of 
such previously taxed earnings and profits (determined under Sec.  
1.959-4 or 1.961-9, as applicable) to the dollar basis pool.
    (iii) Decreases for current year taxes. For each reduction pursuant 
to paragraph (c)(1)(v) of this section to previously taxed earning and 
profits relating to a single dollar basis pool, reduce the basis in the 
dollar basis pool by the amount of the current year taxes giving rise 
to the reduction.
    (iv) Decreases for dollar basis of distributed or transferred 
previously taxed earnings and profits. For each removal pursuant to 
paragraph (c)(1)(vi) or (viii) of this section of previously taxed 
earnings and profits relating to a single dollar basis pool, remove the 
dollar basis of such previously taxed earnings and profits (determined 
under Sec.  1.959-4 or 1.959-7, as applicable) from the dollar basis 
pool.
    (v) Increases for dollar basis of transferred previously taxed 
earnings and profits, adjusted for foreign currency gain or loss. For 
each addition pursuant to paragraph (c)(1)(ix) of this section of 
previously taxed earnings and profits relating to a single dollar basis 
pool, add the dollar basis of such previously taxed earnings and 
profits (determined under Sec.  1.959-7 and adjusted in accordance with 
the next sentence) to the dollar basis pool. In applying the preceding 
sentence, increase (or decrease) the dollar basis of transferred 
previously taxed earnings and profits by foreign currency gain (or 
foreign currency loss) that the transferor covered shareholder 
recognizes with respect to the previously taxed earnings and profits. 
In addition, determine such foreign currency gain or loss without 
regard to Sec.  1.986-1(c)(3)(i) and (ii) (limitations for previously 
taxed earnings and profits resulting from section 965) and by treating 
the deemed covered shareholder in the same manner as a covered 
shareholder.
    (vi) Adjustments for dollar basis of previously taxed earnings and 
profits to which a section 956 amount is allocated. For each 
reassignment pursuant to paragraph (c)(1)(x) of this section of 
previously taxed earnings and profits relating to a single dollar basis 
pool, remove the dollar basis of such previously taxed earnings and 
profits (determined under Sec.  1.959-5) from the dollar basis pool 
relating to the section 959(c)(2) PTEP group from which the previously 
taxed earnings and profits are reassigned and add such basis to the 
dollar basis pool relating to the section 959(c)(1) PTEP group to which 
the previously taxed earnings and profits are reassigned.
    (2) Currency rule. All adjustments to dollar basis pools are made 
in U.S. dollars, determined, as applicable, by translating inclusions 
described in paragraph (d)(1)(i) of this section into U.S. dollars in 
accordance with section 989(b) and current year taxes described in 
paragraph (d)(1)(iii) of this section into U.S. dollars in accordance 
with section 986(a) and Sec.  1.986(a)-1.
    (e) Adjustments to PTEP tax pools--(1) In general--(i) Increases 
for foreign income taxes associated with previously taxed earnings and 
profits received. For each addition pursuant to paragraph (c)(1)(iii) 
of this section of previously

[[Page 95417]]

taxed earnings and profits relating to a single PTEP tax pool, add the 
foreign income taxes that are associated with such previously taxed 
earnings and profits (determined under Sec.  1.959-4(g)) to the PTEP 
tax pool. Assign such associated foreign income taxes to the creditable 
PTEP tax group only to the extent the foreign corporation is deemed to 
pay the taxes under section 960(b)(2) and Sec.  1.960-3(c). See 
paragraph (e)(1)(ii) of this section for increases to PTEP tax pools 
for current year taxes paid or accrued by the foreign corporation on 
the receipt of the previously taxed earnings and profits.
    (ii) Increases for current year taxes. For each reduction pursuant 
to paragraph (c)(1)(v) of this section to previously taxed earnings and 
profits relating to a single PTEP tax pool, add to the PTEP tax pool 
the current year taxes giving rise to the reduction. Assign such 
current year taxes to the creditable PTEP tax group only if the foreign 
corporation is a controlled foreign corporation when the taxes are paid 
or accrued and a credit for the taxes is not disallowed or suspended at 
the level of the controlled foreign corporation (see, for example, 
section 245A(e)(3) and Sec.  1.245A(d)-1(a)(2) and sections 901(k)(1), 
(l), and (m), 909, and 6038(c)(1)(B)).
    (iii) Decreases for foreign income taxes associated with 
distributed or transferred previously taxed earnings and profits. For 
each removal pursuant to paragraph (c)(1)(vi) or (viii) of this section 
of previously taxed earnings and profits relating to a single PTEP tax 
pool, remove the foreign income taxes that are associated with such 
previously taxed earnings and profits (determined under Sec.  1.959-4 
or 1.959-7, as applicable) from the PTEP tax pool.
    (iv) Increases for foreign income taxes associated with transferred 
previously taxed earnings and profits. For each addition pursuant to 
paragraph (c)(1)(ix) of this section of previously taxed earnings and 
profits relating to a single PTEP tax pool, add the foreign income 
taxes that are associated with such previously taxed earnings and 
profits (determined under Sec.  1.959-7) to the PTEP tax pool. Assign 
such associated foreign income taxes to the creditable PTEP tax group 
only to the extent the taxes related to the creditable PTEP tax group 
immediately before the general successor transaction.
    (v) Adjustments for foreign income taxes associated with previously 
taxed earnings and profits to which a section 956 amount is allocated. 
For each reassignment pursuant to paragraph (c)(1)(x) of this section 
of previously taxed earnings and profits relating to a single PTEP tax 
pool, remove the foreign income taxes that are associated with such 
previously taxed earnings and profits (determined under Sec.  1.959-5) 
from the PTEP tax pool relating to the section 959(c)(2) PTEP group 
from which the previously taxed earnings and profits are reassigned and 
add such foreign income taxes to the PTEP tax pool relating to the 
section 959(c)(1) PTEP group to which the previously taxed earnings and 
profits are reassigned. Assign such associated foreign income taxes to 
the creditable PTEP tax group only to the extent the taxes relate to 
the creditable PTEP tax group immediately before the reassignment.
    (2) Currency rule. All adjustments to PTEP tax pools are made in 
U.S. dollars, determined, as applicable, by translating current year 
taxes described in paragraph (e)(1)(ii) of this section into U.S. 
dollars in accordance with section 986(a) and Sec.  1.986(a)-1.
    (f) Timing of adjustments--(1) Annual PTEP accounts. An adjustment 
to an annual PTEP account is treated as made in accordance with the 
timing rules in the following table. In the case of adjustments 
described in paragraphs (c)(1)(iii) through (xi) of this section that 
are treated as made at the same time, such adjustments are treated as 
made at that time in sequence (starting with the adjustment in the 
earliest paragraph).

   Table 1 to Paragraph (f)(1) of This Section--Timing of Annual PTEP
                           Account Adjustments
------------------------------------------------------------------------
                                                         When adjustment
 Adjustment described in this         Description         is treated as
            section                                           made
------------------------------------------------------------------------
Paragraph (c)(1)(i)...........  Increases for amounts   Beginning of the
                                 included in gross       first day of
                                 income under section    the relevant
                                 951(a)(1)(A).           taxable year.
Paragraph (c)(1)(ii)..........  Increases for amounts
                                 included in gross
                                 income under section
                                 951A(a).
Paragraph (c)(1)(iii).........  Increases for receipt
                                 of distributed
                                 previously taxed
                                 earnings and profits.
Paragraph (c)(1)(iv)..........  Increases for
                                 previously taxed
                                 earnings and profits
                                 resulting from
                                 section 961(c) basis.
Paragraph (c)(1)(v)...........  Decreases for current
                                 year taxes.
Paragraph (c)(1)(vi)..........  Decreases for           Concurrently
                                 distributed             with the
                                 previously taxed        covered
                                 earnings and profits.   distribution.
Paragraph (c)(1)(vii).........  Increases for amounts   Concurrently
                                 included in gross       with the sale
                                 income as a dividend    or exchange.
                                 under section 1248.
Paragraph (c)(1)(viii)........  Decreases for           Concurrently
                                 transferred             with the
                                 previously taxed        general
                                 earnings and profits.   successor
                                                         transaction.
Paragraph (c)(1)(ix)..........  Increases for
                                 transferred
                                 previously taxed
                                 earnings and profits.
Paragraph (c)(1)(x)...........  Reassignments for       End of the last
                                 previously taxed        day of the
                                 earnings and profits    relevant
                                 to which a section      taxable year.
                                 956 amount is
                                 allocated.
Paragraph (c)(1)(xi)..........  Increases for amounts
                                 included in gross
                                 income under section
                                 951(a)(1)(B).
------------------------------------------------------------------------

    (2) Dollar basis pools. An adjustment to a dollar basis pool is 
treated as made concurrently with the related adjustment described in 
paragraph (c) of this section.
    (3) PTEP tax pools. An adjustment to a PTEP tax pool is treated as 
made concurrently with the related adjustment described in paragraph 
(c) of this section.
    (g) Bottom-up application to tiered foreign corporations. For 
purposes of applying this section to tiered foreign corporations, this 
section is applied first to the foreign corporation at the lowest

[[Page 95418]]

tier, then to the foreign corporation at the next lowest tier, and so 
on.
0
Par. 21. Section 1.959-4 is revised to read as follows:


Sec.  1.959-4  Exclusion from gross income of previously taxed earnings 
and profits received in a distribution.

    (a) Scope. This section provides the rules for distributions of 
previously taxed earnings and profits under section 959. Paragraph (b) 
of this section excludes previously taxed earnings and profits received 
by a covered shareholder or controlled foreign corporation in a 
distribution from gross income. Paragraph (c) of this section defines a 
covered distribution. Paragraph (d) of this section describes rules for 
analyzing a covered distribution, including rules for determining the 
extent to which a covered distribution is a distribution of previously 
taxed earnings and profits. Paragraph (e) of this section provides 
rules for allocating covered distributions to earnings and profits. 
Paragraph (f) of this section provides a dollar basis rule. Paragraph 
(g) of this section provides an associated foreign income taxes rule. 
See Sec.  1.959-10(c)(1) and (2) (Examples 1 and 2) for examples 
illustrating the application of this section. See also Sec. Sec.  
1.367(b)-2(j)(2)(ii) and 1.367(b)-3(g)(1) for deemed distributions of 
previously taxed earnings and profits under other provisions of the 
Code.
    (b) Exclusion from gross income--(1) Distribution by a foreign 
corporation to a covered shareholder. Previously taxed earnings and 
profits that are distributed to a covered shareholder, other than 
previously taxed earnings and profits relating to the taxable section 
962 PTEP subgroup, are excluded from the covered shareholder's gross 
income.
    (2) Distribution by a controlled foreign corporation to another 
controlled foreign corporation--(i) In general. Previously taxed 
earnings and profits that are distributed by a controlled foreign 
corporation to another controlled foreign corporation are excluded from 
the recipient controlled foreign corporation's gross income, solely for 
purposes of determining the recipient controlled foreign corporation's 
subpart F income and tested income or tested loss, and provided that 
the covered shareholder to which the previously taxed earnings and 
profits relate is a United States shareholder in both controlled 
foreign corporations.
    (ii) Treatment of a specified foreign corporation as a controlled 
foreign corporation. A specified foreign corporation (as defined in 
Sec.  1.965-1(f)(45)(i)(B)) that is not otherwise a controlled foreign 
corporation is treated as a controlled foreign corporation for purposes 
of applying paragraph (b)(2)(i) of this section to previously taxed 
earnings and profits resulting from the application of section 965 that 
are distributed by the specified foreign corporation.
    (3) Additional consequences. Upon a distribution of previously 
taxed earnings and profits, see paragraph (d)(5) of this section for 
adjustments to previously taxed earnings and profits, Sec.  1.961-4 for 
basis adjustments, Sec.  1.986(c)-1 for recognition of foreign currency 
gain or loss if the distribution is to a covered shareholder, and Sec.  
1.960-3 for deemed paid foreign income taxes if the distribution is to 
a United States shareholder that is a corporation or to a controlled 
foreign corporation. See also section 962(d) (previously taxed earnings 
and profits distributed to a covered shareholder and relating to the 
taxable section 962 PTEP subgroup are included in gross income); Sec.  
1.1411-10(c)(1)(i)(A)(1) (previously taxed earnings and profits 
distributed to a covered shareholder and relating to the taxable 
section 1411 subgroup are included in net investment income).
    (c) Covered distribution--(1) In general. A covered distribution is 
a distribution of property made by a foreign corporation to its 
shareholders with respect to its stock, to the extent that the 
distribution is a dividend (as defined in section 316), determined 
without regard to section 959(d), and not including an amount treated 
as a dividend by reason of section 78, 367(b), 964(e)(1), or 1248. In a 
covered distribution, previously taxed earnings and profits are 
distributed in accordance with the rules described in paragraph (d) of 
this section.
    (2) [Reserved]
    (3) Treatment of a partner's distributive share of a covered 
distribution. For purposes of the section 959 regulations, if a portion 
of a covered distribution is made or is treated as made under this 
paragraph (c)(3) to a partnership, a partner's distributive share of 
such portion is treated as a portion of the covered distribution made 
to the partner.
    (d) Rules for analyzing a covered distribution--(1) Determine each 
covered shareholder's share of the covered distribution. First, 
determine each covered shareholder's share of the covered distribution, 
computed as the sum of--
    (i) Any portion of the covered distribution that is made to the 
covered shareholder, and
    (ii) Any portions of the covered distribution that are made to 
upper-tier foreign corporations and assigned to the covered shareholder 
under Sec.  1.951-2.
    (2) Determine distributed previously taxed earnings and profits. 
Second, determine the extent to which each covered shareholder's share 
of the covered distribution is a distribution of previously taxed 
earnings and profits in accordance with paragraph (e) of this section.
    (3) Determine dollar basis and associated foreign income taxes. 
Third, determine the dollar basis of, and foreign income taxes 
associated with, distributed previously taxed earnings and profits in 
accordance with paragraphs (f) and (g) of this section.
    (4) Treat distributed previously taxed earnings and profits as 
distributed pro rata with respect to shares of stock of the foreign 
corporation. Fourth, treat a pro rata portion of all previously taxed 
earnings and profits distributed in each covered shareholder's share of 
the covered distribution as distributed with respect to each share of 
stock of the foreign corporation owned by the covered shareholder, 
determined by multiplying all such previously taxed earnings and 
profits by a fraction. The numerator of the fraction is the sum of any 
portion of the covered distribution that is made with respect to the 
share of stock to the covered shareholder and any portions of the 
covered distribution that are made with respect to the share of stock 
to upper-tier foreign corporations and assigned to the covered 
shareholder under Sec.  1.951-2. The denominator of the fraction is the 
amount of the covered shareholder's share of the covered distribution.
    (5) Adjust previously taxed earnings and profits and make related 
account adjustments. Fifth, decrease the distributing foreign 
corporation's previously taxed earnings and profits, and if applicable 
increase a recipient foreign corporation's previously taxed earnings 
and profits, to reflect the covered distribution and make the related 
adjustments described in Sec.  1.959-3 to each covered shareholder's 
accounts.
    (e) Allocation of distributions--(1) In general. A covered 
shareholder's share of a covered distribution (determined under 
paragraph (d)(1) of this section) is first allocated to previously 
taxed earnings and profits of the foreign corporation that are with 
respect to the covered shareholder immediately before the covered 
distribution (as reflected in the covered shareholder's annual PTEP 
accounts with respect to the foreign corporation), to the extent 
thereof and in accordance with paragraphs (e)(2) through (5) of this 
section. Any remaining portion of such share is

[[Page 95419]]

allocated to the foreign corporation's earnings and profits described 
in section 959(c)(3).
    (2) Priority rules--(i) Section 959(c)(1) rule. Allocate the 
covered shareholder's share of the covered distribution first to 
previously taxed earnings and profits assigned to a section 959(c)(1) 
PTEP group and then to previously taxed earnings and profits assigned 
to a section 959(c)(2) PTEP group.
    (ii) Rules within section 959(c)(1) PTEP groups. In allocating the 
covered shareholder's share of the covered distribution to previously 
taxed earnings and profits assigned to section 959(c)(1) PTEP groups, 
allocate first to previously taxed earnings and profits assigned to the 
reclassified section 965(a) PTEP group, then to previously taxed 
earnings and profits assigned to the reclassified section 965(b) PTEP 
group, and finally to previously taxed earnings and profits assigned to 
the remaining section 959(c)(1) PTEP groups.
    (iii) Rules within section 959(c)(2) PTEP groups. In allocating the 
covered shareholder's share of the covered distribution to previously 
taxed earnings and profits assigned to section 959(c)(2) PTEP groups, 
allocate first to previously taxed earnings and profits assigned to the 
section 965(a) PTEP group, then to previously taxed earnings and 
profits assigned to the section 965(b) PTEP group, and finally to 
previously taxed earnings and profits assigned to the remaining section 
959(c)(2) PTEP groups.
    (3) Last-in, first-out rule. In allocating the covered 
shareholder's share of the covered distribution to previously taxed 
earnings and profits assigned to a single PTEP group or PTEP groups 
with the same priority (for example, the section 951(a)(1)(A) PTEP 
group, section 951A PTEP group, and section 245A(d) PTEP group), 
allocate first to previously taxed earnings and profits that relate to 
the most recent taxable year, then to previously taxed earnings and 
profits that relate to the next most recent taxable year, and so on.
    (4) Section 962 ordering rule. In allocating the covered 
shareholder's share of the covered distribution to previously taxed 
earnings and profits that are assigned to a single PTEP group or PTEP 
groups with the same priority and that relate to the same taxable year, 
allocate first to previously taxed earnings and profits that are not 
assigned to the taxable section 962 PTEP subgroup, and then to 
previously taxed earnings and profits that are assigned to such 
subgroup.
    (5) Pro rata rule. In allocating the covered shareholder's share of 
the covered distribution to previously taxed earnings and profits that 
are assigned to a single PTEP group or PTEP groups with the same 
priority and that relate to the same taxable year and have the same 
classification for section 962 purposes (same priority PTEP), allocate 
to a pro rata portion of same priority PTEP, determined by multiplying 
all same priority PTEP by a fraction, the numerator of which is the 
amount to be allocated to same priority PTEP, and the denominator of 
which is the amount of same priority PTEP.
    (f) Dollar basis rule. The dollar basis of previously taxed 
earnings and profits distributed in a covered shareholder's share of a 
covered distribution (determined under paragraph (d)(2) of this 
section) is computed separately with respect to previously taxed 
earnings and profits relating to a single dollar basis pool, and in 
each case is equal to a pro rata portion of the dollar basis pool 
immediately before the covered distribution. The pro rata portion is 
determined by multiplying all basis in the dollar basis pool by a 
fraction, the numerator of which is previously taxed earnings and 
profits distributed in the covered shareholder's share of the covered 
distribution and relating to the dollar basis pool, and the denominator 
of which is all previously taxed earnings and profits relating to the 
dollar basis pool.
    (g) Associated foreign income taxes rule. The foreign income taxes 
that are associated with previously taxed earnings and profits 
distributed in a covered shareholder's share of a covered distribution 
(determined under paragraph (d)(2) of this section) are computed 
separately with respect to previously taxed earnings and profits 
relating to a single PTEP tax pool, and in each case are equal to a pro 
rata portion of the PTEP tax pool immediately before the covered 
distribution. The pro rata portion is determined by multiplying all 
foreign income taxes in the PTEP tax pool by a fraction, the numerator 
of which is previously taxed earnings and profits distributed in the 
covered shareholder's share of the covered distribution and relating to 
the PTEP tax pool, and the denominator of which is all previously taxed 
earnings and profits relating to the PTEP tax pool. Thus, associated 
foreign income taxes are sourced pro rata from foreign income taxes 
assigned to the creditable PTEP tax group in the PTEP tax pool and 
other foreign income taxes in the PTEP tax pool.
0
Par. 22. Sections 1.959-5 through 1.959-12 are added to read as 
follows:

Sec.
* * * * *
1.959-5 Exclusion of a section 956 amount from gross income to the 
extent allocated to previously taxed earnings and profits.
1.959-6 Allocating and apportioning current year taxes to previously 
taxed earnings and profits of a foreign corporation.
1.959-7 General successor transactions.
1.959-8 and 1.959-9 [Reserved]
1.959-10 Examples.
1.959-11 Transition rules.
1.959-12 Applicability dates.
* * * * *


Sec.  1.959-5  Exclusion of a section 956 amount from gross income to 
the extent allocated to previously taxed earnings and profits.

    (a) Scope. This section provides rules for previously taxed 
earnings and profits to which a section 956 amount is allocated. 
Paragraph (b) of this section defines a section 956 amount. Paragraph 
(c) of this section describes rules for analyzing a section 956 amount, 
including rules for determining the extent to which a section 956 
amount is excluded from gross income under section 959(a)(2). Paragraph 
(d) of this section provides rules for allocating a section 956 amount 
to previously taxed earnings and profits. Paragraph (e) of this section 
provides a dollar basis rule. Paragraph (f) of this section provides an 
associated foreign income taxes rule. See Sec.  1.959-10(c)(4) (Example 
4) for an example illustrating the application of this section.
    (b) Section 956 amount. A section 956 amount is the amount 
determined under section 956 and Sec.  1.956-1 with respect to a 
covered shareholder and a controlled foreign corporation. A section 956 
amount is excluded from gross income in accordance with the rules 
described in paragraph (c) of this section.
    (c) Rules for analyzing a section 956 amount--(1) Determine the 
portion of the section 956 amount excluded from gross income under 
section 959(a)(2). First, the portion of the section 956 amount that it 
is allocated to section 959(c)(2) previously taxed earnings and 
profits, which is determined in accordance with paragraph (d) of this 
section, is excluded from the covered shareholder's gross income.
    (2) Determine dollar basis and associated foreign income taxes. 
Second, determine the dollar basis of, and foreign income taxes 
associated with, previously taxed earnings and profits to which the 
section 956 amount is allocated in accordance with paragraphs (e) and 
(f) of this section.
    (3) Adjust previously taxed earnings and profits and make related 
account

[[Page 95420]]

adjustments. Third, reassign the controlled foreign corporation's 
previously taxed earnings and profits to which the section 956 amount 
is allocated from section 959(c)(2) PTEP groups to section 959(c)(1) 
PTEP groups, and if applicable increase the controlled foreign 
corporation's previously taxed earnings and profits assigned to the 
general section 959(c)(1) PTEP group by reason of section 951(a)(1)(B), 
to reflect the section 956 amount and make the related adjustments 
described in Sec.  1.959-3.
    (d) Allocation of section 956 amounts--(1) In general. A covered 
shareholder's section 956 amount is first allocated to previously taxed 
earnings and profits of the controlled foreign corporation that are 
with respect to the covered shareholder and assigned to section 
959(c)(2) PTEP groups (determined as described in paragraph (d)(2) of 
this section)), to the extent thereof and in accordance with the 
principles of Sec.  1.959-4(e)(2)(iii) through (5). Any remaining 
portion of the section 956 amount is allocated to the controlled 
foreign corporation's earnings and profits described in section 
959(c)(3).
    (2) Determination of previously taxed earnings and profits. In 
applying paragraph (d)(1) of this section, previously taxed earnings 
and profits are determined on the last relevant day of the controlled 
foreign corporation's taxable year to which the section 956 amount 
relates, but are reduced to the extent distributed during the taxable 
year, and are determined without regard to any transfer of previously 
taxed earnings and profits from the covered shareholder on (or after) 
the last relevant day of the taxable year.
    (e) Dollar basis rule. The dollar basis of previously taxed 
earnings and profits to which a covered shareholder's section 956 
amount is allocated (determined under paragraph (d)(1) of this section) 
is computed separately with respect to previously taxed earnings and 
profits relating to a single dollar basis pool, and in each case is 
equal to a pro rata portion of the dollar basis pool determined in the 
same manner as previously taxed earnings and profits are determined in 
paragraph (d)(2) of this section. The pro rata portion is determined by 
multiplying all basis in the dollar basis pool by a fraction, the 
numerator of which is previously taxed earnings and profits to which 
the section 956 amount is allocated and relating to the dollar basis 
pool, and the denominator of the which is all previously taxed earnings 
and profits relating to the dollar basis pool.
    (f) Associated foreign income taxes rule. The foreign income taxes 
that are associated with previously taxed earnings and profits to which 
a covered shareholder's section 956 amount is allocated (determined 
under paragraph (d)(1) of this section) are computed separately with 
respect to previously taxed earnings and profits relating to a single 
PTEP tax pool, and in each case are equal to a pro rata portion of the 
PTEP tax pool determined in the same manner as previously taxed 
earnings and profits are determined in paragraph (d)(2) of this 
section. The pro rata portion is determined by multiplying all foreign 
income taxes in the PTEP tax pool by a fraction, the numerator of which 
is previously taxed earnings and profits to which the section 956 
amount is allocated and relating to the PTEP tax pool, and the 
denominator of which is all previously taxed earnings and profits 
relating to the PTEP tax pool. Thus, associated foreign income taxes 
are sourced pro rata from foreign income taxes assigned to the 
creditable PTEP tax group in the PTEP tax pool and other foreign income 
taxes in the PTEP tax pool.


Sec.  1.959-6  Allocating and apportioning current year taxes to 
previously taxed earnings and profits of a foreign corporation.

    (a) Scope. This section provides rules for allocating and 
apportioning current year taxes for purposes of sections 959 and 
960(b). Paragraph (b) of this section provides the general rule for 
determining which foreign income taxes paid or accrued by a foreign 
corporation may be allocated and apportioned to previously taxed 
earnings and profits. Paragraph (c) of this section provides rules for 
the application of Sec.  1.861-20 to allocate and apportion current 
year taxes among corporate PTEP accounts. Paragraph (d) of this section 
provides additional rules regarding the allocation and apportionment of 
deductions to previously taxed earnings and profits and a currency 
translation rule. See Sec.  1.959-10(c)(3) (Example 3) for an example 
illustrating the application of this section.
    (b) In general. Current year taxes that a foreign corporation pays 
or accrues during its taxable year by reason of a PTEP realization 
event that occurs during the same taxable year are allocated and 
apportioned to the statutory groupings (as generally described in Sec.  
1.861-8(a)(4)) of previously taxed earnings and profits of the foreign 
corporation and to the residual grouping in accordance with the rules 
of paragraph (c) of this section. For purposes of this section, the 
statutory groupings are the corporate PTEP accounts of the foreign 
corporation described in Sec.  1.959-2(d)(1). A PTEP realization event 
is an increase to the previously taxed earnings and profits of a 
foreign corporation by reason of its receipt of a covered distribution 
(as determined under Sec.  1.959-4) or the application of section 
961(c) basis of the foreign corporation to covered gain (as determined 
under Sec.  1.961-9) during the taxable year, as determined under Sec.  
1.959-2(d)(1). Current year taxes that are paid or accrued with respect 
to a PTEP realization event that occurs in a different taxable year may 
not be allocated and apportioned to the corporate PTEP accounts of a 
foreign corporation. See Sec.  1.960-1(d)(3)(ii)(B) for rules regarding 
the assignment of foreign gross income to the statutory and residual 
groupings of income of a controlled foreign corporation when the 
controlled foreign corporation pays or accrues current year taxes with 
respect to a PTEP realization event that occurs in a different taxable 
year.
    (c) Rules for allocating and apportioning current year taxes to 
previously taxed earnings and profits. Allocate and apportion current 
year taxes that a foreign corporation pays or accrues during its 
taxable year by reason of a PTEP realization event that occurs during 
the same taxable year (translated, if applicable, into the foreign 
corporation's functional currency as described in paragraph (d)(3) of 
this section) to its statutory groupings of previously taxed earnings 
and profits and to the residual grouping in accordance with the rules 
of Sec.  1.861-20. For this purpose, foreign gross income that a 
foreign corporation includes under foreign law by reason of a 
distribution that it receives, or by reason of its disposition of 
stock, is assigned to its statutory groupings of previously taxed 
earnings and profits by treating previously taxed earnings and profits 
arising from the distribution or disposition as included in the U.S. 
dividend amount or the U.S. capital gain amount, respectively, for 
purposes of applying Sec.  1.861-20(d)(1). For the definitions of U.S. 
dividend amount and U.S. capital gain amount, see Sec.  1.861-20(b).
    (d) Additional rules--(1) No deductions other than deductions for 
current year taxes paid or accrued with respect to a PTEP realization 
event that occurs in the same taxable year are allocated or apportioned 
to the statutory groupings of previously taxed earnings and profits of 
a foreign corporation. No deductions of a foreign corporation, other 
than deductions for current year

[[Page 95421]]

taxes that the foreign corporation pays or accrues during its taxable 
year with respect to a PTEP realization event that occurs in the same 
taxable year, may be allocated or apportioned under section 861 to the 
statutory groupings of previously taxed earnings and profits of the 
foreign corporation.
    (2) Currency rule. For purposes of this section, if current year 
taxes that a foreign corporation pays or accrues are denominated in a 
currency other than the foreign corporation's functional currency, then 
the current year taxes are translated into the foreign corporation's 
functional currency at the spot rate on the day on which the current 
year taxes are paid or accrued. See section 986(a) and Sec.  1.986(a)-1 
for rules translating current year taxes into U.S. dollars.


Sec.  1.959-7  General successor transactions.

    (a) Scope. This section identifies certain transactions in which a 
foreign corporation's previously taxed earnings and profits with 
respect to a covered shareholder transfer to (and thus become 
previously taxed earnings and profits with respect to) another covered 
shareholder under section 959 (defined as general successor 
transactions) and provides rules for determining the previously taxed 
earnings and profits that transfer. Paragraph (b) of this section 
provides definitions. Paragraph (c) of this section describes rules for 
analyzing a general successor transaction, including rules for 
determining previously taxed earnings and profits that transfer in the 
general successor transaction. Paragraph (d) of this section describes 
a fraction determining the pro rata portion of certain previously taxed 
earnings and profits that transfer. Paragraph (e) of this section 
provides a dollar basis rule. Paragraph (f) of this section provides an 
associated foreign income taxes rule. Paragraph (g) of this section 
provides rules regarding the deemed covered shareholder. See Sec.  
1.959-10(c)(5) (Example 5) for an example illustrating the application 
of this section. See also Sec. Sec.  1.959-8 and 1.959-9, regarding the 
extent to which previously taxed earnings and profits transfer under 
section 959 in a transaction other than a general successor 
transaction.
    (b) General successor transaction--(1) In general. A general 
successor transaction is any transaction in which a covered shareholder 
(the successor covered shareholder) acquires ownership of stock of one 
or more foreign corporations (each, an acquired foreign corporation) 
that, immediately before the transaction, is owned by another covered 
shareholder (the transferor covered shareholder), determined without 
regard to any portion of an acquisition of ownership of stock that 
results from a transaction described in paragraph (b)(2) of this 
section. In a general successor transaction, previously taxed earnings 
and profits of each acquired foreign corporation transfer from the 
transferor covered shareholder to the successor covered shareholder 
(and thus become with respect to the successor covered shareholder) in 
accordance with the rules described in paragraph (c) of this section.
    (2) Certain transactions. A transaction is described in this 
paragraph (b)(2) if the transaction is--
    (i) An issuance of stock or a partnership interest,
    (ii) A redemption of stock (within the meaning of section 317(b)) 
or a liquidating distribution in redemption of a partnership interest, 
or
    (iii) A transfer of stock of a foreign corporation, or any property 
through which stock of a foreign corporation is owned, if such stock or 
property is substituted basis property.
    (3) Additional consequences. Upon a general successor transaction, 
see Sec.  1.961-5 for basis adjustments and Sec.  1.986(c)-1 for 
recognition of foreign currency gain or loss by the transferor covered 
shareholder.
    (c) Rules for analyzing a general successor transaction--(1) 
Determine general successor PTEP--(i) In general. First, determine 
general successor PTEP, which for each acquired foreign corporation is 
computed by multiplying all previously taxed earnings and profits of 
the acquired foreign corporation that are with respect to the 
transferor covered shareholder immediately before the general successor 
transaction by the fraction computed in accordance with paragraph (d) 
of this section.
    (ii) Previously taxed earnings and profits not eligible to transfer 
if the general successor transaction is before the last relevant day. 
In applying paragraph (c)(1)(i) of this section, if the general 
successor transaction is before the last relevant day of the acquired 
foreign corporation's taxable year that includes the general successor 
transaction, then do not take into account (and thus do not transfer to 
the successor covered shareholder) any previously taxed earnings and 
profits that result from an income inclusion of the transferor covered 
shareholder under section 951(a)(1)(A) or 951A(a) for such taxable year 
(as accounted for in adjusting annual PTEP accounts pursuant to Sec.  
1.959-3(c)(1)(i) and (ii)). For example, if the successor covered 
shareholder acquires less than all of the transferor covered 
shareholder's stock of the acquired foreign corporation, and the 
transferor covered shareholder continues to own the retained stock on 
the last relevant day, then any previously taxed earnings and profits 
resulting from the transferor covered shareholder's income inclusions 
under section 951(a)(1)(A) and 951A for the acquired foreign 
corporation's taxable year do not transfer in the general successor 
transaction.
    (2) Determine section 959(e) successor PTEP. Second, determine 
section 959(e) successor PTEP, which for each acquired foreign 
corporation is all the previously taxed earnings and profits of the 
acquired foreign corporation that, under section 959(e), result from 
the application of section 1248 to gain recognized by the transferor 
covered shareholder in the general successor transaction (as accounted 
for in adjusting annual PTEP accounts pursuant to Sec.  1.959-
3(c)(1)(vii)).
    (3) Determine dollar basis and associated foreign income taxes. 
Third, determine the dollar basis of, and foreign income taxes 
associated with, general successor PTEP and section 959(e) successor 
PTEP in accordance with paragraph (e) of this section.
    (4) Transfer previously taxed earnings and profits and make related 
account adjustments. Fourth, transfer general successor PTEP and 
section 959(e) successor PTEP from the transferor covered shareholder 
to the successor covered shareholder and make the related adjustments 
described in Sec.  1.959-3.
    (d) Fraction in determining general successor PTEP--(1) In general. 
In determining general successor PTEP of an acquired foreign 
corporation, the fraction described in paragraph (c)(1)(i) of this 
section is computed as follows. The numerator of the fraction is the 
portion of the acquired foreign corporation's hypothetical distribution 
described in paragraph (d)(2) of this section that, under the 
principles of Sec.  1.951-1(e)(2) through (6), would be distributed 
with respect to the stock of the acquired foreign corporation the 
ownership of which is acquired by the successor covered shareholder in 
the general successor transaction. The denominator of the fraction is 
the amount of such hypothetical distribution. However, if the 
denominator of the fraction would be zero, then the fraction is 
considered to be zero.
    (2) Hypothetical distribution. The hypothetical distribution 
described in this paragraph (d)(2) is a hypothetical distribution 
treated as made by the acquired foreign corporation with respect to 
stock of the acquired foreign

[[Page 95422]]

corporation, immediately before the general successor transaction and 
in an amount equal to the acquired foreign corporation's previously 
taxed earnings and profits with respect to the transferor covered 
shareholder (determined as described in paragraph (c)(1) of this 
section). In the hypothetical distribution, stock of the acquired 
foreign corporation is taken into account only to the extent owned by 
the transferor covered shareholder immediately before the general 
successor transaction, and the earnings and profits of the acquired 
foreign corporation are treated as equal to the amount of the 
hypothetical distribution.
    (e) Dollar basis rule--(1) General successor PTEP. The dollar basis 
of previously taxed earnings and profits composing general successor 
PTEP (determined under paragraph (c)(1) of this section) is computed 
separately with respect to previously taxed earnings and profits 
relating to a single dollar basis pool, and in each case is equal to a 
pro rata portion of the dollar basis pool immediately before the 
general successor transaction. The pro rata portion is determined by 
multiplying all basis in the dollar basis pool by a fraction, the 
numerator of which is previously taxed earnings and profits composing 
general successor PTEP and relating to the dollar basis pool, and the 
denominator of which is all previously taxed earnings and profits 
relating to the dollar basis pool.
    (2) Section 959(e) successor PTEP. The dollar basis of previously 
taxed earnings and profits composing section 959(e) successor PTEP 
(determined under paragraph (c)(2) of this section) is equal to the 
U.S. dollar amount of the income inclusion giving rise to the 
previously taxed earnings and profits (as accounted for in increasing 
dollar basis pools pursuant to Sec.  1.959-3(d)(1)(i)).
    (f) Associated foreign income taxes rule--(1) General successor 
PTEP. The foreign income taxes that are associated with previously 
taxed earnings and profits composing general successor PTEP (determined 
under paragraph (c)(1) of this section) are computed separately with 
respect to previously taxed earnings and profits relating to a single 
PTEP tax pool, and in each case are equal to a pro rata portion of the 
PTEP tax pool immediately before the general successor transaction. The 
pro rata portion is determined by multiplying all foreign income taxes 
in the PTEP tax pool by a fraction, the numerator of which is 
previously taxed earnings and profits composing general successor PTEP 
and relating to the PTEP tax pool, and the denominator of which is all 
previously taxed earnings and profits relating to the PTEP tax pool. 
Thus, associated foreign income taxes are sourced pro rata from foreign 
income taxes assigned to the creditable PTEP tax group in the PTEP tax 
pool and other foreign income taxes in the PTEP tax pool.
    (2) Section 959(e) successor PTEP. The foreign income taxes 
associated with previously taxed earnings and profits composing section 
959(e) successor PTEP (determined under paragraph (c)(2) of this 
section) are zero.
    (g) Deemed covered shareholder--(1) In general. The deemed covered 
shareholder is a hypothetical person that is treated as owning all the 
stock of any foreign corporation that is not owned by a covered 
shareholder. For purposes of transferring previously taxed earnings and 
profits under section 959, the deemed covered shareholder is treated in 
the same manner as a covered shareholder and a reference to a covered 
shareholder includes the deemed covered shareholder. Thus, for example, 
if a covered shareholder sells stock of a foreign corporation to a 
nonresident alien individual, then the sale is a general successor 
transaction and previously taxed earnings and profits of the foreign 
corporation transfer from the seller covered shareholder to the deemed 
covered shareholder under this section. Moreover, if the individual 
subsequently sells stock of the foreign corporation to a covered 
shareholder, then previously taxed earnings and profits of the foreign 
corporation (adjusted consistent with Sec.  1.959-3, including to 
reflect distributions from the foreign corporation to the individual) 
transfer from the deemed covered shareholder to the buyer covered 
shareholder under this section.
    (2) Determining previously taxed earnings and profits that transfer 
from the deemed covered shareholder. In a transaction in which 
previously taxed earnings and profits of a foreign corporation transfer 
from the deemed covered shareholder to a covered shareholder, the 
covered shareholder must use a reasonable method in determining the 
amount and character of the transferred previously taxed earnings and 
profits and in determining the foreign income taxes associated with the 
transferred previously taxed earnings and profits. Such method must 
take into account adjustments to previously taxed earnings and profits 
with respect to the deemed covered shareholder that would have been 
made under Sec.  1.959-3 if the previously taxed earnings and profits 
were respect to a covered shareholder.


Sec. Sec.  1.959-8 and 1.959-9  [Reserved]


Sec.  1.959-10  Examples.

    (a) In general. This section provides examples that illustrate the 
application of Sec. Sec.  1.959-1 through 1.959-9.
    (b) Assumed facts. For purposes of the examples in this section, 
unless otherwise indicated, the following facts are assumed:
    (1) US1 and US2 are unrelated domestic corporations that are 
covered shareholders, each of which uses the U.S. dollar as its 
functional currency and has a combined pool election in effect under 
Sec.  1.959-2(c). Neither US1 nor US2 is a member of a consolidated 
group (as defined in Sec.  1.1502-1(h)).
    (2) F1 and F2 are foreign corporations, each of which is a 
controlled foreign corporation and uses the British pound ([pound]) as 
its functional currency.
    (3) PRS is a partnership.
    (4) Each entity uses the calendar year as its taxable year, and no 
entity has a short taxable year.
    (5) Tables depicting annual PTEP accounts, dollar basis pools, or 
PTEP tax pools do not depict accounts or PTEP groups with a balance of 
zero.
    (c) Examples--(1) Example 1: Exclusion from gross income of 
previously taxed earnings and profits distributed in a covered 
distribution--(i) Facts. US1 directly owns all 100 shares of the single 
class of outstanding stock of F1. In year 3, F1 makes a [pound]300x 
distribution of money with respect to its stock ([pound]3x with respect 
to each share), and the entirety of this [pound]300x is a covered 
distribution (a dividend as defined in section 316, determined without 
regard to section 959(d)). Immediately before the covered distribution, 
F1 has [pound]180x of previously taxed earnings and profits with 
respect to US1, none of which is assigned to the taxable section 962 
PTEP group. This example only analyzes the extent to which previously 
taxed earnings and profits are distributed and excluded from gross 
income under section 959. See paragraph (c)(2) of this section (Example 
2) for an illustration of composition, dollar basis, and associated 
foreign income taxes of distributed previously taxed earnings and 
profits, along with foreign currency gain or loss under section 986(c) 
and deemed paid taxes under section 960(b). See also Sec.  1.961-4 
(basis reductions and gain recognition for distributions of previously 
taxed earnings and profits).
    (ii) Analysis. For purposes of analyzing the covered distribution, 
US1's share of the covered distribution is the entire [pound]300x 
because that amount of the covered distribution is made to US1. See 
Sec.  1.959-4(d)(1). Such share is

[[Page 95423]]

allocated first to F1's previously taxed earnings and profits that are 
with respect to US1 immediately before the covered distribution 
([pound]180x) and then to F1's earnings and profits described in 
section 959(c)(3) and, therefore, is a distribution of [pound]180x of 
previously taxed earnings and profits and [pound]120x of earnings and 
profits described in section 959(c)(3). See Sec.  1.959-4(d)(2) and 
(e)(1). These previously taxed earnings and profits are treated as 
distributed pro rata with respect to the stock of F1 on which US1's 
share of the covered distribution is made. See Sec.  1.959-4(d)(4). 
Accordingly, [pound]1.8x of previously taxed earnings and profits is 
treated as distributed with respect to each share of F1 stock, computed 
by multiplying the [pound]180x distributed previously taxed earnings 
and profits by a fraction, the numerator of which is the portion of 
US1's share of the covered distribution that is made with respect to 
the share of F1 stock ([pound]3x), and the denominator of which is the 
amount of US1's share of the covered distribution ([pound]300x). See 
id. US1 excludes the [pound]180x of previously taxed earnings and 
profits distributed to it from its gross income. See Sec.  1.959-
4(b)(1); see also Sec.  1.312-8(c) (US1's receipt of previously taxed 
earnings and profits does not increase its earnings and profits).
    (iii) Alternative facts: split-ownership--(A) Facts. The facts are 
the same as in paragraph (c)(1)(i) of this section (Example 1), except 
as follows. US1 owns all the outstanding stock of F2, and US1 directly 
owns 80%, and F2 directly owns 20%, of the stock of F1. Thus, US1 
receives a [pound]240x portion, and F2 receives a [pound]60x portion, 
of the [pound]300x covered distribution made by F1. Under Sec.  1.951-
2, US1 is assigned the entirety of the [pound]60x portion of the 
covered distribution received by F2.
    (B) Analysis. For purposes of analyzing the covered distribution, 
US1's share of the covered distribution is the entire [pound]300x, the 
sum of the portion of the covered distribution that is made to US1 
([pound]240x) and the portion of the covered distribution that is made 
to F2 and assigned to US1 under Sec.  1.951-2 ([pound]60x). See Sec.  
1.959-4(d)(1). As is the case in paragraph (c)(1)(ii) of this section, 
such share is treated as a distribution of [pound]1.8x of previously 
taxed earnings and profits with respect to each share of F1 stock (and 
F1's previously taxed earnings and profits with respect to US1 are 
reduced by the [pound]180x of distributed previously taxed earnings and 
profits). Accordingly, US1 is treated as receiving [pound]144x of 
previously taxed earnings and profits ([pound]1.8x x 80 shares of F1 
stock directly owned by US1) and F2 is treated as receiving [pound]36x 
of previously taxed earnings and profits ([pound]1.8x x 20 shares of F1 
stock directly owned by F2). US1 excludes the [pound]144x of previously 
taxed earnings and profits distributed to it from its gross income. See 
Sec.  1.959-4(b)(1). F2 excludes the [pound]36x of previously taxed 
earnings distributed to it from its gross income, solely for purposes 
of determining its subpart F income and tested income or tested loss. 
See Sec.  1.959-4(b)(2)(i).
    (iv) Alternative facts: partnership-structure--(A) Facts. The facts 
are the same as in paragraph (c)(1)(i) of this section (Example 1), 
except as follows. PRS directly owns all the stock of F1. US1 and US2, 
in the aggregate, directly own all the interests in PRS, and PRS's 
partnership agreement provides that US1 has a 60% share, and US2 has a 
40% share, of any of PRS's items of income, gain, deduction, or loss. 
The covered distribution made by F1 is equal to [pound]500x ([pound]5x 
with respect to each share) and thus gives rise to [pound]500x of 
dividend income to PRS, of which US1 has a [pound]300x distributive 
share ([pound]500x x 60%) and US2 has a [pound]200x distributive share 
([pound]500x x 40%). Immediately before the covered distribution, F1 
has no previously taxed earnings and profits with respect to US2.
    (B) Analysis--(1) US1's share of the covered distribution. US1 is 
treated as receiving [pound]300x of the covered distribution, equal to 
its distributive share of the covered distribution. See Sec.  1.959-
4(c)(3). Therefore, for purposes of analyzing the covered distribution, 
US1's share of the covered distribution is [pound]300x (the amount of 
the covered distribution treated as made to US1). See Sec.  1.959-
4(d)(1). For such share, the results are the same as in paragraph 
(c)(1)(ii) of this section.
    (2) US2's share of the covered distribution. US2 is treated as 
receiving [pound]200x of the covered distribution, equal to its 
distributive share of the covered distribution. See Sec.  1.959-
4(c)(3). Therefore, for purposes of analyzing the covered distribution, 
US2's share of the covered distribution is [pound]200x (the amount of 
the covered distribution treated as made to US2). See Sec.  1.959-
4(d)(1). The entirety of such share is a distribution of earnings and 
profits described in section 959(c)(3) because F1 has no previously 
taxed earnings and profits with respect to US2. See Sec.  1.959-4(d)(2) 
and (e)(1). US2 excludes none of its [pound]200x distributive share of 
the covered distribution from its gross income under section 959 
because none of the covered distribution received by US2 is previously 
taxed earnings and profits.
    (2) Example 2: Composition, dollar basis, and associated foreign 
income taxes of distributed previously taxed earnings and profits--(i) 
Facts. US1 directly owns all 100 shares of the single class of 
outstanding stock of F1. In year 8, F1 makes a [pound]225x distribution 
of money with respect to its stock ([pound]2.25x with respect to each 
share), and the entirety of this [pound]225x is a covered distribution. 
On the day of the covered distribution, the spot rate is $1:[pound]0.4. 
Tables 1 through 3 in this paragraph (c)(2)(i) provide F1's previously 
taxed earnings and profits with respect to US1, determined immediately 
before the covered distribution and thus reflecting adjustments 
pursuant to Sec.  1.959-3 for US1's income inclusions under sections 
951(a)(1)(A) and 951A ([pound]80x and [pound]70x, respectively) for 
F1's taxable year ending on December 31 of year 8. Some of the 
previously taxed earnings and profits are previously taxed earnings and 
profits that were distributed to F1 by other foreign corporations in 
earlier years. The adjusted applicable percentage with respect to 
previously taxed earnings and profits that resulted from section 965(a) 
or (b) and relate to the general category is 60%, and the section 
965(c) deduction percentage with respect to previously taxed earnings 
and profits that resulted from 965(a) and relate to the general 
category is 60%.

                              Table 1 to Paragraph (c)(2)(i) of This Section--US1's Annual PTEP Accounts With Respect to F1
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                        Sec.   904 category
                                                      ---------------------------------------------------------------------------------------
                                                                    General category                  Passive         Sec.   951A category
                                                      -------------------------------------------     category    ---------------------------
                     Taxable year                                                                -----------------                               Total
                                                           Sec.         Sec.           Sec.             Sec.       Reclassified  Sec.   951A
                                                       965(a) PTEP  965(b) PTEP    951(a)(1)(A)     951(a)(1)(A)    Sec.   951A   PTEP group
                                                          group        group        PTEP group       PTEP group     PTEP group
--------------------------------------------------------------------------------------------------------------------------------------------------------
Year 8...............................................  ...........  ...........       [pound]50x       [pound]30x  ............   [pound]70x  [pound]150
                                                                                                                                                       x
Year 3...............................................  ...........  ...........  ...............  ...............    [pound]65x          10x         75x

[[Page 95424]]

 
Year 1...............................................   [pound]20x   [pound]20x  ...............              20x  ............  ...........         60x
--------------------------------------------------------------------------------------------------------------------------------------------------------


           Table 2 to Paragraph (c)(2)(i) of This Section--US1's Dollar Basis Pools With Respect to F1
                                            [Combined pool election]
----------------------------------------------------------------------------------------------------------------
                                               Sec.   904 category
-----------------------------------------------------------------------------------------------------------------
                         General category                           Passive category     Sec.   951A category
----------------------------------------------------------------------------------------------------------------
                                                        Sec.              Sec.        Reclassified
     Sec.   965(a) PTEP group           Sec.        951(a)(1)(A)      951(a)(1)(A)     Sec.   951A   Sec.   951A
                                     965(b) PTEP     PTEP group        PTEP group      PTEP group    PTEP group
----------------------------------------group-------------------------------------------------------------------
$40x..............................         $40x             $125x             $115x       $188.5x         $204x
----------------------------------------------------------------------------------------------------------------


                                 Table 3 to Paragraph (c)(2)(i) of This Section--US1's PTEP Tax Pools With Respect to F1
                                                                [Combined pool election]
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                    Sec.   904 category
                                                                  --------------------------------------------------------------------------------------
                                                                                General category                  Passive         Sec.   951A category
                                                                  -------------------------------------------     category    --------------------------
                                                                                                             -----------------
                                                                       Sec.         Sec.           Sec.             Sec.       Reclassified  Sec.   951A
                                                                   965(a) PTEP  965(b) PTEP    951(a)(1)(A)     951(a)(1)(A)    Sec.   951A   PTEP group
                                                                      group        group        PTEP group       PTEP group     PTEP group
--------------------------------------------------------------------------------------------------------------------------------------------------------
Creditable PTEP tax group........................................         $10x         $10x  ...............              $6x          $26x          $4x
Other taxes......................................................  ...........  ...........  ...............               4x  ............  ...........
--------------------------------------------------------------------------------------------------------------------------------------------------------

    (ii) Analysis--(A) Distributed previously taxed earnings and 
profits. The entirety of US1's share of the covered distribution 
([pound]225x) is allocated to F1's previously taxed earnings and 
profits that are with respect to US1 immediately before the covered 
distribution because such previously taxed earnings and profits 
([pound]285x, computed as [pound]150x + [pound]75x + [pound]60x, as set 
forth in table 1 in paragraph (c)(2)(i) of this section), are at least 
equal to such share. See Sec.  1.959-4(d)(2) and (e)(1). Specifically, 
US1's share of the covered distribution is allocated first to the 
[pound]65x of previously taxed earnings and profits assigned to the 
reclassified section 951A PTEP group, second to the [pound]20x of 
previously taxed earnings and profits assigned to the section 965(a) 
PTEP group, and third to the [pound]20x of previously taxed earnings 
and profits assigned to the section 965(b) PTEP group. See Sec.  1.959-
4(e)(2). The remaining portion of US1's share of the covered 
distribution ([pound]120x, computed as [pound]225x-[pound]65x-
[pound]20x-[pound]20x) is allocated pro rata to previously taxed 
earnings and profits that relate to year 8 and, therefore, is allocated 
to [pound]40x of previously taxed earnings and profits assigned to the 
section 951(a)(1)(A) PTEP group and relating to year 8 and the general 
category (computed as [pound]50x x [pound]120x/[pound]150x), [pound]24x 
of previously taxed earnings and profits assigned to the section 
951(a)(1)(A) PTEP group and relating to year 8 and the passive category 
(computed as [pound]30x x [pound]120x/[pound]150x), and [pound]56x of 
previously taxed earnings and profits assigned to the section 951A PTEP 
group and relating to year 8 and the section 951A category (computed as 
[pound]70x x [pound]120x/[pound]150x). See Sec.  1.959-4(e)(3) and 
(e)(5). US1 excludes the [pound]225x of previously taxed earnings and 
profits distributed to it from its gross income. See Sec.  1.959-
4(b)(1); see also Sec.  1.961-4 (basis reductions and gain recognition 
for distributions of previously taxed earnings and profits).
    (B) Dollar basis and foreign currency gain or loss. The dollar 
basis of previously taxed earnings and profits distributed in US1's 
share of the covered distribution (described in paragraph (c)(2)(ii)(A) 
of this section) is computed separately with respect to previously 
taxed earnings and profits relating to a single dollar basis pool, and 
in each case is equal to a pro rata portion of the dollar basis pool 
immediately before the covered distribution (determined by multiplying 
all basis in the dollar basis pool by a fraction, the numerator of 
which is previously taxed earnings and profits distributed in the US1's 
share of the covered distribution and relating to the dollar basis 
pool, and the denominator of which is all previously taxed earnings and 
profits relating to the dollar basis pool). See Sec.  1.959-4(f). Under 
Sec.  1.986(c)-1, US1 recognizes foreign currency gain or loss with 
respect to previously taxed earnings and profits distributed to it, 
determined by translating the previously taxed earnings and profits 
into U.S. dollars using the spot rate on the day of the covered 
distribution and then subtracting from that U.S. dollar amount the 
dollar basis of the previously taxed earnings and profits. US1 does not 
recognize 60% (the section 965(c) deduction percentage) of the foreign 
currency gain or loss with respect to the previously taxed earnings and 
profits relating to the section 965(a) PTEP group. Table 1 in this 
paragraph (c)(2)(ii)(B) provides computations for dollar basis and 
foreign currency gain or loss with respect to each group of distributed 
previously taxed earnings and profits. Thus, US1 recognizes a total of 
$8.8x of foreign currency gain and $28.8x of foreign currency loss.

[[Page 95425]]



               Table 1 to Paragraph (c)(2)(ii)(B) of This Section--Dollar Basis and Foreign Currency (FX) Gain or Loss of Distributed PTEP
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                    Sec.   904 category
                                 -----------------------------------------------------------------------------------------------------------------------
                                                       General category                        Passive category            Sec.   951A category
          Taxable year           -----------------------------------------------------------------------------------------------------------------------
                                  Sec.   965(a) PTEP  Sec.   965(b) PTEP         Sec.                Sec.          Reclassified Sec.   Sec.   951A PTEP
                                         group               group         951(a)(1)(A) PTEP   951(a)(1)(A) PTEP    951A PTEP group          group
---------------------------------------------------------------------------------group---------------group----------------------------------------------
Year 8:
    Distributed PTEP............  ..................  ..................  [pound]40x........  [pound]24x........  ..................  [pound]56x
    Dollar basis................  ..................  ..................  $100x ($125x x      $55.2x ($115x x     ..................  $142.8x ($204x x
                                                                           [pound]40x/         [pound]24x/                             [pound]56x/
                                                                           [pound]50x).        [pound]50x).                            [pound]80x)
    FX gain or loss.............  ..................  ..................  $0 ([pound]40x x    $4.8x gain          ..................  $2.8x loss
                                                                           $1/*[pound]0.4-     ([pound]24x x $1                        ([pound]56x x $1/
                                                                           $100x).             [pound]0.4-                             [pound]0.4-
                                                                                               $55.2x).                                $142.8x)
Year 3:
    Distributed PTEP............  ..................  ..................  ..................  ..................  [pound]56x........
    Dollar basis................  ..................  ..................  ..................  ..................  $188.5x ($188.5x x
                                                                                                                   [pound]65x/
                                                                                                                   [pound]65x).
    FX gain or loss.............  ..................  ..................  ..................  ..................  $26x loss
                                                                                                                   ([pound]65x x $1/
                                                                                                                   [pound]0.4-
                                                                                                                   $188.5x).
Year 1:
    Distributed PTEP............  [pound]20x........  [pound]20x........
    Dollar basis................  $40x ($40x x        $40x ($40x x
                                   [pound]20x/         [pound]20x/
                                   [pound]20x).        [pound]20x).
    FX gain or loss.............  $4x gain            Not applicable....
                                   (([pound]20x x $1/
                                   [pound]0.4-$40x)
                                   x (100%-60%)).
--------------------------------------------------------------------------------------------------------------------------------------------------------

    (C) Associated foreign income taxes. The foreign income taxes that 
are associated with previously taxed earnings and profits distributed 
in US1's share of the covered distribution (described in paragraph 
(c)(2)(ii)(A) of this section) are computed separately with respect to 
previously taxed earnings and profits relating to a single PTEP tax 
pool, and in each case are equal to a pro rata portion of the PTEP tax 
pool immediately before the covered distribution (determined by 
multiplying all foreign income taxes in the PTEP tax pool by a 
fraction, the numerator of which is previously taxed earnings and 
profits distributed in US1's share of the covered distribution and 
relating to the PTEP tax pool, and the denominator of which is all 
previously taxed earnings and profits relating to the PTEP tax pool). 
See Sec.  1.959-4(g). Table 1 in this paragraph (c)(2)(ii)(C) provides 
these computations (and refers to associated foreign income taxes 
sourced from the creditable PTEP tax group as ``creditable taxes'' and 
associated foreign income taxes not sourced from the creditable PTEP 
tax group as ``other taxes'').

                         Table 1 to Paragraph (c)(2)(ii)(C) of This Section--Associated Foreign Income Taxes of Distributed PTEP
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                    Sec.   904 category
                                 -----------------------------------------------------------------------------------------------------------------------
                                                       General category                        Passive category            Sec.   951A category
          Taxable year           -----------------------------------------------------------------------------------------------------------------------
                                                                                  Sec.
                                  Sec.   965(a)  PTEP  Sec.   965(b)  PTEP    951(a)(1)(A)   Sec.   951(a)(1)(A)   Reclassified Sec.   Sec.   951A  PTEP
                                         group                group            PTEP group         PTEP group        951A  PTEP group         group
--------------------------------------------------------------------------------------------------------------------------------------------------------
Year 8:
    Distributed PTEP............  ...................  ...................       [pound]40x  [pound]24x.........  ..................  [pound]56x.
    Creditable Taxes............  ...................  ...................               $0  $2.9x ($6x x         ..................  $2.8x ($4x x
                                                                                              [pound]24x/                              [pound]56x/
                                                                                              [pound]50x).                             [pound]80x).
    Other Taxes.................  ...................  ...................  ...............  $1.9x ($4x x
                                                                                              [pound]24x/
                                                                                              [pound]50x).
Year 3:
    Distributed PTEP............  ...................  ...................  ...............  ...................  [pound]65x........
    Creditable Taxes............  ...................  ...................  ...............  ...................  $26x ($26x x
                                                                                                                   [pound]65x/
                                                                                                                   [pound]65x).
    Other Taxes.................
Year 1:
    Distributed PTEP............  [pound]20x.........  [pound]20x.........
    Creditable Taxes............  $10x ($10x x         $10x ($10x x
                                   [pound]20x/          [pound]20x/
                                   [pound]20x).         [pound]20x).
    Other Taxes.................
--------------------------------------------------------------------------------------------------------------------------------------------------------

    (D) Deemed paid taxes. Under section 960(b), because F1 is a 
controlled foreign corporation in which US1 is a United States 
shareholder, US1 is deemed to pay the foreign income taxes properly 
attributable to previously taxed earnings and profits distributed to 
it, which are the foreign income taxes that are both associated with 
the previously taxed earnings and profits and sourced from the 
creditable PTEP tax group. See Sec.  1.960-3(b). Thus, US1 is deemed to 
pay $51.7x of foreign income taxes ($2.9x + $2.8x + $26x + $10x + 
$10x). Under Sec.  1.965-5(c), US1 is disallowed a credit for 60% (the 
adjusted applicable percentage) of the foreign income taxes deemed paid 
with respect to the previously taxed earnings and profits relating to 
the section 965(a) PTEP group or section 965(b) PTEP group,

[[Page 95426]]

with the result that in each case US1 is disallowed a credit for $6x of 
the foreign income taxes deemed paid with respect to each of those 
groups of previously taxed earnings and profits ($10x x 60%).
    (E) Account adjustments. To reflect the covered distribution, the 
distributed previously taxed earnings and profits, the dollar basis of 
the distributed previously taxed earnings and profits, and the foreign 
income taxes associated with the distributed previously taxed earnings 
and profits are removed from US1's annual PTEP accounts, dollar basis 
pools, and PTEP tax pools with respect to F1. See Sec.  1.959-
3(c)(1)(vi), (d)(1)(iv), and (e)(1)(iii). These adjustments are treated 
as made concurrently with the covered distribution. See Sec.  1.959-
3(f). In addition, the distributed previously taxed earnings and 
profits, and the foreign income taxes associated with distributed 
previously taxed earnings and profits, are removed from F1's corporate 
PTEP accounts and corporate PTEP tax pools for US1, and these 
adjustments are also treated as made concurrently with the covered 
distribution. See Sec.  1.959-2(d).
    (iii) Alternative facts: distribution of built-in loss property--
(A) Facts. The facts are the same as in paragraph (c)(2)(i) of this 
section (Example 2), except that, in the covered distribution (which 
continues to be [pound]225x), F1 distributes property other than money. 
At the time of the covered distribution, the fair market value of the 
property is [pound]225x and F1's adjusted basis of the property is 
[pound]250x. Thus, the covered distribution decreases F1's earnings and 
profits by [pound]250x. See sections 301(b)(1) and 312(a)(3).
    (B) Analysis. The results are the same as in paragraph (c)(2)(ii) 
of this section and thus the covered distribution decreases F1's 
previously taxed earnings and profits by [pound]225x. The remainder of 
the [pound]250x decrease to F1's earnings and profits under section 
312(a)(3) is accounted for by decreasing (including below zero, if 
applicable) F1's earnings and profits described in section 959(c)(3) by 
[pound]25x.
    (iv) Alternative facts: distribution to a foreign corporation--(A) 
Facts. The facts are the same as in paragraph (c)(2)(i) of this section 
(Example 2), except as follows. US1 directly owns all the stock of F2, 
and F2 directly owns all 100 shares of the single class of stock of F1. 
Thus, F2 receives the entirety of the [pound]225x covered distribution 
made by F1. Under Sec.  1.951-2, US1 is assigned the entirety of the 
[pound]225x covered distribution received by F2.
    (B) Analysis. The results are the same as described in paragraph 
(c)(2)(ii) of this section, except that F2 excludes the [pound]225x of 
distributed previously taxed earnings and profits from its gross income 
in accordance with Sec.  1.959-4(b)(2), US1 does not recognize foreign 
currency gain or loss with respect to the distributed previously taxed 
earnings and profits in accordance with Sec.  1.986(c)-1(c), and F2 is 
deemed to pay the $51.7x of foreign income taxes that are both 
associated with the distributed previously taxed earnings and profits 
and sourced from the creditable PTEP tax group in accordance with Sec.  
1.960-3(c). In addition, the distributed previously taxed earnings and 
profits ([pound]225x), the dollar basis of the distributed previously 
taxed earnings and profits ($566.5x), and the foreign income taxes 
associated with the distributed previously taxed earnings and profits 
($51.7x + $1.9x = $53.6x) are added to US1's annual PTEP accounts, 
dollar basis pools, and PTEP tax pools with respect to F2. See Sec.  
1.959-3(c)(1)(iii), (d)(1)(ii), and (e)(1)(i). Only the $51.7x portion 
of the associated foreign income taxes that F2 is deemed to pay are 
assigned to the creditable PTEP tax group within US1's PTEP tax pools 
with respect to F2. See Sec.  1.959-3(e)(1)(i). These adjustments are 
treated as made at the beginning of F2's taxable year ending on 
December 31 of year 8. See Sec.  1.959-3(f). In addition, the 
distributed previously taxed earnings and profits, and the foreign 
income taxes associated with the distributed previously taxed earnings 
and profits, are added to F2's corporate PTEP accounts and corporate 
PTEP tax pools for US1, and these adjustments are also treated as made 
at the beginning of F2's taxable year ending on December 31 of year 8. 
See Sec.  1.959-2(d).
    (3) Example 3: Current year taxes imposed on a covered 
distribution--(i) Facts. US1 directly owns 60%, and US2 directly owns 
40%, of the single class of outstanding stock of F2. F2 owns all the 
outstanding stock of F1. In year 3, F1 makes a [pound]500x covered 
distribution to F2. Foreign withholding taxes of [pound]75x 
([pound]500x x 15%) are paid on the covered distribution. F2 takes 
foreign income taxes into account when paid, the withholding taxes meet 
the definition of current year taxes for F2's taxable year ending on 
December 31 of year 3, and, other than pursuant to section 245A(d), no 
credits for taxes are disallowed or suspended at the level of F2. On 
the day of the covered distribution, the spot rate is $1:[pound]0.5. 
Under Sec.  1.959-4, the entirety of US1's [pound]300x share of the 
covered distribution ([pound]500x x 60%) is a distribution of F1's 
previously taxed earnings and profits with respect to US1, and none of 
US2's [pound]200x share of the covered distribution ([pound]500x x 40%) 
is a distribution of previously taxed earnings and profits. The 
distributed previously taxed earnings and profits consist of 
[pound]120x of previously taxed earnings and profits assigned to the 
section 951(a)(1)(A) PTEP group and relating to year 2 and the passive 
category (Character A PTEP), [pound]80x of previously taxed earnings 
and profits assigned to the section 245A(d) PTEP group and relating to 
year 2 and the passive category (Character B PTEP), [pound]70x of 
previously taxed earnings and profits assigned to the section 
951(a)(1)(A) PTEP group and relating to year 1 and the general category 
(Character C PTEP), and [pound]30x of previously taxed earnings and 
profits assigned to the section 951(a)(1)(A) PTEP group and relating to 
year 1 and the passive category (Character D PTEP), as summarized in 
table 1 in this paragraph (c)(3)(i). This example only analyzes the 
allocation and apportionment of the current year taxes and related 
adjustments to previously taxed earnings and profits accounts. See also 
Sec.  1.959-4 (exclusion from gross income of previously taxed earnings 
and profits received in a distribution); Sec.  1.986(c)-1(c) (no 
foreign currency gain or loss recognized in distributions of previously 
taxed earnings and profits to a foreign corporation); Sec.  1.961-4 
(basis reductions and gain recognition for distributions of previously 
taxed earnings and profits).

                        Table 1 to Paragraph (c)(3)(i) of This Section--Distributed PTEP
----------------------------------------------------------------------------------------------------------------
                                                                  Sec.   904 category
                                      --------------------------------------------------------------------------
                                           General category                     Passive category
             Taxable year             --------------------------------------------------------------------------
                                         Sec.   951(a)(1)(A)      Sec.   951(a)(1)(A)      Sec.   245A(d) PTEP
                                              PTEP group               PTEP group                 group
----------------------------------------------------------------------------------------------------------------
Year 2...............................  .......................  [pound]120x (Character   [pound]80x (Character
                                                                 A).                      B).

[[Page 95427]]

 
Year 1...............................  [pound]70x (Character    [pound]30x (Character
                                        C).                      D).
----------------------------------------------------------------------------------------------------------------

    (ii) Analysis--(A) In general. As a result of the covered 
distribution, which is a PTEP realization event, F2 has [pound]300x of 
previously taxed earnings and profits with respect to US1 and [pound]0 
of previously taxed earnings and profits with respect to US2. The 
foreign gross income that F2 includes by reason of its receipt of the 
covered distribution is assigned to the statutory groupings, which are 
described in Sec.  1.959-2(d)(1), and residual grouping by treating the 
previously taxed earnings and profits arising from such distribution as 
included in the U.S. dividend amount for purposes of Sec.  1.861-
20(d)(1). See Sec.  1.959-6(c). The relevant statutory groupings are 
F2's corporate PTEP accounts that were increased by reason of its 
receipt of a covered distribution which was previously taxed earnings 
and profits with respect to US1 and the remaining portion of the 
covered distribution is assigned to the residual income grouping. See 
id. The [pound]75x of current year taxes imposed on the covered 
distribution is allocated and apportioned to the previously taxed 
earnings and profits (US1's share of the covered distribution) and the 
residual income grouping (US2's share of the covered distribution) pro 
rata, with the result that [pound]45x ([pound]75x x [pound]300x/
[pound]500x) is allocated and apportioned to previously taxed earnings 
and profits arising from the covered distribution and the remaining 
[pound]30 ([pound]75x x [pound]200x/[pound]500x) is assigned to the 
residual income grouping. See id.
    (B) Allocation and apportionment of current year taxes among PTEP 
groups. The [pound]45x of current year taxes allocated and apportioned 
to the previously taxed earnings and profits arising from the PTEP 
realization event with respect to US1 is further allocated and 
apportioned among the section 904 categories and PTEP groups within 
each corporate PTEP account that is increased by reason of F2's PTEP 
realization event. See Sec.  1.959-6(b) and (c). Accordingly, 
[pound]18x of current year taxes is allocated and apportioned to 
Character A PTEP ([pound]45x x [pound]120x/[pound]300x), [pound]12x of 
current year taxes is allocated and apportioned to Character B PTEP 
[pound]45x x [pound]80x/[pound]300x), [pound]10.5x of current year 
taxes is allocated and apportioned to Character C PTEP ([pound]45x x 
[pound]70x/[pound]300x), and [pound]4.5x of current year taxes is 
allocated and apportioned to Character D PTEP ([pound]45x x [pound]30x/
[pound]300x), each within F2's corporate PTEP account with respect to 
US1.
    (C) Account adjustments--(1) Shareholder-level accounts. After the 
current year taxes are allocated and apportioned to the corporate PTEP 
accounts of F2 with respect to US1, the previously taxed earnings and 
profits in US1's PTEP groups within its annual PTEP accounts are 
reduced to reflect the current year taxes allocated and apportioned to 
the corresponding PTEP groups of F2. See Sec.  1.959-3(c)(1)(v). These 
adjustments are treated as made at the beginning of F2's taxable year 
ending on December 31 of year 3. See Sec.  1.959-3(f). Concurrently 
with this reduction, US1's dollar basis pools with respect to F2 are 
reduced by $90x, the U.S. dollar amount of the reduction that reflects 
the current year taxes allocated and apportioned to the distributed 
previously taxed earnings and profits ([pound]45x x $1/[pound]0.5), and 
$90x of current year taxes is added to US1's PTEP tax pools with 
respect to F2. See Sec.  1.959-3(d)(1)(iii) and (d)(2), (e)(1)(ii) and 
(e)(2); see also section 986(a) and Sec.  1.986(a)-1 (translation of 
foreign income taxes into U.S. dollars). Tables 1 through 3 in this 
paragraph (c)(3)(ii)(C) summarize the adjustments to US1's accounts to 
reflect the current year taxes.

     Table 1 to paragraph (c)(3)(ii)(C)(1) of This Section--US1's Annual PTEP Accounts With Respect to F2--
                                       Adjustments for Current Year Taxes
----------------------------------------------------------------------------------------------------------------
                                                                  Sec.   904 category
                                      --------------------------------------------------------------------------
                                           General category                     Passive category
             Taxable year             --------------------------------------------------------------------------
                                         Sec.   951(a)(1)(A)      Sec.   951(a)(1)(A)      Sec.   245A(d) PTEP
                                              PTEP group               PTEP group                 group
----------------------------------------------------------------------------------------------------------------
Year 2...............................  .......................  [pound]18x reduction...  [pound]12x reduction.
Year 1...............................  [pound]10.5x reduction.  [pound]4.5x reduction..
----------------------------------------------------------------------------------------------------------------


   Table 2 to Paragraph (c)(3)(ii)(C)(1) of This Section--US1's Dollar
Basis Pools With Respect to F2 (Combined Pool Election)--Adjustments for
                           Current Year Taxes
------------------------------------------------------------------------
                           Sec.   904 category
-------------------------------------------------------------------------
        General category                     Passive category
------------------------------------------------------------------------
                                         Sec.           Sec.   245A(d)
 Sec.   951(a)(1)(A) PTEP group    951(a)(1)(A) PTEP      PTEP group
-----------------------------------------group--------------------------
$21x reduction ([pound]10.5x x    $45x reduction      $24x reduction
 $1/[pound]0.5).                   (([pound]18x +      ([pound]12x x $1/
                                   [pound]4.5x) x $1/  [pound]0.5).
                                   [pound]0.5).
------------------------------------------------------------------------


[[Page 95428]]


  Table 3 to Paragraph (c)(3)(ii)(C)(1) of This Section--US1's PTEP Tax Pools With Respect to F2 (Combined Pool
                                  Election)--Adjustments for Current Year Taxes
----------------------------------------------------------------------------------------------------------------
                                                                  Sec.   904 category
                                      --------------------------------------------------------------------------
                                           General category                     Passive category
                                      --------------------------------------------------------------------------
                                         Sec.   951(a)(1)(A)      Sec.   951(a)(1)(A)      Sec.   245A(d) PTEP
                                              PTEP group               PTEP group                 group
----------------------------------------------------------------------------------------------------------------
Creditable PTEP tax group............  $21x increase            $45x increase
                                        ([pound]10.5x x $1/      (([pound]18x +
                                        [pound]0.5).             [pound]4.5x) x $1/
                                                                 [pound]0.5).
Other taxes..........................  .......................  .......................  $24x increase
                                                                                          ([pound]12x x $1/
                                                                                          [pound]0.5).
----------------------------------------------------------------------------------------------------------------

    (2) Corporate-level accounts. Concurrently with the adjustments 
described in paragraph (c)(3)(ii)(C)(1) of this section, the previously 
taxed earnings and profits in F2's corporate PTEP accounts for US1 are 
reduced by [pound]45x and the foreign income taxes in F2's corporate 
PTEP tax pools for US1 are increased by $90x. See Sec.  1.959-2(d).
    (4) Example 4: Section 956 amount--(i) Facts. Individual A, a 
citizen of the United States, owns all the outstanding stock of F1 and 
does not make an election to apply the provisions of section 962 for 
any taxable year. For F1's taxable year ending on December 31 of year 
3, the last relevant day is December 31 and Individual A's section 956 
amount (amount determined under section 956 and Sec.  1.956-1) is 
[pound]200x. At the beginning of the last relevant day, F1 has 
[pound]125x of previously taxed earnings and profits with respect to 
Individual A, all of which relate to F1's taxable year ending on 
December 31 of year 1 and are assigned to section 959(c)(2) PTEP 
groups. On the last relevant day, F1 makes a [pound]75x covered 
distribution to Individual A, the entirety of which is allocated to 
(and thus is a distribution of) F1's previously taxed earnings and 
profits with respect to Individual A under Sec.  1.959-4. This example 
only analyzes the extent to which the section 956 amount is allocated 
to previously taxed earnings and profits and excluded from gross income 
under section 959, along with related adjustments to annual PTEP 
accounts. See also Sec.  1.959-3(d) and (e) (related adjustments to 
dollar basis pools and PTEP tax pools).
    (ii) Analysis--(A) Allocation to previously taxed earnings and 
profits. Individual A's section 956 amount is first allocated to F1's 
previously taxed earnings and profits that are with respect to 
Individual A and assigned to section 959(c)(2) PTEP groups on the last 
relevant day, but reduced to reflect the covered distribution 
([pound]50x, computed as [pound]125x - [pound]75x). See Sec.  1.959-
5(c)(1) and (d). The [pound]50x portion of the section 956 amount 
allocated to previously taxed earnings and profits is excluded from 
Individual A's gross income. See Sec.  1.959-5(c)(1). Under section 
951(a)(1)(B), Individual A includes the remaining [pound]150x of the 
section 956 amount (translated into U.S. dollars in accordance with 
section 989(b)) in its gross income.
    (B) Annual PTEP account adjustments. To reflect the section 956 
amount, the [pound]50x of previously taxed earnings and profits to 
which the section 956 amount is allocated are reassigned from section 
959(c)(2) PTEP groups to section 959(c)(1) PTEP groups within 
Individual A's annual PTEP accounts relating to F1's taxable year 
ending on December 31 of year 1, and then [pound]150x of previously 
taxed earnings and profits are added to Individual A's annual PTEP 
accounts relating to F1's taxable year ending on December 31 of year 3, 
where they are assigned to the general section 959(c)(1) PTEP group. 
See Sec.  1.959-3(c)(1)(x) and (xi). These adjustments are treated as 
made at the end of the last day of F1's taxable year ending on December 
31 of year 3. See Sec.  1.959-3(f)(1).
    (5) Example 5: General successor transaction--(i) Facts. US1 
directly owns all 100 shares of the single class of outstanding stock 
of F1. On June 30 of year 3, US1 sells 40 shares of stock of F1 to US2 
for money equal to the fair market value of the shares. Section 304 
does not apply to the sale. Immediately before the sale, F1 has 
[pound]180x of previously taxed earnings and profits with respect to 
US1, none of which resulted from an income inclusion of US1 for F1's 
taxable year ending on December 31 of year 3 under section 951(a)(1)(A) 
or 951A(a) because F1 has no subpart F income or tested income for such 
taxable year. As a result of gain that US1 recognizes on the sale and 
includes in gross income as a dividend under section 1248(a) by reason 
of F1's earnings and profits described in section 959(c)(3), F1's 
previously taxed earnings and profits with respect to US1 are increased 
by [pound]20x under section 959(e) and Sec.  1.959-3(c)(1)(vii), 
concurrently with the sale. This example only discusses the extent to 
which previously taxed earnings and profits transfer under section 959. 
See also Sec.  1.959-3 (related adjustments to annual PTEP accounts, 
dollar basis pools, and PTEP tax pools); Sec.  1.986(c)-1 (recognition 
of foreign currency gain or loss with respect to transferred previously 
taxed earnings and profits).
    (ii) Analysis--(A) In general. The sale is a general successor 
transaction in which F1 is an acquired foreign corporation, US1 is the 
transferor covered shareholder, and US2 is the successor covered 
shareholder. See Sec.  1.959-7(b)(1). As described in paragraphs 
(c)(5)(ii)(B) and (C) of this section, there is [pound]72x of general 
successor PTEP and [pound]20x of section 959(e) successor PTEP. Such 
previously taxed earnings and profits transfer from US1 to US2, 
concurrently with the general successor transaction. See Sec.  1.959-
3(f)(1).
    (B) General successor PTEP. General successor PTEP is a pro rata 
portion of F1's previously taxed earnings and profits that are with 
respect to US1 immediately before the general successor transaction 
([pound]180x), determined by multiplying all such previously taxed 
earnings and profits by 40%, which is the percentage of a [pound]180x 
hypothetical distribution treated as made by F1 immediately before the 
general successor transaction that would be distributed with respect to 
stock of F1 that US2 acquires in the general successor transaction. See 
Sec.  1.959-7(c)(1)(i) and (d). Thus, there is [pound]72x of general 
successor PTEP, sourced pro rata from each PTEP group within each of 
US1's annual PTEP accounts with respect to F1. See also Sec.  1.959-
7(e)(1) and (f)(1) (rules for determining the dollar basis and 
associated foreign income taxes of general successor PTEP).
    (C) Section 959(e) successor PTEP. Section 959(e) successor PTEP is 
all [pound]20x of F1's previously taxed earnings and profits with 
respect to US1 that, under section 959(e), result from the application 
of section 1248 to gain recognized by US1 in the general successor 
transaction. See Sec.  1.959-7(c)(2); see also Sec.  1.959-7(e)(2) and 
(f)(2) (providing the dollar basis of section 959(e) successor PTEP, 
and providing

[[Page 95429]]

that the foreign income taxes associated with section 959(e) successor 
PTEP is zero).
    (iii) Alternative facts: previously taxed earnings and profits not 
eligible to transfer--(A) Facts. The facts are the same as in paragraph 
(c)(5)(i) of this section (Example 5), except as follows. F1 has 
[pound]10x of subpart F income for its taxable year ending on December 
31 of year 3 and thus US1 includes [pound]6x ([pound]10x x 60% of stock 
of F1 retained by US1) in its gross income for such taxable year under 
section 951(a)(1)(A). Consequently, F1 has an additional [pound]6x of 
previously taxed earnings and profits with respect to US1 immediately 
before the sale.
    (B) Analysis. The results are the same as described in paragraph 
(c)(5)(ii) of this section. None of the additional [pound]6x of 
previously taxed earnings and profits transfer to US2 because the 
general successor transaction is before December 31 of year 3, the last 
relevant day of F1's taxable year that includes the general successor 
transaction. See Sec.  1.959-7(c)(1)(ii).
    (iv) Alternative facts: deemed covered shareholder--(A) Facts. The 
facts are the same as in paragraph (c)(5)(i) of this section (Example 
5), except that the purchaser of the shares of stock of F1 is a 
nonresident alien individual (Individual B).
    (B) Analysis. The results are the same as described in paragraph 
(c)(5)(ii) of this section, applied by substituting the deemed covered 
shareholder (who is a hypothetical person treated as owning all the 
stock of F1 owned by Individual B) for US2. See Sec.  1.959-7(g). Thus, 
if a covered shareholder subsequently acquires a portion of Individual 
B's stock of F1, then a portion of F1's previously taxed earnings and 
profits with respect to the deemed covered shareholder (adjusted 
consistent with Sec.  1.959-3, including to reflect any distributions 
from F1 to Individual B) transfer from the deemed covered shareholder 
to the acquiror covered shareholder.


Sec.  1.959-11  Transition rules.

    (a) Scope. This section sets forth transition rules for the section 
959 regulations. Paragraph (b) of this section addresses the 
establishment of annual PTEP accounts, dollar basis pools, and 
corporate PTEP accounts and provides for adjustments to reflect the 
transition tax under section 965. Paragraph (c) of this section 
addresses the establishment of PTEP tax pools, corporate PTEP tax 
pools, adjusted applicable percentages, and section 965(c) deduction 
percentages. Paragraph (d) of this section treats a domestic 
partnership (including an S corporation) as a covered shareholder for 
periods in which Sec.  1.958-1(d)(1) does not apply. Paragraph (e) 
converts accounts of a domestic partnership (including an S 
corporation) to accounts of covered shareholders owning interests in 
the domestic partnership when both Sec.  1.958-1(d)(1) and the section 
959 regulations apply.
    (b) Establishing annual PTEP accounts, dollar basis pools, and 
corporate PTEP accounts and adjustments for section 965 transition 
tax--(1) In general. When applying the 2019 notice provisions pursuant 
to Sec.  1.959-12(c) (interim application of 2019 notice provisions), 
or the section 959 regulations (other than Sec. Sec.  1.959-8 and 
1.959-9) pursuant to Sec.  1.959-12(d) (optional early application), to 
a taxable year of a foreign corporation, annual PTEP accounts, dollar 
basis pools, and corporate PTEP accounts are established and adjusted 
in accordance with the rules described in paragraphs (b)(2) and (3) of 
this section.
    (2) Establishment of accounts--(i) In general. As of the beginning 
of the first taxable year of the foreign corporation to which the 2019 
notice provisions apply, or, if earlier, the first taxable year of the 
foreign corporation to which the section 959 regulations (other than 
Sec. Sec.  1.959-8 and 1.959-9) apply, a reasonable method 
(consistently applied) must be used to establish annual PTEP accounts, 
dollar basis pools, and corporate PTEP accounts reflecting the foreign 
corporation's previously taxed earnings and profits, including to 
reflect adjustments to previously taxed earnings and profits that would 
have been made if the principles of Sec. Sec.  1.959-2 through 1.959-5 
and 1.959-7 were to have previously applied. Establishing accounts in 
accordance with the preceding sentence includes conforming any of a 
covered shareholder's existing previously taxed earnings and profits 
accounts with respect to the foreign corporation, or dollar basis 
accounts with respect to the previously taxed earnings and profits, to 
the requirements of Sec.  1.959-2. In addition, a covered shareholder 
is treated as consistently applying a reasonable method only if the 
covered shareholder and any covered shareholders with which the covered 
shareholder joins in filing a Federal income tax return apply that 
method with respect to all foreign corporations in which the covered 
shareholders own stock.
    (ii) Multi-year accounts--(A) Previously taxed earnings and 
profits. To the extent a covered shareholder has an account reflecting 
previously taxed earnings and profits of the foreign corporation that 
relate to two or more taxable years and are described in the next 
sentence (multi-year PTEP account), a reasonable method to conforming 
the multi-year PTEP account to the requirements of Sec.  1.959-2 
includes treating such previously taxed earnings and profits as 
assigned to the general section 959(c)(1) PTEP group or the section 
951(a)(1)(A) PTEP group (as applicable) within an annual PTEP account 
that relates to the last taxable year of the foreign corporation ending 
on or before December 31, 2017, and the section 904 category to which 
the multi-year PTEP account relates. Previously taxed earnings and 
profits are described in this sentence to the extent they are described 
in section 959(c)(1)(A) by reason of section 951(a)(1)(B) and not by 
reason of section 959(a)(2); described in section 959(c)(1)(B), 
including by reason of section 959(a)(3) (before its repeal); or 
described in section 959(c)(2) by reason of section 951(a)(1)(A) and 
without regard to section 965(a), 965(b)(4)(A), 951A(f)(2), 245A(e)(2), 
959(e), or 964(e)(4).
    (B) Dollar basis. To the extent a covered shareholder has an 
account reflecting the dollar basis of previously taxed earnings and 
profits of the foreign corporation that relate to two or more taxable 
years (multi-year dollar basis account), a reasonable method for 
conforming the multi-year dollar basis account to the requirements of 
Sec.  1.959-2 includes treating previously taxed earnings and profits 
to which the multi-year dollar basis account relates as having a dollar 
basis equal to a pro rata portion of the multi-year dollar basis 
account, and placing that dollar basis into the related dollar basis 
pool. The pro rata portion is determined by multiplying the multi-year 
dollar basis account by a fraction, the numerator of which is 
previously taxed earnings and profits to which the multi-year dollar 
basis account relates, and the denominator of which is all previously 
taxed earnings and profits to which the multi-year dollar basis account 
relates.
    (3) Adjustments for section 965 transition tax--(i) Increases for 
amounts included in gross income under section 951(a)(1)(A) by reason 
of section 965(a). When adding previously taxed earnings and profits to 
annual PTEP accounts to reflect an amount a covered shareholder 
includes in gross income under section 951(a)(1)(A) with respect to the 
foreign corporation by reason of section 965(a), assign such previously 
taxed earnings and profits to the section 965(a) PTEP group (rather 
than the section 951(a)(1)(A) PTEP group).
    (ii) Increases for section 965(b) reductions. For purposes of 
adjusting

[[Page 95430]]

annual PTEP accounts and dollar basis pools, treat an amount that a 
covered shareholder would have included in gross income under section 
951(a)(1)(A) with respect to the foreign corporation but for section 
965(b) and Sec.  1.965-1(b)(2) or 1.965-8(b), as applicable, as 
included in the covered shareholder's gross income under section 
951(a)(1)(A) with respect to the foreign corporation, and assign 
previously taxed earnings and profits resulting from such treatment to 
the section 965(b) PTEP group (rather than the section 951(a)(1)(A) 
PTEP group).
    (c) Establishing PTEP tax pools, corporate PTEP tax pools, adjusted 
applicable percentages, and section 965(c) deduction percentages--(1) 
In general. As of the beginning of the first taxable year of a foreign 
corporation to which the section 959 regulations (other than Sec. Sec.  
1.959-8 and 1.959-9) apply pursuant to Sec.  1.959-12(b) (general 
applicability date) or, if applicable, Sec.  1.959-12(d) (optional 
early application), PTEP tax pools, corporate PTEP tax pools, adjusted 
applicable percentages, and section 965(c) deduction percentages 
reflecting the foreign corporation's previously taxed earnings and 
profits must be established in accordance with the rules described in 
paragraphs (c)(2) through (4) of this section.
    (2) PTEP tax pools and corporate PTEP tax pools. PTEP tax pools and 
corporate PTEP tax pools are established by adding a pro rata portion 
of the foreign corporation's prior-law PTEP group taxes with respect to 
a prior-law PTEP group (defined in this paragraph (c)(2)) to each PTEP 
tax pool with respect to the foreign corporation, determined by 
multiplying such prior-law PTEP group taxes by a fraction. The 
numerator of the fraction is the balance of the prior-law PTEP group 
that is previously taxed earnings and profits relating to the PTEP tax 
pool, and the denominator of the fraction is the balance of the prior-
law PTEP group. For purposes of this paragraph (c)(2), prior-law PTEP 
group taxes and prior-law PTEP groups mean PTEP group taxes and PTEP 
groups, respectively, as defined in Sec.  1.960-3 as contained in 26 
CFR part 1 revised as of April 1, 2024.
    (3) Adjusted applicable percentage. An adjusted applicable 
percentage is established with respect to all of the foreign 
corporation's previously taxed earnings and profits assigned to the 
reclassified section 965(a) PTEP group, reclassified section 965(b) 
PTEP group, section 965(a) PTEP group, and section 965(b) PTEP group 
within a covered shareholder's annual PTEP accounts relating to the 
same section 904 category by calculating a weighted average of the 
applicable percentages (as defined in Sec.  1.965-5(d)) with respect to 
the previously taxed earnings and profits. The weighted average is 
determined as the sum of the product of each such applicable percentage 
and the amount of previously taxed earnings and profits to which the 
applicable percentage relates, divided by the sum of the amount of 
previously taxed earnings and profits described in the preceding 
sentence. For purposes of this paragraph (c)(3), applicable percentages 
and previously taxed earnings and profits are determined as of the 
beginning of the taxable year.
    (4) Section 965(c) deduction percentage. A section 965(c) deduction 
percentage is established with respect to all of the foreign 
corporation's previously taxed earnings and profits assigned to the 
reclassified section 965(a) PTEP group and section 965(a) PTEP group 
within a covered shareholder's annual PTEP accounts relating to the 
same section 904 category by calculating a weighted average of the 
percentages for which foreign currency gain or loss recognized under 
section 986(c) with respect to distributions of the previously taxed 
earnings and profits would be reduced under Sec.  1.986(c)-1 as 
contained in 26 CFR part 1 revised as of April 1, 2024. The weighted 
average is determined as the sum of the product of each such percentage 
and the amount of previously taxed earnings and profits to which the 
percentage relates, divided by the sum of the amount of previously 
taxed earnings and profits described in the preceding sentence. For 
purposes of this paragraph (c)(4), percentages for which foreign 
currency gain or loss would be reduced under Sec.  1.986(c)-1 and 
previously taxed earnings and profits are determined as of the 
beginning of the taxable year.
    (d) Treatment of domestic partnerships (including S corporations) 
before application of Sec.  1.958-1(d)(1). For purposes of the section 
959 regulations, a domestic partnership (including an S corporation) is 
treated as a covered shareholder for any taxable year of the domestic 
partnership to which Sec.  1.958-1(d)(1) does not apply. If a domestic 
partnership is treated as a covered shareholder, then rules regarding 
distributions of previously taxed earnings and profits apply to the 
domestic partnership in its capacity as a covered shareholder before 
those rules apply to covered shareholders that own interests in the 
domestic partnership. In such a case, for example, a covered 
distribution made to the domestic partnership is first a distribution 
of the distributing foreign corporation's previously taxed earnings and 
profits with respect to the partnership and then, to the extent 
remaining, a distribution of the distributing foreign corporation's 
previously taxed earnings and profits with respect to covered 
shareholders owning interests in the partnership.
    (e) Converting domestic partnership-level (including S corporation-
level) accounts to partner-level accounts after the application of 
Sec.  1.958-1(d)(1)--(1) In general. As of the beginning of the first 
taxable year of a domestic partnership (including an S corporation) to 
which both Sec.  1.958-1(d)(1) and the section 959 regulations (other 
than Sec. Sec.  1.959-8 and 1.959-9) apply (pursuant to Sec.  1.959-
12(c) (general applicability date) or (d) (optional early 
application)), the domestic partnership's accounts described in Sec.  
1.959-2 with respect to a foreign corporation are converted to accounts 
of covered shareholders owning interests in the partnership in 
accordance with the rules described in paragraphs (e)(2) through (4) of 
this section.
    (2) Rules for converting accounts--(i) Allocate previously taxed 
earnings and profits to each covered shareholder--(A) In general. 
First, allocate a pro rata portion of the foreign corporation's 
previously taxed earnings and profits with respect to the domestic 
partnership to each covered shareholder owning an interest in the 
partnership at the beginning of the taxable year, determined by 
multiplying all the foreign corporation's previously taxed earnings and 
profits with respect to the partnership by a fraction. The numerator of 
the fraction is the liquidation value of the covered shareholder's 
interest in the partnership, and the denominator of the fraction is the 
aggregate liquidation value of all partners' interests in the 
partnership (determined in each case under paragraph (e)(2)(i)(B) of 
this section).
    (B) Liquidation value. For purposes of this paragraph (e)(2)(i), 
the liquidation value of a partner's interest in the partnership is the 
amount of cash the partner would receive with respect to the interest 
if, at the beginning of the taxable year, the partnership (and any 
partnership through which the partner indirectly owns an interest in 
the partnership) sold all of its property for an amount of cash equal 
to the fair market value of the property (taking into account section 
7701(g)), satisfied all of its liabilities (other than those described 
in Sec.  1.752-7), paid an unrelated third party to assume all of its 
Sec.  1.752-7 liabilities in a fully taxable transaction,

[[Page 95431]]

and then the partnership (and any partnership through which the partner 
indirectly owns an interest in the partnership) liquidated. Moreover, 
any change to a partnership agreement made with a principal purpose of 
altering the allocation of previously taxed earnings and profits under 
this paragraph (e)(2)(i) is disregarded.
    (ii) Compute dollar basis and associated foreign income taxes. 
Second, treat the dollar basis of, or foreign income taxes associated 
with, previously taxed earnings and profits allocated to each covered 
shareholder as the same as what would be the dollar basis of, or 
foreign income taxes associated with, the previously taxed earnings and 
profits under Sec.  1.959-4 if the previously taxed earnings and 
profits were distributed at the beginning of the taxable year.
    (iii) Eliminate the domestic partnership's accounts and increase 
covered shareholders' accounts. Third, eliminate the domestic 
partnership's annual PTEP accounts, dollar basis pools, and PTEP tax 
pools with respect to the foreign corporation. Concurrently with such 
eliminations, increase each covered shareholder's annual PTEP accounts, 
dollar basis pools, and PTEP tax pools with respect to the foreign 
corporation to reflect the foreign corporation's previously taxed 
earnings and profits that are allocated to the covered shareholder or 
the dollar basis of, or foreign income taxes associated with, the 
previously taxed earnings and profits, as applicable.
    (3) Coordination with section 986(c). No foreign currency gain or 
loss is recognized with respect to previously taxed earnings and 
profits under section 986(c) as a result of previously taxed earnings 
and profits ceasing to be with respect to the domestic partnership 
pursuant to this paragraph (e) (notwithstanding Sec.  1.986(c)-1).
    (4) Coordination with deemed covered shareholder rules. The 
portion, if any, of the foreign corporation's previously taxed earnings 
and profits with respect to the domestic partnership that does not give 
rise to an increase to a covered shareholder's annual PTEP accounts 
with respect to the foreign corporation under paragraph (e)(1) of this 
section becomes previously taxed earnings and profits of the foreign 
corporation with respect to the deemed covered shareholder for purposes 
of subsequently transferring the previously taxed earnings and profits 
under section 959. See Sec.  1.959-7(g) for rules regarding the deemed 
covered shareholder.


Sec.  1.959-12  Applicability dates.

    (a) Scope. This section sets forth applicability dates for the 
section 959 regulations. Paragraph (b) of this section provides the 
general applicability dates. Paragraph (c) of this section provides 
interim application for certain provisions. Paragraph (d) of this 
section allows early application.
    (b) In general. Sections 1.959-1 through 1.959-7 and 1.959-10 and 
1.959-11 apply to taxable years of foreign corporations beginning on or 
after [date of publication of final regulations in the Federal 
Register] and to taxable years of persons for which such taxable years 
of those foreign corporations are relevant.
    (c) Interim application of 2019 notice provisions--(1) In general. 
For taxable years of United States shareholders (and successors in 
interest) ending after December 14, 2018, and to which Sec. Sec.  
1.959-1 through 1.959-7 and 1.959-10 and 1.959-11 do not apply pursuant 
to paragraph (b) or (d) of this section, and taxable years of foreign 
corporations ending with or within such taxable years, the 2019 notice 
provisions (defined in paragraph (c)(2) of this section) and Sec.  
1.959-11 apply.
    (2) 2019 notice provisions. The 2019 notice provisions means 
Sec. Sec.  1.959-1(c) (treatment of an S corporation), 1.959-2 
(accounting of previously taxed earnings and profits), 1.959-3 
(adjustments to shareholder-level accounts and, consequently, foreign 
corporation-level accounts), 1.959-4(e) and 1.959-5(d) (allocation of 
distributions and section 956 amounts), and the relevant definitions in 
Sec.  1.959-1(b), along with treating previously taxed earnings and 
profits as distributed under section 959 only to the extent that the 
distribution is a dividend (as defined in section 316), determined 
without regard to section 959(d). For purposes of applying the 2019 
notice provisions, the PTEP groups listed in the following table may be 
used in lieu of the PTEP groups listed in Sec.  1.959-2, the portions 
of Sec. Sec.  1.959-2 and 1.959-3 relating to PTEP tax pools, corporate 
PTEP tax pools, adjusted applicable percentages, and section 965(c) 
deduction percentages do not apply, and the portions of Sec. Sec.  
1.959-3 through 1.959-5 and 1.959-7 relating to the timing of 
adjustments and determinations do not apply.

                      Table 1 to Paragraph (c)(2) of This Section--2019 Notice PTEP Groups
----------------------------------------------------------------------------------------------------------------
                 Section 959(c)(1) PTEP groups                            Section 959(c)(2) PTEP groups
----------------------------------------------------------------------------------------------------------------
               Group                        Description                 Group                 Description
----------------------------------------------------------------------------------------------------------------
Reclassified section 965(a) PTEP    Earnings and profits        Section 965(a) PTEP    Earnings and profits
 group.                              described in section        group.                 described in section
                                     959(c)(1)(A) that were                             959(c)(2) by reason of
                                     initially described in                             section 965(a).
                                     section 959(c)(2) by
                                     reason of section 965(a).
Reclassified section 965(b) PTEP    Earnings and profits        Section 965(b) PTEP    Earnings and profits
 group.                              described in section        group.                 described in section
                                     959(c)(1)(A) that were                             959(c)(2) by reason of
                                     initially described in                             section 965(b)(4)(A).
                                     section 959(c)(2) by
                                     reason of section
                                     965(b)(4)(A).
Section 951(a)(1)(B) PTEP group...  Earnings and profits
                                     described in section
                                     959(c)(1)(A) by reason of
                                     section 951(a)(1)(B) and
                                     not by reason of section
                                     959(a)(2).
Reclassified section 951A PTEP      Earnings and profits        Section 951A PTEP      Earnings and profits
 group.                              described in section        group.                 described in section
                                     959(c)(1)(A) that were                             959(c)(2) by reason of
                                     initially described in                             section 951A(f)(2).
                                     section 959(c)(2) by
                                     reason of section
                                     951A(f)(2).
Reclassified section 245A(e)(2)     Earnings and profits        Section 245A(e)(2)     Earnings and profits
 PTEP group.                         described in section        PTEP group.            described in section
                                     959(c)(1)(A) that were                             959(c)(2) by reason of
                                     initially described in                             section 245A(e)(2).
                                     section 959(c)(2) by
                                     reason of section
                                     245A(e)(2).
Reclassified section 959(e) PTEP    Earnings and profits        Section 959(e) PTEP    Earnings and profits
 group.                              described in section        group.                 described in section
                                     959(c)(1)(A) that were                             959(c)(2) by reason of
                                     initially described in                             section 959(e).
                                     section 959(c)(2) by
                                     reason of section 959(e).
Reclassified section 964(e)(4)      Earnings and profits        Section 964(e) PTEP    Earnings and profits
 PTEP group.                         described in section        group.                 described in section
                                     959(c)(1)(A) that were                             959(c)(2) by reason of
                                     initially described in                             section 964(e)(4).
                                     section 959(c)(2) by
                                     reason of section
                                     964(e)(4).

[[Page 95432]]

 
Reclassified section 951(a)(1)(A)   Earnings and profits        Section 951(a)(1)(A)   Earnings and profits
 PTEP group.                         described in section        PTEP group.            described in section
                                     959(c)(1)(A) that were                             959(c)(2) by reason of
                                     initially described in                             section 951(a)(1)(A) and
                                     section 959(c)(2) by                               not described in another
                                     reason of section                                  PTEP group.
                                     951(a)(1)(A) and not
                                     described in another PTEP
                                     group.
Section 956A PTEP group...........  Earnings and profits
                                     described in section
                                     959(c)(1)(B), including
                                     by reason of section
                                     959(a)(3) (before its
                                     repeal).
----------------------------------------------------------------------------------------------------------------

    (d) Early application--(1) In general. Sections 1.959-1 through 
1.959-7 and 1.959-10 and 1.959-11 may be applied to a taxable year of a 
foreign corporation not described in paragraph (b) of this section, and 
then must be applied to all succeeding taxable years of the foreign 
corporation not described in paragraph (b) of this section, if the 
conditions described in paragraphs (d)(2) through (4) of this section 
are satisfied. The foreign corporation described in the preceding 
sentence is the early application corporation and any taxable years to 
which the early application corporation applies Sec. Sec.  1.959-1 
through 1.959-7, 1.959-10, and 1.959-11 pursuant to the preceding 
sentence are the early application years.
    (2) Consistent application condition--(i) In general. The 
provisions described in paragraph (d)(2)(ii) of this section are 
applied in their entirety to the early application years and all 
taxable years of covered shareholders for which the early application 
years are relevant. In addition, Sec. Sec.  1.959-1 through 1.959-7, 
1.959-10, and 1.959-11 are applied in their entirety pursuant to 
paragraph (d) of this section to all taxable years that both are of 
foreign corporations that are related to the early application 
corporation and end on or after the later of the last day of the first 
early application year and the first day on which the foreign 
corporations are related to the early application corporation. For 
purposes of the preceding sentence, foreign corporations are related if 
the foreign corporations bear a relationship to each other described in 
section 267(b).
    (ii) Provisions. The provisions described in this paragraph 
(d)(2)(ii) are Sec. Sec.  1.163(j)-7(g)(2)(ii), 1.245A(d)-1(d), 1.312-
6(f), 1.312-8(c), 1.861-20, 1.904-6(e), 1.905-3, 1.905-4(c)(6), 1.951-
1, 1.951-2, 1.951A-1(d), 1.951A-2(c)(1)(vi), 1.952-1(c)(4), 1.954-
1(c)(1)(iii)(C), 1.959-1 through 1.959-7, 1.959-10, 1.959-11, 1.960-1, 
1.960-3, 1.961-1 through 1.961-5, 1.961-8 through 1.961-13, 1.965-
5(d)(5), 1.986(a)-1, 1.986(c)-1, and 1.1502-59.
    (3) Open period of limitations condition. The period of limitations 
on assessment for each taxable year described in paragraph (d)(2) of 
this section is open under section 6501.
    (4) Written consent condition. Each covered shareholder described 
in paragraph (d)(2) of this section provides to the early application 
corporation a written statement in which the covered shareholder 
consents to apply the rules described in paragraph (d)(2) of this 
section to the taxable years of the covered shareholder described in 
paragraph (d)(2) of this section and affirms that the period of 
limitations on assessment for each such taxable year is open under 
section 6501.
0
Par. 23. Section 1.960-1 is amended by:
0
1. Revising paragraph (a)(1);
0
2. Revising paragraphs (b)(1) and (b)(3);
0
3. Removing paragraph (b)(12);
0
4. Redesignating paragraphs (b)(13) through (b)(16) as paragraphs 
(b)(12) through (b)(15), respectively;
0
5. Revising newly redesignated paragraph (b)(15);
0
6. Redesignating paragraph (b)(17) as paragraph (b)(16), and revising 
newly redesignated paragraph (b)(16);
0
7. Adding a new paragraph (b)(17);
0
8. Removing paragraphs (b)(18) through (b)(21);
0
9. Redesignating paragraphs (b)(22) through (b)(24) as paragraphs 
(b)(18) through (b)(20), respectively;
0
10. Removing paragraph (b)(25);
0
11. Redesignating paragraphs (b)(26) and (b)(27) as paragraphs (b)(21) 
and (b)(22), respectively, and revising newly redesignated paragraphs 
(b)(21) and (b)(22);
0
12. Removing paragraph (b)(28);
0
13. Redesignating paragraphs (b)(29) through (b)(38) as paragraphs 
(b)(23) through (b)(32), respectively;
0
14. Revising paragraphs (c)(1)(i) through (iii);
0
15. In paragraph (c)(1)(iv), removing the language ``Sec.  1.960-3(b)'' 
and adding the language ``Sec.  1.960-3'' in its place;
0
16. Removing paragraph (c)(1)(v);
0
17. Redesignating paragraphs (c)(1)(vi) and (vii) as paragraphs 
(c)(1)(v) and (c)(1)(vi), respectively;
0
18. Revising newly redesignated paragraphs (c)(1)(v) and (vi);
0
19. Revising paragraph (c)(2);
0
20. Revising paragraph (d)(1);
0
21. Revising paragraphs (d)(2)(i) and (d)(2)(ii)(A) and (D);
0
22. Revising the heading of paragraph (d)(3) and the introductory text 
of paragraph (d)(3)(i);
0
23. Revising the last sentence of paragraph (d)(3)(i)(A) and the last 
two sentences of paragraph (d)(3)(ii)(A);
0
24. Revising paragraph (d)(3)(ii)(B); and
0
25. Revising paragraphs (e) and (f).
    The additions and revisions read as follows:


Sec.  1.960-1  Overview, definitions, and computational rules for 
determining foreign income taxes deemed paid under section 960(a), (b), 
and (d).

    (a) Overview--(1) Scope of Sec. Sec.  1.960-1 through 1.960-3. This 
section and Sec.  1.960-2 provide rules for attributing foreign income 
taxes paid or accrued by a controlled foreign corporation to its income 
that a corporate United States shareholder of the controlled foreign 
corporation takes into account in determining its subpart F inclusion 
or GILTI inclusion amount. This section provides definitions, 
identifies the statutory and residual groupings for purposes of section 
960(a) and (d), and sets forth computational rules for determining the 
amount of income and taxes assigned to each grouping. Section 1.960-2 
provides rules for computing the amount of foreign income taxes deemed 
paid by a corporate United States shareholder of a controlled foreign 
corporation under section 960(a) and (d). Section 1.960-3 provides 
rules for determining the foreign income taxes that are deemed paid by 
a corporate United States shareholder in a controlled foreign 
corporation, or by a controlled foreign corporation that is a 
shareholder in another controlled foreign corporation, under section 
960(b). This section, Sec.  1.960-2, and Sec.  1.960-3 provide the 
exclusive rules for determining the foreign income taxes deemed paid by 
a domestic corporation or controlled foreign corporation under section 
960. Only foreign income taxes paid or accrued by a controlled foreign

[[Page 95433]]

corporation that are properly attributable under these rules to an item 
of income that a corporate United States shareholder of the controlled 
foreign corporation includes as a subpart F inclusion or GILTI 
inclusion amount may be deemed paid by the domestic corporation under 
section 960(a) or (d). Only foreign income taxes that are properly 
attributable under Sec.  1.960-3 to previously taxed earnings and 
profits that are distributed by a controlled foreign corporation may be 
deemed paid by a domestic corporation or a controlled foreign 
corporation under section 960(b). This section, Sec.  1.960-2, and 
Sec.  1.960-3 also apply for purposes of any provision that treats a 
taxpayer as a domestic corporation that is deemed to pay foreign income 
taxes or treats a foreign corporation as a controlled foreign 
corporation for purposes of section 960. See, for example, sections 
962(a)(2) and 1293(f).
* * * * *
    (b) * * *
    (1) Annual PTEP account. The term annual PTEP account has the 
meaning provided in Sec.  1.959-1(b).
* * * * *
    (3) Current taxable year. The term current taxable year means the 
U.S. taxable year of a controlled foreign corporation which ends with 
or within the U.S. taxable year of a United States shareholder of the 
controlled foreign corporation.
* * * * *
    (15) Previously taxed earnings and profits. The term previously 
taxed earnings and profits has the meaning provided in Sec.  1.959-
1(b).
    (16) PTEP group. The term PTEP group has the meaning provided in 
Sec.  1.959-1(b).
    (17) PTEP realization event. The term PTEP realization event has 
the meaning provided in Sec.  1.959-1(b).
* * * * *
    (21) Specified section 959(a) distribution. The term specified 
section 959(a) distribution means a distribution of previously taxed 
earnings and profits, as determined under Sec.  1.959-4, that a 
domestic corporation that is a United States shareholder in a 
controlled foreign corporation receives (or is treated as receiving 
pursuant to Sec.  1.959-4(c)(3)) from the controlled foreign 
corporation and that is excluded from the income of the recipient 
domestic corporation under Sec.  1.959-4(b)(1).
    (22) Section 959(b) distribution. The term section 959(b) 
distribution means a distribution of previously taxed earnings and 
profits, as determined under Sec.  1.959-4, that a controlled foreign 
corporation receives from another controlled foreign corporation and 
that is excluded from the income of the recipient controlled foreign 
corporation for purposes of determining the recipient controlled 
foreign corporation's subpart F income and tested income or tested loss 
under Sec.  1.959-4(b)(2).
* * * * *
    (c) * * *
    (1) * * *
    (i) First, items of gross income of a controlled foreign 
corporation for the current taxable year are assigned to section 904 
categories and included in income groups within those section 904 
categories under the rules in paragraph (d)(2) of this section. See 
section 959 and the regulations thereunder for rules regarding the 
receipt of a section 959(b) distribution by a controlled foreign 
corporation.
    (ii) Second, deductions (other than for current year taxes) of a 
controlled foreign corporation for the current taxable year are 
allocated and apportioned to reduce gross income in the section 904 
categories and the income groups within a section 904 category. See 
paragraph (d)(3)(i) of this section. Additionally, the functional 
currency amounts of current year taxes are allocated and apportioned to 
reduce gross income in the section 904 categories and the income groups 
within a section 904 category. See paragraph (d)(3)(ii) of this 
section. For rules regarding the allocation and apportionment of 
foreign income taxes paid or accrued by a foreign corporation to 
previously taxed earnings and profits, see Sec.  1.959-6.
    (iii) Third, for purposes of computing foreign income taxes deemed 
paid under section 960(a) and (d), eligible current year taxes that 
were allocated and apportioned to income groups in the section 904 
categories are translated into U.S. dollars in accordance with section 
986(a) and Sec.  1.986(a)-1.
* * * * *
    (v) Fifth, paragraphs (c)(1)(i) through (iv) of this section are 
repeated for each next higher-tier controlled foreign corporation in 
the chain.
    (vi) Sixth, with respect to the highest-tier controlled foreign 
corporation in a chain that is owned directly (or indirectly through 
one or more partnerships) by the domestic corporation, foreign income 
taxes that are deemed paid under section 960(b)(1) in connection with 
the receipt of a specified section 959(a) distribution by the domestic 
corporation are computed under the rules of Sec.  1.960-3.
    (2) Current taxable year items. For a current taxable year, the 
items of income and deductions (including for taxes), and the U.S. 
dollar amounts of current year taxes, that are included in the 
computations described in this section are the items that a controlled 
foreign corporation accrues and takes into account during the current 
taxable year. An item of income with respect to a current taxable year 
does not include an amount included as subpart F income of a controlled 
foreign corporation by reason of the recharacterization of a recapture 
account established in a prior U.S. taxable year (and the corresponding 
earnings and profits) of the controlled foreign corporation under 
section 952(c)(2) and Sec.  1.952-1(f).
* * * * *
    (d) * * *
    (1) Scope. This paragraph (d) provides rules for assigning gross 
income (including gains) of a controlled foreign corporation for the 
current taxable year to a section 904 category and income group within 
a section 904 category, and for allocating and apportioning deductions 
(including losses and current year taxes) and the U.S. dollar amount of 
eligible current year taxes of the controlled foreign corporation for 
the current taxable year among the section 904 categories and income 
groups within a section 904 category. See Sec.  1.959-6 for rules for 
allocating and apportioning foreign income taxes paid or accrued by a 
foreign corporation to previously taxed earnings and profits.
    (2) * * *
    (i) Assigning items of gross income to section 904 categories. 
Items of gross income of a controlled foreign corporation for the 
current taxable year are first assigned to a section 904 category of 
the controlled foreign corporation under Sec. Sec.  1.904-4 and 1.904-
5. Income of a controlled foreign corporation cannot be assigned to the 
section 951A category. See Sec.  1.904-4(g). But see Sec.  1.959-
2(b)(2)(i) for rules relating to the assignment of previously taxed 
earnings and profits to PTEP groups within an annual PTEP account, 
which may assign previously taxed earnings and profits to the section 
951A PTEP group.
    (ii) * * *
    (A) In general. Gross income within a section 904 category is 
assigned to a subpart F income group, tested income group, or residual 
income group under the rules of this paragraph (d)(2)(ii). See Sec.  
1.959-2(d) for rules regarding the accounting of previously taxed 
earnings and profits by a foreign corporation.
* * * * *
    (D) Residual income group. The term residual income group means the

[[Page 95434]]

income group within a section 904 category that is not in a subpart F 
income group or tested income group. For purposes of this paragraph 
(d)(2)(ii)(D), treat items of gross income that give rise to previously 
taxed earnings and profits described in Sec.  1.959-6(b) as gross 
income in a residual income group. See paragraph (d)(3)(ii)(B) of this 
section for rules regarding the assignment of foreign gross income to 
the statutory and residual groupings of income of a controlled foreign 
corporation when the controlled foreign corporation pays or accrues 
current year taxes with respect to a PTEP realization event that occurs 
in a different taxable year.
* * * * *
    (3) Allocation and apportionment of deductions among section 904 
categories and income groups within a section 904 category--(i) In 
general. Gross income of a controlled foreign corporation in each 
income group within each section 904 category is reduced by deductions 
(including losses and current year taxes) of the controlled foreign 
corporation for the current taxable year under the rules in this 
paragraph (d)(3)(i). For purposes of this paragraph (d)(3), allocate 
and apportion current year taxes arising by reason of a PTEP 
realization event that occurs in the same taxable year to the residual 
income group within a section 904 category under Sec.  1.959-6(c). For 
additional rules regarding the allocation and apportionment of 
deductions (including foreign income taxes) paid or accrued by a 
foreign corporation to previously taxed earnings and profits, see Sec.  
1.959-6.
    (A) * * * See paragraph (d)(3)(ii) of this section for special 
rules for allocating and apportioning current year taxes to section 904 
categories and income groups.
* * * * *
    (ii) * * *
    (A) * * * For special rules regarding current year taxes paid or 
accrued with respect to a PTEP realization event that occurs in a 
different taxable year, see paragraph (d)(3)(ii)(B) of this section. 
For purposes of determining foreign income taxes deemed paid under 
section 960(a) and (d) and Sec.  1.960-2, the U.S. dollar amount of 
eligible current year taxes is assigned to the section 904 categories 
and income groups to which the eligible current year taxes are 
allocated and apportioned.
    (B) Current year taxes that a controlled foreign corporation pays 
or accrues that relate to a PTEP realization event that occurs in a 
different U.S. taxable year. If a current year tax is allocated and 
apportioned by reference to foreign gross income that includes 
previously taxed earnings and profits with respect to a PTEP 
realization event that occurs in a different taxable year, the foreign 
gross income is assigned to the subpart F income group, tested income 
group, or residual income group to which the income that gave rise to 
the previously taxed earning and profits would be assigned if that 
income were recognized by that controlled foreign corporation under 
Federal income tax principles in the current taxable year. For example, 
a net basis tax paid or accrued with respect to a section 959(b) 
distribution that occurred in the preceding taxable year would be 
assigned to a section 904 category and to a subpart F income group, 
tested income group, or residual income group by reference to the 
income that gave rise to the previously taxed earnings and profits.
    (e) Current year taxes related to a residual income group are not 
deemed paid. Current year taxes paid or accrued by a controlled foreign 
corporation that are allocated and apportioned under paragraph 
(d)(3)(ii) of this section to a residual income group cannot be deemed 
paid under section 960 for any taxable year, except to the extent such 
taxes are allocated and apportioned to previously taxed earnings and 
profits under Sec.  1.959-6 and deemed paid by a domestic corporation 
under Sec.  1.960-3.
    (f) Example. The following example illustrates the application of 
this section and Sec.  1.960-3.
    (1) Facts--(i) CFC1 and CFC2. CFC1, a controlled foreign 
corporation, conducts business in Country X. CFC1 uses the ``u'' as its 
functional currency. At all relevant times, 1u = $1. CFC1 owns all the 
stock of CFC2, a controlled foreign corporation. All the stock of CFC1 
and CFC2 is owned (within the meaning of section 958(a)) by corporate 
United States shareholders that use the calendar year as their U.S. 
taxable year. CFC1 and CFC2 both use the calendar year as their U.S. 
and foreign taxable years.
    (ii) Income of CFC1 and CFC2. In Year 3, CFC1 earns 2,000,000u of 
gross income that is foreign base company sales income, and 1,000,000u 
of interest income from unrelated persons, for both U.S. and Country X 
tax law purposes. Under Country X tax law, CFC1's interest income is 
exempt from tax. In Year 3, CFC1 also receives a section 959(b) 
distribution from CFC2 of 4,000,000u of previously taxed earnings and 
profits, in the general category and relating to a single PTEP group 
and taxable year. There are no foreign income taxes associated with the 
previously taxed earnings and profits distributed by CFC2 at the level 
of CFC2 under Sec.  1.959-4. The section 959(b) distribution is treated 
as a dividend taxable to CFC1 under Country X tax law. In Year 3, CFC2 
earns no gross income and receives no distributions.
    (iii) Deductions of CFC1 and CFC2 other than taxes. For both U.S. 
and Country X tax purposes, in Year 3, CFC1 incurs 1,500,000u of 
deductible expenses other than current year taxes that are allocable to 
all gross income. For U.S. tax purposes, under Sec. Sec.  1.861-8 
through 1.861-14T, 1,000,000u of the deductions are apportioned to 
CFC1's foreign base company sales income and 500,000u of the deductions 
are apportioned to CFC1's interest income. Under Country X tax law, 
1,000,000u of deductions are apportioned to the 4,000,000u treated as a 
dividend, and 500,000u of deductions are apportioned to the 2,000,000u 
of foreign base company sales income. Under Country X tax law, no 
deductions are apportioned to the interest income. Under Country X tax 
law, CFC1 pays eligible current year taxes of 900,000u on a base of 
4,500,000u (7,000,000u gross income - 1,000,000u exemption and 
1,500,000u deductions) consisting of 3,000,000u (4,000,000u - 
1,000,000u) of previously taxed earnings and profits, 1,000,000u of 
interest income (exempt from tax under Country X law), and 1,500,000u 
(2,000,000u - 500,000u) of foreign base company sales income. In Year 
3, CFC2 has no expenses (including current year taxes).
    (2) Analysis--(i) CFC2. Under paragraph (c)(1) of this section, the 
computational rules of paragraph (c)(1) of this section are applied 
beginning with CFC2. However, CFC2 has no gross income or expenses in 
Year 3. Accordingly, the computational rules in paragraphs (c)(1)(i) 
through (iv) of this section are not relevant with respect to CFC2. 
Under paragraph (c)(1)(v) of this section, the rules in paragraph 
(c)(1)(i) through (iv) of this section are then applied to CFC1.
    (ii) CFC1--(A) Step 1. Under paragraph (c)(1)(i) of this section, 
CFC1's items of gross income for the current taxable year are assigned 
to section 904 categories and included in income groups within those 
section 904 categories. Under paragraph (d)(2)(i) of this section and 
Sec.  1.904-4, the interest income is passive category income and the 
foreign base company sales income is general category income. Under 
paragraph (d)(2)(ii) of this section, the 1,000,000u of interest income 
is assigned to a subpart F income group (the ``FPHCI income group'') 
within the passive category because it is foreign

[[Page 95435]]

personal holding company income described in Sec.  1.954-
1(c)(1)(iii)(A)(1)(i) that falls within a single group of income under 
Sec.  1.904-4(c)(3)(iii) for passive income that is subject to no 
withholding tax or other foreign tax. The 2,000,000u of foreign base 
company sales income is assigned to a subpart F income group within the 
general category (the ``FBCSI income group''), because it is foreign 
base company income described in Sec.  1.954-1(c)(1)(iii)(A)(2)(i). 
Under paragraph (d)(2) of this section, the 4,000,000u of previously 
taxed earnings and profits is treated as a U.S. dividend amount (as 
defined in Sec.  1.861-20(b)(21)) and is assigned to the residual 
income group within the general category for purposes of applying 
section 960(a) and (d) and Sec. Sec.  1.960-1 and 1.960-2.
    (B) Step 2--(1) Allocation and apportionment of deductions other 
than taxes. Under paragraph (c)(1)(ii) of this section, CFC1's 
deductions for the current taxable year are allocated and apportioned 
among the section 904 categories and income groups within a section 904 
category that were increased as provided in paragraph (c)(1)(i) of this 
section. Under paragraph (d)(3)(i) of this section and Sec. Sec.  
1.861-8 through 1.861-14T, 1,000,000u of deductions are allocated and 
apportioned to the FBCSI income group within the general category, and 
500,000u of deductions are allocated and apportioned to the FPHCI 
income group within the passive category. Therefore, CFC1 has 
1,000,000u (2,000,000u - 1,000,000u) of pre-tax income attributable to 
the FBCSI income group within the general category and 500,000u 
(1,000,000u - 500,000u) of pre-tax income attributable to the FPHCI 
income group within the passive category. For U.S. tax purposes, no 
deductions other than eligible current year taxes are allocated and 
apportioned to the 4,000,000u of previously taxed earnings and profits 
in CFC1's residual income group within the general category because no 
deductions of CFC1 other than deductions for current year taxes are 
allocated and apportioned to previously taxed earnings and profits 
under section 861. See paragraph (d)(3)(i) of this section and Sec.  
1.959-6(d)(1).
    (2) Allocation and apportionment of current year taxes. Under 
paragraph (c)(1)(ii) of this section, CFC1's current year taxes are 
allocated and apportioned among the section 904 categories and income 
groups within a section 904 category that were increased as provided in 
paragraph (c)(1)(i) of this section. Under paragraphs (d)(3)(i) and 
(ii) of this section, for purposes of allocating and apportioning taxes 
to reduce the income in a section 904 category or an income group, 
Sec.  1.861-20 (as modified by Sec.  1.904-6(c)) is applied to 
determine the amount of foreign taxable income, computed under Country 
X tax law but characterized under Federal income tax law, in each 
section 904 category and income group that is included in the Country X 
tax base. For Country X tax purposes, 1,000,000u of deductions are 
allocated and apportioned to CFC1's 4,000,000u of previously taxed 
earnings and profits, which is assigned to the residual income grouping 
within the general category, 500,000u of deductions are allocated and 
apportioned to the FBCSI income group within the general category, and 
no deductions are allocated and apportioned to the FPHCI income group 
in the passive category. Therefore, for Country X tax purposes, CFC1 
has 3,000,000u of foreign taxable income assigned to the residual 
income group within the general category, 1,500,000u of foreign taxable 
income assigned to the FBCSI income group within the general category, 
and no taxable income assigned to the FPHCI income group within the 
passive category. Under paragraphs (d)(3)(i) and (ii) of this section 
and Sec.  1.959-6, 600,000u (3,000,000u/4,500,000u x 900,000u) of the 
900,000u eligible current year taxes paid by CFC1 are related to the 
residual income group within the general category, and 300,000u 
(1,500,000u/4,500,000u x 900,000u) are related to the FBCSI income 
group within the general category. No current year taxes are allocated 
or apportioned to the FPHCI income group within the passive category 
because the interest expense is exempt from Country X tax. See Sec.  
1.959-6 for rules allocating and apportioning the 600,000u of current 
year taxes among the corporate PTEP accounts, section 904 categories, 
and PTEP groups. Thus, for U.S. tax purposes, CFC1 has 3,400,000u of 
previously taxed earnings and profits (4,000,000u - 600,000u) in the 
residual income group within the general category (see Sec. Sec.  
1.959-2 and 1.959-3 for rules relating to accounting for previously 
taxed earnings and profits), 500,000u of income in the FPHCI income 
group within the passive category, and 700,000u of income (1,000,000u - 
300,000u) in the FBCSI income group within the general category.
    (C) Step 3. Under paragraph (c)(1)(iii) of this section, for 
purposes of computing foreign income taxes deemed paid under section 
960(a), CFC1 has $300,000 of current year taxes in the FBCSI income 
group within the general category. Under paragraph (e) of this section, 
the United States shareholders of CFC1 cannot claim a credit with 
respect to the $600,000 of taxes on CFC1's income in the residual 
income group under section 960, except to the extent the taxes are 
allocated and apportioned to previously taxed earnings and profits 
under Sec.  1.959-6 and deemed paid by a domestic corporation under 
section 960(b) and Sec.  1.960-3.
    (D) Step 4. Under paragraph (c)(1)(iv) of this section, the United 
States shareholders of CFC1 compute current year taxes deemed paid 
under section 960(a) and (d) and the rules of Sec.  1.960-2. None of 
the Country X tax is allocated to CFC1's FPHCI income group. Therefore, 
there are no current year taxes deemed paid by CFC1's United States 
shareholders with respect to their passive category subpart F 
inclusions. Country X tax equal to $300,000 is allocated and 
apportioned to CFC1's FBCSI income group. Therefore, $300,000 of the 
current year taxes are deemed paid by CFC1's United States shareholders 
with respect to their general category subpart F inclusions. See Sec.  
1.960-2(b)(5) and (c)(7) for examples of the application of section 
960(a) and (d) and the rules in Sec.  1.960-2. The remaining $600,000 
of Country X tax is allocated and apportioned to the residual income 
group within the general category with respect to the previously taxed 
earnings and profits and will generally be allocated and apportioned to 
previously taxed earnings and profits under the rules in Sec.  1.959-6.
    (E) Step 5. Paragraph (c)(1)(v) of this section does not apply 
because CFC1 is the highest-tier controlled foreign corporation in the 
chain.
    (F) Step 6. Paragraph (c)(1)(vi) of this section does not apply 
because CFC1 did not make a specified section 959(a) distribution.
0
Par. 24. Section 1.960-3 is revised to read as follows:


Sec.  1.960-3  Foreign income taxes deemed paid under section 960(b).

    (a) Scope. This section provides rules for determining foreign 
income taxes that are deemed paid under section 960(b) with respect to 
the receipt of distributions of previously taxed earnings and profits. 
Paragraph (b) of this section describes the foreign income taxes that a 
domestic corporation is deemed to pay with respect to its receipt of a 
specified section 959(a) distribution. Paragraph (c) of this section 
describes the foreign income taxes that a controlled foreign

[[Page 95436]]

corporation is deemed to pay with respect to its receipt of a section 
959(b) distribution. For rules regarding the maintenance and adjustment 
by a foreign corporation of corporate PTEP accounts and corporate PTEP 
tax pools with respect to each of its covered shareholders, see Sec.  
1.959-2(d). For rules regarding the maintenance and adjustment by a 
covered shareholder of annual PTEP accounts and PTEP tax pools with 
respect to a foreign corporation in which it owns stock, see Sec. Sec.  
1.959-2(b) and 1.959-3(c) and (e).
    (b) Foreign income taxes deemed paid under section 960(b)(1)--(1) 
In general. A domestic corporation that is a United States shareholder 
of a controlled foreign corporation is deemed to have paid the foreign 
income taxes that are properly attributable to a specified section 
959(a) distribution that it receives from the controlled foreign 
corporation and that have not been deemed to have been paid by a 
domestic corporation under section 960 for the current taxable year or 
any prior taxable year. A credit for foreign income taxes deemed paid 
under this section may be subject to disallowance under other 
provisions of the Code or regulations in this title that apply at the 
level of the United States shareholder.
    (2) Properly attributable. The foreign income taxes that are 
properly attributable to a specified section 959(a) distribution are 
the foreign income taxes that are removed under Sec. Sec.  1.959-
2(d)(2) and 1.959-3(e)(1)(iii) from each creditable PTEP tax group (as 
defined in Sec.  1.959-2(b)(4)(ii)) by reason of the specified section 
959(a) distribution.
    (c) Foreign income taxes deemed paid under section 960(b)(2)--(1) 
In general. A controlled foreign corporation is deemed to have paid the 
foreign income taxes that are properly attributable to a section 959(b) 
distribution that it receives from another controlled foreign 
corporation and that have not been deemed to have been paid by a 
domestic corporation under section 960 for the current taxable year or 
any prior taxable year.
    (2) Properly attributable. The foreign income taxes that are 
properly attributable to a section 959(b) distribution received by a 
controlled foreign corporation are the foreign income taxes that are 
removed under Sec. Sec.  1.959-2(d)(2) and 1.959-3(e)(1)(iii) from each 
creditable PTEP tax group (as defined in Sec.  1.959-1(b)) by reason of 
the section 959(b) distribution.
0
Par. 25. Section 1.960-7 is amended by:
0
1. In the first sentence of paragraph (a), removing the language 
``paragraph (b)'' and adding the language ``paragraphs (b) and (c)'' in 
its place; and
0
2. Adding a new paragraph (c).
    The addition reads as follows:


Sec.  1.960-7  Applicability dates.

* * * * *
    (c) Sections 1.960-1 and 1.960-3 apply to taxable years of a 
foreign corporation that begin on or after [date of publication of 
final regulations in the Federal Register] or are early application 
years (as described in Sec.  1.959-12(d)), and to taxable years of a 
domestic corporation that is a United States shareholder of the foreign 
corporation in which or with which such taxable years of such foreign 
corporation end. See Sec. Sec.  1.960-1 and 1.960-3 as contained in 26 
CFR part 1 revised as of April 1, 2024, for a version of these sections 
applicable to prior taxable years.
0
Par. 26. Section 1.961-1 is revised to read as follows:


Sec.  1.961-1  Overview, definitions, and rules of general 
applicability.

    (a) Overview--(1) In general. The section 961 regulations provide 
rules for basis adjustments related to previously taxed earnings and 
profits. Section 1.961-1 sets forth definitions and rules of general 
applicability. Section 1.961-2 describes the types of property units 
and types of basis for purposes of applying section 961. Section 1.961-
3 provides basis increases for income inclusions. Section 1.961-4 
provides reductions to basis and gain recognition for distributions of 
previously taxed earnings and profits. Section 1.961-5 provides basis 
adjustments for foreign currency gain or loss and for general successor 
transactions. Sections 1.961-6 and 1.961-7 are reserved. Section 1.961-
8 describes the consequences of positive derived basis. Section 1.961-9 
describes the consequences of positive section 961(c) basis. Section 
1.961-10 describes the consequences of negative derived basis and 
negative section 961(c) basis. Section 1.961-11 provides for the 
inclusion by United States shareholders in a controlled foreign 
corporation of the controlled foreign corporation's income arising 
under section 961(c). Section 1.961-12 provides examples illustrating 
the application of the section 961 regulations. Section 1.961-13 sets 
forth transition rules. Section 1.961-14 sets forth applicability 
dates. See Sec.  1.1502-59 for additional rules for a consolidated 
group.
    (2) Scope. This section sets forth definitions and rules of general 
applicability for purposes of the section 961 regulations. Paragraph 
(b) of this section provides definitions. Paragraph (c) of this section 
provides rules relating to S corporations. Paragraph (d) of this 
section provides an anti-avoidance rule.
    (b) Definitions. The definitions in Sec.  1.959-1(b) apply for 
purposes of the section 961 regulations, with the following additions.
    Acquired partnership. The term acquired partnership has the meaning 
provided in Sec.  1.961-5(c)(1).
    Common basis. The term common basis means a partnership's adjusted 
basis of an item of property, excluding any basis that is solely with 
respect to a specific partner (for example, a section 743(b) basis 
adjustment or derived basis).
    Covered gain. The term covered gain has the meaning provided in 
Sec.  1.961-9(c)(1).
    Derived basis. The term derived basis means basis described in 
Sec.  1.961-2(d)(2).
    Derivative ownership unit. The term derivative ownership unit has 
the meaning provided in Sec.  1.961-2(d)(1).
    Lookback PTEP. The term lookback PTEP has the meaning provided in 
Sec.  1.961-9(f)(3)(ii).
    Lower-tier partnership interest. The term lower-tier partnership 
interest has the meaning provided in Sec.  1.961-8(d).
    Midyear transaction. The term midyear transaction has the meaning 
provided in Sec.  1.961-3(c)(2).
    Mirrored PTEP. The term mirrored PTEP has the meaning provided in 
Sec.  1.961-9(f)(2)(ii).
    Negative derived basis. The term negative derived basis means the 
amount by which derived basis with respect to a covered shareholder of 
a derivative ownership unit is less than zero.
    Negative section 961(c) basis. The term negative section 961(c) 
basis means the amount by which section 961(c) basis with respect to a 
covered shareholder of a section 961(c) ownership unit is less than 
zero.
    Net foreign currency gain. The term net foreign currency gain has 
the meaning provided in Sec.  1.961-5(b)(2).
    Net foreign currency loss. The term net foreign currency loss has 
the meaning provided in Sec.  1.961-5(b)(2).
    Nonrecognition transaction. The term nonrecognition transaction has 
the meaning provided in section 7701(a)(45).
    Positive derived basis. The term positive derived basis means the 
amount by which derived basis with respect to a covered shareholder of 
a derivative ownership unit is greater than zero.
    Positive section 961(c) basis. The term positive section 961(c) 
basis means the amount by which section 961(c) basis

[[Page 95437]]

with respect to a covered shareholder of a section 961(c) ownership 
unit is greater than zero.
    Property unit. The term property unit has the meaning provided in 
Sec.  1.961-2(b).
    Relevant taxable year. The term relevant taxable year has the 
meaning provided in Sec.  1.961-3(b).
    Section 951(a)(1)(A) inclusion amount. The term section 
951(a)(1)(A) inclusion amount has the meaning provided in Sec.  1.961-
3(c)(1)(ii).
    Section 951(a)(1)(B) inclusion amount. The term section 
951(a)(1)(B) inclusion amount has the meaning provided in Sec.  1.961-
3(c)(1)(iii).
    Section 961 regulations. The term section 961 regulations means the 
regulations in this part issued under section 961.
    Section 961(a) ownership unit. The term section 961(a) ownership 
unit has the meaning provided in Sec.  1.961-2(c).
    Section 961(c) basis. The term section 961(c) basis means basis 
described in Sec.  1.961-2(e)(2).
    Section 961(c) income. The term section 961(c) income has the 
meaning provided in Sec.  1.961-11(b).
    Section 961(c) ownership unit. The term section 961(c) ownership 
unit has the meaning provided in Sec.  1.961-2(e)(1).
    Section 961(c) PTEP. The term section 961(c) PTEP has the meaning 
provided in Sec.  1.961-9(f)(1).
    Transferred units. The term transferred units has the meaning 
provided in Sec.  1.961-8(b)(1) or Sec.  1.961-9(c)(1), as applicable.
    Transferring partnership. The term transferring partnership has the 
meaning provided in Sec.  1.961-8(b)(1).
    Upper-tier partnership. The term upper-tier partnership has the 
meaning provided in Sec.  1.961-8(d).
    (c) Treatment of an S corporation--(1) In general. Except as 
provided in paragraph (c)(2) of this section, for purposes of the 
section 961 regulations, an S corporation is treated in the same manner 
as a domestic partnership, a reference to a domestic partnership 
includes an S corporation, and shareholders of an S corporation are 
treated as partners of such partnership. See section 1373(a). As 
applicable, the treatment of an S corporation and its shareholders 
under the preceding sentence is determined by replacing any 
partnership-specific provision with the equivalent provision for S 
corporations (for example, a reference to an adjustment under section 
705 to a partner's basis in its partnership interest refers to the 
adjustment under section 1367 to a shareholder's basis in its stock of 
an S corporation).
    (2) Treatment as a covered shareholder for taxable years for which 
elective entity treatment applies for Sec.  1.958-1(d)(1) purposes. See 
Sec.  1.961-13(c) for a rule treating an S corporation as a covered 
shareholder for any taxable year of the S corporation for which Sec.  
1.958-1(d)(1) does not apply and Sec.  1.961-13(d) for a transition 
rule converting basis with respect to an S corporation to basis with 
respect to covered shareholders owning interests in the S corporation 
once the S corporation is no longer treated as a covered shareholder.
    (d) Anti-avoidance rule. If a transaction, series of transactions, 
plan, or arrangement is engaged in with a principal purpose of avoiding 
the purposes of section 961 and the section 961 regulations, then 
appropriate adjustments are made, which may include adjustments to 
disregard the transaction, series of transactions, plan, or 
arrangement.
0
Par. 27. Section 1.961-2 is revised to read as follows:


Sec.  1.961-2  Types of property units and basis.

    (a) Scope. This section describes the types of property units and 
types of basis for purposes of applying section 961. Paragraph (b) of 
this section defines a property unit and provides the general rule for 
basis of a property unit. Paragraphs (c) through (e) of this section 
provide definitions and rules for section 961(a) ownership units, 
derivative ownership units, and section 961(c) ownership units, 
respectively. See Sec. Sec.  1.961-3 through 1.961-11 for basis 
adjustments and the effects of basis and Sec.  1.961-12(c)(1) (Example 
1) for an example illustrating the application of this section.
    (b) Property unit. A property unit is a section 961(a) ownership 
unit, derivative ownership unit, or section 961(c) ownership unit, as 
applicable (defined in paragraphs (c) through (e) of this section). 
Basis in a property unit must be established and maintained in U.S. 
dollars in accordance with this section and the adjustments prescribed 
in the section 961 regulations.
    (c) Section 961(a) ownership unit. A section 961(a) ownership unit 
is a share of stock of a foreign corporation directly owned by a 
covered shareholder, or an interest in a partnership directly owned by 
a covered shareholder and through which the covered shareholder owns 
stock of a foreign corporation. A covered shareholder is provided 
adjusted basis in a section 961(a) ownership unit.
    (d) Derivative ownership unit--(1) In general. A derivative 
ownership unit is a share of stock of a foreign corporation directly 
owned by a partnership and owned (indirectly) by one or more covered 
shareholders through only one or more partnerships, or an interest in a 
partnership directly owned by another partnership and through which one 
or more covered shareholders own stock of a foreign corporation through 
only partnerships. A partnership is provided derived basis in a 
derivative ownership unit in accordance with paragraph (d)(2) of this 
section.
    (2) Derived basis. Derived basis is basis of a derivative ownership 
unit that must be established and maintained separately with respect to 
each covered shareholder that owns the derivative ownership unit 
through only one or more partnerships. Derived basis with respect to a 
covered shareholder may be a positive or negative amount and is treated 
as an attribute of the partnership that directly owns the derivative 
ownership unit.
    (e) Section 961(c) ownership unit--(1) In general. A section 961(c) 
ownership unit is a share of stock of a foreign corporation directly 
owned by a controlled foreign corporation and owned (indirectly) by one 
or more covered shareholders. A controlled foreign corporation is 
provided section 961(c) basis in a section 961(c) ownership unit in 
accordance with paragraph (e)(2) of this section.
    (2) Section 961(c) basis. Section 961(c) basis is basis of a 
section 961(c) ownership unit that must be established and maintained 
separately with respect to each covered shareholder that owns the 
section 961(c) ownership unit. Section 961(c) basis with respect to a 
covered shareholder may be a positive or negative amount and is treated 
as an attribute of the controlled foreign corporation that directly 
owns the section 961(c) ownership unit. Section 961(c) basis applies 
only for the purposes prescribed in the section 961 regulations and, 
therefore, for example does not affect the amount of the controlled 
foreign corporation's gross income or the amount of its earnings and 
profits.
0
Par. 28. Sections 1.961-3 through 1.961-14 are added to read as 
follows:

Sec.
* * * * *
1.961-3 Basis increases for certain income inclusions.
1.961-4 Basis reductions and gain recognition for distributions.
1.961-5 Basis adjustments for foreign currency gain or loss and for 
general successor transactions.
1.961-6 and 1.961-7 [Reserved]
1.961-8 Application of positive derived basis to covered 
shareholders' distributive shares of gain or loss.

[[Page 95438]]

1.961-9 Exclusion from gross income of previously taxed earnings and 
profits resulting from positive section 961(c) basis.
1.961-10 Gain recognition for negative basis.
1.961-11 Amounts included in gross income of United States 
shareholders.
1.961-12 Examples.
1.961-13 Transition rules.
1.961-14 Applicability dates.
* * * * *


Sec.  1.961-3  Basis increases for certain income inclusions.

    (a) Scope. This section provides the increases to basis under 
section 961 for inclusions under sections 951(a) and 951A(a) and Sec.  
1.961-11. Paragraph (b) of this section provides the general rule, 
pursuant to which, to reflect a covered shareholder's income inclusions 
for a controlled foreign corporation's taxable year, basis of certain 
property units (shares of stock of the controlled foreign corporation 
directly owned by the covered shareholder, property through which the 
covered shareholder owns (indirectly) stock of the controlled foreign 
corporation, and shares of stock of the controlled foreign corporation 
owned (indirectly) by the covered shareholder), is increased. Paragraph 
(c) of this section describes the specific rules for increasing basis 
pursuant to paragraph (b) of this section. Paragraph (d) of this 
section determines certain basis increases based on distributions of 
previously taxed earnings and profits by the controlled foreign 
corporation during the taxable year. Paragraph (e) of this section 
determines certain basis increases based on a hypothetical 
distribution, to the extent paragraph (d) of this section does not 
increase basis. Paragraph (f) of this section provides limitations on 
basis increases in certain cases. See Sec.  1.961-12(c)(2) (Example 2) 
for an example illustrating the application of this section.
    (b) In general. To reflect a covered shareholder's income 
inclusions for a taxable year of a controlled foreign corporation (such 
taxable year for which this section is being applied, the relevant 
taxable year), basis of property units that are shares of stock of the 
controlled foreign corporation owned by the covered shareholder, and 
basis of any property units through which the covered shareholder owns 
stock of the controlled foreign corporation, is in each case increased 
in accordance with the rules described in paragraph (c) of this 
section. Generally, under those rules, basis increases begin at the 
level of stock of the controlled foreign corporation and then tier 
through property units through which the covered shareholder owns such 
stock, with at each level basis increases allocated among property 
units based on how previously taxed earnings and profits resulting from 
the income inclusions are, or likely will be, distributed on the 
property units (thus, the allocations may differ from the extent to 
which the income inclusions are attributable to the property units). 
Solely for purposes of this section, a reference to the basis of a 
property unit means adjusted basis in the case of a section 961(a) 
ownership unit, derived basis with respect to the covered shareholder 
in the case of a derivative ownership unit, or section 961(c) basis 
with respect to the covered shareholder in the case of a section 961(c) 
ownership unit.
    (c) Rules for increasing basis--(1) Determine amount of income 
inclusions giving rise to increases to basis--(i) In general. First, 
determine the amount of the covered shareholder's income inclusions 
with respect to the controlled foreign corporation for the relevant 
taxable year that give rise to increases to basis under section 961, 
computed as the sum of the section 951(a)(1)(A) inclusion amount and 
section 951(a)(1)(B) inclusion amount (defined in paragraphs (c)(1)(ii) 
and (iii) of this section).
    (ii) Section 951(a)(1)(A) inclusion amount. The section 
951(a)(1)(A) inclusion amount is the sum of any amount (in U.S. 
dollars) that the covered shareholder includes in gross income with 
respect to the controlled foreign corporation for the relevant taxable 
year under section 951(a)(1)(A) or 951A(a) or Sec.  1.961-11.
    (iii) Section 951(a)(1)(B) inclusion amount. The section 
951(a)(1)(B) inclusion amount is the amount (in U.S. dollars) that the 
covered shareholder includes in gross income with respect to the 
controlled foreign corporation for the relevant taxable year under 
section 951(a)(1)(B).
    (2) Determine if any midyear transactions occur. Second, determine 
if any midyear transactions (which affect the timing of certain basis 
adjustments under paragraphs (d) and (e) of this section) occur within 
the relevant taxable year. A midyear transaction is any sale, exchange, 
or other disposition (including an issuance or redemption) occurring 
before the last relevant day of the relevant taxable year and involving 
one or more items of property that, immediately before or after the 
sale, exchange, or other disposition are stock of the controlled 
foreign corporation owned by the covered shareholder or property 
through which the covered shareholder owns stock of the controlled 
foreign corporation.
    (3) Apply actual distribution rule. Third, if, before the last 
relevant day of the relevant taxable year, the controlled foreign 
corporation distributes previously taxed earnings and profits with 
respect to the covered shareholder in a covered distribution 
(determined under Sec.  1.959-4), then increase basis for a portion of 
the section 951(a)(1)(A) inclusion amount in accordance with paragraph 
(d) of this section.
    (4) Apply hypothetical distribution rule. Fourth, increase basis 
for any remaining portion of the section 951(a)(1)(A) inclusion amount 
and the section 951(a)(1)(B) inclusion amount in accordance with 
paragraph (e) of this section.
    (d) Actual distribution rule--(1) In general. For each distribution 
described in paragraph (c)(3) of this section (starting with the 
earliest distribution), increase basis of property units that are 
shares of stock of the controlled foreign corporation and, if 
applicable, property units through which the covered shareholder owns 
such shares, in accordance with paragraphs (d)(2) and (3) of this 
section. Treat each such increase to basis as made at the beginning of 
the first day of the relevant taxable year, unless the distribution is 
made after any midyear transactions, in which case treat each such 
increase as made immediately after the midyear transaction that most 
recently precedes the distribution.
    (2) Increases to basis of shares of stock of the controlled foreign 
corporation. Increase the basis of each property unit that is a share 
of stock of the controlled foreign corporation that the covered 
shareholder owns on the last relevant day of the relevant taxable year 
by the amount of the adjustment required under Sec.  1.961-4 (basis 
reductions and gain recognition for distributions) to such basis by 
reason of the distribution, subject to the following limitation. Do not 
increase the basis of the share by an amount greater than the product 
of the section 951(a)(1)(A) inclusion amount, reduced by all increases 
to basis under this paragraph (d)(2) by reason of earlier 
distributions, and a fraction, the numerator of which is the portion of 
the distribution that is made with respect to the share, and the 
denominator of which is the amount of the distribution.
    (3) Increases to basis of property units through which the covered 
shareholder owns stock of the controlled foreign corporation. If, when 
the distribution is made, the covered shareholder owns stock of the 
controlled foreign corporation through one or more property units, then 
increase the basis of each such property unit by the portion

[[Page 95439]]

of the hypothetical distribution described in paragraph (e)(2) of this 
section (modified as described in the next sentence) that would be 
distributed with respect to the property unit in accordance with 
paragraph (e)(3) of this section, subject to the limitations in 
paragraph (f) of this section. For purposes of this paragraph (d)(3), 
the hypothetical distribution is treated as made when the distribution 
of previously taxed earnings and profits is made, the amount of the 
hypothetical distribution is equal to the increase to basis under 
paragraph (d)(2) of this section by reason of the distribution of 
previously taxed earnings and profits, and, at the level of the 
controlled foreign corporation, the hypothetical distribution is made 
in the same manner as the distribution of previously taxed earnings and 
profits.
    (e) Hypothetical distribution rule--(1) In general. Increase the 
basis of each property unit that the covered shareholder owns on the 
last relevant day of the relevant taxable year by the portion of the 
hypothetical distribution described in paragraph (e)(2) of this section 
that would be distributed with respect to the property unit in 
accordance with paragraph (e)(3) of this section, subject to the 
limitations in paragraph (f) of this section. Except as provided in 
paragraph (e)(4) of this section, treat a portion of each such increase 
to basis as made at the end of the last day of the relevant taxable 
year, determined by multiplying the amount of the increase to basis by 
a fraction, the numerator of which is the section 951(a)(1)(B) 
inclusion amount, and the denominator of which is the amount of the 
hypothetical distribution. Treat the remaining portion of each such 
increase to basis as made at the beginning of the first day of the 
relevant taxable year on which the covered shareholder owns the 
property unit, unless there are any midyear transactions, in which case 
treat each such remaining portion as made immediately after the last 
midyear transaction occurring during the relevant taxable year.
    (2) Hypothetical distribution. The hypothetical distribution 
described in this paragraph (e)(2) is a hypothetical distribution 
treated as made by the controlled foreign corporation, through all 
property (if any) through which the covered shareholder owns stock of 
the controlled foreign corporation, to the covered shareholder on the 
last relevant day of the relevant taxable year. The amount of the 
hypothetical distribution is equal to the section 951(a)(1)(A) 
inclusion amount, reduced by any increases to basis under paragraph 
(d)(2) of this section, plus the section 951(a)(1)(B) inclusion amount. 
In the hypothetical distribution, stock of the controlled foreign 
corporation and other property is taken into account only to the extent 
owned by the covered shareholder on the last relevant day, and the 
earnings and profits of the controlled foreign corporation and any 
foreign corporations through which the hypothetical distribution is 
treated as made are in each case treated as equal to the amount of the 
hypothetical distribution.
    (3) Distribution rights. The portion of the hypothetical 
distribution that would be distributed with respect to a property unit 
is determined under the principles of Sec.  1.951-1(e)(2) through (6). 
However, an earlier distribution affects property units' distribution 
rights for purposes of the hypothetical distribution to the extent such 
earlier distribution results in the section 951(a)(1)(A) inclusion 
amount increasing basis under paragraph (d) of this section.
    (4) Certain increase to basis for section 951(a)(1)(B) inclusion 
amount. If basis of a property unit is increased pursuant to the second 
sentence of paragraph (e)(1) of this section, and at the end of the 
last day of the relevant taxable year the covered shareholder either 
does not own the property unit or owns the property unit in a manner 
different than how the covered shareholder owns the property unit at 
the time of the hypothetical distribution described in paragraph (e)(2) 
of this section, then treat such increase to basis as made immediately 
before the transaction in which the covered shareholder ceases to own 
the property unit in the same manner as it owns the property unit at 
the time of such hypothetical distribution. In addition, treat such 
increase to basis as made after the determination of any amount that 
must be included in gross income as a dividend (for example, under 
section 1248 or Sec.  1.367(b)-4) as a result of such transaction.
    (f) Limitations--(1) Section 961(c) ownership units that are not 
stock of a controlled foreign corporation. Section 961(c) basis of a 
section 961(c) ownership unit is increased only if the section 961(c) 
ownership unit is a share of stock of a controlled foreign corporation.
    (2) Taxable section 962 previously taxed earnings and profits. The 
portion of an income inclusion that gives rise to previously taxed 
earnings and profits relating to the taxable section 962 PTEP subgroup 
does not increase adjusted basis of a section 961(a) ownership unit or 
derived basis of a derivative ownership unit.
    (3) Derivative ownership units that are partially owned by foreign 
corporations. If a derivative ownership unit is owned (indirectly) by 
one or more foreign corporations, then an increase to derived basis of 
the derivative ownership unit resulting from a hypothetical 
distribution described in paragraph (d)(3) or (e)(2) of this section 
cannot exceed the portion of the hypothetical distribution that would 
be distributed to the covered shareholder through only the derivative 
ownership unit and any interests in partnerships.


Sec.  1.961-4  Basis reductions and gain recognition for distributions.

    (a) Scope. This section sets forth the rules for reducing basis and 
recognizing gain under section 961 for distributions of previously 
taxed earnings and profits. Paragraph (b) of this section describes 
adjustments to section 961(a) ownership units in the case of 
distributions of previously taxed earnings and profits to a covered 
shareholder. Paragraph (c) of this section describes adjustments to 
derivative ownership units in the case of distributions of previously 
taxed earnings and profits through one or more partnerships to one or 
more covered shareholders. Paragraph (d) of this section describes 
adjustments to section 961(c) ownership units in the case of 
distributions of previously taxed earnings and profits to a controlled 
foreign corporation. Paragraph (e) of this section provides timing 
rules for when adjustments are treated as made. Paragraph (f) of this 
section provides rules regarding the treatment of gain recognized under 
this section. See Sec.  1.961-12(c)(3) (Example 3) for an example 
illustrating the application of this section.
    (b) Adjustments to section 961(a) ownership units--(1) In general. 
If a covered shareholder receives previously taxed earnings and profits 
that are excluded from its gross income under section 959(a) and Sec.  
1.959-4, then the resulting adjustments under section 961 to the 
covered shareholder's adjusted basis of section 961(a) ownership units 
are determined in accordance with the rules described in paragraph 
(b)(2) of this section.
    (2) Rules for adjusting basis--(i) Determine amounts of 
adjustments. First, determine the amount of the adjustment to the 
covered shareholder's adjusted basis of each section 961(a) ownership 
unit, which is equal to the dollar basis of, and foreign income taxes 
associated with, previously taxed earnings and profits that are 
received with respect to such section 961(a) ownership unit (determined 
under Sec.  1.959-4), but only including foreign

[[Page 95440]]

income taxes for which the covered shareholder is allowed a credit 
under section 901.
    (ii) Reduce basis. Second, reduce the covered shareholder's 
adjusted basis of each section 961(a) ownership unit by the amount of 
the adjustment to such adjusted basis (determined under paragraph 
(b)(2)(i) of this section), but not below zero.
    (iii) Recognize gain. Third, to the extent that the amount of an 
adjustment to the covered shareholder's adjusted basis of a section 
961(a) ownership unit (determined under paragraph (b)(2)(i) of this 
section) exceeds such adjusted basis, treat the covered shareholder as 
recognizing gain with respect to such section 961(a) ownership unit in 
accordance with paragraph (f) of this section.
    (c) Adjustments to derivative ownership units--(1) In general. If, 
through a partnership, one or more covered shareholders receive 
previously taxed earnings and profits that are excluded from the 
covered shareholders' gross income under section 959(a) and Sec.  
1.959-4, then the resulting adjustments under section 961 to the 
partnership's derived basis of derivative ownership units are 
determined in accordance with the rules described in paragraph (c)(2) 
of this section. In the case of tiered partnerships, each tiered 
partnership's derived basis of derivative ownership units is adjusted 
as described in paragraph (c)(2) of this section, starting with the 
partnership at the lowest tier.
    (2) Rules for adjusting basis--(i) Determine amounts of 
adjustments. First, determine the amount of the adjustment to the 
partnership's derived basis with respect to each covered shareholder of 
each derivative ownership unit, which is equal to the dollar basis of, 
and foreign income taxes associated with, previously taxed earnings and 
profits that are both with respect to such covered shareholder and 
received with respect to such derivative ownership unit (determined 
under Sec.  1.959-4).
    (ii) Reduce positive derived basis. Second, reduce the 
partnership's derived basis with respect to each covered shareholder of 
each derivative ownership unit by the amount of the adjustment to such 
derived basis (determined under paragraph (c)(2)(i) of this section), 
but not below zero.
    (iii) Reduce positive section 743(b) basis (if applicable) and 
increase negative derived basis. Third, to the extent that the amount 
of an adjustment to the partnership's derived basis with respect to a 
covered shareholder of a derivative ownership unit (determined under 
paragraph (c)(2)(i) of this section) exceeds the related reduction to 
positive derived basis (determined under paragraph (c)(2)(ii) of this 
section), reduce the covered shareholder's positive section 743(b) 
basis adjustment of such derivative ownership unit (if applicable), but 
not below zero, and then, if applicable, reduce such derived basis 
below zero, but only to the extent permitted under paragraph (c)(3) of 
this section.
    (iv) Recognize and allocate gain. Fourth, to the extent that the 
amount of an adjustment to the partnership's derived basis with respect 
to a covered shareholder of a derivative ownership unit (determined 
under paragraph (c)(2)(i) of this section) exceeds the aggregate of the 
related reductions to derived basis (determined under paragraphs 
(c)(2)(ii) and (iii) of this section) and positive section 743(b) basis 
(determined under paragraph (c)(2)(iii) of this section), treat the 
partnership as recognizing gain with respect to such derivative 
ownership unit in accordance with paragraph (f) of this section, and 
allocate the gain solely to the covered shareholder.
    (3) Limitation on reducing derived basis--(i) In general. An 
adjustment to a partnership's derived basis with respect to a covered 
shareholder of a derivative ownership unit can reduce (or further 
reduce) such derived basis below zero only to the extent of the amount 
of common basis of such derivative ownership unit available with 
respect to the covered shareholder (determined under paragraph 
(c)(3)(ii) of this section), less, if applicable, the covered 
shareholder's negative section 743(b) basis adjustment of the 
derivative ownership unit (expressed as a positive amount).
    (ii) Determining common basis available with respect to the covered 
shareholder. In applying paragraph (c)(3)(i) of this section, the 
amount of common basis of the derivative ownership unit available with 
respect to the covered shareholder is equal to the product of the 
following amounts--
    (A) The partnership's common basis of the derivative ownership unit 
(translated, if applicable, into U.S. dollars at the spot rate on the 
day on which the adjustment described in paragraph (c)(3)(i) of this 
section would be treated as reducing basis), reduced by all negative 
derived basis of the derivative ownership unit (determined immediately 
before the adjustment described in paragraph (c)(3)(i) of this section 
would be treated as made); and
    (B) A fraction, the numerator of which is the amount by which the 
adjustment described in paragraph (c)(3)(i) of this section would 
reduce derived basis with respect to the covered shareholder below zero 
if derived basis could be reduced without limitation, and the 
denominator of which is the sum of the amounts by which the adjustment 
described in paragraph (c)(3)(i) of this section and any concurrent 
adjustments to derived basis with respect to other covered shareholders 
would reduce derived basis of the derivative ownership unit below zero 
if derived basis could be reduced without limitation.
    (d) Adjustments to section 961(c) ownership units--(1) In general. 
If a controlled foreign corporation receives previously taxed earnings 
and profits that are excluded from its gross income under section 
959(b) and Sec.  1.959-4, then the resulting adjustments under section 
961 to the controlled foreign corporation's section 961(c) basis of 
section 961(c) ownership units are determined in accordance with the 
rules described in paragraph (d)(2) of this section.
    (2) Rules for adjusting basis--(i) Determine amounts of 
adjustments. First, determine the amount of the adjustment to the 
controlled foreign corporation's section 961(c) basis with respect to 
each covered shareholder of each section 961(c) ownership unit, which 
is equal to the dollar basis of, and foreign income taxes associated 
with, previously taxed earnings and profits that are both with respect 
to such covered shareholder and received with respect to such section 
961(c) ownership unit (determined under Sec.  1.959-4).
    (ii) Reduce basis. Second, reduce the controlled foreign 
corporation's section 961(c) basis with respect to each covered 
shareholder of each section 961(c) ownership unit by the amount of the 
adjustment to such section 961(c) basis, including below zero, but only 
to the extent permitted under paragraph (d)(3) of this section.
    (iii) Recognize and assign gain. Third, to the extent that the 
amount of an adjustment to the controlled foreign corporation's section 
961(c) basis with respect to a covered shareholder of a section 961(c) 
ownership unit (determined under paragraph (d)(2)(i) of this section) 
exceeds the related reduction to section 961(c) basis (determined under 
paragraph (d)(2)(ii) of this section), treat the controlled foreign 
corporation as recognizing gain with respect to such section 961(c) 
ownership unit in accordance with paragraph (f) of this section, and 
assign the gain solely to the covered shareholder.

[[Page 95441]]

    (3) Limitation on reducing section 961(c) basis--(i) In general. An 
adjustment to a controlled foreign corporation's section 961(c) basis 
with respect to a covered shareholder of a section 961(c) ownership 
unit can reduce (or further reduce) such section 961(c) basis below 
zero only to the extent of the amount of adjusted basis of such section 
961(c) ownership unit available with respect to the covered shareholder 
(determined under paragraph (d)(3)(ii) of this section).
    (ii) Determining adjusted basis available with respect to the 
covered shareholder. In applying paragraph (d)(3)(i) of this section, 
the amount of adjusted basis of the section 961(c) ownership unit 
available with respect to the covered shareholder is equal to the 
product of the following amounts--
    (A) The controlled foreign corporation's adjusted basis of the 
section 961(c) ownership unit (translated, if applicable, into U.S. 
dollars at the spot rate on the day on which the adjustment described 
in paragraph (d)(3)(i) of this section would be treated as reducing 
basis), reduced by all negative section 961(c) basis of the section 
961(c) ownership unit (determined immediately before the adjustment 
described in paragraph (d)(3)(i) of this section would be treated as 
made); and
    (B) A fraction, the numerator of which is the amount by which the 
adjustment described in paragraph (d)(3)(i) of this section would 
reduce section 961(c) basis with respect to the covered shareholder 
below zero if section 961(c) basis could be reduced without limitation, 
and the denominator of which is the sum of the amounts by which the 
adjustment described in paragraph (d)(3)(i) of this section and any 
concurrent adjustments to section 961(c) basis with respect to other 
covered shareholders would reduce section 961(c) basis of the section 
961(c) ownership unit below zero if section 961(c) basis could be 
reduced below zero without limitation.
    (e) Timing of basis reductions--(1) Basis of stock. A reduction to 
basis of stock of a foreign corporation under paragraph (b), (c), or 
(d) of this section is treated as made concurrently with the 
distribution giving rise to the basis reduction (and before any other 
adjustment to basis by reason of the distribution, for example, under 
section 301(c)(2)).
    (2) Basis of partnership interests. A reduction to basis of an 
interest in a partnership under paragraph (b) or (c) of this section is 
treated as made concurrently with the adjustment under section 705 to 
such interest in the partnership by reason of the distribution giving 
rise to the basis reduction.
    (f) Treatment of gain--(1) In general. Gain treated as recognized 
with respect to a section 961(a) ownership unit, derivative ownership 
unit, or section 961(c) ownership unit under paragraph (b), (c), or (d) 
of this section is treated as gain from a sale or exchange of such 
ownership unit occurring concurrent with when the adjustment described 
in that paragraph would be treated as reducing basis.
    (2) Gain recognized by a partnership. Gain treated as recognized by 
a partnership under paragraph (c) of this section constitutes an item 
of gain solely with respect to the covered shareholder to which it is 
allocated and has no effect on any partnership's computation or 
allocation of any other item under section 703 or 704 or on the covered 
shareholder's capital account. The gain is treated as the covered 
shareholder's distributive share of gain of the partnership (derived 
through each partnership through which the covered shareholder owns the 
partnership recognizing the gain, if applicable) and is taken into 
account in adjusting basis under section 705.
    (3) Gain recognized by a controlled foreign corporation. Gain 
treated as recognized by a controlled foreign corporation under 
paragraph (d) of this section is gain recognized pursuant to section 
961(c). Such gain applies only for purposes of determining amounts 
included in gross income of United States shareholders of the 
controlled foreign corporation under Sec.  1.961-11 and, therefore, for 
example does not affect the controlled foreign corporation's items of 
gross income for purposes of section 952 or 951A or its earnings and 
profits.
    (4) Translation rule. If applicable, gain treated as recognized by 
a partnership or controlled foreign corporation under paragraph (c) or 
(d) of this section is translated into functional currency at the spot 
rate on the day on which the gain is treated as recognized.


Sec.  1.961-5  Basis adjustments for foreign currency gain or loss and 
for general successor transactions.

    (a) Scope. This section sets forth the rules for adjusting basis 
under section 961 for foreign currency gain or loss recognized with 
respect to previously taxed earnings and profits under section 986(c) 
and for general successor transactions. Paragraph (b) of this section 
provides the adjustments for foreign currency gain or loss. Paragraph 
(c) of this section provides the adjustments for general successor 
transactions. Paragraph (d) of this section coordinates with section 
743(b).
    (b) Adjustments for foreign currency gain or loss--(1) In general. 
If a covered shareholder recognizes foreign currency gain or loss with 
respect to a foreign corporation's previously taxed earnings and 
profits under Sec.  1.986(c)-1 in a transaction other than a 
distribution of the previously taxed earnings and profits, then basis 
of property units that are shares of stock of the foreign corporation 
owned by the covered shareholder, and basis of any property units 
through which the covered shareholder owns stock of the foreign 
corporation, is in each case adjusted in accordance with the rules 
described in paragraphs (b)(2) through (4) of this section. Generally, 
under those rules, basis adjustments begin at the level of stock of the 
foreign corporation and then tier through property units through which 
the covered shareholder owns such stock, with at each level basis 
adjustments allocated among property units based on proportionate 
shares of foreign currency gain or loss. Solely for purposes of this 
paragraph (b), a reference to the basis of a property unit means 
adjusted basis in the case of a section 961(a) ownership unit, derived 
basis with respect to the covered shareholder in the case of a 
derivative ownership unit, or section 961(c) basis with respect to the 
covered shareholder in the case of a section 961(c) ownership unit.
    (2) Determine net foreign currency gain or loss. First, determine 
the amount of foreign currency gain or loss that gives rise to 
adjustments to basis, computed by comparing the sum of all foreign 
currency gain and the sum of all foreign currency loss that the covered 
shareholder recognizes with respect to the foreign corporation's 
previously taxed earnings and profits in the transaction under Sec.  
1.986(c)-1(b), without regard to Sec.  1.986(c)-1(b)(3)(i) and (ii) 
(limitations for previously taxed earnings and profits resulting from 
section 965). The excess of the sum of foreign currency gain over the 
sum of foreign currency loss is net foreign currency gain, and the 
excess of the sum of foreign currency loss over the sum of foreign 
currency gain is net foreign currency loss.
    (3) Determine each property unit's share of net foreign currency 
gain or loss--(i) In general. Second, determine each property unit's 
share of net foreign currency gain or net foreign currency loss by 
multiplying the net foreign currency gain or net foreign currency loss, 
as applicable, by a fraction (which is based on a hypothetical 
distribution by the foreign corporation of previously

[[Page 95442]]

taxed earnings and profits with respect to which the covered 
shareholder recognizes, or would recognize, foreign currency gain or 
loss in the transaction). The numerator of the fraction is the portion 
of the hypothetical distribution described in paragraph (b)(3)(ii) of 
this section that, under the principles of Sec.  1.951-1(e)(2) through 
(6), would be distributed with respect to the property unit, and the 
denominator of the fraction is the amount of such hypothetical 
distribution.
    (ii) Hypothetical distribution. The hypothetical distribution 
described in this paragraph (b)(3)(ii) is a hypothetical distribution 
treated as made by the foreign corporation, through all property (if 
any) through which the covered shareholder owns stock of the foreign 
corporation, to the covered shareholder immediately before the 
transaction. The amount of the hypothetical distribution is equal to 
all previously taxed earnings and profits of the foreign corporation 
with respect to which the covered shareholder recognizes (or, but for 
Sec.  1.986(c)-1(b)(3)(i) and (ii), would recognize) any foreign 
currency gain or loss in the transaction. In the hypothetical 
distribution, stock of the foreign corporation is taken into account 
only to the extent owned by the covered shareholder immediately before 
but not immediately after the transaction, and other property is taken 
into account only to the extent owned by the covered shareholder 
immediately before the transaction. The earnings and profits of the 
foreign corporation and any foreign corporations through which the 
hypothetical distribution is treated as made are in each case treated 
as equal to the amount of the hypothetical distribution.
    (4) Adjust basis--(i) In general. Third, adjust the basis of each 
property unit in accordance with paragraph (b)(4)(ii) or (iii) of this 
section, as applicable, starting with property units at the lowest tier 
and subject to the limitation in paragraph (b)(4)(iv) of this section. 
Treat each such adjustment to basis as made immediately before the 
transaction (and therefore take the adjustments into account in 
determining the Federal income tax consequences of the transaction).
    (ii) Basis increases for net foreign currency gain. In the case of 
net foreign currency gain, increase the basis of each property unit by 
the property unit's share of the net foreign currency gain (determined 
under paragraph (b)(3) of this section).
    (iii) Basis reductions and gain recognition for net foreign 
currency loss. In the case of net foreign currency loss, reduce the 
basis of each property unit by the property unit's share of net foreign 
currency loss (determined under paragraph (b)(3) of this section) or 
recognize gain in accordance with the principles of Sec.  1.961-4 
(applied by treating such share of net foreign currency loss as the 
amount of the adjustment to basis described in Sec.  1.961-4(b)(2)(i), 
(c)(2)(i), or (d)(2)(i), as applicable).
    (iv) Limitation for section 961(c) ownership units. Section 961(c) 
basis of a section 961(c) ownership unit is adjusted only if the 
section 961(c) ownership unit is a share of stock of a controlled 
foreign corporation. A specified foreign corporation (as defined in 
Sec.  1.965-1(f)(45)(i)(B)) that is not otherwise a controlled foreign 
corporation is treated as a controlled foreign corporation for purposes 
of applying this paragraph (b)(4) to foreign currency gain or loss with 
respect to previously taxed earnings and profits resulting from the 
application of section 965(a).
    (c) Successor basis--(1) In general. In a general successor 
transaction, derived basis of each partnership in which the successor 
covered shareholder acquires ownership of a partnership interest (each 
an acquired partnership), and section 961(c) basis of each acquired 
foreign corporation, transfers from the transferor covered shareholder 
to the successor covered shareholder (and thus becomes derived basis or 
section 961(c) basis with respect to the successor covered shareholder) 
in accordance with the rules described in paragraph (c)(2) this 
section. Solely for purposes of this paragraph (c), a reference to the 
basis of a property unit means derived basis with respect to the 
transferor covered shareholder in the case of a derivative ownership 
unit, or section 961(c) basis with respect to the transferor covered 
shareholder in the case of a section 961(c) ownership unit.
    (2) Rules for transferring basis--(i) Allocate basis before 
adjustment for foreign currency gain or loss. First, for each property 
unit directly owned by an acquired partnership or acquired foreign 
corporation, allocate to the successor covered shareholder a pro rata 
portion of the basis of the property unit immediately before the 
adjustments pursuant to paragraph (b) of this section by reason of the 
general successor transaction, determined by multiplying such basis by 
a fraction. The numerator of the fraction is the value of the interest 
in the acquired partnership or stock of the acquired corporation, as 
applicable, ownership of which is acquired by the successor covered 
shareholder in the general successor transaction. The denominator of 
the fraction is the total value of all the interests of the acquired 
partnership or all the stock of the acquired foreign corporation, as 
applicable, that the transferor covered shareholder owns immediately 
before the general successor transaction.
    (ii) Adjust allocations for foreign currency gain or loss. Second, 
adjust the allocation of basis of each property unit as follows. 
Increase the allocation to the successor covered shareholder by the 
amount of the increase to basis of the property unit pursuant to 
paragraph (b) of this section by reason of the general successor 
transaction. Decrease the allocation to the successor covered 
shareholder by the amount of the reduction to basis of the property 
unit pursuant to paragraph (b) of this section by reason of the general 
successor transaction.
    (iii) Transfer of successor basis. Third, transfer basis from the 
transferor covered shareholder to the successor covered shareholder by 
reducing basis with respect to the transferor covered shareholder, and 
increasing basis with respect to the successor covered shareholder, of 
each property unit by the amount of basis of the property unit 
allocated to the successor covered shareholder under paragraphs 
(c)(2)(i) and (ii) of this section (if such amount is positive) or, if 
such amount is negative, by increasing basis with respect to the 
transferor covered shareholder and reducing basis with respect to the 
successor covered shareholder by such amount, expressed as a positive 
number. Treat each such transfer of basis as made concurrently with the 
general successor transaction.
    (3) Deemed covered shareholder--(i) In general. For purposes of 
transferring basis under this paragraph (c), the deemed covered 
shareholder is treated in the same manner as a covered shareholder and 
a reference to a covered shareholder includes the deemed covered 
shareholder. Thus, for example, if a covered shareholder sells an 
interest in a partnership that directly owns stock of a foreign 
corporation to a nonresident alien individual in a general successor 
transaction, then derived basis of the partnership transfers from the 
seller covered shareholder to the deemed covered shareholder under this 
paragraph (c). Moreover, if the individual subsequently sells the 
partnership interest to a covered shareholder, then derived basis of 
the partnership (adjusted consistent with the section 961 regulations, 
including to reflect distributions from the foreign corporation to the 
individual) transfers from the deemed covered shareholder to the buyer 
covered shareholder under this paragraph (c).

[[Page 95443]]

    (ii) Treatment as controlled foreign corporation stock. Solely for 
purposes of determining section 961(c) basis that transfers to or from 
the deemed covered shareholder under this paragraph (c), any foreign 
corporation in which the deemed covered shareholder is treated as 
owning stock is treated as a controlled foreign corporation (to the 
extent the foreign corporation is not otherwise a controlled foreign 
corporation). Thus, for example, if a covered shareholder sells stock 
of an upper-tier foreign corporation that directly owns stock of a 
lower-tier foreign corporation to a nonresident alien individual in a 
general successor transaction, the upper-tier foreign corporation's 
shares of stock in the lower-tier foreign corporation remain section 
961(c) ownership units and section 961(c) basis of the upper-tier 
foreign corporation transfers from the seller covered shareholder to 
the deemed covered shareholder under this paragraph (c) even if the 
upper-tier foreign corporation ceases to be a controlled foreign 
corporation as a result of the sale. Consequently, if the individual 
subsequently sells the stock of the upper-tier foreign corporation to a 
covered shareholder and, as a result, the upper-tier foreign 
corporation becomes a controlled foreign corporation, then section 
961(c) basis of the upper-tier foreign corporation (adjusted consistent 
with the section 961 regulations, including to reflect distributions 
from the lower-tier foreign corporation to the upper-tier foreign 
corporation) transfers from the deemed covered shareholder to the buyer 
covered shareholder under this paragraph (c).
    (iii) Determining basis that transfers from the deemed covered 
shareholder. In a transaction in which basis of a derivative ownership 
unit or section 961(c) ownership unit transfers from the deemed covered 
shareholder to a covered shareholder, the covered shareholder must use 
a reasonable method in determining the amount of transferred basis. 
Such method must take into account adjustments to basis with respect to 
the deemed covered shareholder that would have been made under the 
section 961 regulations if the basis were with respect to a covered 
shareholder during the time that it was with respect to the deemed 
covered shareholder.
    (d) Coordination of successor derived basis with section 743(b). 
For purposes of a basis adjustment under section 743(b) with respect to 
a derivative ownership unit directly owned by an acquired partnership, 
the amount of any basis adjustment with respect to the successor 
covered shareholder to the acquired partnership's assets is calculated 
under Sec.  1.743-1(d) and allocated under Sec.  1.755-1(b) by 
including any derived basis in the basis of the derivative ownership 
unit that is transferred to the successor covered shareholder under 
paragraph (c)(2) of this section for purposes of gain and loss 
calculations and basis allocations under those provisions.


Sec. Sec.  1.961-6 and 1.961-7  [Reserved].


Sec.  1.961-8  Application of positive derived basis to covered 
shareholders' distributive shares of gain or loss.

    (a) Scope. This section describes the consequences of a 
partnership's positive derived basis. Paragraph (b) of this section 
applies positive derived basis to covered shareholders' distributive 
shares of gain or loss recognized by a partnership on a sale, exchange, 
or other disposition of derivative ownership units. Paragraph (c) of 
this section describes related basis adjustments to certain partnership 
interests directly owned by a covered shareholder. Paragraph (d) of 
this section describes related basis adjustments to certain lower-tier 
partnership interests directly owned by an upper-tier partnership. See 
Sec.  1.961-12(c)(4) (Example 4) for an example illustrating the 
application of this section.
    (b) Sale, exchange, or other disposition of derivative ownership 
units with positive derived basis--(1) In general. In a sale, exchange, 
or other disposition by a partnership (transferring partnership) of one 
or more derivative ownership units (transferred units), each partner's 
distributive share of gain or loss recognized by the transferring 
partnership on the sale, exchange, or other disposition is first 
determined without regard to derived basis (taking into a partner's 
section 743(b) basis adjustment). Then, positive derived basis is 
applied to each covered shareholder's distributive share of such gain 
or loss in accordance with paragraph (b)(2) of this section. Such 
application of positive derived basis to a covered shareholder's 
distributive share is treated as an application of positive derived 
basis by the transferring partnership, unless the covered shareholder 
owns the transferred units through multiple partnerships, in which case 
only partnerships in which the covered shareholder directly owns an 
interest are treated as applying the positive derived basis.
    (2) Application of positive derived basis--(i) In general. A 
covered shareholder's distributive share of gain or loss with respect 
to transferred units (determined without regard to derived basis, and 
expressed as a negative amount in the case of a distributive share of 
loss) is adjusted by subtracting the transferring partnership's 
positive derived basis with respect to the covered shareholder of the 
transferred units, subject to the limitations in paragraphs (b)(2)(ii) 
and (iii) of this section, as applicable.
    (ii) Limitation in nonrecognition transactions. In a nonrecognition 
transaction, the amount of positive derived basis that is taken into 
account in applying paragraph (b)(2)(i) of this section with respect to 
the covered shareholder is limited to the excess of the amount of 
positive derived basis that would be taken into account by the covered 
shareholder but for this paragraph (b)(2)(ii) over the covered 
shareholder's share of the gain realized but not recognized by the 
transferring partnership with respect to the transferred units. The 
covered shareholder's share of such realized-but-not-recognized gain is 
determined by multiplying the amount of that gain of the transferring 
partnership by a fraction, the numerator of which is the covered 
shareholder's distributive share of gain recognized by the transferring 
partnership with respect to the transferred units (determined without 
regard to derived basis), and the denominator of which is the amount of 
gain recognized by the transferring partnership with respect to the 
transferred units (determined without regard to derived basis).
    (iii) Limitation on loss. Positive derived basis can create or 
increase a distributive share of loss only if loss is, or would be if 
there were a loss, recognized by the transferring partnership on the 
sale, exchange, or other disposition of the transferred units and a 
current deduction in respect of the loss is, or would be, allowable.
    (iv) Translation rule. If applicable, positive derived basis is 
translated into functional currency at the spot rate on the day on 
which the sale, exchange, or other disposition occurs.
    (c) Basis adjustment to top-tier partnership interest. In the case 
of a partnership interest that is directly owned by a covered 
shareholder and through which the covered shareholder owns the 
transferred units described in paragraph (b) of this section, adjusted 
basis of such interest is adjusted under section 705 after taking into 
account the partnership's application of positive derived basis to the 
covered shareholder's distributive share of gain or loss with respect 
to the transferred

[[Page 95444]]

units (determined under paragraph (b)(2) of this section).
    (d) Basis adjustments to lower-tier partnership interests. In the 
case of a partnership interest (lower-tier partnership interest) that 
is directly owned by another partnership (upper-tier partnership) and 
through which a covered shareholder owns the transferred units 
described in paragraph (b) of this section, the upper-tier 
partnership's basis in such lower-tier partnership interest is adjusted 
as described in this paragraph (d). Common basis in the lower-tier 
partnership interest is adjusted under section 705 without regard to 
the application of positive derived basis to the covered shareholder's 
distributive share of gain or loss with respect to the transferred 
units (determined under paragraph (b)(2) of this section). Concurrently 
with and taking into account the adjustment under section 705, derived 
basis with respect to the covered shareholder of the lower-tier 
partnership interest is reduced by the amount of positive derived basis 
applied to the covered shareholder's distributive share of gain or loss 
with respect to the transferred units (determined under paragraph 
(b)(2) of this section) or gain is recognized in accordance with the 
principles of Sec.  1.961-4 (applied by treating such amount of applied 
positive derived basis as the amount of the adjustment to basis 
described in Sec.  1.961-4(c)(2)(i)). If there is more than one lower-
tier partnership, adjustments to derived basis under this paragraph (d) 
are made starting with the partnership at the lowest tier.


Sec.  1.961-9  Exclusion from gross income of previously taxed earnings 
and profits resulting from positive section 961(c) basis.

    (a) Scope. This section describes the consequences of positive 
section 961(c) basis. Paragraph (b) of this section excludes from gross 
income previously taxed earnings and profits resulting from the 
application of section 961(c) basis to covered gain. Paragraph (c) of 
this section defines covered gain. Paragraph (d) of this section 
describes rules for analyzing covered gain. Paragraph (e) of this 
section provides rules for applying positive section 961(c) basis to 
covered gain. Paragraph (f) of this section provides rules 
characterizing covered gain as previously taxed earnings and profits. 
Paragraph (g) of this section provides a dollar basis rule. Paragraph 
(h) of this section provides a rule allocating previously taxed 
earnings and profits to shares of stock. See Sec.  1.961-12(c)(5) 
(Example 5) for an example illustrating the application of this 
section.
    (b) Exclusion from gross income of previously taxed earnings and 
profits resulting from section 961(c) basis. Previously taxed earnings 
and profits that result from the application of a controlled foreign 
corporation's section 961(c) basis to covered gain are excluded from 
the controlled foreign corporation's gross income, solely for purposes 
of determining the controlled foreign corporation's subpart F income 
and tested income or tested loss, and provided that the covered 
shareholder to which the previously taxed earnings and profits relate 
is a United States shareholder in the controlled foreign corporation.
    (c) Covered gain--(1) In general. Covered gain is all gain 
recognized by a controlled foreign corporation on a sale, exchange, or 
other disposition of one or more section 961(c) ownership units that 
are shares of stock of a single corporation (transferred units), 
determined without regard to loss recognized on any transferred unit 
and without regard to section 961(c) basis. Covered gain includes 
amounts treated as gain from a sale, exchange, or other disposition 
(for example, under section 301(c)(3)), other than gain recognized 
pursuant to section 961(c) (for example, for distributions of 
previously taxed earnings and profits in excess of basis under Sec.  
1.961-4(d)). Section 961(c) basis is applied to covered gain, and 
previously taxed earnings and profits result from such application of 
section 961(c) basis, in accordance with the rules described in 
paragraph (d) of this section.
    (2) Coordination with dividend recharacterization provisions. 
Section 964(e)(1) (or any provision of the Code or regulations in this 
title that would treat covered gain as a dividend in whole or in part) 
does not apply to the portion of covered gain to which section 961(c) 
basis is applied and that, consequently, is previously taxed earnings 
and profits.
    (d) Rules for analyzing covered gain--(1) Determine each covered 
shareholder's share of the covered gain. First, determine each covered 
shareholder's share of the covered gain, computed as the portion of the 
covered gain that is assigned to the covered shareholder under Sec.  
1.951-2.
    (2) Apply section 961(c) basis. Second, apply the controlled 
foreign corporation's positive section 961(c) basis to each covered 
shareholder's share of the covered gain in accordance with paragraph 
(e) of this section.
    (3) Characterize covered gain as previously taxed earnings and 
profits. Third, characterize the portion of each covered shareholder's 
share of the covered gain to which section 961(c) basis is applied as 
previously taxed earnings and profits of the controlled foreign 
corporation in accordance with paragraph (f) of this section. Such 
characterization does not reduce previously taxed earnings and profits 
of the foreign corporation in which shares of stock are transferred 
units or any foreign corporation in which stock is owned through the 
transferred units.
    (4) Determine dollar basis. Fourth, determine the dollar basis of 
previously taxed earnings and profits resulting from section 961(c) 
basis in accordance with paragraph (g) of this section.
    (5) Treat resulting previously taxed earnings and profits as 
recognized with respect to particular transferred units. Fifth, treat 
previously taxed earnings and profits resulting from section 961(c) 
basis as recognized with respect to particular transferred units by 
allocating such previously taxed earnings and profits in accordance 
with paragraph (h) of this section. Such allocation is taken into 
account, for example, in applying section 964(e)(1) (taking into 
account paragraph (c)(2) of this section) to gain recognized with 
respect to a particular transferred unit.
    (6) Adjust previously taxed earnings and profits and make related 
account adjustments. Sixth, increase the controlled foreign 
corporation's previously taxed earnings and profits to reflect 
previously taxed earnings and profits resulting from section 961(c) 
basis and make the related adjustments described in Sec.  1.959-3 to 
each covered shareholder's accounts.
    (e) Application of positive section 961(c) basis--(1) In general. 
In a sale, exchange, or other disposition in which a controlled foreign 
corporation recognizes covered gain, the controlled foreign 
corporation's positive section 961(c) basis with respect to a covered 
shareholder of the transferred units is applied to such covered 
shareholder's share of the covered gain (determined under paragraph 
(d)(1) of this section), to the extent thereof and subject to the 
limitation in paragraph (e)(2) of this section.
    (2) Limitation in nonrecognition transactions. In a nonrecognition 
transaction, the amount of positive section 961(c) basis that is taken 
into account in applying paragraph (e)(1) of this section with respect 
to the covered shareholder is limited to the excess of the amount of 
positive section 961(c) basis that would be taken into account by the 
covered shareholder but for this paragraph (e)(2) over the covered 
shareholder's share of the gain realized

[[Page 95445]]

but not recognized by the controlled foreign corporation with respect 
to the transferred units. The covered shareholder's share of such 
realized-but-not-recognized gain is determined by multiplying the 
amount of that gain of the controlled foreign corporation by a 
fraction, the numerator of which is the covered shareholder's share of 
covered gain with respect to the transferred units (determined under 
paragraph (d)(1) of this section), and the denominator of which is the 
amount of covered gain with respect to the transferred units 
(determined under paragraph (c)(1) of this section).
    (3) Translation rule. If applicable, positive section 961(c) basis 
is translated into functional currency of the controlled foreign 
corporation at the spot rate on the day on which the sale, exchange, or 
other disposition occurs.
    (4) Unused positive section 961(c) basis. See Sec.  1.961-11(c)(2) 
and (e) for rules applying positive section 961(c) basis in excess of 
covered gain to gain recognized pursuant to section 961(c).
    (f) Characterization of covered gain as previously taxed earnings 
and profits--(1) In general. The portion of a covered shareholder's 
share of covered gain to which section 961(c) basis is applied 
(determined under paragraph (d)(2) of this section) is characterized as 
previously taxed earnings and profits with respect to the covered 
shareholder (section 961(c) PTEP) in accordance with the rules 
described in paragraphs (f)(2) through (4) of this section.
    (2) Mirroring rule--(i) In general. The portion of section 961(c) 
PTEP that does not exceed the amount of mirrored PTEP (defined in 
paragraph (f)(2)(ii) of this section) has the same character as a pro 
rata portion of mirrored PTEP. The pro rata portion is determined by 
multiplying mirrored PTEP by a fraction, the numerator of which is the 
portion of section 961(c) PTEP described in the preceding sentence and 
the denominator of which is the amount of mirrored PTEP.
    (ii) Mirrored PTEP. For purposes of this paragraph (f)(2), mirrored 
PTEP is--
    (A) All previously taxed earnings and profits that transfer from 
the covered shareholder under Sec.  1.959-7 in the sale, exchange, or 
other disposition in which the covered gain is recognized (or that 
would so transfer if the transferred units were sold in a general 
successor transaction); and
    (B) All previously taxed earnings and profits that would exist if 
foreign income taxes associated with previously taxed earnings and 
profits described in paragraph (f)(2)(ii)(A) of this section 
(determined under Sec.  1.959-7 and, if applicable, translated into the 
functional currency of the foreign corporation to which the previously 
taxed earnings and profits would relate at the spot rate on the day on 
which the sale, exchange, or other disposition occurs) were treated as 
an additional amount of such previously taxed earnings and profits.
    (iii) Currency rule. For purposes of this paragraph (f)(2), if any 
previously taxed earnings and profits described in paragraph (f)(2)(ii) 
of this section are denominated in a currency other than the functional 
currency of the controlled foreign corporation recognizing the covered 
gain, then such previously taxed earnings and profits are translated 
into such controlled foreign corporation's functional currency at the 
spot rate on the day on which the covered gain is recognized.
    (3) Lookback rule--(i) In general. The portion of section 961(c) 
PTEP that is not characterized under paragraph (f)(2) of this section, 
if any, and that does not exceed the amount of lookback PTEP (defined 
in paragraph (f)(3)(ii) of this section) has the same character as a 
pro rata portion of lookback PTEP. The pro rata portion is determined 
by multiplying lookback PTEP by a fraction, the numerator of which is 
the portion of section 961(c) PTEP described in the preceding sentence 
and the denominator of which is the amount of lookback PTEP.
    (ii) Lookback PTEP. For purposes of this paragraph (f)(3), lookback 
PTEP is all previously taxed earnings and profits that both--
    (A) Resulted from an income inclusion under section 951(a) or 
951A(a) of the covered shareholder attributable to the transferred 
units (including stock owned through the transferred units); and
    (B) Were related to a taxable year of a foreign corporation ending 
during the 36-month period that ends on the day on which the covered 
gain is recognized.
    (iii) Currency rule. For purposes of this paragraph (f)(3), if any 
previously taxed earnings and profits described in paragraph (f)(3)(ii) 
of this section are denominated in a currency other than the functional 
currency of the controlled foreign corporation recognizing the covered 
gain, then such previously taxed earnings and profits are translated 
into such controlled foreign corporation's functional currency by 
translating the U.S. dollar amount of the income inclusion giving rise 
to the previously taxed earnings and profits at the spot rate on the 
day on which the covered gain is recognized.
    (4) Section 245A(d) PTEP rule. The portion of section 961(c) PTEP 
that is not characterized under paragraphs (f)(2) and (3) of this 
section, if any, is characterized as relating to the section 245A(d) 
PTEP group, the taxable year of the controlled foreign corporation in 
which the covered gain is recognized, and the general category income 
under section 904(d)(1)(D).
    (g) Dollar basis rule. The dollar basis of previously taxed 
earnings and profits with respect to a covered shareholder that result 
from section 961(c) basis (determined under paragraph (d)(3) of this 
section) is equal to the U.S. dollar amount of the section 961(c) basis 
giving rise to such previously taxed earnings and profits.
    (h) Allocation of previously taxed earnings and profits--(1) In 
general. Previously taxed earnings and profits with respect to a 
covered shareholder that result from section 961(c) basis (determined 
under paragraph (d)(3) of this section) are allocated to transferred 
units in accordance with the rules of paragraph (h)(2) of this section.
    (2) Rules--(i) Stacking rule. First, allocate to each transferred 
unit an amount of previously taxed earnings and profits equal to the 
lesser of the amount of positive section 961(c) basis with respect to 
the covered shareholder of the transferred unit (to the extent taken 
into account in applying paragraph (e)(1) of this section) and the 
portion of the covered shareholder's share of the covered gain that is 
recognized with respect to the transferred unit.
    (ii) Pro rata rule. Second, allocate to each transferred unit a pro 
rata portion of any amount of previously taxed earnings and profits not 
allocated under paragraph (h)(2)(i) of this section, determined by 
multiplying such amount by a fraction. The numerator of the fraction is 
the portion of the covered shareholder's share of the covered gain that 
is recognized with respect to the transferred unit, less the amount of 
previously taxed earnings and profits allocated to the transferred unit 
under paragraph (h)(2)(i) of this section. The denominator of the 
fraction is the amount of previously taxed earnings and profits not 
allocated under paragraph (h)(2)(i) of this section.


Sec.  1.961-10  Gain recognition for negative basis.

    (a) Scope. This section describes the consequences of negative 
derived basis and negative section 961(c) basis. Paragraph (b) of this 
section sets forth a rule requiring gain recognition for negative 
derived basis. Paragraph (c) of this section sets forth a rule 
requiring gain recognition for negative section 961(c) basis. See Sec.  
1.961-12(c)(6) and (7)

[[Page 95446]]

(Examples 6 and 7) for examples illustrating the application of this 
section.
    (b) Gain recognition for negative derived basis--(1) In general. If 
a partnership has negative derived basis of a derivative ownership 
unit, then, in any transaction involving the derivative ownership unit 
(for example, a sale, exchange, or distribution under section 
301(c)(2)), the partnership is treated as recognizing gain with respect 
to the derivative ownership unit in accordance with the rules described 
in paragraphs (b)(2) through (5) of this section.
    (2) Amount of gain--(i) In general. The amount of the gain 
recognized is equal to the additional amount of gain, plus the lesser 
amount of loss (expressed as a positive amount), that the partnership 
would have recognized in the transaction if, immediately before the 
transaction, the partnership's common basis of the derivative ownership 
unit were reduced by all negative derived basis of the derivative 
ownership unit. Thus, for example, in a sale of the derivative 
ownership unit, the amount of the gain recognized is generally equal to 
the sum of all negative derived basis of the derivative ownership unit 
and, in a nonrecognition transaction, the amount of the gain recognized 
may be less than the sum of all negative derived basis of the 
derivative ownership unit.
    (ii) Special rule if derivative ownership unit ceases to be a 
derivative ownership unit. If the derivative ownership unit is not a 
derivative ownership unit immediately after the transaction (including, 
for example, because the derivative ownership unit is redeemed, or 
becomes directly owned by a foreign corporation or covered shareholder, 
in the transaction), then, notwithstanding paragraph (b)(2)(i) of this 
section, the amount of the gain recognized is equal to the sum of all 
negative derived basis of the derivative ownership unit.
    (iii) Translation rule. If applicable, negative derived basis is 
translated into functional currency at the spot rate on the day on 
which the transaction involving the derivative ownership unit occurs.
    (3) Allocation of gain. A pro rata portion of the gain is allocated 
to each covered shareholder, determined by multiplying the amount of 
such gain by a fraction. The numerator of the fraction is the negative 
derived basis with respect to the covered shareholder of the derivative 
ownership unit, and the denominator of the fraction is the sum of all 
negative derived basis of the derivative ownership unit.
    (4) Treatment of gain. The gain is treated in the same manner as 
gain recognized under Sec.  1.961-4(c) for distributions of previously 
taxed earnings and profits in excess of basis (and thus the rules in 
Sec.  1.961-4(f) apply to the gain), except that the gain is recognized 
concurrently with, but separate from, the transaction.
    (5) Negative derived basis eliminated to the extent it gives rise 
to gain. Negative derived basis is eliminated to the extent it 
increases the amount of gain recognized under this paragraph (b), 
concurrent with the transaction.
    (c) Gain recognition for negative section 961(c) basis--(1) In 
general. If a controlled foreign corporation has negative section 
961(c) basis of a section 961(c) ownership unit, then, in any 
transaction involving the section 961(c) ownership unit (for example, a 
sale, exchange, or distribution under section 301(c)(2)), the 
controlled foreign corporation is treated as recognizing gain with 
respect to the section 961(c) ownership unit in accordance with the 
rules described in paragraphs (c)(2) through (5) of this section.
    (2) Amount of gain--(i) In general. The amount of the gain 
recognized is equal to the additional amount of gain, plus the lesser 
amount of loss (expressed as a positive amount), that the controlled 
foreign corporation would have recognized in the transaction if, 
immediately before the transaction, the controlled foreign 
corporation's adjusted basis of the section 961(c) ownership unit were 
reduced by all negative section 961(c) basis of the section 961(c) 
ownership unit. Thus, for example, in a sale of the section 961(c) 
ownership unit, the amount of the gain recognized is generally equal to 
the sum of all negative section 961(c) basis of the section 961(c) 
ownership unit and, in a nonrecognition transaction, the amount of the 
gain recognized may be less than the sum of all negative section 961(c) 
basis of the section 961(c) ownership unit.
    (ii) Special rule if section 961(c) ownership unit ceases to be a 
section 961(c) ownership unit. If the section 961(c) ownership unit is 
not a section 961(c) ownership unit immediately after the transaction 
(including, for example, because the section 961(c) ownership unit is 
redeemed, or becomes directly owned by a covered shareholder, in the 
transaction), then, notwithstanding paragraph (c)(2)(i) of this 
section, the amount of the gain recognized is equal to the sum of all 
negative section 961(c) basis of the section 961(c) ownership unit.
    (iii) Translation rule. If applicable, negative section 961(c) 
basis is translated into functional currency of the controlled foreign 
corporation at the spot rate on the day on which the transaction 
involving the section 961(c) ownership unit occurs.
    (3) Assignment of gain. A pro rata portion of the gain is assigned 
to each covered shareholder, determined by multiplying the amount of 
such gain by a fraction. The numerator of the fraction is the negative 
section 961(c) basis with respect to the covered shareholder of the 
section 961(c) ownership unit, and the denominator of the fraction is 
the sum of all negative section 961(c) basis of the section 961(c) 
ownership unit.
    (4) Treatment of gain. The gain is treated in the same manner as 
gain recognized under Sec.  1.961-4(d) for distributions of previously 
taxed earnings and profits in excess of basis (and thus the rules in 
Sec.  1.961-4(f) apply to the gain), except that the gain is recognized 
concurrently with, but separate from, the transaction. Thus, the gain 
is recognized pursuant to section 961(c) and therefore applies only for 
purposes of determining amounts included in gross income of United 
States shareholders of the controlled foreign corporation under Sec.  
1.961-11.
    (5) Negative section 961(c) basis eliminated to the extent it gives 
rise to gain. Negative section 961(c) basis is eliminated to the extent 
it increases the amount of gain recognized under this paragraph (c), 
concurrent with the transaction.


Sec.  1.961-11  Amounts included in gross income of United States 
shareholders.

    (a) Scope. This section sets forth rules regarding amounts that 
United States shareholders of a controlled foreign corporation must 
include in gross income under section 961(c) to account for gain 
recognized by the controlled foreign corporation pursuant to section 
961(c) (for distributions of previously taxed earnings and profits in 
excess of basis under Sec.  1.961-4(d), for foreign currency loss in 
excess of basis under Sec.  1.961-5(b), or for negative section 961(c) 
basis under Sec.  1.961-10(c)). Paragraph (b) of this section provides 
the general rule. Paragraph (c) of this section allocates gain 
recognized pursuant to section 961(c) to a United States shareholder. 
Paragraph (d) of this section adjusts allocations of gain to reflect 
transfers of stock of the controlled foreign corporation. Paragraph (e) 
of this section determines loss recognized under section 961(c) with 
respect to a United States shareholder. See Sec.  1.961-12(c)(8) 
(Example 8) for an example illustrating

[[Page 95447]]

the application of this section. See also Sec.  1.961-3, regarding 
basis increases for an inclusion under this section.
    (b) In general. If a United States shareholder owns stock of a 
controlled foreign corporation on the last relevant day of a taxable 
year of the controlled foreign corporation, and the controlled foreign 
corporation recognizes gain pursuant to section 961(c) within that 
taxable year (all such gain, section 961(c) income), then the United 
States shareholder includes in gross income the amount of section 
961(c) income that is allocated to the United States shareholder 
(determined under paragraph (c) of this section). The inclusion is for 
the United States shareholder's taxable year in which or with which the 
controlled foreign corporation's taxable year ends and is treated in 
the same manner as an amount included in gross income under section 
951(a)(1)(A) solely for purposes of increasing basis under Sec.  1.961-
3 and translation into U.S. dollars under 989(b).
    (c) Allocation of section 961(c) income. For purposes of paragraph 
(b) of this section, the amount of the controlled foreign corporation's 
section 961(c) income that is allocated to a United States shareholder 
is the excess (if any) of--
    (1) The sum of any portions of section 961(c) income that are 
assigned to the United States shareholder under Sec.  1.961-4, 1.961-5, 
or 1.961-10, adjusted, if applicable, in accordance with paragraph (d) 
of this section as a result of transfers of stock of the controlled 
foreign corporation; over
    (2) The amount of loss that the controlled foreign corporation is 
treated as recognizing under section 961(c) with respect to the United 
shareholder in accordance with paragraph (e) of this section.
    (d) Rules for transfers of stock of the controlled foreign 
corporation--(1) General successor transactions--(i) General successor 
transaction occurring before the last relevant day. For purposes of 
paragraph (c)(1) of this section, if the controlled foreign corporation 
is an acquired foreign corporation in a general successor transaction 
that occurs before the last relevant day of the controlled foreign 
corporation's taxable year, then treat a pro rata portion of section 
961(c) income that is both recognized before the general successor 
transaction and assigned to the transferor covered shareholder under 
Sec.  1.961-4, 1.961-5, or 1.961-10 as instead assigned to the 
successor covered shareholder, determined by multiplying such section 
961(c) income by the fraction described in Sec.  1.961-5(c)(2)(i) for 
determining the controlled foreign corporation's section 961(c) basis 
that transfers in the general successor transaction.
    (ii) General successor transaction occurring on or after the last 
relevant day. For purposes of paragraph (c)(1) of this section, if the 
controlled foreign corporation is an acquired foreign corporation in a 
general successor transaction that occurs on or after the last relevant 
day of the controlled foreign corporation's taxable year, then treat a 
pro rata portion of section 961(c) income that is both recognized after 
the general successor transaction and assigned to the successor covered 
shareholder under Sec.  1.961-4, 1.961-5, or 1.961-10 as instead 
assigned to the transferor covered shareholder, determined by 
multiplying such section 961(c) income by the fraction described in 
Sec.  1.961-5(c)(2)(i) for determining the controlled foreign 
corporation's section 961(c) basis that transfers in the general 
successor transaction.
    (2) Other transfers. The principles of paragraph (d)(1) of this 
section apply to transactions, other than general successor 
transactions, in which the controlled foreign corporation's 961(c) 
basis transfers to another covered shareholder.
    (e) Determining loss under section 961(c)--(1) In general. For 
purposes of paragraph (c)(2) of this section, the amount of loss that 
the controlled foreign corporation is treated as recognizing under 
section 961(c) with respect to the United States shareholder is, 
subject to the limitations in paragraph (e)(2) of this section, equal 
to the sum of the controlled foreign corporation's positive section 
961(c) basis with respect to the United States shareholder of section 
961(c) ownership units that are sold, exchanged, or otherwise disposed 
of by the controlled foreign corporation within the controlled foreign 
corporation's taxable year, reduced by the amount of such positive 
section 961(c) basis that is applied to covered gain under Sec.  1.961-
9.
    (2) Limitations--(i) In general. Positive section 961(c) basis of 
section 961(c) ownership units increases the amount of loss that the 
controlled foreign corporation is treated as recognizing under section 
961(c) only if loss is, or would be if there were a loss, recognized by 
the controlled foreign corporation on the sale, exchange, or other 
disposition of the section 961(c) ownership units and a current 
deduction in respect of the loss is, or would be, allowable.
    (ii) Loss recognized only to the extent of certain gain. Positive 
section 961(c) basis of section 961(c) ownership units that are shares 
of stock of a single foreign corporation increases the amount of loss 
that the controlled foreign corporation is treated as recognizing under 
section 961(c) only to the extent of the portion of the amount 
described in paragraph (c)(1) of this section that is recognized with 
respect to stock of such foreign corporation.
    (3) Translation rule. If applicable, positive section 961(c) basis 
of section 961(c) ownership units is translated into the controlled 
foreign corporation's functional currency at the spot rate on the day 
of the sale, exchange, or other disposition of the section 961(c) 
ownership units.


Sec.  1.961-12  Examples.

    (a) In general. This section provides examples that illustrate the 
application of Sec. Sec.  1.961-1 through 1.961-11.
    (b) Assumed facts. For purposes of the examples in this section, 
unless otherwise indicated, the following facts are assumed for U.S. 
tax purposes:
    (1) US1 and US2 are unrelated domestic corporations that are 
covered shareholders, each of which uses the U.S. dollar as its 
functional currency and chooses to claim a credit for foreign income 
taxes pursuant to section 901. Neither US1 nor US2 is a member of a 
consolidated group (as defined in Sec.  1.1502-1(h)).
    (2) F1, F2, and F3 are foreign corporations, each of which is a 
controlled foreign corporation and uses the British pound ([pound]) as 
its functional currency.
    (3) PRS1 and PRS2 are partnerships.
    (4) Each entity uses the calendar year as its taxable year, and no 
entity has a short taxable year.
    (5) There are no adjustments under section 743(b) to the basis of 
any partnership property.
    (c) Examples--(1) Example 1: Types of property units and basis--(i) 
Facts. US1 directly owns 60, and US2 directly owns 40, of the 100 
shares of the single class of outstanding stock of F1. F1 directly owns 
all 50 shares of the single class of outstanding stock of F2. This 
example only analyzes the types of basis provided under section 961 in 
the items of property.
    (ii) Analysis. Each of the 60 shares of stock of F1 directly owned 
by US1 and the 40 shares of stock of F1 directly owned by US2 is a 
section 961(a) ownership unit in which the covered shareholder (US1 or 
US2) is provided adjusted basis. See Sec.  1.961-2(c). In addition, 
each of the 50 shares of stock of F2 directly owned by F1, a controlled 
foreign corporation, is a section 961(c) ownership unit in which F1 is 
provided

[[Page 95448]]

section 961(c) basis. See Sec.  1.961-2(e)(1). F1's section 961(c) 
basis in each section 961(c) ownership unit is maintained separately 
with respect to each of US1 and US2. See Sec.  1.961-2(e)(2). Further, 
each of the section 961(a) ownership units and section 961(c) ownership 
units is a property unit, and adjusted basis or section 961(c) basis in 
the property unit, as applicable, is maintained in U.S. dollars. See 
Sec.  1.961-2(b).
    (iii) Alternative facts: partnership structure--(A) Facts. The 
facts are the same as paragraph (c)(1)(i) of this section (Example 1), 
except that US1 and US2, in the aggregate, directly own all the 
interests in PRS1, and PRS1 directly owns all 100 of the shares of 
stock of F1.
    (B) Analysis. The interest in PRS1 directly owned by each of US1 
and US2 is a section 961(a) ownership unit in which the covered 
shareholder (US1 or US2) is provided adjusted basis. See Sec.  1.961-
2(c). In addition, each of the 100 shares of stock of F1 directly owned 
by PRS1 is a derivative ownership unit in which PRS1 is provided 
derived basis. See Sec.  1.961-2(d)(1). PRS1's derived basis in each 
derivative ownership unit is established and maintained separately with 
respect to each of US1 and US2. See Sec.  1.961-2(d)(2). Further, as is 
the case in paragraph (c)(1)(ii) of this section, each of the 50 shares 
of stock of F2 directly owned by F1, a controlled foreign corporation, 
is a section 961(c) ownership unit in which F1 is provided section 
961(c) basis, and that basis is maintained separately with respect to 
each of US1 and US2. Moreover, each of the section 961(a) ownership 
units, derivative ownership units, and section 961(c) ownership units 
is a property unit, and adjusted basis, derived basis, or section 
961(c) basis in the property unit, as applicable, is maintained in U.S. 
dollars. See Sec.  1.961-2(b).
    (2) Example 2: Basis increases for income inclusions--(i) Facts. 
US1 directly owns all 100 shares of the single class of outstanding 
stock of F1, and F1 directly owns all 50 shares of the single class of 
outstanding stock of F2. Thus, the shares of stock of F1 directly owned 
by US1 are section 961(a) ownership units, and the shares of stock of 
F2 directly owned by F1 are section 961(c) ownership units. For F2's 
taxable year ending on December 31 of year 3, the last relevant day is 
December 31 and US1 includes $80x in gross income under section 
951(a)(1)(A) (its pro rata share of F2's subpart F income, translated 
into U.S. dollars in accordance with section 989(b)) and $120x in gross 
income under section 951A(a) (the portion of its GILTI inclusion amount 
that is treated as with respect to F2 for the taxable year under 
section 951A(f)(2)). F2 does not make any covered distributions, and 
therefore does not distribute any previously taxed earnings and 
profits, during the taxable year. This example only analyzes basis 
increases for the income inclusions. See also Sec.  1.312-6(f) (income 
inclusions increase US1's earnings and profits); Sec.  1.959-3 
(adjustments to previously taxed earnings and profits accounts).
    (ii) Analysis--(A) In general. To reflect US1's income inclusions 
for F2's taxable year ending on December 31 of year 3, basis of shares 
of stock of F2, and basis of shares of stock of F1 (property units 
through which US1 owns stock of F2), is in each case increased in 
accordance with Sec.  1.961-3. See Sec.  1.961-3(b). In the case of 
stock of F2, F1's section 961(c) basis with respect to US1 is increased 
because shares of stock of F2 are section 961(c) ownership units and F2 
is a controlled foreign corporation, as required by Sec.  1.961-
3(f)(1). In the case of stock of F1, US1's adjusted basis is increased 
because shares of stock of F1 are section 961(a) ownership units. 
Paragraph (c)(2)(ii)(B) of this section provides the specific increases 
to basis.
    (B) Increases to basis of each property unit. The amount of US1's 
income inclusions with respect to F2 that give rise to increases to 
basis under section 961 is $200x ($80x + $120x). See Sec.  1.961-
3(c)(1). In determining the specific increases to basis, the actual 
distribution rule in Sec.  1.961-3(d) does not apply because F2 does 
not distribute any previously taxed earnings and profits before the 
last relevant day. See Sec.  1.961-3(c)(3). Thus, the hypothetical 
distribution rule in Sec.  1.961-3(e) determines the entirety of the 
increases to basis for the income inclusions. See Sec.  1.961-3(c)(4). 
Under the hypothetical distribution rule, the basis of each share of 
stock of F2 is increased by $4x ($200x / 50 shares), and the basis of 
each share of stock of F1 is increased by $2x ($200x / 100 shares), 
which in each case is equal to the portion of a $200x hypothetical 
distribution treated as made by F2 through all tiers to US1 on the last 
relevant day that would be distributed with respect to the property 
unit. See Sec.  1.961-3(e). These increases to basis are treated as 
made at the beginning of F2's taxable year 3 because there are no 
midyear transactions and the entirety of the $200x of income inclusions 
is under section 951(a)(1)(A) or 951A(a). See Sec.  1.961-3(c)(2) and 
(e)(1). Accordingly, at the beginning of F2's taxable year 3, F1 
increases its section 961(c) basis with respect to US1 of each share of 
stock of F2 by $4x, and US1 increases its adjusted basis of each share 
of stock of F1 by $2x.
    (iii) Alternative facts: midyear transaction and actual 
distribution rule--(A) Facts. The facts are the same as in paragraph 
(c)(2)(i) of this section, except as follows. On January 1 of year 3, 
US1 directly owns all the stock of F2. On March 31 of year 3, F2 
distributes previously taxed earnings and profits to US1 (pro rata with 
respect to the shares of stock of F2) and, consequently, US1 is 
required under Sec.  1.961-4 (basis reductions and gain recognition for 
distributions) to adjust its adjusted basis of each share of stock of 
F2 by $3x (the sum of the dollar basis and associated foreign income 
taxes of the previously taxed earnings and profits that are distributed 
on the share). On June 30 of year 3, F1 is formed and US1 immediately 
contributes all its stock of F2 to F1 in exchange for 100 shares of 
stock of F1. Thus, before the contribution, shares of stock of F2 are 
section 961(a) ownership units and, beginning as of the contribution, 
all the shares of stock of F1 are section 961(a) ownership units and 
all the shares of stock of F2 are section 961(c) ownership units.
    (B) Analysis--(1) In general. To reflect US1's income inclusions 
for F2's taxable year ending on December 31 of year 3, basis of shares 
of stock of F2, and basis of shares of stock of F1 (property units 
through which US1 owns stock of F2), is in each case increased in 
accordance with Sec.  1.961-3. See Sec.  1.961-3(b). In the case of 
stock of F2, because shares of the stock are section 961(a) ownership 
units before the contribution and section 961(c) ownership units after 
the contribution, the type of basis that is increased depends on the 
timing of adjustments. Specifically, in the case of stock of F2 and an 
increase to basis that is treated as made before the contribution, the 
basis that is increased is US1's adjusted basis because shares of stock 
of F2 are section 961(a) ownership units before the contribution. In 
the case of stock of F2 and an increase to basis that is treated as 
made after the contribution, the basis that is increased is F1's 
section 961(c) basis with respect to US1 because shares of stock of F2 
are section 961(c) ownership units after the contribution and F2 is a 
controlled foreign corporation, as required by Sec.  1.961-3(f)(1). In 
the case of stock of F1, US1's adjusted basis is increased because 
shares of stock of F1 are section 961(a) ownership units. Paragraph 
(c)(2)(iii)(B)(2) of this section provides the specific increases to 
basis.
    (2) Increases to basis of each property unit. The amount of US1's 
income inclusions with respect to F2 that give

[[Page 95449]]

rise to increases to basis under section 961 is $200x ($80x + $120x). 
See Sec.  1.961-3(c)(1). In determining the specific increases to basis 
for the income inclusions, the actual distribution rule in Sec.  1.961-
3(d) applies because F2's distribution of previously taxed earnings and 
profits is made before the last relevant day. See Sec.  1.961-3(c)(3). 
Under the actual distribution rule, basis of each share of stock of F2 
is increased by $3x, which is equal to the adjustment required under 
Sec.  1.961-4 to the basis of such share by reason of the distribution, 
and thus basis of stock of F2 increases by $150x in total ($3x x 50 
shares). See Sec.  1.961-3(d)(2). These increases to basis are treated 
as made at the beginning of F2's taxable year because the distribution 
is made before the contribution of all the stock of F2 to F1, the sole 
midyear transaction occurring within the taxable year. See Sec.  1.961-
3(c)(2) and (d)(1). Then, the hypothetical distribution rule in Sec.  
1.961-3(e) determines increases to basis for the remaining $50x of 
income inclusions ($200x of income inclusions - $150x of basis 
increases to stock of F2 under the actual distribution rule). See Sec.  
1.961-3(c)(4). Under the hypothetical distribution rule, the basis of 
each share of stock of F2, and the basis of each share of stock of F1, 
is increased by the portion of a $50x hypothetical distribution treated 
as made by F2 through all tiers to US1 on the last relevant day that 
would be distributed with respect to the property unit. See Sec.  
1.961-3(e). These increases to basis are treated as made immediately 
after the contribution (the sole midyear transaction occurring within 
F2's taxable year). See Sec.  1.961-3(e)(1). Table 1 in this paragraph 
(c)(2)(iii)(B)(2) provides the increases to basis.

 Table 1 to Paragraph (c)(2)(iii)(B)(2) of This Section--Basis Increases
          To Reflect US1's Income Inclusions With Respect to F2
------------------------------------------------------------------------
                                              Basis increases
                                 ---------------------------------------
                                   January 1 of year
                                           3           June 30 of year 3
------------------------------------------------------------------------
US1's adjusted basis of stock of  ..................  $0.5x increase for
 F1 (100 shares).                                      each share ($50x
                                                       hypothetical
                                                       distribution /
                                                       100 shares).
Stock of F2 (50 shares):
    US1's adjusted basis (before  $3x increase for    ..................
     contribution).                each share
                                   (actual
                                   distribution
                                   rule).
    F1's section 961(c) basis     ..................  $1x increase for
     with respect to US1 (as of                        each share ($50x
     contribution).                                    hypothetical
                                                       distribution / 50
                                                       shares).
------------------------------------------------------------------------

    (iv) Alternative facts: partnership structure and section 
951(a)(1)(B) inclusion--(A) Facts. The facts are the same as in 
paragraph (c)(2)(i) of this section (Example 2), except as follows. US1 
is a citizen of the United States (rather than a domestic corporation), 
referred to as Individual A for purposes of the rest of this paragraph 
(c)(2)(iv), and does not make an election to apply the provisions of 
section 962 for any taxable year. PRS1 directly owns all the stock of 
F1, and Individual A owns 60%, and a nonresident alien individual owns 
40%, of the interests in PRS1. Thus, the interest in PRS1 directly 
owned by Individual A is a section 961(a) ownership unit, the shares of 
stock of F1 directly owned by PRS1 are derivative ownership units, and 
the shares of stock of F2 directly owned by F1 are section 961(c) 
ownership units. In addition, for F2's taxable year ending on December 
31 of year 3, Individual A includes $80x in gross income under section 
951(a)(1)(A) (its pro rata share of F2's subpart F income, translated 
into U.S. dollars in accordance with section 989(b)), $120x in gross 
income under section 951A(a) (the portion of its GILTI inclusion amount 
that is treated as with respect to F2 for the taxable year under 
section 951A(f)(2)), and $50x in gross income under section 
951(a)(1)(B) (the portion of its section 956 amount that is not 
allocated to previously taxed earnings and profits, translated into 
U.S. dollars in accordance with section 989(b)).
    (B) Analysis--(1) In general. To reflect Individual A's income 
inclusions for F2's taxable year ending on December 31 of year 3, basis 
of shares of stock of F2, and basis of shares of stock of F1 and basis 
of Individual A's interest in PRS1 (property units through which 
Individual A owns stock of F2), is in each case increased in accordance 
with Sec.  1.961-3. See Sec.  1.961-3(b). In the case of stock of F2, 
the basis that is increased is F1's section 961(c) basis with respect 
to Individual A because shares of stock of F2 are section 961(c) 
ownership units and F2 is a controlled foreign corporation, as required 
by Sec.  1.961-3(f)(1). In the case of stock of F1, PRS1's derived 
basis with respect to Individual A is increased because shares of stock 
of F1 are derivative ownership units. In the case of Individual A's 
interest in PRS1, Individual A's adjusted basis is increased because 
its interest in PRS1 is a section 961(a) ownership unit. Paragraph 
(c)(2)(iv)(B) of this section provides the specific increases to basis.
    (2) Increases to basis of each property unit. The amount of 
Individual A's income inclusions with respect to F2 that give rise to 
increases to basis under section 961 is $250x ($80x + $120x + $50x). 
See Sec.  1.961-3(c)(1). The hypothetical distribution rule in Sec.  
1.961-3(e) determines the entirety of the increases to basis for the 
income inclusions. See Sec.  1.961-3(c)(3) and (4). Under the 
hypothetical distribution rule, the basis of each property unit is 
increased by the portion of a $250x hypothetical distribution treated 
as made by F2 through all tiers to Individual A on the last relevant 
day that would be distributed with respect to the property unit 
(determined by regarding stock of F2 and other property only to the 
extent owned by Individual A on the last relevant day). See Sec.  
1.961-3(e). In addition, because 20% of the $250x of income inclusions 
is under section 951(a)(1)(B) ($50x/$250x), 20% of each increase to 
basis is treated as made at the end of the last day of F2's taxable 
year (which is when the previously taxed earnings and profits resulting 
from the income inclusion under section 951(a)(1)(B) are added to 
previously taxed earnings and profits accounts), with the remaining 80% 
treated as made at the beginning of the taxable year (which is when the 
previously taxed earnings and profits resulting from the income 
inclusions under sections 951(a)(1)(A) and 951A(a) are added to 
previously taxed earnings and profits accounts). See Sec.  1.961-
3(e)(1). Table 1 in this paragraph (c)(2)(iii)(B)(2) provides the 
increases to basis.

[[Page 95450]]



 Table 1 to Paragraph (c)(2)(iv)(B)(2) of This Section--Basis Increases
     To Reflect Individual A's Income Inclusions With Respect to F2
------------------------------------------------------------------------
                                              Basis increases
                                 ---------------------------------------
                                   January 1 of year    December 31 of
                                           3                year 3
------------------------------------------------------------------------
Individual A's adjusted basis of  $200x increase      $50x increase
 its interest in PRS1.             ($250x x 80%).      ($250x x 20%).
PRS1's derived basis with         $2x increase for    $0.5 increase for
 respect to Individual A of        each share ($250x   each share ($250x
 stock of F1 (100 shares).         / 100 shares x      / 100 shares x
                                   80%).               20%).
F1's section 961(c) basis with    $4x increase for    $1x increase for
 respect to Individual A of        each share ($250x   each share ($250x
 stock of F2 (50 shares).          / 50 shares x       / 50 shares x
                                   80%).               20%).
------------------------------------------------------------------------

    (3) Example 3: Basis reductions and gain recognition for 
distributions--(i) Facts. US1 and US2, in the aggregate, directly own 
all the shares of the single class of outstanding stock of F1. In year 
3, F1 makes a covered distribution (pro rata with respect to the shares 
of stock of F1). Under Sec.  1.959-4, the entirety of the portion of 
the covered distribution received by each of US1 and US2 is previously 
taxed earnings and profits excluded from the covered shareholder's 
(US1's or US2's) gross income. In addition, the sum of the dollar basis 
and associated foreign income taxes of the previously taxed earnings 
and profits that are distributed on each share of stock of F1 owned by 
US1 is $6x, and the sum of the dollar basis and associated foreign 
income taxes of the previously taxed earnings and profits that are 
distributed on each share of stock of F1 owned by US2 is $4x. 
Immediately before the covered distribution, US1's adjusted basis of 
each of its shares of stock of F1 is $4.5x, and US2's adjusted basis of 
each of its shares of stock of F1 is $3x. Each of US1 and US2 is deemed 
to pay the entirety of the associated foreign income taxes of the 
previously taxed earnings and profits distributed to it under section 
960(b) (because all such taxes are sourced from the creditable PTEP tax 
group and the covered shareholder is a United States shareholder of F1) 
and is allowed a credit under section 901 for the entirety of such 
taxes. This example only analyzes adjustments to basis of US1's and 
US2's shares of stock of F1 (section 961(a) ownership units) under 
section 961. See also Sec.  1.959-3 (adjustments to previously taxed 
earnings and profits accounts).
    (ii) Analysis--(A) In general. Under Sec.  1.961-4(b), each of US1 
and US2 reduces its adjusted basis of, and if applicable recognizes 
gain with respect to, each share of stock of F1 on which it receives 
previously taxed earnings and profits. The specific adjustments are 
provided in paragraphs (c)(3)(ii)(B) through (D) of this section and 
summarized in table 1 in this paragraph (c)(3)(ii)(A).

 Table 1 to Paragraph (c)(3)(ii)(A) of This Section--Basis Adjustments Resulting From F1's Distribution of PTEP
----------------------------------------------------------------------------------------------------------------
 
----------------------------------------------------------------------------------------------------------------
                                       Basis immediately          Adjustments to basis under Sec.   1.961-4(b)
                                        before the covered
                                        distribution.
----------------------------------------------------------------------------------------------------------------
US1's adjusted basis of its shares of  $4.5x for each share...  $6x adjustment for each  $4.5x reduction to
 stock of F1.                                                    share.                   basis (to $0).
                                                                                         $1.5x gain recognized.
US2's adjusted basis of its shares of  $3x for each share.....  $4x adjustment for each  $3x reduction to basis
 stock of F1.                                                    share.                   (to $0).
                                                                                         $1x gain recognized.
----------------------------------------------------------------------------------------------------------------

    (B) US1's receipt of previously taxed earnings and profits. As a 
result of US1's receipt of previously taxed earnings and profits, the 
amount of the adjustment to US1's adjusted basis of each of its shares 
of stock of F1 is $6x, the dollar basis and associated foreign income 
taxes of the previously taxed earnings and profits received on the 
share. See Sec.  1.961-4(b)(2)(i). Consequently, US1 reduces its 
adjusted basis of each of its shares of stock of F1 ($4.5x) to $0 and 
then is treated as recognizing $1.5x of gain with respect to the share 
(computed as the excess of the $6x adjustment to basis over the $4.5x 
reduction to basis). See Sec.  1.961-4(b)(2)(ii) and (iii).
    (C) US2's receipt of previously taxed earnings and profits. As a 
result of US2's receipt of previously taxed earnings and profits, the 
amount of the adjustment to US2's adjusted basis of each of its shares 
of stock of F1 is $4x, the dollar basis and associated foreign income 
taxes of the previously taxed earnings and profits received on the 
share. See Sec.  1.961-4(b)(2)(i). Consequently, US2 reduces its 
adjusted basis of each of its shares of stock of F1 ($3x) to $0 and 
then is treated as recognizing $1x of gain with respect to the share 
(computed as the excess of the $4x adjustment to basis over the $3x 
reduction to basis). See Sec.  1.961-4(b)(2)(ii) and (iii).
    (D) Timing of adjustments. The reductions to adjusted basis 
described in paragraphs (c)(3)(ii)(B) and (C) of this section are 
treated as made, and the gains described in those paragraphs are 
treated as recognized, concurrently with the covered distribution. See 
Sec.  1.961-4(e)(1) and (f)(1).
    (iii) Alternative facts: previously taxed earnings and profits 
received through a partnership--(A) Facts. The facts are the same as in 
paragraph (c)(3)(i) of this section (Example 3), except as follows. 
PRS1 directly owns all the shares of the single class of outstanding 
stock of F1, and US1 and US2, in the aggregate, directly own all the 
interests in PRS1. Under Sec.  1.959-4, the entirety of the portion of 
the covered distribution treated as received by each of US1 and US2 
through PRS1 is previously taxed earnings and profits excluded from the 
covered shareholder's (US1's or US2's) gross income. In addition, the 
sum of the dollar basis and associated foreign income taxes of the 
previously taxed earnings and profits that are both with respect to US1 
and distributed on each share of stock of F1 is $6x, and the sum of the 
dollar basis and associated foreign income taxes of the previously 
taxed earnings and profits that are both with respect to US2 and 
distributed on each share of stock of F1 is $4x. Immediately before the 
covered distribution, for each share of stock of F1, PRS1's common 
basis is $2.5x, its derived basis with respect to US1 is $3x, and its 
derived basis with respect to US2 is $2x. This

[[Page 95451]]

paragraph (c)(3)(iii) analyzes adjustments to basis of PRS1's shares of 
stock of F1 (derivative ownership units) under section 961. See also 
Sec.  1.961-4(b) (related adjustments to basis of US1's and US2's 
interests in PRS1).
    (B) Analysis--(1) In general. Under Sec.  1.961-4(c), PRS1 reduces 
its derived basis of, and if applicable recognizes gain with respect 
to, each share of stock of F1 on which US1 or US2 receives previously 
taxed earnings and profits through PRS1. The specific adjustments are 
provided in paragraphs (c)(3)(iii)(B)(2) through (5) of this section 
and summarized in table 1 in this paragraph (c)(3)(iii)(B)(1).

  Table 1 to Paragraph (c)(3)(iii)(B)(1) of This Section--Basis Adjustments Resulting From F1's Distribution of
                                                      PTEP
----------------------------------------------------------------------------------------------------------------
 
----------------------------------------------------------------------------------------------------------------
                                       PRS1 derived basis         Adjustments to PRS1 derived basis under Sec.
                                        immediately before the                      1.961-4(c)
                                        covered distribution.
----------------------------------------------------------------------------------------------------------------
PRS1's derived basis with respect to   $3x for each share.....  $6x adjustment for each  $4.5x reduction to
 US1 of its shares of stock of F1.                               share.                   basis (to negative
                                                                                          $1.5x).
                                                                                         $1.5x gain recognized.
PRS1's derived basis with respect to   $2x for each share.....  $4x adjustment for each  $3x reduction to basis
 US2 of its shares of stock of F1.                               share.                   (to negative $1x).
                                                                                         $1x gain recognized.
----------------------------------------------------------------------------------------------------------------

    (2) US1's receipt of previously taxed earnings and profits through 
PRS1. As a result of US1's receipt of previously taxed earnings and 
profits through PRS1, the amount of the adjustment to PRS1's derived 
basis with respect to US1 of each of PRS1's shares of stock of F1 is 
$6x, the dollar basis and associated foreign income taxes of the 
previously taxed earnings and profits that are both with respect to US1 
and received on the share. See Sec.  1.961-4(c)(2)(i). Consequently, 
PRS1 reduces its derived basis with respect to US1 of each of its 
shares of stock of F1 ($3x) to $0 and then reduces such derived basis 
below zero in accordance with the limitation in Sec.  1.961-4(c)(3), 
which permits a $1.5x reduction below zero to the derived basis because 
$1.5x of PRS1's common basis of the share is available with respect to 
US1 (as described in paragraph (c)(3)(iii)(B)(4) of this section). See 
Sec.  1.961-4(c)(2)(ii) and (iii), (c)(3)(i). Further, PRS1 is treated 
as recognizing $1.5x of gain with respect to each of its shares of 
stock of F1 (computed as the excess of the $6x adjustment to basis over 
the sum of the $3x reduction to positive derived basis and the $1.5x 
reduction of derived basis below zero), and this gain is allocated 
solely to US1. See Sec.  1.961-4(c)(2)(iv); see also Sec.  1.961-
4(f)(2) (taking the gain into account in adjusting US1's basis in its 
interest in PRS1 under section 705).
    (3) US2's receipt of previously taxed earnings and profits through 
PRS1. As a result of US2's receipt of previously taxed earnings and 
profits through PRS1, the amount of the adjustment to PRS1's derived 
basis with respect to US2 of each of PRS1's shares of stock of F1 is 
$4x, the dollar basis and associated foreign income taxes of the 
previously taxed earnings and profits that are both with respect to US2 
and received on the share. See Sec.  1.961-4(c)(2)(i). Consequently, 
PRS1 reduces its derived basis with respect to US2 of each of its 
shares of stock of F1 ($2x) to $0 and then reduces such derived basis 
below zero in accordance with the limitation in Sec.  1.961-4(c)(3), 
which permits a $1x reduction below zero to the derived basis because 
$1x of PRS1's common basis of the share is available with respect to 
US2 (as described in paragraph (c)(3)(iii)(B)(4) of this section). See 
Sec.  1.961-4(c)(2)(ii) and (iii) and (c)(3)(i). Further, PRS1 is 
treated as recognizing $1x of gain with respect to each of its shares 
of stock of F1 (computed as the excess of the $4x adjustment to basis 
over the sum of the $2x reduction to positive derived basis and the $1x 
reduction of derived basis below zero), and this gain is allocated 
solely to US2. See Sec.  1.961-4(c)(2)(iv); see also Sec.  1.961-
4(f)(2) (taking the gain into account in adjusting US2's basis in its 
interest in PRS1 under section 705).
    (4) Available common basis. For each of PRS1's shares of stock of 
F1, the amount of common basis of the share that is available with 
respect to each of US1 and US2 is determined by multiplying $2.5x (the 
common basis of the share, reduced by all negative derived basis of the 
share existing immediately before the distribution being analyzed, of 
which there is none) by a fraction. See Sec.  1.961-4(c)(3)(ii). The 
numerator of the fraction is the amount by which PRS1's derived basis 
with respect to the covered shareholder of the share would be reduced 
below zero if derived basis could be reduced without limitation and, 
accordingly, is $3x in the case of the derived basis with respect to 
US1 (computed as the excess of the $6x adjustment to basis over the $3x 
reduction to positive derived basis) and is $2x in the case of derived 
basis with respect to US2 (computed as the excess of the $4x adjustment 
to basis over the $2x reduction to positive derived basis). The 
denominator of the fraction is the sum of the amounts by which any of 
PRS1's derived basis of the share would be reduced below zero if 
derived basis could be reduced without limitation ($5x, computed as the 
$3x with respect to US1 plus the $2x with respect to US2). Therefore, 
for each of PRS1's shares of stock of F1, there is $1.5x of common 
basis available with respect to US1 ($2.5x x $3x/$5x) and $1x of common 
basis available with respect to US2 ($2.5x x $2x/$5x), and this common 
basis permits a $1.5x and $1x reduction below zero to derived basis 
with respect to US1 and US2, respectively (as described in paragraphs 
(c)(3)(iii)(B)(2) and (3) of this section). See also Sec.  1.961-10(b) 
(gain resulting from negative derived basis is allocated to covered 
shareholders in proportion to relative negative derived basis).
    (5) Timing of adjustments. The reductions to derived basis 
described in paragraphs (c)(3)(iii)(B)(2) and (3) of this section are 
treated as made, and the gains described in those paragraphs are 
treated as recognized, concurrently with the covered distribution. See 
Sec.  1.961-4(e)(1) and (f)(1).
    (iv) Alternative facts: previously taxed earnings and profits 
received by a controlled foreign corporation--(A) Facts. The facts are 
the same as in paragraph (c)(3)(i) of this section (Example 3), except 
as follows. US1 and US2, in the aggregate, directly own all the 
outstanding stock of F2 and are United States shareholders of F2. F2 
directly owns all the shares of the single class of outstanding stock 
of F1. Under Sec.  1.959-4, the entirety of each of US1's and US2's 
share of F1's covered distribution is previously taxed earnings and 
profits excluded from F2's gross income for purposes of determining its 
subpart F income and tested income or tested loss. In addition, the sum 
of the dollar basis and associated foreign income taxes of the 
previously taxed

[[Page 95452]]

earnings and profits that are both with respect to US1 and distributed 
on each share of stock of F1 is $6x, and the sum of the dollar basis 
and associated foreign income taxes of the previously taxed earnings 
and profits that are both with respect to US2 and distributed on each 
share of stock of F1 is $4x. Immediately before the covered 
distribution, for each share of stock of F1, F2's adjusted basis is 
[pound]1.25x, its section 961(c) basis with respect to US1 is $3x, and 
its section 961(c) basis with respect to US2 is $2x. On the day of the 
covered distribution, the spot rate is $1:[pound]0.5. This paragraph 
(c)(3)(iv) analyzes adjustments to basis of F2's shares of stock of F1 
(section 961(c) ownership units) under section 961.
    (B) Analysis--(1) In general. Under Sec.  1.961-4(d), F2 reduces 
its section 961(c) basis of, and if applicable recognizes gain with 
respect to, each share of stock of F1 on which it receives previously 
taxed earnings and profits. The specific adjustments are provided in 
paragraphs (c)(3)(iv)(B)(2) through (5) of this section and summarized 
in table 1 in this paragraph (c)(3)(iv)(B)(1).

  Table 1 to Paragraph (c)(3)(iv)(B)(1) of This Section--Basis Adjustments Resulting From F1's Distribution of
                                                      PTEP
----------------------------------------------------------------------------------------------------------------
 
----------------------------------------------------------------------------------------------------------------
                                       F2 section 961(c) basis    Adjustments to F2 section 961(c) basis under
                                       immediately before the.                  Sec.   1.961-4(d)
                                       covered distribution...
----------------------------------------------------------------------------------------------------------------
F2's section 961(c) basis with         $3x for each share.....  $6x adjustment for each  $4.5x reduction to
 respect to US1 of its shares of                                 share.                   basis (to negative
 stock of F1.                                                                             $1.5x).
                                                                                         $1.5x gain recognized.
F2's section 961(c) basis with         $2x for each share.....  $4x adjustment for each  $3x reduction to basis
 respect to US2 of its shares of                                 share.                   (to negative $1x).
 stock of F1.                                                                            $1x gain recognized.
----------------------------------------------------------------------------------------------------------------

    (2) F2's receipt of previously taxed earnings and profits with 
respect to US1. As a result of F2's receipt of previously taxed 
earnings and profits with respect to US1, the amount of the adjustment 
to F2's section 961(c) basis with respect to US1 of each of F2's shares 
of stock of F1 is $6x, the dollar basis and associated foreign income 
taxes of the previously taxed earnings and profits that are both with 
respect to US1 and received on the share. See Sec.  1.961-4(d)(2)(i). 
Consequently, F2 reduces its section 961(c) basis with respect to US1 
of each of its shares of stock of F1 ($3x) to $0 and then reduces such 
section 961(c) basis below zero in accordance with the limitation in 
Sec.  1.961-4(d)(3), which permits a $1.5x reduction below zero to the 
section 961(c) basis because $1.5x of F2's adjusted basis of the share 
is available with respect to US1 (as described in paragraph 
(c)(3)(iv)(B)(4) of this section). See Sec.  1.961-4(d)(2)(ii) and 
(d)(3)(i). Further, F2 is treated as recognizing [pound]0.75x of gain 
with respect to each of its shares of stock of F1 (computed as the 
excess of the $6x adjustment to basis over the sum of the $3x reduction 
to positive section 961(c) basis and the $1.5x reduction of section 
961(c) basis below zero ($1.5x excess), with such excess of $1.5x 
translated into British pounds at $1:[pound]0.5), and this gain is 
assigned solely to US1. See Sec.  1.961-4(d)(2)(iii) and (f)(4). 
Moreover, the gain applies only for purposes of determining amounts 
included in gross income of US1 and US2 (the United States shareholders 
of F2) under Sec.  1.961-11. See Sec.  1.961-4(f)(3).
    (3) F2's receipt of previously taxed earnings and profits with 
respect to US2. As a result of F2's receipt of previously taxed 
earnings and profits with respect to US2, the amount of the adjustment 
to F2's section 961(c) basis with respect to US2 of each of F2's shares 
of stock of F1 is $4x, the dollar basis and associated foreign income 
taxes of the previously taxed earnings and profits that are both with 
respect to US2 and received on the share. See Sec.  1.961-4(d)(2)(i). 
Consequently, F2 reduces its section 961(c) basis with respect to US2 
of each of its shares of stock of F1 ($2x) to $0 and then reduces such 
section 961(c) basis below zero in accordance with the limitation in 
Sec.  1.961-4(d)(3), which permits a $1x reduction below zero to the 
section 961(c) basis because $1x of F2's adjusted basis of the share is 
available with respect to US2 (as described in paragraph 
(c)(3)(iv)(B)(4) of this section). See Sec.  1.961-4(d)(2)(ii) and 
(d)(3)(i). Further, F2 is treated as recognizing [pound]0.5x of gain 
with respect to each of its shares of stock of F1 (computed as the 
excess of the $4x adjustment to basis over the sum of the $2x reduction 
to positive section 961(c) basis and the $1x reduction of section 
961(c) basis below zero ($1x excess), with such excess of $1x 
translated into British pounds at $1:[pound]0.5), and this gain is 
assigned solely to US2. See Sec.  1.961-4(d)(2)(iii) and (f)(4). 
Moreover, the gain applies only for purposes of determining amounts 
included in gross income of US1 and US2 (the United States shareholders 
of F2) under Sec.  1.961-11. See Sec.  1.961-4(f)(3).
    (4) Available adjusted basis. For each of F2's shares of stock of 
F1, the amount of adjusted basis of the share that is available with 
respect to each of US1 and US2 is determined by multiplying $2.5x (the 
[pound]1.25x of adjusted basis of the share translated into U.S. 
dollars at $1:[pound]0.5, reduced by all negative derived basis of the 
share existing immediately before the distribution being analyzed, of 
which there is none) by a fraction. See Sec.  1.961-4(d)(3)(ii). The 
numerator of the fraction is the amount by which F2's section 961(c) 
basis with respect to the covered shareholder of the share would be 
reduced below zero if section 961(c) basis could be reduced without 
limitation and, accordingly, is $3x in the case of the section 961(c) 
basis with respect to US1 (computed as the excess of the $6x adjustment 
to basis over the $3x reduction to positive section 961(c) basis) and 
is $2x in the case of section 961(c) basis with respect to US2 
(computed as the excess of the $4x adjustment to basis over the $2x 
reduction to positive section 961(c) basis). The denominator of the 
fraction is the sum of the amounts by which any of F2's section 961(c) 
basis of the share would be reduced below zero if section 961(c) basis 
could be reduced without limitation ($5x, computed as the $3x with 
respect to US1 plus the $2x with respect to US2). Therefore, for each 
of F2's shares of stock of F1, there is $1.5x of adjusted basis 
available with respect to US1 ($2.5x x $3x/$5x) and $1x of adjusted 
basis available with respect to US2 ($2.5x x $2x/$5x), and this 
adjusted basis permits a $1.5x and $1x reduction below zero to section 
961(c) basis with respect to US1 and US2, respectively (as described in 
paragraphs (c)(3)(iv)(B)(2) and (3) of this section). See also Sec.  
1.961-10(c) (gain resulting from negative section 961(c) basis is 
allocated to

[[Page 95453]]

covered shareholders in proportion to relative negative section 961(c) 
basis).
    (5) Timing of adjustments. The reductions to section 961(c) basis 
described in paragraphs (c)(3)(iv)(B)(2) and (3) of this section are 
treated as made, and the gains described in those paragraphs are 
treated as recognized, concurrently with the covered distribution. See 
Sec.  1.961-4(e)(1) and (f)(1).
    (4) Example 4: Use of positive derived basis--(i) Facts. US1 and a 
nonresident alien individual, in the aggregate, directly own all the 
interests in PRS1. PRS1 directly owns all the shares of the single 
class of outstanding stock of F1 (derivative ownership units). In year 
3, PRS1 sells all the stock of F1 for money equal to the stock's fair 
market value. Section 304 does not apply to the sale. US1's 
distributive share of gain recognized by PRS1 on the sale is $60x, 
determined without regard to derived basis. Immediately before the sale 
(and taking into account any adjustments under Sec.  1.961-5(b) 
resulting from the sale), PRS1's positive derived basis with respect to 
US1 of the shares of stock of F1 is $50x in total. In addition, PRS1 
has no negative derived basis in any of the shares. This example only 
analyzes the application of positive derived basis to US1's 
distributive share of gain on the sale. See also Sec.  1.959-3 
(adjustments to previously taxed earnings and profits accounts); Sec.  
1.959-7 (transfer of previously taxed earnings and profits in general 
successor transactions); Sec.  1.986(c)-1 (foreign currency gain or 
loss recognized in general successor transactions).
    (ii) Analysis. PRS1 is treated as applying its $50x of positive 
derived basis with respect to US1 of the stock of F1 to US1's $60x 
distributive share of gain on the sale. See Sec.  1.961-8(b). As 
result, US1's distributive share of gain on the sale is adjusted by 
$50x, to a $10x distributive share of gain. See also Sec.  1.961-8(c) 
(for purposes of adjusting US1's adjusted basis of its interest in PRS1 
under section 705, US1's distributive share on the sale is $10x of 
gain).
    (iii) Alternative facts: positive derived basis creates a 
distributive share of loss--(A) Facts. The facts are the same as in 
paragraph (c)(4)(i) of this section, except that PRS1's positive 
derived basis with respect to US1 of the shares of stock of F1 is $75x 
in total. In addition, if there were a loss in PRS1's stock of F1, PRS1 
would recognize all such loss in the sale and a current deduction in 
respect of the loss would be allowable.
    (B) Analysis. PRS1 is treated as applying its $75x of positive 
derived basis with respect to US1 of the stock of F1 to US1's $60x 
distributive share of gain on the sale. See Sec.  1.961-8(b). As 
result, US1's distributive share of the gain on the sale is adjusted by 
$75x, to a $15x distributive share of loss. See also Sec.  1.961-8(c) 
(for purposes of adjusting US1's adjusted basis of its interest in PRS1 
under section 705, US1's distributive share on the sale is $15x of 
loss).
    (iv) Alternative facts: tiered partnerships--(A) Facts. The facts 
are the same as in paragraph (c)(4)(i) of this section (Example 4), 
except as follows. US1 and a nonresident alien individual, in the 
aggregate, directly own all the interests in PRS2. PRS2 and a 
nonresident alien individual, in the aggregate, directly own all the 
interests in PRS1. US1's distributive share of gain recognized by PRS1 
on the sale (through its interest in PRS2) is $55x, determined without 
regard to derived basis.
    (B) Analysis. PRS2 is treated as applying PRS1's $50x of positive 
derived basis with respect to US1 of the stock of F1 to US1's $55x 
distributive share of gain on the sale. See Sec.  1.961-8(b). As 
result, US1's distributive share of gain on the sale is adjusted by 
$50x, to a $5x distributive share of gain. See also Sec.  1.961-8(c) 
(for purposes of adjusting US1's adjusted basis of its interest in PRS2 
under section 705, US1's distributive share on the sale is $5x of 
gain); Sec.  1.961-8(d) (for purposes of adjusting PRS2's common basis 
of its interest in PRS1 under section 705, PRS2's distributive share of 
gain is determined without regard to the application of positive 
derived basis; concurrently with the adjustment under section 705, 
reducing PRS2's derived basis with respect to US1 of the interest in 
PRS1 by $50x, the amount of positive derived basis applied to US1's 
distributive share of gain).
    (5) Example 5: Use of positive section 961(c) basis--(i) Facts. US1 
and a nonresident alien individual, in the aggregate, directly own all 
the shares of the single class of outstanding stock of F1. F1 directly 
owns all the shares of the single class of outstanding stock of F2 
(section 961(c) ownership units). In year 3, F1 sells all the stock of 
F2 for money equal to the stock's fair market value. Section 304 does 
not apply to the sale. F1 recognizes [pound]100x of gain on the sale, 
determined without regard to loss recognized on any share and without 
regard to section 961(c) basis. This [pound]100x is covered gain and 
US1 is assigned a [pound]60x portion of the covered gain under Sec.  
1.951-2. Immediately before the sale (and taking into account any 
adjustments under Sec.  1.961-5(b) resulting from the sale), F1's 
positive section 961(c) basis with respect to US1 of the shares of 
stock of F2 is [pound]50x in total (as translated from U.S. dollars 
into British pounds at the spot rate on the day of the sale). In 
addition, F1 has no negative section 961(c) basis in any of the shares. 
Table 1 in this paragraph (c)(5)(i) provides the previously taxed 
earnings and profits of F2 that transfer from US1 in the sale to a 
successor covered shareholder under Sec.  1.959-7 (total of 
[pound]44x), along with the foreign income taxes that are associated 
with such previously taxed earnings and profits (total of [pound]6x, as 
translated from U.S. dollars into British pounds at the spot rate on 
the day of the sale for purposes of Sec.  1.961-9(f)(2)). This example 
only analyzes the extent to which previously taxed earnings and profits 
result from the application of F1's section 961(c) basis and are 
excluded from F1's gross income under section 961(c). See also Sec.  
1.959-3 (adjustments to previously taxed earnings and profits 
accounts); Sec.  1.986(c)-1 (foreign currency gain or loss recognized 
in general successor transactions).

 Table 1 to Paragraph (c)(5)(i) of This Section--F2 PTEP Transferring From US1 & Associated Foreign Income Taxes
----------------------------------------------------------------------------------------------------------------
                                                                      Sec.   904 category
                                             -------------------------------------------------------------------
                                                      General category              Passive        Sec.   951A
                                             ----------------------------------     category         category
                Taxable year                                                   ---------------------------------
                                                    Sec.        Sec.   245A(d)        Sec.
                                                951(a)(1)(A)      PTEP group      951(a)(1)(A)     Sec.   951A
                                                 PTEP group                        PTEP group       PTEP group
----------------------------------------------------------------------------------------------------------------
Year 2:
    Transferred PTEP........................  ...............  ...............  ...............       [pound]10x
    Taxes...................................

[[Page 95454]]

 
Year 1:
    Transferred PTEP........................      [pound]7.2x        [pound]4x      [pound]4.8x              18x
    Taxes...................................             1.8x               1x             1.2x               2x
----------------------------------------------------------------------------------------------------------------

    (ii) Analysis--(A) In general. For purposes of analyzing the 
covered gain, US1's share of the covered gain is [pound]60x because 
that amount of the covered gain is assigned to US1 under Sec.  1.951-2. 
See Sec.  1.961-9(d)(1). All [pound]50x of F1's positive section 961(c) 
basis with respect to US1 of the stock of F2 is applied to such share. 
See Sec.  1.961-9(d)(2) and (e)(1). As a result, [pound]50x of the 
covered gain is previously taxed earnings and profits of F1 with 
respect to US1, characterized as described in paragraph (c)(5)(ii)(B) 
of this section. See Sec.  1.961-9(d)(3) and (f)(1). F1 excludes the 
[pound]50x of previously taxed earnings resulting from section 961(c) 
basis from its gross income, solely for purposes of determining its 
subpart F income and tested income or tested loss. See Sec.  1.961-
9(b).
    (B) Character of previously taxed earnings and profits resulting 
from section 961(c) basis. The mirroring rule in Sec.  1.961-9(f)(2) 
determines the specific character of all [pound]50x of F1's previously 
taxed earnings and profits resulting from section 961(c) basis because 
the amount of such previously taxed earnings and profits does not 
exceed the amount of mirrored PTEP, of which there is [pound]50x. See 
Sec.  1.961-9(f)(2)(i). The mirrored PTEP is the previously taxed 
earnings and profits described in table 1 to paragraph (c)(5)(i) of 
this section, determined by treating foreign income taxes associated 
with transferred previously taxed earnings and profits as additional 
previously taxed earnings and profits ([pound]44x + [pound]6x). See 
Sec.  1.961-9(f)(2)(ii). Under the mirroring rule, the [pound]50x of 
previously taxed earnings and profits resulting from section 961(c) 
basis have the same character as the [pound]50x of mirrored PTEP, as 
summarized in table 1 in this paragraph (c)(5)(ii)(B). See Sec.  1.961-
9(f)(2)(i); see also Sec.  1.961-9(g) and (h) (dollar basis rule and 
rule for allocating previously taxed earnings and profits to specific 
shares of stock).

         Table 1 to Paragraph (c)(5)(ii)(B) of This Section--F1 PTEP Resulting From Sec.   961(C) Basis
----------------------------------------------------------------------------------------------------------------
                                                                Sec.   904 category
                                 -------------------------------------------------------------------------------
                                             General category              Passive category       Sec.   951A
          Taxable year           ------------------------------------------------------------      category
                                                                                             -------------------
                                         Sec.           Sec.   245A(d)           Sec.          Sec.   951A PTEP
                                   951(a)(1)(A) PTEP      PTEP group       951(a)(1)(A) PTEP         group
-----------------------------------------group-----------------------------------group--------------------------
Year 2..........................  ..................  ..................  ..................  [pound]10x
                                                                                               ([pound]10x +
                                                                                               [pound]0).
Year 1..........................  [pound]9x.........  [pound]5x.........  [pound]6x.........  [pound]20x
                                  ([pound]7.2x +      ([pound]4x +        ([pound]4.8x +      ([pound]18x +
                                   [pound]1.8x).       [pound]1x).         [pound]1.2x).       [pound]2x).
----------------------------------------------------------------------------------------------------------------

    (iii) Alternative facts: unused section 961(c) basis--(A) Facts. 
The facts are the same as in paragraph (c)(5)(i) of this section 
(Example 5), except that the amount of F1's covered gain is [pound]70x 
(instead of [pound]100x) and US1 is assigned a [pound]42x (instead of 
[pound]60x) portion of the covered gain under Sec.  1.951-2.
    (B) Analysis. For purposes of analyzing the covered gain, US1's 
share of the covered gain is [pound]42x, and [pound]42x of F1's 
[pound]50x of positive section 961(c) basis with respect to US1 of the 
stock of F2 is applied to such share. See Sec.  1.961-9(d)(1) and (2), 
(e)(1). As a result, [pound]42x of the covered gain is previously taxed 
earnings and profits of F1 with respect to US1, with the same character 
as a pro rata portion of the previously taxed earnings and profits set 
forth in table 1 to paragraph (c)(5)(ii)(B) of this section, determined 
by multiplying all such previously taxed earnings and profits by 84% 
(computed as $42x of previously taxed earnings and profits resulting 
from section 961(c) basis divided by [pound]50x of mirrored PTEP). See 
Sec.  1.961-9(d)(3), (f)(1) and (2). Moreover, the [pound]8x of F1's 
positive section 961(c) basis that is not applied to the covered gain 
is taken into account only for purposes of determining amounts included 
in gross income of United States shareholders of F1 under Sec.  1.961-
11.
    (6) Example 6: Gain recognition for negative derived basis--(i) 
Facts. US1 and US2, in the aggregate, directly own all the interests in 
PRS1. PRS1 directly owns all the shares of the single class of stock of 
F1 (derivative ownership units). In year 3, PRS1 sells all the stock of 
F1 for money equal to the stock's fair market value. Section 304 does 
not apply to the sale, and the shares of stock of F1 remain derivative 
ownership units immediately after the sale (because the buyer is a 
partnership the interests in which are owned by one or more covered 
shareholders). PRS1 recognizes $2x of loss with respect to each share 
of stock of F1, determined without regard to derived basis and 
allocated to US1 and US2 in accordance with section 704. Immediately 
before the sale (and taking into account any adjustments under Sec.  
1.961-5(b) resulting from the sale), for each share of stock of F1, 
PRS1's derived basis with respect to US1 is negative $1.5x and its 
derived basis with respect to US2 is negative $1x. This example only 
analyzes the consequences of negative derived basis in the sale. See 
also Sec.  1.959-3 (adjustments to previously taxed earnings and 
profits accounts); Sec.  1.959-7 (transfer of previously taxed earnings 
and profits in general successor transactions); Sec.  1.986(c)-1 
(foreign currency gain or loss recognized in general successor 
transactions).
    (ii) Analysis. As a result of negative derived basis, PRS1 is 
treated as recognizing gain with respect to each share of stock of F1. 
See Sec.  1.961-

[[Page 95455]]

10(b)(1). For each share of stock of F1, the amount of such gain is 
$2.5x, which is the lesser amount of loss ($2x, expressed as a positive 
amount), plus the additional amount of gain ($0.5x), that PRS1 would 
have recognized with respect to the share if PRS1's common basis of the 
share were reduced by $2.5x (the sum of all PRS1's negative derived 
basis of the share), and thus all negative derived basis gives rise to 
gain. See Sec.  1.961-10(b)(2)(i); compare paragraph (c)(6)(iii) of 
this section (scenario where less than all negative derived basis gives 
rise to gain). A pro rata portion of the $2.5x of gain treated as 
recognized with respect to each share of stock of F1 is allocated to 
US1 and US2 by multiplying the amount of such gain by a fraction, the 
numerator of which is PRS1's negative derived basis with respect to the 
covered shareholder of the share ($1.5x in the case of US1, and $1x in 
the case of US2), and the denominator of which is the sum of all PRS1's 
negative derived basis of the share ($2.5x). See Sec.  1.961-10(b)(3). 
Thus, in addition to the allocation in accordance with section 704 of 
the $2x of loss that PRS1 recognizes with respect to each share of 
stock of F1, US1 is allocated $1.5x, and US2 is allocated $1x, of the 
$2.5x of gain treated as recognized by PRS1 with respect to each share 
of stock of F1. See Sec.  1.961-10(b)(4); see also Sec.  1.961-4(f)(2) 
(gain allocated to US1 or US2 is taken into account in adjusting US1's 
or US2's basis in its interest in PRS1 under section 705).
    (iii) Alternative facts: section 301(c)(2) distribution--(A) Facts. 
The facts are the same as in paragraph (c)(6)(i) of this section 
(Example 6), except as follows. PRS1 does not sell any stock of F1. In 
year 3, F1 makes a distribution that is $10x with respect to each share 
of its stock. None of the distribution is a covered distribution 
because F1 has no accumulated or current year earnings and profits in 
year 3. Immediately before the distribution, for each share of stock of 
F1, PRS1's common basis is $12x, its derived basis with respect to US1 
is negative $1.5x, and its derived basis with respect to US2 is 
negative $1x. Thus, section 301(c)(2) applies to the entirety of the 
$10x that is distributed with respect to each share of stock of F1. 
This example only analyzes the consequences of negative derived basis 
in the distribution.
    (B) Analysis. PRS1 determines the amount of gain it is treated as 
recognizing as a result of negative derived basis by calculating the 
additional amount of gain that it would have recognized with respect to 
each share of stock of F1 under section 301(c)(3) if its common basis 
of the share were reduced by $2.5x (the sum of all PRS1's negative 
derived basis of the share). See Sec.  1.961-10(b)(2)(i). Specifically, 
if PRS1's common basis of each share were reduced by $2.5x, the common 
basis would be $9.5x ($12x - $2.5x), such that the distribution of $10x 
on the share would result in $9.5x being treated as a return of basis 
under section 301(c)(2) and $0.5x being treated as gain recognized 
under section 301(c)(3). Thus, PRS1 is treated as recognizing $0.5x of 
gain with respect to each share as a result of the $2.5x of negative 
derived basis of the share, and PRS1 retains the remaining $2x of 
negative derived basis of the share (which, under these facts, is equal 
to the portion of the common basis of the share that is not reduced by 
the distribution under section 301(c)(2) ($12x - $10x, or $2x)). A pro 
rata portion of the $0.5x of gain treated as recognized with respect to 
each share of stock of F1 is allocated to US1 and US2 by multiplying 
the amount of such gain by a fraction, the numerator of which is PRS1's 
negative derived basis with respect to the covered shareholder of the 
share ($1.5x in the case of US1, and $1x in the case of US2), and the 
denominator of which is the sum of all PRS1's negative derived basis of 
the share ($2.5x). See Sec.  1.961-10(b)(3). Thus, US1 is allocated 
$0.3x, and US2 is allocated $0.2x, of the $0.5x of gain treated as 
recognized by PRS1 with respect to each share of stock of F1. See Sec.  
1.961-10(b)(4); see also Sec.  1.961-4(f)(2) (gain allocated to US1 or 
US2 is taken into account in adjusting US1's or US2's basis in its 
interest in PRS1 under section 705). Immediately after the 
distribution, for each share of stock of F1, PRS1's derived basis with 
respect to US1 is negative $1.2x (negative $1.5x + $0.3x) and its 
derived basis with respect to US2 is negative $0.8x (negative $1x + 
$0.2x). See Sec.  1.961-10(b)(5).
    (7) Example 7: Gain recognition for negative section 961(c) basis--
(i) Facts. US1 and US2, in the aggregate, directly own all the shares 
of the single class of stock of F1 and are United States shareholders 
of F1. F1 directly owns all the shares of the single class of stock of 
F2 (section 961(c) ownership units). In year 3, F1 sells all the stock 
of F2 for money equal to the stock's fair market value. Section 304 
does not apply to the sale, and the shares of stock of F2 remain 
section 961(c) ownership units immediately after the sale (because the 
buyer is a controlled foreign corporation). F1 recognizes [pound]2x of 
loss with respect to each share of stock of F2, determined without 
regard to section 961(c) basis. Immediately before the sale (and taking 
into account any adjustments under Sec.  1.961-5(b) resulting from the 
sale), for each share of stock of F2, F1's section 961(c) basis with 
respect to US1 is negative [pound]1.5x and its section 961(c) basis 
with respect to US2 is negative [pound]1x (as translated from U.S. 
dollars into British pounds at the spot rate on the day of the sale). 
This example only analyzes the consequences of negative section 961(c) 
basis in the sale. See also Sec.  1.959-3 (adjustments to previously 
taxed earnings and profits accounts); Sec.  1.959-7 (transfer of 
previously taxed earnings and profits in general successor 
transactions); Sec.  1.986(c)-1 (foreign currency gain or loss 
recognized in general successor transactions).
    (ii) Analysis. As a result of negative section 961(c) basis, F1 is 
treated as recognizing gain with respect to each share of stock of F2. 
See Sec.  1.961-10(c)(1). For each share of stock of F2, the amount of 
such gain is [pound]2.5x, which is the lesser amount of loss 
([pound]2x, expressed as a positive amount), plus the additional amount 
of gain ([pound]0.5x), that F1 would have recognized with respect to 
the share if F1's adjusted basis of the share were reduced by 
[pound]2.5x (the sum of all F1's negative section 961(c) basis of the 
share), and thus all negative section 961(c) basis gives rise to gain. 
See Sec.  1.961-10(c)(2)(i); compare paragraph (c)(7)(iii) of this 
section (scenario where less than all negative section 961(c) basis 
gives rise to gain). A pro rata portion of the [pound]2.5x of gain 
treated as recognized with respect to each share of stock of F2 is 
assigned to US1 and US2 by multiplying the amount of such gain by a 
fraction, the numerator of which is F1's negative section 961(c) basis 
with respect to the covered shareholder of the share ([pound]1.5x in 
the case of US1, and [pound]1x in the case of US2), and the denominator 
of which is the sum of all F1's negative section 961(c) basis of the 
share ([pound]2.5x). See Sec.  1.961-10(c)(3). Thus, US1 is assigned 
[pound]1.5x, and US2 is assigned [pound]1x, of the [pound]2.5x of gain 
treated as recognized by F1 with respect to each share of stock of F2. 
Moreover, the gain applies only for purposes of determining amounts 
included in gross income of US1 and US2 (the United States shareholders 
of F1) under Sec.  1.961-11. See Sec.  1.961-10(c)(4); see also 
Sec. Sec.  1.961-4(f)(3) (the gain does not affect F1's items of gross 
income for purposes of section 952 or 951A or its earnings and 
profits).
    (iii) Alternative facts: section 351 exchange with boot--(A) Facts. 
The facts are the same as in paragraph (c)(7)(i) of this section 
(Example 7), except as follows. Instead of the sale, F1

[[Page 95456]]

contributes property, including all its stock of F2, to F3, a 
controlled foreign corporation, in exchange for stock of F3 and money 
equal, in the aggregate, to the fair market value of the contributed 
property. Other unrelated persons also contribute property to F3 in 
exchange for stock of F3 as part of the same transaction. Section 
351(b) applies to F1's exchange, but sections 304 and 362(e) do not, 
and no income inclusions are required under Sec.  1.367(b)-4. The 
shares of stock of F2 remain section 961(c) ownership units immediately 
after the contribution (because F3 is a controlled foreign 
corporation). In the exchange, for each share of stock of F2, F1 
receives stock of F3 and [pound]10x of money but recognizes no gain 
because F1's adjusted basis of the share is [pound]2x greater than the 
fair market value of the share. Immediately before the exchange (and 
taking into account any adjustments under Sec.  1.961-5(b) resulting 
from the exchange), for each share of stock of F2, F1's section 961(c) 
basis with respect to US1 is negative [pound]1.5x and its section 
961(c) basis with respect to US2 is negative [pound]1x (as translated 
from U.S. dollars into British pounds at the spot rate on the day of 
the exchange). This example only analyzes the consequences of negative 
section 961(c) basis in the exchange.
    (B) Analysis. F1 determines the amount of gain it is treated as 
recognizing as a result of negative section 961(c) basis by calculating 
the additional amount of gain that it would have recognized with 
respect to each share of stock of F2 under section 351(b) if its 
adjusted basis of the share were reduced by [pound]2.5x (the sum of all 
F1's negative section 961(c) basis of the share). See Sec.  1.961-
10(c)(2)(i). Specifically, a [pound]2.5x reduction to F1's adjusted 
basis of each share would convert a [pound]2x loss on the share into a 
[pound]0.5x gain, which would then be recognized pursuant to section 
351(b) in the exchange. Thus, F1 is treated as recognizing [pound]0.5x 
of gain with respect to each share as a result of the [pound]2.5x of 
negative section 961(c) basis of the share, and the remaining [pound]2x 
of negative section 961(c) basis of the share is retained (which, under 
these facts, is equal to the loss in the share that is not recognized 
in the exchange ([pound]2x, the excess of the adjusted basis of the 
share over the fair market value of the share)). A pro rata portion of 
the [pound]0.5x of gain treated as recognized with respect to each 
share of stock of F2 is assigned to US1 and US2 by multiplying the 
amount of such gain by a fraction, the numerator of which is F1's 
negative section 961(c) basis with respect to the covered shareholder 
of the share ([pound]1.5x in the case of US1, and [pound]1x in the case 
of US2), and the denominator of which is the sum of all F1's negative 
section 961(c) basis of the share ([pound]2.5x). See Sec.  1.961-
10(c)(3). Thus, US1 is assigned [pound]0.3x, and US2 is assigned 
[pound]0.2x, of the [pound]0.5x of gain treated as recognized by F1 
with respect to each share of stock of F2. Moreover, the gain applies 
only for purposes of determining amounts included in gross income of 
US1 and US2 (the United States shareholders of F1) under Sec.  1.961-
11. See Sec.  1.961-10(c)(4); see also Sec. Sec.  1.961-4(f)(3) (the 
gain does not affect F1's items of gross income for purposes of section 
952 or 951A or its earnings and profits). Immediately after the 
exchange, for each share of stock of F2, the functional currency amount 
of F3's section 961(c) basis with respect to US1 is negative 
[pound]1.2x (negative [pound]1.5x + [pound]0.3x) and its section 961(c) 
basis with respect to US2 is negative [pound]0.8x (negative [pound]1x + 
[pound]0.2x). See Sec.  1.961-10(c)(5).
    (8) Example 8: Amounts included in gross income of United States 
shareholders--(i) Facts. US1 and US2, in the aggregate, directly own 
all the shares of the single class of stock of F1 and are United States 
shareholders of F1. F1 directly owns all the shares of the single class 
of stock of each of F2 and F3 (section 961(c) ownership units). For 
F1's taxable year ending on December 31 of year 3, F1 recognizes 
[pound]50x of section 961(c) income. The section 961(c) income consists 
of [pound]10x of gain recognized as a result of F1's receipt of 
previously taxed earnings and profits from F2 and [pound]40x of gain 
recognized as a result of F1's sale of stock of F3 with negative 
section 961(c) basis. US1 and US2 are assigned equal portions of the 
[pound]10x gain under Sec.  1.961-4(d) (basis reductions and gain 
recognition for distributions) and US2 is assigned all the [pound]40x 
gain under Sec.  1.961-10(c) (gain recognition for negative basis). F1 
has no positive section 961(c) basis in any of the sold shares of stock 
of F3. This example only analyzes the allocation of F1's section 961(c) 
income and resulting inclusions in gross income of United States 
shareholders under section 961(c).
    (ii) Analysis. Under Sec.  1.961-11, F1's [pound]50x of section 
961(c) income is allocated to each of US1 and US2 by adding up the 
amounts of the section 961(c) income that are assigned to each United 
States shareholder. See Sec.  1.961-11(c). No additional computations 
are required because F1 does not recognize any loss under section 
961(c) and there are no transfers of stock of F1. See id. Thus, US1 is 
allocated [pound]5x ([pound]5x of gain with respect to stock of F2 plus 
[pound]0 of gain with respect to stock of F3), and US2 is allocated 
[pound]45x ([pound]5x of gain with respect to stock of F2 plus 
[pound]40x of gain with respect to stock of F3), of the section 961(c) 
income. Accordingly, US1 includes [pound]5x in its gross income and US2 
includes [pound]45x in its gross income, in each case for the United 
States shareholder's (US1's or US2's) taxable year ending on December 
31 of year 3 and translated into U.S. dollars in accordance with 
section 989(b). See Sec.  1.961-11(b). Under Sec.  1.961-3, each of 
US1's and US2's income inclusion increases its adjusted basis of its 
stock of F1 by the U.S. dollar amount of the inclusion.
    (iii) Alternative facts: loss under section 961(c)--(A) Facts. The 
facts are the same as in paragraph (c)(8)(i) of this section (Example 
8), except as follows. F1 is treated as recognizing [pound]7x of loss 
under section 961(c) with respect to US2 because F1 has positive 
section 961(c) basis with respect to US2 in some of the sold shares of 
stock of F3 and, under Sec.  1.961-9, all but [pound]7x of such 
positive section 961(c) basis is applied to US2's share of covered gain 
recognized by F1 on the sale of stock of F3.
    (B) Analysis. Under Sec.  1.961-11, F1's [pound]50x of section 
961(c) income is allocated to each of US1 and US2 by first adding up 
the amounts of the section 961(c) income that are assigned to the 
United States shareholder ([pound]5x in the case of US1, and [pound]45x 
in the case of US2) and then reducing (but not below zero) such sum by 
the amount of loss F1 is treated as recognizing under section 961(c) 
with respect to the United States shareholder ([pound]0 in the case of 
US1, and [pound]7x in the case of US2). See Sec.  1.961-11(c). Thus, 
US1 is allocated [pound]5x ([pound]5x - [pound]0), and US2 is allocated 
[pound]38x ([pound]45x - [pound]7x), of the section 961(c) income. 
Accordingly, US1 includes [pound]5x in its gross income and US2 
includes [pound]38x in its gross income, in each case for the United 
States shareholder's (US1's or US2's) taxable year ending on December 
31 of year 3 and translated into U.S. dollars in accordance with 
section 989(b). See Sec.  1.961-11(b). Under Sec.  1.961-3, each of 
US1's and US2's income inclusion increases its adjusted basis of its 
stock of F1 by the U.S. dollar amount of the inclusion.


Sec.  1.961-13  Transition rules.

    (a) Scope. This section sets forth transition rules for the section 
961 regulations. Paragraph (b) of this section addresses the 
establishment of derived basis of a partnership and section 961(c) 
basis of a controlled foreign corporation. Paragraph (c) of this 
section treats a domestic partnership (including an S

[[Page 95457]]

corporation) as a covered shareholder for periods in which Sec.  1.958-
1(d)(1) does not apply. Paragraph (d) of this section converts basis 
with respect to a domestic partnership (including an S corporation) to 
basis with respect to covered shareholders owning interests in the 
domestic partnership when both Sec.  1.958-1(d)(1) and the section 961 
regulations first apply.
    (b) Establishing derived basis of a partnership and section 961(c) 
basis of a controlled foreign corporation--(1) In general. As of the 
beginning of the first taxable year of a foreign corporation to which 
the section 961 regulations (other than Sec. Sec.  1.961-6 and 1.961-7) 
apply pursuant to Sec.  1.961-14(b), a partnership's derived basis of 
derivative ownership units, and a controlled foreign corporation's 
section 961(c) basis of section 961(c) ownership units, that are shares 
of stock of the foreign corporation or property through one or more 
covered shareholders own stock of the foreign corporation must be 
established in accordance with the rules described in paragraphs (b)(2) 
through (5) of this section.
    (2) Derived basis--(i) In general. The partnership's derived basis 
of each derivative ownership unit is established by increasing derived 
basis with respect to each covered shareholder by the U.S. dollar 
amount of derived basis with respect to the covered shareholder that 
would exist at the beginning of the taxable year (and therefore would 
not have been decreased in a distribution or general successor 
transaction, for example) if the principles of Sec. Sec.  1.961-2 
through 1.961-5, 1.961-8, and 1.961-10 were to have previously applied, 
determined using a reasonable method (consistently applied to each 
foreign corporation whose stock is owned by the partnership and with 
respect to each covered shareholder that owns an interest in the 
partnership). In the case of a domestic partnership, the increase 
described in the preceding sentence is determined without regard to an 
income inclusion of the domestic partnership or any lower-tier domestic 
partnership (for example, an income inclusion of the domestic 
partnership under section 951(a)(1)(A) that occurs in a period before 
Sec.  1.958-1(d) applies to the domestic partnership).
    (3) Section 961(c) basis. The controlled foreign corporation's 
section 961(c) basis of each section 961(c) ownership unit is 
established by increasing section 961(c) basis with respect to each 
covered shareholder by the U.S. dollar amount of section 961(c) basis 
with respect to the covered shareholder that would exist at the 
beginning of the taxable year (and therefore would not have been 
decreased in a distribution or general successor transaction, for 
example) if the principles of Sec. Sec.  1.961-2 through 1.961-5, 
1.961-9, 1.961-10, and 1.961-11 were to have previously applied, 
determined using a reasonable method (consistently applied to each 
foreign corporation whose stock is owned by the controlled foreign 
corporation and with respect to each covered shareholder that owns 
stock in the controlled foreign corporation).
    (4) Treatment of a specified foreign corporation as a controlled 
foreign corporation. A specified foreign corporation (as defined in 
Sec.  1.965-1(f)(45)(i)(B)) that is not otherwise a controlled foreign 
corporation is treated as a controlled foreign corporation for purposes 
of the application of the principles of Sec.  1.961-3 to an income 
inclusion under section 951(a)(1)(A) by reason of section 965(a).
    (5) Anti-duplication rule. Derived basis or section 961(c) basis is 
increased under this paragraph (b) to reflect an income inclusion under 
section 951(a)(1)(A) or 951A(a) only to the extent such an increase 
would not duplicate basis (including basis previously used) at the 
level of the partnership or the controlled foreign corporation, as 
applicable, to reflect the income inclusion (for example, in the case 
of a foreign partnership, basis previously provided under Sec.  1.965-
2(h)(5)(ii)).
    (c) Treatment of domestic partnerships (including S corporations) 
before application of Sec.  1.958-1(d)(1). For purposes of the section 
961 regulations, a domestic partnership (including an S corporation) is 
treated as a covered shareholder for any taxable year of the domestic 
partnership to which Sec.  1.958-1(d)(1) does not apply. If a domestic 
partnership is treated as a covered shareholder, then rules regarding 
derived basis (of a partnership that is owned by the domestic 
partnership) or section 961(c) basis (of a controlled foreign 
corporation that is owned by the domestic partnership) apply to the 
domestic partnership in its capacity as a covered shareholder before 
those rules apply to a covered shareholder that owns interests in the 
domestic partnership. In such a case, for example, covered gain 
recognized by a controlled foreign corporation and assigned to the 
domestic partnership is first previously taxed earnings and profits by 
reason of the controlled foreign corporation's positive section 961(c) 
basis with respect to the domestic partnership and then, to the extent 
remaining, previously taxed earnings and profits by reason of positive 
section 961(c) basis with respect to covered shareholders owning 
interests in the domestic partnership.
    (d) Converting basis with respect to domestic partnerships 
(including S corporations) to basis with respect to partners (or 
shareholders) after the application of Sec.  1.958-1(d)(1)--(1) In 
general. As of the beginning of the first taxable year of a domestic 
partnership (including an S corporation) to which both Sec.  1.958-
1(d)(1) and the section 961 regulations (other than Sec. Sec.  1.961-6 
and 1.961-7) apply (pursuant to Sec.  1.961-14(b)), the rules described 
in paragraphs (d)(2) through (4) of this section apply to convert--
    (i) A lower-tier partnership's derived basis with respect to the 
domestic partnership of derivative ownership units (if such derived 
basis was earlier established pursuant to paragraphs (b)(2) and (c) of 
this section) to derived basis with respect to covered shareholders 
owning interests in the domestic partnership; and
    (ii) A controlled foreign corporation's section 961(c) basis with 
respect to the domestic partnership of section 961(c) ownership units 
(if such section 961(c) basis was earlier established pursuant to 
paragraphs (b)(3) and (c) of this section) to section 961(c) basis with 
respect to covered shareholders owning interests in the domestic 
partnership.
    (2) Rules for converting derived basis with respect to a domestic 
partnership--(i) Allocate derived basis to each covered shareholder. 
First, allocate a pro rata portion of the lower-tier partnership's 
derived basis with respect to the domestic partnership of each 
derivative ownership unit to each covered shareholder owning an 
interest in the domestic partnership at the beginning of the taxable 
year, determined by multiplying the derived basis with respect to the 
domestic partnership by the fraction described in Sec.  1.959-
11(e)(2)(i)(A) for the covered shareholder and the domestic 
partnership.
    (ii) Transfer derived basis. Second, transfer to each covered 
shareholder the portion of the lower-tier partnership's derived basis 
with respect to the domestic partnership of each derivative ownership 
unit that is allocated to the covered shareholder under paragraph 
(d)(2)(i) of this section.
    (3) Rules for converting section 961(c) basis with respect to a 
domestic partnership--(i) Allocate section 961(c) basis to each covered 
shareholder. First, allocate a pro rata portion of the controlled 
foreign corporation's section 961(c) basis with respect to the domestic 
partnership of each section 961(c) ownership unit to each covered

[[Page 95458]]

shareholder owning an interest in the domestic partnership at the 
beginning of the taxable year, determined by multiplying the section 
961(c) basis with respect to the domestic partnership by the fraction 
described in Sec.  1.959-11(e)(2)(i)(A) for the covered shareholder and 
the domestic partnership.
    (ii) Transfer section 961(c) basis. Second, transfer to each 
covered shareholder the portion of the controlled foreign corporation's 
section 961(c) basis with respect to the domestic partnership of each 
section 961(c) ownership unit that is allocated to the covered 
shareholder under paragraph (d)(3)(i) of this section.
    (4) Coordination with deemed covered shareholder rules. The 
portion, if any, of the lower-tier partnership's derived basis with 
respect to the domestic partnership, or the controlled foreign 
corporation's section 961(c) basis with respect to the domestic 
partnership, that does not increase derived basis or section 961(c) 
basis with respect to a covered shareholder becomes with respect to the 
deemed covered shareholder for purposes of subsequently transferring 
the basis under Sec.  1.961-5(c).


Sec.  1.961-14  Applicability dates.

    (a) Scope. This section sets forth applicability dates for the 
section 961 regulations. Paragraph (b) of this section provides the 
applicability dates.
    (b) Applicability dates. Sections 1.961-1 through 1.961-5 and 
1.961-8 through 1.961-13 apply to taxable years of foreign corporations 
that begin on or after [date of publication of final regulations in the 
Federal Register] or are early application years (as described in Sec.  
1.959-12(d)) and to taxable years of persons for which such taxable 
years of those foreign corporations are relevant.
0
Par. 29. Section 1.962-1 is amended by:
0
1. Removing the last sentence in paragraph (a)(3); and
0
2. Adding paragraph (a)(4).
    The addition reads as follows:


Sec.  1.962-1  Limitation of tax for individuals on amounts included in 
gross income under section 951(a).

    (a) * * *
    (4) See section 959 and the regulations in this part issued under 
section 959 for rules regarding previously taxed earnings and profits, 
including previously taxed earnings and profits assigned to the taxable 
section 962 PTEP subgroup (as defined in Sec.  1.959-2(b)(2)(ii)(A)).
* * * * *


Sec.  1.962-3  [Removed].

0
Par. 30. Section 1.962-3 is removed.
0
Par. 31. Section 1.965-5 is amended by:
0
1. In the introductory text of paragraph (d)(1), removing the language 
``and (d)(3)'' and adding the language ``through (d)(5)'' in its place; 
and
0
2. Adding paragraph (d)(5).
    The addition reads as follows:


Sec.  1.965-5  Allowance of credit or deduction for foreign income 
taxes.

* * * * *
    (d) * * *
    (5) Adjusted applicable percentage for certain taxable years. For 
taxable years to which Sec. Sec.  1.959-1 through 1.959-7 and 1.959-10 
and 1.959-11 apply (see Sec.  1.959-12), the term applicable percentage 
means ``adjusted applicable percentage'' as defined in Sec.  1.959-
2(b)(2)(iii)(A), except for purposes of Sec.  1.959-11(c)(3) (initial 
determination of the adjusted applicable percentage).
0
Par. 32. Section 1.965-9 is amended by adding paragraph (d) to read as 
follows:


Sec.  1.965-9  Applicability Dates.

* * * * *
    (d) Applicability date for adjusted applicable percentage. Section 
1.965-5(d)(5) applies to taxable years of foreign corporations that 
begin on or after [date of publication of final regulations in the 
Federal Register] or are early application years (as described in Sec.  
1.959-12(d)) and to taxable years of persons for which such taxable 
years of those foreign corporations are relevant.


Sec.  1.985-5  [Amended].

0
Par. 33. Section 1.985-5 is amended by removing the language 
``(e)(2),'' from the last sentence in paragraph (a) and removing and 
reserving paragraph (e)(2).


Sec.  1.986(a)-1  [Amended].

0
Par. 34. Section 1.986(a)-1 is amended by:
0
1. In paragraph (c), removing the language ``PTEP group taxes (as 
defined in Sec.  1.960-3(d)(1))'' from the first sentence and adding 
the language ``the corporate PTEP tax pool (as defined in Sec.  1.959-
1(b)) or any covered shareholder's PTEP tax pool (as defined in Sec.  
1.959-1(b))'' in its place.
0
2. In paragraph (e)(1) removing the language ``PTEP group taxes'' and 
adding the language ``a PTEP tax pool'' in its place.
0
3. In paragraph (e)(2) removing the language ``PTEP group taxes (as 
defined in Sec.  1.960-3(d)(1))'' in the first sentence and adding the 
language ``the corporate PTEP tax pool (as defined in Sec.  1.959-1(b)) 
or any covered shareholder's PTEP tax pool (as defined in Sec.  1.959-
1(b))'' in its place, and removing the language ``PTEP group taxes'' in 
the second sentence and adding the language ``a PTEP tax pool'' in its 
place.
0
4. In paragraph (e)(3) removing the language ``PTEP group taxes'' in 
the last sentence and adding the language ``a PTEP tax pool'' in its 
place.
0
Par. 35. Section 1.986(c)-1 is revised to read as follows:


Sec.  1.986(c)-1  Foreign currency gain or loss with respect to 
previously taxed earnings and profits.

    (a) Scope. This section provides rules for the recognition of 
foreign currency gain or loss with respect to previously taxed earnings 
and profits (as described in section 959) under section 986(c). 
Paragraph (b) of this section provides rules for distributions of 
previously taxed earnings and profits to a covered shareholder and 
certain transactions that transfer or eliminate previously taxed 
earnings and profits. Paragraph (c) of this section provides a rule for 
distributions of previously taxed earnings and profits to a foreign 
corporation. Paragraph (d) of this section provides definitions. 
Paragraph (e) of this section provides the applicability date of this 
section. See Sec.  1.961-5 for related basis adjustments in certain 
cases and Sec.  1.959-10(c)(2) (Example 2) for an example illustrating 
the application of this section. See also Sec.  1.367(b)-2(j)(2) for 
the interaction of certain nonrecognition transactions and section 
986(c).
    (b) Recognition of foreign currency gain or loss--(1) In general. 
If, in any transaction, previously taxed earnings and profits with 
respect to a covered shareholder are distributed to the covered 
shareholder or cease to be with respect to the covered shareholder (for 
example, because the previously taxed earnings and profits transfer 
from the covered shareholder in a general successor transaction or are 
eliminated by reason of an election under section 338(g)), then the 
covered shareholder recognizes foreign currency gain or loss with 
respect to such previously taxed earnings and profits in accordance 
with the rules described in paragraphs (b)(2) through (4) of this 
section, subject to the exception in paragraph (b)(5) of this section 
for transfers of previously taxed earnings and profits other than in a 
general successor transaction.
    (2) Determining foreign currency gain or loss. Foreign currency 
gain or loss is determined by comparing the U.S. dollar amount of the 
previously taxed earnings and profits described in paragraph (b)(1) of 
this section on the day on which the transaction occurs to

[[Page 95459]]

the dollar basis of the previously taxed earnings and profits. If the 
U.S. dollar amount exceeds the dollar basis, the excess is foreign 
currency gain. If the dollar basis exceeds the U.S. dollar amount, the 
excess is foreign currency loss. If applicable, the U.S. dollar amount 
is determined by translating the previously taxed earnings and profits 
into U.S. dollars at the spot rate on the day on which the transaction 
occurs. See Sec. Sec.  1.959-4 and 1.959-7 for determining dollar basis 
in distributions and general successor transactions, respectively.
    (3) Limitations--(i) Section 965(a) previously taxed earnings and 
profits. In the case of previously taxed earnings and profits that are 
described in paragraph (b)(1) of this section and relate to the 
reclassified section 965(a) PTEP group or section 965(a) PTEP group, 
only a portion of foreign currency gain or loss with respect to the 
previously taxed earnings and profits is recognized, determined by 
multiplying the amount of the foreign currency gain or loss by the 
excess of 100 percent over the section 965(c) deduction percentage with 
respect to the previously taxed earnings and profits.
    (ii) Section 965(b) previously taxed earnings and profits. No 
foreign currency gain or loss is recognized with respect to previously 
taxed earnings and profits that are described in paragraph (b)(1) of 
this section and relate to the reclassified section 965(b) PTEP group 
or section 965(b) PTEP group.
    (iii) Taxable section 962 earnings and profits. No foreign currency 
gain or loss is recognized with respect to previously taxed earnings 
and profits that are described in paragraph (b)(1) of this section and 
relate to the taxable section 962 PTEP subgroup.
    (4) Treatment of foreign currency gain or loss. Foreign currency 
gain or loss described in paragraph (b)(1) of this section is 
recognized concurrently with the transaction and is treated as ordinary 
income or loss from the same source, and relating to the same section 
904 category, as the income inclusion to which the previously taxed 
earnings and profits are attributable.
    (5) Exception for transfer of previously taxed earnings and profits 
other than in a general successor transaction. Except as provided in 
Sec.  1.367(b)-2(j)(2)(i), no foreign currency gain or loss is 
recognized with respect to previously taxed earnings and profits when 
the previously taxed earnings and profits transfer to another covered 
shareholder in a transaction other than a general successor 
transaction.
    (c) Distributions of previously taxed earnings and profits to a 
foreign corporation. No foreign currency gain or loss is recognized 
with respect to previously taxed earnings and profits when the 
previously taxed earnings and profits are distributed to a foreign 
corporation.
    (d) Definitions. The definitions in Sec.  1.959-1(b) apply for 
purposes of this section.
    (e) Applicability date. This section applies to taxable years of 
foreign corporations that begin on or after [date of publication of 
final regulations in the Federal Register] or are early application 
years (as described in Sec.  1.959-12(d)) and to taxable years of 
persons for which such taxable years of those foreign corporations are 
relevant. See Sec.  1.986(c)-1 as contained in 26 CFR part 1 revised as 
of April 1, 2024, for a version of this section applicable to prior 
taxable years.
0
Par. 36. Section 1.1411-10 is amended by adding a sentence at the end 
of paragraph (c)(1)(i)(A)(1) to read as follows:


Sec.  1.1411-10  Controlled foreign corporations and passive foreign 
investment companies.

* * * * *
    (c) * * *
    (1) * * *
    (i) * * *
    (A) * * *
    (1) * * * See section 959 and the regulations in this part issued 
under section 959 for rules regarding previously taxed earnings and 
profits, including previously taxed earnings and profits assigned to 
the taxable section 1411 PTEP subgroup (as defined in Sec.  1.959-
2(b)(2)(ii)(A)).
* * * * *
0
Par. 37. Section 1.1502-59 is added to read as follows:


Sec.  1.1502-59  Previously taxed earnings and profits and related 
basis adjustments.

    (a) Overview and scope. This section addresses the consequences to 
consolidated groups of previously taxed earnings and profits of foreign 
corporations, including under section 959 (regarding exclusions from 
gross income of distributions of previously taxed earnings and profits 
of foreign corporations) and section 961 (regarding basis adjustments 
to the stock of foreign corporations and other property). Paragraph (b) 
of this section provides definitions. Paragraph (c) of this section 
provides rules to treat a consolidated group as a single covered 
shareholder for purposes of the rules relating to previously taxed 
earnings and profits. Paragraph (d) of this section addresses the 
application of section 961 to consolidated groups. Paragraph (e) of 
this section addresses members that join or leave a consolidated group. 
Paragraph (f) of this section contains examples. Paragraph (g) of this 
section provides the applicability date of this section.
    (b) Definitions. The definitions and rules of general applicability 
in Sec. Sec.  1.959-1 and 1.961-1 apply for purposes of this section, 
with the following additions:
    (1) Departing transaction. The term departing transaction has the 
meaning provided in paragraph (e)(3) of this section.
    (2) Group derived basis. The term group derived basis has the 
meaning provided in paragraph (d)(2)(ii) of this section.
    (3) Group section 961(c) basis. The term group section 961(c) basis 
has the meaning provided in paragraph (d)(2)(ii) of this section.
    (4) Joining transaction. The term joining transaction has the 
meaning provided in paragraph (e)(2) of this section.
    (5) Member shareholder. The term member shareholder means a member 
that owns stock of a foreign corporation.
    (6) Section 959 rules. The term section 959 rules means section 959 
and the section 959 regulations.
    (7) Section 961 rules. The term section 961 rules means section 961 
and the section 961 regulations.
    (c) Single covered shareholder treatment under section 959--(1) 
Overview. This paragraph (c) addresses the application of the section 
959 rules to a consolidated group. Paragraph (c)(2) of this section 
provides the general rule that treats the group as a single covered 
shareholder. Paragraphs (c)(3) through (5) of this section describe the 
application of this general rule: paragraph (c)(3) of this section 
addresses the maintenance of group PTEP accounts; paragraph (c)(4) of 
this section provides for the allocation of PTEP among members; and 
paragraph (c)(5) of this section addresses intercompany transfers of 
foreign corporation stock. Where other provisions of the Code or 
regulations reference the section 959 rules (for example, sections 
960(b) and 986(c)), the treatment described in this paragraph (c) 
applies for purposes of the application of those provisions.
    (2) In general. For purposes of applying the section 959 rules, 
members of a consolidated group are treated as a single covered 
shareholder. However, each member computes and takes into account its 
own items with respect to the stock of foreign corporations (including 
items allocated by a partnership, or assigned from a controlled foreign 
corporation, to the

[[Page 95460]]

member). For example, if a member receives a distribution from a 
foreign corporation, that member takes into account the tax 
consequences of the distribution.
    (3) PTEP accounting. For purposes of applying Sec. Sec.  1.959-2 
(regarding accounting of previously taxed earnings and profits) and 
1.959-3 (regarding adjustments to shareholder-level accounts relating 
to previously taxed earnings and profits)--
    (i) A consolidated group establishes and maintains a single set of 
annual PTEP accounts, dollar basis pools, and PTEP tax pools with 
respect to a foreign corporation whose stock is owned by one or more 
members (for example, a consolidated group has a single combined pool 
election under Sec.  1.959-2(c)); and
    (ii) A foreign corporation establishes and maintains a single 
corporate PTEP account and corporate PTEP tax pool with respect to a 
consolidated group.
    (4) Allocation of group accounts--(i) In general. When necessary 
(for example, to determine a member shareholder's section 956 amount or 
foreign currency gain or loss under section 986(c)), the relevant 
amount of the consolidated group's accounts described in paragraph 
(c)(3) of this section is allocated among the member shareholders. The 
relevant amount is the amount that the single covered shareholder would 
access if all members of a consolidated group were treated as a single 
covered shareholder. The allocation is made in proportion to each 
member shareholder's share of the item at issue relative to the total 
amount of the item for all member shareholders.
    (ii) Application to covered distributions--(A) Overview. The 
allocation rule in paragraph (c)(4)(i) of this section applies if one 
or more member shareholders receive, or are assigned under Sec.  1.951-
2, a portion of a covered distribution (each, a member's portion), then 
each member shareholder is allocated a portion of the group's accounts 
described in paragraph (c)(3) of this section to determine the extent 
to which the member's portion is previously taxed earnings and profits 
under Sec.  1.959-4.
    (B) The relevant amount of the covered distribution. For purposes 
of allocating the group accounts, the relevant amount is the amount of 
the total portion of the covered distribution received by or assigned 
to all member shareholders (group's portion) that would be previously 
taxed earnings and profits to a single covered shareholder. This amount 
is determined under Sec.  1.959-4 based on the consolidated group's 
accounts described in paragraph (c)(3) of this section.
    (C) Member shareholder's PTEP amount for covered distribution. The 
extent to which the member's portion is previously taxed earnings and 
profits under Sec.  1.959-4 is determined by multiplying the amount 
determined under paragraph (c)(4)(ii)(B) of this section by a fraction. 
The numerator of the fraction is the member's portion, and the 
denominator is the group's portion.
    (5) Intercompany transfers. Because a group maintains a single set 
of accounts under paragraph (c)(3) of this section (that is, member 
shareholders do not have their own accounts), an intercompany transfer 
(within the meaning of Sec.  1.1502-13(b)(1)) of the stock of a foreign 
corporation is not a general successor transaction as defined in Sec.  
1.959-7(b).
    (d) Basis under section 961--(1) Overview. This paragraph (d) 
addresses the application of the section 961 rules to consolidated 
groups. Paragraph (d)(2) of this section contains the general rule 
providing for single- or separate-entity treatment of the group with 
respect to different types of property units. Paragraphs (d)(3) and (4) 
of this section, respectively, address basis increases and reductions 
under section 961. Paragraph (d)(5) of this section addresses the use 
of the group's basis to determine gain or loss on a property unit.
    (2) Treatment of property units--(i) Section 961(a) ownership 
units. Because member shareholders directly own section 961(a) 
ownership units, adjustments to these ownership units under the section 
961 rules are made separately to member shareholders' actual ownership 
interests.
    (ii) Derivative ownership units and section 961(c) ownership units. 
Members of a consolidated group are treated as a single covered 
shareholder for purposes of accounting for the basis of derivative 
ownership units and section 961(c) ownership units. Therefore, a 
partnership has a single derived basis with respect to a consolidated 
group in a derivative ownership unit (group derived basis), and a 
controlled foreign corporation has a single section 961(c) basis with 
respect to a consolidated group in a section 961(c) ownership unit 
(group section 961(c) basis).
    (3) Basis increases for income inclusions and gains--(i) In 
general. Adjustments under Sec. Sec.  1.961-3 (for inclusions under 
sections 951(a), 951A(a), and 961) and 1.961-5(b) (relating to foreign 
currency gain) are determined based on each member shareholder's 
respective income inclusions under sections 951(a) and 951A(a), foreign 
currency gain under section 986(c), or income inclusions under Sec.  
1.961-11. To the extent the adjustment is to a section 961(a) ownership 
unit, the adjustments are made separately to each member shareholder's 
section 961(a) ownership unit. In contrast, to the extent the 
adjustment is to a derivative ownership unit or a section 961(c) 
ownership unit, the adjustment is made to the group derived basis or 
the group section 961(c) basis.
    (ii) Example. A member (M1) directly owns all the stock of a 
foreign corporation (CFC1), which directly owns all the preferred stock 
in another foreign corporation (CFC3). Another member (M2) owns all the 
stock of a foreign corporation (CFC2), which owns all the common stock 
of CFC3. M1 and M2 have section 951(a) inclusions resulting from CFC3's 
subpart F income. M1's basis in its CFC1 stock, which is determined 
separately with respect to M1, and the group section 961(c) basis in 
CFC1's preferred stock in CFC3, are both adjusted based on M1's 
inclusion. Similarly, M2's basis in its CFC2 stock, which is determined 
separately with respect to M2, and the group section 961(c) basis in 
CFC2's common stock in CFC3, are both adjusted based on M2's inclusion.
    (4) Basis reductions--(i) Reductions to basis of section 961(a) 
ownership units. Reductions to the basis of section 961(a) ownership 
units under Sec. Sec.  1.961-4 (for distributions of previously taxed 
earnings and profits) and 1.961-5(b) (relating to foreign currency 
loss) are determined on a separate-entity basis. See paragraph 
(d)(2)(i) of this section.
    (ii) Reductions to derived basis or section 961(c) basis. This 
paragraph (d)(4)(ii) coordinates the application of the section 961 
rules to determine how to reduce group derived basis and group section 
961(c) basis under Sec. Sec.  1.961-4 and 1.961-5.
    (A) Step 1: Proportionate allocation of derived basis and section 
961(c) basis. When the section 961 rules apply to reduce derived basis 
or section 961(c) basis, the group derived basis and group section 
961(c) basis is allocated to the member shareholders. The allocation is 
made in proportion to each member shareholder's share of the item at 
issue relative to the total for all member shareholders (for example, 
in proportion to a member shareholder's PTEP amount for a covered 
distribution, as described in paragraph (c)(4)(ii)(C) of this section).
    (B) Step 2: Separate entity basis reduction. The member 
shareholders separately apply the section 961 rules to make the 
necessary basis reductions,

[[Page 95461]]

taking into account the amount of group derived basis and group section 
961(c) basis allocated to that member in paragraph (d)(4)(ii)(A) of 
this section (step 1) (for example, see Sec.  1.961-4(d) for 
adjustments to section 961(c) ownership units for distributions of 
previously taxed earnings and profits to a controlled foreign 
corporation owned by member shareholders). To the extent the basis 
reduction exceeds the relevant basis in the ownership unit with respect 
to the member shareholder, the partnership or controlled foreign 
corporation recognizes gain (for example, see Sec.  1.961-4(f)), which 
is allocated or assigned to the member shareholder.
    (C) Step 3: Recombination of derived basis and section 961(c) 
basis. After applying the rules in paragraphs (d)(4)(ii)(A) and (B) of 
this section, to the extent there is any remaining positive derived 
basis or positive section 961(c) basis, or any resulting negative 
derived basis or negative section 961(c) basis, those bases are 
combined to produce the group derived basis or group section 961(c) 
basis for the relevant ownership unit.
    (5) Use of group derived basis and group section 961(c) basis to 
determine gain or loss--(i) Section 1.961-8(b)(1) gain or loss. This 
paragraph (d)(5)(i) applies when a member shareholder is allocated a 
distributive share of gain or loss as described in Sec.  1.961-8(b)(1). 
For purposes of applying positive derived basis under Sec.  1.961-
8(b)(2), the member shareholder is allocated a portion of the relevant 
group derived basis in proportion to the member shareholder's ownership 
interest in the foreign corporation described in Sec.  1.961-8(b)(1) 
relative to the aggregate of all ownership interests in the foreign 
corporation of all member shareholders. The relevant group derived 
basis is the amount of derived basis the single covered shareholder 
would access if all members of the consolidated group were treated as a 
single covered shareholder.
    (ii) Section 1.961-9(c) covered gain. This paragraph (d)(5)(ii) 
applies when a member shareholder is assigned a share of covered gain 
under Sec.  1.951-2. For purposes of applying positive section 961(c) 
basis under Sec.  1.961-9(e), the member shareholder is allocated a 
portion of the relevant group section 961(c) basis in proportion to the 
member shareholder's share of covered gain relative to the total for 
all member shareholders. The relevant group section 961(c) basis is the 
amount of section 961(c) basis the single covered shareholder would 
access if all members of a consolidated group were treated as a single 
covered shareholder.
    (e) Consequences of joining or leaving a consolidated group--(1) In 
general. For purposes of applying the section 959 rules and the section 
961 rules, a transaction in which a member shareholder joins or leaves 
a consolidated group is treated in the same manner as an acquisition or 
disposition of the stock of a foreign corporation owned by the member 
at the time the member joins or leaves the consolidated group, as 
applicable. Paragraphs (e)(2) and (3) of this section coordinate the 
application of Sec. Sec.  1.959-7 (general successor transaction rules) 
and 1.961-5 (successor basis rules) to transactions in which a member 
shareholder joins or leaves a consolidated group, respectively. 
Paragraph (e)(4) of this section coordinates the application of section 
986(c) to such transactions. The rules of this paragraph (e) apply only 
to transactions treated as acquisitions or dispositions of stock of the 
member shareholder (for example, if a member shareholder is sold to an 
unrelated party and an election under section 338(h)(10) is made, 
paragraph (e)(3) of this section does not apply).
    (2) Joining transactions--(i) In general. A transaction (joining 
transaction) in which a corporation (joining member) becomes a member 
of a consolidated group is treated in the same manner as a general 
successor transaction. In the joining transaction, the transferor 
covered shareholder is the joining member, the successor covered 
shareholder is the consolidated group, and the consolidated group is 
treated as acquiring ownership of all the stock of foreign corporations 
owned by the joining member. Thus, for example, any previously taxed 
earnings and profits in the joining member's annual PTEP accounts with 
respect to a foreign corporation are added to the consolidated group's 
annual PTEP accounts with respect to the foreign corporation. 
Similarly, a controlled foreign corporation's section 961(c) basis with 
respect to the joining member in a section 961(c) ownership unit is 
added to the controlled foreign corporation's section 961(c) basis with 
respect to the consolidated group in that unit, and a partnership's 
derived basis with respect to the joining member in a derivative 
ownership unit is added to the partnership's derived basis with respect 
to the consolidated group in that unit.
    (ii) Combined pool election. The consolidated group's combined pool 
election status pursuant to Sec.  1.959-2(c) controls after a joining 
transaction.
    (3) Departing transactions--(i) In general. A transaction 
(departing transaction) in which a member shareholder (departing 
member) ceases to be a member of a consolidated group is treated in the 
same manner as a general successor transaction. In the departing 
transaction, the transferor covered shareholder is the consolidated 
group, the successor covered shareholder is the departing member, and 
the departing member is treated as acquiring ownership of all the stock 
of foreign corporations owned by the departing member at the time of 
the departing transaction. Thus, for example, any previously taxed 
earnings and profits in the consolidated group's annual PTEP accounts 
with respect to the foreign corporation are allocated between the 
consolidated group and the departing member shareholder. Similarly, a 
controlled foreign corporation's section 961(c) basis in a section 
961(c) ownership unit with respect to the consolidated group is 
allocated between the consolidated group and the departing member, and 
a partnership's derived basis in a derivative ownership unit with 
respect to the consolidated group is allocated between the consolidated 
group and the departing member.
    (ii) Combined pool election. The departing member retains the 
consolidated group's combined pool election status under Sec.  1.959-
2(c). However, if the departing member joins a new consolidated group, 
paragraph (e)(2)(ii) of this section applies to the new consolidated 
group.
    (4) Coordination with section 986(c). Joining transactions and 
departing transactions do not result in recognition of foreign currency 
gain or loss under section 986(c) (notwithstanding Sec.  1.986(c)-1). 
Thus, for example, the dollar basis of previously taxed earnings and 
profits in a joining member's annual PTEP accounts carries over when 
adding the previously taxed earnings and profits to the consolidated 
group's annual PTEP accounts pursuant to paragraph (e)(2)(i) of this 
section.
    (f) Examples--(1) In general. This paragraph (f) provides examples 
illustrating the application of this section. These examples do not 
discuss every consequence of the transactions under related provisions 
of the Code and regulations.
    (2) Assumed facts. For purposes of the examples in this paragraph 
(f), unless otherwise indicated, the following facts are assumed:
    (i) USP, USS1, and USS2 are domestic corporations, each of which 
uses the U.S. dollar as its functional currency. USP is the common 
parent of the P consolidated group (P group), USS1 and USS2 are members 
of the P group, and

[[Page 95462]]

all the stock of USS1 and USS2 is owned by USP.
    (ii) F1 and F2 are controlled foreign corporations, each of which 
uses the British pound ([pound]) as its functional currency.
    (iii) PRS1 is a partnership.
    (iv) Each entity uses the calendar year as its taxable year, and no 
entity has a short taxable year.
    (v) There are no adjustments under section 743(b) to the basis of 
any partnership property.
    (3) Example 1: Exclusion from gross income of distributed 
previously taxed earnings and profits--(i) Facts. Each of USS1 and USS2 
directly owns 50 of the 100 shares of the single class of outstanding 
stock of F1. In year 3, F1 makes a [pound]300x distribution of money 
with respect to its stock ([pound]3x with respect to each share), and 
the entirety of this [pound]300x is a covered distribution (a dividend 
as defined in section 316, determined without regard to section 
959(d)). Immediately before the covered distribution, F1 has 
[pound]180x of previously taxed earnings and profits with respect to 
the P group, none of which is assigned to the taxable section 962 PTEP 
group.
    (ii) Analysis. For purposes of analyzing the covered distribution 
under Sec.  1.959-4, the P group is treated as a single covered 
shareholder. See paragraph (c)(2) of this section. The P group's share 
of the covered distribution is the entire [pound]300x because the 
entire covered distribution is made to members of the P group 
([pound]150x to USS1 plus [pound]150x to USS2). See Sec.  1.959-
4(d)(1). The [pound]300x are allocated first to F1's previously taxed 
earnings and profits that are with respect to the P group immediately 
before the covered distribution ([pound]180x), and then to F1's 
earnings and profits described in section 959(c)(3). Therefore, the 
[pound]300x consist of [pound]180x of previously taxed earnings and 
profits and [pound]120x of earnings and profits described in section 
959(c)(3). See Sec.  1.959-4(d)(2) and (e)(1). These previously taxed 
earnings and profits are treated as distributed pro rata with respect 
to the F1 stock on which the P group's share of the covered 
distribution is made. See Sec.  1.959-4(d)(4) and paragraph (c)(4)(ii) 
of this section. Accordingly, [pound]1.8x of previously taxed earnings 
and profits is treated as distributed with respect to each share of F1 
stock. See id. USS1 and USS2 each excludes the [pound]90x (([pound]150x 
/ [pound]300x) x [pound]180x) of previously taxed earnings and profits 
distributed to it from its gross income. See Sec.  1.959-4(b)(1) and 
paragraph (c)(4)(ii) of this section. Moreover, the distributions of 
previously taxed earnings and profits to USS1 and USS2 do not result in 
any investment adjustments under Sec.  1.1502-32 (see Sec.  1.1502-
32(b)(5)(ii), Example 9) or adjustments to earnings and profits (see 
Sec. Sec.  1.312-8(c) and 1.1502-33). Because this analysis depends 
only on F1's PTEP with respect to the P group, these results do not 
depend on whether USS1 or USS2 owned F1 stock or had income inclusions 
with respect to F1 during the taxable years to which the distributed 
previously taxed earnings and profits relate.
    (4) Example 2: Basis increases for income inclusions--(i) Facts. F1 
has two classes of stock outstanding. USS1 directly owns all 100 shares 
of F1 common stock, and USS2 directly owns all 100 shares of F1 
preferred stock. F1 directly owns all 50 shares of the single class of 
outstanding stock of F2. The shares of F1 stock directly owned by USS1 
or USS2 are section 961(a) ownership units, and the shares of F2 stock 
directly owned by F1 are section 961(c) ownership units. For year 3, 
USS1 includes $60x and USS2 includes $40x in gross income under section 
951(a)(1)(A) with respect to F2 (their pro rata shares of F2's subpart 
F income, translated into U.S. dollars in accordance with section 
989(b)). F2 does not make any covered distributions, and therefore does 
not distribute any previously taxed earnings and profits, during the 
taxable year.
    (ii) Analysis--(A) In general. To reflect USS1's and USS2's income 
inclusions for year 3, the basis of the F2 stock and F1 stock is 
increased in accordance with Sec.  1.961-3. See Sec.  1.961-3(b). F1's 
section 961(c) basis in the F2 stock with respect to the P group is 
increased based on the total inclusions of the P group, because members 
of a consolidated group are treated as a single covered shareholder for 
purposes of accounting for basis of section 961(c) ownership units, and 
because all of the P group's inclusions arise with respect to this F2 
stock. See paragraphs (d)(2)(ii) and (d)(3)(i) of this section. USS1's 
adjusted basis in the F1 common stock and USS2's adjusted basis in the 
F1 preferred stock are increased based on each member's separate 
inclusion, because adjustments to section 961(a) ownership units are 
made separately to member shareholders' actual ownership interests. See 
paragraphs (d)(2)(i) and (d)(3)(i) of this section.
    (B) Increases to basis of each property unit. The amount of the P 
group's income inclusions with respect to F2 that give rise to 
increases to basis under section 961 is $100x ($60x + $40x). See Sec.  
1.961-3(c)(1) and paragraph (d)(3) of this section. Under Sec.  1.961-
3(e), the section 961(c) basis with respect to the P group of each 
share of F2 stock is increased by $2x ($100x / 50 shares). The basis of 
each share of F1 common stock owned by USS1 is increased by $0.60x 
($60x / 100 shares) and the basis of each share of F1 preferred stock 
owned by USS2 is increased by $0.40x ($40x / 100 shares). These 
increases to basis are treated as made at the beginning of F2's taxable 
year. See Sec.  1.961-3(c)(2) and (e)(1). These adjustments to the 
basis of the section 961(a) ownership units may be different from the 
adjustments that would be made under Sec.  1.961-3(e) if they were all 
held by a single owner.
    (C) Section 1502 basis and E&P adjustments. USP increases its basis 
in its USS1 stock by $60x and in its USS2 stock by $40x, reflecting 
each member's inclusion in income under section 951(a)(1)(A). See Sec.  
1.1502-32(b)(2)(i). Because the income inclusions increase USS1's and 
USS2's earnings and profits (see Sec.  1.312-6(f)), USP's earnings and 
profits are increased under Sec.  1.1502-33(b)(1).
    (5) Example 3: Basis reductions and gain recognition for 
distributions from upper-tier foreign corporation--(i) Facts. USS1 and 
USS2 directly own all the shares of the single class of outstanding 
stock of F1, with USS1 owning 60 shares and USS2 owning 40 shares. In 
year 3, F1 makes a pro rata covered distribution to USS1 and USS2. 
Under Sec.  1.959-4, the entirety of the covered distribution is 
previously taxed earnings and profits with respect to the P group and 
excluded from the members' gross income. In addition, the sum of the 
dollar basis and associated foreign income taxes of the previously 
taxed earnings and profits that are distributed on each share of F1 
stock is $6x. Immediately before the covered distribution, USS1's 
adjusted basis in each share of its F1 stock is $8x, and USS2's 
adjusted basis in each share of its F1 stock is $5x. Each of USS1 and 
USS2 is deemed to pay the entirety of the associated foreign income 
taxes of the previously taxed earnings and profits distributed to it 
under section 960(b) (because all such taxes are sourced from the 
creditable PTEP tax group and the member is a United States shareholder 
of F1) and is allowed a credit under section 901 for the entirety of 
such taxes.
    (ii) Analysis. Under Sec.  1.961-4(b), each of USS1 and USS2 
separately reduces its adjusted basis in each share of F1 stock on 
which it receives previously taxed earnings and profits and, if 
applicable, recognizes gain with respect to those shares. See paragraph 
(d)(4)(i) of this section. The adjustment to each share of F1 stock is 
$6x, the sum of the

[[Page 95463]]

dollar basis and associated foreign income taxes of the previously 
taxed earnings and profits received by the member on the share. See 
Sec.  1.961-4(b)(2)(i). The basis of each of USS1's shares of F1 stock 
is reduced to $2x ($8x original basis - $6x adjustment). See Sec.  
1.961-4(b)(2)(ii). The basis of each of USS2's shares of F1 stock is 
reduced to $0x, and USS2 recognizes $1x of gain per share ($5x original 
basis - $6x adjustment). See Sec.  1.961-4(b)(2)(ii) and (iii). These 
adjustments are treated as made concurrently with the covered 
distribution. See Sec.  1.961-4(e)(1) and (f)(1).
    (6) Example 4: Basis reductions and gain recognition for 
distributions from lower-tier foreign corporation--(i) Facts. USS1 and 
USS2 directly own all the shares of the single class of outstanding 
stock of F1, with USS1 owning 60 shares and USS2 owning 40 shares. F1 
directly owns all the shares of the single class of outstanding stock 
of F2. In year 3, F2 makes a covered distribution to F1. Under Sec.  
1.959-4, the entirety of the covered distribution is previously taxed 
earnings and profits that are with respect to the P group and excluded 
from F1's gross income for purposes of determining its subpart F income 
and its tested income or tested loss. In addition, the sum of the 
dollar basis and associated foreign income taxes of the previously 
taxed earnings and profits that are distributed on each share of F2 
stock is $6x. Immediately before the covered distribution, F1's 
adjusted basis in each share of F2 stock is [pound]1.50x, and its 
section 961(c) basis with respect to the P group in each share is $5x. 
On the day of the covered distribution, the spot rate is $1:[pound]0.5.
    (ii) Analysis. Under Sec.  1.961-4(d), F1 reduces its section 
961(c) basis in each share of F2 stock on which it receives previously 
taxed earnings and profits. If applicable, F1 recognizes gain with 
respect to those shares. These adjustments are made separately with 
respect to USS1 and USS2. See paragraph (d)(4)(ii) of this section. 
First, under paragraph (d)(4)(ii)(A) of this section, for each share of 
F2 stock, F1's section 961(c) basis with respect to the P group is 
allocated proportionately to USS1 ($3x, or 60%) and USS2 ($2x, or 40%). 
Next, under paragraph (d)(4)(ii)(B) of this section, the basis 
reductions are made separately for each of USS1 and USS2. For each 
share of F2 stock, USS1's portion of F1's section 961(c) basis ($3x) is 
reduced by USS1's share of the dollar basis and associated foreign 
income taxes ($3.60x = 60% x $6x). See Sec.  1.961-4(d)(2). Because the 
reduction exceeds the positive section 961(c) basis, it must be tested 
against the limitation in Sec.  1.961-4(d)(3). The amount of F1's 
adjusted basis in each share that is available with respect to USS1 is 
[pound]0.90x (60% x [pound]1.50x), which is equal to $1.80x. Because 
$1.80x is greater than $0.60x, USS1's portion of F1's section 961(c) 
basis is reduced to negative $0.60x ($3x - $3.60x), and no gain is 
recognized under Sec.  1.961-4(d)(2)(iii). Similarly, USS2's share of 
F1's section 961(c) basis in each share of F2 stock ($2x) is reduced by 
its share of the dollar basis and associated foreign income taxes 
($2.40x = 40% x $6x). The amount of F1's adjusted basis in each share 
that is available with respect to USS2 is [pound]0.60x (40% x 
[pound]1.50x), which is equal to $1.20x. Therefore, USS2's portion of 
F1's section 961(c) basis is reduced to negative $0.40x ($2x - $2.40x), 
and no gain is recognized under Sec.  1.961-4(d)(2)(iii). Finally, 
under paragraph (d)(4)(ii)(C) of this section, the separately computed 
section 961(c) bases are recombined. As a result, F1's section 961(c) 
basis with respect to the P group in each share of F2 stock is negative 
$1x (negative $0.60x + negative $0.40x = negative $1x). The reductions 
to section 961(c) basis are treated as made concurrently with the 
covered distribution. See Sec.  1.961-4(e)(1) and (f)(1).
    (iii) Alternative facts: distribution in excess of basis. The facts 
are the same as in paragraph (f)(6)(i) of this section (Example 4), 
except that the sum of the dollar basis and associated foreign income 
taxes per share of F2 stock is $9x instead of $6x. The application of 
paragraph (d)(4)(ii)(A) of this section is the same as in paragraph 
(f)(6)(ii) of this section. When applying paragraph (d)(4)(ii)(B) of 
this section, the basis reductions per share are $5.40x (60% x $9x) for 
USS1 and $3.60x (40% x $9x) for USS2. Because the reductions again 
exceed the positive section 961(c) basis, they must be tested against 
the limitation in Sec.  1.961-4(d)(3). The amounts of F1's adjusted 
basis in each share that are available with respect to each member are 
the same as in paragraph (f)(6)(ii) of this section. For USS1, because 
the $1.80x limitation is less than $2.40x ($3x section 961(c) basis - 
$5.40x adjustment), USS1's portion of F1's section 961(c) basis per 
share is reduced to negative $1.80x, and $0.60x ($2.40x - $1.80x) of 
gain per share is recognized under Sec.  1.961-4(d)(2)(iii), with this 
gain assigned solely to USS1. Similarly, for USS2, the $1.20x 
limitation is less than $1.60x ($2x section 961(c) basis - $3.60x 
adjustment). Therefore, USS2's portion of F1's section 961(c) basis per 
share is reduced to negative $1.20x, and $0.40x ($1.60x - $1.20x) of 
gain per share is recognized under Sec.  1.961-4(d)(2)(iii), with this 
gain assigned solely to USS2. The basis of USS1 and USS2's F1 stock is 
increased under Sec.  1.961-3 to reflect the gains recognized by F1 and 
included in the member's gross income pursuant to Sec.  1.961-11. 
Finally, under paragraph (d)(4)(ii)(C) of this section, the separately 
computed section 961(c) bases are recombined. As a result, F1's section 
961(c) basis with respect to the P group in each share of F2 stock is 
negative $3x (negative $1.80x + negative $1.20x = negative $3x).
    (7) Example 5: Use of positive derived basis--(i) Facts. USS1, 
USS2, and a nonresident alien individual, in the aggregate, directly 
own all the interests in PRS1, with USS1 and USS2 owning equal 
interests in PRS1. PRS1 directly owns all the shares of the single 
class of outstanding stock of F1 (derivative ownership units). In year 
3, PRS1 sells all the F1 stock to an unrelated party for money. The 
distributive share of the gain recognized by PSI is $30x to each of 
USS1 and USS2, determined without regard to derived basis. Immediately 
before the sale (and taking into account any adjustments under Sec.  
1.961-5(b) resulting from the sale), PRS1's positive derived basis with 
respect to the P group in the F1 stock is $50x in total. In addition, 
PRS1 has no negative derived basis with respect to the P group in any 
of the shares.
    (ii) Analysis. In applying PRS1's positive derived basis with 
respect to the P group in the F1 stock, a pro rata portion of such 
derived basis is taken into account with respect to each member. See 
paragraph (d)(5)(i) of this section. Thus, because USS1 and USS2 own 
equal interests in PRS1, $25x (or 50%) of the derived basis is taken 
into account with respect to each of USS1 and USS2. Accordingly, for 
each of USS1 and USS2, PRS1 is treated as applying $25x of derived 
basis to the member's $30x distributive share of gain on the sale. See 
Sec.  1.961-8(b). As result, each member's distributive share of gain 
on the sale is adjusted by $25x, to a $5x distributive share of gain. 
See also Sec.  1.961-8(c) (for purposes of adjusting each member's 
adjusted basis in its PRS1 interest under section 705, the member's 
distributive share of gain on the sale is $5x).
    (8) Example 6: Use of positive section 961(c) basis--(i) Facts. 
USS1, USS2, and a nonresident alien individual, in the aggregate, 
directly own all the shares of the single class of outstanding stock of 
F1. USS1 and USS2 own an equal number of shares of F1. F1 directly owns 
all the shares of the single class of outstanding stock of F2 (section 
961(c)

[[Page 95464]]

ownership units). In year 3, F1 sells all the F2 stock to an unrelated 
party for money. F1 recognizes [pound]100x of gain on the sale, 
determined without regard to loss recognized on any share and without 
regard to section 961(c) basis. This [pound]100x is covered gain, and 
each of USS1 and USS2 is assigned a [pound]30x portion of the covered 
gain under Sec.  1.951-2. Immediately before the sale (and taking into 
account any adjustments under Sec.  1.961-5(b) resulting from the 
sale), F1's positive section 961(c) basis in the F2 stock with respect 
to the P group is [pound]50x (as translated from U.S. dollars into 
British pounds at the spot rate on the day of the sale). In addition, 
F1 has no negative section 961(c) basis with respect to the P group in 
any of the shares.
    (ii) Analysis. In applying F1's positive section 961(c) basis with 
respect to the P group of the F2 stock, a pro rata portion of such 
section 961(c) basis is taken into account with respect to each member. 
See paragraph (d)(5)(ii) of this section. Thus, because USS1 and USS2 
own equal interests in F1, [pound]25x ([pound]30x / [pound]60x, or 50%) 
of the section 961(c) basis is taken into account with respect to each 
of USS1 and USS2. All [pound]25x of the section 961(c) basis taken into 
account with respect to each of USS1 and USS2 is applied to the 
member's [pound]30x share of the covered gain. See Sec.  1.961-9(d)(2) 
and (e)(1). As a result, a total of [pound]50x of the covered gain is 
previously taxed earnings and profits of F1 with respect to the P 
group, characterized in accordance with Sec.  1.961-9(f)(2) through 
(4). See Sec.  1.961-9(d)(3), (f)(1) and paragraph (c)(1) of this 
section. F1 excludes the [pound]50x of previously taxed earnings 
resulting from section 961(c) basis from its gross income, solely for 
purposes of determining its subpart F income and tested income or 
tested loss. See Sec.  1.961-9(b).
    (g) Applicability date. This section applies to a taxable year of a 
consolidated group for which a taxable year of a foreign corporation is 
relevant if such taxable year of the foreign corporation begins on or 
after [date of publication of final regulations in the Federal 
Register] or is an early application year (as described in Sec.  1.959-
12(d)).

Heather C. Maloy,
Acting Deputy Commissioner.
[FR Doc. 2024-27227 Filed 11-29-24; 8:45 am]
BILLING CODE 4830-01-P`