[Federal Register Volume 74, Number 111 (Thursday, June 11, 2009)]
[Rules and Regulations]
[Pages 27868-27890]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E9-13521]



[[Page 27867]]

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Part II





Department of the Treasury





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Internal Revenue Service



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26 CFR Parts 1 and 602



Application of Separate Limitations to Dividends From Noncontrolled 
Section 902 Corporations; Final Rule

Federal Register / Vol. 74, No. 111 / Thursday, June 11, 2009 / Rules 
and Regulations

[[Page 27868]]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Parts 1 and 602

[TD 9452]
RIN 1545-BB28


Application of Separate Limitations to Dividends From 
Noncontrolled Section 902 Corporations

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations, temporary regulations, and removal of 
temporary regulations.

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SUMMARY: This document contains final regulations regarding the 
application of separate foreign tax credit limitations to dividends 
received from noncontrolled section 902 corporations. The American Jobs 
Creation Act of 2004 (AJCA) modified the treatment of such dividends 
effective for taxable years beginning after December 31, 2002. The Gulf 
Opportunity Zone Act of 2005 (GOZA) permits taxpayers to elect to defer 
the effective date of the AJCA amendments until taxable years beginning 
after December 31, 2004. The final regulations provide guidance needed 
to comply with these changes and affect corporations claiming foreign 
tax credits.

DATES: Effective Date: These regulations are effective on June 11, 
2009.
    Applicability Dates: For dates of applicability, see Sec. Sec.  
1.861-9(k), 1.861-12(c)(5), 1.902-1(g), 1.904-2(h)(1) and (2), 1.904-
4(n), 1.904-5(o)(2), 1.904-7(f)(10), 1.904(f)-12(g)(5), and 1.964-1(d).

FOR FURTHER INFORMATION CONTACT: Richard Chewning at (202) 622-3850 
(not a toll-free number).

SUPPLEMENTARY INFORMATION

Paperwork Reduction Act

    The collections of information contained in the final regulations 
have been reviewed and approved by the Office of Management and Budget 
in accordance with the Paperwork and Reduction Act (44 U.S.C. 3507(d)) 
under control number 1545-2014. The collections of information in the 
final regulations are in Sec. Sec.  1.904-7(f)(9)(ii)(C) and 1.964-
1(c)(3). This information is required, with respect to Sec.  1.904-
7(f)(9)(ii)(C), to notify the IRS that taxpayer has made the election 
to defer the applicability of the provisions of section 403 of the 
AJCA. With respect to Sec.  1.964-1(c)(3), this information is required 
to notify the IRS and domestic shareholders of a foreign corporation of 
elections made to adopt or change a method of accounting or taxable 
year of the foreign corporation.
    An agency may not conduct or sponsor, and a person is not required 
to respond to, a collection of information unless it displays a valid 
control number.
    Books or records relating to these collections of information must 
be retained as long as their contents may become material in the 
administration of any internal revenue law. Generally, tax returns and 
tax return information are confidential, as required by 26 U.S.C. 6103.

Background

    On April 20, 2006, a notice of proposed rulemaking by cross-
reference to temporary regulations (REG-144784-02) under sections 861, 
902, 904, and 964 of the Code and temporary regulations (TD 9260) (the 
2006 temporary regulations) were filed with the Office of the Federal 
Register. On April 25, 2006, the notice of proposed rulemaking by 
cross-reference to temporary regulations and the 2006 temporary 
regulations were published in the Federal Register (71 FR 24543 and 71 
FR 24516, respectively). Corrections to the 2006 temporary regulations 
were published on August 21, 2006, and December 26, 2006, in the 
Federal Register (71 FR 48474 and 71 FR 77264, respectively). Comments 
were received. A public hearing was not requested and none was held. 
After consideration of the comments, the proposed regulations are 
adopted as amended by this Treasury decision.

Explanation and Summary of Comments

    The IRS and the Treasury Department received written comments on 
the 2006 temporary regulations. Those comments are discussed in this 
preamble. These new regulations make several changes to the 2006 
temporary regulations to take into account comments received, while 
adopting without amendment most of the temporary regulations. The 
significant comments and revisions are described in this preamble.

I. Interest Expense Apportionment

A. Interest Expense of a 10/50 Corporation

    Section 904(d)(4)(A), as amended by the AJCA, provides that any 
dividend paid by a noncontrolled section 902 corporation (10/50 
corporation) shall be treated as income in a separate category based on 
the separate category of the underlying earnings and profits being 
distributed (look-through treatment), effective for taxable years 
beginning after December 31, 2002 (post-2002 taxable years), without 
regard to when the distributed earnings were accumulated. For purposes 
of apportioning interest expense of a 10/50 corporation in order to 
apply the dividend look-through rule, Sec.  1.861-9T(f)(4) of the 2006 
temporary regulations generally applies the same principles as Sec.  
1.861-9T(f)(3) (apportionment of interest expense of a controlled 
foreign corporation). Under these rules, interest expense of a 10/50 
corporation may be apportioned using either the asset method or the 
modified gross income method. Regardless of the interest expense 
apportionment methods used by its majority domestic corporate 
shareholders, the 10/50 corporation (or the majority domestic corporate 
shareholders on behalf of the 10/50 corporation) may elect to use any 
of the methods described in Sec.  1.861-9T or Sec.  1.861-9 (that is, 
the modified gross income, tax book value, alternative tax book value 
or fair market value method) to apportion the 10/50 corporation's 
interest expense.
    Section 1.861-9T(j)(1) provides a rule for ``tiering up'' the 
income of tiers of controlled foreign corporations (CFCs) that use the 
modified gross income method to apportion interest expense. Under that 
rule, the lowest-tier CFC's interest expense is allocated and 
apportioned based on its gross income, and its gross income reduced by 
such allocated and apportioned interest expense is then treated as 
gross income of the next-higher-tier CFC for purposes of apportioning 
the higher-tier CFC's interest expense. These steps are then 
essentially repeated, moving up the tiers. A commenter requested that 
the IRS and the Treasury Department clarify the mechanics of 
apportioning interest expense when tiered corporations elect different 
apportionment methods. This commenter raises issues that are beyond the 
scope of this regulation project and therefore are not addressed in 
this document.

B. Definition of ``10 Percent Owned Corporation''

    Prior to revision by the 2006 temporary regulations, Sec.  1.861-
12T(c)(2) required an affiliated group using the tax book value method 
in apportioning its interest expense to adjust the basis of stock in 
any ``10 percent owned corporation'' that is held directly by members 
of the group to reflect each member's pro rata share of such 10 percent 
owned corporation's earnings and profits (or deficit in earnings and 
profits). The rule, as revised by the 2006 temporary regulations, 
applies to stock

[[Page 27869]]

of a 10 percent owned corporation not only where its stock is held 
directly by members of the affiliated group, but also where its stock 
is held indirectly through a partnership or other pass-through entity. 
The revision was effective on April 25, 2006, and applied 
prospectively. The IRS and the Treasury Department stated in the 
preamble to the 2006 temporary regulations that the revision was a 
clarification.
    A commenter questioned why the regulations include a prospective, 
rather than a retroactive, effective date, if the revision clarified 
existing law. The IRS and the Treasury Department maintain that the 
revision is a clarification of existing law but continue to believe a 
prospective effective date is appropriate because the prior regulations 
were ambiguous.

II. Carryover of Unused Foreign Taxes Under Section 904(c)

    In the case of unused foreign taxes attributable to dividends from 
a 10/50 corporation with respect to which the taxpayer was no longer a 
qualifying shareholder as of the first day of the taxpayer's first 
taxable year ending after the first day of the 10/50 corporation's 
first post-2002 taxable year, Sec.  1.904-2T(h)(1) provides that the 
unused foreign taxes are allocated among the taxpayer's separate 
categories in the same percentages as the earnings in the 10/50 
corporation's non-look-through pool or pre-1987 accumulated profits 
``would have been assigned had they been distributed in the last 
taxable year in which the taxpayer was a domestic shareholder in such 
corporation.'' In response to a comment, Sec.  1.904-2(h)(1) of the 
final regulations clarifies that such taxes will be allocated as if 
look-through treatment applied in the year of the hypothetical 
distribution.

III. Look-Through Rules as Applied to 10/50 Corporations

A. General Application of Look-Through

    With respect to applying the look-through rule to any dividend paid 
by a 10/50 corporation in a post-2002 taxable year, Sec.  1.904-
5T(c)(4)(iii) of the 2006 temporary regulations provides that any 
dividends paid in a post-2002 taxable year to a domestic corporation by 
a 10/50 corporation with respect to which the domestic corporation 
meets the stock ownership requirements of section 902(a) are treated as 
income in a separate category in proportion to the ratio of the portion 
of earnings and profits of the 10/50 corporation attributable to income 
in such category to the total amount of earnings and profits of the 10/
50 corporation.
    A commenter expressed concern that in some cases, where a domestic 
shareholder meets the stock ownership requirements of section 902(a) 
but has a relatively small ownership interest, the administrative 
burden on both the taxpayer and the IRS of applying look-through to 
earnings and foreign taxes in a 10/50 corporation's look-through pools 
could be significant. The commenter asserted that the process of 
obtaining and analyzing multiple years of historical financial data to 
ascertain the exact portion of distributions that relate to specific 
categories of income can be challenging, particularly where 
distributions relate to earnings from certain historical periods (for 
example, those during which the taxpayer did not own stock in the 10/50 
corporation). The commenter indicated that the reconstruction and safe 
harbor methods provided in Sec.  1.904-7T(f)(4)(i) and (ii) of the 2006 
temporary regulations, respectively, reduce difficulties in 
reconstructing historical accumulated earnings and taxes accounts of a 
10/50 corporation, but those rules apply only to undistributed earnings 
and taxes accumulated in non-look-through periods and do not apply to 
distributions of earnings accumulated in look-through pools. The 
commenter suggested that the IRS and the Treasury Department consider 
providing an elective safe harbor approach for domestic shareholders 
who own a relatively small interest, such as 15 percent or less, in the 
10/50 corporation, which would characterize a dividend paid by a 10/50 
corporation as income in a separate category by reference to the gross 
revenue of the 10/50 corporation for the last three years or a similar 
abbreviated period, with anti-abuse rules to address distortions.
    The IRS and the Treasury Department recognize that in some 
circumstances a domestic shareholder of a 10/50 corporation (as well as 
a noncontrolling shareholder of a controlled foreign corporation (CFC)) 
may face difficulties in substantiating accumulated earnings and taxes 
accounts of the 10/50 corporation (or CFC) on a look-through basis. 
However, the IRS and the Treasury Department believe use of a safe 
harbor is appropriate only as a limited rule for reconstructing 
earnings and taxes accumulated during prior year periods when the look-
through rules did not apply to dividends from 10/50 corporations. An 
ongoing safe harbor is not appropriate because the statutory look-
through rules, which apply to all domestic shareholders meeting the 
stock ownership requirements of section 902(a) (that is, 10 percent), 
generally require substantiation, and if the look-through treatment of 
a dividend from a 10/50 corporation has not been adequately 
substantiated, section 904(d)(4)(C)(ii) requires that such dividend be 
treated as passive income. See also Sec.  1.904-5T(c)(4)(iii) of the 
2006 temporary regulations.

B. Substantiation of Look-Through Treatment

    Section 1.904-5T(c)(4)(iii) of the 2006 temporary regulations 
provides that a dividend from a 10/50 corporation is treated as passive 
income if the look-through characterization of the dividend is not 
substantiated to the satisfaction of the Commissioner.
    A commenter expressed concern that if a 10/50 corporation has high-
taxed income outside the general and passive categories a taxpayer may 
intentionally fail to substantiate the look-through characterization of 
a dividend from the 10/50 corporation in order to achieve cross-
crediting. The commenter suggested that the final regulations include 
an anti-abuse rule for situations where the Commissioner determines 
that a taxpayer deliberately failed to substantiate the look-through 
characterization of the dividend. The commenter suggested that the 
anti-abuse rule could provide that in such a situation the earnings and 
associated taxes would be placed in a separate sub-basket to prevent 
cross-crediting. Alternatively, the commenter suggested that the final 
regulations could apply rules similar to the rules of section 907. 
Finally, the commenter suggested that the inadequate substantiation 
rule in Sec.  1.904-5T(c)(4)(iii) should be revised to conform to the 
rule in Sec.  1.904-7T(f)(4)(iii), which provides that the Commissioner 
will allocate the undistributed earnings and taxes in the non-look-
through pools to the foreign corporation's passive category only if the 
Commissioner determines that the look-through characterization of such 
earnings and taxes cannot reasonably be determined based on the 
available information. The IRS and the Treasury Department agree with 
this latter suggestion, and the rule in Sec.  1.904-5(c)(4)(iii) of the 
final regulations adopts this comment.

C. Application of Section 904(h) to 10/50 Corporations

    For purposes of the section 904 foreign tax credit limitation, 
section 904(h) (section 904(g) prior to redesignation in the AJCA) 
provides that certain income derived from a United States-owned foreign 
corporation which would be treated as foreign source income under other 
Code provisions is

[[Page 27870]]

treated as U.S. source income. This resourcing rule applies to certain 
payments of interest and dividends by a United States-owned foreign 
corporation as well as inclusions in gross income under sections 951(a) 
and 1293 to the extent the payments or inclusions are attributable to 
income of the United States-owned foreign corporation from sources 
within the United States. Section 904(h)(6) generally defines a United 
States-owned foreign corporation as any foreign corporation if United 
States persons (as defined in section 7701(a)(30)) hold 50 percent or 
more of either the total combined voting power of all classes of voting 
stock or the total value of the stock.
    Section 1.904-5(m) provides rules for the resourcing of certain 
amounts received or accrued (or treated as received or accrued) by a 
United States shareholder (as defined in section 951(b)) from a United 
States-owned foreign corporation. Section 1.904-5T(m)(1) of the 2006 
temporary regulations clarified that the resourcing rule applies not 
only to CFCs but also to 10/50 corporations that meet the definition of 
a United States-owned foreign corporation, and Sec.  1.904-5T(m)(2)(ii) 
and (4) provide rules for resourcing interest and dividend payments 
from 10/50 corporations.
    In the preamble to the 2006 temporary regulations, the IRS and the 
Treasury Department stated that this revision clarified that the rules 
for resourcing interest and dividends also apply to a 10/50 corporation 
that meets the definition of a United States-owned foreign corporation.
    A commenter suggested that the inclusion of 10/50 corporations 
within the resourcing rule of Sec.  1.904-5T(m) was not simply a 
clarification and that the combination of referring to this provision 
as only a clarification and the prospective application of the rule is 
confusing. In addition, the commenter requested guidance on the 
appropriate treatment of dividends from 10/50 corporations for 2003 
through 2006 under section 904(h) (section 904(g) as applicable for 
those years). The commenter suggested that Sec.  1.904-5T(m) be made 
retroactive to 2003 (or 2005 for taxpayers electing to apply the pre-
AJCA section 904(d) rules to assign dividends paid by 10/50 
corporations in their 2003 and 2004 taxable years to a single separate 
category for dividends from all 10/50 corporations) to match the 
retroactive effective date of the statutory changes to the look-through 
rules for 10/50 corporations and of the Sec.  1.904-7T rules for 
reconstructing non-look-through pools.
    This comment is not adopted. The IRS and the Treasury Department 
continue to believe that the revision is a clarification of existing 
law. A retroactive effective date is unnecessary, however, because the 
statute provides the applicable rule.
    A commenter suggested that, because section 904(h) applies exactly 
the same rule to both section 951(a) and section 1293 inclusions, Sec.  
1.904-5(m)(5) (other than the special rules for related person interest 
expense which are incorporated by cross-reference) should also 
reference section 1293 inclusions from United States-owned 10/50 
corporations. The IRS and the Treasury Department agree, and Sec.  
1.904-5(m)(5) of the final regulations adopts this comment.

D. Treatment of Earnings and Taxes Accumulated During a Non-Look-
Through Period

i. Reconstruction Method
    Section 1.904-7T(f)(2) of the 2006 temporary regulations provides 
that any undistributed earnings and foreign income taxes in the non-
look-through pools of a 10/50 corporation that were accumulated and 
paid as of the end of the 10/50 corporation's last pre-2003 taxable 
year are treated as if they were accumulated and paid during a period 
in which a distribution would have been eligible for look-through 
treatment. Section 1.904-7T(f)(4)(i) of the 2006 temporary regulations 
provides that in order to substantiate the look-through 
characterization of the earnings and taxes in the non-look-through 
pools, the taxpayer must make a reasonable, good-faith effort to 
reconstruct the non-look-through pools of earnings and taxes for each 
year in the non-look-through period, beginning with the first year in 
which earnings were accumulated in the non-look-through pool. Section 
1.904-7T(f)(4)(i) further provides that reconstruction will be based on 
reasonably available books and records and other relevant information, 
and must take into account earnings distributed and taxes deemed paid 
in the non-look-through period as if they were distributed and deemed 
paid pro rata from the amounts that were added to the non-look-through 
pools during the non-look-through period.
    In recognition of the difficulty in reconstructing the pools, the 
IRS and the Treasury Department stated in the preamble to the 2006 
temporary regulations that a reasonable approximation of the amounts 
properly included in the look-through pools, based on available records 
obtained through reasonable, good-faith efforts by the taxpayer, will 
adequately substantiate the reconstruction required by the statute.
    A commenter suggested that clarification of what constitutes other 
relevant information would be helpful. The IRS and the Treasury 
Department do not adopt this comment because the substantiation 
requirement requires evaluation of the facts and circumstances of each 
situation.
    With respect to earnings accumulated and foreign taxes paid in the 
2003 through 2006 taxable years, a commenter suggested that the rules 
in the 2006 temporary regulations concerning the look-through 
characterization and reconstruction of earnings and taxes in the non-
look-through pools need to be clarified to provide that taxpayers are 
required to determine the sub-characterization of earnings and taxes, 
if relevant. As an example, the commenter stated that if a 10/50 
corporation conducts a financing business but does not itself qualify 
as a financial services entity within the meaning of Sec.  1.904-
4(e)(3)(i), a qualifying shareholder of the 10/50 corporation must (if 
the shareholder does not elect the safe harbor method) determine what 
portion of the non-look-through earnings qualify as active financing 
income as defined in Sec.  1.904-4(e)(2)(i). Such a determination would 
be necessary in order to determine whether the income would be placed 
in the separate category for financial services income upon 
distribution to an upper-tier financial services entity. The IRS and 
the Treasury Department agree with this comment that sub-
characterization of earnings and taxes is required, if relevant, in 
determining the look-through characterization of earnings and taxes in 
the non-look-through pools and in reconstructing such pools. However, 
the IRS and the Treasury Department believe that the 2006 temporary 
regulations already require reconstruction as if look-through applied 
for all section 904 purposes, including any relevant sub-
characterization of the earnings and taxes pools. Accordingly, the 
final regulations adopt the rule in the 2006 temporary regulations 
without change.
ii. Safe Harbor
    Section 1.904-7T(f)(4)(ii) of the 2006 temporary regulations 
provides a safe harbor in reconstructing the non-look-through pools 
under which a taxpayer may allocate the earnings and taxes in the non-
look-through pools ratably to the look-through pools on the first day 
of the 10/50 corporation's first post-2002 taxable year in the same 
percentages as the taxpayer (or the qualified group member that owns 
the

[[Page 27871]]

10/50 corporation) properly characterizes the stock of the 10/50 
corporation in the separate categories for purposes of apportioning the 
taxpayer's (or qualified group member's) interest expense in its first 
taxable year ending after the first day of the 10/50 corporation's 
first post-2002 taxable year. If a taxpayer elects to use the safe 
harbor method with respect to a 10/50 corporation that uses the 
modified gross income method to apportion interest expense for the 10/
50 corporation's first post-2002 taxable year, earnings and taxes in 
the non-look-through pools are allocated to the look-through pools 
based on an average of the 10/50 corporation's modified gross income 
ratios for its taxable years beginning in 2003 and 2004. The IRS and 
the Treasury Department stated in the preamble to the 2006 temporary 
regulations that the two-year base period rule is necessary to avoid 
potential distortions associated with allocating earnings and taxes 
from the non-look-through pool to the look-through pools based on the 
10/50 corporation's modified gross income for just one taxable year.
    A commenter suggested that other potential distortions are not 
addressed in Sec.  1.904-7T(f)(4)(ii), such as instances in which a 
material change in the foreign corporation's operations (or asset 
composition) would distort the characterization of the non-look-through 
earnings and taxes under the safe harbor method. The commenter 
suggested that conditioning the use of the safe harbor method on the 
lack of any material change in the foreign corporation's operations, 
structure, assets or income from the non-look-through period would 
reduce the likelihood of a distortion.
    The IRS and the Treasury Department acknowledge that the safe 
harbor method does not address all potential distortions. However, the 
purpose of the safe harbor method is to provide certainty and to 
minimize administrative burdens. The IRS and the Treasury Department 
believe that revising the safe harbor method to reflect the commenter's 
suggestion would diminish these benefits of the safe harbor method.
    A commenter also suggested that the regulations should include 
guidance on how the safe harbor method election is to be made and the 
time frame for making the election. The commenter suggested that 
taxpayers should be allowed to elect the safe harbor method 
retroactively, on an amended return or during audit.
    The IRS and the Treasury Department agree with this comment. The 
final regulations provide that taxpayers may choose to use the safe 
harbor method on either timely filed or amended tax returns or during 
audit. However, if a taxpayer chooses to use the safe harbor method on 
an amended return or in the course of an audit, the taxpayer must make 
appropriate adjustments to eliminate any duplicate benefits arising 
from application of the safe harbor method to taxable years that are 
not open for assessment. A taxpayer's choice to use the safe harbor 
method is evidenced by simply employing the method. No separate 
statement need be filed.
    In addition, the final regulations clarify that the safe harbor 
method is only available as a transition rule for taxpayers who were 
required to characterize the stock of the foreign corporation for 
purposes of apportioning interest expense in the taxpayer's first 
taxable year ending after the first day of the foreign corporation's 
first post-2002 taxable year. The safe harbor is not available to 
determine the look-through treatment of earnings accumulated by a 
foreign corporation that did not have a shareholder that was entitled 
to look-through treatment in such a year.
iii. Treatment of a Deficit Accumulated in a Non-Look-Through Period
    Section 1.904-7T(f)(5) of the 2006 temporary regulations provides 
that if there is an accumulated deficit in the non-look-through pool of 
a 10/50 corporation or a CFC as of the end of the foreign corporation's 
last pre-2003 taxable year, the deficit and associated taxes, if any, 
are treated as if they had been accumulated and paid during a look-
through period. The earnings and deficits in earnings making up the 
accumulated deficit are assigned to the look-through pools based on 
where the foreign corporation's income and expenses or losses would 
have been assigned had they been incurred during a look-through period, 
or, if the taxpayer uses the safe harbor method, the deficit is 
allocated based on how the stock of the foreign corporation is properly 
characterized for interest expense apportionment purposes.
    A commenter suggested that the regulations should clarify that, for 
shareholders not using the safe harbor method, one or more separate 
income categories could have positive earnings, while one or more 
separate income categories could have a greater deficit. Thus, for 
example, if a 10/50 corporation had a $100 deficit accumulated in its 
non-look-through pool as of the end of its last pre-2003 taxable year, 
the deficit could consist of a $200 deficit in general limitation 
income and $100 earnings in the separate category for shipping income.
    The IRS and the Treasury Department believe that Sec.  1.904-
7T(f)(5) of the 2006 temporary regulations is clear that, as part of 
reconstruction of a non-look-through pool that contains an accumulated 
deficit, one or more separate income categories could have positive 
earnings, while one or more separate income categories could have a 
greater deficit, and that therefore, the rule does not need to be 
revised to reflect the comment.
iv. Section 952(c) Recapture Accounts
    In response to a comment, Sec.  1.904-7(f)(7) of the final 
regulations provides that section 952(c)(2) recapture accounts 
maintained by a CFC with respect to dividends received from a 10/50 
corporation that were subject to the earnings and profits limitation of 
section 952(c)(1) are allocated to separate categories in the same 
manner as the associated post-1986 undistributed earnings.
v. GOZA Election
    Conforming changes are made to the transition rules at Sec.  1.904-
7(f)(9) for taxpayers electing to defer the applicability of the look-
through rules for two years to reflect changes in response to comments 
made with respect to the general transition rules of Sec.  1.904-
7(f)(7).

E. Pre-Acquisition E&P

    Section 904(d)(4)(C)(i)(II), as amended by the AJCA, provides that 
the Secretary may prescribe regulations regarding the treatment of 
distributions out of earnings and profits of a 10/50 corporation for 
periods before the taxpayer's acquisition of the stock to which the 
distributions relate (pre-acquisition E&P). Such distributions may be 
out of post-1986 undistributed earnings accumulated by a 10/50 
corporation before the specific shareholder acquired its stock or out 
of pre-1987 accumulated profits accumulated before the 10/50 
corporation had any qualifying shareholder. The 2006 temporary 
regulations extend look-through treatment to dividends out of earnings 
and profits accumulated in non-look-through periods during which a 10/
50 corporation or a CFC had no qualifying shareholder and do not 
restrict look-through treatment of dividends paid to a new qualifying 
shareholder of an existing 10/50 corporation. The preamble to the 2006 
temporary regulations stated that the IRS and the Treasury Department 
believe that look-

[[Page 27872]]

through treatment of pre-acquisition earnings is the more appropriate 
policy result than passive category treatment, if look-through 
characterization can be adequately substantiated under Sec. Sec.  
1.904-5T(c)(4)(iii) and 1.904-7T(f)(4).
    A commenter suggested that the extension of look-through treatment 
to pre-acquisition E&P is inappropriate because the liberalized cross-
crediting of foreign taxes permitted by this treatment may encourage 
tax-motivated acquisitions in order to traffic in excess foreign taxes. 
The commenter suggested that the IRS and the Treasury Department 
exercise the regulatory authority under section 904(d)(4)(C)(i)(II) to 
create new separate categories for pre-acquisition earnings and 
profits.
    This comment is not adopted. The IRS and the Treasury Department 
continue to believe that look-through treatment of pre-acquisition 
earnings, where the earnings and taxes are substantiated, is the more 
appropriate policy result. Moreover, denying look-through treatment to 
dividends of earnings of a 10/50 corporation accumulated prior to a 
specific shareholder's acquisition of stock entails unacceptable 
administrative complexity associated with maintaining multiple sets of 
look-through pools starting on different dates for different 
shareholders. Accordingly, the final regulations adopt the rule in the 
2006 temporary regulations without change.

IV. Recapture of an Overall Foreign Loss or Separate Limitation Loss 
Incurred in a Separate Category for Dividends From a 10/50 Corporation

    Section 1.904(f)-12T(g)(1) of the 2006 temporary regulations 
provides that where a taxpayer had an overall foreign loss (OFL) or 
separate limitation loss (SLL) in a separate category for dividends 
from a 10/50 corporation, the OFL or SLL account is recaptured in 
subsequent taxable years out of income in the same separate categories 
in which the stock of the 10/50 corporation is properly characterized 
for purposes of apportioning the taxpayer's interest expense in its 
first taxable year in which dividends from the 10/50 corporation are 
eligible for look-through treatment (that is, its first taxable year 
ending after the first day of the 10/50 corporation's first post-2002 
taxable year).
    A commenter suggested that a rule providing for recapture of the 
OFL or SLL from the other separate categories in the same proportions 
that post-OFL or SLL dividends from the 10/50 corporation would have 
been assigned to such other separate categories had look-through 
applied would be more consistent with Sec.  1.904-2T(h)(1) and (2) 
(carryovers of excess foreign taxes from 10/50 baskets) and Sec.  
1.904-7T(f)(2) and (3) (characterization of non-look-through pools as 
if look-through had applied) that generally take the approach of 
following the consequences that would have applied if look-through had 
always been in effect. This comment is not adopted. The IRS and the 
Treasury Department stated in the preamble to the 2006 temporary 
regulations and continue to believe that recapturing losses from income 
earned in subsequent years is a forward-looking concept, and that 
reallocating OFL and SLL accounts based on the interest expense 
apportionment ratio (as opposed to, for example, reallocating losses 
based on reconstructed non-look-through pools) is consistent with that 
concept.

V. Regulations Under Section 964

 A. Tax Elections, Adoptions of Method of Accounting or Taxable Year, 
and Changes in Method of Accounting or Taxable Year Made on Behalf of a 
CFC or 10/50 Corporation

    The 2006 temporary regulations at Sec.  1.964-1T(c)(2) and (3) 
provide rules allowing the majority domestic corporate shareholders of 
a 10/50 corporation to make an election, adopt a method of accounting 
or taxable year, or change a method of accounting or taxable year on 
behalf of the 10/50 corporation. The 2006 temporary regulations also 
allow the controlling United States shareholders of a CFC to make an 
election, adopt a method of accounting or taxable year, or change a 
method of accounting or taxable year on behalf of the CFC. Section 
1.964-1T(c)(2) provides that for the first taxable year of a foreign 
corporation beginning after April 25, 2006, in which such foreign 
corporation first qualifies as a CFC or 10/50 corporation, any method 
of accounting or taxable year allowable under this section may be 
adopted or elected by such foreign corporation or on its behalf 
notwithstanding that, in previous years, its books or financial 
statements were prepared on a different basis, and notwithstanding that 
such election is required by the Code or regulations to be made in a 
prior taxable year. Section 1.964-1T(c)(6) further provides that such 
actions may be deferred until the first year in which the computation 
of the foreign corporation's earnings and profits is significant for 
U.S. tax purposes, and includes a nonexclusive list of significant 
events for taxable years beginning after April 25, 2006.
    Section 1.964-1T(c)(4) of the 2006 temporary regulations 
acknowledges that a 10/50 corporation may have had a significant event 
in taxable years beginning on or before April 25, 2006, such as a 
distribution with respect to which the corporation's shareholder could 
claim a deemed-paid foreign tax credit under section 902. In order to 
determine the allowable foreign tax credit, at the time of the 
distribution the 10/50 corporation's domestic corporate shareholder 
would have had to compute the 10/50 corporation's earnings and profits, 
even though no procedure was then available for the controlling 
domestic shareholders to adopt or elect accounting methods on the 10/50 
corporation's behalf. Section 1.964-1T(c)(4) provides that in this 
situation the 10/50 corporation's earnings and profits shall be 
computed as if no accounting method elections were made and any 
permissible accounting method not requiring an election and reflected 
in the books of account regularly maintained by the 10/50 corporation 
for purposes of accounting to its shareholders had been adopted. 
Thereafter, in taxable years beginning after April 25, 2006, the 10/50 
corporation, or its controlling domestic shareholders, must obtain the 
consent of the Commissioner in order to change a particular accounting 
method or methods (or its taxable year) pursuant to the applicable 
revenue procedure. A commenter suggested that in post-2006 years the 
controlling domestic shareholders of a 10/50 corporation should be 
permitted to change accounting methods on its behalf without obtaining 
the consent of the Commissioner or making adjustments to the 10/50 
corporation's earnings and profits under the principles of section 481 
to prevent the duplication or omission of amounts attributable to 
previous years. This comment is not adopted. The IRS and the Treasury 
Department believe that it would be inappropriate to give the 
controlling domestic shareholders of a 10/50 corporation this type of 
``fresh start.''
    A commenter recommended simplifying the procedures in Sec.  1.964-
1T(c)(3) of the 2006 temporary regulations by which controlling 
domestic shareholders may make an election or adopt or change a method 
of accounting or taxable year on behalf of a foreign corporation. 
Specifically, the commenter suggested that Sec.  1.964-1T(c)(3)(i) and 
(ii) be revised to provide that where a United States shareholder 
changes a method of accounting on behalf of a CFC of which it is the 
sole shareholder, such shareholder need file

[[Page 27873]]

only the original Form 3115 with its tax return, and need not file the 
statement (described in Sec.  1.964-1T(c)(3)(ii)) that is required to 
be filed with each controlling domestic shareholder's tax return. The 
IRS and the Treasury Department agree with the comment and believe it 
is equally applicable to changes in the taxable year of the CFC. 
Accordingly, Sec.  1.964-1(c)(3)(ii) of the final regulations provides 
that in the case of a controlling domestic shareholder that is the sole 
shareholder of a CFC, no separate statement need be filed if the 
information described in Sec.  1.964-1(c)(3)(ii) is included on Form 
5471 (Information Return of U.S. Persons With Respect to Certain 
Foreign Corporations) and Form 3115 (Application for Change in 
Accounting Method) or Form 1128 (Application to Adopt, Change or Retain 
a Tax Year), as applicable, filed with respect to the CFC with the 
shareholder's return for such taxable year.

B. Section 481(a) Adjustments

    Prior to its expiration, Sec.  1.964-1T(g)(5) provided that 
adjustments to the appropriate separate category of earnings and 
profits and income of the controlled foreign corporation was required 
using the principles of section 481(a) to prevent any duplication or 
omission of amounts attributable to previous years that would otherwise 
result from any election or adoption of a method of accounting. This 
provision was cross-referenced in Sec.  1.964-1T(c)(4) of the 2006 
temporary regulations. Commenters requested clarification regarding the 
mechanics of making the adjustments according to the principles of 
section 481(a), such as the period over which the section 481(a) 
adjustment is spread and whether a correlative section 481(a) 
adjustment should be made at the domestic shareholder level in order to 
capture an increased subpart F inclusion that would have been generated 
had earnings and profits initially been determined using the method 
subsequently elected or adopted. One commenter suggested that the 
regulations state specifically that the applicable domestic principles 
should apply so that the section 481 adjustment would be taken into 
account in determining the current earnings and profits of the CFC or 
10/50 corporation beginning with the year of change and for the same 
period as the adjustment is taken into account for purposes of 
computing taxable income.
    In response to the comment, Sec.  1.964-1(c)(2) of the final 
regulations provides that adjustments to the appropriate separate 
category (as defined in Sec.  1.904-5(a)(1)) of earnings and profits 
and income of the foreign corporation shall be required under section 
481 to prevent any duplication or omission of amounts attributable to 
previous years that would otherwise result from any change in a method 
of accounting. The details concerning the section 481 adjustment are 
addressed in applicable revenue procedures. See, for example, Rev. 
Proc. 2008-52, 2008-36 IRB 587.

C. Miscellaneous Cross-References

    The 2006 temporary regulations included in Sec.  1.964-1T(c)(4) 
cross-references to expired Sec.  1.964-1T(g) that are updated in the 
final regulations. In addition, Sec.  1.964-1(c)(2) of the final 
regulations adds cross-references to Sec. Sec.  1.985-5, 1.985-6, and 
1.986-7, which provide that a qualified business unit must make 
adjustments to its earnings and profits when it changes its functional 
currency or begins to use the dollar approximate separate transactions 
method of accounting.
    Section 1.964-1(b)(1)(v) includes a cross-reference to ``paragraph 
(d) of this section.'' Because of revisions to Sec.  1.964-1, that 
cross-reference and a similar cross-reference in Sec.  1.989(b)-1 were 
no longer effective. The final regulations replace the cross-references 
to paragraph (d) with the appropriate cross-reference to section 988 
and the regulations under that section.

Special Analyses

    It has been determined that this Treasury decision is not a 
significant regulatory action as defined in Executive Order 12866. 
Therefore, a regulatory assessment is not required. It has also been 
determined that section 553(b) of 5 U.S.C. chapter 5 does not apply to 
these regulations, and, because the regulations do not impose a 
collection of information on small entities, the Regulatory Flexibility 
Act, 5 U.S.C. chapter 6, does not apply. Pursuant to section 7805(f) of 
the Code, the notice of proposed rulemaking preceding this regulation 
and temporary regulations were submitted to the Chief Counsel for 
Advocacy of the Small Business Administration for comment on their 
impact on small businesses.

Drafting Information

    The principal authors of the final regulations are Richard Chewning 
and Jeffrey Parry of the Office of Associate Chief Counsel 
(International). However, other personnel from the Treasury Department 
and the IRS participated in their development.

List of Subjects

26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

 26 CFR Part 602

    Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

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

PART 1--INCOME TAXES

0
Paragraph 1. The authority for part 1 continues to read in part as 
follows:

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


0
Par. 2. Section 1.861-9 is amended by removing paragraphs (h)(5)(iii) 
and (i)(4), revising paragraphs (a), (b), (c), (d), (e), (f), and 
(g)(1)(i), and adding paragraph (k), to read as follows:


1.861-9  Allocation and apportionment of interest expense.

    (a) through (f)(3)(i) [Reserved]. For further guidance, see Sec.  
1.861-9T(a) through (f)(3)(i).
    (f)(3)(ii) Manner of election. The election shall be made by filing 
the statement and providing the written notice described in Sec.  
1.964-1(c)(3)(ii) and (iii), respectively, at the time and in the 
manner described therein. For further guidance, see Sec.  1.861-
9T(f)(3)(ii).
    (f)(3)(iii) and (iv) [Reserved]. For further guidance, see Sec.  
1.861-9T(f)(3)(iii) and (iv).
    (4) Noncontrolled section 902 corporations--(i) In general. For 
purposes of computing earnings and profits of a noncontrolled section 
902 corporation (as defined in section 904(d)(2)(E)) for Federal tax 
purposes, the interest expense of a noncontrolled section 902 
corporation may be apportioned using either the asset method described 
in Sec.  1.861-9T(g) or the modified gross income method described in 
Sec.  1.861-9T(j). A noncontrolled section 902 corporation that is not 
a controlled foreign corporation may elect to use a different method of 
apportionment than that elected by one or more of its shareholders. A 
noncontrolled section 902 corporation must use the same method of 
apportionment with respect to all its domestic corporate shareholders.
    (ii) Manner of election. The election to use the asset method 
described in Sec.  1.861-9T(g) or the modified gross income method 
described in Sec.  1.861-9T(j) may be made either by the

[[Page 27874]]

noncontrolled section 902 corporation or by the majority domestic 
corporate shareholders (as defined in Sec.  1.964-1(c)(5)(ii)) on 
behalf of the noncontrolled section 902 corporation. The election shall 
be made by filing the statement and providing the written notice 
described in Sec.  1.964-1(c)(3)(ii) and (iii), respectively, at the 
time and in the manner described therein. For further guidance, see 
Sec.  1.861-9T(f)(4)(ii).
    (iii) Stock characterization. In general, the stock of a 
noncontrolled section 902 corporation shall be characterized in the 
hands of any domestic corporation that meets the ownership requirements 
of section 902(a) with respect to the noncontrolled section 902 
corporation, or in the hands of any member of the same qualified group 
as defined in section 902(b)(2), using the same method that the 
noncontrolled section 902 corporation uses to apportion its interest 
expense. Stock in a noncontrolled section 902 corporation shall be 
characterized as a passive category asset in the hands of any such 
shareholder that fails to meet the substantiation requirements of Sec.  
1.904-5(c)(4)(iii), or in the hands of any shareholder that is not 
eligible to compute an amount of foreign taxes deemed paid with respect 
to a dividend from the noncontrolled section 902 corporation for the 
taxable year. See Sec.  1.861-12(c)(4).
    (f)(5) through (g)(1)(i) [Reserved]. For further guidance, see 
Sec.  1.861-9T(f)(5) through (g)(1)(i).
* * * * *
    (k) Effective/applicability date. Paragraph (h)(5) of this section 
applies to taxable years beginning after December 31, 1989. Paragraph 
(i) of this section applies to taxable years beginning on or after 
March 26, 2004. Paragraphs (f)(3)(ii) and (4) of this section apply to 
taxable years of shareholders ending on or after April 20, 2009. See 26 
CFR 1.861-9T(f)(3)(ii)(last sentence) and (4) (revised as of April 1, 
2009) for rules applicable to taxable years of shareholders ending 
after the first day of the first taxable year of the noncontrolled 
section 902 corporation beginning after December 31, 2002, and ending 
before April 20, 2009.

0
Par. 3. Section 1.861-9T is amended as follows:
0
1. Remove paragraph (b)(6)(viii).
0
2. Revise the last sentence of paragraph (f)(3)(ii) and paragraph 
(f)(4).
0
3. Add paragraph (k).
    The revisions and additions read as follows:


Sec.  1.861-9T  Allocation and apportionment of interest expense 
(temporary).

* * * * *
    (f) * * *
    (3) * * *
    (ii) * * * For guidance relating to the time and manner of this 
election, see Sec.  1.861-9(f)(3)(ii).
* * * * *
    (4) * * * For further guidance, see Sec.  1.861-9(f)(4).
* * * * *
    (k) Effective/applicability dates. Paragraph (b)(6) of this section 
applies to losses on any transaction described in paragraph (b)(6)(i) 
of this section that was entered into after September 14, 1988. 
Paragraph (b)(6) of this section also applies to any gain that was 
realized on any transaction described in paragraph (b)(6)(i) of this 
section that was entered into after August 11, 1989. Taxpayers may also 
apply paragraph (b)(6) of this section to any gain that was realized on 
any transaction described in paragraph (b)(6)(i) of this section that 
was entered into after September 14, 1988, and on or before August 11, 
1989, if the taxpayer can demonstrate to the satisfaction of the 
Commissioner that substantially all of the arrangements described in 
paragraph (b)(6)(i) of this section to which the taxpayer became a 
party during that interim period were identified on the taxpayer's 
books and records with the liabilities of the taxpayer in a 
substantially contemporaneous manner and that all losses and expenses 
that are subject to the rules of paragraph (b)(6) of this section were 
treated in the same manner as interest expense. For this purpose, 
arrangements that were identified in a substantially contemporaneous 
manner with the taxpayer's assets shall be ignored. For further 
guidance, see Sec.  1.861-9(k).

0
Par. 4. Section 1.861-12 is added as follows:


Sec.  1.861-12  Characterization rules and adjustments for certain 
assets.

    (a) through (c)(1) [Reserved]. For further guidance, see Sec.  
1.861-12T(a) through (c)(1).
    (2) Basis adjustment for stock in nonaffiliated 10 percent owned 
corporations-- (i) Taxpayers using the tax book value method--(A) 
General rule. For purposes of apportioning expenses on the basis of the 
tax book value of assets, the adjusted basis of any stock in a 10 
percent owned corporation owned by the taxpayer either directly or, for 
taxable years beginning after April 25, 2006, indirectly through a 
partnership or other pass-through entity shall be--
    (1) Increased by the amount of the earnings and profits of such 
corporation (and of lower-tier 10 percent owned corporations) 
attributable to such stock and accumulated during the period the 
taxpayer or other members of its affiliated group held 10 percent or 
more of such stock; or
    (2) Reduced (but not below zero) by any deficit in earnings and 
profits of such corporation (and of lower-tier 10 percent owned 
corporations) attributable to such stock for such period.
    (c)(2)(i)(B) through (c)(3) [Reserved] For further guidance, see 
Sec.  1.861-12T(c)(2)(i)(B) through (c)(3).
    (4) Characterization of stock of noncontrolled section 902 
corporations--(i) General rule. The principles of Sec.  1.861-12T(c)(3) 
shall apply to stock in a noncontrolled section 902 corporation (as 
defined in section 904(d)(2)(E)). Accordingly, stock in a noncontrolled 
section 902 corporation shall be characterized as an asset in the 
various separate limitation categories on the basis of either the asset 
method described in Sec.  1.861-12T(c)(3)(ii) or the modified gross 
income method described in Sec.  1.861-12T(c)(3)(iii). Stock in a 
noncontrolled section 902 corporation the interest expense of which is 
apportioned on the basis of assets shall be characterized in the hands 
of its domestic shareholders (as defined in Sec.  1.902-1(a)(1)) under 
the asset method described in Sec.  1.861-12T(c)(3)(ii). Stock in a 
noncontrolled section 902 corporation the interest expense of which is 
apportioned on the basis of gross income shall be characterized in the 
hands of its domestic shareholders under the gross income method 
described in Sec.  1.861-12T(c)(3)(iii).
    (ii) Nonqualifying shareholders. Stock in a noncontrolled section 
902 corporation shall be characterized as a passive category asset in 
the hands of a shareholder that is not eligible to compute an amount of 
foreign taxes deemed paid with respect to a dividend from the 
noncontrolled section 902 corporation for the taxable year, and in the 
hands of any shareholder with respect to whom look-through treatment is 
not substantiated. See Sec.  1.904-5(c)(4)(iii).
    (5) Effective/applicability date. Paragraphs (c)(2)(i)(A) and (4) 
of this section apply to taxable years of shareholders ending on or 
after April 20, 2009. See 26 CFR Sec.  1.861-12T(c)(2)(i) introductory 
text, (2)(i)(A), (2)(i)(B), and (4) (revised as of April 1, 2009) for 
rules applicable to taxable years of shareholders ending after the 
first day of the first taxable year of the

[[Page 27875]]

noncontrolled section 902 corporation beginning after December 31, 
2002, and ending before April 20, 2009.
    (d) through (j) [Reserved]. For further guidance, see Sec.  1.861-
12T(d) through (j).

0
Par. 5. Section 1.861-12T is amended as follows:
0
1. Paragraph (c)(2)(i) introductory text is removed.
0
2. Paragraph (c)(2)(i)(A) is revised.
0
3. Paragraph (c)(2)(i)(B) is removed.
0
4. A paragraph heading is added to the undesignated text following 
paragraph (c)(2), which is designated as new paragraph (c)(2)(i)(B).
0
5. Paragraph (c)(4) is revised.
0
6. A new paragraph (c)(5) is added.
    The revisions and additions read as follows:


Sec.  1.861-12T  Characterization rules and adjustments for certain 
assets (temporary).

* * * * *
    (c) * * *
    (2)(i)(A) [Reserved]. For further guidance, see Sec.  1.861-
12(c)(2)(i)(A).
    (B) Computational rules. * * *
    (4) [Reserved]. For further guidance, see Sec.  1.861-12(c)(4).
    (5) [Reserved]. For further guidance, see Sec.  1.861-12(c)(5).
* * * * *

0
Par. 6. Section 1.902-1 is amended by revising paragraphs (a)(4)(ii), 
(a)(6), (a)(7), (a)(8)(i), (c)(8), (d)(1), (d)(2)(i), and (g) to read 
as follows:


Sec.  1.902-1  Credit for domestic corporate shareholder of a foreign 
corporation for foreign income taxes paid by the foreign corporation.

    (a) * * *
    (4) * * *
    (ii) Fourth-, fifth-, or sixth-tier corporation. In the case of 
dividends paid to a third-, fourth-, or fifth-tier corporation by a 
foreign corporation in a taxable year beginning after August 5, 1997, 
the foreign corporation is a fourth-, fifth-, or sixth-tier 
corporation, respectively, if at the time the dividend is paid, the 
corporation receiving the dividend owns at least 10 percent of the 
foreign corporation's voting stock, the chain of foreign corporations 
that includes the foreign corporation is connected through stock 
ownership of at least 10 percent of their voting stock, the domestic 
shareholder in the first-tier corporation in such chain indirectly owns 
at least 5 percent of the voting stock of the foreign corporation 
through such chain, such corporation is a controlled foreign 
corporation (as defined in section 957) and the domestic shareholder is 
a United States shareholder (as defined in section 951(b)) in the 
foreign corporation. Taxes paid by a fourth-, fifth-, or sixth-tier 
corporation shall be taken into account in determining post-1986 
foreign income taxes only if such taxes are paid with respect to 
taxable years beginning after August 5, 1997, in which the corporation 
was a controlled foreign corporation.
* * * * *
    (6) Upper- and lower-tier corporations. In the case of a sixth-tier 
corporation, the term upper-tier corporation means a first-, second-, 
third-, fourth-, or fifth-tier corporation. In the case of a fifth-tier 
corporation, the term upper-tier corporation means a first-, second-, 
third-, or fourth-tier corporation. In the case of a fourth-tier 
corporation, the term upper-tier corporation means a first-, second-, 
or third-tier corporation. In the case of a third-tier corporation, the 
term upper-tier corporation means a first- or second-tier corporation. 
In the case of a second-tier corporation, the term upper-tier 
corporation means a first-tier corporation. In the case of a first-tier 
corporation, the term lower-tier corporation means a second-, third-, 
fourth-, fifth-, or sixth-tier corporation. In the case of a second-
tier corporation, the term lower-tier corporation means a third-, 
fourth-, fifth-, or sixth-tier corporation. In the case of a third-tier 
corporation, the term lower-tier corporation means a fourth-, fifth-, 
or sixth-tier corporation. In the case of a fourth-tier corporation, 
the term lower-tier corporation means a fifth- or sixth-tier 
corporation. In the case of a fifth-tier corporation, the term lower-
tier corporation means a sixth-tier corporation.
    (7) Foreign income taxes. The term foreign income taxes means 
income, war profits, and excess profits taxes as defined in Sec.  
1.901-2(a), and taxes included in the term income, war profits, and 
excess profits taxes by reason of section 903, that are imposed by a 
foreign country or a possession of the United States, including any 
such taxes deemed paid by a foreign corporation under this section. 
Foreign income, war profits, and excess profits taxes shall not include 
amounts excluded from the definition of those taxes pursuant to section 
901 and the regulations under that section. See section 901(f) and (i) 
and paragraph (c)(5) of this section. Foreign income, war profits, and 
excess profits taxes also shall not include taxes for which a credit is 
disallowed under section 901 and the regulations under section 901. See 
section 901(j), (k), and (l), and paragraphs (c)(4) and (8) of this 
section.
    (8) Post-1986 foreign income taxes--(i) In general. Except as 
provided in paragraphs (a)(10) and (13) of this section, the term post-
1986 foreign income taxes of a foreign corporation means the sum of the 
foreign income taxes paid, accrued, or deemed paid in the taxable year 
of the foreign corporation in which it distributes a dividend plus the 
foreign income taxes paid, accrued, or deemed paid in the foreign 
corporation's prior taxable years beginning after December 31, 1986, to 
the extent the foreign taxes were not attributable to dividends 
distributed to, or earnings otherwise included (for example, under 
section 304, 367(b), 551, 951(a), 1248, or 1293) in the income of, a 
foreign or domestic shareholder in prior taxable years. Except as 
provided in paragraph (b)(4) of this section, foreign taxes paid or 
deemed paid by the foreign corporation on or with respect to earnings 
that were distributed or otherwise removed from post-1986 undistributed 
earnings in prior post-1986 taxable years shall be removed from post-
1986 foreign income taxes regardless of whether the shareholder is 
eligible to compute an amount of foreign taxes deemed paid under 
section 902, and regardless of whether the shareholder in fact chose to 
credit foreign income taxes under section 901 for the year of the 
distribution or inclusion. Thus, if an amount is distributed or deemed 
distributed by a foreign corporation to a United States person that is 
not a domestic shareholder within the meaning of paragraph (a)(1) of 
this section (for example, an individual or a corporation that owns 
less than 10% of the foreign corporation's voting stock), or to a 
foreign person that does not meet the definition of an upper-tier 
corporation under paragraph (a)(6) of this section, then although no 
foreign income taxes shall be deemed paid under section 902, foreign 
income taxes attributable to the distribution or deemed distribution 
that would have been deemed paid had the shareholder met the ownership 
requirements of paragraphs (a)(1) through (4) of this section shall be 
removed from post-1986 foreign income taxes. Further, if a domestic 
shareholder chooses to deduct foreign taxes paid or accrued for the 
taxable year of the distribution or inclusion, it shall nonetheless be 
deemed to have paid a proportionate share of the foreign corporation's 
post-1986 foreign income taxes under section 902(a), and the foreign 
income taxes deemed paid must be removed from post-1986 foreign income 
taxes. In the case of a foreign corporation the foreign income taxes of 
which are determined based on an accounting period of less than one 
year,

[[Page 27876]]

the term year means that accounting period. See sections 441(b)(3) and 
443.
* * * * *
    (c) * * *
    (8) Effect of certain liquidations, reorganizations, or similar 
transactions on certain foreign taxes paid or accrued in taxable years 
beginning on or before August 5, 1997--(i) General rule. 
Notwithstanding the effect of any liquidation, reorganization, or 
similar transaction, foreign taxes paid or accrued by a member of a 
qualified group (as defined in section 902(b)(2)) shall not be eligible 
to be deemed paid if they were paid or accrued in a taxable year 
beginning on or before August 5, 1997, by a corporation that was a 
fourth-, fifth- or sixth-tier corporation with respect to the taxpayer 
on the first day of the corporation's first taxable year beginning 
after August 5, 1997.
    (ii) Example. The following examples illustrate the application of 
this paragraph (c)(8):

    Example. P, a domestic corporation, has owned 100 percent of the 
voting stock of foreign corporation S at all times since January 1, 
1987. Until June 30, 2002, S owned 100 percent of the voting stock 
of foreign corporation T, T owned 100 percent of the voting stock of 
foreign corporation U, and U owned 100 percent of the voting stock 
of foreign corporation V. P, S, T, U, and V each use the calendar 
year as their U.S. taxable year. Thus, beginning in 1998 V was a 
fourth-tier controlled foreign corporation, and its foreign taxes 
paid or accrued in 1998 and later taxable years were eligible to be 
deemed paid. On June 30, 2002, T was liquidated, causing S to 
acquire 100 percent of the stock of U. As a result, V became a 
third-tier controlled foreign corporation. In 2003, V paid a 
dividend to U. Under paragraph (c)(8) of this section, foreign taxes 
paid by V in taxable years beginning before 1998 are not taken into 
account in computing the foreign taxes deemed paid with respect to 
the dividend paid by V to U.

    (d) Dividends from controlled foreign corporations and 
noncontrolled section 902 corporations--(1) General rule. If a dividend 
is described in paragraphs (d)(1)(i) through (iv) of this section, the 
following rules apply. If a dividend is paid out of post-1986 
undistributed earnings or pre-1987 accumulated profits of a foreign 
corporation attributable to more than one separate category, the amount 
of foreign income taxes deemed paid by the domestic shareholder or the 
upper-tier corporation under section 902 and paragraph (b) of this 
section shall be computed separately with respect to the post-1986 
undistributed earnings or pre-1987 accumulated profits in each separate 
category out of which the dividend is paid. See Sec.  1.904-5(c)(4) and 
(i), and paragraph (d)(2) of this section. The separately computed 
deemed-paid taxes shall be added to other taxes paid by the domestic 
shareholder or upper-tier corporation with respect to income in the 
appropriate separate category. The rules of this paragraph (d)(1) apply 
to dividends received by --
    (i) A domestic shareholder that is a United States shareholder (as 
defined in section 951(b) or section 953(c)) from a first-tier 
corporation that is a controlled foreign corporation;
    (ii) A domestic shareholder from a first-tier corporation that is a 
noncontrolled section 902 corporation;
    (iii) An upper-tier controlled foreign corporation from a lower-
tier controlled foreign corporation if the corporations are related 
look-through entities within the meaning of Sec.  1.904-5(i) (see Sec.  
1.904-5(i)(3)); or
    (iv) A foreign corporation that is eligible to compute an amount of 
foreign taxes deemed paid under section 902(b)(1), from a controlled 
foreign corporation or a noncontrolled section 902 corporation (that 
is, both the payor and payee corporations are members of the same 
qualified group as defined in section 902(b)(2) (see Sec.  1.904-5 
(i)(4)).
    (2) Look-through--(i) Dividends. Any dividend distribution by a 
controlled foreign corporation or noncontrolled section 902 corporation 
to a domestic shareholder or a foreign corporation that is eligible to 
compute an amount of foreign taxes deemed paid under section 902(b)(1) 
shall be deemed paid pro rata out of each separate category of income. 
Any dividend distribution by a controlled foreign corporation to a 
controlled foreign corporation that is a related look-through entity 
within the meaning of Sec.  1.904-5(i)(3) shall also be deemed to be 
paid pro rata out of each separate category of income. See Sec. Sec.  
1.904-5(c)(4) and (i), and 1.904-7. The portion of the foreign income 
taxes attributable to a particular separate category that shall be 
deemed paid by the domestic shareholder or upper-tier corporation must 
be computed under the following formula:
[GRAPHIC] [TIFF OMITTED] TR11JN09.004

    (g) Effective/applicability dates. This section applies to any 
distribution made in and after a foreign corporation's first taxable 
year beginning on or after January 1, 1987, except that the provisions 
of paragraphs (a)(4)(ii), (a)(6), (a)(7), (a)(8)(i), and (c)(8) of this 
section and, except as provided in Sec.  1.904-7(f)(9), the provisions 
of paragraph (d) of this section apply to distributions made in taxable 
years of foreign corporations ending on or after April 20, 2009. See 26 
CFR 1.902-1T(a)(4)(ii), (a)(6), (a)(7), (a)(8)(i), and (c)(8) (revised 
as of April 1, 2009) for rules applicable to distributions made in 
taxable years of foreign corporations beginning after April 25, 2006, 
and ending before April 20, 2009, and 26 CFR 1.902-1T(d), except as 
provided in 26 CFR 1.904-7T(f)(9) (revised as of April 1, 2009), for 
rules applicable to distributions made in taxable years of foreign 
corporations beginning after December 31, 2002, and ending before April 
20, 2009.


Sec.  1.902-1T  [Removed]

0
Par. 7. Section 1.902-1T is removed.

0
Par. 8. Section 1.904-0 is amended by revising the section heading and 
the entries for Sec. Sec.  1.904-5(m), (m)(5), and (n), and 1.904-7(f) 
to read as follows:


Sec.  1.904-0  Outline of regulation provisions for section 904.

* * * * *


Sec.  1.904-5  Look-through rules as applied to controlled foreign 
corporations and other entities.

* * * * *
    (m) Application of section 904(h).
* * * * *
    (5) Treatment of inclusions under sections 951(a)(1)(A) and 1293.
* * * * *
    (n) Order of application of sections 904(d) and (h).

[[Page 27877]]

Sec.  1.904-7  Transition rules.

* * * * *
    (f) * * *
    (1) Definition of non-look-through pools.
    (2) Treatment of non-look-through pools of a noncontrolled 
section 902 corporation.
    (3) Treatment of non-look-through pools of a controlled foreign 
corporation.
    (4) Substantiation of look-through character of undistributed 
earnings and taxes in a non-look-through pool.
    (i) Reconstruction of earnings and taxes pools.
    (ii) Safe harbor method.
    (iii) Inadequate substantiation.
    (iv) Examples.
    (5) Treatment of a deficit accumulated in a non-look-through 
pool.
    (6) Treatment of pre-1987 accumulated profits.
    (7) Treatment of post-1986 undistributed earnings or a deficit 
of a controlled foreign corporation attributable to dividends from a 
noncontrolled section 902 corporation paid in taxable years 
beginning before January 1, 2003.
    (i) Look-through treatment of post-1986 undistributed earnings 
at controlled foreign corporation level.
    (ii) Look-through treatment of deficit in post-1986 
undistributed earnings at controlled foreign corporation level.
    (iii) Substantiation required for look-through treatment.
    (8) Treatment of distributions received by an upper-tier 
corporation from a lower-tier noncontrolled section 902 corporation, 
including when the corporations do not have the same taxable years.
    (i) Rule.
    (ii) Example.
    (9) Election to apply pre-AJCA rules to 2003 and 2004 taxable 
years.
    (i) Definition.
    (ii) Time, manner, and form of election.
    (iii) Treatment of non-look-through pools in taxable years 
beginning after December 31, 2004.
    (iv) Carryover of unused foreign tax.
    (v) Carryback of unused foreign tax.
    (vi) Recapture of overall foreign loss or separate limitation 
loss in the single category for dividends from all noncontrolled 
section 902 corporations.
    (vii) Recapture of separate limitation losses in other separate 
categories.
    (viii) Treatment of undistributed earnings in an upper-tier 
corporation-level single category for dividends from lower-tier 
noncontrolled section 902 corporations.
    (ix) Treatment of a deficit in the single category for dividends 
from lower-tier noncontrolled section 902 corporations.
    (10) Effective/applicability date.


0
Par. 9. Section 1.904-2 is amended by revising paragraphs (a) and (h) 
to read as follows:


Sec.  1.904-2  Carryback and carryover of unused foreign tax.

    (a) Credit for foreign tax carryback or carryover. A taxpayer who 
chooses to claim a credit under section 901 for a taxable year is 
allowed a credit under that section not only for taxes otherwise 
allowable as a credit but also for taxes deemed paid or accrued in that 
year as a result of a carryback or carryover of an unused foreign tax 
under section 904(c). However, the taxes so deemed paid or accrued 
shall not be allowed as a deduction under section 164(a). Paragraphs 
(b) through (g) of this section and Sec.  1.904-3, providing rules for 
the computation of carryovers and carrybacks, do not reflect a number 
of intervening statutory amendments, including the redesignation of 
section 904(d) as section 904(c) for taxable years beginning after 
1975, amendments to sections 904(d) and (f) regarding the application 
of separate limitations in taxable years beginning after 1986, the 
limitation of the carryback period to one year for unused foreign taxes 
arising in taxable years beginning after October 22, 2004, and the 
extension of the carryover period to ten years for unused foreign taxes 
that may be carried to any taxable year ending after October 22, 2004. 
However, the principles of paragraphs (b) through (g) of this section 
and Sec.  1.904-3(b) through (g) shall apply in determining carrybacks 
and carryovers of unused foreign taxes, modified so as to take into 
account the effect of statutory amendments. For transition rules 
relating to the carryover and carryback of unused foreign tax paid with 
respect to dividends from noncontrolled section 902 corporations, see 
paragraph (h) of this section. For special rules regarding these 
computations in case of taxes paid, accrued, or deemed paid with 
respect to foreign oil and gas extraction income or foreign oil related 
income, see section 907(f) and the regulations under that section.
* * * * *
    (h) Transition rules for carryovers and carrybacks of pre-2003 and 
post-2002 unused foreign tax paid or accrued with respect to dividends 
from noncontrolled section 902 corporations--(1) Carryover of unused 
foreign tax. Except as provided in Sec. Sec.  1.904-7(f)(9)(iv) and 
1.904(f)-12(g)(3), the rules of this paragraph (h)(1) apply to 
reallocate to the taxpayer's other separate categories any unused 
foreign taxes (as defined in paragraph (b)(2) of this section) that 
were paid or accrued or deemed paid under section 902 with respect to a 
dividend from a noncontrolled section 902 corporation paid in a taxable 
year of the noncontrolled section 902 corporation beginning before 
January 1, 2003, which taxes were subject to a separate limitation for 
dividends from that noncontrolled section 902 corporation. To the 
extent any such unused foreign taxes are carried forward to a taxable 
year of a domestic shareholder beginning on or after the first day of 
the noncontrolled section 902 corporation's first taxable year 
beginning after December 31, 2002, such taxes shall be allocated among 
the taxpayer's separate categories in the same proportions as the 
related dividend would have been assigned had such dividend been 
eligible for look-through treatment when paid. Accordingly, the taxes 
shall be allocated in the same percentages as the reconstructed 
earnings in the noncontrolled section 902 corporation's non-look-
through pool and pre-1987 accumulated profits that were accumulated in 
taxable years beginning before January 1, 2003, out of which the 
dividend was paid, in accordance with the rules of Sec.  1.904-7(f), 
or, if the taxpayer uses the safe harbor method of Sec.  1.904-
7(f)(4)(ii), in the same percentages as the taxpayer properly 
characterizes the stock of the noncontrolled section 902 corporation 
for purposes of apportioning its interest expense in its first taxable 
year ending after the first day of the noncontrolled section 902 
corporation's first taxable year beginning after December 31, 2002. See 
Sec.  1.904-7(f)(2) and (4). In the case of unused foreign taxes 
allocable to dividends from a noncontrolled section 902 corporation 
with respect to which the taxpayer was no longer a domestic shareholder 
(as defined in Sec.  1.902-1(a)) as of the first day of such taxable 
year, such taxes shall be allocated among the taxpayer's separate 
categories in the same percentages as the earnings in the noncontrolled 
section 902 corporation's non-look-through pool or pre-1987 accumulated 
profits would have been assigned had they been distributed and eligible 
for look-through treatment in the last taxable year in which the 
taxpayer was a domestic shareholder in such corporation. The unused 
foreign taxes that are carried forward shall be treated as allocable to 
general limitation income to the extent that such taxes would otherwise 
have been allocable to passive income, either on a look-through basis 
or as a result of inadequate substantiation under the rules of Sec.  
1.904-7(f)(4).
    (2) Carryback of unused foreign tax. The rules of this paragraph 
(h)(2) apply to any unused foreign taxes that were paid or accrued or 
deemed paid under section 902 with respect to a dividend from a 
noncontrolled section 902 corporation paid in a taxable year of the 
noncontrolled section 902 corporation ending on or after April 20, 
2009, which dividends were eligible for look-through

[[Page 27878]]

treatment. See 26 CFR Sec.  1.904-2T(h)(2) (revised as of April 1, 
2009) for rules applicable to such unused foreign taxes with respect to 
a dividend from a noncontrolled section 902 corporation paid in a 
taxable year of the noncontrolled section 902 corporation beginning 
after December 31, 2002 and ending before April 20, 2009, which 
dividends were eligible for look-through treatment. To the extent any 
such unused foreign taxes are carried back to a prior taxable year of a 
domestic shareholder, a credit for such taxes shall be allowed only to 
the extent of the excess limitation in the same separate category or 
categories to which the related look-through dividend was assigned and 
not in any separate category for dividends from noncontrolled section 
902 corporations.
* * * * *

0
Par. 10. Section 1.904-2T is amended by revising paragraphs (a), (b), 
(c), (d), (e), (f), (g), and (h) to read as follows:


Sec.  1.904-2T  Carryback and carryover of unused foreign tax 
(temporary).

    (a) through (h) [Reserved]. For further guidance, see Sec.  1.904-
2(a) through (h).
* * * * *

0
Par. 11. Section 1.904-4 is amended as follows:
0
1. Remove paragraph (c)(2)(i).
0
2. Redesignate paragraphs (c)(2)(ii)(A) and (c)(2)(ii)(B) as paragraphs 
(c)(2)(i) and (c)(2)(ii), respectively.
0
3. Remove the language ``Sec.  1.904-6(a)(iii)'' from the second 
sentence in newly-designated paragraph (c)(2)(i) and add the language 
``Sec.  1.904-6(a)(1)(iii)'' in its place.
0
4. Remove the language ``paragraph (c)(2)(ii)(B)'' from the last 
sentence in newly-designated paragraph (c)(2)(i) and add the language 
``paragraph (c)(2)(ii)'' in its place.
0
5. Remove the language ``paragraph (c)(2)(ii)(A)'' from the first 
sentence in newly-designated paragraph (c)(2)(ii) and add the language 
``paragraph (c)(2)(i)'' in its place.
0
6. Revise paragraphs (c)(3) and (c)(4) introductory text.
0
7. Add paragraph (n).
    The revisions and addition read as follows:


Sec.  1.904-4  Separate application of section 904 with respect to 
certain categories of income.

* * * * *
    (c) * * *
    (3) Amounts received or accrued by United States persons. Except as 
otherwise provided in paragraph (c)(5) of this section, all passive 
income received by a United States person shall be subject to the rules 
of this paragraph (c)(3). However, subpart F inclusions that are 
passive income, dividends from a controlled foreign corporation or 
noncontrolled section 902 corporation that are passive income, and 
income that is earned by a United States person through a foreign QBU 
that is passive income shall be subject to the rules of this paragraph 
only to the extent provided in paragraph (c)(4) of this section. For 
purposes of this section, a foreign QBU is a qualified business unit 
(as defined in section 989(a)), other than a controlled foreign 
corporation or noncontrolled section 902 corporation, that has its 
principal place of business outside the United States. These rules 
shall apply whether the income is received from a controlled foreign 
corporation of which the United States person is a United States 
shareholder, from a noncontrolled section 902 corporation of which the 
United States person is a domestic corporation meeting the stock 
ownership requirements of section 902(a), or from any other person. For 
purposes of determining whether passive income is high-taxed income, 
the following rules apply:
    (i) All passive income received during the taxable year that is 
subject to a withholding tax of fifteen percent or greater shall be 
treated as one item of income.
    (ii) All passive income received during the taxable year that is 
subject to a withholding tax of less than fifteen percent (but greater 
than zero) shall be treated as one item of income.
    (iii) All passive income received during the taxable year that is 
subject to no withholding tax or other foreign tax shall be treated as 
one item of income.
    (iv) All passive income received during the taxable year that is 
subject to no withholding tax but is subject to a foreign tax other 
than a withholding tax shall be treated as one item of income.
    (4) Dividends and inclusions from controlled foreign corporations, 
dividends from noncontrolled section 902 corporations, and income of 
foreign QBUs. Except as provided in paragraph (c)(5) of this section, 
all dividends and all amounts included in gross income of a United 
States shareholder under section 951(a)(1) with respect to the foreign 
corporation that (after application of the look-through rules of 
section 904(d)(3) and Sec.  1.904-5) are attributable to passive income 
received or accrued by a controlled foreign corporation, all dividends 
from a noncontrolled section 902 corporation that are received or 
accrued by a domestic corporate shareholder meeting the stock ownership 
requirements of section 902(a) that (after application of the look-
through rules of section 904(d)(4) and Sec.  1.904-5) are treated as 
passive income, and all amounts of passive income received or accrued 
by a United States person through a foreign QBU shall be subject to the 
rules of this paragraph (c)(4). This paragraph (c)(4) shall be applied 
separately to dividends and inclusions with respect to each controlled 
foreign corporation of which the taxpayer is a United States 
shareholder and to dividends with respect to each noncontrolled section 
902 corporation of which the taxpayer is a domestic corporate 
shareholder meeting the stock ownership requirements of section 902(a). 
This paragraph (c)(4) also shall be applied separately to income 
attributable to each foreign QBU of a controlled foreign corporation, 
noncontrolled section 902 corporation, or any other look-through entity 
as defined in Sec.  1.904-5(i), except that if the entity subject to 
the look-through rules is a United States person, then this paragraph 
(c)(4) shall be applied separately only to each foreign QBU of that 
United States person.
* * * * *
    (n) Effective/applicability dates. For purposes of determining 
whether passive income is high-taxed income, the grouping rules of 
paragraphs (c)(3) and (4) of this section apply in taxable years ending 
on or after April 20, 2009. See 26 CFR Sec.  1.904-4T(c)(3) and (4) 
(revised as of April 1, 2009) for grouping rules applicable to taxable 
years beginning after December 31, 2002, and ending before April 20, 
2009. For corresponding rules applicable to taxable years beginning 
before January 1, 2003, see 26 CFR Sec.  1.904-4(c)(2)(i) (revised as 
of April 1, 2006).

0
 Par. 12. Section 1.904-4T is amended by revising paragraphs (c), (d), 
(e), (f), (g), (h)(1), and (h)(2) to read as follows:


Sec.  1.904-4T  Separate application of section 904 with respect to 
certain categories of income (temporary).

* * * * *
    (c) through (h)(2) [Reserved]. For further guidance, see Sec.  
1.904-4(c) through (h)(2).
* * * * *

0
Par. 13. Section 1.904-5 is amended by revising paragraphs (a) 
introductory text, (a)(1), (a)(4), (b), (c)(2)(iii), (c)(4)(iii), 
(i)(1), (i)(3), (i)(4), (i)(5) Examples 4 and 5, (m)(1), (m)(2)(ii), 
(m)(4)(i), (m)(5)(i), (n), and (o)(2) to read as follows:


Sec.  1.904-5  Look-through rules as applied to controlled foreign 
corporations and other entities.

    (a) Definitions. For purposes of section 904(d)(3) and (4) and the

[[Page 27879]]

regulations under section 904, the following definitions apply:
    (1) The term separate category means, as the context requires, any 
category of income described in section 904(d)(1)(A) and (B) (or 
section 904(d)(1)(A), (B), (C), (D), (F), (G), (H), or (I) for taxable 
years beginning before January 1, 2007) and in Sec.  1.904-4T(b) (or 
Sec.  1.904-4(e) for taxable years beginning before January 1, 2007), 
any category of income described in Sec.  1.904-4(m), or any category 
of earnings and profits to which income described in such provisions is 
attributable.
* * * * *
    (4) The term noncontrolled section 902 corporation means any 
foreign corporation with respect to which the taxpayer meets the stock 
ownership requirements of section 902(a), or, with respect to a lower-
tier foreign corporation, the taxpayer meets the requirements of 
section 902(b). Except as provided in section 902 and the regulations 
under that section and paragraphs (i)(3) and (i)(4) of this section, a 
controlled foreign corporation shall not be treated as a noncontrolled 
section 902 corporation with respect to any distributions out of its 
earnings and profits for periods during which it was a controlled 
foreign corporation. In the case of a partnership owning a foreign 
corporation, the determination of whether a taxpayer meets the 
ownership requirements of section 902(a) or (b) will be made with 
respect to the taxpayer's indirect ownership, and not the partnership's 
direct ownership, in the foreign corporation. See section 902(c)(7).
    (b) In general. Except as otherwise provided in section 904(d)(3) 
and (4) and this section, dividends, interest, rents, and royalties 
received or accrued by a taxpayer from a controlled foreign corporation 
in which the taxpayer is a United States shareholder shall be treated 
as general category income. See paragraph (c)(4)(iii) of this section 
for the treatment of dividends received by a domestic corporation from 
a noncontrolled section 902 corporation in which the domestic 
corporation meets the stock ownership requirements of section 902(a).
    (c) * * *
    (2) * * *
    (iii) Allocating and apportioning expenses of a noncontrolled 
section 902 corporation. Expenses of a noncontrolled section 902 
corporation shall be allocated and apportioned in the same manner as 
expenses of a controlled foreign corporation under paragraph (c)(2)(ii) 
of this section, except that the related person interest rule of 
paragraphs (c)(2)(ii)(C) and (D) of this section shall not apply.
* * * * *
    (4) * * *
    (iii) Look-through rule for dividends from noncontrolled section 
902 corporations. Except as otherwise provided in this paragraph 
(c)(4)(iii), any dividend that is distributed by a noncontrolled 
section 902 corporation and received or accrued by a domestic 
corporation that meets the stock ownership requirements of section 
902(a) shall be treated as income in a separate category in proportion 
to the ratio of the portion of earnings and profits attributable to 
income in such category to the total amount of earnings and profits of 
the noncontrolled section 902 corporation. A dividend distributed by a 
noncontrolled section 902 corporation shall be treated as passive 
income if the Commissioner determines that the look-through 
characterization of such dividend cannot reasonably be determined based 
on the available information, or if such dividend is received or 
accrued by a shareholder that is neither a domestic corporation meeting 
the stock ownership requirements of section 902(a) nor a foreign 
corporation meeting the requirements of section 902(b). See paragraph 
(i)(4) of this section. See Sec.  1.904-7 for transition rules 
concerning the treatment of undistributed earnings (or a deficit) of a 
noncontrolled section 902 corporation that were accumulated in taxable 
years beginning before January 1, 2003.
* * * * *
    (i) Application of look-through rules to related entities--(1) In 
general. Except as provided in paragraphs (i)(2), (3), and (4) of this 
section, the principles of this section shall apply to distributions 
and payments that are subject to the look-through rules of section 
904(d)(3) and this section from a controlled foreign corporation or 
other entity otherwise entitled to look-through treatment (a ``look-
through entity'') under this section to a related look-through entity. 
A noncontrolled section 902 corporation shall be considered a look-
through entity only to the extent provided in paragraph (i)(4) of this 
section. Two look-through entities shall be considered to be related to 
each other if one owns, directly or indirectly, stock possessing more 
than 50 percent of the total voting power of all classes of voting 
stock of the other entity or more than 50 percent of the total value of 
such entity. In addition, two look-through entities are related if the 
same United States shareholders own, directly or indirectly, stock 
possessing more than 50 percent of the total voting power of all voting 
classes of stock (in the case of a corporation) or more than 50 percent 
of the total value of each look-through entity. In the case of a 
corporation, value shall be determined by taking into account all 
classes of stock. In the case of a partnership, value shall be 
determined under the rules in paragraph (h)(4) of this section. For 
purposes of this section, indirect ownership shall be determined under 
section 318 and the regulations under that section.
* * * * *
    (3) Special rule for dividends between controlled foreign 
corporations. Solely for purposes of dividend payments between 
controlled foreign corporations, two controlled foreign corporations 
shall be considered related look-through entities if the same United 
States shareholder owns, directly or indirectly, at least 10 percent of 
the total voting power of all classes of stock of each foreign 
corporation. If two controlled foreign corporations are not considered 
related look-through entities for purposes of this section because a 
United States shareholder does not satisfy the ownership requirement 
set forth in this paragraph (i)(3), the dividend payment will be 
characterized under the look-through rules of section 904(d)(4) and 
this section if the requirements set forth in paragraph (i)(4) of this 
section are satisfied.
    (4) Payor and recipient of dividend are members of the same 
qualified group. Solely for purposes of dividend payments in taxable 
years beginning after December 31, 2002, between controlled foreign 
corporations, noncontrolled section 902 corporations, or a controlled 
foreign corporation and a noncontrolled section 902 corporation, the 
payor and recipient corporations shall be considered related look-
through entities if the corporations are members of the same qualified 
group as defined in section 902(b)(2) and the recipient corporation is 
eligible to compute foreign taxes deemed paid with respect to the 
dividend under section 902(b)(1).
    (5) * * *

    Example 4. P, a domestic corporation, owns all of the voting 
stock of S, a controlled foreign corporation. S owns 5 percent of 
the voting stock of T, a controlled foreign corporation. The 
remaining 95 percent of the stock of T is owned by P. In 2006, T 
pays a $50 dividend to S and a $950 dividend to P. The dividend to S 
is not eligible for look-through treatment under paragraph (i)(4) of 
this section, and S is not eligible to compute an amount of foreign 
taxes deemed paid with respect to the dividend from T, because S and 
T are not members of the same qualified group (S owns less than 10 
percent of the

[[Page 27880]]

voting stock of T). See section 902(b) and Sec.  1.902-1(a)(3). 
However, the dividend is eligible for look-through treatment under 
paragraph (i)(3) of this section because P owns at least 10 percent 
of the voting power of all classes of stock of both S and T. The 
dividend is subpart F income of S that is taxable to P.
    Example 5.  P, a domestic corporation, owns 50 percent of the 
voting stock of S, a controlled foreign corporation. S owns 10 
percent of the voting stock of T, a controlled foreign corporation. 
The remaining 50 percent of the stock of S and the remaining 90 
percent of the stock of T are owned, respectively, by X and Y. X and 
Y are each United States shareholders of T but are not related to P, 
S, or each other. In 2006, T pays a $100 dividend to S. The dividend 
is not eligible for look-through treatment under paragraph (i)(3) of 
this section because no United States shareholder owns at least 10 
percent of the voting power of all classes of stock of both S and T 
(P and X each own only 5 percent of T). However, the dividend is 
eligible for look-through treatment under paragraph (i)(4) of this 
section, and S is eligible to compute an amount of foreign taxes 
deemed paid with respect to the dividend from T, because S and T are 
members of the same qualified group. See section 902(b) and Sec.  
1.902-1(a)(3). The dividend is subpart F income of S that is taxable 
to P and X.

* * * * *
    (m) Application of section 904(h)--(1) In general. This paragraph 
(m) applies to certain amounts derived from controlled foreign 
corporations and noncontrolled section 902 corporations that are 
treated as United States-owned foreign corporations as defined in 
section 904(h)(6). For purposes of determining the portion of an 
interest payment that is allocable to income earned or accrued by a 
controlled foreign corporation or noncontrolled section 902 corporation 
from sources within the United States under section 904(h)(3), the 
rules in paragraph (m)(2) of this section apply. For purposes of 
determining the portion of a dividend (or amount treated as a dividend, 
including amounts described in section 951(a)(1)(B)) paid or accrued by 
a controlled foreign corporation or noncontrolled section 902 
corporation that is treated as from sources within the United States 
under section 904(h)(4), the rules in paragraph (m)(4) of this section 
apply. For purposes of determining the portion of an amount included in 
gross income under section 951(a)(1)(A) or 1293 that is attributable to 
income of the controlled foreign corporation or noncontrolled section 
902 corporation from sources within the United States under section 
904(h)(2), the rules in paragraph (m)(5) of this section apply. In 
order to determine whether section 904(h) applies, section 904(h)(5) 
(exception if a United States-owned foreign corporation has a de 
minimis amount of United States source income) shall be applied to the 
total amount of earnings and profits of a controlled foreign 
corporation or noncontrolled section 902 corporation for a taxable year 
without regard to the characterization of those earnings under section 
904(d).
    (2) * * *
    (ii) Interest payments from noncontrolled section 902 corporations. 
If interest is received or accrued by a shareholder from a 
noncontrolled section 902 corporation (where the shareholder is a 
domestic corporation that meets the stock ownership requirements of 
section 902(a)), the rules of paragraph (m)(2)(i) of this section apply 
in determining the portion of the interest payment that is from sources 
within the United States, except that the related party interest rules 
of paragraph (c)(2)(ii)(C) of this section shall not apply.
* * * * *
    (4) Treatment of dividend payments--(i) Rule. Any dividend or 
distribution treated as a dividend under this section (including an 
amount included in gross income under section 951(a)(1)(B)) that is 
received or accrued by a United States shareholder from a controlled 
foreign corporation, or any dividend that is received or accrued by a 
domestic corporate shareholder meeting the stock ownership requirements 
of section 902(a) from a noncontrolled section 902 corporation, shall 
be treated as income in a separate category derived from sources within 
the United States in proportion to the ratio of the portion of the 
earnings and profits of the controlled foreign corporation or 
noncontrolled section 902 corporation in the corresponding separate 
category from United States sources to the total amount of earnings and 
profits of the controlled foreign corporation or noncontrolled section 
902 corporation in that separate category.
* * * * *
    (5) Treatment of inclusions under sections 951(a)(1)(A) and 1293--
(i) Rule. Any amount included in the gross income of a United States 
shareholder of a controlled foreign corporation under section 
951(a)(1)(A) or in the gross income of domestic corporate shareholders 
that meet the stock ownership requirements of section 902(a) with 
respect to a noncontrolled section 902 corporation that is a qualified 
electing fund under section 1293 shall be treated as income subject to 
a separate limitation that is derived from sources within the United 
States to the extent such amount is attributable to income of the 
controlled foreign corporation or qualified electing fund, 
respectively, in the corresponding category of income from sources 
within the United States. In order to determine a controlled foreign 
corporation's taxable income and earnings and profits from sources 
within the United States in each separate category, the principles of 
paragraph (m)(4)(ii) of this section shall apply. In order to determine 
a qualified electing fund's earnings and profits from sources within 
the United States in each separate category, the principles of 
paragraph (m)(4)(ii) of this section shall apply, except that the 
related person interest rule of paragraph (m)(2) of this section shall 
not apply.
* * * * *
    (n) Order of application of section 904(d) and (h). In order to 
apply the rules of this section, section 904(d)(1) shall first be 
applied to the controlled foreign corporation or noncontrolled section 
902 corporation to determine the amount of income and earnings and 
profits derived by the controlled foreign corporation or noncontrolled 
section 902 corporation in each separate category. The income and 
earnings and profits in each separate category that are from United 
States sources shall then be determined. Section 904(d)(3), (d)(4), and 
(h), and this section shall then be applied for purposes of 
characterizing and sourcing income received, accrued, or included by a 
United States shareholder in the controlled foreign corporation or a 
domestic corporate shareholder that meets the stock ownership 
requirements of section 902(a) with respect to a noncontrolled section 
902 corporation that is attributable or allocable to income or earnings 
and profits of the foreign corporation.
    (o) * * *
    (2) Rules for noncontrolled section 902 corporations. Paragraphs 
(a), (a)(1), (a)(4), (b), (c)(2)(iii), (c)(4)(iii), (i)(1), (i)(3), 
(i)(4), (i)(5), Examples 4 and 5, (m)(1), (m)(2)(ii), (m)(4)(i), 
(m)(5)(i), and (n) of this section apply to distributions from a 
noncontrolled section 902 corporation that are paid in taxable years of 
the noncontrolled section 902 corporation ending on or after April 20, 
2009. See 26 CFR 1.904-5T(a), (a)(1), (a)(4), (b), (c)(2)(iii), 
(c)(4)(iii), (i)(1), (i)(3), (i)(4), (i)(5), Examples 4 and 5, and 26 
CFR 1.904-7T(f)(9) (revised as of April 1, 2009) for rules applicable 
to distributions from a noncontrolled section 902 corporation that are 
paid in taxable years of the noncontrolled section 902 corporation 
beginning after December 31, 2002, and ending before April 20, 2009. 
See 26 CFR 1.904-

[[Page 27881]]

5T(m)(1), (m)(2)(ii), (m)(4)(i), and (n) (revised as of April 1, 2009) 
for rules applicable to distributions from a noncontrolled section 902 
corporation paid in taxable years of such corporation beginning after 
April 25, 2006, and ending before April 20, 2009. For corresponding 
rules applicable to taxable years beginning before January 1, 2003, see 
26 CFR 1.904-5 (revised as of April 1, 2006).
* * * * *

0
Par. 14. Section 1.904-5T is amended by revising paragraphs (a), (b), 
(c), (d), (e), (f), (g), (h)(1), (h)(2), (i), (j), (k), (l), (m), (n), 
(o)(1), and (o)(2) to read as follows:


Sec.  1.904-5T   Look-through rules as applied to controlled foreign 
corporations and other entities (temporary).

    (a) through (h)(2) [Reserved]. For further guidance, see Sec.  
1.904-5(a) through (h)(2).
* * * * *
    (i) through (o)(2). [Reserved]. For further guidance, see Sec.  
1.904-5(i) through (o)(2).
* * * * *

0
Par. 15. Section 1.904-7 is amended by revising paragraph (f) to read 
as follows:


Sec.  1.904-7   Transition rules.

* * * * *
    (f) Treatment of non-look-through pools of a noncontrolled section 
902 corporation or a controlled foreign corporation in post-2002 
taxable years--(1) Definition of non-look-through pools. The term non-
look-through pools means the pools of post-1986 undistributed earnings 
(as defined in Sec.  1.902-1(a)(9)) that were accumulated, and post-
1986 foreign income taxes (as defined in Sec.  1.902-1(a)(8)) paid, 
accrued, or deemed paid, in and after the first taxable year in which 
the foreign corporation had a domestic shareholder (as defined in Sec.  
1.902-1(a)(1)) but before any such shareholder was eligible for look-
through treatment with respect to dividends from the foreign 
corporation.
    (2) Treatment of non-look-through pools of a noncontrolled section 
902 corporation. Any undistributed earnings in the non-look-through 
pool that were accumulated in taxable years beginning before January 1, 
2003, by a noncontrolled section 902 corporation as of the last day of 
the corporation's last taxable year beginning before January 1, 2003, 
shall be treated in taxable years beginning after December 31, 2002, as 
if they were accumulated during a period when a dividend paid by the 
noncontrolled section 902 corporation to a domestic shareholder would 
have been eligible for look-through treatment under section 904(d)(4) 
and Sec.  1.904-5. Post-1986 foreign income taxes paid, accrued or 
deemed paid with respect to such earnings shall be treated as if they 
were paid, accrued or deemed paid during a period when the related 
earnings were eligible for look-through treatment. Any such earnings 
and taxes in the non-look-through pools shall constitute the opening 
balance of the noncontrolled section 902 corporation's pools of post-
1986 undistributed earnings and post-1986 foreign income taxes on the 
first day of the foreign corporation's first taxable year beginning 
after December 31, 2002, in accordance with the rules of paragraph 
(f)(4) of this section.
    (3) Treatment of non-look-through pools of a controlled foreign 
corporation. A controlled foreign corporation may have non-look-through 
pools of post-1986 undistributed earnings and post-1986 foreign income 
taxes that were accumulated and paid in a taxable year beginning before 
January 1, 2003, in which it was a noncontrolled section 902 
corporation. Any such undistributed earnings in the non-look-through 
pool as of the last day of the controlled foreign corporation's last 
taxable year beginning before January 1, 2003, shall be treated in 
taxable years beginning on or after January 1, 2003, as if they were 
accumulated during a period when a dividend paid by the controlled 
foreign corporation out of such earnings, or an amount included in the 
gross income of a United States shareholder under section 951 that is 
attributable to such earnings, would have been eligible for look-
through treatment. Any post-1986 foreign income taxes paid, accrued, or 
deemed paid with respect to such earnings shall be treated in taxable 
years beginning on or after January 1, 2003, as if they were paid, 
accrued, or deemed paid during a period when a dividend or inclusion 
out of such earnings would have been eligible for look-through 
treatment. Any such undistributed earnings and taxes in the non-look-
through pools shall be added to the pools of post-1986 undistributed 
earnings and post-1986 foreign income taxes of the controlled foreign 
corporation in the appropriate separate categories on the first day of 
the controlled foreign corporation's first taxable year beginning after 
December 31, 2002, in accordance with the rules of paragraph (f)(4) of 
this section. Similar rules shall apply to characterize any previously-
taxed earnings and profits described in section 959(c)(1)(A) that are 
attributable to earnings in the non-look-through pool.
    (4) Substantiation of look-through character of undistributed 
earnings and taxes in a non-look-through pool--(i) Reconstruction of 
earnings and taxes pools. In order to substantiate the look-through 
characterization of undistributed earnings and taxes in a non-look-
through pool under section 904(d)(4) and Sec.  1.904-5, the taxpayer 
shall make a reasonable, good-faith effort to reconstruct the non-look-
through pools of post-1986 undistributed earnings and post-1986 foreign 
income taxes (and previously-taxed earnings and profits, if any) on a 
look-through basis for each year in the non-look-through period, 
beginning with the first taxable year in which post-1986 undistributed 
earnings were accumulated in the non-look-through pool. Reconstruction 
shall be based on reasonably available books and records and other 
relevant information, and it must account for earnings distributed and 
taxes deemed paid in these years as if they were distributed and deemed 
paid pro rata from the amounts that were added to the non-look-through 
pools during the non-look-through period.
    (ii) Safe harbor method. A taxpayer that was eligible for look-
through treatment with respect to a distribution from the foreign 
corporation in the taxpayer's first taxable year ending after the first 
day of the foreign corporation's first taxable year beginning after 
December 31, 2002, may allocate the undistributed earnings and taxes in 
the non-look-through pools to the foreign corporation's look-through 
pools of post-1986 undistributed earnings and post-1986 foreign income 
taxes in other separate categories on the first day of the foreign 
corporation's first taxable year beginning after December 31, 2002, in 
the same percentages as the taxpayer properly characterizes the stock 
of the foreign corporation in the separate categories for purposes of 
apportioning the taxpayer's interest expense in its first taxable year 
ending after the first day of the foreign corporation's first taxable 
year beginning after December 31, 2002, under Sec.  1.861-12T(c)(3) or 
Sec.  1.861-12(c)(4), as the case may be. If the modified gross income 
method described in Sec.  1.861-9T(j) is used to apportion interest 
expense of the foreign corporation in its first taxable year beginning 
after December 31, 2002, the taxpayer must allocate the undistributed 
earnings and taxes in the non-look-through pools to the foreign 
corporation's look-through pools of post-1986 undistributed earnings 
and post-1986 foreign income taxes based on an average of the foreign 
corporation's

[[Page 27882]]

modified gross income ratios for the foreign corporation's taxable 
years beginning in 2003 and 2004. A taxpayer may also use the safe 
harbor method described in this paragraph (f)(4)(ii) to allocate to 
separate categories any previously-taxed earnings and profits described 
in section 959(c)(1)(A) that are attributable to the non-look-through 
pool. A taxpayer may choose to use the safe harbor method on either a 
timely filed or amended tax return or during an audit. However, a 
taxpayer that uses the safe harbor method on an amended return or in 
the course of an audit must make appropriate adjustments to eliminate 
any duplicate benefits arising from application of the safe harbor 
method to taxable years that are not open for assessment. A taxpayer's 
choice to use the safe harbor method is evidenced by employing the 
method. The taxpayer need not file any separate statement.
    (iii) Inadequate substantiation. If a taxpayer does not use, or is 
ineligible to use, the safe harbor method described in paragraph 
(f)(4)(ii) of this section and the Commissioner determines that the 
look-through characterization of earnings and taxes in the non-look-
through pools cannot reasonably be determined based on the available 
information, the Commissioner shall allocate the undistributed earnings 
and taxes in the non-look-through pools to the foreign corporation's 
passive category.
    (iv) Examples. The following examples illustrate the application of 
this paragraph (f)(4):

    Example 1.  P, a domestic corporation, has owned 50 percent of 
the voting stock of S, a foreign corporation, at all times since 
January 1, 1987, and S has been a noncontrolled section 902 
corporation with respect to P since that date. P and S use the 
calendar year as their U.S. taxable year. The first year in which 
post-1986 undistributed earnings were accumulated in the non-look-
through pool of S was 1987. As of December 31, 2002, S had 200u of 
post-1986 undistributed earnings and $100 of post-1986 foreign 
income taxes in its non-look-through pools. P does not use the safe 
harbor method under paragraph (f)(4)(ii) of this section to allocate 
the earnings and taxes in the non-look-through pools to S's other 
separate categories and does not attempt to substantiate the look-
through characterization of S's non-look-through pools. The 
Commissioner, however, reasonably determines, based on information 
used to characterize S's stock for purposes of apportioning P's 
interest expense in P's 2003 and 2004 taxable years, that 100u of 
the earnings and all $100 of the taxes in the non-look-through pools 
are properly assigned on a look-through basis to the general 
limitation category, and 100u of earnings and no taxes are properly 
assigned on a look-through basis to the passive category. Therefore, 
in accordance with the Commissioner's look-through characterization 
of the earnings and taxes in S's non-look-through pools, on January 
1, 2003, S has 100u of post-1986 undistributed earnings and $100 of 
post-1986 foreign income taxes in the general limitation category 
and 100u of post-1986 undistributed earnings and no post-1986 
foreign income taxes in the passive category.
    Example 2.  The facts are the same as in Example 1, except that 
the Commissioner cannot reasonably determine, based on the available 
information, the proper look-through characterization of the 200u of 
undistributed earnings and $100 of taxes in S's non-look-through 
pools. Accordingly, the Commissioner will assign such earnings and 
taxes to the passive category, so that as of January 1, 2003, S has 
200u of post-1986 undistributed earnings and $100 of post-1986 
foreign income taxes in the passive category, and the Commissioner 
will treat S as a passive category asset for purposes of 
apportioning P's interest expense.

    (5) Treatment of a deficit accumulated in a non-look-through pool. 
Any deficit in the non-look-through pool of a noncontrolled section 902 
corporation or a controlled foreign corporation as of the end of its 
last taxable year beginning before January 1, 2003, shall be treated in 
taxable years beginning after December 31, 2002, as if the deficit had 
been accumulated during a period in which a dividend paid by the 
foreign corporation would have been eligible for look-through 
treatment. In the case of a noncontrolled section 902 corporation, the 
deficit and taxes, if any, in the non-look-through pools shall 
constitute the opening balance of the look-through pools of post-1986 
undistributed earnings and post-1986 foreign income taxes of the 
noncontrolled section 902 corporation in the appropriate separate 
categories on the first day of its first taxable year beginning after 
December 31, 2002. In the case of a controlled foreign corporation, the 
deficit and taxes, if any, in the non-look-through pools shall be added 
to the balance of the look-through pools of post-1986 undistributed 
earnings and post-1986 foreign income taxes of the controlled foreign 
corporation in the appropriate separate categories on the first day of 
its first taxable year beginning after December 31, 2002. The taxpayer 
must substantiate the look-through characterization of the deficit and 
taxes in accordance with the rules of paragraph (f)(4) of this section. 
If a taxpayer does not use the safe harbor method described in 
paragraph (f)(4)(ii) of this section and the Commissioner determines 
that the look-through characterization of the deficit and taxes cannot 
reasonably be determined based on the available information, the 
Commissioner shall allocate the deficit and taxes, if any, in the non-
look-through pools to the foreign corporation's passive category. If, 
as of the end of a taxable year beginning after December 31, 2002, in 
which it pays a dividend, the foreign corporation has zero or a deficit 
in post-1986 undistributed earnings (taking into account any earnings 
or a deficit accumulated in taxable years beginning before January 1, 
2003), the deficit in post-1986 undistributed earnings shall be carried 
back to reduce pre-1987 accumulated profits, if any, on a last-in 
first-out basis. See Sec.  1.902-2(a)(1). If, as of the end of a 
taxable year beginning after December 31, 2002, in which the foreign 
corporation pays a dividend out of current earnings and profits, it has 
zero or a deficit in post-1986 undistributed earnings (taking into 
account any earnings or a deficit accumulated in taxable years 
beginning before January 1, 2003), and the sum of current plus 
accumulated earnings and profits is zero or less than zero, no foreign 
taxes shall be deemed paid with respect to the dividend. See Sec.  
1.902-1(b)(4).
    (6) Treatment of pre-1987 accumulated profits. Any pre-1987 
accumulated profits (as defined in Sec.  1.902-1(a)(10)) of a 
controlled foreign corporation or noncontrolled section 902 corporation 
shall be treated in taxable years beginning after December 31, 2002, as 
if they were accumulated during a period in which a dividend paid by 
the foreign corporation would have been eligible for look-through 
treatment. Any pre-1987 foreign income taxes (as defined in Sec.  
1.902-1(a)(10)(iii)) shall be treated as if they were paid, accrued or 
deemed paid during a year when a dividend out of the related pre-1987 
accumulated profits would have been eligible for look-through 
treatment. The taxpayer must substantiate the look-through 
characterization of the pre-1987 accumulated profits and pre-1987 
foreign income taxes in accordance with the rules of paragraph (f)(4) 
of this section. If a taxpayer does not use, or is ineligible to use, 
the safe harbor method described in paragraph (f)(4)(ii) of this 
section and the Commissioner determines that the look-through 
characterization of the pre-1987 accumulated profits and pre-1987 
foreign income taxes cannot reasonably be determined based on the 
available information, the pre-1987 accumulated profits and pre-1987 
foreign income taxes shall be allocated to the foreign corporation's 
passive category.
    (7) Treatment of post-1986 undistributed earnings or a deficit of a 
controlled foreign corporation

[[Page 27883]]

attributable to dividends from a noncontrolled section 902 corporation 
paid in taxable years beginning before January 1, 2003--(i) Look-
through treatment of post-1986 undistributed earnings at controlled 
foreign corporation level. Dividends paid by a noncontrolled section 
902 corporation to a controlled foreign corporation in post-1986 
taxable years of the noncontrolled section 902 corporation beginning 
before January 1, 2003, were assigned to a separate category for 
dividends from that noncontrolled section 902 corporation. Beginning on 
the first day of the controlled foreign corporation's first taxable 
year beginning on or after the first day of the lower-tier 
corporation's first taxable year beginning after December 31, 2002, any 
post-1986 undistributed earnings, or previously-taxed earnings and 
profits described in section 959(c)(1) or (2), of the controlled 
foreign corporation in such a separate category shall be treated as if 
they were accumulated during a period when a dividend paid by the 
noncontrolled section 902 corporation would have been eligible for 
look-through treatment. Any post-1986 foreign income taxes in such a 
separate category shall also be treated as if they were paid, accrued 
or deemed paid during a period when such a dividend would have been 
eligible for look-through treatment. Any such post-1986 undistributed 
earnings and post-1986 foreign income taxes in a separate category for 
dividends from a noncontrolled section 902 corporation shall be added 
to the opening balance of the controlled foreign corporation's look-
through pools of post-1986 undistributed earnings and post-1986 foreign 
income taxes in the appropriate separate categories on the first day of 
the controlled foreign corporation's first taxable year beginning on or 
after the first day of the lower-tier corporation's first taxable year 
beginning after December 31, 2002. Any section 952(c)(2) recapture 
account with respect to such a separate category shall be allocated in 
the same manner as the associated post-1986 undistributed earnings. The 
taxpayer must substantiate the look-through characterization of such 
earnings and taxes in accordance with the rules of paragraph 
(f)(7)(iii) of this section.
    (ii) Look-through treatment of deficit in post-1986 undistributed 
earnings at controlled foreign corporation level. If a controlled 
foreign corporation has a deficit in a separate category for dividends 
from a lower-tier noncontrolled section 902 corporation that is a 
member of the controlled foreign corporation's qualified group as 
defined in section 902(b)(2), such deficit shall be treated in taxable 
years of the upper-tier corporation beginning on or after the first day 
of the lower-tier corporation's first taxable year beginning after 
December 31, 2002, as if the deficit had been accumulated during a 
period in which a dividend from the lower-tier corporation would have 
been eligible for look-through treatment. Any post-1986 foreign income 
taxes in the separate category for dividends from the noncontrolled 
section 902 corporation shall also be treated as if they were paid, 
accrued or deemed paid during a period when the dividends were eligible 
for look-through treatment. The deficit and related post-1986 foreign 
income taxes, if any, shall be added to the opening balance of the 
controlled foreign corporation's look-through pools of post-1986 
undistributed earnings and post-1986 foreign income taxes in the 
appropriate separate categories on the first day of the controlled 
foreign corporation's first taxable year beginning on or after the 
first day of the lower-tier corporation's first taxable year beginning 
after December 31, 2002. The taxpayer must substantiate the look-
through characterization of the deficit and taxes in accordance with 
the rules of paragraph (f)(7)(iii) of this section.
    (iii) Substantiation required for look-through treatment. The 
taxpayer must substantiate the look-through characterization of post-
1986 undistributed earnings, previously-taxed earnings and profits, or 
a deficit in post-1986 undistributed earnings in a separate category 
for dividends paid by a noncontrolled section 902 corporation in 
taxable years beginning before January 1, 2003, by making a reasonable, 
good-faith effort to reconstruct the earnings (or deficit) and taxes in 
the separate category at the level of the controlled foreign 
corporation on a look-through basis, in accordance with the principles 
of paragraph (f)(4)(i) of this section. Alternatively, the taxpayer may 
allocate the earnings (or deficit) and taxes to the controlled foreign 
corporation's look-through pools under the safe harbor method described 
in paragraph (f)(4)(ii) of this section at the level of the controlled 
foreign corporation. If the taxpayer uses the safe harbor method, the 
earnings (or deficit) and taxes shall be allocated to the controlled 
foreign corporation's look-through pools in the appropriate separate 
categories on the first day of the controlled foreign corporation's 
first taxable year beginning on or after the first day of the lower-
tier corporation's first taxable year beginning after December 31, 
2002. The allocation shall be made in the same percentages as the 
controlled foreign corporation would properly characterize the stock of 
the lower-tier noncontrolled section 902 corporation in the separate 
categories for purposes of apportioning the controlled foreign 
corporation's interest expense in its first taxable year ending after 
the first day of the noncontrolled section 902 corporation's first 
taxable year beginning after December 31, 2002. Under Sec.  1.861-
12T(c)(3), the apportionment ratios properly used by the controlled 
foreign corporation are in turn based on the apportionment ratios 
properly used by the noncontrolled section 902 corporation to apportion 
its interest expense in its first taxable year beginning after December 
31, 2002. In the case of a taxpayer that uses the safe harbor method 
where the lower-tier noncontrolled section 902 corporation uses the 
modified gross income method described in Sec.  1.861-9T(j) to 
apportion interest expense for its first taxable year beginning after 
December 31, 2002, earnings (or a deficit) and taxes in the separate 
category for dividends from the noncontrolled section 902 corporation 
shall be allocated to the look-through pools based on the average of 
the noncontrolled section 902 corporation's modified gross income 
ratios for its taxable years beginning in 2003 and 2004. In the case of 
a controlled foreign corporation that has in its qualified group a 
chain of lower-tier noncontrolled section 902 corporations, the safe 
harbor applies first to characterize the stock of the third-tier 
corporation and then to characterize the stock of the second-tier 
corporation. Where a taxpayer uses the safe harbor method with respect 
to a lower-tier noncontrolled section 902 corporation with respect to 
which the taxpayer did not meet the requirements of section 902(a) as 
of the end of the upper-tier controlled foreign corporation's last 
taxable year beginning before January 1, 2003, the earnings (or 
deficit) and taxes in the separate category for dividends from the 
lower-tier corporation shall be allocated to the upper-tier 
corporation's look-through pools in the separate categories in the same 
percentages as the stock of the lower-tier corporation would have been 
characterized for purposes of apportioning the upper-tier corporation's 
interest expense in the last year the taxpayer met the ownership 
requirements of section 902(a) with respect to the lower-tier 
corporation if the look-through rules had applied in that year. If a 
taxpayer does not use the safe harbor method described in this 
paragraph (f)(7)(iii), and the

[[Page 27884]]

Commissioner determines that the look-through characterization of the 
earnings (or deficit) and taxes cannot reasonably be determined based 
on the available information, the Commissioner shall allocate the 
earnings (or deficit) and associated foreign income taxes to the 
controlled foreign corporation's passive category.
    (8) Treatment of distributions received by an upper-tier 
corporation from a lower-tier noncontrolled section 902 corporation, 
including when the corporations do not have the same taxable years--(i) 
Rule. In the case of dividends paid by a lower-tier noncontrolled 
section 902 corporation to an upper-tier corporation where both are 
members of the same qualified group as defined in section 902(b)(2), 
the following rules apply. Dividends paid by the lower-tier corporation 
in taxable years beginning before January 1, 2003, are assigned to a 
separate category for dividends from that corporation, regardless of 
whether the corresponding taxable year of the recipient corporation 
began after December 31, 2002. Post-1986 undistributed earnings, 
previously-taxed earnings and profits, and post-1986 foreign income 
taxes in such a separate category shall be treated, beginning on the 
first day of the upper-tier corporation's first taxable year beginning 
on or after the first day of the lower-tier corporation's first taxable 
year beginning after December 31, 2002, as if they were accumulated 
during a period when a dividend paid by the lower-tier corporation 
would have been eligible for look-through treatment under section 
904(d)(4) and Sec.  1.904-5. Dividends paid by a lower-tier corporation 
in taxable years beginning after December 31, 2002, are eligible for 
look-through treatment when paid, without regard to whether the 
corresponding taxable year of the recipient upper-tier corporation 
began after December 31, 2002.
    (ii) Example. The following example illustrates the application of 
paragraph (f) of this section:

    Example.  M, a domestic corporation, has directly owned 50 
percent of the stock of foreign corporation X, and X has directly 
owned 50 percent of the stock of foreign corporation Y, at all times 
since X and Y were organized on January 1, 1990. Accordingly, X and 
Y are noncontrolled section 902 corporations with respect to M, and 
X and Y are members of the same qualified group. M and Y use the 
calendar year as their U.S. taxable year, and X uses a taxable year 
beginning on July 1. Under Sec.  1.904-4(g) and paragraph (f)(10) of 
this section, a dividend paid to M by X on January 15, 2003 (during 
X's last pre-2003 taxable year) is not eligible for look-through 
treatment in 2003. However, under Sec.  1.861-12(c)(4), M will 
characterize the stock of X on a look-through basis for purposes of 
interest expense apportionment in its 2003 taxable year. Under Sec.  
1.904-2(h)(1), any unused foreign taxes in M's separate category for 
dividends from X will be carried over to M's other separate 
categories on a look-through basis for M's taxable years beginning 
on and after January 1, 2004. Under paragraph (f)(2) of this 
section, any undistributed earnings and taxes in X's non-look-
through pools will be allocated to X's other separate categories on 
July 1, 2003. Under Sec.  1.904-5(i)(4) and paragraphs (f)(8)(i) and 
(f)(10) of this section, a dividend paid to X by Y on January 15, 
2003 (during Y's first post-2002 taxable year) is eligible for look-
through treatment when paid, notwithstanding that it is received in 
a pre-2003 taxable year of X.

    (9) Election to apply pre-AJCA rules to 2003 and 2004 taxable 
years--(i) Definition. The term single category for dividends from all 
noncontrolled section 902 corporations means the separate category 
described in section 904(d)(1)(E) as in effect for taxable years 
beginning after December 31, 2002, and prior to its repeal by the 
American Jobs Creation Act (AJCA), Public Law 108-357, 118 Stat. 1418 
(October 22, 2004).
    (ii) Time, manner, and form of election. A taxpayer may elect not 
to apply the provisions of section 403 of the AJCA and to apply the 
rules of this paragraph (f)(9) to taxable years of noncontrolled 
section 902 corporations beginning after December 31, 2002, and before 
January 1, 2005, without regard to whether the corresponding taxable 
years of the taxpayer or any upper-tier corporation begin before or 
after such dates. A taxpayer shall be eligible to make such an election 
provided that--
    (A) The taxpayer's tax liability as shown on an original or amended 
tax return for each of its affected taxable years is consistent with 
the rules of this paragraph (f)(9), the guidance set forth in Notice 
2003-5 (2003-1 CB 294) (see Sec.  601.601(d)(2) of this chapter), and 
the principles of Sec.  1.861-12(c)(4) for each such year for which the 
statute of limitations does not preclude the filing of an amended 
return;
    (B) The taxpayer makes appropriate adjustments to eliminate any 
duplicate benefits arising from the application of this paragraph 
(f)(9) to taxable years that are not open for assessment; and
    (C) The taxpayer attaches a statement to its next tax return for 
which the due date (with extensions) is more than 90 days after April 
25, 2006, indicating that the taxpayer elects not to apply the 
provisions of section 403 of the AJCA to taxable years of its 
noncontrolled section 902 corporations beginning in 2003 and 2004, and 
that the taxpayer has filed original returns or will file amended 
returns reflecting tax liabilities for each affected year that satisfy 
the requirements described in this paragraph (f)(9)(ii).
    (iii) Treatment of non-look-through pools in taxable years 
beginning after December 31, 2004. Undistributed earnings (or a 
deficit) and taxes in the non-look-through pools of a controlled 
foreign corporation or a noncontrolled section 902 corporation as of 
the end of its last taxable year beginning before January 1, 2005, 
shall be treated in taxable years beginning after December 31, 2004, as 
if they were accumulated and paid during a period in which a 
distribution out of earnings in the non-look-through pool would have 
been eligible for look-through treatment. Such earnings (or deficit) 
and taxes shall be added to the foreign corporation's pools of post-
1986 undistributed earnings and post-1986 foreign income taxes in the 
appropriate separate categories on the first day of the foreign 
corporation's first taxable year beginning after December 31, 2004. In 
accordance with the principles of paragraph (f)(4) of this section, the 
taxpayer must reconstruct the non-look-through pools or, if the 
taxpayer chooses to use the safe harbor method, allocate the earnings 
and taxes in the non-look-through pools to the foreign corporation's 
look-through pools in the appropriate separate categories on the first 
day of the foreign corporation's first taxable year beginning after 
December 31, 2004. Under the safe harbor method, this allocation is 
made in the same percentages as the taxpayer properly characterized the 
stock of the foreign corporation for purposes of apportioning the 
taxpayer's interest expense in the taxpayer's first taxable year ending 
after the first day of the foreign corporation's first taxable year 
beginning after December 31, 2002. See Sec.  1.861-12T(c)(3) and Sec.  
1.861-12(c)(4). If a taxpayer does not use the safe harbor method 
described in paragraph (f)(4)(ii) of this section and the Commissioner 
determines that the look-through characterization of the earnings (or 
deficit) and taxes cannot reasonably be determined based on the 
available information, the earnings (or deficit) and taxes shall be 
allocated to the foreign corporation's passive category.
    (iv) Carryover of unused foreign tax. To the extent that a taxpayer 
has unused foreign taxes in the single category for dividends from all 
noncontrolled section 902 corporations, such taxes shall be carried 
forward to the appropriate separate categories in the taxpayer's 
taxable years beginning on or after the first day of the relevant

[[Page 27885]]

noncontrolled section 902 corporation's first taxable year beginning 
after December 31, 2004. Such unused taxes shall be carried forward in 
the same manner as Sec.  1.904-2(h)(1) provides that unused foreign 
taxes in the separate categories for dividends from each noncontrolled 
section 902 corporation are carried over to taxable years beginning on 
or after the first day of the noncontrolled section 902 corporation's 
first taxable year beginning after December 31, 2002, in the case of a 
taxpayer that does not make the election under this paragraph (f)(9). 
The electing taxpayer shall determine which noncontrolled section 902 
corporations paid the dividends to which the unused foreign taxes are 
attributable and assign the taxes to the appropriate separate 
categories as if such dividends had been eligible for look-through 
treatment when paid. Accordingly, the taxpayer must substantiate the 
look-through characterization of the unused foreign taxes in accordance 
with paragraph (f)(4) of this section by reconstructing the non-look-
through pools or, if the taxpayer uses the safe harbor method, by 
allocating the unused foreign taxes to other separate categories in the 
same percentages as the taxpayer properly characterized the stock of 
the noncontrolled section 902 corporation for purposes of apportioning 
the taxpayer's interest expense for its first taxable year ending after 
the first day of the noncontrolled section 902 corporation's first 
taxable year beginning after December 31, 2002. The rule described in 
this paragraph (f)(9)(iv) shall apply only to unused foreign taxes 
attributable to dividends out of earnings that were accumulated by 
noncontrolled section 902 corporations in taxable years of such 
corporations beginning before January 1, 2003, because only unused 
foreign taxes attributable to distributions out of pre-2003 earnings 
are included in the single category for dividends from all 
noncontrolled section 902 corporations. To the extent that unused 
foreign taxes carried forward to the single category for dividends from 
all noncontrolled section 902 corporations under the rules of Notice 
2003-5 were either absorbed by low-taxed dividends paid by 
noncontrolled section 902 corporations out of the non-look-through pool 
in taxable years of such corporations beginning in 2003 or 2004, or 
expired unused, the amount of taxes carried forward to the separate 
categories on a look-through basis will be smaller than the aggregate 
amount of taxes initially carried forward to the single category for 
dividends from all noncontrolled section 902 corporations. In this 
case, the unused foreign taxes arising in each taxable year shall be 
deemed attributable to each noncontrolled section 902 corporation in 
the same ratio as the dividends included in the separate category that 
were paid by such corporation in such year bears to all such dividends 
paid by all noncontrolled section 902 corporations in such year. Unused 
foreign taxes carried forward from the separate categories for 
dividends from each noncontrolled section 902 corporation to the single 
category for dividends from all noncontrolled section 902 corporations 
will similarly be deemed to have been utilized on a pro rata basis. The 
remaining unused foreign taxes are then assigned to the appropriate 
separate categories under the rules of paragraph (f)(4) of this 
section. Unused foreign taxes shall be treated as allocable to general 
category income to the extent that such taxes would otherwise have been 
allocable to passive income (based on reconstructed pools or the safe 
harbor method), or to the extent that, under paragraph (f)(4)(iii) of 
this section, the Commissioner determines that the look-through 
characterization cannot reasonably be determined based on the available 
information.
    (v) Carryback of unused foreign tax. To the extent that a taxpayer 
has unused foreign taxes attributable to a dividend paid by a 
noncontrolled section 902 corporation that was eligible for look-
through treatment under section 904(d)(4) and Sec.  1.904-5, any such 
unused foreign taxes shall be carried back to prior taxable years 
within the same separate category and not to the single category for 
dividends from all noncontrolled section 902 corporations or any 
separate category for dividends from a noncontrolled section 902 
corporation. See Notice 2003-5 for rules relating to the carryback of 
unused foreign taxes in the single category for dividends from all 
noncontrolled section 902 corporations.
    (vi) Recapture of overall foreign loss or separate limitation loss 
in the single category for dividends from all noncontrolled section 902 
corporations. To the extent that a taxpayer has a balance in a separate 
limitation loss or overall foreign loss account in the single category 
for dividends from all noncontrolled section 902 corporations under 
section 904(d)(1)(E) (prior to its repeal by the AJCA), at the end of 
the taxpayer's last taxable year beginning before January 1, 2005 (or a 
later taxable year in which the taxpayer received a dividend subject to 
the separate limitation for dividends from all noncontrolled section 
902 corporations), the amount of such balance shall be allocated on the 
first day of the taxpayer's next taxable year to the taxpayer's other 
separate categories. The amount of such balance that is attributable to 
each noncontrolled section 902 corporation shall be allocated in the 
same percentages as the taxpayer properly characterized the stock of 
such corporation for purposes of apportioning the taxpayer's interest 
expense for its first taxable year ending after the first day of such 
corporation's first taxable year beginning after December 31, 2002, 
under Sec.  1.861-12T(c)(3) or Sec.  1.861-12(c)(4), as the case may 
be. To the extent that a taxpayer has a balance in a separate 
limitation loss account for the single category for dividends from all 
noncontrolled section 902 corporations with respect to another separate 
category, and the separate limitation loss account would otherwise be 
assigned to that other category under this paragraph (f)(9)(vi), such 
balance shall be eliminated.
    (vii) Recapture of separate limitation losses in other separate 
categories. To the extent that a taxpayer has a balance in any separate 
limitation loss account in a separate category with respect to the 
single category for dividends from all noncontrolled section 902 
corporations at the end of the taxpayer's last taxable year with or 
within which ends the last taxable year of the relevant noncontrolled 
section 902 corporation beginning before January 1, 2005, such loss 
shall be recaptured in subsequent taxable years as income in the 
appropriate separate category. The separate limitation loss account 
shall be deemed attributable on a pro rata basis to those noncontrolled 
section 902 corporations that paid dividends out of earnings 
accumulated in taxable years beginning before January 1, 2003, in the 
years in which the separate limitation loss in the other separate 
category arose. The ratable portions of the separate limitation loss 
account shall be recaptured as income in the taxpayer's separate 
categories in the same percentages as the taxpayer properly 
characterized the stock of the relevant noncontrolled section 902 
corporation for purposes of apportioning the taxpayer's interest 
expense in its first taxable year ending after the first day of such 
corporation's first taxable year beginning after December 31, 2002, 
under Sec.  1.861-12T(c)(3) or Sec.  1.861-12(c)(4), as the case may 
be. To the extent that a taxpayer has a balance in any separate 
limitation loss account in any separate category that would have been 
recaptured as income in that same

[[Page 27886]]

category under this paragraph (f)(9)(vii), such balance shall be 
eliminated.
    (viii) Treatment of undistributed earnings in an upper-tier 
corporation-level single category for dividends from lower-tier 
noncontrolled section 902 corporations. Where a controlled foreign 
corporation or noncontrolled section 902 corporation has a single 
category for dividends from all noncontrolled section 902 corporations 
containing earnings attributable to dividends paid by one or more 
lower-tier corporations, the following rules apply. The post-1986 
undistributed earnings, previously-taxed earnings and profits described 
in section 959(c)(1) or (2), if any, and associated post-1986 foreign 
income taxes shall be allocated to the upper-tier corporation's other 
separate categories in the same manner as earnings and taxes in a 
separate category for dividends from each noncontrolled section 902 
corporation maintained by the upper-tier corporation are allocated 
under paragraph (f)(7) of this section. Accordingly, post-1986 
undistributed earnings, previously-taxed earnings and profits, if any, 
and post-1986 foreign income taxes in the single category for dividends 
from all noncontrolled section 902 corporations shall be treated as if 
they were accumulated and paid, accrued or deemed paid during a period 
when a dividend paid by each lower-tier corporation that paid dividends 
included in the single category would have been eligible for look-
through treatment. If the taxpayer uses the safe harbor method 
described in paragraph (f)(7)(iii) of this section, the earnings and 
taxes shall be allocated based on the apportionment ratios properly 
used by the lower-tier corporation to apportion its interest expense 
for its first taxable year beginning after December 31, 2002. Any 
section 952(c)(2) recapture account with respect to the single category 
shall be allocated in the same manner as the associated post-1986 
undistributed earnings. The taxpayer must substantiate the look-through 
characterization of the earnings and taxes in accordance with the rules 
of paragraph (f)(7)(iii) of this section. If the taxpayer does not use 
the safe harbor method and the Commissioner determines that the look-
through characterization of the earnings cannot reasonably be 
determined based on the available information, the earnings and taxes 
shall be assigned to the upper-tier corporation's passive category.
    (ix) Treatment of a deficit in the single category for dividends 
from lower-tier noncontrolled section 902 corporations. Where a 
controlled foreign corporation or noncontrolled section 902 corporation 
had an aggregate deficit in the single category for dividends from all 
noncontrolled section 902 corporations as of the end of the upper-tier 
corporation's last taxable year beginning before January 1, 2005, such 
deficit and the associated post-1986 foreign income taxes, if any, 
shall be allocated to the upper-tier corporation's other separate 
categories in the same percentages in which the non-look-through pools 
of each lower-tier corporation to which the deficit is attributable 
were assigned to such corporation's other separate categories in its 
first taxable year beginning after December 31, 2002. If the taxpayer 
uses the safe harbor method described in paragraph (f)(7)(iii) of this 
section, the deficit and taxes shall be allocated based on how the 
taxpayer properly characterized the stock of the lower-tier 
noncontrolled section 902 corporation for purposes of apportioning the 
upper-tier corporation's interest expense for the upper-tier 
corporation's first taxable year ending after the first day of the 
lower-tier corporation's first taxable year beginning after December 
31, 2002. The taxpayer must substantiate the look-through 
characterization of the deficit and taxes in accordance with the rules 
of paragraph (f)(7)(iii) of this section. If the taxpayer does not use 
the safe harbor method and the Commissioner determines that the look-
through characterization of the deficit cannot reasonably be determined 
based on the available information, the deficit and taxes shall be 
assigned to the upper-tier corporation's passive category.
    (10) Effective/applicability date. This paragraph (f) shall apply 
to dividends from a noncontrolled section 902 corporation that are paid 
in taxable years of the noncontrolled section 902 corporation ending on 
or after April 20, 2009. See 26 CFR Sec.  1.904-7T(f) (revised as of 
April 1, 2009) for rules applicable, except in the case of a taxpayer 
that makes the election under paragraph (f)(9) of that section, to 
dividends from a noncontrolled section 902 corporation that are paid in 
taxable years of the noncontrolled section 902 corporation beginning 
after December 31, 2002, and ending before April 20, 2009. See 26 CFR 
1.904-7T(f) (revised as of April 1, 2009) for rules applicable, in the 
case of a taxpayer that makes the election under paragraph (f)(9) of 
that section, to dividends from a noncontrolled section 902 corporation 
that are paid in taxable years of the noncontrolled section 902 
corporation beginning after December 31, 2004, and ending before April 
20, 2009. However, taxpayers may choose to apply paragraph (f) of this 
section in its entirety in lieu of 26 CFR 1.904-7T(f) to all dividends 
paid in periods covered by the temporary regulations, provided that 
appropriate adjustments are made to eliminate duplicate benefits 
arising from application of paragraph (f) to taxable years that are not 
open for assessment.

0
Par. 16. Section 1.904-7T is amended by revising paragraphs (a), (b), 
(c), (d), (e), and (f) to read as follows:


Sec.  1.904-7T  Transition rules (temporary).

    (a) through (f) [Reserved]. For further guidance, see Sec.  1.904-
7(a) through (f).
* * * * *

0
Par. 17. Section 1.904(f)-0 is amended by adding the entries for Sec.  
1.904(f)-12(g)(1), (g)(2), (g)(3), (g)(4), and (g)(5) as follows:


Sec.  1.904(f)-0  Outline of regulation provisions.

* * * * *


Sec.  1.904(f)-12  Transition rules.

* * * * *
    (g) * * *
    (1) Recapture of separate limitation loss or overall foreign 
loss in a separate category for dividends from a noncontrolled 
section 902 corporation.
    (2) Recapture of separate limitation loss in another separate 
category.
    (3) Exception.
    (4) Examples.
    (5) Effective/applicability date.
* * * * *


0
Par. 18. Section 1.904(f)-12 is amended by revising paragraph (g) to 
read as follows:


Sec.  1.904(f)-12   Transition rules.

* * * * *
    (g) Recapture in years beginning after December 31, 2002, of 
separate limitation losses and overall foreign losses incurred in years 
beginning before January 1, 2003, with respect to the separate category 
for dividends from a noncontrolled section 902 corporation--(1) 
Recapture of separate limitation loss or overall foreign loss in a 
separate category for dividends from a noncontrolled section 902 
corporation. To the extent that a taxpayer has a balance in any 
separate limitation loss or overall foreign loss account in a separate 
category for dividends from a noncontrolled section 902 corporation 
under section 904(d)(1)(E) (prior to its repeal by Public Law 108-357, 
118 Stat. 1418 (October 22, 2004)) at the end of the taxpayer's last 
taxable year beginning before January 1, 2003 (or a later taxable year 
in which the taxpayer received a dividend subject to a separate 
limitation for dividends from that noncontrolled section 902 
corporation), the amount of such balance shall be allocated on the

[[Page 27887]]

first day of the taxpayer's next taxable year to the taxpayer's other 
separate categories. The amount of such balance shall be allocated in 
the same percentages as the taxpayer properly characterized the stock 
of the noncontrolled section 902 corporation for purposes of 
apportioning the taxpayer's interest expense for its first taxable year 
ending after the first day of such corporation's first taxable year 
beginning after December 31, 2002, under Sec.  1.861-12T(c)(3) or Sec.  
1.861-12(c)(4), as the case may be. To the extent a taxpayer has a 
balance in any separate limitation loss account in a separate category 
for dividends from a noncontrolled section 902 corporation with respect 
to another separate category, and the separate limitation loss would 
otherwise be assigned to that other category under this paragraph 
(g)(1), such balance shall be eliminated.
    (2) Recapture of separate limitation loss in another separate 
category. To the extent that a taxpayer has a balance in any separate 
limitation loss account in a separate category with respect to a 
separate category for dividends from a noncontrolled section 902 
corporation under section 904(d)(1)(E) (prior to its repeal by Public 
Law 108-357, 118 Stat. 1418 (October 22, 2004)) at the end of the 
taxpayer's last taxable year with or within which ends the last taxable 
year of the noncontrolled section 902 corporation beginning before 
January 1, 2003, such loss shall be recaptured in subsequent taxable 
years as income in the appropriate separate categories. The separate 
limitation loss shall be recaptured as income in other separate 
categories in the same percentages as the taxpayer properly 
characterizes the stock of the noncontrolled section 902 corporation 
for purposes of apportioning the taxpayer's interest expense in its 
first taxable year ending after the first day of the foreign 
corporation's first taxable year beginning after December 31, 2002, 
under Sec.  1.861-12T(c)(3) or Sec.  1.861-12(c)(4), as the case may 
be. To the extent a taxpayer has a balance in a separate limitation 
loss account in a separate category that would have been recaptured as 
income in that same category under this paragraph (g)(2), such balance 
shall be eliminated.
    (3) Exception. Where a taxpayer formerly met the stock ownership 
requirements of section 902(a) with respect to a foreign corporation, 
but did not meet the requirements of section 902(a) on December 20, 
2002 (or on the first day of the taxpayer's first taxable year 
beginning after December 31, 2002, in the case of a transaction that 
was the subject of a binding contract in effect on December 20, 2002), 
if the taxpayer has a balance in any separate limitation loss or 
overall foreign loss account for a separate category for dividends from 
that foreign corporation under section 904(d)(1)(E) (prior to its 
repeal by Public Law 108-357, 118 Stat. 1418 (October 22, 2004)) at the 
end of the taxpayer's last taxable year beginning before January 1, 
2003, then the amount of such balance shall not be subject to recapture 
under section 904(f) and this section. If a separate limitation loss or 
overall foreign loss account for such category is not subject to 
recapture under this paragraph (g)(3), the taxpayer cannot carry over 
any unused foreign taxes in such separate category to any other 
limitation category. However, a taxpayer may elect to recapture the 
balances of all separate limitation loss and overall foreign loss 
accounts for all separate categories for dividends from such formerly-
owned noncontrolled section 902 corporations under the rules of 
paragraphs (g)(1) and (2) of this section. If a taxpayer so elects, it 
may carry over any unused foreign taxes in these separate categories to 
the appropriate separate categories as provided in Sec.  1.904-2(h).
    (4) Examples. The following examples illustrate the application of 
this paragraph (g):

    Example 1.  X is a domestic corporation that meets the ownership 
requirements of section 902(a) with respect to Y, a foreign 
corporation the stock of which X owns 50 percent. Therefore, Y is a 
noncontrolled section 902 corporation with respect to X. Both X and 
Y use the calendar year as their taxable year. As of December 31, 
2002, X had a $100 balance in its separate limitation loss account 
for the separate category for dividends from Y, of which $60 offset 
general limitation income and $40 offset passive income. For 
purposes of apportioning X's interest expense for its 2003 taxable 
year, X properly characterized the stock of Y as a multiple category 
asset (80% general and 20% passive). Under paragraph (g)(1) of this 
section, on January 1, 2003, $80 ($100 x 80/100) of the $100 balance 
in the separate limitation loss account is assigned to the general 
limitation category. Of this $80 balance, $32 ($80 x 40/100) is with 
respect to the passive category, and $48 ($80 x 60/100) is with 
respect to the general limitation category and therefore is 
eliminated. The remaining $20 balance ($100 x 20/100) of the $100 
balance is assigned to the passive category. Of this $20 balance, 
$12 ($20 x 60/100) is with respect to the general limitation 
category, and $8 ($20 x 40/100) is with respect to the passive 
category and therefore is eliminated.
    Example 2.  The facts are the same as in Example 1, except that 
as of December 31, 2002, X had a $30 balance in its separate 
limitation loss account in the general limitation category, and a 
$20 balance in its separate limitation loss account in the passive 
category, both of which offset income in the separate category for 
dividends from Y. Under paragraph (g)(2) of this section, the 
separate limitation loss accounts in the general limitation and 
passive categories with respect to the separate category for 
dividends from Y will be recaptured on and after January 1, 2003, 
from income in other separate categories, as follows. Of the $30 
balance in X's separate limitation loss account in the general 
category with respect to the separate category for dividends from Y, 
$6 ($30 x 20/100) is with respect to the passive category, and $24 
($30 x 80/100) is with respect to the general limitation category 
and therefore is eliminated. Of the $20 balance in X's separate 
limitation loss account in the passive category with respect to the 
separate category for dividends from Y, $16 ($20 x 80/100) will be 
recaptured out of general limitation income, and $4 ($20 x 20/100) 
would otherwise be recaptured out of passive income and therefore is 
eliminated.

    (5) Effective/applicability date. This paragraph (g) applies to 
taxable years ending on or after April 20, 2009. See 26 CFR 1.904(f)-
12T(g) (revised as of April 1, 2009) for rules applicable to taxable 
years beginning after December 31, 2002, and ending before April 20, 
2009.
* * * * *

0
Par. 19. Section 1.904(f)-12T is amended by revising paragraphs (a), 
(b), (c), (d), (e), (f), and (g) to read as follows:


Sec.  1.904(f)-12T   Transition rules (temporary).

    (a) through (g) [Reserved]. For further guidance, see Sec.  
1.904(f)-12(a) through (g).
* * * * *

0
Par. 20. Section 1.964-1 is amended as follows:
0
1. Revise paragraph (a)(1).
0
2. Remove the last sentence of paragraph (a)(2).
0
3. Revise paragraphs (b)(1)(v), (c)(1)(v), (c)(2), (c)(3), (c)(4), 
(c)(5), and (c)(6).
0
4. Remove and reserve paragraph (c)(8).
0
5. Add new paragraphs (a)(3) and (d).
0
6. Designate the undesignated text preceding paragraph (c)(1)(v) as 
paragraph (c)(1)(vi) and revise it.
    The revisions and additions read as follows:


Sec.  1.964-1   Determination of the earnings and profits of a foreign 
corporation.

    (a)(1) In general. For rules for determining the earnings and 
profits (or deficit in earnings and profits) of a foreign corporation 
for taxable years beginning before January 1, 1987, for purposes of 
sections 951 through 964, see 26 CFR 1.964-1(a) (revised as of April 1, 
2006). For taxable years beginning after December 31, 1986,

[[Page 27888]]

except as otherwise provided in the Code and regulations, the earnings 
and profits (or deficit in earnings and profits) of a foreign 
corporation for its taxable year shall be computed for all Federal 
income tax purposes substantially as if such corporation were a 
domestic corporation by--
* * * * *
    (3) Translation into dollars. In the case of a foreign corporation 
with a functional currency other than the United States dollar 
(dollar), see sections 986(b) and 989(b) for rules regarding the time 
and manner of translating distributions or inclusions of the foreign 
corporation's earnings and profits into dollars.
    (b) * * *
    (1) * * *
    (v) Foreign currency. If transactions effected in a foreign 
currency other than that in which the books of the corporation are kept 
are translated into the foreign currency reflected in the books, such 
translation shall be made in a manner substantially similar to that as 
prescribed in section 988 and the regulations under that section for 
the translation of foreign currency amounts into United States dollars.
* * * * *
    (c) * * *
    (1) * * *
    (v) Taxable years. The period for computation of taxable income and 
earnings and profits known as the taxable year shall reflect the 
provisions of section 441 and the regulations under that section.
    (vi) Applicable requirements. Except as provided in paragraphs 
(c)(2) and (c) (3) of this section, any requirements imposed by the 
Code or applicable regulations with respect to making an election or 
adopting or changing a method of accounting or taxable year must be 
satisfied by or on behalf of the foreign corporation just as though it 
were a domestic corporation if such election or such adoption or change 
of method or taxable year is to be taken into account in the 
computation of its earnings and profits.
    (2) Adoption or change of method or taxable year. For the first 
taxable year of a foreign corporation beginning after April 25, 2006, 
in which such foreign corporation first qualifies as a controlled 
foreign corporation (as defined in section 957 or 953) or a 
noncontrolled section 902 corporation (as defined in section 
904(d)(2)(E)), any method of accounting or taxable year allowable under 
this section may be adopted, and any election allowable under this 
section may be made, by such foreign corporation or on its behalf 
notwithstanding that, in previous years, its books or financial 
statements were prepared on a different basis, and notwithstanding that 
such election is required by the Code or regulations to be made in a 
prior taxable year. Any allowable methods adopted or elections made 
shall be reflected in the computation of the foreign corporation's 
earnings and profits for such taxable year, prior taxable years, and 
(unless the Commissioner consents to a change) subsequent taxable 
years. However, see section 898 for the rules regarding the taxable 
year of a specified foreign corporation as defined in section 898(b). 
Any allowable method of accounting or election that relates to events 
that first arise in a subsequent taxable year may be adopted or made by 
or on behalf of the foreign corporation for such year. Adjustments to 
the appropriate separate category (as defined in Sec.  1.904-5(a)(1)) 
of earnings and profits and income of the foreign corporation shall be 
required under section 481 to prevent any duplication or omission of 
amounts attributable to previous years that would otherwise result from 
any change in a method of accounting. See paragraph (c)(3) of this 
section for the manner in which a method of accounting or a taxable 
year may be adopted or changed on behalf of the foreign corporation. 
See paragraph (c)(4) of this section for applicable rules if the amount 
of the foreign corporation's earnings and profits became significant 
for United States tax purposes before a method of accounting or taxable 
year was adopted by the foreign corporation or on its behalf in 
accordance with the rules of paragraph (c)(3) of this section. See 
paragraph (c)(6) of this section for special rules postponing the time 
for taking action by or on behalf of a foreign corporation until the 
amount of its earnings and profits becomes significant for U.S. tax 
purposes. See also Sec. Sec.  1.985-5, 1.985-6, and 1.986-7 relating to 
adjustments to earnings and profits of a QBU required when the QBU 
changes its functional currency or begins to use the dollar approximate 
separate transactions method of accounting.
    (3) Action on behalf of corporation--(i) In general. An election 
shall be deemed made, or an adoption or change in method of accounting 
or taxable year deemed effectuated, on behalf of the foreign 
corporation only if its controlling domestic shareholders (as defined 
in paragraph (c)(5) of this section)--
    (A) Satisfy for such corporation any requirements imposed by the 
Internal Revenue Code or applicable regulations with respect to such 
election or such adoption or change in method or taxable year 
(including the provisions of sections 442 and 446 and the regulations 
under those sections, as well as any operative provisions), such as the 
filing of forms, the execution of consents, securing the permission of 
the Commissioner, or maintaining books and records in a particular 
manner. For purposes of this paragraph (c)(3)(i)(A), the books of the 
foreign corporation shall be considered to be maintained in a 
particular manner if the controlling domestic shareholders or the 
foreign corporation regularly keep the records and accounts required by 
section 964(c) and the regulations under that section in that manner;
    (B) File the statement described in paragraph (c)(3)(ii) of this 
section, at the time and in the manner prescribed therein; and
    (C) Provide the written notice required by paragraph (c)(3)(iii) of 
this section at the time and in the manner prescribed therein.
    (ii) Statement required to be filed with a tax return. The 
statement required by this paragraph (c)(3)(ii) shall set forth the 
name, country of organization, and U.S. employer identification number 
(if applicable) of the foreign corporation, the name, address, stock 
interests, and U.S. employer identification number of each controlling 
domestic shareholder (or, if applicable, the shareholder's common 
parent) approving the action, and the names, addresses, U.S. employer 
identification numbers, and stock interests of all other domestic 
shareholders notified of the action taken. Such statement shall 
describe the nature of the action taken on behalf of the foreign 
corporation and the taxable year for which made, and identify a 
designated shareholder who retains a jointly executed consent 
confirming that such action has been approved by all of the controlling 
domestic shareholders and containing the signature of a principal 
officer of each such shareholder (or its common parent). Each 
controlling domestic shareholder (or its common parent) shall file the 
statement with, and on or before the due date (including extensions) 
of, its own tax return (or information return, if applicable) for its 
taxable year with or within which ends the taxable year of the foreign 
corporation for which the election is made or for which the method of 
accounting or taxable year is adopted or changed. In the case of a 
controlling domestic shareholder that is the sole shareholder of a 
controlled foreign corporation, no separate statement need be filed if 
the information described in this paragraph (c)(3)(ii) is included on 
Form 5471 and Form 3115 or 1128, as applicable, filed

[[Page 27889]]

with respect to the controlled foreign corporation with the 
shareholder's return for such taxable year.
    (iii) Notice. On or before the filing date described in paragraph 
(c)(3)(ii) of this section, the controlling domestic shareholders shall 
provide written notice of the election made or the adoption or change 
of method or taxable year effected to all other persons known by them 
to be domestic shareholders who own (within the meaning of section 
958(a)) stock of the foreign corporation. Such notice shall set forth 
the name, country of organization and U.S. employer identification 
number (if applicable) of the foreign corporation, and the names, 
addresses, and stock interests of the controlling domestic 
shareholders. Such notice shall describe the nature of the action taken 
on behalf of the foreign corporation and the taxable year for which 
made, and identify a designated shareholder who retains a jointly 
executed consent confirming that such action has been approved by all 
of the controlling domestic shareholders and containing the signature 
of a principal officer of each such shareholder (or its common parent). 
However, the failure of the controlling domestic shareholders to 
provide such notice to a person required to be notified shall not 
invalidate the election made or the adoption or change of method or 
taxable year effected.
    (4) Effect of action or inaction by controlling domestic 
shareholders--(i) In general. Any election, or adoption or change of 
method of accounting or taxable year made by the controlling domestic 
shareholders on behalf of the foreign corporation pursuant to paragraph 
(c)(3) of this section or any other provision of the regulations (for 
example, Sec.  1.985-2(c)(2) or (3)) shall be reflected in the 
computation of the earnings and profits of such corporation under this 
section to the extent that it bears upon the federal income tax 
liability of the domestic shareholders of the foreign corporation. Any 
such action shall bind both the foreign corporation and its domestic 
shareholders as to the computation of the foreign corporation's 
earnings and profits for the taxable year of the foreign corporation 
for which the election is made or for which the method of accounting or 
taxable year is adopted or changed and in subsequent taxable years 
unless the Commissioner consents to a change. The preceding sentence 
shall apply regardless of--
    (A) When the action was taken;
    (B) Whether the foreign corporation was a controlled foreign 
corporation or a noncontrolled section 902 corporation at the time the 
action was taken;
    (C) When ownership was acquired; or
    (D) Whether the domestic shareholder received the written notice 
required by paragraph (c)(3)(ii) of this section.
    (ii) Inaction or untimely action. In the event that action by or on 
behalf of the foreign corporation is not undertaken by the time 
specified in paragraph (c)(6) of this section and such failure is shown 
to the satisfaction of the Commissioner to be due to reasonable cause, 
such action may be undertaken during any period of at least 30 days 
occurring after such showing is made which the Commissioner may specify 
as appropriate for this purpose. In the event that action by or on 
behalf of the foreign corporation is not undertaken by the time 
specified in paragraph (c)(6) of this section and such failure is not 
shown to the satisfaction of the Commissioner to be due to reasonable 
cause, earnings and profits shall be computed as if no elections had 
been made and any permissible accounting methods not requiring an 
election and reflected in the books of account regularly maintained by 
the foreign corporation for the purpose of accounting to its 
shareholders had been adopted. Accordingly, if the earnings and profits 
of a noncontrolled section 902 corporation became significant for 
United States income tax purposes in a taxable year beginning on or 
before April 25, 2006, the corporation's earnings and profits shall be 
computed as if no elections had been made and any permissible 
accounting methods not requiring an election and reflected in the books 
of account regularly maintained by the foreign corporation for purposes 
of accounting to its shareholders had been adopted. Thereafter, any 
change in a particular accounting method or methods or taxable year may 
be made by, or on behalf of, the foreign corporation only with the 
Commissioner's consent.
    (iii) Computation of earnings and profits by a minority shareholder 
prior to majority election or significant event. A shareholder of a 
foreign corporation may be required to compute the foreign 
corporation's earnings and profits before the foreign corporation or 
its controlling domestic shareholders make, or are required under this 
section to make, an election or adopt a method of accounting for 
federal income tax purposes. In such a case, the shareholder must 
compute earnings and profits in accordance with this section. Such 
computation shall be made as if no elections had been made and any 
permissible accounting methods not requiring an election and reflected 
in the books of account regularly maintained by the foreign corporation 
for the purpose of accounting to its shareholders had been adopted. 
However, a later, properly filed, and timely election or adoption of 
method by, or on behalf of, the foreign corporation shall not be 
treated as a change in accounting method.
    (5) Controlling domestic shareholders--(i) Controlled foreign 
corporations. For purposes of this paragraph (c), the controlling 
domestic shareholders of a controlled foreign corporation shall be its 
controlling United States shareholders. The controlling United States 
shareholders of a controlled foreign corporation shall be those United 
States shareholders (as defined in section 951(b) or 953(c)) who, in 
the aggregate, own (within the meaning of section 958(a)) more than 50 
percent of the total combined voting power of all classes of the stock 
of such foreign corporation entitled to vote and who undertake to act 
on its behalf. In the event that the United States shareholders of the 
controlled foreign corporation do not, in the aggregate, own (within 
the meaning of section 958(a)) more than 50 percent of the total 
combined voting power of all classes of the stock of such foreign 
corporation entitled to vote, the controlling United States 
shareholders of the controlled foreign corporation shall be all those 
United States shareholders who own (within the meaning of section 
958(a)) stock of such corporation.
    (ii) Noncontrolled section 902 corporations. For purposes of this 
paragraph (c), the controlling domestic shareholders of a noncontrolled 
section 902 corporation that is not a controlled foreign corporation 
shall be its majority domestic corporate shareholders. The majority 
domestic corporate shareholders of a noncontrolled section 902 
corporation shall be those domestic corporations that meet the 
ownership requirements of section 902(a) with respect to the 
noncontrolled section 902 corporation (or to a first-tier foreign 
corporation that is a member of the same qualified group (as defined in 
section 902(b)(2)) as the noncontrolled section 902 corporation) that, 
in the aggregate, own directly or indirectly more than 50 percent of 
the combined voting power of all of the voting stock of the 
noncontrolled section 902 corporation that is owned directly or 
indirectly by all domestic corporations that meet the ownership 
requirements of section 902(a) with respect to the noncontrolled 
section 902 corporation (or a relevant first-tier foreign corporation).
    (6) Action not required until significant. Notwithstanding any 
other provision of this paragraph, action by or on behalf of a foreign 
corporation (other

[[Page 27890]]

than a foreign corporation subject to tax under section 882) to make an 
election or to adopt a taxable year or method of accounting shall not 
be required until the due date (including extensions) of the return for 
a controlling domestic shareholder's first taxable year with or within 
which ends the foreign corporation's first taxable year in which the 
computation of its earnings and profits is significant for United 
States tax purposes with respect to its controlling domestic 
shareholders (as defined in Sec.  1.964-1(c)(5)). The filing of the 
information return required by section 6038 shall not itself constitute 
a significant event. For taxable years beginning after April 25, 2006, 
events that cause a foreign corporation's earnings and profits to have 
United States tax significance include, without limitation:
    (A) A distribution from the foreign corporation to its shareholders 
with respect to their stock.
    (B) An amount is includible in gross income with respect to such 
corporation under section 951(a).
    (C) An amount is excluded from subpart F income of the foreign 
corporation or another foreign corporation by reason of section 952(c).
    (D) Any event making the foreign corporation subject to tax under 
section 882.
    (E) The use by the foreign corporation's controlling domestic 
shareholders of the tax book value (or alternative tax book value) 
method of allocating interest expense under section 864(e)(4).
    (F) A sale or exchange of the foreign corporation's stock of the 
controlling domestic shareholders that results in the 
recharacterization of gain under section 1248.
* * * * *
    (d) Effective/applicability dates. Paragraphs (c)(1)(v) through 
(c)(6) of this section apply to taxable years ending on or after April 
20, 2009. See 26 CFR Sec. Sec.  1.964-1T(c)(1)(v) through (c)(6) 
(revised as of April 1, 2009) for rules applicable to taxable years 
beginning after April 25, 2006, and ending before April 20, 2009. 
However, taxpayers may choose to apply paragraphs (c)(1)(v) through 
(c)(6) of this section in their entirety in lieu of 26 CFR Sec. Sec.  
1.964-1T(c)(1)(v) through (c)(6) for periods covered by the temporary 
regulations, provided that appropriate adjustments are made to 
eliminate duplicate benefits arising from the application of paragraphs 
(c)(1)(v) through (c)(6) of this section to taxable years that are not 
open for assessment.


Sec.  1.964-1T  [Removed]

0
Par. 21. Section 1.964-1T is removed.


Sec.  1.989(b)-1  [Amended]

0
Par. 22. Section 1.989(b)-1 is amended by removing the language 
``within the meaning of Sec.  1.964-1(d)(5)'' and adding the language 
``described in Sec.  1.988-1(d)(1)'' in its place.

PART 602--OMB CONTROL NUMBERS UNDER THE PAPERWORK REDUCTION ACT

0
Par. 23. The authority citation for part 602 continues to read as 
follows:


    Authority:  26 U.S.C. 7805.


0
Par. 24. In Sec.  602.101, paragraph (b) is amended by removing the 
entry for ``Sec.  1.964-1T'' and adding the following entries in 
numerical order to the table to read as follows:


Sec.  602.101  OMB Control numbers.

* * * * *

------------------------------------------------------------------------
                                                             Current OMB
     CFR part or section where identified and described      control No.
------------------------------------------------------------------------
 
                                * * * * *
1.904-7....................................................    1545-2104
 
                                * * * * *
1.964-1....................................................    1545-2104
 
                                * * * * *
------------------------------------------------------------------------


    Approved: March 24, 2009.
Linda E. Stiff,
Deputy Commissioner for Services and Enforcement.
 Bernard Knight,
Acting General Counsel of the Treasury.
[FR Doc. E9-13521 Filed 6-10-09; 8:45 am]
BILLING CODE 4830-01-P